Life Science REIT PLC

LSE:LABS

Earnings Call Analysis

Earnings Call Transcript 2023-Q2

[Simon Farnsworth, executive]

Well, good morning, everyone. I'm pleased to be presenting the June 2023 half year results for Life Science REIT and to provide you with an update on the further progress that we're making in the business. My name is Simon Farnsworth. I'm the Managing Director of Ironstone, the REIT's investment adviser. I'm joined by David Lewis, our Finance Director; and Ian Harris, our Director of Asset Management.

I'm going to start by setting the scene and providing you with a market update. David will then walk you through our financial results for the 6 months and Ian will then dive into some of the detail on key portfolio activity and ongoing asset management initiatives.

Just before we kick off, I just want to mention two things. Firstly, today's presentation is being recorded, and a replay will be available on our website afterwards. And secondly, there will be an opportunity for investors and analysts to ask questions at the end of presentation. So the first 6 months of 2023 has been a period of solid operational performance that's despite the ongoing macroeconomic headwinds.

Real estate values across all sectors have been recalibrating in response to the risk-free rate, but sectors such as life sciences, with compelling occupational themes and supply-demand imbalances have weathered the storm well and have well positioned for continued growth. So here are the headlines. The valuation of our portfolio is up in absolute terms, 3.9%, reflecting good progress on developments, and we've added GBP 1.2 million of Contracted Rent driven by leasing at our assets, including Rolling Stock Yard in London's Knowledge Quarter where we set new record rents for lab space in London.

So while the market is undoubtedly cold, we are signing rents ahead of our business plan, and this is set to continue. As a result of our activity, 75% of completed developments are now let or under offer and we've increased our overall portfolio occupancy by 7% to 89%. The ERV of the investment portfolio is more than GBP 17 million, offering significant further earnings upside to be captured through our leasing activity. While maintaining our development and refurbishment program is key, we are very aware of the wider economic context, and we remain measured and flexible in our approach.

We're revolving our offer to take advantage of plug-and-play laboratory shortages in our core markets and Ian will talk about this more later. Turning to the financial performance. We've increased earnings per share to 0.9p, enabling us to pay a 1p dividend at the interim stage in line with last year. NTA per share is lower, mainly driven by last year's second half dividend payment.

The balance sheet management has proven to be absolutely critical over the last 12 months across the entire real estate sector. Our successful refinancing means we are well placed to deliver on our strategy. We can fund development and refurbishments at a relatively low cost, and we have sufficient liquidity to complete all our committed CapEx over the next two years. I'm now going to provide an update on what's happening in the U.K. Life Science industry and what that means for the real estate sector. The U.K. is well positioned as you are aware as a global leader in the world of science and technology underpinned by the excellence of these academic institutions and the talented labor pool, particularly in the Golden Triangle where we are focused.

Life Sciences has demonstrated resilient so far in 2023, but it's not entirely avoided the broader economic challenges. On this slide, I've set out some of long-term key structural drivers, which you all be familiar with. And these continue to underpin a very positive long-term outlook for U.K. Life Sciences with the recent agreement for the U.K. to remain in the Horizon in Europe program being a further boost for the sector.

In the shorter term, economic uncertainty has had an impact from the real estate markets. Investment volumes are down, but this partly reflects the reluctance to sell and deals are actually still transacting at tight yields. At the end of June, there was over GBP 600 million worth of life science related properties under offer to a wide variety of investors from ranging from private equity to sovereign wealth funds.

And this suggests an uptick in volumes is on the near horizon. There's certainly been a shift in the funding dynamics across U.K. Life Sciences. While venture capital funding has slowed down. Other sources of capital have emerged to compensate. Big Pharma and M&A has been very active with more than GBP 3.6 billion invested in the last 6 months as they look to accumulate smaller innovative businesses to supplement their own R&D activities.

Private equity, including sovereign wealth funds who typically invest at later stages at venture capital when the business model is better established, have also being more active, as you can see from this chart here. This underscores a broadening investor base in the industry and enduring confidence in the sector driven by these long-term structural themes.

So I'd now like to look at the demand-supply imbalance in our real estate markets. In Cambridge, takeup is higher year-on-year and current requirements have increased over 1.2 million square feet now for laboratories alone. This compares to available space back at the end of June of just over 7,000 square feet of fitted labs. We're seeing rents for 40 fitted labs increased to over GBP 70 a square foot and continues to rise.

So in this context, our offer at Cambourne Park looks highly affordable. We've just completed our rebranding there, targeting science and technology businesses, and Ian will talk more about that in due course. A similar story can be seen in Oxford, which has 48,000 square feet of available laboratory space. This represents just a 1/3 of the average annual take-up in the city, and we're currently seeing more than 0.5 million square feet of known laboratory requirements in the market. Office rents in Oxford now have exceeded GBP 60 a square foot and fitted labs are now in excess of GBP 75 a square foot and continuing to rise.

Again, this compares with GBP 30 a square foot for offices and GBP 55 for fully-fitted labs at Oxford Technology Park for high-quality space in an excellent location. We're right next to Begbroke's Science Park, the source of our -- our 2 most recent lettings and we're forging a strong network across Oxford, for example, through Oxford Science Enterprise to help us source new occupiers for the park.

So in both these cities, the chronic supply, demand and balance is expected to persist for at least the next few years. As a result, annual rental growth is forecast at 2.6% for Oxford and 3.8% for Cambridge over the next 5 years, which compares very favorably with the rest of the property sector. Just turning to London. Here, the market is developing rapidly and with firm believes that Knowledge Quarter around Kings Cross and Pancras has the potential and, in our view, over the years the premier life science cluster in Europe.

And this has been demonstrated by MSD's recent commitment to their GBP 1 billion headquarters opposite Kings Cross station. Specific Life Science real estate data is less readily available in the London market, but 2023 looks like being around 45,000 square feet of take-up to the half year. And that compares to Life Science related requirements of around 700,000 feet across the London market.

Of course, much has been made about the ability to turn offices into laboratory space. And while this can be done successfully in some cases, not all offices are suitable for conversion. Proximity to academic and scientific institutions is absolutely key. That's what's driven the success of Oxford and Cambridge and the Knowledge Quarter. Structural features of the building are also important. So while supply is likely to creep up, not all of that is going to be suitable for the kind of Life Science occupiers that we're targeting.

The predominant requirement in London, particularly is a smaller fitted laboratory space. So understanding the market and having a specialist team who can assess occupied business plans and credit qualities, absolutely paramount. Our recent letting at Rolling Stock Yard at GBP 110 a square foot, a record rent for London to a Syncona backed company is a great example of that strategy.

So on that note, I'm now going to hand over to David, who will talk you through our financial results and our debt strategy.

[David Lewis, executive]

Thanks, Simon. So I'm delighted to present some further detail on our half year results, which now reflect the full 6 months of revenue and costs of the assets acquired in early 2022. We continue to deliver strong operational performance with a focus on development activity and asset management initiatives as well as ongoing new lettings, which will significantly benefit our earnings performance for the full year. Headline numbers are an NTA of GBP 306 million and an NTA per share of 87.4p with positive adjusted earnings of GBP 3.2 million or 0.9p per share. Net borrowings are GBP 82 million, which is a net LTV of 20.3% on a property valuation of GBP 402.9 million.

Turning first to adjusted earnings, which were GBP 3.2 million for the period, a GBP 2.5 million increase on the comparable period in 2022. This is driven by an increase in revenue to GBP 7.6 million from GBP 5.6 million, primarily from the 2022 acquisitions. Operationally, we have excellent rental collectibility of 99% and property operating expenses of GBP 1 million are stabilizing as we lease up space on Cambourne Park and Rolling Stock Yard reducing our void costs.

Net finance costs reflect the refinancing of the existing HSBC facility in June, adding Bank of Ireland as an additional lender and repayment of the OTP Fairfield facility in February. And we have also declared a 1p per share interim dividend in respect to the first half of year -- half of 2023, payable in October.

The next slide shows a bridge of the NTA per share from 90p at December 2022 to 87.4p at June '23. So on the right-hand side of the slide, you can see that this had been driven by the 3p 2022 interim dividend payment and the 1.2p like-for-like portfolio valuation decline.

This is actually offset on the left-hand side of the slide by the 2p increase in the value of the development portfolio. On the next slide, looking at the liquidity and debt position. For June 2023, net borrowings were GBP 82 million and available liquidity was GBP 68 million, a reduction from GBP 138.2 million at year-end. That reduction was primarily due to the repayment of the OTP Fairfield development debt in February 2023, a dividend payment of GBP 10.5 million and funding further development of our assets.

The new facility announced in June comprise of GBP 100 million fully drawn term loan capture a maximum interest payable of 4.5% per annum until March 2025. And GBP 40 million of that is defined as a green loan and represents the group's first green financing.

There is also a GBP 50 million RCF tranche at SONIA plus 2.5%, which will be drawn on a quarterly basis to fund development at OTP with expected CapEx draw down profile with SONIA fixed by a forward starting interest rate caps at 2.2%. And the next slide attempts to demonstrate that. So this is purely for illustrative purposes to demonstrate that we have sufficient liquidity to meet our committed OTP CapEx requirements whilst being 100% hedged against interest rate risk. At June 2023, the gross LTV was 25.1%. And as we draw on the RCF, the gross LTV will increase from a maximum of 36.3%, so we're very confident we will remain within our 30% to 40% gearing target.

The draw down profile matches our forward starting caps. This assumes also that our CapEx is valued pound for pound, and there is no further uplift in valuations as the buildings are completed and move from development to investment. And now I'll hand you over to Ian to discuss our ESG commitments and our portfolio.

[Ian Harris, executive]

Thanks, David, and good morning, everyone. I'd like to start by saying a few words about ESG. It is central to the way we do business because our occupiers are global leaders in science and technology. They expect a modern and sustainable place to work, and they have highly ambitious ESG commitments of their own. Reducing our impact on the environment is a key focus, therefore. And to drive that, we'll be setting our own net zero carbon pathway later this year. Right now, we're working on improving the quality of the data, so we can better measure occupier emissions to inform our activity and support our occupiers with their carbon reduction plans.

Other environmental initiatives include introducing green lease clauses on all new leases, setting our own sustainability standards for acquisitions, refurbishments and developments and engaging generally with our occupiers.

We've also made good progress on EPCs. 97% of the portfolio is now A to C rated as compared to 65% just a year ago. And most of those C-rated properties are at Cambourne, and they'll be addressed through our refurbishment and repurposing plans, which I'll come on to a little bit later.

This slide gives a snapshot of the portfolio. We have 6 assets with a range of opportunities from ground-up development at OTP to near- and longer-term laboratory repurposing opportunities, notably at Cambourne and Rolling Stock Yard. You can also see the key portfolio stats here. Two highlights particularly to point out are the jump in occupancy to 89% from 82% in December, reflecting our leasing activity and the significant uplift that we've seen on developments, which has driven our valuation performance, which I'll come on to now.

The total value of the portfolio is now nearly GBP 403 million, up 3.9% on an absolute basis. The like-for-like movement on the investment portfolio was down 1.3%, with declines mainly attributable to 2 assets where the current valuation is aligned more to offices than it is to lab space. They are pre repositioning in other words. So they took the hit that the office sector took generally.

Developments are up 8%, driving a blended revaluation gain of 0.8%. Our continued leasing activity and the repositioning initiatives that we've delivered and the positive market dynamics that Simon talked about, have all supported positive like-for-like ERV growth on average across our core locations.

Turning to leasing. We were pleased to welcome 4 new Life Science occupiers to the portfolio in the first half of the year, taking a total of 22,600 square feet across Rolling Stock Yard, Oxford Tech Park and the newly repositioned Cambourne Park, Science and Technology Campus. Getting deals over the line is taking longer, as Simon has said, but we are encouraged by the level of inquiries we're seeing, and they are firmer and generally less speculatively than they were perhaps a year ago.

We're achieving higher rental levels with deals ahead of December's ERVs. The occupiers we're signing span the range of Life Sciences and have taken a mix of wet lab, dry lab, write-up space and pure office accommodation, adding a total GBP 1.2 million to the rent roll. Post period end, further Life Science lettings of 11,000 square feet are completed at Oxford Technology Park to Oxford Gene Technology adding a further GBP 200,000 to the rent roll, and we have a further 37% of the innovation quarter under offer.

So as we repurpose from offices to laboratories and we deliver more Life Science space to the market, Oxford Technology Park, the proportion of our rental income that we derived from Life Science tenants in increasing significantly. As of December '22, that proportion stood at 39%. This has increased to 47% at the half year with lettings to Beacon therapeutics, Oxford Ionics, Arcturis data and Rakon. And post period end, it's increased again to 51% with the lettings to OGT that I referred to earlier. Including deals currently under offer or where terms are agreed, the figure rises yet again to 55%.

And I think this evolution really demonstrates that we are delivering on the strategy that we set out at IPO. Turning now to the progress we're making at some of our major assets. Let's start with OTP Oxford Technology Park. Our building program is progressing well. 5 of the 12 buildings are now completed and 5 more are due to complete on a phased basis between now and May of next year.

We completed two Life Science leases in the period, one post period end and five leases are currently in [indiscernible] hands. So overall, 75% of the completed development space is now either let or under offer. Most importantly, over the past 16 months since acquisition, we've driven a 33% increase in the rental rates of the larger hybrid units at OTP from GBP 15 to GBP 20.

That's a really strong endorsement of the quality of the space we're delivering as well as the strength of demand. Following the success of the fully-fitted land project at Rolling Stock Yard, we're looking to replicate this strategy at Oxford Technology Park in Unit 7 of the IQ. These will be smaller, more flexible units targeting growing Life Science businesses, a part of the market that's critically undersupplied, particularly in that fitted sector. And when it comes to that all-important amenity offer that I keep referring to, we've submitted the planning application to change the use of one of the IQ units to a sustainably themed cafe together with co-working space, bookable presentation room and event space. And subject to planning being received, this will be operational by Q2 of next year.

Going forward, we're working with the professional team to amend the design of the final two buildings, buildings 10 and 11 at the park. We feel that there's a gap in the market for unit sizes between what we can currently offer in the IQ at the smaller end of the scale and the larger hybrid units.

So we're working up a scheme for two terraces of units between 10,000 and 20,000 square feet which will target higher rents and complete our offering to potential tenants. Turning now to Cambourne, the rebranding and repositioning exercise that we've been working on is now complete. And Cambourne Park Science and Technology campus has been launched to the market.

This coincided with our first Life Science letting in the period to Rakon. We took just under 5,000 square feet of dry lab write-up space and offices in building 2020. So to build on this, we're now looking at converting 10,000 feet of vacant offices to four small fully-fitted wet lab facilities, again, using the Rolling Stock Yard model.

We are in for planning, and we expect to receive consent next month. Subject to that consent, we'd expect this project to deliver rents in the region of GBP 50 to GBP 55 a square foot compared to the prevailing level for offices at GBP 25 and on that note, I'll pass you back to Simon.

[Simon Farnsworth, executive]

Thanks very much, Ian. So what does all this activity mean for the company as we look forward. As it can be seen from this income bridge, there is significant upside to come through reversion and asset management activities. So we've broken this down into easily identifiable buckets. Firstly, we have GBP 1.3 million of in-built reversion. And by this, I mean, mark-to-market of existing income that will largely be captured through reviews and lease expiries.

Secondly, we have GBP 1.9 million of income to come through the lease-up of existing vacant space, 1 floor remaining at Rolling Stock Yard space at Oxford Tech Park and Cambourne. And thirdly, we have GBP 6.5 million of rent to be realized through letting of under construction building at Oxford Tech Park. As of today 39% of that is already pre-let or under offer. And finally, we have the remaining buildings, 10 and 11, which Ian just talked about at OTP, which are forecast to contribute a further GBP 1.8 million of income, although we expect that number to rise as we redesign those units as Ian just discussed.

So this totals a further GBP 10.2 million of achievable rent, representing almost 3p per share in earnings. And it's important to note that we're basing this analysis of our valuers existing today, ERVs, we're not factoring any growth into these numbers beyond today's rents. So of that GBP 10.2 million, we now have 25% either secured or in legals. And this is significant progress, but there is a lot more to do.

So despite the headwinds and the malaise impacting the economy and even more specifically, the real estate sector over the last year, we've continued to deliver on the asset management initiatives to drive rental and capital growth and provide much needed space for a growing sector at the heart of the U.K. economy. We expect key market indicators to continue to stabilize and liquidity to return to the capital markets, presenting us with further opportunities for the business. Our strategy of actively derisking development exposure through pre-letting and fixed price funding contracts is the right one in the current environment and positions us well to drive returns for shareholders and to capitalize on the demand that we're seeing in these key markets today.

We're having encouraging conversations with a range of prospective occupiers, and I look forward to providing further updates on leasing progress in the very near future. And at the same time, we are maintaining our discipline around capital allocation and our strict focus on this strong growth sector puts us on an exciting trajectory building this best-in-class portfolio with a range of opportunities to enhance value for our shareholders.

So that concludes the formal part of the presentation. And we now welcome questions from the floor or from people listening online.

[Unknown Analyst]

I just wonder if you can provide a bit more color on the ERV uplift that you saw this year, specifically against the offices against the Life Science buildings and how their performance was between those 2.

[Simon Farnsworth, executive]

Yes. The bulk of the ERV uplift has come through the refurbishment projects that we're carrying out so and the development at Oxford Tech Park. So as Ian alluded to, I think the ERVs now on the bigger units and even the smaller units of the Tech Park have moved on anything between 20% and 33% since acquisition back in May of 2022. The ERVs have been relatively flat on the -- as Ian said, on offices that are valued as offices. So Herbrand Street in Blooms, for instance, we have had an uptick in the ERV there.

But generally, we're seeing good growth across the portfolio and we expect that to continue. The forecast of the brokers of 2.8% to 3.5% per annum over the next 5 years, I think our sort of fairly straight line forecast. What we're seeing is some fairly hefty jumps on a deal-by-deal basis across the portfolio.

[Unknown Analyst]

This is James from [indiscernible]. Just when we look at the yields of some of your assets in Rolling Stock Yard in particular versus on a comparable office building in the same location, they are quite a bit low. I'm just wondering, is that because some of the upside is already in the kind of valuation for the conversion from office to labs? Or is that what you're seeing kind of Life Science buildings going forward in those locations?

[Simon Farnsworth, executive]

I think we're seeing it across the Board. I mean I think it reflects the rental growth prospects for these buildings. I think if you look at the London offices generally, I think they were down about 2.5% in June to December on the CBRE index, whereas what we're seeing in the Life Science world at the moment is it's a real rental growth play. And I think Rolling Stock Yard demonstrates that. I mean we've achieved, as I said at the time, we've taken the base office around there from GBP 65 to a lab rent of 110. We know that rents now further down the road, they're quoting GBP 130 at [ Tribeca ] and various other schemes. So we're looking to sort of move those rents on already.

[Unknown Analyst]

Okay. So the upside still to come when you do convert from basic office space to the last.

[Simon Farnsworth, executive]

I mean Cambourne, I think Ian, do you want to talk through the economics of the Cambourne excessive more competitive.

[Ian Harris, executive]

Absolutely, I mean the Beacon side of -- the letting to Rakon, for instance, which was effectively done at office levels was a GBP 25 a foot. If we spend the money on converting 10,000 square feet and building 2020, we'll be providing a fully-fitted product, and we'll be doubling the rent. We'll be looking at certainly a rent beginning with a 5, which more than justifies the CapEx expenditure in the first place, and that's still a low base to come from when you look at the Cambridge market in a wider perspective.

[Unknown Analyst]

You are sort of all up ERV of GBP [ 26 ] million. I mean is that all funded by the GBP 6 million to GBP 8 million liquidity you have in your balance sheet and remains within your target gearing ratio?

[Simon Farnsworth, executive]

Yes. That's existing contained within the portfolio as it stands at the moment and doesn't reflect any year-on-year rental growth.

[Unknown Analyst]

And Herbrand Street, the outlines in terms of reduction in value in the period. Can you just -- I've not seen the asset understanding. Could you tell us a little bit more about it?

[Simon Farnsworth, executive]

Yes. Herbrand Street is sort of an iconic sort of [indiscernible] building touching in Bloomsbury. It's currently let to a company called Thought Machine, which is a fintech company. They've got 3 years left on their lease. We bought it as part of obviously a Knowledge Quarter play. I mean it is [indiscernible] ECL. Thought Machine occupied. It's a very high-tech building inside, even though it's sort of nearly 100 years old in terms of the fabric of the building.

It's got a huge clear [indiscernible] big concrete slabs, good floor ceiling height. So we'll make a wonderful Life Science building as and when we get that space back. I think the key there is that it's not all happening once, Mike, we're sort of building out OTP, doing what we want to do at Cambourne and then when we've finished those projects, then Herbrand Street will be the next major sort of capital project in probably 3, 3.5 years' time.

[Unknown Analyst]

Is the [ rezoning ] barrier to get into the Life Science usage?

[Simon Farnsworth, executive]

No, you don't need planning to changes. The building is listed Grade 2. So we actually don't have empty rates on it either if it does become vacant. Thought Machine really well-capitalized business. I mean they're well backed by JPMorgan and Lloyds, and never a strong financial covenant, but you don't need planning to changes.

No further questions, anything coming through. No. Okay. All right, then look thanks, everyone, for attending this morning, and we look forward to sort of seeing you all in the near future. Thanks very much.