Real estate credit: targeted solutions for a shifting market landscape

A shift in opportunity: why real estate credit, and why now?

The appeal of real estate credit isn't new. However, the forces shaping today’s market have made the opportunity more pronounced and, in many respects, more attractive than in prior cycles. Rising interest rates over the past five years, along with expectations that rates may remain higher for longer, have resulted in one of the best investment periods for real estate credit, especially for Manulife Investment Management "Manulife IM". Manulife IM’s real estate credit platform has capital to deploy in the market, and no historical positions are impacted by valuation decreases.

Real estate credit returns are driven by contractual current income and fees, with less dependence on asset appreciation and minimal current cash flow. These characteristics improve predictability during periods of uncertain valuation outlook and rising interest rates, particularly when loans are appropriately underwritten and structured, secured by high-quality collateral, and partnered with experienced sponsors with strong balance sheets. Because outcomes rely more on coupon and loan structure than on a rebound in property values, investors don’t need to time the market bottom to pursue attractive returns and can commit to more predictable returns over time.

A key driver has been a reset in real estate valuations. As pricing has adjusted across sectors (down 11.1% to 17.4% from peak)¹, lenders can originate new loans with leverage based on reset values and stronger structural protections. Higher base rates and wider spreads have also improved all-in yields and transferred a larger portion of current return from the equity position to the debt position.

Generating current income

Returns are primarily driven by contractual income either from asset operations (i.e. current cash flow) or capitalized within the funding of the loan (interest reserve), limiting the dependency on asset appreciation. While asset appreciation is expected when lending on transitional or construction projects, investing in a credit position can provide greater predictability, especially during periods of valuation volatility.

Real estate credit lending can benefit from downside protection embedded in the capital structure, as it sits senior to equity. Covenants and collateral provide additional support. Bridge and transitional loans can also play a practical role in portfolios because they tend to be shorter duration and floating rate. In a higher-for-longer world, that matters. Floating-rate coupons move with the base rate (often tied to 30-day SOFR), helping keep income aligned with the rate backdrop.

Large universe of deals

The U.S. real estate credit universe includes well over $6.6 trillion of outstanding real estate debt across public and private markets. 

With $3.1 trillion of expected maturities remaining over the next five years, the refinancing market is expected to provide a durable source of lending opportunities. Years 1 through 3 remain elevated due in part to extensions and modifications, creating a broad and recurring opportunity set for disciplined, flexible lenders who can structure for downside and stay selective.

As interest rates have risen, equity business plans have taken longer to come to fruition, leading to increased demand in the bridge and transitional lending market. This is due to the longer time taken to get to a stabilized outcome – either a sale or permanent financing. 

Further, as real estate valuations continue to reset, acquisition volumes will increase, leading to a larger and more diversified universe of credit investment opportunities. 

These factors have created an environment in which private real estate credit providers can focus on well-structured investments backed by institutional-quality assets while benefiting from bespoke loan-level protections based on equity-like diligence.

Flexibility and diversification

Real estate credit offers multiple dimensions of diversification, including property type, business plan, capital structure, loan profile, and execution channel. This breadth of opportunity allows managers to dynamically allocate capital across construction, bridge, transitional, and securities investments to capitalize on relative value opportunities throughout market cycles. With a team of investment professionals that can deploy across the real estate credit universe, Manulife IM’s real estate credit platform seeks to deliver attractive risk-adjusted returns and all-weather portfolio performance through disciplined credit underwriting across varying market environments.

Delivering incremental alpha with appropriate risk management 

As is common across private credit markets, prudent use of leverage will be an important component. Leveraged approaches use repurchase warehouse facilities and loan-on-loan financing arrangements, complemented by mezzanine loan originations where risk-adjusted opportunities are attractive. These tools will be employed with a disciplined focus on downside protection while also enabling the Fund to enhance diversification, optimize capital efficiency, and actively manage liquidity.

Repurchase warehouses and loan-on-loan facilities carry certain risks, including: (i) dependence on capital market liquidity and lender demand, (ii) sensitivity to collateral value deterioration, and (iii) compliance with financing covenants. However, the benefits can substantially outweigh these considerations, particularly given the flexibility available today. The current repurchase warehouse financing market has evolved to provide real estate credit lenders with features that limit the impact of broader market volatility on their financing structures. These changes have brought the repurchase warehouse market more in line with loan-on-loan financing, though not fully. These leverage solutions allow investors to: (i) enhance returns without materially increasing the credit risk profile of the underlying loan investments, (ii) scale investment platforms efficiently, (iii) increase diversification across a broader portfolio of assets, and (iv) benefit from reliable access to capital and greater certainty of execution.

Relative to broader public and private market investment strategies, real estate credit offers highly customizable risk/return profiles that can be tailored to investor objectives, with the potential to generate double-digit returns in certain market environments. Importantly, these returns can often be achieved while maintaining the protections associated with a senior position in the capital structure, including first mortgage security. In contrast, real estate equity investments generally offer greater upside potential but bear the first-loss risk and occupy a more subordinate position in the capital stack.

A targeted pipeline designed to capitalize on the current market environment, coupled with a well-diversified financing strategy, is essential to achieving target returns while mitigating downside risks and protecting against events that could erode performance.

Real estate credit at Manulife IM

Manulife IM’s real estate credit platform leverages the firm’s global real estate capabilities, which include an integrated equity and real estate research team, combined with local market expertise and institutional-scale resources. This integrated approach provides access to a consistent pipeline of opportunities with high-quality, well-capitalized sponsors and supports rigorous due diligence to structure investments with customized downside protections. Relative to competitors, the platform is well situated to capitalize on the market opportunity given its ability to structure and execute bespoke transactions for borrowers.

Real estate credit has historically demonstrated resilience during periods of market volatility, supported by the contractual income and structural protections inherent in debt investments. As part of one of the world’s largest insurance organizations, Manulife IM applies a disciplined, risk-focused investment approach, emphasizing capital preservation, rigorous underwriting, and comprehensive portfolio oversight throughout the investment lifecycle.

Notes:

1 Peak-to-trough calculations use indexed appreciation returns from NCREIF-ODCE. More recent data suggest that appreciation returns have turned positive, but relative to the prior cyclical peak from 2021 to 2022 (depending on property type), overall indexed values remain down.