Good morning, ladies and gentlemen, and welcome to the Automotive Properties REIT third quarter results conference call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Wednesday, November 14, 2018. I would now like to turn the conference over to Milton Lamb, Chief Executive Officer and President. Please go ahead.
Great. Thank you, Joanna. Good morning, and thank you for joining us. With me today on the call is Andrew Kalra, our Chief Financial Officer. Our financial statements and MD&A for the quarter are available on our website and on SEDAR. Please be aware that certain information discussed today may be forward-looking and that actual results could differ materially. We will also be discussing certain non-IFRS measures. Please refer to our SEDAR filings for additional information on both our risk factors and non-IFRS measures. Our Q3 results demonstrate continued growth in all of our key financial performance metrics. Property rental revenue in the quarter increased by 11.7% from Q3 of 2017. Cash NOI was up 11.9%. Our 1.4% growth in same property cash NOI reflects the steady organic growth we generate from contractual rent increases.
Funds from operations and adjusted AFFO were up 4.1% and 5.3%, respectively, from Q3 of last year. Both FFO and AFFO were up slightly. During the quarter, we completed the CAD 55.5 million acquisition of two automotive dealership properties in major metropolitan markets for AutoCanada, one of Canada's largest and leading owners and operators of automotive dealerships. The two properties include the BMW Laval Automotive dealership property located in Laval, Quebec, part of the metropolitan Montreal area, the Sherwood Park Volkswagen property located in Sherwood Park, Alberta, part of the Edmonton metropolitan area. This continues our focus on the major metropolitan markets. Our portfolio is now approximately 89% in the VECTOM markets. These additions of these properties are expected to be accretive to the REIT's run rate of AFFO per unit on a leverage-neutral basis. BMW Laval was built in 2000 and substantially renovated in 2011 and 2012.
It includes 127,000-foot-plus full-service BMW dealership facility and a MINI dealership. It is located on 8.4 acres along a major retail arterial road, surrounded by high-end dealerships and mid-density residential. Sherwood Park was built in 2015 and includes a 49,000 full-service Volkswagen dealership located on approximately four and a half acres, with convenient access to the Yellowhead Highway in an area of substantial commercial development. Affiliates of AutoCanada are now the operating tenants of these properties, have been entered into an 18-year triple-net lease with the REIT. These leases include contractual annual rent increases after the third year of the lease that is based on the consumer price index. AutoCanada Holdings, Inc. will provide an indemnity to the REIT with respect to all the lease obligations.
We're pleased to complete our first acquisition with AutoCanada, highlighting our focus on partnering with leading automotive dealership operators that are active in the consolidating industry. Our portfolio now includes four of the top dealership groups in the country, including the top three groups by dealership franchise count. Concurrently with the transaction, we announced that we entered into an agreement to sell 5.1 million units of the REIT on a bought-deal basis for gross proceeds of approximately CAD 55.1 million. This offering was successfully closed on October 16th. We used the net proceeds from the offering to repay the debt incurred to fund the AutoCanada properties transaction, positioning us well for future growth. Looking ahead, we remain focused on taking advantage of the dealership industry consolidation, expanding our property portfolio in the metropolitan markets across Canada while increasing AFFO in support of the unitholder distributions.
I'd now like to turn it over to Andrew Kalra to review our results and financial position in more detail. Andrew?
Thanks, Milton. Good morning, everyone. Property rental revenue increased to CAD 11.8 million in the quarter, up from CAD 10.6 million in Q3 last year, reflecting continued growth from property acquisitions and contractual rent increases across most of our portfolio. Total and same property cash NOI for the quarter were CAD 9.3 million and CAD 8.4 million, respectively, representing growth of 11.9% and 1.14% compared to Q3 a year ago. Cash NOI growth was attributable to acquisitions completed subsequent to Q3 last year, as well as contractual rent increases, which also drove growth in our same property cash NOI. G&A expenses for the quarter were approximately 7.3% of our cash NOI, compared to 6.9% in Q3 last year. The slight increase was attributable to non-cash compensation expenses related to the REIT's equity incentive plan and other costs. Net income for the quarter was CAD 5.7 million, compared to CAD 12.7 million in Q3 last year.
The variance was primarily attributable to the change in the fair value adjustment for Class B LP units, partially offset by NOI growth, changes in fair value adjustments for interest rate swaps, and investment properties. FFO for the quarter was CAD 6.7 million, or CAD 0.249 per unit diluted, up from CAD 6.4 million or CAD 0.244 per unit in Q3 last year. AFFO totaled CAD 6.1 million or CAD 0.228 per unit, up from CAD 5.8 million or CAD 0.222 per unit. FFO and AFFO growth was primarily due to the impact of the properties acquired subsequent to September 30th last year. The REIT declared and paid total distributions of CAD 5.4 million to unitholders in the quarter, or CAD 0.201 per unit, representing an AFFO payout ratio of 88.2%, down from 90.5% in Q3 last year.
There were fair value increases of CAD 1.5 million and CAD 6.5 million to the REIT's value investment properties for the quarter and year to date, respectively. These increases resulted primarily from cap rate compressions in Vancouver and Calgary and overall NOI growth from contractual rent increases. The assessment by the REIT of the overall portfolio resulted in an implied capitalization rate of 6.5%, which is consistent with year-end 2017. Valuation inputs are supported by quarterly market reports from an independent appraiser. I'll conclude with a review of our liquidity and capital resources. Over the last year, we increased and extended all three of our credit facilities. These transactions have further insulated us from potential interest rate movements and significantly enhanced our financial flexibility and acquisition capacity.
In the quarter, we increased the amount available under the revolving portion of facility three to CAD 43.9 million in order to close the BMW Laval and Sherwood Park Volkswagen acquisitions. The REIT had CAD 339 million outstanding on its credit facilities at the end of the quarter, with an effective weighted average fixed interest rate on debt of 3.48%. The REIT's debt to GDV was 53.1% at quarter end. Following the closing of our equity offering in mid-October, the net proceeds were used to pay down the debt incurred to fund the BMW Laval and Sherwood Park Volkswagen property acquisition, reducing our overall debt by CAD 52.4 million. The two properties remain unencumbered. We are well-positioned to continue our growth, AFFO per unit with our embedded contractual rent increases, mid- to long-term interest rate certainty, strong liquidity position, and the continued advancement of our growth strategy.
I'd like to turn the call back to Milton for closing remarks.
Thanks, Andrew. We're pleased with our continued growth in revenue, NOI, FFO, and AFFO, as well as the steady growth in our portfolio's NAV, demonstrating strong underlying value creation for our unitholders. The success of our acquisition program has played a large role in this, along with our stable long-term leasing profile with contractual rent escalators, disciplined financial management, and our demonstrated ability to access capital to drive continued growth. Our transaction with AutoCanada in the quarter was strategically important to us and further raises our profile within the Canadian automotive dealership community. Again, we now have four of the top Canadian dealership groups in our portfolio. Our equity offering further enhanced our liquidity and grew our market capitalization to over CAD 300 million, continuing the strong momentum since our IPO just over three years ago.
We remain confident in our outlook and focused on continuing to strengthen our portfolio by capitalizing on accretive consolidation opportunities, growing our cash flow in support of unitholder distributions, and building long-term value for our unitholders. This now concludes our remarks, and we would now like to open up the line for questions. Joanna, please go ahead.
Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Should you have a question, please press the star followed by the one on your touch-tone phone. Should you wish to decline from the polling process, please press star followed by two. If you are using a speakerphone, please lift the handset before pressing any keys. Your first question is from Jonathan Kelcher from TD. Jonathan, please go ahead.
Thanks. Good morning.
Good morning, Jon.
First question, just on the AutoCanada. I'm sure you saw that they're looking to do more in sale leasebacks. Can you maybe give any sort of commentary on that, to the extent you're able?
Sure. We've had discussions with them for years, including the successful one last quarter. We certainly don't comment on rumors. We continue to focus on major metropolitan markets. Certainly enjoy a good relationship with them, but can't really comment on that deal.
Okay. You said in your remarks that the deal raised your profile. Has it helped to push along or open up any more discussions with other dealership groups?
Opening up a bit. Advancing? Yes. Certainly, the more deals we do with groups that are non-Dilawri, the more that the dealership community understands that we are there to be utilized for their growth strategy and consolidation strategy, and that certainly helps.
Okay. Then just secondly, on your development, it looks like you're mostly done your spending on that.
Yeah.
You've turned it over to the tenant. When does that start paying rent?
I guess two comments there. One is the remaining spend we have is the tenant inducement, once they've completed work. Everything else we have completed on time, on budget. To your question, they should start paying rent in mid-January. Not should, they're obligated to start paying rent in mid-January.
When would your remaining CAD million and change sort of go to them for the fit out?
It depends on their timeline, but I would think sometime in Q1.
Okay, thanks. I'll turn it back.
Thank you. Your next question is from Brad Sturges from Industrial Alliance. Brad, please go ahead.
Hi, good morning.
Good morning, Brad.
Just following up on Jonathan's question about your discussions with other dealership groups. I guess, where are you seeing the most traction right now or the change in that dialogue? Is it with the smaller, the mid-tier groups that are progressing along on changing their business strategy, or maybe give a little context in terms of the dynamics of the conversation, how that's evolving?
Sure. It kind of straddles. What we're seeing is some of the small to mid are either deciding to look at potentially exiting. Those are either being bought by other small to mids who want to grow in scale, or certainly the larger automotive dealership groups are still looking at the right opportunities, and still want to be active in that consolidation world. It's a bit, when you're talking to small to mid, are they looking at ramping up? Are they looking at taking advantage of consolidation availability to actually exit and take some profits and go? We're probably talking to more of the groups that are on the consolidating side, and they can range from the kind of small to mid, up to the large.
There's still more exploratory discussions from these types of groups, or are they more advanced than that at this stage?
It's across the board.
Okay.
Some of these deals take a lot longer than traditional real estate deals because it's alongside of operations deals. It's varied, and you'll see some deals that you think are getting close to the end, and they take a pause. Other deals are a hurry up offense. The AutoCanada deal that we completed, that was probably about three and a half weeks from handshake to close. About 48 hours between, "Would you be interested in these assets?" to, "Yes, let's close it.
In terms of your balance sheet and thinking about leverage, are you still targeting long-term on sort of mid-50s leverage?
We're comfortable in that range because we have a very clean bottom line. We don't have TIs, we don't have vacancy, we don't have CapEx. Yeah, we're still comfortable in the mid-50s.
Got it. Okay, great. Thank you.
Thank you. Your next question is from Matt Logan from RBC Capital Markets. Matt, please go ahead.
Thank you. Good morning.
Good morning, Matt.
Just following up on Brad's question on leverage. Understanding that you're comfortable in the mid-50s range, where would you expect leverage to average over the course of 2019 in terms of capital deployment?
With the most recent equity offering, obviously, we have some capability to go out there, and we plan to go out there and do acquisitions. It really depends on our pace of acquisitions. That's a really hard question to answer without kind of pinning what quarters and what months we're doing the acquisitions on. I think it's comfortable to say that in that mid-50s, we're certainly comfortable at that level. It's just how quickly we get there on the acquisition side. We probably went with a bit of a larger raise this time because we like what we're seeing in the marketplace.
Okay. Fair enough. For modeling purposes, how should we be thinking about the cap rate on the AutoCanada acquisition?
We've been doing deals at approximately 6.6% to call it 7.5%. The interest rate market, the fact that I really like that BMW Laval property, and Edmonton remains solid, and you can argue that very easily that Alberta's coming back nicely. I would say it's in the lower end of that range, it's certainly not hitting a new low by any means.
Fair enough. As we think about cap rates, your IFRS cap rate has been effectively constant since the IPO. How would we think about the IPO portfolio cap rate compared with changes in portfolio composition over the last few years?
Obviously, we've ramped up a bit more in Montreal and Edmonton. They would be a higher cap rate than would be a Vancouver and arguably, a Toronto. It's a bit of a blending, as you can imagine. The Vancouver reduces that cap rate average, and rightly so. It's very tough to buy in Vancouver right now. Really, it does depend on the markets you're looking at. As I mentioned, we continue to like focusing on the majors and especially the VECTOMs.
I guess put differently, it would be fair to say you've seen cap rate compression for the IPO portfolio, but portfolio composition changes have basically kept it flat.
Yeah. We moved up over time our Calgary cap rates, and on the last quarter, we pulled it back just a bit. Vancouver and Toronto, it's really hard to argue that over the last three years you haven't seen cap rate compression, and we've certainly seen that in our portfolio valuations.
Indeed. Last question from me, just on Dilawri's rent coverage and trailing 12-month EBITDA. That's declined over the last couple of quarters. Can you maybe provide any color on that?
Whether it's Dilawri or conversations we've had with the different dealership groups across the country and just the industry overall, after record years in 2015, 2016, and 2017, there was certainly a bit more inventory and expectations put on dealerships, which means probably a higher inventory. With the higher inventory, it probably means higher gross sales, but arguably lower margins. A bit of a pendulum swing. It'll be interesting to see what the manufacturers are asking dealers to take next year. I would think the record year-over-year-over-year that is now kind of plateauing, we're off a bit, but we're off to what used to be record numbers in 2017. I think the next few years will be very stable, a bit of plateauing. Whether it's Dilawri or otherwise, I think this year you've seen tighter margins across the dealership community.
From our world, those are profitable margins, so that means we still get paid rent.
Yes, the rent coverage still remains very healthy.
Very healthy. The industry remains very healthy.
That's a great color. All from me. Thank you very much.
Thank you. Your next question is from Tal Woolley from National Bank. Tal, please go ahead.
Hey, good morning.
Good morning.
Wanted to talk a little bit about credit availability for the dealers. I'm just wondering, obviously, the industry is still running very hot, but it has cooled off a little bit. I'm just wondering for the dealers, what is their credit availability like from their local banks and stuff like that as the cycle might turn? I wonder if you've got any sort of historical commentary, because it seems to me like this would sort of be an opportunity too for you to replace some of that financing, if the industry continues to cool a bit.
Yeah. I smile at the cooling because when you go
Yeah
red hot to red hot, you're cooling. It's probably not a bad place to be.
Yeah.
From our understanding, we certainly talk to a lot of the same banks that finance a lot of the dealership groups because they're part of our various lending syndicates. They still remain very interested in lending in the marketplace. I would say that's not an exact answer to your question, but one thing that does happen is we are more of a resource when people are looking at M&A and taking equity off the table to do other acquisitions.
If they are looking at our cost of capital compared to their cost of capital, we probably have the ability to push through interest rate increases because it's apples to apples, versus if we're just knocking on a door to buy real estate in just a pure and isolated basis. When we're talking about the effect of interest rates going up over the last two to three quarters, they understand that conversation implicitly. It doesn't include a lot of explanation, which is good.
Okay. Just lastly, in your conversations with Dilawri right now, any sense of what they might have available in asset sales over the next 12 months?
Yes, obviously they have to, within 90 days, and that can be 90 days before or 90 days after, on either developments or acquisitions, provide us that right of offer. We certainly understand what their portfolio is, they have not disclosed and not put anything publicly on when and what they're doing with their developments they're doing. They continue to be on the same sort of pace of five to six assets a year of new acquisitions or new open points, including which approximately half of those would include real estate. They certainly focus on the markets that we like, the metropolitan markets. We're very happy we still have that relationship very strong.
Okay, that's great. Thank you, Milton.
Thank you. Your next question is from Mark Rothschild from Canaccord. Please go ahead, Mark.
Thanks. Good morning, guys.
Good morning, Mark.
Maybe just following up on a question you were just answering. In regards to interest rates increasing, were you saying that you're able to get a little bit higher cap rate going in on deals, or are you able to maybe negotiate better lease increases? Just want to make sure I understand that.
There's only a few levers that we have, so it's either the price or the rent increases. I think the conversation to Tal's part of the question is, does this mean there's going to be more availability because money is no longer free for dealers? I would say the answer is, we would think yes, I think that helps us. On the pricing, as it is a flow-through, whether it's on their leverage or on, in some ways, our leverage, and we charge them rent, it's an easier conversation to explain why we need certain returns. To your comment on rental escalations, you'll notice on the AutoCanada, the CPI is a good thing. We're starting to look at mixing up our leases between contractual hard-coded rent increases and some that float with CPI.
Okay, great. Just in regards to the property taxes, which seem to be a little higher this quarter, is that just something we should kind of expect that it's going to jump around quarter to quarter, or is there anything specific now?
Yeah, it'll jump around quarter to quarter in terms of how they're billed, and that's how we account for it. We do accrual on a quarterly basis, but sometimes there'll be timing differences.
Understood. Okay, great.
At the end of the day, it ends up being a flow-through.
It's a flow-through.
Right. Yeah, no, I understand.
Yeah.
Yeah. Okay, thanks.
Thank you, ladies and gentlemen. As a reminder, should you have any questions, please press star one. Your next question is from Pammi Bir from Scotia Capital. Please go ahead.
Thanks. Good morning. Just as you look at some of the players at the table on transactions, have you noticed any change in who's there and maybe just some commentary on who you're seeing at this stage?
On the table as in buying audience?
Yeah, just who are you bumping up in terms of when you're bidding on acquisitions? Has there been more interest in this space from other financial players or, again, the dealership owner base?
Yeah, it still remains pretty quiet on competition. We've talked before that Brookfield with Capital Automotive they've popped their head up once or twice this year. On the institutional side, we're not seeing it. On the private side, we rarely see it. Certainly dealers, especially with the availability of bank financing, can often decide to keep it on their own balance sheet. I think that's easier for them to do when they're buying one deal at a time and slowly growing. If the pace picks up or they're looking at small to mid-size portfolios, those are bigger tickets to do. Really, it's still the dealers owning their own, and then, we don't really run into bid situations.
Great. That's it for me. Thank you.
Thank you. At this time, we have no further questions. You may proceed.
All right. Well, thank you, everyone, for joining us. We look forward to talking to you shortly. All the best.
Ladies and gentlemen, this concludes today's conference call. We thank you for participating, and we ask that you please disconnect your lines.