Fundraising: Denominator effect impacts debt strategies

This year’s slowdown in private markets fundraising, fuelled in part by the denominator effect, has led to significantly less capital being allocated to real estate debt strategies. However, managers believe the outsized returns on offer in the property lending market will entice investors back.

The denominator effect saw investors’ alternative assets account for a greater share of their portfolios as public holdings fell in value earlier this year. New allocations to private markets, including real estate, therefore became impossible for many.

Affiliate title Real Estate Capital Europe data shows $6.3 billion was raised globally in H1 in debt funds that reached final close – down from more than $30 billion in H1 2022. Across the wider global private real estate market, $72.3 billion was raised in H1, the lowest amount of first-half fundraising since 2013.

“Fundraising is incredibly challenging across private real estate markets,” says James Jacobs, global head of real estate within the private capital advisory team at financial advisory firm Lazard. “Volumes are down anywhere from 40 to 60 percent, year-on-year. All real estate strategies are more difficult to raise for, and debt is not an exception.”

However, among active investors, Jacobs sees a keen interest in property debt. “Investors tell me real estate debt is among their highest priorities. Most believe real estate credit is mispriced and there are equity-like returns on offer for credit risk. So, the money that is out there is flowing into real estate debt strategies. The asset class is getting an outsized share of the wallet.”

Selective investors

While this year’s fundraising figures so far are low, managers have set out to raise fresh capital. US mega-manager Blackstone is aiming to raise $8 billion for its global Blackstone Real Estate Debt Strategies V. In Europe, Geneva-based Edmond de Rothschild Real Estate Investment Management said in July it is aiming to raise €600 million for its second debt strategy. Meanwhile, Italian manager Generali set out in February to raise €1 billion for its second senior lending fund.

In June, alternative lender Velo Capital held a €136 million first close on its Velo Mezzanine Credit Fund, for which it is targeting €600 million. Speaking at the time, managing partner Emanuele Bena said the denominator effect made fundraising more difficult, as well as investors being more selective. But he reported strong feedback from investors. “I’ve been in European real estate for 20 years – I’ve never seen a market as supported as the real estate credit market today.”

Jorge Veiga, head of client solutions for the UK, Nordics, and Middle East at Empira Group, is responsible for the Swiss manager’s relationships with investors across those regions. While he acknowledges the presence of the denominator effect, he argues it is having a dwindling impact. 

“For many investors, their equities portfolios are almost fully recovered,” he says. “If you were to have asked me in Q1 about the denominator effect, I would have said it was a major consideration, but allocations are now coming back. Admittedly, there is a reduced ticket size across the market, so those that would have previously made allocations of €70 million typically are now looking at €35 million tickets. So, it is still having an impact.”

Now is a good time to be in front of investors, believes Veiga. “By mid-to late 2024, things will gradually get back to normal, so it is important to show investors dealflow and be on their minds.”

More challenging fundraising conditions are adding to the performance of real estate debt strategies today, says Jacobs. “Alternative lenders that have already raised capital are happy because they believe they have a generational opportunity ahead of them. That is partly driven by limited liquidity, so they know if fundraising became too easy, these attractive market rates would be eroded away.”