This article is sponsored by LaSalle Investment Management
US-headquartered real estate manager LaSalle Investment Management launched its London-based debt and special situations business in response to the global financial crisis in 2009. It has since raised multiple funds across its mezzanine, whole loan, residential development finance and special situations strategies focused on the UK and continental Europe.
Ali Imraan, a managing director with the company, is fund manager of LaSalle Real Estate Debt Strategies IV – the latest fund in LaSalle’s mezzanine series, which has a €1 billion target size. Real Estate Capital caught up with Imraan to find out how the coronavirus pandemic has affected the lending landscape and where the opportunities lie in the year ahead.
Has covid-19 had an impact on investor demand for real estate debt?
We were fundraising for our flagship fund, LREDS IV, when covid hit, and so it was a very good test case of what was happening with demand. Even pre-covid, investor appetite for real estate debt had been crystalising and maturing. Investors realise that they are not getting any yield via traditional means, and so they are increasing their allocations to private credit, and part of that goes to real estate debt.
We found that, despite the pandemic, investors’ appetite did not necessarily change, although perhaps where they wanted to invest did. Some were keen to move from doing senior loans to higher-risk products, whereas others took the opposite approach, preferring to move down the risk curve into senior debt. It depended on each investor’s view of risk and how they planned to allocate their portfolios. Some investors are looking for a lower risk profile, with lower yield, while some are looking to outperform, meaning they are looking for higher internal rates of return. It is similar to how people think about equity – there are different buckets depending on how much risk you are willing to take.
We did find that more investors wanted to talk to us about private debt, and the tickets that they were investing were larger than we had seen in any of our previous funds, so they were committing more money to our strategies. We held a second close on LREDS IV, which currently stands at €585 million of its €1 billion target, and we have several investors at different stages of approval and closing which will take us well over our target. That gives you some indication of the momentum in the market.
Where are the opportunities in the European lending market?
Covid has exacerbated the massive bifurcation in the market: there are assets which have just gone from strength to strength, logistics being the clearest example of that. Equity and debt pricing have rebounded and gone beyond where they were before the pandemic hit, even though there was a bit of a pause as lenders worked out what covid meant for the market.
It is a similar situation in the residential market, especially in residential-to-rent or multifamily. Investor appetite and demand has continued to grow for both equity and debt. Pricing is at least at pre-covid levels, or even better for some of the prime schemes.
The most interesting sectors, from our perspective, are the ones where we think there are dislocation opportunities. Hospitality is the perfect example of this. It was plunged into crisis when people could no longer travel, and a lot of hotels are typically held by very asset-rich individuals or corporations, who are often liquidity poor. This means we are seeing assets starting to trade and there are very well-capitalised specialists looking to buy into this sector.
On top of that, there were a lot of equity and debt providers in the hospitality sector, pre-covid. Now, the field is clearer, and it is a great opportunity from a lending perspective for an organisation like LaSalle, which has really worked to understand the sector. You are lending to very well-capitalised sponsors on a readjusted basis, and this market reset opens the door for the better operators to outshine everyone else.
How do you feel about offices?
That is the really big question at the moment. There is clearly going to be a big change in the occupancy model, but, for now, I do not think anyone knows what that is. Location is going to be super important – being in big city centres with good connectivity will be crucial – and the wellbeing aspect and ESG factors will also be more important for investors and tenants.
Are alternative sectors attractive from a lending perspective?
We are big believers in some alternative sectors from either a whole loan or mezzanine perspective. As well as student housing, one of things we like and are looking at very hard is self-storage. The residential dynamics in some markets mean house prices keep going up and up, making it harder for people to upsize, and that creates a need for self-storage.
It is fair to say that the traditional banks have stepped back from any sort of value-add opportunity – anything with leasing or refurbishment risk, for example. But that creates opportunities for people like us who are much more asset-focused and can lend on the basis of a good business plan. We have also been very active on the construction finance side in recent years.
In which geographies do you see the most attractive risk-adjusted returns?
For us, the key markets are the big ones in Western Europe. We are very active in the UK and, despite Brexit, there are fundamental strengths in the UK economy, especially around London and the south-east.
We have also been very active in Germany, the Netherlands, France and Spain. I think Spain is a market that we will be watching a little bit more closely, because the impact of the pandemic is less clear with some of these more tourism-driven markets. On the other hand, it could rebound even more quickly, and we think there is a fundamentally strong case for places such as Madrid and Barcelona.
Historically, we have not done a lot of deals in the Nordics purely because we have not found the size of deals to suit us. But more recently we have been active there because we are finding more portfolio deals, and the fundamental story is very strong in those economies.
Are you seeing many distressed debt deals for your special situations fund?
Yes, but in hospitality rather than in retail. With hospitality, the trajectory pre-covid was very strong, and I think we can have a view of where we are going to be in 2023 or 2024 and that creates much better structural opportunities for us.
Retail is going through a very big structural shift and there is more pain to go. That makes it much harder to find opportunities right now because we are still in an adjustment period, although perhaps there will be some in time. It is likely that the opportunities in retail will be to change its use, especially in markets like the UK which are oversupplied.
How have debt returns changed?
Even though the market does compress, and you get slight differences from year to year, returns have been relatively stable. We have been generating between an 8 percent and 11 percent gross internal rate of return across our funds, and that has not changed. Even if you look at it from a whole loan perspective, typically returns have remained relatively stable.
One of the things that we are finding, especially in the mezzanine space, is that there are some very core deals which are falling below that 8-11 percent range, but they tend to be for assets which are long let with strong incomes. But we can still generate very strong returns across most mezzanine deals even looking forward.
The benefit of a platform like LaSalle, with its deep real estate expertise, is that we can work out where we think the right risk-reward is and we can also flex up or down in the capital structure. If we think there is great relative value in a certain jurisdiction, we can take advantage of that.
Covid has created two opportunities: either similar return for a better risk position, such as in hotel and office deals. Or the other way round: better return for the same risk.
Where are the main risks for the coming year?
I do not think we are out of the woods on covid yet. There is a question mark around what the endgame is, and when we will get there. There has been a lot of liquidity support in the market, which has kept it stable. I do not believe the withdrawal of that support will be a big shock to the market, but it is very difficult to know.
In terms of investment themes, although we remain very active in logistics which has had a very strong run, we so keep an eye on at what point, the basis may become too steep. That will be driven by the rotation from retail into ecommerce, and whether that momentum continues.
The question around offices is massive. Whatever changes come will have big implications for capital investment options. The questions we ask ourselves are about relative value – right now we believe the best value deals are found in core cities and core locations. We are willing to take refurbishment risk in the right place. But as the market goes along, does that change? Is there so much money in those core locations that we find better relative value elsewhere? It is certainly something we will continue to monitor.