[+] Non-Bank Lenders Throw Embattled Commercial Sector a Lifeline

As non-bank lending activity in commercial real estate continues to heat up, participants and analysts say that private lenders are providing lifelines to developers and landlords turned away by the big banks. Risk levels for borrowers and the economy at large are within acceptable limits, advocates say, despite the stresses in the commercial property and construction sectors. “Commercial real estate has been the flavour of the month, the soup du jour , for investors recently,” Nick Goh told The Urban Developer . “But during the past year or two, with investors reducing their allocation to risk, debt has become preferable to equity. “We’re talking to a lot of developers, borrowers and investors who have never used private credit before.” ▲ Centuria Bass Credit chief executive Nick Goh. But Goh, Centuria Bass Credit chief executive, says that despite a large uptick in private lending to commercial real estate in recent years, up 56 per cent from 2018 to 2022, there is still plenty of room for more growth. “Australian private lending is lower than other jurisdictions,” he said. “In the US and Europe, major banks are under 50 per cent of commercial real estate credit markets.” Non-bank finance in Australian commercial property is around 10.5 per cent, while it contributes around 35 per cent in the EU and UK, and as much as half in the US. Standard &amp; Poor’s Global Ratings senior director Craig Parker says, “It’s not necessarily that they’re more sophisticated markets, it’s just that they have a bigger pool of providers of debt”. However, Parker says Australian financial instruments don’t facilitate commercial property debt to the extent that other jurisdictions allow. In the US, for example, investors can purchase securitised real estate debt through stock exchanges. “You might have a landlord with a similar asset as to what you’d find in Australia but they’ve got a more diverse borrowing base,” he says. Bridge loans option for worried office owners Recent office tower woes have meant caution from major banks about playing in the sector. Parker says that S&amp;P has about 40 per cent of its rated Australian office landlords on a negative outlook. “Predominantly [those rated negative] are going to have higher vacancies over the next two years,” he says. ▲ Standard &amp; Poor’s Global Ratings senior director Craig Parker. “Or they could be completing a debt-funded development, and they’re having to wear that, while at the same time dealing with subdued rentals. “Then you’ve got a market which is showing a paucity of asset sales, because we’re in a period of price discovery, and people are waiting for distressed assets to come along. “Or they’re waiting for further visibility into what discount rates they should be applying.” But rather than an avalanche of hedge funds and loan sharks swooping on fire-sale office space, Australia is likely to have more office owners taking up bridge loans from responsible private lenders, according to Goh. He argues that the flexibility and sector-specific expertise of private lenders can make them more suitable for that kind of finance than traditional banks. “We’ve got a type of borrower of greater substance and scale. Whether for the speed of getting approval, accessing a slightly higher loan-to-value ratio, or they’ve had a valuation which changes their cap rate so they need a bridge,” he says. “The banks are still the best organisations for providing generic, larger loans, and vanilla credit products. But I think bridge loans are one of the areas that private lenders do best.” ▲ Atlanta, Georgia: Parker says Australian financial instruments don’t facilitate commercial debt to the same extent as other jurisdictions, including the US. Goh says that lending to construction is also on the rise. Medium-sized residential developments are particularly suited to working with a private lender who doesn’t require the pre-sale commitments that a bank might. Non-banks riskier but manageable: RBA The Reserve Bank has argued that commercial property private lenders receive a relatively high proportion of their capital injections as equity, with investors keeping more skin in the game. As perceived risk in lending to commercial real estate has risen, the share of equity in commercial property lenders’ assets has risen from under 15 per cent in 2018, to almost 30 per cent today. While that reflects a riskier operating model, a recent RBA report argued that the “reduced connection to banks and the greater use of equity funding helps to limit the risks to the wider financial system”. The RBA notes, however, that non-bank lenders to other sectors (including residential mortgages), particularly those who securitise loans in packages, are a different species. Meanwhile, commercial property private lenders are maintaining prudential risk appetites as they get deeper into deals. “With the pullback of bank lending for property developments, non-banks are financing more senior tranches of developments, which are less likely to incur losses,” the RBA report says. “Historically, banks that funded senior tranches of developments would carry out due diligence on the project. “Less involvement in development deals by banks means that non-banks and other investors are increasingly becoming responsible for carrying out due diligence on borrowers.” ▲ The sector’s growth is a benefit to the economy and borrowers, says Goh. The RBA has notes that, while plenty of data on non-bank lenders to residential mortgages exists, there’s a dearth of quantifiable information on activity in commercial property. In part, that’s because non-bank lenders have less rigorous reporting requirements. The commercial property sector is particularly opaque, the RBA claims, because many lenders operate as trusts, rather than registered financial corporations. Goh points to the 2021 IPO of Qualitas, and the involvement of superannuation in providing credit to the property sector, as examples of the stature of the participants in private lending. “There’s a spectrum of private lenders. The professionalism of the larger part of them, they’re sophisticated organisations,” he says. “There’s always elements of predatory lending in any sector, particularly growing sectors with a lot of new names popping up. “But at the end of the day, the way to combat that kind of thing is diligence and reputation—knowing who you’re working with. “The growth of the sector is a benefit to the economy and to borrowers. “More choice, more competition, is good.” You are currently experiencing The Urban Developer Plus (TUD+), our premium membership for property professionals. Click here to learn more.

[+] Non-Bank Lenders Throw Embattled Commercial Sector a Lifeline

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