- Rising cash rate pressures commercial borrowers
- Lenders becoming more selective in loan approvals
- Construction and investment lending appetite weakened
Lenders are becoming increasingly selective amid the escalating cash rate environment and putting pressure on a range of commercial projects and developments according to a new survey.
Stamford Capital’s Real Estate Debt Capital Markets Survey 2023 found that 46% of lenders 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 Interest Coverage Ratio (ICR) of between 1x and 2x, which is sharply up from 45% in 2021.
While the cash rate pain is not expected to ease any time soon with only 31% of respondents expecting the Reserve Bank of Australia (RBA) will reduce rates this year.
Joint Managing Director at Stamford Capital, Michael Hynes said 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 Hynes.
“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.”
Michael Hynes, Joint Managing Director at Stamford Capital
According to Hynes, 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.”
Pre-sales expected to become lending linchpin
With the construction sector plagued by rising costs, labour shortages and insolvencies, 52% of lenders anticipate major banks to decrease construction lending.
In addition, 33% of respondents also expect decreased investment loan activity.
According to the survey, product demand will become critical to securing access to capital.
Pre-sales are expected to regain importance as a crucial lending criterion in construction lending. According to a survey, only 18% of respondents are willing to finance projects with zero pre-sales in 2023, which marks a decrease from 30% in 2021 and 22% in 2022.
While most respondents planned to keep their current pre-sale requirements, 15% of lenders 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.
Non-bank lenders are showing an 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
According to the survey, most asset cycles are in a state of decline – particularly commercial office, retail and residential development sites.
Despite signs that commercial office and retail assets were recovering in 2022 – 63% of respondents said 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.
Retail continues to face challenges due to an oversupply in certain areas, while online shopping continues to thrive even after the COVID-19 pandemic. Additionally, reduced household spending is anticipated, influenced by the increasing pressures of the cost of living.
The residential outlook seems to be improving, 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; 62% of respondents see them in decline.
The strength of industrial assets continues, however more than half (52%) of survey respondents believed the industrial market is at its peak.
Hope on the horizon, but not yet for build-to-rent
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.
However, the build-to-rent model (BTR) model still faces challenges as it requires a long-term income view, backed by large balance sheets and multi-asset cross-collateralisation, said Hynes.
“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.”
