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Edited Transcript of VHP.NZ earnings conference call or presentation 9-Aug-20 10:00pm GMT

Full Year 2020 Vital Healthcare Property Trust Earnings Call

Auckland Aug 11, 2020 (Thomson StreetEvents) -- Edited Transcript of Vital Healthcare Property Trust earnings conference call or presentation Sunday, August 9, 2020 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Aaron G. B. Hockly

Vital Healthcare Property Trust - Fund Manager

* Chris Adams

Vital Healthcare Property Trust - Executive Director of NorthWest, Developments & Acquisitions

* Michael Groth

Vital Healthcare Property Trust - CFO of Vital Healthcare Management Limited

* Richard Roos

Vital Healthcare Property Trust - MD of Australia

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Conference Call Participants

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* Adam Lilley

Craigs Investment Partners Limited, Research Division - Research Analyst

* Arie Dekker

Jarden Limited, Research Division - Head of Research

* Nick Mar

Macquarie Research - Analyst

* Shane Solly

Harbour Asset Management Limited - Director & Portfolio Manager

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Presentation

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Operator [1]

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Thank you for standing by and welcome to the Vital Healthcare Property Trust 2020 Annual Results Conference Call. (Operator Instructions)

I would now like to hand the conference over to Mr. Aaron Hockly, Fund Manager. Please go ahead.

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [2]

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(foreign language) Welcome to the full year results presentation for Vital Healthcare Property Trust. My name is Aaron Hockly, Vital's Fund Manager. With me today is CFO, Michael Groth; as well as Richard Roos and Chris Adams, Executive Directors of the Property Portfolio and Projects, respectively.

Due to COVID-19 restrictions, particularly in Melbourne, where my 3 colleagues are located, we are delivering this presentation from 4 different locations. Our apologies in advance if there are any technical issues as a result.

We will take you through the highlights of the 2020 financial year, provide an overview of some new targets and strategies for Vital and give an insight into how the health care sector is faring, at least from Vital's perspective in both New Zealand and Australia. There will be an opportunity for questions at the end of the call.

Slide 4 provides an overview of Vital, the owner of over $2 billion of real property in New Zealand and Australia, with the longest weighted average lease expiry in the sector at 18.1 years, providing a revenue stream of over $100 million per annum. Vital has close to 100% occupancy; debt-to-assets of 38.7%; and a $280 million current development pipeline, with additional projects available when current projects complete.

I'm very pleased to release a new medium-term target for Vital of 2% to 3% growth in AFFO and distributions per unit per annum, whilst maintaining our conservative payout ratio. This growth in adjusted funds from operations, or AFFO, is expected to be achieved through a combination of underlying property income in the existing portfolio, enhanced by acquisitions and developments.

Vital remains the only listed specialist health care landlord on the NZX and is the fourth largest listed property vehicle in New Zealand by market capitalization.

Vital invests in health ecosystems in New Zealand and Australia, and Slide 5 illustrates our current and target asset allocations as well as an explanation of what each subsector comprises. These are new allocations for Vital and seek to balance property quality, income diversity, earnings growth and earnings stability. In the upper-left quadrant are hospitals, which currently provide over 80% of Vital's income. Currently, all of Vital's investments in this subsector are private hospitals, split across surgical, rehabilitation and mental health. However, we are eager to expand into public facilities and are ready to assist governments in New Zealand and Australia as they respond to the health and economic impacts from COVID-19.

Hospitals are complicated assets with high barriers to entry, are typically long-leased to very large hospital operators and they typically have the lowest yields of our investment universe, reflecting their lower relative risk. Examples of our assets in this subsector include Ascot Hospital in Auckland, Epworth Eastern in Melbourne and Lingard Private Hospital in Newcastle. A lower target allocation to this subsector reflects that our future growth is more likely to come from other subsectors as hospitals have very large assets, which are really traded. However, most of Vital's hospitals are considered core, and we are targeting 50% to 70% of Vital's income to be derived from hospitals going forward.

In the bottom-left quadrant is outpatient facilities, which we have historically referred to as medical office buildings. We are seeking facilities where care is delivered from such as GP or specialist clinics and which form part of a health care precinct. Leases are typically much shorter than hospitals, the assets are often multi-tenanted and can attract a variety of users. Examples include Mons Road in Sydney, which is part of Australasia's largest medical precinct centered around Westmead Public Hospital. Tenants at Mons Road include Imaging, IVF and other consulting services. Vital's exposure to this subsector is currently 12% within our target range of 10% to 20%.

Development forms a key part of our strategy, including leveraging our existing hospital assets to expand medical precincts. An example includes the recently completed Lingard Day Surgery next to Lingard Private Hospital, which Chris will speak more to shortly.

In the upper-right quadrant is aged care, currently constituting 6% of Vital's assets by value and providing 8% of Vital's income. We are targeting to increase this to 10% to 20%. Vital's targets in this subsector are limited to residential aged care villages. Some may think of them as nursing homes rather than retirement living. And we are seeking to acquire larger, modern, purpose-built facilities with single bedrooms.

Due to some caution around aged care in general, we are only seeking to partner with leading operators with substantial net assets. Examples of Vital's exposure to the subsector include the 3 assets acquired in March of this year for $60.1 million, leased to Bolton Clarke for over 16 years.

Finally, in the bottom-right quadrant is life sciences and research. These are biotech, pharma or other research facilities. Vital does not currently own any properties in this subsector, and our initial focus is likely to be in New Zealand, given our competitive advantage here.

To give a real life example, we would be delighted to fund and develop a school of rural medicine in New Zealand, in partnership with one or more of the universities or the government. Given New Zealand is now in election mode, I should note that we could work with either national's policy of a third medical school or labor's policy of multidisciplinary training hubs. And we have experience in delivering both very large facilities as well as smaller bespoke ones.

These new Board-approved asset allocation bands form part of our broader portfolio strategy, designed to provide earnings growth sourced from a diversified and defensive asset base.

Turning to Slide 6. An investment in Vital units is an investment in the only specialist NZX-listed landlord of health care property, with no ASX-listed equivalent. It is an investment in a uniquely defensive sector, supported by a high level of nondiscretionary and government spending and demand increasing due to aging populations and technological advances. Investors receive exposure to both New Zealand, where 25% of our assets are located, and Australia, where the remaining 75% are located.

Vital's market-leading WALE of over 18 years as well as its diversified asset and tenant base provide income security. Vital's newly announced target of 2% to 3% growth in AFFO per unit per annum and a corresponding increase in distributions is supported by rental growth under existing leases; 99.4% occupancy; and on average, only 1.3% of leases expiring annually over the next 10 years. Organic property income growth will be enhanced by targeted acquisitions and a significant pipeline of approved and potential developments.

Turning to FY '20 highlights. Cash earnings measured by AFFO increased by $3.3 million primarily due to a 2.5% increase in net property income and a 7.2% reduction in costs. AFFO was up 7.5% in absolute terms, which is 5.6% per unit.

NTA increased by 2.9% to $2.38 per unit primarily due to $45.7 million of property revaluation gains. $75.4 million was invested in acquisitions, and $88.5 million invested in developments and other capital works.

There are 3 figures we provide in our results to give color to our earnings growth over FY '20. Like-for-like, same currency rental growth was 1.6%. This provides a direct comparison of the increase in income in those assets held over FY '19 and FY '20. Our earnings growth, including all contributors, such as acquisitions and developments, was 2.5%. And as requested by several investors, we also strip out the ForEx impact from this 2.5%, and this is how the 3.4% shown on the table on Slide 9 is derived.

The relatively modest amount of COVID-19 allowances reflects the defensive nature of Vital's earnings. As shown on the table on this slide, acquisitions, developments, lease reviews and new leasing all contributed to earnings growth. It shouldn't be surprising that these are the key areas we will focus on going forward. Richard and Chris will provide more detail shortly.

Slide 10 shows Vital's significant outperformance versus other NZX-listed property groups, including a 13.4% outperformance over FY '20. This is on a total return basis, reflecting distributions and unit price appreciation.

Slide 11 illustrates part of the reason for Vital's outperformance. Vital's real estate level returns have outperformed office, industrial and retail markets in Australia over the last 1-, 3- and 5-year periods. We have compared our portfolio to Australia, given this is where the majority of Vital's assets are located, and a lack of readily available data for New Zealand. Note that these figures are to 31 March, so our outperformance for June is expected to be higher.

Unfortunately, our proposed foreign-exempt listing on the ASX did not meet the required 75% eligible voting threshold to proceed. 66% of eligible unitholders voted in favor. In addition, NorthWest, holder of 25% of Vital's units, was unable to vote but supportive of the transaction. $8 million of costs relating to the proposal were expensed during FY '20. Whilst we are disappointed with the outcome, the Board and management are reflecting on feedback received as part of the process. There are no immediate impacts on Vital's strategy or operations.

I will now hand over to CFO, Michael Groth.

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Michael Groth, Vital Healthcare Property Trust - CFO of Vital Healthcare Management Limited [3]

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Thank you, Aaron, and good morning. If I can now turn your attention to Vital's financial results and capital management for the year ended 30 June.

Turning to Slide 14. Vital reported a solid result in the current environment, highlighting the resilience and defensive nature of the health care property sector and it's place as an essential service national infrastructure. Statutory profit before tax was $70.3 million versus $107 million in 2019. At an operating level, before unrealized fair value movements, profit before tax and other income was up 20.9% compared to the prior year result of $34 million.

FY '20 adjusted funds from operations or AFFO, the key financial performance metric for the group, was $47.2 million or $0.1045 per unit, up 7.5% and 5.6%, respectively, on pro forma AFFO for 2019. A full reconciliation of operating profit to AFFO is provided in the appendices to this presentation on Slide 36.

Distributions to unitholders were in line with guidance and remained steady at $0.0875 per unit for the year.

Key highlights for the year included solid growth of 2.5% in net property income, underpinned by like-for-like property income and constant currency basis rental growth of 1.6%; the contribution from the acquisition of the Bolton Clarke portfolio in March and the advancement and completion of a number of development projects, which Chris will provide further color on shortly; a modest impact of approximately $0.5 million related to COVID-19 rental abatements; and prudent credit loss provisioning. Later in this presentation, Richard will go into further detail on the impact of COVID-19 for both the group and its tenants.

Corporate costs were up $1.1 million for the year as the one-off costs associated with completing the fee and governance review were incurred and new and increased nonrecoverable foreign investor land tax surcharges in Australia came into effect.

Strategic transaction costs of approximately $8.0 million predominantly associated with the unsuccessful foreign-exempt listing proposal were fully expensed in the current year.

Management fees were down $7.2 million driven by a lower incentive fee as growth in net tangible asset was subdued for the period and the base management fee benefited from the introduction of the tiered fee regime for the first time; and a decline in the net finance expenses, predominantly reflecting the impact of a lower interest rate environment on the group's unhedged borrowings. The 30 June weighted average effective interest cost at 3.59% versus 4.4% last year.

On Slide 15, I draw your attention to Vital's solid balance sheet. Net tangible assets per unit increased to $2.38, up 2.9% versus 2019. Debt-to-gross assets was 38.7% at 30 June as the group continued to invest in its development pipeline and settled on its acquisitions of the Bolton Clarke portfolio by tapping available debt headroom. Investment properties increased almost $250 million or 13.6% for the year, reflecting continued progress on the development projects, the acquisitions highlighted above and net revaluation gains of $45.7 million for the year.

Movements in other assets and other liabilities were underpinned by the repayment of the related party advance earlier in the year and increased deferred tax liabilities following property revaluations, plus an increased mark-to-market liability on the group's interest rate swaps following the rapid fall in interest rates towards the end of the year.

Consistent with prior years, unitholder funds and units on issue have both increased, reflecting units issued under the distribution reinvestment plan and settlement of the managers' incentive fee.

The key drivers to NTA per unit increasing to $2.38 are outlined on Slide 16. Property revaluations, net of deferred tax, and the stronger Australian dollar at 30 June contributed to $0.08 and $0.04 per unit of the increase, respectively. This has been partially offset by the units issued to the manager for the 2019 incentive fee, the foreign-exempt listing proposal costs expensed during the period and the impact of a lower interest rate environment on the valuation of the group's interest rate swap book.

Slide 17 summarizes the group's borrowing position and near-term financing objectives. Overall, the group maintains both a solid and flexible balance sheet, underpinned by the attractive characteristics of the health care property sector. This is a position that we are focused on enhancing in the coming year as we seek to optimize our capital structure, both in terms of extending near-term expiries and also via the introduction of new financiers to the group.

Turning to Slide 18, where we present further information on the group's borrowing facilities. As I touched on earlier, the group's balance sheet is both solid and flexible, with the bank loan-to-value ratio currently at 40.2% versus a covenant of 50%. I'm also pleased with the current status of discussions with potential banks to refinance the upcoming maturity, with strong appetite being expressed by both the existing and a number of new to the group lenders.

With approximately $225 million of undrawn capacity, the group is well positioned to support its committed opportunity pipeline and to pursue further opportunities as they arise.

I will now pass you across to Richard, who will provide an update on the property portfolio.

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Richard Roos, Vital Healthcare Property Trust - MD of Australia [4]

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Thank you, Michael, and again, good morning, everyone.

Turning to the portfolio overview and update starting on Page 20. As shown on the slide, we have grouped the assets in the Vital portfolio into 4 categories to provide a better understanding of the portfolio and its makeup. It is worth noting that each category is performing well, notwithstanding the challenges of the past few months. The first category is private hospitals, Australia. Vital owns 20 hospitals made up of acute surgical, stand-alone rehab and stand-alone mental health facilities. Some of Vital's large acute surgical hospitals like Maitland have mental health or rehab embedded in the facility. These hospitals are leased to 4 major private hospital operators and represent 62% of the value of the portfolio, with a weighted average lease term or WALE of 19.9 years.

The second category is private hospitals, New Zealand. Vital owns 8 hospitals in partnership with 5 hospital operators in New Zealand, all surgical facilities. Our New Zealand hospitals represent 20% of the total value of their portfolio on a WALE of 22.3 years.

Our third category is outpatient facilities. Vital owns 8 outpatient facilities or multi-tenant medical office buildings, made up of diagnostic services, general and specialist consulting practices and other allied health services. There are 5 such facilities in Australia and 3 in New Zealand, representing 12% of the portfolio by value on a WALE of 6.2 years.

The final category is aged care. With the recent acquisition of the Bolton Clarke aged care facilities, Vital now owns 8 aged care facilities in Australia with 2 operator partners. Aged care currently represents 6% of the portfolio value on a WALE of 16 years. Overall, as shown on the chart on Page 20, hospitals represent 82% of the portfolio by value. And aged care and outpatient facilities, the remaining 18%.

Now turning to Slide 21. In summary, the Vital portfolio represents $2 billion invested in 44 core health care properties with over 120 tenants. Rent growth for FY '20 was 1.6% on a like-for-like same currency basis. And notwithstanding the economic challenges created by COVID-19, management is forecasting positive rental growth in FY '21 through a combination of CPI and fixed rental increases. It's worth noting that most of Vital's annual rent reviews that are tied to CPI have a [floor] of 0% or have a CPI+ structure.

The chart on -- the charts on Page 21 demonstrate the diversity of our tenants by rent and geographic location. While acknowledging that a significant driver of our portfolio growth over the past 8 years has been our relationship with Healthe Care, there are a number of new and/or growing tenant relationships, including Acurity in New Zealand, Epworth in Australia, and more recently, Bolton Clarke in aged care that we expect will contribute significant growth moving forward and further enhance the diversification of the portfolio.

Turning to Slide 22. The Vital Board has recently approved a new 5-year portfolio strategy for Vital. This portfolio strategy is designed to provide direction on the makeup of the portfolio for the next 5 years.

The strategy has a number of key principles or characteristics that differentiate Vital from many other REITs. These include: Acuity. Vital's focus will continue to be on facilities that offer higher acuity services and are, therefore, a core part of the health ecosystem. In seniors living, this means a focus on aged care, which involves nursing and care services and not retirement living, which is a lifestyle offering. In outpatient facilities, it means a strong preference for acquisitions in medical precincts, with large public or private hospitals to create synergies and enhance tenant retention.

Investment characteristics. We employ a multifaceted approach to investment that strongly considers asset level IRRs, but also other investment criteria, including portfolio diversification, development opportunities, earnings growth and tenant relationship. Our portfolio strategy is designed to support AFFO target growth of 2% to 3% through active management, including maximizing greenfield and brownfield development opportunities, which Chris will provide detail on shortly. We will not only apply these criteria to new investments, but we will also regularly review the existing portfolio as part of a divestment recycling process to increase portfolio quality.

Location. We will continue to focus on New Zealand and Australia, as Aaron mentioned, broadly keeping the current 25%-75% portfolio split between the 2 countries. Our focus is on larger metropolitan areas with growing populations that drive expansion of existing hospitals and create new development opportunities.

On Slides 23 and 24, we provide an overview of the impacts of COVID-19 on the portfolio. The portfolio and our core health tenants held up well in New Zealand and Australia during a challenging period. Tenants in New Zealand benefited from a short, sharp lockdown that has to date eliminated community transmission of the virus and allowed a quick rebound in demand.

In Australia, there has been significant levels of government support for the health care sector as well as support programs for small businesses. Vital's focus during the COVID-19 lockdowns has been to provide our smaller tenants, those without a strong balance sheet or access to additional capital. In Australia, the government introduced a Code of Conduct, which mandated landlords to provide rent relief to tenants with turnover of less than $50 million on a proportionate basis to their decline in turnover.

In New Zealand, Vital voluntarily applied similar rent reduction principles in support of our tenants. Fortunately, due to the strong rebound in demand for medical procedures and strong government support, total rent abatements were less than $300,000 in FY '20. Rent deferrals across FY '20 and FY '21 are expected to be less than 5% of net rent, with virtually all of the current deferred amounts to be repaid in CY '20.

On Slide 24, we provide additional color on the impact of the COVID restrictions on our key asset groupings. In April, with concern increasing over the rising number of COVID cases and a focus on preserving short supplies of personal protective equipment, as well as ensuring adequate hospital beds were available for COVID patients, elective surgeries were canceled in both Australia and New Zealand.

In Australia, the federal and state governments provided funding agreements to maintain the financial viability and capacity of the private hospital sector as well as providing financial support to other large health care providers. In New Zealand, while the government did not provide sector-specific support, it did provide significant wage support that allowed our private hospitals to retain its staff during the restrictions.

In both Australia and New Zealand, we have seen a strong rebound across the health care sector driven by a quick recovery in surgical volumes once restrictions were lifted in mid-May.

In aged care, we have seen little to no impact to date on our aged care operators. Like our operators, we are concerned about the disproportionate impact of this virus on the elderly and are proud to be associated with the effort to keep them safe.

Activity in our outpatient facilities was significantly impacted across the region from early April until mid-May. But government support for small businesses, along with technological adoptions like telehealth, helped to provide income for our tenants and allow them to provide necessary patient services.

Turning to the current situation. While New Zealand is fortunate to have no current community spread of COVID-19 and our tenants are operating in near-normal conditions, there was differing levels of community spread in Australia. Currently, all states in Australia are operating under similar conditions to New Zealand, with the exception of Victoria, which is under a very stringent lockdown expected to continue for another 5 weeks.

As mentioned, our hospital operators and general medical tenants are recovering well in both Australia and New Zealand from a difficult quarter. With continued state government support in Victoria and strong surgical volumes elsewhere due to pent-up demand, we are also seeing flow-through improvement in demand for rehabilitation services. The demand for mental health support, which was already a high-growth service area, is expected to see sustained high levels of demand as a result of the current pandemic.

In summary, health care and health care real estate is demonstrating during this challenging period why it is considered a defensive place to invest.

I'll now turn over the presentation to Chris Adams, our Executive Director of Projects, to provide an update on our developments.

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Chris Adams, Vital Healthcare Property Trust - Executive Director of NorthWest, Developments & Acquisitions [5]

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Thank you, Richard, and good morning, all. Turning to Slide 26. Vital has a long history of development in the portfolio, which we see as fundamental in terms of driving earnings growth and value, but also to enhance the overall portfolio in order to improve the quality of our facilities; enhance our tenant's operating business to drive earnings and, therefore, tenant quality; also to assist in providing high-quality health services to the community. In order to do this, we have a team with significant sector experience to shape and deliver projects. This enables us to deliver a portfolio of development projects that are larger in scale than in the past.

Slide 27. In terms of development strategy, the current pipeline of projects of $280 million, of which circa $200 million of spend remains, positions us firmly in the target range for development within the fund of 10% to 15% of portfolio value. Importantly, much of the development is undertaken in partnership with operator partners via a very high levels of precommitment and, most often, a return on cost structure, whereby final rent is calculated by defined yield against the final cost.

As a result of the partnership approach with operators and our own internal skill set on identifying new opportunities, we have a healthy pipeline of potential future projects. Overall, the current projects are expected to derive a 6.1% return on cost and the current contracted projects are funded via existing deadlines, with identified opportunities funded via asset recycling, as touched on by Richard.

FY '20 completed projects on Slide 28. The last year saw the completion of 2 key projects, the Hills Sydney for mental health services and Lingard Day Surgery in Newcastle. Both of these projects were delivered successfully despite the challenges of COVID with them being completed in May and June of this year. Importantly, they have been extremely well received by users post commissioning.

The Hills adolescent mental health unit was full within a few weeks of completion with strong feedback. Also, Lingard opened with very positive feedback from clinicians, staff and patients. The basis of the Lingard project is to decant lower acuity work from the existing hospital, to free up the centers there and to create a more efficient setup in the day surgery. This adds to what is a major health precinct, with a Vital investment of $190 million, noting the overall facility as one of the leading hospitals in the Newcastle region.

Committed developments on Slide 29. This slide provides an overview of the current $280 million of work in progress, demonstrating the spread of project yields to current bond rates of an excess of 500 points and the impact of development, reducing the overall age and improving the quality of the portfolio.

In respect of age, a 2-year reduction is forecast an overall portfolio age at mid-2022 driven by development, with a busy year of completions in 2021.

I will talk to larger projects shortly. But note we had suspended smaller projects at Eden Queensland and Northwestern Tasmania to manage risk in regard to COVID. But both are expected to resume shortly, although Eden will now be staged.

Epworth Eastern on Slide 30. A key project for the fund at $126 million, it is part of a very major health precinct. The fund's total investment at completion of this stage is circa $380 million, and it is one of Melbourne's leading private hospitals. The 14-level tower is making good progress with the structure well underway.

The current impact of the lockdown in Melbourne is being worked through. But unlike the prior lockdown in New Zealand, construction is continuing, albeit at reduced levels. As such, we will see -- likely see some form of program impact, but the overall cost impact of COVID is covered by project contingencies based on reasonable assumptions at this time.

Wakefield on Slide 31. Again, another key project for the fund at circa $100 million. It is making good progress. The structure was recently completed for Stage 1. Importantly, the building is base-isolated, above building code, and this will make it one of the most seismically resilient buildings in New Zealand on completion.

The project was shut down like all construction in New Zealand as part of the COVID shutdown, although we are now at 100% capacity and expected to see completion of Stage 1 in the second quarter of 2021 -- calendar '21. We will then move to Stage 2 of the project, with the combined Stages 1 and 2 providing for the near-complete rebuild of the hospital.

And finally, Royston on Slide 32. This project is now 1 of 2 components, an overall $19 million spend. The existing upgrade expansion of the current hospital, which is nearing completion, and a new day surgery being undertaken for a joint venture between the hospital and a significant group of leading surgeons in the region. This day surgery is expected to complete in late 2021, with the construction having commenced.

I'll now hand back to Aaron.

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [6]

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Thanks, Chris. Turning to our outlook on Slide 34. We are delighted to confirm that we have met our FY '20 distribution guidance of $0.0875 per unit, representing 83.7% of AFFO. We have also provided FY '21 distribution guidance of at least $0.0875 per unit.

As noted earlier, we are now targeting 2% to 3% growth in AFFO and distributions per unit per annum. However, in light of a number of uncertainties arising from COVID-19, the Board considers it prudent not to increase distribution guidance at this point. Our distribution guidance includes allowances for COVID, asset recycling and extending and diversifying Vital's debt.

As discussed, we remain focused on providing earnings growth and are deploying strategies across developments, acquisitions and asset recycling to achieve this, whilst also maintaining our high-quality portfolio.

We will now take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Arie Dekker from Jarden.

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Arie Dekker, Jarden Limited, Research Division - Head of Research [2]

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Just -- the first question is just around COVID support. Can you just provide a bit of color on what's happening in the early months of FY '21 in terms of deferrals? And also what your expectation is on the level of deferrals at this point that you'd be making for first half '21?

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [3]

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Good morning, Arie, and thanks for the question. So we did note, as part of the presentation, COVID impacts both for FY '21 and FY '20. So rental abatements for FY '20 are sub $300,000. We have made an allowance of a bit over $250,000 as well in terms of provisional debts. And then rent deferrals for FY '20 and FY '21 are expected to be below 5% of net rent and expecting that all of that deferred rent be fully repaid by the end of this calendar year.

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Arie Dekker, Jarden Limited, Research Division - Head of Research [4]

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Sure. I mean it looks like deferrals in the second half '20 were circa 8%. Has that run rate reduced in these early months of first half '21?

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [5]

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Yes. The 5% overall for the calendar year -- I'm not sure where the 8% is coming from, but that's okay. Yes. I mean, certainly, as Richard was mentioning, as restrictions ease, as hospital operators go back to full operating capacity, it certainly picks up. I might hand over to Richard to allow him to make some more comments.

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Richard Roos, Vital Healthcare Property Trust - MD of Australia [6]

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Yes. Thanks, Aaron. I think just the only additional piece of context that I can provide is that all of our major hospital operators, without exception, paid full rents for August, if that provides any additional context for you.

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Arie Dekker, Jarden Limited, Research Division - Head of Research [7]

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Sure. No, that's helpful. And then just in terms of the receivables, they obviously stepped up with the deferrals that you've provided. There's a note in the accounts that suggests that the majority of the deferrals sit with one tenant. Am I reading that correct? Is there one tenant that accounts for them? Or are they sort of in line with the rental contribution?

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [8]

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Thanks, Arie. I'll hand over to Michael to make some comments.

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Michael Groth, Vital Healthcare Property Trust - CFO of Vital Healthcare Management Limited [9]

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Good morning, Arie. So you're right, so there's one tenant that, that balance predominantly relates to, it's about $4.5 million. As Aaron was explaining earlier, that -- we fully expect that, that amount will be settled in cash during the FY '21 financial year.

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Arie Dekker, Jarden Limited, Research Division - Head of Research [10]

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Yes. And to, I guess, your comments, do you expect it by first half '21 given that you're saying that the deferrals that you've made to date are expected to be repaid in this calendar year?

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Michael Groth, Vital Healthcare Property Trust - CFO of Vital Healthcare Management Limited [11]

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That's -- largely speaking, that's correct. So it's spread over a number of months commencing this calendar year. There is a tail that extends into next calendar year. But by 30 June -- this time next year, so 30 June next year, we expect the full amount to have been repaid.

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Arie Dekker, Jarden Limited, Research Division - Head of Research [12]

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And then just with reference to the comments you made around the full collection of rents in August, are you extending credit and deferrals to this tenant any further from here? And if so, how far are you willing to go with that tenant?

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Richard Roos, Vital Healthcare Property Trust - MD of Australia [13]

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Thank you again, Arie. It's Richard Roos here. Again, we expect moving forward, based on the situation in Australia and even with the lockdowns in Victoria, given these are national tenants, we would expect them -- on the basis of very strong demand and potentially some level of rolling lockdowns, we would expect them to be in a position to pay full rents given the high level of government support and the pent-up demand.

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Arie Dekker, Jarden Limited, Research Division - Head of Research [14]

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Sure. But you would -- you will extend, with the lockdowns to those tenants, a bit further in the meantime. Is that correct?

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Richard Roos, Vital Healthcare Property Trust - MD of Australia [15]

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I think what we'd say is we would look at the situation if it evolves at that point. But the tenant has indicated that they do not require any additional support at this time.

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Arie Dekker, Jarden Limited, Research Division - Head of Research [16]

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Wonderful. Great. And then just a couple of quick ones. Just in terms of the divestments that you've signaled, would it be fair to say that the original aged care assets that you purchased may be included in the assets earmarked for divestments? And is there anything else you can say in terms of where those divestments are targeted?

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [17]

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I don't really want to go into too much detail about specific assets at this point. Obviously, we have a number of assets that we're considering over the whole portfolio and over a decent period of time. So as they happen, we'll make announcements at that point.

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Arie Dekker, Jarden Limited, Research Division - Head of Research [18]

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And then just in terms of valuation and your expectations sort of going into FY '21, do you sort of have a view on where you think valuations might go directionally?

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [19]

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Well, I think valuations going forward, regardless of COVID-19, are probably going to be more rental growth-orientated rather than cap rate compression-orientated. I think that would have been true regardless of the situation. We are expecting that given a number of -- where we're seeing a number of transactions recently in the market, that there's potential for some longer-length leases to perform particularly well. And you will have seen in the valuations released today that some of the shorter-leased assets with some upcoming vacancies, that there's been a bit less support for those assets. So that's probably going to continue to play out for the rest of the year.

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Operator [20]

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Your next question comes from Nick Mar from Macquarie.

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Nick Mar, Macquarie Research - Analyst [21]

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Just on the new asset allocations. Can you just provide a bit of context on how you've arrived at those bands, whether it's based on the depth of the market for each category or something different?

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [22]

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Yes. I think it's a mixture of balancing both where we see the size of the market, so hospital is obviously the biggest part of the market and also the most defensive part of the market, and then providing some earnings growth from other asset allocation. So it's a mixture of both the assets that are available, plus where we want to see in terms of the earnings growth going forward.

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Nick Mar, Macquarie Research - Analyst [23]

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Cool. And to get kind of hospitals within the target range, how much net portfolio growth do you think you need through kind of acquisitions and developments?

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [24]

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Yes. And I should have said at the start that this is a 5-year target. So it's not a -- something we're trying to achieve in a particular time frame. And if we're sitting here and it's 5 years time and we have a greater exposure to hospitals than the 70%, that wouldn't necessarily be a bad thing. We're just trying not to surprise the market if they come down over time.

So you'll see there that we're already 80% exposed to hospitals. So if you think about future acquisitions, being primarily in the other sectors, it will step up over time. So there's not really a set math so -- that's being reached by a certain date.

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Nick Mar, Macquarie Research - Analyst [25]

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Yes. And outside of the $100 million flagged, is there anything else that would be -- likely to be sold within that 5-year target to provide additional funding?

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [26]

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Yes. I think we've identified a number of assets that are longer-term potential disposal opportunities. We haven't publicly released either what those assets are or the quantum of them. But as we see -- as we find better opportunities for Vital as a portfolio, there's certainly opportunities for us to divest assets, particularly as we roll out the development pipeline.

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Nick Mar, Macquarie Research - Analyst [27]

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Cool. And then just on the kind of outlook and dividend. Under the proposed restructure, you guys were comfortable with putting out a target payout ratio for AFFO. The commentary is talking about how it's growing with -- the AFFO growth you're talking about. How come you guys didn't proceed with the AFFO-based payout policies for the current structure?

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [28]

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So there's just too much uncertainty at the moment. So we're happy to put out the distribution guidance, which is what we've done historically. I would expect that the payout ratio is probably in line with where we've been previously. But like -- if you think about the bulk of our investor base, which are largely retail investors that depend on the income from the trust, we'd rather provide a fixed level of distributions and adjust the payout ratio rather than doing the reverse.

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Nick Mar, Macquarie Research - Analyst [29]

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Okay. No, that's great. And sorry, just to clarify on the AFFO growth target. Does that include kind of the development returns and balance sheet deployments that you'll be seeing over the kind of 5 years? Or is that kind of steady state with the portfolio top line growing and everything like that?

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [30]

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So that's the target overall. So that includes the contribution that development makes. We are saying that, that will be over a medium term. So you may have -- particularly where you have high levels of development completions happening in one period of time, you may see that go up a bit. But it allows for divestments, it allows for extending the debt, it allows for a range of other measures, which improve the portfolio overall.

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Operator [31]

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Your next question comes from Adam Lilley from Craigs Investment Partners.

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Adam Lilley, Craigs Investment Partners Limited, Research Division - Research Analyst [32]

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Just a quick one from me. So when talking about guidance, you're including the words allowance for the diversification of your debt. Given that it is looking -- you obviously will be doing some of that shortly, what kind of margin pressure are you expecting from this refinancing needs to come?

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [33]

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Thanks for the question, Adam. I'll hand over to Michael.

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Michael Groth, Vital Healthcare Property Trust - CFO of Vital Healthcare Management Limited [34]

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Adam, good morning. So we are expecting a little margin pressure around debt. But we don't expect it's going to materially change our overall cost of debt when you consider it on a portfolio basis. Obviously, there are a few variables in there, including effectively the term at which that debt is arranged for. But from an overall outlook perspective, we're not expecting it to change materially.

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Adam Lilley, Craigs Investment Partners Limited, Research Division - Research Analyst [35]

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Sure. So kind of headline overall weighted cost of debt you expect to remain pretty in line, but again that's kind of going to be a mix of falling interest rates, higher interest rate swaps rolling off, but mix of the -- the extension of tenure and diversification?

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Michael Groth, Vital Healthcare Property Trust - CFO of Vital Healthcare Management Limited [36]

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That's right, yes.

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Operator [37]

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(Operator Instructions) Your next question comes from [Rowan Coleman Smith] from Forsyth Barr.

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Unidentified Analyst, [38]

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Just a couple of quick ones. First of all, I'm not sure if it's been covered off. But when you talk about life sciences and research facilities, I'm not particularly familiar with those sorts of assets. Can you really give us an idea of the yields and IRRs that you kind of expect from those?

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [39]

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Yes. So life sciences and research are typically either government-led or pharmaceutical company, so you might think about -- are university. We don't release particular IRRs across the whole portfolio. What we release is that 2% to 3% growth in AFFO target and the weightings and the acquisitions that we're looking to make, including developments as well, are targeted at achieving that. So obviously, all assets are based on risk. And if you've got something that's very long-leased to a government that you could expect a lower yield than, say, say, aged care, that it will depend on the assets.

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Unidentified Analyst, [40]

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Okay. And then just finally, just on gearing, it's come up a little bit as you've developed that. You're talking about some asset sales. But kind of you don't really or haven't been able to find a medium-term kind of target range. What sort of kind of gearing levels are you comfortable with, just cognizant of having a DRP on also in the lower dividend payout ratio? I mean are you retaining capital?

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [41]

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Sure. I'll hand over to Michael to make some comments.

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Michael Groth, Vital Healthcare Property Trust - CFO of Vital Healthcare Management Limited [42]

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[Rowan], good morning. Look, we're very comfortable where we're at in terms of the gearing ratio. That's something that we focus on pretty extensively when we consider our opportunity pipelines and where we're at, at the moment. So around that 40% mark is on a bank LVR, or a 35%, 36% mark on a true gearing ratio is something that we're very comfortable with.

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Unidentified Analyst, [43]

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And maybe another one for you, Michael, as my last one. You're talking about extending the tenure of debt. You've only talked about bank [hedge rates] in the presentation, but are there other sources like USPP or potentially bonds that are effective?

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Michael Groth, Vital Healthcare Property Trust - CFO of Vital Healthcare Management Limited [44]

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Absolutely. So they're all part of the mix. And in my earlier response, it's a trade-off and it's a balancing decision just at the moment. The USPP market, in particular, is probably one of our key areas of focus. But pricing in that market has expanded materially through the COVID-19 moment. It is starting to tighten again. It's something that we're watching very closely.

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Operator [45]

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Your next question comes from Shane Solly from Harbour Asset Management.

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Shane Solly, Harbour Asset Management Limited - Director & Portfolio Manager [46]

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Three questions from me. First one, can you just talk a little bit about the provisions that the -- well, we could -- the rental provisions you made for the current period? And two is just -- this is not deferred, this $250,000 number? A little bit of color around that?

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Michael Groth, Vital Healthcare Property Trust - CFO of Vital Healthcare Management Limited [47]

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Sure, Shane. Michael here...

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [48]

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Sure -- okay.

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Michael Groth, Vital Healthcare Property Trust - CFO of Vital Healthcare Management Limited [49]

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Thanks, Aaron. So it's a general provision that we've taken as a prudent measure just due to the uncertainty around COVID-19. So we don't have specific receivable balances that we're concerned about at the moment. But as a measure of prudency, just with the heightened level of uncertainty, we've taken a $250,000 additional provision.

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Shane Solly, Harbour Asset Management Limited - Director & Portfolio Manager [50]

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Okay. And is it -- in a normal year, you would not have much, if anything, in there?

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Michael Groth, Vital Healthcare Property Trust - CFO of Vital Healthcare Management Limited [51]

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That's correct. I think the last time we had a bad debt expense was 2 or 3 years ago. So -- and that reflects the nature of the quality and the tenants of the portfolio. So that's not part of our business.

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Shane Solly, Harbour Asset Management Limited - Director & Portfolio Manager [52]

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Just my second question, just to clarify on the AFFO payout for the period. So can you just walk through how you got to 83.7%? Are you -- what have you assumed on the Australian listing costs and the deferral component in the 83.7%?

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Michael Groth, Vital Healthcare Property Trust - CFO of Vital Healthcare Management Limited [53]

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Perhaps, Shane, can I refer you to Slide 36 in the presentation? That slide...

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Shane Solly, Harbour Asset Management Limited - Director & Portfolio Manager [54]

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Okay. Yes. No, I've seen that slide. But -- I looked into the slide, but -- yes, I have seen that. I'm just sort of observing, there's some interesting interpretations you can make about your AFFO payout here. So to the point you haven't defined it, it does leave a question mark. So if you can talk about that.

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Michael Groth, Vital Healthcare Property Trust - CFO of Vital Healthcare Management Limited [55]

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Yes. So the -- obviously, the listing costs or the expenses associated with pursuing that option have been excluded because that's a non -- in our view, that's not an ongoing business activity, so it's not operating earnings related to normal operations of the trust. And therefore, we've excluded it from AFFO.

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Shane Solly, Harbour Asset Management Limited - Director & Portfolio Manager [56]

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Yes, okay. Yes. Okay, my third question, just going back to the gearing strategy relative to the asset strategy. Does the gearing band or gearing range move with the asset mix weights as you potentially change the framework of what you own? Do you change the gearing bands?

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Michael Groth, Vital Healthcare Property Trust - CFO of Vital Healthcare Management Limited [57]

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Aaron, I might have a crack at this. So no, those gearing bands are looked at on an overall basis, taking into consideration the risk profile of the group. We think with each of those categories or subsectors of asset classes across the portfolio, they all represent a high quality, a high defensibility in terms of cash flows, the things that we're looking that support gearing targets, sort of where they are at the moment.

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Operator [58]

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There are no further questions at this time. I'll now hand back to Mr. Hockly for closing remarks.

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Aaron G. B. Hockly, Vital Healthcare Property Trust - Fund Manager [59]

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Thanks, everyone, for your time today. We -- a transcript of the results call will be on our website later this afternoon. And happy to take any questions via e-mail or phone call follow-up as well. Thanks, everyone. Have a good day.

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Operator [60]

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Thank you. That does conclude the conference for today. Thank you for participating. You may now disconnect.