07/12/2022

THE COST OF CAPITAL PUTTING PRESSURE ON UNDERPERFORMING ASSETS AND DEVELOPMENT SITES BUT BANK APPETITE IS UNHINDERED

Financing commercial property and development projects is a different proposition in the upward rate cycle we are experiencing, where bank policy and hurdle rates are changing faster than applications can be processed. Recently we caught up with James Kelder of Green Finance Group to discuss the approach that major financiers are taking to the changing landscape. Here’s what we’re seeing on the ground. ​​​​​​​

​​​​​​​1. How has the appetite of the top-tier lenders changed over the past 6-months? And how is that reflected in their lending policy? (LVR, ICR, Geographical/Asset Class Appetite)

The biggest change in appetite has been driven by the rising cost of funds and its effect on the Interest Coverage Ratio’s & overall serviceability. Recently, I’ve observed some banks reducing their coverage ratios, allowing them to continue lending at traditional LVR’s. Overall appetite for certain asset classes & geographical locations remains varied across the banks; however, no major changes have been observed.  

2. Are any areas of the market or asset classes proving particularly difficult to obtain funding for?

 Tighter-yielding assets can make it difficult to meet metrics if you don’t have a substantial cash contribution.
Partially tenanted assets, low WALE assets can be problematic in meeting bank assessment hurdles and require lenders to up the risk curve.
 Development finance has been problematic with increased funding & construction costs resulting in higher project equity requirements.
 NDIS Assets – I haven’t observed any major banks adopt a consistent approach to this emerging asset class
 Interestingly, for developments, I’m observing project-related site values coming back less than “as is” values indicating that land values or construction costs need to reduce to make sites stack for developers

3. Will the role of private lenders change as we continue this upward Interest rate cycle?

Private lending is more suitable for value-add projects looking to benefit from increased gearing against end values. Banks are reducing coverage ratios, so I won’t see this type of lending for passive hold investors. Non-bank lending may assist some commercial property borrowers if their asset values decline and they want to maintain interest rates.  If construction costs continue to rise, lower presale requirements will also make private lending attractive, allowing developers to recoup elevated costs when selling on project completion.

4. What are lenders saying about construction costs? Are they pricing further escalation into credit applications?

Banks are still scrutinising the builders of projects and the financial means of sponsors to complete projects in case of cost & time overruns. They are still adopting higher-than-traditional contingencies in place for overruns.
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5. Are you recommending your clients fix their rates?
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I don’t recommend fixing rates unless clients want certainty around repayments and/or are hedging against major lease expiry.  In my opinion, the premium for longer-term money compared to current floating rates makes it quite unattractive. Recently, when we have reviewed hedging strategies, capped rates or blended capital structure has provided a good combination of stability and overall cost of funding.     

​​​​​​For further information contact:

Hugh Menck MRICS
Head of Capital Transactions
0432 560 589
HMenck@bne.mcgees.com.au

Jake Taylor
Executive – Capital Transactions
0491 901 488  ​​​​​​​
JTaylor@bne.mcgees.com.au