Thank you for standing by, and welcome to the Centuria Office REIT FY24 Results Conference Call. 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 Jesse Curtis, Centuria Group, Head of Funds Management. Please go ahead.
Thank you, operator, and good morning, everybody. Thank you for joining Centuria Office REIT's financial year 2024 results presentation. My name is Jesse Curtis, Centuria's Head of Funds Management. Presenting today is Belinda Cheung, COF Fund Manager, Grant Nichols, Head of Listed Funds. Also present in the room is Tim Mitchell, Group Head of Investor Relations. Starting on slide 3, I would like to commence today's presentation with an acknowledgment of country. We are 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 in each country, to their unique culture, and to their elders, past and present.
Despite the prevailing challenges in the office sector, the market is showing signs of improving tailwinds, with return-to-office mandates coinciding with limited new office developments and population growth, leading to a larger white-collar workforce. Investment in transport infrastructure, such as the Sydney Metro and Brisbane Cross River Rail, will improve commutability, especially to metropolitan and near city office markets. COF has a young, diversified office portfolio that is well-positioned to benefit from these trends. In today's presentation, we will cover strategy execution over the past four years, an overview of COF's FY 2024 performance, FY 2024 financial results, a portfolio overview, and concluding with a market outlook and guidance statement.
Moving to slide 4, Centuria Office REIT is managed by Centuria Capital Group. Centuria has over AUD 21 billion of assets under management and employs a significant team of professionals around the country dedicated to maximizing unitholder value. COF unitholders benefit from deep real estate expertise across the Centuria Group, including a fully integrated property facilities and asset management platform. Synergies from being part of the group's wider office real estate portfolio and strong alignment, as Centuria is COF's largest unitholder, ensuring the manager's interests are strongly aligned with yours as unitholders. Before we pass over to Belinda, Grant Nichols, the former COF Fund Manager, will provide an overview of COF's long-standing strategy and track record of active management.
Thanks, Jesse. Before I begin on slide six, I would like to make a quick comment on the management changes that occurred during the half. Centuria has a demonstrable track record of promoting from within, which provides not only a level of consistency, but retains knowledge within the group. In the case of COF, while I no longer manage the fund day-to-day, I remain an integral part of COF's management alongside Belinda and Jesse, and the expertise I gained throughout the past five years as Fund Manager is accessible to all within the group. COF's long-standing vision and strategy remain unchanged, and I look forward to continuing to work with Belinda in executing that strategy.
We aspire for COF to be Australia's leading domestic pure-play office REIT, with a primary focus on delivering income and capital growth to investors from a portfolio of high-quality Australian office assets within metropolitan and new city markets that are differentiated by sustainability, amenity, and connectivity. These unique attributes capitalize on the continued bifurcation between prime grade stock and secondary assets, underpinning COF's continued robust occupancy rates. The results that Belinda and I present today reflect the execution of this strategy, supported by the deep real estate capability of the broader Centuria team to drive value for unitholders, which I'll cover in the next slide.
Since 2020, the office sector has faced challenging macroeconomic headwinds, including a high inflationary and interest rate environment, as well as structural and cyclical shifts in the market and the future of office. Over this time, management has navigated through the uncertainties presented, and through active management, have achieved a strong leasing track record with over 200,000 square meters or nearly 80% of the portfolio leased. Carried out proactive capital management initiatives, refinancing over AUD 1.8 billion of debt, including extending the debt duration and amending debt covenants, executing AUD 1.3 billion of hedging, and improving the quality of the debt book by expanding to 6 domestic and international lenders.
Completed AUD 1.2 billion of strategic transactions involving buying high-quality assets and selling non-core assets, which have resulted in a 9% improvement of the proportion of A-grade assets within the portfolio and reduced portfolio age by 3 years. These completed initiatives, particularly the recent sales and refinancing, which results in no debt expiring until FY 2028 and increased debt covenant headroom, has COF well-placed to take advantage of the office tailwinds we expect in the medium term, while weathering any continued short-term volatility. I will now pass over to Belinda to talk through the FY 2020 result—FY 2024 results on slide 8.
Thank you, Grant, and good morning, everyone. COF delivered FY 2024 FFO of AUD 0.138 per unit and distributions of AUD 0.12 per unit, in line with guidance. Leasing was executed over 42,000 sq m, or 15% of portfolio net lettable area, including renewing our largest tenant, the Commonwealth Government, for 10 years over their existing footprint at William Square. Capital management was a major focus, and we recently refinanced AUD 862 million of debt, negotiating additional debt covenant headroom for our interest cover and loan-to-value ratio requirements. Debt extensions with no debt expiring before FY 2028, with no change to debt margins. We executed AUD 139 million of divestments at an average 2% discount to book value.
The portfolio is underpinned by strong tenant covenants, with 72% of rental income supported by ASX-listed, national, and multinational tenants, and with 93% occupied and had a 4.3-year weighted average lease expiry at that 30 June. On slide 9, we provide FY 2025 FFO guidance of AUD 0.118 per unit and distribution guidance of AUD 0.101 per unit, with distributions expected to be paid in quarterly installments. Key drivers of the change in FFO include leasing downtime estimates applied. We are assuming no FY 2025 income for full floor vacancies and expiries across a number of assets in challenged leasing markets. Reduced income from the divestment of four assets in FY 2024, used to repay debt and reduce interest, and an increase in the overall cost of debt, with about 5.5% expected in FY 2025.
The change in forecast FFO is driven by leasing challenges in some markets, namely Docklands and St Leonards, not ubiquitous across all Australian office markets. Further, the volatility created from increased debt costs may moderate during FY 25, as COF's all-in cost of debt is expected to be relatively consistent with the current marginal cost of debt. Based on the recent trading price, the distribution guidance equates to a yield of circa 8%. Considering that, with the implied value of COF's portfolio at AUD 5,500 a square meter, just less than half the replacement cost, we believe cost provides an attractive, compelling distribution yield and value for the quality of the underlying assets in the portfolio. Slide 10 illustrates net absorption data for the major Australian office markets from 2020 to 2024.
Net absorption is a measure of tenant demand, with positive absorption indicating growing tenant occupation or demand. We continue to see many markets experience positive net absorption over this period, but Prime Grade office is the clear preference compared to secondary office stock. COF's exposed markets have had a strong performance during that time, particularly fringe markets in Melbourne, Brisbane, and Sydney. Turning to slide 11. We believe the COF portfolio has been cultivated to provide quality, high connected, and affordable office space that is consistent with the style of workspace that both tenants and investors increasingly seek. That is, higher quality accommodation in new generation buildings that provide healthy, lifestyle-oriented 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 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 93% meeting A-grade specification. Highly efficient buildings with a 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 generous car parking availability, and a price point that is relatively affordable. Slide 12 illustrates the shift in today's discussion around the return to work and the future of office.
People are returning to the office. The public transport data shows the number of trips increased fivefold over the last 2 to 3 years. Return to office mandates were first driven by some large corporates, then banks, and as recent as last week, the New South Wales State Government. These employers have asked their staff to come back to the office with the aim of rebuilding company culture, fostering better collaboration and mental health and well-being. The growing number of employer-led return-to-office mandates indicates potential growth in the demand for office space in the medium term. Looking ahead at the future of office supply on slide 13. We also expect future supply to materially reduce over the medium term, as development feasibilities continue to be impaired by rising costs.
Replacement costs have increased 40%, which is reflected across all components of a development feasibility: construction, leasing, financing, even if land value remains the same. The hypothetical cost to build an A-grade office in Metro Sydney is over AUD 15,000 a square meter. This is more than double COF's average property value and almost three times its implied value based on the recent trading price.
Further, the hypothetical feasibility indicates economic rents may have increased by approximately 60% since 2020. COF's average rent is AUD 550 per sq m, which compares quite favorably to new developments that would require rents in excess of AUD 1,000 per sq m.... Moving to the FY 2024 financial results on slide 15. COF delivered funds from operations of AUD 82.2 million, or AUD 0.138 per unit. Gross property income increased 3% on a like-for-like basis, but the movement has been offset by recent divestments. The increase in direct property expenses is due to inflation in various property costs, particularly statutory charges, being land tax and council rates. Due to the sustained rises in interest rates, finance costs have increased to AUD 46 million over FY 2024. The average all-in cost of debt incurred was 4.9%.
COF declared and paid distributions of AUD 0.12 per unit across the period, in quarterly installments, representing a payout ratio of 87%. Over time, we have been reducing the payout ratio for COF, which is in line with our capital management considerations noted on slide 16. COF recently completed an AUD 862 million refinance with existing lenders, which resulted in a number of beneficial outcomes. First, debt covenant requirements were renegotiated. The interest cover ratio was reduced to 1.7 from 2 times. The maximum loan-to-value ratio was increased to 60% from 50%. These new covenant requirements provide significant headroom to the 30 June ICR of 2.8 times and an LVR of 41%. Secondly, debt duration was extended to over 4 years from 2 years, meaning there is no debt expiring before FY 2028.
This has all been executed with no change to margin, demonstrating the lender's strong ongoing support for COF. Sale proceeds from COF's AUD 139 million divestments during the year were used to repay debt and reduce interest costs. AUD 50 million of excess debt headroom were also canceled to further reduce interest costs, bringing the pro forma facility headroom to AUD 85.5 million. At 30 June, gearing was 41%, and 63% of debt was hedged. Moving to the portfolio overview on slide 18. COF's portfolio comprises young, quality assets positioned in Australian metropolitan or near city office markets. Following divestments, the A-grade office portfolio weighting increased to 93%, and the average NABERS rating increased to five stars.
Importantly, this portfolio is underpinned by the quality of tenants, boasting over 70% of portfolio income derived from government, listed, and multinational tenants. Slide 19 examines COF's lease expiry in detail. Achieving high portfolio occupancy is a key management focus, and we are actively seeking outcomes to further improve COF's occupancy and lease expiry profile. During the year, COF executed more than 42,000 square meters of leasing, equating to 15% of portfolio NLA, while maintaining a 4.3-year WALE. COF's occupancy at 30 June was 92.5%. Our primary leasing focus for FY 2025 is existing vacancies at 818 Bourke Street and 201 Pacific Highway.
Unfortunately, while we are currently seeing decent levels of tenant demand in a number of Australian office markets, Docklands and St Leonards remain challenging leasing environments, and we have not assumed any income from full floor vacancies in those buildings during FY 2025. Slide 20 showcases the variety of tenant-focused initiatives undertaken by the in-house Centuria management team.
This includes providing additional amenity in the form of refurbished common areas, wellness facilities, town hall, collaboration or event spaces, and flexible co-working solutions. The combination of these initiatives have resulted in increased market rents, weighted average lease expiry, and full occupancy. This is a particularly significant outcome at 154 Melbourne Street, considering the asset was facing a 55% expiry two years ago. On slide 21, we look at the value add opportunities explored at 818 Bourke Street in Docklands. COF entered into a conditional 10-year lease with ResetData, a new generation data server provider that uses proprietary liquid immersion cooling technology to run data centers in a smaller footprint than traditional data centers. This allows data centers to be located in existing office buildings rather than outer city warehouses.
818 Bourke Street is one of the first sites to be selected due to the building's attributes, including its existing infrastructure for critical services left from a prior tenant and its position above a power substation. ResetData is an example of Centuria seeking alternate use and ways to diversify income streams, and at 818 Bourke Street, the introduction of data center rents can help address the existing vacancy in Docklands. Now turning to divestments on slide 22. COF divested 4 non-core assets for AUD 139 million during the year, with an average 2% discount to the prevailing book values. These are direct market transactions that underpin COF's net tangible asset backing and demonstrate the REIT's comparative liquidity with an average asset size of around AUD 100 million to peers with large-scale assets.
In the last two years, there have been significantly high volume of completed transactions for assets below the AUD 150 million mark, evidencing the high demand from the deep buyer pool for small-scale assets. The REIT's wider portfolio improved post divestments, benefiting from A-grade asset exposure, increasing to 93% and a young portfolio age of 17 years.... Moving on to valuations on slide 23. COF externally valued 14 of its 19 assets as at 30 June 2024. Through FY 2024, the portfolio weighted average capitalization rate expanded 65 basis points on a like-for-like basis to 6.58%, which is the highest cap rate of its comparative peer set. Following valuations, COF's Net Tangible Assets, or NTA, is AUD 1.80 per unit.
COF's average valuation as at 30 June 2024 was about AUD 7,000 per sq m, comparing favorably to increasing replacement costs, which we're estimating to be more than double and almost three times the implied value. Now, turning to sustainability on slide 24. COF continued to demonstrate its commitment to environmental, social, and governance, ESG initiatives, and improved sustainability performance by participating in the Real Estate GRESB assessment, achieving a strong 4-star GRESB rating. We announced new sustainability targets earlier this year. COF is targeting zero Scope 2 emissions, with 100% of its portfolio's Scope 2 electricity sourced from the equivalent of 100% renewable energy by 2028. Additionally, the REIT aims to eliminate gas and diesel use from its operations by 2035, where practicable.
During the period, we commenced the electrification process for two assets across 550,000 square meters in the portfolio. COF further committed to improving its energy efficiency, with its NABERS Sustainable Portfolio Index energy rating increasing to five stars, supported by ongoing solar installation projects to reduce our carbon footprint. During the period, 260 kW of solar was installed in our buildings, increasing COF's total installed capacity to circa 1,400 kW. The environmental data for 2024 will be included in Centuria's 2024 sustainability report, which will be made available in Q4 this calendar year. Moving to anticipated office market tailwinds on slide 26. We have touched on the impaired office development feasibilities, which is likely to dramatically reduce new office supply over the medium term.
COF estimates that the economic rents required to support new developments have increased circa 60% since 2020, and the COF portfolio is valued at less than half replacement cost. Construction costs and labor shortages may be partially attributed to the significant infrastructure projects, taking the lion's share of talent and supplies. Several transport infrastructure projects that could be beneficial to COF's portfolio in the medium term include the Sydney Metro and Brisbane's Cross River Rail, which will provide easy commutability to the fringe, metropolitan, and near city office markets. Again, work from office is gaining momentum, with a rising number of companies mandating full-time office attendance.
Additionally, Centuria's office tenant customer survey showed only 13% of our tenants allow fully flexible working arrangements, which is decreasing year on year. We have previously mentioned bifurcation of prime and secondary markets, which has continued throughout FY 2024. CBRE research shows nearly three quarters of office relocations were at the same or higher market rents. We refer to this as premiumization. That is, businesses seeking prime assets to attract employees back into the office, to be closer to customers, and align with their ESG targets. Finally, population growth is expected to positively impact office occupier demand, with an estimated 27% increase in office-based workers. Let's look more closely at Sydney Metro's likely impact on slide 27.
Typically, there is a lag in recognizing new transport infrastructure's added value on nearby commercial office. With reduced commute times and forecast population growth, the breadth of Sydney's population is expanded in the west and south. The Metro provides better connection from these areas to the north, which is anticipated to positively impact COF assets in Chatswood and St Leonards, and also to South Eveleigh.
COF's FY 25 priorities are outlined on slide 28. 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. Concluding on slide 29. For FY 25, COF provides FFO guidance of AUD 0.118 per unit and distribution guidance of AUD 0.101 per unit, with distributions expected to be paid in quarterly installments. Based on the recent trading price, the distribution guidance equates to a distribution yield of circa 8%. Thank you for your interest in Centuria Office REIT. I will now hand back to the operator and invite any questions that you might have.
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. In the interest of time, we ask that you please limit to two questions per person. Your first question comes from Murray Conallin from Morgans Financial Limited. Please go ahead.
Morning, Belinda, Grant, and Jesse. Just keen on drilling into your guidance assumptions a little bit more, please. Given that comment that you made about assumptions for full floor vacancies to remain vacant for the full year. Would it be fair to say that your assumption is that the portfolio, on average, for FY 25, is slightly more vacant than where it is today, that 7.5% vacancy number?
That 7.5 vacancy number is mainly concentrated in Docklands, so that's 818 Bourke Street, and 201 Pacific Highway in St Leonards. We have assumed no income for FY 2025 across those buildings, so you can make that assumption.
Got it. And then, could we also just touch on 85 Ann Street, please, that comment, it looks like included that building as well. Could you just touch on the, I guess, the nuances of that building, that expiry and how things are going in the Fortitude Valley market?
Yep. I'll start off by saying that, Fortitude Valley market is a very vibrant precinct. 85 Ann Street is a building that's located, it's a great location. The expiry that you're referencing is the Macquarie space, where they occupy 3 floors. Their expiry end of year, will occur in January next year, and for their space, we have assumed no income for the remaining period in FY 25. With leasing these days, a lot of tenants are, or a lot of potential occupiers are coming out a lot earlier, than their expiry, and leasing deals are taking a little bit longer to negotiate. So for us, we put in some prudent assumptions that there is no remaining income for FY 25.
Got it. Thanks. And then, could we just touch on your plans around capital management and that gearing number now in the early 40s. Do you foresee the need to be continuing with this asset investment program that you've been working through over the course of the last year? And I mean, I guess, could you, you know, would you be able to, I guess, quantify where you would like to see that gearing number get to?
Yep. Thanks, Murray. In FY 2024, we sold four assets. That was part of our capital management plan to bring down gearing. This year, we've actually looked at refinancing debt, so AUD 862 million of our debt was refinanced, and as part of that, we were able to renegotiate our debt covenants, giving us ample debt covenant headroom.
Gotcha. So would that imply that you're comfortable in the early forties for gearing?
Yes.
Perfect. Thank you.
Thank you. Once again, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. Your next question comes from Tom Boadle, from UBS. Please go ahead.
Morning, Belinda. I was just interested in just sort of following on from the capital management point, the distribution this year... Now, thanks for giving us leasing and maintenance CapEx. The distribution is essentially 113% of your AFFO on my calculation, and, you know, with gearing over 40%, would there be plans to get this down to be below AFFO?
We might loop in with you afterwards to double-check that AFFO calculation, Tom. We are very comfortable with the distribution that we are giving guidance to. Over time, for the last few years, we actually have been reducing our payout ratio to address for things like CapEx and incentives, but we are very-
Yeah
comfortable with where guidance is.
I mean, you've got maintenance CapEx at AUD 7 million and incentives at AUD 12 million on the slides. That's AUD 19 million across the two. So pretty. Yeah. So I'd assume it's essentially 23% of your FFO, and you're only retaining 13.
We're pretty comfortable with where our distribution guidance is for FY 25.
If you then sort of think forward, I think you mentioned previously mid-30s on sort of a gearing target. What's the path to get there? I mean, how many assets are you looking to sell, or is it more a question of waiting until values recover?
I think at this point in time, our major focus is debt covenants. We've renegotiated our debt covenants with all the lenders, and we have ample debt covenant headroom.
Okay. So no current plans to bring the gearing down in the short term?
If we find opportunities, we will consider it, but at this point in time, there is no plan set in stone.
Okay, thanks.
Thank you. Once again, if you wish to ask a question, please press star one on your telephone. We'll now pause a moment to allow for any final questions to register. Thank you. We have a follow-up question from Murray Conallin, from Morgans Financial Limited. Please go ahead.
Hi, just one more from me, please. Just on the data center tenancy in the Docklands, I was wondering whether you could just potentially put a bit more meat on the bone there in terms of how much space is going to be taken up? What those terms look like? And I mean, I guess whether there's any scalability in this building or others based on how much excess power capacity, I guess, the building has.
Thanks, Murray. I'll preface this by saying that this lease is still conditional on a few things, including the availability of power to the building and also local council's planning approval. For us, the lease so far, we have agreed to 608 sq m, and the capacity, our maximum capacity is 1.5 MW.
Got it. And that's, sorry, that's the capacity for the whole building or for the 608 square meters?
That's for the 608 square meters. However, we're still waiting for confirmation from the power authority.
Got it. Do you have any feel for whether the building itself has any excess capacity and whether or not that footprint could be increased?
So to provide a bit more context, the space that they're they will be taking up is leftover from the Ericsson space. It's the old Ericsson comms room, so there's already existing infrastructure in there. They were using it to run their comms servers, and that already had power flowing up through. So there's existing infrastructure. I think, another important point to note is 818 Bourke Street is located right above a substation. So in terms of scalability, it's, it's actually quite limited where you can put these types of, of data centers. They always need access to power, and it's, it's not prevalent in all buildings, but it just happens to be there at 818 Bourke Street.
Got it. Thank you, Belinda.
Thanks, Murray.
Thank you. There are no further questions at this time. I'll now hand back to Belinda Cheung for closing remarks.
Once again, thanks for your interest in Centuria Office REIT. If you have any follow-up questions, please don't hesitate to contact Tim Mitchell or myself. Thank you, and have a lovely day.
Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.