In recent months, some leading real estate names, including Kennedy Wilson, Delancey, Tristan and Ares, have announced their intention to enter the European debt market, attracted by the risk-adjusted returns on offer and diversification benefits.
They also aim to capitalise on the retrenchment of traditional lenders caused by the pandemic, a trend that began following the global financial crisis (GFC) more than a decade ago.
The appeal to new entrants is clear. Returns from debt investments can be more immediate than in the equity market, with typical investment periods as short as 12 to 24 months versus hold periods of three years plus for equity strategies.
Although debt returns are typically lower, they offer the same yield profile but with reduced risk. This is attractive given market uncertainty and is a hedge against the additional risk these businesses are managing through their equity investments.
Furthermore, higher-leverage debt options can be aligned to more conservative investment strategies. For example, in the event a debt deal goes wrong, the investment committee is usually highly experienced in a specific sector and so a recovery situation comes with less risk than it might to, say, a bank.
This surge in popularity has the potential to create a ‘race to the bottom’, leading to deals not being priced or structured for their commensurate risk, one cause of the GFC. This could restrict overall returns in a scenario where a wider portfolio of loans is under water at high LTVs with suboptimal returns.
Undoubtedly, many new players will replicate the success they have had in the equity market in other geographies. But in an increasingly crowded debt market, against a unique macro-economic backdrop, there will be challenges, with lack of experience perhaps most significant.
Since the GFC, there have only been short periods of a ‘normal’ cycle, with Brexit and Covid artificially disrupting the market and forcing investors, developers and lenders into a prolonged reactionary mode.
The more experienced lenders have thrived. Their bankers and credit boards know the clients well. There is an understanding that while making quick decisions on a deteriorating deal might be the fastest way of getting their money back, it might not be in the wider interest of the relationship or long-term capital preservation.
Senior debt providers with less pressure to deploy capital, who have a more conservative approach to underwriting, have a far greater ability to be flexible if the market moves suddenly. Underwriting in sectors such as BTR and logistics requires a high level of sophistication. The ability to structure bespoke loans to ensure they can survive a change in market dynamics is critical.
And all this before any major change in interest rates, which we all know is inevitable, with the impact likely to be significant.
At Investec, we have more than 30 years’ experience providing finance across various sectors, building a £2.5bn loan book through multiple cycles with a successful track record of lending during downturns.
Many of our borrowers have been with us for more than 20 years. We understand their strategies and the sectors they are active in, which has allowed us to be flexible, patient but also innovative.
Erin Clarke is relationship director at Investec Real Estate