The open-end Strategic Credit Fund is designed to deliver potential risk-adjusted returns and income by investing across the spectrum of credit investing opportunities in multifamily. Our most recent bond purchase showcases this flexibility with a portfolio of multifamily properties that meet our criteria for investment in vintage, duration and geographic diversity. And it underlines our objective of providing investors with risk-adjusted income and capital protection.
Why We Like the Bond
The latest addition to the Strategic Credit Fund is a 2021-vintage, 10-year floating rate K-Deal B-Piece bond with a face value of $56 million. The bond collateral is composed of 18 loans backed by multifamily real estate, originated by Freddie Mac. It has a weighted average duration of 88 months at acquisition and a debt service coverage ratio of 1.75x. B-Pieces, originally introduced in 1994, reflect relatively low losses because the assets are well-built real estate that are cash flowing and support debt service. Freddie Mac’s track record as a conservative loan underwriter gives us additional confidence as a purchaser that the loans have been well vetted.
All the loans were originated in late 2020, or very early 2021, and the underlying collateral started with 40 loans. With 18 loans remaining, that means 22 loans have been prepaid over the three-year hold of the pool so far. We like the vintage because it preceded the run-up in multifamily asset pricing experienced later in 2021 and 2022—two vintages that we continue to avoid. The debt service coverage, or DSCR, is 1.75x: For every dollar of interest and principal payment required by the borrowers, there’s $1.75 of cash flowing off the property.
Strategic Credit Fund Floating Rate Bond
Freddie Mac’s Proven Lending History
Freddie Mac’s history as a premier multifamily lender in all parts of the market cycle is proven: It straddles three recessions, the internet bubble, the Global Financial Crisis and the COVID-19 pandemic. It recorded its biggest loss, 0.42% of total loans, in 2006. And while every bond purchase represents a risk, historical data shows that even amid real shocks, Freddie Mac losses have been minimal compared with the volume of loans.
The bond, which we purchased on the secondary market, holds assets that are geographically dispersed across the U.S., many in Sunbelt states in which we already invest. None of the loans expose the Fund to New York or California; we believe both states’ restrictions regarding business and rent present investment challenges.
Freddie Mac B-Pieces, Historical Loan Performance
Source: Freddie Mac Multifamily Loan Performance Database. Includes multifamily whole loans, K-Deal loans and SBL loans. Assumes a 7-Year B-Piece representing 7.5% of total loan pool with 35.0% leverage and 10.0% levered annual return.
How We Acquired the Bond
We chose this particular bond because we believe in the quality and vintage of the collateral, the portfolio’s geographic diversification, and because we understood the multifamily real estate behind it. The bond was offered to Origin Credit Advisers off-market by a group that we have traded with in the past. Not only did we get first look, but we also got first pick. We were offered the bond at fair value because the seller had exposure to other asset classes beyond multifamily and required liquidity.
As part of our due diligence process, we leveraged the power of Multilytics℠, our proprietary suite of machine-learning models, to generate reports on the overall health of the loans, how the assets are performing in their local markets, and the probability of default, among other metrics. We cross-referenced this information with other resources and our understanding of the markets themselves.
Relationships Mean Access
For us, it’s the physical assets underlying a potential deal that determine whether we invest or not. But it’s our relationships with traders and sponsors that often gives us access to review potential bonds for our Fund. This portfolio of assets met our criteria for purchase, but we would not have been able to even consider the opportunity if we hadn’t built a strong relationship with the trader—one that goes beyond the numbers in a deal.
We’ve been working with this group for several years and it has come to trust our institutional knowledge about the multifamily sector and our perspective on the collateral and the sponsors underlying a bond, even if we decide not to execute on that bond ourselves. Bond traders study relative value among diverse potential opportunities, in multifamily, office, hospitality, from Freddie Mac and Fannie Mae and CRE CLOs, and it’s a challenge to be an expert in everything. We believe that because our experience and understanding encompass both the physical real estate and credit, we differentiate ourselves in a meaningful way from others in this space, which allows us to get those key “first looks” more often.
Learn more about how debt financing works and how we vet bonds for the Strategic Credit Fund.