Lincoln Frost

The Subtle Art of Dealing with Contradiction

At present investors of all asset classes are focused on inflation, as surging demand and warped global supply chain constraints drive up price pressures to new highs. This environment has brought me to a personal edict – focusing on what I’m able to control. Inflation and interest rates are determined by the market, and market outcomes do not come in pick-and-choose packaging. Therefore, isn’t it best to focus on what one can control when structuring deals?

An inflationary environment is not easy to navigate. It is fraught with uncertainty, especially when inflation is at a multi-decade high. Private credit and its underlying asset classes are no different. But a few rules of thumb apply – and if things are indeed historic in proportion, why not look at history for some answers…

The recent inflation spike and upward movement in interest rates and bond yields has reduced the commercial real estate and bond yield spread. Looking at the nation’s history prior to the 90s, we can see that this is not new.

Investment volume in Australian commercial real estate remains solid, supported by factors including the relative strength of the Australian economy, relatively attractive returns and the reopening of the Australian economy following the COVID-19 pandemic. If anything, Australian commercial real estate transaction volume remained resilient in the June quarter of 2022, despite higher interest rates and bond yields. Transaction volume totalled $11.3 billion for the quarter, the second strongest Q2 on record, topped only by the $16.3 billion recorded in Q2 2021. The office sector recorded the highest transaction volume ($4.6 billion) of the main CRE (commercial real estate) sectors. ‘Other’, which includes hotel and student accommodation, had the second highest volume ($2.9 billion) followed by Industrial ($2.0 billion) and Retail (1.9 billion).

In private credit, success depends on quantifying investment risk, ensuring that risk is effectively priced, and managing changes in risk throughout an investment’s life. The same is true for the operators of the underlying assets.

For one, in the context of commercial real estate, shorter lease terms would allow rents to remain marked-to-market more often, thus benefitting the investor. Longer-term contracts for midstream investments could also offer some degree of explicit inflation management as revenues rise with higher demand. Leases or contracts with annual increments in-line with inflation and expense pass throughs again seem to work well. Assets in low supply market will likely benefit from a high growth and inflationary environment.

Other trends to consider (and arguably one could say are having more influence than inflation itself) are e/q-commerce and migration to urban/rural centres.

Finally, my tip is to avoid excess leverage, as assets with longer-term fixed rate debt benefit in an inflationary environment, as debt gets paid down with inflated dollars over time.

Australia has been a beneficiary of a powerful economic restart but disruptions will persist as global markets and investments react to a multi-speed, multi-region recovery. These dynamics present both challenges and opportunities for real asset investors around on how to identify secular growth themes, capitalise on structural trends and build resilience while aligning with long-term investment objectives.

Whether an investor is looking to construct higher income portfolios with cash flow generating assets or take on more construction/development risk with higher potential gains, or some combination of both, the versatility of real asset strategies is a particularly attractive characteristic in the modern investment marketplace.

Commercial Real Estate: The Investment Underdog?

In the time of crypto and the metaverse, it’s important to blow wind back into the sails of commercial real estate investment. Despite an ever-expanding definition, we mustn’t forget commercial real estate’s one non-degenerative feature — it’s an income stream.

In commercial real estate investment, cashflow is underpinned by steady rental revenue streams, offset by maintenance costs throughout the life of the asset. This net revenue stream makes the sector appealing to investors of various appetites.

The modern commercial real estate sector is beyond just office space. There are niche subsectors within subsectors all of which share one common attribute — to utilize their services one must pay rent. Understanding how to better utilise and cost-out these spaces is an ongoing journey, underpinned by effects from residential market conditions, such as population growth, housing affordability and household formation. If the residential environment is favourable, we can expect strong growth in commercial markets over the medium-term.

The widely accepted WFH-model produced mixed results for Office property sectors. while the never-ending rise of eCommerce created equally mixed results for the Retail property sector. The moral of the story for investors is that businesses are responding to the changing fortunes — some, for example, by creating single facilities for multiple business purposes, such as a shipment centre with offices or a showroom.

Other opportunities to keep abreast of:

For industries unable to operate on a WFH basis, think wellness and hospitality, these tenants continue to have healthy business margins being owned and operated only by experts in their fields.
The newest contender from the Atlantic is the Build To Rent (BTR) subsector. The market has experienced strong activity over recent years. Currently, 13,000 units are being built across 40 projects.

Australia’s fourth largest export is education, and international students need places to live. The short-term fix for student housing, traditionally, has been to cost-efficiently ‘modernise’ dated apartment units. However, given the size of demand is increasing, new builds will become the reality.
The net effect is that our present and future workforce need both more housing, and also more convenient housing, built with access to amenities and transportation in mind.

What to be weary of: rising construction costs can arguably be brushed off as a short term thing, but the absence of capital can not. State governments are each coming up with their version of how to assist the household with acquiring their first property, or even have more agency over their rents. But the long-term solutions have to be built on business fundamentals.

This brings me to my final topic, the appeal to the global institutional investor. The events at FTX, while a cautionary tale, touch on something equally vexing and incongruous. Star-studded (global) institutional investors investing in novel unsubstantiated businesses have felt their digital losses in the real economy. It’s a bit like having an imaginary friend stealing your real wallet. So next time (maybe this time) have a real customer pay for a real space for a real business with a real currency in a real jurisdiction.

Corporate real estate ticks those boxes.

Lincoln Frost
https://au.linkedin.com/in/lincoln-frost

Interest rates and private credit: a classic mismatch

In the face of market uncertainty, private credit has the long-held reputation of being a relatively stable, resilient investment offering. This reputation was tested through the first half of 2020 and into most of early 2021, when inflation was just a transitory phenomenon and didn’t require wall-to-wall coverage. Post-COVID, like the rest of world, we now contend with newer economic and geo-political (and climate) challenges. So it becomes the better question to ask — how attractive does private credit remain to investors when confronted with our new reality of rising interest rates, as well as the opportunities (and challenges) of a more open Australia?

Under the above circumstances, inflation is a double-edged sword to private credit. It creates both appealing and unappealing effects at the underlying sector level i.e. corporate, real estate and consumer segments.

In the past, I have mentioned how a large portion of private credit loans are floating rate, and therefore they generally provide some protection to investors against inflation (see this article). Based on the soundness of the lending practices of the originator, investors benefit from rising interest income and the underlying deals should ultimately generate higher yields. Across the investor class, this exposure should complement rival traditional fixed-income investment options.

However, rising inflation (and in this instance rising interest rates) will ultimately increase credit risk as borrowers are stuck with higher input costs and rising debt servicing requirements, creating substantial financial pressures.

In the last few months, we have seen countless instances of companies in the tech/construction sectors in particular, announcing layoffs as well as insolvencies. While devastating for those involved, we haven’t seen a chronic credit-induced crisis in either consumer or corporate balance sheets. If this translates, there will likely be greater emphasis on credit selection and a lower risk appetite.

This tells us very little about what is actually happening… but there are evident reasons to both invest and practice scrutiny when it comes to lending…a classic mismatch.

As for the economy: open borders mean more people, implying more opportunities for businesses as rate hikes are abated. While this is far from dismal, it’s still challenging. Private credit has a large exposure to the real estate sector, regardless of the type of development. So there are reasons to be cautious when it comes to lending. BUT we can confidently report that private credit isn’t being disproportionately affected and we’re not seeing a scarcity of demand/scarcity of funds entering the system. In the last couple of months, if anything, there have been headlines of developers returning deposits.

Pervasive cost pressures are still prevalent in the sector, rather than dwindling demand.

(After) Thoughts on Central Banks, Monetary Policy and Credit Intermediation

“Today’s central banks typically affect asset prices through primary dealers, or big banks, to which they provide liquidity at fixed prices — so-called open-market operations. But if these banks were to become less relevant in the new financial world, and demand for central bank balances were to diminish, could monetary policy transmission remain effective?” — Christine Lagarde (2018)

The financial system globally plays an important role in transmitting monetary policy to the real economy. Whenever a central bank adjusts its policy instruments, it relies on various financial intermediaries to translate the monetary change into the financing conditions for firms and households.

This inevitably brings us to the importance of bank and non-bank finance in the economy.

Non-bank financial intermediaries have steadily gained non-negligible market share, across various sectors, since their genesis. ] Progressively, a growing number of these firms are adopting market finance to satisfy the demand for credit. For central banks, it is crucial to understand how these developments matter for the transmission of monetary policy.

Specifically in Australia, concentration and distribution of non-bank finance operate between the short-term and medium-term interest rates, with many being pegged to the Bank Bill Swap rate (BBSW). The relative role of non-bank finance (and bank finance, for that matter) varies markedly across geographic locations, sectors and firm sizes, and affects parts of the Australian economy unevenly.

So how relevant is non-bank finance for monetary policy in Aus? Let’s investigate.

Non-banks have taken on substantial duration, liquidity, and credit risks on their balance sheets. Increased risk-taking can give rise to liquidity mismatches and affect the capacity of non-bank financial entities to absorb losses in a downturn. This has the potential to create systemic risk, impairing the monetary policy transmission mechanism.

Conversely, the credit activities of alternative lenders have several potential benefits. Firstly, the entrance of non-bank competitors leads to more competition and diversification in the financial sector. Secondly, a larger role for super funds and other institutional lenders lowers the need for maturity transformation in the market and could lower funding problems and systemic risks. Thirdly, as nonbank mortgage lenders have a limited amount of funds, they could/can only lend only if “the deal stacks up”.

Outstanding Mortgage-Backed Securities (MBS) totalled USD$13 trillion globally in 2020, with the outstanding US Residential MBS market remaining the largest, totalling USD$9 trillion. All the while, according to AUSTRAC data, there are now more than 600 non-bank lenders, making up around 7% of all debt financing in the country.

So, to answer the perennial question — how relevant is non-bank finance to monetary policy?

Australia remains a bank-based economy, but the rising prominence of non-bank finance has important ramifications for the transmission of monetary policy. Despite significant cross-state/geography/sector heterogeneities in financing structures persisting the rise in non-bank finance has been largely immune to policy. Yes, we’ve seen it respond to the real effects of policy, but the very structure of the non-bank lending sector has been unresponsive -even during heightened periods of financial stress.

https://allcap.finance/after-thoughts-on-central-banks-monetary-policy-and-credit-intermediation/

Image source: Forkast News

Durations and other consequences of rising interest rates...

“Ultimately as the world readjusts to a post-covid, non-zero interest world, solutions (forcibly or otherwise) have become more bespoke. We believe it is a worthwhile exercise for investors to reconsider private credit, especially in times of heightened uncertainty.”

With still rising in 2022, investor bond portfolios may be underwater. We only have to look to the UK, which is experiencing what can best be described as duration risk in its fixed income markets, and for some this means entire pension funds going insolvent.

In a rapidly rising yield environment driven by global inflationary pressures, private debt offers returns that are more attractive than traditional fixed income securities, which typically carry more duration risk - the risk of capital loss when bond yields are rising.

Private debt returns are typically ‘floating rate’ in nature, with lower (nearer to zero) duration risk. Returns are driven by a spread over a benchmark rate, depending partly on the credit quality of the borrowing party. Private lenders more readily dictate loan terms, benefit from greater control, and capture a higher premium due to a more captive audience. Direct lending is also less volatile relative to public fixed income assets, given that these private credit assets, including lend-out and hold assets, are not publicly traded and are not typically valued on any regular basis.

Read on.

https://allcap.finance/durations-and-other-consequences-of-rising-interest-rates/

Despite mounting economic uncertainty, the biggest issue for apartment markets nationally is not demand, but supply.

The sudden unanticipated rise in construction costs has disrupted entire project pipelines, invalidating previous project feasibilities and resulting in projects being delayed or cancelled. The collapse of building companies is also to blame, with developers having to return pre-sale purchasers’ deposits. Creative solutions, like re-negotiating with buyers to revise prices or switching to a build-to-rent (BTR) model, have meant that projects will be delivered - but the question of “when” remains unanswered.

The net effect of all this is a severe bottleneck in the supply pipeline of apartments. Approvals and completions have fallen across all dwelling types since 2021, and still-rising interest rates will have spill over effects on the broader housing market through macro-economic channels, including currency, borrowing, and financing effects.

In an already tight rental market, this persistent imbalance of supply is worsening the perceived apartment shortage.

However, like all good challenges, there is the opportunity to fix this - enter the institutional investor. Investing in high density residential projects can offer institutional investors diversification and stabilised long-term returns, in comparison to traditional commercial asset classes. Investors will be attracted by the presence of a captive (rental) audience, at least in the near term, and institutionally developed rental apartments will be crucial in providing a critical source of housing supply in Australia.

There is also the opportunity to go further and establish a private-institutional partnership. This would offer institutional investors access to a wide range of residential asset classes, while ensuring that the “little guy” private developers are also able to compete and operate beyond just apartments. Together with an infusion of capital, this kind of expansion will open more of the residential sector to competition.

Apartment shortages and sidelined institutional investors | Allcap Finance Despite mounting economic uncertainty, the biggest issue for apartment markets nationally is not demand but supply. First, a sudden unanticipated rise in construction costs has disrupted the entire project pipeline. Invalidating previous project feasibilities, rising costs have resulted in pro ...

Allcap Finance is thrilled to see the Akin residential project commence construction, after we successfully arranged the construction finance for the development earlier in the year. Located in South Brisbane on the coveted Merivale Street, the construction of the 30-story tower is being undertaken by Descon Group Australia.

Rounding off the team is DBI Architects, who have been working with buyers to customise the design of their new homes. This unique, future-focused design extends to amenities including number plate and facial recognition, full home automation provisions and a thriving rooftop intended to replicate the best of the city’s social life - including private dining rooms and outdoor barbecue and dining spaces, commercial kitchen, wine cellar and cinema.

Best wishes to all the delivery team on a successful journey ahead.

Akin by Tallis Property Group construction update video in South Brisbane Akin's groundbreaking commenced in February this year, with the development soon to take shape on its coveted Merivale Street site. Watch our construction update video to learn more. Desc...

At the Union with Harold D. of ICC Development Group last weekend. I thought I’d share these pictures, as there’s got to be some sort of lesson around relationships being built over shared commiserations… no? It wasn’t the Wallabies' night, but we weren’t to know that when these were taken on the field during warm-up – exhilarating!

A big thank you to Harold and ICC Development for the invitation and the matching scarves.

Team Vista is an organisation close to my family’s heart. It was founded by my late father, Kerry William Frost, and continues to be lovingly (and tirelessly) run by my mother, Kerry Anne Frost. Team Vista’s mission and purpose is to improve the poor living conditions in the community of Moshi, Tanzania, through education sponsorships and physical donations.

If young people can get through school, healthy and hopeful, many more doors are opened and they are in a better position to break the cycle of intergenerational poverty. The Team Vista sponsorships have lifelong impacts, and ALLCAP Finance is honoured to support two students, who have gone through primary and secondary education, and are now in college and university.

I invite you to read more about Team Vista and some recent updates below.
https://www.lincolnfrost.com.au/post/team-vista-allcap-update

The size of non-bank securitisation issuance has grown fourfold since 2012 and now attracts over 24 individual participants, meaning non-bank lenders are now able to attain cheaper costs of capital.

While not the most traditional, it could be the new norm if one’s balance sheets are big enough. So investors are asking – how big is it?

The recent successes of the non-bank lending sector have brought in interested local and international asset managers, with the scale of some NBLs allowing them access to public markets.

So, what we’re seeing is an uptick in pace and value of capital, and the non-bank sector offering niche items such as capital that is privately funded, as well as something more mainstream like securitised debt. And with size comes economies of pricing – the bigger you are, the cheaper your cost of capital.

Read more:
https://allcap.finance/how-big-is-it-securitisation-by-non-bank-issuers/

Federal policy responses over the past two years ensured that the Australian economy through the COVID-19 pandemic remained resilient. Benchmarked against our global peers, the nation had a stronger post-pandemic recovery than many might have expected. Early focus on the housing and construction sector was instrumental in creating new jobs and investments across the development chain.

However, fast-forward to 2022 and otherwise accommodative policies are now blamed for the reverse - this being a slow delivery pipeline and a gradually rising deterioration of housing affordability and material shortages. Our nation’s capital cities rank among the least affordable in the world, and these hardships are spreading to regional markets.

The role of the development and construction (D&C) industry down-under cannot be understated, contributing to 9% of Australia’s GDP in 2021, with 11% of Australian jobs depending on the industry. So, fondness for revisionist history aside, we think it’s imperative to address these challenges both within the D&C sector and the broader macro context to better identify what is causing this mismatch. Read more below.

Learning never stops, no matter the stage of your career…

The increasing economic uncertainty brought about by the pandemic has placed unprecedented pressures on financial markets across the world.

The property sector has become an unfortunate victim to this calamity.

These issues and the ongoing uncertainty are impacting loan terms offered to borrowers as credit risk has been repriced all pointing towards an unwillingness to lend.

However recent changes in regulation have added a level of flexibility to Australian property.

Head to the link below to get a better understanding of how the Australian property sector has been impacted by the COVID-19 pandemic…

https://allcap.finance/show-me-the-money/

I know from experience that yes, some people are naturally good leaders but for others, it is something that needs to be learnt and continually worked on. I believe that it is crucial when leading people to always be trying to better yourself to improve your mentoring or leadership skills.

In September 2021, I had the opportunity to work closely with the developer of Aspire Gold Coast, Stoyan Kieceec.

My team and I at ALLCAP Finance assisted with arranging senior land acquisition capital.

I was also able to directly invest in the project alongside the other owners, and am now Director and partner on the project.

The DA for this project has been lodged for a $170M luxury apartment development over 24 floors.

Watch this space for updates on the development progress.

Having good nerves has gotten me through a lot…

ALLCAP finance have been supporting Team Vista since 2016.

Team vista is a charity that supports communities in impoverished countries to have better access to education.

ALLCAP finance has donated $20,000 to Team Vista, currently operating out of Tanzania, and pays for two members of the Moshi Tanzanian community to attend university.

For more information about the Team Vista Charity and the support we give them, follow the link below:

http://www.teamvista.com.au/lincoln-frost.html

Proud to announce that a few weeks ago, Allcap Finance secured a partnership with Reward Homes to deliver 488 house and land products for the Singleton region.

Over the last 12 months, we have been diversifying the way in which ALLCAP works with our clients. Off the back of this, we have entered a JV partnership with Reward Homes, recently securing two beautiful land subdivision sites in the Singleton region in NSW.

349 Bridgman Road Obanvale (370 lots)
133 Pioneer Road Hunterview (117 lots)

We have a very supportive council behind us on both developments and we are excited to bring these projects to life.

I would like to say a massive thank you to Michael McCrudden and the team at Reward Homes for the confidence in working with us, and to Ratu Knight from Isoa Group for helping to secure the site and act as our development manager.