Probitas: Investors shift away from real estate debt funds

After a relatively strong fundraising year in 2017, appetite for the strategy is on the decline, according to the placement advisory firm’s new survey.

Following a robust year of capital raising in the strategy, more institutional investors are now turning their backs on real estate debt, according to a new research report from placement advisory firm Probitas Partners.

In the firm’s Real Estate Institutional Investor Trends for 2018 Survey, 38 percent of respondents said they do not invest in debt-focused funds of any sort, double from 19 percent last year, the survey said.

However, this still leaves the majority of investors – more than 60 percent – that are investing in real estate debt funds. Investing in funds focused on distressed/stressed debt purchased at significant discounts was the most popular strategy, with 27 percent of respondents expressing interest. Subordinated mezzanine debt and senior debt were also listed as strategies, and 14 percent said they were interested in more than one investment strategy.

A record $30.53 billion in capital was raised in the real estate debt strategy in 2017, according to PERE data. Many investors that previously committed to real estate debt funds re-upped with those funds’ successor vehicles, Probitas managing director Kelly DePonte said. The largest such funds that closed last year were all the second through fifth vehicles in their respective series, he pointed out. However, this year’s survey showed a shift in interest away from debt.

“They don’t have an infinite interest in the sector,” he said. “They’re not looking to invest in 10 to 12 managers. They’re more likely to invest in four or five, and they’ve sort of made their bets for now.”

In terms of investor allocations, real estate debt is most often a sub-sector of the larger real estate bucket. The typical private debt investor investing from that separate allocation is less likely to understand in detail the collateral backing real estate debt, and is less likely to commit to real estate debt funds, according to DePonte.

While many investors have previously expressed interest in real estate debt because of the perceived safety of being above the equity in the deal, there is a concern about the relative newness of the strategy. Real estate debt funds as separate investment vehicles grew in popularity after the financial crisis, when banks became more constrained in their lending due to regulatory capital requirements and investment funds stepped in to fill the financing gap. As a result, many real estate debt funds have yet to go through a full real estate cycle, according to DePonte. At what many investors consider is the top of the market, a number of LPs are becoming concerned about how funds will perform during a downturn, he said.

Although the survey indicates reduced interest in debt funds this year compared to last year, the flow of capital has yet to stop. Global capital raised for private equity real estate debt funds reached $7.85 billion during the first-quarter of 2018, surpassing the $7.36 billion raised during the same quarter in 2017, according to data from PERE sister publication Real Estate Capital.

US investors led the movement into real estate debt and still hold dominance in the market, but the emergence of European institutions into the space is noteworthy, JLL Corporate Finance global head of funds advisory Matilde Attolico told Real Estate Capital. The Real Estate Institutional Investor Trends for 2018 Survey was based on responses from 41 senior professionals from a variety of institutional investors, including pension plans, sovereign wealth funds, consultants and endowments. More than half of the respondents were based out of the US, with the remainder coming from Asia and Europe.