Earnings Call: Q2 2024

Oct 17, 2023

Summary

15th-period DPU was JPY 3,090, while forecasts rise to JPY 3,750 for the 16th period, supported by asset-sale and redemption gains. Growth strategy emphasizes bridge funds, asset trades and strong rent renewals amid capital-market and rate uncertainty.

Welcome to the 15th fiscal period earnings presentation for LaSalle LOGIPORT REIT, ended August 31, 2023. In the 15th fiscal period, LLR's portfolio was able to maintain a solid investment performance amid the uncertain capital market environment that poses a major challenge in steering the external growth strategy. At the end of last year, we established a new bridge fund, and this year we have been aiming to implement a flexible and agile external growth strategy. As part of this strategy, we conducted a public offering in June of this year for the first time in about 2 years and acquired 3 new properties. At the same time, however, we received various feedback from investors during the marketing of the public offering, which provided us with a valuable opportunity to consider how we should take the next step in this market environment. Yesterday, at the same time as the announcement of the financial results, we also announced several new initiatives, which I will explain along with the financial results presentation materials. Please refer to page 3 for a summary of the operational highlights. First, regarding distributions, the DPU for the 15th fiscal period was JPY 3,090, 5 yen higher than the forecast. The DPU for the 16th fiscal period, ending February 2024, is expected to be JPY 3,750, approximately 20% higher than the previous forecast of JPY 3,136. This is due in part from redemption gains from the Suminoe project and other transactions announced today. Second, we announced an asset trade deal yesterday. We will sell a part of our interest in LOGIPORT Nagareyama B and acquire new properties. The sale will occur across 3 fiscal periods, and we expect the gain on the sale to boost distributions until the fiscal period ending February 2025. In addition, a portion of the proceeds from the sales will be used for matters such as the acquisition of new properties from a bridge fund and new investments from the asset trade deal. This will maintain portfolio earnings and secure dry powder, which will be preserved for future growth initiatives. Alternatively, depending on the future level of LLR's unit price, we will consider using the funds to acquire our own investment units. Third is about Osaka Suminoe Logistics Center. We acquired the land with leasehold interest in 2019 as the first development project under the excess return strategy. Ever since we switched it to an indirect investment in 2021, it has been under development with the sponsor and subsequently achieved stable occupancy and now has been transferred to a bridge fund. This investment is planned to be redeemed, and a one-time gain from the redemption will be added to distributions in this fiscal period. With regard to investments in development projects, in July of this year, we announced a new investment in the Sendai project. Along with the Matsudo project, these development projects continue to progress. Fourth, after acquiring 3 properties from a bridge fund through a public offering in June, we will continue to have approximately JPY 270 billion in pipeline properties. In the current capital market environment, we will utilize the bridge fund to maintain flexibility in acquisitions. Lastly, internal growth continues to be strong thanks to the LaSalle group's AM and leasing capabilities. 100% of the lease renewals, which amounts to approximately 250,000 square meters, have already been completed. This is more than double the size of a normal fiscal period. Please refer to page 4. This is regarding the actuals for the 15th fiscal period DPU and the earnings forecast for the 16th and 17th fiscal periods. In the 15th fiscal period, DPU landed at JPY 3,090. The dilution caused by the public offering in June and the higher leasing expenses not normally experienced was covered by a one-time distribution in excess of retained earnings. We also experienced increases in office and parking lot income and lower than expected utilities costs. In the 16th fiscal period, there are two major boosting effects. One is a gain on redemption of our investment in the Osaka Suminoe Logistics Center development project for plus JPY 245, and the other is the gain of plus JPY 590 from the sale of LOGIPORT Nagareyama B in November. This is the first of three settlements as this sale will occur across three fiscal periods. In addition, we expect a full fiscal period contribution from the three properties acquired in July and higher NOI from properties we currently own. Also, we will have conservative estimates on borrowing costs as we tighten our cost control. As a result, the forecasted DPU for the 16th fiscal period is JPY 3,750, up 21.4% from the previous period. In the 17th fiscal period, the second sale of equity interest in Nagareyama B is scheduled in March, which will continue to boost DPU from gains on the sale. However, the absence of the redemption gain on the Suminoe project and the expensing of property taxes on the three properties acquired in July will be factors for the lower DPU. On the other hand, new earnings contributions will come from the effects of the asset trade deal, as well as a full fiscal period contribution from the Inuyama Logistics Center, which is to be acquired from a bridge fund. The completion of the expansion of the cold storage warehouse at LOGIPORT Kitakashiwa will also contribute to internal growth. As a result, distribution for the fiscal period ending August 2024 is projected to be JPY 3,566. Please see page five. We will explain our future investment strategy. First, with regard to our portfolio strategy, given the current level of unit prices and the capital market environment, we recognize the need for a growth strategy that does not rely on public equity offerings. Therefore, we position the sale of properties as one financing method to secure funds for future growth. We will also consider returning the proceeds to unitholders in the form of allocating the procured funds in the acquisition of our own investment units. We will carefully consider if this will contribute to the improvement of unitholder value. In addition to selling properties, we will also consider strategic asset trade deals as a specific option to maintain and improve the profitability of the portfolio and to expand the future pipeline. Particularly in an environment where competition to acquire properties remains intense, we believe that sourcing through asset trade deals is a means worthy of consideration. In terms of asset strategy, the LaSalle group will continue to support LLR's high occupancy and its efforts to continue to close the rent gap by making use of its AM and leasing capabilities. In our excess return strategy, we have recently achieved a return on investment for our first development project, the Osaka Suminoe Logistics Center. Although it takes more time compared to the value up of low-occupancy properties, the second and third development projects are underway, and we plan to capture more opportunities with development projects. As for the Osaka Suminoe Logistics Center, since the current environment for acquisition by LLR is not deemed as appropriate, it will be transferred to a bridge fund where LLR will make additional investment. For the time being, LLR will secure income from this investment in the form of dividend income and wait until the acquisition environment is ready. By investing in properties with stable occupancy in a manner that does not require a public offering, we will secure income with high capital efficiency and aim to earn excess income while lowering the book value of properties. We continue to ensure flexibility in the timing of acquisition by LLR. We will continue to enhance the flexibility of managing the pipeline properties by establishing more bridge funds. Please refer to page six. First, I would like to provide an overview of the asset trade deal announced today. The purpose of this transaction is to return proceeds from the sale of the property and to raise funds without relying on a public offering. Since this is a rather complicated transaction, we will explain the details over the next three pages. First, regarding the sale, 37.5% of the ownership interest in LOGIPORT Nagareyama B is to be sold for approximately JPY 13.1 billion. We expect to record a total gain on sale of approximately JPY 3.4 billion, and the gain will be added to the DPU in each fiscal period. Just to be clear, there is absolutely no reason for investors to believe that there will be a decrease in revenues or profit for the next three fiscal periods that we are trying to compensate for. Next, of the JPY 9.7 billion in funds obtained from the sale, JPY 5.9 billion will be used for two initiatives to maintain portfolio earnings, and the remaining JPY 3.7 billion will be dry powder for future growth initiatives. Firstly, JPY 2.7 billion will be used for the two properties and asset trade deal. In order to increase capital efficiency, this acquisition will be made through an indirect investment via an SPC. Secondly, a new logistics facility in Inuyama will be acquired for JPY 3.2 billion. This property is located in the Chubu area and has been managed by a bridge fund since last year. The free rent period has ended, and the property is now in stable condition. Please refer to page seven. This section provides an overview of the assets to be acquired in this asset trade deal. First, the Inuyama Logistics Center to be acquired from a bridge fund is a single-tenant property with a total floor area of approximately 3,000 tsubo. The entire building is leased by a 3PL operator headquartered in Aichi Prefecture to handle consumer goods as a delivery base to drugstores. The property is located in the Chubu area, where demand is expected to grow in recent years, in an area with the highest concentration of distribution centers for consumer goods covering the Nagoya metropolitan area and for industrial goods to nearby factories. Following this, LLR will acquire two properties, Nanko Logistics Center and Yachiyo Logistics Center, in phases through an SPC. The transaction value is roughly equivalent to the sale of the ownership interest in Nagareyama B. As of the first settlement in November, LLR will acquire JPY 800 million in specified bonds and JPY 390 million in preferred equity in the SPC. Nanko Logistics Center, with a total floor area of approximately 11,000 tsubo, is currently leased to two 3PL operators, with an average contract term of approximately nine years. Yachiyo Logistics Center, with a total floor area of approximately 4,500 tsubo, is entirely leased to a 3PL operator, with a contract term of approximately 12 years and approximately eight years remaining. Both properties have medium to long-term upside potential as rents are more than 10% lower than market rents. These two properties will be future pipeline properties, and since both properties have stable occupancy, LLR will be able to enjoy stable income through the specified bonds and preferred equity. The interest rate of the specified bonds is 9% per annum, and a double-digit yield can be expected when preferred equity is included, making the funds highly efficient. Through this asset trade deal, LLR can maintain its portfolio income while securing funds for future growth. Please see page 8. This section summarizes the settlement timing of the sale and acquisition of this asset trade deal. Both sales and acquisitions will be made across multiple phases. The sale of Nagareyama B will be settled equally in three phases of 12.5% equity each. The first is scheduled for November, the second for next March, and the last for next September. For the two asset trade deal properties, we also plan to acquire in stages with the first 20% interest in Nanko Logistics Center to be acquired in November, followed by the remaining 80% interest in two equal installments in March and July of next year. Yachiyo Logistics Center will be acquired in a lump sum in November. The contribution of funds for the acquisition of the specified bonds and preferred equity by the fund will also be made pro rata to the amount of each transaction. This asset trade deal is a transaction that meets the needs of each party involved. The appropriate need to adjust the terms and conditions of this deal is the outcome for this complex result. The Inuyama Logistics Center is scheduled to close at the beginning of the next fiscal period ending in August 2024, and a full fiscal period income contribution will be from the next fiscal period. Please refer to page 9. We would like to explain another transaction announced today, the redemption of preferred equity from the Osaka Suminoe Logistics Center development project. This project is the first investment in a development project under the value-added strategy launched in 2019. Looking back at the initial history of the project, we sourced the land with leasehold interest on our own, held the land as leasehold interest for approximately two years, and enjoyed stable income as land rent. Construction began in December 2021, and after a period of value add creation through development and leasing, construction was completed in March of this year. The preferred equity will be redeemed as the property is on track to achieve stable occupancy. The redemption of the preferred equity is expected to result in the recording of a gain on redemption of JPY 450 million as income attributable to LLR. Originally, LLR had a preferential right to acquire the property after stable operation, but considering the current capital markets environment, we decided not to acquire the property immediately, but to transfer it to the bridge fund for warehousing. We will make an additional investment of JPY 190 million in the bridge fund by utilizing part of the funds from the redeemed preferred equity and will receive the income from the property as dividends from this investment. Since this was a development project from a sale and leaseback of the factory's land with leasehold interest, this project took four long years to complete. In the process, however, LLR secured income from various forms, such as land rent, profit from redemption of the investment in the development project, and dividends for its investment in the bridge fund. The excess return strategy that LLR has adopted has been changing with the change in environment. We will continue to aim for excess returns with projects such as the Osaka Suminoe Logistics Center. Please see page 10. The value-added investments that LLR has made are characterized by indirect investments through the use of SPCs. With the redemption of the preferred equity investment in the Osaka Suminoe Logistics Center, all of our investments in the initial three value-added investment projects, namely LOGIPORT Amagasaki and LOGIPORT Osaka Bay, have now reached their exit points. Since then, both the form of investment and the number of deals have changed over the past few years, so we have once again organized the current status of value-added investments by investment objective. Broadly speaking, the methods can be divided into three boxes on the right. The first is an investment in a bridge fund. The purpose of which is to ensure flexibility in external growth strategies, allowing for a five-year investment period and the ability to acquire both low and stable occupancy properties. After the acquisition of the Inuyama Logistics Center, there will be five properties remaining in the bridge fund, bringing the fund's investment balance to JPY 790 million. Four of these properties are in stable operation, and therefore, a constant flow of dividend income can be expected in the future. The four properties acquired from the bridge fund total JPY 26.4 billion, including the Inuyama Logistics Center announced this time, as well as LOGIPORT Kyoto, Aisai Logistics Center, and Kariya Logistics Center, acquired through the public offering in July. The bridge fund will continue to serve as a flexible and agile destination for acquiring pipeline properties currently worth approximately JPY 70 billion. The second is an investment in an SPC, which was formed through this asset trade deal that owns and manages only properties with stable occupancy. The main purpose of this investment is not to ensure flexibility in external growth, but rather to increase LLR's earnings by securing a high yield with a small amount of capital. Therefore, the ideal property would be limited to properties with stable occupancy, but also have downside protection due to relatively long lease terms and current rents that are lower than market rents. The properties exchanged in this asset trade deal met this criteria. For the two JPY 13 billion properties, LLR will acquire JPY 2 billion in specified bonds, in addition to the JPY 740 million in preferred equity, enabling it to make it a highly efficient capital investment. Third, we invest in development projects. Since this type of investment has a higher risk-return ratio than other types of investments and is a long-term investment, we select individual projects on a case-by-case basis. Currently, we are investing a total of approximately JPY 2 billion in two projects, Matsudo and Sendai, covering an area of approximately 60,000 square meters. Please see page 11. This is the pipeline list that we show you each fiscal period. There are three updates for this quarter. One sponsor development project has been announced and added. A development project in Sendai, we announced this investment in July in a press release, has been added. Two new investments in the asset trade deal, as explained earlier, has been added. A total of four new projects has been announced. Since the ownership structure of pipeline properties has been diversified with vehicles such as the formation of bridge funds, the list of value-add investment projects on the right side of this page briefly classifies them. The sponsor-developed properties that have been transferred to the bridge fund after stable operations are labeled as Managed by LRF2. We are preparing to form a subsequent bridge fund to temporarily acquire the sponsor development properties, as well as the two properties that are currently labeled as Forward Commitment. Development projects, including potential ones, are listed in purple on the right side, but the form of each individual project varies. While we maintain a total pipeline size of approximately JPY 270 billion, our priority will be to use our bridge fund as a base and to leverage our acquisition flexibility until a suitable environment for acquisitions arises in the future. Please see page 12. The following section summarizes the overall position of the portfolio's internal growth, both actual and forecasts. In the 15th fiscal period, the average occupancy rate remained high at 99.0%, and renewals or tenant replacements were completed for all of the 80,000 square meter leases, whose leases had expired, resulting in an average rent increase of +4.7% for the leased properties. As we have reported in the past, the 16th fiscal period saw lease renewals of approximately 250,000 square meters, more than double the usual period. As of this moment, 100% of the contracts have already been completed. This is a result of the collaborative efforts of our AM team and the sponsor's leasing team to capture tenant demand. The average rent increases for all parcels was +4.4%, but particularly large rent increases were realized for four properties: LOGIPORT Sagamihara, LOGIPORT Kita-Kashiwa, LOGIPORT Sakai, and LOGIPORT Kawasaki Bay. The 17th fiscal period is also progressing smoothly with approximately half of the leases having been completed, and strong demand has been confirmed with an increase of +6.3% for the leases that have been completed thus far. The gap between the in-place rent and our target rent is about 4% for the entire portfolio, and the gap between the in-place rent and the spot rent is about 9%, suggesting that there is still room for internal growth. Please see page 13. Inflation has been taking effect in Japan for some time now, and we have identified three topics related to this. First, on the left side, we once again summarize the internal growth results for the past three years. Currently, of the 21 properties owned by LLR, excluding land with leasehold interest, the portfolio is roughly divided into 18 properties with fixed leases and three Higashi Ogishima properties with a mix of fixed and Japanese standard leases. This ratio is approximately eight to two on a leasable area basis. The remaining lease contract terms are 3.2 years for the fixed lease properties and 1.4 years for the three Higashi Ogishima properties. Of the fixed lease properties, rent increased by a weighted average of +5.5% in the 450,000 square meter area that expired in the past six fiscal periods, or approximately 40% of the leasable area of the properties. In the three Higashi Ogishima properties, contracts expired for 210,000 square meters, or about 75% of the leasable area of the three properties in the last six fiscal periods. The weighted average increase in rents was +6.8%. Both of these levels are well above inflation. In addition, at LOGIPORT Osaka Bay, an existing tenant requested a long-term contract in conjunction with their willingness to make a large capital investment. With a term of 20 years, we have taken measures against rising prices by introducing a clause to revise the rent and linking the revision to CPI every five years. Lastly, regarding trends in utility costs, the bottom right-hand corner shows the trend of utilities' marginal profit for the past six fiscal periods. The ratio to NOI is less than 0.5%, so the impact is minimal. Please see page 14 for our initiatives regarding financial management. First, we refinanced a total of JPY 7.5 billion in August of this year. The loan has two tranches, one with floating interest rates and the other with fixed interest rates, both with a term of 6.5 years. We recently reduced the amount of floating rate loans, increased the ratio of fixed rate loans, and extended the average loan term to seven years. Both of these measures were taken to address the risk of rising interest rates in light of recent interest rate trends, which are on an upward trend. The average borrowing rate has increased at about the same level as the current base rate increase, but the borrowing spread has increased only slightly, even taking into account the lengthening of the borrowing period. With the uncertain interest rate market environment continuing into this year, we believe it is necessary to manage our finances with an eye on the risk of future interest rate hikes. We will continue to strive to maintain average debt maturities and fixed ratios while keeping a close eye on the level of borrowing costs. On the right side, key financial indicators after refinancing are shown. The short-term bridge loan of JPY 10.4 billion procured in connection with the acquisition of the properties in July will be considered for long-term financing by June of next year, while keeping an eye on the interest rate market environment. Since this bridge loan is a temporary short-term floating loan, the financial indicators are shown with and without the bridge loan in parallel. Please see page 15 for the update on cash management. First, the balance of cash on hand is JPY 10.7 billion as of the end of August, plus an additional JPY 3.7 billion to be added as a result of the recent asset trade deal. This total of JPY 14.5 billion does not include the amount that is scheduled to be spent on various investments and other transactions that have already been announced at this time. On the right side, we summarize our policy for future cash use. The topics are listed as one through four, but please understand that this order is not a priority order. The contents announced previously already included one through three, investments in bridge funds, indirect investments, and capital investments. Based on the most recent investment unit price trend, we are specifically considering the acquisition of our own investment units in number four. This will be an option for future use of funds. Although we intend to adapt our cash usage in a flexible manner in accordance with trends in the capital market environment, we aim to perform steps one through four with a certain level of continuity. Please see page 16 for our ESG initiatives. In addition to the successful GRESB assessment result, this fiscal period will focus on the off-site PPA efforts. We have been making daily improvements in property operations and energy efficiency. For example, solar power generation for our on-site consumption began operating at LOGIPORT Kawasaki Bay last year. As a next step, we are promoting an off-site PPA scheme in which electricity derived from renewable energy sources generated on the premises of one of our properties is supplied to another property LLR owns. Specifically, solar power generation equipment is planned for installation on the roofs of LOGIPORT Shinmoriya and LOGIPORT Kashiwa-Shonan, and a system is being prepared to use the electricity generated to the five properties of LOGIPORT Sagamihara, Kita-Kashiwa, and the three Higashi Ogishima A, B, C buildings. With a capacity of 4.3 megawatts to be installed at the two properties, we expect to reduce CO2 emissions by approximately 3.7 million kilowatt-hours per year, and will also contribute to reducing electricity costs by securing a less expensive source of electricity. Based on annual power generation data in 2022, it is estimated that the project will reduce costs by approximately JPY 42 million per year, or JPY 21 million for each fiscal period. That concludes the explanation of the financial results. Thank you very much for your attention.