Thank you all for standing by, and welcome to the Centuria Industrial REIT FY 2022 results presentation. At this time, all participants are in a listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question at that time, you'll need to press star, then one on your telephone keypad. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your speaker, Jesse Curtis, Fund Manager of Centuria Industrial REIT. Thank you, Jesse. Please go ahead.
Good morning, and thank you for dialing into Centuria Industrial REIT's full year financial year 2022 results. I'm Jesse Curtis, CIP's Fund Manager. Joining me today is CIP's Assistant Fund Manager, Michael Ching. I would like to commence today's presentation with an acknowledgement of country. I'm joining you from the lands of the Gadigal people of the Eora Nation. Centuria manages property throughout Australia and New Zealand and pays its respects to the traditional owners of the land in each country, to their unique culture and to their elders, past, present and emerging. Throughout the year, CIP achieved significant leasing success across the portfolio, driven by tenant demand for urban infill markets, where industrial space is in very short supply. In fact, Australia now has one of the lowest industrial vacancy rates in the world. Subsequently, the REIT benefited from strong double-digit rental growth on prior passing rents.
To capture the strong tailwinds of the sector, CIP considerably expanded its portfolio with both strategic short WALE acquisitions and by executing value add development opportunities to support the income of the REIT. These activities resulted in the portfolio growing to AUD 4.1 billion across 88 assets and being able to deliver on our upgraded FFO guidance for FY 2022. Moving into FY 2023, inflation and rising interest rates present a heightened cost of debt, and in setting CIP's guidance, we have factored these forecast impacts. However, the operating environment for industrial property remains strong with elevated tenant demand and sustained rental growth forecast. CIP remains well-positioned to benefit from the industrial market strength and deliver its strategy into FY 2023. Earlier today, we published various documents on the ASX, including this results presentation, which I'll step you through now.
Today, we'll provide an overview of CIP's full year portfolio activities and a financial year 2023 outlook, along with earnings guidance. At the conclusion of the presentation, we will offer the opportunity for questions. Let's begin on slide four. CIP is an externally managed REIT that forms part of the larger Centuria Capital Group family, a leading Australasian real estate fund manager operating under the ASX ticker code CNI. With more than AUD 20 billion of assets under management, Centuria Capital Group specializes in real estate markets, including decentralized offices, urban infill industrial assets, cost-efficient healthcare property, daily needs retail, large format retail, and agriculture across Australia and New Zealand. It also provides non-banking real estate financing for the Australian market through Centuria Bass Credit. Centuria is a strong supporter of CIP, and there is a clear alignment with the broader Centuria business.
Advantages of being managed by Centuria is that the group has a long and successful track record in property funds management and has a substantial commercial property platform. With in-house property and facilities management, Centuria provides deep leasing capability and hands-on management of the CIP portfolio. Slide five outlines CIP's unchanged strategy. To deliver reliable income and capital growth from a high-quality portfolio of industrial assets across Australia. Our consistent vision is to remain as Australia's leading domestic pure-play industrial REIT. Slide six details CIP's key metrics. The portfolio, as at 30 June, was valued at AUD 4.1 billion, with 88 high-quality industrial assets, high occupancy of approximately 99%, and a WALE of 8.3 years. CIP delivered on its upgraded FFO guidance of AUD 0.182 per unit and its distribution guidance of AUD 0.173 per unit.
Net tangible assets also increased 11% to AUD 4.24 per unit during financial year 2022. Turning to slide seven, which outlines CIP's financial year 2022 summary and an outlook. Our team's active management approach drove strong leasing success, with terms agreed over more than 185,000 sq m during the year, accounting for 14% of the portfolio. Most significantly, re-leasing spreads showed growth of 11% over prior passing rents. This strong leasing activity supported valuation growth, up AUD 326 million from FY 2021. CIP's income is well supported with over half generated by its top 20 blue-chip customers. Importantly, 20% of CIP's income is derived from CPI indexed leases, and circa 30% of portfolio leases expire before FY 2026, providing further opportunities to harness the market's strong rental growth.
Portfolio increased with 23 high-quality urban infill industrial acquisitions and three development spots secured for a combined AUD 765 million. The REIT also divested AUD 45 million worth of assets at a 32% premium to book value, with proceeds recycled into accretive opportunities. CIP maintains a strong balance sheet, with gearing at 33.2% from a diverse range of lenders and a staggered debt profile. During the period, we broadened our capital sources through a bond issuance and achieved a Moody's Baa2 rating with stable outlook. We acknowledge that inflation and a change in the interest rate environment has created an increased cost of debt. In formulating CIP's financial year 2023 FFO guidance, we have provided buffers to manage potential interest rate movements. Specifically, we have forecast an average BBSW rate of 3% over financial year 2023.
There remains both potential upside and downside risks to this forecast, and we will continue to monitor guidance. That said, the industrial property market nationally remains strong, and we anticipate CIP will deliver like-for-like net property income growth over the financial year 2023 period. For FY 2023, CIP provides FFO guidance of AUD 0.17 per unit and distribution guidance of AUD 0.16 per unit, with distributions expected to be paid in quarterly installments. Based on the recent trading price, the distribution guidance equates to a yield of 5.4%. Moving to slide nine. Despite having extremely low vacancy rates, Australia still provides relatively affordable industrial rental rates in comparison to established markets in America, the UK, and Southeast Asia. With continued tenant demand, this demonstrates a long runway of rental growth for industrial rents in Australia to converge with other markets around the world.
Looking locally on slide nine, positive industry tailwinds support further occupier demand and strong market rental growth. As previously mentioned, the domestic market has one of the lowest vacancy rates in the world. Put simply, supply cannot keep up with demand. Research shows approximately 3.5 million sqm of average forecast demand annually until 2025, despite approximately only 1.3 million sqm annually of supply to be delivered in that same period, showing a large mismatch between supply and demand. Already, only halfway through calendar year 2022, we have seen approximately 2.4 million sqm of gross take-up, demonstrating we are likely to exceed original take-up expectations for 2022 and further the gap between supply and demand.
Couple this with historic low vacancy, and despite already seeing double-digit rental growth, this is providing further opportunity to capitalize on rent reversions within CIP's portfolio. I'll now hand you over to Assistant Fund Manager Michael Ching to take you through the financial results.
Thanks, Jesse. Moving to the FY 2022 financial results on slide 11. CIP delivered funds from operations of AUD 111.7 million or AUD 0.182 per unit over FY 2022, which was in line with the upgraded earnings guidance provided at the half year. Gross property income increased by AUD 42.1 million to AUD 199.1 million as a result of acquisition and positive leasing outcomes achieved over the year. Pleasingly, income on our like-for-like portfolio of assets was up 3.4% in FY 2022, driven by leasing success and increased occupancy. The AUD 1.8 million of other income recorded in FY 2022 relates to the coupon received on our South side Industrial Estate development in Dandenong South.
Under the development management agreement, CIP received a coupon on all capital deployed until practical completion of the asset. Capital management initiatives undertaken during the year enabled CIP to manage the interest rate expense in FY 2022, despite a rising interest rate environment in the second half of the year. CIP delivered distributions of AUD 0.173 per unit in line with guidance, and with strong NTA growth, delivered a strong return on equity of 15.2% over the year. Looking at capital management in more detail on slide 12. During the year, CIP was assigned a Baa2 rating with a stable outlook by Moody's Investors Service and subsequently completed its inaugural six-year, AUD 350 million medium-term note issuance in December 2021.
This issuance, together with the introduction of two new lenders during the year, broadened CIP's range of capital sources and increased its weighted average debt maturity to 4.4 years. Approximately AUD 300 million of new equity was also raised during the period. Gearing at the end of FY 2022 was 33.2% and an interest cover ratio of 5.4 times. Both provide substantial headroom to our debt covenants. In FY 2023, we expect that CIP's all-in cost of debt would be materially higher than the 2% incurred through FY 2022. To reiterate, in making guidance, we have adopted an interest rate forecast with buffers to manage potential further interest rate volatility. The floating BBSW forecast averages 3% over FY 2022.
Having ended FY 2022 with AUD 259 million of cash and available debt headroom, and with only AUD 50 million of debt maturing in FY 2023, CIP's balance sheet remains robust and continues to be well supported by its financiers. Now on to slide 14, which shows a snapshot of CIP's portfolio composition and geographic spread of our assets. The portfolio value as of 3rd June was AUD 4.1 billion across 88 high-quality industrial assets, more than 98% of which are under freehold ownership. We maintain critical mass in each of our core markets with a 90% weighting to the strong performing eastern seaboard markets. Through targeted acquisitions over the year, CIP increased its exposure to core urban infill markets to 85% of the portfolio.
We expect these land-constrained urban infill markets close to population catchments and with limited future supply to outperform on rental growth over a sustained period, and consider our increased exposure to these locations as one of CIP's main competitive advantages. I will now hand back to Jesse to take you through leasing and transactions over the year.
Thanks, Michael. Taking a closer look at portfolio leasing and WALE on slide 15. During financial year 2022, CIP executed a significant volume of leasing, having completed 49 individual leasing transactions across over 185,000 sqm of industrial space. This leasing success represented 14% of the portfolio. Most importantly, we achieved an 11% average leasing spread over prior passing rents, demonstrating the embedded growth within CIP's portfolio and rising market rents across all Australian markets. Our leasing success included 27,000 sqm at our south side industrial estate development in Dandenong South, bringing the asset to 67% pre-committed. Renewal of Opal Packaging across 19,000 sqm as a manufacturing facility in Bibra Lake, Western Australia.
Looking forward, the portfolio offers a near-term opportunity to capture the continued rising market rents with 30% of income expiring over the next three years. Looking now at slide 16. Transactions during financial year 2022 have continued to complement the scale and quality of CIP's portfolio. A focus on urban infill assets increased CIP's exposure to industrial markets with limited land supply and competition. These markets are forecast to outperform in terms of tenant demand and rental growth. CIP secured AUD 765 million of urban infill industrial properties across 23 high-quality industrial assets and three development sites during the period. Acquisitions provided a short average WALE of 4.3 years, again, providing an opportunity to capture rental reversions in the near term. Importantly, 100% of CIP's acquisitions were in land-constrained urban infill markets with the lion's share located across Australia's eastern seaboard.
CIP also recycled capital with the divestment of two non-core assets with AUD 45 million, providing an average 32% premium over prior book values. Our leasing success has extended to our value add projects, which are detailed on slide 17. CIP continues to focus on opportunities to leverage Centuria's management capabilities through value add projects to reposition and refurbish assets to drive value for investors. Recently completed projects include 160 Newton Road in Wetherill Park, New South Wales, which was acquired in July 2021. We undertook a refurbishment program and leasing results, achieving a 21% valuation uplift. Next was 8 Lexington Drive in Bella Vista, which was acquired in May 2021.
Refurbishment works are underway and a 10-year deal was achieved with Amazon, providing a 5.5% yield on cost and providing a 45% increase in value from acquisition. Active projects include One International Drive, West meadows in Victoria. A rolling refurbishment program is underway to reposition the multi-unit estate to capitalize on significant rental growth experienced in the Melbourne market. Across financial year 2022, rents at the asset increased 22%, increasing the acquisition yield on cost to 9%. With a short WALE of two years, near-term reversion provides additional upside of the asset. Moving to slide 18 and our development pipeline. Development activities provide CIP the opportunity to introduce new sustainable assets into our portfolio that capitalize on current strong rental market. These assets include the latest sustainability initiatives and aim for five-star Green Star Ratings.
CIP's recently completed industrial facility in Bundamba, Queensland, was awarded one of Australia's first five-star Green Star Ratings under the new system. It's a pleasure to announce the development is now fully leased to two high-quality tenants in Australia Post and Jaycar. We are also approaching practical completion for our Southside industrial estate in Dandenong South. Leasing is progressing extremely well with 67% of the 40,000 sqm estate pre-committed. This again illustrates the high demand for sustainable urban infill industrial assets. Leading on from acquisitions, slide 19 details our sites consolidation strategy. This has been a long-standing strategy of the REIT to build scale within land-constrained urban infill submarkets. CIP has now achieved nine separate examples of consolidated landholdings in key markets around the country.
Most notably, three adjoining assets in Wetherill Park, creating a 5.3 hectare site, providing future potential development within this highly desirable land-constrained market. CIP secured an additional five acquisitions in Derrimut, Victoria to increase the total submarket landholding to 25 hectares across 10 assets worth AUD 245 million. The Derrimut portfolio now provides assets ranging from 3,000 sqm - 14,000 sqm and a diverse subsector of customers. This consolidation strategy is beneficial to unit holders as it provides optionality for future development site to scale to meet the growing demands from industrial users while maintaining income and access to rental growth. It also provides diversity across tenancy size and type to facilitate higher portfolio retention, leveraging a network effect from that scale, which we'll touch on in a moment. Slide 20 outlines our customer base.
CIP's key focus is to ensure ongoing reliable income streams, with 56% of CIP's income derived from its top 20 blue chip customers, most of whom are ASX-listed multinational or national companies. During the period, CIP introduced a number of new high-quality tenant customers through leasing and acquisitions, and the portfolio is now supported by 167 diverse tenant customers, adding to the resilience of CIP's income streams. A long-standing focus for the CIP team is building strong relationships with our tenant customers. Slide 21 illustrates the networking effect across the portfolio, which leverages the scale CIP has built to grow and service customers across multiple locations. This networking effect drives value by assisting customers to expand their businesses by offering multiple sites throughout Australia and reducing downtime on our vacancy and increasing retention.
The large tenant base also provides invaluable insights into future demand from our customers, which allows us to leverage our development pipeline. A great example of this is Australia Post, who recently expanded their real estate footprint with us at our new development in Brisbane. In fact, multi-location customers account for 33% of CIP's gross lettable area, and CIP had an average of only one month downtime in FY 2022, supporting the benefits of scale and a customer-focused strategy. Turning to valuations on slide 22. Net tangible assets, or NTA, continued to grow with 11% increase during FY 2022. The growth in NTA was driven predominantly by valuation gains of AUD 326 million, an 11% increase on a like-for-like basis. Valuation uplift was driven by major leasing and continued demand for industrial assets. Moving to sustainability initiatives on slide 23.
CIP, by its nature as a REIT, has no staff and is solely a portfolio of assets. CIP is externally managed by Centuria Capital Group and aligns itself to Centuria's sustainability framework consisting of three core strategies. Conscious of climate change relating to environmental considerations, valued stakeholders relating to social initiatives, and responsible business principles referring to governance. Specific to the environment, during financial year 2022, CIP joined the NABERS Accelerate program, which is looking to create a standardized energy efficient rating for warehouses and cold storage facilities. Our social initiatives are measured through both Centuria's annual tenant satisfaction survey and employee engagement survey. Both produced excellent results during the year. 96% of surveyed tenants were satisfied with Centuria as their landlord, and 94% of Centuria's employees are proud to work at the company. Centuria is also committed to gender diversity and inclusion.
At present, there is roughly a 40-60 split between female and male staff. In relation to CIP, our responsible entity board has 50% female representation. Also on the governance front, we have adopted the Task Force on Climate-related Financial Disclosures recommendations. This means climate change is now a standard investment consideration, with plans being developed across the Centuria portfolio. Over to slide 24, which illustrates a few case studies. For CIP's current development pipeline, we are targeting a 5-star Green Star rating. This high rating was achieved at our Bundamba asset in Queensland, and we aim to replicate the success at our Southside Estate in Melbourne, which is under development, and our two pipeline projects at Campbellfield and Canning Vale.
Additionally, we have worked with our key tenant customer, Woolworths, to deliver green energy through solar power systems on the assets they lease from us. Woolworths has a goal to use 100% green energy by 2025. The solar project on our Townsville Distribution Center is now complete, and the Warnervale project is currently being installed. To conclude on slide 26. Globally, industrial real estate continues to benefit from strong tailwinds. E-commerce and a tenant focus on securing supply chain resilience are driving strong demand. According to JLL data, Australian industrial property remains one of the most favored investment sectors. Despite having seen rents rise across all markets, rent growth remains in its infancy domestically. Sustained high demand from industrial users across the Australian market has driven an extremely low vacancy rate of less than 1%.
Typically, supply of new space into markets brings supply and demand back into balance. However, with labor shortages, supply chain disruption, and limited industrial zoned land, the volume of supply is not meeting forecast demand. Additionally, substantial increases in both industrial land prices and construction costs is putting upward pressure on economic rents. This backdrop is creating an environment for prolonged rental growth, particularly within urban infill markets. As Australia's largest domestic pure-play industrial REIT, CIP has delivered a strong result in financial year 2022. Substantial leasing was undertaken and significant re-leasing spreads were achieved reflective of the strength of the market. Strategic acquisition of short WALE value-add and development assets re-risk the portfolio to gain greater near-term exposure to rental growth, while divesting a number of non-core assets at a premium to book value.
Valuation gains drive NTA to AUD 4.24, and together with acquisitions, grew the portfolio to AUD 4.1 billion. Looking to the year ahead, the changing in interest rate environment has resulted in a higher cost of debt and in formulating CIP's guidance, we have provided buffers to manage potential interest rate volatility. However, as outlined in this presentation, the operating environment for industrial remains strong. Over financial year 2023, we expect CIP to benefit from the market strength to deliver like-for-like NOI growth on the back of continued rental growth. For FY 2023, CIP provides funds from operation guidance of AUD 0.17 per unit and distribution guidance of AUD 0.16 per unit, with distributions expected to be paid in quarterly installments. Based on the recent trading price, this equates to a distribution yield of 5.4%.
Thank you for listening, and at this point, I will open the call to any questions.
Thank you. We will now begin the question and answer session. If you'd like to ask a question, please press star then one one on your telephone keypad and wait for your name to be announced. Please stand by while we compile the Q&A roster. Our first question comes from Caleb Wheatley at Macquarie. Please go ahead.
Good morning, Jesse and team. Thank you for your time this morning. My first one was just around what's informing guidance. You provided some color on the BBSW there, but commentary around like-for-like NOI expected to increase, sitting at 3.4% today, and obviously some pretty positive outlook in terms of the supply-demand mismatch, as you mentioned. Are you able to provide anything in terms of what we might expect in terms of like-for-like NOI growth going into FY 2023?
Thanks for the question, Caleb. Look, I think during the presentation, we gave some pretty good color around where we're seeing the market dynamics for industrial and certainly around where we're seeing rental growth. If you look at what we achieved this last 12-month period, that was showing re-leasing spreads of 11% over prior passing rents. For the year ahead, we've got 5% of the portfolio that will expire. The balance of the portfolio is linked, about 20% is linked to CPI, and then about 75% of the portfolio is linked to fixed indexations of circa 2.8%-2.9%. When you aggregate those, you should get a pretty good read as to where we think like-for-like NOI should land.
Yeah, that's clear. Just on this other income line item, looks like that's ticked up to about AUD 2 million in the second half of 2022. Are you able to just provide a bit of color in terms of how exactly that derives, and if there's any expectations for that item going into FY 2023 as well?
That item covers off a coupon that we receive on development projects within the portfolio. The way two of our fund-through developments work, and I'm specifically talking about our Southside development in Dandenong South and our Campbellfield development in the north of Melbourne. As we deploy funds into each of those developments, we in turn receive a coupon back from those developers. That coupon is in the vicinity of 4.5% that we receive on both of those. We anticipate that other income will carry into FY23 on the back of Southside completing and Campbellfield starting, and may even drag into 2024.
Okay. Sure. That's clear. Just a final one from me on guidance. Are you able to provide any color in terms of what you're expecting on revaluations that'll inform the responsible entity fees through FY 2023 as well?
We're holding values flat throughout FY 2023.
Fantastic. Thank you. Just one final one from me. Just on the outlook for the hedging profile and managing interest expenses. Looks like there might be about AUD 300 million or so of hedging rolling off by the end of 2023. Just wondering how you're viewing your willingness to execute on additional hedging from here and other means of managing interest expenses throughout the year.
Yeah. We've spoken about holding a flexible hedging strategy, and to date, we've seen a pretty big variance between the cash rate and what the forward-looking swap curve looks like. That's now starting to normalize, and we'll take the opportunity to, where we see appropriate, putting hedging in place or exploring caps.
Sure. Is there a minimum hedging policy that sits within CIP?
50%.
Okay. Thank you very much for your time.
Thanks, Caleb.
Our next question comes from Lauren Berry at Morgan Stanley. Please go ahead.
Morning, guys. Thank you. Just on the guidance again, you said that there's a material step up in the cost of debt. Are you able to give us, you know, a range of what you're thinking of that the all-in cost of debt is gonna be?
We've given guidance that our BBSW or floating rate we've averaged 3% or forecast 3% on average over the course of FY 2023. If you then look at margins in the market at the moment, at somewhere between 130 and 160 basis points, that should give you a pretty good view as to where all-in incremental cost of debt should land.
Okay. Got it. Your leasing spreads were obviously very good. Are you able to talk about what kind of spreads you're seeing in the different markets that you're in?
Absolutely. Both Sydney and Melbourne, we're seeing the most significant re-leasing spreads. Both those markets, over the last 12-month period to June, experienced near 20% growth in both of those markets. We're certainly seeing, of the result we've delivered to date, significant movements in both Sydney and Melbourne rents. However, looking into FY 2023, we're seeing both Brisbane and Perth really starting to fire in terms of the rent growth in those markets. Right across the country, the average vacancy rate now sits at less than 1%. There's a very, very strong environment and a mismatch between supply and demand, which is generating solid rent growth in all markets.
Okay. Cool. Just probably final one from me, your stock is trading on a very large discount to NTA at the moment. What are your thoughts on perhaps, you know, selling some of your assets to prove up the value at this point in the cycle?
I think if you look back at our history of managing this vehicle over the last five years, we've sold about AUD 150 million of assets over that period at approximately a 20% premium to book value. This last year, we've sold AUD 45 million of assets, an average premium of 32% over book value. We'll continue to find opportunities where we've maximized value or see mispricing of assets to capitalize on that.
Okay. In terms of your guidance, what are you assuming for acquisitions and disposals this year?
Nothing that we haven't otherwise announced.
Okay. Awesome. Thanks, Jesse.
Thanks, Lauren.
Our next question comes from Tom Bodor at UBS. Please go ahead.
Good morning, Jesse. Just wanted to sort of go back to that hedging piece and, you know, I think all your hedging's rolled off by the end of 2024, calendar 2024. At that point, you know, interest rates, say some forward curves could be substantially higher and obviously then your interest cover comes down. How close to your covenant are you comfortable operating? How much headroom do you need at a minimum?
Sorry, can you repeat the question, Tom?
I was just wondering what sort of the minimum headroom you're prepared to operate with relative to your interest cover ratio.
I think we're comfortable with where we're at today. I think if I sort of address your comments on forward-looking interest rates, I think there are a number of different focuses. There's a number of different forecasts out there in the market that, you know, there's one CBA forecast that says rates will peak over this year and then come off into FY 2024. I think we'll continue to assess the market. We'll continue to watch the interest rate environment, and where we see appropriate could get initiatives in place to manage the vehicle.
Okay. Sure. At 5% interest rate, your interest cover drops close to 2 times and that's where you're coming in. Are you comfortable being that close to the covenant?
As I said, Tom, we'll continue to monitor debt markets and put appropriate initiatives in place to manage the debt.
Okay, thanks. On the other question is on the payout ratio. It sort of dropped from 95% to 94% based on your guidance. Where do you want that to be long term?
Somewhere between 90% and 95%, we've consistently said.
Okay. All right. That's great. Finally, if you do sell assets as you sort of say you've continued to do over the years, do you think you would look to then redeploy into buying new assets or just reduce gearing at this point?
We'll continue to assess that on a case by case basis.
Okay, thanks.
Our next question comes from Richard Jones at JP Morgan. Please go ahead. .
Oh, good morning, Jesse. Just interested in whether you can provide some color on industrial transaction markets and just how they've shifted over the last six months. Can you maybe just discuss is it, you know, is it as competitive and whether you're seeing, you know, pricing soften any particular parts of the market?
Yeah. I think transaction volumes have certainly dropped in the first half of this calendar year. They're certainly not at the elevated levels that we've seen in previous years. But we're still seeing very, very strong support and investment demand for industrial assets. There are a number of acquisitions that we could run you through out there in the market that provide very, very strong support for not only our current NTA, but you know, some results potentially in excess of that. I think transaction volumes will continue to probably moderate over this medium term, but to date, we haven't seen any evidence that values have seen any kind of decline across industrial. I think one of the major things driving that is the rent growth story.
Yeah. Okay. Can I just ask, just in terms of your discussion with valuers, just their thoughts on discount rates and how they might be moving?
All of that, we have had discussions with our valuers into our June 30 valuations, as are disclosed in the accounts today. At the moment, those valuations haven't shown any softening in those assumptions.
Are they—I mean, obviously, rates have moved a lot from certainly a cash rate perspective and long bonds have been pretty volatile, but just, you know, can you touch on how they're thinking about incorporating that into their DCFs?
You'll have to talk to the valuers about that one, Richard.
You can't give us any feedback though, Jesse, on what they're saying to you?
As I said, Richard, I think that's better gotten from the horse's mouth.
Okay, we'll ask the horse. In terms of where the portfolio rent sits versus market, you obviously talked about 11% reletting spreads. Can you give us a rough mark to market on the under-renting in the portfolio as it sits today?
Yeah. Based on valuer assessment of the portfolio, if we carve out our two biggest assets being Telstra and Arnott's, the portfolio sits at roughly 5% underlet on valuer assessment. Our management view of that is it's obviously wider than that. In a market that's moving day by day and we're seeing better deals every day and better rental growth every day, your next question is probably gonna be, can I tell you what our view is? It is literally changing day by day, but it's certainly more than that 5%.
Okay, good one. Thanks, Jesse. That's it for me.
Our next question comes from Andrew MacFarlane at Jarden. Please go ahead.
Oh, hi, Jesse and Michael. Look, just one quick one for me. Just on the development site front. Just wondering, obviously, you're entering into a lot of funds through, so pricing is obviously relatively well-known. Are you seeing anything in terms of counterparty risk on delivery, or are you seeing anything that would give you concerns from a timing perspective in terms of supply chain?
I think there's two things on that, Andy. One, on the timing side, both of our fund through developments have coupons, so whether they are delayed or not delayed, we will still receive income on those assets until they reach practical completion. In terms of the counterparty risk, the parties that we have entered into across our building contracts, our developer fund throughs are extremely strong covenants, and we have appropriate security and step-in rights to be able to complete those developments should there be any risk there. To date, we have been very comfortable with the parties we have contracted with on both.
Yep, makes sense. Final one for me, just in terms of development as well. If you were pricing something today, obviously, you're doing more and more development. What do you think the yield on cost would look like today and how would that have differed to, you know, some of these other projects you've entered into in the last 12 months?
The last two developments that we announced earlier in the year demonstrated yields on cost above 6%.
Any expectations for what that might look like over the next 12 months?
I expect we'll probably consider that. We will consistently see that above 6%.
Got it. Thanks, Jesse.
Our next question comes from Ben Brayshaw at Barrenjoey. Please go ahead.
Hi, Jesse. Thanks for the presentation. I was wondering if you could just comment on construction cost inflation for distribution, what you're seeing in the pre-lease market, over the course of the last 6-12 months, just, I suppose, what you consider to be the increase in the cost required to justify new development. Any comments or feedback on that, please?
Across the market, if we go 12 months or 18 months ago, construction costs have probably come up somewhere between 25% and 40% over that period. That's had a pretty strong pressure, upward pressure on economic rents. But on the flip side of that, the pre-lease market has been exceptionally strong. Take Sydney as an example. About 70% of the stock being developed today is pre-leased, and we're anticipating that will continue to grow. Melbourne's in a very, very similar situation at the moment, with about 75% of stock within the Melbourne market pre-committed.
Just as a follow-up to that, if I may, roughly the economic rent required to justify new construction at current land values. I mean, how do you see that across Sydney and/or Melbourne? Just interested as to sort of the range that you could perhaps talk to around that, please.
I think if you're looking at some of the rates paid for infill development sites within metropolitan Sydney at the moment, that's pushing AUD 2,000 a sq m, and our back of the envelope says that that rent needs to be well in excess of AUD 200 a sq m. If you're looking down in Melbourne, again, I'm broad-brushing these markets, but you're looking at economic rents somewhere in the vicinity of AUD 150 a sq m for average product in Melbourne based on current land rates and build rates.
Thanks, Jesse.
Our next question comes from Edward Day at Moelis. Please go ahead.
Morning, Jesse. Just from a tenant demand perspective, are there any sectors in particular, you know, you're seeing stronger demand from others?
E-commerce, warehousing, and distribution have certainly been the two out-performers in terms of where the majority of demand has come from. That said, manufacturing is still a very strong contributor to our leasing volume. About 20% of all leasing volume comes from manufacturing users across the market. While we've certainly seen an uptick in e-commerce and general distribution center and warehousing tenants, we've also continued to see manufacturing businesses hold their share of market leasing.
Thanks. Just on your expiry profile, so you've got 5.5% expiring in 2023. Do you see any scope to bring forward some of the expiry from 2024 and 2025 and sort of blend and extend style deals?
For the right deal, potentially we will. There's obviously the trade-off, Ed, of the sooner you do the deal, the more of the upside you give away further down the road. We'll continue to look at opportunities where we can bring forward expiries. In some cases, we're better off waiting.
Great. Thank you.
Our next question comes from Sholto Maconochie at Jefferies. Please go ahead.
Hi, everyone. Just a couple follow-ups. As you said, the portfolio on the value was sort of 5% under-rented. What do you think the spreads will be this year, given they were 11% last year? What are you forecasting the sort of spreads like or range of spreads for this year?
I think as I said before, Sholto, the market is moving at a pretty rapid rate at the moment. Any forecast I give you today is probably gonna be under where it actually lands. We're not providing, but I think if you look at
sort of all similar to 2022 or obviously strong growth in 2022, but it'd be probably potentially less than the 11% you got in 2022.
I think you can.
Given where rents have run.
I think you can continue to expect very strong relet and spreads across our portfolio.
Okay. Just on the derivatives. I noticed you had in your cash flow statement, you paid, like in this year, AUD 13.1 million for borrowing costs and derivatives. You sort of talked through, I think it stepped up materially from the second half. I think first half was AUD 5 million borrowing costs for derivatives, sorry, and AUD 1.9 borrowing costs, and that's gone to AUD 8 million and AUD 2.3. Just wanna see what was that for? 'Cause hedging's gone up. Is that for hedging or what was that so high for the year?
Sholto, it's Michael here. The predominantly that was to do with the hedging that was taken out during the course of the year and the restructuring of debt that we undertook in the first half of the year as well.
It looks like it stepped up in the second half. Did you do a lot more hedging in the second half? Because it did go up a bit now.
We did take out hedging in the second half. Yeah. We did take out hedging in the second half as well, yeah.
Was any collars or sort of caps and things like that on? Or was this pure hedging?
No, we did. Just hedging. Yeah.
Okay. What was the goodwill write-off for A&I of AUD 10.5? Why was that written off again? For the period, it was a goodwill expense.
Why did you write that off?
That was the longstanding item back from when we took over from 360 Capital Group. At this point, we decided was the right time to be writing that AUD 10.5 million off.
Okay. I think let's talk about demand from sectors. Are you concerned that if there's obviously consumer retail sales are strong and people are improving their supply chains. If there's a slowdown in demand, does that worry you for the next four months on the consumer perspective and demand for goods? Do you worry about that, or is it so far you're not seeing any of that? Because the data doesn't suggest any slowdown yet.
I think it depends on your exposure. The majority of our exposure is with non-discretionary goods, which we anticipate will continue to be very, very well supported. I think you can't also underestimate the severe lack of supply, and virtually no vacancy in the market. Even if there was a slowdown in demand, the supply/demand equilibrium is well and truly out of balance in favor of the landlord at the moment.
Okay. Just on it's Lauren's question about talking about their gearing. Obviously, asset values are holding firm this year, but if you look at the yields, they're still pretty tight and you're getting circa 5.5% yield on cost on the recent acquisitions. Have you considered selling like half of the Telstra assets on a 3.1 cap? That's a AUD 560 million asset, like potentially half of that to redeploy into refashioning and development where you get a higher return than market. Is that something you'd consider?
As I said earlier.
It's accretive if you sold it.
As I said earlier, Sholto, over the five years we've managed this vehicle, we've divested about AUD 150 million worth of assets. All at a strong premium to book value. We'll continue to assess opportunities where we think they're right within the portfolio.
Okay. Just finally, when you said construction, you expect yield on cost to be greater than 6%. How is that? I know rents have risen, but if you're getting greater than 6% now and costs are up 25%-40%, how are you sort of still getting over 6% for this year? Is it 'cause you've locked in contracts or they're already fixed price, so you haven't got that cost escalation in it?
All our current developments that we have on foot are all on fixed price contracts.
Okay, that's great. Well, thanks very much for your time. Thank you.
Our final question comes from Adrian Atkins at Morningstar. Please go ahead.
Hi, Jesse and Michael. Just most of my questions have been answered. Just for borrowing costs, you know, obviously very low in FY 2022, how much interest is capitalized and what should we expect going into 2023?
No interest is capitalized, so there'll be none going into FY 2023.
Okay. Just in terms of strategy, you've kinda touched on it a bit, but, you know, you guys have grown the portfolio pretty aggressively by acquisitions in the past. I'm just, you know, with interest rates where they are, is that still the strategy or is it time to be more cautious?
I think the way we're thinking about our acquisition strategy is where we can find accretive opportunities, noting the current market conditions, we'll continue to look to deploy them, particularly where there's an opportunity to grab rental growth, and realize that rental growth in the near term. If you look back at our last two years of acquisitions, it has almost exclusively been short WALE value-add and development assets where we can get that rental or income pop on the other side. For our forward-looking strategy, it's going to remain the same. Where we find those opportunities that provide an accretive outcome for REIT, we'll look to deploy.
Okay, thank you.
Thank you, everyone. We have no further questions, so I'll turn the call back for closing comments. Thank you.
Thank you everyone for dialing into the call and for your ongoing support of Centuria Industrial REIT. If you have any follow-up questions, please don't hesitate to contact either myself, Michael, or Tim Mitchell, our Group Head of Investor Relations. We look forward to discussing our results with you over the next few weeks.
Thank you, everyone. This does conclude the call today. Thank you all for joining. You may now disconnect.