About this Interview
Brae Sokolski is the Founder and Chief Investment Officer of MaxCap Group - one of Australia's leading commercial real estate debt & investment specialists.
The Interview, Brae Sokolski Transcript
*Please note, this transcript was auto-generated and some inaccuracies may exist.
Rob Langton 00:00
Hi, I'm Rob Langton from DevelopmentReady our interview series delves into the lives of Australia's most respected properly thought leaders and decision makers and uncovers what makes them tick. This is The Interview. Our next guest is Brae Sokolski founder and chief investment officer of MaxCap Group, Brae thanks for your time this afternoon. As I understand it, you launched max cap group around March 2007. Tell us a little bit about your background and the background of the business I suppose.
Brae Sokolski 00:28
My background's quite diverse, and I certainly don't have finance and property running through my veins. I actually studied law at university and then went into sort of a commercial role at FMCG business, Cadbury Schweppes, and thought I wanted to stay in sort of marketing sales role within that industry. But I was going to use it more as a, I guess, a learning ground for me to pick out what's important in business, learn from people's virtues and vices and go out and do something on my own fairly quickly.
I sort of had a three to five year plan to start a business in my late 20s, always fairly entrepreneurial. And as things would have it, my business partner, Wayne Lasky, who I've known since we were in primary school, and we'd always said we're gonna go into business together at some stage during the course of school, he was at Visy Industries, also very lateral to what we're doing now. And we actually started a business which had first right of refusal on RMIT technology, through a mutual connection, and we're able to commercialise some technology coming out of out of it basically, at our discretion, which is fantastic, because we saw so much diversity in so many different opportunities. And it's venture capital effectively.
So, you know, we launched probably half a dozen different products, and five of them fell, but one of them was very successful, which is a solar energy, advanced solar energy technology, that got sold into China. And that sort of reached the end of its lifespan that, that relationship with RMIT. And we were looking for something new and Wayne's father actually is in property. And he had dealt with two guys who had previously run a very similar business, business model, to MaxCap and they'd sold the business and wanted start again.
And Wayne and I, we're looking for something to do. And something meaty to bite off as having more sort of a long term horizon and thought, you know what, this is a great opportunity, we're going to learn the ropes from these experience, guys. And hence we were thrust into the world of real estate finance without any experience just before the GFC amazing. Yeah, so very serendipitous how that all came about.
Brae Sokolski 02:17
And have you seen the business evolve over the past 13 years? As I said, you launched it in March 2007. So prior to the GFC, how has it evolved and grown over that 13 or so years?
Brae Sokolski 03:15
The landscape of commercial real estate debt has changed so dramatically in that time, pre GFC, the banks, you know, were a pure oligopoly when it came to a commercial real estate debt, and that were lending developers up to 100% of development costs. borrowers have moved from one bank to another on the back of 10 basis points, it was an incredibly aggressive environment with the major banks. And there was basically no room for other players, even mezzanine finance, because banks were so aggressive with their gearing, mezzanine finance was really the dominion of second tier lenders.
Lenders have wanted to deal with borrowers that weren't necessarily credit worthy. It wasn't seen really as a legitimate asset class, pre GFC. So, to be honest, our model as we started was in a market where it was relatively defunct what we're offering. Yeah, so we acted more as an advisor to some major property players in terms of sourcing the best bank finance. Then with the GFC, there was a massive market dislocation. The oligopoly remained in place but all the sudden the banks had to leverage down.
So rather than offering 100% of costs that we're offering 75 to 80% of costs. And that's when mezzanine finance really started to mature and develop into a legitimate asset class in Australia and MaxCap started to be active in that space, and sourced institutional capital and develop different types of strategies to participate alongside the banks and grew our mezzanine finance book to be the largest in Australia on the back of that institutional capital. So that was sort of the second wave of dramatic change within that 13 year period.
Then came 2015, 16, when APRA, the regulator all of a sudden decided put its foot on the bank's neck and that they were overweight and real estate, and forced the banks basically to retreat from real estate lending, and open up this whole new opportunity for non bank lenders to participate and actively fund credit worthy strong developers. Rather than being sort of another layer of finance for either banks, all of a sudden, you could be at the forefront of competing against the banks. Once again, I think we were fairly prescient in seeing that opportunity ahead of time, and we had lined up some very large institutional capital to participate as a, in first mortgage lending.
So we hit the ground running when that next wave of dislocation happened. And we're able to capitalise on that opportunity and be at the forefront of that non bank lending space. And from that point till now, it's obviously continued to grow, as the banks have continued to retreat. And we're seeing a much more mature and diverse and dynamic commercial real estate debt market. Now, vis a vie where we were in 2007.
Rob Langton 06:15
So in terms of the alternative lending space at the moment, how, how has it changed in terms of the competitiveness? And how do you stay at the forefront of being one of the competitive lenders in the marketplace?
Brae Sokolski 06:26
That's a very good question. The non bank lending space was effectively not exist in a decade ago. So when this major dislocation happened in 2015 2016, and as this tectonic shift from banks to non banks, all of a sudden, yeah, there was this universal acknowledgement of, you know, his major opportunity.
So there are some established players that have been doing it for quite some time, like ourselves and and a number of others. But then all of a sudden, there was this influx of competition, both from domestic and global institutions. And the competitive advantage we had is, we'd already had an established brand name. And we have very strong relationships with borrowers through the advisory function that we sort of started and grow the business through the mezzanine financing, or providing these top tier developers.
So we established our credentials, and the relationships and relationships really is still what holds us in exceptionally good stead in the marketplace. You know, the ability to fall back on your track record, the referrals you get by virtue of you know, delivering on commitments to borrowers. And to have that confidence and certainty of funding, knowing when you issue a term sheet, you're going to be there to fund and having the sustained track record of success in doing so. That's very difficult. And it's a very high barrier of entry, even if you've got big global capital and coming invading your chest without having that background and trenched.
Understanding the Australian market and those relationships, it is difficult to still penetrate. And whilst we are very competitive capital, and you know, very adroit with structuring finance, that stuff's all secondary to relationships, and meeting commitments and people being able to rely on you. And like I said, that's what creates high barriers to entry in any financial services business, and continues to set to set us apart from the competition.
Rob Langton 08:40
And you mentioned relationships there. Have you gone about building relationships with your key clients and some of those really prominent developers, whether they're in Melbourne, whether they're in Brisbane, Sydney, Perth, how do you go about building a relationship with some of those guards?
Brae Sokolski 08:54
Yeah, I mean, relationship building is one of those intangible things, Rob, you know, like, I'll maintain business development, the ability to open door and close door. That's still the single most valuable commodity anyone can bring to a business across industries. So there is no science behind relationships. It's about empathy. It's about emotional intelligence. It's about integrity. It's about people enjoy your company, genuinely enjoying doing business with you.
Because whilst Yes, you have to look through things through a commercial lens, if you actually like someone, and they're offering exactly the same thing as someone who you don't like, you're gonna gravitate to that person where you have the natural affinity with. So, you know, for me, that's, I think that's the highest skill I have and go and learn at a university.
Yeah, my law degree means absolutely nothing. When I'm at a lunch, wining and dining a client and trying to convince him to do business with MaxCap, your intellects irrelevant. You academia is irrelevant. It just comes down to the connection. So that's, I guess the best answer I can give. And I've tried to inculcate that. Within the business, and you know, at its essence, it's actually just being a good person and doing the right thing. And if you promise something, make sure you deliver on it. People don't forget that.
Rob Langton 10:12
And what about the regulatory environment at the moment with APRA and all these different organisations and government bodies? How do you go about navigating that that environment? And do expect more or less regulation over the coming years?
Brae Sokolski 10:40
Yeah, well, we are, we're in a privileged position where we aren't regulated by APRA as a non bank lender. So we have an AFSL. So it's an ASIC regulation, but APRA have no regulatory power over commercial real estate lenders, that aren't ADI's, Australian deposit taking institutions.
The reason why I feel we've, future proofed, in that regard is when on a balance sheet lender, like the banks, so we are an investment manager, which effectively means whilst we co invest alongside our private or institutional capital, we're effectively representing that capital and investing on their behalf. So if you know God, hope that doesn't happen. But if something happened to MaxCap, and the business collapsed, the structure is such that way investment manager, you just bring in a different trustee effectively to manage that mortgage, and the capital still stays on foot, still liquid, and you're funding your commitments.
Whereas if a bank collapses, its balance sheet, and you can no longer family commitments. And that's the difference. And that's why they have these capital ratios, and all this rigorous safeguards around protecting and preserving their businesses, because we can't afford them to collapse, A, because they're so large, but also B, because of the fact that they're actually directly lending the money not acting as an investment manager.
So I don't think we'll ever really be the cynosure of goals or regulatory eyes be by virtue of that, you know, I do believe that in time, the regulatory regime will probably encompass non bank lenders more around the credit standards, then the balance sheet. preservation, we've already put that in place and have very rigorous processes. So that doesn't hold any fear for us.
Rob Langton 12:46
Just on that, I was gonna ask you, where where does the capital originate from? I mean, obviously, it would be high net worth individuals, family offices, but where else? Do you really get that capital input into the business?
Brae Sokolski 12:58
Yep, good question. So there's really three key buckets of capital for us. One is the mandates we have with the superannuation funds, which are effectively criteria against which we can invest their money, we go do the origination do our own internal credit, and then it gets signed off by the super funds, but we have exclusive right to access their money to invest.
That's typically for very, very large scale transactions, then we have another bucket of capital, which is discretionary funds, which we raise capital from smaller institutions and privates. And it's a pool fund effectively, once again, against criteria, and we manage that money on their behalf and manage a pool of loans in that fund. And that typically has a closed end. So it might be a four or five year fund might have 10, 15 loans that we manage on their behalf. And then we distribute income accordingly, and then close the five and return the capital on conclusion.
And then the third and final one is what we call syndicated loans, where for one reason or another doesn't meet the parameters of the mandates or discretionary funds. And a lot of transactions fit within this mould and we'll go and effectively raise money on a deal by deal basis issue an IM each investor, signs off on their commitment against the memorandum. And then we'll bring together could be anything between two or three investors up to 20 investors into one loan and and then go on to the next one and raise the capital again. So they're the three ways that we effectively operate in the market.
Rob Langton 14:41
And what about the equity side of the business? I think I read or saw recently that you're starting to invest in projects yourselves and develop projects potentially yourself. Think about that.
Brae Sokolski 14:52
Well, that's a very that's a burgeoning business unit for us to really grow Engine for the business moving forward will never be developer, it's important I qualify that Rob, we don't want to be a developer, we don't profess to be, we surely don't want to be competing against our clients. But what we are is a capital partner. So we're a developer client needs a joint venture partner doesn't want to find the equity in its entirety or doesn't have the capacity to fund the equity in its entirety for development, we'll look at the project and look to be effectively in a first loss position alongside that developer as a joint venture partner.
And it's important that we separate that business from our debt business because I conflicts. And they can arise if you're doing both debt and equity. But more importantly, to different skill set, yes, you need to understand real estate in both functions of the business. But looking at transactions from a direct investment perspective and a first loss position, as opposed to looking at investments from a debt perspective, very different dynamic.
So we have resources that are much more experienced in asset ownership and acquisition in our direct investment, rather than financing in our in our debt business. The beauty of the direct investment businesses, you're able to control your destiny more effectively, that in the investment business, because in the debt business, you're relying on the activity of your clients, on developers actually buying sites developing out. Whereas in direct investment business, it's easy to approach clients to be more proactive about supporting them to get developments off the ground. So I've seen particularly through COVID, it's been a very active and successful component of our business,
Rob Langton 16:40
just in terms of, of sectors that you're targeting at the moment or sectors that you're avoiding. I mean, you know, you deal with the breadth of developers, as I mentioned, the opening right across the East Coast, and even in New Zealand now as well. So there must be some sectors that you're really seeing growth opportunities in and others that you're trying to reduce risk and exposure. And tell us about that.
Brae Sokolski 17:03
I mean, they're sort of self evident at the moment, you know, the sectors that are difficult, and have uncertainty associated with them, particularly hospitality and hotels, and commercial office, where West, we're not bearish about the prospects of those asset classes, longer term. But in the immediate term, we definitely are reserved, by virtue of there just being a lot of a high degree of uncertainty as to when those asset classes are going to recover. So we're certainly not actively pursuing exposure in hotel and an office.
We're very bullish around industrial, the whole COVID experiences only reinforced how critical e-commerce is to the, to the ecosystem of the economy. That whole last mile thesis resonates really strongly with us. With very, very active in that space. from both the direct investment in the debt perspective, we're still very buoyant about residential, I feel like there's going to, by virtue of COVID, supply, is going to fall off a cliff in two or three years because no projects being activated, and is the housing crisis that we had, you know, the precipitated the you know, the large lot of supply, I guess, from 2015 to 2019, still hasn't been rectified. It's still not in an equitable environment with regards to supply demand and supply for housing.
So we feel that if you can activate project and just get it moving, you know, the story on completion is going to be very positive come 2023, it is difficult to sell off the plan. Hence, this huge movement towards multifamily and build to rent, because you don't have the same challenges of having to sell off the plan, when there's very little incentive for buyers. And you can get the product built, and then hold it and, you know, perspective, we have a very good deal on completion. But yeah, we are we are still very active and very keen to support residential development.
Rob Langton 19:20
It's perfect timing, actually, that you mentioned build to rent there. What's your assessment of it? Are you bullish? It sounds like you're relatively bullish on its growth here in Australia. And I suppose the second part of that is, are you seeing many of your developer clients take a close look at it or actually take the plunge and start to build those sort of builds around?
19:38
Right. Yeah. I think it's overhyped. You know, every developer is looking at build to rent there's no doubt it's, it's the flavour of 2020. There's definitely a place for it, but I do still believe it's a niche asset class and will remain so for some time. The problem we've built around Australia is it doesn't have The tax strike and how the tax structure in Australia to support it. So it's very difficult for a built around product to stack up unless you're a large institution and can fund it through.
Because if you look at it from a traditional conventional development finance model, because the on completion asset is a low yielding asset, the interest servicing is very challenging. So, because the interest savings challenging, you reverse engineer it and say, Well, welcome we finance on completion that we're comfortable, right, which is typically sub 50% loan to value. Whereas, for a bill to sell with adequate prices, you're at 65%. And that 15% difference, because on the return on equity, if you're to begin another 15%, on the end value of the product of the of the project, it's going to have a very much inimical effect on your IRR.
So for private developers, it's really difficult to make stack up for institutions with a lot of capital, a lot of lazy capital that can afford to fund that throw, and debt doesn't matter. They make sense. And that's why saying operators have the yoke of marowak proliferating the built around product in Australia. And I think those institutions will continue to play in that space. And it's no doubt an emerging asset class in this country, but it's still in mature. I don't think it's, you know, going to occupy 50% of all products. You know, in a decade's time, like, you know, some pundits are suggesting, but it definitely has its place in Australia,
Rob Langton 21:42
On tax and tax reform we've just seen and I know you do a lot of business in New South Wales, we're just saying some proposed reforms there in terms of stamp duty and land tax. Do you have an opinion on that? And what effect it might have down the track for developers or developer clients?
Brae Sokolski 21:57
Well, I mean, Stamp Duty has always been the bugbear of, of every developer, every private developer, particularly. Because if by removing the stamp duty concession, which all states have done, it takes away the incentive for buyers off the plan. Especially if there isn't a an influx of of demand for particular project begs the question, why would a buyer purchase if they don't need to, and they can wait until completion, they don't have 10% sitting idly in a bank account for two years that the uncertainty as to what's going to transpire in that two year period, he just waits towards the products in flight. So I'm a huge advocate for re establishing the an incentive through Stamp Duty concessions to better motivate buyers to purchase off the plan and enable more projects to be activated and more supply to come online. And the knock on effect obviously is better housing affordability, you know, moving forward. So I think that is a very obvious tax reform that all state governments should be looking at.
Rob Langton 23:22
So just on mezzanine finance, I know it's a popular topic amongst developers tell us about what it is and how it can assist in in what they're doing.
Brae Sokolski 23:31
So mezzanine finance effectively allows developers to lever up their debt. So it's a layer of finance above and beyond the senior debt. So if you look at a capital stack, that the senior debt which is first mortgage lending, which is last in, first out when a project completes, you'll have mezzanine or second mortgage lending, which is second in and second out when a project completes. And then you have the developers equity, typically saying the debt in conventional terms will go to 65% of the value of the end product, or 80% of the cost. mezzanine finance will typically take you to 75% of the end value of a product, or 90% of the cost and then 10% equity.
So it gives you another sliver of debt that enables you to better utilise your equity and typically generate a better return on investment for the developer. Now, critically for us. The litmus test of whether a developer should be using mezzanine finance is I should I should be using it if they don't have to use it. And my by that, I mean, it's not a substitute or a way to get a project off the ground. We don't have enough capital to fund it is a means by which you can release equity that you'd otherwise have in the project to better utilise elsewhere.
So there's opportunity costs, your equity being tied. Often a project and you can go and acquire another site, or utilise it for another purpose or generate a better return on investment than what you're paying for that mezzanine finance, because the mezzanine finance by virtue of being higher risk than the first mortgage finance or the senior debt is at a more expensive, right. A lot of developers have always used structured finance, which is what mezzanine and senior debt together is classified as and used very effectively as part of their business model.
A lot of developers will pick and choose which projects they'd like to use a structured financing, which projects that use just typical vanilla senior debt. And then they're developers that are very conservative, and don't see the point in pain, maintain interest rates for debt, and will only use first mortgage funding. So it does depend on the risk appetite of the developer depends on the idiosyncrasies of a particular project, and what else the developer wants to do with their capital. But it definitely has a very pivotal role to play in development finance in Australia.
Rob Langton 26:06
What are you What's your take on on when traditional banks may return to really getting into the market and providing the same level of finance that they were prior to 2020? Or 2018? for them?
Brae Sokolski 26:17
Yeah, well, one thing I'm certain of is, the banks will never get back to the oligopolistic position they held in commercial real estate debt in this country, prior to the GFC. Hi, high 80s, in terms of their proportion of all commercial real estate debt in this country. So 87 88% is what they paid that, that's now come down to close to the 70%. And our house view is that will erode further to around the 50 to 60% Mark, which I see as being a healthy debt market, you need the diversity, you need the non banks to be active.
You don't want this homogenous bank product or the reliance on four major lenders, particularly when they're disempowered these days by virtue of the regulator and they're not able to make their own decisions on capital deployment. Will their regulator potentially loosen the the restrictions? Yes, I think the treasurer is a big proponent of less regulation, at the moment is particularly targeted on retail lending, and home loans. But I do believe it will translate to perhaps more laissez faire regulation for the banks on commercial real estate debt over the next few years. And I think that will enable them to come into market and compete a little bit more actively than I have been.
But no, they'll never return to that same to this position of preponderance and the non bank lending. Dynamic is here to stay. And in my mind is is a healthy and necessary part of any credit market, irrespective of geography. And you look at the US and European experiences with a much more mature and complex credit markets. And non bank lenders or institutional capital typically occupies at least 50%. Of all lines written in those markets. And I believe that's where we're heading. And I believe that's a healthy proportion for institutional versus First Bank capital in this country.
Rob Langton 28:24
On a global scale. how attractive Do you think Australia is as a destination for investment, as a result of the handling of COVID that we're seeing this year as compared with the UK or the US or any other country? For that matter? Do you think there will be an influx of new capital into Australia?
Brae Sokolski 28:41
Yeah, I think COVID reinforces what a safe haven, Australia is. You know, being obviously in Ireland, and not having porous borders, makes it a lot easier for us to manage through a pandemic. So I think if anything, it's going to hold our real estate marketing in great stead come the recovery. And, you know, come the time when borders reopen, and there's a vaccine, and we can return to business as usual. You know, I think those particularly the key gateway CD, global gateway CDs in Melbourne and Sydney, which are already on a very steep upward trajectory in terms of attracting global capital prior to COVID. They'll come out of this only bigger and stronger.
Rob Langton 29:23
What's your thoughts on on the market for the next 12 to 24 months? Where's it headed?
Brae Sokolski 29:29
I think that'd be really strong recovery in residential values in Melbourne and Sydney. I don't think Sydney hasn't come off all that much. But obviously Melbourne has been has been particularly hard hit. I think we'll see a bounce in mid 2021. And then a very strong recovery from that point forward.
I do have a very sanguine view of the real estate market in this country generally. And, you know, I think the asset classes that I'm uncertain about with which is hotel and office I'm loathe to sort of forecast where they'll head over the next 12 to 24 months only to say that occupancy rights particularly in the office are going to be very slow to to recover and what their post COVID normal looks like for for the large corporates particularly, and how much office space that we're looking to occupy visa, they were they were pre COVID? You know, that's the big question.
And there's no doubt going to be a shift a cultural shift in the way employees interact, and the amount of time employees spend at home versus in the office. And how that translates to demand for for office space is going to be fascinating to see in the ensuing years.
Rob Langton 30:53
Two final ones to finish on a you're a passionate horse racing fan and advocate. Where did that passion come from? I think I read that to you watching it on television once because there was no other sport to watch. And you sort of learned about it through there. Is that true? And secondly, where's your passion for horse racing now?
Brae Sokolski 31:10
Yeah, it's interesting. I mean, I actually had an aversion to horse racing growing up as a kid. And I'd always turn the channel off when the sports news turned to that topic. And I just started taking active interest. In my final year of school, just as a distraction from exams is around that same time in the Spring Carnival, I just wanted a way to break it up. And it went from being sort of a passing interest, to a passion to, you know, the venerable obsession now.
And, you know, it all comes back to that connection with the horse, being around horses, spending time in stables, watching track work, and just this majestic animal. And the, you know, the connection that you have with the animal, that's the most important thing to be passionate about the industry. If you don't have that passion for the animal, then you're never going to be passionate about the industry. And you know, Winston Churchill said it best when he said, the outside of a horse is good for the inside of a man and there is something about being close to horses that just make you feel great. But to me, the, the appeal in terms of the industry goes obviously beyond just the love of the animal. And I love the whole analytical challenge of doing form of, of the breeding side of things and delving deep into pedigrees.
And I find it quite a cerebral outlet for me. And you know, I don't want to look at racing through a commercial lens, because I do that every day with my business. So I try to avoid looking at it in terms of dollars and cents. To me, it's just the challenge of being successful, and achieving great things in the industry. And that's what drives me. And the whole ownership piece where you can actually be part of a sport, as non athlete, It's the only sort of mainstream sport that gives you the access to be in the huddle, with the jockey and the trainer before a race, they feel part of the sport and that you can change the course of history as an owner by making critical decisions, which I have in the past.
And that empowerment, I think is what is so magnetising about horse ownership and what drives me to continue to be actively involved in and seek success and bring new people and clients into the industry and say their their joy at participating in winning a race for the first time
Rob Langton 33:41
And the thrill of winning the Melbourne cap or one of the other major group one races, what's that, like, if you can describe.
Brae Sokolski 33:49
The most exhilarating thing you can experience? And, you know, I've had, you know, professional footballers, one premierships involved in horses and say to me that actually was more electrifying winning major race than it was being part of the Premiership.
So Dennis pagan, you know, is a good example. He recently said it was 10 times better winning now the Darby with Johnny be angry than it was, you know, winning a Premiership with North Melbourne. Now, he might have been getting caught up in all the hubris of the aftermath of the race, but it gives you sort of some insight into just how, like, what an incredible experience it is and how much you feel part of that victory, not as a spectator, but as an integral protagonist in the sport. So yeah, it's it's something that's very difficult to explain, but I hope everyone gets the opportunity one day to experience it.
Rob Langton 34:42
Brae it's been an absolute pleasure having you on our program. Thanks so much for your time this afternoon.
