PE Firms Ramp Up Real Estate Debt Funds

LONDON (Reuters) – Debt funds set up by real estate private equity players could capture as much as a fifth of the global property lending market in 2009 as banks recoil further from the credit-starved sector, Swisslake Capital AG’s CEO said.

Chief Executive Bernhard Koehler told Reuters many private equity funds originally set up to snare distressed bricks and mortar were now lining up to fill a vacuum left by banks smothered by losses from mortgage-related assets.

“There’s a big need for these funds, even if they can’t solve all the problems,” Koehler said.

“The majority of fund managers are skilled in identifying opportunities in any market, and they see good returns can be achieved by taking on the role of a bank,” he said.

In research exclusively obtained by Reuters, Swisslake — one of Europe’s biggest real estate private equity investment advisors — said debt funds managed by private equity players grabbed a 12.6 percent foothold in the world’s real estate lending market in 2008.

Koehler estimated this market share could grow to 20 percent this year, as a wave of fresh financing requirements threatened to overwhelm the world’s barren credit markets.

“Our calculations show around 85 billion pounds (of UK real estate debt) will need to be refinanced before 2012 … and that’s just the UK,” said Koehler.

“That’s an enormous challenge for the whole industry. And there are very few banks willing to satisfy this,” he said.

According to Swisslake, a total 43 debt funds comprising more than 57 billion euros of seed capital were launched by real estate private equity specialists in 2008, almost double the number of launches seen in 2007.

These funds provide all types of debt, ranging from conventional mortgages to mezzanine finance. In some cases, where owners fail to refinance, debt funds can also profit by taking possession of the underlying asset and restructuring it.

Koehler said he expected the number of 2009 debt fund launches to eclipse the 2008 tally as the potential to make double-digit percentage returns tempts more cash-rich fund managers to act.

“From our point of view, debt funds can be great income-producing investments. With cash-on-cash yields of between 7 and 8 percent and average target IRRs of around 15-16 percent on a net basis, these are quite attractive numbers,” he said.

Real estate specialists are not the only private equity players to spot potential to make handsome returns from stricken credit markets.

At the SuperReturn private equity industry conference on Tuesday, Leo Black, the founder of Apollo Management LP, told delegates he expected to strike more debt investments than classic buyout deals over the next two years.

In the past, real estate debt funds were mainly focused on plugging demand for finance in the United States, with very few vehicles launched in 2006 and 2007 targeting European or Asian markets, Swisslake’s research showed.

But last year, Swisslake identified a remarkable move toward these more neglected markets, and Koehler said this trend was set to continue in 2009.

“We could see double the number of new launches in Europe, but it is hard to predict because there is demand for debt everywhere,” he said.

By Sinead Cruise
(Editing by Will Waterman)