Japan Metropolitan Fund Investment Corporation (8953) Earnings Call Transcript & Summary

Good afternoon, everybody. This is Mashida, in charge of the management of Japan Metropolitan Fund Investment Corporation. Today, I'll be presenting the financial results of JMF for the 47th fiscal period. Now please look at Page 2. This report outlines the growth strategy currently being implemented by JMF and the quantitative targets announced in the previous fiscal year. Again, as a quantitative target, we set the goal of increasing DONAV or DPU divided by NAV to 5% and continuously grow NAV. By achieving this target, we aim to raise investment unit prices to a level above NAV. Please take a look at Page 3. I will now explain the progress of our quantitative targets. As actions to achieve the quantitative targets, we've set out to raise our portfolio NOI by 10% over the medium term, return sales gains by at least JPY 300 per unit per fiscal year and further improve earnings by replacing assets and utilizing LTV capacity. NOI increased from JPY 29.2 billion in fiscal year 46 to JPY 31.3 billion in fiscal year 49, 7% increase in 1.5 years and an annualized growth of 4.6% is significant improvement. We succeeded in making major progress toward NOI increase of 10% Next, I'd like to discuss the return of sales gains. Since the previous announcement of financial results, we made a series of announcements. We succeeded in selling at a level significantly higher than the book value and appraisal value. We secured a large amount of sales gains that will be a source of a return of JPY 300 per unit per fiscal period for 3 years until the 53rd fiscal year ending August 2028. Finally, regarding external growth, we acquired a new office portfolio from Fujisoft at approximately JPY 70 billion with an NOI yield of 4.7% and an unrealized gain ratio of more than 30%, improving DPU through asset replacement. We'll make significant progress toward achieving our targets in both internal growth, return of profits from sales and external growth. At the same time, we'll eliminate portfolio rent gap 10% for internal growth, actively replace assets to increase sales gains, continue with CRE carve-outs to achieve disciplined external growth. Please take a look at Page 4. DPU for the 47th fiscal year rose 0.4% from the previous period to JPY 2,820, reaching record high. The 48th DPU is expected to hit record high of JPY 2,952. 49th will be JPY 2,850. The 49th fiscal period is down from the 48th. However, there is a bidding closed at last weekend. And if we properly execute this deal, we'll be back to the level. NAV per unit also hit a record high at the end of the 47th due to the increase in appraisal value associated with improvement in NOI, rising 2.2% from the previous period to JPY 123,500. This means CAGR of 5% over the past 2.5 years starting in the 42nd period and a 48th due to the acquisition of an office portfolio with large unrealized gains from Fujisoft, NAV per unit is expected to rise further. The major point of today's announcement is that underlying EPU of the portfolio has improved significantly, calculated by excluding amortization of goodwill and sales gains from net income. Despite rising interest rates and the establishment of certain level of interest rate buffer, primarily due to the previously mentioned NOI improvement, the forecast is expected to increase by approximately 7% from JPY 2,300 level in the 46th period to JPY 2,500 in the 49th. Please see Page 5. This section outlines the results of internal growth, the main driver of our growth strategy. The average annual growth of existing portfolio NOI over the past 2 years and next year is expected to be 3.2% over the total 3-year period, a further increase from 3% indicated in the previous period. This growth is supported by increase in the rent for urban retail facilities and offices as well as in parking lot revenue, card fee revenue and ancillary income such as new signage. The portfolio rent gap still exists at 10%. Market rents continue to rise and additional income such as parking lot revenue is expected to increase in the future. Price hike in general may increase percentage lease revenue. We will continue to achieve internal growth that exceeds expectations of investors. Please see Page 6. I will explain the progress of return of profit from sales. In third asset sales announced so far, we expect to generate approximately JPY 15.8 billion in gain from 47th to 49th. About JPY 3.3 billion of this is returned in the 47th and the portion is transferred to the reserve for reduction. A total of JPY 14.6 billion, including the reserve will be returned by the 53rd, ending August 2028. Of course, we will continue to sell assets, so we will continue to strive to obtain capital for return and improve DPU over medium term. Please see Page 7. I will explain external growth. In the 47th fiscal period, we were able to sell at high prices and buy at low prices, which is the principle of external growth. With regard to asset sales, we successfully sold properties of the significant unrealistic losses at prices higher than book value, transferred assets with limited growth potential and risk of rental decline, exceeding their appraisal value at nearly double the appraisal value and book values. Regarding acquisition, a relatively new office portfolio from Fujisoft has been acquired at higher than implied cap rate and an unrealized profit margin of more than 30%. Going forward, with regard to asset sales, since we focus on sales activities in fiscal period 47th, we are currently considering sales of approximately JPY 10 billion. One of the assets closed bidding the last weekend. We should be able to sell above the appraisal value. Going forward, we plan to sell about JPY 40 billion of assets. We are receiving unexpectedly high offers even for assets not currently designated for sale. We'll continue to make use of these offers to sell them at high prices and return the capital gains. Next, I'd like to discuss asset acquisition with preferential negotiation rights or a high likelihood of acquisition amounts to approximately JPY 30 billion. These are balanced with office, retail and residential, and the NOI yield exceeds the implied cap rate. In addition, although I cannot give specific details, there are several CRE carve-out deals in consideration after Fujisoft. We will build a pipeline with discipline as a new initiative. We will consider not only income returns, but also capital returns as well. We aim to establish a framework that enables stable dividend payouts from capital gains, not only by utilizing unrealistic gains from existing properties, but also by obtaining capital returns from new investments such as value-up projects in retail properties. Some of the assets acquired from Fujisoft are located in areas suitable for residential. We may sell them to condominium developers after tenants leave. This is an investment for capital returns. Investment capacity is maintained sufficiently through future asset sales and LTV capacity. Also, due to an increase in cash flow and appraisal value, LTV will continue to decline and investment capacity will increase further. Since we have sufficient investment capacity, we will consider capital increase when we have an assurance that such a capital increase will have a positive impact on investment unit price. Not to mention DPU and NAV will have to improve. Please see Page 8. Generally speaking, diversified REITs tend to be undervalued by the market compared to the specialized REITs, so-called conglomerate discounts exist. There are several possible reasons for conglomerate discounts. Presence of underappreciated sector, sector-based expertise may not be as good or from the investor standpoint, the difficulty in conducting valuation assessment. On the other hand, we believe there is a premium for diversified REITs. JMF is a merger of retail REIT and office REIT with specialized expertise and KJRM as a whole manages REITs and private placement funds with high expertise across sectors. In particular, the combination of retail and office is compatible and easy to generate synergies. With its high retail expertise, JMF is in a position to maximize its effectiveness. For example, during COVID-19 pandemic, both office and retail were weak. But service tenants such as beauty clinics had momentum. We used our retail tenant relations in office buildings and invited service tenants to realize upside. Recently, as office rents are surging, we are inviting office tenants to the upper floors of the Omotesando area and establishing setup offices for further upside. In terms of external growth, we have a wide range of investment targets. We can replace assets rather quickly, respond to bulk deals and multipurpose applications and new applications as well. In addition, we may invest in anticipation of the sector cycle. JMF has acquired high street assets at low cost during the pandemic. We made major acquisitions before housing rents and office rents began to rise. If we operate properly, diversified REITs may achieve a kind of growth that cannot be imitated by specialized REITs and will operate towards a diversification premium. In addition, we will evolve our disclosure to make it easier for investors to value. We'd appreciate it if we could have discussions at one-on-ones and other events. Next, I would like to explain the points of the financial results for the 47th and also the forecast for the 48th using Pages 9, 10 and 11. First of all, for the 47th fiscal year, operating revenue, income and net income all exceeded the guidance announced on April 21, 2025, with EPU closing at JPY 3,016, up 11.9% and EPU closing at JPY 2,820, up 1.8%. Despite a decrease in revenue due to additional sales, NOI was able to significantly increase mainly in complex urban retail and office sectors and both revenue and net income. Next is our 48th fiscal period forecast. Operating revenues, operating income and income all significantly exceeded the forecast for April 21, 2025. EPU is projected to increase by 16.8% to JPY 3,242 and DPU up by 3.6% to JPY 2,952. Primary factors are the recognition of additional gains on sale of properties and external growth, driven by the acquisition of office portfolio from Fujisoft. This is expected to generate revenue significantly exceeding the drop in revenue from the sale of additional properties. For existing properties, we plan to implement strategic investments such as implementing additional sales promotion initiatives to boost sales in retail facilities and advancing restoration work with the aim of enhancing future earnings. Excluding strategic investment costs, the existing portfolio is excluded. We are expected to see steady revenue growth, primarily driven by cumulative contribution from rent rises and lease-ups for mixed-use and office properties as well as rent increases for residential properties. Furthermore, while we continue to anticipate a certain degree of rate hike based on the current environment, nonoperating income and expenses are expected to improve as a result of refinancing completed to date. For the first time, we are announcing a forecast for the 49th fiscal period. We project EPU to drop by 7.8% period-on-period to JPY 2,990 and DPU to drop by 3.5% period-on-period to JPY 2,850. While operating revenue, profit and income for the period are all projected to fall below the 48th fiscal period forecast, this is primarily due to differences in gain on sales and NOI and underlying EPU have -- are steadily increasing. Although revenue declined due to the expensing of fixed asset taxes on properties acquired in the previous period and the impact of property dispositions, the increase in revenue from existing properties has more than offset these losses. This was also driven by the effects of the strategic investments explained earlier for the 48th fiscal period. We anticipate robust growth, particularly in mixed-use and retail facilities. Regarding the existing borrowing costs, refinancing in 49th fiscal period incorporates a 40 basis point upward buffer from current interest rates, leading to an expected increase over the previous period. However, if the rate hike remains within the buffer, the impact will shift to an upside. Furthermore, as previously stated, if the disposition for which bidding closed last weekend is successfully executed, we plan to raise DPU to the same level as the 48th period. This concludes the financial results for the 47th fiscal period and the forecast for the 48th and 49th fiscal period. Moving on, I would like to highlight the main points starting from Page 13 and onwards. Please refer to Page 14. Regarding internal growth, I will first explain the characteristics of JMF's portfolio. All segments, including retail, office and residential feature rent gaps and upside potential. The Retail segment is centering on short-term and fixed-term lease contracts, primarily in urban commercial centers, where revenue-based rents are achievable. The office segment has a rent gap exceeding 10%, while residential segment is located in densely populated urban areas with nearly 5% rent gaps. Page 15, I will explain specific results of the internal growth initiatives. This period's lease renewals saw robust rent rise across all sectors achieving portfolio rent increase rate of 7.7% and DPU impact of JPY 32 per fiscal period notably. The increase rate for hotel and retail properties significantly increased, exceeding 10%. In addition, the proportion of rent increases among lease renewals exceeded 50% across all sectors, with residential properties achieving increase in nearly all cases, reaching 78%. Please take a look at Page 16. First, regarding retail properties, rents in existing portfolios are growing at an average annual rate of approximately 3%. This high growth rate is driven by rising market rents and nearly 0 vacancy. Please refer to Page 17. First, regarding sales trend during the 47th fiscal period. Sales performed well in all areas near major railway stations and residential districts, driven by renewal and inflation. Meanwhile, high street sales temporarily declined due to the impact of the Hong Kong originating prophecy, but gradually recovered from August onward and now have returned to the same level of the previous year. This year, revenue-based rent rose in the 47th fiscal period, driven by terminal station areas and residential neighborhoods. From the 48th fiscal period onwards, the recovery in high street sales added to this, and existing portfolio is growing at the pace of 3%. With revenue-based rates set for 60% of retail tenants, we can expect further rise in revenue-based rent as sales continue to expand. Kindly take a look at Page 18. Specific examples are listed. At Mozo Wonder City, the large-scale renewal carried out this spring has led to sales growth and increased revenue-based rents. Combined with cost reductions achieved through bidding process for property management and building maintenance companies, the appraisal value rose 6.2% this period. At Cute Harajuku, proactive rent adjustment and tenant replacement capitalizing on increased commercial demand along Takeshita Street achieved rent uplift of over 20%. We're actively pursuing NOI improvement for master leased properties as well. At AEON Naha Shopping Center, by collecting usage fees from tenants corresponding to CapEx investments, it is expected to yield 13.2% NOI increase. To achieve a rent increase even in master leased properties is also the strength of JMF. Turning to Page 19. Next, regarding offices, we continue to achieve robust rent growth, capitalizing on active leasing market and delivering steady results. At JMF Building Sakae 01 acquired last year, rent increases were achieved with multiple tenants, either through contract renewals or before the expiration of ordinary lease contracts. This resulted in increase in appraised value close to 2% within only 8 months of acquisition. At JMF Building, Ueno 01 where the main tenant is scheduled to vacate during the 48th fiscal period, backfilling is already in progress with leases being signed at higher rent levels than those of the previous tenant. Cost reduction efforts have also progressed, leading to 6.9% increase in the appraisal value for the current period. Regarding Twin 21 at the time of the previous results announcement, approximately 2,500 tsubo of vacancy had emerged in the MID Tower, but the backfilling is now nearest complete, accompanied by rent increases. Please refer to Page 20. Regarding residential properties, rent increases continued with high growth rate of 7.3% on tenant replacement and 2.6% at the time of rent renewal. Rent uplift is particularly strong in Tokyo Metropolitan area. Additionally, dividend yield significantly improved to over 8%, driven by strong rent increases in private REIT investments and gain from asset replacement. Also for hotels of OMO3 and Tokyo Akasaka, which operates under a fixed plus revenue-based rent structure, has seen a significant increase in variable rent, more than doubling compared to the 43rd period, 1 year after its opening. Kindly refer to Page 21. In addition to rent increases, we are pursuing a number of initiatives to enhance NOI, such as car and bicycle parking revenue, signage billboard revenue, card processing fee and other ancillary income sources. By steadily accumulating these improvements across individual properties, we anticipate NOI impact of approximately JPY 110 million per fiscal period. These efforts are contributing to robust NOI growth. We have also included examples of integrated premium realization through internal growth, as mentioned earlier. By strategically replacing tenants, transitioning from office to retail and vice versa, we have achieved significant upside potential. Please refer to Pages 23 to 26. This section outlines our achievements in external growth and asset replacement. While we will omit specific details, let me explain the outline of the sale and lease agreement from the CRE carve-out deal with Fujisoft. On Page 25, the agreement with Fujisoft incorporates a rent revision clause that allows rent adjustment every 3 years based on the change in prevailing office market rates. This office market rent adopts the market rent for each property location area as published by multiple office brokers. Data shows that during periods of inflation, the rate of increase in office market rents tend to exceed that of CPI. The rental structure enables robust income growth fueled by inflation. Reviewing the past trend over the past year, rents in office market where this property portfolio is located have risen by approximately 4%, demonstrating that significant rent increase can be expected at the time of lease contract renewal. Please take a look at Page 28. We will now discuss finance and sustainability. Regarding financing, considering the current funding environment, we will implement a fixed rate borrowing as a core of our funding strategy. We executed financing focusing on medium-term fixed rate borrowing, resulting in a fixed rate ratio of 93% and a long-term debt ratio to be 96.9% for the 47th period. Furthermore, the 48th and 49th fiscal periods, refinancing will primarily be conducted at the long-term fixed rate, considering the possibility of interest rate hikes over the next 2 periods, a buffer of 20 basis points for the 48th period and 40 basis points for the 49th period. Regarding sustainability, we achieved the highest external recognition by earning the highest rating of 5 stars in the GRESB Real Estate Assessment for 5 years in a row. Finally, I would like to talk about our strategy. As strategies across J-REITs continue to converge to achieve higher unit price, we believe the key going forward lies in how J-REITs can differentiate themselves and achieve higher growth. JMF possesses the largest asset base among diversified REITs, providing the strength to engage in aggressive rent negotiations without concern over potential vacancy risks at individual properties. Our main asset, primarily urban retail facilities have 5- to 6-year lease contracts. Lease renewal for tenants who signed fixed-term leases during COVID-19 pandemic will peak between '26 and '28. We see significant upside potential in rent revision, and we will negotiate aggressively. Furthermore, JMF leverages cross-sector asset management to attract tenants in the most rent-generating use category at any given time. This enables us to achieve high NOI growth unattainable by specialized REITs, thereby creating clear competitive differentiation. KJRM, the asset manager of JMF possesses advanced asset management capabilities that do beyond those of typical J-REIT operators. This includes over 20 years of retail facility operation experience and expertise in opportunity fund operations. As demonstrated by its track record with JMF and IIF, KJRM leverages a broad network of relationships from operating companies to international funds to excel in maximizing property sale values. Furthermore, leveraging the strength of its sponsor, KKR, JMF continues to achieve external growth through CRE carve-out deals, an area that is difficult for competitors to replicate. By leveraging these strengths, we will strive for steady income growth and sustainably enhancing unit price performance with the ultimate goal of maximizing total returns for our investors. That concludes my presentation. We will be receiving questions.

[Operator Instructions] From SMBC Nikko Securities, Torii-san, please.

This is Torii speaking from SMBC Nikko Securities. I have three questions. First of all, about asset acquisition. So there is a possibility of major acquisitions. And this time, there was a number of assets acquired from Fujisoft. And also, as you mentioned, there are high probability ones, JPY 30 billion with the first rights. And also, there are several carve-out deals that may possibly happen. And for these deals in the current transaction market, there may be some assets already available in the market. So is that the case? Do you have a special source of information that is only available to KKR Group? So including the acquisition power or the capabilities, can you elaborate on the acquisition situation? And then also, the second question is about sales. So there is JPY 10 billion and then JPY 50 billion in total possibly. And then so how would you characterize these assets that you are looking into selling? And in Page #23, I see these are the suburban retail shopping centers and revenue is now maximized. So there are not many upside anymore. Or if you look into the suburban shopping centers where the revenue may decline going forward and also in urban facilities, there may be some facilities where we can't really expect upside. So if you can discuss about how you decide on which assets to sell. And then the third question is, I think that for you, you are strong with urban assets and you have the power to increase the rents. And then especially for the retail facilities or the assets in urban areas, I do look at the data myself. But recently, the market, I wonder if the rents are still strong or if we have come to a pretty good level. And also if market-wise, if it's still difficult to increase, then if there are any individual circumstances. So if we can discuss about urban facilities as well.

Thank you very much, Mr. Torii-san. So number one, regarding asset acquisition, well, let me briefly explain about transaction market. So now it's not only about us, but I know it's increasing in general. And especially for the urban assets, everybody is expecting higher NOIs. And in retail locations like Ginza, 1% level and in Shirogane or Takanawa, in residential areas, we are around a 1% level. So that's the kind of yield. And our market is quite tight at the moment. So at this kind of yield, well, we cannot really acquire, so we have to utilize our own network and use KKR information source or looking at the carve-out deals. And then the pipeline we have built so far, we have been using our own network and KKR sponsored carve-outs. And second question about asset to sell, how we pick out the assets to sell. Torii-san, I think you explained well. Number one, we focus on suburban retail facilities where upside may not be expected going forward. And also in office, when a tenant leaves, then we have to decide if it's better to try the backfill or get the sales gains instead by selling to residential developers. So we are assessing individual property during the evaluation process, trying to seek the right balance. And then for the urban facilities, sometimes we do get very high offers. So for the investment unit price, sometimes it's better to seek the sales gains by selling at the higher prices. And then about urban facilities market in general, as I said at the beginning, the momentum of the market is strong. And so we're trying to see if we can get the sales gains. And I can't really say exactly where in Ginza, but there's JPY 400,000 that's been offered for the multiple floors. And also in Omotesando, tsubo price is nearly JPY 400,000 for the mezzanine types. So the market is pretty good. And then the market rate always follows. And then also the luxury brands, we can't really take the data on their rates. So we basically have to follow. But market-wise, it's been quite strong. And in these strong market circumstances, we have to identify the strong tenants and then ask for the higher rents. And that's actually our strength. So with this, we are aiming at achieving higher than market NOI improvement.

Thank you, Mr. Torii-san. Next, from Mizuho Securities, Mr. Ohata-san, please.

My name is Ohata of Mizuho Securities. I have one question. Page 3, an executive summary of the internal growth on the left-hand side, NOI growth of 10% on midterm basis that is mentioned on this page. According to the presentation made previously, taking 3 years' time or 4 years' time, you are trying to achieve that level. Are you making advancement in your plan?

The timing of achieving 10% over a 3- to 4-year period. I mentioned that the urban type retail sectors. Between 2026 and 2028, there will be a lease contract renewal coming for those who sign the lease contract at that time and they grew quite solidly. So we were able to make advancement and we can achieve that level rather than waiting for another three years.