RioCan Real Estate Investment Trust (REIUN) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the RioCan Real Estate Investment Trust First Quarter 2023 Conference Call and Webcast. As a reminder, this conference call is being recorded. I'd now like to turn the conference call over to Ms. Jennifer Suess, Senior Vice President, General Counsel, ESG & Corporate Secretary. Ms. Suess, you may begin.

Thank you, and good morning, everyone. I am Jennifer Suess, Senior Vice President, General Counsel, ESG & Corporate Secretary of RioCan. Before we begin, I would like to draw your attention to the presentation materials that we will refer to in today's call, which were posted together with the MD&A and financials on RioCan's website yesterday evening. Before turning the call over, I am required to read the following cautionary statement. In talking about our financial and operating performance and in responding to your questions, we may make forward-looking statements, including statements concerning RioCan's objectives, its strategies to achieve those objectives as well as statements with respect to management's beliefs, plans, estimates and intentions and similar statements concerning anticipated future events, results, circumstances, performance or expectations that are not historical facts. These statements are based on our current estimates and assumptions and are subject to risks and uncertainties that could cause our actual results to differ materially from the conclusions in these forward-looking statements. In discussing our financial and operating performance and in responding to your questions, we will also be referencing certain financial measures that are not generally accepted accounting principle measures, GAAP, under IFRS. These measures do not have any standardized definition prescribed by IFRS and are therefore unlikely to be comparable to similar measures presented by other reporting issuers. Non-GAAP measures should not be considered as alternatives to net earnings or comparable metrics determined in accordance with IFRS as indicators of RioCan's performance, liquidity, cash flows and profitability. RioCan's management uses these measures to aid in assessing the trust's underlying core performance and provides these additional measures so that investors may do the same. Additional information on the material risks that could impact our actual results and the estimates and assumptions we applied in making these forward-looking statements, together with details on our use of non-GAAP financial measures, can be found in the financial statements for the period ended March 31, 2023, and management's discussion and analysis related thereto, as applicable, together with RioCan's most recent Annual Information Form, that are all available on our website and at www.sedar.com. I will now turn the call over to our CEO and President, Jonathan Gitlin.

Thanks so much, Jennifer, and thank you to everyone that's joined RioCan's senior management team today. I'm going to start the call today the same way that I'm going to end the call, with an acknowledgment that the market continues to be volatile. Fear of recession, interest rates, inflation, access to capital, regional banking vulnerabilities, these thoughts are top of mind for all of us. To suggest otherwise would be unrealistic. That said, even in the face of these macro-level gyrations, RioCan continues to perform exceptionally well. We've strategically and responsibly managed every facet of our business over which we have control. Despite the market volatility, I'm proud to reiterate our commitment to the guidance we presented at our February 2022 Investor Day and the FFO guidance we provided in our last call. With each successive quarter since our Investor Day, our operating results reflect the precision with which we execute our strategy. So let's dive into our Q1 operating results. And I'll simply say these results speak for themselves. They support our confidence in achieving the ambitious growth targets that we set out in our 5-year plan. Just like the quarters that preceded it, the first quarter of 2023 demonstrated our portfolio's quality, our tenants' resilience and our team's extraordinary depth and capability. By every measure, RioCan's well-positioned assets, stable tenant mix and development progression drove strong results that translate into predictable outcomes. These results reflect our focus on the pillars that support our 5-year plan: resilient retail, customer centrism, intelligent diversification and responsible growth. Our commitment to these pillars continues to yield results. Our assets are in Canada's major markets, in densely populated areas with high average household incomes of CAD 135,000 and an average population of 250,000 people within a 5-kilometer radius of your average RioCan property. RioCan's portfolio has never been more defensive. The percentage of our net rent generated from strong and stable tenants increased to 86.8% this quarter. Same-property NOI for the quarter grew by 3.4%. FFO per unit was CAD 0.44. This reinforces our confidence in our FFO per unit target of CAD 1.77 to CAD 1.80 per unit for the entire year. Healthy new and renewal leasing spreads results created a strong blended leasing spread of 12.3%. Retail committed occupancy was 98%, and rent per square foot for new leasing in the quarter was CAD 28.57, well above the average net rent for the portfolio, which is CAD 21.13. These exceptional occupancy levels, retention rates and leasing spreads continue to be driven by intense demand for RioCan's quality retail space, the sort of retail space that's, well, simply put, in short supply. Your management team will continue to operate with excellence and find strategies that mitigate the impacts of current concerns, such as interest rates, an anticipated recession and more limited access to capital. It's worth taking a moment to unpack these issues in the context of RioCan's business. In seeking an explanation of how we've maintained and will continue to extract such strong operating results with such a volatile backdrop, I'm going to start with the bigger picture; namely, the country within which we operate. Yes, so I'm starting broad, but it matters. In today's global context, numerous attributes distinguish Canada as an incredible place to conduct business and, even more specifically, to own and to operate retail property. Consider our banking sector. Canada has a regulated and relatively stable banking system where reputation and relationships matter. RioCan has access to capital and substantial liquidity. We consistently demonstrate the ability to utilize our established network and [indiscernible] track record to access the most efficient forms of financing. The retail landscape in Canada is also vastly different than in much of the world. Compared to the U.S., Canada has far fewer competing tenants for retail category. We also have approximately 40% less square footage of retail per capita than the U.S. A few factors will continue to temper the supply of retail space, including Canada's tight zoning regulations. In addition, the vast gulf between replacement cost and market values makes building new retail a very unlikely proposition. And then there's our commitment to immigration. Canada is the fastest-growing country in the G7 and is projected to welcome approximately 0.5 million qualified, productive newcomers each year. These new Canadians naturally gravitate to transit-oriented, major market locations in lease negotiations for precisely the kind of well-located bricks-and-mortar spaces that RioCan offers. This was clearly evidenced by the immediate and pronounced demand for our Bed Bath in Canada. Upon the retailer's CCAA filing in February, RioCan commenced negotiations with numerous box tenants who expressed interest in all 13 of our locations. Despite the positive progression of these negotiations, several strong retailers chose to take a more secure route, and they purchased locations directly from the receiver who is running the process. In total, 10 of RioCan's locations were snapped up in the auction process run by the receiver. Retailers were unwilling to risk losing these sites. And for RioCan, the process resulted in the ability to fill the spaces with strong tenants, 0 downtime and no outlay of capital. Regarding our 3 locations that weren't sold through the CCAA process, we finalized 1 lease, and we're in final-stage negotiations for the remaining 2. The current supply-demand dynamic is expected to continue for the foreseeable future. This dynamic is one of numerous factors that bolster our confidence. It's also worth noting that as the real estate transaction market starts to pick up, we're seeing an increase in the number of data points that suggest that high-quality assets are holding their value. Specifically, in spite of interest rate fluctuations, we're seeing limited impact on cap rates for major-market, open-air retail centers. The type of retail that comprise our portfolio is also very relevant. Our properties generate resilient and growing income from a strong and stable base of tenants anchored by necessity uses like grocery stores, pharmacy and value retailers, while these are precisely the uses that perform well and generate organic growth even in turbulent economic conditions. Simply put, high-quality properties plus high-quality tenants result in high-quality cash flows. These factors, in turn, support strong valuations. As you know, RioCan complements organic growth with intelligent diversification. Despite market conditions, our success in this area further supports our confidence. There is considerable detail regarding our development program in our disclosure. However, I'm going to provide a few highlights for you. We've leased approximately 94% of the total commercial space at The Well, which, as you hopefully all know by now, is our flagship mixed-use development in Toronto. 82% of the retail component is leased, which represents a 10-percentage point increase over the previous quarter. We have an additional 6% in advanced negotiations, for a total of 88% of the retail space either leased or in advanced negotiation. Our 6 condo townhouse projects under construction are 86% presold, achieving 96% of pro forma gross revenue. We've got significant deposits for these units, which provide security against the unlikely, but always possible, scenario of homebuyer defaults. Between 2023 and 2026, RioCan will realize approximately CAD 860 million in sales revenue from these projects. Our residential rental revenue also continues to increase. This rental revenue diversifies our cash flows and offers high embedded growth potential. RioCan Living now has 10 purpose-built residential buildings in operation. Demand for these units continues to be excellent. The NOI generated from our residential rental operations in the first quarter was CAD 4.3 million, an increase of CAD 1.9 million over the same period last year. There is, however, no question that interest rates are creating unwanted pressure. RioCan has taken meaningful steps to keep that expense as low as possible. We've proactively employed various financial tactics, including staggering the maturities of long-term debt and limiting the use of floating-rate debt, to minimize exposure to interest rate fluctuation. As Dennis will explain to you shortly, we've benefited from hedging activity, where we took advantage of significant dips in the bond market and locked in favorable government of Canada bond rates for both future, planned and prior financing activity. These measures are all part of our commitment to responsible growth, which, again, Dennis will speak about in a moment. The last factor that supports my conviction in RioCan's ability to deliver long-term value cannot be underestimated. It's the team. This team has weathered pandemics, tenant departures, recessions, financial meltdowns and more. This team, like our portfolio, has demonstrated resiliency and the ability to deliver in any kind of conditions. Each day, their talent, creativity and commitment drive our strategy forward. I'm grateful for them and I confidently say that your trust is in very good hands. As always, we're prudently managing risk, maintaining a healthy balance sheet with strong liquidity and access to various financing channels. Our high-quality portfolio and operational excellence provide respite against the volatile macroeconomic environment and give us the confidence to reaffirm our guidance for the year. The objectives in our 5-year plan were established with purpose and conviction, and they're achievable in almost any environment. There are many words we can use to describe the economic environment: tumultuous, volatile, unstable. I'm going to say it more informally: I mean, it's pretty nuts out there. But what I want to leave you with is the words to describe RioCan's performance in this same environment: predictable, solid, stable, sustainable. This foundation, strength of vision and demonstrated commitment to responsible growth will continue to serve our unitholders well and, at the same time, position the trust for continued success as market stability returns. With that, I'll turn the call over to Dennis, who will take you through our balance sheet and provide insight into how it continues to support RioCan's quality and growth. Dennis, over to you.

Thanks, Jonathan, and good morning to everyone on the call. RioCan's strong results this quarter were driven by continued operating strength, as seen across a number of KPIs, from occupancy to retention ratio to leasing spread. Over the last number of quarters, RioCan has consistently delivered operating results that are among the strongest in its history. This is a testament to the quality of the portfolio as it stands today, which continues to benefit from the long-term macro tailwinds that have created a supply-demand dynamic that is favorable for our business. FFO for the quarter was CAD 0.44 per unit; CAD 0.02, or 4.8%, higher than the same period last year. Same-property NOI growth of 3.4% in our commercial real estate, which was driven by our strong operating performance, increased FFO by CAD 0.02 per unit. An additional CAD 0.02 per unit increase was driven by the ramp-up of development in our residential rental operations. We also [ added lease files to ] the quarter, predominantly related to a single tenant in Alberta that has already been backfilled, which provided another CAD 0.01 per unit. These increases were partially offset by higher interest expense, which net of higher interest income reduced FFO by CAD 0.01 per unit. Finally, assets sold over the course of last year, net of the benefit of prior year share buybacks, reduced FFO per unit by CAD 0.02. This short-term drag on FFO per unit due to asset sales occurred because a large portion of the capital generated from these sales was recycled into development projects that have yet to stabilize. Despite this short-term impact, we firmly believe that recycling capital from the sale of lower-quality assets into high-quality development assets with greater growth potential will further enhance our portfolio and create substantial value in the medium to long term. Turning to our balance sheet, net asset value per unit at the end of the quarter was CAD 25.83 per unit, an increase of CAD 0.10 per unit from Q4 2022. The NAV increase was driven by retained income after distribution, adding to our equity. Our FFO payout ratio of 59.3%, the lowest among our peers, allows us to retain earnings on our balance sheet and reinvest in our business, which we expect will compound value over the long term. This was partially muted by a modest fair value write-down in the quarter of CAD 17 million, which left our investment property value essentially flat, at CAD 14 billion. Net debt to EBITDA trended downward slightly, ending the quarter at 9.48x. EBITDA contributions from development deliveries are the primary driver in decreasing net debt to EBITDA, with 66,000 square feet of net leasable area delivered in the first quarter, out of approximately 600,000 square feet expected to be delivered this year. As development deliveries accelerate over the balance of the year, we expect our net debt to EBITDA to continue its downward trend through this year and into the next. Increased EBITDA was partially offset by an increase in proportionate net debt of CAD 68 million as we continue to invest in our development properties, including related assembly acquisitions, partially offset by CAD 42 million of funds raised through completed dispositions. As for financing activities, we completed a number in the quarter, evidencing the continued availability of capital in the Canadian market, especially for high-quality borrowers like RioCan. In January, we refinanced CAD 200 million of bank term debt with a 3-year bank term debt at 4.93%. In March, we issued CAD 200 million of 4.6-years unsecured debentures at a rate of 5.18%, including the benefit of hedges, a rate that was 43 basis points below the market at that time. Proceeds of the issuance were used to repay existing debentures upon maturity in April. Also in March, we secured CAD 126 million of CMHC financing for our Queen & Ashbridge residential rental project. The debt has a 10-year term and will be drawn over the construction period, converting to a term loan upon project completion. The interest rate is fixed at 3.07%, and the amortization period is 50 years. This is an example of what RioCan can achieve by incorporating affordability, energy efficiency and accessibility into its projects. Finally, subsequent to quarter-end, we extended our CAD 1.25 billion corporate credit line by 1 year, to 2028. This extension was on existing terms. We've continued to use interest rate hedging to reduce risk in our planning. During the quarter, we entered into a CAD 300 million bond forward hedge for planned financing activity later in the year, fixing a 7-year government of Canada bond rate at 2.63%. We also swapped certain construction loans to fixed, bringing our floating rate exposure down to 5.4% of total debt. Our hedging activity, combined with our liquidity of CAD 1.7 billion and unencumbered asset pool of CAD 8.3 billion, mitigates risk and provides us with the financial flexibility in the current market conditions. In summary, the strong results in the first quarter are a testament to RioCan's high-quality portfolio, operational excellence, leasing prowess and development expertise, while our necessity-based tenants and strong balance sheet insulate us from risk. With that, I will pass the call to the operator for questions.

[Operator Instructions] First question comes from Sam Damiani with TD Cowen.

Just on the capital markets. Are you all finding it much harder to dispose properties today in the current environment? And how would that impact your capital deployment plans over the next few years?

There's this view that no one is buying properties these days, and at the same time, no one is looking to sell properties a bunch these days, because no one is certain as to where appropriate cap rates are. But I think that is starting to dissipate and you're seeing a few more transactions take place, which sets the mark as to where properties should be valued. And I think that's opening up a little bit of a channel in terms of commercial transaction activity. And so we're not -- I mean, look, first of all, as you know, it's not a significant part of our plan this year to sell a lot of assets. But to the extent we are looking to sell assets, whether it's from a qualitative perspective or a quantitative perspective, we have a reasonable amount of buyers who are counterparties that we're dealing with in all regards. They come from different stripes and colors, but they're there. So I don't think that it is a very strained investment environment. And certainly, there's a little more clarity that's been provided by these data points. I'm happy to turn it over to Andrew Duncan, our CIO, just to reflect on that, if there's any more reflections. Andrew?

No. I think, John, you're absolutely correct. We're seeing not nearly as much activity as past years, but we're definitely seeing an increase in activity. And to your point, I think the buyer pool is very diversified. You're seeing privates, you're seeing family offices take advantage of some of the opportunity, where they may not have been players previously.

Sam, Dennis here. I do think it's important to reiterate though that our base case plan does not require us to sell assets to fund our development program. Our retained cash flow plus project-level debt covers off our commitments from a development perspective. So that part of the plan is covered. If opportunistically we can sell assets and recycle into other assets, for example, like you've seen in some of our [ disclosure ] recently, we'll do that, but it's not a requirement for us at this point. And that's a testament to our low payout ratio.

That's great. And I guess, a big part of the capital inflow for RioCan over the next few years is the completion of the condos underway, over CAD 800 million coming back to the REIT. When you look at those sites specifically, those locations specifically, I guess, do the market sales in those neighborhoods give you confidence that that revenue is going to come in for sure?

Yes. Keeping in mind, Sam, that the vast majority of that revenue is already, call it, locked, in that they are subject to binding purchase agreements with robust deposits in place. So we feel very confident in the vast majority of that. With respect to the units that are under development but haven't yet been purchased, we're starting to -- I mean, I think there was a lull in the market at the end of 2022, and it's starting to pick up now as people are, as buyers are starting to reconcile with the realities of the new interest rate paradigm. So we do feel confident in that number materializing.

And what I would add as well, and Jonathan hit this in his comments, is that we're seeing the rates are higher than pro forma on a per square foot or per unit basis. And Jonathan [ had a comment that ] we sold, I think it was, like, 86% of the units where that represents in the mid-90s percent of the gross -- 96% of the gross profit being locked in. That delta, obviously, is the fact that we've been selling at a higher rate per square foot than the original pro formas.

Okay. Great. Last one for me. Just on the leasing discussions. Are you seeing it take any longer to get tenants to sign on the dotted line? Or any change in the leasing discussions over the last few months that you've seen?

I'm going to hand that one over to Oliver Harrison, our Head of Leasing and Tenant Experience. Oliver, any commentary to Sam?

No. We seem to be moving forward at a velocity that's been consistent with the last 12 months. So nothing has changed.

So very strong, really good momentum, which echos what I said about the market, in general. Good retail, like the kind that RioCan owns, is in short supply right now, Sam. And I think there's no better sound bite than our Bed Bath situation, where, like, we didn't even have an opportunity really to deal with them because they're in such high demand.

That's a great outcome, and congratulations there. Before signing off, I'll just say that I walked The Well on Monday, and it looks fantastic. So congratulations.

Thanks so much, Sam. I always appreciate your views on The Well. I know that you've been paying close attention to it. And we're as excited or, I'd have to say, more excited than you are for that one to be completed.

[Operator Instructions] We now turn to Lorne Kalmar with Desjardins.

Congrats on a nice start to 2023. Just on the leasing spreads, nice little jump from 4Q. Just wondering, was there some nuances to that number? Or is that sort of the new normal, going forward?

I mean, look, leasing spreads are a pretty volatile metric because, like, it's a pretty small sample size that is utilized each quarter to come up with it. So you will get swings based on, like, a large lease renewal or a large new lease that was done. So this quarter was quite favorable. I think that we said in our 5-year plan that our objective is to be in the high single digits. And based on market conditions, we fully intend to adhere to that objective. So sometimes you're going to see things like this above 12% combined, and sometimes we might see single digits, but we think that the run rate, Lorne, is in that high single digits, and we're very confident behind that guidance. John, any further -- anything to say?

The only thing I'd add, Lorne, is that with our occupancy on the retail side being at 98%, we now have the luxury to really revisit some of our transitional tenants, tenants that we don't deem as strong and probably aren't as high of rent payers. You will see some positive bumpiness over time, where we're taking out some of these deals, which will be lower than market rents and sometimes at points, at more fully net offerings. So we're not going to change our guidance, but we will see a bunch of that over the next year or 2, provided our occupancy is maintained at 98%, which we expect it to.

Okay. So would it be fair to say kind of 98% is sort of, like, fully stabilized occupancy? It'd be kind of tough to push it anywhere beyond that materially higher, I guess.

From a retail perspective, Lorne, I would say that that is, to us, stabilized. From an office perspective -- I mean, our headline occupancy overall is lower than that 98%. So there's definitely, let's call it, opportunity on the office segment.

There is definitely a lot of opportunity in the office segment. On development spend, you guys maintain the guidance. Just wondering if there's -- if you were thinking of starting any new developments of significance this year.

Well, we've got a lot on the go in the ground, and that's what the guidance for this year speaks to. In terms of greenlighting, it's a tricky environment. Interest rates have obviously, I would say, distorted pro formas a little bit. And what we're going to do is, as always, take a disciplined approach to assessing each of these opportunities. And we have IRR hurdles, and should some new opportunities meet or exceed those hurdles we're going to consider them, but we also have to consider them in the context of some other uses of capital; meaning, paying down debt, doing acquisitions in some cases which have higher outcomes or better outcomes and more immediate outcomes. So it's a bit of a wishy-washy answer to your question, but the bottom line is we're going to assess these one at a time and we're going to take into consideration a number of factors that will lend to that sort of conclusion of whether we greenlight or not. It's a bit more of a risky environment to commence development with this kind of backdrop. So we're probably not going to be as aggressive as if we had this conversation 6 months ago or a year ago. But as we've always said, the beauty of RioCan is that should we decide to pause on greenlighting any of our construction, we have very capable, very high functioning shopping centers that are producing income. So we're not necessarily losing out by delaying any development starts.

The other thing that happens, Lorne, as you know, is it doesn't take a lot of capital to invest in advancing the ball on the pipeline. So moving as many of these projects to shovel-ready, getting zoning, dealing with cleaning up any kind of constraints on the projects. And so our team continues to advance the ball on that, which does add value without putting the kind of burden that you have on the balance sheet when we start getting into construction. Construction costs have been inflating for a while. The other thing we've seen, though, and you guys, many people on this call, cover the residential REITs, rents are also moving pretty dramatically upward as well. So we have to take all of these into consideration.

Fair enough. And then last quick one for me. Can you guys give any more color on the Montreal multifamily acquisition you guys announced?

Sure. It's an asset that we acquired right on the island of Montreal. Very good demographics. Good area. Close to transit. Close to a very strong community. And we feel it fits very well within the RioCan Living constructs of what we want to provide to our constituents. It's not a very large transaction, but it has very good economic attributes to it; namely, we see good rental growth, particularly once we take over the management of it, and we also see a very favorable debt of -- well, a very favorable existing debt scenario there, where we inherited 10-year debt that's at a very favorable rate. So between the 2 of those elements, we feel that this will have a very good IRR outcome for us. And as I said, in our 5-year plan that we put out in our Investor Day, we were always looking to augment our development program with, we call them, singles and doubles, a few acquisitions from time to time, which we demonstrated last year in our acquisition of Market at Laval, and this just represents one of those great opportunities to allow us to get up to that objective of between CAD 55 million and CAD 60 million of residential NOI. So we're quite pleased with it.

Okay. And the 124 units, are they stabilized? Or still in lease-up?

They are stabilized.

The majority of them are stabilized.

Our next question comes from Pammi Bir with RBC Capital Markets.