Good afternoon, ladies and gentlemen. Welcome to the Crombie REIT second 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 for the operator. This call is being recorded on Thursday, August 9, 2018. I would now like to turn the conference over to Claire Mahaney-Lyon, Investor Relations. Please go ahead.
Thank you, Brittany. Good day, everyone, and welcome to Crombie REIT's second quarter conference call and webcast. Thank you for joining us. This call is being recorded in live audio and is available on our website at www.crombie.ca. Slides to accompany today's call are available on the Investor Relations section of our website under presentations and events. Joining me on the call are Don Clow, President and Chief Executive Officer, and Glenn Hynes, Chief Financial Officer, Executive Vice President, and Secretary. Today's discussion includes forward-looking statements. As always, we want to caution you that such statements are based on management's assumptions and beliefs. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. Please see our public filings, including our annual information form for the year ended December 31st, 2017, for a discussion of these risk factors.
I would now like to turn the call over to Don, who will begin our discussion with comments on Crombie's overall strategy and outlook. Glenn will follow with a review of Crombie's operating and financial results and discuss our capital allocation and funding approach. Don?
Thank you, Claire, and good day, everyone. Our strong second quarter results announced last night prove that our core portfolio is performing very well. We've achieved 9.4% growth diluted AFFO per unit, advanced our mixed-use major development pipeline, and continued the execution of our capital recycling program. Occupancy for the REIT reached a new all-time high of 96.1%, the highest in Crombie's history as a public company. In addition to our solid quarterly financial results, our capital recycling program has been very successful. Through the sale of assets that are deemed lower growth and/or non-core to our strategy, we were able to improve portfolio quality and redeploy proceeds into more strategic efforts such as development. Year to date, we've closed on CAD 194 million of asset dispositions in line with IFRS fair values and are negotiating and evaluating another CAD 200 million of asset sales.
Recycling of capital at amounts in line with IFRS fair values at a time when our units are trading materially below NAV validates our prior statements that our units are mispriced. Our development pipeline is heavily weighted towards the major urban markets across Canada, with 17 of our 23 projects located within major cities. These assets currently produce solid operating returns at a 5.3% yield while we move through the various planning and approval phases. Before providing an update on our development projects, I'm going to make a couple of comments about our development team. Crombie has an experienced development team right across the country that's creating value over time. In addition to my 20-plus years of residential development experience, our team of 20 professionals includes expertise across development, construction, and design.
From myself to SVPs to managers, we have decades of experience, and a sizable portion of that is residential. We're working alongside our development partners every step of the way, communicating with them daily, providing our insight and expertise, and learning from them wherever possible. Let's discuss the great work our development and construction teams are doing on our own and with our partners. On Vancouver Island, where land is scarce and limited, Belmont Market, near Victoria, B.C., will be a vibrant open-air center and the dominant retail node of the West Shore communities. This project is being 100% developed by Crombie. Belmont Market's taking shape with the paving of the internal roadways, parking, and sidewalks to be complete by the end of the summer. Phase 1 of the retail will be complete this fall, with handover to our tenants scheduled for September.
Sobeys is now underway with the construction of a new Thrifty Foods Store, which is expected to open in the spring of 2019. Phase 2 has also begun. Our Davie Street project in Vancouver's West End is moving along well. The market is extremely strong in this area for residential rental, with vacancy rates at or around 1%, and rents growing at an astonishing 5.7%, according to CMHC. Excavation material has been removed from the site, and the lower level of parking garage is beginning to take form. 95% of our costs have been tendered and are on budget. Commercial leasing has been very strong, with rents coming in in excess of our pro forma. Avalon Mall is one of the best regional shopping centers in Atlantic Canada and the dominant center in Newfoundland and Labrador.
Our redevelopment plan of this asset, where Crombie, again, is the 100% owner and developer, is progressing as planned, with Phase 1 scheduled to be completed in 2019. Parking garage is near completion, and just two weeks ago, the pedway from the parking garage to the mall was installed. The interior of the existing mall is under renovation, and Cineplex has commenced construction of its 30,000-square-foot The Rec Room concept. We're building new CRU in the remaining stair space, a new mall expansion, and creating an additional pad site. We're in negotiations with numerous international and national first-to-market tenants, which will enhance Avalon's merchandising mix, drive additional customer traffic, sales productivity, and in turn, rental growth.
The return metrics on this phase are truly phenomenal, as we're estimating our yield on cost will be in the range of 10%-13%, demonstrating that well-located and well-managed retail is far from dead and is, in fact, thriving. Le Duke, our latest addition to our pipeline, is being built as CAD 124 million development and is adjacent to the new Bonaventure Greenway in Old Montreal. Vacancy rates in Montreal decreased to 2.8%, with rental growth remaining strong. Our 25-story mixed-use tower will contain 390 residential rental units above a 25,000 sq ft urban format, IGA. The new structure will incorporate the existing heritage building, integrating the two-story facade, maintaining the current character and streetscape. Excavation is nearing completion, with the project expected to be completed in 2020.
Steps from the Bronte Beach Park and Marina in Oakville, Ontario, our Bronte Village development presents a special luxury rental opportunity in a vibrant, unique, and highly sought-after community, surrounded by lakefront parks, running and walking trails, shopping, grocery stores, restaurants, and cafes. Demand for residential rental is very strong in Oakville, with vacancy rates around 1%, a 16-year low, and rental rates growing at approximately 4% for CMHC. This CAD 277 million development will include 480 units of refined residential living, rental living, and a 30,000 sq ft Sobeys. Project kicked off this quarter. The demolition of the enclosed shopping center is now complete.
Based upon current estimates and market conditions, we expect Crombie to invest approximately CAD 450 million in our first five major developments that, at current cap rates, are expected to be worth approximately CAD 600 million-CAD 750 million, effectively creating CAD 150 million-CAD 300 million of value, or CAD 1-CAD 2 per unit of net asset value in NAV over the next two to three years. In closing, we're very pleased with this quarter's results, the pace, and the pricing of our dispositions, as well as our execution of the development pipeline. We're focused on doing what is best for our real estate and the communities in which we operate, including our strategy to position a portfolio to generate consistent growth that will create short, medium, and long-term shareholder value.
Our experienced operating and development teams across the country are successfully driving the transformation of Crombie from a landlord of neighborhood need-based retail to a fully integrated owner-developer of retail and residential real estate in Canada's top markets. With that, I'll now turn the call over to Glenn, who will highlight our second quarter financial results and discuss our capital and development program funding approach.
Thank you, Donny, and good day, everyone. Diluted AFFO per unit increased 9.4% to CAD 0.26 versus the same quarter last year. Our Q2 AFFO payout ratio improved to 85.3%, compared to 93.6% at the end of Q2 of 2017. Diluted FFO for the quarter was solid at CAD 0.30 per unit, up 5.6% over the same quarter last year. Our FFO payout ratio continues to improve and ended the quarter at 72.7%, versus 76.7% for the same period in 2017. On a cash basis, same-asset NOI increased by 2.9% in the quarter as compared to the same quarter last year. Growth was driven by improvements in occupancy, rental step-ups, and rental uplifts from redeveloped properties. On the leasing front, during the first quarter, we renewed 138,000 sq ft with an increase of 3.4% over expiring rate.
Taking a closer look, 113,000 sq ft of 2018 expiries were renewed at +2.8%, with 25,000 sq ft of future year renewal completed at 7.6%. As Donny mentioned, committed occupancy was 96.1%, the highest in Crombie's history as a public company. We ended the quarter with 175,000 sq ft of committed space, boosting future NOI growth. G&A, as a percentage of property revenue for Q2, was 4.4%, or CAD 4.6 million, an improvement from the 5.1%, or CAD 5.2 million in Q2 of last year. The improvement was mainly driven by CAD 494,000 in tax reorganization costs incurred in Q2 of last year. Cap rates remained stable with our IFRS cap rate at 5.99% for the quarter, up seven basis points from the first quarter. We've mentioned this on previous calls, I'd like to reiterate our methodology.
Crombie calculates its NAV based on market cap rates and trailing 12-month in-place NOI, versus some who use next 12 months NOI. In addition to our already conservative approach, IFRS and our weighted average cap rate excludes the fair value of future developments and air rights until projects are complete and income-producing. As Donny mentioned in his opening remarks, we estimate that our active developments could add one to CAD 2 per unit of NAV in the next two to three years. We finished the quarter with debt to gross book value on a fair value basis of 49.9%, versus 49.6% at the end of Q1. Our goal remains to reduce leverage over time in order to continue to de-risk our balance sheet.
Debt to trailing 12-month EBITDA was 8.5 times, an improvement from the 8.6 times in Q1 of this year. Our interest and debt service coverage ratios remain strong. We continue to focus on improving our capital structure and de-risking our business. During the quarter, we repaid the balance of our 2018 maturing mortgages at CAD 35 million, reducing our interest costs and growing our unencumbered asset pool to approximately CAD 1.1 billion, which is up 8% from Q1. Our unencumbered assets now account for 22% of our IFRS fair value of investment properties. Our balance sheet remains strong and flexible, with increasing access to the unsecured bond market. We have roughly CAD 360 million of available liquidity, and our weighted average interest rate and fixed rate debt sits at 4.18%. We recently announced the redemption of our CAD 74.4 million of 5.25% Series E convertible debentures.
Which should result in about CAD 1 million of annual interest savings. We're executing as planned on our strategy and capital allocation priorities, directing disposition proceeds into compelling and higher-returning developments. Assets we've identified within our portfolio as potential sources of capital are either non-core or lower growth. Year to date, we sold CAD 194 million of assets, deployed capital into developments, and acquired CAD 101 million portfolio from our partners at Empire. With our current momentum on recycling capital and free cash flow, we're confident that we can fund our future investments and improve our balance sheet at the same time. In closing, our core portfolio remains strong, as is clear by our record occupancy, solid same-asset property cash NOI, cash flow growth, and improving payout ratios. Our core business is not only strong, but also e-commerce resilient, and a wonderful complement to our development pipeline.
As we look to the future, we remain acutely focused on creating short, medium, and long-term value through disciplined capital allocation, through the performance of our core property portfolio, and through our development and intensification programs. Thank you for listening. We're now happy to respond to your questions.
Thank you. Ladies and gentlemen, we will now begin the question and answer session. If you have a question, please press the star followed by the one on your touch-tone phone. You will hear a three-tone prompt acknowledging your request, and your questions will be pulled in the order that they are received. Should you wish to decline from the polling process, please press the star followed by the two. If you are using a speakerphone, please lift the handset before pressing any key. Your first question comes from Sam Damiani from TD. Please go ahead.
Thank you. Good morning.
Good afternoon, Sam.
Just on the development plans for the next maybe two years, roughly maybe three, can you clarify just the amount of spend that is going to be required and what the sources of that capital are going to be?
As we said in our presentation, Sam, we're planning to spend approximately CAD 450 million on our first five projects over the next two to three years. Funding for that is really in place with the disposition program that we've managed to achieve during the first half of the year and with the visibility we have on dispositions in place, or at least in negotiations today, we believe we can fund that program. That's as simple as it is. I believe we are continuing to work importantly with Sobeys on our pipeline. Again, as we've said, we have a CAD 4.5 billion pipeline that we're planning to do over the next 10-15 years.
We're working very closely with them to ladder that program out over those next 10-15 years, so we end up with a very consistent program of development over that timeline.
Great. You're definitely looking at more dispositions to fund that program. Is that?
We have a predisposition to dispositions. No, that's.
Can I quote you on that?
You can, yeah. It's a mouthful. I got it from Claire, so she can take credit for it. Yeah, we do. It's obviously a less dilutive type of activity in terms of raising funds for us. We're very focused on that. Given the nature of our product, as we've proven year to date, grocery-anchored product is still in favor across the market, even though there's a fair amount of it on the market from some of our peers. We still end up with a very, I think, strong market for our product. We're quite confident in our ability to achieve that over the next little while.
Great. Thank you. Just a couple questions on cap rates. The Park Lane asset that was sold, could you share the cap rate on that with us?
Sam, that's a difficult one. That was a 270,000 sq ft property with office, retail, and sort of the income in place is sort of to be modeled by the buyer. I think we'll just say we're very happy and satisfied with the value, but to put a cap rate other than that wouldn't be a lot of utility in that. We're not disclosing a cap rate because, and also with the movie theater and all the moving parts there's certainly a dynamic income there that's a little bit more complicated than the traditional grocery-anchored center that we're very happy to provide cap rate detail on.
Makes sense. On the acquisition from Empire this quarter, what was that cap rate?
It's just over 6.5%.
Right. Okay. Just finally, the province of Nova Scotia there, the office lease is coming up in about a year. What's the status of renewal negotiations there?
We're working very closely with them. We have a great relationship with them, especially our local team here in Halifax. We'll continue to work with them and basically see how things play out.
Okay. Turn it back. Thank you.
Thank you.
Your next question comes from Howard Lee, from [B.RiX. Please go ahead.
Hi. Good afternoon.
Good afternoon.
I want to go into the acquisitions, this quarter. Most of the properties are non VECTOM and increase your Quebec and Western Canada exposure. Can you go over that, and versus the dispositions in the quarter?
Sure, Howard. The key thing on the acquisitions, over 40% of the value in the income is in VECTOM markets. For example, there is assets in the Edmonton market, there is assets in the Gatineau market, Châteauguay, Edmonton, as you go down the list of the properties in the MD&A. We are pleased about having a strong VECTOM composition of the acquisition. Secondly, it gave us some growth in Quebec. If you look at our market share, we are substantial in the West and more substantial in Atlantic Canada than in Central Canada. We got access to some good, strong IGA and other Sobeys-branded product in Quebec, which is a market we want to continue to grow in. That was the primary presence of the acquisition. What was your question with respect to the disposition assets?
Just comparing the geographies of the dispositions compared to the acquisitions and getting a sense of where that might head up in the next couple of quarters.
I wouldn't look forward, what we sold in the second quarter, there was some secondary market assets in markets like Red Deer and Napanee, which were sort of more secondary market related. The Northern portfolio, which was a 50% disposition where we continue to have a managed interest in those properties. Those tended to be lower growth assets, non-development potential assets. Again, non-development potential assets, but in more urban markets. That was a transaction that we consummated at a sub 5.5% cap rate.
Okay. No, that's good. The increase in the cap rate, just for this quarter, for your overall portfolio, was that driven by, I'm guessing it's probably not from dispositions and it's just actually from the remaining portfolio?
Yeah, a few moving parts. We did have two impairments in the quarter. You'll notice on the P&L, we had CAD 8 million impairment relating to two properties. Because we're on IFRS cost versus fair value, we're obliged to report our impairments when they occur. We do this. That moved a few basis points of cap rate. I think the rest of it was just moving parts in the ordinary course, acquisitions, dispositions, and obviously looking at our ongoing market data. I think it moved six or seven basis points, so it really wasn't much.
Yeah. Okay. The JVs for the Le Duke and the Bronte Village, I noticed they're not in the financials yet. I guess it's going to be reported next quarter when the actual title is transferred?
That's correct. August, we note in the MD&A that we expect those things to be consummated in August, they should be in our Q3 reporting.
Great. Just one more. Glenn, do you have the figure for the reimbursement of property taxes for the quarter or for the first six months?
Reimbursement of property taxes?
The recoveries for the property taxes.
I'm not sure I understand. Are you talking recovery rate, Howard, or what are you speaking to?
For the actual revenues. In the notes, I think they're lumped in the financial statements note for revenue. They're lumped in with the rental revenue.
Yeah, let's take that off-line. I'm happy to provide that, but I don't think we've got that at hand right now. Drop me a note, and we'll get that information to you.
Sounds good. Thanks, guys. I'll have a follow-up.
Your next question comes from Tal Woolley from National Bank. Please go ahead.
Hi, good afternoon.
Good afternoon.
Hi, Tal.
You've got your Series A debentures, I think, coming due sort of in Q4. What are your preliminary thoughts on how to refinance that right now?
First of all, we have CAD 175 million backstop facility in place, which we put in place back in Q4 of 2017. Our game plan ultimately is to issue new unsecured notes to take out the maturing notes. We put the backstop facility in place just as a secondary precaution late last year. Our game plan there, Tal, would be to do a new series of notes. Our preference would be to go out a little longer duration. We'd like to continue to build a ladder in the unsecured note space. We currently have only issued out as far as five years duration, so we'd like to look at six, seven years as possible duration for that replacement series of notes. That'll be something we'll look at in the next few months.
Given that we have the backstop facility in place, it's not an urgent priority to do it fairly soon, but we're looking at doing it between now and the end of October.
Okay. That's great. I can't remember whether Empire's sort of last store closure announcements were previous to the last call or not. Did you have any stores that were affected by that last, I think there was about 10-15 stores, I can't remember.
Yeah. That was announced actually, nothing new in that news.
Yeah.
I think from memory, they announced 10 total closures, of which four were applicable to us.
Three discounts.
Three that were planned to be reopening as discounts. There was really one ultimate closure, which is a-
Okay
property that will be a major development project.
Royal Oak.
Yeah, in Vancouver. No impact. That was announced, I think, back in January-
Yeah
In terms of the gains. You're right, the closures are actually taking effect here now in the summer of this year.
Okay, perfect. Thanks.
Thanks, Tal.
Your next question comes from Pammi Bir from Scotiabank. Please go ahead.
Thanks. Good afternoon.
Hi, Pammi.
You're doing well on your disposition program with the proceeds in line with IFRS values. Are you seeing any sort of cap rate shifts in some of the markets more recently? You mentioned, Donny, that there is a fair amount of product out there. Just curious as to what you're seeing there.
Yeah. Obviously, a number of our peers, and I won't name them, but they are out there with significant amounts of product in the market, and obviously, they're secondary and tertiary market assets. What we're seeing for our product is obviously some very strong results year to date. I think continuing going forward, we'll continue to see good results. As we've talked about before, we're looking at doing both a blend of non-core And partial interest in core. That combination allows us a lot of flexibility in terms of how we do deals and when. We'll be able to, I think, work around, call it that flooding of the market, at least the secondary, tertiary markets, if we want to, depending on the nature of the deal.
I don't see it affecting us significantly, quite frankly, but you don't know until you actually transact the deals.
Right. Just going back to your comments about the additional CAD 200 million that you're planning to sell. Is that all non-core, or would some of that be core assets or partial interest sales?
What I would say, it would be a combination of both, is what we're call it working on off-market deals primarily in the marketplace. We'll, again, choose what's best for Crombie at the time. We have a number of deals, obviously, to do, call it our target dispositions. You need to have a certain number out in the market and basically feeling out what's going to work out best for us. I'd say you always have a little more out in the market, testing the waters and seeing where things are, to ultimately achieve the result that you want.
Got it. That's helpful. Just maybe, coming back to the development team comments. As the amount of development activity increases, the pipeline is obviously quite large. Do you feel that you have the sufficient resources in place at this stage to manage the process? Or do you see yourselves perhaps adding more bodies over time, more expertise? If so, would there be any incremental G&A tied to that?
First and foremost, we're working with partners, out of the first five projects, two of them are done by Crombie 100%, and they're 100% retail. The three mixed-use, obviously, as people know, and we've announced publicly that we have obviously great partners in Westbank and Prince Developments out of Montreal. They really provide the development talent, and we'll actually provide the operating talent as well on those projects. Importantly, as we've said to a number of investors, we're what we call active-passive development management people. We've got a good team. I wanted, in my remarks, to stress that I've got 20-years-plus residential experience in my background, and we've got 20 other people inside of Crombie that have significant residential as well already. It's not like we don't have any.
The real question will be when do we want to take on one ourselves? We're going to consider that over the next few years as we look forward at our different opportunities with Sobeys. In terms of the overall team, I'm comfortable with where we are given the way that we are doing transactions today. It is obviously development, a hard-to-get, and I think very complex talent to obtain in the marketplace. We'll be, I think, looking to add more people as we go forward. Does it disaffect our G&A? I don't think it does materially.
I think that one of your peers just released some statistics and many different metrics on G&A in the last few weeks, and I thought it was a decent report, and it showed that Crombie was, call it lower or just below the middle of the pack in terms of G&A. That's carrying some G&A costs towards development. I believe that we'll be able to manage those types of costs over time, and certainly we'll be adding We need great talent to do great things. As I said to a lot of people, that development pipeline is a world-class development pipeline. We need world-class people to do it, and we'll continue to add as we see fit.
Got it. Thanks very much.
Your next question comes from Tal Woolley from National Bank. Please go ahead.
Sorry, I forgot to ask this on my last round. When you look at the CAD 450 million spend program, how are you thinking you might use construction financing and other tools through that period? What sort of LTVs do you think you could use to sort of let the banks or other lenders fund the cost of it?
Sure. Tal, we use a variety. On Davie Street, for example, we did something a little bit more novel. We put in place 10-year permanent financing, both construction and permanent financing. We did it through CMHC, we locked in a 10-year interest rate of 3.22%, 3.224% to be precise. That's 10-year financing. The funds are in escrow. Small negative carry through the development phase, but gives us security. The loan to cost on that project was very strong, around the 80% range. That was very good. On the other two JVs that we're doing in both Le Duke and Bronte, we're looking at more traditional bank construction financing, call it floating rate BA plus financing. Generally speaking, we're in the 80%-plus loan to cost on those.
Once we finish the construction, we will look at what the permanent financing options are, whether it is unsecured notes, whether it is CMHC mortgages, or whether it is traditional mortgages. We are very comfortable. There is a great supply of bank financing for the construction side. Clearly what we will do in the REIT is we want to lower leverage over time, but we will have a disproportionately higher amount of leverage on construction. We will be continuing to pay off. You will probably have noticed in our financials, we paid off over CAD 100 million of mortgage debt year-to-date. So all of the mortgages that have come due, plus our ongoing principal payments, are extinguishing mortgage debt, which is reducing our on-balance sheet debt. If we can get inexpensive, higher leverage in these JVs for the development and construction program, we will take advantage of that.
Keeping the total aggregate leverage of the REIT at a lower level going forward. So that is the game plan.
Okay. If you could just talk a bit about the potential major developments that you outlined. When I look at something like the Avalon Mall project, your projected returns there, double digits, that is great. If you had CAD 500 million of those, that would be fantastic, right? I am wondering, when I look at the potential major development list, you have got both commercial and residential expansion for all of the projects. I am wondering if you can sort of talk qualitatively about that pipeline, how much of the CAD 2.5 billion-CAD 4 billion, how much of that is in your kind of mixed-use, or residential, and how much of those really sort of tasty retail projects are there in that bucket too? Maybe you can maybe offer some color around that.
There is not a lot, Tal.
Yeah.
Avalon is a very unique project. It's the Yorkdale of Newfoundland and Labrador. It's a dominant regional shopping center. In fact, it's really the only regional shopping center in Newfoundland and Labrador, the entire province. What I will stress to you is that almost all of the mixed-use project is mixed-use development in the major urban markets. We've said 17 out of the 23 are in basically Vancouver, Toronto, Calgary, and now Montreal. All of those have huge differentials between the yield on cost and, call it a sale cap rate. For the most part, our forecast is in the mid fives. What we're doing today, we call it 5%-6%, but most of them are in the mid to high fives on a yield on cost basis.
In markets where cap rates today in Vancouver on this quality of residential would be in the low threes, if not, it's hard to believe, maybe even in the high twos. In Toronto, you'd be talking mid threes. The differential's extreme. It's a wonderful thing for us. That's where we try and articulate that we can create a tremendous amount of NAV. If we really wanted to, we could sell one or sell two to generate the capital to fund that development program almost into perpetuity. It gives us not only great NAV creation, but tremendous flexibility in terms of how we fund our business. Really, I think for the long term, as we've said many times, we generally think long term, because we have major shareholders that are long-term investors.
Our primary interest is building and creating communities that are A+ real estate that have long-term cash flow. There's lots of flexibility, and so it's a wonderful opportunity. To be truthful, the major mixed-use in the major urban markets is the opportunity. This is world-class real estate, whereas the Avalon is a great property, but it's a one-off for us, in my view. I would prefer to focus on the major urban market stuff.
Gotcha. Thanks very much.
Thank you.
Ladies and gentlemen, as a reminder, should you have a question, please press the star followed by the one. There are no further questions at this time. Please proceed.
Thank you for your time today, and we look forward to updating you on our progress on our Q3 call in the coming months. Goodbye.
Thanks everybody.
Thanks everybody.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your line.