0:05

Welcome to the Fear and Greed business interview. I'm Sean

0:08

Aylmer. Australia is still in the midst

0:10

of a housing crisis. House prices have

0:12

risen for 15 consecutive months. Rents

0:14

are soaring. Demand is outstripping supply.

0:17

Today, I wanted to look at one possible

0:19

solution to help ease the housing crisis.

0:21

Could private credit make

0:24

a real difference? Remember, this is general information

0:26

only, and you should always seek professional advice

0:28

before making investment decisions. Alan

0:31

Greenstein is the Chief Executive Officer and

0:33

Co- Founder of Zagga, an Australian

0:35

boutique investment manager and non- bank

0:37

lender, and a great supporter of this podcast.

0:39

Alan, welcome back to Fear and Greed.

0:42

Thank you, Sean. Nice to be here again.

0:44

We're talking much more about private

0:47

credit nowadays, as banks become

0:49

much more particular about who they

0:51

lend to. Has private credit in

0:53

Australia... I

0:55

get the potential for it. Previously,

0:57

has it ever really been a big part of the residential

1:00

landscape, historically?

1:02

Sean, I think private credit has been

1:04

around ever since people

1:07

first started lending money to one another.

1:09

There's always been, let's just called

1:11

it a gray market, where privateers have

1:14

operated. But certainly over the last

1:16

two decades, private credit

1:19

has emerged from the murky

1:21

background and has become much

1:24

more acceptable on the forefront. That's not to

1:26

say that over the last couple of decades it wasn't

1:28

still considered to be lender

1:30

of last resort type lending. In other

1:32

words, you were unable to get the money

1:34

from anywhere else, so you went to a privateer.

1:37

And as a result of that, you're considered to be high

1:39

risk and you paid a lot of money. I

1:41

would say that certainly since the GFC,

1:44

and more particularly since

1:46

COVID, private credit

1:49

has not only become an accepted

1:51

part of the funding waterfall, but

1:53

that many of the private credit operators today

1:56

are really highly credible,

1:58

highly competent, and highly

2:00

effective at what they do. And I would

2:02

imagine that a number of borrowers now

2:05

see private credit as being their first

2:07

port of call for finance, before

2:09

they go to the bank. So private credit has definitely

2:12

grown enormously, and I think it's

2:14

here to stay, and also here to grow. And

2:16

that's not only the case across the

2:18

world. In Australia, we're

2:20

beginning to see that... We

2:22

see that private credit is about 10%

2:24

of the market right now. That's forecast

2:27

to grow to about 25% of the market

2:29

in the next four to five years, which

2:31

means that one out of every four

2:33

deals will be a private credit deal.

2:36

But in the US, this is already at about 50%

2:38

of the market. So it can only grow.

2:41

And the point there is when it becomes such

2:43

a... Well, it is now an accepted asset class,

2:45

in a sense, on both sides of the equation,

2:48

for investors and also for borrowers. But

2:50

that also perhaps not so

2:52

good for the middlemen, but it

2:54

actually makes it a more competitive market, which

2:56

is actually, again, better for both sides

2:59

of the market.

3:00

Yeah, absolutely right. I think the critical

3:03

thing about competition and about it being competitive,

3:05

private credit is definitely a

3:07

low barrier to entry market, especially

3:09

if you're in the non- regulated market, if you're

3:11

on the commercial side. Obviously, if you're lending

3:14

to individuals in respect of their own residential

3:17

properties, you've got to deal with all of

3:19

the credit, they're regulated loans. But the

3:22

large majority of the privateers are not

3:24

at that end of the market. And, eventually,

3:26

therefore, being a lender is not hard

3:28

to do. So I guess it really comes

3:30

down to the quality of the lender and

3:33

the quality of the borrower. And that determines

3:35

the quality of the investment. So

3:37

from an investor's point of view, I

3:39

think you've got to look very closely at the counterparties. From

3:43

a borrower's point of view, you've got to make sure you're getting

3:45

the money from a credible lender because you want to

3:47

make sure the money's going to be there when

3:49

you need it.

3:50

Okay, so let's talk about the housing

3:53

crunch that's going on now and how private

3:55

credit can help.

3:58

Where do we stand with that? I

4:01

outlined what's going on in the housing market, and we all

4:04

know the story very well. How

4:06

can private credit help?

4:08

That's a good question, Sean. And I

4:11

think the way private credit really helps

4:13

right now, from a developer

4:15

point of view, is that there's an almost

4:17

insatiable appetite for

4:19

residential type development

4:21

in Australia today. I think

4:23

as we all understand, we've got

4:26

huge immigration. The population

4:28

is growing. We've got an influx of people.

4:30

Our large metropolitan areas are not getting

4:33

smaller, they're getting bigger. The metropolitan

4:35

boundaries, Greater Sydney, Greater

4:38

Melbourne, Greater Brisbane,

4:40

et cetera, are all extending now. They're

4:43

becoming wider and wider. And more and

4:45

more people need to be accommodated. We're

4:47

going to take in about 250,000

4:50

extra people a year for the next four

4:52

or five years, according to the immigration department,

4:55

to equalize the skill shortage.

4:57

And all of these people need somewhere to live.

4:59

Now, when you need somewhere to live, you also

5:01

need somewhere to go to school. You need somewhere to shop.

5:04

You need somewhere to park. You

5:06

need somewhere where your healthcare needs can be

5:08

satisfied. You need somewhere to pray,

5:11

et cetera, et cetera, et cetera. So the housing

5:13

market has a massive knock-

5:15

on effect on all of the other things

5:17

that need to be built. Now, that's

5:19

on the one side, that's where the demand is coming

5:21

from. The traditional funders

5:24

of this have been the banks. And the banks have

5:26

really got two problems. Through no fault of their

5:29

own, they've got massive regulatory and

5:31

prudential risk issues, which they need to deal

5:33

with. And that generally makes them

5:36

unwilling participants in certain types

5:38

of lending. Or more particularly, creates

5:41

restrictive lending practices for them.

5:43

They cannot be as agile and

5:45

commercial as entrepreneurial

5:47

as, say, a privateer can be. And,

5:50

secondly, banks have to operate within

5:52

very, very strict and finite

5:55

credit criteria. And those don't always

5:57

suit the market. And, generally, the banks are

5:59

a couple of steps behind the market. So,

6:01

today, if a developer wants to put something

6:04

up that is not 100%

6:06

within the bank's credit specs,

6:09

the developer is going to have a real difficulty

6:12

finding the money for that. Now, to a developer,

6:14

time is money. The quicker they get this

6:16

thing out the ground, the quicker they're going to get their

6:19

return. So developers have started

6:21

looking for alternative sources

6:23

of finance. And the private

6:25

credit market has been there to provide

6:27

that alternative source of finance. Now,

6:29

as developers have come to private credit,

6:31

more and more so private credit

6:33

has grown. And that's really how the market has grown.

6:36

Now, speaking only for Zagga, I can't

6:38

speak for others, but if we speak

6:40

to the kind of developers

6:43

that we're currently funding, they are

6:45

all clients of the large banks.

6:47

They come to us because we're able to

6:49

do the deal quicker for them, and we're a little bit

6:51

more flexible. It's not to say we compromise

6:54

on our credit in any shape or form. In fact,

6:56

I'd like to believe that our credit is as

6:58

robust, if not more robust, than the banks.

7:00

But because we don't have these gargantuan

7:03

structures, we're able to turn this around a

7:05

lot more quickly. And we're able to be

7:07

a bit more flexible on pre- sales

7:09

or other kinds of conditions, et cetera, to make

7:12

it worth the borrower's while. The quid

7:14

pro quo for that is the borrower's got to pay a bit

7:16

more money. And the advantage then to the

7:18

investors, they're going to get a better return than

7:20

if they leave their money sitting in a deposit account

7:23

or return account. And that's really how the cycle

7:25

is working.

7:26

Stay with me, Alan, we'll be back in a minute. I'm

7:36

speaking to Alan Greenstein, CEO and

7:38

Co- Founder of Zagga. I

7:40

suppose you're relying on the fact, particularly in residential,

7:43

people repay loans. That's the

7:45

great thing about property.

7:47

Yeah, I think, Sean, what's important to

7:49

understand there is that most of the private

7:52

credit operators are not

7:54

funding the individual owner

7:57

at the end of the day. The banks are still very much in that market.

8:00

We're funding the developer who's

8:02

building the unit. But I guess,

8:04

just to take your point, what we have

8:06

seen over the last four or

8:08

five years, and what maybe we would've expected

8:11

to see, but what we haven't seen, is

8:13

pre- sales are still holding up. So

8:15

to the extent that developers have pre- sold

8:17

units, the market is strong.

8:19

People who have paid for their units are

8:21

not letting those units go, even if the development

8:24

is taking longer, because property prices

8:26

have gone up. So the banks are still funding

8:29

the end user, but that is allowing

8:31

cash to churn through the system, and for the developers

8:34

to be able to repay their loans to the private

8:36

credit lenders.

8:37

Okay, so on the investor side with

8:39

Zagga, who are your investors

8:42

primarily?

8:43

So from a Zagga point of view, and I would say this

8:45

is true for most of us in the market, we

8:47

have a range of investors ranging

8:49

from high- net- worth individuals,

8:51

including self- managed super fund

8:54

trustees; to family

8:56

offices; to smaller institutions.

8:58

We, at Zagga, have a number of

9:01

smaller institutions who also

9:03

fund our loans. Whereas, some of the other players

9:06

are much bigger than us and they would've much

9:08

larger institutions, including sovereign

9:10

wealth funds. But I guess the point that

9:13

you're making, and that I'm making, is

9:15

that the investor population

9:18

for private credit ranges from

9:21

the single high- net- worth individual sophisticated

9:23

investor, all the way through to

9:25

the large financial institution. And

9:27

many of them are foreign. Some of the statistics

9:30

that are coming out today suggest that

9:32

foreign investment will make

9:34

up about 48%

9:36

of the market over the next five years, which would've

9:40

quadrupled over what it was two

9:42

decades ago. So we're seeing a lot of foreign

9:44

interest.

9:45

Okay. And so we've talked about residential then and

9:48

lending to developers,

9:51

what else does Zagga do? What other areas

9:53

are you lending to?

9:55

So from Zagga's point of view, our model is

9:57

quite simple. We will lend

9:59

for any legal business

10:02

purpose or any legal loan purpose,

10:04

provided that we can get first mortgage

10:06

security over the property. So

10:09

not every single one of our loans

10:11

is for a property purpose, i.

10:13

e. a development. We could be funding

10:15

a management buyout. We could be funding the

10:17

purchase of stock. We could be funding

10:20

some other business purpose, cash

10:22

flow funding. The first deal

10:24

we actually did was a buyout of one partner

10:27

over the other. But provided we have

10:29

a real property security,

10:31

i. e. a first mortgage over property,

10:34

together with any of the other guarantees that

10:36

we need based on the actual

10:38

credit assessment that we do of that deal,

10:41

we can just about fund any loan purpose

10:43

that lends itself to that type of security

10:45

structure.

10:46

You've answered this question earlier on, but where

10:49

does private credit go? So with that as background,

10:51

that's the kind of thing that Zagga and

10:53

others are providing money for.

10:56

What do you think the landscape looks like in

10:58

10 years time, in terms of someone

11:00

looking for finance?

11:02

Okay, let's talk about it from a finance point

11:04

of view, and then, if you don't mind, I may talk about it from

11:06

an investment point of view.

11:07

Yeah, yeah.

11:07

I think in terms of somebody looking for finance,

11:09

the market is going to grow. Because

11:12

as private credit grows

11:15

into the market and attracts more market share,

11:17

it itself becomes more sophisticated.

11:20

It is able to fund larger loan

11:22

sizes. It becomes more

11:24

accepted as an acceptable part of

11:26

the funding waterfall. And as I said

11:29

earlier, if the American and

11:31

the European experience is anything to go

11:33

by, and the trend that we're currently

11:35

seeing in Australia remains on

11:37

trend and is indicative of something

11:39

coming, then this market is going to grow

11:41

to being about 25%

11:44

of the total lending market

11:47

in Australia for commercial real estate

11:49

debt. That's not the total market, the commercial

11:52

estate debt market. So that part

11:54

of it is going to go. I'm not specifically

11:56

talking about unsecured

11:58

business finance or those kinds of things.

12:01

I'm not in that market and I don't understand it well

12:03

enough. But I see no reason why

12:05

that shouldn't continue to increase either.

12:08

So, fundamentally, I believe private

12:10

credit will continue to grow. The two

12:12

aspects of that will be the banks will continue

12:15

to become less efficient, not

12:17

more efficient. The banks will naturally

12:19

go to the bigger, larger, more complex

12:21

transactions. And the middle

12:24

part of the market will get taken up by the private

12:26

operators. So over 10 years, I

12:28

think it can only increase. Just to be able to talk

12:31

from an investment point of view, I

12:33

think that what's important, and what we haven't really

12:35

spoken about is, why are investors funding

12:38

private credit? And the simple result

12:40

is returns. Investors are now

12:42

earning between 8% and 10%, maybe even

12:45

more, for something that is a reasonably

12:48

safe, secure, but very

12:50

transparent, very consistent, and

12:52

very non- correlated return. So

12:55

if I've lent into the private credit market,

12:57

if I've put money into a

12:59

one year or 18 month deal at a 65% or 66%

13:03

loan to value ratio, and it's paying me 9%

13:05

or 9. 5% per annum, that

13:08

is not going to be impacted by the

13:10

bond rate or what the equities

13:12

market does. And I'm going to get my return

13:15

and I'm going to cash out my return. Yes, I have a tax

13:17

consequence for that, but that is a stable,

13:19

consistent, transparent,

13:21

reliable return. So in these markets

13:24

where there's high inflation, but we're not quite

13:26

sure what's going to happen geopolitically,

13:28

where there's a lot of volatility around,

13:31

an investor wants a safe haven for their money,

13:33

but they also want the highest possible return.

13:36

Now, as long as those conditions remain,

13:38

there are always going to be investors to

13:40

fund private credit.

13:42

Alan, thank you for talking to Fear and Greed.

13:44

Thank you so much for the opportunity, Sean.

13:46

That was Alan Greenstein, CEO and Co- Founder

13:49

of Zagga, that's Z-A-G-G-A, Zagga,

13:52

a supporter of this podcast. This is

13:54

the Fear and Greed business interview. Remember, this is

13:56

general information only, and you should seek

13:58

professional advice before making investment decisions.

14:01

Join us every morning for the full episode of Fear

14:03

and Greed, daily business news for people who make

14:05

their own decisions. I'm Sean Aylmer. Enjoy

14:07

your day.