Japan Real Estate Investment Corporation (8952) Earnings Call Transcript & Summary

Hello, everyone. I'm Naoki Umeda, CEO of Japan Real Estate. I want to walk you through our performance review for the period ended March 2021. At the performance review meeting about 3 years ago. I told about 100 participants who gathered in one of our meeting rooms that we should all get out of the meeting room on a very beautiful day like today. I'd rather go out on a golf course and give my presentation in between playing golf and you would be lying at a tropical beach and tuning in to our performance review on your iPad. And I said that day may come sooner rather than later. That was 3 years ago. Today, we are under the state of emergency across Japan, so I doubt anybody is listening to this earnings call on a tropical beach right now. But of course, we can do that very easily with today's technology. So the day I was talking about has come. Now please allow me to digress a little bit. I recently finished reading the book titled The Tyranny of Merit written by Michael Sandel Professor at Harvard. The Japanese translation is now available, so many of you perhaps may have read it already. This book is fantastic and inspiring in the sense that it makes us pay attention to and think about, from many angles, the inconvenient truth, that the gap between the rich and the poor hasn't narrowed but keeps widening. And the book also got me thinking, what could happen to our society if the gap remains growing where the rich and near-rich people are working from resort or their summer houses, while those who can't afford such a luxury continue to be forced to commute and work long hours? That can lead to more division in the society and could possibly lead to more violence. And I think we should do something to prevent such injustice from happening in the future. What do you think? Now let's get started with the performance review. Please take a look at Page 3. The dividend payout for the period ended March 2021 was JPY 11,320 per unit, up for 14 consecutive periods. For the next 2 periods, it will be JPY 11,350 per unit; and after that, it will be JPY 11,100 per unit, as you can see them at the right-hand of the chart. I'm going to give you more details for the dividend forecasts. Let's move on to Page 5. Here is our view on the situation surrounding our business during the March 2021 period. New demand for office space remained sluggish as companies kept a wait-and-see attitude given the prolonged state of emergency put in place to curb the infections. As a result, both market vacancy rates and our portfolio's vacancy rates were gradually rising. We also saw the market rent pass its peak and the pace of upward rent revisions among existing tenants began to slow down. Let me also briefly talk about shop restaurant tenants. As part of our rent assistance program for tenants, we granted temporary rent reduction to some of our restaurant tenants, pulling down revenue by JPY 42 million for the March 2021 period. The next thing I want to talk about is the office market outlook in Japan. First of all, I think that the slower-than-expected vaccine rollout in this country is likely to suppress tenants' appetite to look for new space for some time to come. So even though I can't say it for sure, new demand will stay limited for a year or so, and vacancy rates will continue to edge up in the meantime. But if and when the beginning of the end of this pandemic appears in sight, and I think it is possible to see it in 6 months at the earliest, companies and big corporations in particular may start trying to find yet another new way of working. And as the search for new work style begins, we expect there will be more tenants that move out than move in at first. But we also expect to see the needs for better locations and a working environment begin to grow again and rise gradually, and we are well positioned to absorb that kind of demand. Of course, there are companies that continue to embrace remote working. But I guess, actually, quite a number of companies will insist on working in the office once they can choose to do so. And as more companies explore different ways of working, the workspace and office buildings in particular will be increasingly expected to function, to facilitate communication, innovation, education or corporate culture penetration among employees. Also, this is something I talked about before, the demand for greener office building or health and well-being has been rising and may become even bigger going forward. Of course, this is all happening as we are trying to become carbon-neutral around the world. So looking a little further ahead, we expect that the office market will be slowly divided into 2 extremes: Office buildings that are chosen and loved by tenants and those that are not. And I think it should take a very long time before we would see every office building being 100% occupied regardless of its quality. Please take a look at Page 6. It is within this context that we go ahead with the strategic portfolio replacement and share with our unitholders the gains on sales of properties through such asset replacement. The basic principle is to distribute about 1/20 of the period end balance of our internal reserves in each fiscal period. On the lower half off of the page is the profile of Otsuka Higashi-Ikebukuro building and the prices as well as other details about its disposition, which is scheduled to take place in August. When it comes to portfolio replacement, acquisition and disposition do not necessarily happen at the same time. We think the more realistic pace of replacement is somewhere between 2 and 3 years. Next, please go to Page 8. Here are the financial results for the period ended March 2021. First, let us compare the results with those of the previous period. Please take a look at the table on the upper right side of the slide for the factors that explain the variance. Rent and service charges from existing properties fell following the rise in vacancy rates. But some of this drop was recouped with the full period contribution of Link Square Shinjuku, which we acquired in the previous period. As a result, operating revenues came in almost flat at JPY 34.9 billion for the March 2021 period. Repairing expenses went up slightly from the extremely low levels of the previous period, but that increase was absorbed by the big drop in utilities expenses. So operating profit also came in almost flat at JPY 16.4 billion compared with the previous period, as you can see in the middle of the slide. In the period ended September 2020, we posted a gain on the donation of non-current assets of JPY 110 million. It was a gratuitous transfer of the underground passage which was constructed as part of the property development next door. Of course, we didn't have the kind of one-off item for the March 2021 period, and that's why ordinary profit was down by about JPY 100 million from the previous period to JPY 15.5 billion. Things become a little bit more complicated when you look at the lines below ordinary profit. As we announced before, we began to distribute 1/20 of the period-end balance of internal reserves for dividend payment from the March 2021 period, and that process was reflected in 2 lines of the P&L. One is income taxes deferred and the other is provision of reserve for tax purpose reduction entry. To put it more simply, the balance of internal reserves at the end of the September 2020 period was JPY 3.7 billion, and we spent 1/20 of that, or JPY 180 million, to pay for dividend. And this made up for the absence of the nonoperating income of JPY 100 million which I explained earlier. That is how DPU came to be JPY 11,320 for the March 2021 period. Now to compare the results with our own forecast we made 6 months ago, please see the table at the lower right for the factors that explain the variance. Operating profit beat our own forecast by JPY 389 million, thanks to the fact that rent and service charges increased slightly more than expected and property management expenses and utility expenses were kept well under control. Dividend per unit also beat the forecast by JPY 290 per unit. Next, take a look at our balance sheet on Page 9. Actually, there is nothing special to explain about the balance sheet, except the number for the period-end balance of internal reserves, which you can find at the bottom right of the page. We've added the number because it is extremely difficult to see how much internal reserve we have just by looking at the balance sheet, even though we have proclaimed that we spent 1/20 of the internal reserves. Let's move on to talk about the forecast for the next 2 periods. Please take a look at Page 10. First, we are going to discuss the forecast for the period ending September 2021. During this period, we will dispose Otsuka Higashi-Ikebukuro building and expect to post JPY 2.530 billion gain on the sale of real estate property, a big boost for revenue as well as profit. For more details, please refer to the list of factors that explain the variance shown on the upper right of the slide. Vacancy rates are expected to keep going up and rent and service charges will fall by JPY 300 million a accordingly, which will bring our property-related revenue down by JPY 500 million or so for the September 2021 period. Now when it comes to expenses, property-related expenses are expected to rise as utilities expenses will go up in summer, and the property and other taxes will increase because of the buildings we acquired last year. And that is why we expect property-related profits to go down by JPY 686 million. But ordinary profit will increase to JPY 17.140 billion, up more than JPY 1.6 billion because of the gain on the sale of real estate property. And for this gain on the sale of real estate property, we are going to use the special tax exemption scheme concerning asset replacement and to reserve about JPY 1.4 billion. That will enable us to secure JPY 15.720 billion for dividend payment, which is on par with that of the March 2021 period and pay a dividend of JPY 11,350 per unit. And just so you know, we are not going to spend from the internal reserves for the September 2021 period because we will be able to pay enough dividend from the gain on the sale of the property. As for the forecast for the period ending March '22. Again, you can check the list of factors on the lower right of the slide. The headline is that property-related revenues are expected to edge up, while property-related expenses will remain unchanged from the September 2021 forecast. That leads us to expect our property-related profits to go up by JPY 240 million, but ordinary profit is expected to fall JPY 2 billion to JPY 15.140 billion because there will be no gain on sale of real estate property. The JPY 2.5 billion gain which we have for the September period will be gone for the March 2022 period, but we will have JPY 4.9 billion for the period-end balance of internal reserves. So we are going to distribute 1/20, or about JPY 250 million, to pay for dividend. That is why DPU forecast is JPY 11,100 for the period ending March 2022. The next thing I want to talk about is internal growth. Please take a look at Page 13. As you can see the graph on the upper left of the slide, our portfolio occupancy rate stood at 97.9% at the end of March 2021. And we expect the occupancy rate to keep sliding to 97% by the end of September this year. And when you look at the right end of the bar chart just below, it shows that vacated office spaces exceed newly leased office spaces due to the rise in vacancy rates, but the rate of rent change upon tenant replacement remains in positive territory. Now please take a look at Page 14. As you can see the graph on the upper left of the slide, there were upward rent revisions worth JPY 19.8 million per month, whereas there were downward rent revisions of JPY 4 million per month for the period ended March 2021. The downward rent revisions were due to rent reductions granted to some of our shop restaurant tenants. The next graph to the right shows that the percentage of upward rent revisions has moderated to 35.6% for the period ended March 2021 as compared to the most recent preceding periods, that's probably because of market influences. Let's move on to Page 17 and take a look at the market rent of our portfolio properties shown in the graphs on the left side of the slide. 32 properties saw their market rent decline for the March 2021 period, and most of them were properties in Tokyo Central 5 wards. The market rent in Tokyo declined for the first time in about 8 years. On the right side of the slide is the chart showing the rent gap. The rent gap narrowed slightly, following the drop in the market rent, at negative 9.3% at the end of March 2021. I want you to take notice of the footnote just below this chart. So far, we've been calculating the rent gap by excluding some agreements, such as fixed-term lease agreements in which revenues are fixed for a year or longer. But from this time on, in order to fulfill the request made by many of you, we've changed to include all the agreements for the rent gap calculation. So the numbers you see today may not seem consistent with the numbers you saw in the past, but the shape of the graph is almost the same as before. Now let's jump to Page 26 to talk about the latest appraisal value of our portfolio. The total appraisal value of our portfolio was JPY 1.2539 trillion at the end of March 2021. 27 properties saw their appraisal value increase, while the appraisal value declined for 13 properties. So it is just a coincidence that the total appraisal value remain unchanged from the previous period. Of course, the unrealized gain increased by JPY 4.2 billion as the book value declined. The ratio of unrealized gain to the book value rose to 30.2%. As a result, the net asset value per unit now stands at JPY 581,877, as shown in the graph on the right. The final topic I want to share with you today is about ESG. Please take a look at Page 28. The first thing I want to talk about is the results of GRESB assessment. We have been selected as a sector leader for Asian-listed office sector. So you can say we are at the top among those who receive a 5-star rating. Also, we identified the following KPIs and set the targets for 2030, such as the goal for carbon emissions reduction or the number of Zero Energy Buildings. You may already be familiar with them because I briefly explained about them in the last performance review call. Please go to the next page, Page 29. We have raised JPY 10 billion through what is called sustainability-linked loan, the first such arrangement in the J-REIT industry. The lender is the Norinchukin Bank. This innovative arrangement gives us an incentive of lower interest rates in exchange for meeting the sustainable targets set and agreed by both parties. For us, we have to clear the target of reducing carbon emissions by 35% or owning 5 Zero Energy Buildings by 2030. For more details, please take a read of the 2 green bullet points on the slide. I want to thank the Norinchukin Bank for wonderful cooperation and great entrepreneurship. I also want to add that our Higashi-Gotanda 1-Chome building is now certified ZEB-ready by BELS. Let's jump to the last page for today, Page 33. That's the final page for today. And as always, we want to finish with the carton picture of me playing golf. I'm about to hit my second shot on a par 5. By the way, did you notice that I'm wearing the same outfit as Hideki Matsuyama, who became the first Japanese male golfer to win The Masters? We are caught in a strong gale from the sea, and the wind is gusty from time to time. I could go for an eagle if the wind would subside, but that's just too risky on a day like today. If I fail, I would fail miserably. So on the day like today, I should play smart and execute good course management to keep my ball out of harm's way. I have decided to lay up the ball to the right and make sure to carry to the green on the third. And that's exactly the same cautiousness that we apply in the management of our portfolio. And that brings to an end of my presentation. Thank you very much for watching.