Chair and Head of Social Infrastructure’s Letter

Continuing to pursue new opportunities in social infrastructure to enhance income sustainability and resilience.

Dear Unitholder

Charter Hall Social Infrastructure REIT (CQE or the REIT) continues its focus on enhancing its social infrastructure portfolio with a diligent approach to asset acquisitions and disposals, as well as leasing and development, matched with prudent capital management.

CQE has delivered a resilient performance through a challenging year impacted by the COVID-19 pandemic. CQE remains well capitalised with gearing at an all-time low of 16.4%, liquidity comprising cash and undrawn facilities of $289.6 million, no debt maturities until March 2023 and liquidity to fund contracted property acquisitions and developments as well as capitalise on new investment opportunities.

CQE has strong property fundamentals with its long weighted average lease expiry (WALE) portfolio and strong tenant mix in the childcare sector that benefits from significant government support. We continued to focus on improving portfolio quality and tenant covenants through a combination of new leasing transactions, acquisitions, disposals and completion of developments. This activity resulted in the WALE increasing by 2.8 years or 28.3% to 12.7 years.

For the year, CQE generated earnings per unit of 16.5 cents and distributed 16.0 cents per unit (cpu), both unchanged from the previous year. Operating earnings of $51.1 million represents an increase of 15.6% on the prior year with net tangible assets as at 30 June 2020 of $2.92 per unit.

CQE’s statutory profit for the year of $85.9 million has increased by 25.0% on the $68.7 million level achieved for FY19.

As part of CQE’s strategy, CQE will continue to pursue opportunities in social infrastructure to enhance the portfolio and improve its income sustainability and resilience.

COVID-19

CQE has and continues to support tenants impacted by COVID-19 through this challenging period. Rental relief provided by CQE to tenants as a result of COVID-19 has amounted to $5.4 million. This included $3.8 million of rental relief which was provided in exchange for an average 6.2 years in lease extensions across 40 leases.

Government funding throughout the COVID-19 period has highlighted the essential nature of childcare with governments allowing childcare centres to remain operational with no required parent contributions. The Child Care Subsidy funding system re-commenced on 13 July 2020 together with a transition payment through to September 2020, to offset the loss of JobKeeper payments to operators.

Property portfolio performance

During the year, CQE has continued to focus on improving portfolio quality and tenant covenants through a combination of new leasing transactions, acquisitions, disposals and completion of developments.

This included finalising new 20-year leases on 40 properties operated by Goodstart with improved terms for both parties, including fixed annual increases. Five new 15-year leases were concluded with other tenants. In addition, 48 of 52 five-year options were renewed by tenants, demonstrating the low substitution risk of these assets.

Overall, CQE has seen a significant improvement in the portfolio metrics through FY20, as follows:

• Increase in WALE to 12.7 years from 9.9 years;
• Majority of leases (53.6%) now on fixed rent reviews for FY21 and beyond; and
• Improved lease expiry profile with only 4.4% of leases expiring within the next five years as at June 2020, down from 18.9% at June 2019.

Acquisitions / Development program

Acquisition activity during the year included the settlement of 11 existing childcare properties for $64.8 million at a purchase yield of 6.3%, with a further 3 existing childcare properties contracted for $12.6 million at a purchase yield of 6.4%. These acquisitions all have strong lease covenants with quality tenants and average lease expiries of 16.2 years.

CQE continued to dispose of noncore assets to recycle capital into properties with more favourable property fundamentals. During the year, there were 40 property disposals totalling $59.4 million which included 26 New Zealand assets disposed in April 2020, with the majority of these being smaller properties with an average WALE of 5.7 years.

CQE’s development pipeline comprises 24 properties with a forecast completion value of $149.2 million. Five developments were completed in FY20 with a completion value of $27.5 million and a yield on cost of 6.7%. Another 2 developments have completed since 30 June 2020 with a completion value of $15.3 million. It is forecast that a further 9 developments will complete in FY21 which will improve the quality of the portfolio and add to the earnings profile of CQE.

Property valuations

During the year, 348 properties were valued, which resulted in a valuation increase of 5.8% over 30 June 2019 values. Overall yield has remained constant across the portfolio at 6.2%.

Importantly, evidence of relative stability in valuations for childcare centres has been seen through market transactions of $43 million during June and July 2020 at average yields of 5.9%.

Capital management

In March 2020, CQE increased its debt facilities to $500 million, providing undrawn capacity of $214.0 million to fully fund contracted existing property acquisitions and development pipeline.

Following CQE’s institutional placement of $100 million in May 2020, gearing has reduced to 16.4% leaving CQE well positioned to manage the ongoing impact of the COVID-19 pandemic and capitalise on long WALE social infrastructure opportunities that may arise.

CQE has diversified funding sources with no debt maturity until March 2023 and a weighted average debt maturity of 4.1 years.

Childcare market

The key drivers of increasing childcare demand remain as follows:

• Childcare is an essential labour supply mechanism, critical to allowing Australians to return to work during/ post COVID-19; and
• Significant learning benefits to young children with the quality of childcare services continuing to improve.

Long day care (LDC) usage increased by 3.6% (27,800 additional children) from December 2018 to December 20191.

As at 30 June 2020, there are 8,0351 LDC centres in Australia, a net increase of 291 (3.8%) for FY20. Rolling annual growth since June 2016 in LDC centres has been 3.8%1, consistent with the growth in children using LDC centres of 3.8% over the corresponding period.

Outlook

CQE will continue with its strategy to provide investors with stable and secure income and capital growth through exposure to social infrastructure property. As part of this strategy, CQE will pursue new opportunities in social infrastructure to enhance income sustainability and resilience.

CQE confirms that based on information currently available (including with respect to the COVID-19 pandemic), continued tenant performance and barring any unforeseen events, the FY21 forecast distribution guidance is estimated to be 15.0 cpu. CQE will continue to pay quarterly distributions.

Finally, we would like to thank our unitholders for your continuing investment in CQE.

Grant Hodgetts
Non-Executive Chairman

Travis Butcher
Fund Manager