Real Estate funds have learned leverage lessons of GFC

Mike Taylor

Managing Editor/Publisher, Financial Newswire

11 January 2023

Australian real estate funds are better positioned to cope with continuing market challenges than they were in the lead-up to the global financial crisis (GFC), according to an analysis by research and ratings house, Zenith.

The latest Zenith Real Asset sector report suggests that there is unlikely to be a repeat of frozen property funds which were a feature of the GFC because property funds have kept their leverage within sensible limits.

“Overall, Zenith considers the level of leverage across its Australian Property peer group to be sensible and managed appropriately,” the sector analysis said. “We highlight the substantial headroom available to bank covenants which provides a buffer to a reduction in net income, increases in interest costs and potential falls in asset values.”

Looking at gearing levels, the analysis suggested that the property funds had plenty of “headroom” before they were likely to hit trouble.

“Similar to our LVR testing, Zenith analysed the fall in asset values required for the Real Estate – Australia peer group to breach their respective gearing limits, all else being equal,” it said. “As evidenced in the chart below, we can see there is ample headroom to gearing limits across the peer group. Asset falls required to breach these limits ranging between 25% and 78%.”

“There are limited avenues to reducing gearing, either through equity inflows (which can’t be relied upon), through asset sales or cutting expenditure or fund distributions. In normal market environments, managers close to their gearing limits will be limited in their ability to acquire assets, implement capital expenditure, or may need to consider the disposal of assets prematurely or without realising the full value. In a market downturn, managers with healthy headroom to gearing limits will maintain greater flexibility and are less likely to be forced into undesirable actions such as asset sales.”

“We believe that gearing levels remain moderate from a historical context, with the average gearing level across Zenith’s Australian Property peer group significantly lower than industry ranges pre-GFC. In the event of downturn, this puts the current peer group in much stronger position.”

“Overall, Zenith consider the current peer group to be managing their balance sheets appropriately. We consider the high headroom to lending covenants to be prudent and see the overall gearing to sensible and low relative to history and in keeping with current conditions.”