Real estate debt broadens appeal with investors

Commercial real estate debt is gaining a firmer foothold in investors’ strategies as they look to diversify.

The need to mitigate market risks in light of recent steep cash rate hikes by central banks is further strengthening the appeal of debt strategies — a more stable alternative to shield investors from market volatility.

“Across the Asia Pacific region, central banks are increasing cash rates or adjusting exchange rates because of a massive, swift change in global monetary policy,” says Paul Brindley, Head of Debt Advisory, Asia Pacific, JLL.

Interest rates in some markets have risen by as much as 250 basis points in less than six months, JLL data shows. This rapid change is further accelerating the reallocation of capital into debt investments.

In fact, around 21% of investors are planning to deploy more capital in the debt space this year, according to JLL’s Investor sentiment barometer.

“Despite the potential for a slowdown in markets, some institutional investors continue to seek avenues to deploy capital,” says Brindley. “A growing number of investors are opting to invest in debt over equity for its stability, trading off upside for cash returns.”

In more volatile markets where investors may not have the data points to invest in equity, debt provides an alternative at a lower risk point and with more downside protection, Brindley says.

As banks focus on the impact on rising base rates and incumbent sponsors, opportunities are emerging, particularly for non-bank lenders who can take higher risks, to tap demand for development financing.

“For sponsors that can’t meet the traditional metrics required to secure commercial bank financing or are seeking flexibility on covenants, borrowers are pivoting to the range of non-bank lenders that can provide such accommodations,” says Matthew Duncan, Head of Debt Advisory, Australia, JLL. “Lenders’ flexibility around interest servicing covenants can be a very valuable protection.”

Debt strategies are also typically broader and non-sector specific, which makes it easier for investors to respond to the market opportunity and to pivot between different sectors where opportunities arise, Duncan adds.

Deals closed by JLL, for instance, range widely from ground-up development to permanent financing for performing asset classes such as logistics and recovering asset classes like hotels.

Diversification and competition will dominate as key themes for the region’s debt market, according to Duncan.

“To compete with entrenched banks, non-bank lenders will have to find ways to add value to real estate deals through methods such as alternative structures, reduced covenants, or higher and more flexible leverage,” says Duncan.

Further forward, the speed of processing loans will enhance competitiveness.

“The ability to respond quickly will allow lenders to take advantage of the potential opportunities caused by any distress in the market,” says Brindley. “As the market matures for non-banks and debt funds, banks may still have a role to play in providing leverage to debt funds, much like in the U.S. and Europe.”

Conditions right now may still favour commercial banks. But as leading markets in the Asia Pacific region — namely Australia, New Zealand, Singapore, Hong Kong, and China — close the gap with more established debt markets globally, a secular shift is underway, Brindley concludes.