How will this impact investors?
Higher interest rates have significantly impacted home lending in Australia, according to Simon Arraj (pictured), founder and director of private credit investment manager Vado Private.
Arraj noted that according to new data from the Reserve Bank of Australia (RBA), the growth in business credit is surpassing the growth in housing credit as the Australian Bureau of Statistics (ABS) reported a rise in the Consumer Price Index (CPI), largely due to increasing housing costs.
The CPI increased by 1.0% in the June 2024 quarter and 3.8% annually, compared to 3.6% in the March quarter. Vado Private noted this is the first annual CPI inflation increase since the December 2022 quarter, driven primarily by rising housing expenses.
According to the RBA, seasonally adjusted growth in housing credit was 4.7% in June, compared to the previous year. Personal credit, including credit card lending, grew by 2.8%. In contrast, business credit, which includes lending to non-financial businesses, grew by 7.8% over the same period.
“With housing being the biggest contributor to annual inflation, we are still seeing sticky inflation,” Arraj said. “Rental price inflation rose 7.3% and remains higher due to very low vacancies in capital cities and constrained supply. New dwelling price inflation of 5.1% is also keeping property prices elevated.”
Impact on investors
Despite the higher interest rates, demand for business credit remains strong. For investors, returns on private lending are attractive, with interest rates on private debt typically floating. This has led to increased investor returns in line with official RBA rate hikes.
“Private credit investments can deliver investors yields of around 10% per annum, which is more than double the typical yields on one or three-year term deposits, and a 3% to 4% premium to the returns on Australian investment grade corporate bonds,” Arraj said. The S&P Australia Investment Grade Corporate Bond Index returned 6.8% over the year to 31 July 2024.
Research from the International Monetary Fund (IMF) in 2024 highlights the benefits of private credit. Since the global financial crisis, direct lending has provided higher returns and lower volatility compared to leveraged loans and high-yield corporate bonds.
“Broadly speaking, an allocation to private credit can potentially enhance risk adjusted returns, as well as boost diversification and provide a consistent income stream,” Arraj said. “That is why it’s so important for retirees and other retail investors to better understand the resilient returns offered by private credit, especially if official interest rates rise again.”
Arraj also emphasised the importance of due diligence and finding a specialist investment manager to deliver attractive risk-adjusted returns from private credit over time.
In Australia, the private debt market has seen active participation from industry superannuation funds, such as AustralianSuper, Cbus, Hostplus, and UniSuper. These funds have diversified into this asset class due to the attractive returns, and retail investors could benefit by increasing their exposure, Vado Private noted.
Vado Private is an investment manager specializing in providing competitive private credit solutions to property investors, property developers, and business owners. Since 2017, Vado has funded over $500 million in loans across more than 230 transactions.
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