Japan Real Estate Investment Corp

TSE:8952

Earnings Call Transcript 2019-Q2

[Naoki Umeda, executive]

Good morning, everyone. I am Naoki Umeda, CEO of Japan Real Estate Asset Management. I know you are well aware that the office market has been strong for a while not only in Tokyo, but more generally across Japan. And when you think about a reason behind that it seems to me that this boom is not actually cyclical, but more likely a big flow or movement that has real legs to it. And when I dig deeper into that I actually come up with 4 keywords that may shed light on what's happening right now.

The first one is war for talent. It becomes really competitive to hire good people, especially young talented people, men or women, engineers, for example. A lot of companies are racing for talent and an elegant high-class office building is something that those companies are after in order to attract to those talented people. And I think that's partly why demand for office buildings is high right now.

The second keyword is work style. The work style reforms led by the Japanese government are underway. Now there is a general sense that working long hours is bad, but the real purpose of these work style reforms, I believe, is to raise individual productivity of an employee and improve efficiency. So again, more and more companies are looking for an office space that looks conducive to productivity or creativity or one that makes people working there happy. And health and well-being is another buzzword here.

The third key word is ESG, Environmental, Social and Governance factors. An increasing number of companies now spells ESG. So if they publically claim that ESG is important for their business, their office space should also be one that takes ESG seriously. Although, not so many companies choose an office space just because it meets their ESG criteria, I assume that more and more will do so in the future.

And lastly, the fourth keyword is co-working. You can say that the so-called co-working space has seen as exponential growth in Tokyo over the years. When you take a look inside in one of those co-working spaces, the interior is pretty cool and stylish and it comes with a large cozy common area. And it really looks an ideal space for networking and innovation and have got the sense that many have been provided, especially in Tokyo these days, and of course that's one of the reasons why the co-working office market is hot right now. But I think there is another important need that the co-working office spaces are filling in, which is the need to be flexible. For a lot of startups and venture companies with employees as few as 5, for example, in 6 months the number of employees may double, it could be as many as 30 or that could be 2 or 3 people instead. You never know what will happen to those companies, and we know the only thing constant is change.

So renting an office in the form of a regular lease contract doesn't make much sense to them. They would need a lease contract that is more flexible. The co- working office space meets their particular need, provides very flexible environment and offers the terms and conditions, which require no deposit and collect the membership fees instead of rent, which are a little more expensive than rent. And thanks to the emergence of the co-working office space and to the concept of shared office space, small tenants, those with only 5 employees or so are now given an opportunity to lease an office space, a new, big, high-end buildings, which used to be just unimaginable in the past.

The trend that I've just described with the 4 keywords doesn't seem to be transient. This is a very recent trend but I strongly feel that this trend has legs to it, and I expect it to grow really big going forward. What are your thoughts? With this rather long preamble, let's get started with our performance review.

Please take a look at Page 2. This is our performance summary. The dividend per unit was JPY 9,495, up JPY 159 per unit from the period before and it beat the forecast we announced 6 months ago by JPY 355 per unit. And as you can see the graph below on the left side, our dividend payout has been rising consistently for the ninth consecutive period at the end of September 2008. We also expect to raise dividend for the next period and the period after that, so it is highly likely that our dividend payout will rise for the 10th and 11th period in a row that we continue to see healthy growth in our dividend payout going forward.

With respect to internal and external growth as well as our financial strategy, I am going to explain more details later. But let me briefly tell you with regards to external growth that we disposed only the retail units for more ownership of Lit City Building, which sits just in front of Okayama Station in Okayama Prefecture, we sold it at JPY 650 million.

Let's go to the next page, Page 3. This is the summary of the public offering we did back in April this year. We raised JPY 39.2 billion and used that fund to finance the acquisition of the 3 properties, which you can find on the list on the right side of the slide. And as a result of the public offering, we lowered our LTV, the leverage.

Now let's go to Page 5. I will talk about our financial results with the period ended September 2018, and compare that with the period before. As you can see, basically, both revenues and profits soared from the period before. When it comes to operating revenues, let's look at external growth first. If you look at acquired and disposed properties, it was a big net increase of JPY 816 million, which came from the 3 properties we acquired using the fundraised through the public offering minus the disposed ownership of Shibuya Cross Tower, which we sold back in January this year. And with respect to operating expenses, the first item is also acquired and disposed properties, which represents the net amount of the expenses related to the 4 properties I just talked about.

So the expenses for the 3 properties we required would have pushed up the overall operating expenses rather significantly, but because the expenses Shibuya Cross Tower, which we disposed, were almost equally high, on net, the amount of expenses for acquired and disposed properties remains almost flat from the period before helping our profit to rise sharply.

Now with regards to internal growth, existing properties. Rent revenue was up JPY 201 million, which is as a result of consistent rent increase thanks to upward rent revisions and tenant turnovers. As for cash receipt in lieu of reinstatement cost, we received a good deal of it during the period before that's why we see a small drop for this period.

When it comes to operating expenses, utilities expenses went up significantly that's a seasonal factor and it was such a hot summer this year. But overall the operating expenses did not increase as much because property management expenses as well as repairing expenses decreased a little.

Let me tell you just one thing about tax expenses. As you may already know, there was reassessment of the ratable value for land and building taxes effective as of April this year, which has resulted in a significant increase in tax expense. Another thing I want to explain to you is the JPY 270 million gain on the sale of the retail units of Lit City Building, which I mentioned earlier. We applied reduction entry to this gain in accordance with the special provisions for taxation and reserve to 70% of the gain. So the remaining 30% contributed to the dividend payout for this period. As for nonoperating expenses, our interest expenses dropped to JPY 59 million for this period, but the drop was pretty much upset by the PO expenses so there is virtually no change. And as a result of all of these, the post-reduction dividend was JPY 9,495 per unit.

Please go on to the next page, Page 6. Here we compare our results with the forecast we announced 6 months ago. External growth turned out to be in line with expectations. So let me explain about internal growth. First, as you can see, rent revenue beat the forecast. Also we had to gain coming from the disposal of a property, which we didn't anticipate 6 months ago. Now when it comes to expenses, some of them came in lower than our expectations, utilities expenses in particular because we didn't want to underestimate. That's why you see these numbers which are below our forecast. And with respect to nonoperating expenses, interest expenses decreased more than we had expected. As a result, the dividend per unit to substantially beat our forecast because, in fact, we had expected to lower our dividend payout for this period to JPY 9,140 per unit. But it turned out that we were able to raise dividend from the period before and it beat the forecast by JPY 355 per unit to pay JPY 9,495 per unit.

Just in case you think that we could raise dividend because we got a again on the disposal of a property, let me point out that 70% of the gain was reserved, so that the only 30% of its actual value contributed to the increase in the dividend payout. As you can read the note on the right side of the page, the amount of contribution to the dividend was JPY 81 million or JPY 58 per unit.

So out of the JPY 355 per unit, which is the difference between the forecast and the actual, only JPY 58 per unit came from the gain on the disposal. That means even without the gain on the disposal, we could be paying out more dividend than we had paid the period before. Another thing I want to add to this is why we expected to lower the dividend payout. That is, firstly, because we anticipated some impact of the dilution that came with the PO we did back in April when we lowered the leverage. The second reason is the reassessment of the ratable value of our fixed assets, which necessarily inflates expenses significantly. That forced us to come up with a rather conservative estimate for the dividend payout.

Please go onto the next page and then take a look at Page 8. This is the forecast for the current period ending March 2019. At a first glance, it might look as though both revenues and profit would decline from the period before. But when you take out the JPY 270 million, which is the gain on the disposal of the property, both revenues and profit will nicely come better than the preceding period. As you can see the right side of the page, the rent revenue is expected to go up JPY 24 million, while operating expenses for our existing properties are projected to decline. So rent revenue is up and expenses are down, which means operating profit will go up. In addition, with respect to nonoperating expenses, interest expenses will continue to fall and there will be no PO-related expenses in the current period so that will boost our profit even higher. That is why we forecast the dividend payout will increase JPY 55 per unit from the period we just finished to JPY 9,550 per unit.

The next page, Page 9, shows our forecast for the period ending September 2019. Let's take a look at expenses first. The property taxes for the 3 buildings we acquired in 2018 will be added to our expenses and that will push up the expenses by around JPY 140 million. In addition, the ratable value was raised quite significantly back in April this year, but the actual taxes to be paid will go up only gradually over the next 3 years or so thanks to the tax burden reduction measures. That's why we expect the tax expenses to increase another JPY 90 million in the next period. On the other hand, revenues are expected to soar JPY 370 million mainly thanks to a brisk pace of upward rent revisions. So as you can see, for the period ending September 2019, both revenues and profit are expected to go up and that the dividend will be raised yet again to JPY 9,620 per unit, up by JPY 70 per unit.

Next to I want to explain about internal growth. Please take a look at Page 12. The latest occupancy rate of our portfolio at the end of September is 99.2%, the same number you saw 6 months ago. And it remains the highest number ever since we got listed on the exchange. And just so you know, the occupancy rate is expected to tick up to 99.3% for the period ending March 2019. We have been almost fully occupied and will likely to remain so in the future as well.

Please go on to Page 13. Here we are showing the latest figure for the total monthly contract rent of our portfolio. Compared to the last period ended March 2018, the monthly contract rent increased JPY 118 million per month to JPY 4,816,000,000. One big factor that pushed up the monthly contract rent is, of course, the acquisition Shinjuku Front Tower, which took place back in April, but we disposed the retail units of Lit City Building, so on net, the increase is JPY 98 million. That's external growth. With respect to internal growth, we also had our net increase thanks to tenant turnovers and rent revisions. And especially with regards to rent revisions, it's a net increase for the seventh consecutive period.

Let's move on to Page 14. These are market rents of our portfolio. Every 6 months, we ask CBRE to assess market rent for each of our properties, and this time 36 properties out of the 62 properties in our portfolio saw their market rent go up. As you can see the market rent increased generally across the different geographical categories, but in terms of the rate of increase, it seems the properties in other areas outperformed those in Tokyo. Just so you know, no property in our portfolio saw its market rent drop from the period before.

Next is Page 15. With market rents going up, the rent gap has also become bigger, which is a good thing for us. I think it will make much more sense to you if you look at the green line in the chart below. The gaps is getting wider in the sense that market rents are higher than our contract rents, meaning that we continue to be in a position where we have a leverage to negotiate for a higher rent.

Next, we are going to talk about external growth on Page 17. This is Shinjuku Front Tower, we acquired back in April, and the one below is Lit City Building, which we disposed its retail units only. We remain the owner of the office space, which is from level 3 to level 7. You see the prices over here.

Let's move on to Page 19. This is the total appraisal value of our portfolio, which grows in size but also becomes more valuable. The total appraisal value stands at JPY 1,158,140,000,000, which is the highest ever number since we got listed on the exchange. The amount of unrealized gain is JPY 230.2 billion, and the ratio of unrealized gain to the appraisal value is at 24.8%, which is also the highest ever number in our company's history. And based on the latest appraisal value, the net asset value per unit is JPY 535,088, which has been rising for the 13 periods in a row and also hit the record high since our company got listed on the exchange.

The next page, Page 20, shows a summary of the interest-bearing debt. Back at the end of March 2018, our short-term loans increased for a while because we needed to bridge a financing gap ahead of PO, but this time our interest-bearing debt decreased a little to JPY 384.4 billion. Our LTV also declined a little from the period before to 40.2% on a book value basis and a 33.2% on a market value basis. So we believe that our financial standing remains healthy.

Moving on to Page 21. Here we highlighted in yellow the average interest rate for the long-term loans that we need to pay back within the next 12 months and that's for the JPY 25 billion at 0.61% on average.

The recent borrowing costs are described on the right side of the page, and we think that it is still possible to see the interest expenses going down a little bit more from here. And here's how the interest expense has gone down so far and how it is projected to be based on these assumptions. For the period ending March 2019, our projection of the interest expense will not deviate from the assumptions and will be JPY 1,070,000,000. Just below the chart you see our credit ratings, which remain unchanged and our credit ratings continue to be at the highest levels among J-REIT's.

And that's it for the review of our financial performance for the period ended September 2018, but as we did last time, let us briefly discuss our initiatives towards ESG, Environment, Society and Governance. We consider ESG to be one of our top business priorities, and we are fully committed to promoting ESG. I told you last time that we created ESG office back in April with 3 dedicated members of our team working on many different ESG projects. And now we are seeing some tangible results.

Please take a look at Page 25. First of all, with respect to GRESB rating, we've got 5 star this year. Before we got 3 stars, so it is quite an achievement to get 2 more stars. For GRESB public disclosure as well, we've got an A, which is the highest mark. And you can read some of the reasons cited why we deserve an A. Also below that you can see that we obtained third-party assurance for the energy consumption and other relevant data we disclosed. We obtained assurance from auditing firm, Ernst & Young ShinNihon, and I believe we are the first J-REIT company to do so. These kinds of data are being disclosed voluntarily by companies in many different fashions. So you cannot be sure how credible the data are. So obtaining assurance from a renowned auditing firm adds to the credibility of our data. And that I believe is one of the reasons why they gave us an A.

On Page 26, these are some of the initiatives that we are taking on as the asset management company. JRE Asset Management became a signatory to the United Nation's Principles for Responsible Investment, PRI as well as UNEP Financial Initiative. Also we are a member of the UN Global Compact because our sponsor Mitsubishi Estate is participating it as a group. We just not side onto these initiatives but actively participating in real estate working groups of the PRI and UNEP FI, for example. In addition, we are a member of GRESB's Benchmark Committee and have engaged in a discussion in our effort to be part of solutions.

Please take a look at Page 27. This is about green the building certifications. In 2017, 6 of our properties were certified as DBJ Green Buildings, but today 20 properties in our portfolio are certified. And so far on an acquisition price basis, more than half, 58% of our portfolio are Green Building certified properties.

Lastly, on Page 28, we talk a little bit about green bond. Just a couple of weeks ago we issued green bonds worth of JPY 10 billion. What is unprecedented or unique about this green bond is that part of the fund will be allocated to the refurbishment of one of our properties. As you can see at the bottom, some of the fund raised through green bond is going to be used for the refurbishment projects for our Shiba 2Chome Daimon Building, which include the installation of high-efficiency air conditioning and LED lighting to save more energy.

That almost brings to an end of my presentation and this is the last page, Page 29. As usual, we are showing a picture of me playing golf, in fact, I just hit a great driver shot and I'm bringing about the brand-new driver I'm holding in my right hand. For those of you who don't play golf, let me explain a little what's going on here. Speaking of golf drivers, they become so much better these days. The club head, which strikes the ball, becomes much lighter than it used to be and is made out of metal that has high spring effect. As it becomes lighter, the head gets bigger and bigger, the bigger it gets, the wider the sweet spot. In addition, some club heads change the location of their center of gravity to reduce spin and they have many other features as well. Not only the head but shaft is evolving. It's now made of carbon fibers and it becomes more flexible. So if you choose the right club, the best suits your style of swing, you can technically hit a perfect shot. And as it becomes lighter, the shaft gets longer, the longer it gets, the farther you can hit the ball. The technology is improving constantly and evolving fast. The same can be said about office buildings. It's been such an evolution. When I joined Mitsubishi estate, that's 30 years ago, there was no PC on the desk, there was no e-mail and no one had a cell phone. The way we worked was totally different from today. Today raised flooring is ubiquitous, everyone has a PC and a cell phone and that's the environment where we work. And as I mentioned at the beginning, now the different waves are coming, office space as we know it will also change. I'm not sure whether we can call it evolution, but it seems more obvious that the tide is changing right now. We as asset manager ought to feel where the current tide is taking us and always be able to look one step ahead of others, and that's the message I wanted you to take away from this picture. My apologies for talking too long. Thank you very much for your patience.