Recent bank collapses have increased both the risks and the returns available from real estate debt investing.
Trevor Castledine, a managing director of the private markets team at Bfinance in London, more than half of whose institutional clients are from Asia, said that terms for institutional investors will improve if banks withdraw from the sector.
“It’s a great opportunity for private credit lenders targeting better quality properties that have been conservatively valued. For investors, committing today to a fund that is making real estate loans in a space where there is more demand than supply of credit, could be a very good idea,” he said.
“Banks in some markets have retreated to lower risk positions, which is creating greater opportunity,” said Steve Bulloch, managing director and head of Australia, at PGIM Real Estate.
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The sector suits institutional investors with a larger appetite for risk, according to Castledine.
“It’s private wealth, family offices, endowments and sovereign funds – those investors who traditionally are more accepting of risk and complexity, and are more return-seeking because they are in many cases not regulated,” he said.
Bulloch said that he was seeing growing demand from two types of investors. The first are traditional debt investors who were focussed on other sectors, but who now see real estate as a good alternative.
The second are traditional real estate investors shifting allocations from equity to debt to achieve better risk adjusted returns.
“[In the second case], this capital is typically more interested in the higher yield end of the spectrum,” he said.
But Castledine warned that pressure on banks to secure their lending books in the face of bank runs in the US, and the near-collapse of Credit Suisse, could create a funding crunch for parts of the sector judged to pose a particular risk – particularly older buildings, those in locations less in demand with tenants, and those that perform poorly in terms of emissions.
“Certainly, the entire sector is now more of a risk than if the bank failures hadn’t happened. I can see extreme challenges for current lenders, especially around lending for second-tier low quality properties,” he said.
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The withdrawal of banks from real estate lending preceded the recent bank collapses, as banks concerned over falling values in the sector sought to bring loan-to-value (LTV) ratios back within targets.
“[Falling valuations mean that] a bank that was lending at 60% LTV could now be lending at 80% LTV and breaching its risk limits,” says Castledine.
Craig Wilson, a partner in the debt advisory team at global property consultancy Knight Frank said that banks started curbing their activity last year.
“In Q4 2022, the increased cost of debt and softening yields in the real estate market resulted in many bank lenders adopting a ‘wait and see’ approach to lending, with many pausing origination efforts whilst the ‘V’ of LTV stabilised,” he said.
But increasing wariness on the part of banks in Europe and the UK has seen LTVs on new loans fall, too – a trend likely to accelerate in light of recent bank collapses.
“For the senior lending banks in Europe and the UK that have continued to originate over the past six months, almost all have exercised caution due to the pressures on interest cover ratios, with senior leverage down from 55-60% LTV to 45-50% LTV,” said Wilson.
Investors attracted to the return profile of real estate debt at a time of falling capital values have stepped in, in place of the banks, with funds flowing into APAC funds, particularly in the last year.
APAC-focussed funds real estate debt funds raised $3.24bn last year, up from $2.07bn in 2021, according to Preqin.
“With base interest rates having risen substantially in most parts of Asia, the absolute return available for a debt investment is increasingly attractive at a time when rising interest rates and global economic uncertainty have made equity investment more challenging,” said Bulloch.
He pointed to Australia, where interest rates have increased from 0.1% in April 2022 to 3.6% today. “Margins have remained relatively constant [over that time],” he said.