British Land Company PLC (OTCPK:BTLCY) Q2 2024 Results Conference Call November 13, 2023 4:00 AM ET
Company Participants
Simon Carter – Chief Executive Officer
Bhavesh Mistry – Chief Financial Officer
Darren Richards – Head of Real Estate
Conference Call Participants
Matt Saperia – Peel Hunt
Zachary Gauge – UBS
Simon Carter
Good morning, everyone, and thank you very much for joining us for our half year results. Well done for battling in against the storm Debi. We appreciate you coming today. We’ll follow the usual running order. Bhavesh will take you through the financials, Darren the operational performance, and I’ll wrap up on the strategy and the outlook.
But before we do that, I just wanted to share the headlines. We’re really pleased with the operational performance in this half. We’ve continued to lease well right across the business with 1.6 million square feet of leasing, 12% ahead of ERV. We’ve also controlled costs well despite inflation. And taken together, this has led to profit growth of 3%.
The macroeconomic and geopolitical backdrop remains uncertain as we know, and interest rates have increased since we last reported. As a result, we’ve seen further outward yield shift of 23 basis points, though this slowed during the period. Importantly, rental growth has accelerated with ERV up more than 3% across all three of our submarkets. This has cushioned the impact on portfolio values, which were down 2.5%.
In the near term, movements in interest rates, both up and down, will continue to affect property values, but rental growth is likely to be the dominant driver of medium-term performance. We’re now expecting this to be at the top end of our guidance range for each submarket. And as a reminder, that’s 2% to 4% for campuses, 3% to 5% for retail parks and 4% to 5% for London urban logistics.
Combined with a net equivalent yield of more than 6% and development upside, that makes for an attractive future return profile, a key theme today is the importance of being in the right submarkets as bifurcation accelerates. The best parts of London are thriving. Take here at Broadgate, for example. We’re at the northeast corner of the city of London, but performance could not be more different from that of the city. Rents are up nearly 4% in the last six months and vacancy is 3% compared to 11.5% across the city as a whole.
It’s a similar picture with our retail parks. They’re practically full compared to vacancy of 14% across the wider retail market. And in London Urban Logistics, there’s 2 million square feet of demand that can’t be satisfied compared to increasing vacancy for big box. Since we launched our strategy in 2021, our portfolio has been transformed campuses, retail parks and London urban logistics now represent nearly 90% of our business. More of this later.
I’ll now hand you over to Bhavesh who will take you through the financials. Bhavesh, over to you.
Bhavesh Mistry
Thank you, Simon, and good morning, everyone. Let me take you through our financial results for the first half of the year. We delivered £142 million of underlying profit, representing 3.4% growth in the period, driven by 2% like-for-like net rental growth and a continued tight grip on costs. Earnings per share were up by 3.4% at 15.2p, and we’ll pay an interim dividend of 12.16p per share, up 4.8%. Net tangible assets were down 3.9% at 565p per share.
The key movement was a 2.5% decrease in the value of our portfolio due to a 23 basis point increase in yields, which is partly offset by strong rental growth. LTV increased marginally to 36.9% as the impact of value declines was cushioned by disposals we executed at good prices, and the surrender payment we received at 1 Triton Square. Group net debt to EBITDA also improved to 6x.Let’s look at net rental income growth.
Starting on the left of the slide. Net divestments resulted in a negative £6 million through the combination of our well-timed disposal of a share in our Paddington campus and nearly £150 million of retail parks acquired over the last 18 months. Developments reduced net rents by £5 million due to works commencing on the refurbishment of 3 Sheldon Square at Paddington and a rates rebate for Houston Tower received last year after we de-rated it for development.
Provisions for debtors and tenant incentives were £9 million benefit. Although our rent collection has returned to pre-pandemic levels, in this half, we received a payment from Arcadia due to a strong lease guarantee we had negotiated that allowed us to collect close to 90p on the pound on the sums that were owed to us. We also delivered a £4 million increase in like-for-like net rents in the period.
Let me now take you through the drivers of this. On campuses, strong leasing, particularly at Broadgate and Paddington delivered £4.5 million of like-for-like growth, and our campus occupancy now stands at 94%. Lease events can be lumpy, and we saw £4.1 million of campus expiries in the period, mostly at Regent’s Place, whereas leases of runoff, we have chosen to convert some of the space to target innovation and science-based occupiers to drive higher rents in the longer term.
Storey has also been impacted by the timing of expiries and had negative £2 million of like-for-like income due to the timing of expiries at space we expect to fill in the second half. We’re pleased that storey rents continue to be at an average 18% premium over traditional office net effective rents. In Retail & London Urban Logistics, we delivered £6.4 million of like-for-like growth. We continue to see strong leasing, keeping our retail parks full and filling vacant space in our shopping centers. Darren will take you through our operational performance in more detail shortly.
Turning to our income statement. Starting with the gross rental income. Like-for-like growth partly offset the impact of the Paddington disposal in July last year. And as a result, gross rental income was down 2.8% in the period. Property operating expenses reduced by 38% as a function of strong occupancy and the impact of collections I mentioned earlier. As a result, our net rental income margin improved by 340 basis points to 93.9%.
Fees and other income increased by £2 million, with good activity in our Broadgate and Paddington joint ventures. Administrative expenses were also down half-on-half at £43 million as a result of our ongoing focus on cost control. I’m pleased that our actions in the half have reduced our EPRA cost ratio to 14.8%. And whilst we have benefited from some one-offs in the half, we still expect our full year EPRA cost ratio to improve year-on-year. Net finance costs were £57 million, up only £1 million. Our hedging provided protection despite significant increased market rates through a mix of fixed rate debt, swaps and caps. We are fully hedged at September and 99% hedged for the next six months.
Our weighted average interest rate at September was 3.4%. Underlying earnings per share was 15.2p, up 3.4%. Our dividend policy is to pay 80% of underlying earnings per share, resulting in an interim dividend of 12.16p per share, up 4.8%. This is higher than EPS growth as a result of the rental concession restatement made in the prior period. Moving on to NTA. Property valuation declines, reflecting the impact of rising interest rates on real estate asset yields, the dividend paid and other movements together reduced NTA by 51p.
This was partly offset by underlying profit and the surrender premium we negotiated at 1 Triton Square, and Darren will provide more detail on that shortly. As a result of these movements, NTA declined by 3.9% to 565p and our total accounting return was a negative 2%.Turning now to our balance sheet, which I’m pleased to say is in good shape. We continue to have excellent liquidity. At September, we had £1.7 billion of undrawn facilities and cash. And based on our current commitments and debt facilities, we have no requirement to refinance until mid-2026.
In August, Fitch affirmed all our credit ratings, including senior unsecured at A with stable outlook. We’ve completed £600 million of financing activity. For British Land, we extended £250 million of bank revolving credit facilities in the half and post period end, raised four new term loans totaling £350 million, all to 2028.This debt, which is unsecured and flexible continues to support our strategy and has the same financial covenants as all of our unsecured finance with no interest cover covenants. At September, our headroom to covenants remained significant at 45%. Net debt to EBITDA on a group and proportionally consolidated basis have improved to 6x and 8x respectively, while LTV was marginally up at 36.9%.Let’s look at movements in LTV, where we’ve kept a tight focus over the period despite rising market rates, which impacted yields.
Our portfolio valuation increased LTV by 140 basis points. Acquisitions and investments in our committed development pipeline together increased LTV by a further 210 basis points. This was largely offset by disposals of the noncore office and data center portfolio and receipt of the 1 Triton Square surrender premium. And as a result, LTV increased 90 basis points to 36.9%.I wanted to remind you of our capital allocation framework and how we executed our strategy in the period. The resilience of our balance sheet is of utmost importance, and it gives us the flexibility to invest in opportunities as they arise.
As I just outlined, we are pleased to have strengthened it in the half with the disposals and the surrender receipt. And we’ll continue to actively recycle provided the pricing is right and market conditions permit. We remain selective and disciplined in deploying capital into future acquisitions. We acquired Thanet Retail Park for a net initial yield of 8.1%, and we continue to see investment opportunities with strong returns. We also have an attractive development pipeline. In addition to progressing our committed developments, which we expect will deliver £71 million of future rents, we also committed to the Peterhouse expansion in Cambridge.
We remain committed to shareholder distributions and have grown the dividend 4.8% in the period to reflect the strong operating performance of our business. Developments are a key driver of our long-term value creation, and we believe we can still make good returns provided we remain disciplined in our approach, given the changing economic backdrop. Higher market interest rates have increased exit yields, finance costs and returns hurdles.
We now target IRRs of 12% to 14% on our campuses and mid-teens on our London urban logistics developments. Our development pipeline is focused on super prime campuses and London urban logistics, both subsectors where supply of high-quality new space is constrained. As a result for our [best games], we are securing higher rents, which combined with the leveling off of construction costs, can deliver returns above our hurdles. Let me update you on our development pipeline.
On our innovation and life sciences pipeline, as I mentioned earlier, we recently committed to the Peterhouse expansion in Cambridge, where the supply of innovation space is constrained, and we’re already having encouraging customer conversations for a pre-let. At Canada Water, Phase 1 of the master plan is on track. We expect the office and residential plots A1 and A2 to be delivered in Q4 2024.
And the affordable housing, which is presold to the London Borough of Southwark will complete later this year. On our campuses, we are completing the enabling works for 2 Finsbury Avenue and making good progress on pre-let discussions at strong rents, where we expect to achieve an IRR in line with our revised hurdle rates. In urban logistics, we anticipate starting on site at The Box at Paddington and Mandela Way, Southwark early next year.
The Box will be one of the best, most sustainable, last-mile logistics facilities in Central London, and Mandela Way will be one of the first of a new generation of multi-storey warehouses. We expect them to generate strong IRRs above our mid-teens hurdle. Overall, our development pipeline is well placed to generate future returns and our development profit to come is £1.4 billion. Let’s now look at our FY ’24 underlying profit guidance in light of the capital activity we had in the period.
Starting with gross rental income. The surrender of the lease at 1 Triton Square in September and net divestment in the period will reduce net rents in the second half. However, we expect an improvement in our net rental income margin as a result of the Arcadia payment. We improved our guidance range for administrative expenses as we kept a tight grip on costs and expect fee income to be in line with our first half performance.
Finally, we expect finance costs to reduce slightly as a result of the disposals executed, the surrender premium we negotiated in the half, together with our hedging, which provides protection from further movements in market rates. Overall, we are comfortable with current market expectations for underlying profit. So in summary, we have delivered good earnings growth, we have a resilient balance sheet and excellent liquidity, and we maintain a disciplined approach to capital allocation to drive future returns. Thank you.
I’ll now hand over to Darren, who will provide an operations and market update.
Darren Richards
Thank you, Bhavesh. Good morning, everyone. Let me start with valuations. There’s been a significantly slower decline than we saw in the second half of last year, with values down by 2.5% overall. This reflects a 23 basis point increase in yields, which was partly offset by 3.2% ERV growth across the portfolio.
In campuses, values were down by 4%, with yields moving out 32 basis points. However, we saw rental growth of 3.2%, backed up by strong leasing, which I’ll come on to in a moment. Values in Retail & London Urban Logistics have stabilized in the period as marginal outward yield shift of 12 basis points was offset by very good rental growth, particularly in retail parks, which is in line with our revised upwards guidance.
Taking all these movements together, the portfolio net equivalent yield stands at an attractive 6.1%. And we’ve seen rental growth across the whole portfolio, demonstrating that we’re operating in the right parts of the market with the strongest occupational fundamentals. As I said, we’ve had great leasing performance in our campus portfolio with deals on over 368,000 square feet at 7.5% ahead of ERV.
And we’ve seen a noticeable uptick in demand in the period with a further 281,000 square feet under offer at 9.7% ahead of ERV and nearly 1.8 million square feet of negotiations on 1 million square feet of space. At Storey, we’ve done 71,000 square feet of deals in the half with occupancy currently at 87%. Storey remains a well-evolved high-quality flex offer, which we’ve been running for over six years now.
We’re seeing strong levels of interest with opportunities to extend across the portfolio. This activity demonstrates the continued demand for best-in-class workspace and our campus proposition with occupiers placing huge importance on getting the best base in an accessible location with high-quality amenity and environment. This plays directly to the strength of campuses and why we’re consistently reporting strong leasing numbers combined with high levels of occupancy.
At Broadgate, we’ve successfully re-let our under offer on 290,000 square feet of space on a number of newly refurbished buildings across the campus, and occupancy is now at 97%. At Paddington, we’re full and our development at 3 Sheldon Square, which was already 65% pre-let to Virgin Media O2, we now have a further 27,000 square feet under offer, which will take us to 86% pre-let, and we’re still four months away from completion.
As you know, we’re repositioning Regent’s Place as London’s premier science campus. So occupancy is lower at the moment as we refurbish space to target both innovation and science occupiers and high levels of rental reversion. And on that note, let me take you through the activity at 1 Triton Square. This is one of two buildings Meta had Regent’s Place, the others 10 Brock Street, which we recently regeared with them until 2029.
We’ve known for a while that they didn’t intend to occupy 1 Triton and therefore, had time to work up our own plans. So to be clear, when Meta found an occupier for the whole building for the remainder of the term, we proactively decided to take back the space as we knew we had a much better opportunity here. We have a highly adaptable shell building appropriate for storey and labs at lower levels and best-in-class offices above with significant flexibility to respond to market demand and do this quickly given the building’s already completed.
This means we can unlock significantly higher rents, which we think could be in excess of 30% more than Meta were paying, even higher for labs and an exciting opportunity to accelerate our science and innovation strategy at Regent’s Place, all whilst benefiting from a considerable surrender premium to supercharge the economics. Regent’s Place is a key part of our push towards innovation and science-based locations. It’s worth reminding you of a couple of points here. Firstly, life sciences isn’t just about labs.
As important as they are, these companies also need HQ space. And life sciences is key, but it’s just one of the innovation areas we’re targeting. We also have data science and technology, physical sciences, communications, for example, and clean energy and food science, these represent a much bigger universe of companies and areas with huge growth potential.
Secondly, it’s just how important it is to sit within the Knowledge Quarter surrounded by organizations like UCL, Turing, the Wellcome Trust and the Francis Crick Institute, which is why it’s widely recognized as the natural place in London for businesses in these sectors to cluster. The memorandum of understanding we recently signed with UCL demonstrates the benefits of this wider ecosystem. It means we can leverage UCL’s globally recognized brand and network allows our occupiers access to their technical services and facilities and means we’re in partnership with an organization that is a very effective nursery grant for the next generation of occupiers.
It’s worth remembering, for example, that DeepMind came out of UCL. And we’re already benefiting from this with space under offer to another UCL spinout. Also in the past few weeks, we’ve completed 30,000 square feet of lab conversions, and we’re already having conversations with occupiers now that we can show them the space.
Outside London, we recently signed a pre-let at The Priestly Center in Guildford with LGC, a leading global life science tools company at 48,000 square feet of lab and office space, one of the largest life sciences deals in the U.K. this year and the premium for rents in the area. This takes the building to over 60% pre-let ahead of practical completion next year. And in Cambridge, as you’ve heard from Bhavesh, we’ve committed to the 96,000 square foot Peterhouse expansion, the only new office and lab building to be delivered in Cambridge in 2025 and has already attracted strong interest from a mix of businesses.
Now we’ve also made a lot of great progress towards our sustainability targets, something which is now very much embedded as business as usual. As well as being the right thing to do, this drives commercial advantage with occupiers wanting the best and most sustainable buildings. In 2022, 36% of the portfolio was A or B rated. That’s now 50%, and we’re on track to be at circa 60% of the full year. We originally estimated the overall cost to get an A/B rating was £100 million, of which 2/3 would be recovered through the service charge. By the full year, we will have committed to spend £20 million, of which 70% will be recovered.
So we’re very comfortable within our forecast number and absolutely confident we’ll hit the targets in this area. I should mention in this half, we also achieved a GRESB rating of five stars, and our developments scored 99 out of 100, making British Land a global industry leader in this space. Now let me move on to retail. As we outlined at our Investor Day in September and as Simon will cover shortly, parks have emerged as the winning retail format. And this sector continues to deliver. We completed 629,000 square feet of leasing activity in the period at 14.9% ahead of ERV, and we have a further 697,000 square feet under offer at 19.3% ahead of ERV.
Occupancy remains high at 99%, reflecting strong demand from retailers who prefer the format and which led us to upgrade our ERV growth guidance in September. For shopping centers, leasing activity was 500,000 square feet, 13.1% ahead of ERV. This activity improved occupancy, which is now at 97%. And for Meadowhall, where the highest it’s been in a decade following two large deals with Frasers and Zara. While shopping centers are generating good returns for us, as we’ve said previously, we prefer the occupational fundamentals of retail parks, where we also have scale and a market-leading position. Therefore, we’ve identified shopping centers as noncore and intend to exit but at the right time and obviously at the right price. Turning to logistics.
To remind you, we have a pipeline covering 2.9 million square feet with a gross development value of £1.3 billion. These are all state-of-the-art schemes in London targeting last mile occupiers looking to optimize their distribution networks, lower costs and reduce their carbon footprint by using more e-vehicles. We’ve made significant progress in the half. The Box at Paddington, Mandela Way and Enfield, all achieved planning consent, together they account for 730,000 square feet. In addition, we’ve submitted plans for the schemes at Verney Road and Thurrock.
These two total over 840,000 square feet that would take us to over half the pipeline with a planning consent. We continue to expect strong returns on these developments. Rental growth has exceeded our expectations, and we’ve used our development expertise to increase the density of the schemes we’ve taken to planning by nearly 15% relative to our underwrite. We’ve shown the returns here for our upcoming commitments to The Box and Mandela Way.
As you can see, these look pretty attractive, even off their original purchase prices. So our business continues to perform extremely well occupationally with very strong leasing progress, 2.7 million square feet exchanged or under offer in six months, all at significant premiums to ERV because we’re operating in the right areas of the market, innovation and campus space where we’re seeing increase signals of demand, retail parks, the preferred format for retailers and London urban logistics, where we’ve made strong progress with our development pipeline.
Now I’ll hand you back over to Simon for an update on strategy.
Simon Carter
Great. Thank you, Darren. I highlighted earlier that bifurcation is accelerating in our markets. So let me explain what’s driving this, starting with London offices. Early in the pandemic, we formed the view that businesses would need less but better workspace, less as they embrace hybrid working better to reflect new ways of working and to attract and retain talent in a very competitive job market.
So what does better look like? Let’s start with location. Occupiers are gravitating to key transport hubs to make it quicker for their employees to get in. That’s because on average, those employees now live further from Central London, given rising housing costs and the increased flexibility offered by hybrid working. And the employees want to work in an exciting part of town where there are good bars, restaurants, coffee shops and retail.
Sustainability has moved up everyone’s agenda, which is driving businesses to reduce the carbon footprint of their real estate. We all want to work in a building that promotes well-being with good natural light, ventilation and outdoor space. And we all want to feel part of a wider community. Then there’s the experience within the building. I don’t love the expression, but there’s a definite trend to hotelify workspace. We’ve shared spaces feeling more like a hotel or your home.
In this building, for example, the fit out was designed by a leading hotel specialist Universal Design Studio. More people are cycling to work or exercising during the working day. That’s why at 1 Broadgate, we have provisioned for 1,000 bikes together with ample shower facilities. And businesses increasingly want flexibility beyond standard workspace. This includes bookable meeting rooms, additional collaboration space or the use of an auditorium. Our campuses are in the sweet spot of this demand.
It’s no coincidence that headquarters where the trend to upgrade is strongest, represent 80% of our space. All of this is playing out in the market dynamics. The best of London is thriving. The mini budget last year reduced take-up in the first three quarters of this year, which was 25% below the 10-year average, but the forward-looking indicators are positive. Space under offer is 8% above the 10-year average and active demand is 27% higher.
You can see on the graph on the right, the demand from banking and finance is especially strong which is benefiting the city as well as the West End. This improving picture is reflected in our own leasing activity, where we have 1.8 million square feet under negotiation. Quality is clearly in demand. You can see this in the high proportion of take-up for new buildings, which has reached 71%. Cushman & Wakefield are now talking of a 3-tier market, super prime, prime and secondary. Super prime is the top 10% of prime buildings evaluated against the criteria, which includes proximity to major transport hubs, access to cafes and bars, amenity and sustainability credentials as well as the quality of the building.
You can see on the graph that rents and the premiums of these buildings in the city have grown significantly and are expected to grow further. Nowhere is this more evident than here at Broadgate. We’re currently right above Liverpool Street Station, which probably has the best connectivity of anywhere in London. We’re just 35 minutes from Heathrow and less than 10 minutes from London’s Knowledge Quarter.
We’re clearly in an exciting part of town. We benefit hugely from the location at the intersection of London’s financial center with the artisan quarter of Spitalfields, the creative district of Shoreditch, the Old Street tech plus the Barbican is just a stone’s throw away. If you add to the mix, the public realm, amenity and large efficient floor plates, you can see why Broadgate has such broad customer appeal.
Where else would you find global leaders in investment banking, sitting alongside advertising, property, law, asset management, brokerage, technology and fintech. The result is that Broadgate is achieving significantly higher rents and lower vacancy than the rest of the city. A good way to see this growth we’re delivering is to look at the graph on the right. This shows the progression of rents on pre-lets at our three most recent developments. Let’s now turn to retail, and more specifically, retail parks. As we’ve said before, and you’ve just heard from Darren, retail parks have become the preferred format for many retailers.
The space is very affordable. Rents have reduced, business rates rebased. Service charges have always been low, and sales are well above pre-pandemic levels. The occupancy cost ratio of our parks is now 9%, which is down from 18% in 2016. Parks are an ideal format for a broad range of occupiers.
They’re located on major arterial roads with ample free car parking. And stores are large steel boxes, which can be easily adapted. That’s why we’ve seen significant incremental demand coming from discounters, essential retail and multichannel specialists. The restricted planning regime means we’re very unlikely to see much new supply. Taking all this together, it’s no surprise that parks have enjoyed net store openings since 2016, in contrast to significant closures on the high street and in shopping centers. We’re now 99% occupied across the portfolio. These favorable occupational fundamentals combined with limited capital expenditure, liquid lot sizes and the ability to buy below replacement cost make parks a good investment.
We’re the leading owner and operator and have invested over £400 million since 2021. This is a period in which parks were the best-performing sector of MSCI, and we outperformed by 270 basis points. We plan to grow our exposure further, given net equivalent yields of 6% to 7% and forecast rental growth of 3% to 5% per annum. Darren covered the significant progress we’ve made on London urban logistics. We really like the fundamentals here. E-commerce growth drives the entire logistics market, but there are additional tailwinds in London last mile.
These include rising expectations about the speed and convenience of deliveries as well as more stringent requirements for low carbon, low pollution deliveries. Operators can also make substantial savings by being closer to their customers. Added to this, the vacancy is very low in Central London at just 0.4%.So demand dramatically exceeds supply. As a result, these have grown more strongly than the wider logistics market, and we expect them to continue to do so. We’ve assembled a pipeline with an end value of £1.3 billion.
As you know, our approach is to deliver new space via repurposing and densification. Multi-storey is well established in other densely populated cities, but it’s a nascent market in London. We believe our planning capabilities and ability to deliver complex developments give us an edge. And as you heard from Darren, we’re making good progress. During the first half, we received planning consent for the three schemes shown in bold on the slide. Turning now to the outlook.
We’re clearly operating against the backdrop of considerable macro and geopolitical uncertainty. And over the last 18 months, yields have been closely tied to market interest rates, and this is likely to continue for a while. But assuming we’re near a peak in base rates, we expect rental growth to become the dominant driver of medium-term performance. We have better visibility on rental growth than yield movement. Based on our experience in the first half, together with the occupational strength of our submarkets, we expect to be at the top end of our previously guided ranges for campuses, retail parks and London urban logistics. So to wrap up, the strong occupational momentum of the 18 months continues unabated.
That’s a testament to the capability of our people and the quality of our portfolio. Bifurcation is very evident, and we’re benefiting from this in all our submarkets. That’s translating into accelerating rental growth, which, combined with a portfolio yield over 6% and development upside provides an attractive return profile going forward. Thank you for listening. We’re now happy to take any questions as ever.
And Darren and Bhavesh will join me on stage.
Question-and-Answer Session
A – Simon Carter
So I think we’ve got some microphones in the room. So perhaps if we have questions in the room, and then we’ll go to the lines and the webcast. Who’s got the first question? Hand’s gone up over there.
Unidentified Analyst
[Sam Nock] from [indiscernible]. Just two quickly, if I can. So on your slides, you noted that sort of retail parks are 150 basis points yield, they have [100-foot] basements higher than campuses and they’ve also got higher growth in the near future. Do you expect that difference in growth to continue? And if so, sort of what, if anything, makes campuses look attractive if they’re lower yield and lower growth in the medium term?
Simon Carter
And was there a second question there as well?
Unidentified Analyst
Yes. I was just going to ask on the costs. The EPRA cost ratio, if you could sort of point out the main moving parts there? And how much of that is short-term one-offs, how much is long term? Will you expect that to stabilize?
Will it be at that 15% or will it go back up a bit?
Simon Carter
Sure. No, happy to take those. I’ll take the first one, Bhavesh, if you do EPRA cost ratio. So in terms of retail parks, yes, you’re right, we’ve got high occupancy, and we’ve seen rents grow strongly in the period, which does make for very attractive returns. But also in our campus business as well, we saw rental growth over 3%.
We expect to be at the top end of that growth range of 2% to 4%. Yes, they’re a bit lower yielding, but when you factor all that together, you get attractive returns. And also, if you think what we’ve been doing in our campus is a big part of the return storey is the developments where we see double-digit IRRs in the teens. We’ve been recycling out of the more mature office assets and putting it into development. So when you do the combination of the investment and development returns, you get attractive returns ahead of our cost of capital, like we’re able to do in the retail park acquisitions as well.
Bhavesh on EPRA…
Bhavesh Mistry
Yes, so Sam, really pleased with the EPRA cost ratio performance this half. We did benefit from a one-off payment that I referred to, but that aside, we kept a good grip on our admin expenses. We also benefited from fee income. So for the full year, as I guided to, you will see an improvement — we expect to see an improvement from last year’s full year EPRA cost ratio.
Simon Carter
Any other questions in the room?
Matt Saperia
It’s Matt Saperia from Peel Hunt. You talked about the negotiations of 1.8 million square feet of space, but only on 1 million square feet of space. That doesn’t really make sense, but you know what I mean. How does that relationship sit in a historic context? Is that an extreme relative number or is that pretty normal for you in terms of the negotiations versus the quantum of space?
And if it is extreme, what do you think that means for potential pricing going forward? And given that relationship, does it mean that tenants are likely to probably sign up sooner rather than later for some of that space?
Simon Carter
Matt, that sounds like one for Darren.
Darren Richards
It is — it’s, as you’ve noted, on top of the deals that we’ve done in the half and on top of the under offers, that is a big number, 1.8 million. The 1 million is just to demonstrate that it is over quite a wide base of space, but also, obviously, we’re looking at almost two for one in terms of demand. So really strong metrics. We have been at those kind of numbers before historically. It’s not the first time we’ve been there, particularly when we’ve got more exciting development coming through the portfolio.
But what it really means for us looking forward is we’re very confident with that rental growth, growth range we’ve just given you.
Simon Carter
Any other questions? I think there was another and that went up. Rob in the front there.
Unidentified Analyst
Three, one on Meta, one on two FAs thirdly on asset values. On Meta, I thought optically for BL like a sensation of deal, but I wonder if you could give us a bit more of your thinking in terms of the timeframe you’re looking at to, a, decide on the route you want to go down, whether it is splitting space up or whether it’s going down life sciences route and how you think about that? Ultimately, I guess, an element of the return that you make from the Meta trade will be driven by the speed at which you can create an income-generating space again and thus maximize the benefit of the surrender you’ve received. The second one on FA, you said positive progress on pre-letting discussions. What does positive progress mean?
Is that multiple parties we’re talking to? How do I get confident that positive progress is a legitimate comment, I guess? And then just finally, on asset values. It’s great to see asset value declines slowing. I wonder you also highlighted some at the end that you have clearly greater confidence on your forecasting ability around ERVs and around occupier market evolution than you do on asset value. So I also read into your comments today that you’re effectively saying that you think asset values will continue to slow and hopefully get to a point in the near term, assuming that rates don’t increase further, where yield expansion stops or at least is fully offset by ERV growth.
So I guess what gives you the confidence to say that given you rightly made the point that you’ve got a greater — a clearer crystal ball when it comes to occupier markets than it does to yield?
Simon Carter
Sure. There’s three great questions. Darren, do you want to pick up on Meta.
Darren Richards
Yes, sure. So as I said in the prepared remarks, we have — it was a good deal for British Land. We had a choice there. We could either take a rent of effectively £70 a square foot. And by the way, that was set back five years ago.
So it’s an old rent. And then we’ve got a building which we think is capable on a blended basis of over £100 of ERV, and then we got £150 million to help the economics of it as well. So it’s something we obviously considered very carefully, but very strong occupational fundamental surrounding Regent’s Place as well. So in terms of what we’ll do next, just to give you a bit more clarity, we’re probably going to have — we’ll have a period now as I said, we’ve had a good run-up for this. It wasn’t exactly a surprise for us.
So ready to hit the ground running. We’re looking at about 18 months in terms of the fit-out for the building. And we’re already having conversations with people, which is underpinning our confidence on the rents there, 18 months versus the fact that we got effectively seven years back from Meta. So we’re comfortable in the prospects for the timing and the amount of cover that we’ve got by the surrender premium.
Simon Carter
Great. And two FA. So we’re not going to go into details of customer conversations, but you can see from the previous answer to the question around the amount of demand for the space we’ve got, we have multiple conversations ongoing there and we’ll watch this space. Basically, that’s the confidence I can give you there. And then on asset values and yields, yes, look, we don’t control interest rates.
We don’t control sentiment, but ultimately, what is going to drive returns is occupational fundamentals, and they feel really good across our three markets at the moment. We’ve got high occupancy, growing rents and that will come through into values in this period, as you highlighted. Last year, we saw much more yield shift because that was the big spike in interest rates and less rental growth. This has been accelerating rental growth and in two of our three sectors, the parks and the London urban logistics. It fully offset, and it offset more than it did in the previous period in the campuses.
So that’s what we control our products and the markets we’re in.
Zachary Gauge
It’s Zachary Gauge from UBS. Two questions, if I may. The first, obviously, some very impressive numbers in terms of leasing ahead of ERV. ERVs, of course, don’t include incentives. So if you could just touch on what sort of incentives were when necessary to achieve those levels ahead of ERV?
The second one on liquidity. Obviously, a lot of your assets, particularly in the campus space and shopping center space are very large. Very few buyers in the current market, have the sort of equity required to buy those without using leverage. So going forward, I guess if property yields don’t continue to move out or for interest rates don’t continue to move in, then leverage for those sorts of assets remain sort of unaccretive who would potentially the buyers be that could come in at those very large lot sizes without leverage?
Simon Carter
Sure. No, happy to take those up. So on our ERVs, those are always net effective, so they do take into account incentives in there. So that’s fully factored in. And then on liquidity in the market, you’re right, the first nine months of this calendar year, we’ve seen low liquidity, as I think people are adjusting to the higher rate environment and seeing where those rates might top out.
Debt is a bit available for the right assets. I think obviously, as you know, it costs more, but we’ve raised finance very competitively in the period, and I think others will as well. The other thing is on a number of our larger assets when they’re held in joint ventures, the debt tends to be stapled with those assets. So if we were looking for a purchaser for those, the debt would be able to move across with those assets. But look, I expect the debt markets to follow the occupational markets and when you see the occupational strength come through in the right places in the markets, the debt that will follow that.
Darren Richards
Just to give you some color on incentives. Our blend on our office deals was eight years, and the normal rule of thumb is you get 12 months or every — so that’s a bit better than in line with what to expect there and obviously a testament to the quality of the space. In retail, the average deal is about six years for retail park, and we’re giving away about nine months rent-free, which again is very competitive.
Simon Carter
Any more questions in the room? I don’t think so. If we’ve got any questions on the phone lines, we’ll take those first.
Operator
[Operator Instructions] And your first question comes from line of Peter Willman.
Unidentified Analyst
I got a follow-up question on the disposals. So where do you currently see the best opportunities to these class assets and which asset classes — which locations?
Simon Carter
Sure. Happy to take that one. Peter, on the disposal front, we have been, hopefully, fairly clear. Shopping centers for us are probably noncore going forward. We’ll look to recycle capital out of there.
But as Darren very carefully said, when the pricing and the timing is right. And then I expect us to continue to sell some of our more mature office assets and recycle that into the development program and parks. That’s the way you should think about the moving parts.
Operator
There are no further questions on the phone at this time, so I’ll hand back.
Simon Carter
Okay. Do we have questions coming in over the webcast. Yes.
Unidentified Company Representative
So we’ve got two from Adam Shepton. He says, please, could you provide some more color on storey occupancy given its slight drop year-on-year and since March? You say this is due to expiry timing. Can you give any more color on where this sits today? And the second question is, was there any 30th of September valuation impact from 1 Triton Square?
Simon Carter
Sure. Darren, do you want to take the first one on the storey?
Darren Richards
Storey is doing very well, as I said, occupancy is 87%. And — our target for Storey, just given the nature of it, you’re never going to be 100% full because it’s short-term lease space is 90%, so we’re just off that. And at the cost off in any period, you are bound to have some fluctuations around that number, and that’s all that’s happening. We’ve got a lot of incoming, as I said, and we’re looking to extend the format across all three campuses at the moment. So we’re pretty confident there.
Simon Carter
Great. And then there was a question on valuation impact of 1 Triton. And yes, that was factored into the valuation. So we obviously received the surrender premium in the period, and you can see that in our capital column, but the valuation is now on a vacant possession basis for that property, reflecting the fact that the lease has been surrendered at the 30th of September.
Unidentified Company Representative
Mike Prew Jefferies. Do the valuers accurately capture the ERVs, which you seem to be able to beat substantially and consistently? And the second part is, are office tenant leasing inducements stable? And where is the overrenting in the portfolio?
Simon Carter
Darren, do you want to take the one on valuation and reflection of ERV growth?
Darren Richards
Well, Mike, I think — I mean I’ll use, I think you’re asking for the whole portfolio there. The value is obviously will take the evidence that we’ll provide them in a period. As you know, in retail, we are able to consistently beat them. I think the main thing that plays through here again, is we’re only dealing with a small portion of the portfolio in any period of time. So for example, that 600,000 square feet that we’ve done in our parks is really in about 7% of the floor space.
So if you imagine that’s 7% of a retail park, you’ve got over 90% of it where you happen to have that evidence come through. And sometimes it is on different unit sizes. So the value is we’re able to beat them on the deals that we’re doing, but you don’t get the complete benefit of washover. We do think that’s starting to come through, though, if the 4% rental growth adjusts for the half. So we are starting to get washover benefits, and we think we can start closing these gaps pretty quickly.
Simon Carter
Yes. And as a trend, you can see that we had — we were beating the value as rents for a couple of years now quite materially, and that started to be picked up in our ERV growth. So I think what you’re alluding to there, Mike, is beginning to come through. One of the reasons alongside the very high occupancy, we feel comfortable with our ERV growth forecast and being at the top end of those. And then there was a question around the offices and the incentives.
And effectively, the incentives that we’re giving, particularly on the developments have remained pretty static. We tend to do a little bit less than 20% incentives. And so for a 10-year lease, that’s a couple of years for a 15-year lease, it’s three years or a little bit less than that. And on the overrent, Darren?
Darren Richards
For the office portfolio?
Simon Carter
Yes. We don’t really have — with the rent, no —
Darren Richards
We don’t. It’s a reversionary portfolio, and you can see that coming through the yields.
Simon Carter
So overall, across the whole portfolio, we’ve got a positive reversion. And there’s a little bit of negative reversion on the retail parks and the shopping centers that we’ve spoken about previously, but that’s more than offset by the positive reversion we’re seeing in offices. And also, because we’re leasing space ahead of ERV in retail, we’re really eating into that negative reversion when you do comparisons to previous passing rent. Any other questions?
Unidentified Company Representative
A slight follow-up to that from Daniela Lungu, First Sentier Investors. If ERVs are net effective, would you be able to give some color as to what the headline rents and incentives did over the period, meaning if ERVs are up 3%, does that mean headline is up 3% and incentives stable or headline stable and incentives down?
Simon Carter
Yes, it’s more headline up and incentives pretty stable as per my sort of earlier answer, we’re seeing pretty much those 20% incentives in the office or a little bit below that. No more questions anymore in the room. No? Great. Well, thank you very much for joining us this morning.
We really appreciate you coming along, and we’ll see you in six months’ time. Thanks a lot.
Credit: Source link
