Although the pandemic has slowed down real estate transactions globally, it has accelerated the need to reposition assets. Whether it is a change of use to avoid obsolescence or refurbishments to improve safety, convenience and wellness, these projects are taking off across portfolios.
As a result, real estate lenders are gearing up for a surge in demand to finance increasing repositionings. In Europe, the Urban Land Institute and PwC’s 2021 Emerging Trends in Real Estate report, which surveyed 995 investors, found the repurposing of assets from one sector to another on the agenda for nearly three-quarters of respondents. Meanwhile, 41 percent of survey respondents – up from a third last year – were concerned about asset obsolescence in 2021. Nearly half believe this problem will worsen over the next five years.
In some markets, loans to finance such projects have already become more prominent.
Investors concerned about asset obsolescence in 2021, according to a ULI and PwC survey report
“Currently in the UK, in particular in London, there is a higher concentration of refurbishment/repositioning loans than normal,” says David Barry, senior director, debt and structured finance, EMEA at JLL. He adds that around 50 percent of the advisor’s live UK mandates are for this type of loan, which is higher than average.
“By utilising the available refurbishment/development debt, this has enabled the borrowers to boost their equity returns to 14 percent-plus IRR levels,” he notes.
Barry explains that the prevalence of these loans is partly the result of subdued potential for acquisition finance, with covid and travel bans translating into fewer core and core-plus properties on the market. However, he adds that it is also the result of owners, especially those that are more opportunistically driven, wanting to reposition certain properties for a post-covid world.
Jim Blakemore, global head of debt at BentallGreenOak, is witnessing the repositioning trend becoming widespread across major regions. “We have seen covid accelerate the need for capital to reposition, refurbish or rescue real estate assets in the US, UK and European markets,” he says. “The demand for financing to support these plans has increased.”
Michael Cale, co-head of debt investments in the US at Allianz Real Estate, confirms increasing debt capital is flooding the country’s short-term transitional market. However, he notes a supply/demand imbalance, with an excess of capital targeting these opportunities amid a lack of product. That, combined with the ongoing institutional thirst for yield, is driving down yields for real estate debt investors.
In Europe, Allianz is also seeing a trend towards more lending opportunities on transitional assets and developments, says Roland Fuchs, head of European real estate financing. “This is driven by the investment theme of modern, flexible buildings and workspaces, which are sustainably operated and offer ‘smart’ services to users,” he explains. “As a theme, it addresses investor and tenant expectations for sustainable, hybrid working models – the office of the future, combining working from home with a physical office presence. As a consequence, Allianz’s exposure to refurbishment and development transactions has increased in 2020, a trend we anticipate to pursue further in 2021.”
Who is financing value-add?
Alternative lenders are plugging the gap left by traditional banks
Industry participants say alternative real estate lenders are more likely to support value-add deals, given the fact that the banking industry, which has been stepping back from property lending due to tightening regulation over the last decade, is increasingly risk-averse amid the ongoing economic uncertainty.
Miguel Martinez, a director of the corporate finance department at Colliers International, based in Madrid, says bank financing for value-add projects is currently very restricted. “Banks are financing very specific operations, with solvent clients and with a track record with the bank, and prioritising well-located assets,” he says. “In these cases, [loan-to-value] levels have been adjusted downward and interest rates have increased slightly compared to pre-covid levels.” Ravi Stickney of Cheyne Real Estate adds: “In a European context, debt availability from the banks, for assets such as offices, is constrained to senior lending, at low LTVs on long-leased assets. Hence, the supply of bank debt for the short-income or transitional asset profile is severely limited, necessitating the use of capital from the alternative lending community.”
Philippe Deloffre at ICG agrees that non-bank lenders are more present in the value-add space today: “When banks offer debt for value-add players, we have seen them retrenching at lower LTVs, typically at 40-50 percent – which, for an IRR-driven investor, doesn’t help to make it.”
Ravi Stickney, managing partner and chief investment officer of Cheyne Real Estate, says the acceleration of structural long-term trends in how we live and work has left many assets, particularly in the office sector, unfit for purpose – or simply viewed as undesirable in the eventual post-covid world. As a result, the lender is seeing “a lot of demand from owners of assets to embark on projects to reconfigure and redevelop their assets to make them suitable for those long-term trends”.
One example of a “comprehensive refurb to a high standard” is the €96 million senior loan Cheyne wrote to finance the refurbishment of Paris’s Colisée II office building, provided last November to Cain International.
It is not just European offices, though. “Logistics and residential have become the new safe haven, so conversion of existing properties into these two asset classes is now a play that is attracting capital – and debt,” says Philippe Deloffre, managing director and head of European real estate debt origination at ICG.
“I’ve seen a number of instances where hotel operators have been forced to sell some of their assets to recover cash and recapitalise their company,” Deloffre explains. “The new acquirer is planning to convert these assets into multifamily or residential, thinking better performance can be achieved through residential rather than hospitality.” He adds that he has seen this conversion play in Germany and France, where there are some deals in progress into the build-to-rent or micro-living sectors.
“We’re interested in backing these conversions, the extension of an existing asset or lease-up/capex plays,” he says. “We usually provide higher leverage than banks and our capital typically suits operating partners. Our capital would reflect 80-plus percent LTC [loan-to-cost] at high single-digit pricing. Debt liquidity offered by whole loans can support property owners with an ambition to achieve high double-digit IRRs.”
The availability of equity capital targeting value-add opportunities is another decisive factor that is boosting debt requests in the transitional space. “Demand for financing for transitional assets remains robust throughout the US and Europe, driven by the record level of dry powder in real estate opportunity funds and the economic optimism following the ongoing vaccine rollout,” says Scott Weiner, senior partner and global head of commercial real estate debt at Apollo Global Management.
According to data from affiliate title PERE, an estimated $35.4 billion and $36.5 billion were raised in 2020 via opportunistic and value-add funds, respectively. Although 32 percent of the capital raised in 2020 was for opportunistic funds – far lower than the 52 percent raised in 2019 – value-add made up 33 percent of the $110.7 billion total, compared with 23 percent in 2019 and 28 percent in 2018.
That uptick in value-add capital needing to be deployed, combined with covid’s push for asset repositionings, has created the perfect storm for lenders, making them optimistic that more opportunities are sure to materialise.