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Edited Transcript of DXS.AX earnings conference call or presentation 14-Aug-19 12:00am GMT

Full Year 2019 Dexus Earnings Call

Sydney Aug 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Dexus earnings conference call or presentation Wednesday, August 14, 2019 at 12:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Alison C. Harrop

Dexus - CFO

* Darren Joseph Steinberg

Dexus - CEO & Executive Director of DEXUS Funds Management Limited

* Deborah C. Coakley

Dexus - Executive General Manager of Funds Management

* Kevin L. George

Dexus - Executive General Manager of Office

* Ross G. Du Vernet

Dexus - CIO

* Stewart Hutcheon

Dexus - Executive General Manager of Retail and Industrial

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Conference Call Participants

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* Benjamin J. Brayshaw

JP Morgan Chase & Co, Research Division - Analyst

* Darren Leung

Macquarie Research - Analyst

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Presentation

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Operator [1]

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Thank you for standing by, and welcome to the Dexus 2019 Annual Results Conference Call. (Operator Instructions) I would now like to hand the conference over to Mr. Darren Steinberg, CEO. Please go ahead.

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Darren Joseph Steinberg, Dexus - CEO & Executive Director of DEXUS Funds Management Limited [2]

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Good morning, everyone, and thanks for joining us today.

Before I get into the results, I'd like to start with saying how pleased I am with this year's performance, building on the strategy we set out to achieve some 7 years ago. These results clearly show that we are focused on adding value and setting up the growth for the future. Over the next 20 minutes, we will show you that our strategy is on track and has delivered in FY '19 and how this translates into the opportunities for FY '20 and beyond.

Today, you will hear from Alison on the financials, Kevin talking through the strength of the office portfolio. Stewart will talk to our industrial portfolio highlights. Ross will talk about our growing development pipeline, and Deb will cover our funds management business.

I will start with the mega trends that support our strategy and will contribute to our success over the long-term. These include urbanization and growth in pension capital flows. As we've mentioned before, an investment in Dexus is an investment in cities, which is why urbanization represents an opportunity for us as we look to unlock value through acquisitions and developments in and around key economic and transport hubs. When we look at pension flows, we're seeing the growing dynamic in the chase for quality real assets with Australia's key cities now regarded as core investment markets from a global perspective. These mega trends support our objectives of leadership in office and being a wholesale partner of choice.

Turning to the many highlights for the year, some of which were strong leasing resulting in higher occupancy and pre-commitments and developments, maintaining a conservative balance sheet, improved customer sentiment with our fantastic Net Promoter Score result in line with global leading brands and new third-party capital partners attracted to our funds management business. We've also achieved results within our workforce and from an environmental perspective. We've been externally recognized for gender equality, and we have progressed our goal for net 0 emissions by 2030.

It has been a significant year of transaction activity, reinforcing our active approach to portfolio management. You can see that most of these transactions have occurred alongside our third-party partners. Overall, we transacted $3.9 billion, which included $3.1 billion of acquisitions and $800 million of noncore asset sales recycling capital.

We increased our office exposure in core markets while enhancing our embedded pipeline of office development projects in the CBDs of Melbourne and Sydney. The opportunities included acquiring the remaining 50% of the MLC Centre Sydney alongside DWPF, giving us control of one of Sydney's landmark assets that will directly benefit from significant capital investment in the Martin Place precinct -- and pleasingly, the tower is now 99% occupied -- securing properties located in the tightly held Paris end of Collins Street in Melbourne, including 52 and 60 Collins, which we will look to consolidate into a large prime office development; and the 80 Collins Street development, a rare opportunity to invest in a whole block precinct. And finally, we acquired 3 properties providing the opportunity for an office super site, incorporating 56 Pitt Street in Sydney, which Ross will cover shortly.

I'll now hand you over to Alison.

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Alison C. Harrop, Dexus - CFO [3]

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Thanks, Darren, and good morning, everyone. I'm pleased to say that in what was an active year, we have delivered distributions in line with our guidance set at the start of the year.

Turning to the composition of the result. Each of our key earnings drivers contributed positively. Our property portfolio delivered AFFO of $583.5 million, and Kevin and Stewart will talk to like-for-like income across the portfolio shortly. Our funds management business generated $54.6 million, up on last year and ahead of our original guidance. And we delivered trading profits of $34.7 million after-tax from the sale of 32 Flinders Street in Melbourne.

Valuation increases of $773 million were up 5.8% on prior book values albeit lower than the revaluation uplifts booked in the prior year. Investment demand for quality office and industrial properties combined with a [lower] for longer interest rate environment continues to flow through to our capital values. And our weighted average cap rates are now at 5.15% for office and 5.92% for industrial. In office, rental growth drove more than 60% of the portfolio's valuation uplift. Going forward, we expect further value gains off the back of cap rate compression and rental growth.

Looking at the key financial metrics in more detail. Office property FFO increased, enhanced by acquisitions, most of which settled late in the year, and offset by the full year impact of divestments which have enabled us to recycle capital into higher-return opportunities, the vacancy at 240 St Georges Terrace and the delayed tenant payment. Industrial property FFO increased due to developments coming online and particularly strong one-off income achieved across a number of properties offset by divestments.

Management operations income increased due to the establishment of the Dexus Australian Logistics Trust, acquisitions and revaluation growth offset by bidding costs for an above-station development opportunity. Finance costs reduced primarily due to capitalized interest on 240 St Georges Terrace and a lower cost of debt. Our management expense ratio, which we calculate on the gross assets earned by Dexus, reduced to 30 basis points on the back of increased valuations. The underlying business, excluding trading profits, delivered FFO per security of $0.629, up 3.8%. Distribution per security increased 5% to $0.502, and the valuation gains across our total property portfolio were the primary driver of the $0.84 increase in NTA per security to $10.48.

Moving on now to capital management. This year, we continued to improve the diversity of our funding sources with the issue of $425 million of exchangeable notes to fund our 25% interest of the MLC Centre acquisition. We also completed a $900 million institutional placement and $64 million security purchase plan which was upscaled from the original $50 million cap in order to meet demand. The equity raising enabled us to acquire 80 Collins Street in Melbourne while keeping our gearing low. At 24%, gearing is below our target range of 30% to 40% and provides us with the capacity to fund committed projects in our development pipeline and also future opportunities where we see an efficient use of our capital. Our average debt duration remained high at 6.7 years. We have manageable short-term refinancing needs, and our cost of funds at 4% continues to benefit from low interest rates.

Thank you. And I will now pass you on to Kevin.

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Kevin L. George, Dexus - Executive General Manager of Office [4]

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Thanks, Alison, and good morning. It's been an excellent year for the office portfolio, which is well positioned as we enter FY '20. As Darren mentioned, our transactional activity over the year has enhanced portfolio quality. We divested noncore assets in Macquarie Park in Canberra and reinvested in the buoyant Sydney and Melbourne office markets. In particular, we have sought to increase our Melbourne footprint in the right location.

Like Sydney, Melbourne continues to benefit from record infrastructure investment and is underpinned by strong population growth, which is forecast to see it overtake Sydney as Australia's largest city by 2026. Securing high-profile sites in Sydney and Melbourne gives us the opportunity to develop landmark office towers that will generate significant value for the group. Ross will cover these shortly. In other core markets, improving conditions in Perth and Brisbane supported significant leasing activity across our properties.

Turning to our office portfolio metrics. We leased close to 190,000 square meters across the portfolio with an additional 53,000 square meters across development projects, locking in future income streams. Office portfolio occupancy increased to 98% driven by leasing in our largest market, Sydney, as well as Brisbane. Our developments in North Sydney and Perth achieved strong leasing with 100 Mount Street now 96% committed after completing in May this year and 240 St Georges Terrace now 93% committed.

Across the portfolio, like-for-like growth was 3.4% on a net effective basis, which was affected by vacancy at Sydney Olympic Park as well as a tenant dispute in Queensland with timing for receipt of proceeds uncertain at this stage. The Queensland space has already been leased to a new customer who is now in occupation. We continue to capture the strong market rent growth over the last few years as evidenced by re-leasing spreads of 24% across our Sydney CBD portfolio and average portfolio incentives reduced to 13.4% on a gross basis. This year's strong performance has contributed to a 10.6% portfolio total return at 30 June with the portfolio outperforming the MSCI benchmark to 31 March over 3 and 5 years. For FY '20, our focus is to extend our weighted average lease expiry and maximize AFFO across the portfolio, and we expect office like-for-like income growth of 4.5% to 5.5%.

We have embedded upside from our diversified office lease expiry profile with a great opportunity to reset almost 165,000 square meters of space in our Sydney portfolio, which is 8% under-rented between now and the end of FY '22. This represents 23% of office portfolio income. Looking to our key FY '20 expiries, we have already sold 3/4 of the impending expiry at 30 The Bond with minimal downtime, and we are well progressed on the remainder of this space.

Customer centricity remains our primary focus as we continue on our journey of building the world's best office platform. At Dexus, we believe that a focus on better customer outcomes will support a better culture and underpin better performance. Pleasingly, this approach is reflected in the results of our latest customer survey where we achieved a strong customer Net Promoter Score of plus 46, which was a 14-point improvement on last year, and a customer satisfaction score of 8.6 out of 10.

Our customer community is responding well to the products and services we provide to help their workforce engagement and productivity. On this theme, last week, we announced that we had acquired the Australian operations of Six Ideas, a strategic workplace consulting and change management service that we offered to both our office customers and other businesses locally and offshore. For Dexus customers, this new service complements our project delivery group, which provides project management and delivery of new workplace environments. We continue to expand our flexible space products with our fifth Dexus Place set to open in Perth as part of the redevelopment of 240 St Georges Terrace.

Looking to the year ahead. We're conscious that greater global uncertainty could affect office demand in the short term. However, we haven't seen any impact on leasing or inquiry levels in our portfolio at this stage. We expect rent growth in Sydney and Melbourne to taper after strong gains. However, we are confident that we can capture upside in our portfolio in the near-term from the exceptional market rent growth of the last few years. Brisbane and Perth are in the recovery phase of their cycles and are set to benefit from below-average levels of supply over the next 3 years.

Thank you. I'll now hand you over to Ross.

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Stewart Hutcheon, Dexus - Executive General Manager of Retail and Industrial [5]

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Thanks, Kevin. Stewart Hutcheon speaking, talking to industrial. Good morning, everyone.

The industrial portfolio has had a strong year, continuing to benefit from an uptick in logistics and e-commerce demand. As mentioned at the half year, we have brought together the teams in our industrial and retail portfolios to better leverage the synergies and our customer relationships that are common to both sectors. The collaboration of both teams provides our retail and industrial customers with a fully integrated property experience, supporting them through their entire property journey.

Taking a look at the portfolio metrics. Our team leased around 325,000 square meters of industrial space. Portfolio occupancy remained high at 97%, albeit slightly down from FY '18. Incentives reduced to 11.7%. We delivered portfolio like-for-like income growth of 8%, a high result due to one-off income achieved above forecast. Excluding one-offs, this growth was 2.5%. Our portfolio achieved a 1-year total return of 12.9% for the year to the 30th of June, and to 31 March, outperformed the MSCI benchmark over the 1- and 3-year periods. We expect strong demand for industrial space to continue driven by the growing e-commerce thematic and ongoing supply chain investment. Our focus for FY '20 is to maximize synergies across our customer base, and we expect industrial like-for-like income growth of 3% to 4%, excluding one-offs.

I'll now pass you over to Ross.

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Ross G. Du Vernet, Dexus - CIO [6]

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Thanks, Stewart, and good morning, everyone. Our development business continues to go from strength to strength with some significant projects completing this year as well as our continued progress on the development pipeline, which is largely focused at extracting value from existing assets in the portfolios we control.

It is a really exciting time for our development business with the development and concept pipeline sitting at $9.3 billion. This comprises $1.8 billion of committed projects, for which the balance sheet accounts for about half; $5.3 billion of uncommitted projects; and more than $2.2 billion of further projects, which represent a significant long-term opportunity for the group. These include our unsolicited Central Station project here in Sydney; the Ward Street precinct in North Sydney, where we control key sites within this new mixed use precinct which is undergoing redesigning and is adjacent to the new Victoria Cross Metro Station; and Axxess Corporate Park in Melbourne, which is a 20-hectare site located in close proximity to Monash University and which is a future town center.

Importantly, the development pipeline includes landmark office projects in each of the East Coast CBDs. It's well positioned to benefit from transport-related infrastructure. It's income-producing in the predevelopment phase, and it's aligned with our funds management business. 48% of the pipeline is already in a JV-type structure with our existing third-party clients.

The completion of 100 Mount Street was a major milestone for Dexus and our wholesale fund, and it was great to see many of our investors seeing the project firsthand on the recent asset tour. We achieved an unlevered project IRR close to 40% and a yield on cost of 7.8%. We beat our underwrite on both rents and let up time with the project 96% leased, and we achieved rents of up to $950 per square meter net in the high rise.

Touching on the key office development opportunities which will see Dexus play a significant role in the evolution of Australia's major cities. At 60 and 52 Collins Street in Melbourne, which we acquired during the year, we are progressing with plans to lodge a DA for a circa 27,500 square meter premium office tower opposite our recent acquisition at 80 Collins Street. Subject to planning approvals, the earliest this project would complete is 2026. Also in Melbourne, at 180 Flinders Street, we are now more than 80% leased on this very unique office development which adjoins Flinders Lane.

In Sydney, we were very pleased to be able to finalize the amalgamation of a key development site around our existing asset at 56 Pitt Street which, under proposed changes to the Sydney planning laws, will allow for a tower of up to 310 meters and circa 120,000 square meters of NLA. This really is a remarkable opportunity for the group and has just taken us 4 years to consolidate. Also in Sydney, we continue to make good progress with our unsolicited proposal at Central Station and expect a conclusion to the USP process next year. In Sydney -- sorry, in Brisbane rather, following feedback from stakeholders, we've amended our scheme at the Waterfront precinct, and we are targeting conditional agreements with the government before year-end.

Our progress in CBD development should not overshadow the momentum we are having in our industrial development business. During the year, we completed over 67,000 square meters of projects and secured 135,000 square meters of industrial development leasing. As you can see on the slide, we had good momentum at the Foundation of stake in Truganina -- also known as Laverton in Melbourne -- with the completion of the base building for Dunlop and leasing deals across a further 84,500 square meters for the year. We now have just 19,000 square meters of developable product remaining in this precinct.

Looking ahead, our entire leasing effort in West Melbourne will shift to Ravenhall, which we acquired last year, and we secured our first commitment with a food manufacturer over 35,000 square meters. In New South Wales, we achieved planning approval for the infill site at Granville. And at the Quarry in Greystanes, we completed the final stage of Quarrywest.

Turning to trading. In early last week, we did announce that we've reached agreement to sell 201 Elizabeth Street here in Sydney. The sale across 2 tranches follows an extensive process which consider the sale of various interests in the resi/hotel project along with an outright sale. The sale delivers circa $34 million of pretax profits to be realized in FY '20 and a further circa $34 million in FY '21. Considering the softening in the residential market, this provides the best risk-adjusted returns for the project. We've also progressed the sale of the North Shore Health Hub to a health care property fund, HWPF, on a fund-through basis, which we forecast to deliver trading profits across FY '20 and 21.

Through the sale of the first tranche of 201 Elizabeth Street and the fund-through sale of the North Shore Health Hub, we expect to deliver on our FY '20 trading profit guidance of $35 million to $40 million. Our focus on trading is shifting to FY '22 and beyond, which gives the team the capacity to progress and convert the significant opportunities in our core development portfolio.

Thank you, and I'll now pass you over to Deb.

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Deborah C. Coakley, Dexus - Executive General Manager of Funds Management [7]

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Thank you, Ross, and good morning. We continue to build a high-quality diversified funds management business that provides Dexus with a steady income stream and the ability to invest alongside like-minded capital partners on both acquisitions and developments. We're pleased to have attracted partners who are drawn to our multi-sector capability and our ability to drive performance in their investments.

Taking a closer look at the business, we've grown funds under management to $16.2 billion on behalf of 79 partners. Our diversified platform includes 7 vehicles across the office, industrial, retail and health care sectors. Over the year, we welcomed 12 new investors and over the past 7 years, we have attracted $9.2 billion of third-party equity.

Our new investors have enabled us to strengthen our position through the launch of a new fund and participation in a number of acquisitions. We welcomed GIC as a foundation investor in the newly created Dexus Australia Logistics Trust, a $2 billion portfolio seeded with assets from the listed industrial portfolio. We also introduced M&G Real Estate to the Australian -- sorry, to the Dexus Industrial Partnership and extended the partnership's investment period to accommodate a new growth mandate.

Employees Provident Fund of Malaysia joined HWPF and enabled the fund to progress the acquisition of the North Shore Health Hub as mentioned by Ross. And DWPF attracted 9 new investors during the year, including 6 investors who joined through the $340 million equity raise to fund the acquisition of the additional 25% interest in the MLC Centre Sydney. These new partners will benefit from access to Dexus' capability and scale and our ability to co-invest alongside them.

Thank you, and I'll pass back to Darren.

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Darren Joseph Steinberg, Dexus - CEO & Executive Director of DEXUS Funds Management Limited [8]

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Thanks, Deb. Our portfolio will continue to benefit from positive market dynamics with the source of embedded value in our development pipeline across mixed uses and locations. Our diversified funds management business has built-in organic growth within existing and newly established funds and will also benefit from continued growth in pension fund capital flows. And in trading, we have contracted trading profits for FY '20 with a line of sight to future profits.

So to conclude, it's been a great year. We are on track in achieving results. We ended the year with a clear strategy and readiness to respond to both market opportunities and challenges, and I'm proud of how the team has performed over the past 12 months. Even more importantly, we are well-positioned for continued success despite increased economic uncertainty. We have high portfolio occupancy with fixed rental increases, limited supply in our core markets and the Australian office yield spread to bonds remains attractive from a global perspective. We've also locked away trading profits for the next 2 years. Taking all of this into account, we are confident of delivering on our market guidance for the 12 months ended 30th of June 2020 of distribution per security growth of circa 5%.

Thank you. That now ends the formal part of today's presentation. We'll now turn to questions. Please direct your questions to me in the first instance and clearly state your name prior to asking a question.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question today comes from Darren Leung, Macquarie.

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Darren Leung, Macquarie Research - Analyst [2]

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Just a quick one from me. In office, comp NOI guidance is 4.5% to 5.5%. Does that include the payment from that lease tail that was meant to be in FY '19?

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Darren Joseph Steinberg, Dexus - CEO & Executive Director of DEXUS Funds Management Limited [3]

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Alison, do you want to pick that one up?

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Alison C. Harrop, Dexus - CFO [4]

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Obviously, that matter is before the court, so we can't comment directly. However, you can assume that we have made some assumptions around that for the purposes of the guidance for FY '20. I probably can't comment more than that though, Darren.

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Darren Leung, Macquarie Research - Analyst [5]

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That's fine. But is it fair to say that payment hasn't been received and as a result, it's not in the FY '19 numbers?

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Darren Joseph Steinberg, Dexus - CEO & Executive Director of DEXUS Funds Management Limited [6]

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No, it hasn't been received.

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Alison C. Harrop, Dexus - CFO [7]

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Yes, not received yet.

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Darren Leung, Macquarie Research - Analyst [8]

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Okay. So I mean, to -- I suppose an extension of that is if you can't make any assumptions around it, it's factored into your '20 number. I mean is your '20 number, excluding that payment, almost like 1% lower?

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Alison C. Harrop, Dexus - CFO [9]

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No. As I said, I can't really comment on the amount that we've assumed for FY '20 at the moment given the matter's before the court. But we have made a reasonable assumption. That's probably all I can say.

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Darren Leung, Macquarie Research - Analyst [10]

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And I might have missed it on the call, but the industrial one-off income, can you remind us what that payment was?

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Darren Joseph Steinberg, Dexus - CEO & Executive Director of DEXUS Funds Management Limited [11]

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Stewart, do you want to comment on that?

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Stewart Hutcheon, Dexus - Executive General Manager of Retail and Industrial [12]

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Yes, so the 8% down 2.5% is relative to several one-offs across several properties around surrender payments and some insurance payments. I think that's -- that probably covers it, Darren.

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Darren Leung, Macquarie Research - Analyst [13]

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Just a final one in terms of management income. There's obviously the $3.5 million of bid costs. All else being equal, should I think about management income being $3.5 million higher?

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Alison C. Harrop, Dexus - CFO [14]

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Yes, look, I guess essentially, yes, we're obviously doing very well in that business. We've had growth this year in funds and property management, some acquisition, strong leasing, et cetera. So yes, we've -- luckily, we're able to absorb that $3.5 million. But yes, in essence, that's how you should think of it.

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Operator [15]

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Your next question comes from Ben Brayshaw, JPMorgan.

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Benjamin J. Brayshaw, JP Morgan Chase & Co, Research Division - Analyst [16]

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I was wondering if you could give an update, please, or a bit more color on the 2 major development projects that you have in your pipeline in Sydney and Melbourne, specifically, 52 and 60 Collins Street and 56 Pitt Street in Sydney, just where each scheme is in its potential planning and approval process and when you expect to be in a position to potentially commence each one of those projects, please.

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Darren Joseph Steinberg, Dexus - CEO & Executive Director of DEXUS Funds Management Limited [17]

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Ross, do you want to pick that one up?

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Ross G. Du Vernet, Dexus - CIO [18]

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Thanks, Ben. I'll start in Sydney given that we're sort of yet to complete on the final acquisition. It is still some time away. We are working through the planning process at the moment, so we will hopefully lodge a DA in the course of the next 6 months. And that process will, I expect, take probably close to a couple of years. So it will be -- I don't think it's [I shouldn't say] in terms of cycles, but it's going to be probably mid-2020s before I think you see that project kicking off.

Talking to Melbourne, I did make a comment on the call that we didn't see this project really complete until the mid-2020s. This is really driven by 2 things. One is just the timing of lease expiries in the buildings that we bought. So we're not really in a rush. We do have income on those properties, and so we're working steadily through that. That being said, we are progressing, as I've mentioned, securing, I guess, a base scheme, which is 27,500 square meters of NLA and that DA will be lodged over the coming weeks.

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Operator [19]

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There are no further questions registered at this time. I will hand back to Mr. Steinberg for closing remarks.

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Darren Joseph Steinberg, Dexus - CEO & Executive Director of DEXUS Funds Management Limited [20]

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Thank you, everyone, for joining us today. And we look forward to catching up with many of you over the coming weeks. Thank you. Have a good day.