Derwent London PLC

LSE:DLN

Earnings Call Analysis

Amid Challenges, Robust Leasing and Guidance Lift

Despite market adversity, including high interest rates, the company achieved remarkable leasing success in 2023, tripling agreements from the previous year to GBP 28 million, with rates 8% above ERV. The EPRA vacancy rate dropped significantly to 4%. However, valuation pressures led to a 10.6% portfolio devaluation and a 13.8% decrease in NTA to 3,129p. The company forecasts rental growth for 2024 between 2% to 5%, building on a 2.1% ERV growth in 2023. Continued leasing momentum into 2024, with over GBP 2 million in deals, and asset management activities up 30% from the previous year to GBP 41.5 million, signal a robust outlook.

Total Return, Dividend Growth, and Earnings

Closing the year with a total return of -11.7%, the company experienced a minor dip in net rents, bringing the amount to GBP 186.2 million. EPRA (European Public Real Estate Association) earnings per share fell by 4.4% to 102p, impacted by increased expenditures and impairment charges, although the latter half of the year saw a 6% improvement over the first half. Nevertheless, the company proposed a final dividend of 55p, marking a 16th consecutive year of dividend growth, with a 79.5p total dividend for the year, comfortably covered 1.3x by EPRA earnings.

Capital Expenditure and Valuation Adjustments

For 2024, the company anticipates capital expenditures to be around GBP 222 million, which will include significant refurbishments but does not account for any further development profits. The firm also updated its EPC (Energy Performance Certificate) upgrade costs to GBP 95 million due to specific valuation allowances and general refurbishment necessities.

Market Volatility and Capital Recycling

With bond yields peaking at 7% during the summer but then declining to close at 5%, the market demonstrated significant volatility. Looking ahead, consensus leans towards a general downward trend in rates. The company expects to see an increase in capital recycling activities in 2024, stemmed from a robust credit rating and a constructive atmosphere for securing funds.

Property Valuation Impacts and Rental Trends

The company experienced a 10.6% decline in property valuation due to higher interest rates and restricted finance availability, following a 6.8% decrease last year. However, rent evaluations have been trending upwards for four consecutive periods. With the equivalent yield having moved out to over 5.5%, easing pressure on yields is anticipated as interest rates outlook trends downwards.

Environmental Performance and Energy Intensity

A significant portion of the portfolio, 88%, now boasts at least an EPC C rating or better. The company remains focused on improving its buildings' environmental performance as a business advantage, contributing to better rentability and attractive rental uplifts. A noted increase in energy intensity levels in 2023 was attributed to substantial commissioning work.

Post-COVID Office Landscape and Letting Activity

With COVID-19 becoming a less pressing concern, the emphasis has returned to offices as a strategic asset, with businesses favoring quality locations that facilitate culture and well-being. The company saw strong demand for its spaces, evidenced by GBP 28.4 million in rent agreements at an 8% premium to ERV, with significant pre-lets demonstrating the attractiveness of their properties. Asset management activity also increased by 30% from the previous year, maintaining a strong Weighted Average Lease Term (WAULT) and reducing EPRA vacancy to 4%‎.

Future Growth Opportunities and Capital Investments

As part of a long-term strategy, refurbishments are expected to be a larger component of the company's capital expenditures. With a 72% share of its portfolio located in London's West End, the company is poised for positive rental growth and further investment in nearly 1.8 million square feet of on-site and future projects. Emphasizing great design and relationship-driven approaches, the company is committed to investing in its portfolio and seizing emerging market opportunities backed by a robust balance sheet‎.

Earnings Call Transcript 2023-Q4

[P. Williams, executive]

Good morning. Welcome to Derwent London 2023 Full-Year Results Presentation, here our recently opened Member's Lounge DL/28, as well as me, you will hear from Damian, Nigel and Emily. I should then wrap up and we'll have Q&A.Turning to Slide 2 and setting the scene. Despite the challenges, we delivered very strong leasing performance in 2023, with more than GBP 28 million of new rent agreed, 8% ahead of ERV. This was 3x the lettings we agreed in 2022. In addition, we reduced our EPRA vacancy rate by a 1/3 to 4%, with activity across our villages. However, with the weak investment market driven by high interest rates, the outward shifted yields led to a 10.6% decline in underlying value of our portfolio in the year-end, a 13.8% reduction NTA to 3,129p.Notwithstanding that, our developments increased in value and our better-quality buildings again outperformed. We have a high-quality, well-located, and differentiated portfolio, a regeneration pipeline focused on the West End, and a strong balance sheet which gives us capacity to continue investing. We deliberately take a long-term strategic approach, recycling buildings that no longer meet occupier demands with GBP 1 billion of disposals over last 5 years. Supply of space that meets the evolving needs of occupiers is limited, particularly in the West End with a constrained market development pipeline, this is unlikely to change over the next few years and this is leading to an acceleration in rental growth.There are signs that value is beginning to emerge as inflation follows a downward course and the cost and availability of debt becomes more favorable. We're also fortunate to have options and the financial capacity to take advantage of the right opportunities come to market at the right price.So turning to guidance. Consequently, on the back of 2.1% ERV growth in 2023, we are increasing our rental guidance for our portfolio for 2024 to plus 2% to plus 5%. As seen in our 2023 lettings, we expect better buildings continue to outperform. For yields, upward pressure is easing and we believe we are approaching low point in valuations for this cycle. Differentiating Derwent, businesses are becoming more strategic in their real estate planning and more selective in the building and the landlord they choose. The supply-demand dynamics of the West End by comparison to other parts of London is strong and expect to remain favorable over the coming years, supporting our long-term structural preference. We are providing design-led, innovative and sustainable space in well-connected locations, combined with high-quality portfolio, wide amenity, our sophisticated buildings meet the needs of a broad range of occupiers.Slide 4. London is too often viewed as a single market. But in reality, it is a series of sub-markets with quite different operational dynamics and performance. The diversity of London's appeal sets it apart from other global cities. It has a deep pool of businesses, with different requirements ranging from large headquarters on long leases to smaller units, on more flexible terms. It has an enviable transport network, which were made even better by the opening of the Elizabeth line in 2022. London has never been more accessible.Connectivity applies to more than just transport. This is why we maintain our approach to clustering. The West End is tight, in part due to restricted planning environment, with approximately 70% of buildings either listed or in conservation area. The further East, however, the lesser the planning regime -- the looser the planning regime, and the higher the vacancy. Growth in the economy, in jobs, and in the population all support business confidence. This in turn is an important driver of demand for offices and therefore rental growth. As we've highlighted for some time now, the office plays a crucial role for most businesses as the quality and value of the face-to-face interaction is recognized. We have seen an ongoing rise in employees being required to spend the majority of the time in the office.Developing and retaining quality on Slide 5. We continually upgrade our portfolio while selling assets that no longer meet evolving occupier requirements. We are investing in projects to create the next generation of best-in-class space. Our higher quality buildings have delivered a more robust valuation performance over last year and we expect this outperformance to continue. As such, we will carry on developing our pipeline whilst also ensuring that the assets we own are those that are relevant and in demand and that have the potential to be repositioned. 44% of our portfolio has repositioning potential, providing the raw material for the future.I will now hand over to Damian. He'll take you through the financial highlights.

[Damian Wisniewski, executive]

Thank you, Paul, and good morning, everyone. Macroeconomics had a big impact in 2023, further pushing up yields and the cost of finance. Cost inflation, particularly in relation to construction projects, energy and people also increased at a faster rate than office rents. Our 2023 financial highlights are on Slide 7. Yield expansion took EPRA NTA per share to 3,129p, giving a total return for the year of minus 11.7%. Gross rental income was up 2.8%, but property expenditure brought net rents down marginally to GBP 186.2 million. EPRA earnings were correspondingly 4.4% lower at 102p per share, the second half was 6% higher than the first. We have proposed a final dividend of 55p. The 79.5p total dividend for the year makes this our 16th successive year of dividend increases since the merger and it was 1.3x covered by EPRA earnings. Debt ratios will remain strong and the Derwent London balance sheet is among the lowest geared in the U.K. sector.The movement in EPRA NTA per share is shown on Slide 8. The property valuation decline was 516p per share on the wholly owned portfolio and 8p on our share of the 50 Baker Street joint venture. Other figures were close to 2022, but with lower than usual profit on disposal.Slide 9 shows EPRA earnings. Gross rents increased to GBP 212.8 million, but property expenditure, admin costs and impairment charges all increased over the prior year. Administrative expenses were higher after wage inflation and the headcount increase and impairment charges totaled GBP 2.6 million compared to a GBP 1 million reversal in 2022. Net finance costs were almost unchanged and overall, EPRA earnings ended the year at 102p per share. Of this 49.5p was recorded in the first half and 52.5% in the second.Slide 10, gross rents. Developments and refurbishment increased rents by GBP 8 million, with other lettings and asset management adding GBP 7.5 million compared to '22. Breaks and expiries reduced rent by GBP 5.7 million and disposals mainly of [ Charter House Street ] by a further GBP 4 million. On a like-for-like basis, gross rental income was up 1.7%, but the higher cost in impairments meant that net rental income was down 1.4%.Slide 11, this shows a deeper dive into property expenditure over the last 2 years. Irrecoverable service charge costs increased to GBP 6.6 million in 2023. The increase came mainly from capped service charges and balancing charges in the first half. These were influenced by higher vacancy levels and wage growth in areas like cleaning, security and maintenance. We also saw a spike in energy costs through late '22 and early '23. Falling energy costs and lower vacancy rates in the second half saw irrecoverable service charges fall by more than 50% to GBP 2.1 million.Other property costs increased to GBP 17.4 million, largely due to general inflation and some historic rates bills. We're presenting to you today from our second member lounge, which offers facilities and amenities, which differentiate us in the market. This helps attract and retain occupiers and reduces vacancy. The running costs were GBP 1.4 million in 2023, some of which is offset by direct revenue. Overall, property expenditure was GBP 24 million for 2023, equivalent to a 11% of gross rental income.Slide 12 shows project expenditure across the different categories. The major projects on site incurred GBP 117.4 million of spend, of which GBP 20 million went on the residential units for sale at Baker Street, held as trading property, with a further GBP 6.4 million on the retail to be sold to the freeholder on completion. We also spent GBP 35.6 million on a number of smaller refurbishment schemes. The 50 Baker Street JV investment and Old Street quarter together accounted for GBP 4.1 million of expenditure.Slide 13 sets out estimated future project expenditure. We expect to spend about GBP 222 million in '24, including our solar power facility in Scotland and some substantial refurbishment projects in buildings like Stephen Street. Our revised estimate for EPC upgrade cost is now GBP 95 million. Included in this is a specific reduction in the December '23 valuation of GBP 48 million, plus further allowances for general refurbishment as units come back to us.Slide 14 shows our usual pro forma, it includes GBP 228 million of committed CapEx on major projects, only takes account of contracted lettings and sales and allows for no further development profits. We expect to do rather better than this, but it does show that interest cover and loan-to-value ratio remain very affordable under this scenario.Slide 15. Before considering our overall debt position, let's look at how our 2031 green bonds have been trading through the last year or so. The chart here demonstrates the volatility both in rates and credit spreads through the year. The yield climbed to a peak of around 7% in the summer, before falling sharply late in the year to close at 5%. Rates have since picked up a bit with the bonds currently trading around 5.3%. That's roughly what we'd expect to see today for unsecured 8-year money. Note also how the credit spread, which is the orange line, has generally moved lower through the year with a spread on these bonds now about 140 bp over the guilt.Rates may continue to be volatile through 2024, but there's increasing consensus that the general direction is now downwards. Our GBP 83 million secured loan matures in October. And with our stable credit rating and the constructive lending atmosphere for stronger credits, we have already had a number of positive meetings with potential funders. The investment market was slow in 2023. Disposals were low at GBP 66 million and acquisitions only GBP 4 million, but we expect to see capital recycling accelerate in 2024.Slide 16, against this background, our debt ratios shown here all remain solid. Almost all our borrowings are fixed or hedged. We had a weighted average unexpired term of 5 years at year-end and the weighted average interest rate was almost unchanged over the year at 3.17%. Our covenants were very well covered and relationships with all our lenders remain excellent.Thank you. And now over to Nigel.

[N. George, executive]

Thank you, Damian. Good morning, Slide 18. As published, our leasing activity last year was strong with a flight to quality and ERVs moving forward. However, on the capital side, yields continue to move out, impacted by high interest rates and restricted availability of finance. Investment turnover in London was down over 50%. The overall impact was a 10.6% valuation decline and followed a 6.8% decrease last year. The West End where 72% of our portfolio is located, however, remained more robust. Our developments continue to deliver good performance, up 8.1% and despite a 25 basis point outward yield movement. There was good progress on site. However, the key driver of the uplift was the pre-letting activity at Baker Street. Looking at our total property return, this was minus 7.3%, a small outperformance against the MSCI London index of minus 7.9%.Turning over to Slide 19, a bit more on the themes. Having sold GBP 1 billion worth of assets over the last 5 years, we've improved the overall quality, yet retained an active pipeline for the future. As shown on the chart, whilst developments with the star are better quality buildings, those with high capital values continue to be more resilient, driven by the quality of the space, amenity and location. We expect this to continue. However, it is worth noting that over 44% of the portfolio by area provides future opportunities for regeneration and there'll be more from Paul on this later.Slide 20, rents and yields. Our valuation to ERVs were up 2.1% and as shown on the trend, have now been trending upwards for 4 periods. It's important to note that the average is a valuation figure and because of our low vacancy rate, ERVs are mainly for rent reviews and lease renewals. Our open market lettings tend to be achieving higher rents, especially on the better quality space and these can be in the 5% to 10% uplift range. On yields, these moved out across the sector. Overall, there was a 67 basis point movement in the equivalent yield in 2023 and we've seen a 109 basis point movement over the last 18 months. With our equivalent yield now over 5.5% and the downward interest rate outlook, the pressure on yield rises is starting to ease.Now I'll walk through the usual ERV build up Slide 21. Our annualized rent is GBP 206.5 million, with a GBP 103.1 million reversion. GBP 44.6 million of this is contracted under our leases in terms of annualized accounting income after a land for spreading of rent freeze, this figure is GBP 211 million, as shown at the bottom of the chart. All potential income to the right of this is future income subject to appropriate rent-free spreading. On-site developments of Baker Street and network, which both complete in '25 could add GBP 33 million of income. GBP 15.6 million of this is already pre-let.Our smaller projects were up from GBP 2.7 million to GBP 7.5 million over the year, with a large proportion of this space coming back in the last 4 months of the year. This space will be upgraded and marketed later this year and there's opportunity to drive rents here. Vacant space available to occupy is GBP 10.9 million, down from -- down by GBP 6.4 million over the year and this fed through to the lower vacancy rate. And finally, GBP 7.1 million of reversion. Overall, portfolio ERV is up GBP 5 million to GBP 309.6 million even after stripping out disposals, which had an ERV of just under GBP 4 million.Now the investment market, Slide 22. Investment activity was down significantly with interest rates having a big impact on turnover. Debt was not accretive. So the market focused on equity buyers and smaller lot sizes and the West End. Whilst to date, there's been limited distress, we're starting to see earlier breaches now being actioned through consensual sales and we expect this to continue. This is translating into better price discovery and more property being prepared for sale. This could bring some buying opportunities in 2024.Slide 23, capital recycling. The main disposal in '23 was the sale of 19 Charterhouse Street to a family office. Whilst there was refurbishment potential from '25, it was a small project. We've made excellent progress at the private residential element of the Baker Street development. Here, there are 41 high-quality apartments to be delivered in '25. To date, 7 sales of exchange for nearly GBP 40 million at over GBP 3,500 per square foot. So for '24, we feel the investment market is starting to free up and we'll be looking to make several disposals during the year.Moving on now to sustainability, Slide 25. We continue to evolve our plans on our Scottish land and this to be a key differentiator and play an important part in our net 0 pathway. During the year, full planning consent came through on 18.4 megawatt solar park on about 100 acres. We aim to be in the construction phase later this year and complete in '25. It should generate over 40% of our electricity needs for our London managed portfolio. Derwent was one of the first U.K. reach to set verified science-based targets back in 2019.At the time, this was a 2-degree climate scenario and we've now updated this near-term 2030 target to align with an improved 1.5-degree scenario. To achieve these, we require collaboration across the supply chain and industry innovation. In recognition of the quality of our sustainability work, our external ratings have continued to strengthen. Both GRESB and CDP scores rose over the year and we remain top rated with both MSCI and EPRA. During the year, we undertook a detailed review of the methodology use for our various environmental KPIs. The outcome is a closer alignment of floor areas to energy uses, which impacts our energy intensity.Slide 26. Looking now at the metrics on Page 26, the left chart shows our energy intensity level, which did increase in 2023. The principal driver was the extensive commissioning work and occupation of Soho Place, Featherstone Building and Francis House. These projects all completed in mid '22 and we expect their usage to settle down going forward. Overall, energy intensity remains 10% below our 2019 baseline. High energy usage did translate into increased carbon. This was also impacted partly by the rise in the U.K. government's carbon conversion factor, the first annual increase for over 10 years.Finally, looking at EPC, 88% of our portfolio is now rated at least EPC C or above and works have been incorporated into our asset management upgrade plans. It's not clear at this stage whether EPC legislation will be further deferred, but we continue to believe that improving a building's environmental performance is good for business. It will improve let ability and deliver attractive rental uplift.Now over to Emily.

[Emily Prideaux, executive]

Thank you, Nigel and good morning. I'll first provide a summary of London's occupational market and our activity in 2023 before touching on occupier themes more generally. Slide 28, occupational market demand. We've certainly seen occupiers re-engage with their long-term strategic real estate planning. Economic instability, particularly in the first half, led to transactions taking longer to complete and a rise in under offers. However, as confidence recovered through the second half, the pace of take-up increased with Q4 nearly 50% higher than the Q1 to Q3 average and under offers consequently reducing by 25% in Q4. Pre-letting activity remains high as businesses look increasingly early to secure space of the right quality with the right landlord that meets their needs. Encouragingly, active demand is strong, rising nearly 75% to just short of 10 million square feet across a variety of business sectors.Occupational market theme, Slide 29. To touch on some key themes that we're hearing from occupiers, both our own and in the marketplace. There's no doubt that quality continues to drive a lot of decision-making, as well as good design, of course. There are a few other key topics relevant to that overall quality that we hear consistently in our dialogue with occupiers. London, for international global companies, London is being prioritized when it comes to real estate. As Paul has touched on, it is a truly diversity, both demographically and in terms of the business sectors it attracts. It has an unrivaled talent pool and these attributes put it firmly on the world map in terms of being a center activity for business across all sectors.How occupiers are thinking about the purpose of the office continues to evolve, but COVID is most definitely in the rear view mirror. Real estate and the office are firmly back on the agenda as a long-term strategic device. Businesses are undoubtedly opting for office-centric solutions, which continue to prove better, not just in terms of collaboration and productivity, but also for culture and well-being. And finally, location and connectivity, which are becoming more prevalent. Leadership teams increasingly wanting to make it as appealing as possible for their talent to be in the office rather than working from home. Consequently, being in the right location with the right transport links is key and we certainly see this trend continuing.As this slide shows, we've already seen a number of moves from large occupiers coming into more central locations, either from out of town or more periphery submarkets. And there's a long list of smaller occupiers who have also made similar moves. This trend bodes well for our stock being more centrally located. Occupational market supply on Slide 31. As we've said before, averages rarely show the full picture and this is particularly true when it comes to vacancy across London. The West End is tied to only 4.4% vacancy, which is only slightly higher than its long-term average. By contrast, the City is 11.9% and Docklands at 16.7% are both double their long-term averages.6 months ago, there was some concern that 2023 would be a record year for development completions. As can be seen on the chart, in fact, only 5 million square feet was delivered in line with historic levels as completions were delayed. Over the next 4 years, we're confident that the supply will remain constrained.Now turning to our leasing activity on Slide 32. As Paul has mentioned, we had a very strong year for lettings, agreeing GBP 28.4 million of rent at an average of 8% premium to ERV. Our 2 pre-lets at 25 Baker Street to PIMCO and Moelis, which represented 56% of the total were agreed at over 13% of the value as December '22 appraisal ERV. The building is now 75% pre-let, with an average lease term to break of 13.4 years. As a reminder, PIMCO did not exercise their option on the fourth floor, which means that Moelis have now moved up, meaning the rent on the fourth floor has now increased from the GBP 95 per square foot originally agreed with PIMCO to [ GBP 102.15 ] now payable by Moelis. This leaves us with the first and second floors where we have encouraging interest.At Featherstone, 80% of the space is now leased to occupiers across a range of sectors, including advertising, engineering, online insurance and healthcare. Again, we have good interest in the remainder. Our furnished and flexible space continues to meet market demand at the smaller end, with 19 lettings in the year at an average 9.2% premium to the adjusted ERV. I'm pleased to say that momentum has continued this year with strong viewing and activity levels. As of yesterday afternoon, we've completed over GBP 2 million of leasing to date, including PLP at Whitechapel and Starbucks at 1 Oxford Street. In addition, we have a further GBP 2.7 million under offer and there's good early interest at network building, which is due to complete in the second half of 2025.Over to Asset Management on Slide 33. With businesses planning their future space needs at ever earlier stage, we're actively engaged with a number of occupiers on expiries in '26, '27 and beyond. In total, our asset management activity was up 30% compared to 2022 at GBP 41.5 million. The key transaction in the period was Paymentsense at Brunel Building, taking Splunk space under assignment, increasing its overall footprint by 150%. As part of the transaction, we removed the 2029 lease breaks on Paymentsense existing floors and extended the expiry from 2034 to 2036.On the new space, the term was extended by 5 years. Consequently, the term certain on these 5 floors has extended nearly 6 years overall to 12.7 years. In addition, we proactively dealt with a significant amount of the lease breaks and expiries that were due in '24, reducing them from 17% of passing rent at June '23 to 10% at December. This has helped maintain our WAULT at 6.5 years or 7.4 years on a [ top-top ] basis. This activity helped reduce EPRA vacancy by 1/3 to 4% at year-end, with momentum carrying through into 2024. Paul will shortly be talking you through the pipeline, but when it comes to our approach and overall offer. Just a reminder that as well as the beautiful design of the individual assets, we take a considered portfolio approach, providing a superior overall product for the occupier. This includes amenity and service for our DL member initiative, a focus on long-term relationships, as well as tangible sustainability agenda supported by intelligent building software.While HQ space on longer leases remains at the center of what we do, we also have a growing furnished and flexible portfolio at the smaller end, ensuring we meet the breadth of London's varied demand. Together, these will contribute to our differentiated offer having great appeal for today's demand.Thank you and I'll now hand back to Paul.

[P. Williams, executive]

Thank you, Emily. Now on to developments on Slide 36. We've made good progress at 25 Baker Street and Network, both being on program. At December, our appraisals showed a 13% profit on cost and a 5.8% yield. The reduction compared to June is principally because the valuers have moved the investment yield out. Baker Street was of course helped by the very strong pre-lets. These developments offer best in class office space with substantial immunity and leading environmental credentials and we expect they will deliver ongoing outperformance at completion.More on 25 Baker Street, I believe the building will be another fantastic example of a Derwent quality and design. The superstructure of this 298,000 square feet scheme has completed and the glazing is now being installed on the main office block. As our fourth net zero carbon building, it is being delivered responsibly. The current embodied carbon estimate is 600 kilos per square meter. We're targeting BREEAM outstanding and it will be our first NABERS UK rated building. Demand for the residential is strong, as you've heard from Nigel. We have de-risked the majority of the offices with excellent interest in the remainder, rents have been very strong.Turning over, designed by award-winning Hopkins Architects, it occupies an island site in the heart of the Portman Estate in Marylebone. It provides beautiful amenity-rich office space with generous rooftop terraces alongside much needed new retail and FMB set around a delightful landscape courtyard. The facade incorporates a range of luxurious materials including Portland stone and pre-cast concrete. It has fantastic open plan floor plates with Derwent's signature generous floor-to-ceiling heights.Turning now to our on-site development and network. Network on 139,000 square-foot office-led scheme has been designed with sustainability at its core. It will be all electric and we are targeting BREEAM outstanding plus a minimum NABERS U.K. rating of 4.5 stars. Embodied carbon is expected to be 530 kilos per square meter.Turning over. This PSC designer scheme is in the heart of Fitzrovia and is making good progress. The building has an expansive communal roof terrace, wonderful stone and pre-cast concrete facade, opening windows and a beautiful generous reception. It has an exceptional on-site amenity and benefits from close proximity to DL/78, our other member lounge. With three-meter floor-to-ceiling heights, the office floors have been designed to maximize natural light. It will be adaptable, providing occupiers with the best blank canvas in which they can project their brand and which will stand the test of time. We're very encouraged by the level of interest at this early stage.Our medium-term pipeline is on Slide 41. Totaling 390,000 square feet, our next phase of projects comprise 2 great buildings in the core of the West End. We are proposing to commence our office-led scheme at Holden House in mid 2025. The 150,000 square feet development designed by architects, DSDHA will also benefit from the increase in retail demand, unhedged rents resulting from the opening of the Elizabeth line opposite. We will retain the facade which was originally designed by Charles Holden, the architect for many iconic London underground stations.At 50 Baker Street, which we own in a 50:50 joint venture with the Lazari Investments, we have submitted a planning application for 240,000 square feet office-led scheme designed by AHMM with whom we have worked many times. The outcome of the planning submission is due in H1 this year. We will then work up the detailed plans to start on site in early 2026. Our longer-term projects. Over the longer term, our pipeline totals nearly 1 million square feet of mixed use spaces. Projects, Old Street Quarter and 230 Blackfriars Road on the South Bank will help continue the regeneration of these sub-markets.Now on to our refurbishments on Slide 43. Derwent is well known for its refurbishment skills. This is where it all began. We expect refurbishments will form a greater element of overall CapEx over the coming years. As shown on this slide, we see a good opportunity to deliver significant rental uplifts from these schemes with improving sustainability credential which should result in attractive valuation uplifts.So in conclusion, great design, a relationship driven approach on our focus on portfolio wide meeting, sets our distinctive product apart. Combined with our 72% West End weighting, the outlook for rental growth is positive. Our confidence in the prospects for our on-site and future projects, which totaled nearly 1.8 million square feet, means we will continue to start them on a speculative basis.Our strategic positioning is supported by the ongoing strength and appeal of London. This truly amazing global city appeals to both occupiers across a broad range of sectors and a diverse range of investors. The office is widely viewed as a core strategic asset. Occupiers want to be in the best building and this is what we are providing and letting. The macro environment has put capital values under pressure over the last 18 months, but we believe we're now approaching the low point of this cycle.With inflation continuing to trend lower, the improvement in cost and availability of debt over the last few months is feeding through into increasing stability in the investment market. Our strong balance sheet gives us capacity to continue investing in our pipeline and to explore the opportunities that are beginning to emerge. In summary, as you have seen, we have the right product, in the right location, and occupiers pay a premium rent to secure it.Thank you very much. Now for Q&A, we'll take questions from the room first before going to the telephone lines and then to the webcast.

[Robert Jones, analyst]

It's Rob Jones from BNP Paribas. I've got a question on ERVs, one on solar and one on yields. On ERVs, your overall figure, I think it was 8% ahead for this year or sorry, versus deck 22 on GBP 28 million of rents. If you strip out the GBP 16 million of lease of pre-lets, I think the leasing ahead of ERV was 2%. And obviously, ERV growth during the year was also about 2%. For next year, you guide to overall ERV growth the whole portfolio I think plus 2% to plus 5%. What gives you the confidence or I guess, can you give me the confidence that you will end '24 with ERVs x development leasing activity up?

[P. Williams, executive]

Well, firstly, I think we've got a great portfolio. We've got some great refurbishments and some great buildings. We've sold a lot of assets that we felt that there was limited ERV growth. But if you look at some of the buildings we've got across the portfolio, whether it's Stephen Street or in Victoria, you remember that our Francis House scheme and a refurbishment there, we were 8%, sorry at 16% above ERV. So we have got a great, great portfolio. Obviously this flight to quality is continuing, which is why we're investing in the portfolio and developing further.But I think the underlying portfolio is excellent and I think after a few years of limited rental growth across London, it's time for occupies to be paying more rent, and I think they should pay more rent and I think the reality is, it's a very short -- small percentage there. Overheads, we reckon 6% to 8% on rent alone, and I think occupiers will pay good rent to be in a good building, but also with all the amenity that we're offering. So we are confident of this. We got 2.1% last year on a pretty difficult macro world, and I think we've got, I say, the right product in the right location, 71%. So I remain confident that our ERV guidance is the right guidance.But thank you, Rob, for that question.

[Robert Jones, analyst]

So yes, on to solar, lock forwards up in just North of Glasgow. The 100 acres, I think it was 110 before, but what's 10 acres between friends. The yield on cost that you're expecting there, can you give a figure for that? I'm guessing it might be one of the highest in terms of your development.

[P. Williams, executive]

I would refer to the King of Scotland for that question. Nigel?

[N. George, executive]

Yes, I mean there's a couple of things that sort of make it attractive there. We are right next to the grid. The grid has the capacity. So we don't have big capital cost to connect to the grid. Our main costs are the land is pretty small. The main costs are the panels. So you're looking at sort of GBP 20-odd million for the panels. I mean we think the revenue could be about GBP 1.3 million, GBP 1.4 million on that, the planning will have a 25-year life. The panels probably have a 30, 35-year life. So that's a sort of cash flow yield on it, GBP 1.3 million on '20.

[Robert Jones, analyst]

Plus I think the land or the assets of that entity is about GBP 4.7 million or something like that?

[N. George, executive]

Yes, I mean we have 5,500 acres and a whole lot is worth, I think, GBP 30 million. So you're looking at a few thousand pounds an acre for that sort of land, it doesn't have any housing potential land, so it's very much of that.

[P. Williams, executive]

I think also, Rob, see though -- it's a key differentiator. We're going to provide 40% or 50% of grid electricity to our portfolio. So really dark grid electricity to our occupiers would be great for tenant retention. Every occupy we don't are focused on their carbon output to be able to provide them with call great Derwent branded electricity I think is pretty good.

[Damian Wisniewski, executive]

So we'll set up what we call a sleeve agreement, which is basically we put that into the grid and we're allowed to take it out down here.

[Robert Jones, analyst]

And then the last one, quickly on yields. In your outlook comment in the press release this morning, you obviously talked about inflation coming down and I think you said something like yields will follow. To me, I read that as when rates come down, you expect yields to also trend downwards potentially in '24 and therefore capital value is up, do you disagree?

[P. Williams, executive]

I think you read well, but obviously I think reality is, I think we're expecting some cuts in interest rates. I think if -- come down, I think -- we think that yields will follow and I think we'll find some value should start seeing recovery. We're certainly seeing on the investment market more interesting assets coming out. So let's see how it goes and see how the cuts come along. But I think after some pretty big increases, I think we're expecting things to improve.Do you want to add anything to that, Nigel?

[N. George, executive]

No, I mean we mentioned we are seeing more on the market. We're getting the old approach and stuff. So it's starting to unwind. Damian can probably comment on the availability of the financing market, but it is starting to unwind on the availability of stock and transaction.

[Damian Wisniewski, executive]

Yes, I think the second is depend on the timing and the extent of cuts in base rate by the Bank of England. So we have to be aware that things are still tight out there. We do see that easing there. You might see some further outward yield in the first half, but it does feel as though that pressure is easing like it could reverse a bit in the second. But we'll have to wait and see, there's a lot of macro data to absorb before we can take a firm view on that.

[Miranda Cockburn, analyst]

Miranda Cockburn from Berenberg. Just following on the rental side of things, 2.1% ERV growth, you kindly break up the valuation move by different quality of buildings. Can you do that for the ERV or could you do it by EPC rating, something like that, just to give us a feel of the range of ERVs that you're achieving?

[P. Williams, executive]

Well, I think the West End is obviously doing better than the rest. If I look at the lettings we've been doing in White Chapel and in Featherstone, they've held up very well, but they've been pretty, I would say pretty flat. But given the fact that the vacancy rate in the City board area is a bit higher, so we've been pretty pleased with those sort of rents. So I think from a location point of view, the further west you go, the higher the growth is, probably where we do and obviously our better buildings are outperforming.

[N. George, executive]

Yeah, as probably weaker submarket is White Chapel, but we're not getting -- we've had quite a good activity there and we've hit a bad bend in line with ERV at White Chapel. So start with there and then move to the West End where it's much stronger.

[Emily Prideaux, executive]

I think the 2% is obviously the portfolio valuation as well, which includes a lot of the pre-development stock. The 8% that Rob queried earlier is on all new lettings, the pre-lets are actually ahead of that sort of 13%. So those new lettings are of a variety of quality, so that's probably a decent measure of that as well.

[P. Williams, executive]

We do see a green -- look at our Tea Building, the rents for that building are substantially higher for things that are green tea rather than builders tea, if you want to call it. So you'll see, again, back to your point about EPCs and stuff like that, I think there is a green premium. I think people want to make sure they're in a sustainable building and I think we've got some good evidence to support that.

[Damian Wisniewski, executive]

I'd probably add, sorry, Miranda, I had one more thing, I mean, we said our available was about 10.6 at year-end, 30% of that has now been either let or under offer at this 3% to 4% ERV. So two months into the -- of our available, we're talking or agreed terms on we'll let 30% of that and I think that gives us a bit of confidence.

[Callum Marley, analyst]

Callum Marley from Kolytics. Just following up on some of those questions. First one on ERVs, is it fair to assume that going forward that some of those positive ERV numbers you guided to might start flowing through to your like-for-like numbers and remain positive in real terms? And then on that, what are the offsets? So obviously, energy costs were quite high last year, that's expected to come down this year. Could that be offset by potentially higher increase in lounge and customer service charges?

[P. Williams, executive]

Do you want to start with ERV first?

[Damian Wisniewski, executive]

Yes, I mean we've given quite a lot of information on this on Slide 11 and the reason for that is because there are lots of moving parts. These lounges are fabulous. They obviously cost money to run. We believe it's good value for money, but it does feed through to the net rents. Other costs do seem to be getting more under control. We had a very big spike in costs in the second half of last year and the first half of this year, a lot of that has come down. Energy costs appear to be stabilizing. And, so I think it's fair to say that we expect to see the net to growth improve a little bit in '24. It's going to be quite marginal though. It all depends on vacancy rate and exactly what happens and when. But we do start to see a world where rental growth potentially can start to be higher than cost inflation. That's not something we've seen now for quite a few years in the London office sector. So it does feel as though there's a beginning of a change of atmosphere.

[Callum Marley, analyst]

Just on the yield, so you expect capital recycling to increase this year following a hesitant investment market in 2023? Could you provide a little color on maybe where the bid-ask spread is between buyers and sellers? And would you be willing to sell assets below book value this year in order to hit your disposal run rate?

[P. Williams, executive]

We've always been a recycling business and I think if someone came with a good sporting bid, was close to the valuation and we felt actually done our job. I think we'd be sensible about that. We've got options, so we don't need to sell, we need to buy, but we'd like to do a bit more recycling. So I think it depends on what it is. I think, obviously, we've obviously sold a lot of those assets over the last five years where we thought there wasn't any growth. So I think we'd be pretty firm in prices, but I think we always got to be sensible about it.So, Nigel, do you want to add anything to it?

[N. George, executive]

You've got to be realistic and judge each asset as and when I think, but we'll have to see.

[P. Williams, executive]

But we are going to probably do a bit more recycling if this needs some good acquisitions. If we sold something a little bit below, but we thought actually bought something really interesting at a really good price. So I think we'd look at it in that sort of balance.

[Callum Marley, analyst]

There was a slide there that spoke about the development profit on cost around 13%. I look at your kind of discount, the gross asset value today, that's around 27%. What are you penciling in for future development, future profit on costs, given that quite large disconnect? And then maybe where do you start considering alternative capital allocation decisions?

[P. Williams, executive]

Well, just, we don't stop with that first part of the question.

[Damian Wisniewski, executive]

Yes, if I just take you back to sort of the valuers numbers which we show the 13%, they're putting spec yields on it. There's concern over delivery. This is just the general assumptions on appraisals. There's quite a lot of moving parts. I think it's fair to say, valuers have gone on the cautious side, shall we say, at this moment in time. And if you look at that 13%, if we get the lettings right and the yield moved in, say, '25, so you've gone from a spec to a -- a spec to a pre-let on the rest of it, that 13% would take you up to 17% profit on cost. If we achieve, say, the sort of increases in rent we've achieved on the pre-letting of Baker Street, say another, I don't know, say, GBP 10, that would then take you up to a 23%. And if you get a bit more bullish, so your range can probably be 13% to probably 25% and the yield on costs would then move up probably into the low to mid 60s. So an optimistic view, we feel that probably should be where the market settles and we should be able to achieve that, but the values are very cautious at the moment.

[P. Williams, executive]

And we approach our appraisals cautiously. We put interest on the land as well, we don't sort of capitalize development cost fees and stuff like that. So it's a fairly cautious view. You'll find, actually, historically, we've always slightly done better than the slide at the end. Irrespective of your capital allocation, we obviously look at all options. At the moment, we feel developments are making good returns, they've got opportunity to make even better returns going forward. We seem to be right, making the right product, we see demand are very good for new developments. I think that's what we'll continue investing, but if we fail, there are other ways to allocate capital, we certainly could consider it.

[Callum Marley, analyst]

Just more questions on the capital side, please. These investment opportunities that you're seeing emerging, can you give us a sense of what they are? Are you going to be active in buying more future development stock? What's the volume of acquisitions we might expect over the next couple of years? And then in terms of funding that, how far would you push your LTV to pursue them?

[P. Williams, executive]

Well, there'll be couple of interesting assets put on the market recently in the West End which we had a good look at and actually very well bid. Shaftesbury Avenue was very well bid the evening that had been let to WeWork and it was very well bid. I felt -- I think a lot of people looked at it and were quite. I think Vogue House also in Hanover Square was very well bid. So there's a few sort of opportunity plus type assets out there didn't suit us at the time, but we did have a good look at it. In respect of the sort of gearing, I mean, we're at under 28%. I'd be prepared to push it a little bit more, maybe into the early 30s if the right asset came along, maybe little bit higher in the short term. But I've got to keep my Finance Director happy as well. So I think around that sort of level, but I think we are feeling -- we feel there's some opportunities going to come our way. We will recycle it a bit and if we see something really interesting, we should look to buy. We've got that capital, our money is good. We are able to act very quickly and war is out there looking.

[Damian Wisniewski, executive]

Yes, we've always priced low leverage and we continue to do so. It gives us options and makes the business resilient. I think we could stretch the LTV a little bit. We've previously indicated we'd move up to perhaps 35% and with the yields have moved out quite a bit in getting the LTV to where it is today, we focus, as you know, much more on interest cover than we do on LTV. And I think it's important to keep that in mind. The interest cover only fell very marginally last year still 4.1 times. So there's a balance here all the way through. I think that the balance sheet has clearly got a little bit of capacity, but we are a recycler and we will continue to recycle in the normal way.

[Callum Marley, analyst]

Just one follow-up question and related is, should you therefore be more active in selling the large developments completed in the last cycle, ones that you can no longer add as bigger value to, take the capital out of them and recycle into these investment opportunities that you're seeing in the market that could have potentially high returns?

[P. Williams, executive]

Well, possibly. I mean, we obviously got a three-year rule, so things like Soho Place was only recently completed. We may look at one of the bigger assets in due course. We want, obviously, a strong investment market for that. They be, I'm sure they'd be very well bid, I mean, they're very well let on long leases and we obviously would consider it. I don't think, necessarily very much in the short-term, but we've recycled bigger assets in the past, the more mature assets. Obviously, you've got some buildings in bigger state, in Fitzrovia, we're altogether, so breaking that up would have some, give us some thought. But yes, we will be minded at some stage, but not immediately.

[Damian Wisniewski, executive]

Yes, I think those very large lot sizes, I think, are dependent on availability and cost of finance as well. So I think as we see that ease which we're expecting to see, I think you'll see that market improve. So definitely something for the future.

[Adam Shapton, analyst]

It's Adam Shapton at Green Street. Maybe, apologies if this is just a different way of asking same question Ben just asked, but looking at your mix of core income and other on Slide 5, thinking about maintaining particularly the ICR in, there I say, a sort of more normalized interest rate environment going forward and what you've said about cycle. Is this the mix that you expect to have in three to four years or do you want to need to grow the core income share of portfolio?

[P. Williams, executive]

I mean, historically, we've been happy with a 50:50 split between core income and opportunities, at the moment, to have, obviously more of this sort of core income side is pretty good, so at the moment, 56:44 feels pretty comfortable to me. Nigel?

[N. George, executive]

Yes, I mean, we've tracked this many years and it's averaged about 50:50, but it's been right to have core income as at, yes.

[Adam Shapton, analyst]

Debt stays at 5% or so, five years, is that still comfortable thinking about your ICR and what you just said about...

[Damian Wisniewski, executive]

Yes, the equivalent yield on the portfolio is now at or slightly above the cost of long-term debt. So it's obviously an interesting balance to that and the debt is not as accretive as it was two or three years ago. So we have to adjust to that. That, again, supports our low leverage business model. But I think we can see -- one of the things we look for is the visibility of earnings. So if you can get pre-lets on developments, you can take a little bit more risk and perhaps add a bit more value add, but it's a matter of balancing those things out finally. We are keen to grow the earnings again. This is a business which has done that for many years, it's been challenging since 2019 with rental growth lagging, cost inflation, but that does feel as though it's potentially about to move on the other side.

[Adam Shapton, analyst]

And then on the CapEx, the GBP 35 million this year not quite a bit since last year and if I interpret Slide 13 correctly, that not a lot of that has gone on B2C upgrades this year. Can you sort of give some color on the return your getting on that CapEx, if we think about it as sort of inverted commerce defensive? How does that feature into ERV growth?

[N. George, executive]

These are the refurbishments. They really vary from quite small, floor-by-floor, unit-by-unit refurbishments, some of which can make money, some of which don't always, to a quite large refurbishments like the ones we did down in Victoria, which can be as profitable as a major development.

[Adam Shapton, analyst]

Has it helped your ERV growth outlook?

[N. George, executive]

Yes, I think on the whole, we are -- we are very positive about these scheme. We think by upgrading that space, we can grow rents quite significantly and it's actually part of the business model going forward. It's quite hard to give you precise figures because there is quite a range, but we're comfortable that these are accretive overall.

[Adam Shapton, analyst]

On the impairments and to some extent they appear to be there in the first half, is it sort of the same set of problems or is it sort of cycling through? There's a bit of a drift of issues with retail and [indiscernible].

[N. George, executive]

It's very much from the first half really, but there is still weakness amongst some of the smaller retailers and we have a choice as a landlord to either support those retailers or take the space back and perhaps have vacant units. People like gym operators are struggling with margins, so the view we've taken in some of these cases is better to have them there paying some costs, keeping the building alive.

[Adam Shapton, analyst]

Sorry, are there new cases in the second half or is it same...

[N. George, executive]

There have been one or two small failures amongst tenants, in a portfolio of this size, there always are. But these are really quite small amounts that we're talking about. And overall, it's what, 1% roughly of rental income, that's probably a reasonable number going forward.

[P. Williams, executive]

Any other questions? No? Have we got any questions from telephone lines? Not on the webcast? Well, I suppose I should wrap up, say thank you very much for attending today. We're all around later if anyone wants any further questions and come and talk. Oh, we do have question.Paul May. Okay. Paul?

[Operator]

Your line is open, sir. You may proceed.

[Paul May, analyst]

Just a couple from me. Sorry to go over a little bit around, you mentioned around yield expansion, just versus financing cost and yield on cost versus financing cost. Just going back to the last time, rates kind of stabilized if you look at the five-year swap around 4% was around 2002, 2003. I think around that sort of time yielding, your portfolio was about 100, the initial yield about 100 bps higher, reversionary yield about 150 bps higher than it is today. What makes you think that buyers are willing to accept a much tighter spread to financing cost and why should valuations have much tighter spread to financing costs today versus previously when rates were this sort of level?

[Damian Wisniewski, executive]

Well, that's quite a long time ago and I think probably a lot of it comes down to what's happened to rents in the meantime, the affordability of rents. We've come through a pretty exceptional decade where QE has brought financing rates down, brought yields down and as a sector, we've actually seen rental growth being rather slow. As that reverses, there is perhaps room for rents to start growing again. So, Paul, it's a very complicated question and I think we perhaps talk about it in private, but I think our view at the moment is there is room for this to be an acceptable rate. We also expect the cost of borrowing to come down a bit once the Bank of England starts cutting rates. We saw that last year and we think rates may come down a bit further. So I think there's a sense that there's rental growth to come which will improve this balance.

[Paul May, analyst]

Also just a quick follow-up and ask it in a slightly different way. You mentioned about looking at acquisition opportunities. Would you be paying similar initial yields to your portfolio today for those or would you have to accept a higher initial yield to take advantage of those acquisitions?

[P. Williams, executive]

I suppose, okay, it depends what you're buying -- it depends what you're buying and what the opportunities are, is there a near-time growth opportunity, floor area or repositioning the building? I mean, historically, we've never had to worry too much about the initial yield on something if there was 2 to 3 years income ready for you to reposition. So I'm afraid the answer to that question, it depends what you're buying and what it is and I think if it's something where we can add value and add some reposition it or regain the lease or something, then we would certainly look at it. Quite a good example is something like Blackfriars, which is 60,000 feet, big car park at the back, a basic re-development could put 200 on there, there's another little bit next door which you sort of own. If you bought that into play, you could be looking at 500. Now that's a 10-year play. So the answer is you would be happy to pay these sort of yields, if you could find that sort of stock, it's not easy though, but we have done it in the past.

[Paul May, analyst]

Just a final one, wrapping it altogether. I think you mentioned a few times, financing cost not being particularly attractive or accretive at the current stage. Does that imply just looking your net debt to EBITDA is high relative to, say, US peers. So on that metric you are quite levered, would you be then looking at equity funding, seeing that happening more and more in the space? Just wondering, is that a preferred method of funding expansion?

[Damian Wisniewski, executive]

At the right time, I think the idea is the right one. I think this perhaps isn't quite the right time now, but we are believers in scale and at some point we'd like this business to grow. So the conditions aren't quite right today, but I think we would definitely see equity as one of the options going forward.

[P. Williams, executive]

That's right.

[Damian Wisniewski, executive]

Paul, just going back to your early question, I've just had a bit more time to think about it. 2002 was a long time ago. I think one thing to bear in mind is the quality of our portfolio today is substantially higher than it was in 2002. We had a lot of raw material in those days where you'd expect to see a higher yield. Today, we've got much more in the way of completed stock. So I think that we should go away and look at this together, perhaps quietly, but I'd expect to see quite a lot lower yield on the portfolio today than 20 odd years ago.

[Paul May, analyst]

Noted on the scale, we agree.

[P. Williams, executive]

All right, thank you. We've got one more, I think. Robbie.

[Operator]

Our next question over the phone comes from Pieter Runneboom with Kempen.

[Pieter Runneboom, analyst]

I've got two, actually, I've got one. If I look at the asset management activity in '23 and looking at the new rents versus the ERVs from the year before, I see quite a slowdown there. Could you maybe give a bit more additional color on that? The new rent versus Euro fees [indiscernible] came in at plus 1.7% versus plus 5.3% the year before?

[P. Williams, executive]

Yes, this is Page 35.

[Damian Wisniewski, executive]

Page 35, they're all very individual, I don't think you can build a trend from that. Also some of them are where we're trying to gear up for redevelopment down the line, so you're a little bit more flexible on it, but it's not really something you can draw a straight line on, that's -- what's there.

[Pieter Runneboom, analyst]

Then I think about the bid ask spread, if we're looking at assets that are currently being offered to you in the market of the yield seats that are up for sale, in your view, what percentage of this is currently priced attractive or correctly, I should say?

[N. George, executive]

Yes, I think what -- last year, you didn't actually have a great deal out on the market, that's starting to happen now and the sector has seen valuation corrections, those have felt feeding through to the numbers and what we're speaking to the various agents out there. There's quite a lot more coming up. As we touched on earlier, there have been quite a few sort of, what's the phrase extend and pretend last couple of years and we're seeing a few of those actually saying, no, now's the time to sell the buildings and there's been 2, 2 or 4 of those buildings out on the market.

[P. Williams, executive]

We certainly see a few more...

[N. George, executive]

It's starting to...

[P. Williams, executive]

So I think you'll see a bit more activity this year, I think last year it was down, but I think you're seeing more assets being put on the market, more realistic pricing and that should play to our strengths.Okay. Thank you very much, team, for your questions. I think we are wrapping up now. Thank you everyone for their time. Have a good day and we're around if anyone wants to speak to us. Right. Thank you.

[Operator]

This presentation has now ended.