New debt funds struggle as competition increases

If Mipim 2012 marked the zenith of a new wave of debt funds, Mipim 2013 was the moment they took something of a beating.

It started with the announcement days before the event got underway in Cannes that John Feeney had stepped down as head of real estate debt at Henderson Global Investors to join Lloyds Bank Commercial Banking as managing director and head of corporate real estate. The move comes 12 months after Henderson appointed Feeney to lead the execution of investment origination and underwriting at its €15.4 bn global property business.

Market watchers say Feeney’s new job at Lloyds represents a well-deserved promotion and should not be interpreted as a sign that Henderson’s two debt funds are floundering since their launch in May 2012. Nevertheless, the changes at the top will hold up progress, a spokesperson said.

She added that Henderson remains 'firmly committed' to the real estate debt sector: 'We have been engaging with a strategic partner regarding the development of our debt platform and continue to do so. This would add both scale and expertise to our offering. We are optimistic that we will reach a conclusion to these discussions by summer this year.'

Around 20 firms, including Henderson, Aviva Investors 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 David Lebus, an analyst at JLL in London.

But there are challenges, he added. ‘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.’ In Q1 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, King said. ‘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.

‘Paradoxically, despite the lack of financing available, there still isn’t much product to lend on,’ Lebus 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, he said. 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.

Many debt funds are also being forced to chase riskier assets and deals. Some charge more than twice as much as regular lenders. While a bank might be prepared to offer a five-year loan with a LTV of 60-65% for a spread of 195 bps, debt funds may ask for as much as 400 bps.

Debt funds are also unlikely bedfellows for investors seeking long-term strategic financing or refinancing, one senior banker noted. Interest rates are now at a record low, but in a high- interest rate environment, refinancing would simply not be an option, he pointed out.