Argosy Property Limited (ARG) Earnings Call Transcript & Summary

Thank you for standing by. And welcome to the Argosy Property Limited FY '22 Annual Results Briefing. [Operator Instructions] There will be a presentation followed by a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to Mr. Peter Mence, CEO. Please go ahead.

Good morning, and thanks for joining us. I do realize that you've got another result on today, so we'll try to be up-to-date and reasonably succinct. The strength of this business lies in the diversity of the portfolio by sector, by location and by tenant mix. That gives flexibility to support our tenants, particularly important in the year just gone with their changing needs and at the same time, ensuring a resilient business model that allows us to continue to deliver results. Through today, on the agenda page, you'll notice that contrary to what's in the annual report, I've got separate photographs because I look quite short in the annual report, I think Dave must have been standing on a box. As is normal, I'll take you through vision and strategy comments, some highlights for the result and some portfolio highlights, hand over to Dave for the difficult stuff through the financials and then I'll talk about leasing and outlook. Turning through to vision and strategy. A lot of the things that make it achievable for us to deliver on this are the 3 key items; good people, good culture and good values. Hence through that, we've been working through the -- a business strategy that is committed to green and environmental sensitivity, meeting the needs of the market and our tenants, our customers, meeting the needs of the nation and the globe in our part of the belt environment. Looking at a resilient business model and reduced impacts from shock, from change, well illustrated by the last 2.5 years of COVID, which has really been an opportunity for us as a business to engage more closely and more effectively with our customer, the tenant. Diversified framework gives us a few advantages that allows us to reduce the level of volatility. It also enables us to capitalize on mixed-use development work with enhancement from changes in use or complementary additional uses. And you can see that with our current assets, Forge Way in the Albany Mega Centre and in the past, with the recent sale of 25 Nugent Street and 960 Great South Road, both in a change of use scenario. So obviously, the key result highlights really speak for themselves. Property income, fairly solid in a challenging year. Interesting to note that the arrear situation is in pretty good shape in the business. Dave can talk about that a little bit more later on perhaps, but certainly better than you would have expected if you had known what was ahead of the beginning of the year. A good revaluation increase, more than we expected in the second half of the year. We would have to expect with rising interest rates, that will be flatter going forward. We'll expect to see softer cap rates and stronger rentals taking precedence in the short term, particularly in industrial on Auckland and commercial offices in Wellington. Fairly good profit after tax, NTA up to NZD 1.74 and a number of circumstances where you've got potential for change of use or repurposing of assets that if anything, could be conceived as being a little bit light in the years ahead. A dividend in line with guidance at 6.55. And of course, you'll have noted a promise of expectation of a lift for the year ahead. The portfolio remains almost full with just over 1% in vacancy and weighted average lease term of 5.7 years. Now that's before we add in the new Maui Street 15-year lease, which will add around about 0.2 of a year to that. So weighted average lease term looking fairly solid for the short-term issues ahead. Realized rental increase is pretty solid at 3%. And looking ahead, obviously, we'd expect to see further growth in industrial and we can also see some growth interestingly in the Albany Mega Centre based on current inquiry levels. Turning to the sector summary. Firstly, with the industrial space, there are some changes and I think most people will be aware of that. There is really solid net absorption continuing in that market. We're seeing land prices go very, very high based on the scarcity of land. And you've seen over the last 5 years, industrial land values in Auckland increase by about 2.5x. So pretty solid land price growth there. We're also seeing the beginnings of the return of a domestic manufacturing facility possible and of course, construction costs, which have been quite solid in their growth over the year, something of a new normal there. In the office space, obviously, we've got activity at 360 Lambton Quay, where we [ obviously ] finished that development and handing over to stacks, sorry, that's Willis Street, at Willis Street handing over to stacks with rental commencing next month. And 360 Lambton Quay, we're well progressed in the final stages. From the outside, that kind of looks finished and leasing is going pretty well there. We've got commercial terms agreed and we're documenting a lease. 105 Carlton Gore Road, good activity there and we have got a start on site for the fixed price contract. Again, leasing going particularly well. And in the future, we'll have activity in our own building, the Old City Markets. And of course, as previously mentioned, 101 Carlton Gore Road coming right on the heels of 105. In the large format retail sector, I think they've gone reasonably well for us there with the 4 assets at [indiscernible], The Warehouse in Taupo, the Albany Mega Centre and the Dairy Flat, with other property, all looking at a situation where they no longer represent the highest and best use of the land. So those opportunities are here -- there when those leases come through. Portfolio at a glance. And I guess the driver here is the change to the -- strategic change to the weightings where we will expect to see industrial increase over the medium term as the development work continues through there and that will be at the expense of the office space, which will diminish. So over the medium term, moving more firmly into the industrial space with second line in office and large format retail taking up the final spot. Within the regions, we are currently within the bands and there's no real change to those targets. And again, within the target band and the asset mix by value as well. Steve helped me put a slide in there for us with [indiscernible] projections from CBRE and given us a weighting back there. We actually scored reasonably well in the CBRE picks for the year ahead. You'll note the 9% versus 10% on the prior slide in the large format retail. The gap, of course, will be the Albany Toyota, which doesn't really qualify in the same degree. Steve put some work in to try and show a little bit more clearly where the assets are lying. I think that slide gives us a good spread. You can see where the weightings are. But moving to the value-add properties, which is where the activity is, the Bell Avenue property, 2 of them together, of course, that's a new 10-year lease to Peter Baker Transport. Tenders have closed there and looks -- the budget looks as though were appropriate. So I'm happy with that. 5 Allens Road, the lease is already executed there as well. That's in the planning phase. 1-3 and 5 Unity Drive, project is well advanced. It's on time and on budget with an expected delivery date at the 1st of June. 224 Nielson Street and the 8-14 Richmond -- Mt Richmond, the design and the leasing is progressing reasonably well on those. And we've got some good tenant inquiry that we're fielding there. 105, sorry, 101 Carlton Gore Road is pending, as I said, and will follow on from 105 Carlton Gore Road, which we're looking for a completion later -- or early midyear, I'd call that. 105 Carlton Gore Road remains on time and on budget. We have started on site. And as I say, 8-14 Willis Street, we're handed over the building for fit-outs to the tenant and expect rent from next month. So that part going reasonably well. It is really fitting into the new normal, dealing with supply chain issues, forward ordering of key component parts. There's about an 8- to 10-week delay on lifting equipment and about a month's delay to air conditioning equipment at the moment. That is the new normal, we'll have to be pretty focused on making sure that we manage the supply chain and projects ahead. A bit of a value-add case study there with the 2 Bell Avenue properties. As I said, that's where we can have issues with needing to order the long lead time items and big escalation provisions on both sides of the contracting fence, the new normal and how we put that together. But looking fairly tidy at the moment and obviously an encouraging development profit forecast on that one. 105 Carlton Gore Road, leasing activity is really solid here. The development work has started. We are targeting a 6-star rating and pretty confident that we're going to be able to achieve that. The good thing is that of course, with the 101 project coming hot on its heels, overflow leasing inquiry and momentum from this building can be relocated to just a little bit further up the street. So pretty happy with the way that's going so far. The development project slide 8-14 Willis Street, that, as I said, we've handed over, going pretty well. 360 Lambton Quay, the -- we are documenting a lease with the commercials agreed, so really good quality tenants. So we expect to be able to announce that shortly. The Bell Avenue was pre-leased to Peter Baker Transport for a 10-year period. 105 Carlton Gore Road, leases, we've got 2 leases. We're documenting already with commercials that have been agreed. We're negotiating with a further party, which would see that building all but leased. As I say, overflow leasing inquiry relocated just up the road. So that works for us. Annual revaluation slide. Obviously, that was quite encouraging for us over the full year, more in the first half than the second. But the star player was Auckland industrial, but Wellington office also features there with solid demand for seismically sound property and the projections for the Willis Street development to be under market on completion. The sale of 25 Nugent Street has about 25% over book value. So that worked well for us. Offsetting that, the acquisition of Maui Street, which is post-balanced of course, a 15-year triple net lease, 6.7% labor return in the Golden Triangle. We see that Golden Triangle becoming more and more important as the scarcity of industrial land, particularly heavy industrial land becomes more present in the Auckland market. Hand over to Dave to go through the financials.

Thanks, Peter, and hello, everyone. First slide from me is the gross income waterfall. The rent reviews contributed an additional NZD 1.4 million in FY '22. As usual, we've provided some further detail in the appendix to the presentation in reviews. Vacancy and leasing up was also positive by NZD 1.3 million. The biggest contributor here was 7 Waterloo Quay, where we leased up the 3 remaining floors during the year. With a full contribution from the Mt Richmond Road acquisition in FY '22, there was a NZD 0.6 million negative contribution from development. So the completed development at 54-56 Jamaica Drive was more than offset by the withdrawal of 105 Carlton Gore Road during the year. The divestment of the Albany Lifestyle Centre in April last year resulted in a NZD 5.5 million decline in revenue and that was the biggest contributor to a NZD 7.6 million impact on disposals. We provided NZD 1.6 million in COVID-19 rebate this year, which was NZD 2.6 million down on last year and just over half of that was to our retail tenants. The gross property income was NZD 112.5 million compared to NZD 111.5 million last year. Moving on to the next slide, financial performance. Net property income was down by NZD 1.3 million from last year. You need note, there was a NZD 2 million insurance receipt recorded last year that arose through a re-weighting of the deductible allocation between capital and revenue. It was just a re-weighting there last year. Admin expenses were up during the period. This was due to resourcing up the development team, salary increases and additional ESG, health and safety, IT and professional fees. Professional fees, mainly related to tax consulting during the year. The MER ratio was 56 basis points and corporate expenses were 11.2% of net property income. Interest expense was down by NZD 2.9 million during the year, mainly due to higher capitalized interest as well as lower average [ technicals ]. Well and truly capital revaluation gain of NZD 163.7 million. Profit after tax was NZD 236.2 million for the year, which was down on last year's NZD 241.7 million, which included the final insurance receipts for 7 Waterloo Quay. The next slide is distributable income. So after adjusting for revaluation gains, derivatives, et cetera, gross distributable income was NZD 67.7 million compared to NZD 71.6 million last year. Net distributable income was NZD 64.7 million compared to NZD 67.7 million last year. We did note that last year included a one-off forfeited deposit in respect to the final settlement of the Albany Lifestyle Centre. Distributable income per share was 7.68 cents per share compared to 8.14 cents per share last year. Next slide. Adjusted funds from operations or AFFO, capitalization of tenant incentives and leasing costs were lower than last year, which included incentives and leasing costs for 7 Waterloo Quay and 107 Carlton Gore Road. Maintenance CapEx was higher than last year. There was the 7 Waterloo Quay facade, which is largely complete and this reduced AFFO by NZD 10 million net of tax. The largest project outside the 7 Waterloo Quay facade were a new roof at 17 Mayo Road, NZD 1.7 million -- that was at NZD 1.7 million, some tenancy works at 8 Nugent Street at NZD 600,000 and some LED lighting replacements at 320 Ti Rakau Drive at NZD 410,000. Maintenance capital spend, excluding the facade was 53 basis points on total property assets held. Breaking down to NZD 5.8 million spend further, we spent 33 basis points on industrial assets held, 21 basis points on office assets held and 13 basis points on LFL assets held. The audited FFO was 5.73 cents per share and payout ratio was 114%. If you adjust for the facade net of tax, payout ratio was 94%. On to the next slide, investment properties. So we started the year with a portfolio value of NZD 2.05 billion and we ended the year at just over NZD 2.2 billion. Looking at movements for the year, we spent NZD 67 million on development and maintenance CapEx. As noted on the last slide, we spent NZD 20 million on maintenance CapEx during the period, including the facade. In terms of our major development projects, we spent NZD 35.5 million in Willis Street, 360 Lambton Quay, NZD 3 million on finishing 7 Waterloo Quay projects, NZD 1.9 million on 105 Carlton Gore Road and NZD 1.1 million on value-adds. And we can provide a further detailed information after the meeting for anyone who wants that. Transfer to held for sale was the property at 25 Nugent Street. The sale during the year was the Omahu Road in Hastings. Lot of these assets related to the ground lease at 39 Market Place, which we had capitalized to comply with IFRS 16 and then similar to last year. Next slide is NTA per share, we started the year at NZD 1.53, and we ended at NZD 1.74, including 0.7% increase over the year. The biggest contributor to the increase was the NZD 163.7 million revaluation gain in the quarter. Next slide, which looks at our debt to total asset ratio, gearing reduced from 35.9% in March 2021 to 31.1% in March 31, 2022. Our acquisitions in FY '22 and development costs were more than offset by divestments and the impact of the revaluation gains. At March 31, '22, we're sitting towards the bottom end of our target 30% to 40% band. Next slide just shows the debt to total assets position for the last 5 years. And note, we changed our policy from FY '19 onwards to 30% to 40%. Prior to that, we were at 35% to 40%. The next slide, interest rate management. Our weighted average interest rate was 4.14% at March 31 compared to 3.69% last year, an increase of 45 basis points. That's been caused by increasing floating rate and the change in mix between floating and fixed, offset by margin savings on refinancing. Interest cover ratio was 3.1x compared to the bank covenant of 2 and last year's 3.3x. Percentage of fixed rate borrowing was 57% compared to 51% last year. So we have NZD 400 million in fixed coverage at March 31 and another NZD 55 million in forward starts. We have NZD 35 million rolling off in FY '23 and NZD 20 million in FY '24. So we have a fairly flat profile through March '25. Weighted average base rate of the swaps rolling off over the next 3 years is 4.6%. The next slide highlights our debt profile, which includes both our bank financing and our green bonds. We refinanced our NZD 455 million bank facility during the period, pushing out tenure, improving our margins. We will look at extending some of our bank deed again in the next few months. We see that NZD 80 million tranche, which needs to be refinanced by the end of September. Weighted average debt duration is 3.5 years at March 31, '22. So the last slide for me, dividends. We announced today a fourth quarter dividend of 1.6375 cents per share with imputation credits attached of 0.1276 cents per share, brings the full year dividend to 6.55 cents per share, in line with guidance. Record date is June 8 and payment date is June 22. There's no DRP option with this dividend. We move into a new dividend policy in FY '23, aimed between 85% to 100% of AFFO. In FY '23, we expect to pay a dividend of 6.65 cents per share, which will be up 1.5% on FY '22. Now I'll pass it back to Peter for leasing update.

Thanks, Dave. Just quickly running through the leasing, noting that I've perhaps stolen some of my own thunder in giving some of this away already. Leasing during the year was quite positive with 31 lease transactions equivalent to 12% of the total NLA. So that's worked for us reasonably well. And the rest of the data is sitting there in terms of the NLA and the terms sitting through there. The lease expiring rent review profile going forward, looking at the lease expiries for the coming year that's just marginally over 10%, so about the same as last year with that. Of those though the key expiry is sitting there, our Parliamentary Services, at 147 Lambton Quay and we're aware that they will need to extend their occupancy of the building. So we don't think that will go vacant. We're working with them on various options for that at the moment. [indiscernible] 211 Albany Highway, again, we expect that those negotiations will conclude with an extension there. The third large one is Steelpipe at 224 Neilson Street. We're aware that the tenant would prefer to stay. But as you will already be aware, we're hoping that we'll be ready to start development on that side before then. So we will probably need them to leave. Further out and in the following year, is the expiry is in a similar vein at Mt Richmond, where we will need those leases to give us vacancy so we can complete our work and the Thai Airways and the Citigroup Center and obviously, we'd expect that one to be a vacation at this point, but they surprised us before. Looking at the leasing insights. Obviously, industrial remains a sector in flavor and quite happy that we got the acquisitions of our development land at Mt Richmond and at Nielson Street made before the last round of heavy increases. Land prices for good industrial land and South Auckland at the moment, recently seen sales at NZD 2,000 a square meter. If that were to be a development that would imply, based on our numbers of NZD 200 a square meter rental for good quality warehousing. So obviously, saw some growth looking at that sector. Net absorption remains fairly solid and we're starting to see the beginnings of an inquiry, only initial inquiry from domestic manufacturing options where people are concerned about the carbon footprint of delivery and the supply chain issues and therefore are having another look at whether we can manufacture in the country. In the office space, the driver is Wellington office here. And the key things there are seismic ratings, flexibility of use and floor space and the standard and quality of the environment, in particular, end-of-trip facilities and pandering to the public transport rating. So that's a big driver out of Wellington. And as a result, both in Auckland and in Wellington, we expect that there will be the opportunity to repurpose some existing car park space to leasable areas. Large format retail, the increase in cost of industrial land and the stagnation of retail land means that change of use altogether needs to be considered in each retail asset and mixed-use development also needs to be considered, particularly relevant and driving extra value for us out of the 25 Nugent Street sale. A little more forward-looking, focus ahead. We're pretty much going to be saying focused on the strategy, appreciating that we're dealing with an increased interest rate environment, not all of which have been priced in. But probably, the market might be slowing down a little bit faster than had been thought over the last few months. So how long that lasts, don't know. Globally, many countries are reopening and in line with New Zealand. We're starting to see that come through. And there are challenges there with young people, in particular, meaning anyone under 30, looking at potentially going over these. Key focus areas for us remain as they have been doing the bottom-up stock right, addressing the key lease expiries, leasing up vacancies, completion and control of our development activities and commencing the new ones on time for delivery on time. Master planning continues and we're making good progress across our key value-add developments in Mt Richmond and in Nielson Street and we have been building some good healthy market interest there. So that's positive for us. I think timing is probably working in our favor, particularly looking at 224 Nielson Street, there's a notable scarcity in heavy industrial land available for development. I think I've talked in prior announcements about the structural changes and the way we're using property and both of those continue, it is an opportunity for us though to work still more closely with our tenants and to get a better understanding of what our customer actually wants and needs. That will require us to make some changes in our development planning and the way we present our properties. But a lot of that has been already test driven in the Wellington market. So I think we're well placed to be able to deliver on that. Interestingly, with the tragedy going on geopolitically in the Ukraine, the green impacts of that around the world will be felt in countries not just reducing their reliance on oil from Russia but reducing their reliance on oil in general. And I expect that, that will see an increased focus on renewable energy and on alternative modes of transport. So there's plenty to think about for the year ahead and the business is really well positioned to be able to deliver on what we see over the coming year. Happy to take any questions.

Thank you. [Operator Instructions] Your first question comes from Nick Mar from Macquarie.

Just a few from me. On the Carlton Gore assets, it sounds like you've had good leasing inquiry. Is there any reason why given the strong inquiry you haven't sort of pushed the rents a bit harder to try and recover a bit more return on that investment?

Always focused on it Nick and as soon as we can make an announcement, we'll do so on that. But obviously, there are opportunities, the inquiry is good. So we try to do the best deal we can.

But no reason to change the return metrics at this stage versus what you had at the half year?

I think it would be wee bit too early to start partying on it. Let's make sure we've got deliveries and some signatures on documents now.

And then just across the rest of the development pipeline, obviously, there's a couple of wins of the scale in terms of returns, both yield on cost and development margin sort of between [indiscernible] and Carlton Gore. How do you characterize the majority of the sort of redevelopments outside of the really large ones such as Mt Richmond and Neilson that you sort of edit into that pipeline? Are they on the sort of higher yield on cost scale or on the sort of lower side where there's a bit of, I guess, deferred maintenance, if you want to call it that sitting within the construction cost?

I think it's a bit early to place a comment on that just yet. I think we might have to wait until the year announcement, we've got a bit more concrete data in terms of those. But obviously, the Mt Richmond and 224 Neilson Street, you're talking about complete demolition of buildings on site, so there's no deferred maintenance, [Technical Difficulty].

Yes. No, no, I was more focused on the smaller ones because obviously, you've added a whole lot in there, which is good, but just trying to understand where those kind of returns do set for that kind of pipeline. No, that's okay. And then in terms of the portfolio weightings, obviously, you've adjusted those, can you just talk through sort of not kind of having a go, but just what's the point of having weightings if they're going to consistently change as you upweight towards certain sectors and get towards the top end of the band?

So I think the market is pretty keen on knowing what our intentions are for the year ahead and we've been pretty transparent about saying for the last year results that we're moving further into that industrial space that will remain diversified. So I think it's not much more than a tweak. Anyways, it won't happen in the short term, obviously, but I'm interested in knowing what our intention is in terms of acquisitions, sales and developments.

And do you think you intend on changing in the next 2 years, 4 years, 10 years, what's the thinking around it?

Well, obviously, if we did think we probably would have made a change. So at this point, no, we don't have an anticipation of making further changes. But we do quite a bit of research on where we're going and what the options are. Industrial is top of the heap at the moment. It won't always be. There'll be times when other sectors come through. But the way we see it at the moment, those weightings look pretty solid.

Your next question comes from Arie Dekker with Jarden.

Just a few for me too. Just gearing, I mean, obviously, it's sitting at the bottom end of your range at the moment and your committed development is pretty low. But I mean, I guess, just turning to Neilson Street and Mt Richmond, I mean, clearly, you've highlighted the good inquiry there. I mean can you be a little bit more specific around when you'll sort of -- when we can expect you to announce commitment on development there? And how you are sort of thinking about funding for those developments given your expectations that valuations going forward is going to be flatter?

Yes, that's a bit difficult. These things always take longer to actually get across the line than you would expect. But I guess, firstly, we don't get Mt Richmond back to be able to do anything with until the next year and 224 Neilson Street sort of September this year. So there's still a bit of time to go on that. We don't have resource consent finalized for each of those yet. We're working on that at the moment. We could be building either 2 or 3 buildings at Neilson Street, depending on which of the tenant deals comes through first. So probably, I'd be prejudicing myself and taking a big risk if I put dates on those. But the lease expiry profile will probably give you a fair idea as to where we need to be.

Just Arie, on cash. Just terms of capital in our planning, we do have some capital towards the very end of this financial year for both those properties. So if you're looking at what we're going to be spending, we're looking at spending around about sort of NZD 10 million to NZD 15 million this financial year on those 2 properties. So part of Mt Richmond and part of Neilson Street.

Yes. And I take your comments, Pete, on sort of commitment timing on that, but then just turning to the other part of the question, which I guess is sort of on a 12-, 18-month view, how are you sort of thinking about funding the development? And I guess maybe more specifically, I mean, you've -- kind of related, you've kind of signaled some further tilt into industrial and away from office. Can we expect you to see -- to see a couple more noncore office divestments?

I'll answer the first part. The sale of commercial offices, there are a couple that we're reviewing at the moment as we always do each year. So [indiscernible] out of that. I'll let Dave talk about the rest of the funding.

Yes. I think essentially, we've got capacity to fund it through our current debt facilities and also through debt. As I said, we're only just starting Neilson Street and Richmond towards the end of this financial year. And we're not doing the whole property. In fact, we don't get a big chunk of Mt Richmond back for another 5, 6 years. So we can kind of do it in a measured way. So you're not going to see huge chunks of spending from us over the next couple of years. It will be reasonably similar to what you've seen this year.

And then just a quick follow-up on 105 Carlton Gore. I think you mentioned Pete, 2 of the leases reasonably well sort of progressed in terms of the negotiation. I mean, you don't have signatures yet. But just on those 2, how much of the floor area do they cover?

The 2 that we've got will be taking up about 40% of the building and the further one we're negotiating on would see the building basically full.

Your next question comes from Jeremy Kincaid with UBS.

The first one for me is also on the Neilson Street estate. But then the value-add case study you have from Mt Richmond is quite helpful when you say there that the end project value could be over NZD 0.25 billion. Do you have a similar number for the Neilson Street estate could be completed?

Well, I've to work to dig it out. So I think you're looking at spend there about NZD 60 million, Jeremy and a development cost of around about NZD 95 million total, in land and a forecast on completion of about NZD 103 million. Obviously, these aren't completed numbers, they're just estimates at this stage.

The second question for me is just on the office portfolio. If I look at your contract yield, it's around 6% and you've got a portfolio value of NZD 860-ish million. Just tying those 2 numbers together, you get to a [ 52 kind of million dollar ] number for rental income, which was quite different to the NZD 44 million that you reported this year. Could we expect that office income for FY '23 could be up around the NZD 52 million? Or am I...

Well, it will definitely go up because you've got Willis Street coming in and a full year of 7 Waterloo Quay too. So you can expect an increase in office rental in FY '23.

And Jeremy, when you're looking at the valuations, bear in mind that both of those projects I mentioned coming up, they have impacted into the valuation in terms of costs as well. So that will be under quoting the completion.

Your next question comes from Rohan Smit with Forsyth Barr.

Just a couple of ones, hopefully. First one, just looking at the rent reviews, your market reviews look a bit light. I think it was less than 1% increase. Can you just talk through why those were like? Was it sector or asset specific?

I think market views were...

We didn't have that many.

Detail.

We didn't have very many, so it will be asset specific or lease specific issues.

And then the second one is kind of, I guess, following on from a few of these questions around capital. You're trading at a pretty big discount to NTA and others are as well. But I guess, how do you -- can you give us some color on your capital allocation framework? You've obviously got development spend, acquisitions. You did one recently but then also do you include other sources of allocation such as buybacks within that framework because that must present a pretty high hurdle at current kind of levels?

Yes, I don't disagree. Obviously, when we committed to the [indiscernible] our initial share price was in a different place where it is today. And you should always evaluate the share buyback as an option in any acquisition that you're looking at. At the moment, it will be quite challenging to notwithstanding the fact that we sold Nugent Street 28% above book value. It's quite challenging to buy at 28% to 30% discount. So in the current environment, you have to be focused on that.

Yes. But I guess what we've said before, we do have quite a bit of capacity at the moment to do what we need to do in the next few years. And it's not going to be -- we're not going to be doing a huge amount of spending in the next 24 months. So we'll just progress along and then we'll wait and see what happens after a couple of years.

And I guess, you also mentioned you're looking at some office space to divest potentially. Could we -- or could you I guess, accelerate some of those divestments just given that sort of dynamic at the moment? I guess you've got a long tail of relatively small assets that might be quite easy to churn even though the market softened a bit. Do you think there's capacity to do that?

Yes, there's always a balancing act between realizing the best value at the right time, getting the leases and the investment profile of the assets to the right place at the right time based and investing that against the opportunity in the portfolio and outside of, so all of those things. But I mean, you're probably pressing me into a more detailed answer and I can't really give it. But I think the upshot is that we're always focused on all of those issues and try to make the best decision we can at the time, both top down and bottom up.

Your next question comes from Shane Solly with Harbour Asset Management.

Just could you just expand a little bit more on how you're thinking about the impact of higher inflation, higher interest rates and the risk around cap rate expansion?

So I'll start and maybe Dave can follow up. Obviously, we've got to expect cap rate softening in the short term to the degree that the amount of interest rate increase was not projected over the last 12 months. So that's varying. The valuers are expecting some cap rate easing over the year ahead. But in general, they're expecting that to be made up for by improved rentals as we go through that for market rentals at least. Yes, as we've talked before, the long cap rate firming cycle we've seen over recent years has actually been a dis-incentive for rental growth and developers are able to provide new stock at a relatively lower rental. So stability was good for rental growth easing so long as we've got good net absorption coming through that's relatively positive, but the scarcity of land and increasing construction costs are adding a bit of fuel to that rental growth story. So long as we're still seeing net absorption that's in the positive turf and certainly, we are in commercial office space in Wellington, a good size extended and industrial Auckland, we expect to see that get us good rental growth softer overall. And the valuers across the panel have different views, but they're looking or expecting 15% to 25% basis points of leasing in capital run.

Sorry, Shane, just adding to that, if you look at our under renting, we're under rented by 5% in Auckland industrial and under rented at Wellington office by 5% as well. So we've got certainly some catching up to do, I think, in those 2 key segments for us.

I guess just building on that then in terms of your structured rental growth versus market then what's the time frame to do that catch up? And if you come back to the other question about market rental growth versus what you're recording?

Look, I mean, a lot of our leases are fixed. So certainly, we'll take a while to catch up. If you look at next year's profile, we've only got 15% of our reviews market by value and 41% of fixed and 8% of CPI. So we get nice growth out of the CPI stuff but affects us generally between 2% to 3%. So it's just -- it's a matter of time before we do catch up.

Yes. And in terms of, yes, of course, the value is, as I'm sure you understand, the values or valued on market, but the reversion and either the shortfall again from the [indiscernible] for the shortfall. So it will still have a valuation impact when you actually receive the money or not.

Sorry, you talked about your resource for developments, particularly industrial development. Can you just talk about what that increased corporate cost is in the period and what it may be going forward? What does that mean in terms of, I guess, an implied management expense ratio for the group?

Well, we've taken on Marilyn Storey as Head of Development, so that's moved out of asset management into development. We've employed 2 development managers sitting in that corner of the world and [ Fransco ], one of our building engineers, to environmental engineer into that group. We are still looking for a further staff member, but that's proving quite challenging at the moment.

I think it's a pretty good question. I mean I think I expect that we've been gearing up in terms of the team. We haven't been charging the team out to projects. And that's going to be happening from these projects that happen in the next year or so. So you'll find that probably at least NZD 0.5 million worth of that cost, more like potentially [ NZD 0.75 million ] of that cost were moved out to projects. So you'll probably find that our MER ratio will decline next year from what it is at the moment.

Just a final one. So you've provided guidance based on AFFO with a range. Are we going to be at the low end or the top end of that range? And how do we see -- do we see dividends grow from here in the next few years?

We provided some guidance on that, we're in the range of loss, but we -- it got crossed out by our Board yesterday. So sorry, we really can't comment on that, Shane at the moment.

Your next question comes from Lance Reynolds with Aspiring Fund.

So I'm just trying to bring myself a bit up to speed here. So maybe just ask the basic question. With initial yields in the space, I just saw that [indiscernible] has been raising money at 5.7. So I think my back of the envelope is, if you include maintenance CapEx, your initial yields need to kind of lift circa 25% or higher to cover the cost of, I guess, [indiscernible] grade credit debt, which a lot of people wouldn't have. Just in light of that and in light of how the industrial sector is owned and transacted a lot by moms and dads and smaller lot sizes, do you see a lot of pressure coming on that side from people who have had debt gains and then just can't stump up the interest cost step-up and there'll be stuff coming on the market, which could be -- which you could look at them? Is that opportunity real? Or is it generally into lower-scale assets? That's kind of my first question. My second question is just I appreciate the comments around the valuers [indiscernible] fully market rental growth expectations. But I'm more interested on terminal cap rates. And I note that on the year to March, the New Zealand 10-year has gone up 145 basis points. Could you comment on what terminal cap rate expansion has been year-over-year for your industrial valuations?

Let me see if I can get those in order. Firstly, for dealing with cap rates and yields, I think most people are aware of it, and market focus is too much on that at the expense of the internal rate of return because it really should be driven by the rate of return of the property over the 10-year period rather than the past yield at day 1, given that the income stream changes. Value was depending on when those lease expires, depending on the [ DTA ], as a sector they are in that will take a different view, but there's no doubt that the current round of valuations are significantly softer terminal cap rates than they had in the -- even in the interim period. So yes, there certainly has been a change. Of course, they're capitalizing our softer cap rate of terminal rental for most of the industrial sectors as well.

So what exactly has terminal cap rates done in FY '22 versus FY '21 valuations?

It varies across the portfolio. I have to analyze that.

There's information -- Lance, there's information in the appendix on the movement in cap rates.

I'm just interested in terminal cap rates?

Yes. I would have to get back to you on terminal cap rates, but I haven't got that on the appendix at all.

And then on your first point about focus on internal rate of return, I fully agree with you, at the institutional level, but my question was more at the retail level and the [ mesh ] level?

Quite right. We see opportunities coming through with highly geared existing owners. I hope so. Normally, that's what we would see. Some of those small syndication, some of the private syndications and some of the private buyers may well have over extended themselves and some of those opportunities could well fall out during the year. One of the reasons we want to make sure that we're at the bottom end of the gearing range.

I mean is that part of that -- given -- I mean looking at this picture in terms of just the transaction volumes, say, in the last 4 years of interest rates have gone the other way, could that opportunity set be quite large? Or is it more a number of small lots, it's always uneconomic to have a crack at?

At the moment, it's in the latter category. The real estate agencies in general are possibly guilty of talking their own book, but they're still saying that they have more than sufficient demand for the stock that got available, but it is -- I have noticed an increase in the amount of stock coming to the market already. So I guess it depends whether we end up in a recession, how deep that is, how long that is and how much rental growth some of these people are going to be able to get on the way through. So it will be about timing. And you hope that you get some opportunities to pick through. The first ones and the most likely ones will be in the 2 small uneconomic packages. But bearing in mind with the way industrial is looking at the moment with so short of land in Auckland, the brownfield development is a possibility too, just more work, that's all.

Yes. I don't want to be too bearish, but I assume the valuers aren't putting in a recession in the demand forecast, but maybe there is scope there to straighten some stuff out?

Yes, agreed, agree with you.

Okay. If you could come back on the terminal cap rates through one of the analysts, that would be much appreciated.

There are no further questions at this time. That does conclude our conference for today. Thank you for participating. You may now disconnect.