Resilience when it counts
When the going gets tough.
As a financial adviser responsible for allocating your clients’ capital, COVID-19 presented sudden and unexpected challenges for most asset classes.
Risk assets took an alarming hit but rebounded strongly, while defensive assets were mixed, with bonds performing weakly and cash not worth mentioning. Wherever your clients were invested at the time of the shock, they no doubt paid much closer attention to their portfolio and asked more pressing questions about the security of their investments.
CRE debt proves its strength
One of the lesser mentioned defensive assets is commercial real estate (CRE) debt. A CRE debt investment seeks to generate income by providing loans to commercial borrowers who require funding for real estate. Despite the market upheaval during COVID-19, as an asset class it fared remarkably well and continues to offer compelling benefits to investors.
When looking at debt, resilience is best measured in two ways. The first is by counting the “bad” loans as a percentage of total loans in the portfolio.
Figure 1 shows loan impairments within CRE debt for Authorised Deposit Taking Institutions (ADIs) between March 2004 and December 2020. According to APRA, there was no increase in bad loans during 2020. This may come as a surprise to those forecasters who predicted the sky to fall. But for those within the sector, the quality of the lending is clear.
What’s more, CRE Debt now has one of the lowest impairment rates of all asset classes – less than 1%.
That’s the banks. What about alternative lenders?
Within Australian commercial real estate, bank loans make up 93% ($355 billion) of the debt currently provided to commercial borrowers. The remainder (~$25 billion) of CRE debt is provided by alternative (private) lenders, a sector that while small, is well-established and has been growing steadily.
How did non-bank CRE debt perform during COVID?
From what Qualitas has observed in the private CRE debt space, the story is the same. There is no major distress and impairment rates are very low and at similar levels to the ADIs. However, this depends on the experience of the lender and the quality of the borrower. Private CRE debt is a highly specialised asset class that requires the skill of a specialised manager.
QRI delivers solid returns
The Qualitas Real Estate Income Fund (ASX:QRI) was launched in 2018. It aims to provide regular income and portfolio diversification by investing in the CRE debt market.
QRI’s model is simple: it provides access to an actively managed book of around thirty loans provided to well-established Australian commercial property investors and developers. We know all of our borrowers individually, and the loans are high quality.
Here’s where we arrive at the second way to measure the resilience of CRE debt: its returns. QRI’s stable performance during the pandemic – both in returns and in its net tangible asset value – proved its resilience. Throughout COVID, QRI continued to pay monthly cash distributions at attractive risk adjusted returns (meeting its target return of cash + 5%-6.5%) and recorded no impairments in its portfolio.
While its unit price was initially impacted by the COVID-induced bear market (despite no impairments or drop in returns), the unit price recovered quickly to match the Fund’s net tangible asset value in February 2021 as investor confidence returned as a result of the Manager’s direct efforts to support the unit price.
The key is quality lending
Since we launched QRI in 2018, there have been no loan impairments in the portfolio, and no deterioration in net tangible asset value – including during the pandemic. That’s because of the quality of our loan investments and our effective approach to structuring and managing risk within the portfolio.
We apply a judicious investment process to source, filter and select suitable loan opportunities on behalf of our investors. We also actively manage each loan within the fund, right throughout its life cycle.
We are not just a lender; we are experienced real estate experts who are also equity investors in property and therefore understand the issues that impact borrowers. If a borrower gets into trouble, we can use our extensive property expertise to better manage the loan issues and related parties, all with the aim of safeguarding the loan.
The benefits of CRE debt
Commercial real estate debt has weathered the worst of the COVID-19 crisis and continues to offer attractive benefits to investors.
Its income stream– derived from fees and interest on the loans – is reliable. That’s because the terms are agreed upfront and are locked in for the duration of the loan.
It’s a great portfolio diversifier, as it can fit into three asset classes: fixed income, property, or alternatives. An allocation to debt can also diversify your portfolio across the capital structure, reducing risk.
It provides capital preservation. CRE loans are most often secured by first mortgages over a physical property, giving them the highest priority for repayment. Plus, the lender only lends a certain percentage of the property value, providing an ‘equity buffer’ to further protect investors from capital losses.
And finally, while providing exposure to real estate, the debt-based nature of CRE debt means it is less affected by property price fluctuations.
Accessing the opportunity
QRI is readily available through the ASX, and on various platforms.
Visit the fund’s website to find out how you can access this opportunity.
Notices and Disclaimers
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 making an investment decision, you should consider whether the Fund is appropriate given your objectives, financial situation or needs. If you require advice that takes into account your personal circumstances, you should consult a licensed or authorised financial adviser.
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.