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

Welcome to the earnings presentation for Nippon Prologis REIT's fiscal period ended May 2026. Since our inception, we have strived to maximize unitholder value while demonstrating excellent operational and financial performances, including this fiscal period. The following highlights our performances and strategies for this fiscal period. First, our portfolio operations remain strong, and we achieved the highest rent change in our history. We aim to further accelerate rent growth going forward. Second, the market environment supporting this rent growth has improved significantly. The supply-demand balance in the Greater Tokyo and Greater Osaka areas has strengthened meaningfully. Third, we maintain a resilient financial position. This allows us to control debt costs more flexibly and more effectively than our peers in this rising interest rate environment. Fourth, we continue to make steady progress toward our 3% annual stabilized DPU growth target. Let us start with the summary of this fiscal period. Our DPU exceeded our forecast by 40 basis points with continued internal growth driven by high occupancy rate and the strongest rent change since our inception. Our portfolio appraisal value continued to appreciate, and our appraisal-based LTV remained conservative at below 29%. Our leasing activities continued to demonstrate strong performance during the period. The average occupancy for this fiscal period was 98.0%, largely in line with our forecast. For the next 2 fiscal periods, we currently assume high average occupancy rates of 98.4% and 98.6%, respectively, reflecting increasing demand and the competitiveness of our portfolio. Our rents have continued to grow faster. We achieved a 7.0% average rent change for lease renewals and re-leasing for this fiscal period, marking the highest level since our inception. We believe this fiscal period demonstrated that the pace of rent growth has been elevated, supported by the improvement in supply-demand balance. More importantly, our asset management team and leasing team promptly capitalized on this opportunity and achieved this outstanding result through various efforts. These strong rent increases were achieved at large-sized floor space, and therefore, it will substantially contribute to our future revenue growth. Among all lease negotiations, we continue to have no downward rent change and for 94% of the expiring space, we achieved upward rent revisions this fiscal period. Looking forward, leasing for the November 2026 fiscal period is already proceeding well with more than 95% of expiring space already executed or effectively agreed. For the full year 2026, we aim to achieve average rent change exceeding 6%, while some of the leases expiring in the second half of the year have smaller rent gaps due to shorter durations. With the improving rent growth momentum, we are taking a more proactive approach to rent negotiations with tenants to pursue further upside. Driven by a sharp decline in new supply and steady demand, we are seeing stronger momentum for market rent growth. We believe our competitive portfolio continues to demonstrate strong and resilient internal growth, underscoring its differentiation from the broader market. This page illustrates our NOI results and forecasts. Our NOI for this fiscal period was strong at JPY 24.3 billion, in line with our forecast. The average occupancy was slightly below our forecast and leasing commissions were higher due to earlier-than-expected progress in several leases. However, these were offset by the continued rent change, improved utility expense recovery and continued effective operating expense control. For the next 2 fiscal periods, we expect our revenue will continue to grow, supported by higher occupancy and strong rent increases. On the expense side, the amount of utility recovery and leasing commissions may fluctuate, but overall expenses are expected to remain stable. As a result, we expect NOI to grow by 1.2% and 0.2%, respectively. During this fiscal period, some repair and maintenance work was delayed due to the supply constraint caused by the conflict in the Middle East. However, we believe repair and maintenance costs will remain well controlled going forward. Next, let us explain the status of our DPU. Our DPU for this fiscal period was JPY 1,928, exceeding our forecast by 40 basis points. This was supported by the stable portfolio performance and strategic cash management in a rising interest rate environment, which helped offset higher debt costs. Looking ahead, for the next 2 fiscal periods, we expect DPU to continue growing steadily to JPY 1,938 and JPY 1,940, respectively, as a result of continued internal growth, effective control of debt costs and further optimization of the payout ratio. We are strongly committed to generating stable distribution returns to our unitholders. Let's move on to the operating environment and our growth strategies. This slide summarizes our continued growth strategies. First, internal growth remains our highest priority, focusing on absorption of impact from higher debt costs through strong rent growth. We will maintain and further improve our high occupancy rate above 98% and pursue further rent growth by capturing the improving supply-demand balance in both the Greater Tokyo and Greater Osaka. We also continue to accelerate the introduction of CPI-linked rent clauses to enhance our resilience against inflation. Second, we continue to emphasize capital efficiency and view unit buybacks as an efficient use of capital. We closely monitor market conditions and continue to consider them when appropriate. We will also continue to optimize the payout ratio and control our cost of debt through flexible financing strategies. Third, in addition to ongoing asset reshuffling and the distribution of capital gains, we will likely continue to execute additional asset reshuffling and disposals to maintain the high quality of our portfolio. Let us discuss the current logistics real estate market environment in Japan. Now we believe that the soft supply-demand environment is over, and we have entered into a phase of rent growth acceleration. In the Greater Tokyo, the supply peaked in 2023 and continued to decline significantly. The supply in 2025 was roughly half of the peak level and is expected to remain at a similar level in 2026. At the same time, new demand in the first quarter of 2026 reached the highest level in the past 3 years. This is a clear improvement compared with the status 6 months ago. We are observing strong demand driven by 3PL and e-commerce companies, as well as earlier leasing activity in anticipation of future lower supply. As a result, the overall vacancy rate was 9.2% at the end of March 2026. Looking forward, the new supply is expected to average roughly 1.5 million square meters per year. We expect that the demand will exceed new supply and overall vacancy rates should continue to decline. Turning to the Greater Osaka. The supply-demand balance remains very tight. Overall vacancy rate has become further lower at 2.2% and the vacancy rate for properties older than 1 year is only at 1.5%. We view this as an ideal environment for further rent growth because supply over the next 2 years is expected to remain very limited. 1/3 of our portfolio is located in Greater Osaka, and this exposure will continue to drive our internal growth. Construction costs have increased significantly, and there are no signs of decline. Accordingly, development starts continue to decrease. Under the current combination of construction costs and market rents, it is highly challenging to economically justify large-scale new developments and future supply is unlikely to increase until substantial acceleration of market rents is achieved. This page provides useful data on the improvement in the market outlook. The left charts show the expectations of vacancy rates in the Greater Tokyo and Greater Osaka estimated by CBRE comparing with the outlook from about a year ago. Supported by the strong demand and a significant decline in new supply, the latest vacancy forecasts demonstrate significant improvement compared with that of a year ago. By the end of 2027, the vacancy rate is forecast to decline to about 6% in the Greater Tokyo and is forecast to remain in a 1% range in the Greater Osaka. The right chart shows the results of applying CBRE's market rent growth data to our portfolio. As shown, the market rents increased moderately by 0.8% per year over the past 5 years. Going forward, market rent growth is expected to exceed 2% per year. Backed by these market improvements, we believe that our competitive portfolio will achieve rent growth ahead of market trends. Supported by the market improvement, our rent gap against the market has widened to the range from 4% to 5%. Furthermore, if our portfolio were to be rebuilt today with the current elevated replacement costs, the required replacement rent should be 20% higher than the current in-place rents. We believe this wide gap will continue to support upward momentum in market rents and our in-place rents over time. We have summarized our portfolio composition by submarket, along with our portfolio vacancy rates and our achieved rent changes compared with the market vacancy rates as of this fiscal period. Approximately 1/3 of our portfolio is located in the Greater Osaka area, where supply-demand conditions are the tightest among Japan's major logistics markets. This continues to enable us to deliver stronger rent growth than our peers. Also, even in the Ken-O Expressway area, where market vacancy remains relatively high, our properties continue to maintain low vacancy and achieve solid rent change. Market vacancy has also improved across all submarkets compared with that of 6 months ago. We believe this confirms the improvement of broader market environment. We have continued to strengthen the inflation resilience of our portfolio by introducing CPI-linked clauses and generally shortening lease terms. Starting this year, we are introducing automatic CPI-linked or step-up rent revision clauses in all new leases longer than 3 years. For customers who are yet unwilling to accept these structures, we have strategically guided them toward lease terms shorter than 3 years. As shown in the left chart, about 50% of the leases executed in this fiscal period had lease terms of 3 years or less. For almost all leases longer than 3 years, we introduced either automatic CPI-linked rent clauses or step-up rent clauses. The right chart shows our current lease portfolio. Leases with remaining terms of 3 years or less now account for about 50% of the portfolio. This gives us a strong foundation to catch up with market rents more quickly. Going forward, we will continue to accelerate the adoption of CPI-linked rent clauses and shorten lease terms. By increasing the frequency of rent revisions, we aim to translate faster market rent growth into our stronger internal growth. This slide highlights examples of our recent strategic leasing initiatives. As shown on the left, an existing customer decided to vacate the space in the Greater Osaka area. However, by capitalizing on the tight market in the area and the competitiveness of the property, our in-house leasing and property management team secured a new customer with no downtime. As a result, we achieved a strong rent change of 9.1% with CPI-linked rent review clauses. The new customer selected the property as a new hub of their same-day delivery services, citing its excellent location and design to allow single floor operations. In the second example, in the Ken-O Expressway area, one of the key customers had an intent to expand their space, but the property was fully occupied. Without a timely solution, this could have caused a future vacancy risk, but we identified another customer within the same property who was considering returning some space and successfully matched both the customers' needs at the right time. As a result, we avoided future downtime and achieved a solid rent change of 4.5%. In both cases, we maintained high occupancy and achieved strong rent growth by demonstrating strategic and tactical asset management capabilities in complex leasing situations. Next, let us discuss our financial management. We will continue to control our debt costs effectively by leveraging our strong financial position relative to other J-REITs. As shown on the left chart, we have significant advantages in both fixed rate debt ratio of 93.2% and average remaining debt term of 4.1 years, which are significantly higher and longer than average as of this fiscal period. We believe this provides us with meaningful flexibility to manage the impact of rising interest rates. On the right side, we show our latest debt financing status and forecasts. Over the past year, we refinanced JPY 29.9 billion debt at an average debt cost of 1.5% with an average debt term of 4.4 years, incorporating some floating rate borrowings. As a result, while maintaining a high fixed rate debt ratio above 90%, our overall average borrowing cost remained low at only 0.92% as of this fiscal period. Over the next 12 months, we expect to refinance JPY 49 billion at an average debt cost of 2.1% with an average debt term of about 5 years. Based on these assumptions, we expect to maintain a conservative fixed rate debt ratio of 88% and manage our average all-in debt cost at 1.1% as of May 2027. These assumptions include further policy rate increases by BOJ, and we will continue to pursue the optimal debt term and the most efficient fixed to floating mixture for each refinancing. Let us briefly summarize our unchanged financial strategies. We will continue to maintain a disciplined approach to acquisitions with a strong focus on the implied cap rate. We will consider utilizing leverage only when attractive and accretive acquisition opportunities arise, and its upper limit is around 35% of appraisal LTV. In terms of capital efficiency, we will continue to optimize our AFFO payout ratio toward the 85% levels and consider additional upward adjustments to further enhance capital efficiency. For capital allocation, we will continue to pursue the most effective uses, including unit buybacks when appropriate. We will also continue to manage excess cash through higher interest income on bank deposits and other cash investment instruments. Let us move on to our road map towards a stabilized DPU growth target and key takeaways. We have continued to improve the profitability of our portfolio. By maintaining high occupancy and achieving consistent rent growth over time, our same-store NOI has grown consistently. Over the past 3 years, the total growth rate was approximately 3%. While the stabilized DPU growth remains as our key management target, on this slide, we are showing the growth rate of FFO per unit as a more comparable metric across all J-REITs. As you see, we have achieved a 3-year CAGR of 2.8% in FFO per unit, significantly outperforming the 0.5% average growth of logistics J-REIT peers. This outperformance reflects the strength of our execution, steadfast internal growth, disciplined capital allocation and prudent financial management. With the improving logistics market fundamentals and the expected acceleration of rent growth, we believe we are well positioned to continue growing same-store NOI, stabilized DPU and FFO per unit. 18 months ago, we set a medium-term target to grow stabilized DPU by 3% per year. We are now at the halfway point of the 3-year road map. Since when we announced this target, Japanese interest rates have risen faster than we originally expected. Even so, we remain on track toward our target. This slide breaks down the annualized contribution from each key initiative as we work towards stabilized DPU of JPY 1,900 by the November 2027 fiscal period. For internal growth, we have raised our target from 6 months ago, reflecting the stronger rent growth trend. We now expect that the internal growth will contribute more than 2% per year. At the same time, through various financing initiatives, we aim to mitigate the debt cost increase to around 2%. We also expect more than 1.5% growth from efficient capital allocation, including the use of cash and asset reshuffling and around 1.5% growth from further optimization of the payout ratio. Achieving this target remains our highest management priority. We continue to take every available strategic initiative to deliver stabilized DPU growth. To conclude, we continue to achieve high occupancy and accelerate rent growth, supported by our high-quality portfolio and the improving fundamentals of the logistics real estate market. At the same time, we will continue to pursue disciplined capital allocation and financial strategies, leveraging our strong balance sheet to mitigate the impact of higher interest rates. We remain fully committed to achieving our target of 3% annual growth in stabilized DPU and maximizing unitholder value over the long term. Thank you very much for your continued support.