Loan purpose delivery in uncertain times

Performance delivery is important at any time of the investment cycle, but particularly during times of uncertainty. Historically, that is when the better managers and more sustainable strategies stand-out.

The real estate equity and debt markets in Australia have had a gale force tailwind since the Global Financial Crisis. During that time, outperformance has been achieved by many managers driven largely by deploying capital into a rising market fuelled by historically low interest rates.

Post COVID, the market dynamic has changed, with various headwinds including rising interest rates, risk-free rates and construction costs, as well as uncertainty surrounding occupancy caused by post pandemic disruption and a slowing economy. The ability to deliver on promises made previously have become increasingly difficult to fulfill.

For most of the last decade, investors have been focussed on the promised return from an investment, without having too much regard for the commensurate risk. We are now entering a phase where prudent investors will be re-focussing their attention on the risks around a forecast return.

Michael Wood, CEO of Madigan Capital, a privately owned Australian non-bank commercial real estate lender on behalf of major institutional investors, says the focus should always be on maximising the risk-adjusted return of an investment, rather than just the return.

“Downside protection is critical. We would rather invest in a bullet-proof lower returning loan, than a high yielding investment with limited margin for error. What we do try to do is achieve an outsized return for the risk taken with our focus on capital preservation.”

How does experience over three Australian investment cycles help?

Wood says this hard-wired approach from both he and his team comes from decades of experience.

“The senior members of the team average 27 years of real estate and credit experience. Most of us have worked through the 1990’s recession, as well as the GFC, and know things can go horribly wrong.

“That experience is not always valued when capital is abundant and the markets exuberant, but there comes a time at the end of every investment cycle that having lived through periods of major disruption, and the discipline that instils, becomes important.

“We are very careful in our asset selection, our borrower selection, our underwriting, our downside analysis, and our loan structuring.”

How has Madigan’s loan book performed during this period of intense disruption?

Since late 2020, a time of peak disruption from the pandemic, Madigan has returned over $200 million to our investors. Capital has been fully repaid and loans performed as underwritten. Additionally, Madigan has de risked positions through strategic selldowns.

Wood says: ”All loans have either performed, or outperformed our underwriting. That includes a portfolio of Melbourne hotels that were repaid recently, and which endured the Melbourne COVID lockdowns. Through excellent asset management by the sponsor, and our high touch loan management approach working closely with the borrower, the investment delivered an outstanding result for our client and supported the sponsor, assets, and hotel business through one of the most difficult periods in the history of the hospitality sector in Australia.

“We are now in the fortunate position of having returned over $200 million of loan capital to our investors over that period, and provided them with excellent risk adjusted returns.“

What does Wood think about the impact of rising construction costs on the market?

‘We do think the next period is going to be challenging for those managers with heavy construction loan books that are going to require intense loan management given the increasing difficulties facing that sector. We feel very comfortable with our mid-risk strategy. We can lend against some construction, but mostly it is non-construction lending against operating assets. We are not trying to shoot the lights out return-wise. It allows us and our investors to sleep well at night.’