Nippon Prologis REIT, Inc. (3283) Earnings Call Transcript & Summary

Welcome to the Earnings Presentation for Nippon Prologis REIT's May 2025 fiscal period. Since inception, we have strived to maximize unitholder value while demonstrating excellent operation and financial performances, including this fiscal period. For this fiscal period, the following highlights our performances and strategies. First, with the robust internal growth, we continue to demonstrate strong results and DPU growth, outpacing Japan's ongoing inflation environment. Second, we achieved stabilized DPU growth, exceeding the pathway of 3% annual growth target, which we established 6 months ago. Third, we conducted a unit buyback, which contributed to the improvement of our capital efficiency and the higher investment returns. Fourth, we carried out strategic asset reshuffling, resulting in capital gains over five fiscal periods that elevates our DPU growth. Fifth, we have restated our internal growth and financial strategies, leveraging our robust portfolio. Let us start with the financial performances. For this fiscal period compared to our original forecast, our DPU has significantly grown by 13.6%. Our NOI has also exceeded the forecast. One of the reasons is our steady and continued internal growth, represented by the strong average occupancy rate and the average rent growth. Our leasing activities demonstrated tremendous outperformance during the period. The average occupancy for the May 2025 fiscal period was very high at 98.9%, significantly exceeding our forecast. As for both the November 2025 and May 2026 fiscal periods, we expect continued high occupancy rates of 98.4%. Our rents have continued to grow as well. For this period, we achieved a weighted average rent growth of 3.8% for all lease renewals and re-leasing, consistent with the previous fiscal period. At several properties, especially those in Tokyo Bay Area and across a broad range of submarkets, we achieved high rent growth at around 10%. The tenant retention ratio was also significantly high at 94%, and we achieved rent growth for all the new lease contracts. Going forward, we expect further rent growth backed by robust customer demand for our high-quality portfolio. This page illustrates the NOI results for this fiscal period. Our NOI was strong at JPY 24.6 billion, significantly increased from our original forecast by 5.3%, mainly due to the higher occupancy of existing properties, the acquisition of Prologis Park Yachiyo 1, and the positive impact from the accretive asset reshuffling. For the upcoming next 12 months, we anticipate our NOI to remain solid and stable while assuming occupancy rates of 98.4%. There will be some temporary factors such as seasonal fluctuation of net utility income and higher leasing commissions for May 2026 fiscal period, but the impact from them will be minor. Our DPU for this fiscal period was remarkably strong at JPY 1,937, significantly exceeding our original forecast by 13.6%. This was driven by the sum of multiple factors arising from our initiatives, NOI growth of existing properties, the accretive new acquisition, significant capital gains from the asset reshuffling and the effective unit buyback. As for the November 2025 and May 2026 fiscal periods, our DPU is anticipated to be stable, reflecting the expected solid portfolio operations. Please note that we are strongly committed to provide our unitholders with stable distribution returns, offsetting seasonal volatility of our portfolio operations. Let's move on to the progress on our growth target. Six months ago, we clarified a midterm target of 3% annual growth of our stabilized DPU, taking advantage of the strong competitive advantages of our portfolio and attempting to outpace Japan's inflationary environment. In the first fiscal period, we achieved the result well above the pathway of this target. To reach the stabilized DPU of JPY 1,900 by the November 2027 fiscal period, we identified the needed factors over the next 5 periods as follows: number one, more than 3% DPU growth through internal growth, while it may be offset by 2.5% to 3% debt cost increase; number two, 1.5% to 2% growth by use of surplus cash, which would be applicable to additional unit buybacks; and number three, 3.5% to 4% growth by increasing our payout ratio. Additionally, we would be able to add more growth if we conduct accretive external growth, and/or further asset reshuffling during the 5 fiscal periods. On this page, we have summarized the three pillars of our growth strategies: internal growth, financial strategies, and external growth, in light of the current business environment. First, internal growth. We maintain and further improve the high occupancy rate, and we will strive to accelerate strong rent growth. Also, we aim to continue to make our entire portfolio more resilient against inflation. Second, we continue to maximize our equity return by conducting unit buybacks and increasing the payout ratio. Third, as a result of successfully conducted accretive asset reshuffling, our DPU will be elevated by capital gains from the disposition allocated over the five fiscal periods. From February to May this year, we conducted our first unit buyback. We have purchased JPY 10 billion units that is equivalent to 1.5% of our market cap at an average implied cap rate of 4.8%, which significantly exceeds today's market cap rates. This buyback has promoted the continued growth of our stabilized DPU. Under the current environment surrounding J-REIT, comparing the implied cap rates and acquisition cap rates, the subject buyback was one of the most efficient uses of our surplus cash. For future buybacks, we aim to make each size more than 1% of our market cap. Given our current cash position, we have decided not to announce another additional buyback this time. Let us now explain our recent accretive asset reshuffling that further enhances our unitholder value. We have conducted our first asset swap this fiscal period. The new acquisition property, Prologis Park Ichikawa 2, is a high-spec multi-tenant logistics facility located very close to CBD Tokyo that has significant long-term growth potential. In exchange, we have decided to dispose two properties with relatively lower growth potential in our portfolio. As a result of this asset swap, we acquire a new property that has a larger rent gap and significant future economic upside. This deal results in net growth of our gross NOI, further increased net of depreciation, NOI and higher portfolio quality. The NOI yield of Prologis Park Ichikawa 2 is expected to further increase to 4.1% within a year, driven by expected rent growth. This asset swap will be conducted over the five fiscal periods, delivering additional distributions to investors in the amount of approximately JPY 1 billion per fiscal period, significantly elevating our DPU. We would like to emphasize our strategies to build a stronger, more diversified portfolio with higher long-term growth potential. When we identify properties with low rent growth potential, risks of future cost increases and tenant or geographic concentration, we will seriously consider dispositions. With the significant JPY 1 trillion size of our portfolio, we now have greater flexibility to consider future portfolio restructuring. Our portfolio has significant unrealized gains, roughly 40% of its book value. This means that monetization of a property will enable us to return significant capital gains to investors. Then we will reallocate sales proceeds to both future reinvestments and investor distributions to maximize our unitholder value. Since our IPO, we have conducted asset dispositions in the total amount of JPY 49 billion, equivalent to a 0.5% average turnover per year. Considering the property ages and holding periods of our portfolio, we believe that above 1% annual turnover would be ideal to maintain competitiveness of our robust portfolio. This page illustrates the current status of our internal growth environment and initiatives. As shown in the chart on the left, we have significantly improved the structure of our leases to be prepared for the inflation, which would align the pace of our rent growth with potential inflation rates. We are also introducing automatic CPI-linked rent revision clauses into new long-term leases. It is our intent to make the entire portfolio further resilient against future inflation. As for our portfolio, the average market rent has grown by 1.2% per year over the last 5 years, even when the vacancy rate in the Tokyo metropolitan market remained high. It represents the strong competitiveness of our portfolio. Our operating expense structure is also resilient against inflation. Utility expenses are mostly reimbursed by our customers. The pace of property tax increase is modest and the property management fee rate is fixed. In total, 75% of the operating expenses are insulated from the effect of inflation. We now turn to theoretical future rent growth potential from the perspective of rising construction costs. Due to structurally higher labor and material costs, construction costs have dramatically increased over the last several years. Logistics real estate is particularly impacted because its replacement costs have a higher percentage of construction costs. This has resulted in a significant decline in new construction starts in the market. As new supply declines, we believe that market conditions will tighten, reducing vacancy and accelerating market rent growth. In our portfolio, there is 3% to 4% rent gap between in-place and market rents. If our portfolio were to be rebuilt today at the current land and construction costs, new rents would need to be about 20% higher than our in-place rents. Given the continuing strong demand from logistics space users, we expect market rents to increase further over time to justify the current replacement cost. We now explain our current financial strategies to improve capital efficiency. We plan to gradually raise the AFFO payout ratio from the current 80% to 85%, which will generate stabilized DPU accretion by 3.5% to 4%. For the purpose of our leverage management, we have decided to adopt appraisal-based LTV. If we find attractive investment opportunities, we are prepared to raise appraisal-based LTV up to around 35%, which would provide us with significant dry powder to grow. Needless to say, we will strongly focus on our implied cap rate for future acquisitions. Regarding our debt cost, we intend to manage it by carefully balancing debt durations, leveraging our high proportion of fixed rate debt and long maturities. Our capital structure is one of the strongest in the J-REIT community. We will maintain a conservative LTV below 30% on an appraisal basis. This allows us to retain significant growth potential and optionality of future financial strategies. If we were to increase the leverage to 35%, our additional investment capacity would be about JPY 110 billion. On the right bottom, we are showing our latest debt financing status and forecasts. Over the past year, we financed JPY 64 billion at an average debt cost of 130 basis points, keeping our overall borrowing costs low at 84 basis points. We are scheduled to refinance JPY 30 billion over the next year, but the expected increase in our overall debt cost would be marginal. A 10 basis points change in new funding costs is expected to have less than 10 basis points change in DPU. We will take various measures to mitigate debt cost increases while closely monitoring interest rate trends. Let us briefly explain our recent investment unit split and our Investor Relation activities. We have conducted a 3:1 unit split effective at the beginning of this June. We believe the split will broaden our Japanese individual investor base and will further increase the liquidity of our investment units. Also, we have redesigned the layout of our asset management reports to make it more comprehensive for individual investors. The number of investor meeting requests is increasing, especially from U.S. and European institutional investors. Our close ties with such global investors is one of our prominent strengths. Now let us provide an overview of the current logistics real estate market in Japan. Demand for high-quality modern logistics facilities has grown by 14% on average per year over the past decade and is currently remaining at high levels. On the other hand, the recent vacancy rate in the Greater Tokyo market is 11.1% as a result of the significant supply peak in 2023. Going forward, we anticipate that the market conditions will gradually improve. The supply in 2025 is expected to decrease by 50% compared to 2023. We believe that the pace of expected completions in 2026 and beyond will end up being slow despite the current forecast since the number of development starts is shrinking dramatically. Therefore, we expect that the overall vacancy rate will decline and market conditions will significantly improve in coming years. In addition, the current vacancy is concentrated in certain newly supplied large-scale inferior quality properties in terms of locations or building specs and the demand for existing properties, including our portfolio assets remains strong, which is witnessed through our stable occupancy rates. As for the Greater Osaka market, the overall vacancy rate is tight at 3.8%. Properties older than 1 year are showing even lower vacancy rate of 2.5%. The expected completions in 2025 will be relatively large, but over 70% of new supply has already been pre-leased. Thus, the market rent growth is accelerated, reflecting such healthy supply-demand balance for the Osaka market. Rising construction costs are slowing down the amount of new supply of logistics properties. We have observed a significant slowdown in the development starts of logistics properties since the second half of 2023. Accordingly, the future supply is expected to decline significantly. The demand is expected to remain strong, driven by ongoing supply chain reconfigurations and the growth of e-commerce in Japan. We aim to effectively capture the upside from the anticipated improvements of market conditions, including our belief that market rents will converge with replacement cost rents and to realize internal growth through these opportunities and strategic initiatives. Let us remind you of the attractiveness of J-REITs and NPR. J-REITs offer attractive yield spreads. Most logistics properties in Japan are for domestic consumption purposes and thereby insulated from U.S.-driven tariff risks. Supply will decline while demand remains strong. We are committed to achieve our DPU growth target to maximize investor value by leveraging our high-quality portfolio, Prologis' strong sponsor support and sustainable financial strategies. We greatly appreciate your continued support.