Growthpoint Australia (GOZ)

GOZ continued to outperform the S&P/ASX A-REIT 200 Accumulation Index in FY20.

Growthpoint Properties Australia is a publicly traded ASX-listed A-REIT (ASX: GOZ) which specialises in the ownership and management of quality investment property. GOZ owns interests in a diversified portfolio of 58 office and industrial properties throughout Australia, valued at approximately AUD4.2bn, and has a mandate to invest in the office, industrial and retail property sectors. The current composition is two-thirds offices and one-third industrial properties. GOZ is included in the S&P/ASX 200 Index and has a Moody's investment grade rating of Baa2 for senior secured debt. GOZ aims to grow its portfolio over time and diversify its property investments by asset class, geography and tenant exposure through individual property acquisitions, portfolio transactions and corporate activity, as opportunities arise.

This was a year of two parts for GOZ. It was business as usual for the first eight months, which were distinguished by good financial and strategic progress.

However the last four months proved particularly difficult in the Australian context and from March GOZ, like other Australian businesses, was forced to respond to dramatic and immediate changes in the operating environment brought about by the Covid-19 pandemic. As a result of this uncertainty, it withdrew all forward-looking statements.

Although GOZ's earnings were not materially impacted, it reduced its second half distribution to retain a higher level of cash and to protect its long-term value. It announced a total FY20 distribution of 21.8c per stapled security.

Performance

As a result of entering this period on a strong footing and being able to meet the challenges presented by the pandemic, GOZ's FY20 FFO per security was 25.6 cps.

GOZ continued to outperform the S&P/ ASX A-REIT 200 Accumulation Index in FY20, as it has done over the past three, five and 10-year periods. However, significant market volatility from March to June resulted in total shareholder return falling for both the index and GOZ in FY20.

Portfolio highlights

Most leases expiring in FY20 were successfully renewed, including a 25-year lease with GOZ's single largest tenant, the New South Wales Police Force, for their headquarters in Parramatta. This transaction was the largest leasing deal signed by the NSW government in recent years.

Two development projects were completed during the year. In February, GOZ achieved practical completion of Botanicca 3, a 19 447m2 A-grade office building in Richmond, just outside the Melbourne CBD. Leasing of Botanicca 3 was more challenging than GOZ initially expected because businesses are reluctant to move in this uncertain operating environment and the building was vacant on completion. The property has received positive feedback from prospective tenants and GOZ expects to lease the property progressively by the end of 2021, which will have a positive impact on revenue. This development has produced one of the highest-quality metropolitan office buildings in Australia. Sustainability is at the forefront of Botanicca 3, from its solar panels and electric-car charger stations to its energy-efficient design which considers sustainability in heating and cooling.

The expansion of the Woolworths Distribution Centre in Gepps Cross, South Australia, was completed in June and Woolworths, which is a top-20 ASX-listed company and one of the two biggest supermarket chains in Australia, has commenced a 15-year lease extension.

Portfolio occupancy, excluding Botanicca 3, was 97% at the end of FY20, and the portfolio's WALE by income was 6.2 years.

GOZ's 15% interest in APN Industrial REIT (ASX: ADI), which was acquired in 2017, is proving to be a quality standalone investment with an attractive distribution. ADI is aligned well with GOZ's investment strategy focused on office and industrial property. However like all A-REITs, its share price dropped significantly with the impact of Covid-19, which impacted the value of GOZ's net tangible assets.

ESG

GOZ conducts several corporate social responsibility activities internally and this year it also donated to the Australian bushfire appeal. Its strong culture underpins its social and environmental achievements. During the year, GOZ also made good progress towards achieving its sustainability goals, and its Global Real Estate Sustainability Benchmark (GRESB) score increased by 9% to 72.

GOZ is committed to operating in a sustainable way and reducing its impact on the environment. It made progress in its climate change mitigation strategy which is focused on maintaining and growing a portfolio of highly efficient buildings, progressing decarbonisation by 2050 and building climate resilience across the portfolio. Highlights include two substantial solar photovoltaic installations, taking the total number of installations across the portfolio to six. It also committed to begin purchasing accredited renewable power for a number of key sites.

This year, NABERS ranked the GOZ portfolio among the top-10 most energy efficient property portfolios in Australia. In addition, NABERS recognised 100 Skyring Terrace, in Newstead, as the second most efficient office building in Queensland, and GOZ now has two buildings with a rare 6-Star NABERS energy rating, the highest-possible rating. The average NABERS energy rating across GOZ's modern, efficient portfolio is a high 4.9 stars.

Covid-19 response

When the Covid-19 pandemic hit Australia, GOZ's priority was the health and safety of its employees, tenants and the broader community. It implemented all recommended steps to stop the spread of the virus and it temporarily closed its Melbourne head office in mid-March to transition all employees to working remotely. In the face of uncertainty, GOZ committed to retaining its entire staff complement, without reducing working hours or fixed salaries.

GOZ entered this period with a strong balance sheet and capital position, with significant unused debt lines and no debt maturing until FY22. To enhance its liquidity, GOZ established an AUD100m debt facility with a new banking partner in May. It also extended an existing AUD150m facility that was due to expire in FY22, for four years. At 30 June, GOZ had unused debt lines of AUD360m and AUD43m of cash on its balance sheet. There was much capital raising on the ASX and in the REIT sector, and this was both defensive and to reduce debt, but rarely for acquisitions. With its gearing levels at 32.7% as at 30 March 2020 – which is well below its target range – and share prices in the sector down 50% in a few weeks, GOZ was able to choose not to follow suit.

In response to the Covid-19 threat, Australia formed a "National Cabinet" made up of federal, state and territory leaders to enable a united approach, and this body issued a code of conduct for commercial lease arrangements, valid for six months. It took time to get to grips with the code, especially as each state still had slight variations. However, mandatory rent relief was declared for SME tenants with turnovers of AUD50m or less who could demonstrate that their turnovers had been impacted more than 30%, and this will remain in place until September 2020 at least.

In GOZ's portfolio, such tenants included, for instance, the small cafes serving its office buildings, which were not bringing in any revenue. GOZ estimates that smaller tenants represent approximately 3% of GOZ's income and only some of these have been impacted and received relief, which in total has been minimal. Nevertheless, GOZ reached out to them to assist them when it mattered most, while also implementing a Board-approved process to review rent relief requests from bigger tenants. GOZ required detailed information from these tenants so it could understand the impact of the Covid-19 pandemic on their businesses and direct its support to those who needed it most.

Rental abatement provided by GOZ in FY20 totalled AUD800 000 or 0.1% of FFO per security. For accounting purposes, rental deferrals of AUD2.1m form part of rental income and are carried as debtors in its balance sheet.

Collections became a parallel focus during the final quarter of the year, and approximately 97% of rent billed in this period was collected. Considering the harsh economic times, this was an excellent result that underlined the way GOZ has curated its portfolio over the long term. The market generally is now sharpening its focus on the quality of tenants and strength of leases, but this has always been a priority for GOZ and the financial strength of its tenant base is protecting it now.

The market has also been focused on property values since the start of the Covid-19 crisis. There were no material changes to GOZ's property values at year end but it is waiting to see what impact there may be on values over the next six to 12 months.

GOZ's portfolio value reflected a slight increase of just 0.04% in the second half of FY20. However, this was enhanced by an increase in value of some of its long WALE properties such as New South Wales Police Force headquarters in Paramatta and Woolworths' distribution centre in Gepps Cross.

GOZ's exposure is limited to suburban offices and industrial buildings, which are likely to be much less affected by the pandemic than expensive CBD offices and retail properties.

In this context, GOZ is reassessing the best way forward for its development and acquisition pipeline. It is taking a conservative approach and is going to hunker down, but will still keep a keen eye out for compelling opportunities.

When considering acquisitions, the market certainly wasn't a normal one in which to buy properties, especially bearing in mind the border restrictions between Australia's states. Transaction volume was low and is likely to remain so until the economy gets back to work and the situation stabilises. Typically, transactions have become off-market direct approaches, or companies directly offering property sales and leaseback to selected parties.

Prospects

Industrial property, which makes up a third of GOZ's portfolio, has continued its global popularity and is proving to be the top sector in which to be invested. This trend continued in Australia during the pandemic, supported by the shift to online sales. Values proved to be resilient and in some cases have increased, particularly for large institutional grade properties with long WALEs.

While GOZ does not have any retail assets, it's important to mention the performance of this sector and unfortunately retail property was decimated by the impact of Covid-19 due to a structural shift in buying patterns with the shuttering of shops. Many retail properties are on the market for sale now. Listed groups with significant retail property exposure are being hammered by the market, leading to their share prices plummeting. Retail rental collections are poor. Many retailers simply won't pay rent or are only willing to pay a turnover percentage which means that, if shut, they are not liable for any rent. There will have to be a structural shift in rents charged by retail landlords. Unemployment is expected to rise and, given the already high levels of household debt, the outlook for this sector is the least favourable.

Two-thirds of GOZ's portfolio comprises office buildings. Most of these properties are in suburban locations and are expected to perform reasonably well relative to the market overall. They are in areas that are not overbuilt. Many businesses may adopt a "hub and spoke" office strategy going forward, with a central head office and satellite offices in suburban areas. This diversification of office requirements will support business continuity. Work from home is expected to encompass some work hours in smaller suburban offices close to home, which make it easier to travel in a more socially distanced way than commuting to main centres on public transport and waiting in queues to take lifts in 50-storey office blocks. The cost per square metre in suburban offices is also lower. As we are in a global recession, and corporates are cutting back, suburban offices are an advantageous option.

Office densities have increased in recent years and there has been a rise in the trend of hot desking. GOZ expects one impact of Covid-19 to be the reversal of this trend in the light of social distancing requirements, with densities decreasing and space requirements increasing, but being balanced out by more working from home.

Vacancy rates in major office sectors are moving upwards and there are more sub-leasing opportunities in the market. In the past, the trend in this type of situation has been for rent to fall slightly and leasing incentives to increase. With more competitiveness in the market, GOZ's modern office portfolio is well positioned with good occupancy by good tenants, on good leases.

Government assistance for economic stimulus represents more than 10% of Australian GDP. Much of that is dedicated to the JobKeeper payment set up in response to the pandemic, which enables companies to apply to the government to pay staff wages for six months, and is generous but costly. This support runs until March 2021, and there is concern about what the economic effects will be when it comes to an end. A fair bit of economic uncertainty could present some opportunities, but the financial stress hasn't yet reached levels that would encourage this.

"Our best tenant is our existing tenant", has become one of GOZ's key asset management approaches going forward. It is dedicated to building even stronger relationships with tenants in order to retain them. GOZ is focused on renewing leases and extending its support of the small number of retail tenants in its portfolio, so that they can stay in its buildings and start trading successfully again when Australia emerges from the worst of the pandemic.

There is however still a great deal of uncertainty around the effects of the Covid-19 pandemic on GOZ's operating environment and the broader Australian economy, especially in the near-term. Long term, however, Covid-19 is undoubtedly altering the way people work and live, and GOZ might benefit from some of these accelerating structural shifts in the form of increased demand for both its office and industrial assets. GOZ is thus well placed as a sustainable business for the long term.

GOZ top 10 tenants by gross rental contributions (100%)

  Tenants   GLA m2
1 Woolworths   248 169
2 NSW Police Force   32 356
3 Commonwealth of Australia   36 343
4 Country Road Group   23 156
5 Linfox   58 077
6 Samsung Electronics   13 423
7 Bank of Queensland   13 237
8 Lion   12 317
9 Australia and New Zealand Banking Group   13 744
10 Jacobs Group   8 207
Sub-total   459 029
Balance of GOZ   526 356
Total for GOZ (excluding vacancies)   985 385