Good morning. I would like to welcome everyone to the Plaza Retail REIT Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question and answer session. Instructions will be provided at that time for you to queue up for questions. If anyone has any difficulty 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 Chief Executive Officer. Please go ahead, Mr. Zakuta.
Thank you, operator. Good morning. Thank you for joining us on our Q2 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 prospects as we grow our business across our geography. Our highlights are as follows. We have 14 projects under construction and a solid pipeline of deals under development. Our niche of value, necessity, and specialty retail continues to perform well. We have signed renewals or new deals for 755,000 square feet in the first two quarters. That is 200,000 square feet more than in 2017.
In June, we attended the Quebec ICSC Convention. Our leasing team met with 60 retailers or their brokers who are there to do deals, we see continuing demand for space in our market niche. We continue to recycle capital as we have firm deals or have sold 20 properties for CAD 31 million. The sales proceeds are 12% greater than our IFRS values for these properties. The properties that we have sold are non-core and were all part of our KEYreit portfolio. The bulk of these properties would represent our least attractive assets. We will continue to look to surface value from our portfolio. We are seeing a lot of secondary market retail properties coming up for sale as large REITs look to exit these markets. To date, most of these assets are finished product or are being considered as finished product by purchasers.
Some of these assets represent redevelopment opportunities and should be redeveloped. It is clear that current market pricing will not allow us to acquire these assets for redevelopment. There appears to be a surprising demand from private investors, syndicators, and fund managers for secondary market properties. We are very comfortable owning assets in secondary markets, we have too much discipline to chase these deals. We are very active in pursuing new development and redevelopment opportunities. Some of these opportunities are redevelopments of challenged enclosed malls, recycling obsolete retail buildings, new developments following demolition of the existing building or buildings, and new development following land assemblies based on demand from growth-oriented retailers. We've built our business by developing new projects and transforming tired or challenged assets. We continue to be very proactive landlord.
We do not hesitate to initiate change in order to keep up or build value within our existing portfolio, whether it is in making leasing and tenant changes or physical improvements to the properties. Going forward, Plaza will continue to pursue its goal of building value for its unit holders and generating per-unit growth and will continue to differentiate itself from other REITs. I will now turn the call over to Floriana Cipollone, Plaza's Chief Financial Officer, who will provide you with a brief summary of our results for the quarter.
Thank you, Michael. Mainly impacting results for the quarter were non-recurring lease buyout revenues of CAD 1.6 million recorded in the prior year, as well as early mortgage discharge fees incurred in the current year in order to lock in lower rate financing. Impacting the year-to-date results was one month of overlap in interest expense on convertible debentures as the new Series D converts were issued on February 21st, while the existing Series D converts were redeemed on March 27th. Excluding the impact of these three items that are more non-recurring in nature, funds from operations, or FFO, per-unit for the quarter and year-to-date was up 5.5% and 4.7%, respectively, compared to the same periods in the prior year. While adjusted funds from operations, or AFFO, per-unit for the quarter was consistent with the prior year and for the year-to-date was up 0.5%.
The increase in FFO and AFFO was mainly due to growth from developments, redevelopments, and acquisitions, net of property disposals, as well as an increase in other income, mainly due to an increase in third-party leasing and development fees earned from co-owned properties. AFFO was further impacted by higher maintenance, CapEx, and leasing costs relating to new tenancies. Total net operating income was up 3.4% for the quarter and up 2.4% for the year-to-date, excluding the impact of the lease buyouts. Total net operating income was impacted by growth from developments, redevelopments, and acquisitions, net of property disposals. Same asset net operating income was up 0.2% for the quarter and up 0.04% for the year-to-date, excluding the impact of the lease buyouts.
For the quarter, same asset net operating income was impacted by rent increases and lower operating costs, partly offset by lower same asset occupancy, mainly from the enclosed malls, while the year-to-date was further impacted by a CAD 156,000 bad debt expense recorded in the first quarter due to a tenant going into creditor protection. Excluding the impact of the lease buyouts, the one-month overlap of convertible debenture interest, and the early mortgage discharge fees, our FFO payout ratios for the quarter and year-to-date were improved compared to the prior year. Our AFFO payout ratios were slightly higher for the quarter and year-to-date compared to the prior year, mainly due to the higher maintenance, CapEx, and leasing costs incurred. Our leverage ratios ended the year at 48.8% of assets excluding converts and 53.8% including converts. Those are the key points relating to our financial results for Q2 2018.
With that, we will now proceed to open up the lines for any questions.
Thank you. Ladies and gentlemen, we will now conduct the question and answer session. If you have a question, please press the star key followed by one on your touchtone 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. Our first question comes from the line of Kyle Stanley from Desjardins. Your line is open.
Good morning, everyone.
Good morning.
Good morning.
Just a couple questions from me this morning. I was wondering if you could provide us an update on the progress on the lease-up to backfill the space that was vacated last year as part of the early lease termination. How maybe interest has been and how pricing is relative to your expectations.
The space is leased, but it is not revenue generating yet.
Okay. When would you expect that to come?
There were two spaces. One of them is leased. The second one is leased but not opening until, I think, November 2018.
Great. I guess secondly, are there any updates on the Wicker Emporium CCAA process? You mentioned last quarter they were continuing to pay rent at their four locations. Just wondering if that's changed, that they could relinquish maybe one or two leases.
Two of the four were given back. We still have two, and they're paying rent.
Could you provide a bit of color on the disposition of the development property in Anjou? It seemed like a good return there.
Yes. It's a property that we really didn't like. We didn't think it was the type of property that we wanted to own because of its location. We were able to redevelop it, actually sold it to a user. The effective cap rate is like 3.9% because there is some vacancy that the user will occupy. It's really a question of, is this the kind of property, the type of location that we want to own? If it came up as a single offering out on the market, we probably wouldn't look at it because I think the location has some challenges. It came with a KEYreit portfolio. We're happy to exit from that type of property.
Okay, that's great. I guess just the last one for me here. When you're evaluating the enclosed mall vacancy, do you see this as more transitional in nature, or would it be a bit more of a structural issue? I guess, is there potential to re-lease the space, or would it be more of an opportunity to maybe reposition some of those assets?
Just about all the vacancy comes from one shopping center, Village Shopping Centre in St. John's, Newfoundland. We just leased 40,000 sq ft, for call center space that's not on the mall. There's one large mall location that's available there, which is very good space, so we expect to lease it. In this type of property, you're going to see a lot of up and down, continually going up and down. We bought that property with a 40% occupancy level. We brought it up to, say, 95%. It's down at 88% now, and I expect to bring it back over 90%. It's a lot of slugging in the enclosed mall game. I don't think that's a surprise. Our other enclosed malls are pretty stable. Those two other real enclosed malls in Montmagny and Rouyn-Noranda, they're pretty stable and have good occupancy.
Okay. Yeah, that makes a lot of sense. That's it for me, thanks.
Thank you.
Our next question comes from the line of Sumayya Hussain from CIBC. Your line is open.
Thanks. Morning.
Good morning.
Michael, you've spoken previously about the Sears and kind of the derivative impact on more so on your development projects. As you look through your development pipeline, are there specific assets or projects where you would expect more competition, and which ones would those be? Or was that more of a macro statement on just dynamics in retail?
Yeah, I think it's more of a macro. I don't think that we're experiencing serious competition on some of the new stuff that's coming out of the pipeline. I guess I've talked about retailers being very distracted by Sears opportunities and other opportunities like that. That's probably slowed us down, and maybe it's cost us a deal or two in some places. In general, business is still pretty solid for us in our niche. We feel very confident of what we're doing, and how we're going about it, and the type of deals that we want to do.
Okay. Just more of a, I guess, macro environment.
Yes.
On the 1000 Islands Mall, can you update us on your plans for the site and what you're seeing so far in terms of tenant demand there?
We're well underway. The Sears box is in the middle of transformation. It's all spoken for. There's one deal that's not signed. We have a deal, and it's with a tenant that we have a lot of locations with. I consider that deal's going to happen. That's the Sears space. The balance of the frontage is basically spoken for. I think there's going to be one opportunity when we shut down the mall, where we take back the mall space and neighboring space to create a decent strip store. That would be the only available space in the property at this moment in time. We're ahead of schedule, I think. We're making things happen. When you're doing a mall-to-strip simplification, what you really have at the end of the day is frontage.
I mean, you have lots of square footage, some of it's never going to get leased. You have a lot, you have frontage. Once your frontage is gone, you're finished. Our frontage is basically spoken for.
Still targeting by the end of 2019 for it to be-
Yes
stabilized.
Yes.
Okay, great. That's it for me. Thank you.
Thank you.
Our next question comes from the line of Michael Smith from RBC Capital Markets. Your line is open.
Thank you, and good morning.
Morning, Michael.
Some of the other REITs that operate in your neck of the woods, so to speak, they're suggesting that it's actually a buyer's market. In other words, there's a lot of stuff on the market and that prices are not that attractive. I think from what I understood, what you're saying is that prices are still too high. I'm just wondering if you could comment on that. Then as sort of related to that is, given the way retail REITs are being treated on the stock market, would it make sense to step up your sales program if you're happy with prices or?
Okay. In terms of pricing, our geography is very large. We are seeing, you're seeing, I think RioCan's had a lot of success in their secondary market sales program. What we're seeing is there are assets out there that we think should be redeveloped, but there are a number of purchasers because they will get a higher cap rate than they will find in Southern Ontario, are going to step up and buy it and just milk it because they're making fees going in and fees during ownership and don't have the same view of property ownership as we have. We're definitely competing with that, and we've had an attempt at thinking that we could buy some stuff and not have to do a lot of change and development, still make some healthy returns because pricing was going to be favorable to the buyer.
We have not benefited from that approach yet.
Would it make sense to sell some of your assets too?
Yes.
Especially your staple ones?
Yes.
Yeah.
Yeah. That's something that we're running lots of models today to look at perhaps we should be selling some stuff. I think some stuff will sell. The quality stuff is going to sell, I think no matter where it is or what market. If your quality is not good, you're going to be challenged today.
Right.
There are a lot of buyers. We're quite surprised. If you're talking enclosed malls in small town Québec, that's probably a challenge. If you're talking food-anchored and pharmacy-anchored product anywhere, there is demand.
It sounds like you have no shortage of redevelopment opportunities where the real estate is broken. It'd be like you're already doing this, obviously. I'm just sort of looking at the volume of what you're doing, like just recycle the capital from those stabilized properties that are getting an attractive bid into more empty Sears, that type of thing.
Obviously, that's our business model, as you know, and it's all a question about opportunity and pricing. It's got to come to us. If the pricing's not there, then there's no sense in doing all the work that you have to do to transform a property if you're not being rewarded. I think we've been very disciplined over the years, and I expect that we will continue to have that discipline. I think there are opportunities, we're pursuing, we're seeing a lot of stuff. There's a lot of analysis going on today regarding different opportunities in empty buildings and buildings where retailers are relocating to grow or to reposition themselves, and we're on it. That's exactly where we want to be.
Good. Okay. Could you just define non-core for us? Just remind me what you consider non-core.
Yeah.
Obviously, the KEYreit thing is one, just in general.
Non-core. We had a building in Halifax, two stories, a big office component. That's clearly non-core. If you hang around with us, you know that we don't like to do second-floor office. That's like a pro forma dream, guys. Guys do it because it looks good in the pro forma, but ultimately, you don't ever make any money, and it becomes a burden. It can ruin your parking, whatever. There's a whole list of reasons never to do second floor above retail. There was an example of a product with not a lot of parking, second-floor offices, and so that's very non-core. In the case of Anjou, again, I just don't like the location for a variety of reasons. Core to us is food, pharmacy, dollar store anchored product.
All that value stuff that we've been doing year in, year out, that to me is very much core product.
Mm-hmm.
A KFC here, there, or anywhere is not core. We're happy to own them, and we think that they're giving us solid cash flow, but we don't have to own them.
Right. Okay. Can you talk about what retailers are expanding and maybe touch on cannabis stores?
Yes. There's still the usual suspects that are growing. You have the dollar store, you have the pet category, you got PetSmart, you got Ren's, you got Global Pet, you got Mondou, you got Pet Valu, and others, like the entire announcement this week. You have all the TJX banners, the Michaels stores, Giant Tiger, Structube, all the fitness guys, whether it's Movati or Planet Fitness or others. You have Farm Boy, you have Metro banners, you have the quick-service restaurants, the Princess Autos of the world. All that niche continues to grow and is seeking stores in our markets. As far as cannabis is concerned, quite interesting. I think I've talked about, we've delivered three cannabis stores in New Brunswick. They're actually paying rent now, though they're not open. Those are government, they're Liquor Board leases, so in effect, the Liquor Board is owned by the government.
A lot of calls about our Ontario assets. I think we're going to see some benefit. Hard to measure yet what that's going to look like, because I think the whole Ontario program is still unclear. The cannabis retailers are clearly knocking on all the landlords' doors, and we're going to see some activity if it really goes into a private model. Same thing in Newfoundland. Nova Scotia is a hybrid. Quebec is government through the SAQ, or the Société québécoise du cannabis. That's slow moving. There's definitely going to be action and financial benefit from cannabis retail. How it impacts our shopping centers, that's still unclear. We're prepared to do the deals.
What kind of rents do you get? What's the store size rents for the deals you've done and the ones you're talking about? Rent, store size, and TI allowance, or build out.
The New Brunswick, I think, are particular in that New Brunswick government, I think I've mentioned this before, was really quick out of the chute with a very complex building, built to bank and jewelry store specifications. It's a very expensive build out and a very high rent with a 15-year lease.
That was New Brunswick model. I'm expecting, in the private sector, it will be very different. In the public, you're going to see more Liquor Board-like style buildings. Private's going to be different. I haven't seen the Alberta, what's going on out there, hear a lot about it. I think it's a little early to give sort of solid responses and direction. There's clearly going to be a lot of activity, and it's going to be beneficial to landlords, and hopefully you're going to sign the guy that's going to survive, and that's part of the challenge. In the case of a government lease, you're not worried about it. In the case of a private guy, you have to be concerned about who you're working with.
We're careful. We want to be very cautious about that.
Sure. Yeah, that makes sense. Do you anticipate it being mostly in-line type stores or like pads?
I think from a landlord's perspective, the ideal is a freestanding. You take a quick-service restaurant, and you convert it to a cannabis store. Cannabis store, typically between 2,000 and 3,000 sq ft. Our New Brunswick model is 3,000 sq ft. I think they can live with 2,000. That way you have no issues with neighbors or anything, or use clauses, or whatever restrictions that somebody may wish to apply, and off you go. That's ideal. We have some opportunities like that. The stuff that we did in New Brunswick, basically, we built pads. We didn't put it in-line. We would put it in-line under the right circumstances, but we were cautious not to bid some of our, I call our fancier strips that have a really strong tenant base, and we didn't know what the impact would be. We're taking a cautious approach.
Okay, great. Thank you.
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. Mr. Zakuta, there are no further questions at this time.
Thank you, operator. In conclusion, we continue to offer a very different real estate investment opportunity with a focus on per-unit growth and value creation through our accretive developments and redevelopments. Plaza does not buy finished properties from third-party developers or related parties at low cap rates. We are fully internalized and able to develop new retail properties using in-house resources. Plaza locks in consistent long-term returns by financing with long-term debt, generally matched to lease maturities. We've consistently demonstrated our entrepreneurial abilities by adapting to changing market conditions in order to grow our business. Insiders hold an important ownership position and look forward to growing Plaza's distribution in the future. 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.