GDI Property Group (GDI) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the GDI Property Group Annual Results Teleconference. [Operator Instructions] I would now like to hand the conference over to Mr. Stephen Burns, Managing Director and CEO. Please go ahead.

Good afternoon, everybody, and thanks for joining GDI Property Group's annual results and my first. Joining me today is Dave Williams, our CFO. In terms of a quick snapshot, I joined as an interim in March and made permanent in June, just reflecting so far on that journey. I think there's a lot of management changes underway as is Board renewal. I think, effectively, we've had a very good bunch of senior managers that are fully engaged and accountable. In terms of the people we have, I believe we've got the best development expert in the Perth market, who was involved in delivering Brookfield Place but more recently, our WS2. We've got, I would argue, the best leasing expert in the Perth market, John Byrne, who's seen many a cycle. We've got some exciting young talent, which covers us across the government, development, cost procurement disciplines as well as what I believe is the best CFO for an office specialist and the best property due diligence guy in John Garland. I'm here to report that our strategic turning point is well underway. And obviously, we're floating on a much stronger Perth market that, that's underpinning our results, which we're going to discuss today, but also our view on the future. I think in terms of how GDI is positioned, we're well placed to get additional FFO through leasing. So that's point one. Point two, we are expecting some cap rate weakening. As you know, there hasn't been any significant transactions of like. We are seeing increased rents, which is likely to offset some of the cap rate weakness that we're likely to anticipate. And keep in mind that we still have relatively attractive values per square meter when compared with the East Coast markets. GDI is very comfortable with the level of debt and is diversifying funding sources via a combination of recycling assets and executing on strategy. I think it's an important point to make that GDI won't necessarily sit here with its current debt levels for long. It is by its very nature to recycle assets. So I don't think you draw a straight line as to where our debt levels currently are. And we maintain our objective of holding $0.05 distributions through the cycle for the coming future. I think in terms of what are the operational highlights and what's been going on, we feel really comfortable with WS2 and what we've done there. And it's worth just mentioning, look, it's the first timber office building in Perth. It was put in a position that has a really good location. But we're now finding that it has a really good boutique appeal. And what's worth noting right upfront is in terms of being able to deliver something that was conceived back in 2019, we've actually -- we've absolutely killed it on the cost front and we're able to manage that. In part, the glory for that goes to our builder in helping us lock down costs. Where there's been well-publicized circa 30% increases on costs, we were able to get away without increasing our costs and improving our profit. I think in terms of leasing, which is our #1 job, we've leased nearly 1/3 of the Perth portfolio. And it's worth noting that a big chunk of that came in the last 8 months of the year. And the velocity on that feels really good. And we'll go into more detail later. But we're feeling good about using that momentum to carry off more leasing as we look forward. The co-living JV is effectively a new initiative involving the Tulla Group and over 500 rooms. To date, that is proving up to be very positive as we bed down operations and also build a pipeline of future opportunities. If we look at the financial snapshot, basically not much move in the NTA. It's down $0.02 from June last year, during which period, all wholly owned assets were revalued during the financial year. We had a devaluation in 197 St. Georges Terrace, which has the vacancy in it. And we had Westralia Square 1 devalued slightly with a little move up in cap rates. But we had a profit on WS2 for the first time. The weighted average cap rate of 6.55% includes all our other assets, which incidentally with car parks and car yards, we probably have about 20% of our assets in non-office. So that's worth keeping in mind. But they're factored into that cap rate. And we're sitting at a -- about an $8,000 a square meter capital value. Gearing. In terms of the gearing levels, and Dave will go into a lot of detail of this later, we're feeling comfortable with the LVR levels and the ICR levels. Obviously, we're looking to do something on this front as we manage the portfolio going forward. But we're not looking to fire sale assets or do anything like that. Every property has its price. And we will consider when and where that might take place. In terms of our FFO, we feel good, basically maintaining last year's level. But importantly, going forward, we believe that, that will increase quite significantly if we're able to execute on strategy. And AFFO, adjusting for the incentives, we feel good about that as well because it means we're leasing up. So the distribution, as mentioned before, which was reset in November '22, there's no change to that. And the objective is to hold that $0.05 through the cycle. Now I'm going to hand over to Dave to take us through the contributors to the FFO.

Good afternoon, everyone. Our Property Division FFO was up about $4.5 million year-on-year. A big chunk of that was obviously Westralia Square as it's filling up. That was $18.1 million of that versus $12.7 million in the previous year. That continues to increase at leases commence, the Capricorn lease that we have commenced at the start of next calendar year. So '24 should be higher again. The offsetting factor, got a bit of leasing opportunity now at 197 St. Georges Terrace. The major tenant left in July. That created a bit of a hole compared to last year, so $15.4 million versus $19 million the year before, the Mill Green assets. Big positive though from the car parks, we bought them on a 5% passing yield for $68 million, which was $3.4 million. We said that was below -- well below the 4-year average. For the first 6 months that we held them, which was FY '22, they delivered $1.3 million. They had a really strong period, $4.2 million over the 12 months. And occupancies and revenues really accelerated in the second half. And that's reflective of the people coming back to the office in Perth. Co-living JV of $1.1 million for the stub period that we owned it. A lot of that was just bedding down particularly, call it, South Hedland. Pleased to say that the July numbers are very strong in comparison to that $1.1 million. Funds Management revenue pretty much like-for-like to last year. There weren't any transactional deals. Something that, of course, we'd like to look at is the velocity in our funds business. Net interest expense offsets all of the gains from the property business pretty much. So it was a lot higher. Corporate and admin costs were approximately $1 million lower. That is reflective of some one-off items. And then as you can say, the maintenance CapEx is largely to do with money spent at 197 St. Georges Terrace. And you can see the increase in incentives and leasing fees paid of $11.6 million. That's reflective of enormous leasing successes in what is still a too high but contracting incentive market. On debt, we have on the next page. We have a tick over $300 million of drawn debt. We have $41 million of undrawn capacity. Take it to the interest rate caps in July last year, we bought $150 million of caps at 3%. We have topped that up to take it to $300 million for calendar year '23 and then $200 million for calendar year '24 and another $100 million through to June '25. That gives us a lot of comfort around our forward-looking ICR and protecting from adverse rate movements to the upside. We have a July '24 expiry. We are looking and are pleased with progress on diversifying and extending our capital sources. Thank you. Back to Steve.

Look, there's probably a couple of points worth drawing out on the Perth market as a bit of a reminder. The fundamentals are still strong. That's always been probably the case in hand from afar. But if you stand back and look at it, the economy is projected to continue very strongly. Obviously, it's heavily resource-based. But if I point to that chart on the top of the right-hand side, you can see there's a large gap between the exploration and the CapEx spend, which might start to prove up over time. But that gives us some degree of confidence there. Whilst we're at it, the chart below, if we look at the prime rental growth, it's nice to see a double-digit associated with Perth. So we find that very positive. Just turning to the next page, it's worth drawing out a couple of the trends that we see on the ground. 7 quarters of positive absorption is a great thing. And you can't say that about many markets over here. The leasing levels, and I would say the leasing interest, really has become quite dynamic. And in the premium space, where there's only a circa 6% vacancy, there's a lot of demand outstripping supply in that segment of the market. It then flows down to the A grade, where it's a competitive space, there's no argument about that. But we're likely to see, once that premium is fully absorbed or leased, that there's going to be a lot of tenants swimming around in the A-grade space. The indicators continue there. The thing that you really notice when you go to Perth is the high office usage, which is measured at about 80%, 81%. And I'd say also just the activation of the foyers, the general people walking around and the engagement within the core. And that's leading to other trends as well. People are moving in from the outer areas to take advantage of deals and to get proximity for their employees and better amenity but also location. So it's a pretty strong feeling to the market on the leasing front, underpinned by the resources and the government segments. And in terms of the dynamics, we're seeing a lot of interest in ready-made spec space, particularly at the smaller or part floor. So part of the strategies that have been successful on building that there does involve that strategy of designing up and having fit-outs ready, where people can come in straight away. And it improves your terms. It's a lot more active than the whole floor tenant-leading initiatives. And part of that is driven around activity levels for the employees coming down and using the amenities of the buildings, which lends itself to meetings and so forth, new End of Trip now involves conference facilities, something that we spent or spending a lot of time on WS2 to ensure that we've got a really good conference facility, which we can use in the precinct to attract tenants. And it's working a treat. I think in terms of the multiple building choice for A grade, which is 197, we have to come up with a very specific offer to ensure that we catch more than our fair share. And I'm confident that we can do that based on our leasing results achieved this year. Another feature of the Perth market that isn't so prevalent on the East Coast is there's virtually no sublease market over there. If we talk through the next page, another little factor that we've recognized in the Perth market is that WA does very well post shocks. It seems to deliver growth on a sort of plus 5-year basis. So that is the positive outcome for us to think about. Producing states versus services states is a pretty positive theme for us. The level of development space coming on to the market is minimal in the Perth market, which does contrast quite heavily with other markets over here. So supply is not a major issue. And then basically, the absorption story, which I've discussed, is very strong for Perth. We also find that transactional evidence, which there hasn't been much of, is basically is supportive of our evaluations. And on the buyer front, you are still seeing Perth families that are looking to take out value equations. Some of the value buyers and also syndicators, as evidenced by some of those sales, has been quite positive. In terms of the way we think about the Perth market and where the opportunity is, you've just got to remember that it's government and resources. And there is a lot of opportunity on that front and a lot of movement at the moment. And GDI can play into this a little bit with developments like a WS2. And of course, we have a number of prospective development sites either with or in the process of gaining additional DA space to meet that demand. And as mentioned, the tenants are moving from outer region into the CBD core to get better access and amenity for their employees. If we roll through to the next page, the ESG trends. I mean, this train has well and truly left the station in Perth. And part of it is to do with resource economies, companies wanting to, I guess, compensate for the work that they do and to gain their credits where they can, which includes the sort of space and responsibility around the tenancies that they will have. One point that we think is really important and part of the GDI culture is to understand the brown-to-green trend, which can be a very expensive trend indeed when you're looking at prospective buildings to procure for new tenants. And the new technology has got to be priced into the way that we execute on the real estate. I think in terms of the property portfolio on the next page, it's worth keeping in mind that over 20% of our assets are in car parks and car yards. And in addition to that, there's the new co-living JV. Dave, did you have any points on the portfolio there?

No, all good.

Just looking at the next page, which really just gives you a bit of a portfolio leasing outlook. The low-to-medium short-term sort of risk is evident from '24 through to '26. And the current vacancy is really our let-up opportunity, which we're going to be vigorously attacking. For an overall occupancy of around 82.5% and a 5.2% WALE, an average cap of 6.6% with only an $8,000 a meter value, we're feeling pretty comfortable. Our individual portfolio assets. Just a couple of points on each one, but it will give you a feel for how we're tracking. If we look at WS1, there's really only two floors left. And they happen to be the upper floors. And we have interest on those remaining floors. So we do actually have the benefit of a bit of tension in demand. And we think we're well placed to be able to execute on the WS1 vacancy. WS2, really it's the new kid on the block. It's performing very well. We've basically got four floors left to lease. But that doesn't tell the full story because we're entertaining a lot of interest with multiple tenants across those floors. And there's quite a bit of duplication. So we do have strong demand on being able to let those boutique floors up. And we're feeling pretty good about that at the moment. The next building, that's our problem child, 197 St. Georges Terrace. There's an eight- to nine-floor opportunity. It does sit right in the commoditized end of the space, the bubble of space, which is effectively A-grading in Perth. We're looking to attack that by having a multi-floor approach to the way that we do things. We'll divide up some floors. We'll pitch whole floors on some. But effectively, we've got the opportunity to really boost the space that's occupied there. And that's a key initiative for our strategy to lease that up. Just on 5 Mill, it's a good little building. It doesn't seem to ever stay vacant for long because the tenants are really using that as an alternative to Brookfield Place. But it's cheaper and has a really good location and amenity. So we're quite happy with the positioning of that property. Nonetheless, we've got to lease up a few suites there to complete the job. If we're turning on to the next page, you'll see 1 Mill Street. 1 Mill Street is basically a development opportunity. It has a current DA. We're pretty excited about the flexibility that gives us. This is not a spec tenant opportunity. This would be a designated tenant opportunity. So that is not something that we would take risk on, rather we'd price it and presell the leasing. 180 Hay, this presents well as a building. It's a tricky location. And we'd like to fill that with a single tenant and we have inquiry. The car parks, both the car parks, as Dave mentioned, have been performing well, taking the FFO from $1.3 million for the half year in FY '22 to $4.3 million in FY '23. But effectively, they're income-paying development sites if you like to think of them that way. And we have opportunities with respect to these car parks to deliver over time in the same way that we're able to take advantage of the Westralia Square car park and put WS2 on top of it. The next page really deals with some of the assets in the Funds Management business. And I put it there really as an emphasis that we're not just office buildings. We do have 17 car yards around Perth, which very good assets. And they present with lower yields because you're not utilizing all the sites. So that's worth keeping that in mind. We've got Townsville, where we have an office building. That building is something that we'd be happy to let go off at the right price. And turning over into the next page on the funds businesses. It just gives us a bit of a flavor. But we have one of the best trading IKEA businesses in Australia located on one of our properties near Innaloo. We have also a portfolio of assets that we had from the UGL portfolio, including a prospective development site in Broadmeadow/Newcastle that sits right outside McDonald Stadium as well as an asset in WA in Bassenden. That's really a quick snapshot on the property portfolio. And I thought it would be worthwhile giving an update on the strategy. So GDI, from a critical perspective, look, I think it's been static for a while, but a lot of things happening now. And the clear points that have been a criticism can turn to an advantage. And being overweight at Perth, I think at the moment, is probably a good thing. But as the opportunity arises, we can look to change the mix of assets. I mean, we'd rather own 10 $100 million buildings than 2 in Perth. And GDI doesn't have to hold office towers. We don't have to be slaves to the tenants. We'd rather procure space and maximize returns. And keeping in mind that at GDI, small amounts of money will make a big difference to the FFO. So we feel pretty comfortable about being able to change the mix and enhance our profitability. Holding properties through multiple CapEx cycles is not a good thing for a total return specialist to do. So we won't be doing that. Vacancy, that's our opportunity. We run the [indiscernible] vacant buildings. And that's to get the FFO or the income increase. The funding source, as mentioned, through debt but also a compilation of JVs and asset sales will be the way that we will be taking the business. I don't think it's tied anymore. We've obviously got quite a bit of change that we've undergone at the management level. The syndicates, we've got to speed up the velocity there. That means fund profitability as well as making the investors' money there by getting some money back to them before we offer up new opportunities. And that's well in [ train ]. I think in terms of the strategic initiatives, it's very much about lease-up. But we will make sure that we take advantage of any East Coast weakness, which we think has a fair way to go. So we look at that as a transformational opportunity for GDI. We're very focused on ensuring that we have through-cycle funding. Because to be a total return player like that like we are, it gives us opportunity, but it also means we have a fair bit of flexibility in how we deliver returns. So we just want to ensure we've got the funding. The management changes, Board renewal, it's all on the table and underway but with a particular emphasis on senior management accountability. The strategy is to ensure that we say we're going to do something and basically, we don't talk about it until we execute it. So it's basically a deliver strategy on communication. And the optimization plans on each asset, et cetera, is well underway as well as targets. And look, I will just take a sec to point out what we believe is a strong advantage for GDI involving timber and reuse because it is something that we do. And we think that we can use not only with the number of the existing sites we have but also when we look to take advantage of other market opportunities that might exist on the East Coast. Evidence that we're executing, we feel good about leasing up a good chunk of the portfolio. But we're not resting on that, have to get -- really, it's the 197 St. Georges Terrace vacancy and a number of the other properties that we have, such as 1 Adelaide Terrace, which have been an issue for us in terms of leasing. But we're confronting them front on. I think we've been able to consummate the co-living JV with the Tulla Group, which has a really good feel about it to date as we bed down the operations and we get a better feel for the sorts of assets and the price tiering and the occupants or customers for that business. We're feeling like we have a good path forward to earn extra returns with requisite risk. And in terms of the, I guess, partnering with best-in-class, which is a sign of how well the business is going, we think we've been able to do well partnering with the likes of [ Savills ] and an Arup in the execution of WS2. And we see that as really important going forward to have those sorts of relationships and be able to execute with the best parties in their particular area. Sorry, on the next page, I've just -- we've put an in-depth business model to give more description as to what we want to do and how we're going to execute on that strategy. But it would be fair to say that we think we have quite considerable points of difference, which we've listed there, to ensure that we can exploit opportunities. And that really defines the GDI proposition, which is to be the best total return specialist in the office space. But as mentioned, we have other strings to our bow with some of those other businesses in car yards and car parking, which also add to that profitability. Turning on from there. Look, we've been at the forefront of upgrading building some NABERS ratings. The whole ESG tilt now takes on a far more technical tilt. Because to get that brown-to-green costing right, you've got to be very, very careful. It's an area where we think that a lot of the market will misprice assets when they look at them as upgrade opportunities. We want to make sure that we're best in class and we maintain some advantage there. The learnings from the timber and steel approach can be exploited in other markets. And so we're very keen to ensure we can deliver that. We don't need to own office towers. So we don't need to give away 1/3 of the building to tenants and pre-leasing initiatives and so forth. And we'd be happy to take -- GDI would be happy to take space in a Sydney office building, a premium office building at a really low rent. So keep that in mind that we don't have to own those sorts of buildings. The embodied carbon story. We believe there is something behind that. Because if you're preserving carbon by not having to put up a concrete structure, it is a real advantage. And we think that, obviously, our Wellington and Murray and Mill Street car parks can be better utilized with the appropriate structure on top as well. So we're looking towards taking advantage of that attribute. Opportunities, there they are. It's really just looking through potential opportunities involving those assets that I've just mentioned. We do have a DA for Mill. It's got quite a bit of variable usage. It does incorporate some bonus ratios. And we think that we've got some really good flexible space in a great position to be able to take advantage of, doesn't mean we're going to run out there and take on development risk, far from it. So that applies to both Wellington and 1 Mill. Just talking about the FFO opportunities. We've put a slide in there really to give an indication of where we can extract that FFO growth. Clearly, there's a leasing story, which is payable there with the assets, looking at the fully let income versus the as-is income. There's asset optimization through the developments, which obviously like WS2 can add considerably to the profit numbers. Co-living, as Dave mentioned, we've only just had a stub. So there's some pretty good upside or returns available there to GDI. Funds Management, same thing. There's whole array of potential [ funds ] there. And as we increase the velocity, there's the scope to earn additional fees there. And of course, recycling, which comes down to the assets that you're working with. But that can be very transformational and put our assets into alternative places for higher returns. So that's a bit of a snapshot from GDI on the results. And thanks for listening. I'll now open it up for questions.

[Operator Instructions] Your first question comes from Edward Day with MA Financial.

Just one question for me. With 197 St. Georges Terrace on the eight vacant floors, could you just perhaps explain or illustrate how far through you are with regards to, obviously, the spec fit-outs or the suite and in turn, expectations around how long that would take to let up?

Yes, sure, Ed. Sure, sure, sure. Look, we've probably got between eight and nine floors that we can target there. At the moment, there's about four whole floor propositions being discussed at the moment. And then we've got about two part floor discussions going on there. And the problem with those part floor discussions is that they like to discuss alternative floors. So there's probably another couple sitting within that realm. But basically, we are looking at being able to anchor a strategy that says, "Right-o, we'll put four floors of fitted-out spec space up." And the reason for that is that we can basically target that $800 a square meter. We can target our returns and we can measure the return we get on that CapEx a lot more effectively and the start date of those rents. We're still seeing incentives 40%, 30%. But they reduce if you can have that space ready. So the real art in being able to target the two to four floors of spec fit-out space that we want to actually get ready is if we're able to determine largely our own destiny. The whole floor stuff is a bit harder because the lead times to getting that fit out and so forth. And there's no coincidence in the fact that the whole floors have been a bit harder to get out the door. Because this -- for the A-grade space, we have quite an abundance of comparable space. It's a difficult space for the landlords to let up. But the spec stuff, and we've had a lot of studies done on this, one particularly by CBRE, where we can enhance the returns a lot through doing the spec fit-out and having it ready for the tenants to come straight in. And we're actually seeing that play out with 5 Mill, the little building next door. The reason that, that actually gets let really quickly is because it's a part floor environment and it's cheaper. Obviously, it's cheaper than 197 but very competitive. So we think that we can actually do 197 by spending anywhere up to $25 million. But we won't start just earmarking $25 million. We'll look to go, "Can we spend $4 million and manage that?" And we think it will probably come out somewhere in the middle. We might have to spend up to $10 million over the next sort of 14 months. But we'll target that and bring it in as the income comes in.

[Operator Instructions] Your next question comes from Louis Joseph with Algona.

I just wanted a quick question on capital management. I just find it a little difficult to comprehend sort of investing in the co-living JV at effectively 100 cents on the dollar, where by implementing a buyback, you could be buying assets you own, understand, already operate at sort of 40%, 45% discount to NTA. Is the buyback sort of back on the agenda? Especially, you talk about like the dividend reinvestment option has been cost-effective, but option for shareholders to reinvest, but it's tax-inefficient also. So I just want to quiz on the buyback there.

Well, absent any transformational sale, we're not going to be doing a big chunk of buyback because they've got to be funded. That's point one. Point two, would we pick up -- like to buy the stock if we had limitless funding? Yes, sure, we'd do it today. But we don't. So our balance sheet, our assets are a function of our funding, and we need to manage it appropriately. So if we did something transformational, we'd think about it at that point. As for the co-living JV, I think in terms of the returns we're seeing there, they're very good returns. And it was made quite clear that if we think about the JV in terms of what it does for GDI in the short term, it brings a lot of cash in.

There are no further questions at this time. I'll now hand back to Mr. Stephen Burns and Mr. David Williams for closing remarks.

Well, thank you very much for attending the GDI Property Group final results. And we look forward to catching up with you all later. Cheers.

That does conclude our conference for today. Thank you for participating. You may now disconnect.