Nippon Building Fund Inc. (8951) Earnings Call Transcript & Summary

Thank you very much for attending today's presentation. I am Yoshiyuki Tanabe, President and CEO of Nippon Building Fund Management. I will now go over NBF's results for the second half of 2019, which was our 37th fiscal period. I will make my presentation using the handout material. From a fair disclosure perspective, this presentation material has been released on TD-NET as well as on NBF's website at 10:00 a.m. today, Tokyo Time. On Page 23, we show the market data for the business area in Tokyo. As you are probably aware, the environment for office buildings remains strong with vacancy at a record low of 1.53% and the average asking rent at JPY 22,448, up 73 months in a row. The key feature of the upward trend this time around is that it is gradual and is continuing over a long period. I will now go over NBF's results, which also reflects this favorable office leasing market. Please turn to Page 3 of the presentation, where we show the financial highlights. The average occupancy rate during the period, shown at the bottom of the page, was 99.4%, and our portfolio remained almost full. We achieved internal growth through initiatives such as upward rent revisions based on the high occupancy, together with factors such as the full period contribution of G-BASE TAMACHI and Osaki Bright Core acquired in the first half. Our performance and results were robust as in the first half of the year. As a result, our distribution per unit was JPY 11,011, up JPY 451 or 4.3% period-on-period. As for the forecast for the first and second halves of 2020, there will be a decline in DPU because we will not book the one-off income from the replacement of a large tenant in the NBF Shinagawa Tower, which we booked in the first and second halves of 2019. However, we expect our performance to remain robust with internal growth as the driver. Please turn to Page 5. The 2 bar charts show the trend for the past 3 years of our DPU and NAV per unit, which we regard as important metrics in improving unitholder value. We will continue to seek medium to long-term stable growth in these metrics. Now on Page 6 onwards, I will go over the financial results. On Page 6, we summarized the acquisitions and disposals of properties in each period. Please take a look later. On Page 7 is our statement of income for the period. Please see the column highlighted in red, which represents the results for the second half of 2019. Operating revenues was JPY 39.13 billion, up JPY 604 million period-on-period. Operating income was JPY 16.9 billion, up JPY 185 million period-on-period. Net income was JPY 15.5 billion, up JPY 157 million period-on-period. In the second half, we did not book capital gains from property disposals, and there was no addition to the reserve for advanced depreciation. Total distribution was JPY 15.5 billion, equal to net income. As a result, we achieved strong growth in our DPU, which was JPY 11,011, up JPY 451 or 4.3% period-on-period. Now on the right-hand side, I will explain the summary of period-on-period change. First, the breakdown of the JPY 604 million growth in operating revenues. Rental revenues increased JPY 796 million. Out of this, JPY 436 million was from existing properties, which we achieved through successful upward rent revisions and tenant replacements. There was also a growth of JPY 360 million from the full period contribution following property replacements. The JPY 287 million increase in other revenues related to property leasing was mainly due to seasonality in incidental expenses. Meanwhile, there was a JPY 478 million decline in gains on sales of investment properties, which we booked in the first half. For operating income, on the leasing side, there was JPY 426 million growth from existing properties and JPY 240 million growth from the full period contribution following property replacements. Although we did not have the gains on sales of investment properties in this period for which we booked JPY 478 million in the first half, we achieved net growth of JPY 185 million in operating income. The decline in interest expenses was due to better interest rates achieved through refinancing. Next, I will briefly go over our balance sheet on Page 8. The section highlighted in red is the balance sheet as of the end of the second half of 2019. Total assets was JPY 1.043 trillion, almost flat from the end of the first half. Property acquisitions and capital expenditures on existing properties was covered by depreciation, and there were no notable fluctuations in the balance sheet items. Next is the operating results and outlook. I will start with internal growth. Please see the graph on Page 11 showing the occupancy rate and the percentage of floor space of tenants moving in and out. The red line shows the average occupancy rate of the portfolio during the period. The bar graph at the bottom shows the percentage of floor space for which tenants moved in and out during each 6-month period against the entire portfolio. And please take a look at the bar graph. I will explain the status of tenants moving in and out. In the second half, both the ratio of tenants moving in and out was 2.5%, higher than the first half. This was largely due to the replacement of a large tenant in the NBF Shinagawa Tower, which is the light gray section of the bar. As for the dark gray section, which refers to the 70 other properties, the movement of tenants was limited. And the average occupancy rate during the period ended up very high at 99.4%. We expect occupancy to remain very high at 99.2% in the first half of 2020. As for the second half of 2020, at the far right, we are forecasting the ratio of tenants moving out at a somewhat high 2.9%. This is because we are expecting the departure of the single tenant in the NBF Shinkawa Building close to Hatchobori Station in the Chuo ward. However, the ratio of tenants moving out from the remaining 70 properties in dark gray will remain low. As a result, we expect occupancy to be at 98.9% despite the departure of a large tenant. This will give us the opportunity to conduct leasing activities on a sizable amount of floor space while maintaining high occupancy of the portfolio. Next, on Page 12, I will explain the trend in rental revenues. The yellow line represents the period-on-period change in rental revenues from the existing properties only. The bar chart breaks this down into 2 factors. The blue section represents changes in rental revenues from rent revisions with existing tenants. You can see that since turning positive in the second half of 2015, shown at the far left, the upward rent revisions have been continuing stably. And although impacted by individual properties, the extent of the upward revisions has been gradually increasing. We are expecting similar trends in the first and second halves of 2020, and the blue section should stay positive for 11 periods in a row. The green section includes factors other than rent revisions, such as the impact of tenant replacements. For the second half of 2020, the green section is negative due to the departure of the single-tenant property mentioned earlier. However, the effect from tenant replacements will remain positive for the 70 other properties. And the yellow line, which is the total of the blue and green sections, representing the overall internal growth, is expected to be positive. For your reference, we have put in pie charts at the bottom of the page showing the status of rent revisions. The colored parts of the graph represent the portion of the portfolio that was subject to rent revisions in that year. The graph on the left shows the result for 2019. And in the year 2019, 29.5% of the total portfolio was subject to rent revisions. Out of this 29.5%, we were able to raise rents for more than 60% of the tenants, which is equal to 19% of the entire portfolio. And 2019 was a year in which tenants got a better understanding of the current market conditions. The pie chart on the right is what we used as one of the assumptions for our forecasts. In 2020, 35.7% of the portfolio will be up for rent renewal, which is slightly more than the usual period. We have already started negotiations with some of these tenants, but many are still subject to negotiations. So we assumed we will achieve a certain level of upward rent revisions with these tenants and factored this into our forecast. Next, on Page 13, I will talk about the NBF Shinkawa Building mentioned earlier. The tenant currently occupying the entire office portion of NBF Shinkawa Building will be moving out at the end of November 2020 as part of the relocation of its headquarters. Going forward, we will conduct construction work to upgrade the property, including work that can only take place after the tenant has vacated the property. This should improve the competitiveness and asset value of the property, after which we will lease it to the next tenant. Please see the property overview on the left. This is a 30-year-old building acquired in 2002. Over the past few years, NBF has improved the specifications and quality of the building such as by extending the capacity of backup electricity supply to 72 hours. As a result, the appraisal value as of December end was JPY 16.2 billion, an increase of approximately JPY 1.2 billion compared to just 6 months earlier. NBF Shinkawa Building has strong potential within the 1.2-kilometer radius from Tokyo Station and only a 3-minute walk from Hatchobori Station. As for the time line for leasing activities, we are planning to complete the construction work by April 2021 and lease up the property to future tenants. We've just begun leasing activities but have already received several inquiries and have conducted multiple site tours. We plan to lease-up the property quickly, taking advantage of the strong leasing market. Next, I will explain our external growth. In the second half of 2019, we acquired an additional stake in Osaki Bright Core Plaza, as announced in September, and we also made additional acquisitions from individuals in the Nishi-Shinjuku Mitsui Building and Kowa Nishi-Shinbashi Annex B. At the moment, it's quite difficult to acquire properties at reasonable prices from the market, and we will continue to seek steady external growth by using our sponsor pipeline as well as this kind of co-ownership property pipeline. Please turn to Page 15 for the status of our financing as of the end of the second half of 2019. As highlighted in the new funding and repayment section in the upper left, we raised JPY 27 billion of long-term funding in this period. In order to minimize future uncertainties, we made efforts to secure long-term fixed interest funding with an average duration of 7.4 years while maintaining our focus on diversifying the maturities. The average interest rate for the debt we procured in this period was 0.28% compared to the 0.95%, which was the average interest of the debt that matured in this period. We were able to take advantage of the current funding environment and secure low interest rates. As a result, the ratio of long-term fixed interest debt became 93.5%, and the average cost of funding was 0.57%, as shown in the finance data on the upper right. The LTV at the end of the period was at an extremely sound level of 41.6%, almost unchanged from 6 months ago. Our targeted LTV range is 36% to 46%, and we can still borrow around JPY 85 billion if we were to bring up the LTV to 46%. Please see the maturity ladder at the bottom of the page. We have plotted the amounts to be repaid in each year as well as the cost of interest of that debt. Every year until 2023, we will be repaying debt that costs close to 1%. If the current finance environment persists, we can continue to lower our interest expenses through refinancing for the time being. The red sections in the bars represent the debt raised in the second half of 2019. As explained earlier, we secured long-term funding while diversifying the maturities. Next, on Page 17, I will go over the appraisal value assessment. The tables at the bottom left show the period-on-period changes in cap rates and appraisal value. In this period's appraisals, the cap rates were reviewed for properties in regional cities for which there was no cap rate revision in the first half of 2019 and were lowered for 11 properties, mainly in regional cities out of the total of 71 properties. The appraisal value went up for 40 properties, including Central Tokyo properties, for which the average rent unit price and the appraisal rent unit price increased. The 4 reductions in appraisal values were due to changes in the life cycle cost assumptions and other factors. As shown in the table at the top, the unrealized gain increased JPY 11.8 billion to become JPY 274 billion. We expect this upward trend in appraisal values to continue, although gradually, because cap rates could compress even further based on the current finance environment and recent property transactions as well as further improvements in cash flow from increases in rent revenues. Next, I will go over our forecasts on Page 19. The dark red section is the current first half of 2020, and the orange section on the right is the forecast for the second half of 2020. Please see the forecast for the first half of 2020. While we expect to make progress in internal growth reflecting the robust leasing market, revenue and income will decline due to seasonal factors such as air conditioning expenses as well as the one-off revenue from NBF Shinagawa Tower, which we booked in the first and second halves of 2019 not being repeated. We are forecasting total operating revenues of JPY 38.7 billion, operating income of JPY 16.4 billion, net income of JPY 15.1 billion and DPU of JPY 10,720. Please take a look at the summary of period-on-period change table on the right. We expect rental revenues to grow JPY 584 million. Out of this, JPY 530 million will come from existing properties for which internal growth through upward rent revisions and tenant replacements is continuing. You can see how our underlying rental revenue will remain strong. We are also expecting a significant reduction of JPY 92 million in interest expenses. And we will continue to benefit from a decline in our cost of funding. The orange section on the right is the forecast for the second half of 2020, which is 2 periods ahead. We are forecasting operating revenues to be JPY 40 billion, which is an increase of JPY 1.27 billion. We expect the underlying rental revenues to grow JPY 256 million. Although there will be negative impact from tenant departures, there will be a positive effect from upward rent revisions, reflecting the strong leasing market. Other revenues related to property leasing is expected to go up by around JPY 1 billion. Although we will book other income we received in relation to the departure from NBF Shinkawa Building, we will spend roughly the same amount on repair expenses. So there will be no impact at the operating income level. As a result, we are forecasting net income of JPY 15.1 billion and a DPU of JPY 10,750. This sums up our forecasts, and we have graphs on the next page. Rental revenues on the upper left as well as interest expenses underneath that should remain firm. Operating income from property leasing activities on the right as well as DPU are also expected to remain solid despite the one-off impact from the revenue for NBF Shinagawa Tower, which we booked in 2019. In closing, there are several risk factors in the global economy such as the impact of the coronavirus as well as the U.S.-China trade issue. And here in Japan, we are starting to see signs of a slowdown, mainly in the manufacturing sector. Meanwhile, the current situation remains strong overall with sectors such as telecommunications and IT serving as the drivers. Companies are continuing to do well, and demand for office space remains strong, with tenants wanting to secure good talent as well as improved productivity. Today, we explained how we expect internal growth to continue from the second half of 2019 into the first and second halves of 2020. We will seek to lease up the NBF Shinkawa Building early following the tenant departure in the second half of 2020, and we will prepare for future changes while making the most of the current market environment and sustaining our growth. We will continue to accelerate our efforts to achieve this goal. In terms of ESG, we believe this is our social responsibility and are making a firm-wide effort to address it. Consideration towards the environment, social contribution and reinforcing governance are initiatives that are related to all our stakeholders, including unitholders, lenders, tenants and employees. We have outlined some of our efforts at the back of the presentation, so please take a look. This concludes my presentation. Thank you very much for your attention.