The proliferation of capital allocated to real estate via trusted conduits is a natural progression in the sector’s evolution, partly underpinned by globalisation and partly by the global search for risk-adjusted returns across the capital structure, asset classes and geographies, writes Eastdil Secured managing director Riaz Azadi
As the world continues to get smaller, financial markets more interconnected and capital sources more diverse, the need to understand capital demand drivers when investing in commercial real estate is paramount.
Wherever that capital is within the capital stack and whether it is defined as active in debt (via banks, insurers, M-REITs, mezz funds), preferred or common equity, the distinction is in the apportionment of risk and the associated risk-adjusted returns.
Overlay on top of that a broad array of factors: deal volumes and velocity; divergent and increasingly complex regulatory environments; macro-economic factors; cultural, geographic and jurisdictional differences; different and emerging asset classes; plus every piece of real estate being unique, by virtue of its location and demand drivers – all within a global context. Then you have the makings of a very dynamic market and a much greater need to understand the requirements of debt
and equity capital alike.
The conundrum for chief investment officers highlights (albeit at a high asset-
allocation level) is the challenges that come with the increase in capital sources, both debt and equity. Specifically, in a low-yield environment, real estate offers a relatively attractive risk-adjusted return (see table and chart below).
Global and domestic real estate investors are focused on specific markets by sector, geography and return profile, as well as on operators and managers with strong track records. Moreover, these markets and managers are then being directed to strategies across the risk spectrum, whether via public or private markets, debt and equity markets and/or via non-performing or sub-performing loans vs direct acquisitions.
Equity: flowing across borders
This has resulted in several recurring sponsor-related themes predicated on manufacturing the appropriate risk- adjusted return:
l More global capital is being allocated to investors/managers today than has been the case historically, on a fund and separate account basis, as well as via a continued appetite for direct investment;
l More investment has been cross-border, into established, liquid markets, as illustrated by the fact that 50% of the London investment volume in the first half of 2015 has been from non-domestic sources;
l Capital is being raised by sponsors for alternate parts of the capital stack to diversify their assets under management, manage risk/reward appropriately and access real estate exposure in different forms. For example, according to Preqin, private debt managers now hold $185bn of dry powder globally, up 50% from 2010;
l Pending sponsors’ risk appetite, pricing in gateway cities has led equity into regional markets and/or other alternative asset types or non-domestic markets;
l It is a unique market, in that investors can be both active buyers and sellers within the same geography;
l With increased transaction volumes comes increased deal velocity and deal sizes; l A constant flow of new global entrants is increasing market liquidity.
The combination of these themes means that increasingly, for levered investors, the new norm consists of tight timeframes, maintaining appropriate levels of flexibility to deliver their business plans and having a financing partner with debt capital to match the specific investment or fund strategy; they also prefer to have a diversity of lenders.
Debt: an evolving market
Europe’s debt market itself has changed significantly since the global financial crisis, but also continues to evolve in real-time. In 2009-10 much focus was on the debt funding gap, a reference to the leverage in the system and the legacy capital stack.
Today’s market is about debt liquidity available, by reference to either geography, asset type, asset life cycle (i.e. speculative development, weighted average lease length, vacancy rate etc) or deal quantum.
Similar to equity, the debt component has a wide range of funding sources, ranging from retail depositors, money markets, pfandbrief, CMBS markets and insurance/pension liabilities, in addition to public debt vehicles, LPs and family offices.
Further, these debt capital sources are governed by different regulators, tier 1 capital requirements and internal policies. They have different exposure limits and expertise in different geographies, currencies and asset classes, plus resourcing to provide different loan sizes.
Activity has also increased significantly in the secondary loan market, which also forms an important cornerstone with respect to debt liquidity, both on large loans and complex capital structures. At the same time, from a borrower perspective, all these inputs manifest themselves in loan pricing, proceeds and structure.
Understanding Debt and Equity
Given the broad range of lenders, borrowers and collective requirements in addition to the increasing need for speed and certainty, understanding capital demand drivers is key in bringing together the right partnerships.
At a time when global capital continues to diversify its entry point into commercial real estate and many established capital providers are adapting and evolving, trusted advisers as facilitators for capital have grown increasingly relevant, to ensure the market continues to function efficiently.