Automotive Properties Real Estate Investment Trust (APRUN) Earnings Call Transcript & Summary

Good morning. Welcome to the Automotive Properties REIT 2022 Third Quarter Financial Results Conference Call and Webcast. My name is Colin, and I'll be your conference operator today. [Operator Instructions] Please be aware that certain information discussed today may be forward-looking in nature. Such forward-looking information reflects the REIT's current views with respect to future events. Any such information is subject to risks, uncertainties, and assumptions that could cause actual results to differ materially from those projected in the forward-looking information. For more information on the risks, uncertainties, and assumptions related to the forward-looking information, please refer to the REIT's latest MD&A and Annual Information Form, which are available on SEDAR. Management may also refer to certain non-IFRS financial measures. Although the REIT believes these measures provide useful supplemental information about financial performance, they are not recognized measures and do not have standardized meanings under IFRS. Again, please refer to the REIT's latest MD&A for additional information regarding non-IFRS financial measures. This call is being recorded on Friday, November 11, 2022. I would now like to turn the conference over to Milton Lamb. Please go ahead, Mr. Lamb.

Great. Thank you, Tom. Good morning, everyone, and thank you for joining us today. Omnium for today's call is Andrew Kalra, our Chief Financial Officer. We delivered solid year-over-year growth in our key financial metrics in the third quarter, supported by our acquisition program and contractual annual rent increases compared to Q3 of last year. Property rental revenue grew 6.3%. Cash NOI increased by 7.7%. Same property cash NOI increased by 2.2%, and AFFO per unit diluted increased to $0.227 from $0.221. During the quarter, we entered an agreement to sell the Kingston property consisting of 2 dealership buildings to a third-party with a capitalization rate of approximately 6.1%, resulting in a sale price of approximately $18 million and a gain of approximately $1.7 million over our Q2 IFRS fair value. The sale is expected to be completed by the end of November. Our valuation of investment properties declined slightly from the prior quarter to reflect the current market conditions, resulting in a fair value loss of $5.8 million net of the IFRS gain for the Kingston property sale. The capitalization rate applicable to our portfolio increased to 6.37% at quarter end, a nominal adjustment from 6.30 at both the end of Q2 2022 and December 2021.  Our liquidity remains strong, and at quarter end, we had $70 million of undrawn credit facilities and 10 unencumbered properties with an aggregate value of approximately $121 million. As of today, we have approximately $75.5 million of undrawn credit facilities plus the future anticipated proceeds from the Kingston property sale. Our debt to GBV ratio at quarter end was 41.2%. With our solid balance sheet and annual contractual rent increases across our portfolio, we are well-positioned to continue delivering growth in revenue, cash NOI and AFFO per unit while pursuing attractive acquisition opportunities. According to DEROsIA's automotive consultants, new light vehicle unit sales in Canada were down 11.8% for the first 9 months of 2022 compared to the same period of last year, which was primarily due to the supply chain constraints experienced within the retail automotive industry. As we have previously noted, we believe the supply chain constraints will continue into the foreseeable future, and not have a significant impact on our tenant's ability to pay rent as new car margins, used car sales and overall service levels remain strong. I'd now like to turn it over to Andrew Kalra to review our financial results and position in more detail. Andrew?

Thanks, and good morning, everyone. Our Property rental revenue for the third quarter totaled $20.7 million, a 6.3% increase from Q3 a year ago, reflecting growth from properties acquired subsequent to Q3 last year and contractual annual rent increases. Total cash NOI and same-property cash NOI for the quarter totaled $17.2 million and $16.2 million, respectively, representing increases of 7.7% and 2.2% compared to Q3 a year ago. Growth in cash NOI was primarily attributable to acquisitions and contractual rent increases. Growth in same-property cash NOI primarily reflects contractual rent increases across our portfolio. Our G&A expenses in the quarter were in line with our expectations and growth. Net income for the quarter was $8.9 million compared to $30.8 million in Q3 last year. The variance was primarily due to noncash fair value adjustments on investment properties, partially offset by higher NOI and noncash fair value adjustments on interest rate swaps and unit-based compensation. FFO and AFFO for the quarter increased by 1.4% and 2.5% compared to Q3 last year. FFO per unit diluted was $0.237 in the quarter, up from $0.24 in Q3 a year ago, and an AFFO per unit diluted increased to $0.227 from $0.21 in Q3 last year.  This growth was primarily due to properties acquired subsequent to Q3 last year and contractual rent increases. The REIT paid total distributions of $9.86 million or $0.201 per unit in the quarter, representing an AFFO payout ratio of $0.88 -- 88.5%. This compares to the total distribution stage of $9.85 million or $0.201 per unit in Q3, representing an AFFO payout ratio of 91%. The AFFO payout ratio was lower this quarter primarily due to properties acquired subsequent to Q3 a year ago and contractual rent increases. We had $453 million of outstanding debt as of September 30, 2022, with an effective weighted average interest rate of 3.8%. We have a well-balanced level of annual maturities, and our weighted average interest rate swap and mortgage term is 4.9 years with a weighted average term of the surety of 3.9 years. Early 90% of our debt is fixed through interest rate swaps and mortgages, leaving only approximately $30 million of floating nonrevolving debt. We continue to have strong support from our lenders and remain well-positioned to deploy capital on growth opportunities. I'd like to turn the call back to Milton for closing remarks. Thank you very much.

Thanks, Andrew. In response to rising inflation, the Bank of Canada has raised the overnight rate by 350 basis points so far in 2022. This has resulted in the 10-year Bank of Canada bond rate moving up approximately 150 basis points this year. We've consistently completed longer-term swaps or mortgages to insulate our debt from future rate increases. In addition, the contractual annual rent increases across our portfolio partially insulate us from rising inflation. These increases consist of CPI adjustments or set annual rent increases. We're further insulated from inflation due to our triple net lease structure, as property-level operating and energy costs are the responsibility of our tenants. Our same-property cash NOI growth of 2.2% in the quarter was attributable to our contractual rent increases and triple net lease structure. We believe the increase in short-term interest rates to levels at or above long-term rates may provide us with acquisition opportunities as dealers often compare our cap rates to their short-term cost of financing. Given our strong balance sheet and the strength of our existing portfolio, we'll continue to pursue acquisitions on a strategic basis. This concludes our remarks. We'd now like to open the lines for questions. Colin, please go ahead.

[Operator Instructions] And your first question comes from Mark Rothschild from Canaccord Genuity.

Maybe just on the last point, you mentioned that you think that it might lead to more acquisition opportunities. Is this something that you're seeing already or just something that you think makes sense to happen? And connected to that, maybe you could just let us know what would the cost of debt be now in the current market, meaning the all-in, including the spread to finance to get a mortgage on one of your properties?

Okay. 3-part question. The short answer is, a, it makes sense; and b, we're certainly having more discussions and more inquiries and deeper conversations. When it comes down to the short term versus the long term, one of the reasons why we are not as active in 2021 as we might have anticipated, is because the rates were so low and dealers were extremely profitable cost, and the availability of bank financing was plentiful. Now they're still healthy. They can certainly probably get the money. But at the same time, short-term rates, the BAs, your prime rates, you're looking at close to 6%, where on the longer-term money when we're looking at all-in rates, 7- to 10-year money swaps, mortgages, VAs, the whole combination all in, you're probably looking in the mid-to-high 5s. So whereas last year, it would have been at 2.5% to cap rates that we like of 6.25 to 7.25. That was a big gap. Today, it's not.

And then on the IFRS cap rate that you're using, is that, in your view, realistic considering that you said the debt would be mid -- I think you said mid to high 5s into high fine?

Yes. I mean we're -- we did not move our cap rates down tremendously to reflect the lower interest rate costs in '20 and '21. So we've been very consistent. And that tends to be where the market's been in that cap rate range over the last 5, 10 years. So we've been very strong on sticking to our financial modeling on what we want to see because we're 10-, 15-, 20-year leases. We can't just go in for the moment and hope that we can roll these leases over and double them in 6 months. So we've stuck to our stringent underwriting, and it's coming back to where we think we'll be able to play nicely.

And maybe just one more question in regard to asset sales. Is there something unique about this property? Or should we expect to see maybe you calling some other assets that maybe are noncore?

I mean, we can't be afraid to do some capital recycling. At the same time, this was opportunistic. And if you look at the cap rate, it's very similar to the short-term cost of capital right now. So we look at it as what may be coming down the pipeline. And we also look at it as being opportunistic to take a profit on Kingston property.

Your next question comes from Jonathan Kelcher from TD Securities.

Just to continue on Mark's question there. For the Kingston asset, was that -- as opportunistic, did they approach you on the deal?

Yes.

What type of buyer was it?

It's the user.

Okay. And is there any development potential on the property?

I mean, it's Kingston. It's the 2 dealerships, 2 different brands, obviously, and there was an outlying excess land as well that goes with it. So you could argue for the right use there could be. We didn't see that as an immediate. We didn't have an immediate use for it. So it's not the type of development that, if you're asking, is it going to be a different use, higher density, et cetera? The answer is no, not in the short term, not in short to midterm.

So I'm just sort of looking at that at 6.1%, and you raised your overall cap rate to 6.4%. And I can't imagine that the Kingston property would be among your best or your lowest cap rate. So I'm just trying to reconcile that, too.

Yes, this is a short answer. That's why we took a hard look at it and decided that it was a good move to make.

And then secondly, it sounds like your pipeline is heating up, and you guys are obviously reliant on dealer M&A for a lot of your pipeline. Do you think that picks up as we kind of look at a recession over the next year or so, some dealers just wanting to get out of the business?

It tends to ebb and flow and not always in a purely linear logical way. Certainly, they're coming off of 2 very strong years. So sometimes, that can create a buy-sell gap. But at the same time, some of the dealers that are looking at potentially retiring are seeing how long will this run go where we're at kind of white-hot margins and record profits. So it will be a combination of where they kind of feel that they're getting the highest value, but at the same time, the buyers are not willing to just buy based on record profits. They've got to make sure that they're buying on sustainable profitability going forward. So I think you're going to see an active back half of '23, and that could even get moved forward beyond that. And then, certainly, we've always seen end-of-year deals. So I wouldn't be surprised if there's more deals announced in the M&A world over the next 6 to 10 weeks.

Your next question comes from Brad Sturges from Raymond James.

So I guess on the proceeds from the sale at this point, the use would be to repay debt initially? Or do you have maybe an opportunity to redeploy that capital in the short term?

We certainly believe that that will get capital recycled. But as we're waiting, it is kind of nice that that cap rate is very similar to what the cost of our short-term capital. So it's nice when rent equals interest savings. It certainly allows us to be a bit more patient, but we certainly believe that the 6.1 for Kingston, there will be opportunities out there where we can get a higher cap rate.

So things are heating up. And historically, we've seen more deal flow or activity at the end of the year is even in the sort of early in the new year. I mean, how should we think about that sort of pace of maybe acquisition activity at the moment? I guess you're being a little bit more cautious and strategic with your capital. So just trying to consider or understand maybe how to think of the pace of maybe capital deployment from here.

Yes. And part of it can be outside of our control. And the M&A world right now is going a bit slower because OEM approvals are taking a bit longer than normal. And so, in the M&A world, you've got to get your deal in place. But as importantly or more importantly, you need to get the OEM approval where the operator has to before that transaction goes through. So we've been at this for over 7 years. A lot of our life is very up and waiting. And I think that's probably fair to say as we go forward. And at the same time, a lot of the conversations with dealers tend to be slow-moving until they suddenly say, yes, we've had this center contract for 2 to 3 months. We're ready to close. Can you hurry up and join us? So it's really hard to pinpoint the pace.

Your next question comes from Johann Rodrigues from Industrial Alliance.

I was just curious as to what was the buyer of the Kingston. You said it was a user. What's the rationale? What's your thinking for wanting to purchase the property?

Yes. I always find when they're sitting on the other side of the table, they don't give me that answer. It was more in our view, what's the price? Where do we think we can use that capital in the future? What's our short-term cost of debt now? So we looked at up more from how it affects APR as opposed to how it affects them. I also like to do like put words in other people's mouths.

And are you getting -- are you getting inbounds on other properties from users? Or was this kind of a one-time thing?

I mean, we often get -- would you consider, but at the same time, for us, this was an opportunistic capital recycling, and what do we want to do? So you never want to say no, but this is not a situation that we expect to be programmatic.

[Operator Instructions] Your next question comes from Himanshu Gupta from Scotiabank.

So staying on our favor subject today, the cigars. So did you look at the dollar-per-square-foot pricing as well? I mean, 6.1% is great. I'm looking at $720 per foot. Is that the right way of looking at this?

Yes. I'm not sure you got the $720 million. So the 2 properties -- sorry, the 2 buildings combined are just over 41,000 feet, and then you've got some excess land. So in the same way when we buy, we look at price per square foot, we look at, is there another use, what do we think of the land and what do we think of the cap rate. So it's the same underwriting we do. We just do as an underwriting on, is it something we want to opportunistically sell, or is it something we want to opportunistically buy -- or in a lot of cases, do we want to hold the property? So in this case, different metrics, what we're seeing in the head, what cost of capital is right now, and short-term debt, it made sense.

So yes, so that will be something like $450 per foot. And in terms of the in-place rents, let's call it, around $27, I mean, based on your 6.1.Was it below market or above market? I mean, was that a consideration for the user to take the property in terms of the increased rents?

Again, I can't really speak for the investor. We don't like having properties that are above market rent. So I would have said that they were somewhat in line with market, plus or minus, but certainly in line with market. And this is a long-term lease with renewal options.

And then more open-ended question on your entire portfolio in terms of market rents versus in-place rents. I mean, clearly, we have seen a lot on the industrial side of things. replacement costs have gone up as well, and yours is into like 10-, 20-year leases. So are you tracking where your in-place versus your market rents are today, like in the previous province...

We certainly looked at it. I guess 2 comments there would be getting access to it, a, and then b, same with industrial, but cost of land has escalated dramatically over the last 5 years. The cost of construction has escalated dramatically over the last few years. I would think in-place rents within our portfolio compared to replacement rents now to go out, build, develop and then put an economic rent and yield in place. I think, certainly, there is -- today's rents are higher than they were when we started creating this REIT and the acquisitions we've done through the meantime.

And then just a final question on the balance sheet. I think, Andrew, you mentioned $30 million of floating nonrevolving debt. I think that's still variable? So any thoughts to fix that up?

Yes. We follow our strategy of laddering for 3 to 10 years, and we're going to continue to follow that over the foreseeable future. I mean, we're at 90% right now. We're watching the market. It is volatile, and we see some ups and downs, but we're going to continue to follow our strategy and execute accordingly. We need a few more days, like yesterday, of minus 25 on the 10 years. That would be nice.

Your next question comes from Tal Woolley from National Bank Financial.

Yes, I just wanted to talk a little bit about the credit facility just to understand a little bit more how we should think about -- I think your average cost right now across the facility is about 3.8%. I know some of -- you've got the hedging in place. So should we expect that number to stay steady for the next few quarters? Or how would sort of that blended rate -- how should we expect that blended rate to move as we move through 2023?

Yes. I mean we know where rates are now. I mean, the swap rates from 5% to 10%, I mean, pretty much in the bandwidth of 5.5% to 6%. So the expectation is as we continue to follow the strategy of fixing 3- to 10-year laddering and as the -- as some of the swaps mature, we'll see a higher blended rate over the period as we continue to mature based on the current market conditions. I can't tell you exactly where it's going to be, but you can see that we've got 30 that we talked about that's on swaps. And also, we've got another $40 million coming due over -- within a year. So we'll continue to assess on those maturities.

And part of this was, I don't want to say anticipated, but the rates that we've looked at over the last 3 to 5 years, we're at record low levels. And that's why we've always been proactive on going long for most of them were tens, but most -- all of them were 7 attends so that we could be insulated. But I mean, it's not a long-term thing being at 2% to 2.5% that we saw last year.

Just a reminder, in April, we executed on swaps for 8-year terms below 5.

So if I'm thinking assuming nothing dramatic happens with the asset base, like probably by the end of 2023, you're somewhere in the low, mid 4s. Does that sound about right? I was just trying to do the math last night -- sort of where it's pumping out.

Sure. No, I get your modeling, and we don't really provide detailed forward-looking information or forecasting. But based on current rates, the math can be done, and then you can calculate where the blended would be based on current rates based on where maturities are as well.

Well, I mean, every single time we do a model that goes up 30 basis points, and then we finish the model, and it goes down 30 basis points. So it will be interesting to model right now. Yes. Tell me about it. Just another -- couple of quick things about the credit facility to like. You've raised a little bit of money here selling this Kingston property. It obviously sounds like you're going to redeploy fairly quickly. But if you weren't -- you've got the flexibility to just park that cash to, right, if you wanted to against the credit facility.

We've got revolving revolvers. So as of Q3, we had 14.5%. And as of yesterday, we had $10 million that -- so we've got the ability to pay down the revolvers immediately. And just a reminder, those are high for at this point in time right now.

And then if you have more assets to do, you've got like your underlying base facilities that I think you've got one maturing in like 24, if I remember correctly, like, so you'll have like, I would expect them probably like the unswapped rate on that facility probably increases and then you go in and layer in another set of swaps on top of it. That's how this works, right?

So, that 2024 facility would be extended for another 5 years. The swaps would stay in place as is.

So would you at certain points, work with our syndicate lenders to kind of do regular extensions, and they're often kind of refreshed of 3 to 5 years, mostly 5 years? And that would be the BA plus the spread. And then, as Andrew said, you've got swaps on top of that.

And so if when you go to refinance the underlying facility, that rate moves a little bit, we would still expect the swap rate then to sort of increase to reflect that margin. You get the benefit of the plot because... We've been very consistent on the BA plus 150 since we started, and we've renewed a bunch of things a bunch of times. Having said that, the past is not always an expression of the future, but we tend to be strategic when we do it as well, and we tend to enjoy some good support.

So just want to give you clarity there. Carl, just the swap itself is not going to change, right? I think that's been fixed.

But if, for some reason, the banks got toucher...

Credit spread is a discussion, correct? That's a variable point on that, correct? And if that went up, then yes, there would be a little bit of upward pressure on your rate, even though the swap is still in place. That's all I was trying to understand.

Your next question comes from Jimmy Shan from RBC Capital Markets.

So just given your comment about dealers' cost of debt having gone up substantially, and you compare it with your cap rate...

Not just dealers. Overall, the short-term cost of capital -- short-term lending has gone up and that includes dealers and all other industries. But yes, go ahead.

Sure. Yes. So I'm just trying to understand kind of your leverage or pricing power now when you're negotiating these new acquisitions. Are you in a position you feel that you can push deals so that you can get cap rates, say, north of 7%? Are you there yet today in your discussion?

It depends on the market, and it depends on the structure of the lease increases of the annual rent increases. It's always a bit of a balancing act between rental growth and the initial cap rate. But what we are seeing is that last year's Q4 you have on -- we want pricing like industrial pricing has now dissipated, and we're now getting to levels that are starting to make sense for -- I think, for both parties.

Yes, because I'm just thinking if you were able to do deals in the 6s when the cost of debt was materially lower. I'm just trying to think about how that works now, right? I would imagine that you should be able to get acquisition cap rates better than you would have done in the past. Is that a fair way of thinking about it?

Certainly, in the past 2 or 3 years, yes.

There are no further questions at this time. I'll turn it back to you.

That's great. Everyone, thank you very much. Before signing off on this remembrance day, we thank the proud men and women of the Canadian armed forces and remember that they gave their lives to serve our country.

Thank you for joining us today. We look forward to speaking to you again soon.

All the best.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.