Lenders should beware. Recent deals suggest insurers are ready to move into senior debt, says Shayla Walmsley.
Legal & General and M&G this week both announced deals to supply debt finance for student accommodation. L&G has provided a £121m (€148m) 10-year loan to Unite Group, the student housing firm, to refinance a maturing bank loan. It will be the first deal of its kind L&G has done since its investment management arm set up a real estate debt business last year.
M&G, Prudential's asset management business, will provide £266m of client money in senior debt for Round Hill Capital's acquisition of Blackstone's Nido portfolio. Including its agreement to provide a five-year, £115m loan to the IQ Property Partnership fund last month, M&G has built up a commercial lending portfolio of £1.2bn.
M&G also plans to launch two new debt funds. One will be a successor to its existing mezzanine fund including follow-on investors, the other a senior debt fund for third-party investors that will use the expertise built up managing senior loans on behalf of Prudential.
Although an M&G spokesman said it was too early to talk about the fund structures or the target returns, he said there was interest among investors for attractively priced senior debt in a fund whose manager could put capital to work quickly.
A number of other real estate fund managers are rumoured to be looking at combining senior and junior debt strategies, including UBS Global Asset Management and CBRE Global Investors. Henderson Global Investors is another and might launch a €300m senior debt fund in the third quarter.
John Feeney, head of real estate debt at Henderson, said: "We want to position ourselves defensively at the conservative end of the spectrum." The fund manager will focus on high-quality assets such as locally dominant shopping centres.
Owners of secondary real estate assets hoping to benefit from a new swathe of institutional lenders should take note of this conservatism. These new lenders behave like real estate equity investors.
Philip Cropper, executive director at CBRE Real Estate Finance, said: "Most are working on the principle that they will lend on property they would be willing to buy, but not on assets they would not want to own. Relative to the deleveraging that needs to take place, there is insufficient debt, and [it] is targeting a specific marketplace. Investors are not interested in assets that, on an independent basis, wouldn't be able to raise cash."
If cautious core appetite has not changed, the new appetite for senior debt suggests there has been a shift of sorts. Some investors have been in it for a while, of course. They include US insurer MetLife, which has lent on UK office, multi-family, retail and industrial for the past decade.
Paul Wilson, regional director at MefLife Real Estate Investments, said: "We significantly increased our lending in 2011, and we plan to continue to take advantage of favourable market conditions in the region this year."
What is different now is that real estate debt as a market opportunity for investors now has an established model. "Others have done it, and that has made our conversations with investors easier," said Feeney. "There are interesting conversations taking place across the capital structure."
Yet mezzanine and senior debt investors come from very different perspectives. Helmut Mühlhofer, head of debt and capital markets at Allianz Real Estate, pointed out that the insurer's real estate debt investments are effectively fixed income investments.
"The main reason we're investing in real estate debt is not because it's a substitute for buying property," he said. "It's an additional part of fixed income - an alternative to mortgage products, and to corporate and sovereign bonds. A 10-year government bond returns 1.5-1.7%. That's OK as part of an investment exercise, but we're trying to do better than government bonds so we originate real estate loans."
In terms of timeframe, too, this is a slightly different kind of lending: insurers are in it for the long haul. Wilson said the UK has historically been a bank market with shorter loan terms, more prevalent syndications and floating rates. Insurers, in contrast, prefer fixed-rate, longer-term loans. "Over time, the two markets will become more similar as lenders continue to cross borders," he said.
For Mühlhofer, loan terms are the principal differentiator between an insurer such as Allianz Real Estate and another real estate debt investor. "The only difference is the term - we have longer maturities than banks," he said. "These are straightforward fixed-rate loans - just like 50 years ago."