Investors seeking alternatives for refinancing APAC real estate

The spike in interest rates over the past 18 months has significantly impacted the real estate landscape, hitting asset values and causing finance costs to rocket. At the same time, banks in the Asia-Pacific region are becoming increasingly reluctant to lend to real estate due to rising risks and regulation which has created a new opportunity for private debt.

The wider private debt market in Asia-Pacific has grown over the past decade but remains smaller than in the US and Europe; this applies equally to real estate lending.

Indeed, the market is so small that there is no data covering the exact percentage of the overall market accounted for by private debt. It accounts for around 40 percent of real estate lending in the US and 10 percent in Europe.

Chris Mikosh, co-founder at Hong Kong-based private debt firm Tor Investment Management, says: “Five years ago private credit was mainly financing of greenfield development in the region – especially in China – but today, it is being driven by stress and rescue or bridge financings.

“The impact of the rise in rates has yet to be fully absorbed in many markets, and asset owners will likely face a financing gap as both loan-to-value and valuations compress, leaving them with a capital gap which must be filled by some combination of sponsor equity and private credit capital, either mezzanine or stretch senior.”

As the market deals with this dislocation due to rising rates, banks across the region are reducing their exposure to real estate, especially to riskier forms of lending. This is due to the preference toward lower LTV ratios and stabilized assets, meaning they can offer little help to owners looking to refinance assets which have fallen in value.

Historically, Asia-Pacific banks have focused on strong relationship lending and have been inclined to support borrowers rather than enforcing loans. Opinions vary about how much this is changing, but banks in the region have always been more conservative lenders – than in the US, for example – and thus find it hard to lend in the current market.

Regional breakdown

In Australia, the “Big Four” domestic banks have been withdrawing from real estate lending since the global financial crisis, driven by regulation and risk aversion. This has led to Australia being the one market where real estate private debt was thriving before the recent interest rate hikes.

Outside Australia, South Korea and Hong Kong are viewed as markets where there is more potential for lucrative private lending. Andrew Haskins, head of strategy and investor advisory, real estate, Asia-Pacific, at Schroders Capital, stated in a report in September 2023: “In South Korea, anecdotally, it is virtually impossible to obtain bank financing for development in the oversupplied logistics sector.” In Hong Kong, he cited falling investment volumes and “growing risk aversion on the part of the territory’s banks.”

Hong Kong market players say the outlook for asset owners, even large organizations, is difficult due to a weak economy and residential market, as well as substantial oversupply in the office sector. Even well-known asset owners are rumored to be looking for alternatives to bank debt.

The situation in China is somewhat different to the rest of the region. While it has not seen interest rates rise – they have in fact fallen slightly – there is substantial stress and distress due to the implosion of the residential development market and a sluggish post-covid economy.

While the troubles and significant liabilities of big-name developers such as Evergrande and Country Garden have hit the headlines, there is a large number of developers requiring finance that banks are not prepared to provide.

This distress is leading to exceptional measures for developers, says Mikosh. “In China, what is driving demand is absolute desperation of the highest order. The distressed developers are attempting to borrow against incomplete projects or land banks to fund to completion.

“Meanwhile, larger real estate companies which own performing assets are trying to manage public bond maturities by raising equity or private debt. We have seen situations where companies are prepared to pay high teens to borrow at 10-20 percent LTV in order to raise cash so they can deal with problems elsewhere in their business.”

Elsewhere, the persistence of a positive gap between cap rates and financing costs and supportive banks means non-bank lending in Japan remains rare. Singapore is seeing less stress compared with other markets, while in India interest rates were higher than in much of the region, meaning the spike in the past 18 months has had a less dramatic effect.

Window of opportunity

The market dislocation and tightening of bank lending has boosted the returns on offer from private debt lending to real estate. “There is a pretty wide range, but generally speaking the widest swath would be in the 12-15 percent range,” Paul Brindley, head of debt advisory, Asia-Pacific, JLL, says.

Mikosh adds: “Returns range from 10-20 percent-plus depending on nature of the borrower, structure (mezzanine vs senior) and whether it is construction funding or loans on operating assets. In the senior space we are currently seeing returns up to high-teens and mezzanine significantly higher for anything involving a construction piece, given the risks around completion costs.

“In senior secured debt for operating assets, it is also possible to achieve mid-teens returns across sectors. We see stretch senior financings for logistics, hospitality, data centers, office and retail across jurisdictions, which indicates the scarcity of capital in the region in general. Development financing in these subsectors will approach equity-like returns of 20 percent-plus in many Asian countries today.”

There is clearly a window of opportunity for real estate private debt in Asia-Pacific, yet Brindley believes this is not just a cyclical trend. “JLL believes this to be a more structural, and permanent, change to the market, similar to the US and Europe. There will remain a market for non-bank lending in Asia-Pacific,” he says.

“As banks must comply with more stringent Basel III/IV rulings, they will need to be more discerning over their financing underwriting, so there will be financing gaps which non-bank lenders can fill.”