RFA Financial Inc. (RFA) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen. My name is Anas, and I will be your Conference Operator today. At this time, I would like to welcome everyone to the Artis REIT's First Quarter 2022 Results Conference Call. [Operator Instructions] Thank you. Ms. Heather Nikkel, Vice President, Investor Relations and Sustainability, you may begin your conference.

Thank you, operator. Good afternoon, and thank you all for joining us. Welcome to Artis' First Quarter 2022 Results Conference Call. With me on the call today from Artis is Samir Manji, President and CEO; Jaclyn Koenig, CFO; Kim Riley, COO and Phil Martens, Executive Vice President U.S. Region. Our first quarter 2022 results that were disseminated yesterday are available on SEDAR and on our website. A replay of this call will be available until Friday, May 13th. In order to access the replay, please use the telephone numbers and passcode that were provided in yesterday's press release. A recording of this call will also be made available on our website. Before we get started, please be reminded that today's discussion may include forward-looking statements. Such statements involve known and unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied today. We have identified such factors in our public filings with the securities regulators and suggest that you refer to those filings. As we discuss our performance, please keep in mind that all figures are in Canadian dollars, unless otherwise noted. With that, I will turn the call over to Samir.

Thank you, Heather. Good afternoon and thank you for joining us for our Q1 results conference call. As we've done in past quarters and in light of the fact that most attendees on this call have already reviewed our results, I don't plan to reiterate what is already available in our disclosures. Instead I will keep my remarks high level and focused on the progress we've made to date in the implementation of our business transformation plan announced in March 2021. The momentum we gained through 2021 continued through the first quarter of 2022. Our ultimate objective continues to be growing net asset value per unit through value investing in real estate. As we have shared previously, this will be achieved through 3 key pillars in our strategy. The first is strengthening the balance sheet. During the quarter, we sold 1 industrial and 2 office properties, which combined with property sales in 2021, equates to 44 properties sold since last March. Proceeds from these dispositions have been used to fund our NCIB to reduce outstanding debt and to increase liquidity. On the NCIB front, we bought back 4.2 million units at an average price of $12.46, a significant discount to our current net asset value of $19.09 at March 31st. We ended the first quarter with total debt to gross book value of 43%, a significant decrease from the 49.3% we reported prior to the announcement of our business transformation plan. Our overall liquidity remains healthy and strong. The next pillar of the strategy is driving organic growth through development of our assets. This includes enhancing performance at our existing properties as well as growth through new development projects. At March 31st, our portfolio occupancy, including commitments remained stable at 91.6%. And we achieved a 7.8% rental increase on renewals that commenced in the quarter. In terms of development progress, we completed the fifth and final phase of Park 8Ninety in Houston, adding 675,000 square feet of industrial space to the existing 1.1 million square feet across the first 4 phases. Also during the first quarter, we began pre-leasing the first 20 floors of apartments at $300 million in Winnipeg and Earl's who occupy space on the main floor of the building opened for business. The other development projects that we have underway, Blaine 35, Minneapolis and Park Lucero East in Phoenix are coming along nicely. And we're very pleased with the strong leasing interest we've witnessed to date in both projects. The last pillar of our strategy is value investing by redeploying capital into new investments, including core cash flow in hard assets and undervalued publicly traded real estate securities. On March 1st, we, alongside our consortium partners closed on the previously announced privatization of Cominar REIT. This was a milestone transaction for Artis and its unitholders. Since announcing the transaction last October, our conviction in the intrinsic value of Cominar's real estate portfolio and the corresponding value upside in front of us has only strengthened. Artis' total investment in this transaction was $212 million. Of this, $112 million, including our previously owned Cominar units that had a fair value of $13.5 million was allocated to the acquisition of 32.64% of the common equity units in the newly formed entity. The remaining $100 million was invested in junior preferred units that carry an 18% annual rate of return, an attractive return for our unitholders. The difference between the $112 million invested in common equity units and the fair value of the net assets acquired as part of the transaction resulted in a bargain purchase gain at Artis' share of $111.7 million. There is also a tax component to the transaction. And we have recorded a deferred tax liability of $27.8 million as a partial offset to the $111.7 million bargain purchase gain. The bargain purchase gain we recorded this quarter demonstrates the value we are both committed and highly motivated to build for our owners. This significant transaction we hope is reflective of what is possible for Artis and its owners as we continue to evaluate and explore other opportunities. During 2021, we also began accumulating a position in Dream Office which culminated in the announcement that we, together with our joint actors had acquired a 10% ownership position in Dream Office. Subsequent to the end of the quarter, we further announced that our ownership position had increased to 12%. This is one of several strategic public securities investments we have made. We look forward in time to expanding our narrative around specific entities we've invested in. But we will do this in a thoughtful, calculated manner that we believe is in the best interest of Artis' unitholders so as to ultimately keep our cost of investment as low as possible, thereby enhancing the probability of maximizing our returns on the other side. We are off to a good start in 2022. We're looking forward to providing further updates on our progress after Q2. We're also looking forward to holding our Annual General Meeting in-person on June 9 in Toronto. We look forward to the opportunity to meet our fellow owners and other stakeholders at our AGM. With that, I'll turn it back to you -- I'll turn it back over to the operator to moderate the question-and-answer session.

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

So, first question on the asset sales. You did $65 million in Q1. You've got $60 million held-for-sale. How should we think about that this year?

Thanks, Jonathan. I would suggest, as we have previously disclosed, we have earmarked about $500 million of dispositions for 2022 and we remain committed. And while it's clear that most of that will be back-ended by virtue of what we have reported in properties held-for-sale and what we've completed in Q1. We nevertheless are confident we'll be able to achieve what was previously disclosed.

Are you seeing any changes in the market with the increase in interest rates over the last 6 weeks or so?

To date, we have not. But as we all know, the things continue to move in a fairly meaningful manner, including the volatility we're seeing. So at this point, we have not seen any significant change. But obviously a lot remains to be determined as we continue to navigate forward.

Would that -- if there is a change, would that impact the amount, like would you pull back on your sales target?

I don't believe we will. And I say that with the -- on the assumption that if there are changes, they will not be material in nature. Now, obviously, again, we're living in volatile times. So nobody can really clearly predict what the next several months hold in store. But right now we remain committed to the path we're on and general indications suggest healthy demand in the private transaction environment.

And then just on your operations, you had $1.8 million in lease term termination income in the quarter. Was there any -- was that a bunch of small ones? Or was there one large one? Maybe a little bit of color on that. And if you have any lease termination coming up in the next couple of quarters?

In terms of the end quarter, no individually significant ones to bring to the attention of the group. Is there any adding you can do there, Kim, on any future expectations?

Nothing that I'm aware of at the moment. That's more of a onetime item.

Your next question comes from Mario Saric with Scotiabank.

I wanted to come back to this -- the bargaining purchase option, just to get a better understanding of the mechanics of quantifying it. So Samir, based on kind of what you highlighted, essentially the $112 million is the difference between what you think the fair value of the assets you acquired and your purchase price, essentially, which, I guess, indirectly would have been $1.25 a share, which is where Cominar is privatized. So just thinking a bit of differently, are you essentially saying that the assets that you acquired are worth closer to $23 per unit for Cominar unit, which is essentially double what was paid. How should I think about the mechanics behind all of this?

Yes. Thanks, Mario. Remember that we're talking about gross asset values, whereas the equity component of our investment is a much smaller ratio. So one should not take our equity component, which is, again, a significantly smaller ratio of the overall consideration paid for the privatization and the fact that we're seeing an almost double of that number, that doesn't suggest the gross asset -- or sorry, the gross transaction prices double. So if you adjust accordingly, it really on the equity we invested, which at a 100% level is about $350 million. One could and correctly translate that into an additional $350 million of upside through the value delta that we estimate. And that valuation exercise is consistent with prior practice at Cominar with respect to updated appraisals on a certain ratio of assets that rolls on an annual basis and then additional valuations based on prevailing market cap data from third-party sources. So overall, we feel reasonably comfortable in what we're seeing on the valuation front. And that's further validated by a handful of, in these early days, a handful of dispositions that we've actually made on the net 83 assets that we retained in that privatization, where we've been able to divest of those properties at values equal to or greater than the underwritten values or IFRS values that we have on our books.

That was going to be my next question because, I guess, it was noted that the external appraisal was done during the quarter and then pertain to the equity investments as classified. So I wasn't sure if there were actually any assets disposed of within that equity investment that would kind of support the valuation of the $350 million delta 2%.

Yes. No, we feel very comfortable. And again, having a few dispositions under our belt is certainly very comforting.

And are there plans going forward in terms of appraising that equity accounted investment on a routine basis? Or will it be similar to what happened this quarter in terms of just looking at assets as you sell them and using all of this to support?

That's correct. It goes along with our accounting so that net equity investment is recorded at fair value. So you'll see fluctuations quarter-to-quarter. But everything will be marked to the IFRS fair values.

And then can you remind us in terms of Dream Office, how do you treat the valuation for your IFRS purposes? Is it estimated based on the value of Dream that you hold internally, Dream's IFRS end of the year or the trading prices?

The investments in our equity securities are recorded at the market price at the end of the quarter.

And maybe switching gears then to the disposition program, you mentioned the $500 million still kind of intact notwithstanding some of the market volatility that we're seeing here today. You're in the beneficial spot of being able to conduct in both public securities and private market assets. And the latter or the former has seen quite a bit of pressure in the last couple of weeks creating some potentially really attractive opportunities that may have not existed a month ago. Does the volatility in the public market change the eagerness or willingness to sell assets in the private market in order to fund those potentially incremental opportunities? Or do you think you have enough liquidity in that balance sheet to pass it on to really take advantage of the recent volatility in the public markets without redefining or redoing the disposition program?

Generally speaking, Mario, we are on track for our 2022 plan. And if anything, as you've noted, the current environment is presenting some very compelling opportunities that I would say may not result in an acceleration of asset disposition. But certainly will result in an acceleration of redeploying some of our liquidity to capitalize on those opportunities. And that's something that management and our Board are aligned on and continue to have very high conviction around insofar as the objective that I touched on in my commentary that remains unchanged insofar as what our long-term priority is regarding NAV growth and value creation for our owners.

How much capacity do you feel comfortable with on the balance sheet? Like let's say, hypothetically, the private market starts to become more complicated? How much tenacity on the balance sheet do you have, do you think that you can execute on public market purchases without selling interim assets?

Right now we have ample liquidity, as you know. And again, we don't think that will be impacted whatsoever by the timing and outcome of the asset or property dispositions that are either planned or already underway.

Okay. Just last question. On the operational side, the same-store NOI growth came in kind of negative 2.5% in Q1. Do you think it's still possible to get the positive same-store NOI growth in '22? Or is that more of a 2023 trend?

Yes. Thanks for the question. It's really 4 office buildings that are contributing to that negative same-property NOI. In the U.S. it's North Scottsdale Corporate Center, which has been fully re-leased and that lease will commence in June. And then it's also Stinson, which is in Minneapolis. We lost a 128,000 square foot tenant in that asset and that space has also been re-leased in June. So on the U.S. side, things are looking really positive. In Canada, it is 2 properties as well. It is our Bell MTS building in downtown Winnipeg, Bell MTS downsized by 100,000 square feet. And that was really driven by a reorganization of Bell taking over MTS and ongoing reorganization there. And then EMC, we lost a small tenant and are looking to backfill. So I think Q2 could be similar. But towards the latter part of the year, there should start to be improvements with those June leases starting to kick in.

And can you remind me, are there any question marks about the AT&T lease in the U.S., 200,000 square feet [indiscernible] I think less than a year.

Yes. So I believe in the previous quarter, we had talked about the tenant is going to be vacating. They will vacate February 2023. So we have some time. We're actively working on re-leasing that space. But it will be at least almost a year before we have to deal with that. And we're hopeful that we can get that pre-leased before they vacate.

Your next question comes from Matt Kornack with National Bank.

Just trying to understand some of the proportional or equity-accounted information that you've provided and particularly trying to understand how we should model it going forward. So if I take IRS and just multiply by 3 to kind of prorate it, is that okay on NOI? And then on the other operating income or expenses, I think it's in expense, what sort of interest rate should I be using to get to the interest expense associated with that investment?

I can take that one. There are some onetime items included in that other expense. The NOI, I do believe multiplying by 3 is a reasonable assumption. On the other, due to there being some onetime acquisition costs, of the, I believe, it's $11.865 million, approximately $5 million would be ongoing interest expense.

And then just in terms of the balance sheet. I think you report your leverage, excluding kind of the leverage associated with these joint ventures. But it seems like leverage is quite high for IRS. Is that all mortgage debt? Or what is the nature of the lending on that portfolio?

We made reference to this on our last quarterly call. And I'll try and repeat what we shared at that time. When we look at the overall cap structure that was established by the consortium for the privatization of Cominar, we used an LBO model to organize the transaction and structure it. And so, one can work backwards in so far is what is publicly available information, including what we've laid out from an equity component of that transaction. And so it wouldn't take long to then underwrite or analyze that while it's got various components, essentially, you've got a roughly $2.2 billion transaction with about $350 million of equity. And again, the fair value of that $2.2 billion, we believe is higher. And we've already touched on what that quantum or delta equates to approximately. And then, beyond that, just so I could sort of finish the story line because it's important to understand this. And we, again, conveyed this on the last call. The consortium is very committed to reducing that leverage in 2022. And that will be achieved through the disposition of certain assets that, again, in early days, we are seeing very good signs, both in terms of interest level from buyers and on the valuation front. So I hope that helps in terms of just providing that clarity?

Yes. That's very helpful. And in terms of those sales, I mean, what is your anticipated timeline, presumably, you started maybe even before the acquisition, looking at selling some of those trophy assets there? But how should we think of that leverage coming down over a period of time? And is that ultimately re-coursed to Artis or is it cured some way through the joint venture?

Yes, both good -- really good questions. And let me start with the latter. There's no recourse to Artis. That was, again, made clear last call. But I will reiterate that because I think it's important to all our stakeholders to know that. And then, secondly, on the time line standpoint, time is on our side. Having said that, again, there is a complete alignment amongst the consortium partners that we want to see a significant reduction in the leverage by the end of 2022. And we're very confident that we'll be able to achieve that. And if it's helpful in terms of trying to quantify, I would say that at a minimum, a 30% reduction in the leverage. But my expectation is it will be well north of 30% if we are successful in executing what is on our radar for 2022.

And last one for me. Is the buyer base for those assets mostly private entities, pension funds, foreign, domestic? Can you give any indication as to who's looking at buying the properties?