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

Hello, everyone. I am Yoshiyuki Tanabe, President and CEO of Nippon Building Fund Management. Following the Olympic Games, in which the Japanese athletes made a great performance, we are now hosting the Paralympic Games, and the world's attention is directed towards Japan. On the other hand, the state of emergency is still ongoing. Although we would like to present to you in person, 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 first half of 2021, which was our 40th fiscal period. Please see the financial highlights on Page 3. In this period, we had completed the acquisitions of the Shinjuku Mitsui Building and the Gran Tokyo South Tower in January. And in March, we conducted a reshuffling of the portfolio including the disposition of the NBF Minami-Aoyama building, which led to an increase in revenue, income and distribution. The distribution per unit was JPY 11,684, up JPY 684 from the previous period and JPY 334 higher than the forecast in February. In the coming December 2021 and June 2022 fiscal periods, we are forecasting JPY 11,500 and JPY 12,500, respectively. 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 NBF regards as important metrics in improving unitholder value. We were able to achieve positive period-on-period growth for both metrics, and we will continue to seek long-term stable growth. Now on Page 6 onwards, I will go over the financial results. Page 6 summarizes the acquisitions and disposal of properties in each period. There have been several acquisitions and disposals in this period. So 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 first half of 2021. Total operating revenues was JPY 46.2 billion, up JPY 4.46 billion or 10.7% period-on-period. Operating income was JPY 22.7 billion, up JPY 4.06 billion or 21.7% period-on-period. Net income was JPY 21.4 billion, up JPY 4.15 billion or 24% period-on-period. We reserved JPY 2.119 billion of our retained profits, and total distribution was JPY 19.307 billion. As a result, our DPU was JPY 11,624, up JPY 684 period-on-period. Now on the right-hand side, I will explain the summary of period-on-period change. First, the breakdown of JPY 4.46 billion increase in total operating revenues. Rental revenues, which is our base revenue, increased JPY 4.94 billion. Rental revenues declined JPY 313 million for existing properties, but there was a significant contribution of JPY 5.26 billion from property replacement. Other revenues related to property leasing declined JPY 618 million. This was partly due to the seasonality in utility expenses, and the main factor was the termination fee related to a tenant departure from the NBF Shinkawa Building, which we booked in the previous fiscal period. Both items have associated costs, which are of similar amounts and the net impact is minimal. As for operating income, together with an increase from existing properties, there was a significant effect from the property replacement and operating income grew JPY 4.06 billion. As for net nonoperating income and expenses, interest expenses will increase due to an increase in the debt level. But in relation to the JPY 238 million cost for the public offering in the previous period, the overall net nonoperating income and expenses declined JPY 83 million. It may be somewhat complex, because we have booked property disposal gains as well as subsequent reserves and reversals of retained earnings, but we were able to secure growth according to plan on a rental income basis, including the property replacement effect. 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 first half of 2021. Total assets, as of the end of the first half of 2021, increased JPY 107.9 billion period-on-period to become JPY 1.305 trillion. For the asset section, tangible fixed assets increased JPY 197.5 billion due to the acquisition of 3 properties and the disposal of 2 properties. Cash and deposits declined JPY 89.6 billion. This was due to the usage for acquiring new properties. For total liabilities and net assets, interest-bearing debt increased JPY 91 billion in relation to property acquisitions. The balance sheet reflects how we acquired new properties using interest-bearing debt as well as cash and deposits. Now I will explain NBF's management policy going forward. Please turn to Page 11. We have summarized our views on internal growth on the left and external growth on the right. For internal growth, we were initially expecting to see a recovery of the leasing market by the middle of this year. However, the state of emergency is still in effect and we now expect the timing of recovery to be around 1 year later than our initial projection. With Corporate earnings being robust, as employees begin returning to the office following vaccinations, and as the impact of COVID-19 subsides, we expect companies to restart securing office space to attract high-quality talent as well as relocating mainly in the central areas of Tokyo. As a result, we expect demand for high-spec offices in Central Tokyo areas to remain unchanged. And although slightly later than initially expected, we at NBF are also starting to receive inquiries for spaces exceeding 1,000 tsubo. The market vacancy rate is now between 6% to 7%, and we expect it to trend up to around 7%, considering the commencement of leasing activities for the new supply in 2023. Under these circumstances, in terms of NBF's internal growth, with the resumption of economic activities, we will accelerate initiatives to bring in new tenants using the sales capabilities of Mitsui Fudosan. We plan to secure stable occupancy rates using our portfolio concentrated in Central Tokyo, where demand is strong and based on our tenant diversification. In terms of NBF occupancy rate, we plan to make the second half of 2021, the bottom, and will aim for a stabilized occupancy rate of around 97% to 98%. In terms of rental revenues, we expect it to bottom in the first half of 2022, 1 fiscal period after the bottoming of the occupancy rate. For the time being, we expect external growth, which I will explain after this, to be the driver. Next, in terms of trends in external growth. With the BOJ's negative interest rate policy continuing, foreign companies and private funds have strong appetite for purchasing properties and the property trading market is active. Moreover, since last autumn, we are starting to see disposals of offices as part of leaseback transactions due to companies reorganizing their businesses or reviewing their assets owned. For NBF, with its strong sponsor pipeline, a situation such as this is an opportunity to pursue a reinforcement of portfolio quality as well as growth in asset size through initiatives, including property replacements. As shown in the bottom right graph, since 2016, we have been working not only on asset expansion, but active property disposals, thereby strengthening the quality of the portfolio. NBF will shift its focus from internal growth to property replacements as part of our external growth and seek continuous growth. Now on the next page onwards, I will explain NBF's property replacement strategy. Please turn to Page 12. This page summarizes the property replacements announced since this March. Together with the replacements announced in March and the replacement announced yesterday, we are carrying out a total of JPY 198 billion of transactions and building a high-quality portfolio as shown here. The main objective of these property replacements is to strengthen our portfolio quality. However, as shown in the upper right table, we will use the unrealized gains, that are realized through the transactions, to both return to unitholders and build up retained earnings to prepare for a stable growth in the future. NBF's internal growth is in a temporary adjustment phase. We are expecting the second half of 2021 to be the bottom for the occupancy rate and the first half of 2022 to be the bottom for rental revenues, and would like to supplement the slowdown of internal growth through the property replacement strategy. Now I will go over the highlights of the property replacement announced yesterday. Please see Page 13. There are several highlights to this transaction. The first is the improvement in our funding efficiency through the collection of JPY 16 billion of funds. Second, while we collect funds, we increased the actual amount of NOI, improving the NOI yield. It goes without saying that we are focused not only on short-term profitability, but the future cash flow outlook based on factors such as the replacement of facilities. Thirdly, the increase in NAV. We achieved JPY 22,000 or 4% increase through this replacement. Making the portfolio younger and improving the environmental aspects of the portfolio were also important factors. You can see for yourselves the numbers and data on the material. I would like to add a word of explanation. First, the Iidabashi Grand Bloom, which we are acquiring. Please see Page 15. Iidabashi Grand Bloom is a mixed-use property we developed by our sponsor, Mitsui Fudosan, together with landowners. It is a large building in Central Tokyo with 30 floors above ground and a gross floor area of approximately 37,000 tsubo. It is a 1-minute walk from the JR Iidabashi station. It is a large building with the most advanced specifications, including backup power generation facilities that can cover up to 72 hours. This time, we are acquiring around 38% of the office portion and around 84% of the retail portion. The acquisition price is JPY 77.6 billion, and the appraisal NOI yield is 3.5%. This is an acquisition of a very new, high-quality property in Central Tokyo, and we would like to consider actively acquiring additional stakes in the property, making use of the preferential negotiation rights we acquired in the transaction. On the other hand, please see Page 17 for the properties disposed. The NBF Minami-Aoyama Building, which was disposed in March, the NBF Ochanomizu Building, which we announced yesterday, the Nakanosakaue Sunbright Twin, and the Sun Mullion NBF Tower, all had unrealized losses in terms of their appraisal values. However, we were able to sell all of them at a price significantly higher than the appraisal values. Taking advantage of the robust property trading market by disposing these properties, which had unrealized losses for a long time, we have decided to strengthen the portfolio as explained earlier. 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 above 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 3.4% in this period, due to factors such as the departure of a large tenant. On the other hand, the ratio of tenants moving in was 2.4%, 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 1 percentage point to become 97.8%. Because we have a relatively large tenant departure expected in the second half of 2021 as well as first half of 2022, we conservatively forecasted the ratio of tenants moving out at 3.7% and 4.2%. With the tenant departures, the floor area for which we are conducting leasing activities is increasing. Despite the anticipated lifting of the state of emergency and signs of normalization thanks to vaccinations, we are estimating the timing of tenants moving in conservatively. In 2022, leasing will begin for the large number of properties that will be supplied in 2023. However, when considering how the leasing market is affected more by demand trends rather than the increase in supply, and how recent corporate earnings have been quite resilient, we are confident that NBF properties will continue to be in demand from tenants, even as the tenants' needs towards offices becomes more diverse. As for the occupancy rate of our portfolio, we are expecting it to recover after bottoming at 96.7% in the second half of 2021. And we plan to control the stabilized occupancy rate at around 97% to 98% going forward. 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. As for rent revisions, COVID-19-related measures, such as temporary rent reductions for the retail portions of some of our properties, is offsetting the upward rent revisions in the office portions. The extent of the upward revision is getting smaller than in the past, but there still is a gap between market rents and actual rents, and we are still able to negotiate upward rent revisions with tenants. The green section includes all factors other than rent revisions, such as the impact of tenant replacements. In this forecast, because we are expecting the occupancy rate to fall until the second half of 2021, we are assuming rental revenues from existing properties to decline until the first half of 2022, which is 2 fiscal periods ahead. Next, I would like to introduce an example of value-up construction work through strategic investments by highlighting the NBF Shibuya East property. Please turn to Page 21. 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. NBF Shibuya East is a highly convenient building located in the Shibuya area. In order to improve its competitiveness, we renewed the entrance lobby and the rooftop area, as well as making better use of unused space and creating multipurpose spaces. We were able to cater to various tenant needs. Thanks to these initiatives, we have been able to lease up vacant space in this property with a relatively short downtime and at favorable terms and conditions. We will continue to analyze strengths, challenges, return on investment, et cetera, select the candidate properties, and conduct value-up works such as this. Please turn to Page 22 for the financial status as of the end of the period. In this period, as highlighted in the new funding and repayment section in the upper left, we procured JPY 128 billion of long-term funding. As a result, as you can see in the finance data table at the upper right, the average interest rate fell 0.03 percentage points from the previous period to become 0.47%. The average maturity became 6.08 years, which is an extension of 0.73 years. In terms of LTV, we have room to borrow around JPY 92 billion, if we were to raise the LTV to 46%, which is the level we use as the benchmark. 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 further 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 23, we have a list of our recent financings, so please take a look later. Next, on Page 24, I will go over the appraisal value. In this period's appraisals, as you can see in the table at the upper left, the total appraisal value exceeded JPY 1.5 trillion, and the unrealized gain increased JPY 13.4 billion to become JPY 297.3 billion. The tables at the bottom left show the period-on-period changes. Cap rates were almost flat, falling for 11 properties and unchanged for 59 properties. The appraisal value rose for 23 properties, mainly in regional or suburban areas. Next, I will go over our forecast on Page 27. The dark red section is the forecast for the second half of 2021 and the orange section on the right is for the first half of 2022. As explained in the internal growth section, we are expecting internal growth to be negative with a decline in rental revenues and the impact of the commencement of property tax payments for both fiscal periods. On the other hand, the property trading market remains robust. In terms of capital gains following property replacements, we plan to use such gains to offset the slowdown in internal growth as long as the current market continues. However, there will always be ups and downs in terms of how much capital gain we book in a certain period, so we will also use retained earnings to stabilize our DPU. As for NBF's stabilized DPU, we believe the DPU of around JPY 11,000 reflects our fundamental strength, considering the current leasing market. This time, we have decided to distribute part of the capital gain and are forecasting JPY 11,500 for the second half of 2021 and JPY 12,500 for the first half of 2022. We show the image on Page 28 for your reference. Next, I will explain NBF's ESG-related initiatives. Skipping a few pages to Page 45, these are the highlights of initiatives in this fiscal period. Please see the second paragraph. In the previous results announcement in February, I talked about our support and participation in TCFD or the Task Force on Climate-related Financial Disclosures. Since then, we also participated in the CDP Climate Change Program in July. In relation to environmental performance data, we obtained an independent practitioner's assurance report from an audit firm to improve objectivity. Moreover, we have begun introducing non-fossil fuel derived electricity in the common areas of 12 properties we own. At the bottom of the page, this is NBF's first green bond issuance in March of this year. We will continue to focus on the G and S of ESG as well. As a result of these initiatives, as highlighted in the top paragraph, we were included in the MSCI Japan ESG Select Leaders Index this May. This is a highly influential index, and we are glad to be able to inform you about this inclusion. In closing, in terms of the impact of COVID-19 on the Japanese economy, with the progress in vaccinations and the state of emergency expected to be lifted, we anticipate a firm recovery in corporate earnings. As the scheduled tenant departures settle down and tenant leasing activities returning towards the pre-COVID situation, we expect the occupancy rate to bottom in the second half of 2021, and rental revenue to bottom in the first half of 2022 and subsequently recover. Although the tough business environment will continue for a while, as explained so far, we are confident that with the resilience of NBF's portfolio, we can sufficiently cope with both temporary disruptions as well as long-term changes in the market. NBF will use all options available to us, even more than before and meet the expectations of our unitholders. Just to let you know, on NBF's website, we have posted an introductory video of the Shinjuku Mitsui Building. We would have liked to actually show you around the Shinjuku Mitsui Building, which has become NBF's flagship property. However, due to the current situation, we ask you to take a look at our website when you have time. That is all for me. Thank you very much for your attention.