Spreads on Australian commercial real estate debt have widened materially over the past eighteen months. For investors, the temptation is to read a higher headline rate as a better deal. Usually it is the opposite: the rate has moved because the risk has.
What repricing actually tells you
When a lending market reprices, three things are usually happening at once. Banks retreat from a segment, so borrowers who would previously have been funded at bank pricing arrive at the non-bank market. Construction costs and holding costs rise, so feasibilities that worked at the old numbers no longer do. And exit timelines lengthen, so facilities written for twelve months need eighteen.
Each of those pushes the quoted rate up. None of them make the loan better.
Where the protection sits
In private credit, the return you are quoted is the compensation for risk. The protection is somewhere else entirely: in the security position, the loan to value ratio, and the credibility of the exit.
Security position is the one that matters most and gets discussed least. A first-registered mortgage means the lender ranks ahead of everyone else if the asset has to be sold. A second mortgage at a higher rate is not a better version of the same thing: it is a different instrument, and in a downturn it can be the difference between a delayed recovery and a total loss.
Loan to value ratio determines how much the security can fall before capital is at risk. The relevant question is not what the ratio is at settlement, but what it becomes if values fall ten or fifteen per cent and the asset takes twice as long to sell as planned.
The exit is what repays the facility. A dated, contracted exit is worth considerably more than an intention to sell into a market that may or may not be there.
The questions worth asking
- Is the loan in first position, and is that registered?
- What is the loan to value ratio, and against whose valuation, dated when?
- What is the exit, and is it contracted or intended?
- What happens if the exit is six months late: who funds the interest?
- Has the manager lent against this asset class through a downcycle before?
Our position
We lend against Australian real estate at conservative loan to value ratios, with a general limit of 75% for mortgage secured lending, and every loan goes to our credit committee. We decline more transactions than we write. In a repricing market that is not a conservative posture: it is the only one that makes a target return achievable.
This article is general information only. It does not take into account your objectives, financial situation or needs, and it is not a recommendation to buy or sell any financial product.