To state the obvious, the last few years have seen the market mood go from boom to subdued. Despite this, Scott Keck, Chairman of Property Advisory Firm, Charter Keck Cramer encourages those working in the property industry to stay the course - and hold on tight for conditions to improve.
As part of our regular webinars, we recently hosted a panel discussion on asset valuation trends and financing considerations with highly experienced industry experts, Scott Keck along with Darren Kerr, State Director, Property Vic/Tas at ANZ Commercial Banking and Danny Armstrong, Director Banking & International Business at SW Accountants and Advisors to delve in to current property & economic trends, and explore what this means for lending & risk appetite.
Watch the full webinar HERE, or read on for key takeaways.
Current property valuation trends.
The long tail of COVID is now starting to be felt in business due to high interest rates stagflation and supply chain issues. This has significantly changed the willingness of people across the board to participate in the property industry, which is not to say there isn’t interest - only that it is more targeted and discrete.
Notwithstanding the pause in the market, there is still selective interest. I believe that this pause is not likely to be long lasting as it relates to interest rates and supply chain issues, however it could draw out slightly longer, locally, if the Australian economy gets darker” Scott Keck.
As for the trends around valuations, currently, initial yields and internal rates of return on medium-long term passive commercial/industrial/retail investments are remaining relatively unchanged.
Where the issues are arising in this economic environment is in the risk of income. When undertaking a valuation for mortgage or feasibility purposes, valuers or analysts today are much less interested in the initial yield, and much more focused on income, maintenance of income, vacancy factors, rental growth and recovery of outgoings. Assurance of income reliability is paramount in these situations.
For Residential, both in the land subdivision and built form investments, gross realisations remain stable. The problem for this field is the costs associated with time and delays, and the cost of goods increasing over the time of the project. Therefore, developers need to have a greater alignment of cost of sale, and the total cost of development - staying away from the trap of preselling full lots at one value.
Economic Outlook for property.
- The low apartment supply of late will retain the level of demand and prices in the medium-long term.
- Rapidly rising interest rates may affect presales, values and project feasibilities
- There will be a heightened level of builder insolvency due to supply chain issues.
- Construct and sell / construct and hold continue to outperform given the market growth in this area.
Commercial Development /Investment:
- Interest rates will drive debt capacity (LVR) particular low yield projects (sub 4% net)
- Interest rates will put pressure on values/yeilds, particularly where rental growth is limited
- Greater spread between primary and secondary asset yields
Some specific areas ANZ have a current appetite to invest in are:
- Investment - shopping centres, supermarkets and quality industrial assets.
- Development - residential supported by presales, and construct and hold industrial.
- Land/Pre Dev Sites - up to 60% LVR likely to convert to construction in 12 months.
Key Factors impacting the market currently.
Outside factors such as skyrocketing interest rates (and the uncertainty of when they are going to stabilise), rising inflation and the cost of living, along with natural disasters and world events like Covid and the war in Ukraine are making investors nervous given the lack of control around asset values, borrowing capacity and project feasibilities, so they are becoming much more indecisive.
The outlook however may not as bleak as it first appears, with Darren Kerr stating:
“On balance, with the current low employment rate, high levels of consumer and business savings, and the return of overseas students, immigration and tourism, the impact of the negative risk factors is softened. This drives the view that we are well placed to weather this volatility.”
Interest rate forecasts have been extremely volatile of late, however it is important to realise that when put in a long term perspective we are simply likely to be returning to a normalised cycle. The low rates of the last few years have not been seen since the 1970s and are unlikely to be repeated again.
Scott Keck was confident in predicting that:
“We will get into a technical recession in Q1 2023, in Q2 we will be worried, in Q3 RBA will give assurance that rates will be lower, and finally Q4 will see decreases. The end of 2023 should see more stability around interest rates, immigration, supply chain issues and a return of confidence and certainty.”
Key Financing Considerations.
“Customers must bring a strong balance sheet to the table. Which isn’t purely to do with the value of the asset, but considers a diverse investment portfolio and a level of liquidity. This then allows that balance sheet to be moved around to meet the needs of the business. Simply put, a good balance sheet shows that you will “play within your means.” Darren Kerr
Given the weight changes for different lending parameters, some fundamental considerations are increasingly important:
- The borrower’s experience in the field and ability of the business to manage the financial risk are considered with as much importance as the asset quality
- Banks tend to prefer investment lending to assets with long leases and tenant diversity to ensure certainty of rental income to service the loan
- Quality of financial reporting and asset management are vitally important, and along with a strong consultant team will give confidence that there is the right level of support for the project
- Development lending is available to those customers with experience on a similar scale to the proposed project
- Builder due diligence must be completed to ensure there is no risk of insolvency.
As to where to obtain funding, Danny Armstrong stated that diversification in sources of debt funding is becoming more common, with a number of clients sourcing funds from second tier banks and private lenders in the market. This is ultimately due to the tradeoff between price and conditions and the needs of the client.
“At the end of the day, the big four have very strong balance sheets and the lowest cost of funding, so if price is important to you, you should start with the big four. But due to the market strength, and their ability to pick and choose who to fund, they can apply more significant conditions, whereas private lenders will charge you more but be more relaxed around some of the conditions.”
Factors that drive demand in real estate.
“There is a very obvious and clear correlation between good performance in real estate markets and a strong economy. This comes from demand created by strong population growth” Scott Keck.
This starts with the demand for residential rental properties, moving into properties for purchase, then expanding developments that give rise to the needs for secondary areas of real estate i.e. retail, completed in the longer term with commercial and industrial properties.
Different ages drive the need for different types of real estate. This is shown currently by the rise in demand for townhouses.
Regardless of Covid, more people are working remotely which drives a change in office accommodation demand.
Energy/Sustainability issues will also demand that real estate create change in this sector.
- Long term projections
- Population make up - Projects state that by 2080 Australia's population will be 65% Asian. This will have far reaching effects for cultural and housing implications, particularly in Melbourne and Sydney.
- Home affordability - As it becomes more difficult to purchase homes, there will be a greater demand for rental accommodation.