Andrew Jones, LondonMetric | Property Conference 2018

I'm just going to give you a brief overview. As Colin said, I co-founded Metric in 2010. Before that, I was at British Land where I ran the retail business for four years, and before that, I was at a property company called Pillar, where we were the largest owner and operator of retail parks across the UK. So retail is very much in my DNA, although as you'll see from my presentation, we spent the last five years increasingly pivoting away from physical retail to take advantage of the massive channel shift we've seen in consumer shopping behaviors. Seventy percent of our portfolio today is now invested in the logistics sector, historically as Andy probably would have described as a relatively unsexy part of the real estate market.

So just give you a little bit of a background on us. As Colin said, London Metric was formed through the 2013 merger between Metric and London & Stanford. Our strategy since 2013 has increasingly been to take advantage of the technological and social change that is driving our sector. Distribution, long income, and convenience assets make up virtually our entire portfolio today. We've made two structural calls: the first phase into the logistics market, the second structural call, or macro call as we call it, has been prioritizing income and income growth ahead of just being focused on NAV. As the chief financial officer of Unibail-Rodamco, which recently merged with Westfield shopping centers, as famously once said, 'NAV is a lazy metric for lazy people.' We tend to subscribe to that. We think it's important, but we think real estate is all about income and income growth, and we'll come on to talk about that in a little bit more detail over the next few minutes.

We have also consciously rotated out of offices, London residential, and increasingly multi-let retail. We think there are an awful lot of bear traps out there, and whilst we do our best to avoid the majority of them, we are not completely immune. Multi-let retail today accounts for about seven percent of our portfolio, and I suspect if I was standing here in a few years' time, it will be materially lower than that. As you can see on the far right, there's a slide that looks at our total shareholder return over the period, which is all very interesting because if it was going the other direction, I wouldn't have put it in. But I think what's really quite interesting here is if you look at the 2018 number, forty-three percent of your total return over the previous five years has been delivered by the dividends that we've generated and the reinvestment of those. So this is all about income compounding. We subscribe to compounding being the eighth wonder of the world. If you understand it, you will learn it; if you don't, you will pay it. It is undoubtedly the most powerful force in the universe, according to Albert Einstein.

Very briefly, these are the three key pillars of our strategy. First, it is distribution, which reflects some of the things that have been touched on already. The fact that we think the UK consumer is increasingly diverting its channel shift online. As you can see, online sales over the last 12 months up 13%, physical store sales down 1%. I don't think that will come as a great surprise to you. We'll come on to talk about the logistics market. People want to talk about it as one sector, but we actually increasingly look at it three-dimensionally: mega, regional, and urban. I think it touched on the power of long income, the global search for yield in a very low growth and very low interest rate environment. I think real estate has an incredible place to play in this. The idea of being able to own a building that delivers reliable, repetitive, and hopefully growing income is a rarefied commodity, and that will increasingly be the case as the Western world faces this demographic tsunami. Today, 25% of the UK population is of old age dependent; that is due to increase over the next 20 years to 34%. There is going to be a desperate search for income across the globe, not just the Westernized world.

Convenience we'll come on to talk about. That is a play on how we're changing our shopping patterns. For somebody who's historically had joint ventures with Asda and Sainsbury's and numerous ones with Tesco, we think that the channel shift is also affecting how we buy food. As a result, we've increasingly looked at playing what we call the convenience sector, whether it's our little Marks & Spencer's Simply Food. We get very long leases let to very good people, often with some form of indexation compounding built into them. It's what we call our low-energy investments. As you can see, the market share that the discounters, the German discounters in particular, continue to take from our established grocery retailers who are getting disrupted, whether it's watching the video of Jack Ma or whether it's the way in which we are all buying our groceries today.

Looking at how we've pivoted the portfolio, this actually illustrates some of the things I think Andy touched on. Historically, if you look at the pie chart on your left, you would see we had a big exposure to the traditional sectors: retail parks and offices in particular. That would have made up, go back five years, probably eighty percent if not more of IPD. What we've done is we've pivoted increasingly into the logistics market. As I said, we look at it three-dimensionally: mega, regional, urban. With the convenience and long income making up the rest of our portfolio predominantly. As a result, that net rental income number there, we haven't gone from 58.5 million to 90 million. Actually, it would read 90 million. So you can see the pivot away from low-yielding London offices, low-yielding London residential, toward greater income focus has allowed us to increase our income by over 50%. We think that is entirely appropriate for the current investment horizon. We actually believe that income will dominate investment returns for the next decade.

Looking at our rental income, one of the things I think real estate has a terrific place to play, but the problem with it is a couple of things: leases get short, rental growth doesn't happen, and buildings get increasingly obsolete. I think those are things that can interrupt your returns, and that is certainly the case in some of the more traditional sectors of office and multi-let operational retail. One of the things we've consciously set out to do is to guarantee rental growth. 50% of our income today comes from some sort of built-in contractual rental uplift, whether it's a fixed uplift or whether it's an index rent review linked to inflation, whether it be RPI or CPI. There you can see 50% of our rent is subject to traditional open market rent reviews. I think that income growth is going to be a defining characteristic across the sector. If you look at the traditional property market today, outside of what I call the alternatives – self-storage, student, PRS, healthcare, and logistics – it's very difficult to see any organic rental growth across the market. Office, the complete suite of office markets, not just London but the whole of the UK, and I think the same is in retail. The channel shift together with the failure of a number of operators to right-size their portfolios, together with this thing we call the upward-only rent review clause, means we are in a situation where rents across all of retail are at elevated levels which are largely unsustainable.

I've studied the CVA documents from New Look, from Carpetright, Mothercare, and even Carluccio's, and I'm trying to find a correlation between prime or secondary or geographies. I've come to the conclusion that it's indiscriminate. I don't think prime is good and secondary is bad. I don't think experience is good and convenience is poor. I don't think it's about needs versus wants. For us, it just looks fairly indiscriminate. A large part of that is because the real estate sector has been quite happily enjoying the benefits of an upward-only rent review clause over the last 20-25 years, which doesn't account for two major shifts that have taken place over the last decade: one, the global financial crisis, and two, a massive channel shift to online sales.

The distribution portfolio across the UK, and this isn't specific to us, is very much a hub-and-spoke model. The hub being your mega distribution centers. There is a typical blueprint for retailing: you'd end up with probably two massive hubs, one just north of London and one up along the M1, probably in Yorkshire, Doncaster, or Wakefield. So that's your hub. What we're finding now increasingly is retailers needing to put in more spokes into that hub. Those spokes will be around the major urban populations in order to meet your rising delivery expectations. The UK consumer is world-class at internet shopping. If there's a World Cup on this, we would be the winners. As a result, our expectations continue to rise. When I said in our recent results presentation, what was yesterday's 'wow' is tomorrow's norm. Three years ago, a two- to three-day delivery slot would have been fantastic. Today, we're talking about we want it same afternoon. In order to do that, retailers are having to put, and 3PLs as well, more spokes into the hubs. The spokes are surrounding the major cities: Edinburgh, Manchester, Leeds, Liverpool, Bristol, and obviously London. Urban logistics has been a growth area. It's often referred to as last mile, and that will continue to grow. That upstart that arrived from Seattle a few years ago has increased our expectations. Amazon does an unbelievable job. They've created a brand in a very short period of time that we trust to deliver when they say. They've created a brand we're comfortable to pay for, but also they've created a sense of security that if we don't like what we've ordered, we can send it back. One of the things people tend to forget is that whilst online delivery is increasingly important, reverse logistics is a growing market, and that continues to drive volumes. I don't mind if you order ten and send back nine, for me it all requires more warehouse space, so you just keep pressing that button.

When you look across there at the bottom, I'm colorblind, I think it's the bottom shaded area. We show some of our expectations for rental growth across these sectors. We guide on mega rental growth of between one and three percent per annum, and that's triple net, it's clean. You compound it for the next five or ten years. In urban, where land is in shorter supply, where there are competing uses for that land, that is undoubtedly going to be more valuable than a shed that's probably let at five pounds a foot. Everything you can think about that you could put on that land that isn't a warehouse will be more valuable: car showroom, self-storage, student accommodation, retail parks, and obviously residential. So land is in short supply, consumer expectations are driving demand, and as a result, we anticipate net rental growth across this urban logistics sector at somewhere between two, three to six percent. I don't know if that ties in with what you read from the so-called experts in a second across the Cushman & Wakefield, but that's certainly our own experience. Regional sits between the two. The biggest player in the regional market is Amazon. They dominate that market. I think last year they would have accounted for nearly a quarter of the total take-up across the UK. It's a great sector, but it's not quite as competitive as we find in the urban logistics market.

Interestingly, what we have done is fused the relationships we've built up in retail over the last thirty years to give us some competitive advantage against some of the competitors we come up against. It's no coincidence that our major customers in mega distribution are retailers. It's no coincidence that in urban logistics we can continue to focus on trying to extend those relationships into their spoke strategy, with Dixons and Tesco in particular. But undoubtedly, urban will be dominated, as you can see at the bottom, by what we call the 3PL, the third-party logistics operators: DP D, FedEx, GXO, TNT, and of course DHL.

So, turning back to retail, people want to tell you that all retail is bad. It is not. There are pockets where we think we can deliver returns to our shareholders, predominantly dominated by income and the compounding of that. As you can see, long income for us is 12-plus years, let by and large to single tenants on 15-year leases, increasingly linked to some form of RPI. Our retail portfolio today is 100% occupied across all three silos. Our long income is held increasingly in joint ventures. USS, the largest occupational pension scheme in the UK, is attracted to this because they need income to pay their pension holders. That is the role that real estate can play if you choose the right sectors. Convenience and leisure increasingly dominated by the food operators, the disruptors in a different way: the Aldis, the Lidls, and the Simply Foods. Retail parks, it's a good market but it has been overrented for the last ten years, and as a result, our exposure to that sector will increasingly dwindle.

Investment activity, I don't intend to spend a lot of time on this, but it's fair to say, as I've said already this morning, increasing focus for us on urban logistics. That is a market where we think it's a very diverse sector and we think there are attractions for consolidation. We think controlled development has its place in a UK portfolio, but as a REIT with a high dividend payout, that has to be controlled and it will certainly never exceed ten percent of our portfolio. We continue to pivot out of operational retail. We will continue to look at selling assets where we believe the market's expectations of returns from those assets will be ahead of our own.

Before I wrap up, a couple of slides here: one on the occupier market, one on the investment market. The strap line here: we are no longer a nation of shopkeepers. Consumer habits and shopping habits continue to change, as I touched on and as Andy has already touched on. We think the way to play this is increasingly through the logistics platform. We think retail is highly challenged. We think there is a clear and present danger to current valuations of retail assets. Permanent and profound structural changes have taken place across the retail market, and that will continue. We think retailers have to adapt to survive. We think a number of them have left it too late, and as a result, CVA or administrations will be their only option. We believe that rents will by and large continue to fall, irrespective of the upward-only rent review clause. The reason that will happen: it will happen during a CVA, in administration, or indeed at lease expiry. For those of you who haven't had the pleasure of reading Simon Wolfson's review at the end of January on Next, I couldn't recommend it more highly. He talks about 19 lease renewals conducted through calendar year 18 where his average rents fell by 25%. We see that as our central case for large parts of the retail market.

Moving on to the investment market outlook, I think Andy's already touched upon the fact that volumes are going to be down, but it is a polarization. There is limited liquidity in some of the traditional sectors, particularly shopping centers. It is the rise of the alternatives: student, PRS, logistics, healthcare. We think the tectonic plates in retail will continue to shift, which makes monetizing some of those assets more challenging for some. Income will continue to take center stage. We think the compounding strategies of true REIT behaviors will outperform the hyperactive strategies of the REIT pretenders. Development and trading strategies we think will be outmaneuvered by the compounders. The demographic surge, the demographic tsunami that's taking place, will continue to prolong this trend. Liquidity continues to polarize. We think low-energy assets will continue to be in demand, particularly from occupational pension funds, provided that the lot sizes are palatable, and for that we read 30 million or below. The air gets a little bit thinner when you start to move above that. Increasingly for these investors, it's non-operational. They're not interested in running multi-let platforms, not interested in running service charges. They're looking effectively for a bond proxy: full checks a year, and if that rises with RPI, all the better.

So we finish with our output, we call it the killer Ds. We think there will be continuing digital disruption. We think the demographics will continue to drive real estate trends. We think distribution is a winner in this. For our shareholders, increasingly their returns will be driven by their dividend and the compounding of that dividend income, particularly for the next five to ten years. So on that note, I will wrap up and I suppose invite you to join us for some Q&A. Thank you very much.