There is a major shift underway in private real estate fundraising.
According to affiliate title PERE’s Q1 2022 fundraising report published last week, debt prevailed as the most popular strategy for the first time since it began tracking the data in 2008. Significantly, debt accounted for more than 34 percent of total capital raised during the quarter – easily the largest-ever percentage for the strategy over the past 12 years.
Also notable, four of the top five private real estate funds closed in Q1 2022 were focused on mezzanine debt investments, according to the report. All four vehicles – from the $3 billion Oaktree Real Estate Debt Fund III to the $1.7 billion Pretium Residential Credit Fund II – topped $1 billion.
Debt’s fundraising triumph consequently knocked the reigning champion strategy – opportunistic – out of the top spot, a position the latter strategy has held for all but one of the last 12 years. The only other year where opportunistic did not dominate was in 2020, when it claimed 30.25 percent of fundraising volume against value-add’s 30.49 percent. This time, however, opportunistic dropped to its smallest-ever share of 25.18 percent and fell to third place behind value-add, which accounted for 33.03 percent of the capital raised.
What is going on? The popularity of debt is due in part to the current market cycle, as investors typically favour credit plays during times of volatility. Along with opportunistic, real estate debt ranked second among fund strategies where investors intended to allocate more capital in the coming year, with 26 percent of responses in PERE’s Investor Perspectives 2022 Study. Only value-add, with 33 percent of votes, received greater interest from investors for increased commitments.
But we should not expect the dominance of debt in fundraising to be an aberration. Rather, we should regard it a sign of things to come. As noted in the Real Estate Debt 50 2022 ranking, also unveiled last week, real estate debt fundraising activity is expected to continue to gain momentum in the coming years, given a greater understanding of the strategy by the industry.
Credit is no longer viewed primarily as a higher risk and return strategy for fund managers and investors, but one that, in many cases, can have a “core equity-like” profile, as Richard Mack, chief executive and co-founder of Mack Real Estate Credit Strategies, said in PERE’s analysis of the RED 50 ranking. Indeed, senior debt was the most-favoured private real estate debt strategy in PERE’s Investor Perspectives 2022 Study, representing 46 percent of respondents, compared with 24 percent for whole loans and 19 percent for junior or mezzanine debt.
To capitalise on this burgeoning investor demand, an increasing number of managers have been ramping up in the space, with six new firms in this year’s RED 50. Managers that previously focused on real estate equity strategies have gotten in on the action. Ardian and Schroders, for example, have launched real estate debt platforms in the past year and a half. Meanwhile, existing credit players like KKR and Ares Management have made further inroads into the space, with both firms expanding into European real estate debt this year.
As fundraising powerhouses, these marquee names are poised to garner substantial sums of capital for their new or growing real estate debt businesses. Such anticipated activity will ensure that the already elevated fundraising totals that have been amassed for real estate debt will continue to rise in the coming quarters and years. The increasingly widespread acceptance of credit as an important conduit to real estate will be a paradigm shift unlikely to reverse.
This Friday Letter was first published by PERE, our affiliate title.