Good day, welcome to the Centuria Office REIT FY 2023 results presentation. Please note that this call is being recorded. At this time, all lines have been placed in listen-only mode. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question at this time, please press Star, followed by the number 1 on your telephone keypad. To withdraw your question, again, press Star 1. Thank you. I would now like to turn today's call over to Mr. Grant Nichols, Centuria, Head of Office, and Centuria Office REIT Fund Manager. Please go ahead.
Good morning, thank you for dialing into the Centuria Office REIT financial year 2023 results and fund update. My name is Grant Nichols, and I am COF's Fund Manager. Joining me today is COF's Assistant Fund Manager, Belinda Cheung, Centuria Head of Funds Management, Ross Lees, and Group Head of Investor Relations, Tim Mitchell. I would like to commence today's presentation with an acknowledgment 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 and present. FY 2023 was an operationally successful year for COF, with portfolio occupancy increasing, while capital management initiatives have resulted in an improved debt position with no debt tranche expiring until FY 2026.
Earlier today, we published various documents on the ASX relating to the full year results, including a results presentation, which we will go through this morning. Starting on slide 4. COF delivered a solid performance in FY 2023, including paying distributions at AUD 0.141 per unit, in line with FY 2023 distribution guidance, generating funds from operations at AUD 0.156 per unit, which was slightly below FY 2023 guidance, due to the impact of rising interest rates. Recent non-core disposals delivered a pro forma gearing of 36.7%, an NTA of AUD 2, AUD 2.20 per unit, based on a weighted average cap rate of 6%, and increased portfolio occupancy to 97.1%, while maintaining a healthy WALE at 4.2 years. Looking at the results summary in more detail on slide 5.
During FY 2023, COF completed over 42,000 square meters of leasing, representing around 14% of the portfolio's NLA. Of the 42,000 square meters of leasing, over 31,000 square meters related to previously vacant space, which has resulted in portfolio occupancy increasing to 97.1%. Pleasingly, this leasing largely addressed some of the more material vacancies within the portfolio, notably almost 8,000 square meters at 154 Melbourne Street in South Brisbane, 7,000 square meters at 818 Bourke Street in Docklands, and 3,000 square meters at 203 Pacific Highway in St Leonards. During the second half of FY 2023, COF refinanced AUD 225 million of debt while maintaining a diversified pool of six lenders.
The debt refinancing improved the REIT's weighted average debt maturity to 3.2 years, with no debt tranche expiring until FY 2026. The refinancing saw no material change to the weighted average debt margin, and the improved debt maturity profile solidifies COF's capital position and insulates COF from potential increases in debt margins that may occur in the short to medium term. The sale prices achieved for the non-core disposals at 54 Marcus Clarke Street in Canberra and Robina Town Centre Drive were consistent with COF's year-end portfolio valuations, which declined by around 4% from COF's December 20, 2022 portfolio value. As of June 30, 2023, the REIT's weighted average capitalization rate was 6%, with the cap rate expanding 42 basis points across FY 2023. In regards to valuations, there has been a noticeable reduction in transaction volumes across the market.
It is evident that there is greater investment demand for assets valued less than circa AUD 150 million. This is particularly relevant to COF, which has the highest weighted average cap rate in the comparable listed office sector, while at the same time having one of the lowest average asset values of less than AUD 100 million. Belinda will provide further detail on both these points on slide 19 shortly. Looking towards FY 2024. COF's all-in cost of debt is now elevated compared to recent past periods and is expected to be higher in FY 2024 than FY 2023. Higher expected debt costs have impacted FY 2024 guidance.
While COF has a relatively benign expiry profile in FY 2024, the largest two expiries will result in vacancies and downtime through the coming period, with IQVIA vacating around 3,000 square meters in 201 Pacific Highway, St Leonards in July, Ericsson set to vacate around 7,000 square meters in 818 Bourke Street, Docklands in January. Both these tenants were underutilizing their premises since pre-COVID, their departures were not unexpected. For FY 2024, COF provides FFO guidance of AUD 0.138 per unit and distribution guidance of AUD 0.12 per unit, with distributions expected to be paid in equally quarterly installments. Based on the recent trading price, the distribution guidance equates to a distribution yield of 8.4%, which we believe provides an attractive, compelling distribution yield.
While we recognize that this rising interest rate environment causes some future uncertainty, we remain optimistic for Australian office markets. It is worth spending some time looking at the impacts from the evolving workspace on slide 6. Firstly, while acknowledging hybrid working arrangements and increased workplace flex, flexibility are likely to become more prevalent. It is becoming increasingly apparent that the office will remain an important and focal point in many operations, and changes in office utilization may not materially alter footprints. In our view, the impacts from work from home on tenant demand have been overstated. In the 12 months to 30 June 2023, we saw above average tenant demand in a number of markets, particularly those with limited exposure to tech and financial tenants, most notably Brisbane and Perth, which achieved strong net absorption during the year.
Adelaide, Canberra and Perth all had less than 10,000 square meters of sublease availability as of June 30, 2023, a material contrast to Melbourne and Sydney. These stats are reinforced by the results of the Centuria 2023 Office Tenant Survey, where 75% of tenants anticipate retaining or increasing their office space requirements over the medium term. Notably, Centuria's office portfolio is mainly located in Australian office markets, excluding the Sydney and Melbourne CBDs. We've also seen return to office gaining momentum, with public transport utilization increasing and more organizations enacting return to work policies globally. Many of these return to office policies are a reaction to diluting corporate culture and falling productivity. Australian labor productivity recorded its largest ever annual decline in the March 2023 national accounts, with output per hour worked back to December 2019 levels.
Further, a study conducted by the ANU, Wollongong, and Macquarie University found that working from home made the average worker less productive, more anxious, depressed, and lonely, while limiting their professional development. It should be noted that return to office has been materially stronger in Asia Pacific, including Australia, than it has been in Europe and America. This is important because many commentators are suggesting that the current issues confronting U.S. office markets may be a precursor to future office trends worldwide. These return to office stats, coupled with a strong net absorption in markets like Brisbane and Perth, suggest otherwise. Current U.S. office vacancy rates could also be explained by the comparative supply, as the U.S. has 40% more office space per capita than we have here in Australia. Returning to COF specifically on slide 7.
Our strategies and priorities for FY 2024 and beyond are to, firstly, maintain high occupancy. COF has consistently achieved strong leasing results, supported by the internal leasing team within Centuria Property Services, with nearly 170 square meters of leasing completed across the COF portfolio since and through COVID. Continuing this momentum is our primary objective. The next priority is high portfolio quality. Since listing in 2014, COF has materially improved the quality of the portfolio in terms of building age, building grade, environmental performance, and the quality of tenant covenant. Improvement in portfolio quality is important, particularly in the current environment, where there is clear bifurcation in tenant demand gravitating to prime over secondary office space. Thirdly, proactive capital management.
The steps COF took in FY 2023 to preserve a diverse lender pool and expiry profile while maintaining liquidity and debt covenant headroom will continue in FY 2024. Management remains open to considering further asset disposals if they similarly contribute to enhanced portfolio quality. The evolution of COF from listing in terms of portfolio quality is further illustrated on slide 8. We believe the COF portfolio has been cultivated to provide quality, highly connected, and affordable office space that is consistent with the style of workspace that both tenants and investors increasingly seek. Higher quality accommodation and new generation buildings that provide healthy, lifestyle-orientated work environments, efficient floor plates, improved amenity, and competitively priced accommodation. Furthermore, there is increased demand to be located in areas that provide efficient commutes to improve employee workplace satisfaction and attract the best talent.
When looking specifically at the COF portfolio, it has been positioned to deliver on many of these qualities by offering a young portfolio with an average age of 17 years, high-quality assets with 90% meeting A-grade specification, highly efficient buildings with a near 5-star average NABERS energy rating, significant geographic diversification, providing exposure to Australia's better-performing office markets, locations that are easily accessible by both public and private transport, with generally generous car parking availability, and a price point that is relatively affordable. Before I hand over to Assistant Fund Manager, Belinda Cheung, to take you through the financials and portfolio metrics, I will provide a brief overview of the manager and the benefits Centuria provides to COF on slide 9.
COF is an externally managed REIT that forms part of the larger Centuria Capital Group family, a leading Australasian real estate funds manager operating under the ASX ticker code CNI, and included in the ASX 200 index. With more than AUD 21 billion of assets under management, Centuria Capital Group specializes in real estate markets, including decentralized office, urban infill industrial facilities, cost-efficient healthcare property, daily needs retail, large format retail, agriculture, and real estate finance across Australasia. Centuria Capital Group remains COF's largest unit holder and has been a strong supporter in COF's evolution to now be Australia's largest ASX-listed pure play office REIT that is included in both the ASX 300 and FTSE EPRA Nareit index. I will now hand over to COF Assistant Fund Manager, Belinda Cheung.
Thanks, Grant. Moving on to the FY 2023 financial results on Slide 11. COF delivered funds from operations of AUD 93 million, or AUD 0.156 per unit. Gross property income increased by AUD 6.6 million to AUD 183.1 million, reflecting strong leasing outcomes achieved during the year. Due to the sustained rises in interest rates, finance costs have increased by AUD 17.1 million to AUD 36.8 million over FY 2023. The average all-in cost of debt incurred for the year was 4.3%. COF also paid distributions of AUD 0.141 per unit in quarterly installments, representing a payout ratio of 90.5%. Looking at capital management in more detail on Slide 12.
COF refinanced AUD 225 million of debt during the year, which included AUD 50 million of additional facilities and AUD 175 million of current facilities extended across existing lenders. This extended the REIT's weighted average debt maturity to 3.4 years, with no debt tranche expiring until FY 2026. During the year, COF executed AUD 510 million of swaps, increasing the hedging profile to 69.1% and a weighted average maturity of 1.5 years. COF now has 3 times the amount of non-current hedges in place compared to the same time last year. The interest cover ratio, ICR, for 30 June was 3.5 times, and the loan-to-value ratio, LVR, was 39.9%, providing headroom to our covenant requirements of 2 times ICR and 50% LVR.
Following the settlements of the Canberra and Robina assets, the pro forma gearing reduces to 36.7%. We will continue to monitor COF's balance sheet and gearing levels. Onto the portfolio on Slide 14. COF is a portfolio comprised of young, quality assets assembled in Australian metropolitan and near city office markets. Beyond the asset metrics, such as 90% of the portfolio being Grade A with an excellent NABERS SPI energy rating of 4.9 stars, the portfolio is supported by strong tenant covenants. Almost 80% of the portfolio income is derived from government, listed, and multinational tenants, with only a small exposure to SMEs. As seen in Slide 15, the portfolio is also geographically diversified, with a significant portion of the portfolio exposed to well-performing leasing markets, showing strong net absorption over the last 1 year.
This is evidenced by COF completing leasing of over 168,000 square meters, or 56% of portfolio NLA since COVID started. Turning to Slide 16, as noted earlier, one of the key benefits of Centuria's management is the strong capabilities of the in-house asset management team. With a dedicated leasing team, Centuria has consistently maintained high occupancy across all its listed and unlisted platforms. Since COF listed in 2014, Centuria Management has consistently leased a significant portion of the portfolio year in, year out, maintaining high levels of occupancy each and every year. COF continued to complete a significant amount of leasing during the year, with over 42,000 square meters secured, representing 14% of portfolio NLA. This included 20 lease renewals over 11,000 square meters and 42 new leasing deals over 31,000 square meters.
The most significant volume of leasing was completed for 818 Bourke Street in Docklands, where over 8,000 square meters was leased to the Costa Group and the Commonwealth Government, and at 154 Melbourne Street, South Brisbane, where 7,800 square meters of leasing was done to new and existing tenants. Slide 17 is a case study featuring the strategic repositioning of 154 Melbourne Street, South Brisbane, following the departure of a larger tenant within the building during the year. The strategy took into consideration the competition in the surrounding leasing market. Initiatives undertaken to improve building amenity through the refurbishment of a foyer and upgrades to the end-of-trip facilities, as well as improving the work amenity through the introduction of cirque by Centuria, a flexible work solution.
These all contributed to driving tenant demand and resulted in 7,800 square meters of leasing across 12 deals, which improved WALE from 1.2 years to four years and drove occupancy up by 26% to 94.1% at 30 June. Our focused approach on improving the quality of our asset drives tenant demand for our product. Moving on to COF's staggered lease expiry on Slide 18. As a result of the portfolio leasing, COF has increased occupancy to 97.1% and improved the resilience of the leasing profile, with about 90% of the portfolio now expiring at or beyond FY 2025. Maintaining high portfolio occupancy is a key management focus. We are actively seeking outcomes to further improve COF's lease expiry profile.
Our primary focus for FY 2024 are the vacancies and upcoming expiries at 818 Bourke Street, Docklands, and 201 Pacific Highway in St Leonards. Moving on to valuations on Slide 19. COF externally valued 13 of the 23 assets as at June 30, 2023. The portfolio weighted average capitalization rate expanded 42 basis points to 6% over FY 2023, which is the highest cap rate of its comparative peer set. Following revaluations, COF's net tangible assets are AUD 2.20 per unit. COF's average valuation as at June 30, 2023 was AUD 7,377 per square meter, which compares favorably to the increasing replacement costs. As Grant mentioned earlier, while transaction volumes are still relatively low, there is evidence of bifurcation based on quality, leasing risk, and asset size.
Well-tenanted, high-quality buildings under the AUD 150 million threshold have continued to trade on competitive sales metrics. Turning to sustainability on slide 20. COF, by its nature as a REIT, has no staff and is solely a portfolio of assets. COF is externally managed by Centuria Capital Group and aligns itself to Centuria's sustainability framework. A number of COF specific ESG initiatives implemented during the year include the launching of two new sustainability targets: targeting zero Scope 2 emissions by 2028, and targeting to eliminate gas and diesel equipment where practical by 2035. COF has also continued to improve its energy efficiency, with its NABERS Sustainable Portfolios Index energy rating again, increasing again to 4.9 stars, supported by ongoing solar installation projects across the portfolio, reducing our carbon footprint. Centuria is committed to gender diversity and inclusion.
At present, there is roughly a 45%-55% split of female to male staff. The environmental data for 2023 will be included in the Centuria 2023 Sustainability Report, which will be made available in Q4 this calendar year. Slide 21 provides a case study for the development completed at 57 Wyatt Street, Adelaide, earlier this year. Development was executed by Centuria Capital Group's in-house development team and was completed with 5-star Green Star Design & As Built rating and targets a 5.5 NABERS energy rating. During construction, 9% of building waste was diverted from landfill. The building boasts high sustainability credentials, and being fully electric for base and common operations, aligns with COF's commitment to eliminate gas and diesel where practical, as part of its new sustainability targets and adds to the quality of COF's portfolio.
I will now hand back to Grant to cover market outlook and guidance.
Thanks, Belinda. Turning to tenant demand on slide 23, as already mentioned, many, in fact, the majority of Australian office markets demonstrate a positive net absorption through FY 2023, with softness in tenant demand quarantined to the Melbourne CBD and Sydney generally. The strongest market was once again a fringe office market, with Brisbane Fringe demonstrating the strongest net absorption of any Australian office market. Within the Brisbane Fringe, Fortitude Valley saw its vacancy rate reduce 6% year-on-year, which will benefit COF's assets at 825 Ann Street and 100 Brookes Street. There has also been a clear bifurcation trend in the data, with a significant gap between national net absorption rates for prime and secondary space.
This bifurcation might explain why there has been evidence of reasonable face rental growth in a number of markets, suggesting there may be a potential change in the vacancy equilibrium as some secondary office space becomes redundant. Looking forward, we expect there will be a material reduction in supply over the medium term due to rising construction costs, finance costs and CapEx. Combined, these factors have substantially increased the required economic rents that are mostly currently unfeasible. We understand that a number of development sites are consequently looking at alternate uses, such as Build- to-R ent. This will be beneficial for existing quality office portfolios like COF. Concluding on slide 24. As I mentioned earlier, we recognize that an increased interest rate environment creates some future uncertainty, but we remain optimistic for Australian office markets.
Tenant demand has been better than many has predicted, and the majority of expanding industries are office using sectors, with strong projected employment growth for professionals. Looking ahead, we will continue to focus on maintaining high portfolio occupancy, improve portfolio quality, and preserve a solid balance sheet, maintaining sufficient liquidity and debt covenant headroom. For FY 2024, COF provides FFO guidance of AUD 0.138 per unit and distribution guidance of AUD 0.12 per unit, with distributions expected to be paid in equal quarterly installments. Based on the recent trading price, the distribution guidance equates to a distribution yield of 8.4%. Thank you for your interest in the Centuria Office REIT. I will now hand back to the operator and invite any questions that you may have.
Thank you. At this time, I would like to remind everyone, in order to ask a question, please press Star, then the 1 on your telephone keypad. Our first question comes from Tom Bodor with UBS. Your line is open.
Tom, can you hear us?
Sorry, the mute button gets you every time. Thanks very much for your presentation. I just had a couple of quick questions. Thank you very much for providing maintenance, CapEx, and CapEx on incentives. That was really helpful. If I look at your distribution, still above AFFO, if we were to deduct that number from FFO, only a couple of % in 23. I'd just be interested in understanding, you know, if you would like, over time, to be paying out less than AFFO or what your thinking is around that?
Yeah, sure, Tom. I think we've, we've started this for a little while now. We're, we're aiming to get our distribution payout ratio between 85% and 90% of FFO for a smaller portfolio. Albeit, you know, we're, we're a medium-sized portfolio. You do get lumpiness in terms of CapEx payments and incentive payments. That does create a bit of volatility in, in distributions. For FY 2024, we are smack bang in between 85%-90% in terms of what our payout ratio is forecast to be.
Yeah, I'm just interested because, you know, as you say, I noticed that numbers are a bit volatile from year to year, so your maintenance CapEx was 9 basis points and 18 basis points. You know, your incentive CapEx was 25, then 50. If I look at peers, they're quite a bit higher. I appreciate the differences in the portfolio, but, you know, is there not an argument to just say, pay out 95% of, you know, AFFO or a lower number of FFO to ensure that you're sort of never paying out more than AFFO, given the gearing?
Yeah, look, I think when it comes to maintenance CapEx, one of the benefits of having a younger portfolio is that we should have less maintenance CapEx than some of our peers. From that perspective, I think that is going to be an ongoing benefit to, to COF for a little while now. Then in regards to incentives, look, they will bounce around, and it probably refers back to the prior comment I made. For, for smaller or medium-sized portfolios, that number can vary year to year, which makes it hard to peg to an AFFO number if you're looking to get some sustainability into your distribution number.
Okay, clear. Just a quick one around asset sales. You know, are you still looking to sell further assets, if the opportunity is there? I mean, I think it's good progress on the couple you sold, but what, what's your thinking around that?
As mentioned on the call, we remain open to considering asset disposals throughout FY 2024. Look, in the pool of assets that we own, in the markets we operate, most of the transactions that have occurred have been off-market. We will consider those opportunities as they arise throughout the course of the year, particularly if they go to benefit the portfolio overall. As mentioned on the call, one of our key objectives is to continue to improve portfolio quality. I think the sales that we transacted this year, when you think about 54 Marcus Clarke Street, it was one of our oldest assets. It would have been over 40 years, probably approaching 50 years in age. Robina had about a 1-year WALE.
Both those assets certainly did go to not only improving our balance sheet, but improving the overall portfolio quality.
Okay, thanks. Then finally, just be interested in just thoughts around that Docklands market. That's sort of been persistently difficult. Where do you think that will land?
Yeah, look, there's no doubt Docklands has been tough. I think when you're looking at, at leasing markets, generally, Australia, a lot of Australian office markets have been performing quite well. Sydney generally and Melbourne CBD have been struggling, and within Melbourne CBD, Docklands has probably been one of the tougher segments of that market. We've had a really good run in terms of the leasing we completed through FY 2023. We completed in excess of 7,000 square meters of, of leasing or new tenants coming into that building. I completely acknowledge that it's, it's still a grind, and it will probably continue to be over the short to medium term.
Okay, thanks very much.
Your next question comes from Murray Connellan with Moelis Australia. Your line is open.
Morning, Grant Nichols. Morning, Belinda Cheung. Just on your your upcoming expiries in 2024, that's, that's 6% of the income, or 6.4% of income rather. What have you assumed in your guidance number in terms of of retention and leasing up there? To ask the question differently, how much of that 6.4% is, is missing, relatively, from 2024's guidance?
Yeah. In terms of looking at the FY 2024 expiry, the two big ones that expire through FY 2024 is Ericsson at 818 Bourke Street in Docklands. That's circa 7,000 square meters. They expire in January, and they will vacate. We haven't assumed that there will be any income coming into FY 2024 post the expiry. The other major expiry is IQVIA at 21 Pacific Highway. They vacated 3,000 square meters in July, and we've assumed that there will be no income generated from that space for the remainder of FY 2024 as well. When you go past those two expiries, it's mostly bits and pieces from there on. It'll be a combination of assumptions made on those.
Generally, what we've assumed for, for tenants that are expiring, where we don't have a line of sight, is that there will be at least four months downtime following their expiry.
Great, thanks. Maybe just to touch on on FY 25, the major expiry there being the ATO in Perth. Have you had any any engagement with them in terms of what their intentions are?
We're in discussions with the ATO at the moment, but nothing is concluded as yet.
Thanks very much.
Cheers, Murray.
Again, if you would like to ask a question at this time, please press star, then the number 1 on your telephone keypad. Your next question comes from Ryan Chung with Jefferies. Your line is open.
Hi there. Hi, Grant and team. I was just wondering, in relation to the gearing situation, we've noticed that the gearing sort of increased past the top, top end of your target range. How many how many asset sales are you potentially looking at to, to, you know, bring us back in line in terms of dollar value?
Yeah, look, I, I don't think... We haven't made an explicit target in terms of what we're, what we're looking at. It really is dependent on what assets we deem would be beneficial for the overall portfolio quality. You'd also give consideration to the assets where you think you have maximized value. As mentioned on the call, we are open to continuing to look at asset disposals, since we have listed in 2014, we have done a number of asset disposals to improve portfolio quality. We are not issuing a specific target of asset sales that we need to complete. Given where gearing sits at the moment, we are pretty comfortable with where gearing sits.
It is slightly above where our target gearing is, but at the same time, we do have quite a substantial amount of debt covenant headroom, that we are not concerned about at this point in time.
Yep. Thanks. A second question, just on the leasing. I think, there was a bit of a leasing slowdown that second half, where we had in FY 2023, there was only around 12,000 square meters. I think of, my calculations of with leasing executed. Are you expecting a bit of a reversion in terms of leasing momentum, into FY 2024 and onwards?
I think it, it's probably more a function of what we had to lease. If you think about when we started FY 2023, if we go back 12 months, we had 6% vacancy and 14%, I think it was, 6% and almost 10% of the portfolio expiring through FY 2023. We are in a much more benign situation now as a result of the leasing that we've done. Vacancy circuit, 3%, we've got about 6% expiring through the course of FY 2024. A bit of that is a function of, of what we have to lease. As mentioned on the call, we are seeing differences in markets in terms of the amount of leasing momentum that we're seeing.
Sydney has been tough going, Melbourne CBD has been tough going, but outside of that, we have generated a lot of momentum in markets, particularly in Brisbane. I wouldn't say that it's a consistent thing nationally or that you can really read too much into our first half or second half performance.
Great. Thanks a lot for your time.
Thanks, Ryan.
There are no further questions at this time. With that, I will turn the call back to Mr. Grant Nichols for closing remarks.
Once again, thanks for your interest in Centuria Office REIT. If you have any following questions, please don't hesitate to contact myself or Tim Mitchell. Otherwise, thank you and have a nice day.
This concludes today's conference call. You may now disconnect.