Are Banks Regaining Their Appetite for Commercial Real Estate?

As demand for commercial real estate continues to rise in Australia, and non-bank lending grows with it, many have begun to wonder whether banks need to rethink their funding approach to this market.

Stephen Hall, executive director of real estate investment management group, Newground Capital Partners, takes a look at what may be driving banks to make a comeback in this area, and the challenges that lay ahead.

The Post GFC Landscape

“It would be an understatement to say that since the global financial crisis, and the introduction of tighter regulatory requirements, Australian banks have had a reduced appetite for commercial real estate debt,” Hall says.

“Banks are taking fewer lending risks in this area, with the Big 4’s commercial loan portfolios remaining relatively flat in recent years.

“While the Big 4 have traditionally liked to have a debt portfolio that is not biased to one sector, in recent years they have been left significantly exposed to development and construction debt rather than diversified investment debt options.

"As a result, this has dramatically impacted their capacity to increase their exposure in the sector moving forward.”

Hall says this has presented strong growth opportunities for non-bank lenders that have been in the passive asset class of investment properties, such as large office buildings, retail centres and industrial parks.

“Major global players, with significant balance sheets and large appetites for debt product have stepped in to meet these funding needs.”

Banks Under Pressure

Hall says the banks’ reliance on development/construction debt means having to re-write peak asset volumes every couple of years to replace loans that are run off with the completion of developments.

“There is anecdotal evidence that the lack of loans being written in this space, and the reduced loan book sizes, is starting to impact the bottom line.

“Banks are looking around the market in search of transactions that provide attractive investments but can still meet the stringent guidelines in place.”

However the banks face several challenges.

“Firstly, the banks’ own predictions about the demise of the apartment market in states such as Victoria are going to come back to haunt them.

“Without apartment markets being developed and funded by large chunks of debt, it gets increasingly difficult to find other asset classes with size to fund.”

Hall says banks would also need to relax some of their credit requirements for developers.

“Lending at a 55 per cent (or less) Loan to Valuation ratio is not going to work for many developers.

"The equity ask of the developer is traditionally too high to fill, driving the developer to the private debt market for mezzanine or preferred equity.”

Hall also points to quality human resources as a challenge, with many employees, capable of assessing and delivering quality transactions in a commercial and timely manner, leaving the banks in favour of employment with private lenders.

Where does this leave the banks?

“Some of these challenges will be difficult to overcome, and will take time to surmount.

“In the meantime though, non-bank lenders like Newground Capital Partners will continue to provide alternative sources of senior and mezzanine debt financing, particularly development finance.

“While the growth of non-bank lending may not continue at the same pace, the ability to lend more – and importantly, quickly and with certainty – will offset the banks’ cheaper form of more conservative funding.”

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