With two, and potentially three, initial public offerings on the road, it’s a good time to ask: is listing property debt funds a good idea?
No way, say the detractors. They will raise too little. They will be illiquid; they’ll trade at a discount. It’s an expensive way to raise capital and you’d only do it if you couldn’t raise money privately. And anyway, debt is a long-term, potentially risky investment best left to the professionals qualified to do the due diligence work.
Obviously, the teams out there fund raising, and their advisers, disagree. ICG-Longbow, advised by Investec, has gone public on its IPO. It says investors from wealthy individuals through to joe public are interested in the concept of lending to good companies, including property businesses – just look at the early, if modest success, of the retail bond market.
Longbow, which has launched an IPO for a UK senior debt fund, wouldn’t want to tempt fate, but says there is a lot of interest in the promised 6% yield. It looks pretty good compared with the other fare private wealth advisers are serving up.
How do they get 6% returns from senior debt? From lending on higher-yielding property, pointing out not unreasonably that most of the UK property market outside central London now yields 8%. Obviously picking the right property and the right borrowers is key – that’s their job.
What about the risk of property values tanking again? Are they calling the bottom of the market? They haven’t said so, though one might think that.
Their maximum loan-to-value ratios on the loans they will make is 65%, with no subordinated debt, which has the virtue of simplicity and looks very safe. Safer than retail bonds, which are unsecured and more akin to junior debt, though covenants capping issuer’s LTV levels have been put in place on more recent issues.
The shares shouldn’t trade at a discount if ICG-Longbow’s team can, as promised, invest within six to nine months of launch, as the income should be wholly predictable. With investing, maybe less is more, as some private equity fund managers who raised big sums in 2007/2008 found out when it took years to spend it.
Starwood’s IPO has a very different strategy, not yet officially unveiled, so some of what follows is surmise. The group has told investors that it will make 8-9% total returns and pay a 7% dividend yield by investing at 25-70% LTV levels across whole, senior and subordinated loans. So presumably an option is to make whole loans and sell on the lower-yielding, super senior pieces to boost returns.
It will have done its research as to who will be buying – implying that Starwood believes some kind of distribution market for senior debt will return.
This is likely to be driven by fixed-income allocations of pension funds and insurers, not banks. With another dozen or so managers raising capital for unlisted senior debt strategies (p12) we are about to find out just how keen they are.