Debt funds defy uncertainty to raise follow-on capital

Established debt fund managers are expanding as investors continue to choose
exposure to private real estate debt, writes Jane Roberts.

This time last year, the prospects for raising follow-on capital for real estate debt funds did not look propitious.

The first few weeks of 2016 brought volatility in equity and credit markets, continuing concern about slowing growth in China and falling commodity prices. Many shared the view that some European real estate markets had peaked.

As operators in the youngest and least tried of investment markets, managers of capital for non-bank commercial real estate lending might have had most to fear. Yet, as it turned out, appetite from investors for European private real estate debt did not wane. On the contrary, the last 12 months have seen new investors making allocations to the asset class, while existing investors have frequently chosen to ‘re-up’ with managers raising follow on mandates or funds, even if they have taken their time to thoroughly review strategies before signing up.

Two reasons for this stand out: the opportunity and manager track record. Regarding the first, the non-bank lending story that started after the financial crisis has not fizzled out. The need for new capital to fill the many spaces left by banks continues. This can provide both higher risk-returns, but for relatively lower risk than equity investing for real estate investors, and lower but safe returns with regular coupons for fixed-income investors.

The second point is that the early movers have grown into an established cohort of debt fund managers which have delivered their promised returns, and which have arrived at a time in their businesses where they have track records realising investments and repaying in full.

Currently out raising new capital is PGIM Real Estate, formerly Pramerica. Its high-yield debt investing platform is approaching a final close for its latest, sixth high-yield European debt fund (see table below) with New York State Common Retirement Fund signing over $200 million to the fund last October and taking PRECap VI’s commitments past £700 million ($851 million; €796 million).

Alongside peers such as Blackstone Real Estate Debt Strategies, DRC Capital, LaSalle Investment Management and M&G Investments, PGIM Real Estate can now point to a six-year track record of successful high-yield, pan-European debt investing. Its realised internal rates of return are hitting the low double-digit targets set for most of its funds and high single-digit returns for its separate accounts, with lending in 2012-13 said to have significantly outperformed.

Debt funds appear to be not only hitting their own targets, but in some cases, performing better than riskier equity investing strategies. Data collector Preqin reported in a bulletin last August that private real estate debt strategies are largely outperforming value-add and opportunistic strategies for real estate. “Since the second quarter of 2010 the Preqin Real Estate Debt Index saw 18 consecutive quarters of growth,” the research company said, although it should be noted that its sample includes US as well as European debt performance.

This, it added, had driven “greater amounts of capital secured by debt funds launched since 2012, as investors sought exposure to the debt segment. With many investors yet to make their maiden commitment to real estate debt, fundraising looks set to grow in the coming years.”

Emma Huepfl
Emma Huepfl

Emma Huepfl, co-principal at Laxfield Capital, also believes that allocations of capital for debt funds are increasing. Speaking at a January presentation of her firm’s bi-annual UK CRE Debt Barometer, which tracks borrower debt requests in the UK market, she said: “Successful managers are finding that raising follow on capital is getting easier. [Last year] was a tipping point for acceptance of non-bank lending, which has in turn created good lending opportunities. Many institutional investors have accepted that we are in a lower return environment and are seeking to allocate more to alternatives, allowing debt funds to launch senior strategies in addition to higher yield products.

“Alternative lenders proved themselves over the past six months when the wider market was trying to process what the referendum meant and there were signs of credit interruption.”

Spaces left by banks

The strategies of managers recently or currently in the market vary hugely depending on which niche they are looking to lend into and there are products and risk-adjusted returns to suit a spread of investors.

Two of the big beasts in private CRE debt have raised new capital over this tougher period, and fast. By Q3 2016 BREDS had collected $4.5 billion for its third fund within 12 months, much of it from Blackstone’s loyal stable of US pension plan and endowment funds. The fund has a global focus including substantial capital for Europe depending on relative risk-adjusted returns. The target is 10-12 percent which BREDS achieves by originating its own, large loans either on transitional assets or at higher leverage than senior lenders, or through mezzanine lending.

In senior lending for large transactions, AXA Investment Managers – Real Assets, manages more capital than any other non-bank lender, and has just raised a further €1.4 billion of equity from its largely European institutional base for its latest commingled fund. Fund raising for Commercial Real Estate Senior 10 began last summer. However, compared with CRE 9, which closed in 2015 on €2.9 billion, AXA is dialling back with a €1.5 billion hard-cap for the latest fund.

Other managers are targeting larger follow-on senior funds after proving themselves with their first funds, including La Banque Postale Asset Management, Brunswick Real Estate and AEW Europe and its owner Natixis, all of them with a €20 million-€50 million sweet-spot for loans. LBPAM reached a second close in December on €400 million for its latest senior fund which lends in France, Benelux and Germany with some capacity for southern Europe, while AEW/Natixis held a first close last year on €162 million of commitments and have a target of €750 million for their Senior European Loan Fund II, lending into similar jurisdictions.

Brunswick Real Estate is a specialist in Nordic markets. Its first fund originated senior loans in Sweden only, but Brunswick Real Estate Capital II will have two roughly equal pockets of capital, one in Swedish krone and the other euros for Finnish loans, equating to a combined €800 million target.

Deutsche Asset Management’s capital under management for debt jumped three months ago to circa €2 billion when it won a £750 million mandate from German pension fund BVK. Like AXA, Deutsche AM looks for high quality, large senior loans to invest in across UK and Europe, also both originating its own loans and taking participations in syndications.

Andrea Vanni, head of European debt investments, says three financings for its first debt fund closed in Q4 2016. His team has now invested close to €600 million of the €750 million European Senior Loan Fund. Net returns to its investors are 1.8-2 percent, but he stresses these are secured on “good-quality, institutional assets. It’s prime, mainstream bank debt financing”.

Another capital-raising trend is for first movers to expand their product offerings as their real estate lending businesses become more established. Independent credit asset manager AgFe is an example. Natalie Howard, head of real estate there, describes the strategy now after fully investing AgFe’s first, £900 million Real Estate Senior Debt Fund. She says: “We are out fundraising for two more funds: a follow on floating rate fund (AgFe RESD Fund II) with the same investment grade senior debt strategy as the first fund. The target raise is £800 million and the target return LIBOR + 250bps.

“And a new Higher Yield Real Estate Senior Debt Fund aimed at lending senior on more transitional properties; target raise £400 million; target returns 5-6 percent. Both funds will have a first close Q1/2 2017 of circa 25 percent of the target amount, with final closes towards the end of the year.”

DRC Capital, which started life as a mezzanine lender with its first European Real Estate Debt fund in 2009, is onto ERED III. Last year the business added a senior debt programme after being awarded €500 million of capital.

Branching out

ICG-Longbow, another real estate debt fund manager which started life investing in mezzanine then branched into senior lending, added UK residential development lending last year with a £425 million mandate. The group recently closed at its £1 billion hard-cap for UK Real Estate Debt Investment IV, its latest high-yield UK debt fund.

Delegates at CREFC Europe’s conference last November said they welcomed the additional liquidity alternative lenders bring and noted that they can score over banks by being flexible and quick – both services which will help the debt funds continue to invest their capital if market conditions get more difficult or demand for debt weakens.

AXA’s head of CRE Finance, Timothé Rauly, is one who does expect it to get harder to invest well. In 2015, the platform deployed about €4.5 billion in real asset debt, but he “definitely does not” expect to carry on investing at that level in 2017.

“In 2016 we will end up with having about €3 billion of CRE debt investments. [This year] will be the same or slightly less than that, between €2.5 billion and €3 billion,” he says. “The market is competitive and we are trying to be a bit more cautious now. Given the uncertainlty caused by macro events, I would say it is difficult to predict investment for more than three months ahead.”

Debt fund managers look Stateside for yield

When German pension fund BVK awarded a €750 million mandate to Deutsche Asset Management last November for investing in stretched senior and subordinated loans, it was developing an existing relationship. BVK had previously invested in some debt deals arranged by different lenders, including six from Deutsche AM.

The pension fund wants very high quality property and large deals, between €50 million and €250 million each, so it doesn’t want to shoot the lights out and is looking for a blended net return over 4 percent.

Part of the key to finding these deals, says Deutsche’s Andrea Vanni, is including the US as well as Europe in the new mandate. In fact, five of the six previous deals the pair worked on were in North America.

In the last couple of years AXA IM – Real Assets has also been hunting over the pond and its latest fund, CRE Senior 10, is able to invest up to 25 percent of its capital in North America. It has sometimes found deals of scale with better relative returns in the US particularly 24 months ago says head of CRE Finance, Timothé Rauly, though he adds that the premium hasn’t been quite as attractive in the last 12 months. In all, AXA has put $1.2 billion into the US in 20 different deals.

According to Preqin, Gothaer Insurance company – which invests in debt in Europe – planned to commit €400 million-€500 million to between three and five North American-focused private real estate debt funds.