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Lending lessons from previous downturns

Commercial Construction site in Melbourne
5 min read
Significant development will still occur post-COVID, the challenge is to find the most profitable projects. Photo: Shutterstock

Lending lessons from previous downturns

The word ‘unprecedented’ has often been used to describe the events of the past 10 months. But despite its shock arrival and devastating effects, the COVID-19 pandemic is not the first major economic crisis to significantly impact the Australian property market and it won’t be the last.

The word ‘unprecedented’ has often been used to describe the events of the past 10 months. 

But despite its shock arrival and devastating effects, the COVID-19 pandemic is not the first major economic crisis to significantly impact the Australian property market and it won’t be the last.

Although the current global recession is certainly the worst I have seen in my lifetime, we are somewhat lucky as an island nation that we have weathered the virus impact better than most other developed countries.

Earlier this month, we watched the Budget handed down by the Honourable Treasurer Josh Frydenberg - certainly the largest spend by any Australian Government in our history, revealing the scale of challenges before us.

The budget focused on a business-led recovery, relying on confidence in business spending to kick-start an economy in desperate need of a shot of adrenaline to weather those challenges.

With a recovery plan hinging on a vaccine roll-out, the uncertainty is giving rise to a lack of confidence that is pervading our current economy and lives.

There seems to be a consensus that the budget measures were necessary to inject confidence into Australian businesses to invest, continue to trade and create jobs during this recessionary period and to be able to survive and participate in the recovery. 

Many parallels can be drawn from the impact of the early 1990’s recession, even more so than the GFC, in which real estate faced a significant downturn. 

Key indicators like increased unemployment, falling CPI and substantially reduced economic activity were the hallmarks of a recession. 

However, back then, there were much higher interest rates, which made borrowing come at a higher cost. The road to recovery was slow.

But while COVID-19 has re-introduced this familiar uncertainty into every market around the globe, we are seeing some opportunities for growth in certain sectors. 

Not surprisingly, we are seeing sustainable land sales in the suburban areas of our major cities. Particularly in Melbourne where there remains an undersupply of housing in the low to middle income earners bracket and a migration to regional Australia in certain areas. 

Other sectors like CBD offices, student accommodation, retail, hospitality and tourism are substantially down as a direct result of COVID-19. These are distinctive differences to earlier recessions brought on by the pandemic.

During the GFC, Australia’s major lenders retreated conservatively, sending interest rates up and causing a significant drop in the availability of credit. 

Over time, this accelerated the recognition of alternative lenders as viable market players, and very soon we were on our way to recovery, led by a construction boom from 2013 to early 2018.

We are seeing a similar opportunity now for private and institutional capital investors that underpin the non-bank lenders to capitalise on the opportunity to again grow market share and position themselves for the recovery – so long as they are able to navigate the unique risks posed by each real estate sector and apply a high level skill set to assessing these opportunities.  

As the banks reduce their exposure, analysis from Plan1 has indicated that non-bank lending is expected to hit $50 billion by 2024 in commercial real estate.

A sector-specific approach is key

COVID has posed some unusual obstacles - for example, earlier this year we couldn’t get valuers out to properties, and have only recently seen more accurate post-COVID valuations. 

But there’s no doubt that prices have fallen - particularly in the hospitality, CBD office, discretionary retail and tourism sectors.

With JobKeeper easing, it’s right to be asking if now is a good time to be jumping on these low prices, or waiting out the storm.

If there’s a cure for COVID-19, which most people believe and governments around the globe have indicated will likely occur, then most sectors of the real estate markets in Australia are expected to rebound significantly and quickly - with the caveat that some companies are now more comfortable with remote work and may retain a reduced footprint and overheads. 

We’re also expecting a transition into inner-suburban and fringe offices as people choose to work closer to home. 

It may well be sometime before borders open up properly and we can host international visitors, so this will impact across those sectors linked to foreign investment and tourism.

Despite the pandemic-induced economic downturn, there is strong potential across real estate sectors less affected by the pandemic - like residential where we continue to be underbuilt as a nation, where we’re seeing a swing to the local buyer, and more specifically owner-occupiers.

Staying cautiously optimistic

Over the last two months, local financial institutions who had pulled out when COVID-19 first hit are now returning to invest in Australian real-estate. Similarly, we’re seeing an influx of international funds like Goldman Sachs and Blackstone returning to action.

The concluding statement by the Deputy Governor of the RBA late last month stated that “the Australian and the global economies have undergone historic contractions as a result of the pandemic. 

We are now in a gradual and uneven recovery. The recovery is being supported by sizeable fiscal stimulus, particularly in terms of income support for households and business. 

With ongoing financial support from the Australian Government and the intended co-investment from the private sector, Australia’s road to recovery seems to be slowly on its way.

Capital preservation must be our main focus

Last month, major developer Jonathan Hallinan said that while access to debt is improving, finding the most profitable projects will be the real challenge over the coming months.

With some projects we are seeing construction delays due to border closures, import standstills and workforce restrictions, which mean that assets will need to be carefully managed, and all possible eventualities considered on new projects.

The current liquidity credit squeeze actually gives investors more of a choice over where their funds are placed.

It’s essential that lenders are assessing the risks associated with each property and sector pre and post COVID so that risks are managed appropriately, and capital is retained, and everyone benefits.

Partnering with lenders who have a long track record and deep understanding of real estate trends is essential here. 

Combining property nous with proven financial expertise is a crucial element to investing in the Australian property market right now and effectively preparing for the inevitable market turnaround that’s to come.

Access to large capital and the ability to be agile when assessing the right investment, especially during a volatile market, provides project opportunity for borrowers and investment return confidence for investors.

Markets change, they always have. We have first-hand experience of that – the key is being highly selective during the downturn. But in today’s globalised marketplace, news is immediate. So, when the uptick comes, it will be dramatic. Now is the time to be finding the right investment manager/partner and making a plan.

 

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