LOOK AHEAD 2023: ‘There’s money to be made anywhere in the capital stack’

Lahcen Knapp, the chairman of Switzerland-based asset manager Empira, believes 2023 presents an unusual opportunity to invest across the capital stack for managers that are in the enviable position of having fresh capital to invest.

“There is money to be made lending anywhere in the capital stack,” says Knapp, reflecting on the recent increases in the cost of debt creating opportunities to support borrowers’ refinancing challenges.

The observation comes as Knapp prepares to announce the first close of the firm’s sixth debt fund, a vehicle for which the firm is hoping to raise €600 million (£522 million) of institutional investment capital over its seven-year term.

Empira Real Estate Finance Fund 6 will provide senior loans, of up to 60 LTV, in residential and office properties in Germany, Benelux and Austria. The fund 6 is aiming for 5 percent returns from cash-flowing, standing assets in mainly residential, but also office assets, in Germany, Benelux and Austria. “The fund isn’t targeting high returns but they will be stable, and actually represent a good return for a senior loan,” Knapp said.

Diversified lending portfolio, investor base

Fundraising is just one aspect of what has been an expansive year for the company. Knapp said the firm has been lending throughout the year and increased its assets under management by €1.1 billion, to €7.1 billion.

It has also been internationalising its investor base, opening a London office to help develop inroads with UK based institutional investors – as well as in Stockholm, Dubai and Miami. This effort means Fund 6 will be backed by investors that are placing capital with Empira for the first time, in addition to its well-established set of German institutional investors.

These investors also have the potential to access the firm’s existing mezzanine vehicle, which reopened for investment in October. Most of the original investors in that vehicle are keeping their capital in it, and there is now an entry queue. The mezzanine fund’s initial vintage hit cash-on-cash returns of 8-10 percent over its previous eight-year life, Knapp noted.

Empira also offers a hybrid fund that it launched in 2019. Empira Real Estate Finance Fund IV combines mezzanine loans with equity positions – of between 35 and 50 percent – in a development project. So far €400 million has been invested, a strategy Knapp says has yielded 13 percent cash returns for investors.

No-leverage lending

Empira’s debt vehicles do not take on additional gearing, is one reason why Knapp believes the firm is “not feeling the pain as others are.” The firm has been able to underwrite two or three loans per week in 2022.

This activity includes an €80 million 34-month loan for an 11,000-square-metre Berlin office development at a 4.5 percent interest rate and 73 percent loan to project value. Its mezzanine lending includes a €23.6 million facility, at an interest rate of 15 percent, for a 12-month term, which was used to acquire the remaining shares of a residential and commercial project, again in Berlin.

For 2023, however, Empira will be playing it safe by not investing in development because investors, as Knapp says, want investments backed by cash flow. To further protect returns, the vehicle originates loans on a floating-rate basis, which means the pricing of the loans will rise with interest rates and help to hedge against further inflation.

The fund’s other inflation hedge is its investment strategy of channelling the majority of its loans into German residential deals. On the equity side, this has been furthered by the recent launch a vehicle that invests in small-scale urban residential development – which is targeting €500 million of investment capital.

“There is a huge shortage of housing in Germany, we need to build 750,000 units per year but only 100,000 are in construction. The country is also growing, with 2.8 million new people moving there this year. Due to that, rents have gone up by 10 percent. That is the best inflation hedge you can have,” Knapp explains.

Knapp believes Empira’s focus on central Europe means it is investing in what it believes are the most stable markets in the region. But in the coming months, Knapp predicts that Empira will see greater competition from other alternative debt investors as dominant lenders reduce their activities.

“What makes central Europe so interesting [for alternative debt investors] is it is completely under-invested,” says Knapp. “Sophisticated investors from abroad have never discovered Germany because it has been a closed shop, dominated by the German banks. When we go outside of Germany and talk to foreign investors about debt in this market, it feels like we are alone.”

Knapp expects that in 2023, bank lenders will become more constrained by capital requirements under Basel regulations, a phenomenon that will be exacerbated by a worsening outlook for Europe’s residential real estate market, where a substantial part of EU banks’ exposures is located.

“There is a huge gap opening up for alternative financing, probably the biggest in Europe. Real estate credit is a young asset class, especially in Germany, but it is in the process of becoming more institutional and we are seeing that. It all has to come and it will come.”