New funding sources are beginning to nibble away at the major banks’ virtual monopoly on Australia’s $232-billion commercial real estate (CRE) mortgage market.
Apart from crowd-sourcing, peer-to-peer lending and the more traditional domestic and overseas bonds, banks will have soon have to contend with the arrival of institutional money dressed up as debt funding.
On their own, none of these sources is likely to pose a serious challenge to the banks, but collectively – and given time – the story could be a different one.
More ambitious players in the alternative debt market already believe that, in five years or so, the quantum of alternative capital being employed will be sufficient to upset the supremacy of banks in the CRE space.
A handful of Australian fund managers have already launched debt funds to attract institutional capital for real estate loans. Others are in the throes of launching.
Some are working on mandates from both local and foreign institutions keen to test Australia’s emerging real estate debt market.
The managers each aim to raise hundreds of millions to target commercial real estate deals and residential development projects.
Domestic fund managers, like MaxCap and Qualitas, are joined by foreign firms like Forum Partners and CBRE Investors to raise funds from institutions ranging from super funds to life companies.
An early starter in the alternate debt market in Australia is the US-based Quadrant, a former Lend Lease business in the US, bought out and owned by management.
First State Super, default fund for the state governments of NSW and the Australian Capital Territory and Victoria’s health services, recently set aside $500m for lending on commercial property in Australia.
CBRE Investors, which set up a debt division less than two years ago, says lending will rise from around $100 million in 2014 to somewhere between $300-$400 million this year. CBRE believes that achieving a billion-dollar loan book is not that far off.
Sources close to the firm told Business Spectator that the success of the debt business has come as something of a surprise.
It has been reported that foreign life companies, including Metlife of the US, have allocated capital to the Australian market.
These non-traditional lenders are already funding hundreds of millions of dollars worth of projects in both premium office towers and suburban apartments.
They are even providing debt to listed property companies seeking to diversify from bank finance.
No one knows the current size of this alternative financing market, but a rough estimate places the total amount committed to projects from non-bank sources at at least $7 billion, and possibly more.
The bulk of that comes from foreign and Australian super funds forward-funding large office projects.
An estimated 50 per cent of premium office blocks in Australia are being developed and presold through what is known as “forward-funding”.
The most high-profile forward-funding arrangements are between Lend Lease and its key investors in the $6-billion Barangaroo project, located on Sydney’s harbour foreshore.
In separate deals, forward-funders including the Canada Pension Plan Investment Board (CPPIB), the Abu Dhabi Investment Authority, the Qatar Investment Authority and several large Australian super funds, such as Telstar Super, have committed some $4.5 billion to construction of three office towers at Barangaroo.
They are providing capital to fund the development phase and they will become joint ultimate owners of the towers on completion in the next two years.
Developers told Business Spectator that forward-funding was born out of necessity during the global financial crisis when liquidity dried up and banks shied away from real estate lending.
Since then forward-funding has evolved to become de riguer in the financing of large projects at the big end of Australia’s development industry.
Forward-funding gives developers access to capital without having to go to banks. Developers can also de-risk their projects by selling the yet-to-be-completed projects to the end owners.
Investors get in on the ground floor, so to speak -- a distinct advantage in a market where core office towers are tightly held.
The investors also hedge their risks. They come into a project only after the developer has pre-leased a significant proportion of the building to large corporates as anchor tenants, and future rental income has been secured
The rise of an alternative debt market stems from the age-old issue of matching short-term commercial mortgages with the long-dated nature of property investment.
Banks lend on terms of three to five years, although they are starting to go out to seven years.
But property investors want loans of at least 10 years. Westfield, for example, last year tapped the US private placement market for 30-year money.
Sources insist that Australia is crying out for senior debt of seven to 10-year duration, which is more suited to long-term property investors.
Institutional investors, they say, are prepared to lend on 10-year terms against an income-producing asset with secure long leases.
While property investors find duration an issue, property developers find the big banks’ lending criteria too restrictive.
Since the GFC, residential developers have had a particularly challenging time getting working capital from banks.
Banks require substantial presales of apartments. And even then, they will only allow borrowings of 60 to 65 per cent of the cost of the project.
Despite the boom in apartment sales, banks have not eased off on their loan to value ratios (LVRs) on development loans.
Lately, fearing a cooling off in the apartment market, LVRs for residential project financing have tightened to 55 per cent, leaving developers to look to alternative sources to make up the difference.
In Australia, buyers pay a 10 per cent deposit when they purchase off the plan apartments – to be held in trust – with the remaining 90 per cent paid on completion.
The onus is on the developer to raise the debt and equity before undertaking a project.
In contrast, buyers in Asia or Europe fund projects through progress payments, called up at various milestones during the construction phase.
The need to fill the funding gap in Australia has led to a developing market in mezzanine debt and preferred equity. Those providing the funds are usually high-net worth individuals sometimes investing through their family offices.
But increasingly, institutional investors are looking to play a much bigger role.
Today, non-bank lenders are funding the construction of thousands of apartments under construction in Melbourne, Sydney and Brisbane, ranging from several millions to hundreds of millions of dollars.
Asked why now, these non-bank managers say a confluence of factors has opened a window to entry.
New international capital adequacy requirements, coupled with stricter lending guidelines from APRA to cool the residential market, are among factors contributing to banks tightening lending to real estate lending.
In their search for yield in a low-interest rate and low growth global environment, institutional investors are starting to consider new asset classes.
Investing in debt may be new to Australian institutions, but it is a well established asset class in Europe.
Dutch pension funds participate in the residential mortgage funds, offering 25-year housing loans. The Financial Times recently reported that this market made up about 10 per cent of Dutch mortgage origination in the second quarter of 2015.
Non-bank lenders in the US or Europe have shares of between 40 and 60 per cent of the commercial mortgage markets, compared with less than 10 per cent in Australia, say sources.
Nevertheless, non-bank lenders in Australia believe success will come from working with the banks – not against them – in packaging loans that are better suited to property investors and developers.