Derwent London Plc (DLN) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Derwent London Q1 2024 Business Update. My name is Dhavan, and I will be the operator for your call this morning. [Operator Instructions]. I will now hand you over to Paul Williams, Chief Executive.

Thank you very much. Good morning, and welcome to the Derwent London Q1 2024 business update. I'm delighted to say that the momentum in the occupational market that we highlighted with our year-end results is increasing. Since the start of 2024, we've agreed GBP 5.4 million of new leases, and there was a further GBP 4.3 million of rent under offer. On average, the rental new leases in Q1 was at a premium of 9.2% to ERV, with an average lease term to break of 7.4 years. The flight to quality, particularly for our own product continues. In total, 58% of the space we had available to let at the end of 2023 is either being leased or is under offer. I'm also very pleased to announce that we signed a third pre-let at 25 Baker Street. Cushman & Wakefield is taken just over 17,000 square feet on the first floor, reflecting the quality of the space, it significant occupier appeal and following the other pre-lets to PIMCO and Moelis at a rent of GBP 1.8 million of year equates to GBP 107.50 per square foot and is 19% ahead of ERV, providing a further boost to the project's yield on cost. One Oxford Street, UNIQLO, has now opened and is proving a great anchor for the epicenter Oxford Street. Starbucks is also leased one of the retail units, leaving only the 2 smaller retail units available. I'm encouraged by the level of development with detailed negotiations ongoing. Letting activity is well spread across the portfolio with the easing of significant pickup. At the White Chapel Building, for example, where demand has been slowed since the pandemic, activity levels have increased noticeably. Since the start of the year, 116,000 square feet has been leased or is under offer, including PLP Architecture who have taken 22,000 square feet, on 10-year lease at GBP 50 a square foot. Our portfolio appeals to a broad range of occupiers, including those who are more cost conscious, yet still require high-quality space with good amenity and transport connections in lower rental locations. Overall, our EPRA vacancy rate was reduced to 3.7% at 31st of March from down from 4% at year-end. Market vacancy rates were stable in Q1 with the West End tight. The investment market has remained subdued, but we were pleased to sell Turnmill for GBP 77.4 million, 3% ahead of the December's book value, proceeds due later in Q2. Our on-site developments are both in the West End, where the supply demand in balance is greatest. 25 Baker Street façade works are making good progress. The main office building is now 84% pre-let on rent, averaging 15% above the appraisal of ERV. In addition, we have exchanged contracts for the sale of 9 of the 41 private residential units with a combined price of GBP 54 million, comprised of 30% as a total residential area. This reflects a value of GBP 3,920 per square foot, which is significantly higher than the appraisal valuation. At network, super-structure works have commenced with some 80 months to go until completion. We are in discussion with several potential pre-lets and are very confident in the prospects of this mighty rich best-in-class office building. We're also continuing to prepare for our next phase of West End development at 50 Baker Street at Holden House, which together totaled 390,000 square feet. Turning to the financials. Our balance sheet remains very well placed and our gearing this month is the lowest in the U.K. REIT sector with an LTV of just 28%. Project expenditure of GBP 54 million in the quarter was the main driver of the modest increase in net debt to GBP 1.4 billion. Our transit team has made good progress on our replacement facility for the GBP 83 million secured loan, which matures in October with terms already agreed. In summary, with our full year results, we upgraded our rental growth forecast for 2024 to plus 2% to plus 5%. Our leasing activity underpins this forecast alongside the increasing strength of the occupational market for well-located buildings with the right ability. Rental growth is further supported by the shortage of existing supply and constrained market pipeline. We have a strong balance sheet and a regeneration pipeline, we expect, will deliver attractive returns. We are well positioned to benefit from these trends. Thank you. I will now hand back to the operator for any questions.

[Operator Instructions]. The first question is from the line of [indiscernible].

3 quick questions, please. First one, just on the disposal you did, noted 4.9% net yield. Can you just remind us quickly of where yield on costs and development margins sit at Baker Street and Network 1 connects.

So just looking at that information for you. Sorry, yield on cost, Robbie?

5.8.

5.8%.

Got you. Second question, long term, just looking at your vacancy numbers. And as we think about them going forward, do you expect the trends in Baker Street continue to down to 1% from its pre-COVID level? Or is this kind of 3% the new normal?

Well, obviously, we're -- a very active portfolio. Our vacancy rate, I mean, around 4%, I think, is very good. But obviously, from time to time, we will refurbish space or we will take better space to upgrade. So I think it's been in a good place sometime. Obviously, what sort of interest to us also is the vacancy rate in our core areas, so that we -- obviously, with supply is so constrained, for vacancy, particularly in the West End. So for us, that really good strong demand in a constrained market. But this is a very active portfolio. We take space back occasionally to reposition, et cetera. But I would expect the vacancy rate to remain in a very good place over the next couple of years.

Brilliant. And last one, just over the last 2 years, maybe you're moving your portfolio away from the city more towards the West End. I think the breakdown might be something like 75%, 25% now. What is your long-term view on that portfolio ranging? And then as a follow-up, what is your investment view on the London City market today, given that valuations have replaced quite a bit and prime buildings have already been quite a bit more attractive.

That's a very good question. I think first of all -- firstly, we very much like our clusters. And I think West End has performed very well over many, many decades. And I think having a percentage of circa 70% in the West End is very good, particularly, as I say, about 70% of the West End is either listed or is unavailable to redevelop very high. So with those dynamics from a planning point of view, where you can secure planning commissions that we have done for our developments, there's a sort of limited supply, and therefore, good rental growth prospects. So I think the West End has always been tight and I think will remain so. Historically, we haven't really invested in the city. We've very much done very well with our sort of Northern French, whatever you want to call it or the city borders. The White Chapel area has picked up, as I said earlier, but also if you look at [indiscernible], et cetera. So I think those areas will remain pretty important to us. If we found a building of interest in the city at a good price, the way we could have that sort of do it special dust, and I think we would consider it. But that's a market with a much higher vacancy rate, I think, a much higher level of secondary space available there. So I think the market dynamics there is very different. So I would rule it out, but you could rule out that we're not going to go further east in that. I think we're going to have to stay in a central locations because as we've seen over the last couple of years, people are prepared to pay a very good premium rent to be in Central London locations. You see that in West End. You've seen also some good deals in the city. So I think we're going to remain focused in our core areas of the West End about 70% plus our city borders. But also if there's something interesting came up, we would certainly consider it.

The next question comes from the line of Tom Musson with Goldman Sachs.

Just a couple of questions. Firstly, at 25 Baker Street, if you adjust for the lease incentives, how does the net effective rent you secured from Cushman compared to that of the PIMCO and Moelis deals. Just want to get a sense of whether you've seen as much progression there on the net effective as you have at the headline level as you pre-let that building?

Good question. Firstly, interesting, Cushman & Wakefield is 15-year lease. So the actual level of rent-free period will be higher, but a proportion of its rent will be very much in line with that. And I think you could even normally assume something around 20%. The market will probably be about 36 months of the 15-year lease. The rent-free period you've given to Cushman is slightly lower than that. So we've done well on that, but rent-frees still remain around about 20%. So a little bit lower than the market, but probably [ Green Finance ] is relatively in line. But headline rents, as I say, 19% above, and it was very good to secure such a long lease and that's what we're finding quite interesting and people for top-quality space. So we're very happy to consider decent long leases and our [indiscernible] is in a great place. I think you had a second question.

Yes. No, that's helpful. Second one was on Network W1. I think you previously mentioned you were happy to wait a little before pre-letting anything there to let ERVs grow. It seems from your comments like there is gathering interest in that space. What is your latest thinking there now around the pre-let? Do you think we could expect something this year? Or should we be thinking more along the lines of 2025 for that somewhere closer to PC?

Well, I think momentum is very much building up in its demand. We have really been marketing. It doesn't finish until H2 2025. And so that's what, 18 months away and that's when you would normally expect to sort of start seeing some interest. So as I said in the statement, we've got ultimate interest in the asset. And I think the position we need to make is who do we show with and all the rest of it. But I would very much hope that we will be getting a good retail rent rather than a discounted rent for -- as we see rents grow. So I would hope that you would have some good news this year rather than next year. I don't think -- I think that we'll take the view of, someone in the market or in the shop to buy, make sure they sure at a proper price. So we are very encouraged by the level of interest we've got, and we've got multiple discussions and one would hope that we could make some sort of announcement later this year. But with the vacancy rate as low as it is, but having 84% pre-let Baker Street, I'm in a position to make some choices. And we would encourage people to transacted this, but we want to make sure we get good returns.

We have the next question from the line of Paul May with Barclays.

A couple of questions in Turnmill initially for me. Just wondered if you can give some guidance as to the write-down from peak values. Secondly, were you in discussions at the year-end? And what was the write-down in the asset in the second half or over the whole of last year? And can you give any guidance on the equivalent yield or the reversion potential in the asset for the rent review next year? Appreciate you saw at a 4.9% initial yield, which is higher than your portfolio -- the rest of the portfolio. I'm just wondering how the reversion is expected to go next year?

Well, obviously, turning to the question about Turnmill, it obviously came down a value in '23. Other parts of the market has done. I mean, I think, first, if you look at the initial yield, 4.9%, sub-5%, I think most people have been telling us that's a very, very, strong growth. It came down double-digit, Nigel, probably?

Yes. Yes. I mean all the portfolios, I probably have -- I think 3, 6 months of valuation declines. Last year, we were down 10% overall in the 6 months, previously 18%. So overall, the portfolio is down about 18%, and that's probably where...

Make it clear, Paul, we weren't looking to sell this building. We're not -- it's someone approach to us off market. And so our view about what the approach was, yes, but it has to be decent price. So I think we were very happy to be booked. I mean book is -- as you know, the portfolio is probably twice a year independently. The book value is what they gave us at that year-end. But I should say -- could you provide me of your second question? Your line is [ not clear ] by the way.

I was just trying to get a sense on the reversion potential. I think it's due for a rent review next year. So wondering what the 4.9% could become next year?

What is review for rent? I mean, obviously, rent review is -- they're always done on a -- get down to a net effective rent. So they're always as positive. But I would say on reversing yield loan fights right? I mean, we wish to purchase it well. But I think from our point of view, we saw a little rental growth on the rent review. And as I say, we're happy to sell it at sub-5%. And we got where the recycling model get about GBP 80 million back into the business to reinvest elsewhere is a good business. I would say low price.

And then just a separate question on costs, if that's possible. I appreciate cost ratio is relatively high. I understand why given the development-led model of the business. Is there any thought process around trying to bring that down through either increased scale and operational leverage in order to drive a greater income return for investors.

You mean our overall cost rather construction cost.

Yes, yes, overall cost. The cost ratio of the business.

So obviously, we're always mindful of the cost ratio. Our corporate -- EPRA cost ratio is at 28% which is a lot lower than others. And obviously, when you've got to scale, you see more business. In respect the business, obviously, the bigger the business, hopefully below the ratio. And if we could grow the business, we would certainly look to do that, but not to reveal as such.

Paul, this is a Q1 update. We don't provide any further figures. I can tell you that last year's figures, you all noticed, they were elevated by the unexpected high energy costs that we saw through last year. We haven't disclosed any figures in Q1. We'll do that at the half year. But I can tell you, our cost ratio is down in Q1 compared to last year, but we're not disclosing those figures at this day.

Thank you. Ladies and gentlemen, we do have a web questions at this time.

Good.

So we got 2 questions. The first is from Adam Shapton at Green Street is the furnished and flexible ERV beat at 19.8% against the specific first and flexible ERV or is it based on the ERV of normal fix at please?

I will pass it to Emily to answer.

Yes. The uplift that we refer to that is against an already elevated furnished and flexible ERV and is a net figure after any additional cost.

And then the second question is from Zach Gauge at UBS and it is, how is the GBP 50 per square foot letting on the White Chapel Building's PLP compared to the ERV?

And that one is just marginally but it's about 5.3% above ERV with 4,750. So in that marketplace, a good level of rent for that deal.

I think it's very good rent. Good to see a good tenure lease again. So it's interesting to see how that market's picked up. I think we're -- I think that's the end of questions on the web. We got any more questions online?

We do not have any further questions on the audio.

Well -- and I just say thank you very much listening in today. We're very busy. We're encouraged by the active demand across the whole of our portfolio, getting ready for our next phase of development. If you -- any of you guys have got any further questions you'd like to raise, Robbie and the team, rest of us around later today. And obviously, we look forward to catching up fully in terms of beginning of August. And so have a good day, this lovely sunny weather. Take care, everyone.