Why a shortage of debt capital means massive opportunity for investors

It’s hardly a surprise that the alternative investing space is rapidly growing. And Qualitas believes that one particular Australian investment is looking promising at the moment. They aren’t alone, with international investors also eyeing off commercial real estate (CRE) debt.

Andrew Schwartz, Group Managing Director and Co-Founder for Qualitas, believes that risk-adjusted returns are looking favourable in this space, especially when it comes to residential property.

In fact, the demand for CRE debt is so high, combined with regulatory constraints on some traditional lenders restricting supply, that the need for alternative lenders in this space continues to rapidly grow. 

"If you come back to a risk-adjusted return analysis, debt is looking very favourable and it doesn’t necessarily have all the concerns that equity investors have around volatility in the equity market at the moment,” says Schwartz.

In this episode of Expert Insights, Schwartz discusses how the CRE debt market works, why the Australian market is so appealing to international investors, and some of the opportunities in this space.

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The Qualitas Real Estate Income Fund (ASX:QRI) aims to deliver investors a regular stream of income with the added benefit of diversification beyond shares and traditional direct property investments. 

Edited transcript

What is the CRE market and what makes it unique?

When you think about commercial real estate (CRE) debt, you're effectively providing a loan to a participant in the property industry. So, really, at a granular level, worrying about the last dollar of equity valuation is foremost the sponsor or the borrower issue, more than it is yours as a lender. 

Now, at some point, that no longer holds true. If the property declines in value by a relatively large amount, then their problem does become your problem as well. And that's where the expertise of a well-experienced lender comes into play. 

At the moment, what you're finding in Australia is there's a shortage of debt capital relative to total demand. 

We are seeing other banks, who are active participants in the market, not being able to keep up with the demand for debt capital. There is the growth of the alternative market in Australia and estimates vary, but some of the estimates that we look at say that groups like ours now form 9-10% of the total market, and we're growing in size. And the reason for that is the market itself is growing and the traditional financiers are not keeping up with that growth. And so groups like ours are taking market share in this type of environment. 

Like any analysis of supply and demand, where you've got more demand for the capital and less supply, it's very favourable to pricing. If you come back to a risk-adjusted return analysis, debt is looking very favourable and it doesn't necessarily have all the concerns that equity investors have around the volatility in the equity market at the moment. 

What makes the Australian market so attractive to investors?

I think there are a number of factors that make it really attractive to overseas investors, I'd put it down to two main factors. 

The fact is we're quite remote from the rest of the world in a way where we're geopolitically a lower risk compared to many other places in the world at the moment. We've got a very transparent, legal system. It's a great place to live so there's a lot of merit as to why overseas investors think about us from a jurisdiction point of view. 

Also, as mentioned in regard to the debt structure and supply and demand, I quoted the 10% participation rate by alternative lenders in the total debt market. If you go to places like the US and Europe, alternative lenders are closer to 50% of the market as opposed to 10% of the market. 

A lot of investors see very significant runway for absorption of future capital into this market, which they don't see in other parts of the world. 

I think all of that together with where we are and what a great country it is - and the food's fantastic, we've got nice, clean air - really gives rise to why people wish to invest in Australia.

Can you discuss some of the opportunities you are seeing in CRE debt?

At the moment, we are seeing a lot of construction finance, as a general comment. I do think that the demand for new projects has really come alive in terms of feasibilities now making more sense than it did 12-18 months ago, mainly because of the lift in realisation values of residential apartments. And so we are seeing demand there.

We're also seeing demand where developers have completed projects in the last cycle, they may have some stock that they wish to have a residual financing line made available to them and we are very active in our residual financing portfolio as well. We are, across the board, really seeing ongoing demand for our debt capital.