Australian Commercial Real Estate Debt and the Portfolio Puzzle in 2025

In a challenging investment market, the Australian commercial real estate debt market continues to deliver strong and resilient returns for investors. As Bruce Wan, Head of Research for MaxCap Group, explains, this makes a compelling case for more investor attention and greater portfolio allocation in 2025.

Looking into our crystal ball, the investment outlook appears as hazy as ever.

While the most pressing concerns of past years – weak growth, high inflation and rising rates – appear to be gradually unwinding, the world is now confronted with new sources of economic uncertainty, notably with a new policy direction in the US, with escalating risks of trade discord and tariff barriers between China and the United States – the world’s two largest economies.

Already, economists are re-assessing their outlooks for the global economy, reducing their growth expectations as increased tariff barriers look set to inflate import prices, impede the flow of commerce, and reduce economic activity. Undoubtedly, there is a lot of uncertainty for investors, as they contend with this Portfolio Puzzle for 2025… Where do we deploy our capital to find pockets of sustained growth, resilient returns, and genuine diversification?

For many cross-border investors, this search is leading them to Australia, which remains an island of stability in a chaotic world. Moreover, many investors are still being drawn into private credit, for its consistent returns and its increasingly vital role in any well-diversified investment portfolio.

What is commercial real estate debt?

In Australia, this is the market segment that funds the acquisition and development of commercial real estate, which includes office buildings, shopping malls, hotels, distribution warehouses, and residential apartment blocks.

For many years, commercial real estate lending has been dominated by a few major banks. However, banks have been structurally retreating from this space, as the Australian regulator steadily tightened capital reserve ratios and increased risk weightings for real estate development, in a bid to reduce the systemic and contagion risks presented by the banks during the Global Financial Crisis.

Consequently, we are seeing a progressive shift from bank to non-bank lenders in Australia. This process has many years to run, in line with the similar adjustment that has already occurred in North America and Europe. In other words, there is a long runway of growth for non-bank lenders from here.
This structural shift to non-bank lending is a positive development from many perspectives. For regulators, a more diverse set of lenders helps to reduce the volatility in the credit cycle and steadies the economy during a banking crisis. For borrowers, there is great value in having greater security of funding, more flexibility on loan terms like leverage ratios, interest coverage and pre-sale requirements, even if it means higher interest margins. For investors, most importantly, there is improving access to a highly profitable set of private credit opportunities, previously only available to a cosy banking oligopoly.

Why invest in commercial real estate debt?

Simply, investors are here for the better risk-adjusted returns in commercial real estate debt, compared to many other traditional asset classes.

The returns from commercial real estate debt have been firm and resilient over a long period of time, sustained through diverse periods of strong and weak economic growth, and high and low interest rates. The mechanics of this resiliency is simple. Robust immigration into Australia across many decades has sustained housing demand regardless of the economic cycle. Meanwhile, investment loans have shown resilient returns across many interest rate cycles, as lenders nimbly pivoted between fixed- to floating-rate loans as rates fluctuated.

For some investors, lending for construction is sometimes associated with a higher degree of risk. However, the realised outcomes in Australia over the past 18 years have been far more benign, in sharp contrast to similar construction lending markets in Asia, Europe and North America. In Australia, this is a market segment that has been very strong on capital preservation.

The reasons for this are often underappreciated. Loans in Australia are mostly conducted with full recourse, and borrowers may be obliged to cover any capital shortfall from their other asset holdings. Asset values in Australia have been very stable, especially compared to the bigger price corrections seen abroad. In this context, default rates have been very low historically. Even in default, lenders have a very strong capacity to recover any outstanding amounts from borrowers.

Altogether, Australian commercial real estate debt as an asset class has a favourable mix of risks and returns, one that is demonstrated over many cycles and one that compares very well with other traditional asset classes. This sustained performance has been realised through the recent pandemic when weak growth and high rates have brought widespread losses to other asset classes. Indeed, this highlights the benefit of private credit as a vital portfolio stabiliser, at a time when diversification is getting harder to find.

What is the outlook ahead?

The Australian outlook is looking a little better in 2025, with market expectations of slightly higher growth, modestly lower inflation and hence gradually lower rates. This is in the context of a global market outlook with more geo-political turmoil and escalating trade tensions, which causes a lot of investor anxiety about the state of the world and where to find their target returns.

In our view, there continues to be a compelling case for private credit, particularly for Australian commercial real estate debt. While interest rates are likely to drift a little lower in 2025 and 2026, they are still consistent with a higher-for-longer scenario and still expected to sustain resilient credit returns. Meanwhile, the turning point for rates is likely to unleash stronger borrower sentiment, which should support some gains in lending volumes ahead.

By sector, we hold the strongest conviction in residential development. Robust population growth in Australia continues to outpace many parts of the developed world, and also the pipeline of new housing supply. We foresee persistent undersupply of housing for several years ahead, whether it is housing for sale or for rent, from inner-city apartments to urban-fringe land subdivisions.

For other sectors, the outlook is looking brighter. For the first time in several years, we are seeing a concerted rebound in commercial asset prices. For office, the structural erosion of demand from working at home is finally moderating. For retail, the long-running shift from in-store to online retail is also running its course. Alongside the expected decline in interest rates from 2025, there is a broadening suite of tailwinds to support a firmer cyclical recovery in asset prices.

How do I gain access?

Not surprisingly, we continue to see strong investor appetite for Australian commercial real estate debt. For many private investors, there is a choice of investing on a deal-by-deal basis, or via a consolidated fund structure. The most obvious benefit from an open-ended fund comes from its diversification and immediate deployment, as investors may sit across a pool of 50+ loans, which goes a long way to smooth out uneven cash flows. Additionally, there can be liquidity benefits in a fund vehicle, as a larger loan pool is able to sustain monthly redemption windows.

The other big investor consideration relates to manager selection. Certainly, there is more capital competing for deals. Increasingly, we are seeing new start-ups looking to write their first deal or managers branching out into private credit for the first time, without the technical skillset or the appropriate local market experience needed to appropriately price a deal or manage the risks. In this market, deep origination capacity and track record are absolutely vital. With a stronger transaction pipeline, established managers can afford to be more selective on deals, pricing, sectors and sponsors. This allows stronger managers to be far more patient and disciplined on deployment.

Looking ahead, 2025 is shaping up to be another interesting year. For many investors, looking for stability in a volatile world, Australian commercial real estate debt remains an attractive solution to a difficult portfolio puzzle. There is still persistent demand for real estate amid robust population growth. There is still room for growth in lending volumes as banks retreat and interest rates ease. Moreover, Australia remains a highly desirable destination to live, work and invest, given the strong rule of law, stable governance, high-quality educational institutions and an enviable quality of life. Altogether, the commercial real estate debt investment outlook remains highly compelling, given a long track of robust, resilient returns across all market conditions.