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

Ladies and gentlemen, I'm Eiichiro Onozawa, President and CEO of Nippon Building Fund Management. I am pleased to report our Financial Results for the Fiscal Period ended June 30, 2023. Please refer to Page 3 of the investor deck, showing highlights of the current period financial results. During the period under review, as planned, we additionally acquired Iidabashi Grand Bloom and Toyosu Bayside Cross Tower from our sponsor, Mitsui Fudosan in March, and divested Shin-Kawasaki Mitsui Building in January. The main reason for the decrease of the revenues and incomes in the current period are from temporary factors such as the absence of gains on the sales of properties in the previous period, and an increase in costs due to property taxes on properties acquired in 2022, which I will explain in detail later. The most important point I would like to emphasize is the [ interim target ] average occupancy rate. I have expressed in the past that achieving the target occupancy of 97% as to cruising level and maintaining this rate is a critical milestone to improve NBF's performance. I am delighted to announce that we were able to significantly increase the occupancy level from 95.9% in the previous period to 97%. In addition, we are now in a situation we expect the occupancy rate to remain in the 97% range in our forecast assumption. The distribution per unit is JPY 11,500, in line with the earnings forecast announced in February this year. The distribution amount for the next fiscal period ending December 31, 2023, and June 30, 2024, 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 NBF considers as fundamentally important indicators for improving unitholder value. I will now explain the financial results on Page 6 and beyond. On this page, we have organized the status of asset replacements for each period. Please refer to the investor deck for details as there will be property acquisitions and dispositions 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 period ended June 30, 2023. From previous period, operating revenue for the period was JPY 47.0 billion, a decrease of JPY 0.3 billion. Operating income was JPY 20.6 billion, a decrease of JPY 0.9 billion. Net income was JPY 19.3 billion, a decrease of JPY 0.9 billion from the previous period. NBF also booked a reversal of JPY 0.2 billion in retained earnings and total distributions amounted to JPY 19.5 billion. The distributions per unit will be JPY 11,500. I will now explain the change factors on the right side of the page. First, a breakdown of the JPY 336 million decrease in operating revenues. Real estate rental revenues, which are the basis for the above-mentioned revenue increased by JPY 386 million. The breakdown is JPY 103 million decrease due to asset replacement effects. A property sale occurred in January, which was preceded by acquisitions in March, followed by JPY 489 million increase from the existing properties. Other rental revenues decreased by JPY 410 million, but this was due to the absence of cancellation fees recorded in the previous period and a decrease in the utilities revenues from seasonal factors. In addition, gains on sales of real estate and other assets of JPY 1.8 billion decreased by JPY 0.3 billion from the previous fiscal period. The next factor behind the increase in operating expense of JPY 620 million is as follows: the largest increase is JPY 396 million increase in property taxes. This increase reflects the new properties acquired in 2022 and the revaluation of existing properties. Also included are increases in repair and utility costs. The cost burden for utilities is expected to peak in the current period. As a result, operating income decreased by JPY 0.9 billion from the previous period. The breakdown is in the existing properties where rental income increased significantly, but the increase in utilities, property taxes and the absence of cancellation fees resulted in a negative balance of JPY 0.7 billion. Due to gains from dispositions and the accumulation and reversal of retained earnings occurring in both the previous and current periods, the financial results may be slightly confusing. In total, however, decreases in income from existing properties was supplemented by replacing properties and utilizing the gains from 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 June 30, 2023, increased JPY 17.1 billion from the end of the previous period to JPY 1.38 trillion. First, on the asset section. In cash and cash equivalents, there was a JPY 6.1 billion decrease. Fixed assets increased by JPY 23.4 billion, due to capital expenditures of JPY 5.1 billion on the acquisition of 2 properties, and the disposition of 1 property and the depreciation of JPY 7.8 billion. In liabilities, interest-bearing debt increased by JPY 17 billion. In net assets, undistributed earnings decreased by JPY 0.9 billion. As a result, fixed assets have increased by interest-bearing debt and reversal of cash. I will now explain NBF's Management Policy. Please see Page 11. The fundamental policy will remain unchanged with the focus on stable growth of distributions per unit. On the other hand, amid major changes in the real estate and financial market environments, we will carefully execute flexible internal and external growth measures to achieve further stability and expansion of NBF through qualitative and quantitative improvements paying attention to the financial market. 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. Tenant demand for high-spec office space remains firm, as evidenced by the high percentage of Japanese companies back to the office movement in the post-COVID world, coupled with the desire to improve office locations and the quality of the space to attract new talent, leading to increases in floor space. On the other hand, we are aware that some newly supplied buildings in the high-end range were struggling on leasing due to its distance from transportation hubs, creating a sharp contrast in success between more and less desirable options. In summary, while we remain cautious of the potential negative impact from the amount of new supply, we are also encouraged by the increased demand generated by office users, who aspire to grow stronger in this post-COVID environment. In such an environment, NBF's strategy was to prioritize occupancy rates to better position itself for the future. And pursuing this strategy, we were able to significantly improve the overall occupancy rate above the targeted 97% range for the period. Next, in terms of external growth. The office transaction market has remained strong. Although the interest rates have risen due to changes on YCC policy, we still have not seen any weakening on transactional cap rates. 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 continue to pursue continuous growth, while shifting our focus from internal growth to external growth, including replacement. Next is finance. In the current financing environment, we maintain that equity financing continues to be a feasible means so long as NBF can present the sound growth story. As I will explain later in the financial strategy, long-term interest rates are higher than previous levels and future refinancing will be that of low interest loans and bonds of the past. Therefore, refinancing at the current proportion of long-term fixed interest rates as before, will result in a higher total interest payment costs. We will strive to reduce interest rate payments by adjusting procurement periods on the total interest -- interest-bearing debt of approximately JPY 600 billion by utilizing long-term floating rate loans, while carefully monitoring the diversification of repayment dates. Finally, we have a policy for the use of retained earnings and gains on dispositions. As I will explain more in 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 previously, we would like to set the DPU at JPY 11,500 as a lower limit for the time being to enhance returns to our unitholders, while we can realize unrealized gains on properties. I will now explain each growth strategy. Please refer to Page 12 for information on external growth. As explained at the beginning, we have acquired 2 additional properties. Iidabashi Grand Bloom and Toyosu Bayside Cross Tower at the end of March and completed the sale of Shin-Kawasaki Mitsui Building in January. Also on the bottom right of the page, we plan to divest our interest on the Panasonic Tokyo Shiodome Building next March, recording a gain of approximately JPY 1.9 billion on the sale. The transactional market remains very competitive, thus replacing assets will continue to be our external growth policy to improve our portfolio. 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 the ratio of space tenants that have moved in or out during each 6-month period against 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 1.7%. The move-in rate was 2.9%, contributing to the average occupancy rate of 97.0% during the period. For the period under review, positive signs emerged due to the back to the office movement, the desire to improve office locations and increased hiring activities. The average occupancy rate during the period under review improved significantly from 95.9% in the previous period to 97%, due to the leasing strategy that prioritize occupancy rates as explained 6 months ago. If we can maintain the cruising occupancy rate in the 97% range, we believe that real estate rental income, which will be explained on the next page, will improve in the future. Next, on Page 14, I will explain changes in rental income from existing properties. The yellow line graph shows the percentage of 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. NBF will reduce rents as needed for existing tenants, who may be at contracted levels above market in order to maintain occupancy for the time being. The blue line denotes the negative impact of those rent revisions. On the other hand, the green bars include all factors other than rent revisions, such as the impact of tenant turnover. NBF's portfolio can now expect a cruising occupancy rate in the 97% range. And if the take-up of newly supplied properties progress consistently, we forecast rental income from existing properties to turn positive in the second half of 2024. Please proceed to Page 15. 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 42.9%. The long-term fixed interest rate ratio was 90.6%, and the average funding rate was 0.40%, and the average remaining period on debt was 5.7 years, indicating that the company continues to maintain conservative financial management. The balance of interest-bearing debt for the period under review is JPY 594.5 billion, of which JPY 63.0 billion is classified as green financing. The table on the right shows that long-term borrowings for the period totaled JPY 69.0 billion with an average loan term of 7 years, and an average interest rate of 0.55%. I will explain our future debt financing strategy on this page. NBF aims to mitigate increases on interest payments costs from the potential future increase in funding rates by focusing on 3 key indicators. At present, a 10-year fixed interest rate loan will cost approximately 1%, partly due to the YCC change. On the other hand, the interest rate shown above the bar graph of the diversification of repayment dates, denote the average interest rates for interest-bearing debt due for repayment. Beyond 2024, low interest-bearing debt will become due for repayment, which will lead to an increase in costs, if NBF continues to procure funds at fixed interest rates with a term of about 10 years. NBF will place the highest priority on the diversification of repayment dates of interest-bearing debt totaling JPY 600 billion. Thus, we'll increase the ratio of long-term floating rate loans targeting on a long-term fixed rate ratio from 90% to 80% to mitigate rising interest rate costs. As a result, minimizing the impact of rising average funding costs on interest-bearing debt to the present, 0.4 to 0.5 with diversifying repayment debts will yield in a shortening of the average remaining period of the entire liabilities to approximately 5 years. We intend to limit the risks on debt financing and curve the interest rate paid. 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 1.7 trillion, and unrealized gains increased by JPY 4.2 billion to JPY 343.3 billion. The status of each property is shown in the table below left with cap rates declining for 15 properties and maintaining the status quo for 55 properties, with cap rates mostly remaining flat. The appraisal value itself decreased on 13 properties, but this was due to cash flow adjustments for estimated future construction costs on improvements. The next Page 19 explains the forecast. The dark red box is the forecast for the fiscal period ending December 31, 2023. And the orange box on the right is the forecast for the fiscal period ending June 30, 2024. For the period ending December 31, 2023, operating revenue was JPY 45.4 billion. Operating income was JPY 18.7 billion, and net income was JPY 17.4 billion. Excluding gains on sales of real estate and other assets, we expect revenue and income to remain mostly unchanged in the fiscal period ending December 31, 2023. In the real estate rental revenues in the upper row of the increased, decrease factors on the right, we expect a decrease in revenues from existing properties as explained earlier, but revenues from new acquisitions recording full period operation contributions will cover the existing portion deficits in the period under review. Building management costs are expected to rise, but improvements from reduced utility expenses are duly expected. Next, for the fiscal period ending June 30, 2024. Operating revenue is expected to be JPY 46.8 billion, and operating income is JPY 20.5 billion and net income is JPY 19.1 billion. NBF expects an increase in both sales and income in the next 2 fiscal periods due to the projected gain from the sale of the Panasonic Tokyo Shiodome Building. The forecast for real estate rental revenues remains conservative, as the current forecast does not incorporate the acquisitions of new properties. In addition, the increase in property taxes of the property acquired in the previous period under review and interest rates is also factored in. Although there are some factors that may come affect results such as increase in the occupancy rate, realization of rent from new leases, gains on sale and increase or decrease in onetime costs. We will announce a DPU of JPY 11,500 as the lower limit. Please refer to the illustration on Page 20 for a breakdown of changes. Next, please see Page 21. Consistent with the commensurate statement. We will endeavor to make stable distributions with a minimum DPU of JPY 11,500 as our policy utilizing retained earnings and gains on dispositions. For the period ended June 30, 2023, NBF expects to reverse JPY 0.2 billion of retained earnings, bringing the balance to JPY 13.6 billion. Although this forecast does not factor in the replacement of properties other than the Panasonic Tokyo Shiodome Building, we intend to return profits to unitholders by increasing real estate rental income through the replacement of properties and maintenance improvement of occupancy rates as well as through the realization of unrealized gains. Finally, I would like to explain NBF's ESG initiatives. If you would jump to Page 39, it contains the highlights of our efforts during the current fiscal period. During the period under review, greenhouse gas emissions reduction target has been added to our KPI. In addition, we have obtained an SBT certification. Finally, from the high percentage of Japanese companies coming back to work in the post-COVID world, the need for high-quality office buildings remain firm. Following through on NBF's strategy to increase occupancy rates, we believe we have secured a foundation where we'll be able to increase rents as the market recovers. We were also able to formulate a strategy unique to NBF to deal with the increase in interest costs. We recognize that once the other factors converge, we will be able to improve our real estate rental income base profit or EPU. The challenges in the current business environment is likely to persist for some time, but there are positive signs in the market for us to gradually improve the views on the outlook. As we have reported, we are confident that the strength of NBF's 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. This concludes my explanation. Thank you very much for your time.