Banks return to RE credit but funds still have an edge

Banks are returning to real estate lending, according to credit managers, but one industry insider warns of challenges ahead as we may not yet be at the bottom of the cycle.

“The environment is getting more competitive,” Edoardo Crotta, head of real estate credit at Tikehau Capital told Alternative Credit Investor.

“It is a function of LPs and investors which are today allocating more into the credit space and less into the equity space.”

Although commercial banks are coming back to the market, Crotta noted that they are continuing to focus on specific types of products, including residential, leased logistics and offices in core locations, particularly in the UK.

“They are back on just a few asset classes, on the products they like with the sponsors they like, but they’re back in a very competitive way, I would say, from a pricing perspective, if you are looking in the 50 to 60 loan to value range,” Crotta said.

Vincent Nobel, head of asset-based lending at Federated Hermes agreed but noted that banks are more focused on low-risk lending.

“I think the banks still have their likes and dislikes that are suitable to their source of capital,” Nobel said. “And they are very good at doing low leverage loans secured by assets that produce stable income. In that part of the market, pricing is the mechanism through which competition functions. That is not true in all parts of the market.”

Rising competition is creating opportunities for alternative lenders, according to Crotta.

“As a reflection of that, the leverage cost for back leverage is going down, which is also giving an advantage to alternative lenders like us,” he said.

“I think, generally, it’s a good dynamic for the market. The cost of borrowing and availability and depth of the market are coming back, because it’s going to reinforce and even increase transaction volumes for the years to come.”

Bottom of the cycle

Although optimism seems to be returning to the market, Nobel cautioned against assuming the cycle has bottomed out.

“It’s not a given that we’re at the bottom of the cycle,” he added. “We may be, but only time will tell.

“People have had to suffer two or three years of valuation declines and the desirable conclusion becomes, that we must be at the bottom of the cycle. It feels like wishful thinking.”

He pointed to broader uncertainty, saying: “It’s more the fact that we have an economic outlook that is at best stable and a geopolitical outlook that is very messy.”

He added that the impact of Covid, followed by interest rate hikes, means that the end of the cycle has come in two parts.

“As a result, even senior real estate debt outperformed the equity index over a 10-year period,” he said. “That is very unusual. And I know that the future will not be a perfect mirror of the past, but it is an interesting question, I think, to ask is whether the risk premia that are applied in the market are the right ones.

“The increase in the risk-free rate that we’ve seen in the last couple of years has pushed yields out. The question is, has there been enough yield movement to reflect that risk?”