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

I am Masa Moritsu, the asset management company of Industrial & Infrastructure Fund Investment Corporation, hereinafter IIF. Thank you very much for taking the time of your busy schedule to join IIF's investor presentation for the 36th period from February 1 to July 31, 2025. Here is a summary of the financial results. Please refer to the upper section of the slide. The DPU for the 36th fiscal period came in at JPY 3,477, exceeding the initial forecast of JPY 3,450. As for the forecast for the following 37th period, we had revised it to JPY 3,480 in July, reflecting the sale of the IIF Higashi Osaka Logistics Center, hereinafter Higashi Osaka LC. With the additional sale of IIF Kamata R&D Center, hereinafter Kamata R&DC announced on the same day as these financial results, the forecast has been further revised upward to a record high JPY 4,310. Our new DPU forecast for the 38th fiscal period is JPY 3,600, and we expect to achieve this level ahead of schedule, originally targeted for 2027 to 2028. This represents an increase of 3.5% in DPU compared with the 36th fiscal period. For the return on gain on sale from 2 properties is expected to total JPY 4.9 billion, equivalent to JPY 1,960 per unit to be distributed going forward. The NOI growth rate on an existing property basis, which is an indicator of internal growth, will rise by 4.6%. As part of our capital allocation strategy, the proceeds from the asset sales were allocated to property acquisitions, IIF's first-ever investment unit buybacks and loan repayments to enhance unitholder value. Please refer to the lower part of the slide. We have highlighted 3 points: realization of unrealized gain, internal growth and external growth in line with our growth strategy. First, on the realization of unrealized gain. Higashi Osaka LC and Kamata R&DC will be disposed of at prices far exceeding their book values, resulting in a total of about JPY 4.9 billion in gain on sale. Second, on the internal growth. We will realize further upside from our mainstay properties, the Haneda Airport MC, hereinafter Haneda Airport MC and Shonan Health Innovation Park, hereinafter Shonan HIP. NOI of Shonan HIP for the 38th fiscal period is expected to rise by about 35% compared with the 36th fiscal period. Third, on the external growth. We will focus on asset rotation and portfolio realignment. Specifically, we will shift our portfolio to be more inflation resilient by selling limited upside assets and replacing them with assets offering greater internal growth potential. Slide 4 shows the trends in actual and forecast DPUs. Asset sales have been progressing smoothly. And in particular, for the 37th fiscal period, we expect to revise DPU significantly upward to JPY 4,310 due to the recording of gain on sale of Kamata R&DC in a lump sum, marking a new record high. For the 38th fiscal period, we forecast a DPU of JPY 3,600, driven by the second recording of gain on sale of Higashi Osaka LC. DPU, excluding gain on sale, is expected to rise by 4.7% from the 37th fiscal period to the 38th fiscal period. We continue to record gain on sale through portfolio rebalancing, aiming to achieve the JPY 3,600 level of DPU for the time being. NAV per unit for the 36th fiscal period rose to JPY 141,920 from the previous fiscal period. We will continue to actively convert unrealized NAV gains into distributable income. Our priority remains enhancing valuation by driving sustainable growth in DPU through 3 key drivers: To improve valuation, we continue to pursue our 3 growth strategies with a strong focus on enhancing DPU. In the first growth strategy, internal growth, we are targeting an NOI growth rate of 3% per annum. In the second growth strategy, realization of unrealized gain, we aim to return JPY 200 to JPY 400 per unit each fiscal period. In the third growth strategy, external growth, we will focus on asset replacement. Going forward, our policy is to shift the portfolio to one that is resilient to inflation over the medium term. Slide 6 presents our DPU growth targets. We aim to drive DPU growth through 2 key levers: steady organic growth and gain on sales. Although the DPU for the 37th fiscal period is expected to reach a record high of JPY 4,310, as explained on Slides 3 and 4, the DPU forecast of JPY 3,600 for the 38th fiscal period appears lower. This is mainly because gain on sale of Kamata R&DC, which will be recorded in the 37th fiscal period in a lump sum following negotiations with the buyer announced on September 17, 2025, will no longer contribute in the 38th fiscal period. For tax reasons, it has been difficult for IIF to retain gain on sales. And in cases where a large amount of gain will be recognized, we have historically carried out split sales over multiple periods. However, in this case, following discussions with the buyer, the gain was recorded in a lump sum. On the other hand, the initial forecast of DPU, excluding gain on sales for the 37th fiscal period was JPY 3,210. However, we revised it downward to JPY 3,086 due to the absence of income from the disposed properties, the cancellation of a leasing agreement that had been expected at Shonan HIP and a revision of earnings caused by higher utility costs of Shonan HIP. Nevertheless, going forward, excluding the originally assumed gain on sales for the 37th period, we will continue to target 3% annual growth from the baseline DPU forecast of JPY 3,210. For the 38th period, the DPU is expected to rise to JPY 3,231 through internal growth at Shonan HIP and Haneda Airport MC, and we aim to reach the JPY 3,400 level in 2027 to 2028. In addition, we aim to achieve a DPU in the range of JPY 3,600 to JPY 3,800 in 2027 to 2028 by continuously returning JPY 200 to JPY 400 per unit in gain on sale each fiscal period. In the 38th fiscal period, we expect to achieve a DPU of JPY 3,600 ahead of schedule. Going forward, we aim to further exceed the JPY 3,600 level through internal growth and the continuous return of gain on sale. Finally, as shown on the next Slide 7, we will also work to aggressively pursue DPU levels above our growth targets by rebalancing the portfolio toward assets with greater internal growth potential in addition to steady internal growth and gain on sale returns. The pie chart on this slide illustrates the classification of rent revision methods across the entire IIF portfolio. In light of the current inflation and higher interest rate landscape, IIF is repositioning its portfolio toward one with stronger internal growth potential. IIF has historically prioritized the stability of its portfolio, constructing a portfolio primarily composed of long-term fixed contracts. This policy performed well under the deflationary environment as such portfolio generated stable cash flows. However, to continuously enhance unitholder returns amid the shift to an inflationary phase, we should shift our portfolio to the one comprising assets with greater internal growth potential. The right side of the pie chart showcases our initiatives to shift our portfolio to a more inflation-resilient structure. In 2024, under our CRE carve-out strategy, we acquired 29 properties from LOGISTEED, incorporating CPI-linked rent revision clauses into long-term lease agreements. For existing properties, the lease contract for Shonan HIP was converted from a master lease to a pass-through contract, enabling us to pursue further upside potential. At Haneda Airport MC, we added CPI-based adjustment rent revision clauses requiring rents to reset every 5 years to the long-term fixed contracts upon contract renewal. Consequently, approximately 66.7% of our contracts are now adjustable for inflation. The left side of the slide outlines our criteria for disposition: Properties with contracts that have more than 5 years remaining period, land with leasehold interest subject to ultra long-term fixed rents, properties with limited rent revision potential and aging properties likely to face higher CapEx burdens in the future. These properties are targeted for disposition going forward as part of an asset management policy. By replacing these assets with properties with upside potential selected from our disposition pipeline, we aim to reposition the portfolio for stronger cash flow growth potential. Slide 9 summarizes our internal growth strategy. We target annual NOI growth of 3% on an existing property basis. Specifically, for the 5 fiscal periods from the 37th in 2026 to the 41st in 2028 over 2.5 years, we aim to grow NOI by 3% annually, which translates into an increase of about JPY 130 in DPU per year and more than JPY 300 in total over the 5 fiscal periods, 2.5 years. To achieve this NOI growth target of a JPY 300 increase per unit over the 5 fiscal periods, approximately JPY 194 has already been included in the NOI forecast for the 37th to 38th fiscal periods, reflecting internal growth at Haneda Airport MC and Shonan HIP. As for the remaining JPY 100, we expect an additional contribution of approximately JPY 150 to JPY 200 during the 39th to 41st periods, driven by factors not yet reflected in the earnings forecast, such as the leasing of the currently unused space at Shonan HIP from 2027 onward and the impact of shifting utility costs to tenants. In addition, we believe this target is fully achievable through upside opportunities at the time of rent revisions in logistics, factories and other assets as well as upside from re-tenanting at 2 factory properties. Furthermore, from 2029 onward, rent revisions linked to CPI will be added, which, depending on the CPI, are expected to contribute an additional JPY 90 to JPY 140. Slide 10 presents the highlights of our internal growth strategy. At Shonan HIP, starting in October 2025, the current master lease contract with Takeda Pharmaceuticals will be converted to an end tenant pass-through type contract with iPark Institute Co., Ltd., serving as the master lessee. At the time of the 36th fiscal period financial results announcement, we had expected NOI for the 37th fiscal period to be JPY 1,359 million. However, we revised the forecast downward to JPY 1,196 million, considering the cancellation of a new foreign tenant candidate and an increase in utility costs. On the other hand, for the 38th fiscal period, NOI is projected to rise to JPY 1,474 million, reflecting the leasing of approximately 6,000 square meters by a major domestically based pharmaceutical company and the full contribution of rent pass-through. Furthermore, in the 39th fiscal period, NOI is forecast to surpass JPY 1.6 billion through further lease-up and other initiatives with the NOI yield for Shonan HIP expected to rise to approximately 8%. Further upside potential includes end-tenant rent increases upon lease renewals, lease-up of vacant space and cost reductions through the pass-through of utility cost to tenants. Shonan HIP is one of Japan's flagship life science facilities. And as a fully operational asset, operational excellence is the key driver for enhancing asset value. Since our acquisition in 2020, we have been preparing for the pass-through conversion in 2025 by deploying asset managers on site to build operational expertise. As part of such an initiative, in 2023, we established iPark Institute Co., Ltd. with Takeda Pharmaceutical and Mitsubishi Corporation. Slide 11, the graph on the lower left illustrates the trend in end-tenant annual rent. End-tenant rent has increased along with an increase in leased area, recently reaching about JPY 5.0 billion annually. In addition, the average end-tenant rent as a whole has also risen. Over the past year, the average end-tenant rent rose by 4.3% to JPY 7,200 per square meter, while the average contracted rent for new tenants is around JPY 8,400 per square meter, resulting in a rent gap of 17%. We will leverage this rent gap to capture further upside through contract renewals and the attraction of new tenants. The right side of the slide highlights our initiative to convert building A into B-spec, a strategic investment involving the renovation of animal laboratories into biochemistry laboratories. Since our acquisition, the total investment of JPY 1.4 billion for 5 units has generated a strong return of 16.4%. We plan to make an additional investment in approximately 1,000 square meters of renovated units and in Japan's first private sector lease type clean room called iCODE, both of which are expected to deliver double-digit returns. Furthermore, approximately 3,000 square meters of vacant units remain in the facility as investment candidates, representing significant future potential. Slide 12. The graph at the left side of the slide shows the trend of average rent revisions for the entire portfolio over the past 5 fiscal periods. The rent revision ratio has increased by 5.6%, indicating a continued upward trend. The right side of the slide illustrates several examples of rent revisions. At the IIF Koriyama Logistics Center, hereinafter Koriyama LC, we raised rent upon contract expiration and introduced a new CPI-linked rent revision clause. At the IIF Kazo Logistics Center, hereinafter Kazo LC and the IIF Osaka Suminoe Logistics Center, hereinafter Osaka Suminoe LC. We also achieved rent increases to capture the rent gap. We have also succeeded in raising rents not only at contract expirations, but also during rent revision negotiations. Going forward, we will continue to proactively promote internal growth initiatives. Slide 13 shows the schedule of lease expirations and renewals as well as the expiry of Shonan HIP's and tenant contract. We achieved rent uplifts at the IIF Haneda Airport MC and the IIF Koriyama Logistics Center in the 37th fiscal period, and we expect to revise rents upward at the IIF Osaka Suminoe Logistics Center and the IIF Kazo Logistics Center in the 38th fiscal period. Beginning this fiscal period, to reflect the reality of rent increases, we have disclosed lease contracts that are expiring and being renewed through negotiations. From 2029 onward, 29 logistics properties acquired last year with CPI-linked rent clauses will face their first rent revisions. If CPI were to increase by 2% annually, this would have a positive impact of approximately JPY 140 in DPU. Let me move on to capital allocation. Following the sale of Kamata R&DC and Higashi Osaka LC, we returned gain on sale to unitholders and allocated the sales proceeds in accordance with our capital allocation policy. While all gain on sale were returned to unitholders as distributions, the sales proceeds were allocated to the repurchase of our own units, debt repayment and new asset acquisitions. As for asset acquisitions, we utilized the proceeds for a redevelopment project we had been working on for about 2 years, acquiring the newly completed IIF Narashino Logistics Center, hereinafter Narashino LC I in February at an NOI yield of 5.3%. And we also acquired a TK interest in Alps Logistics, backed by 8 properties at a distribution yield of 6.7%. Now let's look at the details of the 2 properties sold. First, Higashi-Osaka LC acquired in 2013. While it has been operated stably, we took the opportunity of the existing tenant's lease expiration to conclude a new 15-year long-term contract in 2023 and achieved a rent increase of about 20%. As a result, the appraisal value rose by more than 70% compared with the time of acquisition. Looking ahead, if we had continued to hold the property, the short-term upside would have been limited, and we anticipated higher CapEx requirements. Meanwhile, with a book value of JPY 2.4 billion, the impact of the sale on the overall portfolio would have been minimal, while the strong logistics market offered a chance for a substantial gain on sale. Taking these factors into consideration holistically, we decided to sell the property. Balancing these factors, we chose to dispose of the asset. The sale of the property generated a gain of approximately JPY 2.6 billion, equivalent to about 13 years of annual NOI after depreciation for this property. We plan to distribute gain on sale over the 37th to 39th fiscal periods. Second, Kamata R&DC acquired in 2012. The property had been operated stably under a long-term contract leased to Tokyo KEIKI Inc. as the sole tenant. However, with the fixed-term lease set to expire in March 2026, we examined 3 options: contract renewal, tenant replacement and disposal and considered our future management policy through deliberations with the tenant. If we were to continue holding the property, the rental upside opportunity would be limited and significant future CapEx would be required for maintenance. In addition, the risk of downtime was elevated due to a prolonged leasing period upon re-tenanting. On the other hand, the surrounding area is largely residential. And given the recent surge in condominium prices, we have identified strong demand from developers seeking conversion to residential use. Taking this into consideration, we determined that selling the property to a developer for redevelopment would be the best way to enhance unitholder value. As a result, we disposed of the property at a price far exceeding both its book value and appraisal value, recording approximately JPY 2.3 billion of gain on sale in a lump sum in the 37th fiscal period. The left side of the Slide 18 shows our track record of return of gain on sales. IIF has recorded gain on sale for 13 consecutive fiscal periods. Average disposal prices over the past 3 years have exceeded appraisal values by 15%, resulting in total gain on sales of as much as JPY 12.6 billion. In terms of asset type, we also have a track record of realizing unrealized gain on sales, not only in logistics but also in R&D facilities and others. The right side of the slide illustrates the development of unrealized gains. Currently, total unrealized gains for the entire portfolio have expanded to JPY 122.2 billion, and we will continue to return these unrealized gains to unitholders through asset replacement. Slide 19 outlines our policy on asset dispositions and the use of proceeds. We have a disposition pipeline of JPY 50 billion to JPY 60 billion, representing 10% to 15% of the portfolio. For the use of proceeds from sale, gain on sales will be returned to unitholders and the remaining proceeds will be allocated to asset acquisitions, buybacks of our own units and debt repayments with a focus on enhancing unitholder value. Slide 20 shows the policy for the use of proceeds from dispositions, which was included in the investor presentation for the 35th fiscal period. Our policy is to prudently determine how to allocate sales proceeds in order to enhance unitholder value. Specifically, when the NOI yield after depreciation is higher than the implied cap rate and the effect of improvement in DPU and NAV per unit is higher than that of a buyback, we choose asset acquisition. Otherwise, we choose either a buyback or debt repayment. Slide 22 outlines our external growth strategy. We continue to focus on asset replacement. The left side of the slide illustrates our disposition pipeline of JPY 50 billion to JPY 60 billion, which includes land with limited upside potential and logistics facilities expected to generate sizable gain on sale. Conversely, acquisition candidates have grown to approximately JPY 70 billion, including those sourced through bridge funds. This acquisition pipeline encompasses a wide variety of asset classes, such as logistics and infrastructure facilities under the CRE carve-out strategy as well as factories. We are particularly targeting assets with clear upside potential such as properties with CPI-linked rent clauses, renegotiation clauses or rent gaps as candidates for future replacement. We also continue to secure flexible acquisition opportunities via private funds, as shown on the right side of the slide. Specifically, in light of the current capital market environment for J-REITs, we will explore various approaches, including forming bridge funds to attract new investors and secure future acquisition opportunities for high-quality assets. The recent Alps Logistics transaction serves as a good example of this strategy in action. Finally, I will touch on our financial strategy. Despite rising borrowing costs, we will monitor interest rate trends carefully and manage borrowing costs through flexible financial measures centered on fixed rate borrowings. Our financial forecasts have conservatively factored in interest costs, assuming a buffer over the base rate as of August 27 when the 10-year JGB stood at 1.625%. For the 37th and 38th fiscal periods, when assuming the base rate rises by 25 basis points, there will be no impact on DPU for the 37th fiscal period and only a modest decline of about JPY 4 in the 38th period. If the base rate rises by 50 basis points, DPU would decline by JPY 6 for the 37th fiscal period and JPY 7 for the 38th fiscal period, both of which are considered to have minimal impact. From the 39th fiscal period onward, we assume an increase of approximately 25 basis points. However, this level is expected to be sufficiently offset by internal growth effects. Slide 26 shows the development of LTV. As of July 31, 2025, LTV stood at about 41.6% on a market value basis and 50.8% on a book value basis, and we intend to maintain it at the current level. Due to the acquisition of Narashino LC I through debt financing, LTV has temporarily increased for the time being. However, we plan to repay debt with the sales proceeds from Kamata R&DC, which will help maintain the current LTV level. This concludes my presentation. We will now move on to the Q&A session.

Question 1, on expanding asset size via asset rotation. In your presentation, you mentioned replacing assets to shift toward a portfolio resilient to inflation. Looking at the amounts in the disposition and acquisition pipelines, they seem roughly the same or acquisitions are slightly larger. As a basic approach, do you intend to prioritize rotating into a portfolio with solid internal growth potential first and then pivot to expanding asset size that is external growth? Or depending on circumstances, would you pursue asset size expansion and internal growth in parallel?

As stated in today's earnings presentation materials, our 3 growth strategies are internal growth, asset rotation and returning gains on sales. Among these, our top priority is to improve our valuation. For the time being, envisioning a 2- to 3-year period, we will prioritize asset rotation. After we have enhanced valuation, we plan to move into a phase of external growth.

Question 2, changes in re-tenanting needs. Aside from Shonan HIP, Slide 9 also discussed internal growth through re-tenanting at factories and similar properties. Could you share an update on what type of companies are showing demand? In other words, on tenant demand?

As you pointed out, Shonan HIP is exhibiting very strong internal growth. In addition, with respect to rotating assets among factory properties, as illustrated by the concept of converting building A into B-spec, we see upside potential through tenant replacement and similar measures. We also believe conditions are in place to enable rent increases at the time of lease expirations.

As a follow-up regarding the factories, what characteristics do the new tenants tend to have when spaces are retenanted?

In terms of new occupants, for example, when a manufacturing tenant vacates a factory, another manufacturer may take the space. In one factory case, an environmental recycling company is also under consideration. Accordingly, we feel the scope of potential retenanting candidates for factories is broadening in this way.