El Segundo-based commercial real estate credit investment firm The TerraCotta Group, which was founded two decades ago, has experienced tremendous growth. With an emphasis on advanced data analytics and quantitative reasoning, the company claims to be one of the few companies operating in the $4 trillion commercial real estate credit market, claiming no principal losses since its inception in 2004.
The company operates in the private credit space, which means it’s a non-bank lender extending credit to borrowers and sponsors – often small and medium-sized privately owned businesses. It’s an important source of funding for the middle market and is growing quickly as banks are broadly withdrawing from lending.
“We look at ourselves as more of a specialist in real estate credit,” Tingting Zhang, founder and chief executive of TerraCotta, said. “Every year, we’re trying to figure out where the demand is coming from, where capital is short supplied, where the problem sector is and how we can solve problems.”
Zhang was born in Xi’an, China and the name TerraCotta plays homage to her hometown – named after the famous Terracotta Army, a collection of terracotta sculptures depicting the armies of Qin Shi Huang, this first emperor of China. Discovered by a group of farmers in 1974, the army serves as a symbol of the emperor’s power and wealth, as well as the quest for immortality.
“I was looking for a name and wanted to be thoughtful about it,” Zhang recalled. “I didn’t want to put my name on the door, so I thought of TerraCotta. It reflects my heritage, and it is also the first man-made material in construction.”
Zhang moved from China to attend the University of California, Los Angeles, where she earned her Master’s in quantitative methods and PhD in international political economy. It was only after, when she was working for a think tank company in New York, that she was exposed to the real estate credit business and eventually decided to branch off to form TerraCotta.
The company specializes in debt financing and, as a platform, approaches deals from a forward-looking philosophy by looking at how it can add value.
“We think about asset types and geographies in a more fluid way,” Zhang said. “We look at investment demand really from the economist point of view; we’re really trying to understand the changes in the broader economy.”
Navigating distress
The company went live only a few years before The Great Recession and because of that was forced to adapt to extreme financial stress quickly. Zhang said this has given TerraCotta a sharper eye and perspective when it comes to navigating today’s challenging lending environment.
“I think that makes us pretty unique in the middle market,” Zhang said. “Most of the (other) real estate credit shops came into place after the GFC. I think our experience during the GFC, as scary as it was, was a really good stress experience for the team. We’re not peacetime generals. We don’t mind rolling our sleeves and working through the problems.”
“We like it when the market changes,” Zhang added. “Actually, we like both the times when the market goes up and when the market goes down. We don’t necessarily like the times when the market is flat. I think that usually creates a lot of the risk-taking behaviors.”
While TerraCotta is somewhat asset type agnostic and has lent on a spectrum of properties, Zhang said she is most passionate about multifamily housing right now – specifically workforce housing given its lack of supply. And while its portfolio spans nationwide, TerraCotta prefers to lend in major cities in California.
In July, the company closed the purchase of San Francisco’s first nonperforming loan portfolio transaction since the Covid-19 pandemic. The purchase price – the lowest in the San Francisco submarket in over 20 years – represents a 32% discount to the outstanding aggregate loan balance of $94 million secured by 12 multifamily properties constituting 459 units.
In terms of Southern California properties, the company provided a $24.6 million industrial outdoor storage bridge loan to finance North Palisade Partner’s Palisade Anaheim Logistics Center last year. And in 2022, TerraCotta funded a $84.7 million bridge loan for the refinancing of Janss Marketplace, a 456,000-square-foot regional retail center in Thousand Oaks owned and operated by NewMark Merrill.
“It’s very driven by where money is needed,” Zhang said. “And usually, when we adopt the approach looking for where demand is not met, we actually end up delivering a good return to the limited partnerships.”
Data-driven philosophy
At the heart of the company’s squeaky clean track record, Zhang says, is data.
TerraCotta has over 155 million parcels in its data warehouse – one parcel equivalent to every property in the U.S. – of which Zhang says the company uses advanced technology to comb through and evaluate a property’s competitiveness.
“In addition, we track all the demographic, economic and secular trends around these properties so we have a clearly defined methodology to understand where demand is coming from and where demand is declining,” she said. “When we make an investment, we are both micro – bottom-up investors, fundamental investors – as well as macro investors. I think that’s rare in real estate.”
The firm’s proprietary data platform is comprised of 10 terabytes of data and sifts through billions of data points – covering property attributes, previous transactions and economic, demographic, locational and orthogonal inputs – to identify opportunities and protect against risk.
Some of the factors the company looks at when it comes to property variables include its walkability score, proximity to transit, parks, a neighborhood’s crime rate, education system ranking, access to grocery stores and more.
“Money is made in the micro, and knowledge is lost if you don’t have the macro knowledge,” Zhang added. “Data is a pretty big aspect, and methodology, taking a macro view, is part of that best strength.”
Zhang says one of the biggest pillars of success has been the proliferation of data – stating every year since the company’s onset real estate data has doubled. Her team started by using classical regression models and later introduced machine learning and artificial intelligence algorithms to better monitor assets and analyze risk.
“There is no substitute for having high-quality investment officers that know how to analyze risk without the use of AI,” George Mitsanas, a principal at mortgage banking and financial advisory firm Gantry Inc. who is based in El Segundo, said. “That’s not to say we’re not going to use AI. We’ll use AI to help make things more efficient, but if someone is relying on AI to judge the risk and they don’t know how to do it themselves, that’s a problem.”
In addition to TerraCotta’s data-driven approach and methodology, Zhang also suggests the company’s culture and diversity have played a factor in the firm’s success as 80% of its borrowers are repeat customers.
Investment vehicles
In order to lend, TerraCotta offers debt financing through its private credit funds – a type of alternative financing for companies that choose not to seek funding from a bank or through corporate bonds. It raises capital for these funds from investors – usually public pensions, global asset managers, family offices and high-net-worth individuals – in exchange for limited partner interests.
The company’s original TerraCotta Credit Fund was launched in 2015. The fund, which Zhang refers to as a lightly levered portfolio, carries current commitments of over $500 million and is expected to grow to $1 billion by the end of next year. She said it’s an evergreen vehicle meant to play a defensive strategy and is ideal for complex transactions, such as office to multifamily conversions.
Next year, TerraCotta plans to launch its TerraCotta Opportunities Credit Fund, a close-ended fund that will invest in opportunistic, sub-performing and non-performing commercial real estate secured loans in the middle market and has a target size of $750 million.
It is also preparing to launch the TerraCotta Stable Credit Fund in the next few years. This credit fund is meant to provide capital similar to banks by offering credit against stabilized commercial real estate collateral. Unique to other funds, TerraCotta plans to employ automated underwriting to create a new experience.
“Banks take 30, 60, 90 days to approve credit,” Zhang said. “For this to be done on the spot, in real time, with this accuracy, and hopefully with the same no loss on performance in our history, we’re very excited about this. We think this is the future of real estate credit.”
Zhang said TerraCotta is actively investing – both on the lending side as well as the distressed side – but is taking things slowly due to market uncertainties around interest rates and the changing political and economic climate.
“We’re not jumping on any asset class that hasn’t gone through a recession,” Zhang said. “We’re always looking for what’s new, but we wouldn’t jump on the bandwagon unless we know it has proven performance.”
Looking forward, Zhang said her short-term goals for TerraCotta are to close the Opportunities Fund, make the Stable Fund and introduce automation. In the long run, she just wants “to become a really good real estate credit investor.”
“I believe that to become a really good real estate credit investor, you have to be very data driven and that has not (always) been the case,” she said. “I’m pleased that we’re bringing this angle to the investment management business, using data in a meaningful way in private investment strategies. I want to see how far I can push this data angle to make the investment process better, more transparent, more repeatable and more accurate.”
