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Edited Transcript of ARF.AX earnings conference call or presentation 11-Feb-21 10:30pm GMT

·48 min read

Half Year 2021 Arena REIT No 1 Earnings Call MELBOURNE Feb 12, 2021 (Thomson StreetEvents) -- Edited Transcript of Arena REIT No 1 earnings conference call or presentation Thursday, February 11, 2021 at 10:30:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Gareth Winter Arena REIT - Company Secretary, CFO & Director * Robert Andrew de Vos Arena REIT - CEO, MD & Director ================================================================================ Conference Call Participants ================================================================================ * Caleb Wheatley Macquarie Research - Analyst * Gareth James Morningstar Inc., Research Division - Strategist * James Druce CLSA Limited, Research Division - Research Analyst * Murray Connellan Moelis Australia Securities Pty Ltd, Research Division - Analyst * Nira Sonah Evans & Partners Pty. Ltd., Research Division - Associate Director of Real Assets * Simon Chan Morgan Stanley, Research Division - VP & Equity Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Thank you for standing by, and welcome to the Arena REIT's Half Year 2021 Results. (Operator Instructions) I'd now like to hand the conference over to Mr. Rob de Vos, Managing Director. Please go ahead. -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [2] -------------------------------------------------------------------------------- Thanks very much, Bernadette, and good morning, everyone. And a very warm welcome to Arena REIT's results presentation for the half year to December 2020. Our announcement, investor presentation and financial statements were released to the ASX earlier this morning. My name is Rob de Vos, Arena's Managing Director. Joining me on the call today is Gareth Winter, Arena's Chief Financial Officer. The format of today's presentation will include an overview of the highlights of the period and an update on our performance against strategy. Gareth will provide us some insight with Arena's financial results and capital management position. And I'll close the presentation with an update on portfolio operations and commentary on Arena's outlook. Of course, there will, as always, be an opportunity for questions at the end of the presentation. Moving into Page 3, our highlights. And I'm very pleased to report that in the 6-month period to 31 December, Arena has achieved positive portfolio investment and community outcomes, which has been aided by an improved operating environment and outlook for our tenant partners. Arena's highlights for the period include statutory profit of $61 million, with underlying cash-based net operating profit of $24.7 million, up 15% on half year '20. We've acquired 7 operating Early Learning Centre properties and completed 9 development projects, including 2 post balance date. Total capital deployed on origination and developments was $74 million. And coincidentally, $74 million is also the anticipated total cost in our replenished development pipeline, which now includes 13 Early Learning Centre projects. We've distributed $0.0735 and have increased our full year distribution guidance of $0.148 for financial year '21, reflecting an increase of 5.7% on the prior period. We've seen further valuation growth across the portfolio, contributing to an increase in NAV, which is up 5% in the 6-month period, and the portfolio WALE has increased to 14.7 years, the longest in the Australian-listed REIT market. Gearing has increased following capital deployment. It remains below 20%, providing balance sheet capacity to take advantage of new opportunities that are consistent with our strategy. We were also pleased to release our Inaugural Sustainability Report in the period, which describes how Arena's portfolio contributes to community access, inclusion and well-being and identifies areas for future focus where improvements can be made. So overall, pleasing headline operational and financial results in another active period for the business. Moving to the next slide. And underpinning those positive outcomes in the first half is Arena's consistent approach, strong industry relationships and high conviction on maintaining our discipline and executing on strategy. Operational highlights for the period under the team's key focus areas are 100% occupancy across the portfolio has been maintained. And despite external challenges during calendar year '20, this reporting period marks 5 consecutive years of 100% occupancy across the portfolio. It's achieving highlights for the quality of our portfolio, strong underlying fundamentals that support the social infrastructure sector and the proactive asset management programs undertaken by the Arena team. Average rental growth was 2.6% across the portfolio for the half. It is worth noting that this does not include the 25 financial year '20 market reviews and 11 financial year '21 first half market reviews. All with one of our larger tenants. We're very close to having those resolved and anticipate the results to be 6% to 6.5% average growth across these assets, which is consistent with results from higher periods. We've acquired 7 operating properties, 6 in Metropolitan Melbourne and 1 in Brisbane, each have been acquired on a preferred long-term triple net lease and an aggregate cost $40 million and provided the net initial yield on all costs, including transaction costs of 6.1% and an initial weighted average lease term of 27 years. We've successfully completed 9 Early Learning Centre developments with 4 existing tenant partners. These projects had a total investment cost of $46 million and a net initial yield on all costs, again, including transaction costs of 6.7%. We've also replenished our development pipeline with the acquisition of 5 new Early Learning Centre development sites, which are pre-committed to an existing tenant partner and 20-year triple net leases. During the period, we made good progress on our renewable energy program. It's focused on working with our tenant partners to install and promote the use of solar and reduce the energy intensity of our portfolio. We installed a further 26 systems over the last 6 months and now have 43 properties that are using solar power. We continue to work with our tenant partners on new opportunities to decrease carbon emissions. Our recent programs alone have reduced over 500 tonnes of carbon emissions annually. In relation to rent relief programs, all of our tenant partners remain compliant with the agreement struck in financial year '20. There's been 1 further rent relief branded for a single operator in Victoria that's totaled $18,000. At the end of January 2021, we had 100% of billed rent collected. As mentioned, our WALE has been extended out to 14.7 years, following new acquisition and development completions. We have sold 3 Early Learning Centres in the period relative to the balance of the portfolio, older and less efficient. Each were located in Queensland, and they were sold to total proceeds of $7.1 million and a premium of 15% to book value. We saw further valuation growth across the portfolio of $35.3 million for the half year, and the passing yield for the portfolio is now 6.13%, I think, compressed by 9 basis points. Moving on to a quick update on COVID impacts for the business on Slide 5. And whilst operating conditions have improved markedly for our tenant partners over the last 6 months, we remain vigilant in assessing the direct and indirect risks of the pandemic. To recap on Arena's 2 primary risks as a result of the pandemic. Firstly, the health and well-being of our team and our consultants and contractors, and as a result, our ability to provide business continuity. And second primary risk is our tenant's ability and willingness to pay rent in a challenging operating environment. In relation to the first risk, our team and our consultants and contractors have and continued to respond exceptionally well. Our business continuity programs, our business systems, stakeholder engagement and governance programs continue without hindrance. And importantly, we've maintained our strong team culture. In relation to the second primary risk, our tenant's ability and willingness to pay rent, pleasingly, the operating environment for our tenants has improved over the last 6 months. All of Arena's properties remained open and trading over the period, delivering essential community services, with no challenges in relation to rent collection, currently with 100% of contracted rent paid and no arrears. All repayments of deferred rent agreed in financial year '20 that are full and due have been paid, and progress on our development and origination programs has largely been unaffected to date. What has been consistent through the pandemic period is the efforts by the federal government to ensure that early learning services remain open and viable, not just for now, but for the important contribution it will make to an enduring economic recovery, allowing working families to get back into the workforce and providing opportunity for better financial security, particularly for women, and assisting economic activity over the medium to long term. We're acutely aware the pandemic is not over, but believe we are well positioned to manage any future challenges as and when they arise. Moving on to the next slide. And it's no doubt the COVID period has provided us an opportunity to reflect further on the importance of community and sustainability. We were pleased and it felt fitting to present our Inaugural Sustainability Report in the period. The report marks Arena's commitment to progress and disclose strategies to address sustainability challenges and opportunities. The main purpose of the sustainability report is to consolidate and communicate the plans, activities and initiatives that are already embedded in the way Arena is managed. The process has provided us an opportunity to assess and identify areas where performance can be improved, and these opportunities are reflected in the report, with a great opportunity to work collaboratively with our tenant partners to effect positive change and drive better financial and environmental outcomes. Renewable energy is an important, current part of this positive change. Through our energy -- renewable energy initiatives, we are delivering operating cost savings to our tenant partners and at the same time, improving environmental outcomes. We also have significant influence on the built form outcomes. We have a leading track record of working with our early learning tenant partners to create or renew efficient, flexible and well-located accommodation at sustainable rents and operating costs. This in turn provides the opportunity for our tenant partners to focus on their core purpose, to deliver essential services to Australian communities. We look forward to keeping you abreast of our progress on our sustainability programs in our Annual Sustainability Report. I'll now pass you over to Gareth to provide an update on the financial results. Thanks, Gareth. -------------------------------------------------------------------------------- Gareth Winter, Arena REIT - Company Secretary, CFO & Director [3] -------------------------------------------------------------------------------- Thanks, Rob, and good morning, everyone. Just on Page 8 presentation, you will find a summary of Arena's operating income statement for the half year, which shows a 15% increase in net operating profit of $24.7 million and a statutory profit of $61 million for the half. The reconciliation of the operating profit to statutory profit included in the appendix to the presentation with the most substantial reconciling item in the periodic revaluation of investment property. Operating EPS of $0.0726 is 1% higher than the comparative period and is in line with our expectations for the first half of FY '21. A couple of points to note around EPS growth. In FY '21, is that the relative growth in the first half was reduced due to a midyear cap raise of $90 million. Price is deployment of our capital on new investment. And EPS growth in the second half of FY '21 will be stronger due to the full period effect of capital deployed in FY '20 and FY '21, which is reflected in our full year distribution guidance. That pattern of first, second half growth is pretty normal for our business. The key driver of the increase in operating profit is the 7% increase in property income, which has been derived from a combination of rent reviews and capital deployment. Like-for-like rent reviews averaged 2.6% in the half, noting that this does not yet include the effect of the results FY '20 and FY '21 market rent reviews, which will be backdated to the review date when finalized. And as Rob mentioned, hopefully, that will be very soon. Arena's ongoing program of investment in ELC developments and new acquisitions contribute to income via our net capital deployment of $74 million in the first half, which included the completion of the 9 ELC developments and the acquisition of 7 operating ELCs in conjunction with tenant partners. This is net of the sale of 3 ELCs for $7 million, 15% above their June '20 independent evaluation. So specific comments in respect of COVID-19 related rent relief arising in the first half of FY '21. Rent abatement was -- in the half was less than $20,000. And is limited to a single-tenant in Victoria, which demonstrates the relative resilience of Arena's portfolio throughout the pandemic to date. There are no bench arrears and all the expected rent from July through January has been received, including the collection of deferred rent. Rent deferred in the first half of FY '21 from rent relief agreements from FY '20 was a net deferral of $750,000, all in the first quarter of FY '21. All rent deferrals are relatively short term, with over 70% of rent deferred in FY '20 to be received in FY '21. And all deferred rent to be received within 3 years with a weighted average collection period of 16 months. Just looking at some other line items in the income statement. Other income includes fees from our health care property syndicate, which was basically extended by investments for a further 2 year term and interest income. Property expenses, a small increase there due to additional allowances for independent valuations and property inspections. Operating expenses, there was a small increase in cash operating expenses in the first half of FY '21, primarily due to costs related to the growth of business, including custodian and corporate insurances. Pleasingly, and this points to the benefit of our internalized management platform, is that revenues increased by comparative $1.8 million and OpEx only increased by $20,000. The reduction in finance costs reflects a combination of the reduced cost of borrowing and the significant expansion of development, increasing the capitalization of interest. Our average monthly WIP balance was $66 million during the first half of FY '21 compared to $26 million in the comparative period. Our overall cost of borrowing reduced to 2.9% compared to 3.15%, and that was mainly as a result of loss of operations during the period. The higher statutory profit of $61 million is primarily due to the growth in net operating earnings and the higher positive net asset revaluations, which were $35 million in the December half versus $20 million in the first half of FY '20. Just looking at distributions per security. Given the substantial deployment of capital in FY '21 to date and greater clarity on the impact of COVID-19, Arena's FY '21 distribution guidance was upgraded in December to $0.148 per security which represents growth of 5.7% on FY '20. We've paid a distribution of $0.0735 per security for the first half as we're effectively straight-lining annual distribution over the course of the year. And as I mentioned, EPS growth will be greater in the second half of FY '21. And as a result, the full year distribution payout ratio is expected to be similar to previous years at around 98% of net operating profits. Turning to Page 9. This slide presents a summary of Arena's balance sheet. The full balance sheet is in the appendix of the presentation. Key points to note are the growth in total assets primarily due to the $74 million invested in acquisitions and developments to date in FY '21 and the asset revaluations of $35 million, which was also the primary driver of the 5% increase in net assets per security. This is less the reduction in cash holdings, which reduced from a bit over $70 million at June to near $30 million at 31 December. Net gearing at just under 20% is well below Arena's maximum gearing range of circa 35% to 40%. However, this level of gearing is providing us with substantial liquidity to fund the existing pipeline and developments and enables us to continue to take advantage of growth opportunities at a low incremental cost of capital. It also provides a buffer around any future market volatility. Gearing is expected to increase by a further 2% as our existing development projects are completed. Turning now to Page 10 and the capital management summary. Again, there are some additional information in the appendix. The approach to capital management continues to prioritize resilience and risk reduction. At 31 December, we had around $120 million of immediately available liquidity through our debt facility and cash reserves to cover the $30 million consisting development commitments outstanding. If in combination with our modest gearing, allows us to actively consider further growth opportunities. Our weighted average debt team is 3 years, and with no expiries before March 2023. New all-in cost of debt reduced to 2.9%, and we expect our interest rate to come up to be maintained in our usual 70% to 80% range. If interest rates remain around existing levels, we expect that our average cost of debt will further reduce over time, and there is still some positive reversion in our hedge book. Finally, it is important to note that Arena is operating well within the requirements of our debt facility, and we have substantial headroom in both our LVR and ICR covenants. I will now hand back to Rob, who will give you an update on Arena's property portfolio. Thanks, Rob. -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [4] -------------------------------------------------------------------------------- Great. Thanks very much, Gareth. And I'm now on Page 12, Arena owns 245 properties across Australia with a value of $1.017 billion. The portfolio is approximately 66 hectares with improvements that are almost exclusively purpose built, which accommodates some 20,000 families in their early learning needs as well as contributing to the needs of 8 communities' primary health care needs in our medical center portfolio and 35 people with high physical support needs in our specialist disability accommodation portfolio. The portfolio is passing yield of 6.13%, which is, as I mentioned earlier, has seen compression over the 6-month period, net 9 basis points which added with rent increases has provided the valuation growth of about 3.9% for the half. We continue to view the portfolio as having compelling value with exceptionally strong occupancy record, the longest WALE in the sector, a land and building rate of under $1,600 per meter, increased investor awareness of essential nature of social infrastructure property. And with current low interest rate environment and strong recent transaction market evidence, we see the likelihood of further yield compression. And as such, the likelihood of further valuation growth. Particularly, diversity of the portfolio has not materially changed in the period. Geographically, we have over 80% of the portfolio located in the eastern seaboard states. In terms of tenant diversification, we continue to improve our spread of tenant partners now totaling 30, with 27% of Arena's income supported by Australia's largest early learning provider, the Goodstart. Moving on to lease expiry. The portfolio 1 was extended 14.7 years during the period. This was a result of new development and acquisition activity. We have no current vacancies and no income expiring in financial year '21 or financial year '22. As you can see in the graph on this slide, we have only 2% of the portfolio's income expiring in the next 7 years and no material concentration of expiries in any year to be on 2043. We have a very long term, highly transparent and predictable cash flows that have annual escalations providing real growth to our security holders. Every one of our Early Learning Centre properties and our Specialist Disability Accommodation properties, provides important operating information data that assists us in asset management and our capital allocation decisions and has been an important tool in assisting the portfolio to remain 100% occupied for the last 5 years. Moving on to our rent review profile on the next slide. And here on this slide, you can see that we've broken down our review structures for the first and second half and the following 3 financial years. In the first column, you can see that the first half consisted of 46.5%. The full year income being subjected to rent reviews at the higher of CPI at 2.5%, 5.9% of CPI, grew 3% of unresolved market reviews, which is, as I mentioned earlier, those 11 properties. Each of those have capped and called at 0% to 7.5%, and we anticipate these will be resolved in the second half of financial year '21, along with the 25 outstanding financial year '20 market reviews. And as mentioned, we anticipate the likely come to be between that 6% and 6.5% growth on those properties. In the second half, with 35% fixed or CPI with a minimum ratchet of at least 2.5%, 4% of CPI and a further 5.8% of market reviews. Looking forward to financial year 2023 and '24, we can see that the vast majority of rent reviews continues to be those fixed or CPI with at least a 2.5% ratchet. Our exposure to CPI is limited to less than 9% per annum. Saying that, if we do get a surprise with increased inflation, we will benefit from the review structures that allow for the higher outcome of CPI or the racheted 2.5%. Each of the market rent reviews in financial year '22 and '23 has that 7.5% cap and the core of prevailing passing rent. And the 17% of income is subject to a market review in financial year '24. Approximately half of that is capped and collared at the 0% to 7.5%, and the remaining half is collared at 0%, so the rent can't go down. It's uncapped for any increase. Moving to Page 15. Our origination programs continued to perform well. We've secured a targeted pipeline of quality Early Learning Centre development projects that will complement the portfolio and deliver future earnings growth. The 9 projects completed in the financial year-to-date have all been designed and completed to sweep each individual's tenant's operations, and our tenant partners have reported strong occupancies in the short time since completion. We anticipate completing 14 development projects through the course of financial year '21 to a further 5 in the second half. In total, our development pipeline has 13 Early Learning Centre projects that are located in Queensland, Victoria, Western Australia and New South Wales, with total forecast cost of $74 million, of which we have capital expenditure outstanding of $30 million. We anticipate that average initial yield on all costs for these development projects will be 6.6%. Each of these development projects are being undertaken on a fund through basis, and we've secured agreement for leases with existing tenant partners on every project in our standard 20-year triple net lease format. Arena has an enviable record in executing on its development pipeline. Over 30% of our current operating portfolio has been developed by us since listing in 2013. We've completed 49 successful Early Learning Centre developments with 11 tenant partners across all Australian states and territories with the exception of the ACP. Moving on to the next slide. In regards to the Early Learning Centre operating environment. As well-being publicized, the federal government support of the early learning sector through 2020 was significant. And for the very most part, well-designed and well received by operators that required support, particularly through the COVID lockdown periods. Both major political parties and Australian communities more generally recognize that a well-performing early learning sector is integral to assisting parents and carriers and particularly females to active workforce in the short term. There's also a growing awareness of the positive lifelong learning prospects of children that attending early learning services and a broader role that, that plays in creating a more socially and emotionally well adjusted community and a more qualified and productive workforce in future generations. In relation to supply, net new supply of Early Learning Centres moderated in calendar year '20. Across the country, there were 397 new long day centers opened and 103 centers were moved from the market to a net addition of 294 centers, against a net addition of 320 centers in 2019. So that's net growth of approximately 3.7%, down from 4.2% in the prior year. There's no real surprises in these numbers from us. Most of that new supply is either underway or close to it prior to the onset of COVID. That made sense to see those projects follow through to completion. In relation to demand, prior to the onset of COVID, Australia reported its highest number of children attending long day care to March 2020, up 13% since the introduction of the Child Care Subsidy to us earlier. The Child Care Subsidy continues to do exactly what it was designed to do, increasing early learning participation, promoting higher workforce productivity and ultimately providing better overall community outcomes. Whilst there has been no new government released on actual numbers of children attending early learning services across the country since the March 2020 quarter, we anticipate from our own data and industry knowledge that demand is continuing to increase at pre COVID levels, particularly for center based services. Moving to the next slide. Arena's early learning portfolio is in a strong position. We're 100% occupied, and we've collected 100% of rent view to 31 January. Every one of our Early Learning Centres is open and trading and every one of those centers provides us business operating data. And that data provides us important information to assist asset management and capital allocation decisions as well as providing insight into the general health of the sector. As we have in previous reporting periods, we've included operating data up to the quarter prior. That data provides underlying operator occupancy across the portfolio has remained stable in that high 70% range. Daily fee growth has increased since December 2019 to reflect an average of $109 per day, which remains significantly below the government's benchmark fee of $135 per day. And as you can see on the graph at the bottom of this page, the government funding package continues to suit our Early Learning Centre portfolio, which is typically geared towards middle-income families. To give you some context, 99% of our Early Learning Centre portfolio has value feed under the government's Child Care Subsidy benchmark fee as of September. Our average rent per place across the portfolio has increased marginally to $2,470 per place. And given that we have developed more than 30% of the portfolio remains highly affordable in our view. The net rent to revenue ratio was 11.3% at September. Moving on to the next slide. In regards to the health care sector, the portfolio -- health care portfolio continues to perform to our expectation. Mega trends for health care also remained positive. A higher number of people are moving into the older age bracket, the higher proportion of the population is living with chronic illness, which underpins an increased need for health care services and the infrastructure to accommodate those services. Our largest health care tenant partner has recently undergone a change of control with the Healius Medical Center business being sold to BGH Capital. As a condition to Arena's consent to that change of control, new security in the form of a 12-month bank guarantee and an obligation for the tenant to provide audited financial reports was introduced. If I Care, our specialist disability accommodation tenant partner, also continues to perform for expectation, maintaining high occupancy, in fact, increasing profitability over the period. Moving on to the outlook. And today, we're reaffirming our distribution guidance for financial year '21 of $0.148 per security, an increase of 5.7% on financial year '20. Income growth is underpinned by contracted annual rent increases and outstanding market rent reviews as well as the full impact of financial year '20 and financial year '21 acquisition and development completions. Looking forward, early learning and health care services are integral to economic recovery and improving community outcomes. And those important themes underpin Arena's portfolio value and investment objective to providing long-term predictable distributions to our securityholders into prospects for growth. We have balance sheet capacity to undertake and take advantage of new opportunities that are consistent with our strategy, gearing at less than 20%, and no debt expiry falling due until March '23. We have a highly engaged and experienced management team with strong industry relationships and in-house development and origination expertise that will assist us in sourcing future opportunities in a disciplined manner. In closing, I would like to thank our tenant partners and our team for contributing to the positive investment portfolio and community outcomes that have been achieved through first half '21. That concludes the formal part of today's presentation, so I'll now pass the call back to the operator to open up for questions. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) Your first question comes from Simon Chan of Morgan Stanley. -------------------------------------------------------------------------------- Simon Chan, Morgan Stanley, Research Division - VP & Equity Analyst [2] -------------------------------------------------------------------------------- Rob and Gareth, the first question I got is your BV guidance, Rob. Have you affected even in the fixed -- the rent reviews, which haven't been completed yet, I guess the 20-odds from FY '20 and 11-odd from FY '21? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [3] -------------------------------------------------------------------------------- There's a small amount that's in there, Simon. But Gareth, you want to talk the details to the guidance and the numbers that are involved? -------------------------------------------------------------------------------- Gareth Winter, Arena REIT - Company Secretary, CFO & Director [4] -------------------------------------------------------------------------------- Sure. So yes, we haven't touched -- we haven't assumed the 6%, 6.5%, put it that way, so there's some upside there. -------------------------------------------------------------------------------- Simon Chan, Morgan Stanley, Research Division - VP & Equity Analyst [5] -------------------------------------------------------------------------------- Okay. And therefore, the back payment -- you get a back payment, too, am I correct? And that all comes through -- for the FY '21, that all comes through as soon as the deal is done? -------------------------------------------------------------------------------- Gareth Winter, Arena REIT - Company Secretary, CFO & Director [6] -------------------------------------------------------------------------------- Correct. That's -- we also have a second (inaudible). -------------------------------------------------------------------------------- Simon Chan, Morgan Stanley, Research Division - VP & Equity Analyst [7] -------------------------------------------------------------------------------- Yes. Cool. Can we just talk a little bit about attendance at your tenants, Rob? Do you -- did I hear you correctly when you said it was back at about 70%? If not, what is it? If so, can you perhaps even talk about the range? Like, what's the best one and what's the worst one? I'm just trying to get a feel for the whole portfolio. -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [8] -------------------------------------------------------------------------------- Yes, no. Absolutely, Simon. So if you look at where we were sort of 9 months ago in the depth of COVID, occupancy and attendance, 2 different things. Attendance has got down to sort of 20% to 25%, mostly that's around the country, including across our portfolio. As that has changed, that's snapped back. And attendance has sustained very quickly, and the difference between attendance and occupancy has narrowed as well. Across our portfolio, attendances and occupancy are sitting at that sort of high 70% range, and that's consistent with where it was pre-COVID. So that's good. And to give you an idea of range, we've got many centers now that are trading at 100% occupancy. And we've got a number that is sitting below 50%. But many of which are sort of new startups, if you like. So not of any concern to us. So in good shape. I've got to say, the optimism that is running through the Early Learning Centre operators is quite high at the moment, and we're certainly seeing families and consumers using the services as they were pre-COVID. -------------------------------------------------------------------------------- Simon Chan, Morgan Stanley, Research Division - VP & Equity Analyst [9] -------------------------------------------------------------------------------- Great. Just my last one. There's no concerns with profitability of your tenants, right? I mean, just been hearing stuff about one of the more prominent child care operators being in a loss position for FY '20. Is that a fair concern? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [10] -------------------------------------------------------------------------------- Absolutely not. I think there has been some discussion around Good Start. They are a not-for-profit. So the reinvestment back into that business is very significant. This is the $1 billion revenue running through last calendar year are a model tenant. So I have heard some discussion around that also. I can say the profitability across our portfolio looked exactly like it was in the part of COVID. There's obviously that difficult period where there was no profit, but effectively, the government had hibernated the industry. So that was a period of 6 months. But we haven't seen across the market any failures of tenants, certainly not in our portfolio. The occupancy rate is high. We're actually starting to see and we're starting to see some impressed that daily fees are being expanded. Daily fees get expanded when occupancy is actually coming back. That's not in result to profitability being there. So no issues in regards to solvency or tenant profitability at this stage. I mean, we watch that obviously very carefully. -------------------------------------------------------------------------------- Operator [11] -------------------------------------------------------------------------------- Your next question comes from Caleb Wheatley of Macquarie. -------------------------------------------------------------------------------- Caleb Wheatley, Macquarie Research - Analyst [12] -------------------------------------------------------------------------------- Just a couple from me. Just on the net rent to revenue ratio. So ticked up marginally to that 11%-ish number. I know you've sort of spoken in the past about a sustainable range of kind of 12% to 14%. How are you thinking about that going forward for your ALC operators? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [13] -------------------------------------------------------------------------------- Yes. I think that's a good question, Caleb. One thing I should probably point out is that is actually an MAT, so it's a moving annual turnover and picks up. So a 4-month period, September to September. It picks the June period in which there's obviously not a lot of revenue running through to the operator. So I think it's probably overstated a little. All else being equal, we anticipate that to come back down. So I think that's point one. Point two, there's still plenty of profitability that's sitting in there for the tenants. So clearly went over from our perspective. We watch it on the gross revenue and report on gross revenue. But on an EBITDAR basis, things are looking healthy and not inconsistent with prior periods pre-COVID as well. -------------------------------------------------------------------------------- Caleb Wheatley, Macquarie Research - Analyst [14] -------------------------------------------------------------------------------- And on that sustainable range, how are you thinking about that potentially ex COVID and other impacts? Is that something that's still in the thinking going forward? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [15] -------------------------------------------------------------------------------- It's absolutely a measure that we watch very carefully. At the moment, if I was to try and be critical and find an area where there was -- prospected some challenge for operators, it's probably in labor. And as I think most of the people on this call might know, that $0.11 that we're taking out $1 of revenue from our operators, there's this $0.50 or $0.55 that's going to labor cost. And that labor is becoming more difficult to source. And that's probably where we see some pressure in regards to expansion of operators expenses. So it's an area that we're looking at. It's not a big issue at the moment, but it's one that's starting to get a little bit of discussion around operators at the moment. -------------------------------------------------------------------------------- Caleb Wheatley, Macquarie Research - Analyst [16] -------------------------------------------------------------------------------- Perfect. And just on the balance sheet and deployment, how has that been going since the update in December '20? How the yield has been looking into rest markets? And what's the outlook there? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [17] -------------------------------------------------------------------------------- Yes. So with the -- from the transaction market and early learning, not -- I guess, things have moved quite quickly in the 6 months where we've reported 44 transactions across the market, sort of over $200 million in value and average yields at about 5.8%. We can certainly participate in those if we want to. We've spoken some time that our filter is very much focused on those sustainable rents. And we're still seeing some good opportunities in there. There's no doubt. But we are being disciplined around making sure that tenant partners that we take on for very long leases are sustainable, not just for now but in the future, as we collectively can. So plenty of opportunities still in front of us. We've obviously, big focus on executing on the 13 projects that we've got underway at the moment. All of that's going well. And we are still in a patch where origination -- we've got some comparative advantage, very strong relationships with tenant customers and, obviously, a position where our branch should allow us to move quite quickly. -------------------------------------------------------------------------------- Caleb Wheatley, Macquarie Research - Analyst [18] -------------------------------------------------------------------------------- Perfect. And maybe just a final one. I know there were some points on the change of Healius control in the last result. Is there any update on what's happening there? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [19] -------------------------------------------------------------------------------- Yes. So that transaction has taken place. So BGH are now in control of the Healius Medical Centers. We had change of control, consent mechanisms in our leases, we sought for increased securities. We've now got 12-month bank guarantees and an obligation for the tenant to provide audited financial reports. We've actually been quite close to BGH and their new sort of management team over the last little while and quite excited by the prospect of them going in there, spending money on the assets that we own and the operations that they manage and own in those services. Look, so whilst it's very early, I'm pleased with where we are to date. -------------------------------------------------------------------------------- Operator [20] -------------------------------------------------------------------------------- Your next question comes from James Druce of CLSA. -------------------------------------------------------------------------------- James Druce, CLSA Limited, Research Division - Research Analyst [21] -------------------------------------------------------------------------------- Rob and Gareth, some of the questions have been asked already, but there's a couple of other aspects I'd like to look at. Firstly, just -- there has been a number of shopping centers talking about installing child care centers. It seems to be a bit of a theme. I appreciate it's a very fragmented market. But do you see this becoming a more significant competition issue looking ahead? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [22] -------------------------------------------------------------------------------- We have been watching what's happening with retail and space generally -- real estate space generally, as practitioners for some time trying to figure about what could be a competitive threat. I think there's some prospect of child care -- successful child care operations moving in into shopping centers. There's some great examples of that, both in -- well, in Brisbane, New South Wales and Victoria. There's a number of barriers. Big one's being security. So if you look at it from a retail, a big shopping center at the moment is really wanting to increase utility and bolt-on. Long day child care doesn't do that. Long day child care is not casual care. You can't grow up if you're shopping -- dropping kids off and go shopping. I think that's something very different. People should understand that difference. Long day child care center-based works best when it's near a primary school, easy to access, has significant barriers in regards to security and persons not being able to sort of peer in and get involved. Shopping centers don't have that benefit in many instances. So what we see is a growing threat, given that obviously, there's a lot of retail space that's looking for use, and there's definitely a big push for community use and health care use in a number of those services. We don't see it as a significant threat to the structure of early learning at this stage. -------------------------------------------------------------------------------- James Druce, CLSA Limited, Research Division - Research Analyst [23] -------------------------------------------------------------------------------- Okay. And just looking at the micro, are there any centers -- anything popping out that you are concerned about, just looking at your portfolio? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [24] -------------------------------------------------------------------------------- You're always concerned about something. I mean, nothing at all. I'll just say, the optimism that's in the Early Learning Centre market at the moment is quite high. It was a very difficult period through COVID. Government stood up very well through that. There is a bit of renewed vigor, I guess, in the sector. We've seen moderated growth in regards to supply. I personally think that, that will probably change a little bit -- that those have got access to credit. We'll get out there and start building more centers. So that's something we'll need to watch, but it's not now. That's probably 18 months or 2 years away, I suspect. But right now, we're in a pretty good space. So no, nothing that's overly worrying us in regards to early learning or health care. -------------------------------------------------------------------------------- James Druce, CLSA Limited, Research Division - Research Analyst [25] -------------------------------------------------------------------------------- Okay. And secondly, just talking about bipartisan support from the government. Is there anything near term that you're sort of thinking about? Or are we still kind of a couple of years away from thinking about politics? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [26] -------------------------------------------------------------------------------- Yes. There's definitely a lot of lobbying. That continues. It's quite strong through the COVID period and continues. I think that it is unlikely that -- certainly, our view is it's not likely to be a material change. It's a position of the incumbent government that it's not likely. And as I mentioned, the child care support and the subsidy system that's in place is working, so I don't think that will change. I think most people know this, I'd encourage anyone that's particularly interested to read the reports or other recent literature by the big accounting firms. There is definitely some gender imbalance issues that need to be sorted through, and I guess, overall, a very much heightened recognition post COVID of the benefits that the service provide back to the workflow. So there's room for it to change. Our expectation -- our base expectation is not to see it change, though. And if it were to change, it would change for the better. I think we've seen the later government's policy that they ran into the last election, obviously, a little bit more stronger than the incumbent. -------------------------------------------------------------------------------- James Druce, CLSA Limited, Research Division - Research Analyst [27] -------------------------------------------------------------------------------- Okay. That's clear. I might be reading the slide a bit wrong, but I just want to get a sense of the -- if you look at your total rent roll, how much is CPI linked? So if you split out fixed -- or 2.5% plus CPI, how much of that bucket is actually CPI? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [28] -------------------------------------------------------------------------------- Yes. It's -- the only -- so that -- So if you look at -- what are we, slide -- so the annual rent review slide, Slide 14. The half year '21, the big blue boxes at the bottom, they're the ratcheted ones. So they will only be CPI if it's over that ratchet 2.5%. So to the extent that we see inflation kick off will be the beneficiaries of that -- above the 2.5%. It's really only the CPI, which is really just our Victorian portfolio of early learning, is 5.9% here in the first half, 4.3% in the second half, and then remains under 9% for each year thereafter. -------------------------------------------------------------------------------- Operator [29] -------------------------------------------------------------------------------- (Operator Instructions) Your next question comes from Murray Connellan of Moelis Australia. -------------------------------------------------------------------------------- Murray Connellan, Moelis Australia Securities Pty Ltd, Research Division - Analyst [30] -------------------------------------------------------------------------------- Rob, it seems like the -- obviously, it's been discussed already, the market for quality child care assets seems quite competitive at the moment. The yield seemed to have obviously tightened a little bit in the last couple of months. I was wondering how that impacts the build-versus-buy decision for you guys and whether or not we can expect the development pipeline to stay relatively full. And then I suppose more broadly, what are your hopes for capital deployment? And what are your comfort levels around gearing at this point in the cycle? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [31] -------------------------------------------------------------------------------- Yes, great. Thanks, Murray. So build-versus-buy, firstly. One of the things that's held us back from buying completely in place income or completed centers is that they don't come with our lease, and that has been a very significant filter. We benefited from every one of our properties having underlying operating data coming to us on a quarterly basis. Very much so over the last number of years. So that has been a challenge. We've been successful in prior periods in teaming up with tenant partners and going -- buying -- ongoing concerns. So that is that the tenant will buy the business, we will buy the real estate, typically provide a refurbishment or rejuvenation, and then with that, introduce our lease on a long-term basis. Those type of opportunities are quite strong and will continue to be. As I mentioned, we saw 103 child care centers come out of the market the last 12 months. Many of those were sort of from obsolescence reasons. And we think that there's good opportunity for some older child care centers to actually be refurbished. Some of those older centers are fantastic locations in areas that's very difficult to access. And with appropriate capital expenditure and the right tenant, you can make very good businesses. So we see opportunity there. We still continue to see opportunity for greenfield development with -- in conjunction with -- in partnership with our tenants. So you'll continue to see a relatively full development pipeline from us is our expectation. So that's all. We have a couple of deployment programs for us. Certainly not slowing down. We've got resources internally. We've got resources available on the balance sheet. That really is against -- I want to get the very best earnings out of it, Murray. We don't need to grow for growth's sake. The stuff that we do is going to be accretive for the long term through the cycle, and assets that we'll hopefully look back in 20 years time and say that they were good buys. -------------------------------------------------------------------------------- Murray Connellan, Moelis Australia Securities Pty Ltd, Research Division - Analyst [32] -------------------------------------------------------------------------------- Sure. And I mean just around -- comment a little around gearing? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [33] -------------------------------------------------------------------------------- Yes, Gareth, you want to talk through balance sheet and gearing? -------------------------------------------------------------------------------- Gareth Winter, Arena REIT - Company Secretary, CFO & Director [34] -------------------------------------------------------------------------------- Yes. Yes, sure. So we have a maximum -- we have a maximum target of 35% to 40%. Obviously, we're sitting down 20% or a couple percent still to go from the completing existing development pipeline. At this point in the cycle, we've been comfortable moving up to around like 30% kind of levels. Over time, you would have seen historically in the last few years that we've been sitting in that upper 20s kind of range into the lower 30s potentially. But at this point in the cycle, you'd see us getting a number of 35%, 40%. -------------------------------------------------------------------------------- Murray Connellan, Moelis Australia Securities Pty Ltd, Research Division - Analyst [35] -------------------------------------------------------------------------------- Sure. And then could you maybe just speak to what the outlook is for the child care fees through 2021? Obviously, no increases put through -- or very few put through last year. What does '21 look like? And I suppose, what is the competitive market look like at the moment? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [36] -------------------------------------------------------------------------------- Yes. Yes. That is the question. So we expect them to -- this is a general comment. We think that the market will actually look for modest fee increases, talking with our tenant partners and others that aren't our tenant partners. But the industry generally is looking for some modest growth in fees. It's fair to say that last year, because of the government subsidization, centers weren't able to put up fees. So if you were a beneficiary of that subsidization, you won't allow to put up the fees. It's obviously changed in the environment that we are now. So assuming no changes to lockdowns and government having to provide additional relief support and operators being able to affect standard market increases, I think that because occupancy is starting to move up again, Murray, you'll see some of our operators and market operators generally starting to move. I think -- I don't want to just push it into a number that we're anticipating, but it wouldn't surprise me if it was a range of sort of 3% to 5%. And typically, that's going to be -- typically, those fees come up by the calendar year or the financial year. We haven't seen a lot of that for the January intake. So we expect that probably around that July period, we'll start seeing fee increases at that point. -------------------------------------------------------------------------------- Operator [37] -------------------------------------------------------------------------------- (Operator Instructions) Your next question comes from Nira Sonah of EAP. -------------------------------------------------------------------------------- Nira Sonah, Evans & Partners Pty. Ltd., Research Division - Associate Director of Real Assets [38] -------------------------------------------------------------------------------- Most of my questions have been answered, but just got a couple more. Quick one on interest expense. How much of that was capitalized during the half? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [39] -------------------------------------------------------------------------------- Gareth, do you want to fill that question? -------------------------------------------------------------------------------- Gareth Winter, Arena REIT - Company Secretary, CFO & Director [40] -------------------------------------------------------------------------------- Yes. Yes. So looking at $2 million. -------------------------------------------------------------------------------- Nira Sonah, Evans & Partners Pty. Ltd., Research Division - Associate Director of Real Assets [41] -------------------------------------------------------------------------------- Sorry, I didn't hear that. Can you please say it again? -------------------------------------------------------------------------------- Gareth Winter, Arena REIT - Company Secretary, CFO & Director [42] -------------------------------------------------------------------------------- We're looking at roughly about $2 million. -------------------------------------------------------------------------------- Nira Sonah, Evans & Partners Pty. Ltd., Research Division - Associate Director of Real Assets [43] -------------------------------------------------------------------------------- Okay, cool. And just in terms of your growth strategy going forward, how do you see like between child care centers and other social infrastructure? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [44] -------------------------------------------------------------------------------- Yes, thanks. So certainly, a lot still to be done in child care is our view. So we won't see anything different there. I think I've said before, we still think that this is an environment where our deepest skills are likely to be where the best results come from. And that is both in child care and health care. We'd love to be doing more in health care. The macro trends that sit behind health care are obviously very strong. It's an incredibly competitive market at the moment. We can obviously compete on yields and obviously got great tenant relations there for the most part. We need to do more than that, we will -- and we'll continue to do so. The sustainability rents is one thing that we're sort of filtering out. So transactions that are happening in the marketplace, I don't think, we're missing any. I think that where we're doing due diligence, we're seeing better risk and reward outcomes on early learning at the moment. So that's -- we've been deploying capital. So I'd like to do more in health care. It would probably be a lot to do -- a lot the same. So that's multidisciplinary medical centers, that's sort of first touch point from the community into health care services. We still see it as a very strong proposition. And it's -- we'd love to do more. -------------------------------------------------------------------------------- Nira Sonah, Evans & Partners Pty. Ltd., Research Division - Associate Director of Real Assets [45] -------------------------------------------------------------------------------- All right. And last question just on recent transactions. Can you provide color on like recent transactions you see in the sector and the price being paid for them? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [46] -------------------------------------------------------------------------------- Is that in respect of early learning or health care? -------------------------------------------------------------------------------- Nira Sonah, Evans & Partners Pty. Ltd., Research Division - Associate Director of Real Assets [47] -------------------------------------------------------------------------------- Early learning. -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [48] -------------------------------------------------------------------------------- Yes. So transaction activity has increased. There's 44 transactions that we've recorded in the 6 months to the end of December. It's at $207 million worth of child care centers exchanged. No question, it's seen some yield compression there. And there's a pretty odd bunch of real estate, too. There's some very older centers, including a couple of older centers that we had. And then the average yield across that period was about 5.8%. The profile of buyer continues to be at sort of high net worth individual. Although we are starting to see some smaller syndicates starting to try and get some -- 3 or 4 centers and start trying to get syndication around those, which would be -- frankly, is competition for us in some respects, but also, over time, may be opportunities for scale acquisitions for us, too. So not too concerned about that. -------------------------------------------------------------------------------- Operator [49] -------------------------------------------------------------------------------- (Operator Instructions) Your next question comes from Gareth James of Morningstar. -------------------------------------------------------------------------------- Gareth James, Morningstar Inc., Research Division - Strategist [50] -------------------------------------------------------------------------------- Just interested on the -- you talked about installing solar power on some of the properties. I was just curious about how the funding works for that? Is that a cost that you guys incur? -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [51] -------------------------------------------------------------------------------- Yes. Thanks, Gareth. It's a program we're pretty excited by. So yes, we got 43 centers now. They've got solar arrays that have been set up. There's a bit of a mixture in regards to how we're funding those. Some -- in very simple sense, the early ones that we did would provide an operating cost that -- let's just say, it was $3 less operating costs, and we would increase our rent by $1. So that would be a net basis of 1/3 to us and 2/3 to the tenant in savings over a period of time. And we'd extend the lease out to make up for capital costs that we would typically pay for. These system is not particularly sophisticated in regards to the power usage requirements -- the Early Learning Centres at least, are not expensive. They're typically between $20,000 and $50,000 of capital expenditure. We have used that as an opportunity to talk to our tenant partners about reducing environmental outcomes. And that's been, in itself, quite a powerful proposition, particularly where tenant partners can start pulling that information back down to underlying consumers and families and talking about the savings for environment that are happening. We have got a fair bit more work to do. We're certainly very happy with the operating results. And from an environmental and a financial perspective, we've been able to extend leases on the back of it. We've been able to increase rents on the back of the capital expenditure that we're doing. Going forward, it might be that we take a step of actually spending a little bit more capital expenditure to get those environmental outcomes because we see that as a good investment financially and environmentally over the medium term. -------------------------------------------------------------------------------- Operator [52] -------------------------------------------------------------------------------- (Operator Instructions) There are no further questions at this time. I'll now hand back to Mr. de Vos for closing remarks. -------------------------------------------------------------------------------- Robert Andrew de Vos, Arena REIT - CEO, MD & Director [53] -------------------------------------------------------------------------------- Thanks. Thanks very much, Bernadette, and thanks, everyone, for your attendance on the call today. That concludes our investor briefing. Please don't hesitate to contact Sam or I directly with any questions, and we look forward to seeing and talking to a number of you over the next couple of days and weeks. Thank you very much. -------------------------------------------------------------------------------- Operator [54] -------------------------------------------------------------------------------- That does conclude our conference for today. Thank you for participating. You may now disconnect.