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

Good morning. I would like to welcome everyone to Canadian Net REIT's 2023 Second Quarter 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 Q2 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'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, 2022, and management's discussion and analysis for the period ended June 30, 2023, which are available on our website at www.cnetreits.com 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 position 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 June 30, 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. During the second quarter of 2023, the team worked diligently amidst the challenging interest rate landscape. As a result, FFO per unit for the 6-month period was up 3%. FFO was positively influenced by organic growth and acquisition made in 2022, somewhat offset mainly by higher interest rate on our line of credit and the sale of our Timmins property in April. At the end of the quarter, Canadian Net REIT posted an occupancy rate of 100% combined with a conservative payout ratio of 54%. All expiring leases for 2023 have been successfully renewed. Looking ahead to 2024, we have 12 leases up for renewal, representing around $1.7 million of NOI. About 40% of these renewals on an NOI basis have already been finalized with another 40% from tenants that are actively engaged in substantial renovation at their own expense, guaranteeing their renewal. Additionally, some tenants have indicated their intent to renew leases even for 2025 and 2026 at healthy spreads, reflecting the strength of their businesses and the quality of our properties. The average lease term across our portfolio stands at 6.7 years. Turning to the transactional activities. The beginning of the quarter saw numerous listings. However, many were either withdrawn from the market or remained pending closure, underscoring the complexities of operating within a fluctuating rate and high debt cost environment. We have seen, however, increased interest in smaller assets in the sub-$2 million category. On the financing front, we successfully renewed 2 loans in Q2 2023 at variable rates. The majority of our 2023 mortgage renewals are slated for Q3 encompassing 7 loans, including these in joint ventures, with a total value of approximately $14.9 million. Although most of them will be renewed, I would like to emphasize that there is an opportunity for the REIT to enhance its available funds by strategically refinancing certain loans. This potential has been made possible by our prudent approach during acquisitions in the past. The mortgages that are approaching maturity predominantly originate from 2018 and are tied to properties that have experienced solid rent increases, early renewals and capital paydown. These properties were acquired with a cautious leverage strategy at the time of purchase. To this date, there remains considerable interest among lenders for assets of our nature. Since the beginning of the second quarter of 2023, we used our NCIB to acquire and cancel 99,400 units of the trust at an average cost of $5.04 per unit. Canadian Net continues to stand out as a deeply discounted REIT in today's market. Our exceptional portfolio bodes full occupancy with 90% of our tenants operating in the necessity-based retail sector on a national level. The responsible payout ratio of 54% complements our operations in a fragmented segment of the real estate landscape providing ample opportunities for growth. As we move forward through 2023, our goal is to optimize the REIT, ensuring a robust foundation for growth. I will now turn the call back to Ben Gazith, who will review our Q2 results in more details. Ben?

Thank you, Kevin. We had another solid quarter. For the 6-month period ended June 30, 2023, we generated FFO per unit of $0.318, an increase of approximately 3% compared to $0.31 in Q2 last year. FFO increased 3% year-over-year to $6.5 million from $6.3 million for the same period last year. These increases were primarily due to the impact of properties acquired subsequent to the second quarter a year ago, 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. During the same period, property rental income was $12.9 million, an increase of 14% compared to $11.3 million in the same period last year. NOI was $9.7 million, up 11% from $8.7 million for the same period in 2022. These increases were also primarily due to the impact of properties acquired subsequent to the second quarter. 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 $332 million as at June 30, 2023, consistent with the value of adjusted investment properties 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 58% at quarter end compared to 56% at the same time last year. Excluding convertible debentures, debt-to-gross assets was 54% compared to 53% last year. Our FFO payout ratio for Q2 2023 was 54%, a slight reduction from 55% in Q2 last year. Our properties are typically financed with fixed rate amortizing mortgages. As at June 30, 2023, there were 2 properties in the portfolio, which were on variable rate mortgages as well as the REIT's line of credit. In addition, bridge loans and our development projects are at 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 $12.4 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 $2.8 million of mortgages associated with properties held for sale. The current average term to maturity on our mortgages is 4.6 years. That summarizes our key results for the quarter. We will now open the line for any questions. Operator?

[Operator Instructions] Our first question comes from Alexander Leon with Desjardins Capital Markets.

I'd like to start off with the $489,000 charge included in maintenance CapEx. I was hoping you guys could provide some color on that.

Yes. We -- under most of our leases, when we do CapEx, it is recoverable. We amortize it with an interest charge. And so our rate of return on this $489,000 is approximately 9% unlevered.

Okay. Great. And then moving on to the -- some of the mortgage maturities. There's quite a wide spread on rates for the remaining 2023 maturities. Just wondering if you guys could provide maybe an average rate on those and how that would compare to current 5- or 10-year rate?

Yes. And so basically, if -- the mortgages coming due in 2023 had an average -- weighted average of 4%, and we're looking at renewing those at an average of 6.3%. The difference on an annualized basis for the REIT will be approximately $400,000 to $450,000.

Okay. Great. And then maybe last one for me, just maybe an update on capital recycling and any updates on the sale of properties held for sale.

No update at the moment, same as last quarter. Lots of people asking questions, but it's very hard. We've seen the inflation number 2, 3 days ago. Next thing you know, the buyer pulls out. And so no updates at the moment.

Our next question comes from David Chrystal with Echelon.

In your prepared remarks, you mentioned that your upcoming debt maturities are low LTV given 2018 acquisitions and there's probably some opportunity for up financing. Can you give a kind of indication of how much up financing there may be in the balance of '23 and maybe looking ahead to 2024 as well?

Yes. For 2023, we're looking at excess proceeds of approximately $2 million. For 2024, I would be honest, it's -- the rates that do not allow us to forecast accurately what will be done. When we refinance property, we remain extremely disciplined. And so we refinance those that we know will be performing exceptionally for the future. And so we evaluated those this year. We made a few decisions, but for 2024, it's too early.

Okay. Fair. And in terms of use of proceeds, I think your line is -- it's prime plus 0.5 to prime plus 1. So you're in and around 8%. And I think you mentioned 6.3% average rate on new debt. Is your best use of proceeds for that $2 million excess paying down the line more activity on the NCIB? Or how do you look at use of proceeds?

The first use is obviously paying down the line. It's very important for us to unlock liquidity in order to be able to acquire more real estate when the right deal comes across. We will be buying units to support the stock as we've done in the past through our NCIB when we see prices that we judge make no sense like around $5. But the main priority of capital recycling is to paying down the line and to remain nimble to do future acquisitions.

Okay. And then maybe a small housekeeping item. Your interest income increased about $50,000 sequentially. Is there anything onetime in there? Or is this recurring? Or how should we look at that run rate?

Nothing onetime. It's -- the loans we have are at prime plus also. So given the increase in rates, that created the increase in income.

It's pretty big sequential increase, though with not a huge change in prime. Or was there any increase in the magnitude of the loans?

No.

Okay. So that's a good run rate then going forward?

Yes.

[Operator Instructions] I'm showing no further questions at this time. That concludes our question-and-answer session. Thank you for your participation in today's conference. This does conclude the program, and you may now disconnect.