When global real estate services and investment firm CBRE Group announced in November that it had acquired Laxfield Capital, a London-based debt specialist, many in the industry saw it as a sign of the times.
As providing real estate loans becomes less and less the preserve of banks, organisations more used to investing in property through equity are stepping into the lending space. And for some, the most efficient route into the credit market is by acquiring a specialist business in the field.
For example, in December, Singapore’s ARA Asset Management bought a majority stake in and formed a joint venture with UK-based lender Venn Partners. Meanwhile, Savills Investment Management, the investing arm of consultancy Savills, has the option of buying the remaining 75 percent of debt fund manager DRC Capital in 2021, following its purchase of a quarter stake in 2018.
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Setting up a real estate debt strategy from scratch is not straightforward, but buying specialists in the field can provide instant expertise and access to proven investor demand. In CBRE’s case, its investment management arm, CBRE Global Investors, has operated a US debt strategy since 2010. The Laxfield team is now in place as its EMEA region credit operation. Speaking at the time of the deal, CBREGI’s EMEA chief executive and chief investment officer, Sophie van Oosterom, said the deal added “in-depth knowledge of the commercial real estate debt business, an experienced team of professionals with a longstanding, excellent reputation and strong market profile”.
At the time of the purchase, Laxfield had £818 million (€966 million) of UK assets under management. Emma Huepfl, who was part of the team that established Laxfield in 2008, says the M&A deal made sense. “There was a real eye-to-eye on investment strategy and alignment of interest in our respective plans, so the timing was good,” she tells Real Estate Capital.
Huepfl leads the team as managing director of debt investments. In addition to her former Laxfield colleagues, she is joined by Marco Rampin, who joined CBREGI from CBRE’s capital advisory arm in July 2019. Rampin – who, before his time as a debt advisor was a real estate banker for organisations including French bank BNP Paribas – is head of debt strategies Europe, a role that requires spearheading the growth of the lending business outside the UK.
Combining CBREGI’s vast real estate investment management resources and Laxfield’s specialist debt expertise makes sense, argues Rampin. “In short, you are bypassing the time it takes to get ready, go out into the market, and get investors to allocate to your strategy, because you can already tick a lot of boxes with your existing track record,” he says.
But what is it about the current European market, and where it is in the real estate cycle, that convinces organisations that there is opportunity to be had in lending against, as well as owning, real estate?
For a start, explains Huepfl, there is strong, ongoing demand from institutional investors to put capital to work in real estate debt, against a backdrop of lower-for-longer monetary policy. She explains that much of the demand is coming from fixed-income investors looking for an uplift from low-yielding corporate and government bonds. According to Huepfl, such investors include UK pension funds and insurance companies, with particular appetite currently from the UK, continental Europe and Asia-Pacific.
“[Debt] can be seen as a defensive strategy”
CBRE Global Investors
“We’re also seeing requirements for debt from the real estate side of some institutions,” Huepfl says. “It can be seen as a defensive strategy, where the outlook for property values is less clear in the current economic environment, and so debt may be a sensible way to de-risk their real estate allocation.”
Borrowers remain disciplined in their appetite for leverage, Huepfl adds, indicating that the debt market shows fewer signs of being late cycle than the equity market.
CBREGI’s UK-focused activities, built on Laxfield’s existing business, include a whole loan debt fund, capable of providing up to 75 percent leverage in loans up to £100 million, a sub-£20 million loans lending line at up to 65 percent loan-to-value, and a special situations funding business. If CBREGI’s equity fund management track record is anything to go by, however, its lending business will grow in the core and core-plus parts of the market, focused on prime locations, with potential for value-add lending deals. There may be opportunities for lenders such as CBREGI to grow in the whole loan market, providing a one-stop shop for borrowers as banks pull back.
Huepfl says investors do not necessarily approach real estate debt with a specific asset focus in mind. “Most investors come to the market working to broad yield requirements and risk tolerance, then look for a manager whose investment philosophy is aligned with their own to create an appropriate strategy,” she explains.
The opportunity for institutional investors to allocate capital to real estate debt is ultimately driven by the continued rise of alternative lenders. Banks have pulled back from the space since the 2007-08 financial crisis, in part because of tighter regulations. Now, there are whisperings that banks are lowering LTV levels further in anticipation of the implementation of the latest round of Basel banking regulations.
“With the gradual implementation of Basel IV standards, banks will face two issues,” says Rampin. “One is to resolve the erosion of equity capital from their existing loan exposures, which is something that UK banks, under their more robust risk management, have already gone through to an extent. The second is what they will do afterwards, considering that the effects of Basel IV are likely to erode further their profitability and flexibility with their lending, especially in terms of LTV and use of balance sheets.”
The obvious consequence is more market share for non-bank lenders, particularly in continental Europe. Although such lenders have provided riskier debt products such as mezzanine loans in recent years, they are gradually aligning themselves more with bank-like products.
“The scope of banks to cover the whole market requirement is definitely decreasing, and that opens up demand for different sorts of finance,” Huepfl says.
She adds that borrowers are more open than ever to approaching non-traditional lenders: “In the UK, we saw initial resistance from borrowers to taking non-bank funding or alternative finance. They may have seen it as last resort funding, but that has changed. Now, borrowers really understand what non-bank lenders do well, and what you go to the banks for.”
Some banks are even beginning to deploy capital by providing finance to alternative lenders as they dial back their direct lending and explore other ways of providing finance, Huepfl says.
Referring to his time working in the property banking sector, Rampin adds: “Before the global financial crisis, the complexity of underlying real estate was overlooked in volume mortgage lending. Financial markets practices and the real world of property became highly disconnected.”
“We need to reproduce the liquidity that capital markets have, and refinanceabilty is key”
CBRE Global Investors
CBREGI’s understanding of bricks and mortar real estate gives it an advantage in the lending space, he argues: “When it comes to debt investments, investors seek types of investment that will produce the closest return to a fixed-income product by investing where equity volatility is reduced. Our deep knowledge of the direct real estate market helps us understand which sectors and locations offer current opportunity and create these ‘sheltered pockets’.”
Rather than simply identifying certain European countries as target lending locations, the team will focus on cities or urban hubs that they believe will outperform the benchmark for the jurisdiction in which they are located. From its current UK loan book, Huepfl and Rampin are keen to see the platform expand into new markets and jurisdictions as it moves into the next stage of its evolution.
“CBREGI’s European footprint was something that was very attractive to us, because it gave us a way to accelerate a plan that we were already working on at Laxfield,” says Huepfl. She adds that the new business will also look at further UK-focused products which “don’t conflict with our existing strategies”.
Locations in established, liquid European economies will feature on the team’s radar. France, Germany and the Netherlands offer clear lending opportunities, Rampin says, with Spain, Portugal, Italy, Ireland, Belgium, Austria and Finland among other countries he mentions. “We may consider a couple of locations in central and eastern Europe – Poland and the Czech Republic in particular, if good opportunities arise – as well as other Scandinavian countries that have also shown relatively strong demand and relative stability but operate in different currencies,” he adds.
The debt team’s overarching aim is to write loans against assets that generate predictable returns over time, primarily targeting traditional sectors including offices, residential and logistics. That might mean providing whole loan products to borrowers that are underserved by the banks, Rampin says: “We need to reproduce the liquidity that capital markets have, and refinanceabilty is key.”
Although Huepfl and Rampin agree the outlook for Europe’s real estate financing markets is generally stable, they say they are conscious of potential headwinds.
“Overall, there is relatively moderate economic growth and that is not helping any investment case, so we need to be wary of that,” says Rampin. He also has an eye on political ructions which, he says, can cause hesitancy among investors, particularly those with a more prudent outlook.
But perhaps the more seismic change is the shift in how buildings are being used: occupiers’ demands, changes in the labour market and the transformation of consumer habits all affect the investment case – and alter how companies, like CBREGI’s lending business, go about underwriting their assets.
A decade ago, the main measure of underwriting was predictability of cashflow, Huepfl explains. But the landscape has changed. “Our key underwriting question now is, does this sponsor have the capability to make sure that asset is going to be relevant to its location during the life of the loan, and will the loan maintain its value at exit?” she says.
That means an acceptance that a property might not be fully leased for the duration of the loan but being confident that the sponsor will deliver its business plan.
“We start with the equity case and get to know that inside out,” Huepfl says. “We take a partnership approach: this is your equity case, and we have a base case on the debt side which will be carefully managed and covenanted to protect it. If the financing is well structured, it helps the borrower grow the value of the asset during the lifetime of the loan.”
In unproven markets, such as co-working, this could prove more difficult, she accepts. The company is unlikely to take on a borrower with no experience in a particular asset type or put its money into emerging locations with little track record.
Huepfl and Rampin are clear that the business is not there to “refinance problem loans” – which means steering clear of most UK retail properties unless the sponsor has a compelling change-of-use proposition or something similar.
“The same would apply to continental Europe,” Rampin says. “Of course, the crisis in retail is less pronounced than in the UK, but again there is ongoing structural change which could affect every other country too.”
Another key factor to consider, both agree, is clients’ increasing concern with environmental, social and governance-conscious investing. Occupiers want a building with a lower carbon footprint, and investors want to allocate capital responsibly.
Getting on board with the agenda as a lender is increasingly important, Huepfl insists: “It will go to value if a two-tier market develops between assets that are very poor in their sustainability rating and those that satisfy what the occupier and the ultimate investor is now looking for. That absolutely needs to be part of the underwriting.”
In increasingly complex real estate markets, factors such as sustainability and shifting patterns of occupier demand are now as much a concern for lenders as for equity investors. For lenders such as CBREGI’s new debt team, the challenge is to match growing demand from sophisticated investors with the finance that borrowers need today, and in the future.
Photography by Micha Theiner