The 7 questions this investor asks in every investment he makes

If you’re watching this video or reading Livewire, chances are you’ve been through the experience of paying off your mortgage - or maybe even you’re in the trenches right now. But have you ever thought of investing in other people’s mortgages as a way to generate returns for your portfolio? Well, you can, and in this episode of The Pitch, AltX co-founder and co-CEO Nick Raphaely is going to show you how.

When you hear about real estate debt in the financial press, chances are you are reading about the state of the commercial real estate market. While we've not seen huge cracks in the commercial real estate markets either here or in the US, it was the subject of a lot of concerns over the last two years given rising interest rates would have destabilised the valuations these properties would have been earmarked at. 

But AltX does things differently, investing in residential real estate debt - backing the construction firms and builders who are putting up everything from apartment blocks to townhouse projects. But given the national insolvencies narrative, the ongoing effects of a huge interest rate hiking cycle, and the soaring cost of labour, is this really a more secure investment opportunity than its commercial counterpart?

We'll ask Raphaely this and other questions in the following interview. 

Edited Transcript

Raphaely: AltX is a lender. We provide capital to borrow security against property in a very similar way to what banks do. We attract borrowers who sit slightly outside of a mainstream bank's criteria. 

When we provide a loan where there's no other money secured against the property, that's called a loan secured by a first mortgage. In the event that the property needs to be sold to repay the lender, we stand first in line to recover the capital. And that is generally the same as the sort of lending that the banks do. 

[In] first mortgage-backed lending, we only do it to a level of 70%, which is our highest loan-to-value ratio for residential security, but essentially if a borrower doesn't repay as an investor, if an asset gets sold, you have first claim on the proceeds to repay what was invested in the deal.

When I speak to people in the real estate space, they point to this huge increase in migration, and the rising cost of replacement on one end supporting prices and on the other end, rapidly rising interest rates and construction insolvencies as factors depressing prices. How do you make sense of all this?

Raphaely: So people often say to us, where are the markets going? What's happening in the property market because you read different things. And I think that the short answer is that there are markets within markets and it doesn't do justice just to say the market is going up or the market is coming down. 

What we find, for example, is the market for speculative land holdings has been under a lot of pressure, because in a lower rate environment, people are prepared to take a punt on something they think might be worth more. The holding costs are relatively low. What that means is the amount of interest you have to pay just to hold a piece of land while you get approval or wait for something to change to build something is relatively low in a higher-rate environment. 

It's like holding a hot potato. You just can't hold onto it for too long. You have to do something with it. So speculative land holdings, as an example, I think [that] is a market which is very soft at the moment. 

Conversely, good quality residential property in prime metro areas is always in demand because supply is so tight. What you find is people who live in these sorts of homes don't want to move and they want to hold onto them. Often, they've owned them for so long that they've paid off their mortgages so they're not under financial pressure. That sort of market is well supported. If one property comes on the market, [it may] be the only one in the suburb [but it may be] well bid up. So I think there are markets within markets, and as a lender, you have to understand that nuance and work out the security you're dealing with. 

Raphaely: I think you really have to go granular on every deal, which is I guess the best and the worst part of our business. It's the worst part in that sense is that it's more difficult to scale the business because it's not like you like BHP and therefore, you can place an unlimited bet virtually on BHP if you're an equity fund manager.

I think you have to go deal by deal. 

• What is the security? 
• What's it worth or what's it likely to be worth? 
• Who is the borrower? 
• How much of their own capital are they putting into it? 
• How strong are they? 
• What's their exit strategy? 
• How does the whole deal pull together and are you comfortable as a lender that you can see a path to getting your capital back without too much friction at the end of the transaction? 

I think it requires a lender with experience and we've been going for over a decade, so I would certainly put ourselves in that camp, but you wouldn't want to be investing with someone who's just hung up their shingle saying that we can do first mortgage lending and give us a go. 

I think that it's one of those things that looks simple on the surface, but once you un-peel it, a lot of things can go wrong if you don't understand what you're doing.

Raphaely: We started in 2012 as a three-person team. Today we're 60-strong with offices in Sydney, Melbourne and Brisbane, and people on the ground in Adelaide and Perth as well. 

We've got well-built-out teams in all the core areas. So, we've got a credit team of 10 people headed by a head of credit who's come out of a bank. We have a head of distribution who has run a very big team and a multi-billion dollar organisation, enabling us to attract a BDM team that brings the first look at the deals to our shop. 

We have a loan management team and we've got a loan servicing team. We have a very well-built-out structure within our business. Importantly within credit, we've got a very experienced property research team that spends a lot of time drilling down on the values of assets. So, I think in short, we have a very well-staffed business enabling us to do the basics in a very diligent, very methodical way, time after time.