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Private credit lenders fill the gap in Australian real estate market

Banks tighten lending amid rising interest rates and slowdown

Private credit lenders are increasing their footprint in parts of the Australian commercial property market, providing alternatives for borrowers as banks scale back higher-risk lending amid a slowdown brought on by elevated interest rates. The funds available for deals are growing as investors including pension funds, sovereign wealth and insurance firms look for meaty returns hard to find in today’s equity markets, especially in the beaten-down real estate sector.

According to a report from the Reserve Bank of Australia (RBA) in March, lenders are expanding into residential and commercial construction as banks slow lending or exit, a sector historically seen as high risk. Some 2,213 construction firms filed for insolvency last financial year, the highest on records going back to 2013, as builders are sandwiched between higher costs and fixed-price contracts.

New commercial property lending by the four major banks, Commonwealth Bank, National Australia Bank, Westpac and ANZ Group, has averaged 1% growth per quarter since June 2022, levels last seen during the pandemic, data from the prudential regulator shows, with exposure to offices and residential contracting.

Private credit lenders fill the gap in Australian real estate market

Private credit offers attractive returns and security

Private credit lenders offer borrowers higher interest rates than banks, but also more flexibility and certainty in funding. Investors can expect returns from 9% to 11% with the added security of loans pledged against real assets like condos or warehouses, often with a 30% to 40% equity buffer, said Paul Notaras, executive director at Barings Real Estate Australia.

“Over the last 12 to 18 months we have seen a lot more institutional investor interest and many are seeing this as an attractive entry point to diversify their portfolios,” said Steve Bulloch, head of Australian real estate at U.S.-based PGIM Real Estate, which expects to deploy a further $1 billion in the country over the next few years.

Australian real estate specialist Qualitas, whose backers include the Abu Dhabi Investment Authority, has nearly doubled funds under management to A$8 billion ($5.07 billion) since mid-2022, with roughly half the increase since this June.

Private credit fills the gap in underserved segments

Private credit lenders are targeting segments of the market that are underserved by banks, such as land development, construction, and value-add projects, where they can charge higher margins and fees. They are also providing mezzanine and preferred equity financing, which rank below senior debt but above common equity in the capital structure.

“We are seeing a lot of opportunities in the residential sector, especially in the build-to-rent and affordable housing segments, where there is strong demand and limited supply,” said Bulloch. “We are also looking at industrial and logistics assets, which are benefiting from the growth of e-commerce and supply chain diversification.”

Notaras said Barings was also active in the office sector, where it sees value in well-located and well-tenanted properties that can withstand the changing work patterns and preferences of occupiers. “We are not afraid of taking some leasing risk, as long as we are comfortable with the quality of the asset and the location,” he said.

Private credit faces challenges and risks

Despite the growing appetite for private credit, the sector faces some challenges and risks, such as regulatory uncertainty, competition, and potential defaults. The RBA has warned that non-bank lenders could pose financial stability risks if they are not subject to adequate oversight and prudential standards.

The sector is also becoming more crowded, as new entrants and existing players vie for deals and compress yields. “The market is very competitive and we have to be selective and disciplined in our underwriting and pricing,” said Notaras.

Moreover, private credit lenders could face higher losses if the property market deteriorates or if borrowers default on their loans. “We are mindful of the macroeconomic environment and the potential impact of interest rate hikes and inflation on the property sector,” said Bulloch. “We are also monitoring the credit quality and performance of our portfolio and taking proactive measures to mitigate any risks.”

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