Almost €10bn has been raised over the last three years across 19 senior, mezzanine and separate account European-focused debt strategies, according to new research by INREV, although the environment for capital raising is proving increasingly difficult.
Around half of this total – €4bn to €5bn – has been raised by senior and mezzanine funds, but this is just 50% of total fund target sizes, while an additional €4bn to €5bn has also been raised by fund managers for separate accounts, according to INREV, in its just-published 31-page research paper released today.
Within the 19-strong combined European senior and mezzanine debt fund market, seven debt funds focus only on senior loans and have an aggregate target raising of €6bn, while a further 12 offer a combination of whole, mezzanine and subordinated loan strategies, with a total final raising of between €3bn and €4bn. See at end of story for INREV’s table.
“Although these figures appear to reflect a growing market, both fund managers and investors have indicated that the capital raising environment remains very challenging,” wrote INREV, adding that a number of funds have cancelled debt fund plans “as they were not confident that they could deploy the capital at the promised returns”.
Ingo Bofinger, head of real estate at Gothaer Asset Management, said: “Debt funds help us to diversify and spread risk across our total investment portfolio and because we entered the market early, we now have a clearer view of its potential.”
Investors’ primary concern about debt funds is the lack of fund managers’ track record.
Vitaliy Tonenchuk, senior research and database manager at INREV, said: “Although there is a limited history around debt fund activity, fund managers should still try and disclose as much as they can on past deals to re-assure investors they are capable of running debt funds.”
In its report – entitled European Real Estate Debt Fund Study – INREV, the European association for investors in non-listed real estate sector, interviewed 23 major debt fund managers, debt investors, advisers, as well as new insurance lenders and has crystallised several defining themes on a market amid a permanent structural change.
INREV wrote that DTZ Research’s estimated €1trn in European real state debt which matures over the four years, inclusive of 2012, to the end of 2015, has given rise to a prolonged opportunity for new lenders – unconstrained by regulatory burdens which has seen banks retreat.
The actual difference between the refinancing need and the available capital from lenders and equity holders – the debt funding gap – is difficult to determine as it is unknown how much of the €1trn of debt will be extended, or purchased by lower or non-leverage requiring buyers.
Based on different research studies, INREV wrote that is estimated to be around €200bn over the next two to three years, while other market participants believe the real figure in hindsight will prove to be substantially lower.
INREV points to two distinct approaches to debt financing. Higher-risk subordinated debt strategies tend to be more suitable for pension funds that view them as a real estate investment, while senior and whole loan strategies are viewed as lower risk and fit into the fixed income investment allocations for insurance companies.
Banks – which currently hold between 85% and 95% of all outstanding real estate loans in Europe’s estimated €2.5trn-sized debt market – are retreating at a time when the simple supply-and-demand dynamics have contrived to improve margins, offering attractive risk-adjusted returns with downside protection from falls in real estate values.
Senior loan pricing has increased substantially during the last five years. Loans are now priced at 250 to 400 basis points over LIBOR/EURIBOR, depending on the country, LTV levels and the type of real estate, according to INREV’s survey, while banks continue to charge between 100bps and 200bps origination fees and 100bps and 150 basis point exit fees.
Pre-crisis, subordinated lenders did not play a major role in the lending mix as banks were prepared to finance up to at least 75%–80% LTV on secondary assets and up to 95% for prime assets.
The rise and rise mezzanine lending
Banks’ scaled back appetite now on average reaches between 50%–60% LTV, INREV’s research aggregated, which explains the rise or mezzanine lenders in the subsequent four years. CBRE estimate that 100 mezzanine lenders have emerged across Europe since 2008.
According to CBRE, 54 mezzanine real estate lenders classify themselves as ‘active’ in Europe, versus 69 at the end of H1 2011. The contraction in ‘active’ lenders has however not led to a reduction in mezzanine lending levels.
Natale Giostra, head of EMEA & UK debt advisory at CBRE – which contributed to INREV’s survey – said: “The overall reduction in liquidity in the European debt markets is impacting on the volume of mezzanine transactions.
“However, it is encouraging to see growth in mezzanine lending levels as well as the continued rationalisation of the market towards a core of committed lenders. As many mezzanine transactions remain confidential, we expect true activity levels to be substantially higher.”
INREV estimates 11 large insurance companies are currently active in European debt financing. Last year in the UK, insurance companies provided an estimated 15% of all real estate loans – within five years this is expected to grow to 30%. See at end of story for INREV’s table.
DLA Piper, the global law firm, published separate research last week which suggested that insurance companies will increase UK commercial real estate lending by £28.1bn over the next five years bringing their total CRE lending stock to £52bn by 2017.
This equates to £5.5bn in annual lending by insurance companies up to by 2017, with the majority of loans across seven to 10-year maturities – sourced from annuity policies sales –at between 50% and 65% LTVs.
Simon Cookson, partner and UK head of real estate at DLA Piper said: “We expect insurance groups firmly to establish their position as lenders, and once they have put in place the requisite in-house infrastructure and expertise, insurers’ provision of CRE lending should continue to expand into the market recovery.”
More commonly CMBS bond investors through fixed income allocations, pension funds are expected to become direct investors in debt funds into next year, wrote INREV.
Pension funds are expected to be subject to similar capital requirements that insurance are experiencing under Solvency II through the Institutions for Occupational Retirement Provision (IORP) Directive. “This means that regulation could also drive a change in their investment patterns which could prompt more allocations to debt investment,” explained INREV.
A number of pensions fund that were interviewed for INREV’s report indicated that investing into real estate debt “is becoming an increasingly interesting option but they do not expect increase their allocation substantially in the near term”.
According to INREV Investment Intentions Survey 2012, real estate debt funds are the most popular mandate among the alternatives investments for investors and fund of funds managers. Around 41% of investors said that they are likely or very likely to make an investment in real estate debt funds in 2012 and 2013.
AEW Europe estimated the aggregate likely participation by insurers, pension funds and debt funds in senior debt over the next five years at a combined €33bn annually.