Ben Miller, CEO of direct-to-consumer alternative asset manager Fundrise, has theorised that these rising rates will force many borrowers to deleverage: to pay down their debts to avoid the costs of a “higher-for-longer” policy on interest rates.
“A zero interest rate policy for 15 years and quantitative easing led to an excess amount of debt buildup. As that debt buildup comes due in a new higher interest rate environment, people have to pay down the amount of debt they have,” Miller said in a recent interview with The Motley Fool.
“You used to have a 3% mortgage; instead, you have a 7% mortgage, which means that if you’re a company or you’re a commercial borrower and just can’t support that, then [you’re] going to have to pay down or sell. That’s a deleverage, reducing the amount of leverage in the system. You’re talking about trillions and trillions of dollars of that. It’s a great deleveraging as a result of higher interest rates hitting the economy.”
For Miller, who built his company by offering individual investors the opportunity to buy into real estate investments, this “great deleveraging” is both a signal to be wary of a potential economic downturn and an opportunity to invest in private credit. In March, he launched the Fundrise Opportunistic Credit Fund to offer “rescue capital” for investors looking to deleverage their debt at lower rates amid the continuing Fed rate hike. The strategy appears to be working, with a 13% annualised distribution rate.
“It is a great time to be a lender because the banks have stopped lending. There’s a supply-demand mismatch. You make great investments when there’s a mismatch between the markets,” said Miller.
“Right now, it’s an incredible time to be a lender because everybody’s being forced to borrow more because of the great deleveraging, and the normal lenders are out of the market. So we’re making loans [with] 12% to 15% interest rates, where they would have been half that one year ago. I mean, it’s a problem for some parts of the market, but a problem is an opportunity.”
A ‘Once in a Decade Dislocation’
When Fundrise launched the Opportunistic Credit Fund, it referred to the current state of private credit lending — the result of what Miller called the great deleveraging — as a “once-in-a-decade dislocation in real estate credit markets.” However, it has also been careful to note that it expects this environment to be relatively short-lived, not extending past 2024.
The fund’s primary strategy is to offer mezzanine loans to real estate developers. These loans are designed to offer a bridge to borrowers who need liquidity to cover the cost of development and who expect to pay back the loans based on the future value of the asset being developed.
“In these instances, the underlying assets themselves are typically unaffected by the financial turbulence happening in capital markets. Most frequently, the borrower is in the middle of a business plan to enhance the value of the property, such as new construction, renovations, or lease-up, and simply needs more time to reach stabilisation and be ready for long-term, fixed-rate debt,” reads Fundrise’s offering page for the fund.
The Bigger Picture
Miller and Fundrise’s position on private credit is part of a bigger picture economic view on the interplay between debt, interest rates, and the real estate market.
In his interview with The Motley Fool, Miller highlighted what he sees as the lag between monetary policy changes and their real-world effects. Referencing economist Milton Friedman’s observation of “long and variable lags” in economic policy, he suggested that the full impact of recent rate hikes is yet to be felt in the economy, arguing that the rate hikes could lead to more pronounced economic repercussions than many anticipate.
“We’re still nine months away from really seeing the impact on the economy, and already you could argue that inflation has come down a ton. This happens a lot in rivers where there will be a flood up the river. It takes a long time for it to come down the river and finally wash out the town,” said Miller.
“There’s the possibility that the Fed reverses itself, but I think it’s highly unlikely. That preparation for the flood, whether it’s a defensive or offensive opportunity, is, I think, the big thing happening in real estate markets.”
Miller also touched on the job market, suggesting that employment figures can be lagging indicators of economic health leading up to a recession. While employment in the U.S. has remained relatively strong throughout the Fed’s increase in rates, Miller argued that potential job losses could be a delayed consequence of the current economic shifts tied to higher borrowing costs and inflation.
“Well, if you look at the history, jobs is a lagging indicator,” he said. “Typically, and I go back to 2007 or 1999, right before every recession, jobs, unemployment were super low. Unemployment in 2007 was at historic lows. In 1999, it was at historic lows and everybody would say, ‘Look, job growth is so strong,’ and then it falls off a cliff.”
Of course, predicting macroeconomic trends isn’t an exact science, but Miller and Fundrise’s perspective is marked by caution regarding the ongoing adjustments in debt and interest rates and the potential lag in impacts from the Fed’s rate increases, as well as a balanced view on the potential for both risk and opportunity stemming from those impacts.