Andrew Schwartz (Group Managing Director and Co-Founder) and Mark Power (Acting Head of Income Credit Funds) provide an update on the fund.Andrew Schwartz: Hi, I’m Andrew Schwartz, Group Managing Director and Co-Founder of the Qualitas Group.
Welcome to the Qualitas Real Estate Income Fund September 2022 Quarterly Presentation.
I’m joined today by Mark Power, Acting Head of Income Credit Funds and the portfolio manager for the Qualitas Real Estate Income Fund – also known as QRI. We are pleased to share this update and demonstrate why Qualitas is well positioned to capture the upside from the rising interest rate environment for our investors.
As the manager of QRI, Qualitas is one of Australia’s leading alternative real estate investment managers with extensive industry experience, institutional-grade governance and a proven track record of delivering attractive returns. We have committed funds under management of over $5 billion across credit and equity fund mandates, specialising in real estate private credit and real estate private equity sectors.
Since our foundation in 2008, Qualitas has invested in or financed assets valued at over $17 billion. Our deep expertise and long-standing relationships have enabled us to build a robust pipeline of growth opportunities for our investors. Our equity analysis and underwriting capability bring a unique and beneficial perspective to our due diligence as a lender, reflected in our strong track record since inception.
Moving now to the highlights for the September 2022 quarter.
I am pleased to report that the underlying fundamentals of the Fund remain sound, with the Fund achieving an income return of 5.58% during the quarter, based on the Fund’s NAV of $1.60.
The Fund’s investments continue to perform in line with expectations, with the Net Asset Value remaining stable at $1.60 at the end of the period. Importantly, since the IPO of the Fund nearly four years ago, and throughout the COVID-19 pandemic, the Fund has experienced zero impairments and no interest arrears, which is a testament to our investment underwriting and asset management expertise.
QRI’s fully deployed portfolio has achieved a high level of diversification through 40 individual loans, which are predominantly first mortgages.
Importantly, noting the current rising interest rate environment, we have been increasing the proportion of variable rate loans in the Fund. QRI’s variable rate exposure has increased to 67% at 30 September, from 54% at June 30 – and this trend is expected to continue. This is in turn driving increased returns for investors.
I would like to make a final comment about the broader investment environment and some recent achievements of the broader Qualitas business. As you may have seen, Qualitas recently announced two significant new mandates. A mandate from the Abu Dhabi Investment Authority (ADIA), announced at the time of Qualitas’ FY22 results, and the more recent $440m commitment from a global institutional investor were both raised at a time of increased volatility across all financial markets. These new raisings highlight the attractiveness of the private commercial real estate (CRE) credit sector across Australia and New Zealand, and institutional investors’ conviction in our investment expertise and asset management platform.
Looking now at a selection of key data points that support our high conviction in financing the residential real estate sector.
Firstly, as you have probably seen reported widely in recent months, vacancy rates across the country are at all-time lows, with the national vacancy rate falling below 1% as at August 2022. Noting that a 3% vacancy rate is considered an equilibrium level, the current national vacancy rate, and the low rates individually in Australia’s largest cities, is indicative of extremely high rental demand and very limited supply in the locations QRI is invested.
The supply situation is not expected to change materially in the medium term, with apartment completions at 10-year lows and forecast to fall further in the post-COVID era. Average apartment completions are predicted to fall approximately 40% from pre-COVID levels, representing 12,000 fewer completed apartments each year and reaching 16-year lows by FY25. The new supply of apartments will be unable to match the current and expected high residential demand.
On the demand side, Australia’s population growth rate is set to recover and grow rapidly, restoring population growth to pre-COVID levels, boosted by the increase in the migration cap to roughly 195,000 people each year to ease labour shortages. This will exacerbate the impact of supply shortages in the residential market as skilled labour requires immediate accommodation.
A key element of the potential solution to the current housing supply shortage and reduced housing affordability is through increasing apartment stock. Apartment prices have not experienced the same magnitude of growth as detached housing over the last few years. As you can see from the chart on the bottom right, the price gap between apartments and houses is at its widest point over the past 13 years and, together with rising interest rates, we would expect to see more of demand naturally directed toward apartments as a result.
Together, these factors provide sustainable tailwinds for residential real estate credit investors such as QRI.
I would like to spend a bit of time now addressing how QRI, and for that matter Qualitas, differ from traditional sources of finance.
QRI is fundamentally different to the traditional sources of finance in a number of important ways, including its capital sources, its risk tolerance and approach to asset and risk management.
QRI’s business model differs to financing by traditional sources of finance as QRI’s returns are not driven by loan volume, and the manager is rewarded and incentivised to maximise returns through diligently selecting and managing investments with the most attractive risk adjusted returns.
From an asset management perspective, QRI does not take a probability-based approach when allocating provisions and assessing default risks. Also, unlike traditional sources of finance, QRI is not subject to APRA regulation.
With 40 loans in QRI’s portfolio, all borrowers are subject to intensive due diligence. Each loan is also carefully reviewed on a monthly basis, with detailed assessment on serviceability, asset valuation, Loan-to-value (LVR) ratio, repayment profile, exit options and any other specific investment risks. These reviews are conducted and signed off the Head of Income Credit Funds and the Head of Investment Risk.
QRI benefits from a highly experienced team of 25 investment professionals. That is a similar size to property financing teams at the big four banks, which have more than 120 times the CRE lending exposure of QRI.
QRI’s loans have a shorter maturity profile at a weighted average of 1.1 years. This allows the manager to rebalance QRI’s portfolio more frequently and respond quickly to changing market conditions.
The traditional sources of finance are expected to continue to reduce exposure to CRE credit due to tighter APRA regulations, and this trend will likely be accelerated by the implementation of Basel III from 2023.
QRI has a strong investment pipeline and is ready to capitalise on more attractive risk adjusted opportunities that typically emerge when liquidity declines in the market.
Relative to its listed peers, QRI has a proven track record in providing attractive investment returns. While boasting the lowest 3-year NAV return volatility, QRI has outperformed all pure-play credit LITs on 3-year NAV return basis, calculated as distributions, plus change in NAV, net of fees.
At the current cash rate of 2.6%, QRI’s target return range is 7.6% to 9.1% – the highest among ASX listed LITs including peers with exposure to equity investments. On a last twelve-month basis, QRI delivered the highest distribution comparing to other ASX listed LITs with exclusively credit investments.
In the current rising interest rate environment, the manager is focused on increasing the proportion of variable rate loans in the QRI portfolio. We are expecting a 90% variable rate loan split within the next 12 months as capital from maturing fixed rate loans is redeployed at variable rates.
QRI’s current fixed rate loans deliver a weighted average gross return of 7.5%, whereas QRI’s variable rate loans return approximately 10%, comprising a credit margin of approximately 7% plus the 90-day BBSY, which was at 3.1% on 30 September. As illustrated in the sensitivity table, the objective of the portfolio is to increase investor returns in line with 90-day BBSY rate as variable rate loan split reaches 100%. QRI investors are in the unique position to benefit from the current rising rate environment.
Mark Power: Hi, I’m Mark Power a Senior Director within the Investment Team and acting Portfolio Manager for QRI
The QRI portfolio remains comfortably within the investment mandate constraints. This has been achieved by having 85% of invested capital secured by senior loans. During the June Quarter the QRI exposure to mezzanine loans decreased from 19% to 15% due to the scheduled repayment of a mezzanine loan in September. The repayment of this loan also had the effect of reducing our total construction loan exposure from 28% to 24%. 90% of the security properties in the portfolio are located in capital cities of Australia. There are two loans not in capital cities, one is a residual stock loan located in Newcastle, New South Wales, the other is a mezzanine loan located in the Sunshine Coast, Queensland. The QRI portfolio also remains within the Manager’s other key targets.
The portfolio composition continues to remain very simple and is diversified with 40 individual loans to a total 34 Borrowers. We know every security property and Borrower intimately to ensure the terms of the loans are adhered to and any potential issues are predicted and dealt with in a timely manner. The portfolio has a weighted average loan to value ratio of 66% and a weighted average loan maturity of 1.1 years (down from 1.4 years in the previous quarter) allowing the Manager to re-price, re-value and re-structure all loans that are due for renewal.
The portfolio continues to be heavily weighted towards the residential sector at 74% which we are comfortable with at this point in time. This comfort is underpinned by the fact we are currently in the midst of a shortfall in residential dwelling supply, that is only expected to become more pronounced in the short to medium term. Exposure to Victoria reduced from 53% to 48% due to the repayment of a mezzanine loan and continued amortisation of several residual stock loans. Pleasingly NSW exposure increased from 29% to 34%, following the successful closure of a predevelopment land loan in Kirribilli, Sydney. Queensland exposure remained stable at 13%, as did South Australia at 4%.
Thank you all for time and I will now hand back to Andrew to wrap up.
Andrew Schwartz: To recap, as the only pure-play CRE credit fund listed on the ASX accessible by retail investors, QRI remains well positioned to continue to provide attractive returns to investors.
This attractive outlook is underpinned by industry tailwinds and QRI’s unique characteristics, including rising base interest rates, increasing risk margins, and a short tenured loan portfolio. In addition, QRI’s high and growing exposure to variable interest rate loans provides further support for our return outlook.
As we have discussed during the presentation, we believe that the current investment environment presents a variety of attractive investment opportunities for experienced managers like Qualitas, which will help us continue to deliver attractive risk-adjusted returns for investors.
Importantly, we remain disciplined in our investment and asset management approach and continue to be diligent with our asset reviews and maintaining the quality of our existing assets.
Thank you for listening to our September 2022 quarterly update for the Qualitas Real Estate Income Fund.
Ends
