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 2023 First Quarter Earnings Conference Call. [Operator Instructions] Again, 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 Q1 2023 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 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 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, 2022, and management's discussion and analysis for the period ended March 31, 2023, which are available on our website at www.cnetreits.com and on SEDAR, 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 March 31, 2023. I will now turn the call over to Kevin Henley, Canadian Net REIT's President and CEO. Kevin?

Thank you, Ben, and good morning, everyone. I'm pleased to be hosting my first earnings call as CEO of the REIT. As many of you know, I've been with Canadian Net REIT since 2017, and I've occupied the position of CFO and most recently Chief Investment Officer. As such, I have been deeply involved in the REIT's growth from 20 properties to 100 today, and this has resulted in a seamless management transition. I'm excited about the growth opportunities ahead of us and eager to lead the REIT and generating strong sustained return for unitholders. The business strategy remains intact with a focus on per unit FFO growth. In the first quarter of 2023, we continued to generate solid financial performance, including a 4% increase in FFO per unit. Importantly, we achieved this result in the face of headwinds, including a soft acquisition market and rising interest rates. This success is attributable to our distinctive business model that features 100% triple net leases. Under these leases, our tenants are solely responsible for variable costs, including insurance, taxes and ongoing operating expenses as well as the management of the property. This has obviously limited our exposure to inflation. This model also enables Canadian Net to operate under a lean management structure with minimal overhead while maintaining industry-leading occupancy level. At the end of the quarter, our occupancy was at 100%. In Q1, we also benefited from the positive contribution of our most recent acquisitions in addition to the organic growth from incremental rent attributable to scheduled rent increases. At the end of Q1 2023, our occupancy was 100%. Only 1 of our 2023 expiring leases -- Q1 2023, sorry, expiring leases remains to be renewed and we expect to complete the renewal over the course of the third quarter. Looking forward to 2024, we have 12 leases coming up for renewal or representing approximately 1.7 million of NOI. Approximately 40% of these renewals have already been completed. The portfolio's weighted average [ life ] term is now of 6.9 years. As I indicated earlier, the M&A market continues to be quiet in Q1 2023. Following the end of the quarter, we started seeing more deals being marketed in our space. Nevertheless, the challenges of high debt cost and fluctuating rates present obstacle in successfully carrying out these transactions while achieving our desired returns. Subsequent to quarter end, we sold a single-tenant restaurant property in Timmins, Ontario, for a total consideration of $1.3 million. The sale price represented a capitalization rate of 6.2%, which was a premium of 19% over our IFRS cap rate. This premium underlines the conservative philosophy we follow with respect to the ongoing valuation of our portfolio. With respect to financing, we had 5 loans coming due in Q1 2023. One of them was on the Timmins property, which was sold. 3 others were renewed during the quarter, and the last 1 subsequent to quarter end. As mentioned earlier, there is significant volatility in rates. But overall, we -- those swings benefited us for those renewals. We refinanced certain properties at rates that were 100 bps lower than initially anticipated. We currently have 2 properties for sale, which are still being marketed. We continue to survey the market for opportunities. And as we move forward, we expect interest rates and capitalization rates to stabilize, translating into a more favorable acquisition environment for the REIT. I will now turn the call back to Ben Gazith, who will review the Q1 results in more detail. Ben?

Thank you, Kevin. We had another solid quarter. For the 3-month period ended March 31, 2023, we generated FFO per unit of $0.157, an increase of approximately 4% compared to $0.151 in Q1 last year. FFO increased 5.3% year-over-year to $3.2 million from $3.1 million in Q1 2022. These increases were primarily due to the impact of newly acquired properties, partially offset by interest on mortgages associated with these properties as well as increases in floating interest rates on the REIT's various lines of credit. . Property rental income for Q1 2023 was $6.4 million, an increase of 18.1% compared to $5.4 million in the same period last year. NOI was $4.9 million, up 15.4% from $4.2 million in Q1 2022. 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 was $329.2 million as at March 31, 2023, an increase of 4.8% compared to $314.1 million a year earlier. We continue to maintain a prudent approach with respect to our leverage and our payout ratio, having a debt-to-gross assets ratio of approximately 59% at quarter end compared to 54% at the same time last year. Excluding convertible debentures, debt to gross assets was 55% compared to 51% last year. The primary reason for the increase is due to the fair market value write-downs during the year on the value of our investment properties. Our FFO payout ratio for Q1 2023 was 55%, a slight reduction from 56% in Q1 last year. Our properties are typically financed with fixed rate amortizing mortgages. As at March 31, 2023, there were 3 properties in the portfolio, which were on variable rate mortgages as well as the REIT's lines of credit. As Kevin had mentioned, subsequent to quarter end, we sold a single tenant restaurant property in Timmins, Ontario, and 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 takeout financing. 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 $14.1 million of mortgages rolling over in 2023, excluding mortgages and our JVs and the bulk of our renewals are now before 2027. Included in the mortgages rolling over are $3.5 million of mortgages associated with properties held for sale. The current average terms of maturity on our mortgages is 4.8 years. That summarizes our key results for the quarter. I will now turn the call back to Kevin for some closing remarks before we open the line for questions. Kevin?

We believe the outlook for our business remains highly positive, with our experienced team, unique low-cost operating model and established debt financing strategy, we are well positioned to make further accretive acquisitions of properties that are too small for larger REITs, but too large for individual investors. We expect that this will drive further solid growth in FFO and drive stronger return for unitholders. We will now open the lines for questions. Operator?

[Operator Instructions] Our first question comes from the line of David Chrystal from Echelon.

In terms of the dispositions, you got about $6 million of office held of sale, 1 closed post quarter. Do you have any visibility on the 2 remaining dispositions in terms of timing or cap rates?

No, I would say no clear path. They are being marketed. The market is very volatile. We've seen the GOC 5-year go up 40 bps this week. So we have interest, people coming around, then obviously, terms and rates, people go back. And so I would say we will sell them, but no visibility as to when exactly.

Okay. And if you look at your portfolio, should we expect to see any more dispositions beyond what's listed for sale?

Not at the moment. The Timmins property, for example, we received an offer we were not expecting, a very good offer. So obviously, when that happens, we have to consider it, we have to be opportunistic. It was also well -- it was scheduled at the same time as the debt renewal. So we avoided any breakup cost there, which makes sense. However, the properties we acquired over the years were acquired strategically at great cap rates. And so even if we were to go out there and sell them, the issue is what do you reinvest in. We don't see a lot of deals on the market. We're happy with our properties. They have great tenants. We have good relationships with them, and they're all very well located. And so for now, I would not forecast any other sales in the portfolio.

And that kind of leads me to my next question. In terms of proceeds, I mean, obviously, the 2 listed for sale have variable rate debt, that I'm guessing that's in the 7% plus range. But in terms of net proceeds, would your first priority be paying down the line?

Yes.

Okay. And then just shifting to the operations. You have no real lease expiries in 2023. What's your baseline organic growth just from contractual escalations?