Charter Hall Retail REIT (CQR) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Charter Hall Retail REIT 2024 Full Year Results briefing. [Operator Instructions]. Please note that this conference is being recorded today for our date 16th August 2024. I would now like to hand the conference over to your host today, Mr. Ben Ellis, Retail CEO. Thank you, sir. Please go ahead.

Good morning, and welcome to the Charter Hall Retail REIT FY '24 Full Year Results. My name is Ben Ellis. I'm the Retail CEO for Charter Hall and an Executive Director of CQR. Joining me this morning is Joanne Donovan, Head of Retail Finance at Charter Hall. I'd like to commence today's presentation with an acknowledgment of country. Charter Hall acknowledges the traditional custodians of the lands on which we work and gather. We pay our respects to elders past and present and recognize their continued care and contribution to country. Now turning to Slide 4 and our highlights for the period. CQR continues to deliver a resilient and growing income stream for our investors. For FY '24, operating earnings per security is $27.4 in line with our full year guidance. Underlying same-property NPI growth was 3.6%, up from 3.3% at the same time last year. This growth is being driven by a unique blend of inflation-linked rental growth from our convenience net lease retail assets, turnover rent from our strong performing supermarkets within our convenient shopping center portfolio and complemented by fixed rental increases from our specialty tenants. Underpinned by our ongoing focus on the resilient nature of nondiscretionary retail, MAT growth remained strong at 3.7%. For the year, we completed 313 leasing transactions, once again achieving positive leasing spreads of 2.7%. Pleasingly, this resulted in our convenient shopping center portfolio occupancy increasing to a portfolio record high of 98.8%, up from 98.6% at June. And when combined with our net less retail assets, our total portfolio occupancy is well above 99%. During the period, we also took advantage of significant off-market, unsolicited interest in our assets and sold 5 non-core shopping centers. This resulted in reduced balance sheet gearing of 26.7% and CQR now has over $400 million of balance sheet capacity. This balance sheet capacity provided CQR with the opportunity to invest alongside one of our existing wholesale capital partners in Mercer to acquire Eastgate Shopping Center in Bondi Junction, an outstanding addition to the CQR portfolio. This acquisition demonstrates CQR's continued commitment to asset recycling into high-quality metro centers with strong investment returns and our wholesale equity partner's ongoing commitment to invest alongside CQR in acquiring premium investment-grade assets. Eastgate Shopping Center was secured by the Charter Hall transaction team, again, demonstrating the value of Charter Hall's management of CQR. Looking forward, we will continue to curate CQR's portfolio to deliver ongoing and resilient income growth and valuation growth for our investors, and we are well positioned to take advantage of attractive acquisition opportunities that may arise. Turning to Slide 5 on the REIT strategy. CQR strategy remains focused on being the leading owner of convenience retail property. We achieved this by investing in dominant convenience retail shopping centers and convenient net lease retail anchored by leading major tenants, including Woolworths, Coles, BP and Ampol. Our convenience-based shopping center portfolio are dominant in their catchments and have high barriers to entry for any potential competition. They offer very high effective yields and a focus on non-discretionary goods and services that are resilient throughout the economic cycle. They also generally benefit from low site coverage. And when coupled with high underlying land value, they offer both potential upside through selective redevelopment as well as long-term valuation growth. [indiscernible] our convenience shopping center portfolio is our net lease retail portfolio. These properties are also focused on everyday needs, goods and services. They offer CapEx-efficient triple net leases, strong tenant covenants and income security from long leases coupled with inflation-linked rental reviews. We remain focused on enhancing the portfolio quality through curation of assets we own, active asset management to drive strong rental growth, utilization of low site coverage allowing for expansion and redevelopment potential and prudent capital management. This strategy continues to deliver a high-quality, resilient and growing income stream for our investors and demonstrates the value of Charter Hall's retail platform, Australia's largest in-house convenience retail platform to the investors of CQR. Slide 6 outlines how we've executed against that strategy and details the increased income growth it has delivered. CQR continues to actively curate our convenient shopping center portfolio and grow our major tenant customer composition. Today, the REITs portfolio consists of high-quality, predominantly metropolitan-located convenient shopping centers, complemented by our convenience net less retail portfolio benefiting from CapEx-free lease structures and CPI-linked rental reviews. CQR's continued diversification of major tenant customers significantly enhances tenant covenant quality and income resilience for the REIT. CQR's 8 major tenant customers now include Woolworths, Coles, Wesfarmers, Aldi, Ampol, BP, Gull, and Endeavour Group, collectively delivering 57% of total portfolio income. And importantly, 22% of this income now comes from our CapEx-efficient net lease retail portfolio that delivers true and consistent inflation-linked rental growth. CQR's 8 major tenants delivered a combined 2.7% income growth for the year. This represents a significant improvement when compared to the portfolio prior to curation and is a major reason why CQR is set to deliver higher-quality income growth looking forward. The REITs continued exposure to a more diversified pool of major convenience retailers and superior long-term income growth characteristics set CQR apart from its peers. Charter Hall's market-leading capability to access off-market opportunities and the ability to partner with other Charter Hall funds to diversify exposure to leading major tenants is a clear competitive advantage for CQR. As we look to the future, the REITs portfolio is structured to continue to deliver strong underlying inflation-linked rental growth and the reduced drag of capital expenditure due to our increasing exposure to triple net leases. Slide 7 details how we delivered against our strategy through active asset management. Following unsolicited off-market offers, we divested 5 non-core retail assets in line with book values. These assets were centers that were either regionally located, competition impacted or where we felt we had maximized the total return potential of the asset. The proceeds from these sales provide the REIT with significant balance sheet optionality. During the period, we also secured 2 excellent portfolio-enhancing assets for CQR. In addition to the previously mentioned acquisition of Eastgate, Bondi Junction we also acquired the Rye Hotel on the Mornington Peninsula in Victoria leased to the market-leading endeavor group on a new 15-year triple net lease and benefiting from inflation-linked rental growth alongside our wholesale capital partner, Hostplus. Importantly, both assets have stronger forecast rental growth and high prospective IRRs than the assets divested and, therefore, provide a more sustainable and growing income stream for our investors. During the year, we were also able to secure a strategic 7.5% stake in HPI alongside Charter Hall Group. All these acquisitions were transacted by the Charter Hall transaction team, again demonstrating the value of Charter Hall's management of CQR and equally demonstrates CQR's ongoing focus on strategic portfolio curation and our continued commitment to asset recycling into high-quality assets and investments with strong return profiles. Additionally, we continue to look for opportunities to unlock further value within our existing portfolio. During the year, we completed the Dan Murphy's pad site development at t Carnes Hill and are nearing completion of a new NIDO childcare facility in Swan View in Western Australia and the Aquatic Achievers swim school at Arana Hills in Queensland. Moving forward, we will continue to actively manage our portfolio and unlock the low site coverage of our assets to create further value and grow income. Slide 8 looks at the impact of cap rate expansion on CQR's portfolio and contrasts it with valuation growth. Strong and high-quality income growth remains a major focus for CQR. This has been demonstrated by active portfolio curation to higher-quality assets, a market-leading number of supermarkets paying turnover rental and an increasing exposure to CapEx-efficient net lease retail benefiting from inflation-linked rental growth. Following 2 years of cap rate expansion, CQR's convenient shopping center cap rates are on a like-for-like basis, sitting where they were in June 2020, 4 years ago. It's a similar story for our net leased assets. Notwithstanding this, our like-for-like asset values are on average 16.6% higher today than they were at the same time 4 years ago. This does not happen without the strong and resilient income growth that has been generated by the CQR portfolio over this period. The blend of higher quality, predominantly metropolitan shopping center assets and our net lease convenience retail portfolio will continue to drive resilient and increasingly CapEx-efficient income growth, differentiating us from our peers. Slide 9 looks at the results of our annual tenant engagement survey. Annually, we continue to partner with Monash University's Business School to survey our center-based tenant customers to deeply understand their satisfaction levels within the CQR portfolio and in their dealings with the Charter Hall team. For our 2024 annual CentreSAT survey, we again achieved a market-leading 99% participation rate with over 1,210 customers providing us with their feedback. Notably, over the past 4 consecutive years, we've continued to positively grow our NPS rating. And importantly, this rating provided by our tenant customers is significantly higher than that of our combined peer sets. Additionally, we maintained a highly satisfied rating on all key metrics. And once again, our tenant customers told us that it's our people and the way they communicate, they're our greatest strengths. Throughout the past 12 months, it's the Charter Hall team and their commitment to maintaining strong tenant customer relationships that has been critical in the ongoing delivery of CQR strategy. It's this ongoing focus on tenant customers that leads to our high tenant retention and strong center occupancy. I would like to again acknowledge and thank the Charter Hall team for their continued efforts and the important work they do each day in our centers and the communities in which we operate. I'll now hand over to Joanne to talk through the financial results for the period before moving to the operational performance in more detail.

Thank you, Ben, and good morning. Our operating earnings and distributions can be found on Slide 11. Total net property income grew by 3.2% to $245.3 million for the year. This increase has been driven by same-property NPI growth of 3.6%, highlighting our portfolio creation towards assets with income growth. Like-for-like shopping center NPI growth was 3.2% and like-for-like net lease retail growth was 5.5%, driven by strong CPI-linked rental reviews. Finance costs have increased, reflecting the significant rise in interest rates. CQR's weighted average cost of debt increased from 3.4% in FY '23 to 4.4% in FY '24. The decrease in other expenses reflects net divestments. We delivered operating earnings of $159.0 million or $27.4 per unit in line with guidance provided to the market. Distribution is $24.7 per unit for the period, which reflects a payout ratio of 90.3%. The difference between statutory and operating earnings is primarily due to valuation and derivative movements. Turning now to Slide 12 on the balance sheet. Investment property has decreased during the year to $4.05 billion, driven by net divestments of $196 million and a net valuation decrease of $40 million. Divestments included the disposal of 5 non-core shopping centers for $315 million, which were all sold in line with book value. The valuation decrease has been the driver of the movement in NTA, which has decreased by 4.7% to $4.51 per unit. It is worth noting that most of this decrease occurred in the first half of FY '24. With cap rates stabilizing in the second half, NTA only declined by 0.7% since December. Our tenants continue to be in a positive position to pay their rent with debt collection at over 99.3% at 30 June 2024. Our key valuation metrics are shown on Slide 13. A 100% of the portfolio was externally revalued over the course of FY '24, with 74% of the portfolio externally valued as of 30 June 2024. The shopping center portfolio value declined by $61 million or 1.9%. This includes capital investment of $65 million over the year. Convenience net lease retail portfolio increased in value by 2.0% or $21 million, driven by CPI-linked rental growth offsetting cap rate expansion. Cap rate movements have stabilized in the second half of FY '24. From December to June 24, shopping centers experienced cap rate expansion of 6 basis points to 6.13% and net lease retail expanded by 1 basis point to 4.94%. Given the transaction evidence in the market, with sales occurring at or above book value, including our own divestments, we believe the continued income growth the portfolio delivers will translate into valuation uplift going forward. Slide 14 highlights our capital management. CQR enjoys diversified funding sources with no debt maturing until March 2026. CQR is in a strong capital position with available investment capacity of $408 million. Balance sheet gearing is 26.7% and look-through gearing is in the lower end of the 30% to 40% range at 32.9%. We are comfortably within our gearing and ICR covenants and during the period, Moody's reaffirmed our Baa1 issuer rating with a stable outlook. In July, CQR completed a zero cost hedge restructure, which provides additional interest rate protection in FY '26. FY '25 is now 62% hedged and FY '26 is 78% hedged. Looking forward, our capital structure, together with CQR's strong underlying property metrics helps position the REIT for future growth. I'll now hand back to Ben to provide an operational update.

Thanks, Joe. Turning now to Slide 16 and the portfolio summary. During the year, our convenience retail shopping center portfolio occupancy increased to an all-time high 98.8%. As noted earlier in the presentation, CQR's portfolio MAT growth remained strong at 3.7%. This growth demonstrates the resilience of the non-discretionary nature of the portfolio and the strength of the REIT strategy, including our ongoing commitment to enhancing portfolio quality through the curation of assets we own. Portfolio WALE remained stable at 7.2 years following continued strong leasing renewal activity. Importantly, the CQR portfolio benefits from having 60% of total income growth directly or indirectly linked to inflation with 27% of income growth linked to CPI and a further 33% of total income growth indirectly linked to inflation through turnover rent mechanisms. Moving now to Slide 17, outlining our tenant customer composition in some more detail. As mentioned earlier, CQR's total portfolio income from major tenant customers is now 57%. Across the major supermarket providers, we remain well balanced between Coles and Wools and continue to partner with Aldi. Importantly, when we look at our exposure to any one specialty retailer, it remains limited, with Specsavers, our largest specialty tenant at 1% of total portfolio income. We retain a clear bias towards everyday needs and convenience-based food, retail and services. Turning now to Slide 18 and our convenience net lease retail portfolio. Our convenience net lease retail assets now represent 28% of CQR's total portfolio by value and 22% of total portfolio income. These assets are all triple net leased, meaning they are free of any capital expenditure and provide a true IRR yield for CQR investors. The rent review mechanisms are all CPI-linked, delivering meaningful income growth of the portfolio with a convenience net lease retail major tenants delivering 4.4% like-for-like rental growth over the year. These convenience net lease retail assets continue to complement CQR's existing convenience-based shopping center portfolio and provide valuable diversification benefits, enhanced tenant covenant quality and security of income with a strong major tenant income growth profile. As previously stated, this major tenant income growth profile is unique to CQR and not available in other less mature or lower-quality retail portfolios. Turning now to Slide 19 and discussing our supermarkets in more detail. Strong trading supermarkets remain the foundation of CQR's convenience-based shopping center portfolio. During the period, supermarkets delivered strong MAT growth of 4.3%. Supermarkets in turnover are an all-time record high of 73%, up from 67% in June and 70% in December 2023. The record number of supermarkets in turnover or within 10% of the turnover and threshold demonstrates the quality of the CQR portfolio and the ongoing ability to grow our supermarket net rental income. Notwithstanding our record high percentage of supermarkets paying turnover or within 10% of their turnover rent threshold, we were still able to complete 22 supermarket-based rental reviews in FY '24. This was achieved through both regular rental reviews where we crystallize percentage rent into our base rent as well as via active negotiations with our anchor tenants to both extend tenor and increase our anchor tenant rental income. In an ongoing and elevated inflationary environment, CQR's high percentage of stores paying turnover rent within 10% of turnover rent thresholds, provides valuable rental growth exposure to inflation. Once again, this is unique to CQR and not as really available in less mature or lower quality portfolios. Turning now to Slide 20 and our specialty tenants. CQR specialty portfolio continues to deliver strong trading metrics. This is a direct result of the quality of our convenience retail shopping centers. They don't want to position within their catchments and our exposure to resilient non-discretionary retail tenants. As a result, over the period, our specialty tenant sales productivity reached a portfolio of record high of $11,077 per sqm, and our tenants' occupancy cost remained stable at 11.4%, providing room for future rental growth. For the period, we completed 313 leasing transactions made up of 108 new leases and 205 renewals, achieving positive leasing spreads of 2.7% across our specialty tenant portfolio. Once again, another year of positive leasing spreads, demonstrating the attractive and resilient nature of our convenience-based shopping center portfolio. Pleasingly, our retention rate also remains high at 82% as tenant customers continue to see the value of long-term partnerships with Charter Hall and the quality of our portfolio. The portfolio of strong sales productivity, sustainable occupancy costs, continued positive leasing spreads and high tenant retention demonstrates the quality of our assets and the defensive nature of CQR's rental income. I'd like to recognize that these results are a direct reflection of not only the quality of our portfolio, but most importantly, the quality and the skill of the Charter Hall management team. I want to thank them for their ongoing efforts, commitment and expertise. Slide 21 looks at our ESG highlights for the period. CQR continues to deliver on its sustainability commitments and remains on track to achieve Net Zero carbon emissions in 2025. Our Power Purchase Agreement with ENGIE commenced earlier this year. We have 17.5 megawatts of solar installed on our rooftops and now have 9 megawatt hours of installed battery capacity with feasibility studies in progress for an additional 5 sites. Pleasingly, our performance has also been recognized with CQR achieving a ranking of first in Australia and New Zealand for listed Retail entities in the 2023 GRESB report. CQR and the Charter Hall team also recognize the important role our centers play in supporting the communities in which we operate. Annually, we delivered a number of national and local initiatives within our convenience-based shopping centers, and we are deeply committed to our partnerships and a responsibility to create shared social value in our communities and across our supply chain. Finally, turning to Slide 23 for outlook and guidance. CQR strategy remains consistent and is focused on convenience retail property that provides a resilient and growing income stream. We'll continue to actively manage the portfolio to improve both the portfolio quality and the quality of income growth that it delivers. Our expectation is that positive leasing spreads, high occupancy levels and MAT growth will continue to drive like-for-like NPI growth. We also expect to benefit from direct and indirect inflation-linked rental growth and our increasing exposure to CapEx-efficient net lease convenience retail. Guidance for FY '25 reflects the zero cost head restructure we undertook post-balance day, which provides additional rate protection in FY '26. Looking forward, the quality of CQR's portfolio coupled with a strong capital structure means that CQR is now positioned for growth. Based on information currently available and barring any unforeseen events, CQR expects FY '25 operating earnings to be approximately $25.4 per unit. Distributions per unit are expected to be in line with FY '24 distribution of $24.7 per unit. That ends the formal presentation. And with that, I now invite questions.

Thank you. [Operator Instructions]. Our first question comes from the line of Simon Chan with Morgan Stanley.

Just wondering if you could give us some color on CapEx -- cash outflow CapEx that you're looking to spend in FY '25? Because if I look through the slide deck, it looks like you spend about $60 in FY '24. And you also mentioned that '25, you need to complete the swim school up in Arana Hills. But how do we think about CapEx next year?

You can expect about a similar number for FY '25, and that's across the pad site developments that we're continuing to do, center upgrades, leasing and operational CapEx just to keep our centers open.

And is that a run rate that you guys are probably targeting like on an annual basis going forward?

Well, it depends on what pad site opportunities...

Exactly, Simon, like if we can unlock further opportunities, we have low site coverage across our properties. We're seeing great leasing activity from strong pad site operators, and that will be opportunities as we go forward.

And the yield on cost of these projects like the childcare and swim school, et cetera, what do we...

It all varies depending on whether we've acquired land or we're utilizing underlying land value in our existing assets, but typically between 8 and double digits, Simon.

And just one more, if I may. Some of incentives across the 300 lease deals or so that you did what did they come in at?

It's pretty flat year-on-year, typically around about 12 months month.

12 months to5 years?

Well lease terms extended out a little bit. It's about sort of a bit over 6% now, but on average, about 12 months for leasing transactions.

With your balance sheet in such a decent position, did you guys give any thought to launching a buyback or some description?

Look, we discuss it at every Board meeting, Simon. It's obviously a capital management structure and an initiative that the Board has undertaken previously. As we currently see it, look, we've been through a pretty decent period of curation to get our balance sheet, capital structures in order to sort of really facilitate earnings growth going forward. Equally, mate, we're currently seeing some pretty attractive opportunities in the market in both the net lease and the shopping center area, which if they came to fruition, could offer some really good opportunity for accretive growth for CQR. But notwithstanding that, if those don't come to fruition, and we continue to trade at a significant discount, then yes, the Board would look at it going forward.

Our next question comes from the line of Stephen Tjia with Barrenjoey.

Just a couple of questions, just following on from Simon's about, I guess, capital recycling. So if you're seeing kind of exciting opportunities at the moment, what's your target hit rate for potential acquisitions? And how should we think about just net transaction activity.

We haven't gone through any net transaction activity this year, Steven. But we'll always look at opportunities. We're opportunistic as it comes out and looks about. But ultimately, anything we do has got to be quality or earnings accretive to the CQR portfolio. And we'll continue to be active. We're not prepared to sit on assets that are competition impacted or have a lower growth potential than what we desire. And obviously, you've seen from our results, our strong NPI growth has been a result of accretion, and we'll continue to be active and opportunistic in that regard.

Just secondly, just talk about your increased expectations for long-term income growth? Just can you say when you [indiscernible] 20 basis points from the first half.

So obviously, we've -- as a result of curation of our assets, we're just continually improving the quality of our portfolio. And what's important for that is it drives better leasing outcomes, better rental growth potential. We've got the highest number of supermarkets internally we've ever had, our highest ever occupancy we've ever had. And I think all of this comes together of being active manager of a portfolio. And as we go forward, we expect to be able to see that quality shine through. And the head restructure we did for us is really important in the context that we're going to start to see a linkage between our strong underlying NPI growth and EPU growth going forward.

So I think it's important to add, we're not seeing for -- on our net expenses, we're forecasting them to be flat -- relatively flat for next year. So we are seeing some higher pressure on insurance and security and cleaning, but that's all been offset by savings to electricity, and that's as a result of the PPA that Charter Hall Group has brought on with Engie, so we get the full 12-month benefit of that over next year.

Our next question comes from the line of Howard Penny with Citi.

Just some read-through from the retail results that have been coming out recently. We've heard a few comments that on store growth, some of the retailers were struggling to grow store growth because of lack of availability of stores. And that together with your high occupancy seems to be a trend in the sector. Are you hearing similar frustrations from your tenants and opportunities in some of the areas to try to drive out that store growth with them?

Yes, absolutely, no doubt, Howard. It's a good question. We are seeing continued strong demand from our predominantly non-discretionary retailers. And as you said, a high occupancy cost is meaning that availability of sites, coupled with a high retention rate is lessened. But that's an opportunity for us and its positive because we're getting continued sales growth, highest ever specialty tenants leases we ever recorded, which is obviously a positive for CQR as we drive better outcomes across the center and our tenants are able to partner with us to build long-term sustainable businesses. And that's a really unique thing that we're going to foster over a long period of time.

And on the pad site development, that seems to be a good use of creating incremental yield on an existing sunken asset base? Do you -- are you able to quantify the potential for doing more of that? Is there a huge opportunity to do more of that in your portfolio?

Look, we've articulated previously that we sort of look across our book, and we can see at least 20 opportunities across that. Now some of those are long term. Some of those are more immediate. But I think 2 to 3, even up to 5 per year is very achievable and it's going to be driven around demand planning and ability to get those things done. But you're absolutely right. We do have low site coverage and we do have really great bits of real estate, particularly with our predominantly metropolitan focus to really drive good outcomes on that sort of underlying land.

And the last question for me, just on HPI, what's the current strategy on that holding? And how do you see that playing out at this stage?

Look, it was opportunistic. We've obviously gone through a lot of asset divestments. It was a great way to offset some of the dilution of asset sales. And ultimately, it's a very liquid holding. We understand the sector deeply, as you'd be well aware, and we'll just continue to monitor and obviously, it's an opportunity for us to continue to hold and take the distribution and/or recycle if the time came up.

Our next question comes from the line of Cody Shield with UBS.

Just on the acquisition front, are there any other Charter Hall entities you look to buy from, use some of that balance sheet capacity?

Look our most recent acquisitions have all been on market. And we've got a very big transaction team here in Charter Hall, as you're well aware. And we are seeing things on market that look interesting. Obviously, our most recent acquisitions being the Rye Hotel and Eastgate Bondi Junction where things we've been able to execute through other off-market participation or successful negotiating through a process. So at this stage, I'd be expecting anything we do. And once again, we're not guiding to it, would be looking at current vintage buying on market.

So it wouldn't be net lease retail kind of assets across the portfolio you'd look at or platform that you'll look at?

No.

Maybe just on some of the New Zealand exposures. You kind of see how – step through how you're seeing trading in some of those assets and how you're thinking about that interplay of a softer New Zealand economy and rate cuts coming through that?

Yes. So obviously, inflation has come off a bit more there. But look, the beauty of our portfolio, Cody, in New Zealand, it's absolute triple net to the highest quality covenants in Z and BP predominantly, which [indiscernible] Ampol. And we just expect to be able to continue to clip through, out of the field yield. These are effective leases, no incentives, no downtime. They're long-term land holdings. They've got great locations, predominantly metropolitan areas. And CPI goes up and down, but it remains consistent. And once again, there's no leakage for CapEx in that. So it provides a great return for us.

And maybe just one more on the '25 guidance. Can you just step through some of the moving parts there just around your cost of debt CPI, what you guys are assuming?

So if you refer to Annexure 1, so we're continuing to see strong NPI growth from both our shopping centers and our net lease portfolios. There obviously is an impact of the 12 months of the net divestments of circa $200 million that we've done and also an impact from higher finance costs as we're going to more normalized cost of debt, but also a slightly higher debt balance driven by some CapEx spend that we mentioned earlier on the call.

So CPI like 3.5% or something like that?

We just posted our census on that, to be frank, Cody.

Our next question comes from the line of David Pobucky with Macquarie Group.

Maybe just on the zero cost hedge restructure, please. Just your thinking around that. So lower hedging this year, but higher next year to a smooth interest expense. So the headwind in '25 by the tailwind in '26.

We just had some really low hedges rolling off in June of next year. They're at 1.1%, and we simply took that in the money position and extended it into FY '26. And you are right as a result, the hedge rate in FY '25 increased from 1.8% to 2.3%. But more importantly, our -- well, we're now 80% hedged for FY '26. And that gives us a lot of confidence about where our finance costs are going to be, and that, coupled with the strong property metrics that we're seeing coming through the portfolio gives us a lot of confidence in growth going forward.

Just on the expectations for valuations. I think because I mentioned, I mean, cap rates stabilized in the second half of '24. So perhaps your expectation over the next 6 to 12 months?

Look, cap rates are funny thing. Obviously, it's a supply and demand-driven equation. And you see more and more activity, which gives greater support to our valuation book. I'd probably point out 2 things. One is cap rates are only one component of valuation movement. We've articulated in the deck this year, it's actually the strong income growth we've generated via the curation of our portfolio, the inclusion of those triple net leases with CapEx efficiency and that CPI rental growth that's really helping drive value. So from our perspective, we expect to see a strong continued market, strong demand for retail, the high effective yields. It's obviously performing well regardless of economic conditions in the convenience space. And then when coupled with the quality of our portfolio, we think we're in a really good place from a valuation perspective. We expect to see values continue to grow in line with income growth as a minimum.

And just one final one for me. I mean you've spoken about acquisitions and acquisition capacity to a degree. But obviously, you've got that target range for gearing. But I mean is there a preferred look through gearing number that you'd be targeting over the medium term? Just trying to get a gauge around your acquisition capacity with reference to that.

Our target gearing range remains at 30% to 40%. That doesn't change. Obviously, as valuations start to grow, that gives us further capacity. And I think the ability for us and the capacity we have gives us a lot of optionality and flexibility to be able to play in accretive opportunities that may or may not arise. And as I said previously in these Q&A, we've seen some pretty interesting things. So early days, but I'm pretty confident that the market is in a good place and that the skill and the depth that Charter Hall transactions team will be able to help us unlock some pretty interesting things to look at during the course of the year.

Our next question comes from the line of Richard Jones with JPMorgan.

Just a follow-up just on the zero hedge restructure. How did you work out the actual amount that you wanted to move from '25 to '26. Was there...

Its predominantly one single hedge we had in place, Jones, whereby it was an amount of money that was expiring -- there was a -- hedge rate was expiring in the course of the financial year, and we utilized that one to blend over the 2 years.

Can we just discuss the payout ratio? I mean historically, it's been sort of 90% to 95% of operating earnings this year based on guidance at 97%. Do we see this as a one-off or a work back for that ratio? How should we think about...

We felt it prudent this year to maintain distributions in line with FY '24, given the strong metrics of our portfolio and our increasing exposure to net lease convenience retail. Over time, as EPU grows, we'd expect to see our distribution payout ratios probably normalize. But once again, we're very comfortable with our position this year, and it's definitely less than earnings.

And just in terms of the balance sheet capacity of $400 million, I mean, that seems a lot. Do you look to reduce this to kind of lower your line fees that you're paying?

Look, do you look at it, obviously, if opportunities to deploy it into accretive opportunities don't eventuate, then yes, sure, we'll have to look at that as a capital management initiative.

Our next question comes from the line of Ben Brayshaw with Barrenjoey.

I was wondering if you could just talk about the market for convenience net lease assets? And just I guess the independent valuation assumptions, whether they're informed by transaction activity or I guess, whether the independent valuers are just taking a view at this point?

No, they're always informed by transactional activity Ben, and we're very comfortable with them. These are the highest quality leases in the sector. They're absolute triple net, they're absolute effective yields. You've had strong rental growth coming through predominantly metropolitan locations with high underlying land value. So from our perspective, the value is backing this of transactional activity, and they're able to look at the quality of these sites and leases to back that up.

So are you saying that -- I mean you're holding them in a cap rate of 4.9% on average there's been, in your billion, sufficient transaction orders to validate that benchmark?

I mean, look, you've got to remember that just because something trades at a 5.5% cap doesn't mean it's the same quality as our portfolio. I mean, we do have the highest quality portfolio in this regard in the country, and everything is comparable based upon relative qualities. Now I think it's important to note that these are independently revalued, and this is the result of those independent revaluations, and they do base it on transactional evidence.

So just to clarify, you're comfortable that, that cap rate is sustainable going forward?

Yes. And look, we've seen them expand out. We've talked in the slide over the period of the last couple of years, but it's that underlying income growth that absolutely drives valuation as well. So the fact of the matter is, whilst the cap rates have went out over time, our valuations for net lease convenience retail have actually increased as a result of that. So we're in a good position, and they'll be independently revalued again, and we'll see what the outcome is at that point in time. But the characteristics of this portfolio remains strong, and I'm always staggered when I see results come through for things like McDonald's and KFC trading at 3 caps, which is well inside this. And a number of those tenants sit inside their net lease convenience retail portfolio. Now we don't get value for that.

Ladies and gentlemen, I'm showing no further questions in the queue. I would now like to turn the call back over to Ben for closing remarks.

Thank you very much for your time today. Looking forward to discussing with all of you in the coming couple of hours and days and wish you the best of luck for the rest of the reporting season.