Earnings Call: Q4 2024

Apr 16, 2024

Summary

DPU rose 23% to ¥3,802, while future distributions are forecast at ¥3,581 and ¥3,602. Strategy shifts toward dispositions, buybacks and off-balance-sheet investment, supported by high occupancy and rent growth.

Welcome to the 16th fiscal period earnings presentation for LaSalle LOGIPORT REIT ended February 29, 2024. As uncertainty in the capital market environment has been continuing this year, LLR unit price was also sluggish during the first quarter of 2024, and we are truly sorry for the inconvenience to our unitholders. Although our unit price appeared to start picking up in late March, it still has not reached a full-fledged recovery trend, and measures to revive the stock price is the urgent theme for us to work on. Under the low interest rate environment, a virtuous cycle of external growth by leveraging low cost of capital was the best way to continue growing. However, in the current environment, we recognize themes such as choosing the optimal financing method, balance sheet management, and capital allocation are getting more attention considering the fluctuating cost of capital. Given this environment, LLR has made a turnaround to its growth and capital strategy for the past six months. For example, in fundraising, we have put forth an ongoing disposition of properties in light of the inversion of the cost of capital between the real estate secondary market and the equity capital market. In our growth strategy, we have been promoting indirect investments in stabilized assets and Bridge funds as the return exceeds the cost of capital. In terms of dividend policy and shareholder return, we split the asset disposition profit for at least four financial periods, and on top of that, we announced a buyback of our own shares. Fortunately, our portfolio management is extremely solid. We have been able to maintain high occupancy rates in the previous period and continue our strong internal growth. Even in a phase of rising interest rates, our analysis indicates that our portfolio is structurally able to absorb the cost of debt. In the stock market, measures to raise the share price by improving capital efficiency and shareholder returns is one of the hot topics. LLR will stay on top of this trend and make the optimal decisions to keep growing by continuing the intimate communication with the investors and stay updated to the vivid market. First, we will explain the highlights of these financial results on page 3. Five operational highlights are summarized on page 3. First, regarding distributions, the actual DPU for the fiscal period ended February 2024 was ¥3,802, a significant increase of 23% compared to the last fiscal period. The main factors were the first disposition of LOGIPORT Nagareyama B and the development profit from the Osaka Suminoe Logistics Center. The sale of Nagareyama B will be settled separately in four consecutive fiscal periods, 12.5% each, up until the fiscal period ending in August 2025. Therefore, the DPU is expected to cruise at approximately ¥3,600. Secondly, regarding the asset trade deal, yesterday we announced an additional disposition of Nagareyama B and new investments in replacement. The additional 12.5% disposition is scheduled to be on March 2025. Part of the proceeds from the disposition will be used to make indirect investments in two new assets. Third, yesterday we announced a share buyback as part of our unitholder return and capital policy. The maximum size of the buyback is ¥6 billion, and the maximum number of units is approximately 2.3% of the total outstanding units. The buyback price will be executed at below P/NAV of 0.9x, will be explained in detail later. Fourth, as announced in the press release on February 14, we have created a new Bridge fund to manage future pipeline assets. This fund has a five-year investment period and JPY 100 billion of capacity for new investment, securing flexibility of external growth. Fifth is internal growth. Internal growth is also solid, with the warehouse area continuing to be almost fully occupied, and the assumptions for the earnings forecast announced yesterday are budgeted that this high occupancy rate level will continue. In addition to achieving stable rent increase revisions and narrowing the rent gap, we have achieved an agreement for a large rent increase for the Japanese standard lease area of the Higashi Ogishima asset. As I will explain in a brief analysis later, even if interest rates rise in the future, our portfolio is structurally capable of absorbing the increase in debt costs. Please refer to page 4. We will explain the results of the 16th fiscal period and our forecasts for the 17th and 18th fiscal periods. In the 16th fiscal period, the company achieved a significant 23% increase in profit compared to the 15th fiscal period due to various factors, such as gain on the disposition of Nagareyama B, gain from development profit from the Osaka Suminoe Logistics Center, dividends from the investment in the Bridge fund, a full-year contribution from the acquired assets, and internal growth. DPU landed at JPY 3,802. From the current fiscal period going forward, the gain from the disposition of Nagareyama B will continue for three more fiscal periods. As a result, the actual level of distribution on a cruising basis is expected to remain at approximately JPY 3,600. For the current fiscal year, the forecast DPU is JPY 3,581, based on the expected contribution of specified corporate bonds and preferred equity investments in an SPC that manages Nanko and Yachiyo, which were invested in last year's asset trade deal and from the expansion of the frozen refrigerated warehouse at LOGIPORT Kitakashiwa. For the following fiscal period ending February 2025, we expect DPU of JPY 3,602, mainly due to the full-year contributions of these assets. Please see page 5. The following is an explanation of our asset management strategy based on the three pillars. As in the previous fiscal year, we will continue to execute our strategy without equity offering, given the uncertain capital market environment. Funding by asset dispositions is our baseline, considering the current highly liquid real estate market trends. While split disposition of Nagareyama B is what we are currently focusing on, we are also willing to capture additional asset trade deal if any opportunities arise. As for the use of proceeds from the dispositions, we have recently announced to buy back our own units while continuing to make high-return indirect investments in stabilized assets. We will keep an eye on both growth investment and unitholder return in order to make the most appropriate decision. Asset strategy will remain unchanged and continue to capture internal growth opportunities. The excess return strategy has become an important alternative to the external growth strategy, and we will continue to take new approaches this year in response to fluctuating market conditions. Two key points are secure flexibility in external growth over a long period of time and selectively make indirect investment in stabilized assets and development projects that will contribute to earnings immediately. Please see page 6. The concept of the growth strategy on the previous page is illustrated on this page. Recently, balance sheet management is becoming the key to success. While maximizing internal growth, on the liability side, we will comprehensively manage assets and liabilities by balancing risk of interest rate rise and liability costs, carefully watching the interest rate market. In addition to that, we will concurrently trade assets and realize gains to return profits to the unitholders, as well as raise funds for additional growth investment and share buyback. In the current environment, pursuing balance sheet expansion may risk damaging unitholder value. We will focus on returns to unitholders while controlling LTV. Instead of expanding LLR's balance sheet, we are expanding off-balance sheet AUM. This is where we utilize the capital of lenders and other private investors, which we have positioned as third-party strategic capital to expand our growth strategy outside of our balance sheet. For each fund or SPV, LLR will make a same boat investment to earn dividend income. LLR will continue to carry out its active management strategy to increase unitholder value by flexibly reflecting the financing methods and use of proceeds in accordance with the fluctuating capital market environment. We hope that this page will help you understand our current management strategy and approach. Please see page 7. This page describes the background of the financing and dividend policy associated with the disposition of the asset and the concept of our goal. First, the reasons for choosing disposition as a financing method may seem obvious. The implied NOI yield, a measure of the cost of capital for REITs, or in other words, a benchmark yield if an equity offering is to be done with the LTV maintained, was in the range of 4.1%-4.4% in the first quarter of this year. In contrast, for example, the actual NOI yield based on the sale price of Nagareyama B is 3.8%, so financing through disposition has a lower cost of capital. Since the real estate trading market for logistics facilities remains strong and the liquidity of operating properties is high, dispositions are more competitive in terms of capital cost. Furthermore, by conducting split settlements over multiple fiscal periods rather than selling in a lump sum and distributing the gain on the disposition on a constant basis, we have been able to increase the payout ratio to approximately 86% on a constant basis from a dividend policy standpoint as well. Assuming the dividend yield remains constant, this will lead to a lower cost of capital for LLR and, from the perspective of unitholders, a higher or more stable unit price. Yesterday, LLR announced the sale of an additional 12.5% interest in Nagareyama B, extending the period for recording the gain on the sale by another fiscal period, which is now fixed until the 25/8 fiscal period. Please see page 8. We will explain about the capital allocation in this page. The proceeds from the two consecutive dispositions of the Nagareyama B to date amount to approximately JPY 13 billion. This figure excludes profit from dispositions. Out of the proceeds of JPY 13 billion, JPY 3.3 billion will be used for the Inuyama Logistics Center acquired from the Bridge Fund in mid-February, JPY 3.7 billion for indirect investment in four operational properties, including the two newly announced properties, and JPY 6 billion for the buyback. As of the end of February 2024, LLR has JPY 10.8 billion of dry powder from the disposal. In addition, yesterday we signed a letter of intent with the buyer stating that we are both willing to consider another asset trade deal of the remaining 50% interest in Nagareyama B, and we will proceed with specific discussions regarding the transaction. Therefore, if a disposition of the same amount were to be realized, we would be on track to raise approximately JPY 25 billion in total. As for the use of the proceeds, we would like to utilize them in accordance with the menu chart shown on the far right. We believe that all of these uses are in line with the investment strategy explained on the previous page. Please see page 9. I will explain the second asset trade deal announced yesterday. The asset to be disposed is what I have just explained, and approximately JPY 800 million of the JPY 3.2 billion in proceeds from the disposition will be used for indirect investment in two new properties. Both acquisitions are 49% interests in TK Equity Interest B, which is the most subordinated equity portion. The underlying assets are the Urayasu Logistics Center and the Okinawa Itoman Logistics Center, both of which are leased to a single tenant. The current rent for both properties is approximately 10% lower than the market rent, so stable cash flow and future upside and downside protection on rent is expected. LLR expects to earn a return in the high single-digit range on its investment in the TK Interest B. Therefore, we expect a high return every fiscal period. Although the contribution may be low in absolute amount as the investment is approximately JPY 800 million, we would like to consider similar investment structures in the future within a certain range of our portfolio while managing risks to a low level. Please see page 10. I will explain the share buyback announced yesterday. First of all, I would like to emphasize the most important point regarding this share buyback initiative. When we say investment at an attractive price, it is from the standpoint of LLR investing from the cash collected from our investors and does not mean that it is the unit price level LLR believe it should be. We believe that J-REIT share buyback is slightly different from those listed corporates in some aspects. Although the nature of returning profits to unitholders is something we both have in common, we believe that in addition to returning profits to unitholders, it must be used in a way that firmly enhances the value of existing unitholders. Since internal reserves cannot be retained and limited, cash must be used effectively. Therefore, as stated in the upper left corner of the slide, the three main purposes of the share buyback is, one, to buyback at an attractive price, two, to have an immediate DPU accretion, and three, to absorb temporary selling pressure. In terms of NAV per unit, attractive investment level would be P/NAV of 0.9 times or below is where we are seeking to buy. The NAV per unit we are talking about is JPY 160,535, which is the NAV per unit after subtracting the scheduled disposition of Nagareyama B from the end of the fiscal period ended February 2024. The 10% discount to the base NAV is approximately JPY 144,000, and the 15% discount is approximately JPY 136,000. The implied NOI yield of LLR is 4.5% within that range. The proceeds from the disposition of LOGIPORT Nagareyama B will be allocated to this buyback, and Nagareyama B had an NOI yield after depreciation of 4.1% based on its book value. Therefore, we believe that exceeding that return is an accretive investment for the buyback. In addition, as shown in the stock price chart to the right, since 2023, LLR's stock price has fallen twice to the level below 10% NAV discount. It is quite possible that the uncertain market environment may continue to create selling pressure on our share, and the announcement of this buyback is meant to prepare for such situation. Flexibly announcing buyback when selling pressure occurs may not always be possible because we may be possessing material non-public information when it happens. Therefore, we find it important to make the buyback announcement simultaneously as the financial results announcement. The maximum amount of buyback is JPY 6 billion, and maximum number of units is 43,000 units based on the amount of proceeds available from the disposition. This represents approximately 2.3% of the total outstanding units. The buyback period is set for approximately 70 business days within the remaining 24/8 fiscal period from today until the end of July. Please note that the buyback may not be made if the share price of LLR stays above this level. Please see page 11. Over the next three pages, I will explain the use of third-party strategic capital I mentioned earlier in the investment strategy. Since 2018, as part of the excess return strategy, LLR has been indirectly investing in low occupancy assets and development projects through SPVs. Based on our track record, such as LOGIPORT Amagasaki, Osaka Bay, and Osaka Suminoe Logistics Center, and LLR's credibility, we have been able to form a successor fund, and our investment asset type and investment formats has become more diversified. We will continue to utilize this strategic capital in our growth strategy. The biggest point in the current market is the ability to increase assets under management off the balance sheet, which we have recently expanded to approximately JPY 100 billion in AUM. In addition to this, we have also secured an additional JPY 100 billion in investment capacity for a total of approximately JPY 200 billion in potential AUM. Furthermore, the use of strategic capital allows LLR to raise funds at a level of capital cost that is lower than our implied NOI yield, allowing us to make investments that can be expected to generate high returns, specifically in excess of 8%. The current size of these investment is only about ¥6.8 billion, less than 2% of total assets, and we will manage the risk with discipline. Please see page 12. This section describes more specific uses of strategic capital and changes in the balance of assets under management. There are three main categories, LRF series to manage blind pooled funds, indirect investment in stabilized assets for long-term investment, joint development projects with external business partners. As shown in the bar chart stacked with the breakdown on the left, the balance under management has been significantly accumulated since 2022 when LLR's unit price has been softening. Of the LRF series, the No. 1 and No. 2 funds have already ended, and the No. 3 fund was established in February of this year. The target size of the No. 3 fund is approximately ¥170 billion, the largest ever. Indirect investment in stabilized assets follows the first project announced in October of last year, and we have now announced up to the third project. These are considered to be distinct from pipeline properties for external growth. Since they have an immediate effect on earnings contribution and are based on the premise of long-term investment. Of course, if the external environment changes, LLR has preferential negotiating rights for acquisition, but basically, we have a lineup of properties targeted as pure investments. The number of development projects has not changed since the last announcement, but the amount of investment is gradually building up as we make additional investment as construction progresses. Please see page 13 for an explanation of the LRF No.3 fund. In a nutshell, it is almost the same structure as the Bridge fund of LRF No.2. In light of the current environment, we call it a Sidecar fund because it is more in the nature of a fund that will run alongside LLR for a longer period, specifically for the next five years. The five assets that were managed by the second Bridge fund were used as seed assets, and two assets that were originally forward committed. The Iwanuma project and the Amagasaki project were newly acquired in February and March. Currently, the total AUM is approximately ¥70 billion, so we have approximately ¥100 billion available for future investment. Even if the capital market environment and unit prices do not recover significantly, we will be able to acquire and manage sponsor-developed projects and externally sourced projects with this Sidecar fund over the next five years. Please see page 14. Other than the previous page, the total amount of properties to be developed by the sponsor, development projects, and the land with leasehold interest in Higashi Ogishima is approximately ¥200 billion. Due to the challenging external growth environment, LLR does not expect to acquire any of these properties at the moment, but construction has begun on three new sponsor development projects. Construction costs are rising, but we have heard that these three projects are progressing without any significant effect under this environment. Same for the development projects LLR has invested in, and development is progressing without any issue. Started leasing activities and already received several inquiries, although no contracts have been signed yet. Please see page 15. Regarding internal growth, we first describe the actual number for 16th fiscal period and the forecast for the next two fiscal periods. In the 16th fiscal period, lease contracts were renewed for a total of 250,000 square meters, more than twice the usual area. As mentioned in the previous presentation, 100% of this area was informally renewed, contributing to internal growth. The average increase in the renewed area was 4.3%. Next, regarding the assumptions for the earnings forecast, we are projecting high occupancy rate for both the current and next fiscal years. As usual, we built our forecasts making certain conservative assumptions, but we are still able to budget for high occupancy. As we always mention, the occupancy rate of our portfolio, especially the Higashi Ogishima property, will structurally appear low due to the relatively large office area, but we expect the leasable area to remain almost full if we adjust the pure warehouse area. The current and next fiscal period's renewal rates are 82% and 41%, respectively, which exceeds the historical trend of renewal rates ahead. Despite the rising vacancy rate in the market as a whole, tenant demand for properties held by LLR has remained strong. The contract renewal area, informal contract renewal rate, and rent increase rate shown on this page exclude the three Higashi Ogishima properties. The rent gap of our portfolio versus the target rent continues to be about 5%. In contrast, the gap with market spot rents, which we review every two years, has increased to about 15% as a result of our latest review. Please refer to page 16. Regarding internal growth, we would like to explain our asset management of the Higashi Ogishima ABC Building, which is one of the features of the LLR. Approximately 20% of the leased area in LLR's portfolio consists of three properties in the Higashi Ogishima ABC Building. Of this 20%, approximately 10% has been switched to a fixed-term lease agreement, while approximately 10% remains Japanese standard lease agreement. However, from the internal growth perspective, the Higashi Ogishima properties are one of the leading assets. In fact, with only 1.4 years remaining on the contract, it is positioned as a property where future upside can be expected amid the inflationary trend. As a matter of fact, the average rent increase over the past three years for the three assets are 6.6%, which is higher than the average for the other 19 properties. One case of rent revision last year, we achieved a large rent increase simultaneously as switching to a fixed lease agreement when a tenant was replaced. In another recent case, there were four areas in which a large rent increase contributed to narrowing the rent gap in the areas that maintained a Japanese standard lease, and a 19% rent increase was agreed for approximately 4,800 tsubo. This is a future internal growth material as this revision takes place after this year. These are largely due to the efforts of our asset management team, but one additional factor might be the rent revision clause in the Japanese standard lease contract, which allows revisions upon consultation at the time of contract renewal. Given the recent trend of rising prices and the growing gap between current rents and market rents, we believe that this clause makes it easier for us to negotiate with tenants. Please see page 17. Financial management. In February, we refinanced JPY 12.0 billion. We have been basically keeping the loan term fixed with fixed interest loan in order to hedge interest rate risk for interest rates rise. In this refinancing, a portion of the short-term floating Bridge fund loan was fixed, and the average loan term was lengthened from 6.3 years to 7.8 years. Base rate increases have driven average borrowing rates higher, but spreads have been maintained with bank support. The current LTV to total assets and LTV to appraised value are 41.9% and 34.8%, respectively. We intend to maintain these levels, but since the LTV to total assets may rise to 42.5% if we fully buy back our shares. In that case, we will consider reducing the LTV by repaying debt. Currently, the average loan term is 7.9 years, and the fixed loan ratio is 90.7%. LLR has a strong financial structure that is able to hedge the risk of rising interest rates. We have a Bridge fund loan of JPY 7.4 billion from the property acquisition last year. We plan to gradually lengthen this loan while keeping an eye on the interest rate market. If the interest rate market settles down in the future, we will consider shortening the maturity ladder while keeping the maturity ladder flat in order to control the cost of debt. This is related to ALM, which we will explain on the next page. Please see page 18. We have analyzed ALM, one of the hot topics in the REIT market. Let me explain about the ALM based on our earnings structure. The 10-year maturity ladder for lease and debt are shown here. Lease maturity ladder is shown on the left, and debt maturity ladder is shown on the right. The first characteristic for lease maturity ladder of LLR is that the lease on the Higashi Ogishima property, as I explained earlier, will be renewed within 2 years, and it keeps rolling. Therefore, in analyzing ALM, the key point is the area where contracts expire within the next 2 years, which accounts for about 40% of the portfolio. This is the most significant feature of LLR. On the debt side, on the other hand, interest-bearing debt due within 2 years accounts for less than 20% of the total. We consider this percentage difference to be one of the key parameters for ALM analysis. For each, we have made a simple simulation of the impact on revenue and net income based on expected future assumptions. On the lease side, the rate of rent increase was assumed to be in the range of +5% to 10% from the rent gap level. On the debt side, the interest rate increase at the time of refinancing was assumed to be in the range of +30-60 BPS. Based on our current PL, revenue is expected to increase 1.1% to 2.1% per annum under this assumption, and if we look at the impact on the net income from interest rate rise at refinancing, it is 1.1% to 3.4% per annum. In other words, we are not expecting a reverse financial leverage, if you would say, in terms of growth rate, and the analysis shows that the rate of increase in revenue will be the same or maintain the same level. While we will continue to make maximum efforts to increase and revise rents, financial management is an element that supports internal growth of LLR, and that it is worth considering switching to variable interest rate or shortening the term when interest rates settle to minimize the increase in refinancing cost, or that reducing LTV and lowering the absolute amount of debt cost. In conclusion, our income structure and debt profile can structurally support internal growth, and we will continue to manage our assets with ALM in mind. Please see page 19. Finally, an update on ESG initiatives. First, for off-site PPA, we have installed new solar power generation equipment on the roofs of LOGIPORT Shinmoriya and Kashiwa Shonan and are continuing to prepare a system to consign the electricity generated to the five properties of LOGIPORT Sagamihara, Kitakashiwa, and Higashi Ogishima ABC Building. In addition to daily improvements in property operations and energy efficiency, last year, as an on-site renewable energy generation initiative, an on-site solar power generation for on-site consumption began operating at LOGIPORT Kawasaki Bay. Half of the solar panels at Kawasaki Bay are leased to power generation companies under the feed-in tariff scheme, while the other half, 3.2 MW of capacity, is for on-site consumption scheme. The actual results for the 16th fiscal period show a reduction in CO2 emissions equivalent to about 550,000 kWh and a reduction in electricity costs of about ¥6 million. We are planning to continue our ESG initiatives that contribute not only to the environment but also to profitability. That concludes our presentation of the financial results. Thank you very much for your attention.