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

Good afternoon, ladies and gentlemen, and welcome to the Morguard Real Estate Investment Trust Third Quarter Conference Call. [Operator Instructions] This call is being recorded on Thursday, October 27, 2022. I would now like to turn the conference over to Andrew Tamlin, Chief Financial Officer. Please go ahead.

Thank you, and good afternoon, everyone. My name is Andrew Tamlin, Chief Financial Officer of Morguard REIT. Welcome to the Morguard REIT Third Quarter 2022 Earnings Conference Call. I'm joined this afternoon by John Ginis, Assistant Vice President of Retail Asset Management; Tom Johnston, Senior Vice President of Western Asset Management; Tullio Capulli, Senior 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 would like to point out that our comments will mostly refer to the third quarter of 2022 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 and which would also apply to any comments that we make on this call. Overall, we are again pleased with the third quarter results, which showed continued improvements in same asset metrics on a year-over-year basis. Net operating income for the quarter increased slightly to $30.4 million in 2022 due to continued improvements in our enclosed mall portfolio results. FFO for the quarter also increased slightly to $16.6 million in 2022 as compared to a year ago. Same-asset net operating income for the third quarter improved 1% from a year ago, buoyed by a 4% increase in same-asset results for our enclosed mall portfolio. This represents the sixth quarter in a row where we've achieved improved same-asset results on a year-over-year basis. Year-to-date, our same-asset net operating income is up 2%, which is supported by a 10% increase in the malls. Interest expense is relatively flat on a year-over-year basis at $13.3 million. The impact of lower debt of approximately $30 million on a year-over-year basis has been offset by higher short-term borrowing rates due to the higher interest rate environment that we find ourselves in. Year-to-date, our interest expenses declined $0.5 million due to the lower debt levels. As mentioned, our enclosed mall results continue to rebound. This rebound started with our malls located in Western Canada, which have seen increases in traffic and sales. These have translated into increases in percentage rent and specialty leasing opportunities. We are also pleased to add opportunities of discriminating tenants such as lululemon and Sephora at some of our Western Canada locations, with possibly more to come. These additions are solid endorsements to both our tenant and customer base. We have noted that while traffic in general at our malls compared to 2019 is down, sales for the most part have either bounced back or exceeded the pre-COVID levels. This speaks to the trend of folks going to the mall to doing purposeful shopping. Sales and traffic for our Ontario malls has continued to improve as well. These were the malls that were hardest hit from a results perspective due to the numerous lockdowns that Ontario imposed under COVID. Rent arrears and deferrals continue to decline since December 31, 2021, although there is still further work to do. Receivable balance for tenants has decreased from $9.2 million at December 31 to $5.8 million at the end of the third quarter. While the uncollected overdue amounts have been allowed for, there is still cleanup needed to document abatements, which have been granted. The vast majority of these amounts outstanding are from Ontario malls and stem from pre-2022 arrears. During the quarter, we had a $73 million fair value loss on our real estate properties as we were required to adjust these assets to fair market value under IFRS. This represented primarily a 25 basis point expansion of cap rates for enclosed mall retail and non-Vancouver office. Combined with earlier 2022 adjustments, we've recorded a $36 million fair value loss on a year-to-date basis. The REIT's PCME or operating and leasing capital reserve was established to be $25 million for the year, which is back to normal levels. We spent approximately $13 million of the $18.5 million 9-month allocation, but we do expect to be more active on the spending in the last quarter of the year, which is typical for us and into next year as we catch up on delayed capital projects and look at higher leasing volumes. Our overall occupancy levels of 91% at September 30 remained slightly higher than both year-end and a year ago. Our current occupancy level for all asset classes of 91% has only changed slightly from the start of the pandemic, which was 93%. This speaks to the fact that in most cases, we've been able to keep tenancy at our quality assets. And now for an update on our leasing efforts. For the rest of 2022, there's approximately 200,000 square foot in retail GLA coming due. While we expect the vast majority of this space to renew, more than half of this represents large tenant -- large national tenants, which have already agreed to renewals. Leasing discussions for retail opportunities have definitely picked up since the start of the year as both current and prospective tenants now have a better handle on what to expect going forward. This has led to numerous conversations about various opportunities at our properties across the country. Office leasing discussions on the other hand, while gaining some momentum, are still somewhat muted as tenants are still trying to figure out their office needs -- what their office needs will be like in the long term in a post-COVID world. Management has had continued ongoing discussions with the provincial government tenant at Petroleum Plaza at Edmonton, which came up for renewal back on December 31, 2020, and is now on overhold. While they have verbally told us that they expect to renew, they've unfortunately still been focused on the response to the pandemic, which has taken priority. At this point, we are looking at 2023 in order to get this completed. Our experience is similar to other landlords who have the provincial government as tenants. Turning to financing and liquidity. The Trust is $168 million in liquidity at the end of the third quarter and $326 million in unencumbered assets. This liquidity position has increased from $163 million a year ago. Looking specifically at fourth quarter mortgage renewals, we are concluding on the refinancing discussions of a mortgage attached to an asset in Calgary in the amount of $149 million. As part of the refinancing of this mortgage, we are looking at a $35 million pay down funded by our lines of credits. The Trust is continuing with the Save-On-Foods development job at Pine Centre, which entails the re-tenanting of the empty Lowe's premises into a new 38,850-square-foot Save-on-Foods grocery store. Demolition of the existing former Lowe's premises is now complete, and we are busy with construction efforts. This is expected to be completed early next year and turned over to the tenant. The addition of grocery further complements the strong anchor tenant profile at this mall and is advanced leasing discussions with some discriminatory tenants looking to come into this marketplace. The Trust has also reached an agreement with Teamtown to convert the empty Home Outfitters space at Heritage Town Center in Calgary into a 34,000-square-foot retail store. This project will cost approximately $3 million from a landlord perspective and will be completed in early 2023. Wrapping up, we are pleased that the resiliency of our assets and the improved results and activity levels from our closed model and retail segment. While there is still room to grow to get back to pre-COVID levels, what we have seen in the last year has been positive. We are looking forward to continued positive leasing conversations for our assets. We saw our enclosed malls remain dominant in their geographical areas, and our strip malls, which are largely grocery-anchored, have performed well in pandemic. Beyond our retail assets, we have high-quality office buildings in Canada's largest markets with a high degree of government to 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. Is the operator there?

[Operator Instructions] Your first question comes from Jonathan Kelcher.

The first question, just -- that was good color on the Calgary mortgage maturity. That $35 million, do you plan just to keep that floating? Or are there any plans to use some of your unencumbered assets to sort of fix that over time?

For right now, we'll just keep that floating as a payment against our line. So yes, no real plans beyond that, although we are looking at other opportunities into 2023.

Okay. And what property was that again?

It's Penn West Plaza in Calgary.

Penn West. And then just for, I guess, the same question as we look to 2023 maturities, I think you're -- in the MD&A says the leverage is about 60%. Do you think you'll have any -- do you think you'll have to do any pay downs on '23 maturities?

It's a little too early to say on that, Jonathan. I mean it is tight, as you noticed. Having said that, we do have pretty strong unencumbered asset pool to dip into and pretty good availability on our lines of credit as well. So I think we'll be fine, but we will be looking closer at that as we move into next year.

Okay. And then just lastly for me. I guess you said office leasing was a little bit more muted. Are you -- can you maybe give a little bit more color on that and where you expect that to go? Is that -- do you think it's more muted due to people thinking about hybrid work? Or do you think it's more muted for recessionary fears or some [ combination ] I guess?

Yes. I mean it's probably a combination of both. Maybe Tullio or Tom, one of you would be prepared to add a bit of color on the office asset class these days.