Entra ASA

OSE:ENTRA

Earnings Call Transcript 2020-Q3

[Sonja Horn, Chief Executive Officer]

Good morning, and welcome to Entra's third quarter presentation, brought to you live here from Oslo. Let's start with some highlights in this quarter.As expected, rental income was up 2% and came in at NOK 589 million versus NOK 577 million in the last quarter. The effects of COVID-19 and infection control measures have had very limited effect on our operations and also on our financials in both in this quarter and also so far into the pandemic.Net income from property management was up with 6% to NOK 383 million versus NOK 360 million in the same quarter last year. Net value changes this quarter of NOK 918 million, whereof NOK 892 million from positive value changes in the property portfolio. The Norwegian property market is seeing an ongoing yield compression after the key policy rates were reduced from 1.5% in the second quarter this year to 0%.Our profit before tax came in at NOK 1.354 billion versus NOK 900 million in the same quarter last year. We've also had a very solid quarter in respect of letting, net letting of NOK 7 million. And we have, on the back of that, also now started to prepare 2 new development projects for the next quarter.As already mentioned, a very high activity in respect of letting. We signed new leases of NOK 71 million or around 32,000 square meters. And as you also have seen, we have continued to sign contracts after the quarter.We terminated contracts of NOK 12 million in the quarter and net letting then of NOK 7 million. Our occupancy rate is currently at 97.4%. That's slightly down from 97.6% last quarter. Average lease duration of 6.9 years.And in this quarter, we also signed some very large contracts. The University of South-Eastern Norway did an extension and also prolongation for 19,300 square meters in Drammen, that's just outside of Oslo. And we also were very pleased to see that WSP Norway signed a new contract for 3,800 square meters in St. Olavs plass 5, meaning that we now are preparing to start that project. Also in Drammen, Konggata 51 and public tenant, Vestre Viken HF, signed or prolonged a contract of 3,500 square meters.In our ongoing projects, we are very pleased to see that Kristian Augusts gate will now be completed in the fourth quarter according to time. And there, we have done a pilot in respect of testing how we can reduce the carbon emissions in our projects to the reuse of materials. And we are pleased to see that we have actually reached a level of 60% reuse in this project. The project will be handed over to our tenant, IWG Group, in the end of this year, and they will open their spaces project there in the new year. For the first 12 months, we have a turnover-based rent on that building. And in the current market situation, we expect that it will take some time before we reach normalized rent levels on this building.At Universitetsgata 7-9, we were very pleased to announced just this morning that we have signed a huge contract of 7,200 square meters with one of our existing tenants, Knowit. They have outgrown their current premises in our building at Sundtkvartalet and will increase their occupancy with 3,000 square meters when moving to this building. That means that occupancy currently is at 86% in this building, and we will have to do some alternations to the floor plans to enable their program, which means that the project cost will be brought slightly up and also affect the yield on cost a bit. However, no material changes on that. And we will get back to more details on this in the next quarter.At Universitetsgata 2, we have our Rebel project. This is our technology hub in Oslo. And also here, we have signed a lease contract, bringing occupancy up slightly to 37%. We can see that we also here have a strong pipeline of leads. And also what we're seeing an effect of now is that, as we have created this hub of technology, we're also starting to attract other companies to our neighboring buildings. One of the reasons for Knowit choosing Universitetsgata 7-9 was also the fact that they wanted to be close to this technology hub. Our refurbishment projects are both proceeding according to plan and on-time and at cost.As mentioned, we will be starting a project at St. Olavs plass 5 in Oslo. This is a building which we have experienced very strong interest for once we put it to the market. And we are now seeing that we have been working with an urban redevelopment of this area around to Tullinkvartalet for quite some time. We have brought in about more than 4,000 students. We are establishing a strong cluster for technology companies, and we are also attracting tenants from CBD into this very new urban area transformed from a sleepy part of the city previously.This building is of 16,500 square meters. It was acquired by Entra in 2019. And with the contract signed with WSP, we now have a pre-let ratio of 21%. And we're also in the final stages of closing another contract, which will bring us up to a pre-let ratio of 48%. The estimated project cost here is at NOK 1.2 billion, and we expect to reach a yield on cost here around 4.8%. The project should be completed in the third quarter of 2022.We're also very excited about announcing that we just, yesterday evening, signed a lease contract for this building at Tordenskjolds gate 12. The law firm Schjødt will be occupying the entire office space in this building, and that brings us up to a pre-let ratio here of 92%. This is a fantastic building located right on the seafront of Oslo next to the city town hall. You can't get anything more prime than this in Oslo. So with the lease contract signed, we're now preparing to start the project. Our estimated project cost here is NOK 1.2 billion, and we are expecting to see estimated yield of 4.4% on this project. Also, this project should be completed in the third quarter of 2020.Okay. It seems we have -- having some trouble with the sound. Are we good now? Okay. Yes. So that was Tordenskjolds gate 12. We thought also we will be giving you an update on our project pipeline this quarter. We have progressed quite a lot on several of these projects. And here, you can see a selection of the projects which now are already sold and which are currently in a marketing phase. These are all projects which have very attractive micro locations within their clusters, and I will start by going through a few of them.At Schweigaards gate 15, that's a building just 300, 400 meters from the Oslo Central Station. It's a beautiful building from 1926. It used to be the headquarters of the Norwegian Customs Authorities. We moved them into 2 other Entra buildings and have since had a dialogue with our Norwegian office for cultural heritage to get approval on the concept we have now put to markets.If you take a look at Stenersgata 1-3 in the middle there, that's also building right next to the Central Station here. It's a building where we have a total of 30,000 square meters of office space. We had originally planned to do the entire redevelopment in one phase. But as one of our public tenants called an option to prolong there, we have decided to split this into a 2-phase redevelopment. The first phase is now put into the marketplace. That's a volume of 16,000 square meters, where we also have some leads currently.To the right, you can see our project at Helsfyr. This is a new development, which has been zoned for 20,000 square meters. This is a cluster just 5 minutes by tube from the Central Station on northeast side of Oslo. It's a very popular cluster for public tenants. And also there, we are working with marketing.Second row at Møllendalsveien 6-8 in Bergen. This is a building we acquired 1 year ago. At that point of time, we had -- we knew that the existing tenant would be moving out. They just moved out this end of this quarter, and we are now also here in final negotiations with a lease contract, which should bring us up to some 40% pre-let ratio. So that means that we expect that we also here will be able to start the project within the next 3 to 6 months.Second building in Bergen is a new-build project which has been zoned for 12,000 square meters. Also here, we have some interesting ongoing discussions with tenants. Jørgen Kanitz gate Sandvika, 12,000 square meters. Here, we need to resolve the existing situation for some tenants before we can start the project, but we also here have quite a lot of interest for the space.At the lower role, we have 3 projects in Trondheim. The 2 to the left are second and third step of the existing plot we have realized the first phase this year. And all our projects in Trondheim, we also are experiencing quite a lot of interest in the marketplace currently. In addition to these zoned projects, we also had an early-stage pipeline currently undertaking zoning, representing an additional volume of around 240,000 square meters.Okay. A few words on the market situation. Norway has remained open with relatively few cases of COVID-19. The situation is currently under control in spite of the fact that we also have seen some increasing number of infections over the last couple of weeks.In respect of the Norwegian office market, what we are seeing is that it seems to be less affected than other large cities in other countries. We have a smaller cities in Norway, meaning that it is easier to enable the commute between office and where people live as the distances are much shorter than you typically see in large metropolitan cities. What we're experiencing here is that quite a lot of people are able to commute into work through either walking, using their bike. Or also, the sales of electrical bikes has really picked up this year.We also experienced that we have enough office space in our buildings to fairly easily adapt to the social distancing requirements. And what we see is that we have a lot smaller buildings in Norway compared to the large metropolitan cities, meaning that we don't really see a lot of challenges in respect of elevator capacity, stairway capacity. In our portfolio, Entra has maybe 2, 3 buildings where the elevator capacity is now constrained as to adapt to the social distancing requirements, but it's not a big problem on a general note.In respect of the Norwegian economy, it is also holding up very well. The national budget was released last week. And there, they stated that they expect GDP to decline with 3.1% this year and pick up again with a growth of 4.1 -- 4.4% next year.When we talk to our customers, we have had quite extensive dialogue with them over the last couple of months. And what we're experiencing is that they're saying that, yes, individual flexibility is appreciated, and they actually do expect that they will continue to give more of that also in a more long-term perspective. However, they're also very clearly stating that as the longevity of the home office situation goes on, it is becoming more difficult to maintain motivation and productivity. So they're very clear that they will definitely be using their offices going forward, but how they organize their offices and how they use the space might change over some time. In respect of our ongoing negotiations, what we're seeing there is also that the demand for contractual flexibility is increasing.Now if we take a look at the office market in Norway. What we -- we have reinstated our consensus report here on the right side. And when talking to the -- or the market -- the 10 leading market specialists are now stating that they expect that vacancies will pick up to more normalized levels in Oslo going forward, meaning around 7% to 8%. However, the picture is very fragmented. They expect to see that we will be above 10% in the fringe areas. And then in the city center of Oslo, we should see vacancies keeping low below the 5%.In respect of market rent growth, what we have seen after several years of strong market rent growth, we saw some tendencies that market rent was decreasing in the last quarter. However, it's fair to state that we saw very low volumes signed in these quarters. What we are experiencing in the marketplace is actually that market rents are holding up very well. And as you can see from the consensus report also, market rent growth is expected to be back on track from -- or through 2021.If we take a look at the markets in Bergen and Trondheim, we are there expecting and seeing also very stable activity and also very stable vacancy levels going forward. In Stavanger, the picture is more fragmented. Naturally, also seeing that they are more exposed to oil and gas industry.In the transaction market, we have, since summer, seen that it has been a very, very active market, and we have seen strong interest both from international and national investors. And yields are due to the reduction in the key policy rates. We've seen a strong downward pressure on the yields and very strong interest in specifically for what would be low credit risk and high quality tenants.And there is also -- currently, according to our consensus report, prime yield has been reduced from 3.7% to 3.5%. There are also some leading specialists which have been quoting now that prime yields are around 3.25%, which is also more in line with what we are experiencing currently in the transaction markets.Anders, over to you.

[Anders Olstad, Deputy CEO & CFO]

Thank you, Sonja. They do say that long pregnancies give beautiful children. And I think regarding to those 2 rehabilitation refurbishment project that we talked about, it's been a long and hard work, and we're very happy that they both come through. They will not show up in our numbers until late 2022. But again, it will provide the growth that we want.Okay. Going into the numbers. I will -- it's been another solid and stable quarter. So we will focus on 3 things: basically, the effect of COVID-19, the value changes and the financing situation. On the revenue side, ended up at NOK 589 million, up NOK 2 million, so basically on par with the second quarter and up NOK 12 million from third quarter 2019. Let me just go quickly through the changes since the last year's third quarter.We acquired one asset in Bergen, yielding NOK 6 million in revenues. We divested 2 assets in Oslo, giving a net negative of NOK 8 million. And then we've taken 4 projects into operations and taken 4 assets out, which basically yields a negative NOK 3 million on the projects -- or contributions from the in and out of projects. This leaves us with a 3.4% like-for-like growth, which is very strong on this quarter as compared to the CPI growth of 1.6%. So again, significantly above CPI growth on a like-for-like. For the year-to-date like-for-like growth, we are 2.3%.Net income from property management coming in at NOK 383 million, so NOK 33 million and NOK 23 million above last quarter and last year, respectively, primarily driven by a combination of higher revenues, lower operating costs and lower financing costs. And as you can see, profit before tax at NOK 1.354 billion, driven again by good operational performance and solid developments or strong value changes on the asset side.Of course, the Q1 stands out particularly, with -- basically, we decided to keep the values of our assets unchanged since the fourth quarter, while at the same time, had more than NOK 300 million in net negative value change on the financial derivatives. So -- but again, on the P&L side, a strong and basically, as expected quarter.Cash earnings coming in at NOK 8.10, basically on the 12 months rolling, giving a CAGR of 12% since 2015. On the bit crowded graph to the right, we basically have said, NAV is coming in at NOK 160, again, up 12% CAGR. If we include the dividends -- I mentioned and said in the NOK 160, we actually been deducting the dividends that we paid out in early October of NOK 2.40. So if we include the dividends that we paid out since 2015 of NOK 24.65, it gives a CAGR of 15% for the NAV. So the triple net, it's 13% and 16%, respectively.Then we have added 2 more metrics. We spoke briefly about this on the last quarterly presentation. EPRA has implemented or will implement, starting in next year, 3 new measures instead of the NAV triple net asset values. They are the net reinstatement value, net tangible assets and the net disposal value. The -- we have plotted the NRV and the NTA on the graph at NOK 162 and NOK 161, respectively. We will come into more details on this later. The net disposal value, basically the breakup value of the company, the assumption from EPRA is that all assets will be divested and you will have a tax effect. We basically pay tax on the gains from the proceeds. This is not how transactions have been done in Norway.We sell assets on SPV level. And the gains we get when we sell an SPV is tax free, for [ calculation ] purposes. So basically, that means the NDV is not really a pressure for us. We will still report it as guided by Entra, but it is the NRV and the NTA that will be relevant. You will find this in some detail described in the back of the third quarter presentations on how we calculate these 2 measures.Beautiful picture. On the effects of COVID-19 on our numbers, as Sonja said, it has been very limited. Let me just go a bit back on what we said after the Q1 presentations. Firstly, we have turnover-based revenues of about NOK 60 million for the full year, i.e., NOK 15 million on the quarter. We estimated that we lost NOK 5 million in the second quarter and NOK 4 million the third quarter based on reduced activity from our tenants, which then feeds into our numbers. So a total of NOK 9 million lost in turnover-based revenues for the last half year.Then in the second quarter, we put provisions in place for bad debt of NOK 11 million. In retrospect, that was too conservative. So what we see now is that we actually reversed 5 of those million in the second -- in the third quarter numbers. So i.e., the expected bad debt from Q2 and Q3 comes out at NOK 6 million. So again, this gives NOK 14 million, NOK 15 million in actual account impact from COVID-19 in Entra's number. And if you compare that to the [ NOK 1.176 billion ] or top revenues on second and third quarter, this means that it's about 1.3% impact, so very module.And the payments that we see in Q4, because we basically invoice upfront due at October 1, is on par with what we've seen in previous quarters. So at least, it seems that we are well on track in terms of delivering our results with just a very minor effect of COVID-19, which is good.On the P&L, it's really sort of no surprise. Let me just make a few comments on those. Admin costs coming in at NOK 42 million, so on level with last year but lower than we expected. We did expect to be at sort of NOK 190 million, NOK 195 million for the year. Now we seem to be pegging towards NOK 175 million.Again, financials coming in at NOK 129 million, so we're now seeing the effect of the reduced interest rate in Norway. And the third point is on the tax payable. Up until now, Entra has not been in a tax payable position, except for one partly owned subsidiary in Drammen, where we pay, give or take, it's been like NOK 12 million, NOK 13 million in tax for a year. We did not expect to be in a tax payable position in 2020, either. The reason is that, without going into too much deals, we pretty have a normal depreciation of NOK 600 million based on Norwegian GAAP. And then we are able to deduct fully the building part in redevelopments.As we have postponed some of these redevelopment projects, that means that we also will be deduct less from our taxable income. So our best estimate now is that we will pay between NOK 20 million and NOK 30 million in tax for this year. And then we will be, if we follow our plans, basically in a nontaxable position again on a group level in 2021. But again, a small tax payable than expected in 2020.On the summary of the known events, this does not include, by the way, the contract that Sonja talked about with Know it U 7-9. So there's an upside there in 2021. It's pretty much unchanged from last quarter. We terminated sort of a contract in Bergen 1 quarter earlier than we expected because we want to start the project there. So that's why we have a NOK 7 million drop for the fourth quarter instead of in the first quarter. Otherwise, we're basically on the back of a strong net letting. We have increased the -- sort of the quarterly revenues by NOK 6 million, NOK 7 million, NOK 8 million for each quarter thereafter. So -- and we're happy to see that it starts picking up now at the end of '21 when U 7-9 and Rebel is coming online. And also, again, the second pickup when Tordenskjolds gate 12 and SOP 5 will be put into operations. So again, it's good to see that we're kind of seeing now that we're back on the top line growth track.On the -- in [indiscernible] we're starting off at NOK 50.7 billion. We invested NOK 328 million in our project. The value changes on the assets coming in at NOK 892 million. As you can see on the pie chart to the right, 2/3 -- or 3/4 of that is driven by the yield compression in Oslo, Drammen and Trondheim. We're still only seeing scratching the surface of the yield compression that we are seeing in the market, but always the -- not always, but the value appraisers are lagging a bit in -- when yields suddenly start moving, especially downwards. And then the last is basically the result of the net letting, which has been very strong on this quarter, again, particularly in Drammen.On the financing part, it's been a very active quarter. We tapped into half year of bond issue, on a 7-year bond issue at 90 bps. We kept rolling our CP portfolio. And more importantly, we extended a bit more than NOK 8 billion in bank debt, extend that for 1 year with our different banks, bringing the term to maturity on the bank portfolio at 4.4 years. That was done on the same terms as pre COVID-19, which again leaves to the bottom.I guess, it's not a financial word, but this is a beautiful, well-staggered debt profile, if we're allowed to say that in finance. It's a combination of cheap, short-term debt from the CP backed by longer-term debt maturities from the bond and the bank market. So again, 5.5 years average time to maturity on the debt portfolio. And we are now almost 3x short-term debt covered by long-term bank facilities, spread between our 5 core banks. So again, it gives us security and it gives us flexibility, and that is not bad for a company like ours.On the debt profile as such, you will see on the left-hand side that about 70% is market-based, bonds and CPs. We have increased the green funding even more this quarter by tapping into that NOK 0.5 billion green bond. So the green part of our debt portfolio is now 44%, up from 41% last quarter and will increase more by the NOK 700 million of green bond that we issued yesterday. So we're now approaching almost 50% of our portfolio which is green.Again, a solid ship, ICR at 3.7 and LTV's at bit south of 40% to 39.5%. And then we also see the results as expected on the average cost of debt, which is now at 2.33%, down from 2.39% last quarter. And if we follow the -- if we use the forward curve, it will come down to 2.25% within a couple of quarters.On the financing situation, just a quick update. Bank financing, as stated, it's open. We have close and solid and long-lasting relationship with our 5 core banks, in alphabetical order: DNB, Handelsbanken, Nordea, SEB and Swedbank. And they are -- these are basically long-term partners of ours. We're happy with those relationships.CP market, it's NOK 1.6 billion on our debt portfolio. It's a fairly small but important part, keeping the cost of debt down. We find that open prices are now at like NIBOR plus 35 bps, so haven't finally come down to the normalized levels of, give or take, 15 basis points, but it's still a very cheap financing, even taking into account that is backstopped by available RCFs.And then on the bond situation, markets are liquid. The pricing is attractive for, call it, high-quality issuers. And so we're now seeing levels which we were sort of used to seeing for Entra, typically a 5-year bond doing at about 80 bps, and NIBOR plus 80 and 7-year, about 20 bps higher.So again, as we said before, in a world of uncertainty, which we still think there is, resilient financing and solid liquidity is key for commercial real estate, and we believe that Entra is well positioned in that respect. Thank you.

[Sonja Horn, Chief Executive Officer]

Thank you, Anders. Some closing remarks. Firstly, reduced interest rates are causing an ongoing yield compression, as both Anders and I have touched upon. And we definitely are seeing also that central attractive properties with long-term cash flows are particularly in favor. And with COVID-19, we're also seeing that trends towards flexibility are being reinforced. And that also means that it will be favoring professional property owners and managers with the ability to help our tenants understand and adapt to future workplace solutions.And we have also had a very solid letting activity, and we are now also expecting to see that we will be starting up several new projects in the coming quarters and already preparing to do 2 new developments based on contracts already signed.That was it for the presentation. And now we will be taking some questions, Tone.

[Tone Kristin Omsted, Head of Investor Relations]

Yes. We have some questions here. One is you talked about contractual flexibility. Can you give some examples?

[Sonja Horn, Chief Executive Officer]

Yes. What we would typically see today is that a tenant renting, say, 5,000 square meters would maybe want to be able to return part of that space, 1,000 square meters, halfway into the contractor along the contract. So that would be one example. And also, what we're doing in St. Olavs plass 5 is that we are keeping one floor rented out on more short-term leases to be able to provide flexibility for companies in growth.

[Tone Kristin Omsted, Head of Investor Relations]

Thank you. And also the [ IDL ] statistics data shows 9% down on rental levels year-to-date in Oslo. What is your take on this?

[Sonja Horn, Chief Executive Officer]

Well, firstly, as I said, the volumes referred to by [ IDL ] statistic is on fairly thin volumes for the last couple of quarters. And this is not something which we are experiencing in the ongoing negotiations, what -- which we have been doing. However, market is fragmented, and there is a very different situation in the fringe areas than what we're seeing in the more up and coming areas where we currently are working with our projects.

[Tone Kristin Omsted, Head of Investor Relations]

And then there's one question for Anders. What is behind the other income in Q3 of the income line?

[Anders Olstad, Deputy CEO & CFO]

Yes. The other income is basically twofold. The first part and the smallest part is the revenue we recognized on the assets at Bryn, just East of Oslo, that will be rezoned and put to JM as part of our partnership. And the rental income from those assets are to be classified as other revenues, and the costs for the associated operations are put into other costs.That's normally like NOK 5 million per quarter on revenues for those. So the remaining part now is on Entra's services, basically, the additional services that we provide to our tenants. That can be a combination of a smaller refurbishments, tenant alterations or basically all the kind of services that we do. We usually do that at a margin of between 6% and 10%. So it's not a core part of our business, but it's an important part for maintaining relationships with our tenants.

[Tone Kristin Omsted, Head of Investor Relations]

Thank you. Then there's no further questions.

[Sonja Horn, Chief Executive Officer]

Okay. Thank you very much. Look forward to seeing you again next quarter. Bye.