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Is now the right time to invest in CRE debt in Australia?

Martin Priestley
Head of Debt, Real Estate, Asia Pacific
Is now the right time to invest in CRE debt in Australia
Based in Sydney, Martin Priestley is the Head of Debt, Asia Pacific, overseeing the origination, portfolio management and business development activities for Nuveen Real Estate across Australia and the broader Asia Pacific region. Here, Martin gives his view on why now  is the right time for investors to engage in commercial real estate (CRE) debt in Australia.

What is CRE debt?

CRE debt is typically structured as a loan secured on commercial real estate. It offers income-focused returns through periodic interest (and principal) payments, culminating with the repayment of the remaining principal either amortising or at maturity.

Why could investing in CRE debt be a good investment strategy?

Well-managed CRE debt can provide performance protection through diversified, stable income streams. CRE debt benefits from a substantial degree of downside protection provided by the ‘buffer’ of the sponsor’s equity. While there is typically no additional upside to debt returns in a rising market, the sponsor’s equity will absorb the first loss in a falling market. In addition, contractually-agreed interest payments insulate the lender from the volatility of a changing rental income profile. As real estate market cycles become shorter and harder to predict, this insulation and degree of certainty is increasingly regarded as highly attractive by investors.

Australian CRE loans usually include covenants which are put in place to protect the lender in the event of capital value or income declines. These typically include loan-to-value (LTV) and debt service cover ratios (DSCR), along with asset-specific covenants such as a ‘cash trap’, where any surplus income not required for debt service can be retained by the lender and used to reduce the loan, and a default clause, which allows the lender to step-in or sell the property if the default covenants are breached. These covenants are typically triggered at thresholds long before the deterioration of income or capital value would leave the lender at risk of first loss.

Why is now a good time to invest in CRE debt?

Real estate equity markets are currently experiencing significant volatility, elevated valuations, and heightened uncertainty. An investor focus on income, given the low interest rate environment, is a welcome addition to the portfolio. As such, the downside protection investment attributes of CRE debt are becoming increasingly sought after; alongside stability, diversification and contracted income. CRE debt presents very competitive relative value, compared to fixed income and direct real estate.

Who are the main players in the CRE debt space?

Although CRE non-bank debt has been a part of the Australian real estate market, the dominance of the major banks, until recently, has restricted investment opportunities for the non-bank sector. Post the Global Financial Crisis (GFC), tightening of regulatory, capital and liquidity requirements have increased the levels of capital to be assigned to CRE. This has led to a tightening of underwriting standards, significant reductions in the leverage of loans, increases in loan pricing and reduced availability.

The slow withdrawal of traditional lenders, as well as the reduction and repricing of available capital, have created a permanent, attractive and executable investment opportunity for non-bank lenders and debt funds to provide a meaningful share of future CRE debt finance in Australia.

 



We see increasing opportunities for well-capitalised, specialist, alternative finance providers with local debt professionals who understand the local markets.


What are the current opportunities in the sector?

In the context of retreating traditional lenders, and the persistent narrow focus, reduced LTVs and wider margins, we see increasing opportunities for well-capitalised, specialist, alternative finance providers with local debt professionals who understand the local markets. Investment opportunities can be found in those assets currently ‘off the radar’ in established markets across Australia.

With robust underwriting, ideally informed by direct real estate expertise, these underserved markets present the most appealing prospect for the selective ‘cherry-picking’ of transactions, backed by strong fundamentals and robust return characteristics.

 

 


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Per Frederiksen
Per Frederiksen
Head of International Advisory Services, Continental Europe
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on factors such as market conditions or legal and regulatory developments. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition.

Any changes to assumptions made in preparing this material could have a material impact on the information presented herein. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible. This information does not constitute investment research as defined under MiFID.

Real estate investments are subject to various risks, including fluctuations in property values, higher expenses or lower income than expected, and potential environmental problems and liability. Please consider all risks carefully prior to investing in any particular strategy. Concentration in the real estate sector makes it subject to greater risk and volatility than other portfolios that are more diversified and its value may be substantially affected by economic events in the real estate industry. Debt instruments are subject to interest risk, inflation risk, credit risk and liquidity risk. International investing involves risks, including risks related to foreign currency, limited liquidity particularly where the underlying asset comprises real estate, differing levels of government regulation and tax implications in some jurisdictions, and the possibility of substantial volatility due to adverse political,economic or other developments.