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

Hello, everyone. I am Yoshiyuki Tanabe, President and CEO of Nippon Building Fund Management. Due to the state of emergency still being in effect, we will be making our results announcement presentation on the web, as we did previously. Thank you for your understanding. I will now go over NBF's results for the second half of 2020, which was our 39th fiscal period. Please see the financial highlights on Page 3. Since last March, the market vacancy rate has entered a period of adjustment after having been literally full. This was due to the increase in secondary vacancies resulting from completions of new buildings as well as the impact from the COVID-19 pandemic. NBF's average vacancy rate during the period also fell by 0.6 percentage points from 98.8% at the end of the first half. However, we achieved growth both in revenue as well as income, thanks to factors including the start of rent payments from tenants that newly moved in, upward rent revisions with existing tenants and the contribution from properties acquired in October. Our distribution per unit was JPY 11,000, which is the same as the forecast announced in October last year. In the first half of 2021, we are expecting a DPU of JPY 11,350, up JPY 20 from the October forecast. As for the second half of 2021, we are forecasting a DPU of JPY 11,050. 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 at NBF, regard as important metrics in improving unitholder value. Although the NAV per unit unfortunately fell slightly due to a correction in the investment unit price at the time of the public offering in October, we achieved steady growth in our DPU. We will continue to seek long-term stable growth of both of these metrics. Now on Page 6 onwards, I will go over the financial results. Page 6 summarizes the acquisitions and disposal of properties in each period. Please take a look later. On Page 7 is our statement of income for the period. The column highlighted in red represents the results for the second half of 2020. Total operating revenues was JPY 41.7 billion, up JPY 3.156 billion period-on-period. Operating income was JPY 18.7 billion, up JPY 1.951 billion period-on-period. Net income was JPY 17.2 billion, up JPY 1.7 billion. With the public offering being conducted during the fiscal period, we used JPY 903 million of our retained profits, and total distribution was JPY 18.1 billion. As a result, our DPU was JPY 11,000, up JPY 14 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 3.1 billion increase in total operating revenues. Rental revenues, which is our base revenue, increased JPY 731 million. Out of this, JPY 247 million was due to internal growth from existing properties, which we achieved through the start of rent payments from tenants who newly moved in as well as upward rent revisions. Moreover, there was a JPY 607 million contribution from properties acquired in the second half of 2020. Other revenues related to property leasing increased JPY 1 billion. This was partly due to the seasonality in incidental expenses as well as the termination fee-related to a tenant departure from the NBF Shinkawa Building, which were the 2 main factors. However, both items have associated costs, which are of similar amounts, and the net impact is minimal. As for operating income, there was an increase in rental income from existing and newly acquired properties, together with a capital gain of JPY 1.3 billion in relation to the Shinkawa Building, leading to an increase of JPY 1.9 billion in operating income. As for net nonoperating income and expenses, interest expenses declined, thanks to lower interest rates achieved through refinancing. However, we booked JPY 238 million of expenses related to the public offering and nonoperating expenses increased JPY 185 million. 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 2020. Total assets as of the end of the second half of 2020 increased JPY 152.9 billion period-on-period to become JPY 1.1974 trillion. I will start with the total liabilities and net asset section. In order to fund the acquisitions of 6 properties that took place between last October and this January, we conducted a public offering, which increased unitholders' capital by JPY 122.9 billion. Meanwhile, interest-bearing debt increased by JPY 24 billion, including the JPY 15 billion issuance of investment corporation bonds. On the asset side, tangible fixed assets increased JPY 36.7 billion, due to the first round of acquisitions of 4 properties last autumn, using the funds raised through the fundraising activities mentioned above. There was a JPY 116.2 billion increase in cash and deposits. We used this to acquire properties, including the Shinjuku Mitsui Building, which was handed over to us on January 8th of this year. Now I will explain NBF's management policy going forward. Please turn to Page 11. On the upper part of the page, we have summarized our views on the office leasing and trading market. First, in terms of internal growth, the office leasing market had been very strong until the COVID-19 pandemic began last February. The occupancy rate and rents were trending at levels higher than the pre-financial crisis levels. And office space had been full for quite a while. This was driven by factors such as companies wanting to expand their office space as well as companies wanting to relocate to more attractive locations in order to hire and retain talented employees. From March onwards, COVID-19 began to have a serious impact and economic activities stagnated. This led to the beginning of the adjustment phase for vacancy rates and asking rents. Since then, the government declared a state of emergency, which led to more people working from home and companies began to seek new ways of working, including more diverse work styles. Going forward, as the impact of COVID-19 gradually eases, companies are expected to resume their floor space expansions as well as relocations to attract talent, especially in the Central Business district. And we expect the demand for high-spec offices in Central Tokyo to remain solid. As for the market vacancy rate, we expect it to trend at around 5% to 6% due to the currently limited supply of new properties. In this environment, NBF will seek internal growth by utilizing our sponsor, Mitsui Fudosan's strong sales capabilities to accelerate the leasing of properties to new tenants as economic activity is resumed. We would like to maintain a stable occupancy rate at around 97% to 98%. Based on our high-quality portfolio concentrated in the Central Tokyo area, for which there is strong demand as well as our tenant diversification. And by conducting proactive value up work on our properties and bringing in Mitsui Fudosan's shared office space to our properties, we will respond to the changing tenant needs including new work styles from both the property side as well as the operational side. Moving on to external growth. And the situation in the trading market for office properties. In the period before COVID-19, it was difficult to acquire properties from third parties due to cap rates being compressed as a result of the BOJ's monetary policy as well as there being only a few properties that are placed on the market for sale. This trend has been continuing even after COVID-19 began. However, since last autumn, there have been cases of companies selling properties as a result of reorganizations of their businesses as well as companies reviewing their asset portfolios. The Japanese real estate investment market tends to have lower volatility in cash flow and credit compared to the West. The negative interest rate policy is expected to continue for the time being, which will mean that cap rates will probably remain compressed. On the other hand, there will be more cases of companies selling their office properties. And as a result, we expect more activity in the trading market going forward. Under these circumstances, we believe now is a good opportunity for NBF with its solid sponsor pipeline to further strengthen the quality of the portfolio and grow in asset size, including the replacement of assets. When we acquire or replace properties, we will continue to appropriately control LTV and secure low interest funding. NBF will continue to seek sustainable growth using both internal and external growth as our drivers going forward. In the next page onwards, I will go over the status of our management, including internal and external growth. I will start with external growth. Please turn to Page 12. In the second half of 2020, we acquired 3 properties, Osaki Bright Tower, the Nagoya Mitsui Main Building and the Nagoya Mitsui New Building in October followed by the stake in NBF Ogawamachi Bldg in November. And then in the first half of 2021, we acquired the Shinjuku Mitsui Building and the Gran Tokyo South Tower in January of this year. The total acquisition price of these properties was JPY 257.7 billion. In order to fund these acquisitions, we raised JPY 122.9 billion in an equity financing last October. As a result, we were able to begin managing the Shinjuku Mitsui Building and Gran Tokyo South Tower from the beginning of the first half of 2021. With these property acquisitions and the equity finance, we have been able to achieve strong external growth exceeding 10%. On the next page onwards, we will explain the properties we acquired and disposed. Please turn to Page 13. The Shinjuku Mitsui Building, which we acquired in January for JPY 170 billion is Mitsui Fudosan's flagship property. This property is a good example of Mitsui Fudosan's urban development concept of adding value with age, improving tenant satisfaction, both in terms of its facilities, such as proactive renewals, and its operations, such as contributing to the local society. As you may already know, this is the largest property owned by a J-REIT. And going forward, we will manage this property as a flagship property, representing NBF both in terms of its facilities as well as its operations. On the next Page 14 is the Gran Tokyo South Tower, which we acquired this January. This is an extremely unique and rare building, directly connected to the JR Tokyo Station. It is a twin tower skyscraper, together with the Gran Tokyo North Tower on the North side. We acquired around 13% of the entire building at JPY 47 billion. This property has been certified as a top level office by the Tokyo government. Together with the fact that the property is highly environment friendly, we regard this property as being another flagship asset for NBF. I will not go into detail about the Osaki Bright Tower, the Nagoya Mitsui Main Building and the Nagoya Mitsui New Building on Page 15 because we discussed these properties in the previous results announcement presentation. Please turn to Page 16. As for the NBF Shinkawa Building, we are selling the East Building and the Residential Tower for JPY 11.9 billion in relation to the termination of the contract with single-tenant last November. We completed 50% of the disposal last December, and the remaining 50% is expected to be disposed this March. We distributed all of the capital gain generated last December. However, we plan to retain all of the capital gain from the disposal planned in March. As a result, our retained profits will be around JPY 8 billion at the end of June 2021. We will continue to use our retained profits flexibly to stabilize our DPU payments during events such as a temporary vacancy following the departure of a large tenant, natural disasters, disposals of properties at a loss or public offerings during the fiscal period. As for the West building, which we will continue to own, we were able to utilize the sales capabilities of Mitsui Fudosan to secure the next tenant who will be moving in, in March. Next, I will explain our internal growth. Please see the graph on Page 17, 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. The ratio of tenants moving out rose to 2.8% in the second half of 2020 due to factors such as the departure of a large tenant in the NBF Shinkawa Building. On the other hand, the ratio of tenants moving in was 0.7% because COVID-19 is making companies spend more time on their decision-making to relocate. As a result, the average occupancy rate during the period fell 0.6 points to become 98.8%. As for the current first half of 2021, we are expecting the ratio of tenants moving out to be 3.4% due to the departure of a relatively large tenant who will be moving to a newly completed building. As for the ratio of tenants moving in, we are expecting 3.0% due to factors, including the new tenant in the NBF Shinkawa Building. Our forecast for the average occupancy rate during the first half of 2021 is 97.5%, considering the possibility of it taking a certain amount of time to lease up properties due to factors such as the state of emergency being declared from January. As for the second half of 2021, which is 2 periods away, we are forecasting the ratio of tenants moving out to be 3.4% and the ratio of tenants moving in to be 3.5%. This factors in the departure and subsequent leasing of a large tenant and the possibility that the current leasing situation could continue until around the middle of the year. As a result, we have kept our forecast for the average occupancy rate during the second half of 2021 at 97.5%. Next, on Page 18, 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. As for rent revisions, we factored in the continuation of temporary rent reductions due to COVID-19 in both the first and second halves of 2021. However, we expect rent revisions to be slightly positive in the first half. And the positive trends to continue in the second half of 2021, although the growth rate will become more gradual. The green section includes all factors other than rent revisions, such as the impact of tenant replacements. As for rental revenues, the state of emergency was declared at the beginning of the year, and we positioned this year as the adjustment phase, during which it will continue to take longer than usual for tenants to make their decisions to relocate. And we factored in a certain amount of downtime between the time a tenant moves out and the rent payment from the next tenant begins. If the COVID-19 pandemic subsides and economic activity goes back to normal, we expect internal growth to turn positive again in 2022 onwards, and we expect to continue growing by using both internal and external growth as our drivers. Next, I would like to introduce 1 of our initiatives in responding to tenant needs becoming more diverse. Please turn to Page 19. We at NBF want our offices to be cherished by tenants over the long term. That is why we strategically conduct value up construction work, mainly on properties with high potential. On this page is the value up work on Shinjuku Mitsui Building No.2. Shinjuku Mitsui Building No.2 was already a competitive property, being a large office with a standard floor plate of 276 above located in the West Exit area of Shinjuku Station. However, in order to make the property even more competitive, we renewed the entrance to the building as well as the lobby, made better use of underutilized space, created a tenants only lounge and cater to changing tenant needs such as by accommodating a bike-sharing service. Thanks to these efforts, we have been able to lease-up vacated space with a relatively short downtime and with favorable terms and conditions. We will continue to analyze the strengths, challenges, competitiveness, return on investment, et cetera, of our properties and selecting the candidates for value up construction work. Please turn to Page 20, for the status of our financing as of the end of the second half of 2020. As highlighted in the new funding and repayment section in the upper left, we raised JPY 37 billion of long-term funding in this period, together with the JPY 102 billion raised in January as funds to acquire properties with. As a result, as shown in the finance data section on the upper right, the average maturity became 6.08 years, and the average cost of funding fell 0.06 points to become 0.48%. The LTV following the property acquisitions and disposals through this public offering is 42.7%, giving us room to borrow around JPY 78 billion if we were to raise 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 on the bar chart. We have been able to flatten the maturity ladder, thanks to the recent funding. And we expect the decline in interest expenses through refinancing to continue for the time being. On the next page 21, we have a list of our recent financings, including the JPY 102 billion we raised in January, so please take a look later. Next, on Page 22, 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 cap rates remained unchanged for all properties. However, the appraisal value rose for 17 properties due to revisions of appraisal rents, et cetera. The appraisal value fell for 9 properties. The main reason was the rise in the outlook for long-term repair expenses. As shown in the table at the top, the unrealized gain increased JPY 2.5 billion to become JPY 283.9 billion. Next, I will go over our forecast on Page 25. The dark red section is the current first half of 2021, and the orange section on the right is the forecast for the second half of the year. Please see the forecast for the first half of 2021. We are forecasting total operating revenues of JPY 46.3 billion, which will be a significant growth of JPY 4.648 billion due to property acquisitions. Operating income of JPY 21.7 billion, up JPY 3.04 billion and net income of JPY 20.3 billion, up JPY 3.08 billion. We will retain the capital gain and are expecting to pay a DPU of JPY 11,350, up JPY 20 from the October forecast. Please take a look at the summary of period-on-period change table on the right. We expect rental revenues to grow JPY 4.8 billion. The breakdown is minus JPY 465 million for existing buildings, despite the decline of JPY 628 million in relation to the NBF Shinkawa Building, there will be significant growth of JPY 5.955 billion due to the acquisition of properties, such as the Shinjuku Mitsui Building. Other revenues related to property leasing is expected to decline JPY 421 million. This is mainly due to the JPY 758 million termination fee for the NBF Shinkawa Building, which we booked in the previous period. However, this fee also had costs associated with it. In terms of our operating income, there will be a decline of JPY 744 million for our existing buildings due to the drop in revenue. However, there will be a significant external growth effect of JPY 4.6 billion from property acquisitions such as the Shinjuku Mitsui Building and operating income overall will grow JPY 3.04 billion. The orange section on the right is the forecast for the second half of 2021, which is 2 periods ahead. We are forecasting total operating revenues to be JPY 44.6 billion and total operating income to be JPY 19.6 billion. Please see the breakdown on the right. The main reason for the decline from the first half of 2021 is the JPY 829 million rental revenue decline for existing properties. As explained earlier, in the internal growth section, as well as the minus JPY 1.5 billion impact in relation to the capital gain for the NBF Shinkawa Building, which we booked in the first half. As a result, we are forecasting net income of JPY 18.2 billion and a DPU of JPY 11,050. This sums up our forecast and on the next Page 26, we have shown the trends in DPU as well as a breakdown of the positive and negative factors. Please turn to Page 26. Here, we show the positive and negative factors when comparing the DPUs between the second half of 2020 and the second half of 2021. The JPY 11,000 for the second half of 2020 includes one-off items such as the capital gain from the NBF Shinkawa Building as well as the use of retained earnings. For both the first and second halves of 2021, we are forecasting internal growth to be negative, reflecting the current state of the leasing market explained earlier. However, with the significant external growth from the full period contribution of newly acquired properties, we have forecasted DPUs of JPY 11,350 and JPY 11,050. Next, I will explain NBF's ESG-related initiatives. With awareness towards ESG rising year-by-year, we at NBF have positioned ESG as 1 of our management priorities, which leads to higher competitiveness of our portfolio. Our efforts include lowering the environmental burden from our portfolio management as well as considering our stakeholders, including the local society and our employees. Please see Page 43, where we have summarized some of our ESG-related initiatives. NBF has begun supporting and participating in TCFD or the Task Force on Climate-related Financial Disclosures as part of our efforts on climate change. In relation to this, we have set a KPI of lowering the CO2 emissions output rate from energy consumption by at least 40% in fiscal year 2030 compared to fiscal year 2013 levels as our long-term environmental performance target. Going forward, NBF will disclose our evaluations and management of climate change related risks and opportunities of our portfolio as well as initiatives and track record in achieving our KPI on our website and ESG report. As for the target of reducing CO2 emissions output rate from energy consumption by at least 40%, NBF has already been working to reduce energy consumption, which is the main cause of CO2 emissions through various methods. Please turn to Page 44. The line graph at the top shows the track record of our efforts in reducing CO2 emissions during the period of 2013 to 2019. In order to reduce CO2 emissions, NBF has been switching the lighting to LED and using energy-efficient air conditioning. We have also been seeking to lower energy consumption through property replacements. At the bottom left, in Section #2 around the middle of the page, we show some examples of NBF reducing the environmental burden through property replacements. We will continue to focus on environmental issues as we build our portfolio in the future and seek external growth that is focused on ESG. In closing, we are hoping that the impact on the Japanese economy from COVID-19 will bottom in 2020 and then move to a steady recovery phase. NBF has conservatively assumed that the impact on our existing properties will last throughout the year 2021 and formulated our forecast accordingly. As we have explained today, although the tough business environment will persist, we are confident that NBF's solid portfolio can sufficiently cope with both short-term market disruptions as well as long-term changes in the market. NBF will continue our efforts to meet the expectations of our unitholders using every option available to us, such as the large external growth we achieved recently. This concludes my presentation. Thank you very much. [Statements in English on this transcript were spoken by an interpreter present on the live call.]