Stamford Capital survey reveals contractor factor the new lending metric

16 May 2024

Stamford Capital has released the results of its annual Real Estate Debt Capital Markets Survey, revealing that builders’ reputations are the new “stop go metric” in development and construction finance. It is the first independent dataset to measure lender sentiment to NSW’s iCiRT, and highlights how its rapid adoption and success position it as a blueprint for other States to follow to minimise development risk.

More than 100 active lenders participated in the national survey, from major trading banks and non-bank lenders to super funds, foreign banks, private financiers, and second-tier trading banks. Over 60% of Survey participants have loan books over $500 million.

The annual survey is the eighth in the series to date and is a leading barometer of lending sentiment and early identifier of market trends.  The results deliver an understanding of how the last 12 months have impacted Australia’s debt capital markets and help forecast what the market can expect leading into FY25.

Stamford Capital’s survey results show an overwhelming 82% of lenders increased their due diligence, catalysed by the combination of builder insolvencies and elevated construction costs. Yet lending appetite remains robust with 90% of lenders surveyed planning to increase their loan book.

Heightened due diligence is being experienced across the board, within both banks and non-bank lenders and causing significant delays in loan applications – with Stamford Capital’s historical data revealing a 53% increase in finance application times compared to two years ago.

“Despite these challenges, lending appetite remains strong for developments with quality builders with plenty of liquidity in the market, while presale and ICR hurdles are moving in an expansive direction,” said Peter O’Connor, Managing Director of Stamford Capital.

But Australia’s housing crisis is far from over, with Stamford Capital cautioning that an overwhelming majority of developments in the pipeline are aimed at the luxury end of the market, rather than on delivering affordable new homes.

“There is a distinct lack of affordable new residential stock coming online. Feasibilities just aren’t stacking up for more affordable developments given high land prices and increased construction costs in our major capitals,” he said.

iCiRT emerging as a key lending metric amidst insolvencies

Stamford Capital’s Survey is the first dataset to examine the impact of the independent iCiRT rating system on lending since its introduction in NSW in 2022 in the wake of the major structural defects identified within the Mascot Towers development.

Recent ASIC insolvency data shows that 2,142 construction companies went out of business between July 2023 and March 2024. Increasing insolvencies, alongside rising construction costs, have led to lenders taking a more rigorous approach to due diligence on construction finance.

“Builder insolvency has been a huge issue for the industry to contend with and while lender appetite remains strong, there is a lot more caution. NSW’s iCiRT has removed the guesswork, minimised risk and delivered greater certainty for both lenders and buyers in NSW and sets an enviable benchmark for other States to follow,” said O’Connor. 

The Survey shows the rapid acceptance of iCiRT ratings, with a third of lenders indicating they take iCiRT ratings into account or plan to in 2024. Interestingly, 43% of these lenders have rejected a loan due to a poor iCiRT rating.

“Reports of increasing attention to lending risk and development finance governance is welcome. These reports come from both mainstream banks and non-bank lenders,” said NSW Building Commissioner, David Chandler OAM.

“More importantly, consumers are benefiting on many fronts. The growing uptake of iCirt ratings points to developer and builder trustworthiness. The growing presence of LDI and DLI 10-year warranty insurance points to building trustworthiness,” the Commissioner added.

The due diligence process now includes more thorough analysis, scrutiny, and stress testing with regards to builder financials. It also involves engaging third-party construction specialists, insolvency practitioners, accounting firms and business analytics specialists to provide additional insights on builders and their financials.

“With the additional focus on due diligence from banks and non-bank lenders, we’re seeing construction deals taking over 50% more time from inception to settlement,” said Mr. O’Connor.

Tight margins squeeze delivery of affordable housing stock

With housing availability limited, and with affordability at historic lows, rising construction costs and land values are hindering the delivery of affordable housing stock.

The Stamford Capital Real Estate Debt Capital Markets Survey illustrates that lenders are less likely to back the delivery of affordable housing due to the tight profit margins posed by these factors, impacting site values and making it difficult to meet lending criteria.

According to the Survey, almost half of respondents perceive the elevated cost of construction to be the biggest barrier to affordable housing delivery. 30% of respondents claimed that land use regulation and planning were the most significant barrier, followed by the cost of capital (9%) and access to funding (8%).

The Producer Price Index indicates a 33% increase in materials prices for housing construction since 2019, with notable price surges in timber, ceramic products and electrical equipment. This is unlikely to improve, with 39% of survey respondents expecting construction costs to increase further in the next 12 months.

As a result, feasibility continues to be skewed toward higher-priced luxury residential development – mostly those which target empty-nesters and downsizers rather than first home buyers.

“From the lending perspective it is hard to see when the housing crunch will ease. Fundamentals simply don’t stack up to develop new residential stock suited to entry-level buyers in our major capitals. As a result, the pipeline continues to focus on more high-end product, with premium pricing – leaving first home buyers with little choice,” O’Connor said.

Despite high demand and the housing shortage, off-the-plan residential sales have become increasingly challenging – especially for luxury developments – leading to a more relaxed approach to presales.

Last year, Stamford Capital’s Survey revealed a cautious sentiment, with lenders planning to maintain or increase residential presale requirements. But interestingly, this year’s focus on due diligence comes with fewer concerns about off-the-plan sales as an indicator of demand. Over 50% of lenders will fund projects with zero to 35% presales and just 9% of lenders are planning to decrease presale requirements this year while almost a quarter of lenders now require no pre-sales at all.

“Luxury residential sales tend to flow differently, with most buyers waiting to view completed stock or sell their family home. If lenders want to deploy their capital and grow their loan book, they likely need to compromise on presales. Again, a contractor rating system like iCiRT can help increase the certainty of the development outcome here,” O’Connor added.

2024: The rise of non-bank lenders

While capital was tightly held in 2023, the tide has turned, says Stamford Capital. 2024 will see an increased appetite to lend, with a whopping 90% of lenders surveyed planning to increase their loan book this year – and almost half predicting growth of over 15%.

A string of successive interest rate rises placed Interest Coverage Ratios (ICRs) firmly in the spotlight last year, with almost three-quarters of respondents in 2023 saying that they had minimum ICR requirements of between 1x and 2x. This year, the Survey illustrates a more relaxed approach, with 28% of respondents saying they have no ICR requirement – an increase from 17% last year.

“Lenders who are prepared to be more flexible with ICRs will find it easier to get deals across the line – and meet their growing appetite to lend,” said Mr O’Connor.

An increase in lending is especially notable amongst non-banks due to an increase in private capital, with funds ready to be deployed. Contrastingly, banks have been more cautious with successive interest rates rises and ICR concerns, making room for non-banks to step in.

Non-bank lenders continue to rise in scale and market share in Australia – in line with a global surge. According to Stamford Capital, Australia is set to follow the US and UK markets, where non-bank lenders comprise 55% and 35% of the market respectively.

“Our experience mirrors the global trend with non-banks presence continuing to grow. In the last financial year almost 80% of our transaction volume was with non-banks. This reflects a sharp increase from 2021, when it sat at just 44%,” said O’Connor.

67% of respondents expect non-banks to increase construction lending, compared to 33% who see major banks stepping up in this space. The appetite for investment lending has also returned, with 64% of our respondents expecting non-banks to increase investment lending and 42% expecting major banks to do the same. `

Interest rate outlook turnaround amid global uncertainty  

Successive cash rate rises were a hurdle for many in 2023, and during the Survey period, a sizeable 67% of respondents expected interest rates to drop marginally by the end of 2024. It seems many anticipated that 2024 would bring some cash rate reprieve, however the current outlook remains unclear.

“It is compelling to see how quickly sentiment and economic predictions can change in response to global markets. In the short timeframe between surveying and data collation – the interest rate outlook has done a complete 360-degree turn. It is a reminder of the volatility of the cash rate expectations,” O’Connor said.

Financial markets have pared back the timing of interest rate cuts from central banks following a string of stronger-than-expected inflation data. A single 25bps cut to interest rates is generally expected this year, compared with previous expectations for 75bps of cuts commencing mid-year. At the time of the Survey, 41% of respondents predicted a rate between 4% and 4.25% by December 31.

However, the timing of monetary policy easing by the Reserve Bank has also been postponed, adding further uncertainly – and some financial markets are even accounting for a modest rate increase following stronger-than-expected Q1 CPI data.

Markets Overview: Commercial office and retail inch to recovery as industrial peaks

Just over a third of Stamford Capital Real Estate Debt Capital Markets Survey respondents identified the commercial office sector as inching toward recovery following a post-COVID period of decline, in contrast to 27% of respondents last year. Over 50% of respondents are seeing a decline in commercial office values – down from 63% last year – while just 6% perceive the market to be in a period of early growth.

Retail markets are displaying some positive signs, with 32% seeing the sector as in decline and 43% forecasting a recovery – up from the 28% who pointed to a recovery last year. While retail markets had to contend with a post-COVID uptick in e-commerce and a reduction in household spending following cash rate pain last year, this year’s report shows a slightly more optimistic outlook.

Industrial markets could be reaching their peak according to 64% of respondents, with 24% of respondents forecasting further growth, as an increased focus on e-commerce and onshore manufacturing bolster the sector’s upward trajectory.