Good morning. My name is Casey, I will be your conference operator today. At this time, I would like to welcome everyone to the RioCan Real Estate Investment Trust second quarter 2018 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 this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, you may press the pound key. Thank you. Mr. Ed Sonshine, you may begin your conference.
Good morning, everyone, thanks for dialing in on this rather dreary day. With me here are several executives from RioCan. The ones who will be speaking will be first, Christian Green, who will read the interminably long forward information warning. Then Qi Tang, our Chief Financial Officer. Then before I come back on, will be Jonathan Gitlin, our newly minted Chief Operating Officer. Be gentle with him, he's got just over a week on the job. I'm sure you'll treat him nicely. With that, I'll turn it over to Christian Green.
Thank you, Ed, good morning, everyone. Before we begin, I'd like to draw your attention to the presentation materials that we will refer to in today's call, which were posted together with the MD&A and financials on RioCan's website earlier this morning. Before turning the call over to Qi, I'm required to read the following cautionary statement. In talking about our financial and operating performance and in responding to your questions, we may make forward-looking statements, including statements concerning RioCan's objectives, its strategies to achieve those objectives, as well as statements with respect to management's beliefs, plans, estimates, and intentions, and similar statements concerning anticipated future events, results, circumstances, performance, or expectations that are not historical facts.
These statements are based on our current estimates and assumptions and are subject to risks and uncertainties that could cause our actual results to differ materially from the conclusions in these forward-looking statements. In discussing our financial and operating performance and in responding to your questions, we will be referencing certain financial measures that are not generally accepted accounting principle measures, or GAAP under IFRS. These measures do not have any standardized definition prescribed by IFRS and are therefore unlikely to be comparable to similar measures presented by other reporting issuers. Non-GAAP measures should not be considered as alternatives to net earnings or comparable metrics determined in accordance with IFRS as indicators of RioCan's performance, liquidity, cash flows, and profitability. RioCan's management uses these measures to aid in assessing the trust's underlying core performance and provides these measures so that investors may do the same.
Additional information on the material risks that could impact our actual results and the estimates and assumptions we apply to making these forward-looking statements, together with the details on our use of non-GAAP financial measures, can be found in the financial statements for the period ended June 30, 2018, and management's discussion and analysis related thereto. As applicable, together with RioCan's current annual information form that are all available on our website and at www.sedar.com. Qi.
Thanks, Christian, and good morning, everyone. Our second quarter results that were issued earlier this morning once again demonstrate the quality and strength of our portfolio. Before I get into our financial and operating results, I would like to update you that as of yesterday, August 7th, we are more than halfway to our disposition target of CAD 2 billion assets with CAD 1.2 billion or 58% of our overall disposition target either closed or under firm or conditional contract. The weighted average cap rate for the asset sales is approximately 6.5% based on in-place NOI, materially in line with our IFRS valuations. As a result of our strategic dispositions, our major market focus has increased by 1.4% from Q1 2018 to 81.4% as of June 30th, 2018, including 43.5% from the GTA. Our COO, Jonathan, will speak more about this shortly.
For the second quarter, we achieved same property NOI growth of 2.1% for the overall portfolio and 2.5% for our major markets portfolio. Our major markets occupancy as at June 30th, 2018, was very strong at 98%, and overall portfolio occupancy was 20 basis points higher than last quarter at 96.8%, including office space, our retail occupancy improved by 30 basis points in the quarter to 97%. For the six months of 2018, higher occupancy in the portfolio, renewed rental growth, and contractual rent increases helped our same property NOI increase by 2.3% for the entire portfolio and by 2.8% for our major markets portfolio. While secondary markets same property NOI was relatively flat over the comparable period.
The strengthening occupancy and the strong same-property performance gains from the sale of marketable securities and our active NCIB program resulted in a 2.5% increase in our FFO per unit from CAD 0.45 in Q2 2017 to CAD 0.46 in Q2 2018, despite CAD 583 million dispositions completed since October 2017 and CAD 4.3 million one-time severance costs in Q2 2018. Excluding the severance cost, our FFO per unit for the quarter would have been CAD 0.47 per unit, a CAD 0.02 per unit or 5.5% increase over Q2 2017. As a result of the FFO per unit growth, our FFO payout ratio improved from 82% for the comparable period in 2017 to 78% in Q2 2018, a 4% improvement, and again, outperformed our 80% target.
Excluding CAD 28.2 million gains from the sale of marketable securities and CAD 4.3 million one-time severance costs, FFO per unit was CAD 0.41 in Q2 2018, versus CAD 0.42 over the same comparable period in 2017, down by CAD 0.008. Temporary loss of CAD 1 million NOI, including co-tenancy loss due to Sears closure, which we have substantially completed re-leasing with income coming to earnings stream in late 2018 and 2019, and CAD 1.2 million lower lease termination fees have led to this CAD 0.008 per unit decrease. It is important to note that this result speaks to the quality of our portfolio, considering dilution effect of the CAD 583 million dispositions completed since October 2017, even with our active NCIB program. Furthermore, we are making excellent progress on our development program, with significant leasing progress as well, as we recently announced with Allied.
Major mixed-use residential projects coming to the earnings stream in late 2018 and 2019, such as the rental and condo towers at the Yonge and Eglinton northeast corner, King Portland Centre , including Kingly Condos, and Frontier Apartments at Gloucester in Ottawa. Jonathan will speak more about our development pipeline and project progress shortly. We will continue to self-fund our development pipeline through our current strategic disposition program and future continuous pruning of the portfolio, as well as strategic partnerships, the sale of air rights, condos and townhouses, sale of marketable securities, and so on. Next, let us look at our balance sheet strength. In our view, the most important measure of a company's financial strength is debt to EBITDA.
Despite our strategic disposition program and approximately CAD 1.4 billion development on the balance sheet, including condo and townhouse developments, our debt to adjusted EBITDA was 7.74 times on a proportionally share basis as at June 30th, 2018, below our target of eight times, and one of the lowest among our peers. Excluding the CAD 1.4 billion development on the book, our debt to adjusted EBITDA would have been approximately six times. In anticipation of receiving substantial disposition proceeds in July 2018, we increased our debt modestly to maximize our NCIB purchase prior to entering the blackout period in late June due to quarter-end reporting. For this reason, our leverage was 42.4% as of the quarter end, slightly above the upper end of our 38%-42% target range.
In addition to a conservatively managed capital structure, we are focused on maintaining access to multiple sources of capital and financing flexibility by growing our portfolio of unencumbered properties. As at June 30th, RioCan's pool of unencumbered assets was CAD 8 billion, which generate 58.3% of our annualized NOI, above our target of 50%, unchanged from the last quarter. All of our debt metrics have met or exceeded our internal targets as at June 30th, 2018. As you can see, we're generating tremendous momentum in our strategic disposition, operations, and development programs. We are confident that we will carry on this momentum into the second half of the year. With that, I would like to turn the call over to Jonathan for update on RioCan's operations this past quarter.
Thanks, Qi, and good morning, everyone. I'm very pleased to provide the operational highlights for the second quarter of 2018. As Ed mentioned, I'm one week into this role as RioCan's Chief Operating Officer, and I can say that I'm truly excited about our progress and future. Q2's strong financial results demonstrate that we're well-positioned to continue driving our strategy forward. I would like to begin by focusing on RioCan's income-producing portfolio, followed by some points about our robust development pipeline. In Q2, our portfolio's operating performance remained strong, underscoring the logic behind our strategic decision to dispose of our secondary market assets. As Qi mentioned, we continue to make excellent progress in the acceleration of our major market focus, with approximately CAD 1.2 billion in transactions either completed or subject to firm or conditional purchase agreements.
Assuming the successful completion of these transactions, rental revenue from major markets will represent approximately 86% of RioCan's overall annualized rental revenue. For context, when we announced the accelerated focus in October of 2017, this same statistic was only 75%. Traction in our disposition program has a direct benefit to RioCan's operational results, as by shedding secondary market assets, RioCan can focus its valuable human and capital resources on extracting income growth and NAV creation from our exceptional assets in Canada's major markets. Q2's results, including strong same property growth and increased occupancy, demonstrate that the overall health of our existing portfolio is strong. As Qi mentioned, our outlook for the remainder of 2018 continues to be positive, and our expectations for same property growth for the full year 2018 remains in the range of 2%-3%.
RioCan's portfolio committed occupancy rate increased from 96.6% in Q1 to 96.8% at Q2 2018. Retail occupancy increased from 96.7% to 97% in Q2. Committed occupancy in the major market portfolio increased to 98%. Our quarterly leasing and renewal results were also strong in Q2 2018. RioCan completed 496,000 sq ft of new leasing in the second quarter at an average rent of CAD 18.26 per sq ft. 196 renewals totaling approximately 1.8 million sq ft of space were completed during the second quarter at an average rental rate increase of CAD 0.62 per sq ft or 4.2%. The average growth rate on renewals was negatively impacted this quarter by six fixed rate renewals that were completed with anchor tenants that included zero growth in rent.
It is important to note that five of the six were in secondary market assets slated for disposition, and the six renewals accounted for 687,000 sq ft of the total GLA renewed this quarter. The average rental rate increase of renewals completed in the major market portfolio was CAD 1.10 per sq ft or 5%. Our retention ratio for the quarter was also very strong at 91.8%. RioCan is poised for additional growth, fueled by the advent of cannabis stores in the Canadian retail landscape. We have already completed 18 leasing transactions totaling approximately 53,000 sq ft of space at an average net rent of close to CAD 32 per sq ft. All but two of these transactions are in properties outside of Ontario. Once the regulatory landscape within this province has been clarified, RioCan expects to see far more demand within its portfolio.
This is just one example of the benefits that will accrue to RioCan as new expansive retailers enter the market. In addition to our substantial retail real estate, RioCan also has approximately 1.9 million square feet of office GLA at our interest. Our office portfolio is currently 93.5% occupied. Some may characterize this as a bit of a drag on our overall metrics. We, however, view it differently, rather as another driver of future growth. Nearly three-quarters of our office portfolio is located in the GTA, where supply is coming under increased pressure and demand is high. With limited vacancy in the core and surrounding areas, there is increasing momentum for offerings that are on or near transit. Not only will this demand fuel higher occupancy, but it will also increase rents, which will benefit our transit-oriented office spaces such as Yonge-Sheppard Centre and Yonge-Eglinton Centre.
There are also significant office components to numerous developments currently under construction, including The Well, King Portland Centre, Bathurst College Centre, ePlace, and 642 King Street. That upon completion will increase the square footage of our office portfolio to approximately 2.5 million square feet at RioCan's interest. Given the demand, as I mentioned before in Downtown Toronto, this newly built office space will make meaningful contributions to our net asset value and future growth. With regards to our expansion and redevelopment, urban intensification, and greenfield development programs, an additional 119,000 square feet of space at RioCan's interest was completed and became income producing in the second quarter. This brings total year-to-date development completions to 237,000 square feet.
An additional 523,000 square feet at RioCan's share is expected to be transferred from PUD to IPP over the remainder of 2018, bringing the total to 760,000 square feet of incremental urban income-producing and NAV-enhancing space. This brings me to our strong and unparalleled development pipeline. Q2, RioCan saw some significant progress in the construction and leasing of major developments. Many of these developments are mixed-use, transit-oriented properties in Canada's major markets, and I'm pleased to see these progressing well. Notable development highlights include substantial completion of construction at RioCan and Allied's 14-story, 273,000-square-foot office tower at King Portland Centre. This space has already attracted several strong tenants, including Shopify, which took possession of nine floors totaling 183,000 square feet in July of this year, and Indigo, which is expected to take possession of four floors totaling 79,000 square feet in September of 2018.
In addition, site excavation continues at The Well and is anticipated to be complete by the end of 2018. The Well's 36-story, 800,000-square-foot office tower located at Front and Spadina in Toronto began construction in Q2. As you may have seen in last week's announcement, together with our partner, Allied, we have made significant progress on the commercial component of this mixed-use project. To date, a lease has been completed with Index Exchange, a global advertising digital marketplace for 200,000 square feet. Another high-caliber user has agreed to lease 125,000 square feet of office space, and Allied and RioCan are finalizing lease transactions with two other office users for more than 533,000 square feet, which would bring the leased area of the office component of The Well to 80%.
Early 2019 will also see the completion of construction of our first two residential rental projects, being eCentral at Yonge and Eglinton in Toronto and Frontier in Ottawa. Both are high-quality projects located in prime areas adjacent to main transit lines and are excellent examples of our RioCan Living residential portfolio. Between the two projects, we will have just under 700 income-producing units in our portfolio by the end of 2019. From Q3 2018 to the end of 2020, we are expecting development completions of approximately 2.8 million sq ft at 100%, or 1.6 million sq ft at RioCan's interest net of air rights sales. These development completions will make significant contributions to our growth going forward. The value created through the completion of our development projects is significant, with the annualized stabilized NOI expected to be approximately CAD 50 million at RioCan's interest.
Our current total development pipeline consists of 66 projects totaling over 26.2 million sq ft. 44 projects, or 12.1 million sq ft, have zoning approvals, and an additional six projects, or 5.4 million sq ft, have zoning approvals that have been submitted. The extent of the zoning approvals we have in place is the result of RioCan initiating our development planning more than a decade ago. Zoning approvals take significant time and effort to obtain, and our current status provides RioCan with a competitive advantage and a five- to seven-year head start relative to our peers. A further 16 projects, with 8.7 million sq ft, have been identified as future density. I would like to point out that these totals do not represent all intensification opportunities that exist within our great portfolio. I am also proud of the community consultation we engage in as part of our development process.
We consult with a number of constituents, including residents, on every project to ensure our development efforts responsibly enhance and evolve in communities and best serve the future needs. If you have driven around Toronto lately, you can see the beginning of RioCan's evolution and the velocity at which the change is occurring. Construction of our mixed-use projects at some of the most iconic intersections in Toronto are underway, including Yonge and Eglinton, Yonge and Sheppard, King and Portland, Bathurst and College, Dupont and Christie, College and Manning, and of course, The Well at Front and Spadina. The Toronto market is just one example of the tremendous value that exists in the portfolio that will be realized in the next decade through our urban intensification and residential development programs in major markets all across Canada. What you see now is just the beginning. In conclusion, our second quarter results were strong.
Our major market results were even better. There are countless opportunities for us to create value from our major market portfolio in the next decade. RioCan is evolving. The future is bright. I look forward to continuing to work closely with RioCan's incredibly strong and deep leadership team to drive our strategy further into the future. Those are the operational highlights. I'll now turn the call over to you, Ed.
Thank you, Jonathan. For over two decades, RioCan has been seen and valued as the largest retail real estate REIT in Canada, with shopping centers virtually everywhere. As a result, over that time span, our unit value has probably been affected the most by the ebbs and flows in the retail sector itself. Of course, the level of interest rates and the state of the economy have a large impact on our valuation as well. These affected pretty well everyone equally. When large retailers ran into trouble or decided to retreat from Canada, there was an automatic assumption that RioCan would be the most affected, and that assumption was usually correct.
Just yesterday, we saw American retail REITs fall somewhat dramatically, largely as a result of the rumored impending bankruptcy of Mattress Firm, which has about 5,000 stores in the U.S., and the actual bankruptcy announced over the weekend of Brookstone. Retail REITs in Canada were also impacted, notwithstanding that neither Firm nor Brookstone have any stores in this country. The foregoing is merely a preamble to the main point of my presentation, namely that as we move into 2019, the transformation of RioCan from what it was to what it will be, will start to become evident to the investing world, including analysts. First, in some ways, we will be smaller. Less units outstanding due to our ongoing NCIB and the fact that we haven't issued equity units for several years, and have no current intention of doing so.
A far lower property count, going from over 300 not too long ago to under 200 by somewhere around this time next year. Our asset value will likely not diminish, as the new assets in which we're investing a large part of the funds generated by capital recycling will have much larger value growth in addition to NOI growth than the assets of which we are disposing. To put some flesh on the bones of my last statement, let me give you some concrete examples and specificity regarding what RioCan is becoming. We already own some of Canada's iconic mixed-use properties. Of our roughly CAD 14 billion in assets today, just under 5% of that is represented by Yonge-Eglinton Centre.
Shortly, on completion of our development on the northeast corner of Yonge and Eglinton, we will have almost CAD 1 billion worth of assets at what is arguably the most dynamic intersection in Toronto, at the meeting point of the city's primary north-south subway line and the soon-to-be-completed Eglinton Crosstown. Our mixed-use assets here will consist of 750,000 sq ft of office space, over 400,000 sq ft of retail on both sides of Yonge Street and connected underground, and 466 newly built rental apartment units. When you add to that our 50% ownership of Yonge-Sheppard Centre, also at the intersection of two subway lines, and include our 50% interest at The Well at Front and Spadina, both of which will have as part of them newly constructed rental apartment towers. The result will be that these three fantastic properties will represent almost 15% of our assets.
When one considers what's going on in each of those areas, I believe they will represent an even larger proportion of our annual NOI and NAV per unit growth. Jonathan has already mentioned the fairly significant office component amounting, again, to about 5% of our net leasable area, which RioCan already owns, and where we see significant growth opportunities over the next few years. We also have new and superbly located office space that will start generating income in 2019, some of which Jonathan has mentioned. I can't stop speaking without also highlighting the superb rental residential portfolio we are in the midst of creating under the name RioCan Living. By this time next year, our first two buildings will not only be complete, but actually have tenants living there.
A 228-unit building in Ottawa, developed with our partner Killam, and a 466-unit wholly-owned rental building at Yonge and Eglinton in Toronto will be the first two completions. Both are adjacent or connected to public transit, both are built to the highest environmental and building standards, and both will contain the most modern and desirable amenities. By 2022, just over three years from now, the RioCan Living portfolio will consist of almost 4,000 rental units, mostly in the GTA, but with good representation in Ottawa and Calgary. All of them will share the characteristics I noted above with respect to the first two buildings. In addition, by 2022, we expect a further 3,000 units to be under construction, including three currently owned sites in the greater Vancouver area.
These totals only include sites we already own, and in many cases, we have owned them for much of our 25-year history. I have no doubt that by 2022, we will have many other locations that we will be already working on and that we expect will work from a zoning and economic perspective. By way of example, the numbers I mentioned above don't include anything for Shoppers World Brampton, where we are currently going through a master planning exercise with the city. Our existing shopping center will, on completion of the Hurontario LRT in 2021, become the transportation hub for this area and is envisioned by the city as ultimately consisting of over 4 million sq ft of mixed-use development. 2018 and into the beginning of 2019 were previously described by me as a bit of a juggling act.
We're in the process of disposing of CAD 2 billion of secondary market assets, while at the same time investing hundreds of millions of CAD annually in new developments, all while ensuring that our use of leverage remains within our target range and our FFO per unit continues to grow. A lot of balls to keep in the air. We have done so, and I am confident that we will continue to do so until the disposition program is completed sometime next year. To date, I believe the market has not appreciated the value that we are creating at RioCan. As our prime goal is, of course, total unit holder return, our task, if this underappreciation continues, will turn from juggling to exploring the many avenues we believe are open to surfacing that value.
Really just starting to do on an entity level what we have been doing for many years on a property level, surfacing value. Thank you, and I'm certainly open at this point, and all of us are, to any questions any of you may have.
Thank you. As a reminder, if you'd like to ask a question at this time, please press star followed by the number one on your telephone keypad. Once again, that's star then one if you would like to ask a question. Your first question here comes from the line of Dean Wilkinson with CIBC. Please go ahead, your line is open.
Thanks, Casey. Morning, everybody.
Morning.
Morning.
Just in light of the substantial progress you've made on the asset dispositions, do you think you could possibly ramp up the development on the other end of it? Are you structurally limited by the zoning and the approvals and the permits and all of the rest of that stuff that's got to go in place there?
That's a good question. We are limited, certainly by the pace of zonings. As Jonathan mentioned, and actually one of my peers once said, the zoning and pre-development speed, it moves at a geological pace. From the time you start thinking about zoning a property till you actually can get zoning and actually be ready to put a shovel in the ground, is typically about three years. Having said that, we are starting to get quite a few properties zoned, and we could proceed a little faster. In fact, in some cases, probably quite a bit. We have other guardrails besides the process, and they're part of those balls I mentioned we're juggling. We are very focused on the strength of our balance sheet.
We think that's critical, and we're not going to go too far in the development program, where our balance sheet gets out of where we want it to be. Secondly, we have distributions to pay and FFO growth to achieve. Every time you put it into development, it comes out of IPP and stops producing cash flow and income. Again, we have to be very measured at this point, into how many properties we put into development at any given time. We currently have about CAD 1.4 billion invested in our development program. I would think that for the foreseeable future, barring any structural changes that may happen, that is pretty close to our limit. The good news is things are finishing, as both Jonathan and I have mentioned.
We've got a lot of buildings, actually, that will be going from properties under development to income-producing over the course just of the next 12 months. In fact, literally hundreds and hundreds of millions of CAD worth moving from one to the other. We've got to keep, and we certainly have the product to do so, a pretty steady pipeline of that going. Barring any structural changes, no, we can't ramp it up much.
Okay, that's great. It still sounds like the restructure at some level does limit your ability to tap into all the value.
It does.
Which-
From a timing point of view.
From a timing point of view, which I could ask you to elaborate, and I know you won't, on the comment of exploring the many avenues.
That is correct. I won't elaborate.
I thought I'd try anyway. Just turning to the Toronto market and all of the residential development going on there, I guess recently we've seen some, I'll call it campaign election promises for the introduction of up to 10,000 affordable units a year, if come kind of thing.
I think Jennifer Keesmaat's got that up to 100,000.
100.
Not per year.
Yes. A lot of people are talking about adding. As you look at the market, and certainly yours wouldn't be in that realm, but what do you think this market can absorb?
I think the amount of absorption in quality rental housing is not the slightest problem, because you've got two big factors going on. I'm going to come back to the affordable housing as well, but you got two big factors going on that are demographic. You've got really quite high real estate prices, which prevents a lot of the younger demographic from becoming homeowners. I think the percentage of people over the course of the next five to 10 years that own homes in our major markets, particularly in Toronto and Vancouver, where the price increases have been the highest. We're starting to see this in Ottawa as well.
A bit of a lagger. In Montreal as well. Early days. You're going to have a natural growth in the number of renters from that side because of the cost of owning housing. Secondly, the generation that I belong to, the baby boomers, many of them, and I can tell you this even from some of my friends, their biggest asset is their home, which has appreciated tremendously over the last five or 10 years. What many of them are doing is selling their home and moving into rental housing, as opposed to buying a condo, because they're looking at it and say, "Hey, you know what? What do I need to sink that capital into a residence for? I can invest it in RioCan units and make a lot of money.
In the meantime, pay a rent that isn't going to go crazy because there's laws." I don't think there's any problem with the newer quality absorption. The third factor I've seen, and I've already seen it start to happen in existing situations, is that people will pay. They won't pay a lot extra, but effectively they are, because they will move into a much smaller unit than what they currently rent when the prices aren't that different, and which we are able to achieve. Because you know what? The difference in quality between the average age of buildings in Toronto and right across the country, the average age of most of these buildings are 40 to 50 years old.
Yeah.
They don't have modern environmental things. The buildings leak air. The elevators. We're busy replacing the elevators right now in Yonge-Eglinton Centre. Once you get past 40 years, they're broken as often as they're working, and they really need to be replaced. Apartment building owners don't replace them so quickly, and they're not modern elevators anyway, so they fix them. There's a lot of reasons people want to live in new buildings. I've just touched on a couple of them. I think between the changes in demographics of renters and the desire of people to live in new buildings, I think the absorption of our products will be fantastic. The second thing you opened it up, affordable housing. We have properties where we've gotten zoning, but it doesn't make sense to build it because we don't think we can get high enough rents because of the area.
We have initiated conversations with the city, particularly in Toronto here, and said, "Look, we can build affordable housing. But guess what? The highest cost we've got are your charges.
Development charges, yeah.
The development charges. The different fees. If you waive those development charges, we will build We've got one site out of Markham and Eglinton where we could probably build close to 1,000 units over the next few years of affordable housing in an area that really needs affordable housing. Quite frankly, with the development charges and other charges the city puts in, can't afford to do it. There's ways of doing it, and we would be happy to participate with the various municipalities, and not just here in Toronto, in creating that affordable housing, but we need some incentives to be able to do so.
Well, let's hope they're listening.
Let's hope.
That's it. I'll hand it back to the queue. Thanks a lot, everyone.
Thank you.
Your next question comes from Pammi Bir with Scotia Capital. Please go ahead. Your line is open.
Thanks. Good morning. Ed, I know you may not answer this, but I'm going to give it a shot, maybe in a different way. Just going back to your comments about unlocking value, it seems like the decision there is partly dictated, I guess, by the unit price. What sort of timeframe would you be thinking about? Is it six months? Is it a year? If you can provide any color.
Yeah. Again, I'm not going to get into any kind of the things that we are thinking about, because all we're doing is thinking about them. Quite frankly, we're very busy right now, and our prime sort of strategic goal, and there's always a few, besides the obvious one of doing better and better on our existing properties, is to complete the disposition of the secondary market properties. To move forward as quickly as we can on the development of our RioCan Living portfolio. What we're going to do with all of those things and try to unlock the value, if the market has not recognized that value, by, let's say, as we roll into 2019, we'll start thinking about it very seriously and exploring alternatives.
I would say for the next nine to 12 months, we got our hands full, we're just going to keep pursuing what we pursue, telling people exactly what we told them today and hoping that the market recognizes the value that's being created and the alternatives that may be open to us to surface that value. I don't think there's any magic formula. I think the various things that can be done are fairly obvious to people. At least they are to us. Okay, Pammi?
Yep. No, that's helpful.
Next year.
Yeah. Stay tuned. Maybe just looking at the asset sales, you've made some good progress again. I guess you're almost 60% done. What can you comment on in terms of the new round of buyers on the conditional CAD 280 million, and then perhaps on other buyers that you're having discussions with? Has that mix perhaps changed much from what you've done in the past? Some color there.
I'm going to say a little bit, but I'm going to turn it over to our new COO, Mr. Gitlin, who still maintains responsibility for this program, as well as other things. Go ahead, Jonathan.
Sure. It's a very similar mix, Pammi. It's made up of private REITs, private individuals, syndicators. A very similar profile to the round of buyers that bought up the initial tranche of assets in early 2018. There are different parties coming to the fold, depending on the geographical region, because like I said, there are some local high-net-worth individuals who like to buy assets that are local to them. We've seen a lot of velocity out of those types of buyers, but by and large, it's a mixed bag.
Great. That's helpful. Just maybe one last one. Going back to The Well. Allied has sorry, cited a 6%-10% unlevered targeted yield on the commercial component. So after you factor in, I guess, residential rental building number 6, which I think you have a 50% stake in, where do you see your yield coming in for The Well? Secondly, is that number excluding or net of the air rights sales?
First of all, as far as the residential component, internally here, because we have different partners, we treat them as two separate projects. I don't think we actually have a melded number. We could probably come up with it if we tried. We're expecting that residential tower to do extremely well. We're working with our partner, Woodbourne. It's all designed. It's got 590 units, which will probably be our single biggest residential building, and we're pretty excited about it. As far as the commercial component, we're quite confident that we will achieve 6% or better as a final yield. You have to appreciate, there's a lot of guesswork at this stage, which is we're really at the very beginning of starting to harden in some of this information.
Allied has done the first lease. We expect over the course of the next month or two to see a lot more. On the retail side, we are holding back and really won't really start leasing until next year. By that time, we think a couple of interesting things will happen. The bulk of the office will be leased. Retailers will understand that there's going to be probably 6,000 people working on site every day, and they will also understand the type of people, and that they're going to be relatively high-paid tech workers, by and large, and information workers. well, not we, our partners on the residential side, the condo side, primarily Tridel, will probably be going to market, I suspect, early next year, with the condominium.
Again, people will start to understand what we're really creating here, which is a site that will have 9,000 to 10,000 people that actually work or live there, never mind all the buildings in the neighborhood. We're holding off the retail leasing and really our guess as to what those retail numbers will be, will come clear in 2019. Having said all that, we're pretty comfortable with that 6% plus number. I hope I answered some of your question.
Yeah. No, that's very helpful. Thanks very much. I'll turn it back.
Thank you.
Your next question comes from Sam Damiani with TD Securities. Please go ahead. Your line is open.
Hi, Sam.
Thanks. Good morning. Just sticking with The Well, I noticed the costs did go up. I wonder if you could maybe offer us a little more specific as to what parts of the project saw the higher cost. Was it the office space, the retail space, common area, base building?
Yeah, I wouldn't break it into those. I would go with your last and just say base building. I don't think it's any secret that construction costs have gone up over the last year and a half. What we've encountered over, I'd say the last four or five months in The Well, is that what we've actually gone into, and we are in the process of hardening our construction costs. Quite frankly, that's the one number in The Well, the construction cost, the higher construction cost, that I think we're getting relatively comfortable with. Having said that, we're working very hard to bring those costs down, through various value engineering techniques. The biggest increase, in fact, I would say the bulk of it, if not exclusively, has been in hard construction costs.
I'm not saying we're contracted, but we're pretty hard costed for about 70% of the total cost of that project at this point.
That's good. These higher costs, have they at all come with higher rents that you're getting on at least the office space today?
Far, again, it remains to be seen. I will tell you that the office deal, there's only one been firm signed, but all the other office deals that we are looking at are ahead of pro forma. Has there been an increase in office rents? Yeah. It's the old story. Just because it costs us more, to deliver that building is not why the office rents have gone up. The office rents have gone up because there's so much demand for the limited amounts of space that is in fantastic locations and in fantastic developments like this one. That's one of the reasons we're holding off on retail. I think there's going to be demand for that space. We're really not talking conventional retail tenants here. There's going to be a lot of local tenants, very heavy into food and entertainment and experiential retail.
We think that those rents will be well ahead of our current pro formas as well. Yeah. You know what? That's why we're pretty comfortable in sticking with that 6% plus yield because yes, costs are up, but so are our expectations and our experience on the income side.
Does the project have a lot of non-rental income, be it parking or signage? Is that meaningful in this case or really not that material?
Yeah. There actually is a fair amount. Jonathan can help me out here a little bit. For example, we announced that Enwave transaction, okay, where we're putting in or they're putting in a 6 million liter tank. Well, it's a wonderful environmental thing. It's wonderful that it's going to be able to service other properties, including some of ours that we own with Allied in the sort of King West area. It's a land lease as well, and they're paying us a very significant land rent for the right to have that tank on our land. We also have very unique digital signage approvals, I think, which is really quite astonishing that we were able to get it. I'll thank Councillor Cressy for helping us on that. I don't know what the numbers are, but they're many hundreds of thousands of CAD per year.
We also have on the commercial side, leaving aside residential, in excess of 700 parking spaces. Yes, we are expecting revenue on that. Notwithstanding, nobody wants to drive in Toronto anymore. I can tell you that every parking lot we own that's at a high-profile location is full, and we're able to increase the rates almost at will, without losing anything. Those are probably the big three, non-typical conventional rental revenue things that we're looking at at The Well, and they're fairly significant.
I think there will be additional opportunities. Given how dynamic this development is, there is going to be a lot of programming opportunities, none of which we've worked into the pro forma at this juncture. I think as it becomes closer to completion, those opportunities will surface.
That's helpful. I have experienced those parking rate increases at the Yonge-Eglinton Centre over the years. Thank you very much.
We thank you for your business.
Just switching over to, Jonathan, your comments about cannabis leases, 18 deals, 53,000 sq ft. I am not sure if that is at 100% of your interest, but what types of spaces are these retailers taking in the properties? How do you look at the creditworthiness of the operators behind the leases?
The spaces are just conventional inline spaces by and large.
Keep in mind, 15 out of the 18 are Alberta, and two, the two here in Ontario, are with the Cannabis Control Board of Ontario, the CCBO.
Yep.
The spaces are generally conventional retail spaces that are in line in our unenclosed centers thus far. They're not extremely sizable. I think they average about 2,500 to 3,000 square feet. With respect to the creditworthiness, I think we assess it the same way we assess any tenant's creditworthiness. We will look at their financials and make sure that they do have a balance sheet capable of paying the rent.
I would add that the bulk of the leases, I think 10 out of the 15 or whatever we've got in Alberta, are with a public company. They're actually a liquor distribution company, if I'm not mistaken.
Sure. Yep.
Listen, the big gold rush will, quite frankly, be depending on what the province finally does. There's been a lot of speculation, does here in Ontario. This is where 40% of the population of Canada is, and presumably at least 40% of cannabis users. Presumably. Well, maybe B.C. is a little over-represented there perhaps. We expect, when I call it a gold rush, there's no question that whatever rules finally come down, they're not going to want four cannabis stores at one corner. There's going to be some control over that, I suspect, no matter whether it goes private or not. The gold rush will be, we've got all the private cannabis users looking to stake a claim at the best locations, many of which we own.
At the risk of making a joke, we're going to have, as I said, 6,000 tech/knowledge workers working at The Well. You think it's a good cannabis location? Probably. We expect premium rents, quite frankly, for a lot of these properties. It's not a big amount of space, but it's a good contributor.
Well, it's not a big amount now, but with Ontario-
It could be pretty big.
It could be a top 25 tenant.
Who knows?
One last question, just on eCentral and Frontier. When specifically do you expect to start marketing the units there?
Q3 or Q4. I think at eCentral, we're going to start writing leases in earnest in October, and on Frontier, we're going to start the leasing process in late September.
Great. Thank you.
Yeah, by the fourth quarter, we'll be able to report on some progress there.
Yes.
Looking forward to it. Good luck.
Thank you.
Your next question comes from the line of Michael Smith with RBC Capital Markets. Please go ahead, your line is open.
Thank you, good morning.
Morning.
Just picking up on the cannabis opportunity. You have, I guess, 15 stores or 18 stores in total, 15 in Alberta, 53,000 sq ft. What do you think the opportunity is in Ontario? I'm sure that you've had lots and lots of inquiries. Is it like 150,000 sq ft, or do you have a ballpark on that?
It's hard to say because a lot of it is going to depend on what the government allows. The last thing I read, I've read everything from nothing to many, is that the betting seems to be, at this point, that they're going to allow a mix of private stores, continuing with the public stores, which is an odd result. Nonetheless, that may be. We have two leases, as I mentioned, with CCBO. I don't know what's going to happen to those. I would guess that the opportunity probably in total in Canada for us might be in that 150,000 to 200,000 sq ft. It really is, Michael, a bit of a guess. Like I say, I suspect it'll be at premium rents. A lot of it's going to depend even what municipalities do.
Richmond Hill, for example, I recall when the first wave of stores were announced, they actually passed a council resolution saying they don't want any cannabis stores in Richmond Hill. They'll send all their customers to Vaughan. I don't know if that's what they're doing. Anyway, it's a bit of a silly statement, nonetheless, municipalities will take positions. Who knows?
Okay. Just switching gears. You've made great progress on your asset sales, about 58%, including those under contract.
58, who's counting?
58. Sorry. Yeah, 58. Just for the balance, do you expect to achieve more or less IFRS book?
Yeah. Now, having said that, we do two things that I think may be a little different than some of our peers. Because we're actively in the disposition market, we know what the market values are. Whereas typically, IFRS values are basically pretty formulaic with some element, obviously, of judgment when it comes to cap rate. Both the judgment and the formulaic parts of it are taken out of it when you go to market. Because then it really is being valued by a willing buyer and a willing seller. Which is the traditional, that I learned in school, measure of fair value. Obviously, you can't do that with a whole portfolio.
We are adjusting our values basically on a quarterly basis now, to really reflect not what's happening in deals, but what we see happening 3 to 6 months down the road. Once we have gone through that process, and like I said, we go through it every quarter, we are quite comfortable that the values we will achieve in the final dispositions will be materially in line with our IFRS values.
Okay, thanks. Once you get through, I know it's early stages and you've still got a lot of asset sales slated, but are you thinking about adding to that CAD 2 billion of planned dispositions?
You know what? It depends on the market reception, and as what goes on. We're constantly jiggling, and we have periodic meetings as to, should we keep this one? Should we not? There isn't a. When we say CAD 2 billion, that was our target. There wasn't an identified CAD 2 billion worth of property. I think our whole secondary market, is about CAD 2.5 billion, at least when we started. Obviously, it's a lot less now. We had looked at that we're going to end up selling about 80% of that, and that's where we came. The original announced targets, Michael, if I recall correctly, was that we were going to get ourselves down to having secondary markets be no more than 10% of our assets, i.e., 90% from major markets. As Jonathan Gitlin mentioned, we're getting there pretty fast. We're up to 86%.
You also have all of our developments as they're completed, they're all in major markets. As they move to IPP and that process is starting to happen. That will bring up the percentage as well. It's really a qualitative decision that we'll be making on a property-by-property basis over the course of the next 6 to 12 months.
Well, thank you. The last question, just on the marketable securities, you've had some nice gains there.
Okay.
What can we expect for the next few quarters?
I think the next few quarters you'll see consistency, because we have other sources of gains. For example, ePlace, that we talked about earlier. We're talking about the substantial completion of the rental tower in the fourth quarter. That doesn't mean you won't have tenants in yet, but it will be substantially complete by the end of this year. Well, that also means the condominium building. If our construction managers are correct, will be substantially complete by the fourth quarter as well, which means you start closings. Obviously, there's gains coming from that. We have Kingly condominium. That'll be gains in 2019, all of which are pre-sold. We've got townhouse projects in Oshawa, that we're building, and which the phase 1, I think about 175 units, is all sold. We have multiple sources of gains.
It's not just securities, so that I can tell you with pretty good confidence. Quite frankly, Michael, this was always the plan, over the course of the last 18 months as we were coming up with these strategies, is that we would have gains to roll up during the entire disposition period and beyond. That would keep our FFO, where it is or growing while all the development projects that we have underway are moving towards completion. There's never really an interruption in that FFO growth over the next several years. That's the larger strategy. So far, it's unfolding the way we wanted it to, and we fully expect that to continue into 2019. That's a very long answer to your question.
No, very helpful. That's it for me. Thank you.
Thank you, Michael.
Your next question comes from Matt Kornack with National Bank Financial. Please go ahead. Your line is open.
Morning, guys.
Hi, Matt. How are you?
Good, thank you. Just want to take the opposite side of Michael's comment on the fair value there. You've now sold a fairly significant amount of assets at higher cap rates than your weighted average, but you haven't budged the weighted average all that much. At the same time, you sold some core assets with what you say is less upside at pretty low cap rates in core markets. Wondering if you're being conservative here on the IFRS cap rate for the remaining portfolio.
Are we being conservative? You know what? I would say, we had this discussion actually in our audit committee meeting yesterday. It's not the first time. When our auditors, who tend to be conservative, think that I think the phrase that we settled on was realistic. I personally think they tend to be conservative. Having said that, I am not on the committee that In fact, they don't even let me in the room because I tend to be a little optimistic perhaps, or less than conservative. They might be a little bit conservative, but quite frankly, I would rather be that way than Sometimes I think some of our peers are maybe a little too aggressive.
I'm not going to get into individual names, when you look at our sale values and you look at the makeup of some of our peers' portfolios, and you look at their cap rates as compared to our disposition cap rates on secondary markets, you go, "Hmm, interesting." On our major market assets, which like I say, or like Qi says, are up to 86%, are we conservative? It's hard to say. Time will tell, I certainly think we're realistic, and we want to be in a position on those assets, not to have to take steps backward. Again, those numbers are important for NAV calculations and I guess to analysts and so on. Where they also reflect is on the leverage calculation. That's one of the reasons why we started to focus last year and try to focus the market.
I think with some beginnings of success on the net debt to EBITDA calculation, which we think is far more important. Typically, ratings agencies, sophisticated investors will tell you that the leverage calculation is one that they don't even look at, because the denominator of that number is quite discretionary.
No, I think there's definitely been a shift within the Canadian marketplace to look more at that figure, even on the equity side, which is fair.
Yeah.
You trade at a fairly deep discount to NAV. I would assume that the pace of your NCIB program, contingent, I guess, on asset sales continuing to be around this CAD 200 million-CAD 300 million per quarter, would be fairly in line going forward?
That's the plan.
Until the disposition program is complete?
That's correct.
Okay. Then just two quick accounting items. G&A was a little higher. Obviously, there was a one-time item there. No change in your view in terms of G&A as the portfolio shrinks in the near term? Should we run pretty much the same number on a revenue basis, or do you expect that to tick up in the interim and then come down, I guess, as these developments are complete and become revenue-generating?
Yeah. Hi, Matt. Our view is certainly we'll continue to take great efforts to bring down the overall G&A, especially with selling so much assets. One thing I do want to point out is that because quite a number of the gross G&A savings as a result of the disposition program is actually recoverable cost to the tenants. It will now be, even though the fundamental, the gross G&A will be the reduction is much greater than you would see in the financial report under the G&A line, just because a chunk of those will be recoverable costs.
No, that makes sense, appreciate that commentary. On capitalized interest, it was a little higher this quarter. Is that a good run rate for the remainder of, I guess, the year, given that The Well is starting to ramp up?
For the year, yes, because it's really, as you can imagine, driven by that balance in development. As we talked earlier, we currently have approximately CAD 1.4 billion on the book for development, including under the POD, property under development, and residential inventory. Because we are ramping up on development, until the major project get completed next year, the POD balance will stay where it is, around that between that CAD 1.4 billion to probably up to around CAD 1.5 billion. That will basically give you the run rate for the capitalized interest.
Our leverage modeling looks that you can sort of maintain current levels given dispositions, combined with the spend on your development portfolio over the next 12 to 24 months. Is that a fair commentary? Once the disposition program is complete, how do you look to funding incremental developments beyond that point?
I'll answer for Qi on that one. The first one, the answer is yes. That model should be pretty accurate. As far as funding in the future, quite frankly, we'll see. I don't think we're ever going to be finished selective dispositions of assets because we're constantly evaluating our portfolio and where we see low-growth properties or no growth or even properties going backwards, we won't hesitate to sell those properties, especially because we have good use of the funds. Now we're getting out sort of a year and a half from now, and I wouldn't want to be more definitive than that right now.
Nope. That's fair. Thanks, guys.
Okay. I think we have time. We've gone over time. I thank you for your interest. We have time for one more question if there is one.
Thank you. Your next question comes from Johann Rodrigues from Raymond James. Please go ahead. Your line is open.
Hi, guys. I guess you've talked a lot about creating value with the development pipeline. A few different analysts have tried to kind of figure out maybe how to better calculate some of that value by asking about questions about The Well and completed projects, I think Pammi did. I wanted to ask it from the other side. Kingly, you guys have finished, 98% leased, all the condos sold. Maybe I was wondering if you were able to give an idea of kind of, I think you spent CAD 85 million, or you will have spent CAD 85 million. What is the value that you guys have created, either the IFRS value of the office component tacked on with the proceeds of the condos?
Then the yields, how would that compare to maybe 2 years ago when it was a little bit less hot of an office market and it was going to be a rental building?
You mean the condo building. Certainly, the condo building, when we made the decision to go as condos, the value creation is significant because we sold it at a much higher value per square foot. On the office building, I'll be honest, we haven't done those calculations, but now that you've asked, we're going to do some. We tend to do them retrospectively rather than prospectively. When the building's finished, the tenants are moved in, we figure out, that's when we mark it up to whatever the current market says. I don't have that information, unless Qi does.
No. We did do some internal, but we do not have that information.
You know what? That's a very good question, and you know what? Over the course of the next few months, we're going to do some work on that.
Okay, great. Just one quick question. Qi, when you're all said and done these asset sales and there's the 10% secondary market assets left over or, safe call 5%-10% over the longer term-
Yep
Can you characterize those secondary assets that you guys want to keep hold of and maybe give an example or two?
Yeah. For example, we own the largest shopping center in Kingston, Ontario. That's not on the disposition list right now. It's a great center. It's a huge piece of property. It's a big power center. I think it's about 700,000 sq ft. It's irreplaceable. Kingston as a city isn't going anywhere. It's got, besides all kinds of educational assets, it's a growing tourist destination because of its location near Prince Edward County, of course, has Queen's University, has the Royal Military College Institute, and has other industries that will keep it growing. That's a city that we're actually seeing rental growth because it's a big city, from the point of view, the market's probably 100,000-150,000. It's not one that's diminishing, but it's not that big that people are building all kinds of new stuff.
We think the value and the leasability of a property like that will continue to grow over the next few years. That'll be something that on an annual basis we'll review. There's an example.
Okay, thanks. Appreciate it. Turn it back.
Thank you. Okay. I think, Casey, that'll do it.
Great. Thank you. Any closing remarks?
No, just to thank everybody for their interest, we'll talk to them all again, in three months, if not sooner.
Thank you. Ladies and gentlemen, this concludes today's conference call. You may now disconnect.