Investor appetite for non-listed real estate debt appears insatiable

Iryna Pylypchuk, research specialist at industry body INREV, says demand for real estate credit shows no signs of slowing.

Over the past decade, the European non-listed real estate debt market has seen notable growth, and there are reasons to believe institutional investor demand for property lending strategies will only continue to increase.

Since 2016, the INREV Debt Vehicles Universe has expanded from 49 vehicles with minimum target equity of €27.1 billion, to 78 vehicles with minimum target equity of €47.5 billion in 2020. In addition, our Fund Manager Survey 2021 shows allocations to European non-listed real estate debt funds increased to account for 8.1 percent of the total volume of allocations to non-listed real estate vehicles – up from 3.6 percent in 2019.

The increase in interest in real estate debt in the past several years has been spurred on by a range of factors, among them stricter banking regulation, market volatility, the need to diversify investment portfolios and the continual hunt for yield.

Iryna-Pylypchuk, INREV
Pylypchuk: a range of factors driving investors to real estate debt

These vehicles offer a stable and steady stream of income through interest and principal payments and provide attractive risk-adjusted returns. Investors also benefit from robust downside protection and low default risk – particularly for senior debt strategies. This is driven by the fact that loans are backed by physical, income-producing assets with values significantly higher than the values of their loans. Senior debt typically offers investors loan-to-value ratios of between 50 percent and 70 percent.

Debt also offers institutional investors an avenue for real estate diversification and helps to minimise the risk of default. Those seeking greater diversification can achieve it by building loan portfolios with a multi-sector, or multi-country approach, with a large number of borrowers and risk spread accordingly.

Preferred debt strategies

While the growth trajectory of non-listed real estate debt is only expected to continue, institutional investors have clear preferences when it comes to their loan strategies.

According to our Capital Raising Survey 2021, senior debt was the most popular strategy behind the substantial increase in overall capital raised for non-listed real estate debt. It accounted for 39 percent of the total capital raised. Whole loan strategies made up 14 percent of total capital raised, while mixed debt strategies which combine senior debt with subordinated debt and preferred equity secured 25 percent of capital raised. The remaining capital was allocated to riskier strategies – including those that mixed senior and subordinated debt, as well as junior and mezzanine strategies, raising 10 percent and 12 percent of capital, respectively.

European investors continue to be the main source of capital for European non-listed real estate debt funds, accounting for 68 percent of the new capital raised in 2020. Investors from North America raised 23 percent of capital for these vehicles – up from 16.3 percent in 2019. Their peers in Asia-Pacific went from 0 to 9 percent over the same period.

The increased interest from overseas investors towards European non-listed real estate is likely due to the gradual evolution and growth of the European real estate debt market – with new products becoming available in recent years – alongside the attractive risk-adjusted returns that debt strategies offer.

A sunny outlook

By all accounts, investors are keen to be part of the continuing evolution of the asset class. The INREV Investment Intentions Survey 2021 revealed that, over the past few years, a growing proportion of investors had indicated their willingness to increase allocations to European debt funds.

And the external environment looks set to only fuel the flames of this enthusiasm. Banks are expected to further retrench from real estate financing due to stricter regulatory oversight and increased corporate losses following the covid-19 pandemic. Similarly, the steady surge of interest in operational real estate will require more real estate loan financing expertise and will create new opportunities on both equity and debt side of the equation.

On this basis, we might well anticipate a substantial expansion of the INREV Debt Vehicles Universe over the coming years.

Iryna Pylypchuk is director of research and market information at real estate industry body the European Association for Investors in Non-Listed Real Estate Vehicles – better known as INREV.