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

Hello, everyone. This is Yoshiyuki Tanabe, President and CEO of Nippon Building Fund Management. A month ago, we explained the new growth of NBF driven by the new acquisition of properties and the issuance of new investment units. We have finalized the results for the second half of 2021, which will serve as the starting point for that strategy. Today, we will be making our results announcement presentation on the web, as we did previously. Thank you for your understanding. Please see the financial highlights on Page 3. In this period, we completed the acquisition of Iidabashi Grand Bloom last September as scheduled. And with the disposal of 3 properties: NBF Ochanomizu Building, Nakanosakaue Sunbright Twin, and NBF Unix Building, as well as other measures, we were able to achieve an increase in revenue, income and distribution. DPU was JPY 11,848, up JPY 164 period-on-period and JPY 348 higher than the announcement this January. For the first and second halves of 2022, we are forecasting JPY 13,000 and JPY 11,500, 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. And 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 second half of 2021. Total operating revenues was JPY 50.3 billion, up JPY 4.1 billion or 8.9% period-on-period. Operating income was JPY 23.0 billion, up JPY 225 million or 1% period-on-period. Net income was JPY 21.7 billion, up JPY 300 million or 1.4% period-on-period. We reserved JPY 2.15 billion of our retained profits and total distribution was JPY 19.578 billion. DPU was JPY 11,848, up JPY 164 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 4.12 billion increase in total operating revenues. Rental revenues, which is our base revenue, declined JPY 690 million. Rental revenues declined JPY 874 million for existing properties, but there was JPY 183 million positive contribution from property replacement. Other revenues related to property leasing increased JPY 335 million. This was due to the seasonality in utility expenses. Together with the JPY 4.47 billion increase in profits from dispositions, there was a significant growth in total operating revenues. Total operating expenses also increased JPY 3.9 billion. A major factor was the disposal loss of JPY 3.2 billion for the NBF Ochanomizu Building, as well as the seasonality in utility expenses and the other ups and downs shown on the slide. As a result, operating income increased JPY 225 million period-on-period. The numbers may be somewhat complex because we have booked property disposal gains as well as the subsequent provision of reserve and reversal for advance depreciation. But together with the portfolio replacement effect, we achieved growth in all 3 metrics of revenue, income and distribution. 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 2021. Total assets as of the end of the second half of 2021 increased slightly from the first half to become JPY 1.307 trillion. For the asset section, tangible fixed assets increased JPY 19.8 billion due to the acquisition of 2 properties and the disposal of 3 properties. Cash and deposits declined JPY 18.0 billion. This was due to the usage for acquiring new properties. Net assets increased JPY 2.4 billion due to the JPY 2.1 billion increase in the reserve for advance depreciation in the first half of 2021. That's all for the balance sheet. 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. As for the leasing market, due to the impact of COVID-19 from 2020, companies started taking more time in their decision-making, while at the same time seeking new ways of using offices, which temporarily slowed down leasing activities in the market. According to data by the brokerage firm Miki Shoji, vacancy in the Tokyo Business District as of the end of January 2022 was 6.26% and seems to be bottoming. However, the recovery in the office leasing market has been delayed by a year from the initial outlook. As for the future, we are assuming that it will take some more time before recovery, considering factors such as infections caused by the Omicron variant. On the other hand, thanks to factors such as the rise in vaccination rate since the latter half of last year, people are starting to come back to their offices and the economy is picking up, thanks to the recovery in corporate earnings. We at NBF are also seeing progress in the leasing of large floor spaces and companies seem to be resuming their decision-making. Some point out the large amount of office supply in Tokyo CBD in 2023. However, we believe the recovery in demand caused by the resumption of economic activity will be a more significant driving for us compared to supply. As the impact of COVID-19 subsides, we expect companies to resume the signing of new leases and/or relocating in order to secure office space that will serve as the core of new work styles, mainly in Central Tokyo. As a result, we believe demand for high-spec offices in Central Tokyo will be even stronger. Under these circumstances, in terms of NBF's internal growth, we will accelerate the pace of bringing in new tenants with the resumption of economic activity and using the strong sales capability of our sponsor, Mitsui Fudosan. NBF will continue to secure a high occupancy rate with our portfolio concentrated in the Tokyo CBD area, for which there is robust demand, as well as our diverse tenant base. We expect NBF's occupancy rate to bottom in the first half of 2022, and will aim for a run rate occupancy rate of between 97% to 98%. In terms of our rental revenues, we expect it to bottom in the second half of 2022 with a 1 period time lag following the occupancy rate. But as I will explain after this, we plan to shift our focus to external growth for the time being. Next, in terms of external growth, the office property transaction market remains robust. This is driven by the heightened investment appetite among a wide range of players, including both domestic as well as international funds, backed by the favorable financing environment and the low credit volatility in Japan. 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. NBF will shift its focus from internal growth to external growth, including property replacements and seek continuous growth. Now on the next page onwards, I will explain NBF's property replacement strategy. Please turn to Page 12. With the aim of strengthening the competitiveness of our portfolio, NBF has been replacing a total of around JPY 300 billion since last March. On the upper left is a summary of the 4 properties we acquired, while at the bottom is the 8 properties we disposed. Please see the total amount at the middle of the page. The total acquisition amount was around JPY 174 billion, while the total disposition price was around JPY 124 billion, and we achieved asset size growth of approximately JPY 50 billion through this major asset replacement. We are working on asset replacement based on various factors, including the NOA amount, NOI yield, the area, environmental performance, et cetera, with the objective of strengthening the competitiveness of our portfolio. As for the changes in metrics before and after this initiative, the NOI amount increased JPY 3.1 billion per annum, and there will be a significant improvement in NOI yield with the acquisition properties yielding 3.9% on average, while the disposition prices were yielding 3.3%. Meanwhile, as companies reform their work styles, properties in Central Tokyo with good access as well as properties with attractive common areas tend to be preferred by tenants. We were able to make the entire portfolio more compatible with new ways of working. Moreover, with a significant improvement in CO2 emission intensity as part of the environmental performance, we were able to improve the quality of our portfolio in all aspects. And as you can see on the bottom right, on the financing side, our LTV is 41.6%, and borrowing capacity, if we were to raise the LTV to 46%, which is the level we use as the benchmark, will expand to around JPY 109 billion. Now let me explain the new acquisitions. First, on Page 13 is the Nakanoshima Mitsui Building. This is Mitsui Fudosan's flagship property in Osaka. With an acquisition price of JPY 44 billion, we believe we were able to acquire a competitive flagship property in the regional areas, especially in the Osaka area for NBF. As you can see in the photo, the property underwent a major renovation in 2019, and with abundant community spaces and co-working spaces, the property can accommodate a diverse range of workstyles. Next, on Page 14 is the additional acquisition of Iidabashi Grand Bloom. This is the second acquisition following last September. The additional acquisition is also from Mitsui Fudosan, and NBF was able to gain the majority share of 58.55% through this acquisition. The total acquisition price will be JPY 113.8 billion, which is the second largest in NBF's portfolio after the Shinjuku Mitsui building, and it will be one of the leading properties for NBF. Moving on to internal growth. Please see the graph on Page 15, showing the average occupancy rate during the period 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 was 3.3% 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 1.4 percentage points to become 96.4%. Because we have relatively large tenant departures expected in the first half of 2022, we conservatively forecasted the ratio of tenants moving out at 4.6%. On the flip side, with the tenant departures, the floor area for tenants moving in will also rise to 4.7%. This includes the starting of the lease contract with a large tenant, which we secured in the latter half of last year. Leasing is expected to 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 we are confident that NBF's 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 96.0% in the first half of 2022, and are forecasting 96.7% for the second half of 2022, and we plan to control the stabilized occupancy rate at around 97% to 98% going forward. Next, on Page 16, 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, although there were many cases of tenants accepting upward rent revisions in this period, there were also individual cases where we accepted rent reductions in order to retain the tenant. And the net effect was slightly negative. In this forecast, we have assumed the rent revision effect to be almost 0 or slightly negative and will flexibly adjust our lease renewal negotiations for each property. Meanwhile, 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 first half of 2022, and are assuming the rent-free periods for when new tenants move in to be longer than in the past. We are assuming rental revenues from existing properties to decline until the second half of 2022, which is 2 fiscal periods ahead. Next, please turn to Page 17. Here, we show a graph of construction costs, including CapEx and repair and maintenance expenses. We added this page because we are often asked about the ups and downs in repair and maintenance expenses and CapEx. And you can see how the fluctuation between periods is caused largely by preparation work highlighted in green. This includes cases where NBF receives restoration expenses upon tenant departures as cancellation fees, and we book both items in our accounts. Another factor is NBF proactively changing the lighting to LED or conducting value up construction work at the time of tenant replacements. In the first half of 2022, the amount will exceed JPY 10 billion due to the restoration and preparation work for the Shinagawa and Shibuya properties, et cetera, but we'll stabilize at around JPY 6 billion of construction work per period. Please turn to Page 18 for the financial status as of the end of the period. There was no change to the balance of interest-bearing debt in this period. As you can see in the finance data table at the upper right, we are continuing our conservative financing with an LTV at the end of the period of 42.1%, long-term fixed rate debt ratio of 95.1%, average interest rate of 0.47%, and average maturity at 5.76 years, and we are continuing our conservative management. 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 funding in this period, and we expect a decline in interest expenses through refinancing to continue for the time being. Next, on Page 19, I will go over the appraisal value assessment. In this period's appraisals, as you can see in the table at the upper left, the total appraisal value reached JPY 1.588 trillion, and the unrealized gain increased JPY 17 billion to become JPY 314.4 billion. The tables at the bottom left show the period-on-period changes. Cap rates were almost flat, falling for one property and unchanged for 72 properties. The appraisal value declined for 13 properties. This was due to adjustments in cash flow factoring in future construction expenses. Next, I will go over our forecast on Page 21. The dark red section is the first half of 2022, and the orange section on the right is the forecast for the second half of 2022. As I explained in the internal growth section, we are expecting internal growth to be negative with the decline in rental revenues for both fiscal periods. On the other hand, the property trading market remains robust. And in terms of capital gains from property replacements, we plan to use such gains to offset the slowdown in internal growth as long as the current market continues. This time, we have decided to distribute part of the capital gain and are forecasting JPY 13,000 for the first half and JPY 11,500 for the second half of 2022. In terms of the breakdown of the DPU, please see the image on Page 22 for your reference. Next, please turn to Page 23. I will explain our policy regarding the use of retained profits and capital gains. As explained in the asset replacement section, with the disposal of 8 properties, we will be reserving approximately JPY 14.1 billion of retained profits by December 2022. We will actively use retained profits reserved within NBF as well as future capital gains for the stable growth in our DPU and of NBF overall. Our distribution policy will be to set a target DPU of JPY 11,500 for the time being until the real estate leasing market stabilizes and moves into the growth stage. And if the DPU, excluding capital gains, does not reach JPY 11,500, we will reverse retained profits or use capital gains to pay out distribution. NBF is aiming to strengthen the quality of its portfolio in the mid to long term through value of construction work and ESG investments, and we would like to use the funds for distribution during these periods. We will prepare and update you on the progress of individual projects as well as the new distribution targets in the next phase of our growth. Next, I will explain NBF's ESG-related initiatives. Skipping a few pages to Page 40 and 41. These are the highlights of initiatives in this fiscal period. On Page 41, we show the materiality which we have newly set at this time. As for our environmental KPIs, we have raised our 2030 CO2 reduction target, from 40% compared to 2013, to 46%, which is in line with the national target. For water usage, the 2030 target is to achieve a 5% reduction compared to 2019, and we have chosen to target to keep the high level of 65% for our recycling ratio. Other than that, we have set KPIs for green building certifications and we will have all our properties certified, including new acquisitions as well as a KPI to fund at least JPY 10 billion per annum through green finance. In closing, in terms of the impact of COVID-19 on the Japanese economy, with the progress in booster vaccinations, et cetera, and the semi state of emergency expected to be lifted, we anticipate corporate activity to go back to normal. In terms of NBF, as the scheduled tenant departure settled down and with tenant leasing activities returning towards the pre-COVID situation, we expect the occupancy rate to bottom in the first half of 2022, and rental revenue to bottom in the second 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 NBS 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. That's all from me. Thank you very much for your attention.