A necessary pause for breath

Real estate debt fundraising was subdued last year, which should prevent a welcome boost to liquidity from becoming overheated.

On the face of it, an overhead visual from AEW Europe at this week’s PERE Europe Summit might have caused alarm among members of the audience hoping to see debt funds continue providing a boost to liquidity in the real estate market.

The chart showed closed-end real estate debt fundraising falling by more than 42 percent from $25.0 billion raised in 2014 to $14.3 billion last year. However, participants on the real estate debt financing panel did not appear unduly worried.

One pointed out that last year’s total was still ahead of the average annual total since 2006, which stands at $11.3 billion. Another said that after the outstanding fundraising years of 2013 and 2014, when a cumulative $42.5 billion was raised, last year represented nothing more dramatic than a pause for breath. The priority now would be finding ways to invest the money already gathered rather than seeking to accumulate yet more of it.

The hope certainly has to be that nothing more troubling explains the apparent drop-off in investor appetite. After all, there is no question that liquidity has been badly affected by the constraints being imposed on the banks by regulators (think Basel III and UK slotting rules, for example), as well as by their own internal credit committees.

In an era of negative interest rates, strong competition to lend and tumbling margins, life for the banks has rarely been tougher. As a consequence, many now opt for the “originate to distribute” model, no longer seeing themselves as the natural long-term holders of debt. From this trend, debt funds have emerged as the new long-term holders and, rather than being in competition with the banks, have developed complementary relationships.

Moreover, the rise of alternative lenders has been welcomed by regulators – involving as it often does the transfer of risk to organisations better equipped to manage it. In certain niche areas of the market, such as providing finance to small developers – where there is a huge unmet demand and a need for timely execution – the role of alternative providers has been invaluable.

For these reasons, a healthy supply of real estate debt funding is a good thing. But maybe we shouldn’t wish for too much of a good thing. After all, a glut of capital and the fierce competition for deals that would inevitably follow could compress returns and make the funds victims of their own popularity. Perhaps that pause for breath should be welcomed.