The rapid increase in interest rates in Australia has been the greatest single factor in why Capital Markets transaction levels have experienced a significant downturn the past few years. 

The outlook for the Australian debt market now is that rates will be higher for longer. Forecasts are for some relief, with rates expected to experience a modest drop in the short term. However, at the time of writing, they are forecast to stay above 3.7% for the next five years and are not expected to drop below 4% until Q1 2026. This signals a new, higher rate funding market is here to stay, and the inherent cost of this needs to be accounted for in both asset values and loan structures. 

With values now having corrected significantly, we are reaching a point where buying – even in the higher interest rate environment – is once more making sense, with debt being accretive to returns, and we expect this will lead to higher transaction levels.

Non-banks set to take larger share in funding market

Fundraising for private credit strategies within real estate in Australia has continued to experience year on year growth in arguably the toughest fundraising market in a decade as debt funds continue to provide attractive risk adjusted returns to investors over traditional direct investment. 

Looking ahead, liquidity in the funding market remains strong, however the balance of bank versus non-bank lenders is expected to continue to shift in the favour of the non-banks with their market share becoming more aligned to other western real estate debt markets. 

While non-bank lenders typically have a higher cost of capital and in turn charge higher interest rates compared to bank lenders, they are able to provide higher leveraged solutions, often up to 70% or 80% loan-to-value ratio. 

For borrowers looking to reduce their equity requirement for value-add and development strategies, borrowing from a non-bank at this higher cost makes sense and for lenders, their risk adjusted returns are higher than ever. 

The proportion of non-bank lenders in Australia’s commercial property market compared to bank lenders has shifted from around 5% 10 years ago to around 15 to 20% now. In the US the ratio of non-bank to bank lenders is around 50%-50%, while Europe is around one-third non-bank and increasing. 

We believe Australia is approximately ten years behind Europe on this trend and we expect non-bank lenders to have at least 30% of market share by the middle of the 2030s.

In addition to the anticipated growth of non-bank lenders, we too expect the number of overseas banks active in Australia to increase in the coming years alongside non-banks with core pots of capital, capable of providing lower cost senior debt financing, diversifying this section of the market, historically dominated by domestic banks.

There is a more structured approach to funding in Australia’s commercial property market

Overall, appetite to lend from both banks and non-banks remains strong, however the risk appetite remains subdued compared to the market pre rate hikes. 

For core assets, bank funding is constrained by interest coverage ratios and is particularly impacting tighter-yielding asset classes such as logistics and the living sectors. Similarly in the development market, senior lenders are cautious on exit strategies and future stabilised values, and leverage is being capped with an increasing number of projects requiring additional mezzanine debt and preferred equity to meet total costs. 

What this means in practice is we expect to see more investments and developments to require a more structured approach to funding. Both at the outset and at refinancing with the capital stack requiring a combination debt and third party equity to realise business plans and minimise the requirement for additional sponsor equity. 

The Australian funding market is better placed than ever before to provide these structured solutions and help unlock more transactions in the medium term as the wider market and asset values continue to stabilise.

Related Readings 

US Giant PGIM Real Estate completes first close of new $750m Australian debt strategy 

Alta Partners with Australia's Ray White Capital