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Real Estate Horizons is a snapshot of key legal topics and market trends across the globe.

Real estate debt funds: where are they now?

By Jo Solomon

For several years now, the market has seen the emergence and continued growth of real estate debt funds in Europe. While always a large presence in the U.S. market, real estate debt funds traditionally had a much lower profile in European real estate lending. The global financial crisis changed this with the downturn in the commercial real estate markets creating a credit drought as banks dramatically reduced their lending. Chief among the new lenders seeking to fill the gap were non listed debt funds.

Since then, the market has seen a proliferation in the number and size of real estate debt funds. However, since reaching a peak in 2017, investment fell more than 40% during the course of 2018. Is this a reflection of waning interest in the asset class or something else?

While it is clear that traditional lenders are firmly back in a dominant position, they do not have pre- crisis levels of liquidity, allowing the real estate debt funds to cement their position in the market.

Additionally, the borrower community has found that assets which do not neatly fall within set lending parameters are more challenging to finance with traditional lenders. Step forward debt funds, some of which will lend against assets and asset classes that are outside the core business of other lenders within the market.

Debt funds can also lend higher up the capital stack than many traditional lenders as banks are subject to capital adequacy requirements which make higher leverage more expensive to provide. Again, debt funds are not constrained in the same way with many pursuing whole loan strategies to highly remunerative effect.

Despite debt funds having more flexibility in terms of risk and leverage, there appears to be limited appetite at present to venture too far up the risk curve. The ability to deploy capital continues to be an issue across the market (both debt and equity) and given current uncertainty, fund managers must be all too aware of making promises to investors they will not be able to keep or worse, losing investments if property prices fall.

One thing is certain however, real estate debt funds are here to stay and have not proved to be a temporary stop gap while the banks sorted out their balance sheets.

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