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 of Elanor Investors Group. Please go ahead.

Good morning and welcome to this results presentation call for Elanor Commercial Property Fund for the 2023 financial year. Thank you for joining the call this afternoon and thank you for your interest in the fund. On the call today, I'll be joined by David Burgess, Joint Head of Real Estate for Elanor Investors Group and Fund Manager of the Elanor Commercial Property Fund. Also joining us is Liz Bors, Head of Asset Management for office and health care at the group; and Paul Siviour, COO of Elanor Investors Group. Before I hand over to Dave, a couple of brief comments mainly in regards to congratulating Dave and the team for what I think is a fantastic result for this fund for the year. Recognizing the challenging market conditions that we all know that exist in the office sector at present to have grown the occupancy for the fund from 96% to almost fully occupied at 98.4% for the year and also achieving the like-for-like rental income growth of close to 10% is a tremendous achievement, as I said, in challenging market conditions. So congratulations to Dave and the team for that. So without further ado, I'll hand over to Dave and Dave, please take us through the results.

Thanks, Glenn, and thanks, everyone, for dialing in today for the ECF results. Starting on Page 4 of the pack. The operational performance of ECF is very strong and that's despite the challenging capital markets that we're in at the moment and importantly, we do start the FY '24 financial year in a very strong position and that's from an income, valuation and capital management perspective. We delivered on our FY '23 FFO and DPU guidance on the back of a very focused asset management and leasing initiatives. As a result, the fund starts financial year '24 with high occupancy of 98% nearly fully occupied and a very low lease expiry profile of just 6% of income for the forthcoming financial year. Asset values have declined with our weighted average cap rate now sitting at 6.95%, some 91 basis points above the national average and 130 basis points above our fee growth. Importantly, we are achieving rental growth across the portfolio and expect to continue that growth given the unique position of market rents being materially below replacement cost rents. Our pro forma gearing post proposed asset sales is 26% and we have extended the average hedge maturity to 3.2 years, which we'll talk about in a moment. Turning to Slide 5 and our results highlights. FFO and DPU were $0.1101 and $0.094 per security for the period, in line with our guidance at the start of the year. Occupancy finished the year at a high 98.4%, which is materially above market and reflects our investment approach of having quality assets that have competitive advantages in their respective markets. Our portfolio WALE is 3.1 years, which provides the right balance of income security, but also access to the rising rents that we're seeing in our markets. Like-for-like rental growth was a very strong 6.8%. NTA at 30 June was $1 due to asset value declines as a result of capitalization rates increasing from 6.1% at the beginning of the period to 6.95%. Balance sheet gearing is 35.1% and, as I've mentioned, with the proposed asset sales of Nexus Centre and Limestone Street reduces to 26%. We have extended and increased our hedge interest rate exposure to close to 80% and will be 100% following the proposed asset sales. Turning to Slide 6. The portfolio's high occupancy was a result of strong leasing during the period. Our office assets are very well occupied and as such 92% of executed leases resulting in tenants either maintaining or increasing their footprint. As mentioned, like-for-like income growth was very strong at 6.8% and leasing spreads across the 25,000 square meters of leases executed over the period was a high 11%. The momentum of leasing has resulted in a low expiry profile into 2024 with only 6% of income expiring. The weighted average portfolio cap rate for the portfolio decreased 14% to 26.95% over the period resulting in an 8.5% decline in asset value. The negative movement in cap rates was partially offset by higher market rent, which are supported by positive leasing spreads that were achieved in FY '23. Looking forward, our portfolio is well positioned with our cap rates well above market average and with assets that have more upward pressure on rents. Turning to Slide 8. The portfolio is priced well below replacement cost, which we expect will result in 2 things. Firstly, it makes it more difficult for new supply to come to the market and we are certainly seeing this in the markets that we are invested in. Secondly, quality assets like we have will have upward pressure on rents, which is evidenced in our FY '23 leasing statistics that Liz will talk about it in 1 moment. In terms of markets, which we summarize on Slide 9. The office markets across Australia have experienced significant divergence in performance. The markets where our assets are located are mostly performing very well as evidenced by the chart. Generally, Southeast Queensland, Perth and Canberra are performing far better than the market for Sydney and Melbourne with growth in occupied stock, positive rental growth and low levels of supply. With that, I'll pass it over to Paul Siviour to talk through the financial results.

Thanks, Dave. We turn to Page 11 of the investor presentation pack released earlier today, which set out the income statement of the fund. The funds from operations were $34.858 million, which reflects a FFO per security on issue of $0.1101 and a distribution of $0.094 per security reflecting a modest conservative payout ratio of approximately 85%. As Dave has mentioned, the fund achieved its guidance in respect of FY '23 and continues to perform at a very high level. The balance sheet is set out on Page 12. Investment properties valued at $555.5 million as at 30 June '23. As David mentioned, NTA per security of $1 and balance sheet gearing at 30 June of 35%. Importantly, that balance sheet gearing reduces to 26% post the asset sales that were announced to the ASX on the 17th of August 2023. The gearing remains within the target range of 30% to 40%. The fund manager and management overview that, taking the opportunity to realize value for 2 assets that were sold out, is the right approach in the current market given that sale price for these assets is only approximately 4% below the independent valuations at 30 June '23. Turning to Page 14 where we've set out the capital management of the fund and it's important to note here that the fund has invested in a number of respects in relation to capital management since 30th of June '23. That is it has increased the tenure of the hedge of the debt facilities of the fund, it expects to lower the leverage of the fund from 35% to 26%, it has taken out further hedging in respect of the interest rate profile to achieve greater interest rate protection and it has also increased the tenure of those interest rate hedges. Notwithstanding those reductions in leverage, the fund is still providing strong guidance of $0.085 per security as distribution for FY '24. The weighted average cost of debt after that hedging I referred to is 4.42%. And on completion of the asset sales and reduction of the debt by approximately $50 million, that will repay the unhedged component of the debt facility and on that basis, the weighted average cost of debt will decline. The fund has very significant headroom in respect of its debt facilities. It's loan-to-value ratio as measured for the purpose of the covenant is 42% against a covenant of 52.5% and that provides headroom of approximately $100 million in respect of any potential movement in the valuation of the office portfolio. Also importantly and reflecting the strong performance of the assets, the fund has quite an exceptional interest cover ratio of 8.4x in respect of the year to 30th of June '23 against a covenant of 3x. I'll now hand to Liz to talk more about some of the asset management initiatives.

Thank you, Paul. So I'll start on Slide 16. The combination of a high quality portfolio, high quality tenants and continued management investments has produced results. We entered financial year '23 with strong occupancy with our proven track record of retaining and attracting high caliber tenants continuing. We finished the year with even stronger metrics. We've increased our occupancy to 98.4% off an already high base of 95% with high caliber tenants entering the portfolio such as Bank of Queensland, ITV Studios and McGrath. 2023 was a busy year with over 25,000 square meters leased during the period. As previously mentioned, our occupancy has increased to 98.4%, but importantly, we have maintained strong leasing terms with average incentive at below 13%. Our average net rent of $504 per square meter are also above valuation rent while we maintained strong annual increases. Our positive leasing spreads have remained strong at 11% with our tenant retention remaining exceptionally high at 83% with 92% of those tenants, they either retained or expanded their footprint. With our average net rent remaining below replacement cost, this provides us with further opportunity to continue to build on these metrics. Turning to Slide 18. Through the execution of our asset management initiatives, we continue to deliver. At 50 Cavill Avenue, we continue to focus on driving market rent and retaining tenants and delivered with 8% leasing spread with average incentives remaining low at 15%. The resetting of market rents across the asset has largely helped offset any cap rate softening resulting in valuation uplift. At Limestone, our focus was increasing occupancy which previously sat around 75%. Once again we delivered finishing the year with 100% occupancy over the commercial area with over 70% of these tenants government backed. We extended the Federal Government across the whole building at Garema at attractive commercial terms. And at 19 Harris Street, our leasing success has produced positive leasing spread and introduced high caliber tenants such as ITV Studios and McGrath Real Estate. Slide 19. We entered FY '23 with 22% of the portfolio's income due to expire in 2024. Throughout 2023, our focus was on mitigating this exposure. By executing on our forward plan leasing strategies, we can now report that that 22% is now reduced to 6%. We activated this by engaging with and renewing major tenants early, including the Federal Government at Garema, Accor in 50 Cavill Avenue and Queensland Government at Ipswich. Our FY '24 income exposure has been reduced by 76% with the remaining expiries of all tenancies less than 1,000 square meters across multiple assets. Our key areas of focus for FY '24 are 2 pronged: to continue to increase rents and to forward sell 2025 expiries. 50 Cavill, 19 Harris Street and WorkZone West are 3 of the portfolio's assets sit in a strong position for rental growth with market rents at a material discount to replacement cost as is the case for all of our assets across the portfolio. Our continued focus on forward selling lease expiries will continue with our attention on both WorkZone West and OG Road, which expires in 2025. Both of these assets are located in markets, which once again have exceptionally strong market fundamentals. We are well progressed at both assets with our dual approach, engaging with current tenants as well as actively participating in market price. Given our track record in executing on our leasing strategies and the strong credentials of both assets, we are confident we will achieve results. Slide 21. The importance of continuing to invest in the needs of our tenant is paramount. We are seeing the results of our continued focus on investing in accessibility, amenity and importantly, ESG reflected in our high occupancy, high utilization, strong tenant retention and engagement. The fund is committed to building on our ESG pathway with our portfolio review completed, net zero road maps completed for 3 of our assets, asset electrification strategy set. We have renewed our Carbon and Weiss certification at 19 Harris Street and WorkZone West and have paid the fund's first portfolio negative rating of 5.1 starts for energy. We continue to be focused on reusing and refurbishing bidouts, reducing our carbon footprint and have completed the portfolio's sustainability improvement plan. These management initiatives are continuing to build on our high quality portfolio and demonstrate our active asset management approach. I'll now hand back to David Burgess, who will talk through the FY '24 guidance.

Thanks, Liz. As we move into FY '24, ECF is well positioned. We've got secure income as you've heard from Liz, we have a strong capital position and we've got opportunities to continue to grow rents. We'll continue to work hard to whatever is within our control. Our guidance for FY '24 is a distribution yield of $0.085 per security, which represents a 10.6% distribution yield. On that note, I will now open up to questions.

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

Just a couple of questions from me. The first question around financial year '24 guidance. When do you assume the settlement of Nexus and Limestone in the guidance?

We've assumed that it's in October, Leanne.

Okay. And the second question is around the Harris Street front. What's your current LVR on that and what is the debt covenants?

Leanne, the current LVR for the Harris Street fund is approximately 62%, covenant is 65%. The fund is fully compliant with all of its banking covenants and has a strong relationship with the debt provider.

Do you have some lease expiries with that asset? Is that correct?

No. The actual main one is the Thomson Reuters space on Levels 5 and 6 and that's a January 2025 expiry. We do have very good engagement.

Yes. We've already got engagement with them, Leanne, [indiscernible]. At the moment, we only have vacancy of around 250 square meters.

Okay. So you think that will be leased up and there's no risk of some I guess valuation decline from upcoming lease expiries on assets?

Actually in the valuation all the let up is conservatively priced into that valuation and that includes that 2025 expiry. So we're very comfortable with the allowance within that valuation. The leasing, as you've seen in the past, have been over 4,000 square meters of leasing that we've done in that building since we acquired the asset. The inquiry is very strong. So we're very comfortable with the direction of that asset.

Your next question comes from Edward Day from Moelis Australia.

Just firstly, on your FY '24 leasing initiatives just with WorkZone West, clearly that's to expire in FY '26. Just your view how you think that positions with regards to passing versus market and I guess initial discussions you're having with tenants?

Maybe I'll start and then Liz can follow-up. Look, I've never been more confident of re-leasing that asset right now. Firstly, that market is performing well. In a fringe market, there's very little vacancy, rents are moving up and that's been reflected in the valuation that we have now where the valuation has gone up despite having cap rates also moving up, that's because the rents are going higher. We think they can do better than valuation in terms of our re-leasing. We've got very good engagement with all the tenants that are within the building. We've also got some very good engagement with tenants that would have liked to be in the building and that's a reflection of where that particular market's at, at the moment. But I'll let Liz speak about that little more.

Yes. Just to echo what Dave said and we are progressed in conversations with both the head tenant as well as the subtenants in the building. So all of them express their desire to remain longer term. And we've also got 1 particular government agency that's expressed it is their preferred option and a larger occupier in the building. So we're running everything in parallel.

That's great. And then just on your leasing spreads, it looks like the major assets there were Harris Street and Cavill Avenue. Is Harris Street I guess under-rented to an extent still?

Yes. Harris Street, that was part of the investment metrics and the passing rents are considered to be under-rented. So if we take Harris Street out of that equation, our leasing spread still sits around high 7%.

Yes. So even without that mark-to-market at Harris, it's still a very, very strong leasing spread result across the 25,000 square meters of leasing that's been done across the portfolio. And importantly, a lot of those deals that we have done are still above valuation. So that's where we have confidence that we can continue to drive rates higher.

[Operator Instructions] There are no further questions at this time. I will now hand back the call to Mr. Burgess for closing remarks.

Thanks again to everyone dialing in and having interest in our Elanor Commercial Property Fund. We look forward to seeing many of you in the near future. Thank you.

That does conclude our conference for today. Thank you for participating. You may now disconnect.