Vicinity Centres (VCX) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Vicinity Centres Fiscal Year '22 Interim Results. [Operator Instructions] I would now like to hand the conference over to Mr. Grant Kelley, CEO and Managing Director. Please go ahead.

Good morning, and thank you for joining us for Vicinity Centres' results call for the 6 months ended 31 December 2021. Before we begin, I'd like to acknowledge the traditional custodians of the lands on which we meet today and pay my respects to their elders past, present and emerging. I extend that respect to Aboriginal and Torres Strait Islander peoples on the call today. Joining me on today's call are Peter Huddle, Vicinity's Chief Operating Officer; and Adrian Chye, our Chief Financial Officer. I will start today on Slide 4. The first half of FY '22 has been a period of significant progress at Vicinity despite another period of disruption for our industry. It was also a period that marked the beginning of a sustained recovery for our business and the retail sector more generally. In summary, we continued with our strategy of delivering growth, while, of course, managing the ongoing challenges of the pandemic. We achieved significantly improved financial results with FFO up 8% to $288 million and statutory net profit up by more than $1 billion to $650 million. Contributing to that result was a significant improvement in cash collections as retail sales increased and an uplift in asset valuations as we emerge from the pandemic. Our first half distribution per security is $0.047, up 38% on the prior year and represents 84% of AFFO. Net tangible assets per security increased by $0.15 to $2.28. Adjusting for the $0.047 per security distribution payment, NTA increased $0.10 to $2.23. This improved performance was driven mainly by a recovery in retail trading. Shoppers were quick to return to retail centers with confidence and capacity to spend once COVID restrictions eased, and this has been accompanied by a faster and more pronounced rebound in retailer confidence. The improvement in leasing spreads and cash collection rates reflect this. That being said, the emergence of the Omicron variant in late December presented a temporary setback to our recovery. We note, however, that with the respective East Coast state governments announcing the spread of Omicron has peaked, we are now starting to see visitation levels once again trend upwards. During the period, we also strengthened our portfolio by acquiring Harbour Town Premium Outlets, bolstering our position as a leader in the attractive and growing outlet sector. We also announced the divestment of Runaway Bay for an 18% premium to book value. Additionally, we progressed the retail and mixed-use development pipeline, advancing a number of projects, which Peter will discuss later. And importantly, we maintained a strong balance sheet with gearing at 26.3% and with $1.8 billion of liquidity. Overall, we are optimistic about future retail trading conditions and confident in the outlook for the second half of this year. Consequently, we are pleased to provide earning guidance for FY '22. Absent any material changes to current COVID conditions, we expect to deliver FFO per security in the range of $0.118 to $0.126 for FY '22, and AFFO is expected to be in the range of $0.095 to $0.103. Turning now to Slide 5 and adding to our growing optimism is the improved macroeconomic environment. Consumer confidence softened recently but remains in line with pre-pandemic levels which, considering the extent of the recent disruption and dislocation, is remarkable. Consumers are currently enjoying a wealth effect created by persistent growth in housing prices as well as an extraordinarily tight labor market, where job ads have risen by a factor of 2.2 since January last year. At the same time, unemployment has reduced by 3.2%. Supporting this, the federal government recently indicated that unemployment is likely to dip below 4% by year's end. And of particular note, the household savings rate is once again more than double the 5-year average and almost 3x pre-pandemic levels. Our experience is that households start spending as COVID restrictions ease. Absent any major changes to current COVID-related conditions, we therefore expect our centers to once again benefit from the redeployment of household savings into consumption. We are, of course, maintaining a watching brief on inflationary pressures and note recent government and RBA commentary on monetary policy and the potential for interest rate rises in the future. I'll now hand you over to Peter, who will provide you with an overview of our operating performance for the half year.

Thanks, Grant, and good morning, everyone. I will start on Slide 7 with a review of our key market trends and our portfolio performance. Our first half of '22 was really a tale of 2 quarters. For nearly half of the performance period, our 2 largest states, Victoria and New South Wales, were in lockdown. Pleasingly, however, states less affected by the pandemic, Queensland, Western Australia, South Australia and Tasmania, continued to deliver strong growth with retail sales 8.9%, up on pre-COVID levels. At a total portfolio level, retail sales in the December quarter were weighed by the New South Wales and Victoria impacts in October. However, in November and December, our critical trading months [ pandemic ], particularly in mid-week, higher levels of visitations on weekends have been very encouraging, driven by consumers seeking experiences only available in major cities. While foot traffic remains below pre-pandemic levels, more purposeful shopping is underpinning persistently strong spend per visit as shoppers visit less frequently but spend significantly more. In November, December, spend per visit was nearly 30% higher than pre-pandemic levels. Strong spend per visit has really supported our retailers, which, in turn, supported our 98.2% occupancy and improved leasing spreads, which I'll discuss in more detail shortly. Consumer habits are generally driven by convenience and/or experience. While online retail continue to grow through the pandemic, almost by necessity, its convenience has been challenged by more recent supply chain and logistic pressures. And overall, we have seen the rate of growth in online sales steadily falling from its peak in September 2020. The strong rebound in retail sales when restrictions ease has been a consistent theme throughout the pandemic, which highlights the ongoing relevance and importance of physical retail to consumers. Resilient trading conditions is a very welcome tailwind driving the synergies recovery and return to growth. And while Omicron represented a temporary setback, I'm pleased to advise that as of the end of January, shoppers were confidently returning to our centers with total portfolio visitation at 76%, and in COVID-unimpacted states, visitation reached 87% compared to 2020. Turning to Slide 8. Since the start of the pandemic, we saw cash collections decline in periods of lockdown and then recover when restrictions ease and as retail confidence strengthens. Following the recent lockdowns in New South Wales and Victoria, the rate of recovery was significantly faster than prior periods, underpinning a pronounced rebound in rent receipts in respect to current and prior months' billings. As at 31 January, collection of gross rental billings in respect to the first half of '22 averaged 80% and this compared favorably to cash collections rate reported at our first quarter update of 74%. Net of estimated waivers in respect to the first half 2022 gross billings, our cash collections rate averaged approximately 92% for the period. As I said, the underlying resilience of the retail sector is supporting our rent collection efforts. And pleasingly, these efforts have resulted in $51.8 million re-estimations of prior period net rent property income, which Adrian will talk to shortly. We expect cash collections to improve progressively once the commercial codes in New South Wales and Victoria expire in March, which will in turn enable us to finalize rent relief agreements. We are working towards completing all rent relief negotiations by the end of the financial year. We were certainly disappointed to see the New South Wales and Victorian government extend the SME codes to March despite lockdowns in those states ending in October last year. With governments confirming that lockdowns are a thing of the past, we look forward to the end of the codes which have proven to be highly complicated and bureaucratic instruments for both retailers and landlords. For retailers not eligible for assistance under the SME codes, our support has taken into consideration the benefits from strong rebounds in traffic and sales following previous waves of the pandemic and subsequent retailer profits, which for some have been at record levels. As a result, our assistance is substantially more targeted towards retailers generally impacted by lockdowns. Importantly, though, assistance provided to retailers who are not covered by the SMEs code has been focused on generating mutual value outcomes in the form of longer-term leases and/or new stores. In summary, we believe lockdowns are a thing of the past, and as a result, we are anticipating that materially less rent relief will be required going forward. Turning to Slide 9. Despite the disruptions, the team delivered strong leasing outcomes in the first half of '22, delivering 643 deals, which represented 101 more deals than the first half of '21 and 60 more deals than the first half of '20. Much of this outperformance was in Victoria, where deal activity was double the same period last year. The volume of leasing deals this half further reiterates that sophisticated retailers have realized the finite nature of lockdowns and see the medium to longer-term necessity of physical retail. Our leasing spreads improved significantly, largely driven by the states less impacted by COVID, where retail sales growth has remained in high single digits versus pre-pandemic levels. We maintained our customary lease terms with more than 70% of new leases having fixed 5% annual increases. And cumulatively, over 90% of all new deals were negotiated with fixed annual increases of at least 4%. Our average new lease tenure extended from 4.3 to 4.8 years over the period, further reflecting retailer confidence in retail trading conditions and importantly, their long-term confidence in physical retail. Once again, retailer administrations remained at very low levels, with just 13 stores entering -- in administration during the period. Our portfolio vacancy remains broadly in line with prior periods as the team successfully leased more than 200 vacant stores in the period, highlighting the strong demand across the country, particularly in Victoria. With strong leasing momentum and very few administrations, our portfolio occupancy was maintained at a high 98.2%. We anticipate demand will grow as we begin to experience a prolonged stabilization of trading conditions. Turning now to Slide 10. Our development pipeline is gaining momentum. The new car park at Chadstone is complete, providing the foundation for growth of this asset. We commenced the expansion of the entertainment and lifestyle precinct with the development due for completion prior to Christmas. Pleasingly, this new precinct has attracted retailer precommitments covering 75% of forecast income. At Bankstown, we have commenced works for a new Coles supermarket and upgraded fresh food precincts. We are also consolidating retail space and relocating the bus interchange to facilitate our larger scale mixed-use projects, which are either DA-approved for certain commercial towers or are in advanced planning for the total master plan. At Box Hill, the retail consolidation in the south precinct is due for completion midyear and will include a new Coles supermarket and refreshed services and food offerings. This project establishes a contemporary retail offer in Box Hill South, which will, in turn, allow Box Hill North to be unencumbered for the commencement of large-scale phase, mixed-use projects for this site. In the last 6 months, we have had significant success attracting top-tier tenants to our office assets. Notably, Officeworks will be relocating its headquarters to Chadstone in 2023 and a 4,000 square meter office will be built at Box Hill South for the leading co-work provider, Hub Australia. At a portfolio level, we are in the market seeking tenant precommitments for more than 130,000 square meters of office towers across 6 centers in our portfolio. In addition to the large scale mixed-use pipeline, we are also working on a number of small-scale modernization projects. We are reinvesting in our centers to enhance the aesthetics, transform the tenant mix and replace dated major retail stores in order to significantly raise the customer offering. We have projects under construction at Mornington, Broadmeadows, Lake Haven, Northgate and Cranbourne and have recently completed important enhancements at Northland, Runaway Bay and Altona Gate. Turning to Slide 11, and you can see some of our major near-term mixed-use projects. With all available space at Chadstone fully leased, we're now securing the first tenants for One Middle Road, an important new office development at the center. Leasing interest is strong, and we expect to announce the first tenants and commence the construction of this project this year. At Bankstown, we have recently gained DA approval for 30,000 square meters of office towers, and like Chadstone, we're in market securing pre-commitments. After considerable government consultation, we have launched our DA for Victoria Gardens in May 2021. This project will further transform the site by adding 800 residential apartments across a number of towers. You can see this in the image at the top right of the slide. We plan to deliver the project in stages and will augment the retail revitalization works we have undertaken over the past 2 years. The image on the bottom left shows part of our master plan vision to completely transform Buranda Village in Brisbane. We've recently submitted the DA outlining our plans to develop an 8,000 square meter of retail and dine-in precinct with up to 600 residential dwellings and 50,000 square meters of office space. The center image at the bottom shows the location of Officeworks' new headquarters at Chadstone. We are completely refurbishing the existing office and delivering a net zero carbon certification and a state-of-the-art amenities in that building. Finally, at Bayside, we have an approved DA to build a 14,000 square meter 8-story tower adjacent to our major regional shopping center located in the heart of Frankston CBD. Frankston is an important location in Melbourne's growing Southeastern corridor, and we anticipate interest to come from government tenants and allied space users. In summary, our key assets are master planned with an understanding of highest and best use outcomes. Larger and smaller tactical developments are strategically phased and can be flexed to take advantage of market conditions. Importantly, we have now substantially transitioned from planning to execution of our mixed-use developments, and you will see further project completions in FY '23. I will now hand over to Adrian to provide an overview of our financial results.

Thanks, Peter, and good morning, everyone. I will start on Slide 13. Despite the continued impacts of the pandemic, Vicinity has delivered a strong financial result for the 6 months ended 31 December 2021. Statutory profit for the first half was $650.2 million, an uplift of approximately $1 billion compared to the 6-month period ended 31 December 2020. The FFO was up approximately $21 million or 7.7% compared to the first half FY '21. The key driver of this increase was a $37 million uplift in net property income. As Peter mentioned, post the lockdowns, we saw a strong rebound in retailer confidence. This positive rebound, combined with our persistent focus on collecting prior period billings, enabled us to reverse $51.8 million of prior waivers and provisions during the half. Net interest expense increased by $20 million due to the unwind of the interest rate swap restructure in the prior period. Due to the high volume of leasing activity and a more normalized level of maintenance CapEx, FY '21 AFFO capital increased by $15 million. The FY '22 interim distribution per security of $0.047 is a 38% increase on the FY '21 interim distribution of $0.034 and reflects an AFFO payout ratio of approximately 84%. Moving now to Slide 14, where I'll provide more detail on our waivers and provisions. As shown in the gross rental billings chart at the top of the slide, first half '22 estimated waivers and provisions of $96 million represents a $51 million reduction relative to the estimated position at first half '21. On a reestimated basis, which includes prior period reversals, total waivers and provisions for this half have reduced by $4 million. We collected 79% of gross billings for this half, 9% more than the same time last year. Pleasingly, these outcomes were achieved despite a higher proportion of the portfolio being subject to lockdown this half, which demonstrates the underlying resilience in our retail portfolio as well as our targeted approach to providing COVID-19 assistance. Going forward, we expect a continued reduction in waivers and provisions as retail remains consistently open. And we will, of course, continue with our targeted approach to COVID-19 assistance. Now to Slide 15 and valuation outcomes. For the 6 months to 31 December 2021, the portfolio recorded a net valuation increase of $320 million or 2.3%. This compares to a net valuation decline of 1.3% in the 6 months to 30 June 2021. Positive growth was achieved across all center types and states with the weighted average cap rate reducing 14 basis points to 5.35%. Our subregional and neighborhood portfolios recorded the strongest growth, highlighting the continued resilience of nondiscretionary-based retail and active purchaser demand. Similarly, the DFO portfolio, again saw strong valuation gains, benefiting from both income growth and cap rate tightening. Regional assets delivered a net valuation increase of 1.5%. And our CBD portfolio saw a modest valuation increase of 0.6%, reflecting the continued impacts of COVID-19 in the short term. Turning to Slide 16 and the balance sheet. Gearing of 26.3% is at the low end of our target range, and we maintain $1.8 billion of available liquidity. Our strong balance sheet position enables us to navigate periods of uncertainty and provides capacity to fund our development pipeline and selectively pursue growth opportunities, such as the recent Harbour Town acquisition. Our debt portfolio remains well diversified, and we have minimal debt maturing until FY '24. Our weighted average cost of debt for the first half was 4.1%, and we expect a similar outcome for the full year given our relatively high hedging levels. We retained our strong investment-grade credit ratings of A and A2 with Standard & Poor's and Moody's, respectively, both with a stable outlook. I'll now pass to Grant to wrap up.

Thanks, Adrian. Turning now to Slide 18, and Vicinity continues to be recognized for its sustainability programs. During the period, we were recognized as the Oceania Sector Leader and #3 globally in the Listed Retail Shopping Center category by GRESB. We now rank #5 on the Dow Jones Sustainability Index, up from seventh last year and have an A- rating for climate disclosure by CDP. We continue our work on modern slavery, assessing and addressing modern slavery risks in our operations and supply chain. We also established and convened a modern slavery working group during the period, which is chaired by Peter Huddle. In November, we concluded our second reconciliation action plan, the Innovate RAP, having rolled out a number of important initiatives across the business. Our community engagement agenda is also being recognized with Vicinity recently listed in the GivingLarge Top 50. And of course, we are also well progressed towards our 2030 net zero carbon target. The emphasis we place on managing climate-related risks and opportunities was also highlighted by our formal support of TCFD. Turning to Slide 19. And as mentioned earlier, we are pleased to provide earnings guidance for the remainder of the year. Our expectation is that FFO per security for FY '22 will be in the range of $0.118 to $0.126, and that AFFO per security will be in the range of $0.095 to $0.103. We are targeting a full year distribution that is within our target payout range of 95% to 100% of AFFO. While we expect the impact of COVID-19 on our business to continue over the coming months and although Omicron had a material impact on visitation in January, particularly at centers located on the East Coast of Australia, we have seen some upward trend in visitation in recent weeks. Importantly, our guidance assumes no material change to current COVID-related market conditions in the second half. And it seems also that the SME codes in New South Wales and Victoria will expire as planned in mid-March. Turning now to Slide 20. And in summary, today's result demonstrates that Vicinity is recovering from the pandemic. Operationally, the team focused on cash collection and leasing outcomes, while managing the disruption caused by lockdowns in New South Wales and Victoria. We took advantage of the strengthening transaction market to enhance our portfolio and drive earnings accretion. We continue to deploy our development spend across a number of projects aimed at upgrading our centers to deliver value. Our balance sheet and credit metrics remain solid and position us well for growth. And we are fortunate to be returning to a supportive macroeconomic environment where retailer and shopper confidence are growing. Vicinity will continue to build on the outcomes delivered in the first half and capitalize also on the momentum which we have in our business, once again, and of course, the continued recovery in retail. Before I hand the call back to the operator, I would like to take this opportunity to acknowledge and thank Vicinity's Board, my executive leadership team and indeed, all of my colleagues at Vicinity for their hard work during the first half of FY '22. Thank you. And with that, we are happy to take any questions.

[Operator Instructions] And the first question will come from Stuart McLean with Macquarie.

First question is just on FFO guidance. Just taking the midpoint of that guidance, it looks like 2 half FFO down about $20 million versus 1 half. Can that just be explained by increase in net rental [ relet ] given the write-backs that occurred in the first half? Or are there some other drivers at play there?

Thanks, Stuart. It's Grant here. I'll ask Adrian to pick that up.

Thanks, Stuart. Thanks for your questions. Yes, look, the $20 million is what you get, I guess, if you go to that midpoint. Really, it's driven by a couple of things. Firstly, as you point out that the waivers and provisions, the reversal and a potential waiver and provision estimate into the second half. The other 2 components are overheads. We are assuming that we'll get to about $90 million of overheads for the full year. So there's probably an extra $10 million of overheads in there as well. And for the outgoings, we expect outgoings to probably increase by about $15 million.

Sorry. Both outgoing...

Sorry. Outgoings of $15 million.

At the property level?

That's correct.

Great. My second question is in regards to NPI. And I was just looking at 2 half '21 at those earnings bridges you provide at the back in the appendix. It looks like 2 half '21 was down $8 million, implying like a $4 million, $10 million recovery this half. Can you just describe what's happening with that NPI line item to go from negative to positive there given occupancy is broadly flat?

Yes. So I think if you look at the bridge on Page, I think it's 32 of the slide deck, you can see that there was various movements throughout the year. Obviously, that elevated surrender payment of $16 million was impacting the first half. So that's unwinding into the second half. There's underlying growth of about $6 million coming through that NPI line, which is about just over 1%.

Yes. So it was that $5 million, $6 million was minus $8 million in the prior half sequentially. And so what is the -- have you seen a rebound in ancillary income coming through the portfolio? Like what's causing the positive movement there in NPI?

Yes. Stu, I think you got it right. Internal income has increased half-on-half. So that's the majority of that increase.

And how far below is ancillary income versus pre-COVID levels as we sit today?

It's still around 30%. Largely, that's car parking, which has continued to be impacted in some of our CBD centers, particularly South Wharf. So we expect that to come back over time.

Great. And maybe a final one for myself. Just in regards to the reduction in footfall, to 84% New South Wales, Victoria ex CBD. What does that mean for tenants that rely on increased dwell times, for example, the cafes and the restaurants, et cetera? What's the outlook there for that portion of the portfolio, please?

It's Peter, Stuart. I'll pick that up. So from our strategy and our approach, the tenants that rely on that dwell time, whether it's leisure or food and beverage and some of those in the CBDs is where we're focusing our assistance moving forward into the future. So -- and then you'll see that in some of the provisioning that we've done is really -- has always been focused on those tenants relying on that footfall and dwell time and less on those tenants that have actually traded quite well through this pandemic period. So we will continue to support those tenants, particularly the ones that might be in the CBDs or large-scale food and beverage and leisure tenants as we go through calendar year '22.

Do you see any medium to longer-term implications there on the outlook for that at the tenant category? Or is your view that footfall return to pre-pandemic levels that will be fine in the medium term?

Sure. That is our view is that particularly once -- for example, CBDs, once commercial occupancy increases, international borders open up and we learn to live with the pandemic, we anticipate normal foot traffic returning in the short to medium term, and we'll support up until that period of time.

The next question will come from Lou Pirenc with Jarden.

Can I just follow up on this, the $61 million of reversal of prior waivers from prior period. Does your guidance for the full year assume any more reversals or does it not?

Lou, it's Adrian here. No, it doesn't.

Okay. But so if -- okay, that's good. Can you just talk -- I mean, you talked a little about your development pipeline. What is the total CapEx that you've committed to for the next few years? And what return do you expect to get on that?

Lou, it's Adrian here again. So I think what we've guided to is about $150 million worth of spend for FY '22. And we probably expect a similar amount to FY '23. We expect the pipeline then to ramp up with the onset of mixed-use opportunities and probably Chatswood from '24 onwards. And that will return, probably closer to the historic levels of $300 million per annum. In terms of return on a stabilized basis, we're looking at returns of 5% to 6%, probably a little bit higher for some of the commercial opportunities where we don't necessarily have to fund the lands given that it's already on our site. In terms of IRRs, we're looking at 10-plus percent, but we risk-adjust projects depending on the specifics of the project.

Great. And then final one for me. Just what do you expect to happen with maintenance CapEx and tenant incentives for the rest of the year?

Yes. I think what we've previously guided on maintenance and tenant incentives is around $110 million to $120 million. We're looking at that coming down a little bit, probably closer to $100 million to $110 million for '22. The key driver of that is a higher retention rate from leasing transactions. So we're actually seeing very positive momentum in leasing, which is reducing the churn. So that's reduced our leasing incentives forecast. The other one is just on maintenance CapEx. We've actually just dialed that back a little bit by about $5 million.

And the next question will come from Sholto Maconochie with Jefferies.

Just a couple of follow-ons from before. Just on the guidance, the write-back of $52 million reversal. That looks like in the 4-D, the rent rate were $91 million this period. It's up about $40 million from the June number. So was it mainly the reversal that drove that? Because if you look at that bridge in the appendix, the [ 51 ] was the biggest impact. And then second half, you've got higher costs, and you've also got the benefit of Harbour Town in there. So does your guidance pretty much assume no more -- very minimal waivers in this period? Or could you give us an indication what you're feeling in COVID assistance for the second half?

Yes, Sholto, I think a good guide is probably to think about the first half -- sorry, the second half '21. And we're showing that on Slide 14. I think we expect probably similar levels, maybe a little bit under those levels for the second half.

Okay. So then 1 half '21, okay. Okay. And then just on the ancillary income, how much was that in the period versus the PCP, the dollar value?

I think it's around 30...

35.

$35 million or $37 million.

Yes. And the PCP, how much was that? Was it a lot lower, I guess?

Yes, it would have been a lot lower by about -- I think it's about $3 million lower.

Okay. And going forward, what was your holdovers? Did they -- did you disclose that? What were they in December versus -- June versus December?

Sholto, it's Peter here, the holdovers came in slightly above 700, which was down on the June quarter. So it's about 7% of leases so...

What was the old one [ 6, was it ]?

We're down about 20-odd in terms of holdovers from the June -- from the June reporting period.

Okay. So the 7% of leases are in holdover versus how many in June again?

8.

8, okay. And then just last question. Again, you said you don't expect any more COVID lockdown sort of mandated. Is that sort of expected after the mid-March that, that's pretty much done and it's all sort of broadly back to normal with shadow lockdowns if ever one would go out.

Yes. Sholto, it's Grant here. That's certainly our assumption. And certainly, it's our strong objective. Just perhaps I can take the opportunity to go into a little bit of detail on that. But we've transferred $300 million of our shareholders essentially earnings across to essentially rent relief since the pandemic began. And if you include our JV partners, that number is $0.5 billion. And obviously, we feel we've done our part. And we would also note that, that relief was targeted at providing relief during periods of lockdown. But of course, now we're in periods where we are living with COVID to quote government policy, which means, of course, no lockdowns. So we are open for business in all of our centers. And we don't see candidly the need to extend the code beyond where it was at the end of last year. We obviously have had an extension through to the middle of March this year, but we are certainly advocating to government very strongly that given there are no lockdowns under the current policy, the need for that rental relief program to be legislated goes away. We'll, of course, work as a good landlord with all of our tenants to work through their requirements as individual businesses, but that does not need to be regulated.

Yes. Okay. And just last one for me on the capital [indiscernible]. If you take the share price today, the current trading is at 20% discount to NTA. You've got the big pipeline, would this be -- assume to say you'd prefer to invest capital towards the developments as opposed to a buyback?

Yes. I mean, obviously, our Board will always assess the best use of capital at any point in time. And therefore, it continues to assess all forms of capital deployment. But we do think that the most accretive use of capital at this point is reinvestment in the development pipeline. And I think as Peter walked through earlier, we've gone through a really detailed program of master planning all of the major assets. You see the benefit of that today where we can flex in to meet the market in areas that are actually highly sought after, such as suburban office. So we'd certainly see those as being the most accretive use of capital at this point.

And just to finalize on that on the last bit on the capital side. In the pipeline, have you thought of putting the sort of suburban office into a spin-off fund? Or what's the sort of strategy on the mixed-use in commercial or -- and/or that you build to rent into a different vehicle, is there any color or advancement on that?

Perhaps I'll ask Peter to talk about build-to-rent, and then I'll come back on the fund point that you started with. But Pete, could you just perhaps pick up the residential uses that you're anticipating?

Yes, Grant. So look, from the mixed-use component, a lot of our forward-facing mixed-use developments are actually commercial in non-CBD centers. And so that really takes advantage of the current market conditions. We're still investigating build to rent as particularly for Vic Gardens, with our joint venture partner there. And so it's still to be determined exactly the residential component to move forward with, whether build to sell or build to rent. Our preference is build to rent subject to financial returns on it. Grant can talk about the funds, but clearly, we have obviously engaged in a funds management approach. We've just appointed a Director of Funds Management which Grant will talk to and how we execute some of the mixed-use developments will be considered in that strategy moving forward.

Yes. Thanks, Pete. And just to come back to that point, Sholto, on funds management. So we're investing in organizational capability. As Peter mentioned, David McNamara, who's joined us from Lendlease, was frankly a massive recruit for us, a 30-year veteran and well known to many who will be on the call today. I'd just note a couple of things. Firstly, we'll have much more to say about this, I suspect, in the August earnings call. But at this point, we're obviously considering all options. What I would note, however, is that we have seen already a significant increase in wholesale capital being allocated to quality retail assets. It's one of the reasons those valuations, from a transaction comp perspective, was so attractive in this cycle. And we'd note that and, hence, the decision to invest in the organization and specifically the recruitment of Dave.

And that would account for the higher overhead that [ investment ] in that function area in the second half?

Yes, it's Adrian here. Yes, there is some vacancies probably into the first half, and that will unwind in the second half. So that's pushing up some overheads. But there is additional investment across strategic initiatives, not just mixed use, but also some adjacencies as well but that's coming to the second half.

And the next question will come from Simon Chan with Morgan Stanley.

Lots to take away from the good result, but I just got a simple question on cash flow. Adrian, if I just keep it very simple. NOI increased by $35 million, $40 million versus prior corresponding period. But if I look at the cash flow statement, operating cash flow before interest expense declined by $35 million. So can you, I guess, talk to what that is, please?

Yes. Sure, Simon. So I think what's impacting the cash flow in NPI this year is the increase in trade debtors. So that's the main shift, if you like. So because we've got that increase in trade debtors, there's a bit of a disconnect between what we're booking in FFO and also on cash flows.

Right. Okay. So basically, your -- the stuff that you've booked, that's a larger portion of what you've booked in revenue that hasn't been collected as cash yet relative to previous periods. That's what you're saying?

Absolutely. That's right. That's right.

Okay. Cool. And just one more for me. I think in the past, you've said about 30% of your income come from SMEs. Just wondering, with this code of conduct extension, which is, I guess, a lot tighter now in terms of qualification, what percentage actually qualifies?

So Simon, you're right. It was previously probably 30% of SMEs. There is a tighter qualification down to $5 million and $10 million as threshold. This probably reduces the qualification down to the low to mid-20s percent. So we still have a number of SMEs in that, that qualify as part of the extension of the commercial code of conduct, even with the lower thresholds.

Okay. Cool. Cool. Okay. And can I just clarify an answer Adrian gave earlier. You said the waivers that you factored into your guidance for the second half would probably be similar to what you -- what second half FY '21 was. Is that correct?

Yes, that's correct.

And the next question will come from Adrian Dark with Citi.

Around 6 months ago, Vicinity announced a strategic refinement. And I note your comments about a stronger transaction market, but also being mindful of the potential behind interest rates. Could you talk about how any shift in the backdrop could influence how you implement the new strategy? And anything we should be concerned with?

Yes, sure, Simon (sic) [ Adrian ]. Just on the overarching question, which is the 6-month reset last year. I think what's probably in plain view here and the reason there wasn't a separate section calling out "strategy," is that we've embedded strategy at every element of the organization, including how we think about the business and how we present it to the shareholders. So I'd note, and consistent with 6 months ago, the 2 Gold Coast transactions which were directly targeted at a capital recycling, in fact, they're about 20 kilometers from each other. That marked a channeling of capital out of essentially a regional asset play and into a DFO play, elevated leasing activity where spreads are improving, which obviously speaks to our core business, and most importantly, given, I think, what we've advocated for several years now, the very strong progress on mixed use. On the innovation side, there've also been a number of developments that we didn't call out specifically in the deck, but which I would highlight for you. And probably the most interesting has been the development of a logistics hub at DFO Homebush, where we've had 20,000 parcel movements in the final 2 months of calendar '21 with potential for 15 more sites. So the strategy is very much embedded into the business. We don't want to distract ourselves from our core mission, which is to generate shareholder return. Hence, there's no separate call-out of that today. On the second part of your question, which is interest rates, what I would note here is that retail almost alone amongst real estate asset classes is a principal beneficiary of inflationary effect. And inflation, of course, is the driver of potential interest rate rises. And I did note a couple of the broker reports this morning speculating on that. But what I would note is that what we are seeing in terms of the recovery, particularly of our sales data, is a direct consequence of that same inflationary pressure. So I just urge everyone to understand that, that's the flip side of the coin. Yes, there is inflation in the system, but it's net positive for retail sales.

And Peter, perhaps a question for you on development. Can you talk about the level of precommitment that you're seeking to commence some of the office projects. And perhaps whether a slower return to CBD offices is a headwind or a tailwind in terms of those mixed-use projects leasing efforts, please?

Adrian, so in terms of precommitments, it's typically between -- typically between 30% and 50% is what we're seeking. And it really depends on the project. It will be project-specific. We have some smaller towers. So for example, the tower that we have at -- the tower that we have at Bayside, the precommitment will be potentially for the entire tower because it's a single office use in that particular tower. So it depends on the project, but typically 30% to 50%.

Sorry, the second half sort of was just whether a slow return to the CBD is assisting your leasing efforts in those locations or perhaps it's a headwind?

No, no, no. It's probably -- again, it's taking advantage of being able to flex a mixed-use pipeline is we are seeing significant interest in highly well-located, non-CBD assets that are linked by a major transport. So we're seeing significant inquiry. So from a commercial leasing point of view, we've enhanced our skill, our capability internally in Vicinity, but also obviously engaged with the broker market, and that's what's driving the regional center commercial leasing activity as front-running our mixed-use pipeline is as a result of that.

The next question will come from James Druce with CLSA.

Just one question for me. I was just thinking about the normalized sales for the whole portfolio. I think you said the COVID-unimpacted portfolio is about 8.9% above pre-COVID levels. Where do you think the whole portfolio will get to?

James, let me pick that up. It's a really -- it is a tricky one. So the one that we essentially look at with most interest is really specialty sales and that's obviously what drives the majority of the rental income. So if you look at -- if you look at the total MAT specialty sales on what we call the COVID-normal states, then that's about 10.2%. Then if you look at the COVID-impacted states, it's substantially higher. But the reason why it's substantially higher is because you're not really comparing apples with apples because you're comparing off a lockdown period. So that's why we reported the November, December sales for New South Wales and Victoria over 2019 levels to give a sense of where productivity growth is at that 5.5% number. So to add to your -- specifically your question, we think, if you normalized everything, we would still anticipate that specialty sales are in the mid- to high single-digit growth over the last 12 months across our portfolio.

And the next question will come from Ben Brayshaw with Barrenjoey.

I'll just keep this brief in the interest of time. I was wondering if you could put some more color around the composition of the holdovers. I think, Peter, you mentioned on the call, there were 700, about 7% of the portfolio. I just appreciate any color or visibility around the categories, i.e. catering, apparel and services?

Yes. So it is about -- sorry, just to clear, it's about 7% -- 7.2% of holdovers is 7.2% of rent. So it's about 10% of leases, about 7.2% of rents compared to June, which was about 8% of rents. So we're down about 40 in terms of holdovers. In terms of the holdovers themselves, about 60-odd percent are in national retailers, the rest are in SMEs. And a substantial portion of it is, I've got to say it's holdovers on our election. So it's in some predevelopment centers that we have, whether it be Myer Centre Brisbane, Chatswood and Bankstown which we're into at the moment. From a category point of view, approximately 50% of those are national retailers. And clearly, as part of our comment around mutual benefit associated with COVID negotiations, we're converting a lot of those national retailer holdovers into longer-term leases as a result of these negotiations at the moment. So from a category point of view, it's probably split evenly across categories. I've got to be honest. There's no specific to food and beverage, which is something that we're really focused on, obviously. Maybe another point that's not necessarily called out in the pack, one of the really strong performances for this half has been the strong performance in leasing spreads and conversion of holdovers for apparel and footwear. That has really -- and that's typically a large [ July ] proportion of our portfolio. And for context, it delivered about a 3% negative leasing spread and a large amount of deals.

And the next question will be from Grant McCasker with UBS.

Just a quick one. A big feature of the last couple of results has been the reversal of provisions. Can you just let us know what the level of under-collected rent has been provisioned on the balance sheet at the moment?

Yes. Thanks, Grant. So in relation to, I guess, unpaid rent, there's about $50 million of uncollected or unpaid rent that we haven't provisioned for. $30 million of that relates to the last -- or the first half FY '22, $20 million relates to prior periods.

That hasn't been provisioned you're saying?

That hasn't been provisioned. That's correct.

And then there is a bucket that has been provisioned on top of that as well?

Yes. So if you look at our balance sheet, if you like, we've got trade debtors of about $191 million, and we've provided that $142 million in waivers and provisions against that $190 million. So there's about $50 million there. That's the unpaid.

Perfect. And then just following on from, I think, Peter's last comment about incentives. Can you make a comment just on incentives for new deals? Any trends worth noting?

It's actually -- so the incentives for the reported period is about 9.9 months for incentives, which was down from about 11.5 months in the June reporting period, which was also down on the December reporting period. So we've got a trend going down on incentives, even though obviously, construction prices have gone up. So we've been managing that particularly well. Some of that's influenced by we have materially lower incentives in our DFO portfolio.

The next question will be from Richard Jones with JPMorgan.

Just in terms of the $15 million higher outgoings in the second half, can you just clarify what's driving that?

Richard, I'll pick up the first bit, I'm sure Adrian will pick up the second. So obviously, we've locked down periods in New South Wales and Victoria. We substantially reduced costs associated with things such as vertical transport, electricity, to a lesser degree, cleaning and security. And as we move to more normalized operating environments in Victoria and New South Wales, they come back to normalized levels. That's a significant component of the $15 million.

Yes. Nothing more to add there. I think that's a good explanation.

Okay. Fair enough. And then just another one, perhaps to you, Peter. Just in terms of the valuers, can you just talk us through what they are assuming in terms of stabilized net property income and where that compares to pre-COVID levels? And then perhaps how it compared to your internal assumptions?

Yes. Look, I might have a first stab at that question. Look, I think it really depends on the type of asset we're talking about. So I think the CBD assets in particular, that's where levels of NPI are going to take a little bit longer to recover. So we're not expecting those levels and the valuers aren't expecting those levels to come back for another 24 months. In relation to the other segments, I think largely, most of that recovery in NPI, the valuers and ourselves are expecting that to occur into the FY '23 period, but really FY '24 for everything to wash out. Just some context, the valuers are still assuming $100 million of COVID assistance or COVID relief in the valuations as at 31 December. So that will wash out over the next couple of periods, I think, and that will lead to hopefully an increase in those valuations.

And thank you. There are no further questions at this time. I'll now turn the call back to Mr. Kelley for closing remarks.

Thank you very much. And if I could just close by thanking everybody for dialing in today and to our shareholders and other stakeholders. We look forward to meeting with many of you in the next 3 weeks. Thank you once again, and have a good day.

Thank you, sir. That does conclude our conference for today. Thank you for participating. You may now disconnect. Thank you.