Private credit in real estate: What happens in a downturn?

Investors considering real estate private credit are quite rightly thinking about the impact of property downturns.

Every investment strategy should rightly be judged not just how it performs when markets rise but how it behaves when they become more challenging.

Hence, if property prices fall, where does that leave the real estate private credit investor?

The answer is more nuanced than many assume.

Unlike equity investors, private credit investors occupy a fundamentally different position at the very top of the capital structure.

That distinction, when combined with disciplined underwriting and conservative loan structures, helps explain why many sophisticated investors increasingly view real estate private credit as a defensive allocation rather than simply a source of income.

Property downturns are not black swan events

Like all asset classes, property downturns are cyclical.

Property markets rise, they plateau and ultimately endure a period of correction.

Every experienced lender expects these market cycles and prepares for them.

Good underwriters assume this.

Only poor underwriters ignore this inevitability.

Professional lenders don’t underwrite for today’s valuation, they underwrite for the consequences if that valuation ultimately proves optimistic.

How property downturns impact owners and lenders

The risk to an owner is fundamentally different and greater than to a lender during property downturns.

That is because lenders are protected by conservative LTV ratios.

To illustrate this, imagine a property tycoon purchases a building for $2m.

The lender provides the capital with a standard 65% LTV.

Hence the value of the loan is $1.3m with the borrower holding equity of $700k.

Now imagine the economy begins to weaken, property is one of the first affected and the market drops 15%.

The building is now only valued at $1.7m after falling in value by $300k.

But that loss is sustained by the owner who’s equity falls to just $400k.

The lender’s $1.3m investment remains protected.

Security matters more than headlines

Real estate private credit is fundamentally a secured lending strategy structured around contractual repayment obligations backed by tangible collateral.

It differs from many other investments where returns rely primarily on market appreciation or business growth.

It underlines how collateral is much more critical than economic forecasts.

Real estate private credit has other built-in features designed to protect investors:

• It offers first-mortgage security placing lenders at the top of the capital stack and generally giving them the option to enforce the sale of a property to recover outstanding debt.

• The security interest is typically formalized in California via a recorded deed of trust, creating a public record of the loan.

• Conservative LTV ratios protect lenders from exposure during property downturns and demand borrowers have significant equity in their projects.

• Independent valuations provide an objective estimate of collateral value rather than relying on the borrower’s opinion.

California’s structural advantage

California is not immune from market cycles and property downturns.

However, it differs from many other markets built primarily on speculative expansion.

California’s long-term fundamentals remain unusually strong, making it one of the more attractive locations for real estate private credit in the country.

Here’s why:

Chronic housing undersupply

A decades-long persistent shortage driven by population growth that has outpaced new construction.

Population concentration

Nearly half of California’s 40 million people live in the greater Los Angeles area including Long Beach, Anaheim, the Inland Empire and Ventura County. It creates sustained demand for housing and preserves value by constraining future supply.

Land constraints

Geography naturally limits new development in many parts of California.

Planning and entitlement complexity

California’s planning, zoning and environmental approval processes are among the most complex in the US, creating high barriers of entry that discourage many participants.

High replacement costs

Construction costs are among the highest in the country due to labor expenses, material costs, seismic building standards and regulatory requirements.

Large and liquid property markets

California boasts one of the largest and most fertile real estate markets in the world. In the event of borrower default, its vast liquidity improves the prospects of refinancing or selling under stress.

The importance of conservative underwriting

With real estate private credit, conservative underwriting is much more important than market forces.

Good lenders focus on what they can control, rather than worry about what they can’t.

That means:

LTV

A conservative value provides a margin of safety ensuring there is sufficient equity beneath the loan.

Borrower quality

The experience, financial strength and track record of the borrower are often as important as the property itself. Conducting due diligence is imperative.

Asset quality

High quality assets with enduring demand tend to be more resilient during property downturns.

Location

Properties in established markets with strong employment, population growth and housing demand are typically more liquid and retain their value during periods of market weakness.

Liquidity

Experienced lenders consider not only the value of the collateral but also how readily it could be refinanced or sold if required.

Exit strategy

Every loan should have one or more clearly defined exit strategies before capital is advanced. Multiple credible exits reduce reliance on a single outcome and enhance the resilience of the investment.

Put your capital to work in California real estate

Sophisticated investors understand that risk is never entirely eliminated.

But it can be managed and priced accordingly.

In real estate private credit, the objective is not to predict every market cycle.

Rather, it is to structure loans in a way that they remain resilient if and when those cycles occur.

That is why asset-backed private credit has become an increasingly important component of institutional portfolios.

Central is a professionally managed mortgage fund designed to generate monthly income through short-term loans secured by California real estate.

Learn more about the fund here and set up a no obligation chat with our team.