As we have outlined in our earlier insights, investing in real estate credit has increased in relative attractiveness given the rising interest rate environment. Through its floating rate structure, where income is adjusted for inflation, and the security attached to the underlying investment in registered first-ranked mortgages over property, real estate credit is expanding its reach within the Australian investment community.
In the hands of an experienced manager with multi-cycle experience its secured nature and position in the capital stack can reduce income volatility and downside risk.
As in all investment decisions, the experience and track record of the asset manager is an important factor. So, what are the key questions investors should ask when considering investing in real estate credit?
What is the scale and depth of the platform?
A broad-based platform offering scale and depth provides a competitive advantage in choosing the right investments.
A diversified platform supports careful and timely assessment of the relative risk-reward profile and diversification benefits of individual loans. It also provides support to the lending manager in consistently applying strict loan criteria, particularly when macro conditions are volatile.
Additionally, a robust and varied platform provides greater depth of experience and capability for assessing the value in the underlying asset as well as the potential pool of buyers.
How is governance embedded in the platform?
The integrity of the asset/lending manager is critical for investor and borrower confidence.
Strong governance is important to protect the lending portfolio and minimise as many risks and unknowns as possible.
For managers listed on the Australian Securities Exchange (ASX) there is the added security for investors in the requirement to comply with strict corporate governance practices, transparent, timely reporting and industry and peer benchmarking.
Institutional-grade managers have greater scrutiny of ongoing management personnel and operational capability, compliance protocols, environmental, social, governance considerations and financial capacity.
What is the experience of the lending team?
There are numerous components in assessing experience in the real estate credit universe.
Firstly, construction experience is essential. A real estate credit manager requires a team of inhouse professionals with specialist expertise across all aspects of building and construction, developed across a range of macro environments. This expertise facilitates careful assessment of loan quality and exit scenarios on a case-by-case basis.
Additionally, a broad range of direct borrower, broker relationships and networks provide a distinct sourcing advantage, securing access to a diverse variety of transactions and encouraging discernment in deal selection.
Expertise in owning and managing the underlying asset is central to success. Management experience should include not only assessing point-in-time metrics of the loan portfolio, such as standard appraisals like loan-to-value ratio (LVR), it should also run deeper encompassing an ability to understand market intelligence, analysis of fundamentals, the integrity of book valuations, macro risks and secular trends.
An experienced manager conducts scenario analysis around builder insolvency, time delays, cost increases, pre-sale or lease defaults. A prudent manager will undertake stress testing in all macro conditions, from the most benign through to riskier settings.
Astute lending practice also requires inhouse ‘workout’ experience. This extends to knowing when to seize control over the secured asset and how to manage the return of capital from that asset.
Navigating choppy seas
Finally, a track-record of investing and managing through multiple cycles is critically important.
The uncertain economic outlook, acute shortages in materials and labour, escalating price shocks, and weather delays across the eastern seaboard have placed builders under significant pressure.
Working through these issues requires pragmatism, genuine conviction and skill in managing the loan on a case-by-case basis in a timely and efficient manner.
In the hands of a disciplined and vigilant manager, real estate credit by design should provide security and attractive risk-adjusted returns across all market conditions. Backed by structural and secular growth drivers with inflation-proofed income and capital risk mitigated by secure lending structures, real estate credit offers compelling relative value.
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