Brookfield Asset Management’s growth in European real estate markets continued apace in 2020, despite – and, to a degree, because of – the market disruption caused by covid.
In May, the $515 billion Canadian investment firm spent £264 million (€288 million) on a 7 percent stake in UK-listed landlord British Land, when UK real estate investment trusts were trading at big discounts to net asset value. It also grew its Europe-focused financial firepower, raising €725 million in a first close for its maiden open-end, core-plus equity fund for the region.
Brookfield has a record of spending big in Europe, with trophy assets including London’s Canary Wharf estate and the mixed-use Potsdamer Platz campus in Berlin. There is, however, one part of Europe’s real estate market in which it has been quieter: debt.
Brookfield’s North American debt platform was launched in 2004, but the firm only began to lend in Europe in late 2017 and has closed just three deals. The highest-profile transaction saw it partner with German insurer Allianz to provide mezzanine debt in an overall €300 million financing of Blackstone’s St Katharine Docks estate in London in 2018. More recently, it closed a loan covering France, Germany, the Netherlands, Italy and Spain.
Its purchase of a majority stake in credit-focused manager Oaktree Capital in March 2019 brought significant exposure to real estate debt. Oaktree has $2.4 billion of property credit under management, including in Europe. Oaktree entered the property debt space in 2010 and is known for high-yielding investments through mezzanine loans, corporate real estate debt and commercial mortgage-backed securities.
Oaktree gives Brookfield credit
In April 2019, Brookfield bought a 62 percent stake in manager Oaktree Capital, bringing $66.5 billion of credit assets into the fold. Oaktree remains separate from Brookfield’s property lending business, but gives the Canadian firm another route into real estate credit.
Oaktree targets high-yielding credit. As Brookfield chief executive Bruce Flatt told sister title PERE at the time of the acquisition: “When stress in credit is robust, they excel more.”
Stress was limited at the time of the purchase. Oaktree’s distressed debt strategy had recorded a composite gross return of 10 percent in 2018, down from 18 percent in 2017, according to PERE coverage. The covid-19 crisis, however, will generate a new round of investment opportunities.
For Flatt at the time, acquiring a credit-focused business was a late-cycle move. “Our goal is to ensure we have capital to serve our clients at every point in the economic cycle,” he said.
However, Brookfield now plans to grow its in-house European real estate debt platform, which the organization stresses is operated entirely separately from Oaktree. In June, it hired a sector veteran, Martin Farinola, to spearhead its European lending drive. Farinola led the property lending arm of Swiss asset manager GAM, which bought the real estate finance business of independent manager Renshaw Bay, in which he was a partner, in 2015. Before that, he worked for Goldman Sachs and BlackRock. He will report to Andrea Balkan, managing partner of Brookfield’s New York-based real estate group, and will be joined in London by Tom Flick, a vice-president in the New York-based real estate finance team.
“Our ambition is to replicate what we have in the US here in Europe”
Speaking to us via videolink from his Canary Wharf office, Farinola admits he is still getting to know the organization. But he is clear on the task ahead. “Our ambition is to grow a scalable business here in Europe,” he says. “After completing our first few deals in the UK and on the continent, I was hired to help lead the expansion and increase our footprint in Europe. Sitting in the same office as our equity team has helped me ramp up quickly on Brookfield.”
In 2017, Balkan said European lending would initially be done through the $3 billion Brookfield Real Estate Finance V, which closed in November 2017, with a net 9-10 percent return target. Up to 20 percent of the fund was allocated to Europe and Farinola says it is still being deployed, with “several hundred million” available to invest.
Brookfield Real Estate Finance V in numbers
$3bn: Capital raised by final close in November 2017, 50% more than its predecessor vehicle
20%: Proportion that can be deployed in Europe
60: Number of investors, 50% of which were Canadian
12-13%: Gross return target
9-10%: Net return target
Source: Brookfield, PERE
He insists there is no target European loan book size. However, the size of the loans Brookfield is aiming to write suggest a significant commitment to the strategy. Mezzanine loans could start from $20 million, with whole loans from $75 million, of which the senior strip can be sold on to traditional lending partners. Development finance is also in the company’s sites. He adds that depending on the risk profile of the deal, the largest loans could be several hundred million pounds.
“The simplest way to put it is, given the size of Brookfield, it’s probably what you would expect us to be in European real estate debt,” says Farinola. “The size of our equity platform in Europe lends itself to us having more of a debt offering and is complementary. Our financing capabilities in North America are large and our ambition is to replicate what we have in the US here in Europe.
“We want to be able to offer investors the ability to invest across the capital stack, including lower-return lending as well as medium and higher-risk. In our mezzanine debt funds, we are looking to generate strong risk-adjusted returns by providing loans on high-quality real estate assets at a discount to the intrinsic value of the real estate.”
One head of a European real estate debt platform, speaking off the record, says the prospect of Brookfield, one of the real estate capital markets’ biggest names, as a more active European property lender is not surprising. “It’s interesting to see they are going for it now,” the source says. “It is probably good timing from the standpoint that a lot of banks are pulling back. Having a multi-strategy debt approach is very useful right now.”
Market sources say the retrenchment of banks from property lending has created opportunities for non-bank lenders to write loans at higher margins than in Q1 but for assets with similar risk profiles. Farinola says Brookfield will provide leverage within the 70-75 percent loan-to-value range, or 65 percent loan-to-cost in development financings.
“We see debt as a more conservative alternative to equity,” he explains. “As an owner and operator of a large amount of real estate, we understand it, so we won’t take unnecessary risk in lending deals. We are not a loan-to-own lender. We are trying to make sound real estate investments. I’m an optimist in the overall macro-environment. But, as a lender, I always need to be pessimistic and take a conservative view.”
BREF V’s four-year investment period ends in 2021. It is understood the company plans to raise follow-on capital for European debt as it continues to scale its platform. The scale and strategy of a future fund will be led by investor demand, he explains.
Given some of Brookfield’s North American private equity real estate peers built European lending capabilities earlier in the current cycle, why is Brookfield doubling down on debt now?
Farinola says the period preceding his hiring allowed Brookfield to test the water. “Andrea and the senior management have approached it very methodically. Our first pan-European deal helped us to understand the legal systems and structures outside the UK and get comfortable with the debt side of transacting in Europe. That was the impetus to them bringing me on board to expand our capabilities, because we think the market share of alternative finance providers in Europe will keep increasing.
“A lot of the traditional lenders are diverting capital towards helping their clients and are dealing with loans on their balance sheets that might not be performing too well in this environment. These traditional lenders have reduced their LTV levels, so there is a need for lenders to provide top-up capital to sponsors or offer whole loan solutions.”
Glass half full
Farinola has more than 20 years’ real estate finance experience, including in his native US and Europe. He says he is one of the industry’s optimists and does not agree with those who think covid-19 will be a gamechanger for real estate.
From a finance perspective, he argues the existence of alternative lenders in Europe will help avoid a repeat of the liquidity drought seen in the wake of the global financial crisis.
“For alternative lenders with dry powder, this is the time to seize the opportunity”
“Bumps in the road caused by this crisis, or Brexit before it, make borrowers call into question the certainty of execution in some of the finance markets. So, they look to alternative lenders to help smooth the bumps. For alternative lenders with dry powder, this is the time to seize the opportunity. Margins have widened and LTVs are lower, which is positive for lenders. Some traditional finance providers and other funds will be managing their existing exposures now. But we don’t have a large existing loan book here in Europe, so we are ready to deploy.”
From a bricks-and-mortar perspective, Farinola believes the fundamentals of real estate sectors will overcome the challenges of the pandemic. “In the long term, I think it will cause small nuances of change across sectors. I don’t think, for instance, the office is going away, because the spontaneity, collaboration and the ability for social interaction with colleagues just cannot be replicated when working from home. Neither can a company’s culture be instilled remotely.
“I think there will be some changes, probably to the positive. There might be more individual space in the office, a move towards paperless, or better filtration units. That lends itself to ESG [environmental, social and governance issues], so I think trends that were happening before will continue and maybe accelerate. For instance, there was always this coming together of online shopping and good physical retail, and that is still going to be the case. During lockdowns, people came to appreciate the things they weren’t able to do.”
Farinola’s faith in the ability of real estate sectors to weather the crisis is reflected in the fact the lending strategy is relatively sector-agnostic. Although development loans may be focused on the most robust sectors, such as logistics, he says investment financing will be offered across sectors, including operational assets such as hotels and student accommodation.
He adds that predictions of sweeping change in real estate due to covid-19 possibly lack perspective. “I don’t want to play it down too much, because, in the short term, there are asset classes that face real issues, such as hotels and retail. But you need to take a long-term view and, being in the middle of a crisis, people are sensitive, and rightfully so. We will survive and thrive.”
Despite his optimistic view, Farinola insists the growth of Brookfield’s European loan business will be measured. “In the initial stages, we will concentrate on deploying the existing fund, and that will mean financing single assets and diversified portfolios.” As the market evolves, he says, so will the opportunities Brookfield seeks.
One challenge covid-19 does present as he attempts to build the business, Farinola admits, is the practicalities of communicating with prospective clients and investors. “It’s very difficult to build business relationships over Zoom calls. But where we have an advantage is in the fact that we have strong existing relationships that we can leverage and grow.”
Where Brookfield stands in US credit
Real estate lending strategy launched in 2004
Led by Andrea Balkan, New York-based managing partner in the firm’s real estate group
Primarily a mezzanine loan book, with the senior elements of whole loans typically sold on
Around $6bn of new debt originated in 2019, with around $1bn held
Investing for the strategy from three funds valued at $5bn
Flagship vehicle focuses on mezzanine at 60-80% LTV, with a 13% return target