Asian institutional investors are betting on returns in US real estate private debt, amid increased confidence in the country’s real estate equity space, according to industry sources.
“The single best risk-adjusted return in the US real estate market today is debt,” Todd Henderson, global co-head of real estate and head of real estate for the Americas at asset manager DWS, told AsianInvestor.
“The combination of regional banks and small banks materially retreating from the market, in addition to the fact that even large banks have restricted their lending, has created a gap in lending.
“That's creating a really unique opportunity, [with] bigger returns on more conservative underwriting at lower attachment points," he said.
Craig Oram, managing director and head of debt originations at LaSalle Debt Investors, described the US real estate market as “a very attractive space to originate debt”, noting several developments in the space.
“In addition to the high interest rate environment, low loan-to-cost and attachment levels combined with limited lending competition are providing attractive returns with greater levels of insulation from higher subordination levels,” he told AsianInvestor.
“Lower loan-to-cost and -value [LTV] versus 2021-22 levels are becoming standard in underwriting, as lenders are limiting leverage given market conditions and future interest rate projections. In 2021 and 2022, average leverage on bridge loans was anywhere between 75% and 85% LTV. Today, loans with the same or slightly higher spreads on similar products are being originated between 60% and 70% LTV.”
Four of the five sources interviewed for this story said they had observed a significant increase in interest in the space among Asian institutional investors.
Their observations appear broadly to be supported by four years of data from Preqin Investor Surveys, which showed global appetite for US real estate investments this year approaching its highest levels since 2021.
“What we’re seeing is Asian investors pivoting into private [real estate] debt,” Indraneel Karlekar, global head of research and portfolio strategies for real estate at Principal Asset Management, told AsianInvestor. “There’s been a significant uptick in capital deployed to it.”
Chris Pilgrim, managing director for Asia-Pacific global capital markets at real estate services firm Colliers, said: “A lot of institutions in Asia-Pacific are specifically targeting the [US real estate] credit market at the moment. The US is generally a very strong market for that because of the availability of capital, the availability of product, and the liquidity of the market.”
THE LONG GAME
Ben Tschann, a partner and co-chair of the hospitality and leisure practice at global law firm Goodwin, said the move by investors into American real estate private debt wasn’t simply a passing fad.
“The market has got longevity to it,” he told AsianInvestor. “There’s such a healthy appetite for it, and there’s a big argument for it: it’s investing in US dollars and investing in an economy that’s obviously mature and robust, and which can withstand pretty significant disruptions.”
Henderson and Tschann pointed to the provision of senior loans, preferred equity, and mezzanine financing as means by which Asian investors were tapping the market, with the latter gaining popularity thanks to its healthy returns.
“To be the first mortgage lender, you're putting out maybe 60-70% of the value of an asset,” Tschann said. “The mezzanine piece involves less capital, but you can get a really healthy return on it. You can put out maybe US$10 million and get a 15%, 16%, 17% return on that, and if you do that over a handful of investments, you’ll have done pretty well by your investors.”
Oram was more sceptical about the risk-return calculus of mezzanine financing, arguing instead that providing senior loans was a safer option.
“With the one-month term secured overnight financing rate projected to remain above 4%, this provides a first mortgage lender with a high single-digit paying loan with significant insulation from any drop in value,” he said. “Mezzanine and B-note investments… carry an outsized amount of risk without the upside benefit.
“Another product that has become increasingly risky is lower-tranche commercial mortgage-backed securities investments,” he said. “These bonds were traditionally considered solid, diverse investments with low volatility. Today, however, they’re secured largely… by office assets, whose performance and value are rapidly deteriorating.”
The Covid pandemic and the resulting practice of working from home have subjected the office segment of the market to considerable stress, making it an outlier amid broader trends. That development appears to be reflected in Preqin Investor Surveys, which show that the proportion of investors naming distressed funds as the most promising investment in US real estate leapt from under 20% in 2022 to more than 45% this year.
“When we look at three of the four major ‘food groups’ — those three being industrial, residential, and retail — the fundamentals are very strong, and it's not a distressed opportunity in these sectors but an imbalance in the supply of, and demand for, credit,” Henderson said. “But on the office side, there are significant distressed opportunities because you have a combination of distressed fundamentals and serious capital market pressure. Those opportunities don’t come without significant risks, and they’re not for the faint of heart.”