12-Month vs. 18-Month Private Credit Investment Terms: Strategic Considerations

In Part 1 of this article, we explored the basics of 12-month and 18-month private debt investments, including why these different terms exist and how Bowery Capital determines terms for the investment deals it puts forward. In essence, term durations are driven by the practical needs of a given commercial real estate project.

In this second part, we’ll dive into the strategic considerations for investors when choosing between these options. We want to help investors understand when and why to select either a 12-month or 18-month investment opportunity.

Let’s get into it.

How Cash Rates and Returns Are Linked

The rate of return on a new private debt investment is, to some degree, “pegged” to the cash rate – roughly +4%-6% premium for most of Bowery’s deals. As the cash rate decreases, the rate of return for new deals will also decrease in-step, maintaining that premium along the way. Similarly, new private debt deals offer higher returns when the cash rate increases.

Here’s how that relationship has played out over the last couple of years.

Moving Rates: Yesterday, Today & Tomorrow

Over the past two years, Australia’s economic landscape has undergone a significant transformation. The Reserve Bank of Australia (RBA) has implemented a series of cash rate increases, marking a dramatic shift from the previous low-rate environment.

In 2019 and early 2020, when the cash rate was 0.75% the average rate of return for Bowery’s deals was 6.75%. Today in 2024, the cash rate is 4.35% and the average return on a Bowery deal is 10.25%. The premium return for new deals increased in tandem with the cash rate.

Rising cash rates had put a dampener on equity markets which were becoming increasingly volatile. This motivated investors to shift and increase their allocation into private debt investments.

What is interesting to note over this recent period was not the fact that the cash rates were rising, but that rates rose so rapidly – often multiples times midway through an existing deal. When our investors exited an investment, they were able to reinvest in a new deal that offered an even higher return than before.

However, as we look to the horizon, many economists believe we’ve reached the summit of this rate-hiking cycle. The prevailing view suggests that rates are likely to ease in the coming period, though the exact timing and pace remain uncertain.

How will a falling rate environment impact investors, especially if the pace of change is rapid? Will they be better off in a 12-month deal or in an 18-month deal?

Easing Cash Rates and Fixed Rate Private Debt Investments

The situation becomes more nuanced when rates are easing. Bowery’s deals offer fixed returns, which provides a layer of protection for investors in a declining rate environment. As market rates decrease, the fixed rate on your existing investment remains unchanged, potentially offering above-market returns as time goes on.

The decision between a 12-month and 18-month deal in this scenario largely depends on your outlook on the pace of rate changes and your assessment of alternative investment opportunities. If you believe rates will decline rapidly, an 18-month term might be more attractive as it locks in the current, higher rate for a longer period. On the other hand, if you think the decline will be gradual or you want to maintain flexibility to explore other investment options, a 12-month term might be preferable.

It’s also worth considering the relative attractiveness of private debt compared to other asset classes as rates ease. While declining rates might make some traditional investments more appealing, the consistent returns and lower volatility of private debt can still make it an attractive option for many investors.

Getting Strategic As Rates Ease: 12m vs 18m?

As we navigate through a potentially easing rate environment, it’s crucial to consider how different investment terms align with your financial goals and life stage.

The Near-Retirement Perspective

For investors approaching retirement, the choice between 12-month and 18-month terms takes on particular significance. Your investment strategy at this stage often prioritises stability, regular income, and capital preservation. So how do you stay the course as rates ease?

Regular Income Streams

In the context of easing rates, 18-month terms can be particularly attractive for near-retirees seeking consistent income. By locking in a higher rate for a longer period, you can ensure a stable, predictable income stream even as market rates decline. This can be especially valuable as you transition into retirement and begin to rely more heavily on investment income to support your lifestyle.

Balancing Growth and Preservation

While income is a primary concern, it’s not the only consideration. The choice between 12 and 18-month terms also impacts your ability to balance continued growth with capital preservation. In an easing rate environment, 18-month terms offer the advantage of maintaining higher returns for a longer period, potentially outpacing inflation and preserving the purchasing power of your investment.

However, 12-month terms still have their place. They offer more frequent opportunities to reassess your portfolio and make adjustments based on changing market conditions or personal circumstances. This flexibility can be valuable in managing risk and ensuring your investment strategy remains aligned with your evolving needs as you enter retirement.

Liquidity Considerations

Liquidity needs sometimes become more pressing as retirement approaches. Here, 12-month terms might have an advantage, providing more frequent opportunities to access your capital if needed. However, if you have other liquid assets or sources of income, the potentially higher returns of 18-month investments could be more beneficial in supporting your long-term financial security.

The Middle-Aged Investor’s Perspective

Middle-aged investors often have different priorities and a longer investment horizon, which can influence their approach to choosing between 12 and 18-month private debt investments.

Flexibility for Changing Goals

The flexibility offered by 12-month terms can be valuable for young investors whose financial goals and circumstances may be more fluid. Shorter terms allow for more frequent reassessment and reallocation of investments, which can be advantageous as career prospects, income levels, and financial responsibilities evolve.

Building a Diverse Portfolio

For middle-aged investors, private debt investments – whether 12 or 18-month terms – can play a crucial role in building a diverse, resilient portfolio. These investments offer an excellent way to balance higher-risk, growth-oriented investments with more stable, income-generating assets. The choice between terms can be part of a broader strategy to achieve the right mix of growth potential and stability across your entire investment portfolio.

Conclusion: Making Informed Decisions in Changing Markets

As we’ve explored throughout these 2 articles, the choice between 12-month and 18-month private debt investments is nuanced and depends on various factors. In a market where cash rates are expected to ease, both options present unique advantages and considerations.

As you consider your options, it’s essential to remember that there’s no one-size-fits-all approach to investing. Your choice should align with your personal financial goals, risk tolerance, and overall investment strategy. Factors such as your age, retirement plans, liquidity needs, and market outlook all play a part in determining whether a 12-month or 18-month investment is more suitable for you.

In a changing economic landscape, what matters most is staying informed and adaptable. Our team of experienced investment directors is here to help you navigate these decisions, taking into account your individual circumstances and the current market conditions.

We encourage you to reach out and speak with one of our investment directors – we’re here to support you on the path to long-term financial success.