Goodman Group (GMG) Earnings Call Transcript & Summary

Good day, and welcome to the Goodman Group First Half Financial Results for FY '23 Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. It is now my pleasure to introduce CEO, Greg Goodman.

Thank you. Good morning, and welcome. I have Nick Vrondas with me on the call this morning. I'd like to begin by acknowledging the traditional owners of the land on which I'm presenting from today, the Gadigal People of the Eora Nation and pay my respects to elders, past and present. Goodman has produced a strong result for the first half of FY '23, delivering operating profit of $877 million and operating earnings per security of $0.464, up 10.7% on the same time last year. Statutory profit was $1.1 billion, which includes the group's share of $1.4 billion of valuation gains. While global markets remain uncertain, our fundamentals are strong, which is supporting development activity, more valuable projects, high occupancy and rental growth and increased assets under management. And as a result, we're in a position to upgrade our earnings guidance with projected FY '23 operating earnings per security growth of 13.5%. Customers are driving structural demand, which combined with the lack of supply is leading to strong rental growth in most regions. To support our customers, we're working closely with them to try and help increase productivity, efficiency, sustainability and resilience in their supply chains. We're seeing customers carry more stock to protect themselves from supply chain disruptions, and we're continuing to significantly invest in the technology. It's clear that they need to be close to the consumer as possible is also increasing to address both their own sustainability targets and to reduce transport emissions and costs. So the quality and location of their facilities has become even more important. So on the demand side, customers are driving increased activity, while ability to supply prime locations is more challenging. Planning has become harder, projects are more complex. And effectively, with the changes in the financial markets, we're seeing a reduction in the competition and supply of buildings moving forward. This has contributed to strong demand in our development workbook which now stands at $13.9 billion across 85 projects around the world. This demand has seen occupancy for projects completed this half now standing at an unprecedented 99.8%. The majority of our work is on redevelopment of brownfield sites with a bias towards multi-story buildings as we continue to optimize the limited land availability. This is in line with our focus on regeneration and our long-term sustainable strategy. Assets under management are almost $80 billion, up 17% on the first half of FY '22. Strong rental growth is supporting valuations and offsetting the effect of expanding cap rates. Across the group and partnerships, cap rates expanded 28 points on average. We saw the largest movements in the U.K. and Europe, where there were around 100 points higher, New Zealand 42 points, while cap rates across Asia remained relatively stable. We also see the potential of further cap rate expansion in the near term. However, strong regional growth is also likely to continue. While our investors remain cautious, we added 2 new partnerships to our management business this half, taking us up to 18 partnerships with some of the world's biggest investors. We also completed partnership extensions and several equity raisings. Turning to Slide 6. We are seeing, as I mentioned earlier, unprecedented rental growth in some of our markets and effectively 0 vacancy. Potential rent reversion to market across our portfolio has continued to expand, with North America at 57%, Australia and New Zealand, 24%, Continental Europe and the U.K., 17% and Asia approximately 3%. The reopening of the borders in China and Hong Kong could be a catalyst for rental growth in those markets. The fundamental pillar of our 2030 sustainable strategy is around the efficiency, productivity, the sustainability of our properties, and we're working with our customers and suppliers in this space. The key area is monitoring and the reduction of carbon emissions having had our science-based targets validated by the science-based targets initiative. Our global solar installations and commitments are increasing and are on track to reach 264 megawatts in FY '23. We're also measuring the embodied carbon in our developments and working to increase the use of low carbon materials. We've also remained staunching our capital management approach, maintaining our strong balance sheet gearing at 9.7%, and $2.8 billion of available liquidity, giving us the flexibility to take opportunities as they present themselves. I'll now hand over to Nick, who will take us through the results overview.

Thanks, Greg. Let's turn directly to Slide 10 to look at our income statement. As usual, we'll first cover the items that relate to the cashback measure of earnings, which we call operating profit and then discuss the items at the bottom of the table. Operating profit excludes the unrealized fair market value gains on properties, the mark-to-market movements and the accounting fair value estimate relating to our employee long-term incentive plan. Overall, FX movements had a $10 million adverse impact on the translation of our foreign income when compared to the prior corresponding period. The impact was mainly on the development line but it was offset with a commensurate benefit in the borrowing costs. This comes about as a result of the movements in the realized costs on our debt and derivatives, and that's how our hedging strategy is designed. Looking specifically now at the movement in investment earnings. Direct property net rental income is slightly lower than the same time last year. This is due to the impact of the $0.3 billion of net divestments over the past 18 months. Over the last 6 months, in particular, we had a net reduction of $0.4 billion after taking into account transfers to and from developments. As previously flagged, we expect to see further reduction in direct net property rental income in the second half, owing to the full period effect of the sales that have already been completed. Since the end of the period, we also completed the sale of some of the development inventories that have been previously stabilized and were generating rental income. We're expecting some of the remaining assets to go into development in the coming years, which will reduce their rental income contribution as we prepare them for redevelopment and during the development phase. The bulk of our investment income, however, comes through our co-investments in the partnerships. Over time, we want to grow this part of the business as we continue to expand our portfolio of assets under management and our investment in it. We also expect growth in rental levels to add to our income. Compared to the same period last year, cornerstone investment income increased by $29 million. Rental growth accounted for $9 million of the increase, which is the result of the like-for-like comparative. The net impact of acquisitions, disposals and development completions contributed nearly $20 million to the growth. Over the past 18 months, we've invested a net $2.2 billion into the partnerships globally, over $1 billion of which occurred in the last 6 months. Nearly half of these investments have been for the purpose of acquiring development sites and funding development CapEx. The majority has related to the acquisition of income-producing assets that are either for future value-add or redevelopment or the acquisition of completed assets from the group. The average income return on our capital contributions to the partnerships has been relatively consistent at around 4%. The low initial yield on their acquisitions being offset by development completions at a higher yield and the rental growth. Consistent with our current development run rate, we expect to continue to contribute equity into our partnerships, which will result in further income growth. Management revenue was up $7 million over the first half of FY '22. The value of stabilized assets under management has grown to $68 billion with the average for the half, up by $11 billion compared to the prior corresponding period. This has been driven by revaluation gains, net acquisitions and the completion of developments. As a result, ongoing management fees have increased by $39 million or [ 21% ] since the first half of the last financial year. Performance and transactional revenues contributed $42 million this half compared to $74 million in this time last year. The reduction has been the result of the timing of calculation dates and the conservative method of recognizing revenue, given the current climate. Over the full year, we expect to see around $60 million of growth in base management revenue due to the growth in stabilized assets in the partnerships. It is also likely there will be additional transactional and performance revenues as we have a significant backlog of unpaid fees and some of these will reach their assessment dates over the next 12 months. We should point out that a significant portion of the fees recognized this half were paid last year. But given the remaining performance obligations, we do not recognize them at that time. Total fee revenue as a percentage of average stabilized AUM was a little over 0.8% this half, and we expect it to range between 0.9% and 1% this financial year. Development remains an important part of our business strategy. We create significant value throughout the development and asset management process. We've continued to execute on these core functions very well despite the challenges the world is facing. So our margins have been sustained. Strong risk management, cost control and rental increases have primarily supported these outcomes. Over the past few years, the strong growth in development volumes has also been a significant driver of this segment. Our work in progress has more than doubled since June 2020, and the average production rate has grown by over 50%. The development period for the projects has increased, so our average annualized production rate has progressively increased from around $5 billion in the first half of fiscal 2021 to around $7 billion this past half. Our activity is diversified globally and across 85 projects in with. In recent years, we've also seen an increase in the volume of work that has been done in the partnerships. But due to the variety of methods in which we contract developments, our earnings are a function of the interaction between margin, volume, timing and the proportion originated on balance sheet and within partnerships. In this half year, realized development income was over $600 million compared to around $560 million for the first half of fiscal '22. In addition to that realized cash income, $0.4 billion of our development income was recognized as revaluation gains. This represents our share of the revaluation gains that accrue to our partnerships as a result of the work they are funding and the assets that are revalued loss on the balance sheet. After deducting the attributed prior period valuation gains on that realized assets, the net result is around $0.2 billion for our share. The outcome over the coming periods will be dependent on the opportunity set that we commercialize, but we have a wide range of options. As a reminder, over the past few reporting periods, we flagged the gains on sale of assets that have been subject to prior fair value movements. These have begun to arise in recent years, given the long-dated nature of the developments and the need to reflect the fair value of our assets where we have begun the development but have not yet completed their sales. We do not reflect these gains in operating profit until the transaction is complete. So in the financial statements, you'll see fair value gains that are higher than that reflected in the operating results reconciliation in the attached appendices. This is a result of the attribution of prior period fair value gains to operating profit in this period. So that those profits are double-counted and can be reconciled over time, we notionally offset them against the current period valuation gains. As at the 30th of June 2022, we had a balance of $430 million of such gains. The current balance is $252 million, which is the net result of the completed transactions and new additions to the list. We expect to see the remaining balance realized in the coming half but at the same time, there are a number of transactions in progress that may add to the total. We remain enthusiastic about the prospects for development demand, which bodes well for our future revenue as well as growth in AUM. Growth in our underlying operating expenses has been moderate as our business continues to be focused on a narrow set of markets, which enables us to grow revenues without significant cost variations. Our employee base is not growing substantially and wage inflation has remained moderate whilst recognizing current market conditions. We also had an increase in some of our compliance costs and IT expenses. There has also been a timing difference associated with the short-term incentive accruals when comparing this period to the prior corresponding period, which explains the overall reduction. We expect our full year operating expenses to be around $385 million. We encourage you to analyze this on a full year basis to smooth out the timing issues. Our aim here is to continue to keep our fixed costs relatively steady and instead to use at-risk variable costs, such as the STI and the LTI plans to incentivize and align our people. Our borrowing costs were down $20 million compared to the first half of fiscal '22. There was the $10 million FX benefit compared to the prior corresponding period, which offset the EBIT translation reduction discussed earlier. Capitalized interest was up $8 million compared to the PCP, given the higher average balance of development assets over the period at the higher WACD. We've also had an increase in interest earned on our cash and derivatives which more than offset the impact of the increase in our net debt and rising interest rates on the relatively small amount of floating rate debt exposure we do have. Our WACD is currently around 2.7%, and is substantially hedged against interest rate movements given the volume of fixed rate debt hedges we hold. Our tax expense was up given the growth in profitability, as you would expect. So as far as the nonoperating items are concerned, we had $0.6 billion of revaluation gains in the half, which represents the group's share of this $1.4 billion in gains across the entire portfolio of assets under management. From this, we've deducted $186 million of now realized prior period gains to get a $0.4 billion net result for the half. Cap rate expansion over the half was 0.3%. This was more than offset by the impact of rental increases. Development valuation gains also continue to contribute to the total valuation results with over $1 billion recorded in the half. Another customary area of difference between operating and statutory profit is the fair value movements on the hedges, which were down $100 million overall. Mark-to-market derivative gains or losses are reflected in the income statement because the group does not apply hedge accounting. These movements should be considered in the context of the $170 million gain reflected directly in equity through the foreign currency translation reserve. As usual, we exclude the accounting cost of the employee LTIP but we include the tested units in the denominator when calculating our operating EPS. This is when they actually have an impact on security holders. The accounting cost has declined mainly due to the valuation inputs and the falling security price. A few remarks now regarding the balance sheet on Slide 11. The FX impact on the balance sheet when comparing December to June was not material. Due to sales over the half year, the wholly owned asset portfolio has decreased by $0.3 billion since June '22. Our share of stabilized assets within our cornerstone investments in partnerships were up by nearly $1.9 billion over the half year. Nearly all of this was the result of the new investments and the completion of developments. Compared to June '22, our development holdings are up by $0.2 billion, with the completions and sales nearly offsetting the additions in expenditures. The average balance over the half year was $0.3 billion higher than the prior corresponding period, in line with the growth in activity levels. Noting again that some $600 million of inventory was classified as stabilized property post-completion. This is up since June '22, but we've sold a substantial portion of this since balanced state. Overall, we've generated $800 million -- over $800 million of cash through operations. $516 million of this is reported through the operating cash flows and the remainder arising from the sales of development properties, which are included in the investing cash flow for statutory reporting purposes. That was nearly $190 million. There's always a difference as well between the timing of distributions and income recognized in the partnerships. That was over $30 million this half. The cash received last year for certain fees that have been recognized in the income statement this year, along with other working capital items such as the timing of incentive payments collectively accounted for about $200 million of differences between operating cash flow and operating profit. The cash generated from our retained earnings funded the majority of the investments we've made, which is consistent with the design of our long-term capital management plans and the distribution policy. As a result, our net debt position has increased by $0.4 billion in the 6 months to December. We have since reversed that in January through the completion of various asset sales. That's a good point to turn to Slide 12. And as we said before, we'll operate our gearing within a range of 0% to 25% with the level to be set with reference to the mix of earnings and activity levels. So in light of the activity and developments, we aim to maintain financial leverage in the lower half of the band in the near term. In addition, we continue to invest in the business to generate strong returns and fund its growth sustainably. That's why our distribution per security is expected to remain at $0.30 for FY '23. And that's all for now. Thanks, Greg.

Thanks, Nick. And how we can turn to the outlook slide on 20. The fundamentals of the business are strong. Rents are growing. Development activity is robust. Margins are healthy. And we continue to attract capital from our partners around the world. The competitive landscape is in our favor, leaving us with plenty of opportunity for growth as we move forward. So we're, therefore, upgrading our guidance to FY '23 with operating EPS growth now projected to be 13.5%. Thank you, and we'll take questions.

[Operator Instructions] And our first question comes from the line of Simon Chan with Morgan Stanley.

My first question, I was just looking through the development slides, and I noticed that the development for third parties or partnerships percentage of your commencements, 68%. I mean, traditionally, that run rate is at 80% or even higher. Is this just a timing thing? Or is this a strategic trend that a decision that you've made to do more on balance sheet going forward?

No. Look, it's a little bit of where it's originated from. I think Nick Vrondas, in his address, talked about many different methodologies and ways we develop and presell sometimes because of more complex planning issues in sites, we take more of the risk on balance sheet for a long period of time. And then we tend to move before we start building buildings. So it's and around specific projects in specific cases rather than any trend line. But what we're trying to do with our partners is make sure that when we are either preselling or doing it with them, we've ironed out some of the issues that may cause concern. So then -- but there's also a pricing advantage in that for Goodman at our end of it. But there's no deliberate change of strategy and our partnerships effectively either developing with Goodman 50-50, developing 100% or effectively buying after we've got planning and sites and the first few buildings out of the ground seems to be the way that number is built up. But Nick, have you got anything further on that?

Well, I mean, Simon, you're right in the sense that over the last couple of years, it's been up around 80%. But if you go back before then, it was traditionally more around that sort of 70% level. So -- but yes, Greg is right. I mean this particular period, it is a little bit of a function of when you take the picture, if you know what I mean, because the 80% that we've been reporting if you reported on the day of actual commencement, that would have been a different figure, it would have been closer to 70% anyway. So it's a little bit fluky in some ways, right? But I think all it highlights is what Greg said is that we have flexibility as to how and when we contract things.

Okay. Fair enough. Your guidance, 13.5% growth, your revised guidance essentially implies your second half will be flat or slightly down relative to the first half. Yet in your comments, you talked about management fees being skewed to the second half. So what's going to be declining in the second half? And like what's the offset for you to hold second half guidance flat?

Mate, we're taking a very prudent view of the market. There's a lot of volatility in the market. We're not there yet. I think it's -- last I checked was mid-February. So we see a good strong year, and we also see going forward some real momentum for us building into '24. So I think we'll leave it at that for the moment.

Great. And my last question, Greg, I think in your prepared remarks, you talked about having done some partnership extensions during the half. Just wondering if you could give us some insights into -- were there any changes to terms of the partnerships? Was there any argy-bargy involved with your investors in light of higher interest rates? Like what happened behind the scenes?

We did full partnerships because they are partnerships. And you don't seem to have argy-bargy with new partners. But no, no, it was all very, very straightforward. And on similar terms and if there was a change in terms, probably improved terms for the manager to be clear. I think it's a real desire and this has changed and free money has changed, quite frankly, where there's a lot more scrutiny on the manager, a lot more scrutiny on the quality, a lot more scrutiny on who the partners want to be with. We think that's a good thing. We think the markets were either robust a year or 2 ago, obviously, interest rates went reflective of where they needed to be. And we can see that now the market can see that now. But I think if you look at the big global investors, they're going to be cautious. They're going to be sensible, and we suspect there will be a rationalization of managers and operations over the next year or 2 because high leverage operations using financial leverage as a way of getting return is clearly off the table, best change the game. And I think it comes back in the favor of the operators being people like Goodman that actually drive outcomes out of the ability to make money out of assets rather than financial engineering. So I think that comes back to our favor, and that's what we're seeing with our big partners around the world.

And our next question comes from the line of Sholto Maconochie with Jefferies.

Just following up on Chan's question, with that mix in the development. Is that -- will that cap interest line because that was obviously higher because of that stuff on balance sheet? Will that sort of be a prominent feature again with that cap interest line running at the same rate as the first half?

Yes, you're around the same level, yes.

Okay. And then you've seen a bit of a stabilization in materials and cost inflation. How are you seeing that in terms of your margin on developments? Is that you've got a lot of rental growth coming through and costs and material costs are stabilizing. How do you see that from your development margins going forward on as such for 24 months?

Yes. Look, the forward-looking margins for us good -- we're being really, really, really selective. That can't be said for everyone in our industry. And effectively, we're not long and wrong on land. Many will be long and wrong. We are certainly not long and wrong. So -- and we're doing a lot of reset now in regard to deals we're doing currently. Europe just recently, we finalized negotiations on 50 hectares. We took another 50 hectares down in Sydney recently. There's a number of deals that are going on in the U.S. and Japan as well. And effectively, we're building in real contingency in those transactions. We're making sure that we are still growing our costs, though, we're not calling costs flat. We're calling them moving with inflation. If you guess on inflation, 6 or 7 or thereabouts. That's what we're building into costs, so we're still building them out. But I think you've got to go to the rental equation and you really need to spend some time on understanding what's happening at the customer level because if you understand what's going on at the customer level, you'll understand what Goodman is doing and why we're doing what we're doing with development and locations and the sustainable features going through the building. Those rental growth numbers haven't been seen in my career, right, 57% in the U.S., well through 25% in Australia. And quite frankly, we're doing renewals now that are 35%, 40% up. South Sydney is going to crack $500 a meter shortly, and we're in the late 400s at the moment. So I think you've got to go to the customer and you got to ask yourselves why, that's what we're spending all our time on. Is -- are those costs being passed on? I suspect so. So Goodman is not of the view that inflation is over any time soon. I think we're going to be in higher growth, inflationary-type environment with higher interest rates for longer than people would like. And when we're looking at our feasibilities and development, we're building that to make sure that we've got appropriate margins for the risk we're taking. But if you look at the customer side, and you look at the demand side, where there's basically 0 vacancy in our major markets we're operating in, obviously, the risk on that side of the equation is lower than it's ever been in my career.

Great. And on that side, is there going to be softening demand? Or you still think quite a lot of demand coming through across your markets?

Yes. Look, demand -- supply can't meet demand in the key markets around the world. And I've mentioned a few issues why some of that is environmental issues is getting a lot harder. It's taking longer. Planning is taking longer. Infrastructure is getting more expensive. So the regeneration of sites is the preferred approach for Goodman because we're regenerating in sites that are already marked as industrial. So we're not plowing greenfield lands and things of that nature. So that's better on the environment, better on the ecology. But effectively, that takes time, and that's where the customers want to go. So yes, everything about it is getting tougher. Goodman over the last few years has restructured its people around the world. So we've got actually not so many white shoes running around salesmen. We've actually got really good technical people that know how to get these things up and know how to get the planning and know how to respect the environment on the way through because that's the game we're in now. It's not about salesmanship. It's actually about getting things out of the ground on time. If you can do that in key locations, you have the demand because the supply is not meeting it.

And then just on that, are you seeing -- do you expect to use some of the balance sheet you've been investing in the partnerships you're buying stuff on balance sheet? Do you think you use balance sheet to warehouse potential opportunistic acquisitions that may emerge this year?

Look, look, I think if you look at the balance sheet and you look at the partnerships, I think you'll see a balance as we have had a balance and that will continue. Will there be some assets that will go off the balance sheet? Yes, there will there's a multi-story program in South Sydney, which I think reaches about $1 billion of work in progress. That's actually assets we own on our own balance sheet, which we will probably partner with one of our big partnerships in Australia. There's probably the preferred approach at the moment. And as that rolls off, there may be some other stuff roll on around the world as well. So it will be balanced. It will be sensible. It will be deep in value. Otherwise, we're not going to get out of it and worry about it. Effectively, we're not chasing big numbers. We're not chasing work-in-progress records, we're not chasing assets under management records. What we're chasing is operating cash flow and operating profit.

Okay. Just finally from Chan's guidance question. What are you forecasting performance fees for the full year? I think it's $42 million in the first half? What are you -- what's that figure forecast this year?

Yes, just work on the basis, work towards 90 points of AUM. And I think you'll find that backs out about 100 in the second half. And then, so you got to look at our management revenue line on a full year basis because of that timing issue of recognition, the base fees are up, 21% half-on-half versus prior corresponding period. We're continuing to complete assets. So -- and there's net acquisitions happening. So the stabilized assets under management are growing and base fees will continue to grow. That's why we're predicting $60 million of growth in base management fees year-over-year.

And our next question comes from the line of Stuart McLean with Macquarie.

Greg, can you just provide a bit of color, please, on the 2 new partnerships that were created during the period?

Look, one is a land partnership effectively. And the other one was some stabilized assets we did effectively with another partner of ours. So look, it was all played pretty close to home people we knew. Nothing really adventurous. We did then finish the capital raising in Europe towards the end of the year, I think earnings up to EUR 400 million.

EUR 450 million.

EUR 450 million. So yes, look, there's good liquidity. The people that are in the business for the right reasons, right? And we've said this a number of times. The game has changed. Interest rates higher, cost of capital has gone up and you need to be an operator. If you just as a -- collect at the wrong price and you leverage it, you're not going to get the return. So there is good demand from our big partners around really sensible stuff that has long-term value, 10-year value. And that is, if you like, infrastructure like. And I think during the pandemic, if anything, industrial was enhanced in regard to its infrastructure qualities and the necessity for it around the big cities of the world. So if there's a bias for what our big partners want to invest in, it's -- industrial is still at the top of the list.

And the second one, so on the completion yield, and I point [indiscernible] I think there's a couple of periods in a row where on completion, probably related some contingencies or get some really good lease-up to accelerate your returns there. Is that something we should expect on an ongoing basis? Or are there some project specifics around that acceleration as you reach completion?

Yes, it's a bit of both. So I think the reality is, well, when we're entering into transactions 6, 9 months ago on a pre-let basis, you can safely assume the rents have probably gone 25% since that mark. So if you look at the stuff we're doing, actually, that is on spec, around the world, there tends to be -- the rents tend to beat the feasibilities pretty handsomely as well, which we've been doing pretty regularly. Yes.

Okay. Great. And just a final question, please. You mentioned in your remarks as well have a good bit of rental growth coming through maybe from the real estate charter. Just what does that also mean in terms of commencements in China and Hong Kong? Is it a little bit more palatable to continue to deploy capital with the reopening there? Or just how are you feeling about those jurisdictions, please?

Yes. Look, we're finishing a couple of developments in Hong Kong. You'd be aware of them, big data center. Clearly, we're in our final stage. And we've also got a big industrial we're finishing. We'll be a little bit more around the regenerative stuff because our portfolio in Hong Kong is primarily when we look at it, and we look at what some land prices have been paid actually just recently, it's fair to say that we're under -- our valuation firstly on replacement costs pretty handsomely. So I think you'll see more regeneration-type activity in Hong Kong. In China, we're just going to be sensible and careful. As you know, we are focusing on 3 markets: Beijing, Shanghai and Shenzhen. And that will be clearly the case. They will tend to be bigger and fewer, but that will make sense. It's very much fee-based though. The development arrangements out of China. So the volume out of China is not a big material impact primarily on the development revenues. I think you'll see more of an impact out of places like Japan, Europe, U.S. and obviously, Australia than you will out of China.

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

75% to 80% of starts and WIP is out of Asia and Australia with much lower contributions in U.S. and Europe. You talked about some big project completions coming through in the Hong Kong. Just wondering if you can kind of touch on where you think demand will come from to kind of offset those rollout for those projects? Or should we expect the WIP to kind of come back in the short term?

Look, I think out of Asia that sort of iterated on before, the projects in the Hong Kong partnership, obviously fee-based. So there's a smaller share than of the -- clearly than of the total and the same in China. So effectively, where you're getting a bigger share of the development profit around Japan, Australia, the U.S. and as well and then through Europe, where most things we're doing in Continental Europe are in 50-50 basis with our partnership or on sheet, if it's starting -- effectively. You'll see that we're not that sensitive to work in progress coming off in Asia, particularly in Hong Kong, or very little sensitivity to it. So we're not giving you a number for work in progress, but it's a bit like I said in my earlier remarks, it's not about a number of big numbers. The law of big numbers is actually about the operational profit where we're generating it, where the customer demand is, where are rents moving at 25%, 30%. That's where we'll be popping our head up. That's what we're doing. We're looking at a number of sites at the moment. In the U.S., a very different market where we were 12 months ago. We think a big advantage and opportunity for us. There's some sites we got under control here in Sydney end of last year. There's a big one that we've just in diligence in finalizing in Europe on the back of a couple of others we've bought as well. So look, we're just deep in the value, thick in the mud trying to make sure that we get the best stuff. So I wouldn't worry too much about whether work in progress 13 or 39. I think 39 is a really good number. But if a few things roll off in Asia, it's rolling up on a fee basis not a real share of the development profit. So characterization and risk is different, right? And the reason we do that in China is clearly because of our risk.

Yes. Okay. And Nick, just to your comments just on the return out of the co-investments. I mean we just look at the average investment in the income. It looks like the yields fall on about 50 basis points. Just wondering if you can kind of call out why that's fallen.

Yes. On average, the basis -- because the revaluation gains hurt you a little bit. So the actual cash yield on cost is before that I've talked about, but the actual yield on a marked basis is a little bit lower, plus where we're investing versus where the overall book is has been a little bit different as well. And then FX has a bit of an impact as well because the balance sheet gets translated at a different rate to the P&L. So that has a bit of an impact, unfortunately, as well.

And I think, Nick, they're more active as well in regard to land and development than they have been.

Yes, that's right. If you look at the composition of the external AUM, 75.5, about nearly $7 billion of that is development. So it's not income generating bearing in mind, these are not yield products. These are total return-oriented investments. The investors are there not for purely distribution. It's really about value creation long term.

Yes. I mean a lot of those trends that you're calling out have been pretty consistent, though over the last 18 months in terms of revals and kind of ramping up the development activity in the farm, just surprised to see that the income return pullback as much, but anyway that's fine.

Our next question comes from the line of James Druce with CLSA.

Thanks for your time. The 99% occupancy, I mean, is incredibly strong. How long can you guys hold it there? The fundamentals still look very, very good. I'm just curious as to how long we can sort of stay at these conditions?

Yes. When we look at '23 and all the business plans for '23 for all the different partnerships around the world, the only reason we'll have a vacant building is we want it vacant so we're going to knock it down is primarily where the only vacancy will come from. The pipeline of demand is really, really, really strong. And I think the other thing that's going into it, an uncertain volatile set of times, people -- teams that also take the bet they've already got. So the renewal rates are really, really high. And then because of the concern about inflation and costs, a lot of people are trying to lock those in a year or 2 earlier as well. So yes, I think as we run through this calendar year and into '24, providing the world doesn't go into a deep recession and there's other issues, I expect it to be pretty strong. But look, we've got to see where interest rates inflation does the consumer get nailed effectively at some point because that will change, obviously, the dynamics of business. But at the moment, with where we're heading, it's very strong, and people tend to be exercising options a year or 2 earlier and trying to lock in even at say 4% or 5% rent growth numbers off the back of our reset to market because 4% today is effectively a pretty good number for people to be locking in if they can.

Yes. Okay. That makes sense. And I missed the message on the gearing. So you're saying it's sort of down in January after a sale and the outlook for the next couple of years. Is it going to be staying around that sort of 9% mark for the balance sheet? Or do you think that will drift up a little bit?

So yes, the comment was -- it's our preference in light of where our activity levels are at the moment and the mix of earnings is to remain in the lower half of the 0% to 25% range. So working capital movements here and there, all range us like where we are right now today, we're at around 7%. But we then get some more inventory buildup, and we could be up over 10%. So somewhere around -- somewhere below 12.5% is the target at this point in time whilst ever the business is in the shape it's currently.

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

I just have a couple of questions both related to the European and U.K. business. Firstly, could you discuss the change in book value recognized across both Europe and the U.K. over the last 6 months, noting that in the presentation, the cap rate for the U.K. is up 120 basis points, it's up around 90 basis points in Europe? So just curious to have asset values being written back in both those markets? And could you clarify what that valuation change has been at the asset level?

Yes. Look, I'll make a couple of comments, and Nick can give you the precise numbers. But I think as you probably know, because you guys would be observing what's happening in Europe. The values came out and basically ripped 25% off pretty well everything. And I think that's about the number for...

That's exactly. Yes.

The U.K. Yes. 25%. And it had nothing to do with what rent growth you had or anything else, quite frankly. We accepted it. We moved on. I think it was about $300 million at the gross line, Nick -- something like that. We obviously booked it, talked to investors about it. They were moved on because they're busily writing everything else down at the same time. So there's no horrendous surprise. Have they overdone it until are things trading inside of where they're valuing things, yes. We've traded a few things inside. We mark the book but time will tell. Obviously, U.K., Europe from an economy point of view is the one that's most concerned for us around the world, the strength thereof. So watching that obviously very closely. But in saying that, we actually don't have vacancies in Europe. We're 99% occupied in Europe, and we're actually having some really good rental growth coming through because of where the CPI has been. But I think that will settle down. And I suspect they are the economies we're watching most closely. And that's where we'd be most careful about spec, for example, where we'd be less concerned about putting spec into L.A. would be more concerned about putting a lot of spec into London or into parts of Europe. So a lot of what we're doing in -- around Europe at the moment and some big projects actually are precommitted and really deep value and big margins is the way we're playing it.

Well, the only other thing I would add is, yes, the Europe cap rate move was similar because there's been more rental growth, the impact of the asset level hasn't been as great. So yes, they have been written down and mark to what value is currently deem is market. Some would argue that -- is that reflective of willing buyer, willing seller in the current environment, you can debate that, but that's kind of where they're seeing it at the moment.

Just to clarify, has there been a change in the capital base for the U.K. partnership? It looks like the investment value in the accounts is down only a couple of percent. So just trying to reconcile that with your comments about the impairment or that the write-back is in the mid-20s?

There's net investment as well.

Yes, there's net investment. And there's also been a couple of tremendously good projects that we're in a development phase and that's obviously pushed it the other way. Even with values doing all the harm they can possibly do, they couldn't do enough harm to some of those.

And just finally, the capital raising in Europe of EUR 450 million. Just could you provide some color on how much GMG's contribution towards that has been?

I would just add. Yes, at pro rata.

Your next question comes from the line of Grant McCasker with UBS.

Just sort of follows on from those queries. You spent $1 billion over the half and your calling out sort of each of the different markets have higher or lower risk, how you see things playing out. But can I get a better understanding of where you've spent that $1 billion, in which partnerships in which regions?

Yes, regionally, Australia and U.S. is the main expenditures. In Australia, it's across a few of the partnerships again, that was part of the equity raise that we did was the biggest one. And in the U.S., we're going to get the one partnership being GNAP and they're funding the CapEx program, and that's where we're putting money.

Okay. And then on the development commencements yield on costs relative to Q1, it seemed to have picked up a lot. So that suggests maybe your own costs in the mid- to high 6s in Q2. How are you -- you must have a pretty good idea of what your own costs are going to be for the second half? How should we think about that over the next 6 months?

Look, I think just a general comment, Nick will make a more specific one. But anything we're looking at starting now commencing or buying plan now. Bear in mind that won't commence now that's probably another 12 months away or so. We're looking at cash on cost as a general comment, higher than these numbers currently. Once again, we want more margin for risk. And if we don't buy a deep value, we won't buy at all, right? So I suspect the new projects we're looking at coming forward, we're putting more contingency and risk in because that's the world we live in. So I think you'll see it trending that way. But Nick, you've got a specific comment.

That's pretty much it. I think the stuff we're looking at the moment will average -- we had -- I think we called it out in the September quarterly, there was an anomalous period where it was a pretty small sample. What you've seen in the second quarter and the rest of the year is going to be more indicative. The mid-6s will be sort of kickoff where we target. But as Greg said, that's based on cost escalation expectations and some rental growth. But history has told us that if we manage things well, we can beat that. And so the 8.3% on completed projects is somewhat of an indication of where we could end up going forward.

And our final question comes from the line of Alex Prineas with Morningstar.

Thanks for the presentation. There's been a lot of talk over the last 12 months or so about the differences in valuations between listed property assets and unlisted assets. So I was just wondering is that -- your view on that, is that an area where valuations of unlisted assets could be improved in parts of the industry? And also the second part of that question is that, is that a topic of conversation that's coming up frequently with capital partners and so on, looking at mainly investors -- investments into your funds?

Yes. No, it's a good question. And the answer is everything is mark-to-market. If there's any material movement that will be marked. That's what the investors expect. That's what's in the main rigs, and they're happening on a quarterly 6-monthly annual basis on rotation. Everything has had a big refresh around the world. We don't sit on bogus numbers that we know that are not real because that's corporately corrupt, quite frankly. So we don't do that and I've got Carl Bicego sitting in the room with me now, making some notes. So no, we mark-to-market, and that's the expectation of our investors. So I don't know where those comments come from. I think they might come from other sectors. But I'm not aware of any partnership I'm involved in or cheer because I cheer them all that we're not marking on a regular basis and carrying them at a true and fair value.

That debate often arises. It's been around since late '80s, and people on this call will recall having that discussion. It tends to get more airtime when public equities are trading at a discount book, not so much when it's the other way around.

Yes. Fair enough. And just a quick follow-up on -- you mentioned before, you're seeing good rental growth in Europe. And the comment was that it's due to where CPI has been. Are you alluding to kind of CPI-linked rental increases? Or are you just more referring to just heat in the market, meaning that you're able to get some good rental negotiations there?

Yes. Look, there are a lot of CPI-type linked leases in Europe, particularly in places like France and what have you. So a lot of it is just coming through naturally. But on the other equation as well, in the assets in the portfolio as we have in Europe, they're very, very supply constrained. So if you are having an open market negotiation, you're getting similar increases actually, if not higher, and we've seen some 25s and 30% increases when we're not dealing with CPIs. So CPI has actually lowered the average to what we're seeing from a market point of view. So look, the same holds is what we're seeing in Australia and the U.S. in particular. And it's going to be really interesting, I think, in regard to China and Hong Kong. Hong Kong basically has been flat for about 3 years and so is China. So it's going to be very interesting to see now they've opened up and there's real supply constraints in both those markets and key areas. I expect there'll be a bit of a catch-up in China and Hong Kong.

And I'm showing we have one last question from the line of Suraj Nebhani with Citi.

So just a quick question on the production rate. Nick, I think you've called out in the presentation that it will continue to stay around $7 billion. I was just wondering how should we think about development earnings going forward with that flat production rate.

Yes. Well, for this year, the $7 billion, we're a shade over that right at the minute, but things come and go. We started the period a little bit below. And we'll average about $7 billion for the year, and that's going to result in a fairly smooth and even sort of development profit result throughout the year, which consistent with our commensurate return above and below the line. You can see what the margins across the projects are in aggregate, and you can see what the mix is. So this year is pretty well predictable and baked. What I flagged is that for future periods, the combination and mix of all those items will determine the outcome we're driving towards as Greg said profitability, not the law of large numbers. So at this stage, we're trying to optimize, and we will optimize the returns out of the projects so that we can deliver shareholders a reasonable sustainable overall growth rate. We're not giving guidance for future years just yet. We'll do that once that we've got through this.

Thank you. I would now like to turn the call back over to CEO, Greg Goodman for any closing remarks.

Thank you, everyone, for your time. And yes, have a good week or the rest of it.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating, and you may now disconnect.