Derwent London PLC

LSE:DLN

Earnings Call Transcript 2024-Q1

[Operator]

Ladies and gentlemen, welcome to the Derwent London Q1 2024 Business Update. My name is Dave, and I will be the operator for your call this morning. [Operator Instructions]. I will now hand you over to Paul Williams, Chief Executive.

[P. Williams, executive]

Thank you very much. Good morning, and welcome to the Derwent London Q1 2024 business update. I'm delighted to say that the momentum in the occupational market that we highlighted with our year-end results is increasing. Since the start of 2024, we've agreed GBP 5.4 million of new leases and there was a further GBP 4.3 million of rent under offer. On average, the rental new leases in Q1 was at a premium of 9.2% to ERV, with an average lease term to break of 7.4 years. The flight to quality, particularly for our own product continues. In total, 58% of the space we had available to let at the end of 2023 is either be leased or is under offer.

I'm also very pleased to announce that we signed a third pre-let at 25 Baker Street. CushmaWatfor is taken just over 17,000 square feet on the first floor, reflecting the quality of the space, it significant occupier appeal and following the other pre-lets to PIMCO and Moelis, the rent of GBP 1.8 billion year equates to GBP 150 per square foot and is 19% ahead of ERV, providing a further boost to the project's yield on cost. On Oxoteet Utica has now opened and is proving a great telecare for the center office street. Starbucks is also at least one of the objective units, leaving only the 2 smaller retail units available I'm encouraged by the level of vol with detailed negotiations ongoing. Letting activity is well spread across the portfolio with the ES a significant pickup.

At the White Chapel Building, for example, where demand has been slowed since the pandemic, activity levels have increased noticeably since the start of the year, 116,000 square feet has been leased or is under offer, including PLP architecture who have taken 22,000 square feet, I have 10-year lease at GBP 50 a square foot. Our portfolio appeals to a broad range of occupiers, including those who are more cost conscious, yet still require high-quality space with good amenity and transport connections in lower rental locations. Overall, our EPRA vacancy rate was reduced to 3.7% at 31st of March from down from 4% at year-end. Market vacancy rates were stable in Q1 with the West Ed tide. The investment market has remained subdued, but we were pleased to surf terminal for GBP 77.4 million, 3% ahead of the separate book value proceeds due later in Q2.

Our on-site in rents are both in the West End, where the supply demand in balance is greatest. 25 Baker Street per side works are making good progress. The main office building is now 84% pre-let on rent averaging 15% and above the appraisal of ERV. In addition, we have exchanged contracts for the sale of 9 of the 4 private residential units with a combined price of GBP 54 million, comprised of 32% as a total residential area. This reflects a value of GBP 3,920 per square foot, which is significantly higher than the appraisal valuation. At network, single structure works have commenced with some 80 months to go until completion, we are in discussion with several potential prelets and are very confident in the prospects of this metric best-in-class office building. We're also continuing to prepare for our next phase of Western Development at 50 Baker Street and Hodous, which together totaled 390,000 square feet.

Turning to the financials. Our balance sheet remains very well placed and our gearing this month is the lowest in the U.K. REIT sector with an LTV of just 28%. Project expenditure of GBP 54 million in the quarter was the main driver of the modest increase in net debt to GBP 1.4 billion. Our transit team has made good progress on our replacement facility for the GBP 83 million secured loan, which matures in October, returns already agreed. In summary, with our full year results, we upgraded our rental growth forecast for 2024 to plus 2% to plus 5%. Our leasing activity underpins this forecast alongside the increasing strength of the occupational market for well-located buildings with the right ability. Rental growth is further supported by the shortage of existing supply and constrained market pipeline. We have a strong balance sheet and a regeneration pipeline, we expect will deliver attractive returns. We are well positioned to benefit from these trends.

Thank you. I will now hand back to the operator for any questions.

[Operator]

[Operator Instructions]. The first question is from the line of Kalim Marley from Colitis.

[Unknown Analyst]

3 quick questions, please. First one, just on the disposal you did expectations on that I noted 4.9% net yield. Can you just remind us quickly of where yield on costs and development margins sit at major strict and network one [indiscernible] .

[P. Williams, executive]

So just looking at that information for you. Sorry, yield on cost, Robbie?

[Unknown Executive]

5.8

[P. Williams, executive]

5.8%.

[Unknown Analyst]

Got you. Second question, long term, just looking at your vacancy numbers. And as we think about them going forward, do you expect the trends in Basic and that down to 1% on its pre-COVID level? Or is this kind of 3% the new normal.

[P. Williams, executive]

Obviously, we were a very active portfolio. Our vacancy rate, I mean, around 4%, I think, is very good. But obviously, from time to time, we will refurbish space or we will take better space to upgrade. So I think it's been in a good place some time. Obviously, what sort of interest to us also is the vacancy rate in our core areas, so that we -- obviously, with supply is so constrained, for vacancy, particularly in the West End. So for us, that really good strong demand in a constrained market. But this is a very active portfolio we take space back occasionally to reposition, et cetera. But I would expect the vacancy rate to remain in a very good place over the next couple of years.

[Unknown Analyst]

And last one, just over the last 2 years, that you're moving your portfolio on a more towards the west end. I think the breakdown might be something like 75%, 25% now. What is your long-term view on the portfolio in -- and then as a follow-up, what is your investment view on the London City market today given that valuations have requested quite a bit and primers you making quite a bit more traction elevates.

[P. Williams, executive]

That's a very good question. I think firstly, we very much like our clusters. And I think West End has performed very well over many, many decades. And I think having a percentage of circa 50% in the West End is very good, particularly, as I say, about 70% of them of the Western desire listed or is unable to redevelop very high. So with those dynamics from a planning point of view, where you can secure planning commissions that we have done for our developments, there's a solid limited supply, and therefore, good rental growth prospects. So I think the West has always been tight and I think we'll rebate. So historically, we haven't really invested in the city. We've very much done very well with our sort of Northern French, whatever you want to call it or the city borders. The white shape area has picked up, as I said earlier, but also if you look at what we've done on in Tarrington, et cetera.

So I think those areas will remain pretty important to us. If we found a building of interest in the city at a good price, the way we could have that sort of do it special dust, and I think we would consider it. But that's a market with a much higher vacancy rate, I think, a much higher level of secondary space available there. So I think the market dynamics there is very different. So I would rule it out, but you could rule out that we're not going to go further east in that. We think we're going to have to stay in a central locations because as we've seen over the last couple of years, people are prepared to pay a very good premium rent to be in Central other locations.

You see that in west, you've seen also some good deals in the city. So I think we're going to remain focused in our core areas of the West End about 70% plus our city borders. But also if there's something interesting came up, we would certainly consider it.

[Operator]

The next question comes from the line of Tom Musson with Goldman Sachs.

[Tom Musson, analyst]

Just a couple of questions. Firstly, at 25 Baker Street. If you adjust for the lease incentives, how does the net effective rent you secured from Cushman compared to that of the PIMCO and Moelis deals. Just want to get a sense of whether you've seen as much progression there on the net effective as you have at the headline level as you pre-let that building?

[P. Williams, executive]

Good question. Firstly, interesting pushable a 15-year lease. So the actual level of rent-free period will be higher, but a proportion of its rent will be very much in line with that. And I think you could even normally assume something around 20%. The market will probably be about 36 months of the 15 year lease. The rent free period you've given to Cushman is slightly lower than that. So we've done well on that, but rent-frees still remain around about 20%. So a little bit lower than the market but probably in France is relatively in line. But headline rents, as I say, 19% above, and it was very good to secure such a lot lease on there. So that's what we're finding quite interesting and people for top-quality space, we're very happy to consider decent monthly and our volts in a great place. I think you had a second question.

[Tom Musson, analyst]

Yes. No, that's helpful. Second one was on network W1. I think you previously mentioned you were happy to wait a little before pre-letting anything there to let ERVs grow. It seems from your comments like there is gathering interest in that space. What is your latest thinking there now around the pre-let? Do you think we could expect something this year? Or should we be thinking more along the lines of 2025 for that somewhere closer to PC?

[P. Williams, executive]

Well, I think momentum is very much building up in its demand. We have really been marketing. It doesn't finish until H2 2025. And so that's what, 18 months away, and that 20 would normally expect to sort of start seeing some interest. So as I said in the statement, we've got ultimate interest in the asset. And I think the position we need to make is who we show with and all the rest of it. But I would very much hope that we will be getting a good retail rent rather than a discounted rent for -- because as we see rents grow. So I would hope that you would have some good news this year rather than I don't think -- I think that we'll take the view is someone in the market or in this shop to buy, make sure they sure they buy at a proper price.

So we are very encouraged by the level of interest we've got and we've got multiple discussions and one would hope that we could make some sort of announcement later this year. But where the vacancy rates and low as it is, having 84% pre-let baker tree, I'm in a position to make some choices. And we will encourage people to transact with this, but we want to make sure we get good returns.

[Operator]

We have the next question from the line of Paul May with Barclays.

[Paul May, analyst]

A couple of questions on mill initially for me. Just wondered if you can give some guidance as to the write-down from peak values. Secondly, where you in discussions at the year-end? And what was the write-down in the asset in the second half or over the whole of last year. And can you give any guidance on the equivalent yield or the reversion potential in the asset for the rent review next year appreciate you saw at a 4.9% initial yield, which is higher than your portfolio, the rest of the portfolio. I'm just wondering how the reversion is expected to go next year?

[P. Williams, executive]

Well, obviously, turning to the question about term it obviously came down a value in '23 other parts of the market has done. I mean I think, first, if you look at the initial yield, 4.9%, sub-5%. I think most people have been telling us that's a very, very, very strong growth. It came down double-digit, Nigel?

[N. George, executive]

Yes. Yes. I mean neither all the portfolios I probably have -- I think 3, 6 months of valuation declines. Last year, we were down 10% overall in the 6 months previously '18. So overall, the portfolio is down about 18%, and that's probably where.

[P. Williams, executive]

Probably make it clear, But we weren't looking to sell this building. We're not -- it's someone approach to us off market. And so our view about what we approach was, yes, but it has to be surprised. So I think we were very happy to be booked. I mean book is, as you know, the portfolio is probably twice a year independently. The book value is the book value is what they gave us at that year-end. But as I say, could speak for that. Could you provide me of your second question? Your line is [indiscernible] by the way.

[Paul May, analyst]

I was just trying to get a sense on the reversion potential. I think it's due for a rent review next year. So I wonder what the 4.9 could become next year?

[P. Williams, executive]

What issue for revenue, I mean, obviously, revenues, it's -- they're always done on a -- get down to a net effective rent. So they look forward as positive. But I would say on reversing yield loan 5s, right? I mean, we wish to purchase it well. But I think from our point of view, we saw a little rental growth on the rent review. And as I say, we're happy to sell it at sub-5%. And we tell the recycling model get about GBP 80 million back into the business to reinvest elsewhere is a good business. I would say low price.

[Paul May, analyst]

And then just a separate question on costs, if that's possible. I appreciate to gas ratio is relatively high. I understand why, given the development-led model of the business. Is there any thought process around trying to bring that down through either increased scale and operational leverage in order to drive a greater income return for investors.

[P. Williams, executive]

You beat our overall cost rather constructure costs.

[Paul May, analyst]

Yes, yes, overall cost. The cost ratio of the business.

[P. Williams, executive]

So obviously, we're always mindful of the cost ratio. Our EPRA cost ratio is at 28% which is a lot lower than others. And obviously, when you've got to scale it more in respective the business. Obviously, the bigger the business, hopefully below the ratio. And if we could grow the business, we would certainly look to do that. But that's to reveal as such.

[Damian Wisniewski, executive]

Paul, this is a Q1 update. We don't provide any further figures. I can tell you that last year's figures, you all noticed, they were elevated by the unexpected high energy costs that we saw through last year. We haven't disclosed any figures in Q1. We'll do that at the half year. But I can tell you, our cost ratio is down in Q1 compared to last year, but we're not disclosing those figures at this day.

[Operator]

Thank you. Ladies and gentlemen, we do have a web questions at this time.

[P. Williams, executive]

Good.

[Unknown Executive]

So we got 2 questions. The first is from Adam Shapton at Green Street is the furnished and flexible ERV beat at 19.8% against the specific first and flexible ERV or is it based on the ERV of normal fix at please?

[P. Williams, executive]

I will pass it to Emily to answer.

[Emily Prideaux, executive]

Yes. The outlook that we sort there is against an already elevated furnished and flexible ERV and is a net figure after any additional cost.

[Unknown Executive]

And then the second question is from Zach Gauge at UBS, and it is how is the GBP 50 per square foot letting on the White Keppel building to PLP compared to the ERV.

[Emily Prideaux, executive]

And that one is just marginally but it's about 5.3% above ERV with 4,750. So in that marketplace, a good level of rent for that deal.

[P. Williams, executive]

I think it's very good rent. Good to see a good tenure lease again. So it's interesting to see how that market's picked up.

I think we're -- I think that's the end of questions on the web. We got any more questions online?

[Operator]

We do not have any further questions on the audio.

[P. Williams, executive]

Well, can I just say thank you very much listening in today. We're very busy. We're encouraged by the active demand across the whole of our portfolio, getting ready for our next phase of development. If you -- any of you guys have got any further questions you'd like to raise, Robbie, the team, risks around later today. And obviously, we look forward to catching up fully in terms of beginning of August. And so have a good day. This lovely sunny weather. Take care, everyone.