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 Third 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 Q3 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 in management's discussion and analysis for the period ended September 30, 2023, which are available on our website at www.cnetreit.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 condition of Canadian Net. These financial measures do not have any standardized definition 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, 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. In the third quarter of 2023, our team dedicated efforts to lease renewals, refinancings and property dispositions. We are happy to report that in addition to the Timmins property sale in Q2, we also sold a restaurant property operated under the Mikes banner in Trois-Rivières, Quebec, for $1.3 million during the third quarter and a Pizza Hut property in Dartmouth, Nova Scotia for $1.65 million in October. These transactions exceeding our IFRS values continue to show our ability to create value while enhancing our capital structure. At the end of the quarter, Canadian Net REIT boasted an occupancy rate of 100% combined with a conservative payout ratio of 55%. All expiring leases for 2023 have been successfully renewed. Looking forward to 2024, we have 12 leases up for renewal, representing around $1.7 million of NOI. Renewed leases account for 74% of expiring NOI, a notable increase from 40% last quarter. We are confident we will be able to renew the remaining 26% in Q1 and Q2 of next year as stipulated in the tenants' leases. The average lease term across our portfolio stands at 6.6%. Despite the strong portfolio performance, this quarter faced challenges due to higher interest rates on mortgage renewals, variable rate debt, and notably, line of credit interest. This resulted in a stable FFO per unit for the period and a slight 5% decrease over the quarter. In terms of transactional activities, there is no significant change from previous quarters. Bid-ask spreads remain too wide to transact. Market sentiment suggests rates will lower in the future, paving the way for increased transactional activities. On the financing front, we renewed 2 loans in Q3 2023, one generating approximately $700,000 of liquidity. About $8.5 million of mortgages, including those in joint venture, remains to be renewed in 2023, with completion expected in the coming weeks. Following mortgage renewals, we anticipate generating around $1.5 million in net proceeds to repay credit facilities. Additionally, during the quarter, we repaid our $1.4 million convertible debenture issued in 2018. As we move forward through 2023 and 2024, our goal is to optimize the REIT's capital structure, ensuring a robust foundation for growth. I will now turn the call back over to Ben Gazith, who will review our Q3 results in more detail. Ben?

Thank you, Kevin. We had another solid quarter. For the 9-month period ended September 30, 2023, we generated FFO per unit of $0.473, consistent with the same period in 2022. FFO for the period ended September 2023 was $9.7 million and was also consistent with the same period last year. FFO was impacted by rental revenues of newly acquired properties and contractual rent step-ups, which was offset by higher interest charges on mortgage renewals, variable rate mortgages and credit facilities. During the same period, property rental income was $19.3 million, an increase of 9% compared to $17.7 million in the same period last year. NOI was $14.5 million, up 8% from $13.5 million for the same period in 2022. These increases were also primarily due to the impact of properties acquired subsequent to the third quarter. The IFRS value of our adjusted investment properties, which is the total of our wholly-owned investment properties and our proportionate share of investment properties held in joint ventures, was $331 million as at September 30, 2023, a decrease of 8% compared to $338 million a year earlier, largely due to the dispositions of 2 properties Kevin mentioned 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 57% at quarter end compared to 58% at the same time last year. Excluding convertible debentures, debt-to-gross assets was 54% compared to 55% last year. Our FFO payout ratio for Q3 2023 was 55%, a slight increase from 54% in Q3 last year. Our properties are typically financed with fixed rate amortizing mortgages. As of September 30, 2023, the REIT's exposure to variable rate debt is composed of 3 variable rate mortgages and its credit facilities. In addition, bridge loans on our development projects are at variable rates until converted to take-out financing. Over the years, our preference has been to take out the longest term available to use on our mortgages in order to mitigate our rate reset risk. We have $5.3 million of mortgages rolling over in 2023, which is excluding mortgages in our JVs, and the bulk of our renewals are not before 2027. 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] We have questions from the line of Patrick Kealey from Echelon Wealth Partners.

Yes, yes. We can hear you.

First question is just on the disposition front. Adjusting for the sale of the Dartmouth property post quarter I believe still you have roughly $3 million in assets held for sale. Just curious if you could provide any updates or additional color with respect to timing and pricing for those assets?

Yes, good question. So those assets are still being marketed as we speak. A little traction on them. So the assets we sold so far, the restaurant properties received extremely -- very good offers off market. The assets that were currently marketed have some buyers looking around, but I would say that the volatility in rates, similar to last quarter, make it very hard for them to commit to a bid. So we have communications, but on the time line, it's hard to tell at the moment. We've seen some decrease in rates, which should help going forward.

Appreciate it. And then just touching on that, those properties are backed largely, I'm assuming, variable rate mortgage, and any net proceeds will be likely going towards the credit facility?

Exactly, yes.

Okay. Okay. And then just sticking on the debt side. Just curious what you're seeing for rates on the remaining '23 mortgages or maybe for '24. And just also wanted to confirm that there was -- you said it was $1.5 million in up financing activity there?

Yes. So rates are very volatile. In the last week, we've had -- we've been very fortunate, we've seen some decrease. So what we see right now is between, I would say, 6.25% to 7% over the last week. Now the range would be closer to 6.25% to 6.5%, which helps us on the more -- the expiring mortgages. The $1.5 million that we will be getting in up financing is on 2 mortgages coming due in the coming weeks. That's when we'll get this. And going forward, obviously, very hard to do a forecast, but we expect slightly lower rates following recent news.

Got it. And then just moving forward on the maintenance CapEx side. Assuming that the bump this quarter is just a little bit of carryover from, I believe, it's the roof maintenance from -- that you discussed last quarter?

Exactly. So this year was big, just we had the $805,000 that were spent on the roof replacement on our [ Kirby ] Lake property. This will be recovered with a 9% rate of return. So this is really -- we started the work in Q2, finished in Q3, and that's why you see an uptick there.

Perfect. And then just last question here. I don't want to hog the call too much. Just looking ahead to 2024, could you provide any color insight as to what you're seeing so far, just sort of respect to leasing spreads and maybe contractual escalators for those expiries?

Yes. So 2024, so far, what we've seen is, I would say, between 10% and 15% on basically leases in place. On new leases, we're currently under negotiation, so very hard to tell. But nothing that is not contractual will be leased at a spread lower than 10%, for sure.

Our next question comes from the line of Alexander Leon from Desjardins Capital Markets.

Maybe just sticking with the renewals there. Last quarter, you guys were up 40%, and I think there was some commentary about a significant amount of tenants that were undergoing renovations. So I'm just curious, out of that progress that was made from last quarter, how much of that was attributable to those tenants doing the renovations? And are there any left for the remaining 26%?

Yes. So, yes. So basically, let me rephrase. So if we include the tenants doing renovations, we would be at 97.5% leased. And then the remainder, 3.5% -- 2.5%, sorry, would be tenants not undergoing significant renovations, but simply tenants that are with leases expiring in September and onward of next year. And so contractually speaking, they don't have to submit their notice as of today.

Okay. Just on the transaction environment, you guys mentioned not much of a change on the bid-ask spreads. They are still quite wide. So what do you expect you need to see to happen before activity accelerates? Is it rate driven? And if that's the case, maybe where you expect you need to see rates to hit before transaction markets improve?

Good question. So the main catalyst for sure is rates, especially in our asset class. Our asset class is national tenants, essential needs. There's never -- rarely a worry about the ability to the tenant to pay vacancy. Our leases are triple net in nature. So for us, rate is the most important driver. What can we expect to see, what's our forecast, very hard to tell. It's always the first one to give up, right, is it going to be the buyer or the seller. I think now we're on a good trend since the past 2 weeks in terms of rates, which will make it a bit easier on the buyer. Hopefully, sellers also adjust slightly, which should help in the coming months.

Okay. Is there any like kind of specific rate you expect if we hit, it will kind of improve the economics from the buy side?

I mean listen, I can't speak for the market in general. It's very hard to forecast such a number. As you know, we've always been, on the Canadian Net side, we're a bottom-up acquirer, right? We've always been very disciplined. So it doesn't matter if the rate is 6%, 6.5%. At the end of the day, if we like the asset, if the purchase price of the asset allow us to reach our required return, then we will do the deal. But it's not like -- we're not awaiting a 6% rate to say, well, now it's time to buy. It's always bottoms-up, opportunity by opportunity. And as for the market, I can't speak for other buyers.

I appreciate the color. Maybe last one for me. Just on the disposition program, I'm just curious, everything that's kind of added to the held-for-sale bucket at this point, is that more opportunistic? Or do you actually have a specific quantum of assets you're looking to sell?

So we did an analysis 2 years ago, and we decided certain assets we want to -- we would like to sell. Not -- obviously, as you can see, we're not rushing to selling. Those are good assets, long leases, solid covenants. And those are the 2 assets you can see in the held for sale. The other assets that we've been disposing of, as I mentioned a bit earlier, are off-market offers from local acquirers at prices that were extremely accretive for us and so we've done them. But as for the disposition program, it's really what you see in the assets held for sale. And until those are gone, we won't add to the list, and we won't sell unless we receive other very good offers.

[Operator Instructions] At this time, there are no further questions. I would like to hand the call back to management for closing.

Thank you, everyone, for taking the time to listen to our call this morning. That concludes our call. Thank you.

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