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

Good morning, and welcome to Pro REIT Second Quarter Results Conference Call. [Operator Instructions] For your convenience, the press release, along with the second quarter financial statements and management discussion and analysis are available on proreit.com in the Investors section and on SEDAR. Before we start, I have been asked by Pro REIT to read the following message regarding forward-looking statements and non-IFRS measures. For remarks today may contain forward-looking statements about its current and future plans, expectations, intentions, results, level 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 estimations and assumptions made based on the factors that management believes are and reasonable in the circumstances. However, there can be no assurance that such estimates and assumptions will be -- proved 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, Pro REIT 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 PRO REIT's MD&A dated August 10, 2022, available at www.sedar.com. Forward-looking statements represent management expectations as of August 10, 2022, and expect as may be required by law. Pro REIT 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 Pro REIT's IFRS results. For a description of these non-IFRS financial measures, please see the 2022 second quarter earnings release and the MD&A. A reconciliation of the non-IFRS to the IFRS results, as applicable, may be found in the earnings release and the MD&A for the 2022 second quarter. Please refer to the non-IFRS as measures section in the MD&A for the second quarter and additional information. I will now turn the call over to Mr. James Beckerleg, President and Chief Executive Officer.

Thank you, operator for the introduction, and good morning, everyone, and welcome to our second quarter call. Joining today in my remarks is Gordon Lawlor, as most of you know, our Executive Vice President and Chief Financial Officer. Also on the call today for questions is Alison Schafer, our SVP of Finance; and Mark O'Brien, our Senior Vice President, Leasing, Operations and Sustainability. Yesterday, we released strong Q2 results both from an operational and a financial standpoint. Our performance, larger results for our increasing presence in the industrial sector as well as the meaningful operational and leasing synergies we continue to achieve. Last week, subsequent to quarter end, we completed our joint venture agreement with Crestpoint Real Estate Investments, a high-profile institutional listing investor. Many of you already know, we now call an industrial portfolio of 42 properties with them, totaling nearly 3.1 million square feet of gross leasable area. Save for one property in Moncton, the joint venture portfolio is located in Halifax's Burnside Industrial Park, one of Canada's strongest industrial zones. I'm very proud of this partnership which actually involved 2 transactions. First, Pro REIT and Crestpoint each acquired a 50% interest in 21 properties owned by a third-party. The cost to Pro Reit was approximately $114 million before closing costs, mainly financed with the proceeds of a 50% interest and approximately $148 million of new fixed rate mortgages. The balance was satisfied with cash on hand and that includes cash from the sale of Crestpoint to a 50% interest in 21 Pro Reit's previously owned properties. That sale to Crespoint represents a second part of the partnership transaction. In detail, Pro Reit sold a 50% interest in 21 properties to Crestpoint for approximately $113.5 million before closing costs. And proceeds, including $49 million in cash -- proceeds included approximately $49 million cash, I'm sorry, with Crespoint, also assuming a 50% interest and approximately $129 million Pro Reit's in place fixed rate are. On a net basis, resulting from the acquisition and the sale allowed for a modest reduction in Pro REIT overall debt level and a profit above our carrying value. The overall transaction has many other benefits for Pro REIT, before it is immediately accretive to our earnings. There is a significant market leasing upside embedded in this desirable portfolio. Given its scale is an opportunity to further increase our footprint in Eastern Canada. And then finally, it allows us to leverage our operational platform as the sole property manager of the entire portfolio. Subsequent to quarter end, we also announced an agreement to sell a portfolio of 9 nonstrategic retail properties to a third-party for just under $19 million prior to closing costs. These properties were all located in Western Canada totaled approximately 94,000 square feet of GLA. The closing of that transaction is scheduled for later in September. Conclusion of that deal will further weight our portfolio towards the industrial sector and again, provide us some net cash for debt reduction. Let me now turn briefly to our operational results for the second quarter. Our industrial sector now accounts for 80% of our gross leasable area on a pro forma basis, reflecting the 2 transactions I just spoke to. It generated a solid 4.7% increase in same-property NOI in the quarter compared to the same period last year. Our smaller retail portfolio also continues to perform well, recording a 3.2% increase in their same property net operating income. We actually believe this reflects our focus on necessity-based retail properties with strong anchor tenants in place. Our Office segment, which now represents just 7% of our GLA on a pro forma basis did record a decrease in same-property NOI, resulting from a onetime adjustment of $137,000 related to a prior period and a small uptick in vacancy in 2 of our 8 -- property portfolio. Part of that vacancy has now been released for a 6-year term successfully commencing on November 1 of this year at rates above the mature lease. It might also be noted by the analyst listening that when excluding the $137,000 nonrecurring adjustment, our overall same property NOI increased by 2.2% in Q2 2022 compared to the same in the prior year period. Rental rates continue to be a growth driver across our portfolio. Mark-to-market net rent spreads at the end of the second quarter was 24% of our total portfolio, including 35% for our important industrial segment specifically. Our occupancies remain firm at 98.3% at quarter end. And I can also report that we have successfully renewed or replaced 82% of the 853,000 square feet of leases maturing in 2022, achieving an average increase of 12.9% over the maturing rent for those leases. So at this point, I'll turn the remarks over to Gordy, who will provide some details on our Q2 financial results.

Thank you, Jim, and good afternoon, everyone. We recorded a solid financial performance in the second quarter. Property revenue grew to $23.7 million, a 33.6% increase compared to the same period in 2021. Net operating income reached $14.3 million, up 33% year-over-year. AFFO totaled $7.9 million, a 36.9% increase compared to the same prior period. These increases were mainly driven by the net transaction activity during the last 12-month period, notably the acquisition of 16 properties and the sale of 3 noncore strategic buildings, sorry, nonstrategic buildings. Basic AFFO continues to steadily improve with 86.5% in the second quarter of 2022 compared to 92.3% for the same period last year. During the quarter, we kept focus on maintaining our strong financial discipline and liquidity position. Debt to gross book value was 51.2% at June 30 down from 58.2% at the same date last year. We remain committed to reducing our debt to gross book value ratio of 50% over the next few quarters. We have approximately $10 million in mortgage renewals maturing in the next 12 months after you take into account the sale of payment of my noncore retail properties that Jim spoke to. The proceeds from the sale will be used to repay approximately $14.1 million of related mortgages maturing in 2023 in January actually with the balance to pay down a term loan. Our liquidity position remains healthy. At June 30th, we had $28 million available under our credit facility compared to $38 million at the end of March. This is mainly a result of some negative working capital in the quarter due to annual property taxes as well as a payout of a small mortgage when it came due. Distributions of $0.0375 per unit were declared monthly throughout the second quarter of 2022. Finally, our weighted average cap rate for the portfolio was approximately 5.7% at the end of the quarter or $155 per square foot down from 6.3% at the end of the second quarter 2021. I'll now turn the call back to Jim for closing remarks.

Great. Thanks, Gordy. To conclude, our management team does remain mindful of the current environment with the macroeconomic uncertainty, high inflation and rising interest rates that we all face each day. However, we do believe our management team and your Board continue to focus with discipline on opportunities that meet our objectives. We believe Pro REIT is advantageously positioned to further drive both performance and growth as we go forward. We remain a robust tenant-based REIT strategically look for the strategically located portfolio, and I am very confident that talent and team that can generate value for all of our stakeholders again as we move forward. So that wraps up for formal remarks this morning with respect to the second quarter, and I'll turn it back now to the operator to take any questions that there are from participating financial analysts. Thanks very much.

[Operator Instructions] The first question comes from Nicholas Telaga of BMO.

So with the recent transactions, the portfolio seeing increase in industrial waiting. I was just wondering your thoughts about the target weighting by asset class moving forward, maybe particularly for retail and office?

We haven't -- it's Jim speaking. Our strategies from a Board perspective haven't really changed from what we chatted about last quarter, and that is we see natural evolution going forward of increased weighting in the industrial sector. That will come from currently unidentified acquisitions on the reenter that market. And to some extent, judicial sales of retail and/or office portfolio, although the office portfolio is not really small. We don't have a specific target date to move out of those 2 sectors. Our retail portfolio especially is managed much like the small bay industrial portfolio. It's strongly anchored by grocery anchors, our drug stores and national chains of that nature. And as you'll see from the numbers that it is performing well. So we don't see any here important strategy to move away from that sector. Sorry, we're waiting for inbound question.

Can you just comment on what you've seen in the transaction market lately and maybe implications for pricing?

It's Gordy Lawlor here. We haven't seen many transactions, especially in our markets in the last give or take 6 months. We've seen some GTA industrial deals track them, but lower airport-related Mississauga. We were the Atlantic Canada deal, if you will. So there was that, and then we haven't too much in Winnipeg Ottawa. So there hasn't been a lot in the last 6 months. It's a time of year or 2 as well besides noise in the market and whatnot, it's July and August. So we expect some pick up here September, October, but it's been quite quiet in the last 6 months. So not a lot of markers on deal or cap rates at this point in time, which I think is reflective of most of the REITs that have promoted at this point in time under valuations, right?

The next question comes from Lorne Kalmar of TD Securities.

Maybe just flipping back to the dispositions quickly. Was that a marketed deal?

Yes. So Mark O'Brien here. We did market it with a broker to Avison Young. We had it in the marketplace, and we did have some inbounds that were -- that we looked at closely. We circled back with 1 of them. It took some time. And certainly with the uncertainties in the rising interest rate environment, it did drag on. But we did have a marketed deal and we do have it under contract for sale with a known end in the Western Canada.

Okay. And can you guys give a little bit of guidance on cap rate?

Yes. So we're -- on a stabilized basis, it's kind of penciling out to a mid-7 cap. And that's a function of low [indiscernible]. These 9 properties were in a 5-year pool with RBC lender. And they were sort of the weakest of the '19 that we bought in this Rexall portfolio. And actually, only 2 out of the 9 are Rexall anchored. So in the open to smaller markets in Western Canada. So we sort of see it as a weaker group -- grouping of the original 19, so reflected in that 7.5 cap.

Okay. So you're going to be more stronger for it. Maybe just flipping quickly to the JV. What do you expect in incremental management fees from managing the 42 properties?

It's Gordy. Management fees will pencil about $800,000, and that incremental fees, including leasing fees would be another $500,000 to $700,000 depending. So give or take, $1 million to $3 million to $1.5 million.

And net of cost or the other costs kind of associated?

No net of cost.

Net of cost, great. And then was there a difference in cap rate between the portfolio you guys disposed of for the 50% interest, I guess, and the one that you acquired?

Yes.

Could you give a little color on that?

Yes. So give or take a 6% on the buy and 5.2% on the sale and largely driven by the assets that we sold, the weighted average rental rate we had in the portfolio, we had was a little bit lower than what we were buying at. So that was part of the reflection of the difference in pricing.

That's great. Then did I see you guys have an additional office vacancy this quarter?

Yes, there was a 2,500 square feet that came due in May that they didn't renew. But that's -- actually, we're looking at this yesterday. We don't -- I mean we think that's fit for a bit, if you will. We've had some moving parts in a couple of our buildings, but the exposure here in the next year we don't think it's any more than another $70,000. And we've got some -- that's an annual number, and then we've got 12,000 feet coming on stream at the end of Q4. So hopefully, we're in a bit of the upside of this number when we go forward.

The next question comes from Mark Rothschild of Canaccord.

You already addressed a lot of what I had. Just maybe if you could expand a little bit on how you're thinking about dealing with your capital now with different objectives, such as reducing leverage, but also wanting to continue to grow?