US investors take driving seat on separate debt road

Institutions use separate accounts to tailor property debt strategies, writes Al Barbarino

A string of big real estate debt mandates won by US commercial property lenders shows growing confidence among large institutional investors seeking greater control over their money.

Compared with pooled debt funds, separate managed account mandates, or SMAs, generally give investors more say over the investments their fund manager makes, often with targets based on yield, total return, minimum debt service coverage, maximum loan-to-value ratio, asset types and geographic diversity.

Tom Mattison, Quadrant
Tom Mattison, Quadrant

“Investors can set parameters to perfectly define the investments they are seeking,” says Tom Mattinson, a senior partner with Quadrant Real Estate Advisors, a manager of five separate accounts and two commingled debt funds, investing in whole loans, mezzanine, CMBS debt and REIT securities.

Investors can shift the type of investments or even cancel the mandate if it no longer views market conditions favourably, says Mattinson, whereas with a debt fund, “you’re locked up for the fund’s term once you’ve signed the subscription and wired the money”, whether that’s five or 10 years.

In June, Los Angeles County Employees Retirement Association committed a further $250m to a $500m real estate debt mandate with Cornerstone Real Estate Advisers. Ares Management won a $700m CRE debt mandate from a large North American speciality life insurer in January, while MetLife won a $500m mandate in March.

Insurers have gravitated towards separately managed accounts as they face diverse needs relating to investment duration, liability structure, return on capital, ratings and regulations, says Todd Schuster, a senior partner with Ares Real Estate Group.

Ares is targeting $15m-50m loans with up to 70% loan-to-value ratios on stabilised assets – or those with a light transitional element – in major US markets.

 Seizing opportunities quickly

“With an SMA, the time to market is fast, so we can seize market opportunities quickly,” Schuster says. “Since SMA assets are on the books of the investor, it provides better liquidity, which can translate into more favourable capital treatment.”

Debt mandate fees also differ from those for debt funds, typically entailing an asset management fee on a sliding scale; for example, a set flat fee up to $100m could drop around 25 basis points at $150m.

Debt funds typically use a promote structure, which means the manager keeps a percentage of excess cash flow beyond the investor’s preferred return, Mattinson says.

The re-emergence of debt since the recession was facilitated because debt returns rival those of equity investments, but are seen as less volatile on a risk-adjusted basis. Investors’ interest in US debt funds, and capital raised, picked up in 2013-14, says Doug Weill, co-founder of real estate investment advisory firm Hodes Weill & Associates, which has advised several managers on capital raising for debt funds.

Debt mandates are harder to track, but debt funds raised $20bn last year, compared with $16bn in 2013, according to data from research firm Preqin. Real Estate Capital’s own data, from PERE Research & Analytics, shows 31 US debt funds currently raising capital (see p34).

“There seems to be a lot of interest in investing in senior debt on transitional assets where investors can achieve 8-10% internal rates of return, and also in short-term debt that’s going to be taken out by permanent debt,” Weill says.

Brant Maller, a partner in law firm Pillsbury’s alternative investments group, adds: “It’s breathtaking how fast these products have grown” with the post-recession “dislocation” of banking markets.

According to Garrett Thelander, executive managing director of capital services at Cushman & Wakefield: “A tremendous amount of money has gone into debt because the life insurance and pension funds realise that it’s hard to buy property today and achieve the same yields.”

That said, some funds could struggle to hit their targeted returns as the market becomes even more competitive.