Earnings Call: Q3 2016

Oct 20, 2016

Summary

Rental income reached SEK 1,573m, identical-portfolio growth was 9%, and property-management earnings rose 23% (13% excluding a prior-year one-off). Portfolio values increased 11% for 9M, while LTV stood at 47%.

Thank you, and welcome to Fabege's interim report for the third quarter. There is currently a high level of uncertainty on the market, and as always, it has been increasing ahead of the reporting period. The fact that there is growing worries is fairly understandable given that rising values bring increased risk. Please turn to page 2. We are hearing that the economy has peaked and that we are heading towards a slowdown. We are also often hearing that rents have reached their zenith and that interest rates are set to start rising. Please turn to page 3. However, what we are seeing in our business is persistently strong demand with a high rise in rents and declining yield requirements. The trend is perhaps about to catch up with us, but personally, I believe that the slowdown will be good for the property market in the long term. The consensus is, after all, relatively healthy growth of just over 2%, which should lead to continued positive trend with a lower risk of overheating. Please turn to page 4. All 3 of our business areas have made an extremely robust contribution to earnings. This is partly due to the strong Stockholm market, but also to positive efforts from our great organization. There are several explanations behind the solid contribution from property management. Our account managers have increased revenues through good renegotiations, while our property managers have lowered our operating costs, and together they have created satisfied customers as our own recent Customer Satisfaction Index measurement gave us proof of. The high contribution from our property development is largely due to the fact that we have been successful on new lettings and thereby have we received a record project volume under production that our skilled employees operates in line with budget. We have also had a positive contribution from transaction, which has both boosted our balance sheet and created conditions for new business projects. Now over to you, Åsa, and page 5. Thank you, Christian. It has been a fantastic year so far with growing rental income, improved earnings from property management, and solid value growth in the property portfolio. Rental income amounted to SEK 1,573,000,000. Increased rental levels and completed project properties are now generating growth. This is despite the sale of Uarda 5, which was vacated on 1st of March. Growth in identical portfolios totaled 9%. Rental income in Q3 include a positive effect of SEK 11 million due to property tax, which relates to the whole period, January to September. The surplus ratio was 72%, which is in line with last year. More normal winter conditions and slightly higher administrative costs due to larger workforce, along with the sale of Uarda 5, all had a negative impact. While increased rental income, including the property tax effect just mentioned, and continued measures to improve efficiency and operations had a positive effect. Central administration costs rose to SEK 53 million. This is largely due to the fact that we have now set aside funds for a larger provision for Fabege's profit-sharing foundation in accordance with a decision by the AGM. Interest expenses declined compared with the previous year as a result of lower average interest rates and a smaller loan portfolio. The average interest rate has risen slightly compared with the year-end, which is down to the fact that we are borrowing less and therefore the derivative cost is being allocated across a smaller volume of loans. The average interest cost is now 2.75%. Earnings in associated companies totaled minus SEK 23 million. The second quarter included a positive gain of SEK 18 million from the closure of old SFF. Otherwise, the item related mainly to losses from Arenabolaget. Overall, earnings from property management increased by 23%. Last year, earnings from property management were negatively affected by the non-recurring effect of depreciation in Arenabolaget. If we take account of this effect, earnings from property management increased by 13% year-on-year. We sold four properties during the year and realized value changes amounted to SEK 182 million. Value growth remained persistently strong in the third quarter. Overall, unrealized value changes totaled SEK 4.5 billion, corresponding to a value growth of 11%. Around 20% of the portfolio is externally evaluated on a quarterly basis. Yield requirements continue to drop. The average yield in the portfolio is now 4.7% as opposed to 4.94% at the year-end. Rising rent levels have gradually had an increasing positive impact on valuation during the year. The increase in value in our major project properties is also persisting. The projects that have been completed or are near completion have now largely had their values revised upwards to reveal their final value. The return in the project portfolio was 82% for the period. The value of the derivative portfolio varies considerably, reflecting the trend for the long-term interest rates. A higher long-term rate in the third quarter meant that the deficit value once again declined. However, over the entire period, the deficit value rose by SEK 131 million, and profit after tax reached SEK 4.3 billion. Now over to slide six. Here you can see the effect of the positive trend we have experienced over the past two years. There has been a strong growth in shareholders' equity, which has risen by just over 50% in the space of the two years. During the same period, the net asset value or EPRA NAV has increased by SEK 55 per share to SEK 144. Our target for the loan-to-value ratio is a maximum of 55%. Continued value creation via project investments, combined with the strong growth in the value of the property management portfolio mean that we are now at 47%, well below. The fact that we have strengthened is also evident from the equity/assets ratio, which is now up at 44%. Now over to slide eight, financing. On the financing side, we are in a calm and stable phase. There is capital available both via the banks and in the capital market. Margins are either stable or showing a slight decline. We are maintaining our strategy of keeping our finance predominantly in banks and supplementing it using the capital market financing. Since terms on the capital market are currently highly favorable, we have no objection to allowing that share of the financing to increase a bit. Bond financing currently amounts to just over 11% of total loans following our issue of SEK 460 million via new SFF in September. SEB has now also joined us as a dealer in our MTN program, which means that we have four major Swedish banks on board. SEB has also published a shadow rating of BBB-minus, which is similar to the ratings that we have received from the other banks. Since the shadow rating system has been called into question, SEB is now the only bank that is still publishing credit ratings that relate to this kind of scale. The issue of an official rating has therefore been raised, and Fabege has decided to await the developments for the time being. We haven't detected any noticeable impact on the issues that we have carried out in SFF during the autumn. Unutilized facilities at the end of the quarter totaled SEK 3.1 billion. In addition, we have an opportunity to borrow more on the capital market via our own MTN program and via new SFF. This provides us with the security to be able to handle both future project investments and take advantage of new business opportunities. Additional fixed interest periods were applied in the third quarter, and at the same time, some of the old, more expensive swaps expired in August. All in all, roughly 67% of the loan portfolio is now bound by interest rate swaps. Then over to page 9. As the property portfolio is gradually environmentally certified, we also want to increase the proportion of green financing. We are only issuing green bonds on the capital market, and from the response we are getting, we understand that the demand for green bonds now outweighs the supply. Meanwhile, we are also in discussions with several of the banks about offering green financing. We believe this is a trend that will only get stronger over time. We're beginning to see a price difference between green and non-green, which we think is attributable to the quality of the assets and the fact that we are reaching a new category of investors. We are confident that this development will continue, and we look forward to a larger proportion of green financing on competitive terms in the future. The current proportion of green financing is now 12%. Then back to Christian and page 9. Thank you, Åsa. I'm now going to talk a little bit about the rental market. Please turn to page 11. Our net letting of SEK 87 million during the year is above our target. But the third quarter was, as usual, a period with few trades. We continued to see strong rental increase in all our areas and a clear flight to quality. During the year, we have achieved an average rent increase of 24% in our renegotiations, which shows how strong the rental market is. We continue to see a clear shift towards quality in all our areas. Please turn to page 12. Here we see our three largest properties. These three properties represent approximately 15% of our portfolio and have a total of over 150 tenants. In modern times, none of these three properties have been fully leased before. Today, there is no vacancies in these three properties, which also gives us a good picture of the strong rental market. I expect that we will see a high business activity as usual in the fourth quarter and with continuous increasing rents. Please turn to page 13. I'm now going to talk a little bit about the transaction market. Please turn to page 14. If we move on to the transaction market, we can see that it's remaining strong and it is contributing to solid value growth, which in percentage terms means an increase of 11% for the first nine months of the year, of which 4 came in the third quarter. Earlier in the year, the value changes were mainly explained by the declining yields. In the third quarter, however, two-third of the changes in value can be explained due to rising rents. I think not only that we will see a continued rise in rents, but also continued fall in yields. The only thing that can change this is, in my opinion, a very sharp slowdown in the economy or business cycle, which very few believes in today. Please turn to page 15. I'm now going to talk a little bit about the transaction market. Sorry, the project market. We have a project portfolio that creates value and of which we can be proud of. We have a good potential to fill up the vacancies that we have in our portfolio. As you can see above, we have vacancies in most of our projects, as which the previous quarter we have launched a major new project. Please turn to page 17. Here you can see Orgeln 7, where Svenska Spel, among others, sat earlier. The property has a very good location close to Sundbybergs station. We invest nearly SEK 1 billion when we completely renovate the house, and we will build on additionally 4 floors and creating in total 36,000 sq m modern premises in a good location. I am convinced that, as usual, we will have filled up the property with tenants by the time it is completed in 2018. Please turn to page 18. Here you can see a model that shows our vision for Solna Business Park that we have introduced during the quarter. Our vision for Solna Business Park means the site will be transformed from an office district into a compact, thriving neighborhood, including more service, housing, and several new office buildings. Please turn to page 19. Uncertainty about the future is high as we look forward. I believe that the business cycle is central for the development of our real estate market. Consensus is that we will have a minor economic slowdown ahead. Personally, I think that it can be positive as it reduce the risk for overheating. If we look upon Fabege's future, we see the favorable conditions that we have made are successful. No matter what we have faced for economic situation, we will continue to have tremendous benefits from these good conditions. Thank you. That was our presentation for the third quarter, and 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. We have a question from the line of Robert Woerdeman from Kempen & Co. Please go ahead. Your line is now open. Good morning. This is Robert Kemper. You mentioned falling yields. Now you have seen 24 bps yield compression year to date. I think at the start of the year, you mentioned that the yield could fall to around 4.5%. Based on the transactions and the potential transactions coming through, is that still your base case or your expectation for the year-end? Hello, Robert. Yes, if I understand you right, you wonder if we will see a reduction of additionally 20 bps this year. I do not believe that we will see 20 bps this year, but I believe that we will see at least 20 bps lower yields before we have reached the bottom. Okay. Is that based on transactions that you are actually seeing in the market, or is it just based on a feeling? I believe that we today have more than 25 bps in difference between the market values in our portfolio and what we can do deals on the market. But as always, it takes a long time before it shows in our valuations, what the market is showing. So it's just lagging. Okay, that's clear. On top of that, you mentioned rising rents. Two questions on that. First of all, where do you expect Arenastaden's prime rents to go to? You mentioned in earlier discussions it could go to between 3,500 and 4,000 SEK. Is that still what you expect, let's say in the next two to three years? That's one. And two, what is actually currently the reversion potential in the portfolio? Thanks. The rent levels in Arenastaden, we have said quite recently that our target is to be between the CBD or inner city and the prime suburbs. And today we are on the top levels of the prime suburbs. We today are asking for rents of around 3,000 SEK in Arenastaden, but our target in five years' time will be to be between. And between today means, I would say above 4,000 SEK. And I think it's possible, but it will take some time. And our target is to reach it in five years' time. And the possibility every year, the renegotiations volume, I believe that even next year is around 15% of the portfolio. I'm not sure about the figure, but that's the normal figure. So I believe that's the best answer you can get from me today, but around 15%. Okay. That's all clear. Many thanks. I remind you that if you want to ask a question, you will have to press 01 on your telephone keypad. There are no further questions at this time. Please go ahead, speakers.