Private Lenders Wearing The Risks

Private lenders are wearing the risks again as debt markets in Australia begin to tighten in the property space, it is causing something of a vacuum, or void in the lending space. This void has been filled – with gusto – from foreign investment firms and wealthy individuals looking to capitalise on the skyrocketing property values in Australia.

But competition is the oxygen that fuels the fires of capitalism and those voids are now becoming crowded with independent lenders and other financier products that are designed to aid those looking to make money on the booming Australian property market. 

The underlying concern of the level of international investment has perhaps been a catalyst for Superannuation funds – flush with cash – are keenly keeping an eye on analysts’ assessments that there is not likely to be a shortage on apartments any time soon. The sky, as they say, is the limit

So, like The Beatles, being in the right place at the right time, all the ingredients are there for alternative finance products to emerge and lenders to make a silent killing on the Australian property market.  

property investment

It is a curious thing that over years of hindsight, we can become slightly complacent in understanding the causes and effects of events that send ripples across the globe. Economically, the recession of 2008 was caused by the US banks “over extending” themselves in their lending to individuals who simply did not have the means to pay back their loans. 

The difference between a recession and a depression quite simply is the economic impact on a country’s GDP, unemployment and “confidence” in spending money. Whilst 2008 didn’t qualify as a depression, it certainly gave the global economy palpitations that it is still reeling from, and there are many analysts who still feel Australia hasn’t been hit with this economic tsunami, yet.

Now, confidence is starting to return to global markets and whilst the banks are licking their wounds and not lending with the frivolity of the Bush-era, many independent lenders are positioning themselves to capitalise on an upturning market.

The commercial real estate lending sector in the US is a multi-billion dollar industry – with the equivalent amount in debt to match it. Private trusts and hedge funds are seeking $42 billion (AUD) for commercial property debt.

These types of firms are more nimble than the sluggish banks in their lending protocol, and are looking to leverage this point of difference. This is a mutually agreeable situation for the banks who are still smarting from the fiasco of 2008 and don’t want to touch anything that has even the smallest amount of risk.

“These guys aren’t scared of an empty building,” said Steven Delaney, an analyst with JMP Securities LLC. “These are the loans banks don’t want. There is a tremendous opportunity and a need for commercial-property owners for more types of financing than the commercial banking industry as a whole is willing to provide.”

In the last year alone, the capital being sought by private equity funds has jumped by 40 percent (source: Pregin Ltd) whilst banks are still avoiding anything remotely risky, in the face of economic growth.

In short, as the global economy slowly drags itself out of the quagmire of a recession, the people that helped accelerate that recession – the Banks – are shying away from any lending that has any risk associated with it.

sydney property

This “once burnt, twice shy” attitude is not wholly due to the banks adopting a sense of caution to what is a potential investment “bubble” but rather it is a reactionary response to the Office Of The Comptroller and the Federal Reserve bodies repeatedly flagging the potential for the property marketing to collapse again.

Paradoxially, companies that were thought to be immune to collapse back in 2008 (Lehman Brothers springs to mind) because of their sheer size are not the ones that are prepared to take on these new risks. Private equity funds are weighing the risks up and have been dipping their toes back in the water over the last few years.

It is an attractive scenario for “Private Money” to adopt the risks associated with lending to what can be a very volatile industry because any losses can be self-contained; “We would lose our money and our investors’ money. It’s not systemic.” Said Scott Rechler, CEO of RXR Reality, a firm that owns about $15 billion real estate in New York, New Jersey and Connecticut.

What is interesting in the post-recession world of lending is that the Banks are now more protected from heavy losses than they ever have previously been thanks to the private equity firms being on the frontline. These firms can absorb much of the losses if a project fails before the tsunami reaches the banks’ coffers.

This has not stymied the banks being agreeable to lending to Private Funds, indeed this sort of lending exhibited one of the fasted growth-rates ever seen rising by almost 23 percent (about USD $41.2 billion) in the last quarter of 2015.

This is playing into the hands of private lenders since they enjoy a much more liberal stance in terms of regulatory stipulations, a luxury that the banks no longer have thanks to the disaster of 2008.

There are “capacity issues when your Office of the Comptroller of Currency is staring at you the whole time,” Barry Sternlicht stated on a conference call with analysts last month. “We like them to keep staring. That’s fine with us, and we want to be a beneficiary of this climate.” Sternlicht, is the CEO of Starwood Property Trust, a Connecticut-based mortgage REIT.

The increased flexibility in their ability to offer loans does not make the non-banks immune to the risks involved however, and as the banks pull away from construction projects due to the tightening of regulatory standards, many private funds are exposing themselves.

New York is in the midst of a construction surge and lenders like Blackstone and Sternlicht’s Starwood are absorbing much more risk than any banks are willing to do. Whilst the dividends are obvious if all goes well, sometimes things do not. Indeed, Blackstone, exposed itself significantly when one developer was looking like they would default on a $285 million dollar loan for a condominium being built in Manhattan. A deal was struck with China’s SMI USA to buy extra time to secure a construction loan for the Central Park tower, slated to be New York’s tallest residential building and Blackstone dodged a mighty bullet.

new york property

Blackstone declined to comment on this turn of events, as did the developers, (Gary Barnett’s Extell Development Co) but one can’t help shake the déjà vu that lenders, now the non-banks, are over-reaching again in terms of what they can comfortably loan out. An observation that is always lost on the spokesperson(s) offering clichés to the press about “low rates” and “good growth”.

And it is not just the loans into the hundreds of millions that cause ripples. Smaller loans are just as problematic. Apollo Global Management recorded a USD $15 billion loss from their loan division thanks to a plunge in rental prices in Williston, North Dakota. The rents have dropped on the back of a drop in crude oil prices, an industry that Williston is firmly entrenched in thanks to its involvement in shale drilling

The general feeling among the smaller firms (the non-banks) is that they can underwrite large loans that the banks cannot match because they assess the risks internally and are not straightjacketed by the regulations imposed on the banks.

The good thing, from the standpoint of a national and global economy is that the risks undertaken by these sorts of private lenders, while they are significant, are unlikely to have the domino effect of toppling century-old financial institutions should they default. The damage will simply be self-contained to their own shareholders and subsidiaries.