Earnings Call: Q4 2025

Apr 22, 2025

Summary

Record DPU of JPY 4,005 and stronger capital returns were supported by buybacks, dispositions, and operating rent growth. Rising capital costs and refinancing uncertainty remain key constraints, while forecasts include further portfolio actions and potential upside.

Thank you very much for participating in today's financial results briefing for the 18th fiscal period ended February 28th, 2025. LLR's share price performance continues to be difficult. We recognize that it is important to objectively analyze the current situation and make flexible management decisions, even in challenging share price performance. Since October 2023, LLR has shifted its strategy to improve profitability and capital efficiency to counter the rising cost of capital and has continuously implemented various measures over the past four fiscal periods. In the current environment, we believe that sticking to the direction of this strategy will lead to an increase in enterprise value. In our last financial announcement, we presented a comprehensive direction of our management concept and initiative towards maximizing shareholder return toward a focus on capital efficiency improvement. This management policy aims to achieve capital profitability that exceeds the cost of capital and then increase the spread by constantly analyzing the current situation with respect to capital earnings and market valuation and promoting initiatives in line with appropriate management directions. I would like to give you an update on LLR's approach to management strategy in line with this goal, based on our analysis of the current situation. In the first section, I will elaborate on DPU and other fund performance-related figures. Page four shows the historical trend of DPU up to the fiscal period ended February 2025. For the fiscal period ended February 2025, DPU landed at JPY 4,005, the highest record since the IPO. This is an increase of JPY 379, or about 10%, from the previous fiscal period. We executed share buyback of about JPY 8 billion, reducing the total outstanding shares by about 3%, which had an effect on DPU by JPY 110. Other than that, NOI and income from indirect investments increased, and the effect of temporary excess earnings distribution contributed to the increase in DPU. Regarding property dispositions, the third disposition of LOGIPORT Nagareyama B was completed in the fiscal period ended February 2025, which also contributed to the continuous increase in distributions. Despite some ups and downs, DPU has remained in the range of JPY 3,600-JPY 4,000 by implementing measures to improve profitability and capital efficiency in an environment where the cost of capital is rising. This translates into a return on equity of mid-7%, based on the most recent net asset value. On page five, you will find our forecasts for the current and next fiscal periods. The forecast DPU for the fiscal period ending August 31st, 2025, has been revised upward to JPY 3,829. This is an increase of JPY 146 from the forecast announced last October, and the main factors are the three listed at the top of the page. Share buyback in the fiscal period ended February 2025, the increase of interest by 10% in LOGIPORT Kawagoe, and the recording of development gain from the Matsudo Matsuhidai project. DPU for the fiscal period ending February 2026 is expected to be JPY 3,474. The LOGIPORT Kawagoe was originally planned to be disposed of 20% and 80% over two fiscal periods, but disposing interest have been changed to 30% and 70%, resulting in a larger decrease in the forecasted DPU in the fiscal period ending February 2026. The projected decrease in NOI is also due to the accelerated dispositions of the same property. It may raise some concerns about the declining trend in NOI due to a series of dispositions. Since the proceeds from disposition were used for share buyback and the buyback was executed at a rate nearly equal to the rate of decline in NOI has not actually decreased when compared on a per unit basis. Given that future buybacks are not reflected in the earnings forecast, we expect that we are able to achieve accretive growth on a per-unit basis. Since the results of these measures will only become apparent after they have been implemented for a certain period of time, we will provide a detailed analysis in our next update. Our forecasted DPU of JPY 3,474 at the fiscal period ending February 2026 does not include undetermined factors such as share buyback amount of up to JPY 4 billion, potential property dispositions, and indirect investment initiatives announced on April 17th. These factors should be considered as upside factors. Last but not least, disposition and investment in LOGIPORT Sayama Hidaka is scheduled to be completed in March 2026, and therefore is not included in this earnings forecast. Please note that this will be recorded in the period ending August 2026 as a part of our continuous disposition efforts. Please turn to page six to see our historical NAV per unit. For the fiscal period ended February 2025, NAV per unit was JPY 165,294. LLR's strategies to enhance shareholder returns, including a series of dispositions and share buyback, are factors that affect the fluctuation in addition to the increase in the value of our portfolio. In the period ended February 2025, there is a negative effect of approximately JPY 1,100 due to the additional disposition of LOGIPORT Nagareyama B and temporary excess earnings distribution. The increase in unrealized gains on properties owned and share buyback at a price lower than NAV per unit boosted NAV per share by about JPY 2,000. Although the total NAV has been on a downward trend due to a series of dispositions and shareholder returns, NAV per unit has been steadily increasing, growing by an average of 4.4% per year over the past four years. On page seven, we show the progress of the total payout on equity, which was presented in the last financial statements as an indicator to measure the improvement in capital efficiency. This indicator is calculated by multiplying ROE by total payout ratio to reflect the high return to shareholders that is a characteristic of REITs. By our definition, ROE is calculated by adding back depreciation expense to FFO, and total payout ratio indicates the return on FFO. In the fiscal period ended February 2025, LLR achieved a very strong return on equity of 7.6% and a total payout ratio of 194% as a result of gain on dispositions and share buyback. We are confident that LLR is making steady progress in improving its capital efficiency. Since this indicator also depends on the size of share buyback, it is appropriate to measure this indicator over multiple periods rather than a single fiscal period. In the case of LLR, the magnitude of share buyback varies because it depends on the share price. On an average basis over the four fiscal periods, including the two forecast fiscal periods, LLR's total payment on equity is 8.4%, exceeding the 8% target and is expected to rise to 9.4% with future share buyback progress. There is also upside potential from pending dispositions and earnings improvements. Chapter 2 updates LLR's strategy framework based on market valuations. On page 9, we provide our concepts on each of the following steps: analysis of the current situation, management direction, and strategy implementation in context of initiative towards maximizing shareholder return with a focus on capital efficiency enhancement, which we explained in our last earnings release. We will provide details starting on page 10. Page 10 provides an update on the current situation analysis. Why has LLR's share price not increased despite the fact that LLR has continued to realize gain on dispositions and shareholder returns since October of 2023? We concluded that the rapid rise in the cost of equity, which outpaced the increase in ROIC, is an impediment to the recovery of LLR's share price. We derived LLR's ROIC and the cost of capital implied from EVA spread. The graph on the left shows that LLR's ROIC has improved from the low 3% to approximately 4% since the strategy change in October 2023. If the cost of capital remains constant, the EVA spread should widen and the share price should rise proportionately. However, the EVA spread implied by the share price has not been widening, but rather has been gradually narrowing. In other words, the increase in the cost of capital has exceeded the increase in LLR's ROIC. The graph on the right shows the change in LLR's cost of equity, as suggested by the daily share price and ROIC. The 10-year JGB yield is also included in the graph, in which some degree of correlation is observed. It can be confirmed once again that the rise in the cost of equity precedes the rise in the cost of debt as interest rates rise. There has also been some discussion recently about how much of the disposition gains are factored into share price. The graph on the right shows that the blue line rises sharply in October 2023 and then stays at the same level for the next 6-month period, after which it rises at the same pace as the slope from the past. In other words, the cost of equity incorporates the disposition gain over the 6-month period, and over the last year, the equity cost of capital tends to rise in line with rising interest rates. Based on this analysis of the current situation, I reiterate our strategic framework on page 11 and 12. Since page 11 is unchanged, I will take this opportunity to provide an update on our balance sheet management on page 12. With the recent decision to sell LOGIPORT Sayama Hidaka, our dispositions accumulate to approximately 10% of total assets. The realized gain amounted to JPY 6.7 billion, or approximately 8% of the total portfolio. As for the allocation of the disposition proceeds, JPY 11.1 billion was allocated to indirect investments aimed at high-return investments, and on the right side of the balance sheet, LLR is steadily increasing shareholder returns. Share buyback totaled JPY 12 billion over the past year and the next 6 months, equivalent to 4.6% of the total outstanding shares. 4.6% is the second-largest magnitude of share buyback among J-REITs. In the fiscal period ended February 2025, LLR paid a special distribution in excess of earnings of JPY 450 million, which contributed to the improvement of capital earnings, together with the full distribution of disposition gains. Why and on what basis do we conduct disposition? When do we end it? To answer this question, LLR believes it is not simply a matter of adding a certain amount of gain on dispositions every fiscal period. As shown on page 13, it is based on the belief that dispositions are efforts to capitalize on properties and to contribute to the enhancement of shareholder value. This is where listed REITs differ most from private REITs. The significance of being listed is that a REIT should always take arbitrage between the public and private markets. We believe it is very important to incorporate this concept in order to achieve the mission of improving enterprise value over the long term, even if it means shrinking asset size. As a reference, the graph on the right shows the changes in LLR's appraisal NOI yield and implied cap rate since the IPO, and we believe that the raison d'être of a REIT is to take advantage of this arbitrage and flexibly iterate the expansion and contraction of the asset size. Please refer to page 14, which describes LLR's current strategy framework, divided into 4 pillars. This presentation material is structured on the 4 pillars. Chapter 3 presents recent portfolio management efforts and directions in portfolio strategy. First, I will explain the LOGIPORT Sayama Hidaka transaction announced on April 21st on page 16 and 17. This transaction is different from the previous ones in that it is not a simple disposition, but a transfer to indirect investment. LOGIPORT Sayama Hidaka will be transferred to an SPV, which will be jointly owned with Dai-Ichi Life Insurance Company in the form of a TK equity interest in which LLR will own approximately 13%. The transaction price is JPY 7 billion, and a gain on disposition of approximately JPY 700 million is expected to be recorded in the fiscal period ending August 2026. Since LLR's investment is JPY 350 million, approximately JPY 6 billion can be allocated to other investments and shareholder returns. In addition, given the risk of the recent rise in interest rates, we are considering fixing the interest rate on our non-recourse loans. Going forward, we will be able to enjoy stable dividends without interest rate risk. Another key objective of the transfer to indirect investment is to offload a property with longer lease contract terms, so that LLR's directly held properties will have a portfolio structure with more internal growth upside. As shown on page 17, each of the previous disposition had its own unique objectives, but in the case of Sayama Hidaka, this new initiative focuses on the third point, property composition with internal growth prospects. Furthermore, we believe that by realizing gains from the disposition of the properties we have worked to enhance their value, we can increase LLR's overall profits and contribute to higher returns for our investors. As shown on page 18, as our aims for dispositions have diversified, as has our approach to portfolio management. We have combined direct and indirect investments to expand assets both on and off the balance sheet. There are three reasons why we manage assets outside balance sheet. The case of Sayama Hidaka falls into the third category, long-term co-investment with private core investors, and is a pattern of joint co-ownership with a third-party core investor from a long-term portfolio management perspective. In the current environment where external growth is difficult, we believe it is important to diversify our ownership styles. As shown in the lower graph, off-balance sheet AUM has increased rapidly over the past several years. The graph shows that off-balance sheet assets decrease when on-balance assets increase, while it increases during periods of on-balance asset size is shrinking. At the end of this chapter on page 19, I reiterate the ratio of the size of assets on-balance sheet and off-balance sheet in the most recent period. Sayama Hidaka accounts for 1.7% of LLR's balance sheet AUM, and after it is transferred to off-balance sheet management, it will account for 3% of LLR's off-balance sheet AUM. Of LLR's total assets, 95% are directly owned assets and 3% are indirectly invested. The size of off-balance sheet assets has reached approximately JPY 260 billion, which is a controlled exposure on the balance sheet. While it is equivalent to approximately 70% of LLR's total asset size. In chapter 4, we will explain our capital strategy, a new and yet a particularly important pillar. First, the capital allocation update on page 21 shows that the total transaction amount is now JPY 37.5 billion due to the disposition of Sayama Hidaka. Out of this JPY 37.5 billion, JPY 10.6 billion has or will be used for indirect investments. An additional JPY 4 billion will be used for the share buyback, which was resolved on April 21st. Share buyback is positioned as an attractive investment based on the recent share price, and if you added JPY 8 billion repurchased in the previous period, our share buyback totals JPY 12 billion. A total of JPY 7.3 billion is allocated for shareholder returns. JPY 6.7 billion from gains on dispositions are already distributed or to be distributed in the future, and JPY 600 million in total is used for excess earning distributions and share buyback for return purposes in the fiscal period ended February 2025. After subtracting these, JPY 7.6 billion is our dry powder, which will be effectively used for new investments or returns to shareholders. On page 22, we have summarized our current stance and priority on new investments. As noted on page 13, there is currently a divergence of the yields between the public and private market, and when the public market is factoring in higher costs of capital sooner than the private market, we concluded that LLR's stock generates the highest risk-adjusted return of all investment options. That is why share buyback currently represents the largest portion of LLR's capital allocation. Indirect investment requires selective investment in the face of rising interest rates and increasing debt costs, unless yields widen in the real estate market. Therefore, we prudently assess the competitiveness and yield spread of potential deals over the medium to long term. Conversely, we are considering debt investments to effectively diversify our indirect investment portfolio during the rising interest rate phase and are considering investing in the second investment mezzanine post Nanko & Yachiyo project. We believe that direct investment opportunities are limited given LLR's current cost of capital and the cap rate in the real estate market. Page 23 shows the progress and effectiveness of the share buyback program implemented since last April. During the period from April to October 2024, the share price was supported at NAV multiple of 0.9 times, partly due to the announcement effect, but the effect faded after October due to the advent of a downward trend in the market. On the other hand, as the share price remained below the target price for buyback, we could accelerate share buyback at NAV multiple of 0.86 times. In addition, LLR's beta was 0.41 at the end of March, the second lowest among J-REITs according to Bloomberg, which contributes to LLR's lower volatility and thus lower cost of capital. As a result, we can say that we were successful in executing share buyback when the stock price was at its lowest. However, we learned that the announcement effect lasts only about six months, and its effect on share prices is not enough to offset the downward pressure. Based on these factors, we concluded that we should focus on share buyback for investment purposes or repurchasing own stock during the downside phase of the market. Page 24 summarizes the details of resolution of the updated share buyback initiative. The previously established shareholder return price band, which purchases at NAV multiple above 0.9 times, is discontinued due to lack of progress, and the funds will be reallocated to the investment price band, which purchases at NAV multiple below 0.9 times. The repurchase amount is JPY 4 billion over the next six months, totaling JPY 12 billion since last year. In chapter 5, we will discuss our asset management status and internal growth. Please turn to page 37. On page 26, we present an update on occupancy rates and lease contract revisions for the previous period and the two forecast periods. The portfolio continues to perform well in terms of occupancy rates and rent growth. Warehouse occupancy rates continue to be nearly full, and rent increases of 7%-8% have been achieved on average. This trend can be seen in both 19 properties with fixed lease contracts and the three properties in Higashi Ogishima, and we can expect continuous solid internal growth. In particular, the three Higashi Ogishima properties have shown sustained success in rent increases in Japanese traditional lease parcels, with some parcels achieving double-digit increases. Over the next year, the pre-lease rate also exceed the historical average, with 86% of offers already made for this fiscal period and 41% next fiscal period. On page 27, we take up Higashi Ogishima ABC as an example of our internal growth initiatives, which is distinctive properties in LLR's portfolio. The major characteristics of these properties are that they have a short WALE of 1.3 years, large rent gaps of more than 20%, and a finely diversified tenants and shipping companies. These three properties account for approximately 20% of LLR's portfolio, and the average rent growth rate over the past three years was 7.8%, which is higher than the rest of the portfolio. The ratio of fixed leases and Japanese traditional leases is almost equal. But as a result of negotiations to increase rents on traditional lease parcels, there are parcels of 100,000 square meters with seven tenants that have been able to increase rent by over 10% in 2025. For example, we were able to agree on terms for a gradual rent increase over a three-year period in Higashi Ogishima B and Higashi Ogishima C. We are committed to asset management and rent increase that exceeds inflation rate. Page 28 is the ALM slide that we update every fiscal period. As interest rates have risen sharply since the beginning of this year, we have revised our assumption of interest rate increases for refinancing. In the refinancing conducted in February this year, the swap cost to fix the interest rate was 125 basis points with five years term, which exceeded our previous assumption, so this ALM slide is based on 50 to 80 basis point increase in interest rates for future refinancing. However, interest rates have become volatile recently, as well as interest rate hedge costs, making the outlook more uncertain. We will continue to prudently focus on ALM management. Our forecast is based on conservative assumptions of 80 basis points for one-month TIBOR, 100 basis points for three months TIBOR, and 150 basis points for the base rate for refinancing. In chapter 6, we will discuss our value-add initiatives, which focus on indirect investments. Firstly, on page 30, we will introduce Matsudo development project, which investment return was press released in March. This was LLR's second development project and the first that we have undertaken with an external partner. In 2021, we acquired the land and existing building through a sale and leaseback, and after demolition of the building, construction began in August 2023, with the leaseback period bridged by a leasing company. The development terms were finalized before construction costs increased, resulting in an IRR of 13%. Although the size of the project is not large as it is a medium-sized property, we expect the development profit to contribute to the distribution for this fiscal period. As with the first project, Osaka Suminoe Logistics Center, we took out the property with a sidecar fund. On page 31, I would like to introduce our mezzanine investment as an indirect investment in light of rising interest rates. LLR revised its investment guideline last August, allowing investment in real estate-related liability assets such as mezzanine debt. One example is the mezzanine bond issued by an SPV whose assets are backed by Nanko and Yachiyo properties, which were acquired in exchange for Nagareyama B. The main benefit of mezzanine investment is diversification of income sources during periods of rising interest rates. In this deal, we also acquired 49% of the SPV's preferred equity, which is the most subordinated equity, and by investing in the mezzanine portion at the same time, as shown in the graph on the right, we will be able to stabilize income in the event if short-term interest rates continue to rise in the future. If we were to invest at floating interest rates, a rise in interest rates would increase LLR's revenue. We believe that mezzanine investments are highly effective in diversifying our indirect investment portfolio, and we intend to position them as one of our investment targets. The progress of our indirect investment initiative is updated on page 32. The sidecar fund, LRF3, now owns 10 assets totaling JPY 140 billion. The fund still has approximately JPY 30 billion of investment capacity remaining. In addition, on April 21st, we announced our investment in an SPV that owns a 49% interest in LOGIPORT Nagoya and a 15% interest in LOGIPORT Kawasaki Bay. In response to the disposition of LOGIPORT Kawagoe announced last October, we agreed to acquire a 15% interest in Kawasaki Bay via an asset trade. The acquisition of LOGIPORT Kawasaki Bay will be executed via the SPV, in which LLR will invest. The SPV will own not only 15% of Kawasaki Bay, but also 49% of LOGIPORT Nagoya, and LLR's expected return is approximately 7% on an investment of JPY 3.7 billion. In conjunction with the disposition of LOGIPORT Kawagoe, we plan to invest in two separate phases, one at the end of June and the other at the end of October this year. Please turn to page 33 to see a brief introduction to cooperation with Mitsubishi Estate Logistics REIT, which was announced on April 17th. We agreed to consider the securitization of some or all of the joint co-ownership interests. There are four such properties, and these are the candidate properties. We envision a scheme where both REITs offload these assets to respective SPVs and then invest in the other's SPV, who will be the acquirer of the properties disposed of by each REIT. I explained earlier about offloading LOGIPORT Sayama Hidaka to indirect investment, and this scheme is a derivative of that. While both schemes are similar in that the property is jointly co-owned outside balance sheet in the long term, it is different that the counterparty is another REIT that owns interest in the same property. This scheme enables us to implement important strategies of listed REITs, such as realizing stable and continuous gain on dispositions and the securing opportunities for high-return investments. We will soon initiate discussions on the selection of properties from the candidates and the formation of SPVs. In chapter 7 or on page 35, we update our balance sheet as of the end of February. LTV was 35% and the debt-to-total asset ratio was 43%, not much changed from six months ago, and we intend to maintain the figures at the current levels. The average borrowing term is 7.6 years with a remaining maturity of 3.8 years, and the fixed rate ratio remains above 90%. The average borrowing rate increased approximately nine basis points from 0.67% six months ago following the February refinancing. Our financial management policy has not changed. We will continue to fix interest rates, although it must be balanced with hedge costs and set maturities that maintain the diversified maturity ladder. Finally, chapter 8 describes our approach to decarbonization. Please turn to page 37. Rather than ESG as a term, it is more accurate to call it an effort toward net zero carbon, and what LLR is prioritizing now is an effort that can reduce CO2 emissions and increase NOI at the same time. As we have briefly mentioned before, an offsite PPA, which enables the transfer of electricity generated from renewable energy sources between portfolios, has started its operation at the rooftop solar power generation facilities at LOGIPORT Kashiwa Shonan and LOGIPORT Shinmoriya. Since these properties are leased to a single tenant, the tenants are already procuring electricity from the roofs. As a way to effectively utilize the roofs, the electricity can be transferred to other LLR properties. Specifically, the five properties, namely Sagamihara, Kita-Kashiwa, and Higashi Ogishima A, B, and C, and reduction of electricity costs can be expected. LLR has adopted the concept of sustainability for improved investment performance, a measure to achieve net zero energy consumption that contributes to improved shareholder value while clarifying priorities based on the energy hierarchy. We will continue to promote the use of LED lighting to improve energy efficiency and the installation of solar power generation equipment for in-house consumption in our portfolio. That concludes the explanation of the financial results. Thank you very much for your attention.