|Jeffrey Williams, fixed income fund manager, Schroders|
UK-based asset manager Schroders has long identified mid-market commercial real estate loans in the US as a target.
“This is a particularly attractive part of the market,” says Jeff Williams, fixed income fund manager, in Schroders’ New York-based securitized credit team. “There is less competition than the market for larger loans and we are not competing with many of the real estate debt funds. You can get very high-quality credits at higher yields.”
One way for a large institutional player to get access to these loans is to buy into a local direct lender and, critically, one with its own servicing platform. To this end, Schroders recently made a 20% equity investment in US-based A10 Capital, which is based in Boise, Idaho, and Dallas, Texas.
The firm writes loans ranging from $1 million to over $30 million per commercial property and is an authorized seller and servicer of the Freddie Mac single-family rental (SFR) pilot programme.
Schroders has invested in the company alongside Gemspring Capital, a mid-market private equity firm based in Westport, Connecticut. The firms now have a controlling interest in the company.
Another direct lender targeting the smaller end of the real estate market is UK-based Omni Partners.
The London-based firm, which has $1.2 billion of AuM runs a private credit strategy specialising in real estate debt alongside a separate equity event-driven hedge fund. It runs three secured lending funds, focusing on UK residential real estate. It focuses further towards the very smaller end of the market with a median loan size of just £350,000, lending to professional investors – either professional landlords or small-scale property developers.
“This is an attractive risk/reward proposition,” explains Elissa Von Broembsen-Kluever, managing director, credit and lending funds at Omni Partners. “The security package on the loans is substantially better than for other types of lending. Your rights as a creditor are strong and you can pursue the receivership route and become a mortgagee in possession. This is far better than traditional direct lending.”
|Elissa Von |
Broembsen-Kluever, managing director, credit and lending funds at Omni Partners
The US mid market has seen the traditional regional and community banks lending to real estate gradually reach their capacity limits, so direct lenders can exploit heightened interest from institutional investors to offer 15- to 20-year fixed rate CRE loans in their place.
US insurers such as Met Life and New York Life are prominent lenders, but now non-US investors are moving in via direct lenders, attracted by the liability matching potential of these assets.
“There is a lot of interest from UK insurance companies as this provides opportunities for longer-dated fixed rate assets,” Williams tells Euromoney. “Longer-dated permanent loans provide 50 basis points to 75bp additional yield, which is meaningful when spreads are not wide to begin with.”
The banks may not be as competitive as they were in this part of the mid market, but – a decade after the collapse of Lehman Brothers – securitization is again an increasingly cheap source of funding for mid-market real estate loans.
“The CMBS [commercial mortgage-backed security] market is mispricing credit risk as investors are moving down the credit curve and chasing yield,” warns Williams. “We like giving up liquidity and moving into lower LTV [loan-to-value] loans in markets that are less crowded.”
He sees the collateralized loan obligation space as increasingly overcrowded as well.
“CLOs are very favourable to issuers at the moment,” he says. “We are almost at the bring-out-your-dead phase of the market: we are seeing deals from guys that only set up shop a couple of months ago. This gives A10 the opportunity to expand diversity – if there is a loan opportunity that is too large for them, then we can participate. We can be there.”
Omni’s real estate strategy has evolved from taking high net-worth and family office money to institutional capital. Again, this is a product of traditional bank funding drying up – in this case in the UK residential space.
The fund makes short-term 12-month property loans and exits by selling the units – often to the growing ranks of UK challenger banks.
While challengers such as Secure Trust are most competitive around the exit, other direct lenders and peer-to-peer players are also taking a closer interest in this trade. Particularly active is Together Financial, which had an outstanding loan book of UK retail and commercial mortgages of £2.8 billion at the end of March. It has funded its expansion in the private securitization market.
“We structured a closed-ended fund with more private equity features than hedge fund features,” explains Kluever. “One of the biggest risks is realization risk: can you sell? If you are closed ended, you can take your time. Brexit has validated the decision to go for a closed-end fund.”
The firm has three secured lending funds, the second of which was raised in 2016 and has returned an estimated net internal rate of return of 11% to date.
The yield curve is inverted for real estate direct lenders with short-term lending such as this far more attractive than writing 25-year mortgages. So, this is another strategy that might attract more yield-hungry investors looking for real estate exposure.
“The phrase ‘direct lending’ has very much been co-opted by the small and medium-sized enterprise space,” says Kluever. “Unless you can be very creative, or centre on a geography, or find an interesting space where you can become a credible player, this is the only place you can get in. It is really difficult to differentiate yourself.”