Thank you. I would now like to hand the conference over to Mr. Scott Pritchard, CEO. Thank you. Go ahead, please.
Thank you, Jody. Good morning everybody. Welcome to the 2017 interim result briefing for Precinct Properties. I'm Scott Pritchard. I'm the chief executive for Precinct, and I'm joined today by George Crawford, Precinct's chief operating officer. The first half of the 2017 financial year has been a very active one. We have completed our first building at Wynyard Quarter on time and on budget. We have commenced construction works at Bowen Campus. We've grown our portfolio occupancy to 99%. We have withstood a significant earthquake in Wellington on the 14th of November last year. Each of these items have had an impact on Precinct's operating and financial performance. We're pleased to be here today to provide an overview of the company's position. The program for today's call is outlined on page two of the presentation.
I will shortly provide an overview of the highlights of the result before taking you through our major initiatives. I'll hand over to George to summarize the interim results and capital management position for Precinct. As well as provide an overview of the market and our portfolio. I'll provide some concluding comments. Upon completion of the presentation today, we'll be happy to answer any questions which you may have. Moving to the highlights page. The first half of the 2017 financial year has seen us record a strong first half profit of NZD 39.1 million. Our operating income has grown 8.7%. Following project and operating CapEx in the period, we have gearing at 20%. At an operating level, we have seen real strength in the performance of our portfolio, with occupancy reaching 99% at balance date.
This level of occupancy is above our long-term average. Reflects the strength of our occupier markets. Following significant leasing over the previous 12 months, we are pleased to report that our weighted average lease term is now 8.1 years after including our development pre-commitments. As I mentioned at the start of the presentation, the Mason Brothers building at Wynyard Quarter was completed in December. Was fully leased on completion. This places the 1st stage of our Wynyard Quarter development to be 100% leased, eight months ahead of completion of the 1st stage. The Wellington portfolio has responded well to the dynamics in that market, with the portfolio in Wellington now 98% leased. We have also progressed our leasing at Commercial Bay with the new PwC Tower now 64% committed. Finally, we are pleased to announce today the conditional acquisition by Precinct of 50% of Generator.
The Generator business offers co-working space for office occupiers based in the Auckland CBD. The philosophies and strategy for Generator are well-aligned with those of Precinct, and we believe strongly that this acquisition places Precinct into a stronger position in a market segment where it has not been particularly active. As you can see, it has been a busy period, and we are very pleased with the position of the business. I will now ask you to turn to section one of the presentation, and I will provide an update on our strategy and progress for our major initiatives. Precinct's broader strategy remains unchanged, which is focused on renewing the quality of its asset base and concentrating its ownership into locations which are strategically relevant.
Outlined on page five are some key achievements in the period which are consistent with our strategy and ensure that we remain on track to achieve our objectives. As already covered, the Mason Brothers building at Wynyard Quarter was certified as practically complete in December 2016 with 100% occupancy. At Commercial Bay, we have progressed the occupancy at the PwC tower with a further two floors leased in the period. Importantly, we have also finalized the acquisition of Queen Elizabeth Square, which was an important milestone for the project. LT McGuinness, our construction contractor for Bowen Campus, started on site on the 1st of November and has made great gains in the last few months. The Wellington portfolio has been significantly repositioned with strong growth in portfolio occupancy following the commitment by the Crown to concluding the WAP II process.
As we all know, the effects of the Kaikoura earthquake, which occurred on the 14th of November, have been ongoing and significant. All but one of our assets in Wellington were reassessed within 48 hours and reopened for our occupiers with little or no damage. For many occupants in the Wellington market, the damage to a number of buildings have led to significant amounts of disruption and very real challenges to business continuity plans. To date, we are aware of up to 100,000 sq m of space which has been withdrawn from the market on a short or long-term basis. This withdrawal is anticipated to lead to increased demand for seismically stronger buildings, particularly buildings that not only provide safety but also provide operational resilience.
While there seems to be some silver linings for the Wellington office market in terms of demand and rental levels, we have been impacted with Deloitte House suffering a material decline in value as a consequence of its structural strength. While the building only suffered relatively minor damage, more detailed assessments have identified further, more significant structural issues. This means that the building will need to be strengthened to ensure it is suitable to meet our occupiers' needs. Finally, we are pleased to announce today the conditional acquisition of a 50% stake in the Generator business. Generator has been operating for six years and has established a strong reputation and track record in providing flexible and high-quality co-working space for those occupiers of a smaller scale in the Auckland market. Turning to page six in a summary of our development activities.
Consistent with previous announcements, our total development activities total to around NZD 1 billion of cost, with an expected yield on cost of 7.5% and an expected return on cost of 18%. Perhaps most importantly, these developments, which will be valued at close to NZD 1.2 billion on completion, will have an average lease term of 13 years, and the majority of which will have structured growth. Importantly, since August, we have progressed our office pre-commitment levels across all of our office developments from 74% in August to 77% now, and remain focused on achieving an 80% pre-commitment by the middle of the year. At Commercial Bay, the project has been well advanced with the demolition of the former Downtown Shopping Center and the establishment of the sub-ground perimeter walls. This has allowed the bulk excavation to commence, which is expected to occur over the next few months.
In parallel with the excavation, the first structural elements of the new tower have now been constructed. This is an important stage for the project as these structural elements allow the tower to be formed ahead of the excavation being completed. Pleasingly, 14 months since we committed to the project, we have advanced our key leasing requirements, and we remain on program and on budget. Over the page, we set out the status of the office tower leasing, with now 64% of the space leased. The average term of these leases is 13.3 years, providing Precinct with high-quality cash flows across this premium office tower. The recent leasing by DLA Piper to two floors in the mid-rise increases our leasing to parties outside of our existing portfolio and leaves us with only six full floors which are available and not currently under offer.
It's important to note that we remain some two and a half years from completion of the tower, so feel very comfortable with the level of pre-commitment. In terms of the retail leasing, we were delighted to conclude the Environment Court process for the Queen Elizabeth Square acquisition in December 2016. This successful outcome now clears the way for a range of retail leasing negotiations to be concluded during 2017. In addition to the retail leasing over the Queen Elizabeth Square portion of the scheme, we are also advancing negotiations with a range of food and beverage operators for Commercial Bay. The new center will comprise up to 25% of food and beverage, so this segment of the market is critical to Commercial Bay's ongoing success.
Finally, Commercial Bay Retail continues to attract a high level of interest given its location on Queen Street and the high demand which CBD retail space is continuing to receive. On page 10, we set out a little more detail on Wynyard Quarter Stage One. This first stage is split into two separate projects comprising the Mason Brothers building and the Innovation building. At the commencement of the project, the Innovation building was 100% pre-committed, while the Mason Brothers building was only 25% leased. At our annual result briefing, we announced that the Mason Brothers building had reached 70% pre-commitment following further leasing to Mott MacDonald. Pleasingly, prior to completion of the building in December, we have leased the remaining vacant space to ensure that the asset is 100% leased.
The Mason Brothers building presented significant complexity given it was a conversion of a historic building with a masonry façade into a premium grade 3-level office building. The building is now valued at NZD 35.9 million and will have a weighted average lease term of 8.5 years. We are pleased with the continued construction progress on the Innovation building. The structure is complete with the façade currently being installed. This building is expected to be complete in July 2017, with ATEED expected to announce a preferred operator for its innovation precinct in the next two to three months. Page 11 sets out a brief overview of the works to date at Bowen Campus. LT McGuinness were appointed as the main contractor for these works and commenced on site on the 1st of November.
To date, they have almost completed their soft strip out of each of the assets and are underway with the staged removal of the existing façades. This project remains as one of Precinct's key initiatives, given its scale and proximity to the Beehive and Parliament House. Following the November 14 earthquake, we are continuing to work with the Crown to understand their ongoing needs for seismically strong office space in Wellington. The final slide on section one is set out on page 12. Importantly, while we have a large focus on those initiatives which are now underway, we continue to assess opportunities which could drive shareholder value in the future. Pleasingly, we have three major initiatives within the existing business comprising future stages at Wynyard Quarter, future stages at Bowen Campus, and the redevelopment of One Queen Street.
To these opportunities, we continue to monitor the market for other opportunities within our strategic focus. I will now hand over to George, who will take you through sections two and three.
Thanks, Scott, and good morning all. Page 14 sets out our financial performance for the half year. On the right-hand side, bridges the operating result between the first half of the 2016 and first half of the 2017 financial years. The changes in the P&L against the comparative period reflect a very active 6 months, with significant development activity underway. We commenced development at Downtown Shopping Center and Bowen Campus, which resulted in that income ceasing, as well as having reduced income from assets which were sold during the comparative period. Offsetting this, we have had a significant reduction in tax expense from development deductions, which I will touch on further shortly. These are significant changes against the prior period, they are entirely as expected given the development activity underway. However, we have had to deal with the unexpected impact of the Kaikoura earthquake.
At an operating income level, as shown on page 15, this has had a one-off impact on our net property income of around NZD 1 million, being a combination of rental abatement at Deloitte Centre and the cost of minor repairs across the portfolio. Taking into account the earthquake-related impacts, we had a strong result for the six months of NZD 0.032 per share, an increase of NZD 0.0025 per share on the comparative period. We confirm today our full-year earnings expectation of NZD 0.062 per share, which is in line with our earlier guidance, with the second half earnings expected to be lower, mainly as a result of Bowen Campus being under development. While the full-year result is impacted by rental abatement at Deloitte Centre and minor earthquake repairs, pleasingly, we expect this to be largely offset by stronger portfolio occupancy.
On page 16, we provide some detail on the tax charge, as signaled last year, our effective tax rate for the period is very low as a result of development-related deductions. The most significant of these relate to the write-off of fixtures and fittings, which were disposed of as part of the demolition of Bowen Campus, as well as the deduction of interest, which has been capitalized to developments. On page 17, you can see that we have now started to draw quite significantly against the bank facilities we put in place at commencement of our projects, we're currently funding around NZD 20 million of development works per month.
While we are fully funded and happy with our current position, we are looking forward in terms of ensuring that we keep good diversity and tenor to our sources of debt, we will look to access longer dated borrowing through the capital markets as opportunities arise. In terms of our hedging, we have taken advantage of favorable markets over the last 12 months since we committed to Commercial Bay, we've put in place additional hedging currently sitting around the midpoint of our hedging ranges. We're comfortable with our current hedging position. Moving on to section three, the market and portfolio overview. On page 19, we've seen a particularly active six months of leasing in our Wellington portfolio. This is reflected in occupancy increasing from 94% to 98% as at balance date. As we stand today, we have no office vacancy in our Wellington portfolio.
This outcome is a result of both the proactive approach we took to leasing, which secured occupancy ahead of new supply, as well as the impact of a very tight market for quality space following the Kaikoura earthquake. I'll touch on the strengthening Wellington occupier market shortly. Auckland continues to experience solid demand and increasing rental levels, with our portfolio in Auckland remaining 100% leased. On page 20, pleasingly, our portfolio weighted average lease term, when we include developments, now sits at a very healthy 8.1 years with a favorable lease expiry profile, with over 40% of our lease expiries now sitting beyond 2026. Page 21 sets out our view on the Auckland market, which continues to show strength. Business confidence continues to be underpinned by positive net migration and the significant amount of capital investment currently underway in the city.
New supply continues to emerge in fringe locations, but this is largely pre-committed. To date, no further core city center supply has eventuated. We focus a bit more closely on the supply outlook on page 22. We continue to see supply being constrained due to elevated construction costs. We also see that further constraints on supply are now emerging from funding, both in terms of developers' ability to access finance, as well as from higher interest rates. While these factors may, at the margin, see land values easing, overall, we see that the risk of new supply is lower now than it was six months ago. This is clearly a positive for well-capitalized developers with fixed construction pricing, such as ourselves.
In terms of the city center retail market on page 23, we continue to see strong demand from retailers for city center space and a real shortage of space with no other competing supply. With a significant number of new and established retailers looking to secure city center stores, the outlook for occupancy and rental growth remains positive. Moving to Wellington on page 24, the market there is currently at a very interesting stage post the Kaikoura earthquakes. For the first time in a long time, we have more positives than negatives on the Wellington market on this slide. While it's still early days, the earthquakes seem to have had a significant impact on occupiers' approach to the seismic strength of buildings, and there now appears to be a greater willingness to pay higher levels of rent to be in strong buildings.
There seems to be a greater recognition of the true costs of business interruption, which can arise from being in a building impacted by quakes. While the full extent of stock withdrawals is still not fully clear, at one stage, there was around 160,000 sq m of space withdrawn from the market, and the amount of stock, which is more significantly impacted, seems to be sitting around 100,000 sq m, as Scott mentioned. Additionally, we have seen all of the available quality space in the market lease, including the new supply pipeline, which was previously somewhat of a concern. Putting that all together, we see that the outlook for occupancy and rental growth in Wellington has changed significantly from six months ago, and we are more positive on the rental growth outlook for that market. Staying with Wellington, on page 25.
Overall, our portfolio performed well in the quake, with most buildings being opened for occupation within 48 hours. In terms of the insurance market impacts, we are hearing that premiums are being increased for Wellington, but with little or no impact for Auckland. We locked in a second-year renewal option for our 2017 insurance renewal in May 2016, which means we are not exposed to market pricing risk currently. Finally, for 10 Brandon Street, Deloitte Centre, as noted by Scott, we have written the asset value down by NZD 12 million. While the damage from the earthquake is significantly less than initially feared, the subsequent inspections have identified previously unknown structural weaknesses. We are currently working through a thorough process of assessing these and designing a strengthening solution.
At the same time, we are conducting a full review of the asset to explore all options in order to ensure that the building's value is being maximized. Moving to the Generator opportunity on page 26 and 27. As Scott mentioned at the start of this presentation, today, we're pleased to announce the conditional acquisition of a 50% interest in Generator. Generator is a co-working space operator currently running three sites, with the main one being on Custom Street within the Britomart precinct. The business has been successfully operating and expanding since it was established by Ryan Wilson in 2011. It has been at the leading edge of the co-working trend in New Zealand and is distinguished from its competition by its focus on creating a curated community of businesses and professionals rather than simply providing workspace.
We are excited to be partnering with Ryan and believe there is strong potential for the future growth of Generator. We think that the combination of Generator's skills, experience, and market position with Precinct's real estate opportunities and ability to support growth will lead to some good opportunities. Those close to real estate markets will be aware of the emerging trend towards co-working, which is another reflection of the major changes in workplace trends, which we continue to see impacting on how occupiers use office space. Both offshore and in New Zealand, we're seeing it expand beyond the typical consultants and startup businesses to include more traditional office occupiers, either as their primary space option during growth phases or to complement more traditional space. For Precinct, our portfolio is heavily skewed to the larger users of office space within the market.
Just 3% of our portfolio comprises spaces of 250 sq m or less, while research indicates that this comprises one-quarter of the total market. While our initial investment is small and not expected to materially impact on our earnings in the short term, we think that the Generator investment is a good opportunity for us to access this important and growing market. I will now hand back to Scott to take us through the balance of the presentation.
Thanks, George, moving through to page 29, being the final slide of the presentation. In conclusion, there's little doubt that global markets and global economies remain uncertain. However, in our view, New Zealand is well-placed with continued growth in population growth, tourism, construction activities, as well as a range of other factors. We strongly feel that Precinct is very well-placed. In both our markets, we have strong occupier markets. The Wellington market presents an opportunity given the events of November 14 last year. We have strategic projects with very significant levels of pre-commitments, importantly, have fixed-price construction contracts with very highly capable construction contractors. We have secured funding in place. We have a capable team, our view is that the timing of the market is supportive of the initiatives that we have underway. Thank you, everyone, for dialing in, and we're happy to answer any questions.
Thank you very much. If you do wish to ask a question, please press the star key then One on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the star key then Two. If you are on a speakerphone, please pick up the handset to ask your question. Thank you. Your first question today comes from Nick Marr from Macquarie. Go ahead. Thank you.
Hey, guys. Just a couple of quick ones from me. On the Deloitte Centre impact, is that NZD 12 million net of any kind of insurance that you're receiving on that?
No. The insurance is not really a factor in what it is that we will need to fund to strengthen the building. It's not a consequence of damage. It's a consequence of more intrusive assessments that have been undertaken and finding issues within the building that were not previously understood. Insurance, there's going to be no insurance proceeds for that asset. We don't expect there to be.
Okay. No, that's clear. On Zurich, the impact on the rent there was attributed to Commercial Bay. How much of that is, I guess, retail going versus any concessions you may have given tenants from disruption?
No, there's been no concessions given to any occupiers in Zurich. It's principally Dick Smith tenancy, and it's also the level 3 tenancy that is required for the development that we've already taken back.
Cool. Just lastly, on the portfolio value, obviously no material revaluation in there. Was it a similar kind of Auckland up, Wellington sideways, so not material enough?
Yeah, look, I think that is the trend. I think it'll be interesting to see how Wellington plays out, because I think there's no question that's a relatively fluid market at the moment. Certainly we're seeing continued strength in Auckland. Following the events of the earthquake, there is definitely a much greater interest from occupiers in that market to pay higher rents to secure space, which does give them buildings which have greater performance in a seismic event.
Great. Thanks, Scott.
Thank you. The next question is from Angus Simpson from UBS Investment Bank. Go ahead. Thank you.
Morning.
Hey, Angus.
A couple of quick questions from me. Just firstly, just on the DLA lease. Just a rough estimate, them taking that floor space of 2,700 meters divided by the total comes out at a number greater than the 4% increase from 60%-64%. Has one of the other tenants dropped in space, or does it just reflect that they are on lower floors and paying a lower rent?
Yeah, 64% is by income. Lower floors, slightly lower rent.
Okay. Then second question, just on an FFO number, didn't disclose that this half, not that I've seen. Could you sort of give a rough estimate of what that was or the parts that make up that, whether that's maintenance, CapEx, incentives, et cetera?
Yeah. Look, I don't have that to hand, Angus.
Yeah. We committed to disclosing FFO with our annual results, we haven't included a disclosure for the half year.
Okay. That's okay. Just a couple of questions on Wellington. What do you think the two second half impact will be at Deloitte Centre?
Look, in terms of Deloitte Centre, we anticipate that the levels up to 13 will be available for re-occupancy shortly. There are some minor repairs needed to be done before we can provide that full occupation. The retail levels are occupied currently. We expect there to be some reoccupation during the second half. In addition to that, we've seen, as I mentioned, our other leasing has been very significant, we're now fully leased across the rest of Wellington, which is a bit ahead of our expectations. That provides a bit of an offset for Deloitte.
There's no insurance in place to cover that vacant period until occupiers can go back in?
No. We have insurance in place for lost income following insured events. You may recall we have an earthquake-related deductible or excess of NZD 10 million. We won't get anywhere near that threshold at which that insurance cover would kick in.
Okay. No, thanks. Just lastly, just the new leases that were signed in Wellington post-earthquake, what was the average WALT of those?
Yeah. The irony is, perhaps we weren't maybe not quite clear enough, actually the majority of the leasing that we did that took our occupancy from 94% to 98% in Wellington occurred before the earthquake. We had actually seen some strength in the market before the earthquake. As it happened, when we could have done with some surplus space in the portfolio immediately after the earthquake, we literally had half a floor that we could offer to some of our existing occupiers. The average lease term on the leases that we've done, which has taken occupancy in the Wellington portfolio from 94% to 98%, is on a weighted average lease term of around six years.
Yeah, thanks. That's all I had.
Cheers, Angus.
Thank you. The next question is from Matt Peake from Craigs Investment Partners. Go ahead. Thank you.
Hi, guys. A couple of questions from me. The first one, in relation to the NZD 12 million write-down of the Deloitte Centre. Is it fair to assume that's an indication of the amount of capital spend to get that building back to the state where it's going to generate similar rental income as it has been? The second question is in relation to the space that's under negotiation at Commercial Bay. Is that coming from inside or outside the existing portfolio? Have you had any further interest from outside the portfolio in relation to the backfill space at the other buildings?
Yep. In terms of the NZD 12 million devaluation of the Deloitte Centre, our expectation is that the cost to strengthen the building will be in the order of sort of NZD 10 million-NZD 12 million. There's still some assessments that need to be concluded, and so the extent of assessments are not yet complete. That at the moment is the estimate that we've been given, hence the write-down. If we did strengthen it, we'd take it through to an NBS score that would be what we think is sufficient for occupiers to then be comfortable to enter into long-term leases again. In terms of the space that's under negotiation on Commercial Bay, that's both from outside of the portfolio and there is one party from within the portfolio. We're continuing to attract pretty good interest on the office tower. We're quite pleased with the current position.
There continues to be sort of discussions on backfill. Off the top of my head, we haven't completed any leasing in the last quarter with regard to backfill. There is pretty significant amounts of discussions going on at the moment, so we feel pretty comfortable about it.
Thanks, guys.
Thanks, Matt.
Thank you. The next question is from Tony Sherlock from Morningstar. Go ahead, thanks.
Good morning, gentlemen. With both these markets, Auckland and Wellington, pretty close to full, could you just discuss the type of change in the trajectory of rental escalators, if that's had any flow-on impact?
Yeah, sure. Well, in Auckland, we've put some disclosure on the result around the outcome of our rent review program and seen growth market reviews of, I think it's around 5% over contract. On our fixed regimes, we've got an average of around 3.8%. I think generally in the Auckland market, we're seeing growth on an annualized basis of that continued growth of around 4%-5%. I don't see that abating, because there just isn't any surplus space around. In Wellington, as I mentioned a bit earlier, it's still a bit fluid. We've seen this reaction to the seismic event in November, and we've certainly seen a pretty strong willingness for occupiers to pay up to secure space. Hard to say whether that's going to entrench itself in the market yet or not, and whether it's going to establish new rental levels.
When you pull 100,000 meters out of a market, it's certainly going to have an effect, particularly when a large chunk of it is what was considered to be sort of A grade space. That is probably yet to play out a little bit in Wellington.
I think what I was more referring to was if tenants were signing up, that move from 94% to 98%, those 6-year leases, if they had rental bumps of 3%, if going forward, that type of pricing pressure enables you to get 4% or 5% bumps in the leases.
I mentioned just a bit earlier, the majority of that leasing that we did that took our Wellington portfolio from 94% to 98% was pre-earthquake. The tension that you're seeing in the market now wasn't around then. The leasing that we did then was broadly in line with market levels. There was a range of review mechanisms. Some were market-based every two or three years. Unclear as to what sort of growth you might get. You might expect that we'll get a bit more than what we first anticipated. The balance were fixed, but if we're getting fixed in Wellington, we're sitting in that sort of 2% range.
Okay. Thank you. The actual NBS score that you envisage bringing Deloitte Centre to from, I think you said it was 40-60 currently.
Yeah.
If you were to spend NZD 12 million, where would that take you to?
To get occupiers comfortable, I think you need to take the NBS score up to around 80%. Any less and you start to lose your competitive advantage when you're in a competitive situation to lease space to occupiers.
Okay. If I go backwards from Auckland, the initial leasing that you did at Commercial Bay versus what you're doing now, could I assume almost like a flat 5% line between what the effective rents were for the initial leases and what you're going to be filling the remaining space, the 36% that's unoccupied at present?
Yeah, look, we do think there's a potential for some growth in the rents relative to what we set in the feasibility. There's only six floors left in the tower. That scarcity value will, we think, drive some growth in rents. The extent of it is unknown, but I'd probably be comfortable to say 5%.
Just last question here. You mentioned 2% fixed escalators for those that have not got two or three-year market resets. What type of escalators are you getting in Auckland versus the 2% in, say, Wellington?
In Auckland, we're probably a bit higher, so we're probably sitting in that sort of 2.5% to 3.5% range.
Okay. Thank you very much.
Thanks, Tony.
Thank you. Once again, if you do wish to ask a question, please press the star key then one on your telephone and wait for your name to be announced. Thank you. There are no further questions in the queue at this time. I will now hand back over to Mr. Pritchard for any closing remarks.
Great. Thanks, Jody. Once again, thanks to investors and analysts who have taken the time to dial into the call this morning. As we've stated a number of times during the presentation, we're really pleased with the steps that we've taken in the last six months towards our longer term strategy, and we really thank you for your support. Have a good day.
Thank you very much. That does conclude the conference call for today. Thank you all for participating. You may now disconnect your lines.