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

Ladies and gentlemen, I am Eiichiro Onozawa, President and CEO of Nippon Building Fund Management from this April. Firstly, allow me to briefly introduce myself. I joined the largest real estate company in Japan, Mitsui Fudosan, in 1988 and since have been involved in office projects in Japan and in the global markets for many years. In particular, I worked in New York at the time of the financial crisis in 2008 when the financial market was in turmoil, and in London at the time of the vote for Brexit. Suffice to say, I have witnessed and lived through these major milestones firsthand. With this experience, I plan to manage Nippon Building Fund Management so that we can further enhance unitholders' value going forward. I'm now pleased to report our financial results for the period ending June 30, 2022. As before, the detailed explanation will be provided through the website. Please refer to Page 3 of the document, showing highlights of the current period financial results. During the period under review, the company completed the additional acquisition of Iidabashi Grand Bloom and Nakanoshima Mitsui Building in March while divesting Sun Mullion NBF Tower in January as scheduled. We were able to close the period with an increase in revenue, income and dividends, mostly by effective asset replacement within the portfolio while expanding asset value from executing equity financing in January. Distribution per unit was JPY 13,476, an increase of JPY 1,628 from the previous period and an increase of JPY 476 from the forecast announced in February. For the next period ending December 31, 2022 and the period ending June 30, 2023, the company plans to distribute JPY 11,500 each. Please see Page 5. The 2 bar graphs denote the changes in distributions per unit and net asset value per unit over the last 3 years, which Nippon Building Fund considers as fundamentally important indicators for improving unitholder value. We were able to achieve a positive year-on-year settlement on both indicators. Our goal for the future is to continue aiming for likewise long-term stable growth. I will now explain the financial results on Page 6 and beyond. On Page 6, we have organized the status of asset replacements for each period. As there are many asset acquisitions and dispositions within the current period, please refer to this page for these details. Next, I will explain the income statement for the current period on Page 7. In the red box in the comparative income statement depicts the financial figures for the current period and the period ending June 30, 2022. From the previous period, operating revenue for the period resulted in JPY 52.215 billion. an increase of JPY 1.88 billion or 3.7%. Operating income was JPY 26.8 billion, an increase of JPY 3.802 billion or 16.5%. Net income was JPY 25.4 billion, an increase of JPY 3.712 billion or 17.1%. In addition, retained earnings of JPY 2.517 billion were accumulated and total distributions amounted to JPY 22.9 billion. The distribution per unit will be JPY 13,476, an increase of JPY 1,628 from the previous period. I will now explain the change factors on the right side of the page. First, let me give you a breakdown of the JPY 1.88 billion increase in operating revenue. Real estate rental revenue, which is the basis of the income, increased by JPY 233 million. The breakdown is JPY 767 million decrease in revenues from existing properties and the JPY 1 billion increase due to the asset replacement effect. Other rental revenues increased by JPY 660 million, but this was a net positive result from a combination of increased revenue of cancellation fees and decreases of revenues on utility bills stemming from seasonal factors. In addition, profits from dispositions increased by JPY 987 million from the previous period resulting in a large increase in operating revenues. The next factor behind the JPY 1.921 billion decrease in operating expenses is as follows: the significant impact was the absence of the JPY 3.273 billion loss from the disposition of NBF Ochanomizu Building that was booked in the previous period. On the other hand, the increase includes taxes and public charges on the Shinjuku Mitsui Building acquired last year and an increase in utilities costs due to high crude oil prices and the weaker yen. As a result, operating income increased by JPY 3.802 billion from the previous period. The results for both the previous and current periods combines profits from dispositions and the accumulation of retained earnings, therefore, potentially making it complicating to decode. Yet the combined results show an increase in revenue, income and dividends, including the effect of asset replacements. Then on Page 8, I will briefly explain our balance sheet. The red box on the left side of the comparative balance sheet shows the figures at the end of the current period. Total assets as of June 30, 2022 increased by JPY 60.8 billion from the end of the previous period to JPY 1.3677 trillion. First, the asset section. Fixed assets increased by JPY 75 billion due to the acquisition of 2 properties and the sale of 1 property. In addition, cash and deposits decreased by JPY 14.5 billion which was used for the new property acquisitions. Net assets. The total unitholders' capital increased by JPY 31.0 billion due to the public offering in January, and total net assets increased by JPY 36.8 billion, mainly due to a JPY 2.1 billion increase in the reserve reduction entry. This concludes my explanation of the balance sheet. I will now explain NBF's management policy. Please see Page 11. This is my first form briefing since assuming the role as President and CEO. However, please rest assured that NBF's investment policy will remain unchanged with stable growth of and sustained distributions per unit as our main focus. On the other hand, amid major changes occurring in the business environment, we will carefully execute internal and external growth measures flexibly to achieve further stability and expansion of NBF through qualitative and quantitative improvements. Within this context, I would like to explain the current market and possible strategies NBF can take in 4 areas. Firstly, regarding trends in the leasing market, the seventh wave of the new COVID-19 infection, Russian's invasion of Ukraine and the weak yen have continued delays in corporate decision-making and search for new ways to use office space, all contributing to the stagnation of leasing activities in the market. According to data from Miki Shoji, a brokerage firm, vacancy rate in Tokyo Business District has been in the 6% range for about a year, indicating that the market has potentially bottomed out. But the recovery of the office leasing market has been slow from the previous forecast. Given the possible impact of large new office supply in 2023, we expect market recovery will require more time. On the other hand, some signs of corporate decision-making resuming can be witnessed by the closing of large floor take-ups in NBF's portfolio. We recognize that the recovery of the office leasing market is more a matter of the demand recovery progressing from the resumption of economic activities and amount of supply itself. And believe that in the process of the conversions of the seventh wave of infections, movements such as office relocations to secure quality personnel will resume, especially in the Central Tokyo area. In this context, we believe that the preference for high-spec offices, especially in Central Tokyo, will increase. In such an environment, NBF's internal growth will be achieved by accelerating the interest of new tenants by taking advantage of our sponsor Mitsui Fudosan's leasing strength as economic activities resume as well as capitalizing on NBF's portfolio being centered in Tokyo, where the diversified tenant clientele creates strong demand. Although NBF's occupancy rate goals have been pushed back from the level I explained 6 months ago, we are aiming for an occupancy rate in the 97% range as the cruising level with the bottom being the fiscal period ending December 31, 2022. Next, in terms of external growth, the office trading market has remained strong. This is due to the Bank of Japan's low interest rate policy and other factors that have increased the appetite for investment among various domestic and foreign players, especially foreign funds against the backdrop of low credit volatility in Japan. In this environment, NBF, which has a strong sponsor pipeline, believes that this is an opportune time to strengthen the quality of our portfolio, including asset replacement and to grow our asset under management. In our core business of real estate rental revenues, we intend to pursue continuous growth while shifting our focus from internal growth to external growth, including asset replacement. Next is finance. First, regarding the current financing environment, we recognize that NBF price to net asset value is above 110% in the equity market, making it possible to raise funds through public offerings. On the other hand, interest rates on debt financing are higher than before, and we have factored future interest rate increases into our forecasts. However, we are taking measures to avoid extreme increases in interest rates paid by locking in more than 90% of our interest-bearing debt through fixed interest rate financing in which repayment dates of these debts are spread out over many periods. The company intends to continue to control the LTV level and maintain good relationships with lenders and operate conservatively in terms of its future financing policy. Finally, we have a policy for the use of retained earnings and gains on transfers. As I will explain in more detail later, it is becoming more challenging to achieve the previously announced DPU level of JPY 11,500 with the current real estate rental income alone. As explained 6 months ago, we would like to strengthen returns to unitholders by setting DPU of JPY 11,500 as the lower limit for the time being until the rental market recovers. Of the DPU of JPY 11,500, JPY 11,000 is based on the assumption that the occupancy rate reaches the cruising level of 97% and the amount of JPY 500 is added to the DPU by utilizing retained earnings. In the next fiscal period and 2 fiscal periods ahead, we intend to distribute JPY 11,500 by utilizing the gain on transfer and retained earnings. The following pages describe the asset replacement of the current period and the following period. But since this was explained at the time of the public offering and the last time, I will omit repeating details. Next, I would like to explain internal growth. Please refer to the graphs on Page 13 for the average occupancy rate and move-in/move-out rates during the period. The red line at the top shows the portfolio's average occupancy rate during the period and the bar graph at the bottom shows ratio of the area of tenants that moved in or out during each 6-month period to the entire portfolio. Please see the bar graph first. This section explains the status of move-ins and move-outs. Vacancy rate for the period under review was 4.3%, mainly due to large tenants moving out. The occupancy rate was 4.4%, with steady progress in backfilling. As a result, the average occupancy rate during the period was 96.3%. In the next fiscal period ending December 31, 2022, we conservatively expect the move-in rate to be 1.9% and the average occupancy rate to be 95.8% despite the completion of major tenant move-outs. For the fiscal period ending June 30, 2023, 2 fiscal periods ahead, we expect 96.1% as tenants moving in exceed those of moving out and we anticipate a full period of occupancy by tenants who moved in December 2022. Looking ahead, we do not expect a dramatic recovery, but we do believe that the economy will continue to level off and that the 97% level can be expected soon as the demand is generated by the resumption of corporate activity. Next, on Page 14, we will discuss changes in rental income from existing properties. The yellow line graph shows the percentage change in rental income of existing properties from the previous period and the bar graph breaks it down into 2 components. The blue bar graph shows changes in earnings due to rent revisions by tenants who continue to occupy the property. With regard to rent revisions, although there were a large number of cases in the period under review where the company agreed to increase rents, there were also cases where rents were reduced in order to secure renewed contracts resulting in a slight decrease in total rents. Although the effect of rent revision is assumed to be slightly negative in the current forecast, we intend to proceed with contract revision negotiations for each building selectively over each deal. On the other hand, the green bars include all factors other than rent revisions, such as the impact of tenant turnover. In addition to the impact of the decline in occupancy rates through the next fiscal period ending December 31, 2022, the current forecast assumes a longer free rent period when new tenants move in than in the past. As a result, we have assumed real estate rental revenues from existing properties will decline until the fiscal period ending June 30, 2023. We believe that the internal growth will stabilize and return to positive territory after bottom out in the fiscal period ending June 30, 2023. Please proceed to Page 15. This is the financial position at the end of the current period. Interest-bearing debt increased by JPY 24.0 billion during the period. As shown in the finance data table on the upper right, the LTV ratio at the end of the period was 42%. The long-term interest rate ratio was 91.3%. The average funding rate was 0.45% and the average remaining loan period was 5.64 years, maintaining conservative financial management. Below that, in July, the short-term borrowings were repaid with the funds from property dispositions. Therefore, the LTV after these events is 41.4% and the borrowing capacity is approximately JPY 110 billion. The table below on Page 16 shows the diversification of repayment dates and the interest rate level is also shown above the bar graph. Although there is concern that funding costs may increase due to future increases in interest rates, NBF also hedges against the risk of rising interest rates by diversifying repayment dates and to targeting at least 90% of its funding with long-term fixed rates, so that interest rate payments do not increase all at once. Next, on Page 17, we will discuss continuing appraisals. As shown in the upper left table, the total value of ongoing appraisals for the period was JPY 1.6822 trillion and unrealized gains increased by JPY 19.1 billion to JPY 336.6 billion. The status of each property is shown in the table below left, with cap rates declining from 54 properties and maintaining the status quo for 19 properties, reflecting the market trend of cap rates further declining. The appraised value itself decreased for 8 properties, but this was due to cash flow adjustments for estimated future construction costs. The current continuing appraisal reflects the current transaction case, which also reflects the declining trend of cap rates. As explained earlier, the Bank of Japan's continued position on suppressing the risk-free rate despite rising interest rates and the weak yen have led to [indiscernible] trading players, mainly foreign capital or likely factors. The next page, 19, explains the forecast. The dark red box is the forecast for the period ending December 31, 2022 and the orange box on the right is the forecast for the period ending June 30, 2023. As I explained earlier in the internal growth section, real estate rental income is expected to decrease at existing properties in both 2 forecast periods and internal growth is expected to be negative. On the other hand, the real estate trading market continues to be brisk, and we intend to use gains on dispositions resulting from property replacements to compensate for the slowdown in internal growth. The distribution is scheduled to be JPY 11,500 for both the fiscal period ending December 31, 2022 and the fiscal period ending June 30, 2023. Please refer to the illustration on Page 24, breakdown of changes in distributions. Next, please see Page 21. In the previous announcement, I explained to you that we will endeavor to make stable distributions with a minimum DPU of JPY 11,500 as our policy for utilizing retained earnings and gains on disposition. This time, I would like to go a little further and explain NBF's policy on the passing on retained earnings and gains on dispositions to unitholders. The balance of retained earnings is expected to be approximately JPY 13.6 billion since the company will also record a gain on the transfers in the ongoing current period. NBF intends to accumulate retained earnings and gains on transfers as much as possible, taking tax efficiency into consideration as a source of stable distributions. On the other hand, we intend to actively pass on these retained earnings to unitholders. The first is the regular withdrawal stated in #1. This will be distributed as a second source of distributions by adding every fiscal period an amount equivalent to 3% of net income, excluding gains or losses on dispositions to the net income from retained earnings and gains on disposition that manifests unrealized gains. In this forecast, I have factored in downtime due to tenants moving out and electricity rate hikes so the DPU to be raised from rental income will slightly be above JPY 10,000. We intend to distribute an additional 3%, equivalent to approximately JPY 300 on top of this. Regarding regular withdrawals, a certain amount will be fixed and reserve for losses on transfer, impairment, large tenant move-outs, disasters, et cetera, but we would like to pass on to unitholders 3% distribution from the excess of reserved amount each period. On this page, I have explained the newly established second source of distribution, which is the additional distribution promised to unitholders over the mid, long term. See next page, 22. This section explains NBF's current distribution policy. In addition to the 3% distribution explained on the previous page, NBF will continue to replace assets to improve the quality of the portfolio while also realizing unrealized gains and passing them on to unitholders. Again, the lower limit of DPU of JPY 11,500 was set at the previous announcement. The expected DPU of JPY 11,000 where this figure is based on the cruising level occupancy of 97% requires an additional JPY 500 from reserves and/or dispositions. Compared to 6 months ago, we expect that internal growth will continue to remain flat due to the impact of the seventh wave of COVID-19 and factors such as high crude oil costs but we will continue to focus on external growth, including property replacement to contribute to DPU growth. We have set our forecast for the 2 fiscal periods ending December 31, 2022 and June 30, 2023 at JPY 11,500 as a lower limit. As I explained earlier on the management policy page, we intend to incorporate NBF's strength into our strategy and manage the property to bring it to the level of DPU JPY 11,500 on a real estate rental income basis, reviewing this level as required. Finally, I would like to explain NBF's ESG initiatives. If you would jump to Pages 41 and 42, it contains highlights of our efforts during the current fiscal period. On Page 41, one of our initiatives during the period under review was the establishment of a department dedicated to ESG at our asset management company. We have also signed up with PRI, a global initiative. Page 42 shows the progress of key KPIs set in February. The CO2 target is a reduction of 46% by 2030, which we are currently achieving 33%. We achieved -- we expect to achieve this goal in the future by changing conventional lighting that can be replaced with LEDs, installing air conditioners with better efficiency and introducing green electricity. Water consumption was also reduced, but this was due in large part due to low percentage of employees who came to work as a result of working from home and other activities. Please check separately for information on green building certification, green finance initiatives and waste recycling rates. Finally, many new factors are included in this forecast such as the impact of the seventh wave of COVID-19, Russia's invasion of Ukraine, the weak yen and high resource prices. We will continue to factor in rising interest rates, but we recognize that the real estate rental income will improve once the other factors subside. As for NBF, we expect occupancy rates to bottom out in the second half of 2022 and real estate rental revenues to bottom out in the first half of 2023 as large tenant move out, settle down and leasing of tenants begins as before. The difficult business environment will continue for some time to come. But as we have reported, we are confident that the strength of NBF portfolio will be sufficient to cope with both temporary disruptions and mid- to long-term market changes. NBF intends to meet the expectations of unitholders by utilizing all available resources more than ever before. That would be all for my explanation. Thank you very much for your time today.