Since the US and other major economies began raising interest rates in 2022, commercial real estate owners have had to adapt to a new financing environment pressured by rising rates and falling values.
Things have been a little different in the Asia-Pacific region, primarily because rates have not risen in China and Japan, its two largest markets. However, throughout the region, there are markets and sectors coming under intense refinancing pressure due to rising debt costs and falling values.
Across the region, CBRE estimates there was $254 billion of outstanding senior commercial real estate debt as of Q2 2023, based on transaction volumes in recent years. The broker also points to a debt funding gap of $5.1 billion set to emerge in the region between 2023 and 2025, due to falling real estate values and more conservative lending. The debt funding gap is the potential shortfall between the original secured debt amount originated and the amount available for refinance at the loan maturity. Asset owners will need to either inject new equity, raise more expensive mezzanine debt or sell assets to make up the shortfall.
The office sector faces the most refinancing difficulties, due to falling values. CBRE predicts a 5-20 percent decline in office values in most markets between 2023 and 2025.
Pressures grow
“Australia has the largest debt funding gap in the region, as buyers and sellers have been more realistic about pricing, which has pushed up yields,” says Henry Chin, CBRE’s global head of investor thought leadership and head of research, Asia-Pacific. “Across the region, the office sector faces the largest funding gap, primarily due to falling capital values.”
Chin adds: “We are also seeing signs of potential distress in the Hong Kong office market. A lack of transactions, apart from a few owner-occupier deals, means pricing information is lacking, but the city is suffering from office oversupply and a weak occupier market, as well as the effects of rising interest rates.”
CBRE estimates that Australia faces the bulk of its funding gap this year, as prices there have adjusted more quickly to the changing interest rate environment. Chin says Australian real estate investment trusts are disposing of non-core assets to fund developments, as development funding is in short supply, while asset owners in need of refinancing are either raising additional equity from partners or using private lenders who offer higher LTVs, at a price.
Paul Brindley, head of debt advisory Asia-Pacific at JLL, says the refinancing risk in Asia-Pacific “varies from country to country,” but points to examples such as “office product in markets such as Hong Kong and Australia, logistics (particularly cold storage) in Korea, and various asset classes in China, particularly offshore financing, which, if available, is not priced as attractively as it used to be.”
However, the prospects for debt-driven distress in the Asia-Pacific region are lower than elsewhere, with the notable exceptions of Hong Kong and mainland China. One reason for this is that lending has tended to be at more conservative levels than in the US.
“Across the region, the office sector faces the largest funding gap, primarily due to falling capital values”
Henry Chin,
CBRE
LTV ratios for senior debt tend to be in the 50-60 percent range in most markets, compared with 65-70 percent in the US. One exception is Japan, where low and stable interest rates have encouraged more aggressive lending. Korea and Australia have seen the biggest changes in average LTVs, falling to 55 percent from 60 percent in the former and from 55 percent to 50 percent in the latter, according to CBRE data.
Furthermore, the relationship-driven nature of Asian banking means lenders are more inclined to support borrowers through difficult times. “We hear that banks are more likely to allow loans to roll over as long as the interest keeps being paid,” says Chin.
Brindley adds that “generally, APAC banks are more conservative than they had been, but at the same time more positively inclined, or at least as positively inclined as other global banks. Overall, we are still positive, but banks are definitely more cautious and cashflow-driven and impose tighter structures than previously.”
China under the spotlight
The picture in mainland China is somewhat different to the rest of the region in that residential development is the major source of its financing distress. Huge residential developers, such as Evergrande and Country Garden, have hundreds of billions of liabilities, including onshore and offshore bonds.
Yields on China developer bonds have also rocketed. In October, yields on China Vanke’s 4.2 percent USD notes due June 2024 went over 50 percent, before falling back below 20 percent. However, there is a growing expectation that China will not allow a wave of bankruptcies in the real estate sector, particularly the largest firms.
Commercial real estate is more stable, although a lack of transactions is impeding price discovery. Market rumor, nonetheless, suggests that some private equity real estate investors with exposure to mainland China commercial real estate may face refinancing trouble over the next 12 months.
The Hong Kong office sector looks vulnerable due to falling occupier demand and substantial oversupply, coupled with rising interest rates and falling values. It is also understood that the Hong Kong Monetary Authority has raised concerns with local banks about their real estate exposure. Pricing in the Chinese Special Administrative Region has not adjusted to current interest rates, which has insulated borrowers from reality somewhat, however more distressed sales are expected.
Interest rates have held steady globally in recent months, suggesting a more stable outlook for 2024. However, CBRE’s Chin warns a lack of repricing – which means Asian property yields remain below borrowing costs – will make Asian assets less attractive to buyers in a recovery. “Markets where prices adjusted quickly will bounce back more quickly compared with Asian markets which have not repriced.”
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