The landscape of property debt investments: where does Capstone fit in?

Property debt has become an increasingly popular investment asset class because it provides high-yield consistent returns secured against property assets. In the case of a sale or refinance of the property, debt is repaid ahead of equity, making it less risky than direct property ownership. Investing into property debt comes in different shapes and sizes, each with its own set of risks and returns. For investors seeking to balance risk with reward, understanding the nuances of these categories is key.

Debt Investment Categories

Firstly, let's explore what the different categories of debt classes are and how the seniority of debt affects the risk to return proposition. Seniority refers to the prioritisation order in which investors are repaid in the event of default. The below diagram is a simplified view of different investment categories.

Senior debt, often referred to as first mortgages, are repaid first and have first rights of access in the event that a loan comes into distress. This means it has less risk than junior debt, otherwise referred to as second/third mortgages, mezzanine debt or subordinated debt. These other debt types are repaid after senior debt and therefore take on more repayment risk. Equity owners generally sit below all debtholders and receive the balance of any sale of the property after all debtholders are repaid in full. Equity owners typically receive higher returns as they take on more risk, but also bear the brunt of any property valuation decline first.

Generally, investors can invest in property debt via:

• Contributory Loans: Here, investors pool their funds to finance a single loan secured by a specific property. The risk is concentrated on the performance of that one property, making it a more targeted but less diversified investment.

• Diversified Property Debt Portfolios: These portfolios spread investments across multiple loans or properties, reducing risk through diversification. While returns are generally more stable and consistent, they tend to be lower than those of single-property loans.

  
  

Property Debt Investment Categories

Property debt investment is an example of asset-backed finance, where the security of the loan is the property itself. The category of property debt, as well as the value of the property, investment criteria and location, are all key to understanding the risk profile of the investment. Some of the key categories include:

• Construction Lending: This involves financing new real estate developments. It’s a high-risk, high-reward category due to project completion uncertainties, but the payoff can be substantial once the development is complete. Construction lending is generally based on a Gross Realisable Value (GRV) based on the revenue of the completed building rather than the current land value, which increases risk if the construction does not finish.

• Bridging Loans: Short-term loans designed to ‘bridge’ the gap between buying a new property and selling an existing one. They typically offer high returns for the short duration and have a clear exit on the loan but do rely on the property transactions completing. Given the short duration of these loans a lender often has undeployed funds between investments which can impact overall returns.

• Residual Stock Loans: These loans finance the unsold stock of completed real estate developments, providing liquidity to developers while they market the remaining properties. They offer moderate risk and returns depending on how quickly the stock is sold.

• Residential Loans: Backed by residential properties, these loans are generally lower risk and offer steady returns. Their performance is closely tied to the strength of the housing market.

• Commercial Loans: These loans finance office buildings, retail spaces, and industrial properties. The risk and return depend on the tenant profile, lease terms, and the economic environment impacting commercial real estate.

• Land Loans: Used to purchase undeveloped land, these loans come with higher risk due to the uncertainty of zoning approvals, development plans, or market conditions. However, they can offer strong returns if the land is developed or sold at a premium.

In all categories of property debt, the Loan to Value Ratio (or Gross Realisable Value in construction lending) as well as understanding the ability to sell the property (i.e. liquidity) is key to assessing the risk of the investment.

Risk vs. Return: Finding Your Balance

The rule of thumb is simple: the higher the risk, the higher the potential reward. Construction lending, subordinated debt and investing in individual loans promise bigger returns but require a higher tolerance for risk. Diversified property portfolios of established properties or land offer more stability with more modest returns.

Why Capstone Income Fund Should Be Your Go-To Choice

Capstone Income Fund brings the best of both worlds. Our strategy is to deliver outsized returns relative to risk. We do that by managing a diversified portfolio of primarily first mortgages and specialising in short-term flexible finance. By specialising in short-term finance (with key categories of lending being bridging loans and residual stock loans), we are able to achieve higher returns due to the length of the loan with less risk than other property debt types because there is generally a clear exit on the loan in the short term and we are less exposed to longer term market fluctuations.

At Capstone Income Fund, you’re not just investing in property debt—you’re investing in a carefully curated strategy designed to maximize returns while mitigating risk. Our team’s experience and market insights ensure your capital is working hard in Australia’s dynamic property market.

Capstone’s unique approach focuses on delivering consistent income while offering investors the opportunity to diversify their portfolios with low volatility. So, whether you're a seasoned investor looking to enhance your income stream or someone new to property debt, Capstone Income Fund offers a great solution for your investment needs. Ready to explore? Learn more at Capstone Funds.