Stamford Capital Survey Tracks Impact of Rising Rates

Stamford Capital has released its annual Real Estate Debt Capital Markets Survey, the first comprehensive dataset analysing the impacts of 13 months of sustained interest rate rises on Australia’s commercial finance sector.

Not surprisingly the data revealed the velocity of cash rate growth over the past 13 months has put Interest Coverage Ratios (ICR) under pressure, with many borrowers in breach. Lender scrutiny is subsequently on the rise, particularly for investment and construction loans while ESG lending continues on a growth trajectory.

The Real Estate Debt Capital Markets Survey 2023 shines the spotlight on continued post-COVID impacts on all asset classes with most property sectors perceived as in decline – notably commercial office, retail and residential apartments. Industrial remains a preferred asset class, yet over half of respondents see the market as peaking.

Interestingly survey respondents see some categories of the residential sector as improving – but it’s the speed that this sector has swung back with that is most significant. But according to the Stamford Capital Survey, lenders haven’t fully embraced the Build to Rent (BTR) model yet with the emerging sector still in infancy in Australia compared to more mature global markets.

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 sixth in the series to date and is a leading barometer of lending sentiment and an 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 2024.

“It is compelling to measure how the cash rate rises and post-COVID climate impact our finance markets. We are in a totally different market compared to a year ago, when cash rate rises were widely anticipated, but nobody foreshadowed the sheer velocity of the rises we have witnessed,” said Michael Hynes, Joint Managing Director at Stamford Capital.

“Now we are dealing with the fall-out of the rapid succession of 12 rate rises in just 13 months, and our respondents expect further rises before the close of the year. Despite market sentiment remaining strong in some asset classes, tightening lending criteria and reduced appetite is playing out,” he said.

Deal Scrutiny Heightens: ICRs Under Pressure from Rising Cash Rate

Lenders are becoming increasingly selective amid the escalating cash rate environment and increasing ICR covenant breaches. According to Stamford Capital’s Real Estate Debt Capital Markets Survey 2023 this is set to continue with 46% of respondents expecting major banks to tighten investment loan credit, and non-banks expected to do the same.

Rising interest rates coupled with vacancies in some market sectors are posing a challenge to developers and investors, with many unable to leverage their properties as they previously did. An overwhelming 72% of Survey respondents require a minimum ICR of between 1x and 2x – up from 45% in 2021.

And the cash rate pain is not expected to ease any time soon with only 31% of Real Estate Debt Capital Markets Survey 2023 respondents expecting the Reserve Bank of Australia (RBA) will reduce rates this year.

According to Stamford Capital, the current lending climate is brutal.

“In today’s market, you either fit the lenders’ criteria or you don’t. It’s binary and there’s no room to pay at the margins,” Hynes said.

Weakened Appetite for Construction & Investment Lending

With the construction sector plagued by rising costs, labour shortages and insolvencies, it is not surprising that 52% of respondents in Stamford Capital’s Real Estate Debt Capital Markets Survey 2023 anticipate major banks to decrease construction lending. In addition, 33% of respondents also expect decreased investment loan activity.

According to Stamford Capital, product demand will become critical to securing access to capital. Pre-sales are tipped to become a key lending criteria in construction lending again with 18% of Survey respondents prepared to fund zero pre-sales in 2023, down from 30% in 2021 and 22% in 2022.

Despite majority of Stamford Capital’s Real Estate Debt Capital Markets Survey 2023 respondents planning to maintain current pre-sale requirements, 15% are set to increase them in 2023 – up significantly from the 6% in 2022.

Amid reduced appetite to fund construction, an overwhelming 76% of lenders surveyed expect to grow their loan books in 2023.

The outlook for construction finance is grim with more than half of Stamford Capital’s Real Estate Debt Capital Markets Survey 2023 respondents expecting to decrease construction lending. Non-bank lenders are showing increased appetite for construction funding with 34% expecting to increase lending for building projects, compared to just 13.5% of major trading banks.

Similarly some 33% of major trading banks plan to decrease loan exposure to investments in 2023, compared to 17% of non-banks.

COVID Impact Continues: Commercial Office, Retail and Residential Sectors in Decline

Sentiment has waned significantly with Stamford Capital’s Real Estate Debt Capital Markets Survey 2023 respondents perceiving most asset cycles in decline – particularly commercial office, retail and residential development sites.

Despite signs that commercial office and retail assets were recovering in 2022 – 63% of respondents now say the commercial office market is in decline and 53% believe retail is in decline, a stark contrast to 49% seeing the retail sector in recovery a year ago.

The post-pandemic commercial office market is characterised by reduced demand and high supply – driven by the continued ‘flight to quality trend’ coupled with the continued popularity of hybrid working styles. A two-speed market is in play with demand for Premium and A Grade space increasing, while B and C Grade office stock remains overlooked.

Retail continues to suffer with oversupply in some locations as online shopping remains popular post-COVID and reduced household spending is expected catalysed by growing cost of living pressures.

Interestingly the outlook for residential property is improving among Stamford Capital’s Real Estate Debt Capital Markets Survey 2023 respondents with 31% of respondents seeing it as recovering while 44% still see it in decline. Not all categories of the market are equal however, with sentiment less optimistic for residential development sites and 62% of respondents seeing them in decline.

Industrial assets continue to perform and remain a sough-after asset globally and 52% of Stamford Capital’s Survey respondents believe the industrial market is at its peak.

Australia’s Housing Crisis Delivers New Hope for Residential Development

Despite continued interest rate rises, a shortage of housing stock amid rising demand has kept Australian residential values resilient.

Demand is earmarked to continue to swell, with an anticipated surge in migration and a forecast net migration of 400,000 in 2023 – the most significant migration spike in over 100 years.

Residential rental vacancies remain at a historic low, presenting compelling opportunities for investors and quality projects in desired locations – despite lenders remaining cautious, rates remain at an all-time low, we are still seeing opportunities for investors.

Future Lending: Expect New ESG Lending Products But BTR Not on Radar

Sustainable building practices remain firmly on the industry’s agenda, with 52% of Stamford Capital’s Real Estate Debt Capital Markets Survey 2023 respondents saying they have or intend to develop loan products favouring assets with environmental, social and governance (ESG) credentials.

This volume could potentially increase following the 2023 Federal Budget announcement of low-interest loans for energy efficient upgrades.

While commercial office assets have long embraced sustainability with established ratings systems enabling ESG credentials to be benchmarked – other sectors have lagged behind and it is evident that change is imminent.

“It is too early to see any meaningful examples of ESG credentials being rewarded by capital, but there is clearly an appetite for change,” said Hynes.

Despite the perfect storm presented by Australia’s continued housing crisis with historically low residential rental vacancy, rising interest rates and declining affordability – Australia’s banking sector is not showing appetite for BTR projects.

According to Stamford Capital, the BTR model requires a long-term income view, backed by large balance sheets and multi-asset cross-collateralisation, making them the domain of institutional players and high-net worth family offices for the time being.

“Right now, you have to be equity heavy to make BTR stack up, and you have to be prepared to hold it for generations. But it’s such a big asset class overseas with proven returns and with global funding, we should see it gain more traction in Australia,” Hynes said.

He noted that recently announced government tax incentives for BTR could help fast-track both developer and lender interest in the emerging sector.

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