Lucrative credit investments.
Private Real Estate Loans. Banks are pulling back from lending on commercial real estate projects. Private investors can fill this gap. The incentive: attractive returns, regardless of developments on the capital markets. "Because there are projects with different risk profiles, the market offers a broad field for every type of investor," says Peter Begler, Alternatives Director at Schroders.
"It's actually a curious situation," Peter Begler reflects: "We have a real estate boom all over Europe. But banks are increasingly pulling out of the real estate lending business."
And that, says the director of alternative products at asset manager Schroders, has nothing to do with the fact that there are no longer any lucrative investments in the face of higher prices. "It's a regulatory issue. After all, the increased capital requirements imposed by Basel II and III mean that the cost of capital for real estate investments, as well as for project development, is getting higher and higher, making it increasingly unattractive for banks. This is good news for investors looking for high-yield investment alternatives in the current low-interest environment. They can step into the breach."
Specifically, it goes like this: For example, a real estate investor wants to repurpose a property that often has a significant amount of unleased space. So he wants to turn an office property into a multi-use building with retail, restaurants and apartments. These are referred to as "transitional properties." After such a rezoning, the idea is, the value of the property should increase, and a higher rent per square foot can be charged.
"But to do that, the developer needs financing for maybe two and a half years. After that, he wants to sell the property at a higher price," explains Daniel Younis, head of real estate debt at Schroders Germany. But the willingness of banks to finance such projects is low. "And since such borrowers often don't have access to the public bond markets either, they pay lucrative interest rates for the financing," says Younis. This is where Schroders' Real Estate Debt division comes in. "We provide the opportunity to finance such projects."
Younis and his colleagues' task now is to find the real estate projects with the best risk-return ratio. They are helped by the fact that this market is currently slow to emerge in continental Europe. A low supply of private loans meets a rising demand for financing.
In the US, the market is already more developed. There, alternative lending in the commercial real estate market has a volume of about $4.8 trillion, which is about 40 percent of the total market of $12 trillion. In the UK, non-bank lending accounts for at least 27 per cent of the total market. In Europe, however, it is less than six per cent.
"However, we expect both the UK and continental European markets to grow over the next ten years to roughly match the ratio in the US market," Begler makes clear. With a total volume of 72 billion euros, that would be just under 29 billion. "And we can already see that the demand for private real estate is increasing, although the supply is currently still quite limited. That's why the chances are currently particularly good to get into the best and most promising projects," explains Daniel Younis.
In total, Younis and his colleagues look at around 1,000 such projects every year, investing in around ten percent of them that they consider to be the most promising. "We already want to see that the value of the property really increases as a result of the planned conversion work and that higher rents are enforceable," explains the expert. "We always ask ourselves the question of how many euros per square metre a converted property has to be rented out at in order for our financing to be secure and whether the corresponding rent level is realistic."
In order not to risk a default, Younis' team attaches particular importance to risk management.
In principle, the investment professionals pay attention to two factors: On the one hand, there is the existing debt. The higher this is, the higher the quality of the property must be. And on the other hand, there is the structural risk - how risky the property itself is. This is about aspects such as the location, the fittings or the rentability. "Overall, it is important to find a balance. Under no circumstances should investors take high risks on both aspects. That's why we have to analyse each individual project and business plan in detail," explains Younis.
At the end of the analysis process is an assessment of the property's future potential. "The decisive factor is how realistic the planned rent increases are after a conversion and how long the property can then be let. That's why it's important to take a very close look at the local supply and demand situation," explains the expert. "This ultimately determines how well the property can be refinanced or sold after the business plan has been implemented. And on that, after all, depends whether we can get our loan back without any problems."
As real estate is also always dependent on local conditions, Younis and his colleagues also draw on around 200 Schroders real estate experts across Europe and locally.
They are not focused on any particular segment of the property market. "While we also see certain areas performing stronger and others weaker due to the pandemic and structural trends," Younis says, "we don't exclude any area." Even a retail center, if the business plan is convincing, may qualify as an investment.
Still, two fundamental risks remain: first, developments in the real estate market itself, and second, the interest rate environment. "Drastic changes in the current situation can jeopardize such projects. If buyers were no longer willing or able to pay the prices required by the project developer, he could find himself in trouble. That's why we see it as our job to find investments that are not dependent on general developments in the real estate market or interest rate trends," says Younis.
That's why good risk management is all the more important, he says, to ensure that only those properties are financed that can hold their own regardless of general trends and do not run into problems when interest rates change. Younis' conclusion: "With such an approach, an admixture of real estate debt, precisely because it does not correlate with developments on the capital market, can be useful for diversifying a portfolio."
Schroders Capital - one brand for all private assets.
Schroders is now bundling its specialist investment capabilities in the area of private assets under the newly launched Schroders Capital brand.
This will bring together the full range of existing products in private equity, securitised products, asset-backed financing, private debt, real estate, infrastructure, insurance-linked securities and BlueOrchard, a specialist in impact investing. This combination will drive knowledge sharing and innovation across Schroders' private assets business.
Due to its significant role in the development of the impact investing industry over the last 20 years, BlueOrchard will retain its distinct brand identity.
Schroder Investment Management
(Europe) S.A., German Branch
Taunustor 1, 60310 Frankfurt, Germany
Peter Begler (069/975 71 72 56)