The evolution of an asset class

The evolution in Europe of post-crisis, non-bank real estate lending funds continues into its seventh year, following the pioneering 2009 vintage funds.

Together with other varied strategies under the “direct lending” umbrella, these real estate debt funds are now firmly established as a distinct asset class in their own right.

We have seen a great deal of activity during our interaction with this market over the last seven years and it has given us much insight into developing trends and issues across several areas that are worth exploring, including market risks, deal trends, development of the investor base and the changing regulatory environment. 


Recent surveys carried out by market participants indicate that confidence in the real estate alternative lending market remains relatively high, with a positive outlook for the asset class as a whole. There are, as always, some macro-economic and political issues which do provide a dampener to those views and are worth reviewing. 

A major cause for concern at the time of writing is the possibility of a “Brexit” from the European Union (EU). By the time this article is published, the outcome of the UK referendum on EU membership will be known, so perhaps some of the market concerns seen in the first half of 2016 will have disappeared because the referendum created so much uncertainty as soon as the promise to hold the vote became fact. Depending on that outcome, the market may continue to harbour uncertainty, particularly for a “leave” majority, or some sort of equilibrium may be reached should the “remain” camp enjoy success.

According to research carried out amongst fund managers, other market risks presenting themselves include uncertainty of timing around expected increases to UK, Eurozone and US interest rates and the knock-on effects those would have on the wider economy, as well as on demand for lending products that are well suited to investors looking for yield in a low interest rate environment. 

That said, the expectation at the time of writing is that any changes to base rates would likely be gradual, diluting their effect in the short term. Some borrowers have been savvy and looked ahead, negotiating with lenders to refinance deals early and lock in favourable long-term rates ahead of any future rate rise.


Deals tend to vary depending on the jurisdiction of the underlying asset, as well as the nature of those assets (prime, development etc.). However, the general consensus is that terms overall, some exceptions noted, still appear conservative when compared to pre-crisis transactions. 

The UK, Germany and France continue to produce the highest volume of new deals, although in some cases more recently, the latter is not viewed in the same category as the UK and Germany. We have also seen a reincarnation of the Spanish market in recent times and a continuing investment into the Nordic region to complete the set of key markets for investment.

It is usually the case that loan-to-values (LTVs) are likely to be higher when loans are advanced by alternative debt funds compared with lending from commercial banks. Market data suggests that LTVs have stabilised, with a further stable outlook in the remainder of 2016. One could draw conclusions from the fact that during 2015, the Bank of England warned of rising leverage levels in the UK commercial real estate sector, stating that “if this trend were to continue, past experience suggests that UK banks could quickly become less resilient to stress in these markets”.

As the non-bank real estate lending market has developed, we have seen a significant increase in the quantity of fund managers and the resultant amount of funds available for investment. This has seen increased competition in the market and caused a trend of decreasing deal margins. Indeed, some commentators suggest that the peak time for higher-yielding investing in the space was during 2011 and 2012. Whilst margin compression has been varied across jurisdictions, the general trend of decreasing margins has clearly been evident among senior deals, with less pressure on subordinated debt such as mezzanine loans. 

The increased number of market participants and the continued appearance of banks on the senior lending scene has also seen a trend in clubs or syndicates being formed and utilised for larger loans. In an era of little underwriting and lower appetite for significant, single-borrower exposure, the possibility of sharing risk amongst lenders has been welcomed in many parts of the market. 


In the immediate post-crisis market, when the real estate debt fund environment was nascent, it was not uncommon for various parties associated with a new fund launch to have to significantly assist investors in their understanding of a range of issues. Discussions around fund structuring, utilisation of different fund domiciles, management fees and reporting requirements were all frequent topics.

We have seen the investor base become sophisticated and appreciative of the various nuances associated with alternative lending solutions. The communication between fund managers and their investors has become more effective and it feels as if the investors are now at ease in terms of their expectations and the reality of the investment opportunity.  

Indeed, a trend we continue to witness is that of co-investment by significant institutional investors which has been done directly by the investor or through a managed account set up by the fund manager on behalf of investors. These arrangements have attracted differing economics for the investor and probably acted as a catalyst for the negotiation of terms by investors depending on their commitments to a particular fund. In other words, many of the trends we saw in the world of private equity more than a decade or two ago are appearing in the world of real estate debt funds. 

We continue to see strong interest in the asset class from institutional investors of all types and an appetite from investors around the globe to deploy capital into European real estate debt opportunities.


The shifting regulatory and tax environment in Europe continues to present challenges to the direct lending sector as a whole and this has an effect on investors and fund managers across fundraising, fund structuring and the making of investments. Much has been written about the regulatory environment and there are too many facets to mention in one article, however it is worth touching on a few of the more pressing issues that we witness.

Regulation of lending activities in Europe has always been disjointed but it does seem that many EU countries realised this was prohibitive at a time when there was a great need for non-bank lending. Following the implementation of the Alternative Investment Fund Managers Directive (AIFMD), the result for compliant fund managers means that there does appear to be an easing, or at least further clarity, of the regulatory concerns for alternative direct lending. For managers conducting business outside of the framework of AIFMD, this may continue to be an area of greater scrutiny and potential further regulatory changes by the European authorities.

The OECD's initiatives in relation to base erosion and profit shifting has certainly been a worry for the alternative lending market for some time. Whilst the OECD intended to pursue those large multinational companies transferring profits to lower tax jurisdictions, it appears that the alternative funds world is likely to be caught up in the fray. 

It's worth noting that the only reason for lending funds utilising jurisdictions such as Luxembourg or Ireland was to ensure minimal tax leakage of the fund structures themselves. The investors in those funds would always have been liable for any taxes due on profits arising from the fund investments. Investors are increasingly focusing their due diligence on the tax structuring of funds and the potential risks to them of any tax challenge, whilst many managers have been changing their operational structures to increase the substance they have in places like Luxembourg, in terms of both physical presence and their activities.

The Solvency II treatment of many debt investments from an investor viewpoint remains uncertain. Many European insurers are keen to participate in the asset class but a problematic capital weighting can make an otherwise highly attractive investment become unappealing. What we have seen from managers trying to solve this issue for investors, is the use of repackaging programmes or a change in fund structures themselves to allow significant insurance investors access to the fund because the investment is offered with a more appropriate capital treatment.

To conclude, our experience suggests that funds will continue to have a role to play in the real estate lending market in the long term and they are likely to seek a greater share of that market.   ?