Lenders wary of construction insolvencies: Brokerage

Commercial property finance brokerage Stamford Capital released the results of its annual Real Estate Debt Capital Markets Survey on 15 May and said that the introduction of NSW’s construction company star rating system has impacted lender turnaround times and loan approvals.

The Independent Construction Industry Rating Tool (iCIRT) is a market surveillance tool that was brought into effect by the NSW government in 2022 and ranks construction companies on a scale of one to five based on factors including capability, conduct, capacity, and capital.

Stamford Capital surveyed more than 100 lenders (including major banks, non-banks, private lenders, and foreign lenders) in April 2024, with the majority of respondents operating in NSW (40.95 per cent). Construction lenders made up 83 per cent of respondents.

The survey said that a third of lenders had taken iCIRT ratings into account or planned to in 2024 when assessing a loan application. Of those that considered the iCIRT rating, 43 per cent of lenders said they had rejected a loan due to a low rating.

The Australian Securities and Investments Commission (ASIC) insolvency data (released in April) said that 2,142 construction companies went into external administration in the nine months to 31 March 2024, making up 27.7 per cent of all company failures in the period.

Stamford Capital said that rising insolvencies and increased construction costs had led to lenders taking a “more rigorous approach to due diligence” for construction loans.

Due to improved due diligence (including improved scrutiny and stress testing), banks and non-banks have had delays in the application process, with the survey revealing a 53 per cent increase in application times compared to two years ago.

The managing director of Stamford Capital, Peter O’Connor, said that construction insolvencies had been a significant issue for the industry. He said: “Builder insolvency has been a huge issue for the industry to contend with and while lender appetite remains strong, there is a lot more caution.

“NSW’s iCIRT has removed the guesswork, minimised risk, and delivered greater certainty for both lenders and buyers in NSW and sets an enviable benchmark for other states to follow.”

Tight lender margins limiting affordable housing

As construction costs rise, Stamford Capital said that lenders were less likely to back loans that delivered affordable housing due to tight profit margins. Stamford Capital’s report said that almost half of the respondents (49 per cent) believed that increased construction costs were the biggest barrier to delivering affordable housing.

A further 30 per cent of lenders said that land use regulation and planning was the most significant barrier, followed by the cost of capital (9 per cent).

Stamford Capital said that lenders have been leaning towards luxury residential lending as a result of heightened construction costs, mostly catering to empty-nesters and downsizers rather than first home buyers.

O’Connor said on the impact of margins on affordable housing: “From the lending perspective it is hard to see when the housing crunch will ease.

“Fundamentals simply don’t stack up to develop new residential stock suited to entry-level buyers in our major capitals. As a result, the pipeline continues to focus on more high-end product, with premium pricing – leaving first home buyers with little choice.

“Luxury residential sales tend to flow differently, with most buyers waiting to view completed stock or sell their family home. If lenders want to deploy their capital and grow their loan book, they likely need to compromise on presales. Again, a contractor rating system like iCIRT can help increase the certainty of the development outcome here.”

Lenders planning to increase loan books in 2024

Stamford Capital’s survey said that 90 per cent of respondents are planning to increase their loan book this year, with almost half of respondents expecting a growth of more than 15 per cent.

The report also said that 67 per cent of respondents expect non-banks to increase their construction lending, compared to only 33 per cent of respondents who expect major banks to expand in this area.

The majority of respondents (64 per cent) also expect non-bank lenders to increase their investment lending, compared to the 42 per cent of respondents that expect major banks to increase their investment lending.

Stamford Capital said that the increase in lending was most notable in non-banks, due to an increase in private capital, while banks have been cautious due to hiking interest rates concerns relating to interest coverage ratios.

The brokerage also expects non-banks to increase in “scale and market share”.

O’Connor said on the growing presence of non-banks: “Our experience mirrors the global trend with non-banks[’] presence continuing to grow. In the last financial year almost 80 per cent of our transaction volume was with non-banks. This reflects a sharp increase from 2021, when it sat at just 44 per cent.”

[Related: Construction loans for new homes at 20-year low: HIA]