Vital Infrastructure Property Trust (VITLUN) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the NorthWest Healthcare Properties Real Estate Investment Trust First Quarter 2023 Results and Conference Call. [Operator Instructions] This call is being recorded on Friday, May 12, 2023. I would now like to turn the conference over to Paul Dalla Lana, Chairman and CEO. Please go ahead.

Thank you, operator, and good morning, everyone. I appreciate you joining us today. I'm joined by Shailen Chande, the REIT's Chief Financial Officer. Together, we are pleased to share with you our results for the first quarter of 2023. But first, I'd like to point out that, during today's call, we may make forward-looking statements as defined under Canadian securities law. While such forward-looking statements reflect management's expectations regarding our business plans and future results, they are necessarily based on assumptions that are subject to uncertainties and risks, which could cause actual results to differ materially. We direct you all to the risk factors outlined in our public filings. And now to the quarter. Our global portfolio of health care real estate continues to differentiate itself from the broader commercial real estate landscape, with 83% of our leases subject to indexation and delivering strong SPNOI growth of 4.4% from an exceptionally stable cash flow profile that is highly diversified and supported by 97% occupancy and a weighted average lease term of 14 years. In the first quarter of 2023, revenue and net operating income both increased by 30% and 25%, respectively, over prior year. However, as a result of higher interest rates, temporarily elevated leverage and lower transaction volumes within the REIT's capital platforms, AFFO per unit declined to $0.17. During the quarter, the REIT implemented a hedging program to fix the interest rate on $900 million of floating rate, foreign currency debt, and for the part of the quarter, the hedges were in place the REIT achieved interest savings of approximately $4 million. Beginning in Q2 2023, the full quarter impact of hedging will result in an incremental interest savings of approximately $0.02 per unit. And over the course of 2023, the collective impact of hedging activities, the U.K. and U.S. joint ventures and noncore asset sales previously announced, are expected to increase per unit AFFO by approximately 20% relative to the current quarter run rate. Our previously announced U.K. JV is progressing well with the REIT securing an investment from an institutional investor to acquire between 70% and 80% of the net equity in the REIT's portfolio. The commitment is subject to final documentation and is expected to close on or before June 30, 2023. Similarly, the REIT's U.S. joint venture initiatives continues to progress, and the REIT remains actively engaged with qualified partners and is working toward commercial terms. Completion continues to be expected in the second half of 2023. The REIT is also pleased to provide an update on its noncore sales program announced last quarter, which has been expanded to include approximately $340 million of properties and is progressing well. The first sale is expected to close on May 31, with the balance of sales expected to follow over the course of Q2 and Q3. Net sales proceeds will be used to repay higher cost debt and are expected to be accretive to AFFO per unit. Inclusive of the noncore sales program, its U.S. JV and the U.K. JV initiatives, the REIT expects to generate between 550 and $600 million of net proceeds in 2023. These proceeds from the above-noted initiatives will be deployed towards reducing variable rate debt repayment on an accretive basis. The REIT remains highly disciplined with respect to capital deployment, and as a result, in Q1, acquisition volumes were muted. That said, the health care real estate market continues to adjust to the rapid change in global interest rates over the last 12 months, with bid-ask spreads beginning to converge and transaction volumes starting to return to prior levels. The REIT remains particularly focused on its health care precinct initiatives. And in particular, it's developed a core fund, which it expects to advance significantly in Q2 and Q3. These are attractive long-term investment opportunities in all of the REIT's markets, which will allow it to pursue and grow its business in the highest quality segments. From a balance sheet perspective, at March 31, 2023, the REIT reported debt to gross book value, including convertible debentures of 57.6% on a proportionate basis. Subsequent to quarter end, the REIT issued an $86.3 million convertible debenture, net proceeds of which were used to repay short-term variable rate debt on an accretive basis. With the successful issuance of the convertible debenture, the REIT has increased its exposure to fixed rate debt, including its in-place hedges to 64%. It refinanced 76% of its 2023 debt maturities and reduced its weighted average interest rate to 4.7%. Considering the approximate $340 million of noncore asset sales and the U.K. and U.S. JVs and associated debt repayment, the REIT anticipates proportionate leverage decreasing by almost 1,000 basis points to 47%, which is in line with its long-term target. Segmentally, I note the following. In Canada, we were on plan with portfolio occupancy remaining stable at approximately 90% and seeing our variable revenues, particularly through parking, continue to rise to pre-COVID levels. Additionally, our Jerry Coughlan Health and Wellness Center development anchored by Lakeridge Health Hospital achieved substantial completion in early Q2. We also continue to make progress on a number of life sciences ambulatory care and health care precinct initiatives, which are gaining momentum and expected to become part of the business in the near future. In the U.S., our portfolio is performing as expected with occupancy at 96% and an almost 9-year weighted average lease term. Our team has successfully integrated the assets acquired approximately 1 year ago and respective management platforms and continues to work closely with our health care tenants and progress on new and renewal leasing activities. In Brazil, we were on time with steady 100% occupancy and continued strong constant currency SPNOI of 6.5%. Operationally, we note that the REIT's major tenant in Brazil, Rede D'Or, continues to deliver exceptionally strong results and is among Brazil's top 10 companies by market capitalization. Europe continues to perform well with occupancy and weighted average lease term stable at 97% and 16 years, respectively. We continue to find good opportunities -- investment opportunities in Europe, allowing us to not only increase scale and critical mass in our existing markets, but also to consider opportunities in adjacent markets. And finally, in Australia, our largest market, occupancy remained steady at nearly 100% and delivered constant currency SPNOI growth of almost 8%, with weighted average lease term of more than 15 years. I'm pleased with the progress we've made during the quarter and post quarter, which advanced the REIT's strategic objectives and produced solid operating results. With deep strategic relationships, best-in-class regional operating platforms and strong access to capital through existing commitments, the REIT continues to transition to a more asset-light business, a best-in-class global health care real estate investment manager. And with that, I'll now turn it over, and ask the operator to open up for questions. Thanks.

[Operator Instructions] Your first question comes from Mike Markidis with BMO Capital Markets.

If I could just start off on the fair value loss that you booked. Perhaps you can give us a little bit more color by region. The reason I ask is just that, I think if we look at the disclosure, it looks like at least in your equity accounted JVs, the values were flat in Australia -- were relatively flat in Australia and Europe. And I think you noted that the values were up in Brazil. So should we infer that the bulk of the negative adjustment would then be the U.S., Canada and the U.K.?

Yes. Michael, I can take that. Yes, that's indeed correct. I note that, on an aggregate basis, our weighted average cap rate expanded by about 10 basis points to 5.5% or so, and the majority of that widening and weighted average cap rate was across the Americas and European platforms.

Okay. Great. So you guys got the -- you did the [ converge ] first quarter, congrats on that, to paydown some more high-cost corporate debt. If we just look at the variable rate corporate debt, how much is the REIT left with after that transaction? And how does the cost on what's left? Because I think you have different tranches and costs compared to the 9.3%. And then the last question for me is just with all the capital repatriation with the U.K., the asset sales and the U.S. JV expected sort of throughout the course of this year. Do you think that you can get the corporate debt down? I mean, excluding the [ converge ] your variable rate corporate debt down to 0 by the end of this year.

Yes. Yes, Michael, I'll take that one as well. So I think your first question, I think the crux of that was with the use of proceeds on the convertible debenture issuance. So the full $86 million where we successfully had the overallotment exercise was used to repay 2 different facilities at the corporate level, and we did achieve that weighted average interest rate of 9.3% in terms of the repayment. So that was as planned. As we talk through our broader initiatives in 2023 between the noncore asset sales, the U.S. JV initiative, and most imminently, the U.K. JV initiative, Paul referenced that $550 million to $600 million of net proceeds and all of that will be used to repay corporate level financing. Some of it may fall within the corporate segment, some may fall in other regional segments, but we do expect to be -- I mean, using the majority of those proceeds to significantly delever and it will take down our floating rate debt exposure to less than 30%.

Got it. Okay. And then just last question for me before I turn it back. I guess the U.K. JV is progressing as anticipated. It's only been 6 weeks, I think, since we last talked. So no changes there. Maybe just with respect to the US, I think the verbiage that you guys talked to put forth in the press release and the MD&A hasn't changed much as well. But maybe, Paul, if you could just explain a little bit how that process is going and if there's been any change or puts and takes with respect to the conversation with the parties at the table as it relates to the U.S. JV.

Yes, thanks. So maybe 2 things I'd just call out that we are planning for the U.S. JV in the second half of 2023. So that hasn't changed. I think in terms of the climate for taking the decision, which is really providing both stability in, I guess, initially in interest rates, but then more directly in asset prices, we're seeing enough transactional activity in the U.S. and -- with our partners and the people that we're talking to that we believe there will be sort of a comfortable level to transact at and a willingness for people to start to reinvest and look at long-term opportunities. Again, health care continues to screen reasonably well in terms of our capital partners sort of at the margin decision. So we're confident that both price and willingness to deploy capital, our focus is certainly is to identify opportunities where we can bring some growth capital to the initiatives. So that's what we're concentrated on right now versus, let's say, a co-invest possibility, and that would be consistent with prior initiatives that we've done in other markets, so.

Okay. And then I -- sorry, just one last one before I turn it back. I think you guys -- one of the assets that you're selling is in the U.S. Maybe just give us some comments in terms of how that property didn't fit with the overall strategy in the U.S.

Yes. So the specific property is the Bakersfield Heart Hospital. And I wouldn't say that it didn't fit fundamentally. What happened is that we had a tenant that wanted to acquire it. They were a not-for-profit and didn't -- and weren't able to contemplate a co-ownership situation. So we're able to find agreeable terms to sell it to this tenant, which is an outcome that happens sometimes. I think what we've also been able to secure is an opportunity set with them on broader real estate opportunities. And so we continue to explore sort of the opportunity to grow with this organization, which is a great tenant, but ultimately, one that wants to and needed to own their real estate directly. So a little bit of backdrop to that. As we mentioned, we're happy with pricing. And again, it wouldn't have been our first decision to exit a good relationship with a good long-term partner. But in this case, it was one that makes sense.

Your next question comes from Tai Woolley with National Bank Financial.

Just wondering on the portfolio of the assets held for sale, can you give us some estimate of the NOI attributable and what secured debt is held against it?

Yes. Tal, I can get more specific on the NOI. It does fit in a couple of different segments. So I mean, it's broadly in line with our IFRS cap rate. It's -- the assets are broadly spread across the portfolio. So I use that 5.5% as a blend. In terms of the secured debt associated with those portfolios, I look to the liabilities held for sale number on the balance sheet, and I think that represents the direct secured level of financing.

Okay. Perfect. And I guess, like your goal here through all these steps with the joint venture creation and noncore sales, the idea is to obviously move the -- your debt ratios down into the 40s. I'd also say, though, like historically, you guys have been very healthy acquirers going forward. And I was just wondering, it's like should we be thinking of like this, 40 level, or the -- your target in the low-40s, that's kind of like the trough because we should expect at some point, particularly if you're starting up a new JV, to begin acquiring more properties again?

Yes. That's a great question, Tai. And the answer is no. I think we are looking to be sort of permanently in the mid-40s in terms of leverage. I think the answer to how we grow comes from becoming increasingly more capital light. So we continue to have a lot of assets on balance sheet beyond the U.S. and U.K. assets that are slated to go in. And then we see that being able to fund certainly the majority of any incremental capital that goes into growth in the future. So that's sort of our plan. And again, sitting here at sort of just over 50% mark look through ownership. I think the target is in the mid-20s. So I'm on that to guide and again, through all regions and all sub-asset classes.

I guess maybe just more generally on the pace. Would you say that like the dollars of asset growth, you're sort of targeting going forward, is maybe a little less than where it's been in the past?

Yes. I think that's certainly for 2023. That's absolutely fair. I think we continue to be, as we've said, cautious about the market. And maybe what I would say in all that, what we haven't seen is things go opportunistic, which might get to a different answer. What we have seen broadly in health care real estate is strong support for existing asset prices and things that are, again, making those prices work within the construct of today's interest rates and return expectations hasn't screened enough to be opportunistic where we would grow beyond that. That said, we have almost $5 billion of kind of 100% debt and equity committed capital in the business as capacity plus what we bring in the U.K. and the U.S. So certainly, we'll be well primed to add over time. It's unlikely that everything matches up perfectly, but we're hopeful that the first direction here will be moving in a more asset-light direction and we see pacing of acquisitions picking up in 2024 fundamentally as the markets come to that equilibrium moment. So our prediction is sort of the first half of 2024, we start to get visibility, comfort maybe around some of the inflation trends. I think that translates into long-term rates, and then ultimately, into values and starts to get to a comfortable equilibrium point in asset [ markets ], which is not the case today. But again, underneath all of that, we continue to see demand for health care real estate assets at exceptionally strong levels. I'd call out the recent MPT transaction on the Healthscope assets in Australia. I think we mentioned that in our last call, but again, that's a very strong look through cap rate on assets that we have, the other half in our portfolio, in our view, the better half, just to be clear. But nonetheless, super strong pricing there. We've seen major transactions happening in Europe at essentially book value or IFRS book value on significant portfolios. And of course, the U.S. is probably the most active of all markets where we started to see that equilibrium come in. So we are getting a sense that maybe we're starting to turn the corner in things. But again, for us, we're not budgeting a super active 2023 in terms of growth outside of some of the developed core initiatives that I've mentioned. And it would be a 50%-ish number to what we've done in prior years as an idea.

Okay. And then just lastly, maybe you can give an update on Australian Unity and where you stand with that? If you can just remind us like what's your current position, how are you holding your position on that? I believe there's a put-call derivative in there? And has there sort of been any movement in terms of resolving that and is this the position you plan to hang on to for the long-term?

Yes, it's a great question. You're probably about a quarter ahead of us, wanting to get fully ahead of it. We do have a pretty active legal process running there just to be direct to the point, which has sort of Q2, early Q3 time lines to it. So I think we'll be in a slightly better position to talk there. But we do like the assets there, and we are sort of committed to growing in Australia with our partner, GIC. So I would just say that I'll leave it there for now. But I think there'll be more visibility on things coming over the next couple of quarters.

And that's a situation where like, if I recall correctly, when you first got involved like you tried to tender to -- or you tried to make a tender offer to shareholders, is it that kind of mechanism that you would have to use to try and increase your position there? Or is there sort of a negotiated solution that you can kind of come up with?

I can't speak to that, but I'll just say that we're the largest shareholder of Australian Unity with our partner at about 18% of the vehicle. And I think all levers are on the table for bringing it to a positive outcome.

[Operator Instructions] Your next question comes from Pammi Bir with RBC Capital Markets.

You mentioned potentially using some of your excess liquidity towards unit repurchases. I'm just curious, how do you balance that? Maybe how active do you expect to be? And how do you balance that story with respect to your debt reduction initiatives?

Yes. It's a great question, Pammi. So I think, first off, we're prioritizing debt reduction as our primary initiative, so it would be secondary to that. And I think, again, it's a practical consideration in the moment of the market disconnect that we're having. So we haven't set specific targets or objectives ahead. And I think it's, again, a secondary initiative. But if things continue to be dislocated for a period of time and if we are successful in managing all of our initiatives, which, we expect to be, it will be a real consideration for us. I mean, it's not what we want to do. But if the market continues to be substantially disconnected for NAV, we have the tools to consider that.

Right. Okay. And then just on the U.S. JV, what sort of your expectation as to where -- I realize, obviously, this is still a negotiation process. But where do you see potential transaction relative to your IFRS book value at this stage?

Yes. We're seeing the market in -- within 5% to 10% of [indiscernible] book value. And I think, as I mentioned before, there's a lot of data points in the U.S. for what we would do, again that's against the backdrop of a JV with some of the attractive features that we like to have, which is long-term capital commitments and appropriate fees and structure to it. So again, that's some of the things that we're seeing out there, and we think that market is reasonably deep.