Why these investors remain steadfast in their approach despite radical market shifts

Wind back the clock a few years and conditions were ideal for commercial real estate and the debt that supports it - heaps of demand, low cost of debt, and plenty of builders and labour available to construct the projects. 

Zoom forward to today and the space is full of landmines - all the positive factors have reversed and things have become far more challenging. 

For one particular player in the space, however, the approach has not changed.

"We have always been incredibly diligent with our credit", notes MaxCap Executive Director, Brae Sokolski. 

"I don't think we're more cautious now than we were in 2020 during the benign conditions... we have a culture of always looking at the worst-case scenario, of sensitising to an Armageddon situation. And that culture hasn't changed."

That approach has held MaxCap in good stead. The company has been in operation for more than 17 years and has done more than 650 deals, and it has "never lost a dollar of capital", says Sokolski proudly. 

In this episode of The Pitch, Sokolski explains why commercial real estate debt remains an attractive opportunity, which sectors MaxCap is finding attractive right now, and how the outlook for the Australian economy will impact the space. 

This interview was filmed on Tuesday 13 February, 2024

Edited Transcript

LW: What’s your outlook for the Australian economy in 2024 and how might that impact commercial real estate?

Brae Sokolski: We have a very cautious perspective. There is a huge amount of uncertainty and volatility, not just economically but geopolitically. There's no doubt that growth is anaemic and will continue to be so for the duration of '24, both in Australia and globally. We all know inflation is too high and has been for some time. 

There has been a moderation of inflation more recently, which is promising, but still well above the RBA target and a significant concern for us. Unemployment is low, but also part of the problem, consumer spending is moderate and business confidence is at very low levels. So the thing that most concerns us as a financier is uncertainty. Having a line of sight and understanding of what's ahead even if it's rather negative, we can still work against that backdrop. Uncertainty is highly destabilising, but it's also the nature of the game. Fortunately, we're in an asset class where we can weather storms and meet that uncertainty head-on.

LW: One of the things that potentially has held up all real estate is the large levels of immigration in Australia. If that were to moderate, what impact might that have?

Sokolski: Well, there's currently not enough housing to accommodate demand. Last year we had 3/4 of a million people enter the country. Something like one in every 20 Australians weren't in the country two years ago. The impetus for migration is there. The lull that we had during COVID has now more than been offset. The housing market, for growth, does not need migration. There is enough demand for new housing supply today, let alone tomorrow. The challenge is how do we bring that supply online? 

What people don't realise is that at the moment - for high-density residential - the replacement cost is higher than the end value. Until that equation is solved, which can only happen with a significant drop in the cost of materials and the cost of trades, which is not going to happen, the best case is stabilisation or that the ceiling on revenues is removed. There will not be the ability to bring significant amounts of new housing supply, and high-density housing supply into the Australian market and solve what is currently a chronic shortage, but what in two or three years in my mind will become a serious crisis.

LW: There's no wall of supply coming, is there? It's not like you can turn the taps on and all of a sudden flood the market with these residential opportunities. It takes time to build this stuff.

Sokolski: Well, that's right. And at the moment it makes no sense to build it. It's not feasible. So large-scale apartment buildings have been a critical factor in new supply in major cities in Australia for the last 20 years. Increasing that density in the cities is critical. Our infrastructure can't cope with continually moving the Greater Melbourne outwards. Yes, that's part of the solution. 

We also need to be moving up and until there's government policy that helps subsidise development and make it commercially viable, we're not going to see 10,000-15,000 apartments coming online, year in, year out as they have in Melbourne and Sydney over the last 20 years. 

If you look at the future pipeline, it's more like 2,000-3,000 year on year, and that's a huge chasm in the housing supply and a real challenge for our governments to try to resolve.

LW: Let's talk interest rates, the topic du jour at the moment. How does it impact the way MaxCap invests when rates both go up and go down?

Sokolski: A real virtue of our asset class in terms of our investors is that we structure our transactions so that we charge a margin over the base. So as the base rates go up, our investors get a higher return. That's great from a capital perspective, but it's a threat from an investment perspective because the higher interest rates hurt the borrowers and hurt asset values, which diminishes the credit. There's a balance. Rates being at zero weren't sustainable, and rates being at 4.5% is unsustainable. Somewhere in the middle of that range is healthy and where the market needs to get to.

LW: Brae, lenders have become more cautious. How does that manifest for MaxCap? What are you guys doing?

Sokolski: We have always been incredibly diligent with our credit. I don't think we're more cautious now than we were in 2020 during the benign conditions; zero interest rates, no construction cost escalations, huge amounts of demand being met by supply, the good old days. But we have a culture of always looking at the worst-case scenario, of sensitising to an Armageddon situation. That culture hasn't changed.

It's held us in very good stead over the last few years when there have been unforeseen events that have impacted our loan book, but we're doing the same things today as we were yesterday. The only thing I will say is that the management of the book has become more intensive. When things don't go right and developers can no longer stay with Plan A and they have to move to Plan B or Plan C, we have to be able to transition with them and help them still deliver the project because that's our source of repayment. 

Yes, if there's a diminution in value, or if the builder's having significant cost overruns, that's typically funded by the other side of the equation, not by the lender. But we still need to work hand in hand with them to ensure that there's the smoothest possible transition from plan A to plan B or plan C. And we've done that extremely effectively over the last few years.

LW: What sectors are you finding most favourable right now? Where are you hunting?

Sokolski: We're very bullish on the living sector. The supply and demand fundamentals are so heavily in favour of the delivery of new housing stock. The challenge, as I alluded to earlier, was making commercial sense of it from a cost perspective. But if a developer can buy the land well enough, find a viable construction price and deliver the product, then we have a high degree of confidence that the end value of that residential stock will be higher tomorrow than it is today.

LW: Let's go from the theory to the practice. What are a couple of projects that you're involved in right now that are of particular note and that you might want to share with the audience?

Sokolski: Well, if we stick with the living sector for a moment, a couple of examples of recent transactions that have the hallmark of MaxCap credit written all over them is a deal that we did with a developer called Deicorp in Rosebery, in the south inner city in the south of Sydney. It's a developer that's had an exceptional track record - one of the largest developers in Sydney who are consistently delivering 1,000 to 1,500 apartments year in, year out. 

They build the product so they control the supply and we're able to fund that large-scale project without pre-sales and it's currently on program, on budget, and they're selling very well as they get closer to completion. 

Another good example with a different profile of the product is in Toorak Village in Melbourne with Orchard Piper, which has more of an owner-occupier profile of apartments than the Deicorp project, which is typically more investor-led, but a quality developer who knows the Inner Eastern precinct of Melbourne very well.

LW: Is there anything else that investors should be mindful of when they're considering commercial real estate debt and or the opportunity with MaxCap?

Sokolski: One thing I'll say to investors is we value your capital like our own. We haven't lost a dollar of investor capital over 650 deals in 17 years of doing business and we don't intend to do so. When you invest with MaxCap, when you give us a dollar of your hard-earned money, we don't take it for granted. We treat that money as if it's our own and we'll not let you down.

LW: So a perfect batting average.

Sokolski: Exactly.

MaxCap Group is a commercial real estate investment specialist

To find out more about Australian Commercial Real Estate investment opportunities, please talk to our team today at mit@maxcapgroup.com.au or visit our website here.