The Attraction of Real Estate Private Credit

There are five specific reasons why I believe an allocation to senior secured real estate private credit has a place in a fixed-income portfolio.

1. Income generation above traditional fixed income

Senior secured real estate credit is currently generating net returns materially above what investors can earn from bank deposits, government bonds or investment-grade corporate bonds.  The premium reflects increased risk from two main sources:- the illiquidity of the asset class and the complexity premium for lending to borrowers who want more flexible capital than banks can provide.

The RBA cash rate is currently 4.35% and individual senior secured real estate loans are currently returning upwards of 7.80% to investors net of fees.  A premium in the order of 3% – 5% over the cash rate is what we expect in the market at any given time.

For an investor whose primary need is income rather than capital appreciation, that premium is significant.

2. Structural independence from public markets

The return from a fixed rate mortgage loan is driven by contractual interest payments — not by daily movements in the ASX or the bond market.  This portion of a retirement portfolio is generally immune from analyst downgrades, company earnings misses or markets taking fright because of economic data or comments from a Federal Reserve official or Donald Trump.

By contrast, in a commercial real estate loan, the borrower owes the same fixed interest payment each month for the life of the loan.  This is actual structural independence from public markets.

3. Inflation protection through rates structuring

Many real estate credit funds — including our own — hold fixed rate loans with the loan pricing being set at inception of the loan and priced as a margin above either the RBA cash rate or the bank bill swap rate.  Borrowers like the certainty of fixed rate loans and many income focused investors also like the certainty of fixed payments for the life of the loan. 

In an environment where interest rates may be moving around, the short duration of the loans give people comfort – they are typically only 12 – 18 months in length and then are repaid and/or renewed with an associated repricing to reflect the prevailing cash rate.

4. Structural seniority — the first mortgage advantage 

When you invest in real estate credit through a senior secured fund, you occupy the most protected position in the capital structure by holding a first registered mortgage over the property. If the borrower defaults, there is a legal right to enforce that mortgage — to take control of and sell the property to recover your capital. Before any equity investor, preferred equity holder, or mezzanine lender receives a cent, you are repaid first. This structural protection is not just theoretical — it’s a legal right embedded in the loan documentation and registered on the title of the property.

It is important to note that this structural protection does not mean it is a risk-free investment.  Property values can fall, enforcement and recovery of the loan through selling the property takes time and unexpected events could delay recovery.  However, the structural seniority, combined with conservative LVRs, provides protection.

5. Diversification within the fixed income portion of a retirement portfolio

Historically, a 60/40 equities / fixed income split has been adopted by financial advisors and portfolio managers constructing a retirement portfolio.  The 40% fixed income portion generates income, while the 60% growth or equities exposure ensures that retirement savings extend to match life expectancy and isn’t eroded by inflation.

Within the 40% fixed income or defensive sleeve, commercial real estate credit provides useful diversification from the government and commercial bonds.  Real estate credit performs best in a stable or rising rate environment.  Government bonds perform best when rates are falling rapidly.  Together, they can provide a more resilient foundation than any single instrument could on its own.