• With less than 10% exposure to existing and new residential real estate in the Merricks Capital Partners Fund we intentionally avoided the stress in the sector in 2021/2022.  Last year it appeared loan covenants were very relaxed, builder margins were irrationally low and there was too much competition in the lending space.
• The lending landscape has evolved, with the ability to insist on better loan coverage, stronger covenants around build contracts and a more rational competitive landscape in loan pricing.
• From a lender’s perspective, in addition to the more appealing nature of loans Merricks Capital believe supply and demands dynamics for residential real estate will remain robust in the current climate.
• Unemployment is at its lowest level in 48 years (Chart 1) and an above average household saving ratio translates to resiliency in servicing higher mortgages.
• Falling dwelling approvals and quarterly dwelling and apartment statistics (Chart 2) reflect responses to higher construction risk and rising interest rates but will compound on the growing housing shortage in the next two years.
• Rental vacancy in capital cities is at a record low nationally (1%) (Chart 3) with asking rent prices up 17.4%YOY (SQM), supporting rental yields and providing a floor to the housing valuation decline.
• Population growth (Chart 4) has increased from 0.5% to 1% in 2022 and is expected to be 1.5%pa in 2023 and beyond. This will translate into a need for 140-150k new dwellings per year to maintain a 1% surplus (vacancy rate) not accounting for the return of travellers and students.

It is Merricks Capital’s view that there is an inherent opportunity to fund new residential development where loan returns are attractive and collateral coverage is significant. The major risk remains in valuation, with our base case expectation of a 10-15% price decline from peak levels. However, with an average LVR of 60-65% and a credit macro hedge in the Merricks Capital Partners Fund, we maintain a significant equity buffer to weather a market downturn.

Last month Merricks Capital closed a $57m facility to finance the development of town houses on the foreshore at Williamstown.  This month we expect to close a $75m residual stock facility with a 60% LVR on recently completed apartments Sydney’s CBD.