Why does Australia have a chronic need for housing?

As Power explains, this is an "unprecedented low" for Australia's vacancy rate - meaning the market is currently running at a level of chronic undersupply. 

This comes as demand levels continue to skyrocket. 

"Population growth is a very big driver, for the demand for new dwellings. If we look at that population growth and break it down, once again, that's running at unprecedented levels" Power says. 

"The net overseas migration number for the 12 months to June 2023 was +517,000 for Australia. Now, that ignores the natural rate of population growth as well, which is a further 90,000-100,000. All those people have to be housed." 

For some perspective, in the 10 years prior to the COVID pandemic, overseas migration was running at around 217,000 a year. And back then, that was considered "incredibly high", Power says. 

And, to make matters worse, Australia is currently not keeping up with its targets when it comes to new housing supply.  

"The Federal Government has put a light on the hill to say that over the next five years, we need another 1.2 million dwellings in this country. Now, that's just to keep up with demand, that's not going to solve the fact that we're already in chronic undersupply," Power says. 

That's 240,000 new dwellings a year. Currently, Australia is estimated to deliver around 160,000 new dwellings in 2024. 

"So in the first year of that five-year target, Australia is falling way, way short," Power says. 

Meanwhile, CBRE estimates that Australia needs 300,000 new apartments over the next four years to keep up with demand. 

"That's 75,000 apartments every single year. Current estimates for this year are at about 60,000, and then you look at future years, and it drops off further again," Power explains.

"Whether you're talking dwellings overall or whether it's just apartments, we're falling well short of where we need to get to. That's why I say the chronic undersupply now is actually going to get worse before it gets better." 

What does this mean for property prices?

This is particularly true for detached dwellings, which prior to the COVID period, traded hands at a 16% premium to apartments. Today, this premium is around 45% - meaning detached dwellings are far more unaffordable than apartments today. 

"The reality is that detached dwellings have become increasingly unaffordable for people, particularly for first-time buyers," he says. 

"We obviously need more affordable supply to come through into the market and apartments can deliver that outcome and provide that entry point into the residential housing market for people that need a roof over their heads at the end of the day." 

The Qualitas Real Estate Income Fund invests in real estate debt/loans. And, given the major supply-demand imbalance in the residential market in Australia, Power unsurprisingly has the strongest conviction in the potential returns in residential real estate, particularly apartments. 

"Even if you're focusing on the apartment market - 75,000 new apartments every year for the next four years - if you were to deliver that, and running on the median average house price and then average gearing of 60%, what that means is that you require $115 billion of debt capital to be invested into that part of the market to deliver that supply," he explains. 

With this in mind, 88% of the fund is exposed to loans in this area of the residential market. However, the team is still willing to deploy capital into other opportunities within the real estate spectrum. 

"If you look at the industrial market - warehouse, logistics - we've got strong conviction there as well," Power says. 

"Much like residential, you've got a scenario where the supply that's being delivered is just insufficient to meet demand. Once again, industrial has record low vacancy rates being evidenced by very strong rental growth within that part of the market, so we are very confident there." 

Office, on the other hand, remains challenged. 

"We wouldn't ignore the office market completely, because in any dislocated market there are often opportunities," he adds. 

He points to premium, high-end office spaces as an example of potential opportunities today, or lower-grade offices that are being redeveloped into premium office offerings. 

The impact of higher rates on yields 

"The Qualitas Real Estate Income Fund is returning high 8% to 9%. Returns in private credit, more generally, are very closely correlated to that variable rate, because we charge borrowers a margin over that variable rate," he explains. 

"You may well find returns coming back slightly. Albeit I think returns will still be really attractive on a risk-adjusted basis relative to other investment opportunities."

For context, QRI is an MREIT (mortgage real estate investment trust) - not an AREIT (Australian real estate investment trust). This means it provides loans to real estate companies or developers, rather than investing in the equity part of the capital stack or physical assets. 

Rising interest rates have been a tailwind for MREITs with many trading at or above NAV. As rates rise, so too does the cost of debt, so a borrower has to pay more to borrow the money, which is then passed onto the MREIT investor in the form of an enhanced return. 

For AREITs however, rising rates have been a headwind with many trading at a discount as compressed returns and distributions have caused more of an assets cash flow being used to service debt. 

In addition, MREITs typically trade at or above NAV, while AREITs are currently trading at a discount. This is because AREITs invest in the equity part of the capital stack - and, given elevated rates have compressed returns and distributions - more of an asset's cash flow is being used to service debt. 

Looking for regular income and diversification?

The Qualitas Real Estate Income Fund (ASX: QRI) aims to deliver investors a regular stream of income (1) with the added benefit of diversification beyond traditional shares and traditional property investments. Find out more. 

Notes: 1. The payment of monthly cash income is a goal of the Trust only and neither the Manager or the Responsible Entity provide any representation or warranty (whether express or implied) in relation to the payment of any monthly cash income. Returns are not guaranteed. The premium achieved is commensurate to the investment risk undertaken.

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