Good day. Welcome to the Goodman Group first half financial results for FY 2023 conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question- and- answer session. To ask a question during the session, you will need to press star one one on your telephone. You will hear an automated message advising that your hand has been raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. It is now my pleasure to introduce CEO, Greg Goodman.
Thank you. Good morning and welcome. I have Nick Vrondas with me on the call this morning. I'd like to begin by acknowledging the traditional owners of the land on which I'm presenting from today, the Gadigal people of the Eora Nation, and pay my respects to elders past and present. Goodman has produced a strong result for the first half of FY 2023, delivering operating profit of AUD 877 million and operating earnings per security of AUD 0.464, up 10.7% on the same time last year. Statutory profit was AUD 1.1 billion, which includes the group's share of AUD 1.4 billion of valuation gains. While global markets remain uncertain, our fundamentals are strong, which is supporting development activity, more valuable projects, high occupancy rental growth, and increased assets under management.
As a result, we're in a position to upgrade our earnings guidance with projected FY 2023 operating earnings per security growth of 13.5%. Customers are driving structural demand, which combined with the lack of supply, is leading to strong rental growth in most regions. To support our customers, we're working closely with them to try and help increase productivity, efficiency, sustainability, and resilience in their supply chains. We're seeing customers carry more stock to protect themselves from supply chain disruptions, and we're continuing to significantly invest in technology. It's clear that their need to be close to the consumer as possible is also increasing to address both their own sustainability targets and to reduce transport emissions and costs. The quality and location of their facilities has become even more important.
On the demand side, customers are driving increased activity while ability to supply prime locations is more challenging. Planning has become harder, projects are more complex. Effectively, with the changes in the financial markets, we're seeing a reduction in the competition and supply of buildings moving forward. Excuse me. This has contributed to strong demand in our development workbook, which now stands at AUD 13.9 billion across 85 projects around the world. This demand has seen occupancy for projects completed this half now standing at an unprecedented 99.8%. The majority of our work is on redevelopment of brownfield sites with a bias towards multi-storey buildings as we continue to optimize the limited land availability. This is in line with our focus on regeneration and our long-term sustainable strategy. Assets under management are almost AUD 80 billion, up 17% on the first half of FY 2022.
Strong rental growth is supporting valuations and offsetting the effect of expanding cap rates. Across the group in partnerships, cap rates expanded 28 points on average. We saw the largest movements in the U.K. and Europe, where they were around 100 points higher. New Zealand, 42 points, while cap rates across Asia remained relatively stable. We also see the potential of further cap rate expansion in the near term. However, strong rental growth is also likely to continue. While our investors remain cautious, we added two new partnerships to our management business this half, taking us up to 18 partnerships with some of the world's biggest investors. We also completed partnership extensions and several equity raisings. Turning to Slide 6. We are seeing, as I mentioned earlier, unprecedented rental growth in some of our markets and effectively zero vacancy.
Potential rent reversion to market across our portfolio has continued to expand with North America at 57%, Australia and New Zealand 24%, Continental Europe and the U.K. 17%, and Asia approximately 3%. The reopening of the borders in China and Hong Kong could be a catalyst for rental growth in those markets. The fundamental pillar of our 2030 sustainable strategy is around the efficiency, productivity, sustainability of our properties, we're working with our customers and suppliers in this space. The key area is monitoring and the reduction of carbon emissions, having had our science-based targets validated by the Science Based Targets initiative. Our global solar installations and commitments are increasing and are on track to reach 264 megawatts in FY 2023. We're also measuring the embodied carbon in our developments and working to increase the use of low carbon materials.
We've also remained staunch in our capital management approach, maintaining our strong balance sheet, gearing at 9.7% and AUD 2.8 billion of available liquidity, giving us the flexibility to take opportunities as they present themselves. I'll now hand over to Nick, who will take us through the results overview.
Okay. Thanks, Greg. Let's turn directly to Slide 10 to look at our income statement. As usual, we'll first cover the items that relate to the cash back measure of earnings, which we call operating profit, and then discuss the items at the bottom of the table. Operating profit excludes the unrealized fair market value gains on properties, the mark-to-market movements, and the accounting fair value estimate relating to our employee long-term incentive plan. Overall, FX movements had a AUD 10 million adverse impact on the translation of our foreign income when compared to the prior corresponding period. The impact was mainly on the development line, but it was offset with a commensurate benefit in the borrowing costs. This comes about as a result of the movements in the realized costs on our debt and derivatives, and that's how our hedging strategy is designed.
Looking specifically now at the movements in investment earnings. Direct property net rental income is slightly lower than the same time last year. This is due to the impact of the AUD 0.3 billion of net divestments over the past 18 months. Over the last six months, in particular, we had a net reduction of AUD 0.4 billion after taking into account transfers to and from developments. As previously flagged, we expect to see further reduction in direct net property rental income in the second half, owing to the full period effect of the sales that have already been completed. Since the end of the period, we also completed the sale of some of the development inventories that have been previously stabilized and were generating rental income.
We're expecting some of the remaining assets to go into development in the coming years, which will reduce their rental income contribution as we prepare them for redevelopment and during the development phase. The bulk of our investment income, however, comes through our co-investments in the partnerships. Over time, we wanna grow this part of the business as we continue to expand our portfolio of assets under management and our investment in it. We also expect growth in rental levels to add to our income. Compared to the same period last year, Cornerstone investment income increased by AUD 29 million. Rental growth accounted for AUD 9 million of the increase, which is the result of the like-for-like comparative. The net impact of acquisitions, disposals, and development completions contributed nearly AUD 20 million to the growth.
Over the past 18 months, we've invested a net AUD 2.2 billion into the partnerships globally, over AUD 1 billion of which occurred in the last six months. Nearly half of these investments have been for the purpose of acquiring development sites and funding development CapEx. The majority has related to the acquisition of income-producing assets that are either for future value add or redevelopment, or the acquisition of completed assets from the group. The average income return on our capital contributions to the partnerships has been relatively consistent at around 4%. The lower initial yield on their acquisitions being offset by development completions at a higher yield and the rental growth. Consistent with our current development run rate, we expect to continue to contribute equity into our partnerships, which will result in further income growth. Management revenue was up AUD 7 million over the first half of FY 2022.
The value of stabilized assets under management has grown to $68 billion, with the average for the half up by $11 billion compared to the prior corresponding period. This has been driven by revaluation gains, net acquisitions, and the completion of developments. As a result, ongoing management fees have increased by $39 million or 21% since the first half of the last financial year. Performance and transactional revenues contributed $42 million this half compared to $74 million in this time last year. The reduction has been the result of the timing of calculation dates and the conservative method of recognizing revenue given the current climate. Over the full year, we expect to see around $60 million of growth in base management revenue due to the growth in stabilized assets in the partnerships.
It is also likely there will be additional transactional and performance revenues as we have a significant backlog of unpaid fees, and some of these will reach their assessment dates over the next 12 months. We should point out that a significant portion of the fees recognized this half were paid last year. Given the remaining performance obligations, we did not recognize them at that time. Total fee revenue as a percentage of average stabilized AUM was a little over 0.8% this half, and we expect it to range between 0.9% and 1% this financial year. Development remains an important part of our business strategy. We create significant value throughout the development and asset management process. We've continued to execute on these core functions very well, despite the challenges the world is facing, so our margins have been sustained.
Strong risk management, cost control, and rental increases have primarily supported these outcomes. Over the past few years, the strong growth in development volumes has also been a significant driver of this segment. Our work in progress has more than doubled since June 2020, and the average production rate has grown by over 50%. The development period for the projects has increased. Our average annualized production rate has progressively increased from around AUD 5 billion in the first half of fiscal 2021 to around AUD 7 billion this past half. Our activity is diversified globally and across 85 projects in width. In recent years, we've also seen an increase in the volume of work that has been done in the partnerships.
Due to the variety of methods in which we contract developments, our earnings are a function of the interaction between margin, volume, timing, and the proportion originated on-balance sheet and within partnerships. In this half year, realized development income was over AUD 600 million compared to around AUD 560 million for the first half of fiscal 2022. In addition to that realized cash income, AUD 0.4 billion of our development income was recognized as revaluation gains. This represents our share of the revaluation gains that accrue to our partnerships as a result of the work they are funding and the assets that are revalued whilst on the balance sheet. After deducting the attributed prior period valuation gains on that realized assets, the net result was around AUD 0.2 billion for our share.
The outcome over the coming periods will be dependent on the opportunity set that we commercialize, but we have a wide range of options. As a reminder, over the past few reporting periods, we flagged the gains on sale of assets that have been subject to prior fair value movements. These have begun to arise in recent years, given the long-dated nature of the developments and the need to reflect the fair value of our assets, where we have begun the development but have not yet completed their sales. We do not reflect these gains in operating profit until the transaction's complete. In the financial statements, you'll see fair value gains that are higher than that reflected in the operating results reconciliation in the attached appendices. This is a result of the attribution of prior period fair value gains to operating profit in this period.
That those profits aren't double-counted and can be reconciled over time, we notionally offset them against the current period valuation gains. As at the 30th of June 2022, we had a balance of AUD 430 million of such gains. The current balance is AUD 252 million, which is the net result of the completed transactions and new additions to the list. We expect to see the remaining balance realized in the coming half. At the same time, there are a number of transactions in progress that may add to the total. We remain enthusiastic about the prospects for development demand, which bodes well for our future revenue as well as growth in AUM.
Growth in our underlying operating expenses has been moderate as our business continues to be focused on a narrow set of markets, which enables us to grow revenues without significant cost variations. Our employee base is not growing substantially, and wage inflation has remained moderate while recognizing current market conditions. We also had an increase in some of our compliance costs and IT expenses. There has also been a timing difference associated with the short-term incentive accruals when comparing this period to the prior corresponding period, which explains the overall reduction. We expect our full-year operating expenses to be around AUD 385 million. We encourage you to analyze this on a full-year basis to smooth out the timing issues.
Our aim here is to continue to keep our fixed costs relatively steady and instead to use at-risk variable costs, such as the STI and the LTI plans, to incentivize and align our people. Our borrowing costs were down AUD 20 million compared to the first half of fiscal 2022. There was the AUD 10 million FX benefit compared to the prior corresponding period, which offset the EBIT translation reduction discussed earlier. Capitalized interest was up AUD 8 million compared to the PCP given the higher average balance of development assets over the period at the higher WACD.
We've also had an increase in interest earned on our cash and derivatives, which more than offset the impact of the increase in our net debt and rising interest rates on the relatively small amount of floating rate debt exposure we do have. Our WACD is currently around 2.7% and is substantially hedged against interest rate movements given the volume of fixed rate debt and hedges we hold. Our tax expense was up given the growth in profitability, as you would expect. As far as the non-operating items are concerned, we had the AUD 0.6 billion of revaluation gains in the half, which represents the group share of this is AUD 1.4 billion in gains across the entire portfolio of assets under management.
From this, we've deducted AUD 186 million of now realized prior period gains to get an AUD 0.4 billion net result for the half. Cap rate expansion over the half was 0.3%. This is more than offset by the impact of rental increases. Development valuation gains also continue to contribute to the total valuation results with over AUD 1 billion recorded in the half. Another customer area of difference between operating and statutory profit is the fair value movements on the hedges, which were down AUD 100 million overall. Mark-to-market derivative gains or losses are reflected in the income statement because the group does not apply hedge accounting. These movements should be considered in the context of the AUD 170 million gain reflected directly in equity through the foreign currency translation reserve.
We exclude the accounting cost of the employee LTIP, but we include the tested units in the denominator when calculating our operating EPS. This is when they actually have an impact on security holders. The accounting cost has declined mainly due to the valuation inputs and the falling security price. A few remarks now regarding the balance sheet on Slide 11. The FX impact on the balance sheet when comparing December to June was not material. Due to the sales over the half year, the wholly owned asset portfolio has decreased by AUD 0.3 billion since June 2022. Our share of the stabilized assets within our cornerstone investments in partnerships was up by nearly AUD 1.9 billion over the half year. Nearly all of this was the result of the new investments and the completion of developments.
Compared to June 2022, our development holdings are up by AUD 0.2 billion, with the completions and sales nearly offsetting the additions and expenditures. The average balance over the half year was AUD 0.3 billion higher than the prior corresponding period, in line with the growth in activity levels. Noting again that some AUD 600 million of inventory was classified as stabilized property post-completion. This is up since June 2022, but we've sold a substantial portion of this since balance date. Overall, we've generated AUD 800 million or over AUD 800 million of cash through operations. AUD 516 million of this is reported through the operating cash flows and the remainder arising from the sales of development properties, which are included in the investing cash flow for statutory reporting purposes. That was nearly AUD 190 million.
There's always a difference as well between the timing of distributions and income recognized in the partnerships. That was over AUD 30 million this half. The cash received last year for certain fees that have been recognized in the income statement this year, along with other working capital items such as the timing of incentive payments, collectively accounted for about AUD 200 million of differences between operating cash flow and operating profit. The cash generated from our retained earnings funded the majority of the investments we've made, which is consistent with the design of our long-term capital management plans and the distribution policy. As a result, our net debt position has increased by AUD 0.4 billion in the six months to December. We have since reversed that in January through the completion of various asset sales. That's a good point to turn to Slide 12.
As we said before, we'll operate our gearing within a range of 0%-25%, with the level to be set with reference to the mix of earnings and activity levels. In light of the activity and developments, we aim to maintain financial leverage in the lower half of the band in the near term. In addition, we continue to invest in the business to generate strong returns and fund its growth sustainably. That's why our distribution for security is expected to remain at AUD 0.30 for FY 2023. That's all for now. Thanks, Greg.
Hey, thanks, Nick. Now if we can turn to the outlook Slide on 20. Fundamentals of the business are strong. Rents are growing, development activity is robust, margins are healthy, and we continue to attract capital from our partners around the world. The competitive landscape is in our favor, leaving us with plenty of opportunity for growth as we move forward. We're therefore upgrading our guidance for FY 2023, with operating EPS growth now projected to be 13.5%. Thank you. We'll take questions.
Certainly. As a reminder, to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please pile the Q&A roster. Our first question comes from the line of Simon Chan with Morgan Stanley.
Hi. Good morning, Greg and Nick. My first question, I was just looking through the development slides, and I noticed that the development for third parties or partnerships, percentage of your commencements, 68%. I mean, traditionally that run rate's at, you know, 80% or even higher. Is this just a timing thing or is this a strategic trend that, you know, a decision that you've made to do more on balance sheet going forward?
No. Look, it's a little bit of where it's originated from. I think Nick Vrondas in his address talked about many different methodologies and ways we develop and pre-sell sometimes because of more complex planning issues and sites. We take more of the risk on balance sheet for a long period of time, and then we tend to move before we start building buildings. It's in around specific projects and specific cases rather than any trend line. What we try and do with our partners is make sure that when we are either pre-selling or doing it with them, we've ironed out some of the issues that may cause concern. There's also a pricing advantage in that for Goodman at our end of it.
There's no deliberate change of strategy and our partnerships effectively either developing with Goodman 50/50, developing 100%, or effectively buying after we've got planning insights and the first few buildings out of the ground tends to be the way that numbers build up. Nick, have you got anything further on that?
Well, I mean, Simon Chan, you're right in the sense that over the last couple years it's been up around 80%, but if you go back before then, it was traditionally more around that sort of 70% level. Yeah, Greg Goodman's right. I mean, this particular period, it is a little bit of a function of when you take the picture, if you know what I mean. The 80% that we've been reporting, if you reported on the day of actual commencement, that would've been a different figure. It would've been closer to 70% anyway. It's a little bit fluky in some ways, right? I think all it highlights is what Greg Goodman said, is that we have flexibility as to how and when we contract things.
Okay, fair enough. Your guidance, 13.5% growth, your revised guidance essentially implies your second half will be flat or slightly down relative to the first half. In your comments you talked about management fees being skewed to the second half. What's gonna be declining in the second half then? Like, what's the offset for you to hold second half guidance flat?
Mate, we're taking a very prudent view of the market. There's a lot of volatility in the market. We're not there yet. I think it's, last I checked was mid-February. We see a good strong year, and we also see going forward some real momentum for us building into 2024. I think we'll leave it at that for the moment.
Right. My last question, Greg, I think in your prepared remarks you talked about having done some partnership extensions during the half. Just wondering if you could give us some insights into, you know, were there any changes to terms of the partnerships? Was there any argy-bargy involved with your investors in light of high interest rates? Like, what happened behind the scenes?
We call them partnerships 'cause they are partnerships. You don't seem to have argy-bargy with your partners. No, it was all very, very straightforward and on similar terms. If there was a change in terms, probably improved terms for the manager, to be clear. I think there's a real desire, and this has changed, as free money has changed, quite frankly, where there's a lot more scrutiny on the manager, a lot more scrutiny on the quality, a lot more scrutiny on who the partners wanna be with. We think that's a good thing. We think the markets were over-robust, you know, a year or two ago.
Obviously, interest rates went reflective of where they needed to be and we can see that now or the market can see that now. I think if you look at the big global investors, they're gonna be cautious, they're gonna be sensible, and we suspect there'll be a rationalization of managers and operations over the next year or two because high leverage operations using financial leverage as a way of getting return is clearly off the table. That's changed the game, and I think it comes back in the favor of the operators, being people like Goodman, that actually drive outcomes out of ability to make money out of assets rather than financial engineering. I think that comes back to our favor and that's what we're seeing with our big partners around the world.
Good to hear. Thanks, Greg. Thanks, Nick.
Thanks, Simon.
Thank you. Our next question comes from the line of Sholto Maconochie with Jefferies.
Hi, Greg and team. Just following up on Chan's question, with that mix in the development. Because that was obviously higher because of that stuff on balance sheet, will that sort of be a prominent feature again with that cap interest line running at the same rate as the first half?
Yeah, be around the same level. Yeah.
Okay. You've seen a bit of a stabilization in materials and cost inflation. How are you seeing that in terms of your margin developments? Is that, you've got a lot of rental growth coming through and costs and material costs are stabilizing. How do you see that from your development margins going forward on a sort of full 24-month view?
Look, the forward-looking margins for us are good, we're being really, really, really selective. That can't be said for everyone in our industry. Effectively, we're not long and wrong on land. Many will be long and wrong. We are certainly not long and wrong. We're doing a lot of reset now in regards to deals we're doing currently. Europe, just recently, we're finalizing negotiation on 50 hectares. We took another 50 hectares down in Sydney recently. There's a number of deals that are going on in the U.S. and Japan as well. Effectively we're building in real contingency in those transactions. We're making sure that we are still growing our costs, though. We're not calling costs flat. We're calling them moving with inflation.
If you guess on inflation six or seven or, you know, thereabouts, that's what we're building into costs, so we're still building them out. I think you've got to go to the rental equation and you really need to spend some time on understanding what's happening at the customer level. Because if you understand what's going on at the customer level, you'll understand what Goodman's doing and why we're doing what we're doing with development and locations, and the sustainable features going through the buildings. Those rental growth numbers haven't been seen in my career, right? 57% in the U.S., well through 25% in Australia, and quite frankly, we're doing renewals now that are 35%, 40% up. South Sydney's gonna crack AUD 500 a meter shortly, and we're in the late 400s at the moment.
I think you've got to go to the customer and you've got to ask yourselves, why? That's what we're spending all our time on. Are those costs being passed on? I suspect so. Goodman's not of the view that inflation's over anytime soon. Well, I think we're gonna be in a higher growth inflationary-type environment with higher interest rates for longer than people would like. When we're looking at our feasibilities and development, we're building that in to make sure that we've got appropriate margins for the risk we're taking. If you look at the customer side and you look at the demand side, where there's basically zero vacancy in our major markets we're operating in, obviously the risk on that side of the equation is lower than it's ever been in my career.
Great. On that side, has there any been softening demand or you still think quite a lot of demand coming through across your markets?
Yeah. Look, look, supply can't meet demand in the key markets around the world, and I've mentioned a few issues why. Some of that is environmental issues. It's getting a lot harder. It's taking longer. Planning is taking longer. Infrastructure is getting more expensive. The regeneration of sites is the preferred approach for Goodman because we're regenerating in sites that are, that are already marked as industrial. We're not plowing greenfield lands and things of that nature. That's better on the environment, better on the ecology. Effectively, that takes time, and that's where the customers wanna go. Yeah, everything about it is getting tougher. Goodman, over the last few years, has restructured its people around the world. We've got actually, not so many white shoes running around salesmen.
We've actually got really good technical people that know how to get these things up, know how to get the planning, and know how to respect the environment on the way through, because that's the game we're in now. It's not about salesmanship. It's actually about getting things out of the ground on time. If you can do that in key locations, you have the demand because the supply is not meeting it.
Just on that, do you expect to use some of the balance sheet? You've been investing in the partnerships. You're buying stuff from balance sheet. Do you think you use balance sheet to warehouse potential opportunistic acquisitions that may emerge this year?
Look, I think if you look at the balance sheet and look at the partnerships, I think you'll see a balance as we have had a balance, and that will continue. Will there be some assets that will go off the balance sheet? Yes, there will. There's a multi-storey program in South Sydney, which I think reaches about AUD 1 billion of work in progress. That's actually assets we own on our own balance sheet, which we'll probably partner with one of our big partnerships in Australia, is probably the preferred approach at the moment. As that rolls off, there may be some other stuff roll on around the world as well. It'll be balanced. It'll be sensible. It'll be deep in value. Otherwise, you're not gonna get out of bed and worry about it.
Effectively, we're not chasing big numbers. We're not chasing, work in progress records. We're not chasing assets under management records. What we're chasing is operating cash flow and operating profit.
Okay. Just finally from Shani's, guidance question. What are you forecasting performance fees for the full year? I think you had AUD 42 million in the first half. What's that figure forecast for this year?
Yeah, just work on the basis, work towards 90 points of AUM. I think you'll find that backs out about 100 in the second half.
Great. Thanks very much.
That means so you've got to look at our management revenue line on a full year basis because of that timing issue of recognition. The base fees are up 21%, half on half versus prior corresponding period. We're continuing to complete assets. There's net acquisitions happening, so the stabilized assets under management are growing and base fees will continue to grow. That's why we're predicting AUD 60 million of growth in base management fees year-over-year.
Thanks, Sholto.
Our next question comes from the line of Stuart McLean with Macquarie.
Good morning. Thanks for your time. Greg, you have to provide a bit of color, please, on the two new partnerships that were created during the period.
One was a land partnership, effectively, and the other one was some stabilized assets we did effectively with another partner of ours. It was all played pretty close to home, people we knew, nothing really adventurous. We did finish a capital raising in Europe towards the end of the year. I think that ends up at EUR 400 million.
EUR 450.
EUR 450 million. Yeah. Look, there's good liquidity. The people that are in the business for the right reasons, right? We've said this a number of times, the game's changed. Interest rate's higher, cost of capital has gone up, and you need to be an operator. If you're just a asset collector at the wrong price and you leverage it, you're not gonna get the return. There is good demand from our big partners around really sensible stuff that has long-term value, 10-year value. That is, if you like, infrastructure-like. I think during the pandemic, if anything, industrial was enhanced in regard to its infrastructure qualities and the necessity for it around the big cities of the world.
If there's a bias for what our big partners wanna invest in, it's industrial is still at the top of the list.
Thank you. The second one is some of the completion yield and 8.3%. I think that's a couple of periods in a row where on completion, you've been able to release some contingencies or get some really good lease up, to accelerate your returns there. Is that something we should expect on an ongoing basis, or are there some project specifics around that acceleration, as you reach completion?
Yeah, it's a bit of both. I think the reality is, well, when we're entering into transactions six, nine months ago, on a pre-let basis, you can safely assume the rents have probably gone 25% since that mark. If you look at the stuff we're doing, actually, that is on spec around the world, there tends to be the rents tend to beat the feasibilities pretty handsomely as well, which we've been doing pretty regularly. Yeah.
Okay, great. Just a final question, please. Mentioned in your remarks as well, having to get a bit of a rental growth coming through maybe from the reopening of China. Just what does that also mean in terms of commencements in China and Hong Kong? Is it a little bit more palatable to continue to deploy capital with the reopening there? Just how are you feeling about that, those jurisdictions, please?
Yeah, look, we're finishing a couple of developments in Hong Kong. You'd be aware of them. Big data centre, clearly, we're in our final stage, and we've also got a big industrial, we're finishing. We'll be a little bit more around the regenerative stuff, because our portfolio in Hong Kong is primarily when we look at it and we look at what some land price has been paid, actually just recently, it's fair to say that we're under, our valuation is actually under replacement cost pretty handsomely. I think you'll see more regeneration type activity in Hong Kong. In China, we're just gonna be sensible and careful. As you know, we are focusing on three markets, Beijing, Shanghai, and Shenzhen, and that'll be clearly the case.
They will tend to be bigger, and fewer, but that'll make sense. It's very much fee-based, though, the development arrangements out of China. The volume out of China is not a big material impact primarily on the development revenues. I think you'll see more of an impact out of places like Japan, Europe, U.S., and obviously Australia than you will out of China.
Great. Thanks very much for your time.
Thanks, Stuart.
Thank you. Our next question comes from the line of Richard Jones with JP Morgan.
Good day, Greg. 75%-80% of starts and WIP is out of Asia and Australia with much lower contributions in U.S. and Europe. You talked about some big project completions coming through in Hong Kong. Just wondering if you can, kind of, touch on where you think demand will come from to, kind of, offset those roll-off of those projects. Or should we expect the WIP to, kind of, come back in the short term?
Look, I think, out of Asia, I sort of iterated on it before. The projects in the Hong Kong partnership, obviously fee-based. There's a smaller share than of the clearly than of the total, and the same, the same in China. Effectively, where you're getting a bigger share of the development profit around Japan, Australia, the U.S. and as well, and then through Europe, where most things we're doing in continental Europe are in 50/50 basis with our partnership or on sheet if it's data centre effectively. You'll see that we're not that sensitive to work in progress coming off in Asia, particularly in Hong Kong, or very little sensitivity to it.
We're not giving you a number for work in progress, but it's a bit like I said in my earlier remarks, it's not about a number of big numbers. The rule of big numbers is actually about the operating profit, where we're generating it, where the customer demand is, where our rent's moving at 25%-30%. That's where we'll be popping our head up. That's what we're doing. We're looking at a number of sites at the moment in the U.S. Very different market to where we were 12 months ago. We think big advantage and opportunity for us. There's some sites we got under control here in Sydney end of last year. There's a big one that we've just in diligence and finalizing in Europe on the back of a couple of others we've bought as well.
Look, we just deepen the value, thicken the mud, trying to make sure that we get the best stuff. I wouldn't worry too much about whether work in progress 13 or 13-9. I think 39 is a really good number, but if a few things roll up in Asia, it's rolling up on a fee basis, not a real share of the development profit. Characterization and risk is different, right? The reason we do that in China is clearly because of risk.
Yep. Okay. Nick, just your comments just on the return out of the current investments. I mean, we just look at the average current investment and the income. It looks like the yields fall on about 50 basis points. Just wondering if you can kinda call out why that's fallen.
On average, the, the basis, 'cause the revaluation gains, hurts you a little bit. The actual cash year on cost is the four that I've talked about, but the actual yield on a marked basis is a little bit lower. Plus, where we're investing versus where the overall book is, has been a little bit different as well. You know, FX has a bit of an impact as well because the balance sheet gets translated at a different rate to the P&L. That, that has a bit of an impact, unfortunately, as well.
I think, Nicky, they're more active as well in regard to land and development than they have been as well.
Well, that's right. If you look at the composition of the external AUM, 75.5, about nearly AUD 7 billion of that is development. It's not income generating. Bearing in mind, these are not yield products. These are total return-oriented investments. you know, the investors are there not for purely a distribution. It's really about value creation long term.
Yeah. I mean, a lot of those trends that you're calling out have been pretty consistent though over the last 18 months in terms of revals and kind of ramping up the development activity in the farms. Just surprised to see that the income return pulled back as much. Anyway, that's fine. Thanks for your time, guys.
Bye.
Thank you. Our next question comes from the line of James Druce with CLSA.
Good morning, Greg. Good morning, Nick. Thanks for your time. The 99% occupancy, I mean, it is incredibly strong. How long can you guys hold it there? The fundamentals still look very, very good. I'm just curious as to how long we can sort of stay at these conditions.
When we look at 2023 and all the business plans for 2023 for all the different partnerships around the world, the only reason we'll have a vacant building is we want to vacant 'cause we wanna knock it down, is primarily where the only vacancy will come from. The pipeline of demand is really, really, really strong. I think the other thing that's going into it, in uncertain and volatile times, people tend to also take the bet they've already got. The renewal rates are really, really high. Because of the concern about inflation and costs, a lot of people are trying to lock those in a year or two earlier as well.
Yeah, I think as we run through this calendar year and into 2024, providing the world doesn't go into a deep, deep recession and these other issues, I expect it to be pretty strong. Look, we've got to see where interest rates, inflation, does the consumer get nailed effectively at some point because that will change obviously the dynamics of business. At the moment with where we're heading, it's very strong and people tend to be exercising options a year or two earlier and trying to lock in even if they're 4% or 5% rent growth numbers off the back of a reset to market because 4% today is effectively a pretty good number for people to be locking in if they can.
Yeah. Okay. That makes sense. I missed the message on the gearing. You're saying it's sort of down in January after a sale and the outlook for the next couple of years, is it gonna be staying around that sort of 9% mark for the balance sheet, or do you think that'll drift up a little bit?
Yeah. The comment was, it's our preference in light of where our activity levels are at the moment and the mix of earnings is to remain in the lower half of the 0%-25% range. You know, working capital movements, you know, here and there, you know, will range us. Like, where we are to right now today, we're at, you know, around 7%. You know, we then get some more inventory build up, and we could be up over 10. Somewhere around, you know, somewhere below 12.5 is the target at this point in time, whilst ever the, you know, the business is in the shape it's currently in.
Very good. Thank you.
Thank you. Our next question comes from the line of Ben Brayshaw with Barrenjoey.
Oh, hi, Greg and Nick. I just have a couple of questions. Both relate to the European and U.K. business. Firstly, could you discuss the change in book value recognized across both Europe and the U.K. over the last six months? Noting that in your presentation, the cap rate for the U.K. is up 120 basis points. It's up around 90 basis points in Europe. Just curious to have asset values been written back in both those markets, and could you clarify what that valuation change has been at the asset level?
Yeah. Look, I'll make a couple of comments then Nick can give you the precise numbers. I think you, as you probably know, because you guys would be observing what's happening in Europe. The value is came out and basically ripped 25% off pretty well everything. I think that's about the number for.
That's exactly it.
U.K. Yeah. 25%. It had nothing to do with what ring broke you had or anything else, quite frankly. We accepted it. We moved on. I think it was about AUD 300 million at the gross line. Nick, you?
Yeah.
Something like that. We obviously booked it, talked to the investors about it. They all moved on because they're busily writing everything else down at the same time. There's no, you know, horrendous surprise. Have they overdone it? Time will tell. Are things trading inside of where they're valuing things? Yeah. We've traded a few things inside where they've marked the book, but time will tell. Obviously U.K., Europe, from an economy point of view, is the one that, you know, most concerned for us around the world, the strength thereof. We're watching that obviously very closely. In saying that, we actually don't have vacancies in Europe. We're 99% occupied in Europe, and we're actually having some really good rental growth coming through because of where the CPI has been.
I think that'll settle down. I suspect they're the economies we're watching most closely, and that's where we'd be most careful about spec. For example, where we'd be less concerned about putting spec into L.A., we'd be more concerned about putting a lot of spec into London or into parts of Europe. A lot of what we're doing in around Europe at the moment, and some big projects actually were pre-committed and deep, really deep value and big margins is the way we're playing it.
Yeah.
Yeah.
Well, the only other thing I'll add is that, yeah, Europe cap rate move was similar, but because there's been more rental growth, the impact at the asset level hasn't been as-.
Yeah
as great. Yes, they have been written down and marked to what value is currently deemed as market. You know? Some would argue that, is that reflective of willing buyer, willing seller in the current environment? You know, you can debate that. That's kinda where they're seeing it at the moment.
Can I just clarify, has there been a change in the capital base for the U.K. partnership? It looks like the investment value in the accounts is down only a couple of percent. Just trying to reconcile that with your comments about the impairment or that the write back is, you know, in the mid-20s.
Yeah.
There's a net investment as well.
Yeah, there's net investment and, there's also been, a couple of tremendously, good projects that are in a development phase and that's obviously pushed it the other way. Even, even with, valuers doing all the harm they can possibly do, they couldn't do enough harm to some of those.
Yes.
Yeah. Thanks, guys. Just finally, the capital raising in Europe of EUR 450 million, just, could you provide some color on how much GMG's contribution towards that has been?
Only just, yeah, our pro rata.
Great. Okay. Thanks.
Thank you. Our next question comes from the line of Grant McCasker with UBS.
Thank you. Good morning. This sort of follows on from those queries. You spent AUD 1 billion over the half, and you're calling out sort of each of the different markets, have higher or lower risk, how you see things playing out. Can I get a better understanding of where you've spent that AUD 1 billion? In which partnerships, in which regions?
Yeah. Regionally, Australia and U.S. is the main expenditures. In Australia, it's across, you know, a few of the partnerships. Gaw, that was part of the equity raise that we did, was the biggest one. In the U.S., we've only got the one partnership being GNAP, and they're funding the CapEx program, and that's where we're putting the money, putting money in.
Okay. Then on the development commencements yield on costs, you know, relative to Q1, it seemed to have picked up a lot. It suggests maybe yield on costs in the mid to high sixes in Q2. You must have a pretty good idea of what the add-on costs are gonna be for the second half. How should we think about that over the next six months?
I think just a general comment, Nick will make a more specific one. Anything we're looking at, starting now, commencing or buying land now, bear in mind that won't commence now, that's probably another 12 months away or so, we're looking at cash on cost as a general comment, higher than these numbers currently. Once again, we want more margin for risk. If we don't buy at deep value, we won't buy at all. Right? I suspect the new projects we're looking at coming forward, we're putting more contingency and risk in because that's the world we live in. I think you'll see it trending that way. Nick, you got a specific comment.
That's pretty much it. I think the stuff we're looking at the moment will average. You know, we had I think we called it out in the September quarterly. There was an anomalous period where, you know, it was a pretty small sample. What you've seen in the second quarter and the rest of the year is gonna be more indicative. The mid-6s will be sort of the kickoff where we target. As Greg said, you know, that's based on, you know, cost escalation expectations and, you know, some rental growth. History has told us that if we manage things well, we can beat that. The 8.3% on the completed projects is somewhat of an indication of where we could end up going forward.
Okay, thank you.
Thank you. Our final
Thank you. Thanks for the presentation. There's been a lot of talk over the last 12 months or so about the, you know, differences in valuations between listed property assets and unlisted assets. I was just wondering, you know, is that your view on that? Is that an area where, you know, valuations of unlisted assets could be improved in parts of the industry? Also the second part of that question is that a topic of conversation that's coming up frequently with, you know, capital partners and so on, looking at making investments in, into your funds?
Yeah. No, no, good question. The answer is everything's mark-to-market. If there's any material movement, it'll be marked. That's what the investors expect. That's what's in the management rights. They're happening on a quarterly, six-monthly, annual basis on rotation. Everything's had a big refresh around the world. We don't sit on bogus numbers that we know that are not real because that's corporately corrupt, quite frankly. We don't do that. I've got Carl Bicego sitting in the room with me now, making some notes. No, we mark-to-market. That's the expectation of our investors. I don't know where those comments come from.
I think they might come from other sectors, but I'm not aware of any partnership I'm involved in or chair, because I chair them all, that we're not marking on a regular basis and carrying them at a true and fair value.
Okay, thanks very much.
Yeah, that debate often arises. It's been around since late 1980s, and people on this call will recall having that discussion. It tends to get more air time when public equities are trading at a discount to book, not so much when it's the other way around.
Yeah, fair enough. Just a quick follow-up on, you mentioned before you're seeing good rental growth in Europe, and the comment was that it's due to where the CPI has been. Are you alluding to kind of CPI-linked rental increases or are you just more referring to just heat in the market, meaning that you're able to get some, you know, good rental negotiations there?
Look, look, there are a lot of CPI type linked leases in Europe, particularly in places like France and what have you. A lot of it is just coming through naturally. On the other equation as well, in the assets and the portfolios we have in Europe, they're very, very supply constrained. If you are having an open market negotiation, you're getting similar increases actually if not higher, and we've seen some 25% and 30% increases when we're not dealing with CPIs. CPI has actually lowered the average to what we're seeing from a market point of view. Look, the same holds as what we're seeing in Australia and the U.S. in particular. It's gonna be really interesting, I think, in regard to China and Hong Kong.
Hong Kong basically has been flat for about three years, and so has China. It's gonna be very interesting to see now they're opened up and there's real supply constraints in both those markets in key areas. I suspect there'll be a bit of a catch up in China and Hong Kong.
Great. Okay, thanks for that.
Thank you. I'm showing we have one last question from the line of Suraj Nebhani with Citi.
Good morning. Thanks for the opportunity. Just a quick question on the production rate. Nick, I think you've called out in the presentation that it will continue to stay around AUD 7 billion. I'm just wondering how should we think about development earnings going forward with that flat production rate?
Yeah. Well, for this year, the AUD 7 billion, you know, we're a shade over that right at the minute, but, you know, things come and go. We started the period a little bit below, we'll average about AUD 7 billion for the year. That's gonna result in a fairly smooth and even sort of development profit result throughout the year, which is consistent with our commensurate return, you know, above and below the line. You can see what the margins across the projects are in aggregate, and you can see what the mix is. This year's pretty well predictable and baked. What I flagged is that for future periods, the combination and mix of all those items will determine the outcome.
We're driving towards, as Greg said, you know, profitability, not the law of large numbers. At this stage, you know, we're trying to optimize, and we will optimize the returns out of the projects, so that we can deliver shareholders a reasonable, sustainable overall growth rate. We're not giving guidance for future years just yet. We'll do that once we've got through this.
Sure. Makes sense. Thank you.
Thanks.
Thank you. I would now like to turn the call back over to CEO, Greg Goodman, for any closing remarks.
Hey, thank you everyone for your time, and, yeah, have a good week for the rest of it.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating, and you may now disconnect.