SmartCentres Real Estate Investment Trust (SRUUN) Earnings Call Transcript & Summary

Good day, ladies and gentlemen. Welcome to the SmartCentres REIT Q2 2022 Conference Call. [Operator Instructions] I would like to introduce Mitchell Goldhar. Please go ahead.

Good morning, and thank you for joining us on our Q2 conference call. I am Mitchell Goldhar, Executive Chairman and CEO, and I am joined by Peter Sweeney, Chief Financial Officer; Rudy Gobin, EVP, Portfolio Management and Investments; and Mauro Pambianchi, Chief Development Officer. Our commentary will refer mostly to outlook and some of our mixed-use initiatives sections of our MD&A which is posted on our website. I refer you specifically to the cautionary language at the front of the MD&A materials, which also applies to the comments any of the speakers make this morning. We are pleased to report that the REIT delivered another solid quarter, demonstrating once again its ability to consistently drive growth starting with our core asset base. Since the rest of my commentary was covered in our press release, I will turn it over to Rudy Gobin to present this results.

Thanks, Mitch. And good morning, everyone. Throughout the second quarter, we saw the underlying strength of our centers in driving leasing activity and customer traffic. Tenants in most categories were back wanting more space and locking up locations in our high-traffic centers. And with virtually 100% of the REITs properties having a full-line grocery and near 70%, including a Walmart supercenter, a wide variety of tenants were back, adding locations to our well-located centers, including dollar stores, the TJX diners, Health and Beauty, the Canadian Tire banners, pet stores, medical, whole line and specialty grocery, distribution, logistics and much more, all driving traffic and improving in our already strong tenant mix in each center. Here are some key highlights. We closed the quarter with an improved occupancy of 97.6% with committed deals. This improvement was widespread across all provinces, including the re-leasing of 2 of the previously vacated HomeSense Fitter Stores, which closed all locations in Canada and 4 within our portfolio at the end of 2021. You may recall that we negotiated a buyout of a significant portion of the remaining 2022 and 2023 rents, which was recognized in our Q4 results. So the re-leasing provides an improved cash flow overall. We are now close to re-leasing the last 2 of the locations at the same or slightly higher rental rates. With this, we see occupancy continuing to improve in the coming quarters and working to get us back to 98%. At the quarter's end, we have already completed or near completed 4.2 million square feet of the 2022 renewals, representing 83% of the maturities in the year and at a 3.6% rental rate excluding anchors. Over 150,000 square feet of leases were executed for bill space during the quarter, and I would add with better covenants than the previous tenancies. New entrants to the market in a number of categories, including health and beauty, furniture, sporting goods and QSRs have started with strong interest in our open format and resilient portfolio. We continue to work with our tenants, helping them to adapt to their changing needs, which gives them the flexibility they need and only serves to strengthen our partnerships and maintain our high long-term occupancy levels. We've been fortunate with no creditor filings in 2022, which speaks to the high quality of our tenants and trusting that the worst is behind us. From a rent collection perspective, we ended the quarter at 98.5%, and subsequent to the quarter, have made further collections relating to the quarter, bringing collections to 98.8%. This is happening simultaneously with higher rental levels and NOI, and we expect further improvement in the coming quarters. Once again, demonstrating the stability and the financial strength of our tenancies. Regarding our premium outlooks in Toronto and Montreal, both continue to improve. And with the signing of another [indiscernible] in the Montreal Premium outlets, we are now at 100% occupancy in both centers. With the pent-up demand, accumulated disposable savings, and the reopening of the Canadian U.S. border, we are experiencing a solid start to 2022. From all perspectives, 2022 is recovering nicely and is shaping up to be a strong year in retail and especially in the value segment, an area where we dominate. As Mitch has said time and time again, this portfolio was built for heavy weather. Our value-focused tenants are adapting. Customer traffic is improving. Occupancy and cash flows are back to near pre-pandemic levels. And most importantly, all of this is happening concurrently with the extensive mixed-use development initiatives already identified in over half of our existing centers, rezoning achievements made and continuing, current construction already in progress in condos, apartments, retirement, self-storage, industrial and retail, as previously mentioned. And all contributing to significant current and future NAV growth. With that, I will now turn it over to Peter Sweeney.

Thank you, Rudy. And good morning, everyone. The financial results for the second quarter reflect the continued steady improvement in our core business, as Rudy has mentioned. For the 3 months ending June 30th, 2022, FFO per unit with adjustments and excluding various anomalous items increased by 5.8% or $0.03 over the comparable quarter last year. This increase resulted principally from improvements in the core businesses NOI as compared to the prior year. Please note that for the quarter, we have presented FFO information net of the impact of anomalous items, including expected credit losses, condo and townhouse profits, income or loss from the total return swap, and the dilutive impact associated with equity units issued pursuant to the acquisition of the VMC West lands. IFRS fair value adjustments in our investment properties portfolio represented an approximate $10 million increase for the quarter, principally reflecting changing assumptions used for some variables in the valuation process as a result of the improved leasing environment that Rudy has mentioned. Otherwise, cap rates and corresponding discount rates did not change in the second quarter, with the exception of an increase in the cap rates used to value the handful of indoor shopping centers in our portfolio. Total assets exceeded $11.9 billion at the end of the quarter as compared to $11.3 billion for the comparable quarter. And on a proportionate non-GAAP basis, total assets exceeded $12.2 billion as compared to $11.5 billion for the comparable quarter. These year-over-year increases are primarily attributed to both acquisitions and fair value gains that have been recorded over the past 12 months. They say that every cloud has its silver lining. And certainly, that was the experience during the quarter for our total return swap. Given the direction of the trust's unit price in the second quarter, over 2 million additional notional units were purchased at an average price of $27.85 by the financial intermediary during the quarter. Accordingly, by the end of the quarter, the total return swap had approximately 3.5 million notional units with an average price of $28.36. Recall that this total return swap initiative was implemented last year as an alternative to an NCIB, and it has approximately 3 years remaining before it's expected to be wound up. It's hoped that over this remaining term that this initiative will continue to provide continued earnings growth while avoiding any longer-term debt financing that is typically associated with an NCIB program. We encourage you also to read the outlook section in this quarter's MD&A, which speaks to the distinctive safety, security, and stability of our core business and its ability to endure stormy weather of many types. Our financial results and the corresponding financial metrics have followed a consistent trend over the last several successive quarters, demonstrating both the safety, security, and stability of the business and the steady continued growth in our operating platform. This foundational strength provides the business with a unique strategic advantage that permits the continued expansion in our development of mixed-use opportunities. We've also continued our focus on further fortifying the strength of our balance sheet. In this regard, we note the following strong debt metrics for the second quarter as compared to the comparable quarter in 2021. Number one, our debt to aggregate assets ratio has now improved to 43% as compared to 44.6% in the comparable quarter. Number 2, in keeping with our strategy to repay maturing mortgages and to grow our unencumbered pool of assets unsecured debt in relation to total debt has increased to 77% from 70%, and our unencumbered pool of assets has continued to grow, increasing to an excess of $8.4 billion at the end of the quarter as compared to $5.9 billion last year. We continue to employ a strategy to repay most maturing mortgages. Accordingly, we expect these metrics to further improve in the future. This strategy has permitted us to gain further agility when considering future financing opportunities and alternatives for a portfolio of mixed-use developments. Given the recent increases in interest rates, our weighted average interest rate for all debt increased during the quarter to 3.3% as compared to 3.27% for the comparable quarter last year. We note that this is the first increase that we've experienced now in approximately 10 years. Rising interest rates by their nature will result in additional interest costs. However, we have structured our debt ladder conservatively to increment staged and manageable maturities to occur over the next several years, and our weighted average term of debt continues at approximately 4.5 years. As of June 30th, approximately 84% of the trust's current outstanding debt is fixed rate debt, which provides tremendous stability during periods of interest rate volatility. For clarity, we have $200 million and $100 million in maturing debentures in May of '23 and August of 2024, respectively. Accordingly, we are continuing to monitor debt capital markets for interest rate movement. However, we are permitted tremendous flexibility when considering refinancing alternatives for maturing debt, which is a meaningful advantage in this current rising rate environment. This historical bias to extend both the weighted average term of our debt and fixing interest rates was deliberate, and is yet another example of the risk mitigation strategy that we have employed now for several years to insulate the trust from interest rate volatility as we are experiencing in this current rising rate environment. As we look to the immediate future and continue to manage through the current uncertain capital markets environment, in addition to the conservative debt metrics noted previously, consider also that when factoring in our cash on hand, together with our new $300 million facility that was established earlier this year to support the $500 million BMC West acquisition. The $150 million new revolving line of credit that was completed late last year, and the $250 million accordion feature associated with our existing $500 million operating line. We have ample liquidity to provide appropriate flexibility for the capital funding requirements associated with our pipeline of development activity. Currently, we are focused on completing several new construction financing facilities to support the developments that were previously mentioned, including the flagship Canadian Tire site and Leaside, our new industrial site in Pickering and the ArtWalk condominium development at SmartVMC. And finally, it's important that we confirm our unwavering commitment to our balance sheet. It has withstood the unprecedented challenges over the last 2.5 years. It has permitted the REIT's development plans to continue without delayer impediment. And it is in a position to serve as the backbone to fund and support the vast of growth-oriented opportunities that lie ahead for smart centers. And with that, now I'll turn it back to Mitch.

Thanks, Peter. As you can tell from our collective remarks and our press release, the portfolio remains strong, and we continue to thoughtfully grow. We are also continuing to focus on our mixed-use intensification program to our Smart Living residential brand, a name that will soon be synonymous with thriving massive planned communities for all Canadians. With that, I will now turn it over to the operator in addressing your questions.

[Operator Instructions] So first question comes from Sam Damiani.

I guess 2 questions for me. First off, just on the funding of the development program. Any plans to step up dispositions or other sources of capital raising in the near to medium term?

Sam. We are in the process of -- we're in negotiations with various entities to potentially joint venture some of our developments. Straight-up dispositions, I mean, they do happen. We don't, at the moment, have anything significant listed for sale, but we have quite a few now properties that are approved for intensification and we have interest from third parties to commit to those. So that's one of several capital raising initiatives that are going on right now.

Is that something that could sort of get across the finish line within the next 6 to 12 months?

Yes. Yes, it's been going on probably more than 6 months. It does take time, as you know. But I think for sure -- I mean, if it gets done, it will get time within the next 6 to 12 months, yes.

Okay. And these are sites where active construction would start in the near-term further sort of alleviating the stress on the REIT's balance sheet?

I mean it depends on everything, but one step at a time. Let's say, the joint ventures get completed, then together, of course, we would decide if we're happy with the conditions to proceed. But being an idea, obviously, doing the joint venture is to proceed, but certainly not going to commit a folly. We don't think it is, but it's obviously a long-term short, medium, and long-term program. It's not the only capital raising program, but it is one that's active. So I mean, we could sell outright sell sites, if we wanted to and thought that was the right thing to do. We're not trying venture them and not develop them. So these are 2 examples of capital raising programs. And obviously, we could also sell right sell retail. But that was so we don't have anything listed. So we are looking at these things every day, we are very committed to putting our balance sheet back where we were, and that's what we want. So we're arraying all of our options every day, and we will get there. It's just a question of which way or ways you're going to get there?

I understand. And just my second area of question is just on the fair values. Just wondering what your thought process was during the quarter. Obviously, given the spike in interest rates, even though they have come down a bit already, but in the context of the portfolio with the Walmart leases with long-term extensions at Flat Reds.

Well, I don't know if you're implying or I don't know what you're implying, but I'd say that the leases with Walmart are flatter or more flatter among the most valuable leases there are in retail in terms of their security and the value they bring to the center themselves. So we don't see them, we definitely do not see the value of those having gone down. Probably that they certainly held their own, new rates have moved, but the centers are busier than ever. And the role they're playing in their communities is increasing because, of course, people are shopping physically more and also because communities are growing and there's no retail growth for all intents and purposes in the markets that we're in. So it's just kind of like exponential. The centers are dominant, most of them in their marketplaces. And in fact, I think we alluded to the fact that we've got sort of a resurgence of new interest. So I don't think it's a very difficult moment in time to say that they go up, but they certainly didn't go down. And in terms of other reasons for values to go up or down, yes, we in a little bit of an uncertain time. And so we're looking very closely at the values of our properties where we're intensifying because obviously, things are a bit in flux right now. But that's temporary. I mean our intensification program is going to go ahead. It's just a question of doing it safely. So those properties values are increasing, but we're just -- we've increased a bunch of them already. We're looking at finding the right valuations for each one of the properties as they get approved or as they get close to getting approved. So hence, long winded way of just saying that's where we landed where we landed, Sam.

Fair to say that you basically -- with an absence of the transaction data points, this wasn't a compelling reason to move the needle in any big way.

Yes. I wish for you before you asked that question, and it was an eloquent way of saying what I said. Absolutely, there's not a lot in terms of data points. But intuitively, I think we'll see value increases in many of our properties where the approvals continue to come through. And I feel that our retail is very solid in terms of its current values and potentially could see some movement upward depending on background macro economics, but very solidly, I think, very in demand, I think we're quite liquid even in this marketplace with no data points.

Next question comes from Jenny Ma from BMO Capital Markets.

I dived a little bit late, so I apologize if my questions are repetitive to what you have discussed before. But I'm just wondering, philosophically, with rates having moved as much as they have over a short time period. Does it change your longer-term strategy in terms of how you think about advancing projects in your development pipeline? And then also how you think about the balance sheet because you've advanced a lot more unencumbered debt over the years to a pretty nice number now. But would you be a bit more tactical over the short term to sort of respond to rate? Or do you really view it as still I guess, transitional or something you can manage through without changing your philosophy on either development or the balance sheet?

I mean, for sure, we're going to forge ahead. We're not going to flinch in terms of the approval process. In terms of proceeding to actually go to market, we are looking obviously very, very carefully before we do that. And yes, with the cooling off of the condo market, obviously, we'll be looking at it with these new conditions in mind. I don't think it changes anything maybe long term for us. I mean, in meantime, we're operating our shopping centers. There's very few properties where we're deciding between building retail and building residential. So we'll continue to operate our shopping centers. We haven't really moved anybody. We have the right to move most of the tenants where we want to build, but we haven't actually given notice in many or most of those cases. So we'll continue to operate the shopping center and we'll make the move when we think it's safe to do it. But ultimately, we do think that we'll get there. And of course, there's a ying-yang with the interest rates. And that is that we hopefully will see some backing off of construction costs. And that doesn't mean there's no market, it just means that for a month or 2 that was seemingly personally no market. But there is a market for housing. And so it won't necessarily get -- a 40-story tower may not get sold out over a weekend, but may get sold out over 6 months or 12 months. And that's fine, something actually quite healthy about that. So we'll continue to forge on, but when it comes to pulling the trigger and actually building, we will be looking left and right and up and down and everything before we actually proceed. But nothing is going to change in terms of our efforts and our energies towards the intensification program.

So you in the pensions you talked about how the floating rate debt on the construction loans have impacted your development pipeline. Do you just sort of see it as something you have to absorb at sort of the developments and that you'll manage the balance sheet over the longer term appropriately? Or do that felt give you pause or cause you to renegotiate or change in negotiations in terms of how you underwrite rental rate?

Well, it's not all rental. I mean -- but yes, I mean, rents are -- okay. I mean it's obviously -- I mean, it's dynamic. So if it was all one way and rates are going up and cost sustain where they are, pricing is going down and demand is going down that equals, we're not going to proceed. But embedded in our pro forma, as always, these variables mature or the data points that you are referring to. And of course, we will if it makes sense, if the returns are risk-adjusted, interesting enough to proceed we'll proceed. But obviously, the equation has changed. But it doesn't mean that the equation doesn't -- isn't good enough to proceed it just we're not going to broadly proceed. We're going to impute at all and decide whether it's something we can proceed. But Remember, we're not buying land, we own the land. We're not out there acquiring new land at market or even in yesterday's market or today's market. We own it. We're operating shopping centers on them, and that was always the intention here. So we're not under pressure to proceed. And we're not -- we don't need to do anything. We'll do it if it's safe to proceed with all those variables that you mentioned in mind. We're not going to develop for the sake of development because we said we're going to sell whatever it is, $14 billion with development, just blidely proceed. We'll do it, but we'll do it carefully and thoughtfully and we'll get there just respecting mother nature.

And then what about on the balance sheet side? If and a big if the spreads between unsecured and secured persist, would you be willing to tap into your unencumbered pool to get some financing at slightly better cost over the short time period? Or is it you're still more committed to maintaining a larger unencumbered pool and leaning on the unsecured market?

I think -- Jenny, it's Peter. I think the latter is the case. Our strong preference is to continue with the strategy that we've employed now for several years, which is continuing to unencumber those properties as mortgages mature. And it's not necessarily only a financial decision, right? It provides the property, many of which or most of which are now subject to rezoning and intensification initiatives. It allows tremendous flexibility and convenience when choosing to take sections of that property off-line for development. So to have an abundance of those properties unencumbered, I think will assist our development program, certainly both in the short and in the longer term. Having said that, there is a bit of a disparity as you mentioned, between bond rates and mortgage rates. However, I think it's fair to say that we're very fortunate to have the support of the Canadian banking community behind us because there are other forms at least for us today of unsecured financing that we're pursuing and those other forms of financing are quite competitive with any secured mortgage-type financing alternatives that you can think about. So at least for now, given where spreads are in the bond market, I think we've said publicly that for now we're not assertively looking at the bond market, and we're pursuing other courses -- but those other courses aren't secured courses, there are other unsecured courses through the Canadian banking community. Does that help?

Okay. Yes, that's very helpful. And then turning to the Pico Land acquisition. I didn't see the numbers tied together, I think, in the MD&A, but it was the $16.6 million for the 38-acre piece. Is that correct?

Yes. That's correct.

That seems like a fairly low price for industrial land and in it's Pickering and there's different submarkets. But can you sort of talk about why that might be or what the opportunity is? Or just how that submarket may be a bit different than the ones that a lot of other players talk about probably on the West End?

Yes. I mean it's owned by the -- it was owned by the government. So we love the area. We think it's a little bit -- flew a little bit under the radar when we identified it a year ago. And yes, so we have a user, which you need to have to be able to buy this particular piece of land. So we were fortunate enough to have that and be able to buy this land. So the reason for the price is to do with, I guess, the government wanting to create activity, jobs and whatnot in Texas and open up this area. So it's called Setana everybody's heard about that area, maybe it's basically Pickering on the 407. So yes, it's an emerging industrial business part, we are on the highway there. Kubota is already there. There's some others under construction, and then there's us. So yes, we have other lands for industrial. We will be talking about those in future quarters. I'm sure where we're up to other potential industrial developments on some of our other properties. But this one, of course, is the first one. And we actually acquired it specifically for this business.

Can you expand on the need to have a user? Is that tied to the government? Or is it just that you [indiscernible]a user to the table?

Yes, you're not allowed to buy the land unless there's an actual operator or tenant. You can't buy the land and speculate on it. They didn't want the land to go crazy in terms of -- then they wanted businesses there on opening day. It's a criteria. It's a condition of acquiring the land. So yes, a user can buy it or a landlord or a developer can buy should they have a tenant. So yes, it's owned by IO Investment Ontario. And it's really -- it's all service that's really well kind of manicured industrial land ready to go basically just in the 95%. So it's really pretty cool. While the rest of the city is going crazy in terms of pricing, and this was reasonable and I think very strategic actually.

So is it a matter of just bringing a user? Because I mean, 38-acres is quite a bit. So is it just an opportunity to find other users to ultimately fill up that space and you start with one? Or I mean...

We're allowed to... Yes, you have to have a user to be able to buy the land. We were able to negotiate what we were able to wish. I don't think we would have been able to negotiate 138 acres, but we were able to sort of as part of the negotiation, I mean we didn't want to go there just to build on 10 acres. It wasn't sort of something that would maybe be something we would do. But through the negotiation, the government saw that it would fulfill their, I guess, their vision of creating assessment there and jobs by getting us started with the user that we had and allowing us to expand from there. So yes, we have surplus lands, but it's all within the parameters of the IO's visionary. Yes.

Okay. So this is a user that's third-party to you and the government?

Yes. So yes, absolutely third party. They're a tenant. And we are sort of anticipating that they'll want to -- need to expand over time and hence some of the extra land. And there's other interest, we have other interests from third parties, but we haven't buttoned it down yet. But the deal that we have with the third party had to be done before we were allowed to acquire land. So...

Now if I look forward, is this like a one-off opportunity that you guys had? Or does the government have more land that is sort of sellable to the market, assuming that the market for development is there to you or any other developers?