The right time for a debt fund?

On the anniversary of listing our first retail fund, I reflected on some of the lessons learned and the opportunities ahead for the Qualitas Real Estate Income Fund (ASX: QRI).

Q. Can you provide a snapshot of QRI?

QRI is a listed investment trust comprised of a portfolio of commercial real estate loans. Qualitas, the Manager of QRI, identifies the lending opportunities and assesses the loans, which are provided to a range of participants in the commercial real estate sector. For example, the loans might be for the purchase or refinance of an industrial or office building, the construction of an apartment building, or the acquisition of land that will be developed in the near term.

The borrowers pay interest and fees to Qualitas, who passes this income onto QRI’s unit holders in the form of monthly cash distributions.

The loans in the portfolio are secured by predominantly first mortgages, and to a lesser extent second mortgages. This provides capital preservation benefits to investors because, in the event that a loan can’t be repaid, Qualitas holds a mortgage over a real estate asset and can recover loan proceeds through this security.

Q. What was the rationale for creating QRI?

It felt like the right time for Qualitas and the right time for the market.

Qualitas was founded in 2008 and since then we have successfully built a loyal client base among institutions and high net worth investors such as pension funds and family offices. We delivered strong risk-adjusted returns by investing across the entire capital and risk spectrum, thanks to a very experienced and deeply connected team of deal originators. The Qualitas team has grown to over 70 people across Melbourne and Sydney ensuring we not only find the right deals, but manage these effectively for our investors.

However, there was no access point for retail investors to invest in our debt platform, and we wanted to allow this to happen.

At the same time, the demand for alternative lenders was higher than ever, with banks stepping back from commercial real estate lending. Pulling all these threads together, it made sense to create a fund that would address demand from investors, and tap into the strong pipeline of lending opportunities.

Q. What were some of the obstacles you overcame in launching QRI?

Because this type of product hasn’t been widely available to retail investors, it’s been important to provide a lot of education and explanation. While Commercial Real Estate (CRE) Debt is an established asset class in other markets, it has traditionally only been available to wholesale and institutional investors in Australia.

However, once we began the process of talking to advisers and investors in the lead-up to our Initial Public Offering in 2018, we were pleased by the level of support we received –and this support has continued in subsequent capital raises.

QRI has been particularly well-supported by the Independent Financial Adviser (IFA) market. I think it reflects the depth of wealth being looked after by advisers, and their focus on looking for the smart options for their clients. A journalist recently described investors as ‘income starved’ (1) , and it resonated with me. It explains the success of a product that combines capital preservation with monthly cash income (2) .

Q. How did investors respond to the launch of QRI?

A. We’ve seen a positive response even though it’s a relatively new type of product in the listed space. We think our investors were drawn to our long and successful track record in real estate investing in the core markets of Australia. Additionally, we have not deviated from our discipline around risk management and ensuring we deal with very experienced and credible borrowers. This is our 12^th year of operating, and we have been very consistent with our strategies for our clients.

The investors we talk to see QRI as a good diversifier for their portfolio. If they are looking for exposure to alternate assets then QRI is another way to access property, with the features of a debt-based investment such as stable income and capital preservation.

Q. Has the past year played out as you expected for QRI?

Investment of the initial capital was slightly slower than expected. We deployed the initial capital over the first 7 months, however this straddled the January holiday period, plus we have a very robust credit assessment process so it takes time to assess and settle loans. In addition, the first half of 2019 was challenging for the whole property sector.

A sense of uncertainty meant activity slowed down across the board. Everyone was especially jittery before the Federal election – Labor was touting negative gearing and capital gains tax changes that would have a significant impact on property investment. As a result, many market participants were just sitting on their hands while they waited for more certainty.

In this environment, Qualitas’ long-term relationships with borrowers were key to ensuring our pipeline remained healthy. We also benefited from a further pull-back by the banks, who continued to reduce their CRE lending appetites. As a result, we were able to progressively deploy QRI’s capital, and increase QRI’s distributions in line with that activity.

In the latter half of the year, we have been seeing a lot more optimism and our pipeline has been strong. It’s why we went back to the market for additional capital in June and September, and as a result, we’ve seen the fund’s size increase by around 50% since listing.

We are already well-progressed in investing this additional capital, and have been pleased with the depth of opportunities we are seeing in the market.

Q. How has the changing interest rate environment affected QRI?

The cash rate is currently 0.75% lower than when we listed the fund. This has both pros and cons.

On the positive side, the relative yield of the fund has made it attractive to investors who might be getting just one or two percent on term deposits in the bank.

On the downside, the lending base rates have also fallen, so we aren’t able to command the same interest rates as a year ago. There is also increased competition in the alternate lending space, which also has put downward pressure on interest rates to borrowers.

However, on balance we are still providing attractive risk adjusted returns to investors. Investors are coming to QRI not just for the yield, but also the capital preservation that comes with loans secured by first or second mortgages.

Q. What’s ahead for QRI?

We remain committed to educating the market about our asset class. We’ve been active in conferences, in media and on our own content hub to help investors understand the risk-and-return profile of CRE debt.

You can’t really fast-track this process – it takes a lot of work in a lot of different channels – but we are continuing to have conversations with investors in a range of forums.

We have also seen that investors appreciate proactive and transparent communication about their investment and the broader Qualitas business so we intend to keep working on this.

We make no secret of our desire to continue growing the fund in a disciplined way. We are focused on matching the amount of capital we raise with the pipeline of lending opportunities we are seeing.

Overall, we think the time is right for a fund that provides regular income to investors and gives borrowers a flexible source of funding. We’re looking forward to the year ahead for QRI.