Australia needs 1 million new homes. This investor wants to be part of the solution

There is a lot that has been written and said about the growth (and growing pains) of the Australian private credit industry. For an industry that did not gain traction until after the 2008 Global Financial Crisis, private credit - and more specifically, non-bank lending - has grown dramatically.

But underneath the hood, the truth is more complex and nuanced than the headlines would have you believe, as Alan Greenstein, CEO and Co-Founder of Zagga Group, an Australian non-bank lender and alternative investment manager specialising in CRED, will tell you.

For instance, the term 'private credit' is home to many components - and painting all parts of the market with the same brush is inaccurate. For its part, Zagga specialises in the commercial real estate debt market across the eastern seaboard of Australia.

In this wire, Greenstein discusses the evolution of the private credit industry in Australia. We'll also discuss the push for greater transparency, insolvencies and defaults in the sector, and the surge in competition.

How should investors think about private credit's place in a portfolio?

Greenstein says private credit has value as a defensive strategy that can earn a higher return than cash while still locking in downside protection. But there is one caveat he would like to issue to prospective investors - Do your due diligence.

"I think that investors generally would be well served to do a lot more due diligence and investigation as to whether the product suits them and whether the fund manager they're using is the right one to give them the product that they need," Greenstein says.

"There is no barrier to entry to being a lender but being a lender requires you to be able to get the money back to your investor with the principal and the interest. Not everyone knows how to do that."

How Zagga tackles the CRE market - and does its due diligence

"95% of what we write are property-related transactions. It could be an acquisition, a land subdivision, development and construction, or residual stock. We operate in the $5-50 million loan size space," explains Greenstein.

Speaking of due diligence, Zagga has a rigorous process for finding the right investments. As Greenstein explains:

1. The size of the loan - "It's likely to get knocked out because less than $5 million is too much effort for the return, and more than $50 million is where we get uncomfortable with the risk management, based on how we judge our core market."

2. The specialty of the loan - "If you bring us an agricultural loan or a specialist asset, a brewery for instance, it's going to get knocked out no matter where it is. We only want to lend into the deepest part of the market.”

3. Is this a loan they want and can sell to its investors? - "Is it actually going to fit within [our investors'] purpose? Even if the loan is good and passes our knockout filters, is there any investor appetite?"

Once Zagga determines the suitability of the loan, the eight (soon to be nine)-person credit team checks a loan's feasibility, tests whether the valuations attached to a loan are realistic, and then carries out additional QS [quantity surveying] analysis on top of the formal inspection to ensure that progress on a project can be verified and any issues can be dealt with. All this is done well before the Term Sheet sees an investor's desk.

The impact of COVID and soaring rates on the CRE debt landscape

The story of the real estate market is well-trodden, especially over the last few years when it comes to subjects like supply chains, labour shortages, and the rise in valuations despite what we knew was coming (soaring inflation which would be counteracted by equally impactful interest rate hikes.)

But the story of housing in Australia, in some ways, remains the same - supply and approvals to build new supply is well short of where it should be.

"We are about a million residences short in Australia as we stand right now. Last year, we approved 13,000 to 15,000 [dwellings]. We need to approve 45,000 a year," Greenstein says.

"So, if you just do the numbers, it's a market that's going to keep on growing and the numbers will adjust accordingly."

Part of the reason supply has been so hampered is the wave of bankruptcies that have hit Tier 1 and select Tier 2 builders across Australia. This, says Greenstein, is where context would be very welcome and important.

"Most of the insolvencies that we saw during COVID and shortly afterwards were all the Tier 1 builders. They were impacted by having fixed contracts, prices blowing out, and they couldn't survive to that extent. It is not something that applies to all builders.”

On transparency and the "extend and pretend" allegations

Finally, the private credit industry is often at the receiving end of allegations that its firms operate in an unregulated environment and that its bad actors simply "extend and pretend". Put another way, lenders could choose to extend the maturity of a loan to avoid recognising a loss on its books, but that's both precarious and immoral. Greenstein says this isn't new and the bad actors will continue to do bad things no matter the environment.

"I think there's a lot of extending and pretending already. And to be honest, I don't think it's necessarily something that's related to the current market. It's very easy to be opaque about a loan. It's very easy to mislead people. It's happened, and it will continue to happen, with certain lenders. But again, you cannot just generalise" Greenstein says.

For Zagga's part, it welcomes the enforcement of appropriate regulation and has always sought to be as transparent as it can be with its investors.

"When our investors see one of our terms sheets, we disclose the name of the borrower, the rate that the borrower is paying, the rate that the investor is earning, the fees, the valuation. Every single one of our loans is risk-rated and has its own return," he says.

"We've been regulated from day one. We wanted it because we thought it would give our investors a lot of confidence about our corporate governance and oversight regime. It has."

Zagga is a well-established, Australian boutique investment manager and non-bank lender, specialising in the private credit real estate (CRE) sector.

Since 2017, they have provided investors with stable, risk-adjusted returns, and repaying more than $1 Bn to investors, without any losses of principal or interest.

To learn more about investing in real estate credit, visit Zagga's website here.