Investors see big future for debt strategies

Real estate managers attribute the growth of credit strategies as well as the increase in real estate equity to asset owners choosing to invest in higher-yielding debt strategies and construction of new core properties because existing core properties are too expensive.

Debt strategies provided managers with the largest boosts in AUM, according to the results Pensions & Investments' top real estate manager survey.

The top three loan managers for U.S. tax-exempt clients all saw their assets rise, albeit from a small base, during the survey period as well. UBS Asset Management was in the first position with assets up 48.2% to $1 billion. Madison Realty Capital was next, with assets increasing 24.5% to $962 million, and third-ranked Canyon Partners Real Estate, a subsidiary of Canyon Partners LLC, saw assets rise 73% to $372 million.

"There is definitely a recognition that core returns have come down," leading many asset owners to invest in credit strategies, said Melissa Reagen, New York-based head of U.S. research at Nuveen Real Estate.

Investors are supplementing their core real estate strategies and adding yield by investing in credit strategies, Ms. Reagen said.

"Investors continue to find that (real estate debt) provides a good relative value compared to fixed income," said Todd Everett, CEO of Principal Real Estate Investors in Des Moines, Iowa. "The yields we are still finding compare favorably to core (real estate) equity."

Overall, the top five mezzanine managers for U.S. tax-exempt institutional investors all saw an increase. Nuveen LLC was at the top with $5.4 billion, an 16.6% increase; Brookfield Asset Management ranked second with $901 million, up 14.6%; PGIM was third with $655 million, a rise of 4.3%; Principal took fourth place with $640 million, up 29%; and AEW Capital was fifth with $254 million, up 118%.

Since 2010, Principal has invested $3.4 billion in subordinated debt transactions including mezzanine, Mr. Everett said.

Although it is a competitive market, there is a lot of capital focused on subordinated transactions, he said.

Yields have come down but they are still good relative to fixed income, Mr. Everett said.

Principal has also been very active developing properties in build-to-core strategies, which is construction of new core properties, focusing on industrial and multifamily, he said.

"Prices certainly are competitive for high quality (core) assets," Mr. Everett said.

Strong tenant demand balances out the construction risk. Industrial is one of the most coveted property types and the time between building a warehouse to leasing it is relatively short. Apartments and warehouses are two of the most stable and predictable property types, he said.

Credit strategies also provide a buffer in a downturn because equity investments are the first to lose money should the property fail to perform, said Eric Adler, London-based chairman of the real estate businesses of PGIM, Inc. and the CEO of PGIM Real Estate.

Not only are investors that had been investing in the asset class now flocking to real estate credit, non-traditional real estate investors are also turning to credit strategies.

Traditional real estate investors see mortgages on core properties as a more stable source of income or a good complement to their core equity strategies, Mr. Adler said.

Fixed-income investors without real estate investments in the past are going further afield for income streams by moving into private debt and core mortgages in search for more yield, Mr. Adler said.