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2021 Commercial Property Debt Market Overview

Thursday 21, Jan 2021
Domenic Lo Surdo, CAFBA Vice President

2021 looks set to be a promising year for Australia’s commercial property debt market. Despite underlying structural shifts to residential and commercial real estate markets and lingering uncertainties over Australia’s post-Covid economy, capital markets are more agile than they were after the last great shock in 2008, led by good liquidity and low interest rates.

The impact of Covid-19 on Australia’s commercial real estate debt and equity markets was the strongest felt since the Global Financial Crisis of 2008. When the full economic and social effects of the pandemic took hold in March and April of 2020, both bank and non-bank lenders stopped lending, with some lenders pulling indicative offers and adopting a No New to Bank policy.

 

While the commercial real estate debt and equity markets were quick to adjust to this shock, uncertainty still remains around the underlying residential and commercial real estate markets which are largely in a period of stasis and facing some significant structural change driven by the pandemic.

 

Covid-19 and The Global Financial Crisis

An important distinction between the Covid-19 shock and the GFC is that banks and non-bank lenders are currently well capitalised. When the effects of Covid-19 on Australia’s economy began to take hold, lenders examined their books in great detail. They went through all their assets (loans) and provisioned where appropriate.

 

This was not the case in 2008, and the banks’ strong capitalization has resulted in very little activity from lenders in terms of enforcing their securities or accelerating repayments.

 

In my view, given their recent behavior, we are unlikely to see a large amount of pressure from banks with respect to non-performing loans in the real estate sector in the coming year. The banks have done a very good job so far for the Australian economy by supporting borrowers who are under pressure. I am less certain that non-bank lenders will be equally as patient.

None of this will become apparent until mid/late 2021. There are a few fundamental reasons for this:

  1. APRA has allowed the banks to defer valuations until March 2021 without impacting capital provisioning on their balance sheets. 

  2. The government placed a moratorium on directors breaching their duties under insolvent trading which has now finished (Covid-19 Safe Harbour defence) and consequently this has reduced insolvencies in market (ironically, to levels below a normal market, despite the fact that we are currently in a recession where we would normally see insolvencies spike); and 

  3. Job Keeper and Job seeker payments remain elevated (albeit the government has indicated that these payments are likely to be reduced/removed through 2021) – probably saving many businesses (so called “zombie companies” from collapse) and the flow on effects into commercial real estate remains unknown. 

 

Liquidity vs. Demand

The major distinction between the Covid-19 shock and the GFC is that the GFC was largely an issue of liquidity in which the banks and non-bank lenders went through a credit squeeze. The Federal Government, along with The Reserve Bank, learnt their lessons from the GFC. Immediately after the onset of the Covid-19 economic shock, government stepped in to pump the banking market and the broader economy with money, and this has flowed into the non-bank market in terms of liquidity and confidence.

 

The Covid-19 event has created a demand problem: migration has stopped, there is no inbound international tourism or foreign students, almost 1 million people are unemployed, and many businesses are suffering or remain closed.

 

Property developers are nervous about developing apartment stock, tenants are concerned with committing to long term leases given the lack of activity in the underlying economy, and landlords are nervous about capitalising on their assets given rental pressures and looming vacancies in many sectors—particularly pubs, hotels, student accommodation, retail and commercial assets.

 

Furthermore, real estate market participants are facing, in my view, the single largest structural change to the underlying demand for space in the last 100 years. There has been many articles written on the demise of the office, the shift to on-line retailing and the impact that this will have on retail investments, the Work From home (WFH) / Work From Office (WFO)/ Work From Anywhere (WFA) phenomenon and what that means for society the suburbs, our cities and our regions. People have reassessed their lives and their need to commute and work or shop in destinations anywhere other than online.

 

It is not my intention to comment on the underlying structural shift in commercial and residential real estate but this is the single greatest impact on credit decisions being made in the banking and the non-banking system. The credit departments and investment committees of our lending partners are all taking a good look at their lending parameters, and the short and long term impacts that COVID 19 will have on the real estate markets and the risks that this poses to borrowers and the debt capital market over the next few years.

 

Throughout the final months of 2020, we have witnessed non-bank capital interests and margin costs falling. The banks are being selective with credit and remain vigilant, however, where a credit is prime with good risk metrics or there is strong lease tail to quality lease covenant in the investment lending space, or strong level of market risk mitigation in the construction space through lease pre-commitment or presales, the banks are willing to fight for business.

 

Capital Markets are Agile in 2021

As brokers our role is to fulfil the needs of our clients. Encouragingly, there is good liquidity in the market and all of our clients will benefit from engaging with brokers given our knowledge of capital, and in particular the growth in the non-bank market.

The capital market in Australia in 2021 is deep and very agile, and the fact that interest rates are virtually zero and longer term bond yields are also near zero, means we have witnessed strong capital flows into non-bank credit markets to invest in real estate credit—particularly post Covid-19.

This bodes well for the commercial property broker. In my view, the value add that a broker can provide to our customers has never been stronger. Although demand and general activity remains subdued, I am somewhat optimistic about 2021 as confidence hopefully begins to return; the capacity to service our customers and the real value we can bring to them will only get better.