Could debt funds go sector-specific?
Alternative sectors such as hotels have been attracting new lenders. Could we see the emergence of sector-specific debt funds? Lynn Strongin Dodds investigates
Hotels and other alternative property sectors are clearly on the radar of new debt providers. At the end of last year, Starwood European Real Estate Finance made its first debt investment by providing financing for The Maybourne Hotel Group, alongside Blackstone and four traditional lenders. More recently, M&G and DRC Capital provided debt finance to Fattal Hotels to buy and manage 20 four-star Queens Moat House hotels in a deal worth €265m. The portfolio, which was acquired from Goldman Sachs, included 15 Holiday Inns, four Best Westerns and one Queens Hotel in cities such as Berlin, Munich, Dusseldorf and Cologne.
Steven Cowins, partner at law firm SG Berwin, has been advising on a number of hotel financing deals. He believes that such is the interest in alternatives like hotels that sector-specific debt funds could come onto the market.
“I think we will see an increase in the number of debt funds targeting alternative assets – whether this is by clear intention at the outset or where they end up allocating debt – because these are the areas where the banks do not want to lend,” he says. “For example, in the hotel sector, I think there will be more deals like the [DRC Capital] and M&G as banks continue to get rid of their historic portfolios and don’t wish to lend on new acquisitions unless they’re prime. Hotels are misunderstood by many institutions but if you look at the IPD index, they have outperformed the main index over the past 10 years.”
It is easy to understand why participants are looking further afield. William Newsom, senior director in the valuation division at Savills, says: “The highly competitive nature of the mainstream markets has driven down returns, and the consequence is that lenders are looking at other parts of the market.
“However, I do not see specialist debt funds for financing alternative types of assets being set up soon. There have been a lot of column inches devoted to organisations setting up senior debt funds from which we have not seen much lending. We need to see more funds for general financing become operational before we get to the specialist type of assets.”
Ashley Goldblatt, head of commercial lending at Legal & General Investment Management, also believes the level of transaction flows will not justify the creation of a debt fund specialising in either hotels or student accommodation. “If you look at those two sectors, they each only account for roughly 1.5% of the Investment Property Databank market, so the pickings are slim, especially as one line of debt can straddle a number of properties. And the opportunity sets get smaller when you think about heterogeneity within them.
“For example, would a hotel debt fund typically target, at one end, Central London five-star, while also looking at say, Travelodge or Premier Inn? Quite likely not, as the characteristics are very different. A further consideration with these sectors, as well as others, such as leisure, is that there is an operational component, and it is important to be able to get at least as comfortable with the business as with the underlying property, which isn’t what everyone has in mind when thinking about real estate debt.”
Simon Redman, managing director, client portfolio management for Europe at Invesco Real Estate, also does “not foresee a hotel debt fund being established because the scope of opportunities would be too narrow and small to be sustainable. Hotels are attractive to investors looking for yield because they have long leases and high, stable income, but it remains a specialist asset class and does require specialist expertise and knowledge to invest.”
Europe will continue to be a fertile stomping ground but the action is more likely to be in the UK where £1.62bn in deals have taken place in the past three years due to company administrations or administrative receivership, according to a new report by Jones Lang LaSalle’s Hotels & Hospitality Group. This year began with the £640m sale of the 42-asset Marriott portfolio controlled by Royal Bank of Scotland to the Abu Dhabi Investment Authority, and the £360m acquisition by Starwood Capital of Principal Hayley, the hotel and conference centre operator, from Lloyds Banking Group. Meanwhile, KSL Partners snapped up Malmaison and Hotel du Vin chains – a total 27 hotels – for £200m from MWB Group Holdings, which was put into administration last November.
Despite the activity, deal flows are unlikely to hit their peak levels. “The main challenges for hotel owners currently are the inflationary costs which continue to escalate while fighting to keep occupancy and room rates up,” says Edward Henson, partner at property investment management company Riverside Capital, who along with private equity group Connection Capital recently bought the Cresta Court Hotel in Altrincham for £2.9m. “As a result, we look at where we can add value through refurbishment or rebranding rather than simply buying assets because they look cheap compared to historic values. There might well be an increase in the number of deals this year, but in my view, values will not go back to the heady purchases that occurred between 2005 and 2007 for many years to come.”
Hotels, though, are not the only alternatives in the spotlight. Student housing has long been attracting attention and market participants are optimistic about its prospects due to its low risk, secure income attributes. Occupancy levels remain high, especially when compared to the vacancy rates in some mainstream sectors. Plus, it outshone other property sectors with total returns of 9.6% in 2012 compared with 4.4% for all office properties and 2.2% for all retail, according to CBRE figures.
Overall, CBRE shows that a record £2.7bn flowed into the sector in 2012, a 125% jump on 2011. This was despite the number of applicants for the 2012-13 academic year slipping 6.6% to 653,600 due to fee hikes to £9,000 from £3,000, according to UCAS figures. The difference in the future is that lenders and investors will be more selective, according to Nick Harvey-Jones, director at CBRE. “There are some pitfalls but it is still in vogue in terms of stability and secured income streams. The result of the fee increases is that there will be more focus on London and the redbrick universities because the supply-demand imbalances still exist. As for financing, debt is cheap and it will be accretive to investors.”
Social housing in the UK is also creating a buzz. Traditionally, local authorities provided the funding, but today housing associations are playing a greater role. “There are roughly 1,700 housing associations and they have to find alternative sources of debt because the banks have withdrawn,” says Phil Ellis, client portfolio director for real estate at Aviva Investors, which launched the REaLM Social Housing fund two years ago. “We are focusing on the UK because we like the regulatory environment and the very secure, long-term, inflation-linked income. However, we have a best-of-breed approach and focus mainly on the medium and larger associations for our sale-and-leaseback approach.”