Earnings Call: Q3 2020

Nov 3, 2020

Earnings release

Good morning. My name is Valerie, and I will be your conference operator today. At this time, I would like to welcome everyone to CTE 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. The speakers on the call today are Ken Silver, Chief Executive Officer of Citi REIT Leslie Gibson, Chief Financial Officer of Citi REIT and Kevin Salzberg, Chief Operating Officer of Citi 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 CTE REIT's public filings for a discussion of these risk factors, which are included in their 2019 MD and A and AIF, which can be found on CTE 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 C. T. REIT's Q3 2020 investor conference call. As the pandemic has unfolded, each quarter of 20 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 CCRA 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 are 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 1. 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 Leslie to discuss our Q3 results in more detail. Thanks, Ken, and good morning. As outlined in yesterday's press release, in the 3rd quarter, CTE completed the vending of a Canadian Tire store and Canadian Tire Gas Plus Gas Bar in Napanee, Ontario. Subsequent to the quarter, The REIT acquired a property consisting of 2 single tenant buildings leased to Marks and Tim Hortons from a third party in Yellowknife Northwest Territories. Additionally, we announced that we will be acquiring 3 Canadian Tire stores from a 3rd 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 Q4 and remain 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, CTE will be spending approximately $77,000,000 on these newly announced investments. And when completed, they will add 311,000 square feet 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 Q3, CTE REIT had 15 properties that were at various stages of development. These projects represent a total committed investment of approximately 180 $7,000,000 $70,500,000 of which has been spent to date and $48,000,000 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 square feet to the portfolio, nearly 94 of which has been pre leased. As at September 30, 2020, CTE 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 in a portion of our 11 Dufferin Place Southeast property in Calgary, Alberta. Lastly, with respect to the impact of COVID-nineteen on our property operations, tenants representing 99.1% of annual base minimum rent fulfilled their October financial obligations to the REIT compared to 99% for September August 98.5 percent for July. The REIT continued to work with tenants whose businesses were negatively affected by the pandemic, including by continuing to participate in the secret program for approximately 50 of our tenants in the Q3. 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 SIRS, to replace the SICRA program. Similar to SICRA, SIRS is applicable for small and medium sized businesses significantly impacted by the COVID-nineteen pandemic. SIRS is effective retroactively for the period beginning September 27, 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 and hence support property owners by ensuring the timely payment of rental obligations via SIRS subsidized amounts. With that, I will turn it over to Leslie for a review of our financial results. Thanks, Kevin, and 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 0.26 $0.02 a slight increase compared to $0.261 per unit in Q3 of 2019. Reported FFO per unit decreased 1.6 percent to $0.299 versus 0 point 3 $4 Net operating income increased $1,200,000 or 1.2 percent in the current quarter compared to Q3 of 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 $1,200,000 Same store NOI slightly decreased by $1,000 or 0.8 percent in Q3 2020 compared to Q3 in 2019, while same property NOI remained relatively flat compared to the prior year. There were several factors impacting these variances. Contractual rent escalations, which contributed nearly $1,700,000 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 CEFR program, which decreased NOI by approximately $800,000 as well as a decrease of $600,000 related to vacancies and lower parking revenues. In addition, the proceeds of about $850,000 received in Q3 2019 from the assignment of the REIT's interest and claim against a former tenant under company's Creditor Arrangement Act negatively impacted same store NOI growth in Q3 2020. Excluding this lump sum payment received in 2019, NOI would have increased 2.2% quarter over quarter and same store NOI would have increased 0.1%. For the quarter, G and 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 3.6 times compared to 3.45 times 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 percent year to date AFFO payout ratio and a low debt to gross book value of 42.2 percent and approximately $331,000,000 available through our committed credit facilities and cash on hand. C. T. REIT's assets with an IFRS value of approximately $6,000,000,000 are 97% unencumbered. In addition, as of September 30, 2020, the book value per unit was $14.75 which is slightly higher than our 2019 year end value of $14.61 and a Q2 2020 value of $14.57 as net income exceeded distributions. Included in our net income in Q3 was a $4,300,000 fair value decrease, which brings our year to date fair value decrease to 33,500,000 dollars 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-nineteen pandemic on the REIT's portfolio. We continue to monitor the market for data points related to similar essential needs net lease retail assets. And with that, I'll turn things back to you, Ken. Thank you, Leslie. 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 first question is from Sam Damiani with TD Securities. Please go ahead. Thank you and good morning everyone. Just a question for either Ken or Leslie. Just on the IFRS, you're buying some arguably tertiary market Canadian Tire stores. We don't know what the Walt was, but that's around a 6.5% cap rate and your overall IFRS is around 6.2%. But 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 for 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. But 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 kinds of assets. Okay. And maybe just one other question. Just given the volatility out in the marketplace and CTREIT's relative resilience, you're putting more capital to work in the types of assets that you know best. But 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. So 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. But 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 sort of follow-up on the 3 Canadian Tire stores acquisition from a 3rd party. Just wondering how did you identify these properties and how did you agree on a cap rate? And just wondering if these acquisitions were done on an opportunistic basis? And did you get any COVID discount on valuation? Hi, Himanshu. It's Kevin. So 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. And then obviously, when this all first 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. And 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 2 of the properties were in Alberta. And since the original discussions, Alberta economy had continued to soften slightly. So all in all, pretty much acquired close to pre pandemic pricing. Obviously, we have a lot of data points in terms of buying Canadian Tire stores and Canadian Tire rents more broadly. So we felt very comfortable with the cap rate and are very happy to be, I guess, acquiring these properties. Sure. Thank you, Kevin. And what is the weighted average lease term on these 3 acquired properties? And 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. I mean, for us, longer is always preferred. The 3 properties we're acquiring here have a lease term slightly under 5 years. So that would be on the shorter end of what we would typically look to buy. But we also, I would say, have a high degree of certainty that they're strong performing stores and that their locations that Canadian Tire will hopefully want to stay in for a longer period. We also bought the property in Yellowknife. And there, the 3rd party tenancy, which is a Tim Hortons, had 17 years of term. And the Benden, we did had 15 years. So typically, we obviously want to go longer and do what we can to extend out our weighted average lease term. But on these ones, we felt pretty comfortable just based on our knowledge of the sites. Got it. And maybe another follow-up there. How is the acquisition pipeline looking going forward? And 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? So I mean 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. So stay tuned. In terms of the underwriting criteria, I mean, 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. So 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. And maybe just last question from me on the lease up on the 11 Dufferin Street in Calgary. Is the format of the property a bit different compared or is there anything specific about the property? Like what has prevented it to be a traditional locked in lease there? Well, 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 with and we're intending to flip it into something longer. It was actually a film production studio. And basically, when COVID 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. So it's a pretty adaptable 100,000 square foot space. We're still showing it to tenants. We're in discussions with 1 particular group who's shown some keen interest. Our hope is we can materialize, as you say, a longer term arrangement. But obviously, there is some softness in Alberta right now. Calgary Industrial, it seems to be holding up okay, especially in 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. So I think it will just take time to find the right occupant and cut a lease. So I think we're still optimistic. We'll have somebody in the next 6 to 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, Jamie. Good morning. Going back to the 3rd 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. So as I mentioned, the weighted average lease term is just under 5 years there, Jenny, and it is a flat rent during that time. Okay. And then with regards to the funding, given that most of it is being acquired from the 3rd parties, is there any element of units being issued or should we presume that it's mostly debt financed? Jenny, it's Leslie. We're going to be using cash on hand in our line of credit to finance the acquisition. Perfect. And then lastly, with regard to the bad debt and secret expense, there's just a little bit of a discrepancy that I wanted to figure out. I think the actual provision total was $800,000 but in the same property NOI, the difference was I think it was $923,000 Is there what am I missing between those two numbers? Nothing, Jenny. Just rounding when we are taking the 9 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. So there is really no difference. Okay. So largely immaterial. And then you had said you have 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%. Yes. We had a revenue that we received. We received about $850,000 in Q3 of 2019 regarding former tenant and we sold a CCAA claim. And so if I exclude that one, then the NOI would have been about 2.2% positive and same store NOI would have been a positive 0.1%, so a little bit better than what we would have 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 and good morning. Just with respect to these leases on these 3rd 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? Pammi, it's Kevin. The short answer is yes, we would like that. We'll see if we can achieve it. I mean, it's subject to certain contractual provisions that are within the lease already around the rent in the renewal term. And so 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 3rd 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 in terms of raising that required capital. But I think, in terms of raising that required capital. But I think people aren't looking to give away the farm, right? So 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. So I think there is stuff out there to be acquired. For us, it's just about measuring risk and return. So 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. So about 90% of the 50 bps reduction in occupancy relates to 11 Dufferin. So that's our 100,000 square foot industrial vacancy that came back to us in the quarter. And 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 entitlement in place and can get at it in terms of, the LRT construction being completed and hopping into, I guess, the first phase of that project. Okay. Is that 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. So I'm not sure I've ever come across that term elsewhere. But as Kevin said, it is purposeful to get the property ready for development. In terms of a status update, concept design and municipal engagement are right at this moment, we are expecting municipal application in the foreseeable future. So the project is proceeding pretty much on schedule. Got it. Just last one, just on the back of this, I guess, the new service program, what do you see bad debt trending a bit lower partly as a result of that? And or any color you can provide in terms of the outlook on that? Pammi, it's Leslie. Yes, we do hope that that service program, when we are provided with a few more details, will help some of the tenants that were previously in the secret program and help them through. But I think the restrictions that are put on and in place and depending what happened with second and future waves are also going to have just as much impact on how those tenants perform. But I think until we hear more details about the service program and see how things are going for those tenants, it's hard to tell for sure. But there's some tenants are being more impacted than others. So 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. Our next question is from Tal Woolley with National Bank. Please go ahead. Hi, good morning everybody. Good morning. Good morning. Just wanted to start with Canadian Tire. Do you expect like 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 There are still assets in Canadian Tire that can be moved into the REIT. I wouldn't couldn't comment right at this moment whether the pace of that would be different going into the New Year or not. Okay. And can you remind me if like do many of the individual dealers actually own their own real estate? Or is it like as part of the structure with Hyre, like they absolutely do not own their own real estate, but the dealer will not own the real estate? Yes. None of the Canadian Tire stores are owned by a dealer. Okay. Got it. And just back to the Canada Square project for a second. In terms of the plans that you have, like is the existing are the existing zoning regulations like sufficient to do what you want to do? Or will there be, we 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. But having said that and existing entitlements. 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. So more work to come. And I think as I mentioned, I think you're going to see an application within the foreseeable future. Okay. And then finally, I think the last one just be for Leslie. You have the Series C debentures coming up, I believe, earlier early next year. Any thoughts about how you're looking at refinancing this? Sure. Thanks, Tal. Yes, the June 1, dollars 150,000,000 of the public ventures do come due. We're definitely monitoring the market right now in terms of U. S. Election, future waves COVID. But we are actively monitoring and seeing what the opportunities may be and are very cognizant of that pending renewal. But 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. So there's definitely other backstops, but we will be actively watching and seeing what our options are over the coming weeks 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, and thank you all for joining us today. We expect our Q4 results will be released in the 2nd week of February and look forward to speaking to you then. In the meantime, we're wishing you all a safe upcoming holiday season. Thank you. This concludes today's call. You may now disconnect.