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

Hello, everyone. I am Yoshiyuki Tanabe, President and CEO of Nippon Building Fund Management. Before I begin, I would like to express my sincere condolences to those suffering from COVID-19 as well as those who have been forced to suspend their business operations. I would also like to extend my deep respect and appreciation to those involved in providing medical and nursing care and are fighting in the front lines for the health and welfare of all of us. This time, due to the circumstances, I will be making the results announcement presentation on the web. I will now go over NBF's results for the first half of 2020. 6 months ago, when I made the previous results announcement presentation in February, there were only several dozens of cases of COVID-19 infections in Japan. However, with the sharp rise in infections, the Tokyo government requested businesses to close and people to stay home, followed by the national government declaring the state of emergency, and our every lives have been severely impacted. In responding to requests from the government and other organizations, NBF has been considering the best interests of each of our stakeholders such as our unitholders and tenants, while thoroughly implementing measures to prevent the spread of the virus. We've also taken various steps such as delaying the timing of rent payments as well as lowering rents for a certain period of time, mainly in relation to our restaurant and dining tenants. We have a summary of such measures on Page 3. So please take a look later. Now I will go over the results and talk about the future outlook. On Page 29, we have market data on the Tokyo business area. In the first half of 2020, the decline of the vacancy rate, which had been continuing for a while, stopped due to factors, including the impact from COVID-19. However, the market environment surrounding offices remain robust. Please see the financial highlights on Page 5. The average occupancy rate during the period was 99.4%, and our portfolio remained almost full. In the first half of 2020, we made progress in internal growth, including upward rent revisions and tenant replacements. Moreover, there were factors such as the contribution from the additional acquisitions of Osaki Bright Core in the second half of 2019 and the first half of 2020, leading to a solid performance following the previous period. As a result, our distribution per unit was JPY 10,986, JPY 266 above the previously announced forecast. As for the forecast for the second half of 2020 and the first half of 2021, there still will be the impact from COVID-19, but we are expecting a DPU of JPY 11,000, which is similar to the DPU in the first half of 2020. Please turn to Page 7. The 2 bar charts show the trend for the past 3 years of our DPU and NAV per unit, which we at NBF, regard as important metrics in improving unitholder value. We will continue to seek long-term stable growth of these figures. Now on Page 8 onwards, I will go over the financial results. On Page 8, we summarized the acquisitions and disposals of properties in each period. Please take a look later. On Page 9 is our statement of income for the period. The column highlighted in red represents the results for the first half of 2020. Both revenue and income declined from the previous period. The main reason was the termination fee, et cetera, in relation to the replacement of a major tenant, which we booked in the previous period, which we did not have in the first half of 2020. Total operating revenues was JPY 38.59 billion, down JPY 543 million period-on-period. Operating income was JPY 16.76 billion, down JPY 155 million period-on-period. Net income was JPY 15.51 billion, almost flat from the previous period. Total distribution was JPY 15.51 billion, equal to net income. As a result, our DPU was JPY 10,986, down JPY 25 period-on-period and JPY 266 higher than our forecast. Now on the right-hand side, I will explain the summary of period-on-period change. First, the breakdown of the JPY 543 million decline in total operating revenues. Rental revenues, which is our base revenue, increased JPY 617 million. Out of this, JPY 526 million was from existing properties, which we achieved through the progress we made in internal growth through upward rent revisions and tenant replacements. Other revenues related to property leasing declined JPY 1.16 billion. Half of this or JPY 527 million was due to the seasonality in incidental expenses. The other half was the termination fee, et cetera, related to the replacement of a major tenant, which we booked in the previous period. Operating income declined JPY 155 million. However, the income decline for existing properties was mainly due to the termination fee, et cetera, mentioned earlier, which we booked in the previous period. We maintained the growth trend in the underlying rental income. As for net nonoperating income and expenses, interest expenses declined, thanks to lower interest rates achieved through refinancing. Next, I will briefly go over our balance sheet on Page 10. The section highlighted in red is the balance sheet as of the end of the first half of 2020. Total assets was JPY 1.04 trillion, almost flat from the end of 2019. Property acquisitions and capital expenditures on existing properties were covered by depreciation. And there were no notable fluctuations in the balance sheet items. On Page 13, we have summarized our outlook on the office market, including the impact of COVID-19. In terms of the current situation of the office market, the Tokyo metropolitan government's request for businesses to close and for people to stay home as well as the national government's declaration of the state of emergency has led to the emergence of new factors in office-based usage, such as the introduction of telework and social distancing. As for the current trend in the leasing market, the office vacancy rate, which had been declining, rose to 2.77% as of July, up from the recent bottom of 1.49% in February this year due to factors, including the impact from COVID-19. Under these market conditions, let me now explain NBF's own situation. As mentioned, for some tenants, mainly restaurant and dining tenants, we are lowering rents for a certain period of time as well as delaying the timing of rent payments. Meanwhile, there have only been a limited number of tenants leaving our properties due to the impact of COVID-19, including our office tenants. There are cases where potential tenants are taking longer than usual to make their decisions move in, and we expect a slight increase in our vacancy rate, but the impact on our overall portfolio will be limited. Based on this situation, I will now explain our outlook on the office leasing market. Work styles will continue to diversify, including the introduction of telework, but the movement will not be in just 1 direction. We expect the demand for high-spec offices in Central Tokyo to remain strong, with companies continuing to invest in good work environments and convenient office locations in order to hire and retain talented employees. The best mix between telework and office work will differ for each company. However, many companies believe that face-to-face communication is the source of innovation. And the importance of office work will remain unchanged even in the post-corona era. Many experts and think tanks are now coming up with their views on the vacancy rates in Tokyo in 2021 and 2022, factoring in the impact of COVID-19. Generally speaking, the expected range in vacancy is between 2% to 6%. And the consensus seems to be that there will not be a sharp spike, like the one we experienced following the financial crisis. The extent of internal growth depends on the outcome of the corona crisis and various scenarios can be anticipated. However, in terms of external growth, we expect an increase in the number of opportunities to acquire properties. We will continue to seek stable growth by using both internal and external growth as our growth engines. And we believe it is in circumstances like this that NBF has an advantage, thanks to the various options for growth available to us. On the following page, we summarize NBF's growth strategies. As explained here, we will seek further growth using our strong capabilities to adapt to the environment based on our strength of having the longest track record among J-REITs, the largest asset size, our high-quality portfolio centered in Tokyo, the comprehensive strength of our sponsor, the Mitsui Fudosan Group and our conservative financial management. Now I will explain our external growth on Page 15. In the first half of 2020, we made the additional acquisition of Osaki Bright Core -- Bright Plaza, which we announced in March. In the current second half of 2020, we will acquire the Osaki Bright Tower as well as the Nagoya Mitsui Main Building and the Nagoya Mitsui New Building, while disposing part of the NBF Shinkawa Building as announced yesterday. As you can see in the summary, these transactions will help grow our asset size and NOI, while the partial disposition of the NBF Shinkawa Building from which the single-tenant will be leaving in November this year, will help make our portfolio almost fully occupied as well as younger in age. Please turn to Page 16. The Osaki Bright Tower is a large high-spec building in the Shinagawa Osaki area, which NBF is focused on. This property is next to the Osaki Bright Core, for which we made an additional acquisition in the first half of 2020, and we will be acquiring an approximately 11% stake in the building at JPY 13.9 billion. This is a large building, redeveloped by Mitsui Fudosan and other landowners, and is highly competitive even in the Osaki area. With its high concentration of offices, we believe its stable cash flow, thanks to the good mix of tenants as well as the status of the lease contracts, will contribute to the future growth of NBF. On the next page is the Nagoya Mitsui Main Building and New Building. This is the flagship property of our sponsor, Mitsui Fudosan in the Nagoya area, located in its most prime location in front of Nagoya Station. NBF will be acquiring a 70% stake in the main building as well as the whole of the new building for a total of JPY 26.2 billion. The main and new buildings are operated together as one and have a total of 14,500 tsubo of gross floor area. The NOI yield is 5.0% for the Main Building and 4.2% for the New Building. We will make use of the master lease by Mitsui Fudosan, and we'll manage this as the flagship property of NBF going forward. Please turn to Page 18. I will go over the disposal of the East Building and the Residential Tower of the NBF Shinkawa Building. As explained in the previous results announcement presentation, the single-tenant occupying NBF Shinkawa Building is going to leave the property in November, and we had been conducting leasing activities to secure the next tenant. Although we received multiple inquiries from potential tenants soon after starting leasing activities, COVID-19 was forcing them to take longer in their decision-making. So we began considerations about disposing the property in parallel to the leasing activities. We were able to reach an agreement with a buyer who will use the East Building and the Residential Tower themselves, and signed the sale and purchase agreement with them. The disposal price will be JPY 11.9 billion, which is above the appraisal value, and the gain of JPY 2.9 billion will be booked over 2 fiscal periods. We will retain some of the gain while distributing some of it, making it a backstop for our DPU. This is a good example of how NBF can make good use of the sponsor pipeline in our external growth and acquire high-quality properties as well as replace properties smoothly, thanks to our high-quality portfolio. These are some of the important strengths of NBF. Moving on to internal growth. Please see the graph on Page 19, 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. Please take a look at the bar graph. I will explain the status of tenants moving in and out. In the first half, the ratio of tenants moving in and out was 1.7% and 1.6%, respectively. The average occupancy rate during the period remained 99.4%, which is literally full. As for the second half of 2020, we have lowered our occupancy rate forecast to 99.0%. While we expect the ratio of tenants moving out to be 2.6%, we have conservatively used 0.9% for the ratio of tenants moving in, considering the fact that it is taking longer than usual for tenant companies to make their decisions to move in. As for the first half of 2021, at the far right, we are forecasting a higher than usual ratio of tenants moving out of 3.4%. This is due to the expected replacement of a large tenant as well as us conservatively assuming a certain number of tenants to move in and out due to the impact from COVID-19. As a result, our forecast for the average occupancy rate during the period is slightly lower at 98.0%. Next, on Page 20, 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 the upward rent revisions are continuing steadily. Thanks to the current rent gap, we believe the upward trend in rents will continue in the second half of 2020 as well as in the first half of 2021, which is when the impact from COVID-19 will be largest even in a conservative scenario. The green section includes all factors other than rent revisions, such as the impact of tenant replacements. For the first half of 2021, the green section is negative due to our conservative assumption of occupancy rates. Please turn to Page 21 for the status of our financing as of the end of the first half of 2020. As highlighted in the new funding and repayment section in the upper left, we raised JPY 35 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 7.7 years, while continuing to focus on diversifying the maturities. The average interest rate for the debt we procured in this period was 0.30% compared to the 0.67%, 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 93.6%, and the average cost of funding fell to 0.54%, as shown in the finance data section on the upper right. The LTV at the end of the period was at extremely sound level of 41.7%, almost unchanged from 6 months ago. The LTV after the property acquisitions and disposal mentioned earlier, is expected to be 42.8% and we will still be able to borrow around JPY 63 billion, if we were to bring the LTV up to 46%, which is the upper end of our targeted LTV range. 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%. So we should be able to continue lowering our interest expenses through refinancing for the time being. The table on Page 22 outlines the funding raised in the first half of 2020 as well as the balance of interest-bearing debt. As you can see on the bottom left, we have issued JPY 15 billion of investment corporation bonds to fund the acquisitions that we have announced. Next, on Page 23, 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 values. In this period's appraisals, the appraisal values rose for 28 properties. Although there were not many properties for which the cap rates were lowered, the appraisal rent assumptions were raised as well as other factors. On the other hand, the appraisal values were lowered for 23 properties. The main reasons included updates in the engineering reports as well as higher property taxes due to revaluations. As shown in the table at the top, the unrealized gain increased JPY 7.4 billion to become JPY 281.4 billion. Next, I will go over our forecast on Page 25. The dark red section is the current second half of 2020, and the orange section on the right is the forecast for the first half of 2021. Please see the forecast for the second half of 2020. We are forecasting total operating revenues of JPY 41.73 billion through the acquisition and disposition of properties, which will be a growth of JPY 3.14 billion period-on-period. Operating income of JPY 17.83 billion, and we are expecting net income of JPY 1.66 billion. We will retain part of the capital gain, and we expect to pay a DPU of JPY 11,000, which is almost equal to the first half of 2020. Please take a look at the summary of period-on-period change table on the right. We expect rental revenues to grow JPY 689 million. Despite COVID-19, internal growth will turn positive, and we expect JPY 204 million of revenue growth from existing properties. For external growth, we expect JPY 604 million growth from property acquisitions. Other revenues related to property leasing is expected to go up around JPY 1 billion. This includes the seasonal impact of utilities expenses as well as the termination fee from our tenants, but both will have expenses related to them. So there will be no impact to our operating income. Meanwhile, operating income will grow JPY 1.07 billion. Income will decline JPY 456 million for our existing properties in the second half of 2020 and the first half of 2021 due to the increase in repair and maintenance expenses to improve the competitiveness of our properties. However, we will achieve income growth overall, thanks to the property replacements and the capital gain from the disposal of NBF Shinkawa Building. The orange section on the right is the forecast for the first half of 2021, which is 2 periods ahead. We are forecasting total operating revenues to be JPY 40.5 billion and total operating income to be JPY 17.29 billion. This is a decline from the second half of 2020. The main reason is our assumption that income from existing properties will fall by JPY 386 million, following the second half of 2020, due to us forecasting the ratio of tenants moving out more conservatively than usual, as explained earlier, in the internal growth section. We are forecasting a decline of JPY 1.07 billion in other revenues related to property leasing. This is due to the seasonal impact of utilities expenses as well as the termination fee of which we plan to book in the second half of 2020, which I explained earlier, not being repeated in the first half of 2021. As a result, we are forecasting net income of JPY 16.07 billion and a DPU of JPY 11,000 after retaining part of the capital gain. This sums up our forecast. And on the next, Page 26, we have shown the trends in rental revenues, which is the source of our profit and our DPU. Please see rental revenues. We have explained the upward and downward factors for rental revenue for the 12 months from the second half of 2020 to the first half of 2021, which is the period for which we have forecasted. Starting from the left, the impact from tenant replacements, excluding extraordinary factors, will be limited at JPY 4 million. Although we will continue to achieve JPY 356 million of positive impact from upward rent revisions, revenue will fall due to extraordinary factors from the impact of COVID-19, et cetera. We will cover that through external growth, resulting in rental revenues for the first half of 2021 to be JPY 36.25 billion, up JPY 362 million over the full year. As for DPU, we believe the target for the time being should be around JPY 11,000, excluding extraordinary items such as capital gains. We will make efforts to continuously achieve this level. In terms of the forecast for the second half of 2020 and the first half of 2021, which will be the periods when we will be most impacted by COVID-19, we are planning to pay a DPU of JPY 11,000 by using part of the capital gain. In closing, there are several risk factors in the global economy, such as the economic slowdown caused by COVID-19 as well as the U.S.-China trade issue. Even here in Japan, there is a sense of slowdown among many companies. In terms of the environment surrounding the office market, there are new elements such as the use of telework as well as the need for more communication space. We think it will take some more time, and one important timing will be when the spread of the coronavirus stops, before companies can determine their actual demand for floor space. NBF believes that our current focus should be on carefully addressing the needs of our tenants. While our priority for mid- to long-term growth should be establishing a competitive portfolio service structure, and we plan to steadily execute these measures. This concludes my presentation. Thank you very much for your attention. [Statements in English on this transcript were spoken by an interpreter present on the live call.]