BNZ’s General Manager of Property Finance talks about interest rate effects, new green building standards and signs of recovery in the commercial property sector | Content partnership
Commercial lending in the current economy has its challenges. As BNZ’s General Manager of Property Finance, Phil Bennett is responsible for all the bank’s commercial real-estate lending, from setting the strategic direction to the team’s various policy and risk appetite settings. Newsroom asked him for his view on the market and his mid-winter predictions.
What’s the impact of interest rates? You can’t have the official cash rate (OCR) go up by 500 basis points and not expect there to be an impact in terms of people’s ability to service debt. A substantial part of all banks’ lending portfolios will now be failing to meet their covenanted debt servicing requirements. No one’s in default, but the reality is that interest rates are likely to stay at around these levels for the next couple of years. The challenge is that property owners and investors can’t increase rents by that amount. On your average three-to-five-year lease there will be rent reviews, but even with a standard clause linking rent to the consumer price index, owners will have to ask themselves what they can afford. Of course, any reduction in net revenue will affect the property’s value. For any customers finding things tough, our advice would be to get in touch as early as possible to explore possible support options.
What trends do you see in general? There continues to be a flight to quality property, a drive for greater sustainability and the need to attract hybrid workers. Nothing’s changing there. Owners have to safeguard the value in their assets by continually upgrading facilities, selecting strong tenants who are seeking to reduce emissions themselves, and increasingly making the commute to work worth it for the hybrid worker.
What should we expect in the medium to longer term? For some customers, interest rates could force capital recycling and they’ll need to consider whether it’s time to exit. If a property can’t command the required rent and in effect becomes a secondary asset, it could be time to sell. Banks will look to support customers with buildings in the right asset class, but owners will need to demonstrate the ongoing performance of the building.
What about asset revaluations? Generally, banks will require a revaluation every one to three years depending on the property and its ownership (for example listed funds versus small off-market investors) to ensure that banks’ 65 percent prudential ratios are maintained. Many properties in the BNZ and other banks’ portfolios are about to be revalued at current market rates.
As a rule of thumb, a building’s yield should be 2 percent above the risk-free interest rate (a bank 12-month deposit or 10-year-bond). So if the rate today is 5.7 percent, the yield or rental returns should be 7.7 percent. That’s fine in a low interest rate, strong market environment, but what if new revaluations come in low? That pushes the 65 percent loan to value ratio (LVR) out of whack and may mean owners need to present to their banks a case that demonstrates how they can improve revenues or reduce their exposure. There could be conversations about the need for rent reviews and other options. There’s a real likelihood that as valuations come in, they will come in lower than two years ago.
What will new green building standards mean? For valuations to stay high and commercial LVRs to be met, some property owners may need to demonstrate improved environmental efficiency. The bank has its own standards to achieve, and these will have a trickle-down effect on suppliers and customers. Since the start of this year, BNZ and about 200 New Zealand financial institutions and large listed companies have been required to publicly report their climate risk or exposure under the Financial Sector (Climate-related Disclosures and Other Matters) Amendment Act. This will ultimately influence businesses choice of partners, suppliers and customers.
To help drive sustainability and reduce the emissions footprint, the Government has proposed amendments to the Building Act to be phased in from 2024, mandating energy performance ratings on bigger scale commercial, public, and industrial property, along with large multi-level apartments, and requiring a waste minimisation plan before any remediation work is undertaken. In the same vein, the Government is investing to decarbonise industry. The ‘GIDI: Commercial Buildings’ fund is managed by the Energy Efficiency and Conservation Authority and seeks to replace fossil fuel boilers used for space and water heating in commercial buildings with heat pumps.
These new regulations will drive increased cost, but that in turn drives net positive returns. Bayleys says the impact on value of upgrades is very positive, with recent statistics suggesting an increase in rental income of 3 percent to 13 percent, enhanced yield return, higher occupancy and retention, and lower operating expenditure.
Are there any signs of recovery? I think the OCR will drop by 2025. Net migration is increasing, new housing is still badly needed and there’s now capacity in the construction sector. Combined with what appears to be a resolution of supply chain issues there are some “green shoots” emerging. I think the time is right for developers to get their toes back in the water. That will require fixed costs and pre-sales and banks will continue to support proven operators in this space. The massive pipeline of infrastructure projects which are being heavily competed for provides a positive backdrop for improvement.
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