Debt fund capital tide still rising in European waters

Euro debt funds’ capital raising in first half of 2014 beats 2013 total, reports David Hatcher.

Capital raised by real estate debt funds has fuelled competition in the financing market this year, particularly in Europe, but managers are resolute that the diversification is positive and sustainable.

In the first half of 2014 alone, funds targeting Europe held final closings on $9.97bn (£6.14bn) of capital, accounting for 53% of all equity raised globally in that period and underlining the strides made by this category of new lenders to property.

The first-half total is up on the $7.21bn of European final closings in all of 2013, itself more than double the capital raised for the continent in 2012 and more than was raised in any year since the downturn,  research from Real Estate Capital’s parent PEI Media Research and Analytics shows.

REC 10.14 p10 pieDespite a squeezing of margins and the record figures, managers say the market will grow further. “Capital flows into Europe reflect the private debt market’s relative immaturity here relative to the US; there is a relatively attractive opportunity that is likely to last longer,” says Dale Lattanzio, managing partner at DRC, which carried out a final closing of its £487m European Real Estate Debt Fund II in May.

“The disintermediation of the banks in Europe is still early in its evolution and because banks were providing 95% of all debt, the size of the opportunity is still large. Conversely, the US market has already experienced this disintermediation and the market there has more balance in terms of bank and non-bank sources of capital.

REC 10.14 p10 table“This leads to resilience in the finance market, which we can see in the relatively rapid recovery of liquidity to normal conditions after dislocation.”

However, there is an emerging awareness  that the number of closings and the competitiveness of the market means debt managers and investors must become more selective and wary if they are to achieve the returns promised when funds were raised.

“A significant amount of debt is changing hands across Europe targeting a variety of strategies, from new lending to distressed acquisitions,” says Michael Zerda, European director at LaSalle Investment Management and manager of LaSalle Residential Finance I, a £440m fund focused on residential development finance.

“The pick up of capital into the sector has increased competition and affected yields across the capital structure. Managers must exercise prudence to avoid repeating past mistakes during times of higher liquidity.”

It has been speculated that some managers have offered to return cash to investors as the squeeze on margins makes initially- promised returns no longer attainable.

However, others say this is not a problem. “The market has become more competitive but that hasn’t been a problem as we took that into account when setting our target returns and explained it to investors at the outset,” one fund manager says.

About 20% of the capital raised for European property debt in the first half
of 2014 was targeting distressed debt investment, not new lending. At its final closing in May, the largest real estate fund to close, Kildare Partners’ Kildare European Partners I, had raised $2bn for distressed investing, mainly in debt (see panel below).

Europe outpaces North America

The data, part of a debt survey covering all private debt sectors for Real Estate Capital’s sister title, Private Debt Investor, shows the increased interest in property debt investment in Europe is in contrast to North America, where the total raised in the first half of 2014 was only $2.71bn, although it followed a higher $8.65bn raised in 2013. Fund raising for North America real estate debt funds peaked at $15.95bn in 2008, when only $70m was raised to target property debt in Europe.

REC 10.14 p11 Charts 1 & 2

The largest real estate debt fund closing in the first half of 2014 was PIMCO’s $5bn Bravo Fund II, which has a global mandate.

In Asia, figures suggest real estate debt funds, while becoming more popular, are still a small part of the market, with $625m raised in the first half of the year – if only $30m less than the total raised in 2013.

Globally, $18.8bn was raised for real estate debt funds in the first half of 2014, which appears roughly consistent with 2013, when $32.11bn was raised during the whole year. Broadly, real estate is becoming more popular with investors in private debt relative to other sectors. Real estate made up 45% of total debt investment in the first half of 2014, the highest level since the downturn, and up from 31% for all of 2013.

The total for all forms of private debt investment in the first half of 2014, including infrastructure and private equity, was $41.8bn. Over the past five years 30 funds have raised $318bn. ■

 Kildare leads the march of the debt fund specialists

Ellis Short made waves on his return to the market, proving there is life after Lone Star, by closing a $2bn fund targeting distressed debt and equity investments through his new company, Kildare Partners.

The former president and head of Asia for Lone Star has since closed in on the €1bn Mars portfolio of 26 German assets bought from Deutsche Bank, and two Irish shopping malls for £130m from Royal Bank of Scotland.

In April Kildare just lost out on buying Nationwide’s €850m Project Adelaide non-
performing loans, secured against German assets, to Oaktree Capital Management.

M&G raised more than $2.3bn in the first half of the year, $1.29bn for its third fund, which targets “stretch senior” or whole loans, and $1.04bn for its second fund, which targets mezzanine lending.

LaSalle Investment Management also closed two funds in the period, totalling $1.4bn: $1.03bn for Real Estate Debt Strategies II, targeting UK and German whole and mezzanine loans, and a second, $346.5m tranche for its Residential Finance Fund I.

AgFe raised the largest single fund focused on originating loans, clinching $1.71bn for UK lending for its Fixed Rate Senior Debt Fund, with a single mandate from retirement specialist LV. It will issue loans of £10m to £100m on investment-grade properties.

REC 10.14. p11 table