With 2022 soon ending, now is an ideal time to reflect on some of the key challenges the past year has presented and anticipate what trends the coming months have in store for the lending industry. Originate Report recently caught up with Jan Brzeski, Managing Director and Chief Investment Officer at Arixa Capital, to get an insider’s perspective on the present outlook of the private lending sector and how his organization plans to sustain its impressive track record of success in the future.
What is your outlook for private real estate lending?
The following year will be challenging for Arixa’s borrowers, comprised of real estate investors and developers who focus on sub-institutional sized residential projects, including for-sale housing and for-rent apartments. They are seeing higher construction costs, much higher interest expense, and declining values. For apartment projects, owners who want to refinance out of our short-term loans to hold projects for the longterm have an opportunity to do so; however, higher rates mean lower proceeds on the take-out loan, so they may need to source additional capital to retain the properties and continue generating an optimal profit margin. The Arixa Capital team has years of experience providing insight to these clients to assist them in navigating transitions between short- and longer-term financing.
But there is an upside to the current market dynamics: we still have a housing shortage, and roughly 2% of all the housing stock in the U.S. becomes obsolete every year, assuming a 50-year average usable life. That means there is a huge need for developers who can reposition or redevelop properties, especially urban infill properties close to the best jobs.
I am confident that some much-needed stability will gradually return to the real estate industry soon. Private lending should resume growth after an adjustment period and some dislocation in the next 12-18 months.
What are the greatest opportunities you see within the lending space and why?
In our segment of lending to borrowers who focus on non-institutional projects, I think our industry is still in its infancy. I compare it to fast food in the 1950s: there are plenty of places to buy a hamburger, but nobody has really developed a formula to replicate a very good, consistent experience across many major metro areas. Our competitors are mainly local players that differ significantly from one market to the next in terms of the scope and quality of services they provide to potential clients.
The greatest opportunity for Arixa is to continue executing over the next 12 years, just as we have in the past 12 years, and consciously control our growth rate without sacrificing quality for quantity. There is nothing to be gained in trying to become a national player overnight. Our goal is to provide an optimal lending experience for each client, encouraging them to return for all their funding needs, which will subsequently enable us to be able to keep on distributing steady returns to investors and sustainably grow and scale Arixa’s presence on the national lending marketplace.
What are the greatest challenges you face and why?
The main challenge for Arixa is the unprecedented rise in interest rates, and the speed with which they have risen, which affects lenders in two primary aspects. First, it puts pressure on real estate values, affecting our borrower’s profitability from preexisting investments. Second, investors expect higher returns from our private debt funds because their other fixed income options are suddenly offering much higher yield. Even banks are offering 4.5% on some CDs right now. One year ago, 2% would have been considered a very high return for a CD. However, many investors still value what private real estate debt funds offer. We have made encouragingly consistent positive returns for our investors in the past year, even though most alternative investment vehicles have delivered sharply negative returns.
What are the primary concerns for the private lending space in the near future?
The biggest risk to our overarching lending strategy is a potential rapid, substantial decline in value on the types of properties and locations where we lend. Our typical loan would take a 25-30% decline in value over a year or two to lead to principal losses. That is still unlikely on residential properties in major urban infill coastal markets where we are actively lending. The run-up in values during the COVID-19 pandemic makes a more pronounced and rapid decline something that we must be more mindful of than we would typically be. Our mantra is to be vigilant and protect our track record in the next 12-18 months. We are confident that our lending strategy adequately mitigates any residual risk and ideally positions us to continue to deliver optimal results to our client base.