The many debt funds on the launch pad may need large resources to take off, writes Jane Roberts
The buzz on the Cannes Croisette at MIPIM this year was that 2012 will be the year of the European senior debt fund.
A lengthening line of fund managers, from private equity players such as Fortress and Starwood to institutional firms such as AEW, Henderson and CBRE Global Investors, are preparing to climb on the bandwagon. Even Goldman Sachs is fund raising for debt.
But while few doubt that Europe’s real estate markets would benefit from new senior debt capital providers, to supplement banks’ reduced capacity, honing strategies and setting up structures that work for investors and regulators will not be easy.
A few insurance groups, notably M&G Investments and AXA, are ahead of the pack. Head of commercial real estate Isabelle Scemama began setting up AXA’s strategy in 2005 and has bought senior loans on the secondary market, or lent alongside banks in the primary market, for AXA clients.
AXA has raised €4.7bn of capital for senior real estate debt from “close to 10 insurance company investors” and expects to invest €2bn this year, “given the excep-tional market conditions for senior lending” Scemama says: “It’s good to see we are not alone. But it takes time and I know what has to be sorted out; I’ve been through it.
“Unlike the US, Europe has lots of different jurisdictions. Everyone talks about Solvency 2, but we already have Solvency 1, so have local regulatory constraints. For example, German insurers cannot invest all over Europe and French insurers generally have maximum loan-to-value ratios.”
AXA offers four debt channels
Scemama’s team invests for its investors via four vehicles: three “under the same umbrella” and AXA France. Its investors initially came from France, Belgium and the UK and now also from Germany, Spain and Japan. But “all investors participate in each loan we invest in, pro rata”, she says.]
Unlike Aviva, another established insurance lender to real estate, AXA’s fixed-income clients invest for diversification, not to match long-term liabilities.
Philip Cropper, CBRE’s head of real estate finance, says an issue for anyone looking to set up a pooled fund rather than segregated mandates or clubs is to keep the investment looking like debt rather than equity.
This is particularly vital for insurers, whose capital charge under Solvency 2 will be lower for balance-sheet real estate debt than direct or indirect property investments. “As soon as you invest in a fund, your interest is an equity, so you are not buying debt,” he says. “AXA’s structure is more like a syndication to keep the investment in the shape of debt.”
Cropper says the number of institutions ready to invest in debt “is widening all the time. There is a recognition that there’s a big hole in senior debt provision, but there are many return requirements and this is not something that will resolve itself soon.”
Henderson Global Investors believes the “development of tailored real estate debt funds” is the most probable outcome. Its newly-appointed real estate debt head, John Feeney, says Henderson is “still exploring what the products will look like”.
But it will invest “at the quality end of the spectrum and conservatively. If there are seven different deals, a wide range of margins will be available and we will be selective, but 350bps seems achievable.” He thinks “real estate and fixed-income investors will invest in the same product”.
CBRE Global Investors’ move into European senior debt investing is being led by Paris-based MD Cédric Engel and UK business head Jean Lamothe, formerly head of Caisse de Depot’s property debt investing vehicle Otéra Capital, with C$8bn of assets.
The manager is talking to big pension and sovereign wealth fund investors about targeting whole loans from 0-65% loan-to-value levels, or the higher “stretched senior” LTV participation in deals, particularly from pfandbrief-funded banks looking to sell debt slices not suitable for the pfandbrief market.
“We could be a smart, disciplined lender of third-party capital,” says Lamothe. “We have the research, servicing business and underwriting skills, plus the property know-how and the fund management capability.”
Pramerica plans two funds
Pramerica Real Estate Investors plans to offer a stretched senior investing strategy in its next fund-raising round, after attracting
£492m of commitments last year for a mezzanine fund (see news). Instead of doing mid-teen mezzanine deals and 8-10% lower-risk deals in the same fund, Pramerica plans to offer two funds with different risk/return profiles. But it is not planning a lower risk/return senior fund, as it wants to work with banks, rather than compete with them.
Rather than targeting loans on prime property, US private equity players are likely to go for business with the highest possible margins, by funding perceived higher-risk asset classes, like hotels; assets with short leases or higher letting risk; or development.
Natalie Howard, a partner at structured credit adviser and asset manager Afge, which is considering a senior debt fund launch, says 600-800bps margins are possible. Last year, Blackstone achieved a 450bps margin on its Mint hotel portfolio sale financing, but the margin would be 600bps now, she says.
Last month, Starwood partner Jeffrey Dishner reportedly said the US firm could make 7-8% returns from senior lending on non-prime UK and German property.
Another way to leverage higher returns is to do bigger deals, but this means raising significant capital. Even a lower-risk, pan- European fund needs scale to get diversification. AXA’s Scemama says: “To launch this kind of pan-European business you need to get size. We started with €1bn, with support from the AXA group.
“If you enter with a ticket size less than €50m it won’t work. Even €500m isn’t big enough, because for diversification, that means €25m deals and banks won’t sell to you. There are also the structuring costs. But you get a premium for big deals. We started with a maximum deal capacity of €50m per loan and now we can do €150m deals.”
CBRE GI’s Lamothe agrees: “Below €1bn is not sufficient, but individual clients could commit €300m-€400m. Club deals will form around vintage-year structures and investors.”
The extent to which new debt providers will originate loans and become true shadow banks is unclear yet, as is whether they will rely on being offered participations in deals banks originate and arrange, or will buy debt on the secondary market.
Origination requires resources
Peter Denton, head of real estate at BNP Paribas, who is believed to have been approached by at least one entrant to European senior debt fund investing, wonders if “people vastly underestimate the resource needed to originate business”.
AXA has a 12-strong real estate debt team and can draw on another 25 staff to underwrite real estate collateral. But the team is only now about to close the first investment it originated itself; it is leading talks with the borrower and appointing a bank to do the arranging and servicing.
Both ways of investing have their costs, but there is little clarity yet about the fees the new managers hope to make. Agfe’s Howard says fixed-income investing is a “volume business”, with 15-20bps base fees – far lower than property fund management fees. “It is super-safe, low-yield, low fees. But you have to be fully compliant, have in-house legal teams, credit committees, loan servicing and so on. Not many people can do all that.”
Regulators shine a light into the shadows of banking world
Shadow banks – non-banks that extend credit and provide other bank-like services – are under the eye of Europe’s regulators. On 14 March, Lord Turner, chairman of the UK’s Financial Services Authority, told an audience at the Cass Business School in London: “We need to ensure that our regulatory response appropriately covers shadow banking as well as banks.”
Turner is working in this area for the UK’s Financial Stability Board, along with other international regulators. He has been asked to look at many shadow banking products, including securitisation and loan funds and to suggest reforms to address perceived risks by the end of the year.