Could alternative lenders help drive a faster recovery?
Despite the lockdown of economic activity since March this year, £5.2bn of credit opportunities have hit our desks at Rivercrown of which £3.3bn meet the target returns for our special situations vehicle, which we launched at the onset of the Covid-19 crisis. Anybody would agree this is an eyewatering level of potential deal volume, but where is the demand coming from?
Broadly speaking, the demand comes from two key camps; sponsors in situational distress needing short term support during this period of crisis, and well-capitalised sponsors who continue to see attractive market opportunities, where a higher cost of capital is still accretive to their cash-on-cash economics.
The reason we are seeing this positive deal flow, is, similar to the aftermath of the 2008 financial crisis. Most major lenders have pulled back from lending into real estate during the current period of uncertainty and are limiting their lending to existing relationships or “no brainer” type deals. Back in 2008, this contributed to a widespread tightening of credit as there wasn’t the depth in the marketplace that alternative lenders now provide. Given that many alternative lenders are now well capitalised and importantly, remain open for business, could their increased presence in the real estate finance market help drive a stronger, faster recovery this time around?
The rise of alternative lenders has arguably been one of the biggest real estate finance stories of the last decade. Many were bred by the last financial crisis, filling the void left by big banks. They include the likes of Blackstone and Oaktree who have now become established debt funds. A further raft of new players followed them into the market – especially late cycle – taking market share from traditional lenders.
It is certainly true to say that in 2008, finance simply wasn’t there for real estate investors in the same way it is today. There are more flexible alternative lenders in the market than ever, and it looks like even more are gearing up to enter. According to The Economist, private equity firms have amassed $1.6trn in dry powder that they can deploy into new deals. With many private equity managers saying they intend to use their expanded credit arms to target attractive risk-weighted returns. Real estate will be a major target.
We also find ourselves in a different crisis to before. Previous real estate crashes (including 2008) were typically boom and bust, where excess liquidity was followed by the taps being turned completely off. The trigger has been different this time. A pandemic, rather than structural issues within the real estate market itself and following years of increased regulation, oversight and discipline, financial institutions and investors remain well capitalised. Monetary and fiscal policies to tackle Covid-19 appear to have put a floor under asset prices and most commentators do at least agree on a recovery, if not the corresponding shape. All this will keep alternative lenders in the marketplace.
Furthermore, contrary to popular, more alarmist commentary, we do not believe the current pandemic signals the end of the office, and we remain strong supporters of the high street and leisure. The human desire for social interaction, together with the ancillary benefits of the office environment encouraging collaboration and mentoring amongst colleagues, as well as the professional relationships formed through doing business will prevail. Consequently, offices, and the mix of retail, leisure, hotel, and residential properties that support workers in city centres will still be needed. And real estate finance to develop these properties will be needed too.
We see the current crisis more as a market dislocation rather than a trigger for more radical structural change. Given the current pause by the major lenders, alternative lenders are well positioned to capitalise on the opportunity, by providing liquidity, offering certain flexibilities around leverage and structure, whilst appropriately accounting for the risk, to provide workable solutions to the sponsor.
Rivercrown launched our Special Situations Credit Vehicle in June 2020, to support borrowers with funding gaps or short-to-medium term dislocation, whilst targeting attractive risk-weighted returns underpinned by good quality real estate and sponsors. We are targeting a variety of structures across the capital stack. We are accepting out of favour sectors providing we are confident in the credibility of sponsor business plans and mitigants to the sector risk such as development upside potential. We are comfortable with hotels, particularly those benefiting from both business and leisure spend. We will also look at retail with the potential to benefit from alternative use, and prime London residential where there is sufficient headroom between our rolled-up debt basis and a discounted valuation.
Of course, we are not about to see a return to the pre-2007 levels of high leverage and fast. Alternative lenders still need to take the time to appropriately assess the risk/reward and structure early warning covenants to avoid the pitfalls of the last crisis. But the significant liquidity and depth to credit markets they provide, coupled with improving market fundamentals, should help avoid a repeat of the liquidity drought seen in the aftermath of the global financial crisis. All this should aid a stronger, faster recovery this time around.
Charles Archer is Head of Debt Investment Management at Rivercrown