Andrew Jones, CEO of LondonMetric Property speaks about the property market

Hello ladies and gentlemen, my name for those of you don't know me, my name is Andrew Jones. I'm the chief executive and co-founder of LondonMetric Property. This morning I'm going to talk you through my thoughts on the real estate market, then we're going to talk about our highest conviction core which is the logistics sector and go through that in a deeper dive, and then go on to give you a little bit more information backdrop about LondonMetric, its history, an overview of the company where we sit today, and also the activity that we hope to execute in the future. And then I'm going to finish off with a look forward slide with our thoughts about where the real estate market's going and the sectors that we want to continue to allocate capital into. So without further ado, I'm going to talk about the structural forces that we're all living with today which continue to have an impact on real estate. The fact of the matter is we've obviously lived through an incredibly difficult period, arguably unprecedented period over the last 18 months or so, and that has accelerated a number of these forces and trends, and consequently they are having a profound and in many cases permanent impact on various real estate sub-sectors. The fact of the matter is technology continues to impact how we work, shop, and socialize. And as you can see there, there are companies that didn't exist five or ten years ago that are now very much part of our everyday lives, whether it's Airbnb in hospitality, flexible working providers such as WeWork and IWG, in transport it's Uber, Lyft, and more recently in retail disruption that initially started with Amazon a decade or so ago in the United Kingdom, now being joined by a number of the rapid delivery grocery companies such as Getir and Gorillas. Obviously in the restaurant trade, disruption is coming in the form of Deliveroo and Uber Eats. Also worth pointing out that we do live in a world of zero interest rates, negligible bond yields, and in many cases melting dividends, and there is therefore an almost desperate search for income. Interest rates, everybody tells me the interest rate is going to rise but nobody can tell me when, but they've been telling me they're going to rise for at least the last 10 years since we came out of the impact of the GFC. Together with that, that scene is also exacerbated by the fact that we are living in what is often referred to as the beginning of a demographic tsunami where people are getting older, they're living longer, and therefore their need for income is indeed great. And we think that the right real estate in the right structurally supported sub-sectors is a phenomenal investment opportunity for some of these investors. And then finally we'll talk about urbanization. Certainly in the commercial world, there's continuing increased competition for space. The fact of the matter is, as a population, our expectations and our aspirations grow every single day. A couple of years ago we might have ordered something online and been happy with a three, four, five-day delivery slot. Now we expect to get it in three, four, five hours, and therefore that is changing the makeup of demand for real estate close to where people live and work, and that's something that will continue to drive our own thoughts around where we want to allocate our capital within the United Kingdom.

The fact of the matter is the UK is a population that has embraced internet shopping probably more than any other population or any other country in the world. Our penetration is higher than almost anybody else. As I said to an investor recently, if internet shopping was an Olympic sport, then we would be on the podium. As a result of some of those structural changes, what we have seen in the UK real estate market has been an increasing polarization of performances. The gap between the winners and losers has never been bigger. As you can see on the chart on the right hand side, back in 2016 the gap was around about 700 basis points between the best performing sub-sector and the worst performing sub-sector. Last year that gap was 3,800 basis points. The fact of the matter is the winners have been unmasked and they win by a greater degree, whereas the losers continue to see value erosion, and that is something that we can expect to continue. Sheds, beds, breads, and meds, for one of a better description, are going to be the standout performers. We think shopping centers will continue to see value erosion as rents continually reset as a result of consumer shopping patterns changing and the demand for physical space dropping. Retail parks, proving that not all retail is the same, retail parks are what we think will be more resilient simply because they offer a degree of convenience that means operators can dovetail their physical presence on a retail park with their online offer more seamlessly than they can in the shopping centre, and therefore you get a true omni-channel operation. If you look back over the last 18 months across the retail piece, department stores and what we refer to internally as apparel retailing has been very, very tough. And that's what dominates shopping centers. Conversely, in retail parks, a lot of the retail parks are dominated by DIY, by the discounters such as B&M, convenience groceries like Aldi and Lidl, home and electricals. Those sectors have done very well. I've also got to add pets in, and those are your traditional retail park tenants, and so they have had a very strong 18 months. They have all had a very good COVID, unlike the department stores and the apparel and fashion retailers that dominate the shopping centers. And then finally the office sector, we have very, very little office assets and very little office experience, but we do think about the office outlook as being uncertain. It's very difficult to predict as the work from home continues to disrupt occupancy, and I don't think we're going to get any clarity from that for a number of years.

And then finally the other macro trend that is going to impact sectorial performances is, as I touched on already, the fact that we live in a world of very, very low interest rates and bond yields. I think that that will see an increasing amount of new investor demand for well-located real estate assets in the right structurally supported sectors that deliver that reliable, predictable, and hopefully growing income stream, which is very, very difficult to get elsewhere in that low interest rate world that we live in today. We often refer to it as TINA: there is no alternative. So just a little bit of the investment backdrop of where the real estate market is today. It's been through various cycles. If I think back to as we came out of the global financial crisis, the fact of the matter is with the benefit of hindsight we should have bought any asset in any sector. Yields were at attractive levels, and in the subsequent years what we have seen obviously is yield compression, and therefore all boats have risen on that particular tide. However, back in 2015-16, we as a business began to look at the various sub-sectors and come on to talk about this because it's relevant to how the LondonMetric portfolio has evolved over the last eight years or so. We started to look at the sectors and try to identify what we think are going to be the winning sectors, and those are the ones that will be structurally supported by the macro trends that were taking place in the wider world. I talked about it before: sheds, beds, breads, and meds. For us, that continued to frame our thought process from 2015 onwards, and that's what drove our big investments certainly into the logistics market but also into the convenience grocery market as well.

Taking a step back on my next slide in the logistics market, looking at it at a holistic level, you've seen a lot of money coming into the sector, not surprisingly, because it's a winning sector in a market that is increasingly polarizing. So as an investor, you've got to run your winners and sell your losers. As a result, we've seen strong performances both from a capital value perspective. Year to date values are up 11%. Huge amount of investment coming in, six billion of demand for investment transactions in H1 this year compared to eight billion in the whole of 2020. The fact of the matter is there are a lot of people wanting to get into this market, and there is a little bit of a FOMO, a fear of missing out. That investor demand is both UK, Far East, American. We've had a terrific insight into the amount of money chasing this market. We recently sold one of our Primark logistics warehouses in Northamptonshire for 102 million to a US investor, yielding around about 4%. That is an asset that we bought for 60 million back in 2013, and all we've done is collect the rent, settle a couple of rent reviews, and enjoy the yield compression over that subsequent eight years. Occupationally, demand for warehouse space is very strong across the whole of the United Kingdom, helped by a lot of occupiers needing to get fit for purpose, being able to overhaul their logistics infrastructure. Some demand has come out of COVID, there's been a restocking taking place, and I think that has seen a big increase in demand over the last 12, 18 months or so. The H1 take-up for 2021 is at 20 million square feet, and that 20 million would be round about where we'd expect a full 12-month take-up to be. What is interesting though, as you can see on the right hand side of the slide, is the fact that 41% of that demand is coming from online retail. Arguably that was not a sector five, six, seven years ago. 41% of the demand is fresh demand, and that is obviously helping the demand-supply dynamics, which in turn is going to lead to superior rental growth.

As the online penetration in the United Kingdom continues to grow, that does require more warehouse space. It's probably worth pointing out that a billion pounds worth of sales that go through a physical store network traditionally would require about 450,000 square feet of space. A billion pounds worth of sales that go through an online channel will require about 1.2 million square feet of logistics space. And that's because the online channel offering needs to account for greater inventory, deeper inventory, they tend to offer much wider ranges, and finally they need to deal with reverse logistics, the number of returns that we have to send back. As a result, it requires a greater footprint of warehouse capacity. So as we see more sales shifting from physical to online, that will drive further demand for warehouse space. I also think that there will be increased demand from a number of operators who look to move away from just-in-time logistics strategies to just-in-case. The fact of the matter is we have had a lot of uncertainty and disruption in global trade over the last 18, 24 months. That might be geopolitical, Brexit causes issues, obviously COVID has had a material impact, but also things like what we refer to internally as the black swan event: nobody foresaw that a tanker could close the Suez Canal for a week and the impact that that has. So I think a number of businesses will increasingly look at their inventory that they hold on the island of Great Britain and maybe decide that we actually need a deeper inventory for certain items, and that could also lead to more demand. And then finally on the supply side, when you see excessive demand you expect the property industry to react to it, and it generally will do. It's more difficult in logistics, particularly in regional urban logistics, because the land isn't there. The fact of the matter is urban land has higher values for almost any other use apart from logistics, whether it's built to rent, student accommodation, retail, office, hotels. The rental value and the capital values of logistics assets are the bottom of that list, and therefore finding new land in urban locations for new supply is extremely difficult. That is why urban logistics is one of our strongest conviction calls. Some of those trades also exist in the regional logistics market, probably not to the same degree, but they still exist. And there are also constraints in the mega shed market, the big box market, which does have some supply restraints but they are not going to be as great as the supply constraints that you get in the urban market.

So when you put those together, you get superior rental growth. You have excess demand, finite supply, so superior rental growth. As you can see on the slide on the left hand side, over the last 10, 11 years or so, you've seen better market rental growth in the logistics sector than anywhere else. The slide on the right-hand side is actually our own experience, and this is not hypothetical rental growth, these are actual rent reviews that we have settled either through open market negotiations or through contractual rental uplifts that we have within our various leases. As you can see, those are the rent reviews that we've settled over our last financial year, and urban logistics is obviously the standout performer there, but again very strong performance coming from our regional assets as well. And mega, whilst it's not as strong as the other two, it's still positive. There aren't many sectors that you can say that about. This is real live data. We continue to populate this slide every time we settle another rent review, and that's information that we'll continue to share with our investors during our half year and full year presentations. Also, what we will continue to do is to analyze why within the various sub-sectors certain geographies are performing better than others. Is it because the South East is going to perform better than the Northeast, or is London going to outperform Birmingham? That's work in progress, but it is something that we will continue to investigate and interrogate so that it can again fine-tune our capital allocation decisions.

So a little bit of backdrop on LondonMetric for those who don't know us. LondonMetric was formed through the merger of Metric Property PLC and London & Stamford PLC back in the first quarter of 2013. Today we are a REIT. We are REIT by definition, but we also think and operate like a REIT. We have a 2.6 billion pound portfolio, I'll come on to talk about that in a bit more detail on the subsequent slides. But the portfolio has gone through an enormous change since our merger eight years ago. We've taken advantage of the structural shifts that have taken place and tried to align our real estate assets towards those. In keeping with our REIT approach, our objective is to deliver a reliable, repetitive, and growing income because we believe that is how we can give you superior investment returns. We pride ourselves on our progressive and covered dividend, and our aspirations are in time to become a dividend aristocrat. We've got a number of years to go before we achieve that accolade, but it's something that is firmly in our sights. I should also say that I am, as I said at the introduction, a co-founder of this company, and as a result myself and my fellow directors have a strong alignment of interest. It is an internally managed company, we are all employees, but we are shareholders first. That affects how we make decisions. We are eating our own cooking. Combined management are now the eighth largest shareholder, so we're on exactly the same side of the page as all of our other investors. There are no conflicts of interest. We stand shoulder to shoulder with all of our investors, and it helps frame our thought process and our decision-making. I often say that it is a powerful message to send out because I do believe that we will attract capital if we treat it correctly, and that is something that we think about deeply.

So then a little bit more into how the LondonMetric portfolio has evolved over those eight years. As you can see, back at the time of our merger in 2013, an eclectic mix of London assets, both residential and office, a quarter of the asset base was in retail parks, and about 20-21% was in the distribution sector. Fast forward eight years, we now have 72% of our assets in the distribution centre, predominantly urban which I've talked about, but also regional and mega investments. I'll come on to talk about those three sub-sectors in subsequent slides. But we've also grown our what we often refer to as our long income portfolio, which is dominated by grocery convenience and also triple net retail. I'll come on to talk about those assets in a little bit more detail later in the presentation. And then there are two small pieces in grey: our retail parks exposure, we think this slide shows us with three retail parks, we've subsequently sold one in Leeds so that number will fall, and other is the offices, our non-core offices that we're in the process of divesting. The portfolio is characterized by long leases, high occupancy, and as you can see there, over half of the rent is subject to some form of indexation, whether it's a fixed uplift, CPI, or RPI. That's something that gives us the guarantee of income growth.

I said I would drill down into the logistics portfolio in a bit more detail. We define these into three silos. Urban logistics would be 100,000 square foot and below, located close to where people live and work. This is a billion pound portfolio today, arguably from a standing start four years ago. It is our strongest conviction call simply because of the attractive demand-supply dynamics that we're witnessing and the superior rental growth that we're collecting. We have over 100 assets, high occupancy, and a weighted average unexpired lease term of eight years, which is slowly creeping up. The rental growth that we've secured over the last three years is around about 4% give or take. Last year the rent reviews we settled delivered 3% per annum over a three-year period, just over 4% per annum. That's why it's one of our strongest conviction calls. Regional is a 500 million pound portfolio across 11 assets, long average unexpired lease terms, full occupancy, and again some strong rental growth metrics there of between 3% and 4%. Then our mega portfolio amounts to three assets, just over 350 million, which would have reduced by roughly 100 million following the sale of the Primark distribution investment that I touched on earlier. Very long lease terms, 15 years, full occupancy, and all of the rents here are subject to contractual uplifts, whether fixed or CPI, and as you can see they're positive 1.5% per annum. Our long income portfolio, as I touched on earlier, is dominated by our grocery and roadside investments, led by people like Aldi, Lidl, more recently Waitrose, but also companies like Co-op and M&S Simply Food. This is convenience groceries either standalone with its own car park or convenience groceries sitting on petrol service stations, where we believe that it operates more as a convenience grocery offer than it necessarily does to just supply fuel. We have very strong views on how that petrol market evolves. The fact of the matter is I don't mind if they're selling petrol, hydrogen, water, gas, diesel, or electricity out of those pumps. It really doesn't bother me. What I do know is that there is a halo spin that's going to take place whilst people are doing those tasks, and that tends to be going in, getting a coffee, buying the top-up grocery food. That market we think is something that's going to evolve as consumer trends continue to shift. Our triple net retail investments are dominated by the discounters, B&M, Home Bargains, The Range, for those of you who are familiar with those brands, but also our furniture investments with DFS and Dunelm, but also some electrical exposure with Currys PC World, and as I touched on earlier, Pets at Home as well. That sector has been out of favor, it's had a very strong 12 months and will continue to have a very strong 12 months because investors are continually attracted to the high initial yield, you can see it there 6.5%, 10-year weighted average unexpired lease term, and also all of those operators, unlike the department store operators and the apparel retailers, have had a very strong period. Then our trade and DIY exposure tends to be dominated by our investments with Wickes, but also with Toolstation and Selco in particular. This is a sector that has benefited enormously from the work from home over the last 18 months. The more time we've been spending at our homes, the more money we've been spending on our homes. This is a sector that we would like to grow our exposure to, subject to finding the right opportunities. And then finally we have a small leisure exposure, which is about 2% of the overall portfolio, dominated by four Odeon cinemas which obviously had a tough time over the last 18 months. We think we can see a way out for the cinema market. I wouldn't say that we were 100% confident about it, but it's something that we are well connected, we have a great relationship with Odeon, we've worked with them over the last 18 months to help get through this difficult period. We think we can see some light at the end of the tunnel, but time will tell. As a portfolio, the long income portfolio has excellent credits, it's long indexed leases, we're benefiting from evolving consumer trends, and we live off an attractive nearly 5.5% net initial yield, we have 14 years unexpired lease terms, we have 100% occupancy, and nearly two thirds of that income is subject to some form of contractual uplift. In the direct property market, we are seeing a lot of investor interest in that, so we expect those yields to compress.

No presentation would be complete without touching on our ESG activity. It's something that we take very, very seriously. Like probably nearly all companies that present to you today, the focus of our activity on this area has intensified over the last few years, and it will increasingly frame our investment decisions because I think it will increasingly frame the pricing of real estate assets. The fact of the matter is, if you don't embrace this evolution, you're going to find that you're holding some assets that look like melting ice cubes. The liquidity for some of these poorer buildings will fall and price will take the pain. This is something that has had a huge amount of attention and focus from us at all levels throughout the organization over the last three or four years. We're not where we want to be, but we're a long way from where we were. Our focus is to continue to build the portfolio around assets that have the EPC ratings A, B, and C, preferably A and B, but A, B, and C. And looking at new investments, I'm happy to buy investments that don't meet those criteria but knowing that through our skills and through our capital I'm capable of reinventing those buildings so that I can bring them back into economic use. That's something that we pride ourselves in, it's something that we have a great skill set in doing, but we also have the capital to do it. The easiest thing in the world for me is to sell assets that aren't A, B, and C and pass the problem down the line to somebody else. We are great stewards of those kinds of buildings because we have the skill set, we have the experience, and we have the capital in order to bring a lot of these maybe redundant, inefficient buildings back into true economic use. That will continue to frame how we think about existing assets, what we want to do with them, but also have a framework for what assets we want to deploy new capital into.

So just a quick look back on our performance over the last few years from our portfolio and also from a shareholder perspective. We continue to grow our net rental income. It's very important to us. We think, as I said before, income is an important contribution to our total property return. It's what's driven our earnings per share. Back at the time of our merger, I think EPS was 4.2p. You can see there on the slide now we're up at over 9p. Repositioning the portfolio, pivoting the assets into the right sectors has allowed us to capture some fantastic earnings growth. Not surprisingly, that's delivered strong property returns because we've been in the right sectors and we've got the right skill set to maximize returns from those assets. That in turn has allowed us to deliver some strong total shareholder returns. That's a combination of not only share price appreciation but also the importance of the weight that we put behind a growing and covered dividend and the reinvestment of that, the compounding impact of it is there for you to see on the bar chart on the right hand side.

So finally on my last slide, I'll look forward, our thoughts on the industry and how we're going to approach the capital that we have invested within LondonMetric. We often refer to this slide as the 4 Ds. Digital disruption: we think that the macro themes will continue to play out, and aligning your real estate portfolio to those macro themes is likely to ensure that you're on the right side of the curve. Hoping, as some management teams no doubt do, that we go back to where we were in 2019 is not a strategy. The fact of the matter is the world has changed, the tectonic plates have shifted. Online retailing has accelerated to over 30%, and whilst that 30% will probably drop back a bit as we get back to full reopening hopefully in the autumn or winter, it's not going back to the 19% it was back in February 2020. A lot of temporary behaviors have become permanent, and that goes for lots of aspects of our working and social lives. The second D is demographics. I touched on a demographic tsunami. People are going to be living longer, there's going to be an almost desperate search for income. I think we are actually seeing this even today. Since the start of the calendar year, the number of investors coming into the sector looking for maybe shying away from low yielding securities and looking at alternatives, which obviously real estate is often described as, for that yield, for that security, is leading to some yield compression certainly within our own long income portfolio. Literally not a day or two days go by without somebody making an approach on one of our long income assets at significant increases in value to what we currently hold them at. That is being driven by the fact that there is this almost desperate search for yield. Our third D is discipline. As co-founders, co-owners of this business, we are aligned with our shareholders perfectly, and that will continue to impact our decision making. We pride ourselves on our process, our rationality, and the discipline of how we make decisions and how we allocate capital because, as I said, we are shareholders first, employees second. Today, urban logistics is our strongest conviction call because of the returns, the rental growth, the demand-supply dynamics that come with it. Long income in the right structurally supportive sectors is our second conviction call, and that is where the focus of our capital going forward is going to be. That will lead to further sales of non-core assets or assets that we think are not capable of meeting that criteria. And then the fourth D is dividend. We are continuing to generate a reliable, repetitive, and growing income stream across our portfolio, and that is what supports our EPS growth, which in turn supports our DPS growth. The fact of the matter is we collect the rent and we want to pass it through to our shareholders just as quickly as possible after taking out the various expenses. A long-term focus on dividend and dividend growth is what allows us to aim for a covered and progressive dividend. It's a simple message, but it's something that we take very, very seriously, certainly more seriously than a lot of our competitors. It's amazing how many of our peers, at the first sign of disruption in COVID back in March last year, were very quick to cut their dividends, suspend their dividends. It's no surprise that when they returned, they came back at different levels to where they were before they went into the COVID crisis. That didn't apply to us. Our dividend progression has continued unabated. On the 25th of August we issued an announcement showing that our first quarterly dividend that will be paid in October will be 2.2p a quarter, which is nearly a 5% progression on where it was this time last year. The fact of the matter is we do believe that that reliable, repetitive, and growing income, if you can do that over a long period of time, the compounding impact of that is the bedrock for attractive returns that we hope to deliver to shareholders. So on that note, that's all from me. I'd like to thank you for your time and your interest in the company and also in the sector, and I wish you a good day. Thank you very much for listening. Take care.