Brian Kane: Hi Lars, can you please give an introduction to Tessin, and some insights about what led to the company being founded in 2014. What did the early days look like?
Lars Almquist: We were founded in the aftermath of the global financial crisis, at a time when the updated Basel banking regulations were making it more difficult for smaller property developers to get the funding they needed from the banks. We saw that there was a gap for us to fill. And that has proven to be the correct analysis – the business has been doing well ever since.
We started with some small residential development projects and have grown from there. It’s all about matching projects with capital. You don’t want too many projects and no capital, equally you don’t want too much capital and no projects. Over the past eight years we have been able to balance these correctly.
However there have been some significant changes. In 2018, we have realised it was prudent for us to broaden our capital base. That means not just relying on crowd investors, but also institutional investors. We had at that time quite a few high net worth individuals who had invested significant sums over the years into the loans on the platform, but we still felt we needed to reach out to the institutions.
As part of our outreach to smaller institutions, we agreed terms with a Norwegian investor, which was our first institutional mandate. At the same time, we agreed terms with quite a large Swedish family office, which has gone on to invest significant sums with us.
This capital from institutions began being deployed in 2019, and around the same time we set up Tessin Capital, which is the entity that I am the CEO of. It’s fully owned by Tessin Nordic, which is now listed on the NASDAQ.
Of the 4 billion plus Swedish krona (SEK) that we have lent to real estate projects across Sweden and Finland since inception, about a quarter has come from the institutional side.
But if you look at 2022, I’d say it’s going to be more than half coming from the institutional side.
In 2021 we did our first bond structure with a Swedish institution, and we signed up with LCM Partners with your help in spring this year, and now have begun deploying that investment.
So the institutional business is going fine, and it’s going to be the dominating business for us going forward. But the crowdfunding platform will always be important, it is a good way to reach out in the marketplace – we have raised significant sums over the years, and we will continue to do so.
Brian Kane: You’re the CEO of Tessin Capital, can you introduce this company?
Lars: When we started Tessin Capital in 2018 we were an entrepreneurial startup with everything that encompasses. Since then we have added staff and capabilities, putting in place the formal processes such as institutional grade loan documentation. It’s been a journey to strengthen the organisation, the routines, the processes, our credit processes. We are very happy where we are with it today, but it will never stop. It will always be a process of ongoing improvement.
From day one, we followed Swedish banking standards for our underwriting, while we also use technology to be fast and agile. That’s why many developers like to work with us – they know that we can be more rapid than the banks to say ‘yes’ or a ‘no’. We don’t have the committees that they sometimes have to wait for, which can add a lot of time to a decision by a bank – for example, the committee has a question, and then the developer has to wait for the response to go up to the committee again when it meets.
So it’s been a good way of working and it has meant that we have had very low credit losses since we began in 2018. Of course we are in a business where people have to trust us in order to be willing to provide us with the capital, so keeping losses under control was extremely important when we started and it still is for the business going forward.
Brian Kane: You started in 2014, and at the time that crowdfunding was really taking off. But as we have seen across the industry, with maturation comes the desire for a broader funding base. For Tessin, what has been the rationale and advantages of having institutions on board?
Lars: Looking back to the first years of operation, 2014-2018, while there was a little bit of trial and error in the beginning in terms of understanding what retail or crowd investors wanted, nevertheless we did manage to fund all the loans on our platform.
We learned over time what opportunities to offer the market, how to price it, and so forth. We became quite good at that. But what we didn’t know at that time was, Could we rely on retail investors if there was a significant downturn in the market? Would they still invest in our loans, or would they sit on the fence? In that case, we wouldn’t have any ability to fund loans. We also didn’t know how much capital we would be able to raise from the crowd over the longer term – it’s been growing continuously, but we didn’t know if we would eventually hit a ceiling.
So we decided that we needed to diversify our capital sources. It was diversification, it was de-risking our business.
It was also motivated by the regulatory situation. We are lightly regulated, which means that we can’t work as an investment bank, we can’t bring onboard more than 200 investors into a single loan. That means that there’s a limit to how much we can raise via the crowd – about 20 million SEK, 2 million euros in a single tranche. You can fund a project with two or three loans, of course, but then there is the risk that you can’t fund it the second or the third time you’re out, because the crowd investors often want to diversify their exposure to various projects. That means if we want to provide developers with loans above 20 million SEK per tranche, we need institutional investors to enable that.
The desire to write larger loans is driven in part by the fact that some of the developers we started to work with in 2014, 2015, and 2016 have grown over time, as we have. Some have become quite large, and wanted to continue working with us, because we had created a very good working relationship. But they were asking us for loans of up to 10 million euros in one tranche, and it became problematic for us.
In addition, not everyone wants to be public with the fact that they are out raising debt. Not everybody wants to be visible on the platform. So it was also necessary for us to be able to have access to capital to fund deals off platform.
We have proven attractive to large global investors, both in terms of the opportunity and our processes, risk management etc. We see additional demand from institutional investors, but for now we are focusing fully on LCM. Over time, I believe we will have the capability to do more mandates in parallel – LCM plus two or three of similar size. We’re not there yet, but maybe a year from now it will be possible.
Brian Kane: You mentioned the idea that retail investors would pull back in tough times, did you see that in 2020?
Lars: When the pandemic struck in March 2020, yes the crowd stopped investing. For a month or so we did very little business. However, as the stock markets started to rebound quite rapidly, then the crowd followed into the new loans we offered. So the crowd didn’t stay away that long, they actually returned much faster than the institutions. The institutional mandates we had at that time had started the year strongly, but stopped in March, and it took around six months for them to return, before they felt fully confident to get back into our loans.
So at that stage it was the platform that hummed along much more rapidly and churned out capital quicker than institutions. Now, today, when you have the Ukraine war and inflation it’s a mixture: We have some institutional clients who are active, some who are a little bit more careful. And the crowd is somewhere in between this – the crowd is still active. We have to offer them slightly higher interest than a few months ago, but that’s understandable with high inflation out there.
So they respond a little bit differently to global events and to local events also, for that matter. But it’s worth pointing out that our crowd investors must meet a threshold which is normally a minimum €5000 in to a specific loan, meaning that our loans are not for the smallest investors. Hence our crowd predominantly consists of semi-professional investors.
However for smaller investors we do offer portfolios. The family office that invests with us builds up stakes of a certain size, and then we take portions of the loans they have invested into and sell them as portfolios to the crowd.
That’s been a better alternative for smaller investors, you get the diversification, if something goes sour, you only risk losing a small part of your investment. And overall, you should get the money back even if that happens.
Brian Kane: You mentioned the Basel banking accords. Post- GFC, one of the changes was a decrease in the LTV that banks could offer to developers, creating a financing gap and increasing demand for mezzanine loans from non-bank lenders. Is that where you are operating?
Lars: When we started, it was primarily to fill this gap that you spoke about. The banks went down from roughly 75 to 60% on LTV, and developers couldn’t always put in the extra capital. We started by offering them mezzanine debt or preferred equity. Then in 2016 we realised we were better off offering debt than preferred equity to the developers. The banks didn’t really care how much equity or preferred equity there was in, as long as they didn’t go above 60% LTV and they had the securities they demanded. It meant we could just as well offer debt on top of the developers equity.
So in 2017 we shifted from preferred equity to debt only, which is always secured with a mortgage on the project. We also utilise other securities – personal guarantees, share pledges, and others.
So we moved into junior debt, snd since then we have continued into senior debt. Today, three quarters of our loans are senior debt. So we have moved down the capital stack. Now, we can lend from zero up to 80-85%, depending on the project, depending on the counterparty risk, etc. Institutional investors like LCM want senior, whole loans, so that’s primarily what to do at the moment.
Brian Kane: Looking at the developers you work with, what is their typical profile? What sort of relationships do you have?
Lars: When we launched Tessin the new banking rules were coming into force, but we were not really an alternative for the mid-sized or larger developers, and banks still wanted to do business with them. But it was no longer profitable for the banks to work with the smaller developers, those doing around five-ten unit projects. So naturally it was this segment we started funding. Then over time, some of these developers have become quite significant – many are running multiple projects – we have grown with them, and have been able to continue and maintain the relationship, even as their funding requirements have expanded over time.
We are not focused exclusively on residential development, we also have a logistics developer who we have worked with since our early days. He has also grown impressively in that time, and is a very important client for us. It is an attractive proposition – usually the developer is able to pre-sell the project, and it’s fully rented out when he breaks ground. So there is very little risk. And it’s usually a very fast process, building a logistics warehouse is normally quite straight forward.
Sometimes we work with cash flow assets. There the banks are more happy to lend to them, so there we face more competition. But the banks are also sometimes difficult, so we are doing more and more of that.
But residential developers remain our bread and butter, small and mid-size developers. We also occasionally speak with quite large companies that are looking to diversify their capital sources. Such a company might be running five projects across Sweden, and come to us for funding for one or two of them. Typical ticket size would be five-eight million euros, divided into three or four tranches over the duration of the project. When we first started out, the typical loan size was in the order of 500,000 to 1 million euros.
Brian Kane: And what is a typical development cycle, are you looking at three years for project completion?
Lars: Normally the cycle we see would be quicker than three years. Most projects we fund are finished within two years. Part of the reason is that there is a lengthy process around receiving all the permits from the local authorities, getting all the plans in place and so on, which takes place before we extend funding.
We come in when they are about to get the final building permit in place, and then the construction process itself is normally quite rapid. Typically it will be completed within 12 to 18 months, rarely more than two years. If it’s a very big project they will take longer, but it is not so often we do the very big projects. We normally max out at around 40-50 units.
If the builders for a residential project are good, they complete it within 12-18 months – if they stretch it out for too long there won’t be any profits. Normally we have the money back within 18 months.
Brian Kane: Obviously inflation is something to consider, namely changes in the cost of building supplies, or increased labour costs for construction sites. Have you seen any impact so far?
Lars: Inflation is a problem for developers as it squeezes their margins. This is a topic we are constantly discussing: Is this a temporary phenomenon? Or is it here for the next five to 10 years? How will it develop? Will the unions start demanding pay rises? How will developers off-set high costs? We don’t know. But so far, the impact on residential developments have been fairly muted.
And I think an important reason here is that compared to many other markets, especially in the UK, there are huge differences across Sweden in terms of prices. If you look at Stockholm, it’s an expensive city. Prices for an apartment in central Stockholm can be around 10,000 euros per square metre, and that is outside of the prime locations. The city is geographically quite constrained by water and parks, and so you can’t really grow the inner city much.
But outside of Stockholm there is plenty of land for development, and you don’t have to go far out before it becomes much cheaper. If you go one hour out of Stockholm the prices for land are around one tenth, and if you travel two hours the prices there will be one twentieth.
So the general trend we see is of more and more city residents moving to residential developments in the expanded commuter belt around the capital. Most of the projects we fund are there. And because of the land price differential, even if a developer has to hike costs by 10% because of increased input costs, for a person moving from Stockholm, the properties remain by comparison good value. We expect this will continue to play out for the next couple of years. By then, we will know much more about whether inflation is persistent, or if it was a temporary phenomenon. We don’t know that yet. But for now, it’s not affecting us that much as you would expect.
Brian Kane: Let’s talk about due diligence. What is it that you can do better and quicker than banks? What are some of the tools or technology you use, and the approach you have?
Lars: Essentially, the team that do the origination or underwriting are bankers, they all have a banking background, and each has worked for one of the big Swedish banks. So we are doing a lot in the same way. Compared with banks, I would say that we check up even more on everyone involved in the project, the people, the boards, looking to see if they have any baggage. And if we find something, we ask them, ‘Can you explain why this happened two years ago, or four years ago?’ etc. And maybe they have a good reason, or maybe they don’t have a good answer. So, we are very thorough in checking up on the people involved in a project. If you are working with people who have a clean record, and have no payment remarks for 10-15-20 years, you know that you can trust these people.
And ultimately, it is important to work with people you can trust, since there can always be delays for all kinds of reasons. The municipality could cause delays, there could be problems with the builder… but even if there are delays, if you work with people you can trust, people who will do everything to deliver, you can expect it will work out. We put a lot of emphasis on this.
Of course we look at the financials of a project, and whether it will be profitable. Will they be able to sell the units? Is there a market out there? What happens if they can’t sell? So we take a careful approach in how we value the projects. Mostly in Sweden units are sold to a private occupier. Sometimes we do bridge finance, or development finance for the construction of rental assets, and then the bank steps in once everything is in place. But in most cases, everything is sold off to the individual buyers when the project is completed.
So when we evaluate a project, we normally look at it as a rental unit, because almost everywhere across Sweden, there is a big pent up demand for rental units, so you would expect that to reflect into rental yields and the rents themselves. What we do is value the finished unit as a rental unit, so we have that safety margin, because if the developer goes into default and isn’t able to finish it, as a last resort we can take it over, and then sell it to a property company as a residential rental asset.
So before offering a loan we look at everything we need to feel safe. We ensure the mortgages and pledges are in place. We don’t look at the cash flow on day one from the operating company – that is important, but normally, they don’t pay interest, they don’t amortise during development, the entire repayment comes at the end.
Often what we see is that banks start at that end, i.e. with the cash flow. And then in the end, when they have approved all of that, they go to negotiate securities with the bank, and then something comes up and the bank can’t deliver. And that could be a month or two months later.
Normally we can return to the developer very quickly and present them an offer based on the securities in place.
So we can respond quite rapidly And then it’s a process of getting through the process in detail.. But you can get back quite quickly saying yes. If you’re good people, this is a project we can finance.
So we can be quite quick. We try to use technology as much as possible. Of course, we tap into all kinds of government sources to get the information we need. In the beginning, we also used our own proprietary method of finding leads, we developed a leads engine that gave us semi-warm leads all across Sweden, so we didn’t have to spend all our time cold calling. So we built up a huge database that we have been able to grow, and then over time we do more and more repeat business.
From an investor side, they like to fund developers that have been on the platform before and who have delivered good projects according to schedule. It’s much easier, of course, to raise capital for a successful developer, for the second, third or fourth time, and so on. So it’s been more and more repeat business. Developers come back to us, and they are growing with us.
Brian Kane: In terms of the funding shift from mainly semi-professional investors i.e. the crowd, to more institutional investors, do the retail investors see a benefit?
Lars: What we do with institutions is primarily off-platform, be it whole loans, or syndication with two or three or four institutions together sharing a loan. So I don’t think the crowd investors really notice any difference. Do we cherry pick certain projects for institutional investors? I wouldn’t say that. We have to provide the crowd with very good opportunities, and everything we do has to go through the process, we won’t approve anything we don’t believe in. If we do offer something on the platform that goes bad, of course, it’s very detrimental to our brand. So it has to be good projects all around.
There have been times when the institutional investors have been so eager to invest, that everything we have originated they have picked up more or less immediately. So we haven’t had enough to offer the crowd. Some of our bigger investors on the platform have complained a little bit, ‘Why don’t you have more projects to invest in? We would like to invest more!’ So that has perhaps been the only impact.
Brian Kane: You’re active in both Sweden and Finland. What was the prospect in Finland, were you following existing clients into the country?
Lars: We actually made an acquisition of a small Finnish funding platform in 2020. They were just starting out – they were in a similar position to where we were in 2016 or 2015. They had good contacts with developers, but struggled with raising the capital. So we bought them. And the team there have been very good at finding projects, doing the underwriting, origination, and all those things.We present these loans on the platform and Swedish investors invest, but also, of course, from the rest of the Nordics and occasionally overseas.
Talking about crowd investors. They are primarily Swedish, but we have investors from all across the Nordics. And we have only brought on a few Swedish institutional investors into Finish loans yet, but that’s something we plan to do more of. You don’t have the currency risk when we work with the Euro-based investors of course, which is a benefit. So we expect to do more business to Finland going forward, it’s been a good market.
Brian Kane: And would you look at expanding into an entirely new market?
Lars: It is something that we are always considering. Norway and Denmark are the obvious alternatives. Maybe now there will be some shakeout due to everything happening with inflation, the war, COVID all that. You have to keep your eyes open on opportunities.
We also see Poland and Germany as potential markets, maybe the Baltics could be an option, but I would expect Norway or Denmark could be next in line.
Brian Kane: Do banks ever refer their clients to you if they have to turn down a loan or can’t complete a developer’s full requirements?
Lars: Sometimes this happens. Nevertheless, the banking landscape in Sweden is quite heterogeneous. You have the four big Swedish banks – SEB Bank, Svenska Handelsbanken AB, Swedbank AB, and Nordea Bank Abp, (which is headquartered in Finland, but most of its assets are in Sweden). Then you have the Norwegian and Danish banks, especially DNB ASA and Danske Bank A/S. All the banks work differently in terms of centralization, office locations etc.
The four Swedish banks have offices all across the country, but SEB is quite centralised. Nordea, Handlesbanken and Swedbank are more decentralised. So there are differences there which will affect how individual banks will work with outside financing like us.
But, in general we do get referrals from banks, and we like to work with them. However it’s not always the case that institutional investors want that, since they typically want the whole loans, they want the first lien themselves. But when it comes to the crowd, when it comes to some institutions, they’re happy with the bank sitting on the bottom 30-40% of the loan. And then we sit on top of that. It’s more like a traditional junior loan. It could go from around 40-50% up to 75-80%, the bank and us together.
Brian Kane: Last year you launched Tessin Properties AB, offering revenue streams coming from direct ownership of properties to retail investors. How does this work?
Lars: Tessin Properties gives us a predictable cash flow, the assets we have are essentially very well located logistics rental units. With these locations we know that if something happens with the tenant, it’s not going to be a problem to rent it out to somebody else. Typically there is 5-10 years left on the lease when we acquire it, and property management is outsourced to professional companies.
So it’s been an ability for us to build up predictable income on the side, we have been able to raise the capital for that on the platform. It was subscribed to quite rapidly. I think we’re going to do more of that going forward, but how much and so on we will see how the market demands, and what we find – we won’t buy too risky assets, we are not in that position to look after them if something happens. So it has to be assets with strong cash flow, with very little property management required.
Brian Kane: Thanks for your time Lars!