Earnings Call: Q4 2016

Feb 2, 2017

Summary

2016 brought 19% property value growth, 10% identical-portfolio rental growth and a 46% LTV. 2017 outlook called for higher rental income, continued project investment and value gains led by rent growth.

Welcome to Fabege's year-end report for 2016. Please turn to page 2. In 2016, we have delivered very strong earnings contribution from all three of our business areas. We want to have good control of our business and low risk of things we cannot influence. Our focus is to work with such things where our own effort can have big impact. Because of that, there are two things I am particularly satisfied with. Number 1 is that we have maintained a high profitability while continuing to reduce the financial risk substantially. We currently have loan-to-value ratio of 46% against 60% two years ago. Number 2 is that our extremely strong result is not only explained by the strong property market in Stockholm. I am very pleased that a substantial portion of the result is created through our staff's good efforts. Please turn to page 3. Here we see a number of performance indicators that are important for the result with the 2015 year's figures in brackets. We have a 23% average increase from our rental renegotiations. We seem to have managed to maintain a good relationship with our customers as our retention rate is 81%, which is the highest we have had. We have reduced our vacancy to 5%. Our surplus ratio remained at 72%, which is good since we lost around 1% on the sale of Uarda 5. Profit margins in project was impressive 87%. 19% of our financing is now green, and we can also see that it is profitable with green financing. Åsa will now tell us more about the 2016 performance. Thank you, Christian, and I will start on page 4. 2016 can be summed up as being a strong year with growing rental income, improved operating surplus, and very high value growth in the property portfolio. Rental income amounted to SEK 2.1 billion. Increased rental levels and completed project properties generated growth. This was despite the fact that the sales transactions conducted during the year reduced the cash flow. Growth in an identical portfolio totaled 10%. The surplus ratio was 72%, which is in line with last year and also in line with our goal for this year. More normal winter conditions and slightly higher administrative costs due to larger workforce, along with the sale of Uarda 5 were offset by increased rental income and improved efficiency in operations. The central administration costs amounted to SEK 70 million, which was also in line with our expectations. Interest expenses declined compared with the previous year as a result of lower average interest rates and a smaller loan portfolio. During the first half of the year, the average interest rate increased as a result of the derivative costs being allocated to a lower loan volume. During the second half of the year, the average interest rate decreased again as a result of cheaper borrowing in the capital markets and some of the old expensive swaps expiring. The average interest cost is now 2.64%. Earnings in associated companies totaled minus SEK 425 million and consisted primarily of one-off items. After the capitalization and change in ownership of Arenabolaget in December, we decided to write down our holdings in Arenabolaget by more than SEK 400 million. This was partly offset by a positive impact associated with the sale of Old SFF. For 2017, we are expecting a negative operating cash flow in Arenabolaget of approximately SEK 40 million-SEK 50 million. This meant that earnings from the property management decreased compared to the previous year, but excluding earnings from associated companies, the earnings from property management increased just to under SEK 900 million. We sold a total of five properties during the year, and the realized changes in value amounted to SEK 491 million, with SEK 200 million relating to an additional purchase price for a transaction carried out in 2010. in the fourth quarter, external valuation of all the real estate that was not valued in Q3 was carried out. Value growth was still very strong, and unrealized changes in value amounted to SEK 7.6 billion for the full year, corresponding to value growth of 19%. Yield requirements continued to fall. The average yield in the portfolio is now 4.53%, as opposed to 4.94% last year. Rising rental levels have gradually had an increasingly positive impact on valuations during the year. The increase in value in our major project properties is also persisting. The yield in the project portfolio was 87% for the period. The value of the derivatives portfolio varies considerably, reflecting the trend in the long-term interest rates. Higher long-term rates in the second half of the year meant that the deficit value declined and the deficit value decreased by a total of SEK 99 million during the year. Tax for the year includes current tax of SEK 83 million relating to prior years, which is covered by deferred tax relating to carry-forward losses. Reversal of deferred taxes relating to property sales of SEK 368 million is also included. Now I will turn to page five. The balance sheet has continued to strengthen in line with the good earnings. Visible equity has increased by SEK 56 per share in two years, and the long-term asset value, the EPRA NAV, has increased to SEK 163 per share during the same period. Our target for the loan-to-value ratio is a maximum of 55%. Continued value creation via project investments, combined with strong value growth, mean that we are now at 46%. Our increasing strength is also evident from the equity ratio, which is now up at 46%. Now please turn to page seven. The banking and capital market remains stable. In line with what we have said before, we have increased the proportion of capital market financing in the portfolio, partly as a result of issuing bonds in our own MTN program and also via SFF. Including the certificate program, capital market financing at year-end equated to 37% of outstanding loans. In January, we issued an additional SEK 300 million through SFF in a bond with a term of over just three years. With the issues, we have not noticed any requirements for external rating, even if this is a topic that is increasingly being discussed. We are pleased that we have created the possibility to issue green bonds, and we are working together with the banks to bring out more green loan agreements. Around 21% of the financing is currently financed by green loans. Both with the banks and most recently with SFF issue, we have noticed that it is also economically advantageous to borrow green. This is a development that we embrace and want to see more of. In January, SEB became a dealer in our certificate program. SEB has also acquired a stake in our backup facility for that program, which has thereby been increased by SEK 500 million, up to SEK 2 billion. Unutilized facilities at the end of the year totaled around SEK 1.9 billion. This provides us with the security to be able to handle future project investments and take advantage of new business opportunities. No further fixed interest periods were agreed in the fourth quarter. Around 63% of the loan portfolio is bound by interest rate swaps. Some of the more expensive callable swaps will expire in March this year, which will have a positive effect on the average interest rate. Thank you. Now back to Christian again to hear more about developments in the rental market. Please turn to page 9. Thank you, Åsa. In our rental market, activity increased again, as expected during the fourth quarter. The second and the fourth quarter are usually the year's busiest periods. Demand, particularly in the city center, is very high, and we continue to see a clear move towards quality. We have the quality that is sought by the customers, which has resulted in our occupancy rate increasing during the year to reach the current 94%. Low vacancies rates and strong demand have resulted in a significant increase in rents in all our areas. in 2016, we did not focus on high net letting as we already had a well-filled project portfolio as a result of good net letting over the past few years. Things went well in 2016 as well, and we signed 182 new agreements during the year with net letting amounting to an impressive SEK 127 million. During the year, we achieved average rate increase of 23% in our renegotiation from a volume of nearly SEK 200 million, which confirms the strong rental market. Please turn to page 10. Here you can see how our revenues will grow in 2017 as a result of new lettings and rent increase. The rental market remains strong in Stockholm, with few vacancies and continued rising rents. With the current economic forecast, with a GDP growth of around 2% in 2017, I expect continued increase in rents and renegotiations increase in 2017 that exceeds the 23% increase achieved in 2016. Please turn to page 12. Now let us take a look at the transaction market and yield requirements. Our transaction business witnessed high levels of activity in the fourth quarter. We divested Uarda 7 in Arenastaden for SEK 1.2 billion, which is double the capital invested, and this is just another good example of our value creation model. The land allocation previously received from the city of Stockholm for residential properties in the Selfoss 1 plot in Kista was taken up during the fourth quarter, and we will develop it in a joint-owned venture with a housing developer. In addition, Fabege entered into an agreement to acquire three properties in Solna from Peab. Fabege also acquired Peab's shares of Visio, which owns development rights in Solna. An additional property, Fortet 2, in Solna was acquired from AFA Fastigheter. The total purchase price for the properties that were acquired was SEK 1.4 billion. Please turn to page 13. The strong property market in Stockholm with rising rents and lower yield requirements has provided very strong value growth. Annualized change in value amounted to just over SEK 7.5 billion, with almost SEK 2 billion of this coming from the project portfolio. The increase in values in the property management portfolio in the fourth quarter was due mainly to higher rents. In the first half of 2016, the impact of declining yield requirements was the main reason for increase in the value. Please turn to page 14. Here you can see how our average yield requirements have developed over the last five years. Yield requirements have fallen equally much in all our three areas, and that is especially the last two years as required yields have been dropped. The forecast is that long-term interest rates will increase slightly, and I think this will generally result in an end to the falling yield requirements during 2017. Changes in value during 2017 will, as has been the case in the past six months, primarily result from rent increase. Please turn to page 16. Now let us take a look at the project portfolio. We are proud of our large portfolio of projects. The investments are continuing at a high rate. The total investment in new construction and redevelopment during the year was just over SEK 2.6 billion, and we expect to maintain this high level through 2017. The profit margins in the project portfolio was 87%. Revaluations of three project properties that are either completed or near completion contributed to the strong change in the value of that project portfolio. In our ongoing major projects that can be seen here, we have what the customers are looking for: modern premises close to commuter rail links. The good demand means that I expect that all the available space will be leased by the time that the projects are completed. Please turn to page 17. As a result of strong net letting in 2016 as well, the main focus of our project activities in 2017 will be to get more of our great project opportunities ready to start with planning permissions. Please turn to page 18. Here we will first have a look of our situation. Viewed over time, the demand in Stockholm is very strong. We also have what the customers want. We have a great potential in Sweden's best project portfolio, and we also have an organization that is constantly evolving and almost always deliver beyond expectations. If we take a look at the prospects for 2017, we know that our cash flow from property management will increase significantly, primarily due to increased revenues from completed projects and renegotiations. We expect good value growth in the property management portfolio, primarily due to rising rents. We also continue to have great value creation in our project portfolio with a high investment volume and a high profit margin. Overall, I'm looking forward to strong result in 2017. Now we are ready for questions. Ladies and gentlemen, if you have a question for the speakers, please press 01 on your telephone keypad and you will enter a queue. After you are announced, please ask your question. Please hold until we have the first question. I remind you that if you want to ask a question, you will have to press 01 on your telephone keypad now. Our first question comes from the line of Peter Papadakos from Green Street Advisors. Please go ahead. Your line is now open. Thank you. I have two questions, please. One on yield. Your performance is at about 4.5%. Christian, where do you envision that the yield going, if it is going to rise due to future rent growth? Could we see it going back towards 5% within the next few years? Is that possible, assuming the yield compression period is over? For Åsa, I guess with the tailwind of values rising and LTV dropping, do you have some sort of a range or a guidance you can give us on where should we be expecting the LTV to be from now on? Thank you. Hello. I start with the last question. I am not sure that I understand your first question. The last question about our LTV. We are very pleased today that we have 46%, and we have a view that we want to have a dynamic loan-to-value. The higher the values go, the lower the loan-to-value we will have. We are very pleased today with 46%. If the values will continue to increase, we will probably lower our loan-to-values even more. That is good to hear. The first question was more in terms of if we stop seeing any yield compression, and it is more about rent growth from now on. I just want to get a sense of where the yield could grow to from the mid-fours due to the rent growth. Yes. I think that the yields won't increase so much if the forecast for the rental growth will be as forecasted. But if they will be much higher, I think we will see a higher yield shift also. I think that also in the short term, if we are talking about 2017, the rental increase will also have a pressure downwards on the yields. So I don't think that we will see an increase in yields from today in 2017. But sooner or later, we will have higher yields than today. But I don't think we will see it in 2017. Okay. Of course, the increase in the future could be back to where we are coming from. We are prepared to have a situation where we can handle that situation if we will go back with an increase of 1.5% higher yields. I see. Okay. Thanks, Christian. Our next question comes from the line of Robert Woerdeman from Kempen & Co. Please go ahead. Your line is open. Good afternoon. This is Robert Woerdeman. First question. You mentioned that you still expect good rental growth in 2017 and perhaps also 2018. Could you quantify where rents are nowadays in Arenastaden? What you expect, let's say, towards the end of 2017, taking into consideration, obviously, the discussions that you have with your tenants right now, and potential future tenants. Yes. We have seen increasing rents during the last two years, and I would say that they are accelerating. If we go to prime suburbs, we have been talking about that we now see 3,000. If we are talking about what we are discussing today, we have several ongoing discussions above 3,000. So there is still an increase, and I would say that we will see rental agreements well above 3,000 during the spring in several suburbs. Okay. If I listen into the 2015 and 2016 conference calls, you were pretty accurate with rental increases towards, I think you mentioned five years out, we can expect Arenastaden to hit the 4,000 SEK. Are you still of that opinion, or has something changed in that view of Arenastaden? That is still our goal, but that is a goal we have in five years' time. It is not 2017. It is a long-term goal, and that is in today's price levels also. So it could well mean higher than 4,500 in five years' time. But I have said that we want to be between the CBD and other prime suburbs in five years' time. Okay. Then just coming back on your comment on that you don't expect any movement in yield for 2017. If you take into consideration your comment just a minute ago on where rents will go and that you see well above SEK 3,000 during spring, that's a jump of 5%-10%, I reckon. Would it be fair to expect a valuation growth throughout 2017 of that same extent, so 5%-7% capital value growth? Yes. As it looks today, I believe that we will see value growth. A little value growth because that we have yields who is lagging, but a little bit bigger part of value creation because of increasing rents, as we have seen the last six months. I think that will continue. Okay. That's all clear. Last question, because it all looks very good in Stockholm. What could derail the strong occupational market in Stockholm? A real big downturn in the business cycle is the biggest threat. That's nothing we see today, but it can happen tomorrow. Okay. That was it from my side. Many thanks.