This article is sponsored by M&G Investments
M&G Investments, the London-based investment manager, launched its real estate debt strategy in the global financial crisis. In 2008, with banks having retrenched, M&G began raising institutional capital for the purpose of lending to property sector sponsors.
It has since built one of Europe’s largest non-bank real estate lending platforms, providing more than €10 billion of senior, mezzanine and whole loan finance through commingled funds and segregated mandates.
With Europe’s property market in the midst of the covid-19 pandemic, Real Estate Capital spoke to M&G’s head of real estate finance, John Barakat, about the implications for debt fund managers.
How have you been spending your time since the covid-19 crisis began?
We began by assessing the impact on the existing investments across our portfolio. Lockdowns across Europe came as Q2 rent was due, so we spoke to our borrowers about how rent collection was going and how much cash they had to hand. At times like these, whether you are well capitalised or thinly capitalised, cash is king.
We also had to consider loans that were due to be closed. For example, we had a hotel loan to a longstanding borrower underway – we both decided now was not the time to be locked into such a deal. We have also spent time communicating with investors. We manage commingled funds and separate accounts, so investors have required different amounts of information.
We have also asked ourselves whether this situation is creating opportunities. We are still open for business, although we have not priced any new loans in the past few weeks. But if we identify relative value in this market, we want to be able to take advantage of it.
How have you handled borrowers’ problems?
The number of borrowers in need of deferred interest payments has been surprisingly small. My expectation is the July quarter payment round will be more challenging because a lot of tenants will have been shut since March, so we are readying ourselves to deal with it.
How are investors reacting to the crisis?
In all crises, most investors close in and examine their exposure to sectors, and that is sensible. But there are definitely some that have been waiting for an opportunity to take advantage of a repricing.
Sovereign wealth funds have capital available, for instance. Other pension funds and insurers will be more focused on balancing their asset allocation. It’s really a case-by-case scenario, but most lenders will be taking a pause to consider their exposure.
Will real estate debt pricing move in managers’ favour?
If you were to start investing in real estate debt from scratch today, and if you did a decent job, you would certainly have the chance to make better returns than if you had been lending in the past two years.
However, most managers have put capital into the market in recent years when it was more competitive than today, so managers’ performance is always dependent on recovering capital that they already deployed. What looked like a conservative loan two years ago might now be suffering from negative cashflow.
Is Europe’s property finance industry in better shape than it was in 2007-08?
Before the GFC, only the banks provided debt capital to European real estate. Now, 15-30 percent comes from debt funds and pension funds. A more diverse pool of capital makes for a healthier, more stable sector. Also, lenders’ hold limits have decreased a lot since 2007. Banks used to put a €1 billion loan on their balance sheets before they would syndicate or securitise, but in recent years they have been more likely to club together to spread risk.
Did Europe’s real estate debt fund industry enter this crisis in good shape?
The big difference between debt funds in the US and Europe is that US funds use warehouse funding lines from banks and so are subject to mark-to-market requirements. Most of my European counterparts are unlevered, so there is not an immediate liquidity issue. Also, each debt fund will have a different exposure to the market, but because managers have expanded into raising capital for senior and whole loan strategies in recent years, risk can be managed better than if they were all just lending high-yielding mezzanine loans.
Some managers have high exposure to sectors like retail and hotels because they provided higher returns. They face the prospect of dealing with distress, so it will come down to how effectively those managers deal with the situation.
How will debt funds emerge from this crisis?
The industry did not exist until after 2008 so most of us have experienced good times with the wind at our backs. There have been ups and downs, but it has generally been a positive trend. Now, we will see how managers navigate through a difficult period.
I’d be shocked if anyone emerges from this unscathed. But private equity goes through cycles and it is a manager’s job to deal with that. All debt fund managers are dealing with an external shock that has hit the whole market, but the outcome will be worse for those that have taken on too much risk.
Overall, real estate debt could emerge from this as a favoured asset class for investors. They recognise debt is defensive, because it provides lenders with security in the form of hard assets.
How can managers get through this successfully?
If the pandemic persists, or if there is a second wave, it will be important to have patient capital. You also need the expertise and judgement to manage your way though. That might be within your team, or it might mean having access to real estate or restructuring advice and needs to reflect the type of capital you manage and whether you can afford to be patient.