As the most influential figures in European real estate gathered on their yachts in the decadent French Riviera, back home, something else was sinking. Real estate has been on a tear since the financial crash as quantitative easing, low-interest rates, and an undersupply of housing has sent both residential and commercial property soaring.
Yet the the new inflationary environment has seen interest rates surge, pushing down the value of portfolios, while the latest banking crises at Credit Suisse and Silicon Valley Bank (SVB) have caused banks to step back from lending to the asset class. Transaction volumes for European real estate have precipitated; the final quarter of last year was the worst on record for European real estate returns, according to an index produced by MSCI, and the volume of London office sales hit a twenty year low.
However, amidst the bank pullback, Cheyne Capital sees real estate debt as an opportunity. The debt specialists are particularly keen on the plugging the gap created by maturing loans, about €200 billion of which will come due in Europe this year. As banks review their liquidity positions in light of unrealised losses, they will decrease their exposure to real estate debt. PGIM Real Estate expects European banks to withdraw as much as €125 billion ($132 billion) from property lending.
The latest £2.5 billion fund raised by Cheyne is a drop in the ocean, but could be a lucrative bet if the assumptions of its founders, Jonathan Lourie and Stuart Fiertz, hold true.
Residential Properties: A Secure Bet
Cheyne’s essential thesis after the financial crash were both correct. First, that stringent capital rules for banks would limit the amount they could lend to real estate. Second, that undersupply and low interest rates would keep property prices rising. Today’s landscape is trickier, in terms of the supply of capital, but less so in terms of the supply of property. Yet Cheyne have continued to focus on residential property in the UK, namely focusing on the new-build sector.
Such loans include a £105 million whole loan to Quintain to fund the development of a residential and office building on the Wembley Park site. A £58 million senior loan for the development of a former office building into 258 high quality apartments in Croydon. A £28 million loan to TopHat Industries to fund the redevelopment of the prestigious Kitchener Barracks site in Chatham, Kent.
The strategy here is simple: finance the conversion of obsolete building types into new build flats in and around London. The reason the risk of doing so is lower, even when UK house prices are 3.7% lower than their August 2022 peak, is that these flats are often sold onto Housing Associations who sell them using a “part buy, part rent” arrangement in line with the Government’s Shared Ownership scheme. Given that the Housing Associations receive grants from the Greater London Authority or Homes England, they are able to buy the flats “off plan.” For example, the Croydon development is run by Legal & General’s Housing Association arm, while the flats will be sold off via the scheme. Shared Ownership’s unique profile, allowing first-time buyers smaller deposits and subsidised rents for residents, mean that there is high demand, thus making Cheyne’s loans relatively secure.
Commercial Properties: A Post-Pandemic Resurgence
Cheyne’s commercial strategy focuses on refinancing of debt in developments like leisure, hotels, and offices that were afflicted by the pandemic, but have been resurgent since. Start with leisure. Cheyne Capital provided a £123 million Senior Loan to MARK as part of the Refinance London Scheme, which is 75% let. The combination of restaurants, office space, and a cinema embodies the return of footfall after the pandemic, giving Cheyne regular predictable interest payments. Similarly with pure play office developments in London. White Lion received a £23m debt facility which will allow for the delivery of a office development site in North London. Yet despite the decline of remote work, hybrid workforces will be looking to downsize and reduce costs, casting doubt over lending to office spaces.
The most significant area for Cheyne is hotels. They provided €200m (£172m) of senior debt to resort hotel group Beaumier, for example. It’s clear to see why. The post pandemic travel rebound, both for leisure and business trips, has boomed, with a nearly 500% jump in bookings between August 2022 and January 2023 compared to the corresponding period in 2021 and 2022. Average room prices have surged accordingly, but with Airbnb’s seeing similar inflation, travelers are opting for hotels instead. The risk for Cheyne is that this pent up demand dies down as rate hikes seep through the economy pushing hotels to the brink once again.
Risks Ahead
The risk for Cheyne Capital is that they are propping up a sinking sector. The post-financial crash boom was a product of the fecund macro environment more than the housing supply. Now that such a sharp change in interest rates has taken hold, the cracks are inevitably forming. Part of Cheyne’s bet surrounds the rental income of such properties over the capital value though. Their bet is that unemployment stays low and energy prices come down, making sure creditors can meet high interest payments. If there was a a default, Cheyne would likely have to take a loss on the securitised assets. That’s one reason why banks might be stearing clear.
The contagion of the bank collapses has been quelled for now, but real estate will still see second order effects. The jury is out on whether private credit funds can fill the banks’ shoes.
Author: Tal Feingold
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