The US, the UK and continental Europe are grabbing debt fund managers’ attention, as banks pull back amid market volatility. But while banks everywhere are retrenching for similar reasons, their weight in different markets creates a disparate set of opportunities on either side of the Atlantic.
In the US, the big banks are still lending against real estate, but they are less active because of macro uncertainties, says Peter Gordon, chief investment officer for US commercial real estate debt at US manager AllianceBernstein (AB). “The smaller regional banks, meanwhile, are struggling with deposits coming out and no deposits going in, so they are going to be less likely to lend today than they were a year ago,” he adds.
Regional banks like SVB or Signature Bank had “a massive inflow of capital” through covid and put that capital to work pressing into the real estate market, Gordon explains. “They did a lot of mortgage loans, but now they [regional banks] have the problem of overweight real estate in some cases and they’re worrying about the pricing of those loans relative to the market today. That combination is making them less likely to lend to real estate today.”
According to research from Allianz, small US banks hold a large share of property loans that are “highly sensitive to cyclical pressures”. At the end of Q1, domestically chartered commercial banks granted $2.79 billion of CRE loans in the US, of which 70 percent are loans provided by small banks. More than half of these loans are secured by non-farm, non-residential properties, which tend to be riskier.
In Europe, real estate banks are also retrenching due to stricter regulations and a macro environment more impacted by the Russia-Ukraine war and subsequent high inflation. However, the opportunity for alternative lenders is more pronounced than in the US, as Europe is more heavily reliant on banks. The US, in comparison, has a “pretty-well” diversified property lending market, with banks representing less than half of the total, says Clark Coffee, AB’s Europe CRE debt CIO.
“In a world where banks are having a degree of stress and pulling back [from] lending, that impacts all markets. But in Europe, where banks make up 90 percent of all [commercial real estate lending] activity, you could imagine why the impact will be much greater,” Coffee says. “There’s going to be a lot of market share given up over the coming quarters, in our view. And it’s a great opportunity for alternative lenders to step in and take that market share from banks.”
Against this backdrop, several blue-chip managers have launched strategies targeting European real estate debt. AB, for instance, which entered the European property market in 2020, is aiming to grow its influence in the region as it seeks €1 billion of capital commitments for its second European debt fund. Other North American managers – such as KKR, CIM or QuadReal – have also recently unveiled plans to expand into Europe.
“[North American credit] funds are here [in Europe] and more are coming over because there is an opportunity,” says Paul Lloyd, co-founder and chief executive at credit specialist Mount Street. “These funds have a lot of capital to deploy, and they are deploying where many European lenders are pulling back due to market uncertainty.”
For Clarence Dixon, global head of loan services at manager CBRE, geographical diversification is a crucial motivation for North American credit funds to cross the Atlantic.
“Many of these funds have been long standing debt funds in the US. And the US market has been, is and will continue to be extremely competitive,” he says. “In the US, you have liquidity, but you don’t always have product. So it’s about a diversity of location, a diversity of jurisdiction, but not necessarily a diversity of asset class because they will remain in the asset classes that they feel comfortable in.”
In January, for instance, Canadian investor QuadReal entered the UK market through a stake acquisition in Précis Capital Partners – now rebranded as Precede Capital Partners – and committed up to £1 billion ($1.2 billion; €1.1 billion) of capital that Precede will use to originate whole loans in the UK residential development sector.
Prashant Raj, the firm’s US real estate debt managing director, sees room for growth for alternative debt in the US, but says the opportunity in the UK has accelerated recently.
“Non-bank lenders have steadily grown their relevance in the US in the aftermath of the GFC and that trend is poised to continue in 2023-24, as US banks remain constrained by their balance sheets and their regulators,” he says. “In the UK, we have seen a similar dynamic at play, albeit initially driven by impending stricter regulatory requirements, but now accelerating with the macroeconomic environment and geopolitical conflicts.”
With significant loan maturities over the next three to five years in the UK, Raj anticipates “a significant need for gap-financing providers as existing loans mature into a higher interest-rate and higher cap-rate environment, where traditional senior lenders will be constrained.”
Germany is a ‘difficult market’
Higher loan pricing for current real estate debt opportunities in Europe is a key factor that makes the region appealing for debt fund managers, argues Nicole Lux, senior research fellow at Bayes Business School.
“Right now, banks don’t want to lend anymore, especially German banks,” she says. “Germany, in particular, is a market that was very difficult to get into. German bank pricing was so low that there was no point for debt funds. But now banks are charging a lot more – from 2.5 to 3 percent only in the senior space – while not really doing new business.”
Borrowers in Germany are currently seeking alternative debt for development projects, especially large ones, Lux says. “For development finance, debt funds are charging from 7 percent upwards.”
Clark Coffee, AB’s Europe CRE debt CIO, agrees Germany was a “very difficult market” for debt funds to lend in at the peak of the cycle. “With the banking stress that we’re experiencing now, I think it will be a much bigger opportunity for alternative lenders in the coming 24 months than it has been in the last 24 months,” he adds.
According to real estate investment firm AEW, from 2023-25, the shortfall between the original principal volume of real estate loans due to mature and the amount of new financing available to repay it is expected to total €16 billion in the UK alone. Add Germany and France, the two largest real estate markets in the continent, and the gap is expected to total €51 billion.
Chris Gow, head of debt and structured finance in the UK for CBRE, says there is currently liquidity in the European debt market, and the funding gap for loans made in 2018-19 that need to refinance now “is comfortably financed” with the exception of offices with weak occupancy.
“We are starting to see from lenders that a number of loans that were written in 2020 and 2021 are in a cash trap. It’s not because there’s anything wrong with the cashflow – the tenancies are in good shape, the properties are full, there’s still rental growth – but [yields have] moved,” Gow notes. “We need to start looking at how many of those loans are going to [be in a] cash trap, how many of those loans are going to need cures or some sort of restructure.”
Lenders can also get attractive margins in the European office market.
“Office is probably going to be the most interesting space for the lending community,” argues Brad Greenway, JLL’s co-head of debt and structured finance. “Over the past 24 to 36 months – especially in markets like London, Paris, Berlin, Frankfurt – you had buyers coming in at very aggressive yields of 3-3.5 percent. But yields have now shifted out to 5-plus percent.”
If these office owners have a refinancing coming up and the existing lender is not getting fresh equity into the deal, then the alternative lenders will fill the gap – at higher rates. “Those types of situations are going to be priced pretty attractively for the lenders. It’s a quasi-equity structure and double-digit return,” Greenway says.
“We are starting to see from lenders that a number of loans that were written in 2020 and 2021 are in a cash trap”
‘The US is a different animal’
Back across the Atlantic, and the story is different. A combination of market dislocation and more conservative lending from banks is creating opportunities for those alternative lenders in the US willing to lend where banks won’t, with some deals providing equity-like returns.
“[In the US] there’s a very limited supply of construction financing for new properties going in, whether it’s multifamily, industrial or hotels,” AB’s Gordon says, adding that he has seen deals for development projects earning a premium of 400-500 basis points.
He gives the example of a live deal to build a hotel providing a 13 percent return for a first-mortgage position to illustrate the overlap of first mortgage-risk and equity-like returns currently seen in some transactions. “In a normal environment, you would not expect to get paid 13 percent on a deal [like this].”
Although alternative lenders remain selective in the office space – particularly when it comes to old stock in gateway cities such as New York, Los Angeles or San Francisco – non-bank lenders now favor other financing opportunities in segments such as resort hotels.
Despite the opportunity set, the number of European managers venturing into the US is smaller compared with their North American peers making the journey to Europe. Big insurers like AXA, which entered the US market in 2014 and acquired a $9.4 billion US commercial mortgage portfolio from Quadrant Real Estate Advisors in 2018, or Allianz, which last year passed the $1 billion mark for US originations, have successfully expanded to the country. But the size and maturity of the property credit market in the US can deter smaller European managers from making the journey.
“The US [commercial real estate credit] market has been there forever with so many tried-and-tested lenders,” Mount Street’s Lloyd says. “A smaller UK or European fund going over to a big, prominent market like the US is probably not going to achieve much initially.
Unless the incoming fund had a reputation of being cheaper, more flexible and quicker to close deals, then why would a sponsor need to borrow away from their existing relationships who have been there for 20 years?”
Lloyd notes that European managers could have better traction in the US via acquisitions.
“The only way to get into the US market is probably to buy something. If European managers have good funding from their investors, they can go and buy a firm that has a track record and that has something of meaning in the US. Those ones that are thinking about going into the US, I think they’ll do it via acquisitions in the next few years.”
CBRE’s Dixon also sees the US as a challenging market for European credit managers to expand into.
“The US is a different animal,” he says. “It’s much easier for a US lender to come to Europe than a European lender to go into the US.
“The US market is 99.9 percent broker-driven. And because there are long-standing interests and relationships between brokers and lenders, that allows them to execute fast and efficiently. European lenders are usually slower in their execution process.
“And brokers don’t have time to wait for European lenders to make a decision, especially when they have to go back to Europe for their credit committee when US lenders will execute within two or three weeks. That is going to remain a challenge.”
Global managers will continue to focus on the US, UK and continental Europe to capture opportunities at attractive pricing as higher interest rates continue to bite. But the opportunity in Europe is better suited to alternative lenders looking to expand from across the pond. Old World managers, for their part, will find it harder to capitalize on the market dislocation across the Atlantic.