Lendlease Group (LLC) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to Lendlease Strategy Market Briefing. [Operator Instructions] I must advise you that this call is being recorded today, Thursday, 3rd November 2022. I would now like to hand the call over to Mr. Tony Lombardo, Global Chief Executive Officer. Thank you, Tony. Please go ahead.

Good morning, and thanks for joining today's call. I'm Tony Lombardo, Global Chief Executive Officer and Managing Director of Lendlease. Joining me today is Simon Dixon, Global Chief Financial Officer. Sitting here at Barangaroo in Sydney, we're on the land of the Gadigal people, and I extend my respects to their elders past and present. I'll be providing an update on progress against our strategy and 5-year road map. Simon will then talk through the financial strategy. We'll then open up for questions. In August 2021, we announced our 5-year road map: Reset, Create, Thrive, to enhance the way we operate to deliver sustained performance. With reset largely behind us, we're now focused on the create phase. We're accelerating our transition to an investments-led company. To achieve this, we continue to reweigh our capital allocation towards the Investments segment. The high-quality and sustainable product created from our development pipeline is anticipated to remain the predominant driver of FUM growth, which is targeted to be more than $70 billion by FY '26. In addition, we are continuing to progress on external opportunities to grow FUM, and we are increasing our capital allocation in this segment. We remain on track to achieve development completions of $8 billion per annum from FY '24. While we operate a capital-light model in the development segment, we believe there is scope to work our capital harder. That will involve bringing in investment partners earlier in the development process, including from day 1 when we secure new projects. Consequently, we are reducing the capital allocation to development. Our construction capability plays a critical role in the delivery of our urban projects. Our goal remains to be a market leader, maintaining the right capability to support operational excellence. We'll continue to be selective by targeting specialist sectors and customers whose values align to ours, including our focus on health and safety. We're proving our superior delivery expertise and certainty to investment partners and external clients. Our stable backlog, combined with growth in other segments will result in the earnings contribution declining to our revised target of 10% over time. Our founder maintain the triple bottom line was essential focus to Lendlease's strategic direction. This ethos has not changed in 60 years. We remain focused on the triple bottom line. We are committed to creating value for all those who interact with us and to making a positive contribution beyond just the places we create. This encapsulated in our statement, creating the places where communities thrive, where we partner to create vibrant and enduring communities that contribute to a more livable and sustainable future. In recent years, we have not delivered the financial return expectations of our investors. We are committed to restoring securityholder value without compromising our safety-first approach or our ethos of environmental and social sustainability. We have narrowed the target range of our ROE, our key financial KPI, to 8% to 10%, reflecting the ongoing shift in becoming an investments-led business. FY '23 marks the start of the create phase of our 5-year road map. We've already made meaningful progress this year against these key elements of this phase. Some highlights include: investments we've launched 3 new core and value-add products in the last 12 months, the Rap 4 fund in Australia, which has now successfully acquired 3 assets, most recently an office asset in Melbourne, which we plan to reposition; an innovation partnership in Asia with PGIM, which secured its first asset in Tokyo; and most recently, we secured an A-grade office building with an existing 25-year tenancy agreement in Moorfields, London with the support of 2 investment partners, which included New South Wales TCO. Development, we've partnered with Mitsubishi Estate to secure the One Circular Quay development in Sydney, securing our investment partner upfront and using our capital more efficiently. With people, we continue -- we recently launched a number of new flagship training programs to continue the investment in our talent and our ability to continue to attract and retain the best people in the real estate sector. In the Annual Growth Survey, which has just been recently come to market, we've once again topped the global office funds ranking and accolade we've achieved for 8 of the past 9 years in each of our 4 operating regions, Australia, Asia, Europe and the Americas, at least 1 of our funds achieved the #1 ranking. Turning to Slide 7. We have optimized our structure to create a more consistent operating model across our regions as well as streamlining our group functions. Global product experts and investments, development and construction support the regions and provide consistency and leverage global expertise. Our regional CEOs continue to be responsible for the overall P&L, execution of the strategy and customer engagement. This has freed up our group team to focus on portfolio management, capital allocation and risk management. Global Enterprise Services provides scalable functional expertise with disciplined cost management. Turning now to Slide 8. We are positioning Lendlease to be an investment-led organization, targeting to have more than $70 billion of FUMs by FY '26. To reach that target, we're pursuing a disciplined product and sector strategy where we have the advantage of scale or deep capability. In workplace, the workplace sector includes office, life sciences and innovation districts. Our current workplace portfolio comprises of more than 30 A-grade sustainable buildings in global cities, which are 97% leased. This portfolio makes up more than $25 billion of our current funds under management. We believe there is significant opportunity for FUM growth in the sector across our target cities. We believe workplace is essential for businesses to continue to build and create culture and identity. Employees are demanding more amenity and reduced commute times, parking, innovative solutions. We're seeing office use rise as companies and their teams find a post-pandemic normal. As part of our $117 billion development pipeline, we have $30 billion in sustainable office buildings as potential future FUM. Residential. The residential category, both residential for rent as well as residential for sale, has tremendous growth potential for the group. We've been growing the build-to-rent or multifamily capability across the U.S. and Europe in recent years with strong demand for the product. To date, this asset class represents $3 billion in FUM. We have approximately 23,000 residential-for-rent units within our current $117 billion development pipeline, representing $28 billion of potential future FUM. Our apartments for sale portfolio spans affordable to luxury and is located in a number of key global gateway cities. The pipeline consists of approximately 32,000 lots with an end value of $38 billion. The Australian communities portfolio comprises approximately 44,000 lots across 16 projects. Retail. Retail represents approximately 28% of our current funds under management. We have a proud history of developing and managing retail assets. Our current portfolio is geographically skewed to Asia Pac region. Going forward, retail will represent a small proportion of the portfolio given the scale we're targeting in the workplace and multifamily sectors. We see data center as a key growth area for the Investment segment. We have $1.3 billion in committed capital, and we'll look to grow further now that we've commenced our first data center in Tokyo, which is 100% let and due to complete by FY '26. We've got a strong track record in social infrastructure development through our integrated model and PP financing capability. The clear focus and interplay between the investments and development segment should see our earnings from both segments move to the 40% to 50% range. Our Construction segment provides the delivery capability for our integrated model as well as design, project management and construction services to our customers. We're targeting this segment to maintain a steady backlog of $10 billion of work and contribute 10% of our earnings. We currently have 38 billion funds and mandates on listed and unlisted markets. Our capability has been formed over decades, with expertise across listed and unlisted markets. The group has deep relationships with global investment partners, which include some of the world's largest real estate investors. We intend to participate alongside our investment partners in the growth of the platform. We're scaling up the teams across our investment management platform with the recent additions of Penny Ransom to leading the global investment team; Vanessa Orth, leading the team in Australia; and Fabien Toscano based out of London, leading our European team. This increasing capability supports the organization to expand our product offering, enhances the value of the assets we manage and provides additional recurring income streams. Turning to development. The $8 billion per annum of development completions from FY '24 represents an almost doubling of the historical completion rate. The 4 key preconditions to reach that -- we target that need to be satisfied when we start a development, they are planning outcomes have to be achieved to commence. We need the capability to deliver. We need to see the investment partner appetite, and adequate market absorption through sector and gateway city diversification. The conversion of the existing pipeline will be the key to maintaining the annual run rate. To that end, more than $8 billion of the pipeline received master planning approval in FY '22. As we approach scale, our strategic objectives are shifting to improving the capital efficiency of the business. We intend to accelerate the capital release of the current portfolio by entering into a joint venture for the Communities business, partnering on existing projects earlier in the development cycle and increasing the partnering on new projects. In terms of capability, our competitive edge in place making, proving track record of delivering urban projects and our end-to-end capability across all aspects of real estate sets us apart. Through the places we design, build and curate, we aim to create destinations where people want to be. Improving livability, environmental sustainability, inclusion, affordability, connectedness, well-being and a sense of community are important elements in incorporating how we create place. Our objective is to maintain a steady backlog of approximately $10 billion, which is diversified by client, sector and geography across construction. Our construction capabilities played an important role in the delivery of urban projects. We have a rich heritage with project management, design and construction excellence across a range of sectors with leading risk, safety and sustainability credentials. A significant proportion of our construction customer base is repeat business, a testament to being a trusted and strategic partner. Working collaboratively with our partners has been essential in mitigating supply chain risk and achieving our sustainability targets. I'll now hand over to Simon, who will step through our financial strategy.

Thanks, Tony, and good morning, everyone. Turning to Slide 13. We have further refined our financial strategy and portfolio management framework or PMF to reflect the evolution of our strategy. There are 3 key objectives to these refinements: to expedite the transition to an investments-led organization, to enhance capital efficiency and to retain more capital to provide additional funding capacity. We believe these amendments will improve our risk-adjusted returns and over time, lower our cost of capital, whilst not impeding our ability to control our pipeline and create best-in-class product for our investments platform. There are a few implications for our PMF, which provides the structure for our financial strategy with changes highlighted on the slide. Starting with capital allocation. We have lifted the invested capital target range for the Investment segment by 10 percentage points to 50% to 70% and reduced the development segment by a corresponding amount to a range of 30% to 50%. The midpoints of these ranges imply a material shift from the current capital allocation, which is approximately 40% investments and 60% development to a capital allocation of 60% investments and 40% development. The target capital allocation on a geographical basis remains unchanged at 40% to 60% for Australia and 10% to 25% for each of Europe, Asia and the Americas. The target EBITDA mix across the 3 operating segments shifts due to the change in capital allocation and maintaining our construction revenue at current levels. Investments and development are targeted to contribute 40% to 50% to EBITDA with construction reducing to 10%. The target returns across the 3 operating segments remain unchanged. They are a return on invested capital of 6% to 9% for investments and 10% to 13% for development and an EBITDA margin of 2% to 3% for construction. The hurdle rates that underpin these returns are long term by nature and have not been adjusted since adopting the PMF back in 2016. Hurdle rates were not reduced during the period when interest rates reduced materially nor do we see the need to lift hurdle rates now that interest rates are normalizing. The slight narrowing of the target ROE range from 8% to 11% to 8% to 10% is primarily due to the change in capital allocation between investments and development. Our capital structure objectives remain unchanged. They are to operate with an investment-grade credit rating, maintain a sufficient liquidity buffer to manage through the cycle and minimize our weighted average cost of capital. Having considered these objectives, our target gearing range remains unchanged at 10% to 20%. And we are confident that we have the financial flexibility with regard to capital deployment, capital partnering and capital recycling to maintain net debt within these stated gearing levels. The distribution policy has been revised with a payout ratio of 40% to 60% from core operating profit reducing to 30% to 50% given we are in a growth phase. While the distributions, each period will be ultimately determined by the Board, we expect near-term distributions to be at the lower end of the range as we fund our growth. Turning to Slide 14 and addressing the funding of our investment-led strategy in more detail. We are confident that our organic capital generation via retained earnings, combined with incremental debt, will enable our invested capital base to rise from approximately $9 billion in FY '22 to approximately $12 billion by FY '26. That capital base is sufficient to fund the group's business plan. The FY '22 starting point for capital is comprised of $5.4 billion of development capital and $3.7 billion of investments capital. Our retained earnings estimate of approximately $2 billion includes the benefit of lowering the payout ratio. Additional debt capacity of approximately $1 billion remains within our target range and includes an allowance of approximately $800 million for noncore cash outflows as we run off the provisions and the working capital unwinds. That estimate has not changed since the FY '22 result. By FY '26, we expect the composition of the capital to change materially. Investment segment capital is expected to almost double to approximately $7 billion, while development capital is expected to be approximately $500 million lower than FY '22 year-end at $5 billion. Moving to Slide 15 on investments. We remain optimistic on the growth outlook for our investments platform. Our developed core products derived from the development pipeline will remain the primary source of funds growth. We have approximately $10 billion of potential additional FUM from our work in progress. These include the multifamily development at 1 Java in New York, Victoria Cross Over Station Development at North Sydney, the Certis Cisco Centre in Singapore, the first of the Data Center Partners assets in Greater Tokyo, and the life sciences development at 60 Guest in Boston. More than 50% of the development pipeline comprises institutional-grade investment assets. We'll be working with our investment partners to keep these assets and grow FUM. Achieving our commencement targets over the period FY '23 to '26 will provide potential FUM of more than $10 billion, although some of those assets will complete post FY '26. We have started to gain traction on external opportunities through the launch of new FUM products and partnerships. There are approximately $3 billion of commitments at the end of FY '22, which Tony discussed earlier. Capital will be directed towards co-investment positions in product derived from the development pipeline as well as new products and partnerships. We generally take larger positions in early-stage life cycle assets and new products for alignment purposes and then reduce our stake as assets stabilize or products mature. This approach has worked well. It's capital efficient and will continue to be adopted. Workplace and residential will be the key growth sectors at an asset class level. Direct investments are anticipated to continue to be reduced as we focus on opportunities that generate additional income streams. Turning to development on Slide 16. We remain confident in our pathway to restoring development ROIC to approximately 10% in FY '24. There are 2 key elements to that. First and most important is generating profit and margin on the portfolio; and second, improving our capital efficiency. Completions of $8 billion in FY '24 remain on track with $7 billion of work in progress scheduled to complete in that year. That is more than a threefold increase on the completions in FY '22, which is key to improving the operating leverage and profitability of the segment. We've listed the key contributors to FY '24 completions on the slide. One Sydney Harbour, Tower 1 is the largest with expected revenue of approximately $2 billion. The project has been a great success with Tower 1 now more than 95% presold. The retail mall at TRX valued at approximately $1.5 billion is now almost 60% pre-let. While we have experienced COVID-related construction delays and costs, our feasibility on the project has held up with the revenue upside cushioning expected margin. The delays will have some impact on returns. The first 2 residential towers with an end value of approximately $500 million are more than 40% presold. Melbourne Quarter Tower, a 75,000 square meter workplace with an estimated value of $1.2 billion is currently 30% pre-let. We also have apartments for rent in London and Chicago completing with both markets currently experiencing strong rental demand. More than 90% of our development pipeline has been secured on capital-efficient terms, including both land management agreements and projects secured on staged payment terms. Notwithstanding these models, which enable us to control a pipeline of $117 billion with capital of $5.4 billion, we believe we can become more capital efficient. Accelerating the release of capital on current projects, along with increased partnering on new opportunities will reduce the likely peak in development capital. More than 90% of our development capital is in projects that are either master planned or in WIP and as such, have largely mitigated planning risk. That provides opportunity to accelerate the introduction of capital partners into these projects. Going forward, we will target an economic interest of less than 50% for projects that are in WIP. In the coming 2 years, we continue to target $8 billion of commencements per annum. The majority of those will come from that $42 billion of pipeline that is master planned. There is diversity by both gateway, city and sector. As shown on the slide, there is $8 billion in workplace, $10 billion in apartments for rent, $8 billion in apartments for sale and $15 billion in communities. In addition to the current pipeline, new opportunities will also arise. One Circular Quay, which we secured early in the new financial year, is one such project. We've started to take expressions of interest for the residential apartments. Early indications suggest significant appeal for this iconic project. We are confident that once the project is launched, presales will reach a level to enable delivery on the tower to commence in the current financial year. We also plan to commence a hotel on the site in FY '23. The total value of the project is estimated at $3 billion. We have commenced 30 Van Ness in San Francisco, a project comprised of 333 apartments for sale and a 26,000 square meter workplace. The project is valued at approximately $1.6 billion. There are several other projects that we expect to commence in FY '23, but we'll only do so when sufficiently derisked for our combination of funding, underlying fundamental real estate demand and certainty on delivery costs. Potential projects include La Cienega, Milan Innovation, Victoria Harbour and Melbourne Quarter. We believe these preconditions will likely be met to achieve our aggregate commencement target. Moving to the Construction segment on Slide 17. As Tony noted earlier, our construction capability remains a key component of our integrated model and the delivery of our urban projects. Our brand is synonymous with excellence and we intend to maintain leadership positions in our desired sectors and markets. A strong focus on customer is key as is a disciplined approach to risk management. This requires carefully managed diversification by sector, geography and client. The increase in scale of the investments and development segments has resulted in the target earnings contribution for construction being progressively reduced over the last decade towards current weighting of 10%. We expect this to be achieved by FY '26. I'll now hand back to Tony.

Thanks, Simon. The group entered the new financial year with significant momentum, providing confidence as we enter the CREATE phase of our 5-year road map. While we anticipate an improved financial performance in FY '23 compared to FY '22, the risks identified at the full year result, in particular, inflation and interest rates, are likely to temper the recovery. The FY '23 outcomes for each of the operating segments are likely to be towards the lower end of the ranges. Those ranges are a return on invested capital for the investments and development segments of 6% to 7.5% and 4% to 6%, respectively; and an EBITDA margin range for the Construction segment of 1.5% to 2.5%. Consistent with previous years, there is also likely to be a skew to the second half largely due to the timing of development completions. We'll continue to remain disciplined on when we invest capital. We'll launch new funds and co-invest when we secure our investment partners to launch a new product. We'll commence developments when we have the confidence that the 4 key preconditions have been satisfied, planning outcomes have been achieved to commence, capability to deliver investment partner appetite and adequate market absorption through sector and gateway city diversification is achieved. The ROE target range of 8% to 10%, which has been narrowed following the refinements to the portfolio management framework, as described by Simon, is expected to be from FY '24. We'll now open up for questions.

[Operator Instructions] Your first question comes from Ben Brayshaw from Barrenjoey.

I just had a question in relation to construction with the target contribution to be approximately 10% in the medium term. Could you perhaps just comment, Simon, on your expectations around backlog revenue and realized revenue, please?

Yes. So Ben, where we stand today is our current backlog is sitting at about $10.5 billion, so we'll anticipate to continue to maintain that backlog around that level and where we anticipate from a revenue standpoint to be in that $6 billion to $7 billion in terms of annual, in terms of range, in terms of each year.

So should we be thinking about the external construction EBITDA as having growth prospects over the medium term? How do you see the growth opportunities there for the profitability of construction?

Yes. I mean I think the key for us on the construction side is really, as we're flagging, is to maintain it at that current level. So we do want to make sure we stay focused and disciplined in achieving our 2% to 3% EBITDA margin. I think what we are really doing is making sure we refine it and have the right cost structure to support that. And that's where we'll be focused as a management team really, around maintaining that disciplined level of portfolio going forward.

Your next question comes from Simon Chan from Morgan Stanley.

What's changed in the last 2 months? Because I remember, when we call out post results, which is quite recent, you were talking about 6 and 6 in '26, and then now it's become 5 and 7 in '26. What's happened in your thinking that's changed in the last 2 months?

Well, I think what we have been flagging, Simon, is 1 of the couple of key things we've just been focused on for us as a strategy on where we create value for our security holders. And a couple of key things as we're pointing out, this transition will happen out to FY '26. So we've been refining the strategy and looking at where we want to place our capital investments going forward. So a couple of key things we are really trying to do is accelerate our investment management growth. And one of the key things we did flag is really pushing into creation of products in both core and value add. And we've gained some traction on that, as we've talked about through the recent products that we've been growing. So where we think and where we think it's quite important for us as a group is to continue to accelerate that. And therefore, we want to allocate a further amount of capital there from an investment standpoint going forward. And that's why we're increasing that to 7 out to FY '26. On the development front, where we've flagged is we want to be more and more capital efficient in terms of how we operate the business. And going forward, a couple of key things we did flag was, over the next couple of years, we are looking to bring in a JV partner into the communities business. As we are launching and going after new projects like we did with the One Circular Quay opportunity here in Sydney, we've brought in the capital partner upfront. We do see an opportunity in a number of our projects where we do have 100% control to look at bringing those capital partners in earlier. So we're just wanting to be way more disciplined around how we're using capital there. And again, that's going out to '26. So we're just flagging how we want to change the risk profile of the group over the next 4 years.

Right. How are partnering up with partners earlier on in the development cycle impact returns? Like will it potentially lower development returns?

What you should see is actually a couple of things as we bring partners in. We will look to secure acquisition fees. We will look to bring in development management fees for doing that earlier. We'll still look to achieve the right return from the project but also bring in to the ability for us to earn performance fees. So hopefully, we'll actually see a better improvement over time as we push towards that capital partnering approach going forward.

Obviously, Simon, there's an adjustment when the capital comes out of the development segment and gets recycled into investments. Obviously, there's an adjustment to the denominator. So there's certainly no change to the overall sort of economics at the project level. But to Tony's point, if anything, we'll look to see whether there's any potential fee streams that can be generated as well. But if you look at our current WIP balance, that's sort of $18 billion plus. And also master planning, we've got a number of projects in there, which have been derisked at various stages. Clearly, the planning has been largely derisked. So they are at a position where it could be attractive and it's attractive to start looking at bringing capital in slightly earlier.

Great. And my final question is just in relation to the update to FY '23 ROIC expectations. I was just wondering, could you go bottom up a little bit, Tony or Simon, and just flag what's happened to some of the projects that's required you to lower the ROIC expectations for the year.

Yes. I think the 3 key areas on the investment side, people and investors are just taking longer with inflation and interest rates. So where we thought we were moving forward with the funds growth, that's probably just going to be just a bit of a slower growth rate this year. So that, to me, comes down to how we're leveraging up our resources as we're growing there. On the development front, again, people again are taking longer and so transactions taking a little bit longer to complete and cap rates are pushing out. So there are a couple of key factors. And then on the construction front, we are seeing no flag this that the U.S. and U.K., we still had to secure a significant amount of work through this year, and that's probably coming through a lot slower. So again, from an operational leverage, we're not going to have that leverage achieved through this year. So we're just flagging that we'll be at that lower end of each of those bands. Really, it's about the economic activity and inflation and interest rates really starting to slow down the timing of transactions and the like.

Well, I'll add to that, Simon. It tends to be across all of the segments. It's a number of items on projects as opposed to 1 or 2 specific projects.

Your next question comes from James Druce from CLSA.

First question is just about the narrowing of the ROE target. If you look at peers that have decent funds management platforms, generally, they're higher ROE than the development piece. So I'm just trying to understand the narrowing of the ROE target over the medium term.

Well, on our ROIC ranges that we've got, so when you look at that allocation, the right range for the Investment segment was running at 6% to 9%, so we've continued to maintain that. All we're saying is we're allocating a higher component of our capital there, which is lower than our development ROIC returns, which are at that 10% to 13% range. So that shift in capital allocation brings with it the lowering of the total range from the original 8% to 11% to the 8% to 10%. So that is the key change that we're making to our outlook from an ROE perspective.

It sounds like from your prepared comments that you're going to be more capital efficient within the investment business as well. Am I reading that correctly?

Yes. The goal will be to really drive that going forward and again, across both development and the investments is to use that capital as efficiently as possible.

Yes. I mean if you look at -- if you sort of define that as the co-ownership interest in the overall FUM that one manages, then, clearly, where we have in markets that are more developed, you look to Australia, where there's a much smaller percentage holding in the overall FUM that's managed versus offshore where we're building out capability and aligning ourselves more with capital, and that can be expected to sort of move down over time, I think as we highlighted in the presentation. So we're definitely striving towards a capital-efficient model on the investment side. And another way to think about it is with the target in FY '26, which remains unchanged of $70 billion of FUM and a target of capital of $7 billion invested into that segment by FY '26, you're looking at sort of effectively a 10% co-ownership interest as a sort of -- as a general target across all of the platform.

Yes. So this is why I don't get -- so if you're reducing your co-investment stakes, essentially increasing your fee strength. So that's why I don't understand why the ROE target hasn't probably shifted up a little bit.

If you look at the -- where -- the fund growth at the moment, a number of the funds, we're invested in the core funds. We've been invested for some time with some of the newer funds that we're going into and some of the product that's been developing will be needed to take a higher stake initially to align with capital, and then we'll bring that down over time.

But just to reiterate, James, our current ROIC range for the Investment segment is 6% to 9%. So we're not changing that. So when we are making that capital allocation, as Simon and I are pointing out, the higher allocation. So that's why the range is shifting downwards, which is lower than the [indiscernible] level.

Yes. Okay. Maybe we'll move on. But I'm saying that, that 6% to 9% probably should change if you're reducing your current stakes that you're planning on. But maybe we'll keep moving. Just on the $8 billion development completions targets, you've obviously got $1 billion defined by FY '24. How does communities sit into that calc? And how do you -- the sort of scenarios can you paint to get to that 1 billion [ completions ].

From that point, we've flagged the communities -- to settle around -- our target is to settle between 3,000 to 4,000 units in any given year. But we -- this year, we carried in $1 billion in terms of backlog. So that's what we've always aimed, to have then completing on an annual basis. So that's what we would be striving to achieve into that '24 year.

Okay. That makes sense. And then in terms of the joint venturing of the communities business, has that progressed at all? Or is that still just on paper?

No, that's something we've been flagging that we'll be looking at. Of course, economic conditions have changed, but we're continuing to proceed to look at that over the next sort of 24 months. So that continues to be a key strategic priority of mine and the leadership team.

That's great. And finally, just on -- looking at your investments piece of majority capital allocation, now majority core investments going to track, does that allow you to get into the rate mix for Australia?

Ultimately, it comes down to your active and passive earnings streams. And if we continue to grow and if passive earnings does grow above, I think it's the 50% to classify for things like Nareit. That could be a potential, but it's not something that we're focused on at this stage.

Your next question comes from Stuart McLean from Macquarie.

First question, just on Slide 16 to the pathway to FY '24 -- ROIC of circa 10%. And just kind of marrying that up with some of the reasons why you've moved to the lower end of the target range for FY '23. So rising cap rates are coming through, I mean, you get to potentially slower -- hard to get the best development delay. [indiscernible] something that potentially coming off the boil. What of those factors continue to play through into '24? And so what gives you the confidence that despite seeing all of this impacting FY '23 earnings today, you can still hit that circa 10% in FY '24 and that doesn't have downside risk to it.

Yes, thanks. It's a good question. It's -- I mean, certainly, as we sit here today, we are being impacted by a number of factors across a number of projects. But if we look into the detail, we've got some issues around sort of settlement delays, so approvals to settle. So this is more of an administrative issue, which is not related to the broader macroeconomic conditions. So one would expect that to fall away next year. We have some planning delays on a couple of projects, which have forced us to kind of guide towards the lower end of the range. Again, they're not related to broader macroeconomic conditions, so we expect those to fall away. There are some pricing impacts as a consequence of cap rate expansion. They've been relatively minor. And again, we factored those in to our kind of reforecast for FY '24 and are comfortable with holding that 10%. So it really is a number of the issues that we're facing could be classified more as timing issues rather than sort of macroeconomic issues in that segment.

Okay. So [indiscernible] transitory issues. Okay. And then kind of a similar one on investments as well, so lowering that towards the 6% hike mark, that's despite already booking $73 million of pretax earnings from sell-down and military housing. What needs to happen to consistently achieve the midpoint of that range on a go-forward basis? Do you need to have more active type earnings in the investment division, performance fees, et cetera, to keep that the midpoint? Or how do we get there?

Yes. I think there's 2 things to note. We are investing in capability, in particular, in Europe and U.S. as we're growing out those platforms. So those platforms are still needing to scale up. So those platforms over time need to grow to the right level of scale and hit those right margin returns. And we've called out that we're going to be operating at a greater than 40% margin on some of the core products that we'll have in place. So I think that's important to know. As we are looking to grow the platform, some of that growth is coming out of those offshore markets. So that's a key thing. On this year, I think where we are existing investors are slowing down and sort of pausing a little bit as they absorb where inflation rates and interest rates are getting to. So for us, it's really around we have products and things that we want to launch. It's actually the speed of launching those new products. And the key to that is also the fee streams that do come through acquisition fees and other things where we are acquiring things. So we do need to get that steady state in some of those fee streams also coming through. So they're a number of the key factors that would need to drive more of that consistency over time.

And on that cost piece and scaling up the funds management platform, is there now, in terms of headcount, we should start seeing that leverage? Or as you continue to push towards $70 billion, you're going to need to put more and more people on, which is going to mean that, that leverage doesn't come through until '26 or even FY '27?

I think where we're aiming to get that leverage through is we're probably in that scale-up mode this year, in particular, really the U.S. and Europe, as I was pointing out, Stuart. I think where we want to be is going forward through '25, '26 actually hitting those consistent returns because we'll have grown the FUM to a -- at a level that we consider we can actually absorb and hit our margin targets that we've set for our teams.

Great. And then just one on the payout ratio as well. It sounds like shifting from circa 40% down to 30%. What's changed there in regards to the outlook for the balance sheet to make that decision to change the payout ratio?

Just wanted to be clear where we need to stand from retaining a level of earnings to fund our future growth. Ultimately, we will pay between that 30% to 50%. So it's moving it from 40% to 60%, so we've stepped it down by 10%. I think it just gives us flexibility to have that retained earnings to fund the growth profile we see that we have available to us within the business going forward.

To fund the pipeline, do you feel you need to recycle capital? Or does that retained earnings give you enough capacity to put an extra $3 billion of capital to work?

I think there was a chart that Simon has got in his section that clearly just steps it out. We're currently roughly at about $9 billion of capital today. And when you look at that Page 14, what we've said is if we continue to drive the right level of performance, we'll retain about $2 billion of retained earnings at this lower range in terms of a distribution payout ratio, and we've got capacity to draw on another $1 billion of our debt. And that's what we're saying. That $3 billion will fund our growth requirements out to '26, which is the $12 billion, which we're flagging as $7 billion investment and $5 billion development.

I mean we'll continue to look at opportunities to recycle where it makes sense to rebalance between development and investment or if there's assets that we would like to cycle out of. But to state the obvious, we don't create capital from that unless we're exiting for above book. I'd also note on that slide, that the net debt -- sort of the incremental net debt, we've effectively netted off the outgoings that we're expecting between now and over the plan period in '26 in relation to the noncore business, which we previously highlighted that $800 million, which we called out at the full year results.

Your next question comes from Tom Bodor from UBS.

I just have a couple of quick ones. The FUM margin at 40% is much lower than peers. I guess how should we think about that at $70 billion, the business is at scale? Does that have potential to be 50% or 60%? Or why do you see that sort of a much lower level than your key peers?

Yes. Look, I think over time, we will be -- again, it's greater than 40% is where we'll be targeting. I think what we are flagging is we've got to scale up in those offshore markets because when I look at the FUM that we've got in Europe and the U.S. today, it's sitting at a couple of billion. Really, to get that right level of scale, you got to be at the $5 billion to $6 billion plus to really drive those operational efficiencies that we need to get to. So we do see there's an opportunity over time to actually get to that [ feed ] right level at 50% and to marry up to where our peers are. But we are investing in that short-term period in terms of getting there over the next few years in terms of growth.

If I can add that, I mean, that will come both from scale but also increasingly looking at value-add products, so moving up the curve into higher fees.

Okay. That's good. And then in terms of offshore, what is the appetite to invest and continue to put capital into sort of your high-risk margins markets like Malaysia and China?

Yes. Look, I think at the moment, I mean, in Malaysia, the key development we've got on foot is really TRX. And so we're coming to that point where we're getting to completion, and we will be looking to recycle out of our current investment position as we complete the retail asset and bring in the right capital partner. So that's definitely something we're focused on, and we're talking to predominantly some of the big local capital partners and pension funds that operate within that market. So there is definitely an appetite for the right asset that's going to have a good long-term outlook. In terms of China, I think, at the moment, people are sort of, again, working through their strategies and portfolio strategies. So we're still in that emerging phase of creating our senior living product there, and we've only got the one project, and we wanted to prove up the business model. So as that progresses, there is an appetite in the build-to-rent senior living space with the aging population, but we're in that proof point. So the next 12 months will be important for us to then talk to our partners to continue to look at how we bring capital into that opportunity going forward.

So would you generally want sort of a higher share from a capital partner though in those markets to limit exposure? Or are you pretty comfortable just to continue to deploy into those markets?

I think we want to make sure we've got the right capital partners to support us. So we're not looking in our China business to put assets directly on balance sheet. We want to prove the senior living model up and then make sure we've got a capital partner to support the growth of that business going forward. So we would want to be in that 25% to 50% from our perspective, from a capital stack when it comes to development and as time progresses, reduce that when it comes to a co-investment position over time. And same in Malaysia. As we're in the development phase, we're already in a joint venture with the Ministry of Finance. When we get that asset into the right shape, would want to have a 10% co-investment long term in the asset from our perspective.

Just one final one. I think you've talked about cap rates increasing. Costs are going up. Debt costs are going up. Construction costs are up. Do you find you're having to move up the risk curve in order to maintain returns on the new work you're looking at?

No, I think, I mean, ultimately, in the construction space, we're pricing based on the current market conditions. And in terms of that risk spectrum, we're not trying to move up the curve. We're just pricing and making sure we factor in escalation. When you look at the current construction book, a large proportion of our work does remain in government, and that's been a key thing. We've been focused at the moment on the social infrastructure side around work that we do also for defense in Australia. So it's just making sure we're picking that right mix of work and risk profile going forward.

And then developments that you're looking at, like how do you mitigate the risk of cap rates increasing when you're committing capital in development?

Yes. I mean at the moment, when we look at any underwrite and when we look at the Circular Quay deal, we're making sure we're looking at what's the right price to pay for the land as we get into that entry price point and ultimately looking to underwrite at the right returns based on the current market. So it really comes down to the assumptions we're putting in. And then at the same time, we are bringing in capital partners and the like. So we're making sure we've got capital that has an appetite to underwrite consistent with where we see the right risk profile to hit our returns, which our project returns haven't changed. We're still after the right mock in that 20%-plus level and the right IRR to the project.

To say that in a slightly different way, I mean, the project returns and hurdles haven't changed, but clearly in the underwriting and the cash flows, we are very cautious at this point of the cycle and adding in a bit more buffer when we're looking at new opportunities. So we are continuing to take a very disciplined approach to deploying new capital.

Your next question comes from Richard Jones from JPMorgan.

Just a couple of quick clarifies. Just the increase in capital and investments, is that going to come from higher co-investment stakes or just higher FUM rolling forward?

So what we will do is we'll most likely have some higher co-investment stakes. As Simon pointed out, if you look at the FUM today, we're -- $44 billion of FUM with circa $3.5 billion of co-investments as we're moving into some of the new products that we're launching for alignment reasons, we've actually held a higher amount, but over time, would anticipate that to reduce. But we're flagging that for our $70 billion, we'll have circa $7 billion, which is roughly about 10% co-investments in the investment section to support that FUM.

Okay. And then aside from One Circular Quay, can you give some examples of where you will bring capital in early to development? What is it about the type of projects that makes sense to bring capital in earlier?

I think what we're flagging is when we look at our master plan book of $42 billion today and like we've done over the last 12 months, we brought in circa $8 billion of capital to support the developed core. So where we see the business moving to, when we look at that, we would like to bring in our capital partners in the same way in what we've done in the last 12 months. So it's really making sure -- when we look at opportunities, we take that approach to accelerate the use of capital earlier and work with our investment partners earlier based on their appetite. And secondly, as we're flagging for new opportunities, what we're doing as a team is making sure we've got the right capital partners upfront and not to just -- for instance, when we created the new life sciences partnership with Ivanhoé Cambridge, we've got the partnership and the capital to go source opportunities. So we're only 25%, and they're 75%. So it's taking that early approach. So we're not putting 100% of the balance sheet into those new opportunities.

Okay. One final question. Just any additional color on cost out or headcount reduction maybe particularly with reference to the construction business?

Look, I think we will continue, as a team, to look to drive efficiency. We've set ourselves some clear portfolio metrics and therefore we'll make sure we've got the right cost of sales to support that and the right overhead level. So it's one thing that will continue to refine last 12 months. We took out a significant amount of cost as part of the reset strategy. There was some $170 million of cost that came out of the business, and we'll get the full run rate benefit of that in this financial year. So we'll continue to maintain a very disciplined cost management approach going forward.

Your next question comes from Sholto Maconochie from Jefferies.

Just a couple of follow-ups. Just on the FUM target of $70 billion. If you just add up all your completions that you put on Slide 16, like your sort of $65 billion, so obviously, you need some inorganic growth. Will it be sort of like buying stuff in the funds like the Moorfields asset recently. Is that how you'll get the extra $5 billion or $6 billion to get your target for those acquisitions within those funds?

That's right, Sholto. A mixture of acquisitions in funds or new products that we do launch, similar we've just done on Moorfields.

Okay. And then just on the [ business wire news ] recently, some changes or management team-wise, is -- would you just have less capital to invest in U.S. construction? Or is it coming about $40 million cost there? Is it sort of a cost out or less capital going to go to some of that construction in the U.S. given the de-weighting from an earnings perspective? Or should we think of any changes there?

Yes. Look, I think we're going to continue to -- and we flagged that we've got to make sure we hit the right levels of work secured both in U.S., U.K. and all our markets. So we will look to make sure we've got the right cost base that supports that portfolio. So I think we'll have to continue to look at how we drive efficiency across everything we do to continue to deliver the 2% to 3% EBITDA margin that we flagged for that sector. So we will continue to look at that as a team.

And then obviously margin, I guess, if it best capital in that market with low margin. But then on the invested capital pathway, that's net of the $800 million outflow for the noncore businesses you've exited. But is -- that doesn't include any sell-down of communities, does it, into a JV? So that pathway to invested capital does not have any sell-down of communities.

No, not per se. And to my earlier point in terms of any sell-down of any asset creates additional capital efforts if it's sold over and above the carrying value on the book. So it doesn't. So we just try to keep this very simple, and we've been pretty conservative. And really, the point to make is the pathway from 9 to 12, which is what we believe we need to do to execute the business plan, is very achievable within our existing capital envelope. We'll clearly keep looking at opportunities to recycle assets, but we haven't assumed any recycling of assets over and above book value in this simple table.

Okay. And then just on [ Chinese ] question on the 10% coinvestment. So would we obviously have less kind investment in Australia where you're larger and a bit more in the offshore markets before you sell down? Is that correct, [ that 10% ]?

And that's correct. And if you look at what we did with Moorfields, we had 75% of the capital, and we put 25% in. And -- but we'll look to release some of that capital going forward. So it's just more about how we support the business to really grow and as they're in that early phase of the growth phase.

And then finally, on Melbourne Quarter, only 30% pre-let. I think even in the paper you guys are looking at a build around in Australia. Would Melbourne Quarter be appropriate for that sort of asset class, given office is not exactly shooting for the lights out in Melbourne? Was that would you look at the next stage there build-around product in Melbourne Quarter?

Yes, I definitely think Brisbane and Melbourne and the Melbourne Quarter product both lend themselves to opportunities to do build through.

Your next question comes from Alex Prineas from Morningstar.

Just you talked about how economic conditions have changed, and that's sort of driving some of these changes to their targets. And you've also sort of talked about some of its timing issues that are expected to resolve. I was interested in terms of the macro underpinning all of your sort of assumptions going forward. Are you generally assuming macro conditions remain about the same or get worse? Or is there some alleviation of macro conditions underpinning that, underpinning your forward expectations? Can you just comment on that generally?

I'll give that a go. It's -- we're -- the way to think about this is generally maintain the same with slight worsening in certain markets in the short term and then recovering to more normalized conditions longer term.

Okay. And longer term -- in terms of getting back to more normalized conditions, what time frame you sort of roughly factoring in?

I would be saying it's the next 12 to 18 months, we see the more challenging conditions with an alleviation after that sort of 18-month period.

Yes. I think things will become obviously a lot clearer as we move into next year, but there's still -- there's quite a bit of uncertainty. And I think that will clear up as we move into the first half of calendar '23.

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

Thank you for all joining. So I really do appreciate that time. So look forward to catching up with everyone post our half year results. So thank you.