This article is sponsored by CAERUS Debt Investments.
2022 may have been a volatile year for real estate markets as the debt funding gap widened and refinancing options started to melt away. But for Dusseldorf-based manager CAERUS Debt Investments, the year proved to be a blur of activity.
In 2022, the senior and whole loan real estate funds advised by CAERUS issued loans totalling around €290 million in a variety of asset classes and regions, including a hotel portfolio and a student accommodation in Germany, a hotel and residential development in Vienna, a diversified 51-asset portfolio and a light industrial complex in the Netherlands. To cap a successful year, the manager also won our award for Alternative Lender of the Year: Germany.
How did the economic uncertainty – inflation, rising rates, uncertainty over RE values – impact the German real estate lending market?
Michael Morgenroth: The German real estate market has been very resilient so far if we consider valuations and compare it to other European markets such as the UK or the Netherlands. At the same time, transaction volumes declined significantly as buyers and sellers have been failing to agree on market clearing prices. This will probably last for some time, if not months. Typically, in Germany you see a valuation time lag of six to nine months. With the magnitude of change we are experiencing today, that is probably closer to nine months.
A lot of buyers are reluctant because nobody wants to catch a falling knife. The changed interest rate environment also means institutional investors have alternative opportunities in other markets, especially in the liquid markets with bonds becoming an alternative again after many years.
This has led to a current reduction in investment activity by institutional investors, resulting in a lack of equity and reduced prices, which is being felt by project developers in particular. Against this backdrop, all financiers have tightened their financing conditions and equity requirements, and financing costs have risen significantly. Therefore, cash is king and we will have a lender’s market for the foreseeable future.
How is market volatility changing the types of opportunities available for non-bank lenders in Germany?
Peter Anthuber: We have seen an extremely high load of development financing requests, which historically would have been financed primarily by banks, but are today heading to alternative lenders. The leverage has reduced, and with interest rates rising the gap between the financing terms of banks and alternative lenders has really narrowed. That has improved our competitive edge. We are also talking to people that we never would have before because of the current pricing.
Previously, we had a focus on the value-add segment, but you can now see a general shift towards core/core-plus. In Germany we also see growth potential in the core segment. Because of internal ratings and requirements of underlying equity, senior bank lenders need to reduce their loan-to-value levels. This level could then be filled with a junior tranche. This is an area that we think could be of high interest.
How do you see the market for alternative lenders in Germany evolving?
PA: Alternative lending has been growing very strongly over recent years. If you look on the banking side, they have been forced to refocus because of regulations and underlying equity requirements which have opened the doors to alternative lenders.
We expect to gain further market share. If you look at the growth in Europe, you will find market penetration of alternative lenders and commercial real estate financing of approximately 10 percent. You already have approximately 30 percent in the UK and 40 percent in the US.
There is no reason why we should not reach a similar penetration rate in Germany. Institutional borrowers are attracted to private debt and clearly it is because of the funding gap.
Banks act procyclically and have reduced their appetite, while we can offer higher LTVs – perhaps lower than before the volatility, but still higher than banks. Overall, there is a higher flexibility of financing that will be provided with private debt.
How are non-bank lenders weighing opportunities in the German senior loan market versus mezzanine and junior debt?
MM: Alternative lenders are definitely looking at both. The German market is highly competitive and over-banked. But non-bank lenders are even better able to compete these days and there is noticeable growth in the whole loan and senior stretch market.
Non-bank lenders can offer a bit more on the LTV side and benefit from a strong return spread. Also, junior tranches are very attractive from our perspective due to the reduced risk compared to mezzanine financing.
On the part of borrowers, there is currently a great need for mezzanine financing. That is a difficult value proposition in the current market environment, we think. Given the valuation uncertainties, it is probably still a bit too early for this.
What are the main headwinds the industry faces in 2023 and beyond?
MM: The biggest threat is probably the reservations of institutional investors due to other alternative liquid investment opportunities. The standstill on the transaction market is reducing the number of deals and volume. The combination of price corrections and increased financing costs will also make refinancing challenging in many cases this year and next.
Due to the price corrections resulting from the changed interest rate environment, there will be consolidation in the alternative lender market, especially on the mezzanine side, and the number of mezzanine lending vehicles will likely decrease somewhat.
But where there are threats, there are also opportunities. Ongoing regulatory pressures on banks are increasing market share for alternative lenders. And while there is reservation from investors, it opens up attractive opportunities for those investors and debt providers that are willing to take the risk. They are likely to be rewarded with very attractive returns at low LTVs.
On a positive note, the market fundamentals are good and significantly better than in the last downturn. In addition, the high inflation rates are leading to significant potential for rent increases, which will reduce the interest-induced price discounts, especially in the existing portfolios.
Which sectors do you see as particularly attractive?
PA: Given market uncertainty, the trend was overwhelmingly a flight to safety and a reduction of risk in 2022. On the geographic side, in continental Europe we have seen an increased focus on Germany.
Office, logistics and residential were the preferred asset classes and there was a clear focus on quality and liquidity of assets. Hotels was another interesting one as that asset class picked up strongly after the shock of the pandemic and can adapt fastest on inflation.
Today, there are interesting new areas and niches emerging such as data centres, healthcare, life sciences and student accommodation, but the important point to add is that we do not focus on just one asset class; we are open to all so long as there are reasonable economic parameters and terms. We will hunt down and go after opportunities across all asset classes if there is the quality and due diligence on risk has been properly performed and satisfied.