Qualitas Real Estate Income Fund (ASX: QRI) Review

April 15, 2024

IIR has completed a review of Qualitas Real Estate Income Fund (ASX: QRI) (“QRI” or the “Trust”). QRI invests in the Qualitas Wholesale Real Estate Income Fund (“Sub-Trust”), which in turn provides direct and indirect exposure to a portfolio of secured commercial real estate (CRE) loans, predominantly in Australia with up to 20% of the portfolio able to be invested in New Zealand. QRI Manager Pty Ltd (the “Manager”) is the Investment Manager of the Trust. The Manager is a wholly owned subsidiary of the Qualitas Limited (Qualitas), an ASX-listed real estate investment management firm with approximately $8 billion funds under management. The Trust has a target distribution return of RBA Cash Rate + 5.0%-6.5% p.a (net of fees and expenses) and pays distributions monthly. The Manager is paid an annual management fee of 1.5375% (including GST) of the Trust’s NAV and is eligible for a performance fee of 20.5% (including GST) on the outperformance of the performance hurdle (cumulative net return of 8.0% p.a). Any direct loans made by the Sub- Trust will receive loan origination fees. There is a fee sharing arrangement whereby up to 33% of these fees will be passed on to the Manager in the event the Sub-Trust is the sole lender and up to 100% will be paid to the Manager in the event the Sub-Trust is a co-lender.

An investment in the Trust is suitable for those investors that are seeking a regular monthly income stream with the potential to generate attractive risk-adjusted returns compared to traditional fixed income investments such as government bonds and term deposits. The Trust has provided low levels of capital volatility since listing with the NAV remaining around the listing NAV of $1.60 per unit. Capital volatility is expected to remain low, subject to no impairments being incurred. The Trust has the potential to diversify an investors fixed income exposure with the Trust’s portfolio having no correlation to the domestic equity market and provides a different risk/return profile to publicly traded bonds. While loans are short-term in nature, the underlying investments are considered illiquid. The LIT structure
provides investors liquidity through the secondary market, offering investors the ability to access the underlying investments without having their capital locked up, which can be the case for unlisted fund offerings in this asset class. The Trust is the only LIT that provides exposure solely to the CRE debt market. While other LITs provide some exposure to the CRE debt market, it is part of a broader portfolio. The portfolio is actively managed and the short-term nature of the loans means that capital will be recycled regularly. As such the income received, while will be provided on a monthly basis, will be dependent on the portfolio composition at any given time.

We have maintained its Recommended rating for the Qualitas Real Estate Income Fund (ASX: QRI). QRI is the only LMI on the market that provides exposure solely to CRE debt and therefore provides a unique investment option for those investors seeking exposure to an alternative fixed income product. The portfolio has delivered improved returns with the Trust benefiting from the increased interest rate environment and has delivered strong risk-adjusted returns with no impairments being experienced in the portfolio to date, resulting in the NAV remaining stable. The Trust has made a number of positive changes since listing, including changing the distribution target to more appropriately reflect potential returns and then subsequently aligning the portfolio with the target distribution yield with the portfolio now essentially fully exposed to floating rate loans, and moving the portfolio from indirect to predominantly direct loan exposure. In terms of meeting the target distribution yield objectives, the Trust has largely achieved this objective on monthly annualised basis however has consistently been at the low end of the range. We view the risk in the portfolio to have increased with an increased exposure to mezzanine debt albeit the mezzanine debt levels are within the target range and were coming from a low base, however the mezzanine loans represent most of the construction exposure and are concentrated to a small number of loans. The Manager has grown AUM substantially over the last five years and has maintained a low level of default events with no capital impairments. With slowing global growth and the prospect of sticky inflation, we view credit risks to be elevated in the current environment which may result in an increased number of workouts required in the portfolio. While credit risks are elevated and the portfolio allocation to mezzanine loans has increased, the portfolio remains predominantly exposed to senior loans which provide an additional layer of downside protection.

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