Profile: Protect the Position

Timothé Rauly, AXA Investment Managers – Real Assets’ new head of funds group, tells Daniel Cunningham that maintaining the firm’s loan portfolio is his priority.

AXA Investment Managers – Real Assets is by far the largest of the non-bank lenders which have carved a slice of the European real estate financing market.

Timothé Rauly

The investment arm of the French insurance giant was the first alternative lender to enter European property debt, back in 2005. After the crisis, when the banks retrenched and institutional money managers entered, the business (known as AXA Real Estate until a September 2015 rebrand) was already ahead of the pack.

AXA IM – Real Assets is now nearing a final close on its 10th commingled senior property debt fund (CRE Senior 10) which had raised €1.4 billion by January and is targeting €1.5 billion, with a final close expected this summer. The firm invests in the debt markets on behalf of AXA insurance companies and more than 40 third-party clients from 10 different countries.

Its real estate lending book stands at €10.5 billion. With infrastructure debt, the platform comprises €14 billion.

In February, the job of managing the real estate funds, debt and equity, fell to Timothé Rauly, who joined the company in 2006 from French REIT Unibail-Rodamco, to handle investments into CRE mortgage loans. After his predecessor in his current role, Isabelle Scemama, was promoted to CEO of AXA IM – Real Assets, Rauly took over the funds group.

AXA’s real estate debt business is viewed in the market as a consistent, large-scale lender which faces the challenge of finding large lending opportunities to reinvest capital as it repays. “In a sense, it is trying to keep pace with itself as the market,” says one debt fund manager.

Speaking to Real Estate Capital at the firm’s Paris HQ, located amid the towers of the La Défense commercial district, Rauly explains that his medium-term task on the debt front is to maintain rather than grow the debt portfolio. “The current investment capacity is designed to replace our former funds, which are already in their run-off phase. We are not trying to grow our book or our lending capacity at the moment.”

CRE Senior 10 will be just over half the size of its predecessor, which closed on €2.9 billion in August 2015. “We know that when there are conditions in the market that make lending on a larger scale more appealing we would be able to raise capital rapidly. If you try to grow too much in the last part of the cycle, you risk losing your track record and your traction with investors.”

The European property cycle, suggests Rauly, is “advanced”, meaning that the firm’s approach to business will be more cautious in 2017, with an emphasis on the most core investments, and a little more risk in specific transactions. In 2015, the business invested €4.5 billion specifically in real estate debt. Last year, it was down to around €3 billion. It is likely that 2017’s total will be circa €2.5 billion.

“The model we operate is that the team looks at as much of the market as it can for us to make sense of the risk/return perspective,” explains Rauly. “If we look at €50 billion of potential deals each year and invest in around €2.5 billion, that’s a 5 percent hit rate. Given where valuations are, it’s difficult to say when the cycle will end – it could easily be in five years’ time. Having said that, we want to remain super-cautious so our risk appetite is lower than it was.”

Syndicated Investments

Lending during 2016 was done primarily via participations in syndicated loans, rather than originating bilateral debt. Between 2012 and 2014, when there was limited liquidity in Europe, the firm used its balance sheet to underwrite loans at higher margins than are on offer today. As liquidity returned, the firm shifted its strategy to focus on taking secondary participations. “It’s about looking at as much paper as we can, to remain selective,” says Rauly.

AXA IM – Real Assets’ participation on behalf of its clients in syndicated loans can be large, up to €400 million in some cases. Recently, it is understood to have taken a £200 million (€236 million) slice of the £334 million senior loan Morgan Stanley provided to Brookfield for the acquisition of London’s CityPoint tower, for instance. “We invest where we feel comfortable with a deal, and if we are comfortable we are able to do a large ticket,” explains Rauly.

“When you spend less time originating and more time comparing value from one deal to another you can offer better value for the benefit of the clients than if you are focused on originating a certain volume over a certain period, which is often done to the detriment of pricing.”

Pricing is very disparate across European real estate debt markets, Rauly argues. “There are many different lenders with different costs of capital and individual objectives, all with varying views on assets.”

Investing in secondary positions can mean inheriting that ‘inefficient’ pricing, Rauly admits, but he argues that by considering so many potential deals, the firm can pick and choose where it sees value. “We pass on a lot of deals because of pricing. They might be acceptable from a risk perspective, but pricing can be too tight in comparison to other asset classes.”

Overall, the firm’s debt funds aim to achieve average pricing of 200 basis points over three-month Euribor. “We think that is the reasonable level in this asset class given where we are in the cycle. Obviously, some deals are done tighter than that, but it is the average that we are delivering.”

The strategy is to identify loans that offer the best relative value in the core markets it covers, which include France, the UK, Germany and Spain, as well as the US, where it entered in 2014. Alongside offices, retail, logistics, hotels and residential property, the firm is also increasingly considering lending to alternative sectors such as student accommodation. Dutch multifamily is one sector which Rauly mentions as an area of interest.

As a manager of institutional money, Rauly admits that he would be pleased to see more fixed-rate paper in the market, but concedes that the vast majority of the European real estate banking market is floating rate. However, he adds that the shorter tenor (typically five to seven years) of the lending AXA IM – Real Assets tends to do is preferable to the longer-term fixed-rate debt some insurers favour. “We remain cautious about long-term CRE financing. Real estate is a real asset and cities and districts can change rapidly, so it is difficult to take a 15-year view.”

The sheer scale of the funds at AXA IM – Real Assets’ disposal gives it the ability to underwrite largevolumes, which Rauly says gives the firm a competitive advantage. “Most of the banks active in the asset class do not have such large underwriting capacity, except a few of the investment banks. Most commercial banks need to distribute rapidly. Size is critical in this market and our size gives us the advantage of being able to extract additional spread on deals and we are known in the market for delivering what we say we will deliver. It’s important whatever stage of the cycle we are in, to use our scale. In order to deploy a €1.5 billion fund, it means we will have to invest around €2.5 billion per year across our entire programme, and so far, we have managed to achieve that.”

The business is split into two teams, handling private and public debt. The public debt side of the business provides it with the ability to participate in capital markets deals. In 2016, for example, it was the majority investor in a €460 million bond that financed Round Hill Capital’s Dutch residential portfolio, in a deal arranged by ABN Amro.

AXA IM – Real Assets is also involved with issuing bonds for REIT clients at low leverage. “From a credit quality perspective, we are more comfortable with it, with strong portfolios backing the debt.”

A priority going forward, Rauly says, is ensuring that the business is as flexible as possible in terms of the types of debt instruments it can issue. “We want to be in the position to look at CRE financing as a whole across geographies and across instruments,” he says, referencing bonds and unsecured corporate lending.

US Focus

An increased focus on the US market is likely. The current fund has a 25 percent investment capacity for the US and is currently around 10 percent invested in that market, which could be increased to around 15 percent. The ability to consider the relative value of US deals fits into the firm’s strategy of considering as much paper as possible.

“The US is a very different market to Europe,” Rauly says, “Thirty percent of lending is done by banks, as much as 35 percent by insurance companies and the balance is between securitisation and mortgage REITs, so it is a much more disciplined market than Europe in terms of structure and pricing.”

The firm is looking at loans priced above 150 bps over three-month Libor in the US, which after hedging costs breaks back to more than 200 bps, often for a lower risk, lower leverage and shorter maturity than comparable deals in Europe. In the US, the firm only invests in loans and does not originate them.

“Eighteen months ago, pricing was far more appealing in the US than in continental Europe. The discrepancy is less obvious now, but there is a different risk. The US does not have the exact same type of sponsor or the same letting market as Europe, for instance. New York does not behave like London or Paris. There is a premium and there is diversification benefit.”

With the 10th fund not yet closed, Rauly says an 11th is a relatively distant prospect, but as the business aims to maintain its assets under management and counter repayments, it is likely to raise additional capital. “It will not be this year, it could be the end of next year, but it is not planned yet.”

Indeed, plenty of ideas for future capital are being discussed, although decisions are yet to be made. “We are also thinking about mixing different expertise internally so that could mean a fund which mixes private debt instruments, including real estate, infrastructure and corporate loans. It might also mean a strategy focused just on real estate but mixing the different instruments we have globally such as bonds and securitisation. Nothing is planned, but we have a lot of ideas on the table which will allow us to continue being flexible and offer value to our investors.”

Talk turns to the challenges which face European real estate finance. Rauly is clear where he sees the potential problem in the market.

“It’s a pricing matter,” he says. “You can do some bad financing later in the cycle. If you do it at a super-tight spread, it’s much more challenging, in particular in an environment where the interest rates are zero, so you have no cushion to absorb losses with the exception of your spread.”

He adds that the banks’ need to replenish their balance sheets puts pressure on bankers to deploy capital. “Probably the biggest risk I see is banks looking at the asset class from a P&L perspective and driving income through upfront fees. An easy way to optimise P&L is to refinance existing positions and take more upfront fees, but that is typically done at a lower spread.

“For me, that is a driver which makes the CRE debt market more cyclical than it should be. We should learn from the US where a significant slice of the market is in the hands of insurance companies and they want a full hold so the borrower cannot repay the loan before maturity.”

Investor demand for exposure to real estate debt does not wane at the advanced part of the cycle, Rauly says. “It’s up to us to make sure we are comfortable with what we are pitching to investors and that we are in a position to deliver what we think is achievable.”

But overall, Rauly argues that the inclusion of insurers – and managers of their money – in the lender landscape is important. “Insurers’ allocations might fluctuate over time, but they are here for the long-term. I think it’s a really good thing for the real estate market. It’s a different type of lender and they have the capacity to invest in scale and keep risk on their balance sheets.” n