New debt fund managers continue to emerge, but capital allocated by investors is still finite, leading to hotly contested marketplace. Andrew Moylan reports
Since 2007, the proportion of aggregate capital raised by private real estate funds allocating all, or a proportion, of their capital to debt investments has increased. Funds focusing solely on debt reached a peak in 2011, accounting for 21% of the aggregate capital raised by all closed-end real estate funds globally. In 2013, funds allocating some or all of their capital to debt investments accounted for 45% of aggregate capital raised by private real estate funds throughout the year.
Nonetheless, the private real estate debt market remains relatively small, with some investors unfamiliar with the strategy and, therefore, unwilling to invest in debt funds. Additionally, with banks increasingly returning to the market, the sector is competitive.
Figure 1 shows annual debt-focused fundraising from 2006 to 2013, demonstrating that 2011 was a particularly strong year, with 29 funds reaching a final close, raising a n aggregate $13bn (€9.5bn). However, in 2011 two funds accounted for 41% of debt-focused capital raised: Blackstone Real Estate Special Situations Fund II and PIMCO Bravo Fund I raised a combined $5.3bn in investor commitments.
Last year, 21 debt funds reached final close, raising a significant $10.7bn, almost double the $5.6bn raised by 20 funds in 2012. The largest fund to close in 2013 was raised by Blackstone Group, with Blackstone Real Estate Debt Strategies II securing $3.5bn in investor capital for debt investments in North America and Europe. As shown in figure 2, other prominent funds to close in 2013 include Pramerica Real Estate Capital IV and ICG-Longbow UK Real Estate Debt Investments III, which raised €820m and £700m (€840m) for investments in Europe and the UK, respectively.
In recent years, a growing proportion of debt fund managers reached their fundraising targets. Despite 2011 being a particularly successful year for debt-focused private real estate fundraising, only 28% of debt funds that closed in the year achieved, or exceeded, their target size. In 2013, by comparison, 75% of funds closed achieved or exceeded their target size, with 19% of funds raising 126% or more of their target. This is encouraging news for managers marketing debt funds, as it illustrates the increasing appetite for these funds among institutional investors.
An examination of the real estate debt funds being marketed over time reveals a significant growth in the aggregate capital targeted by these funds over the two years. Funds currently in the market are targeting $23bn, representing 130% more capital than was sought by funds in the market in January 2012.
This demonstrates the confidence managers have in their ability to raise significant levels of capital from investors for debt offerings.
Correspondingly, the number of debt-focused funds on the road has increased from 28 in January 2012 to 50 in January 2014.
Historically, the number of private real estate debt funds in the market that target North America has consistently been significantly higher than those focusing on Europe, and it is still the most widely targeted region, with a total of 29 funds currently focusing on the region, targeting aggregate capital commitments of $12bn. However, in the last two years many European fund managers have launched new debt platforms and new players have also entered the market. As a result, the number of Europe-focused debt funds has increased from four funds targeting $1.7bn in January 2012, to 18 funds seeking $11bn in January 2014.
In 2010, North America-focused debt funds accounted for 88% of total capital sought by debt funds in the market. Europe only accounted for 8%. However, the proportion of aggregate capital sought accounted for by North America-focused debt funds has decreased to 50% in January 2014, with Europe-focused debt funds accounting for 47% of capital targeted. These include Aalto Commercial Real Estate Loan Programme, which is targeting £1.5bn for senior debt investments across Europe. The 10 largest Europe-focused debt funds alone are targeting an aggregate $8.7bn, representing 38% of the total capital sought by all debt funds in the market.
The risk-adjusted returns offered by debt funds may provide an attractive alternative to equity investments for investors that are looking for stable returns from their real estate portfolios. Consequently, the increase in fundraising for debt funds is the reflection of a significant growth in institutional investor appetite for the strategy. The proportion of limited partners including debt within their fund searches has increased from 8% of investors in December 2011 to 15% in December 2013. Nonetheless, this is significantly lower than the proportion of investors which target value-added, opportunistic and core funds, with 49%, 45% and 43% targeting these strategies in the next year respectively. As such, fund managers currently marketing debt funds have a smaller pool of investors to target, and with a large number of debt funds now in the market, competition is high. Additionally, investors will often look to invest in fund managers with proven expertise in making debt investments. Only a limited pool of managers currently possess a track record of managing real estate debt funds.
A significant 49% of aggregate capital sought by debt funds in the market is by fund managers with no prior experience of raising a debt fund, and 37% of capital sought by funds in market is by fund managers with experience of raising and investing one to two prior debt funds. With investors increasingly seeking to place capital with experienced managers, it is likely that those that can demonstrate particular debt-focused real estate experience will be best placed to quickly attract significant levels of capital for their latest debt vehicles.
Going into 2014, the large number of new fund managers that have launched new debt offerings, particularly in Europe, has led to a crowded and competitive market.
Although a growing proportion of investors are targeting real estate debt funds, the strategy is still relatively new to many of these institutions. This means that a large number are still not expecting to commit capital to funds focusing on debt opportunities. Nevertheless there are many fund managers and institutional investors that believe there are attractive opportunities to invest in debt and a significant amount of capital is likely to be raised by real estate debt funds in 2014.
Andrew Moylan is head of real asset products at Preqin