Opinion is divided over the potential for real estate debt funds becoming an established institutional asset class in Europe, writes Richard Lowe.
EUROPE – Real estate investment managers continue to bet on the prospects for real estate debt funds despite some scepticism over whether they really constitute a viable business plan.
Cornerstone Real Estate Advisers is the latest company to increase its in-house debt investment capabilities with the appointment of Chris Bates as head of European real estate finance. Today's announcement follows recent hires by Hermes Real Estate and Standard Life Investments.
Cornerstone is currently lending in Europe on behalf of its US parent, MassMutual insurance company, but the hiring of Bates is part of its plans to replicate its existing $27bn real estate debt platform in the US and so manage significant pools of third-party capital.
Another company planning to export a successful model from one side of the Atlantic to the other is UBS Global Asset Management. Its $2bn (€1.5bn) Trumbull Property Income Fund in the US invests in "participating mortgages", effectively the same strategy behind its new Participating Real Estate Mortgage Fund (PREMF).
The participating mortgage model enables UBS Global Asset Management to offer whole loans of up to 75% LTV, higher than traditional bank lenders which currently operate at a maximum of 50-55%. It is also cheaper and easier for borrowers than trying to secure mezzanine finance to sit on top of a bank loan.
But what sets the participating mortgage strategy apart from other whole loans is that the lender takes a share of the rental growth and capital appreciation of the underlying property. This is made palatable by explaining that the sharing of the upside is offset by lower costs to the borrower overall.
Anthony Shayle, head of UK debt for global real estate, is confident PREMF can reach a first close in October through ongoing talks with a number of European pension funds and insurers. With "meaningful co-investment" from the fund manager's parent UBS, the plan is to raise £350m (€405m) in total for the 10-year closed-end fund.
Shayle believes the lending market in Europe is undergoing a "permanent structural change" at the same time as a "sea change in the way investors are perceiving debt investments".
He believes there is room for a diverse range of debt strategies to emerge. The majority of prospective investors he is speaking to already have investments in existing mezzanine strategies, and so they are approaching the fund as a way of diversifying their debt exposure by strategy rather than coming to the sector for the first time.
APG did this recently when it backed LaSalle Investment Management to finance residential and student housing projects in the UK. The Dutch pension asset manager has already built up a European property debt exposure through Pramerica Real Estate Investors.
But more sceptical commentators have told IP Real Estate that the prospects for real estate debt funds look to be diminishing. A number of managers are seeing a visible return to the market from traditional European lenders, as well as a growing influx of US lenders and domestic insurers. One fund manager said the availability of debt for the deals in the UK today is considerably greater than it was six months ago.
In June, DTZ released the latest figures from its ongoing analysis of the European financing markets and found that the "net debt funding gap" had shrunk by 42% from $86bn to $50bn over the previous six months. Furthermore, it predicted a "lending capacity surplus" for 2013-14 for the UK, France, Germany and Sweden, which it described as a "remarkable reversal".
Such a turnaround does have implications for debt fund strategies. A significant part of their marketing is based on the supply/demand imbalance in the lending markets, which DTZ's analysis suggested is no longer as skewed as it once was. It should be noted, however, that the DTZ findings are in part predicated on the growth in non-bank lenders filling in some of the gap.
But UBS Global Asset Management's own research suggests the DTZ analysis might be erring on the side of optimism. The title of a recent paper – 'The Big Payback, volume 2 – Easier said than done' – encapsulates the fund manager's standpoint.
"As a house, we've had a contradictory story," says Elisabeth Troni, global strategist at UBS Global Asset Management, implying a contrast to analysis by DTZ and others. Media headlines have increasingly "suggested the situation has been resolved", she says.
The paper reads: "With finance available on high-quality assets in most markets, there is a common perception that things are 'sorting themselves out'. An accompanying belief is that greater debt availability will eventually creep into higher-risk product, as has been the case for equity. We remain suspicious of such expectations.
"Increasing evidence of alternative sources of capital is regularly touted by market participants as a very encouraging sign. And while this is certainly the case, a significant portion of this capital is highly selective and, as yet, slow to progress to market."
There is no doubt there is a huge potential for institutional investors to enjoy attractive returns from European real estate debt investments. But the success of the debt fund sector depends on the ability of investment managers to identify viable strategies and explain them clearly to investors in what is an unpredictable market.