Debt is an apt product for 2018

Core investors’ growing interest in providing debt rather than buying prime assets outright makes sense in this prolonged stage of the cycle.

Much recent talk in the real estate finance markets has centred on the difficulty debt providers face finding deals in a market awash with equity. There is a lot of debt out there, even if much of it is chasing similar types of prime assets in the best locations.

Put simply, the underlying proposition for real estate debt as an asset class is strong, and is getting stronger the further we go into this prolonged cycle.

The latest market survey by real estate industry body the Urban Land Institute and consultancy giant PwC – the annual Emerging Trends in Real Estate – highlighted the positive sentiment towards investing in debt. Indeed, some respondents were quick to sing the praises of investing in debt over equity.

Investors are increasingly funneling their allocations into private debt as an asset class, and a wide variety of traditional equity players in the property markets are considering turning their attentions to writing loans against properties, rather than buying the properties themselves.

Real estate debt is an asset class for the times. With property markets across Europe at, or near, their peaks, properties are fully priced in many cases. Debt can provide investors with access to the continued healthy returns still being delivered by real estate, but with an added layer of downside protection.

Property investors are now dealing with yields at record lows which, combined with low interest rates and rents relatively late in their cycle, is creating a “dangerous business environment”, as one global investment manager surveyed in the report pointed out.

Property players buying at low yields face the prospect of interest rates rising in the years to come and yields moving out, meaning their capital return could enter negative territory.

To offset this scenario, debt is rightly seen as a suitable asset class today. “You can generate great income return while protecting your capital and seeing how markets play out,” one of the fund managers that took part in the survey said.

Allianz Real Estate, for instance, is using debt as the appropriate instrument to enter the UK, due to the risk factor it sees from Brexit. Its head of European debt, Roland Fuchs, recently noted that, through a debt investment, investors can have a risk buffer if they don’t go into the 70 or 80 percent loan-to-value space.

The surge of capital raised for European real estate debt funds demonstrates growing interest in private real estate debt as an asset class by institutional investors. Capital raised in the first nine months of 2017 surpassed last year’s total, reaching €5.3 billion, according to Real Estate Capital data.

An interesting finding from the latest De Montfort University report, meanwhile, shows that the so-called ‘other’ non-bank lenders – predominantly debt funds – was the only group to increase UK origination in the first half of the year, by a remarkable 9 percent from the previous six months.

Debt funds have, therefore, proved to be functioning lenders during a tough period for the lending community, offering the flexibility that senior banks cannot afford.

With core property investors and institutional players looking to debt, non-bank debt providers are bound to keep increasing their activity. This will create an interesting dynamic in the market by boosting competitiveness among lenders, while investors can continue to benefit from this asset class amid uncertain times.

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