Ladies and gentlemen, thank you for standing by, and welcome to the Charter Hall Social Infrastructure REIT 2024 Half-Year Results briefing. At this time, all participants are on a listen-only mode. There will be a presentation followed by a question-and-answer session, at which time, if you wish to queue for a question, you will need to press star one one on your telephone keypad and wait for your name to be announced. Please note that this conference is being recorded today, Tuesday the 13th, February 2024. I would now like to hand the conference over to your host today, Mr. Travis Butcher, Fund Manager. Thank you, sir. Please go ahead.
Good morning, everyone, and welcome to CQE Results Presentation for the Half-Year ended 31 December 2023. Presenting with me today is Scott Martin, Head of Social Infrastructure REIT Finance. I'd like to commence today's presentation with an acknowledgment of country. Charter Hall acknowledges the traditional custodians of the lands in which we work and gather. We pay our respects to elders, past and present, and recognize their continued care and contribution to country. Turning now to Slide 4, key highlights for the half-year were as follows. Operating earnings for the half was AUD 29.6 million, consistent with the prior half despite the increase in prevailing interest rates. NTA per unit, as at 31 December 2023, was AUD 3.93 per unit, which is down marginally on the NTA at 30 June 2023 of AUD 4.04, primarily reflecting the revaluation decrement on the property portfolio recorded in the half.
During the period, we continued with our active portfolio curation, resulting in AUD 22.3 million of divestments being made across six childcare properties. Pleasingly, these were completed at a premium of 8.8% to their previous carrying value. Subsequent to 31 December 2023, CQE successfully refinanced its debt onto an unsecured platform, resulting in the fund's debt maturity increasing to 4.3 years. The fund is also well hedged at 82% of current drawn debt. CQE's portfolio is very well positioned in this current environment, with a strong WALE of 12.8 years, 100% occupancy, and achieving a weighted average rent review of 3.5% for the last 12-month period. Moving to Slide 5, and the social infrastructure market which CQE invests in. At Charter Hall, we define social infrastructure and CQE's investable universe as properties which are delivering essential community services.
Due to the essential nature of the services provided from these properties and the strategic locations where they are situated, these properties provide long leases, either government-backed tenants or tenants operating in government-supported sectors with higher tenant retention. This results in predictable and resilient property returns and a lower correlation to economic cycles compared to other property classes. Social infrastructure is a growing asset class in Australia which will provide future growth opportunities for CQE. Key thematics driving this are both a growing and aging population in Australia, with estimated population growth of 3.9 million people, or 15% over the next 10 years. The number of Australians aged 65 or over is also estimated to double over the next 40 years.
This will require a significant investment in social infrastructure in the future, and governments will not be able to fund all the required infrastructure, creating significant opportunities for private capital. We have detailed five social infrastructure subsectors at the bottom of this slide, being childcare, education, health, government services, and transport, which are key areas of focus where CQE has existing investments and we will see further opportunities for growth. Moving to Slide 6, and CQE's strategy. CQE's strategy remains unchanged, which is to provide investors with secure income and capital growth for exposure to a diversified social infrastructure portfolio. We do this by focusing on enhancing income sustainability and resilience of the assets we own, targeting ongoing capital growth and undertaking continual portfolio curation.
We see the attributes of social infrastructure assets, such as strategic locations, long leases, predictable income growth, and government-supported industries, all critical components to CQE delivering on its strategy. Turning to Slide 7, the broadened social infrastructure mandate has delivered on improving tenant quality, portfolio diversification, and stronger growth opportunities for the fund. From an income perspective, the addition of tenants with enhanced financial strength now sees 17% of CQE's income sourced from direct leases with externally rated government and corporate entities with a credit rating of A-minus or better. Tenant concentration risk has reduced, with our largest tenant, Goodstart, providing 33% of the CQE's income as at December 2023, down from 47% as at June 2020. Income growth is predictable, with 77% of lease income subject to an average of 3% annual fixed escalators.
From a capital perspective, recent portfolio additions include newly constructed assets such as the Mater Health Building in Brisbane, Innovation Quarter in Westmead in Sydney, the TAFE and Wise Medical Centre in Robina on the Gold Coast, and the SA Emergency Services Command Centre in Adelaide. These have been constructed with the latest amenities and environmental designs which are highly desired by tenants. The portfolio is predominantly located in strategic locations due to the provision of essential services, with 83% located in metropolitan areas with high underlying land values which will drive capital returns into the future. We have been actively curating CQE's portfolio to replace properties with obsolescence, trading, or competition concerns, or weaker tenant covenants.
In the last five years, we have divested over 100 childcare properties and our holding in ARF units for a total proceeds of AUD 268 million, which has been reinvested into newer assets with stronger tenant covenants and superior long-term returns. Turning now to Slide 8, and ESG. We remain focused on implementing sustainability initiatives across our portfolio and consider ESG as a driver of long-term value for the fund. Key points to focus on from a CQE perspective are: for the first time, CQE received a GRESB Public Disclosure level of A and improved our score in the management component of GRESB Real Estate Assessment to 29 / 30. We're continuing to roll out solar solutions with our tenant customers, with a further 0.5 MW installed during the half, bringing total installed solar capacity across the portfolio to 1 MW to date.
This will assist CQE to better understand and measure tenant operational performance through information sharing, which is currently not available under existing lease arrangements. And finally, we're really pleased to be able to extend our partnership with major tenant customer Goodstart and their Early Learning Fund that provides families and children facing hardship with fee relief for early learning and care. I would now like to hand over to Scott, who will provide an overview of the financial performance of CQE.
Thanks, Travis, and good morning to everyone on the call. A summary of CQE's earnings for the half-year can be found on Slide 10. Net property income has increased by 10.9% compared to the prior reporting period and has been driven by like-for-like growth of 3.5%, with the balance generated from property acquisitions, development, and disposal activity. The increase in finance costs of AUD 4.4 million period on period is a result of higher levels of drawn debt to fund acquisitions, together with a 0.8% increase in CQE's weighted average cost of debt to 4.5% in this period. This has resulted in CQE delivering operating earnings of AUD 29.6 million, which was in line with the prior corresponding period, with the increase in finance costs offset by strong NPI growth.
This equates to earnings per unit of AUD 0.08, and distributions paid for the half also amounted to AUD 0.08 per unit. Turning to Slide 11, which provides a summary of CQE's balance sheet position at 31 December 2023. During the current reporting period, CQE has divested AUD 24.9 million of childcare properties at or above prevailing book values. CQE independently revalued 100% of the portfolio during the current reporting period, with a net property valuation decrement of AUD 29.3 million recognised as at 31 December 2023. The net property valuation movement has been the main driver of the movement in NTA, which has decreased by 2.7% from AUD 4.04 per unit at 30 June 2023 to AUD 3.93 per unit at 31 December 2023. Turning to Slide 12, which provides a summary of CQE's capital management initiatives.
Post-balance date in January 2024, CQE completed the full refinance of its debt facilities of AUD 850 million, which included moving the facilities to a new unsecured debt platform. The new unsecured debt platform provides CQE with increased operational efficiency and flexibility and provides it with the opportunity to access a wider variety of debt capital markets moving forward. Balance sheet gearing was 32.5%, and look-through gearing was 33.2%, which remain within CQE's target gearing range of 30%-40% and provides considerable headroom to gearing covenants. CQE has diversified funding sources with no debt maturity until July 2027. Based upon the new unsecured debt platform, CQE's weighted average debt maturity has increased from 2.3 to 4.3 years.
CQE's current weighted average cost of debt as at today's date is 4.4%, which reflects the impact of the new unsecured debt platform and is calculated based upon drawn debt of AUD 731.5 million and includes line fees on undrawn debt capacity. CQE has continued to be proactive in relation to its hedging, with 81% of its debt hedged for the remainder of FY 2024 and FY 2025 at an averaged hedge rate of 2.4%. This provides protection against rising interest rates and headroom to ICR covenants. Hedging levels currently in place for FY 2026 are 56%, with a further 27% hedged in FY 2027. I'll now hand back to Travis to continue with the presentation.
Thanks, Scott. On Slide 14, we summarize CQE's portfolio. As detailed earlier in our strategy, we are focused on continual portfolio improvement, and CQE's portfolio metrics remain strong. As at 31 December 2023, CQE owns 360 operating properties with a total value of AUD 2.2 billion across a diversified social infrastructure portfolio. The portfolio continues to be 100% leased, with the WALE sitting in a very healthy 12.8 years and a passing yield of 5.1%. Lease expiries within the next five years remain low at 3.1%, highlighting the importance of the property and lease terms to the tenant's operations, and also the option notice period required under the leases, which can be as long as five years. It's also worth noting that of the 3.1%, only 0.8% are true expiries where there are no tenant options. Moving to Slide 15.
CQE's current portfolio is well positioned to deliver both income and capital growth, with the portfolio heavily weighted to metropolitan locations, comprising 83% of income, and a strong Eastern Seaboard weighting of 82%. As the pie graphs show on the right of this slide, CQE now has a greater tenant and sector diversification, with childcare assets currently comprising 77% of the portfolio and 23% long WALE social infrastructure assets. From a tenant customer perspective, CQE's tenants now include both federal and state governments with significantly improved credit metrics and ability to pay rent over long lease terms. Fixed annual reviews comprise 77% of CQE's lease income at an average rate of 3%, with the balance of lease income based on CPI and market reviews. Weighted average rental growth for the 12 months to 31 December 2023 was 3.5%.
During the period, two market reviews were completed, with an average 6.3% increase across these properties. The first review was a Melbourne property, which achieved an increase of 7.5%, with the second property in Perth achieving a 5% increase. Over the next five years, 46% of CQE's rental income is subject to market reviews. These reviews are all childcare properties and are typically capped at 7.5%. In terms of timing, market reviews comprising 14% of income occur in FY 2025, with circa 10% occurring in each of the following three years. We've provided the split of annual rent reviews on page 22 of this presentation. These reviews will allow CQE to capture rental growth from under-renting across the portfolio, which has been independently assessed by the valuers at approximately 5%.
Gross rent to revenue for the childcare operators, based on tenant data provided under the leases, sits at 11.3%, sitting below market parameters and reinforcing the under-rented nature of the portfolio. Turning to Slide 16. During the period, CQE independently revalued 100% of the portfolio. The portfolio saw a like-for-like valuation decrease of 1.2%, or AUD 26.8 million, with the average passing yield of these properties at 5.1%, up from 5% at June. The valuation decline has been driven by mild cap rate expansion across the portfolio, partially offset by portfolio rental growth during the period. As can be seen from the graph on the right, the value of direct market childcare transactions recorded in the 12 months were approximately AUD 449 million, which is slightly down on the comparative period in 2022. Transaction yields have slightly increased to 5.3%, up from 5.2% in 2022.
As has been proven in previous property cycles, due to the asset size of childcare properties, there is still liquidity in the market, as purchasers are often not relying on borrowings to make property purchases. Investors are continuing to be attracted by properties in essential sectors, which typically have long leases and operators having favorable demographic and government funding tailwinds. During the half, CQE disposed of 6 assets at an average yield of 4.6% and an 8.8% premium to previous carrying value, demonstrating the higher quality of CQE's portfolio compared to the market. It's also worth calling out that the average yield, after deducting non-recoverable multiple holding land tax, was 4.1%. The disposal rationale for each varied but was a combination of smaller centers with average places of 74, shorter WALEs averaging 5.6 years, and centers with higher non-recoverable property outgoings.
Turning to Slide 17 and an update on the childcare industry. The key positive change to the industry occurred in July 2023 with the introduction of the federal government's Cheaper Child Care plan. The improved plan is the key driver of the increased government funding to the sector, with annual federal government spending forecast to increase by 41% to AUD 15 billion in FY 2027. The policy was designed to increase the affordability of childcare through increased subsidy rates and higher family income eligibility. The improvement in affordability has recently been estimated by the ACCC at 11%. During 2023, the childcare sector was the focus of a number of government inquiries from both the ACCC and Productivity Commission. The ACCC inquiry was related to the market for the supply of childcare services. The final report was released in January 2024 and contained a total of 31 findings and eight recommendations.
Four of the recommendations related to refinements to the existing system, with the other four requiring broader policy reform. The ACCC was of the view that while many childcare markets may be operating as could rationally be expected, market forces alone are not meeting the needs of all children and households. Separately, the Productivity Commission is undertaking a review of the childcare sector in Australia with the terms of reference to make recommendations that will support affordable, accessible, equitable, and high-quality early learning. The draft report was released in November 2023, recommending the government provide every child access to three days a week of high-quality education and care. Based on the current status of the reviews, we are of the view that there will not be any material change to CQE or our tenants resulting from these reviews.
Importantly, the reviews have highlighted that childcare is an essential and vital part of Australia's education system as integral to increasing workforce participation. In terms of current operating performance, operators are seeing positive occupancy and trading trends in response to the improved government funding. Based on trading data provided by our tenants, average daily fees have increased by 8.3% during the previous 12 months to AUD 135 per day. It is expected that the combination of improved funding, female labor force participation rates at record levels, and population growth will all provide occupancy tailwinds in the coming years. Moving to Slide 19 and the outlook and guidance. We will continue to execute CQE's strategy to actively manage the portfolio to maintain income security and capital growth. We see social infrastructure as a growing asset class with long-term opportunities for future investment for CQE.
Key thematics driving this are both a growing and aging population, which will require significant social infrastructure investment. Today, we reconfirm that based on information currently available and barring any unforeseen events, the FY 2024 forecast distribution guidance is AUD 0.16 per unit. That concludes the formal component of our presentation. I'll now hand back to the operator and open the line for your questions. Thank you.
Thank you. Ladies and gentlemen, as a reminder to ask the question, please press star one one on your telephone and then wait to hear your name announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Solomon Ziyad with JP Morgan. Your line is open.
Morning, Travis and Scott. Thanks for the presentation. First question was just on the move to the unsecured debt platform from the secured. Obviously, it provides you with more flexibility but provides less security for the lenders. So just curious what the implications are for your debt margins. What are your margins ex line fees now, and have they moved post the refi?
Yeah. Thanks, Solomon. Thanks for the question. Yeah, look, the move to the unsecured platform has come at an increase to our margin. We were previously on an average to a margin of 160 all up. Now that's an extra 10 basis points to 170. I think what is important to note, though, there is we had a weighted average debt maturity of sub-three years. We were looking to go back to the market to refinance. We did test the market with a secured platform as well, and the cost of a new secured platform was not materially different to the new margin that we've got on the unsecured platform. So on that basis, we were very comfortable to make this transition.
Great. That's clear. So just a second question on the operator rent to revenue. It's dropped quite materially, 90 basis points to around 11%. Could you just elaborate on the drivers there? Is this a bit of a read-through for a demand response to the subsidies and driving average daily fees up and average occupancy?
Yeah, Solomon. I think the key one is that we called out the 8% daily fee increase year-on-year. So that's, and obviously, our rental growth over the same period was 3.5%. So it's largely a function of that. Obviously, there's been some uptake in participation as well, so that's always helped that ratio as well.
Yeah. And just a quick one, just on the values. It seems to be fairly heavy devalues in the social infrastructure portfolio. Do you have a split of the childcare versus non-childcare devalues for the half?
Yes. So Solomon, so most of the value decrements come through on those long WALE social infrastructure assets. And that's largely a function of I think from a childcare perspective, there's always been that sub-AUD 10 million market where there's been liquidity and transactional evidence. I think once you get to the larger asset size, there hasn't been that similar evidence. And what you've seen is look, take good examples, the Brisbane Bus Terminal, for example. That had a cap rate at June of 4.13%. Obviously, with the marginal cost of debt where it was, that had to move. So I think you've just got to be careful looking at one period in isolation. But I think, yeah, most of that decrement has come through on the long WALE social infrastructure assets.
Great. Thanks for that. Appreciate it.
Thank you. Please stand by for our next question. Our next question comes from the line of Murray Connellan with Moelis Australia. Your line is open.
Morning, Travis. Morning, Scott. I was just wondering whether you could maybe just give us an update. Six months ago, you mentioned that your current modeling was on an expectation of a payout ratio of 98%-100% to get to that AUD 0.16 guidance range. I was wondering whether the view has changed at all in the last six months or whether you're still thinking that that's most likely where the payout ratio comes in.
No, that expectation holds, Murray.
Thanks. And then just wondering whether you could maybe comment on what your expectations are on where we are in the valuation cycle. And within that, what your thoughts are on the balance sheet at the moment. Obviously, still in the low 30s from a gearing perspective. But just given where we are in the valuation cycle, what sort of comfort levels do you have around that gearing figure? And what will your thoughts be around capital deployments in the near term?
Yeah, Murray, I'll do the first part of that question, then I'll pass back to Scott. I think from a values point of view, I think we're from a rates perspective, we're pretty close to the top. Could be at the top in terms of but I don't like to predict these things either. But I think so we're seeing the values have held up pretty well, which is good. It's like the childcare transactions haven't really missed a beat. And there's still that liquidity with the purchases not using debt to fund these transactions. So I think values and the gearing have held up pretty well. Where it's going to play out the next 6- 12 months, there might be a little bit more cap rate expansion. But I don't see that being at the same level as what we've seen in the last six months.
Yeah, I'll pass back to Scott from a balance sheet point of view.
Yeah. And then just on the headroom, obviously, the covenant is 50%. Asset values need to fall 35%+ to get near that covenant. So current passing yield on the portfolio is 5.1%. We're talking more than 200 basis point expansion there, notwithstanding the benefit we get from the rental growth and insulating that cap rate expansion. So very comfortable where we sit.
Thanks. Then maybe just a quick follow-on from Solomon's question on the rents to revenue ratio. Obviously, I assume that would have been calculated on a six or a 12-month period. I was wondering whether you had any thoughts on what things might look like at passing. Obviously, the government stimulus only really kicked in in July. Would you expect that 11.3% to have contracted much further as we stand today?
Yeah, Murray, I think you had probably the sugar hit from that cheaper childcare plan coming in where you've seen that 8% fee growth. That's been the largest fee growth that I've seen sort of since I've been involved with this vehicle. So I think typically, the run rate was in that sort of 3%-5% fee growth. And then obviously, we've got just ignoring market reviews for a minute, we're running at that sort of 3.5% for the last 12 months in terms of rental growth. So the sort of mathematics of that suggests that will sort of gradually decrease. We've got the opportunity to reset some of those, which really start kicking in in FY 2025, 14%. So I'd really love to start capturing some of that under renting, which we've called out in the presentation.
Thanks very much.
Thank you. As a reminder, ladies and gentlemen, that's star one to ask the question. I'm sure I know further questions in the queue. I would now like to turn the call back over to Travis for closing remarks.
Do you want to just hang on for maybe a couple more minutes just in case there's any more questions? I'm happy to pause for 30 seconds, give people one last chance. Okay. Now it looks like there's no more further questions coming. So thanks, everyone, for your participation. And we're always available for questions if you'd like to ask us offline. Also, look forward to meeting many of you over the coming weeks. Have a great day.