SEGRO Plc (OTCPK:SEGXF) Q2 2022 Earnings Conference Call July 28, 2022 3:30 AM ET
Company Participants
David Sleath – Chief Executive Officer
Soumen Das – Chief Financial Officer
Andy Gulliford – Chief Operating Officer
Claire Mogford – Head-Investor Relations
Conference Call Participants
Pieter Runneboom – Kempen & Co.
Colm Lauder – Goodbody
Frederic Renard – Kepler
Paul May – Barclays
David Sleath
Good morning, everybody, and welcome to our First Half Results Presentation. Thanks to those who braved the travel chaos and made it here in person, but good to see those who are here, but also welcome to everybody joining online, and apologies if my voice sounds a little croaky. I’m pretty sure it’s not COVID. But I’ve unfortunately stepped out – struck down with a bit of a chest and throat infection with impeccable timing.
But we will soldier on anyway. So as usual, I’m going to make a few opening remarks before we go into the – into details of the presentation. And the first and perhaps most obvious thing to say is, the world feels and looks quite different to how it was just five months ago, when we did our full-year results presentation. Clearly the geopolitical and macro environment is much more challenging and the general outlook less certain. But as you’ll gather, as we go through the presentation, we feel confident about our prospects for further growth and outperformance. And that’s due to a number of factors but principally, our occupier markets remain strong, with new supply likely to remain low.
Our own business is in great shape. And our proven strategy is continuing to deliver. And it’s really pleasing to see that in the first half of this year the application of our clear and consistent strategy that we’ve followed for over a decade is continuing to deliver great results. Disciplined capital allocation is the main reason why we have such a fantastic portfolio and it’s the reason why we’re able to produce consistently strong returns and why we expect to continue outperforming the wider market.
Over the past 10 years, we’ve been incredibly selective about where we’ll invest. We’re disciplined on pricing, and we use our local network and market knowledge to go after new opportunities only where we have real conviction about the economics. And we don’t hold on to assets that we believe will underperform. Our focus on operational excellence is about staying close to our customers and markets, serving their needs better than anyone else. And driving rental income and value growth from the portfolio we have. We’re continuing to deliver excellent rental uplifts, offsetting high construction costs on development, and driving the income and valuation of the existing portfolio of built assets.
And we’re underpinning these two property disciplines with an efficient capital and corporate structure, which has given us an LTV of 23%, a low average cost of debt, and one of the longest debt maturity profiles in the sector. Meanwhile, Responsible SEGRO is at the core of our strategy and is being increasingly integrated throughout all areas of our business.
As I mentioned, the industrial markets remain in good shape. We told you in February, that demand was strong and coming from an increasingly diverse occupier base. And that’s continued through the first half of 2022, with record take up in the period and agents predicting the full year to be similar to 2021’s record volume. The structural tailwinds often discussed continue to provide good support. And these trends are much broader and more enduring than the near-term behavior of any single occupier, or, indeed the next quarter’s GDP outlook.
Vacancy rates are also low across most markets. And we anticipate speculative development starts will most likely moderate in the months ahead, which all sets a good context as we go into the second half of the year. I believe our portfolio is in the best shape it’s ever been in. We’ve spent the last decade carefully creating a super strong, modern and well located portfolio that will perform at all stages of the cycle. 2/3 of our capital is invested in urban markets, mostly London and the Southeast of England and other supply constrained locations. These markets are likely to continue delivering strong rental growth, which we can capture as new leases are signed and rent reviews completed.
Whilst most of the rest is in Continental Europe where indexation uplifts are coming through strongly on the back of elevated levels of inflation, but which are also being underpinned for new leases by higher construction costs on development. And of course, on top of that, we have an exceptional land bank, which offers a significant amount of very accretive development growth.
We also have a very diversified customer base. There’s no single name or industry that dominates. And the vast majority of our buildings are extremely flexible and adaptable to many different uses. Personally, I never cease to be amazed at the diversity of occupiers and the different types of uses our buildings are put to, and the dynamic nature of these markets. This is particularly true in urban markets.
Our experience is that whenever you have large numbers of people and businesses clustered together, there’s always going to be demand for space from any number of new or existing occupiers. And the bigger the city, the more diversity and dynamism we see. And the more the city grows, the greater demand for our types of space, and the greater the shortage of land to meet that demand. Because so much of the brownfield land supply is taken up by residential development.
And then finally, I just want to comment on Responsible SEGRO, which continues to play a very significant role in how we’re thinking about our business as we move forward. The engagement of our colleagues in championing low carbon growth, investing in that local communities and in nurturing talent across the group is delivering some excellent progress already and building a strong platform for the years ahead. It’s becoming very much embedded in all our operational and investment decisions. And we’re doing all of this not just because it’s good for business, but it’s also the right thing to do and an integral part of our purpose. And we look forward to providing a full progress update at the year end.
So now on to the main body of the presentation, we produced an inflation beating level of earnings growth, underpinned by strong operating metrics. We’re continuing to take a disciplined approach to capital allocation. And as I’ve already mentioned, we’re confident in the outlook even though there are some wider economic uncertainties at present. So let me now hand you over to Soumen who will take you through the financials.
Soumen Das
Thank you, David. Morning everybody. And so, as Dave has highlighted, the strategies continue to deliver some very strong financial results, which I’ll talk you through this morning. Starting on Slide 9, this slide highlights our key financial metrics for the first half, which have all grown very strongly in the period.
Adjusted profit before tax up to £216 million that’s an increase of 29%. Adjusted EPS is up 22% to 16.5 pence. And you recall from the full-year results that there’s a performance fee from SELP due next year potentially, and that’s being recognized in part again in this period. Excluding that, EPS is up 13% to 15.6 pence. The half year dividend is set at 8.1 pence. That’s in line with our policy of setting at 1/3 of last year’s full-year dividend. The portfolio is now valued at £20.5 billion. That is an increase of 7%. And that’s led to a 10% growth in NAV per share to 1,249 pence. And the balance sheet, as David commented, has – is in great shape with a loan to value of 23%.
So moving to Slide 10. And this is a usual slide that looks at the growth in net rental income, which is the key driver of the growth in earnings. The net rental income grew £41 million in the first half compared to the same period of last year. That’s up to £255 million, an increase of 19%. There’s three main contributors to that growth. Firstly, rent from the standing portfolio grew £14 million.
Now we’ve said for some time, and you can really see it in these set of results. That our portfolio is very well placed to capture rental growth in this high inflationary environment. The like for like growth rate was 7.1%; as you can see in that little box. In the UK, the like for like growth rate was 8.9%, has mainly come from the 29% re-letting spread, on reviews and on expiries.
As I think most of you are aware, the structure of UK leases means that we capture five years’ worth of rental growth at each lease event. And Andy will come on to talk to you shortly about how the embedded growth, we have in our portfolio, through further reversion.
On the other hand in the continent, the growth of – the life for like growth of 4.1% has come primarily from indexation. Now virtually all of our European leases are index linked and the majority of those don’t have a cap. There was a mechanism varies by market over the course of the rest of the calendar year we will pick up further significant increases in cash rent through the automatic contracted indexation that we have across hundreds of individual leases.
Moving on across the chart, the second big factor in the rental increase is the increase in net – is the developer completions, which again have had a big impact of £21 million. And thirdly, investment activity has also had a material impact as we’ve been active in the market across the last year or so. Acquisitions have added a further £17 million offset in part by £7 million due to disposals.
Now looking forward from here, we’d expect rental income to continue to grow strongly through increased like for like growth from reversions and indexation, alongside new rent from the development pipeline.
Turning now to Slide 10 – Slide 11 on the rest of the income statement. Now, you can see in the last column that the growth in rental income in the top line has fed all the way down through to growing profitability at the bottom line. I mentioned earlier that adjusted profit before tax grew 29% to £216 million and EPS was up 22% to 16.9 pence.
Now a quick recap on the SELP performance fee, which is up in the box at the top right, which we’ll need to continue to bear in mind over the next year or so. Now to remind you, a potentially due fee from the SELP joint venture at the 10-year anniversary, which occurs in October 2023. SELP’s strong performance means that based on current valuations, the net receipt could be in the order of €185 million.
Now you have to note though that this calculation is volatile, but we’re acquired by accounting standards to make regular judgments on these things. So at this point, we’ve recognized a net fee of £21 million, which is on top of the £13 million we recognized at December. This will continue to be a matter of judgment until the fee is confirmed in 15 months’ time.
Turning now to the portfolio valuation on Page 12. The portfolio as I mentioned, is valued at £20.5 billion, an increase of 7%. The revaluation was £1.4 billion, reflecting the value we add to the business through asset management and our development initiatives. This added 111 pence to NAV per share accounting for all of the 10% growth in that metric.
The UK, which represents 2/3 of our portfolio, is up 8% and the continent is up 5%. The main differentiator between the two was rental growth, as you can see on this next slide.
So Slide 13, you’ll see some of these drivers of the portfolio growth in more detail. The portfolio yield is 3.8%, the same as at December. And yields have stayed fairly stable across all of our markets. But ERVs have grown strongly 5.9% in a six-month period, which the ahead of inflation over that same time period.
Now the UK is showing better ERV growth than the continent 7.3% versus 3.6%. But you can see that ERV growth in every market. The 4.6% rise in Poland is especially eye catching. That’s the highest that any of us can recall in that market. And just goes to show that the tight supply conditions, our own low vacancy and that strong occupier demand that we’re seeing, will drive strong rental growth across our portfolio in every market.
So just switching topics now and looking at the balance sheet and financing on Slide 14. Now we’ve had a very busy year already, we’ve raised over £2 billion from a range of diverse sources, banks, bond market and private placement investors. Now, given the volatility in the capital markets, this access to a large volume of capital across so many different markets at historically low interest rates remains a key differentiator. We received two new euro bonds in March totaling €1.15 billion and we’ve arranged a further €225 million of private placement notes in June. The average maturity across these three instruments is eight years at an average coupon of 1.9%. So not very different than the debt book that we already had in place.
And we’ve topped this up with further liquidity from our banks, both in the form of new facilities and extending existing ones. So all that activity means that our debt portfolio remains one of the longest and the most diverse in the sector. You see here on Slide 15 that our debt maturity is just under nine years, taking into account the private placement we recently arranged, which we’ll draw in September. The graph illustrates we have debt stretching out to 2042. And the choices are well spread out over the next 20 years. We have no material debt refinancings at the SEGRO level until 2026. 94% of our debt is fixed or capped, which provides a very healthy level of protection against any rises in short-term rates. And the outline bars show the bank facilities, which are largely unused and so provide us with a lot of further liquidity.
So on Slide 16, we summarize our financial position and you can see that we benefit from a balance sheet with low leverage and high liquidity. Loan to value is just 23% and the cost of debt remains low at 1.8%. That strength is recognized in our credit rating. We’re one of the very few issuers globally in the real estate sector with a single A rating. Our liquidity remains high at £2 billion, and that allows us to be very nimble around further capital investment.
Looking forward, as you can see, in the box in the bottom right, we expect to spend at least £700 million on construction and on infrastructure this year, to capture that current occupier market opportunity. And on disposal, look, I’ve said before, we have no non-core assets in our portfolio, given the scale of the restructuring those undertaken between 2012 and 2017. But it is really good portfolio discipline to edit and to trim the portfolio around the edges. We continue to target around 1% to 2% per annum on average, which would imply around £200 million to £400 million of sales each year.
So just wrapping up on the financial side, here on Page 17. I’m very pleased to report, earnings growth of 13%, well ahead of inflation, driven by the capture, the reversion and indexation within the existing portfolio, and driven further by development activity to add new rent. We’ve seen significant rental growth in the period when you measure that by like-for-like growth of 7.1% over 12 months, or ERV growth of 5.9% over six months. We have a strong balance sheet with low leverage, a long debt maturity profile, a low cost of debt, and high liquidity. And this strong earnings growth and financial strength gives us the confidence to grace this half year dividend by 9.5%, which is in line with our longstanding dividend policy.
So with that, I’ll hand you over to Andy.
Andy Gulliford
Thanks, Soumen, and good morning, everyone. Soumen has outlined the strong financial results we’ve produced. I’m going to give some color on current market conditions. And then I’ll move on to discuss the strong operating metrics. We’ve delivered, which have contributed to earnings growth. As you can see from the graph, vacancy remains at historically low levels across all our key markets. The UK has a rate of less than 2% and even Spain, where the market traditionally has more speculative development, is still only 6%. There’s generally been some more speculative development over the last 12 months, but we don’t see that as a significant threat or disruption to our markets.
For example, in the UK, there’s currently circa 2 million square meters underway, but half of that is already under offer. Supply chain and materials availability issues as well as increased financing costs mean that speculative starts are highly likely to reduce in the second half of the year, further tightening availability.
As David showed you earlier, provisional data points to European take-up being very strong so far in 2022, and it’s estimated to get close to 2021’s record level over the next six months. UK take-up hit a record level in H1 and has already significantly exceeded current supply. Occupier inquiries for space continue to be driven by long-term structural drivers, which result in strong, deep and diverse demand.
E-commerce take-up has returned to more normalized levels, which is to be expected with the end of the pandemic, but space is still being taken and pure plays continue to grow just at a slightly slower pace, and that applies to Amazon, too. And there’s still a significant opportunity for retailers on the continent. E-com penetration levels still have a long way to go, with most markets predicted to hit 20% by 2026.
Distribution networks are not set up to deal with this, and we need to adapt and expand. More traditional retailers need to ensure an omnichannel offer to retain customers and market share, which generates both direct and third-party logistics space requirements.
Demand has increased from other sources, too. Manufacturing and more generally from all sectors, adjusting case requirement to hold more inventory for greater supply chain resilience. A 40,000 square meter letting to Ceva at our scheme in Venray in the Southern Netherlands is a typical example. This strong take-up alongside tight supply bodes well for future rental growth in all our key markets.
Much of the data refers to big box rather than urban warehousing as it’s difficult to get reliable statistics for the latter. However, we can categorically say that the supply-demand imbalance is even more emphasized in urban markets due to the acute shortage of available land. So even greater potential for rental growth, the more urban scheme. And looking forward, we don’t really see this market position fundamentally changing. Yes, there may be some short-term reduction in demand given economic conditions, but the chronic shortage of space, coupled with the entrenched long-term themes that are dictating requirements are highly supportive.
We’re seeing this demand continue through the summer, with significant lettings transacted with VIRTUS in Slough and Bosch in Poland during July. So we see a strong second half ahead.
Turning now to our first half performance on Slide 21. Excellent asset and development management, coupled with supportive market conditions have helped us sign £55 million of new rent, just behind H2 2021, which was a record by quite some way. It included new leases signed with existing customers such as Amazon and retailer Kaufland, the latter, including a major re-gear on their current space in Gliwice. And some new customers, such as container shipping specialists, Maersk at SEGRO Park, East Midlands Gateway.
The range of sectors is striking, as you can see from the various logos, emphasizing again the diversity of customers interested in our space. New pre-let signed contributed £28 million to the total. This included our first pre-let at SEGRO Park Coventry Gateway with DHL for a 20,000 square meter parcel delivery center.
And as you can see on the last gray bar on the graph on the left, new rent on existing space also contributed to the high level of new rents signed, £14 million in total, and I’ll return to that a bit later.
The active management of our portfolio continues to deliver strong operating metrics. Our retention rate ticked back up again to 79%, even though we continue to actively take back space to re-lease, move rents forward and capture reversionary potential. You’ll notice we’ve switched to using occupancy as a KPI rather than vacancy. Letting success has meant that the occupancy rate has stayed high at almost 97%. Coming back to the £14 million of new rent from existing assets, a large contributor was a very healthy 24% average uplift on rent reviews and lease renewals in the period, 29% in the UK due to the five-year lease structure and 2% from Continental Europe, which as Soumen showed you earlier, benefits from annual index-linked leases.
Either way, it’s a great hedge against inflation. And there’s still significant reversionary potential embedded in the portfolio that we can secure over the coming years. During the first half, we captured £13 million of the £89 million reversionary potential we reported at our 2021 full-year results. That reversionary potential has itself grown during the period and now stands at £113 million. We’ll be working hard to capture that opportunity. The chart on the right shows the £65 million to go for in the next two, 2.5 years.
Moving now to our development program on Slide 24. We completed 330,000 square meters of new space during the first half in 15 projects. This equated to £15 million of potential headline rent with 87% already leased by the 30th of June. We managed our construction partners closely to ensure materials and labor shortages, coupled with supply chain disruption, did not unduly impact our program and ensured we successfully delivered these projects within time and budget constraints.
While costs have increased, we were able to maintain our margin through increased rents. The yield on cost at 7.3% shows development remains highly accretive when well controlled. We continue to be alert building sensible cost inflation into our underwriting and making sure we back construction contracts with suitable rental agreements to ensure we produce attractive returns.
2/3 of the program was big box warehousing, including our first unit at the high-tech food campus, SmartParc SEGRO Derby. This is a hugely innovative scheme, which seeks to create energy efficiencies and reduce food miles by co-locating food production, assembly and distribution all on the same site. A new multilevel data center on the Slough Trading Estate is another example of intensification, creating additional value. The same land area supported an increase in rent from £1 million to £4.5 million. We also completed highly successful speculative schemes in the supply-constrained markets of urban Frankfurt and inner Paris. [ph] The Frankfurt example on the slide was 82% leased at practical completion in June.
And just a reminder, we’re targeting BREEAM Excellent or local equivalent on all our developments. And with that, I’m now going to hand you back to David.
David Sleath
Thanks, Andy. Thank you, Andy and Soumen. On to the next section, which is about our investment activity. So disciplined capital allocation, as I said earlier, has been the cornerstone of our strategy for a decade or more. And as I also said earlier, it’s the reason why we do have such a fantastic portfolio that’s able to produce the kind of results you’ve seen this year but has consistently performed and we expect to continue doing so. So far this year, we’ve invested a net £548 million of capital.
Development continues to be the main focus of our activity with £284 million going directly into the construction of buildings and the rest of it being about the hopper for the coming years. So that includes £80 million of infrastructure, which is mostly at our schemes in Coventry and Northampton. £220 million of land acquisitions and £145 million of asset acquisitions, which are mostly for midterm redevelopment opportunities. We believe it always makes sense to prioritize capital investment to convert bare land into new income-producing properties.
But beyond that, we do want to add to the pipeline of future opportunities to capitalize on occupier demand. And in an increasingly competitive market, we’ve remained disciplined, focusing on our core markets where we have real conviction over the occupier fundamentals and a clear plan to create value. Meanwhile, we continue to recycle around the edges, disposing of assets, which we expect to underperform relative to the rest as well as selling assets to our SELP joint venture on the Continent. Now the investment market after a very strong Q1 is taking a pause for breath. But we’re convinced the fundamentals of our subsector and especially for assets that can deliver inflation beating rental growth over the medium term, will continue to appeal to investors.
And the good news is that having completed £4 billion worth of disposals in the past decade, we have a super high-quality portfolio of assets, which we believe will perform well even in a more inflationary environment.
So now let’s just touch on the outlook. And the first thing to say is that we believe that the structural drivers will continue to provide support and drive demand even in a recessionary environment. There’s a lot that’s been written and discussed about the slowdown of one particular online retailer. But as Andy said, there are many others still playing catch up in the digital world and generating new demand for space. There are also many who are investing for resilience and better supply chain efficiency, and we have some good examples of that in the first half of this year.
Urban population growth will continue to drive demand from new and existing uses, and will place restrictions on land availability for new supply. And pressures around sustainability as well as, particularly right now, higher fuel costs will continue to drive occupiers to want modern, low carbon and really well-located buildings. There’s a real premium for being in the best location in our industry. These structural tailwinds along with the broader inflationary effects on construction costs and indexation mean pressure on rents remains upwards.
The pressure is being exacerbated by the continued tight supply conditions, which, as Andy alluded to, may get tighter still if funders of specular development are put off by uncertainty and higher interest rates. On top of the extraordinary ERV growth we recorded last year, rents have increased further this year, averaging 6% for the first half, with good uplift seen across all our markets, including Poland. And we’re confident, therefore, of achieving or even beating previous guidance on rental growth given these market dynamics. Because on top of that, we also have tremendous potential to drive profitable growth from our exceptional bank of land and redeveloped assets.
Higher construction costs, witnessed particularly over the last six or 12 months, have been offset by higher rents. So our expected development margins are being maintained with very healthy yields on cost.
The scale of the upside potential has increased materially since 31 December as we’ve added in the development potential of some very attractive redevelopment sites acquired over the recent months. And as a consequence of those additions, the urban part of our development pipeline has also increased materially. Now although it’s a very big program. It’s worth reminding you that, firstly, the bulk of development – our development remains preleased. And with construction periods being relatively short, we’re able to lock in construction prices and quite often an occupier, before we start on site.
And secondly, we have tremendous optionality as to what and when we build and when we start. So we’re able to rapidly turn the tap on or off according to market conditions. So let me just pull together the growth potential embedded within our business already. And here’s the usual income bridge that we show you every six months. And there’s a lot of data there. I won’t go through all of it, but let me just highlight a few points. £540 million is the current cash passing rent. We expect to increase that by £307 million or 57% by capturing the existing reversionary potential in the existing portfolio through our active asset management approach and by completing the current and near-term development projects.
We need to invest less than £1 billion of capital to access that first chunk, which is about finishing off those developments. So a lot of – there’s a lot of growth already baked in for minimal CapEx. Then we have another £386 million of opportunity on the remaining land bank and option land and land that’s under contract. So as of the end of June, the overall potential is now £1.2 billion of cash passing rents at today’s rents, that’s 20% higher than it was in December. Of course, we do expect these figures will increase further as inflation will drive additional indexation uplifts and ERV growth will add to the reversionary potential.
Furthermore, we haven’t included the additional uplift from redeveloping and intensifying income producing industrial assets that currently sit within the investment portfolio. It’s only assets that we’ve acquired redevelopment that have been added into the bank of opportunity. So there’s loads to go out.
So let me summarize on the outlook. As I hope you’ve already heard, occupier demand continues to be strong. There’s, of course, plenty of speculation around the risks of business or a consumer-led slowdown. And of course, we’re not blind to that. But as Andy said, we’re not seeing any evidence of it right now. We’re still seeing a good round of deals. Agents are telling us, occupiers are screaming out for space that they just can’t find yet. And we think the structural tailwinds will continue to provide ongoing support.
Meanwhile, it’s unlikely we’ll see an increase in speculative supply. So the supply-demand balance is likely to remain favorable, even if there were to be a reduction in take-up. Our modern sustainable portfolio in prime locations is designed to perform at all stages of the cycle, and it’s ideally placed to capture further rental growth from index uplifts, from reviews and new leasing, which should continue to drive income growth and valuations across our asset base. And our exceptional land bank has tremendous optionality and offers us the ability to develop a lot of new space within a very attractive yield on investment. All of these things combined with our pan-European operating platform and our strong balance sheet form a unique competitive advantage, which we think bodes well for H2 and beyond.
So just to recap. First half of 2022 has been another great year for SEGRO. We’ve delivered inflation beating earnings growth with strong operational metrics. We continue to take a disciplined approach to capital allocation, and we remain confident in the outlook.
So thank you for listening, and we’d be very happy now to take your questions. I’m hoping most of them are going to be directed Andy and Soumen. But we’re going to go first of all in the room. So if any you wants to ask a question, please put your hand up.
Question-and-Answer Session
A – David Sleath
Yes. Os?
Unidentified Analyst
Good morning. Congratulations on the solid results and outlook. I think one of the really fascinating slides you put up was showing the expectation that 2022 demand will be as high as 2021 or leasing rather than take up. I know this is kind of crystal ball gazing, but can you give us a feel for beyond the second half of this year, how do you think 2023 will evolve on the same basis?
David Sleath
Did you say that one for Andy? I think you didn’t?
Andy Gulliford
I think, sorry, [indiscernible] I mean it’s very difficult to full predict as you’re bound to expect me to say. But if you think that the speculative supply, land is not getting any more available, speculative development, we think will reduce. So that would be the supply for 2023. We’re seeing all the major themes that we’ve discussed in quite some detail over a number of results presentations still playing through tremendous demand from data centers for example, manufacturers are coming into play.
So we’d hope that, what we’re seeing this year will continue forward. So difficult to predict, but supply is not going to get any larger and all the themes of demand are still there. And that’s particularly the case in the urban markets, I have to say, which we are clearly more orientated to.
Unidentified Analyst
Sure. A second question, I guess, related to this is on tenant performance. And I just wonder, given all of the pressures around, I guess, labor cost inflation, fuel inflation, how are you seeing the health of your tenants as you look across your very diverse base. Have you got a watch list of tenants that you’re concerned about looking, I guess, a little more troubled given the pressures that they might be facing? Or is your tenant base looking as healthy as it was, say, six months ago?
Andy Gulliford
In some ways, looking stronger because the quality of our portfolio and locations and the prime nature of the real estate is attracting premium rents and actually the covenant quality of occupiers taking that space is improving. So yes, we do have a few on a watch list, as you’d expect of that sort of bad debt rate is about less than 1% and has been consistently even through the pandemic, dare I say. So we check it regularly. We check covenants when people join us in space. We regularly check covenants on an ongoing basis, but we’re very, very comfortable that we’ve got a very, very healthy set of occupiers in our space.
Unidentified Analyst
Thank you. And maybe just one more for you, Soumen. Look, obviously, the share price performance this year has been – that was down around 30%. And I guess there are many levers that you have to pull, you’ve got balance sheet capacity. So one of the levers that you could pull is a buyback, but we haven’t had any, I think, mention of this or any indication that that’s something you’re thinking about. So could you just recap what your thinking is around a buyback, I guess, given that there are many ways that we could interpret the fact that you’re not looking to do that, maybe you could just give us your thinking around it, please.
Soumen Das
Yes, of course Os. And look, you’re right, I think it’s important that any company has every option on the table to create value. The reality is, I think you’ve heard us say consistently through the whole of this presentation, yes, we see a terrific opportunity to really kind of build into this occupier demand and to grow our overall rental potential. I mean, David showed you the slide that our yields on costs are still 6.5%. But the yield on marginal capital, the yield on build cost because the land is already funded is nearer 10%. So we weigh up the different options in terms of the best use, the best risk-adjusted use of that marginal capital. It’s going to be weighed against the opportunities that we have in front of us, which is to grow our income base at 10% per annum on that land.
So a one-off hit by buying back shares, the discount to NAV weighed up against that future growth opportunity. Right now, we don’t think is the right thing to do, but we do keep it under review, as you’d expect us to.
Unidentified Analyst
Thank you.
David Sleath
Anybody else? We – I think we have a question on the conference line. So let’s open up that one.
Operator
We have a question registered from Pieter Runneboom of Kempen & Co. Pieter, please go ahead.
Pieter Runneboom
Good morning, teams. Thanks for taking my question. I was wondering, how do you look at the risks in your current pipeline? Demand is still very strong. I’d say it will weaken maybe with gas rationing in Germany. We should consider doing less speculative or scale back the run rate.
David Sleath
It’s a question on our view on development.
Andy Gulliford
Development. Yes. Delighted. So we obviously keep things under a watchful eye, as David said in the presentation, I think the thing to say is that the vast majority of our development program is pre-let, which as long as we back, as I was saying in my piece, the agreement for lease with the construction contract, we are very derisked in our development program. So income is there, and we have a construction contract with a fixed price that is backing that. So we know the margins.
Speculative development; we do, do some. I have to say it’s largely urban. So in the very tightest supply markets with the deepest depth of diverse demand. And the space that we’ve been putting into the market has been carefully picked and chosen and has gone extremely well.
You mentioned Germany, where we’ve had a terrific success in Frankfurt. Had a great run in Cologne. Our two big sort of Dusseldorf schemes are great. And in fact, we launched a speculative units of 50,000 square meters on our site at urban housing [ph] and at least three months before practical completion. And we had three parties chasing it for us – chasing us for it. So quite a lot of price tension. We set a record level of rent with that. So we’re careful, we’re prudent. We think about it. We derisk it as much as we possibly can. And when we launch speculative development, we put it into the most supply-constrained markets. And so far, that’s worked well for us.
Soumen Das
I guess Pete just one small thing to add, if you go to your crystal ball as earlier. The best thing about our construction and development program is it takes so little time to build a warehouse. So we don’t need a very long or large crystal ball here. We can see the market that is in front of us. We can see this very low vacancy rate. We can – we know what the construction starts are for speculative development. And piecing that together, we can very much kind of take the risk up or down as we see it at any given point in time. And as Andy says, 70-plus percent of our pipeline is typically pre-leased. So it’s a very measured risk but with a lot of ability in terms of near-term foresight.
David Sleath
Thank you. Any…
Pieter Runneboom
Thanks so much.
David Sleath
Any more questions?
Pieter Runneboom
Yes, thanks so much. I got a second question on acquisitions. So as investment yields on acquisitions seem to move out now. Are there say like yield methods which you would consider becoming more from net buyer in the market.
Andy Gulliford
Acquisitions would be your net buyers.
Soumen Das
So far healthy.
Andy Gulliford
Pieter is asking whether – what’s interesting about acquisitions and given where the market is going, would be potentially consider becoming more net buyers?
Soumen Das
Okay. Yes. Of course, look, I guess it’s sort of again sort of tax in the answer I gave around share buybacks. We keep all of our different options on the table. The reality is a number of years ago, we felt the best use of our marginal capital was through development. So usually our capital buy land and then construct and generating a very healthy premium to the kind of the equivalent asset have it bought on market. There’s nothing really that’s changing our view on that right now.
But you’ve seen us over the last couple of years, acquire assets in some of our key strategic markets, particularly in London and Paris, where we believe there is a potential for us, through our asset management, to really do something by driving rents to create additional value over and beyond what the market was pricing in. So I’m not sure Andy or David should comment, but I don’t think I can – I’m not sure we can see any particular change to that approach going forward. I think the growth will be largely development led. It will be largely pre-let led within that development program. We have a great land bank to really lever into the occupier market. But we obviously will look to opportunistically acquire assets if we think we can drive better returns in the wider market from them.
Pieter Runneboom
That’s very clear. Thanks for answering all the questions.
David Sleath
Okay. And is there any more questions in the room or on the call? Have you got any on the line?
Operator
Our next question…
David Sleath
Okay. Go ahead.
Operator
We have a question on the line from Colm Lauder of Goodbody. Colm, please go ahead.
Colm Lauder
Good morning, gentlemen, and my apologies for not being with you in person today. A couple of questions, which I maybe like to sort of tease out on the diversity of your occupier demand and particularly how that mix has evolved over the half. And I thought it was notable, and you certainly highlighted in terms of the evolution, whereby you’ve seen less take up from the online retailer space and 3PLs, but increasing take-up from the likes of the tech, TMT sectors, et cetera.
And one area of particular interest to me was that 17% of take-up from data center operators. And I’d be curious to understand in terms of how you see that sector evolving given the obvious infrastructure requirements and also potential structural deficits in terms of energy use and resistance of planners, perhaps to grant new data centers, given the strain they will place on the electricity grid. So one, just how you see that sector evolving given infrastructural challenges? And then as a follow-on from that, thinking about how well your sites are placed in terms of being able to provide the right infrastructure and particularly from again, an energy perspective.
David Sleath
Quite a lot in there too. Andy, do you want to kick off some of that, you kick it off.
Andy Gulliford
Yes, sure. So on data center demand, first of all, very, very strong, quite a high proportion or a large proportion driven by the three main hyperscalers who are very, very active in the market at the moment, but also some very good co-location inquiries as well. I mentioned VIRTUS in my presentation, taking another chunk of space from us in the half, and we’ve got other data center pre-lets and inquiries on Slough coming through, which I think will convert pretty shortly as well. So demand-wise, and very strong, I guess, there’s still that move to the cloud, particularly both individual and businesses, taking things to the cloud and people need those data centers to support that move.
In Slough, where they – I’ve got to get this in, because I always like to do this one. We’re the biggest agglomeration of data centers outside Ashburn, Virginia. We’ve got over 30 now on the trading estate. So it’s an absolute sort of epicenter for data centers in the UK, and they’re all termed London one, two, three, so they’re seen as the kind of London supply of data centers. And we feel we’ve got a very, very active program on the trading estate, where we’re taking back space, intensifying the land that we get back and creating multilevel data centers, and we see that continuing because we have power and fiber and particularly power.
We have a very special position on the trading estate with an availability agreement with Scottish and Southern that gives us a particularly strong position in the market, which is why Slough is so favorable. The more you get together, they create an availability zone. They talk to each other and interconnect it with each other. So the more you get, it becomes a honey pot. We are looking to expand that activity, both in the UK, probably West London is the most obvious.
We do have a data center in West London and one in Croydon actually as well. But we’re really looking at the Continent. The main sort of markets, the FLAP-D markets as they’re known, so Frankfurt, London, Amsterdam, Paris and Dublin is in that, although we’re not active, obviously, in Dublin, are very tight, very difficult from a power perspective, difficult from a planning perspective. We think we’ve potentially got more opportunity in Tier 2 markets, which are really coming forward.
Markets like Madrid, Marseille because you have the link with the African continent coming into Marseille. Also outside Frankfurt in Germany, probably Berlin is the kind of next one. So there’s a number of markets that we’re looking at, using our knowledge of data center development and the knowledge and relationship we have with customers to move them across the continent. We’ve done a full reck [ph] if you like, a full look at all of our existing sites, and we’ve got a number that are potentially capable and power is the big determinant.
And we’re also looking at acquiring more particularly in the markets I’ve mentioned. So we see it as a very active part, small in context to our industrial. It will never be the lead piece of SEGRO. We’re doing it on a kind of shell or powered shell basis. So we don’t get involved in the fit-out and the operation of the data centers, but we see it as a really interesting and active adjunct to demand and diversity of customer base that we can appeal to. [Indiscernible]
Colm Lauder
Thank you, Andy. And just one second point as well, just to ask on for the construction cost inflation and how you’re seeing that trending. Obviously, I note from the results that you have mitigated that through rental growth. But just sort of your general view on the second half in terms of what you’re expecting around construction cost inflation?
Andy Gulliford
Yes, sure. So we have well documented, we have seen construction cost inflation, I guess, over the last 12 months. On average, overall across the group, about sort of 20%, some elements more than that. So still, for example, it’s really the kind of energy-driven components that are the highest. And as you say, we’ve been able to clearly pass through that inflation to our customer base, keeping rents moving forward. In fact, it’s been yet another contributor to onward rental growth.
Anecdotally, I think it would be too early to call this at the moment. Anecdotally, we just feel there’s a little more capacity perhaps in the construction market coming through, maybe that’s other sectors sort of backing off a little bit. Anecdotally, we think some of the pricing pressure has come back a little bit. But I’d be cautious about calling a forward look. We’ve obviously got labor costs, labor inflation, there’s obviously energy issues in the sort of autumn. So I wouldn’t want to speculate on that. But just anecdotally, at the moment, it just feels like it’s come off a little bit, still increasing but not at the rate that we’ve previously seen.
Colm Lauder
That’s helpful. Thank you for the detail. Thank you for taking my questions.
Andy Gulliford
Okay.
Operator
Our next question comes from Frederic Renard of Kepler. Frederic, please go ahead.
Frederic Renard
Hello, good morning. Thank you for taking my question. I have three questions actually. Just the first one on a scale of one to 10, how would you assess today the occupiers demand entering into Q3, excluding of course, all seasonal effects we could consider? And maybe considering also that the other quarters, I mean the Q1 and Q2 will be a 10. I’m just trying to figure out a bit the demand there.
David Sleath
Frederic, it’s a very bad line. Could you repeat that?
Frederic Renard
Okay. Is it better now or not?
David Sleath
Yes, if you speak slowly, we’ll hopefully pick it up.
Frederic Renard
Okay. Great. I’m just wondering the strength of the occupiers’ demand there. So I’d say, according to you, on a scale of one to 10, how would you assess the occupiers’ demand entering into Q3, excluding all seasonal effects, obviously, we can expect from the summer and maybe knowing that the previous quarter were at 10.
Andy Gulliford
Okay. So as far as I think I heard you, it’s the strength of the occupier demand kind of Q3 relative to kind of where we saw in Q1 and Q2. Do you want to take that?
Soumen Das
Yes. Well, if our current conversations are anything to go by, maintained and strong, I have to say, we’re always on a kind of – we’re always sort of working ahead of ourselves, if that makes sense. So the deals you see in this half, we’re really working on deals now in the second half and the first half of next year. That’s just the length of time things take to work through, particularly on a pre-let basis, where you’re obviously growing specification and planning and things like that. So as we’ve been saying all through the presentation from a very diverse sources, manufacturing has been interesting that, that has come back in.
In the first half, we saw Alstom take space. We saw Stanley Black & Decker take space. So interesting that that’s increased a little bit. We’re seeing – as a theme, this resilience piece is very strong with people wanting to get inventory close to customer base or close to producers. So that they don’t run out. The pandemic has really sort of led to that just in time going to just in case. So we’re seeing a lot of it, and I mentioned a few in the presentation, a lot of inquiries on that basis as well. So as we sit here today, as David said, confident outlook, and we’ve got some really good conversations ongoing.
David Sleath
Don’t forget, though, that Q3 has two holiday months in it. So don’t necessarily expect Q3 data to be as strong as want to tends to be the weakest quarter. In terms of the take up data and then Q4, we’ll make out for a big one. Yes.
Soumen Das
Terrific.
Frederic Renard
Okay. Thank you. And then maybe just a follow-up on the rent affordability going forward because and there I really mention and focus on 2023 because there today, you announced revising rent of 29% in the UK, open renegotiation. We can expect business rates really climbed to the roof, I’d say, next year. And maybe we can expect also some kind of normalization going forward, at least I hope, in terms of fuel costs and labor costs, et cetera. So I’m just wondering how will it impact your tenant at some point that you will charge them going forward with the reversionary potential that you have a higher rent. And I know that the logistic cost is – rental cost or even logistic cost it’s really a small part. But I’m just wondering – I’m curious to see how is it possible to continue to increase the rent at double-digit factor?
David Sleath
Soumen?
Soumen Das
Yes. Sure. No, it’s a good question. And I think in part, you sort of mentioned the answer. Certainly, putting on the table, if you don’t need to be in a location, then you won’t be in the location and paying the highest rent, our schemes are in the best locations with the best space, and we command premier rental levels. So we’re appealing to a diverse group who need to be there. And the reason they need to be there is their delivery promises to customers. The transport costs that they would incur if they’re in the wrong location and their own employees and labor that they would incur if they weren’t in the right location.
So when you look at rent and even with rates in, it’s a small proportion of the overall occupational cost of an occupier. So we think rents are clearly sustainable going forward. We’ve had no real affordability issues. We’ve had a couple of people who’ve wanted to move to slightly more cost-effective locations. And when we get that, we try and work with them and we try and move them in our own portfolio.
So as an example, we’ve moved some people from the North Circular on the East side of London, where we bought, if you remember, a scheme in Canning Town, where we’ve had rental progression of 14 in place, 21, 29, next year it will be north of 30. But we take them out along the A-13 for those that pitch it out into some more competitively priced space, still very, very good rents for the area, circa sort of £12 to £15 range, but we’re working with customers to do that. But if you need to be there, labor, transport and other costs and indeed, your customer promise will dictate that you’ll need to pay the rents, and we haven’t had a problem with that to date.
Frederic Renard
Okay. Thank you very much. And maybe my final one. At which point do you think the rising interest costs will come to balance the ERV effect on yield in your view, as we already can sense some kind of a slowdown in the investment market, which I guess, it will reflect higher bidding yield.
David Sleath
Rents for yields. When we say at what point would the rise in interest rates start to compromise the rise in ERVs in yields, did you say, Fred.
Frederic Renard
Absolutely. Thanks.
Soumen Das
Look, I think it comes back to some of – in terms of the ERVs exactly what Andy just talked about, actually, which is you’ve got this terrific level of demand for a very wide diverse set of sources. And they’re coming up against a supply situation on the ground, where vacancy rates are incredibly low, and there really isn’t a lot of new space coming through.
So I’ve got to say we reiterate – we’ve shown you that rental growth slide, our sort of medium-term guidance. I think in the short term, we’re going to exceed that because of where inflation is right now. But we’re certainly not minded to feel that we’re not going to hit those numbers over the medium term at all. So there’s just a simple supply-demand imbalance that I don’t think is particularly interest rate sensitive.
In terms of yields, look, yields are a function of lots of different things. And I don’t think we want to speculate I think we won’t speculate as to where yields are going to go or may not go. I think as David said, there’s been a bit of a pause to breathe in the investment market to sort of digest what’s going on in the world right now. But I think when the market sort of comes back to life, assets like ours that are very modern that are able to capture inflation and more in terms of their cash rent parsing, I think will prove themselves to be very, very smart and attractive investments.
Frederic Renard
Thank you. Thank you very much for taking my question. Have a nice day.
David Sleath
Okay.
David Sleath
Thank you, Fred.
Operator
Our next question comes from Paul May of Barclays. Paul, please go ahead.
Paul May
Hi team. Thanks for the presentation. Good set of results. Just a couple from me. Just first on the ERV growth, obviously, coming in below inflation at the moment and also it seems below where some of the brokers are mentioning their rental growth has been achieved in certain markets. So I just wondered, do you think there’s a bit of a lag in those numbers with regard to hitting that market evidence because we are hearing market rents growing faster than inflation as opposed to what you reported today? Or do you think there’s just parts of your portfolio that may not be achieving that level of growth and therefore, may not keep up.
And the second question, marginal finance cost I think you mentioned that you are sort of all in finance costs around 1.9%. But obviously, your more recent stuff is in the fall. [ph] I think marginal finance cost is probably somewhere between 3% and 5% at the moment. Does that impact on any of your sort of uses of capital, whether that be acquisitions or developments? And do you think you’ll see more opportunities to deploy more capital moving forward, given you do have a very strong balance sheet, good access to finance markets, maybe better than others. So if you use to see the higher rate environment as potentially an opportunity for you versus some of the other competitors. Thanks.
David Sleath
Yes. I mean you can think about the ERV point, Paul, is that we’ve reported six months ERV growth.
Soumen Das
Yes. Paul, the ERV growth in the six-month period was 5.9%. And you can correct me if I’m wrong, but I’ve checked every market that we operate in and the inflation numbers for the six months year-to-date vary from 4.5% to about 5.8%. So as far as I can work out, 5.9% is ahead of the inflation rate in any of the eight markets that we’re in. And the like-for-like growth of is 7.1% is a 12-month figure. But remember, that’s a trading figure, because as I say, as we go through the year and we go through the year and we have each indexation event, we will catch up to the level of inflation at that time.
So if some markets ratchet at the first of Jan, but most of our leases in Europe will ratchet on the anniversary date of their leases. So there’s a little bit of a lag in terms of catching up the indexation that’s inherent in the portfolio. But I say I’m afraid I’m not seeing what you’re seeing, which I think our rents are growing at least at inflation, and I think they’re actually growing ahead of inflation.
Paul May
Yes. And relative to – sorry, just on that relative to market rents where we’re hearing UK rent is up 10% plus year-to-date across the board, which utilize London is probably up at sort of 15% to 20% year-to-date. And obviously, you’ve got quite a large London weighting. Just wondered, again, is that a slight lag figure in terms of that, sort of, uber [ph] prime numbers and obviously, it just takes a while to filter through the portfolio. And I suppose what I’m trying to get to is, are you expecting that additional strong rental growth to continue in the next sort of 12, 18 months?
David Sleath
Well, we’ve given you our rental expectations. We update them every year with that chart with the supply and demand dynamics, and we’ll update that again when we get to the end of the year. I would say we are likely to exceed that guidance at least for this year. But the other thing you’ve got to remember is ERVs change when there’s evidence, and we shouldn’t get – I think we’re very happy with the ERV growth we’ve delivered in the first half, but we shouldn’t get too preoccupied with what it is in any one particular market in any one particular period because sometimes there’s evidence to support an increase in it, sometimes there isn’t. And so, it tends to be lumpy. But overall, we’re very comfortable that we can deliver rental growth at or above inflation over the medium term.
Soumen Das
Paul, to take your second question on the higher rate environment, I think the rent is, I think we’ve – as I think we talked about in the presentation, I think we’ve got better access to capital than most. I think you’ve seen that through this period. Remember, the 4% coupon on the most recent piece of debt we did was on the 19-year debt instrument, and that complemented the sub-2% coupons that we achieved in March on a slightly shorter-term debt.
So I would say that if we were in the debt markets today, I suspect the coupon will probably have a three on the front of it. But I’d say that single A rating does us, I think, better access to capital than most out there. So do we think it’s an opportunity? Well, certainly, in terms of the supply side, we’ve mentioned this a couple of times, we do think the higher cost of funding, the higher construction costs are going to reduce any speculative starts that might otherwise have come to market and therefore they will keep the occupier market tight. And I think, therefore, we’re in a very good position to benefit and capitalize on that.
Paul May
Thanks very much.
David Sleath
Thank you.
Operator
Our next question comes from Paul Gori [ph] of CTI. Paul, the line is yours.
Unidentified Analyst
Hi all and thanks for taking the questions. Just a couple from me. The first one is that I mean, obviously, I don’t want to comment on the outlook for yield and the trajectory because there’s been quite a lot of press about kind of deals falling out of bed and kind of the Javelin [ph] portfolio is one close to home that’s been talked about, that there are various points. And with the kind of asking prices, maybe 10% to 15% difference from the offer price, I should say 10% to 15% difference from the asking price. So I wondered if those are sort of numbers you recognize and whether you can comment a bit on the whether that is indeed kind of what you’re seeing on the ground in the investment market today even if the yields kind of haven’t actually reflected that yet.
Andy Gulliford
Yes, of course. Look, the – as I said, I think the reality is there is very little happening on the ground right now. So therefore, it’s quite difficult to give you a proper view, a clear view as to kind of into yields and I say, I think it would be the wrong thing for us to try and speculate as to where they’re going to go.
In terms of specifically on deals not happening on the Javelin piece you mentioned, look, you heard me say it. We’ve got no noncore assets. We don’t need to be selling anything. It’s good lesson in discipline to be doing so. But the reality is if the market isn’t there, there’s no need for us to kind of really push anything through. We’re very happy to hold those assets for the long term. We think they’re going to perform pretty well through the long term. So it’s – I’m not sure there’s much I can really give you in the sense of, we’re not seeing it because we’re not really there to be doing anything at the moment.
David Sleath
I think generally in the market, there’s – there are some buyers that think there will be opportunities. And obviously, they are sitting on their hands through the summer to see what happens. But equally, there aren’t many sellers out there that are motivated, which is why a number of deals have not – that were rumored to be happening have not happened because there’s clearly a gap between buyer and seller expectations. It’s clear that in an interest rate environment where the cost of funding does materially, it’s going to have some impact, it’s going to make the funding more and more expensive for those that are reliant on debt. But equally, as we said earlier, if you’ve got assets that can deliver rental growth above inflation that they’re going to perform well. So we’re pretty comfortable with the shape and the makeup of our portfolio.
Unidentified Analyst
Okay, yes, great. That’s useful color. Thanks. And just the second question just related to the outlook for your cost of debt, I think it’s 75% is floating. I know there were caps above that level, but I don’t think they are kind of – they are not struck yet. So I know you won’t guide specifically to the figures, but can you just give us some color for where you think that could be end of the year, end of 2023 based on all that you know based on some of your – based on the forward curves, kind of the trajectory for the cost of debt and there aren’t major refis coming up in the group Maybe you can comment on the refis and how that might include as well. But yes, just whether it’s 2% by the end of the year, 2.2% in 2023 or broadly, where those numbers might be?
Soumen Das
Sure. So look, in terms of the existing debt book, we’ve got, as I said, 74% of our debt is fixed. 94% is fixed or capped. And those caps are – we put them in at the time around a point or so out of the money. So they’re in the money today, given the moves in short-term rates. The hedging structure is very similar to the average debt maturity. So let’s call it over a year. So we’re really not exposed in terms of the existing debt portfolio to rising rates. That last 10% sort of moves a little bit, but not really very much at all.
Now in terms of incremental debt that we’re putting on, as I say, I think new debt will have a coupon in the three area. And if you look at the business as a whole, well, we’re looking to deploy, call it, £700 million per annum in terms of construction CapEx, which needs to be funded. That’s – and therefore, that has a relatively small impact on the average cost of debt. Because it’s just a law of averages, you’re starting the debt book of, call it, £5 billion. So it will tick up 10 basis points to 20 basis points, but it’s of that order.
Now the one thing I just would also mention is, obviously, there’s two parts to the coupon. One is the underlying swap rate or the underlying interest rate and the second is the credit spread. And I think what was interesting when we issued the private placement notes last month, is that the credit spread that we achieved was actually slightly tighter than what we achieved two years ago. So yes, interest rates have gone up, but interestingly, the perception of risk from the investors’ side had actually come down.
Unidentified Analyst
Yes. Okay. Sorry, just one quick follow-up there, Soumen, I just maybe misunderstood on the caps. When you say then the money, do you mean that the caps have effectively kicked in to limit?
Soumen Das
Yes.
Unidentified Analyst
The uplift. Because I thought the caps were static kind of EURIBOR of 1% or something like that. So obviously [indiscernible].
Soumen Das
Our cap portfolio has typically been put in at around 1% above where the market was at the time we put them in. So most of those caps are in the – I’d say they have – most of them have kicked in or they will kick in the relatively near future if the market is right in terms of expectations of short-term interest rises.
Unidentified Analyst
Okay, understood.
Soumen Das
There’s – essentially there is not a lot of sensitivity to short-term interest rate fluctuations on the existing debt book.
Operator
Thank you. I’ll now hand back to the management team.
David Sleath
Thank you. We’ve got one more question, I think, on the web. Claire has got it.
Claire Mogford
Yes. We’ve got, we have a few actually.
David Sleath
Okay. More than one question.
Claire Mogford
We’ll depend as many as you can. What do you see the risk to occupier demand from a potential recessionary environment and the impact that might have on purchasing power?
David Sleath
Well, I think we covered it during the presentation, which is that we’re not blind to it. We’re talking to our customers and staying close to them. But fundamentally, we believe that the tailwinds, the structural tailwinds are going to be very important in sustaining demand. If there is a slowdown in take-up, it’s most likely to be accompanied by a slowdown in new development starts. So overall, we expect it to be still a positive environment.
Claire Mogford
Thank you. And in terms of the future development pipeline, what are your thoughts on the timing of those starts? Do you have a view on that Andy?
David Sleath
As soon as we can get planning consents and zoning through, which is probably one of the biggest constraints and as soon as we can get materials at the right price and in as many cases as possible, as soon as we can get a customer signature on a piece of paper. It’s – those are the three key things because we’re mostly doing it through – on a previous basis. Andy, anything to add?
Andy Gulliford
No.
Claire Mogford
Thank you. In terms of yields, it’s interesting to see some yield compression in Germany and France in a rising interest rate environment. Can you add any color on what the rationale applied there by the valuers is?
Soumen Das
Again, I think we’ve covered it broadly, which is it comes back to investor demand for quality modern assets that are well let in a space-constrained environment that are able to capture inflation and more in terms of rental growth.
Claire Mogford
Thank you. Rising rents are currently offsetting construction cost inflation, but does that extend to the infrastructure spend required to open up sites for development?
Andy Gulliford
Yes is the answer to that. So when we’re talking about construction costs, land infrastructure, building cost, it’s, in a sense, all in the same pot, and we are moving rents forward that make all of those elements make sense and make margin and return for us, and we’re able to maintain our margins.
Claire Mogford
And another question, could increase business rates and logistics likely dampen rental growth next year? Do you have a view on that?
Andy Gulliford
I think that kind of returns to the affordability argument, so I won’t kind of rehearse that again, but we still think even with elevated business rates, and they will go up. The proportion of, sort of, rent on business rates is still a relatively small part of the occupational model and transport costs are much, much bigger.
Claire Mogford
Perfect. And one final question. You mentioned that speculative development in the broader market may fall given increased uncertainty. However, is there any chance that supply will stay high, that developers will seek greater pre-lets and therefore, that might limit rental growth, they’ll basically cut their rents to be able to pre-let. Is there any risk of that?
Andy Gulliford
I don’t think so because – well, I mean, we talk about speculative development and building availability, but land availability is also incredibly constrained. I mean, particularly in the urban markets that we’re working in. And as David sort of just mentioned, trying to get permitting and actually sort of land released zoned, permitted, is very, very difficult for big box as well as urban. So I don’t see some sort of glut of supply, be it speculative or pre-let coming through to dampen rental growth.
David Sleath
And most speculative development in the market is done by trading developers who are facing increased land prices, increased construction costs and they’re reliant on finding a funding partner, who’s got an increased cost of funding and maybe less confidence in the outlook. So our view is this is the kind of environment – we saw it with the pandemic actually. And we saw it after the Brexit referendum, spec supply drops off when markets are uncertain, and we expect that will happen here.
Claire Mogford
Perfect. I think all of the others we’ve covered in other questions.
David Sleath
Very good.
Claire Mogford
That’s it from the webcast.
David Sleath
Okay. Thank you all very much for listening and straining your ears. And we look forward seeing you next time. Thank you.
Soumen Das
Thank you.
Andy Gulliford
Thanks.
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