Morguard Real Estate Investment Trust (MRTUN) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen, and welcome to the Morguard Real Estate Investment Trust Fourth Quarter for the Year Ended December 31, 2020. [Operator Instructions] This call is being recorded on Thursday, February 18, 2021. I would now like to turn the conference over to Mr. Rai Sahi. Please go ahead.

Okay.

Maybe I'll jump in. Good afternoon, everyone. My name is Andrew Tamlin, Chief Financial Officer of Morguard REIT. I'm joined this afternoon by Tom Johnston, Vice President of Western Asset Management; Tullio Capulli, Vice President of Eastern Asset Management, along with Rai Sahi, Chief Executive Officer and Chairman of the Board. Thank you all for taking the time to join the call. Before we jump into the call, I'd like to just point out that our comments will mostly refer to the 2020 annual MD&A and financial statements, which have been posted to our website. I refer you specifically to the cautionary language at the front of the MD&A, which would also apply to any comments that we make on this call. 2020 was a very difficult year for the real estate industry in general and specifically, Morguard REIT, due to the COVID-19 pandemic. In March, we had to pivot as an organization in order to respond effectively to the demands brought on by the pandemic. And at the top of the list was to ensure the safety of our tenants, our employees and our business. In addition, there was the burden of addressing rent solutions for the tenants that were struggling financially due to the economic shutdown in the spring and had difficulties paying rent. This included administering the CECRA program on behalf of our retail and office tenants. Once the country emerged from the first set of lockdowns into the summer, things looked favorable, both from an infection standpoint and from an economy standpoint. Unfortunately, however, we are back into a second series of nonessential business orders, which have impacted most of the country. While things seem to be worse than the spring from an infection standpoint, the good news is that things do seem to be somewhat better economically and with rent collections this time around. However, the tenant failures, which were primarily as a result from the first series of lockdowns, have had a profound impact on both our net operating income and the resulting valuations that are calculated from the cash flows on the enclosed mall portfolio. Due to the cumulative impact that COVID-19 has had on rent collection, value erosion, net operating income and with multiple lockdowns being enacted by provinces across the country from COVID-19, the Board of Trustees concluded that it was prudent to reduce the distribution by 50% from $0.04 to $0.02 per unit. This will allow the trust to either reinvest its cash flow or pay off debt, both of which would generate future funds from operation. This decision was not taken lightly. While our adjusted funds from operations distribution payout was 77% in 2020, the adjusted cash flow from operations payout, which incorporates working capital changes, was over 100%. Our expectation is that there will be further erosion of net operating income in 2021 due to failed tenants and the impact of COVID-19, along with increased vacancy. In addition, we are expecting elevated operating capital requirements in the future as we address these vacancies in addition to elevated development capital requirements, addressing past vacancies, such as our empty Sears premises at Cambridge and St. Laurent. The combination of a possible further erosion in net operating income in 2021 along with elevated capital requirements was a key factor in the distribution reduction. As part of this initiative, we are continuing to take action to mitigate the effects of the pandemic on our business operations while also focusing on impacts on our staff, tenants and other stakeholders. And looking specifically as to what has been going on with our 7 enclosed malls across Canada, 6 of these were impacted by nonessential business closures during the second quarter, resulting in periods where most tenants were not allowed to operate. The same 6 were subject to nonessential business closures to varying degrees once again as part of the second wave. Only the Pine Centre in Prince George has had no meaningful nonessential business closures or restricted. Two of our larger malls, which happen to be based in Ontario, St. Laurent and Cambridge, have both been subject to nonessential business orders for the last 2 months and have been extremely quiet from a traffic perspective. Now that the CECRA program is complete, there is a new supplementary program that is being offered by the federal government to help with rent relief. The new program will be available until at least June 2021. It will fund up to 65% of rent for businesses that have seen a revenue decline of at least 70%. Businesses that have had revenue fall by less than 70% also receive a gradually decreasing level of support in line with revenue. Businesses that are forced to temporarily shut down by mandatory orders will be able to qualify for funding that covers up to 90% of rent. This relief is paid directly to the tenant by the government, and then it is the responsibility of the tenant to use that money to help fund the rent burden. While this program has been beneficial to tenants that have been impacted by the pandemic, there are caps on this program for larger companies. Collections to date across all asset classes during the fourth quarter averaged approximately 92%. Our office collections have done quite well, averaging approximately 99% for the fourth quarter, while our strip centers were at 97%. Our office tenants include approximately 30% government tenants, which obviously have a solid covenant and our strip centers are largely grocery anchored. Our enclosed regional centers averaged approximately 82% for the quarter, which was approximately double the collections that we were seeing for the malls back in the spring but obviously still well below 100%. Collections for January and February have tapered off somewhat due to the lockdown spread across the country. One thing that we were monitoring is that there is -- that there can be a 2- to 3-month delay between the tenant applying for rent relief under the CERS program, receiving the payment from the government and remitting it off to the landlord. As a total, we collected approximately 90% of our rent in 2020. It is our belief that most of the weaker retail tenants from a year ago have already failed, which is why collections now are somewhat better than the spring. However, we are far from having this pandemic being over. Also, we believe that most businesses seem to be better prepared for the second series of lockdown orders as compared to the first series, which definitely caught most businesses by surprise. Both of these factors seem to have affected collection rates. We have now caught up with the processing of negotiated rent solutions from the spring 2020 rent arrears. Any negotiated abatements or forgiveness of past rents have been charged to bad debt expense. Bad debt expense also includes the landlord contribution to CECRA, failed tenants and an estimate of future uncollectible amounts or tenant failures. Whenever possible, term extensions or other negotiated rights are being exchanged for abatements. In some cases, rent is not being paid by tenants in order to create leverage as part of these discussions. The rent arrears at December 31, 2020, totaled $22 million, including sales taxes. The allowance for doubtful accounts assigned to these arrears totaled $8.8 million or approximately 45%, excluding the sales taxes on the arrears. Bad debt expense for 2020 totaled $15 million, which again includes all the abatements negotiated on the past rent arrears. Over the last 9 months, there have been a number of tenant failures. The trust has been able to keep occupancy for the majority of these locations. Out of a total of 64 locations where tenants have filed, the trust have been able to keep approximately 2/3 of these locations occupied under restructured or percentage rent deals. The closures represent a total of approximately 50,000 in GLA. Looking at traffic patterns, as you might expect, there is some regionality with our enclosed mall results. This is related to the amount of infections that have been identified in the area that the mall operates. For example, traffic at our enclosed mall in Prince George, which has had very few infections, is at approximately 90% normal traffic levels. Whereas traffic at our 2 enclosed malls in Ontario are more in the 50% to 70% levels before the recent nonessential business closures. Now turning to our results. For the 3 months ended December 31, 2020, the trust has recorded $86 million in fair value losses to the portfolio. Most of these adjustments came from our enclosed regional centers and our office assets in Alberta, both due to changes in cash flow assumptions. As a total for the year, our enclosed mall portfolio has seen an erosion of value of almost 30% from both cap rate adjustments and changes in cash flow assumptions. Overall, the fourth quarter of 2020 was a quarter with the results that were impacted by bad debt expense resulting from COVID-19 as well as the recurring year-over-year impact of the Obsidian rent relief negotiated back in the first quarter. This has produced declines in both NOI and FFO metrics on a year-over-year basis. Excluding bad debt expense, our fourth quarter results were somewhat better-than-expected due to elevated amounts of nonrecurring lease cancellation fees as well as some nonrecurring recoveries processed for prior year capital amortization and wage subsidy amounts. Combined Q4 2020 occupancy rates were down slightly at 92% as compared to 93.5% 1 year ago. And now for an update on our leasing efforts. In 2021, there is 965,000 in retail GLA coming up for renewal. Of this, there is 552,000 in GLA from the anchor tenants at lower weighted average rates, which are all expected to renew. Approximately 80% to 90% of the 965,000 has either been renewed or renewals are being worked on. We also expect renewals on the vast majority of the office GLA, which are coming up in 2021 as well. There's approximately 200,000 in GLA coming up for renewal in 2021 for 111 Dunsmuir, which were 2 different tenants. These renewals have been completed with an average rate in the range of $31 to $32 with future steps, up from a weighted average of approximately $25. Management has had continuing ongoing discussions with the provincial government tenant at Petroleum Plaza in Edmonton, which came up for renewal on December 31, 2020, and is now on overhold. While they have verbally told us that they expect to renew, they have been unfortunately focused on their response to the pandemic, which has taken priority. We expect to get this completed in the second quarter of 2021. Turning to financing and liquidity. The trust has $142 million in liquidity at the end of the fourth quarter, which has increased from $127 million at the end of the third quarter and from $52 million at the end of 2019. Helping to enhance liquidity position over the last quarter was the closing of approximately $92 million in upfinancings for the year, along with the sale of a vacant parcel of land for proceeds of $6.8 million. All of these upfinancings were completed for an average interest rate in the range of 2.9% to 3%, which contributed to the decline in net interest expense for the quarter. The trust curtailed discretionary operating capital expenditures for 2020 and also has curtailed it to a certain degree in 2021 in order to ensure that capital is preserved. Other work was postponed due to shortages or logistical challenges resulting from the pandemic. Actual operating and leasing capital expenditures for 2020 totaled $13.3 million against a reserve of $15.6 million and as compared to $22.8 million in 2019. As a result of COVID-19, it is expected that the PCME or operating capital expenditures for 2021 will still be less than the normal amount of $25 million but will be elevated from 2020. The trust has completed the first phase of the redevelopment of the former Sears premises at the Pine Centre Mall in Prince George, British Columbia. The new wing consists of approximately 76,000 square feet of redeveloped GLA and is anchored by a Winners/HomeSense that was completed this summer. Approximately 65% of the space is filled and other retailers that are now open include a BC Cannabis store. The finalization of some of the remnant space, which includes an additional retailer and some small-bay CRU, is expected to take until 2022. The development work on the center in Saskatoon has been continuing and is expected to be completed in the first quarter of 2021. The trust is also pleased to announce another project for Pine Centre, which entails the retenanting of the empty Lowe's premises into a new 38,850 square foot Save-On-Foods grocery store. This will result in the demolition of the existing former Lowe's promises and is estimated to cost in the range of $15 million. This work is expected to be completed in Q3 2022. We believe this will be an effective complement to the mall and will effectively make this mall grocery anchored. The negotiated lease cancellation settlement was negotiated with Lowe's as part of this arrangement and was collected in the first quarter. Wrapping up, while the economy and by extension, some of the REIT's assets are going through their challenges, we do remain positive about a number of aspects of our business. There are absolutely some short-term challenges with our enclosed malls, but most of them remain dominant in their geographical area. And our strip malls, which are largely grocery anchored, have shown resilience in collections. Beyond our retail assets, we have high-quality office buildings in Canada's largest markets with a high degree of government office tenants. We continue to be positive about our business and the objective of building value for our unitholders. We look forward to continuing to execute our strategy, and thank you for your continued support. We will now open the floor to questions.

[Operator Instructions] The first question comes from Jonathan Kelcher with TD Securities.

First question, just, I guess, on the distribution cut. How did you guys settle on the amount?

Well, there are a number of things. This is Rai Sahi. It's not just one thing. There's a number of things, as you know, that we need to retenant a bunch of retail, and we need the cash. And that's probably the main one. And beyond that, you know we have a -- also getting ready to deal with the convertible debenture coming later part of the year. So we need to try to conserve as much cash we can.

Okay. So if that -- if the cut is going to save roughly $15 million in cash per year on an annualized basis, do you think the majority of that goes into -- to retail CapEx?

Retail what?

Retail capital expenditures.

I think it would go into a combination of CapEx and paying down debt or at least added liquidity, Jonathan. So it would be a combination.

Okay. Secondly, just in terms of -- it sounds like you got some lease termination income in Q4 and have some more in Q1 with Lowe's. How much was that in Q4? And how much of that is expected -- or will that be in Q1?

So I can give you a range of that rather than giving a precise number. It's in the $2 million to $2.5 million range, Jonathan.

For which? For Q4 or which one?

Just for the Lowe's one.

Okay. And how about in Q4?

Sorry, what was your other question about?

I think you said in your prepared remarks there that there was some lease termination income in Q4. The results were a little better than you had expected?

Right. So that didn't really come from any one particular tenant. It came across our portfolio of retail and office tenants. We are having conversations with tenants about sublease space and continuing on. And some of those conversations resulted in lease cancellations arrangements and fees. So not any one particular tenant, just more variety.

Okay. And then lastly for me, just on the bad debts. When do you expect that to start to trend lower? The million-dollar question, right?

This is predicting some of the future. We are hoping they will get better. But at this stage, I have a kind of my view in the -- we have, as I said earlier, we have a bunch of vaccines here. We probably have probably another one tough year. And a lot of that coming from retail, and some of that is from office as well. So it's tough to predict anything at this stage.

We have the following question from Jenny Ma with BMO Capital Markets.

Andrew, I just want to clarify the lease termination question that Jonathan asked. So the $2 million to $2.5 million from Lowe, just to be clear, that's going to be recognized entirely in Q1? Or was there some that was already picked up in Q4?

No. That will be a Q1 item.

Okay. And just squarely in Q1 without going into Q2?

Correct.

Okay. Great. With respect to the revenue in Q4, you had mentioned that there was some pickup in nonrecurring recoveries, and we can see that in the P&L. It looks like it was several million dollars. How much of that was the nonrecurring recovery? So in other words, how much is not going to recur in Q1?

I would say it's pretty well -- all of it. So it was really just a situation where there was some year-end adjustments processed. And yes, I would consider that all to be nonrecurring.

Okay. And also, along the same lines, how much of the revenue bump in Q4 was due to seasonal increases, knowing that this year's holiday season is quite a bit different than years past?

As compared to previous quarters, you mean? Or...

How much of it was the contribution to Q4 that we won't expect to see again in Q1?

It's a bit of a tough one at this point, Jenny. I think our Q4 is typically a little bit better because we do have some holiday numbers included in that. So that trending of quarters compared to what they would typically be on a year-over-year basis, I think we would -- we could typically expect that.

Sorry, that would be similar to year-over-year? Or that -- there was a pretty big impact this year versus last Q4?

No. I think the trending that you -- so if you're trying to look at Q1 of 2021, we'll have one more quarter of less revenue because of the Obsidian rent relief that we processed at the beginning of 2020. And then you're just naturally going to see a decrease due to failed tenants in COVID-19. I'd probably prefer not to just put a box around it.

Okay. That's fair. Moving to the government lease at the Petroleum place that you mentioned. So if they've gone into overhold, does that mean that they're paying the old rent for the time being?

Correct. Right.

Okay. So you expect this to settle out? So there'll probably be a rent roll-down expected when this settles out sometime in Q2, you said?

Yes. So -- but what that typically means is that we would probably have to give that money back, assuming that the new lease rate is less than the old lease rate, right?