Real estate debt in Asia Pacific is increasingly cementing itself as an alternative investment class as global investors seek new opportunities to deploy capital into this sector. Tightening lending conditions in some markets, lower level of property yields, and potential rates hike in many markets are catalysts for investors to look for greater debt exposure and creating more transaction activity, according to CBRE. 

There is an increase in the number of investors who are now lending against Asia Pacific real estate assets rather than taking equity positions. The increased interest in this strategy has been influenced by several factors, including a combination of increases in pricing and historically low yields as well as a shortage in investible stock. Additionally, amid a landscape of increasing interest rates by the US Federal Reserve, some lenders in Asia Pacific have adopted a more cautious approach to real estate.

“We are seeing increased demand for investment in real estate debt across the region. Tighter lending conditions in some markets have created opportunities for less traditional lenders, and a number of investors feel there are more attractive risk adjusted returns in debt vs. equity. We see some clients also taking a more strategic medium term position in the capital stack via debt,” says Tom Moffat, Executive Managing Director, Capital Markets, Asia, CBRE.

Moffat told WILLIAMS MEDIA “We believe we will see more lending and partnership opportunities for investors and in China in particular are seeing mid-tier developers and operators looking for investors to provide both debt and equity”

Investor interest in debt is also being supported by a changing composition in the real estate capital stack from the traditional bank loan plus equity format to one where mezzanine finance and preferred equity are rising in prominence. The various types of debt investments available in Asia Pacific are positioned along different points along the risk spectrum, which investors are building into capital allocation strategies.

Sitting at bottom of the capital stack, senior lending is associated with the lowest risk level. While traditionally offered by commercial banks, more non-bank financiers such as insurance companies and pension funds are entering this space – especially so in Australia.

Investors interested in debt strategies in Asia Pacific continue to focus on mezzanine financing and preferred equity. These strategies boost loan-to-value (LTV) ratios or to bridge short-term cash requirements for development projects. In Asia Pacific, activity in this category is being propelled by private equity real estate funds and debt funds.

Specific developments in 2018 include: 

China: 

• New groups looking to increase exposure to the Chinese real estate market given the tightening of traditional domestic lenders. The nationwide deleveraging campaign and the slowdown in residential sales means global investors are gravitating towards development loans, junior and mezzanine debt and non-performing loans (NPLs). 
• Medium-sized Chinese developers are providing opportunities with their growth prospects and attractive returns of 15-20%, boosting investment in mezzanine debt, however, only 40% of the mid-size developers in China are operating with positive cashflows.  
• Opportunities are emerging as national asset management companies and commercial banks accelerate the sale of NPLs.  CBRE estimates the size of the China real estate NPL pool to be worth approximately USD 15 to 20 billion.  

Hong Kong:

• Investment activity remains robust but lower LTV levels by traditional lenders are creating opportunities for mezzanine financing and stretch senior.
• International financiers, sovereign wealth funds and private funds providing mezzanine loans for commercial property acquisitions. Senior loans and mezzanine debt transactions are also gaining momentum, led by offshore sovereign wealth funds.

India:  

• Domestic residential developers continue seeking alternative funding channels as banks tighten the liquidity available for project financing and default rate is increasing.   As a result, developers now prefer to engage with equity partners instead of issuing mezzanine debt.  
• Since 2015, Indian-focused real estate debt funds have raised more than US$ 2.0 billion to provide development debt financing to local residential developers. 
• More recently, international investors are also expanding their exposure in India via debt investment.

According to CBRE, the growing interest and activity around real estate debt in the region and the opportunities available to investors must be caveated with warnings of the various challenges.

“The inevitable maturity of Asia Pacific’s debt market comes with associated risks and challenges typically of an alternative asset class. As most current opportunities in the real estate debt space in Asia Pacific are still in mezzanine debt and development loans, it is critical that investors fully understand the assets they are underwriting,” says Dr. Henry Chin, Head of Research, Asia Pacific, CBRE.

Specifically, sourcing appropriate real estate debt opportunities is the key barrier for investors as the debt market in this region can be challenging to navigate.  Investors should also be aware of currency volatility.  Given the maturity of this asset class, due diligence must be rigorous and involve a thorough assessment of the borrowers’ credit risk.

Despite certain challenges, CBRE anticipates Asia Pacific real estate debt markets to deepen. CBRE Research’s 2018 Asia Pacific Investor Intentions survey published earlier this year found that real estate debt generated stronger interest among investors as the preferred alternative asset class by investors.

Source: CBRE

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