Real Estate

European Real Estate Debt: Why Now?

September 2022 – 6 min read

Against a backdrop of decades-high inflation and rising rates, real estate debt is worth considering—especially given the potential for attractive returns, duration risk mitigation, and diversification.

Highlights:
  • While real estate debt is not a substitute for real estate equity investments, it is highly complementary.
  • There are a number of reasons to increase an allocation to real estate debt, including the potential for attractive returns.
  • Floating-rate real estate loans mitigate duration risk—a perennial challenge for fixed income investors.
  • On a risk-adjusted basis, real estate debt and equity assets have historically outperformed the major publicly traded asset classes.
  • European property debt, in particular, offers powerful diversification benefits for investors.
  • Increasing regulation and a pandemic-induced property-refinancing backlog have created a considerable opportunity for non-bank lenders.
Real Estate Debt & Equity: A Complementary Mix

Strategic property investors—those looking to maximize risk-adjusted returns in the long term—can benefit from an allocation to both debt and equity real estate through the cycle. In particular, fine-tuning investors’ preferred blend, depending on the phase of the property cycle, might be worth considering. For instance, real estate debt exposure can be built up through the top of the cycle, forgoing frothy peak equity returns but limiting the inevitable downside to come. Meanwhile, exposure to real estate equity can be increased during the recovery phase at the bottom of the cycle, when return expectations are rising.

The optimal property debt allocation will depend on the individual investor’s investment objectives including target returns and risk tolerance. The basic principles of investment diversification suggest a minimum and therefore meaningful property debt allocation for the “average” investor to begin at around 15%–20%. That could rise to over 50% for the most risk intolerant long-term capital sources. Real estate debt is not a substitute for real estate equity investments—rather, it is highly complementary.

The Inflationary Environment

High inflation will likely continue in the coming months. Against this backdrop, the U.S. Federal Reserve (Fed), which has set the global interest rate climate for capital markets, is currently in an aggressive tightening phase to attempt to wrestle inflation back under control—almost irrespective of the consequences for growth, in our view. Risks of a global recession are therefore rising, but especially in Europe because of the continent’s additional high dependency on energy from Russia. While the European Central Bank’s (ECB) monetary tightening has lagged behind the Fed, the central bank recently ended an eight-year era of negative interest rates at their July 2022 meeting, hiking for the first time in over a decade and increasing their deposit rate by 50 basis points (bps) to 0 bps.

Want to read the full article?

View PDF

Paul Stewart

Head of Research & Strategy—Real Estate

Joanne Warren

Director, Real Estate Research

Any forecasts in this material are based upon Barings opinion of the market at the date of preparation and are subject to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily indicative of the future or likely performance. Investment involves risk. The value of any investments and any income generated may go down as well as up and is not guaranteed by Barings or any other person. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

Any investment results, portfolio compositions and or examples set forth in this material are provided for illustrative purposes only and are not indicative of any future investment results, future portfolio composition or investments. The composition, size of, and risks associated with an investment may differ substantially from any examples set forth in this material No representation is made that an investment will be profitable or will not incur losses. Where appropriate, changes in the currency exchange rates may affect the value of investments. Prospective investors should read the offering documents, if applicable, for the details and specific risk factors of any Fund/Strategy discussed in this material.

Barings is the brand name for the worldwide asset management and associated businesses of Barings LLC and its global affiliates. Barings Securities LLC, Barings (U.K.) Limited, Barings Global Advisers Limited, Barings Australia Pty Ltd, Barings Japan Limited, Baring Asset Management Limited, Baring International Investment Limited, Baring Fund Managers Limited, Baring International Fund Managers (Ireland) Limited, Baring Asset Management (Asia) Limited, Baring SICE (Taiwan) Limited, Baring Asset Management Switzerland Sarl, and Baring Asset Management Korea Limited each are affiliated financial service companies owned by Barings LLC (each, individually, an “Affiliate”).

NO OFFER: The material is for informational purposes only and is not an offer or solicitation for the purchase or sale of any financial instrument or service in any jurisdiction. The material herein was prepared without any consideration of the investment objectives, financial situation or particular needs of anyone who may receive it. This material is not, and must not be treated as, investment advice, an investment recommendation, investment research, or a recommendation about the suitability or appropriateness of any security, commodity, investment, or particular investment strategy, and must not be construed as a projection or prediction.

Unless otherwise mentioned, the views contained in this material are those of Barings. These views are made in good faith in relation to the facts known at the time of preparation and are subject to change without notice. Individual portfolio management teams may hold different views than the views expressed herein and may make different investment decisions for different clients. Parts of this material may be based on information received from sources we believe to be reliable. Although every effort is taken to ensure that the information contained in this material is accurate, Barings makes no representation or warranty, express or implied, regarding the accuracy, completeness or adequacy of the information.

Any service, security, investment or product outlined in this material may not be suitable for a prospective investor or available in their jurisdiction. Copyright in this material is owned by Barings. Information in this material may be used for your own personal use, but may not be altered, reproduced or distributed without Barings’ consent.

Related Viewpoints