Earnings Transcript for DLN.L - Q1 Fiscal Year 2023
Operator:
Good morning. Welcome to the Derwent London 2023 Full Year’s results presentation, here at our recently opened Members Lounge, DL/28. As well as me, you will hear from you will hear from Damian, Nigel, Emily and me. I shall then wrap up and we’ll have Q&A. Turning to Slide 2 and setting the scene. Despite the challenges, we did have a very strong leasing performance in 2023 with more than £28 million of new rent agreed, 8% ahead of ERV. This was three times the lettings we agreed in 2022. In addition, we reduced our EPRA vacancy rate by a third to 4% with activity across our villages. However, with a weak investment market driven by high interest rates, the average shift in yields led to a 10.6% decline in underlying value of our portfolio in the year end, a 13.8% reduction in NTA to 3,129 pence. Notwithstanding that, our developments increased in value and our better quality buildings again outperformed. We have a high quality, well located and differentiated portfolio, a regeneration pipeline focused on the West End and a strong balance sheet which gives us capacity to continue investing. We deliberately take a long term strategic approach, recycling buildings that no longer meet occupied demand with a billion pounds of disposals over the last five years. The supply of space that meets the evolving needs of occupiers is limited, particularly in the West End. With a constrained market development pipeline, this is unlikely to change over the next few years and this is leading to an acceleration in rental growth. There are signs that value is beginning to emerge as inflation follows a downward course and the cost and availability of debt becomes more favourable. We're also fortunate to have options and the financial capacity to take advantage of the right opportunities come to market at the right price. So turning to guidance, consequently, on the back of 2.1% ERV growth in 2023, we are increasing our rental guidance for our portfolio for 2024 to plus 2% to plus 5%. As seen in our 2023 lettings, we expect better buildings to continue to outperform. For yields, upward pressure is easing and we believe we are approaching low point evaluations for this cycle. Differentiating Derwent, businesses are becoming more strategic in their real estate planning and more selective in the building and the landlord they choose. The supply demand dynamics of the West End by comparison to other parts of London is strong and expect to remain favourable over the coming years, supporting our long term structural preference. We are providing design-led, innovative, and sustainable space in well-connected locations. And with high quality portfolio wide amenity, our sophisticated buildings meet the needs of a broad range of occupiers. Slide 4. London is too often viewed as a single market, but in reality it is a series of sub-markets with quite different operational dynamics and performance. The diversity of London's appeal sets it apart from other global cities. It has a deep pool of businesses with different requirements ranging from large headquarters on long leases to smaller units with more flexible terms. It has an enviable transport network, which was made even better by the opening of the Elizabeth Line in 2022. London has never been more accessible. Connectivity applies to more than just transport. This is why we maintain our approach to clustering. The West End is tight, in part due to the restricted planning environment with approximately 70% of buildings either listed or in the conservation area. The further east however, the looser the planning regime and the higher the vacancy. Growth in the economy, in jobs and in the population all support business confidence. This in turn is an important driver of demand for offices and therefore rental growth. As we've highlighted for some time now, the office plays a crucial role for most businesses as the quality and value of the face-to-face interaction is recognised. We have seen an ongoing rise in employees being required to spend the majority of the time in the office. Developing and retaining quality on Slide 5, we continually upgrade our portfolio whilst selling assets that no longer meet evolving occupy requirements. We are investing in projects to create the next generation of best-in-class space. Our higher quality buildings have delivered a more robust valuation performance over last year and we expect this outperformance to continue. As such, we will carry on developing our pipeline whilst also ensuring that the assets we are in are those that are relevant and in demand and that have the potential to be repositioned. 44% of our portfolio has repositioning potential, providing the raw material for the future. I will now hand over to Damian, who will take you through the financial highlights.
Damian Wisniewski :
Thank you, Paul, and good morning, everyone. Macroeconomics had a big impact in 2023, further pushing up yields and the cost of finance. Cost inflation, particularly in relation to construction projects, energy and people, also increased at a faster rate than office rents. Our 2023 financial highlights are on Slide 7. Yield expansion took EPRA NTA per share to 3,129 pence, giving a total return for the year of minus 11.7%. Gross rental income was up 2.8%, but property expenditure brought net rents down marginally to £186.2 million. EPRA earnings were correspondingly 4.4% lower at 102 pence per share, though the second half was 6% higher than the first. We have proposed a final dividend of 55 pence. The 79.5 pence total dividend for the year makes this our 16th successive year of dividend increases since the merger and it was 1.3 times covered by EPRA earnings. Debt ratios will remain strong and the Derwent London balance sheet is among the lowest geared in the UK sector. The movement in EPRA NTA per share is shown on Slide 8. The property valuation decline was 516 pence per share on the wholly owned portfolio and 8 pence on our share of the 50 Baker Street joint venture. Other figures were close to 2022’s, but with lower than usual profits on disposal. Slide 9 shows EPRA earnings. Gross rents increased to £212.8 million, but property expenditure, admin costs and impairment charges all increased over the prior year. Administrative expenses were higher after wage inflation and a headcount increase and impairment charges totaled £2.6 million compared to a £1 million reversal in 2022. Finance costs were almost unchanged and overall EPRA earnings ended the year at 102 pence per share. Of this, 49.5 pence was recorded in the first half and 52.5 pence in the second. Slide 10, gross rents. Developments and refurbishments increased rents by £8 million, with other lettings and asset management adding £7.5 million compared to ’22. Brakes and expiries reduced rent by £5.7 million and disposals, mainly of Charterhouse Street, by a further £4 million. On a like-for-like basis, gross rental income was up 1.7%, but the higher costs and impairments meant that net rental income was down 1.4%. Slide 11, this shows a deeper dive into property expenditure over the last two years. Irrecoverable service charge costs increased to £6.6 million in 2023. The increase came mainly from capped service charges and balancing charges in the first half. These were influenced by higher vacancy levels and wage growth in areas like cleaning, security and maintenance. We also saw a spike in energy costs through late 2022 and early 2023. Falling energy costs and lower vacancy rates in the second half saw irrecoverable service charges fall by more than 50% to £2.1 million. Other property costs increased to £17.4 million, largely due to general inflation and some historic rate spills. I'm presenting to you today from our second Member Lounge, which offers facilities and amenities which differentiate us in the market. This helps attract and retain occupiers and reduces vacancy. The running costs were £1.4 million in 2023, some of which is offset by direct revenue. Overall, property expenditure was £24 million for 2023, equivalent to 11% of gross rental income. Slide 12 shows project expenditure across the different categories. The major projects on-site incurred £117.4 million of spend, of which £20 million went on the residential units for sale at Baker Street, held as trading property, with a further £6.4 million on the retail to be sold to the freeholder on completion. We also spent £35.6 million on a number of smaller refurbishment schemes. 50 Baker Street JV investment and Old Street Quarter together accounted for £4.1 million of expenditure. Slide 13 sets out estimated future project expenditure. We expect to spend about £222 million in ’24, including our solar power facility in Scotland and some substantial refurbishment projects in buildings like Stephen Street. Our revised estimate for EPC upgrade costs is now £95 million. Included in this is a specific deduction in the December ’23 valuation of £48 million, plus further allowances for general refurbishment as units come back to us. Slide 14 shows our usual pro forma. It includes £228 million of committed CapEx on major projects. It only takes account of contracted lettings and sales, and allows for no further development profits. We expected to do rather better than this, but it does show that interest cover and loan-to-value ratio remain very affordable under this scenario. Slide 15. Before considering our overall debt position, let's look at how our 2031 Green Bonds have been trading through the last year or so. The chart here demonstrates the volatility both in rates and credit spreads through the year. The yield climbed to a peak of around 7% in the summer, before falling sharply late in the year to close at 5%. Rates have since picked up a bit, with the bonds currently trading around 5.3%. That's roughly what we'd expect to see today for unsecured eight-year money. Note also how the credit spread, which is the orange line, has generally moved lower through the year, with the spread on these bonds now about 140 basis point over the gilt. Rates may continue to be volatile through 2024, but there's increasing consensus that the general direction is now downwards. Our £83 million secured loan matures in October, and with our stable credit rating and the constructive lending atmosphere for stronger credits, we have already had a number of positive meetings with potential funders. The investment market was slow in 2023. Disposals were low at £66 million and acquisitions only £4 million, but we expect to see capital recycling accelerate in 2024. Slide 16. Against this background, our debt ratios shown here all remain solid. Almost all our borrowings are fixed or hedged. We had a weighted average unexpired term of five years at year end, and the weighted average interest rate was almost unchanged over the year at 3.17%. Our covenants were very well covered, and relationships with all our lenders remain excellent. Thank you. And now over to Nigel.
Nigel George:
Thank you, Damien, good morning. Slide 18. As published, our leasing activity last year was strong, with a flight to quality and ERVs moving forward. However, on the capital side, yields continued to move out, impacted by high interest rates and restricted availability of finance. Investment turnover in London was down over 50%. The overall impact was a 10.6% valuation decline and followed a 6.8% decrease last year. West End, where 72% of our portfolio is located, however, remained more robust. Our developments continued to deliver a good performance, up 8.1%, and despite a 25 basis point outward yield movement. There was good progress on-site, however, the key driver of the uplift was the pre-letting activity at Baker Street. Looking at our total property return, this was minus 7.3%, a small outperformance against the MSCI, the London index of minus 7.9%. Turning over to Slide 19, a bit more on the themes. Having sold a billion pounds worth of assets over the last five years, we've improved the overall quality, yet retained an active pipeline for the future. As shown on the chart, whilst developments were the star, our better quality buildings, those with higher capital values, continue to be more resilient, driven by the quality of the space, amenity and location. We expect this to continue. However, it is worth noting that over 44% of the portfolio by area provides future opportunities for regeneration and a bit more report on this later. Slide 20, rents and yields. Our valuation to ERVs were up 2.1% and as shown on the trend, have now been trending upwards for four periods. It's important to note that the average is a valuation figure and because of our low vacancy rate, ERVs are mainly for rent reviews and lease renewals. Our open market lettings tend to be achieving higher rents, especially on the better quality space and these can be in the 5% to 10% uplift range. On yields, these moved out across the sector. Overall, there was a 67 basis point movement in the equivalent yield in 2023 and we've seen a 109 basis point movement over the last 18 months. With our equivalent yield now over 5.5% and the downward interest rate outlook, the pressure on yield rises is starting to ease. Now a walk through the usual ERV build-up, Slide 21. Our annualised rent is £206.5 million with a £103.1 million reversion. £44.6 million of this is contracted under our leases. In terms of annualised accounting income, after allowing for spreading of rent freeze, this figure is £211 million as shown at the bottom of the chart. All potential income to the right of this is future income, subject to appropriate rent-free spreading. On-site developments of Baker Street and Network, which both complete in ’25, could add £33 million of income. £15.6 million of this is already pre-let. Our smaller projects were up from £2.7 million to £7.5 million over the year, with a large proportion of this space coming back in the last four months of the year. This space will be upgraded and marketed later this year and there's an opportunity to drive rents here. Vacant space available to occupy is £10.9 million, down by £6.4 million over the year and this fell through to the lower vacancy rate. And finally £7.1 million of reversion. Overall portfolio ERV is up £5 million to £309.6 million even after stripping out disposals which had an ERV of just under £4 million. Now the investment market, Slide 22. Investment activity was down significantly, with interest rates having a big impact on turnover. Debt was not accretive, so the market focused on equity buyers and smaller lot sizes and the West End. Whilst to-date there's been limited distress, we're starting to see earlier breaches now being actioned through consensual sales and we expect this to continue. This is translating into better price discovery and more property being prepared for sale. This could bring some buying opportunities into ’24. Slide 23, capital recycling. The main disposal in ’23 was the sale of 19 Charterhouse Street to a family office. Whilst there was refurbishment potential from ’25, it was a small project. We've made excellent progress at the private residential element of the Baker Street development. Here there are 41 high quality apartments to be delivered in ’25, to-date seven sales of exchange for nearly £40 million at over £3,500 per square foot. But for ’24, we feel the investment market is starting to free up and we'd be looking to make several disposals during the year. Moving on now to sustainability, Slide 25. We continue to evolve our plans on our Scottish land and this is to be a key differentiator and play an important part in our net zero pathway. During the year, full planning consent came through on our 18.4 megawatt solar park on about 100 acres. We aim to be in the construction phase later this year and complete in ’25. It should generate over 40% of our electricity needs for our London managed portfolio. Derwent was one of the first UK REITs to set verified science-based targets back in 2019. At the time this was a two degree climate scenario and we've now updated this near term 2030 target to align with an improved 1.5 degree scenario. To achieve these will require collaboration across the supply chain and in industry innovation. In recognition of the quality of our sustainability work our external ratings have continued to strengthen. Both GRESB and CDP scores rose over the year and we remain top rated with both MSCI and EPRA. During the year we undertook a detailed review of the methodology used for our various environmental KPIs. The outcome is a closer alignment of floor areas to energy uses which impacts our energy intensity. Slide 26. Looking now at the metrics on Page 26, the left chart shows our energy intensity level which did increase in 2023. The principal driver was the extensive commissioning work and occupation of Soho Place, Featherstone building and Francis House. These projects all completed in mid-’22 and we expect their usage to settle down going forward. Overall energy intensity remains 10% below our 2019 baseline. High energy usage did translate into increased carbon. This was also impacted partly by the rise in the UK government's carbon conversion factor, the first annual increase for over 10 years. Finally looking at EPC, 88% of our portfolio is now rated at least EPC C or above and works have been incorporated into our asset management upgrade plans. It is not clear at this stage whether EPC legislation will be further deferred but we continue to believe that improving a building's environmental performance is good for business. It will improve lettability and deliver attractive rental uplift. Now, over to Emily.
Emily Prideaux :
Thank you, Nigel, and good morning. I’ll first provider summary of London's occupational market and our activity in 2023 before touching on occupier themes more generally. Slide 28, occupational market demand. We've certainly seen occupiers reengage with their long term strategic real estate planning. Economic instability particularly in the first half led to transactions taking longer to complete and a rise in under offers. However as confidence recovered through the second half, the pace of take up increased with Q4 nearly 50% higher than the Q1 to Q3 average and under offers consequently reducing by 25% in Q4. Pre-letting activity remains high as businesses look increasingly early to secure space of the right quality with the right landlord that meets their needs. Encouragingly active demand is strong rising nearly 75% to just short of 10 million square feet across a variety of business sectors. Occupational market themes, Slide 29. We'll touch on some key themes that we're hearing from occupiers both our own and in the marketplace. There's no doubt that quality continues to drive a lot of decision making as well as good design, of course. There are a few other key topics relevant to that overall quality that we hear consistently in our dialogue with occupiers. London, for international global companies, London is being prioritised when it comes to real estate. As Paul has touched on, it is a truly diverse city both demographically and in terms of the business sectors it attracts. It has an unrivalled talent pool and these attributes put it firmly on the world map in terms of being a centre activity for business across all sectors. How occupiers are thinking about the purpose of the office continues to evolve but COVID is most definitely in the rear view mirror. Real estate and the office are firmly back on the agenda as a long term strategic device. Businesses are undoubtedly opting for office centric solutions which continue to prove better not just in terms of collaboration and productivity but also for culture and wellbeing. And finally, location and connectivity, which are becoming more prevalent. Leadership teams increasingly wanting to make it as appealing as possible for their talent to be in the office rather than working from home. Consequently being in the right location with the right transport links is key and we certainly see this trend continuing. As this slide shows, we've already seen a number of moves from large occupiers coming into more central locations either from out of town or more periphery sub-markets. And there's a long list of smaller occupiers who have also made similar moves. This trend bodes well for our stock being more centrally located. Occupational market supply on Slide 31. As we've said before, averages rarely show the full picture and this is particularly true when it comes to vacancy across London. The West End is tight at only 4.4% vacancy which is only slightly higher than its long term average. By contrast the City is 11.9% and Docklands at 16.7% are both double their long term averages. Six months ago there was some concern that 2023 would be a record year for development completions. As can be seen on the chart, in fact only 5 million square feet was delivered in line with historic levels as completions were delayed. Over the next four years we're confident that the supply will remain constrained. Now turning to our leasing activity on Slide 32. As Paul has mentioned, we had a very strong year for lettings agreeing £28.4 million of rent at an average of 8% premium to ERV. Our two pre-lets at 25 Baker Street to PIMCO and Moelis which represented 56% of the total were agreed at over 13% of the value as December 22 appraisal ERV. The building is now 75% pre-let with an average lease term to break of 13.4 years. As a reminder, PIMCO did not exercise their option on the fourth floor which means that Moelis have now moved up, meaning the rent on the fourth floor is now increased from the £95 per square foot originally agreed with PIMCO to £102.50 now payable by Moelis. This leaves us with the first and second floors where we have encouraging interest. At Featherstone, 80% of the space is now leased to occupiers across a range of sectors including advertising, engineering, online insurance and healthcare. Again, we have good interest in the remainder. Our furnished and flexible space continues to meet market demand at the smaller end with 19 lettings in the year at an average 9.2% premium to the adjusted ERV. I'm pleased to say that momentum has continued this year with strong viewing and activity levels. As of yesterday afternoon, we have completed over 2 million square feet of leasing to-date including PLP at White Chapel and Starbucks at One Oxford Street. In addition we have a further 2.7 million square feet under offer and there is good early interest at Network building which is due to complete in the second half of 2025. Over to asset management on Slide 33. With businesses planning their future space needs at ever earlier stage, we are actively engaged with a number of occupiers on expiries in ’26, ’27 and beyond. In total, our asset management activity was up 30% compared to 2022 at £41.5 million. The key transaction in the period was Paymentsense at Brunel Building taking Splunk space under assignment, increasing its overall footprint by 150%. As part of the transaction we removed the 2029 lease breaks on Paymentsense's existing floors and extended the expiry from 2034 to 2036. On the new space, the term was extended by 5 years. Consequently the term certain on these 5 floors was extended nearly 6 years overall to 12.7 years. In addition we proactively dealt with a significant amount of the lease breaks and expiries that were due in ’24 reducing them from 17% of passing rent at June ’23 to 10% at December. This has helped maintain WAULT at 6.5 years or 7.4 years on a topped-up basis. This activity helped reduce EPRA vacancy by a third to 4% at year end with momentum carrying through into 2024. Paul will shortly be talking you through the pipeline but when it comes to our approach and overall offer, just a reminder that as well as the beautiful design of the individual assets, we take a considered portfolio approach providing a superior overall product for the occupier. This includes amenity and service via our DL Member initiative, a focus on long term relationships as well as tangible sustainability agenda supported by our intelligent building software. While HQ space on longer leases remains at the centre of what we do, we also have a growing furnished and flexible portfolio at the smaller end ensuring we meet the breadth of London's varied demand. Together, these all contribute to our differentiated offer having great appeal for today's demand. Thank you and I'll now hand back to Paul.
Paul Williams :
Thank you, Emily. Now onto developments on Slide 36. We've made good progress at 25 Baker Street and Network both being on programme. At December our appraisal showed a 13% profit on cost and a 5.8% yield. The reduction compared to June is principally because the valuer’s have moved the investment yield, out. Baker Street was of course helped by the very strong pre-lets. These developments offer best-in-class office space with substantial amenity and leading environmental credentials and we expect they will deliver ongoing outperformance at completion. More on 25 Baker Street. I believe the building will be another fantastic example of Derwent quality and design. The superstructure of this 298,000 square foot scheme has completed and the glazing is now being installed on the main office block. As our fourth net zero carbon building it has been delivered responsibly. The current embodied carbon estimate is 600 kilos per square metre. We're targeting BREEAM Outstanding and it will be our first NABERS UK rated building. Demand for the residential is strong as you've heard from Nigel. We have de-risked the majority of the offices with excellent interest in the remainder. Rents have been very strong. Turning over, designed by award winning Hopkins Architects, it occupies an island site in the heart of the Portman Estate in Marylebone. It provides beautiful amenity rich office space with generous rooftop terraces alongside much needed new retail and F&B set around a delightful landscape courtyard. The facade incorporates a range of luxurious materials including port and stone and pre-cast concrete. It has fantastic open plan floor plates with Derwent signature generous floor ceiling heights. Turning now to our on-site development at Network. Network, our 139,000 square foot office let scheme has been designed with sustainability at its core. It will be all electric and we are targeting BREEAM Outstanding plus a minimum NABERS UK rating of 4.5 stars. Embodied carbon is expected to be 530 kilos per square metre. Turning over. This PSC design scheme is in the heart of Fitzrovia and is making good progress. The building has an expansive communal roof terrace, wonderful stone and pre-cast concrete facade, opening windows and a beautiful generous reception. It has an exceptional on-site amenity and benefits from close proximity to DL/78, our other Member Lounge. With three metre floor to ceiling heights, the office floors have been designed to maximise natural light. It will be adaptable providing occupiers with the best blank canvas in which they can project their brand and which will stand the test of time. We are very encouraged by the level of interest at this early stage. Our medium term pipeline is on Slide 41. Totaling 390,000 square feet, our next phase of projects comprise two great buildings in the core of the West End. We are proposing to commence our office led scheme at Holden House in mid-2025. The 150,000 square foot development designed by architects DSDHA will also benefit for the increase in retail demand and hence rents resulting from the opening of the Elizabeth Line opposite. We will retain the facade which was originally designed by Charles Holden, the architect for many iconic London underground stations. At 50 Baker Street, which we own in a 50/50 joint venture with Lazari Investments, we have submitted a planning application for 240,000 square foot office-led scheme designed by AHMM with whom we have worked many times. The outcome of the planning submission is due in H1 this year. We will then work up the detailed plans for start on-site in early 2026. Our longer term projects. Over the longer term, our pipeline totals nearly 1 million square feet of mixed use spaces. Projects at Old Street Quarter and 230 Blackfriars Road on the South Bank will help continue the regeneration of these sub-markets. Now onto our refurbishments on Slide 43. Derwent is well known for its refurbishment skills. This is where it all began. We expect refurbishments will form a greater element of overall CapEx over the coming years. As shown on this slide, we see a good opportunity to deliver significant mental uplifts from these schemes with improving sustainability credentials which should result in attractive valuation uplifts. So in conclusion, great design, a relationship driven approach and our focus on portfolio wide amenity, sets our distinctive product apart. Combined with our 72% West End weighting, the outlook for rental growth is positive. Our competence in the prospects for our on-site and future projects which total nearly 1.8 million square feet means we will continue to start them on a speculative basis. Our strategic positioning is supported by the ongoing strength and appeal of London. This truly amazing global city appeals to both occupiers across a broad range of sectors and a diverse range of investors. The office is widely viewed as a core strategic asset. Occupiers want to be in the best building and this is what we are providing and letting. The macro environment has put capital values under pressure over the last 18 months but we believe we are now approaching the low point of this cycle. With inflation continuing to trend lower, the improvement in cost and availability of debt over the last few months is feeding through to increasing stability in the investment market. Our strong balance sheet gives us capacity to continue investing in our pipeline and to explore the opportunities that are beginning to emerge. In summary, as you have seen, we have the right product in the right location and occupiers will pay a premium rent to secure it. Thank you very much. Now for Q&A, we will take questions from the room first before going to the telephone lines and then to the webcast.
A - Paul Williams :
Please.
Rob Jones :
Good morning. It is Rob Jones from BNP Paribas Exane. I have got a question on ERVs, one on solar and one on yields. On ERVs, your overall figure I think was 8% ahead for this year or so versus Dec ’22 on £28 million of rents. If you strip out the £16 million of lease of pre-lets, I think the leasing ahead of ERV was 2% and obviously ERV growth during the year was also about 2%. For next year, you guide to overall ERV growth, the whole portfolio I think to plus 2% to plus 5%. What gives you the confidence or I guess can you give me the confidence that you will end ’24 with ERVs ex-development leasing activity, up?
Paul Williams :
Well, firstly, I think we have got a great portfolio. We have got some great refurbishments into great buildings. We sold a lot of assets so we felt that there was limited ERV growth. But if you look at some of the buildings, we have got across the portfolio, whether it is Stephen Street or in Victoria, you remember that our Francis House scheme and refurbishment there, we were at 16% above ERV. So we have got a great, great portfolio. Obviously, this flight to quality is continuing, which is why we are investing in the portfolio and developing further. But I think the underlying portfolio is excellent. And I think after a few years of limited rental growth across London, it is time for occupiers to be paying more rent. And I think they should pay more rent. And I think the reality is it is a very small percentage the overheads. We reckon 6% to 8% on rent alone. And I think occupiers will pay good rent to be in a good building but also with all the amenity that we are offering. So we are confident of this. We got 2.1% last year on a pretty difficult macro world. And I think we have got, I say, the right product in the right location, 71%. So I remain confident that our ERV guidance is the right guidance. But thank you, Rob, for that question.
Rob Jones :
So, yes, onto solar. Lochfaulds up in just north of Glasgow. The 100 acres, I think it was 110 before, but what's 10 acres between friends? The yield on cost that you are expecting there, can you give a figure for that? I am guessing it might be one of the highest in terms of your development.
Paul Williams :
I would defer to the King of Scotland for that question. Nigel?
Nigel George:
Yeah, I mean there is a couple of things that sort of make it attractive there. We are right next to the grid. The grid has the capacity so we don't have big capital cost to connect to the grid. Our main cost, the land is pretty small, the main cost are the panels. So you are looking at sort of 20 odd million for the panels. I mean we think the revenue could be about £1.3 million, £1.4 million on that now. The planning will have a 25-year life. The panels probably have a 30-year, 35-year life. So that's a sort of cash flow yield on it, £1.3 million on £20 million.
Rob Jones :
Plus I think the land or the assets of that entity is about £4.7 million or something like that.
Nigel George:
Yeah, I mean we have five and a half thousand acres and the whole lot is worth I think £30 million. So you are looking at a few thousand pounds an acre for that sort of land. And it doesn't have any housing potential land so it's very much that.
Paul Williams :
I think also Robert, you know, it's a key differentiator. We could provide 40% or 50% of green electricity to our portfolios. So, really dark green electricity to our occupiers would be great for tenant retention. Every occupier we know are focused on their carbon outputs. To be able to provide them with cool green branded electricity I think is pretty good.
Nigel George:
So we'll set up what they call a sleeve agreement which is basically we put that into the grid and we're allowed to take it out down here.
Rob Jones :
And then the last one quickly on yields. In your outlook comment in your press release this morning you obviously talked about inflation coming down and I think you said something like yields will follow. To me, I read that as when rates come down you expect yields to also trend downwards potentially in ’24 and therefore capital values up. Do you disagree?
Paul Williams :
I think you read well but obviously I think the reality is I think we're expecting some cuts in interest rates. I think inflation's come down. I think we think that yields will follow and I think we'll find some value should start seeing recovery. We're certainly seeing on the investment market more interesting assets coming out so let's see how it goes and see how the cuts come along. But I think after some pretty big increases I think we're expecting things to improve. Do you want to add anything to that Nigel?
Nigel George:
No, I mean we are -- mentioned we are seeing more on the market. We're getting the old approach and stuff so it's starting to unwind. Damian can probably comment on the availability of the financing market but it is starting to unwind on the availability of stock and transaction.
Damian Wisniewski:
Yeah, I think to some extent it depends on the timing and the extent of cuts in base rate by the Bank of England. So we have to be aware that things are still tight out there. We do see that easing though. You might see some further outward yield shift in the first half but it does feel as though that pressure is easing and it could reverse a bit in the second. But we'll have to wait and see. There's a lot of macro data to absorb before we can take a firm view on that.
Paul Williams:
Thanks Rob. Right, sorry. Miranda, sorry.
Miranda Cockburn:
Miranda Cockburn from Berenberg. Just following on the rental side of things, your 2.1% ERV growth, you kindly break up the valuation move by different quality of buildings. Can you do that for the ERV or could you do it by EPC rating, something like that, just to give us a feel of the range of ERVs that you're achieving?
Paul Williams:
Well, I think the West End is obviously doing better than the rest. If you look at the recent lettings we've been doing in White Chapel and in Featherstone, they've held up very well. But they've been pretty, I would say, pretty flat. But we've been, given the fact that the vacancy rate in the City Borders area is a bit higher. So we've been pretty pleased with those sort of rent. So I think from a location point of view, the further west you go, the higher the growth is probably where we do. And obviously our better buildings are outperforming.
Nigel George :
Yeah, I mean, probably the weakest submarket is White Chapel. But we're now getting, we've had quite a good activity there and we've hit, it's been in line with ERV at White Chapel. So start with there and then move to the West End where it's much stronger.
Emily Prideaux :
I think the 2% is obviously the portfolio valuation as well, which includes a lot of the pre-development stock. The 8% that Rob queried earlier is on all new lettings. The pre-lets are actually ahead of that, sort of 13%. So those new nettings are of a variety of quality. So that's probably a decent measure of that as well.
Paul Williams:
When we do say green, if you look at our Tea Building, you know, the rents for that building are substantially higher for things that are green tea rather than builder's tea, if you want to call it. So you'll see, going back to your point about EPCs and stuff like that, I think there is a green premium. I think people want to make sure they're in a sustainable building and I think we've got some good evidence to support that.
Nigel George :
Yeah, I’d probably add, sorry, Miranda, and one more thing. I mean, we said our available was about 10.6% at year end. 30% of that has now been either let or under offer at this 3% to 4% ARV. So two months into the year, of our available, we're talking or agreed terms on, we'll let 30% of that. And I think that gives us a bit of confidence.
Paul Williams:
Sorry.
Callum Marley :
Callum Marley from Kolytics.
Paul Williams:
Hi, Callum.
Callum Marley :
Just following up on some of those questions. First one on ERVs, is it fair to assume that going forward that some of those positive ERV numbers you guided to might start flowing through to your like-for-like numbers and remain positive in real terms? And then on that, what are the offsets? So obviously energy costs were quite high last year. That's expected to come down this year. Could that be offset by potentially higher increase in lounge and customer service charges?
Paul Williams:
Do you want to start with each of those?
Damian Wisniewski:
Yes. I mean, we've given quite a lot of information on this on Slide 11. And the reason for that is because there are lots of moving parts. And these lounges are fabulous. They will see cost money to run. We believe its good value for money, but it does feed through to the net rents. And other costs do seem to be getting more under control. We had a very big spike in costs in the second half of last year and the first half of this year. A lot of that's come down. Energy costs appear to be stabilizing. And so I think it's fair to say that we expect to see the net growth improve a little bit in ’24. It's going to be quite marginal, though. It all depends on vacancy rate and exactly what happens and when. But we do start to see a world where rental growth potentially can start to be higher than cost inflation. That's not something we've seen now for quite a few years in the London office sector. So it does feel as though there's a beginning of a change of atmosphere.
Callum Marley :
Thank you. Two more, sorry.
Paul Williams:
Yeah.
Callum Marley :
Just on the yield, so you expect capital recycling to increase this year following a hesitant investment market in 2023. Could you provide a little color on maybe where the bid ask spread is between buyers and sellers and would you be willing to sell assets below book value this year in order to hit your disposal run rate?
Paul Williams:
We've always been a recycling business and I think if someone came with a good supporting bid, was close to valuation and we felt actually done our job, I think we'd be sensible about that. We've got options so we don't need to sell, we need to buy, but we'd like to do a bit more recycling. So I think it depends what it is. I think obviously we've sold a lot of those assets over the last five years where we thought there wasn't any growth. So I think we'd be pretty firm in prices, but I think we've always got to be sensible about it. So, Nigel, do you want to add anything to that?
Nigel George :
You've got to be realistic and judge each asset as and when, I think.
Paul Williams:
But we'll have to see. But we are going to probably do a bit more recycling. And there’s this needs some good acquisitions, if we sold something a little bit but below what we thought well we could actually bow off it, but something really interesting at a really good price, I think we'd look at it in that sort of balance.
Callum Marley :
Final one, please. There was a slide that spoke about the development, profit on cost around 13%. I look at your kind of discount, the gross asset value today, that's around 27%. What are you penciling in for future development, future profit on costs, given that quite large disconnect and then maybe where do you start considering alternative capital allocation decisions?
Paul Williams:
Why don’t you start with the first part of the question?
Damian Wisniewski:
If I just take you back to sort of the value as numbers, which, we showed the 13%. They're putting spec yields on it. There's concern over delivery. This is just the general assumptions on price, also there's quite a lot of moving parts. And I think it's fair to say valuers have gone on the cautious side, shall we say, at this moment in time. And if you look at that 13%, if we get the lettings right and the yield moved in, say, 25%, so you've gone from a spec to a pre-let on the rest of it, that 13% would take you up to 17% profit on cost. If we achieve, say, the sort of increases in rent we've achieved on the pre-letting of Baker Street, say another, I don't know, say £10, that would then take you up to a 23%. And if you get a bit more bullish, so your range can probably be 13% to probably 25%, and the yield on costs would then move up probably into the low-to-mid 60s. So an optimistic view, we feel that probably should be where the market settles and we should be able to achieve that. But the valuers are very cautious at the moment.
Paul Williams :
And we approach our appraisals cautiously. We put interest on the land as well. We don't sort of capitalise to element costs, the fees and stuff like that. So it's a fairly cautious view. You'll find, actually, historically, we've always slightly done better than the slide at the end. Irrespective of capital allocation, we obviously look at all options. At the moment, we feel development to making good returns, they've got opportunity to making better returns going forward. We seem to be making the right product. We see demand as very good for new developments. And I think that's what we'll continue investing. But if we felt there are other ways to allocate capital, we certainly could consider it. Right, sorry. Question at the back. Thank you very much.
Unidentified Analyst:
Just more questions on the capital side, please. These investment opportunities that you're seeing emerging, can you give us a sense of what they are? Are you going to be active in buying more future development stock? What's the volume of acquisitions we might expect over the next couple of years? And then, in terms of funding that, how far would you push your LTV to pursue them?
Paul Williams :
Well, there'll be a couple of interesting assets put on the market recently at the West End, which we had a good look at and actually very well bid. Shaftesbury Avenue was very well bid, they had been let to WeWork, and it was very well bid, I felt. I think a lot of people looked at it and all quietly. I think Vogue House also in Hanover Square was very well bid. So there's a few sort of opportunity plus type assets out there that didn't suit us at the time, but we did have a good look at it. In respect of the sort of gearing, I mean, we're at under 28%. I'd be prepared to push it a little bit more, maybe into the early 30s, if the right asset came along. Maybe a little higher in the short term, but I've got to keep my finance director happy as well. I think around that sort of level, but I think we are feeling, we feel this opportunity is going to come our way. We will recycle a bit, and if we see something really interesting, we should look to buy, we've got that capital. Our money is good. We are able to act very quickly and we're always out there looking.
Damian Wisniewski :
We've always prized low leverage and we continue to do so. It gives us options and makes the business resilient. I think we could stretch the LTV a little bit. We've previously indicated we'd move up to perhaps 35% and as the yields move out quite a bit in getting the LTV to where it is today. We focus, as you know, much more on interest cover than we do on LTV, and I think it's important to keep that in mind. The interest cover only fell very marginally last year, still 4.1 times. So there's a balance here all the way through. But I think the balance has clearly got a little bit of capacity, but we are a recycler and we will continue to recycle in the normal way.
Unidentified Analyst:
Just one follow-up question and related is, should you therefore be more active in selling the large developments completed in the last cycle, ones that you can no longer add as big a value to, take the capital out of them and recycle into these investment opportunities that you're seeing in the market that could have potentially higher returns?
Paul Williams :
Well, possibly. I mean, we've obviously got a three-year roll, so things like Soho Place was only recently completed. We may look at one of the bigger assets in due course. We want, obviously, a strong investment market for that. I'm sure they'd be very well bid. I mean, they're very well let on long leases, and we obviously would consider it, I don't think, necessary very much in the short term. But we've recycled bigger assets in the past, the more mature assets. Obviously, you've got some buildings in a bigger state in Fitzrovia, they're all together, so breaking that up would give us some thought. But, yes, we would be minded at some stage, but not immediately.
Damian Wisniewski :
I think those very large lot sizes, I think, are dependent on availability and cost of finance as well. So, I think as we see that ease, which we're expecting to see, I think you'll see that market improve. So, definitely something for the future.
Paul Williams :
Yes. Oh, sorry. Whose arm was up first, is it?
Adam Shapton:
It's Adam Shapton at Green Street. Maybe, apologies if this is just a different way of asking the same question Ben just asked, but looking at your mix of core income and other on Slide 5. I'm thinking about maintaining, particularly the ICR in a, dare I say, a sort of more normalised interest rate environment going forward and what you've said about the cycle. Is this the mix that you expect to have in three to four years or do you want to need to grow the core income share of portfolio?
Paul Williams :
I mean, historically, we've been happy with a 50/50 split between core income and opportunities. At the moment, obviously, more of this sort of core income side is pretty good. So, at the moment, 56/44 feels pretty comfortable to me. Nigel?
Nigel George :
Yeah, I mean, we've tracked this many years and it's averaged about 50/50, but it's been right to have core income as --
Adam Shapton:
And if your cost of debt stays at 5% or so, but five years, is that still comfortable? Thinking about your ICR and what you just said about --
Damian Wisniewski :
Yeah, I mean, the equivalent yield of the portfolio is now at or slightly above the cost of long-term debt. So, it's obviously an interesting balance that. I mean, debt is not as accretive as it was two or three years ago. So, we have to adjust to that. That, again, supports our low leverage business model. But I think that we can see, one of the things we look for is the visibility of earnings. So, if you can get pre-lets on developments, you can take a little bit more risk and perhaps add a bit more value add. But it's a matter of balancing those things out finally. We are keen to grow the earnings again. Now this is a business which has done that for many years. It's been challenging since 2019 with rental growth lagging cost inflation. But that does feel as though it's potentially about to move on the other side.
Adam Shapton:
And then on the CapEx, so the £35 million this year, I've got a bit since last year. And if I interpret the Slide 13 correctly, not a lot of that has gone. You can see upgrades this year. And can you sort of give some colour on the return you're getting on that CapEx? Should we think about it as sort of “defensive”? How does that feed through to the ERV growth?
Damian Wisniewski :
I mean these are the refurbishments. They really vary from quite small, floor by floor, unit by unit refurbishments, some of which can make money, some of which don't always, to the quite large refurbishments like the ones we did down in Victoria, which can be as profitable as a major development.
Adam Shapton:
Has it helped your ERV growth outlook?
Damian Wisniewski :
Yes, I think on the whole, we are very positive about these. We think by upgrading that space, we can grow rents quite significantly. And so it's actually part of the business model going forward. It's quite hard to give you precise figures because there is quite a range. But I know we're comfortable that these are accretive overall.
Adam Shapton:
Okay. And one last one, if that's okay. On the impairments, and to some extent they appear to be in the first half, is it sort of the same set of problems or is it sort of cycling through and there's a bit of a drift of issues with retail?
Damian Wisniewski :
It's very much from the first half, really. There is still weakness amongst some of the smaller retailers and we have a choice as a landlord to either support those retailers or take the space back and perhaps have vacant units. People like gym operators are struggling with margins. So the view we've taken in some of these cases is better to have them there paying some costs, keeping the building alive.
Adam Shapton:
So sorry, are there new cases in the second half? Or is it same?
Damian Wisniewski :
There have been one or two small failures amongst tenants. In a portfolio of this size, there always are. But these are really quite small amounts that we're talking about. And overall it's, what, 1% roughly of rental income. That's probably a reasonable number going forward.
Adam Shapton:
All right, thank you.
Paul Williams :
Any other questions? No? Have we got any questions for the telephone lines?
Damian Wisniewski:
Not on the webcast?
Paul Williams :
Well, I suppose I should wrap up. Thank you very much for attending today. And we're all around later if anyone wants to ask any further questions. And oh, we do have a question.
Operator:
The question over the phone comes from the line of Paul May from Barclays.
Paul Williams :
Paul.
Operator:
Your line is open, sir. You may proceed.
Paul May :
Hi, everyone. Sorry about that. I was a little bit late pressing the buttons. Thanks for taking the questions. Just a couple from me. Sorry to go over a little bit of old ground. You mentioned around yield expansion versus financing costs and yield on cost versus financing costs. Just going back to the last time rates kind of stabilized, if you look at the five-year swap, around 4% was around 2002, 2003. I think around that sort of time of year in your portfolio was about 100, the initial yield about 100 basis points higher, and the reverse yield about 150 basis points higher than it is today. What makes you think that buyers are willing to accept a much tighter spread to financing costs, and why should valuations have a much tighter spread to financing costs today versus previously when rates were this sort of level? Thanks.
Damian Wisniewski:
Well, that's quite a long time ago. And I think probably a lot of it comes down to what's happened to rents in the meantime, the affordability of rents. We've come through a pretty exceptional decade where QE has brought financing rates down, brought yields down, and as a sector, we've actually seen rental growth being rather slow. As that reverses, there is perhaps room for rents to start growing again. So Paul, it's a very complicated question, and I think we perhaps talk about it in private, but I think our view at the moment is there is room for this to be an acceptable rate. We also expect the cost of borrowing to come down a bit once the Bank of England starts cutting rates. We saw that last year. And we think rates may come down a bit further. So I think there's a sense that there's rental growth to come which will improve this balance.
Damian Wisniewski:
Is it possible just a quick follow up and ask it in a slightly different way? You mentioned about looking at acquisition opportunities. Would you be paying similar initial yields to your portfolio today for those? Or would you have to accept a higher initial yield to take advantage of those acquisitions?
Paul Williams :
I suppose, that sounds --
Nigel George :
It depends on what you're buying.
Paul Williams :
It depend on what you’re buying and what the opportunities are. Is there a near-time growth opportunity in the floor area or a reposition in the building? Historically, we've never had to worry too much about the initial yield on something if there was two to three years income ready to be repositioned. So I'm afraid the answer to that question, it depends what you're buying and what it is. And I think if it's something where we can add value and reposition it or regear the lease or something, then we would certainly look at it.
Nigel George :
I find a good example is something like Blackfriars which is 60,000 feet, big car park at the back. A basic redevelopment could put 200 basis points on there. There's another little bit next door which you sort of own. If you bought that into play, you could be looking at 500 basis points and that's a 10-year play. But so the answer is you would be happy to pay these sort of yields if you could find that sort of stock. It's not easy though, but we have done it in the past.
Paul May :
Okay. Then just a final one wrapping it all together. I think you mentioned a few times financing costs not being particularly attractive or accretive at the current stage. Does that imply, I mean just looking at your net debt-to-EBITDA is high relative to say US peers. So on that metric you are quite levered. Would you be then looking at equity funding and seeing that happening more and more in the space? Just wondering is that a preferred method of funding expansion? Thank you.
Paul Williams :
I mean at the right time, I think the idea is the right one. I think this perhaps isn't quite the right time now, but we are believers in scale. And at some point we'd like this business to grow. So the conditions aren't quite right today, but I think we would definitely see equity as one of the options going forward.
Nigel George :
That's right.
Paul Williams :
Paul, just going back to your earlier question, I just had a bit more time to think about it. 2002 was a long time ago. I think one thing to bear in mind is the quality of our portfolio today is substantially higher than it was in 2002. We had a lot of raw material in those days where you'd expect to see higher yield. Today we've got much more in the way of completed stock. So I think we should go and look at this together perhaps quietly, but I'd expect to see quite a lot lower yield on the portfolio today than 20-odd years ago.
Paul May :
Perfect, thank you very much. Now just on the scale, we agree.
Paul Williams :
All right, thank you. We've got one more, I think, Robbie.
Operator:
Our next question over the phone comes from Pieter Runneboom with Kempen. Please go ahead.
Pieter Runneboom:
Hi, team. Thanks a lot for taking my questions, the last ones. I've got two actually. One, if I look at the asset management activity in ’23 and looking at the new rents versus the ERVs from the year before, I see quite a slow down there, could you maybe give a bit more additional color on that? The new rent versus ERVs in asset management activity came in at plus 1.7% versus plus 5.3% the year before.
Damian Wisniewski:
Yeah, this is Page 35.
Paul Williams :
Page 35?
Nigel George :
They're all very individual. I don't think you can build a trend from that. Also, some of them are where we're trying to gear up for redevelopment down the line, so you're a little bit more flexible on it, but it's not really something you can draw a straight line on.
Pieter Runneboom:
Ah, okay. That's good to know. And then think a bit about the bid-ask spread. If you're looking at assets that are currently being offered to you in the market or that you see that are up for sale, in your view, what percentage of this is currently priced attractive or correctly, let's say?
Damian Wisniewski:
This is bid ask spread?
Nigel George :
Yeah, I think last year we didn't actually have a great deal out on the market. That's starting to happen now. And the sector has seen valuation corrections. Those have felt feeding through to the numbers. And what we're speaking to the various agents out there, there's quite a lot more coming up. As we touched on earlier, there have been quite a few sort of, what's the phrase, extend and pretend, last couple of years. And we're seeing a few of those actually saying, no, now's the time to sell the buildings. And there's been two, three, or four of those buildings out on the market.
Paul Williams :
And we're starting to see a few more of those startings.
Damian Wisniewski:
It’s starting to.
Paul Williams :
So I think you'll see a bit more activity this year. I think last year it was down, but I think you're seeing more assets being put in the market, more realistic pricing, and that should play to our strengths.
Paul Williams :
Okay. Thank you very much, for your questions. I think we're wrapping up now. Thank you, everyone, for their time. And have a good day.
Nigel George :
We’re around.
Paul Williams :
And we're around if anyone wants to speak to us. All right, thank you.
Operator:
Ladies and gentleman, this concludes today’s conference. Thank you for joining. You may now disconnect. Good bye.