CHARTER HALL RETAIL REIT — Call Transcript 2010

Nov 4, 2010

Charter Hall Retail Management Limited

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2010 UNITHOLDER BRIEFING TRANSCRIPT

Thursday, 4 November 2010

MR SOUTHON (Chairman): Good afternoon, ladies and gentlemen, and welcome to the Charter Hall Retail REIT investor update. My name is David Southon, and I am the chairman of the Charter Hall Retail REIT. I am also the joint managing director of the Charter Hall Group. Firstly, I would like to just introduce the CEO, Steven Sewell, just here on my right, your left, and then moving into the board, David Harrison, and the other joint MD of the Charter Hall Group, and also a director on this board. We then have the three independent directors, Alan Rattray-Wood, next to David. We’ve got John Harkness next to Alan, and also Maurice Koop on the end there.

Now, there is no formal business to be put to this meeting today. It really is an update to give you a bit more colour around where things are at, and how the REIT is progressing. We will open up with the Chairman’s address, which will be a general overview, but also a bit of an update on where the market is heading to. Also once I’ve completed that, Steven will give you some more colour around, and some more detail around, how things are progressing within the REIT itself, and then we will move to question time where you can ask any questions that you may have, at that point in time. We have taken on board a number of the questions from you – those that have already written in, and posed those questions, and we tried to answer a lot of those in the presentation that you will see today.

Also, it’s good to see a number of you here again from the Investor Forum that Charter Hall has recently undertook. We had over 1,500 investors attend that forum, and you will probably notice that there are some familiar slides in what you see today, around what you saw at that Investor Forum.

The first thing I would like to address with you is the successful integration of this REIT into the Charter Hall Group. As many of you are aware, Charter Hall acquired the majority of the Macquarie real estate platform in March this year. That included the Charter Hall Retail REIT – formerly known as the Macquarie CountryWide. We did a lot of due diligence, at that time, around the properties.

We inspected properties here in Australia, in the US, and in Europe. We spent a lot of time with the senior management team getting ourselves comfortable, and that they had a very good and solid handle on the Trust itself, but also the strategy moving forward, and we did get ourselves comfortable around both the quality of the assets and the quality of the team. As a conclusion to that due diligence, we moved forward with the transaction, which included acquiring 7.6% interest in the Retail REIT, making us the single largest investor in the REIT at that time, and considerably aligning our interests with the interests of unitholders.

The integration itself has been very successful. I am pleased to say that all of the senior executives within the REIT moved across into Charter Hall. We’ve been able to take what I think are the best bits out of that team, and the best bits of what we already had within the Charter Hall team to be able to integrate this REIT into the broader Charter Hall funds management platform.

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Charter Hall Retail Management Limited

Now, just to give you a little bit of an overview of Charter Hall itself. Charter Hall is a leading specialist property fund manager. We established in 1991 and we listed on the ASX in 2005. We now have over 240 people in seven offices, predominantly around Australia, but also in the US and in Warsaw in Poland.

We have funds under management now in excess of $10 billion across 20 funds that we manage, and we have experienced managers within the organisation, across the core asset sectors of office, retail and industrial. We also have a very strong development reputation through our opportunistic funds and that includes some infill residential.

The Group’s structure: we are vertically integrated, as is suggested here on this slide. You can see that the Charter Hall Property Trust, through which we own the majority of our coinvestments in our various funds, is stapled together with the corporation. We have specialist property services to be able to service the investment platform that you see there in the middle of the slide. So really, as an integrated group, we are able to tap into that deep pool of specialist talent to be able to drive both income and capital growth, right across the funds platform.

The Charter Hall Retail REIT has $2.1 billion under management currently. It’s 136 high quality, predominantly grocery-anchored shopping centres. We have very strong anchored tenants in the likes of Woolworths, Coles, and, offshore, Schnucks in the US.

What’s important about Charter Hall is that we believe that we have the ability to be able to set a very clear strategy, and then implement on that strategy, and so working with the existing management team, we have been able to refine the strategy, and then clearly communicate that to the market. We are 100% focused on the real estate sector, and through the deep pool of talent that I mentioned earlier, we are able to focus in on property fundamentals. You can see that part of that strategy is to reweight to Australia, and I am pleased to say that that strategy is continuing to be executed upon, and currently Australia represents 72% of the net tangible assets in the funds.

I just would like to turn now just to the property market itself, and make a few comments about what we are seeing in the market. We are certainly seeing economic fundamentals showing signs of recovery, and we believe that the property markets across all of those core sectors that I mentioned earlier, are in a recovery phase. Despite the difficult years that we have seen the last couple of years, we are now seeing GDP growth at 3.3 per cent per annum, we are seeing unemployment at 5.1 per cent, and consumer confidence has stabilised, and is now starting to improve. We are seeing demand again across those core sectors, of office and industrial, coming through in quite a strong way, and we are seeing now demand for retail space starting to increase.

Our property teams are certainly more active. We are reporting far higher levels of inquiry, and a great amount of result in leasing activity which Steven will touch on later in the presentation. We are also seeing in the markets the capital liquidity position has improved substantially, and so this is driving an appetite for property again. We are seeing significant deleverage has occurred and we are seeing in Australia that the banks are in a very healthy state, and because of that deleveraging, they again have an appetite for property across the risk return spectrum, from core through to enhanced.

In Australia, on the retail side of things, the retail fundamentals have been somewhat impacted on by the phase out of the economic stimulus, and that has reduced the overall growth rate in retail sales. However, within the CQR portfolio, it’s fair to say that it has remained very resilient, partly due to the strong performance of our major Australian anchor tenants - again, Steven will touch on that – but also the recovery in the mining sector, and also population growth which is very strong in Australia. In Europe, whilst the leasing environment generally there has been subdued, our centres in Poland and in Germany have continued to perform well, and again, Steven will touch on that later in the presentation.

So all of these factors will underpin the future income and capital growth for the Charter Hall Retail REIT, and ultimately will result in both earnings and NTA going forward. This slide – it

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is a good snapshot of the property cycle itself – property is cyclic in nature. This is a slide that compares the subsectors in retail, and the relative yields, and the yields spread between those subsectors. Hopefully you can see that, but the diamonds represent how the yield for CQR is tracking, and as you can see, that we have seen a situation where property values firstly grew in value, and as a result of that, both cap rates and yields dropped, as you can see for peak cap rates there.

Now, as property values fall, cap rates or yields actually rise. And you would see that towards the right-hand side of that slide. You can see considerable spreads there, particularly on a risk-adjusted basis, which indicates that there is some very good buying opportunity, we believe, at this point in the cycle. We believe that we will start to see cap rates across all of the sub-sectors in retail beginning to compress again, and hence, values rising.

So the key objectives in relation to CQR; firstly, it is fair to say that CQR is well positioned for the recovery in the property markets. We have a dedicated and highly experienced team, we have a very high-quality portfolio and we have an enhanced and simplified strategy for CQR. Over the next few years, we will focus on growing the NTA, growing the earnings, and the distributions to investors by re-weighting to Australia with a forecast higher growth rate, and also driving property income so that we can achieve higher capital growth and maximise total returns for investors. Our intention is to do this through a focus in property fundamentals. That is what Charter Hall is about, and we believe that we can execute well on this strategy in terms of driving those total returns for our investors. I would now like to hand over to Steven Sewell, who will give you more of a portfolio review. Thank you.

MR SEWELL (CEO): Thanks, David. Thanks, ladies and gentlemen, for coming along. It is good to see so many familiar face even though we have scheduled it, I think, right on the time that the Oaks was being run down in Melbourne at the Spring Carnival, but it’s good to see you here, taking an interest in the business.

It is fair to say that the last four months for Charter Hall Retail REIT, the portfolio and the business has changed shape fairly dramatically. We have successfully, as David mentioned, integrated into the Charter Hall Group and that has been a very positive experience for myself, and I think I speak on behalf of the whole team.

We have established Australia and confirmed Australia to the market to our investors as a core market for the portfolio and taken substantive steps, in the last 18 months in particular, to exit our investments in the US, enshrining Australia with more than 70% of the asset backing of the Trust. And, as David mentioned, we do have a lot of work underway, a lot of transactions – capital transactions – underway at the advanced stages to progress on the disposal of the balance of those investments in the US and New Zealand in particular, as well as some of the small properties in Australia, to bring that equity back to Australia and put us in that pole position to be able to take advantage of the opportunities that we see.

So I would just like to give you a bit more colour on that, on the strategy, and just confirm how we are going, and also touch on some of the operational stats that we announced to the market this morning.

Just turning quickly to the financial results for 30 June, so they are a little bit of old news and they are also on a pre-consolidated basis just to confuse everybody. You will see there operating earnings of $98.7 million or 6.6 cents. This was pre the five-for-one consolidation. A distribution of 5.3 cents per unit, importantly, at an 80% payout ratio, substantially increased from the previous financial year.

Net asset backing of close to $3.70 - $3.69 – with that, as I mentioned, more than 70% now accounted for the core Australian portfolio, substantially increased on a year ago. And the valuation of the portfolio stabilised from where it was 12 months ago. We are starting to see some cap rate compression in some of the strong markets, particularly in Australia. The portfolio continues to perform well within our expectations, and the operating update that we gave – the first-quarter update through September we gave today demonstrated that, with occupancy sitting at just under 97%, strong property income growth as well as rental rate

Charter Hall Retail Management Limited

growth, with the only negative, really, in the whole portfolio being a continued decline in rental rate growth from the US portfolio, although we are seeing substantive signs of that stabilising and improving.

I think the standout, for our perspective, is the Australian portfolio. It continues to deliver very high occupancy, very strong rental rate growth, and, as David mentioned, underpinned by the anchored tenants, which are predominantly grocery anchored – supermarkets, Coles and Woolworths anchors.

Just to break it into the geographic splits, you can see there Australia, very strong occupancy of 99%, positive income growth and rental rate growth. I think, you know, it is probably worth just mentioning the US market. We have seen very poor conditions in the last 24 months and feedback from Regency, our partner over there in the US – this morning, they have released their results for the third quarter.

They are seeing an increasing sign of tenant activity at the property level. They are starting to see some confidence come back into some of the sub-markets. Their occupancy tracks a fraction below ours at ninety – they’re 92%, we are at 93%. And the rental rate growth – I think the important statistic there is that what they are finding is that a lot of the spaces that they are leasing in the US today have actually been vacant for quite some time – up to 14 months in some situations. So you are basically looking at sort of pre-GFC, post-GFC type operating conditions, which really does account for that negative rental rate growth.

The European portfolio, we have mentioned that we will hold that in the medium term. And really that is a factor of that – it is about 7% of our net asset backing. It does generate close to 20% on a return on equity basis on today’s values on the cash earnings distributed out of that portfolio. And simply that is a situation that we could not repatriate that equity and replace those earnings, and we are more than happy with the operating conditions. We have employed people on the ground in Poland and are very comfortable with that position. Turning to the investment strategy, we have clearly enunciated that our intent is to exit the remaining investments we have in joint venture and wholly owned assets in the US.

We are exiting our joint venture in New Zealand. We are in a process of releasing the equity there. Our partner will buy our 50% interest in New Zealand. And we have also identified and been actively marketing in the last four or five weeks a portfolio of smaller assets – non-core assets – in the Australian markets – about 11 assets with a total value of about $70 million – in most of the states of Australia. As those projects come to completion, over the next three or four months, we will announce those results. The reason we are doing that is to be able to take advantage of the sort of opportunities that we are looking at here in Australia: higher value assets – value of assets that sit in the 40 to 80 million dollar type range – which we forecast will provide much more sustainable – higher and much more sustainable growth prospects for investors.

We are also seeing assets come to the market at pricing that is quite attractive on a historical basis. And we are also very much committed to the redevelopment of our existing portfolio, so using our capital to better enhance the assets that we already own, driving the income growth, driving the security of tender of the anchored tenants, and overall optimising our existing portfolio. We are making significant progress on those disposal transactions. As I mentioned, New Zealand, just as an update, we are in an external evaluation phase. That is expected to be completed this side of Christmas, with potentially settlement in the first quarter of 2011, and we have a number of transactions that we are working on in the US, with our joint venture partners and separately, to look to realise that equity.

Already to date, we have been able to take advantage of opportunities in the Australian market. We are targeting neighbourhood and subregional properties. You can see there in excess of $20 million. We have set ourselves a hurdle of an internal rate of return of in excess of 10%, and we want to try and lift overall the average asset value as well as that average NOI growth prospects of the portfolio. We have acquired to – just on – $100 million of assets to date that meet these criteria. The first were back in March, where we acquired

Charter Hall Retail Management Limited

Mile End in South Australia, our first household retail property, and also Manuka in the ACT, a grocery-anchored property out of the ING Retail portfolio.

In July, we acquired two properties from a Centro-managed syndicate, and we did that in conjunction with an unlisted Charter Hall Direct Retail Fund. And each of these properties has terrific fundamentals, from our perspective, in the anchored tenants and the growth prospects going forward.

Let me just provide a bit more colour on the household retail part of our strategy, which we spoke about this meeting last year, and we have been able to announce, obviously, Mile End in South Australia. We have completed the acquisition.

We have also announced that we have agreed terms to acquire a 50% interest, in whilst it’s only a photo of its sign over the front door, but that is the Home HQ property on Whitehorse Road in Nunawading in Victoria. This asset class we believe in select locations provides very strong weight of average growth for rentals. We believe it is an asset class that is in something of a rebound. We are being very selective about the properties that we would select and look at in this class, hence our labelling of household retail, and we note that more than 20% of all Australian retail sales is actually now accounted for by retailers that typically frequent or tenant the sort of properties that we are talking about.

We are firmly of the view that a portfolio exposure of between 10 and no more than 20% will certainly – it is a well leased and well located assets in this asset class, will provide investors with much more sustainable and higher capital income growth prospects. As I said, in line with this strategy, we announced that we have agreed terms to acquire 50% of the Home HQ property in Nunawading. That is a deal that hopefully will complete this calendar year, for about $31 million for the 50% interest, and that is a superior quality property, anchored by the likes of JB Hi-Fi, Nick Scali, Dick Smith, Sony and Forty Winks, and it will be a great addition to the portfolio.

As I mentioned, redevelopments are core to our strategy, and I think a big plank of the Charter Hall vertical integration is the fact that we do offer all services in-house to the fund. The development team that Charter Hall had certainly has a lot more geographic reach than we have had historically. We now have people on the ground in basically every State of Australia that are able to help us facilitate and work up developments, and we retain very much a commitment to that part of our business. We are looking at a number of projects, and we hope to be able to get back to an annual spend of between 40 and 50 million dollars, on our existing portfolio, looking to optimise the growth.

One of our biggest projects in Singleton, we have a DA Approved. We have since lodged a reapplication for a development approval on a much smaller scale re-development of that property, and that is something that we hope to be able to bring to the market within the next 12 or 18 months for a completion, as well as a number of other projects across our portfolio – really right across the whole country. This is really where the major dramatic change for the Trust has come about, as you would imagine. The capital management initiatives that we have undertaken over a course of the last two or three years, we have greatly restructured the REIT balance sheet, and debt maturity profile to great advantage, offering liquidity to the trust, extended debt tenure, as well as minimising it - in most cases, eliminating any covenants.

The asset sales were completed in the US eliminated over $1.4 billion of $US CMBS debt from maturity, and realised in excess of $220 million of proceeds. We announced about four or five weeks ago that we have agreed terms with our lender, National Australia Bank, to proactively extend our head trust facility to multi-currency facility, out to February 2015 – sorry, September 2015, which overall increases the average – weighted average maturity of our debt facilities, out to 3.2 years. Importantly, there were two aspects of that deal: we reduced the overall costs to the Trust of that facility, but equally as important, we eliminated the last remaining group-like covenant, which was a tangible networked covenant no longer in existence.

Charter Hall Retail Management Limited

So looking now, we have no significant debt maturities until December 2011, which is our Polish debt, and we are in very extended or advanced stages of negotiation on that facility, to extend that out to financial year 2015, and then we have already turned to the German debt, and the Australian CMBS debt, which are the two biggest pieces there you see in financial year 2013, and I’m very confident of being able to deliver, probably this time next year, advice to investors that we’ve been able to extend or re-finance those facilities at a substantial reduction in the interest expense to the benefit of unit holders.

We are committed to growing the value of the portfolio’s assets. We have a lot of people on the ground driving leasing results, driving the property management, increasing the operating efficiencies at the properties, working with our anchor tenants, working with our speciality tenants, and we believe that’s the best way to hopefully reduce that spread between the net asset backing of the Trust, and also provide due confidence and institutional investors’ confidence of our management of the business.

We expect to not only provide the management of the business – sorry, expect to provide you the confidence of the underlying asset backing of fundamental value of the portfolio, but also in our ability at Charter Hall, as a manager of the REIT, to be able to optimise the income and capital growth prospects of the portfolio going into the future, from a key perspective, predominantly investing in Australia in retail assets or shopping centres.

Pleasingly, when we look at the unit price performance over the last 12 months, with every announcement of transactions, whether it be disposal or acquisitions, and certainly from the point in August here, you will see we clearly enunciated the strategy to exit the remaining of our investments in the US. Our unit prices outperformed the sector. They say mimicry is one of the greatest form of flattery, and Westfield announced yesterday that they are going to create an Australian-only vehicle, or a vehicle focussed on their Australian assets, and we could probably lay claim to saying, well, we have sowed the seed for them that that was a successful strategy.

Notably, where we sit today, we still have something of a gap between the unit price as well as the net asset backing, and we are confident, with delivery of each of these transactions that we have underway, that we will be able to close that gap. And obviously I should note that the unit consolidation that occurred was effective 1 September on a five-for-one basis.

So the strategy: the REIT really is well placed to deliver on what is fairly and a very simple strategy. We intend to recycle the equity that we have remaining in the US, New Zealand and in that small group of assets in Australia to either take advantage of those development or acquisition opportunities – and we believe that there are more and more opportunities that will present in the near term as, well as much on the redevelopment side as acquisitions.

We are well placed and progressed on achieving these objectives. We are confident of being able to recycle out of our non-core, very small value assets in Australia and use that equity to invest in higher dollar value assets that, for the long term, will deliver much more sustainable growth prospects for investors. And certainly with the full suite of property services now provided in house at Charter Hall, we are confident of being able to maximise and optimise those operating conditions at each one of our shopping centres.

As I mentioned, Europe is a core hold for the portfolio for the medium term. We have three people on the ground now. We have an office in the Warsaw Financial Centre. We do our own leasing, we do our own lease administration, we have an asset manager on the ground there working up plans to maximise the value of those assets, liaising on a daily basis with our anchored tenants, and we think that is going to pay off handsomely for investors in the short to medium term.

So turning to the outlook: we are extremely confident that FY11 will deliver earnings arising to between 26 and a half and 28 cents and, importantly, will be the top year for earnings. This is as a result of having seen the full-year effect of what we have done in the last two or three years from a perspective mainly of US sell-down of assets, as well as entering into our new debt facilities, predominantly the CMBS facility.

Charter Hall Retail Management Limited

And in light of the portfolio’s performance to date, we are very optimistic of being able to deliver an earnings performance at the half year, and then, at the full year, at the upper end of this range. And I note that, on today’s trading price for $3, this equates to quite a healthy earnings yield of about 9.3%. For the financial year, we are forecasting distributions will be made with a payout ratio of between 80 and 90%, and will assess the actual payout ratio that is required or that is relevant at each of the distribution periods. So in summary, we are confident that our investors – you, the unitholders – will benefit from the clear strategy to reweight to the Australian portfolio.

They will benefit from property valuations that will grow in the Australian portfolio; a focus – a clear and demonstrated focus on property focus that will underpin that capital and income growth of the portfolio, optimising the portfolio’s internal rate of return; a very strong balance sheet position; a very clean debt maturity schedule; and a very clear, clean and improved liquidity position in proving our earnings growth potential as well as payout ratios. I will now hand back to David for the concluding remarks. Thank you.

MR SOUTHON: Thanks, Steven. As mentioned earlier, there is no formal business for today, but we do want to open it up now for questions. When you registered today, you would have been either given a yellow card or a blue card. For unitholders, you will have a yellow card, and means that you are entitled to ask a question. For those with a blue card, it means that you are a guest here today and will not be entitled to ask a question.

If you do have a question, I think we have got some roving mics in the room. Once question time is finished, we would like you to join us – we would like to certainly invite you to join us for some refreshments outside. Both the management team and the board will be present, so if you have got any further questions, there is an opportunity to chat to both management and the board outside after the formal questions have been completed. So we might now open it up for questions. Thank you.

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