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

Hello, everyone. I would like to present the financial results of Japan Real Estate Investment Corporation for the fiscal period ended March 2025. I am Kazuyuki Inoue, President and CEO of Japan Real Estate Asset Management. I succeeded Mr. Kojima as President and CEO on April 1. Now let me begin the presentation. First, please take a look at Page 3 of the presentation pack. I would like to begin by giving you the financial highlights for the period and then talk about our outlook going forward. Let's start with the occupancy rate. Please look at the line graph on the left. The occupancy rate at the end of the March 2025 period rose by 1.1 percentage points from the previous period, reaching 97.6%. The strong office market led us to make consistent progress in leasing with a significant increase in the occupancy rate. This trend continues as we witnessed very robust re-leasing for Shinjuku Eastside Square, where a major lease termination is scheduled for the current period, and we expect that all the vacated space will be filled by replacement tenants by the end of the March 2026 period. Leasing for other properties is also making consistent progress, and we expect the occupancy rate to rise to the 98% level. Next, let me talk about EPU. The upward trend that began in the September 2023 period has continued into the September 2025 period. Thanks to higher occupancy and rent revisions, rent revenues have increased and with our robust control on expenses, including repair costs, revenue growth has outpaced inflation-related cost increases. On the other hand, EPU for the period ending March 2026 is expected to decline compared to the preceding period. This is due to downtime mainly associated with free rent period during the tenant turnover at Shinjuku Eastside Square, as mentioned earlier. Since all the vacated spaces will be occupied, we are showing the full period EPU contribution of those leases in the small bar graph at the top right. The free rent period will conclude during the September 2026 period, so the full period contribution will be reflected from the March 2027 period onward. As I share with you in more detail later, this tenant turnover will result in almost a 20% increase in rent revenues, making it a positive contribution to EPU in the long term. Next, on the right side, you can see the situation of rent revisions. Following on from the previous period, we once again achieved a significant number of rent increases during this period. Further details will be provided later. Next, on Page 4, I'm going to talk about the factors behind the changes in DPU from the previous period, focusing primarily on EPU, which is shown in green in the bar graph. In short, as shown in the upper half of the slide, the internal growth of existing properties significantly outpaced the increase in expenses, leading to EPU growth. In terms of internal growth, we saw a substantial increase in rent revenues due to the full period contribution from new leases at higher rents as well as the start of rent payments at other properties where the free rent period ended. In contrast, for external growth, the second tranche of the disposition of Dojima Tower resulted in a loss of rent revenue, which brought down EPU by JPY 18. The increase in financing cost is another factor. Higher interest payments pushed down EPU by JPY 16. Taking all these factors into account, EPU increased significantly from the previous period, rising JPY 37 to JPY 1,955. Now regarding the DPU for the March 2025 period, we had a gain of JPY 6.5 billion from the second tranche of the disposition of Dojima Tower. And after retaining a portion up to the liable limit for internal reserves, the remaining JPY 532 was allocated as a return to unitholders. As a result, DPU for the period came to JPY 2,487. Next, please turn to Page 5. This section covers the dividend outlook over the next 2 periods. First, let's look at the changes in EPU from the March 2025 period to the September 2025 period. While there is a negative factor of the major lease termination at Shinjuku Eastside Square, rent from other existing properties are expected to increase more to offset this, resulting in a positive impact on EPU worth JPY 21. Additionally, a relatively large amount of one-off revenues is expected for the current period, including income from restoration charges. In terms of financial and other expenses, interest payments are expected to rise due to higher rates and new borrowings associated with the acquisition of CO MO RE YOTSUYA. All in all, the EPU for the September 2025 period is expected to rise JPY 31 to reach JPY 1,986. Next, let's examine the change in EPU from the September 2025 period to the March 2026 period. Although the negative impact of the lease termination at Shinjuku Eastside Square will become more pronounced, this will be offset by increased rent revenues from other properties, leading to a gain of JPY 40 in EPU. We are not expecting as much one-off revenue in the March 2026 period as in the current period, but expenses such as utilities will decrease so that the contribution of internal growth will push up the EPU by JPY 22. Regarding external growth, rent revenues are expected to decline due in large part to the second tranche of the disposition of Akasaka Park Building, resulting in a negative impact of JPY 44. In summary, while rent revenues from existing properties continue to increase, the negative effects from Shinjuku Eastside Square and the drop in one-off revenues will bring down EPU from the current to the next period. However, from the September 2026 period onward, the full contribution of the re-leased spaces at Shinjuku Eastside Square is expected to drive a solid recovery and maintain EPU growth. Now turning to DPU. Please look at the gray sections of the bar graph for the current and next periods. All gains from the first and second tranches of the disposition of Akasaka Park Building will be distributed and part of the internal reserves will be drawn down and added on top of that. As a result, DPU is projected to be JPY 2,511 for the current period and JPY 2,536 for the following period. I will explain the future dividend strategy in more detail later. Next, please turn to Page 6. This section discusses our management strategy aimed at the sustainable growth of unitholder value. The essence of unitholder value lies in our ability to generate cash flow. Therefore, we believe the key driver of value enhancement is expectation for the sustainable growth of DPU and its underlying EPU. To realize the sustainable growth of DPU and EPU, the critical pillar is the medium- to long-term competitiveness of the portfolio. In order to continue growing at a pace that exceeds inflation, we will strive to enhance NOI by maximizing our competitive advantage, its portfolio quality and competitiveness. With the ongoing market trend of shifting office demand toward higher-grade properties, it has become increasingly important to enhance portfolio quality. Accordingly, we will place greater emphasis than ever on replacing our assets with high-quality properties and the capital gains realized through these asset replacements will be returned to unitholders. Next, let's turn to Page 7. Here, we present our specific growth targets for DPU and EPU and the strategies to achieve them. At the last performance review meeting, we emphasized 2 key points: first, to gradually raise the level of EPU and narrow the gap between DPU and EPU. And second, once we see a clear path to narrowing the gap, we will raise the level of DPU accordingly. Since then, we've observed a further strengthening in the market, and we recognize that unitholders' expectations for DPU growth have also increased. In response to this favorable environment, we've reviewed our earnings outlook and now set a clearer and a more ambitious target that is to grow EPU by an average of 3% and DPU by an average of 2% annually over the medium to long term. On the right side of the page, we outlined initiatives to achieve these goals. To achieve a 3% annual growth in EPU, we will raise the occupancy rate beyond the 98% we currently forecast at the end of March 2026, riding the tailwinds of a strong office market. At the same time, we will push for more rent increases, leveraging the current widening rent gap. Additionally, as part of our asset replacement strategy, we acquired CO MO RE YOTSUYA on March 26 and decided to dispose Akasaka Park Building in 6 parts with the first tranche completed on April 1. And going forward, we will continue acquiring high-quality competitive assets while disposing potentially less profitable properties to enhance overall portfolio quality and competitiveness. When it comes to growing DPU at 2% annually, we plan to narrow the current EPU DPU gap of about 20% by using capital gains and retained earnings generated through asset replacements. Specifically, the JPY 23.3 billion gain from Akasaka Park Building disposition will be fully returned to unitholders over 6 periods. This provides a strong foundation to support 2% annual DPU growth. So we are not only aiming to grow both EPU and DPU, but also to reduce the gap between them in a well-balanced and sustainable way. Next, please take a look at Page 9. This section covers internal growth. First, as mentioned earlier, the occupancy rate is expected to rise to a level in the 98% range by the end of the March 2026 period. This reflects the progress in leasing across our portfolio. And on the right side of the page, we have listed the major properties where leasing has made particularly strong progress. As mentioned at the beginning, all the vacated spaces at Shinjuku Eastside Square will be fully occupied. Through multiple contracts, including expansion by existing tenants and leasing to new tenants, we know that approximately 1,000 tsubo will be filled during the current period and about 2,000 tsubo for the next period. From the period ending March 2027 onward, the full rent revenues from these new contracts are expected to come in. On a full period contribution basis, rent revenues from the new contracts will be 20% higher than rent revenues from the terminated contracts. We focused on both quickly filling the vacated spaces and signing better leasing terms, and we successfully achieved both as well as signing with multiple tenants. When it comes to MM Park Building in Minatomirai, multiple large-scale lease terminations in the past kept the occupancy rate low at the 80% range. However, we've been successfully capturing demand for space expansion from existing tenants and relocation needs from external tenants so that the occupancy now recovers to 97.1% by the end of the current period. In addition, further space expansion by an existing tenant has already been confirmed for the next period. And as a result, the property is expected to be almost fully occupied. Next, please turn to Page 10, which covers rent revisions. Looking at the graph in the top left, you can see that as with the previous period, rent increases far exceeded rent decreases on a monthly contract rent basis, indicating that the upward trend continues. In the top right graph, the percentage of rent increases among the contracts up for renewal in each period is shown in green. It has been gradually increasing, and we will raise it even higher. At the same time, we will focus on the rate of increase shown in the bottom right and continue working hard on rent increase negotiations. We recognize that these gradual yet consistent rent increases are critical to counter the rising costs brought about by inflation, leveraging on the strong market and our strength of having a fixed-term lease ratio exceeding 70%, we intend to conduct careful and assertive rent negotiations on a case-by-case basis to drive further rent increases. Next, please turn to Page 11. Looking at the graph on the left, you will see that market rent has continued to rise compared to the previous period. In the 5 central wards of Tokyo, market rent increased for almost all properties and the trend is upward across the portfolio as well. As a result, the rent gap shown on the right side has also seen significant improvement this period, expanding to minus 1.9%. This clearly indicates that the environment is becoming increasingly favorable for negotiating rent increases. Let's jump to Page 13 to discuss external growth. As mentioned at the beginning, we are moving ahead with our asset replacement efforts. In March, we acquired a 13.5% ownership share in CO MO RE YOTSUYA, and we are disposing Akasaka Park Building in 6 installments over the 6 periods starting from this fiscal period. CO MO RE YOTSUYA is a large-scale recently constructed mixed-use building completed in 2020, housing offices, retail stores, residence and some public services, and we acquired a co-ownership share of sectional ownership interest in the office and retail space owned by Mitsubishi Estate. The building is located just a 2-minute walk from Yotsuya Station, offering excellent accessibility. In addition to these attractive features, the property also boasts outstanding visibility and attractive views from the office floors. Its key features make the building highly competitive in the Yotsuya area and beyond. With regards to Akasaka Park Building, the decision to dispose stems from concerns of the building's competitiveness as an office space shaped by changes in work style since the COVID-19 pandemic and subsequent tenant turnover. As a consequence, companies increasingly prioritize location and building grade in selecting their office space. Given the property's relatively poor access from the nearest station and the abundant large office supply in the Akasaka area, we believe that it is difficult for this property to remain competitive and more so for the fact that the building is a large mixed-use property over 31 years old and with anticipated rising repair and renovation costs. On the other hand, the building holds significant unrealized gains and make sizable revenue contribution to the portfolio. That is why we have to carefully consider whether we could control the fluctuations in DPU and EPU with this disposition. So it was fortunate that we received a proposal from the sponsor, Mitsubishi Estate, to dispose the building in 6 installments and came to an agreement with regards to opportunities to acquire properties for replacement. That is how the deal came about. Let's take a look at Page 15. The disposition price is JPY 80.7 billion, which is equal to the appraisal value at the time of the decision to dispose. The gain from each installment is expected to be approximately JPY 3.8 billion to JPY 3.9 billion, and the total gains from the disposition over the 3 years will be JPY 23.3 billion, and the entire amount will be distributed to our unitholders. Please go to Page 16. With the decision to dispose the property, JRE and Mitsubishi Estate also signed an agreement which grants us the right of first negotiation to acquire properties after the value equivalent to that of Akasaka Park Building or JPY 80.7 billion. According to the agreement, the right is valid in principle until the March 2028 period when the disposition is expected to be completed. Please turn to Page 18, which covers our financial strategy. In this period as well, we continued with debt financing through both medium-term borrowings and long-term floating rate borrowings. The average interest rate over the next 2 periods is projected to rise moderately due to the impact of refinancing existing debt at higher interest rates. Domestic interest rates experienced a temporary volatility influenced by the U.S. tariff policy. However, a gradual upward trend is expected to continue going forward. Without significantly changing our borrowing strategy, we will maintain our basic approach centered on long-term fixed rate borrowings while trying to curb the rise in borrowing costs and maintaining financial stability at the same time. And we will remain flexible in pursuing various financing options. The line graph at the bottom indicates the LTV level. From 42.8% at the end of the previous period, it rose to 43.5% following new borrowings related to the acquisition of CO MO RE YOTSUYA in March. The last topic is about ESG. Please turn to Page 22. We raised our target of the percentage of our properties with environmental certifications back in January last year, and we achieved the target. We will continue to promote initiatives to enhance the competitiveness of our portfolio from an ESG perspective as well. At this point, I've covered all the topics I wanted to talk about in the slides. And lastly, I'd like to reiterate our current understanding of the office leasing market and our future initiatives. As you are aware, the recovery of the office leasing market is very strong and continues to grow day by day. In this post-pandemic world, office workers have fully returned to their offices and companies wanting to hire top talent are actively relocating or expanding their offices to high-spec, conveniently located spaces, near stations in anticipation of better recruiting opportunities and higher employee engagement. Our high-quality portfolio in terms of location and grade puts us exactly where we should be and allows us to capture the strong market momentum where high-quality office buildings are being chosen. We remain committed to growing revenue and dividend in the long term in a sustainable way so that we continue maximizing unitholder value. So please stay tuned for what we are up to. That's it for me. Thank you very much.