The recent U.S. banking market volatility has led to concerns around the cost and availability of credit for commercial real estate in Australia. We have stress tested stock specific financing risks – including REITs with U.S. Private Placement exposures – across our portfolio and believe our holdings are well capitalised to fund future developments and acquisitions. In addition, we continue to assess the risk of contagion across the banking system and the implications on commercial real estate markets more broadly, although we believe that the temporary injection of liquidity into the U.S. system via the Bank Term Funding Program has significantly reduced this risk.
A reduction in commercial real estate lending has been on the cards for a while in the U.S., although like in Australia, the listed real estate sector is mostly financed with a diversified and long-dated pool of debt instruments. From our perspective, the situation in the US appears to be focused around private / non-institutional borrowers (who typically borrow with higher leverage / floating debt) or suburban office investments (which have been hit by working from home thematics and significant devaluations). We believe a similar situation in Australia is likely to slowly unfold, however, the institutional market will be relatively resilient due to REITs’ better negotiating leverage with their financiers. We have continued to maintain our substantial long-term underweight to the office sector in anticipation of significant devaluations to redundant stock within the sub-sector.
Overall, we would note that AREITs are in a much better position compared to during the GFC, with low average gearing of 26% (compared to 40-45% during the GFC) and the source of debt is much more diversified and well hedged at >60%. Only 10% of AREIT debt across the large caps expires in the next two years, and interest coverage ratios are expected to be maintained at >4.0x moving forward. When you combine all of these factors, the majority of AREITs are therefore well capitalised to fund any committed developments, dividends, and near-term debt expiries, so the need to issue dilutive capital raisings at a discount to NTA is limited.
From a macro perspective, 10-year bond yields in Australia have come down significantly from their peaks a year ago, which should see support for the sector, particularly the REITs that have been oversold.
