Fresh from raising a third wave of capital for its lending strategy, LaSalle Investment Management debt boss Amy Aznar tells Daniel Cunningham that the market still needs those willing to provide higher leverage.
The market for European mezzanine real estate finance has changed considerably in the seven years since LaSalle Investment Management first raised capital to provide it, reflects Amy Aznar, the firm’s head of debt investments and special situations.
In 2010, LaSalle became one of the first non-bank debt fund managers to offer strips of debt finance between the 55 and 80 per- cent loan-to-value parts of the capital stack to opportunistic property investors which needed higher leverage than the banks could provide.
For lenders, internal rates of return in the order of up to around 14 percent were achievable, as private equity players generated mid-teens returns from investing in Europe’s recovering real estate markets. Today, with returns thinner and a more liquid financing market, IRRs look more like mid to high single digits. As the market has evolved, so has the product, Aznar explains.
“We started out lending pure mezzanine and borrowers would come to us to ask for a junior tranche.They would then pair us up with their preferred senior lender,” she says.
“Over time, that morphed,” Aznar continues. “We team up with the senior lender and we approach the borrower together. We blend the margins, or, alternatively, we write the whole loan ourselves, taking the underwriting risk, and then sell down the senior portion later.The market has become more sophisticated and borrowers’ demands around certainty of execution have changed.”
The sweet spot
This year, Aznar’s team has raised £600 million of fresh capital, targeting parts of the market that remain underbanked. Alongside a capital-raising for its residential development strategy, LaSalle has brought in £334 million for the third in its series of mezzanine and whole loan funds – LaSalle Real Estate Debt Strategies (LREDS) III – which is targeting a final close in Q3 this year “well in excess”, says Aznar, of its predecessor fund, which closed on £600 mil- lion in 2013.
The first LREDS fund generated much of its business through financing acquisitions by opportunistic investors such as Benson Elliot, Ares Management and Blackstone. Indeed, LaSalle provided several mezzanine facilities to the latter as it built its Logicor logistics platform from 2011 and which it recently sold for €12.25 billion to China Investment Corporation. The second fund, and now the third, continue to target acquisitions, although there is an increasing volume of business to be had refinancing high-leverage loans of 2011/2012 vintage.
“For us, LTV of up to 75-80 percent was always our sweet spot,” says Aznar. “What has changed is that the senior attachment point has crept up a bit since the early days – not dramatically – from 55 percent to around 60 percent. But due to the regulatory environment and constraints on banks, senior LTVs have been kept in check. That’s why the mezzanine market has persisted. Some people in 2010 said that it was a window resulting from the market dislocation rather than a persistent investment opportunity. But the mezzanine opportunity was not a window.”
Making numbers work
Despite the limited prospects for capital value growth in core European markets, Aznar argues that private equity funds remain active in seeking value-add investments. The weakened sterling versus the US dollar has prompted a new wave of such activity, she adds.“Private equity firms continue to leverage in the 70-75 percent range because it’s quite di cult to make your numbers work with low leverage and the cost of borrowing in the mid-70s is very accretive.There aren’t many points in history at which firms could borrow at these long-term rates.”
Lending further up the capital stack than senior banks has no doubt become a lot more challenging than it was in 2010. A larger number of non-bank lenders are aiming to write high-leverage loans in a late-cycle market in which value-add strategies generate returns far below those on offer at the start of the decade.
Aznar acknowledges that the mezzanine proposition has changed from a lending margin and IRR perspective: “Early on, just after the financial crisis, pricing on mezzanine was much wider because there was a massive dislocation in the finance market, and while standard mezzanine was in the 12-14 percent range, it has now settled at more sustainable levels – between 7-11 percent.”
The ability to underwrite whole loans, with a view to selling down the senior tranche, can give lenders an edge in winning deals, Aznar explains. “If you blend the senior and mezzanine you can achieve a very competitive margin on the loan at these low interest rates and lock in long-term financing that’s very accretive to equity.”
Some of the non-bank lenders which began life writing mezzanine loans tend to refer to themselves as ‘high-yield’ players, possibly reflecting the wider array of products they o er in order to generate higher-risk, higher-return assets.
Asked how Aznar thinks of what her team provides, she points out that, although the firm writes traditional mezzanine, whole loans and development loans, LaSalle is “down the risk curve” compared with some debt fund peers. Underlying what LaSalle’s debt team does is a focus on prime properties, in line with colleagues within the organisation which invest through equity funds.
“We think of ourselves as a core-plus debt lender, if you will,” says Aznar. “Although we do development loans, they are primarily whole loans, and most assets that we lend mezzanine against are stabilised. Sponsorship is crucial to us. That means we need to be competitive on pricing, so to our bene t across our funds, we’ve had appropriately priced capital, which allows us to generate a good risk-adjusted return for our investors while at the same time allowing us to be competitive for our borrower base and go for the deals we want to do.”
The investor base for private debt has widened, Aznar argues. She notes a higher count of UK institutions in the latest fundraising, alongside continental European, Asian and US insurers and pension funds.
“Real estate mezzanine debt didn’t exist in Europe in the form that it currently does before the global financial crisis. It was a thinner, higher-risk part of the structure. These days, it’s become a more appropriate pro le for institutional investors. Institutions are thinking more broadly about their real estate exposure and they see debt as a product that offers a little more yield and a good cash-on-cash return,” she says.
The £334 million LaSalle now has to spend through the strategy is likely to be deployed in an increasing number of whole loans, in order to act as a single point of contact for a sponsor. An increasing focus on the continental European market is also likely, Aznar says. LaSalle’s business has so far been weighted towards the UK, although the second deal within LREDS III, which the firm was understood to be closing as Real Estate Capital went to press, represented its first whole loan deal in Spain – a significant step for the firm into a market which still has the ability to generate deals offering opportunistic returns.
“It’s related to deal-flow,” explains Aznar of the increasing focus on the European main- land. “Since the UK referendum last year, volumes are down, so you really need to concentrate on the deals you want in the UK. A lot of our borrowers are looking elsewhere, so we are likely to follow clients.”
Several non-bank lenders have raised follow-on capital for high-yielding strategies, including PGIM Real Estate Finance and DRC Capital, prompting some in the market to question how easy it will be to deploy mezzanine debt going forward. Aznar disputes this: “I can list most mezzanine providers on two hands and the majority of them have slightly different strategies. Everyone finds their niche.”
Alongside the mezzanine and whole loan fund, LaSalle has also raised capital for its residential development finance strategy. The firm has brought in £264 million for its LRF III fund, the third in a series which is backed by a mandate from Dutch pension firm APG, alongside a minority investment from LaSalle’s parent company. In total, the programme now stands at around £760 million, with £500 million invested over the past three years.
Development finance is a gap in Europe’s real estate debt market. Specialist providers have entered to provide sub-£10 million loans, but larger lot sizes are difficult to source. Although they have relatively limited capital to deploy, debt funds such as LaSalle are providing an alternative to banks.
“The fund provides higher-leverage development loans than the senior banks are willing to write,” explains Aznar. “We do the whole loan and then we tend to hold it and we have built up the infrastructure to handle monthly drawdowns.”
The fund provides up to 75-80 percent loan-to-cost and, despite the name, will also fund student accommodation, hotels and healthcare development; “anything with a bed,” remarks Aznar.
“The primary focus has always been residential and student housing and that remains the majority part of the strategy, but we also saw opportunities in hotels, serviced apartments, senior living – they all share the same dynamics in terms of a supply/demand imbalance in the underlying sectors and gap in the lending markets in those spaces.”
The fi rm is yet to write a UK built-to-rent residential construction loan, although Aznar says that it is “pretty close” to lending to the burgeoning sector. “There are good oppor- tunities in PRS. It’s clearly an undersupplied market. For a lender, underwriting the oper- ator itself is critical. However, that also goes for student housing and other sectors such as hotels, which we are comfortable with.”
Does the continued uncertainty gripping the UK housing market in the wake of the Brexit vote and the general election resulting in a minority government worry Aznar?
“We’ve been pretty cautious on high-end residential, particularly in central London, for a while,” she explains, “we were never really active in the ultra-prime £3,000-plus per square foot-plus market, and we have been pretty cautious on £2,000 per square foot and above for a while, although it has held up better than many people expected, probably bolstered by the weak pound attracting investment.We prefer to focus on the £1,000 per square foot and below segment, which is more affordable for domestic buyers.”
Aznar points to LaSalle’s £110 million financing of the City North apartment scheme in north London’s Finsbury Park, close to the tube station, as the type of product it is targeting.The geographical reach of the fund has so far been diverse: “We see a lot of opportunity in Manchester and the bigger student towns, we’ve done student housing in Nottingham, a hotel in Cam- bridge,” Aznar says.
Looking forward, the final close of LREDS III is LaSalle’s immediate priority. Beyond that, a strategy LaSalle pursued from 2010 – subsequently discontinued, but which could be revived – is its special situations business. In tune with the ‘core-plus’ ethos of its investment, the strategy involved resolving complicated debt situations relating to quality properties, rather than lending to distressed assets.
“We have had a vehicle making special situations investments in the past and we will likely pursue a similar strategy again in the future,” explains Aznar. “However, our current focus is on our two main funds. Investing for these two funds should keep us busy for a while.”