M&G Investments expanded its €5bn real estate debt investment business last month when it finally closed the M&G Real Estate Debt Fund with €140m of capital. The equity raised is small compared to assets already under management, but fund manager and head of real estate finance John Barakat is at pains to explain that this is just a first closing: “We hope to raise more this year and grow in size; hopefully others will understand what the advantages are.” The fund has been seeded with €100m from in-house client Prudential Assurance, with external European clients the Church Commissioners and a Dutch pension fund also taking about €20m each.
Like others who have tried to raise funds to buy debt, including Duet Private Equity, M&G found capital raising very challenging, after revealing plans to raise up to €1bn in May 2008. Barakat is unwilling to own up to any final target now: “In the past couple of years, competitors have indicated target amounts only to disappoint themselves,” he points out. The closed-ended, seven-year fund’s strategy is to step into the subordinated funding gap created by banks’ withdrawal and the securitisation market’s closure.
“The main lending banks are able to provide 60-65% loan-to-value now, which is obviously less than a few years ago,” says Barakat. “We will underwrite in the gap up to 75-80% LTV, depending on the deal. We certainly won’t lend up to 80% on every deal. “However, we believe in long-term value, especially as we see lower asset values today than two years ago.” With stretched senior and subordinated debt capital far more expensive now than at the top of the market “and a greater appreciation by investors of risk”, M&G is promising its investors bread-and-butter 10-12% returns.
This return comprises the fixed coupon on the debt and any credit spread charged, plus “opportunities to share in value appreciation over the life of the loan, and arrangement and exit fees”. Barakat hopes to get higher returns on some deals. “We believe the opportunity today is to earn equity-style returns with less risk, as there is still equity below our loans,” he says.
The fund will also look for refinancing opportunities. Like others, Barakat expects these to emerge in spades during the fund’s investment period of the next two years. “A large amount of debt will mature over the next two to three years and as capital pressure continues on banks they will be forced to take more significant steps,” he says. “They have a more intensive focus now on entering into deals that make sense.”
The M&G fund’s strategy does not stretch to opportunistic, distressed asset deals. “We wouldn’t take an adversarial position – say, putting a junior piece on an old loan and forcing it through administration,” he says. The American took a grip on the debt fund when he joined M&G in September 2008. He had previously worked at Goldman Sachs, leaving in 2006 to work with US asset manager Resource America, where he raised a property mezzanine fund that was later cancelled because of market conditions.
Stephen Mundy and Patrick Janssen did the initial work on the M&G debt fund and are still part of Barakat’s six-strong property finance team. Last autumn, Barakat brought in former Goldman Sachs colleague Peter Foldvari, and more recently Jamil Farooqi, whose last banking role was at Barclays, Capital, to source and evaluate investments. A year ago, when further falls in value were widely feared, only the most opportunistic investors had an appetite for mezzanine investment. “Then we made attractive investments in the senior space, where returns were higher,” Barakat says. Hopefully, things will be different in 2010 and 2011.
Mighty M&G lends real estate debt team extra muscle
While John Barakat does not have a large origination team, the six members of the real estate finance business do have the advantage of being part of M&G Investments’ huge operation. The Prudential subsidiary manages £169bn of equity, fixed-income and property assets.
M&G Real Estate Finance has access to a rich seam of information from 67 credit analysts in M&G Investments’ fixed income division, which it is part of, and from M&G’s commercial property subsidiary, Prupim.
Barakat says about six separate mandates or client funds have the authority to invest in property debt. “We have clients interested in the entire range of commercial mortgage exposure, from 0-80% loan-tovalue ratios; our strategy is to match investor interest with market need.”
Some of his clients also buy CMBS. “We have hundreds of millions to deploy and expect to invest double or more than in 2009,” Barakat says. Recently M&G Investments was a co-underwriter of a €300m senior facility for ProLogis, alongside insurance group Axa and four banks, in a deal arranged by Goldman Sachs.
M&G has another specialist property team in the fixed-income group, called the real estate income business, which buys direct property and manages the M&G Secured Property Income Fund.