PERE Europe 2023

As real estate equity markets reprice, and with lenders exercising caution amid rising interest rates, investment managers are increasingly viewing debt as an attractive opportunity.

During the PERE Europe Forum in May, hosted by Real Estate Capital Europe’s affiliate title PERE, equity-focused managers frequently raised the topic of credit.

“Retraction is happening at this moment in time,” said Sophie van Oosterom, global head of real estate at UK asset manager Schroders Investment Management, during the opening panel of the three-day event in London. “Banks are stepping back, no longer willing to engage.”

Van Oosterom’s comments echoed the findings of the European Central Bank’s lending survey for the first quarter of 2023, released the week before, which showed a substantial tightening of credit standards for loans or credit lines to businesses. It also predicted a continuation of credit tightening for the second quarter. But the opportunity for alternative providers in private debt, said van Oosterom, is not simply to supply capital but to bring expertise in real estate and an understanding of how to create value.

“We are really thinking about how to drive income… and apply that approach on the debt side as well,” she explained.

Jay Kwan – head of Europe at Canadian manager QuadReal, which formed a partnership with development lender Precede Capital Partners in January – agreed. “Private credit is very interesting to us right now. We have a large lending business in North America, and we just started one here in the UK.”

Kwan reasoned that while it is possible to make value-add returns on both sides of the Atlantic, debt was a “compelling argument”. A value-add deal can generate a 13 percent internal rate of return based on 50 percent leverage, he said, adding: “I could do mezzanine financing, make that same 13 percent and I just need to know that my last dollar won’t be lost unless yields blow out beyond 6.5 percent. And then the money goes out for three, four years, comes back and the equity markets may give more clarity by that point.”

James Boadle, managing director at Oxford Properties, hinted at the Canadian manager’s intentions for Europe. The firm in March hired former Bank of America director Tina Pristovsek as vice-president, real estate finance and capital markets for Europe.

The overall strategy for the business, Boadle said, is finding the best use of capital in an environment of inflation and rising cap rates, with debt as one option. “We believe in credit, we think it makes attractive risk-adjusted returns.”

Tony Brown, global head of M&G Real Estate, part of a business with a longstanding European debt arm, said lending was a “short-term play worth investigating” for would-be lenders: “You can get equity-style returns from credit right now, so that seems an obvious area where increased allocations are likely to flow, certainly over the near term.”

Later that day, Ben Eppley, partner, real assets at US private equity firm Apollo Global Management, told the audience that institutional investor interest in debt was such that, despite having built the debt business – which comprises a €9.4 billion European loan book – from its own balance sheet, the company was considering raising third-party capital.

Mixed blessings

Eppley was on stage with other lenders who gave further insight into the ups and downs of growing a lending business in today’s environment. Ellis Sher – chief executive officer and co-founder of Maslow Capital, a London-based development finance lender – also foresaw borrowers coming under pressure due to persistent inflation and reported it had been already “wreaking havoc” on borrowers’ profits. Sher cast doubt on the idea that the Bank of England’s 25 basis points increase in interest rates in May – its 12th consecutive hike –  could be its last.

“It doesn’t feel like interest rates are going anywhere other than up and interest rate [rises] have so far only [had] a modest impact on inflation. How do you get inflation down if rates stay at 4 or 4.25 percent? I wouldn’t be surprised if, a year from now, they are at 5.5 percent.”

Economic conditions mean Maslow’s IRRs have increased by up to 300bps. “Our investors expect to have a premium above the risk-free rate, otherwise why would they give us their capital?” said Sher. But despite that kind of return, the lender has no plans to move into more highly leveraged deals.

Deploying capital, speakers said, is not straightforward. Sher reported difficulties with issuing capital in sub-£50 million (€58 million) deals because “smaller developers are really struggling through no fault of their own”. He added that the lender’s average ticket size has increased as it seeks to focus on larger transactions, while also financing smaller developers with loans that support sponsors’ schemes to completion.

Daljit Sandhu – co-founder and chief operating officer of UK-based Precede Capital Partners, which also issues development finance – agreed that demand from those struggling to find capital was increasing. But those projects being proposed, she explained, are often “not viable” due to the cost of debt and costs of construction.

Forensic focus

Eppley disputed that active lenders are courting the same deals, despite comments on stage that lender competition for the best deals had compressed spreads. “While it is a fragmented market, it’s not the case [that] all of us are… trying to win the same deals, and we see that on the borrowing side.

“For a sub-£100 million deal seeking 50 percent LTV, you see the clearing banks and German lenders. For transitional lending or development finance it is an entirely different group of lenders. And then, for specific [asset] categories, it gets even more niche. We might take a different view than others on residential, for instance. So, there is liquidity, but it isn’t uniform.”

Jonathan Jay, partner at Conduit Real Estate, a debt adviser, agreed that the market is liquid. “There’s definitely debt available,” he said.

However, he added, what lenders were offering was not always accretive to borrower’s returns: “Either lenders are going to have to change pricing, or the borrowers are going to have to change their expectations.”