Earnings Call: Q1 2019

May 30, 2019

Earnings release

Welcome to the NexSys REIT Q1 2019 Conference Call. As a reminder, all participants are in listen only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. I would now like to turn the conference over to Kelly Hancic, Chief Executive Officer. Please go ahead, sir. Welcome, everyone. Joining me today is Robert Chason, Chief Financial Officer of The REIT. Before we begin, I'd like to caution you in regards to forward looking statements and non GAAP measures. Certain statements made during this conference call may constitute forward looking statements, which reflect The REIT's current expectations and projections about future results. Also during this call, we will be discussing non GAAP measures. Please refer to our MD and A and the REIT's other securities filings, which can be found at sedar.com, to cautions regarding forward looking information and for information about non GAAP measures. So the Q1 of 2019 was another stable quarter for the REIT, which is typically a weaker quarter due to seasonality of expenses. Our AFFO payout ratio continues to be in the low 80s, while our debt to gross book value remains conservative at 51.8%. Things look pretty good for the balance of the year, with revenues from our recent industrial acquisitions in Western Canada beginning on April 1. These assets were purchased at a 9.33% cap rate with mortgage debt of 3.47%, so should add nicely to our AFFO per unit. From a leasing perspective, the overall portfolio ended quarter at approximately 95.6 percent occupancy, up from the previous quarter. We are in advanced negotiations for the last remaining full floor at 2,045 Bruce Stanley, which, if successful, will bring committed space in the property to approximately 91%. We have listed for sale 2 of our smaller properties in Montreal, which represents approximately $7,000,000 in value. And then on the acquisition front, we continue to see a number of deals and hope to continue to be successful in our ability to complete the REIT unit transaction. We were close on 2 properties representing about $25,000,000 in value, but after diligence, we've decided not to continue to pursue them at this time. 1, however, may come back in the future, so there is possibility there. I will now hand it over to Rob Chason to review the financials. Thanks, Kelly. Our portfolio continues to deliver consistent results. Same store NOI was up by approximately $175,000 quarter over quarter with CPI increases on a number of our Western Canadian industrial properties contributing approximately $45,000 of that increase, with changes in occupancy contributing the remainder. As mentioned in the last call, we filled a 23,000 square foot vacancy at 1 of our Montreal area industrial properties with rents commencing on March 1. Our retail office and industrial properties have all performed consistently. Once again, a reminder that the property we acquired in Richmond, D. C. Is undergoing tenant setup and the vendor is obligated to complete the build out of the vendor's cost and a guaranteed NOI until the build out is completed and tenants are occupying and paying rents for their leases. For IFRS accounting purposes, the spender income guarantee is not included in NOI. And accordingly, we have normalized FFO and AFFO to include this. In the quarter, we reevaluated revised timelines for completion of this work, which is now progressing well but had been delayed. As a result, we booked other income in the amount of approximately $2,500,000 in the quarter, which is also excluded from normalized FFO and AFFO. Q1 2019 net income of $4,600,000 was down from Q1 2018 net income of 6,425,000 primarily as a result of fluctuations in fair value adjustments. In Q1 2018, we had a $1,500,000 fair value gain related to 2 investment properties, which were sold in April 2018. In Q1 2019, we had a fair value loss on revaluation of Class B LP units of $2,300,000 due to an increase in the trading price of 3 units at March 31 as compared to December 31. Net income excluding fair value adjustments, distributions on Class B LP units and other income of $5,377,000 was up approximately $298,000 as compared to Q1 2018, primarily due to net acquisitions completed in 2018. Excluding fair value adjustments, other income and distributions like Class B LP units, Q1 2019 results were consistent with Q4 2018 results. NOI was down by approximately $70,000 as compared to Q4, with Q4 having included higher percentage rent income. Normalized AFFO per unit for the quarter of $0.449 increased 5.6% as compared to Q1 2018 normalized AFFO per unit of $0.046 Normalized AFFO payout ratio for the quarter of 81.5 percent is down from 86.1 percent for the same quarter of 2018. Looking to the balance sheet. Our debt to total assets was 51.8% at March 31, 2019. Our $65,000,000 credit facility matures in July of this year and we have $60,000,000 of principal maturities on mortgage debt coming up in the remainder of 2019. We refinanced $37,000,000 of that $60,000,000 in April. We're in discussions with respect to the remainder of debt maturing later in 2019. Bond yields continue to be at relatively low levels with yesterday's 5 year bond yield just 3 basis points off below for the last year, holding well for terms that we may be able to get for these refinancings. I'll now pass it back to Kelly. Thanks, Rob. I'll now open up the call to any kind of questions. Certainly. We will now begin the question and answer session. With Echelon Wealth Partners. Please go ahead. Thanks. Good afternoon. I was just wondering if you could give some color on the refinancing terms of the $36,000,000 or $37,000,000 that was renewed post quarter. It seems like the weighted average interest rate jumped a little bit from last quarter from $386,000,000 to $4.18,000,000 So I was just wondering if you could give us some color on that. Yes. So the refinancings were actually fairly favorable terms. We divided the $37,000,000 at our interest, so the $74,000,000 total mortgage amount. But however, this is on properties that we co own with Sanddawood, our partner. So $37,000,000 in our interest broken into a 5 year tranche, a 7 year tranche and a 10 year tranche. And interest rates on those were in the range of 3.87%, 3.74% and 3.67%. So fairly good rates given where bond yields are at. Right. Okay. And should we I guess, this would be probably in line with what's up to renew for the rest of the year also, right? Yes. I mean, we'll look at different strategies for different properties. We like the longer term debt where we can get it, given how small the spread is between 5 year, 7 year and 10 year money. But yes, for 5 year money, as Kelly mentioned, we did the acquisition at 3.47%. The 5 year tranche on that retail portfolio refinancing was 3 point 67%. So somewhere in that range would be a good estimate for going forward, I think. Okay. And in terms of the acquisition pipeline, can you comment on which segment and geographic position do you see the most attractive opportunities at the moment? I mean, I know that the focus is mainly on industrials, but do you see a good flow of attractive opportunities, especially given the cap rates at the moment? Yes. Well, cap rates are pretty compressed. So there's lots of competition out there for assets. So I see, I guess, there's a lot that is for sale in Quebec, and it's finding things that, I guess, fit our model. We did have one in the Montreal area that we actually dropped. It may come back in the future, but we actually dropped it in our due diligence. And then I had another one out west that last minute they decided to take another course of action with the assets. So that was unfortunate as an industrial asset as well. So those are a couple more that we're looking at, and they're industrial. And it's the same. It takes a little longer because we are structuring them as unit deals for REIT units. So again, a lot of the stuff I do see is Quebec based. We don't spend a lot of time looking in the GTA just because the cost and the low cap rates. So we're looking at ones out west. And if they're tenanted, well tenanted with a solid covenant, we'll start to look at them and continue to look at them. So that's where we see a lot. Okay. And I guess from the transactions that didn't go through at least both, One of them obviously is the one that you were you guys were working on last quarter, correct? Yes, absolutely. Actually, we're working on it for a year. So it was the longest process I've ever seen, but unfortunately, the asset just got some last minute type of vacancy issues. And I just didn't want to take them on at this time with vendor rent obligation. And so we just decided to table it for now, and we'll see if it comes back to us in the future. Right. I guess it's better to know now than after. Yes, absolutely. And just one last question. Last year, it was mentioned on the call that you would like to see an AFFO payout ratio at around 75% this year. Do you think this is still possible? I mean, obviously, the payout ratio is decreasing from quarter to quarter, which is good. But is it still a possibility for 2019? Or are we looking at maybe the front end of next year? Yes. I would think with the asset transaction we just did and some of the leases we have that are going to be rolling in, I think I'm not sure, dollars 75,000,000, but I definitely, I think we'll fall below the 80 range. That's what I'm guessing. And I have to look at it. But that's kind of the target I'm looking at right now. Okay, okay, perfect. Thanks. That's it for me. Thanks, Our next question comes from Brad Sturges with IA Securities. Please go ahead. Hi, there. Maybe just following up on the payout questions there at the end. I guess with that AFFO payout continuing to trend lower, at what point do you foresee the potential to raise distributions? Or do you prefer to still retain cash to fund growth? It's an interesting question that we fancied around at a Board level. And so it is on our radar. Not going to commit anything right now because on the other hand, I do like the cash position that we're in. So we're looking at it. So I think by probably the next Board meeting, we'll sit down and talk about it again. Okay. And if we continue to be successful in leasing and we really start to see a movement, I think we gain more momentum as an option. All right. I guess second question, which I would imagine is happening at the Board level. Just when you think in the context of taking on development risk with the REITs in relation to the Richmond project. I mean, is there any initial thoughts or commentary you can provide in terms of what type of exposure would be appropriate for the REIT today or what the guidelines might be in terms of what the ideal or maximum exposure could be from a development point of view? Yes. I don't think we're there yet. The Phase 1, so the original building where we have the vendor rent obligations, it's moving along quite nicely right now. So it's we'll get more and more comfortable as it continues to gain steam and get built out. And then we'll sit down and have later on, maybe the next quarterly, more earnest chat at the board level of what level we want to proceed from a development risk standpoint going forward. Lastly, I guess, with cap rates compressing and seeing some strong pricing in the market, what's your thoughts on at least opportunistically looking at asset sales, maybe trimming the bond portfolio, that type of thing to high grade? Yes. So we have 2 that we have listed. So that will free up a little bit of cash for us as well. And we'll continue to kind of look at ones that are either underperforming or too small going forward. So definitely something we look at, trying it every quarter. Okay, great. Thank you. Our next question is from Himanshu Gupta with GMP Securities. Please go ahead. Thank you and good afternoon. So just to follow-up on the Richmond Sports Mall, when do you expect the Phase I project to be complete? The Phase 1 should be complete by about the end of the year. I know one of the tenants or a big one that's actually a swim school going in the pools and everything that are going in. That one is expected to be turned over to the tenant in July. So and then the rest will follow. So I'd say by November, December, the project will be substantially complete. Got it. And then the additional vendor rent obligation of that $2,500,000 which you recorded as other income, does that assume that the completion of the project by year end? I mean, if the project is further delayed, will you receive a higher vendor income? So I guess the thing to note is we're guaranteed a level of NOI. And even though for accounting, it doesn't apply to NOI. The amount that we received in respect to this property will be the same, whether we're receiving it from the vendor or whether we're receiving it from the tenants directly. It's just a matter of geography on the P and L. So the total amount of cash we receive won't change if the schedule changes. It's just a matter of who we receive it from. Correct. And then assuming once the Phase 1 is completed and at that point of time, I guess, you think about the Phase 2 or Phase III of the project. But do you have any preliminary thoughts in which direction you want to go with Phase II? No. I mean, the good thing about this project, and this is like the great part, is upon completion of Phase 1, we'll have it reappraised, and it will increase its value on an appraisal because we bought it considerably cheaper from a cap rate perspective than what the market is out there. So there'll be a lift on our NAV rate from that get go. So as we get further along and it's fall and we're going, we have that NAV lift. We know it's there. We'll either decide to and it's a little tricky too because there's an existing tenant in the Phase 2. So it's a little bit of a puzzle piece. So we'll have to either make a decision, full scale development, small redevelopment or do you look to just liquefy and take your profit and go? So those are the type of decisions that we'll have at the Board level. I mean, it'd be how much appetite for risk for a big development project do we want to take or do we want to take the money off the table. Sure. And I guess the decision on Phase 2 is also like a driver on your potential distribution increase given the AFFO payout, I mean, being so low right now? Will that be a driver as well? I mean, assuming where you just once you decide the fate of Phase 2, you can have a better clarity on what kind of payout ratio you want to keep? Yes. Yes, absolutely. Yes. Sure. Okay. And then just shifting gears on Zoos Stanley, and I know there's a full floor vacant. What is the progress here? And what kind of rents are you seeing? Or what kind of interest are you seeing in that vacancy on the vacancy? Yes. We actually are in pretty advanced negotiations with someone. I'm hoping that in the next week or so, that gets piqued. So we will see. Our rents that we've been getting are in the $18 to $22 range per square foot. So depending on how much TI is required in the project. So just remember that 9,000 something foot floor, like our interest is half that because that is a joint venture, so 50% interest. But it's been a lot slower than I thought it would be. But if we are successful here, it's in the 91% range for the building. It won't affect our income that much. This deal wouldn't even start probably until January of next year. So but what it does do is it just solidifies the rent going forward. Sure. And I guess in terms of the acquisition opportunities, and I know you already gave some color there. Is it fair to say that most of your pipeline is industrial and then retail and office will be mostly on opportunistic basis? Yes. Most of the stuff we see and that we go after is typically in the industrial side of things. Every now and then, we see an office building or a retail and we'll take a look at it. But the majority of the things that we do look at right now are in the industrial side. And is there a particular cap rate range are you looking at? Because the last acquisition was pretty healthy at 9.33% cap rate. So do you have any target cap rate or target asset quality or target geography in mind? Yes. I mean, it's a little opportunistic still now, but I mean, a 9.3% cap rate was pretty awesome. I like that one. But we look at 6.5% and above as where we can get some sort of accretion on AFFO per unit. So industrial, it's hard to compete. You're not going to find that in Toronto, GTA, industrial or that. So you have to be a little bit opportunistic there. Retail, you can find a lot to, but we're very careful with the retail. We do have a substantial portion of retail in Quebec already. So I don't overly pursue the retail assets right now. Got it. And that was my next question. How are the retail assets performing? I mean, do you see any impact from store closures and stuff? No. Actually, our I'm looking at the numbers right now and our occupancy in our retail, which is the Quebec based, everything is pretty much Quebec based. The occupancy there is pretty consistently along with our underwriting that we underwrote it at. So the nature of that business is turning tenants. That happens in the retail side. But when I look at the portfolio quarter over quarter, it's hovering right at our underwriting, just slightly over 90% occupancy. So it's been fairly healthy. It tends to be more grocery store, drugstore anchored type of retail more so than fashion retail, I would say. We have Canadian Tire at a few of the locations that's fairly strong tenant for us as well. So the nature of our retail is a little different than some of the retail that has bigger issues. We have a fairly stable tenant base. Sure, sure. And maybe just one last question I can ask on the NOI growth profile. And I know it was flat quarter over quarter sequentially. What percentage of your leases, I mean, do you have CPI increases or annual rent escalators in place? I couldn't give you a percentage. Yes, I mean we have It represents somewhere around 125, 100 depending on what the inflation is per year, but it's somewhere around $125,000 kind of on an annual basis. For CPI. For CPI increased leases. And then we have other leases that have embedded increases. Those increases don't impact our NOI because of straight lining. But I couldn't give you a percentage offhand though. Okay, sure. That's fine. Thanks for the color. I'll turn them back. Great. Thank you. This concludes the question and answer session. I would like to turn the conference back over to Kelly Hancic for any closing remarks. I'd just like to thank everyone for calling in. I look forward to the next call next quarter.