Interest Rates, Inflation and the impact on Commercial Real Estate – what should you pay attention to?
Part 1: The Interplay of rates, inflation and real estate On the first Tuesday of November at around 2.30pm each...
The August RBA meeting saw rates on hold for the 8th consecutive month, with the cash rate target having been at 4.35% since November 2023.
It wasn’t too hard to predict, given the most recent inflation reading which showed CPI rose 1% during the June quarter and of 3.8% over the year. However this has not stopped some economists from calling for a further rate increase to address inflation that has been outside the target band for 11 consecutive quarters.
Though, did you know that Australia has actually been in a per capita recession since late 2023? Immigration growth has been the key factor in preventing the economy from actually dipping into recession, but a further rate rise may well tip the economy into a proper recession.
Should commercial real estate debt investors care about the cash rate target?
Yes, and no.
Yes, insofar as investors should be seeking out returns that offer an appropriate return over the cash rate target for the risk they are taking and compared to other asset classes such as listed equities. Private credit as an asset class, offers lower volatility and almost no correlation to listed markets which can be important in constructing your overall investment portfolio.
No, because we aim to ensure that the return for investors is calculated based upon a credit risk margin over the cash rate target. This credit risk margin or premium takes into account the illiquidity of the loan, complexity which is deal specific (e.g. construction or planning risk) and counterparty risk (how qualified the borrower is to deliver the project on time and budget). This means that no matter the cash rate, we would be attempting to ensure that the return for these risks is sufficient.
On average and depending on aspects such as loan to valuation ratio, the complexity of the transaction, history with borrower, size of deal etc, credit margins are typically around 5% and sometimes as high as 7%.
Rapid and unexpected cash rate increases, such as those we saw between May 2022 and November 2023, can impact this approach since loans are made at fixed rates and it can sometimes take time for the rate rises to flow through to the entire loan portfolio. With this in mind, it can be beneficial to maintain some ‘dry powder’ (cash reserves) for new opportunities and to closely monitor the maturity profile of your real estate loan portfolio.
Corval Avenue Limited ACN 089 265 270 AFSL 238546 (Corval Avenue) is the responsible entity of the Corval Avenue Select Credit Fund ARSN 090 994 326
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