The Growth of Real Estate Debt Funds
In this month’s feature article from Preqin’s Real Estate Spotlight, Chris Beales explores the rise of debt strategies in the private real estate industry in recent years, from the record levels of capital raised by these vehicles to the investors seeking these strategies.
As institutional investors have grown and become more sophisticated, real estate fund managers have created products that can more effectively balance the needs of the institution and provide greater diversification within their real estate portfolios. Private real estate debt vehicles are one such product that have risen in prominence in recent years; in 2010, real estate debt vehicles represented just 9% of all private real estate funds that reached a final close and only 7% of aggregate capital raised, with these figures approximately doubling in 2016 so far (Fig. 1). Furthermore, the $8.6bn in aggregate capital secured by debt funds in 2016 YTD is the third highest amount of any strategy, ahead of both core and core-plus vehicles.
Since 2006, 320 private real estate debt funds have reached a final close, securing $124bn in institutional investor capital commitments. Fundraising for private real estate debt funds has grown significantly in recent years, with $17.8bn raised in 2013, $25.2bn in 2014 and $15.3bn in 2015, vastly surpassing the average capital raised between 2006 and 2012 ($8.1bn, Fig. 2). While fundraising levels fell from 2014 to 2015, the $8.6bn secured from the 18 vehicles that have reached a final close in 2016 so far suggests that full-year figures will be on a similar level to those seen in 2013 and 2015.
In terms of geographic focus, two-thirds of real estate debt funds closed since 2006 primarily target North America, while the region represents a slightly larger proportion (69%) of aggregate capital raised in the period (Fig. 3). While Europe-focused debt funds represent only 18% of funds closed, they have secured a quarter of total capital raised. Interestingly, when looking at funds closed in 2016, Europe-focused debt funds have raised 34% of the aggregate capital, driven by large fund closures such as AgFe’s AgFe Real Estate Senior Debt Floating Rate Fund, which reached a final close in January 2016 on £910mn.
Furthermore, with investors becoming more accustomed to the real estate debt segment and allocating greater amounts of capital to this strategy, fund managers are able to raise larger vehicles. Since 2012, there has been a steady increase in the average size of private real estate debt funds coming to market. 2014 was an outlier, with a record average fund size for this strategy type ($680mn, Fig. 5).
Funds in Market
With institutional investors committing more capital to real estate debt funds in recent years, fund managers are bringing more debt vehicles to market to satisfy demand: both the number and target capital of private real estate debt funds have increased since July 2014, with 65 vehicles currently targeting $31.9bn in commitments, compared with 52 funds targeting $22.7bn in 2015.
In terms of all private real estate funds currently raising capital, debt strategies account for 13% of the number of funds in market and 18% of capital targeted — only six percentage points below the proportion of target capital by opportunistic vehicles (Fig. 7). Mezzanine is the most prevalent strategy for debt investment among funds closed since 2015 and funds currently raising capital; however, there is a larger proportion (23%) of funds in market seeking exposure to bridge loans when compared to the proportion of funds closed since 2015 (5%, Fig. 8). As a method of investment, preferred equity is targeted by a larger proportion of private real estate debt funds in market than funds closed since 2015; this includes one of the five largest funds in market, Pramerica Real Estate Capital VI, which is targeting £1bn to provide senior debt on core and core-plus assets, as well as taking preferred equity positions in properties.
Europe-focused private real estate debt funds in market represent a larger proportion of aggregate target capital than funds that have previously closed; the $13.0bn targeted by 20 Europe-focused funds in market accounts for 41% of all real estate debt target capital, more than the 25% seen for funds closed since 2006. However, North America remains the primary geographic focus for the majority (52%) of target debt capital.
Institutional Investors in Real Estate Debt
Pension funds represent the largest proportion (44%) of institutional real estate investors with a preference for debt vehicles, followed by foundations (16%) and endowment plans (10%). However, when looking at investors’ participation in real estate debt by type, a third of all of sovereign wealth funds actively investing in real estate target debt strategies — the largest proportion of any investor type (Fig. 12). Just under a quarter of all public pension funds active in real estate seek debt opportunities, followed by superannuation schemes (22%), investment trusts (21%) and private sector pension funds (18%).
Private Real Estate Debt Performance
Since 2007, private real estate debt strategies have largely outperformed higher risk value added and opportunistic strategies. While debt strategies were not immune to downturn in the real estate market following the Global Financial Crisis, since the second quarter of 2010 the PrEQIn Real Estate Debt Index saw 18 consecutive quarters of growth, driving greater amounts of capital secured by debt funds launched since 2012, as investors sought exposure to the debt segment (Fig. 13).
With many investors yet to make their maiden commitment to real estate debt, fundraising looks set to grow in the coming years. Preqin’s Real Estate Online details numerous mandates from institutional investors based around the world that plan to commit capital to real estate debt vehicles in the next 12 months. Demand for these strategies has no doubt driven the increase in the number of private real estate debt funds seeking capital, with 25% more funds currently in market than in July 2015. This increased activity in the real estate debt segment from both investors and fund managers appears to be driving debt strategies to the forefront of the private real estate marketplace.
You can read the full Real Estate Spotlight newsletter here. This month’s issue also features a comparison of real estate deals in New York City and London, a look at Asia-based institutional investors in real estate and much more.