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November 27, 2023

Commercial Property Finance: Year in Review

Beginning of the Year

Interest Rate Cycle

The start of 2023 was all about interest rates and the question on everyone’s mind was, “when will they stop rising?”. We saw the RBA raise the cash rate in March, April, May, and June, followed by a four month pause and then another in November. The pause was sufficient to demonstrate that we are near the end of the curve and breathe a little bit of confidence back into the market. The next few RBA meetings will indeed be of great interest and should set the tone for where we go early next year.

What effect did this have on capital markets?

Despite the various challenges of this year, the markets have remained relatively liquid. The first half of the year saw lenders playing conservatively; however, we noticed a distinct change in attitude once the interest rate pauses commenced around the middle of the year. Leverage was pushed back up, particularly for residential development, which most leading indicators suggest will be the asset class of choice over the next few years.

A Strong Residential Apartment Market

The residential apartment market is still undersupplied and has proven the strongest market for 2023. This undersupply has been widely reported, which coupled with now pre-COVID migration levels, means the demand for housing has never been higher. To be able to deliver affordable housing remains a challenge, given historically high land values and the dislocation in the construction sector. This has affected developers’ ability to deliver new stock, as well as purchasers’ ability to afford new stock.

Residential Affordability

In the apartment market, over 80% of what we are funding would be considered owner-occupier, downsizer, or luxury apartment stock. This doesn’t augur well for affordability in the short term, nor a solution for the ongoing rental squeeze. More government intervention seems to be required to solve the problem, either through rezoning, relaxing planning laws, or incentivising mid-market developers to deliver affordable housing accommodation. Build-to-rent could be part of the solution here, however, we are yet to see many (any) active players in the mid-market space, as construction costs, coupled with low rental yields and holding costs make this space a “no go” for anything other than institutional balance sheets. As it is, delivery on these projects in the insto space has been very slow.

Construction Challenges Softening

Dislocation in the construction industry continued throughout 2023. A number of household name construction firms went to the wall, along with many more unknown. Construction costs probably plateaued somewhere around the middle of the year, but remain up anywhere between 30% and 50% since the start of COVID. We may see some softening in construction prices early next year as builders recalibrate their forward-looking workbooks and a slowdown in project starts sees labour shortages soften. It remains to be seen if this will play out; we’re not holding our breath

Commercial Property Yields

Commercial investment assets are still undergoing an unwind, with a bit of “yield softening” to yet play out. We expect this to play out slowly but surely over the next 12-18 months. Positively, there has been no “knee jerk” reaction from the market to date, with the banks continuing to be flexible with existing borrowers, despite Interest Cover Ratio (ICR) breaches. Acting precipitously isn’t in the best interest of the banks, the real test will come at the end of term, when revaluations will likely reveal an LVR and ICR beach. For those in breach, banks will have their hands tied. Borrowers will be faced with the limited options: those who can’t pay down debt or refinance to a non-bank alternative will be forced to sell assets and crystalise their loss. Non-bank lenders are beginning to adapt their product offering to meet the expected fall out of transactions from the banks. Coupled with their ongoing appetite for construction debt, we expect the non-bank footprint to only increase over time.

Debt Capital Markets Survey

At the beginning of this year, we surveyed over 100 lenders about the state of the debt capital markets and their forecasts for the year. While there was still liquidity in the market, lenders indicated they were being far more selective. Over half of respondents expected major banks to decrease construction lending activity, given the construction landscape. Despite the reduced appetite, 76% of respondents expected to grow their loan books this year, suggesting a focus on quality deals with strong sponsors.

The Debt Capital Markets Survey also revealed lender appetite for asset classes, with residential markets at the top, while industrial remained strong but at its peak and commercial office a concern due to increasing vacancy rates and leasing incentives. These preferences have carried out throughout the year.

Interestingly, most respondents believed the cash rate would top out at 4.10% with only 10% of respondents believing we’d see the cash rate as high as 4.25%. Majority of respondents believed that we wouldn’t see the cash rate begin to come down until 2024.

Wrap up

This year we’ve seen a gamut of challenges thrown in front of commercial property: continued rising interest rates and disruption in the construction industry, geopolitical tensions, and global and local economic downturns.

It certainly hasn’t been easy for developers and investors. Transaction settlements are taking longer and borrowing costs are higher, negatively impacting investor and developer IRRs and investors’ cash on cash yields.

Those with access to the complete lender market, capital has always been available for good sponsors and in-demand, well planned assets in prime locations.

Development Funding:

  • Lender appetite to leverage has increased. We are regularly executing deals at 75% LVR (90% of cost), particularly in the residential development space or for good de-risked commercial projects.
  • No presale options available, depending on location, price point.
  • Construction costs seem to be stabilising, giving lenders comfort to lend higher leverage and with less conditionality.
  • We’ve seen banks increase their appetite for residential construction deals in the last quarter after a period of uncertainty. They’re altering their traditional policies of 100% debt cover and seeing transactions settle at as low as 60%.

Investment/Occupier Funding:

  • Borrowing confidence has risen due to more stable borrowing costs. After the rate hike in November, the first RBA meeting of ‘24 will likely set the tone for the year.
  • Banks still slightly wary but remain open to good quality assets and sponsors.
  • Many non-bank options available at increased leverages and with less conditionality to banks.


This year in review was written by Stamford Capital for CAFBA’s Commercial Insider Newsletter.