Welcome to the Qualitas On-Demand CPD Series which seeks to educate the advisor market on all things real estate. Traditionally, income plays a big role in portfolios for Australian investors and with global interest rates at all-time lows, investors are actively searching for alternative investments to achieve consistent and reliable income. Not only is it about reliability of income, it is about maintaining a level of income to continue to fund a living, a lifestyle and a retirement. And that becomes much harder when the combined effect of central banks lowering rates and increased fiscal stimulus efforts leads to asset price inflation, this erodes the effective yields earned by investors. In our presentation “Seeking regular income and diversification in challenging times” we are pleased to introduce you to commercial real estate debt (or CRE debt for short) as an alternative investment which aims to achieve attractive regular cash income whilst preserving capital.This presentation qualifies for CPD points which advisers can register by clicking here.
Qualitas is one of Australia’s leading institutional alternative real estate investment management firms. We specialise in investing across the entire capital structure of real estate debt and equity. Qualitas was established in 2008 during the GFC where banks were pulling back their CRE lending and alternative lenders backed by investor capital identified a unique opportunity to fill the funding gap. We have built up an extensive track record and in our 12 years of our operation, we have invested $3.5Bn of investor capital for real estate assets valued over $12Bn. We have closed more than 130 debt deals and incurred zero loss of capital which is testament to our disciplined investing.
The Qualitas Team is excited to present four modules on our subject topic of CRE debt and income. These are:
Module 1, Investing for Income with CRE debt
Module 2, CRE debt market opportunity
Module 3, Fundamentals and Risks of CRE debt
Module 4, legal framework for CRE lendingYin-Peng Bell:
Hi, I’m Yin-Peng Bell, Director of Strategy at Qualitas and I am responsible listed fund product strategy, marketing and investor relations.Nick Bullick:
Hi, my name is Nick Bullick and I am a Director in our Real Estate Investment Team at Qualitas, and our team is responsible for origination and execution of CRE loans.Daniel Mote:
Hi, I'm Daniel Mote, Head of Legal & Compliance at Qualitas and I am responsible for legal and compliance at Qualitas.MODULE 1: INVESTING IN CRE DEBTYin-Peng Bell:
In this Module we will provide an overview of Investing for Income with CRE Debt.
The CRE debt asset class is gaining in popularity especially for investor’s who are seeking a decent level of income but are more on the risk adverse side and can’t afford to lose capital. As an asset class, CRE debt has been around for decades traditionally invested in by wholesale investors; but it is now becoming more widely available to the retail investor.
The investment universe for income as we know range from your safest being Term Deposits, to various debt instruments, hybrids and then equities as we move up the risk / return scale. Property (in the ownership form) is also a major asset class for income but there are other are debt investments that provide exposure to property such as RMBS (which stands for residential mortgage backed securities) and also CRE debt. CRE debt is predominantly provided by banks. However there is a part of the market that is provided by non-banks or alternative lenders, which is referred to as “private CRE debt”, and this is where the specific alternative income investment opportunity lies. As you can see from the risk return chart, private CRE debt can deliver some attractive risk-adjusted returns compared to other investments, especially when compared to equities and traditional property which are higher up the risk curve. When looking at the capital structure and a wind-up of a company or sale of assets, secured debt is always repaid first, followed by unsecured debt, subordinated debt, hybrids, then lastly equity. The key feature of CRE debt is it is classified as secured debt, the highest priority in the capital structure, so these investors always get their money repaid first.
In this slide, we highlight the importance of alternative lenders’ contribution to the global financial system, i.e. the “credit markets” which represent the total debt provided and utilised globally. On a global scale, debt is almost 50/50 provided by banks and the alternative lenders. Alternative lenders are providing a substantial US$200 trillion worth of debt after decades of year-on-year credit market growth and increased market share taken from banks. Alternative lenders play an important role in the global financial system in that it provides borrowers with not only an alternative source of finance to banks, they are globally accepted as market participants and providers of debt. The deep alternative lending market represents an income-focused investment opportunity for investors across a wide range of debt investments, such as corporate loans, bonds and CRE debt. Investors of debt will also look to invest in Australia, and their capital flows will contribute to the activity and size of the Australian CRE debt market which Nick will cover in more detail in our Module 2.
To recap, alternative lending is where any party other than a bank, provides a loan to a borrower, for any purpose which also includes financing commercial real estate. The main differences between banks and alternative lenders is how they fund lending activities, an alternative lender will raise their capital from mainly investor equity, whereas a bank raises capital from mainly deposits and wholesale funding. Furthermore, an alternative lender in Australia will not be regulated by a APRA, the prudential regulator for Australian banks, also known as Authorised Deposit Institutions (“ADI’s”). Depending on how a lender funds its lending activities and the types of loans provided, it may be regulated by ASIC. Alternative lenders that provide loans to retail borrowers are generally governed by responsible lending laws that are administered by ASIC. The provision of loans by alternative lenders is commonly referred to as private debt as they are not typically or easily traded in secondary markets such as bonds or bank syndicated loans. Alternative lenders range in size of operations, size of funds under management, experience, have many different ownership structures and service both retail and wholesale borrowers.
So now that we understand alternative lending which includes CRE debt, what exactly is CRE debt? CRE debt is essentially a loan provided to finance real estate, both for investment and development purposes. We all know that real estate is an asset class that is heavily borrowed against – in fact it is rare that real estate is purchased outright by 100% equity. The borrower of CRE loans is distinctly commercial, i.e. wholesale and they are typically property developers, private corporations, high net worth groups and individuals that own and develop properties for commercial purposes. It is important to note that these are not home loans to retail borrowers such as individual owner occupiers and investors. CRE loans are secured by real property mortgages, meaning if the borrower cannot repay the loan, the lender has the right to sell the property to recoup repayment. This is the capital preservation feature of this asset class. Lastly, Income for the investor is generated from borrowers paying loan fees and regular interest payments at agreed rates.
Investors can access CRE debt typically through a fund structure, i.e. a managed investment scheme which can be listed or unlisted in which investors can purchase units to invest. An Investment Manager with a specialised skillset in the asset class such as Qualitas, is appointed to manage the fund and invest pooled equity capital into CRE loans on the discretionary basis. The CRE loans generate loan interest and fee income for the Fund, which in turn is paid as a regular cash distribution to investors, typically monthly in line with the interest payment frequency. The role of the Investment Manager is an important one. The Investment Manager will source and originate all lending opportunities, undertake loan assessment and due diligence to ensure it meets the investment objectives and mandate of the fund The investment manager also undertakes active management of the loan throughout its lifecycle to ensure risks are managed such that will not impact the performance of the loan. That is the ability for the borrower to make payment of interest and loan repayment when due.
In terms of asset allocation for your client’s portfolio, we believe that CRE debt is unique in that it can fit into three asset classes. Firstly, fixed income, given CRE debt is a credit instrument which generates a fixed level of income from agreed interest and fees. However, it comes with the benefit of less capital volatility because there is no secondary market trading of private CRE debt - like for example, public corporate bonds, which are priced to market. We also think it fits into property, given it provides exposure to the property market but without the equity risk of investing in property which we will explain in more detail in the Module 3. Lastly, CRE debt can also be classified as alternatives, since it doesn’t exactly fit into the other traditional asset classes. For the majority of investor portfolios, diversification across the capital structure is also important to diversify risk. Hence, an allocation to debt may be suitable for investors looking for less capital volatility, then investing in property. Whilst the determination of asset class allocation is based on individual investor profiles, CRE debt provides additional diversification regardless.
CRE debt is an asset class that has been around for many decades for wholesale investors but it is now becoming more widely available to the retail investor. Investors who prefer less capital volatility or have income targeted strategies, such as retirees, are often attracted to CRE debt.
Investors of CRE debt continue to invest long term in this asset class due to the attractive benefits, these being: The stable operating environment. Alternative Lenders have been operating for more than 30 years in the Australian CRE debt market. It is an accessible asset class for all investor types, whether you are institutional, wholesale or retail. It provides regular, stable income, which is underpinned by agreed loan interest rate and fees. The risk-adjusted returns can be at an attractive premium to the current low cash rate, noting that the premium is commensurate to the risk undertaken. It also provides excellent capital preservation characteristics, as all loans secured by real property mortgages. CRE debt provides the benefit of exposure to the property market without the equity risk of direct property investing. Importantly, it is a simple credit strategy, easily understood compared to other investments, and can provide diversification in an investment portfolio.
Recapping on three key takeaways for this module:
MODULE 2: CRE DEBT MARKET OPPORTUNITYNick Bullick:
- Alternative lending has a significant contribution to the global financial system.
- CRE debt is an alternative way to potentially make income.
- And lastly, CRE debt can provide further portfolio diversification.
In our next module, we'll delve into the CRE debt market dynamics and opportunities for alternative lenders in Australia.
The CRE debt market in Australia is estimated to be around 380 billion, of which banks have a 93% market share, and the remaining 7% gap is provided by alternate lenders, including Qualitas. That translates to a private debt market of around $25 billion. In the private CRE debt market, senior loans represent the deepest pool of opportunities, and the specialised financing of mezzanine is only provided by alternate lenders, not banks. In Modules 3 and 4, we'll explain in more detail the difference between senior and mezzanine loans.
If we look at the more established US and European markets, alternative lenders hold between 45 and 50% market share, which not only demonstrates the importance and prominence of alternate lending in the global financial system, but the potential for growth in the Australian CRE debt market.
The CRE debt opportunity exists for alternate lenders has grown in recent years, due to the following reasons. Year on year, CRE debt market growth is naturally driven by population growth and urban expansion. Number two, a very low interest rate environment, supporting cheaper borrowing, which fuels borrower demand for loans. Number three, the Australian economy has been relatively sound compared to other countries with uninterrupted GDP growth and good population growth. It is expected that post-COVID, these fundamentals will return. And number four, banks have pulled back on its CRE lending, which has widened the gap for alternate lenders to fill.
Not only do banks typically reduce their lending in times of uncertainty and market downturns, but since the GFC, there's been a structural and permanent shift in bank lending appetite for CRE debt as a result of increased APRA and government oversight and regulation.
There are around 50 alternative lenders operating in the Australian CRE debt market, both domestic and offshore. Some lenders just lend while others such as Qualitas also have equity investments in property, which due to being higher up the risk curve, requires a stronger skillset than just being a lender. This type of alternative lender can offer better value for investors by virtue of their wider skillset and experience, especially if required to assist borrowers with managing any difficult loan performance or project issues which may be outside a typical lender's capability.
Offshore lenders may come and go from the market for various reasons, and their presence impacts the level of liquidity and competition in the market. A local presence for a lender is advantageous, given operating in the CRE debt market requires an in-depth understanding of the local market fundamentals. Alternative lenders raise their capital from a range of investors, both wholesale and retail. They offer a range of different investment offerings to suit their various investment appetites. Commercial borrowers are classified as property developers and/or property investors, which can ultimately be private corporations, high net worth individuals, family offices, or even an A-REIT.
An attractive and diverse alternative lender market is beneficial for the following four reasons. Alternative lenders do not compete with banks. They fill the funding gap. It provides more alternative non-bank finance options to borrowers, such as they seek out and demand alternative financing, which is self-perpetuating to further growth of market share. Thirdly, it creates liquidity to support third-party loan refinancing. This can be an important exit strategy to rely on for lenders. Lastly, it improves the efficiency of market pricing, and that investment risk can be more precisely priced in line with other investment asset classes.
The depth and breadth of CRE debt opportunities span across the entire life cycle of real estate which is also quite specific to a real estate sector since some will perform better or worse than others at a point in the market cycle. The typical real estate life cycle starts with vacant land and moves through planning and development milestones and eventually into a completed building that can be occupied.
We ultimately refer to a completed building as carrying less risk and stabilised as the asset is no longer exposed to the risks of planning, development, and construction. It also has the potential to generate income and due to this has a more stabilised market value. Unzoned land is often the riskiest part of the real estate lifecycle as the ultimate use can be unknown or changed and therefore can result in more volatility and range of its market valuation. Loan types you can see relate to each stage of the real estate life cycle:
- Land loans are required to fund land that is ultimately intended to be developed.
- Construction loans are for funding property development and construction costs
- Investment loans are for funding completed buildings that can be occupied or to generate income from tenancies. This also includes residual stock loans which are secured against completed unsold stock from construction projects.
Qualitas is a “through-the-cycle” investor. We are sector agnostic and always seek to invest in the best risk-adjusted return opportunities having regard to the timing within the cycle of the market.
Borrowers will always seek banks for their core funding needs due to their big balance sheets and cheaper costs overall however banks can’t meet all their needs from a funding and service perspective. And it is because of this reason that Borrowers choose to come to Alternative financiers. Borrowers want to access alternative financing solutions that banks can’t provide and they are willing to pay a premium, for essentially four key reasons:
- Flexibility: Banks can have a fairly inflexible set of lending parameters which can exclude a number of quality borrowers and transactions. Restrictions and caps can also be applied to geographies or property sectors. Alternative lenders are more flexible and commercial on terms (such as leverage and pre-sales requirements), and can tailor financing to meet the borrowers specific needs and to meet its own criteria for lending that suits its risk return appetite.
- Availability of financing options: Banks although have large balance sheets, due to APRA regulation are limited to only senior loans, rarely provide land loans and depending on the market cycle have limited appetite for construction loans. They also prefer lending to stabilised income producing assets. Alternative lenders can provide a range of different financing solutions beyond the banks appetite and provide stretch senior loans, and bespoke lending such as mezzanine loans, and the full suite of loan types covering all property sectors. Alternative lenders are more willing to provide a loan for an appropriate risk-adjusted return.
- Timeliness and speed of funding: Banks are known to be slow and inefficient, with many layers of decision making as they are big enough to dictate their own timetable. Alternative lenders, generally due to their smaller and more focused operations, tend to be more efficient and nimbler to move faster on urgent funding needs.
- Relationship: Banks often treat borrowers as an interchangeable commodity. Alternative lenders are generally more relationship focused as repeat lending and deep relationships are highly valued in the private debt market.
As you can see there are many reasons why alternative financing continues to be in demand and borrowers are increasingly becoming more comfortable to deal with alternative financiers. Qualitas, as an experienced manager of CRE debt, has been well positioned in the Australian market and continues to capture business due to our long-standing local presence and deep borrower relationships built on trust and repeat lending.
When determining the interest rate pricing for CRE loans, there is essentially two factors to consider:
- The pricing of the ultimate risk of the loan is determined through the credit assessment process. In Module 3 we will go through credit risk in more detail however the higher the credit risk, the higher the interest rate pricing as investors need to be adequately compensated for risk, and vice versa.
- Market dynamics of supply and demand of credit (i.e. how much or little competition) also impacts the risk pricing:
There is pricing compression when loan supply outweighs borrower demand. For example if there is a lower volume of borrowers transacting and investing in real estate, this will reduce borrower demand. Or if there are more alternative lenders, this increases loan supply. Increase to pricing is where demand outweighs supply. Low interest rates can support property values and generally lead to increased borrower demand. If offshore lenders retreat this can reduce supply of CRE debt.
An experienced manager such as Qualitas will instil discipline in appropriately pricing their loans commensurate to the risk taken for the current market conditions.
It is important for investors to verify that the Alternative Lender understands pricing for risk and is undertaking the appropriate level of risk to achieve target returns. An experienced and quality manager like Qualitas will never go up the risk curve for the sake of achieving excess returns.
Just recapping the three key takeaways to conclude from this module.
MODULE 3: FUNDAMENTALS & RISKS OF CRE DEBTYin-Peng Bell:
- Alternative lenders fill the gap left by banks.
- Borrowers will pay a premium to access more flexible finance.
- Opportunities for CRE lending are diverse and span across the entire real estate sector lifecycle.
In this third module we will look more closely at some key fundamental concepts and risks of the CRE debt asset class.
With any income investment, loss is defined as loss of capital and/or loss of income. In the context of CRE debt this is:
1. Loss of Loan principal. That is, the capital component. This is the risk that the borrower cannot repay the loan and the security property value declines and is insufficient to meet full repayment of the loan.
2. Loss of Loan income. That is, the income component This is the risk that cash flow from the property or other borrower sources will be insufficient to pay the loan interest and fees due to the lender.
Managing the inherent risk of this asset class is key to safeguarding against losses and these risks can be namely the credit risk and the valuation risk, which we will take a closer look at now.
Credit Risk is essentially the determination through assessment of the creditworthiness of the borrower and security property to service the loan. Credit Risk is inherently important for identifying all known risks to a transaction so it can be accurately priced as per what we covered in Module 2. The Credit Risk assessment process involves:
- Assessing the borrower quality, for example what is their financial standing and track record. This also includes other transaction parties such as the builder or guarantor.
- Assessing the property quality, such as where it is located, features, tenancy.
- Assessing the market conditions, such as the macro and micro economic conditions that may impact the borrower’s credit-worthiness and security property performance.
Once these key areas are assessed, the lender can then structure the loan, i.e. determine appropriate loan terms and any financial covenants for the risk that it is willing to take on. An important financial covenant for example is the loan to value ratio. That is how much to lend against the value of the property. Other financial covenants can be the level of property cash flow that covers interest that is the interest cover ratio or the minimum presales to be achieved before construction funding can commence.
Each loan type will have its own key areas of credit risk.
- Land loans are generally not income generating so closer attention to other interest servicing sources which including borrower or guarantor cash flow. Land loans also have the greatest planning risks as each milestone of development approval can impact the property value significantly,
- Construction loans key risk is the delivery and completion of the project. Also whether pre-sales are achieved to start construction and actually do settle in 1-2 years which can be impacted by the market. The borrower and builder track record and expertise is extremely important for mitigating risks.
- Investment loans key risks are around it’s tenancy, occupancy and rental rates which can all be affected by market conditions.
- Residual stock loan risks are whether completed stock is selling and at what value and what rate as proceeds are applied to amortise the loan. They are also not generally income producing so servicing is supplemented by borrower cash flow.
- Builder reputation and quality are also important to consider.
An appropriate tenor is important part of managing credit risk as the longer the tenor, the longer the time lenders are exposed to market risks that may impact the property performance and value. Lenders will best match the loan tenor to their risk appetite. The table below for each loan type represent the typical tenors for these loans when considering the corresponding stage of the real estate life cycle.
The primary repayment / exit strategy of the loan is also important to identify as typically will determine the initial LVR the lender is comfortable with. For example if refinance is the primary repayment then a lender will consider what LVR will a incoming lender refinance the loan and whether any amortisation should apply.
Not only is the initial credit assessment and loan structuring important for managing credit risk, it is important for lenders to undertake ongoing management of each loan to anticipate issues earlier and to ensure loan performance is not impacted, hence preserving investor capital and investor return.
When managing valuation risk, it is important to understand what underpins property valuations which essentially are the following factors:
1. The strength of underlying property cash flow supports the property yield and can be impacted by change in rental rates, occupancy and vacancies. Higher yield properties are also generally valued higher however subject to related asset yields.
2. The point in the market cycle for that sector as a result of economic conditions. How has the property performance been impacted by macroeconomic conditions. During COVID we saw retail property valuations fall due to closure of business from lockdowns. Closed borders also affected migration and population growth which has a broad effect on various property sectors.
3. Supply and Demand. The market conditions determine the supply and demand dynamics. Taking a look at residential, undersupply can be due to higher demand for a particular location and underbuilding, and therefore this can underpin property values.
4. Where investors are investing their capital impacts the relative asset yields between property and other asset classes. Property yields can be negatively impacted if there is more investment into the asset class which drives prices up.
With all these factors in mind, lenders need to consider what is the appropriate LVR and tenor to set for the loan to mitigate any valuation risks identified. Lower LVR’s are more conservative to be able to provide more equity buffer within the security value to accommodate greater risk of a decline of valuations. A shorter Tenor is more conservative as there is a reduced risk that the loan will be exposed to adverse market conditions which could impact valuations negatively.
To better understand how investing in commercial real estate loans provides investors with capital preservation and risk adjusted returns, let’s look at the capital structure of a real estate asset which is essentially one of the sources of funding. When real estate is purchased, the funding sources will typically be the owner’s equity and a loan taken out with a real property mortgage granted in favour of the lender. A real property mortgage gives the lender the right to sell the property to recoup the value of the loan and in the event the borrower cannot repay the loan. The lender will lend up to a certain value of the asset value, this is called the Loan to Value. But as discussed there are downsides risks to manage. The loan value is contractual and fixed however the equity component can increase of decrease with the value of the property – this is what we call the equity buffer and is key to supporting capital preservation for CRE debt investors. If the property is sold, the lender will always get paid first from the sale proceeds, ahead of the equity. Therefore as an investor of CRE debt you have more certainty of being repaid due to priority of repayment and the additional protection of real property security. Even the debt component of the capital stack can be split into layers, creating an additional layer of priority, what we call senior debt and mezzanine debt. Senior debt is first ranking and gets paid in priority to mezzanine which is repaid second, then followed by equity which is always last. The order of repayment also aligns with a relative scale of risk and return. The interest rate is fixed which underpins more predictable debt returns. Debt returns are fixed and known so sit at the lower end of risk / return. Whereas equity returns have both upside and downside risk and sit at the high end of risk / return scale. The capital stack demonstrates that investing in CRE loans gives you exposure to the real estate asset class without the risk of owning the property. Importantly, Qualitas does not invest in more than one part of the capital structure for the same transaction / real estate asset. For example, Qualitas will never invest in both senior and mezzanine or senior and equity for the same real estate asset. Furthermore, a quality manager should have no conflicts of interest when it comes to representing their investors. The best practice is to invest in only one part of the capital structure for the same transaction – always. Intercreditor conflicts can arise if lenders represent different interests within the same transaction on behalf of more than one investor (i.e. senior, mezzanine and/or equity) within the same transaction on behalf of more than one investor as there is always a risk that one investor may be disadvantaged. Module 4 will explain further on the intercreditor structure between senior and mezzanine.
To recap on the key takeaways to leave you with:
MODULE 4: LEGAL FRAMEWORK FOR CRE LENDINGDaniel Mote:
- Managing credit risk seeks to protect CRE debt returns and capital.
- CRE debt ranks first due to its priority position being secured by real property mortgages.
- Lastly, the equity buffer of security property insulates against loan losses.
In this module we will focus on the legal aspects of CRE debt and explain how alternative lenders such as Qualitas structure and document these loans to maximise the preservation of our investor’s capital and leverage off the robust Australian legal framework.
In the Australian CRE debt market a formal contractual loan agreement and security documents are entered into between the lender and the borrower. These documents set up all the agreed terms, conditions and obligations of the loan. These documents are supported by a robust legal framework in Australia that is generally considered to be lender friendly and on par with other OECD countries. This means that Australia’s laws as it relates to lending and insolvency is largely perceived as protecting the rights and interests of lenders over borrowers. Particularly for those lenders that have security over the borrower’s property. In practice, this gives the lender a great deal of control over the lender and property during insolvency. Which further protects the interest of lenders therefore indirectly the investor’s CRE debt. A common concern raised by investors is whether the legal and documentation framework for alternative lending has the same lender rights and protections as bank lending, and the answer is yes. As an alternative lender, Qualitas ensures loans are documented to the highest standard to best reflect the loan credit risk profile.
The approach to loan documentation that Qualitas as a CRE lender takes is that loan terms are tailored and bespoke for each borrower. This ensures that the risk profile of the specific transaction is reflected through the terms, financial covenance and obligations in the loan documents. For Qualitas this is an extensive process that involves external lawyers and sometimes lengthy negotiations with borrowers and their lawyers. This results in what we believe is a high quality loan documentation process, which ensures the right terms and conditions are included. This approach to documentation and lending is generally consistent with the approach that the big banks take to CRE debt lending as part of their institutional or corporate banking activities. This can be contrasted to the standard terms letter of offer documentation process which is used in retail or normal business banking.
This simplified senior loans structure diagram demonstrates the key transaction documents, being the loan agreement, a general security agreement, a guarantee and a first ranking real property mortgage. For CRE debt loans, the borrower is also referred to as a mortgagor, as they grant a mortgage over their property or land in favour of the lender, also referred to as a mortgagee. Sometimes the person who owns the land, and so is the mortgagor, is not the borrower, but could be a guarantor or another party. A guarantee is usually granted by a corporate entity or an individual, which is respectively referred to as a corporate guarantee and a personal guarantee. A guarantee enhances the creditworthiness of a loan because the lender has recourse back to another entity to support repayment and servicing of the loan. Personal guarantees are also commonly used to ensure alignment with key individuals associated with the borrower. The fact that someone has guaranteed the debt of a borrower means the guarantor will be incentivised to ensure the borrower meets the payment obligations under the loan. The loan documentation itself is quite involved and can take between one to three months, or sometimes longer to complete, depending on the complexity of the transaction.
Now looking at a mezzanine loan structure. The additional transaction documents include a standalone mezzanine loan agreement and an intercreditor agreement. The intercreditor agreement, which is between the senior lender, the mezzanine lender and the borrower or mortgagor, is an important document because it formalises and sets the priority of repayment of the loan, whereby the senior lender is repaid first and the mezzanine lender is repaid second.
A failure to repay the loan or a breach of other terms and conditions in the loan will result in the lender having certain rights and powers under the loan documents and at law. Ultimately, the lender will have a right to force the sale of the property and use the proceeds from that sale to repay the loan. The proceeds recovered is important, as it will determine whether the loan is able to be repaid in full or not. Hence the importance of setting the important loan to value at the outset of the loan. This enforcement process is generally seen as an option of last resort. Lenders like Qualitas do not provide CRE debt with the sole intention of enforcing security and selling the property. Lenders only earn the return interest whilst the loan is performing as expected. Notwithstanding this, sometimes borrowers or loans do not perform as expected, and so alternative repayment strategies will need to be pursued. If this were to occur, lenders like Qualitas usually engage in the following process:
- We work with the borrower to determine if they will be able to rectify the problem, following which the loan term continues.
- If the borrower is unable to rectify the problem, we work with the borrower to restructure the term of the loan to our satisfaction. This may involve amendments to the existing loan terms or repayment of part of the loan.
- If a restructure was not agreed or not successful, the lender would begin its enforcement strategy, which is detailed in this slide. This principally involves the lender appointing an insolvency practitioner, among other steps, to step in and take effective control of the property and assets of the borrower and any other security providers. This then allows the insolvency practitioner to undertake a realisation process for these assets, the proceeds from which are used to repay the lender, subject to payments which are mandatorily preferred at law.
The entire loan recovery process typically takes between three and six months for the senior investment loan scenario. However, it is important to note that the timeframe depends on the loan type, the complexity of security, and other factors such as the market.
To summarise the three key takeaways of the module:
- The Australian legal framework for CRE debt is robust and considered lender-friendly.
- Loan documentation for CRE debt is tailored and extensive.
- CRE debt lenders have many options to recover their loan, including a sale of property as a last resort.
Learning about the CRE debt asset class is key to being comfortable to invest in something new and unfamiliar, and at Qualitas we are passionate about educating our investors on this specialised asset class. We are finding more and more investors seeking CRE debt, given its attractive and unique benefits. CRE debt aims to deliver risk-adjusted returns at attractive premiums in a low interest rate environment, whilst providing comfort through the security of the property that capital can be preserved.
Thank you for your time, and we hope you have enjoyed our presentation.