Many of the sector’s established lenders can be expected to proceed with caution as the market enters its recovery phase. However, there are hopes that an overall upturn in investment will present debt providers with opportunities for higher-return lending.
Without the same constraints or exposure to legacy portfolios as the banks, this is an opportunity for alternative lenders. And they have plenty of dry powder, says Knight Frank’s Attenborough. “They are seeing an incredible amount of dealflow,” she says, “and as a result of that they are not changing their risk or their pricing policies or requirements. But what they are able to do is cherry-pick the deals they really want to invest in because, unlike the core banks, they do not need to play catch-up from last year.”
“There is a case for non-core strategies,” agrees Amundi’s Carrez, who believes an all-in return of 175-300bps would be “acceptable” for debt funds in the core-plus/value-add space. However, he adds: “We are being more selective for the most exposed sectors, remaining attentive to financing structure, the capacity to cope with a distressed scenario, and the sponsors’ ability to implement their strategy or business plan.”
BNP Paribas’ Polet sounds a note of caution: “The difficulty with value-add deals, which are more lucrative from the lending perspective, is that the debt funds need to have the teams ready to understand and to be active on this type of deal. It is very difficult to be a passive investor for this type of asset. So, that restricts the liquidity a little. And from the distribution perspective, if we underwrite the transaction as a bank, our experience is clearly telling us that the market is not always keen to accept complex transactions. I think that is an issue for the industry.”
On the sector front, there are signs that the debt funds, at least, are starting to reappraise if not the whole of retail, then parts of it. “Most lenders still want to decrease their retail exposure,” says CBRE GI’s Mook. “But there is also more realism coming with those lenders, that not all retail is doomed. There is obviously a distinction between a supermarket in a strong location versus non-essential shopping centres on the outskirts of a midsize city.”
In January, Apollo signalled a bolder approach to the sector when it wrote a £137.8 million loan to pan-European asset manager M7 Real Estate for nine retail warehouses totalling
one million square feet in the UK. Apollo is banking on rental and capital growth through asset management but also an anticipated repricing of retail warehouses as the logistics function of these properties in the last-mile delivery chain grows.
“There are areas that are a bit more transitional and therefore attract less attention,” says Eppley. “But we still feel from a credit perspective they are protected. And, you tend to get better pricing. There is an element of fragmentation in real estate finance which means there still are pockets of illiquidity that in our view may result in mispricing.”
Welcome guests for hospitality
If anything, sources see more opportunities in that other big sector loser from covid: hospitality, albeit in tourism-related hotels rather than the business and conference end of the sector.
“It is not a fundamentally redundant asset class or concept,” says Jacob Lyons, co-chief executive of Rivercrown, the principal investment and capital markets advisory firm. “Arguably, there has never been a better time to buy or lend money to hotels. Anything that you have seen in the last 12 months is kind of a worst-case scenario. And if you know the worst-case scenario, it is easy to price those assets.”
The alternative lenders are most interested in the hospitality sector, says Mishcon de Reya’s Poole, who is busy advising sponsors in acquisitions and development finance.
“If you believe the markets will come back in the next two to three years to where they were in 2019, and you have got a compelling business plan, by the time you have delivered your asset to the market, the argument goes that the market should be ready for the same level of occupancy and EBITDA as in 2019,” she says. “So, I think there is some appetite, perhaps counterintuitively, for development financing for hotels, compared to say shorter-term and existing assets which might need some restructuring or transitional capital to tide them over the next year or two.”
“Arguably, there has never been a better time to buy or lend money to hotels”
With development finance generally, there is, one source says, “a smaller cast of lenders, more selective than prior to the pandemic”, largely targeting the stronger sectors of logistics and residential. Sponsors and lenders are increasingly adopting a build-to-core strategy to circumvent the pricing issues of logistics.
Meanwhile, the attraction of build-to-rent housing is getting stronger. Investec’s Bladon believes there is scope to finance build-to-rent schemes that have been delayed because of the pandemic: “There is a space for lenders like us to help developer-operators to refinance out of higher-margin development and provide a 12-18-month loan facility to allow them to finish the lettings, stabilise the asset. And then either we can tranche the margin down, or they could go to a very large pension fund that just wants to tuck it away on 30 years debt for, say, a 2.25 percent margin.”
Our sources indicate a smaller pool of available development finance for offices than for other sectors, although some believe this is a huge opportunity to effect positive, long-term change. Knight Frank’s Attenborough says she is advising a sponsor on a build-to-core office scheme: “Core offices going forward must be properties that have really factored in everything that has happened over the last 12 months and offer occupiers what they need. And being able to demonstrate that to lenders is going to be a key factor, which debt advisors will have to take on board.”