Earnings Call: H2 2021

Aug 25, 2021

I would now like to hand the conference over to Ms. Nikki Panagopoulos, Fund Manager. Please go ahead. Good morning, everyone. Thank you for joining us and welcome to the annual results announcement for the Australian Unity Office Fund for financial year 2021. My name is Nicky Panagopoulos and I'm the Fund Manager for AOS and I'm joining you from Melbourne. I'm also joined by Simon Beek, the Portfolio Manager for AOS, who is in Sydney. I was appointed as the AOS Fund Management in July, having spent more than 30 years in the property industry in both listed and unlisted markets, including the last 17 years at Australian Unity. I'm very excited about the opportunity to lead AOS into the next phase of its journey. And I look forward to working with our unitholders and tenants to drive mutually beneficial outcomes. Earlier today, we published various documents on the ASICS, including the annual financial report, Appendix 4A, AOS Property Book and the investor presentation, which we'll go through this morning. Following the presentation, we will have time for Q and A. Let's now turn to Slide 2. Today, Simon and I will take you through the portfolio highlights for financial year 2021, provide details on the outcomes of the strategic assessment that we completed, update the key financial results and provide a property update and financial year 'twenty two guidance and outlook. We will also highlight our AOS portfolio is well positioned, offering affordable accommodation with excellent accessibility and amenity. Let's now turn to Slide 3. Before I start, I would like to take this opportunity to acknowledge the traditional custodians of the land our properties are located on and pay my respects to Elders Park present and emerging. Slide 5. It is pleasing to advise that AOS had an excellent year with funds from operations at the top end of guidance at $0.187 per unit and occupancy increasing by 2% to approximately 96%. The increase in occupancy was driven by strong leasing outcomes with approximately 16,500 square meters completed during the year. This equates to 15% of the portfolio and was largely driven by small to medium enterprise tenants looking for affordable accommodation, closer to home with good amenity and easily accessible by car and public transport for staff convenience. The fund provided approximately $500,000 of rent relief support to tenants impacted by COVID. This equates to about 1% of rental income. Pleasingly, collections remained robust during the year at 98% of financial year 2021 billings and over $1,000,000 of financial year 2020 arrears were also collected. This highlights the resilience of AOS tenants and the benefits of having a diversified and quality tenant base. Most importantly, the high collections demonstrate how we worked constructively with our tenants to ensure they could navigate through a very challenging period to continue their businesses. While we are by no means through this COVID pandemic, we do believe that we have the right framework in place to continue to support our tenants while ensuring returns to investors. At AOS half year results, it was announced that the Board had initiated a strategic assessment to challenge the existing strategy and examine all options to enhance value and generate returns for unitholders. The assessment including obtaining feedback from unitholders was completed during the year. Later in the presentation, I will provide details of the scenario, which were considered the strategic priorities, which were identified and the conclusion reached. For now, I will talk to AOS refined strategy. Let's turn to Slide 6. In July, we announced the conclusion of strategic assessment and I am pleased to provide the outcome, which prevents the refined strategy that delivers on the existing AOS strategy that is it's focused on owning Australian office properties in metropolitan and CBD markets, but complemented by a targeted and diversified portfolio of Australian real estate assets. Maintaining an office focus while investing in other asset classes helps to deliver a diversified income profile, which can withstand economic shocks while maintaining sustainable distributions. Together with active management strategies, including refurbishments, asset recycling and a balanced lease expiry profile, investor returns can be maximized. We believe that a well constructed portfolio with assets focused on affordability, amenity and accessibility will be well positioned to outperform. Let's now turn to Slide 7. IOS Active Management has seen approximately 16,500 square meters of leasing during the year, which equates to 15% of the portfolio NOI. This leasing has driven 2% in occupancy to 95.7% from 93.7% as of June 2020. This is an exceptional result considering it was delivered during periods of extended COVID related lockdowns. There was a good level of leasing activity, particularly at 468 St. Hill Road and at 5 Eden Park Drive with approximately 67% of the 16,500 square meters of leasing completed at these properties. Resulting in the occupancy for 5 Eden Park increasing by 3% to 96% and before success until the road, the weighted average lease expiry increased to 3.9 years from 2.3 years as of June 2020. I'm also pleased to announce that the last vacant suite at 5 Eden Park Drive has just been leased, delivering 100% occupancy. Seasonally, across the transactions, phased rents were typically atoraboveindependent valuations with incentives in line with prior periods. Turning our attention to the major expiries at 10 Valentine Avenue and 30 Pierry Street, the tenants continue to assess their accommodation needs, but their requirements have been delayed, impacted by COVID lockdown in New South Wales and Victoria. We expect them to make decisions as the accommodation requirements become clearer and they're exposed approach. At 10 Valentine Avenue in Parramatta, property in New South Wales is the major tenant, this lease expires in June 2022. As previously communicated, they did not exercise the 5 year option. We've been in regular dialogue with the property in New South Wales team, meeting with them as recently as last week to discuss their occupancy requirements. Property in New South Wales is liaising with a number of New South Wales government departments to finalize their future occupancy requirements. Parramatta remains a core market for Property in New South Wales due to the affordable nature of the market, while also providing excellent transport, accessibility and staff amenities. At 30 Pierry Street Adelaide, Telstra has recently come to the market with a circa 4,500 to 7,000 square meter occupancy requirement. We have been in active dialogue with Telstra's team working through their future requirement and service needs. It is important to note that Telstra does have a lease of 21 level, but does not occupy all of its floors having sublet by to a range of tenants. We have refurbishment strategies underway for 10 Valentine Avenue and 30 Pierry to reposition these assets with sample features including enhancing amenity to maximize the wellness experience. We believe this will position the assets well to capture future leasing opportunities. Let's now turn to Slide 8. Our asset management extends to recycling assets and enhancing portfolio construction. We successfully sold 241 Adelaide Street, Brisbane, an aging leasehold asset requiring significant capital expenditure and we'll redeploy the funds to 96 York Street, Bingley in the City of Logan in Brisbane. The Bingley asset is led to the City of Logan and will be occupied by the Department of Water for a 10 year term with 2 5 year options being newly constructed with sustainable greenstar and energy ratings, the property is well positioned to deliver on sustainable income strategy. We're also considering divesting 32 Phillips Street Parramatta to maintain a balanced portfolio construction in the Parramatta market as we commenced the refurbishment strategy on 10 Valentine Avenue and possibly 2 Valentine Avenue development providing a free commitment to achieve. Let's turn to Slide 10. As discussed earlier, the purpose of the strategic assessment was to challenge the existing strategy and examine options to maximize returns and realize value for the intercultures. We identified 3 broad categories to assess the range of scenarios. They were growing, enhance the portfolio, maintain the current portfolio and divest the portfolio and return capital. We established a comprehensive framework to assess the scenarios, including engagement with many of AOS investors, including institutional, high net worth and retail investors, and assessment of the strengths, weaknesses, opportunities and threats for AOS consideration of the future of office evaluation of AOS portfolio construction including a detailed assessment of AOS properties, tenants and future cash flow and an analysis of AOS position within the listed Real Estate Investment Trust universe. Turning to Slide 11. The outcome of the strategic assessment, which refined the existing strategy, complementing AOS continuing core focus on office with an expanded asset ownership mandate allowing AOS to own commercial real estate that aligns with the key asset attributes of affordability, disability and amenity. Core to achieving this strategy is to focus on enhancing the current portfolio, enhancing through acquisitions and divestments, enhancing through asset repositioning and development and enhancing through potential large scale portfolio combination. We've already started to deliver on our portfolio enhancement in a number of ways, including the divestment of 241 Adelaide Street in Brisbane, the acquisition of 96 York Street, Bingley, the potential divestment of 32 Phillips Street in Parramatta, the initiatives being considered at 30 Kiry Street, Adelaide and Valentine Avenue, Parramatta and the ongoing assessment of the potential merger with the diversified property funds. Specifically on the investigation of the merger with DPF, we continue to believe this opportunity has financial and strategic merit. Over the last several weeks, management has been focused on finalizing year end accounts and preparing the results presentation. We continue our assessment of the merger and expect to update the market over the coming weeks. Various other initiatives were considered as part of the strategic assessment, including maintaining the current portfolio in various structures and divesting the current portfolio. These options didn't achieve the strategic priorities. In particular, a full portfolio divestment presented significant uncertainty around what process could actually be returned to unitholders and when. Further details regarding value uncertainty are included in the appendix. Finally, I would note that while strategic assessment has been completed, our focus will remain on maximizing churns and realizing value for unitholders. I'll now hand over to Simon, who will provide an update on AOF's annual results. Thank you, Nicky. And turning to Slide 13. As Nicky discussed, AOF had a strong FY 2021 with FFO of $0.187 per unit at the top end of guidance. Distributions of $0.15 per unit were in line with guidance. The profit for the year increased by $10,000,000 to $23,300,000 The increase was due to a combination of low borrowing costs, low trust expenses, improved valuation outcomes and again on the mark to market valuation of interest rate swaps. The NCA for the year was $2.71 per unit. Turning to Slide 14. All assets were independently revalued during the year with an overall increase from 30th June 2020 independent valuations of $5,950,000 The portfolio capitalization rate turned by 25 basis points to 5.84%. The 2 Macquarie Park assets experienced strong valuation growth, driven by strong leasing outcomes and cap rate compression. 2 to 10 Valentine Avenue, Parramatta also increased in value, driven by an increase in the valuation of the development site. The valuation of 30 Pirie Street Adelaide reduced due to an increase in the capital expenditure refurbishment allowances. Turning to Slide 15. The capital structure of AOF remains robust. Gaming is 28.4 percent with $190,800,000 of debt drawn against $250,000,000 of debt facilities. The drawn debt will increase post the settlement in 96 York Street, Benleigh in December this year. The cost of debt has reduced to 2.9% as of today and is expected to reduce further once an interest rate swap expires later in June 2020. There remains significant headwind to the debt covenants. I'll now hand back to Nicky, who will provide an update on AOS portfolio positioning. Thank you, Simon. Now let's turn to Slide 17 and portfolio positioning. As discussed, the AOS portfolio is built around 3 key themes, affordability, amenity and accessibility. AOS states to hold assets that are positioned in markets that offer great amenity with retail or open space convenience and are hardly accessible with existing infrastructure or will benefit from future infrastructure investments. AOS underlying allocation of 67% by book value to metropolitan markets and 33% to the smaller Australian CBDs with affordable rents positions it well. Turning to Slide 18. The markets where AOF assets are located, which are highlighted in orange on the table, have grown effective rents between 53% 68% discount to Sydney CBD. In a cost conscious environment where employees are seeking to work closer to home, we believe these markets are well positioned as they offer a distinct cost advantage while typically having greater visibility and amenity staff. AOS average capitalization rate of approximately 5.8 percent is at the top end of the yield range for these markets and provides an opportunity for valuation growth. Turning to Slide 19. The environmental credentials of ALS portfolio are a key focus. An important objective of the upcoming refurbishment programs will be to improve the environmental credentials and implementing initiatives to enhance the occupancy experience and wellness. Enhancing the portfolio's neighbors ratings and collaborating with tenants to implement ESG initiatives in lease agreements is also a key focus. From a social and governance perspective, AOS aligns with the Australian Unity Group more broadly and benefits from the group's broader expertise and built on the group's framework of community focused, connection and diversity, reconciliation and the model slavery assessment criteria. Importantly, AOS as a majority independent board. Turning to Slide 20, I'm pleased to provide FFO guidance of CAD 0.18 to CAD 0.185 per unit and distribution guidance of CAD 0.152 per unit for financial year 2022. FFO guidance includes an allowance for the disposal of 241 Adelaide Street, Brisbane, the acquisition of 96 York Street, Binley, additional rent relief support to tenants impacted by the COVID pandemic, noting the recent lockdown in Sydney and Melbourne and for the potential sale of 32 Phillip Street Parramatta. Our focus remains on enhancing value and delivering this possible returns to unitholders. To achieve this, the near term priorities are to drive the active management strategy and deliver leasing outcomes to maintain and improve sustainable distribution. To execute on the asset refurbishment initiatives to improve occupancy levels, rents and capital values. Deliver on portfolio repositioning priorities and including the settlement of 96 York Street Bingley and exploring the divestment of 32 Phillips Street, Parramatta. And finally, maximize value for unitholders by implementing the refined strategy. In closing, I thank you for your time today and for your investment in AOS. We look forward to continuing to advance the priorities listed and providing an update to investors in due course with a focus on delivering the best possible returns. This concludes the formal part of our presentation. I will now pass you back to the moderator for Q and A. Thank The first question we have comes from Lianne Truong from Ord Minett. Please go ahead. Good morning, Simon. Good morning, Mickey. Just some questions from me. The first one, read the financial year 2022 guidance. It looks like it's below financial year 2021. You did touch a bit on that. Can you just explain, I guess, or talk about what assumptions in terms of rental relief and the divestment of $32,000,000 Philip, that you've assumed in there? Hi, Leanne. Thanks very much for your question. Yes, I will I'll hand over to Simon with regards to discuss on the rent relief assumptions because they have been modeled to a degree on what we witnessed in 2021, but he can provide more detail on that. And really from the 32 Phillips Street assumption, we've assumed that if we take the asset to market, noting the recent lockdowns now in New South Wales, appetite might be difficult to sell that asset this side of 'twenty one calendar year. But with our assumptions assume that possibly in quarter 1, there may be the possibility of that asset transacting. But I will just hand over to Simon because he has had within the financials, he has sort of allowed for a period of downtime for both the rent free and the sale. So Simon, handing over to you. So the main differences between the FY 'twenty one and FY 'twenty two financial year will be, I mean, 2 forty one Adelaide Street is obviously owned for that for pretty much the whole of FY 'twenty one, whereas it's been disposed of and it won't be owned at all during FY 'twenty two. 241 Adelaide Street, as we mentioned, we have recycled the cash into 86 York Street. But 86 York Street, the time of the settlement of that, that will not be until December. So effectively, you missed a 6 months' worth of income in relation to that. As Nicky previously mentioned, we are seeing the disposal to Phillips Street, but that won't be until probably until after the second half of the year. And in terms of COVID rent relief, we are seeing a similar level of COVID rent relief will have to be provided to support tenants compared to the F1 'twenty one levels. So in FY 'twenty one, we had about $350,000 and we're assuming a similar level into FY 'twenty two. Thanks, unless you have any more queries. Yes. Just on 32 Philip Street, I'm wondering what the strategy is there. There's a few lease expiries coming up there or a major lease expiry coming up. Are you going to look to sell it with that lease expiry or I guess renew or do some leasing activity before you sell that asset? Do you want to do it, Nicky or may? I don't mind. So I'll answer. So I mean, we are in discussions with GE Finance as well as some of the subtenants at the moment. Ideally, we would like to finalize those discussions prior to sale. But yes, I mean, it will all depend upon it at the time and shape. So I can't provide certainty either way. We will test the market's appetite. But ideally, we will finalize those discussions. And if I can jump in there as well, Lianne. I think the reality is that we are looking on embarking. As Simon said, to add to Simon, we're actively engaging with GE, but their expiry is in 2023. So it's still got a couple of years before it expires. But we are looking at embarking on our refurbishment projects. So if we can dispose of 32 fluids with still a 2 year lease term, then that would be an attractive proposition. I think that would provide also an opportunity for someone who's acquiring it, the opportunity to determine how they want to proceed with GE and the subtenants that currently exist in the property. Thanks. And just a final question from me. What's the timing in terms of the proposed merger? Good question, and thanks for that. I think we as we sort of communicated in the presentation, we've been working on the annual results and the presentation over the last month or so and have also been continuously discussing the merger proposition. At this point, we are still investigating the proposal, which we think has strategic merit and we will come out to the market over the next month, I'd say, or 2 or 3 weeks with a further update. Okay. Thanks guys. Thank you. The next question we have is from Marie Connellan from MA Financial. Thank you and Simon. I was wondering whether you could just give us a bit more color around the repositioning projects and marketing processes at Perry Street in 10 Ballantyne. Maybe just a bit of a better sense the timing around those projects. And I guess just what the level of inquiry has been so far? Yes. Thanks, Mario. I'll take that on board. Well, we have with both those refurbishment projects, have got a project team on hand to start that's been looking at the refurbishment and repositioning of those assets. If I talk initially about 30 Pierry Street, there is an existing lease in place, and Telstra do lease the whole building. So commencing some of those works are in collaboration with and with discussions with Telstra and understanding also their service needs as part of the future expiry. So commencing those research works is a collaboration, and we haven't determined how that's going to proceed at this stage because it's still because they do have a lease over the whole building. However, we are engaging on the type of offer and amenity that we're looking to present to the building and try and getting a collaborative approach with that. With 10 Valentine, there's again property in New South Wales that's got an existing lease over their entire building. We are in our position for working on that refurbishment design and intent with, again, the collaborating with property in New South Wales. I think as we sit here today, both and property in the refurbishment at 10 Valentine is of a similar ilk to that we're trying to achieve with 30 Perry and improving the amenity for it to be sustainable and introduce convenience and wellness to it. So the challenge we have is bringing all those refurbishment works with given tenants. And so that's a collaborative approach. And we do have to be mindful that the leases that are in place as well. So from a timing perspective, we're still working through that, but it is working with both those sitting tenants in a collaborative way. Thanks very much. If I can maybe just query on 150 Charlotte Street and that expiry of the lease of Boeing, would your assumption still be that Boeing will retain that tenancy? That Boeing, sorry, I didn't hear that bit. Sorry, Murray. Would you still expect them to would your assumption still be that they remain a tenant beyond the Cross 24? Yes. That's exactly right. Again, with all our tenants, we have collaborative discussions about their future occupancy. I think it's a bit too early to call with and for Boeing to make a decision, but all the discussions that we've been having and lean us to believe that they will be staying in situ and that's our assumption. I do note that they have refurbished some of the amenities within their premises. And in particular, they've integrated and upgraded their security system within the building, which is it was a proxy exercise. And we've been doing some work to improve their amenity and their connectivity between the floors. So from our perspective, it's our belief that they'll be staying well, I shouldn't say that. We are collaborating and it's our assumption that there's a good opportunity there. Okay. Thanks, Simon. I don't know if you want to add to that because and just bear with me Murray because I've been here for the last month, so I'm just getting myself on board with all the discussions today. The only thing I will add is they have also, over the past couple of years, been expanding within the building. And as such, we're optimistic that we will be able to renew them in due course. But as Mishi said, because it's rising until FY 'twenty four, it's a little bit too early to renew them at this time. Okay. Thanks. Thank you. No, ma'am, at this stage, it seems that we have no further questions. Do you have any closing comments? No. Well, I'd just like to thank everyone who listened in today, and I hope you found that useful. And as I said earlier, AOS Management and Board are here to maximize returns for investors and we can provide further details as we go along.