Aviva mulls pan-European debt fund

Aviva Investors is mulling the launch of a pan-European debt fund following its recent announcement that it is to establish its first UK debt fund.

James Tarry, who joined Aviva as fund manager for real estate debt last November, told PropertyEU that strong investor demand for debt funds makes it an opportune time to enter the market.

Aviva’s first debt fund will invest in senior real estate loans in the UK, Tarry said. ‘The real estate debt supply constraint in the European market is well-documented and we are now beginning to see investor interest in the attractive risk-adjusted returns that senior debt offers,’ he said. Tarry declined to comment on the fund’s target annual return.

However, according to David Lebus, an analyst at JLL in London, such funds typically generate an annual return of 5% to 6% if the loans are for prime stock, which rises to 7% to 10% for more opportunistic investments.

UK MARKET
The fund will focus on the UK market and will lend on core and core-plus assets, including offices, retail and logistics, across the UK. Typically, the fund will underwrite loans of between £25 mln (€29 mln) and £50 mln at up to 65% LTV, Tarry said. Aviva is working with colleagues from Aviva Commercial Finance, which currently manage a loan book of around £10 bn of real estate loans.

The investment firm has already started capital raising for the fund and expects investor interest to come from UK and European pension funds and insurance funds, as well as possible interest from sovereign wealth funds. It is hoping to make its first investments this year, Tarry said.

In the first quarter of this year, there were 38 senior and mezzanine debt funds in the pipeline of raising capital, according to senior analyst at C&W in London, Mike King. Based on the minimum target fund size, this suggests that the funds are looking to raise €24.6 bn. This is up from 15 funds in the same period last year, according to King. ‘However, the likelihood of all these funds reaching a close is unlikely. Given the competition, fund managers are having to work hard to secure capital and, on top of this, due diligence requirements can be onerous,’ he said.

LENDERS LINE-UP
According to Preqin, $8.7 bn (€6.6 bn) of capital was raised by 34 European real estate funds in 2012. Nonetheless, this is down considerably from a peak of $33.5 bn (€25.6 bn) in 2007, when 127 such funds raised capital.

Around 20 firms, including Henderson Global Investors, US-based Renshaw Bay, the boutique alternative asset management and advisory firm, and US-based Starwood Capital Group, have announced their intention in the past year to set up European debt funds, as alternative investors jostle to plug the debt gap left by many European banks who have become increasingly conservative in their lending.

‘The appeal is pretty strong because there is still a fundamental lack of real estate financing,’ said Lebus of JLL.

Nonetheless, there are challenges, according to Lebus of JLL: ‘The biggest challenge is that all of these funds are chasing the same investors, so it will be interesting to see how many of them have successful closings. Paradoxically, despite the lack of financing available, there still isn’t much product to lend on,’ he added.

In the past year, fund managers have been increasingly promoting debt funds as a ‘new and sustainable’ investment product, according to Dirk Richolt, head of real estate finance at CBRE in Frankfurt. Typical investors in such funds are those who previously targeted private equity funds promising a yield of 15% to 20%.

However, if debt funds are to appeal to a broader market, a few factors will need to be considered, according to Richolt at CBRE. Yield expectations will need to be less ambitious and ‘volumes have to be scaled upwards substantially in order to achieve economies of scale and to establish a more bank-like infrastructure’.

It would also make more sense, according to Richolt, to refrain from determining target yields for such funds in absolute numbers but, rather, as relative to capital market yields. ‘Considering the necessity of longer and unlimited terms, a capital market product seems to be a much more attractive and efficient alternative,’ he added.