Industrial & Infrastructure Fund Investment Corporation (3249.T) Earnings Call Transcript & Summary

In my capacity as the newly appointed Executive Officer and Head of the Industrial Division of the Investment Corporation's asset anagement company, I welcome you to this video presentation of IIF's results for the 34th fiscal period, the 6 months from February 1, 2024, to July 31, 2024. Presentation materials were uploaded to and can be accessed from the Investment Corporation's website. Without further ado, I would like to begin by commenting on the 3 key highlights of the fiscal period under review and ask that you turn to the executive summary on Page 2. Directing you to the left side of the page and the first highlight of the fiscal period under review, IIF reported an increase in revenue and income in the 34th fiscal period compared with its previous announcement. This was due to a variety of factors, including the acquisition of 28 properties following public offering, the subsequent disposal of 3 properties and upswing in revenue on the back of tenant turnover at existing properties and successful efforts to reduce borrowing costs. As a result, IIF's distribution per unit or DPU came in 3.5% higher than the initial forecast. Turning to the current 35th and following 36th fiscal periods, revenue and income are again expected to improve. Underpinned by this anticipated revenue and income growth, DPU in the 35th fiscal period is projected to climb 1.5% compared with the initial forecast and 1.8% to JPY 3,450 in the 36th fiscal period. IIF stabilized DPU is estimated to climb 4% compared with the forecast level prior to the public offering in February. This estimated 4%, reflects the 3% growth disclosed at the time of the public offering and an additional 1% attributable to internal growth and contributions from the acquisition of new properties. Turning to the second highlights summarized on the right side of the page, IIF is shifting to an inflation resistant portfolio in a bid to address the current inflation environment. In addition to introducing CPI linked rents at newly acquired properties, this shift includes revising its fixed rent master lease to a pass-through agreement, whereby IIF receives the same amount of rent from end tenants at IIF Shonan Health Innovation Park from October 2025. Furthermore, in pursuing internal growth at existing assets, IIF has secured increases in rent at manufacturing, R&D and logistics facilities. Finally, as a third highlight, IIF has worked to increase the value of its assets by promoting corporate real estate or CRE carve-out deals as well as redevelopment projects. For example, IIF announced details of its acquisition of IIF Hyogosanda Logistics Center 2 just the other day. At the same time, full-scale work on redevelopment of IIF Narashino Logistics Center 2 has begun. As my first investor presentation following my recent appointment, I would like to take this opportunity to elaborate on my thoughts regarding IIF's medium- to long-term growth strategies as well as its portfolio. Please turn to Page 4. Guided by its basic principal supporting Japan's industrial activities from the perspective of real estate, IIF listed on Tokyo Stock Exchange in 2007 as the only J-REIT specialized in industrial properties. Notwithstanding the current large number of logistics REITs, IIF remains the only REIT in Japan to specialize in industrial real estate, including manufacturing, R&D and infrastructure facilities. Looking back over the past 17 years, I believe that the industrial real estate with which IIF is currently involved, is experiencing an unprecedented tailwind owing to changes in the structured industry and growing awareness towards the need to promote capital efficiency by Japan's corporate sector. Organizing this instance into 4 investment themes, I believe that the opportunity exists for IIF to take a significant leap forward. Moreover, with a change in the investment corporation sponsor in 2022, IIF has gained access to new real estate solution proposal methods, namely CRE carve-out deals in collaboration with KKR, greatly expanding the breadth and quality of property acquisitions in concert with private equity teams. Meanwhile, as far as the J-REIT market is concerned, valuations have weakened owing to the impact of rising interest rates both at home and abroad. Despite its overall firm fundamentals, IIF's net asset value or NAV per unit has declined. Against this backdrop, IIF will work diligently to secure profit growth in the short term while increasing asset value. In this manner, every effort will be made to improve valuations. While carefully monitoring the cost of capital, energies will also be directed towards providing high returns to unitholders over the medium to long term by capturing the vast amount of available investment opportunities. IIF will, therefore, engage in activities that reflect positively on its standing as a publicly listed stock that is capable of enjoying the fruits of its growth. Commenting further on the data on Page 4, we have classified changes in the industrial real estate environment into 4 investment themes from an industrial real estate investment perspective. These are governance reform, return to domestic market supply chain restructuring, life sciences and new asset classes associated with industrial restructuring. As far as governance reform is concerned, Japanese companies are facing unprecedented pressure to improve capital efficiency. Under these circumstances, we anticipate asset-light needs will increase in the future. In addition, as the manufacturing industry returns to the domestic market, we project upswings in both new construction and manufacturing, and R&D facilities as well as accompanying new logistics needs. Moreover, IIF Shonan Health Innovation Park acquired in 2020 is attracting growing demand. This reflects mounting interest in facilities that promote open innovation amid the shift through and rapid expansion of bio and next-generation pharmaceuticals, largely in the drug discovery field. Turning to new asset classes. Demand is on the rise for generative AI and related data centers as well as in energy and resource related fields. From an infrastructure perspective, IIF acquired a central tank terminal project in collaboration with KKR's infrastructure team in 2023. Looking ahead, IIF will continue to cultivate infrastructure assets, will leverage network and tenant relationships it has nurtured to date. As far as IIF is concerned, I'm convinced that each of these investment themes will lead to the increased acquisition of assets going forward as well as internal growth opportunities. Moving on to Page 5, I would like to touch on IIF's medium- to long-term growth strategy. From an external growth perspective, IIF will continue to acquire assets through real estate solution proposals that contribute to improvements in corporate governance based on CRE and CRE carve-out strategy. The Investment Corporation will also engage in selective investments that focus on cash flow growth potential, unrealized gains and redevelopment potential. Moreover, steps will be taken to utilize the sales proceeds and gain on sales that come from the vigorous replacement of assets. In addition to the strong pursuit of internal growth, IIF will strengthen its resistance against inflation by introducing CPI-linked rents and implementing other measures. Coupled with value of work at IIF Shonan Health Innovation Park, IIF will look to consider expansion of work in the future. Turning to the investment corporation's financial strategy, IIF will leverage its stable financial base, focusing on controlling debt costs against the backdrop of an upward trend in interest rates, and broaden fund procurement methods. Looking ahead, IIF will work to integrate each of these measures, pursue DPU and NAV growth and improve the total return to investors while carefully monitoring trends in capital markets. Directing your attention to Page 6, I will touch briefly on IIF's medium- to long-term portfolio building policy. IIF will continue to focus on through logistics, factory and R&D facility and infrastructure fields in its efforts to build an asset portfolio. The number of listed J-REITs currently stands at around 60, with approximately 60% of the investment corporation portfolio comprised of logistics properties, IIF is increasingly being compared with logistics REITs. In the future, IIF will focus on factories, R&D facilities and infrastructure assets, all features of the investment corporation as a part of efforts to differentiate and diversified portfolio and increase profitability. In the life science field, in particular, IIF is looking to build on the expansion plans that are already in place. From a logistics facility perspective, the investment corporation will continue to pursue acquisitions that focus on cash flow growth, implementing such measures as the introduction of CPI-linked rents, redevelopment potential and unrealized gains by utilizing its accumulated know-how. In its asset replacement activities, IIF will take advantage of the favorable real estate market and proactively replace properties with identified issues as well as logistics facilities with a certain degree of upside from a medium- to long-term perspective to improve the quality of its portfolio and distribute gains on sales. Working to help expand the scale of assets and amid the capital costs of J-REITs that continue to hover at a high level, KJR management as the asset management company maintains the team and functions of a private placement fund. In addition to direct on-balance sheet acquisitions by the investment corporations, steps will also be taken to consider expanding assets under management through both public and private placements while utilizing co-investment schemes through SPCs such as [ Logesty ] acquisition completed the other day. Please turn to Page 8. In its effort to carry out its growth strategy going forward, IIF has formulated a new investment management policy in the face of future inflation. To date, the Investment Corporation has endeavored to build a stable portfolio, underpinned by long-term fixed lease contracts while placing the utmost priority on avoiding a declining rent. Taking into consideration expectations of a future inflationary environment, IIF believes it is essential to update funds investment management policy. Under the new policy, IIF will accordingly work to improve the total return through NAV growth, in addition to DPU growth. At the same time, the Investment Corporation will place considerable importance on shifting to an inflation resistant portfolio. Here on Page 9, we provide a comparison between IIF's total return and the average for J-REITs. As you can see, the Investment Corporation's total return at 9.9% has outperformed the average for J-REIT for the past 5 years. We believe this high return is a reflection of IIF's unique management strategy. By the same token, we believe that the addition of the CRE carve-out strategy following a change in IIF sponsor is a vital adjunct in improving total return. Turning to Page 10, we provide details of the [ Logesty ] case study acquired during the 34th fiscal period as an example of a carve-out deal. In this instance, IIF acquired 28 core logistics facilities in prime locations throughout Japan, from a leading 3PL company or JPY 108.2 billion. Accounting for the total unrealized gain and an average unrealized gain ratio of JPY 11.3 billion and 10.5%, respectively, coupled with the introduction of CPI linked rents, successful steps have been taken to improve total return. We take great pride in the fact that KJR management has brought this deal together by leveraging its comprehensive capabilities that combine 20 years of management skills and know-how with outstanding human resources. Looking at the CRE carve out deal in more detail here on Page 11, the ability to put forward real estate solution proposals in collaboration with the KKR Group led to the resolution of certain logistic issues and improvement in corporate competitiveness. In the future, we will continue to build a track record in these deals that help resolve key issues faced by Japanese companies. Please turn to Page 12. As I mentioned a moment ago, IIF has historically focused on long-term fixed lease contracts to provide the underlying strength of its portfolio. Of late, however, the investment corporation is making steady progress in a shift to inflation resistant focus. Lease contracts with CPI-linked clauses already account for 15% of the portfolio as a whole. Once again, as was mentioned earlier in this presentation, the lease structure at IIF Shonan Health Innovation Park will shift from a fixed rent master lease to a pass-through agreement, whereby IIF receives rent from end tenants from October 2025. Since end tenants are for the most part under contract for a period of 3 to 5 years, 44.4% of the total are inflation resistant agreements. Put another way, IIF internal growth potential is steadily expanding. An overview of IIF's financial results was covered at the start of his presentation. As such, I will refrain from commenting further on the data provided on Pages 14 and 15. Please turn to Page 16. The bar graph at the left side of the page, [ plot trends ] in IIF's NOI for its portfolio as a whole over the past 2 years. As you can see, NOI increased 27.3% owing to large-scale acquisition of properties. On an existing that is same-store basis, NOI has improved 5.2% annually. The data on this page is also a clear indication that IIF's profitability has substantially improved over the past 2 years. largely on the back of such factors as increases in rents, reductions in costs and improvements in the balance of utility income expenditures at existing properties. Directing your attention to the bar graph at the right side of page, IIF's NAV per unit has grown 3.4% over the same 2 years. Next, I would like to elaborate on the status of the current operating situation and ask that you turn to Page 18. Introduced at the time of the previous public offering is a property over which IIF have maintained preferential negotiation rights, the decision has been made to acquire IIF Hyogosanda Logistics Center 2 in this instance. Currently under development by [ Logesty ] this property located in the industrial park in the Sanda area, is scheduled for completion in November this year. A lease agreement over the entire building has been concluded with [ Logesty ] with plans for a pharmaceutical company to take up space as the end tenant. Moreover, and in addition to the CPI-linked clause incorporated into the 30-year fixed term lease contract, which continues to trigger expectations regarding cash flow growth potential. The unrealized gain ratio of 9.3% is another key point. Furthermore, IIF is considering a variety of measures, including the expansion of buildings based on the multiple properties acquired at the time of the previous public offering that are exhibiting room for floor expansion. In light of the many questions received during the previous investor presentation, I would like to once again elaborate on the upside associated with CPI linked rents on Page 19. First, many revisions are initially conducted after 5 years and every 3 years thereafter. The first revision, namely rents after 5 years, is based on the rate of core CPI increase over the period. Assuming the core CPI increases 1% each year for the next 5 years, the rate of increase will come in at plus 5.1% on a repetitive 101% calculation over 5 years. Based on the aforementioned, the rent after 5 years is calculated by multiplying this plus 5.1% by the current rent. This in turn translates to JPY 243 million per fiscal period or a positive contribution to DPU of JPY 96. While the annual increase in core CPI is capped at 2%, a floor has also been set to ensure that rents do not fall below original levels following the region. As a result, the lease contract is extinguished as an upside only agreement. IIF acknowledges that rents from the properties illustrated on this page will remain unchanged over the next 5 years. In order to keep pace with inflation in the short term, steps will therefore be taken to secure internal growth and other existing properties. Moreover, IIF will work diligently to increase portfolio earnings over the long term as the upside from CPI-linked properties kick in after 5 years. Moving on to IIF Narashino Logistics Center 2, please turn to Page 20. Work to redevelop IIF Narashino Logistics Center has officially commenced, including the confirmation of tenants. Utilizing unused floor area, both the area and appraisal value of the property will substantially increase compared with predevelopment levels. On a simple calculation basis, the price of existing land for [indiscernible] comes in approximately JPY 220,000. Compared with the balance of business income expenditures in the event, a developer purchases new land in the [ Trucks Logesty ] facility, the potential is to secure sufficient profitability to meet the rising cost of construction. In this instance, SMFL Mirai Partners Company Limited will serve as a development bridger. In employing a bridge scheme, successful steps will be taken to avoid any downtime during the redevelopment period by eliminating large temporary expenses and receiving land rent during construction. On the completion of construction, IIF will retain preferential negotiation rights over future new buildings with no obligation for acquisition. At the same time, the scheme is structured in a way that ensures the exercise of preference right at an appropriate time, while monitoring conditions and capital markets. Jumping into Page 22, IIF's pipeline continues to expand on the back of efforts to inform governance in Japan's corporate sector. and the subsequent surge in liquidation needs. Against this backdrop, IIF has already secured preferential negotiated rights over several properties. Currently, around 37.2% of deals in investment corporations pipeline under detailed consideration are comprised of manufacturing, R&D center and infrastructure facilities. From an asset class perspective, IIF will continue to acquire properties that contribute to a well-balanced portfolio. Turning to the next page, I would like to comment further on IIF Shonan Health Innovation Park. Acquired in 2020, IIF is undertaking a host of value of initiatives while working to revitalize the facility under the master lease with Takeda Pharmaceutical. From October 2025, plans were in place to reorganize the operational structure. As indicated at the right of the page, the master lease with Takeda Pharmaceutical will be replaced with a pass-through format directly within tenants. While originally operated by Takeda Pharmaceutical, the facility has been managed by iPark Institute and operating companies established by 3 shareholders, IIF, Takeda Pharmaceutical and Mitsubishi Corporation and staffed by a team of around 40 research professions since April 2023. Going forward, iPark Institute will serve as a pass-through master lessee. Earlier in this presentation, I touched on growing interest in life sciences. As background, we've witnessed robust demand for rental laboratories amid the surge in construction costs. Moreover, global competition for new drug development has become increasingly complex and intense owing to the incidence of COVID-19 and other pandemics. Under these circumstances, the global standard is now for start-ups, academia, pharmaceutical companies and venture capital companies to collaborate under the one roof, rather than major pharmaceutical companies developing drugs on their own. Taking the aforementioned into consideration, facilities that possess the sophisticated operational capabilities to combine these requirements and the equipment necessary to conduct advanced clearance from day 1 are accordingly extremely attractive to tenants. Since acquiring IIF Shonan Health Innovation Park in 2020, IIF is focused on revitalizing the facility by promoting tenant turnover and attracting new tenants in a bid to fill vacant space, all under the overarching mission of building a life science ecosystem. Leasing activities continue to progress smoothly. At the same time, IIF is working to realize an upside across the facility as a whole by shifting to rent pass-through master leases, setting a high unit price of end tenants rents compared with master leased rents and increasing occupancy by filling vacant spaces. As indicated here on Page 24, IIF is considering additional construction within the existing site in a bid to meet growing tenant demand. While plans are yet to be finalized, the investment corporation has launched study to assess profitability and consider the most appropriate scheme. This includes confirming tenant demand, consulting with public authorities and looking into the selection of a construction company. Furthermore, value expectations centered on the facility are high over the long term in light of the scheduled opening of [ Marioka New Station, JR Tokaido line ] in 2032 as well as the start of urban development plans in [indiscernible] area as a health innovation center. Please turn to Page 25. Here on this page, we provide certain examples where rents increased for major tenants at the time of contract renewal. These examples not only cover logistics facilities, but also manufacturing as well as R&D centers. This ability to increase rents reflects a variety of factors, including the [ license of renewing ] long term contracts, logistics facilities and traditionally prime locations and rent caps at the time contracts expire. Rent increases are also indicative of the asset management team's determined efforts on renovation proposals, the shift to LED lighting and the renewal equipment as well as win-win solutions that also benefit tenants. Directing your attention to Page 26, I would like to comment on the status of property-owned contracts. As illustrated at the right of the page, rents have increased for close to half or 46.3% for tenants whose contracts have -- will expire between the 31st and 36th fiscal period. The average rent increase ratio in this instance is 16.8%. Accounting for those instances where rents decreased, the overall increase is 5%. In overall terms, trends are on an upward trajectory. As we look to the future, every effort will be made to skew internal growth in the short term amid the inflationary trend. Changing track, I would now like to elaborate on Investment Corporation's financial strategy. Please turn to Page 28. IIF is inherently resilient to increases in interest rates. As you can see, IIF is distinguished by a stable financial base. Borrowings are largely undertake on a long-term fixed interest rate basis with maturities and borrowing costs higher than the J-REIT average. While for the most part, retaining its focus on long-term fixed interest rate borrowings, IIF will work to control costs and maintain financial stability by adopting a flexible approach. This includes undertaking a portion of this debt on a floating interest rate short-term basis. Looking at trends here on Page 30, loan-to-value or LTV on a book value basis came in at 50.8% as of the end of the 34th fiscal period. Accounting for the growth in unrealized gain, LTV on an appraisal value basis was 42.4%. In the future, IIF will work to manage LTV on a book value basis at around 50%. In closing, I would like to touch on Investment Corporation's sustainability initiatives on Page 32. IIF had originally set its Scope 1, Scope 2 greenhouse gas emissions target for 2030 at 42%. Through the adoption of [ RE100 ] and implementation of energy conservation measures, IIF reduced GHG emissions by 42.3% in 2023, achieving this medium- to long-term target. The investment corporation will continue to reduce emissions going forward. Details of other sustainability initiatives are provided on Pages 33 and 34 of the presentation materials. Data regarding IIF's operating results, earning forecast and factors that contribute to an increase or decrease is outlined from Page 35. I ask that you review at your leisure. This then concludes my presentation. I thank you for your interest and attention. I would now like to open the floor to questions.

A brief Q&A session on IIF's July 2024, 34th fiscal period results following the presentation on September 13, 2024. 4 participants put forward a total of 11 questions. The following is a summary of the questions raised and answers provided. Question. Is the pipeline for property acquisitions mainly comprised of collaborative projects with the sponsor? Answer. The ratio of pipeline properties is split evenly between collaborative projects with the sponsor and projects identified through the investment corporation's own route. Looking ahead, IIF will engage in acquisition activities, based largely on this 50-50 split. Question. You included life science facilities when commenting on IIF's efforts to build the portfolio over the medium to long term. What are your thoughts on the possibility of acquiring this particular asset class, from a pipeline perspective, our life science facilities included in deals under detailed consideration. Answer. In light of the upswing in life science related demand, we would first like to revitalize IIF Shonan Health Innovation Park. As far as the acquisition assets is concerned, we intend to focus on an extension project as outlined on Page 24. In addition, steps have been taken to establish iPark Institute, which serves as the facilities operating company. Working through iPark Institute, we will participate in urban development activities in the surrounding area. Moreover, other local governments have expressed an interest in undertaking urban development focusing on the life science field. Here, IIF or KJR management, will take part by proposing an assortment of real estate solutions as opportunities arise. Question. Looking outside the acquisition of new properties from [ Logesty ] is there any progress in the introduction of CPI linked rents and existing properties? And what is the status of initiatives? Answer. Recognizing that tenants are unaccustomed to this concept, there are difficulties in introducing CPI linked rents at existing properties. Accordingly, we are looking to increase the ratio by incorporating CPI linked rents clauses in sale and leaseback transactions where these contracts are generally prepared from scratch, mainly for newly acquired properties. In addition, the majority of CPI linked rent lease contracts are structured in a way that first revision negotiations are set after 5 years. Taking into consideration profitability for the portfolio as a whole under the current rising interest rate environment, we anticipate that rents will increase at existing properties through to the time of first CPI-linked revisions and then after 5 years. The increase in revenues at newly acquired properties attributable to movements in CPI will be added to the rent. Accounting for these factors, we will work to review the type of contracts while keeping a close eye on the overall balance of the portfolio. Question. Listening to your presentation, I get the impression that you will continue to actively promote external growth. What then are the preconditions for undertaking a public offering? Answer. IIF policy for acquiring properties through public offerings remains unchanged. The decision to undertake a public offering must be linked to increases in DPU and NAV per unit as well as an improvement in unitholder value. Investor sentiment is also a key factor in the decision-making process, which we will qualitatively ascertain through discussions, with security firms. Question. What is the current implied cap rate. What are your thoughts on the implied cap rate as a factor in your decision to undertake a public offering? Answer. We are looking at an implied cap rate before and after depreciation of around 4.5% and 3.5%, respectively. As far as property acquisition benchmarks are concerned, we are targeting a net operating income or NOI after depreciation of between 3.5% and 4.5%. From the perspective of improving total return, one benchmark for the unrealized gain ratio is 10%. Question. The NOI yield after distribution and NOI yield after taking into consideration, the continuous distribution of surplus cash of IIF Hyogosanda Logistics Center 2, coming at 3.5% and 3.7%, respectively. Was the decision to acquire the property made because this is roughly the same level as the implied cap rate after depreciation? Answer. When acquiring a property, steps are indeed taking to ascertain the implied cap rate level. The implied cap rate plays an especially prominent role at the time of public offerings and depends on the method of financing when undertaking an acquisition. The decision to acquire IIF Hyogosanda Logistic Center 2 was made partly because plans in place to utilize own funds. Question. There was mention of buybacks at the recent Investor Day. Are there any criteria for implementing buybacks? Answer. While there is no clear policy on what level of buybacks should be implemented, we believe that the acquisition properties would contribute more to increasing unitholder value as opposed to buybacks given the current level of IIF's unit price. Based on this understanding, the decision was also made to acquire IIF Hyogosanda Logistics Center 2. Question. What are your thoughts on the cost of capital? Is it your understanding that the acquisition of a property at a discount through a CRE carve out deal will pay for itself even when the capital cost is relatively high? Answer. While it depends on unit price and property yield, a decision is made after taking into consideration improvements in DPU and NAV per unit in the event of an acquisition following a public offering. In addition, in leveraging our private placement team, we will pursue opportunities to acquire properties through co-investment schemes, utilizing SPC as well as through bid screens. Question. While IIF's LTV is exhibiting an upward trend, can we regard the current LTV level as the upper limit? What is your financial policy? Answer. IIF's LTV based on book and appraisal value comes in at 50.8% and 42.4%, respectively. We do not see the immediate need to lower LTV and the policy to maintain LTV at the current level. Question. IIF undertook the acquisition of a large-scale [ Logesty Deal ] to a public offering in collaboration with the sponsor, KKR. Has this had an impact on subsequent acquisition opportunities? Answer. We believe that as a result of the [ Logistydeal, ] both IIF and KJR management profile in the markets improved. We are fielding inquiries and witnessing opportunities to participate in projects and co-investment proposals as a potential part and therefore, consider the impact to have been positive. Question. Interest rates are likely to increase in the future. Can you provide us with your in-depth view of interest rates? Answer. As indicated on Page 29 of the presentation materials, we are looking at a buffer with respect to interest rates in forecast for the 35th and 36th fiscal periods. The fact that interest rates did not increase as much as initially estimated, is one reason behind the 34th fiscal period upside. Moving forward, IIF will work further to secure the internal growth of existing properties. Looking at trend data on Page 16, the NOI unit has exhibited 5.2% increase over 2 years on a same-store basis. The goal is to target a 3% to 4% increase in NOI yield on a same-store basis over the next 3 years. Trends NOI yield are projected to remain positive even after factoring in further hikes in interest rates. We anticipate 1% increase even in the event of an industry increase on the back of the internal growth effect on DPU growth. [Statements in English on this transcript were spoken by an interpreter present on the live call.]