Chief Executive, Great Portland Estates
Interview with Toby Courtauld and Nick Sanderson
Results & outperformance ...
About Toby Courtauld
In a June 2014 interview, Toby Courtauld, Chief Executive of Great Portland Estates, stated that the business had performed "very well" over the previous year, with the portfolio valuation up nearly 19% and net asset value (NAV) up almost 28%. He attributed this to exceptional results in the development business, which rose 31%, and rental growth of 8.2%, which he said outpaced the market average of around 6%. Courtauld claimed the company beat all of its main comparative benchmarks for the year. Courtauld also discussed the company's strategy, noting that with yields at relatively low levels, the firm aimed for high operational gearing and low financial gearing. He highlighted that loan-to-value was around 25%, interest cover was above four times, and the weighted average interest rate was 3.5%. He expressed confidence in future performance, citing low average rents in core London office and retail locations, and predicted continued rental growth, particularly in retail on streets like Oxford Street and Bond Street, where he said demand was high and new supply limited.
Transcript (43 segments)
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Interviewer0:04
How would you characterize these results and what's driven growth in the year?
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Toby Courtauld0:08
Well I think these are very strong results. So you have seen the growth being driven by a valuation increase of eight percent over the year and within that a very strong performance from our development portfolio up 20.1 percent and crucially again we have delivered performance ahead of the IPD central London index which is our main comparator. So if you were to look at the West End for example, we have delivered a capital return of almost 11 versus the IPD capital return of the West End portfolio of 6.7, so big outperformance driven as I say largely by strong developments. Why have they gone up so much? Lettings. We have been very strong in our lettings during the year and crucially pre-lettings beating the rents that we underwrote these developments at and doing it faster. We've also seen rental value growth during the year up 4.9 percent against the IPD market in central London of 3.9, so again we've been able to run faster than the market and those are the main reasons.
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Interviewer1:03
And Nick, a pretty solid set of financials there. What numbers stand out for you?
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Nick1:09
I'd say the results are better than the solo, I think they're very strong. I mean looking at our key metric NAV per share, that's up just under 11.4% growth in the final quarter and now more than double over the course of the last four years. Rent roll is up more than 30 percent, earnings just under 30, so looking at our key financial metrics we're coming in ahead of where market expectations are. Add to that development profits of more than 50 percent, 14 million of pre-lettings and a balance sheet in strong shape with LTV of sub 33, I'd say these numbers show the business is in very good shape.
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Interviewer1:43
Very good shape. And Toby, what trends are you seeing in terms of retail and office space within the London commercial property market?
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Toby Courtauld1:48
Well if you go back to the growth in ERVs, that rise tells you that there is demand for office space and the fact that we had another very strong leasing year also tells us that we're seeing good demand for our space. And the announcement we put out on Monday is the latest piece of evidence that supports that with, I think, the largest letting we've ever done, roughly 142,000 square feet, annual rent of 8.3 million per annum to the law firm Bird and Bird, is just another piece of evidence of the fact that there is demand out there for good quality space. At the same time, the supply of space coming through from the market from the development community is not particularly worrying. In fact I think if you look over the next three to four years, we can see rents continuing to rise because the supply side is not delivering too much by way of new space, so the outlook for the rental story is we think pretty strong as it stands.
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Interviewer2:42
And tell me about the retail story.
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Toby Courtauld2:44
Well the retail story is very similar. Remember our portfolio is principally Oxford Street, Regent Street and Bond Street in retail, and in those three streets we have extremely strong demand again largely from overseas retailers looking for a presence in the West End market. And we again have seen rents rising up seven odd percent for us in our West End retail portfolio, roughly in line with the market, a little bit ahead but roughly in line with the market, but strongly driven by this excess of demand over supply.
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Interviewer3:11
And Nick, from your perspective where do you see rental values going from here?
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Nick3:16
Well I think the key point is we've seen just under five percent growth this year and across the board we've been consistently letting ahead of those levels. I think as Toby says, the demand side is improving and at the same time the supply side is very tight, vacancy rates continue to be at historic lows, there seems to be no opening up of speculative development financing available to the level of supply, we expect to continue to be constrained, so we think the outlook from here is positive. I think an important thing to remember there is our average office rent is around 38 pounds a square foot, there's already around 12 percent reversionary potential within the portfolio, so either way there's a lot for us to play for.
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Interviewer3:51
Toby, you seem to be able to read the property cycle better than most. Where would you say it is at present?
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Toby Courtauld3:58
Well the property cycle for any property company is the key issue to get right. We saw it in 2009 with the companies that had too much development risk and too much leverage when markets went south, which we were able to use to our advantage and actually as an aside, 53% of GPE's assets have been bought since 2009, so we really went into the market in a big way to create the opportunities that we are now executing. So where do we sit today in the cycle overall? Well I think the rental story is as we have been describing, I think there is a good period of growth to come largely because of the fact that the economy in the UK is still picking itself out of recession and as that growth comes through and I think most people are beginning to believe more strongly than they were say this time last year that growth is around the corner, as that growth comes through combined with a limited amount of supply, you should see rents rising particularly in core markets like Central London.
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Interviewer5:00
How for how many years can we expect rental rises?
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Toby Courtauld5:02
I think that's a very difficult question to answer. We spend a lot of time thinking about where we are on the cycle and if I knew the exact answer I certainly wouldn't tell you now because we'd want to execute sales ahead of the peak of the next cycle. Rest assured though, we will do what we did last time which is make sales ahead of the peak, reduce gearing ahead of the next peak and reduce development risk ahead of the next peak so that we can take advantage of the next downturn as we did in 2009.
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Interviewer5:31
And given such strong results, couldn't you have done more on the dividend? What can you say about your dividend cover?
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Toby Courtauld5:35
Well I mean we are unashamedly a total return stock but as you'll have seen we've continued to grow the dividend up 2.4 percent this year and the key phrase is always to be consistent and maintain our consistent but progressive dividend policy. I think one of the things that the market is aware of and we're absolutely aware of is we're going through a short period where the dividend is not fully covered. That is absolutely in line with our intentions and absolutely in line with what we experienced in the last development cycle where we took rental income off the table to be able to replace it with higher and better quality income which will drive both rental growth going forward but more importantly will drive total returns. So as we sit here now, we expect to be back to full dividend cover within the next 12 to 24 months.
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Interviewer6:27
Can you talk a little bit more about your development portfolio and the performance in the year?
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Nick6:30
Sure. So we have five schemes on site and those five schemes are already 63% pre-let and I think that pre-letting process was one of the main reasons for the strong performance in the valuation of those assets over the year. And most recently we saw with the Federal Lane announcement this week the strength and quality of those opportunities and the fact that we were able to persuade a major law firm to sign up for 20 years. The other principal schemes in the committed program are the Wigmore Street projects where we have one floor still to let that is now under offer and on the remaining floors that we have already pre-leased we've been beating market rents there and beating ERVs, so that has again shown the quality of the space shining through. We have a scheme on the South Bank which is a 20-story tower, we've let half of that already and the remainder will be in the market come the summer and we have good interest there and high hopes for the profits coming out of that scheme. And then in the city we have City Tower where we are due to finish our major refurbishment scheme again in the summer and again we have good levels of interest. And I think the theme that we can draw from the program at the moment is the quality and level of interest we have is very encouraging.
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Interviewer7:47
Nick, how much of the development profit were you able to crystallize in the year?
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Nick7:49
So far this cycle we've delivered five schemes delivering an average profit on cost of 55%. This year we completed two schemes both fully pre-let both in the West End, delivering a profit on cost of 51% or in real money terms 79 million pounds. To date we're actually holders of those assets and part of the reason is these are great properties in great locations led to strong tenant covenants on long leases but we still think there is more rental value growth to come. So as a consequence we think these assets will continue to perform and out deliver our cost of capital, so for the time being we're happy holders.
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Interviewer8:24
Toby, has the planning on Rathbone Place panned out?
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Toby Courtauld8:26
So we submitted our planning application for 414,000 square feet which was some 10 odd percent higher than the numbers that had been assumed at the point that we acquired the site and 10 odd percent higher than the Royal Mail planning application which we subsequently withdrew. It's a terrific location right opposite Crossrail on the northern side of Oxford Street in the really interesting end of Oxford Street at the eastern side where there's a lot of regeneration already happening but will be happening over the next 10 years as well with the new tube station and Crossrail. And 414,000 square feet divides into a mix of office and some residential and some retail around a new public open square. So we're essentially creating a new place and that new place will I think be very exciting when it's completed. It will take a while to build so we're aiming to be on site during next year and finishing towards the end of 2015 early 2016.
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Interviewer9:26
Now when you look at your development pipeline and the number of uncommitted projects, does that tell us something about your risk appetite at present? What's the game plan from here?
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Toby Courtauld9:35
Good question. I think one of the key issues for any development company, any property company, is to make sure that you always have a pipeline of opportunity that stretches well into the middle distance so that you can pick and choose from those projects depending upon how the planning and the design process plays out and how market conditions unfold because clearly you don't want to have too much development risk at any one time particularly if you have a 2009 event all over again. So in our case we've spent the last five years or so building up this future pipeline with a really nice staggering of opportunity all the way through to 2022, some of which we will choose to do in the next two years and some of which we are working on for 2021, 2022 at the back end where we believe the timing might be right and where leases allow us to get access to those buildings. But I think at two and a half million square feet today being the total program covering something like 55% of the existing asset base, I don't think it's ever been stronger. The pipeline we have is as good as it's ever been today.
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Interviewer10:36
And Nick, just how strong is the balance sheet at present and how much financial firepower would you say you have to fund future developments?
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Nick10:42
Well I think the balance sheet is in great shape. We're continuing to run low leverage so LTV is sub 33, interest cover is 2.4 times, we have no near-term debt maturities, our next maturity is not until late 2015. We've continued to diversify our sources of debt funding so more than 60% of our debt at the moment comes from the non-bank market and at the same time we've kept our interest rate very low so our weighted average interest rate of 3.7% continues to be one of the very lowest in the sector. We also have good liquidity so we look ahead to delivering our development program. Our committed capex to come is around 103 million, compare that to 282 million of cash and undrawn credit facilities, we're in great shape to deliver that. Then one starts to think about our near-term program with our great access to debt funding and our track record of capital recycling, I think we're very well positioned to deliver the higher returns we expect to achieve from our development program.
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Toby Courtauld11:41
And one of the reasons the market at the moment is so interesting for companies like us who can access the debt markets that Nick describes is that the vast majority of the players are unable to get access to that sort of quality low-cost debt which means the supply pipeline in London will remain we think quite tight. So if you look at the next three to four years of supply, the merchant developer is still unable to get access to that sort of credit which means that players such as us have the field not quite to ourselves but certainly with less competition. I think that's a real USP of businesses like ours at the moment.
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Interviewer12:21
You've been pretty active on the acquisition front. How much of the capital has been deployed from your equity raising from last November?
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Toby Courtauld12:28
That's right. We raised 137 million net from the shareholders last November because we saw a spike in the number of opportunities available for us to buy at good accretive total returns to our existing business. So we went into the market since which we have invested something around 80 odd percent, slightly more than 80% of that capital, so it's largely all already invested. The balance I think will go into acquisitions over the next six or so months as we find them and I'm sure we will because in fact if you look at our track record of acquisitions in the last four years, it's been extremely successful. The unlevered internal rate of return of all of those deals done since the 2009 rights issue is something in the mid-teens percent unlevered which is very strong and I expect us to carry on finding opportunities to buy.
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Interviewer13:17
And Nick, have you been happy with the yields that you've made on these acquisitions?
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Nick13:20
I mean there are 10 purchases this year, all of them delivering attractive day one accretive running yields. And in fact looking at the purchases since the placing, they've been averaging about a five and a half percent net initial yield which is almost double the yield that we've been selling properties on through the course of the year. But actually much more important to us is the total return that these investments will deliver. So some of the metrics we think about are: are we buying at a good entry price? And yes we are. We've been buying at a typical 30% discount to replacement cost. The kind of real estate we've been buying has been on low rents averaging around 34 pounds a square foot. And most important of all, everything that we've been buying has got an opportunity for us to improve the assets going forward, so we can improve the rental income, we can drive values further ahead. So on that metric, very happy with the purchases that we've been undertaking.
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Interviewer14:08
And Toby, looking at one of your most recent acquisitions that is Old Street, that's in the tech belt. Does that mean a slight shift away from the focus from the City in the West End?
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Toby Courtauld14:17
No, in fact we've been in that neck of the woods before. Before my time but we have owned assets in and around the Old Street roundabout before. What we liked about that acquisition was all of the traditional characteristics we look for were present: low cost per square foot, capital value in this case around about 307 pounds a foot, an inefficient existing building which we were able to buy for a price which when you look at its efficiency looks very attractive, something around 200 pounds per square foot if you price it appropriately. Rent low 22 pounds a foot, the tenant has a break clause in 2015 and if they exercise it you get access to the building to be able to improve it, and in an area where tenant demand is not only strong but growing for the reasons you highlight. In other words the TMT industry is collecting around that part of the world partly through government incentive packages and partly because that's where they've often been. So it has a lot of the characteristics we like: we can improve the building, the pricing is good beneath replacement cost, the running yield was attractive and it wasn't in the market.
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Interviewer15:18
And given that you've deployed most of the equity capital, what next? Are you looking to raise further equity capital?
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Toby Courtauld15:29
Well I think by anybody's measure the equity placing that we did in November went very very well. We had very strong support from our shareholders, we were able to effectively cover the books within five minutes of the London market opening and we priced the trade at above NAV per share. But as I mentioned, the most important thing is that we've actually been able to deploy that capital accretively into the market into what we think are very attractive opportunities. But I think as I mentioned earlier, our balance sheet is in very strong position at the moment, we have good liquidity to deliver on our existing business plans. However, as we look forward, if we see opportunities beyond our current resources that we think will deliver returns that will accrete to shareholder value, we will absolutely consider it again. But at the moment it's not something that we're actively pursuing.
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Interviewer16:19
Toby, as you said your letting activity has been particularly strong this year. Has that surprised you?
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Toby Courtauld16:24
Yes and no. I think the surprising bit has been the rates we have been able to achieve because they have been ahead of the underwriting numbers that we assumed. The bit that hasn't surprised me is the fact that we've let the space we have and that hasn't surprised me because the buildings are as good as they are, they are located in as good a locations as they are, so we always knew they would lease and we designed them to come into the market at a point when we felt there was going to be a shortage of supply. So as long as there was an element of demand, we felt pretty confident that we would attract tenants into these buildings. So as I say, yes and no. Better rents slightly ahead of expectations, the fact that we've let them very strongly I'm not that surprised by. And by the way, we still have more to go, so this is not a question of that was yesterday's story, we've done it, we've still got more leasing to go. The team is very focused on getting that leasing done and I fully expect it to continue beating in-place estimates.
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Interviewer17:22
And in numbers terms, what are you seeing in terms of lettings and void points?
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Nick17:26
Yeah, very strong leasing numbers again. We've delivered more than 13 million new rents through the course of the year and averaged around 8% ahead of the ERV. And actually we've had a very strong start to the new financial year, actually more than 11 million of new lettings in the last couple of months including 14 million of pre-lettings in the last six months alone. Our void rate remains very low, it's actually fallen through the course of the year down to around 2% today. And our tenant seems to be in very good shape, we're collecting more than 99% of rent within seven days of the quarter end, our level of delinquencies are absolutely de minimis. So our performance on the asset management side has been very strong.
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Interviewer18:06
Toby, you say there's more to come. How much more growth do you think you can get from your asset management and leasing activities?
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Toby Courtauld18:11
A lot. I mean this is a business which is 12% reversionary and that's on rents that were marked to market in March. We think the rents from March have a good progression to come, so we think there is growth from those levels. So the story of growth for GPE is all about really three things: firstly delivering those developments, getting those developments finished and let; secondly accessing that reversion through simply bringing those rent reviews in and collecting that excess cash; and thirdly market rental growth. So we will, as we have described, see those rents rising and over time that will feed through into our cash flows and into our valuations as we're able to position our buildings for higher rents over the next few years. So I think there's a lot to go for.
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Interviewer19:03
And finally, what's the outlook?
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Toby Courtauld19:05
The market is very supportive for what we're doing, particularly in the West End where 81% of the business sits. And that's supportive because there is more tenant demand than I think there will be space available at the top end of the market, so the better quality buildings. So the market is supportive. The story of GPE is all about the delivery of these development projects which we are already seeing are delivering significant surpluses. We will find new opportunities to buy into the market to create further value, equally we will continue recycling assets where we have created value and crystallizing cash back in so that we can redeploy into new opportunities. And that traditional business model that we have been pursuing in the last four years since 2009 has been very successful and I expect us to be able to carry on delivering good growth using that same model.