Arena REIT (ARF) Earnings Call Transcript & Summary

Thank you for standing by and welcome to the Arena REIT FY '23 Results Call. [Operator Instructions] I would now like to hand the conference over to Mr. Rob de Vos, Managing Director. Please go ahead.

Thanks everyone and good morning. Welcome to Arena REIT's 2023 Financial Year Results Presentation. I'm Rob de Vos, Managing Director of Arena and with me is Gareth Winter, our Chief Financial Officer. Today we will highlight the key achievements over 2023 and provide an update on the performance of the business against investment objective and strategy. Gareth will provide detail on Arena's financial results and capital management position and I'll finish the presentation by discussing the portfolio and sharing my thoughts on Arena's outlook in a changing investment environment. As always, we'll have plenty of room for questions at the end. Financial year '23 marked Arena's 10th year as a listed business and over 20 years as a trust exclusively investing in social infrastructure property. Over the last 2 decades, the business has developed, owned and managed a leading portfolio of social infrastructure, providing positive investment returns to our investors and delivering positive social impacts to the many Australian communities in which we invest. Despite a new investing environment emerging over the last 12 months, characterized by higher inflation and higher interest rates, financial year 2023 was again underpinned by that growing community demand for the essential community services that Arena accommodates. And that demand for those services alongside with the disciplined capital, asset and interest rate management has again provided for overall positive outcomes across the portfolio and for the communities in which we invest. The highlight for financial year '23, and I'm on Page 3 for those following presentation materials, include a statutory profit of $74 million and an underlying cash-based net operating profit of $60 million, which is up 6% on financial year '22. Our net asset value per security was stable as increase in portfolio capitalization rates was offset by increases in passing market rents. We've made further positive steps on our sustainability programs achieving net zero organizational scope 1 and 2 emissions and advancing our solar renewable programs that are now installed at 83% of the portfolio. We've completed 10 early learning center development projects and replenished the development pipeline which will support future earnings growth. Understanding the needs of our tenant partners and the community demand for the services has allowed for us to achieve long-term efficient earnings growth and we anticipate that to continue as today we are providing distribution guidance for financial year '24 of $0.174 per security, reflecting an increase of 3.6% on financial year '23. Moving to the next slide. In an environment of heightened external risks, Arena remains committed to our disciplined approach and strategy which has resulted in long-term positive outcomes for our stakeholders. This year's highlights for the period across key management focus areas are the successful divestment of 2 health care properties early in the changing market at an average yield of 4.4% and a premium to June '22 book value of 2.5%. These properties were less efficient and had lower utilization compared to the rest of the health care portfolio and the funds were reinvested into new projects in our development pipeline. We've maintained a long weighted average lease expiry profile for the portfolio of just under 20 years through lease extensions and the delivery of WALE accretive new projects during the period. We've seen the portfolio passing yield expand by 25 basis points over the last 12 months to an average portfolio yield of 5.16%. The negative valuation impact of this has been mitigated by passing market rent growth across the portfolio with the average like-for-like annual rent increase for the period of 6.8%. The portfolio continues to have high occupancy at 99.7%, a testament to the quality of our assets, the robust fundamentals of the social infrastructure sector and the proactive management efforts of the Arena team and our tenant partners. We've made further progress with our renewable energy program, collaborating with our tenant partners to install solar panels and reduce the energy intensity of our portfolio. These initiatives are lowering utility costs for our tenants at a time of significant increases in other operating expenses. These programs also contribute to a reduction in carbon emissions. Our solar renewable energy installation for Goodstart alone has avoided 1,300 tonnes of carbon being emitted in the last 12 months and across the portfolio we've avoided 3,300 tonnes of carbon being emitted in financial year '23. We've acquired 2 operating properties with an existing tenant partner, 1 in Queensland and 1 in South Australia for a combined $7.8 million. These properties provide a net initial yield of 6% and have an average initial lease term of 25 years. We completed 10 early learning center developments for a total investment cost of $65.1 million. These projects deliver a net initial yield of 5.8% on all costs, including transaction costs. We've also expanded our development pipeline with the acquisition of 9 new early learning center development sites. Each project has been pre-committed to a new 20-year triple net lease to an existing tenant partner. Moving on to an update on our sustainability programs on Page 5. We believe that Arena's focus on sustainability across everything we do best positions the business and our stakeholders to achieve positive long-term commercial outcomes. We have a disciplined investment process and being an internalized manager with strong governance protocols means that we're aligned with investors for the long term. We're looking for sustainable growth and quality in our financial metrics, consistent with our investment objective of delivering predictable distributions to our investors with the prospect of growth. Arena's portfolio facilitates access to essential community services that provide a positive social impact. Achieving those positive social impacts provides access to a wider pool of efficient capital, like our recently entered sustainability linked loan with our banking partners, or the increasing prevalence of ethical and for-purpose investment managers on our register. We work with our tenant partners to invest the capital necessary to provide efficient, flexible and well-located accommodation at sustainable rents, allowing them to focus on their core purpose to deliver essential services to communities throughout Australia. Some of the specific sustainability outcomes we've worked on and achieved over the last 12 months include zero organizational scope 1 and 2 emissions and certified carbon neutral by Climate Active for our business operations. Our Board renewal programs have provided an opportunity for us to achieve better gender balance and achieve our target 40:40:20 model. We've facilitated a material increase in the use of renewable energy, reducing our tenant partners' utility costs and reducing negative impacts on the environment. We've completed our inaugural Physical Climate Risk Assessment and completed the first year of Arena's Modern Slavery roadmap. Further detail in relation to these achievements and our sustainability activities will be provided in our 2023 sustainability report, which is scheduled to be released in late September. I'll now pass you over to Gareth to provide detail on our financial results.

Thanks, Rob, and good morning, everyone. Just turning you to Page 7 of the presentation, you will find a summary of Arena's operating income statement for the year, which shows a 6% increase in net operating profit of $60 million and a statutory profit of $74 million. There is a reconciliation of net operating profit to statutory profit included in the appendix of the presentation with the most substantial reconciling item being the periodic re-evaluation of investment properties. Our operating EPS of $0.171 is 5% higher than the prior year, with the key driver of the increase in operating profit being the 11% increase in property income offset by an increase in finance costs. The increase in property income has been derived from a combination of rent reviews and capital deployment. Like-for-like rent reviews averaged 6.8% in FY '23, noting that 90% of rent reviews in FY '23 had a direct link to CPI outcomes. The annualization of the FY '23 CPI credits provides further protection to our cash flow into FY '24 as the increase in cost of debt also annualizes into FY '24. Arena's ongoing program of investment in ELC developments and new acquisitions contributed to earnings by capital deployment, the completion of the 10 ELC developments during FY '23 with the total project cost of $65 million, the addition of 9 new ELC developments to the pipeline and also the acquisition of 2 operating ELCs in conjunction with our tenant partners. We've also continued our program of selective capital recycling with proceeds of $33 million from the sale of 2 health care properties midyear at a premium to their June '22 book value to be reinvested into new development opportunities. Rent collections and tenant rent affordability are resilient, and the $800,000 of COVID related deferred rent was also collected during the year in accordance with the [ great ] payment terms. Our COVID-related rent deferrals were relatively short term with only $300,000 of deferred rents still to be collected over the next 6 months. The deferred rent has previously been recognized as income in the relevant period and booked as a receivable with only the cash to be collected. Just looking at some other line items. Property expenses reduced primarily due to lower allowances for independent valuation costs and property inspections compared to the increased spend from 12 months ago post COVID lockdowns, where there was some catch-up required. Looking at OpEx, there's been a modest decline in cash operating expenses compared to the prior year. Managing costs in a high inflationary environment has obviously been important and there's also -- the reduction is largely due to variation in staff and remuneration mix. Pleasingly, property revenues increased by $7.6 million in the year while operating expenses slightly reduced, and our cash-based MER remains around 30 basis points. The $4.6 million increase in finance costs is due to a combination of changes in both rate and volume. I'll talk more on rates when we run through capital management. But overall rate contributed a little over half the increase in finance costs while the average volume of drawn debt and the increase in facility capacity during FY '23 contributed to just under half of the increase in the finance costs. Capitalized interest on our development book in FY '23 was relatively steady in comparison to '22 at just over $3 million in both years. The lower statutory profit in FY '23 of $74 million is primarily due to the positive asset revaluations of $17 million and this is compared to the $254 million in FY '22. Just looking at distributions, we have paid a distribution of $0.168 per security for FY '23 representing growth of 5% which is part of our FY '23 guidance, so exactly in line with that, with the payout ratio being consistent with recent years. What is apparent is that the CPI based rent review mechanisms have been effective in offsetting the increase in debt funding costs during FY '23 and still demonstrate growth in earnings and distributions. For FY '24 we have provided distribution guidance of $0.174 representing an increase of 3.6%. In terms of baseline assumptions, for the floating rate we're picking up the forward curve which is averaging out an assumption of around 4.25%. At the moment for any forward hedging we're using a blended swap rate which we use -- a blended 5-year rate which also comes out at around 4.25%. Given the recent moderation in inflation, for CPI we have assumed 3.85% as the average annual rate across the 4 quarters of FY '24. And guidance is otherwise established on our usual status quo basis and assumes no asset sales or deployment of capital beyond the current development program and no material change in general market or operating conditions. Just turning to Page 8. There's a waterfall chart showing the changes in relativities for EPS for the period. To note the impact of the key drivers of the growth has been the CPI linked rent reviews and the deployment of capital and acquisitions and developments offset by funding costs. The relativity of each component is a little different to usual this year as rent reviews have contributed more than recent history and the development is slightly less which is to be expected given the interest rate and inflation environment. Turning to Page 9 on financial position. This slide presents a summary of Arena's balance sheet. The full balance sheet is in the appendix of the presentation. Key points to note here are the 3% growth in total assets, primarily due to the $70 million invested in acquisition and developments during the period offset by asset sales and asset revaluations of $17 million which combined with the DRP are the primary drivers of the increase in net assets per security. Our new investment CapEx in FY '23 is a little bit below our run rate in recent years which really reflects investment discipline in a market that is in transition on pricing to accommodate the new cost of funds but with net gearing at a relatively low 21% which remains well below our maximum gearing range of circa 35% to 40%. We have retained substantial capacity to fund the existing pipeline and developments and consider growth opportunities. And as we've talked about in recent years, this level of gearing also provides a material buffer around market volatility at this point in the cycle. Just turning to Page 10 and a summary of our capital management. Our approach to capital management is directly linked to our investment objective of predictability of distributions with scope for growth over the medium term. Accordingly, we prioritize resilience and risk reduction through relatively low gearing, ongoing high levels of hedge cover, regular extension of debt facility terms and maintaining immediately available liquidity in excess of our development commitments. Certainly the consistent execution of our capital management strategy combined with the natural inflation protection provided by a substantial volume of rent reviews directly linked to CPI has protected our net operating income in an environment where inflation and interest rates have materially increased in an extremely short time frame. During the period, the debt facility was expanded by $70 million to a total capacity of $500 million and we have a $158 million of immediately available liquidity to cover the $66 million of development commitments at 30 June. This liquidity in combination with our modest gearing is allowing us to actively consider new investment opportunities. In conjunction with the mid-year refinance, we also developed a sustainable finance framework and introduced a sustainability link loan overlay on the debt facility with a range of sustainability-related targets across our solar program, emissions reductions and modern slavery and there is a modest pricing adjustment in relation to those targets over time. The weighted average debt term has been extended to 3.7 years, noting that the first expiry is almost 3 years away in March '26. Our March '24 expiry was extended out to March '28 during the year. Our all-in weighted average cost of debt has increased over the course of FY '23 from a spot rate of 2.9% at June '22 to a spot rate of 3.95% at June '23. The average cost across FY '23 was 3.75%. The weighted average cost of debt quoted is all-in and includes the cost of all undrawn facilities. The respective contributions to the increase in the cost of debt over FY '23 are 44 bps from floating rates, 31 bps from swap rates and 30 bps from expanded liquidity and relative pricing on extension of debt term. Just looking at hedging. The primary objective of our hedging program remains smoothing rate changes through the cycle with a substantial and rapid increase in floating rates during FY '23, mitigated by a practice of holding consistently high levels of hedge cover. At 30 June, we had hedge cover of 88% for a weighted average term of 3.5 years and a weighted average rate of 2.03%. Only 5% of the swap book expires in FY '24. This hedging volume is above our usual run rate of around 80% that you would have seen us carry in recent years. [ The overs is ] hedging effectively taken out in advance of future debt drawdowns to fund the existing development pipeline. The extra hedging was added a few months ago to take advantage of a dip in swap rates during the period when some offshore banks were experiencing liquidity issues. As the development pipeline is funded, we expect the hedge cover will return to our normal range of 70% to 80% during FY '24. Finally, it is important to note that Arena continues to operate with substantial headroom in both our ICR and LVR covenants. I'll now pass you back to Rob, who will give you an update on Arena's property portfolio.

Thanks very much, Gareth. I'm now on Page 12 of the presentation. As of 30 June, Arena owned 272 properties across Australia with a value of $1.51 billion. The portfolio is just over 76 hectares in area and predominantly residentially zoned with improvements that are purpose built for our tenant partners. The portfolio accommodates over 27,000 families in their early learning needs across the country. Our health care portfolio contributes to meeting the primary health care needs of 8 communities and a higher acuity care of 35 people with high physical support needs in our SDA portfolio. The growth in the demand for the essential services we accommodate along with our and our tenant partners' disciplined and proactive management programs has resulted in the portfolio being in an excellent position. At just under 20 years, the portfolio has the longest contracted rent profile in the REIT sector. And to give that some context, the value of contracted future rent is well in excess of the current total portfolio value with an exceptionally strong occupancy record, and the portfolio has low single asset concentration, with the largest single asset accounting for less than 2% of the value of the portfolio. The land and building rate, that is dividing the current balance sheet market value of the portfolio into the site area, equates to just under $2,000 a meter, which continues to look like compelling value when measured against other real estate sectors. The passing yield is 5.16%, which has seen expansion of 25 basis points in the last 12 months. We expect to see further short-term yield expansion in real estate markets, including the social infrastructure property sector. And you can see in the appendix of our presentation that the early learning transaction yields are at the lowest margin over the Australian government bonds post the GFC. So we think it's sensible to expect that we'll see expansion yields to better reflect changes in investors' cost of capital. A mitigating factor for yield expansion is of course rental growth, which the portfolio is very well positioned, not only as a result of current strong trading conditions for our tenant partners, but also for our long-held focus of ensuring our rents had room for growth, so effectively coming from a lower base. Geographically, we have about 80% of the portfolio located in the high population eastern seaboard states, with a relatively minor increase in overall exposure to South Australia in the period following development, completions and acquisitions in metropolitan Adelaide. In terms of tenant diversification, we continue to improve our spread of tenant partners, now totaling 35, with 24% of Arena's income supported by Australia's largest early learning provider Goodstart. Moving to lease expiry profile on Page 13. With some minor leasing programs in this financial year on 2 small health care suites, which combined equate to about 0.5% of income, we're confident of a positive outcome on both of those programs over the course of financial year '24. And as you can see in the graph on this slide, we've less than 3% of the portfolio's income expiring prior to 2030, and no material concentration of expiries in any year to beyond 2046. These are very long-term cash flows that have contracted annual escalations providing inflation protection in the current higher inflation environment. All of the leases are triple net with no exposure to variable property expenses. So highly efficient and highly predictable. Moving on to our rent review profile on Page 14. The average like-for-like annual rent escalation for financial year '23 was a 6.8% increase higher than previous years as a result of the majority of the portfolio's income being exposed to an annual escalation that is the higher of an agreed amount or CPI. 95% of financial years '24, '25, '26 and '27 have annual rent reviews that are contracted at CPI or the higher of a fixed agreed amount or prevailing CPI or are a market rent review. We had a relatively low exposure to market rent reviews in financial year '23, with 6 reviews completed and 1 that remains outstanding. 4 of the reviews had a cap of a 7.5% increase and every one of those reviews reached that cap. And the 2 uncapped reviews achieved an average increase of 20%. Looking forward, we have 9.7% of the portfolio's income subject to a market rent review in financial year '24. These relate to 38 childcare properties. All of those market reviews have a collar at the passing rent, so the rent can't go backwards. And 29 of the reviews are subject to a cap of a 7.5% increase, whilst the other 9 properties have no cap on increase. We're anticipating further short-term growth in market rents of childcare properties as a result of generally strong operating conditions characterized by higher occupancy and increases in daily fees, which have been subsidized by additional government funding across the childcare sector. Whilst labor costs are also increasing for our tenant partners, on average, the affordability of rent is improving with the gross accommodation cost across the portfolio reducing to 10.5%. So whilst we've seen strong rent increases across the portfolio, particularly from those uncapped market rent reviews over the last 12 months, average affordability for tenant partners has actually improved. Moving to Page 15. The environment for development and construction was challenging throughout financial year '23, particularly in the second half with heightened cost inflation and higher interest costs for all contractors, leading to well-publicized solvency challenges across the construction industry. Whilst we have not had any direct exposure to insolvency challenges from our building contractors to date, we have had some relatively minor delays on some of our projects as a result of more challenging conditions. Importantly though, we've been sheltered from any meaningful negative economic impact as a result of the fund-through nature of those projects, which provides contractual protections for time and cost overruns. We were pleased to complete 10 early learning center projects in the financial year, which were located in Queensland, New South Wales, Victoria and South Australia, with 5 existing tenant partners. Each project was designed to suit each individual tenant's operations and pleasingly all of the projects are operating in line with our and our tenant partners' expectations in the first year of trading. We've secured 9 new early learning center development projects in a period that will complement the portfolio and deliver future earnings growth. Generally, we've been more cautious on origination programs, particularly in the second half, preferring to be patient and ready to exploit any price dislocation on targeted opportunities in a changing investment environment. Looking forward, our development pipeline has 16 early learning center projects that are located in Queensland, Victoria, South Australia and New South Wales with a total forecast cost of $112 million, of which we have capital expenditure outstanding of $66 million. We anticipate that the average initial yield on all costs, including transaction costs for these development projects will be 5.4%. Each of these development projects are being undertaken on a fund-through basis where Arena has, again, contractual protection from cost and time variability and we've secured agreement for leases with existing tenant partners on every project in our standard 20-year triple net lease format. Arena is a development partner of choice in the early learning sector. In the last 10 years, we have developed [ to own ] 70 childcare developments for 14 tenant partners, which have been undertaken in all states and territories with the exception of the ACT. These projects have increased access to early learning services for over 7,800 children and provided our investors access to an excess of $28 million of current annual rent. Moving on to the next slide. And demand for early learning services increased in the period as a result of population growth and increasing participation rates. And we expect that demand for services will further increase in the short term as a result of the additional federal government subsidization, which was implemented last month and lifts the maximum childcare subsidy rate to 90% for the first child in care and maintains the 95% subsidization rate for any subsequent child in care, as well as reducing the rate that the childcare subsidy tapers to increase the maximum family income threshold for eligibility from $354,000 to $530,000. This additional investment of $5 billion from the federal government is designed to provide a significant economic and social return to Australia, including increased workforce participation, better economic security, particularly for women, and improving the lifelong learning prospects of children. These new affordability measures for working families are timely in the context of recently released ABS data that the net out-of-pocket cost for childcare services as of June this year, the highest on record, and had already eroded the affordability measures introduced by the previous coalition government in March. A shortage of appropriately qualified and experienced labor is again a growing challenge across the sector that needs to be addressed to service the anticipated increase in demand that will follow the increased funding. It is our expectation, and more importantly, that of our tenant partners, that labor costs will continue to increase in the short term, which added with increases across consumables, regulatory and accommodation costs for early learning operators will again lead to increased daily fees. In order to assess and improve ongoing affordability for working families, the federal government has instructed the ACCC and the Productivity Commission to undertake reviews. The ACCC released its interim report in June, which focuses on prices, supply and demand for childcare, and initial examination of the childcare subsidy. The ACCC's final report is due in December. And consistent with its pre-election promise, the Albanese government has also instructed the Productivity Commission to investigate and make recommendations that will support affordable, accessible childcare, including considering a universal subsidization for all families at a 90% subsidization rate. The Productivity Commission's initial report is due in November this year, and a final report is due in June next year. Despite increasing demand for services, we've seen another year of subdued net new supply of childcare centers. There was a net increase of approximately 250 centers across Australia in calendar year '23, an increase of 3% in that 12-month period. And we expect that net new supply will continue to be constrained in the short term due to higher construction costs, increasing regulatory requirements, which will increase the obsolescence risk of older and less efficient centers, and overall higher return hurdles for investors. Moving to the next slide. And in this market context, Arena's early learning portfolio remains in a very strong position. We're 100% occupied and our tenant partners' average underlying business occupancy is the highest on record. Average daily fees have increased to $129 per day at March, which remains below the current government's benchmark fee of $151 per day, which is indexed to inflation. As you can see on the graph at the bottom of the page, the government funding package continues to suit our early learning center portfolio, which is typically geared towards middle-income families. And to give that some context, 90% of our early learning centers have daily fees under the government's childcare subsidy benchmark fee as at March. Our average rent per place across the portfolio has increased to $2,914 per place. And as we've developed more than 1/3 of the portfolio over the last 10 years, remains highly affordable in our view. Despite strong rent increases across the portfolio, rent affordability as measured against gross revenue has reduced to 10.5%. Moving on to the next slide. And we reduced the portfolio's exposure to health care property in the first half with divestments totaling $33 million at Bondi and Caboolture which provided a modest premium over their June '22 book value. The remaining 9 properties that accommodate health care services in our portfolio continue to perform to management's expectation and we continue to be attracted to the right new health care opportunities. Our investment thesis being that the community demand for health care services and the infrastructure to facilitate access to those services will continue to increase as a result of Australia's growing and ageing population. Saying that, we are wary in the short term of reduced health care visitations and therefore operator margins as a result of growing household cost pressures and reduced participation rates of private health care insurances. In our usual disciplined way, we'll be patiently looking to deploy capital where we are targeting quality over the long term that will support our investment objective. Moving on to the outlook and today we're announcing full year distribution guidance for financial year '24 of $0.174 per security, an increase of 3.6% on financial year '23. The portfolio is in a strong position. Underlying occupancy for our tenant partners is at the highest position on record and strong rental growth has been absorbed through our tenant partners' ability to lift daily fees with the assistance of further government subsidization for working families. We have a 20-year WALE with a transparent and highly predictable rental profile that has inflation protection. 88% of our borrowings are hedged for a weighted average term of 3.5 years at a rate of just over 2%. Future income growth will be underpinned by contracted annual rent increases, as well as the impact of our financial year '23 and '24 acquisition and development completions. Looking forward, despite the likelihood of further economic uncertainty, including the potential for slowdown in economic activity, Arena's outlook remains positive. Early learning and health care services are integral to economic stability and improving community outcomes. And those themes underpin Arena's portfolio value and investment objective of providing long-term predictable distributions to our security holders with prospects for growth. We have balance sheet capacity to patiently take advantage of new opportunities that are consistent with our strategy with gearing at 21% and no debt expiry falling due until March '26. And our experienced management team has strong industry relationships and in-house development and origination expertise that will assist us in sourcing future opportunities and exploiting price dislocation in a changing investment environment. In closing, I'd again like to thank our team and our tenant partners for contributing to the positive outcomes that have been achieved in financial year '23. That concludes the formal part of today's presentation. So I'll now pass the call back to the operator to open up to the questions. Thank you.

[Operator Instructions] Your first question comes from Caleb Wheatley from Macquarie Group.

My first question was just around the return from the development book. So at the first half, Rob, I think you flagged some incremental development discussions where pricing potentially up to around that 6% mark. Also noting that the development completions were at a higher yield than the forecast yield on costs for the year. Are you able to provide any color on the composition of those projects over the past 6 months and how you're thinking about pricing on a go-forward basis, please?

Caleb, we have got a pipeline that's got 16 projects in them. We've got a dip in the middle of those that saw some sharper pricing, so if you like the balance of both the development pipeline sitting at that sort of mid 5% to 6%. New projects that we're looking at, at the half, are sort of around that 6%, it's probably moved another 25 points. We're probably looking at the moment at opportunities that's 6.25% to 6.50%. And we think that that belongs -- we think that's probably going to be achieved more so on the rent growth side. The market has been frustratingly resilient in regards to holding up pricing.

And just to get a bit more understanding about that dip in the middle, are we still sort of working through that dip? And if so, how much longer until we potentially start to see that improvement on the other side?

Right, a little bit of that depends on just, I guess, new acquisitions and what we actually replenish. We are sort of actively looking at things a little bit more patiently than what we have and cautiously than what we have in our prior periods, as you would have seen in the results. But that dip will sort of see its way through over the next 6 to 12 months as we complete the majority of the pipeline that sits in there at 16. But our expectation is that we'll continue to originate, and I think we've got good prospects to continue to fill that 6.25% to 6.50%. So that means -- in summary, that means that we'll probably see a development pipeline yield that sits not dissimilar to where we are at the moment if we continue to originate that 6.25% to 6.50% as we move out some smaller-yielding assets in the short term. I will make the point that those smaller-yielding assets probably got much better rental reversion though, Caleb. So that's one thing that we're just sort of keeping a bit of an eye on. Those rents look reasonably low, even though they were set sort of 18 months, 2 years ago, against what's happening in the market.

Yes, that makes sense. And so just on the development cost front or anything else that's potentially driving margins on the other side, has that inflation subsided to some level or...

No. The honest answer is no, it hasn't, not in the work that we've been doing more recently. I think what we're seeing at the moment is better protection of margins, which I think is healthy for the construction industry, particularly at that lower end. So no, we're still seeing moderate cost inflation coming through and certainly not -- certainly not a slowdown in cost inflation from our perspective.

Great. My second question just around tenant affordability and health in the ELC sector. So you noted net rent revenue moderated slightly, remains really low historically. Just in the context of some of the inquiries you've flagged into the sector, can you provide any commentary on the health of the ELC tenant base? How they're viewing affordability of rents and any thoughts on, again, the rising labor costs that you've flagged as a headwind from an operator point of view as well, please?

Yes, so both Productivity Commission and ACCC reports underway. Interim report for the ACCC was released. It did look a little bit into -- primarily it was really in regards to pricing as an exercise of reconnaissance of what's going in there, a very significant one, I should say. I guess from an operator's health perspective, true of our business and all the operating data that we receive, and I think reflective of the market, higher occupancy and a propensity to lift daily fees to absorb higher costs. So top line revenue in pretty good shape across the industry is our viewpoint. That's been absorbed somewhat by higher consumables, as you'd expect, higher regulatory costs, which are -- and accommodation costs, which all 3 of those are sort of sitting at inflation. And then the outlier being labor costs, which is the, as you know, sort of labor-intensive industry is the one to watch. That's sitting at about $0.60 in every dollar that is being generated by tenants at the moment. And we think that with that increased demand for services as a result of that government -- extra government funding, Caleb, that we'll see extra pressure coming on that labor force, which necessarily will mean it's one to watch.

And just noting your comment there on being able to lift daily fees, are there any anecdotes from an end-user point of view in terms of affordability from a consumer getting a little bit harder from what you're hearing in your tenant base, or is it still largely being accepted at this stage?

Largely being accepted at this stage. I think the -- if you look back at the affordability measures the previous government did, reduced out-of-pocket costs by about 4%. So it's quite successful, that affordability measures. We've got the new funding coming through, that extra $5 billion from the coalition -- the new [ Labor government ] coming through. And we haven't seen quite what that means for demand, but I think everyone is expecting that will reduce overall out-of-pocket costs for consumers, which is necessary, and I made that point on the presentation, is necessary because we are seeing high and into double-digit daily fee growth.

Your next question comes from Lou Pirenc from Jarden.

Rob and team great presentation. Just on your market rent reviews, you mentioned the unkept ones at about 20%. Can you give any color on where you believe your overall portfolio is compared to market rents at the moment in terms of over [ on the rental ]?

Yes. Always a tough one to provide. We've obviously got quite a disparate portfolio, Lou, but we've got rents at the moment across the portfolio of $2,900 per place. From an economic perspective, it's very difficult to, I guess, build new stock at anything close to sort of $3,500 a meter across Australia at the moment. So that gives you some idea against, I guess, new stock. 1/2, or about 1/3 of the portfolio has been developed by us over the last 10 years. So we think we've got a relatively new portfolio relative to the market. And we've obviously got good trading conditions, as we sort of talked on. So we think that is -- some of all of that means that we've probably got positive reversion in the rents. I wouldn't hazard a guess, and I certainly wouldn't guide towards the uncapped, that 20%, albeit we've had some great results there over a period of time. Many of those, including the 2 that we had in the period, hadn't had a market rent review for 10 years. So it had been sort of going up at that sort of 3% or CPI, but hadn't caught up to the business operating results. So positive, I wouldn't hazard a guess as to percentage, but it is in a better position than what we were 6 months, 12 months, 18 months ago, Lou.

Makes sense. And then, I mean, clearly you have a great balance sheet, and you're a dominant player in the market. Are you seeing any signs of some of your peers, landlords, starting to struggle? So would acquisitions or other opportunities, be more likely in the next 12 months, or do you think it's too early?

Still a bit early, I think, Lou. The asset class has actually performed really well. There has been a number of sort of smaller operators, landlords that have actually set up small portfolios. We've been watching those with interest. But the underlying real estate has actually performed quite well, which I think will shelter some of the protection -- give some protection to those that might have high leverage positions. But it is an avenue of growth that we are looking at actively and we will continue to do that. But I think probably too early to point to anything specifically.

Great. And then 2 quick questions for Gareth, if I may. Any changes in debt margins that you've seen in your recent refinancing? And also, I mean, clearly great cost discipline in the last 12 months. What are you expecting there for the next 12?

In terms of debt margins, we had 14 bps increase when we refi-ed and did some extensions. So fairly negligible. So we continue to watch, obviously, credit spreads with interest. But because we have a rolling portfolio of, I guess, of facilities, we're not really exposed at any one particular repricing period in terms of cost changes. So again, it's about that smoothing impact over time. In terms of costs, we're basically looking at it as an inflation style increase. As I said in the presentation, we're assuming an average annual CPI of 3.85% across the year. Obviously, starting at a higher level at the beginning of the year, and then obviously we're downgrading that over the course of FY '24 to get to that average. That's pretty much what we're picking up.

Your next question comes from James Druce from CLSA.

Just following on from Lou's question, what are your margins? Is it around 160 basis points, 170 basis points, or has it tipped up a bit?

We're a little bit less than that overall.

Yes, okay. And just on -- a curious question, is there any seasonality in the daily fee increases that you see quarter-on-quarter?

There is some seasonality, but we tend to run a moving annual, James, to smooth that seasonality out.

Okay. So the move from March to June was pretty small compared to the prior months. So you're saying just look at it on a long run, 12-month basis?

Best way to do it is a 12-month rolling, yes.

Okay, that's great. And then how do we think about the lag between when inflation is printed to where that actually hits your rent roll?

Yes, so the rent reviews are reasonably evenly spread over the course of the year. Obviously, they're each quarter, and we look at the rent reviews in that period and adjust it to the CPI for that period. They're actually state-based CPI measures. So a national level is indicative only. But then it takes obviously up to potentially 12 months for the full effective flow through.

Yes, it's clear. And one last question, just on the development and acquisitions, I think at the half year, we were sort of looking at closer to $90 million for the year. I think it's printed at $70 million. Is that right? And if that's the case, what sort of things have been pushed out?

Yes, I think at the half, James, we were sort of, the view that we would have, I guess, opportunities that would have been secured, would have been consistent with the second half of the prior, if that makes sense, which would have sort of tallied to that sort of $100 million, which we'd got quite accustomed to as a run rate. I think what we've seen is more resilience in the sector. Interestingly, we saw more transactions come up in the second half, and they were at sharper yields than what they were in the first half from a market perspective. So that was a bit of a surprise to us. And we have, I guess, been a little bit more patient in the past 6 months, thinking there's probably better buying opportunity in front of us rather than behind us. So that's -- look, we've probably got the deal flow coming through the front door, but probably been a little bit more judicious in regards to what we're actually engaging on at the moment.

Your next question comes from Steven Tjia from Barrenjoey.

Great result. Just 1 question from me. Just thinking about how do you kind of view the supply and demand balance within the early learning centers? So there was 3% in net new supply of centers, but demand drivers and female participation and the LDC rate both look at all-time highs to me. How are you viewing that balance?

Yes, the best way to look at it is what's the ultimate outcome of the mixture of supply and demand? And at the moment, we're seeing higher occupancy and the ability for tenants to, and the market generally to lift daily fees, Steven. So I think the result of that is that the supply is not keeping up with the demand, and that's prior to the extra $5 billion that the government is obviously putting into the system to stimulate further demand. So we think that there is an under supply at the moment of infrastructure, but more predominantly an under supply of labor, which will be an impact for demand in time. But as it stands, 3% is not enough to satiate the underlying demand for services.

Your next question comes from Murray Connellan from Moelis Australia.

I appreciate that you've already discussed the rent to sales ratio having ticked down a little bit, but I was wondering whether you could just unpack a little bit around what you're seeing with regards to new leases being struck. What sort of rent to sales ratio do you typically see on those new leases? And given tenant affordability constraints in other parts of the cost base, has that ticked down at all over the past 2 years?

Yes, that's a good question. So probably not a lot of change in regards to the ratio. So 12% to 15% is the gross accommodation cost. Anything above 15% starts looking marginal from an operator's perspective. Yes, that hides the fact that we've seen quite strong growth in rents to absorb those high costs that you rightly point to, Murray. So we're seeing higher rents, high starting rents in projects across the country. And I guess if you looked at it on a net basis, we have seen an improvement, and that is we're seeing higher profitability per place and higher profit margins across at least our 3.5% of the accommodation market that we own. So that is pointing towards a better net position for operators as well as gross.

Your next question comes from Ben Brayshaw from Barrenjoey.

Rob, I just have a quick question on your independent valuations. Could you talk about the internal rate of return assumed in current book values for both the health care and the childcare assets? And when you look at the independent valuation assumptions from your own perspective, does your house view differ on the growth outlook assumed in those valuations?

Yes, that's a good question, Ben. So look, the IRR has changed for different properties. As in general we've seen lower rent growth across health care that's been for some time. I think there's a little bit of -- where our rents started from but the growth rate hasn't been as strong there. And we're also being held down interestingly by more fixed in the health care component. So it's kind of balancing out if that makes sense we'll see rent growth I think stabilize a little bit to where we are from the market perspective which is different to the childcare. We are seeing, as other callers rightly pointed out and as we announced, higher market rent growth in our book there. So values are sort of seeing that. We're probably being a little bit more cautious on rent growth. We've always been a very strong lens on affordability. We don't want people baking in 20% market growth in rents. I think it's very dangerous in this environment. As to IRRs, they're sitting at sort of high single digits and not dissimilar on both. It's the divergence on order committee and Board and management's view. We don't -- we have a very robust governance protocol that runs around evaluation programs and I think over the last number of periods we've had strong discussions with valuers about views in regards to particularly rents but also yields and are comfortable there is not a divergence between independents' and management's views.

There are no further questions at this time. I'll now hand back to Mr. De Vos for closing remarks.

Thanks very much for everyone's attendance on the call today. We look forward to catching up with a number of you over the coming days and weeks. Thanks very much.

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.