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We are pleased to announce that Franklin Global Real Assets Fund (FGRAF) has made an initial investment in the Benefit Street Partners Real Estate Opportunistic Debt Fund II (ODF II).  This marks FGRAF’s first foray “down the capital stack” to the debt side of the investment universe, specifically real estate debt. 

In the context of the current landscape, the managers of FGRAF have identified and acted on what  they believe is a sizeable opportunity in private real estate debt. In their view, the asset class is in a position to deliver equity-like returns to investors via a multitude of different lending options in a variety of sectors.  This paper provides an overview of ODF II, expands on the rationale behind FGRAF’s investment thesis, provides an outlook for the asset class and explains how the investment diversifies FGRAF’s current portfolio and exposures.
 

Strategically Focused on the Middle Market

The Benefit Street Partners Real Estate Opportunistic Debt Fund II (ODF II) is a closed-end, specialty real estate strategy that focuses on investing in middle-market transactions primarily in senior and junior commercial real estate debt. The fund aims to achieve attractive risk-adjusted returns while preserving capital by investing in a diversified portfolio of real estate debt and related equity investments. ODF II targets a net internal rate of return (IRR) of 13%-16% and an annualized cash yield of 8%-10%.

The strategy is built around four key components:

  • An extensive deal sourcing network: Benefit Street Partners (BSP) maintains an extensive network of strategic partners from which to source attractive real estate debt opportunities. Approximately 50% of deals originate through existing relationships, contributing to a robust US$1.5B-plus deal pipeline.
  • Middle market focus: The fund primarily targets debt investments in the US$15 million to US$75 million range, focusing on U.S.-based middle-market real estate debt. This segment is considered underserved and offers compelling investment opportunities due to limited competition and a more decentralized market.
  • Transitional lending expertise in multifamily lending: BSP has significant experience in the multifamily sector, having committed $9.5 billion in multifamily loans since 2017. This expertise allows BSP to take on additional levels of complexity and types of debt structures, including construction financing and other opportunistic transitional investments.
  • Flexible portfolio construction: ODF II invests across the entire capital stack, including senior debt, subordinated debt, bonds, notes, and other opportunistic investments. This flexibility allows the fund to tactically pursue and allocate capital to the most attractive opportunities.
     

The Opportunity

Franklin Global Real Assets Fund (FGRAF) has chosen to invest in ODF II for several reasons that align with its investment thesis and strategic objectives:

A fragmented market: The commercial real estate lending market is fragmented and experiencing significant dislocation, particularly in the middle market segment. Traditional lenders are tightening underwriting standards and de-leveraging their balance sheets, creating a prime opportunity for private credit funds like ODF II to fill the void. With US$1.6 trillion of real estate debt maturing in the next three years, there is a substantial refinancing need that ODF II is well-positioned to address.

Attractive risk-adjusted returns: In the context of today’s market environment, ODF II's target net internal rate of return (IRR) of 13%-16% and annualized cash yield of 8%-10% are highly attractive. The fund's focus on senior and junior debt provides a diversified mix of income-generating assets capable of producing equity-like returns with a comparatively more insulated downside.

Diversification and alpha generation: By investing in ODF II, FGRAF gains exposure to private real estate debt, diversifying its portfolio beyond equity investments. The goal of the move down the capital stack  is to enhance FGRAF's risk-adjusted returns and provide a stronger and more stable income stream. Additionally, ODF II's focus on multifamily and other resilient sectors aligns with FGRAF's objective of generating alpha through prudent underwriting and strategic asset allocation.

An experienced management team: BSP's real estate team comprises over 80 professionals with extensive experience in commercial real estate lending, including senior managing directors with an average of over 20 years of industry experience. The team's track record of strong performance and disciplined investment process further supports our confidence in ODF II's ability to deliver on its investment objectives.
 

A Positive Outlook for Private Credit

The outlook for commercial real estate debt, particularly in the middle market segment, remains positive as ongoing dislocation in the market, driven by the pullback of traditional lenders mixed with regional banking challenges, creates a sustained opportunity for private credit funds like ODF II. In this fragmented and less-centralized market landscape, well-capitalized funds can  take advantage of an extensive pipeline of attractive lending opportunities.

The multifamily sector continues to exhibit robust fundamentals, including consistent rental growth, positive net absorption and stable valuations which have been underpinned by a chronic undersupply of housing units within the United States. With approximately US$500 billion of multifamily loans maturing over the next three years, we believe the demand for refinancing in this sector will be high. Refinancing challenges faced by real estate equity investors due to rising rate environment and the subsequent widening of cap rates have enhanced the demand for private credit solutions.

Finally, the U.S. economy continues to demonstrate resilience with strong corporate balance sheets, persistent economic growth and consumer demand. All these elements are supportive of  the stability and performance of commercial real estate debt investments.

FGRAF's investment in ODF II aligns with its strategic objectives of diversifying its portfolio, generating attractive risk-adjusted returns, and capitalizing on current opportunities offered by the market. ODF II’s focus on middle-market real estate debt, robust deal pipeline and stringent underwriting standards guided by an experienced management team position it well to potentially deliver on its own investment objectives and contribute positively to FGRAF's overall portfolio performance.