This is what has been happening with real estate debt since investors picked themselves up after the initial Brexit shock, according to some pretty cheerful debt fund managers out now raising capital.
At a journalists’ briefing in London this week, Standard Life Investments’ head of research and strategy for real estate, Anne Breen, pointed out that UK gilts had come down to under 1 percent after the 23 June vote and the subsequent 25 basis points Bank of England interest rate cut. By her reckoning, senior commercial real estate debt was yielding 190 bps more (at 31 August).
David Paine, the insurance group’s head of real estate, said such a yield premium was attractive enough in a world of ever-lowering return numbers, and it was showing through in a definite pick-up in interest in recent weeks in Standard Life Investment’s own senior CRE debt fund.
So, for insurance companies and pension funds, that margin is a big tick for CRE debt in the liability-matching box.
Debt’s defensive quality is a tick in a second box, as far as de-risking institutional investors see it. If they fret about where UK real estate values might be headed, and want to be in the safest part of the investing capital stack, then debt will give them fewer sleepless nights right now than equity.
Looking back, three months after the event, it is true that values did not collapse after the referendum vote, despite seven open ended funds (OEFs) closing in the face of record redemption requests. Standard Life manages one of them, and Paine said the fund (which remains closed) had “realised sales at around 5-6 percent discounts to pre-Brexit values”. CBRE’s last monthly index (6 September) said the decline in capital values slowed in August taking the fall in the first two months after Brexit to -3.8 percent and the total return decline to -3 percent.
However, privately, no one is saying that values have already found a floor. The OEFs will have accounted for the overwhelming majority of the £3.2 billion of UK property sold in July and August, Paine said. They have been coy about exactly what they’ve been selling but with one or two stand-out exceptions, it seems to have been the most liquid kind of stock: as you would expect, it is high-quality, well-let, in £20-40 million lot sizes.
So far, hardly any very large assets have been brought to the market and few secondary property sales have tested it.
There is one more stand-out reason why debt funds put a tick in investors’ boxes; they are taking business, at good margins, from banks.
UK loan margins have risen as a consequence of the higher risk, by an average 30-50 bps, and banks have been re-pricing or even dropping deals they were considering financing pre-the referendum vote. As Natalie Howard of debt fund manager AgFe told Real Estate Capital recently: “We have seen deals come back to us which clearers had previously under-priced us on, and which had since been re-priced by the clearers. Borrowers are speaking to lenders that can move quickly so they are coming to firms like ours”.
Another debt fund manager wonders whether the German pfandbrief banks will pull back too, though for a different reason brought on by Brexit. If the UK leaves the EU and the European Economic Area in future, UK loans will not be eligible as collateral for the pfandbrief market. While the UK could apply for nominated status, which the US, Canada, Switzerland and Japan have, there could be a period of uncertainty while this is sorted out. “If I was a pfandbrief lender, why would I do a lot of deals now if my cost of capital could change when I refinance them?” he asks.
The pie may be smaller, but with banks more cautious, non-bank lenders are likely to have a bigger slice of it in the last few months of 2016.