Property debt: Late-cycle path

Private real estate debt remains a popular asset class with investors, AXA’s Timothé Rauly told Daniel Cunningham at Private Debt Investor’s Capital Structure Forum.

Fixed-income investors can successfully diversify their portfolios by putting capital into real estate debt vehicles. That was the message from property-focused participants at the Capital Structure Forum, hosted in London in November by Real Estate Capital’s sister title, Private Debt Investor.

Europe’s largest real estate debt fund manager – AXA Investment Managers – Real Assets – was represented by Timothé Rauly, head of its funds group. In an onstage discussion with Real Estate Capital editor Daniel Cunningham, Rauly provided insight into managing a €10 billion-plus property debt book in a late-cycle market.

Daniel Cunningham: How do you balance scale with keeping a diversified portfolio?

Timothé Rauly: We want to maintain the size of our real estate loan book as it is today. If you cannot allocate more than €100 million per transaction, you cannot be impactful. So, if you want maximum exposure in a single loan to be no more than 3 percent to 5 percent of the book, and you want to allocate more than €100 million per transaction, you need at least €3 billion to €5 billion under management, so at AXA IM we use company insurance capital with third-party capital to achieve this.

DC: Which asset classes do you prefer?

TR: Logistics is basically hedging what retail is losing, so that’s a key bet for us. Logistics is supported by expected rental growth, which is something we believe in basing our core return on. Given where the market is, we look at everything – so we discover sectors from a pragmatic perspective. The key asset classes we’re looking at are student accommodation and the healthcare sector. Healthcare is lowly correlated to GDP growth and there are not many players in that field, so we like it. Multifamily has always been an asset class that we like from a risk perspective, but from a capital-allocation perspective it has not gained the most traction for us.

DC: Would you lend to the UK private rented sector at this stage in the market’s development?

TR: It’s a bit too early, but we like it, especially when it’s cash-flow producing. So we have a few assets in our book, including UK assets, but not as much as we would like.

DC: What are your core geographies?

TR: We do not have core geographies. The market is competitive everywhere in the world on any asset class. We can deliver relative value [through real estate] from a risk-return perspective, but we do not have strong preferences on geography. Having said that, we opened in the US market three years ago, due to increased competition in Europe, and the idea was to increase the assets we are looking at with a view to being as selective as we have been in the past.

DC: How do you break into the US market, given how large its spread of lenders is?

TR: It is indeed a very competitive market, but a more sophisticated market as well. Banking, the insurance market and securitisation are all adding to greater value across asset classes so that pricing on real estate doesn’t go below a certain level. In Europe, certain banks are always willing to accept lower spreads.

DC: What’s your view on Southern Europe?

TR: It was a super-nice place to invest in 2013, for sure. It’s much more competitive than it was, so it’s only a bit better than lending in, say, France. So, we are selective.

DC: Why do you deploy so much capital through participation in syndicated loans originated by other lenders?

TR: In Europe, the market is still highly intermediated by banks, they are 90 percent of the volume. Trying to change that market on your own is just impossible. So, the position is to look at as much as we can while partnering with banks, rather than competing with them. We have the capital, they have the network and they do not necessarily have a big final allocation to any single deal, so we are here to help them. Having said that, in the past, when the market was more difficult with less underwriting, we were doing origination. We think it’s important in the current market to look at five different deals at the same time and select the two best, rather than be focused on a single deal and run the risk of failing to win it.

DC: Where are we in the cycle?

TR: It’s always very difficult to predict when you are at the peak, but we are late cycle, without any doubt. But that’s the case across most asset classes we can look at – not only the real estate sector. It’s true there’s pressure on the equity side of the CRE market. On a relative basis, the market is not too overvalued, but on an absolute basis, it is expensive.

DC: So, how are you adjusting your lending, accordingly?

TR: In 2017, we lent less than we did in the previous few years, when we invested close to €4 billion per year. We are down to €2.5 billion. It’s clear that we are focusing on protecting our book and being more sensitive to where we are in the cycle, so taking lower risk.

DC: Your latest debt fund [CRE Senior 10, which closed on €1.5 billion in September 2017] is around half the size of its predecessor. Does that speak to the strategy of maintaining, rather than growing, the book?

TR: Yes, it’s the maximum we wanted to raise. We could have done much more but we were not sure we would find the assets. It was more to do with our view on the market, rather than the strength of investor demand.

FINDING ALPHA IN THE MIDDLE MARKET

Europe’s real estate mid-market presents the clearest opportunity for private debt fund lenders, argued panellists at the Private Debt Investor Capital Structure Forum.

“The vast majority of capital that’s been raised for dedicated private debt strategies focused on real estate in Europe is concentrated with the larger managers, and naturally they have to do larger deals,” said Clark Coffee, head of real estate at debt fund manager Tyndaris. “In the sub-€50 million ticket size there’s a shortfall of capital. On the flip-side, from a demand profile, the majority of transactions happen in that mid-market space.”

Investors can expect in the region of a 300 to 500 basis points premium on returns for being in the smaller segment of the market, continued Coffee.

“A lot of US money that comes to Europe says, ‘we only want to do large deals in the major cities’, so we see a significant oversupply for what you might regard as trophy or very core assets in big cities and that has led to the margins coming right in and covenants getting much more relaxed than they have been,” agreed Anthony Biddulph, CEO of capital markets advisor Capra Global Partners.

Asked by moderator Jeffrey Griffith, of advisory firm Campbell Lutyens, about the strength of investor demand for private real estate debt in heavily banked Germany, Hans-Peter Dohr, managing partner of investment advisory firm ICA said: “One of the problems we see is that the very big brand names get a lot of the allocations from small- and medium-sized investors because they rely on the brand names in the absence of internal capabilities to evaluate investment strategies.

“One of the tasks we have is to find managers who are capable, who have all the skills, who have worked various cycles, to deploy capital in their funds.”

Coffee argued that the case for private debt is strong in this final third of the cycle, but some investors need convincing. “The real problem is equity guys like to see equity returns, so if it’s an equity guy controlling the book, the idea of taking the certainty of a 5 percent rather than the possibility of a 15 percent – he’ll always choose the 15 percent. That’s the biggest hurdle to get over.”

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