alstria office REIT AG

XETRA:AOX

Earnings Call Analysis

Alstria Office Q3 2023 Stable Performance

In Q3 2023, Alstria Office REIT demonstrated a consistent operational performance with revenues up by 3.7%, despite a 21% drop in Funds from Operations (FFO) due to increased leverage and interest costs. The portfolio value remained stable, as gains from capital expenditure offset a decrease of approximately EUR 91-92 million. New lease volume decreased, with large leases over 5,000 sqm becoming rarer and smaller leases under 2,000 sqm turning more common. The proposed dividend of EUR 1.41 per share will move the net Loan-to-Value (LTV) closer to the target of 50%. The firm remains committed to refurbishment over new construction, aligning with its focus on reducing embodied carbon.

Company Operational Performance and Balance Sheet Development

Alstria's operating business is progressing as planned, with a slight uptick in revenue by 3.7% compared to the same period in the previous year. The Funds From Operations (FFO), however, have dipped due to an increase in leverage, which in turn has led to higher interest costs. The company's leasing activities are consistently robust, nearly mirroring last year's performance despite a marginal decrease in new leases. This was counterbalanced by the retention and extension of existing tenants' leases. Financially, the balance sheet has evolved predictably, excluding the proposed special dividend. Portfolio value has faced some headwinds with a EUR 91-92 million portfolio devaluation, but this was offset by capital expenditures on the property, giving the appearance of stability.

Leasing Pipeline and Balance Sheet Details

The leasing pipeline remains substantial, with a higher quantity of active leases indicating a shift toward smaller-sized leases. On the balance sheet front, investment property values are stable due to the interplay between depreciation and capital expenditure. As for the net financial debt and Loan-To-Value (LTV) ratio, they are holding steady with a slight decrease in equity because of asset devaluation. A snapshot pro forma analysis reflecting the recommended dividend payout shows that it would push the net LTV closer to the 50% target, decrease Global Real Estate Investment Trust (G-REIT) equity ratio above the minimum threshold of 45%, and reduce the EPRA Net Tangible Assets (NTA) by the dividend amount.

Profit and Loss Dynamics

Alstria experienced a modest increase in rental income, indicating strong operational performance against a backdrop of a difficulty in the investment market. The Fund for Operations (FFO) has seen a 21% decrease, mainly attributable to the cost of increased leverage and higher interest rates. There was a reduction in Selling, General & Administrative (SG&A) expenses compared to the previous year, resulting from exceptional costs incurred in 2022 related to a transaction with Brookfield being eliminated. The FFO bridge indicates that finance costs had the most significant negative impact on the company's financial performance.

Net Financial Debt and Refinancing Status

Alstria has been proactive in refinancing its debt, successfully managing 2023 exposures and working on 2024 mortgage loans. The company's average debt maturity stands at 3.5 years, but there's an expected increase in the average debt cost due to bonds maturing in 2025 and 2026. Pro forma alterations, post-dividend, mainly affect the company's cash position and an additional EUR 100 million credit line drawdown. This activity anticipates an extension in average debt maturity and marginal increase in overall debt capacity.

Environmental, Social, and Governance (ESG) Initiatives

Alstria's ESG approach highlights a strong commitment to reducing embodied carbon by prioritizing refurbishments over new builds. In 2022, the company achieved a 26% reduction in energy usage across its portfolio, which is advantageous compared to the EU averages. Alstria's focus on retrofitting assets has also led to notable savings in primary energy consumption. Moreover, they aim to transition from fossil fuels to electricity and district heating, the latter of which are likely to decarbonize sooner. In terms of occupational carbon, emissions largely originate from tenants' operations, an area beyond the company's direct influence.

Business Outlook and Strategy

The company maintains an optimistic outlook for the leasing market, observing strong activity in smaller spaces which may indicate some potential for rental growth. Tenants are prioritizing space quality over price, suggesting a trend towards higher-quality offerings. The investment market, on the other hand, is expected to be stagnant with minimal transactions anticipated for the end of 2023 and possibly extending into the first half of 2024, due in part to a significant bid-ask gap. Alstria continues to concentrate on its strong refurbishment pipeline, believing in the sustained demand for modern prime office spaces catering to tenants' evolving needs.

Dividend Policy and Potential Additional Dividends

Alstria has suggested a special dividend of EUR 1.41 per share. Any consideration for distributing additional dividends beyond the proposed EUR 250 million would follow a formal process, which requires adequate notice and compliance with governance regulations. This implies any substantial change in dividend payouts cannot be requested and completed on a short-term basis.

Earnings Call Transcript 2023-Q3

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the alstria office REIT-AG results Q3 2023 Call. At our customer's request, this conference will be recorded. [Operator Instructions]

And I will now hand you over to Olivier Elamine, who will start today's conference. Please go ahead.

[Olivier Elamine, executive]

Thank you very much. And thank you, everybody, for joining us for the Q3 result presentation from alstria. My name is Olivier Elamine from cloudy Hamburg this afternoon, and I'm here with Ralf Dibbern, which is heading alstria's Investor Relations. Before we move on, a short reminder of the disclaimer regarding the forward-looking statements and the duty to update.

And without undue delay going into the quarter results. The operating business of alstria has developed according to our plans, with revenue slightly up year-on-year at 3.7%. FFO is down, as you would expect, given the increase in the leverage that we have in the company and the increase Therefore, of the interest operating business is performing well, with our overall leasing activity pretty much in line with what it was last year. I will comment a bit more on that later on in the presentation. But we had slightly less leases, which were compensated by more retention and lease extension from existing tenants.

The balance sheet has developed again as expected, and that's obviously prior to the special dividend that we have suggested to the AGM, which we will hold on the 1st of December. And as always for those calls on the third quarter, we have published this morning our ESG report, which I encourage you to have a look at, and I will be commenting on that as well in a minute.

If we look back at the portfolio, the slide with you following alstria, you know pretty well, there have not been massive changes in the overall portfolio of the companies. The investment market being pretty slow right now, we have not been extremely active on that front. The overall value of the portfolio has remained around about stable for the third quarter, but that's relative stability is actually driven by 2 conflicting elements.

One of them is the decrease in the value of the portfolio by around EUR 91 million, EUR 92 million, which was compensated by CapEx spend on the portfolio, which basically gives us apparent stability, which translates still in the P&L and a loss at the end of the quarter. From a rental perspective and the vacancy rate, we remain pretty much stable. And the same is true then for the valuation yield. Letting volume, as we discussed before, we had 16,000 square meter of new leases, around 60,000 of renewal. The average rent on the portfolios have continued to go up slightly compared to where it was at the end of last year. What we're seeing right now on the letting market is still an active market, and we're still seeing some rental growth happening whenever we are leasing space. However, and this was a comment that we've made already in the 2 previous quarters this year, there is a lack of substantial large leases currently in the marketplace, and most of the leases we're working on are smaller leases. And what I mean by smaller leaders is lease which are usually smaller than 2,000 square meter. So the large leases of 5,000-plus are becoming extremely rare right now in the marketplace.

Our leasing pipeline is probably just as big as what it was last year. but the number of leases we're working on is 3 or 4x bigger, which reflects the reduction in size of the leases. And I'm sure we will have the opportunity to discuss that further if you're interested in the Q&A.

If we move to the balance sheet. Investment property, we've discussed that a second ago, remained relatively stable, which is reflecting the net impact of some devaluation and the CapEx that was spent, for like the sake of clarity, we did not have an external valuation in the Q3. So this will only come with our annual results presentation, and we haven't started that process yet.

Before you ask, equity is slightly down as a result of this devaluation and our net financial debt is pretty much in line with what it was before. Net LTV at 44.5%, reflecting the change in cash and the stability of the amount of debt. And the EPRA NTA, as we discussed before, very much stabilized, EUR 14.50.

Pro forma from the dividend that we suggest, we thought we could give you a snapshot. So the pro forma analysis that you're having here is only compounding the effect of the dividend payment, which is, in actual fact, translate into reduced cash of EUR 250 million and reduced equity of around about the same amount.

The dividend we're suggesting is around EUR 1.41 per share. That will increase our net LTV closer to our overall guidance and target, which is 50%. It would reduce our G-REIT equity ratio, but keep it comfortable above the minimum required of 45%, and it will obviously reduce the EPRA NTA by the amount of dividend that we are paying out. Dividend never made anybody richer, it's just reduced kind of NAV and translate that into cash for the shareholders.

If we look at the P&L, we have a slightly higher rental income than last year for the same period, which is reflecting the operational performance of the company, which, as we've discussed before, is still relatively strong. Putting aside the investment market on the letting side, we still had a strong performance. This is also obviously relating to the impact of the strong indexation that we have on our leases, most of our leases being related to CPI.

Fund for operations are down 21%, which reflects essentially the increase in leverage and, therefore, the additional interest rate cost which are impacting the FFO. SG&A are down year-on-year. And if you remember, we've been discussing that over the last few quarters. This is essentially reflecting the fact that, in 2022, there was a number of elements -- extraordinary element in there which were related to the transaction with Brookfield and those elements, have been now washed out and that's explained mainly the reduction in SG&A that we are seeing year-on-year.

If we move into the FFO bridge, and just to see how the operational performance of the company has developed. Again, it shouldn't come as a surprise. The biggest impact that we have in the FFO bridge is related to the financial result, which is EUR 16.7 million down. On the other operating results, this is related to a number of tenant compensation that we have captured in the year 2022, which we did not have this time around because less tenant has been leaving the portfolio. But the main material impact here is really related to the financing cost and the higher LTV and more expensive debt, which is negatively impacting overall FFO.

Moving on, on the debt side. On the net financial debt, we have been successfully refinancing our debt exposure for 2023. We have a little bit of further debt exposure in 2024 coming due, which are -- the maturity we are currently working on, which are 2 mortgage loans on our portfolios. And the next bond maturity that we have is going to come in 2025.

Our average debt maturity is currently 3.5 years and our -- obviously, our average cost of debt is crawling up and will be crawling up as we move forward given that the 2025 and 2026 bonds are yielding substantially below where the marginal cost of debt of the company is today.

Again, looking at the financial debt slide, pro forma of the dividend. So here, the main impact is essentially the change in the cash position of the company and the fact that we have been drawing down on EUR 100 million credit line that we have secured recently from one of our banking partners. You can see the impact pro forma of those elements on the slide on the overall debt capacity, with the extra debt coming up and maturing in 2028 and the average debt maturity is extending slightly because of that impact.

Moving away for a few minutes from the numbers and the KPI and the finance, and looking a bit more into our ESG report and what we've been doing over the years. As you know, we have been extremely focused as a company almost since inception on the issue of embodied carbon, and we are actually glad that more and more in the industry are getting aware of the issue of embodied carbon in the way it needs to be addressed.

The way we are looking at it as a company as the best approach for the embodied carbon is to basically not to get involved into new construction as much as possible, and remain, as much as possible, within the refurbishment business, which is exactly what we're doing as a company. The purpose of the slide that you have here, which might be a bit obscure is -- and that's one of the main theme of our ESG report is the real estate industry is spending an enormous amount of time and energy trying to measure exactly and precisely how much embodied carbon goes into new construction and/or in construction in general, and a lot of arguing that as long as we have not measured properly, we can't really play and kind of reduce it. Our view is slightly different. We know that there is a lot of embodied carbon within construction. There is no point into knowing exactly how much that is, and we should be working on reducing it as much as we can. And we actually think that regulation is going to force us to go there no matter what we do as an industry. So we are happy that we have been taking the route we're taking. And we believe that the business that we're having, which is to continue refurbishing and retrofitting existing assets, it's probably going to lead to a substantial better result than the one where you are building up a new building on greenfield development.

If we look at the average results that we have generated over 2022 with respect to our sustainability, on the operational carbon this time, we have been reducing our energies across the portfolio by around 26% year-on-year. And this is not simply as an effect of our greatness. I think we should not confuse a bit of luck here with how good a manager we are. It has a lot to do with the fact that there was a milder winter. Some of it has to do with the work that we have been doing on the portfolio. But we end up the year with an average of 101 kilowatt hours per square meter per year.

And to put that in perspective, the overall EU target is -- for the net zero targets across the EU is at 85. So we're still like 15 kilowatt hour per square meter per year higher than the average, but we're pretty close. And the average that you have across the EU, depending on the sources that you're using, is closer to 150, 160 kilowatts so we're doing kind of substantially better than the average across the European Union.

We have been working, as we discussed, a lot on retrofitting assets. An average project takes around 35 months. We usually spend 315 kilograms CO2 per square meter of build, but we also reuse 68% of the material that we have on site. And we usually save, on average, substantially north of 30%, which is the EU taxonomy target from primary energy, with an average across our project at around 47% of primary energy reduced from start to finish. If we look at very simple KPIs, and again, this is really a very small snapshot of our ESG performance. I would encourage you to look at the report itself. We are showing on this slide the distribution of our energy across the portfolio with obviously the aim to reduce as much as possible fossil-fuel heating, which is an ongoing process, and relying more on electricity and district heating, which are the 2 fuels that are likely to decarbonize first and faster.

And we're also showing the split between GHG emission. As you can see, the lion's share of the emission is still coming from the tenants and the tenant operation within the portfolio, which is obviously outside of our control, but it's still happening within our realm. So that's going to be it for me on the ESG. And again, I encourage you to look at our website and we would be happy to answer any questions you would have on that front, either in the call or take them off-line.

If we go back to the underlying business, our outlook is not fundamentally different from what we have discussed. In the half year, we still see that the leasing markets are active, and we expect them to remain active, with a caveat that this is happening essentially on smaller area size. And in that segment, we do see some rental growth happening where tenants are looking to a better quality space and are less concerned about the price they're paying, but are more concerned about the ability of the asset and the space to deliver the kind of added value they're looking for their office.

On the investment market, we still expect to have no to limited activity in the end in 2023. I think it's pretty much too early to say whether 2024 is going to kick start again. But there is still a massive gap between where bid and ask spread are, and I think anybody which is currently in the market and selling an asset is considered as being distressed. And therefore, you're seeing a substantial reduction in overall volume in the investment market, which I think might last probably for the first 6 months of 2024 at least.

We are, as a company, focusing on continuing working on our portfolio and our refurbishment pipeline, which offer still substantial opportunities. And we are plowing on with our plans. We think that there is currently room to continue to deliver modern prime space to office tenants, which are going to be looking for it as they are reshuffling to their office portfolio. So we're still very much comfortable within the underlying business plan, and approach of the company has been having to [ bolster ] the market and its portfolio. And we're looking forward to continue on our project in that realm.

So that's it on my side, for the Q3. I will be happy to take any questions you might have as part of the Q&A. Thank you very much.

[Operator]

[Operator Instructions] Our first question today comes from Michael Chakardjian from BNP Paribas.

[Michael Chakardjian, analyst]

I had a few questions. So you had $170 million of encumbered assets during the quarter. Was this used to raise the $100 million of bank debt you showed that matures in 2028? And if so, can you tell us the terms on it? And the implied LTV, which I believe would be 60%. The second question is, in your 1H results, you noted that there were significant legal transactions executed with respect to related parties during the reporting period. Was this also the case in the current quarter?

And third question is, can you provide an update on the Brookfield's [ topco ] loan that is maturing in a few months? Have you been kept in the loop in the discussions? Are you preparing already to -- actually, many more dividends in case, has there been any discussions on that? That's it for me for now.

[Olivier Elamine, executive]

Yes. So to take -- well, first of all, thank you very much for the question. And to take them one by one. The EUR 170 million of encumbered asset, it is actually the loan that we have taken. It's a 5-year loan, as you rightly mentioned, 60% current LTV. Our loan are usually covenant-lite in the sense that we don't have any default covenant in our mortgage loans, but they come with cash trap component if there is a default, so -- if there were a breach of the covenants. So we don't have any default covenant, and I think that's important to bear in mind.

All those loans are on the balance sheet of the company. So there are recourse to the entire balance sheet of the company as well. It's -- and as you rightly mentioned, it's a 5-year loan. The spread over Euribor is around 150 basis points for that specific loan. We -- on the related party transaction that you mentioned, this is related to the fact that our shareholder has been active into the marketplace in buying some of our bonds, which basically trigger a related party transaction, simply because they are a shareholder and they become our creditor as well. And they've been doing that, I mean, over the last few quarters and trying to take advantage of the weakness in the underlying bond market. And that's basically what explains that. I don't have real visibility in -- I mean, beyond what is currently in our numbers, how much of that is happening, because we're just being influent essentially at the end of the quarter about the amount of related party transaction impact.

[Michael Chakardjian, analyst]

Were there any happening during this quarter?

[Olivier Elamine, executive]

I think they were. Yes, that's what you see in our reports. So the number have increased compared to last quarter. With respect to the topco loan, I mean, we are not in the loop because this is for us equity essentially. So we don't have substantial visibility on that. We know there are conversation happening, but we're not involved in any of those conversations. And I mean, from a company perspective, that loan is -- I mean, have no recourse to any of our assets. So from our perspective, it's literally equity. So we look at it as so.

[Michael Chakardjian, analyst]

And then am I right to assume then if Brookfield wanted to have more cash upstream, there would need to be a process which you need to be in the loop on, and then have a -- you need to do some governance to approve it before you could just say like, hey, please send up some more dividends?

[Olivier Elamine, executive]

Yes. So the dividend that we're paying out today, I think, shouldn't come -- or we're suggesting to pay out today shouldn't come as a surprise. Essentially, when we announced the transaction with Brookfield and as part of the transaction, we already discussed and already disclosed to the market that we would be releveraging the company. And as part of that process, we would be issuing around EUR 850 million of new mortgage debt, which we did, and selling around EUR 150 million of assets, which we did. And we would pay the proceeds of those 2 transactions [indiscernible].

[Michael Chakardjian, analyst]

I understand. But really I'm asking about if they wanted to do any additional dividends above the EUR 250 million, that there would be a process that would have to follow and they can't just ask you for more now and you would need more heads up than to, say, like a month essentially?

[Olivier Elamine, executive]

Yes. So I mean, alstria is still an abundant company. So my job is to take care of the corporate well-being of the company. So -- and so my objective is not to pay a dividend, my objective is to make sure that the company operate properly and follow proper governance rules. So we would not be paying a dividend if we don't have the means to do it. And yes, they cannot just come and take the money out of the bank account, if that's what your question is. It needs to follow...

[Michael Chakardjian, analyst]

And then can I squeeze one more question in? Can you give us some CapEx guidance for the next year or 2 and what you believe are could be maintenance levels of CapEx? So basically, I'm just trying to see, do we expect CapEx to go down? What's your committed development CapEx like for the next year or 2? And what would your maintenance be if you wanted to actually reduce your CapEx spending?

[Olivier Elamine, executive]

So essentially, we spend -- we have been spending around EUR 150 million on annual basis on capital expenditure, which is like that encompass almost everything. So maintenance and investment in the portfolio. And we basically work on relatively small projects that are committed one after the other. So our total commitment is usually not as big as that. With our current plan -- and the way we've been funding for those CapEx -- and that's unrelated to Brookfield, not Brookfield. The way we've been funding those CapEx over the years have been through property disposals, where we basically recycle the cash of the disposals into CapEx.

What we are -- so we still have cash on balance which would allow us to go for another probably 12 months of CapEx, so for next year. If there is no activity in the investment market and if we're not able to dispose of assets, then we will need to kind of slow down on our CapEx activity. But that's not the case as we speak from today's perspective. So we're very much dependent -- and the speed at which we can deploy CapEx is very much dependent on our ability to -- or actually to the investment market to restart and our ability to sell within the market.

[Michael Chakardjian, analyst]

Your yield on cost in your development, could you remind us what it is again?

[Olivier Elamine, executive]

Yes, it's around 6%, 6.5%.

[Michael Chakardjian, analyst]

Would it not be more efficient to use that capital to buy back bonds or to...

[Olivier Elamine, executive]

Well, that there is clearly an argument about that, and there is a discussion about whether or not we should be buying back bonds. But at the end of the day, we're still a real estate company, so -- and capital allocation is something you need to look at quite carefully. 6.5% is the yield on cost, but it's not necessarily the total returns because we would expect that you're going to have some yield compression. So our total return and leverage return would be closer to 8%, 9% on those assets and levered.

So return on equity is probably kind of double digit. Whereby, depending on which bond you're looking at, the return, it's probably slightly short of that. But it's clearly -- I mean, it's clearly a question that we need to ask ourselves.

[Operator]

Our next question comes from the line of Kai Klose from Berenberg.

[Kai Klose, analyst]

Two questions. The first one, could you indicate what is the current amount of amortization in the -- alstria has to pay for the outstanding mortgage loans? And then how has this maybe changed in new loans being waived from a bank's perspective, if they're asking a more [ annual ] amortization?

[Olivier Elamine, executive]

The answer is 0, and we never paid less than 0.

[Operator]

The next question comes from the line of Toby Hanson from Boundary Creek.

[Toby Hanson, analyst]

I wondered if you could give a figure for what the rental reversion is in the current portfolio.

[Olivier Elamine, executive]

That's a tricky question because it's really dependent on what you call rent reversion. So the average rent that we're currently getting on alstria's portfolio is around EUR 14 per square meter, EUR 199 million contractual rent. And I think if you believe what the external value is saying, the argument is that fully let, so assuming everything is let everywhere. But with the current shape and form of the portfolio, your ERV would be closer to somewhere around EUR 240 million, which would give you like a 20% reversion in the portfolio.

In reality, we usually never relet a building in the shape and form in which it is today. Because our business plan is to invest CapEx in the building and to move the kind of EUR 14 per square meter that we have on average somewhere around -- between EUR 25 and EUR 30, which is more where the prime market trend is going to be in the different markets in which we evolved. And that's usually what we have been doing over time.

So we tend to invest somewhere around EUR 1,500 to EUR 2,000 per square meter of CapEx, and move the rent from 14% to almost kind of double it or try to get to level where we would double the rent. And this is the kind of business plan that we usually run on our assets. So I don't know if I'm answering your question, but what I'm saying is if you look at the reversion that we're showing, assume that you keep the asset as they are, which we usually don't.

[Toby Hanson, analyst]

Perfect. No, no, that's helpful, nonetheless. And then you mentioned that you were in talks and there was program [ in the ] June and August bank loan maturities for next year. Can you give us a guide on when this process might be finished? I mean it seems like if I just look at the LTV levels at which you've [ got the ] recent bank debt, then does it sound like the banks are being kind of any more kind of cautious around exposure to you or being more cautious on the LTV levels?

[Olivier Elamine, executive]

I mean, we -- I mean, some of those loans have extension options which are in our hands. So basically, we would just need to send a notification that we would like to extend, and that's on one of those loans. The other ones, we are currently in discussion with the banks to extend the maturity. But you need to bear in mind that this is a loan where we actually increased the volume with the same bank a few months ago. So -- and we have not increased the maturity at that time because we also signed another loan with the same bank, and then we were just using -- we're going to reuse the documentation.

So I think those conversations are doing well. We don't have really an LTV issue right now with the banks, and I don't expect that we have the one, simply because those 2 loans were valued by the banks less than 12 months ago and the banks are still comfortable with that. With respect to the exact timing, the sooner the better. But in today's market, basically -- I mean, if you look at the priority of the banks and where they're putting their efforts, I'm afraid we're not on the top of the list of the things they're concerned about. So this is basically where we tend to fall behind the queue on when they have time to basically cater for us because there's still like 8 months on both those loans. What we're also trying to do or starting to do and what we'll start to do in early 2024 is to start working on the bond maturing in 2025 and then prepare for the refinancing of that. Also, most probably in the mortgage market looking at how the bond market is playing. So I don't know whether that answers the question.

[Toby Hanson, analyst]

Yes, that's very helpful. And yes, let's hope you [ stay off ] the interest list for the bank.

[Operator]

[Operator Instructions] At this time, there appear to be no further questions.

[Olivier Elamine, executive]

Well, then thank you very much for your interest in the company. As usual, if you have follow-up questions or if you want to take some of the conversation more privately, please feel free to reach out either to Ralf or myself, we'll be more than happy to accommodate your questions. And we're -- we'll be also looking forward to have our presentation and discussion around the full year results of the company sometime in early 2024.

Thank you very much for your interest. Have a nice afternoon. Bye-bye.

[Operator]

Thank you. That does conclude our conference for today. Thank you all for your participation. You may now disconnect.