AEW UK REIT plc (AEWU.L) Earnings Call Transcript & Summary

Good morning, and welcome to the AEW UK REIT plc Investor Presentation. [Operator Instructions] Before we begin, I would like to submit a certain poll. And I would now like to hand you over to Portfolio Manager, Laura Elkin, good morning.

Thanks, Alex, and good morning to everyone. You're joining us here on a rather rainy morning in London. Apologies that you don't have us on video this morning as we normally like to join. We had a few IT issues this morning, but hopefully, you can hear us loud and clear coming through old-school by design. Just doing a recap on the company and starting with a summary of our strategy. So during the last quarter, we passed through our 10-year anniversary, which is really exciting for us. Really great to have kind of reached that milestone for the company, 10 years of outperformance and 10 years of, of course, our very high dividend. Yes, really pleased with that. We haven't yet got our official 10-year MSCI performance figures. So I'm afraid we'll have to show those to you next time. But the strategy that I'm running you through here is the same strategy that we have been running for the course of the last 10 years. So that is based on value investment principles. And what I'm going to do is I'm going to focus today on the investment criteria down the right-hand side of this page. And that will really sort of give you, hopefully, paint a clearer picture of what we mean by value investment principles. But all of that leads to, as I've just set out, our market-leading dividend of 2p per share per quarter, which we have paid now for 39 consecutive quarters and our total return that we're delivering as well being very strong, both against its listed peer group and against the wider U.K. commercial property market. So really pleased with our ongoing performance. So just touching on these investment criteria. And as I said, these have been the same throughout the last 10 years. We are sector-agnostic, and that means that we look across the whole of the U.K. commercial property market. We don't really have any constraints at all in terms of sectors. So it means that at any point in a cycle, we can find value sort of reacting really to the sort of economic climate that we find and the occupier demand at that time and the -- of course, the investment pricing that we find at that time. Another part of this investment criteria that is absolutely key to us is location, location, location. And this is something which is really come through in every single purchase that we make. We are looking to buy high yields, but we won't be buying those high yields in locations that we don't believe they can be sustainable. So we received a significant number of investment asset introductions throughout the year into the thousands. And we analyze all of these, some at very high level based on pricing, but it's those that deliver high yields in sustainable locations, in sustainable properties, and those are the ones that we're looking to target. We mentioned those book values here and coming back to those value investment principles that I mentioned at the beginning, we think that this is really important to ensure optionality going through our business plans. We like to write our business plans with a plan A, a plan B, a plan C because, of course, during a 5- to 10-year hold period, a multiyear hold period, really, we don't always know what's going to happen. So we want to have various ways of leading to that high income that we pay out or that capital appreciation that you've known to you've come to know from our performance, different ways of delivering that to make sure that, that's as nailed on as it can be during, as I say, a multiyear hold period. And those really for me the most important part of our investment criteria.

Good morning, everyone. Henry Butt here speaking. I'm just going to pick up this next slide, which is obviously a snapshot of the portfolio as at the end of the period, the 30th of June. So just first, looking at the valuation, GBP 215.8 million. It was a fairly sort of quiet quarter in terms of valuation performance. However, we were up a smidge at 0.05%. We are yet to see the U.K.-wide valuation performance yet. The figures haven't been released, but we expect it to be a quiet quarter across the U.K. And in terms of kind of the valuation performance, it was mainly coming from our retail holdings that on the high street and our retail warehousing. And that's kind of mainly been driven by kind of investor and occupier sentiment really. You will appreciate that retail has had a tough time over the past 10 years with the move to e-commerce. But it is really good to see that retailers are committing themselves now to physical locations. High streets have shortened, but they are very much alive and kicking the best properties in the best location and echoing Laura's message a couple of minutes ago. And we are now seeing vacancy rates stable on the high street, which have stabilized now for quite a while in retail warehousing and some really strong sales in Q1 of this year, which is really positive given that Q1 tends to be the quietest quarter of the year. And it is expected that those retail sales will grow going into the year with potentially more rate cuts and increasing household income and sort of more power to spend. So yes, it's really been a quarter of retail, and we are, in general, seeing a renaissance in particular on the high street. 34 properties in the portfolio, Leicester being the most recent acquisition. We'll touch on that purchase later on the presentation. And again, a net initial yield of 8.13%, a reversion of 8.87%, so 74 basis points between the 2, and that is what the asset management team here at AEW is focused on going after that rental growth and driving that income. The portfolio has an average passing rent of GBP 7.30 per square foot. So we are starting off at a relatively low base, which illustrates the potential for income growth within the portfolio, which is obviously very important for earnings. The vacancy rate tends to yo-yo between about 10% and 5%. We're currently just shy of 7%. That vacancy is found in the Queen Square office in Bristol, where we are carrying out a refurbishment and are in sort of final stages of looking to get that space fully let. We have some quite high vacancy at our industrial park in Wakefield. However, that is all in what is physically and economically obsolete office block, which we are planning on demolishing and carrying out an IOS letting, which is industrial open storage. So once that is demolished, our vacancy rate will decrease. And then we have a bit of vacancy at our retail warehousing parks in Shrewsbury and Barnstaple, where we are in the latter stages of letting those units and at Runcorn, which we've touched on in previous quarters where we've carried out spec-ed refurbishment unit -- refurbishments of 3 units one, which we've let and two, we are in the process of marketing. You'll appreciate that in the summer months, marketing does tend to slow down. So we would expect to see a pickup in that letting activity in the autumn. Cash and debt and debt position is the same, GBP 60 million debt facility fixed until May 27 at 2.96%. And in terms of capital cash deployment, now that we have bought both Hitchen and Leicester following the sale of Coventry, we have no cash left to spend. We're fully invested, but do acknowledge that, that includes a normal cash buffer and cash allocated towards ongoing asset management initiatives. Just finally, just touching on the pie charts on the right-hand side of this slide, industrial has decreased over the past sort of 2, 3 years or so, down from its peak at 60% to 37%. And we have seen our retail sectors increase where we've been doing some countercyclical buying and buying those assets which pricing has been very attractive. And just touching on what I've already said on this slide, it's great to see renaissance in the retail, and we would look to hopefully benefit from that and improving investor and occupy demand for that sector.

I was also just going to say, Henry, it's interesting that you focus there on the amount of interest that we have in some of our vacant units at the moment because I think a couple of people have queries sort of since the announcement that we made a couple of weeks ago, why our earnings for the quarter were a little bit lower than they have been at some points in the past. And the answer to that question is that, of course, Leicester was bought towards the end of the quarter. So we haven't appreciated from full quarters of income there. And of course, we've got some really positive outlook on quite a few lettings coming up as well.

Thank you, Laura and Henry. This is George Elliot speaking, Fund Controller of the company. I'm just going to take you through a few performance slides now, the first of which focuses on our performance versus our peers. Really, I feel this graph embodies everything really that Henry and Laura touched on what is the output of this strategy and the intellect behind it. I think the first obvious comment to make is if I draw your eyes to the far right of this graph, you can see the IAV performance and actually a degree of outperformance has actually been consistently widening now for coming up to 3 years. And for me, who, in my role focuses on the financial performance of the company, all that tells me is not only is this strategy sustainable, but it also operates well in all market cycles. You'll remember that kind of coming out of the back of COVID, property valuations, et cetera, were doing very well, whereas they've been relatively muted for the last 18-odd months. And yet, despite that, we've continued to perform exceedingly well. Now there are a few reasons for this. One of, of course, is the consistency of the payment of our dividend, which is to remind you, 8p a year or 2p per quarter. But also as Henry mentioned already, it's our asset management approach. It's the active nature of that. It's the fact that we aren't dependent on property churn in order to deliver performance, but we can actually invest in our own portfolio. Again, as Henry has just said there, we've got cash already allocated to further initiatives, which we would hope to further drive NAV performance and outperformance indeed. I think the last comment I'll make on this graph is in kind of a point of intersection with our peers kind of around 2019, 2020. Of course, Laura has mentioned, we've just reached the 10-year anniversary of the company. And really that point of intersection marks halfway through that journey around 5 years. Now when we look at property and when we kind of divide our asset management strategy for it, typically, that will kind of be on a 5-year time horizon. So to me, it's no surprise that really the outperformance has started 5 years after we bought our initial glut of properties. But overall to kind of emphasize the headline stats an 11.4% 5-year annualized NAV total return to 31st of March and 6.6% outperformance of our nearest peer, which given the performance of our peers recently, which you'll all be aware of, is no mean feat. Taking you to this next slide, really what is the underlying derivative of our NAV performance. Well, of course, much of it is our direct property performance, and that's what this slide focuses on. Again, to reiterate what Laura just said, I'm expecting to receive our 10-year MSCI performance figures actually next week. So we'll be able to present those to you in the next iteration of this presentation. But despite that, looking at these bars here, again, a few key indicators for me. Firstly, if we look at kind of like the 5-year and 7-year annualized performance, you'll note that actually outperformance and the degree of outperformance is highly consistent. Now for me, why is that important? Again, it highlights the consistency of the strategy and the sustainability of its performance. This also shows me that it's not a thematic company. Of course, many of you will remember the days of industrials booming during COVID and their valuation is doing very well. Well, for us, we kind of maintained our strategy of being diversified. And this is really why it's enabled that consistent performance and prevented volatility in it. And of course, it's that which has enabled the consistency of our dividend. And lastly, for me, what's really important is over every time period you're viewing here, 6 months, 12 months, 3 years, 5 years and 7 years, we have outperformed our benchmark and the MSCI benchmark and also by a significant degree. It's that, that led us, of course, to winning last year, the MSCI award a 3-year annualized property total return. Again, just to highlight those key statistics at the top of this graph, we have a 5-year property total outperformance of 7.7%, unsurprisingly relatively in line with our NAV outperformance against our peers. So very impressive and very encouraging. We're certainly dedicated to maintaining this. This will probably be a mix of the 3 of us talking about this slide. But while I'm still on the topic here. Also key to our property performance and our NAV total return performance is the intellect and decision-making behind when we dispose of an asset. So what this graph shows is every property we have disposed of in chronological order since the company's inception. Of course, you can see Central Six Retail Park on the far right, our most recent disposal. And before I hand over to Henry back to talk about some examples of these and the reasoning behind them, I think it's important to note that much of why we have performed as well as we have is that we have a very disciplined approach to property disposals. I never normally wish to draw attention to the negatives. But for me on this graph, they're very important is that at times, sometimes the property has come to the end of the road and one has to be disciplined in saying, "Okay, we've done all the asset management initiatives we can on that property." We've driven this as far as we can and actually now is the time to cut the losses, so to speak, and reinvest those proceeds into high-yielding properties, of which I'm sure Henry will talk through for the rest of the presentation. So handing back to Laura and Henry.

Yes. I mean just touching on obviously, of course, we covered them off in previous presentations. But I suppose, George has touched on the red bars. I'll touch on some of the blue. Coventry obviously being the most recent disposal, selling about GBP 10 million more than what we acquired the site for. And you would have seen actually in our most recent announcement that the remainder, the ramp of that property, the Triangle site, the council and the JV with Friargate has action that option to take that office. So that asset will no longer be a part of the portfolio going forward. But yes, if you look at sort of Milton Keynes and Leeds and Bradford, more recent sales, that's a very good example of the selling out of industrials for yields in the low 6s and obviously, subsequently, we reinvested that into high-yielding properties over the course of the past 2 years, which Coventry actually was one of them with a relatively low and short haul period for us. We sold out of the DP warehouse in Deeside, obviously producing no income. And we took the decision at that time not to do a respective refurbishment and capture rental growth and then sell the asset having let the property, but to sort of skip that and just sell to an owner occupier at what was a premium to DP at a price that was close to what the investment value would have been had we done the work and not factoring in the cost of doing refurbishment. Again, South Kirby, Basingstoke and Mooreside, Swinton, which sits to the left-hand side of Oxford, more industrial sales, selling out of lower-yielding assets at a time when the sector was very hot and reinvesting into high-yielding assets. And again, finally, Eastport, Oxford and the one that sticks out like Swinton bought that for GBP 8.2 million, yielding 9% did and see that income drop off throughout the whole period. But in doing so, we secured an alternative use life sciences and health care, and that enabled us to crystallize the very successful sale of GBP 29 million. And then just finally, George has touched on the red bars. I think we obviously went through an asset management process with those assets. But obviously, we also continue to remind you that alternative uses and underwriting our investments with alternative uses and having the optionality to take assets to different uses is very important. And that theme sort of underpins the sales of these 2 assets, Glasgow, which was an office, which through time with sort of the sector and having a structural change became a little bit more peripheral, and we ended up selling that to a student developer. And Blackpool retail obviously has had its ways, but there were upper parts there, which were of interest to the buyer there. So that enabled us to sell those assets despite not being our best examples of what we've done in the course of the past 10 years. I'm going to hand over to Laura, who's going to just touch on the current investment markets and the buying opportunity that we're seeing in the U.K. currently.

Thanks, guys. Yes, this slide, really the best way, I think, of showing you what we think is a very strong opportunity at the moment here in U.K. commercial real estate. As you can see from tracking this red line, which shows average capital values, we are at the lowest point in the value life cycle since our IPO. And really, that's a really exciting thing to be able to say to you because we absolutely believe in the strength of our pipeline and the opportunities that we can acquire out there in the market at the moment. We can see that values haven't recovered since the conservative mini budget in late 2022. And this is expected to happen as interest rates start to fall and as the U.K. investment market starts to normalize. So yes, this is the greatest buying opportunity I think we've seen during the life cycle of the company. And given some of the great successes that we've had, as Henry has just shown you on the previous slide and some of the -- what we believe are genuinely exciting things that we've done for some of our assets during the last 10 years, then yes, it is really quite exciting for us to be able to sit here to you today and show you this slide, which is really representative of our pipeline. And when we talk about this slide, a lot of people say, "Gosh, well, why did you go out and sell a lot of your assets so that you can appreciate from this great buying opportunity?" Of course, if it's a great buying opportunity in general, it tends to be a less strong selling opportunity. So that is why that is not a particularly relevant strategy across the portfolio very widely at the moment. And of course, with a lot of our assets, we continue to work through specific business plans. So a lot of our assets are simply not at the point in their life cycle that we would like to let go of them. However, of course, there are some specific circumstances around assets. Coventry that we sold at the end of last year, we very much were able to maximize the value of that asset and we will have now by the time that we've invested those proceeds into other high-yielding assets, have achieved both capital appreciation and income appreciation through going through that process. So I'm not saying that we cannot achieve best value from any sale at the moment, but that's more of a comment that's applicable to sales across the board. It is a very good time to be buying U.K. real estate, but less good perhaps for sellers. And here, we're just showing you the inverse of this. So of course, at a time when there are lower values, then this is generally the case that we would be able to access high yields, and that's absolutely what we're seeing today. So this pipeline that we can access at the moment represented by these average values here in U.K. commercial property, not only the lowest values, but also the highest yields that we've seen available since the IPO of this company. And of course, for a company that is looking to pay out a high level of income, this is, again, a very exciting opportunity. And really, why is all of this happening? Well, one of the reasons is because the U.K. investment market has been experiencing less competition, less players, less lower -- much lower transaction volumes since that conservative mini-budget in September, I think it was '22. And with less participants in the market, there's less transparency around pricing, there is more mix pricing. And of course, as value investors, that is absolutely what we want to see. times when we can acquire properties out of line with their long-term fundamentals and then we can actively manage them. Handing back to Henry, who will talk about Leicester, our latest acquisition.

Thanks, Laura. So yes, here's Leicester and sort of roughly 8-acre site just away from Leicester City Center, which is one of the fastest-growing U.K. urban areas, which is obviously very positive. We bought the property for GBP 11.15 million, GBP 103 a square foot and a 10.6% net initial yield with the reversion to come with upcoming rent reviews. Just touching on that cap per square foot, GBP 103 a square foot. Now these are modern purpose-built units, which could very easily be moved into alternative uses. And that cap per square foot, it would be less than what it would cost to build these units. And there's some really good value there. Also, typically, when you buy these sort of city center leisure and retail parks, they've got a very low site coverage. So there's an opportunity to add value through potentially building other units on this site, notably maybe a hotel and there's the potential for some EV charging or maybe a drive-thru restaurant pod. Currently, the property is let to Odeon, Mecca Bingo, Nando's and Spirit Pub, which is a strong trading pub naturally being located next to Leicester City Football Club and the rugby stadium as well. Odeon trades very strongly here and the property was entirely sort of refurb to Odeon's Luxe standard a couple of years ago. So we've sort of really sort of got deep in our DD here and that gave us the confidence to buy this asset. And same can be said actually for the Mecca Bingo as well, and we are sort of -- we understand that there are other operators who would be keen to potentially take that Mecca Bingo. So 2 very strong trading leisure assets and throwing off a really cracking yield for the company. Now as I said, purpose-built modern units, these also could be taken to alternative uses. You can see this potentially being a last-mile logistics or trade counter location. Leicester is obviously well-known for its education. So student potentially, people, I would say, an asset that we really like doing exactly what we want day 1, throwing off some great income with potential for rental growth, but lots of sort of options up our sleeve in the medium to long term. So Laura mentioned that we are coming well. We've had our 10-year anniversary. And this slide really shows the performance and the track record of the strategy over the years. So moving from 2017 to 2025 from left to right. And I suppose the main themes with this chart, which you will appreciate there's quite a lot going on here, but you also sort of acknowledge that the portfolio has had an active 10 years. But I think the main themes really are first is the consistency of the income. So that is the blue bar, which runs across here. You can see that, that income has been pretty consistent, and that is obviously what has enabled us to pay out the 8p dividend now for 10 years, 2p per quarter for 39 consecutive quarters. And secondly, we really touched on some sort of countercyclical buying and selling. So we were buying retail and offices at a time that values look very attractive there. We bought industrials at a time when we've seen very little rental growth and higher yields in sort of secondary industrials and have done really well selling out of those. More recently, we have been buying again in the high street and some really cracking office locations in bath. So that countercyclical buying and of course, selling is massively important to the total return theme of the company. Also diversification, In recent years, there has been a theme that people want to be very sector-specific. However, diversification in the portfolio has enabled us to drive this total return at times when some sectors are performing less strongly and others perform more strongly. And that is exactly where we want to be. It means we can sort of roll with the punches and really sort of decide how we drive this performance. And then finally, sort of asset management and alternative uses. And we really get a skin of our assets, and we are not relying on yield compression to drive values and total return. We are adding income. We are adding value through asset management and alternative uses is very much a part of that, giving Oxford is the sort of very obvious example of an alternative use securing a really, really successful sale. So yes, this is, I think, a very meaningful slide. And please do have a dive into it and just see kind of where that performance has come from the past 10 years. That's all for me. I'm going to hand back to Laura, who's going to conclude the presentation. Thank you very much.

Thanks, Henry. Yes, I think hopefully, that's been a useful summary. As Henry says, the slides that we presented today are available on the platform. And please do come back and have a look because we know that sometimes we put quite a lot on our slides, particularly that one that Henry has just presented, which gives an awful lot of detail in sort of how we feel that we have been able to generate this long-term outperformance. So please do go back and have a look. I also direct anyone towards our website who's interested in learning more about the company. We show our full portfolio of assets on our website. And of course, you can access all of the latest news, access videos like this, access some further content as well and of course, all of our corporate documents. So please, if you are seeking any further information on the company, then please, I would draw your attention there as well. But just to conclude, we are really pleased with the company's position at the moment. Passing through 10 years and to see that sort of 10 years achieving the level of outperformance that we have, we feel, yes, incredibly grateful to have been on this journey and excited about the future because when we look at this pipeline and the really strong proposition that we think the U.K. commercial property market presents today, we also feel very excited about the performance that we think we can generate in future periods. Alex, do you want us to go straight to Q&A?

Yes, sorry, Laura, [indiscernible] go ahead.