LDR Capital Property Fund (LED) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Elanor Commercial Property Fund investor conference call. [Operator Instructions] I would now like to hand the conference over to Mr. Glenn Willis, CEO. Please go ahead.

Thank you very much, and good afternoon. Welcome to this results presentation, presentation of Elanor Commercial Property Fund's first half results for this financial year. Thank you for joining this call today. We appreciate your interest in the fund. With me on the call today, I'm joined by David Burgess, Co-Head of Real Estate for Elanor Business Group and Fund Manager of ECF. I'm also joined on the call by Liz Bors, Head of Leasing and Investment for our Office division; and Paul Siviour, Chief Operating Officer of Elanor Business Group. And we'd be delighted to -- look forward to taking questions at the end of the presentation. And for the presentation call today, we'll be referring to the presentation pack that we released to the ASX this morning. Before I hand over to David, I'd like to make some brief remarks in regards to the achievements that the team has made for ECF over the half. It's been another half of terrific progress for ECF on all fronts. The successful execution of strategic leasing and ESG initiatives has been very pleasing. The team has done a tremendous job in asset managing the fund in those aspects. Another terrific acquisition was effected during the half, with the acquisition of 50 Cavill Avenue, a high -- another high investment quality asset for the fund. In the short time that this team has managed that asset, we've achieved great progress and the valuation uplift for that acquisition. And also, the half -- the fund experienced a strong increase in capital value, which is obviously a direct reflection of the income performance of the fund but also the capital value prospects for the assets in the fund and the portfolio more generally. So in summary, I'm pleased with the progress and of the half, of terrific progress for ECF. And against that background, I look forward to now handing over to David to talk about the fund in more detail.

Thanks, Glenn. First half of this financial year has been extremely active for the fund, and our investment approach has proven to be correct, that is owning assets that have a differentiated competitive advantage. We have been focused on ensuring our assets continue to meet the demand for tenants and specifically, requirements in this new era of office accommodation. We have invested in our assets and have a road map to a carbon-neutral portfolio. Our investment thesis for our recent acquisition of 50 Cavill Avenue is proving to be correct with immediate valuation uplift as a result of positive leasing momentum at that asset. As a result of our initiatives, we have achieved valuation increases of $18 million across the portfolio, and our NTA has increased 5% to $1.19. We are pleased to reaffirm our FFO and distribution guidance for the full year. Turning to Slide 6. The fund continues to deliver strong results across all metrics. FFO for the period is $0.055 per unit, which reflects an attractive 10% annualized yield. And our DPU of $0.047 per unit reflects a high 8.5% distribution yield. As I mentioned, NTA has increased to $1.19, reflecting the strong valuation increases. Occupancy is a high 95.6%, which pleasingly includes heads of agreement signed at Cannon Hill over 2,000 square meters. This occupancy level across the portfolio is significantly above market averages, reflecting the competitive quality and competitive advantages our assets have. Gearing is at the lower end of our target range at 32.8%. And importantly, our interest rate is 97% hedged. Turning to Slide 8. The quality of our portfolio and the competitive advantages of our assets have contributed to the strong performance of the fund, not only in this half, but since we listed the vehicle in 2019. The assets in our portfolio meet the needs of tenants. For example, the average age of assets in the portfolio since last refurbishment is only 8 years. 200 Adelaide Street is a great example of that, seeing very high-quality assets differentiated offering in their respective markets. The average floor plate across the portfolio in a large 1,800 square meters. This provides total flexibility for tenants. For example, WorkZone West with 2,400 square meter floor plates that can easily be subdivided and Nexus Centre with 2,000 square meter floor plate, which fits both full-floor and part-floor tenants. We have above-average parking ratio across our portfolio at 1 bay per 96 square meters NLA. If we exclude the 2 CBD assets, it's very high at 1 bay per 52 square meters. And our average NABERS Energy rating is 5.2 stars. And we have a very acute focus on continuing to improve our ESG credentials, which Liz will talk about in moment. Given the portfolio of quality asset position in their markets, we have attracted very high-quality tenants, many of which we have renewed or expanded over recent times, and this can be seen on Slide 9. Turning to Slide 10. Across our assets, we have been focused on ensuring they continue to meet the demand of our tenants. For example, providing additional amenity at Nexus Centre, improving fit-outs at Cannon Hill. ESG is a key focus, and we have a road map to a carbon-neutral portfolio following successful execution of this at WorkZone West. This has resulted in leasing success across many of our assets. And importantly, deals completed are in line with pre-COVID pricing as opposed to market declines across most parts of the commercial office market during this COVID period. The result of these initiatives is a strong $18 million or 3.7% uplift on property valuations. Immediate uplift has been seen at Cavill Avenue, as mentioned previously, as a result of successful leasing initiatives and there's been strong results at time of 200 Adelaide Street and Nexus Centre, where we invested capital and had successful leasing. Importantly, there are more immediate opportunities to create value in the portfolio, and this includes opportunities at Cannon Hill, where we have heads of agreement, and other assets, including Garema Court. On Slide 12, we just highlight our average valuation metrics across the portfolio, and it remains very attractively priced. The weighted average capitalization rate 6.33% for this quality portfolio. Importantly, our average gross rent is a very low $515 per square meter. And in many instances, our rents are well below economic rent. As such, there is potential to continue to drive these rents higher. And the portfolio is priced an attractive rent per square meter just under $6,800 per square meter. I'll now pass over to for Paul Siviour to talk through the financial results for the period.

Thank you, David. Turning to Page 14 of the presentation. The fund generated funds from operations for the half of $14.33 million on a weighted average number of securities on issue that reflected a funds from operation per security of $0.055 and a distribution per security has been paid or declared of $0.0470. The guidance remains unchanged with a forecast distribution per security of $0.094 for the year FY '22. Turning to the balance sheet on Page 15. The fund has a conservative capital position with a net gearing ratio of 32.8% and NTA per security of $1.19. That reflects the $18.1 million increase in the value of the fund's portfolio during the half, and that increases from the position immediately following the acquisition of Cavill Avenue during the half. Importantly, on Page 16, the fund is in a very strong position in respect of both its weighted average debt to maturity and its interest rate hedging profile. The fund has drawn debt of $184.8 million, as I mentioned, reflecting a gearing ratio of 32.8%. Importantly, that debt has a weighted average maturity of 3.1 years, and the interest rate in respect of that debt is hedged with an average hedge maturity of 2.7 years. The fund enjoys an average cost of debt at the moment of 2.19%, and that level is locked in, in relation to the hedging profile that I have mentioned already. I'll now pass to Liz Bors to talk more about the market and the assets in particular.

Thank you, Paul. We're starting on Slide 18. For the employment sectors, the improved metrics translate to increased demand and confidence in the office market. What we have seen on ground is the consistent increase in demand for assets with superior amenities, accessibility and flexibility with an overarching focus on ESG. Employers, more than ever, have to create a competitive edge in its war on talent. The office environment and its fit-out plays a major role in their success. We expect that 2022 will continue to see an increase in leasing demand for high-quality assets with a point of difference. To Slide 19 now. 50 Cavill Avenue is an example of a higher-quality asset attracting strong leasing demand, being a strategic asset acquisition for Elanor. In the first quarter of ownership, we have achieved valuation uplift of close to $5 million, which has been achieved through the outperformance of our leasing assumptions against our acquisition underwriting. Specifically, we are achieving higher rents, higher tenant retention, lower incentives and less downtime. Our leasing strategy identifies further areas which will continue to drive opportunities and value at 50 Cavill Avenue. Slide 20. We have continued to invest strategically in our assets, which has resulted in tenant retention, tenant expansion and enhancing value. At Mount Gravatt, we have improved our tenant amenity with new end-of-trip facilities, outdoor areas. And over the last 12 months through this investment, we've retained 2 of our major tenants, being Bunnings and Coles. 200 Adelaide Street is an exceptionally higher-quality heritage building which has a clear point of difference in its market. We have invested in improved tenant amenities throughout the asset and have facilitated the expansion of our anchor tenant hub. In both of these assets, our strategic investment has led to leasing success and valuation uplift over the last 12 months of 22% and 26%, respectively. Slide 21. Across our portfolio, we have further value to be realized. At Corporate Drive, we have a strategic approach to value creation with the recent execution of a heads of agreement on over 2,000 square meters. This combined with the Abacus dx lease increases the WALE at Corporate Drive 7 years, occupancy to 90% with further valuation uplift in the short term. Garema is an iconic Canberra asset positioned in a highly desirable location with large flexible floor space, abundant natural light and balconies and outdoor areas on most floors. It has a potential for broad appeal from both the public and private sector. Importantly, we have a leasing strategy underway to create rental and valuation upside through value enhancement initiatives ahead of the current tenant lease expiring. Slide 22. WorkZone West is an example of what our key focus on ESG has achieved. WorkZone West is the first and only 6-star NABERS carbon-neutral asset in Western Australia. The success and knowledge base gains from the WorkZone West process has provided us with a pathway portfolio-wide to replicate this success. And we intend to start rolling this out in the next financial year. ESG initiatives have a clear social and financial benefit to both occupiers, investors and asset owners. We are committed to continuing to invest in best practice. I'll now pass over to Glenn for his closing remarks.

Thanks, Liz, and thank you, Dave. The performance of the commercial property fund, as I said at the start, has been very pleasing. But the performance that, that fund has achieved over the last half and over the last 2 years has been nothing short of exceptional, particularly when taking into consideration the market conditions that the -- that all assets that have contended with. But the performance of ECF over the last half, again, is testament to the investment approach, the very clear investment approach that targets assets with differentiated positions and true sustainable competitive advantages. Having an acute focus on that has proven very, very beneficial for the performance of the fund. Coupled with having the, we believe, the right investment approach, the team has done a tremendous job in managing the assets over the period. And that's -- and that asset management capability, coupled with our investment approach, augurs very well for ECF going forward, augurs well for growing income and growing capital value. So against that background, we look forward to taking questions at this juncture.

[Operator Instructions] Your first question comes from Leanne Truong from Ord Minnett.

My first question is just in regards to your guidance. So in 1 half '22, FFO was $0.055 per share. So that implies your 2 half will be lower than the first half. Can you explain, I guess, why you're expecting a lower second half?

Yes, Leanne, we can. The $0.055 is a weighted average FFO per security in respect of the half. And you'll recall that Cavill Avenue was acquired toward the end of August when additional securities were issued in the fund. So that weighted average is obviously increasing that amount in the first half. It does have some impact in the second half, but a more muted impact. We'd also say the guidance remains the guidance. However, the fund continues to perform ahead of expectations.

Okay. And I guess, just on that, I mean, Cannon Hill, we mentioned a heads of agreement has been signed. I assume that, that -- you don't have that in your guidance, that assumption that, that will end up being executed.

That's correct, Leanne, and we -- if you recall, we didn't have any letup for that vacancy for this financial year, and I'd assume that, that's the right way to approach it.

Yes. And assuming that does get executed, when do you expect to receive income from that asset?

Next financial year.

Next financial year, yes. And just a last question from me. It looks like Limestone Centre, the vacancy is down a bit there. How are you seeing the market there? And also, it's interesting that even though the vacancies are up, your valuation on the asset is also up. Can you just go through that asset?

Yes, it's Liz here. I can speak to the leasing at Limestone. We have 2 government units who we are speaking to and are very much engaged on Limestone. One of those would take out all of the vacancy and the other one would take a substantial part of that. So we've seen a lot of positive headway in terms of leasing in the Ipswich market over the last month, I would say.

Yes. And just to add to that, Leanne, I think you've heard us talk about that asset previously, where we have sticky tenants and a very long-term strong cash-on-cash yield over that asset. The only reason for a bit more vacancy was one particular tenancy amalgamated 4 of their offices into 1. Otherwise, we're very confident about the ongoing substantial cash flows coming from that asset together with the inquiry that Liz just talked about. In terms of the valuation, you're right, that has gone up a little bit. There was a -- all of our assets in this period have been externally revalued. The number of valuers were rotated off and new valuers rotated on. And a different view was taken in terms of discount rate, cap rates and market rates for that asset.

And just one more question around the guidance. I mean Nexus Centre, you ended up renewing Coles, I mean, for a smaller space. But what have you assumed in terms of guidance for that asset? Were you assuming some, I guess, vacancy for a period of time?

Our assumptions were that we did renew a portion of their size.

Your next question comes from Ed Day from MA Financial.

Dave, I'm just keen to get your view on the valuations. I know you just said that they were all externally valued during the period. But somewhere like Cannon Hill, where you've got the heads of agreement, will you get that asset revalued once that deal has been executed?

Yes, correct, Ed. That heads of agreement was executed post period end, where the valuation was obviously done into year-end. I think I've mentioned before that there has been comparable sales in this immediate location in the 5% type range. So we do -- we think that there's potential for upside, but we'll get it externally valued for next period.

And are there any other assets in the portfolio? I mean Ipswich is probably one, right, if you get some deals done there where you think there's still a bit of cap rate compression to come through?

Yes. Look, I think that slide that you talked about, average rent, average cap rate, even our average discount rate, it is all very attractive metrics, I think, with upside. I'd point to the fact that the average rent is what gets us excited about what we can try to create value as much as what that -- it does to cap rate compression. But a couple to point out, Garema Court, for instance, where there's transactions that are trading in the 4.5% type range in that market for good quality medium- to long-term leases, we have a great opportunity in Garema, given the quality of that asset, of resetting the existing tenancy or re-leasing and repositioning that asset. So there's a great opportunity for value creation on that asset, and that will come from both rents and cap rate compression. But importantly, where we created value so far in the portfolio, if you notice, has all come from assets where we have invested capital and had successful leasing that has resulted in cap rate compression. So practically, what we have done is created the value upside and there's various opportunities within the portfolio. I hope that answers your question.

Your next question comes from Aiden Bradley from Shaw and Partners.

Just a couple of quick ones. So just confirming Cavill Avenue settled 31st August. So the rental income is 3 months as reported. So September, October, November, December, 4 months, sorry. Is that correct?

Yes. Yes. That's correct.

Yes. Great. And just over here in the West, obviously we're opening up to the world again. WorkZone West, any comments updates on where CIMIC or the sublessees just on that asset? And any updates from the last time we spoke?

Yes. Look, we've had some goes at some of the sublessees. So if you recall, there's around 75%, 80% of that asset is subleased to about 5 different tenancies, all of very high caliber that we would welcome in our portfolio. As we get close to that lease expiry, there will be more negotiations where we can take over those leases and spend, but also have commercial discussions with the head lessee. One thing, the investment thesis on that particular asset when we acquired it a few years back was around the pricing of the market rent that we proxy asset that which is significantly below economic rent. The thesis is working in the fact that the market rent is gradually improving, improving upwards albeit still well below economic rents. For example, the market rent on that asset is around $430 per square meter. Economic rents to rent this type of building is around $600 per square meter. So while we're in this -- while we're in that growth position with this quality asset, we can only see further upside on its market rents, which will create value. So it's a fine line at what point do we start negotiating with those sublessors.

[Operator Instructions] Your next question comes from Mark Skocic from Kinetic Investment Partners.

Good result. Well done. Just a couple of questions. This one may be for Liz or David, I'm not sure. You both mentioned ESG several times in your call -- in your spiel. Do you think we're actually at a period in time now where prospective tenants are now openly asking about ESG credentials on buildings they're looking to lease, please?

Yes. Great question, Mark. The ESG is at the forefront of tenants now. And we are actively speaking to our tenants, and it is very much front of their agenda about what we are doing at the moment and how we can help them with their tenancies and their businesses on their ESG credentials. And in our view, it's only going to get greater and greater. And the gap between assets that have strong ESG credentials and that don't will widen. So it become more prevalent. Some of our international tenants have requirements that they need to report back to their global Board about what they are doing on the ground with regards to ESG. So as you rightly picked up, this is a key focus for us. We're really pleased with what we've achieved at WorkZone West, and we have a road map for the rest of the portfolio. Liz, there's anything to add?

No. I think to reiterate what David was saying, we're actually surprised at -- it's so important not just to the occupiers, investors, landlords alike, and it's something that, in tenant meetings, it once would never have been raised, but now, it regularly is. And they're really looking to the landlord how we can support them in their ESG reporting as well.

And so just as a follow-up, if you don't mind, both of you or either of you. If an existing tenant is actually asking that like the example David had of an international tenant, whatever, if you have to spend some money on the property, doesn't it give you more pricing power to increase the rent? How does that -- out of interest, how does that actually work then?

Yes, there's actually some great research that's come out around that. And it's more prevalent in overseas markets in Europe and the U.S. where those assets with strong ESG credentials, in my mind, in terms of rent levels and in terms of total return are quite a large difference and getting wider. So the investment -- and some of the initiatives you're doing on the environmental side, some of them don't cost a lot of money, around monitoring or -- yes, and issues...

And one of the other areas is solar, like the rolling out of solar, which we are about to commence across the commercial portfolio. Think an immediate energy savings by having solar, a number of our buildings are growth assets. So therefore, that translates to an uplift in income as well, particularly in the growth assets.

Okay. That's great. And just to squeeze another question in, Glenn, seeing you've actually reported all your companies at the moment, obviously we're in an inflationary environment. Every company we speak to is talking about it. I'd just be interested to hear your thoughts on what you think being in an inflationary environment with obviously interest rate upside risk means to your -- well, either your assets and/or your sector, please?

Mark, it's Glenn here. I'll make some comments here. But as I said on the call earlier today in regards to interest rates, we've been planning, we've been, I guess, forecasting for interest rates to bias upwards for some time. Not that we were forecasting -- wanted to be a forecaster of interest rates, it's just that when we invest in real estate assets, we take the view that investors that invest in real estate assets are investing in property risk, not interest rate risk. And that's the fundamental behind how we look at, I guess, hedging. And this portfolio does have good interest rate hedging in place for it. So it's protected for the medium-term interest rate increases. Having said that, if we were to make a judgment, we continue to believe that price bias upwards, but probably not substantially. But all in all, as we invest, we always invest with a view to hedging our interest rate risk because, as I said, it's not -- an investment in real estate shouldn't be an interest rate risk play. In terms of cap rates, where cap rates will go, I guess, vis–à–vis inflation and therefore, the interest rates, yes, the gap between -- or the margin between cap rates, real asset cap rates and indirect, are still at historical highs. So our view is that interest rates can bias us upwards, but cap rates not so. And if you add to that the, I guess, the weighted capital looking to invest, particularly to invest in great assets like this fund has, we feel positive about the cap rate performance in a macro sense going forward.

Maybe I could just add to that for one moment in relation to the office sector in our portfolio specifically. In terms of the office sector, there's still a lot of unmet demand from investors that want exposure to our key markets in Australia that haven't got fit. And even of late, there was a multibillion-dollar fund that's been raised, with Sydney CBD office being primary, #1 investment choice for that fund. They haven't invested in Australia yet. So there's still a whole deck of capital despite the upward-biased interest rates that want to get fitted in Australian commercial office. What gives me comfort in this portfolio is that rental price point I talked about before where we are, in many instances, well below the economic rent for many of our assets. And this inflationary environment and what you've heard about building costs, et cetera, makes it harder to get new supply to the ground. And if it does, it's going to be at a higher economic rent than what it was previously. So that augurs well for this type of portfolio, it's of good-quality assets that meet demands of the local market at attractive rental price points. So the rents should and we believe, continue to believe, they will continue to survive.

And just your gut feel on how below you are -- so how much lower than economic rent, can you like give us a feel?

It varies a lot on asset by asset so -- I don't have a general portfolio average. But as I said on the call, the WorkZone West is a good example where around $170 a square meter below the economic rent. And that's been probably looking at best possible life without factoring in elevated building costs for that $600 a square meter economic rent I mentioned for -- to replace WorkZone. Things like 50 Cavill is $50 million below placement costs when we acquired that building. Garema Court is another one. Economic rents there are now at $600 a square meter, we're at $475. So there's a number of examples across our portfolio.

There are no further questions at this time. I'll now hand back to Mr. Willis for closing remarks.

Thank you very much, and thank you all for joining this call today. And we do appreciate your interest in and support of the Elanor Commercial Property Fund. We look forward to providing further updates progress of the fund over the course of this half. Thank you very much.

And you may now disconnect.