Canadian Net Real Estate Investment Trust (NETUN) Earnings Call Transcript & Summary

Good morning. I would like to welcome everyone to the Canadian Net REIT's Third Quarter 2022 Earnings Conference Call. [Operator Instructions] I would like to advise everyone that this conference is being recorded. I would now like to turn the conference over to Ben Gazith, Canadian Net REIT's Chief Financial Officer. Please go ahead, Mr. Gazith.

Thank you, operator. Good morning, everyone, and thank you for joining us on our Q3 2022 results conference call. Before we begin today, we are obliged to advise you that in talking about our financial and operating performance and in responding to questions today, we may make forward-looking statements, including statements concerning Canadian Net's objectives and strategies to achieve them as well as statements with respect to our plans, estimates and intentions or concerning anticipated future events, results, circumstances or performance, which are not historical facts. These statements are based on our current expectations and assumptions and are subject to risks and uncertainties that could cause our actual results to differ materially from the conclusions in these forward-looking statements. Additional information on the risks that could impact our actual results and the expectations and assumptions we applied in making these forward-looking statements can be found in Canadian Net's most recent annual information form for the year ended December 31, 2021, and management's discussion and analysis for the period ended September 30, 2022, which are available on our website at www.cnetreit.ca and on SEDAR at www.sedar.com. We will also refer to non-IFRS financial measures today, which are widely used in the Canadian real estate industry, including FFO, AFFO and NOI. Canadian Net believes these financial measures provide useful information to both management and investors in measuring the financial performance and financial condition of Canadian Net. These financial measures do not have any standardized definitions prescribed by IFRS and may not be comparable to similarly titled measures reported by other entities. For more information, please refer to the section Non-IFRS Financial Measures of our MD&A for the period ended September 30, 2022. I will now turn the call over to Jason Parravano, Canadian Net REIT's President and CEO. Jason?

Thank you, Ben. Good morning. In the third quarter of 2022, we continue to execute our business strategy. We've maintained a portfolio of 101 properties at a near 100% occupancy level. During the quarter, we completed 2 acquisitions while adding 2 new tenants to the portfolio, a Midas in Fredericton, New Brunswick and in Rona in Chateauguay, Quebec. We continue to add properties to the portfolio that diversified the tenant mix as well as the geographies we are exposed to, strong retail properties in A-locations and secondary markets. More so, these properties fall within the category of essential needs-oriented retail. We completed the development of a QSR in the city of Terrebonne, which opened at the beginning of September. We currently have 2 ongoing projects. One of those will be coming online prior to the end of the year, which is the redevelopment of an old Burger King into a Benny&Co. in the city of Jonquière. In the beginning of 2023, we expect to deliver an ongoing development of a Benny&Co. in Mont-Laurier. In the next quarters, we also want to begin the development of 2 previously announced additional locations for the Benny&Co. banner. The REIT has a 40% interest in all of the projects mentioned. Shifting to what we're seeing in the market and the macroeconomic landscape. Popular topic of conversation right now is inflation and interest rates. Our business, which is focused on owning and acquiring properties on a triple-net lease basis, allows us to be somewhat immune to inflation as higher operating costs are borne by the tenant. The REIT's offering costs for our properties are almost exclusively charged back to our tenants under the structure of the leases with very few exceptions. As the year progresses, this continues to be the case. With respect to interest rates, we have been able to take advantage of mortgage assumptions at pre-hike levels, which allow us to take advantage of meaningful spreads between interest rates and going in cap rates. Prior to the end of the quarter, the REIT has put 2 properties for sale, which penny on interest will likely close in the first quarter of 2023. We do not expect to close any further acquisitions prior to the end of 2022. We continue to survey the market for opportunities and the most efficient way to deploy our capital. I'll now turn the call back over to Ben, who will look at our financial performance. Ben?

Thank you, Jason. We had another great quarter. For the 9-month period ended September 30, 2022, Canadian Net reported an FFO per unit of $0.474 compared to $0.434 per unit for the same period in 2021, which represents an increase of 9%. FFO reached $9.4 million (sic) [ $9.7 million ] compared to $7.8 million for the same period, which represents an increase of 24%. These increases were primarily due to tax of newly acquired properties, partially offset by interest on mortgages associated with these properties as well as increase in floating interest rates on the REIT's various lines of credit. During the same period, the trust property rental income was $17.7 million compared to $14 million for the same period in 2021, which represents an increase of 26%. NOI reached $13.5 million compared to $10.4 million for the same period in 2021, represents an increase of 30%, and the increases were also primarily due to the impact of newly acquired properties. The IFRS value of our adjusted investment properties, which is the total of our wholly owned investment properties and our proportionate share of the investment properties held in joint ventures, amounted to $338 million, an increase of 26% compared to $268 million a year earlier. We continue to maintain a conservative approach with respect to our leverage and our payout ratio, having a debt to gross assets ratio of 58% compared to 50% at the same time last year. The primary reason for the increase is due to the fact that we had completed an equity raise in August 2021. Our FFO payout ratio, which increased slightly to 54% from 52% a year earlier, has remained consistent quarter-over-quarter. With respect to our leasing of the year, we have completed all of our 2022 renewals, which represent approximately $200,000 of NOI, with no tenant turnover. The leasing spreads on those renewals, which included contract renewals as well as new leasing agreements for existing properties, was approximately 20%. We have 10 leases expiring in 2023, which represents approximately $800,000 of NOI, of which 90% have either been renewed or we were able to enter into new leases in space that a previous tenant was not renewing. The remainder of the lease renewal should be completed by the end of the fiscal year. The portfolio [ as vault ] on our leases is currently 7.2 years. Our properties are typically financed with fixed rate amortizing mortgages. There are 3 properties in the portfolio, which are on variable rate mortgages as well as the REIT's line of credit. As Jason mentioned, we are in the process of selling 2 properties, both of which have variable rate mortgages. In addition, bridge loans on our development projects are at a variable rate until converted to take-out financing. There's one mortgage renewal remaining in 2022 with a balance at maturity of less than $1 million as of today's date. Over the years, our preference has been to take out the longest term available to us on our mortgages in order to mitigate our rate reset risk. We have $15 million of mortgages rolling over in 2023, excluding mortgages and our JVs, and the bulk of our renewals are not before 2027. Included in the mortgages rolling over are $3 million of mortgages associated with properties held for sale. The current average term to maturity on our mortgage is 5.2 years. That summarizes our key results for the quarter. We will now open the lines for any questions. Operator?

[Operator Instructions] Our first question comes from Kyle Stanley with Desjardins Capital Markets.

I missed the beginning, so I apologize if you did mention this. But I'm just wondering, did you have any Benny&Co. come online in the quarter? Or do you expect any to come online in the fourth quarter?

Yes. We had the first one in Terrebonne come online September 5, if I'm not mistaken. And we expect one more prior to the end of the year and another one in the first quarter of 2023.

Okay. And then is that most of the $10.7 million investment that was announced late last year? Or is there still a few that you expect, I guess, in the balance of the year?

So the investments that was announced last year was the total project cost for those that were going to be completed, and we have 2 more, which are going to be launching under construction in the spring of 2023.

Okay. Fair enough. And then I think you did mention selling 2 assets. I'm just wondering if you're able to elaborate there at all in terms of pricing or, I guess, what's driving the desire to sell.

We had always looked at the property portfolio, and we regularly look at properties that we want to either hold for the long term or properties we feel will be a good opportunity to take advantage of private capital demand to sell them. So there's 2 properties that we feel interested in selling, and we feel there'll be a demand for at the moment. And it's more so just to look at the revenue streams that come from those properties. A couple of them have local operators, and our preference is to have properties with national covenant revenues. So these are properties we've owned for, call it, 5 or 6 years, which we feel would fit better in someone else's portfolio than ours going forward or the portfolio we want to have going forward.

Okay. Fair enough. And then, I guess, just last one. You did walk through kind of your mortgage maturity profile. Just wondering for next year, maybe what the cadence of the mortgages maturing or if there's any kind of big chunks throughout the year and where the average rate would be? You give the range. But I'm just curious as we think about modeling forward.

Yes. So next year, like I said, excluding the mortgages we have in JVs, we have about $15 million expiring, of which $3 million or $5 million are probably associated with properties that are going to be sold. So that leaves us with approximately $10 million of mortgages rolling over. Those mortgages are probably have an average rate right now somewhere around the same average rate portfolio, so around 3.5%. Some of those are expiring earlier in the year, I would say by the end of Q1, while the rest of them are spread out between Q2 and the end of Q3. That being said, we expect -- it's tough to say we expect because there's so much volatility right now in the bond market as well as the stock market, as you all know. But if we can expect somewhat consistency between now and, call it, the end of Q1 2023, we expect those mortgages probably rolled over in the mid- to high-5s. And if we see some lightning in the buying bond market by the end of 2023, which is what people are calling for, again, what we expect to see, but no promises there, we would expect that those will be -- I hope those will be rolling over in the mid-5s or somewhere in that range. So if you see an average of high-5s at the beginning of the year and an average of mid-5s at the later half of the year, I would assume somewhere between a 5.5 and 5.75 average rollover for those mortgages.

[Operator Instructions] Our next question comes from David Chrystal with Echelon Wealth Partners.

Just -- you provided a bit of commentary on the leasing for '22 and '23. For 2023, can you provide some color on lift you got on the 80% that's been addressed to date?

Yes. So 2023 was the actual -- the renewals are actually all contract renewals. So none of them actually got reset. No new lease -- well, the exception of one new lease for a space that was being vacated. So I would say the average is probably sitting between -- we have one left -- probably around 7% or 8% on those -- on that $800,000 of NOI that's renewing. Some of them are a little bit higher, some of them are a little bit lower.

And on the 20% that is not yet addressed, where are discussions at in terms of stage and negotiations there?

It's 10% not yet addressed it. It's literally all of it is, is we haven't hit the notice period yet. And when dealing with large tenants, sometimes if you don't hit the period -- the minimum notice period as stipulated in the lease, it won't even pick up the phone. So it's just a question of the properties are in queue, and we'll cross that bridge once the notice period is up.

And would it be a fair assumption just to call it kind of 7%, 8% on that as well and lump it in with the 90% you've already done?

I think that remaining lease is a little bit lower than that, but that's why I'm saying the average on the full $800,000 is probably around 7%.

Okay. Okay. Perfect. And then just switching to kind of your acquisition outlook and the pipeline, are you seeing a lot of product? And are you seeing any shift in cap rates? And anything attractive in your markets and with your kind of credit quality of tenants?

We're seeing products. People are always testing the market. I think we're still in a period of price discovery. So there is that gap between vendor expectation and purchaser appetite. But private capital is active at the current time. Like I said, we put 2 properties for sale a couple of weeks ago -- or sorry, about just over a week ago. And the interest has been all from private buyers. And given the property size, I didn't expect institutional buyers being interested in that kind of stuff. But I think we're still in a period of price discovery, but also in a period of, like I mentioned, very high volatility, especially on underlying mortgage rates. So it's very, very difficult for people to underwrite a property when they get under contract day 1 and day 5, the rates have fluctuated by 35 points. And who knows, by the time they close, where the rates will finish at? So that being said, I don't suspect a lot of trades to happen between now and the end of the year. I don't see any sellers in a hurry to sell assets. I don't see any sellers in a -- being squeezed to sell any assets or being forced on any assets because of being over levered. I think we should see a very flat market finishing off 2022 and probably similar for the first quarter of 2023.

And in terms of your balance sheet and liquidity, obviously, if those 2 assets transact, there'll be a little bit of a bump in cash from the net proceeds. But is there an opportunity to pull any cash out on your '23 mortgage refinancings? And are you comfortable with the leverage where it is today or going any higher? Or would you like to see it lower?

So leverage where we're at today is sitting around 58%. With respect to the renewals we have in 2023, there's definitely an opportunity to refinance those properties, but what you'd be doing by refinancing those properties -- and like I said, we're also making the assumption that rates will stay somewhat similar or at a higher level in 2023 than what they've been historically. And we had a long conversation yesterday during our Board meetings just discussing that is, are you comfortable with refinancing or releveraging yourself at a rate with 200, 300 points spread than you've historically had? So I think it's a question of we're not going to marry ourselves to refinancing at higher rates at the current time. We're going to see how the situation evolves and come, in due course, make that decision based on our needs at that time.

[Operator Instructions] And I'm not showing any further questions at this time. I would now like to turn the call back over to management for any closing remarks.

Once again, thank you very much, everybody, for taking the time to hear our call this morning and pleased to share with you our Q3 2022 earnings. We didn't mention it earlier, but as described in our press release, we are increasing distributions once again going into 2023 with a 1.5% increase, bringing a total increase of 176% since we started distributing. So again, pleased to share our results with you and looking forward to the next quarter. Thank you very much.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.