In an evolving financial landscape, where traditional banks have reined in their lending practices, a significant void has emerged, paving the way for commercial real estate debt to become a key player.
Matthew Afflitto, distribution director at Jameson TTB, noted APRA’s restrictions since 2014 have limited banks’ lending capabilities, thereby dimming the capital and credit availability for the property sector.
This, according to Afflitto, “creates a ripe environment for non-bank lenders to provide solutions for those developers looking for capital.”
The demand for capital in Australia’s real estate sector is staggering, with an estimated need of $115 billion to construct new homes over the next four years.
Tom Cranfield from Sydney’s alternative investment firm Zagga Group emphasised the massive opportunity for the market to bridge this capital gap.
“If we have a marketplace that is roughly $50 billion currently, and there’s a $115 billion per annum need, filling that gap with more capital from investors in that alternatives bucket is a huge opportunity for the market,” he said.
This sentiment is echoed across the industry, signalling a significant shift towards alternative financing methods.
Cathy Houston (pictured above), managing director for real estate credit at MA Financial, highlighted the growing mainstream acceptance of private credit.
“The whole private credit space as an investment class has become less alternate and part of core investment strategies, which it should be,” Houston said. “The depth of that market is increasing in Australia, which is bringing more stability and more investors coming in.”
With an estimated global CRE debt market worth $450bn and growing, the role of non-bank lenders becomes increasingly crucial, especially as banks fall short.
The infusion of private capital, as highlighted by Knight Frank’s report showing a $14.8bn investment in Australia’s commercial market, underscored the vital role of alternative lending.
Neil Odom-Haslett from Abrdn pointed to similar trends in the UK.
“This creates a funding gap, which for Abrdn is opportunity for our debt funds to lend in a market on asset classes where values have corrected,” he said.
Repricing in the Australian real estate market has also notably affected deal flows, with CBRE reporting a significant 31% drop in national investment volumes to $24.1bn in 2023 from the previous year.
“The Aussie market is small in comparison to the UK and Europe, hence why it is still in its infancy in respect of the alternate lenders entering the market, and dominated by the banks,” Odom-Haslett said.
Cranfield suggested that while the current returns in the senior secured investment sector might not be compelling, there is a notable potential for market engagement and growth in the foreseeable future.
He highlighted the challenge of filling project funding gaps, which require more capital than non-bank lenders can provide.
“We haven’t had a proliferation of sovereign wealth and institutional capital at low yields,” he said. “Hence why we have been looking for domestic and international capital and investing and educating developers and investors with CRE debt.”
Houston noted a rising trend in CRE debt, highlighting the growing confidence developers and investors have in non-bank lending within the real estate sector. She emphasizes the appeal of non-bank lenders' flexibility and their personalised approach to loan management.
“It’s about them becoming more comfortable... and understanding the way they are managing those loans,” Houston said.
This flexibility is contrasted with the more standardised, volume-driven approach of large lenders, as pointed out by Afflitto, who remarked that “large lenders are often led by volume... while CRE debt providers look at it more commercially.”
In response to this market dynamic, Pallas Capital has introduced a new lending initiative, Pallas Funding Trust No. 2, specifically designed to address a market gap in medium-sized CRE loans ranging from $2m to $25m.
Gallen identified a specific market blind spot, explaining, “There is a blind spot in the market in the $10m to $30m range... too small to attract interest from larger non-banks and too large for some of the CMBS or high-net-worth funded business.”
Despite not competing on price with major banks, Pallas Capital sees opportunity beyond pricing, recognising other critical factors influencing market participation.
The attractiveness of the CRE debt market has not gone unnoticed, leading to a surge in new entrants during the pandemic. However, the evolving market conditions have weeded out those unable to withstand the pressures.
Entering the commercial real estate debt space might seem straightforward, but scaling presents significant challenges.
“Stepping into this space with a small amount of capital is feasible,” Gallen said. “Yet, building scale and establishing a business of substance relies heavily on the quality of your team.” This reality creates a formidable barrier for new entrants aiming to make a lasting impact.
Developers like Lendlease and Dexus have also ventured into this space, utilising it as a diversification tool and leveraging their market presence for a stable income stream amidst challenging times.
“For bigger players, it offers a stable income stream and fits well into their strategy, especially in these challenging times of cost escalations and rising interest rates,” Houston said.
Read the MA Financial article here, as well as the original post on Urban Developer.
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