commercial real estate

Property owners could face a widening funding gap as loans need to be refinanced

Crunch Time for Commercial Property Borrowers

Funding Gap Is Widening

With many commercial real estate loans needing to be refinanced over the next two years, property owners are faced with a widening funding gap, Florence Chong writes

Much has been written about the emergence of a residential mortgage cliff since interest rates started to rise in 2022. Not much, at least until now, has been said about the mortgage cliff that will impact commercial property owners.

Crunch time has arrived, with many borrowers needing to refinance loans over the next two years. Compounded by higher costs of borrowing and declining valuations for their assets, commercial property owners are staring at a widening funding gap.

How big that gap is is hard to know. Economist David Rees, writing for Madigan Market Insights, talks about a ‘capital gap’ of $39 billion. Others say that extrapolating the impact of a pull-back from commercial lending by Australia’s Big Four could see Australia face a commercial real estate (CRE) funding debt gap of up to $100 billion in coming years.

Rees drills down on the implications of a decline in asset values and higher market interest rates to look at the state of leverage and interest rate cover ratios. He writes: “At current exposure levels for major banks, we estimate a 20 per cent decline in average core commercial asset value implies a capital gap of approximately $39 billion; alternatively, a 300 basis points rise in the cost of the debt implies a capital cap of approximately $21 billion.

image shows a quotation mark

At current exposure levels for major banks, we estimate a 20 per cent decline in average core commercial asset value implies a capital gap of approximately $39 billion – David Rees

“These core sectors account for 70 per cent of commercial property lending by major Australian banks and the banking sector. Other lending – residential, tourism, leisure and other residential (like build-to-rent and student housing) faces a gap of $6.1 billion. But because lending to these subsectors is around 77 per cent of exposure limits, they are less vulnerable to the emergence of a capital gap.”

Filling this capital void will likely take a number of forms, Rees writes, including equity, preferred equity, convertible notes, bond issues and secured lending.

“Through 2024 and beyond, asset owners will require access to flexible and alternative sources of capital in order to optimise capital structures and retain their ability to maximise portfolio value in the medium to longer term,” he says.

Herein lies an opportunity for those who still believe in real estate but are not ready to take on equity exposure. Debt is considered the best option, offering lower risks in today’s unsettled market because it is the last money in and the first out of a real estate deal.

Although they may appear slow on the uptake, interest in debt is apparently growing among super funds. Non-bank lenders say they are fielding more inquiries than before, and that some of these conversations have reached the investment committee level of super funds. It will still likely take a while before allocations are made.

Michael Wood, Chief Executive Officer of Madigan Capital Partners, says the perennial issue is asset allocation and the question of where real estate debt fits within a diversified investment portfolio. “You are starting to see consolidation of real estate and infrastructure. It will be interesting to see how that impacts our asset class,” he says.

He believes there is better appreciation of the return characteristics of debt investment, which, he says, is similar to investment in commercial real estate, but with the advantage of having ‘natural liquidity’ – shorter duration and lower risk.

Rob Hattersley, Group Head of Capital Markets at MaxCap, says that, with CRE debt, the investor is ‘typically in self-liquidating transactions’.

“You therefore don’t have the same liquidity risks as real asset investing. Your protection is that you are in a mortgage position which typically allows you 30-40 per cent headroom to cover any correction of underlying assets you are funding.”

The early prime movers are AustralianSuper, Cbus and VFMC, with VFMC one of the largest super investors in the sector. AustralianSuper has $1 billion with MaxCap on revolving credits, while VFMC is known to invest via Madigan Capital. It is thought to have exposure offshore as well as in Australia.

Despite an obvious lack of super fund support, many billions have been channelled into CRE debt, with residential apartment projects and the living space more broadly having been a favourite for some time. MaxCap has built up a loan book of some $7 billion.

Lenders are writing bigger cheques. Madigan, a relatively young company, is believed to be working with Bain Capital to underwrite a $500-million refinancing package for Public Hospitality Group.

image shows a quotation mark

The impact of regulation on the major banks is resulting in them being increasingly weaker competitors for the more sophisticated non-banks – Rob Hattersley

Michael Wood told [i3] Insights the firm’s average loan size has risen to $50-$60 million and that it is now targetting loan sizes of up to $100 million.

The bulk of money funding CRE credit in Australia today comes from offshore from the likes of GIC, ADIA, APG and the local arm of Hong Kong-based PAG. GIC alone is understood to have at least three mandates with separate Australian managers.

Such is the conviction of growth in this market, which is already well-established in the US, the UK and Europe, those institutions such as ADIA, Apollo and CC Real (an Austrian investment house) have taken positions with lenders like Qualitas, MaxCap and Madigan respectively. They have a ringside seat to development of the CRE market in Australia.

Apart from the immediate funding need for refinancing existing loans, Australia’s Big Four banks are pulling back to lend selectively to big property groups on what is known as a ‘whole-of-client’ approach.

Hattersley says that, traditionally, the top four banks have owned close to 90 per cent of the CRE market, but that that share has shrunk to 71 per cent today. He says the market expects this share to continue to drop to below 50 per cent, and, if that comes to pass, Australia faces a funding gap ‘north of $100 billion’.

“The impact of regulation on the major banks is resulting in them being increasingly weaker competitors for the more sophisticated non-banks,” he says. “You are in an inflationary low-growth environment with an expanding cap rate in real estate. This is putting significant near-term pressure on real asset values. With a negative correlation to real assets, CRE is delivering outsized returns for lower risk.

“In many cases, where the cost of debt exceeds underlying yield on the direct real estate, many owners are finding themselves at risk of a downturn which accentuates the risk of a correction,” says Hattersley.

Entry to the CRE market is through placement of mandates with a manager on a defined strategy, with investors usually allocating $500 million for each mandate. A range of non-bank lenders now run pooled funds and they accept a small amount of capital to access a diversified portfolio of debt.

The advantage of investing through a fund is that the capital goes to work to generate returns from day one. Discreet mandates, however, could take up to six months to commit and a further six to 12 months to be fully drawn and to start producing returns.


[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.