By Anna Jozsa

Director, Credit & Asset Management

The Asia Pacific Loan Market Association (APLMA) has introduced a new real estate financial facility agreement tailored specifically for the Australian market. Developed by the APLMA’s Australian real estate sub-committee, this agreement aims to standardize documentation and practices in the Real Estate Investment Trust (REIT) sector, addressing the unique challenges faced by investors and lenders. Building on the English Loan Market Association (LMA) practices, this agreement is customized to cater to multi-property secured syndicated investment transactions, capturing the distinct characteristics of Australian real estate finance. This article explores the key features of the agreement, compares the Australian and UK models, and discusses the future implications for the Australian market.

A facility agreement tailored to the Australian real estate financing market

In the absence of an Australian market standard for real estate finance facility agreements, investors and lenders have historically adapted and tailored corporate-style facility agreements. However, this makeshift solution is suboptimal. The purpose of developing a facility agreement specific to real estate finance is to secure market consensus and standardise a document that captures the unique characteristics of real estate finance transactions. For example, the new agreement reflects the reliance on property as security, particularly its value and rental income, the quality of property management and provisions to protect leasing agreements.

The new agreement serves as a foundation document for multi-asset secured transactions, excluding construction facilities, with necessary modifications for the Australian market, such as reducing the number of bank accounts from six to two and introducing Australia-specific property covenants.

Covenant testing protocols

Two key financial covenants play a central role in the finance agreement: the loan-to-value ratio (LVR) and the interest cover ratio (ICR). LVR covenants are tested quarterly or bi-annually based on the most recent valuation, which is typically conducted annually. The ICR, usually set between one and a half to two times, is assessed annually and is based on net property income, either from actual receipts or accruals. In Australia, lenders rely on information provided by the borrower as there no direct access to borrowers’ account. As such, no direct covenant testing is undertaken. By comparison, in the UK, a “common-sense check” is undertaken to detect any discrepancies by way of having direct access to the borrower’s rental bank accounts so lenders can check the balance of actual receipts against borrowers’ received rental income.

However, for some real estate sectors these methods to gauge the true financial health of properties may be insufficient, particularly for operational assets like hotels which tend to require alternative metrics like EBITDA (earnings before interest, taxes, depreciation and amortization). Separately, non-bank lenders favour forward-looking interest cover ratio (FLICR) metrics when tenancy refurbishments are involved.

Default remedies

The facility agreement lacks specific guidance on remedies for covenant breaches. LVR breaches are typically addressed through collateral revaluation or loan amortisation. Additionally, preferred cure routes include increasing portfolio revenues to enhance asset values, reducing accrued ICR interest, adding properties to secured collateral pool.

In some cases, pre-payment into a blocked account (controlled by the lender), which is released upon performance improvement, is acceptable. However, this solution is less preferred to loan amortisation by lenders, as prepayments into a blocked account does not reduce outstanding liabilities. Financiers also tend not to like ICR cures as this solution can obscure long-term property-level issues.

Bank Account Management

The facility agreement simplifies bank account management by requiring just two accounts, compared to the six typically used under the UK’s LMA standard. Comparing the two models reveals notable technical differences in market standard protocols.

In addition to the principal General Account and Proceeds Account, theUK model requires the following banks accounts:

(i)      the Rent Account, where rental income is paid by tenants. In the UK, lenders have oversight of this account and whether tenants have accrued rental arrears or failure to pay;

(ii)     the Equity Cure Account, specifically for capital ringfenced for to cure covenant defaults;

(iii)     the Pre-payment Account, for asset sale proceeds, potential insurance proceeds and lease proceeds, such as when tenants vacate early and pay an early lease termination fee; and

(iv)    the Interest Reserve Account, used to put capital aside to cover future interest payments, typically three to six months ahead of time.

By contrast, the Australian model is more simplified, requiring just two core bank accounts:

(i)      General Account

Operated by the obligor, this account holds all income and is used for business operations, including dividend payments. Controls are minimal, with lock-ups triggered by review events or defaults. Account bank deeds are necessary to mitigate operational risks, including loss of control. In cases where deeds cannot be obtained, alternatives include opening new accounts within the syndication or securing an acknowledgment of security from the bank.

(ii)     Proceeds Account

Operated by the security trustee, this account handles various proceeds, such as disposal, lease prepayment, and insurance prepayment proceeds. The timing for applying proceeds is crucial, and provisions allow proceeds to be shared between the borrower and lenders. Disposal of assets typically requires lender consent unless proceeds are applied through mandatory prepayment waterfalls. This contrasts with UK conventions, where each property is allocated a loan amount. This practice is not yet common in Australia but may be worth considering. This streamlined approach provides flexibility, but careful negotiation around lender consent and proceeds management remains essential.

Notable Australia-UK differences

APLMA’s new real estate financial facility agreement reveals different market standards and practices between Australia and the UK. While the UK’s LMA’s practices and documentation were the foundation for the new APLMA agreement, this by no means indicates that Australia is moving more towards a UK model.

In Australia, borrowers transfer the exact interest payments into an agent account, whereas in the UK, the agent runs the entire payment waterfall (i.e., rent account, interest due to lenders, etc). In performing scenarios, after payments are made across the waterfall anything left over is transferred into the borrower’s General Account for operating costs and capex, etc. Overall, the most material between the two systems is that UK lenders, and their third-party agents/ servicers, have a greater degree of control over the visibilities of rental monies, including potential rental arrears accrued and records of late payments.

The comparisons reveal that the Australian borrower-lender market remains much more relationship-focused, while the UK environment has moved to an ever-stricter rules-based approach, since the GFC. Perhaps Australia’s geographical distance from Europe has enabled a more trust-based relationship model to endure, which is unlikely to change anytime soon. UK and European lenders with ambitions to finance Australian real estate are more likely to have to adapt to Australia’s market standards. International lenders have had little success in exporting overseas market protocols into the Australian markets, to our knowledge.

However, that is not to say Australian borrowers are inflexible to adapt – on the contrary, there may be some cases where international standards do gain traction in Australia, but these are likely to be relatively minor issues. For example, we have seen recent instances where Australian borrowers are willing to adapt Allocated Loan Amounts (ALA) in multi-asset loan collateral pools. ALAs assign a loan allocation to each asset at the outset of the loan, which provides clarity to both parties in the event of an asset sale as to the level of required amortisation. In Australia, ALAs do not typically exist, and the amortisation amount typically resolved through negotiation when the asset is sold.

The Australian truth-based system can potentially expose misaligned borrower-lender incentives and perspectives. However, amicable resolution can also reinforce the strength of the relationship-based model. In the UK, lenders would not leave this scenario to a future test of the borrower-lender relationship. There is a rule and agreement for most conceivable scenarios which gives clarity upfront, which reduces risk. For a UK lender, failure to include an ALA could either prevent the loan securing internal credit committee approval or incur an increased loan margin to account for an unquantified risk. We foresee this is an area where Australian lenders may seek to emulate the UK model, but overall, the Australian real estate finance protocols are likely to remain more different than similar in the years ahead.

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Anna Jozsa, Director of Credit and Asset Management in APAC at Trimont, has 15+ years of experience in performing and non-performing debt and asset management, facility agency, loan operations and servicing. Anna has extensive cross-border experience from both the UK and Australian banking industries, having worked with leading banks and loan agency firms in both countries.

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