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'm pleased to report our financial results for the fiscal period ended December 31, 2023. On the financial highlights. Please refer to Page 3 of the investor deck, showing highlights of the current period financial results. During the period under review, we completed the exchange of Yodoyabashi Flex Tower and NBF Ueno building and the disposition of NBF Shibakouen building. The average occupancy rate during the period steadily improved from 97.0% in the previous period to 97.4%. The financial figures show an increase in both revenue and income due to an increase in occupancy rates and a decrease in utilities and other costs, which I will explain in detail later. The most important point that I would like to emphasize is the increase in our average occupancy rate. I have expressed in the past that the occupancy rate had recovered to the 97% level and that we would work to further maintain and improve the occupancy rate. The average occupancy rate for the period under review improved significantly to 97.4% by our efforts. In addition, we are now in a situation where we can expect the occupancy rate to remain in the high 97% range in our forecast assumptions. The distribution per unit is JPY 11,500, in line with the earnings forecast announced August last year. The distribution amount is scheduled to be JPY 12,500 for the next fiscal period ending June 30, 2024, and JPY 12,000 for the fiscal period ending December 31, 2024. 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 December 31, 2023. From the previous period, operating revenue for the period was JPY 47.3 billion, an increase of JPY 0.3 billion. Operating income was JPY 20.7 billion, an increase of JPY 0.1 billion. Net income was JPY 19.5 billion, an increase of JPY 0.1 billion from the previous period. NBF also booked a reversal of JPY 48 million 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 318 million increase in operating revenues. Real estate rental revenues, which are the basis for the abovementioned revenue, increased by JPY 230 million. As for the breakdown, while revenues from the existing properties decreased by JPY 205 million, real estate rental revenues increased by JPY 436 million due to the asset replacement costs conducted last year. Other rental revenues increased by JPY 255 million, but this was due to cancellation fees and an increase in utility revenues from seasonal factors. In addition, profits from dispositions of JPY 1.7 billion decreased by JPY 0.1 billion from the previous fiscal period. The next factor behind the increase in operating expenses of JPY 192 million is as follows. The larger increase was in building management and repair expenses due to acquisitions, and utility expenses peaked in the previous period and have been on a downward trend. But there were some properties under condominium ownership where utility expenses were included in building management expenses. As a result, operating income increased by JPY 126 million from the previous period. The breakdown is in the existing properties where rental income decreased, but the decrease in utilities and asset replacement effect resulted in an increase from the previous period. Due to gains from dispositions in both the previous and current periods, the financial results may be slightly confusing. In total, however, decreases in income from existing properties were supplemented by replacing properties. 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, 2023, decreased JPY 0.3 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 an JPY 8.9 billion increase by the disposition in November 2023. Fixed assets decreased by JPY 9.1 billion due to capital expenditures of JPY 4.8 billion on the acquisition of 2 properties and the disposition of 2 property and depreciation of JPY 7.9 billion. In liabilities, interest-bearing debt decreased by JPY 2.0 billion. In net assets, retained earnings decreased by JPY 0.2 billion. As a result, interest-bearing debt decreased, and reversal of cash increased by the disposition in exchange. I will now explain NBF's management policy. Please see Page 11. The fundamental policy will remain unchanged with a focus on stable growth of distributions per unit. On the other hand, in 2024, with major changes in the real estate and financial market expected, we will carefully execute flexible internal and external growth measures to achieve further stability and expansion of NBF through qualitative and quantitative enhancement, 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, after shift of the new coronavirus to Category 5, there has been a back-to-the-office movement as evidenced by the high rate of attendance by Japanese companies, and tenant demand for high-spec offices remain firm due to location improvements and new employment. The market vacancy rate improved despite the concerns about the impact of large supply in Central Tokyo in 2023. On the other hand, it is true that there are clear winners and losers in some price ranges and areas. Although increase in rents will be our focus for the future, we will need to keep a close eye on the market because of another wave of supply expected in 2025. In such an environment, NBF's strategy was to prioritize occupancy rate to better position itself for the future. We were able to increase the average occupancy rate to 97.4% and set the occupancy rate in the upper 97% range in the current forecast as a result of our leasing strategy. Our goal is to improve upon the unit rent going forward. Next, in terms of external growth, the office transaction market has remained strong. Although the interest rates have risen due to changes on the 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 terms of the market environment, the YCC correction and the lifting of negative interest rate policy are no doubt headwinds for J-REITs. However, NBF intends to respond to this situation by being flexible on debt financing, such as the use of long-term floating rate loans and adjustment of financing periods. Finally, we have a policy for the use of retained earnings and gains on dispositions. In the current period, there was also a gain from the disposition of properties due to its replacement, and the DPU was set at JPY 11,500 in line with the earnings forecast. Due to the large amount of profit on disposition for the periods ending June 30 and December 31, 2024, the DPU forecasts were set at JPY 12,500 and JPY 12,000, respectively. I will now explain each growth strategy. Please refer to Page 12 for information on external growth. This page provides an explanation of the effect of portfolio placements announced from 2023 onwards. On the announcement basis, a total of JPY 177.9 billion is expected to be replaced with JPY 100.7 billion for the 4 properties acquired and JPY 77.2 billion for the 5 properties transferred. As a result, AUM will increase by JPY 32 billion, and a gain of JPY 11 billion will be recorded from the disposition. In terms of profitability, the NOI will increase by JPY 1.4 billion, and the NOI yield will also improve. The average age of the 5 disposed property is 20.2 years, while the average age of the 4 acquired properties is 6.6 years, significantly improving the quality of the portfolio. Please refer to Page 13. This page lists the main properties among the replacements. Please see the right-hand side. This is an exchange transaction between older Yodoyabashi Flex Tower and NBF Ueno building, which was conducted last November. The transaction was reached due to NBF's interest, which aims to build a highly competitive and diversified portfolio in primate areas in each city, and that of the counterparty, which prefers Tokyo area properties having met. NBF also expects a profit from disposition of NBF Shibakouen building in the current building. Therefore, the transaction was decided to be an exchange in this case. The book value of the Yodoyabashi Flex Tower was reduced by utilizing the profit on disposition of the NBF Ueno building, resulting in an acquisition with a yield of 4.9%. On the left is the Toyosu Bayside Cross Tower. This is the third time NBF acquires a portion of this building. This time, the acquisition will be a combination of office space and retail of the LaLaport shopping mall. The total interest will be 47.69%. The lower part shows the disposed property. As for Gran Tokyo South Tower, the building was acquired in 2021, but due to tenant turnover and the impact of COVID, both occupancy rates and NOI yields have remained stagnant. Due to this current state, we have decided to sell the property as the sales proceeds from this disposition along with replacement of properties aforementioned will contribute to a higher unitholder value than continuing to hold on to Gran Tokyo South. We have elected to dispose of NBF Shibakouen building, factoring in the future potential of this property against the profits that can be enjoyed today. In addition, we have scheduled the disposition of Tsukuba Mitsui building in the period ending December 31, 2024, taking into account future capital expenditures against the profits that can be recorded now despite the current high-yielding returns. The transactional market remains very competitive. Thus, replacing assets will continue to be our external growth policy to improve our quality of portfolio. On Page 15, I would like to explain internal growth. Refer to the graphs on Page 15 for the average occupancy rate and move-in and 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 moved in or out during each 6 months period against the entire portfolio. Please see the bar first. This section explains the status of move-ins and move-outs. The move-out rate for the period under review was 3.4%. The moving-in rate was 3.4% as well. The benefit of a full year of occupancy by tenants who moved into the building during the previous period contributed to an average occupancy rate of 97.4%. For the period under review, positive trends have continued due to the back-to-the-office movement and the desire to improve office locations and also increased hiring activities after COVID has been classified as a lesser threat. Although there were concerns about the impact of the large supply in 2023, the market vacancy has improved, partly due to strong corporate performance and NBF's occupancy rate is in the 97% range cruising level. Although we remain cautious on the potential impact from large supply of offices in 2025, NBF's portfolio should be able to maintain occupancy in the high 97% range until the 2 periods ahead. 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 period, and the bar graph breaks it down into 2 components. The green bar shows the impact of tenant replacement. The replacement impact in the current period led to slightly reduced yields to tenant move-outs, but it is expected to return positive in the next 2 periods from a significant increase in revenue from new tenants. The blue bar graph shows changes in earnings due to rent revisions by tenants who continue to occupy the property. Rent revisions are expected to be negative in terms of revenue, partly due to efforts to retain large-scale tenants at a time when they were concerned about the large supply in 2023. Conversely, the number of tenants who have agreed to increase their rent are on the rise, contributing to the trend on reducing the total negative ranges. 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 high 97% range. We expect rental income from existing properties to turn positive as the market improves. 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 left corner, the LTV ratio at the end of this period was 42.8%, and long-term fixed interest rate ratio was 90.5%. The average funding rate was 0.4%, and the average remaining period on debt was 5.2 years, indicating that the company continues to maintain conservative financial management. Below that, the total debt capacity is approximately JPY 83 billion. The balance of interest-bearing debt for the period under review is JPY 592.5 billion, of which JPY 63 billion is classified as green financing. As explained in the previous period, NBF's debt financing policy is to diversify repayment deadlines so that they are not concentrated at one time, as shown in the graph on the maturity ladder. At the same time, the policy is to use long-term floating rate borrowing and adjust the procurement period to reduce the interest payments. Next, on Page 18, 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 1.8 billion to JPY 345.1 billion. The status of each property is shown in the table below left, with cap rates declining for 41 properties and maintaining status quo for 28 properties, resulting in overall decline in cap rates. The appraisal value itself decreased on 13 properties, but this was due to increases on estimated costs such as property tax and utilities. The next page, 21, explains the forecast. The dark red box is the forecast for the fiscal period ending June 30, 2024, and the orange box on the right is the forecast for the fiscal period ending December 31, 2024. For the period ending June 30, 2024, operating revenue is JPY 50.1 billion. Operating income is JPY 23.7 billion, and net income is JPY 22.3 billion. Despite a decrease in real estate rental income, an increase of JPY 3.3 billion in a profit from disposition is expected to result in an increase in both revenue and profit. 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 deficits in the period under review. Property taxes and building management costs are expected to rise, but repair costs are expected to be reduced. Next, for the fiscal period ending December 31, 2024, operating revenue is expected to be JPY 50.4 billion. Operating income is JPY 23.5 billion, and net income is JPY 22.0 billion. In the 2 periods ahead, revenues are higher than the next period due to the expected gain on the sale of the Tsukuba Mitsui building and positive property rental income, but net income will be lower due to the absence of profit from dispositions in the next period. Although an increase in the occupancy rate, realization of rent from new leases, profits from disposition and increase or decrease in costs may occur. And we will confirm the DPU, including return on profit on disposition of JPY 12,500 in the fiscal period ending June 30, 2024, and JPY 12,000 in the fiscal period ending December 31, 2024. Please refer to the illustration on Page 22 for a breakdown of changes. Next, please see Page 23. The left-hand side shows the balance of retained earnings, which is expected to be JPY 16.4 billion due to the profit from disposition of the Tsukuba Mitsui building in the period ending December 31, 2024. For contingency purposes, we anticipate a fixed reserve amount of approximately JPY 7 billion, which is around 0.5% of total assets, to cover potential events such as disasters or the departure of major tenants. Any accumulated amount exceeding the fixed reserve will be considered based on factors such as rental income from real estate, cost conditions and expected gains from future transfer, with the aim of achieving stable growth in DPU. The graph on the right represents the breakdown of DPU. NBF aims to increase the distribution based on rental income, which corresponds to the orange portion. Additionally, we plan to utilize retained earnings and gains from transfer to achieve stable growth in DPU. We also intend to achieve stable growth in DPU by utilizing retained earnings and profit on disposition. I would like to emphasize again that due to the large amount of profit on disposition for the periods ending June 30 and December 31, 2024, the DPU forecast were set at JPY 12,500 and JPY 12,000, respectively. Finally, I would like to explain NBF's ESG initiatives. If you move over to Page 40, it contains the highlights of our efforts during the current fiscal period. You can see the progress of the main KPIs on Page 42 and 43. The rate of green building certification on Page 43 shows an achievement of 97.2%. Seen on Page 44, we have also carried out a quantitative evaluation as recommended by TCFD. Details are also available on the website. Finally, from the high percentage of Japanese office workers 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, our baseline has improved to forecast occupancy rate in the high 97% range. In addition, as the office market is on the trend of recovery with rising tenant demand, we intend to improve on our property rental income-based profits in the future through further tenant negotiations upon lease renewals. 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 will be all for my presentation. Thank you very much for your time.