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

Ladies and gentlemen, I'm Eiichiro Onozawa, President and CEO of Nippon Building Fund Management. Within the JV industry, unit prices are trading lower than our assessment due to the rise in long-term interest rates since the Bank of Japan's monetary policy meeting last December and the large supply of office buildings in the leasing market, especially in Central Tokyo this year. However, we are determined to break free from this difficult situation by utilizing NBF strength. And I would very much appreciate your continued support. I am now pleased to report our financial results for the fiscal period ending December 31, 2022. As before, this presentation 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, as planned, we disposed of 3 properties, including Toyo-cho Center building at the beginning of the period and completed the acquisition of Toyosu Bayside Cross Tower from our sponsor, Mitsui Fudosan in November. The distribution per unit is JPY 11,500, in line with the earnings forecast announced last August. The distribution amount for the next fiscal period ending June 30, 2023, and December 31, 2023, are scheduled to be JPY 11,500, respectively. Please see Page 5. The 2 bar graphs denote the changes in distributions per unit and net asset value per unit over the past 3 years, which Nippon Building Fund considers as fundamentally important indicators for improving unitholder value. The large proceeds from the sale of Sun Mullion NBF Tower contributing to the increased distribution amount recorded in the previous period may appear as a dividend reduction in comparison to this period. However, NBF's NAV has been increasing, and NBF intends to continue aiming for 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. Please refer to the document for details as there will be property transfers in and out within the current period. 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 December 31, 2022. From the previous period, operating revenue for the period was JPY 47.3 billion, a decrease of JPY 4.8 billion or 9.3%. Operating income was JPY 21.5 billion, a decrease of JPY 5.2 billion or 19.4%. Net income was JPY 20.2 billion, down JPY 5.1 billion or 20.2% from the previous period. The company also accumulated JPY 0.7 billion in retained earnings and the total distributions amounted to JPY 9.561 billion. The distribution per unit will be JPY 11,500. I will now explain the change factors on the right side of the page. First, let me give you a breakdown of the JPY 484 million decrease in operating revenues. Real estate rental revenues, which are the basis for the above-mentioned revenue increased by JPY 395 million. The breakdown is JPY 113 million decrease from the existing properties and JPY 508 million increase due to the asset replacement effect. Other rental revenues decreased by JPY 450 million, but this was due to the absence of cancellation fees recorded in the previous period and an increase in utilities expense including an increase in air conditioning costs during the summer. In addition, gains on sales of real estate and other assets decreased by JPY 4.7 billion from the previous fiscal period. The next factor behind the increase in operating expenses of JPY 361 million is as follows. These include building management costs due to seasonal factors, et cetera, as well as increased utilities costs and deferred repair costs due to high crude oil prices and weaker JPY. As a result, operating income decreased by JPY 5.2 billion from the previous period. Although it is difficult to understand because gains on dispositions and the accumulation of retained earnings occurred in both the previous and current periods, the financial results covered the negative impact of the existing properties by replacing the portfolio and utilizing the gains on dispositions. 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 December 31, 2022 increased JPY 1.0 billion from the end of the previous period to JPY 1.3 trillion. First, the asset section. In addition to a JPY 4.6 billion increase in cash and cash equivalents, fixed assets decreased by JPY 3.3 billion due to the acquisition of one property and the disposition of 3 properties and depreciation of JPY 7.9 billion. In liabilities, interest-bearing debt increased JPY 3.0 billion. In net assets, undistributed earnings decreased by JPY 5.1 billion. As a result, the balance sheet reflects the funding of acquired properties by the sale of 3 properties. I will now explain NBF's management policy. Please see Page 11. The policy will remain unchanged with a focus on stable growth of distribution per unit. On the other hand, the major changes in the 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. First, regarding trends in the leasing market. Leasing activities remained limited due to the ongoing delay in corporate decision-making and searching for new ways to use office space in the wake of Russian invasions of the Ukraine and other factors. According to data from Miki Shoji, a brokerage firm, the vacancy rate in the Tokyo Business District has remained in the 6% range for more than a year. But the recovery of the office leasing market has been slow from the previous forecast. Given the possible impact of large 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. Market recovery in office buildings is expected to be accompanied by an increase in post COVID moves such as office relocations to secure high-performing human resource, mainly in Central Tokyo, amid an expected recovery in corporate earnings despite the transformation of work style through the use of work from home and other factors. 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 centered on Central Tokyo where the diversified tenant clientele creates strong demand. NBF's occupancy rate is expected to bottom out at 95.9% in the current fiscal period, and to recover to this 96% range, aiming for an occupancy rate target of 97% as the cruising level after 2024, when the leasing of the large block supply in Central Tokyo and secondary vacancies will be completed. Next, in terms of external growth, the office transaction market has remained strong. Although the interest rates have risen due to the changes in the Bank of Japan's monetary policy, we still have not seen an increase in the cap rate on transactions. In this environment, NBF, which has a strong sponsor pipeline, believe 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 continue to pursue continued growth while shifting our focus from internal growth to external growth, including replacement. Next is finance. First, regarding the current financing environment, NBF's P/NAV is below one multiple in the equity market and the unit price is not at a level we are satisfied with, considering NBF's capabilities, including its current portfolio of quality assets and distribution levels. 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 measure to avoid an extreme increase in interest rate payments since more than 90% of the interest-bearing debt is financed at fixed interest rates and repayment deadlines are diversified. The company intends to control LTV levels 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 dispositions. 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 current real estate rental income alone. As explained 6 months ago, if we are able to realize unrealized gains on the property, we would like to set the DPU at JPY 11,500 as the lower limit for the time being to enhance returns to our unitholders. On Pages 12 and 13, you will find an overview of Toyosu Bayside Cross Tower acquired in the period under review and Iidabashi Grand Bloom, which is scheduled to be acquired this March 2023. To reiterate, Toyosu Bayside Cross Tower was acquired for JPY 14.7 billion last November and an additional acquisition for JPY 21.6 billion is planned for March this year. This is the third additional acquisition for Iidabashi Grand Bloom, bringing the total investment to JPY 138.9 billion. Toyosu Bayside Cross Tower is shown on Page 13 which was also acquired from the sponsor, Mitsui Fudosan. The appraisal NOI yield is 3.5%, but the actual NOI yield is 3.7%, making this a good purchase for a relatively new property directly connected to Toyosu station. The most recent replacements are listed on Page 14. As noted on the lower left, the disposition of the Shin-Kawasaki Mitsui Building was completed in January of this year. Although the current yield on this property is high, we foresee an increase in CapEx given the building's 33 years of age, therefore, decided to dispose off this asset before it affects future cash flow. Since we have completed dispositions of properties with unrealized losses, our future focus on replacing current properties may not immediately contribute to future accretive cash flow growth. Next, I would like to explain internal growth. Please refer to the graphs on Page 15 for the average occupancy rate and move-in -out rates during the period. The red line at the top shows the portfolio's average occupancy rate during that period. And the bar graph at the bottom shows the ratio of the area of tenants that moved in or out during each 6-month period of the entire portfolio. Please see the bar graph first. This section explains the status of move-ins and move-outs. The move-out rate for the period under review was 2.6%, mainly due to large tenants moving out. The move-in rate was 2.2%, resulting in an average occupancy of 95.9% during the period. In the next fiscal period ending June 30, 2023, we expect the average occupancy rate to be 96.1%, conservatively assuming an occupancy rate of 1.6% and a move-out rate of 1.6% despite the completion of major tenant move-outs. In the fiscal period ending December 31, 2023, move-ins will be -- will exceed move-outs but is expected to remain flat at 96.1%. NBF intends to execute leasing activities, prioritizing occupancy rates, partly due to the lower supply this year. Next, on Page 16, I will explain changes in rental income from existing properties. The yellow line graph shows the percentage change in rental income of existing properties from the previous quarter, and the bar graph breaks it down into 2 components. The blue bar graph shows changes in earnings due to rent revision by tenants who continue to occupy the property. Regarding rent revisions, although there were some cases where rents were reduced in order to secure renewed contracts, there were also a large number of cases in the period under review in which the company agreed to increase rents, resulting in no increase or decrease in total. Although the effect of rent revision is assumed to be slightly negative in the current forecast, we intend to proceed with contract revision rate negotiation for each building, giving priority to occupancy rates. On the other hand, the green bars include all factors other than rent revisions, such as the impact of tenant turnover. In the current forecast, free rent at the time, new tenants move in is assumed to be longer than actual. And although real estate rental revenues from existing properties will increase in the fiscal period ending June 30, 2023, we assume the decrease in the fiscal period ending December 31, 2023. Please proceed to Page 17. This is the financial position at the end of the current period. As shown in the financial data table in the upper right corner, the LTV ratio at the end of the period was 42.2%. The long-term fixed interest rate ratio was 91.5%. The average funding rate was 0.44% and the average remaining period was 5.56 years, indicating that the company continues to maintain conservative financial management. The table below on Page 17 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 increase in interest rates, NBF also hedges against the risk of raising interest rates by diversifying repayment dates and targeting at least 90% of its funding with long-term fixed rates so that interest payments do not increase all at once. During the period under review, we raised JPY 33 billion with an average maturity of 8.7 years and an average interest rate of 0.62%. We also actively engaged in green finance with a current balance of JPY 40.0 billion. Next, on Page 19, we will discuss continuing appraisals. As shown in the upper left table, the total value of ongoing appraisals for the period was JPY 1.6 trillion, and unrealized gains increased by JPY 5 billion to JPY 339 billion. The status of each property is shown in the table below left with cap rates declining for 32 properties and maintaining status quo for 39 properties with cap rates declining further. The appraisal value itself decreased for 11 properties but this was due to cash flow adjustments for estimated future construction costs on improvements. This ongoing appraisal is believed to reflect the downward trend in cap rates based on current transaction cases. In addition, as explained earlier, this may be due to the continued brisk trading activity by various players despite the rising interest rate environment. The next Page 21, explains the forecast. The dark red box is the forecast for the fiscal period ending June 30, 2023, and the orange box on the right is the forecast for the fiscal period ending December 31, 2023. As explained earlier in the internal growth section, real estate rental income is expected to increase in the next fiscal period ending June 30, 2023, mainly due to the accrual of rent after the downtime of occupying tenants. But for the 2 fiscal periods ahead, real estate rental income is expected to decrease at existing properties and internal growth is expected to be negative. In terms of cost, we have factored in an increase in utility costs for about JPY 400 per unit. Currently, we pass on approximately 70% of the cost to tenants for their exclusive space use but we have begun negotiations for further pass-on of costs. On the other hand, the real estate trading market continues to be active and we intend to utilize the JPY 1.8 billion gain from the sale of the Shin-Kawasaki Mitsui Building in the next fiscal period. The distribution amount is scheduled to be JPY 11,500 for both the period ending June 30, 2023, and the period ending December 31, 2023, as the minimum distribution amount will be maintained by utilizing the gain from the sale and return earnings. Please refer to the illustration on Page 22 for a breakdown of changes in distributions. Next, please see Page 23. 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 dispositions. Since the gain on the disposition is also recorded in the fiscal period ending December 31, 2022, the balance of the retained earnings is expected to be approximately JPY 13.9 billion. NBF will continue to replace assets to improve the quality of the portfolio while at the same time, we intend to realize unrealized profits and return them to our unitholders. In this forecast, the EPU on a real estate rental basis, excluding gains on disposition is about JPY 10,000. The rental market is currently pressured by large supply and secondary vacancies as well as rising electricity costs. But on the other hand, the sales market remains strong, and we intend to maintain the DPU of JPY 11,500 for the time being, when gains on disposition can be recognized. Accordingly, we have set our forecast for the 2 fiscal periods ending June 30, 2023, and December 31, 2023, at JPY 11,500 as a lower limit. As explained earlier on the management policy page, our policy is to incorporate NBF's strength into strategy and manage the properties to bring it to above the level of DPU JPY 11,500 while expanding rental income by improving occupancy rates and utilizing gains on dispositions and retained earnings. Finally, I would like to explain NBF's ESG initiatives. If you would jump to Page 41, it contains highlights of our efforts during the current fiscal period. During the period under review, we published a scenario analysis recommended in the TCFD. As for the progress of other KPIs, we expect to be able to disclose the results for 2022 in the next investor presentation material after receiving a confirmation process of the third-party guarantee. Finally, the current forecast incorporates post-COVID office usage conservatively. We will continue to factor in rising interest rates, yet we recognize that real estate rental income will improve once other factors subside. As for NBF, we will focus on maintaining and increasing occupancy rates as a priority until the business's strong financial results transform into active expansion and relocation directives. The difficult business environment will continue for some time, but as we have reported, we are confident that the strength of NBF portfolio will be sufficient to cope with both temporary disruptions and long-term market changes. NBF intends to meet the expectations of unitholders by utilizing all available resources. That would be all for my explanation. Thank you very much for your time.