Nexus Industrial REIT (NXRUN) Earnings Call Transcript & Summary

Thank you for standing by. This is the conference operator. Welcome to the Nexus Industrial REIT Second Quarter 2022 Results Conference Call. [Operator Instructions] And the conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Mr. Kelly Hanczyk, Chief Executive Officer. Please go ahead.

Thank you. I'd like to welcome everyone to the 2022 Second Quarter Results Conference Call for Nexus Industrial REIT. Joining me today is Robert Chiasson, the Chief Financial Officer of the REIT. Before we begin, I'd like to caution with regard to forward-looking statements and non-GAAP measures. Certain statements made during this conference call may constitute forward-looking statements, which reflect the REIT's current expectations and projections about future results. Also during this call, we will be discussing non-GAAP measures. Please refer to our MD&A and the REIT's other securities filings, which can be found at sedar.com for cautions regarding forward-looking information and for information about non-GAAP measures. It was another solid quarter in the books. As mentioned in the previous quarter, we look forward to the balance of 2022 and 2023, where we will begin to see significant rental rate growth in the portfolio, especially in our Southwestern Ontario portfolio. In the second quarter, we closed on an 80% interest in development land with RFA Capital Partners in Hamilton, Ontario, where we plan to build a 250,000 square foot industrial building with completion in late 2024. This is our second parcel of land in Hamilton with RFA for future development. And subsequent to the quarter, we have closed on a third development parcel. In Southwestern Ontario, our London portfolio was not only primed for significant rental rate growth but also has the ability to add additional square footage to our existing facilities. We have submitted for permit for the construction of 100,000 square foot addition to our building at 1285 Hubrey Road, which we hope to break ground early next year. In addition, we currently are negotiating with existing tenants in the portfolio for another approximately 100,000 to 125,000 square feet of expansion to their existing premises. And the REIT has 22 acres of excess land in the Titan industrial site in Regina, Saskatchewan, that was acquired in February 2022, and we have completed the design build package and they're actively marketing to build approximately 300,000 square feet build [indiscernible]. We also have the option to transact on 10 additional acres of additional land at the Acropolis warehouse facility located on the Edmonton airport grounds. As mentioned last quarter, we are under contract with 3 additional properties, a brand-new strong covenant distribution center in Ottawa to be completed in January 2023. And one in London, which is a unique deal, which is in the process of having a 150,000 square foot new addition being built and expected to be completed mid-2023. This is an extremely valuable site as there is significant additional land to continue to expand the facility as the trend continues to grow. And then thirdly, an approximately 85,000 square foot cross-dock facility to be built in Balzac, Alberta, with one of the REIT's existing tenants, which is expected to be completed in late 2023. Subsequent to the quarter end, we closed on a 94,000 square foot strong tenanted A-class industrial facility in Quebec City, where we assume debt at the rate of 3.63%. We have also laid conditions on a 75,000 square foot industrial facility in Montreal where we will see annual rental rate increases of approximately 3.5%. We're also in due diligence on a 4-building approximately 450,000 square foot industrial portfolio in Southwestern Ontario for approximately $37 million, which is at a very attractive cap rate and a price per square foot that we believe will provide considerable value to the REIT. As you can see, we have an active pipeline of deal flow, but we will slow this process after these transactions and focus on developing the aforementioned sites and higher returns within our existing portfolio. In Richmond, BC, we continue with the redevelopment of approximately 60,000 square foot building for 2 tenants. It is now expected that completion and possession to occur in mid-September as the final setup of their space is nearing. This will be a world-class facility upon completion. We're also planning a 74,000 square foot edition, which would provide significant lift to the REIT's NAV. We're also applying for bonus density, which if approved, would allow for approximately 450,000 square foot of additional usable square feet to be built in the future, providing additional value to the site. In Montreal, we continue to work with our developer on the sale of the excess land at Les Halles d'Anjou. The developer is still moving along with approvals from the city. It is expected now that our first payment from them will be in February 2023. On the disposition front, we have sold a retail property located in Châteauguay, Quebec for $8.3 million. and the purchaser has waived conditions on a mixed-use property in Longueuil, Quebec. Post-sale and post-closing of our industrial acquisitions, the REIT holdings will increase to approximately 87% of NOI derived from the industrial sector. Our 3-building office portfolio will be relaunched in the fall when it is anticipated that interest rates stabilize and the acquisition market begins to open up. In addition, our retail mall in Victoriaville, Quebec, will be launched for sale in the fall now that we have completed a lease extension and expansion with our largest tenant. We've also -- we also continued to negotiate a deal with a nonsolicited offer for a portfolio of noncore assets that would allow us to recycle this capital in the future. I will now hand it over to Rob Chiasson to give greater detail of the REIT's financials.

Thanks, Kelly. As Kelly mentioned, we put some more of our capital work on July 11 when we acquired a $19 million property in Quebec and we have a firm deal on another $18 million acquisition and another $37 million deal under diligence. The acquisitions completed in Q1 contributed to the REIT's results for a full quarter in Q2 and we saw our AFFO payout ratio come down from 96.7% in Q1 to 90.3% in Q2. Absent the impact of the $460,000 unrealized foreign exchange loss in the quarter, the payout ratio would have been 87.4%. The unrealized FX loss negatively impacted per unit measures by $0.06. We have approximately $150 million of recently acquired properties that are unlevered, and will begin to borrow against these properties in the third quarter to close the properties we have under contract. As anticipated, acquisitions completed mid-Q1 generated an additional $1.5 million of NOI in Q2 as compared to Q1, partially offset by higher associated interest expense. Our Q2 G&A was approximately $500,000 lower than Q1, primarily due to the timing of RSU expenses driven by vesting. Q3 will see the positive impact of rental rate growth reported in our Q2 MD&A as well as leasing deals concluded subsequent to quarter end. All of this contributed to an increase in normalized FFO per unit from $0.19 for Q1 to $0.20 for Q2, $0.21 excluding the unrealized foreign exchange loss in the quarter. AFFO per unit increased from $0.165 for Q1 to $0.177 for Q2 and it would have been $0.183, excluding the unrealized foreign exchange loss in the quarter. For the remainder of 2022, we have approximately $20 million of mortgages at a weighted average interest rate of 3.55% that will mature. In 2023, we'll have approximately $50 million of mortgages with a weighted average interest rate of 4.26% that will mature. Bond yields have come back recently, almost 100 basis points off the recent highs. I'll now turn the call back to Kelly.

All right. Thanks, Rob. We will open up the line to any questions that you may have.

[Operator Instructions] Our first question comes from Brad Sturges of Raymond James.

I appreciate the additional disclosures on the leasing front there. Just on the -- I think, 91,000 square feet, you're kind of in advanced negotiations on -- in terms of renewals. Can you give us a sense of what you're expecting from a rent spread perspective?

Yes. I think -- let me just look here. Trying to just see what's included in that. We have [indiscernible]. I'd say, overall, on there, you're probably around 100% spread. I'm trying to figure what the 191,000...

The 191 that's mainly in London. Is that correct?

Yes. The majority of it. When I look at the balance. So in April of next year, we have 35,000 square feet where we'll probably see approximately $8 a foot -- $7 and $8 a foot lift on that. We have another one in -- come to end of January of next year, about 115,000 square feet where we'll probably see about $4.50 a foot on that. And then we had 44,000 square feet come up in -- start with July of this year where we saw, I think, it's $2 and a change on that 44,000 and then another one that comes up and starts in November, where we see about $1.20 lift on that.

Okay. And then just more from a modeling perspective, but how should we think about the nonindustrial expiries coming up? Or would it be kind of more stable rents on renewal? Or how should we think about the spread there?

Yes. So when I'm looking at the next 12 months on the retail portfolio from a larger scale here, we're probably faring fairly well, to be honest. So it will be kind of, I'd say, slight growth, not extreme, maybe 1% or 2% on the retail portfolio. And when I go down to look at the office side of things, I think that would be probably stable or -- yes, right around stable. No real growth there.

Okay. Just turning to the asset sale side, obviously, turning to complete some transaction there. How is pricing still trending relative to your book value and where your expectations were maybe at sort of the process of valuations so far held into your expectation?

Yes. So with the 2 that we did sell, I would say just slightly below book value. We pulled the 3-building portfolio because we're marketing it, interest rates were driving up significantly, which put everybody seemed to have a pen down. So we've pulled it and we're holding it as a fall because I think now that interest rates have stabilized, they'll generate a greater amount of interest. So that's what we kind of have planned for Victoriaville in the 3 office assets. It's hard to tell right now the institutional side buyers and that have gotten pens down for a while just until interest rates stabilize. So I think hopefully, September, October, November, that will turn around once things are clear in the market.

You're working through the process on the Western Canadian industrial potential bit there. I mean, where are you in that process? Is there any -- can you give any thoughts in terms of a potential transaction at this point?

It's a little bit early, but what I can say we've been back and forth a few times, and we put our final kind of terms to paper and they're in the process to see if that works for them and their financing. I'm cautiously optimistic that we'll have a deal, but you never know.

Our next question comes from Kyle Stanley of Desjardins.

Would you be able to just talk about the contractual escalators you're getting on new leases across the portfolio? And just generally, maybe where you see the average escalation currently?

Yes. So we have our CPI increases out left and when I look at what we've done and what we're doing in Southwestern Ontario right now, I'd say there's significant contractual. For example, we did do one, I believe, at 7.50 that then goes to 8 -- 8.25, 9, 9.75, something along those lines. So they are in Southwestern Ontario, they're kind of averaging, I'd say, 7% to 10% on the renewals that we've recently done.

Okay. Perfect. Maybe just switching over to your view of the acquisition market currently. I mean it sounds like, obviously, you've got a portfolio under diligence. Are you seeing the same volume of off-market deals that you have in the past? And then how are you thinking about capital allocation here? You did mention maybe a slowing down a little bit once maybe you can finalize this portfolio in Southwestern Ontario and moving over to development, but maybe just a bit more information there on that portfolio in Southwest Ontario back from your existing vendor? Or is this a new relationship?

Yes. So let me say we had Quebec City one under contract before. So we closed on it. It's a solid asset, great addition to the portfolio. The one that we have waived due diligence on sale leaseback, nice property again in Montreal area with 3.5% negotiated rental rate increases. So I think for same store, it's good on the rental rate increases. And then the Southwestern Ontario kind of fell in our lap, and the cap rate is just extremely attractive and so nicely accretive for us. It's well on a price per square foot. It's very cheap. And from an in-place rental rate standpoint, it's well below market. So we looked at that transaction and nicely accretive for us. So we're going to move forward with it if it due diligence all pans out, which we're in the process of doing right now. But after that, we've kind of gone pen down. And that may change when we see how the Western Canada portfolio goes on the sale process because then we will have some cash again, but we're being more selective. But you can see we have a number of development opportunities. So we will need cash to complete those. So and those are higher returning for us. So we're trying to focus a little bit right now on that development side and turning through what we have in, I'd say, be very opportunistic on the acquisition side if we see a deal like the one in Southwest Ontario, which I forgot to answer, is a separate vendor than our London vendor. If we see that kind of deal come forward, we'll act on them. But this one is just -- the pricing was exceptional, and we jumped on it.

Okay. And just two kind of quick housekeeping modeling questions. The vendor rent obligation added to FFO was up maybe about 150,000 sequential. I'm just wondering how we should interpret that, that your expectation of kind of the NOI once that becomes fully operational?

Yes. So I think we added August and July. And so we amortized in the amounts that are current and we accrued 2 months up till December 1, I believe. I think that there's roughly about $200,000 a month of vendor rent obligation that will come back to NOI once that Phase 1 is fully tenanted and the tenants are paying rent. There's adjustment happening. There is the adjustment for future, like the adjustments going through other income for future NOI and then there's the stuff that we would have accrued last quarter that we're adjusting in our normalized AFFO for.

Okay. No, that makes sense. And just the last one is provide a little more detail on the FX loss and maybe why it's just not added back to your FFO?

Well, we follow the Realpac white paper, and it doesn't seem to allow for a FFO add-back. It allows for an add-back where you have foreign investments that are being translated back, but doesn't allow for any other add-backs. So we've got about a USD 10 million liability that sits on our balance sheet relating to an acquisition that we completed in 2021. And so when we fair value that to the FX rate at the end of the quarter, it generated the $500,000 FX loss.

Our next question comes from Gaurav Mathur of iA Capital Markets.

A couple of quick questions at my end. So we've seen this period of price discovery happen across most industrial markets in Canada, even though there has still been a record high demand for assets. So just in your opinion, do you think we're closer to finding a tentative flow price in some of these markets? Or are we still some way -- or are there still some ways to go, given that underwriting remains extremely strong and rents continue to grow.

Yes. It's interesting time right now, right, because of interest rates and where they're going to settle. So it looked like, I don't know, a month ago or 3 weeks ago, the 5-year was so expensive that we thought there'd be some cap rate decompression, but now it's going the other way. And it's an interesting time just to see where demand is going from an acquisition side. So a lot of guys have gone pens down. So the number of buyers there right now are fewer, but I expect that to ramp up in the fall. And then from a rental rate standpoint, I think there's still significant room to grow. You're seeing it in GTA. You're seeing it in Southwestern Ontario. I think in London, they quoted new rental rate of $11 and change. So I think that's slightly optimistic just because it was based on relatively few transactions. The rental rates are pushing and they're continuing to push. So I think we still have -- I think we have still quite a bit of steam in the rental rate growth in last end in Ontario and Quebec. And I think we will see pretty strong activity in the fall. That's what I'm predicting.

Okay, fantastic. And just staying on the rental rate theme here. How are you thinking about leasing velocity going into 2023 with the upcoming lease renewals? I mean is that something that's proving to still be a bit of a pen-down situation among possible tenants or tenants pushing forward and looking for space in the noncore markets.

No, for sure. We're in discussions on expanding existing tenants in our portfolio. And we're lucky to have quite a bit of land that we can build on. So some of our largest tenants that really aren't going anywhere are looking to expand their space. So -- and I'm talking about a tenant that's been at $4 and change and that rental rate is going to be significant. And if we can build, it's going to be a nice return for us there. So we're seeing rental rate growth across the board. So I think overall -- and even in Edmonton and Calgary, you're seeing movement, you're seeing strong demand. So I think overall, the fundamentals in the industrial sector are still strong. They'll see them strong in 2023.

I think we're seeing early renewal discussions more often than tenants putting off renewals.

Okay. Great. And just lastly on this. How are you thinking about leasing costs going forward because I understand that [indiscernible] demand is there, but is there anything on the leasing cost, which may surprise on the upside?

It depends. I mean when we're talking about some of the ones that we have here, other than a possible broker commission, there's no significant leasing costs here, which is in the Southwestern one, which is Southwestern Ontario, which is the majority of our expiry. So the demand is such that it's a landlord market, not a tenant market. So that bodes well.

Our next question comes from Jimmy Shan of RBC Capital Markets.

New lease expiry schedule here is -- in 2024 in Alberta, there's about 245,000 feet coming due and it's at $19 rent. I just wondered if you could talk a little bit about that. I'm not exactly sure, but that release, it just kind of stands out on the schedule.

Yes. So I believe that's MasTec, one of our tenants in Blackfalds, Alberta. So I think, currently, they're subletting and there's a fair amount of land attached to that, which is why the rental rate is higher.

Yes. And to be honest, at this point right now, those markets are improving, but I think we'd be a little bit high on a rental rate renewal, but it's a little bit too soon to tell.

Okay. And the majority of that 240,000 square feet are those guys?

I think the other one in there is Canada Cartage towards the end of 2024. I honestly don't have 2024 [indiscernible], but I guess, certainly get back to you with more details off the call.