New players vie with banks as Asian debt game changes

Insurance firms begin to challenge banks’ dominance in the region, reports Paul Yandall.

While Asia’s disparate markets offer investors a variety of real estate opportunities, one theme slices through when it comes to lending: local banks are still the first choice for debt.

A combination of low interest rates, regulatory restrictions on foreign lending or loan-to-value (LTV) ratios and aggressive competition from banks have combined to check the region’s alternative lending market.

“Together with proceeds from pre-sales, bank debt remains the dominant source of financing for Asian real estate,” according to PwC’s Emerging Trends in Real Estate Asia Pacific 2016 report.

In Tokyo, found to be the top pick for investment this year by the Asian Association for Investors in Non-listed Real Estate Vehicles (ANREV), access to bank debt has never been easier. LTV ratios are reaching 90 percent, at rates of 200-250 basis points.

In Singapore, banks are lending at up to 70 percent LTV ratios for commercial property at 280 basis points. In Hong Kong, commercial property lending is restricted to a maximum 40 percent LTV ratio, stifling interest from the more ambitious players in the alternative debt market.

In Australia, the dominance and aggression of the “Big Four” banks – ANZ, Commonwealth Bank, NAB and Westpac– has made life hard for alternative lenders.

Nick Crockett
Nick Crockett

But the banks have not had it all their own way in the region. Basel III capital requirements are making it more expensive for them to lend on property, global institutional investors seeking yield are entering the debt market and increased competition for hard assets are turning other investors, some with very deep pockets, towards lending.

“Six or seven years ago, a non-bank debt market started to really develop in the UK and wider Europe, whether it was insurance providers wanting to match their liabilities, or debt funds raising money from pension finance or sovereign funds,” says Nick Crockett, head of CBRE’s capital advisors team in Asia Pacific (APAC).

“Some markets here are further ahead than others, such as Australia and Japan, but we see that same natural development we saw in the UK and Europe coming to APAC.”

Insurers step up the pace

Driven by the hunt for yield, insurance companies in particular have started entering APAC with MetLife, Prudential and Manulife among others having recently deployed capital, or seeking to do so.

The increasing transparency, attractive spreads, good security and the fact that it is a strong match for insurers’ long-term annuity liabilities have made real estate debt a more important area for institutions.

At the same time, Basel III, which is designed to strengthen the regulation and risk management of the banking sector, must be implemented by 2019.

Banks will need to increase their capital reserves to match increased risk sensitivity to real estate loans. Higher LTV facilities will incur higher risk weightings and require higher levels of capital held in reserve. For commercial real estate, the risk weight can reach up to 150 percent of the loan, pushing banks down the risk curve, particularly from development lending.

Felicity Ambler
Felicity Ambler

In Australia, alongside Basel III, a raft of lending rules for banks have also been introduced by the Australian Prudential Regulation Authority, to help take the heat out of the housing market.

“That has opened up the funding gap even more for alternative lenders to come into the space,” says Felicity Ambler, head of distribution at Australia’s MaxCap Group.

MaxCap manages more than A$3.6 billion of commercial real estate for its domestic and international institutional clients. It is a small slice of Australia’s A$232 billion commercial real estate mortgage market, but the overall alternative lending component is tipped to grow.

Whereas once the major Australian banks were prepared to lend at up to 75% LTV levels on commercial property, now they have withdrawn to around 50-60%. Mezzanine lenders are now deploying in what was once traditional senior loan space.

“It’s a great opportunity,” says Ambler. “We are starting to see a number of large institutions and superannuation funds recognise the opportunity, because the funding gap is growing so much, so some strong relative returns are now available.”

Across the wider APAC region, banking regulations such as the Basel accords implemented in the wake of the global financial crisis are partly blamed for the fall in growth in commercial and residential real estate bank lending across the region; from 15 percent per annum between 2005 and 2008, to just 7 percent between 2011 and 2014, according to CBRE.

The hardest hit markets have been India and China. In India, lending growth fell from 33 percent in 2005-08 to 10 percent in 2011-14, spurring the creation of Indian-focused property funds providing equity or debt to the subcontinent’s developers.

In China, real estate corporate bond issuance grew by more than 70 percent to $18 billion between 2011 and 2014, as banks became more conservative, leaving domestic developers to turn to the bond market for finance. Issuance across the region reached more than $21 billion in the first half of 2015, with Chinese developers accounting for more than $13 billion.

By contrast, CMBS or even RMBS in APAC has failed dismally to recover to the levels reached in its strongest markets, Australia and Japan, since the financial crisis. Relatively cheap lending by the region’s local banks and the growing sources of alternative finance is filling the void once occupied by mortgage-backed securities.

“It’s difficult to see why CMBS would be advantageous in this market,” says CBRE’s Crockett.

Typical lending terms

Fight for assets fuels debt

Fierce competition for assets in the region is also fuelling interest in debt. More than 16 percent of respondents in the ANREV Investment Intentions Survey 2016 say they will increase their allocations to real estate debt in the region over the next two years.

Real estate-related debt investments in APAC, assuming a rough guide of around 50 percent loan-to-value ratio, totalled around $64 billion in the region for 2015 – about level with 2014’s total in US dollar terms but an overall increase when measured in local currencies, according to JLL.

“That will only increase in 2016 and 2017,” says Stuart Crow, head of JLL’s Asia Pacific capital markets team. Investors are looking at different ways of accessing real estate deals, he adds, because the market for hard assets is very competitive and they want more direct exposure to real estate, rather than investing via blind pool funds.

However, as always, there are risks. Turmoil on China’s stock markets and the devaluation of the renminbi over the past year has created currency uncertainty.

“In China, a number of the deals carry domestic and offshore finance,” says Robert Scholten, head of Asia real estate finance for ING. “Obviously the revenues of most of the underlying assets are denominated in local currency, so when the renminbi is a bit under pressure and has been depreciating, that creates a bit of a mismatch.”

The renminbi and Australian dollar devaluations in recent months were behind currency risk exposure being voted the second major concern for investors in the region, according to the Investment Intentions Survey 2016, second only to the category ‘transparency and market information’.

China’s fundamentals still good

Despite the devaluation and the turmoil at the start of the year in the country’s stock market, the long-term fundamentals for China remain good, says JLL’s Crow.

“We leased more space in Shanghai and Beijing last year than we ever have before and we don’t see any drop-off in interest from investors, nor any drop-off in potential returns from that market,” says Crow.

“The other story is China’s capital coming out of the country. That’s had a huge impact on other markets such as Australia, which has been a big beneficiary of Chinese capital.”

That flow of capital into Australia is helping lenders like MaxCap raise its first debt fund.

“It will be a high-yield debt fund with a mix of uni-tranche or whole loans and mezzanine bridging facilities,” MaxCap’s Ambler says. “It’s our first fund, so we’re looking at a A$250 million cap, targeting Australian assets and returns of 10 percent.”

There are no debt-specific regional funds targeting assets across APAC yet, according to Michael Wood, executive vice-president at debt investor Quadrant Real Estate Advisors. But there has been progress in educating the market about debt’s benefits.

“Six years ago, when you talked to people about real estate debt as an asset class, they’d look at you as if you were from another planet,” says Wood. “Now, if there’s one thing I‘m certain of, it is that you will see a fundamental change in how institutional investors participate in this market.”