Thank you for standing by. My name is Eric, and I will be your conference operator today. At this time, I would like to welcome everyone to the Choice Properties Real Estate Investment Trust second quarter 2024 earnings conference call. All lines have been placed on mute to prevent any background noise. 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 followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. I would now like to turn the call over to Erin Johnston, Senior VP of Finance. Please go ahead.
Thank you. Good morning and welcome to Choice Properties Q2 2024 conference call. I'm joined here this morning by Rael Diamond, President and Chief Executive Officer, Mario Barrafato, Chief Financial Officer, and Niall Collins, Chief Operating Officer. Rael will start the call today by providing a brief recap of our second quarter performance and provide an update on our transaction and development activity in the quarter. Niall will discuss our operational results, followed by Mario, who will conclude the call with a review of our financial results before we open the lines for Q&A.
Before we begin today's call, I would like to remind you that by discussing our financial and operating performance and in responding to your questions, we may make forward-looking statements, including statements regarding Choice Properties' objectives, strategies to achieve those objectives, as well as statements with respect to management's beliefs, plans, estimates, intentions, outlook, and similar statements concerning anticipated future events, results, circumstances, performance, or exceptions that are not historical facts. These statements are based on our current estimates and assumptions and are subject to risks and uncertainties that could cause actual results to differ materially from the conclusions in these forward-looking statements.
Additional information on the material risks that can impact our financial results and estimates and the assumptions that were made in applying and making these statements can be found in our recently filed Q2 2024 financial statements and management discussion analysis, which are available on our website and on SEDAR+. With that, I will turn the call over to Rael.
Thank you, Erin, and good morning, everyone. We are very pleased with our performance this quarter, as once again, we delivered solid operating and financial results. Our portfolio continues to deliver stable and growing cash flow. We maintained near full occupancy in the quarter at 98%, achieved strong leasing spreads of 48.2%, and delivered same-asset cash NOI growth of 4.4%. Our strong operating metrics this quarter reflect the strength and resilience of our portfolio. FFO for the quarter was impacted by the timing of lease termination income and certain one-time costs related to our continued focus on operational efficiency. Excluding these impacts, FFO increased 5.7% year-over-year. On the retail side, we are seeing certain discretionary retail tenants impacted by the overall health of the Canadian consumer. However, our grocery-anchored, necessity-based retail portfolio is performing exceptionally well. The demand for our space is strong.
Our leasing team is actively working with many of our tenants who are looking to further expand their footprints. In industrial, despite the slowdown in rent growth, demand for well-located, high-quality assets remains strong, as evidenced by our leasing activity this quarter. We remain confident in our ability to deliver growth through our industrial development pipeline. Our prime locations, large contiguous blocks of land, and attractive land costs allow us to deliver high-quality product into the right segments of the market at competitive rental rates. Our residential assets are also performing well, with two newer assets both over 80% leased and are expected to stabilize this year. Although the current environment will impact certain developers focused on condos, limited residential construction stocks, and overall lack of housing availability provide long-term tailwinds for the residential asset class.
Turning back to activity in the quarter, in pursuit of maintaining our market-leading portfolio, we continue to execute on our capital recycling program. This involves completing approximately CAD 114 million in total real estate transactions in the quarter. Specifically, we acquired two grocery-anchored retail assets worth CAD 33 million and successfully disposed of four properties totaling CAD 81 million. The first was the acquisition of Cornerstone Power Centre in Fort Saskatchewan, Alberta, by purchasing our partner's 50% stake for about CAD 21 million. We now fully own this 200,000 sq ft high-quality grocery-anchored shopping center. The second acquisition was a vacant 13,000 sq ft standalone retail property in Toronto for approximately CAD 12 million and concurrently leased it to Loblaw for 15 years. Loblaw plans to open a small-format No Frills on the site as part of their overall small-format store expansion plan.
This transaction is an example of the strategic benefits of our relationship to both Choice and Loblaw. Our disposition activity included the sale of our non-managing partnership interest in two retail properties in Alberta and two retail properties in Saskatchewan for total proceeds of approximately CAD 81 million in the quarter. We also continue to add value through our development pipeline with a near-term focus on commercial development. During the quarter, we transferred approximately 44,000 square feet of retail GLA through ongoing intensifications of our neighborhood centers. This intensification included a 17,000 square foot Shoppers Drug Mart in Alberta and a ground lease to Nautical Lands Group in Bradford, Ontario. This is the first of six ground leases with Nautical Lands, where they are developing independent living options for adults over 65. 55, sorry.
This is a great partnership for Choice, as it is complementary to our retail sites and will generate a stable and growing cash flow stream for Choice. Our active industrial developments are progressing well. At Choice Caledon Business Park, we're progressing on the first two phases, providing 1.75 million sq ft of new logistics space. The first phase is a land lease to Loblaw with site servicing underway. The second phase leads to a leading logistics provider is in the tendering stage, with construction expected to start later this year. Our portfolio's performance and ability to deliver on our strategic priorities, regardless of the economic climate, is entirely supported by the strength of our balance sheet and the quality of our credit. I often speak about the importance of prudent capital management and risk management.
Despite encouraging inflation prints and the Bank of Canada making its first interest rate cuts in June, the interest rate environment remains volatile. We do not foresee a substantial drop in long-term interest rates in the near future. We believe that companies with strong balance sheets like ours will consistently outperform in the long run. As a result, our team is committed to preserving our industry-leading balance sheet. They demonstrated their ability to do just this through our financing activities and the credit rating upgrade we received in the quarter, which Mario will speak to shortly. But first, I'll pass the call over to Niall to discuss our operational results. Niall?
Thank you, Rael. Good morning, everyone. As Rael mentioned, our portfolio continues to perform well, and we are pleased with our operating performance for the quarter. Occupancy remains strong, ending the quarter at near full occupancy of 98%. During the quarter, our portfolio had approximately 816,000 sq ft of leasing expires. We renewed 743,000, achieving a 91% tenant retention. These renewals were completed at an average rent spread of 48.2%. We also completed 88,000 sq ft of new leasing, contributing to positive absorption of 15,000 sq ft. Our retail portfolio occupancy remained stable at 97.7%. During the quarter, 390,000 sq ft expired, and we renewed 350,000 sq ft at an 89.7% retention. The lease renewal spreads averaged 12.8% above expiring rents. The majority of our lease renewals were in Ontario, with strong spreads across several retail categories.
We also completed 41,000 sq ft of new retail leasing in the quarter, offsetting 40,000 sq ft of expiries not renewing in the quarter. Of the non-renewed space, approximately half has backfill commitments that will achieve, on average, 13.4% higher net rents compared to previous tenancy, and we have strong interest in the remaining space. As Rael mentioned, demand for necessity-based tenants remains strong as retailers continue to seek out well-located, well-anchored properties. However, in the current economic environment, consumers continue to be more cost-conscious, creating pressure for tenants whose businesses rely on discretionary spending. Fortunately, we have a small number of these tenants on our watch list. As most of our tenants are necessity-based, we do not expect a significant impact on our 2024 performance. During the second quarter, we generated CAD 1.2 million in lease surrender revenue. CAD 800,000 was for the settlement of our Nordstrom's location in Edmonton, Alberta.
We also continued with our Loblaw store optimization program, generating CAD 400,000 of lease surrender revenue at the grocery store in Cambridge, Ontario. This space was backfilled by a new tenant at higher rental rates. We turn our attention to 2025 for a moment. We have 48 Loblaw locations up for renewal, consisting of 47 retail locations and one industrial site, totaling 3.2 million sq ft. Subsequent to the quarter, we renewed 46 of these locations, totaling 3.1 million sq ft at a weighted average term of five years. The base rent for the 46 locations increased on average by 8.4% over expiring rent. The two sites that were not renewed are stores that have gone dark. The first is in Coquitlam, BC, a site with a long-term redevelopment plan. The second site in Laval, Quebec, we intend to sell as part of our capital recycling program.
Our industrial portfolio occupancy also remained stable at 98.8%, with 424,000 sq ft of expiries, and we renewed 391,000 sq ft for a tenant retention of 92.2%. The lease renewal spreads averaged 105.9% above expiry. This was largely driven by 180,000 sq ft of renewals in Ontario at spreads of 184.3%. We also completed 47,000 sq ft of new leasing. While I recognize that the growth in the industrial market has slowed, we still have significant embedded rental growth in our portfolio, as our average in-place rent is CAD 9.32 compared to CAD 9.16 last quarter. For the remainder of the year, we expect a modest decline in occupancy due to a few known vacancies, which were contemplated in our plans and outlook. Our team is actively working on backfilling this space. I will now pass it over to Mario to discuss our financial performance.
Thank you, Niall. Good morning, everyone. Once again, we're pleased with our financial performance for the second quarter. Our business is strong operationally and remains well-positioned to continue to deliver high occupancy and strong same-asset NOI and FFO growth. Our reported funds from operations for the second quarter were CAD 184.7 million for CAD 0.255 per unit. FFO in the quarter was impacted by certain non-recurring items, including restructuring costs of CAD 3.3 million related to the outsourcing of a portion of our accounting function, offset by the reversal of a CAD 1.7 million provision related to a tenant dispute in our industrial portfolio, and lease surrender revenue of CAD 1.2 million for a net cost of CAD 400,000 to FFO. On a per-unit diluted basis, our reported second quarter FFO of CAD 0.255 per unit reflects an increase of approximately 0.4% from the second quarter of 2023.
When normalizing for year-over-year non-recurring items, including the CAD 8.4 million lease surrender income reported in Q2 of last year, FFO per unit increased 5.7%. This increase was driven by strong same-asset and transaction NOI, partially offset by higher interest expense net of higher interest income. Strong leasing activity contributed to same-asset cash NOI growth of CAD 10.2 million or 4.4% compared to the second quarter of 2023. By asset class, retail same-asset cash NOI increased by CAD 5.5 million or 3%. The increase was primarily driven by higher base rent on renewals, new leasing and contractual rent steps, and higher capital and operating recoveries. Industrial same-asset cash NOI increased by approximately CAD 4.7 million or 11.8%. This increase was primarily due to higher base rent from leasing activity, higher capital recoveries, and the reversal of the provision following the resolution of a tenant dispute.
Excluding the tenant dispute resolution, our industrial portfolio increased by 7.4% year-over-year. Turning to our balance sheet, our IFRS NAV for the quarter was CAD 13.79 per unit, an increase of CAD 76.6 million or 0.7% over the last quarter. Our NAV growth was driven by the contribution of CAD 47.2 million from operations, fair value gains of CAD 25.5 million on our investment properties, and income resulting from the reversal of a prior year transaction-related provision of CAD 38.6 million, which was partially offset by a fair value loss of CAD 27.9 million on our investment in units of Allied Properties, where we're required under IFRS to mark-to-market this investment to its trading price at the end of each period.
Our fair value gain on investment properties in the quarter was largely driven by cash flow growth in the retail industrial portfolio, partially offset by a seven basis point cap rate expansion within our industrial portfolio due to continued price discovery in certain GTA and Vancouver assets. In our retail portfolio, we recorded a fair value gain related to cash flow growth and minor cap rate adjustments. In our industrial portfolio, we recorded a fair value loss primarily due to cap rate expansion on certain properties with longer-term leases. This was partially offset by gains from cash flow growth as leases roll over to market rental rates. Our mixed-use and residential portfolio was relatively flat. Now, turning to financial activities for the quarter, we continue to focus on prudent capital management and ended the quarter in a solid financial position with strong debt metrics and ample liquidity.
Our debt-to-equity ratio was 6.9x when you factor in the cash raised on our recent unsecured debenture issue, which I'll expand on shortly. We also have CAD 1.5 billion available on our credit facility and approximately CAD 12.8 billion of unencumbered properties. During the quarter, we completed CAD 788 million of new debt financings for an average term of 10 years and an interest rate of 5%. This includes the issuance of CAD 500 million in unsecured debentures at 5.03% for a term of approximately 7 years. The proceeds have been invested in a fixed-rate GIC earning 5.5% interest until September, when we will apply the funds to repay a portion of the maturing CAD 550 million Series K senior unsecured debentures. For our debt denominator computation, we have netted the cash against the debt to avoid the double count.
Additionally, we completed a series of mortgage financings, totaling CAD 288 million at a weighted average rate of approximately 5% and a term of approximately 15 years. This included a CAD 120 million 10-year loan secured by a six-property industrial park in Edmonton, a CAD 90 million 25-year loan secured by a 25-year Loblaw land lease at our Choice Eastway Industrial Centre, and the assumption of mortgages totaling CAD 45 million on disposed assets at an average rate of approximately 3.4%. These proceeds were used to repay approximately CAD 82 million of construction debt, and the remainder used for general purpose or reinvested at attractive yields. Having completed these financings, we have limited remaining debt exposure for 2024.
We're also pleased to have received a credit rating upgrade from Standard and Poor's to BBB Plus, who cited the strength of our grocery-anchored retail properties, our strategic relationship with Loblaw, and our commitment to maintaining prudent credit measures as reasons for the upgrade. Before I conclude, I wanted to provide a bit more color on our restructuring costs in the quarter and the impact to our full-year outlook. In an effort to drive operational effectiveness and after thoughtful analysis, we've decided to outsource a portion of the company's operational accounting platform to a third-party vendor to create process efficiency and advance the use of technology across our business. We anticipate that the total restructuring costs for 2024 related to this outsourcing will be approximately CAD 7 million.
Given the strength of our overall performance this year, as well as additional Loblaw rightsizing income anticipated in the second half of 2024, we do not expect this restructuring to impact our 2024 financial outlook. And with that, Niall, Erin, and I would be glad to answer your questions.
At this time, I would like to remind everyone, in order to ask a question, please press star, then the 1 on your telephone keypad. Your first question comes from the line of Lorne Kalmar. Please go ahead.
Thank you very much and good morning, everybody. Maybe just on the retail side, I think this is maybe one of the first times we've kind of heard you guys mention the watch list versus us asking about the watch list. Just wondering, what types of tenants are these? Are they maybe more individual or sole proprietorships? And what's the appetite for backfilling like?
The backfill is quite strong. As we said, we have very few tenants on our watch list because most of our tenants are really necessity-based grocery and the like. We're really seeing problems around discretionary spending. So it's largely big box, fashion and power centers, small CRU where there's QSRs and mid-price sit-down restaurants. That's where we're seeing some weakness. But we're monitoring it. And as I said, there's not a lot of those in our category.
Just in terms of the backfilling side of it, who would you guys be expecting to sort of step in in the event some of these went dark? What type of tenants?
It's more where there's franchisees and they're trying to either pay back debt or sell out their business. But we are replacing with a similar. And we don't have challenges. We're using Loblaw, small format, and value retailers to backfill as well. So we're not having a challenge backfilling the real estate.
Okay. That's just very helpful. And then maybe just flip into the industrial side of things. You mentioned a couple of non-renewals. Could you maybe quantify what you expect the impact on occupancy and maybe same-property NOI to be over the balance of the year from those?
So we expect the conservative, we were looking at around 200,000 sq ft of potential vacancy, which will pull it from about 98.8%, maybe down to high 97% or just under 98%. As we said in our notes, a lot of this was planned for. So we're expecting it, and it's included in our outlook.
Okay. Perfect. And then maybe just lastly, I think when we last spoke in May, Rael, I believe you guys were hoping to do about CAD 150 million-CAD 200 million of Loblaw's transactions. If that is, in fact, if I'm recalling that correctly, how do you sort of see the balance of the year evolving on that front?
Hey, Lorne, thanks for the question. You are correct. It's probably closer to the 150 number, and it will start in Q3, and then some of it may trickle into Q4.
Okay. Perfect. Thank you, everybody, so much.
As a reminder, if you'd like to ask a question, please press star, followed by the number one on your telephone keypad. Your next question comes from the line of Sam Damiani with TD Securities. Please go ahead.
Thank you. Good morning. I hope you all can hear me.
Yep.
Oh, great. So just, I guess, first question is on the industrial development pipeline. The two active projects, the costs did increase about 3.5% quarter-over-quarter. I want to even get a little more detail on what drove that. And if the rents didn't change, that would change the yields by about 25 basis points if my math is correct. So just curious, I guess, what was going on there.
Yeah, Sam, I don't think it's anything significant. It was just really a small increase in, I'd say, internal allocations, interest, G&A, and then the phasing of the master plan costs to those phases. It was minor tweaks, I would say. The yields are still in line with where we previously disclosed.
Okay. Okay. Fair enough. And just, I guess, on the industrial side, are you getting closer to starting another project, starting construction on another project, either with or without pre-leasing?
Look, we're actively marketing the site. I think what the broker, and I think the broker communities are very pleased because they see all the activity on our site. We either say they're going, and they definitely are stalled. We've got so much work on the site at the moment with all the servicing, with the Loblaw building, and with the spec development that the earliest we actually Q1, Q2 of 2025. And we'll have to assess where the market is then, but right now, we feel very confident that we should be in a position to go at that time.
Oh, great. Great. And I tried to catch what you were saying, Rael, on the, I guess, the deal with Nautical Lands.
Sam, can you hear us?
Yes. Can you hear me fine? Hello? Is this better? Hello?
Hi. Sam, did you hear us?
I did hear you. Can you hear me?
Now we can. We didn't get it after we completed our just spoke about the industrial development.
Okay. I know. I did hear. And my next question is just on the retail side. It looks like about 160,000 sq ft of new active starts in the retail development pipeline year to date. And I guess a lot of it is with this Nautical Lands Group. And just wanted to clarify, you said there's six sites that you're doing with them. And just to be clear, they're ground leases, and what sort of use is the development?
Yeah. They're building rental communities focused on a population segment, 55 and older. And we view it as very complementary to our site. One of the six ground leases we've already transferred, and the other five will come over the next quarter, two years or so.
These are comparable yields to if you were going to develop ground-based retail yourself?
Superior yields to that.
Are these high-rise or low-rise? What sort of projects are they doing?
They're generally around six-story, so they're mid-rise on a suburban basis.
Okay. Great. Fantastic. Okay. Last question for me, Mario. I think you mentioned you got a mortgage on the Choice Eastway development. I didn't quite hear the numbers. Sorry, could you just repeat that?
Yes. Well, it was a mortgage. I think it was about.
25-year mortgage.
The 25-year mortgage was about 5%. I don't recall the number, but it was with a little Lifeco.
You don't recall the amount?
90 million mortgage, Sam.
Is the 90 at your Choice's share or at 100%?
Choice's share.
If I'm not mistaken, the cost on that was CAD 94 million. So that's a pretty good capital payback.
Yeah. This was overall a great deal.
Yep. Okay. Great. Congratulations on a good quarter. I'll turn it back.
Next question comes from the line of Pammi Bir with RBC Capital Markets. Please go ahead.
Thanks. Good morning. I just wanted to come back to the industrial portfolio again. And maybe can you just expand on some of the commentary from a leasing standpoint, some of the dynamics you're seeing? Is it taking any longer to get leases done? Are you offering any sort of concessions or extended free rent periods or any changes in terms that you're seeing? Thanks.
I can't say. No, at the moment, we're not offering any concessions. We're still seeing a lot of interest. I think the value is our in-place rents at the moment and the uplift, our spreads, our retention. I think what was reflected in the quarter is a good indication of where we'll finish the year, where we're getting high retention and strong spreads. We're not seeing that kind of weakness in our portfolio based on our locations.
Okay. Just in terms of some of the occupancy slippage in the industrial portfolio that you do expect, I think, later this year, which markets were those, and what's your sense of timing of getting that space released?
So the biggest is probably in the west, and it's smaller bay units, 1.5-3,000 sq ft where it's local operators. That's where we're seeing some weakness. And Ontario as well. As I said, we've got some planned. But it's the releasing of it. We've been conservative about our releasing assumptions both on rate and on downtime.
Got it. Mario, can you just come back to your comments on the, I think, you mentioned some of the factors that leave your 2024 guidance for FFO pretty much intact. But I think you mentioned in that comment that you expect, I think, some additional income from Loblaw's portfolio optimization, if I'm not mistaken. Can you just maybe expand on that?
Yeah, probably. So in our outlook, the incremental costs from the restructuring will be more than offset by some lease surrender income. So for the second half of the year, with the right sizing, we probably expect about CAD 6 million of lease surrender maybe for around four of the third quarter and two of Q4. And so when you factor that against the cost, our outlook remains the same.
I guess the releasing or the outlook for those additional properties where they expect to surrender. What is the thinking going forward on those?
We're working through a lot of those leases. They are already negotiated as we kind of finish out the year. So as Mario said, we don't expect it to have an impact on the quarter. They're going back in at higher rents.
Okay. At higher rents. Got it. And then just from a capital recycling standpoint, still fairly active, I guess, on dispositions, what's sort of the outlook for the balance of the year as you think about that pipeline?
Yeah. Probably what we said over the last quarter to two years that we, again, very focused on trying to be balanced. So our expectation is that the dispositions would be very close to the amount of acquisitions. So for this year, I don't know, roughly CAD 200 million of acquisitions and CAD 200 million of dispositions.
Thanks very much, Rael. I'll turn it back.
Your next question comes from the line of Sumayya Syed with CIBC. Please go ahead.
Thanks. Good morning. Just firstly, on the Loblaw industrial leases, wondering if the renewal options there are structured the same as the retail ones, and what was the lift on industrial versus retail in that 8.4 average spread that you achieved in the quarter?
We had one industrial, and the spread was 10%.
Okay. And then I guess looking at the lease renewal, so you've now addressed about half of next year's maturity. So for any of the third-party leases that roll next year, are you finding that leasing spreads are holding in the high single-digit range, or where are they landing?
Correct. I agree.
Okay. And then just lastly, Rael, maybe an updated commentary on the transaction market. If you're seeing the buyer pool has changed or still largely local, private, and just thoughts around the availability of financing with the groups that you usually transact with?
Yeah. Look, I think it's very similar to what it was last quarter, where there continues to be this big bid-ask spread between seller's expectation and what buyers are willing to pay. We have been able to transact because, as you said, we're more focused on their private market. And given the quality of the assets and the tenancies generally in place, they are able to get financing. And in a few cases, we've given VTBs, but they're not significant amounts of VTBs just to help bridge the purchase for a short period of time.
Okay. And what would be the average term on the VTBs you have?
Generally, one year.
One year. Okay. Okay. That's everything. Thank you.
I would now like to turn the call back over to Rael Diamond, CEO, for closing remarks. Please go ahead.
Thank you, Erin. And thanks to everyone for your interest, your investment in Choice, and for joining us this morning. Hope you all have a great weekend.
This concludes today's call. Thank you all for joining. You may now disconnect.