Earnings Call: Q2 2020

Aug 7, 2020

Good afternoon, ladies and gentlemen. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to Artis REIT's 2nd Quarter 2020 Conference Call. After the speakers' remarks, there will be a question and answer session. Today's discussion may include forward looking statements, which include statements that are not statements of historical fact and statements regarding Artis REIT's future financial performance and its execution or initiatives to deliver unitholder value. Such statements are based on management's assumptions and beliefs. These forward looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. Please see Artis REIT's public filings for a discussion of these risk factors, which are included in their annual and quarterly filings, which can be found on Artis REIT's website and on SEDAR. Thank you. And I would like to turn the meeting over to Mr. Armin Martins. Please go ahead, sir. Thank you, moderator. Good day, everyone, and welcome to our Q2 2020 conference call. So again, my name is Armin Martins. I'm the CEO of ArtisSuite. With me on this call is Jim Green, our CFO Kim Rania, our EVP of Investments Phil Martens, EVP of U. S. Operations Jackie Koenig, SVP, Accounting and Heather Nichols, VP of Investor Relations is on the call as well. So again, thanks for joining us, folks. I'll begin, as usual, by asking Jim Green to review some of our financial highlights, and then I'll wrap up with some market commentary, and then we'll open the lines for questions. Go ahead please, Jim. Thanks, Erwin, and good afternoon, everyone. So I guess the strange times we talked about last quarter are continuing. However, economies in both the U. S. And Canada are gradually reopening and life is getting closer to a new normal despite the ongoing presence of COVID-nineteen in our economies. For artists, and I think for most weeks, July August have seen progressively stronger rent collections than that experienced in April, May June. On the Canadian operations, Artis to date has not participated in the SICRA program as proposed by the federal government. However, in both countries, we have been working with our tenants as needed to provide rent deferrals or in some cases, we've provided rent abatements in exchange for an early renewal or a longer term on the lease. To the end of June, our rents receivable were approximately $12,000,000 with a further $4,000,000 due under deferral agreements that have been executed with our tenants. And while we feel the majority will ultimately be collected, we did book a reserve approximately $3,000,000 against these balances, which we feel is adequate to cover any potential rent defaults. For July, we've collected 91.8 percent of our rents due by July 31. And counting amounts collected in July on prior balances, we've collected 93.1 percent of the rents due in the 2nd quarter. Based on that statistic, it sounds like I'm contradicting myself a little bit about July being stronger. But the way we apply payments is if a tenant was in arrears at June 30 and they made a payment during July, we treat that as paying off the oldest arrears first before the July rent shows as being paid. You'll recall that our REIT has been working on a planned series of new initiatives and we're nearing completion of that program, including buying back our units as planned under the NCIB. We've really done that component of the initiatives. However, our ability to sell assets and pay down debt has been impacted by the uncertainty caused by COVID-nineteen. We are, however, starting to see some buyer interest returning, and we expect to see sales activity pick up in Q3 and Q4 this year and into the first half of next year. And as we've stated previously, we plan to use proceeds from further asset sales to pay down debt and further strengthen our balance sheet. Based on our Q2 NOI, the REIT was 47.4% weighted in Canada and 52.6% in the United States. Some of the swing this quarter to be much larger in the U. S. Was that all of our retail assets are located in Canada, and this segment has the largest share of the allowance for bad debts. As we move forward, however, we expect the majority of future asset sales will likely be in Canada, and we expect this ratio to continue such that greater than 50% of our income will come from assets in the United States. On asset class basis, we are presently 47.5 percent weighted in office, 17.2% in retail and 35.3% in industrial. Artis continues to be active in new developments and redevelopment of our existing properties. We did not start anything new this quarter given the COVID lockdowns, but we continued to work on the projects already under development. And to June 30, we have approximately $134,000,000 invested in these projects. During the quarter, there was roughly a further $35,000,000 invested in development projects, and we completed 1 project and transferred it to regular income producing properties. As detailed in the MD and A, we have several development projects that remain underway, including the mixed use residential tower at 300 Main in Winnipeg, new industrial space in Houston and a small retail development already fully leased as additional density on one of our retail sites in Winnipeg. Also as detailed in the MD and A, we have several development projects in the planning stages where we've not actively started. Some of these are virtually ready to go as soon as the COVID situation seems to stable. Our balance sheet remains relatively consistent with debt to GBV on a proportionate share basis at 52.5% this quarter versus 52.3% at year end. One thing I don't usually touch on, but I will this quarter is that Artis has a fairly significant portion of our debt maturing in the next 12 months with $564,000,000 of mortgage debt in addition to an unsecured debenture for $250,000,000 Roughly $33,000,000 of the mortgage debt will be repaid just by the regular schedule and principal repayments, and we've already renewed approximately $80,000,000 of the mortgages or roughly 33% of the amount that falls due in 2020. We are not anticipating any difficulty in refinancing the rest. The mortgage debt is spread across approximately 20 properties. Our NOI this quarter was $70,200,000 compared to $71,900,000 last quarter. So drop of $1,700,000 created primarily by almost $3,000,000 as a provision against doubtful accounts and some lower parking revenue as some of our tenants work from home. We can't necessarily cancel the leases, but they can't stop paying for parking if they choose to on a month by month basis. And that was partially offset. We were almost $1,000,000 gain on foreign exchange due to higher rates during the quarter. And we also had other than the debt allowance, we had same positive same property income that also contributed to the NOI. So despite the drop in NOI, FFO for the quarter was up $40,000,000 to $49,400,000 from $46,400,000 last quarter, with the $1,700,000 drop in NOI being substantially more than offset by lower interest expenses on our debt as well as reduced corporate expenses. FFO on a per unit basis came in at $0.36 this quarter compared with $0.33 last quarter and was flat unchanged at 36 from the same quarter last year. We added a little bit of new disclosure this quarter breaking out our FFO from each asset class just using the percentage of NOI as a method of allocation. So on this basis, we earned $0.17 of FFO from our office portfolios, dollars 0.13 from industrial and $0.06 from retail. AFFO for the quarter was $0.27 again up from Q1 but flat to Q2 of 2019. Our payout ratios for the quarter are very conservative, 38 0.9% of FFO and 51.9% of AFFO. Results from operations on a same property basis were down to a negative 2% this quarter. You may recall in prior quarters, we had presented a stabilized same property calculation, which eliminated properties planned for disposition and also backed out the Calgary office portfolio. We were planning on just eliminating the stabilized result this quarter, but as a major factor in the negative same property result was the allowance booked for doubtful accounts. We did present the number excluding the allowance and that have resulted in positive same property growth of 1.2%. The Industrial segment continues to be the strongest performance in both countries with 6.1% growth in Canada and 3.3% growth in the United States. On the income producing property portfolio, we are valued on our balance sheet at fair value and this quarter continued to be a little bit challenging to determine fair value as there has not been a lot of asset sales recently. However, there's no hard evidence of cap rates, discount rates or market rents have moved substantially adequate coverage. And at the end of Q2, we did not feel any significant further adjustment was warranted. We actually wound up with a increase being booked with the main driver of the increase being the Industrial segment led by the Ontario industrial properties where the increase in value is largely driven by increasing rental rates. So as we report those investment properties at fair value, we are able to calculate a net asset value per trust unit on an IFRS basis and our calculation just uses the equity on our balance sheet less the equity held by unitholders and then divided by the number of common units outstanding at the end of the quarter. So net asset value per trust unit on that basis was $15.40 this quarter compared to $15.52 last quarter. Net decline of $0.12 due to several factors, the largest of which was foreign exchange, which on a stand alone basis would have decreased our NAV by $0.42 Other financial instruments, which consist mainly of the debt swaps, included a further $0.03 drop in the following interest rates and our distributions for the quarter were $0.17 And offsetting those three reductions was a gain of 0.34 dollars from our income for the quarter, plus a $0.09 gain from the fair value adjustment and a $0.07 gain due to the purchases under our NCIB. So Artis ended the quarter with $40,000,000 of cash on hand and $172,000,000 undrawn on our line of credit. And based on what we know today, we feel that's more than adequate liquidity to get us through the remainder of the COVID crisis, and we look forward to more normal times. So that completes the financial review for now. I'm happy to answer questions later, but I'll pass it back to Arvind for a bit more discussion first. Keep well, everybody. Okay. Thanks, Jim. So folks, this has been a volatile and unprecedented year, of course, as you know. But as it applies to artists, we feel that the worst is already behind us. We really do. ARTIS is performing very well this year. We continue to make good progress in all key strategic fronts and are delivering strong performance metrics for our unitholders. Our rental increase of same property NOI, our FFO and AFFO per unit are all solid numbers. Rent collections are good and are already improving. Watch for more monthly updates from us in August September as we move forward that will demonstrate an improving trend. So we're in great shape and things are looking up. Looking ahead, given our very conservative payout ratio of AFFO for 52% and the progress we've made on our strategic initiatives, debt reduction is and will be a top priority for us. As Jim mentioned, falling floating interest rates are a natural boost to our earnings, which we think is structural and will remain with us long term. So lower for longer or lower for even longer is clearly the new normal for interest rates. It is our view that liquidity and availability of credit will continue to improve as we get to the other side of this shutdown. And all of this, of course, will be good for real estate at revaluation. Our property disposition program slowed during Q2, of course. But looking ahead for this year, we anticipate selling at least another $200,000,000 of properties by year end and another $200,000,000 during the first half of next year. So $400,000,000 of properties during the next 12 months, all retail and office properties. And again, the price is consistent with our IFRS NAV of $15.40 and again used for debt reduction. I might add that we already have over $20,000,000 of properties under contract or LOI for sale and another $100,000,000 under discussion of paper being traded. So nobody need to be concerned about our ability to get this done and paid on our debt, and nobody should even be surprised to see us get all $400,000,000 done by the end of this year. And when I say done by the end of this year, I mean either close or at least unconditional. But we see good momentum, good traction in our disposition program now coming back for us. It's important to note, of course, that as our financial metrics improve, so does our portfolio of property. We're continuing to reduce our office and retail rating and increasing our ownership of industrial properties. We're streamlining and high grading our portfolio as well as reducing the number of secondary markets we're in. So one could say this is basically a private equity model that we're implementing to maximize unit order value, just that we're also minimizing debt in the process. On balance, our overall portfolio is performing well. Again, we own almost $2,000,000,000 of industrial properties with a very which has a very good track record and continue to deliver solid organic growth on both sides of the border. And our industrial development pipeline is on track to deliver excellent results as well. Stay tuned for more good news on this front as we move to expand our industrial development pipeline with institutional joint venture partners this year in the very near future. And as a little fun fact, we don't disclose it as well as we could or should, but in the past 5 years, Artis has, in fact, developed over $300,000,000 that's U. S. Of new generation industrial properties that generated an IRR for us, an average IRR of over 30%. And so we feel good about that asset class. We have a very good track record in developing new generation industrial. We're going to continue to grow that. Now in terms of our retail properties, it's important to note that they represent just 17% of our total NOI and they're all open air service sector strip malls. And of that retail component, we estimate that approximately 80% of our tenants are selling products and services that are essential in quotations, if you will, essential in the sense that the shopping has to be done primarily in person, not online. So folks, by now you've noticed that Artis is not your grandmother's diversified REIT anymore, all right? We're not your typical diversified REIT anymore, and we feel we really should not be compared to diversified REITs anymore. It had an 83% weighting. Artis is now in office and industrial REIT with just some retail on the side, which is very resilient retail. And as mentioned, we'll be continuing to shrink both our retail and office weighting whilst growing our industrial. And just to go back a little bit in history, we've done a lot of heavy lifting in the last 3 years to transform and improve artists. In the last 3 years alone, we've reduced our Alberta weighting from 36% to 16%, our Calgary office from 15% down to 2%. Our retail is down from 26% to 17%. So in the last 3 years, office down from 51% to 48% and industrial is up from 23% to 35% and climbing. So again, a lot of heavy lifting in the past 3 years. If you look at investor presentations, we're targeting by the end of next year to be at 10% retail, to be at 50% industrial, that's 50% and 40% office. And we'll get there. When we say we're going to sell $400,000,000 of real estate at our NAV and we might get paid on our debts, we will. And when we say we'll hit these targets and asset class allocation, we will or we'll even do better. As I said, a lot of heavy lifting is behind us, and we feel like we're walking going downhill now. This pandemic was a serious distraction. But in our case, given the nature of our portfolio, being office and industrial primarily, the worst is behind us. But in the event, I think, also about assets that we quoted for this folks For this quarter, folks, it was a good quarter for sure. We feel we're going to end the year well. We'll have a very good year this year, and next year would be an even better year. So now I'll turn the floor over the mic over to the moderator and open the lines for questions. Thank you, sir. And your first question will be from Jonathan Kelcher at TD Securities. Please go ahead. Thanks. Good afternoon. Arvind, can you maybe, I guess in your prepared remarks there, you kind of hinted at maybe some sort of JV development fund or something like that. Can you maybe expand on that a little bit? Yes. So if we're targeting a fund of $100,000,000 in equity that in turn could be lever to develop $300,000,000 of new generation industrial. We've got at the beginning of our pipeline already tied up in terms of properties, a large and new industrial development in Phoenix and another smaller one in Minneapolis to get the ball rolling. And there's 2 ways to skin the cat. One way or another, we're getting a lot of interest, like a lot of interest from institutional equity partners. The easy way out is for us to just do one joint venture at a time as we move forward with our pipeline. In a perfect world, we'd like to have the fund established in advance and committed. But either way, we'll be moving ahead with names. You'll recognize the names when have the deal done for industrial for a joint venture, new generation in industrial in Phoenix. And the reason we're doing this, I mean, in a perfect world, we'd like to use our own capital on 100%. But right now, we're as we all of our positive cash flow is being used to pay down debt as we sell our buildings, pay down debt, improve the balance sheet, which will give us a better price multiple. And therefore but in parallel with that, we don't want to stop doing industrial development deals. So we would be the GP. It would be a ninety-ten deal, 10% equity from Artis, 90% from the JV partner. We'll get an asset management fee. We'll get an override on the leasing, and we'll get a promote structure as well, which will that will juice up our IRR a lot. Does that help you? Yes. That is helpful. Thanks. And then just switching gears a little bit. Jim, you talked about having a lot of mortgage debt coming due in the next 12 months. What sort of rates are you seeing right now? So the spreads are definitely gone up in both Canada and the U. S. But the with the declines in both BA rates and LIBOR rates, I think the all in coupon to the borrower, we would be pretty close to our expiring rates. So call it 5 year debt still sub-three percent and you get up to 10 year debt, it might be a little over 3%. And would you be looking to fix more of that? On some properties, yes. If it's a property that we plan to hold long term, then we would look to place a longer term piece of debt on. Fixed rate somewhere, right? We either fixed rate or protected by a swap, yes. Okay. That works for me. I'll turn it back. Thanks. Thank you. And your next question will be from Matt Logan at RBC. Please go ahead. Thank you and good afternoon. Armin, looking through the Q2 bad debts, can you give us a little bit of color on the operating performance of your Canadian office assets and how those compare to your office properties in the U. S? So I'm going to got the data there, Jim. You have the breakdown. It's yes, and now we'll let let's show it in there. I think we're a little bit shyer on the Canadian side than the U. S. Side. What have we got there? Correct. The allowance for doubtful accounts is larger in the Canadian office than in the U. S. Office. The biggest piece, of course, is the retail allowance, but total office allowances, I'm sorry, roughly $850,000,000 out of the 2. Yes. It's a tough one to call. In the last 90 days, tenants it was a little easier to renew a lease, I guess, if a tenant was forced to renew. But to do a new lease was challenging. It was however, it was spotty. I know in Toronto at our Concord corporate place there, we've got some good leasing done in the last 90 days actually. We made some good progress. And then other situations, tenants, we're just not making any decisions. We'll do the visual to virtual tours and all that, but that's not making many decisions. Now specifically, we can't really tell you which tenants might be a challenge. Obviously, but the tenants where we were having rent collection problems are generally the ones that have some tie into retail. So if they were either a head office or servicing the retail sector, then those tenants were struggling a little bit. Yes. If you've got a head office of a retail tenant, that's a retail operator or head office of a restaurant operator, that's a bit of a challenge. And sometimes tenants just wanted to push back and say, during these unprecedented times, let's be partners in rent reductions. And then so we go back and say, nice try. So let's get back to paying rent, and that should demonstrate. I mean, for a good reason, we always help a good tenant. But if they don't need help, then we won't get that help. But we definitely feel, as we move forward, office market and the industrial market is back to pre COVID times. Industrial market is strong and robust. Office market is not 100% back to pre COVID times yet, but improving. And retail is what it is. It does depend what kind of retail you have. We definitely feel and see our retail NOI improving. We think the bond is behind us with retail. But would it be fair to say the difference between Canada and the U. S. From an office standpoint might be more tenant specific as opposed to cultural differences or how the tenants are perceiving the value of office space on one side of the border or the other? That's I would say that. I would say that as well. We're hearing and reading about the trend to more work from home and larger corporations can afford that, I guess. I think as the dust settles, there won't be as much work from home as we think, but there will be more work at home than there used to be. And then on the other side of that, that ledger is that tenants will invariably need more space square feet per employee than they used to need as well. And hopefully, that balance is not in favor of the landlord over time. And have you done any notable office leasing on either side of the border since the pandemic began? Or have the has the leasing mostly been in the industrial portfolio? Most portfolio? Mostly industrial, but a little bit here in Canada as well. And I don't I'm going to let you want to wait a little, I don't keep on this, any new leasing on the office side. And it's we'll have our next leasing meeting is next week, next monthly meeting. But it's and it's been neutral. It's been fairly neutral on the office on both sides of the border. But we I know our corporate plans are there that we saw some good improvements there. And I mean down in Vancouver, the Kinkade office, but then we're getting good momentum there as well. So it's a bit spotty, but these are times when people were just caught like deer in the headlights and put their pens down, said let's just wait and see. And that's and for now, the people have got their pens in their hands again and want to do business again. Yes. I could add that we've also ramped up our virtual tour. So we've done, I guess, video of vacant space and posted been able to post that online, which is also helpful leasing activity. So as we were able to ramp that up, you can kind of see the leasing activity pickup as well. That's a good color. And maybe just changing gears here. The fair value marks during the quarter were about $12,000,000 Can you tell us what drove those write ups and tell us if there have been any changes in your valuation inputs from an IFRS standpoint? No, the valuation approach remains unchanged. We do most of our values on a discounted cash flow basis. And so what was driving the increases in value were generally rent increases. We didn't change discount or terminal cap rates or original cap rate type assumptions. That's largely what we were seeing from the external appraisers and we get a certain number of external appraisals done each quarter and then we make sure that our valuation models are mirroring theirs. And last question for me, just on your disposition program. Last quarter, you talked about selling about 100 $200,000,000 to $200,000,000 in 2020 and laid out a 2021 target for about $600,000,000 Are those plans still largely unchanged? And maybe just an update on where those stand. Well, we're definitely confident of our ability to sell $200,000,000 by the end of this year and $200,000,000 by end of first half of next year, again, office and retail. We'll see what if we continue to we want to get our debt down to closer to 45% of GBV and our EBITDA to 8x. And I don't know if I don't think $48,000,000 $400,000,000 gets us quite there. So in the second half of next year, you should expect us to continue selling down to do that. Appreciate the commentary. That's all for me. Thank you. Yes. Thank And at this time, Mr. Martins, we have no other questions registered, sir. Please proceed. Busy day for all the analysts and a busy week. Anyways, I want to thank you, moderator, and thank you, everyone, who has participated on the call for your interest and looking forward to updated analyst reports next week and to more for more dialogue as we move forward. Feel free to reach out to us anytime with questions and more information and more dialogue as we said. Thank you very much. Have a good weekend, everyone. Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.