CT Real Estate Investment Trust (CRTUN) Earnings Call Transcript & Summary

Good morning. My name is Valerie, and I will be your conference operator today. At this time, I would like to welcome everyone to CT REIT's Q2 2022 Earnings Results Conference Call. [Operator Instructions] The speakers on today's call are Kevin Salsberg, President and Chief Executive Officer of CT REIT; Lesley Gibson, Chief Financial Officer of CT REIT; and Jodi Shpigel, Senior Vice President, Real Estate of CT REIT. Today's discussion may include forward-looking statements. Such statements are based on management's assumptions and beliefs. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. Please see CT REIT's filings -- public filings for a discussion of these risk factors, which are included in their 2021 MD&A and 2021 AIF, which can be found on CT REIT's website and on SEDAR. I will now turn the call over to Kevin Salsberg, President and Chief Executive Officer of CT REIT. Kevin?

Thank you, Valerie, and good morning, everyone. We're very pleased to welcome you to CT REIT's Second Quarter 2022 Investor Conference Call, which I feel fortunate to remind our listeners marks my first call as President and CEO. As we have all witnessed since our last quarterly update, the overall economic picture has become increasingly more challenged and the global financial outlook even more uncertain. Central banks continue to increase rates, elevated levels of inflation persists and the prospects for an economic slowdown seem more pronounced. In the face of such an opaque market context, however, CT REIT continues to deliver strong and stable results and growth in AFFO per unit. Our portfolio of primarily net lease assets, complemented by a growing industrial base, provides a solid foundation. Our long weighted average lease term and minimal debt maturities over the next few years insulate us from much of the current market-based risks that exist in today's environment. As well, our privileged relationship with Canadian Tire provides a growth pipeline that is consistent and meaningful. And our prospects beyond our core portfolio, including third-party acquisitions, intensifications and servicing value in underutilized assets, provide additional avenues for us to explore as we navigate through these uncertain times. We are truly fortunate to find ourselves in a position to be able to continue delivering meaningful growth, all while prudently managing risk. And as always, from this position of relative strength, we will continue to monitor the market for new opportunities. With respect to what we accomplished in the quarter, I could not be prouder of the achievements of our team. We delivered several significant project completions that Jodi will speak to shortly, and the diversity of these investments certainly highlights the internal capabilities and strengths that we have built at CT REIT over the last few years. By adding nearly 600,000 square feet of GLA to the portfolio and increasing our weighted average lease term via the completion of certain strategic lease extensions, we continue to meaningfully grow and improve our asset base as well as demonstrate how we work together with Canadian Tire to achieve our mutual objectives as it relates to our portfolio and their expanded store and supply chain network strategies. I am very pleased to welcome Jodi Shpigel, our Senior Vice President, Real Estate, to have her first conference call with CT REIT this quarter. Jodi has been a great addition to our senior executive team and has most definitely hit the ground running. So with that, I will turn the call over to Jodi to provide an overview of our investment, leasing and development activities. Jodi?

Thanks, Kevin, and good morning, everyone. As highlighted in our press release yesterday, we were pleased to announce 2 new investments this quarter totaling $30 million, which, once completed, will add an incremental 149,000 square feet of GLA to the portfolio at a weighted average cap rate of 6.81%. These new projects include a vend-in of land and the development of a new Canadian Tire store in Lloydminster, Alberta and the expansion of an existing Canadian Tire store in Stettler, Alberta. As Kevin highlighted, we had a busy quarter with respect to our investment and development activity. In total, we completed 12 previously announced investments totaling $111 million and added 590,000 square feet of GLA to the portfolio. These projects included the expansion of our Coteau-du-Lac distribution center; the development of a new Canadian Tire store in Moose Jaw, Saskatchewan; the completion of Phase 2 of our Orillia, Ontario redevelopment; land acquisitions in Sherbrooke East, Quebec and in Invermere, British Columbia; and also the expansion of 7 Canadian Tire stores. At the end of the second quarter, CT REIT had 28 properties that were at various stages of development with 6 projects currently expected to be completed by the end of this year. The projects in our development pipeline represent a total committed investment of approximately $366 million on completion, $90 million of which has already been spent and $150 million of which we anticipate will be spent in the next 12 months. Upon completion, these projects will add a total incremental gross leasable area of approximately 1.2 million square feet to the portfolio, 99% of which has been pre-leased as at quarter end. In the second quarter, we also completed lease extensions for 3 Canadian Tire stores and 1 Canadian Tire distribution center. As a result, the weighted average lease term of our portfolio increased to 8.6 years, one of the longest in the sector. In addition to the CTC lease extensions, we are also happy to announce that we have successfully re-leased the 100,000 square foot unit at our 11 Dufferin industrial building in Calgary, Alberta. Based on the strength of our property and the Calgary industrial market, we were able to secure this new tenancy with a third-party logistics provider very quickly, achieving a 25% increase over expiring rents with minimal invested capital and new rent to begin prior to the end of this year. With this most recent lease commitment, our portfolio remains 99.4% occupied, in line with the last quarter. I will now turn it over to Lesley to review our financial results. Lesley?

Thanks, Jodi, and good morning, everyone. As Kevin highlighted, we are very pleased with the results delivered by the REIT this quarter. Second quarter AFFO per unit on a diluted basis was $0.284, an increase of 2.5% compared to Q2 of 2021, primarily due to the impact of NOI variances, partially offset by increased personnel costs, which included the retirement expenses of our former CEO. It should be noted that this is the last quarter that we expect to incur these retirement-related expenses. Excluding this onetime cost, AFFO per unit was $0.287, up 3.5% from the same period last year. Diluted FFO per unit this quarter was $0.313, a slight increase compared to $0.310 in Q2 of 2021, as the growth in FFO exceeded the increase in the weighted average units outstanding. Net operating income was $104.1 million for the quarter, an increase of 3.7% or $3.7 million compared to Q2 2021. This NOI growth was comprised primarily of 2.4% growth on a same-store basis and 2.8% growth on a same-property basis. Same-store NOI for the quarter grew by $2.4 million or 2.4% as a result of contractual rent escalations contributing nearly $1.6 million, including the 1.5% average annual rent escalations included in the Canadian Tire leases, with the balance of the growth primarily from the continued recovery of capital expenditures and interest earned on the unrecovered balance, which contributed approximately $0.7 million in the quarter. In the second quarter, adjusted G&A expenses as a percentage of property revenue were 3.1%, which was above the 2.5% in Q2 2021. As previously mentioned, the accelerated amortization of long-term compensation costs related to our recent CEO transition have run to the P&L and drove slightly higher G&A expenses through the end of Q2, which amounted to $0.5 million in the current quarter. Excluding this transition cost, adjusted G&A as a percentage of property revenue would have been 2.7%, comparable to the 2.5% in Q2 2021. With respect to our portfolio fair value, the REIT recorded a small adjustment of $6 million on our investment properties for the second quarter of 2022. Determining fair value this quarter was particularly challenging in the absence of comparable sales transactions. We continue to apply our same and consistent methodology in looking at property valuations and seeking external support from the appraisal community, which informs our view of the market. This led to no change in our overall cap rates during the quarter of 6.05%, with the increase in fair value being driven by higher NOI within our portfolio of properties, including those projects completed in the quarter. It should be noticed, however, that our retail and industrial average cap rates did increase each by a couple of basis points, respectively, this quarter. But due to the increased relative weighting of our industrial properties due to the transfers from properties under development, which had a lower relative cap rate than our average cap rate, the overall average remained consistent with Q1. With the rise in interest rates that we have seen thus far in 2022 and the prospects for future Central Bank hikes for the balance of the year, we are anticipating the potential for upward pressure on cap rates in the coming quarters. Distributions in the quarter were $0.212 per unit, 5.7% higher than the second quarter of 2021 due to increases in the rate of distribution, which became effective with the monthly distributions paid in July 2021 and July 2022. This resulted in an AFFO payout ratio of 74.6% for the quarter, in line with the 74.5% for the same quarter last year. Turning now to the balance sheet. Our debt metrics remain strong with the interest cover ratio at 3.7x in Q2 2022, consistent with the 3.7x reported in the second quarter of 2021. CT REIT's indebtedness ratio has improved almost 40.2% as at June 30, 2022, compared to 40.9% last quarter and 41.2% as at year-end. The decrease in the ratio was primarily due to the increase in fair value adjustments made to properties as well as acquisition intensification and development activities completed in 2022, exceeding the growth in indebtedness. In the current interest rate environment, we are delighted to be largely insulated from refinancing risk as we have no public debentures scheduled to mature until 2025 and almost no variable rate debt. Our liquidity remains strong with $294 million available through our committed credit facilities along with [ $3 million ] of cash on hand and a further $300 million available on our uncommitted facility with Canadian Tire Corporation. And with that, I will turn it back to the operator for any questions.

[Operator Instructions] Our first question is from Himanshu Gupta with Scotiabank.

So just on the valuation comment there, I mean, obviously, lower adjustment or very minor adjustment down in Q2. And Lesley, I think you mentioned that you expect upward pressure on cap rates in the second half of the year. So maybe can you elaborate that? Any thoughts what kind of potential impact you could see there?

I mean it's not so specific, Himanshu. I think with continued pressure of inflation, with the expected increases in interest rates that are still to come, I think those are generally correlated with increase in the cap rates. So that's definitely something that we're looking at on the horizon. We just haven't seen that actually in practice and seen that in any kind of comparable transactions that would inform our view of the market just yet.

Okay. So transaction activity has been slow, but have you got any like appraisals done or any local sentiment coming through suggesting one way or the other?

Yes. Himanshu, we actually had 36 appraisals done as of Q2, representing about 11% of our portfolio, and that was one of the, obviously, key inputs to expand those covered geographies, markets, et cetera, across our portfolio. So based on some of that feedback and other things such as the cap rate surveys and the other stuff that are provided by the various appraisal firms, we took a view that, that was really a flat overall cap rate for us. There was very little changes into the properties that were of our type.

Got it. And then just on the development spend for the next 12 months, I think you mentioned $150 million to be deployed. How do you look to finance that? I mean any thoughts of excluding the unsecured debenture market here?

Himanshu, we're fortunate to be having sitting on a bit of cash. We generate a fair bit of cash flow from our operations. So those would be the first 2 sources. We have a significantly -- a significant amount of our credit facilities that are undrawn, so that would be our primary one. Obviously, our past practice has been typically when we reach a certain level of draw on our lines, that our profits would be to term that out in the unsecured debt market. I think that would still be something that we're looking towards. But obviously, depending on the rate of spend and how fast that goes, we'll determine when we might be in the market in the future.

Got it. And maybe a final question from my side. On Canada Square, any update there? And then what occupancy reduction are you expecting in the near term? And probably how much NOI erosion should we model it?

In terms of the development, Himanshu, continue to work with Oxford in response to the community and stakeholder engagement process. That remains ongoing. We're updating and revising the master plan scheme as we speak. Our hope is that we'll be in a position to resubmit an application by the end of this year. That process obviously takes time. As we've mentioned previously, we cannot begin the development or at least Phase 1 of the development until the LRT is completed. There's been no new announcements, to my knowledge, around the timing of completing that project. Although it is clear, driving to work every day, that work continues and is ongoing. So we're just working through that process more generally. Obviously, we've mentioned in the past that as we set the stage for the first phase, we'll see some NOI erosion in the property as we de-lease or manage expiries as we work towards that start date. I won't give any specific guidance at this time with respect to the quantum or timing.

All right. And maybe just one follow-up. I mean, obviously, cost of build financing has moved up quite a bit compared to, let's say, the last 2 years. Does that change anything in terms of your Canada Square plans in terms of the mix of the property, like residential versus office or other components within the property?

In terms of mix, no. I mean the mix is actually somewhat prescribed as it relates to the zoning on the site. I have to remind everybody, we can build about 3 million square feet of total GLA, and we have to replace a large component of the commercial that exists as at today. From a financing perspective, we'll obviously be in discussions with our partner, Oxford Properties, in terms of the optimal financing structure as we look to set the stage for the initial Phase 1.

Our next question is from Tal Woolley with National Bank Financial.

Just wondering, with all of the completions this quarter, do you have a sense of like -- and particularly since you've got one that's in like a big DC coming online that's accounting for a big chunk of the square footage, just can you give us a sense of what the net rent will be on the added square footage this quarter? I just want to make sure there's no big deviation from sort of where the average net rent is right now.

Are you talking about the 590,000 square feet that was completed that came online or the new 2 new projects we announced?

The 590,000.

I would say they would be in line with our current rents. Obviously, the industrial property will probably be a little bit lower, but it would also be in line with our industrial portfolio. They were all set at market. So I don't think there'll be much in the way of deviation from the average.

Okay. And then I appreciate the conversation you've sort of given around assessing fair value this quarter. I guess my question is this, like going through that process with the appraisals and your own work and talking to the community -- the broader community, would it sort of suggest to you that maybe you could have been more aggressive prior to this move in rates with respect to cap rates?

And just to make sure I understand your question, you mean over the last number of years running down our cap rates?

Yes, that you possibly like you could have been a little bit -- you could have maybe brought up valuations a little bit more prior to this move in cap rates, just given where things kind of are sitting right now.

Well, I think we've always pegged our cap rates where we think the market is. I would certainly suggest we've taken a conservative view of the market, both over the last number of years as cap rates have trended down, and I think we would likely take a similar approach as we anticipate possible movement upwards. But no, I don't think we should have been more aggressive. I think this gives us a little bit of leeway to wait for this period of price discovery to unfold and figure out really where cap rates land. I mean we don't want to be guessing at where our fair value is. We want to be using our, as Lesley said in the call remarks, our consistent similar methodology to pinpoint where we think the value of our portfolio sits.

Okay. And then just maybe you can give a little bit of color in terms of what you're seeing in terms of third-party acquisitions. Obviously, I would expect volumes probably significantly lower than it normally is. And anything you can say with respect to pricing of assets right now?

Yes. In the retail space, for sure, transaction volume has really just ceased through Q2. I've seen a couple of new offerings come to market. So I think it will be really interesting probably as we head into the Q4 end-of-year period to see if those trade and at what price is. On the industrial side, I think we're seeing a bifurcation of product type where there's a much greater interest in short-term lease and even small day product where people still feel like they can get at the rent expiries and mark-to-market. The longer-weighted average stuff is still very much of interest. I think it's just the IRRs are a little bit more challenged. So probably on a cap rate basis, those will -- we'll see expansion there. And there's probably a few trades that are in the market right now that could set the benchmark on that. So I think you'll continue to see that. I think on the retail, just further to kind of your initial question, I think what we saw in the cap rate survey was coming from a relatively higher base. It's probably less subject to larger swings on a percentage basis in terms of valuations and cap rates.