Qualitas Real Estate Income Fund (ASX:QRI) Quarterly Update, June 2022

Andrew Schwartz (Group Managing Director and Co-Founder) and Mark Power (Acting Head of Income Credit Funds and Head of Build-to-Rent Debt Fund) 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 June 2022 Quarterly Presentation.

I’m joined today by Mark Power, Acting Head of Income Credit Funds and portfolio manager for QRI.

We’re delighted to share this update and demonstrate why Qualitas is well positioned to capture the upside from the rising interest rate environment for our investors.

First, some key points about the Qualitas Group and our role as manager of QRI.

Qualitas is one of Australia’s largest alternative real estate investment managers with extensive industry experience, institutional grade governance and track record.

We have committed funds under management of approximately $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 either invested in or financed assets valued at over $15 billion. Our deep expertise and long-standing relationships have enabled us to build a robust pipeline of growth opportunities for our investors. Our equity skillset brings a unique and beneficial lens to our due diligence as a lender, reflected in our track record of zero loss of investor capital in private credit since inception.

Let’s move now to the specifics of QRI and the highlights for the second quarter through to 30 June 2022.

QRI provides a unique offering as the only pure play listed alternative commercial real estate credit fund in Australia and New Zealand available to retail investors.

The Fund has achieved its target return of the RBA cash rate + 5.0% to 6.5% and is currently operating within the target range. In June, QRI reported a last twelve month (“LTM”) distribution return of 5.34%, calculated on an average LTM NAV of $1.60.

In relation to asset management, there have been no impairments or interest arrears since the IPO and during COVID-19, and the current historical NAV is $1.60.

The fully deployed portfolio has achieved diversification through 40 individual loans which are predominantly first mortgages. Of the overall portfolio, 54% of new loans are based on variable interest rates, an increase of 23% from March 2022.

Let’s focus now on the potential benefits of the rising interest rate environment for investors, and the opportunities it presents for QRI to deliver attractive risk adjusted returns for our investors.

We have identified several key thematics which make this current market environment beneficial for credit funds.

Firstly, the highly defensive nature of commercial real estate income as investors’ interest is secured against real assets with good levels of equity buffer. For retail investors, this opens the door to opportunities previously only accessible by institutional and high net worth investors.

Second, for investors seeking yield with protection from volatility and inflation they can leverage QRI’s expertise, singular focus on credit and its track record in maximising outcomes for borrower and lender during periods of market volatility.

For QRI investors, the strong LTM yield of 5.34% with an annualised distribution of 5.85% for June which is trending up with the cash rate.

Thirdly, during rising interest rates, it creates an environment of widening credit risk margins. What this means is in addition to an increase in interest rates to borrowers due to cash rate increases, risk margin set over and above cash rate is also increasing. These combined result in greater returns for investors.

The other key point about the current environment is that banks traditionally retreat during market volatility, which for QRI means that we can leverage our extensive borrower network and strong reputation to capture the deep pipeline of credit opportunities with improving risk adjusted returns.

Across the sector, commercial real estate debt impairment remains low, despite growth in commercial real estate transactions, with QRI maintaining a fully secured portfolio with strong credit profile and weighted average loan maturity of 1.4 years as at 30 June 2022.

Fixed rate loans in the portfolio deliver a weighted average interest return of 7.9%, whereas variable loans are yielding 7% plus 3-month BBSY at ~2.3%. As fixed interest loans mature, repayments will be re-invested in variable loans which are currently yielding a higher return.

Hypothetically if the portfolio reaches 100% variable loans, at current weighted average variable loan margin of 7% and assuming BBSY is 3%, the total gross interest return will be 10%.

QRI is expected to reach a 90% variable loan split within the next 12 months.

Critical to Qualitas’ ability to deliver for investors through uncertain economic times, is our expertise, reputation and strong track record for discipline, and vigilance.

We remain committed to disciplined and active management of all loans in the portfolio ensuring all requisite interest payments were made on time, and all repayments were received on time.

With elevated risks in the current environment, we continue to prudently review all existing and new investments, with a focus on serviceability, asset valuation, LVR and inflation sensitivity.

Our vigilant management, combined with significant experience working with borrowers in financial difficulties, has meant no loss of investor capital since inception in our private credit business. This is a vital part of the Qualitas story, and we work diligently to ensure it’s maintained.

We have various risk mitigation strategies to manage construction and mezzanine loan risk, allowing for multiple layers of buffer to provide protection, including those designed to protect against rising construction costs, such as an assumed ~5% cost overrun by developers and builders, a minimum 5% performance bond from builders and a personal guarantee from developers which Qualitas holds long-term relationships with.

As a sophisticated investor, we believe the market conditions are favourable for mezzanine debt to deliver attractive risk-adjusted returns, with recent pricing around 11%-15%, as compared to returns of 6%-8% on senior debt with an LVR of up to 65%.

I will hand over now to Mark who will provide greater detail regarding the portfolio.

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 81% of invested capital secured by senior loans. During the June Quarter the QRI exposure to mezzanine loans increased from 6% to 19% as we took advantage of a reduction in risk appetite from traditional banks, which provided the opportunity to deploy capital into 3 new mezzanine loans, with a strong risk adjusted return profile.

96% of the security properties in the portfolio are located in capital cities of Australia. The one loan not in a capital city, representing 4% of the portfolio, is located in Newcastle, NSW South Wales and is a residual stock loan.

The portfolio composition continues to remain very simple and is diversified with 40 individual loans to a total 33 Borrowers. Importantly, 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 67% and as Andrew mention earlier the portfolio has a weighted average loan maturity of 1.4 years 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 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 remained stable at 53%, Queensland exposure increased from 8% in March to currently 13% in June, due to the successful closure of a new mezzanine loan in that state, whilst exposure to NSW reduced from 32% in March to 29% in June due to loan repayments.

Thank you all for time and I will now hand back to Andrew to wrap up.

Andrew Schwartz: Thank you, Mark. To conclude, I would like to revisit, and reinforce, why QRI is well-positioned to capture the upside from the rising interest rate environment and deliver for its investors.

An environment where the combination of rising interest rates, rising risk margins and the short duration of our loan portfolio, with 54% variable interest rate loans, provides a solid foundation for the ongoing attractive risk-adjusted returns for the benefit of our investors.

Our offering is unique. QRI is the only dedicated commercial real estate credit fund accessible by retail investors in Australia on the ASX.

We have the expertise and the experience. By recognising the risks inherent in the current economic environment, we create multiple opportunities to deliver attractive risk-adjusted returns for investors.

We have the history. Our track record demonstrates our ability to deliver stable monthly income with no loan impairments throughout the cycle.

We are vigilant and disciplined. It is our absolute priority that we remain vigilant with our asset reviews in order to maintain the quality of our existing assets.

While the current period of interest rate and inflation recalibration can be unsettling for investors, as managers of this portfolio we believe it represents an exciting environment that allows investors to reap the benefits of a new set of dynamics. Dynamics which we believe provides more pricing growth relative to a highly liquid price compressing setting, which has dominated the market for the previous 10 years.

Thank you for listening to the QRI quarterly update. That brings an end to this presentation. Thank you.


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