Debt funds see rise in demand as banks retreat further

Debt funds will continue to profit from the heightened need for financing and the tougher regulations that have seen banks pull back strongly from the market, a new study from investment manager Empira on alternative financing shows.

Despite the current lull in investment, Empira expects overall financing volumes from alternative lenders to rise. Head of research Steffen Metzner cites a lack of supply, particularly in the housing market, partly caused by stricter demands on sustainability.

Banks are now also facing a stricter regulatory environment. "Basel III has tightened the requirements for banks' risk management, thus pushing certain loans off banks' balance sheets. Project developments, for example, are now rather unpopular with banks, especially when it comes to properties that are difficult to value due to a lack of comparable properties in the bank's rating system," said Metzner. These would include properties in the retail, leisure and hotel sectors, he added.

With this more restricted outlook, dealing with banks may have other disadvantages for borrowers. "Banks usually take a very schematic approach to credit assessment and sometimes have very rigid limits up to which loan-to-value ratio they would go. Anything that is no longer on bank balance sheets basically should look for other sources of financing," said Metzner, whose company is itself a debt financier.

The alternative financiers such as debt funds have the advantage of being more flexible, can make speedier decisions, are not constrained by rigid LTV limits and can provide more tailor-made solutions to customers. These advantages invariably come at a price. But that price is attractive enough to have drawn many new entrants, domestic and foreign, into the market. Low yields on direct investment on the equity side has also enticed many fund providers to switch to lending their own money on others' projects.

One such provider is Edinburgh-headquartered Abrdn, which is raising funds for a €1bn senior lending vehicle, its first debt fund dedicated to continental Europe. It already operates a €3.3bn debt portfolio focused on UK properties.

The strategy of the new fund will be to procure senior loans of between €20m and €150m, with the sweet spot being in the €40m-€80m range, with the focus on office, residential and logistics. The geographical preference will be Ireland, France Germany, Spain and the Benelux.

Meanwhile, Edmond de Rothschild REIM said it had amassed more than €350m for its debt platform by end-2022, surpassing its original target of €300m. The capital commitments relate to its Real Estate Debt European High Yield I fund (€170m) and a separately managed fund (€180m) for a single German institutional investor. It has already financed six transactions, including a Stg35m whole loan on a logistics property in London, its first in the UK.

In Berlin, the FAP Group has changed its €300m FAP BREF 1 closed-ended real estate debt fund into an open-ended vehicle with unlimited duration, and said it expects to raise an additional €100m by the end of the year.

The fund, which was launched at the end of 2018, allocates subordinated capital to existing properties, revitalisation projects and developments throughout Germany. The fund's backers are all German institutions, who despite the difficult market environment, stumped up a further €65m alone in Q4 2022.

According to managing partner Hanno Kowalski, "The conversion from a structure with limited duration into an Evergreen was incited by investor demand. Several parties wished to remain invested in the fund and are planning to raise their equity commitments."

"The fund is structured defensively in terms of its assets, geographies, markets, leverage and LTVs as well as its sponsors. This makes it the only core-mezzanine product for real estate financing in German-speaking Europe."