Octopus corrals £230m for short-term loan strategy – Exclusive

The specialist lender is targeting double-digit returns in the UK bridge finance market.

Investors have backed Octopus Property’s strategy of providing UK property loans at tenors as short as one month, with the firm hitting a hard-cap of £230 million (€266 million) on its latest fund.

The London-based specialist lender, a division of investment firm Octopus Group, provides finance to borrowers which typically need funds quickly to acquire often vacant properties. A typical Octopus loan is between £1 million and £5 million with an average 12-month duration, across a variety of property types.

Through this short-term and bridge lending strategy, the firm is aiming to generate gross returns of 10-11 percent and net returns of 8-10 percent for the fund – Commercial Real Estate Debt Fund II – head of commercial property Ludo Mackenzie told Real Estate Capital.

That would represent a moderate decrease from the first fund in the series, which raised £130 million of investor capital by 2014 and generated a gross internal rate of return of 12.5 percent and 10.5 percent net by December 2017.

“Rates for commercial bridging have come in by 250 basis points in the last five years, due to increased competition in the sector,” Mackenzie said. “The cost of our capital is not pegged to interest rates, but to the cost of equity, and the return that equity is seeking has come in during the last five years.”

The sponsor in a typical Octopus loan typically opts to fund an acquisition using short-term debt as an alternative to their own equity or seeking private equity, Mackenzie added. “The hurdle rate private equity is seeking was 15 percent five years ago and around 10-12 percent today,” he said.

Octopus tested the prospect of a follow-on fund with its existing investor base shortly after the UK’s referendum on EU membership, before widening its discussions to new UK and Continental European institutions.

“In the aftermath of the referendum, appetite for UK-centric strategies was very thin, but as Brexit negotiations have progressed and as investors have become desensitised to it as a subject, appetite has returned,” Mackenzie said.

Octopus set out with a target of raising £200 million for CREDF II and held a first close on £115 million last September. The £230 million raised by its final close came from nine external investors, plus a £30 million contribution from discretionary funds managed by Octopus. The external investors comprise pension funds from the UK, the Nordics and Switzerland, as well as two fund of funds vehicles.

Short-term, asset-backed lending offers investors comparable returns to equity, while mitigating risk by capping leverage at 70 percent, said Mackenzie, noting that the first fund’s average loan-to-value was 58 percent.

Despite the transitional nature of the underlying assets, McKenzie’s argument is that the fund offers investors greater protection than higher-leverage mezzanine loan funds, or even senior funds with loan tenors in the five-year range. “Five-year lending gives investors no visibility on their exit,” he said.

By writing short-dated loans and recycling capital through the fund’s life, Octopus aims to originate more than £600 million in the coming three years. Since the fund reached first close in September, it has written 19 loans with a combined value of £105.4 million.

Like other specialist lenders within the alternative sector of the UK property lending market, Octopus began by raising retail money for its debt strategy. Its switch to institutional capital came in 2014 and the wider group now manages more than £1.8 billion of institutional funds. In addition to its first CREDF vehicle, Octopus raised CREDF Syndication, a £140 million sidecar fund, with capital provided by existing investors in 2016.

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