The traditional classification of offices, retail and industrial as the ‘core’ commercial property segments and everything else as ‘alternatives’ is looking increasingly outdated.
Across European markets, real estate investors are adding non-mainstream assets to their portfolios. Demographic trends and changes in end user demand are giving rise to a structural shift in the real estate sector. The continent’s ageing population is creating a need for a greater variety of care homes, while the undersupply of housing in some areas, coupled with rising expectations of the quality of rental accommodation, is fuelling the development of build-to-rent apartments.
The days are gone when hotels were considered to be as ‘alternative’ as property investors and lenders were prepared to go. As the real estate rulebook is rewritten, the so-called alternative sectors will feature more prominently in investment and lending strategies. This will require a greater appreciation of the nuances of individual property types, rather than simply lumping them together in the ‘others’ category.
Data published this week highlighted buyers’ willingness to invest outside the mainstream. Cushman & Wakefield reported that investment in alternatives such as hotels, residential property and care homes had reached a record 42 percent share of the overall UK market during the first quarter of the year, with £4.7 billion (€5.3 billion) invested. According to Knight Frank, investment in the country’s purpose-built student accommodation, investment-grade private rented housing and senior-living rental sectors is expected to reach £87.3 billion this year, rising to £146 billion by 2025.
The topic of lending to alternative sectors ran through the panel discussions at the Commercial Real Estate Finance Council Europe’s Spring Conference, which took place in London on 16 May. As one debt fund manager at the event pointed out, there is a huge amount of capital – both debt and equity – focused on the core property segments, while the availability of finance elsewhere becomes patchier.
To a degree, there is a late-cycle dynamic at play in the increased focus on alternatives. A lack of supply of core assets, and the consequently high prices for those that are available, will encourage some capital providers out of the mainstream. However, the structural shift in real estate means there are deeper reasons for the rise in alternative investments. An increasing number of real estate investors consider the purchase or development of alternative assets as a canny bet on the types of property that are likely to attract future demand.
The imbalance in the demand and supply of debt in Europe’s micro-sectors presents a compelling proposition for those lenders with a greater-than-average risk appetite. Debt specialists at the CREFC conference noted the high cash-on-cash yields that assets from alternative sectors can produce.
They also recognised that financing alternative assets requires an understanding of the drivers of demand for each sub-sector. This in turn means prospective investors will need to gather data on relatively illiquid parts of the market. The ability to structure a loan to account for the operational nature of many alternative assets will also be crucial. Some attendees at the conference spoke of the need to take a quasi-corporate finance approach to assets and base their loans on the covenants of the operators.
Financing alternative assets will be a central theme in the autumn edition of Real Estate Capital, and we welcome insight from lenders and borrowers on how best to approach such sectors from a debt perspective. As the real estate industry evolves, these assets will come into greater focus for investors and lenders alike.
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