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Is now the right time to invest in CRE debt in the U.K.?
Based in London, Christian oversees the origination, portfolio management and business development activities for Nuveen Real Estate’s debt platform in Europe. Here, Christian gives his view on why now is the right time for investors to engage in commercial real estate (CRE) debt in the United Kingdom.
Why could investing in cre debt be a good investment strategy?
Well-managed CRE debt provides performance protection through diversified, stable income streams. CRE debt benefits from a substantial degree of downside protection provided by the ‘buffer’ of the sponsor’s equity. While there is typically no additional upside to debt returns in a rising market, the sponsor’s equity will absorb the first loss in a falling market. In addition, contractually-agreed interest payments insulate the lender from the volatility of a changing rental income profile. As real estate market cycles become shorter and more difficult to predict, this insulation and degree of certainty is increasingly regarded as highly attractive by investors.
U.K. CRE loans usually include substantial performance covenants, put in place to protect the lender in the event of capital value or income declines. These typically include a ‘cash trap’, where any surplus income not required for debt service can be retained by the lender and used to reduce the loan, and a default clause, which allows the lender to sell the property if the default LTV is breached. These covenants are typically triggered at thresholds long before the deterioration of income or capital value would leave the lender at risk of loss.
As such, the potential downside protection investment attributes of CRE debt are becoming increasingly sought after; alongside stability, diversification and contracted income. CRE debt presents very competitive relative value, compared to fixed income and direct real estate.
The resulting retrenchment of traditional lenders, as well as the reduction and repricing of available capital, has created a permanent, attractive and executable investment opportunity for non-bank lenders and debt funds to provide a meaningful share of future CRE debt finance in the U.K..
Brexit has reinforced the bank retrenchment away from commercial real estate, with a slower, more selective transactional approach. This has opened up further opportunities for non-bank lenders to achieve higher returns on the same quality of asset, with speed of execution increasingly held at a premium. Direct investor activity has been buoyed by the prolonged low-yield capital market environment, but with parts of the U.K. real estate market looking late cycle, and Source: CASS CRE Lending Survey 2017 & Mid-2018. Traditional Bank Lenders (RHS) Margin (2007=100)(LHS) Is now the right time to invest in CRE debt in the U.K.? well-documented geo-political uncertainties, in our opinion, CRE debt’s future returns look very compelling. A CRE debt strategy offering potential downside protection and income-focused returns is well positioned to offer investors competitive relative value.
What is CRE debt?
CRE debt is typically structured as a loan secured on commercial real estate. It offers income-focused returns through periodic interest (and principal) payments, culminating with the repayment of the remaining principal at maturity.Why could investing in cre debt be a good investment strategy?
Well-managed CRE debt provides performance protection through diversified, stable income streams. CRE debt benefits from a substantial degree of downside protection provided by the ‘buffer’ of the sponsor’s equity. While there is typically no additional upside to debt returns in a rising market, the sponsor’s equity will absorb the first loss in a falling market. In addition, contractually-agreed interest payments insulate the lender from the volatility of a changing rental income profile. As real estate market cycles become shorter and more difficult to predict, this insulation and degree of certainty is increasingly regarded as highly attractive by investors.
U.K. CRE loans usually include substantial performance covenants, put in place to protect the lender in the event of capital value or income declines. These typically include a ‘cash trap’, where any surplus income not required for debt service can be retained by the lender and used to reduce the loan, and a default clause, which allows the lender to sell the property if the default LTV is breached. These covenants are typically triggered at thresholds long before the deterioration of income or capital value would leave the lender at risk of loss.
Why is now a good time to invest in CRE debt?
Real estate equity markets are currently experiencing significant volatility, elevated valuations, and heightened uncertainty. An investor focus on income, given the low interest rate environment, is now paramount.As such, the potential downside protection investment attributes of CRE debt are becoming increasingly sought after; alongside stability, diversification and contracted income. CRE debt presents very competitive relative value, compared to fixed income and direct real estate.
The investment attributes of CRE debt are becoming increasingly sought after; offering stability, diversification and contracted income.
Who are the main players in the CRE debt space?
Although CRE debt has always been a fundamental part of the U.K. real estate market, the dominance of banks, until the global financial crisis (GFC), heavily restricted investment opportunities for traditional investors. Since the GFC, stricter regulatory, capital and liquidity requirements have increased the burden on banks’ balance sheets, which has led to a tightening of underwriting standards, significant reductions in the leverage of loans, and substantial increases in loan pricing.The resulting retrenchment of traditional lenders, as well as the reduction and repricing of available capital, has created a permanent, attractive and executable investment opportunity for non-bank lenders and debt funds to provide a meaningful share of future CRE debt finance in the U.K..
How has Brexit impacted the sector?
Since the U.K. announced its decision to leave the European Union, real estate market performance has proven far more resilient than consensus projected. However, given the political and economic complexities of any European negotiation, market forecasts vary significantly, and largely still imply a degree of pricing correction as markets begin to gradually ‘normalise’. Tellingly, most anticipated valuation declines would remain well within the buffer offered by the borrower’s equity in a sensibly structured loan.Brexit has reinforced the bank retrenchment away from commercial real estate, with a slower, more selective transactional approach. This has opened up further opportunities for non-bank lenders to achieve higher returns on the same quality of asset, with speed of execution increasingly held at a premium. Direct investor activity has been buoyed by the prolonged low-yield capital market environment, but with parts of the U.K. real estate market looking late cycle, and Source: CASS CRE Lending Survey 2017 & Mid-2018. Traditional Bank Lenders (RHS) Margin (2007=100)(LHS) Is now the right time to invest in CRE debt in the U.K.? well-documented geo-political uncertainties, in our opinion, CRE debt’s future returns look very compelling. A CRE debt strategy offering potential downside protection and income-focused returns is well positioned to offer investors competitive relative value.
What are the current opportunities in the sector?
In the context of retrenching traditional lenders and the persistent narrow focus on prime assets, increased opportunities for well-capitalized, specialist, alternative finance providers exists. Investment opportunities can be found in those assets currently ‘off the radar’, particularly core-plus assets in established markets. With robust underwriting, ideally informed by direct real estate expertise, these undeserved markets present the most appealing prospect for the selective ‘cherry-picking’ of transactions, backed by strong fundamentals and robust return characteristics.
Important Information:
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on factors such as market conditions or legal and regulatory developments. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions made in preparing this material could have a material impact on the information presented herein.
This material is provided for informational or educational purposes only and does not constitute a solicitation of any securities in any jurisdiction in which such solicitation is unlawful or to any person to whom it is unlawful. Moreover, it neither constitutes an offer to enter into an investment agreement with the recipient of this document nor an invitation to respond to it by making an offer to enter into an investment agreement.
This material may contain “forward-looking” information that is not purely historical in nature. Such information may include projections, forecasts, estimates of yields or returns, and proposed or expected portfolio composition. Moreover, certain historical performance information of other investment vehicles or composite accounts managed by Nuveen may be included in this material and such performance information is presented by way of example only. No representation is made that the performance presented will be achieved, or that every assumption made in achieving, calculating or presenting either the forward-looking information or the historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein by way of example.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Nuveen to be reliable, and not necessarily all-inclusive and are not guaranteed as to accuracy. There is no guarantee that any forecasts made will come to pass. Company name is only for explanatory purposes and does not constitute as investment advice and is subject to change. Any investments named within this material may not necessarily be held in any funds/accounts managed by Nuveen. Reliance upon information in this material is at the sole discretion of the reader. Views of the author may not necessarily reflect the view s of Nuveen as a whole or any part thereof.
Past performance is not a guide to future performance. Investment involves risk, including loss of principal. The value of investments and the income from them can fall as well as rise and is not guaranteed. Changes in the rates of exchange between currencies may cause the value of investments to fluctuate.
This information does not constitute investment research as defined under MiFID.
This material is provided for informational or educational purposes only and does not constitute a solicitation of any securities in any jurisdiction in which such solicitation is unlawful or to any person to whom it is unlawful. Moreover, it neither constitutes an offer to enter into an investment agreement with the recipient of this document nor an invitation to respond to it by making an offer to enter into an investment agreement.
This material may contain “forward-looking” information that is not purely historical in nature. Such information may include projections, forecasts, estimates of yields or returns, and proposed or expected portfolio composition. Moreover, certain historical performance information of other investment vehicles or composite accounts managed by Nuveen may be included in this material and such performance information is presented by way of example only. No representation is made that the performance presented will be achieved, or that every assumption made in achieving, calculating or presenting either the forward-looking information or the historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein by way of example.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Nuveen to be reliable, and not necessarily all-inclusive and are not guaranteed as to accuracy. There is no guarantee that any forecasts made will come to pass. Company name is only for explanatory purposes and does not constitute as investment advice and is subject to change. Any investments named within this material may not necessarily be held in any funds/accounts managed by Nuveen. Reliance upon information in this material is at the sole discretion of the reader. Views of the author may not necessarily reflect the view s of Nuveen as a whole or any part thereof.
Past performance is not a guide to future performance. Investment involves risk, including loss of principal. The value of investments and the income from them can fall as well as rise and is not guaranteed. Changes in the rates of exchange between currencies may cause the value of investments to fluctuate.
This information does not constitute investment research as defined under MiFID.
