Opportunities and risks in the Investment Property portfolio
Risks and opportunities associated with cash flow primarily pertain to changes in rental income and property expenses. The occupancy rate and rents have a significant impact on rental income. The occupancy rate in turn is dependent on net lettings. Tenant stability and their ability to pay influence the risk of customer bad debts.
Rental income
Growth in the Swedish economy is the primary engine driving demand for office premises. Increased demand leads to lower vacancies and rising rents. Vacancies and rents are also impacted by new production.
Fabege’s property portfolio is concentrated to sub-markets with favourable growth potential and commercial premises, with an emphasis on office space, account for 99 per cent of operations. Accordingly, employment figures and developments in the Stockholm office market are of considerable significance for Fabege’s operations.
Since commercial leases have a term of a certain number of years, changes in rents do not achieve full effect during a specific year. Newly signed leases generally have a term of three to five years, including a period of notice of nine months and an index clause related to inflation. Rents for the company’s lease portfolio are currently deemed to be in line with market levels.
Normally, about 20 per cent of the lease portfolio is renegotiated each year. Fabege works closely with its customers and is receptive to their changing needs. The risk of increased vacancies in the investment-property portfolio is deemed minor considering the portfolio’s central locations and stable customers.
The lease portfolio is spread among many sectors and companies of different sizes. The largest tenants in terms of value are all stable companies and comprise a limited portion of the total number of tenants. With the aim of limiting the credit risk, Fabege’s credit policy governs the checks and assessments that are made of the customers’ ability to pay. Th e tenants’ ability to pay is strong and rent losses are negligible.
Fabege’s portfolio of modern office premises in central locations generates a stable cash flow from management operations. However, when project operations are conducted, buildings are vacated, which has an adverse impact on cash flow for a period of time.
Property expenses
Property expenses include regular operating and maintenance expenses, property tax, ground rent and administration and letting expenses. Regular operating expenses largely comprise tariff -based expenses such as heating, electricity and water. Fabege is pursuing a successful effort to reduce its consumption of heating, electricity and water, with a target of achieving 20 per cent lower consumption over a five-year period as of 2009. Fabege also conducts regular lease negotiations and procurements aimed at reducing costs.
A large portion of property expenses is paid for by tenants, thus reducing the company’s exposure. The standard of the property portfolio is deemed to be high.
Key figures in Fabege’s investmentproperty portfolio
In 2011, the rental market in Stockholm was strong and the key fi gures with the greatest impact on cash flow in the investment-property portfolio improved. The occupancy rate in the overall portfolio, including project properties, improved to 90 per cent (88). In the investmentproperty portfolio, the occupancy rate rose to 92 per cent (91). The rents in renegotiated contracts increased 7 per cent on average. Net lettings amounted to SEK 130m, which will have a positive impact on rental flows and key figures in 2012 and 2013. Customer bad debts totalled SEK 1.4m, corresponding to 0.01 per cent of rental income.
In 2011, the share of cancellable leases was 16 per cent, corresponding to annual rent of SEK 291m, of which SEK 218m was extended by existing tenants. Fabege’s average remaining lease term for commercial leases was 3.5 years at year-end. At the start of 2012, only 12 per cent of leases, corresponding to a rental value of SEK 232m, fall due for either cancellation or re-negotiation. During 2012, the occupancy rate in the portfolio will increase through a positive net of occupancies/vacancies. None of the ten largest customers are due for re-negotiation or relocation in 2012.
In terms of costs, work continued on reducing energy consumption, which is the largest cost item. In 2011, energy consumption declined 6 per cent. The aim for 2012 is an additional 4 percent reduction. Operating costs per sqm were an average of SEK 223 (239).
Opportunities and risks in the Project portfolio
Opportunities and risks in the project portfolio primarily pertain to project risks related to schedule and the cost level in the procurement process for construction services. A high occupancy rate in project properties reduces the risk of vacancies and lost cash flow when the property has been completed and transitions to the management phase.
Procurement of major projects
Fabege annually conducts project-procurement processes involving significant amounts. Fabege’s Project Managers, who possess extensive experience and expertise, are responsible for these procurement processes, which are conducted with the support of framework programmes, framework agreements and agreement templates.
Key figures in Fabege’s project portfolio
In 2011, Fabege conducted five major new builds and conversion projects. The five projects will be completed successively in 2012 and will transition to the management phase. All projects are within budget and on schedule. The projects are expected to generate a direct yield on total capital invested of approximately 7-9 per cent. Fabege’s objective is for project investments to generate value growth of at least 20 per cent on invested capital. In 2011, Fabege invested SEK 1,457m in the project portfolio, which created value growth of SEK 418m, corresponding to a yield of 29 per cent. The remaining income potential of the five major projects, after relocations during the fourth quarter, totals about SEK 280m, of which SEK 187m is backed by leases. The occupancy rate in the project portfolio was 78 per cent at year-end.
The market value of the project properties was SEK 6.4bn at 31 December 2011. As a result of completions, SEK 4.4bn will transition to the management phase in 2012 and begin generating cash flow. The full impact on cash flow will not be seen until January 2013.
Opportunities and risks in property values
Properties are booked at fair value and value changes are included in profit or loss. The value of the property is determined according to generally accepted methods. Fabege has the value of about 25 per cent of its portfolio appraised externally at the end of each quarter. The value of the remaining properties is appraised internally. Accordingly, the entire property portfolio is valued by an external appraiser at least once a year.
Changes in rents, vacancies and yield requirements in the market have an impact on the value of the properties. Fabege’s properties are concentrated to central Stockholm and its immediate surroundings. The value of the property portfolio is in part a result of how Fabege develops its property portfolio through its leasing and customer structure and through property improvements, and in part the result of external factors that impact demand in Fabege’s markets. Stable customers and modern premises in prime locations provide a strong foundation for maintaining property values, also during economic downturns. The continued advancement of Fabege’s project and development properties is creating value
growth in the portfolio. Th e market price is impacted by expected future net operating income and the buyer’s yield requirements, as well as access to and the terms and conditions of fi nancing.
Key figures in Fabege’s property portfolio
In 2011, the value of the property portfolio increased. A higher occupancy rate and improved cash flows, as well as declining direct yield requirements had a positive impact on the value trend of the properties. Unrealised value changes in the investment-property portfolio totalled SEK 675m. Meanwhile, the project portfolio contributed to value growth of SEK 418m. The average yield requirement in the portfolio was 5.7 per cent (5.9) at year-end. Th e combined market value was SEK 29.2bn at year-end, corresponding to about SEK 26,400 per sqm. The portfolio includes development rights for about 400,000 sqm with an average carrying amount of SEK 2,500 per sqm.
In 2011, the direct yield on the properties was 4.3 per cent and the total yield was 8.8 per cent.