During the pandemic, several property types that were once viewed as alternative or niche have emerged as favourites among institutional capital.
Specialised strategies such as senior housing, student accommodation and data centres were budding in the UK before the covid-19 outbreak, as well as, to a lesser extent, in continental Europe. Since then, those and other cutting-edge property types have established a foothold in the region and are well on their way to becoming mainstream real estate investment schemes, as they are in other parts of the world.
Last year, Real Estate Capital Europe tracked 30 major loans in the UK and continental Europe related to student accommodation, age-based housing – ranging from general retirement communities to more specialised care facilities – healthcare-orientated properties, data centres, research laboratory space and movie studios. That is more than the previous two years combined.
By 25 July, Real Estate Capital Europe had tracked a dozen such transactions this year, a slower pace than 2021, but still on track to finish well ahead of any other year on record. Real Estate Capital Europe’s database is not an exhaustive accounting of the European real estate debt market, but it indicates the direction of the industry by capturing the biggest transactions. In this case, the trajectory of the alternative property market is decidedly on the rise.
Following good advice
There are myriad factors contributing to the rise of these specialised properties, including demographic shifts and technological advancements. But, ultimately, much of the credit goes to the early success stories and the more accommodative capital markets that have sprouted up in their wake.
Major transactions that have closed this year include HSBC and Investec’s £700 million (€831 million) loan to UK-based Ark Data Centres for several data centre development projects in the country, and London-based investment firm Cain International’s £260 million loan to Shinfield Studios to finance the construction of a film studio in Reading, UK.
Lenders’ embrace of alternative property types did not materialise out of thin air. Debt advisers have played an integral role in this maturation process.
“Advisers can be invaluable, particularly in the sectors in which we are active, a lot of which are nascent, in terms of augmenting our relationships that we have in-house,” says Josh Miller, head of European transactions for Harrison Street Real Estate Capital, a Chicago-based alternatives specialist that has been in Europe since 2015. “Across all three of our funds, we have used debt advisory firms and they do a great job, frankly.”
Like Harrison Street, many early market movers in the UK and Europe have been US firms looking to expand their footprint, or global groups adapting strategies from other parts of the world, notes Maud Visschedijk, regional head of equity, debt and structured finance at services firm Cushman & Wakefield.
While these groups may have had strong track records in other markets, local lenders often lack comparable deals in their home markets to underwrite loans with viable terms. This is where a knowledgeable adviser can make all the difference, Visschedijk says.
“Something that clients really appreciate is that we help them bridge the knowledge gap that still exists,” she says. “We have specialist teams and we have a lot of data, so by educating lenders we can create liquidity for them, so they can do better deals.”
In continental Europe, these situations often come down to explaining why a piece of property is worth more than the sale price a typical buyer – or the rent rate a typical tenant – would be willing to pay for an asset, Visschedijk notes. Many cutting-edge property types – especially those broadly classified as residential, as well as specialised workspaces like research labs – derive their profits from their operating components, typically by providing a premium experience.
“For those specific asset classes, where you really need to understand the value of the operations behind the real estate, we really add value by educating lenders,” she says.
Andrew Wilson, managing partner of the London-based firm Bayhead Advisers, notes that many of his alternative real estate assignments have been focused on data centre projects, a subject he has direct experience with operationally, not only from a real estate perspective.
Wilson was hired as the chief financial officer of data centre operator Global Switch in 2002 in the wake of the 2000 collapse of the dotcom bubble. He was elevated to chief executive two years later and returned the company to profitability by 2006. The sector has evolved since then, Wilson says, but its driving forces – chiefly the consumption of online content and the need for more data storage capacity – have only accelerated.
Still, many lenders were initially hesitant to invest in these types of assets because they are so technical and operationally complex. But Wilson believes that assumption misconstrued the true appeal of the product.
“Once a tenant moves in, it is quite expensive in terms of the equipment they put in, and logistically difficult to move out again,” he says. “Data centres have a high customer retention level. Some of them may be short-term agreements but, ultimately, they are quite sticky.”
The largest data centre markets in Europe are Frankfurt, London, Amsterdam and Paris, according to a first quarter market report from the real estate services firm CBRE. During the first three months of this year, London and Amsterdam saw the greatest growth in capacity, adding 46MW and 11MW, respectively.
Wilson says there is a growing appetite among lenders to back data centre assets outside major cities, where land is more favourably priced, but some lenders maintain strict geographical restrictions. Even within the UK, some London-based firms are unwilling to lend in Scotland or Northern Ireland, he notes.
“There is just that realistic, boots-on-the-ground factor as to whether they are going to start diversifying geographically,” he says. “If they go quite wide, it becomes more difficult to lend and manage.”
Some lenders need to be presented with several opportunities before they understand the fundamentals of certain emerging property types, Visschedijk says, adding that by the second or third presentation, most lenders can grasp the appeal.
Still, some large lenders are not equipped to operate in these spaces. German banks, Visschedijk notes, base their underwriting on the mortgage lending value of a property, a conservative principle that prohibits the inclusion of anything that could be deemed speculative. This means borrowers with novel real estate strategies are out of play for them.
Because of this, many of the most active lenders for cutting-edge property types in Europe are global investment banks such as HSBC, Deutsche Bank and Citi, Visschedijk adds, because they already have exposure to these strategies in the US and elsewhere.
The story is a bit different in the UK, which embraced alternative real estate strategies earlier than its continental counterparts. This disparity is evidenced in Real Estate Capital Europe’s database, which only tracked 10 significant loans related to cutting-edge property types in continental Europe between 2017 and 2020, compared with more than 40 such transactions in the UK.
Because alternative property types have a longer history and more comparable transactions to set pricing against, Edward Horn-Smith, managing director of the specialist debt advisory Arc & Co, says finding interested lenders has become less of a challenge in recent years.
“We have seen the first few lifecycles within most of these alternative sectors and as a consequence of that, we have the professional capacity within the various sectors to be able to manage risks,” Horn-Smith says.
The most mature emerging property type in the region is student accommodation, which accounts for nearly 60 percent of alternative loans tracked by Real Estate Capital Europe since the beginning of last year. Most of these assets are in the UK. Unlike other institutional property types, which are clustered around London, notable transactions have taken place throughout the country, in regional hubs such as Liverpool, Edinburgh and Cardiff, as well as university towns such as Guildford, Coventry and Nottingham.
“PBSA [purpose-built student accommodation] is undoubtedly one of the biggest, strongest sectors in the UK over the last three years,” says Horn-Smith. “Covid impacted that to a certain extent, but we have seen it come back with a vengeance.”
Miller says the student accommodation ecosystem in the UK, from lenders to developers to institutional buyers, is second only to the US. In continental Europe, he has seen demand for these assets surging in southern Europe, particularly Spain, Portugal and Italy.
Residential strategies broadly, including senior living and purpose-built rentals, are on the rise in most of the major markets in Europe, Miller notes, as are life sciences labs. Overall, the region has a long way to go to catch up with the US, but he expects the learning curve to be much less steep.
“The UK and Europe may mature faster than the US because now there is a bit of a roadmap,” he says. “Over the last couple of years, there has been a significant quantity of capital that has been raised on the equity side and on the debt side, to pursue opportunities in these alternative sectors. So it may be a shorter process from start to finish.”
Debt advisers in the region are striving to make that catch-up period as short and painless as possible. But doing so requires them to stay on top of an ever-evolving real estate capital landscape, Wilson notes.
“The role here for finance advisory providers is really to do the legwork on who is active and lending in the market, in what sectors – and that is an ever-changing piece [of it],” Wilson says. “They are constantly changing their appetite criteria.”