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Edited Transcript of CMW.AX earnings conference call or presentation 24-Feb-17 12:00am GMT

Thomson Reuters StreetEvents

Interim 2017 Cromwell Property Group Earnings Call

Feb 26, 2017 (Thomson StreetEvents) -- Edited Transcript of Cromwell Property Group earnings conference call or presentation Friday, February 24, 2017 at 12:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Paul Weightman

Cromwell Property Group - MD and CEO

* Michael Wilde

Cromwell Property Group - CFO

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Conference Call Participants

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* Robert Freeman

Macquarie - Analyst

* Darren Leung

Macquarie - Analyst

* Sholto Maconochie

CLSA - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by and welcome to the half-year 2017 Cromwell results presentation. At this time, all participants are in a listen-only mode. There will be a presentation, followed by a question and answer session. (Operator instructions)

I must advise you that this conference is being recorded today, Friday February 24, 2017. I would now like to hand the conference over to your first speaker today, Mr. Paul Weightman, Chief Executive Officer for Cromwell, thank you, please go ahead.

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Paul Weightman, Cromwell Property Group - MD and CEO [2]

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Good morning, I'm Paul Weightman and with me this morning is our Group CFO, Michael Wilde. Cromwell today reports first-half operating profits at December 31, 2016 of AUD78.7 million, representing AUD0.045 per security and supporting distributions of AUD0.042 per security. Cromwell's demonstrated good progress in the first half in its leasing renewal program and in its key funds management and value creation strategies.

During the 2016 financial year, we realized AUD169 million from asset sales. This allowed us to recycle capital to invest for the future in a number of key strategic growth opportunities. Strong and stable cash flows from our portfolio, recurring revenues from our funds management business, and income streams from the assets we're developing and repositioning give us the confidence to maintain our track record of consistently increasing distributions to securityholders.

Today we've also unveiled a new brand and visual identity. The change follows almost two years of work integrating the Australian and European arms of the business. Cromwell continues to grow and evolve and it became apparent that it was time for our brand and visual identity, which are both nearly 20 years old, to properly reflect the scale and breadth of the business.

The new brand will bring together our Australian and Europeans arms of the business, making it easier for us to consistently communicate the value we provide to our investors, capital providers, tenants and other stakeholders in the various markets and countries in which we operate. We will progressively roll out the new brand in all of our locations from today.

Just turning to each of the business segments. The property segment operating profit was AUD62.5 million which represented 79% of total operating profit. Overall portfolio valuations increased by AUD41.4 million net of property improvements, lease costs and incentives, and our weighted average cap rate improved to 6.96%.

Tenant quality remains strong, with government and government-related entities contributing 42% of gross income. The portfolio had a weighted average lease expiry of 6.35 years and a vacancy rate of 8% by gross passing income.

Increases in rental income in most New South Wales assets have been offset by the previous forecast loss of income in two assets, namely 100 Huntington Avenue and Lovett Tower in Canberra which are both earmarked for future repositioning and development. Net property earnings on a like-for-like basis, including those two assets, decreased by 5.7%. However, across the rest of the portfolio, excluding those two assets, net property earnings increased by 1.9%.

The result reflected the successful execution of Cromwell's lease renewal program, with tenants including the Therapeutic Goods Administration taking up their five-year renewal option over TGA Complex in Canberra; the Bureau of Meteorology renewing their lease over 15,400 square meters at 700 Collins Street; and the Queensland University of Technology who renewed their lease for a little over 9400 square meters at Musk Avenue, Kelvin Grove. Those renewals alone amounted to more than 43,000 square meters.

The office space that we've refurbished at 700 Collins Street attracted strong tenant interest, with a further 5000 square meters leased to Open Universities Australia and Pacific Hydro in the half. Refurbished space in our Mary Street asset has been leased and we continue to receive good enquiry on any vacant space.

We've also seen improved take up and increased demand in our Gold Coast asset, with activity levels rising ahead of the Commonwealth Games. All of our New South Wales and Victoria office assets, other than Northpoint tower which is being redeveloped, are very close to being fully leased. We expect to see stronger tenant demand and net effective rental growth in New South Wales and Victoria in the near future.

With limited opportunities to acquire assets in a highly competitive market, we're focused on creating value in our existing portfolio and managing the AUD300 million investments we're making into Northpoint Tower in North Sydney and the new Department of Social Services national headquarters at Tuggeranong Office Park in Canberra. Both projects remain on track and will contribute earnings growth and valuation uplifts to the Group in the near future.

Funds management operating profit was AUD16.4 million which represented 21% of total operating profit, and total assets under management as at 31 December 2016, stood at AUD9.8 billion. The wholesale funds management business continues to be active, trading EUR3 billion of European property assets, with EUR1.7 billion of assets being sold and EUR1.3 billion of assets being acquired on behalf of private equity investors during the calendar year.

Operating profit from the wholesale funds management business was AUD9.8 million. We'll continue to focus on broadening the private equity and limited partner investment base in the European business and on leveraging those relationships across the wider business.

Retail funds management operating profit of AUD6 million included performance fees from the renewal of the Cromwell Riverpark Trust. The Trust returned 14.9% per annum to investors from inception to June 30, 2016. This was a great result for investors and unitholders voted overwhelmingly to extend the Trust for a further five years in July 2016.

In New Zealand, the Oyster Group assets under management at December 31 stood at NZD977 million which represented a 30% growth in the 2016 calendar year. The team at Oyster have had another strong year. They reopened the Oyster Direct Property Fund which provides investors with exposure to over NZD240 million of commercial property assets, and are also currently managing the acquisition and syndication of the NZD210 million 43,500 square meter Millennium Centre.

Distributions of AUD5.9 million were received from the Group's 9.83% stake in Investa Office Funds. During the presentation of the Investa Office Fund's half-yearly results yesterday, a number of matters were raised regarding Cromwell's written proposal to IOF in November and its interests in pursuing a transaction with IOF. Investa Listed Funds Management Limited has said that Cromwell's proposed confidentiality agreement and standstill arrangements are not market standard. However, we point out that the standstill arrangements proposed by Cromwell are consistent with those agreed between IOF and Dexus in 2015.

And despite IOF's assertion that there's been no correspondence with independent directors since its 3 February announcement, there's been continual correspondence and communication in relation to this matter between the advisors to Cromwell and the advisors to IOF, and this continued up until the week ending February 17. In fact, it was Investa Listed Funds Management's suggestion that matters should be discussed between our respective advisors.

As announced on February 20, Cromwell sees value for IOF within a range of AUD4.45 to AUD4.75 per IOF security. Cromwell's recently been granted FIRB approval to acquire units in IOF greater than the 10% threshold proscribed under the Foreign Acquisitions and Takeovers Act. We remain open to continuing discussions with ILFML and its advisors, with a view to putting forward an increased cash offer to all IOF unitholders.

Michael, can I just ask you to take us through section 4 and our cash management arrangements.

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Michael Wilde, Cromwell Property Group - CFO [3]

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Thank you Paul. As at December 31, 2016, Cromwell held cash and cash equivalents of AUD80.2 million. Group gearing was 43.8%, 45% on a look-through basis. Net tangible assets per security have increased by AUD0.05 to AUD0.86. The Group's debt facilities continue to be well diversified across eight lenders and a convertible bond issue, all with varying maturity dates.

Future interest rates are hedged through an interest rate cap to May 2019. The Group has a weighted average debt expiry of 3.2 years, with 79% not expiring until FY20 and beyond. Moody's Investor Service continues to assign a Baa3 issuer rating for the Group and a stronger Baa2 for the secured debt platform. And, Paul, our current hedging program has seen our average interest rate for the half year decrease to 4.03%.

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Paul Weightman, Cromwell Property Group - MD and CEO [4]

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Thanks Michael, and that's down from 5.25% for the year ending 30 June 2016.

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Michael Wilde, Cromwell Property Group - CFO [5]

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That's correct.

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Paul Weightman, Cromwell Property Group - MD and CEO [6]

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In terms of outlook, Australia continues to experience moderate economic growth. We expect interest rates to stay relatively low as we continue to transition from the mining investment boom. We expect real estate capital values to continue to compress due to offshore demand for property assets in developed markets and in anticipation of rental growth in Sydney and Melbourne.

Bond rates have increased from cyclical lows and further rises will, at some point, begin to impact on property values. In the short-term this impact will be countered to some extent by manufactured rental growth, particularly in New South Wales and Victoria.

Our portfolio is 65% weighted to the Sydney and Melbourne office markets, where low vacancy rates and stock withdrawals have already led to lower incentives and higher rents. Our exposure to the weaker resource states is limited to Queensland, where we're seeing some promising leasing success in both Brisbane and on the Gold Coast.

Canberra remains an ongoing focus for us. We were successful in renewing the lease of TGA for a further five years, and I'm confident that we'll be able to make positive announcements on our Woden, Tuggeranong and Centenary House assets in the second half. Our European platform offers considerable opportunity for growth. One-third of global real estate transactional volumes within Europe and its population of 508 million people is 20 times larger than that of Australia.

Cromwell confirms its FY17 guidance and expects FY17 operating profit to be not less than AUD0.084 per security, with a distribution of not less than AUD0.0834 per security. That represents an operating profit yield per security and distributions per security yield of not less than 8.32% and 8.26% respectively based on our closing price of AUD1.01 on 23 February 2017.

Vincent, I will throw back to you for questions.

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Questions and Answers

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Operator [1]

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Thank you. (Operator instructions) Our first question today comes from the line of Robert Freeman from Macquarie. Please ask your question.

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Robert Freeman, Macquarie - Analyst [2]

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Good morning guys. There's obviously a lot of information out there available on IOF. What metric or what single piece of information would you say is most important for your capital partners?

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Paul Weightman, Cromwell Property Group - MD and CEO [3]

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What they want to see are forward cash flows in large part. We're getting to the point in the market where NTA is almost irrelevant. They're looking at the cash that the platform will throw off over the short- to medium-term.

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Robert Freeman, Macquarie - Analyst [4]

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Okay. When do the agreements expire with these capital partners that you have?

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Paul Weightman, Cromwell Property Group - MD and CEO [5]

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They're open.

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Robert Freeman, Macquarie - Analyst [6]

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Okay. Just on the Cromwell website there was commentary around some of IOF's recent leases and not a lot of information available to assess cash flows, so similar with your comment, Paul. Do you think Cromwell can start releasing announcements essentially as leases are signed, and we can get some detail from Cromwell as well?

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Paul Weightman, Cromwell Property Group - MD and CEO [7]

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I think we generally do as best we can with material leases. Clearly if they have an impact on earnings and they're material we have a continuous disclosure obligation. I don't think there's anything that we've done that would change our forecasts or guidance. In terms of material leases, I think we've had a practice of doing that.

In our case I think the issues that most people are interested in is what will happen with future expiries. There's generally an assumption that for a number of assets they will be leased on a like-for-like use, whereas that's not the case with assets that are in our trading or repositioning pool.

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Robert Freeman, Macquarie - Analyst [8]

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Yes. I mean I was just going through all the announcements from last year and I think the only lease announcement I could see was TGA, and obviously that was the exercise of an option. But it didn't seem to have any information on the new terms, the escalator, the incentive. Do you think you should start to disclose that on some of these bigger deals?

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Paul Weightman, Cromwell Property Group - MD and CEO [9]

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I think if they're not disclosed there's certainly information that a buyer would be interested in, and they fall to the range of information that we've asked for so that we can put a higher bid to IOF unit holders. So if it -- I can understand that if there is information that you don't feel is material in the market, you have no obligation to disclose it. In circumstances where you have a buyer who wants to put the best offer possible to all unit holders, it's clearly information that goes to a determination of value.

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Robert Freeman, Macquarie - Analyst [10]

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Yes. Then just these potentially positive announcements on Woden, Tuggeranong and Centenary House, what would a positive announcement look like in your mind?

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Paul Weightman, Cromwell Property Group - MD and CEO [11]

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I think, Rob, as you'd appreciate we don't sit around and wait for leases to expire and then get surprised that we have no income. Every asset has within its lifecycle an opportunity for repositioning or redevelopment, repurposing. These are all assets that have a variety of uses, and we've been working diligently to develop options for each of those assets.

That would frankly range from either new leases on refurbished space or alternative uses. We're working on all of those options, and I think given the timing of lease expiries and the opportunity to get access to the assets to actually undertake value creation programs, the next six months are the window for us where we would expect to be in a position to announce to the market the options that we're proceeding with.

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Robert Freeman, Macquarie - Analyst [12]

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Thanks guys.

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Paul Weightman, Cromwell Property Group - MD and CEO [13]

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Thank you Rob.

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Operator [14]

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Our next question today comes from the line of Darren Leung from Macquarie. Please ask your question.

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Darren Leung, Macquarie - Analyst [15]

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Good morning guys. Thanks for taking my questions. Just the first one, in terms of your gearing look through, 45% at the moment, how should we think about where we are in the cycle versus your distributions continuing to grow at the rate they are versus your current gearing levels?

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Paul Weightman, Cromwell Property Group - MD and CEO [16]

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Clearly there are a number of components to our current capital structure. Our headline gearing is impacted by the fact that we have borrowings to support the stake that we have in IOF. Clearly that will change if we roll into an acquisition with capital partners to buy the platform. I think on a portfolio-gearing basis, Michael, we're...

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Michael Wilde, Cromwell Property Group - CFO [17]

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At the lower end of the range, Paul. (Inaudible) the actual secured portfolio.

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Paul Weightman, Cromwell Property Group - MD and CEO [18]

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I think we've consistently said we're comfortable with that, so I think you've got to look -- the way we look at it is that our debt is attributable to the assets that support it, and we're conservatively geared on a portfolio that throws off a lot of stable cash flow. We have a strategic initiative on IOF that is supported in the short-term by a capital stack that we expect to change over the medium-term.

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Darren Leung, Macquarie - Analyst [19]

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Okay. Just on that comment, would you be looking to hold the current investment stake in any of the funds that you manage? If you were to (inaudible)?

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Paul Weightman, Cromwell Property Group - MD and CEO [20]

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We have (inaudible) investment stake in a fund such as the one that we have proposed for the IOF platform.

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Darren Leung, Macquarie - Analyst [21]

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Okay. I mean if I circle back to your earlier comment, if you say that's temporary, how would you alleviate your gearing if you intend to retain that stake?

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Paul Weightman, Cromwell Property Group - MD and CEO [22]

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If an acquisition was funded on the basis of a combination of debt and equity, we would be able to support an ungeared co-investment within that fund that would provide alignment and be at a meaningful level.

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Darren Leung, Macquarie - Analyst [23]

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Okay. Just a final one from me, looking through the accounts, the AUD38.3 million of funds management revenue, given your AUM has declined just through the asset sales in Europe, can you give us a sense of what is base fees, funds management fees, property management fees, versus transaction fees?

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Paul Weightman, Cromwell Property Group - MD and CEO [24]

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I think we've consistently said the European business, in terms of its average length of fund term, is relatively short compared to what we would have with long-term open funds in Australia in a funds management platform. That's good and bad. It throws off a lot of transactional fees. You get a degree of volatility. In some years you're going to buy more; some years you're going to sell more. To some degree that depends on the timing of execution of transactions.

We can say that 50% comes from asset and property management fees, and 50% comes from transactional fees, but in a sense that's meaningless when you have funds that have a relatively short term, because they're all linked to the length of term of the fund.

But I'm very comfortable that the initiatives that we've announced to change and evolve over time the nature of that business into one that has longer-term funds with more recurring income are successful, and we're continuing to promote those. Our objective is to have a business in Europe that is less volatile, more stable, and that has earnings that are more highly predictable over a longer period of time.

That having been said, it provides the opportunity for great one-off results, and I think we saw in the last financial year that those one-off transactional fees can have a meaningful impact to earnings and to our capacity to manage cash to fund distributions over a longer period of time.

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Darren Leung, Macquarie - Analyst [25]

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Excellent, thanks guys.

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Operator [26]

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Our next question today comes from the line of Sholto Maconochie from CLSA. Please ask your question.

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Sholto Maconochie, CLSA - Analyst [27]

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Hi Paul and team. I just -- it's already been answered, but I'll just follow on from a couple of them. Just on the IOF stake, when does it get to the point where it's just a distraction and it's obviously been dragging out a while? It's been accretive given the distribution in the share price. How patient are your capital sources and is there a point where you just say we'll still -- let's get out on a profit and just move on? What's the sort of -- or are you very patient to sit with that passive investment going forward?

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Paul Weightman, Cromwell Property Group - MD and CEO [28]

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We're very patient, Sholto. We think there should be engagement, obviously. We think that engagement has the capacity to provide a significant benefit to all IOF unit holders. At the moment we are pursuing a course that we think should result in us getting access to information to be able to put a proposal or offer to IOF unit holders that they will look at as compelling.

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Sholto Maconochie, CLSA - Analyst [29]

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What are the sticking points on that CA? We've heard -- what are your main issues? Is it just more cash flows, three years of cash flows? Is that the main issue? I assume that you -- obviously if you get those cash flows you can't buy more stock because it's material information, but what's the sticking point on -- with the CA?

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Paul Weightman, Cromwell Property Group - MD and CEO [30]

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Well, look you're right. In a sense part of what is seeking to be imposed on us is superfluous, because yes, we are governed by the insider trading rules. We clearly can't buy stock if we have insider information. The sticking points for us are the term of a standstill, and in that regard we don't think 12 months is reasonable.

Frankly we can't have a standstill that keeps us on the sidelines if an internalization proposal is put forward, or if ICPF or another shareholder increases its stake. We fail to see how either of those things could be of benefit to IOF unit holders, or as Penny suggested yesterday, that they wouldn't negate the effect of the whole standstill altogether.

So what we're asking for simply is an arrangement similar to the document that was agreed with Dexus. I think that's a pretty fair indication that it was market standard in those terms.

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Sholto Maconochie, CLSA - Analyst [31]

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I think the -- I may be wrong, but my understanding is that the Dexus one only had 12 months at a current year forecast. It didn't have that three years. Is that correct, my understanding? (Inaudible).

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Paul Weightman, Cromwell Property Group - MD and CEO [32]

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Dexus was granted full due diligence after its initial proposal. So they had the capacity to access a detailed data room with all the information relevant to the business. We haven't asked for that to put a price forward. We've asked for simple information that will give us the capacity to assess near-term cash flow.

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Sholto Maconochie, CLSA - Analyst [33]

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All right. Makes sense. Then just I'll switch back to the operating business quickly, on the lease expiries I noticed that Health House you've got a DA conversion to student housing. Is that going to be sold, or you'll do it yourself, or how -- obviously it expired -- it's almost 2.7% of rent coming up in June 2017. Are they moving out straight away, or is that going to be extended, and how do you deal with that risk?

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Paul Weightman, Cromwell Property Group - MD and CEO [34]

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Watch this space. I think it goes back to my previous comment that that's an asset that sits in our trading value-add pool. We bought it well. We've had a bucket load of income coming off it over the last four or five years. The leases expire in June and November. That gives us the capacity to stage development. There is also third-party interest in the asset, so we're at the stage where we are making decisions to optimize the value and return that we've made from the investment.

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Sholto Maconochie, CLSA - Analyst [35]

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But the government is moving out in June and November for the two buildings?

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Paul Weightman, Cromwell Property Group - MD and CEO [36]

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I expect so. They've -- despite the fact that government from time to time makes decisions that may not be long-sighted, I doubt that they're going to stay in those assets. Frankly I think it's at a stage where if we're going to develop them, it's an opportune time to do so.

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Sholto Maconochie, CLSA - Analyst [37]

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But you'd obviously bring in third-party capital for that.

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Paul Weightman, Cromwell Property Group - MD and CEO [38]

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I think we've previously announced that if we proceed with a student accommodation fund, that we have support from Redefine and another investor to do that. So it's an asset that sits unencumbered in our balance sheet. It gives us the capacity to generate the capital to give us more firepower to do other things, or it gives us the opportunity to roll that investment into a fund with other co-mingled capital.

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Sholto Maconochie, CLSA - Analyst [39]

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Yes. Thanks. All right, that's everything from me. Thanks very much for your time.

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Paul Weightman, Cromwell Property Group - MD and CEO [40]

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Thanks Sholto.

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Operator [41]

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(Operator instructions) It seems we have no further questions on the line today. I would now like to hand the conference back to Mr. Weightman for closing remarks.

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Paul Weightman, Cromwell Property Group - MD and CEO [42]

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All right, thank you very much Vincent, and thanks to everybody for participating in the call. We look forward over coming weeks to meeting with most of you and to addressing any further specific questions that you have at that time. Thank you and good morning.

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Operator [43]

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Ladies and gentlemen, that concludes our conference for today. We thank you all for your participation. You may now disconnect.