We all know the story: following the 2008 systemic crisis, liquidity was scarce and there was an established credit crunch across the whole economy, which was particularly acute in the real estate sector. The European CMBS market came to a halt, banks lost appetite for property lending on their balance sheet, and the post-crisis capital allocation requirements compounded this further.
In the wake of this new era, sensing an opportunity, a number of new players entered the devastated property lending market such as real estate professionals, former bankers, asset and fund managers backed by family offices, off-shore capital and some institutions, attracted by the opportunity to set-up boutique lending operations, often with very-focused strategies. They were eager to grow fast and their presence relieved some of the pressure in the market by offering an alternative source of finance, which was supported by the beginnings of a recovery in some markets. In the UK in 2010, the alternative lenders’ market share across all sectors was 11 percent, which grew to about 25 percent by 2014, with a similar trend witnessed in continental Europe. Alternative lenders are now present across the entire real estate lending market providing senior, mezzanine and development finance, although most tend to specialise in certain markets and products to match their risk/return requirements.
We entered this market in 2008 with the launch of our first fund focussed on commercial real estate mezzanine. We have since launched a senior commercial loan fund (European) and a UK development finance fund, supported by the growing appetite from both investors and borrowers (property developers, asset managers, real estate institutions, UHNWI). In total we have raised over €600m, across four funds, and have provided 125 loans for a total of €1.5bn, consistently delivering returns in the low teens.
The Market Recovery
During the past 24 months, the liquidity situation in Europe has evolved substantially: base rates are at a record low, banks have found a renewed interest in real estate lending (at least for the prime and core assets) and CMBS is slowly reappearing, albeit in a less aggressive format and in more modest volumes. As a result, margins offered to borrowers are eroding, loan-to-value (LTV) is going up, and real estate developers and investors often have several financing options to choose from. This obviously creates a new conundrum for the alternative lenders who were initially attracted by higher margins and a reduced competition. Is the party over?
We don’t think so. Alternative lenders are standing up to the renewed competition and banks are not winning back the market shares lost during the crisis years as easily or quickly as they thought. Debt funds are still widely present in core European markets, the UK, France, and Germany, mainly in residential, retail and logistic sectors, but also in alternative sectors such as hotels, self-storage and student accommodation. Their offering also tends to focus more on mezzanine (tranches above 60 percent LTV), development finance and short term bridges (before planning, sale or a longer term refinancing). These are the areas where mainstream lenders are typically less competitive due to regulatory capital constraints.
To remain competitive at the higher end of the market, for larger transactions (£50M +), debt funds are also increasingly keen on loan syndications, where they syndicate the loan among themselves or by teaming up with banks (using pari-passu structures or senior/junior splits). This allows them to deliver a comprehensive offering to their borrowers.
Our own experience has been of an exceptionally busy first half. Since January we have screened around 150 opportunities, of which around 40 have been approved by our credit committee and around half have closed, meaning that we have provided over €230m of property lending up to the end of July 2015.
Here to Stay in the European Financing Landscape
The alternative lenders are clearly resisting the return of the banks and structured products such as CMBS in spite of the tougher competition and market conditions. This resilience is based on a series of built-in strengths:
- Borrowers are attracted by more bespoke and tailor-made financings offered by the smaller debt funds that are more flexible than high-street banks and CMBS lenders with their set criteria. This is true for investment loans but even more crucial to development finance.
- Debt funds and other alternative lenders have the ability to be much more reactive. They can move quickly providing loans in a matter of weeks, often considerably faster than institutional players.
- Debt funds are not only attracting borrowers but they are also an increasingly favoured investment for institutions eager to get real estate exposure at a relatively low risk. By going to smaller funds they can more easily retain an element of control.
Those elements have allowed the alternative end of the market to grow and prosper, and it is now a key pillar in the European financing landscape. We expect it to successfully coexist with other forms of finance for many years to come.