Real estate debt: whatever happened to the liquidity premium? 

At a glance

• Private debt markets react with a delay to public market movements: there is a typical 18-month lag in bank margins adjusting to changes in the bond markets.
  
  
• Bank lenders seem to factor in their cost of funding rather than a CRE-specific liquidity premium, therefore, syndication transactions cannot be the sole source of return nor the optimal way to generate liquidity premium.
  
  
• The average liquidity premium of 48 basis points is low compared to the typical 80-120 basis points commonly assumed.
  
  
• To achieve a higher premium, investors could target a 300-basis point margin over Euribor to stabilize returns and avoid negative premiums. Investing in smaller, renovated properties can mitigate risks, while exploring less active market segments enhances diversification and bargaining power for lenders.

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When making the case for private assets, general partners typically quote the existence of a liquidity premium over the equivalent public investments. Over the four quadrants of investment, listed equity, private equity, Fixed Income and private debt, investors gaining exposure to private markets expect to be rewarded for relinquishing the ability to exit a position at will and subjecting themselves either to gating mechanisms or to holding their position to maturity.

This research piece will investigate the liquidity premium in private real estate debt in Europe over the past decade, attempting to identify some of its drivers.