Interim Report Q3 2023
Division into the business areas of Education, Community, Residential
SBB has successfully and strategically built up its unique property portfolio. During the quarter, a clear division into three business areas was implemented aimed to facilitate governance, increase transparency and improve the conditions for raising capital. This division also entails a specialization within each business area, providing conditions for increased profitability within each segment over time.
Education owned jointly with Brookfield
SBB’s education operations encompass properties of SEK 42.7bn with an average remaining lease term of 13 years. Over the first nine months of the year, net operating income rose by 9.4 percent for comparable portfolios.
SBB has agreed to divest a further percentage of EduCo, which holds educational properties, to Brookfield Super-Core Infrastructure Partners, such that SBB will subsequently hold slightly less than 50 percent. Brookfield is one of the world’s largest and most competent infrastructure investors. Through the transaction, EduCo achieves a financial position enabling an investment grade credit rating, while raising some SEK 8bn in additional liquidity for SBB. EduCo will repay all loans from Nordic banks as more attractive terms can be obtained via other sources, such as through the US capital market.
Together, SBB and Brookfield will build on the unique platform of educational properties that SBB has created. CEO Leiv Synnes SBB’s transaction with Brookfield results in that EduCo in SBB’s income statement will be reported as discontiuned operations due to a deconsolidation of SBB’s segment Education. This will be illustrated in the table down below. Henceforth profit from property management will decrease, along with the interest and debt costs. During a normal year, the profit from joint ventures/associated companies will increase for SBB and the share of the result that will be allocated to the minority will decrease. It is a complex transaction, but the final product is that earnings per share will remain the same excluding the strategic and financial gains the change creates.
New partners are planned for Sveafastigheter, SBB’s residential platform
For a long time, reasonably priced residentials have been in short supply in Sweden and there are no political signals that this relationship will change within the foreseeable future. On the contrary, the shortage will probably increase due to population growth and as new productions of rent-regulated residentials are increasingly postponed due to the situation with increased costs in new production. Accordingly, we still see substantial demand for our rent-regulated residentials and little risk of increasing vacancies.
The Residential portfolio amounts to SEK 29.4 billion. Net operating income for SBB’s residentials increased by 13.6 percent for comparable portfolios over the period. The regulated rent level normally lags behind strong inflationary increases, with rents normally rising more than inflation over extended time series.
Recruitment of management is in progress for Sveafastigheter, which will hold SBB’s total stocks of residentials. Sveafastigheter will move to new premises in December.
Accordingly, the new Sveafastigheter will be a unique platform for developing and managing rent-regulated residentials in Sweden. To be able to raise capital beneficially on its own merits, the intention is for Sveafastigheter to receive an external equity contribution in 2024. In connection with this, SBB’s financial position is also strengthened, enabling a reduction of SBB’s debt and its exposure to current funding sources
Company structuring of community properties
The Community business area encompasses a portfolio with public tenants in areas including elderly care units, government infrastructure and healthcare facilities. The portfolio is valued at SEK 46.2bn and has an average lease term of seven years. For comparable portfolios, growth in net operating income amounted to 12.1 percent over the period and the occupancy rate was 96 percent.
SBB is involved in several discussions regarding sales of properties to existing tenants. An example of this is the sale of a hospital in Norway for NOK 2,815m, where a total NOK 1,700m was invested in the property. The process from construction to sales thereby generated NOK 1,115m in cash flow. This is an example where SBB profitably developed social infrastructure.
Long term, SBB expect favourable conditions for further investment in the business area. The demand and need for community service properties in the Nordics will increase and SBB has both the expertise and the building rights for future development of cash flow properties
Net operating income for comparable portfolios increased by 12.5 percent
SBB’s earnings capacity is gradually improving and offers low downside risk, regardless of economic circumstances. This is an important and stabilizing factor. For comparable portfolios, rental income increased by 9.5 percent compared with the corresponding period in the preceding year. The economic letting ratio continued to increase and amounted to 96.3 percent (95.2) with the vacancy rate of 3.7 percent being predominantly due to planned projects.
The general price increases will continue to have a positive impact on income.
Net operating income decreases overall and so does operating profit from associated companies/JV. This is due to SBB selling poperties to reduce the indebtedness.
Value change, properties – 8.9 percent
Value changes include general rent development, re-negotiations of existing agreements and newly signed leases generating higher net operating income which contributed positively to unrealized value changes. The negative change in value is explained by higher yield requirements. During the period, the property portfolio experienced a negative change in value of 8.9 percent, of which 2.7 percentage points were attributable to the third quarter.
Over the past 18 months, SBB’s average yield requirements increased from 4.35 percent to 5.22 percent, at the same time as the consumer price index rose by 18 percent, meaning that the real decline in value for SBB’s fully indexed properties can be estimated at 31 percent during this period.
Hopefully, we are at the end of the correction in market prices brought about by higher market interest rates. Interest rates rise and fall, while indexed rents usually only rise. Over a slightly longer time perspective than the next quarter, it is possible to take a confident view of the value trend for SBB’s property portfolio. Over extended time series, the value trend for SBB’s properties will continue to exceed inflation.
A larger proportion of equity is needed
SBB will continue to adapt to higher interest rates by reducing the share of debt and increasing the share of risk capital.
Over the past 15 months, SBB has been actively selling properties for SEK 8,4bn and shares in part-owned companies.
Over the past 15 months, SBB has also raised SEK 2,36bn in risk capital in a new joint venture. On the whole, SBB has decreased its interest-bearing liabilities by SEK 20,377bn over the past 15 months.
SBB will maintain a cautious stance on share dividends and coupon payments on hybrid bonds until the financial position has improved. The exception is the dividend approved by the Annual General Meeting.
Strong liquidity necessary
Negative speculations on SBB’s future has weakened the company’s financing possibilities during the year, in turn affecting the company’s liquidity. This has, in turn, contributed significantly to lowered credit ratings.
To eliminate significant uncertainty factors that may lead to significant doubt about the company’s capacity to finance the operations, a number of liquidity-strengthening processes have been initiated, some of which have already been completed. SBB is dependent on the refinancing of the company’s education operations being completed, with the company thus receiving SEK 8bn.
The major actions planned by SBB aim to strengthen the company’s financial position, reduce dependence on individual sources of capital and create optimal financing opportunities. The work will continue until the company regains a reasonable level of financial risk. An objective measure of reasonable risk is an investment grade credit rating.
Average interest rate of 2.29 percent
On average, SBB’s senior debt, excluding preference shares and hybrid bonds, carry an interest expense of 2.29 percent (1.89) with an average interest maturity of 3.1 years (3.4). On average, the bond loans mature over 3.8 years at an interest rate of 2.43 percent. SBB reduces the effect of a higher interest rate by reducing the need for new loans or the refinancing of existing loans. This is done by selling properties and by injecting equity.
No vacancy risk in projects
Over the past 12 months, the number of apartments in production decreased from 3,752 to 2,219. SBB’s new production currently contracted and in progress requires SEK 1,782m in investment, continuing through 2025, of which more than half of the capital has been financed externally. The contribution from net operating income will be SEK 274m or 15.4 percent of the remaining investment. It is worth pointing out that we have no vacancy risk in the project portfolio as all of the community service properties are fully leased with index adjustment. Zoning plans including residentials and community properties for a total of about 100,000 m2 GFA are expected to be legally effective in the upcoming quarters. The value generated in new projects will not be realized until the circumstances have improved.
Sustainability in focus
SBB has continued to work on the energy efficiency of the property portfolio. During the quarter, 22 projects were completed, reducing both energy consumption and climate impact. The energy projects form a central element of the efforts to achieve the long-term sustainability targets, they will contribute to climate adjustment while reducing the company’s exposure to high energy prices.
During the period, certifications of 34 properties were completed, corresponding to 4.3 percent of the property portfolio’s total market value. To become certified, a building undergoes a thorough quality control of its characteristics and performance – this includes checking the choice of materials, the presence of hazardous substances, the buildings indoor environment and energy performance.
Outlook
Rent-regulated residentials and properties with long lease terms with the public sector are holding up well even though the economy continues to slow down. SBB is continuing to benefit from increasing rent levels and occupancy rates that will remain high during coming years.
Our personnel is delivering good results, with property-related key ratios showing their strength. Occupancy rates and rent levels are increasing, for example, generating a good surplus ratio.
SBB needs to continue adapting the business based on challenging financial markets. It is largely a matter of lowering the debt level and reducing the dependence on individual funding sources.
SBB’s historical transactions show an ability to adapt the business to new conditions.
Leiv Synnes, CEO