QRI Quarterly Update, December 2020

Company Presentations

Qualitas Real Estate Income Fund (ASX:QRI) Group Managing Director & Co-Founder Andrew Schwartz, Global Head of Real Estate & Co-Founder Mark Fischer, and Director, Real Estate Nick Bullick present the quarterly update.

Andrew Schwartz:

Hello, I'm Andrew Schwartz, Co-founder, Group Managing Director of Qualitas. The Qualitas team is pleased to present today the QRI, December 2020 quarterly review. I'd like to introduce Mark Fisher, Global Head of Real Estate and a member of the Qualitas executive team who will be co-presenting alongside myself and Nick Bullick, Director of Real Estate.

Mark Fischer:

Hello, I'm Mark Fischer, Co-founder of Qualitas and Global Head of Real Estate, responsible for leading the Qualitas investment team across both real estate debt and equity investments.

Nick Bullick:

Hi, I'm Nick Bullick, a Director within the Real Estate investment team at Qualitas and my team is responsible for origination and execution of CRE loans.

Mark Fischer:

During the December quarter, the trust target markets stabilised following the heart of the Covid-19 pandemic, Qualitas continued to experience significant deal flow, which allowed us to be selective in the investments that we pursued. We were pleased to see that borrower demand remained robust, allowing the trust to invest in 11 new loans, totalling $112 million using proceeds from loan repayments, as well as a partial redemption of the trust investment in the Qualitas Senior Debt Fund. Of these new investments, we were able to secure two, new mezzanine lines for the trust with attractive risk return metrics.

Importantly, as a result of the strong deployment in the past quarter, the trust capital is now fully allocated to investments until the end of June, 2021. We are confident based on the current loan portfolio and subject to no unexpected repayments, that the strong invested position of the trust will underpin a consistent level of distributions to investors of no less than 6% per annum.

The trust continued to recalibrate the portfolio to a post Covid-19 environment with 83% of the QRI loan portfolios, underlying security properties, having been revalued since the onset of Covid-19 to reflect new market conditions. When all brought together, the trust ended the calendar year in a strong position, with all capital fully allocated into a portfolio of investments that have substantially had terms reset for the post Covid-19 environment.

The trust continues to meet its objectives of capital preservation, a diverse portfolio of loans and achieving its target return, with a net return of 6.45% per annum, and a distribution return of 6.15% per annum for the December quarter. This continues the track record of the trust of providing regular, monthly distributions to investors at a compelling premium on a risk adjusted basis to the very low cash rate. The QRI portfolio of 36 loans remains well diversified across loan type, ranking, location, sponsor and property sector and there were no impairments on the loan portfolio in the last quarter, with the NAV remaining at no less than $1.60 since the IPO and throughout the Covid-19 period.

Andrew Schwartz:

Moving to the market and fund update, the team and I will provide a detailed overview of the CRE debt market and the fund performance. The manager has a positive outlook on the CRE debt market as the Australian economy stabilises following Covid-19, and supported by the unprecedented lower cash rate of 10 basis points. Demand for CRE debt remains robust as borrowers continue to seek alternative lenders, largely due to their needs not being met by the banks, both from a lending appetite and service perspective. Importantly, borrowers are now also more comfortable seeking alternative lending than ever before.

In particular, mezzanine construction opportunities are increasing as developers seek to maintain their banking relationships in the current environment, and are now returning to traditional mezzanine capital provided by alternative lenders to fill the funding gap for their projects. The manager continues to focus on opportunities within its core markets of Sydney and Melbourne, working with tier one sponsors in the mid market where attractive mezzanine construction loan opportunities are continuing to present.

The manager is comfortable with accepting more mezzanine exposure into the portfolio given the improving market conditions. The CRE debt market was exceptionally busy in the lead up to Christmas and New Year holidays, particularly with the volume of deal settlements for alternative lenders. Overall, the CRE debt market conditions held firm. However, the manager is conscious of any negative impact from the recent fluctuating Covid-19 infections in Sydney, Melbourne, and Brisbane, which have resulted in the closure of state borders.

Our CRE debt pipeline has never been stronger and we continue to benefit from the good deal flow fuelled by strong borrower demand. We are actively originating across all loan types and sectors. However, focusing predominantly on Eastern seaboard, our core markets. We are comfortable originating new loans ahead of available capital for QRI and the Qualitas holds our funds which we believe facilitates efficient deployment. Our CRE debt pipeline of 400 million represents still opportunities in different stages of due diligence, from initial early screening to mandated lines, to investment approved loans. We believe that this is a very solid position to be in at this point of the cycle. The QRI will benefit directly from this in the upcoming months to come.

Mark Fischer:

Since the onset of Covid-19 in March 2020, a significant amount of security properties within the portfolio have been revalued in conjunction with new and extended loan terms or to reset terms on existing lines. In total, 23 security properties securing 26 loans of $234 million have had their properties revalued, which represents 83% of the QRI loan portfolio by value.

The quantum of these reevaluations undertaken during market volatility is significantly beneficial to the trust portfolio, as it appropriately reflects and reconfirms market values of the security properties, with underlying support to commercial real estate valuations coming from Reserve Bank interest rate reductions of 40 basis points over the same period. Furthermore, reevaluations are important for managing the weighted average, LVR, of the trust portfolio, which has been trending down, now at 62% compared to 64% in March 2020. Not withstanding that the trust recently increased his exposure to mezzanine loans.

During the quarter, we are pleased to see the unit prices traded back near par reflective of improving market sentiment and our increased efforts as a manager to improve secondary demand and liquidity. In particular, our efforts focused heavily on leading market education for real estate credit as an investment strategy, whilst boosting investor communication and reach to ensure the market and our investors fully understood that the portfolio was maintaining stable NAV, that there were no impairments and hence the high credit quality of the portfolio continued.

Nick Bullick:

QRI has performed well and we are pleased to deliver a quarterly net return of 6.45% and distribution of 6.15%, which is at the upper band of the target return. Over the past 12 months, the distribution return to investors was 6.08% demonstrating a healthy return in what has been a challenging year. We are confident based on the current loan portfolio and subject to no unexpected repayments, that our strong and vested position will underpin a consistent level of distributions to investors of at least 6%. We are also forecasting monthly distribution return is expected to be in the upper range of the current target return of the RBA cash rate, plus 6.5% until March 2021. As we seek to increase direct mezzanine loan exposure of 15% into the fund, this is also likely to be a accretive to trust returns.

On slide 10, this provides a transparent breakdown of the trust portfolio composition, gross income split between fee income and base interest, and importantly, our gross versus net return. I draw your attention to the $42 mil in cash, which is currently allocated to a senior loan, which is expected to close in February.

We continue to undertake monthly reviews of the QRI loan portfolio and Arch Finance notes. As per our latest review, we have no impairments or arrears on QRI loans. Arch Finance note interest continues to be serviced and therefore no impairment is required. In respect to the underlying Arch Finance loan pool, arrears are very low at 2% out of a total of 219 loans. In terms of assessing our impairments, we have significant equity buffer in our secured properties. Most of our loans contain sponsor guarantees and interest reserves, and we undertake very regular revaluation of our security.

In this section, we will go into more granular detail of the invested portfolio as of 31 December 2020.

We continue to meet our portfolio targets from the perspective of our formal mandate, as well as our additional manager internal targets set, demonstrating our discipline construction of the portfolio. We settled two, mezzanine construction loans during the quarter, which increased the mezzanine exposure to 15%, which comprises of 8% of direct mezzanine loans and 7% Arch Finance notes. In the medium term, we're targeting 15% direct exposure to mezzanine loans, which we believe is appropriate at this point in the cycle. So when accounting for the Arch notes, the mezzanine exposure will be approximately 22%, however, within the mandate target range of 20 to 35%.

The trust unit redemption and Qualitas senior debt fund was also finalised with $22.2 million of capital returned in December, for reinvestment into direct, new loans and a further $22.2 million was redeemed on the 1st of January. The redemption reflects our strategy of investing in direct loans rather than indirectly through Qualitas wholesale funds. This has reduced exposure to Qualitas wholesale funds from 33% to 26%.

Over the past 12 months, the portfolio has been rebalanced and during the December quarter, we introduced two mezzanine construction loans, increasing exposure from 1.5% to 8%. We strategically positioned the portfolio to increase our mezzanine exposure, given the attractive risk return metrics currently being presented in the market. Both new mezzanine loans have pre-sale coverage of 100% of both the senior and mezzanine loan limits. To accommodate the increased mezzanine, senior land loans and senior construction loans were reduced to 23% and 8% respectively. As at 31 December, the Trust’s capital is now fully allocated and the remaining cash will be invested in senior loans that will settle during now until June 2021.

Our investment activity during this quarter was exceptionally strong, reflective of a very busy period leading up to the holiday season. We settled seven new loans and extended four new loans. We also had six loans repay on schedule, and the net result was an increase of QRI loans to a total of 36. The weighted LVR of the portfolio has increased slightly to 62% as a result of introducing the higher levered mezzanine construction loan, however still lower than at this point last year. The portfolio continues to be predominantly invested in Qualitas core markets of Melbourne, Sydney and Brisbane, which equates to 95% of the invested portfolio, and we don’t see this changing significantly in the medium term. We do, however, expect to be more balanced between New South Wales and Victoria over time. 

On slide 16, this provides a breakdown on how interest is paid across the loan portfolio. A large portion of the loans are backed by sponsor group cash flow, and we currently have no loans in arrears or impaired. Loans with capitalised interest increased to 11% from 2% last year due to introducing two mezzanine construction loans. As part of our normal liquidity management, the Trust always reserves cash to pay distributions on the component of income that is capitalised. As of 31 December, 83% of positions in the QRI loan portfolio were subject to fixed interest rates. We have traditionally had a high proportion of fixed interest positions within the QRI invested portfolio, as it provides both the Trust and the borrowers certainty of income and interest costs respectively. The high portion of fixed rates is also advantageous for Trust returns in the declining interest rate environment.

We currently maintain 39% weighting to senior investment loans, as these loans represent the stabilised part of the portfolio as the interest is generally paid by sponsor cash flow or income generated from tenants in the property. During the quarter, we closed five investment loans and were repaid on four loans.

Senior construction loan exposure has reduced from 11% to 8%, as loans were repaid upon project completion via settlement of pre-sales. The portfolio maintains its favourable weighted LVR of 51%. The construction loan portfolio is performing to schedule. We are satisfied with the level of pre-sales and in particular, how the builders have managed progress through the Covid-19 work restrictions.

The waiting to land loans has reduced further from 28% last quarter to 23% this quarter due to two loans, repaying. However, this was offset by two new land loans settled. The weighted LVR of 63% also held firm. Of the two land loans that were repaid, one was due to refinance by construction financing provided by another Qualitas fund, and one was due to a conversion into a mezzanine loan in the QRI portfolio. During the quarter, we closed two new mezzanine construction loans, totalling $25.8 million, both provided to Melbourne based projects. One loan was provided to an existing borrower and the other was provided to a new borrower, which we'd been targeting for a lengthy period of time and we're very pleased to convert this opportunity.

One of these new mezzanine loans was the result of refinance an existing land loan within the Qualitas senior debt fund. The existing mezz loan is tracking on schedule and we're happy that pre-sale debt cover is approximately 120%.

The Arch portfolio of 200+ loans has performed well, recording low arrears, which has not impacted interest servicing of the Arch notes. As at 31 December, there are currently three loans in arrears, totalling 2% of the loan pool. Arch finance has enforced security on two loans. However, it is expecting full loan recovery from the sale proceeds. The Arch note investment continues to be attractive given it is paying cash interest income, and presents excellent portfolio diversification benefits. I'll now hand back to Andrew to wrap up our quarterly update

Andrew Schwartz:

2020 closed as one of the toughest years for global economies, which has reset the way we live. Despite the uncertainty, we navigated this well and met the trust investment objectives, delivering consistent and attractive returns to QRI unit holders, whilst preserving capital. We increased the frequency of our investor reporting and investor engagement and launched a CPD education program on commercial real estate debt.

We remain conscious of any negative impact from the recent fluctuating Covid-19 infections across Australia, which have resulted in the closure of state borders. Looking forward to 2021, we are hopeful of a less exciting environment. However, we maintain a positive outlook for the CRE debt investment. That concludes the presentation. Thank you for your time.


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