How private lending can offer diversification in SMSF portfolios

October 2020

Content provided by Zagga

 

Recently Business Insider posted an article ranking the best and worst performing Australian super funds for 2020 with returns falling within the range of -2% to 9%.

YES – you read right. NEGATIVE TWO PERCENT!! Depending on where you are in your retirement planning cycle, this negative return can have a significant impact on your overall wealth position.

There’s no doubt that current investment yields are at an all-time low so in the current low-interest rate environment, how can self-directed investors, including SMSF trustees, earn higher yield without a disproportionate increase in risk?

Many SMSFs tend to build a barbell-style investment portfolio: low return cash investments to stay safe, balanced by higher-return equities, further up the risk spectrum, to increase returns.

At present, most deposit products are returning under 1% p.a, and if you’ve been investing in equities, you would have experienced the ups and downs of the equities market recently. You may have sold and exited on time, you may have done so at the wrong time, or you may not have exited and are still riding the rollercoaster; the key thing is, you don’t make your money (or loss) until you exit.

Additionally, as you are managing your own SMSF, you are most likely facing a number of challenges:

  1. Market Volatility – high risk, high returns? Or low-risk low returns? Or does it resemble a rollercoaster from your childhood theme park?
  2. Sequencing Risk
  3. Record low yields
  4. Traditional alternative asset classes hold more risk

Self-directed investors tend to be very knowledgeable on traditional investment opportunities and channels but what about alternative options that can offer attractive yields without a commensurate increase in risk? And yes – such alternatives do exist; marketplace lending is one such alternative asset class.

Lending against secured property has been the preserve of banks for a long time and marketplace lending is a growing alternative asset class that can offer eligible investors the opportunity to add a ‘middle ground’ to their investment portfolio to create more balance and potentially increase yields without commensurately increasing risk.

As an example, there are private lenders who offer investment opportunities through the funding of loan opportunities underpinned by a registered first-mortgage over real property in Australia.

Generally, these properties are independently valued and, as an investor, you may have direct access to the underlying mortgage – although this varies from lender to lender.

As with all investment products, there are risks involved but investing in an alternative asset class such as this, is risk of a manageable kind as generally, you retain full control over:

  • whether you are going to invest in each of the loan opportunities presented to you
  • the amount you wish to invest (subject each offering’s minimum investment threshold)
  • the loan term, loan-to-valuation (LVR) ratio, loan purpose and security location against which you are prepared to invest.

In other words, if the loan opportunity doesn’t satisfy your requirements, you do not need to invest in it.

Many, when hearing about marketplace lending for the first time, often approach with trepidation and ask – Why does this gap exist in the Aussie market? If these loans are creditworthy, why won’t the banks fund them? And if not the banks, why not another second-tier lender? Why would they need to pay a higher premium to find funding?

These are fair questions as many often have the misconception that if the banks are not funding the loan, then the loan transaction, or the borrower, is not creditworthy. This is simply not reflective of the many lending applications that are declined by the banks.

The gap has always been extant in the Australian market, however, is now more prevalent. This is mostly owing to a pull-back by the banks which took a hammering following the Royal Commission into Banking about 18 months ago. Prior to that, the banks were pressured by the regulators, mostly the Australian Prudential Regulatory Authority, to tighten lending into the residential sector. The result is that banks have tightened their credit policies on what was already an onerous, extensive and inflexible regime.

Post COVID, banks have become even more risk-averse, focusing on managing their existing books, and making it even harder for their existing customers to access loan funding.

There has always been a healthy margin between primary lenders and private lenders. Private money is more expensive and comes at a cost as it generally comes more quickly and with more flexibility. That is not to say the credit is sloppy or in any way inferior to the banks and traditional lenders, it’s just that private lenders make things happen faster, are more commercial in their approach, and can make decisions faster when required.

From our experience, borrowers who approach us are those that have previously enjoyed facilities from a major bank, and in many cases, have long standing relationships. However, these borrowers – often large property development firms, simply cannot afford to wait the six months it will take for their banks to make a decision. That extensive wait-period is easily covered by the cost of taking a private loan and getting stuck into their projects.

An alternative asset, such as that offered by Zagga, generally fits into any well-balanced investment portfolio. It is not there to be a replacement for any other asset; it is there to ‘prop up the middle’ – something between the high risk/high returns, and the low-risk/low returns.

The investor returns offered for private lending investment differs from lender to lender so SMSF Trustees interested in this alternative asset class should look around to find one that suits their investment objectives and preferences.

 

To find out more about private lending into mortgage-secured loans, we invite you to view this short video – https://youtu.be/UGl8FEEcXlg – Zagga CEO & Co-Founder, Alan Greenstein, shares his thoughts and views on the recently reported super fund returns on 2020, and how an alternate asset class, such as that which Zagga offers, can provide that MIDDLE GROUND in any well-diversified investment portfolio.
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