What could the new cycle hold for real estate debt investors?

4 min read 20 Jan 25

Real estate debt is attracting increasing attention from investors globally, as well as new market entrants, with the potential for equity-like returns for credit investing like never seen before. As we move into a new cycle, we look at the opportunities for non-bank lenders.

Lending dynamics within the real estate debt realm look particularly attractive in the current market, from our perspective. The ability to lend at lower debt bases, based on a reduction in property values, means lenders are typically exposed to lower risk. Meanwhile, higher interest rates support loan margins on an absolute and relative value basis. In essence, debt investors could be well-positioned to tap into a sweet spot, considering the current factors at play.

The asset class’s staple benefits hold firm – namely a significant equity cushion, given equity is eroded before debt in the event that a property’s value falls; in addition to typically predictable cash flows, as a result of regular loan repayments. 

“We believe the coming year could be a particularly attractive entry point for non-bank lenders to target outsized risk-adjusted returns, as the market continues to recover.”
 

The defensive nature of real estate debt could also help investors navigate what may be an uneven real estate recovery. As we move into a new cycle, we expect many assets to benefit from a cyclical upswing, however some assets are also likely to face further decline. Investing on the debt side could therefore reduce potential downside risk, given its position in the capital stack.

Any lingering concerns over further value erosion may be negated by investing in first-ranking, senior debt. For those looking for higher returns, other forms of lending may also be appealing – for example mezzanine financing for refurbishment projects.

Increasing real estate deal flow

Following a period of stagnation in the property transaction market, confidence is returning among both equity and debt investors. Interest rates are expected to have peaked, and are likely to move lower going forwards, while real estate values have largely stabilised or begun their recovery phase – even in more challenged markets. Real estate fundamentals also look robust, as recovering demand meets heavily constrained supply.

This sets the scene for an increase in buying, selling and lending opportunities, as the new cycle begins. As lenders move past an “extend and pretend” mentality, we expect to see more refinancings across sectors and geographies, while new deals – including refurbishments and developments – will need their equity supported by leverage.

Gaining traction in real estate debt

Non-bank lenders are well placed to gain traction particularly in parts of the market where banks are less active. In particular, debt availability for development financing is shrinking, given the less favourable balance sheet treatment associated with these loans. We see this as a compelling opportunity to lend against refurbishments and new developments at moderate leverage and potentially attractive returns, financing tomorrow’s best-in-class real estate. 

Equally, local lenders may not necessarily have appetite for multi-jurisdiction exposure. The ability to structure cross-border portfolios therefore has the potential to unlock opportunities for non-bank lenders that are able to navigate multiple property markets and legal regimes. 

Discretion over capital, paired with lean decision-making processes, can also compare favourably in some cases with banks’ processes – specifically where more than one bank is required to provide financing. A lender’s ability to provide whole loans – loans at a higher leverage point – and hold them to maturity can also be a key differentiator.

Expanding opportunities in Europe

We see interesting pockets of opportunity in markets and sectors across Europe, aligned to long-term structural trends. Alleviating Europe’s housing backlog will require substantial capital flows, which is creating significant financing opportunities. We believe non-bank lenders should be well-positioned in multiple markets, as many existing lenders reach exposure limits. Though margins can be tight in the residential sector, non-bank lenders are still able to add value compared to local lenders, and lenders that are less keen to take on development risk. 

Equally, the development of Continental Europe’s purpose built student accommodation (PBSA) and build to rent sectors could create another notable source of opportunities for non-bank lenders. Given that these sectors are at an earlier stage in their evolution than the equivalent markets in the UK, lenders with experience in these asset classes could be well-positioned relative to local banks, which may only be prepared to provide smaller loans or lower leverage. 

A potentially attractive entry point

Notwithstanding political and regulatory risks, the real estate debt outlook is largely positive for non-bank lenders, in our view. We believe the coming year could be a particularly attractive entry point for non-bank lenders to target outsized risk-adjusted returns, as the market continues to recover.

We also expect increased central bank scrutiny on banks to be a continued theme, with the potential to impact the composition of the lending landscape. This is likely to increase the scope for alternative lenders; particularly those with the ability to allocate larger amounts in single transactions, we believe.

However, this is an environment in which lenders need to be selective in where they invest debt, and how they structure it. Having seen high capital flows into sectors such as PBSA and hotels, some valuations could look elevated, for example. Leveraging local real estate expertise will therefore be integral to underwriting robust loans with sustainable credit structures and Loan to Value (LTV) levels. 

 

The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast. 

Find out more about our real estate capabilities

Find out more