Home / Private debt / Don’t fear the headlines, residential property remains resilient

Don’t fear the headlines, residential property remains resilient

Private credit opportunities continue to grow despite rate hikes
It's easy to get a negative view on property if you only look at the headlines and ignore the data.
Private debt

“Take a reality check” when looking at the newspaper and reading the headlines of gloom and doom in the property market, says Omar Khan, head of wholesale capital at multi-billion-dollar alternative asset manager Alceon Group. Khan was speaking alongside Robert Bezette at The Inside Network’s recent Income and Defensive Asset symposium, which sought to lift the lid on some of the more unique income investments in Australia today.

It’s easy to get a negative view on property if you only look at the headlines and never the data, and thus make assumptions about the health of the private lending sector that has been central to housing construction for the last decade. Khan points to the reporting of clearance rates, which in recent weeks have been as low as 50 per cent, but in actual fact, as negotiations take place during the week, are still averaging close to 71 per cent. “This is just 5 per cent down from the peak of the market,” he explained.

“The Melbourne market is incredibly diverse and elastic,” added Bezette, noting that changing tastes, during and after COVID ,have resulted in under- and over-supply in various areas and types of assets at different times, but few have sustained over multiple months. This has supported strong returns in private lending, whether in the form of construction, land banking or excess stock loans, with unlisted borrowers willing to pay higher rates of interest for more efficient lending by lenders, like Alceon, which truly understand the counter-parties with whom they are dealing.

  • This latter point has been central to the massive growth in the private lending sector, having reached $133 billion, of which Khan says real estate represents $20 billion a year. “The land development sector is three times bigger than in 2008,” he says, pointing to the change in APRA requirements that ultimately penalised the Big Four banks for making anything but residential mortgage-backed lending.

    This opened the door to a cohort of groups that have extensive experience in the sector, understanding the nuances of residential property construction, and are able to price the risk accordingly. So much so that Alceon is among many groups who have, in over a decade, never lost capital for their investors. “Why are the returns so attractive?” asked Khan rhetorically: “it’s quite simply timing. It can take as long as nine months for a bank to approve a construction finance loan, which is a significant cost for projects that typically last less than two years. Ultimately, a faster loan can lead to a higher rate of return, even if the interest rate is higher than what could otherwise be achieved.”

    The benefits for investors are well-known, being the short duration of loans and “natural liquidity” that comes from regular maturities. The duration of any investment is typically between 9 to 24 months, with most being repaid in full within 12 to 18 months. Combined with the fact that interest payments are set at a rate above the prevailing bank bill rate, making them floating-rate, and there’s little question as to why the sector has been so popular with institutional and wealthy investors alike.

    As an asymmetric asset class, being that the upside is capped at the interest payment, so all the risk is on default, it is important to understand the situation when an investor can lose. Khan presented a theoretical construction loan, of $100 million, with a targeted rate of return of 10 per cent. “More than 50 per cent of pre-sales would need to fall-through on settlement for investors to start losing return, but not capital,” explained Khan, highlighting the importance of conservative loan-to-value ratios and protection mechanisms.

    Many investors have the spectre of the GFC in their minds when looking at private lending strategies within the property sector, but Bezette highlighted the unique conditions that prevailed at the time and ultimately contributed to the failure of many private lenders and poor returns. “The banks were competing in the market before the GFC,” he explained, adding further fuel to an already strong fire with fund managers, lenders and banks alike lending capital at an incredible rate.

    Today looks very different, he explains, mainly because “banks are retracting, not competing,” which has changed the game. “The market is now more diversified with better governance” than at any point in the past. On the risk of cost over-runs, Khan says the industry is moving on from the “perfect storm”  of higher costs partly through self-regulation, noting that Alceon is actively involved in dealing with borrowers should conditions become more difficult.

    Staff Writer




    Print Article

    Related
    Take a hard look at leverage in private lending: Challenger

    As many as half of all Australian private lending managers are using leverage to juice their returns, according to Challengers Investment Management, exposing themselves and their investors to mark-to-market risk.

    Staff Writer | 14th Mar 2024 | More
    Don’t wait for a recession to get into ‘misunderstood’ distressed debt

    You don’t need the world to end to start investing in stressed and distressed debt, according to RBC BlueBay, but it helps. And what looks to be a multi-year uptick in defaults is creating plenty of opportunities.

    Staff Writer | 11th Mar 2024 | More
    Covenant-lite loans ‘like driving a car without a steering wheel’: Epsilon

    A business may appear to be robust, but a savvy lender that is responsible for the capital of its investors needs to be constantly across the mountain of variables that can present themselves.

    Tahn Sharpe | 31st Jan 2024 | More
    Popular
  • Popular posts: