Private debt remains best value real estate investment asset class

By Paul Norman - Thursday, March 08, 2018 15:29

Private debt remains the best value asset class for real estate investors, attracting significant volumes of capital but with lenders remaining disciplined in balancing risk and return, according to CBRE’s latest Four Quadrants report.

The report, which reviews the relative value of what CBRE terms the real estate investment universe’s four quadrants – public equity, private equity, public debt and private debt – finds that a seemingly unquenchable thirst for European debt fund launches “represents the logical strategic consequence of our long-stated arguments of the relative value of the private debt quadrant, an understandable tactical allocation given the maturity of the cycle in many markets, and a necessary and beneficial restructuring of the quadrant as new attitudes to risk (in part driven by regulation) forces traditional providers of debt to reduce exposure”.

It argues that none of these forces will be in retreat in 2018, and so it expects private debt to “remain extremely popular throughout the year”.

CBRE’s UK Four Quadrant pricing model compares relative values across the universe of real estate investment options by calculating required and expected return for each Quadrant, and then interrogating any gap to understand the extent to which this represents a pricing signal.

In the private debt space CBRE notes an increasing tendency for lenders to focus on refinance risk.

It writes: “In assessing viability on an ongoing basis, lenders have for some time paid more attention to the debt yield rather than the interest cover ratio (ICR) – given extremely low interest rates have rendered ICRs fairly comfortable, and a perhaps justified concern over real estate pricing in an era of low yields. This latter prudence is coming to the fore as lenders stress refinance prospects for five year loans into the early 2020s: common hurdles include assumptions that interest rates will be above where swap curves are predicting and some outward drift in property yields.”

It says the high volume of new entrants to the market has not yet put significant downward pressure on margins.

Given the competition it says those “looking for an edge in 2018” should adopt as flexible an approach as possible, “to both asset, geography and perhaps most crucially capital structure: lenders who are able to offer borrowers a one-stop-shop, subsequently distributing parts of the loan they are not interested in holding, rather than forcing borrowers to go to more than one provider to secure all the finance they desire, will have a significant advantage in the coming year”.

CMBS return?

With regards to public debt CBRE points out that three well trailed issuances recently involving Blackstone and a portfolio securitisation by Santander that mixed CMBS and CLO structures at last means meaningful transactions have taken place. It is cautiously optimistic that more will follow.

“These deals may indeed herald an upturn in issuance that will endure into 2018. With more and more investors seeking access to real estate debt, the public debt space could be set to benefit if pricing remains attractive relative to other forms of ABS. It is difficult to say for certain if this will be the case. If we were to make a slightly leftfield projection for 2018 however, it would be that we think more buyers and sellers will explore the development of structures similar to the tenant credit lease which is common in the US, in particular in the long-income market.”

In terms of public equity it points to the number of very significant M&A deals agreed in Q4, an "escalation of the trend of earlier in the year".

In CBRE’s opinion “investors are seeking to build scaleable, operationally efficient platforms of real estate in sectors benefitting from disruption”.

In terms of private equity CBRE highlights the “impressive” weight of money targeting European real estate.

But it warns that “investors are proceeding with caution where imminent capital growth is not expected”.

The market preference it says remains for diversified funds, “a function of historically higher rate of income distribution”.

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