Concrete Analysis | Commercial real estate debt investment makes a comeback
Renewed interest and appetite, especially in Europe, comes as investors increasingly seek better risk-return profiles with higher, stable yields
In the years before 2007, a significant expansion of real estate debt occurred globally, especially in Britain and elsewhere in Europe. This was driven by lenders providing unprecedented leverage at historically low loan margins and an "originate to distribute" model that transfers transaction risk to a third party. By mid-2007, the ability to securitise or syndicate commercial real estate loans virtually ceased in the British primary market, and secondary market volumes slowed considerably. Banks were left with low-yielding, over-leveraged property loans to manage.
Since then, the loan market has faced tightened economic and regulatory pressures affecting capital ratio requirements, leverage ratio limitations, legacy asset concentration and the requirements of rating agencies and investment analysts and investors, reducing balance sheet exposure. Many global banks have cut back on loans.
Historically, banks have provided the majority of debt finance. According to Morgan Stanley Research, in 2012 banks and bank-related lending comprised 90 per cent to 95 per cent of the market in Europe and Britain. Asia-Pacific has a similar reliance at 75 per cent to 80 per cent, while the US is at 55 per cent to 57.5 per cent.
Investors are increasingly seeking a better risk-return profile with higher, stable yields. Against the economic backdrop of reduced debt supply and the low-yield conditions, capital markets have begun to play a major role in supplying finance for real estate debt.
This has brought about renewed interest and appetite in commercial real estate debt as an attractive and competitive investment asset class, especially in Europe. Both Asian and global investors have greater accessibility to high quality commercial real estate assets for medium and long-term yield.
CRE debt, a loan secured by a commercial real estate property, is in many aspects similar to a fixed-income, bond-like investment as tenants support quarterly interest payments. It can be tailored to match the risk-return profile of investors.
Commercial property debt's ability to generate handsome and predictable returns while absorbing significant income and property market volatility makes it an attractive investment. The net rental income generated by the property is typically higher than the debt servicing requirements and the value of the property is higher than the loan amount. In short, the very nature of CRE debt is conservative and has a defensive risk profile.