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Edited Transcript of GRI.L earnings conference call or presentation 27-Nov-19 9:45am GMT

Full Year 2019 Grainger PLC Earnings Call

Newcastle Upon Tyne Dec 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Grainger PLC earnings conference call or presentation Wednesday, November 27, 2019 at 9:45:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew Saunderson

Grainger plc - Director of Investment and PDMR

* Helen C. Gordon

Grainger plc - CEO & Executive Director

* Vanessa Simms

Grainger plc - CFO & Executive Director

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Conference Call Participants

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* Christopher James Millington

Numis Securities Limited, Research Division - Analyst

* Keith Crawford

Peel Hunt LLP, Research Division - Analyst

* Kieran Adrian Lee

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Miranda Sarah Cockburn

Panmure Gordon (UK) Limited, Research Division - Analyst

* Sander Bunck

Barclays Bank PLC, Research Division - VP of Real Estate Equity Research

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Presentation

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Helen C. Gordon, Grainger plc - CEO & Executive Director [1]

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Thank you for those that have been waiting patiently. Good morning, everyone, and welcome to Grainger's Full Year Results. I'm pleased to report that this has been a year of growth and further transformation for Grainger. We have a strong set of results. Our pipeline of new developments is now flowing and our income is further boosted by our GRIP acquisition that we made earlier this year.

This business now has more revenue delivered through strong resilient net rental income than sales. We have doubled our net rental income since the start of the strategy, and we're well ahead of plan.

So we've achieved a lot this year. So we're going to have a full presentation today as you can tell by the weight of the packs. So the format for this morning is that I will take you through the highlights and, in particular, the progress we're making on our pipeline, why it has been a transformational year for Grainger, and the successful acquisition and integration of the GRIP portfolio. Vanessa, our CFO, will take you through the financial review. She'll explain in more detail how we have assimilated GRIP into our portfolio and she will take you through our exciting investment in our CONNECT technology platform. I'll then update you on the market and Grainger's approach to it as well as a deeper look at our business, and in particular, our new portfolio.

And as we live in changing political times, I'll run through the 3 main political parties' headlines on housing, and we'll then have an opportunity for Q&A, and I'll ask Andrew Saunderson, our Director of Investments; and Mike Keaveney, our Director of Land and Developments, to join us in answering your questions.

The quality of all new products is exceptional. At Grainger, we believe a good home is essential to people's well-being and can enrich their lives. The Grainger team are committed to delivering great homes and great customer service. The sector that we operate in delivers compelling long-term returns. Its growth in returns are strongly linked to inflation. Its resilience is underpinned by the demand for good rental housing, which is growing at a time when the supply is shrinking. This is a vast market opportunity to professionalize the sector and Grainger is leading in this.

We are the largest operator, but we also have a GBP 2 billion pipeline. We have designed our business to respond to the sector's needs by researching the best locations, delivering great customer service, accessing land through partnerships and organizing our balance sheet and technology to continue to lead. So this year is one of strong performance. Our profit before tax is up 30% at GBP 131.3 million. Our adjusted earnings are in line with expectations at GBP 82.5 million, and this is slightly below last year, which was boosted by the sale of our WIP joint venture.

Our net rental income is up 45% at GBP 63.5 million, and our like-for-like rental growth is up -- it's 3.6%. And on our PRS portfolio, we're up to 3.4%, up from 3% last year.

We have a total property return of 5%. And this year, we have delivered exceptional growth in our income through our acquisition of the GRIP portfolio and our new building program, which we started constructing 3.5 years ago and is now delivering at pace. We have commissioned and launched 1,152 homes in this financial year. And this year, we were selected by TfL as its partner on its London estate, which has an initial seed portfolio of 7 sites, which is 3,000 homes. And this, together with our other partnerships, is going to boost our pipeline from 2021.

Our regulated portfolio continues to be resilient. We have GBP 302 million of additional value in our reversionary surplus, and the majority of that is in our regulated portfolio. And that, of course, is not included in our NAV, and this is even after we've crystallized GBP 23 million of that reversionary surplus during the year.

Our operational platform continues to improve, delivering outperformance, and our gross to net figure on our stabilized portfolio was down to 25.2%. We're leading in technology to further enhance our operational platform through our CONNECT program, which Vanessa is going to take you through later.

I am particularly pleased that we have continued to make progress in our ESG achievements, achieving second place in all residential property companies across Europe in our GRESB benchmark.

So overall, it's been a year of strong performance. I said it's been a transformational year. Last year, when I presented the results to you, we had GBP 591 million investment in our operational PRS portfolio. Today, we have GBP 1.525 billion, almost tripling our portfolio, and we have a further GBP 2 billion in the pipeline. This business is now predominantly a PRS business. The balance of earnings is predominantly now rental.

We're delivering way ahead of our plan of less than 4 years ago. And part of that transformation has been the acquisition of the GRIP portfolio. The portfolio is now fully integrated and with the 1,152 new homes, we have a passing rental of GBP 70 million per annum. But we're also building for tomorrow.

We have our partnership with TfL, which is now signed, and we're preparing our first projects for planning, and we're delivering over 1,000 new homes again next year. And as Britain's leading residential landlord, we're taking our leadership on sector engagement with the government and with opinion formers to make our sector more resilient in the longer term.

To support this transformation, we're investing in our operational platform, our investment in the CONNECT -- in CONNECT and by continually enhancing our processes which -- whilst focusing on cost. I'm particularly pleased about the improvements that Grainger team has made to the gross to net reductions delivered this year and also about the improvements in service levels the team have delivered during the year at a time where we've kept our overheads and costs stable. We continue to optimize our capital structure, and all of this activity supports our ability to scale this business further and to get the operational leverage and benefits of scale.

Part of our transformation was the acquisition we announced here a year ago of a high-quality London and South East portfolio, GRIP. And last year, we said this portfolio has a strong strategic fit. It will give scale to our business. We can leverage our -- the operational synergies, and it will bring financial benefits to the group, and most importantly, to shareholders.

We've delivered on all of those promises. We also said that it had a number of value-add opportunities, and the portfolio was positioned 8% below average London rents despite its high quality. I'm pleased to say that the GRIP acquisition has been -- enabled us to deliver enhanced returns from day 1.

We said we'd deliver income growth and it's added GBP 17.7 million of additional rent in the 9 months of ownership. In terms of like-for-like growth in the 9 months that we've owned GRIP, we've seen a 3% increase, and that's way ahead of the market. This acquisition transformed our portfolio so that now the majority of it is PRS income. We have fully integrated GRIP into our business.

When we acquired it, we said that we saw GBP 70 million of added value. We've already delivered GBP 13.6 million, and we still have the development profits to come. The preemption in the previous GRIP structure restricted Grainger's growth in London and the South East. The acquisition of GRIP enabled investment in this area on our own balance sheet which, of course, includes the assets that we hold with TfL. And in addition to TfL, we have already secured GBP 103 million of assets in London and the South East.

We said, overall, that this new resilient income stream would improve our credit rating, and I'm pleased that S&P gave us an upgrade shortly after we've completed the acquisition in December 2018.

Now Vanessa is going to take you through more of the details around the financial impact, but overall, this has been a successful acquisition for Grainger and has helped us to transform the business.

Turning now to our pipeline. We've made significant progress. As I mentioned a year ago, we had GBP 591 million in operational PRS. The PRS portfolio now is over GBP 1.5 billion. Our operational portfolio as a whole is GBP 2.6 billion, and we have a further GBP 732 million in our secured pipeline, which is nearly 3,200 homes, and GBP 683 million in planning and legals.

If we then add our share of the TfL portfolio of 3,000 homes, and that's another GBP 600 million of investment, you can see that the majority of our current portfolio and future portfolio by asset value is PRS.

Our regulated tenancies, whilst a very important source of revenue, will be a much smaller part of our business in the future. So when I look at Grainger's end of year review, as a result of the activities during the year and the investment over the last 4 years, we are a very different business that is performing well against a good market backdrop. And I'm going to hand over to Vanessa to take you through the details of the financials.

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Vanessa Simms, Grainger plc - CFO & Executive Director [2]

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Thank you, Helen, and good morning, everyone. This morning, I'll update you on our financial performance for the 2019 financial year and then I'll just take a few moments to run through our CONNECT platform.

We have delivered a strong operating performance in 2019. We have repositioned our income profile, and we've accelerated our growth strategy through the acquisition of GRIP, and our growth will continue as we are now delivering our pipeline schemes at pace.

Our earnings and balance sheet now have greater reliance on our PRS portfolio, which generates more resilient returns. We achieved 3.6% like-for-like rental growth, and our net rental income increased by 45% as a result of our investment activity and our strong rental growth.

In line with expectations, our adjusted earnings are below the prior year, and that's due to the timing of sales and a one-off profit on the sale of our WIP joint venture last year. In line with our policy to distribute 50% of our net rental income, the proposed full year final -- the proposed full year dividend will increase to 5.19p per share. And following the recent announcement from EPRA regarding the revised NAV measures, we have adopted these early, and we've included both the existing and the new measures in our results.

The EPRA net tangible asset value is the most appropriate measure for Grainger, and at the year-end, this stood at 278p per share. And in terms of our debt, our LTV remains at 37%, and our cost of debt has reduced further to 3% as we continue to look into the lower rates for the longer term.

And throughout 2019, the composition of our earnings has moved significantly with recurring net rental income now providing a greater contribution to our earnings and the residential sales profit. And this transition is a key component of our strategy, and it will grow further as our pipeline continues to deliver.

Our 2019 results include 9 months of net rental income from GRIP and our annualized passing net rent has increased to GBP 70 million, of which 70% of this is from our PRS portfolio. Our gross-to-net operating cost ratio at 26.1% reflects the higher ratios for the new PRS assets during the stabilization period, and this factors in the void and the letting costs.

Our operating efficiency has improved further with our stabilized portfolio gross to net at 25.2%. And we've continued to sell well despite an uncertain housing market, reflecting the resilience of the properties within our regulated portfolio.

We maintained our sales velocity, and we have sold ahead of valuation, albeit with lower volumes available for sale, following the strong sales performance that we had at the end of 2018 and a lower vacancy rate this year.

Our development for sale activity concluded this year. So going forward, as our PRS pipeline stabilizes, our development profits will be accounted for within the valuation gains. And our overheads remained flat despite the growth in our portfolio, and this is demonstrating the operational leverage that we have in our business model.

We've significantly grown net rental income this year. Our net rent increased by 45% as a result of the investment activity and achieving strong rental growth and maintaining strong operating margins. The GRIP acquisition, combined with the lease-up of new development completions, has added GBP 19.3 million. And our like-for-like rental growth of 3.6% is again ahead of the market. We saw 3.4% like-for-like rental growth in our PRS assets, and this compares to a 3% last year, and it reflects the quality of our offering and our operations.

The rental income on the regulated tenancies are RPI linked, and this has continued to perform well, with a 4.4% annualized rental growth.

And EPRA recently issued new guidelines on its definition for net asset values for adoption for next year. And on this slide, we've set out both the existing and the new NAV measures. I'm sorry to spring this one on you today, but we quite like being first.

So the revision includes the introduction of the net debt for net tangible assets, which in our view, is the most relevant net asset value for Grainger, and it will be our primary measure going forward. The EPRA net tangible assets reflect the tax that will crystallize in relation to the trading portfolio, and it excludes the volatility of the mark-to-market movements on our fixed rate debt and our derivatives, which are unlikely to be realized.

I think one point to note with the net tangible asset value measure is that it excludes the goodwill and the intangible assets. And whilst it's been our recent practice to write-off goodwill, the adjustment is, therefore, simply the intangible assets. And our intangibles are largely the investments in technology, which we know do add good value in an operating business.

And the reversionary surplus in our portfolio, again, is excluded from NAV metrics, and this stands at GBP 302 million, and it equates to an additional 49p per share before tax. And this bridge shows a movement in our net tangible asset value over the year. So our net rent, softer overheads contributed 7p per share, and our sales profit above the prior year market valuation has delivered 3p per share and our valuation growth has contributed 10p per share. Our overall valuation increased by 1.9% with our PRS portfolio delivering the strongest growth at 3.3%. And our regulated portfolio remained broadly flat on the prior year.

The majority of our PRS portfolio is valued on a net rent on a yield basis with rental growth, the key driver of our valuation. And as our PRS portfolio grows, our valuation will have greater alignment to rental growth, and this is further enhancing the strength of our balance sheet.

And our business model continues to generate strong cash flow, which supports our growth strategy and the reinvestment into our high-yielding PRS pipeline. Our net debt increased by GBP 239 million as a result of the GRIP transaction and bringing the GRIP debt onto our balance sheet. We have generated GBP 184 million of cash from operations. That's a result of our strong operating performance and the timing of the development sale proceeds. And during the year, we have also completed GBP 88 million of asset recycling, and we've invested GBP 235 million into our PRS pipeline.

In the coming year, we're planning to invest around GBP 350 million into our secured pipeline. And our capital structure remains in a strong position with the flexibility to support our growth. Our LTV remains at 37%, and we do expect to operate within our 40% to 45% target range in the coming year as we make significant investment into our PRS pipeline. And following the GRIP acquisition, we received an upgrade of 1 notch in our corporate credit rating. And we see a path to further improvement as our pipeline stabilizes.

We refinanced the GRIP debt with a GBP 275 million facility from Rothesay Life, reducing the cost of this facility from 3.2% to a blended rate of 2.3% for a 7 and a 10-year duration. And since year-end, we've also secured a new GBP 50 million facility with Wells Fargo for 5 years with two 1-year extension options. And our incremental cost of debt currently stands at 1.7%, and that's against a GBP 430 million headroom.

Our fully drawn cost of debt is 2.9%. And our funding strategy to diversify our sources of funding and secure a lower cost of debt for the longer term is well advanced. As our portfolio -- PRS portfolio grows, we will continue to align our debt structures with the growth in our investment assets.

And as Helen mentioned, we fully integrated GRIP into our business, and we are delivering ahead of our plans. Immediately, on the acquisition, we restructured the corporate entity, and we voluntarily exited the REIT regime, and then we delisted from the Jersey Stock Exchange. And that activity delivered a GRIP overhead saving of around GBP 4 million. And we refinanced the debt, as I've just mentioned, so reducing the cost of GRIP debt by more than 1/3.

And our detailed asset knowledge enabled us to integrate the portfolio into our operating platform immediately, and we have reduced the gross-to-net operating cost ratio from 32% to 25%, in line with the rest of our stabilized portfolio. And customer feedback has actually dramatically improved as a result of aligning the operations and removing that third-party approval process, and that's improving our responsiveness.

We've also delivered a 3% like-for-like rental growth over the 9 months of ownership, and this is feeding through into our valuations. And asset management plans have progressed well, adding GBP 13.6 million of value since acquisition. We recycled GBP 39 million of the GRIP assets profitably. We have -- refurbishment program is 60% complete, and that's been delivering a 10% profit on cost. And we've got 2 development schemes in progress at the acquisition, and they are both progressing well to budget and in line with our plan.

And since acquisition, we have secured GBP 103 million of additional PRS schemes, and we have a further GBP 175 million in the planning and legal process across London and the South East, which we now have the freedom to undertake on our own balance sheet.

And following the update today on our pipeline, this slide illustrates the net rental income progression as our pipeline stabilizes. Our passing net rental income now stands at GBP 70 million, which reflects a full year of GRIP and strong letting performance on the recent development completions. The annualized uplift in our passing net rent from our secured pipeline is shown here on the left of the graph, and this should increase to GBP 112 million as our secured pipeline stabilizes. And we anticipate an average stabilization period of at least 6 months after the new developments complete, and therefore, the reported income will lack the passing net rental income by a similar period.

So taking the schemes in the planning and legal process and all of the 7 seed sites in the TfL partnership, our net rental income has the potential to more than double where we are today. And this growth in net rental income underpins our dividend progression.

Over the past 12 months, we have accelerated our PRS growth strategy, and we have repositioned our earnings profile and our balance sheet. Our performance is increasingly aligned to rental growth, and our growth plans are delivering at pace. As we continue to grow our pipeline and take advantage of the structural growth opportunity within the private-rented sector, our operational leverage will continue to enhance our returns. Our integrated business model, our high-quality pipeline and our operating platform places us in an excellent position to continue to build on our leadership in the U.K. residential markets.

So that concludes our financial results. So I'll just take a few moments just to run you through our CONNECT operating platform.

Our CONNECT platform brings together the best-of-breed PropTech to optimize our operating capabilities and create the next step change for our business. Our CONNECT platform is being designed to deliver operational excellence, which will underpin our continued success, and that's through enhancing the customer experience; improving our operating efficiency, which is to increase the scalability of our platform and, importantly, protect our license to operate. And this is starting to deliver enhanced returns for our shareholders. As our pipeline is now delivering high-quality homes, our CONNECT platform will match this with a market-leading digital experience for our customers.

Our platform is being designed around our customer journey, and it will continue to differentiate our business through integrating our customer-facing technology with our back-end operating system and capturing the data to improve our business intelligence. And CONNECT is equipping all aspects of our business. We have already launched some of the elements of the digital platform within our new developments, and we will continue to roll these out across our portfolio over the coming months.

On this slide, I've shown the 8 core components of our technology. Our customer relationship management tool will improve our targeted digital marketing and it will speed up our conversion rates and reduce our void periods. We've seen the benefits of this already coming through in our recent development launches where we leased up Finzels Reach within 3.5 months. And we have successfully secured pre-leasing in Clippers Quay and in Brook Place in Sheffield.

And another exciting aspect to CONNECT is the introduction of a new revenue management tool. And this enables us to automate the dynamic property pricing and it will improve our rental yields. The main operating efficiencies are realized through the integration of our assets and our property and our financial management systems. And this integration enables the automation of high-volume activities contributing to the scalability of our platform and enhancing our productivity.

And in addition, our data will provide greater insight and analytical capabilities, which will enable continuous improvements and enhancements to our product, our operation and our future investments.

So here, I've just summarized the 4 key areas of benefit from our CONNECT platform. We've already started to see some of these enhancements in our operating platform improvements to our gross-to-net ratio and avoiding overhead increase as our portfolio grows. Our rental optimization will also enable us to maintain our rental growth ahead of the markets. And CONNECT will continue to provide Grainger with a leading operating platform and the benefits of operational leverage, and these will be magnified as our pipeline is delivered.

So after our Q&A session today, we'd welcome you to stay if you have the time. We just wanted to show a couple of short videos on CONNECT, which some of you may well have seen previously at our Capital Markets Day. So thank you for your time. I'll hand back to Helen.

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Helen C. Gordon, Grainger plc - CEO & Executive Director [3]

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Thanks, Vanessa. I opened this morning by talking about the strength of the investment case and the supply and demand imbalance within the market, and I thought it's worth spending a few moments just looking at that.

The PRS market is becoming more mature. In the years from 2000 to 2017, it's more than doubled. And demand is set to grow by a further GBP 2.7 million, but we're seeing a slowing of supply by our main competitor group, and that's the exodus of the small buy-to-let landlord. And the figures are even more dramatic this year with the fall from the peak of 120,000 buy-to-let mortgages being written down. So that's now down to about 50,000 per annum.

It's not just the entry of the larger-scale private landlord into the market, but it's the fiscal and regulatory changes, and the demands on the individual landlord in creating a high-quality rental product.

Yet demand for renting is growing across all age groups. So demand is rising and supply is falling. So -- also in our core market, London, the new housing supply overall is also falling significantly. And this all gives a strong backdrop, not only to our existing stabilized portfolio, but also our new portfolio coming through. So that's underpinning future returns.

Now it would be remiss of me during such a heightened time in politics not to mention where rental housing sits in relation to the 3 main political party manifestos. At Grainger, we spent time with all of the main political parties. And this shortage of housing and the housing crisis is one that is acknowledged and recognized across all parties.

From the time that we spent with them, we know that they are aligned across the political spectrum in wanting to see the delivery of more house building generally, but across all sectors, be that council housing, housing for rent and housing for sale.

So the Conservative Party are extremely keen on homeownership, but they are also strong supporters of professionalization of the build-to-rent sector. They acknowledge the role of build-to-rent, and recent Conservative policy has supported this with a more benign planning regime for the build-to-rent sector.

Labour is focused on building more council houses and has strongly supported the concept of tackling the dodgy landlord, and the support of the professionalization of PRS and improving management standards. Now the Labour manifesto does have reference to rent controls within it. The discussions with the Shadow Secretary of State for Housing indicates that they are supportive of the long-term professional landlord. In the manifesto, rent controls would limit regular uplifts within the lease with inflation, which is largely Grainger's current practice. Both the Labour and Conservative Party support long-term tenure, which, of course, is aligned with Grainger's view on customer retention.

The Liberal Democrats are also keen on improving rental standards and supporting the professionalization of the private-rented sector, but they support an initiative of Help to Rent, supporting the under 30s, which will enable them to start renting.

So all parties are supportive of the contribution our sector can make to the supply of housing, which is why we focused our dialogue on our leadership position in professionalizing the private-rented sector. Improving standards for rental housing across the U.K. and thereby improving lives, health outcomes and productivity is important for the country, and all 3 main political parties appear to recognize this.

I talked about the general backdrop and the large opportunity that we have, 2.7 million new rental homes are needed. And we are creating shareholder value by creating great homes. Now you will be familiar with our operational model, which is that we originate or develop the right product, we invest in the right locations and we operate our own homes keeping our customers close. It's replicating this model that is proving a barrier for entry for those wanting to access this market. But it is also this model that has helped to secure some of our key partnerships.

So first, starting with Originate. Our ability to create through development or forward funding our own product to our own specification is building quality and resilience into our long-term rental stream. 1,152 rental homes delivered this year and some great buildings, which I'm going to talk about in a moment.

In terms of investment, we continue to source great opportunities. Our capital allocation is continually refined and developed, and we have secured opportunities for schemes in all of our key cities and have started to develop clusters, which will give us more efficiency within the business. This pipeline of over GBP 2 billion of new stock in great locations is creating shareholder value.

And finally, in our operations, operating efficiently. Over the past year, we have focused on operating efficiencies. I was slightly skeptical as to whether we could get below the 26% gross-to-net mark. But this year, we're at 25.2% in terms of our gross to net on stabilized store, which is a remarkable achievement by the team, particularly as they have improved customer satisfaction at the same time. So the Grainger team is delivering excellent customer service. Complaints are down and repairs are responded to more quickly, and we're increasingly getting improved customer satisfaction scores. And this is important as we deliver more buildings across the U.K. so that we can create, within our home and platform, brand loyalty.

This slide shows how we focused on our investment priorities. It's our proprietary research and informs our investment decisions. We're looking at locations where there is strong existing demand and strong growth prospects. We annually review these cities. We are rigorous in our investment analysis, and we have a series of city champions, who not only look at the macro, but also the micro locations within a city. This approach has proved successful in sourcing great buildings, and we are seeing our clusters developing. And I can confirm to you that our underwriting is robust, as we are now delivering our schemes, and we're delivering rents ahead of our original underwriting.

Our sourcing success in new homes by this approach of rigorous investment analysis has delivered our existing and future pipeline and here are just some of the schemes with their timing. One of the most difficult aspects of delivering a portfolio is access to land, in part due to the competition from the housebuilders. And this is why we have developed the right credentials to access land in partnership with the public sector. Grainger is a trusted partner by the public sector. Not only do we have the experience of leading in the sector, but our business model of Originate, Invest and Operate enables us to partner without creating complicated consortium or third-party investment.

A highlight of this year was our partnership with TfL. This partnership has a shared vision to create high-quality rental homes in London connected to both communities and infrastructure. We documented and signed our partnership in under 100 days. As well as first-class sites, our partners are committed to leading in design, innovation and sustainability in our sector, and we are moving quickly with the sites going through the preplanning consultation at the moment, and we'll be submitting planning applications early in the new year. These 7 seed sites provide variety and are complementary to our existing Grainger portfolio.

Across our portfolio, we are delivering great homes. This year, 1,152, all of high quality and generating 5-star Google reviews. Our schemes at Clippers Quay in Manchester and Hawkins & George in Bristol are seeing strong letting performance, enhanced by our CONNECT lead-to-lease technology. Our suburban homes at Wellesley have been extremely popular with families and are leasing ahead of expectations. And our recently launched Brook Place in Sheffield has been getting great reviews on its amenity design and, in particular, it's gym.

So next year, we're looking forward to delivering Pontoon Dock in London, Silbury Boulevard in Milton Keynes, Gore Street in Manchester and Apex House at Seven Sisters. All well-connected, well-designed schemes with high standards, quality amenity and excellent ESG credentials.

Part of the key to our success in a high level of customer retention is the work that we put in to building communities. We see our rental homes as more successful with a strong community. It leads to lower churn, greater retention, more referrals, lower voids, less marketing, lower cost and improves our gross to net and also the way that the customers view the satisfaction within the building. In short, it maximizes our net rental income.

We have recently launched a program of continuous improvement into how we support our communities, how we improve our customer service and support the resilience of our communities in order that we outshine all of the local competition. And we believe great customer service is key because this business is a B2C business and is driven, therefore, by the level of customer service. It is, compared to many other real estate industries, intensive.

In the case of our new schemes, there are not many real estate opportunities where you get to meet your landlord on a daily basis, not just through technology, but actually in your building. We appreciate that housing is a critical human need and, therefore, when delivering good customer service, it is important that we are accessible and responsive.

Grainger's approach is to put service in-house where customers can interact with us on a daily basis, and this is still an unusual approach in the U.K. Less than 150,000 homes out of 4.5 million have this level of service. We're looking to enhance this through our use of technology and the CONNECT platform that Vanessa has described. And all of this integrated intensive in-house customer service enables us to improve our investments, inform our design and support our underwriting. And this is important for our shareholders as it delivers stronger, more sustainable rental income returns.

So in summary, it's been a year of transformation, further growth and strong performance. We've made a step change in our rental income and a change in the balance of our business. PRS is now the dominant part of our business. Furthermore, we have a good growth trajectory with successful partnerships and sites secured for the future and a positive pipeline that is now delivering and growing our resilient net rental income.

CONNECT will enable us to extend our leadership position. We're delivering well ahead of plan, and our momentum accelerates as we see exceptional returns for our shareholders in this sector.

Thank you. I'm now going to invite your questions. And we have various members of the senior Grainger team in the room, but I'd like to invite Andrew Saunderson, our Director of Investments; and Mike Keaveney, our Director of Land and Developments, to join us. For those listening in, I'm unable to take your questions, but please do e-mail me or my colleague, Kurt Mueller, and we will respond to them.

Has anyone got a question? We have overdone it with a 40-minute presentation.

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Questions and Answers

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Christopher James Millington, Numis Securities Limited, Research Division - Analyst [1]

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Yes, a few if I could, please. Firstly, I just wonder if you could just comment generally around the sales market in 2019. We hear a lot of noise around it. Your performance looks pretty good. And maybe in that, you could just tie in the reasons for the lower vacancy rates as well in the regulated portfolio and whether or not that's going to change as we look forward to 2020?

Second one is really just about what your plans are for asset recycling in 2020. It's kind of a key cash component to help the funding of the PRS pipeline?

And the final one is really just REIT conversion. This shift over towards rental income and away from sales income seems to be going a bit quicker than we all expected. So does that bring the potential REIT conversion forward? I understand it's not imminent, but just any thoughts on that?

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Helen C. Gordon, Grainger plc - CEO & Executive Director [2]

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Thanks, Chris. So yes, we talked a lot about income, but not as much about sales. I'll give the headlines, then I will ask Andrew to comment on that one. In terms of our regulated portfolio, you'll know there's a long-term average, about 6% comes vacant. We had a very strong end to the last year, and about a 5.9% vacancy rate this year. So in terms of our residents within our regulated tenancies, the average age is 79 for a single and 76 for a couple. So we might see some acceleration of that number over time. It was just literally the timing within the year, and then I'm going to ask Andrew to talk about the sales market generally.

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Andrew Saunderson, Grainger plc - Director of Investment and PDMR [3]

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Yes. So just in terms of the market generally, I think it's clear from what we're all seeing that transaction volumes are lower than they have been historically. But that, in a sense, doesn't not suit us because we are a definite seller. So when we place something on the market, we are there to sell it. We're not selling as part of a chain. So people do know that if they're looking at a Grainger property that they are -- it is therefore in the markets to buy. We're not just testing it to determine what the price is, so we can remortgage it or just know what our property is worth. We are there to sell, and we're demonstrating that we are able to sell and sales that we've undertaken since we started the new financial year are in line with valuation.

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Helen C. Gordon, Grainger plc - CEO & Executive Director [4]

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Your second question was about asset recycling, which is a discipline that we introduced into the business a couple of years ago or 3 years ago now. I think this is a good investment discipline when you actually take out the lower-performing assets. We recycled GBP 88 million this year. You probably -- that's probably a little bit higher than average. We recycled one of the GRIP assets. But on average, we're probably going to be running around GBP 50 million to GBP 75 million a year of asset recycling. But we do have potential to do that.

And then your third question, I'm going to pass to Vanessa, which is one that we discuss all the time, which is timing for REIT conversion.

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Vanessa Simms, Grainger plc - CFO & Executive Director [5]

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So in terms of REIT conversion, I would say, we'll probably be in the right position of the balance of our portfolio in about 5 years' time. I think that would be our estimate at the moment based on the run-off of our trading portfolio, which is our regulated assets and the pipeline as that comes through. Thinking about 5 years' time, that sort of seems like it's the right timing.

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Helen C. Gordon, Grainger plc - CEO & Executive Director [6]

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Other questions? Miranda?

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Miranda Sarah Cockburn, Panmure Gordon (UK) Limited, Research Division - Analyst [7]

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Miranda Cockburn from Panmure. Just one question on the capital growth on the valuation. PRS portfolio is up 3.3%. Obviously, most of that was from the rental growth coming through. Was there anything from developments? Or this is your development completions? Any uplift from that?

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Helen C. Gordon, Grainger plc - CEO & Executive Director [8]

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Vanessa, do you want to take it?

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Vanessa Simms, Grainger plc - CFO & Executive Director [9]

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Yes. So we still have about 23% of our PRS assets valued on an HPI basis rather than a rent on a yield basis. So these are the assets that have fewer units within them, so they're still valued on a discount to vacant possession value. So usually, it's somewhere between 0% and 5% discount to the vacant possession value. And -- so those have tracked HPI and then about the remaining is what's tracked the rental growth. So they're at sort of 3.2%, 3.3%, in line with the rental growth. And then we had about GBP 16 million, GBP 17 million of development profits recognized in the year, which, so overall, is a similar figure.

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Helen C. Gordon, Grainger plc - CEO & Executive Director [10]

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Questions? Keith?

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Keith Crawford, Peel Hunt LLP, Research Division - Analyst [11]

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I'm trying to get my brain around the enormity of the efforts you're making. It is a huge undertaking this. And as I understand it, you're tilted towards the middle market for your tenancies and all the associated services, which are essential now, of course, particularly computers, preferably not crashing on a Monday now -- which the world does. So I also very much appreciate this to the -- Page 7, I think the indication of the GRIP acquisition is very interesting. And your comments on politics, that's fun, of course. Unfortunately, there are some dodgy politicians as well as some dodgy landlords. So it's -- just turning that into detail that would be murder. But anyway, we live in that world, unfortunately. So that's that. And congratulations, very interesting.

And just your -- I think being market leader is very interesting. It's a highly fragmented, and there seem to be quite a lot of strange people wanting 10,000 units, hundreds of them apparently. So that's all very interesting. I just wanted to ask you, I didn't get in my own mind, what proportion of your projected portfolio, including what your -- was in legals, you hope will be in London and the South East? What proportion of the PRS do you think broadly, broadly?

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Helen C. Gordon, Grainger plc - CEO & Executive Director [12]

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It's pages -- at the back of the pack, you've got...

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Vanessa Simms, Grainger plc - CFO & Executive Director [13]

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50.

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Helen C. Gordon, Grainger plc - CEO & Executive Director [14]

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Yes. It's about 50%.

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Vanessa Simms, Grainger plc - CFO & Executive Director [15]

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Page 50.

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Helen C. Gordon, Grainger plc - CEO & Executive Director [16]

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Yes. But it's -- at the moment, it's about...

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Vanessa Simms, Grainger plc - CFO & Executive Director [17]

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So once the pipeline develops, yes.

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Helen C. Gordon, Grainger plc - CEO & Executive Director [18]

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We have -- Keith, we've got the majority -- because of the acquisition, it skewed it at the moment. And -- but a lot of our new developments are coming through in the region, so the balance will get back into London and the regions. But as you see from that investment chart, London still remains the most resilient rental market in the U.K.

Sander?

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Sander Bunck, Barclays Bank PLC, Research Division - VP of Real Estate Equity Research [19]

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Sander Bunck, Barclays. One question for me, and it's about affordability and especially for in regions. Do you have a sense about affordability for the development completions in some of the regions? And specifically, when looking at build-to-rent as opposed to people can actually purchase a house. So say that someone comes into market, wants to live somewhere, what is the average cost of renting it from you versus actually getting out of mortgage through whatever kind of scheme? And how does that broadly compare?

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Helen C. Gordon, Grainger plc - CEO & Executive Director [20]

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Yes. So we look at -- part of the work that we do when we underwrite is actually look at local salaries and affordability. And quite often, you get it tagged to house prices, but there are lots of reasons why people rent rather than buy. Might be access to the deposit, might be that they don't intend to stay in that location. And if I think about our schemes in, say, for example, Bristol and Manchester, it's about having a lifestyle that they can live in the city center. So there's a whole variety of reasons, but we do look across. And most of the time, because we are both related to salaries and affordability, the further away you get from London, the more closely aligned you're going to be with the ability to buy a house versus pay rent.

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Sander Bunck, Barclays Bank PLC, Research Division - VP of Real Estate Equity Research [21]

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And then just on cost of (inaudible) as you rent versus dows a few mortgages as reflected in (inaudible)

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Helen C. Gordon, Grainger plc - CEO & Executive Director [22]

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Yes, I suppose you've got to take the view whether you're going to be helped to provide a decent deposit as well. I think if you were just talking about average mortgage payments and average rents, the further away from London you get, more similar they are.

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Kieran Adrian Lee, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [23]

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Kieran Lee from Berenberg. Just a quick one on the regulated tenancies, again. I know that you're sort of disposing 6-plus percent a year. How small will that sort of portfolio have to get before you say, actually, now is the time we move it on our admin cost burdens, get into such an extent, it's better with somebody else?

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Helen C. Gordon, Grainger plc - CEO & Executive Director [24]

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So we already have that process within our asset recycling where we've got remote portfolios. For example, we sold during the year, our portfolio in Cornwall, which was just harder for us to access and manage. So we have that as part of our investment discipline anyway. I think the thing to focus on is our GBP 302 million of reversionary surplus. And in selling them, we would lose access to that, which is actually quite an attractive return. And we have this really lovely transition, which is as we sell down the regs, we're investing in the PRS. Your point about management, we actually manage them on the same platform with the same team. So actually, we are transitioning people between the 2 teams.

Anything to add to that, Andrew?

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Andrew Saunderson, Grainger plc - Director of Investment and PDMR [25]

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The only thing I would possibly add to that is in addition to the reversion of -- reversionary surplus, there are the value-add opportunities that the portfolio offers. And that we don't necessarily get access to that until we get vacant possession. So that's the potential to obtain planning commission and sell with the benefit of planning -- obtain planning commission and then refurbish ourselves and derive the development uplift as well. So it does offer some additional potential over and above just that pure reversionary surplus.

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Helen C. Gordon, Grainger plc - CEO & Executive Director [26]

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Any other questions? That's probably the function of a very big pack. So thank you for joining us this morning. If you think of anything afterwards, please do e-mail, and thanks very much for coming. I'm going to play the CONNECT videos, which is our new technology platform. And hopefully, some of you will have seen these before.

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