CHARTER HALL GROUP — AGM Information 2010

Nov 10, 2010

Charter Hall Group

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2010 ANNUAL GENERAL MEETING

WEDNESDAY, 10 NOVEMBER 2010

MR ROXBURGH (Chairman): Welcome. First, I’d like to introduce my fellow board members. David Southon, Joint Managing Director; David Harrison, Joint Managing Director; Roy Woodhouse, Deputy Chairman; Glenn Fraser, Chairman of the Audit Committee; Cedric Fuchs, Executive Director; and Colin McGowan, Non-Executive Director and Colin is Chairman of the Investment Committee. I would also like to make an apology for Peter Kahan, who is the Chief Executive of the Gandel Group in Melbourne. Unfortunately, Peter has contracted chicken pox and he did not want to inflict that upon us so last night he asked me to present his apologies but I think he’s probably on the line, he was going to try to dial in. I have got a nod there, yes; Peter Kahan is on the line so if you at some time want to talk to him, I am sure he will reply.

I would also like to welcome Anne Brennan today, she is on the Myer board and she is at a Myer board meeting in Melbourne so Anne cannot even come in on the line. But she joined us about six weeks ago and as I said, she is committed to that board meeting, which was a prior arrangement. She sends her apologies. Anne has worked in a variety of roles in both large corporates and professional service firms. She has had 30 years experience in financial management, treasury, audit, risk management and taxation and in investor relations. She is currently a Non-Executive Director of Myer and recently served as an Executive Director at Coates Group and prior to this she was the CFO at CSR. Earlier, she qualified as a chartered accountant, serving for many years at both Ernst & Young and at KPMG in Ireland and in Australia.

Patrice Derrington, a member of the board from the time that the company listed on the stock market. Patrice resigns today and doesn’t seek re-election. She will resign at the conclusion of the meeting. She initially served as Chairman of our Audit Committee for five years but following her move to New York, she retired as Chairman of the Audit Committee but remained with us on the Audit Committee. She has decided to stay in New York, which makes it rather difficult to attend our board meetings and therefore she, with great regret, is retiring from the board today. We express our appreciation to Patrice for her service and the work she has done for Charter Hall and we wish her well in New York.

Also present today, Jelte Bakker, who is our CFO sitting here; Nathan Francis, Company Secretary; we have Rob Baker from Pricewaterhouse who is here to field questions relating to the audit of Charter Hall should you have any of those; and Stewart McCulloch from Allens Arthur Robinson, so thank you Stewart, he is our legal advisor. I would like now to introduce our Joint Managing Directors, who will provide a snapshot of the year just past and make a few comments about what you might expect to see this year, so I will first hand over to David Southon and he will kick off and then be followed by David Harrison. Thank you.

Charter Hall Group

MR SOUTHON (Joint Managing Director): Thank you, Kerry. Good afternoon, ladies and gentlemen. David and I would just like to give you a little bit of an update today, a bit of an overview of the Group just to remind you where the Group is at, but also to talk a little bit about where we are seeing the property market at the moment and how we are positioned to capitalise on that market moving forward. So the Group, as you are aware, is a leading specialist property fund manager. We established in 1991. We now, I am pleased to say, have over 240 people with seven offices in Australia and in other parts of the world, now with an office in the US in Chicago and also Warsaw in Poland. Our funds under management now exceed $10 billion across office, retail, industrial and in the opportunistic space infill residential projects. We have got a very experienced management team with expertise in funds management and development.

In March this year we completed the acquisition of the Macquarie Real Estate platform, and as part of that transaction we spent a lot of time working through the due diligence on the assets and also working with the senior management team to get ourselves comfortable with that particular acquisition. I’m pleased to say we did get ourselves comfortable at the time and made a decision not only to acquire the management rights, but as part of that acquisition to co-invest in CQO, the office REIT and also the Charter Hall Retail REIT, CQR, and the direct fund within that business. We at the time were the single largest investor in CQR and CQO. And we have really taken the Group forward now to position it as one of Australia’s largest specialist real estate fund managers.

We have got a diversified source of equity across the Group with our expansion into listed capital having already well-established our position with wholesale investors and retail investors. We have got a very high quality, well-resourced platform with our existing team and I am very pleased to say that the integration of the former Macquarie staff into the Charter Hall business is now substantially complete. So looking at the business model as it is today, as I mentioned, $10.2 billion of funds under management. It is a vertically integrated business model, and what we mean by that is that we have specialist skills to service the investment management side of the platform where we hold our co-investments and manage our funds and in the corporation side of our business, there we provide shared services to the various funds and investment management division within the organisation.

We have products across the risk return spectrum, and as I mentioned, across mainstream asset classes of commercial, industrial, retail and infill residential. So in the Group structure you can see we have got a little bit more hierarchy now in the business, obviously, with a broader platform and a greater number of people. We have empowered our people within the organisation to drive the business both at an investment management level and really the fund decisions and investment decisions are made at that level, and they can reach down into a specialist shared services division to be able to take advantage of asset management services, development management services, property management services.

The business itself, as a vertically integrated business, collects income, property income, from its co-investments across the funds management platform but also drives income through the service fees that we earn through servicing the platform. So our strategy and goal is to be Australia’s leading specialist fund manager. We believe that we can maximise long term returns for our investors through focusing on property fundamentals to drive both income and capital growth in all of our property portfolios under management. We are utilising the services of our specialist service divisions, generating a combination, as I mention, of both fees and property income through the co-investments in our managed funds. And we have and will continue to position the funds to capture the property market recovery to capitalise in increased equity flows into the property space and also to achieve strong and sustainable earnings growth from a diverse range of income streams across the Group.

So where do we see the property markets going? In our view, there are very strong signs that we are in a property market recovery. The economic fundamentals are showing signs of recovery; unemployment has fallen and is sitting now at 5.1%, and in Australia we have strong growth rates with GDP at 3.3%. And consumer confidence has stabilised and we expect that to improve.

Charter Hall Group

So because of this we are seeing demand for property start to re-emerge and the supply fundamentals here in Australia particularly are pretty healthy. And improvement in the debt markets also correlates to asset prices improving. So with the credit crisis over the last three years we had a situation where it was very difficult to get access to equity; debt markets were considerably constrained and as a result of that, the demand side of the equation was just not there.

Now, as we are seeing that re-emerge we are starting to see growth come back into our market, both in terms of rental growth - so income growth - and also capital growth as cap rates begin to stabilise and, in some instances, compress. So this table here or chart here indicates what we are seeing in terms of cap rates in the market; it shows the movements in those rates. Capitalisation rates are a key metric in property valuations. As cap rates rise, property values fall and over the last two years we saw property values fall by up to 30 %. As a result of that, as you can see on the chart, the cap rates or yields moved out to a level that now we are seeing very attractive buying opportunities, but we are also seeing the opportunity within our existing portfolio for growth.

As we expect, and as you can see by the trend on the graph there, these cap rates will begin to compress as the demand increases in the market. It is not unreasonable to expect that by 2013 this graph will take on a bell curve appearance as that recovery really starts to take shape. Now, our business is well positioned to take advantage of increasing equity flows and an increasing demand for property, and a lot of that we are seeing coming through the flows - the increasing flows into superannuation funds. So currently we have got $1.26 trillion of super funds under management across Australia. That is forecast to grow to somewhere between $2.5 to $3 trillion by 2020, and that is just at the compulsory 9% contribution. That is expected to increase as the government has been talking about it for some time.

That is a considerable growth rate. We are seeing net inflows each year of $60 billion per annum, and there is an 11% allocation of those funds to property. And we are seeing those funds finding their way both into wholesale or unlisted property fund investments, and also into the listed space.

So just to recap on our FY10 full year results. We have obviously already announced these, but just to recap on these you can see for FY10 strong operating earnings at just under $35 million. That translated into an earnings per security of 4.11 cents and a distribution of 3.2 cents per security, which was a payout ratio of just under 80%.

As I mentioned, funds under management has increased to $10.2 billion, but really with that broader platform and larger platform we have not really seen the benefits in this financial year - the FY10 financial year - flow through to those results, and we will start to see that come through in FY11, which is why we are projecting the growth that we are projecting for FY11. And it is fair to say that in Charter Hall’s case that FY10 does represent very much our trough year, and we expect to see strong growth from there.

Total Group assets, as you can see, increased on a net basis there to $773 million, and our gearing, assuming the consolidation of our core plus retail fund, is very low on the balance sheet of 6.5%. Now, the interesting thing about this bar chart is that it shows where the revenues are derived within the business.

There is about $74 million of revenue across the business, and you will see that the strongest bar charts there are property income and base management fees. That is pretty good from an annuity perspective and we are pleased to see that obviously. But as you move to the right hand side of this chart you will see how the business has performed during difficult periods. We have been able to maintain the capacity to grow those areas of our business quite significantly as property markets recover, and this is where we will see a substantial amount of the growth in earnings come from as we move through that recovery over the next three years.

Charter Hall Group

Whilst we describe our business very much as a fund management business, we also have a very strong alignment of interest with our investors at the underlying fund level through the coinvestments that we have. So as at 30 June 2010, we had co-investments sitting at about $580 million across the various funds, and you can see there it creates the income streams that is, the property income streams that we are benefiting from within the business. You can see the sort of sector diversity, 50% of that in office and on the industrial side, 14%, and 36% in retail. Geographic diversity internationally, 77% of that currently sits in Australia. But as we execute on our strategies to re-weight to Australia across our – particularly our two listed REITs, you will see that proportion increase here in Australia, where we think we will see higher growth coming through, both in income and in a capital sense.

The quality of the portfolio is also pretty important, and we have a very high-quality portfolio. You can see there, across the co-investments that we have, there is a weighted average lease expiry of 6.6 years. But if you run your eye down on the left-hand bar charts, you can see very strong weighted average lease expiries for each of those funds that we manage.

And it is also important to note, on the right-hand side of the slide there, the calibre of the tenants. The top 10 tenants that we have across our portfolio – a majority of those are either government, national or international tenants. Now, I will hand over to David Harrison, who will give you a little bit more colour around the quarterly update.

MR HARRISON (Joint Managing Director): Thanks, David. We have had a very busy 12 months, and particularly in the last three months we have made various announcements, which reflect the growth of our business. As David mentioned, a big proportion of the earnings in Charter Hall are coming from rental income via our co-investments and our asset management or fund management fees. In the last three months, we have launched a Direct Industrial Fund. We announced in July the first asset was a 15-year lease to Toll Holdings. We are pleased to announce that the equity raised since July exceeds $30 million. In fact, just in the last couple of days, it has topped $35 million of equity. And that has allowed us to make further acquisitions, which I will talk about in a little more detail.

We have also raised over $130 million in retail investor funds this calendar year through the equity raisings in 130 Stirling Street, the Martin Place Trust and obviously the industrial fund I just talked about. Pleasingly our core part of our businesses, which has been our Australian superannuation fund and offshore wholesale fund clients that have supported the office fund and the industrial fund, have also been active, and we have now secured $175 million – from existing and new investors – of new equity, and that has given us the capacity to make a number of substantial acquisitions, which I will just talk about in a bit of detail.

We are also progressing through the final phases of restructuring the Core Plus Retail Fund, which will be marketed to our financial advisers and retails investors as a direct retail fund.

In terms of off-market acquisitions, in the last few months, we have finalised and announced the acquisition – $75 million acquisition of an A-grade, 33,000 metre office tower in Melbourne known as 570 Bourke Street, and we have also acquired one of the largest single-asset A- grade office towers in Brisbane, known as Brisbane Square. It is the headquarters of both Brisbane City Council and Suncorp.

That was a $300 million acquisition, 50% between Charter Hall’s Core Plus Office Fund and 50% in partnership with one of our wholesale clients, Telstra Super. That was a very important acquisition, very attractive metrics, as it has improved the weighted average lease term and the internal rates of return and distribution yield for CPOF.

Also recently we have announced for our Core Plus Industrial Fund another major acquisition, which is a new Woolworths distribution centre with a 25-year leaseback for around approximately $75 million. That was secured at a yield of 8.6%.

And as I mentioned earlier, our Direct Industrial Fund, having secured the Toll property we announced in July, has recently acquired another distribution centre in Sydney, which is a 15year lease to Australia Post. Combined with terms we have agreed for a third acquisition,

Charter Hall Group

which is a 13-year lease to Grace Worldwide in Willawong in Brisbane, will bring the total assets in that fund to just under $70 million in the space of three months. So that has been a very pleasing addition to the suite of Charter Hall funds. I think, finally, if you look across the Group, the Charter Hall Property Trust, which is part of the Group, its co-investments in all of our funds that David talked about earlier, around $582 million, has an average weighted lease term to maturity – or to expiry – of 6.8 years, which is very high by industry standards, and a weighted average rent review, or WARR, of 3.5% per annum, driving the sort of income growth that we are expecting from our property portfolio going forward.

Just quickly, I talked about the metrics on the Brisbane Square 57,000 square metre A-grade tower. Only four years old, and as I said, major anchored tenants are Brisbane City Council and Suncorp. Interestingly – the first time I have seen this in a long time – we have been able to secure debt that goes through for 16 years, to 2026, as part of that transaction. I talked about the industrial fund earlier. This just is a slide that summarises the yield metrics for both the Woolworths acquisition for the wholesale fund and then the smaller investments of Australia Post in Sydney of around 8%, and we have been able to secure that below – both those properties - below independent valuation.

Just looking at another driver of the Charter Hall earnings is our development business. As you can see on this slide, we have $2.3 billion of development pipeline. That is not all active. As the table shows you, there is about $600 million that is what we see as active projects. They are committed, they are funded and they are moving forward through their development phase. The opportunities reflect the pipeline that is yet to move into active. Many of those projects are pending and, as we move through the course of financial year 11 and into 12, those opportunities will convert into active projects, and therefore you will see us execute on a development pipeline of about $2.3 billion.

It is important with development that, yes, it drives development fees in the Group, but it also provides accretive returns to our investors in our existing funds in what is appearing to be an improving and rising property market. Just to give you an example of a recent announcement. Our Opportunistic Fund No. 5 had a major development site here in Sydney, you can see, on the coast at Little Bay, which is in the eastern suburbs of Sydney. We have recently announced bringing in a major joint venture partner for 50% of that project, a Malaysian-listed development group, TA Global.

That is a milestone event for the project, because it now gives, with CHOF5 and our partner, the funding capacity to develop what will be a $600 million project, which will produce over 500 dwellings on completion, over a four year timeframe. This is the sort of project that Charter Hall has executed upon over its history since the early 1990s and something that we continue to focus on, both within the existing portfolio and looking at new opportunities throughout the Group.

Just coming back to the Group, in terms of capital management, we have heard, right throughout the GFC, debt duration gearing levels is very important. We have taken our eye off the ball there. Whilst we are moving out of the GFC as a Group, the board and the investment committees of all of our funds are very focussed on taking a cautious approach to capital management, both in terms of maturity and in terms of absolute gearing levels. You can see there that the various debt durations for each of the funds, and clearly this was as of 30 September. As an active manager, we are constantly looking to extend those maturities, and hopefully, in the next three months, some of those funds will have extended their debt maturities even further beyond the duration that you see on that graph.

I think, importantly, on the right hand side, we have given you some colour on both the fund gearing level, which is a balance sheet gearing measure, and then a look through gearing. And we are comfortable that the funds are tracking within their target ranges. Obviously debt was a dirty word during the GFC, but we need to recognise that, in a rising market, that it does add some income and capital accretion to your overall return. So whilst we are being cautious, we do not want to eliminate debt altogether in our funds in an improving market.

Charter Hall Group

So how is Charter Hall capturing the recovery story? Over the last couple of years, we have sold over $3 billion of property to either reduce gearing, reposition the portfolio and, importantly in our opportunistic funds, sell assets that our development team have completed because that is the nature of those investment mandates.

Interestingly, whilst a lot of the sales have been to offshore investors, we are not seeing a very strong investment demand coming from domestic wholesale funds, super funds. The REIT market is starting to buy assets again, and there is increased competition coming from offshore investors looking to both buy investment assets and development assets. Charter Hall has also repaid or refinanced over $3.5 billion of debt, which, as I said earlier, has been focused on reducing gearing. Importantly, the boards of all of the funds have also looked at setting lower and more appropriate gearing targets, having regard to what we have been through in the GFC and just having one eye on the fact that, even though debt capacity and availability of debt has improved substantially in the last six to nine months, you have just got to be careful about how long that lasts. So we are taking a very cautious approach.

In terms of the distribution power ratio for the listed REITS, we have reduced those. We are paying out at a level that we are comfortable with. The earnings that we are retaining are more than paying for maintenance capex and other capital items, so we think those distribution payout ratios are not only sustainable, but will improve as the market moves forward.

What else are we doing? Obviously, we are looking to simplify the capital and ownership structure in all of the funds we manage. At a headstock level at a Charter Hall Group level, during the last 12 to 18 months we have simplified the business model and, as David mentioned earlier, we have got very little or very low gearing at the Group level. We do have capacity, and we are looking to maintain liquidity in terms of undrawn debt capacity in all of our funds.

In terms of moving forward on asset sales, there will be strategic asset sales, we have previously announced, in things like our retail REIT. Some of the smaller assets that are not necessarily going to hit our target returns. They are being marketed. We have announced that we are looking to re-weight the REIT portfolios further towards Australia with a sell down of half of the US office portfolio to a Charter Hall funded wholesale investors. But we are also, at the same time, looking to take advantage of the buying and as I mentioned earlier, you have seen our wholesale office fund, our industrial fund, our listed retail REIT and, more recently, a new launched direct industrial fund all being active buyers at the bottom of the cycle, buying assets that we believe will produce very strong returns for our investors going forward and, importantly, produce strong returns for Charter Hall as a co-investor in those funds.

I think also what we are recognising is the new normal, as people are framing it, investors are looking for confidence that property is going to return, to produce the income yield and the stable capital growth that it has always done. And that is something that Charter Hall Group is looking to provide to its investors and to the investors in our managed funds.

I will just quickly mention the proposed security consolidation, Kerry will go through the formal part of this proposal but, in essence, we have proposed a one for four security consolidation. If the shareholders approve that today, that would be effective on 12 November, which is on Friday. The number of securities will reduce from just over 1.2 billion to 306 million Charter Hall securities. There would be deferred settlement trading under the ticker code CHCDA until 25 November, and the first day of normal trading would be 26 November. The best way to explain what has happened is that all of the metrics that you are used to - whether it is earnings per share, distributions, share price - increase by four times.

So why are we doing it? The benefits are that we will reduce - and evidence has suggested, because we have recently implemented this in both our office and our retail REIT, that we will reduce the volatility of the share price. So, for example, pre-consolidation a one cent movement in the Charter Hall share price would reflect a 2% movement in the value, but postconsolidation that will only reflect a 0.4% change in the value. And that is important because

Charter Hall Group

that essentially will reduce volatility and the perception of risk about the stock and it obviously potentially lowers the beta of the stock which means it’s much more attractive for investors and particularly institutional investors.

It does reduce the trading cost for investors; it better aligns the number of securities on issue to the sector and our peers. I think importantly - and once again, I can say this has happened with our listed REITs - it does improve the market perception and broadens the appeal of the stock. So they are the reasons why we have moved forward, but as you have been given the opportunity, that is entirely a shareholder decision and hence we have had a vote about that.

So let us just move to, finally, the outlook; Charter Hall Group as both a fund manager and REIT is very focused on our earnings growth, and we believe our earnings grown will come over the next few years from margin expansion across our business.

And what I mean by that is as revenue grows, because we have got generally a fixed overhead, there will be strong increase in profitability across all of our businesses, and we are starting to see that come through already. We are well placed to take advantage of the recovery in the property markets, and I think importantly, as David mentioned, we are very strongly leveraged to the growth in superannuation funds in Australia. That is not just the big industry funds or the super funds, all of us have got some form of superannuation, it is compulsory. Whether it is a do it yourself super fund or whether you invest through someone else that is managing that for you, there is an increased demand for those allocations to go into real estate.

After a period of the GFC where people reduce their allocations to real estate, we are now seeing the large super funds and even the financial advisors are starting to get investors to increase their allocations to real estate. And we think that is going to place Charter Hall in a strong position, given that we are providing very good quality investment product to both retail investors, institutional and wholesale investors, and of course our listed investors in the REITs. I think also the Group has formulated clear strategies across all the funds and we are very focused on the income and the capital growth prospects. Medium to long term performance will be underpinned by property values, but that is something out of our control. What is in our control is how we can control the profitability of the business and to create the sort of earnings growth that we believe is possible. There is equity flows, growth in equity flows in property, as I said earlier, and Charter Hall is well positioned as a specialist property fund manager to take advantage of those.

In terms of earnings and distribution guidance, subject to there being no material change in market conditions, which obviously the market is improving, as I said earlier, for real estate, we expect our FY11 earnings per share to be around five cents per security, which represents growth of about 20% on the previous financial year. Based on the financial year DPS of five cents or 20 cents post-consolidation - so you multiply everything by four - that DPS would represent around four cents per security or 16 cents on a post-consolidation basis which, as the slide says, represents very strong DPS growth of 25%. Thank you for your attention.

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