Private real estate lending in emerging Asian markets, particularly by real estate funds and institutional investors, is expected to see continuing increase in demand, buoyed largely by a scarcity of traditional funding sources, a CBRE report has estimated.
A report on the real estate debt market in Asia Pacific has found that although pure real estate debt structures are yet to evolve in the region, private equity real estate funds with an opportunistic investing strategy are increasing their debt investments in Asia. Chief among the reasons is the potential to earn higher returns from debt as compared to equity investments in commercial property. And for institutional investors, low bond yields and intense competition for core quality assets have been the driving factors prompting them to invest in real estate debt by providing long-term senior loans at a competitive rates.
“Non-bank lenders have already embedded themselves into the region’s private real estate debt market, with real estate funds behind 42 percent of the region’s property debt investments and institutional investors making up 20 percent, according to the Asia Pacific Investor Intentions Survey 2015,” said Ada Choi, senior director, CBRE Research Asia Pacific. “Activities by these new lending sources have redefined the traditional layers of the capital debt structure in response to financing and liquidity demands of both development projects and standing investments across different Asia Pacific markets, while also aligning with lenders’ specific risk-adjusted investment strategies.”
Australia, India and China have been pegged as the most opportunistic markets for debt investments. In mature markets such as Australia, institutional investors such as insurance companies and pension funds have started providing long-term senior lending for commercial property acquisitions. The tenor of such financing is around seven to ten years at an interest rate of 4.5 percent. According to the report, borrowers in the country are keen to secure these long-term loans at the current low interest rates before the expected rate hike by the US Federal Reserve.
On the other hand, markets such as India and China are seeing an increase in preferred equity and mezzanine financing deals due to banks’ reluctance to provide development finance. Pre-sales in China – the major funding source for real estate developers – have reduced in the last few years, forcing smaller local developers to turn to foreign funds for residential development projects. In India too, foreign funds and non-banking financial institutions (NBFC) are becoming alternative funding sources.
According to the report, IRRs of around 19 percent to 23 percent could be generated from straight debt, mezzanine debt and preferred debt structured deals in India.
The general draw towards the private debt market has increased in part because of the slowdown in bank lending. Bank lending in Asia Pacific declined from 15 percent in the period between 2005 and 2008 to 7 percent between 2011 and 2014, adversely impacting small and medium sized investors and developers, according to the report. The public debt market, where many listed real estate developers and REITs are securing financing, has also been out of reach for smaller scale developers with less favorable credit rating scores.
These constraints will only tighten further as more regulations are imposed. The BASEL III framework, for instance, which is set to be enforced in 2019, is expected to make underwriting requirements for lending more stringent.