Key Considerations When Selecting a Private Debt Fund

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MARKET INSIGHTS

January 21st, 2025

Understanding Security in Private Lending

Private debt has become increasingly appealing to investors looking for stable returns in their portfolio. And it’s no wonder why – as traditional banks become more constrained by regulatory requirements, private lenders are stepping in to fill crucial gaps in the market. But here’s the thing: not all private debt funds operate the same way. Understanding what sets the best funds apart can make all the difference to your investment outcomes.

The Fundamentals of Secured vs Unsecured Lending

Let’s start with the basics: what exactly makes a loan “secured”? Simply put, secured lending means the loan is backed by a tangible asset – typically property – that can be sold to recover funds if needed. Think of it like having a safety net: if things don’t go according to plan for the borrower, there’s still a clear path to protecting your investment.

This is precisely why Bowery Capital focuses on first mortgage secured lending. We’ve found this approach offers the sweet spot between attractive returns and robust investor protection. While some funds might chase higher returns through unsecured lending, we believe the additional risk isn’t worth the potential reward.

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The Priority of Payment

Here’s something crucial to understand about secured lending: not all security positions are created equal. First mortgages offer significantly more protection than second mortgages. Why? It’s all about priority. If a property needs to be sold to repay loans, first mortgage holders get paid out completely before second mortgage holders see a single cent.

This is why Bowery Capital primarily focuses on first mortgages. In the very rare instance when we do participate in second mortgages, it’s only when we control the first mortgage position as well. This gives us complete control over the security – something that’s absolutely crucial for protecting our investors’ interests.

The Hidden Risks of Second Mortgages

Let’s talk about why second mortgages can be riskier than they appear on paper. Imagine this scenario: you’re involved in a construction project with a first mortgage of $4 million at 60% LVR and a second mortgage picking up the next 20%. Sounds reasonable, right?

But here’s what can happen: the builder encounters problems and walks off the site halfway through. The new builder needs to take on liability for the existing work and quotes $3 million to complete what was originally supposed to cost $2 million more. Suddenly, your equity buffer has vanished.

And it gets worse. During the resolution process, interest keeps accruing on both mortgages. Legal fees start piling up. The first mortgage holder gets paid all of their accumulated interest and costs before the second mortgage sees a cent. We’ve seen situations (not at Bowery Capital) where what started as a seemingly conservative position turned into a significant loss for second mortgage holders.

Even in simpler scenarios, like a residential mortgage, the risks can compound quickly with second mortgages. Market downturns, extended sales periods, and additional costs can quickly eat away at the second mortgage holder’s security position.

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How Quality Funds Maintain Consistency

Delivering stable returns isn’t just about picking good loans – it’s about building a resilient portfolio that performs in all market conditions. At Bowery Capital, we achieve this through several key strategies.

First, we carefully manage our loan-to-value ratios based on both the quality of the security and the borrower’s profile. A developer with a strong track record of successful projects might secure a slightly higher LVR than someone less experienced. But here’s what makes us different: we’re not just looking at numbers on a page. We take the time to understand each borrower’s business model, their experience, and their capacity to execute.

We also diversify our loan book across different property types and locations. This means if one sector of the market faces challenges, the overall portfolio remains stable. It’s like not putting all your eggs in one basket, but making sure each basket is also particularly sturdy.

What this fundamental means for our investors is that they can move from one investment opportunity to the next while maintaining relatively stable returns.

Managing the Investment Cycle

Smart portfolio management also means having a pipeline of quality loans ready to go as existing loans mature. This requires deep market knowledge and strong relationships with quality borrowers – something that takes years to build. When one loan matures, another should be ready to take its place, ensuring investor capital remains productively deployed without compromising on quality.

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The Human Element

Numbers tell part of the story, but successful private debt investing is fundamentally about relationships. At Bowery Capital, we’ve built our reputation on really knowing our borrowers – understanding their businesses, their challenges, and their capabilities. This hands-on approach helps us spot potential issues before they become problems.

Risk Mitigation Strategies

The best funds don’t just wait for problems to emerge – they actively work to prevent them. This means for construction loans – detailed project feasibility study, ongoing monitoring of project milestones, and frequent communication with borrowers.

At Bowery Capital, we take this a step further. We conduct regular portfolio stress testing, maintain conservative LVR buffers, and have clear processes for managing loans that show early warning signs of stress. Which is why we have, to date, maintained a spotless track record of returning every dollar of capital and interest back to our investors.

Our team regularly reviews market conditions and adjusts lending criteria accordingly. We also maintain strong relationships with key property market participants, giving us early insights into market trends and potential risks.

Securing Your Investment Future: Making an Informed Choice

When it comes to choosing a private debt fund, looking beyond headline returns is crucial. You need to understand how the fund protects your capital, manages risks, and maintains consistent returns through different market cycles.

At Bowery Capital, we believe in transparency. We’re always happy to discuss our approach in detail with potential investors – because we know that understanding how we protect and grow your investment is just as important as the returns we generate. Ready to learn more about how our relationship-focused approach to private debt could fit into your investment strategy? Let’s talk!

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You came here because you wanted to invest in your future with our mortgage fund. So, why wait?

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