Thank you for standing by, and welcome to the Arena REIT FY 2022 results teleconference. All participants are in a listen-only mode. There will be a presentation, followed by a question and answer session. If you wish to ask a question, you will need to press the star key followed by the number one on your telephone keypad. I would now like to hand the conference over to Mr. Rob de Vos, Managing Director. Please go ahead.
Thank you very much, operator, and good morning, everyone, and a very warm welcome to Arena REIT's results presentation for the 2022 financial year. Our announcement, investor presentation and financial statements were released to the ASX earlier this morning. My name is Rob de Vos, Arena's Managing Director. Joining me on the call today is Gareth Winter, Arena's Chief Financial Officer.
Our presentation today will include a summary of highlights for the financial year and an update on our performance against strategy. Gareth will provide insights and detail into Arena's financial results and capital management position, and I will close the presentation with an update on portfolio operations and commentary on Arena's positive outlook in a changing investment environment. As always, there'll be a Q&A opportunity for questions at the end of the presentation.
Moving into the presentation on page 3, and despite the lingering direct and indirect impacts of the pandemic, changing work patterns, increased inflation and increased interest rates, the community need for services that Arena accommodates has remained strong. In this context, I'm pleased to report that financial year 2022 has been another successful year for business.
We've made solid progress against our investment objectives and ultimately achieved strong outcomes for our investors and ongoing positive outcomes for the many communities across Australia that rely on the essential services delivered from our tenant partners at Arena-owned properties. Arena's highlights for the financial year 2022 include a record statutory profit of AUD 334 million, an underlying cash-based net operating profit of AUD 56 million, which is up 8.4% on financial year 2021.
We've seen further valuation growth across the portfolio, contributing to an increase in net asset value, which is up 32% over the 12-month period. We've made further positive steps on our sustainability programs. We are pleased to announce today that Arena REIT has been certified carbon neutral by Climate Active for business operations in 2021, 2022.
We've also advanced our sustainability programs across our investment portfolio, with solar renewable energy systems now installed at over 200 properties, including 100 installations that were completed in the last 12 months. We've completed six early learning center development projects and replenished the development pipeline, which will support future earnings growth. We upgraded our financial year 2022 distribution during the period to AUD 0.16 per security, which reflected an 8% increase on financial year 2021.
Today, we are providing distribution guidance for financial year 2023 of AUD 0.168 per security, reflecting an increase of 5% on financial year 2022. Moving to the next slide. In an environment of heightened external risks, it is Arena's high conviction of maintaining our discipline and executing on our strategy that will underpin positive outcomes.
The highlights of the period under the team's key focus areas are in portfolio management. We've sold two early learning centers that relative to the balance of the portfolio, were less efficient and had lower utilization. They sold for total proceeds of AUD 10.1 million and a premium of 15% to book value. We've seen further valuation growth across the portfolio of AUD 254.5 million over the 12 months.
That starting yield on the portfolio is now 4.91%, having compressed by 86 points over that 12-month period. Our portfolio WALE has been maintained with lease extensions and WALE-accretive new projects being delivered throughout financial year 2022. The portfolio remains 100% occupied, which has been the case for over six years, and highlights the quality of the assets, the strong underlying fundamentals that support the social infrastructure sector, and the proactive management programs undertaken by the Arena team and our tenant partners.
Average rental growth was 4.1% across the portfolio, and the escalation mechanisms in our leases are doing exactly what they are designed to do, providing investors real growth in a low inflation environment, as has been the case up until recently, and maintain their real value in a higher inflation environment as we are in now.
During the period, we made further progress on our renewable energy program that is focused on collaborating with our tenant partners in installing and promoting the use of solar and reducing the energy intensity of our portfolio. These activities will reduce the operating costs of our tenants in an environment of otherwise steep increases in operating costs and reduce carbon emissions by approximately 2,700 tons per annum.
We've received 100% of our contracted rent due in financial year 2022, including all of the deferred rent payable under the COVID relief programs struck back in financial year 2020. We've acquired seven operating properties, six in South Australia and one in Melbourne. All have been acquired on a preferred long-term triple net lease and in aggregate cost AUD 47 million and provided a net initial yield on all costs, including transaction costs of 5.4%, and an initial weighted average lease term of 24 years.
We've completed six early learning center developments, and these projects had a total investment cost of AUD 36 million and a net initial yield on all costs, again, including transaction costs of 6.4%. We've also replenished our development pipeline with the acquisition of 9 new early learning center development sites.
Each project has been pre-committed on a new 20-year triple net lease, and combined they have a forecast cost of AUD 56 million. I'm moving now to an update on our sustainability programs. As you've heard me before, sustainability is fundamental to our investment approach, and we believe that best positions the business and our stakeholders to achieve positive long-term commercial outcomes.
With a disciplined investment process and being an internalized manager with strong governance protocols means that we are aligned with our investors for the long term. We're looking for sustainable growth and quality in our financial metrics, not short-term balance sheet scale. Arena's portfolio facilitates access to essential community services that provide a positive social impact.
We work with our tenant partners to invest the capital necessary to provide efficient, flexible, and well-located accommodation at sustainable rents, allowing them to focus on their core purpose to deliver essential services to communities throughout Australia. Further detail in relation to our sustainability activities will be provided in our 2022 sustainability report, which is scheduled to be released in late September.
The key outcomes over the period include an increase in collaboration with our tenant partners, including undertaking tenant workshops as part of our Partnerships for Positive Change program, a material increase in renewable energy, and reducing our tenant partners utility costs and reducing those negative impacts on the environment. We've improved action on climate change, including greenhouse gas inventory of Arena's financed emissions and inaugural TCFD-aligned climate risks and opportunity disclosures.
We've been certified carbon-neutral under Climate Active for business operations in 2021, 2022 and analyzed operations and supply chains to assist us to voluntarily opt into Modern Slavery Reporting. I'll now pass you over to Gareth to provide further detail on our financial results.
Thanks, Rob, and good morning, everyone. Just turn to page seven of the presentation, and you will find a summary of Arena's operating income statement for the year, which shows 8% increase in net operating profit to AUD 56 million and a statutory profit of AUD 334 million for the year. The reconciliation of that operating profit to statutory profit included in the appendix of the presentation, with the most substantial reconciliation after the net periodic revaluation of investment property.
Our operating EPS at AUD 0.163 is 7% higher than the prior period, with the key driver of the increase in operating income being 11.3% increase in property income, which has been derived from a combination of rent reviews and capital deployment.
Market-like rent reviews averaged 4.1% for the year, and I think that over 80% of rent reviews in FY 2022 had a direct link to CPI outcomes. For comparison, the national quarterly CPI averaged 4.4% during the FY 2022. Using a national annual rate is a simplified way of looking at our CPI-based rent reviews, as the actual reviews are staggered throughout the year and use state-based quarterly CPI measures. The recent higher quarterly CPI prints will provide further inflation protection to our cash flow into FY 2023 and FY 2024.
Also contributing with Arena's ongoing program of investment in ELC developments and new acquisitions, which continued gaining via capital deployment of AUD 105 million in FY 2022, including the completion of six ELC developments with total CapEx of AUD 36 million, the addition of nine new ELC developer projects to the pipeline with CapEx of AUD 56 million, and the acquisition of seven operating ELCs in conjunction with tenant partners for AUD 47 million.
We've also continued our program of selective capital recycling with proceeds of AUD 10 million from the sale of two ELCs during the year at a 15% premium to book value to be reinvested into the developer pipeline. Some specific comment on debt collections for the year. Arena's portfolio has continued to demonstrate high resilience.
There are no rent arrears, and all contracted rent is being received, including the collection of AUD 1 million of deferred rent during the year. Our COVID-related rent deferrals were relatively short-term, with only AUD 1 million of deferred rent still to be collected by December 2023. Deferred rent has been previously recognized as income and is booked as a receivable, with only the cash to be collected.
Just looking at some other items, property expenses, while relatively small, the scale has been primarily increased due to additional allowances for independent valuation costs and property inspections and some growth in the portfolio. Looking at our operating expenses, there's been a relatively modest increase in operating expenses compared to the comparative period from FY 2022, which has been highlighted at the half year.
This is due to a combination of factors such as corporate insurance and custodian fees, and also building our ESG capabilities. It's substantially due to the implementation in FY 2022 of the outcome of an independent remuneration review completed in late FY 2021. The rem review was focused on making sure Arena's remuneration framework was in line with contemporary market practice and the remuneration of Arena's team was in line with market, and importantly in the current environment, was to assist with staff retention.
I note that it has been four years since the last independent rem review was performed. Building on this is the benefit of the internalized management platform of dealings and costs. I suppose that while property revenues increased by AUD 6.8 million in the year, OpEx increased by less than AUD 500,000, and our cash MER remains well below 40 basis points.
Our expectation is that underlying costs will not grow at the same rate in FY 2023. Increase in finance costs is due to a combination of factors, the most substantial being a higher operating debt balance from the completion of 20 development projects over the past two financial years, which moved them from a period of capitalization interest and WIP to operating and the commencement of rental payments, and an expansion of our debt facility by AUD 100 million during the year to fund the developer pipeline.
Due to our ongoing high levels of hedging, the recent increases in floating rates have had only a very minor impact in the final quarter of the FY 2022. Higher statutory profit of AUD 334 million is primarily due to the growth in net operating earnings and also the positive asset revaluations of AUD 254 million during the year.
We've established FY 2023 distribution guidance of AUD 0.168 per security, which represents growth of 5% on FY 2022. I think it's worthwhile touching on some brief comments around guidance this year. There is still a degree of uncertainty on future interest rate movements and inflation, and some obvious and substantial divergence between market rates and the views of a variety of market commentators, bank economists, et cetera, on where and when rates and inflation will stabilize.
It's fair to say that we've left a bit more of a buffer in the distribution guidance this year than normal, and we will now see how the year unfolds. We have allowed for a further expansion in liquidity, an average BBSW across FY 2023 of circa 3%, with floating rates into the mid-3s by June 2023, and also adding incremental hedging when required to maintain our hedging in the usual 70%-80% range at the 5-year swap rate.
We forecast inflation at a quarterly annualized average of 6% across FY 2023, and there is obviously some complexity in the timing of the rent reviews occurring throughout the year. The full contribution from the CPI review isn't necessarily occurring until FY 2024.
Turning to page eight, the presentation, it's a waterfall chart demonstrating the relativity of the individual items supporting EPS growth, noting the impact in FY 2022 of the key drivers I've just discussed in approach to the rent reviews and deployment of capital in acquisitions and developments, offset by OpEx and funding mix, which is primarily expanded liquidity in the debt facility and the DRP.
Turning to page nine, this slide presents a summary of Arena's balance sheet. The full balance sheet is in the appendix to the presentation. Key points to note are the growth in total assets, primarily due to the AUD 105 million invested in acquisitions and developments during the year, and the asset revaluations of AUD 254 million, which is also the primary driver of the 32% increase in net assets per security.
Net gearing at 20% is well below Arena's maximum gearing range of circa 35%-40%. So that this level of gearing continues to provide substantial capacity to fund existing pipeline developments and allows us to take advantage of further growth opportunities, and also provide a buffer around any future market volatility as well.
Turning to page 10, it's got a capital management summary. Our approach to capital management continues to prioritize resilience and risk reduction through relatively low gearing, ongoing high level of hedge cover, regular extension of debt facility terms, and maintaining immediately available liquidity in excess of our development commitments. During the year, the debt facility was expanded by AUD 100 million, and at 30 June, we have over AUD 100 million of immediately available liquidity to cover AUD 88 million of future development commitments.
This liquidity, in combination with our modest gearing, allows us to actively consider further growth opportunities. The weighted average debt term of 3.4 years has now expired before March 2024, noting that our March 2025 expiry will extend out to March 2027 during the year.
Our relatively high ongoing hedge cover of 77% at 30 June for a weighted average term of 4.3 years, combined with the natural inflation hedge provided by the rent review mechanisms that are directly linked to CPI outcomes, provides us with substantial protection around our operating income in an environment where inflation and interest rates may rise.
Our all-in cost of debt as at 30 June has shown a modest increase of 25 basis points from the prior year, which is reflective of the circa 100 basis points increase in floating rates over the last quarter of FY 2022 on the unhedged portion of the debt. Finally, it is important to note that Arena is operating well within the requirements of our debt facility, and we have very substantial headroom in both our LVR and ICR covenants. I will now hand back to Rob, who will update us on the Arena's property portfolio.
Great. Thank you very much, Gareth. I'm now on page 12. As of 30 June, Arena owned 263 properties across Australia with a value of AUD 1.46 billion. The portfolio is just over 70 hectares in area, predominantly residentially zoned, with improvements that are purpose-built for our tenant partners. The portfolio accommodates o ver 25,000 families in their early learning needs across the country.
Our healthcare portfolio contributes to meeting the primary healthcare needs of eight communities and higher acuity care for 35 people living with high physical support needs in our SDA portfolio. The growth in the demand for the services we accommodate, along with our tenant partners' disciplined and proactive management programs, has resulted in the portfolio being in an excellent position. In 20 years, the portfolio has the longest contracted rent profile in the REIT sector.
To give that some context, the value of contracted future rent is well in excess of the current total portfolio value. With an exceptionally strong occupancy record, having had no vacancy in over 6 years, the portfolio has low single asset concentration, with the largest single asset accounting for only 2% of the value of the portfolio.
The land and building rate remains at just over AUD 2,000 a meter, which looks like compelling value when measured against other real estate asset classes. The passing yield was 4.91%, which has seen compression of 86 basis points in the last 12 months, which, added with rent increases, has provided valuation growth of just under 22%. Exceptional valuation growth in the period.
In the more recent environment of increasing interest rates, we do see the likelihood of some yield expansion in real estate markets, including in the social infrastructure property sector. A mitigating factor for yield expansion is, of course, rental growth, for which the portfolio is well positioned, not only as a result of having strong occupancy and triple net leases, and the fact that the vast majority of our leases escalate in line with inflation, but also a long-held focus of ensuring our rents have room for growth, so effectively coming from a lower base. Sector diversity for the portfolio has not materially changed in the period. Geographically, we have over 80% of the portfolio located in the high population eastern seaboard states.
In terms of tenant diversification, we continue to improve our spread of tenant partners, now totaling 34, with 25% of Arena's income supported by Australia's largest Early Learning provider, Goodstart. Moving on to the lease expiry on page 13. As you can see on the graph on this slide, we have less than 4% of the portfolio's income expiring prior to 2030, and no material concentration of expiries in any year to beyond 2045.
These are very long-term cash flows that have contracted annual escalations, providing inflation protection in the current environment. All of the leases are triple-net, with no exposure to variable property expenses, so highly efficient and highly predictable. There's some very minor leasing to do this financial year at two properties in Brisbane and Perth, which combined equates to about 0.9% of income.
We're confident of a positive outcome on both of these programs. The last point I want to make, or emphasize on this slide is that every one of our early learning center properties and our SDA properties provide us important business operating information that assists us in our asset management and capital allocation decisions.
It's been an important tool in assisting the portfolio remain 100% occupied for over six years, and it's particularly important in the current inflationary environment. Moving on to our rent profile, on page 14. Here on this slide, we've broken down our rent review structures for financial year 2023, 2024, and 2025.
At the bottom of the first column on that graph, you can see that 79% of this financial year's income is subject to a review at the higher of CPI or a fixed amount, which is generally 2.5%-3%. Moving up that column, 10.7% of this year's income is subject to a CPI-only increase.
If you add those two components together, that is the dark blue and dark gray components of the column, you can see that just over 90% of this financial year's income escalate in line with CPI. Further up the same column, we have 7.5% of fixed reviews, which average to around 3%, and 2.2% of income subject to a market review. These market reviews relate to seven early learning centers.
Four of the reviews are capped and collared at between no increase and a 7.5% increase, and three are collared but have no cap on the increase. It's a similar profile in each of our financial year 2024 and 2025. However, in financial year 2024, we have more market rent reviews totaling about 15% of that year's income.
All of those reviews have a collar at the passing rent, so the rent can't go backwards, and half of the reviews are subject to a cap of a 7.5% increase, while the other half have no cap on an increase. Flipping to page 15, the environment for development construction was challenging throughout financial year 2022, particularly in the second half, with heightened construction cost inflation, extreme weather events, and more recently, higher interest costs for all contractors.
In this context, we've seen relatively minor delays on some projects to date. Importantly, we've been sheltered from any meaningful economic impact as a result of the fund-through nature of our development programs, which provides contractual protections for time and cost overruns. The six early learning center projects completed in the financial year were located in metrop olitan Brisbane and Perth. Each were designed to suit each individual tenant's operations.
Pleasingly, all of them are operating in line with our and our tenant partner's expectation in their first year of trading. Four projects that we had originally anticipated completing in the second half of financial year 2022 will now complete in the first half of this year. In the absence of any worsening in the development and construction environment, we anticipate completing 12 projects over the course of financial year 2023.
Our origination programs continue to perform to our expectation. We've secured a targeted pipeline of quality early learning center development projects that will complement the portfolio and deliver future earnings growth. Looking forward, our development pipeline has 20 early learning center projects that are located in Queensland, Victoria, South Australia, and New South Wales, with a total forecast cost of AUD 139 million, of which we have capital expenditure outstanding of AUD 88 million.
We anticipate that the average initial yield on all costs, again, including transaction costs for these development projects, will be 5.5%. Each of these development projects are again being undertaken on a fund through basis, where Arena has contractual protection from cost and time variability. We've secured agreement for leases with existing tenant partners on every project in our standard 20-year triple net lease format.
As I've mentioned before, Arena is a leader in early learning center development in Australia and has an enviable record on executing on its development pipeline. By value, more than a third of our early learning center portfolio has been developed by us since listing in 2013. In that time, we've completed 60 development projects with 14 tenant partners across all states and territories, except the ACT.
These projects have increased access to early learning center services for over 7,000 children and provided our investors access to in excess of AUD 22 million of current annual rent. Moving on to the next slide. A quick update on the early learning center operating environment. Both major political parties recognize the importance of a well-functioning childcare system.
Changes to the Child Care Subsidy that were implemented in March 2022 by the previous Coalition federal government have had the effect of reducing the out-of-pocket cost of childcare services by 4.6%, according to recently published ABS data.
It has been well publicized, the newly elected Labor Federal Government has committed to further reduce the cost of childcare for Australian families by lifting the maximum Child Care Subsidy rate to 90% for the first child in care, and maintain the 95% subsidization rate for any subsequent child in care. The government has proposed reducing the rate that Child Care Subsidy tapers and to increase the maximum family income threshold for eligibility from AUD 354,000 to AUD 530,000.
This additional investment of about AUD 5 billion is designed to provide a significant economic and social return to Australia, including increased workforce participation and ultimately higher tax receipts, better economic security, particularly for women, and improving the lifelong learning prospects of children, in turn, creating better socially and emotionally well-adjusted communities, and a more qualified and productive workforce for future generations.
Demand for early learning services increased in the period, and the additional federal government subsidization, which is proposed to be implemented in July 2023, is designed to further increase demand for early learning services. The current challenge for the early learning operators that needs to be addressed to service that increased demand is a shortage of labor.
Like most industries across Australia, the current labor pool is simply too low, and as a result, operators' labor costs have increased as businesses seek to retain and attract staff. It is our expectation, and more importantly, that of our tenant partners, that labor costs will continue to increase in the short term, which added with increases across consumables and accommodation costs will lead to increased daily fees. In relation to supply, there was a net increase of 224 centers across Australia in financial year 2022, an increase of 2.7% in the twelfth-month period, which equals the lowest annual growth rate since 2016.
There's no real surprises in these numbers from us, as the majority of those new centers in this period commenced development in the early stages of the pandemic when activity was lessened due to the unknown impacts of COVID-19 at that time on the economy, childcare demand, and construction processes. We expect that future periods will see higher levels of new supply due to the increased government support of the sector, and as smaller, less efficient, and older centers continue to be replaced by newer, more efficient centers.
Moving to the next slide. Arena's early learning portfolio remains in a very strong position. We are 100% occupied, and we have collected 100% contracted rent through financial year 2022. Every one of our early learning centers is open and trading.
Every one of those centers provides us business operating data, and that data provides us important information that assists asset management and capital allocation decisions, as well as providing insight into the general health of the sector. As we have in previous reporting periods, we've included operating data up to the quarter prior, and that data provides average underlying operator occupancy is in line with March 2021, which was the highest rate in five years.
Daily fees have increased to AUD 120 per day, which remains significantly below the government's benchmark fee of AUD 140 per day, which is indexed to inflation. As you can see on the graph at the bottom of the page, the government funding package continues to suit our early learning center portfolio, which is typically geared towards middle-income families.
To give this some context, 96% of our early learning centers have daily fees under the government's Child Care Subsidy benchmark fee as of March. Our average rent per place across the portfolio has increased to AUD 2,663 per place, and particularly given that we've developed more than a third of the portfolio over the last nine years, remains highly affordable in our view.
Despite strong rent increases across the portfolio, rent affordability as measured against gross revenue for our operators remains at under 11%. Moving on to the next slide and an update on the healthcare sector and our portfolio. The healthcare portfolio continues to perform to our expectation. Like early learning, the macro trends for healthcare also remain positive.
A higher number of people are moving into the older age brackets, and a higher proportion of the population is living with chronic illness, which underpins an increased need for healthcare services and the infrastructure to accommodate those services. Despite the prospect of some yield expansion in real estate markets, we continue to see increased investor interest in Australian healthcare property, which is reflected in further increases in the asset values for our healthcare portfolio.
Arena took advantage of the current environment to divest the PHC Darlinghurst property and wind up the trust and syndicate, which crystallized a 13.6 compound annual total return for those investors over a 20-year investment period. While we continue to be attracted to new opportunities in the healthcare property market and aspire to grow as part of the portfolio, we'll be doing this in our usual disciplined way.
We're looking for quality over the long term that will support our investment objectives, not short-term scale. Moving on to the outlook. Today, we are announcing full-year distribution guidance for financial year 2023 of AUD 0.168 per security, an increase of 5%.
The portfolio is in a strong position, 100% occupied, 100% of rent collected, a 20-year WALE with a transparent and highly predictable rental profile that has inflation protection. Income growth will be underpinned by those contracted annual rent increases, as well as the impact of our financial year 2022 and 2023 acquisition and development completions.
Looking forward, despite the likelihood of further economic and geopolitical uncertainty, Arena's outlook remains positive. Early learning and healthcare services are integral to economic stability and improving community outcomes.
Those themes underpin Arena's portfolio value and investment objective of providing long-term predictable distributions to our security holders with prospects for growth. We have balance sheet capacity to take advantage of new opportunities that are consistent with our strategy, with gearing at 20% and no debt expiry falling due until March 2024.
With our experienced management team with strong industry relationships and in-house development and origination expertise, that will assist us in sourcing future opportunities and exploiting price dislocations should that occur. In closing, I'd like to thank our team and our tenant partners for contributing to the positive investment portfolio and community outcomes that have been achieved in financial year 2022. That concludes the formal part of today's presentation. I now pass the call back to the operator to open up for for questions. Thank you, operator.
Thank you. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star two. If you're on a speakerphone, please pick up the handset to ask your question. Your first question comes from Caleb Wheatley from Macquarie Group. Please go ahead.
Morning, Rob and Gareth. Thank you for your time this morning. Just had a couple of follow-up questions. Constance, you provided good color on expected CapEx into FY 2023. Are you providing an average inflation expectation or what sort of growth you're expecting out of inflation component of the portfolio into FY 2023 on average?
Yeah, yeah. I mentioned it was 6% as a quarterly average across the year. Obviously, the last couple of CPI prints have that at 8%. We're tempering, I said, inflation expectation over the remainder of FY 2023.
Perfect. There was also a comment around an allowance for a further expansion of liquidity. Looks like there's about AUD 110 million of undrawn debt, which seems like that's enough to fund the existing development pipeline. How much more liquidity might we expect to be, I guess, put into the platform through FY 2023?
Obviously from an ongoing perspective, we always make sure we have enough to cover our development commitments at any point in time, but obviously got a pipeline of opportunities that we're looking at. We've been looking at circa AUD 100 million in terms of additional liquidity, and that's what we did during the last year as well.
Great. Thank you. Next one was just on the development pipeline. Volumes are remaining quite high, which is a positive. It looks like the year on cost has come down about 40 basis points over the half. Can you provide any additional color around the drivers of this and any comments around cost inflation you're observing if that is one of the drivers?
If I could add to that, Caleb, it is simply cost inflation. I think that you'll find that we've got some of those that are sort of mid-range, so that will be completed in 2023, 2024, will be slightly lower yielding as we're sort of picking those up in, you know, obviously six to 12 months. Going forward, we're hoping we're starting to see a little bit of retreat from some of the cost inflation that we've seen on the development works, both in respect to materials and labor.
We hope that continues. As I think we made the point gently through the presentation, certainly open for good new business and, you know, if there's any price dislocation, we're gonna be in a position that we can exploit that.
Be able to make a comment on what you've seen on cost inflation over the past 6-12 months in the numbers.
Yeah. Yeah, certainly can do that. It's a little bit hard because we're, you know, different states, different jurisdictions, different build qualities. You know, there's commentary in the paper. You know, we've definitely seen steel increases around that sort of 50%. We've seen timber increase.
The biggest challenge for us has really been in that we're not developing overly sophisticated properties and not caught in supply chain issues of importing. It's been around the playscapes and time around playscapes. You know, we had four projects that were delayed immaterially, but the reason for that was really around wet weather, which has been a bigger challenge than cost inflation over the last period.
We had something like two months average across those four projects of wet weather time, Caleb. If you strip that out, you know, it's really just those sort of materials, steel, and timber and labor seems to be getting a little bit better at the moment.
Yeah. Some of your peers have spoken to pulling sort of 10%-15% over the past 12 months. Is that broadly in line with what you're seeing across-
Feels-
Your own materials?
That feels about right. Yeah.
Yeah. Perfect. Thank you. Last question from me, just around labor costs. So flagged again by you guys in the presentation there, being flagged by operators as well as a concern. How do you think about that net rent to revenue ratio now going forward? I think historically, you've spoken to a 12%-14% range being sustainable. It feels like there might be a little bit downside, a bit of downside risk to that. What do you feel is sort of more sustainable in terms of that net rent to revenue now in the existing environment?
I don't think there'll be a dramatic change in that. I think that for the large part, those increase in costs are going to be pushed onto ultimate consumers with higher daily fees. Ultimately those consumers, as families across Australia, will be supported by that increase that's proposed by the Albanese government, Caleb. I think the real risk is, you know, if there's any delay in that additional funding from the federal government. Not seeing any major risk to the accommodation cost as we reported. It's at under 11% at the moment.
Great. Thank you. That's all I had. Thanks very much for your time.
Thanks, Caleb.
Thank you. Your next question comes from Lou Pirenc from Jarden. Please go ahead.
Yeah, good morning, and thanks for the presentation. Can I just follow up on those development yields? Is there a level where you are just not comfortable given the, you know, the rising cost of capital? To start new developments. Is it, are we close to that?
There always is, Lou. Yep. There's no doubt about that. You know, we've seen, obviously our cost of capital, as strong as it is, there's still deals going out there that are below what we would think is acceptable. That is partly the ma rket that we're in.
Competing with those that, you know, perhaps don't look at their cost of capital as strongly as we do, given the sort of low value size. Yes, we're certainly missing out on a few of those. Are we getting close to it? I think that we're probably seeing yields push the other way.
We've seen, you know, in the direct market a little bit of evidence over the course of the last couple of months that, you know, a bit of yield expansion there. As I said, the inflation on developments seems to be sort of, you know, plateauing, which, you know, I think will open up some opportunities for us frankly, but what used to be, you would have people coming in the door sort of, you know, seeking something with 4% on it, and then in completion value, it's just that paradigm's completely changed. You know, now there's more sensible numbers.
As we always have, we've put a bit of a 10-year Aussie government bonds versus childcare, and you can see the childcare yields in the appendix. The interesting thing on that, not only have we had one of the tightest margins over the last few years, there's also a little tick up on the yields if you look at the very far right of that as well.
Thank you. Can I just follow up on that? In terms of your 4.91%, I think, average cap rate, where do you see that compared to those market transactions, either before or after the evidence of some yield expansion? I guess in other words, how conservative do you think your 4.91% is?
That's the right number for 30 June. I think the point I'm making is that the ingredients are there for yield expansion. We've seen a little bit. I think we've seen only seven transactions in financial year 2023 that would suggest that yields have pushed back over sort of 5%, as a market comment, Lou.
You know, I think I made the point on the presentation that you know, there's some protection available with our leases and the rent growth. You know, we report passing yields. You can do the math yourself. You know, I think 25 basis points expansion is something like 5% rent growth. I think we'll be protected in sort of nominal dollars on capital value if we see some of that rent growth come through as well.
Makes sense. A final one from me. Any opportunities to do more asset recycling? I think you sold two assets one healthcare, one childcare, this period or this year.
Yeah.
Should we expect more of it?
Not in a material way. There's always, you know, sort of every quarter, we sort of go through and sort of run the book, having a look at what we think will participate strongly and what will be sort of lower quarter. I rule over that. You know, the run rate of a couple each year or even each half is probably something that I think investors should expect.
Great. Thank you.
Thanks, Lou.
Thank you. Your next question comes from James Druce from CLSA. Please go ahead.
Yeah. Hi, good morning, Rob. Good morning, Gareth. Just wanted to talk about balance sheet. Obviously, it's in a very strong position at 20% gearing. It has been assisted over the past few years from some very strong asset value growth, which looks like that will start to flatten. But looks like you're still going to get some reasonable volumes on acquisitions and developments. I'm just wondering how much would you allow that gearing to rise before you'd start to feel uncomfortable as you allocate capital? Yeah.
Yeah. You're correct. Obviously, we look at our current development pipeline, we've got AUD 88 million to spend on that'll push the gearing up a few percent into, you know, towards the mid-20s. We talk about a maximum gearing ratio of 35%-40%.
But that's through the cycle. Obviously the way that property values have been depressed in recent years, we've left a bit more of a buffer there. You know, we're certainly comfortable up to 30%, at this point in the cycle and maybe a little over that. Obviously we'll view how asset values, how that goes over the next 6-12 months. As I said, we have some inbuilt protections to deal with our underlying asset values, which Rob has discussed in terms of rental income growth.
Yeah. Okay. That's clear. Secondly, you mentioned on the call you're sort of expecting 6% inflation, but you mentioned that the timing of that would sort of come through 2023, 2024. Can you just provide a bit more color about how that actually occurs?
Yeah, sure. They're all state-based suppliers. They're not quite a national average. Can be quite a variation across individual states on a quarterly basis. With 250-odd properties we'd reviewed throughout the year. Whilst you can say that you could bundle it all over and you say that it was a quarter each quarter, obviously if you're getting a 6% rent review in January of 2023, you're gonna get half the benefit in year five 2023 and half the benefit in year five 2024 because they're not the same.
Yeah. I sort of get that. I was just wondering how to
Yeah.
What sort of contribution would be relative 2023 to 2024 if it is even or if there is a skew?
There's a slight skew just because of the, I guess, different quarterly rates all flow into an annualized rate at different points in time. Those that have just had reviews, obviously were not at the annualized rate. If you had 10% in the June quarter, they didn't get 8% increases on an annualized basis. It was much lower. It's more than 10% for those guys.
James, it would be also true to say that there's slightly more rent reviews to anniversary dates of leases in the second half as well.
Yeah. Yeah. Okay, that's good. Okay, that's clear. Thank you.
Thank you. Your next question comes from Jeff Spector from Goldman Sachs. Please go ahead.
Good morning, guys. Just a quick one from me. In the past, you've highlighted just, you know, growing outside of childcare, but just wondering, you know, just given where funding costs have gone and, you know, cap rates are still, you know, pretty tight in the market across social infrastructure, and also just given, you know, cost inflation on the development side, just how are you thinking about that? Then I'll have a follow-up just on the development side as well.
Yeah. Thanks, Jeff. We still aspire to do more than just early learning centers. We at the moment and likely in the short to medium term continue to see the best risk-adjusted returns there. I think that's just a reflection of a lot of capital chasing, particularly healthcare type yields.
You know, our view is, I suppose, you know, again, we're sort of seeing the better risk-adjusted returns where our deepest skill set is and you know, no aspiration to have the biggest balance sheet in town. We prefer to get the best and highest quality earnings, which is consistent with our investment objective. We're there to participate. I can say that we're doing a hell of a lot of underwriting, a lot of reconnaissance.
You know, we're keeping up with the market, but you know, it's not. We're not comfortable putting our balance sheet in the opportunities being presented to us over the last little while. You know, frankly, our hope is that there is a bit of price dislocation and it will allow an entry point that makes sense for our investors.
Thanks, Rob. Just turning back to your comments there, just on healthcare. I mean, of the development pipeline that you have, how much is weighted toward there, if any? Then too, could you potentially grow that over time? I mean, realizing you guys over the past few years have invested in SDA assets there, and that's a government-backed sector along with the other subsectors as well. Just keen on your thoughts there, growing that through the development pipeline. Going forward, are there any other subsectors that might be attractive within the-
Yeah.
Within the health subcategory?
Yeah. The answer to the first question is no. All of the AUD 139 million of development work in front of us is early learning. In regards to funding via development healthcare is it would be fair to say the type of assets that we're you know interested in the healthcare space are you know sort of community-based assets and if they have a level of specialization whether it be just you know imaging et cetera that sits in them Jeff.
I guess slightly more sophisticated than the early learning space. What is true and what I think we can leverage on is the partnership approach that we take with our tenants. We've got some great relationships in the healthcare industry.
To the extent that we, you know, have the right opportunities and the development to assist those network expansions, we'll undertake those. My view at the moment is that there's enough players that are taking on those risks at numbers that we wouldn't be comfortable with in the current market. Again, hopefully that changes in time.
Regarding SDA, yes, there's been a couple of deals we've sort of thrown SDA. I think I've made this point a number of times. We're really interested in, you know, the sort of higher end SDAs, the higher physical support needs and has higher barriers to entry. We're not interested in the SDA that is salt and pepper through apartment buildings.
You know, they've got a different layer of risk, and typically have lower barriers to entry and ultimately are, in many instances, lower. You know, there's lower profitability for the operators, Jeff. Continue to watch that space. There's a hell of a lot that needs to be done in that space. I think, yeah, we will continue to watch them. If there are the right opportunities, I can assure you we'll be slipping there, having a swim.
Thanks for the color, Rob.
Thanks, Jeff.
Thank you. Once again, if you wish to ask a question, please press star one. Your next question comes from Murray Connellan from Moelis Australia. Please go ahead.
Morning, Rob. Morning, Gareth. Rob, I think you mentioned on the call that your guidance assumes an average base rate for the year of 3% on the debt costs. I was wondering whether you could just give us a feel for your margins at the moment and whether or not you're expecting much of a change there year-on-year.
Yeah.
It's 3% on the floating rate, with average, but moving up to mid-3s%, over the course of the year, I guess, as an outlook. Margins, obviously there's been a bit of a change in credit spreads, more recently over the last six months. We don't necessarily expect it's gonna materially elevate our credit spreads.
We haven't done a refinance in calendar 2022, so the last one was done in the first half of FY 2022. Expectations, yes, there'll be some movement there, but we don't think it's going to be material from our perspective. I think it's more around just adding the additional liquidity and the fixed cost of doing so that is allowed for in our numbers.
Got it. Just in terms of your hedging, obviously, you guys are fairly well hedged across FY 2023 and FY 2024. Given where funding costs are at the moment and the costs of locking in longer term hedges, are you planning on doing much going into sort of 2025 and beyond in the near term or keen to take more of a wait and see approach there?
I guess we've been taking a wait and see over the last couple of months. If we talk about the philosophy of our hedging program or the strategy behind it really is around smoothing cash flows through the cycle. I think we have to accept that rates will go up and rates will go down over time.
Our strategy really looks at smoothing through the cycle, adding incremental hedges as we draw down debt, and obviously as they roll off, we replace them with new ones. It's more around, I guess, maintaining a consistent level of hedging, which provides us predictability over time as opposed to trying to guess where the market's going.
I think over the last six years, it's our average hedging has been about 7%-9.5%. I think it comes out at. It's about, I guess, demonstrating consistency in that. We've allowed for an average of the five-year swap rate in our forecast, at least in terms of coming up with guidance. We're allowing for the fact that rate's gonna be a little bit higher over time.
Got it. Thanks, Gareth.
Thanks.
Thank you. There are no further questions at this time. I'll now hand back to Mr. De Vos for closing remarks.
Thanks very much. Thanks for your attendance on the call today, and we certainly look forward to seeing a number of you, hopefully in person, over the next couple of days and weeks. Thanks, everybody.
That does conclude our conference for today. Thank you for participating. You may now disconnect.