Hermes Investment Management is not only considering deals to invest fully the commitments to its existing UK commercial property debt portfolio, but has not ruled out creating a similar proposition to facilitate investments across the Continent, according to comments from Vincent Noble, head of Real Estate Debt at Hermes Real Estate.
Currently, the Hermes Real Estate Senior Debt fund invests in its namesake, where the manager looks for strong interest cover, solid underwriting and the guarantee it sees in “robust properties”.
Hermes’ Vista UK Residential Real Estate fund provides access to the UK private rented sector through a partnership with Countrywide, while its Property Unit Trust operates as a pooled tax-exempt UK property investment.
In terms of the Senior Debt portfolio, Nobel says the process rests on the ability to perform correct underwriting of the property, which means understanding the market that the property exists within, its letting potential, and building up a picture of, for example, the cashflow it can offer.
Using the broader property expertise across the Hermes group has helped in developing the fund, Nobel says. So far it has done deals on eight loans, equivalent to some £250m out of the £400m made available at launch via the fund’s cornerstone investor.
Returns so far have been running a bit ahead of expectations, Nobel says, noting that a few years ago property debt was seen as a type of fixed income to compare against assets such as corporate bonds.
However, he says that it offers other defensive aspects, and that he as a manager can access a spectrum of debt opportunities.
The types of deals being considered by Nobel and colleagues has been shifting, he adds.
Where a few years ago deals around the £100m-£200m range were considered the sweet spot in terms of pricing power in deal negotiations, today this sweet spot is in the £20m-£30m range and includes hotels, light industry and offices.
The UK is a different property market to others in the region, Nobel notes, adding that it can be described as “manageable” because of the similarities between regions – excluding inner London, which arguably is a property market all of its own. There may be local reasons not to do deals, such as the balance between supply and demand for, say office space, in a town not seen to produce the desired levels of income return; but the reverse can also be true.
Debt driven deals tend to look more at properties offering long term letting potential, Nobel says. In contrast, a development in the UK market such as the regeneration of the Kings Cross area of London may be more equity driven.
Properties being redeveloped are another area where refinancing is necessary, and therefore creates opportunities for a debt fund of the type being run at Hermes; new skyscrapers going up in London tends to be the exception proving the rule in this respect, Nobel says. Meanwhile, investments in UK commercial property generally benefit from factors such as the typical long term lease with upward only rent reviews. Stability is also important and factors such as Brexit “don’t help”.
Nobel, whose role at Hermes was first announced in November 2014, says that he has been focused on building on the track record of the property debt portfolio he runs, but that it is now time to start thinking about engaging further, for example, through roadshows. This also makes sense in terms of the fund structure, which can accept both smaller or larger capital commitments, he says.
Nobel says that Continental Europe is at a slightly different part of the cycle with regard to property and how it is funded, but that he sees similar challenges in terms of refinancing needs and the hunt for yield. Alternative lenders are stepping in.
Such developments are causing Hermes to consider the possibility of launching a similar strategy for investors based on the Continent. Currently such investors can invest in the UK focused portfolio, but there is cost and risk associated with currency, particularly because this type of strategy – investing in property debt – is designed to be more of a low risk, low return approach. And with much of the loans business done on the basis of floating rates, hedging these rates back to other currencies such as the euro can affect the proposition.
If such a strategy can be replicated on the Continent it makes it easier for investors in this respect, Nobel adds.
That said, Europe does present other challenges compared to the UK, being described as more fractured beyond the urban centres such as Paris or Frankfurt This is not only a question of jurisdictional issues: it is also geographically a bigger area, which raises questions about how to access equivalent levels of ongoing knowlege about local market conditions – even down to the level of the individual town or city – in the same way that such knowledge is accessed for the current UK focused strategy.
However, Nobel also points to Hermes feeling confident about Europe when it comes to its business development plans. There is nothing to put on the table currently in terms of a fund investing in commercial real estate debt linked to Continental European property, but neither does he state that such a product would never form part of Hermes’ offering.