In the above video message, I introduce the theme of this letter. Please watch the video before you continue reading this 2025 Monark CEO letter.
Dear Monark Investors,
Welcome to 2025.
This letter is written on a sweltering summer day. The beaches are crowded, the roads quiet, and the air conditioners doing their very best.
This is truly a time of contrasts. Radiating heat outside. A cool and productive inside. A time of declining inflation, and crippling cost of living. Stock markets at all-time highs, and more and more business failures. Strong employment and record debt.
Shakespeare would be proud. These are the best of times. And the worst of times.
What does this mean for investors?
Why are there so many apparent contradictions?
How best can one navigate this somewhat schizophrenic environment?
As has been our style in previous letters, we’ll consider the broader investment climate, share some thoughts on today’s private credit environment, and conclude with a few notes on Monark.
Three mighty narratives
There’s a joke about two young fish going on their morning swim. They come across an older fish who says to them, “G’day. How’s the water today?” The two young fish look confused. One of them asks, “What’s water?”
We have something important to learn from this exchange.
In our recent update to investors in Monark’s three High Yield Debt funds, we spoke about the power of the narrative:
Behind every price there’s a mood. And behind every mood there’s a narrative.
The narrative is the story. The common belief at any given time. It’s the story we tell ourselves. It’s the story we believe, and what we believe others believe. Simply, it is group reality.
As an investor we can choose to adopt one of two mindsets. We can be part of the narrative. Or we can observe the narrative. The former is a passionate player. The latter, a dispassionate watcher.
We described three mighty narratives that inform the framework, the perspectives, and the conversations of today’s investment universe. Specifically, that:
1. We are in an interest rate cutting cycle and lower rates mean stronger consumers, higher profits, more liquidity, greater corporate activity, and higher valuations.
2. We are on the cusp of a giant leap in technology (Artificial Intelligence and quantum computing) which means new products, greater productivity, improved margins, higher profits.
3. The election of Donald Trump portends a business-friendly era of lower corporate taxes, less red tape, labour flexibility, lower energy prices, and higher profits. A boost to the already acknowledged “American Exceptionalism”.
These three complementary narratives fill the pages of financial media and investor briefs. They dominate conversations around the boardroom table, on golfing greens, at poker games, bridge clubs and whisky evenings. They are today’s investment reality.
They are the water.
The narrator from Tim Rice and Andrew Lloyd Webber’s exceptional musical, Joseph and the Amazing Technicolour Dreamcoat, opines early on in the script, “all that I say can be told another way”.
And so it is with a narrative. We mused that, like any narrative, part of it is objectively true. Part of it is somewhat optimistic. And some of it completely ignores the facts and historical experience.
We then spent a fair amount of (compelling, we hope) text challenging each point and providing an alternative perspective.
Whether today’s narrative still has legs – and we really are living through a time when financial fortunes have been, and will continue to be, made – or whether 2025 will turn out to be one of those years where gravity and sobriety assert themselves, is not the point.
Like Yogi Berra complained many years ago, “It’s tough to make predictions, especially about the future”.
The key message in both our investor update, and indeed, this part of our letter, is to caution our investor partners to be aware of, and not to become part of, the narrative. Specifically, that at times like these, it is most important to avoid being sucked into today’s zeitgeist and maintain an objective countenance.
We summed up with the words, a narrative built on objective fundamentals is generally sustainable. A narrative built on selective data, new-age optimism, and hyped politics, is generally not.
Be an objective watcher. Not a passionate participant.
Test the water.
Some thoughts on today’s Australian commercial real estate private credit market
Private credit has become the hottest investment sector in Australia.
Investors are attracted to its compelling risk-return profile – and increasing availability, a result of the vacuum left by major banks.
Gold is the only other major alternative asset class rivaling private credit’s dominance. In both cases investors are likely questioning the validity of the bullish narrative, are sensing the underlying uncertainty and fragility in financial markets, and are turning to assets with more defensive qualities.
Whilst private credit is an established asset class in all advanced economies, its emergence in Australia is relatively new. It is a fact (not narrative) that Basel 3 (legislation introduced to derisk the banking system after the GFC) restricts the kind of lending banks can make, opening new opportunities for competitors like Monark. Furthermore, most banks operate at a scale that precludes them from profitably investing the time required to perform the necessary due diligence and modelling on “smaller” projects, again opening space for competitors to move into.
The Australian private credit market is in its infancy and can be expected to continue growing. It’s no surprise, therefore, that larger players have developed an appetite for existing private credit platforms with Regal Funds acquiring Merricks Capital, HMC buying Payton Capital, and CapitalLand purchasing Wingate.
We sense these acquisitions signal an important development. Our prediction is that increased competition for these larger vanilla loans will drive down pricing, resulting in investments providing a generally less compelling risk-return.
Why so?
With larger players comes more investment capital. In an article appearing on 9 January in the AFR, covering the launch of our new High Yield Debt Fund (Series 3), we warned that “the law of diminishing marginal returns was ‘hard at work in the private credit sector’”. That “there is a limit to the number of emerging and established developers with attractive projects and the ability to deliver”. And that “we prefer(ed) not to chase a deal”.
In an article appearing on 9 August last year, Macquarie’s Global Strategist Viktor Schvets was quoted as saying, “there’s too much capital to go around”. He meant that generally, in all markets.
How will we respond?
As larger non-bank lenders battle it out for market share, driving down the cost of capital on larger vanilla projects, Monark will continue to focus on middle market opportunities.
Our focus on the Australian “middle property market” has become our competitive advantage. We continue to believe that this market, characterised by reasonably inelastic pricing supported by the strong demographic shift to “downsizers” as the Australian population ages, will continue its strong performance record.
Importantly, the middle property market segment is difficult for the larger non-bank lenders to compete in profitably. These opportunities require more intensive due diligence and creative structuring. Therefore, they are less conducive to the scalability required for lenders seeking to deploy large amounts of capital. Monark has set itself up to profitably cater to this market segment.
Our value proposition to developers in the middle property market remains consistent – our culture of partnership, the experience of the team in the middle property market, and our ability to provide capital. These attributes are attractive to developers navigating a more challenging market.
Accidents ahead
In the immortal words of Warren Buffett, “Only when the tide goes out do you discover who’s been swimming naked.”
In our opinion, over the next few years, we expect an increase in the number of accidents (high-profile builder and developer defaults), as the newly-minted institutional platforms race to deploy large balance sheets into the sector. In addition, some loans previously deployed by the acquiree platforms to “bulk up” prior to acquisition may also reveal themselves to be hurried and problematic.
We recall a conversation a few years ago with one of our larger investors who had concluded that all private credit was reasonably safe due to the presence of security and the margin of safety provided by a conservative loan to value ratio (LVR).
This in response to our positioning Monark as arguably operating in the most conservative and stable parts of the development market.
But he had yet to experience an impairment with the several managers he invested with and therefore did not regard our investment philosophy as a compelling point of difference.
Until now…
Now, after several high profile business failures, the risks associated with private credit funding property development are more apparent.
These failures, we believe, are constructive in two ways. Firstly, they draw investor attention to the nuances of development risk. No two borrowers are the same. No two projects are the same. And there’s a lot more to a sound investment than simply an attractive advertised return and a conservative LVR.
Secondly, whilst secured private credit is no doubt a generally robust asset class, the next 12-18 months will demonstrate our assertion that ultimately it is the expertise and skill set of the fund manager which will differentiate whether problematic loans can be managed to preserve capital and deliver projected returns. Anyone can write a cheque. But the actual quality of the investment is often not apparent, with the underlying merits of the project, the extent of the due diligence process, the skills involved in structuring the funding and associated legal agreements, and the efforts applied to the oversight of the project from inception to exit, playing crucial roles.
Bringing these thoughts together, Monark is structured in such a way so as to avoid the pressure to deploy our investors’ funds. Specifically, we have patient shareholders and modest overheads. More so, all shareholders and senior executives have made material investments in all Monark funds and our single-project co-investments. We are acutely aware of competing corporate priorities whereby the pressure to deliver earnings can clash with the need for patience and caution. We believe that the absence of pressure on Monark to deploy, our choice of a particularly secure part of the Australian real estate market, combined the competence, experience and expertise we have assembled in our team, will allow Monark to successfully navigate a more competitive industry.
Legendary investor Charlie Munger (Warren Buffett’s late business partner) warned, “show me the incentive and I’ll show you the outcome”. This is instructive advice as management wrestle with the need to deploy funds to grow earnings in an environment offering a limited amount of truly investable projects.
Our clear priority has been, and will continue to be, the quality of our investment opportunities.
We have always believed that a careful and conservative mindset is the responsible way to manage our investors’ capital. But with a global investment narrative that has most assets priced for perfection, combined with a surfeit of capital chasing a finite number of quality projects, we believe this mindset more relevant than ever.
Series 3 launches
We have noted in previous letters that the complexity surrounding many property developments today is an environment in which we thrive. In stable, high-margin times, the cost of funding dominates. Capital becomes a commodity. Where developers seek a funding partner to deliver a bespoke, optimal funding solution, the value provided is paramount.
Having earned a reputation as an entrepreneurial, lateral-thinking financier, we are attracting more and more enquiries and seeing a number of attractive investment opportunities. This ongoing demand for capital has ensured our senior-debt-only Prime Credit Fund has been able to accept and deploy new investments over the course of 2024, whilst offering investors an attractive cash yield of approximately 9.5% per annum.
We also launched the third in our series of High Yield Debt funds (Series 3) in November. We anticipate this fund mirroring the success of the first two funds, both of which we expect to achieve their 15% per annum targets. We expect to launch Series 4 later this year. Current investors will receive a guaranteed allocation, and we are inviting new investors to register their interest.
We hoped you enjoyed reading our perspectives and look forward to sharing our next letter in August.
We wish you every success for 2025
Warm Regards
Michael Kark and the Monark team
CEO and Co-Founder, Monark