Good morning, and welcome to Automotive Properties REIT 2022 Q2 financial results conference call. My name is Sylvie, and I will be your conference operator today. At this time, all lines are in a listen-only mode. Following management's remarks, we will conduct a question-and-answer session. Please be aware that certain information discussed today may be forward-looking in nature. Such forward-looking information reflects the REIT's current views with respect to future events. Any such information is subject to risks, uncertainties, and assumptions that could cause actual results to differ materially from those projected in the forward-looking information. For more information on the risks, uncertainties, and assumptions related to forward-looking information, please refer to the REIT's latest MD&A and annual information form, which was available on SEDAR. Management may also refer to certain non-IFRS financial measures.
Although the REIT believes these measures provide useful supplemental information about financial performance, they are not recognized measures and do not have standardized meaning under IFRS. Again, please refer to the REIT's latest MD&A for additional information regarding non-IFRS financial measures. This call is being recorded on Tuesday, August 16, 2022. I would like to turn the conference over to Mr. Milton Lamb. Please go ahead, sir.
Great. Thank you, Sylvie. Good morning, everyone, and thank you for joining us today. With me on the call is Andrew Kalra, our Chief Financial Officer. We continued our track record of solid financial performance in the Q2 with growth in all of our key performance measures. Compared to Q2 of last year, property rental revenue grew by 6.5%. Cash NOI increased by 6.7%. Same-Property Cash NOI was up 2.3%, excluding bad debt recovery from last year. AFFO per unit diluted increased to 22.9 cents, up from 22.1 cents. Our valuation of investment properties remained consistent with our prior quarter.
The capitalization rate applicable to our portfolio was 6.3% at quarter end, up from 6.25% at the end of Q1, as NOI increases from the investment properties were offset by adjustments to valuation and points to reflect the current market conditions, including rising interest rates. In April, we also extended one of our credit facilities to 2027 and increased the non-revolving portion to CAD 226.3 million, retaining the same credit spread. We subsequently entered into interest rate swaps that reduced our interest rate risk. We have strong liquidity. At quarter end, we had CAD 24.2 million of undrawn credit facilities and 10 unencumbered properties with an aggregate value of approximately CAD 122.3 million. Our debt-to-GBV ratio at quarter end was 41.2%.
With our solid balance sheet and the annual contractual rent increases across our portfolio, we're well positioned to continue delivering solid financial performance to unitholders while pursuing attractive acquisition opportunities. According to DesRosiers Automotive Consultants, new light vehicle unit sales in Canada were down 11.8% in the H1 of 2022 compared to the same period of last year. This was primarily due to the supply chain constraints experienced within the retail automotive industry. We believe these supply chain constraints will continue into the foreseeable future and will not have a significant impact on our tenants' ability to pay rents as new car margins, used car sales, and overall service levels remain strong. I'd now like to turn it over to Andrew Kalra to review our financial results and position in more detail. Andrew?
Thanks, Milton, and good morning, everyone. Our property rental revenue for the Q2 totaled CAD 20.8 million, a 6.5% increase from Q2 a year ago, reflecting growth from properties acquired subsequent to Q2 last year in contractual annual rent increases. Total cash NOI and same-property cash NOI for the quarter totaled CAD 17.1 million and CAD 16.1 million, respectively, reflecting increases of 6.7% and 2.3% compared to Q2 a year ago. Growth in cash NOI was primarily attributable to acquisitions and contractual rent increases. Growth in same-property cash NOI primarily reflects contractual increases across our portfolio. Our G&A expenses in the quarter were in line with our expectation and growth.
Net income for the quarter was CAD 31.2 million, an increase of 74.6% compared to CAD 17.9 million in Q2 last year. The increase was primarily due to higher NOI and non-cash fair value adjustments for interest rate swaps, Class B LP units, and unit-based compensation. FFO and AFFO for the quarter increased by 2.1% and 3.8%, respectively, compared to Q2 last year. FFO per unit diluted was CAD 0.241 in the quarter, compared to CAD 0.236 in Q2 a year ago, and the AFFO per unit diluted was CAD 0.229 compared to CAD 0.221 in Q2 a year ago. This growth is primarily due to properties acquired subsequent to Q2 last year and contractual rent increases.
The REIT paid total distributions of CAD 9.85 million or CAD 0.201 per unit in the quarter, representing an AFFO payout ratio of 87.8%. This compares to total distributions paid of CAD 9.85 million or CAD 0.201 per unit in Q2 last year, representing an AFFO payout ratio of 91%. The AFFO payout ratio was lower this quarter, primarily due to properties acquired subsequent to Q2 a year ago and contractual rent increases. We had CAD 454.4 million of outstanding debt as at June 30, 2022, with an effective weighted average interest rate of 3.8%.
We have a well-balanced level of annual maturities, and our weighted average interest rate swap and mortgage term is five years and two months, with a weighted average term maturity of four years and two months. Currently, 91% of our debt is fixed through interest rate swaps and mortgages. In April, we extended the maturity of facility one for a five-year term to June 2027, with the same credit spread, and increased the amount available under our non-revolving component of the facility by CAD 50 million. Immediately thereafter, we completed CAD 40 million of swaps for an average term of eight and a half years at a blended rate of 4.75%. The balance of CAD 10 million remains at floating rates. We continue to have strong support from our lenders and remain well positioned to deploy capital on growth opportunities.
I'd like to turn the call back to Milton for closing remarks. Thank you very much.
That's great. Thanks, Andrew. In response to rising inflation, the Bank of Canada has raised overnight rates, and this has resulted in the ten-year Bank of Canada bond rate moving approximately 100 basis points in 2022. We've consistently completed longer term swaps and mortgages to insulate our existing debt from future interest rate increases. We continue to monitor the impact of the rising interest rate environment and inflation on our property portfolio and the overall real estate industry. The contractual annual rent increases across our portfolio partially insulate us from the rising inflation.
The increases consists of CPI adjustments or set annual rent increases. They drove same-property NOI, Cash NOI increase of 2.3% in our Q2 . We're further insulated from inflation due to our triple-net lease structure, as our property level operating and energy costs are the responsibility of tenants.
Given our strong balance sheet and the strength of our existing portfolio, we'll continue to pursue acquisitions on a strategic basis. That concludes our remarks. I'd now like to turn it over for questions. Sylvie, please go ahead.
Thank you, sir. Ladies and gentlemen, if you would like to ask a question, please slowly press star followed by one on your touchtone phone. You will hear a three-tone prompt acknowledging your request. If you would like to withdraw from the question queue, please press star followed by two. If you're using a speakerphone, we do ask that you please lift the handset before pressing any keys. Please go ahead and press star one now if you have a question. Your first question will be from Sairam Srinivas at Cormark. Please go ahead.
Thank you, Sylvie. Good morning, Milton, Andrew.
Good morning.
Congrats on a good quarter. Just looking at the numbers, Milton, could you just speak about the capital allocation opportunities you're seeing in front of you, from a growth perspective?
Yeah. Last year with the extremely low interest rates, you saw a lot of very low cap rates. We're starting to see that kind of spread get a bit more normal right now. Last time we saw interest rate increases, we're able to take advantage of that and be active. We are still looking ahead and very intrigued by what we're gonna see over the next 18-24 months.
That's clear. Milton, thank you. I'll turn it back.
Thank you. Next question will be from Mark Rothschild at Canaccord. Please go ahead.
Thanks. Morning. Maybe just following up on those.
Good morning, Mark.
Hey. Maybe just following up on those comments. Can you just expand a little bit on just deal flow in general. Do you see that there is gonna be a lot of product or decent amount of product coming to market? Does the way the dealers are operating now and their profits impact that at all?
I think some of the profits may have delayed things slightly because obviously dealers have been doing very well over the last two years plus. That just continues to trend. What we're seeing is with the supply chain we're expecting to see that open up a bit over the next 12 to 18 to 24 months. That's probably gonna result in the continued acceleration of the consolidation. We tend to work with the groups that like to take advantage of that consolidation to build up a significant portfolio, either regionally or nationally. We certainly see and traditionally we've seen more deals occur in Q4. We've talked about that previously. I n real estate it tends to be two seasons.
In auto real estate, or auto M&A, it tends to be in Q4 and maybe leaking into Q1 with deals that were actually done in Q4. We're still expecting to see that. There has been a bit of a lag as well as people calibrate what does it mean with the higher interest rates environment. We were always competing against very short-term capital and when short-term overnight 90 days were as low as they were, it was tougher to compete than when they're there's less of a spread between long-term and short-term as there is now.
Great. Then maybe just to try to put some numbers on your comments about spreads, are you expecting to see deals happen at maybe the low 6s or even lower on the cap rates? Or with your comments, should we assume that you'll be able to maybe get properties closer to a 7?
Well, outside of BC, we never have really broken below 6. We kept everything pretty close last year. You could argue with the lower interest rates, you could have gone lower on the cap rates, but we've kept things pretty consistent on what our expectations are as these are long-term commitments that we're making. I mean, the money that used to be interest rates or mortgage rates of 2.5 are now up at 5.5. That certainly allows us to get a spread of the 6% plus. That's what we'd certainly wanna do. We've traditionally bought in that 6.25-7.25 range. I still think we'll see opportunities in that range.
Okay, great. Thanks so much.
Thank you. Next question will be from Scott Fromson at CIBC. Please go ahead.
Thank you and good morning, gentlemen.
Good day.
Just wondering, have you seen just following on Mark's comments on M&A, have you seen a change in the tone of conversations with potential vendors just in terms of generational wealth transfer perhaps wanting to get ahead of a potential recession that could depress auto sales or anticipation of lower valuations?
Not the first one, not on the auto sales side. We have certainly had some inquiries, further conversations, deeper conversations with groups that thought that if you look at the housing market, if you waited every single month, it seems the house was worth more, whereas that's plateaued or come off a bit. It's the same sort of thing. We've been in a 20-year bull run on real estate. Some people are scratching their heads saying "Is it plateauing? Is now a good time to look at estate planning, look at taking some money off the table?" We're certainly seeing it more on the real estate side where everything is not euphoric at all times. What do you wanna do longer term?
That I think will continue to be some interesting conversations and should lead to some good opportunities.
Thanks, Milton. Has there been a change in tone of conversations on alternative real estate use, basically highest and best use?
I think you mean alternative as in the auto versus retail, because there has been.
Exactly
in the fact that once upon a time we were known as cyclical, and because of COVID and even global financial crisis, people are now looking at us as a lot more secure and essential retail. That's certainly given us an advantage and allowed us to get rewarded a bit for what we've talked about before. I still think there's room for that to continue to kinda digest and get more investors on site. On the highest and best use we work with our tenants. Most of these assets are longer term.
As the industry continues to evolve on the auto dealership retail side there may be opportunities to work with some of our existing tenants, 'cause we certainly do have sites out there that are in great locations and could certainly have density opportunities. W e have long-term leases with high quality tenants.
Thanks, Milton. I'll turn it over.
Thank you. Next question will be from Frank Liu at BMO Capital Markets. Please go ahead.
Good morning, everyone.
Good day.
Just want to touch on the auto sales figures. I understand like the H1 of 2022, the decline year-over-year was mostly driven by the supply constraints. Just looking forward, 'cause I read about some news online about some cars, new models in 2023 are with interest rate of over 7% or lease interest rate over 7%. Just want to understand the broader like the macro of the auto retail industry. Have you heard anything about like declining sales or customers not really looking to get a long-term loan for car loan? Do you expect that all will attribute to a continued declining auto sales?
Yeah. No. The short answer is pick up the phone and call a dealer and ask for a car, see what the reaction is. The reaction is the model has changed a bit from walk in and buy to you've got to pre-order. The supply chain issues that have gone on for the last two years have created a dent in supply that is gonna take a while to absorb. I don't disagree with you that higher interest rates may change behavior on some consumers, but the overall matching of supply and demand still remains very tight on the supply side and still remains lagging on the ability to fulfill the demand that still exists.
You've seen some movement in used car prices where a year ago, you could potentially see a one-year-old car selling for more than a new car because there was no new cars available. That's plateaued a bit to being very profitable as opposed to ridiculously profitable. It's still gonna take a while to catch up for that lag in supply and meet the demand that already exists.
Yeah, that makes sense. Thanks for the color. I'll turn it back.
Thank you.
Next question will be from Jonathan Kelcher at TD Securities. Please go ahead.
Thanks. Good morning.
Good day.
First question, just on acquisitions, assuming they do pick up in the latter part of this year and the leases you negotiate, are you going to be more inclined to try and get CPI-based leases, or are you still sort of agnostic between that and a set fixed rate?
I don't think we've ever been agnostic. We've looked for a bit of a balance between some with CPI and some with fixed. It also comes with what's the deal? There's only so many levers that you can talk about on a long-term, kinda, sale-leaseback situation. Are you looking more at cap rate, or are you looking more at your rental escalations, and how do you balance the two? I think it's gonna be a bit of bucket A and a bit of bucket B.
That's fair enough. Just on the debt side and the floating to fixed, and I guess the terms range from half a year on out. Roughly how much comes due over this year and next? Based on where current rates are, what are your expectations on the impact on your overall interest rate?
Andrew, do you want to take this?
Yeah, sure. Thanks, Bill. Jonathan, over the year, it's gonna be about approximately, let's say, CAD 20 million-CAD 30 million coming due. And that's-
Is that over the back half of 2022?
Back half of 2022. That's based on all three of the facilities. Our approach has always been to ladder. We've taken three- to 10-year laddering. We'll watch that as rates move. Right now, obviously, short being the same as long. What we did in the past, just in April, we went to a blended 4.75% with eight and a half-year maturity. We're gonna follow that strategy and see where the rates fall.
Where would rates be right now, sort of five-ten-year?
Well, 10 years, probably, north of four or five all in with the interest rate swaps.
Okay. Five, about the same? You said short-term.
Yeah, I would say within that bandwidth.
Okay. Just, the other thing is there's some, the conversion of Class B units in the quarter. Is there any color you can or care to give on that?
Just reorg. They have the right to exchange those units, so and then they've taken that right. There's really nothing, not no other further color to provide.
Okay, thanks. I'll turn it back.
Thank you. Next question will be from Brad Sturges at Raymond James. Please go ahead.
Hi there. Just going back to a previous question about on new acquisitions, could you be in a position to maybe push for a higher fixed rate, or could we see a similar kind of fixed rate escalator within new lease agreements? I think you've been kind of around 1.5% range historically.
I'm sorry, 4.5% on?
Sorry, 1.5% rent escalator.
Oh, 1.5. Yeah. I was wondering where the 4.5 came from. Okay. Dilawri has been 1.5. I mean, that's similar to a CT or a Choice model. It really depends on cap rates, location, the structures. There's only so many levers I can play with. Certainly in an interest rate environment that we have right now, it allows us to potentially push on some escalations. The one cautionary thing would be the interest. Sorry. The inflation that we've seen over the last 12 months. I don't know how it's gonna stay this high for this long for that much longer.
Long-term set rates still have a very good portion that you want to know what's happening. Certainly the CPI on inflationary environments like we have right now give us a nice kicker. We do look for a bit of a balance.
, I think you've talked about a long-term leverage target of closer to 50%. You're running quite a bit below that. Obviously, it gives you a good flexibility from the balance sheet perspective. In the short term, how comfortable are you in terms of pushing leverage, and what should we think about in the short term in terms of levering up a bit to do acquisitions?
With the right opportunities, yeah, we don't mind getting up to or near 50. We certainly believe what we saw last year in that interest rate environment pushed cap rates to a level that weren't as attractive as we have seen in the past, nor what we expect to see going forward. A bit of an anomaly. We certainly didn't get caught in that anomaly, which we're happy about now. We're looking forward to putting that money to use in more of the traditional bandwidth on cap rates.
Based on maybe preliminary discussions of where you are within the pipeline, you could be looking at for the fall, do you think there'd be more appetite to take back stock on either side or should it be expected to be more cash deals?
As we continue to mature and we continue to demonstrate a very strong historical track record, those conversations on unit takebacks are gaining more momentum. It really depends on each individual vendor's family, estate, tax, all sorts of different factors. Certainly as we're a known entity with a very good track record, it makes those conversations a lot easier. Certainly taxes are not going down. That certainly makes it more attractive to do in exchange for units.
Okay. Thanks. I'll turn the time.
Thank you. Next question will be from Jimmy Shan at RBC Capital. Please go ahead.
Thanks. Just a follow-up on the acquisition cap rate. A lot of the U.S. Net lease businesses are talking about cap rates moving 25, 50 basis points higher, some of them 100 basis points. I guess two full question. I'm curious if you think that's kinda where you think we're gonna be heading over the next little while here. And when you're pricing deals today, how are you thinking about it? You talked about that range of 6.25, 7.25. Are you do you feel like you can push it to the higher end of the range to get a deal done?
Yeah. I mean, if you're comparing it to U.S. net leases, they were able to push down their cap rates dramatically over the last 18 months. We were disciplined. We're not gonna see the same bounce because we didn't go down and do 4 caps. We've been consistent in that since our IPO in 2015. I mean, in 2015, we were at an average of 6.5, and currently we're at an average of 6.3. I think more what is happening is the market's coming back to where we're comfortable and like to trade and like to do acquisitions, versus taking advantage of last year's incredibly low interest rates, getting a bit euphoric and committing to long-term deals at very, very low cap rates.
We've avoided that. We did certainly look forward to the fact that the spread between mortgage rates and cap rates has narrowed to a level where it's starting to be more and more attractive to do sale-leasebacks versus just take financing out at 2% with your local bank.
Right. Makes sense. Do you track cap rates at all in the U.S., in terms of auto deals and like is there anything there that you look at it all?
I would certainly hope so. Yeah, absolutely.
Yeah.
There's a number of things that we're watching in the States. A t a minimum, there's learnings. There always tends to be a bit of a lag between what happens in the States because they have greater deal velocity than we do in Canada. It allows us to see more what's happening in the market at a faster pace and kinda take those learnings and understand as we're moving forward in Canada. Absolutely, we're watching what's happening in the States.
What is happening with respect to acquisition cap rates?
It went quiet, extremely quiet. Then vendors were demanding rates that they would have got prior to the interest rate growth. In many ways, you almost saw a cap rate to debt inversion, where debt was at a higher number than the cap rates were. That meant there weren't a lot of trades. Now vendors are starting to understand, and at the same time you're starting to see the long end of the bond go down a bit. That bridge between buy and sell is starting to shrink. We expect to see a lot more deal velocity in Q3 in the States, and that's what we're tracking and watching.
In the meantime, it's a bit of a sit on your hands, wait until vendors understand that no one can get the 2% money anymore and what's real cost of capital and real ability to do cap rates. I think you're gonna see a lot more activity in the States in Q3 and Q4. If you look at some of our other Triple Net Lease REITs out of the U.S., they're starting to perform very well and trade very well again. So that is a nice leading indicator that they're gonna have confidence, their investors have confidence to step back into the market. When they step back in, it's not gonna be based on 2021, 2020 interest rates, it's gonna be based on today's interest rate environment.
That's helpful. Thank you.
Thank you. Next question will be from Alex Leon at Desjardins Capital Markets. Please go ahead.
Hi and good morning.
Good day.
I've only got one quick question for you guys.
Yeah.
I'm wondering if you've seen the banks adjust their lending to the dealerships at all?
Sorry, you mean their spread?
Spreads or just quantum, the deal flow.
I mean if you look at the publics especially what we can track a lot easier out of the states, the Penskes, Lithias, et cetera they still continue to perform extremely well. Among the bankers, and we speak to a number of bankers that do auto retail and real estate, obviously. They don't seem to have a lot of worries, especially on the operational side. Where they're gonna stretch on real estate LTVs, again, everyone's kinda pricing what they believe current value is, and it's not quite as euphoric as it would have been last year. I don't think that's a comment on auto I just think that's a comment on real estate overall.
Okay I appreciate it. Thanks for the color.
Thank you. Once again as a reminder ladies and gentlemen if you would like to ask a question, please slowly press star followed by one on your touchtone phone. Your next question will be from Himanshu Gupta at Scotiabank. Please go ahead.
Thank you and good morning. Just on the CPI-linked leases, do you look at like, the look-back CPI? Leases in 2022 will reflect the CPI inflation rate in 2021.
Mm-hmm.
I mean it's a question. Is that how it works?
Yeah. I mean you've got your base year and then as it continues to move up, it gets reset. It's always on the 12-month anniversary from the original lease date.
Okay. Are there any caps on escalations as well? Like if CPI moves by 5% can you still move the leases by 5%?
Yeah. We've talked more specifically in press releases as we do the announcements, but each one of them is different. Some of them there was a holiday at the beginning other ones have caps, other ones are open. Other ones have bases not less than and some have not more than. So there's a variety of leases and a variety of CPI clauses within our portfolio.
Okay. If I look at the same-property Cash NOI growth this year tracking, like, mid-2% versus, like, mid-1% the previous years. The inflation in 2022 it's still pretty strong compared to last year.
Mm-hmm.
Do you think this run rate is going to continue the next year as well? Like mid 2% or probably higher than that?
Well, it's partially as you said gonna depend on future CPI. We have a significant base of our leases with 1.5% annual increases and the other are in the portfolio or with CPI. Y ou probably can't give you a run rate because there are variable components that are gonna depend.
I mean, it's nice having the base of 1.5 and then where we have CPI or other. W e've also had some that, where every five years we get a bump. it it's a bit cloudy to kinda sit here and tell you exactly what it'll be going forward and we don't do that.
Right.
It's nice having the 1.5 as the baseline and then a bit of a kicker on top as we get to take advantage of either five-year renewals or CPI.
Got it. Is it fair to say that the H2 of the year same-property NOI will be very close to the H1 of the year?
As I said, it'll depend on variables that we don't have a lot of control over. We have a base of 1.5, and we have other leases with CPI.
Okay fair enough. I'll turn it back. Thank you, guys.
Thanks.
Thank you. At this time, Mr. Lamb we have no further questions. Please proceed.
That's great. Thank you for joining us today. Enjoy the rest of your summer. Thanks, everyone.
Thank you, sir. Ladies and gentlemen this does indeed conclude your conference call for today. Once again, thank you for standing. Thank you for participating. At this time, we ask that you please disconnect your lines.