Starwood believes seniority will produce £1bn rewards

Dishner and Denton lead private equity firm’s push into European senior debt, writes Lauren Parr

Starwood Capital sees a definite opportunity in European senior debt and has appointed Peter Denton from BNP Paribas to hit the fundraising trail imminently. Denton, hired two months ago, will run the group’s debt investments in Europe, spanning distressed debt and non-performing loans, real estate loan origination and performing paper, including whole loans and mezzanine pieces.

Denton reports to Starwood’s international president Jeff Dishner, right-hand man of Starwood founder, chairman and CEO Barry Sternlicht, whose sights are set on the creation of a £1bn European debt fund. Dishner, who moved to London last year to focus on buying distressed loan portfolios as well as developing new lending, will make further appointments this year.

Starwood – or all the non-bank property lenders now raising funds combined, for that matter – will not fill the gap left by the banks, Dishner admits. But he adds: “There will be successful people that are able to raise a lot of capital in this space; we’re still trying to decide how to go about it.”

Starwood’s existing investors comprise pension funds, insurance companies, sovereign wealth funds and wealthy individuals. For the fund, he expects to target “a diversified funding source”. The geographic extent of fund raising has not yet been determined, but potential backers are likely to fall into the lower risk/return camp.

“For a lot of investors the question is: ‘Are you looking at relative or absolute rates of return?’ Absolute-return investors want to make 20% on their money; someone that’s looking for a relative-risk return would say: ‘If I can earn a 7% rate of return for a 35-40% loan-to-value piece of paper, then that’s a really good risk-adjusted return, because the probability of a default is really low’.”

With senior debt scarce and margins not about to fall any time soon, the opportunity for the likes of Starwood is clear. “Given where spreads are today, on a relative-risk basis, we think high-yielding senior loans look quite attractive,” Dishner says.

It’s just a case of “trying to find the lower relative risk-adjusted returns that people think are attractive in today’s market, given how much volatility there is. “It’s not for everybody,” Dishner adds. “Some investors are more absolute-return- focused and this is a business that makes a 7% return; therefore, even if it is a low-risk strategy, it just won’t do it for them.

Senior lending not for the opportunistic

“The people contemplating entering the senior space are not doing it for an opportunistic fund trying to make high rates of return; they’re raising separate capital from different sources to make what they think is a great risk-adjusted rate of return.”

In the run-up to raising capital for its senior debt fund, Dishner says Starwood has invested through two existing pockets of capital: “Our opportunistic fund, which is where we buy distressed debt and non-performing loans; and a public company called Starwood Property Trust, through which we invest in performing debt.” The latter, which is a US mortgage REIT, has carried out nearly €200m of mezzanine deals in the UK and Germany over the past 12 months.

Starwood operates differently to fellow private equity players such as Fortress, which  lend with a view to owning the assets. “When we lend on real estate or buy performing paper, we make a good loan on a good piece of real estate to a good-quality borrower,” says Dishner. “We’re not doing it to get control of the real estate; if that happens, we probably made a mistake with our underwriting etc.”

Starwood has done deals on its own as well as in clubs, all of which tend to be in the three-to-five-year range. Its margins depend on “how deep we are in capital stack; if it’s a senior loan to 50% LTV, it’s priced differently to a senior loan to 75%”.

Starwood’s CMBS-buying days are mainly in the past, since spreads have come in considerably, but “we look at it from time  to time”. In February it bought $95.4m of B-notes in Blackstone’s re-issued Centre Parcs securitisation, having owned a $143.9m investment in the previous deal.

“For the most part we’re working directly with borrowers that have debt maturing and are trying to help find a financial solution for them to extend their financing so they avoid defaulting,” Dishner says.

Fostering good relationships with various borrowers is fundamental to this process, he adds, while finding the right type of investors focused on relative returns is the require-ment for the launch of the senior debt fund.

Where Starwood is similar to other private equity real estate fund managers looking to invest in senior loans – such as Fortress and Renshaw Bay – is that they all still have to raise the capital. All being well, it is thought the fund’s first closing could take place after the summer, with a final closing by the end of this year.