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Real estate debt: are non-bank lenders here to stay?

3 MIN READApril 16, 2019
Non-bank real estate lending is still a relatively new market in Europe, dating back to the aftermath of the global financial crisis (GFC). Andrew Macland, head of European Debt at PGIM Real Estate, explains how the GFC changed the landscape of real estate debt: “The European market was dominated, and to a large extent still is, by standard clearing banks and investment banks. With the banks retrenching post-crisis, it opened up a massive opportunity for non-bank lenders, including ourselves, to replace traditional lenders in providing investment grade, core mortgages. It also opened up a big opportunity for a value-add strategy, because the banks were lending much lower, or not at all.” 

PGIM Real Estate established its European debt platform in 2009, adopting a two-pronged approach that targeted value-add style returns, through its existing PRECap strategy, together with strategies catering to its investment grade investor base. Macland explains further: “We do investment grade-equivalent lending, which is low risk and tends to target around 100 - 250 basis points over relevant Libor/Euribor rates - what we call ‘core’ debt investing - and we invest all the way through to equity-alternative strategies, targeting absolute returns of say 12% - 15%.”

Value-add strategy

PGIM Real Estate’s value-add debt strategy allows it to invest across the capital stack, from junior debt to preferred equity, in order to achieve the best risk-adjusted returns. Typical investments might involve under-managed assets and Macland describes a recent example: “We backed a sponsor to acquire a block on Oxford Street, which was under-managed, had had no money spent on it, and the quality of tenants was very poor. We backed the sponsor to buy it, to empty it, then spend money on refurbishing and reletting it. That was a value-add deal, so it had co-investment equity, it had mezzanine, and we also underwrote the whole of the senior loan and then syndicated it.”

When it comes to value-add, working with the right partner is just as important as finding the right asset, says Macland.  “The sponsor in that Oxford Street deal is a global specialist in high-end retail. They have a strong track record and we have done several other deals with them. They add value to the underlying real estate and we back that value creation. In terms of capital protection, we like real estate that’s going to be improved, because it de-risks the position, creates a more liquid product, and it’s also how we boost our returns - we participate in the value creation.”

Debt exposure demand

PGIM Real Estate has invested nearly US$10bn in European real estate debt strategies on behalf of global investors. “That’s US$10bn which offers investors in Europe a return profile, that wasn’t available to them pre-GFC,” says Macland. “Previously, alternative lenders offering investors with these styles of return didn’t have a foothold in the European market on any sort of scale at all.” 

Investor demand remains as strong as ever, observes Macland. “A lot of investors are looking to either allocate to fixed income alternatives or get exposure to European real estate via debt. There has been a huge shift in the last 12 months - pension funds and insurance companies are looking at their liabilities and finding that hold-to-maturity debt investments actually match them very well.” 

In particular, says Macland, “we’re seeing quite a big push into the core, investment grade space because it offers diversification and a good alternative to corporate bonds, very simply.” 

PGIM Real Estate, says Macland, has recently won several large mandates to invest in investment grade core mortgages. In the value-add space, says Macland, PGIM Real Estate is still investing quite heavily, “whether because of dislocation from the banks, or because it’s now an accepted type of capital.” Furthermore, as with the comparison between real estate debt and fixed income, “a lot of institutional clients who traditionally would have put their money into equity are now looking at real estate debt as a better alternative for them.”

Market cycle

“We’re cautious, but although we’re long into the real estate cycle, it’s a healthy market for investing in real estate debt,” says Macland, partly because liquidity and leverage have not been driving real estate pricing this time around. “There’s been a weight of money coming into real estate that’s still not satisfied, but a lot of that money doesn’t need leverage, or doesn’t need high levels of leverage.”  

Regulatory change has helped, he reckons: “The way banks have been lending in Europe, at this point in the cycle, has not been particularly aggressive. The pfandbriefe banks in Germany have been limiting lending in the UK following Britain’s referendum to leave the EU. And the UK clearing banks have been restrained by the combination of slotting and Basel regulations. There hasn’t been an overflow of credit driving the real estate market. Banks are lending lower - lower LTVs -  and lending less. Development particularly has been constrained.”

Permanent market shift

Non-bank lenders now have a firm foothold in the real estate debt market, in Macland’s view. “There’s been a permanent shift in the way that lending is done in the market, with
non-bank lenders becoming much more prevalent, regardless of the risk profile,” he says. “ I don’t really see that changing, because this shift is beneficial to both investors and borrowers.”

Between investment grade and value-add strategies, Macland sees a big gap in the middle, which PGIM is actively addressing. “People approach lending in that gap in very different ways - and the market is increasingly competitive. We do operate in the middle, but have traditionally tended to do that for our separate account investors. We’re actively looking now at this spec to be able to provide a consistent source of capital for borrowers and investors, as we’ve achieved scale at the other two ends of the risk-return spectrum.”

Real estate lending and investment will be discussed further at Deutsche GRI 2019 on 8-9 May in Frankfurt, at British & Irish GRI 2019 on 15-16 May in London, and at Europe GRI 2019 in Paris on 11-12 September.
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