Institutional appetite for debt funds on the up

Institutional appetite for debt funds is showing no sign of abating, despite deepening global geopolitical uncertainty, according to Andy Moylan, head of real estate products at Preqin.

‘Institutional appetite for debt has increased over the last year, driven by the low interest rate environment and real estate still being perceived as a stable asset class,’ Moylan said. ‘Germany has always been an important market for debt funds because of its liquidity and the fact that there’s a lot to lend on. There is still a lot of capital looking at German debt.’

There are 25 Europe-focused real estate debt vehicles today which, collectively, are hoping to raise €15.1b of investor capital, according to Preqin. The largest of these is AXA Investment Managers – Real Assets’ CRE Senior 10 fund, which has a target size of €1.5b. The fund can invest in both Europe, including Germany, and the US. Pramerica Real Estate Capital VI is targeting Western Europe, the UK and Ireland and has a target size of €1.2b. AEW Europe’s Senior European Loan Fund 2 has a target size of €750m and can invest in markets such as Germany, France, the UK, Italy and Spain.

Debt funds grow their market share

Debt funds are not the blip that some in the industry predicted. In fact, they have grown their market share to 10%, according to De Montfort University in Leicester, UK.

‘European debt funds offer something different to traditional lenders – tailor-made solutions. They are complementary to traditional lenders and they’ve stood the test of time,’ said Henri Vuong, director of research at INREV. ‘The trend is also for bigger and bigger funds because the larger the fund, the more it can diversify.’

For debt funds to succeed today, it’s a ‘game of scale’, according to Jim Blakemore, a partner at real estate investor and lender GreenOak Real Estate in London. ‘Debt funds really need scale to work. You need a European and a global investment team. Funds need to be bigger to work, which is why larger and larger funds are being raised. And investor appetite is there for them.’

GreenOak is believed to have amassed a $1.5 bn war chest to invest in European debt within the next two years. The company declined to comment.

Debt funds on the hunt for new opportunities as core margins tighten

Loan margins on core loans tightened again last year and cannot fall much further, according to lenders across the board. Today, loan margins on core assets in Germany’s ‘Big Six’ can be less than 80 bps, a figure which rises to around 150 bps for longer-term loans of 10 years.

‘Loan margins are still shrinking,’ said Moylan. ‘This means that debt funds that have the capacity to go up the risk curve probably will. They might look more to mezzanine debt rather than senior debt. Equally, they might focus more on the asset classes that traditional lenders can be less willing to lend on, such as alternative assets.’

One fund manager paying more attention to alternative assets is AEW Europe, according to its CEO Rob Wilkinson: ‘We have adapted our strategy since we launched our first debt fund in 2012 because the reality is that loan margins on core assets in Germany can be just 100 bps or up to 150 bps in France and the UK,’ he said. ‘That’s a real change in the market. To achieve better returns, we’ll look at loans on assets such as logistics that aren’t the key focus of major banks or at the cross-border element, where we have an advantage.’

AEW Europe had the second close for its Senior European Loan Fund 2 (SELF 2) last December and has now raised over €400m towards its target of €750m. ‘We expect to have one-to-two closes this year as well to take us to that target,’ Wilkinson added. ‘It’s a harder market than when we raised SELF 1 because it’s more difficult to gauge how much investors want to commit to debt funds.’

One way to entice investors, especially in Germany’s ‘very competitive market’ is to offer ‘an  illiquidity premium to investors because they expect a premium over traditional credit instruments  such as bonds’, according to Antonio de Laurentiis, head of CRE Finance, at AXA IM – Real Assets. ‘Loans secured by alternative assets are the best way to get good returns in Germany because loan margins are typically higher, at between 170 bps and 220 bps for good quality senior loans,’ he said.

AXA IM’s CRE Senior 10 Fund is its first debt fund that can invest up to 25% in the US. The fund could also invest up to similar levels in Germany, de Laurentiis said. ‘We are driven by risk returns, so we’re very flexible. We only lend senior debt and our typical LTVs are around 55% to 65%. There are three cards that we try to play: size – being the biggest debt platform in Europe gives us and our clients an edge in the syndication market, so we can easily underwrite deals up to  €400m. Secondly, we are flexible when it comes to geography. Also, we have real estate DNA, which means we don’t have to look only at conventional asset classes, such as offices. We can also look at alternative assets where there is a premium on the debt side.’

Vuong agrees that the mezzanine debt portion of the market could offer opportunities: ‘It only represents a small part of the market, largely because people are still cautious about taking on too much risk. However, there could be some potential for mezzanine debt in a balanced market where you want a slice of every pie. The big question is interest rates: when will they start to rise in Europe and how quickly will that happen?’

Debt providers torn on how looming Brexit will affect lending markets

Alternative lenders are struggling to agree on how the Brexit will affect lending markets, both in the UK and in continental Europe. For some, the Brexit is creating a raft of opportunities, according to Tim Mycock, the development director at Reditum, a London-based alternative lender specialising in mezzanine and bridging loans. ‘There’s been a huge change in the market in the past 12 months,’ he said. ‘It’s been a massive opportunity for us. There has been increased dislocation between borrowers and lenders, especially when some lenders have pulled back on LTVS. That creates a real need for bridging loans and there’s more of an appetite for entrepreneurial lending.’

De Laurentiis agrees: ‘The Brexit can create opportunities, particularly if banks reduce their lending in the aftermath, which could result in some prime deals being done at lower LTVs and improved margins, creating opportunities for alternative lenders such as us. In this market, you have to be very opportunistic and selective.’

Other lenders are less bullish. Once Article 50 is triggered on 29 March, some fear it could put a dampener on both the lending and the investment market in Europe. ‘Some investors could take a wait and see approach, much like after the Brexit vote last June. Other investors might show more appetite for Germany and continental Europe,’ Moylan said.

For many investors, geopolitical uncertainty is hanging like a dark cloud over European lending markets. ‘If someone says it doesn’t, they’re missing the boat,’ Blakemore said. ‘The Goldilocks environment of low interest rates is on its way out. Interest rates are rising in the US and look set to do so in Europe, too. Property markets are changing. Our gearing in the UK is lower than it used to be because of uncertainty regarding the Brexit.’

Ultimately, though, investor sentiment will win through and lenders will follow investors, irrespective of the market, many in the industry say. ‘There are a lot of macro factors that influence investment, including geopolitical uncertainty,’ Mycock said. ‘Ultimately, it depends on investors. Demand is key. If demand is there, people will fund it.’