Company Interview / Arena REIT staying defensive in an unpredictable market

Main Points:

Arena REIT's (ASX: ARF) recent decline in net profit but a steady rise in incomeThe company's defensive position in an unpredictable market, with a particular highlight on childcare real estateArena REIT's dedication to sustainability and renewable energy initiatives

Rob de Vos, CEO of Arena REIT, outlines the company's financial performance, with a reported fall in net profit of 22.5% to $57.5 million. However, Rob highlights Arena REIT's commendable income increase of 4.7% to $62 million alongside a declaration of a distribution per security of 17.4 cents. Rob further emphasizes the positive earnings position resulting from strong net property income and a secure interest rate hedging profile.

In response to the challenging market conditions, Rob shares that Arena REIT has made strategic moves to situate itself advantageously. The company's approach to hedging protects against potential interest rate fluctuations while allowing for cash flow. Rob also speaks about the promising prospects of childcare real estate projecting an accelerated value increase, and commends their high occupancy rates held since their 2013 listing, bolstered by long term leases.

Arena REIT recently publicised intentions to acquire or develop approximately ten new childcare centres to meet growing demand. Rob also addresses the 22.5% profit drop citing property revaluation as a prime factor. Furthermore, he reaffirms the company's commitment to meet its 5% increase in full year 25 for distribution guidance. Lastly, Rob applauds their ongoing sustainability programme, yielding incredible results with almost 90% of Arena's portfolio powered by solar energy.

Full unedited transcript:

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Irena rate has reported a 22.5% fall in net profit to $57.5 million. Income rising 4.7% to $62 million. Its declared distribution per security of 17.4 cents, up 3.6% on the prior year. The company, reaffirming its full year 2025 distribution guidance at 18.2 $0.05 per security. Let's get the details, though, from the horse's mouth, so to speak. Arena CEO Rob DeVos joining me now. Thanks so much for your time, Rob. Just talk me through, in your words, the highlights from the year. Fantastic. Well, I think I think 2024 for us was a year of predictability. Um, and as you pointed out, we had a, uh, a cash based earnings, uh, increase of about 4.7%, which is the metric that we use, which is the justed funds from operations. So that was pleasing. That was supported by strong net property income at about 8% increase across the board. Uh, we had rent reviews. Uh, at a market, um, 7.7% increase and an average of 4.9% increase. So

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a mixture of those things with, uh, with development completions, uh, supported a reasonably strong top line, uh, position. Um, from an interest rate perspective, you've probably heard a lot um, the audience probably heard a lot in regards to the impacts of interest rate on real estate. We've entered that position in a in a strong position in 2024, uh, relatively low gearing. Uh, and, uh, you know, an interest rate hedging profile that protected. It's protected, uh, the business in its cash flows from, uh, from a lot of that pain. Uh, all of that's meant a relatively strong net earnings position for the business. Um, so, you know, positive statutory profit, uh, and, uh, and a positive cash based operating earnings, um, I think I think the really interesting thing for us at the moment is where the market sits, uh, you know, having and looking to 20, 25 and, um, uh, some of the audience may be aware that we actually undertook a post on state capital raising, which has reduced that balance sheet down. So that was a big focus for our results is what does that reduce balance sheet look like into 25.

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And how does that open up opportunities. And Rob, how I guess is well you hedge given that the market and Michelle Bullock seemed very divided about what could happen next with rates. It's it's a it's a topical point. I think there's a there's a very strong bet in the real estate market and some of the vehicles and some institutional and include private investors that will see a very rapid reduction in interest rates. We've taken a little bit more of a circumspect view. We're the beneficiaries of top line growth that are our leases that are attached to inflation. If inflation is higher, we'll probably see higher or more persistent higher interest rates. We've got a hedging profile that protects us, but at a rate that will allow for that sort of cash flow to come through. So you've sort of got the best of both worlds there. Juliet, which is, which is great. Um, I do think that we're likely to see, in fact, you're starting to see transaction activity, at least in the childcare market, um, starting to compress, which is the early sort of indicator that you'll see, you know, perhaps childcare, real estate values is increasing from this point. So, you know, that's an

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interesting, interesting, interesting place for us to be with a balance sheet that's got capacity and, and, you know, perhaps a bit more liquidity in the real estate markets. Well, let's talk as well about your rental, I guess, how how well you're looking in terms of those, um, I'm losing my words, but you know what I mean in terms of occupancy, because it's pretty full, right? It is. Yeah. So we've um, so for we were listed in 2013. So a bit over a decade now and we've been at or near full capacity. We've got 99.7%. Uh, is it balanced out this year? Um, there's a couple of things behind that. We've got very long term leases. Um, most of those, you know, 200, 276 properties across the country, most of those provide underlying operating data. That is the data that our tenants, how many families are attending, uh, their level of profitability. And from that, we can make asset allocation decisions in regards to the curation of our portfolio. It also gives us some really good insights into what's happening in the childcare and healthcare sectors. So as it

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stands today, we've seen a lot of government support post-Covid, uh, into, um, into the early learning sector for all the right reasons. You know, there's sort of three pillars as we see it. Um, uh, workforce productivity, um, better female economic security. Uh, and lastly, and quite topically at the moment is a better socialization and better learning outcomes for our young children. Um, and with NAPLAN results that we were sort of hearing about over the last week or so, I think we'll see higher degree of focus on that in the next little while. Well, absolutely. Let's talk about that. Because a couple of weeks ago, you announced plans to acquire or develop about ten childcare centers. We know that a lot more childcare is needed in Australia. Talk us through your strategy here. Yeah. So we've we've developed about 77 projects across the last 8 or 9 years. Um, in early learning we our portfolio accommodates about 32,000 families. So we're very proud of the social or the positive social impact that that provides. Um, looking forward, we've got a development pipeline

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of 21 projects across the country in communities that have a latent demand for new childcare services. Each of those are what we call a fund through. So we've got a tenant partner that we've that we're working with. They've committed to a long term lease. We've committed to facilitate the development of those projects is about $139 million. We expect a return of about 6% or commencing return of 6%. Um, the real benefit for us and our unitholders, consistent with our investment objective over the next 20 years, we expect those rents to increase. And, you know, communities to continue to use those services have profitable tenants delivering good, good, good community services and ultimately our investors receiving those long term and growing cash flows. When you look, though, at the 22.5% drop that we announced, will, we reported that you have seen in your profit. What was that mainly due to? Is that property revaluation? It's exactly right. Yep. So we as a we have sort of

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two, two two levers for growth. One is um valuation growth And over the last number of years we've seen very strong valuation growth as yields have compressed is the is the market over the last couple of years. Inflation particularly pushing out and risk free rates pushing out. You've seen yields expand. So across our portfolio that's about 23 basis points of expansion. Um that was that that valuation was mitigated over the year. We made about $4 million of additional money, but it's less than the prior period. So that, uh, that that reduction in statutory profit against the comparison period is really more about the, the unrealized gains being less than, than what they were the prior year. Uh, it's a better measure, perhaps, to use the the cash based FFO, which was $62 million, up about 4.7%, and you forecasting about a 5% increase in full year 25 for your distribution guidance. Um, talk us through, I guess, your plans to continue to return to investors. Yeah. Well, look, we've, um, we've got a portfolio of triple net leases, which reduces the

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volatility of, um, uh, operating expenses for us. We're internalized managed fund manager, which means that we've got an alignment and a cost structure that doesn't leak out money to an external fund manager. So that keeps us, uh, efficient from the earnings that we make. Um, we've talked before about that high net property income line growing, um, uh, escalating each year. Um, and, uh, with that gives us a payout ratio that can be quite high. Uh, as a result of that and the new acquisitions that we've announced, um, uh, we are expecting a 5% increase in distribution guidance. We're announcing a re announcing our distribution guidance at 5% increase. Uh, we're very pleased with that. It's, um, it's consistent with our investment objective of delivering long term, predictable distributions with the prospects of growth. Um, there's nothing baked into that. That's, uh, that's new. We're not expecting any challenges for our operating partners as part of that growth. Um, we're expecting to complete the developments that we've got underlined, but we're not making any blue sky into that either. So, you know, from our perspective, uh,

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it is, uh, as we have done over the last ten years, much of the same. So a good base for distributions and paying back our investors that support our growth. And just a quick word, as well, Rob, on your sustainability and emissions goals.

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Uh, so we've, um, you're pretty excited about the sustainability program we've been on. So, you know, as it stands today, about 90% of arena's portfolio, uh, is powered by the sun. And that's, uh, you know, it's a wonderful, wonderful program that we've been on really for the last five years and working in collaboration with our tenants to do that. Um, we've not got sophisticated properties. These are not difficult programs to undertake, but they are careful ones that, um, uh, ultimately providing lower utility costs for our, our tenant partners at a time where they've seen increased costs, uh, across the board. Um, but also some, some fantastic outcomes from a sustainability perspective, you know, um, over over 4000 tons emitted a, uh, being diverted, I guess, or not being committed to in the portfolio of carbon, uh, which is something we're pretty proud of. We've also got, um, a number of other initiatives that are underway. We've announced an emissions reduction plan, uh, that will see us at zero emissions reduction, uh, to 2050 and some interim targets there that we'll be talking

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more about in our sustainability report that comes out in September.