Prior to the economic downturn, debt funds represented a small part of the real estate fund industry, but their importance has grown considerably in recent years. Before the financial crisis, real estate equity funds were able to deliver very strong returns, something which would be much harder to achieve in the current financial markets seen in the US or Europe. With financing from traditional lenders much scarcer, many fund managers saw the opportunity to generate returns by investing in real estate debt. Preqin's Real Estate Online database shows that ninety-three percent of capital raised in 2006 was by funds focusing solely on equity. In subsequent years the proportion of capital raised by funds making debt investments has increased significantly. In 2009, 12% of capital was raised by solely debt funds, with a further 24% of capital raised by funds making a combination of debt and equity investments. In 2011, a total of $8bn was raised by funds focusing on debt investments, which represented 14% of all capital raised in the year. Notable funds to close last year included the $2.9bn Blackstone Real Estate Special Situations Fund II and AXA Real Estate’s €1bn CRE Senior 1. While less capital has been raised for specialist debt funds in 2012 to date, the proportion of capital raised by funds which incorporate debt investments as part of their strategy has increased. Fifty-six percent of capital raised in the period January to October 2012 was by funds which are making debt investments to some extent.
There has also been a significant increase in investor appetite for real estate debt funds in the past year. Of the investors expecting to make investments in the coming 12 months, 23% are targeting debt funds, up from just 8% in Q4 2011. In comparison, appetite for other real estate strategies has remained fairly consistent. Fifty-three percent of active investors are targeting core funds, an increase of 6% from Q4 2011, while 44% are targeting opportunistic investments, up from 42% in Q4 2011. Value added strategies are also targeted by 44% of investors, a 3% decrease from Q4 2011.
Debt has evolved from a niche segment of the real estate fund market into a central part of the industry with more than half of all funds closing in 2012 investing in debt to a greater or lesser extent. The launch of a number of large debt funds in the third quarter of the year suggests that this is unlikely to change, with fund managers increasingly looking to build debt platforms in order to take advantage of the shortage of bank lending within the real estate market. While many investors are yet to consider the sector, an increasing number are looking to invest in real estate debt and it seems likely that more will examine these opportunities in greater depth in the coming months.