Growing funding gap fuels investor move toward European debt funds

With traditional lenders maintaining caution as stricter banking regulations (most recently Basel III) limit their lending capacity, and high regulatory capital requirements make operations more expensive, there is increased room for European debt funds, a new Inrev survey reveals.

In the latest Q3 2023 INREV Consensus Indicator Survey, 34.6% of respondents said that they are moving to alternative lenders in their search for financing – a notable increase from an already elevated 29.1% in Q1 2023.

Alongside this, evidence from the NCREIF / CREFC Open End Debt Aggregate revealed that the correlation of US debt returns to core real estate returns in the US is low to moderate. This indicates that private real estate debt and private real estate equity strategies are complementary, which is also likely true for the same components across the European market.

Moreover, as banks become increasingly hesitant to raise their allocations to real estate, sustainable finance presents another strategic opportunity for the ESG-focused debt proposition by alternative lenders.

Iryna Pylypchuk, INREV director of Research and Market Information, said: ‘At times of change, there are always opportunities, and it looks like non-listed real estate debt funds are proactively accessing this timely opportunity to step up. The evident growth of non-listed debt funds increases diversity of lending sources and promotes healthy competition in the European non-listed real estate lending market. In turn, it should also bring more stability.’

According to the Inrev survey, around €36 bn worth of assets are expected to come to the market in the next ten years from the closed end fund liquidation pipeline in the INREV Vehicle Universe alone, and the broader market estimates a €94 bn funding gap.

Current market conditions and higher cost of debt in the ‘higher for longer’ interest rate environment have made the lending landscape more complex.

After a decade of quantitative easing, the recent sharp and sudden shift to quantitative tightening has proven to be a shock for the markets. The INREV Asset Level Index reveals that debt service coverage ratios (DSCR) have experienced a notable decrease from their peak.

In 2021, the average DSCR stood at 9.67, with the rental income 9.67 times higher than the debt servicing payments. This dropped to 5.11 in 2022, and to 3.17 at the beginning of 2023.

However, there is some reassurance, as the average leverage in the non-listed European market is much lower than levels seen during the global financial crisis (GFC). The average level of gearing in both core and value added real estate funds has dropped to historic lows – falling to 22.2% and 38.52% in the first half of 2023, respectively. This is well below their equivalent post-GFC peaks of 57.1% and 39.7%.


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