STATESIDE: Real estate debt, 2.0

For many private equity real estate firms, the global financial crisis didn’t just yield a wave of distressed debt opportunities, but gave birth to brand-new businesses. Private equity real estate firms such as The Blackstone Group and Colony Capital began investing in real estate debt at that time, buying troubled mortgages from banks that needed to write off the assets, or lending to borrowers that were unable to secure loans from traditional lenders that had pulled back from providing financing. 

The global credit markets have recovered significantly since those days, but the formation of new real estate debt platforms just keep on coming. Last month, Kohlberg Kravis Roberts (KKR) and TPG Real Estate both were in the news for their respective plans to build dedicated real estate debt platforms, after several years of making real estate equity investments. 

Despite being at least several years behind many of their peers, KKR and TPG aren’t necessarily late to the party, because real estate debt opportunities continue to abound. Much of the pipeline is expected to come from a wave of commercial real estate debt maturities over the next few years. But there’s another factor now in play that was only beginning to emerge during the financial crisis: regulation.

“Debt markets continue to offer an interesting opportunity,” according to a July 2014 report from Prudential Real Estate Investors. “While pricing and availability of debt is improving, the regulatory environment for banks, which provide about 50 percent of real estate debt in the United States and 75 percent in Europe, is toughening.” The regulations effectively will restrict the amount of capital that banks will be able to lend, which has ushered in an influx of nontraditional lenders to close the funding gap.

TPG, for example, has created a new mortgage real estate investment trust, TPG Real Estate Finance Trust, to own the Deutsche Bank existing portfolio as well as originate new loans. TRT, which is expected to become a global lender over time, will represent a new business line for TPG, one that focuses on performing mortgages, will be distinct from the purchases of large distressed debt portfolios that the firm already has been making on behalf of its real estate equity business.

The two real estate debt businesses share some similarities. Aside from the timing of their entry into the market, both firms are assuming large teams from other companies in conjunction with the launch of the new platforms. As of press time, KKR was due to bring aboard several investment professionals from Rialto Capital Management to begin investing in preferred equity, mezzanine debt and other credit opportunities.  Meanwhile, TPG has snapped up a team of 11 origination and risk-management professionals from Deutsche Bank’s special situations group, as part of its acquisition of a 75 percent stake in a $2.5 billion high-yield real estate loan book. 

The team lift outs make sense, since both firms are launching their new platforms at a time when their competition is already entrenched in the credit space. To capture their share of the opportunity, they will need to hit the ground running. 

A key difference between the two platforms, however, is that TPG already has a nearly fully formed business. With the acquisition of the Deutsche Bank portfolio, the firm has the team and assets already in place, and also lined up new equity, having raised more than $750 million to make new originations through TRT. 

TPG declined to comment on the deal. However, according to one source familiar with the matter, this transaction also is the result of the new regulatory environment. Given regulatory constraints, Deutsche Bank is said to have wanted to offload the loan portfolio, since it was required to limit its exposure to such mortgages, which are backed by commercial real estate assets that are in transition, typically properties with relatively high vacancy or that are being converted into new uses. 

PERE understands that the investment bank also wanted to maintain an ongoing relationship with the business so that it could continue to offer this type of transitional loan product to clients.  That’s one of the reasons for its retaining of a minority stake in the assets, and its search to find a buyer that would keep the existing team and business intact. But there may not have been a slew of prospective buyers, because the type of firm that would be most likely to agree to such terms would be one that didn’t already have an existing debt platform.

TPG will have one of the few, if only, real estate debt platforms with an ongoing relationship with one of the world’s largest banks. It’s clear that every private equity real estate firm that has expanded into the debt space has made its foray in different ways. In the case of TPG, this entry involved a rather unique approach to building a business, and this should continue to serve TPG well.