Debt on the Menu?

In recent years, investors have flocked to private debt, in particularly Private Credit, which involves lending to operating companies. This growth has opened the door for adjacent credit strategies, such as Real Estate and Infrastructure ending. But how do investors evaluate these options, and which strategy stands out today?

What Are the Choices?
Private debt offers various sub-strategies, but three main asset classes dominate:
• Corporate Credit: Accessible, largescale strategy with a broad investor base.
• Real Estate Debt: Backed by physical assets, benefiting from higher recovery rates.
• Infrastructure Debt: Offers long-term exposure with low correlation to other credit assets.

Real Estate and Infrastructure debt strategies provide hard asset security and extensive loan covenants typically providing more stable and higher recovery rates through the lending cycle. Corporate credit is the largest and most accessible of the three, favoured by large funds capable of deploying significant capital.

The Current Opportunity in Real Estate Debt
Historically, Real Estate and Corporate credit performance has been highly correlated and closely tied to the business cycle. However, the past few years have been unusual. Pandemicdriven government interventions and inflation hikes caused a spike in interest rates. As a result, Real Estate struggled with rising costs and no short-term income growth, while Corporate profits surged as revenue increases outpaced input cost inflation.

Real Estate values dropped, reflecting the higher interest rate environment and structural shifts in demand, particularly in sectors like office. Now, with property values stabilizing, Real Estate Debt presents a compelling opportunity. New 
loans secured against assets that have rebased lower in value give lenders a favourable position, especially with limited available debt capital in the market supporting pricing.

Is Private Credit Still the Place to Be?
Corporate credit has performed surprisingly well during the recent rate-hike cycle, with elevated profit margins, strong credit performance and high corporate valuations. However, warning signs are starting to emerge. The speculative grade default rate is rising, and many US corporates in the private credit market are not generating enough free cash flow to cover their debts. In Europe, bankruptcies are increasing while new business formation is stagnant.

These trends suggest weaker corporate performance may be on the horizon as the effects of the slowing economy and higher rates finally take hold. High current valuations leave room for significant price corrections, making Corporate 
Credit potentially more vulnerable.

Don’t Forget Infrastructure
Infrastructure Debt shares some similarities with Real Estate Debt—both offer hard security and involve assessing the specific underlying asset's ability to service the loan. However, infrastructure carries unique risks, such as political, contractual, and technological factors.

It has a proven track record of historically low default rates and a low correlation to other credit assets. Despite compressed pricing, its defensive nature and the ongoing need for global infrastructure projects make it an attractive strategy for investors seeking longer-term exposure.

Are Investors Being Paid for the Risk?
Considering the markedly different fundamental outlook for these underlying asset classes, you might think market pricing would already reflect their different risk outlook. Corporate credit spreads have tightened significantly as liquidity flows into the sector, even as credit quality weakens. In contrast, Real Estate lending remains capital-constrained, with lenders maintaining pricing power and benefiting from improved credit metrics. The dominance of bank lending in European real estate, coupled with tightening capital regulations, supports this positive pricing dynamic for alternative lenders.

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