Traditional senior lenders’ retreat from European real estate has left a gap that has been filled by fund managers, insurers and others engaged in ‘shadow banking’ – a fact not lost on regulators, nor on investors aspiring to the enhanced long-term ‘yield’ returns promised by many debt funds.
Until recently, only well-established debt managers were able to raise substantial funds. As investors put a premium on experience, a number of high-profile managers looking to raise debt funds to sit alongside equity products were rebuffed for lacking the requisite track record.
Inevitably, investors favoured US managers with this experience and a number raised significant war chests to deploy globally. The interest in debt funds peaked in 2011 with 25 funds reaching final closings with around $10bn of commitments. One Blackstone fund alone raised a phenomenal $2.9bn. But most of this cash was from US investors more familiar with viewing debt as a distinct asset class.
This previous all-round US focus is changing in many ways. Last month, KKR saw the value in buying home-grown European credit fund manager Avoca Capital. DLA Piper is receiving significant instructions from US managers setting up European funds, many of them aimed at European institutions. More importantly, a growing number of European managers are successfully raising funds in their own backyard, including M&G’s UK Companies Financing Fund, which received £200m from the UK government last year.
M&G has also spotted great investor appetite for exposure to a mixture of senior, typically Arated credit and higher-risk mezzanine debt. It is closing two big real estate debt funds, M&G REDF II and III, investing in mezzanine and stretch senior debt respectively. Investors can invest in either or both, depending on their risk profile.
While the funds have separate investment strategies and target returns, they will also be able to invest alongside each other, providing a one-stop shop for borrowers. Clearly, demand in Europe remains fairly vigorous. As recently as June, ICG closed its third UK real estate debt fund at the not-insignificant hard capitalisation of £700m.
One feature of this market appears to be that lesser-known managers are gaining traction. In a September report, Preqin identified that 30% of debt investors are willing to invest in first-time managers, against 12% for private real estate investors as a whole. This contrast with our experiences in, say, 2011 implies that too much money is chasing high-quality opportunities. It even raises that big question: is this a bubble?
In practice, we have seen European managers and investors climb a learning curve in relation to debt, and greater flexibility offered to investors to gain their commitments; the latter includes managers offering parallel ‘side car’ vehicles with strict geographical restrictions for institutions otherwise precluded from investing in higher-risk real estate in some parts of Europe.
Similarly, DLA Piper has helped managers arrange managed-account type investments for European institutions that are uncomfortable with collective investment in an unfamiliar asset class. As long as some restraint is shown on both sides and managers don’t overcommit to investors as to the level of investments they can make in today’s market, we are optimistic about developments in Europe’s alternative credit market.
Tighter regulation, the key that originally opened this market to alternative credit providers, could one day swing things back in banks’ favour. But with national regulators only just finding their way around the EU Alternative Investment Fund Managers Directive, amongst other things, this doesn’t appear to be an immediate prospect.
In any case, banks are unlikely to want a return to the previous status quo. Moreover, most people believe shifting to a balanced, US-style, finance market would be a good thing. European debt fund managers and investors seem to be embracing the learning and evolution we need to maintain an orderly market in debt funds.
Gawain Hughes is a partner at law firm DLA Piper