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Debt funds are not one-cycle wonders

Investors remain keen on real estate debt, as recent fund closes, including more than £1 billion for PGIM Real Estate, demonstrate.

Investors remain keen on real estate debt, as recent fund closes, including more than £1 billion for PGIM Real Estate, demonstrate.

PGIM Real Estate’s close of its sixth European property debt fund on more than £1 billion serves as a reminder that investors continue to demand access to private debt investments, including real estate debt.

Pramerica Real Estate Capital VI’s investors included public and private pension funds, sovereign wealth funds and insurance companies from the Americas, Europe, the Middle East and Asia-Pacific, according to the firm.

When the first wave of real estate debt funds was raised earlier this decade, there was much debate as to whether they would be a flash in the pan. Some argued that as banks continued to hold back from financing European property, opportunistic managers were raising capital on the promise of high returns in order to take advantage of a temporary gap in the market. For others, the emergence of private property debt funds marked the start of a gradual shift in the make-up of Europe’s real estate finance market to more closely resemble the US sector, in which banks have long been only a part of the picture.

Ongoing debt fundraisings, several by companies which have now built a track record and are raising follow-on capital, suggest longevity in the real estate debt fund market. Real Estate Capital data as at the start of May showed there were 27 debt funds with known targets above €100 million actively fundraising for European strategies, seeking an aggregate of more than €14 billion.

This week, one of those funds announced a final close. Omni Partners’ Omni Secured Lending III raised £340 million (€402 million), a significantly higher total than its two predecessor funds. There are also suggestions of new entrants into the space. BNP Paribas Investment Partners, for instance, is one big brand planning a debt strategy.

For the UK market at least – where the majority of Europe’s property debt funds are based – De Montfort University’s latest CRE lending market report, released last week, provides some context. ‘Other non-bank lenders’, as the research terms those alternative lenders that are not insurance companies, were the only category of lenders (aside from UK banks and building societies) which enlarged their market share of outstanding loans during 2016, from 7 percent to 8 percent.

They remain a small part of the market. The ‘other non-banks’ originated £4.4 billion in 2016, according to De Montfort, dwarfed by bank origination at £35.4 billion. However, pre-2008, 95 percent of lending was done by banks, whereas 23 percent was by non-banks in 2016.

As long as interest rates remain low and institutional investors require a stable source of additional yield, their demand for real estate debt will remain high. However, it is becoming more challenging for debt fund managers to deploy capital as the cycle progresses. Some managers complain about the ongoing task of recycling capital from vintage funds as original loans repay; hitting return targets which were agreed three or more years ago is almost impossible, unless risk parameters are drastically altered.

But there is a belief among debt fund managers that there is life in the credit cycle yet, with underbanked segments of the market still ripe for alternative lenders. For some, that means continuing to seek out high-yield opportunities; PGIM Real Estate’s latest fund is seeking double-digit returns for whole loans, mezzanine and preferred equity. For others, the emphasis is shifting towards providing safer senior debt to the mid-market where there is plenty of demand but limited supply.

The universe of European real estate debt fund lenders remains small-scale, but it continues to be subject to significant investor demand. Those that have established themselves in the space seem determined to prove that they are not one-cycle wonders.