Steadfast hosts a third party managed Real Estate Credit Fund (RECF or the “Fund”) on its platform. RECF seeks to ensure that its investment portfolio is geographically diverse and backed by a broad range of real assets. The Fund invests throughout the commercial real estate capital stack, with a focus on senior secured or first mortgage residential and commercial real estate debt in the USA, in addition the fund invests in Triple Net Lease (NNN) real estate. In making these investments RECF makes use of the expertise and knowledge of its investment manager. RECF has adopted a long-term strategic approach to investing and focusses on identifying value.    

Permitted Assets

Senior /First Mortgage Loans

These loans are secured by commercial real estate and have the highest priority in the event of default. The loans may vary in duration and can be fixed or floating rate; however, targeted loans are typically floating rate and shorter duration. These investments may include whole loans or pari passu participations within such senior loans.

Due to the property owner providing an equity cushion of typically 30% of the property value, investing in senior/ first mortgage loans represents a lower risk credit profile.

Triple Net Lease (NNN)

Typically these properties have tenants with long-term leases and tenants are responsible for property operating expenses such as insurance, utilities, maintenance capital expenditures, and real estate taxes. Triple Net Lease investments typically provide long-term stable cash flows from high quality, credit worthy tenants, and as such are low risk and a useful way in which to extend the duration of our credit portfolio.    

Residential Mortgage-Backed Securities (RMBS)

Residential mortgage-backed securities (RMBS) are a debt-based security, backed by the interest paid on loans for residential property. The interest on loans such as mortgages, home-equity loans and subprime mortgages is considered to be a comparatively low rate of default risk for which a relatively high rate of interest may be charged, since there is a high demand for the ownership of a personal or family residence. Investors who are attracted to this kind of security also want to be protected from the risk of default inherent with individual loans of this kind. A portion of this risk may be mitigated by pooling many such loans to minimize the risk of an individual default, in addition, through the inclusion of structural credit enhancements, which are commonly included in the form of debt tranching and/ or debt service reserves, investors are provided with the choice as to the degree of risk an investor wishes to assume.

Understanding the degree to which the residential property owner is providing an equity or first loss cushion is always a primary mitigant to the credit risk being assumed by investors.

Commercial Mortgage-Backed Securities (CMBS)

Commercial mortgage-backed securities (CMBS) are fixed-income investment products that are backed by mortgages on commercial properties rather than residential real estate. CMBS provide liquidity to real estate investors and commercial lenders alike.

The underlying securities of CMBS may include a number of commercial mortgages of varying terms, values, and property types—such as multi-family dwellings and commercial office real estate. CMBS can offer less of a pre-payment risk than residential mortgage-backed securities (RMBS), as the term on commercial mortgages is generally fixed.

The mortgage loans that form a single commercial mortgage-backed security act as the collateral in the event of default, with principal and interest passed on to investors. The loans are typically contained within a trust, and they are highly diversified in their terms, property types, and amounts. The underlying loans that are securitized into CMBS include loans for properties such as apartment buildings and complexes, factories, hotels, office buildings, office parks, and shopping malls.

Because CMBS are complex investment vehicles, they require a wide range of market participants including investors, a primary servicer, a master servicer, a special servicer, a directing certificate holder, trustees, and rating agencies. Each of these players performs a specific role to ensure that the CMBS performs properly.

Commercial Mortgage-Backed Securities (CMBS) B-Piece

A common feature of commercial mortgage-backed securities is the “breaking-up” of the collateral pool and associated cash flows into various tranches or classes, each of which having a different credit risk profile and rate of return. Each tranche is structured with a difference credit quality and a different priority of payment. A CMBS B-piece is the secondary tranche in a CMBS loan structure, B-notes carry higher risk and higher returns when compared to the investment grade A-note tranche. In the event of a default by the underlying borrowers, B-notes are paid after the investors of the A-note tranche.

After the financial crisis of 2008, the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed, for CMBS and B-notes, the regulations now require originators to retain a portion of the B-notes for a minimum period of five years, thereby ensuring some alignment of interest of investors with that or the originator or sponsor.

Mezzanine and Subordinated Debt

Mezzanine loans are made to the owner of the commercial real estate and typically are secured via the equity interest in the said property or other properties. These type of loans are subordinate to a senior loan but senior to the owner’s equity. These loans may be tranched into senior and junior mezzanine loans and the loans are structured with various covenants and more extensive assurances being provided to the mezzanine lender than the senior debt lenders will obtain.

Preferred Equity

Preferred equity typically pay a preferred return from the investment’s cash flow rather than an interest payment, often the preferred equity investments are cumulative in nature allowing time for the borrower to heal in the event that there is insufficient cash flow to pay the preferred dividends immediately. These interests are not secured by the underlying real estate, but upon the occurrence of the preferred equity dividend being in arrears, the preferred equity typically has the right to effect a change of control with respect to the ownership of the property.   

Other Real Estate Securities

Under this category, collateralised loan obligations (CLO’s) that are collateralised by pools of real estate debt instruments and are comprised mainly of senior loans.

Portfolio Construction

As shown in the illustrative capital stack, the appropriate level of leverage employed depends upon the risk of the underlying investments. Similarly, one needs to be highly cognisant of the degree of risk being assumed when investing in different parts of the Real Estate capital stack. 

The focus of the Fund is on the First Mortgage segment of the capital structure and over time, with earnings retentions of the Fund, move slowly up the risk curve to include Mezzanine and Preferred Equity. These higher risk positions will be smaller in size so as to ensure granularity to the portfolio construct.     

Illustrative Commercial Real Estate Capital Stack