Australian Unity Office Fund (AOF) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to the General Meeting of Unitholders of the Australian Unity Office Fund. My name is Peter Day, and I am the Chair of Australian Unity Real Estate Investment Limited, which is the responsible entity of the Australian Unity Office Fund. Turning to Slide 2. In particular, I would like to welcome all unitholders who have joined us online to participate in this virtual meeting. It is 10:00 a.m. and I have been informed that a quorum is present, so I am pleased to declare the general meeting of the Australian Unity Office Fund open. First of all, we pay our respects to and acknowledge the traditional custodians of the lands on which this meeting takes place and wherever you may be. and pay respect to elders both past, present and emerging. Today's meeting is being held online. This allows unitholders, proxyholders and guests to attend the meeting virtually. All attendees can watch a live webcast of the meeting. In addition, unitholders and proxy holders have the ability to ask questions and submit votes. Turning to Slide 3. Questions can be submitted at any time. [Operator Instructions] Please note that while you can submit questions from now on, we will not address them until after the presentations for the meeting have occurred. Please also note that your questions may be amalgamated together if we receive multiple questions on the same topic. If we run out of time to answer all unitholder questions, we aim to answer them in due course by contacting the unitholder or by posting responses on our website. You will note from the Notice of Meeting that there are no formal items of business to be voted on at this general meeting. While the Australian Unit Office Fund (sic) [ Australian Unity Office Fund ], or AOF for short, is not formally required to have an annual general meeting, we believe that hosting a meeting of unitholders around this time of year is an important opportunity for unitholders to hear from and speak with directors and management. Turning to Slide 4. I'll begin by introducing you to the Board of Directors and the management team of AOF. My fellow directors are nonexecutive and independent directors Eve Crestani and Don Marples, who are also both members of the Audit & Risk Committee, with Don being Chair of that committee. Greg Willcock and Erle Spratt are both Nonexecutive Directors. Emma Rodgers and Liesl Petterd, the company's secretaries of AUIREL, are also in attendance. With us today from the management team are James Freeman, AOF's Fund Manager; Simon Beake, AOF's Portfolio Manager; Giovanna Reale, AOF's Senior Asset Manager; and Tim Kemp-Bishop, Senior Asset and Capital Transaction Manager. James will shortly present the Fund Manager's address. I would also like to acknowledge the broader management team within Australian Unity, who also support the funds activities. The strong performance of AOF -- that AOF has experienced to date is a function in large part due to their dedication and commitment in delivering AOF's strategy. Our financial auditor, PricewaterhouseCoopers, is also in attendance, represented by George Sagonas. George is the PricewaterhouseCoopers partner responsible for the audit of the financial statements of AOF for the year ended 30th of June 2020 and is available to answer questions regarding the audit. Before we proceed further, it is important to note that the information in this presentation is general information only and should be read in conjunction with AOF's annual financial report lodged with the ASX and other announcements made by AOF. I would like to highlight that all reports and announcements are also available on the AOF website, australianunityofficefund.com.au. Turning to Slide 5 and turning to the agenda for today. I will provide some high-level comments on AOF's portfolio and on some events that have impacted AOF over the last 12 months or so. James Freeman, AOF's Fund Manager, will then provide you with further details on the FY '20 performance, along with an update on activities that have occurred since 30th of June 2020 and AOF's outlook. After the formal presentation, we will respond to any questions received from unitholders during the meeting and invite unitholders to ask any further questions. Turning to Slide 6 and turning to my presentation. Firstly, I would like to thank unitholders for your ongoing support in what has been a very difficult and challenging year for many. The Board and management are focused on delivering the best possible returns for AOF's unitholders. Turning to Slide 7. I am pleased to report that despite the unexpected and challenging operating environment that COVID-19 presented, we were able to pay a strong distribution to unitholders for FY '20 of $0.15 per unit, representing a yield of over 7% based on the 30th of June 2020 closing unit price. This demonstrates the resilience of the AOF portfolio during the COVID-19 pandemic, with the defensive characteristics of the portfolio centered on well-located assets with high-quality tenant base and conservative capital structure. Pleasingly, the resilience of the portfolio means that we have been able to provide FY '21 distribution guidance of $0.15 per unit, delivering distributions in line with FY '20. During FY '20, AOF experienced significant corporate activity. The last meeting of AOF unitholders was held in November 2019, which was to consider the unsolicited proposal from a consortium comprised of Charter Hall and Abacus entities to acquire all units in AOF under a scheme of arrangement. The scheme was not approved by the requisite majority of AOF unitholders. An off-market takeover bid was subsequently made by Starwood Capital Group in January 2020. However, this bid lapsed in March. While this corporate activity, together with the impact of the COVID-19 pandemic, consumes significant board and management time, it is pleasing to note that AOF and the portfolio continued to perform well on a number of fronts. These included, first of all, obtaining development approval for a commercial office building of approximately 28,000 square meters at numbers 2 to 10 Valentine Avenue, Parramatta. This drove a $14.5 million increase in the independent valuation as at 30th of June 2020 to $134.5 million. A suitable tenant precommitment is currently being actively sought, strengthening the balance sheet during the year with total debt facilities increasing to $250 million and no debt expiring until October 2022, actively managing the portfolio to deliver strong leasing outcomes during financial year '20 with approximately 6.6% of the portfolio by net lettable area leased. Subsequent to 30th of June 2020, further leasing activity has occurred, including a restructure of the CPSA lease at the 5 Eden Park Drive of approximately 7,000 square meters, which increased the weighted average lease term for that property from 4.2 years as at 30th of June 2020 to 4.6 years as at August 2020 and finally, modifying operations at AOF's buildings to ensure tenant safety in response to COVID-19. We also activated the distribution reinvestment plan effective from the September 2020 distribution, with a pleasing take-up rate of 22% for the September 2020 distribution. The Board believes the distribution reinvestment plan provides an efficient way to enhance the balance sheet position through incremental equity. It provides an effective way for unitholders to increase their investment in AOF without incurring brokerage costs. And through increasing the overall capital base and AOF units on issue, the distribution reinvestment plan may facilitate an increase in AOF's trading liquidity. In February 2020, a change in the ownership of AOF's responsible entity, AUIREL was announced with AUIREL no longer being wholly owned by the Australian Unity Group. AUIREL is now owned by Australian Unity Capital -- Keppel Corporation, which is a joint venture owned by subsidiaries of Australian Unity Limited and Singapore-based Keppel Capital Ltd. As part of this change, Keppel Capital is entitled to appoint a nonexecutive director for the Board of AUIREL, with Erle Spratt being appointed in June 2020. Erle is the Australian head of Keppel Capital and has extensive experience in property development and funds management across Australia and Asia. My fellow directors and I look forward to working with Erle on the Board, and I feel sure that AOF will benefit from Erle's extensive property experience and insights. At the same time, Kirsty Dullahide, a director appointed by Australian Unity, resigned from the AUIREL Board. And I would like to acknowledge and thank Kirsty for her contribution and service to the Board. Greg Willcock remains on the Board as the Australian Unity-appointed nonexecutive director. Importantly, the change in ownership did not impact the investment management and property management agreements with the Australian Unity Group, with the existing arrangements remaining in place. AOF and the Board of AUIREL continued to be able to draw on the resources, infrastructure and expertise of the broader Australian Unity Group, including the dedicated management team of James, Simon, and Giovanna. In closing, while COVID has caused changes to our daily lives and economic disruption across all sectors, including the office market, your Board and management team is focused on delivering the best possible returns for AOF unitholders. At all times, your Board evaluates the optimal strategy for both individual properties and the overall portfolio positioning. The recent divergence between the traded market price of AOF's units and the reported net tangible asset value reflects, we think, both overall market sentiments generally, plus the impact of lower liquidity in AOF units. Given this current dynamic, we are actively exploring a number of initiatives with a focus on delivering the best possible returns for AOF unitholders. James will shortly touch on a number of the initiatives we are continuing to progress, including the potential development at 2 Valentine Avenue in Parramatta, the potential divestment of 241 Adelaide Street in Brisbane and potential value-add opportunities at 32 Phillip Street in Parramatta and 2 Eden Park in Macquarie Park. AOF's portfolio has demonstrated its resilience during a global pandemic. And the Board is pleased that it was able to continue to provide investors with stable distribution returns throughout FY '20 as we understand the importance of paying sustainable distributions to our unitholders. We look forward to continuing to deliver attractive returns to investors during FY '21 and beyond. The portfolio is well positioned, supported by strong management to continue and create value for AOF's unitholders. I'd now like to invite James Freeman, the Fund Manager of AOF, to provide an update on the fund's performance for financial year 2020 and provide an update on activities that have occurred since 30th of June 2020. James was appointed AOF's Fund Manager in February 2020, and he and the rest of the management team have done an excellent job in managing AOF to deliver on the fund strategy during this time and to optimize returns for shareholders. James?

Thank you, Peter, and good morning, everyone. I am pleased to present a summary of AOF's full year results to 30 June 2020 and provide an outlook for the year ahead. Turning to Slide 9. AOF continues to perform well. The underlying portfolio has been resilient despite the impacts of the COVID pandemic, with rental collections remaining strong at 92% for the June quarter and steadily improving since to be 97% of the full rent roll for the September quarter. This, combined with the fund's robust capital structure, including significant debt covenant headroom and no debt maturing until October 2022, enabled the fund to pay a distribution of $0.15 per unit for FY '20 and provide distribution guidance of $0.15 per unit for FY '21. Based on the 30 November 2020 closing price of $2.15, this represents a yield of approximately 7%, attractive in the current low rate environment. During the quarter, we activated the distribution reinvestment plan, allowing unitholders to reinvest their distributions with new units issued at a 1% discount to the unit price over the pricing period. Pleasingly, we had approximately 22% of unitholders by value participate in the DRP. Turning to Slide 10. Since July 2019, it has been a particularly busy period for leasing. Approximately 18,300 square meters, equivalent to over 15% of the portfolio by area, has been leased or is now under offer. Since June 2020, excellent progress has been made on our vacancies and FY '21 expiries, with portfolio vacancy reduced by 1.3% to 5% and expiries in FY '21 reducing from 4.3% to 3.2%. One market which has performed particularly well is Macquarie Park, which has an attractive price point with gross effective rents of approximately 40% of Sydney CBD and a high concentration of firms in the pharmaceutical, logistics and technology industries, which are typically performing well in the current environment. At June 30, 2020, the fund had 4 FY '21 expiries over 400 square meters. We have now leased or have under offer 3 of these, leaving just 1 tenancy over 400 square meters expiring in FY '21. One of our asset -- one of our Macquarie Park assets, 2 Eden Park Drive, is now 100% occupied. At our other Macquarie Park asset, 5 Eden Park Drive, an existing lease with CPSA was restructured with Saluda Medical leasing level 1; while Aegros, who acquired CPSA, leased the production and warehouse facilities, representing over 7,000 square meters of leasing. As part of the transaction, Saluda extended the lease by 3 years to June 2029. Through derisking a larger expiry and extending the term on Level 1, the independent valuer increased the valuation of the property by $4 million to $70 million. Elsewhere in the portfolio, 241 Adelaide Street in Brisbane has been particularly active with 5 agreements reached during the September quarter, totaling over 1,500 square meters. Turning to Slide 11. The fund has not been immune to the current economic uncertainty and disruption that the COVID pandemic has created. At the onset of COVID, our first priority was to ensure the safety of our tenants, visitors, contractors and staff at our buildings and putting in place measures to address these. We have been proactive in supporting our tenants, mitigating the impact to our unitholders and positioning the fund to start to emerge from the pandemic in a strong position. As at 30 June, approximately 11% of the portfolio by gross monthly income had requested proportionate rental relief under the relevant states' Mandatory Code of Conduct Legislation, or the Code. This increased to approximately 15% as at September as the second wave impacted Victoria in particular. Management is working with each tenant on a case-by-case basis to assess their entitlement under the Code and will provide further information at the half year results. Positively, throughout the period, collections have remained strong, sitting at 92% for the June quarter and are beginning to improve further, sitting at 97% for the September quarter. The outlook is improving, with government-imposed movement restrictions easing, state borders reopening and positive news around potential COVID vaccines. This is translating into higher occupancy rates within our buildings as tenants gain confidence to return to the office. Capital expenditure during the office floor refurbishments is being targeted to reduce touch points with initiatives such as touchless tapware and soap dispensers and lift applications. To ensure our valuations fully reflect the current environment, all properties were revalued as at 30 June 2020. Whilst capitalization rates were broadly in line with the prior year, external values adjusted key metrics such as growth rates, downtimes and incentive assumptions to account for the current environment. We are now in the process of revaluing the full portfolio as at 31 December 2020. Turning to Slide 12. While there has been some great progress on vacancy in FY '21 expiries, management are also focused on the major upcoming expiries across the portfolio. We are in regular dialogue with each of our major tenants. At 10 Valentine Avenue in Parramatta, the Property NSW lease expires in June 2020. Property NSW are in the process of reviewing their various departments and locations and required tenancy space. 10 Valentine Avenue is one of the best located assets in Parramatta. It is highly accessible, being close to Parramatta railway station and has great amenity, including the nearby Westfield Parramatta Shopping Centre. It is also very affordable with Parramatta's gross effective rent less than half of Sydney CBD. We believe these attributes position us well for the upcoming lease negotiations. At 30 Pirie Street in Adelaide, Telstra's lease expires in February 2023. Like most major corporates, Telstra is reviewing their business and its office space requirements going forward. We believe that 30 Pirie Street provides attractive accommodation for Telstra as it is a well-located A grade asset and provides an attractive price point, particularly compared to Telstra's occupancy costs in other markets. As Telstra do not currently need all their leased area, they have sublet 5 of the lower floors to 3 separate tenants, including to Boeing Defence, who we have an existing relationship with at 150 Charlotte Street in Brisbane. We are seeking to retain Telstra over their future area required and convert the subtenants into direct tenants, well ahead of the Feb 2023 expiry. Turning to 32 Phillip Street in Parramatta. There is a lot happening in the immediate vicinity of the building. Firstly, the Light Rail is under construction on Church Street, and Parramatta Council is proposing to build the civic walk, a pedestrianized walkway from 32 Phillip Street to Parramatta railway station, both of which would improve the accessibility to the site. The New South Wales state government is well advanced in their plans for the Powerhouse museum, which will be transformational on the immediate area, and I'll cover this stuff in more detail in my later presentation. GE is the sole office tenant expiring in June 2023. We have initiated discussions with GE regarding their longer-term tenancy requirements. Of note, out of the 8 office floors, 6 are sublet, which provides an opportunity to lease those floors directly to sitting tenants, diversifying the tenancy expiry profile. At 150 Charlotte Street in Brisbane, there is still 3.5 years to run on Boeing's lease. So it's too early for them to engage in discussions. Our focus here has been to enhance the tenant experience, positioning the asset well for future leasing discussions. Targeted capital expenditure is being completed to enrich the overall appeal and usability of the asset for Boeing. Turning to Slide 13. As we move through FY '21, we believe the AOF portfolio is well positioned to capitalize on the current conditions with an allocation of 59% by book value to metro markets and 41% to the smaller capital CBDs. We expect these markets to outperform the major CBDs as tenants focus on accommodation that is affordable, provides solid amenity and is highly accessible to their workforce. Naturally -- or nationally, there has been some major infrastructure spending with AOF's markets benefiting. Be it Macquarie Park with the recent metro rail completion, Parramatta with the major infrastructure projects underway, including the Light Rail, metro rail and proposed civic walk and Powerhouse precincts, or St. Kilda Road, which will benefit from the $11 billion metro tunnel project delivering a new Anzac station. Meanwhile, Brisbane will continue to benefit from projects such as the Cross City Rail (sic) [ Cross River Rail ]. AOF's assets are located in markets with rentals, which are a fraction of Sydney CBD's rental, with gross effective rental ranging between approximately 32% and 48% of Sydney CBD's rent. In an environment where affordability is key, with employees wanting to work closer to home to reduce travel time, we believe the metro markets and smaller CBDs will outperform. Turning to Slide 14. At 2 Valentine Avenue, Parramatta, substantial progress has been made on the development opportunity. During FY '20, site-specific planning approval and development approval was received, locking in development approval for approximately 28,000 square meters. The development approval resulted in a $14.5 million year-on-year increase in valuation for the asset, with further substantial value expected to be generated through to completion. Following a competitive tender process, Buildcorp was selected as the preferred builder and have been appointed to complete early works to reduce future project deliveries. Full construction works will not commence until after a suitable tenant precommitment and financing are obtained. We are currently investigating the ability to link 2 and 10 Valentine Avenue together as part of a campus offering to enhance the arrival experience and create shared facilities across both assets. This would enable larger users to have a more connected presence across both assets. The finalized design will require further development approval, but will enhance our flexibility and options as we seek precommitments for 2 Valentine and a renewal at 10 Valentine Avenue. Overall, the asset is forecast to deliver a yield on cost of over 7% and would significantly enhance the overall portfolio quality and metrics. Turning to Slide 15. Management have an active asset management approach and seek to add value where possible. A few examples of value-adding opportunities currently being investigated across the portfolio are 32 Phillip Street. With the area likely to be transformed with the expected delivery of the Powerhouse museum and civic walk, we're investigating opportunities for the highest and best use of the asset. We are also investigating opportunities for 32 Phillip Street to integrate into the wider Powerhouse Precinct through a ground floor refurbishment. By improving the overall ground floor and tenant amenity, this should position us well to drive rental growth for the asset and assist in upcoming lease discussions. 2 Eden Park Drive. Macquarie Park is benefiting from its central location, coupled with strong infrastructure and retail amenity. 2 Eden Park is a large landlord. Over 10,000 square meters located very close to the metro rail station and is currently only developed to a full space ratio of approximately 1:1. Current zoning is 2:1, and there are community consultation groups seeking to increase the area zoning. We are investigating the long-term future development opportunities to position our site well to benefit from any future uplifts in zoning. Turning to Slide 16. If we turn our attention now to the current economic backdrop, we are now 9 months on from the onset of COVID-19 and positively, we appear to be emerging from the worst of the pandemic. Business conditions and confidence have rebounded strongly and are both now positive. Three COVID-19 vaccines are all progressing well in trials with a claimed efficiency rate of around 90%, fueling positive sentiment. Consensus for real GDP is forecast to jump in FY 21 to 3% growth compared to a 3.6% contraction for FY '20. Office occupancy rates have been increasing month-on-month for most of the major markets, excluding Melbourne, due to the extended lockdown. The Reserve Bank of Australia recently cut the cash rate by a further 0.15% to 0.1%, a record low, driving bond yields lower and making property yields even more attractive on a relative basis. Across AOF's markets, the prime yield midpoint ranges from approximately 5.26% to 6.25%, a large premium to cash and 10-year bonds. I would note we've included further economic and market information in the annexure of this presentation. Turning to Slide 17. We are pleased to reconfirm our FY '21 distribution guidance of $0.15 per unit, which on the 30 November 2020 closing price, represents a yield of circa 7%. This guidance is subject to no material change in market conditions, no material change to the portfolio and no unforeseen events. Currently, earnings guidance is not being provided for FY '21 due to the uncertainty around the impact of COVID-19 on the fund. However, as market conditions continue to improve, the level of certainty for FY '21 earnings also improves. Once the board has sufficient certainty that it can provide meaningful earnings guidance, the market will be updated. Turning to the immediate focus. Management are working to close out the tenant rent relief to be provided to eligible tenants required under the Mandatory Code of Conduct. Leasing up vacancy, derisking upcoming expiries, in particular those with major tenants, remains a key focus. Where there are subleases in place, we are aiming to turn them into direct leases where possible. Negotiations are ongoing with interested parties for the divestment of 241 Adelaide Street, and we will update the market if suitable sale terms are achieved. We continue to seek a tenant precommitment for 2 Valentine Avenue in Parramatta and investigate other opportunities across the portfolio to add value for unitholders. The Board and management continue to review our strategy and remain focused on delivering the best possible return for AOF unitholders. That concludes the formal part of the presentation. And I would like to thank you for your continued support. I look forward to continuing to work with the Board and the Australian Unity management team in delivering strong performance to AOF unitholders. I will now pass back to the Chairman of AUIREL, Peter Day.

Thank you, James, for providing that update on the market and the portfolio, particularly the development since 30th of June. [Operator Instructions] I will now confirm with the company secretary whether we have received any questions for either the auditor, management or myself. There being no questions and no further questions. I would like to again thank you all for attending our virtual meeting today and for your ongoing support as AOF's unitholders. I now close the meeting.