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

Good afternoon, everyone. Thank you for joining today our performance review for the period ended March 2022. My name is Shojiro Kojima. I am President and CEO of Japan Real Estate Asset Management. I took over the position of CEO on April 1, when Mr. Umeda retired. It's a pleasure to meet you all. Despite the rather eventful market in which we find ourselves today, our commitment for maximizing our unitholder value for a long term is and will remain unchanged. With that, let's go straight to our results for the period ended March 2022. This is my first time to walk you through the performance review, and there is just one thing I want to say before I begin. I am not going to make any significant change to our overall asset management policy from the days for my predecessor was at the helm. That is to say, as I mentioned at the beginning, we will remain committed to taking a long-term view to maintain and maximize value for our unitholders. We are keenly aware that our unitholders expect us to ensure stability in asset management, and we will continue to meet that expectation. So let me walk you through the presentation and begin with the earnings highlights. Please take a look at Page 3 for DPU summary. The dividend payout for the period ended March 2022 was JPY 11,400 per unit, up JPY 44 a unit from 6 months earlier and just in line with our own expectations. The dividend rose for 16 consecutive periods. On the right end of the bar chart below, you see the dividend forecast for the next 2 periods. For the period ending September 2022, it is JPY 11,500 per unit. And for the period after that, period ending March 2023, it is JPY 11,000 per unit. We will continue to stick to our stable dividend policy. I will come back to this topic with more details later in my presentation. Let's go to Page 4. Here is the management dashboard and a brief summary of the operating highlights during the period ended March 2022. Let's look at the upper left box for internal growth. The period end occupancy rate improved from 96.5% from 6 months earlier to 97% for the period. The increase in monthly contract rent due to tenant turnover was JPY 12 million a month. The average rent we charge is still slightly lower than the market rent, which means that we still have some room to raise our rent and we could successfully raise rent at the time of rent revision by JPY 4 million a month. I will talk about our external growth just below later in the presentation. If you look at the box on the upper right for our financial strategy, you'll see that there is no big change. We borrowed JPY 25 billion to finance the acquisition of Toyosu Front and LTV as at the end of the period ended March 2022 briefly climbed to 43.5%. But as I will explain later, we are scheduled to dispose Harumi Center Building at the end of May and use the fund to repay the JPY 25 billion on the same day. That will bring back our LTV to 42% by the end of this month. Our average interest rate continues to get lower, thanks to refinancing to 0.39% at the end of March 2022. Let's take a look at our ESG initiatives in the box at the lower right of the page. We reviewed and revised our CO2 emissions reduction target we announced back in 2020, and we set new more ambitious targets instead. We also identified a materiality, which refers to material issues that can have a major impact on many aspects of our company. We have sorted out our priorities and are ready to press ahead with our ESG initiatives. Also Daido Seimei Niigata Building became the second property in our portfolio to receive the ZEB Ready Certification. We also raised the funds through the sustainability linked alone for the third time. Please go to Page 5. On this page, we first to describe the current business climate and the future outlook, and then I want to explain how we will navigate through this challenging time. Please take a look at the text within the box on the left side of the page. Currently, the rise in the vacancy rate is slowing down somewhat, but demand for office space is expected to remain soft for some time to come. We also expect that there will be a relatively large displacement of space ahead in the properties in our portfolio, which will cause a temporary rise in our vacancy rate. With that as a backdrop, I want to explain how we will address that in terms of short-term tactical tools and midterm strategic approach. Let me start with the short-term tactics. There are 3 things. First, for properties with large vacancies or with weak leasing prospects due to supply and demand or competitive situations in the area, our tactical approach is to focus on raising the occupancy rate by allowing flexibility to offer temporary incentives such as free rent and other rent concessions. Second, we can look to proceeds from property sales. We have been undertaking the strategic property replacement within our portfolio for quite some time. If we have a gain on sale of a property, we'll be able to use the proceeds to pay for a dividend. And third, we can use our internal reserves. We have at our disposal these tools to mitigate as much as possible the impact of the current market softness on our ability to pay a stable dividend. We also have a midterm strategic approach. Our strategy is to create value that exceeds the market levels for medium term. There are also 3 things. First, this may not sound strategic, but we are convinced that our portfolio is of higher quality compared with that of our competitors. Therefore, once we pull through this period of rising vacancy rates, we believe that each of our properties will begin to attract more prospective tenants. In other words, we will continue to keep the high quality of our portfolio. The second is strategic portfolio replacement. I will give you more details on that on the next page. We will continue to undertake our strategic portfolio replacement so that our office properties will remain chosen and loved by tenants. What I mean by that is, generally speaking, office buildings that are chosen and loved by tenants are the ones that are large, recently built and near a train station. While these attributes are expected to remain the usual criteria for sought-after office buildings, some change may be in the offing, especially in the light of what has happened to the way we work in the so-called post pandemic world. We always pay attention to and keep pace with the changing times as we formulate our portfolio strategy. The third is ESG. You already know that our actions towards ESG are very progressive. I believe that ESG will be an increasingly important factor in the selection of office buildings, that is why we are going to put more focus on and a resource into ESG. And we expect that that will make Japan real estate outperform the market benchmark as an office REIT. I will share with you more detail on ESG later. The next page, Page 6 summarizes the recent events about external growth and our portfolio replacement. We disposed one property and acquired 3 properties during the period ended March 2022. In addition to that, we have decided to dispose Harumi Center Building, as you can read the text on the upper left side of the page. The transaction is scheduled to be completed at the end of this month. We acquired the 3 properties, Toyosu Front, GRAND FRONT OSAKA and Otemachi Financial City North Tower at JPY 52.8 billion in total. We sold Nagoya Misono Building and are going to sell Harumi Center Building at the price of JPY 26.9 billion in total. These replacements will generate a JPY 4.6 billion gain on property disposals, lower the average age of our properties, increase the asset size by JPY 24.2 billion and raise NOI by JPY 961 million a year. I will give you more detail about each of these properties later in my presentation. Page 8 shows an overview of the results, but I will discuss our earnings from the perspective of changes in the dividend per unit, so let's skip this page and go to Page 9. This is our balance sheet at the end of March 2022. Let me just touch upon the internal reserves for here. Please take a look at the small table at the bottom right of the page with the title reference in parenthesis. The period end balance of internal reserves increased JPY 388 million to JPY 5.6 billion following the transfer of part of the proceeds of the sale of Nagoya Misono Building to the internal reserves, and this translates into JPY 4,076 per unit. Let's go to Page 10. If you take a look at the bottom of the table, you see that the occupancy rate at the end of March 2022 was at 97%, as I mentioned earlier. We expect the rate to go down to 94.2% at the end of September this year, mainly because relatively large displacement of space is expected during this period. Of course, we want to fill these vacancies as soon as possible by carrying out our leasing strategy with agility and flexibility. Next, please go to Page 11. On this page, I want to spend a few more minutes to provide a thorough explanation of the factors that determine the dividends paid per unit. Let's take a look at the dividend paid for the period ended March 2022 and compare that with that of the previous period ended September 2021. When you compare the first 2 green bars on the left, you see that the decline in rent and service charges for the existing properties brought down the per unit dividend only slightly by JPY 42, almost in line with the previous period's level. Other property-related revenues, which included a temporary increase in cancellation charges and cash receipts in lieu of bringing statement costs as well as an increase in utilities revenues, pushed up the per unit dividend by JPY 231. Property-related expenses, on the other hand, rose due to an increase in property management expenses, utilities expenses and repairing expenses pulling down the per unit dividend by JPY 504. The increase in repairing expenses may seem enormous, but that's only because we spent much less on repairs in the period before. So the level of spending on repairs is simply getting back to novel. Utilities increased both in terms of revenue and expense, thanks in large part to the energy prices, which started to rise sharply early this year. The impact of external growth comes from the acquisition of GRAND FRONT OSAKA and the full period contribution of Otemachi Financial City North Tower, boosting the per unit dividend by JPY 174. The dark blue part of the bar represents the gain on the sale of Nagoya Misono Building minus the transfer of part of its proceeds to the internal reserves. That pushed up the per unit dividend by JPY 552. As a result of all this, the dividend paid for the period ended March 2022 was JPY 11,400 per unit. Next, I want to talk about the forecast for this period ending September 2022. Let's compare the 2 green bars in the middle. As I explained earlier, the decline in rent and service charges for the existing properties due to the relatively large displacement of space will lower the per unit dividend by JPY 777 from the preceding period. Other property-related revenues are expected to decline because we want to have the same level of cancellation charges or cash receipts in lieu of reinstatement cost as we do in this period, despite the fact that utilities revenues are expected to keep rising. The impact will bring down the per unit dividend by JPY 164. The impact of property-related expenses on the per unit dividend, however, will be smaller than it was in the preceding period. Utilities expenses are expected to increase, but reinstatement cost will be lower. Property-related expenses will push down the dividend per unit by JPY 168. External growth during this period will still have a limited positive impact on the per unit dividend. Although there will be a positive impact of the full period contribution of Toyosu Front which we acquired at the end of March this year, there will be no leasing revenue from Harumi Center Building once we dispose the property at the end of May. In addition, expenses related to external growth, including property and other taxes for GRAND FRONT OSAKA and Otemachi Financial City North Tower will increase. The impact of external growth will be just JPY 38 per unit on the upside. Speaking of the gain on the sale of Harumi Center Building, its impact on the per unit dividend will be JPY 1,566 after the transfer of part of its proceeds to the internal reserves and other deductions. The dividend for the period ending September 2022 will be JPY 11,500 per unit. And lastly, I'm going to touch upon the forecast for the period ending March 2023 and compare the last 2 bars on the right. The impact of the large displacement will linger into the period ending March 2023, and the declining rent and service charges for the existing properties will continue to lower the per unit dividend by JPY 144. Property-related expenses are expected to increase due to an increase in repairing expenses, and that will bring down the per unit dividend by JPY 144. The disposal of Harumi Center Building and the loss of its leasing revenue will pull down the per unit dividend by JPY 43 for the period ending March 2023. And at this moment, we are planning to use the internal reserves so that we can add JPY 1,389 per unit to the dividend. That will lead us to paying JPY 11,000 per unit as a dividend for the period ending March 2023. Of course, how much we should spend from our internal reserves to pay a stable dividend is still unclear because we may dispose another property or properties in the next 12 months. And if we do, we may not have to spend down the internal reserves as much as we expect today. So I just want you to understand that there is some degree of uncertainty with regard to that. Let me add a few more things about external growth. On Page 13 and Page 14, we are showing details about GRAND FRONT OSAKA and Otemachi Financial City North Tower, respectively. But I'm going to skip these pages because we did talk about these 2 acquisitions in the last performance review. Please go to Page 15. We acquired a 24% co-ownership share of Toyosu Front from Mitsubishi Estate at JPY 25.5 billion in March 2022. As you all know, the Toyosu district is home to not only many office buildings, but also diverse urban amenities such as commercial facilities and residential buildings within the Tokyo Bay Area. This property, in particular, boasts excellent accessibility as it is directly connected to Toyosu station through the underground passageway and people can enter the building without getting wet on rainy days. I also want to talk about the properties we disposed. Please take a look at Page 16. We talked about the disposal of Nagoya Misono Building in the last performance review. This time we have decided to dispose Harumi Center Building at the end of this month. The expected disposition price will be JPY 3.3 billion higher than the appraisal value. Also, the disposition price of Harumi Center Building will be almost the same as the acquisition price of Toyosu Front, which I just talked about. We have a property in the Harumi district within the Tokyo Bay Area called Harumi Front, so this replacement is going to help us further diversify the geography of our portfolio within the Tokyo Bay area. Let's move on to talk about internal growth. Please go to Page 18. First, I want to take a look at the changes in our portfolio occupancy rate in recent years. We show it in the graph on the upper left of the page. As I said earlier, the occupancy rate at the end of March 2022 was at 97%. You see the occupancy rate is edging up towards the end of the chart. The rate improved by 0.5 percentage point from the end of the preceding period. The chart on the upper right shows the tenant turnover rate. It's been going up, thanks to an increase in cancellations and replacements. Now I want to take a look at the line chart at the bottom. It shows historical changes in the rent change rate. The rent change rate has been gradually declining since its peak during the period ended March 2020. The latest number is 91.9% and a step below 100. Dipping below 100 means that the rent of newly leased space is lower than the rent of vacated space. For the period ended March 2022, the majority of the vacated space was found in Central Tokyo where the rent is generally higher than in other areas, while the majority of the newly leased space was found in other regional cities where the rent is cheap in the first place. I just want you to understand that, that is the primary reason why the rate has fallen sharply. The next topic I want to talk about is rent revisions. Please go to Page 19. The bar chart on the upper left shows historical changes in monthly rent due to rent revisions. You can see that upward revisions of monthly rent have been slightly down since around 2 years ago, but the upward revision itself still continues. Also, even if you look at the chart on the upper right, you can see that the percentage of downward rent revisions on a monthly contract rent basis still remains very small, although the percentage of upward revisions, the green area is getting smaller, and the gray area, the percentage of the rent that remains unchanged is getting bigger and bigger. Let's go to Page 20. This page explains what are the factors that determine the change in the monthly contract rent compared to that of the preceding period. As I have explained so far, even though the leasing market shows signs of softness, we achieved a JPY 12 million in net increase in monthly contract rent due to tenant turnovers, which is shown as a difference between the green and the yellow bars on the left. Also, if you look at the 2 short bars in the middle, you can see that the monthly contract rent increased JPY 4 million on net due to rent revisions. Furthermore, the pair of the green and the yellow bars on the right represents the increase in monthly contract rent due to external growth. On net, it's an increase of JPY 121 million. And just so you know, any data about GRAND FRONT OSAKA were not available in all the numbers I mentioned in the explanation of internal growth, except the occupancy rate on Page 18, because we didn't have consent from all the owners of this building for the disclosure of the data. If you got hold of these data, there would certainly be a positive impact on our overall monthly contract rent. Please go to Page 22. This is about market rent and the rent gap. The 3 charts you see on the left side of the page are showing historical changes in market rent for the properties in our portfolio by different areas. Out of the 64 properties, 27 properties saw their market rent unchanged and 37 of them saw a drop in their market rent. And you see that more properties in Tokyo Central 5 wards saw their market rent falling than those in any other areas. Accordingly, the rent gap is shrinking as shown in the graph on the right. As you may know, the rent gap is calculated as actual rent revenue minus market rent revenue, so a negative rent gap means that there is room to raise rent to at least the level of the market rent. The latest rent gap is negative 3.3%, and it's very low. In other words, it has become more difficult for us to raise rent than before. It suggests that we are in a critical moment where we should focus on raising the occupancy rate rather than rent probably by offering some temporary incentives to our tenants to stay with us. The next topic is our financial strategy. Please go to Page 25. As you know, we can keep reducing interest costs through refinancing as the Bank of Japan keeps interest rates low with its record monetary easing. Also, the graph at the bottom shows that our debt maturities are diversified over extended periods of time. Please take a look at Page 26. Our LTV remains at extremely low levels. We still keep high credit ratings as shown in the table on the lower right of the page. When you look back at the graph above, the green line shows historical changes in our LTV. The latest LTV is at 43.5%. And as I explained when I talked about our earnings highlights, we will pay back some of the debt with the proceeds from the disposal of Harumi Center Building at the end of May. So our LTV will go down to around 42% by the end of this month. Now let's skip a few pages and go to Page 30 to talk about the appraisal value and unrealized gains of our portfolio. Unrealized gain increased JPY 25.3 billion from 6 months earlier and the ratio of unrealized gain to the book value was at 31.6% at the end of March 2022. This is primarily because the market cap rate fell for the majority of our properties, reflecting challenging market conditions. The last topic I want to talk about is ESG. Please take a look at Page 32. I mentioned briefly at the beginning that we would be able to achieve our CO2 emissions reduction target we announced in 2020 sooner than expected, and so we set a new target back in March this year. Our original target was to reduce our carbon emissions by 35% by 2030 as measured by intensity. Our new targets are set at cutting emissions by 80% by 2030 in gross emissions and achieving carbon neutrality by 2050. And we've submitted these targets to the SBTi, science-based targets, an international joint initiative. Furthermore, to the right, when it comes to the RE100, the global corporate renewable energy initiative, our targets are to achieve 90% by 2030 and 100% by 2050. Please go to the next page, Page 33. We have identified and clarified key ESG priorities as materiality. We also asked for the experts opinions in this process. Speaking of ESG, we tend to focus on what is being done for the environment. But as you can see, we take a balanced approach and set specific KPIs, targets and guidelines for society and governance as well. This is just 1 example of our ESG activities on Page 34. Daido Seimei Niigata Building received ZEB Ready Certification. ZEB is the acronym for Net Zero Energy Building and ZEB Ready is one of the grades of the certification. It is the second property in our portfolio to receive the certification after Higashi-Gotanda 1Chome Building. We are going to continue to work on it to have more properties received the ZEB Certification. We also raised funds through the Sustainability-Linked Loan or SLL, for the third time in November last year. We will continue with our ESG activities in terms of fundraising as appropriate through the SLL or a green bond. Last but not the least, please take a look at Page 37. It's a familiar cartoon picture of a scene in the golf course. It's been almost like a tradition started by my predecessor. We have been asked on several occasions what's going to happen to this space. To me, the composition of this picture seems to signify the closing of an era and suggests nothing else. I might add that I'm not wearing any golf gloves in a picture, handed down the baton from Mr. Umeda with the fist bump. It is what it is, no more, no less. And that's all for me. Thank you very much.