PGIM RE: the rising appeal of real estate debt during the late-stage cycle
Debt investing is growing in popularity as it allows investors to limit risk exposure compared to equity investments in a first-loss position, says PGIM Real Estate.
While the attractiveness of holding debt, rather than equity, increases during a downturn, increasing market scale and opportunity can also encouraging capital flows to debt strategies, PGIM Real Estate argues.
Greg Kane, Executive Director, Head of European Research at PGIM Real Estate, explains:
“Since the global financial crisis, banks have remained constrained by an increased regulatory burden, creating an opportunity for alternative lenders to either expand from an established base, in the case of the United States, or grow significantly from a small base, as in Europe and Asia Pacific. The reduction in the size of the CMBS market has added to the scope for private lenders to participate in market activity.
“Looking beyond both the cycle and regulatory factors, it is important to note that the opportunity set for real estate investors is larger once debt is included than if only equity opportunities are considered. Of the estimated $20 trillion of real estate in global developed markets – a figure which excludes privately-owned residential – only $7.2 trillion is invested in either private markets or held by firms listed publicly.
“For an equity investor, the $7.2 trillion of invested stock more-or-less defines the opportunity set for income-producing investments, i.e. excluding development projects. In contrast, a debt investor can also potentially access stock that is non-invested, including assets that are owner-occupied or held outside of the institutional investment market, for example in the public sector or by high-net-worth owners.
“Combining an assessment of prevailing LTV ratios on equity holdings with an estimate of current real estate debt holdings suggests a total opportunity set of $11.5 trillion worth of real estate available to lend against. While many equity transactions carry little or no debt, this is more than offset by the fact that debt investors can participate in refinancing even if there is no underlying equity transaction.”
LTV ratios have been lower in this cycle as compared to pre-global financial crisis, which supports the view that lenders and borrowers have been prudent in this cycle.
Further, spreads on real estate loans have held up well as QE has driven down yields on market-traded fixed income assets. The excess spreads offered by real estate loans are increasingly attractive to a wide pool of investors, although conditions still favour specialist real estate lenders that can step in and manage a property to recover or grow values if the borrower defaults, PGIM Real Estate added.
PGIM Real Estate’s analysis continues tomorrow.
