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With real bank credit remaining well below Q4 2009 levels in all developed markets bar France and Japan, according to the BIS, demand for alternative sources of funding is rising – particularly in Europe.
The funding gap between European maturing commercial property debt and the amount banks were prepared to refinance hit €42 billion last year, according to advisory firm Navigant.
Direct lenders focus on mid-market, secured debt financing transactions that are too small for traditional debt capital markets but require more leverage than banks are willing to provide, usually in the €25 million to €200 million range.
Most direct lenders use a debt fund structure to provide commercial property financing on behalf of institutional investors looking to match long term liabilities, providing attractive returns and higher leverage for borrowers – at a price.
“There’s an increasing amount of alternative money that is targeting real estate, so it’s definitely a growing area,” says Floris Hovingh, director and head of lender coverage at Deloitte. “We’ve seen a number of alternative debt funds being set up, some smaller ones and some larger ones like Partners, Pramerica, and Pricoa.”
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Real estate survey 2014: Results index |
Hovingh says what is new is the ability to do senior or stretch senior real estate debt. “Previously, there was always the ability to do mezzanine real estate debt from alternative lenders,” he says. “But these new funds are able to increase the senior LTV to a level that is potentially higher than you could get with senior or even where you would get to with mezzanine, but do it for blended pricing anywhere from 4% to 7% or 8%.”
Direct lenders do not typically target London or other prime property that can be easily financed with senior debt with a 65% LTV for 100 basis points over Libor, but rather secondary and tertiary locations using a unitranche structure to provide 75% or 80% of funding priced at 4% to 5% over Libor. That compares to typical mezzanine pricing of around 10%.
The $79 billion alternative asset manager Ares Management exported its US Business Development Company model to Europe in 2007, focusing on corporate cash-flow deals in the illiquid middle-market, and more recently commercial real estate debt. Ares’ real estate unit has been buying European CRE for the past decade, primarily in the UK and Germany, with more than $2.9 billion under management.
“The opportunity in Europe is similar to what has played out here in the US, but in many respects it’s more acute,” says Todd Schuster, senior partner and global head of real estate credit investment programmes at Ares.
Aggressive lending
The banks’ share of commercial real estate debt in the US has been falling for 25 years and is now below 50%. But in Europe, aggressive, cheap lending that crowded out rival capital sources means banks still hold more than 90% of the €2.7 trillion market.
“When the financial crisis hit there were other established sources of commercial real estate debt in the US besides banks, but that still really isn’t the case in Europe,” says Schuster.
“On top of today’s deleveraging, the 80%-90% LTV loans banks made prior to the financial crises continue to have significant embedded losses. So there’s a significant opportunity for lenders like us to come in and fill the gap and do it with more realistic LTVs.”
Ares, which is engaged in capital raising for European real estate debt through separately managed accounts and employs capital from its US-based Real Estate Investment Trust, says it may launch a comingled CRE debt fund in the coming year.
