Thank you for standing by, and welcome to the Growthpoint Properties Australia 1H 2023 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'd now like to hand the conference over to Mr. Tim Collyer, Managing Director. Please go ahead.
Good morning, welcome to Growthpoint Properties Australia's first half results for financial year 2023. I'm Tim Collyer, Managing Director of Growthpoint. Joining me this morning are Michael Green, Chief Investment Officer, Sam Sproats, Executive Director of Funds Management, and Dion Andrews, Chief Financial Officer. We will take you through the presentation, then we'll be happy to answer any questions you may have. On slide four, I'm pleased to present an overview of our first half results. Growthpoint has delivered positive funds from operation growth of 12.5%, driven by net property income growth of 19%, demonstrating the quality of our directly- owned portfolio. In September, we completed the 100% acquisition of Fortius Funds Management, a key growth opportunity for the group.
Funds under management were maintained at AUD 1.9 billion since acquisition. The business is contributing positively to our FFO. Over the half, strong leasing of over 89,000 square meters, alongside several property transactions, meant we were able to maintain our portfolio WALE of 6.3 years and have pro forma gearing just below our target range at 34.5%. On slide five, we outline our performance in the half against our strategy. We settled the acquisition of a high-quality, long WALE office asset in Dandenong in July, contributing portfolio income in the half and supporting the long-term resilience of the portfolio. We also entered a contract of sale for our Brisbane CBD office asset, 333 Ann Street, which subsequently settled in January, further focusing our portfolio on city fringe and metro locations. Our portfolio occupancy is 94%.
We are seeing good leasing momentum on current vacancies. Michael will discuss our post-balance state leasing further in his slides. We're excited about the funds management growth opportunity for fund investors and for the group's security holders, with the aim of delivering incremental growth to earnings and income stream diversification. Moving to slide six. Growthpoint's total security holder returns have outperformed the AREIT sector over the long term, with the recent sell-off in the market impacting the sector and group performance. Our return on equity of 16.2% over 10 years speaks to our track record of providing value. The group security price is currently trading at a substantial discount to our NTA, reflecting equity market conditions at present for the sector. On slide seven, whilst the market anticipates further cash rate rises in the short term, there are some positive indicators going forward.
Global pressures on inflation are easing, and the recent inflation high in Australia is expected to moderate over 2023 and return to near the RBA's target range in 2024. Interest rate market pricing indicates that rates are expected to fall in 2024. When the cash rate peaks in the near term, this is expected to give commercial real estate investors more confidence in the cost of capital and lead to greater transactional activity. Continued inflation pressures on construction costs will likely lead to higher economic rents for new buildings, which could favor existing office buildings where quality accommodation and amenity is offered, favored by tenants in the flight- to- quality environment. A strong jobs market and growth in white-collar employment has been a positive for the office sector.
Unemployment remains historically low, whilst it is forecast to increase, there is a fundamental shortage of workers, including white-collar employees. We have seen the recovery of net migration, which supports the economy, help to meet demand for skilled workers and could contribute to the continued high levels of demand in the industrial sector. Moving to slide eight. Growthpoint is well-positioned to navigate the changing market. Positive net absorption has been a feature of the group's fringe and metro office markets relative to other office markets since 2021. Our well-located A- grade office portfolio is positively placed to meet tenant demand, with a greater portion of the white-collar workforce continuing to return to the office. Demand remains strong in the industrial sector, with the market continuing to see high levels of tenant inquiry and historic low vacancies.
Our industrial portfolio continues to be fully occupied with strong demand when re-leasing vacancies occur. Whilst transaction volumes in the Australian commercial property market have moderated over 2022, foreign investment continues to be around 1/3 of volumes. There remains significant capital to invest in commercial real estate in Australia. That concludes my opening remarks. I'll now hand over to Michael.
Thanks, Tim. Slide 10 provides an overview of Growthpoint's AUD 5 billion balance sheet portfolio as of 31 December. The portfolio is comfortably weighted 2/3 to the office sector, where Growthpoint have a leading market position in the A- grade, highly green- credentialed metropolitan office markets, and 1/3 in the industrial market, where our well-located portfolio continues to benefit from strong market rental growth across the country at 100% occupancy. The portfolio's resilient income stream is principally derived from high-quality corporate and government tenants. Active leasing over the half has maintained the group's WALE at 6.3 years. A consistent focus for Growthpoint is to actively manage and maintain the overall quality of the portfolio.
To that end, we finalized the acquisition of the government services office in Dandenong, an A-grade, five-star NABERS Energy- rated office building, which houses several Victorian Government departments, which actively service the Melbourne Southeast growth corridor. Purchased on a 5.3% income yield, this asset leased to the Victorian Government for over nine years, will provide a steady, growing income stream for the group into the future. We also divested 333 Ann Street in Brisbane, Growthpoint's only true CBD asset outside of our holding in Canberra. We had actively managed and repositioned the leasing, undertaking over 5,000 sq m of leasing, equating to over 30% of the building over the last 18 months. The proceeds of the sale have been used to repay debt. On slide 11, we continue with our key portfolio metrics.
Growthpoint's office portfolio decreased in value on a like-for-like basis by approximately AUD 165 million or 5%. This was primarily driven by 23 basis points of yield decompression across the portfolio, with the market and valuations responding to a higher cost of capital. The portfolio valuation also reduced due to the group negotiating an early surrender of a lease with a key tenant, Lion, at our 5 Murray Rose Avenue, Sydney Olympic Park property. Growthpoint has collected the approximate present value of Lion's lease sale to their former April 2024 expiry in this half, and is now actively leasing the 12,000 sq m, six-star NABERS- Energy- rated A- grade office building. The leasing market is responding positively to the quality of this offering, and we are focused on re-leasing the property well before Lion's former 2024 lease expiry.
The office portfolio continues to be well leased with a 6.6-year WALE. We anticipate that the reduction in the office portfolio occupancy to 91% will be temporary, as we have good momentum on leasing campaigns we are currently conducting. Growthpoint's AUD 1.7 billion industrial portfolio valuation is largely unchanged across the half, with strong market rental growth and some good leasing results, largely offsetting 23 basis points of market cap rate softening. Our industrial portfolio continues to be 100% leased, with occupier demand for quality industrial space remaining high. Moving to slide 12. Positive net absorption has been a feature of both CBD and metropolitan office markets over the last 12 months. Despite sentiment towards the office sector, positive net absorption and moderate levels of base rental growth have prevailed across the majority of office markets in which Growthpoint invests.
We have continued to witness a flight to quality by office occupiers and an increasing interest from large corporate and government tenants in leasing highly energy efficient buildings. The group's A- grade office portfolio, which has an average NABERS Energy rating of 5.2 stars, is well positioned to meet this demand. On slide 13, positive rent growth and record levels of vacancy persist across all Australian industrial markets. The group's portfolio continues to benefit from the healthy occupier demand, whilst the national vacancy rate remains at 0.6%, industrial rents are forecast to continue to rise. We are seeing little to no downtime if one of our industrial properties becomes vacant, which speaks to the continued high level of market demand and the appeal of our industrial portfolio. Defensive characteristics of the group's portfolio are illustrated again on slide 14.
As mentioned, we maintain the group's WALE to 6.3 years over the half. Since Growthpoint's inception in 2009, managing leasing risk is something we have always prided ourselves on, and this will continue to be a key focus of the group going forward. The chart shows that over the next two financial years, Growthpoint has 6% and 7% of income expiring in FY 2024 and FY 2025 respectively, a relatively manageable lease expiry profile. Moving to slide 15. The group have been actively leasing approximately 89,000 sq m, representing 5.2% of the portfolio over the half. Post balance date, the strong leasing momentum has continued with approximately 4% of the portfolio by income being leased or is currently under heads of agreement to be leased.
In the office market, we are witnessing state and Commonwealth government space requirements being particularly active. Growthpoint's highly green- credentialed office portfolio already derives 39% with income from various government tenancies, and we are well-positioned for future requirements. Through our leasing, we continue to push fixed rent review growth, locking in 3.6% and 3.7% average rent reviews across our office and industrial leasing, respectively, over the half. This will assist in propelling Growthpoint's income growth for years to come. Moving to slide 16. Growthpoint was pleased again to be classified as a sector leader by GRESB in 2022. We have maintained our high portfolio energy and water NABERS Energy Ratings, and our NABERS indoor environment rating has improved to 4.4 stars from 4.2 stars in June. We continue to work towards achieving net zero by our 2025 target.
Over the half, we've commissioned or installed four solar installations in Queensland and Victoria. We are progressing with a further seven solar projects across the portfolio. I'll now hand over to Sam to discuss the group's fund management business.
Thank you, Michael. I'm Sam Sproats, Executive Director of Funds Management. Today, I'll provide a brief outline of the funds management business and our progress since September 2022. The successful integration of the funds business is ongoing, with positive feedback received from funds investors. The fund investments have exposure predominantly across the office, retail, mixed-use property sectors, and debt investments. We have recently divested property assets of AUD 55 million since the acquisition, including the sale of 99 Gawler Place in Adelaide, South Australia in December 2022, which I will touch on shortly. Funds under management saw a positive movement of AUD 12 million to 31 December 2022 since the acquisition, including external valuations of 52% of the property assets with a 0.7 uplift in the value of investment properties across the funds.
The disruption and dislocation in the current commercial property market presents opportunities for the fund's value- add strategies. The experience, patience, and disciplined approach of the funds business remains key in a changing market, with a number of opportunities considered in the period since completion. The group is well-positioned moving forward with the combined execution capability and experience across the team. On slide 19, we look at a recent case study, 99 Gawler Place, a B-grade office tower located in the Adelaide CBD that was extensively upgraded and successfully re-leased. This is a good example of the value add strategy that the funds team have specialized in for over 30 years. We identified value in an out of favor B-grade market with a multi-let tenancy profile and some vacancy. To attract a broader tenant base, we executed a multi-floor spec fit-out strategy.
We enhanced tenant amenities to the building, upgrading the entry lobby statement and experience, cosmetically improving the common areas and bathrooms, and introducing end-of-trip facilities and wellness rooms for all occupiers. We achieved an improvement to the sustainability and NABERS Energy Rating to 4.5 stars with upgrades to key building services and optimizing operational efficiencies. The asset was sold in December 2022, returning an equity IRR of 19.8% per annum and an equity multiple of 1.83x to fund investors. Moving to slide 20. A key strategic priority and growth opportunity for the group is to grow the funds management business, targeting 10%-20% of group EBIT over the medium term. Observationally, there continues to be a significant domestic and international capital to invest in commercial real estate in Australia.
There is opportunity within the current disrupted and dislocated markets where the funds business can leverage and target attractive equity IRR outcomes for fund investors. Opportunities include establishing new funds and strategies, including new asset classes or sectors in the future. The opportunity for the group to co-invest and underwrite acquisitions with balance sheet capacity. The potential for the group to warehouse investments and build on our capability to execute more transactions more efficiently with higher execution certainty. I'll now hand over to Dion to take you through the group's financial results.
Thanks, Sam. Starting on slide 22, we analyze the components that have led to our strong FFO growth per security of 12.5% over the half year. On the plus side, we've seen strong NPI growth, funds management revenue for the first time, and reduced securities on issue due to the securities buyback program being active during the half. These gains are partially offset by higher interest expense and operating costs. Looking more closely at NPI, there are two main drivers. The first is a full contribution from assets previously acquired, which accounts for almost half of the increase. The other key driver is a surrender fee from Lion at our 5 Murray Rose assets. This has skewed NPI to the first half, with no income from that asset currently forecast in the second half.
The increase in operating costs is really down to an increase in headcount, driven by the expansion of the portfolio and the acquisition of Fortius. I'll have further detail on the debt costs a little later on. Pleasingly, the result of these movements was our ability to increase distributions per security by 2.9% during the half. On slide 23, we have highlighted the key FFO increase include an increase to net property income, with the key driver being the surrender of fee at 5 Murray Rose, as previously discussed. The investment property acquisitions added a further AUD 0.006 per security to FFO, and funds management revenue contributed AUD 0.004 per security.
Offsetting these gains were the increase in interest expense due to higher debt levels for acquisitions of property, Fortius, and the securities buyback, as well as higher debt costs, with the all-in interest rate of drawn debt moving from 2.9% at December 2021 to 4.2% at December 2022. Finally, the other category is largely the increase in operational expenditure. NTA per security decreased to AUD 4.25, or by 6.8% from 30 June 2022. Most of this was due to the reduction in office valuations as cap rates expanded by 23 basis points over the half. Turning to slide 24, we see pro forma gearing increased by 290 basis points to 34.5% at 31 December, remaining just below the group's target range of 35%-45%.
The key drivers of the increase were the settlement of the GSO Dandenong property and acquisition of Fortius, partially offset by the sale of 333 Ann Street. The other downward driver was the valuation of office portfolio, as previously discussed. We still have latitude to utilize our AUD 357 million in debt headroom to support our funds management business or utilize the buyback program. Our distribution payout ratio for the half is below the bottom of the target payout ratio range. However, due to the first half revenue skew discussed earlier, this is expected to return to a ratio of 82% at the midpoint of our full year guidance, which we've reaffirmed today. On slide 25, we take a look at our capital position, clearly one of the most topical points at this time.
Our weighted average cost of debt was 4.3% at December 31, up from 3.4% at June 30. We now have no debt maturing until FY 2025 after introducing two new financiers to our banking group in the half. We also increased our fixed debt position to 67% by entering AUD 170 million of interest rate swaps during the period. The weighted average maturity of fixed debt is three years, providing a measure of protection to the market's expectation of increased interest rates in the shorter term. We have ample headroom to our debt covenants. We provide a sensitivity to these on slide 41 in the appendices. We have good levels of available liquidity and are comfortable with our gearing and fixed debt percentage. In short, we feel we're in a strong capital position and able to withstand the more turbulent times ahead. I'll hand back to Tim to wrap up.
Thank you, Michael, Sam, and Dion. On slide 27, we outline the group's investment proposition. We have a long track record of performance with disciplined management. We are the largest ASX-listed owner focused on the well-performing city fringe and metropolitan markets. We own and manage a high quality, defensive portfolio of modern office and industrial properties. Our modern A-grade, long- WALE office portfolio continues to perform well and is positioned to match tenant demand in the flight to quality, providing the foundation for our business. In an industrial growth market, our diversified logistics and warehouse portfolio is well-placed to capture future rental income growth. The successful funds management business is a growth opportunity, and we are well-positioned to leverage the group's balance sheet to support that growth. Moving forward, the defensive characteristics of the AREIT sector should see more investor interest in a slowing economy.
The group is attractively priced on metrics such as FFO and DPS yield and discount to NTA, which presents an opportunity for investors. Moving to slide 28. Over the second half, we are focused on leasing current office vacancies, supporting the growth of the funds management business, and moving towards delivery of our net zero target by 2025. Now to guidance on slide 29. We are pleased to reaffirm our financial year 2023 FFO guidance of AUD 0.255-AUD 0.265 per security and a financial year 2023 distribution of AUD 0.214 per security. This represents a 2.9% increase on the financial year 2022 distribution. The group is well-positioned to manage through the current macroeconomic volatility with our high quality, defensibly- positioned portfolio, with a consistently strong WALE and leading asset management capability.
We remain committed to providing our security holders with sustainable income returns and capital appreciation over the longer term. That concludes our prepared remarks this morning. Thanks very much for your attendance today. Thank you also to the Growthpoint team, our external stakeholders, and security holders for your continued support. We'll now open up the lines and are happy to take questions.
Thank you. If you wish to ask a question, please press star then one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star two, and if you are on a speakerphone, please pick up your handset to ask your question. Our first question today comes from Caleb Wheatley at Macquarie Group. Please go ahead.
Good morning, Tim and team. Thank you for your time this morning. My first question is really just on the financials as we go into second half 2023. I think the comment around NPI was that increase, about half of it was driven by surrender payments. If I take the AUD 23 million, that implies about AUD 11.5 million coming from the surrender payment. Is that the right way to understand it? If so, how should we think about the underlying growth going into the second half, particularly given that leasing on foot that Michael mentioned, and obviously interest expenses through the second half of the year, please?
Thanks, Caleb. Dion here. Your understanding of the first half is right. As far as looking forward, clearly, our guidance would suggest that FFO is lower in the second half compared to the first. Obviously, we're not having, well, sorry, we don't assume any income from 5 Murray Rose, for example, and also 333 Ann Street has been sold, so no income there.
Great. Thank you. My second question is just around the balance sheet. Gearing's down to 34.5% on a pro forma basis. Obviously, sitting below the target range, but just keen to hear your thoughts on how you're thinking about potentially capacity from here, or are you comfortable sort of sitting at the lower end of the range given some questions around asset values moving forward? How are you feeling about capacity from a balance sheet perspective?
Yeah, thanks. Look, we are very comfortable where we're sitting. As you point out, we're just below our target, the bottom of our target range. We have plenty of capacity, AUD 357 million of undrawn. We have 67% of our debt fixed for three years, providing some measure against any upward rate movements. Clearly, valuations, we're not certain where they will go, we have a range for a reason. If there was some further devaluation, if we moved into the range, that's not gonna bother us too much, and we stand ready to support certainly the funds management business or other capital initiatives such as the share buyback, which we've announced is extended today. We're comfortable doing that. We always look at a number of factors whenever allocating capital to ensure that, yeah, we're looking after those dual purposes of Growthpoint to provide growing distributions and capital appreciation over time.
Yeah. It sounds like being prudent, obviously. You're still looking to potentially deploy some capital, whether that be into co-investment interests, which I know you've liked previously, the fund management platform, or the buyback. Is that fair?
Yes, that's fair.
Great. And in terms of, I guess, the, how you're thinking about those opportunities for deployment, you mentioned the extension of the buyback. Obviously, funds management is becoming a big focus for the team there. How would you think about, I guess, relative preference between, you know, those sorts of opportunities, obviously bearing in mind strategic and financial returns off the back of them?
Thanks, Caleb. It's Tim here. Yes, obviously, we, you know, a major priority is to support the funds management business and grow that business. Also, you know, at the same time, we obviously keep an eye on our share price, and if we see that the business is being undervalued or there's opportunities to increase returns through the buyback, we'll do that. We have bought a business to support with capital where appropriate.
Great. That's all from me. Thank you for your time this morning again.
Thank you.
Thank you. Your next question comes from Annabelle Atkins at JP Morgan. Please go ahead.
Hi, Tim and team. Thanks for your time this morning. Just following on from Caleb's last question, is there a co-investment you are targeting in some of these assets, or will it be dependent on the asset, in the funds management business, that is?
Thank you, Annabel. It's Tim here. It will be dependent on the particular fund, or it may be a co-investment in a property with a capital partner. Typically, you know, we have notionally said, you know, we'd like to co-invest with other investors in funds 10%-15% of the equity.
Okay. Yep. Just on the surrender payment, can you just give a bit more color on the Skyring Terrace? You've been able to re-lease 2,000 sq m of that, you got it, the rest of it under heads of agreement. You previously stated that you're pretty confident that heads of agreement would go through. Is that still the case?
Annabel, it's Michael here. Yes. We're as confident as you can be when you've got a non-binding heads of agreement that's in place.
Okay.
Yeah.
Did that surrender payment on Skyring Terrace, did that all come through in the first half 2023? Is that what you're saying?
Yeah. Look, it did. It's Dion here. It did. It's more in the ordinary course of business, that one, and, you know, we're pretty confident leasing it up, you know, in this half. That's more in the ordinary course and not a major impact.
Yeah, I'd also say it wasn't a surrender payment. It was the fact that the tenant that was there went into administration. It was the bank guarantee that we were drawing down.
Right. Okay. Just one more question. You touched on one of your slides on market fundamentals, looking at the PCA office occupancy numbers ranging, you know, between that 65%-80% range. Just interested what it is across your portfolio, just because you do have a high weighting to government tenants, and I know they have been pretty lenient on the return to work.
Yeah. I mean, it's interesting. It's Michael again here. The different government departments have approached it differently. I mean, New South Wales Police, for example, have been in and active for the entire duration, clearly because they're an emergency service. Our broadly, the percentages are tracking what's happening in the PCA statistics at the moment. You know, we can definitely see here in Melbourne that there's a big push return to the office going on right now. You walk around the CBD or metro markets, and it's certainly busier than it was three months ago. You know, anecdotally from the tenants that we speak to regularly, there is definitely a push going on from management to get people back in the office, which is a great thing.
Right. Okay. Just one more, if I may. The deval on Charles Street in Parramatta, one of your assets, was quite significant. Can you just give us more color on the reason behind that?
I mean, it's simply down to basis point movement on the market yield going up 25 basis points [audio distortion]
Okay, thanks. That's it from me.
Thank you. Your next question comes from Edward Day at MA Financial . Please go ahead.
Morning, Tim and team. Michael, just firstly for you, I just wanted to clarify, did you say that post balance date, you've done another 4% of leasing?
It's either leased or is in heads of agreement to be leased, yeah.
Is there any color you can provide around that?
I'm not gonna provide any further color on it. We'll have a quarterly out in another month or so's time that'll give some more color on it. Yeah, I think that's enough at this stage.
Okay. Just on the industrial leasing done during the period, 9% of portfolio income, just interested in some of the re-leasing spreads there.
Broadly, industrial portfolio had 4% positive leasing spreads across leasing that was done, slightly higher on our renewals. The office portfolio was pretty flat on leasing spreads as well. I assume that was gonna be the next question.
Thank you. Then the last one-
Very limited downtime on the industrial portfolio as well. I think maximum probably had a month of downtime between tenants vacating, tenants coming in. Really the principal reason for tenants leaving in the industrial market was down to growth and our growing facilities that we had. As I said, we were able to backfill them expeditiously.
Thank you. Last one, just on slide 25, you've got your fixed rate, the profile there. Wondering, Dion, if you can just provide some color on your margin, and whether you've seen that move at all?
Margin on new debt, for example?
Yes.
Yeah. Look, it's a little higher than it was three months ago. 10 to 15 basis points is what we're hearing from the bankers if we needed to enter new facilities now compared to what it was. Nothing material. There's ebbs and flows in that, of course, as they issue into the market to support their borrowing here. They're getting pricing information all the time. Yeah, nothing material.
Thanks very much.
Thank you. Once again, if you do wish to ask a question, please register by pressing star then one on your phone. Your next question comes from Steven Tjia from Barrenjoey. Please go ahead.
Hi, team. Just any insights you could provide into office market leasing, just around the volume of inquiries so far into this year compared to, you know, last half?
Hi, Steven. Michael here. We've definitely seen a pickup since the last half, and as I said, I think more positive sort of attitude towards the office coming back into— people coming back into the office. Decision-making is still taking some time for groups. I think the inquiry levels are up in most of the markets that we look at. As I mentioned, we're seeing particularly strong inquiry levels coming through both state and federal government requirements at the moment.
Thank you. Your next question comes from Alex Prineas at Morningstar. Please go ahead.
Thank you. Thanks for the presentation. First question, I was just interested in the impact on NTA of the Fortius acquisition. Presumably all the, you know, the cash consideration comes off the NTA. The, obviously the intangible components of that business don't contribute to the NTA. Were there any kind of tangible components of it? Can you sort of run through how that works and, yeah, were there any sort of parts of it that do contribute to the NTA?
Look, Alex, it's Dion here. There's a, there's some full notes on this in the actual half-year accounts, which will explain it more fully. In effect, there was AUD 45 million payment for the business plus a net asset adjustment. Those net assets are like- for- like, they don't impact your NTA, that adjustment. Really it's the AUD 45 million, that is split into intangibles, whether it be management rights, performance rights or just pure intangible. That is really what the reduction to the NTA is composed of.
Okay, thanks. Yeah, I'll check out that note and let you know if I've got any more. Just second question, just around, so, just to follow up on the office leasing conditions question from before. Are tenants still looking for significant expansion and contraction options in their leasing, or is that preference reducing now?
Alex, it's really specific to the particular tenant requirements. I think you'll see that larger tenants, even preceding COVID, were often after, you know, flex rights in one direction or the other. It's not something that typically smaller sub, you know, 2,000- m tenants are able to access, not something that we've seen across our portfolio.
Okay, thanks. That's all from me.
Thank you. Once again, if you would like to ask a question, please register by pressing star then one on your phone. We'll just pause momentarily to allow any questioners to register. Thank you. As we are showing no further questions for today, that concludes our conference. Thank you for participating. You may now disconnect.