You are now leaving Centuria Australia
and entering Centuria New Zealand.
by Stuart Wilton and Doug Hoskins, Co-Heads, Unlisted Funds
From the morning newspapers to dinner table chatter, it’s hard to escape discussion of interest rate rises. Largely, interest rates affect the cost of borrowing money. In commercial real estate markets, there are three rates we pay attention to, cash rates, swap rates and bank credit margins.
The Reserve Bank of Australia (RBA) sets the cash rate, which is the interest rate on unsecured overnight loans between banks. It serves as a benchmark, which money can be lent or borrowed in financial markets and has a significant impact on mortgage and deposit rates, as well as Australia’s currency exchange rate.
Swap rates refer to the interest rate that a lender sets in exchange for locking in debt for a fixed rate for a period of time, which reduces its exposure to variable rate movements.
Put simply, the bank credit margin is the difference between what financial institutions borrow at and what they lend at. It’s what we pay the bank for the debt.
When individuals or businesses borrow money, the interest they pay is the swap rate (fixed) or the variable rate (floating) – or a combination of the two – plus the bank credit margin. In May 2022, the Reserve Bank of Australia increased the cash rate for the first time in 11 years, which has now risen from 0.10% to 1.35%. As a result, this has had a significant impact on the cost of borrowing and the debt market’s future expectations around inflation
Typically, each time a Centuria unlisted fund acquires a property (whether a single asset or multiple assets) approximately 50-60% of the cost is funded with equity – the collective amount of money raised from investors. The remaining 40-50% is funded with debt. Therefore, if the cost of debt increases then this, in turn, affects the price a fund can pay for an asset and the distribution (return) it can pay to investors.
For example, in August 2021 the single asset unlisted fixed-term fund, Centuria Government Income Property Fund, secured a three year swap rate at 0.60%. Today, a three year swap rate is around 3.70%, meaning the total interest cost increased by 3.10%.
Our current view is that swap rates are currently overpriced, which is an outlook shared by a vast majority of Centuria’s lenders and economists. This is evidenced very clearly in where the current swap rates are trading versus economists view on the terminal cash rate.
For this reason, Centuria is now looking at alternate strategies to manage interest rate volatility and fund performance such as larger buffers and contingencies on refinancing assumptions and interest rate forecasts. Our priority remains funding with the most competitive cost of debt capital in order to optimise fund performance and we will continue to regularly monitor interest rate exposures and update our investors accordingly.