Developers Turn to Private Credit on Completed Assets

Private credit manager Ironstate Capital Partners is seeing increased opportunities to provide investment facilities on completed commercial real estate (CRE) assets.

Director Rohan Barraclough (pictured above) says that borrowers are increasingly looking to non-bank lenders to fund investment assets and that investors can access attractive risk-adjusted returns without planning or construction risk, which are key features of many CRE private credit investments.

“Banks are still requiring relatively strong interest cover ratios (ICRs) based on prevailing interest rates, which is limiting their leverage on investment assets. With the market pricing in further cash rate reductions, we see less risk of interest serviceability deteriorating than at the bottom of the interest rate cycle.”

Private credit market

In 2016, APRA undertook a review of CRE lending and communicated their findings to the banks in early 2017. The review identified land and development finance as riskier segments of the market, which resulted in reduced appetite from banks for these types of lending. 

Much of the growth in CRE non-bank lending has been due to the banks retreating from these areas of the market, which can have significant planning and construction risks. As the private credit market has grown, planning and construction risks have therefore shifted from banks into the portfolios of private credit funds.

Changing market dynamics

Following APRA’s review, banks remained active providing investment facilities on completed, income producing assets. However, as the cash rate increased, interest serviceability covenants became harder to meet, leverage provided by banks reduced, and we’ve seen instances of banks requiring borrowers to reduce debts on investment facilities to remain within ICR covenants.

Vendors are now looking to private credit to provide bridging finance that will enable them to take assets in market in the next 12-24 months. Having seen the first cash rate reduction in more than four years, sponsors are increasingly looking to hold assets with the expectation that possible cash rate reductions are likely to support values of income-producing CRE assets and may enable private credit facilities to be refinanced by banks.

Attractive risk profile

Investment facilities provide investors an opportunity to gain exposure to private credit, but with no planning risk, no construction risk, and lower sponsor risk.

“Lenders are not reliant on councils, builders or sponsors adding value to their security. In a downside scenario, lenders have security over completed assets and interest servicing is often supported by income generated from the asset.”

Supply constraints

Increased construction costs have made it more challenging to deliver new developments. This increase in replacement costs is limiting new supply across much of the CRE market, which should support occupancy rates and leasing activity on existing assets.

Like most non-bank lenders, Ironstate Capital Partners also funds land and development facilities, which often have higher returns than investment facilities. However, investment facilities can provide a solution for investors seeking exposure to private credit without planning and construction risks.

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