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How real estate debt has performed this cycle

AEW's analysis of 970 European real estate loans written since 2003 demonstrates a widening range of pricing as the market has developed.

European real estate loans were generally priced within a relatively narrow range before the onset of global financial crisis in 2007. However, the more diverse composition of the post-crisis lending industry and the more precise pricing of risk have resulted in a wider range of all-in pricing in the years since.

This was among the findings of an analysis, conducted by real estate investment management firm AEW, of records which detail the terms of 970 individual real estate loans originated between 2003 and 2018 inclusive.

Hans Vrensen, head of research and strategy at AEW, said the analysis was the first time individual contracted loan terms had been analysed and published on such a scale in Europe.

The data were compiled by extracting the initial loan pricing from individual loan records, including: 460 published by data provider Real Capital Analytics covering 2003 to 2018; 384 collected by AEW and the debt fund management business of AEW and Ostrum Asset Management covering the same period; and 126 collected by Real Estate Capital from the start of 2016 to the end of 2018 as part of our Lending Data downloadable database.

Vrensen said the widening of the spread of all-in interest rates – margin plus the five-year swap rate – in the primary origination market demonstrated the impact of quantitative easing policies between 2009 and 2012.

“It also shows the period of high activity in the 2005-07 period, when lenders did not differentiate loan pricing much across the risk spectrum,” said Vrensen. The range became tight in 2006 and 2007, as competition was at its fiercest level during the last cycle, with CMBS lenders particularly active. However, the five-year swap rate was higher than in recent years, which meant higher all-in pricing.

“In the immediate post-crisis era, during 2008-12, our data confirm that little new lending was done as most existing loans were extended,” said Vrensen. “After 2012, our data indicate a wider range of primary interest rates, as lenders priced risk more precisely.”

Vrensen also plotted the returns performance of private real estate debt against listed real estate bonds – including CMBS and bonds issued by REITs – and corporate bonds, to explore, from an investor perspective, the differential between the debt products from 2009 to 2018.

“Since around 2015, REITs have been able to access very low pricing in capital markets,” he said. “This explains why listed real estate bonds have generated a lower return for investors than private real estate debt investments since then.”

However, both types of real estate debt instrument have outperformed listed corporate bonds. “This is largely due to the very large global investor base for corporate bonds bidding up prices and keeping returns modest,” Vrensen explained. “Despite their mostly secured credit quality, private real estate debt and listed real estate bonds require more work and specialised know-how.”

Further analysis showed private real estate debt to be a more volatile asset class than listed real estate or corporate bonds over the 10 years to 2018. The upside and downside spikes of private real estate debt were recorded at 11.7 percent and -7.9 percent respectively.

“This higher level of private real estate debt volatility is directly linked to the primary nature of the data, taking into account all-in interest rates for newly originated loans in each quarter, instead of a series of bonds over a longer period,” explained Vrensen.

“The fluctuations in real estate loan pricing reflect that this was a period during which the market was subject to change. Lenders were dealing with new regulations and new entrants came into the market with differing costs of capital.”

AEW also combined fixed-income and equity asset total returns data to show the correlation coefficient between asset classes. Vrensen said that both private real estate debt and private real estate equity offer cross-asset investors potential diversification benefits from their low or negative correlations with other investments.

“Most investors in real estate equity are alternative investors, so benchmark themselves against equities rather than bonds. It is logical that private real estate equity is the best option for diversification.”

However, he added that private real estate debt’s low or moderately negative correlation with other investments showed it was an option for investors to diversify their portfolios.