Institutional investors could consider the issuance of new performing senior and mezzanine debt as a lower risk opportunity in real estate, according to a new paper, “Real estate debt – from crisis comes opportunity”.
The paper says that widespread economic meltdown has resulted in significant value destruction, but it has also created investment opportunities for non-bank lenders to selectively and profitably bridge a funding gap.
The paper outlines why now may be an attractive time for institutional investors to commit assets to specialist funds investing in real estate debt and the opportunities for non-traditional lenders such as institutional investors.
According to Mercer the financial crisis has created material structural changes in the global real estate market, caused by falls in property values and constraints on the ability of banks to re-lend coming from Basel II and III banking regulations.
The lowering of banks’ loan-to-value ratios means borrowers need significantly more capital in order to secure a loan than was previously the case, and one way of filling this gap is with mezzanine debt.
The combination of these elements puts real estate fund managers in a good position when negotiating debt terms with borrowers, resulting in favourable returns for investors.
Paul Richards, European head of Mercer’s real estate boutique, says that following the drop in values in real estate markets and new regulatory restrictions on banks, borrowers are finding it increasingly difficult to refinance their debt following traditional routes. This has created great investment opportunities for non-traditional lenders, such as institutional investors.
Estimates from Mercer put the funding gap for Europe at more than $195 billion in 2010-2011, with half coming from the UK and a third from Spain. In the US, the gap is estimated at $300 billion to $400 billion for the next three years, provided LTVs stay at the current level, and in Australia, the gap is estimated at $8.8 billion.
“We believe this investment opportunity will exist until the funding gap in real estate has disappeared. This is unlikely to happen until loans made at the top of the market in 2007 have been repaid, refinanced, restructured or foreclosed,” Richards says.
“As with any investment opportunity there are inherent risks. Investors must be careful to consider how such an opportunity fits within their own investment strategy and portfolio. There should also be considerable emphasis on the review and selection of the best managers.”