Schroder Real Estate Invest H1 2025 Earnings Call Transcript

Quartr
Provided by Quartr
November 26, 2024

There are 3 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Schroeder Real Estate Investment Trust interim results presentation. My name is James Lowe. I look after sales for the Schroeder Investment Trust Business. I'm very pleased to be joined here in the studio this morning by my colleagues Nick Montgomery and Bradley Biggins, who are going to shortly be talking about the SRIT interim results. Now just a bit of a couple of things to mention before we get into this.

Operator

If you would like to ask the guys a question, please do so through the Q and A tab on your screen. That will come through to me and I'll ask at the end of the presentation. You also now should be able to download a couple of things on your screen. That's a copy of the results, the presentation, should you want to follow along with us. But that's all from me for now, and I'll pass you over to the guys to start the presentation.

Speaker 1

Fantastic. Thanks, James. And thanks, everybody, for joining us for the unaudited interim results, as James said, for the 6 month period to 30th September. I hope you'll see that they are another set of resilient results. I think importantly, we continued relative outperformance of our particularly our benchmark.

Speaker 1

And as you'll see on the opening slide here, we were very pleased over the period for that to be recognized by MSCI, which is data across the industry, for the highest risk adjusted return over the 10 years to December 'twenty three for both the UK real estate, but actually also for European real estate more generally. So just in headlines, where are we? Well, we continue to believe that we are well positioned. We continue to have a high and growing income return and that's complemented by the really sector leading debt profile. You would have seen, I hope, in the results already that that has led us to announce a further dividend uplift, which reflects on last night's closing price, a dividend yield of around 7%, so remaining at an attractive level.

Speaker 1

And importantly, dividends were fully covered over the interim period. Very strong balance sheet, as I mentioned, sector leading, and we'll provide a bit more detail on that later. And I guess despite, if you like, those benefits, the share price still reflects today a 14% discount. I think positively, we are getting visibility on future earnings growth. I think the strategic evolution that we have strong support for at the end of 2023 is leading to increased demand for the shares.

Speaker 1

And in fact, other changes, for example, the changes to the PRPS rules also may mean that we see improved demand for externally managed trusts where we have, you know, a more fair assessment of the actual underlying costs. So, where are we? So I guess the first thing to say is the headline number is a NAV total return of 4%, so a healthy number. And why was that? Well, if it was having that higher exposure to the growth sectors, particularly multilet industrial and retail warehousing.

Speaker 1

What we're showing on the right hand side for those who don't know us quite so well are amongst our largest assets. So those 6 assets there represent almost 50% of our portfolio value. If you just very briefly at the top, those 2 multi net industrial estates are in fact our biggest two assets of a combined value of almost 100,000,000 combined also over 100 tenants giving out great granular income that we have across the portfolio. Our 2 biggest office positions, you can see there, our in fact, a university building in Bloomsbury, which we've spoken about before, fantastic location continuing to benefit from increased demand as a result of not least the Elizabeth line, but also what's happening in and around the universities and life science in that part of London. Mixed use assets in Manchester, lots of asset management going on there.

Speaker 1

And finally, at the bottom, we're showing you our 2 largest retail assets, where we've had some great asset management activity, which we will touch on briefly later on. So 62% now allocated to those high growth sectors of Multilek Industrial and Retail Warehousing. I mentioned the outperformance and more on that later on. Likewise, that strong shareholder support, we spent an awful lot of time rightly getting out there talking to both existing shareholders, but also new shareholders and actually particularly targeting retail investors through platforms such as InvestMe Company and it has genuinely driven increased demand for our shares, both from specialist REIT investors, but also, as I say, the retail investor base where across those 3 main platforms that you'll all be familiar with, they now represent about 20% of our shares, a significant uptick over recent years. And final point to note, we're seeing very healthy levels of activity, particularly as we've come out of a normal summer slowdown.

Speaker 1

And that is really what's allowed us the confidence to move the dividend on again by 3%. And Bradley will give you some details later on, on the progress that we're making reducing our vacancy rates. So here's a headline number again. So a NAV increase over the 6 month period of 1%, which combined with dividends paid resulted in that NAV total return of 4%. Interestingly, and I guess just to show how the market appears to have turned, that compared with a 1.1% return over the 6 month period to September 23.

Speaker 1

And in fact, likewise, 1.1% for the full year to March 24. So we are seeing that the market recovery is as we have expected. And as I've noted earlier on, good outperformance at the underlying portfolio level, 6 month portfolio capital growth of 0.9 percent for us versus 0.3% for our MSCI benchmark. Continuing to invest in our assets, we made a point when we announced our strategic evolution that we would be investing more, particularly in initiatives that are improving our sustainability performance, but in doing so, also driving that green premium. Notable investment, particularly at our office at the time in Edinburgh, where we've in fact just completed a lease to, as it happens, a sustainability consultant having achieved an EPCA rating and more of that to come later.

Speaker 1

And you can see the build there that takes us to that NAV per share of 59.4 pence, which compares to the share price closing last night at 51p. As we have noted before, we have a long term, low cost, fixed rate loan facility. We are unable or not required to apply the fair value of that loan within our NAV. Were we too, that will be a positive value of about $17,000,000 or 3.5p per share as at the end of September. And with what's happened with bond yields, more on that later, that value, if anything, has gone up a little bit.

Speaker 1

Now, earnings, obviously, most importantly for shareholders. So we announced over the period the 2% increase in dividends, as I say, a further 3% post the period end. I think the key numbers to look at here probably are, if you look at the combined rental income and share of net income in joint ventures lines, so essentially our portfolio income, That increased over the 12 month period from $14,000,000 to $15,100,000 so actually an increase of about 6%. And that was also having allowed for the 2 office sales that we completed over that period. We did receive a little less from ancillaries or other income.

Speaker 1

So we had a little bit less coming through things like surrender premiums, dilapidations payments. We generally take pretty cautious view on those numbers. I think most importantly is to look at that recurring rental line and also look at what we have also delivered post period end, which Bradley will talk to you later. Very close management of expenses. We are very disciplined in the way that we run our P and L for the company and that has been reflected in expenses being under control.

Speaker 1

Where we have seen the higher expenses come through, it's generally linked to activity, obviously, letting fees, leasing fees, etcetera, which will obviously go through in terms of increased IFRS income and earnings. Rent collection remains strong. So the latest stats over this period are up at 98%. And as you can see, very, very, very healthy levels. You saw on the previous slide, 0 bad debt adjustments over the 6 month period.

Speaker 1

And then final point to note, you can see there were 2% uplift in dividends paid over the period and that important number, 102% covered, obviously, with the further dividend increase announced. Now, as we said before, there are 2 elements that give us confidence around our dividend and earnings. Obviously, firstly, it's top line earnings growth or rental growth. I guess, of equal importance is a great visibility that we have on our loan interest payments. We think this genuinely is sector leading.

Speaker 1

You can see here on the right hand side, the average interest rate on the drawn debt of 3.5%. The average maturity across both our loans of 9 years with our Canada Life loan facility, you can see there of CHF 130,000,000 locked in at 2.5% for another 11.5 years. We are and we've been clear that we are looking to move the loan to value down in line with our long term target range of 25% to 35% net. Obviously, values are helping a bit, but we are progressing some sales. 1 is exchanged actually post period end that Bradley will talk to.

Speaker 1

But we have more planned and in progress and more on that in due course. I guess just to bring that dividend and particularly the progressive dividend policy into clear focus, we're showing here the progression to the most recent announcement we've made there of 0.879p which is the quarterly dividend that we will be paying in December. I know for a lot of you, Q4 'nineteen feels a long time ago, but we use that actually because that was a dividend immediately prior to the Canada Life refinancing that we did. And actually, if you look at the dividend since that point, we're up about 35%. And obviously, we hope to continue growing that dividend when we feel it is sustainable.

Speaker 1

Now, I'm not going to go through all of these. I've told you obviously that we've won that 10 year MSCI award, but actually, you know, if you look over all time periods now, we are outperforming over the 3 month period, which we're showing here as well. Obviously, the 6 month number there, which is most relevant to these results, 3.8% for the portfolio versus MSCI at 2.6%. We tend to focus on the 3 year number when we're looking at the impact of our activity. And I guess it's just interesting to note that over the 3 years on an annualized basis, the income return was 6% versus the benchmark at 4.4%.

Speaker 1

And interestingly, our industrial assets also delivered a healthy premium over the benchmark at 5.1% versus the benchmark at 4. But actually also, and this is largely driven by our industrials, our rental value growth over that same 3 year period of September was actually 6.6%, which compared to the benchmark at 3.7%. Again, driven by industrial as was the benchmark, but our industrials over that period was 11% versus the benchmark at 8.4%. So very healthy levels of rental growth, importantly, in absolute terms, but also ahead of the benchmark. Now just a few slides on the market.

Speaker 1

I think we do feel that the market has turned, but there has, as you will all know, been a reasonable degree of volatility following the budget and obviously the subsequent U. S. Election. The chart on the left hand side here is showing you the implied probabilities for interest rates from options. And what's happened is over the recent period, those red boxes have moved back to the right as the market's taken a more cautious view about the direction of interest rates with the next decision obviously later in December.

Speaker 1

I guess more positively, we've obviously seen inflation fall from a headline level of 11%. I think the markets were a little bit surprised by the print most recently, but inflation is moving in the right direction, albeit there is still that tightness in the labor market, which means that, you know, we are, I guess, a little bit more cautious about how fast and how and when rates will fall. But I think, consensus, our view is rates will fall, but at a slower rate than previously envisaged perhaps by the market. We've made the point before, obviously, about the relationship between property yields and that 10 year guilt rate, which has moved from, you know, sort of high 3s to mid 4s post those political events. We do still think, though, by the end of this year and into next, the average initial yield for the market at around 5 by the time we get there will reflect, you know, just over 100 basis point premium over 10 year gilts.

Speaker 1

I think importantly, and again, one of the key reasons why we have delivered that long term performance at property level is we already have a significant head start. Our initial yield at 6% is already 100 basis points over that average for real estate, which does give, we think, more protection and potentially upside if we do see rates fall ahead of expectations. Sorry, what's happened there? Sorry. So now what does that only turns performance?

Speaker 1

Again, a lot of these numbers are familiar, but you can see on the left hand side the significant correction we saw from the middle of 'twenty two and through to where we are today. And you can importantly see, obviously, with industrial having fallen furthest fastest, because it was coming off a lowest yield, that is now picking up. We are seeing more investment activity in that sector. Obviously, offices continuing to move downwards. I think it is important to note that particularly in the bigger regional cities, we are seeing now more healthy levels of return to work.

Speaker 1

There was a survey done very recently showing almost 80% return to work over 3 or more days in the big regional cities. And we are beginning to see that come through in terms of occupational demand, obviously, against a backdrop across the office market more broadly of relatively low levels of supply and particularly low levels of new development. And I guess it's that limited or constrained development that is leading to the high rental growth and really just to draw that significant contrast between what capital values are doing, obviously falling 25% roughly since that mid-twenty two points and what we're seeing in terms of nominal growth coming through on rents, 10% up on average over that same period, very different to the experience through the GFC in the early '90s or late '90s, I should say, into the early 2000s. And as I've noted already, obviously, our portfolio generating more return than that. So what does that mean for the investment market?

Speaker 1

Well, volumes remain low. It is worth noting and that's shown here both on the left hand side in terms of quarterly investment in the UK, but also the cumulative numbers you can see there with the dotted line for this year. We do, however, typically have a lag in the real estate markets, particularly as obviously as we come through the summer period where it is quieter. And certainly on the ground, we are seeing more evidence of transactional activity, particularly focused obviously at the industrial sector, but actually even now within London and the regional office market, as I say, nascent, but we are beginning to see more transactional activity, particularly some private money targeting better quality real estate. And likewise, we are also seeing for the first time in a long while, a recovery in the retail market and actually some quite positive headlines, particularly coming out of the discount food operators.

Speaker 1

And obviously, we're benefiting from that within our portfolio, but also some of the bigger retailers like Inditex, Next, actually making some really quite positive comments about building out their physical retail offer. So just to finish off on the market, what does this mean? Well, the first thing to note is the only certainty is these forecasts are wrong. But I think what we can say is that we do think we're moving into a new cycle. We think the outturn this year for average UK real estate will be, you know, somewhere around 5% with values possibly even up a little bit.

Speaker 1

But actually, once you look into 2025, if we do assume an average income return of, let's say, 5%, and as I said earlier, we've got a head start to 6%. But also, if we do see rental growth of 2% or 3%, you can get to an above average return for the next few years without assuming any significant reduction in yields. So if we do see interest rates move in line with expectations perhaps of a few months ago, that would add to the return. But we think if a sector is delivering a return of between 7%, 8%, 9%, 10% over the next few years, we will see more capital allocated to the sector. And we will see, again, more demand for both direct real estate but also investment companies.

Speaker 1

So I will therefore pause and I'll hand over to Bradley.

Speaker 2

Thanks very much, Nick, and good morning, everybody. So as a reminder, in December last year, we updated the investment objective of the company to require us to make a meaningful improvement in the sustainability profile of our assets whilst we own them. We'll measure our progress against this objective using 2 KPIs that are set out in our investment policy. And there's an asset level KPI where we use our proprietary ESG scorecard, and there's a portfolio wide KPI based on our net zero carbon pathway. And to reiterate, the key reason for making this strategic change is because we believe that this would enhance the long term total returns we can provide for shareholders.

Speaker 2

In short, we think we can profitably manufacture the green premium. And briefly, on the right hand side, we show a proof of concept, and this is based on our work that we've done at Stany Green Trading Estate in Manchester. So the total return for the asset that we've achieved since acquisition in December 2020 has been 17% per annum, and this compares to the MSCI All Industrial benchmark at 7% per annum. So really strong outperformance there. And shortly, how did we achieve this?

Speaker 2

Well, we've been able to secure a passing yes, we've been able to secure rents on the new green units that are 39% above the rents that we've achieved on the older brown units. And it's not just a higher rent we've achieved. We've got better tenants on better terms. And also note that these units we're comparing are on the same estate. And the value has also put a keener yield on there.

Speaker 2

So for the green units, we're looking at 5.35%, whereas on the brown units, it's 6.5% to 7%. And as we're making progress with this strategy, we're seeing these higher rents come through on other assets, and we'll touch on a few as we go through the slides. And then a final point on Staunee Green. So now that the new development is complete and we're letting it up and we've made really good progress recently, the next phase is to bring some of the older units up to a similar standard of the new units or as close as possible in order to close that rental gap to that 39%. Moving on to the next slide.

Speaker 2

We'd like to talk through St. Anne's House, which is a mixed use building in Manchester City Centre. We've got 5 floors of offices with ground floor retail. So what we've done at St Anne's is we carried out a sustainability audit. And the output of that audit has been the ESG scorecard, the results of which you can see on the left hand side, but also recommendations for interventions we can make to improve the sustainability performance of the asset.

Speaker 2

So the works that we've started already, we're undertaking a major refurbishment of the ground floor and the basement floor. We're making improvements to the facade of the asset, and we're also undertaking a Cat A refurb of the 5th floor. Now in terms of what we're doing to improve the sustainability performance that I mentioned, we're adding new glazing in places on the external facade, and that should enhance the energy and carbon performance of the asset, as shown on the left hand side, but also the fabric of the assets will improve. So we'll see that score go up. On the ground and basement floors, we're adding meeting rooms, a studio, breakout areas.

Speaker 2

And all this is to improve the community aspects of the asset. And you'll see the community and social integration score should improve over time. We're also making progress in the electrification of the asset. So we're installing new HVAC systems, for example, which improve the air quality and the health and well-being of our tenants. So again, you should see that score improve over time.

Speaker 2

And finally, what we should see as a result of all these works is the tenant profile improving, so it will attract better tenants. Also, the certifications and ratings will improve, so we're getting EPCs of A on our refurbs, for example, whereas the building EPC is currently a D. And then overall, the net benefit of all of these interventions is that we should use less energy, less resources. So you'll see the Energy and Carbon score improve further as a result. And then the question is, taking a step back, this is costing us around £2,400,000 this phase of refurb.

Speaker 2

Is it worthwhile? Well, we think we can move the rent on from the current passing level of £19 per square foot to £28 per square foot. That's an increase of 48%. And as a result, we have forecasted a 5 year IRR of 13%. So we think this is a really compelling case study, and we think it's another really strong example of the strategy in action.

Speaker 2

And at the year end, we will report an updated scorecard, which will reflect some of the works we're completing at the moment. We'd also like to touch on a couple of pipeline initiatives that we have in the portfolio. So sometimes what we find is that there's a higher value use for our assets, and we've got 2 examples here. So on the left hand side, we're showing Langley Park Industrial Estate in Chippenham. This is located in the centre of the town, right by the train station.

Speaker 2

And what you can see in the top image are yellow units that are currently occupied by Siemens. These are very old units. And when Siemens vacate, they will need extensive work. But actually, we think that there's a higher value use. And in this case, it's built to rent.

Speaker 2

So just to recap, Siemens are due to leave in June 26. But actually, we think they're going to need to stay until late 2028. So the first step will be to agree a rent with Siemens for that period of time. And we think, clearly, we're in a strong position there. And then in the meantime, we'll be working on planning for the Build to Rent scheme.

Speaker 2

And at the end, we think that there's a market value for this Build to Rent scheme of £10,000,000 to £20,000,000 roughly. And that compares to the current site value of £9,000,000 roughly. So you can see it's really compelling rationale for pursuing that route. Then on the right hand side, we show Hayward House, which is an office in Cardiff. So it's currently 2 stories and is used for traditional office use, but also a university use some of the space for a course that they're running at the moment.

Speaker 2

And what we've seen in the local area is a lot of conversions to purpose built student accommodation. And this is a city centre location. Cardiff is a huge university city, so we saw the opportunity to go down that route ourselves, and we're currently in the process of going through a pre application with the Council. So the asset has a current value of GBP 4,200,000 and we think we can achieve a residual appraised value of GBP 7,000,000 to GBP 10,000,000 So again, a really compelling opportunity there. Moving on to the portfolio.

Speaker 2

Many of you will be familiar with this slide. On the left hand side, we show some important metrics for the fund, for the portfolio. And what we draw out here is the granular nature of the portfolio. So we think this makes it more resilient. So we've got 39 properties and more than 300 tenants.

Speaker 2

But we also highlight the really attractive income profile of the portfolio, which Nick highlighted earlier too. So you've got a 6.1% net initial yield, which is well ahead of the benchmark of 5.1% and well ahead of the cost of our debt at 3.5%. In addition, we've got a really attractive reversionary yield of 8.5%. Now the difference between that net additional yield and the reversionary yield is around £10,000,000 of rent. And to put that into context, our current annualised dividend is around £17,000,000 So this shows that if we can capture this reversion, it gives a really good opportunity to make continued growth in that dividend.

Speaker 2

On the right hand side, we show the structure of the portfolio in terms of sectors. And really, the key point to take away here is that 62% of the portfolio is allocated to the higher growth sectors of Multile Industrial and Retail Warehouses. So the void currently stands or as at the 30th September, stands at 11.2%. And whilst that is within the 10 year range of 5% to 13%, we actually think we'd probably, on a run rate basis, be closer to around 8%. And the reason it's a touch higher than normal is that we've recently finished developments and major refurbishments of some of our assets, particularly in the industrial sector.

Speaker 2

And we made some really good progress in recent months tackling this void, and it's been really positive as well. So as Stoney Green, of the 1.9% void, 1.1% is now a letter under offer. And I'd also like to highlight Swindon, where we, post period end, completed the letting of Unit C at £280,000 per annum. So pretty material rent coming in. And that's off the back of a really extensive sustainability refurb.

Speaker 2

The rent's £8.25 per square foot, which is a third higher than the previous passing level. It's also ahead of the September ERV of £8. And then finally, I highlight Stacey Bushes in Milton Keynes, which is our largest asset by value. It's a multi let industrial estate. And we have recently let 19 Holland Lane, or we've got it under offer, at £255,000 per annum.

Speaker 2

That is £15 per square foot, which compares to the £13 per square foot ERV as at September. And then to put that into the context of the estate, so was it worthwhile spending this money to create a really green asset? Well, the current passing level across the estate is around £8 per square foot, and the ERV for the whole estate is £10 per square foot. So just to recap, the rent achieved is 50% ahead of the average ERV of the site. We touched on that reversionary profile of the portfolio earlier.

Speaker 2

And just to bring that into context, how are we going to achieve that reversion of £39,000,000 over time? Well, we've got some fixed uplifts over the next 24 months, of which £700,000 has already been realized since the 30th September. And then there's another £2,200,000 of fixed uplifts to go. So that's based almost entirely on existing leases and is almost entirely rent free periods expiring. I touched on Staring Green previously, but to put the numbers into focus, the £600,000 of rent, which was void as at 30 September, more than £200,000 is now let, and there's another £120,000 under offer.

Speaker 2

So after this activity, there will only be 1 unit vacant. And then finally, there are units where the ERV is in excess of the passing rent. So as rent reviews come around and as leases expire and we regear, put new leases in, we'd expect to push the rents on, as we have been doing. And finally, I previously touched on the vacant space, where we made really good progress since the 30th September. So just to wrap up for me, we've got a really interesting pipeline of H2 Asset Management activity, both underway and already completed.

Speaker 2

So I already spoke to Stirling Court, where we achieved that really impressive rent of £8.25, a third higher than the previous passing and ahead of the September ERV. We've exchanged contracts to sell a small office in Bedford called Howard House. The price achieved there is GBP 1,475,000 which is 23% ahead of the book value as of the 30th September. And as Nick says, we've got some interesting progress on another sale live at the moment. And finally, we're progressing our planning application in order to get Lidl into our retail warehouse scheme in Salisbury called Churchill Way West.

Speaker 2

And that's going to make a real material difference to the passing rent at the site. In fact, when the works are all complete and if they complete as planned, the passing rent will increase by 144% on the 30th September 2024 level. And then in terms of what else can we do to enhance the returns of the fund, to push the earnings on, to grow the dividend, well, we can target disposals of around £40,000,000 And if we were to sell our lower yielding assets, so 1 or more of them, at around a yield of 5.5 percent and then initially pay down our uncapped RCF, which has a cost a marginal cost of 6.6%, that will be immediately earnings accretive. But we can then reinvest into our higher growth areas, so multi let, retail warehouse, at we'll be targeting yields of 7%. So an illustrative run rate benefit, if we did that for £40,000,000 would be an increase in earnings of £600,000 And then as Nick touched on earlier, we're always looking to control our costs, and we will continue to do so.

Speaker 2

And as we reduce that void, we should also reduce our property costs as well. So with that, I'll hand back to Nick for a closing summary and keen to take any questions.

Speaker 1

Great. Thanks, Bradley. So just to wrap up, I'd just reiterate that first point there that we think we're well positioned with that higher income return and importantly, that low debt cost. Just a couple of final points. We do think the market is turning.

Speaker 1

It has stabilized. There is volatility for the reasons I've summarized. But we think actually, the sector is now structurally supported, low development pipeline, restricted supply more generally and importantly rental growth continuing, which will be we think the key driver of returns rather than assuming any significant fall in yields. We think our portfolio has lots of opportunities to take advantage of that. You hope, you know, you've taken comfort from some of the examples we've given where we have live activity that we've either completed or is ongoing.

Speaker 1

And I guess final point, you know, very encouragingly, a lot of that activity is driven by our new strategy. It is where we are delivering those sustainability enhancements to deliver that green premium. And importantly, we hope differentiate ourselves from peers over time. So I'll pause there, hand back to James. Thank you.

Operator

Thank you, Nick. Thank you, Bradley. And thank you for everyone for sending in your questions. And if you do have more questions as we go through this, please send them in, and I will ask the team as we go through. So maybe just there's a couple of different style of questions here, some questions around the market, some more granular detail on the strategy and the trust.

Operator

So maybe just starting maybe at market level,

Speaker 2

because that's

Operator

sort of what we finished with the overview. So Nick, maybe coming to you. Question here just around whether our tenants are feeling potentially in the future the business rates are going to affect them in any way. We've obviously seen some policy changes under the new Labour government. Is there anything that is playing out on the ground recently, particularly since the change of government that you see as a risk?

Speaker 1

Look, I think there are risks that we are cognizant of, and we've all read the headlines post the mix increase and tax increases from particularly the leisure operators, obviously, 1 or 2 of the seed market chains. I mean, I guess, the first thing to note is we have a low exposure to those types of operators, particularly a low exposure to the leisure sector. So although I think there is an issue there, I think if I look at our tenant mix, the granularity of the tenant mix, but also our rent collection stats, they're as good as they ever have been. I think we are expecting perhaps there might be further changes coming, for example, in relation to business rates and a rebalancing between, for example, what the bigger rate payers, particularly the big boxes, logistics operators may pay with an equivalent, obviously, reduction, particularly on the focus on the high street. Again, I don't think we'll be adversely impacted by that.

Speaker 1

Our industrial assets are generally multi let, granular. So I think there will be an impact more broadly. But I hope and expect that because of our granularity, because of our portfolio exposure, we shouldn't be adversely impacted.

Operator

Thanks, Lenny. You just touched on the term big box. I'm going

Speaker 1

to ask

Operator

you the question, which has got that within it. So one of our listeners has asked quite rightly for some more detail on our views on the various different subsectors within Industrials. Obviously, we've got a large proportion in our own portfolio, multi let. Obviously, we just spoke about big box there. How do we see that playing out in the future?

Speaker 1

So look, I would say that the logistics sector and industrial sector generally are structurally supported still. We obviously showed the stats where industrial values obviously fell ahead of the other sectors because yields got to such a low level. But the reason they were at that low level is because the market was pricing in continued healthy levels of rental growth and that's what's happening, okay. So I think we are positive about the logistics and industrial sector as a whole. I guess for us, because we have that income bias and also because we feel we can add more value to a multi industrial estate, that's where we've tended to focus our efforts.

Speaker 1

And I would say also, we expect higher rental growth relative to big box from multi let, mainly because the supply is more constrained. If you look at the new development, we haven't got the stats here, but we've shown them previously. If you look at the percentage of new developments coming through as a total space for big box versus multi let, big box has consistently been higher. Now that's partly because there's been more bigger users wanting that space. But equally, I think we would say still the multi let should deliver better returns.

Operator

Great. Thanks, Nick. So we're now going to move on to some more specific questions. And maybe Bradley coming to you here for this question. A question here from one of our listeners just asking for a bit more information on the break and expiry profile over particularly over the next 12 months?

Speaker 2

So we have a walk to earliest break of 5.5 years, which has increased quite markedly over the last year or so. It was around 5, maybe 18 months ago. So we have worked hard to increase the lease length where we complete our asset management initiatives. So the idea is we create the value rather than buying that value. So a longer term lease, perhaps inflation linked, would be too low a yield for us to acquire, but we can create that.

Speaker 2

So I think our wall has been moving in a really positive direction.

Operator

Good stuff. Maybe staying with you, Bradley, but Nick obviously chipped in. Question here, a bit more of a technical question around regs actually. So sorry for asking you, Bradley, first, but it may come to Nick after you, Bradley. What percentage of the portfolio does not currently meet the MEs regulation?

Operator

And what is the estimated cost of upgrading these units in the portfolio?

Speaker 2

So I think it's either 0 or very close to 0. Okay. So any units that don't meet these can't be let for another reason. It's like a tiny amount.

Speaker 1

Yes. Yes. And I think it's worth noting, on the second leg of that question, mean, we're giving more guidance than we have done previously about the amount of CapEx we're putting into our assets. We will as we complete the net zero carbon audits across the portfolio, We will continue to provide more information to shareholders on how much we expect we'll be investing in addition to deliver those sustainability enhancements. We will be using our end of year business plans to really provide more clarity on that with the results next year.

Speaker 1

So that is the aim. Now it's worth also noting, with our strategy, we are never going to have 100% EPCA. You know, this is essentially a transition strategy. We are buying, as we showed with that St. Anne's Manchester example, we are buying B Class buildings, investing in them, turning them into AA- buildings.

Speaker 1

So we are always going to be on that journey of improvement.

Operator

Yes. So you're setting up my questions perfectly today, Nick, because we were straight on to the next question, which is a really good question. So Bradley, you've obviously spoken about St. Anne's and the developments that we're looking to do there. You spoke really clearly through the costs and then the potential IRR, I think, was 13% that's being sort of highlighted here.

Operator

What's the risk to that situation, which I think is a really fair question?

Speaker 2

So I guess taking a step back, when we acquired the asset, we had a view that we could push the rents for in the 1st place. And that's because we have an office in Manchester. We've got an office specialist team. So the guys are on the ground. They know what rents are kind of going on other assets that we own or other assets that they're just aware of.

Speaker 2

So the first risk is, are we making that judgment correctly? Are we kind of we don't want to overestimate that potential rent. A second element is how much is it going to cost to achieve the sort of the type of office that would attract the right tenants to pay those rents. And then, of course, there's a estimate of the return. So they are the risks that go into it.

Speaker 2

And we think that we're good. Our kind of bread and butter is taking property risk. We don't just buy and hold. We want to go in and make real changes to an asset to create a return. And I think, in an environment where interest rates are higher and where whilst we do expect interest rates to decline, it's going to take a very long time and it will be small increments.

Speaker 2

You can't just rely on yield compression. You have to be actively creating value. And I think that's what we bring as a manager.

Speaker 1

Yes, I agree with that. I think it's having the specialist capabilities. That's what allows you to mitigate the risk. As Bradley has said, we've got 100 people in the UK real estate team across all the different specialist parts of the market and obviously also sustainability specialists, 6 subject matter specialists just in sustainability. So we mitigate a risk by drawing on that collective experience, other projects that we've done, obviously, in Manchester, having our actual team in Manchester, obviously, is very helpful.

Speaker 1

You know, we can be there every day in the same way, you know, for Stanley Green example, that's just south of Manchester. That was driven by, you know, our local teams up there. So I think it's having that having an expertise, sensible and cautious underwriting is really what helps us mitigate that risk.

Operator

Yes. And another point that you touched on in the presentation was operational excellence. So maybe just expand slightly on how that fits into this? I know you've been talking over a couple of results now about how important it is that that part of the business has developed as well.

Speaker 1

Yeah, look, I mean, operations, it covers a very wide range of everything we do. I think everything from, you know, the approach to property management, service charge management, amenities for occupiers, occupier engagement, occupier surveys, occupier relationships to ensure that, you know, we actually know the people in our buildings and we are responding to them. And obviously, the whole sustainability dimension now, you know, the way that we're approaching our net zero carbon audits, the investment we're making in our own technology platform to allow us to properly understand and analyze data and deliver those improvements. I mean, it's across that whole spectrum, which you really only get from a large manager. I mean, these things require significant investments in technology, in people, in time.

Speaker 1

So it's across the piece. And ultimately, that's what you're seeing coming through the returns. It's the top line research, sector allocation, but also that bottom up operational aspects.

Operator

Yes, sure. Thanks, Nick. Just sticking on the sustainability point because there's one more question, which I will ask you on that point. Could you just give us an example, Bradley, maybe, and I'm sure there are examples in the portfolio already, where you've undertaken a sustainability upgrade project? What's the typical time that takes to go through from start to finish?

Operator

And I guess that what are the dynamics of play there? I guess it differs in different projects, but do you is there a point in time where the asset is suddenly ready to let? Or are you able to do partial renovation and then have tenants coming in over time? How does that work on well, particularly on our assets?

Speaker 2

Yes. It's a good question. And I think St. Anne's is actually a pretty good example because the renovations we're undertaking at the moment relate to the ground floor, basement and 5th floor and some of the external facade. So that means that there's other floors that aren't currently being refurbed.

Speaker 2

And the reason for that is they're currently let and there are tenants in there. So as the tenants come out, we'll then go in and probably undertake a cat A refurb with that floor. And then eventually, over time, you'll have an asset that is rather than being EPC D, it'll be EPC A or B. And all the rental levels will have increased. And that does take time.

Speaker 2

Real estate takes time. It's a real physical asset in the world that's being used. And it's hard to put a specific time on it, but it depends on the lease expiry profile of each asset that we're working on.

Speaker 1

Yes. It varies by project. And actually, incrementally versus a standard refurb, it doesn't take necessarily longer. There's an additional cost aspect to it. There's a technical aspect to it, again, back to having our specialties capability.

Speaker 1

But what we're trying to do is, as Bradley has said, is in most cases, manage income at the same time. So that's why projects like Staunton Green, St. Anne's, we're doing those things partly to improve existing building stock, but also partly to ensure that we're earning income at the same time as delivering those improvements.

Operator

Yes. Thanks, Nick. Question on one of the office assets that you mentioned that's come through. And this asset actually, one of my favorite assets being originally from Bedford, so Howard House office in Bedford, for those of you not so familiar as I am, 23% ahead of carrying value. What does that say about the rest of the portfolio?

Operator

That's an exceptional level of premium to existing value. How do you think about the rest of the portfolio in that context? That must make you pretty positive about a number of the other assets in the portfolio?

Speaker 2

Yes. I mean, from my perspective, yes, it does. And I think a point to add, Nick spoke about the market. And there is better liquidity for the smaller assets. So we're talking about quite small assets here.

Speaker 2

So I think that's kind of been reflected in the price. So maybe valuers are just a bit nervous about pushing on cat val per square foot, etcetera, in the valuations because of the lack of deals in the higher value segments of the market. But what we're seeing in the smaller parts of the market is you can achieve some really attractive prices on sale. And we've done that for a series of our assets actually over the last couple of years and hoping to do it for more.

Operator

Yes. Fantastic. Maybe we'll just come up to 45 minutes. Maybe chance for one final question. Maybe I'll come to you, Nick, for this.

Operator

I guess this is a really good question, probably, to finish with, actually. The point here that the listener is making is that share price is up about 20% in 6 months, fantastic outcome for any more recent investors in the last 6 months. Clearly, discount is narrowing, which is great. As you've alluded to in your comments, we're seeing new demand. I've certainly seen new investors coming onto the share register through the conversations I'm having.

Operator

Where do we go from here? What do you see what are you looking at the next 12 months and thinking that's where we want to be?

Speaker 1

Yes, great question. Look, I think, 1st and foremost, we're focusing on what we can most control, right? And that is driving the earnings growth that we believe is inherent in the portfolio to continue to deliver a sustainable and progressive dividend policy, right? That fundamentally, that's what we're about. We're about driving higher earnings growth And hopefully, we've given a sense today that there is that continued upside, we believe, through that approach.

Speaker 1

I think if we continue delivering that, then all things equal, we may see a further improvement in share price rating. I think what you've heard today also is alongside delivering the earnings growth from our existing assets, there's potentially some rotation that we can do within the portfolio to also add to the earnings. So whether we're selling assets, Brad has mentioned a couple, lower yields, redeploying into high yields, which is what we've always done, then that could potentially add to that earnings growth. Longer term, if you look at what we've delivered from the portfolio, we've tended to get more bang from our bigger assets for every buck. And therefore, if we could deliver accretive growth, then that's something that we would look very seriously at, particularly at the moment, because, you know, A, we've got a relatively low cost base, both in terms of the true TR, but also if you look at our debt cost.

Speaker 1

And so if you're comparing that with buying yields, you know, 6.5% to 7%, it's accretive. So I think, you know, step 1 is continuing to deliver what it says on the tin. If that does deliver a further improvement in the rating, then we would love to be in a position where we can grow. But look, it has to work for shareholders. And at this stage, we've got to focus on the day job.

Speaker 1

Perfect.

Operator

Well, thank you. That's all we have time for just to say to our listeners. Thank you to Bradley. Thank you to Nick. I certainly hopefully you agree, if you've been listening to this, that it's another very strong set of results.

Operator

I'm certainly seeing talking to investors that there seems to be more positivity around U. K. Real estate than there has been for a long time. We've certainly seen that in the share price and the rating this year. If you have any further questions, please do feel free to get in touch with myself or your normal Schroder's contact.

Operator

Hopefully, you are now seeing a feedback form on your screen. Please do fill that in. We do appreciate your feedback and we do read them, I promise. But with that, that's all from us today. Thank you very much for spending your time this morning listening to us, and we'll speak to you all again very soon, I'm sure.

Operator

Goodbye.

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Earnings Conference Call
Schroder Real Estate Invest H1 2025
00:00 / 00:00