Towards the end of 2023, ‘stay alive till ’25’ was a mantra I heard repeatedly. It neatly captured the prevailing sentiment among investors. After what had been a bruising year marked by spiralling inflation and high-profile banking collapses, many felt that the best strategy was to lie low and wait things out for a while.

While I thought this view was overly pessimistic, it did have some grounding in reality. Conditions were undoubtedly challenging. Inflation and the higher interest rates used to try to contain it led to countless projects being put on hold, and deployment opportunities for investors dried up as a result. Confidence seeped out of the market.

Although macroeconomic conditions continue to be turbulent, the picture for the UK real estate industry has certainly improved. A rate-cutting cycle is now well underway, with the Bank of England having cut rates to 4.25% this month. We’re seeing confidence return, and our own pipeline is strong, with enquiries up 35% year-to-date compared to the same period last year.

Debt in high demand

With conditions having improved, we anticipate strong demand for debt funding throughout the rest of the year as the industry works to address the UK’s chronic undersupply of homes. Indeed, our own estimates based on data available show that the UK Living Sector’s debt market demand over the next three years will be between £40-45bn alone. For Europe as a whole, this figure exceeds €150bn.

A significant portion of that debt will be provided by non-bank lenders, which have become a cornerstone of the market since banks began retrenching from real estate and development finance post-2008

To briefly recap, that retrenchment was initially in response to the immediate shockwaves triggered by the GFC and the resulting credit impairments they suffered, followed by the raft of regulatory changes that compelled institutions to give such lending activity a higher risk weighting. Problems were often exacerbated when banks were using short term liquidity instruments to fund longer term liabilities – often the impairments were liquidity crunches, rather than value.

By pursuing a disciplined credit underwriting and loan management approach akin to their regulated banking counterparts, non-bank lenders stepped in and, in a relatively short space of time, have built exceptionally strong loan portfolios and significant credibility with both capital markets and borrowers. Loans are also being funded predominantly from equity capital, and as such, duration mismatches are no longer a feature.

Unsurprisingly, institutional investors seeking increased exposure to UK real estate debt funding and its attractive risk-adjusted returns are now focused on identifying which of these non-bank lenders they should back.

The choice for investors

I may be biased, but the smart institutional capital will be funnelled towards specialist funds which are focused on specific areas of the market. There are a few reasons for this.

Firstly, specialist real estate debt funds are invariably led by experts with deep knowledge of the specific markets they operate in. While generalist investment funds certainly have broad expertise, their understanding of both risk and opportunity in a particular market is rarely as nuanced. Lending in a constantly evolving space like residential, with its various living classes, is complex and requires specialist teams that know exactly how to navigate it.

Secondly, specialists are uniquely placed to provide the kind of bespoke financing solutions that are required for challenging projects such as major mixed-use development schemes or the redevelopment of distressed assets. This enables them to pursue complex deals that generate particularly strong returns for investors.

Finally, specialists are typically much more adaptable to market shifts than generalists. They are less encumbered by bureaucracy and rigid risk models and can move quickly to capitalise on new opportunities and deploy capital. For example, last year, having identified an increasing demand for bridge capital within the living sector, we were able to move quickly to expand our offering to include bridge and inventory lending solutions.

While macroeconomic uncertainty persists, the UK’s urgent need to build more houses means demand for real estate debt will be high for years to come. Understandably, investors from around the world will be working out how to get exposure to this attractive market. Make no mistake, specialist funds, with the expertise, appetite for risk and flexibility they offer, are their best bet.