Good morning, ladies and gentlemen. Thank you for standing by. I would like to welcome everyone to the Plaza Retail REIT Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a Q&A session. Instructions will be provided at that time for you to queue up for questions. If anyone has any difficulties hearing the conference, please press star zero for operator assistance at any time. I would like to advise everyone that this conference is being recorded. I will now turn the conference over to Mr. Michael Zakuta, Plaza's Chief Executive Officer. Please go ahead, Mr. Zakuta.
Thank you, operator. Good morning. Thank you for joining us on our Q3 2018 results conference call. We are legally obliged to tell you that today's discussion includes forward-looking statements. We'd like to caution you that such statements are based on management's assumptions and beliefs. These forward-looking statements are subject to uncertainty and other factors that could cause actual results to differ materially from such statements. Please refer to Plaza's public filings for discussion of these factors. We continue to be very positive about our business and the pursuit of our objectives of building value for our unit holders and creating per-unit growth. Our strong pipeline of deals will deliver robust growth in 2019, particularly in the second half of the year as new revenues kick in. Our niche of value, convenience, and specialty retail continues to perform. In early October, we attended the Toronto ICSC convention.
Our leasing team met with over 70 retailers or their brokers. The mood was even better than expected. Those present were there to pursue deals. We see continuing demand for space in our market niche. Today's growth-oriented retailers are found in the following categories: value, grocery, pets, sporting goods, specialty business, QSR, fitness, and our newest retail category, cannabis. All the cannabis retailers were present to proceed deals in Ontario. Our leasing deal volume is solid. We remain confident that these activity levels will continue into 2019. We continue to see an important number of secondary market opportunities. I wish to share with you our perspective of these markets. Within the category of secondary markets, there are many distinctions. There are markets that are under-retailed and markets that are over-retailed.
There are small markets demonstrating solid demographics and growth. Markets showing very poor demographics and slow or no growth. There are markets that are underestimated. There are markets that should be avoided. There are a number of under-the-radar markets that represent interesting sales and profit opportunities for retailers. In short, developing and owning retail in secondary market is a specialization within our sector. The larger property owners that are currently exiting these markets are, generally speaking, passive investors that were attracted to the higher yield of secondary markets but did not build or possess an operating platform that focuses on these markets. Being active in these markets every day provides us with a much better appreciation of what works and what does not work in secondary markets.
The active developer has a true advantage as they are constantly interacting with retailers and adjusting to changes in retail real estate. Given the acceleration of the pace of change in Canada, this advantage has never been more important. We have often taken a very contrarian view of our industry. At present, as everyone is exiting secondary market retail, we are looking to go against the trend and pursue secondary market retail assets. We are very active in pursuing new development and redevelopment opportunities across our geography. Some of these opportunities are redevelopments of challenged enclosed malls, recycling obsolete retail buildings such as vacant Sears stores, new developments following demolition of an existing building or buildings, and new development following land assemblies based on demand from growth-oriented retailers. At our current unit price, we're obviously not raising equity capital.
In order to fuel our growth, we have initiated a capital partner arrangement whereby private capital funds a portion of our new deal equity in exchange for participation in our new deals. In addition, we will continue to recycle assets that are very mature and not core to our business, and we will continue to access term debt that is both relatively inexpensive and very available. Retail-oriented REITs such as Plaza continue to be very much out of favor with investors. You may have noticed that we did not announce a distribution increase with the publication of our results as we have done for the last 15 years. Our board is of the opinion that we are not receiving credit for or being properly recognized for these distribution increases. As an alternative, for the first time in our history, we will use our capital for unit buybacks.
Of course, we will continue to invest in new projects. We will gauge the market's reaction and act accordingly. We strongly believe that our development and value-added business model will produce continued FFO, AFFO, cash flow, and NAV growth. This growth may not be linear at all times, and the development cycle may be longer in today's environment, but we believe that we will ultimately produce the desired results. Current market conditions represent an interesting buying opportunity for REIT investors. Floriana is unable to attend today's call. Her absence is not business-related. In terms of our results, FFO per unit, the quarter was up 1.1% over the prior year, mainly driven by growth in NOI from developments and redevelopments. AFFO per unit was down 6%, mainly due to higher leasing costs incurred for new tenancies.
Mainly impacting results for the year to date were non-recurring lease buyout revenues of CAD 1.6 million recorded in the prior year. Higher early mortgage discharge fees incurred in the current year in order to lock in lower rate financing, as well as the timing of issue of new Series E converts versus redemption of the Series D converts. Excluding the impact of these three items that were more non-recurring in nature, FFO per unit for the year to date was up 3.2% over the prior year. While AFFO per unit would've only been 1.8% lower. Again, FFO was further impacted by higher leasing costs related to new tenancies. These are the key points relating to our results for Q3 2018. With that, we'll now proceed to open up our lines for any questions. Operator?
Thank you. Ladies and gentlemen, we will now conduct the Q&A session. If you have a question, please press the star key followed by one on your touch tone phone. You will hear a one-tone prompt acknowledging your request. Your questions will be polled in the order they are received. If you would like to decline from the polling process, please press pound. Please ensure you lift the handset if you are using a speakerphone before pressing any keys. One moment please for your first question. Your first question comes from Sumiya Subisain with CIBC. Please go ahead, your line is open.
Thanks. Michael, as you look to 2019, any other tenant departures or lease buyouts on the radar? Just what kind of same property growth should we expect now that you have replacement tenants in place and better occupancy at the mall as well?
Okay. First question, we're not anticipating other serious tenant bankruptcies, but they always do occur, and they have occurred over the life of my business career. That's very hard to respond to that question. I do anticipate material lease buyback going forward. There are some deals that are being worked on that we think make a ton of business sense. Obviously, they have an impact when you're reporting thereafter, but they are extremely lucrative for the landlord. As far as same asset growth, again, I think it's modest, but I think it's 1%. There's always noise or something going on. Of course, if we do a lease buyout early in the year, which is possible, it has an impact going forward for the rest of the year.
Right. I guess the timing of the lease buyouts isn't known at this point in time. It might just pop down the road.
Well, we have two opportunities. We have a very interesting offer. We're very close. We're CAD 100,000 apart. I expect that it'd probably happen. What's the timing? I can't answer that. I really don't know.
Okay. That's fair. Just on your development pipeline, noticed that you moved part of Shops at Galway into active development and have some commitments in place to What's been the profile of the tenants there? Just based on the current interest, when do you see it becoming stabilized?
Well, they're always going to be a long-term project, executed in phases. As one of my people said this week, it's finally out of the mud. That means we're out of the ground. Steel is up. The first part of the project was a land sale to Costco in the back end, which really provides a solid anchor. That building is up, it's enclosed, and we'll expect it to open in February. We started the first phase of our development, about 60,000 sq ft for national value style retailers. That building is up. We're out to tender for another 40,000 sq ft. We expect to have about 120,000 open in 2019, and there'll be further construction and launches of additional phases going forward.
Okay. So far meeting your initial expectations.
In terms of leasing demand, it's been a tough slog. It's been a tough slog actually to get the municipal development process concluded. That's been our biggest delay. There is demand, and people are seeing. If you visited the site, I think you'd be very impressed with what it looks like and how it's being transformed. We're very excited from that point of view. Now we've got to get more deals over the finish line, signed and finished. There's negotiations on a number of deals, and now it's a question of getting them papered, finished, and delivered.
Great. Thanks for the update. I'll turn it back.
Thank you.
Your next question comes from Michael Smith with RBC Capital Markets. Michael, your line is open.
Thank you, and good morning.
Good morning.
I just wanted to talk about your, a little bit of a change in our, probably, I guess, a big change in your capital allocation, not increasing dividends and stepping up buybacks. I wonder if you could just give us some color as to what the discussions were. The fortunate thing about real estate is when it trades below NAV, it is an easy way to create value. On the other hand, you've got the longest track record of consecutive dividend increases, something that sounds like you're willing to give up.
Well, obviously, a difficult discussion, tough decision. We're in November of 2018, right? 2019 still has a long way to go. Clearly, the disconnect between what we feel is our value and the price of our unit is so great that unit buyback is very compelling. If you look at not only the yield, but you look at what you're buying the units, the discount that you're getting, boy, it's a tough situation for us. We think the discount is just way too great, and it's compelling to buy back units. There's only so much capital, and it's got to be deployed responsibly. For the time being, I think it's prudent to do what we're doing. We got a huge pipeline, both official and unofficial. We need capital to fuel that pipeline.
Is it fair to say that you see the value of your net asset value higher than your book value of CAD 4.50-ish?
Yes, absolutely. For a variety of reasons. If you look at the whole how IFRS and how the value is put together, it's put together through a process. That process is very objective, and it's got to be consistent. I don't believe that it's representing our true value. If you want to put a specific cap rate on every deal, as opposed to using cap rate metrics and put that against NOI, you're going to see greater value. I don't think that we're seeing the value of what's in the pipeline, what's under contract to come through, and we're not seeing any value for our platform or our infrastructure.
The disconnect is historically high.
Yeah. Just to clarify, you see the hard value of your platform has enormous value. If you put that aside for a second, if I'm hearing you correctly, what you're saying is that just the hard assets alone, never mind the platform, is worth way more than CAD 4.50.
That is correct.
Yeah. With that, and I know there's a lot of, let's say, the larger REITs playing in smaller markets, and so they're exiting, so you're stepping up. What was the discussion like about selling, just selling a bunch of assets to fund maybe even a bigger buyback or buyback plus dividend?
If you saw, we're an active seller this year. As you've seen, and we'll continue to be an active seller of what we consider the mature non-core assets.
Right. Yeah.
That's hard to predict, but there's definitely activity, and it's really interesting. The very, very small assets are being very, very well-priced today.
There seems to be a strong demand.
What about, and I know this kind of goes against the grain to a certain extent, but what about an asset that maybe is only partially, you still have upside. There's still value to be created, but the discount to your buying back your units is more attractive, let's say, than completing the remaining upside of a smaller development. Any discussion on that or thoughts or?
No. I think our business is developing and redeveloping and creating value. I don't think you want to let go of stuff that you haven't polished up and maximized. Our strategy has always been maximize it and put it into the portfolio. Again, today, given market conditions, we're going to sell more than we would normally sell. We're giving up some equity on new projects with our capital partner structure. We're receiving, in effect, mezz financing from our capital partner. That makes our capital work harder, enhances our returns. We're in actually really, really good shape. The market isn't recognizing that because we have deals, and we're being creative in how we structure them so that we can make them work, and we can enhance our returns.
Yeah. The other, I guess, advantage of that is that you're keeping your platform very active with outside capital so that you have more opportunity to sell assets if you need to. I think the market should welcome you buying back stock, especially at these discounts. Just switching gears. It sounds like a very positive ICSC, 70 retailers, a good mood, basically. A lot of categories are expanding. What do you think that will result in kind of like a growing rent or growing occupancy? Maybe just give us some thoughts as to what you think that means.
I think it improves occupancy. Growing rents is very case specific in our business. When we go to an ICSC, our principal goal is to make sure that we show our new projects and we lease them and we move them along, and we judge retailer interest for what we're doing, and we try to motivate people to come to the table and sign up with us. That's really the goal and how we look at things. We're not looking at it to say, "Okay, because there's" Yeah, demand does help move rents up. The cannabis demand is probably moving rents up in Ontario because all of a sudden space is coveted.
It's quite interesting.
Other markets, is that not the case for other markets?
Well, you have to go across the country. In New Brunswick, where we have three stores open, they're government-owned, Liquor Board-owned. Quebec is Liquor Board-owned, has been very disorganized and hasn't rolled out a big program. From our geography, PEI has a few stores. We're not involved. Newfoundland as well, we have not been involved. Nova Scotia is through their liquor stores, so there wasn't great demand for space. The demand for space is obviously in Alberta and Ontario. We're not active Alberta developers, so we're not plugged in there. We're just hearing that there's a lot of activity, and obviously in Ontario, my leasing guys are very popular.
Right. Okay. Well, that's good. They're happy then. No wonder the mood, yeah. Just switching gears again. I wonder if you could And I know you've always kind of gone against the grain to a certain extent, but sounds like it's even more pronounced now. I wonder if you could just expand on your comment about going against the grain a little bit.
Yeah, well, no, clearly, we're seeing the large players exit the secondary markets, and that's pretty obvious, and you guys probably see it even more than we do across the country. There are opportunities, and we're working hard to try to take advantage of those opportunities, either to buy stuff at a pricing that we think can give development-style returns with little development or even if there's a development angle, that's even better. We're seeing a lot of product. There's a lot of analysis being done by our people. What it's going to translate into final deal volume is hard to tell or predict today. We've never seen so much activity and so much offering of product in our world, and I'm really talking about Atlantic Canada in particular.
Should we expect that with more, let's say, private money helping to partner with private funds, that you'll have more participation type deals where you sort of a kicker if you hit your projections?
Yeah. That's the route that we're obviously taking. There's different structures to the deal. Our sort of standard structure today is that we would own 50%, but we'd only put 20% of the equity, and our partner would lend us the 30% at 5% for five years. That's the kicker.
Until at the end of five years?
At the end of five years, we've hopefully added enough value that we can readjust our equity.
You basically pay off that loan.
Pay off the loan after five years.
After five years, that loan is 30% of the equity, which presumably will be worth more in five years.
Absolutely, yes.
Okay, great. Thank you.
We also have the structured deal with promotes and that. Again, it's deal specific, but that's the formula that we're seeing the most of.
Good. Great. Thank you. I'll turn it back.
Ladies and gentlemen, if there are any additional questions at this time, please press the star followed by the one. As a reminder, if you are using a speakerphone, please lift the handset before pressing the keys. Your next question comes from Mike Markidis with Desjardins. Mike, your line is open.
Hi, Michael. On your comments on the capital partner arrangement, I know this is something that you've kind of done to different degrees in the past. Is that to suggest that there's a formal arrangement with a specific partner now that might contemplate something with a much bigger size to it?
There is a formal arrangement with a group. What's the volume? Time will tell. We present the project. If they want in, everything's all pre-established. We've already done a deal, so the paper's all in place, and if they're not interested, then we'll go out and do it ourselves, or we'll syndicate it, or we'll do another structured deal.
This group, is this the structure being set in stone in terms of being the structure you just described to Michael, being 50% of the equity, but you only yet lent 30%? Is that the?
That's the structure with the group that we've signed up with.
Okay.
With other groups, again, it could be different, and we've always done things differently depending on the deal. Every deal has a different personality, and the investor has a different personality. We try to adjust to that. That's the structure that we have in place on a formalized basis.
Does this group have first rights in terms of you sell first to them first?
Yeah, we're giving them first look at deals.
Okay. If something big were to come across or substantial, how do you think about because while that does get your kicker, it also introduces more leverage into your capital structure as well. When you think about your balance sheet today, how big would you be willing or comfortable letting that type of structure go?
I don't think we're a big deal style player, firstly. We always try to be very diversified in terms of the types of deals that we do, geography and have lots of different deals going on at one time, not be all focused on a large transaction. We are prepared to move our debt levels up, somewhat, based on market conditions. We're not going to go crazy. I think that we can afford to do that and that it'll be lucrative for the business to do so.
Okay, is there a formal equity commitment from-
No.
From this partner? No.
No.
Okay.
No, it's just we have a memorandum of understanding, which says, "Here's the deal, and are you in or you're out?
Okay.
If we have existing relationships elsewhere, obviously it doesn't apply. Not every deal is going to go to our capital partner, because we have other relationships on a geographical basis with regional landlords or players.
Okay. Just earlier on your comments in terms of secondary market opportunities, you gave a great color, not just with respect to what your expertise are, but just the state of different markets. If you think about your portfolio today, are there any markets where you've kind of Some you said that are over-retailed and should be avoided. Are there any of those markets in your portfolio today or, not because you're not skilled in terms of being able to recognize them, but maybe the conditions have changed recently, or is it pretty clean right now?
Yeah. There definitely. It's also within a market, you have to look at it almost on a sectorial basis. If you look at Halifax, for example, there's Dartmouth, there's Halifax, there's inner city, there's out. There are pockets that represent opportunity, and there are pockets that do not represent opportunity. One has to be careful. I think we've always been very careful, and that's really based on our Atlantic Canadian roots, where you've always had to approach deals a little differently than in Southern Ontario or Montreal, where you have strong growth and a different demand profile.
Stated alternately, you've been very focused on these markets. You're staying ahead of the curve. The rush by bigger players to exit is perhaps they just don't have the same level of intensity identifying these.
Well, they have a different business model.
Yeah.
I respect that 100%. Our business model is such that we can operate, we're very close to the action. It does, I think, give an advantage. We've been saying that for years much everybody's listening. You can get things done. If you're sitting in Toronto or Montreal, you're not going to get it done. I think we proved it over and over again.
I'm confident that we continue to do so. I think it's going to be easier because there's less competition.
Okay. Sorry if I don't believe, correct me if I'm wrong, that you have an NCIB in place today. Is that something that will be up and running fairly quickly?
We do.
You do? Okay.
Yeah.
Have you acted on that yet?
Not yet. No.
Not yet, okay.
Expected to be acted on.
Okay. Last question from me, just with respect to your commentary and the enthusiasm everywhere from people on this whole cannabis thing. In Ontario, what's your view? Do you see this as being a sustained source of demand, or is it just going to be a one-time sort of rush to the market, and then all of a sudden you got to be really careful with respect to who you underwrite and you're going to see some of these stores close perhaps?
Wow, that's really hard to predict. Obviously, there's a rush. Once somebody has a license, I guess that's going to be somewhat powerful. There's going to be consolidation. I don't think the rush is going to be sustained. That would be my take if I had to make a prediction, but there's clearly going to be a rush for a period of time until all of sort of the demand is fulfilled and the guys hit their 75 stores. That's a limiting factor. It's going to be really interesting. The rules are not 100% clear. I think they were further clarified yesterday or last night. That's helping us. I would expect to see not only ourselves, but most of the Ontario landlords announcing deals going forward. It's going to be interesting.
It's going to be a little bit of a windfall for the landlord community certainly in the short term.
How are you guys approaching the whole credit risk when you're underwriting these deals? Is it something? Obviously, your deals with the government are pretty easy. In Ontario, is this something you need to be a little bit sort of scrutinized really carefully, I would imagine.
Yeah. We're dealing with experienced players, firstly. In a lot of the instances, we're not spending any capital. The capital is coming from the retailer. If we have an existing store, it's like, "Here it is, guys. Do what you want to do." That makes it a lot easier. We're going to take some KFC down. We're going to build a product that's going to be something that can be easily recycled. That's part of the challenge is figuring out credit risk here.
Okay. That's very helpful. Thanks, Michael.
Thank you.
Mr. Zakuta, there are no further questions at this time.
Thank you. Our look for our business is very positive. Going forward, we'll continue to pursue our goals as Plaza grows via new developments and redevelopments, takes advantage of its strong leasing and development infrastructure, adapts to changing market conditions, and positions itself to take advantage of opportunities. Continues to take advantage of long-term debt market and recycles capital by selling mature finished product and using the proceeds to invest in higher yielding projects. We have consistently demonstrated our entrepreneurial abilities in order to grow our business. Thank you for participating in today's call.
Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your lines.