All participants, please stand by. Your conference is ready to begin. 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 Q2 2022 Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question- and- answer session. If you would like to ask a question during that time, simply press star then the number one on your telephone keypad. To withdraw your question, press star then the number two. The speakers on today's call are Kevin Salsberg, President and Chief Executive Officer of CT REIT, Lesley Gibson, Chief Financial Officer of CT REIT, and Jodi Shpigel, Senior Vice President, Real Estate 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 filings, public filings for a discussion of these risk factors, which are included in their 2021 MD&A and 2021 AIF, which can be found on CT REIT's website and on SEDAR. I will now turn the call over to Kevin Salsberg, President and Chief Executive Officer of CT REIT. Kevin?
Thank you, Valerie, and good morning, everyone. We're very pleased to welcome you to CT REIT's second quarter 2022 investor conference call, which I feel fortunate to remind our listeners marks my first call as president and CEO. As we have all witnessed since our last quarterly update, the overall economic picture has become increasingly more challenged and the global financial outlook even more uncertain. Central banks continue to increase rates, elevated levels of inflation persist, and the prospects for an economic slowdown seem more pronounced. In the face of such an opaque market context, however, CT REIT continues to deliver strong and stable results and growth in AFFO per unit. Our portfolio of primarily net lease assets complemented by a growing industrial base provides a solid foundation.
Our long weighted average lease term and minimal debt maturities over the next few years insulate us from much of the current market-based risks that exist in today's environment. As well, our privileged relationship with Canadian Tire provides a growth pipeline that is consistent and meaningful. Our prospects beyond our core portfolio, including third-party acquisitions, intensifications, and surfacing value in underutilized assets, provide additional avenues for us to explore as we navigate through these uncertain times. We are truly fortunate to find ourselves in a position to be able to continue delivering meaningful growth, all while prudently managing risk. As always, from this position of relative strength, we will continue to monitor the market for new opportunities. With respect to what we accomplished in the quarter, I could not be prouder of the achievements of our team.
We delivered several significant project completions that Jodi Shpigel will speak to shortly, and the diversity of these investments certainly highlights the internal capabilities and strengths that we have built at CT REIT over the last few years. By adding nearly 600,000 sq ft of GLA to the portfolio and increasing our weighted average lease term via the completion of certain strategic lease extensions, we continue to meaningfully grow and improve our asset base, as well as demonstrate how we work together with Canadian Tire to achieve our mutual objectives as it relates to our portfolio and their expanded store and supply chain network strategies.
I am very pleased to welcome Jodi Shpigel, our Senior Vice-President, Real Estate, to her first conference call with CT REIT this quarter. Jodi Shpigel has been a great addition to our senior executive team and has most definitely hit the ground running. With that, I will turn the call over to Jodi to provide an overview of our investment, leasing, and development activities. Jodi?
Thanks, Kevin, and good morning, everyone. As highlighted in our press release yesterday, we were pleased to announce two new investments this quarter totaling CAD 30 million, which, once completed, will add an incremental 149,000 sq ft of GLA to the portfolio at a weighted average cap rate of 6.81%. These new projects include the vending of land and the development of a new Canadian Tire store in Lloydminster, Alberta, and the expansion of an existing Canadian Tire store in Stettler, Alberta. As Kevin highlighted, we had a busy quarter with respect to our investment and development activity. In total, we completed 12 previously announced investments totaling CAD 111 million and added 590,000 sq ft of GLA to the portfolio.
These projects included the expansion of our Coteau-du-Lac distribution center, the development of a new Canadian Tire store in Moose Jaw, Saskatchewan, the completion of phase two of our Orillia, Ontario redevelopment, land acquisitions in Sherbrooke East, Quebec and in Invermere, British Columbia, and also the expansion of seven Canadian Tire stores. At the end of the second quarter, CT REIT had 28 properties that were at various stages of development, with six projects currently expected to be completed by the end of this year. The projects in our development pipeline represent a total committed investment of approximately CAD 366 million on completion, CAD 90 million of which has already been spent, and CAD 150 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 approximately 1.2 million sq ft to the portfolio, 99% of which has been pre-leased as at quarter end. In the second quarter, we also completed lease extensions for three Canadian Tire stores and one Canadian Tire distribution center. As a result, the weighted average lease term of our portfolio increased to 8.6 years, one of the longest in the sector. In addition to the CTC lease extensions, we are also happy to announce that we have successfully re-leased the 100,000 sq ft unit at our 11 Dufferin industrial building in Calgary, Alberta.
Based on the strength of our property and the Calgary industrial market, we were able to secure this new tenancy with a third-party logistics provider very quickly, achieving a 25% increase over expiring rents with minimal invested capital and new rent to begin prior to the end of this year. With this most recent lease commitment, our portfolio remains 99.4% occupied in line with last quarter. I will now turn it over to Lesley to review our financial results. Lesley?
Thanks, Jodi. Good morning, everyone. As Kevin highlighted, we are very pleased with the results delivered by the REIT this quarter. Second quarter AFFO per unit on a diluted basis was CAD 0.284, an increase of 2.5% compared to Q2 of 2021, primarily due to the impact of NOI variances, partially offset by increased personnel costs, which included the retirement expenses of our former CEO. It should be noted that this is the last quarter that we expect to incur these retirement-related expenses. Excluding this one-time cost, AFFO per unit was CAD 0.287, up 3.5% from the same period last year.
Diluted FFO per the unit this quarter was CAD 0.313, a slight increase compared to CAD 0.310 in Q2 of 2021, as the growth in FFO exceeds the increase in the weighted average units outstanding. Net operating income was CAD 104.1 million for the quarter, an increase of 3.7% or CAD 3.7 million compared to Q2 2021. This NOI growth was comprised primarily of a 2.4% growth on a same-store basis and 2.8% growth on a same-property basis. Same-store NOI for the quarter grew by CAD 2.4 million or 2.4% as a result of contractual rent escalation, contributing nearly CAD 1.6 million, including the 1.5% average annual rent escalations included in the Canadian Tire leases.
With the balance of the growth primarily from the continued recovery of capital expenditures and interest earned on the unrecovered balance, which contributed approximately CAD 0.7 million in the quarter. In the second quarter, adjusted G&A expenses as a percentage of property revenue were 3.1%, which was above the 2.5% in Q2 2021. As previously mentioned, the accelerated amortization of long-term compensation costs related to our recent CEO transition have run through the P&L and drove slightly higher G&A expenses through the end of Q2, which amounted to CAD 0.5 million in the current quarter. Excluding this transition cost, adjusted G&A as a percentage of property revenue would have been 2.7%, comparable to the 2.5% in Q2 2021.
With respect to our portfolio fair value, the REIT recorded a small adjustment of CAD 6 million on our investment properties for the second quarter of 2022. Determining fair value this quarter was particularly challenging in the absence of comparable sales transactions. We continue to apply our same consistent methodology in looking at property valuations, seeking external support from the appraisal community, which informs our view of the market. This led to no change in our overall cap rates during the quarter of 6.05%, with the increase in fair value being driven by higher NOI within our portfolio of properties, including those projects completed in the quarter. It should be noted, however, that our retail and industrial average cap rates did increase each by a couple of basis points respectively this quarter.
Due to the increased relative weighting of our industrial properties due to the transfers from properties under development, which are at a lower relative cap rate than our average cap rate, the overall average remained consistent with Q1. With the rise in interest rates that we have seen thus far in 2022 and the prospects for future central bank hikes for the balance of the year, we are anticipating the potential for upward pressure on cap rates in the coming quarters. Distributions in the quarter were CAD 0.212 per unit, 5.7% higher than the second quarter of 2021 due to increases in the rate of distribution, which became effective with the monthly distributions paid in July 2021 and July 2022.
This resulted in an AFFO payout ratio of 74.6% for the quarter, in line with the 74.5% for the same quarter last year. Turning now to the balance sheet, our debt metrics remain strong, with the interest cover ratio at 3.7 times in Q2 2022, consistent with the 3.7 times reported for the second quarter of 2021. CT REIT's indebtedness ratio has improved and was 40.2% as of June 30, 2022, compared to 40.9% last quarter and 41.2% as at year-end. The decrease in the ratio was primarily due to the increase in fair value adjustments made to property, as well as acquisition, intensification, development activities completed in 2022 exceeding the growth in indebtedness.
In the current interest rate environment, we are delighted to be largely insulated from refinancing risk as we have no public debentures scheduled to mature until 2025 and almost no variable rate debt. Our liquidity remains strong, with CAD 294 million available through our committed credit facility, along with CAD 23 million dollars of cash on hand and a further CAD 300 million available on our uncommitted facility with Canadian Tire Corporation. With that, I will turn it back to the operator for any questions.
Thank you. At this time, I would like to remind everyone in order to ask a question, please press star then number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Our first question is from Himanshu Gupta with Scotiabank. Please go ahead.
Thank you, and good morning. Just on the valuation comment there, I mean, obviously low adjustment or very minor adjustment down in Q2. Lesley, I think you mentioned that you expect upward pressure on cap rates in the second half of the year. Maybe can you elaborate that? Any thoughts, what kind of potential impact you could see there?
It's not just specific, Himanshu. I think, you know, with continued pressure on inflation, with the, you know, expected increases in interest rates that are still to come, I think those are generally correlated with, you know, increases in cap rate. So you know, that's definitely something that we're looking at on the horizon. We just haven't seen that actually in practice and seen that in any kind of comparable transactions that would inform our view of the market just yet.
Okay. So, transaction activity has been slow, but have you got any like appraisals done or any broker sentiment coming through suggesting one way or the other?
Yeah. As you mentioned, we actually had 36 appraisals done as of Q2, representing about 11% of our portfolio. And, that was one of the obviously key inputs to cover geographies, markets, et cetera, across our portfolio. So you know, based on some of that feedback and other things such as the cap rate surveys and the other stuff that are provided by the various appraisal firms, you know, we took a view that was really a flat overall cap rate for us. There was very little changes into the properties that were of our type.
Got it. Thank you. And then, just on the development spend, for the next 12 months, I think you mentioned CAD 150 million to be deployed. How do you look to finance that? I mean, any thoughts of exploring the unsecured debt market here?
Himanshu, we're fortunate to be, you know, sitting on a bit of cash. We generate a fair bit of, you know, cash flow from our operations. So, those are the first two sources. You know, we have a significant amount of our credit facilities are undrawn, so that would be our primary one. Obviously our past practice has been typically when we reach a certain level of draw on our lines that, you know, our preference would be to term that out in the unsecured debt market. You know, I think that would still be something that we're looking towards. Obviously, depending on the rate of spend and how fast that goes, we'll determine when we might be in the market in the future.
Got it. Thank you. And, maybe final question from my side. On Canada Square, any update there? And then what occupancy reduction are you expecting in the near term and p robably, you know, how much NOI erosion should we model it?
In terms of the development, Himanshu, continue to work with Oxford in response to the community and stakeholder engagement process that remains ongoing. We're updating and revising the master plan scheme as we speak. Our hope is that we'll be in a position to resubmit an application by the end of this year. You know, that process obviously takes time. As we've mentioned previously, we cannot begin the development or at least phase I of the development until the LRT is completed. There's been no new announcements to my knowledge around the timing of completing that project, although it is clear driving to work every day that work continues and is ongoing. So, we're just working through that process more generally.
Obviously we've mentioned in the past that as we set the stage for the first phase, we'll see some NOI erosion in the property as we de-lease or manage expiries as we work towards that start date. Although can't give any specific guidance at this time with respect to the quantum or timing.
All right. And, maybe just one follow-up. I mean obviously, you know, cost of refinancing has moved up quite a bit compared to, let's say, the last two years. Does that change anything in terms of your Canada Square plans, in terms of the mix of the property, like residential versus office or other component within the property?
In terms of mix, no. I mean, the mix is actually somewhat prescribed as it relates to the zoning on the site. You know, to remind everybody, we can build about 3 million sq ft of total GLA, and we have to replace a large component of the commercial that exists, as at today. You know, from a financing perspective, we'll obviously be in discussions with our partner, Oxford Properties, in terms of the optimal, you know, financing structure, as we look to set the stage for the initial phase I.
Okay. Got it. Fair enough. I'll turn it back. Thank you guys.
Thank you.
Thank you. Our next question is from Tal Woolley with National Bank Financial. Please go ahead.
Hi. Good morning.
Morning.
Morning.
Just wondering with all of the completions this quarter, do you have a sense of like, and particularly since you've got one that's in a, you know, like a big DC coming online that's accounting for a big chunk of the square footage, just can you give us a sense of what the net rents will be on the added square footage this quarter? I just wanna make sure there's no big deviation from sort of where the average net rent is right now.
Are you talking about the 590,000 sq ft that was completed that came online or the two new projects we announced ?
Uh, the 590 .
You know, I would say it would be in line with our current rents. Obviously the industrial property would probably be a little bit lower, but it would also be in line with our industrial portfolio. You know, they were all set at market, so I don't think there'd be much in the way of deviation from the average.
Okay. And then you know, I appreciate the conversation you've sort of given around assessing fair value this quarter. I guess my question is this, like, going through that process with the appraisals and your own work and talking to the community, the broader community, would it sort of suggest to you that maybe you could have been more aggressive prior to this move in rates with respect to cap rates?
And just to make sure I understand your question, do you mean over the last number of years running down our cap rates?
Yeah. Thank you. You possibly—like, you could have maybe, you know, brought up valuations a little bit more prior to this move in cap rates, just given, you know, where things kind of are sitting right now.
Well, I think we've always tagged our cap rates where we think the market is. You know, I would certainly suggest we've taken a conservative view of the market, both, you know, over the last number of years as cap rates have trended down, and I think we would likely take a similar approach as we anticipate possible movement upwards. No, I don't think we should have been more aggressive. I think, you know, this gives us a little bit of leeway to wait for this period of price discovery to unfold, and figure out really where cap rates land. I mean, we don't wanna be guessing at where our fair value is. We wanna be using our. As Lesley said in the call remarks, our consistent similar methodology to pinpoint where we think the value of our portfolio sits.
Okay. And then just, maybe you can give a little bit of color in terms of what you're seeing in terms of third-party acquisitions. Obviously, I would expect volumes probably significantly lower than it normally is. Anything you can say with respect to pricing of assets right now?
Yeah. In the retail space for sure, transaction volume has really just ceased through Q2. I've seen a couple new offerings come to market, so I think it'll be really interesting probably as we get into the Q4 end of year period to see you know if those trade and at what prices. On the industrial side, I think we're seeing a bifurcation of product type where you know there's much greater interest in short-term lease in even small bay product where people still feel like they can get at the rent expiries and mark-to-market. The longer weighted average stuff is still very much of interest. I think it's just you know the IRRs are a little bit more challenged. So, probably on a cap rate basis, those will.
We'll see expansion there. And, there's probably a few trades that are in the market right now that could set benchmark on that. I think you'll continue to see that. So, I think on the retail end, you know, just further to kind of your initial question, and I think what we saw in the cap rate survey was coming from a relatively higher base. It's probably less subject to larger swings on a percentage basis in terms of valuations and cap rates.
Okay. And then, If you can just remind me, is there an automatic like rent formula on the renewal for the CT-CTC leases? I would've known this cold at the time of the IPO, but it's been a long time since then. I can't remember the exact formula for this one.
We're happy to remind you, Tal. It's Okay. So, the leases prescribe that rent in a renewal term is to be set at market, not less than the amount paid at the end of the initial term, and not greater than a ceiling that you know, it's somewhat tied to inflation, but capped at about 112%.
And so, can you give the average renewal spread on the leases that have been renewed thus far?
Yeah. I mean, to remind you, Tal, we've talked about this in past calls. Even though that's what the lease calls for in discussions with CTC, we have thus far with those IPO or subsequently acquired Canadian Tire properties agreed to continue the annual rent escalations as they exist in the lease through the renewal term. On average, that would be the 1.5% annual increases. As of now, that formula seems to be working, but that's not to suggest at any point in time either party couldn't go back and say they wanna stick by the letter on the contract.
Perfect. All right. Thanks, everybody.
Thank you.
Thank you. Once again, please press star one at this time if you have a question. Our next question is from Jenny Ma with BMO Capital Markets. Please go ahead.
Thank you. Good morning. Maybe just a clarification on, Kevin, on what you just mentioned about the CTC renewal term. So, you said the ceiling is not more than 112% of the expiring rent. Is that correct?
Yes, correct.
And now, is that a weighted average, which would include the rent steps, or is that CAD 112 on day one of the renewal, and then there's rent steps on top of that?
That's 112%. Well, it's to be set at a market rent, so that's presumed to be a flat amount for the five-year option.
Okay.
That 112% is the amount greater than the rent on the last day of the expiring term.
So, that is a weighted average then. Is that one way to think about it?
For the five-year renewal, yes.
For the duration of the lease? Yeah. Okay. So, I guess my question is, given the inflation we've seen, like, are there any triggers or data points where you start to sort of rethink that 1.5% rent step? I'm not sure how much wiggle room there is with CTC, but is that something you might be seeing when you're negotiating with some of your smaller tenants? I recognize you guys don't have many of them, but what I'm just trying to think through is at what point do you start to see inflation figure into negotiating some of these rent escalations?
I don't think it has any influence on the discussions we're having with our smaller tenants. I think, you know, we've been pretty successful with our renewal program there, albeit, you know, a much smaller percentage of our portfolio. I think, you know, on average, we're probably seeing rental lifts in the high single- digits. You know, obviously, inflation is a consideration as we think through our renewals with the entire. We certainly like the 1.5%, which provides, you know, organic growth in the base portfolio. The compounding effect of that escalation is also somewhat meaningful to us over an extended period of time.
You know, it remains to be seen, obviously, the length of time that the inflationary period is with us and also its impact specifically on retail rents. I think as of right now, we're pretty content with the structure. Obviously, as we get to each discrete lease negotiation, we're thinking our way through it and what makes sense for us and what makes sense for Canadian Tire. Obviously trying to look at the portfolio on a holistic basis as well, just to make sure we're continuing to transact on market terms and it works for both parties.
Okay, great. And, I want to turn to my next question on the debt capital markets. Recognize you guys have very little rolling or floating, so that's a good position to be in these days. But, maybe this is for Lesley, are you getting any indications on what unsecured debt is coming in at and what that spread might be to secured debt, and if it remains elevated as we've seen in the past few months?
Yesterday . I mean, we, you know, we do follow the market and see sort of what some of the other peers and people are doing. You know, we're not currently actively in the unsecured market, so as it relates to our specific asset, no specific comps. Yes, obviously there's been a number of times over the years and et cetera, where the secured debt is a cheaper option, et cetera. I think we also, I guess, yes, as you mentioned, fortunate not to perhaps have any immediate term needs for some of that. I think we'll still look at, you know, not just the rate, but also the flexibility that some of the unsecured debt does give us. We'll definitely look at both, but I'm not sure that just because the secured debt is less expensive now that you'll see a big change in our financing strategy.
Okay. I guess my follow-up to that is it's definitely gonna be academic because there's no real need for it. Is there a point at which the spread between unsecured and secured become wide enough that CT would consider going secure? I mean, I know you like the flexibility, but CT has a lot of it. Is that something worth considering, or would the flexibility be the paramount consideration?
No, Jenny, I think there's definitely an inflection point where we would consider you know, pieces of secured debt. You know, we do have a number of assets that you know, could easily be suited to sort of be circled up into a pool of assets to be securitized. You know, there is definitely that. You know, we also have Canada Square, where we do have property level debt with our co-owner, Oxford Properties. You know, that strategy for that asset will continue to have some property specific secured debt as well.
Okay, great. Thank you very much. I'll turn it back.
Thank you. Our next question is from Pammi Bir with RBC Capital Markets. Please go ahead.
Thanks. Good morning. Just in terms of the 6.8% cap rate just on those new investments, I know it's not a huge amount, but you know that is a bit higher than the cap rate the last several quarters of investments in the low sixes. I'm just curious, was that maybe a function of anticipating some higher financing rates, or just maybe the nature of the assets or their locations?
Hi, Pammi. I'd say a little bit of both. I mean, they were in smaller markets in Alberta. We're also kind of being mindful of the current rate environment. You know, I think we were satisfied with the yield on the project. You know, I think, obviously, going forward, as we enter into new terms on new deals with Canadian Tire and other prospective tenants, we're being mindful of our cost of financing and certainly to make sure that our development investment activity remains accretive.
Thanks very much. That's all I had.
Thank you.
Thank you. Our next question is from Sam Damiani with TD Securities. Please go ahead.
Thanks. Good morning, everyone. The only question I had was just on your discussions, ongoing discussions with Canadian Tire, with respect to, you know, potential, you know, new expansions or additional stores in the next, sort of near to medium term. You know, how does that pipeline look today versus, I guess, historically in terms of is it above average, below average, kind of in line with the average in terms of framing how we should think about, you know, square footage growth on the retail side going forward?
Sure. Sam, as you'll recall, Canadian Tire held an Investor Day earlier this year, where they announced some updated CapEx programs, one of which was related to the bricks- and- mortar both in the retail and the supply chain. Obviously, CT REIT is a net beneficiary of that program, as we'll be funding a large component of it. I would say historically, related to, you know, average since IPO, we'd probably be above average. Historically, as it relates to our run rate, in terms of project announcements and what you currently see in our development table, over the last, call it year and a half, we're probably expecting more of the same going forward.
That's great. Thanks very much. I'll turn it back.
Thank you.
Thank you. As there are no further questions at this time, I will turn the call over to Kevin Salsberg, President and CEO, for closing remarks.
Thank you, Valerie. We delivered solid results in the second quarter, improving the quality of our asset base and securing additional lease extensions with Canadian Tire, all of which serves to highlight the durability of our business model. Our focus remains on expanding our exceptional retail and industrial asset base while adding to our robust pipeline of development opportunities in order to continue to drive growth in AFFO per unit and distribution. With our strong balance sheet, CT REIT is well positioned to navigate through this current period of uncertainty, and we will continue to be opportunistic with the goal of delivering attractive risk-adjusted returns for our unitholders over the long- term. Thank you all for joining us this morning. I hope you all enjoy the rest of your summers, and we look forward to speaking to you again in November after we release our Q3 results.
Thank you. This concludes today's call. You may now disconnect.