AXA IM Alts: Taking a holistic view on real estate debt

Global head of CRE private debt Antonio de Laurentiis explains how AXA IM Alts has adapted its deployment strategies to meet risk/return expectations amid market volatility.

In 2005, AXA IM Alts (formerly known as AXA IM – Real Assets) was the first non-banking institution to enter the European real estate debt market. The debt platform is now global, managing more than €24 billion of assets under management and raising €23.6 billion over the last five years, positioning the business as the largest commercial real estate debt fundraiser in the world over the past five years.

The real estate debt team is part of the AXA IM Alts group, which has €188 billion of AUM globally, including €88 billion of real estate and €84 billion of private debt and alternative credit.

According to Antonio de Laurentiis, global head of CRE private debt, real assets, being agile, proactive and assessing relative value in a wider real estate and fixed income investment context is crucial to managing a successful lending strategy.

Amid challenging market conditions, de Laurentiis argues it is essential for real estate lenders to adapt their deployment strategies, with a focus on debt yield and megatrends such as urbanisation and decarbonisation.

What do you see as the major challenges facing alternative lenders?

Antonio de Laurentiis, AXA IM Alts

We are in an environment where you need to anticipate and not react. And that means you must have a long-term, look-through approach to the cycle. We start with a top-down assessment of which asset classes will be more resilient than others to the inflation and volatility we have in today’s market.

Identifying that resilience comes from our conviction in the importance of four main megatrends. The first is urbanisation, which is a key driver today for the residential sector in all its forms. The second is the ageing of the population, which is independent of the economic cycle and supports sectors such as life sciences.

The third is digitalisation. We have seen how during the pandemic people have been shopping more online, supporting the logistics sector. But it also supports data centres, which is another asset class where we are seeing growth in demand.

The fourth megatrend, which encapsulates all of them, is decarbonisation. On the one hand, it presents risk because you need to look at your portfolio and address obsolescence, the capex required and changing regulations. But ESG is also an opportunity because the sectors that are the most ESG-efficient will be the most resilient and demanded by both tenants and investors.

There also needs to be a bottom-up approach because the real estate sector is so complex. You need to go into the details of each deal; it is important for an alternative lender to combine a fixed income-like market approach with a real estate investment mindset.

One of the advantages we have as part of a big real estate player is in our market knowledge from people on the ground who let, develop and sell assets. If you are anchored in the industry, you can better understand and anticipate the realities of the assets and not only rely on third-party valuation reports. Proximity with the tenants, developers and construction companies enables us to anticipate increasing development costs, for example, even before they are reflected in the valuations.

How are you adapting your approach to deploying investor capital amid changing market conditions?

We remain consistent in the way we underwrite deals, and we have always been a big advocate of looking at debt yield, rather than only at loan-to-value, because it is a good measure of assessing the long-term sustainability and resilience of cashflow and comparing debt levels vs historical metrics.

But we are increasingly focused on creating value-add and rental growth by positioning our lending more towards development or taking some letting risk. For example, we are providing a €300 million financing to a logistics portfolio in France that consists of a mix of new assets, speculative developments and pre-let developments. We are taking letting and development risk, but we think it is still prudent considering the mix of the portfolio.

“We are financing assets that will be new, on long-term leases and that are ESG-efficient”

Another way we are adapting our lending strategy is with a greater focus on obsolescence, which is linked to decarbonisation in the sense that we need to finance the long-term assets of the future, and that must mean they are ESG-compliant. When we finance older assets, we are increasingly factoring in the likely refurbishment costs or capex in our underwriting. We are not looking for sponsors that just sit on their portfolios and collect cash because all sectors are becoming more and more operational.

This is obvious in asset classes like hospitality, but even offices have more short-term leases now – you are not only buying into leases, you are also buying into the tenant’s operational performance and the capacity of the sponsor to attract and retain tenants.Ultimately, we are financing assets that will be new, on long-term leases and that are ESG-efficient. In five years, we will feel much more comfortable refinancing those kind of assets versus financing a portfolio that is perhaps fully income-producing from day one, but at risk of obsolescence and lease maturities. To mitigate the effects of inflation, you need to have that long-term approach.

What does an alternative lender need to offer in today’s marketplace?

Agility – the capacity to have dynamic allocation. Our job is to assess relative value and build a portfolio with attractive risk-adjusted returns.

You should be able to play the real estate cycle in terms of geographies by moving your focus from one country to another as a function of the cycle. There are some asset classes where you want to be more prudent and wait to see how the equity markets may do before entering on the debt side.

You must also have the capacity to stop and go as a function of where you see value. Being a very big global player offers this capacity because you are active across jurisdictions and can move your allocation across them. There are some assets where we see more relative value as a debt vs an equity play at this stage of the cycle.

Agility also requires taking a 360-degree view of the asset class. Generally, when investors such as insurers or pension funds come to real estate private debt it is mainly as an alternative to fixed income. Alternative lenders need to have an eye on what is happening in the public markets. If the public market is telling you there is a massive repricing, you cannot pretend that nothing is happening. That is why working with your fixed-income team is important.

But real estate is a very inefficient market – it is complex, illiquid, and not transparent. Our job as an investment manager is to see as many deals as possible and choose the best ones. One thing investors will always demand is very rigorous underwriting because managers are here to keep and hold our positions, and in the worst case, even to manage the assets in the unfortunate event that we need to take over the properties. And that goes back to the difference between financial services players and alternative lenders, and why we decided at the outset to put the debt platform within the real estate department.

How are your lending strategies changing in the current market?

When some logistics properties are trading at 3 percent net initial yield and interest rates rise, the reality is that if you want to use leverage then you have a cap on LTV, which is probably much lower than some borrowers had expected before. If the yield is 3 percent and the debt cost is 3 percent – interest rates plus margin – then we will need to take all this into consideration.

I advise our investors to look at sectors like logistics through a slightly different lens. Is it not better to take a little development or letting risk? On day one it looks like additional risk, but in the long term it will deleverage your transaction and you can still have a pricing premium. That kind of risk does not necessarily mean higher leverage, but requires a better understanding of the deal, which is why you need real estate experts behind the financing.

With a sector like hospitality, assets are benefiting from the reopening of the borders and people’s renewed appetite to travel. But you need to factor into your underwriting that if there is a slowdown of the economy, people may travel less often. It comes back to which hotels are best performing and the location, and that comes back to selectivity.

It is the same for retail. Not all retail is dead. There is some very good high street retail in continental Europe where rental levels and valuations are satisfactory. But you probably want to be prudent and leverage them at a lower level than you were doing pre-covid and asking slightly higher pricing. It is not black and white.

However, we will never sacrifice location. We never go to secondary locations – even when the market was topping out two or three years ago – to look for additional spread. We prefer to remain in prime locations and eventually take a little letting risk. And that has proven to be a good strategy given the widening pricing differential between prime and secondary.

Because we are focusing on prime locations, it does not mean that we only do core deals. We can do core, core-plus, value-add and development – but in the right location and with the right sponsor. And it has to be with the right ESG strategies because, for us, ESG is not only a question of reporting but a key underwriting element of all our investments.

In terms of selection, what we try to avoid is binary risk. With a five-year financing and an eight-year income from a single tenant, the risk is very binary, because if the tenant leaves you are caught out. We prefer multi-let or portfolios. Diversification is key.

Going deal by deal

Unlike several years ago, there is no obvious answer to where the most attractive risk-adjusted returns lie in the current market.

AXA IM Alts’ Antonio de Laurentiis increasingly sees real differences between prime and secondary deals emerging, unlike before covid, when there was a convergence in pricing.

“Today, you have defensive asset classes like logistics and residential where everybody wants to invest, and on the other side the offensive asset classes like office, retail and hospitality, where people are more cautious,” he says. “We see them all as tiered markets.”

But the reality is more complex and requires nuances. He observes that investing is more complex now because defensive asset classes can be overpriced or loan structuring can be very weak. On the other hand, there can be attractive pricing in offensive asset classes with entry points because the valuations have been rebased and leverage is lower.

“Once you define your megatrends you really need to go into the details, deal by deal.”