I would now like to hand the conference over to Mr. Peter Huddle, Chief Executive Officer and Managing Director. Please go ahead.
Good morning, and thank you for joining us at Vicinity Centres' results call for the six months ended December 2022. Joining me on today's call is Adrian Chye, our Chief Financial Officer. Before we begin, I'd like to acknowledge the traditional custodians on the lands on which we meet today and pay my respects to their elders, past and present.
I extend that respect to Aboriginal and Torres Strait Islander peoples on the call today. I will start on slide five. Our interim FY23 results reflects a continuation of the positive momentum delivered in FY22, as well as our disciplined approach to delivering long-term sustainable growth. The Australian retail sector continues to enjoy elevated growth despite near-term uncertainty, and the residual impacts of the pandemic on Vicinity are now largely limited to the ongoing recovery of our CBD assets.
During the half, we continued to deliver quality retail property management and leasing outcomes across our assets. We are firmly in execution phase of our retail and mixed-use development pipeline. We have strengthened our JV and third-party capital relationships, and our strong balance sheet and credit metrics continue to be a source of competitive advantage, which enables us to invest in existing growth initiatives and at the same time fund potential accretive investment opportunities that align with our strategy.
Adrian will talk to the financials in more detail shortly, but at a headline level, Vicinity delivered a net profit after tax of AUD 176 million for the half. At an operating level, we delivered strong results as the business continues to strengthen post-pandemic. Importantly, FFO grew 24% over the prior period, largely driven by 21% growth in NPI.
At 25.7%, gearing remains at the low end of our target range of 25%-35%, and 81% of our drawn debt is hedged. The board declared an interim distribution of AUD 0.0575 per security, representing a payout ratio of 79% of AFFO. Finally, our strong first half financial and operational performance has enabled us to upgrade our FY 2023 full year earnings guidance.
With the impacts of the pandemic increasingly behind us, I believe it is worth reinforcing Vicinity's competitive advantages or, said differently, our investment proposition. We have what we believe is one of the best asset portfolios in the sector. Chadstone is unashamedly the cornerstone of our business.
Being one of the premier shopping centers globally, Chadstone is unrivaled in the Australian marketplace, with sales rising to more than AUD 2.6 billion by end of year 2022. We are the market leader in the growing outlet sector, we have ambitions to extend our leadership position. We have the best retail CBD portfolio of any Australian landlord, we have actively invested in these assets during the pandemic to position them for full recovery.
We are the leading Australian luxury landlord. We value our strong partnerships with luxury brand owners, we are working together to expand existing and new luxury precincts in our premium assets. This year, our luxury sales exceeded AUD 1 billion, despite the absence of Chinese tourists.
We have more than 10 assets in key metropolitan locations with attractive retail and mixed-use development opportunities, where substantial progress has been completed in master plan approvals. Under my leadership, our disciplined approach to balance sheet management will continue with low gearing, high near-term hedging, a well-diversified debt book, and a commitment to maintaining strong investment-grade credit ratings to ensure we can access debt capital to fund growth opportunities.
Our results today demonstrate execution across all our strategic priorities, which is delivering sustainable earnings growth through the cycles and for the long term. A six-month period's sustained recovery and minimal COVID impact drove strong retailer sales growth, which in turn led to a buoyant leasing activity and improved financial performance. Despite heightened near-term uncertainty, retailer confidence has remained high.
The retail sector continues to be a benefactor of an extremely tight employment market and robust household income growth, together with elevated savings rates. While we have seen some softening in the housing market, average house prices remain elevated relative to pre-COVID levels, which is continuing to underpin a wealth effect for homeowners.
Importantly, we continue to see international arrivals increase for migration, tourism, and education, which for us will benefit our premium DFO and CBD assets. Conversely, we are yet to see material sales reduction resulting from recent interest rate hikes on domestic spending. However, we are mindful of the resetting of fixed-rate mortgages this year and the potential impact this may have on discretionary consumption.
While we are expecting the rate of sales growth to moderate in the second half of FY23, our first half results has set a strong foundation for full year 23 earnings. Compared to international peers, the Australian retail sector has a degree of structural resilience. Australian shopping centers have always had a broader offer than overseas markets, including a range of non-discretionary offers such as grocery and fresh food, banking and other services.
These tenants stimulate customer traffic and generate a higher frequency of visitation. On the supply side, the development or expansion of larger format shopping centers remains constrained relative to prior years and decades. This is partly as a result of planning policy that rightfully favors existing centers around which communities and infrastructure have been built. is also fundamentally aligned to growth requirements of retail markets today.
Consequently, Australians' premium shopping centers generally have lower vacancy rates than their global peers, with occupancy sitting at more than 98%. The role of the physical store is also expanding, which in turn is driving increasing leasing demand and increased occupancy. We have said previously, the future of retail requires an omni-channel offer.
The function of the store is expanding to include showrooming, significant expansion in range of offers, provision of fulfillment and return of all orders, and is overall a more cost-effective means of customer acquisition. Our national footprint of diverse retail assets positions Vicinity as a partner of choice with growth-orientated retailers who are able to leverage our network of convenience, CBD, outlet, and premium centers.
Of course, we are developing a number of our retail assets into thriving retail, commercial, and residential precincts that not only meet market demand and provide further security holder value in their own right, but collectively multiply the value created by each stand-alone asset. At Vicinity, we believe that having a sustainable business is critical to creating long-term value for all of our stakeholders.
During the period, our sustainability program was once again recognized on a global stage. GRESB ranked Vicinity as the sector leader of Australia and New Zealand for listed retail shopping centers and third globally in its 2022 survey for the second consecutive year. In the Dow Jones Sustainability Index annual survey, Vicinity ranked eighth out of more than 450 real estate companies globally.
As we look ahead, there is plenty more to do as we truly operationalize and embed sustainability practices into our business, and I look forward to continuing to share our journey on this. This half was the first full period with no COVID restrictions impacting trading in any states. Consequently, we saw very positive momentum across all of our sales categories and geographies.
Improved portfolio visitation over Q1 and Q2 highlighted shopper preferences for a physical retail experience. Adding to this, the annual growth rate of online sales measured by NAB continues to slow from 14.5% in June to 2.3% in October 2022, and the latest data showed almost flat growth. In the December quarter, visitation excluding CBDs averaged 93% of 2019 levels. On CBDs, we have been very pleased with the continual positive momentum.
Visitation in December quarter reached 80% of 2019 levels. International arrivals surpassed 60% of pre-COVID levels, with China's international borders recently reopening. We are optimistic the momentum of CBD recovery will continue. The confluence of improving visitation, properly functioning supply chains, and growth in both sales and margins for retailers has supported retailer confidence. We have seen leasing activity increase as a result.
This has also supported improved cash collections. During the half, collections of gross rentals billings strengthened to 97%, up from 93% for the second half of FY22. Major and national retailer co-collection rates are now at pre-COVID levels. While it remains an area of ongoing focus, the SME collection rate has improved considerably to 92%. Finally, outstanding COVID rent relief negotiations are largely agreed.
Retail sales growth in the half almost defies the reality of rising interest rates and household inflationary pressures. Total portfolio retail sales for the half were up 20% compared to 2019 or 6.3% on an annualized or CAGR basis over the three-year period. Importantly, specialties and mini majors recorded the highest growth by category with a combined CAGR of 7.3% compared to 2019, which ultimately resulted in improved leasing margins.
Apparel and footwear, leisure, jewelry, and retail services recorded standout performances with consumers continuing to invest in themselves post-pandemic. Food retail growth was strong, delivering 10.5% CAGR, in part driven by price inflation. Cafes and restaurants continue to improve, delivering a CAGR of 7.6% as shoppers choose to spend more time in centers and enjoy connecting in person.
This is particularly pleasing, given cafes and restaurants are predominantly SME-owned and operated. Demonstrating the value of a regionally diverse portfolio, our Queensland assets have performed exceptionally well with local and international tourism to the state boosting performance. Of course, Chadstone continues to set the standard for retail.
This global destination continued to deliver strong growth with annual sales more than 10% above pre-COVID levels, justifying the ongoing retail and mixed-use development activity. Part of Chadstone's success is attributed to the performance of luxury retailers. Our 63 luxury stores have delivered a 16% CAGR over the past three years. With more brands coming to market, growing store footprint, and continued expansion into a younger customer market, we are confident in the outlook for luxury long term. Turning to our leasing performance.
Our leasing team executed its highest level of deal activity since Vicinity was formed in 2015, negotiating 833 deals in the period. Consequently, occupancy improved 30 basis points since June 2022. A significant focus has been on converting shops on holdover to longer term leases. In the half, holdovers reduced by almost 200 stores, and as a percentage of income, holdovers are down to 5.7% from 7.4% at June 2022.
Leasing spreads were flat for the half, improving from negative 4.8% for FY22. More than 96% of deals were negotiated with greater than 4% annual rent increases, and the average new lease term was 5 years. Spreads across Chadstone and the DFOs have returned to high single digits, which is reflective of the favorable trading conditions and strength of those assets.
In fact, at our recently acquired DFO, Uni Hill and Harbour Town Gold Coast, we have executed on key tenant remixing not only to enhance the offer of those centers, but we have also delivered double-digit leasing spreads, further enhancing the original investment case for those assets.
In summary, for the half, we have executed more leasing deals by total number and total dollars at better leasing spreads, and also increased occupancy. Importantly, we have done so by introducing exciting on-trend retailers that will drive greater customer visitation and sales, and which we can expand across our national network of retail centers. I'll now hand the call to Adrian to discuss our financials in more detail.
Thanks, Peter. Good morning. Statutory profit for the half was AUD 176 million, reflecting a strong rebound in FFO and a modest valuation decline. As Peter outlined, the FY 2023 interim result was driven by our focus on sustainable growth that is underpinned by quality operating metrics and prudent financial stewardship.
This is reflected by the 24.1% and 20.5% growth in FFO and NPI respectively. Of course, our strong income growth also benefited from the absence of COVID lockdowns, as well as the sustained resilience of the retail sector during the half. Our cash collection rate of 97% of gross billings is approaching pre-COVID levels and was up 18 percentage points on the same time last year. This was a key driver of the AUD 78 million uplift in NPI.
Adding to this, the strong retail sales environment, together with our persistent focus on collecting prior period billings, resulted in an AUD 25 million reversal of prior year waivers and provisions. Driving NPI growth in the half, was positive rental growth supported by our standard lease terms which incorporate fixed annual increases of between 4%-5% for our specialty leases and improving leasing spreads.
Percentage rent also increased, reflecting our successful luxury strategy and the extremely strong sales growth, and an acceleration of the recovery in ancillary income, benefiting from the strength and rebound in visitation and sales in the half. It's important to note that FY 2023 NPI is positively skewed to the first half due to the benefit of prior year waivers and provisions, together with seasonality, timing, and the expectation of a softening in trading conditions in the second half.
Net interest expense increased by AUD 6 million, mainly due to transactions and development completions. Naturally, we expect a further increase in interest expense in the second half. While net corporate overheads increased AUD 6 million in the half, principally due to timing and one-off impacts, we expect full year 2023 net corporate overheads to be in line with FY 2022.
On maintenance, capital, and leasing incentives, as in previous years, the majority of this spend is expected to be weighted to the second half. Consequently, we are still forecasting a total spend of around AUD 100 million for the full year. The FY 2023 interim distribution per security of AUD 0.0575 represents a 22% increase on the prior period.
We expect the full-year distribution payout ratio to be towards the lower end of the target range of 95%-100% of FFO. Moving on to valuations. For the six months to 31 December 2022, the portfolio recorded a modest valuation decline of 0.7%. AUD 109 million, with the weighted average capitalization rate softening by three basis points.
Collectively, our premium asset portfolio comprising Chadstone, the CBD assets, and the DFO centers, delivered positive valuation growth, reflecting buoyant leasing activity and quality outcomes. The strength of Chadstone was even further demonstrated this half, with an AUD 53 million valuation uplift driven by both income growth and a 12.5 basis point tightening of the asset cap rate following development approvals during the period.
The regional, sub-regional, and neighborhood portfolios recorded valuation declines, reflecting softer valuation metrics which were based on recent transactional evidence. Turning to our capital structure. Vicinity's balance sheet remains in great shape and provides us flexibility to navigate periods of uncertainty and the capacity to fund accretive investment opportunities.
Gearing of 25.7% remains at the low end of our target range. We have no debt expiring in FY 2023 and minimal drawn debt expiring in FY 2024. Our hedging levels are above 80%, and we have ample liquidity of AUD 1.3 billion to fund our committed projects and near-term debt expiries.
Our debt duration is 4.5 years based on debt drawn, and we entered into additional AUD 500 million of hedges during the period, taking our hedged debt duration to 4.2 years. We retained our strong investment-grade credit ratings of A and A2 with S&P Global Ratings and Moody's respectively, both with a stable outlook. Thanks. I'll now pass back to Peter.
Thank you, Adrian. Turning now to our development pipeline and our new leisure and dining precinct. The Social Quarter at Chadstone will open March the first this year. This development extends the current entertainment and lifestyle precinct into a contemporary indoor-outdoor environment with views towards the Melbourne CBD skyline. We look forward to formally welcoming the Officeworks team as the development of their new head office is scheduled to be complete in the coming months.
Also at Chadstone, we have commenced the new nine-level One Middle Road commercial tower that includes the new Adairs head office, along with a refurbished and expanded fresh food and al fresco dining precinct. This is Vicinity's first fully integrated mixed-use development, where the office tower will be integrated with the retail precinct over multiple levels of the center, and completion is expected prior to Christmas 2024.
During the period, we opened a new Coles anchored fresh food precinct at Box Hill Central. This project includes upgrade to mall finishes and the introduction of dual frontage restaurant precincts, which opened to Carrington Road. The new development is fully leased and trading well. Construction of a new 4,000 square meter office podium above the center is complete and fully leased to Hub Australia, the site is expected to open its doors next month.
At Bankstown Central, we also opened a Coles anchored fresh food precinct known as The Grand Market, we expanded the mini major precinct to introduce a number of exciting new tenants to the center. The completion of projects at both Box Hill and Bankstown paved the way for the next phase of their development, unlocking of the assets for major mixed-use projects that have been authority approved.
At Chatswood, we have commenced early works for the lower ground fresh food mall and dining precinct upgrades. The development will revitalize and expand the existing fresh food mall, while the dining area will include a range of cafes, fast food, and quick service restaurants.
This is the first step in a major redevelopment which, subject to relevant approvals, includes an elevation of the center's offer, including expanded luxury precinct as well as a new rooftop office village. Moving now to our earnings guidance. Given the strong half-year results, we are pleased to upgrade our FY23 earnings guidance. FFO per security and AFFO per security are now expected to be in the range of 14-14.6 cents and 11.8-12.4 cents, respectively.
Even when adjusting for the benefit of prior year waivers and provisions, our upgraded FY23 guidance is above the top end of our original guidance range. We are targeting a full year distribution towards the lower end of our payout range of 95%-100% of AFFO. Before I hand the call over to the operator for Q&A, I wanted to touch on my recent appointment as Vicinity's CEO and Managing Director.
Naturally, I'm honored to be leading a company with such a strong team, a prized portfolio of assets, and an organization with significant potential for growth. As discussed today, I believe Vicinity has the right strategy in place to deliver long-term growth. Under my stewardship, we will have an even greater emphasis on driving a performance culture that is focused on property excellence, profitable growth, customer centricity, and disciplined capital management.
Having been with Vicinity since 2019, my feet are already under the desk. I'm motivated to get going on delivering our priorities and growth agenda. I look forward to sharing more on this at the appropriate time. Thank you. I'll now hand the call over to the operator for Q&A.
Thank you. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star two. If you're on a speakerphone, please pick up the handset to ask your question. A reminder that we do ask participants to limit themselves to asking two questions. Your first question comes from Sholto Maconochie from Jefferies. Please go ahead.
Hi, Peter and the team. A great and a strong result. Just you touched on the second half, potentially softer trading conditions. How was January trading, if you've got that figure available?
Hey, Sholto. It's Peter here. We haven't rolled out January at this stage. Our indications in the marketplace is that sales are softening a little bit, particularly after the last interest rate rise in February. Hence the reason. We had a very strong, obviously, six months for the end of December. We started to see a softening in December sales. We're still growth, and we expect that through the second half.
Okay. Second question, how are you progressing on bringing capital partners to develop on pipeline, and would you consider any asset sales going forward as well?
Yeah. Look, in terms of the capital partners, we've commenced the process in the middle of January, that process is primarily for Buranda, which, as we announced, we received our DA approval on that just before the end of the year. We have substantial approvals in place for Box Hill, we're also progressing substantially with Vic Gardens. For that, our ideal strategy is to bring capital partners in. Sholto, we've commenced that process. We're in that assessment at the moment, as soon as we get to an outcome, we'll advise the market accordingly.
All right. Great. Thanks so much for your time. Cheers.
Thank you. Your next question comes from Lou Pirenc from Jarden. Please go ahead.
Yeah. Thank you. Good morning. I might just ask about the leasing spreads. You called out, I mean, clearly there's improvement that you called out, Chatswood Chase and the DFOs, very positive. Where's the weakness to offset that? Can you talk about that?
Yeah, sure, Lou. Essentially, if you break the leasing spreads down a little more, we're probably positive 3% across our premium assets, including the CBDs, Chatswood Chase and DFOs, and probably around about the -3% to 3.5% across the rest of the core portfolio
. It's not too dissimilar to where we were in a pre-COVID conditions, where the premium portfolio is performing extremely well, and there's still a bit of negative leasing spreads in the core portfolio. Even if you look at that core portfolio, it's substantially better than it was over the last number of reporting periods, particularly even just before COVID as well. That's generally the split.
Thank you. Second question. Can you just highlight, you mentioned that ancillary income is coming back. Where are you compared to pre-COVID levels, roughly, in terms of that ancillary income?
Lou, from our point of view, we're right on the number, to be honest. We're essentially at FY19 ancillary income levels. I would add we've put some capital to grow some of those business lines, including our media business, which has performed well. And we've still got some, a little bit of ways to go in terms of controlled parking and some of our casual leasing space. But essentially, we're at the same number as FY19, which is about AUD 100 million, a bit over AUD 100 million.
Great. Thank you.
Thank you. Your next question comes from Simon Chan from Morgan Stanley. Please go ahead.
Hi. Good morning, Peter and Adrian. Hey, I was hoping Adrian could elaborate on his comments about the skew of earnings to the first half, because I was just doing some quick math. It looks like even if I strip out the provision reversal, your guidance midpoint to midpoint is implying second half to go backwards on first half by about AUD 40 million. You know, AUD 35 million-AUD 40 million. Look, I get interest expense will be a factor, but, like, what else is there for you to think you're gonna go backwards by AUD 30 million-AUD 40 million?
Thanks, Simon, for your question. You're right. We are expecting a pretty significant skew from first half to second half. If I just break down those components, interest expense, we're expecting, you know, about AUD 10 million to come through through increased weighted average cost of debt and also volume driven into the second half.
In terms of, you've already talked to the AUD 25 million of prior year waivers and provisions. There's probably about AUD 25 million of other items which are skewing the result. They're kind of driven by about four key factors. The first one is around loss of rent. We've got, particularly Chatswood, fresh food kicking off in this half. There'll probably be an increased loss of rent going into the second half.
Ancillary income tends to be a little bit weighted to the first half as well, given Christmas trade. Car parking and CML tend to be a little bit more heavily weighted to the first half. Marketing and outgoing, there's a slight skew there as well.
Finally, as Pete touched on, we are expecting some softening conditions in the second half. We've made an allowance for some softening in that second half in that result. That should give you an idea of how we're thinking about that split. You know, I guess how you're thinking about your numbers is similar to what we're thinking about.
That's good. Thanks. Hey, Peter, just wondering if you got any update on your funds management aspirations because I think David McNamara's been there for about 12 months now. Just wondering what sort of progress have you guys made on that side of things?
Simon, maybe I was a bit vague in the answer to that first one. The process that we're in at the moment, which Dave is leading, is a appointment process for strategic advisors with us to essentially bring that third party capital in for Buranda, Box Hill and potentially Vic Gardens as well.
We think that process will take a couple of months. We're in the closing stages of appointments, and then we will be tapping into those marketplaces. From post our reviewing a strategy in terms of how we wanna kick off our funds management, this is our first step into that, into that arena, if that's helpful.
Yep, that's clear. Thanks. Thanks. Thanks, Adrian.
Thank you. Your next question comes from Ben Brayshaw from Barrenjoey. Please go ahead.
Hi, Peter. Congratulations on your appointment as CEO. I was wondering if you could talk about the recovery profile for CBD visitation sitting at sub 80% across the portfolio. You mentioned international was picking up. How close are CBD assets to their income being stabilized in the last six months?
Hi, Ben. First, thanks for your comments. Secondly, look, CBDs, we're happy with the way CBDs are at the moment. They're still nowhere near where we need them to be. For maybe a bit more further breakdown, traffic's up to about 80% of pre-COVID levels. Our valuations are still sort of 22% off peak, or, you know, pre-COVID levels.
Sales are improved. It depends on the asset. They're probably at around about 10%-15% down on pre-COVID levels. What we think is... Maybe for some other context, particularly in Victoria, which I think, to be quite frank, has done a better job on driving business back to CBDs. We've got traffic back to 100% of pre-COVID levels on weekends.
That's, that's sort of the broad scenario. In terms of our provision in this, majority of what we're providing for, which is around about that AUD 30 million mark for the rest of the year, is related to ongoing sustainable initiatives for CBDs. We still think it's gonna take a period of time, until CBDs come back to whatever the new normal is gonna be for them.
Opening of the international borders is clearly going to help and CBD office workers in a more meaningful way is also going to help. Fundamentally... The other thing, Ben, is we've spent a lot of time and effort in remixing our CBD assets to really take advantage of what we call those day tripper and destinational shopper.
We think it's not gonna occur in this second half, and we've provisioned appropriately for it. We would love to have a crystal ball, but I think it's gonna take a little bit longer and depends really on CBD office worker return and the return of international tourism.
Thanks, Peter. Could you clarify as well, I thought I heard you say in the presentation, but perhaps I didn't get this down correctly, that Chadstone sales were up 10% versus pre-pandemic? Just seems a little soft. If you could comment on that, please.
Chadstone sales are pretty close to AUD 2.7 billion now. On a comp basis, it's bearing in mind that substantially went down, Chadstone sales. Ben, I'll come back on the absolute comp basis for you just after the call. We're about double-digit, small double-digit increase on pre-COVID.
Okay. It's lagging the rest of the portfolio. I was just wondering if you could maybe talk about some of the factors there that maybe have weighed on the recovery in relation to Chadstone.
The fundamentals around Chadstone, a lot of what's driving Chadstone at the moment, one, obviously we've done significant remixing through Chadstone. We've increased the size of many stores, it's had exceptional sales performance through its luxury categories.
Across all categories, we've had strong growth in sales across Chadstone, but really the luxury categories are growing at circa 15% CAGR since 2019 at Chadstone. That's what's also helped us deliver to that close to AUD 2.7 billion sales result.
Okay. I'll have a chat offline. Thanks, Peter.
Okay.
Thank you. Your next question comes from James Druce from CLSA. Please go ahead.
Good morning, Peter. Good morning, Adrian. Do you have a occupancy cost number now that sales have been pretty clear for six months?
We didn't report one, James, but it's circa around 14%. To Ben's question before, if you adjust for the strength of luxury sales, which obviously have an influence on occupancy costs, and if you exclude it, you're closer to around about 14.8%.
Yeah. Okay. Does that mean so rents are up 10% since pre-COVID and sales are up 20? Is that a fair number?
Probably there's always a bit of a time gap between sales increases and your ability to adjust rents on both on the way up and the way down. It's probably broadly similar to those numbers.
Okay. if I combine that as a first question, what are you assuming for leasing spreads for the second half? That's my second question.
We're assuming leasing spreads are softening. Typically, we've spent a lot of effort in the first half of this reporting period. It's a record number of deals really driven by a really favorable leasing environment. We wanted to conclude those on longer term leases. Leasing spreads for the second half are assumed at around slightly over negative 3%. That takes into account an assumption around softening in sales.
Thank you. Your next question comes from Richard Jones from J.P. Morgan. Please go ahead.
Hi, good morning, Peter and Adrian. Just in relation to the valuations, just interested how value assumptions have changed around occupancy downtime and leasing spreads in your most recent round of valuations, and whether there's been a movement in their discount rate? Then maybe just part B, just whether those assumptions are consistent with what you guys are seeing?
Yeah, no, I'll take that one, Richard Jones. Thanks for the question. Probably hasn't been a lot of movement, to be honest, in terms of some of those underlying assumptions. We've probably had a little bit of an improvement in growth rate, in terms of income growth rate, and I think that's really reflected, or that's really reflecting probably improving conditions coming out of COVID, where, you know, valuers did take a significant cut to kind of outlook for growth rates.
In terms of downtime, and kind of leasing, there hasn't really been a significant change. In terms of discount rate, yes, they have started to push out a little bit more than cap rates. That is being factored into some of the valuations as well.
I'll just add to that.
Okay.
Richard, we're also. The further we get away from COVID, some of the COVID provisions within the valuations are starting to come out as well. That's influenced the result. The other thing that's influenced the result is whilst cap rates have softened, they're seeing real signs of growth in our cash flows through the leases, and that's been taken into account in the overall number.
Can I ask what their leasing spread assumptions are? I think they've previously kind of double digits. They've obviously been getting a little bit better, but your spreads have improved a lot.
Yeah. I think the leasing spread data that they're using is pretty similar, I think, to what we're expecting in our portfolio as well. They're factoring and improving in that leasing spread, and also they're putting some slightly stronger growth rates in there as well. You know, I think the theme is that the valuers are expecting that, you know, income growth is still going to be reasonably solid going forward, and that will offset, I think, some of the cap rate softening that will come through, which we expect over the next six to 12 months.
Okay. Just one final question. Sorry, Peter. Just under your leadership, just in terms of evaluating the entire portfolio, do you see the entire portfolio as core?
I'm sorry, Richard, I missed that. Do I see what? Sorry.
Just the portfolio. Do you see all of the assets within the portfolio as core over the medium term?
Oh, sorry. Yeah. Look, I think the strategy that we have in place is the right strategy. There will be a few changes to it. We're putting the entire portfolio over a prioritization lens. Part of that, to some of the questions are on this call, was also to look at how best to ensure we get the best return for our shareholders, and some of that may be in terms of funding our development pipeline.
As a result of funding the development pipeline or potentially even some opportunistic transactions that suit our strategy, some of that may require some recycling of assets similar to what we did with the transaction between Runaway Bay and Harbor Town last year.
I think you'll see more activity in that space, but it'll only be. You know, we have no plans right at the moment, but it'll only be to ensure that if there is any divestments, it's divesting at the right time in the market to fund value creating activity.
Great. Thanks, guys.
Thank you. Your next question comes from Grant McCasker from UBS. Please go ahead.
Hi, good morning, Peter. Just wanted to dwell on your comments talking about the sort of the NPI deteriorating a little bit in the second half for a softening sales environment. You know, we've only really got a few months to go. I know you're not providing guidance for 2024, but how are you thinking about occupancy, re-leasing spreads, sales as we head into 2024, given the sort of deteriorating consumer over the full year, not just the next couple of months?
That's a good question, Grant. I should ask you that question. look, you know, we're through obviously we're reporting to the end of December. We've already had a bit of a discussion on this call around January in terms of performance. From our point of view, we probably do shy on the conservative side than normal. In terms of FY24, we haven't begun that process in earnest at this point in time. We do over the next three months. If that leads to a different outcome, then we'll come back to the market.
At this point in time, after a succession of interest rate rises led as a result of inflation, we do see that there will be a tightening in the economy and hence the reason why, you know, we've left various provisions in place, and we'd rather be more conservative than bullish in terms of that. It probably doesn't answer your question. I don't have the crystal ball on it. Over the next couple of months, we're going through the work in terms of FY 2024 on a detailed line-up basis on every single asset, and we'll roll it up.
Okay. Excellent. Just a second question. On your development portfolio, can you outline outside of Chadstone, the leasing demand you're seeing for non-retail, components, predominantly sort of office, and how are those discussions progressing?
Look, I mean, it's a good question. I mean, obviously we kicked off a lot of development activity at the moment. You'll see under construction, we've constructed a lot of retail development around food and leisure. Chadstone, we've kicked off the office project, which was pre-leased in with Adairs that we announced into the market, and we're obviously building Officeworks.
We also next month, it's a smaller development, but we open a co-working commercial leasing facility with Hub Australia in Box Hill South, which is completed construction and ready to move in. We've progressed with some other flex co-working offers in the market. At this point in time, we haven't made any market announcement on non-co-working outside of Chadstone commercial tenants at this particular point in time.
To a certain degree, in terms of what we're doing at Buranda, Box Hill, in terms of the third-party capital funding at the same time, we're into the market to pre-lease those from a commercial point of view. The other key one that we're in market responding to opportunities is Bankstown. There's nothing that is concluded at this point in time.
Okay. Excellent. Thank you, Peter.
Thank you. Your next question comes from Stuart McLean from Macquarie. Please go ahead.
Good morning, and good time. item. How do we set that to a goal of 24 months as you two start to ramp up and your development pipeline again? Should we see improvement there? How do you think that item, please?
Stuart, sorry. I'm on a bad line myself, but I didn't get much of that question. If I paraphrase, was it associated with the cash flow across our development pipeline for two years?
No, sorry about that. The question is regarding the expectations for funds management and property management, as you start to develop more, on a go-forward basis.
Hey, Stuart. Adrian here. I might take that. I think in terms of fee income, we've had a pretty strong first half in terms of fee income. That's to do with the retention of Midland Gate, which we didn't expect probably the start of the year, given the investors in VIP were looking to sell that asset.
They've subsequently retained that asset, that's provided some benefit into fees. I guess there's been a rebound in NPI and some earlier than expected starts in our developments, particularly at Chadstone. I think going forward, we'll probably have a little bit of an increase in fees as we kick off some of these major projects.
I'm thinking about, you know, Chatswood in particular, you know, if that's board approved and that kicks off into FY 2024/2025, that'll add to fees. There will be some lost rent as well that'll offset some of that fee benefit going forward. I think as we move further into delivery and execution of our pipeline, we will get some additional fees through there, but offset by some of the loss of rent through that period.
Thank you. Second question, just regarding the mixed-use pipeline and should start to see some residential development start. Are they mainly build to rent, build to sell? And what capabilities you brought in-house, regarding, execution, for those, developments, please?
The residential developments are built for rent. If you look at the key ones that are more front-ended, the first one being Victoria Gardens, our joint venture partner on Victoria Gardens. The Salta Group, led by the Tarascio family, who are residential developers across Melbourne, and more specifically in the area that we're partnered with them on that particular asset.
We jointly manage that asset. They bring a lot of residential development expertise. We bring the master planning design expertise with them to that asset, and we've also started to build up our residential capabilities, including a head of residential and other developers and project managers with significant residential capability.
In terms of the OpCo on that particular asset, again, it will be the Salta Group that is the OpCo on the residential component of that. In terms of other opportunities, be it Box Hill, Buranda, that will be determined through the course of the next six to 12 months, which will be about 12 months ahead of the start time of those developments in terms of the OpCo component of it.
It's a work in progress in terms of building up our capability and operating model for the residential component. Our mixtures component is front run really by the commercial opportunities at this stage.
Thank you very much.
Thank you. Your next question comes from Alex Prineas from Morningstar. Please go ahead.
Thank you. Good morning. On the development pipeline, could you provide a bit more comment around how construction costs are going at the moment, and what your outlook there is for construction costs?
Yeah. Hi, Alex. It's Peter. Yeah, I mean, clearly last year, or was not an easy year to commence constructions or developments due to the fact of the construction costs. That said, we did commence quite a fair bit of smaller work and also some larger work at Chadstone as well.
What we're seeing leading into the back end of last year and the start of this year, is a freeing up, particularly of the material supplies into the marketplace. We're seeing reduction in costs associated with particularly logistics of getting materials from overseas into Australia.
We're seeing reduction in total material costs, and we're also seeing the contractor and importantly, the subcontractor market freeing up with some availability, which is having some positive impact in terms of cost escalations. We're seeing a better market this year than we were, particularly in the last nine months of last year.
From our point of view, though, we're conscious in terms of construction costing. All the development that we do is on land that we own. We have long-dated development applications associated with that land. We ensure that when we commence a development, that, you know, we do look at developments on a look-through basis, but we wanna be in a position that we're returning appropriate returns to our shareholders. We are patient if needed. That hasn't stopped us developing. We've just got to wait for the right time in the marketplace.
Thanks. Just in terms of that, you know, the pressure that has been on construction costs, has that also put pressure on things like maintenance CapEx costs and lease incentives to the extent that the incentives might relate to fit outs and things like that? Because those are, you know, smaller, you know, construction or, you know, fit out, project, are they more able to be cost-contained?
Look, and you'll see it in our results, our lease incentive and maintenance costs have been pretty well managed in the first six months of this reporting period. They're typically back-end loaded, on those type of things they typically occur in the second half of our reporting period. Alex, it's the same scenario. It's the same cost increases.
Our retailers that fit out stores or the more maintenance capital works that we do around our shopping centers have the same, broadly the same impact in terms of cost escalation that the larger projects have had. In fact, some of them may even have had more.
What we have, I think we reported in this reporting period, lease incentives paid at about 8.6 months rent on an average five-year lease, which is lower. The team has done a particularly good job in terms of that. A lot of them is weighted towards our premium outlet portfolio, which by the nature of that portfolio, typically has a lower lease incentive for those type of deals. To answer your question, typically, the same construction cost increase occur in that space as well.
Okay, thanks for that.
Thank you. There are no further questions at this time. I'll now hand back to Peter Huddle for closing remarks.
Okay. I'd like to thank everyone who participated on this call. A particular call-out to the Vicinity team for the collective way we delivered the result in the six months to December of this year. I think from our point of view, we believe that we have a very strong diversified portfolio and that we have the right partnerships in place to deliver long, sustained earnings.
From our point of view, the portfolio is really important because it is a diversified portfolio that we can sell across the chain, particularly across our premium CBD and DFO outlets. As we spoke about a lot in this call, it is a material component for us in terms of execution of our development strategy.
Again, it will be ensuring that we do that in a judicious way, particularly around balance sheet management. For us, I'd like to thank everyone with us on the call, and I'm sure we'll catch up in one-on-one meetings at a later point in time. I'll pass back to the operator to conclude the call.
Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.