Good morning. My name is Valerie, and I will be your conference operator today. At this time, I would like to Welcome everyone to CT REIT's Q3 2020 earnings results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during that time, simply press star then the number one on your telephone keypad. To withdraw your question, press the pound key. The speakers on the call today are Ken Silver, Chief Executive Officer of CT REIT, Lesley Gibson, Chief Financial Officer of CT REIT, and Kevin Salsberg, Chief Operating Officer of CT REIT. Today's discussion may include forward-looking statements.
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 CT REIT's public filings for a discussion of these risk factors, which are included in their 2019 MD&A and AIF, which can be found on CT REIT's website and on SEDAR. I will now turn the call over to Ken Silver. Ken?
Thank you, operator, and good morning, everyone. Thank you all for joining us for CT REIT's third quarter 2020 investor conference call. As the pandemic has unfolded, each quarter of 2020 has had a somewhat different focus. At the end of Q1, the priorities were crisis management, focusing on the health and safety of our employees, tenants, their employees and customers, and on preserving liquidity. In Q2, the focus shifted to the financial health of our relatively small portfolio of ancillary and non-essential retail tenants, working with them to manage through the crisis and in preparing to participate in the CECRA program. With continued high occupancy and rent collections, the resilience of our business model shone through in the quarter and was recognized by our board, who declared a distribution increase, which took effect in September.
In Q3, our focus has once again returned to building for the future while managing the pandemic-related issues in the present. We're delighted to announce a number of new investments marking a return to our growth strategy. These new investments are consistent with what we have been pursuing since day one: low-risk net leases with strong covenants while leveraging our relationship with Canadian Tire to acquire well-located and highly desirable locations within their markets. We are confident these kinds of assets will stand the test of time, both in the short term, in the face of the ongoing pandemic, and in the longer term. With that, I'll turn things over to Kevin and Lesley to discuss our Q3 results in more detail.
Thanks, Ken, and good morning. As outlined in yesterday's press release, in the third quarter, CT REIT completed the vend-in of a Canadian Tire store and Canadian Tire Gas+ gas bar in Napanee, Ontario. Subsequent to the quarter, the REIT acquired a property consisting of two single-tenant buildings leased to Mark's and Tim Hortons from a third party in Yellowknife, Northwest Territories. Additionally, we announced that we will be acquiring three Canadian Tire stores from a third party. These properties are located in Drayton Valley and Leduc, Alberta, as well as Saint-Jean-sur-Richelieu, Quebec. As noted in our release, this new investment is anticipated to close in the fourth quarter and remains subject to customary closing conditions.
We are very pleased to be resuming our investment activities based on the strength and resiliency of our business model, and these newly announced acquisitions will be a great complement to our existing portfolio of Canadian Tire properties and third-party net leased assets. In total, CT REIT will be spending approximately CAD 77 million on these newly announced investments, and when completed, they will add 311,000 sq ft of gross leasable area to the portfolio. They are expected, in aggregate, to earn a weighted average cap rate of 6.58%. At the end of the third quarter, CT REIT had 15 properties that were at various stages of development. These projects represent a total committed investment of approximately CAD 187 million, CAD 70.5 million of which has been spent to date and CAD 48 million of which we anticipate will be spent in the next 12 months.
Upon completion, these projects will add a total incremental gross leasable area of 785,000 sq ft to the portfolio, nearly 94% of which has been pre-leased. As of September 30th, 2020, CT REIT's occupancy rate was 98.8%, in line with last year's Q3 rate, but down slightly from Q2 2020, reflecting the end of a short-term tenancy and a portion of our 11 Dufferin Place SE property in Calgary, Alberta. Lastly, with respect to the impact of COVID-19 on our property operations, tenants representing approximately 99.1% of annual base minimum rent fulfilled their October financial obligations to the REIT, compared to 99% for September and August and 98.5% for July. The REIT continued to work with tenants whose businesses were negatively affected by the pandemic, including by continuing to participate in the CECRA program for approximately 50 of our tenants in the third quarter.
I should also note that subsequent to the quarter end, the federal government announced a new rent relief program, the Canada Emergency Rent Subsidy, or CERS, to replace the CECRA program. Similar to CECRA, CERS is applicable for small and medium-sized businesses significantly impacted by the COVID-19 pandemic. CERS is effective retroactively for the period beginning September 27th, 2020, and will be provided directly to tenants on a sliding scale up to a maximum of 65% of eligible expenses.
In addition to the 65% subsidy, a top-up of 25% is available to tenants who are temporarily shut down by a mandatory public health order issued by a qualifying public health authority. We are hopeful that this new program will assist tenants in need of enhanced support property owners by ensuring the timely payment of rental obligations via CERS subsidized amounts. With that, I will turn it over to Lesley for a review of our financial results.
Thanks, Kevin, good morning, everyone. Our Q3 2020 results continue to be sound despite the headwinds of the pandemic. We reported a diluted AFFO per unit of CAD 0.262, a slight increase compared to CAD 0.261 per unit in Q3 2019. Reported FFO per unit decreased 1.6% to CAD 0.299 versus CAD 0.304. Net operating income increased CAD 1.2 million, or 1.2% in the current quarter compared to Q3 2019. The primary contributor for the increase in the NOI growth was the acquisition of income-producing properties and properties under development completed in 2020 and 2019, which contributed approximately CAD 1.2 million. Same store NOI slightly decreased by CAD 700,000 or 0.8% in Q3 2020 compared to Q3 2019. Same property NOI remained relatively flat compared to the prior year. There were several factors impacting these variances.
Contractual rent escalations, which contributed nearly CAD 1.7 million to same store NOI growth, which includes the 1.5% on average, contained within the Canadian Tire store leases. This was offset by the expected credit losses for tenants who were significantly impacted by the pandemic, including the bad debt expense related to the rental abatements and rent relief under the CECRA, which decreased NOI by approximately CAD 800,000, as well as a decrease of CAD 600,000 related to vacancies and lower parking revenues. In addition, the proceeds of about CAD 850,000 received in Q3 2019 from the assignment of the REIT's interest and claim against a former tenant under the Companies' Creditors Arrangement Act, negatively impacted same store NOI growth in Q3 2020. Excluding this lump sum payment received in 2019, NOI would've increased 2.2% quarter-over-quarter, and same store NOI would've increased 0.1%.
For the quarter, G&A as a percent of property revenue, excluding fair value adjustments, amounted to 2.1%, slightly less than the 2.2% for Q3 in the prior year. The improvement reflects elevated spend in 2019 associated with the implementation of the new ERP system. Moving over to liquidity and our financial condition for the quarter. The interest coverage ratio increased to 3.6x compared to 3.45x for Q3 of the prior year. The increase in the interest coverage ratio is due to both a decrease in the interest expense and an increase in the NOI in the current quarter compared to Q3 2019. Our balance sheet continues to be strong with a conservative 76.8% year to date AFFO payout ratio and a low debt to gross book value of 42.2%, and approximately CAD 331 million available through our committed credit facilities and cash on hand.
CT REIT's assets with an IFRS value of approximately CAD 6 billion are 97% unencumbered. In addition, as of September 30th, 2020, the book value per unit was CAD 14.75, which is slightly higher than our 2019 year-end value of CAD 14.61, and the Q2 2020 value of CAD 14.57 as net income exceeded distributions. Included in our net income in Q3 was a CAD 4.3 million fair value decrease, which brings our year to date fair value decrease to CAD 33.5 million. The decrease in the fair value adjustment on investment properties is primarily due to the updated inputs and assumptions in the property appraisal models, reflecting the impact of the COVID-19 pandemic on the REIT's portfolio. We continue to monitor the market for data points related to similar essential needs, net lease retail assets. With that, I'll turn things back to you, Ken.
Thank you, Lesley. I know it's a busy time for many of our listeners. I'll turn the call back to the operator for any questions.
Thank you. Our 1st question is from Sam Damiani with TD Securities. Please go ahead.
Thank you, and good morning, everyone. This is a question for either Ken or Lesley. Just on the IFRS. You're buying some arguably tertiary market, Canadian Tire stores. I don't know what the WALT was, but that's around a six and a half cap rate, and your overall IFRS is around 6.2. Your overall sort of market footprint would be arguably more primary market than what you're investing in right now. Do you see the low interest rates pulling down cap rates for the most stable retail properties, like many of which that you own? I'm just wondering how you think about your IFRS fair value in this environment.
Sam, it's Ken. Maybe I'll just kick things off. I would say generally we're seeing valuations for the kind of assets we own to be stable. We haven't seen any significant movements. Obviously, there haven't been a lot of data points to draw on. Generally, the feedback that we've had and the experience that we've had in the market would suggest that cap rates have been pretty steady for those kind of assets.
Okay, maybe just one other question. Just given the volatility out in the marketplace and CT REIT's relative resilience, you're putting more capital to work in the types of assets that you know best. Given the difference in valuations, at least based on perception, for more multi-tenant retail properties that do require more leasing, do you see this potentially as an opportunity to take the REIT into more multi-tenant retail and reduce the concentration on Canadian Tire? Does that at all make sense for the REIT during this time of dislocation?
Sam, certainly when the market is disrupted as we've seen, it can create interesting opportunities. I would say in terms of the strategy we're pursuing, we're going to continue on the path that we're on, which is primarily focusing on net lease assets. The extent to which those kind of net lease assets which fit our criteria that are not Canadian Tire assets, those would certainly be things that we would be looking at. I don't think you'll see that we'll be diving into significant acquisitions in the multi-tenant space.
That's great. Thank you, and I'll turn it back.
Thank you.
Thank you. Our next question is from Himanshu Gupta with Scotiabank. Please go ahead.
Thank you, and good morning.
Good morning.
Just a follow-up on the three Canadian Tire stores acquisition from a third party. Just wondering, how did you identify these properties, and how did you agree on a cap rate? Just wondering if these acquisitions were done on an opportunistic basis, and did you get any COVID discounts on valuation?
Hi, Himanshu, it's Kevin. The deal was sourced off-market based on existing relationships that we had with the owner. We had been in discussions with them for some time, actually even pre-pandemic, working towards a potential deal. Obviously when this all 1st hit in the early parts of, I guess Q2, put our pens down in an effort to preserve liquidity. As we kind of went through Q2 and the early parts of Q3 and with our strong operating results and the resiliency of the portfolio, we decided it was prudent to pick it back up.
I would say there was a slight repricing in the asset, but very, very minor and probably less related to the tenancy or COVID and more related to the fact that two of the properties were in Alberta. Since the original discussions, Alberta economy had continued to soften slightly. All in all, pretty much acquired close to pre-pandemic pricing. We have a lot of data points in terms of buying Canadian Tire stores and Canadian Tire rents more broadly. We felt very comfortable with the cap rate and are very happy to be, I guess, acquiring these properties.
Sure. Thank you, Kevin. Then what is the weighted average lease term on these three acquired properties? Just wondering, given the uncertainty in the market, is there any attempt to acquire properties with perhaps a longer lease term in order to minimize the risk?
Sure. For us, longer is always preferred. The three properties we're acquiring here have a lease term slightly under five years, so that would be on the shorter end of what we would typically look to buy. We also, I would say, have a high degree of certainty that they're strong-performing stores and that they're locations that Canadian Tire will hopefully want to stay in for a longer period. We also bought the property in Yellowknife, and there, the third party tenancy, which is a Tim Hortons, had 17 years of term. The other vend-in we did had 15 years. Typically, we obviously want to go longer and do what we can to extend out our weighted average lease term. On these ones, we felt pretty comfortable just based on our knowledge of the sites.
Got it. Maybe another follow-up there. How's the acquisition pipeline looking going forward? As you resume new investments post-COVID, do you think the underwriting criteria will change, or are you looking to avoid certain store types or certain markets which perhaps have become a bit weaker due to COVID?
The pipeline is, at this point, I would say still opportunistic. We're not seeing a lot of stuff being marketed, but continue to have a lot of dialogue. I think there's a lot of stuff you can buy off-market right now. Stay tuned. In terms of the underwriting criteria, I think it's actually the pandemic has reinforced exactly what we're looking for, which is strong covenant, essential needs retail, fundamentally good underlying real estate. And obviously, as we just discussed, long-term leases. I think on a risk-adjusted basis, we still very much like that space, and we're hopeful there'll be more opportunities in the coming quarters.
Sure. Thank you. Maybe just last question from me on the lease-up on the 11 Dufferin Place SE in Calgary. Is the format of the property a bit different compared, or is there anything specific about the property? What has prevented it to be a traditional long-term lease there?
The short-term arrangement that we had with the party that just vacated was actually supposed to be a longer term lease. They sort of had an option to occupy it for a couple of months, and were intending to flip it into something longer. It was actually a film production studio. Basically, when COVID-19 hit and they couldn't get their actors up from L.A. or wherever they were coming from, they decided to give back the space. It's a pretty adaptable 100,000 sq ft space. We're still showing it to tenants. We're in discussions with one particular group who's shown some keen interest. Our hope is we can materialize, as you say, a longer-term arrangement.
Obviously, there is some softness in Alberta right now. Calgary industrial, it seems to be holding up okay, especially in that mid to large bay-type space. I think service or small bay product is a little bit more challenging right now, but that's not what we're dealing with. I think it'll just take time to find the right occupant and cut a lease. I think we're still optimistic we'll have somebody in the next 6-12 months in there and paying rent.
Sure. Thank you, guys. I'll turn it back.
Thank you. Our next question is from Jenny Ma with BMO Capital Markets. Please go ahead.
Thank you. Good morning.
Good morning, Jenny.
Going back to the third-party acquisition, can you tell us about the lease structure and whether or not it differs from the 1.5% annual rent steps that you have for most of the portfolio?
Sure. As I mentioned, the weighted average lease term is just under five years there, Jenny. It is a flat rent during that time.
Okay. Thank you. With regards to the funding, given that most of it is being acquired from the third parties, is there any element of units being issued, or should we presume that it's mostly debt-financed?
Jenny, it's Lesley. We're going to be using cash on hand and our line of credit to finance the acquisition.
Perfect. Then Lesley, with regards to the bad debt and CECRA expense, there's just a little bit of a discrepancy that I wanted to figure out. I think the actual provision total was CAD 800,000, but in the same property NOI, the difference was, I think it was CAD 923,000. What am I missing between those two numbers?
Nothing, Jenny. Just rounding when we are taking the nine-month year-to-date number and what we reported last quarter and this quarter. The rounding just rounds perhaps a little bit less ideally than it would be. There is really no difference.
Okay. Largely immaterial.
Yes.
You had talked about some same property numbers excluding some items. Could you just repeat those? I missed them when you were speaking initially.
Sure, Jenny.
I think it was 2.2%.
Yeah. We had a revenue that we received. We received about CAD 850,000 in Q3 of 2019, regarding former tenant, and we sold a CCAA claim. If I exclude that one, then the NOI would have been about 2.2% positive, and same store NOI would've been a + 0.1%, so a little bit better than what we would've reported.
Okay, great. That is all for me. Thank you very much.
Thanks.
Thank you. Our next question is from Pammi Bir with RBC Capital Markets. Please go ahead.
Thanks. Good morning. Just with respect to these leases on these third-party acquisitions, when they do come up for renewal, is the intent to sort of switch them, I guess, to the structure that you would typically do with your other Canadian Tire leases?
Hey, Pammi. It's Kevin. Short answer is yes, we would like that. We'll see if we can achieve it. It's subject to certain contractual provisions that are within the lease already around the rent and the renewal term. We'll just have to, I guess, negotiate it at the time, if not earlier.
Got it. Just from an acquisition perspective, I guess coming back to the commentary there, are you seeing any more opportunities from third parties that might be looking to perhaps raise some liquidity?
It's Kevin again, Pammi. Short answer is yes. I think there are a number of private and public players out there who had disposition programs in place pre-pandemic, and obviously have certain commitments to meet and still view capital recycling as an option in terms of raising that required capital. I think people aren't looking to give away the farm. They're happy to sell on market terms, and I think they're deeming market terms to be pricing that is comparatively similar to pre-pandemic levels for that strong covenant, that essential needs retail. I think there is stuff out there to be acquired. For us, it's just about measuring risk and return. We're in discussions, as we always have been, with lots of various groups, and our hope is we can find a few more gems like the ones we just bought.
Great. Thank you for that. Just with respect to, I guess the incremental rise in vacancy, keeping in mind it is obviously very modest, but can you comment on the re-leasing prospects for some of that space and also perhaps some color on the drop in occupancy at Canada Square?
Sure, Pammi. I'll take that. About 90% of the 50 basis points reduction in occupancy relates to 11 Dufferin. That's our 100,000 sq ft industrial vacancy that came back to us in the quarter. As I mentioned, there's some groups that we're in discussions with, so I'm not going to repeat myself there, but the balance being really Canada Square, and I would describe the vacancy there as being purposeful, just in terms of gearing up to be in a position to redevelop the property. Obviously, once we have our municipal entitlements in place and can get at it in terms of the LRT construction being completed and hopping into, I guess, the 1st phase of that project.
Okay. Any further updates on, I guess, the timing of that project or?
Pammi, it's Ken. Just a further comment on vacancy, firstly, on Canada Square. We call it de-leasing the property. I'm not sure I've ever come across that term elsewhere, but, as Kevin said, it is purposeful to get the property, pardon me, ready for development. In terms of a status update, concept design and municipal engagement are proceeding, and while we can't put a date on it right at this moment, we are expecting a municipal application in the foreseeable future. The project is proceeding pretty much on schedule.
Got it. Just last one. Just on the back of this, I guess the new CERS program. Do you see bad debts already trending a bit lower, partly as a result of that? Or any color you can provide in terms of the outlook on that.
Pammi, it's Lesley. Yes, we do hope that the CERS program, when we are provided with a few more details, will help some of the tenants that were previously in the CECRA program and help them through. I think the restrictions that are put on and in place and depending what happened with 2nd and future waves, are also going to have just as much impact on how those tenants perform. I think until we hear more details about the CERS program and see how things are going for those tenants, it's hard to tell for sure. Some tenants are being more impacted than others. We do hope over time that bad debt sort of continues to trickle down, but I'm not expecting that to disappear in Q4.
Great. Thanks very much. I'll turn it back.
Thank you. Once again, please press star one at this time if you have a question. Our next question is from Tal Woolley with National Bank. Please go ahead.
Hi, good morning, everybody.
Good morning.
Morning.
Just wanted to start with Canadian Tire. Do you expect over the next year, you are obviously, potentially one of the liquidity providers to the corporation? Any chance that we would expect to see maybe a higher number of dropdowns from Canadian Tire? Are there any assets they would still like to move into the REIT over the next year?
Tal, it's Ken. There are still assets in Canadian Tire that can be moved into the REIT. I couldn't comment right at this moment whether the pace of that would be different going into the new year or not.
Okay. Can you remind me if, do many of the individual dealers actually own their own real estate, or is it as part of the structure with Tire, like they absolutely do not own their own real estate? Like the dealer will not own the real estate.
Yeah. None of the Canadian Tire stores are owned by a dealer.
Okay. Got it. Just back to the Canada Square project for a second. In terms of the plans that you have, are the existing zoning regulations sufficient to do what you want to do, or will you have to seek new zoning, and when would we expect to see that application and the ultimate decision?
Tal, there are existing planning documents, if you like, that apply to the Canada Square property, and existing entitlement. Having said that, given the size and complexity of the project, there is a process that you'll see beginning to unfold where those entitlements will be further crystallized. More work to come, and I think, as I mentioned, I think you're going to see an application within the foreseeable future.
Okay. Finally, I think this last one will just be for Lesley. You have the Series C debentures coming up, I believe early next year. Any thoughts about how you're looking at refinancing this?
Sure. Thanks, Tal. Yeah, the June 1st, CAD 150 million of the public debentures do come due. We're definitely monitoring the market right now in terms of U.S. election, future waves of COVID. We are actively monitoring and seeing what the opportunities may be, and are very cognizant of that pending renewal. At the same time, we don't feel a lot of pressure because we have plenty of liquidity on our line of credit and other sources. There's definitely other backstops, but we will be actively watching and seeing what our options are over the coming weeks and months.
Okay. That's great. Thanks so much, everybody.
Thank you.
Thank you.
Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to you, Mr. Silver.
Thank you, operator. Thank you all for joining us today. We expect our fourth quarter results will be released in the 2nd week of February and look forward to speaking to you then. In the meantime, we are wishing you all a safe upcoming holiday season.
Thank you. This concludes today's call. You may now disconnect.