Charter Hall Group (CHC) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Charter Hall Group 2022 Full Year Results Briefing. [Operator Instructions] Please note that this conference is being recorded today, Thursday, 25th August 2022. I would now like to hand the conference over to your host today, Mr. David Harrison, Managing Director and Group CEO. Thank you. Sir, please go ahead.

Good morning, and welcome to the Charter Hall Group FY '22 results, which is our 17th full year results presentation having listed on the Australian Stock Exchange in June 2005. I'm David Harrison, Managing Director and Group CEO of Charter Hall Group. Presenting with me today is Sean McMahon, our Group Chief Investment Officer; and Russell Proutt, our Group Chief Financial Officer. I would like to commence today's presentation with an acknowledgment of country. Charter Hall is proud to work with our customers and communities to invest in and create places on lands across Australia. We pay our respects to the traditional owners, their elders, past and present, and value their care and custodianship of these lands. Turning now to Slide 5 and the highlights for the year. As you can see, Slide 5 highlights the continuation of growth and resilience in our business. Operating earnings post-tax was $542 million or $1.156 per share or per security, up 89.5% compared to previous corresponding period. And I'd also note that the group EBITDA of $730 million equates to $1.55 per security. Our FY '22 post-tax earnings return on contributed equity was 31.4%. A leading return within the AREIT sector and the ASX 100, a metric we continue to focus on as an indicator of the value that we have been creating for our security holders. The group's property investment portfolio grew to $2.9 billion as we continued investing alongside our partners and within our funds, generated from both net valuation growth and reinvestment into our balance sheet portfolio through co-investment with fund partners. The group delivered a 23.2% property investment return, inclusive of an attractive 5.6% PI yield and continued NTA growth, driven by the outperformance of our fund co-investments. FUM growth continues to be strong, with property funds under management up 25.5% in the period, or an additional $13.3 billion. And when we include the partnership with the Paradise Investment Management business acquired in December, that takes group FUM to $79.9 billion. Further, in the last 2 months, we boosted this growth by $3.5 billion in the first 2 months of FY '23 in terms of property funds under management. This growth show us undertake $8.5 billion of gross transactions during FY '22 as we continue to actively curate our portfolios to drive performance via net acquisitions and a growing development work in progress, or WIP. The group's balance sheet remains resilient, with 0 net gearing and a Baa1 credit rating, whilst the 27.5% NTA growth for the year reflects the quality of our long lease investments, asset and sector selection, particularly industrial and triple net lease portfolios. Finally, the group's investment capacity of cash and undrawn debt stands at $7.9 billion. We note that this does not include committed, but uncalled equity commitments, which further increases the capacity. Our focus remains on delivering sustainable growth for securityholders, replenishing dry powder, strengthening resilience and a vigilant focus on property fundamentals. Slide 6 outlines our strategy, which I'm pleased to say has not changed for many years. We use our expertise and customer relationships to create value and generate superior returns for our investors. We allotted $4.7 billion of gross equity during the financial year. All of our equity sources contributed to these net inflows. Of the $8.5 billion of gross transactions, we acquired approximately $7 billion and divested a further $1.5 billion of assets. In addition, we invested $2.7 billion in our development pipeline, providing our investor customers access to new investment product and enabling them to deploy capital into unique opportunities not generally available in the open marketplace. Our focus remains on ensuring we manage portfolios to preserve capital and drive resilient income returns, optimizing the earnings growth from assets we manage. Finally, we continue to focus on investing alongside our capital partners, deploying an additional $153 million during the year. The CHC Property Investment, or PI portfolio, delivered a 23% return for our CHC securityholders, as mentioned earlier. Turning to Slide 7, which highlights the consistent growth in earnings and distributions Charter Hall Group has delivered for its securityholders. Including our revised earnings guidance today, you can see, over a 5-year period, this has averaged 25.4% annual growth in post-tax earnings while we continue to deliver sector-leading annual distribution growth. Turning to Slide 9, which depicts the FUM growth over the last 12 months and split by sources of equity over the last 5 years. Portfolio curation is an important driver of FUM performance. We continue to be an active buyer and seller of assets, constantly looking to improve portfolios and deliver growth. We are particularly focused on bifurcation in office and industrial markets, where we believe modern assets will command much higher occupancies and much lower vacancy rates than older stock. Importantly, this translates into assets that provide ongoing rental and capital growth and this period was no exception, with net valuations again contributing to FUM growth, reflecting the defensive qualities and attractive nature of our assets. Our partnership with Paradise Investment Management also builds upon our core strategy of partnering with wholesale and retail investor customers. The PIM FUM of $14.3 billion increases group FUM to $79.9 billion as of 30 June, which has expanded to over $83 billion with the FUM I mentioned in the first 2 months of FY '23. And it extends our relationship with new institutional and retail customers, and also provides an opportunity for Charter Hall to introduce our existing customers to the Paradise business. As indicated in the graph on the right-hand side of the slide, we have seen a 5-year compound annual growth rate of 27% in property funds under management. The growth has been consistent across all of our equity sources, providing all equity investors access to our growth opportunities and diversity of investment opportunities with both sector-specific and diversified offerings. Turning to Slide 10, which summarizes the group funds under management portfolio. From a group FUM perspective, we remain well diversified across 2 key elements, property sectors and equity sources. The addition of the partnership with Paradise this year further extends that diversification. As a result, we are able to provide multiple deployment opportunities to our investor partners. This gives the group a significant number of avenues for growth. Turning to Slide 11, where we summarize activity in the group property funds management portfolio. We have curated Australia's largest diversified property portfolio, generating more than $2.9 billion of rent annually on behalf of our investors. The scale of our portfolio brings significant advantages, providing opportunities to partner with tenants across sectors and multiple investment opportunities for our investors. We remain well diversified by equity source and by sector, where we have selected and curated portfolios, which have captured the strong growth in logistics and triple net lease assets, predominantly with CPI index rent reviews. Meanwhile, the young age or modern nature and long WALE of our national office and industrial portfolio has helped us drive sector-leading occupancy rates, which ultimately leads through to rental and asset value growth. Our Long WALE and convenience retail portfolios have been curated to focus on assets that can deliver genuine earnings growth through exposure, both directly and indirectly to inflation, low occupancy costs and taking advantage of the benefits of our cross-sector tenant relationships. I think this week's CQR results are a good indication of the strength of our shopping center portfolio and the diversified nature of that convenience retail portfolio. The Group WALE remains strong at 8.6 years. Occupancy across the entire property portfolio is high at 98% and the weighted average cap rate of 4.37% reflects the quality of our assets. Just turning to Slide 12, and a very important slide that demonstrates the depth, but more importantly, the quality of our diversified tenant customers. We see our customers as investors and tenants. We don't distinguish between them in terms of importance, and many of our tenants are also ownership partners or potential vendors in our sale and leaseback program. Our top 20 tenants make up 60% of the platform's net rental income of $2.9 billion, which is clearly growing with the growth in assets since 30 June. These tenant customers include a high proportion of government tenant customers, but also tenants in industries within essential nondiscretionary thematics. We have spent the last decade building our portfolios to focus on these resilient tenants and industry, knowing that the economic cycle will not always be favorable. 23% of platform leases are triple net. And generally, that means net effective rents, so no incentives in those sectors. And we have cross-sector relationships that continue to drive platform growth. 21% of the platform net income is from CPI-linked leases, providing our investors strong protection in a high inflationary environment. The resilience of our major tenant customers and our concentration towards essential industries underpins the defensive nature of our portfolios and their ongoing performance. Slide 13, and our transactional activity. Strong equity flows saw us active in deploying equity into developments, acquisitions predominantly off-market or portfolios, while sale and leaseback transactions continue to be a feature of our growth. We're active across all sectors, and we're particularly active in off-market transactions that we generated directly, including the privatization of both the ALL Property Group and Iron Gate, which, combined, created another $3.5 billion of assets under management. Our ability to execute upon these complex transactions for the benefit of our investors is a key capability of the group and a continuation of the group's history of being able to complete successful listed M&A activity. Our repeat sale and leaseback customer transactions are also a healthy sign of delivering on our customer-centric objectives and is also a good sign that we're delivering with those partners given that we're doing repeat transactions in terms of sale and leaseback. On Slide 14, we've provided a summary of our development activity, which clearly drives deployment, enhanced yields on cost and IRRs and, obviously, FUM growth. The group continues to progress various developments across its portfolio, creating investment-grade properties and adding significant value through enhancing both income yield and total returns. The development book has grown strongly during the period and now stands at $16 billion. Industrial development continues to grow with the total industrial pipeline growing from $3 billion to $5.9 billion in the year, with the value of committed projects up from $1.5 billion to $2.8 billion, while restocking in our land banks has also lifted uncommitted projects from $1.5 billion to $3 billion. So in terms of development completions and committed developments, we've virtually doubled our metrics from a year ago. Our office pipeline, as I mentioned earlier, has also grown, and we look to procure dynamic office spaces built to meet the evolving needs of our tenants. Our recent council approval for Chifley South, another 50,000-square meter addition to what I still believe is the best CBD site in Australia, is an example of the value add that we're creating for our customers. Recent transactions such as a further partnership with our long-term partners, GIC, on 555 Collins Street is another further example of how we can use our development skills to attract high-quality capital. The forward pipeline of committed projects will generate high-quality, long-lease assets for our funds and partnerships, while providing attractive incremental FUM growth for CHC and enhancing our credentials to attract capital. Slide 15 shows our equity flows for the year. Our strategy of accessing multiple sources of capital continues to deliver growth in all segments. Our pooled funds continue to generate strong investor interest. And I note with interest over $700 million of new equity flows into our flagship office fund, CPOF, which takes total raisings over the last couple of years to close to $1.5 billion in a market where there is some angst around the future of workspace. I would note that we are seeing very clear evidence of workspace ratios increasing and major tenant customers being prepared to commit for the long term to CBD office projects. Our Wholesale Partnerships business has been very active, with 2 highlights being our partnership with Hostplus and CLW on the privatization of ALE Property Group and of course, the more recent completion of the Irongate transaction with our existing customer, PGGM, completing those 2 major privatizations over the last 12 months. Meanwhile, our direct businesses had an outstanding year with inflows of approximately $110 million per calendar month and totaling about $1.3 billion for the year. In summary, we continue to enjoy the support of capital partners given our ability to successfully deploy capital in attractive acquisition and developed to core opportunities. Investing alongside them to cement strong alignment of interest and generate healthy returns for both our investor partners and CHC securityholders. I will now hand over to Sean McMahon, our Chief Investment Officer.

Thanks, David, and good morning, everyone. As David has discussed, our property investment portfolio provides a strong alignment of interest with our investor customers, while also ensuring that securityholders benefit from our investment expertise. Our property investment portfolio has increased to $2.9 billion. Occupancy remains strong at 97.3%, and the portfolio WALE remains robust at 8.2 years. Our weighted average rent review at 3.6% is high and benefits from the significant exposure we have to CPI-linked rental increases. Our weighted average cap rate has firmed to 4.55%, reflecting the quality of the assets we have invested in. The portfolio remains well diversified across sectors and by investment, with an over 80% weighting to the core East Coast markets. We continue to allocate incremental group capital to investments in Long WALE retail, social infrastructure and industrial and logistics assets. The growth in the property investment portfolio reflects the group's desire to continue to invest alongside our investor customers ensure a strong alignment of interest. Now turning to the property investment movement. During the period, our investment property portfolio grew to $2.9 billion, with increased valuations and additional new investments. Our ability to recycle capital to support new fund initiatives and drive returns for securityholders is an important part of the success of the group. The chart on the right-hand side shows the growth of our total property investment. Pleasingly, our PI yield remains attractive at 5.6%. Turning to Slide 19 and the resilience of our PI earnings. As David spoke to earlier, we have consciously spent the last decade concentrating our tenant exposure to nondiscretionary and resilient tenants and industries. As can be seen on this page, the same is true for our property investment earnings. These are characterized by the high quality of the tenants that provide the income, the diversity of sectors which produce them and the lack of concentration risk or single asset exposure in deriving them. 80% of PI net income comes from leases that grew at fixed annual increases of 3.5% a year, delivering annual income growth at a rate above the RBA's inflation target band. The remaining 20% of leases are CPI-linked, ensuring good exposure to additional growth in an elevated inflationary environment. No single asset contributes more than 5% of portfolio investments, and our tenants are heavily weighted towards nondiscretionary industries. More broadly, across the platform, we enjoy strong tenant customer relationships. These relationships often span asset sectors and multiple properties. 71% of our tenant customers lease more than 1 tenancy from us, and 32% of our tenants are customers across more than 1 asset class. And this also feeds back into transactions, with our significant sale and leaseback activity providing off-market opportunities to also grow our funds. Let's now move to ESG on Slide 20. As a business, we remain very focused on ESG as a strategic differentiator. We believe that delivering environmental and social value, in partnership with our tenant and investor customers, will support long-term sustainable growth and returns. We've now completed $2.5 billion in sustainable finance transactions. And this represents approximately 10% of our debt book and is external validation of the attractive environmental performance and rating of our assets. We also continue to make significant progress in our goal of achieving scope 1 and 2 net zero carbon emissions by 2030 for assets under our operational control. We've now achieved a 54% reduction in emissions against our FY '17 baseline, driven by 100% supply of renewable electricity to our workplace, office and industrial and logistics sectors. We are very pleased to announce that we've entered into a 7-year power purchase agreement with global renewable energy giant, ENGIE, to supply 100% electricity from renewable sources across the group's property portfolios over 7 years. This PPA provides for the procurement of 151 gigawatts of renewable energy per annum from state-based wind and solar renewable energy projects to 152 Charter Hall sites, roughly equivalent to powering approximately 26,000 homes annually. As part of the agreement, Charter Hall is a foundation clean energy partner for 3 solar farms currently in development, supporting the build-out of Australia's renewable energy infrastructure. Pleasingly, our achievements have been externally recognized with Charter Hall ranked 8th in the Financial Times-Nikkei Asia-Pacific Climate 200 leader list. On Slide 21, we detail some of the commitments we made to the communities in which we operate. Aligned to our pledge 1% commitment, we invested $1.27 million in social enterprise and community initiatives, up 72% from FY '21. We've also delivered over 191 employment outcomes for vulnerable young Australians. We know that ESG continues to be a key thematic for investors assessing their portfolios and sustainability is central to how we conduct our business and always has been. Our ultimate goal is to be a role model in the Australian property sector by creating environmental and social value alongside sustainable growth and returns. I will now hand over to Russell to provide details on the financial result.

Thank you, Sean, and good morning to everyone on the call. As David highlighted, the group reported statutory earnings of $911 million and operating earnings of just under $543 million, both of which are the highest in Charter Hall's history. Operating earnings were up more than 90%, while group EBITDA was more than double FY '21, driven largely by the funds management business. Property investment grew 16% with additional net investments made during the year, and development income was comparable to FY '21. Funds management EBITDA of $552 million represent an increase of 170% over FY '21. I will expand further on funds management performance on the following slides. We continue to size our distributions based on target annual growth rate of 6%. And for FY '22, this results in an earnings payout ratio of 35% and retained earnings of more than $350 million. Turning to Slide 24 and looking at the funds management business in more detail. This segment continues to drive organizational growth. The base fund management revenue increased more than 35%, reflecting the growth in capital during the year. At more than $370 million, transaction performance revenue were more than 4.5x higher than FY '21, reflecting a year of significant transaction activity and performance fee realization as a result of outperformance of the group's funds and partnerships. Property services revenues were up nearly 17% as the scale of the business grows and activity levels increase, including the provision of development management and leasing services to our funds and partnerships. Several key factors contributed to the growth in operating expenses, including increase in head count and wage level across the business, which is by far the greatest contributor to the cost increase. Other factors included reduced impact of COVID as business normalized compared to FY '21 and increased expense relating to long-term incentive program, which are accrued annually despite being measured over a multiyear period. For the year, the funds management EBITDA margin was 79%. And if transaction performance fees were excluded, this margin was 54.4%, demonstrating the continued profitable growth of the business. Turn to Slide 25, which illustrates the evolution of the platform and the value of scale in driving profitability. The chart on the left-hand side shows the profitability profile of our funds management business since FY '17. The top black line shows the absolute earned EBITDA margin, including all transaction performance fees showing FY '22 is nearly 80% margin. Now adjusting for the more variable components of revenue, the second line shows that EBITDA margin achieved has doubled from FY '17 from about 27% to more than 54% in FY '22. The chart on the right-hand side shows composition of key revenue drivers relative to operating expenses and the rate of change over the last 5 years, where all categories of revenue have outpaced expense growth. The combination of scale and investment performance provides the greater potential for transaction performance fees as reflected in the more than $640 million earned in the last 3 years. Now moving on to Slide 26, which shows our balance sheet at 30 June. And as you can see, the group continues to be in a very sound financial position. With nearly $600 million of cash, we are currently at 0 net gearing or in a net cash position. The investment portfolio has increased by $500 million and now stands at $2.9 billion. Most importantly, the returns on capital metrics are very strong for the year, reflecting this year's profitability and our continuing ability to employ capital effectively. Maintaining strong return on capital metrics is fundamental to ensuring the business employs capital effectively to generate earnings growth on a per security basis. Now on Slide 27, we provide an update in relation to the debt funding across the business. Our financing strategy is tailored to the particular investment vehicles, the nature of holdings and investor profiles and are typically done to investment-grade metrics. And more than $25 billion of total facilities and more than $15 billion executed during the year, we've grown our borrowing capacity in line with our growth and extended our maturity profile. Approximately 90% of our facilities mature after or beyond FY '25. Across the group, average gearing was approximately 27%. The platform's average cost of funding was 3.1%, with interest for 57% of drawn debt hedged at an average tenor of 2.5 years. The business continues to diversify debt capital sources and will access bank and capital markets across multiple jurisdictions. We've also completed $2.5 billion of green financings across multiple funds. And as has been referenced earlier, the group had nearly $8 billion of available liquidity or investment capacity at 30 June and is well positioned to continue to support further growth. Now I will hand back to David to provide an update regarding transaction activity since 30 June and earnings guidance for FY '23.

Thank you, Russell. Now turning to Slide 29, which provides an update of group activity completed so far this financial year in the last 7 weeks. As you can see, we continue to be active deploying across the platform and have completed $3.5 billion of net property acquisitions in the last 2 months. We are pleased to have successfully completed the Irongate privatization and to continue our office pricing strategy with the 50% acquisition of Southern Cross Towers in Melbourne. Property FUM now stands at $69.1 billion and group FUM at $83.4 billion. Now turning to Slide 30 and our earnings guidance. Based on no material adverse change in market conditions, FY '23 guidance is for post-tax operating earnings per security of no less than $0.90 per security. FY '23 distribution per security guidance is for the continued 6% growth over the previous financial year. That now ends the prepared remarks, and I now invite your questions.

[Operator Instructions] And our first question will come from Sholto Maconochie of Jefferies.

And a good result. Just a quick question on the Paradise. It looks like the FUM went down about $4 billion between December and some of that's market related. But what are the outflows in that business over that 6-month period?

Thanks for the question, Sholto. Like I've said for 17 years, we're not going to give composition or guidance. Yes, you're right. It's a combination of market pricing and some outflows, but we're not going to give a compositional indication. And as it shows, we're pretty happy with the first 6 months of performance, which is sort of well ahead of what we expected.

Yes, it looks that way. $13 million versus $10 million, sort of 10-ish, so it looks good. And then just on the transaction, really good run rate to date in the first quarter '23. A lot of those were struck probably a bit earlier in the year. What are you seeing now if you look at today's coming to September in sort of investor appetite for transactions in the market? What are you sort of seeing on pricing and opportunities in the market to keep that run rate elevated?

Well, I think your question is more around where market activity is at the moment. Last few months, despite rising bond yields, there has still been pretty strong volume of transaction activity. It's nowhere near what it was in 2021, but there's still solid transactional activity in most CBDs. I think it's fair to say the depth of buyer demand and the propensity of people to sort of sit on their hands for the time being has sort of shallowed out the volume of activity. If I sort of go across different sectors, no surprise, anything with CPI-linked rent reviews are still being bid pretty strongly. We think the sort of Long WALE retail, convenience retail sector will continue to attract good buyer demand. And I think you're seeing a plethora of evidence of institutional capital still being prepared to buy good quality assets. Our partnership, we're bringing GIC into 555 Collins Street, an example of that. And when I sort of think about other markets like industrial, yes, there's no doubt that the volume of transaction in industrial is going to be lower than it has been for the last couple of years. But it's still sitting at record low vacancy rates. I haven't seen vacancy rates in most major markets as low as they are in my career, and that's driving good market rental growth. And I think as we get through FY '23, I think you'll all be surprised at the volume of office transactions that get printed in major CBDs.

And on pricing, is it still -- is there any firming -- sort of firming -- the cap rate sort of widening out a bit? Or you have -- it's not too early to see that given the volumes we've seen?

It's too hard to sort of make a rule of thumb because it's all asset by asset. There's no doubt, and I've said this for years, long-term capital prices, their return expectations on their long-term expectation of bond yields, not the spot bond yield. So we weren't seeing capital flow into markets in 2020 and '21 when 1% bond yields weren't the predicted 10-year average bond yield. So I think -- and you're starting to see an inverse yield curve in most bond markets around the world, particularly Europe and the U.S. So our view is that they'll be elevated for this year, next year and things will start tapering off after that. And I think our long-term capital partners are sort of looking through the sort of short-term spikes in inflation and bond yields and sort of making decisions for the longer term. So I don't want to get drawn into how many basis points. I think cap rates may soften or have softened. I think the reality is it's going to come down to -- like I talked about with industrial, you might see sort of static cap rates or even a bit of softening in industrial, but you're going to get very strong market rental growth. So they tend to offset each other. And I think we're going to go through a period of what I call the bid-ask spread, where there's a gap between vendor expectations and buyers. And my experience is it sort of takes 12 months for that spread to narrow. So we'll watch transactional activity during the course of this financial year and probably sit here at a year's time, and as I said, the market might be surprised at the volume of transactions we see.

Yes, that makes sense. And then your development pipeline almost doubled year-on-year. And if you look at the first half, second half, you did $1.6 billion of completions. Do you think that will be elevated going this year, this quarter last result around that sort of $2.5 billion to $3 billion per year now, so a bit more than historically?

Yes. Well, completions have doubled. And if you look at our committed and uncommitted development pipeline, and you look through an average development period in industrial or office, by definition, our completions are going to keep growing. Office is, obviously, going to be pretty lumpy because we've got some long-term projects like Chifley South that got approved by council this week. But we've got some fantastic projects that are in their construction phase that complete during calendar '23, including the Amazon anchor, 555 Collins Street in Melbourne, the 60 King William project in Adelaide, we're well out of the ground on the Aussie Post headquarters at Richmond in Melbourne and well out of the ground on our 360 Queen Street project in Brisbane. So what has been most impressive is the volume of precommitment demand for industrial, which is why you've seen both pre-leased development WIP grow strongly. But as you can also see, we've got a pretty significant uncommitted development pipeline that we've secured in both industrial and office. So yes, we don't see that changing. And as I called out, there's 3 major advantages of having a pretty elite development capability in those sectors. A, we can create a brand-new product that you can't otherwise buy in the open market; b, it is very attractive for our fund investors to be getting those enhanced yields and IRRs; and c, from a CHC perspective, it allows us to keep growing our development management revenue and create sort of positive jaws in margins in that part of our business. So that's -- it's not deliberate. It's not just an accident and all of a sudden, we're growing our development pipeline. It's been a deliberate strategy for the last 7 or 8 years.

And our next question will come from Ben Brayshaw of Barrenjoey.

Could just expand a little bit more on the growth in the development pipeline over the last 6 months? It's up circa $3 billion. And just secondly, in terms of how you're seeing opportunities to add to that over the next 12 months in either the office or logistics sector, clearly, I suppose with rationalization of capital, just interested in your thoughts on how that might play out in so far as freeing up development sites going forward?

Look, Ben, I don't know what more I can add to what I said to Sholto. The route is that if I take it sector by sector, our industrial and logistics pipeline is being funded by predominantly wholesale funds and partnerships, the strong appetite from our wholesale capital to keep deploying it. If you look at our tenant customer slide, where 60% of our income comes from the top 20 customers, it's no accident that there's a lot of repeat business across sectors with those customers. A lot of our major retailers are also big users of logistics space. So we're pretty customer-centric. So we're really looking at securing land that can satisfy the demand of our repeat business customers. And as I said earlier, it's really tight in those sectors. Equally, in our office pipeline, we've not only secured some great pre-leased projects and been able to secure tenant commitments from the likes of Amazon or where super government on a couple of projects, Telstra on the Adelaide project. And my view is there's going to be a big bifurcation, particularly in office and industrial markets where the tenant customers want modern space. So I think there'll be a big delta between relatively low vacancy rates in modern office buildings in all markets. And the older buildings of 30, 40 and some of them are 50 years old, they're really going to struggle to retain tenants. So I think probably more so than any time in my career, we're going to see a big bifurcation in vacancy rates in modern buildings versus older buildings. And I also have the same view in industrial. I think the demands of industrial customers is changing and changing very quickly. So that's why you'll continue to see us divest older stock. I think we've been averaging sort of $1 billion to $1.5 billion of divestments a year. I don't see that changing as we sort of curate our portfolio. And as my executive team get older, our portfolios will get younger. So that's basically the strategy.

Yes. And just a final question on inflow over the last 6 months. Wholesale has been in the order of $1.6 billion in direct. Could you just comment on the key drivers of the wholesale inflow? And secondly, direct in the order of $600 million seems to have held up well. Has that come as a surprise as, obviously, interest rates have adjusted?

Ben, nothing comes as a surprise for me and Charter Hall. It's all a long-term deliberate strategy. We've got a privileged position that we've developed in the direct market. We have very strong performing funds, as you can see from the deck. We have always been very focused on not going for the higher yield, higher risk assets that then create higher risk on value reduction. So our portfolios in the direct business of institutional quality. And I think that's holding us in a good position to continue to attract capital from direct self-managed super fund investors and clients of our major financial adviser, wealth management groups. On the wholesale side, the Wholesale Partnership business is continuing to attract capital. I mentioned the GIC transaction with 555 Collins Street. If you look at Hostplus partnering with us on the ALE take private and then PGGM on the Irongate take private, they're examples of where we're able to use our expertise and market knowledge to secure a product that is not normally that easy to secure. So I don't see that changing. I think the team in the pooled funds, in the CPOF, our leading office fund, I think has done a 12.8% return for the last 10 years, virtually 20% above the peer set in the MSCI index. Over the last 2 years, it's probably generated close to $1.5 billion of equity inflows, which is a testament to the quality of that portfolio and our team at a time when there's been a lot of question marks about the future of office. And as you know, in the industrial pooled fund, CPIF, we've had a good run of both securing and deploying capital, and I don't see any reason why both those funds that are providing fantastic returns to investors are not going to continue to attract capital over time.

And our next question will come from James Druce of CLSA.

David, just my first question just around where you're going to put your balance sheet capital near term. Is there anything specific that you're thinking about? Or is it more the sort of co-investment in the broad portfolio?

Look, I think our balance sheet is as strong as we've ever had. We had nearly $600 million of cash on our balance sheet at 30 June. When we think about how to deploy balance sheet capital, we're pretty proud of the very high return on contributed equity we've been able to deliver for our investors. So when we look at how best to shape that, there's no doubt partnering with our wholesale capital on things like the Irongate transaction makes sense. When we look at seeding new funds or partnerships, that's a sensible strategy because we're generally taking a relatively small minority stake in bringing larger capital partners for those sort of transactions. I think we also have delivered very high returns on invested capital in our development investment earnings segment, where we've been able to secure land that, for whatever reason, was not necessarily attractive to our funds or partnerships at the time. And we've been able to secure planning approvals and then pre-lease them and then deliver a stabilized product to our core funds. So that's a segment that I think we will continue to invest in. It's provided very high returns for us, and it's essentially a capital-light segment as we stabilize and sell those sort of site opportunities once they're stabilized to our funds and partnerships. And -- but we're patient. We've got probably one of the lowest average portfolio gearing levels that the business has had. And as I said, we've got a very strong balance sheet. We have plenty of capacity to deploy. So we'll be selective. As you can imagine, I can't go into the specifics, but we have a plethora of sort of opportunities to look at, and we'll continue with our co-investment strategy, where we're a relatively small stake owner in funds and partnerships. That is how we think we can drive maximum or optimal EPS growth for the Charter Hall Group.

Okay. Yes, that makes sense. And just maybe on the operating expenses for the next 12 months. Do you expect that to be roughly in line with the second half? Or do you expect some basic growth coming through there in terms of just looking at the overheads really?

Yes. Look, you'd always expect some growth as we continue to grow the business, but you're not going to see the quantums that we saw year-over-year. Because like I said, there was a few things that happened during the comparative periods where it was a little bit depressed in the prior year, but also we made sure we invest in the business where we needed to, whether that be in development or finance or operations, and we won't see that kind of same investment level going into this year. But I would expect, as we grow our business, our overall expenses will increase. But as you saw on the margin slide, we're very focused on ensuring that the core operations margins continue to grow in time. So the rate of change should continue to be behind where -- much behind where you see the revenue growth.

Yes. And I'd just add, we have invested in the platform both in our people and in non-employee expenses for the last few years. And we think we've got ourselves to a point where we can significantly scale up the operation and create positive jaws. The other thing I'd say is that we are quite focused, and you've seen it for the last 5 or 6 years with the growth in the triple net leased assets in our platform, focusing on low -- what I call low FTE intensive funds under management. There's no doubt it's more profitable for a fund manager to be managing assets that have triple net leases. We're not doing the normal management intensity that you do in large office and industrial portfolios. So as we move forward, both assets within those sectors, office and industrial, as I said, the strategy to create more modern portfolios. And if you look at the development book, the average size of assets is growing both in office and industrial. So that creates economies of scale as well.

And our next question will come from Lou Pirenc of Jarden.

Sorry, you broke up for a bit. Two quick questions. David, in the past, you've said a low interest environment wasn't very conducive for sale and leasebacks. I know you've done sale and leasebacks. But are you seeing signs of a rising interest environment creating more conversations with owners of real estate that may want to partner with you?

Absolutely, Lou. I've been listening for 7 or 8 years to CFOs and treasurers of major corporates telling me, "Oh, we don't need to do sale and leaseback, we'll just go and borrow more money." Well, those days are over because the cost of the corporates borrowing money has risen, and therefore, the relative merits of doing sale and leaseback are going to be stronger in this environment than they ever have been. As you can see from the various acquisitions we've done recently, CQR with [ GOL ], with very strong initial yields and CPI indexation, that's a sign of things to come for us. I think we're going to see more and more corporate sale and leaseback in industrial and logistics sectors. And I think we will probably see a lot more of this happening in what I call the sort of broad social infrastructure sector. I think you're going to see it across telecommunications. Obviously, we did the Telstra Exchange transaction in 2019, which has been a fantastic result for our partners in that portfolio. Because I'll remind everyone, CPI plus 0.5% is looking pretty good at the moment in terms of rent reviews. And I think we're going to see more government sale and leasebacks. There may be some 51, 49 type partnerships with both corporates and governments because the -- whether you're a federal government, state government, local government, they got the same issue that corporates have got. All of a sudden cost of debt is much more expensive than it used to be. So we see significant opportunities ahead for that. And given that we've got a market-leading position in sale and leaseback, and frankly, some pretty good references from existing customers that continue to do repeat business with us, I think we're well placed to access those sort of opportunities.

And then just on the development income line. I know it's relatively small, but with the doubling of the pipeline, should we expect to see that grow? Or will most of that come through to partnership income, transaction fees, et cetera?

Look, my view is I don't like anything not growing in Charter Hall. So that's all I'd say.

And our next question will come from Stuart McLean of Macquarie.

First question is just on the outlook for property investment earnings, please. So the 5.6% yield, as we stand today, I was wondering how that moves going forward 12 months with the rising interest cost that will come through. If you can just provide a bit of color there would be great, please.

Look, I don't need to give you any further feedback than the whole sectors given investors around rising cost of debt. What I would say is that it depends on the portfolio. So clearly, where we have CPI indexation, strong market reversions coming in, in certain sectors, I think our NPI line can keep pace with our rising cost of debt. The actual cost of debt and how long it's hedged is very different by different funds. But we are reasonably comfortable that we should be able to sort of maintain that. But there are pressures on it. There's no doubt the cost of debt, if it doesn't get offset by a rising NPI line, will cause some short-term pressure or downward pressure on the PI yield. The thing I'd say about the PI yield in CHC is that it's a relative that the growth in that PI is a relatively small delta in terms of the overall growth of CHC's earnings. But you don't have to be Einstein to work out over the last 5 or 6 years, PI yields have come down as cap rates have come down and in the current environment, cost of debt is putting pressure on those sort of distribution yields. And I'd also note that we're quoting PI yield after we have deducted our fees at a fund level. So we're getting the same distribution yield from a PI perspective as all of our partners in the various funds and partnerships. So it's sort of one of those things that I'm not going to give specific guidance on where it might be at a spot rate in 12 months or 24 months. But yes, clearly, it's come down over the last few years. I don't know if you want to add anything more, Russ.

Yes. The only other thing I'd add is it's obviously impacted by the mark-to-market on the valuation of the holdings. So the reason it's also come down over time is that the denominator is increasing in value and proportion to the earnings. So those are the factors that have been pushing it down until now, but it is mostly going to be the interest in the underlying funds that will affect the outcome of the yield going into FY '23.

So it sounds like the key takeaway there, if we're thinking about that yield on a go-forward basis, is you kind of expect NPI growth broadly to offset any increase in interest costs. Is that the key takeaway as we think about the next 12 months?

Well, the maths is pretty simple, mate. If you -- to maintain your PI yield, you need your NPI growth to offset any increase in the cost of debt. And yes, there's a few other things that change that, whether the funds are lowering the gearing or increasing the gearing. But -- yes, the only other thing I'd add, Stuart, is if the implied blowout in cap rates that the listed market is telling us is going to happen happens, well, we've got to tailwind the PI yield in front of us. But we're not in the camp that the implied yields that are trading in the market have got it right anyway.

Okay. And second question, just on some of the key performance fees that are coming through. I was wondering for CLP, you have to provide a testing date there, whether that's in the near term or if that's towards the end of the financial year, please.

In quarter of FY '23.

And then just on the guidance as well. Do you have to provide any additional color on assumptions around those performance fees or movement in asset valuations as well, please?