Good morning. My name is James, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Choice Properties Real Estate Investment Trust fourth quarter results conference call. All lines have been placed on mute to prevent any background noise, and after the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you'd like to withdraw your question, press the pound key. Thank you. Archana Sharma, you may begin your conference.
Thank you, James, and good morning, everyone. Welcome to the Choice Properties REIT Q4 and year-end 2018 conference call. This call is also being webcast simultaneously on our website at choicereit.ca. Before we begin, we would like to advise you that some of the statements made this morning may contain forward-looking information, including statements concerning Choice Properties objectives, strategies to achieve those objectives, as well as statements with respect to management's beliefs, plans, estimates, intentions, outlooks, and similar statements concerning anticipated future events, results, circumstances, performance, or expectations that are not historical facts. These statements are based on our current estimates and assumptions and are subject to a number of risks and uncertainties that could cause actual results to differ. We refer you to the cautionary statements contained in our financial reports, including the MD&A for the year ended December 31st, 2018, and other public documents for the full details.
These forward-looking statements are made as of today's date. Choice Properties REIT assumes no obligation to update or revise them to reflect new events or circumstances except as required by law. On today's call, we have our Chief Executive Officer, Stephen Johnson, our Chief Operating Officer, Rael Diamond, and our Chief Financial Officer, Mario Barrafato. I will now turn it over to Stephen.
Thank you, Archana. Good morning, everyone, and thank you for taking the time to attend our Q4 and year-end 2018 conference call. Yesterday, we put out two news releases, one for our quarterly earnings results, and the other, we announced my decision to retire as CEO of Choice Properties, which will be effective as of May 1st of this year. We also announced Rael Diamond as my successor, and I am absolutely delighted with this appointment. Rael has been a valuable partner of mine over the last seven years, both as President and COO of CREIT, and most recently in his role as COO at Choice Properties. Rael has nearly 20 years of experience in asset management and real estate operations. He has the trust of our organization and the respect of the industry. Rael is very well-suited to lead Choice Properties into the next chapter.
I will be working with Rael to transition the CEO role between now and May 1st, and after May 1st, I will serve as an advisor through to May 2020 as our organization continues to execute its strategy. On to the other news release, which summarized our Q4 results. We were very pleased with both the financial results and the operational results for the fourth quarter and for the full year of 2018. Our results met expectations. Operationally, same-asset net operating income was up 1.4% for the quarter, and period-end portfolio occupancy remained strong at 97.7%. Our development program delivered 105,000 sq ft of new leasable area, and our capital recycling continued with the sale of CAD 107 million of non-core assets and the reinvestment of CAD 75 million into high-quality income-producing properties.
Our fourth quarter results have built upon the positive momentum that we have had since the merger of CREIT and Choice Properties at this time last year. The combination of CREIT and Choice was a transformational transaction. Choice now has an enterprise value of approximately CAD 16.4 billion. Since closing the Choice-CREIT transaction, our management team has spent a considerable amount of time working on the integration of the two businesses, and the integration continues to go very well. This involves many important steps, each of which must be completed in the context of a long-term business model and strategy for the combined entity. While our business has grown substantially, our primary goal remains the same, the ownership of a high-quality income-producing real estate portfolio. Our business now, for the most part, has evolved into two functional areas, our income-producing property, or IPP portfolio, and our development business.
Our IPP portfolio generates a high-quality rental revenue stream. Net operating income on an annualized basis is now well over CAD 900 million, and there are contractual rent escalations in a significant part of our portfolio. We are positioning our IPP portfolio to provide long-term stability and net operating income growth over time. Our development business is now divided into 5 categories, including retail intensification, redevelopment, greenfield, major mixed-use, and residential projects. In our currently active development program, we anticipate investing approximately CAD 1.1 billion, of which CAD 500 million is already invested. A significant portion of the balance of the CAD 1.1 billion will be invested to complete our high-quality residential projects, now at various stages of development within the Greater Toronto Area.
It is also significant that beyond the current development program of approximately CAD 1.1 billion, we have a pipeline of additional development opportunities on sites already owned. This includes a number of sites planned for major mixed-use development, three of which are in an active pre-development stage, where we are finalizing land assemblies and working through the zoning process. The three properties are located in key urban markets with close proximity to public transit. There are two sites in Toronto and one site in Coquitlam, British Columbia. Each of these mixed-use projects will include a significant residential component. It is also important to note that there are a number of other sites which we now own, that have significant potential as major mixed-use projects. It is just too early to credibly quantify the total extent of this opportunity. We expect it to be meaningful over time.
The important point is that we already own these sites. Our development business is a very exciting part of our REIT that will add high-quality assets to our portfolio, and we anticipate will contribute to growth in our net asset value. In summary, from a macro perspective, we are building our business for stability and growth. Our focus is to position both our IPP portfolio and our development business to grow net operating income, to grow cash flow, and to grow net asset value over a long-term investment horizon. Mario will now provide an overview of our financial results for Q4, and then Rael will provide an overview of some of the operational and investment highlights. Mario?
Thank you, Stephen, and good morning, everyone. I'll begin with a brief overview of our results and then comment on our balance sheet. Overall, our fourth quarter results were in line with our expectations and reflect the stability that is inherent in our portfolio. Our reported funds from operations for the fourth quarter was CAD 171.9 million, or CAD 0.256 per unit diluted. With the exception of CAD 400,000 of lease surrender fees, there were no unusual items in the quarter. FFO per unit for the quarter was consistent with amounts reported last quarter. On a year-over-year basis, FFO per unit declined CAD 0.026 per unit compared to the fourth quarter of last year, primarily due to the change in capital structure resulting from the CREIT acquisition. As communicated last quarter, adjusted funds from operations for the fourth quarter reflects increased maintenance capital spending relative to prior quarters.
This is merely a function of timing, bringing the year-to-date amount of maintenance capital spending in line with our annual expectations. On a full-year basis, our AFFO exceeded our distributions by CAD 52 million, and our AFFO payout ratio was 89.5%, both in line with our expectations. Included in our results was stable year-over-year growth in our same-property cash NOI. For the quarter, same-property cash NOI, excluding development activities, increased by 1.4%, and for the year, same-property NOI growth was 2.4%. Furthermore, our overall period-end occupancy remained unchanged at 97.7% compared to the third quarter of 2018. Slightly negative absorption was offset by a net increase in occupancy arising from property transaction activity and developments coming online. At December 31, retail occupancy was 98%, industrial occupancy was 97.8%, and office occupancy was 92.3%. Overall, very solid operating results. Now turning to our balance sheet.
On the transaction front, our capital recycling program continued with two dispositions during the quarter for proceeds of CAD 107 million and the acquisition of four properties at a cost of CAD 78 million. These acquired properties consist of one industrial and three retail properties, and Rael will provide more color on these investments. We continue to be active on the development front with ongoing investments of CAD 88 million in the quarter, bringing our full-year spending to CAD 242 million. As well, CAD 45 million of development properties were transferred to income-producing status during the quarter, bringing our year-to-date transfers to CAD 193 million. Our book net asset value increased marginally quarter-over-quarter, as our net earnings for the quarter were offset by cash distributions and an adjustment to the fair value of our investment properties.
For the quarter, we had a fair value loss of CAD 20 million, which was mainly due to changes in leasing and capital spending assumptions for specific assets in the portfolio. It was a quiet quarter from a financing perspective, as we had a net decrease in our outstanding debt, having a net repayment of CAD 62 million on our credit facility and mortgage repayments of CAD 9 million. This was offset by CAD 10 million in new mortgages, which had an average term of five years and a weighted average interest rate of 4%, and we also had CAD 11 million of new construction loans. Our financial metrics remain solid. Using amounts from our proportionate balance sheet, our debt to gross book value is approximately 47%, and normalized leverage and interest coverage ratios are eight and three times respectively.
These metrics are further backed by CAD 1.2 billion of liquidity on our credit facility and CAD 11.8 billion pool, a pool of unencumbered assets. Overall, this was another strong quarter for Choice. We end the year having made significant progress on our integration and with two full quarters of financial results, provided a baseline for the new combined entity. I'll now turn the call over to Rael.
Thank you, Mario, and good morning, everyone. As Stephen mentioned, I'll provide a brief overview of our income-producing portfolio and an update on transaction activities. Our consolidated portfolio of income-producing assets includes 731 properties comprising 67 million sq ft of GLA. This high-quality portfolio includes retail, industrial, office, and residential properties and is located across Canada with a concentration in Canada's largest markets.
Our retail portfolio is primarily focused on necessity-based retail tenants. This portion of our portfolio is the foundation of our reliable cash flow. The stability is attained through our strategic relationship with Loblaw. This relationship provides a strong anchor tenant on long-term leases, resulting in stable, secure, and growing cash flows. We continue to add to our retail portfolio through development, including a mix of greenfield development, redevelopment, and intensifications. In Q4, we completed and transferred a total of 105,000 sq ft of retail development at a total cost of CAD 45 million. This includes 73,000 sq ft of intensifications and redevelopment projects, which are primarily focused on adding at-grade retail density to our existing portfolio of retail assets at a cost of CAD 35 million, and 32,000 sq ft of greenfield development at a cost of CAD 10 million.
For the year ended 2018, we completed and transferred approximately half a million sq ft of retail development at a total cost of CAD 182 million. Our development initiatives are key components of our business model, providing the opportunity to add high-quality real estate to our portfolio. Our industrial portfolio includes 113 properties and approximately 16.5 million sq ft of GLA. The properties include Loblaw distribution facilities on long-term leases and high-quality distribution and warehouse facilities in key industrial markets across Canada that readily accommodate a broad range of tenants. In terms of industrial development, Choice is now 100% leased at its recently constructed 665,000 sq ft modern distribution facility on Pelly Road in Milton, Ontario. We have finalized long-term leases for approximately 515,000 sq ft with Kimberly-Clark, a multinational consumer products company. The remaining 150,000 sq ft was leased to a distributor of flooring products on a long-term lease.
The rents achieved exceeded our original pro forma by more than 15%. This asset will be a great addition to our industrial portfolio as it is in the GTA west sub-market of Milton, one of the strongest industrial markets in the country, and will be transferred to income-producing status in Q1 of 2019. Our office portfolio. Fundamentals in most large office markets in Canada are healthy due to a strong economy and robust job growth. In the GTA, there is significant tenant demand and limited availability. Our portfolio is almost fully occupied when considering all committed leasing. Office property fundamentals in Calgary continue to be challenging. In Q4, we significantly reduced our exposure to the market with the sale of our 50% interest in Sun Life Plaza for CAD 104 million.
The decision was based on several factors, including the current market conditions and the lease expiry profile of the asset. Ultimately, we believe there are better uses of our capital, including new acquisitions like the Loblaw vend-ins and funding our ongoing development program. Our residential platform provides an opportunity to further diversify our portfolio. Choice has been working on expanding our residential platform. Currently, we have three residential rental assets that are income producing and another seven rental residential assets that are in various stages of development. We are also currently under contract to acquire another rental residential development site located between Grosvenor Street and Grenville Street in Toronto. When complete, these residential projects will represent approximately 1,500 units at Choice's share. This includes over 1,000 units located in the GTA, all of which are in close proximity to major transit. We're excited about the prospects of our residential initiatives.
I would like to provide an update on transaction activities. During the quarter, we closed on the acquisition of three grocery-anchored income-producing retail properties from Loblaw for a total cost of CAD 55 million. This includes a 104,000 sq ft grocery store in Calgary with an ancillary liquor store, a gas bar, at a purchase price of CAD 32 million. This asset is in the expanding residential community of Seton in Southeast Calgary. 103,000 sq ft standalone grocery store in Ottawa at a purchase price of CAD 15 million and an 80,000 sq ft retail center anchored by Loblaw and a liquor store in Bedford, Nova Scotia for CAD 9 million. These properties are all subject to long-term leases with Loblaw. We acquired a 130,000 sq ft industrial building from Weston Foods for approximately CAD 20 million.
The asset is located in the Langley submarket of the Greater Vancouver area and is subject to a long-term lease with Weston Foods. Greater Vancouver is one of Canada's tightest industrial markets and there is extremely short supply of industrial assets, making this a very attractive acquisition. These transactions highlight the competitive advantage of our strategic relationships with both Loblaw and George Weston. We expect that these relationships will continue to be an excellent source of opportunities in the future. That concludes my comments. I would now like to pass it back to the operator for questions.
At this time, I'd like to remind everyone, in order to ask a question, please press star followed by the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Sumayya Syed from CIBC. Go ahead, please. Your line is open.
Thank you. Just firstly, congrats to Stephen and Rael.
I'll just open up, I guess.
Thank you
On a more high-level front first. Just now that the REIT is close to finishing the first full combined year, how do you look at capital allocation? Do we see a return to continuous dividend growth, or is the priority more on de-leveraging? Just your thoughts there.
It's Stephen. Thank you for your comment. There's three or four questions in there. We're in the process, basically, of resculpturing our strategy in many ways. Certainly, directionally, the most important thing is the quality of the IPP portfolio. We anticipate some culling of that over time. In terms of level of debt, over time, again, directionally, we expect our debt levels to decrease, but no immediate plans or no specific target at the present time.
Okay, thanks. Can you just remind us on the yield on your residential developments and how they stack up across the different markets?
Yeah, sure. It's Rael speaking. The yields would all be what we've been achieving are slightly north of 5%. For example, the one in Toronto, VIA 123, we completed that in a very, very robust market, and we exceeded well in excess of 5%.
Okay. That haven't really changed from, say, about a year ago.
No, because much of the land that we had acquired was acquired pre the run-up in land prices.
Great. Just lastly for me, there was a little reference to a change in assumptions around leasing and capital spend, specifically on some retail assets. What kinds of assets were those? Are they grocery-anchored, or was it more of a primary versus secondary market dynamic?
Hey, Sumayya. It's really varied. These are just normal assumptions based on timing or some capital spend. No individual was significant, and there was no real trend to take from that. It was just updating our financial valuations.
Okay, thanks. I'll turn it back.
Your next question comes from the line of Michael Smith from RBC Capital Markets. Go ahead, please. Your line is open.
Thank you and good morning. Congratulations, Stephen, and wish you the best in your retirement. Congratulations, Rael.
Thank you, Michael.
Welcome news. Just a couple of questions. For 1880 Eglinton and 2280 Dundas and your Coquitlam properties, you've got a lot of residential there. I know it's early stages. From a big picture, what are you thinking in terms of condo versus rental? Obviously, rental gives you a long-term income, but condo, in some cases, the economics are so skewed towards condo. I'm just wondering how you're thinking about that.
It's Stephen, Michael. Thank you for your comment and congratulations to you as well on your retirement.
Thank you.
It is too early to talk about the, or from our perspective, to determine the mix between rental, residential, and condo. Clearly, there is some advantage basically to doing a portion of it as condo, but our objective is to build our IPP portfolio. Our bias is to maintain as much ownership as we can, which essentially means more rental residential. The competitive advantage we have is that these are on sites that we already own, and we've owned for quite some period of time. Our ability to do less condo and more rental residential basically would be greater than, say, if we were to just buy the sites at market today. Clearly our bias is to do as much rental residential as we can on these mixed-use projects.
Mm-hmm. Sure. That makes sense. Do you anticipate, again, I realize it's early stages, but have you given any thought in terms of partners for those? They're very large projects, or are they given your time horizon and your goals to build the IPP portfolio, are you thinking more on your own?
We have not. We've certainly discussed it internally, whether bringing in a partner would be appropriate. Right now, our plan is to do them on our own.
Okay, great. Just switching gears. I know it's only been a couple of full quarters. When do you anticipate the integration to be more or less behind you?
Most of it is done, Michael. There's always little things, basically, that will continue, but the bulk of it is behind us. Some of the larger items were systems. We were on two different enterprise systems, so that was completed effective January 1st. That was both the conversion to one system, so we're all on the same platform. As I say, that's completed. Office consolidations are more or less complete. The balance of them will be completed during the course of 2019. Personnel reorganization was completed mid-year last year. Most of the major things have been done, Michael.
Okay, great. Lastly, for the three Loblaw acquisitions and the acquisition from Weston, would they typically be the usual lease term where there's usual 1.5% bumps every year?
Hey, Michael. It's Rael. On the Loblaw side, yes, it is 1.5% bumps every year. On the Weston Foods side, it is slightly higher than that.
Great. Thank you. That's it from me.
Thanks, Michael.
Your next question comes from the line of Pammi Bir from Scotia Capital. Go ahead, please. Your line is open.
Thanks. Good morning. Stephen, congratulations on the retirement, and just an outstanding track record over the years. Rael, congrats to you as well. Just coming back to the comments around leverage. As you take on more development, do you expect that we may actually see leverage move up rather than down, or at least make it a bit more challenging to reduce?
Yeah. Certainly, the development program makes it a little more challenging, but it may move up a bit. We anticipate directionally, as I said earlier, trying to reduce leverage over time. We are generating cash, and we do plan a divestiture program at some point in time. As I say, directionally, we would like to reduce it, but it may mean that it goes up a bit in the short term.
As you take these projects on, is the intention to primarily fund them, again, through perhaps because their sites are already owned, like contributing the land, as your equity source and maybe retain cash as well, rather than any equity issuance to fund these programs?
No. What we're focused on now, as I mentioned, our current active program is about CAD 1.1 billion, of which we've already invested about CAD 500 million. To fund that balance, we expect basically to do that with a combination of three things: cash flow that we're generating, maybe some increase in debt, and possibly some divestitures.
Okay. Just with respect to acquisitions, do you have a sense of what we could see from Loblaw vend-ins over the next 12 months or so, and how any third-party opportunities may fit into the equation as well?
We do not have a target for that. We don't have a number to give you. We simply do not have a target for that. We look at each one, each individual opportunity, whether it's a vend-in or whether it's a third-party potential acquisition on the merits of the particular opportunity. We will continue to do that on a go-forward basis.
Great. That's it for me. Thank you.
Okay, thanks very much. Thanks for your comment.
As a reminder, if you'd like to ask a question, please press star followed by one on your telephone keypad. Your next question comes from the line of Sam Damiani from TD Securities. Go ahead, please. Your line is open.
Thank you. Good morning. Congratulations again. Happy to wish you all the best. Stephen, you've been a founder of the Canadian REIT industry, and so this is quite a moment for our sector. Admirable career, wish you all the best. Rael, obviously, congratulations, and well deserved. Just looking at the acquisition opportunities. Actually, I wanted to talk about development, actually. The past CREIT development activity has been quite active with various private partners. How do we see that program going forward with those same private developers for Choice?
Sam, it's Stephen. Thank you for your comment. Look, we've been very successful in our partner relationships and finding partners that have helped us achieve our goal in terms of finding development opportunities and executing with a lot of expertise. With each of our partners, in most of these, we've had long-term relationships with, and we will continue to work with them as we go forward to look at new opportunities and not only on acquisitions but full development projects. We don't see that changing as one of the competitive advantages we've had, and it's a competitive advantage just because we have these partners in place and a long, trusting relationship with them.
Would you envision adding more projects to the active construction pipeline in the near term?
Right now, our active one, I don't think so. Nothing substantial. As I mentioned in my comments, we have the three major mixed-use projects that are in an active pre-development stage. Those take many years to kind of complete the pre-development stage, get your zoning done, and so on. Nothing material, Sam, at this stage. That could change next quarter. We may find an opportunity we like, but as we sit today, nothing material, nothing substantial.
Okay. The topic of vend-ins. Is there an opportunity or an expectation that Weston could provide additional opportunities in the near term for acquisition for Choice?
Absolutely. It's part of the relationship. We have a strategic relationship with Loblaw, again, as Rael mentioned in his comments, it's a competitive advantage for us. We expect basically there will be opportunities for the vend-in of high quality, grocery-anchored retail over the coming years.
Okay. Just onto the strategy, which I think you used the word, in the process of resculpting it in some ways, in some aspects. With respect to culling more of your properties, is this something that could be proceeding in a more meaningful way in the sort of near term, in the next year, or do you see this evolving really more over sort of the medium term, one to three, five years down the road? What is the sort of timeframe on that strategy?
Yeah. As you know, basically with any REIT, there are restrictions on how you manage your divestiture program. It's probably a medium term, to use your phrase, strategy, as we execute that. We have no intention, basically, of announcing a major divestiture program at the present time. We really look at it as our plan right now at the present time, basically, is that we would do it in an orderly manner over a number of years. That's consistent with what we did in 2018. As we mentioned, we completed about CAD 107 million of divestitures in Q4. We expect basically that will escalate somewhat, but it's a medium-term strategy, Sam.
Thank you. That's very helpful. I'll turn it back.
Okay. Thank you.
Your next question comes from the line of Tal Woolley from National Bank Financial. Go ahead, please. Your line is open.
Hi, good morning, congratulations to you both. I just wanted to start off by asking a bit about if you were able to sort of quantify the pipeline of assets that there might be at Weston for you to acquire. Can you sort of quantify the amount of properties that might be there for Choice to acquire over time?
We aren't able to quantify it, but they would be of very similar characteristic to the one we purchased in Langley, B.C. Essentially from our perspective, an industrial facility that they may be using either as an industrial facility or as a bakery asset that could be converted in the future to an industrial asset. We aren't able to quantify the exact number or quantum.
Okay. A good chunk of their business is in the U.S. too, as well. Is that something that would interest Choice?
Tal, it's Stephen. At the present time, no.
Okay. Just a quick question on the CapEx. Just to be clear, from your commentary between sort of the leasing and the property capital expenditures, around CAD 80 million a year for the combined organization looks about a correct number to be using?
Yeah. A little bit higher if you take into account that CREIT only had two-thirds of a year in there. There's a bit more.
Right
CapEx at the CREIT side. Yeah. Really what you saw was just a function of timing. By the time you contract out, a lot of it was roofs and paving. By the time you contract it gets seasonal. Really, it's just a function of timing. The quantum is in line with the direction you mentioned.
Okay. Just lastly, if I've done my math correctly, it does look like your equity accounted investments did sort of tick up and produced a little bit more FFO this quarter than last. Was there anything that changed significantly within that portfolio that we should be aware of?
To be honest, Tal, we kind of run the business on a proportionate basis.
Yeah
Sorry, I really couldn't tell you exactly what's in that line. Our joint ventures have been performing well. I can drill down to find out exactly what drove that.
Okay. That's great. Thank you very much.
Thanks, Tal. Thanks for your comment.
There are no further questions in queue at this time. I turn the call back over to Stephen Johnson.
Thank you, everyone. Thanks again for taking the time this morning to attend our conference call. Enjoy the long weekend.
This concludes today's conference call. You may now disconnect.