This article is sponsored by Goldman Sachs
In December 2017, Goldman Sachs held a final close on Broad Street Real Estate Credit Partners III – a debt fund designed to originate high-yielding senior and mezzanine loans against US and European property.
Through a combination of third-party investor capital and balance sheet and employee co-investment, Goldman Sachs raised a total of $6.4 billion, inclusive of $2.1 billion of term financing.
Approximately 75 percent of the fund has been committed, half of which consists of loans backed by European real estate. Goldman Sachs provided an £875 million (€1 billion) loan in 2020 to Deutsche Finance International and Yoo Capital to fund their redevelopment of the Olympia London exhibition centre. The Broad Street Real Estate Credit Partners funds are housed in the private real estate business within the asset management division, which has invested more than $50 billion in real estate equity and credit strategies since 2012. Real Estate Capital spoke to Goldman Sachs partners Peter Weidman and Richard Spencer about the private real estate debt market.
How does Europe fit into your real estate credit strategy?
Richard Spencer: Europe has been an expanding piece of the business for us, particularly in the past five or six years. Real estate debt is a US and European strategy for us, but we have a single vehicle for both markets. We began our real estate credit strategy following the 2007-08 financial crisis and there was zero allocation to Europe in our first fund. Our second fund, which closed in 2014, was 20 percent allocated to Europe. Our current fund, which is 75 percent deployed, is 50 percent Europe. The strategy is opportunity-led, but, over the years, we have seen more interesting opportunities in Europe, relative to other markets.
Peter Weidman: Investors have indicated that they like that relative value approach.
We have a global investor base, including investors from Europe that use the strategy as a method of investing inside and outside of Europe, but also investors from the US and Asia that are seeking ways to deploy capital in Europe.
What are investors looking for when they invest in real estate debt?
RS: We have a varied investor base, ranging from sovereign wealth funds to insurance companies, pension funds and large family offices. There are two main ways they tend to think about real estate debt. First, they see a premium in private credit origination, as opposed to strategies where investments are made through secondary participations in loans. Investors see the illiquidity premium of an origination strategy as a way to generate more yield than is available from other fixed income products. The weighted average yield on our portfolio is 9 percent and it has been relatively consistent across the three funds, so this is not a strategy with big fluctuations in returns. Second, investors see credit as an interesting way to play the real estate markets, on a relative value basis. The types of assets we finance are transitional properties, including developments. Investors can gain exposure to high-quality real estate, but at a lower risk point than that of the equity investors. Investing in a 60 percent loan-to-value loan, and earning 8-9 percent is an interesting way to generate a good return without taking the last 40 cents of risk. So, that type of investor thinks about real estate debt relative to other things they could be doing in the real estate market.
Why do you believe investor demand for the asset class has grown?
PW: It is difficult to pinpoint whether the driver in recent years has been the overall growth of the private credit industry, or investors transitioning to more defensive real estate strategies the later we got into the cycle. Overall, investors are very familiar with the private real estate debt market now. When we launched the strategy after the financial crisis, we had to educate investors about real estate debt and how we would go about making loans. Now, everybody knows about real estate debt and conversations are focused on investors finding out exactly what the strategy is and how it fits with their portfolio. These days, there are few investors that are not interested in real estate debt and just want to do real estate equity.
How do investors view Europe as a lending market?
RS: In 2013, when we were raising capital for our previous fund, people saw Europe as being in a later recovery from the financial crisis than the US. They wanted exposure to Europe because they saw that spreads were wider due to less capital being available. They considered Europe to be the frontier of the real estate debt market.
At that time, investors were considering Europe as a cyclical opportunity during the reconstruction of the European real estate market. We had to convince them that this was not a cyclical opportunity, but a structural one. The way banks thought about real estate credit pre-financial crisis is probably never coming back, and there has been real growth in the private capital markets – you can see it across corporate credit, infrastructure debt and all types of private debt.
How has covid affected lending conditions?
RS: In an environment like covid, the premium on offer for originating loans increases. Lenders need to look through the short-term impact on the market and take a longer-term view on the value of the real estate. During 2020, we found opportunities to work with household name sponsors that you would not typically associate with borrowing at the types of yields we want to earn. They did so because it was a difficult market, and they needed certainty of funding.
Q2 2021 is playing out slightly differently. As is the case across most capital markets, spreads are tighter, prices are up and people want to deploy capital ahead of what they believe will be a recovery in Europe. So, there is no doubt that the market in Europe is competitive for the best assets and the best borrowers. It means we need to use our relationships and ability to do complex transactions to find good investments in this environment. Our funds are among the largest in the high-yield real estate credit space and they allow us to identify what we see as the best 10-15 loan deals available to us across the US and Europe each year.
What was your experience of the covid crisis in the US?
PW: We saw a recognition from borrowers that they valued having a lender as a partner, rather than as an adversary. We were reasonable with sponsors that experienced difficulties, in part because we hold our loans in entirety, so have complete control over them.
This is possible because of our fund’s unique financing structure. While many of our competitors struggled with margin calls or mark-to-market requests on their own credit facilities, we did not face those problems. We have a dedicated fund asset-backed credit facility to leverage our capital, which we put in place with non-bank lenders at the start of the fund’s life. It means we have the right to work through any amendments to loan deals without needing to seek approval from a lender. It allowed us to work through issues with our borrowers. That financing facility was probably the most important thing that helped us get through the crisis last year.
Have you changed the structure of your European loans in response to the crisis?
RS: We always look for the best risk-adjusted returns, so loan structure is case-by-case. That said, in the current market, senior development or refurbishment finance often offers the best value. There is sponsor demand for large, complex financing packages to enable repositioning and redevelopment schemes. When we see the mezzanine market tighten, we can pivot to the senior debt market and find more interesting structural protection, and more interesting returns. Over time, mezzanine might become more compelling again, and we are flexible so we can shift back to that part of the market. But, because of the enhanced complexity required, senior development, in many cases, currently offers a better risk-return.
A prime example is our £875 million Olympia London loan. It was the largest loan we have done. We liked the real estate – it is an iconic asset – and we liked the team and the exceptional scheme they have designed. It was a complex loan to write from a real estate and a capital markets perspective, and it gave us the opportunity to bring our investors into the deal.
Which sectors appeal to you?
PW: Our lending can be broadly split into two buckets. First, lending into sectors with a thematic driver, such as build-to-rent – a small sector, but one which is subject to huge growth, particularly in the UK. Second, on the opportunistic side, we look at sectors that are out of favour, but where we can use our industry knowledge to make outsized returns. In Q4 2020, for example, we closed a loan in Ireland on two hotels. We also closed a loan on the fringes of the City of London on a mixed-use property with an office component. In a world where people are running away from out of favour sectors, we provide capital to quality borrowers with quality projects.
How are you aiming to mitigate risk when lending into sectors with uncertain futures, such as offices?
RS: Take offices: it is difficult to predict what demand will be in the next few years as we come out of the pandemic. But we believe there is demand for best-in-class assets. So, in our fringe City of London deal, we liked the quality of the real estate in an undersupplied market. We liked the technical aspects of the property, its digital connectivity, and its environmental, social and governance features. So, I don’t know if office demand is going to be X million square feet or Y million square feet, but I do know that building is going to be one of the best available when it is delivered, and our leverage point means we have a very defensive exposure to it.
Peter Weidman is a partner, private real estate at Goldman Sachs in New York. Richard Spencer is a partner, private real estate at Goldman Sachs in London.