All participants, thank you for standing by. Your meeting is ready to begin. Good morning. My name is Julian, and I will be the conference operator today. At this time, I would like to welcome everyone to CT REIT's second quarter 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, please press the pound key. The speakers on the call today are Ken Silver, Chief Executive Officer of CT REIT, Louis Forbes, Chief Financial Officer of CT REIT, and Kevin Salsberg, Senior Vice President 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 filing for a discussion of these risk factors, which are included in our 2017 MD&A and AIF, which can be found on CT REIT's website and on SEDAR. I would now like to turn the meeting over to Mr. Ken Silver, Chief Executive Officer of CT REIT. Please go ahead, Mr. Silver.
Thank you, operator. Good morning, everyone. We're very pleased to welcome you to CT REIT's second quarter 2018 investor conference call and to share with you the results of another strong quarter. I trust our audience has been enjoying the great summer weather, and I'll keep my comments brief so you can get back out and enjoy it, or go to your next call if you're an analyst. All the hallmarks of CT REIT were once again on display in Q2. Attractive growth in AFFO per unit, a strong balance sheet, conservative financial management, disciplined and low-risk investing, and a well-considered and long-term view to creating value for unit holders. Executing our strategy delivers attractive results at low risk, and that combination of growth and security remains the focus of our efforts.
With that, I will now turn the call over to Kevin Salsberg, our Senior Vice President of Real Estate, to discuss our leasing, investment, and development activities. Louis Forbes, our Chief Financial Officer, will then briefly review the financial aspects of the quarter. I'll wrap things up before turning the call over for questions. Kevin?
Thanks, Ken, and good morning. As described in yesterday's release, we are pleased to announce four new projects this quarter for an aggregate total investment of CAD 24 million. These new projects include two new Canadian Tire store expansions in Kincardine and Midland, Ontario, the acquisition of land from a third party, which will allow for the expansion of an existing Canadian Tire store in Val-d'Or, Quebec, as well as the development of a 34,000 sq ft Canadian Tire store in Mount Forest, Ontario. These investments, when completed, will result in an incremental 120,000 sq ft of gross leasable area being added to the portfolio and are expected to earn an average going-in cap rate of 6.57%. In the second quarter, we completed the intensification of an existing Canadian Tire store in Listowel, Ontario, and the development of a Canadian Tire store and Canadian Tire Gas+ gas bar in Amos, Quebec.
Including the completed intensifications, the REIT invested CAD 20.6 million during the quarter and added approximately 67,000 sq ft of incremental GLA. Subsequent to quarter end, we completed the vend-in of an existing Canadian Tire store and Canadian Tire Gas+ gas bar in each of Belleville and Gananoque, Ontario, the vend-in of a redeveloped Canadian Tire store in Picton, Ontario, and the vend-in of development land in Grande Prairie, Alberta, where a new Canadian Tire store is expected to be completed by the fourth quarter of 2019. These vend-ins will add roughly 300,000 sq ft of incremental GLA once completed. For clarity, CT REIT acquired the Picton property from a third party subject to a ground lease with Canadian Tire in Q2 2017. In Q3 2018, the REIT purchased Canadian Tire's leasehold interest in the property.
Canadian Tire had recently redeveloped and intensified this location and has entered into a new lease with the REIT. At the end of the second quarter, CT REIT had 13 properties under development, representing a total committed gross leasable area of 712,500 sq ft and a total committed investment of CAD 148.4 million upon completion. As of June 30th, 2018, on a committed basis, our portfolio is 98.7% occupied. Canadian Tire Corporation represents 92.5% of our annualized base minimum rent and occupies 94.5% of CT REIT's GLA. All of these metrics are relatively unchanged from a year ago. Beyond what was completed during and subsequent to Q2, we continue to make progress as expected on the balance of our development projects as detailed in our latest MD&A. With that, I will turn it over to Louis for a review of our financial results.
Thanks, Kevin. In Q2 2018, we reported FFO per unit of CAD 0.292 as compared to CAD 0.283 per unit in Q2 of 2017, an increase of 3.2%. AFFO per unit was CAD 0.241 as compared to CAD 0.231 in the comparable period, representing a 4.3% growth rate. Net operating income was CAD 86.3 million, increasing 7.6% over the CAD 80.2 million of NOI reported for Q2 2017. This growth was primarily driven by acquisitions of income-producing properties, the completion of properties which were under development in the prior year, and contractual annual rent escalations. The same-store growth rate of 1.8% and same-property growth of 2.0% were driven by the average annual rent escalations of 1.5% contained within the Canadian Tire store and CTC's distribution center leases, which are generally effective January 1st, the recovery of capital expenditures, and the related interest earned.
Also included in these amounts were certain rent and expense recoveries from Sears that we had previously written off. G&A expenses as a percentage of property revenue were relatively flat at 2.3% versus 2.2% in Q2 of 2017. G&A expenses increased 14.1% versus Q2 2017, primarily due to increased personnel expenses related to the variable components of compensation awards and increased headcount. Interest expense increased by CAD 2.4 million, or 10%, compared to Q2 of the prior year. This increase was primarily due to increased interest on the debentures issued in June 2017 and February 2018, partially offset by savings resulting from the redemption of Series 10-15 Class C LP Units in May 2017, savings from reduced utilization of the bank credit facility, and increased interest capitalization on development projects during 2018.
The net effect is that the REIT has replaced inexpensive short-term debt with longer-term fixed-rate debt, which has served to reduce CT REIT's interest rate and refinancing risks. The REIT recorded a fair value adjustment of CAD 12 million for the second quarter of 2018, a decrease of CAD 2.6 million versus Q2 2017. As you may recall, Q2 of 2017 included a gain in value of an industrial property located in Quebec, primarily due to a slight decrease in the cap rate for this property. There were no similar gains recorded during Q2 2018. With respect to the balance sheet, we continue to maintain a strong financial position. At June 30, the REIT's indebtedness ratio was 46.2%, a slight improvement over the 46.7% reported last quarter.
We have approximately CAD 280 million available on our credit facility, as well as approximately CAD 2 million of cash, which puts our balance sheet in a strong and liquid position. Debt, as compared to earnings before interest, taxes, and fair value adjustments, was 7.4 times, lower than the 7.62 times reported in Q4 2017 and primarily related to EBIT fair value growth exceeding the growth of CT REIT's total debt. As of June 30, 2.13% of the REIT's debt bears interest at floating rates compared to 8.53% at December 31. The reduction is related to the planned repayment of the CTC bridge facility and repayments towards the bank credit facility. Also, as at June 30, 333 of the REIT's assets were not encumbered, representing approximately CAD 5.5 billion, or 98%, of our assets.
The interest coverage ratio was 3.39 times in the second quarter, which was slightly lower compared to the prior year value of 3.5 times. The decrease, which we do not view as material, is mostly the result of interest and financing charges increasing at a rate larger than that of income before interest, taxes, and fair value adjustments. Our AFFO payout ratio this quarter was consistent with Q2 2017 at 76%. I would also like to take a minute to speak to the trend in our book value per unit. At June 30, 2018, the book value per unit was CAD 13.71, representing 2.4% growth over the book value of CAD 13.39 reported at the end of Q4 2017.
The following are contributing factors to this increase: A higher value for the income-producing properties due to ongoing growth in the cash flow resulting from the annual rent increase, ongoing recoverable CapEx spend, and retained AFFO. On a trailing basis, combining distributions and book value per unit growth, CT REIT has, since IPO, consistently delivered a total annual return in excess of 10%. With that, I will turn it back to Ken.
Thanks, Louis. To wrap things up, we're delighted with the results of another solid quarter. Our prospects for growth, whether with CTC or otherwise, remain very attractive, and we look forward to sharing our progress with you in the quarters and years to come. Now, Operator, I'll turn the call back to you for any questions from our listeners.
Thank you. At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. We ask that you please pick up the handset or step closer to the speakerphone system when asking your question to provide maximum audio clarity. We'll pause for just a moment to compile the Q&A roster. Thank you for your patience. Our first question is from Sumayya Syed from CIBC. Please go ahead.
Thanks. Morning. Just on the new vend-in announced this quarter, can you tell us a little bit more about the Mount Forest market and what you saw there that you liked?
I'm sorry, Sumayya. Can you repeat the question?
Yeah, just on the vend-in announced with the quarter, the Mount Forest market, and what dynamics there that were appealing to you.
Oh, okay. Thank you. Sorry about that. In Mount Forest, Canadian Tire had an old facility in that town. It'd been there for many, many years. It's typical of the kind of market where Canadian Tire can do very well and has obviously a very strong brand equity and franchise. It was simply an opportunity to move the Canadian Tire facility into a better location, in a much better facility, much larger, and to move from a lease with an unrelated third party to a property owned by the REIT.
Okay, thanks. Just, you guys have mentioned a bit of an update to your external evaluation process. Can you just expand on the change and the rationale there?
Sure. Sumayya, it was really a productivity initiative. We had not seen over the four and a half years that we've been public, large changes in values in the small value assets. We are continuing under the new proposed process to get data points that will inform the internal evaluations of those assets the same way we have all along. We just thought it was an efficiency move.
Okay. That's all from me. Thank you.
Thank you.
Thank you. Our next question is from Jenny Ma from BMO Capital Markets. Please go ahead.
Hi, good morning, everyone.
Good morning.
Louis, a question about the additional recoveries coming from Sears. Could you quantify what that impact was in Q2 and confirm that all those loose ends coming from Sears have been settled as of Q2, with regards to the recoveries? It looks like there was an impact on straight-line rent as well, possibly from the lease-up to Canadian Tire at the DC space.
Okay. All good questions, Jenny. Observant. With respect to the Sears impact on the second quarter NOI, it was approximately a CAD 300,000 positive impact. We had certain accounts receivable on the books during our first quarter, at the end of the first quarter, we took full provisions against those receivables and managed to collect CAD 300,000 during the second quarter. That's the first part of your question. The second part of your question is, the Sears process, as you may understand from the newspapers, continues to run its due course, we still have certain types of claims within that process, we wouldn't hold out any hope for anything further happening on that front. Your third question about straight-line rent accounting, you're absolutely right.
The new lease with Canadian Tire at the Calgary DC did contribute to an increased component of the straight-line rent revenues in Q2.
I want to confirm if the timelines were still on track, with what you guided last quarter as far as the lease-up at the DCs. Has there been any incremental lease-up in the smaller center, or is it pretty much still where we were when we last spoke in May?
Hey, Jenny. It's Kevin. We have made progress. We don't really have anything to say specifically right now. The prospective interest from tenants has been relatively strong, and we are continuing to work our way towards getting a lease. Nothing to say now, but hopefully soon.
Okay. I guess the way to think about the two line items I referred to earlier was, there was a positive CAD 300,000 impact on the recoveries in Q2 that probably won't recur in Q3, barring any other settlements, I guess. The straight-line rent is a reasonable run rate going forward?
On the straight-line rent, this is very small, we live to talk about small numbers. The CTC lease commencement date was not April 1st. It was mid-quarter.
Okay. Right.
May 1. There's a two-month impact in Q2, there will be a three-month impact in Q3.
Gotcha.
Other than that, yes.
Okay. Then any other one-time items we should be aware of in the numbers?
No.
Okay, great. I will turn it back. Thank you.
Thank you. The following question will be from Sam Damiani from TD Securities. Please go ahead.
Thanks, and good morning. Jenny ran off a lot of the questions I was going to ask. The quarter was unusually strong. Usually CT REIT is very predictable, and I think you beat the Street by a penny, which we're just trying to figure out where that variance is. Louis, you mentioned CAD 300,000 from Sears. Was that a negative NOI impact in Q1, such that the incremental change in Q2 was actually CAD 600,000?
We did record some revenue from Sears in Q1 because they paid us some revenue in Q1.
Oh, okay.
The amount we recorded in Q2 was slightly larger than the amount we recorded in Q1, but not much.
The gross amount was CAD 300,000, as you said.
Right.
Okay. Any progress on further acquisitions? The pace overall has been slowing a little bit. Just wondering what your outlook is for total investment volume for the balance of the year.
Hi, Sam. It's Ken. Nothing's changed in terms of our growth potential or the opportunities we see out there. I guess we'd expect to see some variance in announcements from quarter to quarter or even year to year. We continue to have the benefit of obviously the healthy organic growth that we've got built into the portfolio of leases with Canadian Tire. We complement that growth with the continuing vend-in properties, ongoing developments, and intensification with CTC and the other banners, and third-party acquisitions. I'd say some of what we do is ongoing. The vend-ins and the ongoing developments with CTC anchor developments is relatively predictable. What's less so is the third-party acquisitions, which I would call somewhat more opportunistic. That can lend to or contribute to the lumpiness in our investments.
What about the Brampton former DC? Any sort of clarity on what the REIT's involvement is and timing at this stage?
Well, I can tell you that we're very much involved, and we're proceeding with some preliminary planning for the redevelopment of the site, and are in discussions with the City of Brampton. There is a broader municipal process underway in the City of Brampton that impacts this site. We continue to view this 90-acre site as a very attractive opportunity for us in the future. I'm just not attaching any kind of timeframe to it at this point.
I think initially when this opportunity arose, it was viewed as primarily a commercial development site. Has that changed at all?
Well, I think the western part of the site, which is across from the Bramalea GO Station, we would view, and I think that's consistent with the city's perspective, that it would be a mix of uses and some intensification on that site. I think probably commercial, retail or office at that corner. The balance of the site, we continue to view as ongoing employment uses.
Industrial. No residential, particularly on that site at this stage?
No, I wouldn't say that that's a priority for that site.
Okay. Thank you very much.
Thank you.
Thank you. The next question is from Michael Smith from RBC Capital Markets. Please go ahead.
Thank you and good morning. Ken, we have seen some inflations in development costs, and I'm just wondering if you could comment on how that is affecting you, if at all.
Hi, Michael. It's Ken. I think that the inflation that people are talking about in construction is predominantly, but not exclusively, but predominantly in high-rise construction in urban markets. I think that's where it's manifesting itself so the strongest.
Basically, given the projects you have on the go and the fact that they're not high-rise, you really haven't noticed that much of a change, I guess.
No. Construction people will only tell you the costs go up.
Yeah. Of course.
We see that, but I wouldn't say that it's a problem.
Okay, great. Any updates on your head office?
Well, generally, I could tell you that we're seeing some good progress on the Canada Square project. Earlier this year, the board of the TTC and Toronto City Council approved the terms of a new and amended ground lease for the property that will facilitate the redevelopment. Obviously, that was a pretty key step in the process. I'd also tell you that preliminary design and concept planning is more or less complete and is moving to the next stage of design development. I don't have anything to announce at this point other than to say, generally, we're pleased with the progress on the project.
That was obviously a big milestone with that ground lease.
Yeah. I think we were obviously always optimistic that we would have a successful outcome with the TTC in the city. Certainly, there's a great deal of alignment in seeing something happen on the site. Yes, I would say that's an important step.
Great. Thank you.
Thanks.
Thank you. The next question is from Pammi Bir from Scotia Capital. Please go ahead.
Thanks. Good morning. Just maybe building on that last question at Canada Square. Can you comment on what perhaps the potential density mix might look like?
I'd say, Pammi, it's going to be a mixed-use development. There's going to be an office component, a retail component, and residential. It'll be developed in a variety of phases over a period of years.
If you had to, I guess maybe just potentially estimate of perhaps when that process might start, in terms of development. Any initial thoughts there?
Well, as I said before, the redevelopment of the property is certainly, I guess influence might be an understatement by the development of the Crosstown LRT. We need that to reach a certain point in the development so that we can get access to lands to kickstart the development. I'm not anticipating a shovel in the ground, say before the end of 2021.
Okay. That's definitely helpful. Louis, maybe just going back to some of the comments from last quarter, I think you'd mentioned that there was an expectation for about a CAD 750,000 drop in net operating income for the Calgary distribution space as it transitioned from Sears to Canadian Tire. Again, maybe just to clarify, maybe close the loop here. The only adjustment then going forward is really just this CAD 300,000, recovery or the one-time recovery in Q2? Any sort of sorry, remaining lease up of the Canadian Tire vacancy.
Yes, maybe restating what you've said. I did say we expected a CAD 750,000 drop. That amount has been amended by the CAD 300,000 surprise that we mentioned earlier in the call. You're right, Canadian Tire's occupancy of 25 Dufferin started May 1st. We'll have a full three months contribution next quarter. That will help. Then it's subject to what Kevin has commented on in terms of the backfilling at 11 Dufferin. That will be further positive news, presumably, at some point in the future.
Got it. Just one last one. In terms of the post-quarter end investments that you mentioned, what was the estimated total value of those investments and the estimated cap rate?
We might have to circle back with you on that, Pammi.
Okay, great. Thanks very much.
Thank you.
Once again, please press star, then the number 1 on your telephone keypad in order to ask a question. The next question will be from Tal Woolley from National Bank Financial. Please go ahead.
Hi, good morning. I just wanted to ask quickly about the size of the retail development pipeline. You've been managing to take on new projects and to complete them successfully. Is there any chance that you could take on more, like take that CAD 150 million and increase that? Is there any thought to that going forward, or are you still very much limited by sort of what Tire would like to do in that regard?
Well, it's Ken speaking. We're not limited in any way. We're selective in what we're doing, and we work very closely with Canadian Tire in terms of what their plans are for their network. As you can see by some of our announcements, we're well into planning for 2020, in terms of the pipeline of projects that Canadian Tire hopes to deliver to its operators. I'm not sure if that answers your question.
Yeah, no, that's fair. I was just trying to get a sense of if there, given how successful it has been, whether they're considering just trying to take on more at the same time. It does sound like it is sort of contingent on what Tire's development plans are. Is that fair?
Yes, that's right. I'd say, clearly, that's a very attractive area of growth for us is to have that relationship with an anchor tenant like Canadian Tire and develop new store properties for them. That's clearly a priority for us, as well as we look for other opportunities in the marketplace where we can add value.
Yeah. I guess just my next question is, we've seen a lot of the other retail REITs really trying to hone their focus on major market exposure, and there's a lot of assets in the market, in secondary markets. If I just think about Tire sort of retail heritage, those are often markets where they're incredibly strong and they account for a disproportionate amount of retail activity. You're five years out from the IPO now. Have you had a conversation with Tire about maybe doing more in these secondary markets, but maybe not with them as the sort of lead partner? Maybe thinking about doing more in some of these small markets. Is that somewhere where you could have an advantage and maybe do a better job than some of the people that are out there?
Well, it's very observant because we do feel that we do have an advantage in those markets because of the relationship with Canadian Tire and because they're such a strong tenant and operator in those kind of markets. Our ability to work with Canadian Tire and identify secondary markets where there is attractive household and income growth is, I do believe, a competitive advantage for us. You can see that in our investing program in some of the markets where we have chosen to do greenfield development or replace stores. When Canadian Tire is doing that, it's a signal that they're doing very well.
Yeah
that if they need a larger store or want incremental development.
Okay. That's great. Thank you very much.
Thank you.
Thank you. The next question is from Sam Damiani from TD Securities. Please go ahead.
Thank you. I was just going to ask a similar question, but more specifically about diversification away from Canadian Tire. Your closest peers in the real world have pursued some meaningful diversification away from their sort of major tenant relationship. Just wondering, does that in and of itself represent a desired goal, either in the medium or long term for the REIT?
Sam, it's Ken. I think there's two ways to answer that question. One is, I would say our appreciation of the benefits that the relationship with Canadian Tire delivers to the REIT and to our unit holders is clearer to us with the passage of time. The ability to leverage that relationship and create value and do it in a relatively low-risk way is clearly our competitive advantage. Leveraging that relationship, creating value in markets, both urban and secondary, is a great opportunity for us, particularly to the extent that some are either exiting or overlooking secondary markets. We can really create value there in a low-risk way. The practical aspects of diversification is, I used to joke that we'd have to do CAD 5 billion of non-Canadian Tire to diversify away from Canadian Tire, and that we wouldn't be able to find CAD 5 billion to invest in.
If we did, people would still think we were the Canadian Tire REIT. My perspective is diversification from Canadian Tire is neither desirable nor realistic.
Thank you.
Thanks.
Thank you. There are no further questions registered at this time. I will turn the call over to Ken Silver, CEO, for closing remarks.
Thank you, everybody, for joining us this morning. We expect our results to be released the first week of November, and we look forward to talking with you then.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you all for your participation.