DEXUS (DXS) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Dexus 2020 Annual Results Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Darren Steinberg, Chief Executive Officer. Please go ahead.

Good morning, everyone, and thanks for joining us for our 2020 full year results presentation. Firstly, I hope you're all well. We appreciate you taking the time to join us today, and we look forward to speaking with as many of you as we can over the coming days and weeks. We are certainly in interesting times. It was only 6 months ago that here in Australia we were dealing with the devastation caused by the bushfires and the smoke haze in our East Coast CBDs. Now we're in the midst of a pandemic, which is impacting all businesses, big and small. Before I start, I'd like to acknowledge and thank our people. They've done an excellent job in adapting to a new normal, whether it be working in the office, at home or on-site at our properties. And pleasingly, we had about 250 people in the office here in Sydney yesterday. Their professional approach has ensured the health, safety and well-being of our customers and visitors to our buildings, which is our #1 priority. Today, you will hear from Alison on the financials; Kevin covering our office business; Deb on our funds management business; Stewart talking to our industrial business; and Ross providing a development and investments update. And as usual, we'll finish with questions. Looking at the result for the year. And despite the challenges caused by COVID-19 having an adverse impact on our financial result and share price, we continued to progress our strategic objectives and delivered some solid operational achievements for the year. Importantly, we were able to deliver a distribution in the second half, resulting in the full year distribution being in line with last year. Alison will cover the details of our rent collection, but the key takeaway is that we have been successful in collecting rent. We strengthened our relationships with our funds management partners, delivering on their investment mandates and establishing a new fund. We've made great progress on city-shaping development projects in Sydney, Melbourne and Brisbane. And we improved our portfolio composition through asset recycling, divesting noncore and lower returning assets. From a strategic perspective, we continued our track record of delivering on strategy. The pandemic hasn't changed our view on the growing megatrend of urbanization. Dexus is an investment in Australian cities and investing in high-quality real estate in Australia's major cities remains a key element of this strategy. The office portfolio is outperforming its benchmark and has maintained high occupancy. We have strong customer relationships as demonstrated in our customer Net Promoter Score. Our future projects in our development pipeline, which are currently uncommitted, set us up to deliver long-term value beyond the recovery period for both Dexus and our third-party capital partners. Our diversified funds management business is performing, continues to attract interest from new capital and is a key partner for us in major projects. Finally, we've delivered on our ambitious sustainability targets, which build on the progress we've made over the past 10 years. And the scenario analysis we undertook this year will be beneficial to our business. As I said before, these achievements are underpinned by our strong balance sheet and disciplined approach to capital management. I'll now hand you over to Alison.

Thanks, Darren, and good morning, everyone. As you would expect, we have seen a change in our results due to the impact of COVID-19, particularly in the last quarter. As the pandemic unfolded, maintaining the strength of our balance sheet was a key priority. And our cost base came firmly into focus to offset the macro impacts of COVID-19 and to be able to protect the sustainable financial position of our business. Rent relief, as determined by the federal government's code of conduct, played a big part in terms of the impact to our financials for the year but also allowed us to actively support the viability of our small business customers most affected by the crisis. We withdrew our full year guidance for distribution per security growth and the associated assumptions in late March 2020 due to the uncertain environment. But pleasingly, we're able to reinstate revised guidance at the start of June following further clarity on rental collections and cash flow. As Darren mentioned, delivering a distribution was an achievement and we recognize the importance of this to our investors. Turning to the composition of the result. Our property portfolio delivered AFFO of $615.9 million. And a key highlight was like-for-like income growth of 2.4% across the office portfolio, which includes the impact of rent relief and the provision for expected credit losses. Our management business generated FFO of $71.5 million, up significantly from FY '19 on the back of increased contributions from funds management, property and development management and also benefiting from some nonrecurring cost savings. And we delivered trading profits of $35.3 million net of tax, in line with last year. Valuation increases of $612.4 million across the total portfolio were up 3.9% on prior book values, with the valuations reflecting the independent views of valuers across our portfolio. The valuation results at 30 June 2020 followed the strong portfolio of valuation uplift of $724.4 million recorded at 31 December 2019, demonstrating the quality of our property portfolios in this uncertain environment. Our portfolio weighted average cap rates now stand at 4.97% for office and 5.66% for industrial. Over the next 12 months, we expect quality asset values to remain resilient, with some impact from softer assumptions relating to rental growth, incentives and downtime. Looking now at the key financial metrics in further detail. Rent relief measures had a significant impact on AFFO and distribution per security. Office property FFO increased, enhanced by fixed rental increases, development completions and the acquisitions of 80 Collins Street in Melbourne and the remaining interest in MLC Centre in Sydney but were partly offset by rent relief measures. Industrial property FFO reduced due to the divestment of the second tranche of the DALT portfolio and rent relief measures. Net finance costs rose as we ceased capitalizing interest at key development projects. Underlying FFO per security increased by 1%, and NTA per security increased by 3.6%. Our focus on delivering sustained value source achieved distribution and AFFO per security of $0.503, which was consistent with last year and in line with the revised guidance provided at the beginning of June. Turning to rent collections and rent relief. We felt it was important to clearly articulate our position and the COVID-19 impact on our original guidance. For FY '20, we collected 98% of rent across the total portfolio and in the last quarter of the year collected 92%, which enabled us to have sufficient cash flow to pay a second half distribution. However, the FY '20 distribution per security was impacted negatively by 6.6% due to COVID-related direct and indirect impacts. Around 70% of this or $26 million related to direct impacts, including estimated rent relief at 30 June 2020 of $19.2 million as well as a provision for expected credit losses of $6.8 million, with the remainder being indirect impacts relating to opportunities forgone due to the onset of COVID-19. Our initial response included a number of cost savings measures, including annual leave initiatives, a freeze on recruitment and nonessential consultancy spend and temporary reductions in remuneration, which resulted in nonrecurring cost savings of 2.1% of distribution per security growth. Moving on to capital management. We maintained a strong and conservative balance sheet with pro forma look-through gearing of 24.3%, which was below the target range of 30% to 40%. We sourced additional liquidity, including $700 million medium-term notes and bank debt facilities totaling more than $1.1 billion. We divested properties, providing us with enhanced liquidity, and Ross will cover off shortly on our continued focus on selective asset recycling over the near term. To strengthen our debt profile, we increased debt duration to 6.9 years and diversified our funding sources. We have circa $300 million of debt expiries in late FY '21 and limited current development commitments of circa $180 million to the end of FY '22. We continue to retain strong credit ratings, and the strength of our balance sheet provides capacity to fund projects in the current and future development pipeline. Thank you, and I will now pass you on to Kevin to cover the office business performance.

Thanks, Alison, and good morning, everyone. Today, I'll share insights on how the portfolio is performing and our thoughts on the evolution of the workplace. Our inquiry volumes in the third quarter of the financial year, which was before the restriction measures were put in place, exceeded the peak period in 2018, and this is consistent with data from our major agency partners. The silver lining for the market is that corporate Australia was in good shape prior to COVID-19. All business is impacted by pandemic, as Darren mentioned, and we are pleased to be able to support our small business customers through rent relief. Our portfolio is performing well, leading to the crisis with high occupancy and significant leasing success, including 80 Collins Street, which achieved record rents and set new benchmarks for the Melbourne CBD. Inquiry volumes plummeted in April but have slowly been improving since, with the exception of Melbourne, which dropped again following the announcement of strict lockdown measures. Many companies, particularly financial services in Sydney, are looking to take advantage of softer conditions and seeking to upgrade to higher-quality space. Our response to COVID-19 has involved significant effort from our property and finance teams. The assessment and provision of rent relief takes considerable time, and we continue to work on finalizing agreements with those most impacted. From an operations perspective, as Darren mentioned, our immediate priority has been to ensure the health and safety of people in our buildings. Our property management teams mobilized quickly to ensure our buildings supported safe operations at each phase of restrictions. We've also taken an active role in helping Australian businesses return to their offices in a safe manner by working with the authorities on lift capacities, reopening end-of-trip facilities and working with our food and service retailers to create COVID-safe environments in each asset. The full year office portfolio performance was solid but clearly impacted by the last quarter. We leased around 88,000 square meters, with 65% of deals done in our Sydney portfolio. Occupancy remains high at 96.5%, with a decrease from FY '19, which was largely due to expiries in Sydney and Brisbane, and 11 deals across circa 3,700 square meters not proceeding as a result of COVID-19. Notwithstanding the difficult leasing environment, we were able to complete some leasing deals in April and May, including a new lease with an international bank at MLC Centre and a new lease at 2 Dawn Fraser Avenue and Sydney Olympic Park. Our weighted average lease expiry decreased slightly, while average portfolio incentives increased to 17.1% driven by deals in Brisbane and Perth. As Alison mentioned, like-for-like income growth was 2.4%, impacted by rent relief measures and a provision against a proportion of rent deferrals. The portfolio achieved a 1-year total return of 7.5% at 30 June and continued to outperform the PCA/MSCI office benchmark at 31 March over 1, 3 and 5 years. Turning to our office portfolio expiry profile. We are working to limit our expiries in the near term to 13% of portfolio income in any 1 year. A number of our FY '21 and '22 expiries are in Sydney, and we expect that vacancy will increase in the near term as a result of relocations from 123 Albert Street in Brisbane and 60 Castlereagh Street in Sydney. Our focus is on retaining occupancy above the market benchmark as we have done in past years. But with occupier demand expected to be soft in the short term, we need to strike the balance between maximizing occupancy and striking deals that don't diminish our performance when the market improves. Most of us have now spent a period of time working from home. Many won't have done that before. Most of us have found a way to make it work, that we are all aware of its limitations. Our customers have engaged in flexible work practices for some time and are likely to experiment with new workplace models in the short term as they seek to understand and optimize the physical and virtual workplace. What's become apparent though, through our customer surveys and direct feedback, is that the physical workplace is a key driver of business productivity through the role it plays in facilitating culture, collaboration and innovation. Hiring and training were cited as being less effective when people are not physically together, and we also know it's difficult to schedule innovation via virtual interaction and the new ideas and ways of doing things are sprouted more effectively in person. Already, we're seeing examples in key gateway cities where leading companies are making long-term property decisions and investing significantly more in their workplace to optimize their performance. In Manhattan, 2 new office developments have benefited. Facebook has committed to 68,000 square meters for their new East Coast base, and AIG has committed to 35,000 square meters for their new office. In London, Baker McKenzie has committed to 14,000 square meters. And here in Sydney, Atlassian will occupy 55,000 square meters at their new headquarters in Sydney's Tech Central. The current situation is a real opportunity for Dexus as business looks at how to manage a desire by their staff for more flexible work practices. Flexibility is something not new to us. Focusing on this issue for our customers has underpinned our leasing and portfolio performance. We have been evolving our office business model for many years to provide products and services that support more flexible and productive workplaces, as you've seen through our investments in Dexus Place and SuiteX. We're also well positioned to increase our scale in these products as opportunities open up. Our goal is to provide a seamless experience and make things simple and easy for our customers. And we're proving to be a valuable work space partner by helping our customers reimagine their workplace strategies through our consulting team, Six Ideas by Dexus. With Australia in recession, we can expect subdued tenant demand and higher vacancy rates in our core office markets for the year ahead. The office sector is cyclical, and periods of weak net absorption are not unusual. Typically, short periods of contraction are followed by longer periods of expansion, and we expect this cycle to be no different. In times like this, high-quality assets can be expected to hold their value better than lower quality assets due to the appeal to both occupants and investors. As I mentioned earlier, we're starting to see early signs of a flight to quality, which will mean that better space will lease first. With prime grade representing 94% of our office portfolio, we're well positioned to lead into the recovery. Thank you. Deb will now take you through the funds business.

Thanks, Kevin, and good morning, everyone. Our funds management business has successfully delivered on its strategic objectives this year, growing our partnerships and launching new funds. We have built a trusted platform with strong governance and strategic and transactional capabilities across office, industrial, retail and health care sectors for our existing partners. And we continue to assess opportunities for domestic and international capital seeking to invest in Australian property. In the current environment, we are focused on delivering performance and navigating unprecedented market conditions for our capital partners while accelerating the expansion of our funds management platform, including through a series of opportunity funds commencing with the Dexus Real Estate Partnership 1, which we announced yesterday. Taking a closer look at our funds management business. We have built a $15.5 billion business with 77 investor relationships, raising circa $955 million of new equity in FY '20. Our diversified funds management platform includes 7 vehicles across office, industrial, retail and health care sectors. And our funds management business provides Dexus with a steady income stream and access to a diverse range of capital sources, enhancing our ability to invest in opportunities alongside like-minded partners and to deliver on our strategy through the cycle. The Dexus Wholesale Property Fund, or DWPF, is our market-leading wholesale diversified fund that continues to outperform its benchmark. A global leader in sustainability and governance, the fund aims to improve futures through real estate investment. Responding to market conditions, we have been active in changing the composition of the fund's portfolio over the past 3 years, increasing exposure to office, high-quality industrial and down-weighting retail. We are focused on ensuring the fund continues to outperform over the long term and leverage its value-creating $1.9 billion development pipeline. Performance has been key for our investors in this fund, and it is pleasing to see the continued outperformance to the benchmark at 30 June even in these unusual times. Health care is an attractive asset class in a growing sector with exceptional long-term potential, and our Healthcare Wholesale Property Fund, HWPF, continues to attract strong investor appetite. HWPF has a high-quality, sustainably oriented portfolio and the ability to satisfy unlisted investor interest through a significant pipeline of opportunities. The fund has increased to over $650 million, attracting $80 million in new equity and has grown through the acquisition of high-quality assets in Adelaide, Sydney and Brisbane. The fund continues to deliver strong performance, achieving a 1-year return of 10.9% and has delivered a return since inception of 9.2%. Our focus is on executing the pipeline acquisitions and completing the North Shore Health Hub Dexus development while remaining active in the market. Turning to the other funds on the platform. We've leveraged our existing partnerships to execute growth initiatives through a combination of acquisitions and developments. The Dexus Australian Logistics Trust is a fund that has continued to deliver on its investment strategy, acquiring 8 high-quality properties in Sydney and Melbourne post 30 June. We'll continue to grow this fund through actively acquiring and activating its development pipeline. Our other industrial fund, the Dexus Industrial Partnership, has an active acquisition mandate and has leveraged the platform to grow the funds under management. The Dexus Australian Commercial Trust was established this year in joint venture with existing fund partner, GIC, to acquire the 50% joint interest in Rialto Towers. We'll continue to leverage Dexus' capabilities to drive performance in this iconic Melbourne asset. And the Dexus Office Partnership continued to outperform against its benchmark over 1, 3 and 5 years. This partnership has a $2.9 billion pipeline of city-shaping office developments in partnership with Dexus, which Ross will talk to shortly. And finally, as mentioned earlier, we have launched the Dexus Real Estate Partnership 1 with Dexus having an ownership interest. This is the first in a planned series of opportunity funds that will diversify our funds management business by investment type and capital source. Thanks, and I'll hand over to Stewart to cover the industrial platform.

Thanks, Deb, and good morning, everyone. Dexus manages a $5 billion industrial business with a $2.2 billion portfolio held on balance sheet. As Ross will take you through shortly, we have around $900 million of development projects that we are building out alongside our third-party capital partners. We continue to enhance the portfolio with quality of well leased assets through developments and selective acquisitions. The portfolio is continuing to benefit from an uptick in logistics and e-commerce demand as well as sectors that have experienced growth during the crisis, such as essential services, food and beverage, data centers, cold storage and pharmaceuticals. Looking at the industrial portfolio metrics. We leased 181,500 square meters of industrial space across 95 transactions in FY '20. Occupancy remained strong at 95.6%, yet this is a decline of 1.4% on FY '19 due to vacancy at Axxess Corporate Park. The weighted average lease expiry reduced slightly on FY '19 being 4.1 years for FY '20. Effective like-for-like income was down 2.1%, impacted by Axxess Corporate Park, rent relief measures and provisions. We delivered a 1-year total return of 11.8% at 30th of June, and the portfolio is outperforming the PCA and MSCI industrial benchmarks over the 1-, 3- and 5-year time periods to 31 March. I'll now hand you to Ross to run through our development pipeline.

Thanks, Stewart, and good morning, everyone. Notwithstanding the current uncertainty, it really is an exciting time for our development business. We're making great progress on our significant pipeline of projects, including Central Place here in Sydney, which is shown on the slide. This project, which we own a 50% interest through the Dexus Office Partnership, had its state significant planning proposal approved last week. This approval secures development rights of over 150,000 square meters of GFA across the combined site with our co-owners, Frasers. This is the gateway site for the state's tech and innovation precinct and will be a project that will transform the Southern CBD. Development is a key way in which we look to drive performance in the portfolio and to grow our funds business, and you can see that in the completions this year. We completed over $1.1 billion of projects. These included the repositioning of 240 St Georges Terrace, overseeing the development of the $355 million Calvary Adelaide Hospital for our health care fund, $90 million of industrial completions and key office projects like 80 Collins Street in Melbourne and The Annex in Brisbane. Post the $1 billion of completions in FY '20, the group development pipeline sits at over $10 billion, half of which relates to the Dexus balance sheet interest. Our development pipeline principally comprises of existing rent-collecting assets that have development potential. We have 3% of the balance sheet FUM committed to developments today, which is well below our notional limit of 15%. Within our uncommitted pipeline of projects, we have arguably the best portfolio of city-shaping projects in the country, with prime development sites secured in the eastern seaboard CBDs, all of which we have been progressing through the planning phase this year. At Waterfront Brisbane, we launched a compliant DA for 126,000 square meters of NLA in a 2-tower scheme. This builds on our agreement with the Queensland Government to acquire freehold interest in the adjacent land. I've already mentioned some of the recent milestones at Central Place here in Sydney, which will adjoin Atlassian's new global headquarters. The schemes for both Central and Waterfront enable these projects to be staged in line with the level of tenant demand. At 60 Collins Street in Melbourne, we've secured approval for a reference scheme that provides NLA of about 27,000 square meters on this prime corner site at the Paris end of Collins Street. And in Sydney, our Pitt & Bridge Street Precinct represents a significant development opportunity by the proposed changes under the new Sydney planning controls, and we've lodged a draft planning proposal with council. From cities to [ paddies ] and our circa $800 million industrial development pipeline, is progressing well, and we'll add over $500 million to our funds business once complete. We've had particularly good momentum at our Ravenhall estate in Melbourne, which adjoins the Caroline Springs' train station and where we've recently committed to a 25,500 square meter industrial facility, and we continue to feel very strong interest. Development remains a preferred path for us to grow our industrial platform. With industrial land values cooling, we expect opportunities to present themselves over the coming year. While Dexus has an impressive development pipeline, it's important to put in context that the balance sheet is largely invested in core real estate in core markets, backed by long-term leases with fixed increases. More than 95% of the portfolio is income-producing. About 10% of the portfolio is income-producing today but has embedded development opportunity in the medium term. As you can see on the previous slides, we're working very hard to ensure we're in a position to realize these development opportunities when conditions are favorable. To fund the $10.6 billion development pipeline, we are fortunate that about half of this pipeline already sits with existing third-party capital relationships. This will provide organic growth of over $5 billion to our funds business. For the balance sheet, we are in a strong position today with low leverage, but the pipeline of both development and acquisition opportunities is large. So we will look to execute on further asset sales and sell down interest in these projects over the coming years. All of this will improve the portfolio quality, enhance returns and help us to grow our funds business. As I mentioned, asset recycling is an important part of our strategy that enables us to organically fund our development pipeline and new acquisitions. This will become increasingly important for us in the period ahead with volatile equity markets, depressed equity prices and private market investment demand remaining relatively strong, particularly for quality assets which we have in abundance. As you can see on this slide, this is not something new for Dexus. As an active manager, we have consistently been recycling capital from the portfolios to fund growth and to improve the portfolio's performance. The trading business exemplifies this strategy of adding value through development and recycling capital. We delivered another strong year of profits in FY '20, and we've derisked future years, contracting circa $85 million of pretax profits for FY '21 and '22. In the year ahead, we're focused at activating the next stage of Frederick Street in St Leonards as well as replenishing the pipeline. Thank you, and I'll pass you back to Darren.

Thanks, Ross. As you can see, our business is well positioned for the current environment. An investment in Dexus is an investment in high-quality earnings streams that includes access to earnings from our funds management business and trading profits. Our prime office portfolio is backed by strong tenant covenants and will benefit from a flight to quality. We are increasing our investments into growing property sectors like industrial and health care, with large pools of capital that have the ability to grow through the cycle in our expanding funds business. This is all supported by our conservative capital management approach, which has ensured we have a strong balance sheet. Once we are through the pandemic, we expect office demand to keep expanding. Offices will remain relevant, and we'll continue to have a core role to play for business in the development of corporate culture, collaboration and innovation. Office property is a long-term asset class and has shown its resilience through the cycle. Over the past decade, office markets have been driven by solid employment growth. Around 5,000 white-collar jobs have been added to the Sydney CBD every year over the past decade and 38,000 jobs across broader Sydney. While the pandemic will interrupt this, growth will resume post COVID. Going forward, we expect a continued evolution of work space trends. So to conclude, the team has covered our 5 immediate priorities today. As KG mentioned, we're helping Australian businesses return to their workplaces safely to a place where they can drive their productivity, and we will continue to work with our customers on the future of work space. We will make decisions that set up the group to perform over the long term, and we will selectively recycle assets, which may result in short-term earnings dilution but will enable us to reinvest into opportunities that we believe will drive stronger investor returns over the next decade. You've heard our focus on funds. And in our city-shaping development pipeline, we will do the work to make sure we can activate projects when the time is right. From a distribution perspective, we intend on paying a distribution in line with free cash flow for FY '21. But due to the continued uncertainty in the economic environment, we are not providing guidance at this point in time. Thank you. I'll now pass you back to the operator to open up for questions.

[Operator Instructions] The first question comes from Sholto Maconochie with Jefferies.

Is that better? Can you hear now?

Yes, we can hear you now.

Okay. Great. Just on retention, do you have a figure for office and industrial you could provide for the full year at all?

KG?

I do. The office numbers, 60 -- low 60s, Sholto. And Stu, do you have the industrial?

Yes, we're down to around about 52 after 1 large hit here in a big Sydney shed. So that came from about 70 prior year.

Okay. And then was that the main driver of that weak like-for-like in industrial? Was that tenant, the part of the shed in Sydney?

Yes, that's 1 of the drivers, I mean one of it. Fact we face in the industry is that the business and office parks are a lot tougher environments to lease in. So obviously, at Axxess Corporate Park in South Sydney, we've won some downtime, the Homemaker center as well. And yes, the vacancy at Kings Park. We got the COVID relief as well that by code, and therefore, law, we've had to swallow it, too. So that's been offset by strength in the core logistics portfolios, but that's the reason why.

And what's your -- remind us your SME exposure in industrial again?

Places like Axxess, a whole lot of SMEs, I don't have a percentage for you. But it's safe to say in the last quarter, there's a whole bunch of incubator suites out there, 100 to 150 square meters with one-off operators in them that we've had to support, as I say, by law.

Yes. Okay. And then just switching gears to the rent collection. You provided with office, 94%. If you included the city retail in that, what would that have come down to?

About 92%. It's actually not that material because city retail is not a big part, Sholto. So it doesn't actually materially change that number, to be honest.

5%.

Yes. Of the portfolio, yes, but in terms of the -- yes, it doesn't change it that much, to be honest.

And then just on the cash collection, you had a waterfall on Slide 8. Can you just clarify a couple of things on that regarding the waivers? You've got a footnote, $7 million there.

Yes. Well, so those waivers are tenants who are currently in arrears -- well, were in arrears at 30 June. We have also though -- in our FFO, we've also taken a hit of $11.8 million for tenants who weren't in arrears at 30 June. Obviously, that doesn't form part of that water -- that cash flow. But it's still an impact to AFFO. So the total impact to AFFO for those rent waivers was $19.2 million for the year.

That's for full year. Okay. I'll look at the detail after the call.

Slide 42 in the pack, that also has a lot more detail Sholto.

I'll save everyone's time and look at it later. And then on the surveys, obviously, the survey says every -- all the employees want people back to work, and it's good for innovation. But is there any negative surveys you've done where employees don't want to go back to work? Or is it all rosy?

Look, I think it's -- there's obviously a few recalcitrants that like the luxury of their home if they're set up well. But look, I think the reality, Sholto, is that most organizations prior to the pandemic were already embracing flexible work practices through either formal or informal flex arrangements. Now that's what we do at Dexus. We've done it for some time. And that evolution didn't really stop the growth of our office markets over the past decade, where in Melbourne alone -- Darren mentioned Sydney, but Melbourne grew 15% over the decade in size. So I think the whole work-from-home thing is interesting. Also, I think it's understandable that some businesses has been a bit in media lately. Some businesses are flagging changes to their workplace model as a result of this enforced work-from-home experiment that seems to have worked to some degree, as I mentioned. So I appreciate the temptation to craft real estate strategies to save significant rent, particularly in a period of when revenues and profits are down. But I think that the challenge, though, for business leaders will be to understand the aspirations of their people as well as the trade-offs of experimenting with flexible arrangements. I think the key is that most of the 6,000 staff we surveyed indicated that they were interested in more flexibility and the opportunity to work from home more often but don't want to give up their desk to work from home on a permanent basis. So I think the office, to me, feels like it's going to continue to play a significant role in driving those things Darren spoke about, culture, collaboration, innovation. There'll clearly be short-term demand impact. But I think that's more as a result of the recession, then increased flexible work patterns, to be honest. And that might moderate new supply in the short term. But I think the long-term future is going to be very much linked to white collar employment growth.

And then just on that, you got occupancy slipped off a bit. You're flagging, I think in your commentary an increase in vacancy in '21. Do you have a sort of figure where you think that may increase for your portfolio?

Look, it's hard to call. We're not giving guidance on that at the moment. But I think we're expecting rents to be under pressure. Probably more on the incentive line, we think face rents are going to hold. But clearly, business is not in long-term decision-making mode at the moment. There's probably going to be maybe more short-term decisions around holding over short-term leases until a bit of certainty and certainty returns to the economy and the market. So it's hard to call, but we're going to be working very hard to maintain our occupancy well into the 90s.

Kevin, you might want to mention some of the transactions that you've undertaken in the past 4 to 6 weeks?

Yes. So it's been encouraging. In the quarterly update, we'll hopefully give you some more color, but we have managed some major transactions, renewals in Brisbane, in Sydney. We've done some big global companies in some of our major assets like Farrer. And yes, you'll get some more color in the March quarter. But the market is -- has slowed from an inquiry perspective, but it's not dead. There are forward-looking organizations that are looking to get set. Some will take advantage of these soft conditions and do very well for themselves. I mentioned some of those global examples. Big business, smart business is getting on with it and sees this very much as a cyclical issue that we'll all get through. So we need to be mindful of that and make sure that the deals that we cut are sensible, and we're not cutting our nose off to spite our face and ignoring a recovery on the other side.

And just finally one for Deb. On the fund, was $17 billion external at the February result, now it's sort of $15.5 billion. There's been some asset sales and some acquisitions. What's the driver of that in that decline in the third-party fund?

Sholto, basically, the major decline was the loss of the Australian mandate. So there was just over $2 billion mandate that we managed, which has now transferred off our platform. So yes, there's been some divestments of assets, but there's also been some acquisitions and completed developments, but ultimately, it was the Australian mandate.

Our next question comes from Darren Leung with Macquarie.

Just a follow-up on a few of those. So just on office leasing volumes. So in your first half in December, it is about 53,000 square meters. You did about 33,000 for the March quarter. You're reporting 88,000 today for the full year. So that implies you've only gotten about 2,000 square meters done for the fourth quarter. Is -- I suppose, question one is, is the math correct? And two, why is such a low volume of deal done, if it is?

Yes. Pretty good maths, Darren. Last quarter was pretty flat, subdued. As I mentioned, a couple of deals done. I think in terms of volume though across development and the portfolio, I think it was 114,000 in total for the year. But in the portfolio, I think 88,000 the numbers we're giving you are at ownership, so the actual size of the deals were somewhat larger. But yes, it was a pretty awful time in office real estate, those 3 months.

Yes. As we said just previously on the previous question, activity has picked up apart from Melbourne, which is very flat, as you would expect, but activity has been good, and we look forward to updating you in September of the deals that the team has executed in the last few weeks.

Yes. It's fair. It's pretty tough to lay something when you can't see the site. But perhaps to give a proxy because obviously, you've produced some pretty good operating metrics so far, but been on new leases. What was the leases done in terms of re-leasing spreads in incentives for the last 7 weeks?

Well, I think the Sydney re-leasing spreads for the year were pretty encouraging at just shy of 15%. Melbourne, I think, is 8% or 9%. Perth, Brisbane were still negative spreads given where those markets were at going into COVID anyway. The last quarter deals, there's not many to look at, but those deals were flat, so not negative. So I think we're pretty encouraged, actually, the MLC transaction, which we'll give you more color on later in the year, is probably more incentive than we were at maybe 6 months ago or clearly but still a pretty good outcome. So I think the point I was making in my presentation was the better quality assets are going to do better through this period. And whilst the bargaining power swung to the customer end, the better quality stuff will still have choice, and you could probably set out a deal if you think that it doesn't represent good value for you because you know there's going to be interest at some point for that space. So it's striking the balance for us to make sure we get the right tenant on the right basis. And clearly, we're going to have to meet the market where we feel challenged. But for the better quality stuff, and we've got a lot of it, we're going to do the right thing for our unitholders.

Yes. Well, it's fascinating for the good quality stuff. Believe it or not, in Gateway last week, a tenant was gazumped for a full floor because they tried to push incentive to buy, and Kevin and the team at least did it at a sensible incentive. So that did shock me.

Yes. And it's a good outcome for the portfolio to get a flat re-leasing spreads, what's the average incentive that you're providing probably to the [ U.S. ], if you could speak what's the market, I suppose, what that tenant is asking for?

Yes. Look, it's a good question. I think that when you look at our average incentive at 17.1% for the year, I think in terms of where we are now, we're probably more in the mid-20s. I think it's just pushed out to that extent. Pleasingly though, face rents are holding at the moment. I think probably a function of maybe a little bit of optimism around some of the media around a vaccine. I think people are -- if you're feeling like maybe the recovery is very much linked to that and vaccine is not far away, maybe that's optimistic. But I think at the moment, face rents are holding, incentives are pushing out clearly, but we'll wait and see.

Okay. And that mid-20s number is a combined number in the sense that you've got a mix of effective deals and there are still. So for the deals that do get to receive incentives assuming the low 30s. Is that a fair conclusion?

Any in the low 30s at all. I mean KG's talking mid-20s on new deals.

Yes. In Sydney, look, I think some of our -- some landlords will print deals maybe in the next 6 or 12 months if they're under pressure potentially in the low 30s. I haven't seen too much at that. We're certainly very fixed in the 20s on stuff we're contemplating. But I can't speak for anybody else. I can only talk to what we're doing.

Yes. And just a quick update on the Grosvenor stake. So the media is obviously indicating you guys looking to sell your stake there. Any updates on that process or how it came about, please?

This round closes tomorrow, so we can't give you any update, except to say that there's probably a dozen people in the data room. And as always, the agents are very positive of a good outcome. So we'll wait and see.

Okay. And then just on that Slide 42 around the COVID-19 credit provision and recognition. Can I just confirm, sorry, it looks like you've taken that $6.8 million credit provision. Do we compare that against the amount deferred, which is the $3 million in the footnote, plus anything that's weighted?

You should look at the total arrears balance effectively. So that provision is taken across the total arrears position. So it's not just against what's deferred.

Yes. What's the total arrears, $12 million?

So you can see in that slide where we've done the cash collected on that's -- back on Slide 6, you can see outstanding is $20 million.

Yes.

If we look at some of those deferrals and then we make an estimate. So we have a quite a process to go through where we kind of look at risk adjusted, what tenants, what categories they're in, what size they are, whether they're eligible for relief or not, et cetera, et cetera, and then we do a calculation off the back of that.

And then Ross or maybe Alison, you made a comment around asset values, you expecting to be a bit lower. So how much further do you expect them to be?

No. I'm not sure that I was saying that. I think what I was saying was that for -- if quality assets will probably be -- held that value, and you've seen some of that demonstrated by the sale of 45 clients that we just made. I think you will undoubtedly see some softer assumptions running through those vals. So what Kevin has been talking to, some of that higher incentive, maybe extended downtime, some of that will make its way through in those DCF vals you'd imagine, but I think we're still seeing that for property -- for quality property, the values are still holding up at this point.

Good to hear. If that's the case, given your balance sheet strength, is it a good time to launch a market buyback or any other form of capital management?

Yes. Very good question. I think what you'll see from us is we'll finalize some of these sales, and then we have a variety of options of what we do with the balance sheet strength. We'll undoubtedly see really good buying opportunities. And of course, one of the best buying opportunities right now, where our stock is trading, is our own stock. However, that's a one-off permanent reduction in capital that will give us a short-term boost to AFFO while putting money into either the developments or other acquisition opportunities provides long-term returns for investors. And we're about running this company for the long term. So buyback is certainly one of the things we'll look at. And as the year unfolds and as we get more certainty, you'll see us put a number of initiatives into action.

All right. And just final one for me. Just on industrial. Sorry, you've obviously had a few assets moving around that portfolio, DALT [ been formed ], et cetera, DALT was a pre COVID decision. Can you remind us or have dividend update in terms of what your target allocation is to industrial in the COVID or post COVID world, please?

Darren, it's Ross. We don't have a target allocation per se to industrial. I think as we've spoken to you and investors over time, we see industrial is providing very, very low returns going forward. And for us to get our required levels of return, our investment in industrial needs to be alongside third-party capital partners, and we are looking to do a little bit more development on balance sheet to drive those returns. So industrial is going to be -- obviously, it's a very hot asset class at the moment. Realistically, returns out of that sector is going to be very, very tight. And so yes, I think for us, we're keen to keep putting money to work in that sector, but it needs to be alongside third-party capital and most likely with a bit more tilt into development.

Our next question comes from Suraj Nebhani with Citigroup.

A couple of my questions have been answered. But just in terms of the leasing in the last quarter, Kevin, can you say if there were any change in leasing terms, like lease length or something like that?

Yes. Look, I mentioned the 11 deals that we had at heads that fell over as a result of COVID. And most of those were tenants in the market that have held over or renewed short term in their existing premises until they get a bit more clarity about where their business is going and where the economy is going. So I think that's probably the most fundamental change in terms of the moment that we're seeing just a tilt to short-term leases rather than locking in long term for some, but not all businesses, but some businesses.

Yes. Fair enough. And are you sort of expecting that to continue near term? Or is it sort of -- do you see that as COVID linked?

Well, I think it's COVID linked. It's recession linked. I don't have a crystal ball on when we're going to find a way out of this. But I think there's 2 camps. There's those that are taking a longer-term view and are getting on with long-term planning decisions. Some of those examples, I cited globally. And then there are others that probably need a little bit more certainty before they commit their organizations to longer-term real estate decisions.

All right. And can you just remind us of the expectation for market trends for Sydney and Melbourne for the next 12 months, please? Like what do you guys expect?

Well, I think the key -- the key thing -- Ross can talk to maybe his outlook on the investment side. But from a leasing fundamentals, you can expect effective rents to come off probably in the order of 10%, possibly as much as 20% in some assets. And that's more as a result of incentives elevating. I think that's probably the key shift. And there will be probably, at the moment, a lower volume of transactions in the very short term, but that's probably the key change. Ross?

Acquisitions, we're still seeing and cap rate perspective for the good quality stuff, we are getting several inquiries every week for good quality assets. I think secondary assets will suffer a little bit. So as a result of that, I think you'll see cap rates and discount rates stay the same or tighten potentially a little bit for the top line commercial assets in the East Coast, in particular.

Sure. Sure. And so just interested in any examples of -- I think you guys have talked about flight to quality. But any sort of examples you can give on that yet, let's say, since COVID has it or maybe more like in July or something like that?

We -- look, I can't -- it's not finalized yet, but we have a financial services group coming out of B grade accommodation, looking very hard at 60 Castlereagh Street is an example. And there are others. But yes, typically, we're seeing financial services groups looking to take advantage at the moment and upgrade, and it will give you more color at the quarterly update.

We update the quarter, we've also seen a financial services company coming from the outer part of the CBD into the core as well, which we'll update you on in September.

On the investment side, we still continue to field unsolicited offers for assets in the portfolio. But interestingly, all those offers are centered around, let's call it, the high-quality assets, the prime-type assets, which is fortunate for us, as Kevin said, 95 -- 94% of the office portfolio is prime grade after we adjust for the development inventory that we have. So I think we can expect to continue to be well bid in the portfolio, and that gives us lots of options as to how we think about recycling capital.

Okay. Okay. A couple of questions for Alison, please. So just on the accounting of the rental relief measures. It seems as though you have taken, I would say, arguably a conservative approach on the relief measures with a lot of the impact in FY '20 FFO already. So just wondering if you can clarify what is the impact expected in '21 from the deals that haven't been finalized.

Yes. Just to confirm, yes, you're right. I mean we have taken a pretty conservative position in those FY '20 numbers, and a lot of that is still estimated at this point. So whilst the team, Kevin and the team, are working really hard to work through all of those applications for rent relief, it does take some time. So we did have to make an estimate at 30 June. I think what you can assume for '21 -- we're not giving guidance clearly, but there's another 3 months of rent relief to go under the code. So you'd imagine something similar to the impacts that you've seen in '20 for the last quarter would be replicated to September, but it could be more, could be less, as I said, because we haven't actually completed all of those deals yet. It's hard to know exactly where all of those will land. And obviously, there is some debate about extension of code of conduct and those kind of things, which would obviously have an impact, too.

Would you expect some of those credit losses that have been written off to come back potentially once the deal is defined?

Yes. Look, I think in all of those, in the rent waivers that we've put through, the P&L and in the provision that we have, we have, I would say, been conservative. Now some of the deals that we're actually doing are probably coming in slightly better than what we had anticipated and estimated. But as I said before, we haven't -- we still have a long way to go to get through all of the rent relief requests that we're working on. And typically, some of the harder ones are probably going to be the last ones. So it's still really hard to say at this point where -- how it will wash up. But I do think we've been probably fairly conservative in those numbers.

Okay. Makes sense. I would agree. And just on weighted average cost of debt, that was down fairly significantly from 4% in '19 to 3.4% this year. Just wondering if you can provide an outlook for '21 on weighted average cost of debt?

I think it will probably be around the same. I mean obviously, interest rates are very low. If you look at kind of what deals you can do and not that we're proposing to do that many more deals, you can see we've got massive headroom at $1.6 billion. But you can borrow from the bank at the moment for 5 years for about 2.50% and even 10 years at about 3%. So I'd imagine that, that weighted average cost of debt is going to remain pretty similar.

Should we expect some change in the hedging structure if some of those asset sales that were spoken about, they get crystalized?

Sure. I mean we always -- we look at the amount. Hedge, you can see were quite high, relatively high, I guess at the moment at 78%. If -- as and when we recycle assets, we always look at that hedge position and take a view as to how appropriate it is, and we'll continue to do that.

Our next question comes from James Druce with CLSA.

Firstly, just on the distribution and the lack of guidance for this year. You've had this a couple of your office peers, small office peers providing guidance. You're collecting 90-odd percent rent. Just trying to understand that decision. Secondly, can you provide some rent collection numbers for July and given that we're sort of most away through August, August as well, please?

Yes. Look, I suppose we've said we're very active with regard to some potential asset sales at the moment. And with the amount of uncertainty in the environment you've seen, the business is generating a fair bit of cash at the moment, and we said we'll pay a distribution in line with that free cash flow. But at this point in time, I don't think it's prudent to give guidance.

Okay. And then on the rent collection for July and August?

Guys, you got the number?

Yes, July would be 90-plus percent. August, a little tricky because you kind of bill halfway through the month and then you don't start collecting. So it's a bit tricky to say for August, but certainly July well into the 90s.

Okay. Any big difference between industrial and office there?

No. Yes, no, no. No.

Okay. Then just for -- well, I understand you've got an asset in your DWPF fund in Melbourne that you're selling at the moment, maybe on Flinders Street. Just can you talk about pricing?

Look, the only thing I'd say with pricing is -- it is an attractive price for that fund. And we look forward to announcing the outcome of that in due course.

And I think just to reiterate earlier comments that high-quality assets will continue to be well bid by private capital in this sort of market. And I think you're going to see more transactions like that over the coming 12 months, and I think 452 will be an example of that.

Okay. And then just in the NPI numbers for office and industrial, just the lease surrender income. Where did that sit compared to the run rate for prior years?

Well, as you know, we don't really disclose the quantum of that number. So we're probably not going to disclose it this year either.

Okay. A trend perhaps?

Well, I think you imagine if there's less leasing, there's going to be less surrender payments. That's all I would say.

Your next question comes from Tom Bodor with UBS.

I was just wondering if you could talk to the conversations you're having with clients around any sort of fit-out changes or the changes in the way that they might use space? And then following on from that is, do you think the sort of structural changes we're going to see will dictate what assets you divest? Or do you sort of see that as a change following COVID and it's just around what the asset return profile is that determines the divestment?

Okay. Kevin, why don't you pick out the first part, and then Ross, you can talk to the second one.

I think the -- right now the immediate changes that are being looked at and executed on are just the physical occupancy around the restrictions and what's required to comply with the Safe Work Australia guidelines. So that's the immediate impact to the workplace. I think the longer term, what companies are contemplating as they work through what their business looks like coming through this, it's probably a little bit early to say. Now I think all the groups that we're working with, both our workplace consulting team and just doing discussions with our property team and even our projects team. People are not at that point yet when they're definitive around a wholesale change to their workplace model. The key issue they're trying to address at the moment is, well, if we -- we've demonstrated an ability to be able to support more flexibility, how do we actually make that work because the investment in both technology and systems and processes to support that hybrid model is not easy to make happen. So they're trying to get their head around how that works. But in terms of what the physical building impacts are, way too early to call. I think the key impact is probably a bigger focus, which we've been at for a while, healthy buildings and a whole lot of strategies around Axxess air filtration systems and all of those things that make for a healthier building.

Yes. I think the only thing I'd add is Kevin made some great comments in his presentation around all the things we're doing from a platform perspective to solve issues of flexibility and really deepen the relationship with our customers. And I think if you think about the transition the customers are going to go through over the coming years, that just provides an awesome opportunity for us to deepen that relationship with customers. And I think that's something that we're very much looking forward to as a business. From an investment divestment perspective, I think as KG said, it's probably too early to tell, and there's nothing material that we would sort of weigh into our divestment considerations at this point in time.

Okay. That's very clear. And then just final one for me, just on the nonrecurring cost savings. Just was wondering if you could just quantify how much that added to the management line.

No, but I don't know if you've seen in the -- when we've shown the rent guidance, what we had proposed for guidance, it adds about 2.1% on that slide. So I don't know if that -- if you've seen that. And essentially, that was a whole mix of things but some stopping hiring, not spending money on consulting, some annual leave stuff and then obviously, some executive remuneration reductions.

Your next question comes from Todd McFarlane with DWS.

Just looking at Page 52, if you can just help me reconcile how effective like-for-like growth in office is higher than the sales growth on average incentives, increased cost were down, occupancy is going down. Is there a timing difference there? Or are you essentially separating each leasing, whether it's effective or flat across the portfolio before the metrics are in?

I think will come back to you on that one, probably takes a little bit of time to work through.

The second one then. What is the retention rate for the half year?

60. And Stu?

[indiscernible]

Okay. Okay. Sorry. I'll just ask the third question. Yes, there's been a steady decline in your office WALE over the past 4 to 5 years from sort of north of 5 to low 4s now. Yes, part of this might be flexible operated deals. But just on -- I know you've got a strategy of getting your average lease expiry to low 13 going forward, which will sort of assist, but where do you like to see that metric over time?

So I think the WALE, typically, for us, if we can sort of have it in the high 4s, that's probably a comfortable place for us. But I think realistically, in this period, with some of the larger expiries that we've known about for a while, development affected assets as well, you'll see that run down a little bit more. And then we are going to be doing some shorter-term deals, which I think are sensible in this period. I'd rather be doing shorter-term deals in this market, not paying away bottom of the market, 10-year incentives and then recalibrating those leases in a few years' time. So you will see the WALE run down a little bit in the next 12, 18 months. But I think as we recover out of this situation, that WALE will start to push out. And then as some of the -- as some of the development stock comes back into the book as well, you'll see the WALE jump up again.

There are no further questions at this time. I'll now hand back to Mr. Steinberg for closing remarks.

Okay. Thank you, everyone. And we look forward to catching up with all of you over the coming days and weeks. Have a good day.