Choice Properties Real Estate Investment Trust (OTC:PPRQF) Q2 2024 Results Conference Call July 19, 2024 10:00 AM ET
Company Participants
Erin Johnston – Senior Vice President-Finance
Rael Diamond – President and Chief Executive Officer
Niall Collins – Chief Operating Officer
Mario Barrafato – Chief Financial Officer
Conference Call Participants
Sam Damiani – TD Cowen
Pammi Bir – RBC Capital Markets
Sumayya Syed – CIBC
Operator
Thank you for standing by. My name is Eric, and I will be your conference operator today. At this time, I would like to welcome everyone to the Choice Properties Real Estate Investment Trust Second Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions].
I would now like to turn the call over to Erin Johnston, Senior VP of Finance. Please go ahead.
Erin Johnston
Thank you. Good morning, and welcome to Choice Properties’ Q2 2024 conference call. I’m joined here this morning by Rael Diamond, President and Chief Executive Officer; Mario Barrafato, Chief Financial Officer and Niall Collins, Chief Operating Officer. Rael will start the call today by providing a brief recap of our second quarter performance and provide an update on our transaction and development activity in the quarter. Niall will discuss our operational results followed by Mario who will conclude the call with a review of our financial results before we open the lines for Q&A.
Before we begin today’s call, I would like to remind you that by discussing our financial and operating performance and in responding to your questions, we may make forward-looking statements including statements regarding Choice Properties’ objectives, strategies to achieve those objectives as well as statements with respect to management’s beliefs, plans, estimates, intentions, outlook and similar statements concerning anticipated future events, results, circumstances, performance or exceptions that are not historical facts.
These statements are based on our current estimates and assumptions and are subject to risks and uncertainties that could cause actual results to differ materially from the conclusions in these forward-looking statements. Additional information on the material risks that can impact our financial results and estimates and the assumptions that were made in applying and making these statements can be found in our recently filed Q2 2024 financial statements and Management Discussion and Analysis, which are available on our website and on SEDAR.
And with that, I will turn the call over to Rael.
Rael Diamond
Thank you, Erin, and good morning, everyone. We’re very pleased with our performance this quarter as once again we delivered solid operating and financial results. Our portfolio continues to deliver stable and growing cash flow. We maintained near full occupancy in the quarter at 98%, achieved strong leasing spreads of 48.2% and delivered same asset cash NOI growth of 4.4%. Our strong operating metrics this quarter reflect the strength and resilience of our portfolio.
FFO for the quarter was impacted by the timing of lease termination income and certain onetime costs related to our continued focus on operational efficiency. Excluding these impacts, FFO increased 5.7% year-over-year.
On the retail side, we are seeing certain discretionary retail tenants impacted by the overall health of the Canadian consumer. However, grocery-anchored necessity-based retail portfolio is performing exceptionally well. The demand asset base is strong. Our leasing team is actively working with many of our tenants who are looking to further expand their footprints.
In industrial, despite the slowdown in rent growth, demand for well-located high-quality assets remains strong as evidenced by leasing activity this quarter. We remain confident in our ability to deliver growth through our industrial development pipeline. Our prime locations, large contiguous blocks of land and attractive land cost allow us to deliver high-quality product into the right segment of the market at competitive rental rates.
Our residential assets also performing well with two newer assets, both over 80% leased and are expected to stabilize this year. Although the current environment will impact certain developers focused on condos, limited residential construction, start and overall lack of housing availability provide long-term tailwinds for the residential asset class.
Turning back to activity in the quarter, in pursuit of maintaining a market-leading portfolio, we continue to execute on our capital recycling program. This involves completing approximately $114 million in total real estate transactions in the quarter. Specifically, we acquired two grocery-anchored retail assets worth $83 million and successfully disposed of four properties totaling $81 million.
The first was the acquisition of Cornerstone Shopping Centre in Fort Saskatchewan, Alberta, by purchasing our partners 50% stake for about $21 million. We now fully own this 200,000 square foot high-quality grocery-anchored shopping center. The second acquisition was a vacant 30,000 square foot standalone retail property in Toronto for approximately $12 million and concurrently leased it to Loblaw for 15 years. Loblaw plans to open a small format note rolls on the site as part of their overall small format store expansion plan. This transaction is an example of the strategic benefits of our relationship to both Choice and Loblaw.
As division activity included the sale of our non-managing partnership interest in two retail properties in Alberta and two retail properties in Saskatchewan for total proceeds of approximately $81 million in the quarter. Versa continues to add value through our development pipeline with a near-term focus on commercial development. During the quarter, we transferred approximately 44,000 square feet of retail GLA through ongoing intensifications of our neighborhood centers. This intensification included a 17,000 square foot shopper drug bond in Alberta and a ground lease to Nautical Lands group in Bradford, Ontario.
This is the first of six ground leases with Nautical Lands, where they are developing independent living options for adults over 65 — 55, sorry. This is a great partnership for Choice as it is complementary to our retail sites and will generate a stable and growing cash flow stream for Choice.
Our active industrial developments are progressing well. At Choice Caledon Business Park, we’re progressing on the first two phases providing 1.75 million square feet of new logistics space. The first phase is a land lease to Loblaw with site servicing underway. The second phase lease to a leading logistics provider is in the tendering stage with construction expected to start later this year.
Our portfolio’s performance and ability to deliver on our strategic priorities regardless of the economic climate is entirely supported by the strength of our balance sheet and the quality of our credit. Often speak about the importance of prudent capital management and risk management. Despite encouraging inflation fronts and the Bank of Canada making its first interest rate cut in June, the interest rate environment remains volatile. We do not foresee a substantial drop-in long-term interest rates in the near future. We believe that companies with strong balance sheets like ours will consistently outperform in the long run.
As a result of our team — as a result, our team is committed to preserving our industry-leading balance sheet. They demonstrated the ability to do just this through our financing activities and the credit rating upgrade we received in the quarter, which Mario will speak to shortly.
But first, I’ll pass the call over to Niall to discuss our operational results. Niall?
Niall Collins
Thank you, Rael, and good morning, everyone. As Rael mentioned, our portfolio continues to perform well and we are pleased with our operating performance for the quarter. Occupancy remained strong ending the quarter at near full occupancy of 98%.
During the quarter, our portfolio had approximately 816,000 square feet of lease expiries. We renewed 743,000, achieving a 91% tenant retention. These renewals were completed at an average rent spread of 48.2%. We also completed 88,000 square feet of new leasing, contributing to positive absorption of 15,000 square feet. Our retail portfolio occupancy remained stable at 97.7%.
During the quarter, 390,000 square feet expired and we renewed 350,000 square feet at an 89.7% retention. The lease renewal spreads averaged 12.8% above expiring rents. The majority of our lease renewals were in Ontario with strong spreads across several retail categories. We also completed 41,000 square feet of new retail leasing in the quarter, offsetting 40,000 square feet of expiries not renewing in the quarter. Of the non-renewed space, approximately half has backfill commitments that was achieved, on average, 13.4% higher net rents compared to previous tenancy, and we have strong interest in the remaining space.
As Rael mentioned, demand for necessity-based tenants remain strong as retailers continue to seek out well located, well anchored properties. However, in the current economic environment, consumers continue to be more cost-conscious, creating pressure for tenants whose businesses rely on discretion spending. Fortunately, we have a small number of these tenants on our watch list as most of our tenants are necessity-based, we do not expect a significant impact on our 2024 performance.
During the Q2, we generated $1.2 million in lease surrender revenue, $800,000 was for the settlement of our Nordstrom’s location in Edmonton, Alberta. We also continue with our Loblaw store optimization program, generating $400,000 of lease surrender revenue at the grocery store in Camberos, Alberta. This space was backfilled by a new tenant of higher rental rates.
We turn our attention to 2025 for a moment. We have 48 Loblaw locations up for renewal, consisting of 47 retail locations and one industrial site, totaling 3.2 million square feet. Subsequent to the quarter, we renewed 46 of these locations, totaling 3.1 million square feet at a weighted average term of 5 years. The base rent for the 46 locations increased on average by 8.4% over expiring rent. The two sites that were not renewed are stores that have gone dark. The first is in Coquitlam, BC, a site with a long-term redevelopment plan. The second site in Laval, Quebec we intend to sell as part of our capital recycling program.
Our industrial portfolio occupancy also remained stable at 98.8% with 424,000 square feet of expiries, and we renewed 391,000 square feet for a tenant retention of 92.2%. Our lease renewal spreads averaged 105.9% of expiry. This was largely driven by 180,000 square feet of renewals in Ontario at spreads of a 184.3%. We also completed 47,000 square feet of new leasing.
While I recognize that the growth in the industrial market has slowed, we still have a significant embedded rent to growth in our portfolio as our average in place rent is $9.32 compared to $9.16 last quarter. For the remainder of the year, we expect a modest decline in occupancy due to a few known vacancies, which were contemplated in our plans and outlook. Our team are actively working on backfilling this space.
And I will now pass it over to Mario to discuss our financial performance.
Mario Barrafato
Thank you, Niall. Good morning, everyone. Once again, we’re pleased with our financial performance for the second quarter. Our business is strong operationally and remains well-positioned to continue to deliver high occupancy and strong same asset NOI and FFO growth. Our reported funds from operations for the second quarter was $184.7 million or $0.255 per unit. FFO in the quarter was impacted by certain non-recurring items, including restructuring costs of $3.3 million related to the outsourcing of a portion of our accounting function, offset by the reversal of a $1.7 million provision related to a tenant dispute in our industrial portfolio and lease surrender revenue of $1.2 million for a net cost of $400,000 to FFO.
On a per unit diluted basis, our reported second quarter FFO of $0.255 per unit reflects an increase of approximately 0.4% from the second quarter 2023. When normalizing for year-over-year non-recurring items, including the $8.4 million lease surrender income reported in Q2 of last year, FFO per unit increased 5.7% and this increase was driven by strong same asset and transaction NOI, partially offset by higher interest expense, net of higher interest income.
Strong leasing activity contributed to same asset cash NOI growth of $10.2 million or 4.4% compared to the second quarter of 2023. By asset class, retail same asset cash NOI increased by $5.5 million or 3%. The increase was primarily driven by higher base rent on renewals, new leasing and contractual rent steps and higher capital and operating recoveries.
Industrial same asset cash NOI increased by approximately $4.7 million or 11.8%. This increase was primarily due to higher base rent from leasing activity, higher capital recoveries and the reversal of the provision following the resolution of a tenant dispute. And excluding the tenant dispute resolution, our industrial portfolio increased by 7.4% year-over-year.
Now turning to our balance sheet. Our IFRS NAV for the quarter was $13.79 per unit, an increase of $76.6 million or 0.7% over the last quarter. Our NAV growth was driven by the contribution of $47.2 million from operations, fair value gains of $25.5 million on our investment properties and income resulting from the reversal of a prior year transaction-related provision of $38.6 million which was partially offset by a fair value loss of $27.9 million on our investment in units of Allied Properties, where we’re required to drive for us to mark to market this investment to its trading price at the end of each period.
Our fair value gain on investment properties in the quarter was largely driven by cash flow growth in the retail industrial portfolio, partially offset by a 7-basis point cap rate expansion within our industrial portfolio, due to continued price discovery in certain GTA and Vancouver assets.
In our retail portfolio, we recorded a fair value gain related to cash flow growth and minor cap rate adjustments. In our industrial portfolio, we recorded a fair value loss primarily due to cap rate expansion on certain properties with longer-term leases. This was partially offset by gains from cash flow growth as leases rollover to market rental rates. Our mixed use and residential portfolio was relatively flat.
Now, turning to financial activities for the quarter. We continue to focus on prudent capital management and ended the quarter in a solid financial position with strong debt metrics and ample liquidity. Our debt-to-EBITDA ratio was 6.9 times when you factor in the cash raised on our recent unsecured debenture issue, which I will expand on shortly. We also have $1.5 billion available on our credit facility and approximately $12.8 billion of unencumbered properties.
During the quarter, we completed $788 million of new debt financings for an average term of 10 years and an interest rate of 5%. This includes the issuance of $500 million in unsecured debentures at 5.03% for a term of approximately seven years. The proceeds have been invested in a fixed rate GIC earning 5.5% interest until September, when we will apply the funds to repay a portion of the maturing $550 million Series K senior and distributed ventures. For our debt-to-EBITDA computation, we have netted the cash against the debt to avoid the double count.
Additionally, we completed a series of mortgage financings totaling $288 million at a weighted average rate of approximately 5% and a term of approximately 15 years. This included a $120 million 10-year loan secured by a six property industrial park in Edmonton a $90 million, 25-year loan secured by a 25-year Loblaw land lease at our Choice Eastway Industrial Center and the assumption of mortgages totaling $45 million on disposed assets at an average rate of approximately 3.4%. These proceeds were used to repay approximately $82 million of construction debt and the remainder used for general purpose or reinvested at attractive deals.
Having completed these financings, we have limited remaining debt exposure for 2024. We’re also pleased to have received a credit rating upgrade from Standard & Poor’s to BBB plus. We cited the strength of our grocery-anchored retail properties, our strategic relationship with Loblaw and our commitment to maintaining prudent credit measures as reasons for the upgrade.
Before I conclude, I wanted to provide a bit more color on our restructuring costs in the quarter and the impact to our full year outlook. In an effort to drive operational effectiveness and after thoughtful analysis, we’ve decided to outsource a portion of the company’s operational accounting platform to a third-party vendor to create process efficiency and advance the use of technology across our business.
We anticipate that the total restructuring costs for 2024 related to this outsourcing will be approximately $7 million. Given the strength of our overall performance this year, as well as additional Loblaw rightsizing income anticipated in the second half of 2024, we do not expect this restructuring to impact our 2024 financial outlook.
And with that, Niall, Erin and I would be glad to answer your questions.
Question-and-Answer Session
Operator
[Operator Instructions]. Your first question comes from the line of [Indiscernible]. Go ahead.
Unidentified Analyst
Thank you, very much and good morning, everybody. Maybe just on the retail side, I think this is maybe one of the first times you kind of heard, you guys mentioned the watch list versus us asking about the watch list. Just wondering, what types of tenants are these? Are they maybe more individual or, sole proprietorships? And what’s the appetite for backfilling like?
Rael Diamond
[Indiscernible] the backfill is quite strong. It’s not, we as we said, we have very few tenants on our watch list as most of our tenants are really necessity-based grocery and the like. It’s — we’re really seeing problems around discretionary spending. So as far as big box, fashion and power centers, small CRU where those QSRs and, like, midtown — mid-price sit down restaurants. That’s where we’re seeing some weakness, but we’re monitoring it. And as I said, there’s not a lot of those in our category.
Unidentified Analyst
And just in terms of the backfilling side of it, like, who would you guys be expecting to sort of step in, in the event some of these went dark? What type of —
Rael Diamond
Look, it’s more where there’s, franchisees, and they’re trying to either pay back debt or sell out their business, but we are replacing with it similar. And we don’t have challenges. We’re using, Loblaw small format and value retailers to backfill as well. So, we’re not having a challenge, backfilling the real estate.
Unidentified Analyst
Okay. That’s just very helpful. And then maybe just flipping to the industrial side of things, you mentioned a couple of non-renewals. Could you maybe quantify, what you expect the act on occupancy and maybe SP NOI to be over the balance of the year from those?
Rael Diamond
So, we expect, the conservatively we’re looking at around 200,000 square feet of potential vacancy, which will pull from about 98.8% maybe down to high 97% or just under 98%. As we said in our notes, a lot of this was planned for, so we’re expecting it, and it’s included in our outlook.
Unidentified Analyst
Okay. Perfect. And then maybe just lastly, I think when we last spoke in May, Rael, I believe you mentioned you guys were hoping to do about $150 million to $200 million of Loblaws transactions. If that is in fact, if I’m recalling that correctly, how do you sort of see the balance of the year evolving on that front?
Mario Barrafato
Hey, [Indiscernible]. Thanks for the question. So, you are correct. Let’s go closer to the 150 number and it will start in Q3 and then some of it may trickle into Q4.
Unidentified Analyst
Okay. Perfect. Thank you, everybody, so much.
Operator
[Operator Instructions]. Your next question comes from the line of Sam Damiani with TD Securities. Please go ahead.
Sam Damiani
Thank you. Good morning. I hope you all can hear me.
Unidentified Company Representative
Yes.
Sam Damiani
Okay. So just, I guess, first question is on the industrial development pipeline. The two active projects, the costs did increase about 3.5% quarter-over-quarter. Wondering if you can give a little more detail what drove that? And if the rents didn’t change, that would change the yields by about 25 basis points, if my math is correct. So just curious, I guess what was going on there?
Rael Diamond
Yes. Sam, I don’t think there’s anything significant. It was just really a small increase in, I’d say internal allocations, interest, G&A and then the phasing of the master plan costs to those phases. But it was minor tweaks, I would say. The yields are still in line with where we previously disclosed.
Sam Damiani
Okay, okay. Fair enough. And just I guess on the industrial side, are you getting closer to starting another project — starting construction on another project either with or without preleasing?
Rael Diamond
Look, we’re actively marketing the site. I think what the broker and I think on the broker communities are very pleased because they see all the activity on our side. We understand they’re going and they definitely are stalled. We’ve got so much work on the site at the moment with all the servicing with Loblaw building and with the spec development. The earliest we actually [Indiscernible] in Q1, Q2 of ‘25. And, we’ll have to assess where the market is then, but right now we feel very confident that we should be in a position to go with that time.
Sam Damiani
Great. And I tried to catch what you’re saying Rael on the I guess the deal with Nautical Lands.
Erin Johnston
Sam, can you hear us?
Sam Damiani
Yes. Can you hear me fine? Hello? Is this better? Hello?
Erin Johnston
Hi. Sir, did you hear us?
Sam Damiani
I did hear you. Can you hear me?
Erin Johnston
Now we can. We didn’t engage after we completed our we just spoke about the industrial development.
Sam Damiani
Okay. I know I did hear. And my next question is just on the retail side. The looks like about 160,000 odd square feet of news active starts in the retail development pipeline year-to-date. And I guess a lot of it is with this Nautical Lands Group. And just wanted to clarify, you said there’s six sites that you’re doing with them. And just to be clear, are there ground leases and they’re what sort of use is the development?
Niall Collins
Yeah, they’re building rental communities focused on a population segment 55 and older. And we view it as very complementary to our site. One of the six ground leases we’ve already transferred, and the other five will come over the next quarter, two years or so.
Sam Damiani
And these are comparable yields to if you were going to develop ground-based retail yourself?
Niall Collins
Superior yields to that.
Sam Damiani
Are these high-rise or low-rise? What sort of projects are they doing?
Niall Collins
They’re generally around 6 stories. So, they’re mid-rise on a suburban basis.
Sam Damiani
Okay, great. Fantastic. Okay, last question for me. Mario, I think you mentioned you got a mortgage on the Choice Eastway development. I didn’t quite hear the numbers. Could you sorry, could you just repeat that?
Mario Barrafato
Yes. Well, it was a mortgage. I think it was what?
Unidentified Company Representative
25-year market?
Mario Barrafato
The 25-year mortgage was about 5%. And I just I don’t recall the number, but it was a Lifeco.
Sam Damiani
You don’t call the amount?
Mario Barrafato
It’s a $90 million mortgage, Sam.
Sam Damiani
And is the 90 at your Choice’s share or at a 100%?
Mario Barrafato
Choice’s share.
Sam Damiani
If I’m not mistaken, that was the cost on that was $94 million so that’s a pretty good pretty good capital payback.
Mario Barrafato
Yeah, this is overall a great deal.
Sam Damiani
Yeah. Okay. Great. Congratulations on the good quarter. I’ll turn it back.
Operator
And next question comes from the line of Pammi Bir with RBC Capital Markets. Please go ahead.
Pammi Bir
Thanks. Good morning. I just wanted to come back to the industrial portfolio again and maybe can you maybe just expand on some of the commentary from a leasing standpoint, some of the dynamics you’re seeing, taking any longer to get leases done. Are you offering any sort of concessions or extended free rent periods? Or any concessions or extended free rent periods or any changes in terms that you’re seeing? Thanks.
Niall Collins
Hi, Pammi, it’s Niall. No, at the moment, we’re not offering any concessions. We’re still seeing a lot of interest. And I think the value is our in-place rents at the moment and the uplift. Our spreads, our retention, I think what was reflected in the quarter is a good indication of where we finished the year where we’re getting high retention and strong spreads. So, we’re not seeing that kind of weakness in our portfolio based on our locations.
Pammi Bir
Okay. And then just in terms of the some of the occupancy slippage in the industrial portfolio that you do expect, I think, later this year, which markets were those? And what’s your sense of timing of getting space released?
Niall Collins
So, the biggest, is probably in the West and it’s smaller bay units, 1,500 to 3,000 square feet where it’s local operators. That’s where we’re seeing some weakness. And Ontario is as well. We’ve more we have as I said, we’ve got some planned. But it’s the releasing of it. We’ve been conservative about our releasing assumptions both on rate and on downtime.
Pammi Bir
Got it. Erin, can you just come back to your comments on the I think you mentioned some of the factors that leave your 2024 guidance for FFO pretty much intact. But I think you mentioned in that comment that you expect — some I think some additional income from Loblaw’s portfolio optimization, if I’m not mistaken. Can you just maybe expand on that?
Erin Johnston
Yes, Pammi. So, like in our outlook, so the incremental cost from the restructuring will be more than offset by some lease surrender income. So, for the second half of the year with the rightsizing, we probably expect about $6 million of lease surrender, maybe four around four of the third quarter and two of Q4. And so, when you factor that against the cost, our outlook remains the same.
Pammi Bir
And then I guess the releasing or the outlook for those additional properties where they expect to surrender, what is the thinking of go forward on those?
Erin Johnston
We’re working through a lot of those leases are already negotiated as we kind of finish out the year. So as Mario said, we don’t expect it to have an impact on the quarter. They’re going back in at higher rents.
Pammi Bir
Okay. At higher rents, got it. And then just from a capital recycling standpoint, still fairly active, I guess, on dispositions. What’s sort of the outlook for the balance of the year as you think about that pipeline?
Mario Barrafato
Yeah. Probably what we said over the last, call it two years that we again very focused on trying to be balanced. So, our expectation is that the dispositions would be very close to the amount of acquisitions. So, for this year, call it, no, I don’t know, roughly $200 million of acquisitions and $200 million of dispositions.
Pammi Bir
Thanks very much for that. I’ll turn it back.
Operator
Your next question comes from the line of Sumayya Syed with CIBC. Please go ahead.
Sumayya Syed
Thanks. Good morning. Just firstly on the Loblaw Industrial leases, wondering if the renewal options there are structured, the same as the retail ones and what was the lift on industrial versus retail in that, 8.4 average spread that you achieved in the quarter?
Mario Barrafato
We had one industrial and the spread was 10%.
Sumayya Syed
Okay. Then I guess looking at the lease renewal, so you’ve now addressed about half of next year’s maturity. So, for any of the third-party leases that roll next year, are you finding that leasing spreads are holding in the high-single-digit range? Or where are they landing?
Mario Barrafato
Correct. I agree.
Sumayya Syed
Okay. And then just lastly, Rael, maybe an updated commentary on the transaction market, if you’re seeing the buyer pool has changed or still largely local or private and just thoughts around the availability of financing with the groups that you usually transact with?
Rael Diamond
Yeah. Look, I think it’s very similar to what it was last quarter where, there continues to be this big bid-ask spread, between caller sellers’ expectation and what buyers are willing to pay. We have been able to transact, because as you said, we’re more focused on that that private market. And given the quality of the assets and the tenancy is generally in place, they are able to get financing. And in a few cases, we’ve given VTBs, but they’re not significant amount of VTBs, just to help bridge the purchaser for a short period of time.
Sumayya Syed
Okay. And what would be the average term on the VTBs you have?
Rael Diamond
Generally, one year.
Sumayya Syed
One year. Okay. That’s everything. Thank you.
Operator
I would now like to turn the call back over to Rael Diamond, CEO for closing remarks. Please go ahead.
Rael Diamond
Thank you, Eric, and thanks to everyone for your interest, your investment in Choice and for joining us this morning. Hope you all have a great weekend.
Operator
This concludes today’s call. Thank you all for joining. You may now disconnect.
