Octopus raises £115m for second UK fund – Exclusive

The latest fundraising by niche UK lender Octopus Property shows investors are targeting high returns by backing short-term real estate debt strategies.

The boutique London-based firm has held a £115 million (€131 million) first close on its Commercial Real Estate Debt Fund II, which will provide property loans with terms as short as three months in the UK real estate market.

Its predecessor fund, which has reached the end of its investment period, generated a gross IRR of 12.6 percent to June 2017, and the second is understood to be targeting returns not significantly below that mark.

Octopus, formerly known as Dragonfly Property Finance, is aiming to raise £200 million, with a March 2018 final close expected. That would enable it to lend more than £500 million in the next three years, it estimates.

A handful of ‘specialist’ firms are targeting high-yielding, small-ticket loans in the UK market. Speaking to Real Estate Capital, Ludo Mackenzie, Octopus Property’s head of commercial property, argues that credit strategies can provide attractive returns coupled with downside protection.

“Equity investors seeking returns over 10 percent IRR will typically be employing a degree of leverage. It would only take yields to move back to where they were in 2014 for returns to fall to zero or negative,” explains Mackenzie. “On the other hand, a lender at 70 percent LTV, and assuming 5 percent cost of recovery, has a 25 percent margin of safety. It would take a significant outwards shift in yields to bring about that level of correction. People are investing in debt funds to access equity-like returns and hedge against a potential market correction.”

Around two-thirds of investors in the CREDF II fund were existing investors from the maiden fund, which reached a £130 million final close in 2014. In addition to the first fund, Octopus also raised £35 million in a top-up fund in 2016 – CREFF-S. Between the two vehicles, Octopus has lent more than £420 million, secured by UK commercial property.

The investors in CREDF II are mainly UK pension funds, with a credit fund of funds also understood to be a significant contributor.

Prior to raising institutional capital in 2014, Octopus invested retail money, with a total of £2.6 billion of lending since 2009, when the real estate strategy was launched. Demonstrating the granularity of the lending, that total has been deployed across more than 2,600 loans.

The returns achieved by firms like Octopus are driven by the specialist nature of the loans. This type of lending takes place outside the institutional real estate market, with clients typically property companies of varying scales, private equity players and private individuals. In Octopus’s case, the sweet spot is loans of between £1 million and £5 million, with with a typical duration of 12 months. It lends to residential development projects, and existing commercial properties across a variety of asset classes.

Sponsors are usually completing time-pressured acquisitions, with a need for bridging finance, or are aiming to fund transitional properties which do not benefit from the income streams bank lenders usually require.

“A lot of the lending market does not want to lend short-term, or below £10 million. From a borrower’s perspective, we provide loans that are more versatile than traditional bank finance and cheaper than private equity,” explains Mackenzie.

Others are active in this space, albeit each with tailored strategies. In June, Pluto Finance raised more than £500 million for its senior and bridge residential finance strategies. In May, Jonathan Samuels, the founder of Octopus Properties – back when it was Dragonfly – launched property bridging finance provider Octane Capital with the backing of Pamplona Capital Management.

Firms have come and gone at the niche end of the UK real estate lending market, but the handful that are on repeat strategies are catering for a part of the market which larger lending organisations do not have the appetite for.