Derwent London Plc (DLN) Earnings Call Transcript & Summary

I think we're all here. Good morning, and welcome to the Derwent London 2023 Interim Results presentation. Probably also could say welcome to this summer, at last. Today, you will hear from Damian, Nigel, Emily and me. I shall then wrap up with Q&A. Now turning to Slide 2 and the overview. Today, we've announced further letting progress at 25 Baker Street and Featherstone. We're seeing good demand for our distinctive branded space and pre-letting continues. London is a great city, and I'm sure you've all seen how busy it is, the breadth and depth of its appeal and shortage stands apart from other cities around the world. London, particularly the West End faced an increasing shortfall of high-quality offices, businesses are fully engaged with their occupational strategies. We delivered near record leasing activity in H1, having pre-let half of our major on-site development of 25 Baker Street to PIMCO in February. Moelis has now taken 2 floors. The commercial space is 76% pre-let, all presold, some 18 months ahead of completion. As well as securing 2 very high-quality tenants on long leases, they're paying a substantial 13% premium on average to December's ERV. Emily will provide further details. Now it's not just pre-lets where we've had success. Good progress has been made reducing vacancy. At June, it was 4.5%, nearly 2% below December. You can see on Slide 2, the other key leasing transactions. Now the economic backdrop for the U.K. remains uncertain. And whilst the July inflation data injected some optimism into financial markets, there's still more progress to be made with central banks continuing to raise interest rates. We expect some volatility to continue both economically and politically, but operationally, we are letting well to new occupiers and have a very strong retention rate. Derwent London started 2023 well positioned. We have low average and less than -- sorry, low leverage and less than GBP 100 million of medium-term refinancing requirements. Fixed price construction costs have now been agreed for both of our on-site development projects. Combined with our low cost of debt, we're delivering attractive returns from these schemes. Our equivalent yield increased 25 basis points in the first half to 5.13%. With inflation and interest rate expectations continuing to evolve, we expect our portfolio to be more resilient than the wider market with the West End to outperform the city. Portfolio valuation, ERV growth of H1 was 1%, and it was in line with our guidance, which we are leaving unchanged to north of plus 3% as an average across our portfolio. We expect better quality buildings to deliver higher growth. Turning now to Slide 3. Our clear strategy means we are well positioned. In 2021, we outlined our intention to keep our modern prime buildings for longer, in addition to supporting a higher total return, and this has also ensured we stayed ahead of the EPC curve. Over 65% of our portfolio is already 2030 compliant. Our long 7.2-year average lease let gives us good visibility on income, enhancing our strong position and giving us additional capacity to push ahead with our deep pipeline of best-in-class developments and refurbishments, which was maintaining high interest cover. 72% of our portfolio is in the West End and our on-site and medium-term developments would increase this weighting further. Occupiers plays considerable importance on immunity. Our lounge DL/78 has been very well received and has played an important role in several leasing and asset management transactions. We look forward to the opening of a second lounge in Old Street later in H2. Our member approach, on which Emily will provide more details later, is an important brand differentiator for Derwent as is our bespoke approach to flex. We are well placed to continue delivering above-average returns over the long term. Our unique brand of distinctive designed buildings are in demand. London is a vibrant global city that has delivered a strong performance over longer term. Economically, it comprises nearly 1/4 of U.K. GDP, which contributes to a positive employment outlook. Job creation is an important driver of office demand. Furthermore, businesses across London, unlike other major cities, represent a diverse range of sectors and industries supported by its world-class infrastructure. The planning range across London is getting tighter, but our long-term relationship with the borrowers as well as our reputation and expertise allows us to navigate a more complex world. Combined with the increase in cost of finance and construction, the choice for occupiers is shrinking. The trend towards occupier recentralization is causing further market tightness. The opening of the Elizabeth line has led to a significant positive impact on transport connectivity. Office market rents along the line have outperformed, and more than 80% of our portfolio is within 10-minute walk of an Elizabeth line station. The London office market has continued to bifurcate as businesses increasingly recognize the many benefits of occupying the best base for their existing and, of course, future talent. It is important to be aware of averages. Supply is tighter and demand is stronger in the West End when compared to the city. Capital allocation on Slide 5. We take a strategic and long-term approach to capital allocation. Since 2018, our principal focus has been improving the overall quality of the portfolio. We've sold GBP 900 million of assets with lower repositioning potential and have recycled proceeds into developments and refurbishments, which had delivered attractive returns. Over the coming months, we anticipate an increase in number of motivated sellers as lenders take a more cautious approach on refinancing. Our preference is to acquire future repositioning opportunities. Our experienced management team has seen many cycles. We have a deep pipeline of regeneration opportunities. And combined with our balance sheet capacity, it means we are neither a forced buyer nor a force seller. We remain disciplined in our approach to capital allocation. Thank you. I'll now hand over to Damian to take you through the financial results.

Thank you, Paul, and good morning, everyone. Looking first at our financial highlights on Slide 7. EPRA NTA per share declined 5.2% in the first half to 3,444p mainly due to further outward yield shift in the property valuation. Gross rents were up 3.9% to GBP 105.9 million, but higher irrecoverable property costs have seen net rents fall to GBP 90.9 million, giving a 7% drop in EPRA earnings per share compared to H1 '22. We're looking in more detail at the reasons for this later as some of these costs should reduce in H2. We're increasing the interim dividend again, this time by 2.1% to 24.5p per share. And the balance sheet remains very strong with a high level of liquidity. Borrowings and net debt were almost unchanged from the year-end, that the EPRA LTV ratio has increased slightly to 25% on the lower valuations. The movement in EPRA NTA is shown on Slide 8. As you can see, the main change from last time is a downward revaluation movement, equivalent to 178p per share on the wholly owned portfolio and 4p per share on the 50 Baker Street joint venture. Slide 9 shows EPRA earnings. As mentioned earlier, gross rental income has increased with additional income from Soho Place and Featherstone. However, with higher average vacancy rates through H1, property expenditure was up to GBP 13 million in the first half. Higher staff costs have also taken admin expenses to GBP 19.2 million, and net finance costs also increased to GBP 19.6 million. This was because capitalized interest was GBP 2 million below H1 '22 with cumulative expenditure on the major project much lower this year. Rent collection remains very strong overall, but we've taken a cautious view on the economic outlook and increased impairment provisions against receivables, mainly in relation to hospitality and gym operators. There was a corresponding charge of GBP 1.9 million in the period against the release last time of GBP 0.5 million. Slide 10 shows the movements in gross rents. Developments and refurbishments increased rents by GBP 6.3 million with asset management adding GBP 2.9 million compared to H1 '22. Brakes and expiries reduced rent by GBP 2.6 million, but GBP 0.9 million of this came from emptying the network building for redevelopment. Disposals of New River Yard and Charterhouse Street also decreased rents by GBP 2.6 million. On a like-for-like basis, gross rental income was up, but the higher irrecoverable property costs and impairments meant that net rental income was down a little. Slide 11 shows how property costs have moved over the last year or so. Our average vacancy rate was roughly 2% higher through the first half of 2023, which took void costs to GBP 2.4 million, though they were lower than in the second half of 2022. Lettings made recently at the Soho Place retail, office floors at Featherstone and elsewhere should see this reduce further in the future. Exceptional energy costs through the last winter also triggered some service charge caps. Unusually, we've also seen GBP 1.1 million of balancing charges from 2022, reflected in the first half, as service charge reconciliations were completed. Repair costs were up, too, and ground rents reflected the regear at Soho Place in H1 '22. Slide 12 shows the GBP 69 million of first half project expenditure allocated across the balance sheet. The main projects incurred GBP 56 million of CapEx, mainly at 25 Baker Street and Network. GBP 7.2 million was spent on the residential units for sale at Baker Street, which are held as trading property with a further GBP 1.9 million on the commercial space to be sold to the freeholder on completion. Future expected CapEx is on Slide 13. Almost all of these costs are now fixed with about GBP 100 million expected to be incurred in the second half. EPC upgrade costs are estimated at GBP 100 million after the sale of Charterhouse Street in January and taking account of cost inflation in the period. GBP 51.6 million was a specific deduction in the external June valuation, with further allowances there for general floor-by-floor refurbishments. Slide 14 shows our usual pro forma, taking account of the GBP 294 million cost to build out the committed major projects, plus sales and lettings contracted up to June. The required spend is covered by available facilities, and leverage remains modest. Slide 15. A strong balance sheet has really been more important. At the half year, we had liquidity of GBP 562 million, a weighted average unexpired debt term of 5.6 years, low leverage and strong interest cover. 98% of our borrowings were at fixed rates, plus we retain an unused GBP 75 million interest rate swap of 1.36% until April '25. Uncharged properties totaled GBP 4.4 billion available as potential security for any future secured borrowings. These characteristics enabled Fitch to reaffirm our credit rating in May as BBB+ with a stable outlook, the senior unsecured rating being A-. All our debt covenants are very comfortably covered, and relationships with our lenders remain very good indeed. Thank you very much, and now over to Nigel.

Thank you, Damian. Good morning. The leasing market has remained buoyant as shown by our H1 activity. The flight to quality space continued with both demand and rents holding up. However, this was not enough to offset the weak investment market. Here, there was lower turnover with buyers concerned at the level of interest rates and the limited funding availability. The outcome was a further upward yield movement in the first half. This translated into valuation declines of 3.7% or roughly half the figure we saw in H2 last year. Within the valuation, our developments continue to deliver good performances and profits on the back of construction progress and pre-letting well ahead of completion. They were up 10.6%. Total property return for H1 was minus 2%. This was, however, a beat against the MSCI London Index, which was minus 3.2% and was driven mainly by our development returns. Looking at the themes, Slide 18. The demand for quality space continues as seen by our pre-letting activity at Baker Street. ERVs are positive, but vary depending on quality of accommodation. The pace of rental growth is showing signs of accelerating. Having sold GBP 900 million of assets since 2018, we've somewhat reshaped the portfolio, holding our finished product for longer yet remaining an important pipeline of opportunities. As shown on the chart, the better quality buildings are more resilient, and we expect this to continue. It is important to note that some of the lower-value properties per square foot are our projects for the future. These include Greencoat and Gordon House, 250 Euston Road and 20 Farringdon Road. Slide 19. Turning to a little bit detail on rental value and yields. ERV across the portfolio, which mainly relate to rent reviews and lease expiries, were up 1%. Offices were 1% and retail at 1.3%. On yields, these moved out across the sector. We saw a 25 basis point movement on our EPRA portfolio following a 42 basis point movement in H2 last year. Yields are now back to 2014 levels. Slide 20, build up of ERV. Annualized rent is GBP 203.3 million with a further GBP 43.3 million contracted under our leases. In terms of annualized accounting income, after relying on spreading of rent freeze, this is 208.5 million, as shown at the bottom of the chart. All the ERV to the right of this is still to come. On-site developments at 25 Baker Street network, with both complete in 2025, could add GBP 32.4 million to the income. With the PIMCO letting it earlier in the year and Moelis announced today, we are well ahead of target. Available space is 12.1 million, down 30% over the first half, and this fed through to the lower vacancy rate. Overall, the portfolio's ERV is up slightly to GBP 305.6 million even after stripping out disposals, which had an ERV of just under GBP 4 million. Now investment activity Slide 21. We continue to sell less growth properties with GBP 65 million of sales. The main disposal was 19 Charterhouse Street to a family office. Whilst there is refurbishment potential here from 2025, this is relatively a small project. There were no acquisitions. Investment outlook, Slide 22. Investment liquidity this year has been a lot lower than the long-term average with the market in a wait-and-see mode. U.K. lenders have limited appetite for new loans to real estate, giving equity buyers the edge. Consequently, activity is focused on sub-GBP 100 million lots and mainly in the West End. The implications of near-term refinancings are starting to work through the system. We are aware of several short-term loan extensions that have been secured by owners only where there is a clear asset management plan, but banks are being very selective. Anecdotally, the agents are talking about an increase in the number of properties being prepared for sale for H2. As the number of motivated sellers rises over the next 12 months, there should be greater clarity on pricing and potential opportunities for us to buy. And then finally, an update on sustainability. To enable a better focus on our energy performance, we've now rolled out our Intelligent Building technology across 7 buildings. This is about 30% of the portfolio by floor area, and we are collecting meaningful data. This gives us detailed patterns on energy usage. The next step is to use analytics to achieve integrated efficiencies across buildings to produce energy savings. We're pleased how this program is going. In Scotland, we've now received the full consent for our solar park. This could provide about 40% of our electricity used by our managed portfolio in London. This is a great message for our occupiers. It will also take us a step closer to net zero carbon as it will reduce our operational carbon footprint by about 30%. The aim is to be operational in about 18 months. Finally, embodied carbon is an important consideration in all our developments. Both our on-site developments are within the target range of less than 600 kilograms per square meter, and we continue to challenge all the design team on these and work on our future pipeline. Thank you, and now Emily.

Thank you, Nigel, and now to the occupational market, Slide 26. Take-up across London slowed through the first half. Set against this, however, space under offer increased by 50% and businesses are certainly engaged with their longer-term occupational strategies. Demand is strong with a wide variety of different sectors represented. As the flight to quality continues, particularly for larger businesses, pre-lets continue to be an important part of the market, representing nearly 1/3 of space currently under offer. We expect this trend to continue for reasons I'll outline on the next few slides. Slide 27. A key challenge occupiers face is low supply. Overall vacancy across the market is elevated. But as occupier requirements become ever more discerning, an increasing proportion of the available space doesn't make the grade. Availability is not evenly spread. The vacancy rate in the West End is sub-4%, 1/3 of the level in the city and over 1/4 of that in the Docklands. Despite a spike in deliveries in 2023, looking ahead, the development pipeline remains constrained. 45% of the pipeline is already pre-let, only 6.9 million square feet of speculative completions over the next 4 years in Central London. This is equivalent to less than 7 months of supply based on the longer-term take-up levels. A similar shortage can be seen in both the West End and the city. Now looking at occupied strategies on Slide 28. There's been a clear shift in the narrative from employers and leadership teams over the last 6 months. Agile working is here to stay and indeed, forward-thinking businesses had embraced it well before the pandemic. But increasingly, agile working means more time in the office than elsewhere. This slide summarizes press reports on a variety of company's occupational strategies. Importantly, we found little evidence of businesses planning of future with remote-only working practices. A recent report by Knight Frank found that 87% of the 357 global companies it surveyed expect to have an office-centric organizational work style, supporting our own experience that occupiers continue to plan for peak occupancy. As time goes on, the importance of the office environment for a business' culture, its development and training of talent as well as its overall collective productivity is being proven. Now looking at Slide 29. Over the 2 years since COVID, 74% of Central London take-up has been occupiers expanding their floor space. And looking forward, we expect this to continue. Our occupier survey from January found 80% of those surveyed expect their floor space requirements to increase or remain the same over the next 5 years. And Knight Frank had a similar response at 77% of those surveys over the next 3 years. Now turning to our own leasing activity. The first half of 2023 was our second strongest H1 for lettings, with GBP 19.3 million of new rents signed on average, 9% ahead of ERV and with an 11-year average term certain. This included our first major pre-let of 106,000 square feet to PIMCO at 25 Baker Street in February. I'm pleased to say that momentum has carried on into the second half with a further GBP 7 million of new leases signed over the last 6 weeks, 11% ahead of December ERV. 25 Baker Street is now 76% pre-let or presold with Moelis signing up for 50,000 square feet at a healthy 10% to the June ERV. In addition, Featherstone is 70% let with Tide signing up for 15,000 square feet in line with ERV. We also had a successful period for Asset Management, Slide 31, with GBP 11.7 million of reviews, renewals and regears, completing nearly 5% ahead of ERV. Our retention/reletting rate was very strong and at 86% in H1 is back to pre-COVID levels. Combined with new leases, vacancy reduced to 4.5% through the first half from 6.4% at December. We have good visibility on our expiry profile. And as Paul will touch on later, some of those expiries provide great opportunity for good value uplift through refurbishment. Now moving on to our brand and product differentiators. With so much discussion over the last few years around the office, whilst perhaps an obvious statement, it's important to note that not all offices are the same. I therefore want to highlight just some of the key areas, which make us, our buildings and our brand different. We're very confident in our product, which is focused on truly innovative, best-in-class design, tangible customer-focused service and amenity as well as a considered portfolio approach to flex. Our distinctive design-led spaces are focused on the people that occupy them. Through innovative design and high-quality materials, we continually push boundaries to create architecturally striking buildings and workspace. Sustainability is embedded throughout. As you've heard from Nigel, implementation of our Intelligent Buildings program continues across the portfolio, and the occupier market is seeing the value in our integrated portfolio approach in this regard. Now looking at our customer-focused service and amenity, Slide 35. Derwent's offer extends well beyond the bricks and mortar. Customer service and our member approach is integral. Any individual working in our buildings is considered a member with tangible benefits accessible to them, an important factor in attraction and retention. With dedicated customer teams, we maintain strong relationships with our occupiers at all levels. The second of our lounges DL/28 will open this autumn in our Old Street village, following very positive feedback from our occupiers on DL/78. This portfolio immunity is available to and highly valued by both our existing members and potential occupiers. Finally, on flex, Slide 36. We don't take a one-size-fits-all approach to flex, rather we tailor space to meet market demand across the board. Our buildings are designed to be flexible and our long life low carbon approach means space is adaptable to the needs of a diverse range of occupiers. As well as leasing space to third-party serviced office providers, we offer a variety of furnished and flexible workspaces, each designed for the relevant submarket and at the right specification. This extends now to 128,000 square feet. In total, flex accounts for just under 6% of our whole portfolio, in line with the London office market. Now over to Paul on the pipeline.

Thank you, Emily. Turning to our on-site developments on Slide 38. We're on site at 2 major West End projects, which together total 435,000 square feet. At June, our projects as shown attracted 17% profit on cost, up from 11% in December and a 5.9% yield on cost. Of course, this does not factor in the further positive impact of the pre-let Moelis, which was signed in August and a substantial premium to ERV. 25 Baker Street in more detail. The superstructure is going up quickly. The main office block is now up to level 7 and progressing at a rate of a floor every 3 weeks, the private residential block on the left has topped out. We're really pleased with the strength of demand and indicative pricing for the private residential units. As well as being visually appealing, we're also delivering it responsibly by using lower carbon methods of construction and materials. The embodied carbon footprint has been managed down to 600 kilos of carbon per square meter. On completion, we are targeting BREEAM Outstanding and NABERS U.K. rating of 4.5 stars or better. Now you'll now see a short video, which highlights the quality of the space and materials as well as the amenity of this beautiful net zero carbon development. The Hopkins design scheme occupies an eye of the site in the heart of The Portman Estate in Marylebone. It provides a mix of best-in-class office space, much needed new retail and F&B units set in a beautifully landscaped courtyard plus residential. In keeping with a distinctive design approach, the facade will incorporate a range of luxury materials, including poodle stone and precast concrete, which complement the generous rooftop terraces and shared amenity. You can now see why both PIMCO and Moelis have chosen 25 Baker Street for their new headquarters. Now let's turn to network. This PSC design office-led scheme sits in the core of our Fitzrovia village, and is a short walk for the Tottenham Court Road Elizabeth line, one of London's busiest stations. While early days, construction is running on budget and on time with a completion target for H2 2025. Fitzrovia is one of the most supply-constrained submarkets in the West End, giving us confidence in the leasing prospects for this best-in-class building, which also benefits from its close proximity to DL/78. Network is a generous and highly sustainable development designed to provide occupiers with the best black campus on which they can project their brand. The reception provides an impressive double high entrance, combined with a large rooftop terrace and the building has significant immunity. Network has also been designed with sustainability at its core. It will be all electric, and we're targeting a minimum NABERS U.K. rating of 4.5 stars or above and BREEAM outstanding, and our body -- carbon estimate is 530 kilograms of carbon per square meter. Our future development pipeline is well stocked. The next phase of West End projects, which are expected to start from 2024 total 390,000 square feet. 50 Baker Street, our 50-50 joint venture with Lazari Investments will deliver best-in-class office space to the Marylebone submarket, further leasing success at 25 Baker Street opposite. And given the favorable imbalance between demand and supply, we are confident this building will be successful. Our Holden House in Oxford Street, we are finally leasing the refresh of our plans to increase the office content of this heritage building. And of course, in the longer term, our project, Old Street Quarter and 230 Blackfriars Road on the South Bank have potential to deliver nearly 1 million square feet of mix use space that will help continue the regeneration of both submarkets. Now to rolling refurbishments. Derwent has long been recognized for our creative approach to refurbishment. As we outlined with our full year results, refurbishments will form an increased element of our overall CapEx over the coming years. EPC work will be incorporated into broader asset and amenity upgrades to ensure that we deliver sustainable space that appeals to occupiers. As you can see on this slide, we expect this activity to result in substantial rental uplifts. To summarize, London is busy and is expected to continue to deliver attractive long-term growth. The occupational market is strong for the right product. The tight planning and lending environment are causing some developers to first schemes, leading to a muted supply-side response. Combined with an already constrained supply of high-quality space, the level of pre-letting is rising as occupiers become ever more discerning. The office remains central to the vast majority of businesses, and we've seen more occupiers expanding their floor space than contracting. The investment market is expected to remain subdued in the near term as potential investors adopt a wait-and-see approach. We remain opportunistic should attractively priced deals emerge, but do not need to buy given the returns we expect to deliver from existing pipeline. In the West End, supply is tight, development pipeline is more constrained, and there is less leverage. We, therefore, expect a stronger rental growth and more resilient yield outlook over the medium term. Derwent now is a clearly recognizable brand, established through many years of consistent delivery of space that exceeds occupier requirements. In the year-to-date, we have delivered a near-record leasing performance and encouraged by momentum across our business. The macro environment has been impacting sentiment, particularly over the last 12 months with higher inflation and corresponding interest rates leading to yield expansion, but our clear and consistent strategy means we are well positioned with a strong balance sheet and a high-quality portfolio. We're going to take Q&A now. I think we've got some microphones in the room, and then we will move over to the telephone lines on the webcast. So I would like you to take some questions.

Max, Numis. Just on 25 Bakers Street, that's now 75% pre-let, so it's substantially derisked. How do you think about that leasing strategy going forward, given how tight the market is looking? Will you look to pre-let more or hold off until completion to try and get that higher rent?

Well, for my part, I'd like to be a bit greedier. Even greedier, 2025, we're going to see some good rental growth. If someone comes along with a great covenant and is prepared to pay a decent rent. If you just look at the rents that everybody on the team have achieved well ahead of our ERVs, then I think we could hold out if we want to, I think we've got, what 5, 0,000 square feet potentially let. So I think my view is to -- if we got someone who will pay a retail rent, then good. Otherwise, we can afford away. Emily, would you like to add anything to that?

Yes. So we've got the PIMCO option on the fourth floor, which runs until November. So we've got either 25,000 or 50,000 left until that point. But I think if you look at how we've delivered on the lower floors, the option floor is at 95 and the more recent lettings are at 100. So I think we're planning to continue in the same vein and be patient.

Great. And just one other follow-up. On the rolling refurbishments, what's your kind of target yield on cost for that?

That's a very good question. I mean they are rolling refurbishment. So each project would have a different return to really how big it is. Nigel?

I mean our developments are yielding around about 6% before we start progressing rent. So our current level is, I think, 5.9%, but if we achieve some more rental growth, it will probably push above 6%. So you're in that sort of the ballpark. The question really is how much CapEx do these need in terms of repositioning. But most of them have got sort of GBP 20 plus uplift potential in them, which would probably create sort of GBP 600 in value, less CapEx and timing. And they're in exceptional locations, all the cross...

[ Callum Morley from Colytics ]. So just looking at Slide 2 to start with where you kind of comment that renewals and new lettings are being signed at around 8% or high single digits above ERV, but you're still guiding to that 0% to 3% ERV range. Can you comment on why there's a disconnect there, please?

I think, firstly, to make a point, it's an average across the portfolio. And obviously, some of the parts of the portfolio are opportunities for the future. So in some respects, what we will be doing is doing short-term lettings, maybe occasionally be below ERV to keep the income going. So it's an average across the portfolio. And you'll see some outperformance on it. I will take a view that I'd rather be sensible with the outlook rather than be overpromising and we're up, I think, plus 1%. We tend to beat our guidance rather than underperform. And I'd like to continue doing that. I have to say I feel confident about the portfolio. We have sold well, but we've also kept the better assets. And I think if you look at the possible refurbishments, I think they will guide. So I think we're trying to be sensible about where we are on guidance. And I'd say, it's an average valuation of ERV. It's not headline rent. And obviously, you can see the headlines go up quite substantially. Nigel, do you want to add anything to that?

I mean the only thing I'd add is we've got a vacancy rate of what I think it was about 4%. So you're talking about 90-odd percent of the portfolio. So this is GBP 11 million, still a relatively small sample. And the other thing is quite a lot of rent reviews. It's a lot harder to do a rent review than do a letting or if you've got a lease renewal outside the act, you can pay to be a bit tougher on rent views. There's a lot more tech -- it is harder to achieve than if you're letting space in the market.

I think what's also positive is, we'll be keeping the better assets for long. If you look at where the valuation pull forward is compared to this what you could like call a tail, they're already down 1 in a bit percent. And I think again, you'll probably see some good ERV there. But it's a guidance for this year. And obviously, the world has been a little bit unhappy, but we're not unhappy, we're very positive.

I'd probably just -- so those refurbishment opportunities there until you actually do the job on them, the ERVs are going to just probably plateau until you spend the CapEx and drive the rent GBP 40. So the values at the moment are not building that project in until you can sort of commit to it or you have visibility on what the tenant is going to do. So that's probably only that's holding it back then.

That's great. And then just turning to the back, Slide 94, if that's okay. So it's kind of the developments on-site profit on cost. So if you look at the table, I think it's 17% on development, 25% in a good case, what are the profit and costs that you are likely to require new developments going forward, especially given that you're trading at around a 20% discount to GAV and assuming no risk?

Well, we normally use target of sort of 15% profit on cost and something like a development in the order of high 35, 36. Obviously, as at December, valuations have gone down, so your developed returns on sites with it had come down. And if you look at -- but obviously, you could see the effect of a pre-letting. It takes your profit and cost quite substantially. This obviously is pre-Moelis, which will probably add a little bit more few more percent to that. So around the sort of 15% would be enough for us to take off. Damian?

Yes. But we certainly target a minimum of that. We normally find that -- because we're quite cautious in our assumptions, we build in void and a number of others with quite low ERVs. We normally find through the course of the project, those returns improve. And that's one of the things we've demonstrated here today. So when we last sat here in February, we were looking at 11% for these identical projects. Today, we're at 17%. We're probably heading towards 20% after the latest pre-lets. But we like to start with a number we think we can beat.

It's probably just -- these are Knight Frank, our assets valuations. They're not predicting they are December and June numbers, they're not what you think you're going to get in 2 or 3 years' time, so they are as at the time. But as Damian said, progression would normally be beaten the today valuation.

And then one more, if I may. Just assuming you guys saw the news on WeWork yesterday. Kind of what do you make of the news over the medium term and maybe some of the dynamics for traditional landlords over the more flexible shorter lease?

I mean we have flex within our portfolio, and it's doing very well. We've got some partners, people like Ford who do very well. We do our flex advantage where we're getting good premiums. Undoubtedly, it's here to stay. It's always represented about 6% of the market is probably represented a higher percentage of news than 6%. Let's see what happens. Obviously, there's been interesting stories over the years and there are other operators out there. If something happened, obviously, the occupiers there would have to find new space. But what's interesting for us and supports our variation is we're getting decent, long leases, 15-year leases at our new developments. And I think they have some values, so we're going to have a range of things. So we'll have to wait to see. I think London has got a variety of flex operators. And we'll have to see. Undoubtedly, we will have some headlines. But for us, we're letting well for our best space.

We don't have WeWork.

We don't have them in our portfolio and never have.

Ben Richard from SocGen. Just you're seeing potential for acquisition opportunities, if I understand right, in the coming year or 2? What might we expect there? What sort of return requirements have you got for those, just in terms of modeling perspective, what might we expect?

It's only just starting. There's 2 or 3 builders on the market that have come through in distress actually. One of them is a WeWork building where the lease is being torn up. So I think it's very early days at the moment, but it's the start of the process of more stuff coming out. I mean, ideally I would like to buy our traditional stuff like a Blackfriars where it's 60,000 square feet now, and you can potentially go to 200,000. That may be 3 or 4 years' time of -- but that's what we'd love to buy, quite hard to find, but we have done it in the past, and we'll keep our eye open.

We obviously have capacity. But obviously, we've got a big pipeline as well, which we're very excited about. I think we spent, what, GBP 200 million a year, Damian.

Yes. This is a time to have a good strong balance sheet as well. We won't get carried away and go on a spending spree. I think there is opportunity emerging, possibly even more so than years than today. So we're looking, we're always interested, we're not in a rush. We're confident we will find very interesting opportunities over the next 18 months or so.

So just a follow-up to that. What would be a sort of upper limit for loan to value that you'd be prepared to push to?

That's always an interesting question. We're at 25% today. We don't really want to go much into the 30s. I think 30% would be a level at which we would be starting to get concerned. We've always had a recycling business model. I think you saw on one of the slides. We sold about GBP 900 million in the last 5 years. Now obviously, the markets are slightly slower at the moment, but you can expect us to be selling quite a bit over the next 5 years. As you sell more, you can then potentially buy more. And our product has always been in high demand. So as we come through this cycle, the longer leases that we're now creating create good value. The market will return for that product. And that will enable us then to restock for the future.

And just one final question on the sort of bifurcation in the market. You're obviously well positioned locationally for a strong market, tight market in the West End. How do you see the ERVs diverging, say, your West End versus non-West End? Might we see ERVs declining for the non-West End buckets, whilst ERVs grow in the West End, is that plausible?

Well, I mean, I'll make a point then I'll pass it over to Emily. Obviously, we're very delighted to let the available space at Featherstone, but it was in line with ERV. And currently that market has been a little bit more difficult. But it's a great product, and we're a great believer in the area. Obviously, the West End, which is a lot tighter market, well, achieving double digits above the ERV. So I suspect the declines will be more likely further East should go in London from the rather West. Emily, do you want to add to that?

Yes. I think it's more the periphery locations that we're likely to see decline. I think the supply shortage is both West End and city. Some of the big houses, Knight Frank yesterday, and others have increased their rental growth forecast in both city and West End. I think 5% in the West End and 3% in the city yesterday. So I think from a core East and West, we're anticipating growth, perhaps quicker though, in the West End, where the supply is there a bit tighter.

Neil Green from JPMorgan. Just one really. Obviously, the big 2 developments at 25 Baker Street and Network, both complete in 2025 and the comments you made around Fitzrovia being quite a supply-constrained market. Just interested to get your take on whether you've had the incoming on that work already from potential leasing perspective, please?

Yes. So I think the key difference, even though the timing is similar there sort of 6 months apart is the size of the floor space, so networks around 17,000 square feet versus 25,000 square feet. So yes, we've had some early approaches, earlier discussions, nothing concrete yet, but I suspect over the next year, it's very limited supply in Fitzrovia. So watch the space.

I think we're well covered. But again, is H2 2025, market's going to be improving. If some comes along, pays a decent rent, great. But we're very confident. If I suspect, but you may correct me, Emily, we'll be above than that.

Yes, we're anticipating we'll be more than that.

Any other questions? Have we got any questions on the telephone?

[Operator Instructions] We have a question from the line of Paul Gori from CTI.

I just want to follow up on the recoverable cost overruns. I appreciate that you've included a slide on it, which is really helpful. But given the impact, it's kind of so immaterial and someone might missing. I think we need to sort of make sure I understand it completely. It sounded like the drivers were the increased energy costs and there's change in vacancy. But if I look at the first half of this year versus the second half of last year, I think EPRA vacancy was down 200 basis points. And obviously, the energy cost kind of peaked around August, September last year. So I'm trying to understand why the first half this year would be so much more than the second half last year. Can you just sort of square that circle for me?

If you look at the slide on Page 11, if you look at the void cost itself, it's actually lower in the first half of this year than it was in the second half of last year. It's actually an average vacancy rate, not the end or the beginning of the period. So the average vacancy rate through H1 was about 2% higher than it was through H1 '22. The vacancy rate was actually pretty high also in the second half of '22. So you've seen the vacancy costs come down a bit. We have had this very exceptional period of very high energy costs, and that was really through the winter. Service charges have come down in March. But in the first quarter of this year, we did hit some caps. And you'll see that there was quite a big spike, in case we don't have many capped service charges out there. But when we had these exceptional energy costs, they pushed us over those caps. That figure should come right down in the second half. And then we've got this rather unusual the balancing service charges. Again, this was mainly due to exceptional costs coming through from last year. As we end the service charge years and then reconcile the service charges, they're all audited. There's then a balancing charge or a balancing allowance paid back off or collected from tenants. And again, when you got an slightly elevated vacancy rate, some of that comes back to us. So again, you've got this rather unusual situation. It's the combination of a higher-than-average vacancy rate and these rather exceptional energy costs. So we're expecting those figures to come back quite nicely in H2. I hope that answers the question.

That's very clear, Damian. Just a quick follow-up would be on the cap service charges. Again, I didn't know that was the thing. Do you know what roughly percentage of the service charges? Is it a very small portion? Or is this a fairly standard?

I mean there are 2 aspects of this. First of all, is how many of our leases have got cap service charges. The answer is around about 10%. The next thing is where is the cap. If the cap is double the service charge, it's not likely to hit you. If it's around about the sales charge, you might get some impact. And the caps do vary quite a lot. We don't advertise cap service charges as one of our amenities, but it is something which sometimes, particularly in older buildings, tenants do require.

I think the one in Stephen Street, which we inherited when we bought the building. But that -- when the tenant leaves that, it will be get refurbished.

Yes, Stephen Street and Farringdon Road are the 2 bigger ones. We have seen a very odd period where energy costs literally tripled. And that gave rise to some very high service charge demands through the winter. We're now back to much lower energy costs again. So we shouldn't see that unless there's another spike in energy costs.

Have we got any further questions? Robbie?

So we've got one question on the webcast from Andrew Saunders of Shore Capital, which is, to what extent will further disposals support future development as opposed to drawing more debt?

I mean I can answer that. Obviously, the short term, we do fund the development pipeline with debt. I think our history shows very clearly that this is a recycling business model. It always has been. We managed to sell usually roughly between GBP 100 million and GBP 300 million a year, roughly an average of GBP 200 million. Our CapEx is around about GBP 200 million a year, maybe a little less. The business retains cash of about GBP 50 million a year after paying payment of the dividend. So we have a net funding requirement, if we stand still on debt of about GBP 150 million of sales net. So that gives us quite a bit of flexibility. We've already sold GBP 65 million this year. We shall see what happens in the second half. We've got a couple of interesting buildings out there, which I know would be very attractive. So I think in the short term, we're probably fine with a bit of debt. In the medium to long term, the recycling business model is here to stay.

I think that's it. Thank you very much, indeed, for everyone attending. Thank you for those that listened to it. The team is around today, if anyone got any follow-up questions. Thank you again for your attendance. For those who are off on some holidays, have a nice time. And stay in touch, please. Thank you very much.