Rising interest rates and likely increases in loan margins will support growth in whole loan returns in the European property market, according to Sam Mellor, head of Europe and Asia-Pacific real estate debt at investment manager Barings.
The manager, a subsidiary of US insurer MassMutual, this week announced it has raised more than €650 million of investor capital for its European whole loan strategy, which comprises a mix of separate accounts and commingled funds. A mandate from a Nordic pension and insurance client accounted for €300 million of the newly raised capital.
Mellor argued that market conditions support the strategy, through which Barings plans to provide unlevered, floating-rate whole loans secured by core-plus and value-add property.
“Given the rising rate environment and expectations of widening spreads, we expect total returns for the whole loan space to be positively impacted,” Mellor said.
“The changing market fundamentals are enabling the team to be more selective in approaching deals, with the ability to achieve more attractive pricing for lower risk, core-plus assets, or achieve higher absolute returns for loans where the underlying properties have a significant business plan.”
Barings is mainly targeting its preferred sectors of logistics, office and residential – including student housing, build-to-rent and private rented sector housing. It will target the UK, Germany, Spain, the Netherlands, the Nordic region, Ireland and France.
The firm will typically target stabilised loan-to-values ranging from 50 percent to 65 percent, but it can invest in loans of up to 75 percent loan-to-cost.
Mellor said a lack of competition from banks in this part of the market is resulting in attractive spreads and risk-adjusted returns. “Banks are being increasingly deterred from providing real estate loans as a result of higher capital charges imposed by Basel III regulations, with capital charges rising as the lender takes more business plan exposure at the underlying property level, creating more opportunities for alternative lenders such as Barings.”
He added that sponsors with ESG-focused business plans are a key source of demand for the strategy. “The majority of the loans we invest in will include ESG improvements as part of the business plan. We are dealing with institutional sponsors who are seeking excellent ESG outcomes for their investors and so are aligned with our counterparties.
“Loans that have capex as part of the business plan will be underwritten with allowances for increases in costs. In these current inflationary times, the team is using real time data from our broader platform – where we are developing projects as a principal – to ensure our cost inflation assumptions are conservative.”
Mellor argued that the strategy can withstand the current economic uncertainty. “We believe our strategy is well positioned to weather periods of inflationary pressure and a rising rate environment due to several factors. We invest in floating rate loans and will therefore have low interest sensitivity – as base rates rise, so do total returns. Furthermore, our strategies are unlevered, and we target sensible stabilised LTVs to ensure we have significant downside protection against the risk of price volatility in capital values.”
He added that it is a good time to be a lender in the whole loans market. “Real estate debt offers the potential for strong downside protection coupled with rising base rates and total returns. The whole loan strategy provides exposure to real estate markets and is an alternative to a more traditional fixed-income allocation.”
In 2021, Barings wrote 14 loans with a total volume of around €1.1 billion across its debt strategies in Europe and Asia-Pacific. It almost doubled its loan commitments to more than €3.4 billion in assets under management.