Institutional Funding and Private Debt Markets
BY NICK JACOBSON | WEDNESDAY, 1 MAY 2024
Soaring interest rates have hit office and retail landlords hard, prompting a wave of write-downs across the commercial property sector, with Dexus, Mirvac and Vicinity Centres all booking portfolio losses in their recent annual financial results and with further devaluations likely. Indeed, values have dropped so substantially because of the rising cost of capital that from an interest cover perspective, many borrowers will find it difficult to get their loans renewed upon maturity. This will create a significant refinancing gap that the major banks are unlikely to accommodate at the same leverage levels, and borrowers will be forced to find other means to achieve a refinancing of that existing asset, albeit with a much lower interest cover ratio.
That will mean the pricing for alternative private lenders on these refinancings is likely to be very attractive, with the RBA Cash Rate increased 13 times over the past 24 months and overall pricing for non-bank loans increasing from the low-to-mid single digits to the low double digits.
The Australian private credit market contains a variety of different loan structures and instruments that provide bespoke solutions to accommodate many different risk and return objectives for institutional investors.
Obviously, the higher the risk, the higher the premium received for that risk.
This can range from investment grade to non-investment grade debt, non-leveraged to leveraged debt, and senior secured debt to subordinated or mezzanine debt (which earns a higher coupon for sitting behind senior debt). In terms of maturities, a variety of different tenors are available, but most are within five years. There is also a small but growing proportion of opportunities beyond five years, particularly in the infrastructure sector.
Australia’s private financing structures are bank-like and low-risk, which, when combined with premium pricing and below-trend currency rates, makes us a comparatively appealing investment destination in comparison to many other developed nations. We’ve also seen international credit investors pivot away from China in recent times, and with few developed market alternatives to Japan in APAC,
the relative returns on offer in Australian real estate private credit are appealing
to Sovereign Wealth Funds, Global Pension Funds, and insurance company investors. Portfolio diversification and rising interest rates are also fuelling growth in offshore institutional investors’ commercial real estate private credit investment in Australia – it has become much more attractive. Our relative economic and political stability and our regulatory systems – including insolvency laws – all entice inbound investment.
The number of senior secured private debt managers is small but expanding. Lower competition provides more appealing relative value, as seen by typically greater spreads when compared to similarly rated term loans. Australian real estate private debt is typically at a floating rate and, herefore, provides a level of inflation protection, while the senior position in the capital structure provides defensive characteristics in the current market environment.
It is also common for Australian transactions to have more conservative initial leverage and maintenance covenants that are assessed on a regular basis throughout the loan’s term.
Hotel construction lending in the major capital cities, with returning inbound travel (both offshore and interstate), also provides an ongoing investment opportunity. The stock of existing hotels in the nation’s CBD is largely dated, and the level of amenities in them is limited and poor, yet the returns hoteliers are currently making are extraordinary.
We see a great opportunity for fringe CBD hotel development – Surry Hills in Sydney is a good case in point.
We also see significant potential for attractively priced stretch senior loans (including junior tranches) to meet the estimated $10bn bank refinancing gap at maturity facing borrowers across office, retail and industrial sectors.
Wingate’s approach to optimising results during periods of dislocation is to stay true to our thematic convictions, focus on strong sponsors and quality real estate, invest at an attractive basis or attachment point and emphasise conservative capital structures, focusing on duration and durability.
Rather than attempting to time the market, we believe that this strategy, along with measured capital deployment over the next three years, offers the best odds of delivering good risk-adjusted returns. We believe the disproportionate risk-reward in real estate private credit will likely last several years. Some of the best real estate investment vintages have occurred following a market disruption. I believe we are in the midst of a very appealing one.