Pro Real Estate Investment Trust (PRVUN) Earnings Call Transcript & Summary

Good morning, and welcome to the PROREIT 2022 First Quarter Results Conference Call. [Operator Instructions] For your convenience, the press release, along with the first quarter financial statements and management's discussion and analysis are available at proreit.com in the Investors section and on SEDAR. Before we start, I have been asked by PROREIT to read the following message regarding forward-looking statements and non-IFRS measures. PROREIT's remarks today may contain forward-looking statements about its current and future plans, expectations, intentions, results, levels of activity, performance, goals or achievements or other future events or developments. Forward-looking statements are based on information currently available to management and on estimates and assumptions made based on factors that management believes are appropriate and reasonable in the circumstances. However, there can be no assurance that such estimates and assumptions will prove to be correct. Many factors could cause actual results, levels of activity, performance, achievements, future events or developments to differ materially from those expressed or implied by the forward-looking statements. As a result, PROREIT cannot guarantee that any forward-looking statement will materialize, and you are cautioned not to place undue reliance on these forward-looking statements. For additional information on the assumptions and risks, please consult the cautionary statement regarding forward-looking statements contained in PROREIT's MD&A dated May 11, 2022, available at www.sedar.com. Forward-looking statements represent management's expectations as at May 11, 2022. And except as may be required by law, PROREIT has no intention and undertakes no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. The discussion today will include non-IFRS financial measures. These non-IFRS measures should be considered in addition to and not as a substitute for or in isolation from the REIT's IFRS results. For a description of these non-IFRS financial measures, please see the 2022 first quarter earnings release and MD&A. A reconciliation of non-IFRS to IFRS results, as applicable, may be found in the earnings release and MD&A, for the 2022 first quarter. Please refer to the non-IFRS measures section in the MD&A for the first quarter for additional information. I will now turn the call over to Mr. James Beckerleg, President and Chief Executive Officer. Please go ahead.

Thank you very much, operator, and good morning and welcome everyone to our first quarter analyst call. Joining me today on the call is Gordon Lawlor, our Executive Vice President and Chief Financial Officer. And also on the call joining us is Alison Schafer, our Senior Vice President of Finance; and Mark O'Brien, our Senior Vice President of Leasing, Operations and Sustainability. Let me just begin this morning, and my brief remarks, by highlighting a significant milestone that was achieved in the first quarter of 2022. At March 31, we reported over $1 billion in assets for the first time in our history. It's something that we, as the management team, are truly proud of, and we believe it reflects a disciplined execution of our strategy, made possible by the strength and commitment of the entire PROREIT management team. Our decision to fully focus on growth in the industrial segment of our portfolio is bearing fruit and yielding attractive rewards, which we'll see in our financial statements. Our properties in the industrial sector now account for over 63% of our base rent and 79% of our gross leasable area. You will see that our industrial same-property net operating income was up a very robust 5.4% for the quarter when compared to the same period last year. We're also pleased with our retail portfolio, which performed well during the quarter, recording a 4%, same-property net operating income increase. This reflects, we believe, both the high quality of our assets and their tenants performing well in mid-market Canadian cities with strong economies, where our investments are focused. During the quarter, our office segment, which now represents less than 10% of our base rent, was negatively impacted by a short term vacancy, on 29,000 square feet in a single tenant building. However, all should note, and I'm pleased to advise that this space has been fully re-leased as of April 1, 2022, to a new tenant on a 15-year term and at a higher base rent than the matured lease that was in place up until December 30. Excluding this single vacancy, which accounts for approximately $200,000 of lost net operating in the quarter, our retained property net operating income growth for all segments was 2.7% higher in the first quarter of 2022 when compared to the same period a year earlier. Rental rates continue to be the key driver in all of our geographic markets. Mark-to-market net rent spread at the end of the first quarter was 21% for our total portfolio and 30% for our industrial segment specifically. So we see a lot of upside across those sectors. The cyclical review of our portfolio by independent appraisers continued with 5 of our industrial properties completed this quarter. This exercise resulted in a net fair value gain of just over $40 million by the end of the quarter, raising our IFRS NAV to just under $8, $7.94 at quarter end. The occupancy rate of our portfolio remains strong at 98.5% at March 31. And very importantly, we have already renewed or replaced fully 68% of the 853,000 square feet of lease maturing in 2022 and achieving an average increase of just under 12% over the maturing rental. Gordy will now take over and give some reports on our actual financial result for this period.

Thank you, Jim. Good morning, everyone. We recorded solid financial results in the first quarter. Property revenue grew $24.3 million, a 39.9% increase compared to the same period in 2021. This growth was mainly driven by net acquisition activity in the last 12 months. Net operating income reach $14.1 million, up 39.5% year-over-year. AFFO totaled $7.8 million for the first quarter of 2022, a 44.1% increase compared to the same prior period. Both increases resulted from net acquisition activity, in the last 12 months. We successfully reduced our basic AFFO pay ratio to 87%, for the first quarter of 2022 compared to 91.5% for the fourth quarter of 2021. Excluding the impact of temporary office vacancy Jim mentioned, payout ratio was approximately 85% in Q1, 2022. I'm also pleased to report that our balance sheet has continued to strengthen. Total debt amounted to $529.9 million at the end of the quarter and debt to gross book value amounted to 51.2%, down from 57.5% a year earlier. Our debt to gross book value ratio was positively impacted by net fair value gains on investment properties of $40.3 million recorded in the quarter, reflecting both cap rate compression and increased cash flow projections on the properties in question. Last call, we discussed our target to bring our debt to gross book value ratio below 50%. We're pleased to confirm that we expect to reach this target before year-end. Our liquidity position also remains healthy with $38 million available under our credit facility at quarter end. Our weighted average interest rate on mortgage debt was 3.4% at the end of the quarter compared to 3.66% at the same date last year. Distributions of $0.0375 cents per unit were declared monthly throughout the first quarter of 2022. Finally, our weighted average cap rate for the portfolio was approximately 5.7% at the end of the quarter or $154 per square foot, down from 6.5% at the end of the first quarter of 2021. I'll now turn the call back to Jim for closing remarks.

Thanks, Gordy. So to conclude, although we are operating in a challenging environment, in many regards, actual economic activity in Canada has been robust since the beginning of the year. And looking ahead, our growth outlook remains positive as we see demand in the industrial sector, especially, remaining historically high. We along with everybody else, of course, are faced with a rising interest rate environment, but we do believe that we are appropriately positioned and have the time to adjust to this changing environment. We have no significant mortgage debt coming due in 2022. And strategically, we have always maintained a diversity of debt maturities that are appropriate for the overall debt and weighted average least term of our portfolio. And this means, we took steps to extend our debt maturity profile in 2021, [ addressing ] any immediate shot from the rising rates. We also benefit from a low-risk tenant base that we expect to withstand the impact of the current inflation and any [ kind of ] recessions ahead. Our tenant roster certainly demonstrated its resilience to the pressure of the pandemic over the last 2 years. The entire team at PROREIT is focused on the future, and we remain fully committed to pursuing strategies that are accretive to the REIT and to the benefit of all of our stakeholders. So that wraps up our formal remarks this morning. And I'll turn the call back over to the operator to take any sessions from participating analysts. Thank you.

[Operator Instructions] Your first question comes from Mark Rothschild, Canaccord.

So obviously there was some softness in the quarter in the office portfolio, though that space has been re-leased. As you progressed on this strategy of growing in industrial, I know in the past, you've stated that you're very happy with the performance of the other asset classes. And for the most part, they continue to do well, if not very well. Have you changed your thoughts at all about that, whether it's because of volatility in other asset classes or with continued strength in industrial?

Well, Mark, I don't think we have changed our outlook in the last 6 weeks. I mean, this specific suburban office is a good news story for us. I mean, we had known for some period of time that the tenant, which was a full building tenant, part of the Canada Post, was leaving. And it was -- our leasing group team successfully [ helped ] set it up, and we knew this was happening some period of months ago. And the rest of our office portfolio is substantially -- save for one building, substantially in Suburban Ottawa and continues to perform pretty well. So I guess we have a handful of retail properties in the market right now, and we'll see how the bids work for them. But we're not -- we would like to see some further transactions in any of those sectors outside of the industrial before we took any strategic decision. So we're comfortable with their performance. Retail is up like 4% year-over-year. And so I don't think -- we're glad just to see industrial slowly dominate in the portfolio. A long answer, but...

No, no, that's helpful. But with the lease -- when that office portfolio being done, would you consider maybe selling that asset now as probably the value is easier to recognize? Or you just want to own that asset because it is a good property?

Well, that specific asset, I guess we would always entertain bids on it, but it's now subject to a 15-year lease from a solid tenant. And so, certainly if there's pressure in the markets, we wouldn't be in any rush to sell. But, yes, as we said before, I mean, if specific instances of opportunity for selling some assets in these other sectors outside of industrial, comes along, we may take advantage of it. But it's not something we're totally focused on. This is not stable income as far as we can see into the future. And there's steps in rent.

I understand. Okay. That's helpful. And maybe just one more question on the pipeline for acquisitions and what you're seeing in deal flow and as far as any changing in pricing over the last little while. It's been a little quiet late. Just curious what you're seeing.

I guess I would answer, a little bit, yes. I mean there are good opportunities -- some good opportunities in the market, but we've seen deal flow slow. I don't think we've seen any specific pressure on cap rates as yet. I mean our independent appraisals, which are market transaction supported, certainly aren't showing any of that. But I think the markets in -- I mean all markets are in just a little bit of a pause, trying to assess what's happening and see a little bit of stability before we're transacting. We're looking at some different opportunities right now that should still provide accretion to the REIT.

[Operator Instructions] Your next question comes from Lorne Kalmar, TD securities.

Maybe just following up on Mark's question. Does the change in the debt financing environment impact your acquisition strategy at all or your outlook for acquisitions at all?

It's Gordy here. I mean, no, not really. I mean we play in a bit of a different market than the 3 cap GTAs and GMAs and all of those types of things. So, obviously there's pressure on just the bond rate now and spread, so we're seeing that. But again, when we look at it that way, we still -- the way we look at things, we like to put fixed rate debt on things. We don't like to leave things open. And a floating rate environment is not probably the way to be in the next 1.5 year. So, all of those things have to work for us. And as you know, when we underwrite acquisitions, I mean, we underwrite them and leave room in our debt numbers so that we can execute and close. So nothing has changed from that standpoint. We're just watching the market and seeing what's going on. And every day has been different, this week and last week. So, eventually this will settle down in the next few months, we think, to the positive and negative, and then we'll move on from there.

Yes, it's definitely been exhausting. So, I guess it's fair to say, as acquisition opportunities come up, you guys still expect to be active?

Yes. We expect to be active. We buy $300 million this year, like we did in 2021. We're just watching the market, and seeing where it goes. It's only May 11 or 12, so we've still got a half a year to go.

Fair enough. And you guys kind of touched on the disposition. I think you said you had about $30 million held for sale when we spoke about, I guess, 6 weeks ago. Any material update there or still just being impacted by sort of the broader volatility?

There's negotiations occurring on those transactions, but we have nothing specific to announce.

All right.

I mean I can say they're within our target expectations.

Okay, fair. Hopefully that changes for you guys. The retail SP NOI was pretty solid. Was there anything onetime in there? Or was it lapping some bad debt? Just wondering because it was a pretty good number.

Alison speaking. There was no significant onetime in the quarter results. It's just mainly driven by the increase in occupancy in the sector and increases in rates on renewals and there was some rent bumps in there as well.

So you think you can keep it going for the balance of the year in that 4% range? Or is that a little bit lofty?

It's Gordy. So we have to look at what rolls in the next 6 months, but that's a good number. But we've seen 2% to 4% over the quarter, so I think that's not unusual for us in the retail piece.

Okay. And then just last one from me. There's been chat about that Valero site that's come up right pretty much next to Burnside Park. Any thoughts on that, what it could mean for the area? And if it's something you guys would look at or JV on, or something like that?

So the Halifax guy will take this answer. It may be right next to Burnside, but it's a bit different. So, it's a good -- it's got rail out there. It doesn't have pure highway access and it's certainly got shipping. But I mean -- I think that piece of real estate was on the market last year, wasn't it on the market?

It's been on the market for 12 months.

Yes. So I think it kind of went no bid. So people are thinking about that. I mean -- but I read...

It's residential [indiscernible].

Yes, it's got -- so one of the -- I read an interesting article, and maybe others have read as well, this is prime location for a [ 700,000 ] to [ 800,000 ] square foot building. So the only thing is, me as the Halifax guy, I haven't seen too many 700,000 or 800,000 square foot buildings in Halifax yet. Not to say that it won't happen. So we're monitoring it. But it's an interesting model to see what goes on there, basically, let's say.

As a former refinery property, it's got to be some environmental challenges.

Thank you. There are no further questions at this time. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.