Boutique property specialist Montello Capital Management started life in 2008 as a short-term bridging lender at a time when the established bank funding players were challenged by the turbulent economic backdrop.
Managing director Christian Faes, who has a background as a lawyer with Clifford Chance and Deutsche Bank, says he identified a business opportunity in the disruption caused by bank funding lines being pulled, and joined forces with chartered surveyor Ian Thomas.
“It was a complementary skill set. Initially, we just had a couple of high net-worth investors, which allowed us to get a bit of a track record in the market, but a hugely frustrating way to get any scale in terms of what we were doing.
“At that time there were no bank funding lines available to new, relatively untried lenders, so we went down the route of setting up our first fund in early 2010.”
This was the Montello Income Fund, which Faes describes as “a very plain, vanilla, UK UCIS fund, giving investors a fixed return”.
The underlying assets were first charge mortgages against property in the UK, with a strong focus on the London residential market.
Widening the remit
But with the UK’s retail distribution review making it more difficult to promote the UCIS fund, Montello moved into offshore distribution, to Hong Kong initially, then Japan, Dubai, Abu Dhabi and other expat centres where the London residential property story was a popular one.
“The Asian guys were saying, ‘Love the concept, love the underlying assets the fund uses and invests in but the structure you’ve got in the UK isn’t that efficient for us.’ So that’s when we looked at Luxembourg.”
This led to talks with the Luxembourg regulator, which said the remit of the short-term mortgage fund primarily based in London was too narrow and needed to be widened out to across the UK, as well as investing in broader real-estate opportunities.
Thomas says that played into their skill sets. “We see a lot of opportunities that aren’t necessarily lending but joint mentor opportunities with experienced operators and developers. This wider scope has allowed us to look at other areas with the assistance of CBRE in terms of further due diligence on the actual proposition.
“The broadening of scope has enabled us to expand the business as well and expand the reach of what we can do with the fund.”
So the Luxembourg-domiciled Montello Real Estate Opportunity Fund was born, with exposure primarily in the south-east, and more specifically 90% of it lent within the M25 motorway, which Thomas says was driven by the need for liquidity.
“It’s probably less the case now than it was but those markets over the past five years have been far more liquid. If you had to sell a property in those locations, you had maybe 10 potential buyers, whereas if you were in the North, you might have one who’s going to knock you on the price at the last minute.”
All in the timing
Liquidity is also helped by the nature of the underlying loans, Thomas says, which last an average of six months. “It’s not got a load of component assets that are geared and it’s got very short-duration assets, which do turn over often. That also means you don’t have an extended period where you’re exposed to the market.”
A typical example, which completed a few months ago, was where an investor was buying the last block of flats within a scheme from a property developer, at a 20% discount.
“We provided him a loan at 60% of his purchase price, so we’re way down in terms of the actual exposure against that asset, and he’s just going to sell them and capitalise on making 20% over the next six months.
“That was a situation where it did not make sense for him to have a long-term loan because he was going to be out of it very quickly and he wanted to be able to pay it back down as he sells the units,” Thomas explains. “We could complete that in two weeks, and his typical lenders couldn’t do that anyway, so he’d have missed the opportunity to get that discount.”
Faes points out that he has seen other property funds in this space go wrong through having a huge exposure to one project or over-capitalisation in certain areas.
The average deal size is around £2m, and they are all built properties rather than in development.
One of the key considerations when underwriting a loan is the borrower’s exit strategy, and Montello “drills down quite far” to make sure it is realistic, says Faes. “In this sort of market you do have some borrowers who say, ‘I’m going to be able to get x for it,’ and you just think, ‘Well, you might if you take three years to sell it but that’s not commercial, it needs to be a more realistic price.’”
In addition, the overall loan to value is 65% across the board, which provides a lot of headroom in terms of the investor’s equity above our positon before we start to see any effects, Thomas says.
Measuring risk
Pulling back from the micro analysis of the deals, how does Montello do due diligence on the risks of the London and south-east property market? Thomas says that comes back to the selection of the assets that it lends against, not just in the fund but generally within the business.
“We back investors who are buying property for yield. They aren’t buying a single house in Mayfair they are hoping to improve and then find one buyer who’s going to be paying £5,000 a square foot. That’s not our business.
“Our business is someone who’s buying four or five flats in the East End and refurbishing them. They can get a 7% or 8% yield on cost on those assets and then they either put them into their existing portfolio, which we see evidence of, they sell down a few or they do a mixture of the two.”
Thomas adds that underlying the assets is a yield, so if the worst comes and the market locks up, you know it is going to produce some income.
Faes says the fact that the London market has slowed down is a positive. “Eight months ago we were scratching our heads, thinking if it continues to go at that pace it’s going to be a fairly short-lived market.”
Loan rangers
Thomas also underlines the point that the loans are short term, to professional people Montello has been backing with funding and who have seen many cycles themselves.
“They are now a lot more prepared than they were in previous cycles, and they don’t want to overextend. They are asking to keep their costs down and they have cash so they do not need to take the maximum loan on the property. They know that to get the refinance, the maximum loan probably does not make the best sense. Plus, it will cost them more.
“We are pretty cautious. Equally, it’s not a risk-free investment. There is exposure to the UK property market within it, although it’s mitigated by the fact we aren’t buying the properties directly and there is a lot of equity headroom above our positions on each of the loans.”
Redemptions are always potentially an issue with property funds but Faes says Montello is well diversified in its funding, with two UK-based funds and now the Luxembourg fund and two bank-funding lines.
“We know how susceptible bank funding lines are in a market turmoil as well. Something we’ve been recently developing is a LendInvest platform, which is an online peer-to-peer platform that effectively gives us another source of liquidity in the market. We do have a lot of flexibility among our various different sources of funding.”
He also says none of the funds have any large cornerstone investors. “That doesn’t mean we can’t suffer liquidity issues because of people redeeming but at the same time there are no real issues with large investors. They’re uncorrelated investors.”
It is definitely the biggest challenge for the business. Faes says: “We’re not a Schroders but we’re well known in the mortgage market, so we have been very focused in what we’ve done in terms of trying to originate deal flows. We see about £150m a month of loan applications come through the door, which is really key.
“Obviously, that’s a big funnel. We’re not interested in doing the vast majority of those but they are all sorts of relationships and deals we can whittle down to the best opportunities for the funds to invest in.”
