Jonathon Pullin – Portfolio Manager
Over the past decade, the landscape of commercial real estate lending in Australa has undrgone a structural transformation. But not all of the commonly believed truisms that result hold water, argues Barwon Investment Partners’ Jonathon Pullin.
According to commercial real estate services and investment firm CBRE, non-bank lenders have expanded their share of the commercial credit market from around 4 per cent in 2016 to approximately 16 per cent by early 2024, as authorised deposit-taking institutions (ADIs) have stepped back from 96 per cent to 84 per cent of the market over the same period. Although difficult to accurately measure, CBRE more specifically notes that the non-bank share of the commercial real estate credit market has more than doubled, to approximately $43 billion, or roughly 9 per cent of the total market for commercial real estate credit.
The shift has been largely driven by tigther regulatory scrutiny following the GFC and the Hayne Royal Commission. Together with an ongoing demand for credit, these factors have created a growing cohort of borrowers underservedby the major banks. Initially, this environemnt allowed non-bank lenders to write high-margin loans to high-quality real estate developers and invstors, attracting substantial capital inflows and spurring the growth of new entants. These entrants include a diverse mix of private credit funds, asset managers, mortgage REITs, insurance companies, family offices, and fintech platforms. For investors, this also introduced a broader range of yield-bearing investments, appealing to those seeking stable, income-based returns.
However, as competition has increased, we have seen a gradual decline in underwriting standards in some areas of the non-bank market. Many lenders have taken on higher-risk positions by funding lower-quality borrowers, expanding their first mortgage exposure to construction projects, and easing covenant requirements (such as the loosening of loan-to-value ratio, or LVR, limits). Lenders adopting these measures have done so to maintain loan volumes in the face of strong cash inflows, and to offset the pressure from shrinking profit margins. While data in this segment remains opaque, Barwon’s observations suggest a softening in average credit quality across the non-bank market. Furthermore, despite a growing propensity to take on risk, the investment returns in these products have not appeared to increase commensurately, which implies a degradation in risk-weighted returns.
Meanwhile, the narrative that banks have meaningfully withdrawn from commercial real estate or corporate lending appears to be overstated. According to KPMG, the major Australian banks grew their loan books by 5.7 per cent in 2024, with business lending growth outpacing that of consumer lending. Importantly, this expansion has not been accompanied by a proportional rise in expected credit losses, an indication that credit quality remains robust within the banking sector. Furthermore, we have more recently observed a material increase in competition from bank participants across most real estate sub-sectors, particularly in relation to the provision of construction funding. We expect this will further impact on the competitiveness of many non-bank funders who have leaned into construction lending to deploy capital. This may also amplify the necessity for these groups to adopt riskier underwriting measures.
In Barwon’s Real Estate Credit strategy, our investment philosophy reflects this reality. We recognise that banks remain particularly active and competitive in the construction phase of real estate developments and in the provision of longer-term investment loans secured by established income-producing assets, as these loan types align closely with their underwriting standards. Rather than compete in these spaces, we focus on segments where banks are structurally less present. In our first-mortgage strategy, this means providing funding during pre- and post-construction stages to experienced and well capitalised borrowers. This can include funding secured by well-located development land, residual stock, and commercial assets trading-up to stabilisation. This philosophy also underpins our mezzanine debt strategy, where avoiding direct competition with banks allows us to build complementary capital relationships that create a consistent flow of high-quality transactions.
In an increasingly crowded and competitive lending environment, discipline matters. Our commitment to quality over quanity ensures that our portfolio is protected from the dilution of credit standards we are seeing across the broader non-bank commercial real estate lending landscape. As the market continues to evolve, so too will our approach to ensure we’re extracting what we believe to be the highest risk-adjusted returns across commercial real estate debt.
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