More debt funds expected in the 60-80% LTV space

The loosening of the regulatory framework since May of this year by Germany's financial watchdog BaFin has led to a growing interest among investors in both setting up and availing of debt funds as an alternative source of real estate financing, according to the Hamburg-based consultancy group TPW, a division of Baker Tilly Roelfs. The most potential is seen for funds concentrating on the tranches between 60% and 100% of the LTV ratio.

TPW concludes that tranches below 60% of LTV, the senior tranches, are only of marginal interest for debt fund providers, as the interest rates at this level are simply too low; the yield perspective for investors buying in at that level are unattractive.

At 60% to 80% there is less lending available, with many of the traditional lending banks much more reticent to lend due to their Basel III commitments. However, here is where there is a lot of demand, and because of the higher risk at this level, yields are also higher than with senior tranches.

According to Martina Hertwig, a partner at TPW in Hamburg, "We estimate that fund investors – depending on their risk tolerance – can achieve IRRs of between 8% and 15%. Debt funds here in Germany are not really competing directly with the banks, but rather are a complimentary vehicle to bank financing, and help to fill in the gaps that have emerged on the financing landscape since Basel III. We're expecting to see more debt funds and banks working together, with maybe the bank taking on the senior tranche and the debt fund taking the tranche at 60% to 80% of the LTV.

There are a number of arguments in favour of institutional investors getting into debt funds, says TPW. Among them are the huge number of investors looking for acceptable yields. For insurers, there are benefits of investing in debt funds rather than holding real estate directly, as a result of the Solvency II legislation. While investments in real estate held directly require 25% equity capital, they can invest in debt funds for about half that.

Previous BaFin regulations had made it complicated for investors to access the market for debt funds, but these have been considerably loosened since May. Debt funds can now make fresh loans, restructure, or prolong existing loans far more easily.

Aykut Bussian, head of fund solutions at TPW, says "Because of these changes we can now really expect that debt funds are likely to play a more significant role in future. We've already seen how in other countries – particularly in the USA – this has already happened. Numerous new funds have come to Europe since 2013 – according to Scope there were already 53 funds set up here in June 2015, of which nine were set up in the first half of this year alone. These 53 funds are targeting total capital investment of €33.8bn."