Q1 2022 Choice Properties Real Estate Investment Trust Earnings Call

April 28, 2022

Rael Diamond: million square feet in different stages of the rezoning and planning process. This development pipeline provides us with tremendous opportunities in both the near and long term to add high-quality assets to our portfolio and create long-term value. I'm now gonna pass the call over to Anna. Anna.

Anna Kennedy: Thank you, Rael, and good morning, everyone. As Rael mentioned, our operational results for the quarter were strong due to increased consumer traffic and retailer confidence across the retail portfolio, and sustained high demand from industrial users. We continue to see positive momentum, particularly in new leasing activity commencing in future periods. Despite having tenant retention that was lower than usual, our period end occupancy remained strong at 97% compared to 97.1% last quarter. We completed 127,000 sq ft of new leasing commencing in the quarter. We had approximately 825,000 sq ft of lease expiries in the quarter, and we renewed 359,000 sq ft at leasing spreads 5.3% higher than expiring rents.

Anna Kennedy: Tenant retention at 43.5% was lower than in past quarters, resulting in negative absorption of 339,000sq ft. We re-leased 450,000sq ft of this vacated space at more favorable rents commencing in future periods, the majority being industrial space in the GTA and in Calgary. Turning to our asset classes. Our approximately 45 million sq ft retail portfolio, which consists of open air centers with necessity-based tenants, once again delivered stable results. Retail occupancy declined slightly to 97.4%, down 10 basis points from the prior quarter due to temporary vacancy that has been backfilled. We completed 270,000sq ft of renewals in the quarter at rents 6.5% above expiry, reflecting tenant retention of 72%.

Anna Kennedy: We also had 43,000 sq ft of new retail deals commencing in the quarter. The desire for retailers to locate in our necessity-based centers remains strong. Retailers are actively looking to open new locations and expand their store networks. There has been strong interest from pharmacies, fitness, furniture, decor, discount stores, and quick service restaurants, all eager to expand and upgrade existing locations. We completed several new deals with retailers in these industries during the quarter. Industrial fundamentals remained strong in 2022. The acceleration of e-commerce in Canada and the shortage of available space has continued to create a supply-demand imbalance for distribution and logistics warehouses, driving increases in rental rates across the country.

Anna Kennedy: The GTA availability rate was down 10 basis points from Q4 of 2021, while Edmonton and Calgary saw the largest quarterly decreases in availability, falling 110 basis points and 80 basis points, respectively. The national availability dropped to 1.6%, an all-time historic low. Occupancy in our industrial portfolio decreased 100 basis points in the quarter, finishing at 97.1% occupied. This was due to 390,000 sq ft expiring in the quarter, of which 66,000 was renewed. The decline in vacancy is mainly attributable to two large anticipated lease expiries, one in Alberta and the other in Ontario. We have been able to capitalize on strong industrial market fundamentals, and these spaces have been re-leased effective Q2 of this year at new rents, significantly exceeding the expiring rents.

Anna Kennedy: 170,000sq ft of this space, which is in Calgary, has been re-leased. 113,000sq ft within the GTA has been leased commencing 1 April, with leasing spreads 150% higher than the expiry and limited landlord capital required. With this transaction in the GTA, our 6.6 million sq ft Ontario portfolio remains fully occupied on a committed basis. The Calgary market continues to improve and is benefiting from the growth in logistics tenants, as well as greater economic certainty, fueling demand for spaces 10,000sq ft and under. We also completed 55,000sq ft of new deals in Alberta, which took effect in the quarter.

Anna Kennedy: We are pleased with the improved leasing conditions in Alberta and the fact that our Western Canadian portfolio, at 95.1% leased, is outperforming the market. The Halifax industrial market also continues to thrive, with vacancy rates hitting a record low of 1.9% in the quarter. During the quarter, we renewed a 20,000 sq ft tenant at rents 31% above expiry. Demand for rental residential continues to increase as the lifting of pandemic restrictions brings residents back into urban centers. Our rental residential portfolio consists of three stabilized assets, which ended the quarter at approximately 96% leased. Our two newest assets, The Brixton and Liberty House, located in the West Queen West and Liberty Village neighborhoods respectively, are 61% leased.

Anna Kennedy: We expect The Brixton to reach stabilized occupancy by Q3 of this year, and Liberty House by Q2 of next year, if not sooner. Our operating results in the quarter were strong, reflecting the strength and resilience of our portfolio. We remain confident that our portfolio will continue to deliver solid operating results through the balance of 2022. I'll now pass the call over to Mario to discuss our financial performance.

Mario Barrafato: Thank you, Anna, and good morning, everyone. As Rael mentioned, we're pleased with our strong start to 2022, with continued high rent collections and positive leasing momentum. Our reported funds from operations for Q1 was CAD 175.1 million, or 24.2 cents per unit. On a gross dollar basis, our FFO for the quarter increased by CAD 4.5 million compared to the prior year. This was primarily due to higher same asset net operating income, partially offset by the impact of net disposition activity over the trailing twelve months. In addition, we had a decline in interest expense due to lower leverage, and we also had higher interest income from new mezzanine loan advances. Included in FFO was CAD 1.6 million non-recurring NOI from successful realty tax appeals.

Mario Barrafato: On a per unit basis, diluted FFO was CAD 0.242. This was up 2.5% compared to CAD 0.236 in Q1 2021. We're pleased we've been able to maintain stable occupancy and consistent same-store results for 6 consecutive quarters. Same-store cash NOI increased by 3.2% compared with Q1 2021. By asset class, retail increased by CAD 7.2 million or 4.2%. These increases reflect contractual rent steps and higher tax and capital recoveries, as well as a reduction in bad debt expense of CAD 1.1 million and the non-recurring tax appeal I mentioned earlier. Industrial increased by CAD 757 thousand or 2.2%, and this was driven by positive demand fundamentals, partially offset by the temporary vacancies that Anna mentioned.

Mario Barrafato: Mixed use, residential, and other increased by CAD 444,000 or 5%, and this was driven by positive leasing in our residential assets, coupled with a decline in bad debt expense of CAD 300,000. This was partially offset by the challenges in our remaining office portfolio. When including the CAD 1.7 million of total bad debts, total Same Store Cash NOI increased by 2.6%. Our business continues to be supported by our industry-leading balance sheet and disciplined approach to financial management. We reported a significant increase to our net asset value in the quarter, with a total increase of CAD 452 million or 4.8%, marking the seventh consecutive quarter we've recognized NAV growth. This was driven by investment property fair value gains and contributions from operations.

Mario Barrafato: We are pleased to report that fair value gains on our investment properties were CAD 418 million, driven by strong fundamentals for industrial real estate, both income-producing and development properties. As well, our reported gains reflect the demand for essential retail and the progress in our development pipeline. The fair value gains in the quarter demonstrate the strength of our overall portfolio and the future value creation potential of our development pipeline. We continue to improve our debt metrics this quarter and maintain ample liquidity. Our leverage was 39.5% at the end of the quarter, an improvement of 2.8% compared to Q1 of 2021. Our debt-to-EBITDA ratio was 7.2 times, consistent with that of Q4, and down from the 7.6 times reported in Q1 of 2021.

Mario Barrafato: From a liquidity perspective, we maintain approximately CAD 1.5 billion in available cash, comprised of CAD 1.4 billion of available credit and CAD 35 million in cash and cash equivalents. This is further supported by approximately CAD 12.4 billion of unencumbered properties. Lastly, we continue to strengthen our portfolio through strategic acquisitions and trimming of non-core assets through our capital recycling program and our development program. Excluding the sale of our office properties, which Rael referred to earlier, we successfully and opportunistically sold approximately CAD 55 million of income-producing properties deemed non-strategic to our core portfolio, while acquiring approximately CAD 65 million of properties in the quarter. Since the start of the year, there has been a significant increase in interest rates, with the Bank of Canada already hiking the overnight rate by 75 basis points and several further hikes anticipated for the remainder of 2022.

Mario Barrafato: Additionally, longer-term rates have increased, with the Bank of Canada ten-year benchmark yield increasing by 120 basis points from the beginning of 2022 to approximately 2.8% currently. In this high-rate environment, our priorities will remain the same. We'll maintain a high level of liquidity and a balanced debt maturity ladder. Our current strong liquidity profile provides us flexibility in refinancing the approximately CAD 620 million of debt obligations coming due in the remainder of 2022. We are fortunate to have access to several sources of capital, including unsecured debentures, commercial mortgages, CMHC financing, and property dispositions. Overall, we're incredibly pleased with our strong start to 2022. We continue to deliver stable and resilient operating results while driving strong net asset value growth.

Mario Barrafato: The resilience in our earnings, in conjunction with our conservative balance sheet and our commitment to prudent financial management, will allow us to navigate through market volatility in a rising interest rate environment. With that, I would now like to turn the call back to the operator for questions.

Operator: At this time, I would like to remind everyone, in order to ask a question, press star one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Our first question comes from Jaz Cumberbatch with TD Securities. Your line is open.

Jaz Cumberbatch: Hi, good morning.

Anna Kennedy: Morning.

Mario Barrafato: Morning.

Jaz Cumberbatch: Jas on the phone with Sam. Just a couple of questions for me. Just starting with Golden Mile, firstly, the commencement of that project still slated for 2023? Secondly, you know, just looking at the recent moves in interest rates and inflation, has that all impacted your desire to proceed with the project?

Anna Kennedy: Jas, thank you for your question. The timing was a little unclear in your question. It is our intention to be in a position to start construction in 2023, end of 2023. You know, obviously we're gonna have to assess the status of construction pricing at that time. But overall, we're very, very excited by the project. We think, obviously it's a transformational development. We've actually done some commercial leasing, and we think, look, ultimately very enthused, and we'll have to assess it at the time in 2023.

Jaz Cumberbatch: Okay. Understood. Just sticking with Golden Mile, just in terms of the costs themselves, when do you expect contracts to be negotiated in effect for that project?

Anna Kennedy: We haven't even got engaged. Our partner is Daniels on that project on the first phase, and we will work with them on the construction management process. Lastly, obviously closer to the time, call it mid-2023, we'll have better clarity.

Jaz Cumberbatch: Okay. Thanks for your color. I'll turn it back.

Operator: Our next question comes from Mark Rothschild with Canaccord Genuity. Your line is open.

Mark Rothschild: Thanks. Good morning, guys. In regards to the same property NOI, which is definitely a little bit above where you previously indicated what you expected for the year, there was some non-recurring income in there, but would you increase at all what you think from maybe, I think you previously said 1.5% to 2%. Do you think now that you can do better, and how much of that would change based on the sale of office assets?

Mario Barrafato: Well, maybe I can start, and then Anna can fill in the blanks. It's usually, like, you know, our target is 1.5% to 2%, given that much of our portfolio, long-term leases with contractual rent steps. As Anna mentioned, what we're seeing is a bit more robust activity in our kind of non-Loblaw portfolio. I think we'll be actually closer to that 2%, above 2% in the retail for this year. On an overall basis, because the industrial has this transition in tenancies with some downtime, we won't see a lot of growth in industrial this year, but the table will be set for 2023.

Mario Barrafato: As far as office goes, yeah, like, pretty much we transition from having NOI from those office properties to now having a distribution, a steady distribution. That will stabilize the FFO, but it won't, there will be nothing in NOI, except for those five properties remaining. Again, with them being in that situation they're in with Calgary, we're seeing some decline in NOI there. Overall, like, we still think this year, for the whole portfolio, we should be in between 1.5% and 2%. Pretty strong given that there's not much contribution from industrial.

Mark Rothschild: Would you increase though from that 0.5% to 2% that you had took previously because of the sale of the office assets?

Mario Barrafato: Yeah, because there would have been some decline in NOI. I think, yeah, probably north of 2, Mark. Yeah, there would have been some decline. Again, office wouldn't have that big of an impact compared to the whole portfolio.

Mark Rothschild: Okay, great. I don't know if you disclosed, but in your disclosure, I'm not sure if I saw it, but can you let us know what the leasing spreads were in the retail portfolio?

Anna Kennedy: Yeah, the spreads in the retail were 7.1% over expiring rents.

Mark Rothschild: Okay. Maybe one to ask also for industrial.

Anna Kennedy: For industrial, we had very limited lease rollover. They were actually flat. We had just the 60,000 or so sq ft rolling in Alberta because we had those two big spaces that we re-leased, so they aren't in our spreads.

Mario Barrafato: Anna, maybe speak to the leasing spreads we're seeing on those bigger spaces, the forward leasing.

Anna Kennedy: Yeah. On the forward leasing, as I said in the GTA, you know, we're seeing spreads of, you know, sometimes 100% to 150% above expiring. We're also starting to see strong rental rate lift in Alberta, you know, 20% to 30%. I think it's important to note that for the deals that we're reporting in industrial, you know, they were done a year ago, right? That's the market's really moving quickly, so you're gonna expect to see higher spreads from us in future quarters.

Mark Rothschild: Great. Thanks, Lana.

Anna Kennedy: So far it was flat. I didn't answer your question. I feel bad, Mark. I did everything but answer.

Mark Rothschild: No, I sort of got that. Yeah. I understand.

Anna Kennedy: Thanks.

Mark Rothschild: Thank you so much.

Mark Rothschild: Our next question comes from Jenny Ma with BMO Capital Markets. Your line is open.

Jenny Ma: Thanks. Good morning. I'm looking at the IFRS cap rates that you have by asset class, and I know there was a reclassification with a new category of mixed use residential and other, which I presume includes office. I'm just wondering if there was any reclassification from retail into mixed use, or is this really mostly an office bucket for now?

Rael Diamond: No, there wouldn't have been a big reclassification. Mostly the mixed use. It's just a handful of properties, and it's mostly office that has retail. Anna, you can...

Anna Kennedy: Yes. The majority of it is office that are long-term holds for us to have a mixture of office and retail like 22 St. Clair and Bathurst and Lakeshore, you know, that is anchored by a grocery store and you know other retailers who are long-term holds. Then our residential portfolio, which has some retail as well as residential.

Jenny Ma: Oh, okay. It would be office properties that have the other components that you now basically call mixed use. Is that correct?

Anna Kennedy: Right.

Jenny Ma: Basically, not a lot of changes in the buckets then.

Anna Kennedy: No.

Jenny Ma: Okay. Gotcha. With the sale to Allied of the 6 assets, I'm just wondering your thoughts on the office portfolio as it stands at 3.5%. Is it at the point where you're pretty satisfied with your holding? I know in the original announcement you talked about the remainder being, you know, mostly core to Weston. Is there anything else in the office portfolio that you view as non-core?

Rael Diamond: Yeah, Jenny. In total, we own eight office assets or eight assets that we previously used to call office. We break it up as three assets that are core, and those are primarily leased to, you know, Weston Group entities, and then five assets that we will sell over time. Those five assets are two in Halifax, one in Montreal, and two in Calgary. We'll sell them at the right time.

Jenny Ma: Okay, great. I just wanted to turn over to industrial, obviously an asset class that you want to continue growing in. It's nice to see the improvement in Alberta, and I'm just wondering about your thoughts on Calgary versus Edmonton, just given the, I guess, you know, proximity of the two markets. Like, how do you see those markets evolving? If there's increased interest in logistics and warehousing in Calgary, does that, you know, is it really focused on Calgary? Do you think it'll be evenly spread out between Calgary and Edmonton? How do you see that playing out over time?

Anna Kennedy: Well, you know, the demand from logistics tenants is greater in Calgary, definitely. Obviously, there is still, you know, some element of e-commerce servicing of that sort of Edmonton and North market. The larger hubs are in Calgary, so it's hard to see right now how that will spill over into Edmonton.

Jenny Ma: I guess my question is, you know, do you see a divergence in sort of the outlook for Calgary and Edmonton because of the greater weighting towards logistics? Or do you think Edmonton will evolve to, you know, be more of a service to the oil industry, or just more of a localized market with most of the logistics being favored in Calgary given their proximity?

Anna Kennedy: No, I do, I do think there is a bit of a divergence that, yeah, for sure, like, logistics users favor Calgary.

Jenny Ma: Mm-hmm.

Anna Kennedy: Sorry if I wasn't clear previously. I do think with the, you know, spike in oil prices we're seeing and, you know, more optimism in general in Calgary, you know, that's helping the Edmonton market as well, where they're, you know, it's also driven by smaller businesses and the oil and gas sector. That market is improving as well, as is Calgary.

Jenny Ma: Okay, great. Thank you very much.

Anna Kennedy: No problem.

Operator: Again, if you would like to ask a question, please press star one. Our next question comes from Tal Woolley with National Bank Financial. Your line is open.

Tal Woolley: Hi. Good morning, everybody.

Rael Diamond: Morning to you, Tal.

Tal Woolley: Just sort of a question around how you're sort of presenting your development. Like, when we look at the projects under active development, and it's got a, you know, expected total spend, like, once it's under construction, about how much of the budget is actually locked in by that point?

Rael Diamond: Tal, when we list it as active development, the bulk of the budget is actually locked in. For example, the big item that became, you know, active in the quarter was the Choice Industrial Centre in Vancouver.

Tal Woolley: Yep.

Rael Diamond: We're around 90% locked in at that point.

Tal Woolley: Okay. Got it. Like, about how long prior to construction do you start locking in all of those items then?

Rael Diamond: It's really very fluid at the moment. You know, previously contractors would hold prices for you for a longer period of time. What we're seeing is people or contractors basically give you very limited time to hold prices. You know, it's just very fluid at the moment, just given the changing prices, impact on supply chains, et cetera. You don't have that opportunity to lock it in on some components ahead of time. We are very fortunate, and you know, we have a very strong team who've been really forward-thinking. For example, you know, there are groups that have been caught building a rental building or residential tower without appliances.

Rael Diamond: We've actually pre-planned, for example, on our Ottawa project. We've already purchased all the appliances, and they're sitting in a warehouse. We've been very fortunate there. We have a very strong group who's forward-thinking and have been, you know, obviously looking up our risks and trying to lock in prices or, you know, protect costs as much as they can.

Tal Woolley: Yeah. Okay. If we think about on the industrial side, like obviously the stuff you've got under development right now, you know, you're seeing yields with, you know, roughly 6% to 8% range, you know, which is great given how, you know, strong the industrial market is. When we look out to the stuff you've still got in planning, do you think you can still achieve those same types of yields going forward?

Rael Diamond: Look, we recognize there's been an increase in construction costs generally across the board. The good thing on industrial rents have kept up pace, if not outpaced, where construction pricing is. Where our huge competitive advantage is our land price. Like if you just look at the assembly we've done in Caledon, you know, where land may be trading at sometimes CAD 2 or 3 million an acre, we've assembled that land at sub CAD 1 million an acre. We have a huge competitive advantage at land pricing, which will translate into premium yields that we can deliver the industrial assets to.

Tal Woolley: Okay. You see, it's the land price that you think is, like, really the advantage over-

Rael Diamond: Yeah.

Tal Woolley: You know, if you were just going to market and buying and trying to buy your way into a project today.

Rael Diamond: It's the land price and then the land size. You know, there are not many groups who have control on, call it 380 acres of developable land in the GTA. Like, I can't think of many groups like that.

Tal Woolley: Got it. Just on the tenant side, I just noticed, I just wanted to make sure. FGF Brands, that's the group that bought the Weston Foods asset?

Rael Diamond: That is correct.

Tal Woolley: Okay. Just on the retail side, are you getting a sense like, you know, Loblaw has been very big on, you know, trying to operate with a click and collect model as sort of e-commerce grows across the country? Are you getting a sense for like, what sort of changes they may be looking at making to the store footprints across their banners over the next little while? Anything you can share there?

Rael Diamond: Nothing we can share yet. We can't comment obviously on Loblaw, but we've worked with Loblaw to facilitate if it's parking spots or, you know, portions of a store that has, you know, manual MFC. We've worked with them to modify, but nothing else that we can really comment on. We'll just continue to work together because as you know, we have a very strong relationship, and we, you know, obviously wanna help them, you know, in their space needs.

Tal Woolley: Okay. That's great. Thanks very much, gentlemen.

Rael Diamond: Thank you.

Operator: There are no further questions at this time. I'll turn the call back over to Rael Diamond for closing remarks.

Rael Diamond: Thank you, Chantal. Well, just to summarize, we're very pleased with our Q1 results. We're in such a great position. We have a high quality portfolio, a phenomenal development pipeline, and as Mario Barrafato said, this is really supported by an industry-leading balance sheet. Thank you for your interest, your investment in Choice, and for joining us this morning.

Operator: This concludes today's conference call. You may now disconnect.

Q1 2022 Choice Properties Real Estate Investment Trust Earnings Call

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