Solid lessons emerging from times of crisis
Author: Mark Eggleton, The Australian Financial Review
Australia’s commercial real estate debt (CRED) investment market has been forged from the embers of two of the most difficult global crises of recent years which have positioned it as one of the stronger alternative asset classes for investors.
Put simply, CRED is a fixed income instrument, or loan, secured by commercial real estate where the primary purpose of the loan concerns the use and/or improvement of that asset.
Commercial real estate includes industrial land, office buildings, retail centres, logistics assets, vacant land, residential (high and low density) and hotels. It can cover vacant land, assets under construction or transition, and established/operating assets.
Wayne Lasky is the founder and managing director of leading non-bank lender, MaxCap, and says CRED’s evolution in Australia really began in earnest during the global financial crisis back in 2008.
“The GFC had the most profound impact on the commercial real estate debt asset class because of the major structural dislocation that ensued,” Lasky says.
A major contributor to this impact was the federal government’s decision at the time to guarantee bank deposits of up to $250,000 in local deposit-taking institutions which, says Lasky, “had the unintended consequence of wiping out the non-bank sector of the day”.
Consequently, in addition St George Bank and Bankwest were consumed by Westpac and CBA respectively and the foreign banks retreated, the big four’s market share grew to over 85 per cent virtually overnight.
“The Aussiegopoly [the big four banks], came back with a vengeance, essentially resulting in a one size fits all offering in market. This is highly problematic for commercial real estate because it’s idiosyncratic by nature,” Lasky says.
“The reason being is you have different real estate sectors with assets at different stages of their life cycle which need diverse funding solutions.“
The upshot of the banks basically holding all the cards in the CRED market was a credit squeeze at the time “as capital couldn’t seamlessly find its way to credit-worthy commercial real estate lending opportunities”.
Lasky says MaxCap, which was formed in 2007, held the view the new paradigm was not healthy for the sector and regulatory intervention would be introduced as had occurred in North American and Continental Europe. Unfortunately, while a number of these global markets saw a more stringent regulatory environment put in place through the international Basel regulatory framework, Australia was slow to follow and didn’t commence the Basel requirements around bank capital adequacy ratios until 2017.
This meant that until 2017 the big banks’ hold on the CRED market didn’t really loosen and while there are now restrictions and restraints on their lending capacity, their historical strength in the space still sees them with a combined market share of over 70 per cent.
For a company such as MaxCap who were well-placed to benefit from any regulatory changes as property sector players looked to find finance outside of the major banks in a more regulated market, the slow pace of reform was frustrating.
Lasky says MaxCap’s belief was “sophisticated investors, both private and institutional would step in to fill the gap and would benefit from the healthy returns available” if and when regulation came to pass.
In that initial wait, the company primarily worked with high net worth individuals and family offices – both of which were looking for an asset class providing outsized returns relative to the risk taken.
By 2015, the company had brought in some of the nation’s largest superannuation funds who were keen to invest in the property debt sector as a defensive asset offering good returns.
Fast forward to 2020 and last year’s Covid crisis presented another challenge for the nation’s CRED markets but this time things were a little different. For starters, the regulatory environment had substantially changed and interest rates headed to historical lows globally.
While Lasky thought of Winston Churchill’s mantra “to never let a good crisis go to waste”, he believes initial investor reaction was similar to the GFC where uncertainty and fear created inactivity – they didn’t know how to react.
“Investors were effectively thrust into a dark room and the door was slammed shut behind them,” he says.
While many felt moving forward in the dark invited danger, MaxCap knew from its GFC experience that CRED performs strongly in times of crises. Quality investments would remain as quality post-pandemic and as the major banks and non-bank lenders receded from the market, opportunities abounded for MaxCap and its investors looking for reliable returns with downside protection in a global market downturn.
Research commissioned by MaxCap and undertaken in collaboration with Sydney’s University of Technology, examining the company’s loan book and their returns, indicated CRED returned high alpha across different strategies. Put simply, it significantly outperformed market benchmarks.
What the research found was that “CRED appears to be a highly effective portfolio diversifier as it tends to perform relatively well during such periods of strain in the economy and financial markets”.
A key reason for MaxCap’s outsized performance across its portfolio in the current climate is the company believed the best borrowers with the highest quality commercial real estate still need debt during a crisis.
“We weren’t going to be a fair weather lender and importantly [in a crisis] we were able to be selective, investing in the highest quality commercial real estate loans,” Lasky says.
The result of MaxCap’s bullish approach over the past year is the company’s funds under management grew to around $4 billion.
“Furthermore, we currently have no impairments in our portfolio, which is in line with our track record since inception in 2007 which is now over 420 loans and in excess of $10 billion invested over that period of time,” Lasky says.
For Lasky, the primary objective of commercial real estate debt is to preserve the principle investment, even under highly adverse scenarios. “We don’t commence the lending program until we’re comfortable that the loan over the facility term can withstand a number of shocks to the borrowers business plan” he says.
“It’s really only in those circumstances if you can gain comfort over that, that one would actually commence lending,” he says.
And while the UTS research found private CRED through non-bank lenders is increasingly occupying a highly and increasingly important place in the local investment landscape, for Lasky CRED has the potential to become the “captain of the defence” for astute investors who recognise that they’re able (by virtue of increased allocations to this asset class) “to preserve capital and importantly, also deliver outsized returns relative to risk”.
Find your return in commercial real estate debt. Learn more at maxcapgroup.com.au/cred
Article source, The Australian Financial Review: https://www.afr.com/companies/financial-services/solid-lessons-emerging-from-times-of-crisis-20210512-p57rab