IPE RE Conference: What happened to the big opportunity in real estate debt?

The lack of transactions among alternative real estate lenders in Europe was thrust into the spotlight at the IPE Real Estate Global Conference in Madrid.

In a panel discussion playfully entitled, Become a lender not a borrower, moderator David White, head of real estate debt strategies for Europe at LaSalle Investment Management, presented a detailed rationale for investing in the asset class. He also set out what drove value in real estate lending and the returns that could be expected for lending different parts of the capital stack, yet the discussion often came back to the question of why European real debt volumes seemed to be struggling.

According to LaSalle’s estimates, $3.3trn (€3.05trn) has been allocated to real estate equity in Europe, while $1.8trn is “sitting” in debt strategies. “Fundamentally speaking, debt is under-allocated as an asset class within Europe,” said White.

Noting a recent INREV survey, which found that 84% of investors planned to increase their exposure to real estate debt, he said: “There are plenty of alternative lenders in the market, but there isn’t a whole lot of debt in the structure particularly from the alternative funds space.”

Peter Hobbs, managing director, head of private markets at adviser Bfinance, raised the question of why more capital had not been raised for real estate debt strategies. “It is striking,” he said. “Ten years to the end of 2022, real estate was around 20-25% of all corporate debt capital raised every year; last year it was just 6%.”

This is despite a growing consensus last year that real estate debt investments were very attractive due to rising interest rates and the withdrawal of traditional lenders. Capital raising “So, it is very surprising that it fell away and did not come into the space,” Hobbs said.

He offered some possible explanations: “It is probably a combination of things. One is there is value elsewhere. For example, private corporate debt is fantastic now in terms of the spreads; a lot of capital is flowing there. I also think a lot of investors are saying, ‘real estate is a bit messy, let’s stick to private corporate debt’.

“I think the INREV survey is right in that a lot of people want to be in real estate debt, but within real estate [allocations] no one has liquidity. Many core investors are stuck in a redemption queue and want the liquidity. Also, for many investors real estate debt is not really real estate.”

Brian Niles, co-CEO of Morgan Stanley Real Estate Investing (MSREI) and head of MSREI Europe, said his firm had liked the credit space, but he added: “As an equity player I think optionality is something that is not always factored in. At this stage of the cycle when we have had valuations go down, I like the equity play. There is potential for a more positive skew than a negative skew after valuations have adjusted.”

He said: “I would have answered the question differently back in 2021. We just saw inflation bringing uncertainty that also brought [with it] the value of actually owning an asset, which can generate income growth over the long run. That is factoring in a little more to people’s understanding of what it means to own the asset.”

Jay Kwan, managing director and head of Europe, QuadReal Property Group, said the Canadian investor had successfully invested in real estate debt, but growing competition in the space had made it challenging.

“On the one hand, it has been a fruitful experience,” he said. “We have closed loans on elevated base rates and good structuring. Those loans have been fantastic. But the downside is that the strategy has been met by a lot more participants offering more solutions than there are problems.

“Secondly, the sector has failed to reach velocity. There are a lot of great intentions and great teams being set up, but at the same time people are asking when the deals are going to come. So, we are happy with what we have done. We just wish we had done a lot more.”

Niles remarked: “When I talk to investors, there seems to be a lot of interest in the space. In terms of deal actually happening, there does not seem to be a lot happening. I think part of the reason is I am not sure how many firms want to borrow at some of the levels… promised to investors as opportunities.

“I think there will be opportunities and we are a bit early here. There will be opportunities to help plug a funding gap, but I think for the most part firms can continue to extend existing financing and not take expensive financing.

“There is still a bid ask spread, so what is holding back debt volume is on the demand side. Ultimately, those who have existing capital structures are hanging on as long as they can. Rates are not coming down capital, the water is rising, and there is a little bit of a stand-off between those who do have the ability to make loans and the borrowers.”

Niles continued: “Over time, the question will then become do I take the money that is more expensive than I would like or do I sell the asset? That will really depend on the specific circumstances of those assets. The reason it hasn’t happened yet is because people are hanging on and hoping but that doesn’t mean it won’t happen.”

Hobbs replied: “But that doesn’t explain the fall-off of capital raising.” Niles added that those that possess dry powder have not deployed it all. “But I do agree with you that the corporate debt space is really attractive to investors and that has drawn a lot of attention,” he added.

Kwan agreed: “It feels like there is an extended staring process where people are waiting to see if rates get cut first and by how much or does maturity come first or do regulations bite? What is going to happen first. Who is going to blink first? During that period, there are expressions of interest, but volumes are pretty anaemic.”

Kwan said candidly one of the reasons his group had been less successful at being competitive was because of the entry of equity investors. He gave the example of residential equity investment firms no longer liking the price point of equity participation relative to the return available through credit. “Everyone is doing the same thing and that just drives down pricing. If everyone is following the capital in the exact same sector, they are not necessarily going to get outsized returns.”

When panellists were asked what was keeping them awake at night, many agreed geopolitical events was one. The debt panel discussion had immediately followed a presentation on geopolitics by NATO international security director Sajjan Gohel. “I think that presentation will keep all of us up,” quipped Kwan.

Aside from that, Nicole Lux, COO of Finloop, said what was keeping her awake at night was ESG issues. “I would come back to ESG. I am glad we have seen examples during the conference of what can be done with office properties, but what I am worried about – and why I am quite hesitant going into equity – is who is going to fund all the refurbishment and upgrading of all this space? How much is going to be needed until 2023 and beyond in Europe?”

Hobbs said his main concern was if the CIOs at institutional investors began to lose confidence in real estate in preference to other asset classes, such as infrastructure or corporate debt. “Maybe real estate could be squeezed out,” he said.