Centuria Office REIT (COF) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Centuria Office REIT FY '26 Results Call. [Operator Instructions] I would now like to hand the conference over to Mr. Grant Nichols, Head of Listed Funds for Centuria Capital. Please go ahead.

Good morning. Thank you for joining Centuria Office REIT's Full Year 2026 Results Presentation. My name is Grant Nichols, Head of Listed Funds for Centuria Capital. Presenting with me today is Belinda Cheung, Centuria Office REIT Fund Manager; and Cameron Mullen, COF Deputy Fund Manager. Starting on Slide 3. I would like to commence today's presentation with an acknowledgment of country. We are joining you from the lands of the Gadigal people of the Eora Nation. Centuria manages property throughout Australia and New Zealand and pays its respects to the traditional owners in each country, to their unique culture and to their elders past and present. The past year has demonstrated improved momentum across Australia's office markets with increased leasing activity, positive rental growth and signs of asset value stabilization. This is occurring amid constrained future supply and the ongoing repurposing of office spaces for alternate use, particularly in metropolitan markets. As a result, there is a positive outlook for stronger occupancy and rental growth in the markets COF is exposed to. COF's FY '26 performance reflects this positive momentum. And in today's presentation, Belinda and Cameron will cover an overview of COF's performance, COF's financial results, operational performance, and conclude with a market overview and guidance. Moving to Slide 4. Centuria Office REIT is managed by Centuria Capital Group, which has over $22 billion of assets under management. COF unitholders continue to benefit from Centuria's deep real estate expertise, including a fully integrated property, facilities and asset management platform, synergies across the group's broader office real estate portfolio, and strong alignment as Centuria and COF's largest unitholder and the manager's interests are strongly aligned with yours as unitholders. Turning to Slide 6. COF's vision and strategy remains unchanged. We aspire to be Australia's leading pure-play office REIT. We are focused on generating sustainable and quality income streams and executing initiatives to create value across our portfolio of high-quality office assets that offer leading sustainability, amenity and connectivity. The results the team presents today reflect the execution of this strategy, supported by the deep real estate capability of the broader Centuria team. I will now pass over to Belinda.

Thank you, Grant, and good morning, everyone. Let me begin on Slide 7. FY '26 was an important year for COF. While office markets continue to recover at different speeds across the country, we believe many of the foundations for future growth are now firmly in place. Throughout the year, our focus remains on 3 priorities: preserving income through leasing, strengthening the balance sheet, and positioning the portfolio to benefit from improving market conditions. I'm pleased to report the successful execution and outcomes across these priorities. During FY '26, COF delivered funds from operations, or FFO, of $11.02 per unit and distributions of $10.01 per unit, both in line with guidance. COF completed almost 40,000 square meters of leasing, representing 14.5% of portfolio NLA, one of the strongest leasing years in its history. This activity addressed a significant portion of expiries, preserved portfolio occupancy, and captured positive rental reversion across a number of assets. From a capital management perspective, we refinanced $1 billion of debt, reduced margins, extended debt expiry, and completed the sale of 9 Help Street at a 12.5% premium to book value using the proceeds to repay debt. These initiatives improved financial flexibility while supporting portfolio quality and reduced gearing. COF reported stabilizing valuations, which have been underpinned by sustained rental growth across the portfolio and improving leasing conditions in a number of our markets. These outcomes provide encouraging evidence that office market fundamentals are improving and that COF is well-positioned for FY '27. Turning to the guidance on Slide 8. For FY '27, we provide FFO guidance of 11.3 per unit and distribution guidance of 0.09 per unit. The FY '27 distribution represents an 80% payout ratio. We believe this is an appropriate setting in the current environment, retaining additional flexibility to support leasing initiatives, manage capital prudently, and position the REIT for future growth. This outlook reflects several factors. First, the disposal of 9 Health Street. We believe this transaction was the right capital management outcome given the premium achieved and the strategic benefits delivered to the portfolio. Secondly, guidance incorporates conservative assumptions for existing vacancy and lease expiries. Improving leasing conditions are supporting activity across the portfolio, although tenant decision-making and lease commencement timing still remain key variables. We continue to make good progress on a number of negotiations across the portfolio. And finally, we expect the positive rental growth achieved across recent leasing activity to support the income growth over FY '27. So Slide 9. Throughout FY '26, we have seen increasing evidence that conditions across many Australian office markets are improving. A key driver of this improvement is the supply outlook. Future office supply remains heavily constrained by elevated construction costs and development feasibility challenges. In all domestic markets, economic rents sit materially above market rents. And importantly, the gap continues to widen, and this is expected to constrain future supply for the foreseeable future. We expect this gap in rents to be a key catalyst for future rental growth. At the same time, demand is increasingly focused on high-quality existing office stock that offers strong amenity, sustainability credentials, and transport accessibility. The COF portfolio provides all this but at a significantly lower cost compared to an equivalent new development. As tenants seek quality space without paying new construction premiums, we expect existing assets like those within the COF portfolio to be increasingly attractive. I will now hand over to Cameron to take you through the financial results and portfolio overview.

Thank you, Bel. Moving to our financial results on Slide 11. COF delivered funds from operations of $66.9 million or 11.2 per unit. Net property income decreased primarily due to asset divestments executed during the year and higher portfolio vacancy. Finance costs increased by $2.5 million to $48.7 million over the first -- over the full year. The average all-in cost of debt incurred for FY '26 was 5.2%. COF declared and paid distributions of 10.01 per unit across the period in quarterly installments, representing a payout ratio of 90.1%. Slide 12 details COF's capital management. As Belinda mentioned, during the period, COF completed a $1 billion loan refinance with existing lenders, resulting in beneficial outcomes such as extended debt duration to 4.3 years and a reduction in margins by circa 30 basis points. COF maintains sufficient liquidity and debt covenant headroom with no debt expiring until FY '29. At June 30, 2026, COF remained 76% hedged, providing a defensive position to rising REITs and support earnings stability from further REIT-driven volatility. COF settled the divestment of 9 Help Street Chatswood in June for a gross price of $90 million. The net proceeds of the transaction were used to repay debt, reducing gearing to 43.7%. The interest cover ratio for 30 June 2026 was 2x and the loan-to-value ratio was 44.8%, providing comfortable headroom to our covenant requirements of 1.75x and 60%. Turning to COF's portfolio on Slide 14. COF's portfolio comprises young quality assets positioned in Australian metropolitan and near city office markets. COF's portfolio of 18 assets is truly diversified with no single state exposure greater than 26% Importantly, the portfolio is underpinned by the quality tenants boasting over 74% of the portfolio income derived from government, multi-national corporations, and listed entities. The quality of our tenant base demonstrates the portfolio's appeal with 65% of tenants being large corporates, occupying tenancies greater than 2,000 square meters. Moving to Slide 15. Leasing was a key highlight for FY '26 with almost 40,000 square meters leased across 47 transactions, representing 14.5% of the portfolio. We secured over 17,000 square meters of new leasing and approximately 23,000 square meters of renewals, contributing to positive portfolio re-leasing spreads of 5%. Notable outcomes included extending a major government tenant at 8 Central Avenue for a further 5 years, over more than 7,700 square meters, and securing a new 7-year commitment from Apparent Communications in the same property. Executing 2 full leases at 203 Pacific Highway to drive.com.au and NEXTDC, taking that asset to 100% occupancy. In Queensland, we completed 5 new leases and 1 renewal at 825 Ann Street, achieving average re-leasing spreads of 18%. These results demonstrate the continued appeal of our assets to both corporate and government occupiers and the benefits of our active asset management approach. Turning to our lease expiry profile on Slide 16. COF remains well-positioned with only 4.7% of portfolio income expiring in FY '27, providing strong medium-term income visibility. Importantly, these expiries are currently around 6% under-rented relative to market, creating an opportunity to capture positive rental reversion as leasing occurs. Achieving high portfolio occupancy remains a key management focus, supported by a well-staggered lease expiry profile and improving leasing conditions across our markets, we are actively pursuing opportunities to further enhance portfolio occupancy and extend income visibility through proactive tenant engagement, targeted leasing initiatives and asset strategies tailored to local market conditions. I will now hand back to Bel to take you through the valuation summary for the period.

Thank you, Cam. Now turning to valuation outcomes on Slide 17. It is encouraging to note FY '26 was the second consecutive year of positive valuation movements and provides evidence of continued stabilization. At $1.8 billion, the portfolio has an average valuation of about $6,900 per square meter. Again, valuations improved despite a further increase in capitalization rates. The portfolio weighted average cap rate expanded to 7.04% during the year. However, this expansion was more than offset by underlying rental growth. Valuers adopted average market rental growth of 4.4% across the portfolio, reflecting improving fundamentals and increasing rental tension across a number of our markets. The positive leasing outcomes delivered during FY '26 translated into valuation gains across a number of assets, particularly at 8 Central Avenue, 100 Brookes Street, and 825 Ann Street. Taken together, these results provide us with further confidence that rental growth is beginning to offset valuation pressure from capital markets and is contributing to a more stable outlook for the portfolio. Turning to Slide 18. Despite the portfolio's improving fundamentals, we believe COF continues to trade at a significant discount to underlying asset values. At $15,500 per square meter, the estimated replacement cost of a modern metropolitan office building is 2x the current value of COF's portfolio and almost 3x the implied valuation based on the current trading price. This disconnect is also reflected in capitalization rates. There is a 230 basis point spread between COF's weighted average cap rate and the implied cap rate of approximately 9.4%. These are difficult to reconcile with the improving leasing conditions, rent growth, and stabilizing valuations we have reported today. We believe this disconnect presents a compelling value proposition within the COF portfolio for long-term investors. Moving to Slide 19. The sale of 9 Help Street demonstrates COF's disciplined approach to capital management and portfolio optimization. The asset was sold at a 12.5% premium to book value and delivered a 12.3% IRR over our ownership period. Beyond reducing gearing and providing direct to market evidence, this transaction is one of a number of strategic divestments we have executed over time that have resulted in improved portfolio quality. While divestments can address gearing, it can also impact earnings. This has been one of the factors contributing to COF's FFO history. As a result, we remain disciplined in assessing opportunities to transact where pricing, portfolio outcomes, and capital management objectives are appropriately aligned. Now turning to sustainability on Slide 20. Sustainability outcomes are increasingly supporting leasing outcomes. We continue to see corporate and government occupiers place greater emphasis on electrified energy-efficient buildings that align with their own decarbonization pathways. We are on track towards COF's target of Zero Scope 2 emissions by 2028, supported by 1.6 megawatts of solar installed across our assets. More than half of the portfolio is now electrified. And pleasingly, much of the progress achieved to date has come from relatively low-cost initiatives. COF's strong sustainability credentials, including a 5.1-star NABERS SPI rating. Tenant engagement and community partnerships continue to deliver positive outcomes for key stakeholders, not only improving environmental performance, but also enhancing the quality, resilience. and long-term appeal of the portfolio. We maintain a positive outlook for Australian office markets for the reasons detailed on Slide 22. Australia continues to benefit from strong population growth, expanding white-collar employment, and a comparatively resilient economic trajectory, providing supportive backdrop for long-term office demand. At the same time, future office supply remains highly constrained. Inflated construction costs and a tight labor market has severely impacted feasible developments in metropolitan markets, giving way to continued rental growth for prime assets. Obsolescence-led office withdrawals are expected to further accelerate this trend. We also believe AI will reinforce demand for quality office space. While AI may disrupt some roles, history shows productivity gains ultimately support economic growth, business formation, and higher-value work. As judgment, leadership, and collaboration become increasingly important, we expect demand to continue concentrating in well-located, sustainable, and amenity-rich buildings. Together, these trends are likely to further widen the bifurcation between high-quality and lower-quality office assets, positioning COF's portfolio well for the years ahead. COF's FY '26 priorities are outlined on Slide 23. Our focus remains simple: execute leasing transactions to promote sustainable earnings, maintain a high-quality portfolio, and preserve balance sheet flexibility so that COF is well-positioned to capture the opportunities emerging across domestic office markets. Closing on Slide 24. For FY '27, COF is providing FFO guidance of 11.03 per unit and distribution guidance of 0.09 per unit. While market conditions continue to improve, our focus remains on execution and generating sustainable income growth and long-term value for unitholders. Thank you for your continued interest in Centuria Office REIT. We look forward to updating you on our progress throughout FY '27. I will now hand back to the operator and welcome questions you may have.

[Operator Instructions] Your first question comes from Lauren Berry with Morgan Stanley.

I just wanted to start with the decision to set the dividend at 0.09 or 80% payout ratio. Looking at the last couple of years, you've been paying out well over 100%, and it looks like you're implied to pay out over 100% in FY '27 as well. Why not cut the dividend to 100% payout ratio or less to give you more flexibility on the incentive side? I'm just wondering why you want to keep it over 100% payout.

At 80%, we believe this strikes the right balance between the current income and the long-term value creation for the fund. We have previously mentioned that 80% is our long-term payout aspiration. And I think just given where this year has gone and how stable the portfolio is now, I think it is a very sustainable payout ratio to maintain.

So you're happy to pay out over AFFO going forward?

AFFO is something that we don't typically guide to and we haven't in the past. And one of the main reasons why is because things like CapEx and leasing incentives can be quite lumpy, and it really depends on when major deals will be done. For us, looking into FY '27, we don't actually see too much expiries. We've got 4.7% of expiries coming up in FY '27. So I think it's a relatively sustainable measure to use this year.

This year. But in FY '28, you've got a significant amount of expiry coming up. If you do see incentives increasing a lot into FY '28 because of the volume of expiry, could we expect the payout ratio to be cut further to account for that?

It's very difficult for us to provide distribution guidance to '28 at this point in time, given that we still have quite a while to go until then. So we will provide the market with more updates then. I think the way we're thinking about it is 80% is a through-cycle distribution payout ratio we think is sustainable.

Your next question comes from Andrew Dodds with Jefferies.

Just one for me. It looks like you've got 154 Melbourne Street in the accounts as held for sale. I'd just be interested to hear sort of how you're thinking about this potentially sort of factoring into guidance and I guess, some of the other building blocks into '27 guidance that you're happy to call out at this stage.

Well, it's listed as held for sale at the moment, but we have factored -- it's got very little impact on FY '27 outlook, Andrew. So at this point in time, I wouldn't put too much weight on that.

Right. And just any of the other sort of building blocks for '27 guidance that you can call out?

Yes, definitely. So on our FY '27 guidance slide, we would have pointed out that the key contributors to FY '27 guidance is due to the divestment of 9 Help Street in Chatswood. We also have like-for-like property income growth and also because of the refinancing that we did during the year and because of the sale of 9 Help Street, we've got slightly reduced debt costs that are contributing to a pretty stable outlook on FY '27 earnings.

Your next question comes from Cody Shield with UBS.

Just want to pick up on Dodds' question there, just on 154 Melbourne. Just trying to get my head around how that's not going to impact the '27 number. I mean you've got the benefit from the debt refi of about 30 basis points. Can you provide any color on the yield you're expecting on settlement for that asset?

Yes, Cody. So the impact that we're expecting is -- if we sell an asset, depending on when or during the year, that will have a bigger impact. If you sell earlier, it will potentially have a bigger impact on FFO. We're not expecting anything in the first half. At the same time, looking at the passing yield for the building and interest cost, it's almost offset. So I'd say that the impact on the overall earnings cost is very immaterial.

Okay. Is there anything else going on at the NTA line that we need to be aware of? Like, for example, property expense growth may be a little bit higher than you anticipated?

Nothing that's too far out of the ordinary. I think the key driver for the net income is we've got positive leasing spreads, coupled with all the other leases on foot has about 3.5% rent review put through it. So it's a combination of these things.

Okay, sure. Maybe just on divestment activity from here. I mean, how are you thinking about the potential of selling some other assets, I mean, maybe across Brisbane or Canberra, some of those assets with '27 expiry?

I mean we usually get the best outcome selling assets if we can sell an asset that's a little bit better leased. That's definitely an outcome that we'd like to achieve. I'm not opposed to doing divestments across the portfolio, and I think 9 Help Street is good evidence of that. Over the last few years, we have sold a number of assets. But obviously, we need to balance the outlook on earnings as well as gearing. We are prioritizing gearing, but I think we can extract a bit more value out of the existing portfolio before we execute any further sales. All I'm saying is we'll take a very measured approach. If we receive unsolicited offers that are worth considering, we'll definitely take it to the Board for consideration.

Your next question comes from Tom Bodor with Jarden.

Just picking up on one of the answers to Lauren's question around maintenance CapEx and incentives. You mentioned that they can be quite lumpy. But looking at the last 2 years, they've been almost identical at maintenance CapEx at 7.1 million, incentives between 10 million and 11 million. Where do you forecast these line items in '27 on the basis of the leasing you've got today?

Tom, I guess we don't provide any guidance around those 2 items because it highly depends on the timing and if leasing is done across the remaining expiries. But I'd say, over the last 2 years, we have done really high amounts of leasing, which has resulted in higher leasing-related CapEx. So if there is less leasing done in the next year, I also expect those numbers to be less.

So is that another way of saying you think it will be less than, say, 10 million next year?