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

Thank you for standing by and welcome to the Australian Unity Office Fund half year results call. [Operator Instructions] I would now like to hand the conference over to Ms. Nikki Panagopoulos, Fund Manager. Please go ahead.

Thank you, Darcy. Good morning, everyone. Thank you for joining us and welcome to Financial Year 2022 Half Year Results Announcement for the Australian Unity Office Fund. My name is Nikki Panagopoulos and I am the Fund Manager for AOF, and I am joining you from Melbourne. I am joined by Simon Beake, the Portfolio Manager from AOF, who is in Sydney. Earlier today we published various documents on the ASX, including the interim report for the half year ended 31 December 2021, Appendix 4D, AOF's property book and the investor presentation, which we will go through this morning. Following the presentation, we will have time for Q&A. Let's now turn to Slide 2. Before we start, I would like to take this opportunity to acknowledge the traditional custodians of the land our properties are located on and pay my respects to elders past, present and emerging. I come to you today from the Wurundjeri land here in beautiful Melbourne. Turning to Slide 3. Today I will provide you with an overview of the first half of financial year 2022, update you with the financial results, provide an update on the portfolio of opportunities and provide an update and financial year '22 guidance and outlook. The image on this slide represents a render of the repositioning opportunity at 10 Valentine Avenue Parramatta. I'll talk to this opportunity further through this presentation. Now let's turn to Slide 4. It is pleasing to advise that AOF is on track to meet full year guidance with funds from operations for the half year of $0.095 per unit and distribution of $0.076 per unit. Pleasingly, occupancy increased by 1.2% to 96.9%. The increase in occupancy was driven by strong leasing outcomes with 4,500 square meters leased during the first half of financial year 2022. This equates to 5% of the portfolio and was largely driven by small to medium enterprise tenants looking for affordable accommodation with good amenity and easily accessible by car and public transport for staff convenience. At AOF's financial year 2021 results, it was announced that we would divest 32 Phillip Street Parramatta to enhance the fund's portfolio construction. And I am pleased to announce that we successfully sold and settled the property for $66 million, a 5% premium on the 30 June 2021 independent valuation. On 17 January 2021, AOF announced that it had terminated the merger implementation deed with a diversified property fund. I will also provide further information on AOF's continued focus on maximizing unitholder returns in the coming slides. Turning to Slide 5 and AOF's future portfolio consideration. The fund's multi-tenanted properties performed strong during the first half of financial year 2022. Strong leasing resulted in occupancy increasing to 95.7% with a WALE of 4 years for the multi-tenanted properties. Since 31 December 2021, a further 2,000 square meters of net lettable area has been executed and is under -- or is under signed heads of agreement. The portfolio also offers a once in a generation refurbishment and repositioning opportunity at 3 properties following the expected lease expiries of the fund's 3 largest tenants. The expiries represent 51% of the fund's NLA and 59% of gross income. The expected expiries will put pressure on the fund's ability to deliver sustainable distribution, but funding of the opportunities also requires consideration. To continue to focus on maximizing returns, 3 options are being assessed. They are to deliver their refurbishments and repositioning while maintaining strong occupancy for multi-tenanted assets; to divest some or all assets and return capital to unitholders; to consider our portfolio sale by our corporate transaction. Let's now turn to Slide 6 and explore the 3 options further. The portfolio offers optionality to maximize unitholder returns. Firstly, maintaining a high occupancy in multi-tenanted assets provides sustainable income from approximately half of the portfolio by area. The remaining assets provide refurbishment and repositioning opportunity with various initiatives underway including: a development application which has been lodged for a refurbishment strategy at 30 Pirie Street; as represented in the image on this slide, development approval is in place for a new 28,000 square meter office building at 2 Valentine Avenue; a development application is underway for refurbishment and redevelopment at 10 Valentine Avenue; and a refurbishment and redevelopment master plan for 150 Charlotte Street is being developed. Separately, we're also considering the portfolio construction and assessing whether unitholder returns can be maximized through divestment of some or all assets with capital return to unitholders. Submissions have been received from real estate agents and are being assessed. We expect to appoint agents in the week commencing 7 March. The fund has also received inbound inquiries from parties with engagement commenced and confidentiality agreements signed. Information has been provided to enable parties to assess if a proposal for AOF or its assets can be submitted. Let's turn to Slide 8. AOF had a strong first half financial year '22 with FFO of $0.095 per unit, a 3.2% increase driven by fixed rent reviews and increased occupancy. Distributions of $0.076 per unit were in line with full year guidance. The profit for the year was $6.8 million, which is $13 million reduction from the December 2020 half year due to the revaluation of 150 Charlotte Street, which I will discuss further shortly. The fund's NTA is $2.67 per unit. Turning to Slide 9. All assets were independently valued with an overall decrease of $3.6 million. The portfolio capitalization rate firmed by 7 basis points to 5.77%. 5 Eden Park Drive, Macquarie Park and 64 Northbourne Avenue, Canberra experienced valuation growth driven by strong leasing outcomes, improved occupancy and capitalization rate compression. The valuation of 150 Charlotte Street has been decreased as the major tenant, Boeing Defense Australia, signed a nonbinding heads of agreement at another property. The valuation reflects increased letting up and capital expenditure allowances. The capitalization rate also softened by 25 basis points to 6.25%. Turning to Slide 10. The capital structure of AOF remains robust. Gearing at 31 December 2021 was 21%, an increase following the settlement to 96 York Street, Beenleigh. Current gearing sits at a conservative 26% with $167 million of debt drawn against $250 million of debt facilities. A 31 December 2021 cost of debt of 3.8% reflects that only 53% of the debt facility was drawn. Assuming fully drawn, the cost of debt would have been 2.4%. There remains significant headroom to the debt covenant. Let's turn to Slide 12. The AOF portfolio offers dual opportunities. Value add opportunities at 2 and 10 Valentine Avenue, 30 Pirie Street and 150 Charlotte Street are supported by 5 income-producing multi-tenanted properties with strong WALE of 4 years and occupancy of 95.7%. Turning to Slide 13. In assessing the value-add refurbishment and repositioning opportunities, we note that the fund's largest 3 tenants representing 51% of NLA and 69% of gross income have lease expiries between June 2022 and June 2024. The expected vacancies at the 3 properties are for a once-in-a-generation opportunity to refurbish and reposition them to their former PCA A-grade status. All 3 assets were constructed in the late '80s, with 2 of the assets underpinned by property lease-up files and Telstra in its construction. The continued occupancy provided for limited repositioning opportunities to date. All 3 assets are exceptionally well located, offering good amenity and accessibility within metropolitan and major CBDs. The assets offer good natural light and sweeping views with transport and infrastructure at their doorstep. 10 Valentine Avenue and 30 Pirie Street also sit on island site. Turning to Slide 14 and delving into the detail of the value-add refurbishment and repositioning opportunities. The initiatives being considered are: at 10 Valentine Avenue as a vacant property, a reclad opportunity exists to increase the floor space by circa 3,000 square meters taking the total NLA to in excess of 19,000 square meters. [ We are ] joining 2 Valentine Avenue provides the opportunity to construct a development approved 28,000 square meter office tower with strong environmental credentials. The combined property forming Valentine Place creates a premium campus style office offering. Turning to Slide 15. 30 Pirie Street offers an opportunity to be repositioned to current PCA A-grade creating a workplace in the heart of the Adelaide CBD that is attractive to tenants while delivering flexible workplace solutions and sustainability initiatives. 150 Charlotte Street offers a short-term opportunity to refurbish the ground floor amenity and a longer-term opportunity, which includes the possibility of future site amalgamation. Turning to Slide 17. AOF active management has seen 4,500 square meters of leasing during the half year, which equates to 5% of the portfolio NLA. The leasing has driven a 1.2% increase in occupancy to 96.9% from 95.7% as at June 2021. 64 Northbourne Avenue and 5 Eden Park Drive were particularly active with half of the portfolio leasing completed at these properties. The occupancy at 64 Northbourne Avenue increased by 14% to 94.4% with 5 Eden Park increasing by 4% to 100%. I am also pleased to announce that the last vacant suite at 64 Northbourne Avenue has just been leased delivering 100% occupancy upon execution of lease agreement. Our active management acquisition and divestment strategy has resulted in the successful divestment of 32 Phillip Street for $66 million, 5% above prior independent valuation and 96 York Street, Beenleigh was acquired. The property is an A-grade office building leased to the city of Logan for 10 years from February 2022. Turning to Slide 19. I am pleased to confirm FFO guidance of $0.18 to $0.185 per unit and distribution guidance of $0.152 per unit for financial year 2022. Our focus remains on maximizing unitholder value. To achieve this the near-term priorities are: to maintain our active management strategy on the multi-tenanted assets delivering strong leasing and occupancy outcomes, progress refurbishments and repositioning opportunities on the value-add assets and assess the divestment of some or all assets by individual sales, portfolio sales or a corporate transaction. In closing, I thank you for your time and for your investment in AOF. We look forward to continuing to advance the property priorities listed and providing an update to investors in due course with a focus on maximizing unitholder returns. This concludes the formal part of our presentation. I'll now pass you back to the moderator for Q&A.

[Operator Instructions] Your first question comes from Murray Connellan from Moelis Australia.

First off, I was just wondering whether you could provide a little bit more color on current strategic directions. Maybe just on some of the considerations you're taking into account with regards to the fund's strategic future. So for instance, would disposal offers -- would offers from outside bodies to acquire some of your buildings at current asset values be favorably considered or is it still too early to say?

Thanks very much for your question, Murray. Look, I think, as we've disclosed, we are undertaking a process and looking at 3 options and in being able to determine the best option to maximize value for unitholders, we need to assess the 3 options individually. So taking individual asset sales separately without having to assess the 3 options is probably a bit premature.

Just a similar question, although I apologize if -- I suppose you've already answered it to a certain extent. But I was just wondering with regards to the repositioning plans at 30 Pirie Street and 10 Valentine, would your expectation be that those repositioning plans commence upon those assets becoming vacant or, once again, is that all subject to the strategic plan being firmed up?

That's a very good question. And yes, we are assessing those options and those refurbishment options and we would progress 10 Valentine if it was to become vacant. And assuming development application was achieved, we would progress on that basis. And 30 Pirie Street, the work can commence at any time subject to council approval and tenant engagement. So we'd be able to manage that providing that was the strategy forward for that asset.

[Operator Instructions] The next question comes from Leanne Truong from Ord Minnett.

Just a question about the asset sales or corporate transactions. When do you expect that to be finalized, a rough time period?

That's a very good question, Leanne. But at the moment, we are assessing these options. The timing for the conclusion of these options is probably a little bit unclear at this moment. We are engaging with parties on a corporate transaction and hope to appoint the agents, as I said, commencing sometime next week to start the asset sale investigation process. From a timing perspective, it is dependent on the market and it is a bit unclear as we sit here today.