Derwent London PLC

LSE:DLN

Earnings Call Analysis

Improved Financials and Updated Guidance Signal Positive Outlook

In the first half of 2024, Derwent London showcased a robust performance despite a 2.7% decline in EPRA NTA per share to 3,044p and a nearly flat total accounting return. The firm's strong rental income helped offset valuation falls, leading to a 6.5% increase in EPRA earnings. Management reported stabilized yields and rising rents, prompting an upgraded rental growth guidance for 2024 to 3-6%. The interim dividend increased by 2% to 25p per share. Future development prospects remain optimistic with ongoing projects in London's West End, expected to contribute significantly to returns amidst a projected positive market backdrop.

Navigating a Recovering Market

In the first half of 2024, Derwent London showcased resilience amid a recovering rental market. The company reported a modest decline in EPRA Net Tangible Assets (NTA) per share of only 2.7% to 3,044p, a significant improvement compared to previous years. The stabilization of yields, aided by declining interest rates, has created a backdrop for growth, leading to a near-flat total accounting return of -1% despite significant market pressures. With rent collection remaining strong, this period demonstrates an environment ripe for growth, particularly as the company expects positive total returns for the second half of the year.

Driving Income through Strategic Leasing

Derwent London achieved noteworthy leasing activity, securing GBP 10.8 million in new rent since the start of 2024. This includes a remarkable 10% premium over estimated rental values, indicative of strong tenant demand for quality spaces. The company's EPRA vacancy rate improved to 3.2%, compared to the overall market vacancy of 8.3%, emphasizing its competitive positioning. Rentals increased by 1.7% on a like-for-like basis, while net rents rose 3.4%, attributed not only to strong demand but also to lower property costs and impairments.

Optimistic Growth Projections

For 2024, Derwent refined its rental growth guidance to between 3% and 6%, up from the earlier range of 2% to 5%. This guidance reflects an expectation of sustained growth driven by limited supply and high demand in the market, particularly noted within the West End, where available space is at a premium. The anticipated acceleration in rental growth aligns well with the company's broader strategy to capture higher returns from its existing properties and developments.

Financial Stability and Dividends

Financially, the company is well-positioned, with EPRA earnings increasing by 6.5% to GBP 59.2 million, equating to 52.7p per share. Despite rising costs, administrative and finance expenses remained stable year-on-year, indicating effective cost management. The interim dividend was increased by 2% to 25p per share, showcasing a commitment to shareholder returns while maintaining a dividend cover of 1.3 times based on EPRA earnings.

Development Pipeline and Future Prospects

Looking ahead, Derwent anticipates an intense period of capital expenditures, with an estimated GBP 103 million expected in the second half of 2024 alone, potentially marking one of the company's highest annual spends in this area. The long-term development pipeline includes around 1 million square feet of new space expected to be delivered over the next four years, focusing predominantly in the lucrative West End. These developments, which are projected to yield at least 6%, are crucial for position the company not only to capitalize on rising rents but also to drive further value through asset repositioning.

Outlook for Investment and Acquisitions

Despite a competitive environment, Derwent remains on the offensive concerning acquisitions. With a robust balance sheet and GBP 566 million in cash and undrawn facilities, the company is well-equipped to seize opportunities as they arise. Executive leadership indicated a willingness to push the loan-to-value (LTV) ratio to the early 30s percentage-wise, allowing for expansion and investment into promising properties without overly relying on external funding.

Conclusion: Confidence Amidst Caution

In summary, Derwent London's earnings call reflects a company navigating the complexities of a recovering property market with strategic foresight. The rise in rents, strong focus on core developments, and investor-friendly dividends indicate a commitment to sustainable growth and shareholder value. Coupled with the anticipated rental growth and proactive acquisition strategies, the management's confidence positions Derwent as a compelling player in London's real estate sector.

Earnings Call Transcript 2024-Q2

[P. Williams, executive]

I think we're all here. Good morning. Welcome to Derwent London 2024 Half Year Results Presentation. As well as for me, you will hear from Damian,Nigel and Emily and then I shall wrap up with Q&A. But before we start results, I'm delighted to say that we achieved a resolution to grant planning permission on Tuesday for our next range of project at 50 Baker Street, which we had a joint venture with Lazari.

In turning to Slide 2 and an overview of our performance. London's occupational market has continued to strengthen, and I'm pleased to say that the rental growth we achieved in H1 was the highest half yearly performance since 2016. Demand for high-quality, well-located space is deep and broad-based and supply is limited. We continue to deliver leasing success with GBP 10.8 million of new rent agreed since the start of the year, nearing 10% above ERV, which includes GBP 8.8 million in H1.

This takes our leasing activity over the last 18 months to over GBP 40 million. We also have GBP 3.4 million under offer. We're seeing good activity across the portfolio, including our furnished and flexible space. Our EPRA vacancy reduced to 3.2% from 4% in December, which is less than half the market vacancy rate of 8.3%. Supply is tightest in the West End with only 2.8 million square feet of speculative space currently under development and a low vacancy.

Our 2 on-site developments and next phase of projects are all deliberately in the West End. 25 Baker Street is 84% pre-let on rent substantially above ERV, and we are confident in the leasing prospects for network. Based on the latest rents, the schemes or forecast producer development yields of at least 6%.

Now with our 2023 results in February, we said that yields were stabilizing. We believe that we are now at the end of this cycle and Q2 valuations broadly stable according to MSCI and our valuation is down only 1.7% on over the 6 months. We're seeing an increase in number of interesting and well-priced opportunities come to the market and have the balance sheet and the ambition to buy.

Now on to guidance. In February, our rental guidance for 2024 was plus 2% to plus 5%. Rents across our portfolio were up 2% in H1 and the ongoing imbalance between supply and demand gives us the confidence to further upgrade our guidance for the year between plus 3% and plus 6%.

A positive London market is shown on Slide 3. The last few years have been tough for the real estate sector, and particularly the end of very low interest rates, which has led through to a yield-driven reduction in capital values. Following last week's rate cut by the Bank of England with further interest rate cuts in the horizon and the easing of availability of debt, then officials look increasingly attractive to a range of investors. Average ready show the whole picture over across London, the vacancy rate is 8.3%, but look beneath surface and 2 patterns emerge.

First, availability of the West End is substantially less than the city and docklands and secondly, grade availability remains below 2%. As the flight quality allocation continues, the pace of rental growth is accelerating, particularly in the West End.

Now the positive market backdrop is feeding through into higher total returns on Slide 4. Our total return model has 3 foundations: first, earnings. Our long WAULT underpins our attractive rental income stream, our ability to lease space well and attractive yield of developments further drive income growth, and of course, effective cost control and visibility on the cost of debt, of course, very important.

Secondly, rental growth. You've already heard about the strong occupational market backdrop and how this is feeding through into rents. The scale of our asset management team in capturing reversion also plays a key role.

The third component of our total return is the value we create through asset repositioning, whether redevelopment or refurbishment. Relative to yields on investment assets or projects deliver high yield on cost, which translates through into an attractive profit. We have around 1 million square feet on-site or due to commence over the next 12 to 18 months, and we have a long established track record of pre-letting space well. We anticipate delivering increasingly attractive total returns over the coming years, given the combination of stable yields and growing rents.

I will now hand over to Damian to take you through the financial results.

[Damian Wisniewski, executive]

Thank you, Paul, and good morning, everyone. The financial highlights for the first 6 months are on Slide 6 and show an improving position. While EPRA NTA per share fell 2.7% to 3,044p the decline was much smaller than last year. Yields continued to move up in the first quarter, but have since stabilized, helped by more positive interest rate news and our rents are rising. The total accounting return in H1 was almost flat at minus 1%, with income close to offsetting the valuation fall.

We're expecting a positive total return, both in the second half and for the year as a whole. EPRA earnings have increased 6.5%. Costs under good control and all our debt and balance sheet ratios are strong. We've increased the interim dividend by 2% to 25p per share, continuing our track record of progressive dividend increases and the annual dividend remains 1.3x covered by EPRA earnings.

The movement in EPRA NTA is shown on Slide 7. Most of the figures are close to H1 '23, but the revaluation deficit on wholly owned properties was only 84p per share this time, less than half the 178p per share in H1 '23.

EPRA earnings are on Slide 8 and rose to GBP 59.2 million or 52.7p per share. Gross rents have increased and property expenditure and impairments, which were both affected by high energy costs in 2023, fell by GBP 2.4 million to GBP 12.5 million. Rent collection remained very strong overall, which enabled us to reduce the impairment charges compared to H1 '23. Admin and finance costs were close to last year despite strong wage and cost inflation across our supply chain. After several years, when our input costs have grown faster than our rents, we may now be approaching a point when rents can grow more quickly than the underlying rate of inflation.

Slide 9 shows the movements in gross rents. Developments and refurbishments increased rents by GBP 2.4 million, while Asset Management added GBP 3.2 million compared to the first half of '23. Breaks and expiries reduced rent by GBP 3.5 million, but some of this will enable us to refurbish space and market it at usefully higher rental levels. Like-for-like gross rental income was up 1.7% compared to this time last year, with net rents growing by 3.4%, helped by lower property costs and impairments.

Slide 10 shows property costs in more detail. Irrecoverable service charges were closer to a normal level in H1 at GBP 2.8 million. Void costs reduced due to lower average vacancy rates. Caps were lower than in H1 '23 and came largely from repair costs at a few buildings like Stephen Street. Other property costs were in line with expectations.

Finally, our lounges, which set us apart and help attract and retain occupiers across the portfolio. The cost of running these rose to GBP 1.2 million in the first half as DL/28 at Old Street opened late in 2023. Income from these facilities is also growing, but as expected, we anticipate a small overall deficit in the future.

Slide 11 shows project expenditure across the portfolio, which grew to GBP 108.6 million in H1 '24. The 25 Baker Street and network office projects incurred GBP 47.6 million in the first half, and refurbishment costs included GBP 7 million at Stephen Street, where we are refurbishing the second floor and carrying out EPC upgrade works. GBP 25.9 million was incurred on the residential units for sale at 25 Baker Street held as trading property. Sales here are going well with GBP 68 million now exchanged. A further GBP 4.1 million of expenditure came from the retail space held as trading stock to be sold to freeholder on completion.

Future estimated CapEx is on Slide 12. We currently expect GBP 103 million of spend in H2, which would make this one of our highest ever years for CapEx. EPC upgrade costs have reduced to GBP 91 million due mainly to the works being carried out at Stephen Street. GBP 156 million is currently forecast for 2025.

Slide 13 shows our usual pro forma, taking account of the GBP 155 million cost to build out the committed major projects, plus disposals and new income contracted up to the end of June. The required spend is covered by available facilities, and both interest cover and loan-to-value ratio remain comfortable.

Slide 14. Last week's interest rate cut was very welcome, but rates remained relatively high through the first half. Rather than fixing into these higher rates, we signed a new GBP 100 million unsecured term loan with NatWest in June, which was drawn in full in July. This took undrawn facilities and unrestricted cash up to GBP 566 million at the half year, ready for the maturity of the GBP 83 million fixed rate loan in October.

Our GBP 175 million convertible bonds fall due in June 2025, and we expect to put in place additional refinancing over the next year, taking advantage of the recent easing of fixed rates. 98% of our debt is at fixed rates or hedged. So the period-end interest rate on our debt was almost unchanged at 3.15% using the cash coupon on our convertible bonds. Fitch confirmed our credit rating in May at BBB+ with a stable outlook. And the unsecured credit senior rating is A-. All debt covenants are very comfortably covered and relationships with our lenders remain excellent.

Thank you. And now over to Nigel.

[N. George, executive]

Thank you, Damian, and good morning. Slide 16. The valuation benefited from improved leasing market, stronger rental growth and further good performance from our developments. However, this was not quite enough to offset the outward yield shift. Overall, there was a 1.7% valuation decline with the West End continuing to be more robust. Our 2 developments, 25 Baker Street Network, which complete next year were up 4.3%. Both saw rental growth and there was further leasing activity at Baker Street. Our total property return was just positive at 0.3%, which was an outperformance against the MSCI Index, which was down 0.1%.

Slide 17, a little more on the valuation themes. As mentioned, our developments, which are now about 10% of the portfolio delivered a good performance. Over the last 2 years, the underlying increase is nearly 11% with further surpluses to come, boosted by rental positive rental outlook and potentially some yield tightening on quality assets. The 6% yield on cost assumes current ERVs, so there may be some further upside and more detail is in Appendix 40.

As shown on the chart on the right, our better quality buildings those with capital values over GBP 1,500 per square foot continue to be more resilient, driven by the quality of the space, amenity and location. Whilst there was some outward yield shift, it was generally offset by rental growth and rent free runoffs. On properties with lower capital values, over 50% of these are earmarked for our future pipeline. So there's good upside, both from planning and development returns.

On EPCs, it's worth noting that Knight Frank have allocated GBP 44 million as a cost within the valuation. This is down from GBP 48 million at year-end, mainly following the installation of air source heat pumps at Stephen Street.

Turning to rent and yield Slide 18. You've heard from Paul that we've upgraded our ERV estimate for the year, and a little more color on this. Valuations were up 2% over the 6 months. As shown on the chart, this trend has been improving since the end of 2020 and was the strongest 6-month performance since the second half of 2016. Looking at our letting activity, we achieved good rents compared to ERV and lettings were across all our villages. Our average rent passing is attractive at GBP 50 a square foot.

Turning to yields. There was an 18 basis point outward movement against a 42 basis point outward movement in the previous 6 months. The cycle appears to have reached the bottom. While much depends on the outlook for interest rates, the consensus is for a series of managed rate cuts and reduction last week was a start. With our equivalent yield now over 5.7% and the reversion yield over 6%, when coupled with a positive outlook for rental growth, returns on a forward-looking basis are beginning to be attractive.

Now the usual buildup of ERV on Slide 19. Our annualized passing rent at GBP 199.4 million was down from December, mainly due to the sale of Turnmill early in the year. There is GBP 111.7 million of reversion in the portfolio to give an ERV of over GBP 311 million. As shown, GBP 48.6 million of this is contracted uplift, so already in our accounting rent roll, which is GBP 206.5 million. The balance of GBP 63.1 million is a 25% reversion and is subject to appropriate rent-free spreading on lettings.

The developments of Baker Street network when complete in '25 could add GBP 34 million to the rent roll, and that's up from GBP 34 million -- sorry, GBP 33 million at year-end. GBP 17.4 million or over 50% of this is pre-let. Our smaller projects could add GBP 9.7 million. Vacant space available to occupy is GBP 8.4 million, down from GBP 10.9 million at year-end reflecting in the lower vacancy rate. Finally, there's GBP 11 million of underlying lease reversion within the portfolio, and this is up 55% on the basis of improving ERVs.

Slide 20. Investment market. Investment activity remains below long-term trend. Whilst rental growth is picture is more positive for most investors, the cost and availability of debt has held activity back. However, the sweet spot remains the West End and smaller lot sizes. Our main disposal was terminal in Farringdon for just over GBP 76 million, a single let property and this went to a private buyer.

On the buying side, we're now starting to see more stock coming through, which is encouraging for acquisitions. While some is distressed, others offer shorter leases, needing expertise to reposition. We have that skill set. Also, the repricing is now starting to provide interesting value in the market.

Finally, a sustainability update, Slide 22. Total energy usage was down 8%, driven by our continued tenant engagement and EPC works at Stephen Street. This fed through to lower intensity as shown. We continue to differentiate and progressing our solar park plans at Scotland is a good example. On completion, this could deliver over 40% of our managed portfolio electricity needs and is an important ESG message not only to our current but also our future occupiers. Following planning consent last year, we're on site with ground preparation and access works. We are out to tender on the solar panels and installation contractor. Completion is expected in '26.

Now over to Emily.

[Emily Prideaux, executive]

Thank you, Nigel. And now turning to key themes in respect of the occupational market. As Paul touched on earlier, London truly is a diverse and thriving city, with excellent transport links and connectivity, a rich and varied pool of talent and a highly sophisticated real estate market. London has proved itself resilient in times of global and national economic hardship consistently outperforming the U.K. as a whole in terms of GDP growth. It's unsurprising, therefore, that a broad range of sectors continue to prioritize London for their offices, driving active demand.

Quality and good design remain key factors in decision-making with occupiers requiring innovative and adaptable space that fosters collaboration, flexibility and well-being. So whilst the role of the office continues to evolve, we're now seeing a clearer focus on office-centric solutions. Prime locations with good amenity and transport connectivity have become a necessity with Crossrail proving an increasingly important role. Our portfolio is well placed to benefit from this. Existing supply that satisfies these requirements is limited, a trend which we expect to continue for some time and lead to an acceleration in rental growth, in particular, across the West End.

The development pipeline is constrained as far out as 2028, and the planning backdrop remains challenging. As such, we expect that gap between demand and suitable supply to continue to increase.

Slide 25, market fundamentals. Encouragingly, if we look at the key indicators of the occupational market, trends across the board are showing positive trajectory, with good momentum and market recovery, particularly evident in the first half of this year.

Taking a closer look now at occupier demand on Slide 26. As we head into the second half of the year, occupier sentiment is increasingly upbeat, with political stability and the first cut to the base rate last week, businesses faced greater certainty in forward planning and decision-making. So whilst take-up across Central London in the first half of 2024, was lower than the long-term average, there was a clear uplift through the period, and we expect this trajectory to continue. Space under offer in Central London is 20% above average. Since the start of H2, several notable West End deals have transacted, further reducing supply, including BDO's 220,000 square foot pre-let of the end building and monday.com's assignment of meta space in Rathbone Place.

Demand for prime space is increasing. With active demand now at 11.2 million square feet at the end of June as occupiers continue to look further ahead.

Looking now at market vacancy on Slide 27. Vacancy rates for London fell slightly to 8.3%. However, vacancy varies hugely across submarkets and grade, with the West End rate almost half that of the city and prime vacancy rate across London at just 1.8% with 42% of the market development pipeline already pre-let, only 7.3 million square feet of speculative schemes are due to complete over the next 4 years.

Next slide in our portfolio lettings. We've had good letting activity in the year-to-date at GBP 10.8 million on average 9% above December 23 ERV, and that excludes short-term lettings on pipeline stock. This includes GBP 8.8 million of lettings in H1, GBP 3 million of lettings across our furnished and flexible units and GBP 1.8 million of pre-lets at Baker Street. Activity was well spread across the portfolio in respect to location with 1/3 of activity being at The White Chapel building.

We're optimistic for the remainder of 2024 with a further GBP 3.4 million of lettings under offer as of today. Several ongoing pre-letting discussions for Network and 25 Baker Street, where the latter is now 84% pre-let.

And in respect of asset management on Slide 29. We secured GBP 6 million of rent reviews, renewals and regears in the first half of '24, just ahead of ERV. In respect to renewals, the deals below ERV reflect short-term lettings largely at 50 Baker Street to facilitate our now consented scheme. I'm pleased to say that in the first half of the year, our retention and reletting late was very strong at 86%. Combined with new leases, portfolio vacancy reduced to 3.2% through the first half of the year. And finally, rent and service charge collection levels both remain very high, just under 100%.

Slide 31, looking at our product. Having heard about the key drivers for the occupiers now to how we are responding to this, always looking ahead to deliver the right product for our marketplace, design, innovation, sustainability are fundamentally in all that we do. And we're always aspired to be leaders in our field, delivering premium product and the very best offices for London. At the larger end, we provide best-in-class HQ offices on long leases. At the smaller end, we offer our bespoke furnished and flexible solution, which is tailored to the building and the submarket within it, which it sits.

Our total flex space across the portfolio is circa 5% of total area. Providing a mix of larger long-term Cat A space as well as the shorter-term flexible and fitted space meets demand in the market while providing us with a well-balanced portfolio and a longer walk. To further enhance the Derwent London product, be it that HQ space or the smaller flexible space, over the last 5 years, we've developed our DL member offer. Since launching these initiatives, alongside our offices, we've had very positive feedback from occupiers and indeed the market, proving their value in attracting and retaining tenants and demonstrating strong demand for our product and brand.

Deals well ahead at ERV at 45 Whitfield Street on furnished and flex product and longer larger lettings to the likes of Buro Happold at Featherstone and Cushman & Wakefield at 25 Baker Street are all examples where our membership offer has been integral to the deal.

Design and innovation. We always look to innovate and disrupt and we never compromise on good design, whether it's refurbishing, more heritage space or delivering new build. We're design-focused creating long-life low carbon intelligent buildings that meet the evolving requirements of occupiers, large or small, across a broad variety of sectors. High-quality design and materiality, sustainability and best-in-class portfolio service and amenity are all fundamental factors of the Derwent London product.

And to bring this all to life I'll now hand over to Paul to talk you through some of the exciting schemes in our forthcoming pipeline where these principles are being applied.

[P. Williams, executive]

Thank you very much, Emily, and I will take you through developments which you said on Slide 34. And the strength of our balance sheet gives us the capacity to develop speculatively or even in more difficult economic environment we've seen recently. We have a deep pipeline of regeneration opportunities give us the ability to grow our returns. Over the next 4 years, we expect to deliver around 1 million square feet of distinct new Derwent space with a similar amount over longer term. Whilst the majority of this is redeveloped, refurbishment forms an increasing proportion of our pipeline. We're currently on site on 2 projects totaling 0.4 million square feet, both of which is due to complete in 2025. The next phase, which comprises 2 redevelopments add comprehensive reversion totals in excess of 0.5 million square feet. Now all in the West End, the prospect for these best-in-class buildings is strong.

Now attractive development returns are shown on 35 Our approach to development appraisal is conservative. We use today's rents and tomorrow's costs. We have a long track record of achieving strong records on developments as well as being on time and on budget, delivering stronger returns than initially forecast. As you can see, the yield on cost for our 2 on-site projects at 25 Baker Street, our network is currently 6%. However, the average rents achieved on the at 25 Baker Street is 15% ahead of the appraisal rents. By way of a sensitivity, the yield on cost increased by 30 basis points for every GBP 10 per square foot by which we exceed the value as June ERV on the remaining speculative space.

Turning over. The ERV of the project has increased by 14% to GBP 21 million since we started on the site in 2022. Part of this is due to pre-debt activity. This supports our view that the rents for the best space in the right location are rising.

Slide 37. We have had a significant success at 25 Baker Street ahead of completion in H1 2025. 84% of the main office building is already pre-let on long leases averaging 13.6 years, leaving just 33,000 square feet to lease. And 13 of the 41 private residential yields have been presold at an average capital value of GBP 3,770 per square foot, substantially ahead of the appraisal. In partnership with the Portman Estate, our retail leasing campaign has been launched on the retail courtyard, which sits at the heart of the project. Early retailer conversations are encouraging.

Now turning now to our on-site project in Network, which has showed on Slide 38. Located in Fitzrovia, it is a short walk away from DL/78, our first occupier lounge. We're making great progress with the core complete and a super structure up to Level 4. The project has been desired responsibly, applying principles of the circular economy from the outset, including designing in the use of recycled raise access for it amongst others. This has helped keep the forecast embodied carbon intensity low and approximately 530 kilos per square meter, significantly ahead of our 2025 target.

Across Fitzrovia, there is very limited existing amenity and space under construction. Demand however, is strong, and we are in conversation with several potential occupiers covering a range of requirements. We're confident in the leasing prospects for this beautiful quality building.

Slide 39. And the next phase of our regeneration projects. At 530,000 square foot, our next phase of West End projects is substantial and supported our ongoing total return. Holden House, which is due to come in to the mid of next year, are behind the facade redevelopment represents a 66% uplift in Flora area. With a higher office content than previous plans, we're excited to deliver a much space in a location which continues to benefit the [indiscernible] and its prime location on Oxford Street. 50 Baker Street, which we owned at a 50-50 joint venture with Lazari, we secured resolution to [indiscernible] planning on Tuesday for our plans, which will see us nearly double the existing floor area to 240,000 square foot and works are expected to commence in early 2026.

At Greencoat & Gordon House in Victoria, we're proposing a comprehensive refurbishment of this charming 140,000 square foot former Army and Navy store. With great bones and floor to Sealy Heights, we're really excited by the opportunity this provides in particular, given our successes at Francis House, which is leased to Edelman and 6 to 8 Greencoat Place, which is led to Flora, both substantially ahead of ERV.

The longer-term pipeline is set out on Slide 40. This extends to about 1.1 million square feet, the first of which is the comprehensive refurbishment of 20 Farringdon Road. We've worked with our occupiers to align a block date, which facilitates the repositioning is very well located building in the heart of Farringdon. [indiscernible] quarter, our acquisition is expected to complete from 2027 with the existing hospital in its closing and relocating to the new facility in Saint Pancras. We're progressing our plan for this 2.5-acre site, which has the potential to deliver an exciting mixed-use scheme with a mix of living and commercial uses.

And at 230 Blackfriars Road, we are proactively driving the income profile to ensure opportunity ahead of proposed redevelopment, which we expect will be commenced from 2030. Whilst our plans remain at a relatively early stage, the site has the potential to triple, even quadruple the floor area.

Now to conclude on Slide 42. As you've heard, we are very well placed to take a voltage the cyclical recovery and to deliver attractive total returns. London is an extraordinarily diverse and vibrant city with a broad appeal to a wide range of growing in businesses. Well occupiers one from their space and from their landlords continues to evolve. The importance of location, amenity and adaptability cannot be underestimated. Abated to this space, however, is in short supply, and the market pipeline is constrained. This is leading to an acceleration in the pace of rental growth.

Our member strategy has been well received by existing occupiers and has played an important part to bring new businesses to the portfolio. Our spaces in demand with low vacancy and high retention rates. Plus, we have significant momentum with new [ deals ] being signed well above ERV at both existing buildings and space under construction. We have a deep pipeline of projects largely in the supply-constrained West End. With an ongoing recovery in the U.K. economy and a positive outlook for job creation in London, office yields looking increasingly attractive. And our strong balance sheet gives us the capacity and ambition to continue investing in regeneration, whilst exploring the increasing number of acquisition opportunities coming to the market.

Thank you. We will now take questions in the room before moving to those online. Just a reminder, I think the microphones are now in your seats, and I think you have to press the button in order to trigger them. Thank you very much.

[Callum Marley, analyst]

Callum Marley from Kolytics. Two questions, 1 big picture. We saw another London office REIT complete a rights issue earlier this year. Do you see the same level of opportunity in the market? And if all these tailwinds that you stated are coming through is now the time to kind the offensive as well?

[P. Williams, executive]

I think we are on the offensive we're investing a lot into the pipeline, and we do have an ambition to buy. Also, we have a very strong balance sheet. So the need to go to a rights issue is less pressing. Obviously, we saw a really interesting opportunity. for a major acquisition that we could consider all sorts of options, including possibly a rights issue. But for me, at the moment, all the great things about the business, we have optionality. We could buy, we could develop and [indiscernible]. We don't have to look to market for money. But if we saw an opportunity, as I said, we will certainly do so. Damian, do you want to add to that?

[Damian Wisniewski, executive]

Yes. I think scale is increasingly interesting. And we certainly don't want to shrink the business. If the right opportunities come up, we would look at something more interesting. But there are other forms of capital as well. We could -- we've always had a recycling business model. That will continue. We can extend the debt a little bit further as well. And there are other things available to us, too. So right issue is not the only option, but it's definitely one of the options.

[P. Williams, executive]

Callum your second question?

[Callum Marley, analyst]

Yes. Just following up on that. I think you commented, I might have misheard, about smaller spaces coming to market through distressed sellers. Is it maybe a fair assumption that you could be more active in that smaller space? And then how do those kind of repositioning returns differ to some of the other more traditional HQ returns?

[P. Williams, executive]

I'm not sure we mentioned distress, but certainly, we see more opportunities. Nigel?

[N. George, executive]

We are seeing more opportunities. There's a little bit of distress out. There's not anything like that was in 2007, but there is the odd bit of distress out there. But the one thing in real estate leases do get shorter. And there's quite a few buildings starting to come through with shorter leases, not shorter space, I think shorter leases. With the ESG question mark and all of that, some are looking quite interesting for us where we can. We've got the skill set to reposition, drive the rent. So that's the sort of area where we are seeing a bit more activity out there.

[P. Williams, executive]

I mean the banks on [indiscernible], we're seeing some interesting properties at a sensible -- hopefully sensible prices that certainly we'd like to acquire. Thank you, Callum. Who's next? Please?

[Maxwell Nimmo, analyst]

Max Nimmo from Deutsche Numis. Just a quick one on the yield shift. The 18 bps, if you could just explain a little bit for that split was roughly between kind of City Borders and the West End, presumably West End stayed a lot tighter and City Borders went out a bit more.

[N. George, executive]

I'm going to do it slightly a different way. We saw a little bit sort of 10 bps on the bigger lot sizes. So we have 2 or 3 of those, those were 10. And then we saw a little bit more on the shorter lease stuff that's sort of lower end. And that's probably the division more than the city and the West End. I think the numbers are in the back on the city and the West End. But the bigger lot sizes did a little bit and the smaller, shorter leases did a little bit on the average of about 18.

[Maxwell Nimmo, analyst]

Great. That's really helpful. And then maybe just kind of following up to that, you talked a little bit about you now at 5.73% on the portfolio overall. It sounds like from what you're saying that you feel that could potentially have overshot a little bit if rates do come down as they're expected to? Is -- do you think there's the potential for particularly in the West End perhaps or specific assets that the yields could come back in a little bit?

[P. Williams, executive]

Obviously, you moved out -- so the West End moved out a lot less than the city. I think they moved out about 70 basis points since the lower yields. I think the city borders 200 basis point. And they've always been a bit more resilient. But I do think -- I said we're going to -- we thought the yields were stabilizing in February. We think they're there now. I think with interest rates coming down, there should be an opportunity for some yield contraction.

I don't think it's going to rush down quickly, and I don't necessarily think it will get down to very low as you're happy before where interest rates were so low. But I do think investors increasingly look at -- loved and see some value, and I think there is an opportunity, some value growth. So stabilizing stable. Let's hope we can see a little bit of improvement as well.

[N. George, executive]

Yes. I think I'd add to that, if you look at our development stock, the value is essentially there on a spec basis, if it's not let. So you could expect potentially, if we get the leasing quite a bit of tightening on that, they would have been -- those sort of buildings were probably the peak of the market, say, 4% the development yield 6% in a bit. You feel it should close in quite a bit I think about.

[P. Williams, executive]

I think strategy, we decided some years ago, 2 or 3 years ago, we'd keep the better buildings for longer, and I think they've definitely outperformed over the last 2 to 3 years. I think these were very much in demand. So let's see what happens.

[Maxwell Nimmo, analyst]

Great. And maybe just one last follow-up, if I can. Just on the leasing side on network building, potentially, that's this time -- second half of '25. And would you expect perhaps a bit more leasing in that for now? And maybe what's a good assumption for a lease-up period post completion for that?

[Emily Prideaux, executive]

Given the floor plate size of network, which is sort of 15,000 to 20,000, which is on the smaller side, we'd normally expect that activity to be within as you go into the last sort of 12 to 18 months pre-PC. So we're in a key moment now. We did have a fairly lengthy discussion with party on the whole earlier in the year, which has fallen away not to go somewhere else, but they've pulled their requirement from the market temporarily. So we've now got a number of discussions on smaller chunks as we anticipated at the outset, it will likely go multi-let, but we'd be confident of some activity looking ahead.

[P. Williams, executive]

It's a great product, and we would expect to multi-let it. And we're not disappointed with progress. We've got 18 months to go and a great leasing team. So let's see what happens. Thank you Max. Yes, please.

[Adam Shapton, analyst]

Adam Shapton from Green Street. 2 on external growth and 1 sort of flex topic, on 50 Baker Street, where are you now in terms of risk appetite? So would you commit without a pre-let there? We know the market is tight, but clearly, we're talking a bit longer date in terms of 50 Baker Street. And then on the buying opportunities you're saying, could you say a bit about location profile? Like is it typically core West End, we intentionally waited to West End. And then tell you the third one or...

[P. Williams, executive]

Yes, please.

[Adam Shapton, analyst]

And then just on flex, so moving towards sort of 9%, 10% total flex exposure, including third-party operators. Do you have a number in your head strategically of what the right percentage of your GLA should be flex oriented in the medium to long term?

[P. Williams, executive]

I'll try to answer those questions and pass on to Emily as well. 50 Baker Street, firstly, we have always built speculatively. I think if you go out there requiring a pre-let in order to start, I think that sort of gives us sort of -- we should give something away. So I think we've always had the confidence and the balance sheet to build speculatively and it goes back to we're building through difficult times, both Brunel and 80 Charlotte Street, 2 of our most successful projects. So we would certainly start 50 Baker Street speculatively. Very delighted to obtain our plan ambition the other night. That's old lease sold from the Portland State and good conversations held there.

So you should anticipate we would start in early 2026. But interesting, I think Emily touched on the point about active demand. Occupiers are looking at earlier and earlier in respect of space. So you may get some acquire set. So -- but we're very confidence, to be honest, with rents growing as quickly as they are. We're not in a rush. We've let really well. And if I'm sitting here today, very much like tomorrow's rent rather than today's rent.

So I would -- I'd have the confidence of our product in a location where we see really good active demand and a very, very restricted markets. So we're very happy to stop speculatively. Why don't we just move on a little bit to flex, because we have been growing there. And I think our furnish and flex model has been working very well.

Emily, I think you want to give a quick view cut on that?

[Emily Prideaux, executive]

So we -- under the heading of Flex, obviously, we furnished and is managed, we don't do the managed other than by a third party, which is the likes of 4 or so who works and others. And our growth is more organic. Our vacancy is obviously very low, but now everything that comes back to us under 10,000 square feet, we would appraise on both Cat A delivery and furnished and flex. And we'd look at that in its relevant submarket and viability accordingly.

So we would anticipate it to grow. If you look at the market as a whole in London, the flex market with the big booms of the WeWork's and things peaked at sort of 6%, 7%, it's constantly gone back between about 4% and 6%. So it sits around sort of 5% with new entrants and people coming in and out. And we mirror that plus a bit more on some of our smaller assets. Obviously, it's all complemented as well now with the deal member piece, which in those core villages makes quite a big difference in terms of the offer.

[P. Williams, executive]

And turning now to your location question, I mean, it's always very nice to add to the portfolio in the areas where we've got things over 70% of the West End is tighter. I think we are looking to acquire. I have to say I think Farringdon is a market where things could grow substantially there with the benefit of it. But I could buy there. I certainly would look and our Director of Investments is here and he is working hard to ensure that we do look. I feel the thought if something really interesting came along in the city that would add some good bones. It was an interesting building and was sensibly priced or let's say, very sensibly priced, I wouldn't rule that out. But we wouldn't go any further east on that. Let's just say that.

But I think mostly add to the department we've been buying, and we put a building, obviously, Blackfriars going forward. But there are a few more opportunities coming. We've been looking around the last few weeks and there is few more interesting properties available. And hopefully, we can secure some of them. Thank you for your 3 questions, please.

[Zachary Gauge, analyst]

It's Zachary Gauge from UBS. Two questions. I mean 1 is really a follow-on from that. When obviously, if we look at your pipeline longer term, that becomes heavily shifted towards the city rather than the West End. You've obviously got the 2 sort of more near-term ones in the West End. Do you not feel a need, given everything you're saying about the positive dynamics in the West End to be sort of bolstering your mid- to long-term pipeline in this market given the success of the current schemes in particular?

Second question, Page 18, you show your rental growth versus MSCI on that chart. It's a little bit surprised to see since 2020, it looks like you've underperformed MSCI ERV growth for the Central London office market. Just a little bit surprised on that, given obviously the West End weighting and quality of portfolio, if you could sort of touch on perhaps why you think that's been the case, that would be great.

[P. Williams, executive]

So your questions about -- Nigel, do you want to deal with the first thing about the 2020?

[N. George, executive]

I mean I think you got on the MSCI index, you've got to compare our portfolio to the MSCI. If you look at there's a page in here with our data, which shows our core income is roughly half of our portfolio. You've then got future appraisals, you then got under appraisal. Now that right-hand side, we maintain -- you try and drive the income, but you're not refurbishing, you're lagging a bit. So this number here is the portfolio -- EPRA portfolio valuation.

So you've got a bit of lagging on the future stuff. But overall, I mean, for us, it's -- the total property return is beating the index. So you're absolutely right in isolation, but I think you then need to look at the rest of the portfolio and bring that into account like the quality buildings outperforming and the developments outperforming.

[P. Williams, executive]

To answer your first question, don't underestimate how busy we all are. There is a huge amount of work going on with it across the port movement. The developments get the headlines, but we've got an awful lot of refurbishment where it's going on across, particularly the West End, Stephen Street is a good example where we can really grow it. So what I'm excited about is some assets within that portfolio where we could drive rents from the GBP 50s to GBP 80s per square foot. They don't get the headlines, so the new planning commissions a GBP 240,000 square foot you got a quite some benchmark space coming up potentially in Stephen Street. It's a very active portfolio.

If I could build more in the near term of the West End, I would, and we say we've been looking to do. Obviously, long term, we've got some great 2 strategic sites, which are Central London location, where we think we could create some really great scheme. So this is a very active business, lots of going on. As I say, the development seemed to get the headlines, but there's an awful lot of [indiscernible] where we can drive rates. I think Nigel said earlier, our average rent is around GBP 50 per square pet because that topped up to GBP 60. There's good opportunities to grab some good strong rents going forward, partly why we think ERV guidance, we've increased again today. Thanks, Yes, please.

[Neil Green, analyst]

Neil Green from JPMorgan. Just one from me. Damian, you mentioned that you were looking to maybe do some more refinancing activity over the coming couple of years. How has the listed bond market or the convertible market, perhaps changes an option over the last couple of weeks compared to the more traditional bank financing, please?

[Damian Wisniewski, executive]

Well, the good news is that most of those capital markets are quite open for us at the moment. Pricing has got more attractive, too, particularly in the bond market in the last few weeks. It was a little elevated and quite volatile through the first half. So we were very pleased to take GBP 100 million facility from our friends at NatWest, but it's given us a bit more time. I think you will see us do more in the second half and next year.

The convertible bond market is attractive, but I think we need the share price to respond a little bit to all the good news we've been talking about today before that's something we would rush out and do. But at some point, I suspect we will do a convert, whether it's in time for the June 2025 redemption, I don't know. But there are certainly some of the bond markets getting increasingly attractive. U.S. private placement market is also good as well. So really, I think we have a lot of options. I'm glad we didn't rush out and do something early. But I do think we're going to see more attractive pricing in the second half.

[P. Williams, executive]

Have we got any more questions? Yes, please.

[Unknown Analyst]

Just another one on capital allocation. So on disposals, the successful developments of the last cycle that you've retained what's your intention for disposing of them? And how does that fit in with how you see life cycle and depreciation of those buildings?

[P. Williams, executive]

Good question. I mean, as I say, we decided 3 years ago to keep the better buildings for longer, they performed extremely well. If you look at how they performed compared to the average of the portfolio. I think they're down what, 10% versus 20%, I think that was the great thing. As I said previously, I think nothing's forever. I think at some stage, we will consider a bigger disposal. Luckily, we've got options. We don't need to sell. I think we'd obviously wait for the market to be somewhat stronger.

We will consider the properties regularly. We've just come away from a strategy day, well, we will consider what we should do with each asset, but also asset management opportunity. Let's stop giving once you've done them. So -- but I think you will see at some stage that you won't see it this year, but over the next year or 2, we should look at one of the bigger assets and see what we do with them. And they are fabulous buildings, really well built. And I'm sure in a more normalized market with things stable where I think they get some good demand.

[Damian Wisniewski, executive]

Yes. I think you've got to link the lot size and the debt markets together. One of the reasons you haven't seen the activity that perhaps we have seen in the past is that debt market was, a, expensive; b, not that easy to tap into and that's held back big lot sizes. You've seen it particularly in the city, but also in the West End. Now that should start to relax a little bit over the next year or so. One big building is worth 3 or 4 small buildings. So I suspect at some point when the market is ready, you'll see us recycle 1 or 2 of those bigger assets. But we're in no great rush.

[P. Williams, executive]

Well, thank you very much, indeed, for attending today. We've got 2 more. We've got some of the -- sorry, I do -- those on the -- Robbie, conference call got [indiscernible] through. Good. Thank you Please.

I think we got 2 coming through or 1 coming through. Well, patience is one of my strong points.

[Operator]

[Operator Instructions] Your first telephone question is from the line of [ Ramsey Elif ] from Kempen.

[Unknown Analyst]

First one, you mentioned the opportunities arising and you have the balance sheet. So my question would be how far are you willing to push LTV to acquire? And the second one, of course, we've seen an article that Derwent pulled disposal in Fitzrovia. Is there anything you can comment on that?

[P. Williams, executive]

Well, I'll start with a little bit on the balance sheet. We're about 29%. I'd be prepared to push it a little bit into the early 30s, but I bet it defer to my Finance Director.

[Damian Wisniewski, executive]

Yes, I think we have to remember where we are in the cycle. This is a cycle where values look as though they're getting pretty close to the bottom. That's where you expect the LTVs to be higher. Our debt hasn't actually gone up in the first half. It's virtually bang on where it was in December. The LTV has crept up a little bit. We would be comfortable taking the LTV up into the low 30s. I'd say -- if you want a top level, it's probably 35%, but I'd prefer to keep it below that.

That implies GBP 200 million, GBP 300 million, GBP 400 million worth of additional debt. I think that's probably on the top side. That's not a target -- but for the right opportunities, we could certainly get there in the short term. We've always focused far more on interest cover and increasingly now on net debt to EBITDA than LTV. So looking at all those together, I think there is room for a bit more debt in the portfolio, but we're not going to suddenly become a highly leveraged business.

[P. Williams, executive]

In respect of your question about Fitzrovia, look, we had it approached. We thought it was an interesting asset. We sort of well let's see how far I go to see what other interest we could have. We had actually a fair amount of interest, but the pricing was just a little bit less than we really hope for. It's a great asset. It's still got some asset management to play. And we thought given the fact the balance sheet is strong, we're not under pressure to sell. We've got option. We made a decision we'll keep it either.

Having said earlier, we've got a very strong price for Turnmill, well ahead of our book value. Our job has been done there. So we've decided to take some money off the table there and said it very well. I think people thought it was extremely well sold. So one of the benefits of the business is we do have some options. You'll probably see a little bit of selling, I'm not prepared to say something that is suboptimal. It was reasonably well bid, but not to levels that we're hoping for. So we'll keep it and we'll make money going forward. Thank you for your questions.

[Operator]

The next question is from the line of Paul May from Barclays.

[Paul May, analyst]

Just following on from the last question. I assume when you pulled an asset because it hasn't met the ask price that you're looking for that the valuers have written down those values quite materially to reflect the big pricing given it's a willing buyer, willing seller valuation process, not just holders valuation process. Also wondered what is the appropriate discount you think for large assets? You mentioned that smaller assets are transacting, but larger assets aren't and other value was reflecting that in a discount on larger assets.

And then the final one, I think you mentioned a few times that as rates come down, the transaction market will improve. But if you look at swap rates, which is arguably the rate that matters for a buyer, those are already reflecting quite materially lower base rates. So -- and yet the transaction market still remains subdued. So I'm just wondering if it's not lower rates, because you can already get lower rates that's going to unlock the transaction market, what will it be in your view that could unlock the transaction market?

[P. Williams, executive]

Nigel, do you want to start with some of that?

[N. George, executive]

Yes. I mean if you look at the bandwidth before -- where we got the interest and the value, it wasn't that far apart. I mean you took a couple of percent, it was -- but it wasn't enough for us on a forward-look basis. We had a floor vacant there, which we were back to refurb and then the approach game, we thought we'll test the market. And that forward look wasn't in the pricing. So we want to do the asset management, but there wasn't a massive divergence between the valuers and the sort of figures they were getting to.

[P. Williams, executive]

Just go to the bigger assets?

[N. George, executive]

Yes. I mean, as I mentioned, I mean, there's a lot of components to the bigger assets, location, quality, length of lease. And our bigger assets to have that with the long lease [indiscernible] have placed very long leases. But they did reflect the sort of scarcity of transactions in the market by moving these out to, I think it was 10 or 15 bps on over the half year.

[P. Williams, executive]

I think on your third question, and I could pass it back to Damian also on debt. With respect to the [indiscernible], I think people have been waiting for a bit of for first [indiscernible]. Obviously, the world has been a little bit unhappy for 6 months. It is interesting to see so many -- a few assets being now put on the market and people be sense about the sort of pricing thing. So I think you will -- hopefully, we'll see an uptake in turnover. Damian, on the debt?

[Damian Wisniewski, executive]

Yes. I think on the swap rates, they've come down quite quickly and quite recently, I mean looking at the -- they've been moving around. It's been a quite a volatile week as we've seen. But we're not far off 3.5% for the 5-year swap now. It wasn't far or 4 very long ago. You have to give a bit of time for these things to settle down. We are certainly conscious of more people looking and kicking tires than they were even a few months ago. But you've got to give the investment market time to actually come back to life. These are big transactions. People need time to get their pencils out and work out how the spreadsheet works.

So I think you will see increasing transaction volumes, Paul. But to give it a little bit of time, as we know, it's an uncertain world out. There's a lot of things people are trying to weigh up, but the lower rates are definitely a big help.

[P. Williams, executive]

Thank you, Paul. Have a good day. We've got those that calls and nothing on the webcast, John? So I shall say thank you very much, deep for everyone who's been attended today. Thanks. [indiscernible] all did. The team is around you've got any further questions you want to ask, please come in, come talk to us. And for those who are going off on summer holidays, have a great time. Thank you very much.