Huge demand, lack of supply, net migration - this market is far from dead

Looking at your current investment opportunities, they span different states, regional, suburban, what are the common characteristics that they share?

Craig Schloeffel: At Payton Capital, we describe ourselves as a mid-market lender, and what that means is that our typical debt size that we have is between $5 and $50 million. The typical characteristics of our projects are as follows: 

We've focused on the residential space for the last couple of years and that's meant that you'll see a lot of residential development that looks like greenfield sites that have a development application in place, or are almost at development application stage. It could be greenfield lots under construction or it could be a good mix of residential housing, apartments, townhouses, et cetera.

The other thing that you'll note with Payton Capital is we focus on the eastern coast of Australia. So our projects are in Victoria, New South Wales, and more recently, Southeast Queensland.

Interest Rates

Chris Conway: Craig, let's talk interest rates. It's the big topic at the moment. What is your current view on the interest rate cycle? Has the RBA gone too far?

Craig Schloeffel: Well, that’s certainly the question all Australians are asking, and we did think that the interest rate cycle was near the top until the most recent jobs data came out and it was very strong. Inflation is something that hurts all of us, so the RBA has a very tricky job to try and balance inflation and the needs of everyday Australians.

Chris Conway: And Craig, how is that impacting the type of investments that Payton is offering to clients?

Craig Schloeffel: 

We've had a tilt towards residential property for quite a time now, and certainly there's persistently strong demand in that sector. So we are focused and we'll continue to focus on the residential development sector.

The economy

Chris Conway: Craig, what's your view on the economy?

Craig Schloeffel: It's in an interesting state right now. We've got some mixed signals in the economy. If I look at things like very high inflation, interest rates rising the fastest on record, you'd say we're in a bit of trouble. You counter that with property prices starting to increase, record low jobs numbers, and yet the overlay of that is consumer confidence at all-time lows. There are some very mixed signals in the economy right now.

Chris Conway: The RBA revealed recession modelling as high as 80% probability. How would a recession impact the demand for non-bank lending?

Craig Schloeffel: The great thing about non-bank lending or commercial real estate debt is that it's uncorrelated to other asset classes. 

We've found through multiple market cycles that you can still safely invest in our asset class. 

We believe even if Australia does hit a recession, the mix of lack of supply of property, expected rate cuts early next year, and record immigration will give some real tailwinds to the residential sector.

Australian property

Chris Conway: Craig, what is unique about the Australian property market and does it provide any shelter for inflation?

Craig Schloeffel: The Australian property market is uniquely positioned within the Asian region, and for that, we've got a huge demand of people trying to come into our country (particularly skilled workers) which bring with them money, great skills that they can add to the economy, and they all want a place to live. 

What we've found is that the huge immigration expected into the country in the next couple of years will certainly bring with it a demand for residential property particularly. 

But as people find places to live, we've got to create places for them to work, and that brings with it obviously other commercial and industrial and therefore retail spaces. So the whole property industry benefits from new Australians.

Chris Conway: Craig, in a recent update, you talked about migration being an important factor for the property market. Can you just elaborate on the thesis there a little bit?

Craig Schloeffel: The ABS has recently put data out to say that we're expecting 800,000 to 900,000 new Australians in the next couple of years based on the immigration data. We know from that, 70-80% of these people are going to settle in the major cities and most of them on the East Coast. We therefore feel that the huge amount of new Australians coming will need somewhere to live, and what we also know is many will start in an apartment before later looking for a house to live. So both the apartment market in the residential space as well as the housing markets to follow. So greenfield markets should benefit hugely from the immigration coming through.

Non-bank lending

Chris Conway: Craig, between 2019 and 2021, non-bank lending rates were as close to bank lending rates as we've probably ever seen. Spreads have since widened as wide as 400 to 600 basis points over bank. What's your view on the forward outlook?

Craig Schloeffel: During the pandemic, we saw a huge influx of capital to our space as bank rates, and therefore depositing rates, fell to almost zero. Investors were looking for a great place to park their funds and get a risk-adjusted return commensurate for this. Since rates have gone up and as we know, they've gone up the fastest on record, investors are now looking at our market and saying, is there an appropriate risk-adjusted return? Spreads have widened off bank, but that's naturally a function of coming off the floor of zero and returning to the longer-term average. 

We feel that with spreads widening, it gives investors a fantastic opportunity to once again take advantage of the risk-adjusted return in our space and also protect themselves from inflation.

Chris Conway: Craig, you've talked about the rich opportunity set and the return profile currently available. Craig, do those returns come with any increased risk?

Craig Schloeffel: Risk is a really interesting concept in the private lending space because within our asset class you've got different sub-sectors such as residential, you've got office, you've got hotel, you've got industrial, et cetera. What we have seen is borrowers have certainly come under a lot of pressure of late in the construction side because they've had increased costs of supply, they've had shortage of supply, they've had short availability of labour, being very difficult to procure. 

What we have found though in the residential market where we focus is that the strong tailwinds of huge demand, lack of supply, overseas migration bringing in new capital and certainly new demand has meant that we feel that the residential market is going to be very strong over the next couple of years. 

And a well-positioned first mortgage managed well by a strong manager will provide a huge opportunity for investors to take advantage of this.

Chris Conway: Craig, just a couple of quick follow-up questions. How much of the portfolio is currently in residential?

Craig Schloeffel: Currently we've got about 85% of our book in residential.

Chris Conway: And how long ago did you tilt the portfolio to residential?

Craig Schloeffel: During COVID, we sat down as an executive team and really analysed the property market and we looked at hotel, we looked at retail, specialist retail, and we looked at the office market and we couldn't get a clear view forward of what those sectors were going to do. And for us, we erred on the side of caution and then we took a tilt towards residential.

Chris Conway: Your ownership structure is a little bit different than most fund managers here at Payton. Can you explain what that is for investors and why?

Craig Schloeffel: Our ownership structure is something we're really proud of at Payton. The ownership structure is 40% is owned by the Payton family, 40% is owned by staff, but what's unique to Payton is 20% of our business is owned by the Payton Foundation. And so what that means is by investors or borrowers working with Payton, whether they choose to engage with our foundation at all, they're still contributing to us providing benefit to the 16 charities that we partner with through the Payton Foundation.

Chris Conway: Craig Schloeffel, thanks for appearing on Livewire Market's Income Series for 2023.

Craig Schloeffel: Thank you so much.

Learn more

Payton provides an opportunity for investors to access the Australian private debt market, which was traditionally the domain of large scale banks. Visit our website to find out more.