Problems bubbling away in real estate market

In Australia banks are conservative in their leverage financing and the property loans are concentrated with the top four lenders.

Oaktree Capital Management’s head of Australian real estate, Ben Coughlin, had some interesting things to say at the Turnaround Management Association’s annual conference at Crown Sydney. He described the state of the US credit markets as very capital constrained and fragmented.

“My colleagues in the US believe it is the calm before the storm,” he said. Of particular concern was the community and small bank market, comprising about 5000 banks providing 50 per cent of credit in the US.

There were 4600 that had about 25 per cent of real estate exposure on their balance sheet and a combined $US1 trillion of real estate at a time the market is down about 30 per cent and the office property market about 50 per cent. Leverage was higher in the US, where 70 per cent financing on assets was not uncommon.

Situations can occur where there is no equity left and no recourse, with the owner walking away and throwing the keys to the banks.

Coughlin said the better banks were working with borrowers and giving them time so they did not wind up with too many keys at once.

However, Australia was a contrast, where the banks were far more conservative in their leverage financing and the property loans were still very concentrated with the top four lenders. Their books were clean.

They had given ground on project and construction financing, and he suspected that is where there were going to be problems as they were picked up by other lenders.

He added that with more liquidity coming into the market there was a creep to higher levels of leverage or sharper pricing.

Australia had a golden period for private credit and increasing capital flows into the real estate markets, but now there was a move towards investment in an equity that may be 30 per cent cheaper than it was a year ago.

Yet raising capital could be hard for listed real estate stocks, with equity investors still suspicious about book valuations and that companies were marking down assets enough.

While asset values had come off 9 per cent, and “the air was being let out of the tyre slowly”, on the direct market, discounts were far steeper.

Listed groups would argue a lack of transactions made it hard to provide an accurate valuation.

He said the answer was likely it was somewhere in between.

Unless groups marked down assets, they would not be able to raise capital.

Open ended funds subject to redemptions were more vulnerable to distress, he said, adding that freezing redemptions and selling assets were very blunt tools to deal with the matter.