HAWK study in the field of real estate management shows
Real estate loans, also known as real estate private debt (REPD), which are not issued through bonds but are granted directly by banks and institutional investors, are an ideal addition to a real estate portfolio, according to the study.
"Real estate private debt is an excellent addition to a real estate portfolio," says Prof. Dr. Wilhelm Breuer, Professor of Real Estate Finance and Investment at HAWK. The basis of the study he directed is the master's thesis by Jonas Englert in the Real Estate Business Studies programme, which examined the diversification potential of real estate portfolios through the addition of real estate private debt. PrimeraAdvisors GmbH initiated and accompanied the study. Breuer comments: "Contrary to its relevance, this topic has received little attention in the literature so far, so that there are currently no comparable studies.
Real estate private debt is attracting increasing interest among institutional investors, even outside the banking sector. Real estate debt can be financed either directly or indirectly via a private debt fund.
While alternative lenders in the US market have been active in the REPD segment since the loosening of the segregated banking system in the 1960s, the initial trigger in Europe was the reaction to the real estate crisis of 2007/2008. Since then, banks have been regulated more strongly than before by the international banking reform programme Basel III. New minimum requirements for capital, equity and liquidity are important reasons for an increasing reluctance of banks to engage in real estate lending.
The resulting gaps are increasingly being filled by alternative lenders such as insurance companies, pension funds or debt funds through the provision of REPD. Institutional real estate investors can take advantage of this by diversifying their real estate portfolios by investing in commercial real estate loans, i.e. REPD, for the purpose of risk reduction.
Within the scope of the work, the diversification potentials that can be achieved in this way were examined. For the US market, the Giliberto Levy Commercial Mortgage Performance Index (GLCMPI) provides publicly accessible data for an analysis of the performance of REPD. The "NCREIF Property Index" (NPI) was used as a benchmark for the property portfolio to be diversified. Portfolio theory formed the theoretical foundation of the study. The indices were evaluated over the largest possible observation period from 1978 - 2021: (graphic1)
It can be seen that real estate portfolios achieve a higher return with a higher risk during the period under review. The GLCMPI contains only loans with fixed interest rates. Since the volatility of the returns is influenced by a mark-to-market price of the loans, the risk would tend to be even lower for an index containing loans with variable interest rates.
Due to a favourable correlation between assets from a risk perspective, diversification potentials can be exploited. The slightly opposing yield movements over time ensure that the risk-defining standard deviation of a real estate portfolio can be reduced disproportionately to the yield by adding REPD. This effect can be seen in a risk-return diagram (graphic 2).
A risk-free interest rate is included in the calculation of the Sharpe Ratio (SR). This was determined using the yield of 10-year US government bonds. The arithmetic mean of the bond yields at the year-end price is 5.77% over the observation period from 1978 to 2021. The maximum SR composition thus consists of 55% NPI and 45% GLCMPI. The graphical representation is made with the help of the capital market line. This connects the risk-free interest rate with the tangential point on the efficiency line.
Especially institutional investors who are particularly risk-averse for internal strategic reasons or due to external restrictions can benefit from the risk-reducing properties of REPD in asset allocation. By limiting the loan-to-value ratio (LTV) in lending, investors are protected to a certain extent from a loss in value of the properties. This has a positive effect on the diversification potential between real estate investments and real estate private debt. Increasing the transparency of the risk-return profile and the diversification potential of adding REPD to a real estate portfolio could lead to an acceleration of the share of alternative institutional lenders in real estate financing in Europe.
