The thematic behind the next building boom

Across Australia, the built form is facing a resurgence. From developing vacant land to constructing big, shiny office towers, there is a huge market for credit to fund the next building boom. MaxCap Group were prescient investors. They tapped into the commercial real estate debt market in the midst of the GFC, when structural dislocation in financial markets was at its peak. Managing director and co-founder Wayne Lasky said it was “a scalable and sustainable opportunity” and now, with FUMA of $4 billion and, having invested $10 billion in commercial real estate loans since inception, the team’s early entry into this market has paid off.

Over the past few years, the competitive landscape has changed for the better. Regulatory intervention from APRA opened up the market to a more diverse mix of bank and non-bank lending and it has provided a strong tailwind for debt markets.

The entire commercial real estate debt (CRED) market is now circa $360 billion. In this wire, Wayne Lasky breaks down the opportunities in this market, how this strategy fits into the fixed income suite and why this opportunity is so difficult to access.

 

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Can you explain the CRED market and why investors should consider a CRED allocation into their portfolio? 

I think if we start with a bit of context: About 10 years ago, the asset class (commercial real estate debt) didn’t really exist. If you cast our minds back, this is the time pre-GFC. But immediately following the GFC, there was a real structural dislocation and the four major banks’ share of the market grew from 65% to 85%, to circa 90%. Not long after that, there was a regulatory intervention and there was a fairly large funding gap.

So MaxCap was quite prescient with respect to the opportunity, we thought there was going to be a very substantial, scalable, and sustainable opportunity. I’m very pleased to say that that’s why things have panned out, but with respect to the actual asset itself, so when you’re thinking about real estate debt, in simple terms, it’s a loan and it’s a loan secured against commercial real estate.

The primary purpose of those loans typically is for the use or improvement of that asset. When we’re thinking about those loans, they’re like a fixed income instrument, meaning that the return is fixed over a period of time, we’d refer to as the facility loan term. So that has a fixed maturity date. I think the other key feature to understand about real estate debt is that the lender is taking security really to preserve its capital under a number of less than favourable scenarios that may occur into the future. And because of that, there’s a lot of focus on capital preservation and that’s a real attribute of commercial real estate debt relative to some other asset classes.

How long is the duration of these loans? 

It really does depend about where you’re looking at the real estate life cycle. So if we’re thinking about it, in simple terms, you might have some vacant land. You might want to construct on that land. So if you have vacant land, you might have the vacant land for 12 to 24 months. If it’s construction, it might take you two years, to three or four years to develop the asset on that site.

If you’re thinking about assets that are currently in the built form, a classic example would be commercial office. With commercial office you would see by walking down the street, there’s some of them that are a bit older than others. They reach an economic end date and you need to add some value to them. So those value-add opportunities, subject to the extent of them, they can tend to go from anywhere from 18 months to three years, but then there are also core assets, the big shiny buildings that often need long-dated funding, so that can range from seven to up to 15 years.

How big is the Australian CRED market and can you describe the competitive landscape? 

Very large!

The real estate, commercial real estate market, circa $360billion. Think when we’re thinking about the competitive landscape, I think the key point I would make is it’s really important to have a healthy mix of bank and non-bank funders, their rationale for that is really two-fold. I think in the first instance we think about real estate as idiosyncratic. So every piece of real estate, whether it’s in a sector-specific, so obviously industrial real estate, vastly different needs to residential, where it is in terms of geographical positioning will often require some different attributes to the funding package, but also where it sits in its lifecycle. So what is the actual strategy for the real estate? So you can see that a one size fits all approach is never going to suit an asset class that’s so idiosyncratic.

But increasingly what’s become very important currently is a seamless transmission of credit to credit worthy borrowers and credit worthy assets. And so that’s critically important to the economic recovery of this country right now.

So if we don’t have a deep and quite a broad finance universe, you run the risk, of course, then of not having that transmission of credit. And then you can have a real systemic issue. So it’s pleasing to see that we are experiencing further competition emerge, but I would say that competition relative to the size of the funding gap in the market and that funding gap that we estimated to be circa $60 billion comes about through a decade or so’s worth of structural dislocation in the finance markets, particularly in the banking sector, with the regulator having to intervene to impose these capital provision ratios to deliver the bank’s exposure to commercial real estate.

So, in essence, whilst there is competition, there isn’t enough competition relative to the size of that funding gap. And I think the other critical point to note here is there are really serious high barriers to entry to come in and lend in the commercial real estate space. I think first and foremost, amongst those, you really do need to have a very long track record because a borrower is not just going to come to you because you say, “Hi I’d like to lend you some money”, right? They’re going to go buy an asset, there’s a lot on the line. You better be there and deliver on the terms.

So it’s quite difficult to just enter the relationships that underpin those opportunities. So if you want to get access to the best loans in the market, they’re not available in the public market.

So, because it’s a private market, it’s quite hard to access the opportunities. And then I think, fundamentally, if you’re going to successfully manage a loan portfolio, which often requires a lot of active management, you need to really have a very big investment into an institutional-grade platform. And that’s not something you can sort of click your fingers and create overnight. So they do think there are some substantial barriers to entry, but at the same time, I think it’s pleasing to see that there is some additional competition emerging in the market.