Recently, private credit has been making headlines in the financial news based on concerns that the underlying loans supporting some of these various other funds may not be sound.
Understandably, these headlines have led a few investors to reach out and ask the obvious question “What does the negative news about other private credit funds mean for my Fundrise investments?”
The simple answer is that it largely isn’t relevant, the type of loans that Fundrise invests in are very different from the types of loans that these other private credit funds invest in.
In other words, while both strategies may fall under the broad category of “private credit” the two are apples and oranges; entirely different in terms of underlying assets, valuation, and security.
In short, we feel as good about the Fundrise private credit strategy today as we have at nearly any point in the past decade. This is in large part due to the fact (as we’ve shared many times before) that real estate assets remain generally depressed in value, and the Fundrise private credit strategy entails lending to these relatively undervalued assets at very attractive cost bases and with a significant real equity cushion behind us.
We continue to methodically seek out and deploy into as many deals as we can find that fit within this focused buy box. One potential silver lining from the current "private credit" headlines is that it could lead to a broader pullback by institutional investors from private lending, regardless of credit quality, leaving those of us who are more discerning in our focus with an opportunity to once again fill the resulting gap.
To provide a bit more background, let us walk through these differences in detail:
The Fundrise Private Credit Strategy
At Fundrise, we almost exclusively lend against real assets, meaning we are lending to real estate companies that, as borrowers, are using that capital to buy, build, and operate physical real estate properties; mostly residential real estate properties such as apartment buildings or build-to-rent communities.
We target loan-to-value ratios of between 70-85% of either our best estimate of the true “value” or the actual cost of the project (whichever is lesser).
That means that there is generally anywhere from 15-30% of real cash equity behind us, that the borrower and their investors have put into the deal. That money is in the first lost position, meaning that if the borrower were to fail to repay our investment, we could take over the asset and own it at a cost basis of roughly 70-85% of what we believe the true value would be.
Generally, our view is that the period of greatest risk for these types of investments is during the construction phase (when applicable). Once the project is delivered and begins leasing up, we believe that risk falls dramatically as the asset is now readily marketable, and has increasing cash-flows from rents which can be used to pay interest or fixed-return on the investment. Our portfolio today includes a mix of investments across various development lifecycles, from projects still under construction to fully stabilized, income-producing properties.
The big question generally in private credit (or private lending as some call it) is what is the value of your collateral.
If you make a loan at 70% loan-to-value, that means that the asset you are lending against would have to see a 30% decline in value before you would be at any risk of losing principal. And, if you did a good job determining “value” then that loan is likely in a relatively safe position, especially if you are investing in an asset like residential rental real estate where a 30% decline is extremely rare (even in scenarios like the 2008 great financial crisis).
Again, as we’ve noted in nearly every investor update, real estate values today remain depressed relative to their long-term trend lines. Our view is that good real estate today is effectively “cheap” meaning that as a buyer you are getting good value.
And as a lender you are getting even better value. In other words, not only do we feel good about our LTV position of 70-85% of value, but we believe that if over the next several years interest rates fall and values rise, then the effective loan-to-value of many of our positions could end up being as low as 50-65% LTV, further supporting the notion that investors are achieving a very attractive risk adjusted return.
What's happening with the other “private credit” funds
Most of the other private credit funds that you read about in the news do not invest in real estate loans.
Instead, they make various other kinds of loans. Some lend to operating companies, like a chain of auto-repair shops or private software companies. Others may invest in smaller pools of loans like consumer credit card debt or auto-loans.
While not always true, very often these loans are backed primarily by the cash-flow streams or income from the business or group of individuals, as opposed to a real asset such as a real estate property.
So what’s happened?
In short, the market has begun to question the true “value” of the assets backing many of these loans.In other words, if a private credit fund made a loan to a software company at 60% of the estimated “value” of that business, but that business (or other businesses like it) have seen 30% or more declines in value, then the risk of losing principal on that loan may start to come into question.
Likewise, if a pool of loans made to consumers to buy used cars starts to see those consumers stop paying their loans because they’ve been laid off or rising costs are impacting their finances, then once again the market begins to question the likelihood that those loans get paid back in full.
Broadly, the market is saying “these companies you’ve been lending to have been valued at historically high levels and now we think they may be coming down in value, so we are concerned that the loans you made may not get paid back in full.”
In fact, in a few extreme scenarios, there have been instances where loans in the magnitude of hundreds of millions of dollars have been made to companies that it turned out never to have existed, and that the underwriting and diligence in making those loans was lacking…the result being that those loans were completely wiped out.
AI has only added fuel to this fire. The recent “SaaS-pocalyse” saw many software companies lose huge chunks of value in only a matter of days, as investors reacted to the news that AI companies like Anthropic and OpenAI were launching new features that essentially would do the same thing as these companies but at a fraction of the cost.
All in all, the broader concern is that these private credit funds have been lacking rigor in their diligence and underwriting processes, while lending against “values” that had reached their peak and now that those values are coming down there is a question as to whether or not many of those loans risk losing principal.
As Warren Buffett would say, it’s only once the tide goes out that you find out who was swimming naked.
Looking ahead
We cannot say whether or not it’s fair to characterize the broader private credit market as being at risk (as many of these news stories seem to imply). The reality is that we (Fundrise) don't know enough about anyone else’s portfolios to pass judgement on the credit quality.
The industry has gotten large enough and has been hot enough, that inevitably there probably are groups that were loose in their underwriting standards.
Additionally, it is fair (in our opinion) to point out that generally many other private credit funds have been lending against assets that have been priced at relatively high values, and that AI is a significant enough game changer that some of those companies may genuinely be at risk of losing significant value.
However, again in our opinion, the investment structure of lending capital at a discounted basis to an asset's true value in exchange for a fixed-return is not a model that is going anywhere anytime soon, and at least when it comes to the real estate industry (and more specifically the assets that we are focused on) it remains a very compelling risk-adjusted return in today’s market.
Not all private credit is created equal. What matters is what's behind the loan, which for Fundrise means real assets in real markets with real equity behind us. As always, we welcome any feedback or questions from investors, as we know this is a topic that is very much top of mind for some of our investors.
