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Resilience in real estate debt: who’s responsible for ESG?

14 Dec 2023

In a recent article, I highlighted some key takeaways from a panel discussion on the real estate debt market that I moderated at the 4th Annual Real Estate Europe Forum in October. The main takeaway from that piece was that experts agree that it’s a good time to be a lender. In this article, I’m going to provide some additional insights from the panel discussion. Here’s a look at the panellists’ views on recent fund launches, ESG and its impact on the industry, and more. 

The volume of fund launches is down

With traditional lenders pulling away from the commercial real estate market this year due to concerns over falling property values, alternative lending firms have been looking to exploit the funding gap. However, while there has been a lot of willingness to raise capital, fundraising has been challenging, said the panellists.

Some managers have managed to successfully launch and close funds in recent months. For example, PIMCO recently successfully closed its second U.S. real estate debt fund, CRED II. This was a $3 billion fund – more than double the size of the firm’s first property credit fund. Ares Management has also raised fresh capital for its real estate debt business lately, taking its total assets under management here to over $11 billion.

Yet in general, the market has been quite slow, with fund closings taking much longer than they did in the past. In the current environment, even marquee managers have found it hard to raise capital. As a result, the volume of fund launches is down overall.

Now, panellists agreed that institutional investors still see real estate debt as an important asset class. However, they noted that in the current environment, investors are demanding improved fund terms and negotiating carry models and hurdle rates with GPs. Some investors are wanting to hold off to see how 2024 plays out in terms of both the macroeconomic and geopolitical environment.

Given the challenges with raising capital, some managers are considering launching with segregated managed accounts (SMAs) in order to start working with certain investors sooner.

ESG issues are complex

As for the impact of ESG on the commercial real estate industry, panellists agreed that it is significant.

Today, ESG is a key factor for tenants. Whether it’s financial services companies occupying prime office buildings or logistics companies renting out warehouse space, organisations are looking for properties that incorporate ESG because these properties can help to reduce costs and mitigate risks. At the same time, ESG is also a key factor for lenders. With investors looking to make their portfolios greener, lenders are having to incorporate ESG into their lending criteria.

Yet right now, many buildings still aren’t up to scratch when it comes to ESG. So, the big question is – who is going to finance the transformation of commercial real estate assets to make them greener? Will it be the owners? Or will it be the lenders?

Where this issue gets complicated is valuations; Net Zero is a relatively new concept, there is no way of assessing how the cost of transitioning an asset will impact its value. Similarly, there is no way of determining the cost of doing nothing to an asset. Ultimately, we don’t yet have the data to accurately price in ESG improvements.

It’s worth noting, however, that in July, a group of commercial lenders in the UK, in association with the Royal Institute of Chartered Surveyors (RICS), published guidelines designed to make it easier to understand ESG’s impact on commercial property. The guidelines – which RICS described as a “useful starting point” – aim to help lenders better understand the market value of an asset in this context.

Adding further complexity on the ESG front is government regulation. A good example here is a recent dispute between retailer Marks & Spencer and UK Secretary of State, Michael Gove. Marks & Spencer wanted to demolish its Oxford Street building and build a new store. However, Gove blocked the proposal, arguing that a rebuild would emit far more carbon than a refurbishment. Going forward, Gove’s ruling is likely to be seen as a precedent for developers and planners when it comes to major demolish and rebuild projects in the UK.

Interest rates to stay higher for longer

Finally, turning to interest rates, the view among the panel was that we may have seen peak rates. However, panellists agreed that rates are likely to stay higher for longer. And the view was that if rates were to fall in the next 12-24 months, they might only come down by 1-2%. This higher-rate environment should continue to favour real estate debt strategies over real estate equity strategies since lenders should be able to continue charging high interest rates.

Read Part I – Resilience in real estate debt: behind the headlines

About the event

The Resilience in Real Estate Debt panel discussion took place at the 4th Annual Real Estate Europe Forum in October. During the panel discussion, panellists shared their perspectives on the state of the real estate debt markets and discussed the value of investing in debt given the current state of the global economy. The panellists were: David White, Head of LaSalle Real Estate Debt Strategies, Europe, LaSalle; Omega Poole, Head of Funds Management, LendInvest; David Renshaw, Managing Director & Co-Head, Fiera Real Estate Debt Strategies (Europe); and Justin Fiaz, Partner, Pluto Finance.

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