Why RIAs Should Consider Private Real Estate Debt for Clients

Private real estate debt funds, AKA mortgage funds, provide your clients with diversification, strong returns, and something they can truly understand.

For high-net-worth individuals, particularly retirees, RIAs aim to build portfolios that offer income stability and downside protection. One often overlooked opportunity is private real estate debt, also known as a private mortgage fund. With inflationary concerns on the rise and volatility in the stock market, private real estate debt provides a compelling alternative for RIAs and their clients looking to diversify beyond traditional securities.

In this article, we’ll explore why RIAs should consider private real estate debt for their clients, its potential advantages, common investor hesitations, and how Capstone Capital Partners' private mortgage fund could be a game-changer for those seeking steady returns.

3 Big Reasons to Invest in Private Real Estate Debt

Here are a few compelling reasons why RIAs use private real estate debt as part of their clients' portfolios:

1. Hedge Against Inflation

Unlike traditional fixed-income instruments like bonds, real estate-backed loans have the potential to adjust with inflation. As property values and rents increase, private real estate debt funds can continue generating returns through the interest paid on loans. Additionally, real estate debt is often secured by tangible assets, meaning the underlying value of the loaned capital is tied to real estate that appreciates over time.

Dr. Jim Dahle, founder of The White Coat Investor, gives a compelling argument: "If you really believe that stocks are going to provide you a 3%-6% nominal return, why wouldn’t you just invest in a real estate lending fund that pretty reliably generates a 7%-12% return…?”

2. Portfolio Diversification

Private real estate debt provides exposure to the real estate market without the unique risks of owning the property itself. Moreover, private debt has a low correlation with the stock market, making it a hedge against volatility.

Private real estate debt also performs well compared to other investment vehicles. In fact, during periods of market turbulence, real estate has historically outperformed the S&P 500 in terms of risk-adjusted returns, providing a stabilizing force within a broader portfolio.

“The extreme market dislocation caused by COVID-19 has incentivized investors to reevaluate their portfolios and reassess their market risk. As the recession grips the equity and debt markets, alternative asset classes, particularly multifamily real estate, can add increased stability to a portfolio in a highly volatile macro environment.”

An excerpt from Kingbird Investment Management’s whitepaper titled “STABILIZING A PORTFOLIO IN A VOLATILE ENVIRONMENT: Investing in an Uncertain and Volatile Economic Environment”

3. Assets Your Clients Can Believe In

If your client, for example, feels most comfortable investing in Texas real estate, you can find a mortgage fund composed of properties only located in Texas. Your client can then review the actual properties their investment is tied to. This is often not the case with larger publicly-traded funds.

Photo by Lara Jameson

Addressing Concerns Against Mortgage Funds

Despite the advantages, some investors forego private real estate debt funds. Below, we’ll explore some common concerns and explain why these probably shouldn’t be deterrents for most of your clients.

1. Lack of Liquidity

One of the primary concerns with private real estate debt is the lack of liquidity. Investors may be hesitant to lock up their funds in a longer-term investment without the ability to sell quickly like they can with stocks or bonds. Private mortgage funds often have lock-up periods of 1 to 2 years. Capstone’s Growth Fund, for example, requires 18 months of commitment.

But consider this:
While private real estate debt is less liquid, its stock-like returns and low correlation with the stock market compensate well for this limitation. Many private mortgage funds offer returns between 7% and 12%, with Capstone's private real estate debt fund targeting a 10% return. This far outpaces traditional fixed-income investments. 

2. Concerns About Hard Money Lending

Some investors may hesitate to invest in private real estate debt due to concerns about hard money lending (or “alternative lending”) in general. This is usually just a matter of being unfamiliar with hard money. 

One of the main apprehensions is that some hard money lenders may approve suboptimal borrowers – those with less-than-perfect credit or a limited track record – to lend money to. This matters to investors because it is these borrowers they depend on to repay their loans, thus generating the investor’s return.

But consider this:
While it's true that hard money loans are more accessible to a broader range of borrowers, reputable lenders have stringent due diligence and underwriting practices that significantly mitigate these risks. For example, Capstone Capital Partners, established in 2012, boasts a low foreclosure rate of only 2% across its large portfolio of successful projects.

An established hard money lender evaluates market value, property condition, location, and income potential to ensure the property serves as adequate collateral for the loan amount. Good lenders are often working with long-term, repeat borrowers – thus lowering the risk even further.

3. High Minimum Investment

Private real estate debt funds often require a high minimum investment, which can be a barrier for some investors. However, high net-worth individuals usually aren’t limited by a minimum investment of $100,000, as is the case with Capstone’s Growth Fund.

But consider this:
While the minimum investment requirement is higher than that of public securities, investors with sufficient capital won’t consider this a limitation.

Explore Capstone Capital Partners

The Capstone team!

If you are an RIA exploring the benefits of private debt funds, consider Capstone Capital Partners. We were established in 2012 and boast a low foreclosure rate of only 2% across our large portfolio of successful projects. Every client, including our RIA friends, are family to us. Most of our borrowers are long-term, repeat clients.

We’re more than happy to meet in person or arrange a call. First, tell us a little bit about yourself. We’ll be in touch!