The Qualitas Real Estate Income Fund (ASX: QRI) listed on the ASX on 27 November 2018. In this article, Tim Johansen, Managing Director, Capital & Debt, discusses the Fund’s performance since then, the market conditions, and how demand for Commercial Real Estate Debt continues to grow.
Q: It’s just over six months since you listed the Fund. What does the portfolio look like now?
A: As the Investment Manager for QRI, Qualitas spent the first half of 2019 investing the money raised during the Initial Public Offering.
By the end of May we had deployed 78% of the Fund’s capital, achieving good diversification across loan type, geography and property sector. This includes exposure to 25 loans on a look-through basis, in addition to the Arch Finance Warehouse Trust Notes, which were added in March. These notes provide exposure to a portfolio of around 200 senior first mortgage loans.
We have paid a monthly distribution to investors since the first month, and this has increased each month as the Fund capital has been invested. In May, the monthly net return was 5.13% p.a.[i] and we are forecasting a July month return of between 7.00% and 7.50% p.a[ii].
Q. Have credit and property market conditions changed since last year?
A. Since we launched QRI, we’ve seen a change in the type of finance that’s in demand.
The first half of 2019 was characterised by negative sentiment in the residential market, leading to lower investment activity. A combination of falling prices and policy uncertainty led to lower pre-sales of new developments. In turn, this led to less demand for mezzanine construction loans.
However, there was good momentum in land and investment loans, as investors took advantage of more moderate pricing to acquire assets, or refinanced to hold onto sites until a more robust feasibility is achieved.
Overall, there continues to be a robust level of CRE lending activity, but with more opportunities in the senior loan market, versus mezzanine loans.
Q. Have these changed conditions impacted the Fund portfolio?
A. As a result of evolving market conditions, Qualitas has created a portfolio that is somewhat lower down the risk/reward curve. However, we have done this consciously and carefully. Our 10-year track record has been achieved by maintaining discipline and patience in all market conditions, and this is true for QRI. We won’t take on undue risk just to increase returns.
While this can make deployment slower, it ultimately protects investors, because we don’t compromise on credit quality. Our robust deal filtering framework screens out the majority of opportunities, but that means we have confidence in the ones we do take on.
Q. Are you seeing any impact on the market following the re-election of the Coalition Government at a Federal level?
A. A number of factors appear to be improving sentiment around the residential housing sector. Taken together, we expect that the combination of lower interest rates, Coalition tax cuts and a new First Home Buyer scheme will be positive.
This won’t be overnight though. Economic conditions remain soft, which is what prompted the RBA’s interest rate decision. Credit availability for both home buyers and developers continues to be constrained, reflected in lower construction starts and housing approvals, as well as lower pre-sales.
While sentiment has become more positive, in the short-to-medium term, we expect to see continued opportunities for senior land and investment loans.
This is because, in this phase of the cycle, developers and asset owners with access to capital will make the most of lower values to acquire new sites. Those who already have land will look to take advantage of a recovering market by seeking out pre-sales to activate sites.
The advantage of the short tenor of loans in the portfolio – around 18-24 months for most – is that we have the ability to rebalance the portfolio as market conditions change.
Q. How do you view the state of the Commercial Real Estate lending market at the moment?
A. The CRE lending market continues to face a funding gap, as banks retreat due to regulatory pressure and capital requirements.
The size of this market is significant and continues to grow. The most recent figures, released in March this year, show that the market size is $282b – the result of more than 4% growth over the course of 2018[iii].
This is a market that banks are increasingly sharing with alternative financiers like Qualitas.
Clients who used to approach their bank for senior lending are now approaching us as well as, or instead of, a bank.
This isn’t limited to residential developers – we are seeing more commercial flows, such as industrial and office assets. These asset owners are looking for certainty and speed in their funding, and flexible deal structures. We can provide these things in a way that the banks often can’t.
This communication has been issued by The Trust Company (RE Services) Limited (ACN 003 278 831) (AFSL 235150) as responsible entity of The Qualitas Real Estate Income Fund (ARSN 627 917 971) (Fund) and has been prepared by QRI Manager Pty Ltd (ACN 625 857 070) (AFS Representative 1266996 as authorised representative of Qualitas Securities Pty Ltd (ACN 136 451 128) (AFSL 34224)).
This communication contains general information only and does not take into account your investment objectives, financial situation or needs. It does not constitute financial, tax or legal advice, nor is it an offer, invitation or recommendation to subscribe or purchase a unit in the Fund or any other financial product. Before acting on any information contained in this communication, you should consider whether it’s appropriate to you, in light of your objectives, financial situation or needs.
While every effort has been made to ensure the information in this communication is accurate; its accuracy, reliability or completeness is not guaranteed and none of The Trust Company (RE Services) Limited (ACN 003 278 831), QRI Manager Pty Ltd (ACN 625 857 070), Qualitas Securities Pty Ltd (ACN 136 451 128) or any of their related entities or their respective directors or officers are liable to you in respect of this communication. Past performance is not a reliable indicator of future performance.
[i] Refer to the QRI May performance update report released to ASX for further details. Monthly net return p.a. is calculated as the annualised net income earned for the month, divided by the average NAV for that month.
[ii] Based on full investment occurring by 30 June 2019, and there are no unexpected loan drawings or repayments. This is a forecast only and circumstances may change. Forecast July month return represents the first month where all existing and forecast investments earn a full month of income.
[iii] APRA Quarterly Authorised Deposit-taking Property Exposures December 2018 (released 20 March 2019); 4.2%YOY Growth December 2017 – December 2018.