Workspace Group Plc (WKP) Earnings Call Transcript & Summary

We've seen enough of that now. So firstly, just like to welcome you all to our Half Year Results Presentation, which we are holding at Salisbury House at our new Eventspace for the first time. And, yes, I guess, in terms of the order for today, just running through that, I'll start with an overview of the business and activity in the first half of the year. Dave's then going to take you through the financials in a little bit more detail, and then we'll finish with a view on the outlook for the business in the coming years. I just want to say a little bit more about Salisbury House. I think it's a great example of what we do best at Workspace. I mean, this is a lovely, iconic building built in the early 19th century, 1901, in fact. It's a listed building. It's sitting on one corner of Finsbury Circus, 220,000 square feet, one of our larger buildings. Now, we acquired this building in 2017. And since then, it's been subject to a rolling refurbishment, really bringing it up to modern standards. And this includes -- actually, when we can get larger space back, actually subdividing that, upgrading it for a whole range of our SME type customers, it's a great location for them, right next to Moorgate and obviously, also the Elizabeth Line. We've also been able to unlock lots of the original features in this building. It's fantastic, taking up the floor coverings, also taking off the wall coverings, being able to unlock lots of the original features of this building. The most recent addition to that is also the central reception area that we've now created, giving a real focus to this building, as well as, of course, the Eventspace that we're in today. I do think it's a fantastic example of how we at Workspace can bring vibrancy and new life to what was a tired building, albeit a characterful building in the center of London. Just moving on then. So in terms of definitions, one of the things that's frustrating for us sometimes is the generic description of us as an office business. What I've highlighted here on the left-hand side is some typical definitions of what people call office. They're not most exciting descriptions. A room or part of a building where people work, sitting at desks; place of business where professionals or clerical duties are conducted. Very functional descriptions of office space. It really doesn't do justice to what our customers make of the space that we provide. We much more prefer the actual description on the right-hand side. It's where people come together to create businesses and nurture them and grow them. It's really a much more aspirational description, rather than a very functional description on the left-hand side. And bear in mind also that a lot of our customers, around half of them actually use their space in very different ways to more traditional office use. So whether it's a lab space, whether it's a video production business, a podcaster, a fashion design business, that whole different range of uses of space, which their customers engage with us on. Equally, actually, with people that actually have traditional -- more traditional offices. So desks and computers, you'll see then that the fit-out is very much more creative than you might find in a larger Central London corporate. It then reflects their brand, their culture of the businesses that they have. So it's very important, I think, sometimes when people describe us as an office business to think actually much more broadly about what does that really represent? There's a similar confusion, I'd say, around the use of the word flex and flex models across the sector. I mean, it's great that we've seen this explosion of flex over the recent years, but not all flex is the same. And we've highlighted this before, the flex models with the likes of IWG and previously WeWork, the serviced office model, that's very different to ours. And likewise, these flex models that some of our peers such as GPE, providing flex space, again, a very different model. Ours is a flex model, very much specifically focused around the needs of SMEs. It's something that's evolved as we've worked with those SMEs over the last 35 years. It's that flexible operating model, combined with our extensive property portfolio and our scalable operating platform that really differentiates us in the market that we operate in. And I'll come back to that later in the presentation. So, moving on to the results for the first half of the year. I'm pleased to say we've continued to see good income growth. Rental income up 9% in the first half of the year, with trading profits up 7%. And on the back of that, we've increased our interim dividend by a further 7% to 9p in the first half of the year. On the flip side, we have seen a reduction in valuations in the first half of the year. This is largely due to the outward movement on yields, very much like the rest of the office sector. Our yields on our like-for-like portfolio were around 45 bps in the first half of the year. Going back to that trading performance, a core focus for our business. We've seen consistently good levels of customer demand. And the top 2 charts here, enquiries converting to monthly lettings showed a good, healthy consistency of performance. And just to remind you, in terms of intensity, that's 108 enquiries every single week. That's 23 lettings every single week during the first half of this year. And that level of intensity is hugely important to us because it means that we can actually monitor demand and pricing across the whole of our portfolio, and really then adjust our pricing and work out where we're seeing stronger demand. And so we can take advantage of opportunities, equally deal with challenges as they arise. Given the strength of demand you see on the bottom left there, the like-for-like occupancy has been stable. And actually, that's important again because that means that we can then drive pricing and capture reversion across our portfolio. And as a result of that, you'll see the bottom right that actually we've been able to uplift like-for-like rent per square foot by 6.6% in the first half of the year. That's a tremendous achievement. And on the back of that, our like-for-like rent roll is also up by a similar amount, 6.3%. Just want to talk about lettings in a little bit more detail. And on the left-hand side, I'd always like to bring something different to the presentation. This time, I've just broken out our lettings by size on the left-hand side of this chart. And the reason I've done that is just to highlight actually that what we do see at the moment is actually a much stronger demand for smaller space. So, you'll see that just under 90% of our lettings are under 1,000 square feet. It's always been a bias towards the lower end, but actually, this time in the economic cycle, we always see stronger demand for smaller space. And as a result of that, what we do try and look at is to try and subdivide space to cater for that demand at the lower end in terms of size. And I'll come back to that a little bit later. On the right-hand side, a breakdown of the demand by sector. And there's no news -- no news here really. It's just to highlight a diversity of our sort of demand by sector. Very consistent with what we've seen in previous years and indeed of the breakout, if you look at our overall portfolio. It just reflects that really the diverse demand from creatives across London, that London is a real global hub for a whole range of industries. I'll just give you a little bit more feel of the sort of customers we're talking about when we talk about these industry sectors. So, just giving you here 4 examples of customers that have taken new space with us in the first half of the year. On the left there is the first one, Muddy Machines. They're a service-based business based around robotics for the agriculture industry. It's a good example of a technology business, not one you'd necessarily think of straight away. They're based at our site Light Box out by the Chiswick Roundabout. Then we've got TALA. TALA, a company that's been with us for a while. They've just moved into China Works in Vauxhall. They're a sustainable, affordable, activewear provider, so very much in the fashion design business sector, which, again, we've seen a lot of demand from over recent years. The third one there, Goalhanger, a well-known podcaster. They've moved into space at our Kennington Park Business Center. And lastly, in the professional services sector, a recruitment company, Instant Impact, who are focusing on talent sort of recruitment for SMEs. So, just 4 good examples of companies that take space with us. And the great thing here is, where else would they go? We're the ideal fit for them in terms of their demand for the sort of space they want. And these are the sorts of companies that actually sometimes people forget about. These are the driving force of the SME vibrancy in London, the real driver of the London economy, the unsung heroes, I'd say of the London economy. And in terms of asset management as well, it's been a busy first half of us. We're still progressing well with a number of larger projects, Leroy House in particular. It's a scheme in Islington. It's a refurbishment and an upgrade, an extension of our existing building that we had there. That should be reopening in the early part of next year, the first half of next year. But we also spend a lot of money on actually what I would call more minor projects, but actually very attractive to us. And we've highlighted this in the last presentation. These typically last 3 months to 6 months, but actually give us very strong returns relatively quickly as well, which I like. And I've just given you some 6 examples there of what we're doing. And again, you'll notice a lot of that is around what I mentioned earlier is about subdivision of space, taking back larger space, subdividing it for the sort of demand that we're seeing at the moment at attractive pricing at smaller units that we can provide. And again, it just highlights also something [ abreast ] about our portfolio. We've got buildings. It's very easy to actually change their configuration. So, very adaptable to changes in demand. So as I said at the moment, we're taking a lot of space back and subdividing it because that's where the strength of demand is. And then lastly, just on the right-hand side there, we are progressing with our disposal of non-core assets, GBP 93 million disposal in the first half of the year, and we already sold another GBP 13 million of the non-core assets in the second half of the year with more to come. Okay. Just like to hand over to Dave now to take you through the financials in a little bit more detail.

Thanks, Graham. Morning, everybody. So as Graham said, it's been a good first half. Net rental income was up 9% to GBP 61 million, reflecting the strong stable occupancy we've had and strong increases in pricing over the first half of the year. Admin expenses were up just 2% to GBP 11.6 million, with synergy savings following the McKay acquisition, offsetting inflationary increases. Net finance costs increased to GBP 18.3 million, reflecting the rise in interest rates over the past year and the higher average net debt following the acquisition of McKay. So overall, good growth in trading profit after interest, up 7% to GBP 31.1 million. There was a decrease of GBP 177.4 million in the property valuation, resulting in a loss before tax of GBP 147.9 million. Adjusted earnings per share was up 5% to 16.1p. And in view of the growth in trading profit, we'll be paying a fully covered interim dividend of 9p, up 7% on the prior year. Slide 13 looks at the movement in net rental income in a bit more detail. On an underlying basis, adjusting for acquisitions and disposals, rental income was up 8% to GBP 59.3 million, with occupancy broadly stable. This is fundamentally driven by the increase in average rents, with like-for-like average rent per square foot up around 10% over the last year. Although the majority of service charge costs are recovered from our customers, the high levels inflation that we've seen in the U.K. over the last year resulted in a small increase in unrecovered service charge costs and other non-recoverable costs. These were offset by higher sundry income, with underlying net rental income also up by 8%. Total rental income benefited from the progress on recent acquisitions, which contributed GBP 7.3 million in the first half, more than offsetting the impact of disposals with total net rental income up by 9%. Turning to the balance sheet. Investment property decreased by GBP 236 million to GBP 2.5 billion. This was partly offset by lower net debt, with total net assets reducing to GBP 1.6 billion. Overall, EPRA NTA was down 10% to GBP 8.32. Slide 15 shows the change in the value of investment property over the last 6 months, with an increase from CapEx of GBP 34 million, outweighed by disposals of GBP 92 million and an underlying revaluation decrease of GBP 178 million. This next slide sets out the key drivers of the revaluation movement. There's lots of detail here. But on the left-hand side, you can see the valuation at 30th of September by property category. And on the right-hand side, you can see the valuation movements since March. In the first row is the like-for-like portfolio, which accounts for around 3/4 of the overall value. There was a 5.6% decrease in the like-for-like valuation, driven by a 45 basis point outward yield movement with equivalent yield now at 6.7%. That's now a 100 basis point yield movement over the last 18 months. And at 6.7% in absolute terms, our equivalent yield remains not only higher than much for the market, but also around 250 basis points higher than 5-year swap rates and our average cost of debt. Despite the strong increase we've seen in rents over the last 6 months, equivalent yield is still around 150 basis points higher than our initial yield with significant opportunity for further reversion. Following the strong post-COVID recovery in pricing we saw last year, ERV growth has returned to more historically normal levels. On average, ERVs were up around 1% in the first half. However, we saw stronger growth in ERVs for smaller spaces, which account for the majority of our lettings, with an increase of around 2% in the 6 months, the units under 1,000 square foot and pricing broadly flat for larger spaces. Valuation movements for non-like-for-like categories were also largely driven by market yields, albeit with more pronounced yield movement in the South East offices, reflecting the broader market outside London and with redevelopments also impacted by lower residential values and higher expected build costs. The significant yield expansion we've seen over the last 18 months has been driven by macroeconomic events. And whilst the potential for volatility remains, inflation is coming down, and there appears to be increasing confidence that interest rates have peaked with markets now pricing in rate cuts next year. Much of the impact of yield movements on our valuation over that time has been offset by ERV growth. And whilst, as I say, this has now returned to more historic levels, the opportunity to mitigate further yield movements remains and as yields stabilize, the opportunity to drive valuation growth. On this slide, we show how NTA per share might change for a range of movements in both yield and ERV on the like-for-like portfolio. With equivalent yield already relatively high at 6.7%, further yield movements have relatively less impact. As an example, a further 25 basis point yield movement would be largely offset by a 2.5% increase in ERV, with NTA in that encased, falling by around 1% to GBP 8.21. Moving on to cash flow and net debt. Overall, net debt decreased to GBP 867 million at the end of September, with cash from operations, largely funding dividend payments of GBP 32 million and the GBP 92 million of proceeds from disposals more than offsetting a capital expenditure of GBP 36 million. When considering capital allocation, we remain focused on a strong balance sheet and a disciplined approach to gearing. We continue to recycle capital from selective disposals into our rolling pipeline of refurbishment and redevelopment projects, with CapEx weighted towards smaller, quicker, high-returning asset management projects such as unit subdivisions. In the medium term, we also expect to see increasingly attractive opportunities to recycle capital into property acquisitions. The majority of the group's net debt comprises long-term fixed rate facilities totaling GBP 665 million, with shorter-term liquidity provided by committed bank facilities. Together with GBP 4 million of cash, this gave us a total of GBP 133 million of cash and available facilities at the end of September. Disposals made in the period meant that despite the fall in property valuation, LTV remains comfortable, increasing marginally to 34%. Average interest cost was also broadly stable at 4.1%, with interest cover well ahead of our 2x covenant at 3.5x. Net debt to EBITDA continued to improve towards our 7.5x target, reducing from 9.3x to 8.5x. Following the recent extension of the maturity of our bank facilities to 2026, on a pro forma basis, we have an average drawn debt maturity of 4.1 years with no maturities until August 2025. Looking forward, we have good earnings momentum and expect further progress in the second half of the year. Rental income will be underpinned by the 6.3% growth in like-for-like rent roll that we saw during the first 6 months, as well as further uplift from reversionary pricing on new deals. The recent high levels of inflation appear to be moderating, which will reduce pressure on costs, the majority of which are recovered from our customers. The disposals we've completed in the first half of the year have reduced our debt, which combined with stabilization of interest rates should result in lower interest costs in the second half. Capital expenditure in the second half will be around GBP 30 million, which we expect to be more than offset by second half disposals. So in summary, we have a robust balance sheet, good momentum and well set for a full-year -- good full-year performance. And I'll now hand back to Graham to talk through the longer-term opportunity.

Okay. Well, thanks, Dave. And as I said, I would like to just run through now what I see is the growth opportunity for Workspace in the coming years in a little bit more detail. So firstly, in terms of the market, based on -- on the left-hand side is sort of the latest estimate of the size of the London market in terms of number of businesses, just over GBP 1 million in total. Within that, though, our target market is a smaller, more focused element, which is SMEs largely in the service and creative sectors that employ people. Latest estimate suggests that market is around 134,000 businesses across London. We've got 4,000 customers. So, we've got around a 3% market share of this addressable market in London. So, there's still plenty to go for, for us. In terms of the spread of those target SMEs across London and you'll have seen this chart before, it's a very broad spread in terms of location across London. Only 1/4 of the SMEs in terms of our target population are in those more central areas of London. And that's really one of the questions that people have raised with us sometimes is, why is the competitor market for you so fragmented? Well, if you want to be a large player in this market, you need to have a widespread of properties across London, and that's a challenge for a lot of competitors. So when we look at the challenges and opportunities, we are very excited. We do think we have a really significant competitive advantage. And if I just ran through the reasons why we believe that to be the case, first of all, we do have a broad spread of properties across London, which we own. 5 million square feet of space across 76 locations across London. Crucially as well, we've got the buildings that we own are very well -- work very well for a multi-let configuration. Not all buildings work well for our model. We also have a high level of brand recognition. And alongside that are teams of trusted landlord, particularly relevant when we talk about the challenges that some other competitors like WeWork have had. We also have got a flexible offer, as I've highlighted previously. They're very much aligned with the needs of our SME population. And I guess another crucial point is we've got a scalable operating platform that delivers us efficiencies that you can't achieve when you only own 1 or 2 buildings and you're competing against us. And lastly, we've got teams both in our centers and both in our central operations and have got years of experience and knowledge and expertise around managing the needs of our SME population. So really, for us, what we see is a significant competitive advantage to take advantage of what we see is a very large fragmented market opportunity. So what would that look like in terms of future income growth? Well, first of all, and Dave mentioned earlier, the rent reversion. We have a significant level of rent reversion across our portfolio. Around GBP 32 million of potential upside to rents. And if I just run through these in turn, and first, on the left-hand side, within our core like-for-like portfolio and our South East offices, we've got around GBP 18 million of rent reversion. And rent reversion is, for us, is bringing all of our occupancies and our business centers and buildings up to 90% occupancy and bringing everyone up to current pricing levels. And if we can achieve that in our core like-for-like and South East offices portfolio and most of it is actually within the like-for-like portfolio, we can, as I say, garner around GBP 18 million of upside on rental income. And given that actually, most of our leases are relatively short term, typically a 2-year lease, we can capture that rent reversion, moving people up to current pricing relatively quickly, either on renewal or actually when they change their space requirements. Equally, of course, we can capture that when new customers come into our portfolio. So potentially, we can capture that reversion within the next 2 years to 3 years. On the right-hand side, in terms of project activity, firstly, in terms of projects completed, there are 8 projects that we've now completed. We're now letting them up, target being to move them all up to 90% occupancy. We're well underway there. We're at 75% occupancy overall at the moment. If we can move those all up to 90% occupancy, there's a GBP 3 million of additional rent to come from actually achieving that 90% occupancy level at current ERVs. And then lastly, in terms of projects underway, these are projects currently underway, a range of projects all finishing in the next 1 to 2 years. Once they are completed, we then, of course, have got the task of letting them up. But if we can achieve what we've done with pretty much all of our other refurbishment, redevelopment projects, if we get them back to 90% occupancy, there's a further GBP 11 million of rental income to come from those as well. So in total, from those 3 categories, there's GBP 32 million of uplift in rental income to come, a lot of it over the next 1 to 2 years and obviously, spreading out to 2 years to 3 years on some of the projects underway. Alongside that, we can also drive income from actually increasing on pricing, as measured by ERVs. What I'm showing on this chart here is actually the ERVs, the average ERVs across our like-for-like portfolio. There's 42 properties in our like-for-like portfolio. And I've shown here the range of average ERVs across those buildings. And you'll see there's no surprise, there's quite a large variation depending on location. So at one end, you've got, for example, Fuel Tank at Deptford. Average ERVs here, GBP 22 a square foot. No surprise to see at the other end, some of the more centrally located buildings. So The Frames at Shoreditch, the average rent there, average ERV is GBP 77 a square foot. So, we've got this very broad range of price points across London. Equally, within any one building, we've got a variation in pricing as well. So Leather Market, London Bridge, average rent around GBP 48 a square foot. Some units in that building are priced at as low as GBP 15 a square foot. Other units are GBP 80 a square foot. We've got a broad variation because bear in mind, every unit has different characteristics in the building. So whether you are in the basement or the top floor, a very different price point. And this is diversity in pricing, both across the portfolio and also within each of our buildings, that gives us a really fantastic opportunity to tap in to different demand at different pricing levels for different types of customer. Equally, for existing customers, they can move up or down in terms of pricing as their circumstances change. In addition, overall rents over the last 18 months have grown significantly. ERVs have grown by 15% over the last 18 months across its portfolio. And we're, indeed, we're back at most of our centers now across this like-for-like portfolio at or slightly ahead of pre-COVID levels. And a lot of that growth over the last 15 months, 18 months has been really capturing again the COVID pricing levels, the lower pricing levels that we actually had to price at during COVID. So having now reached back to pre-COVID levels of pricing, I would expect a much more normalized rate of growth in ERVs as we go forward. And typically, if you go back over time, the pricing growth per annum in ERVs will be up to around 5% per annum. So the other element of growth for us have been very successful in terms of delivering very good returns over a long period now is our project pipeline. And this is really just to highlight here, the forward-looking projects that we've still got in the pipeline. They stretch out much further timelines to some of the other near-term opportunities we've got, but a really exciting opportunity for us to actually garner good returns from the repositioning around 1 million square feet of new and upgraded space across our portfolio. Now the timelines in terms of delivery of these projects will depend upon getting planning for some of them, getting vacant possession, as well as intentionally phasing our projects to make sure that we can overall maintain a strong level of income growth across the portfolio. And indeed, actually this is not a land bank. These are actually good income earning assets they stand today. In fact, across this portfolio of pipeline is around GBP 21 million of existing rent roll. So we've got a real opportunity to grow it, but equally, it's a good income earning set of assets already. So when you put that all together, then you'll have seen this waterfall chart before. We've got a very significant opportunity to grow income strongly over the coming years. Initially, on the left-hand side, highlighting the rent reversion, GBP 32 million of upside from driving the rent reversion across our portfolio. That's the like-for-like portfolio, that's the completed projects and the projects underway. That's around 23% uplift on the rent we've got today of GBP 142 million. So a significant opportunity to grow income over the coming years. As I say, most of this should be delivered over the next 2 years to 3 years. So, you can see a very strong underpinning of income growth in the coming 2 years to 3 years. On top of that, of course, we also got pricing opportunities to push pricing forward. We've got the delivery from our project pipeline over time and, of course, then also the opportunity to actually garner returns from future acquisitions. So overall, I think we've got a very good story around being able to drive strong income growth, profit growth and of course, on the back of that, dividend growth. And the majority of that is under our own control. So in summary, we are a highly operational business, with a distinctive offer focused around the SME community in a fragmented market where we think we've got really exciting opportunity. And our success, just to highlight again, remind you, it's really much down to the skills and expertise of the team that we have across Workspace. And I'd just like to say thanks for our team for all their efforts in the first half of this year. It's been a fantastic effort. And as David just highlighted, we've had a good first half of the year and we're well set to deliver strong trading performance for the full year. Now in terms of valuations, we have seen a reduction in valuations. We may see further yield movement. But I would like to think that some of it, if not all, can be offset by our active asset management and any further growth in ERVs. And then looking beyond the current year, I do think we've really got a very exciting opportunity to continue to grow income, drive dividend growth, equally in time also take opportunity in this fragmented market with our significant competitive advantage, take advantage of acquisition opportunities as well. So, I think we're well set both near term and longer term for significant growth in this business. And on that note, I'd like to thank you all for your time this morning and now open up for any questions you may have. So just to take, can we first of all take questions from the floor here before we then open up the calls through the conference call and webcast. Please, if you can have your name and company you represent when you ask the question.

Bjorn Zietsman, Liberum Capital. Just a quick question. You mentioned that you may be willing to take advantage of acquisition opportunities. Just looking at your LTV levels, would you be considering reducing those LTV levels or increasing them? And are you comfortable with the current leverage?

Yes. I mean, I think, as Dave mentioned, we are very conscious of maintaining tight discipline over sort of, if you like, gearing. I think, obviously, we've got further disposals we're planning for the second half of this year, which should help actually hold the gearing constant. Equally, I think you're right. I mean, we are conscious of maintaining a sensible LTV. So, we certainly wouldn't want to overstress the balance sheet. But equally, if there are good opportunities out there, good income earning asset opportunities, we will look at those. But I think you're right, we would want to maintain a sensible level of LTV.

Max Nimmo at Numis. Maybe just a quick one to follow up there. A sensible level, is that 35-ish below? Is that what we're kind of roughly...

I think where we are today and ideally getting down to around 30% through the cycle, yes.

Okay. Great. And the other question I had was just on -- you talked about ERV growth getting back to kind of more historic normalized levels. I do know that that's 1% in the first half. It's quite a long way behind that sort of 5% level. And I appreciate in the last year, there was quite a bit of a catch-up effect. You were up sort of 13% on that front. But it stands out in a time when many of your "peers", I don't want to use that word, but are accelerating on the rental growth front. And you're obviously quite a bit lower at 1% there. So how should we think of that? Is that just a one-off effect because of what we've had before and the catch-up we've had? Or is there something else there?

No. I mean, I think you've got to be conscious of the price rises that our customers have seen over the last 2 years. I mean, we highlighted on renewals in the first half of the year. On average, our customers have seen a 20% increase in their rents. So, we are aiming to try and maintain the -- retain our customers alongside actually push pricing forward. I think we've seen, as you say, a very strong growth over the last 18 months. We've seen a slow rate of growth in the first half of the year. I think we'll be cautiously pushing forward pricing in the second half of the year where we see opportunity. But I think this year, we will be probably a slower rate of ERV growth than historically we've seen. But equally, I think longer term, I still see opportunities to continue to push pricing forward. Alongside that, of course, though, we've got significant amount of reversion to bring actually customers up to current pricing levels. A lot of those, obviously, have signed deals over the last 2 years. And there is going to be quite a significant jump in pricing for a number of them. So, I think we are conscious in this more challenging economic environment, not to push pricing too fast. And if I was critical of sometimes in the past, we've actually just kept pushing pricing and actually at the expense of occupancy. Our core focus will be to make sure we can keep those in check so that we can maintain good occupancy levels, push pricing forward where it makes sense. But actually, at the moment, I think the biggest opportunity for us is to continue to capture the reversion across our portfolio.

Callum Marley from Kolytics. Congratulations on another 6 months. Just looking at the recent economic data that has come out over the past month or so, it appears from a surface level that the UK economy is beginning to slow. Could you just comment on the health of the different small medium businesses in London? And any specific challenges they might be facing? And then as a follow-up. What is your outlook for these businesses going into 2024? Are they still looking at upsizing? Or are you looking at downsizing, maybe some occupiers to keep them in the portfolio?

Yes. I mean, it's hard to generalize because we've highlighted, we've got such a broad spread of business across different sectors. But I think what we're still seeing is on, on average, there's far more companies in our portfolio expanding than contracting, which is always a good sign for us. I mean, I think in more challenging times, we've seen it reverse and then go back over the GFC and certainly through COVID. So, we're not seeing any dramatic signs of a downturn in the vibrancy of that customer base. Equally, there will be challenged -- some sectors more challenged than others in this current economic environment. So my outlook for next year would be at the moment is, given what we're seeing on the ground is a steady performance, not stellar. I think there are lots of challenges for any company in any sector at the moment. But certainly nothing that would suggest a significant downward trajectory from where we are today.

Adam Shapton from Green Street. Not to sort of flog the ERV topic too much, but just maybe digging into what you've disclosed. So 0 ERV growth in larger units, 2% of smaller units. So just a 2-part question. First is, can you split that smaller unit ERV growth into genuine organic growth and units where you, for example, installed air conditioning or done other kind of like refurbs. So is there -- if you haven't done any of that CapEx, would there been ERV growth there? And then more broadly on this large versus small unit points. It's on Slide 10. All of your projects include unit subdivision. Is this a sort of structural point about your customer base needs less space per business than it used to, but is willing to pay higher rents? Or is it that your portfolio just wasn't quite the right shape for what industry required? What's the story there?

No, yes. I think, on the first point, without disappointing you, I don't think I can give you the answer of the split between those in the existing space. I mean, we generally upgrade space as we get it back before, actually, a new customer comes in. That's part of our new, normal unit prep. But I would say, as much of that demand is from internal customers renewing or taking new space within the portfolio. And the attraction for us of smaller spaces, generally, it gets a higher premium. So, we typically about GBP 5 higher average ERV for smaller space than larger space. So, actually, the move towards smaller units is something we like because actually we can get a higher price point, albeit the gross to net is slightly adverse. In terms of the demand characteristics, we've always see this. In this stage of the cycle, it's not so much come about customers downsizing because as I said, actually, more customers at the moment are expanding than contracting. It's just that demand generally is there's a lot more business creation at the smaller end of the market in this current environment. Larger customers tend not to be the ones that are growing, taking more space at this stage in the cycle. We do always see and if we go back over the last 2 cycles that I've seen, we always see stronger demand at this stage in the economy for smaller space from much smaller businesses growing and coming into our space. I can guarantee you that as the economy recovers, we'll be actually then removing those subdivisions and creating larger space, which is, again, what we saw in 2013, 2014. So it's very much a sort of a reflection of where we are in the economic cycle.

It's James Carswell from Peel Hunt. The statement talks a little bit about some of the service charges rising given inflation, and I appreciate you passed that most of that onto your customers. But I'm just thinking, does that slightly inhibit the rental growth you can achieve in the short term because, obviously, the all-in cost is already rising?

Absolutely right. Dave?

Yes. I mean, obviously, we do pass it on. So, there is an impact on net rent. But what we've seen over the first half and building on what we've seen previously, the growth we can achieve generally outweighs that. So yes, there is some small impact. I think it's -- obviously, it's helpful that inflation is now coming down. And certainly, the pressure that we've seen over the previous 12 months is going to be hopefully much less over the next 12 months. So, I think it's a reducing issue rather than anything else.

And obviously, we benefit by virtue that we did hedge our energy costs. So that helped mitigate some of the impact on our customers. But you're right. I mean, I think some time people forget, it's an all-in cost that people see. So it's both the service charge cost. And of course, for those that do pay rates, although about 50% of our customers don't, the ratable costs as well are all part of what our customers see as a total cost of occupation.

Denese Newton from Stifel. Just to follow up on those service charges. Obviously, you've done very well hedging your energy costs upfront, but those hedges will roll off. What will be the impact of that?

Well, I guess, since we hedged, prices have gone up very significantly and then come down again quite significantly. So if you look at where market pricing is now, it is slightly ahead of where we've hedged. So, there would be some uplift. Having said that, we are at the moment in the process of hedging even longer term actually. So, I would hope that we won't see a significant impact. As we said, the majority of that cost is passed on to customers. But I'm hoping that we -- partly because the market's moved, recovered a bit, but also because the hedging that we're putting in place, it should be a modest impact going forward, I think.

I think it's worth highlighting that sometime people forget, because we procure energy for a majority of our customers, we have much more leverage in terms of buying energy than your typical landlord. So actually, as a scale player in the market, we can actually get better deals and certainly on a longer-term basis as well. Any other questions from the floor? Okay. Any questions remotely?

The first question comes from the line of Paul May with Barclays.

Just a couple from me. On the first one, I just wondered what are the yields expected on developments, refurbishments as in yield on cost? And does this make sense against marginal financing costs, which I think you said was around 7%? And the second one, more broadly on the business. What are you planning to do to address the higher cost base, cost ratio, lower EBIT margin that you generate? You mentioned equivalent yields are above in-place weighted average cost of debt but are below marginal. And when adjusted for your EBIT margin, your EBIT yield, even at ERV is materially below the marginal financing cost. So firstly, what are you going to do to address that? And then secondly, does the 30% LTV at 7% cost makes sense when your EBIT margin is materially below that -- EBIT yield, sorry, is materially below that?

Okay. I'll kick off on the reversion, then you can answer the question on....

Okay. You might have to repeat a few of them, but we'll give it a go.

I guess in terms of our refurbs, redevelopment pipeline, we're pretty rigorous on looking at the returns that we want before we'll start on any project. As I said, these are not land bank opportunities. These are good income-earning assets. So, there's not a burning hole in our sort of pocket by not progressing them. Our target typically would be at least an 8% ungeared IRR over 5 years from any project we want to progress with. And that is going to be the maximum as we go forward. And if we can achieve those returns, we'll continue to run them as is until we're comfortable with both the returns and any risks around contractors, suppliers, et cetera, and timelines for delivery. And I'm very happy with the projects we've got underway. I think they're all good -- very good projects, will give us good returns. So both Leroy House and also the other 2 Chocolate Factory and The Biscuit Factory in Bermondsey are all good projects that we're very excited about. Equally, I'd say, in terms of new projects, as you say, I mean, we are going to be very challenging around the returns, and we will hold off until we think those make sense. Generally though, I'll have to say all of them are looking very attractive in terms of opportunity. But none actually are being really commenced in the next 6 months. So, we've still got a bit of time given the sort of fluctuations in the sort of cost of materials, timelines for delivery of schemes to actually take a very cautious view at the moment around starting any program until we're very confident about the returns, which is why in the meantime, we're still focusing on a lot of the smaller projects where we have got much better control over costs given the shorter time scales as well as the very good returns we're getting from them. Dave, in terms of gearing and marginal cost?

Yes. I mean, as you say, so equivalent yield at the moment, 6.7%, marginal cost of debt about 7%, so pretty similar. As I said, I think the expectations now are for rent -- sorry, for interest rates to stabilize and then people are pricing cuts. The 5-year swap is about 4.2% versus SONIA at 5.2% at the moment. So, I would expect that marginal cost of borrowing to be coming down below the equivalent yield. In terms of cost ratio and what we would expect, we've obviously been growing EBITDA over the last 2 years, 3 years, recovering from COVID. And as Graham has said, we've got significant opportunity for reversion just that alone bringing up rents by about GBP 30 million, which will obviously flow through to EBITDA margins. So, I think I would expect us to be improving those EBITDA margins over the next 2 years quite significantly. As I said, cost inflation coming down as well. So both of those things, I guess, we've been -- the whole sector has been in a perfect storm over the last couple of years. But I think the trajectory for that is improved moving forward.

And I think, obviously, the marginal cost of debt, I mean, we are bringing down the drawings on our marginal facilities by virtue of the disposals that we've made and continue to make. So, we're very focused on bringing down that marginal cost of debt.

I think I can follow-up on that. Can you still hear me?

We will.

The next question comes from the line of Ventsi Iliev with Kempen.

So, you show the slide with the distribution of like-for-like properties in terms of the ERV level. Naturally, some properties are below the average and naturally some are above. But my question is, is there potential to bring the level for the properties below closer to the average? Or is it more a function of the location of those properties?

The answer to that is yes. I mean, some of those are going to be subject to the refurbishment, redevelopment plans we've got in place. A good example would be actually in The Chocolate Factory in Wood Green. It's an area that we do see potential for quite a significant uplift in rents over time. The challenge we've got with moving the rents up is you've got to make sure that there's a demand of the customers at a higher price point. And that's really the traction we have across London. The gentrification of London is actually timing the uplift in the quality of the space with actually being able to actually capture pricing at that higher level. So the answer is yes. I mean, equally, notwithstanding the lower pricing, actually, the growth rates we can achieve at some of those centers from their current rents without actually major refurbishment or redevelopment actually are quite significant. So what I like is, actually, we do have demand at different pricing levels, all giving us good growth. But yes, in time, I would like to bring up some of those lower sort of priced units to the higher level. And in fact, we've highlighted in the past, a good example would be in Hackney in Mare Street. It was an old industrial unit, which actually we've now repositioned as a sort of a high-end business center. And we've pretty much doubled or actually more than doubled, trebled the rents there by virtue of actually repositioning that building. But it has to be done hand in hand with actually the gentrification, the change in the nature of demand from SME to that location.

We have a follow-up from Paul May with Barclays.

Sorry about that. I didn't realize you could still hit me. Just following up on the second question around, I suppose the EBIT yield versus the marginal financing cost. Because I think even with a recovery in EBITDA up to ERVs, you still end up with a quite materially lower EBIT margin -- or EBIT yield, sorry, versus your financing cost. So, just trying to understand why leverage is something that you think is appropriate, given it would be effectively loss making from an income perspective?

I think, as we said, I think the focus is on driving down leverage. So, we've made the GBP 92 million disposal in the first half, GBP 13 million so far in the second half. So, we are continuing to make those disposals to bring down leverage. And as Graham says, as we pay off the marginal debt, say, 3/4 of the debt is a longer-term fixed rate and those are lower rates. So the average rate on the fixed rate debt is about 2.9%. So as we make those disposals, bring down that leverage and pay off the marginal debt, it obviously brings down our overall interest cost quite significantly.

Just following up on that. You mentioned earlier, I think on wanting to look for opportunities, wanting to make acquisitions, looking at developments. Obviously, that would increase your financing and require marginal financing costs to do so, I assume. So, I wonder how you're sort of squaring everything and reconciling all the various things you're aiming to do? Does it ultimately mean that growth will be funded through equity? Or do you still plan to fund that through debt?

I mean, I think over time, I don't think anything at the moment, but we look at both the debt and the equity markets to fund our growth. We think there's great opportunity there. I don't think there's any need for us to actually do anything significant in terms of being able to deliver growth over the coming years based on what's under our control. Equally, we will look to recycle assets that we own, maybe into other opportunities over time. But I think we're conscious, as you highlight, that actually we got to maintain a prudent balance sheet and it's got to make economic sense. So, I think we are very measured in our approach. But equally, a lot of the opportunity be internal opportunity as well. We are investing north of GBP 60 million a year at the moment in our CapEx because we know we can get very good returns from that investment.

Just one question from the web from Allison Sun of Bank of America about disposal. So asking what type of assets we're expecting to dispose of in the future?

Yes. Well, I mean, I guess, initially, we've got the stub end of the non-core assets. So, there's around GBP 35 million of those, which hopefully will complete in the second half of the year. They are a combination of industrial estates and some residential schemes. Over and above that, we've got our normal recycling. We've always got a tail of properties within our portfolio, where we look on a rolling basis at the returns we may get from those. And actually, if we think we can recycle those funds into more attractive opportunities, we will do that. So that would be a combination of any number of the assets we've got. So it could be some of the light industrial assets we own. It could be equally some of the office assets we own, So we will look across our portfolio. But when you got a GBP 2.5 billion portfolio, there's always opportunity. We've got a lot of properties. We've got a lot of angles around our portfolio. So, I would say that we are looking at the moment, as I say, to dispose the non-core, but there'll always be other opportunity to make disposals. Any other, Clare? Okay. Right. Okay. On that note, I'd like to thank you all for your time today and wish you a good day.

This presentation has now ended.