Cromwell European Real Estate Investment Trust

SGX:CWBU

Earnings Call Transcript 2023-Q1

[Operator]

Good afternoon, and welcome to today's European -- Cromwell European REIT First Quarter 2023 Business Update Briefing. [Operator Instructions] Now I will hand across to the CEO of the manager of the Cromwell European Real Estate Investment Trust REIT, Simon Garing.

[Simon Garing, executive]

Thanks Cara, and hello everyone and thank you very much for joining us today. I will start with a brief recap and overview of CEREIT before I hand over to Shane for financials and for the portfolio highlights, and then, obviously, Cara will moderate for Q&A. As an introduction, CEREIT owns EUR 2.5 billion or around EUR 4 billion [indiscernible] in incremental real estate basically made to office and logistics as we continue to put towards the majority held in logistic assets. It's a sizable portfolio with almost 2 million square meters with an average asset sales of around EUR 25 million, a liquid market segment. Around 86% of the assets are located in Western Europe and the Nordics. We have identified almost 20 tentative assets for substantial development and rejuvenation opportunities to enhance and further future for the portfolio. Turning to Slide 4. It shows that CEREIT current high distribution yield of over 10% is underpinned by over 1,000 basis, 92% of our entities backed by government, MNC and blue-chip companies providing income resilience in a slowing economic environment. Our cash collection was close to 100% and [indiscernible] is lower today than a year ago. As part of our portfolio construction, no 1 industry trade sector makes up more than 15% of the portfolio. With tenants from the finance industry only accounting for approximately 11% of the total rent.

The [indiscernible] has now accounted at around 27% of the portfolio, helping to reduce concentration risk, an important factor for our credit rating and bondholders that are on the line today. Cromwell Property Group is the sponsor and asset manager of Cigarette. Cromwell has a strong alignment of interest with all unitholders with EUR 400 million invested through a 28% stake in the rate. One of CEREIT key strengths and point of difference is Cromwell's highly experienced local teams in the 11 countries across 14 offices with over 20 years of track record in Europe sourcing off market opportunities operating in the local leasing markets and managing vast networks to support CEREIT. Slide 6 summarizes the first quarter's strong portfolio performance. Net property income grew 3.6% compared to last period, mostly due to the 16% growth in the light industrial logistics sector. Like-for-like NPI growth was up 4.2% on the PCP, with the logistics sector 9.5% higher and offers still up a credible 1.8% on a like-for-like NPI basis. CEREIT's strong operational performance was mainly driven by active leasing, growing the occupancy with positive rent reversions of almost 7% and especially in office with high annual inflation indexation in most leases also contributing.

While we don't pay a distribution for the first quarter, in light of the market volatility, we have shown an indicative DPU for the quarter of EUR 4.12 which is marginally higher compared to the most recent December quarter distribution on a quarterly basis and only 2.4% down on the first quarter last year. The higher finance costs from higher debt from our CapEx program and higher margins have offset the positive rental income. Gearing is slightly above the board policy range of 35% to 40%, but this should be addressed by upcoming vestments. Our recent refinancing of EUR 250 million leaves us with no debt maturing until fourth quarter of next year, and we increased our hedging recently to take advantage of the very inverted yield curve in Europe. Moving on to sustainability. We just published our fifth annual sustainability report, some highlights here, but we are making great progress in collecting data with energy data now gathered for 91% of the portfolio. This is up from 29% from the 2019 recovery levels. CEREIT's total recorded absolute greenhouse gas emissions were 61,000 tonnes, a drop of 14% compared to pre-COVID levels. Renewable and low carbon energy sources now account for 43% of total energy consumed across the portfolio.

In other metrics, water consumption intensities fell by 26%. After the amount of recorded waste that we recycled was nearly double that again at the pre-COVID 2019 levels. It's also really important and pleasing to note that we are in 1 of 4 Singapore REITs with a AA MSCI ESG rating. Turning to Slide 8. We now have the first 2 buildings that are BREEAM, green certified, of which 25 are office assets representing 77% of the overall office portfolio by value. Our 77% is significantly higher than the European office market, which CBRE estimate only 20% of the total office stock is green certified. Providing us at a very competitive advantage as tenants are increasingly looking for these green-certified buildings with improved staff amenities. Green leases now represent 24% CEREIT's total leases up for a 10% a year ago. And again, this reflects the change in the mindset of tenants, who are now also going to reduce their own environmental impact and work with landlords such as us [indiscernible]. I'll now turn it over to Shane to refer in details.

[Shane Peter Hagan, executive]

Thank you, Simon, and good afternoon. I'll firstly run through analysis of the key line items of the first quarter results. Firstly, gross revenue was 4.2% higher beyond year, mainly attributable to rent inflation indexation and from net acquisitions made in 2022. Operating expenses were 5.2% higher on the back of higher inflation. However, it's pleasing to note that the nonrecoverable expenses portion was EUR 6 million, and this is the same as the same period last year. This means that any increased costs have been able to be passed on to tenants Overall, net property income was just -- was over 3.6% higher year-over-year, and this was mostly due to the strength in the life industrial logistics sector which, as Simon mentioned, was up 9.5% on a like-for-like basis. Finance costs were considerably higher due to a combination of new borrowings to fund acquisitions and developments, higher interest rates on our floating debt and higher margins on new facilities signed recently. I'll talk more about this in the capital management section later. These high finance costs as well as the absence of rental income from the 2 office properties under development in Milan and Rome, resulted in the indicative distributable income coming in 5.8% lower.

However, if we include a top-up of realized investment gain in lieu of these 2 properties located for development, then the indicative DPU including this divestment gain would only be 2.4% lower than last year and actually higher than the last sequential quarter, as Simon mentioned. Turning to Slide 11. The numbers in the dark blue boxes show the like-for-like DPU in the 5 years since leasing. The underlying DPU growth of 1% per annum at IPO should be seen positively in the context of COVID, rising interest rates and the Russian invasion. It really underpins CEREIT's resilience. In the first 2 years, management fees were paid in units, which provided artificial boost as this cost actually gets added back for DPU population. It effectively means the distribution payout in the first 2 years was more than 100% of the earnings.

In FY 2020, we started paying the management fees in cash which had a onetime reset effect to bring deadline DPU down to the underlying earnings. This operating DPU in the blue boxes provides a true picture of operating performance by excluding the artificial boost from the fees paid and used out of capital in the first 2 years. It is interesting to note that more REIT managers have recognized this and recently started to pay some or all of their management fees in cash and not in the form of new units to themselves. And based on market presentation, 9 out of 40 CEREIT now pay 100% of their management fees entirely in cash and more than half around 23 of them have opted to pay at least 50% in cash. This improves the overall quality of the CEREIT distribution payouts. CEREIT aggregate leverage ratio was 40.6%, well inside our covenants, but marginally higher than the board policy of 35% to 40%, largely due to a temporary timing difference between development expenditure and our divestment program. We are in advanced negotiation for the sale of selected nonstrategic assets. We remain committed to maintaining CEREIT investment grade rating of at least BBB- with a stable outlook. In March '23, we amended and restated an existing facility with new commitments into a EUR 70.6 million, 3.5 year sustainability-linked loan with our existing lenders. Following this, CEREIT has no near-term refinancing requirements until the end of 2024. The interest coverage ratio has remained high at 5x, well in excess of loan and EMTM Covenants. We have also commenced discussions to refinance the maturing debt facility, which is only due at the end of '24 as I mentioned and planned to extend the revolving credit facility for up to another 5 years.

Last year, we bought an interest rate for a notion of EUR 210 million at a 60 basis point strike. This took to 75% of total debt being hedged or fixed until the end of 2024. The interest rate currently has a fair value of almost EUR 10 million. Recently, we entered into a notional EUR 100 million cap at 3% and call up at 2.25%, which now takes us to 84% hedged fixed until the end of 2024 and 64% to the end of '25, as shown in the red line in the chart. The 3 months Euribor is now above 3%, so we expect the all-in interest rate to increase to around 3.85% up 40 basis points since December, where the 3-month Euribor was at 2.13%. The higher Euribor with a higher margins on the new debt facilities coupled with asset sales to reduce gearing will have an impact on DPU this year, all other things being equal. And now I'll move on to discuss portfolio management.

Slide 15, this shows CEREIT's portfolio occupancy admit reversion. In the first quarter, we leased almost 5% of the portfolio with a positive rent reversion of 6.7%. Similar to the positive rent reversion of 7.6% seen in the second half of last year. High inflation and favorable market fundamentals across both office and logistics continues to support higher rates. Portfolio occupancy remains high at 95.8%, 100 basis points higher than the equivalent period last year and largely unchanged quarter-on-quarter. In addition to the new leases closed in the first quarter of 2023, we have derisked 35% of the next 6 months of lease breaks, expiries as at the 31st of March. Advanced positive discussions are already underway for our 2025 office leases across our 1 located Grade A Dutch office assets, and this is purely at higher rates.

On slide 17, the chart on the right-hand side shows the portfolio waiting by country to keep in perspective the occupancy by country side on the left-hand side. The Netherlands, Italy, France and Germany account for 75% of the portfolio, and these are all above 95% occupancy. Finland and Poland office show a weaker performance which is explained by the secondary location of these assets. We have already initiated sales program for some of these assets that make up in total about 13% of the portfolio. In the first quarter, tenant retention was high at 76% for the portfolio. The WALE remains above 4.5 years, while the WALB is a shorter 3.2 years due to the break options with the Italian government and the typical French leases in particular.

Slide 18 reflects CEREIT's light industrial logistics sector occupancy, which remains close to a record level at 98%, underpinned by 44,000 square meters of leasing. Rent reversion was positive 4.6% with a tenant retention of 58%. One highlight in the sector was a new lease closed at Parc de Docks in Paris, 3,500 square meters signed at rents over 9% higher. And we are now really securing metals of EUR 160 per square meter in this property, up from EUR 90 per square meter 5 years ago. So a 9-year lease at Parc des Dock, Paris was signed at a 13.5% positive rent reversion and 5 new leases and renewals of various durations at Veemarkt in Amsterdam were signed at 12.5% to 14.5% positive rent reversion. The state of WALE here has increased to 4.9 years. These charts show the European market data for the logistics sector. The chart on the top left shows high quarterly take-up on the logistics space during the last few years with another good start seen in 2023 in spite of the slowing economy. The green line shows that the overall European logistics vacancy sits at a new record amount of 2.3%, actually similar to our own vacancy of 2% in the sector. While take-up has slowed down marginally with few empty sheds available to be leased and reduced supply underway. REITs continue to grow, with the latest quarter-on-quarter increase reported at 2%. This situation is partly explained by the chart on the top right, while Europe e-commerce growth has accelerated since COVID, some of the key markets in which we operate, e-commerce is expected to have further room to grow as a percentage of total retail sales. as shown in the pale-blue boxes.

For example, Italian online sales as a proportion of the total retail sales is projected to grow another 6.2%, the Netherlands by 7.8% and even the U.K. is expected to grow by 6% to almost 1/3 of the sales being online. This further projected take-up of e-commerce and continued onshoring of industrial, such as the microchips and renewable energy industries back into Europe validates our pivot to the majority of logistics assets in our portfolio. Slide 20 shows CEREIT's office portfolio occupancy and rent reversion. We estimate that approximately 75% of CEREIT's office portfolio have been characterized as Grade A with 25% being older and higher-yielding Grade B and grade C. This slide shows the leasing activity in our portfolio actually picked up pace this quarter. The team signed new and renewed leases for 39,000 square meters or approximately 4x the space as compared to a year ago, and we secured a healthy 8.1% rent reversion with a substantial 83% tender attention. A new 2,600 square meter lease was signed in HubSpot in the Netherlands for 10 years at a positive 21% rent reversion, and this was with a major energy company. As mentioned earlier, we are in advanced discussions for the key 2025 office lease suppliers, which will considerably de-risk the portfolio and should have a positive impact to valuation.

Slide 21 shows the European office sector leasing activity, where rental values continue to grow positively in well-located Grade A assets. What many investors may not appreciate here in Asia, is that European office space take-up has been hitting back to pre-pandemic levels, along with low supply, this has led office vacancy rates to 4% to 8.5% for all grades of office vacancy across all of CEREIT's office markets. This shows the EU market office market, in particular, are really outperforming the U.S. peer group. More notable in the mill chart CEREIT's key Grade A office market have substantially lower vacancy at a very tight 3.6% with Milan down to 2.7% vacancy, a vastly different situation into other global office markets. I earlier mentioned the lower-performing Polish and Finnish Grade B office assets, and the chart on the far right shows the higher vacancy of the office market at 13.2% which gives further context to our intention to divest some of these assets in these 2 markets in the medium term. We believe that our focus on rejuvenating suitable older but well-located assets in Milan, Rome and Amsterdam will drive superior risk-adjusted returns in the medium to long term. and take advantage of tenants' increasing needs for attractive stupimenities and green labeled holdings. And with that, I'll hand back to Simon to talk about economics.

[Simon Garing, executive]

Thanks, Shane. So Oxford Economics forecast, the Eurozone GDP to grow by about 0.8% this year and 1% in 2024 before picking up beyond. The improvement appears to be limited to services and is slightly uneven across the countries with Southern European countries in a bit of a position with flattish profit in Germany and France. Restrictive financial and credit conditions alongside tighter monitoring fiscal policy settings may prevent recovery from gaining momentum in second half. Slide 24 shows the ECB has downshifted it's spiking pace to 25 basis points in May last week, signaling that it's nearing end of its tightening campaign. Oxford Economics forecast to further 25 basis point rate hikes in June and July this year and expect the ECB to pause after this. while Cromwell's in-house research team expects the rates may pick slightly higher at around 4% in the back end of this year. In terms of what that means to the dividend, a 100 basis increase in the Euribor to 4%, clearly impacts CEREIT's annualized DPU by $0.29 per unit or only 1.8%. In other words, we were largely through the interest rate cycle and the impact through on earnings. Headline inflation inched up to 7% in April, breaking 5 straight months of 4 readings, notably still well below the previous peak. As you can see on the chart on the right, as Europe enters the warmer spring and summer period, energy price is no longer contributing to the rise in inflation. While core inflation eased for the first time in a year, there are a number of themes identified in this slide, which could cause inflation to be higher for longer.

As you can see on Slide 26, European real estate investment activity was very weak in the first quarter, down 50% in volume as compared to the same period a year ago. The rise in financing costs and reduced leverage available by lenders has predictably led to heightened uncertainty and difficulties in pricing assets. These challenges translate into a drop in liquidity across all European real estate markets and could impact the timing of CEREIT planned EUR 400 million asset sales over the next 2 to 3 years and put some upward pressure on the LCV. The Russian-Ukranian war has certainly impacted investor confidence in the border nations like Poland and Finland, even if the fundamentals are not as materially impacted by the war. Valuations across the border underlie pressure as a result CEREIT's portfolio average initial yield is a healthy 5.7%, which provides a good buffer to the finance costs. Our #1 focus this year is to manage the balance sheet and asset sales and gearing levels and provide confidence to our bond and equity investors to help close the current 33% gap to the NAV of CEREIT's trade of EUR 2.3 billion and $0.15 to par value on our November 2025 MTN. And obviously, the high perpetual securities yield.

So in conclusion, we point to active asset management, delivering on our long-term investment strategy and responsible capital management to support a higher unit price. Starting with Asset Management, our focus remains on like-for-like income growth, maintaining high occupancy and loan WALE. The South European market fundamentals support our view that we will see further inflation increases in both grade A office and logistics market rents to offset the pickup in the financing costs. This should also offset some of the valuation impact from rising cap rates. In terms of investment strategy, I'm confident that we will reach a majority in the portfolio weighted to logistics and industrial by the end of this year.

Given CEREIT's current high cost of capital, we have put a temporary hold on acquisitions. Active divestments in office and in other aspects will help fund the development pipeline and offset the potential picture on LCV. We have commenced discussions with our banks to refinance the 2024 maturing debt and the RCF to further reduce the balance sheet risks. I am pleased with the support from our banks here to date and the hard work of Shane and our treasury team. The selective sales and degearing program, along with the rising finance costs will have a short-term impact on earnings, but we are doing everything possible to minimize this impact. while also taking the opportunity to improve the overall quality of the portfolio and provide investors with transparency on our path forward. I thank you for your continued investment and support as we navigate the macro headwinds with our resilient portfolio and dedicated management team. Thank you. And now with that, Cara open up to some questions. Thank you.

[Operator]

[Operator Instructions] We have first question from Rachel.

[Unknown Analyst]

I have 2 questions. First of all, what is the liquidity like in Europe? And as the REIT manager confirms that you can execute your divestment program for 2023. The second question is on Parc de Dock, how much will it cost over the period? And how are you funding it? Also, what are your expected returns? And will the stabilized yield be higher than your cost of debt. Oh sorry, I have the third one also, sorry, the third one is what is the cost of debt like in Europe now? Are you in a REIT rather borrowing at Euribor plus the spread?

[Simon Garing, executive]

Sure. Let me thank you for the questions. On the liquidity, we mentioned that the total volume of transactions in the first quarter was down 50%. We're fortunate in that many of the assets that we are looking to sell are not the big $500 million or the $1 billion mega deals that are struggling to find appropriate levels of financing. So our average asset size is around $26 million. So it's a much more liquid part of the market. Not only is it the institutional end, but we're also seeing private client investors in that sort of bite-sized dentists and doctors, et cetera. In terms of our competence, we've made the comment that over the next 2 to 3 years, we've identified around EUR 400 million of assets. That's more than we need from a CapEx and redevelopment pipeline. So it's got a conservative buffer in there. But certainly, the signs of the current stages of negotiations with our current sales, it's not the full 400 million. Obviously, we're not selling all 400 this year. But what we've targeted for sale this year, we're very pleased with the progress we're making with the various buyers. Some of our assets are being sold to local developers. So these very older B, C Grade office assets are able to be converted to condominiums or student housing or university buildings. So that's being sold to a higher and better use, if you will. And then some of our other office assets in the very core markets, such as Milan, again, we point out that the office markets in great A space is very tight at only a 3.6% vacancy and in Milan itself 2.7%. So we've got some really good traction on one of our Milan office assets, again, because the property fundamentals are very strong. In terms of Parc des Dock, for those -- Parc de Dock is logistics site in Paris. In the bottom of that picture is the new Paris Olympic Village for the next year's Olympics and then a new stadium just to the right-hand side of our property. And the new Paris Hospital is just in the left-hand side. So again, very well located. We're now 3 years into a 5-year planning process with the local Paris municipality, the local council and the French government with it's very strategic sites. It's a little early to outline exactly what will be granted from a commission, building permission perspective. But the diagram on the left-hand side, the plan on the left-hand side, should give you some sense of the scale that this is a very substantial project. It could be as much as 200,000 square meters of new commercial space, both logistics, life science labs, residential to accommodate all new workers in this district. So we're a couple of years away from being able to give you really concrete feasibility analysis, which I think was the second point of the Parc de Dock question, which was around stabilized yields on the project. But just as a reminder, we bought this site to EUR 96 million, and it's currently valued at around EUR 116 million. None of the development upside is currently in the valuation. The valuation is just as an as-is basis, given that it's currently about 74,000 square meters of very old last mile logistics will ease to the lots of UPS et cetera. So a bit early to talk about total projects, but we're really pleased with the progress, and we've got some very good dialogue happening with the local municipality in the local government. So we're certainly heading in the right direction. And I guess, watch this space as we work through those plans and the project feasibility. Our Board is also attained to point out to investors that we're very mindful of the risk appetite not just of the Board, but also of the REIT investors. So again, we point to the fact that the there is a cap of development risk of 10% of the total portfolio being committed in projects. This project can be very long term, could be over 10 years, just given a size and scale. But again, we'll manage the risks appropriately and we certainly won't put so much on the plate that it risks the overall portfolio. In terms of the Third question, I'll hand that over to Shane.

[Shane Peter Hagan, executive]

Yes. Thanks. So in relation to the debt and interest costs. So I mentioned before, we have now 84% of the debt, which is fixed and we have an average rate of 2.7% on that debt. I also mentioned that if the 3-month Euribor which increased to 4% then our total all-in rate would increase to 2.85%. So that's only just moving the 16% that is floating. So a couple of points is that the 4% of the Euribor, if you look at the yield curve today, longer-term rates are below 4%. So, if we can just go back to that slide. So you can see that there is an expectation that there's not the yield curve. This is just the 3-month Euribor, but there is an expectation that Rex will drop over time, and you can see that in the yield curve. And we think that, that will coincide quite honestly with the expiry profile of our debt. So we are fixed for 2 years and by the end of those 2 years, we would hope that we see the interest rates down to similar to what the yield curve is showing in today's terms.

[Unknown Analyst]

Okay. Sorry, I just want to clarify earlier, I think for Parc des Dock, you mentioned that it is currently valued at... is it 116 million or 160 million?

[Simon Garing, executive]

Yes, sorry, it's -- close to 1-6-0, 160. So we've gone from 96 to 160. And that's with very little movement in cap rate that is predominantly rent growth given the last mile logistics demand in [indiscernible].

[Operator]

[Operator Instructions] Simon, I might pass it back to you for closing remarks.

[Simon Garing, executive]

Thanks Cara, thank you to everyone for joining in this very busy period. In conclusion, we're very pleased to report to be very strong operating performance of the portfolio with grown high levels of occupancy, very good like-for-like income growth driven by very strong rent reversion, high tenant retention in our office and highlighting the bifurcation in the office markets, but if you have green certified grade A boardings, that you're certainly picking up or we are picking up market share from the old properties that may not have AC, may not have air filtration systems that's obviously post-COVID environment a lot of the employers are looking for.

So that underlying operating performance is almost offsetting the impact from the rise in interest rates. So to deliver a quarterly DPU that's slightly up on December quarter and only marginally about 2.4% less than the first quarter of last year, we think is a very pleasing result given the macro environment. In terms of our focus over the next 6 to 9 months, certainly going to be on completing the asset sale program in part to fund the very accretive development pipeline that we have as well as offsetting any downward pressure that may still be lagging in valuation cycle that's something that, again, we're very focused on.

So with that, thank you very much for everyone's attendance, and thank you for your investment and support of CEREIT. Thank you.

[Operator]

Okay. That's a wrap, thank you.