The cost of borrowing is one of the biggest issues facing owners and developers of commercial property right now, with the unprecedented run of interest rate increases restricting lending options for many developers and investors.
CBRE directors Alex Nikolaou and Richard Zhao, who lead CBRE’s New Zealand debt advisory and structured finance team, say the market’s expectation for the official cash rate to peak around the third quarter of this year looks fairly likely.
“The question on everyone’s lips is when we will see the Reserve Bank complete the current round of monetary policy tightening. Despite the latest CPI inflation figures coming out at the lower end of expectations, inflation remains stubbornly high, so we’re expecting another increase, possibly two, before the OCR peaks in late 2023,” says Nikolaou.
“Inflation coming in below expectations is definitely positive news, but we’re not convinced it will slow the Reserve Bank’s OCR pathway. The short term focus will be on non-tradeables and labour market reports; including low unemployment rates and wage inflation, which are driving ‘sticky’ inflationary pressures. The upcoming Budget may also add fuel to the fire.”
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While an end to the aggressive series of rate hikes by RBNZ may be in sight, a decrease in the OCR is a much more distant prospect, Zhao says.
“The Reserve Bank will hold the OCR steady for some time before considering any cuts. Inflation remains well above the target band of between one and three per cent and the bank wants to see inflation firmly stabilised. Therefore the OCR will likely remain high until recession is firmly entrenched and property prices are holding steady, at which point the bank will be comfortable with beginning to gradually decrease the OCR. In our view that will not happen for another 12 to 18 months.”
The fact that the yield curve is showing signs of flattening, longer term interest swap rates (ie, base rates) did not move significantly following April’s OCR increase of 50 basis points. This also demonstrates the market pricing in an upcoming end to interest rate increases.
Swap rates for terms of two years and beyond are currently sitting below the OCR, presenting an opportunity for some borrowers seeking longer term debt. The three year swap rate has reduced from 5.12% in early March to 4.62% for the start of May.
When the OCR will eventually bottom out, and at what level, is also hinted at in long term rate expectations. Westpac’s latest estimates show 10 year government bond yields settling at 3.50% around the end of 2024, with the OCR bottoming out at 3% in June 2025, says Nikolaou.
“We’re expecting the OCR will stabilise to between 3% and 3.5% over the next three years. Current long term swap and government bond rates suggest the Reserve Bank’s future easing, likely triggered by a ‘hard landing’ recession.”
Commercial property developers frustrated by the unlikely prospect of any short-term relief to the current high cost and restricted availability of bank lending are increasingly turning to alternative funding sources, says Tim Rookes, managing director of CBRE’s Christchurch office.
“A number of international non-bank lenders have entered the New Zealand market recently, leveraging an opportunity in a market where restricted mainstream bank lending is a major issue for many developers looking at getting projects out of the ground.”
While the major banks’ appetite for risk remains relatively subdued over the next 12-24 months, the alternative lending market is expected to grow further, with more local and international lenders entering New Zealand, Rookes adds.
“Some of these lenders have a higher tolerance for risk and are willing to look at funding a wider range of projects in the local market, albeit at a higher cost to borrowers. However, many alternative lenders are also proceeding extremely cautiously and demonstrating a low risk appetite in the current market.”
The challenge in this environment is finding solutions for clients looking to commence property development projects, Zhao says.
“It’s definitely more challenging to get deals across the line at the moment, whether it’s with alternative lenders or banks, while lenders across the board are looking to minimise their exposure to construction and settlement risk.
“The silver lining is that New Zealand’s historically higher cost of funding as compared to other mature debt markets has enhanced its attractiveness for offshore lenders and is directing their investment to our shores.”
As more clarity emerges around the interest rate outlook, the market is expected to accept softer property cap rates and embrace new lenders. More transactions will then occur as borrowers begin to accept the current environment, he says.
- Article supplied by CBRE
