Australia’s push to control a housing bubble by reining in bank lending to property developers has unleashed a highly profitable market for shadow lenders, including international hedge funds.
The lenders are funding some developers at more than double the interest rate for the same type of loans that banks were providing just a few months earlier, a reflection of how some construction firms have been forced outside the regular banking system to secure financing.
“Effectively, the risk hasn’t changed, but the pricing today is about 12 per cent, not the 6 per cent that banks were charging 12 months ago – so you are getting very attractive spreads of almost double in this space,” said Martin Scott, the Australian head of the Swiss-based Partners Group, an investment manager with some $US65 billion in assets.
The lenders are generally attracted to developers with pre-sold apartments in otherwise unfinished
The lenders are generally attracted to developers with pre-sold apartments in otherwise unfinished projects. There are no figures on the size of this market, but Dan Simmons, a Hong Kong-based partner with hedge fund OCP Asia, which is providing funding, estimates it is worth tens of billions of dollars.
The broader shadow banking market in Australia is about 7 per cent of total financial assets, the country’s central bank says.
Australia’s home prices doubled in the 12 years to the end of 2016 so last year, Australia’s regulators imposed measures that forced banks to take fewer lending risks and made securing mortgages for investors, particularly foreign investors, more difficult.
That caused a sharp pullback in construction lending by mainstream banks and once rampant buying interest from Chinese flittered away, hitting developers and opening up a funding gap.
Feeling the squeeze from the measures, Australia’s only listed residential real estate agency, McGrath Ltd, issued a profit warning last month.
In a global low-rate environment, the likes of Kohlberg Kravis Roberts & Co, Goldman Sachs & Co and Nomura have joined local firms including Qualitas, Alceon Group, and Wingate Group to lend senior debt to real estate developments, according to market sources.
Demand was so high for properties near Sunnybank, that it spilled into surrounding suburbs. This picture was taken in Upper Mount Gravatt earlier this year.
“All the big PE funds are bringing their special-sits (situations) groups in to fill this funding gap, because effectively these are equity-type returns in debt positions,” Scott said.
Partners Group secured annual returns of close to 15 per cent by providing senior debt to two pre-sold projects in Brisbane and Melbourne, Scott said.
He declined to identify the projects because they were private. But he said one of them had been unable to secure bank loans because many of its apartments had been pre-sold to Chinese buyers, who are finding it more difficult to take money out of China because of tight capital controls and who face stiff taxes on purchasing new property from Australian authorities.
Regional hedge funds, such as OCP Asia, are also swooping in.
OCP’s Simmons said its multi-billion dollar fund had invested over $600 million in senior debt in construction projects, securing returns in excess of 15 percent.
“We are seeing settlements take longer but buyers are definitely coming up with the funds,” Simmons said.
“We are funding developers that have pre-approved projects with healthy profit margins that only lack a bank to finance them,” he said.
Simmonds warned that many developers who had not pre-sold their projects would struggle to pay higher funding costs.
For now, lenders and borrowers in this shadow market do not see significant risks.
The Reserve Bank of Australia said in its fourth-quarter bulletin that it was “monitoring” shadow bank lending to property, acknowledging that “on a large enough scale it could damage financial system resilience.”
The government has also pledged to give the APRA, the banking watchdog, the power to collect information about the sector, to consider potential formal oversight of the funds, finance companies and securitisation vehicles that are not currently under its umbrella.
The funds chasing the high returns from lending to these projects shrugged off concerns of the risks involved after such a sharp run up in housing prices. Scott estimated prices would need to fall more than 40 per cent to adversely impact Partners Group.
Luke Heartman, the chief executive of one of Australia’s biggest private developers Metro Property Development, said the higher cost of borrowing is manageable as demand for property continues to grow.
“Our product is continuing to settle and perform well,” he said, highlighting a low level of rental vacancies.
“Our target is a minimum return (on capital) of 22 per cent.”
reposted from domain.com.au