Earnings Call: Q2 2019

Aug 1, 2019

Good afternoon, ladies and gentlemen. My name is Leone, and I'll be your conference operator today. At this time, I'd like to welcome everyone to Artis REIT's 2nd Quarter 2019 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Thank you. Today's discussion may include forward looking statements, which include statements that are not statements of historical facts and statements regarding Artis REIT's future financial performance and its execution of 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 facts 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. I would now like to turn the meeting over to Mr. Armin Martin. Mr. Martin, please go ahead. Thank you, moderator. Good day, everyone, and welcome to our Q2 2019 conference call. So again, my name is Armin Martin, the CEO of Artis REIT. With me on this call is Jim Green, our CFO Phil Martens, EVP of U. S. Operations Kim Rielly, EVP of Investments Heather Nickel, VP of Investor Relations and Jackie Koenig, SVP of Accounting. Again, thanks for joining us. I'll now ask Jim Green to review our financial highlights with some metrics, and then I'll wrap up with some market commentary. Then we'll open the lines for questions. Go ahead, please, Jim. Thanks, Eimron, and good afternoon, everyone. To keep my comments relatively short, I think as probably the majority of people on the call are aware, our Q3 earnings press release on November 1, 2018 announced a series of new initiatives for the REIT. We've been very busy executing on that strategy, which I suspect will become the main focus of this call. So I'll touch on that in a minute and then no doubt there'll be questions on it after. The impact of executing the strategy has in our opinion resulted in one of the best quarters for us in quite a while. So very pleased with our results this quarter. I'll touch on a couple of highlights and then turn it back. Artis remains a diversified commercial REIT, investing in office, retail and industrial properties with assets in 5 Canadian properties, 6 U. S. States. Based on Q2 NOI, the REIT is now 52.5 percent weighted in Canada, 47.5% in the United States. Since last quarter, that is down a little bit in Canada and up a bit in the U. S. As we announced with our initiatives, we expect the U. S. To become even a larger piece of our operations. On an asset class basis, now 52.2 percent weighted in office, down a bit from last quarter 19.5% weighted in retail, also down a bit from last quarter 28.3 percent weighted in industrial, up from last quarter. Historically, Artis has had a larger presence in the province of Alberta. We have been reducing that presence. I think very successfully, we sold another Calgary office building this quarter. We do continue to have a presence in the Calgary office market, but it's becoming a pretty small piece of our NOI. For Q2 specifically, it contributed 6.1% of the REIT's NOI. Relatively small exposure to Calgary office tenant maturities in the near future with only about 85,000 feet left to complete in 2019, only 46,000 feet maturing in all of 2020. Not a ton of risk to roll over in that market, which continues to be somewhat difficult. Artis continues to be active in both new developments and redevelopment of our existing properties. At the end of June, we had approximately $146,000,000 invested in projects considered under development. During the quarter, there was roughly $38,000,000 a little more actually invested into the development projects transferred approximately $93,000,000 properties from under development to completed projects. So pleased to see those projects completed and the income from them helping our metrics. As detailed in the MD and A, there are several new development projects that remain underway, including a new residential tower, 300 Main Street in Winnipeg, a new industrial space in Houston, Phoenix and Denver. We also have several development projects in the planning stages where the construction has not actively started. They're all progressing well through the development stages. Able to maintain our balance sheet, debt to GBV is actually up just slightly this quarter to 51.9 from 51.7 last quarter. Main driver of the small increase in debt to GBV is the timing of purchases for our planned unit buyback compared to asset sales, which will happen in future quarters. So we anticipate bringing debt to GBV back under 50% as quickly as we can with the asset sales being completed. Our EBITDA interest coverage ratios remain healthy despite carrying a bit higher debt at the present time. Unit buyback combined with good same property growth, completion of the developments is having a definite positive effect with FFO coming in at $0.36 this quarter, up from $0.34 last quarter and up from 0.32 dollars in the comparative quarter last year. So year over year, roughly a 12.5% increase in FFO, very pleased with that. AFFO comparably up $0.02 this quarter from last quarter to $0.27 and up $0.03 from Q2 of 2018. Again, that translates to about a 12% increase in AFFO year over year. Payout ratio is extremely conservative, 38.9% of FFO, 51.9 percent of AFFO. So just a quick update on the initiatives. I'm sure you'll hear more from Armin and Kim on in a minute. But the new initiatives had the goal of increasing cash flow, increasing unit values by increasing NAV, improving the focus and quality of our portfolio. Distribution was reset to $0.54 annually, resulting in a very conservative payout ratio, as I just mentioned, freeing up cash to fund our development pipeline. Plan also included selling non core asset sales somewhere between $800,000,000 to $1,000,000,000 and this process is well underway. Note at June 30, we've completed sales of roughly $236,000,000 We have a further $398,000,000 in our held for sale classification. We anticipate most of those will close in the next 2 or 3 quarters. You'll note from the subsequent events section that one more property has closed already in the month of July. Further properties are anticipated to be added to the held for sale group in the coming quarters. Initiatives also included using a portion of our sales proceeds to buy back our units using our NCIB, and we started this soon as the announcement was made in November of last year. From November to June 30, we had repurchased 12,900,000 units, a cost of just over $135,000,000 Used our line of credit to fund these purchases and plan on repaying the line as assets sell. That ties back into the reason for the debt being a little higher than it was at year end. In our opinion, the plan to buy back units is well on track and probably ahead of schedule where we anticipated we would be. That's on just a couple of highlights from the operations and I'll pass it back to Armin. So on the fair value of investment properties, they're all, of course, valued at fair value, was a decline this quarter of roughly $24,500,000 Major changes were due to lower values on some of the properties we've sold or are planning to sell. As we anticipated when we set out into this program, we anticipate that entire group of $800,000,000 to $1,000,000,000 will sell at or above our IFRS value. However, some of the ones that we have sold first were actually a bit below the IFRS value. We've recorded that write down this quarter. We anticipate selling assets in coming quarters that will be above our interest value such that it sets out at the end of the program. I touched briefly on the debt to GBV. We do remain comfortable with it. It's a little higher than we would like it to be obviously, but we think that will come down in coming quarters. Unencumbered assets will remain strong at roughly 1,900,000,000 dollars The unsecured line of credit remains at $700,000,000 Non revolving unsecured very comfortable with our credit facilities and available liquidity. Touch on same property for a minute. It's always a nice one see that that is also a very nice positive this quarter, up 2.9% in functional currency and a positive 4.6% once foreign exchange is factored in. We also present a stabilized same property calculation, which eliminates the properties planned for disposition, as well as the entire Calgary office sector, which have to consider that stabilized. So as we back those out, the growth in same property would have been 4.6% in functional currency, 6.37% once FX is factored in. Industrial continues to show the strongest performance across the asset classes in both countries with 2.1% growth in Canada, 12% growth in the United States. On EBITDA metrics, the main ratios we track are EBITDA interest coverage and debt to EBITDA. Both those metrics EBITDA interest coverage, we're very comfortable with it. Debt to EBITDA actually proved a bit this quarter to 8.8. Percent. We're also pleased with that. Touch on that for a minute. So given that we fair value the properties, we can recalculate the net asset value per trust unit. The net asset value came in this quarter at $15.37 compared to $15.55 from last quarter. So it is down. There's a drop of $0.18 quarter over quarter. If you look on the income statement at the impact of FX, both on the income statement and on other comprehensive income, there was a $0.19 loss on FX. So more than 100% of the decline in NAV is driven by FX. There is also the loss from straight values that I mentioned before, offset by the income exceeding distributions and also a gain from the unit buyback program. For subsequent events, I guess we ended the quarter with $95,000,000 cash hand and $173,000,000 undrawn on the line of credit. We're very comfortable with our liquidity. Several events in the subsequent events note, which we believe continue to reflect our strategy, intelligent recycling of capital and we plan to continue to focus on a strong balance sheet and the overall quality of our portfolio. That completes the financial review. Very pleased with FFO growth, pleased with property growth, pleased with the development activities. I got to say this is one of the nicest conversations I've gotten in a while. So much appreciated. Thanks everyone and I'll pass it back to Armin. Okay. Thanks, Jim. So again, folks on balance, we feel we're on track to having a much better year this year than last year. And as mentioned, we're making good progress on all fronts and delivering strong performance metrics for our unitholders. So our weighted average rental increase is our same property NOI growth our NOI growth in total, our FFO and AFFO per unit are all solid and improving numbers and even our EBITDA debt metrics improved a little. And as mentioned, we are making great progress on the strategic initiatives that we announced last Q3 last year. So we're in the Q3 of these initiatives and we're looking forward to the next quarter already. The distribution is very conservative payout ratio in the low 50%. It's the lowest payout ratio of all the commercial REITs on the TSX. We feel it's quite bulletproof, safe right now and for the future. Our unit buyback program has, of course, been very successful and accretive. We're well ahead of plan there. Our dispositions are ahead of plan. Definitely feel confident that we'll be able to achieve 80% of our 3 year plan by the end of this year, if not even more. We're very confident we'll be able to successfully dispose of at least $600,000,000 of our properties, if not more, by year end. On time and on price, on balance, It's not always a straight line, but on balance, on prices that correspond to our NAV of over $15 per unit. Meanwhile, our portfolio is performing well. Office markets are still inconsistent, but this is I still feel this is the year that things level off for our portfolio in Calgary and that will help us a lot. Meanwhile, our retail and industrial properties have a very good track record and continue to deliver solid organic growth. And our development pipeline is on track and continues to deliver good results as well. We invite you to look at our MD and A and investor presentations for more color here. I think it's important to note that not only are our financial metrics improving, but so is our portfolio of properties, okay? So we're reducing our office and retail weighting and we're increasing our ownership of industrial properties. We're also reducing the number of secondary markets that we're in. Our Calgary office exposure is consistently shrinking. Our U. S. Retail exposure will soon be 0 and the remaining retail properties that we have will shrink from 20% to 15% of our total portfolio, but it will be open air properties and in Western Canada only. So we feel we're in a good place there. And as we mentioned, office will be shrinking and waiting and industrial will be increasing. So looking ahead, we'll continue to work hard to keep our buildings full whilst bringing the rents up to market and consistently streamlining and improving our portfolio. We clear the integrity of our balance sheet and our credit rating as well as implementing our new strategic initiatives continue to be of utmost important to us. So that's our quarter. Folks, again, we thank you for joining us on this call. We'll open I'll ask the moderator now to open the lines for questions. Thank you. Your first question is from Jonathan Kelcher from TD Securities. Jonathan, please go ahead. Thanks. Good afternoon. Hello. First question, it looks like you had about $800,000 of lease termination in there in the quarter. What did that relate to? The biggest piece of that was actually an industrial tenant in the Phoenix market. Terminated early. By Yes, sorry. And since then has been replaced with another tenant. So the space is redone and we collected a fee from the tenant that left. That's good. And then on the $93,000,000 that you transferred from developments in the quarter, how much NOI did that add this quarter? Approximately $700,000 of income this quarter from those developments. And is that a good run rate? Were they all transferred at the beginning of the quarter? That stabilized for a quarter or is it That's not true of the quarter, yes. What was in May and you were in June. Okay. So that should go up in Q3 then? On ballpark, those would have been developed to roughly a 7% yield on the development properties? Correct. Okay. And then just lastly, it looks like you've slowed down the share buybacks post Q2. Can you maybe give us our thought your thoughts on how you're looking at that right now? Sure. So that was just getting up about the level where we wanted to cap off the debt. So deliberately, we did slow down the unit buybacks. We'll resume as we close some more sales and get our debt down a little bit. But we didn't want it to get too much higher and get anybody fussing over the debt levels. Do what is our debt in Q3, we want it to be lower than our debt in Q2. Okay, fair enough. I'll turn it back. Thanks. Thank you. Your next question is from Matt Logan from RBC Capital Markets. Matt, please go ahead. Good afternoon. After a strong same property NOI growth print this quarter, how should we be thinking about growth on a currency neutral basis over the next 12 months? Hoping or thinking. We're cautiously optimistic. Our cautiously optimistic that we can stay in that bandwidth and the same that we are this was a pretty good quarter. Maybe we dipped 100 bps, but we still I still always think on down to between 2% and 3% and when we hit 4% that's a bonus for us. And on your sale process, with the pullback in bond yields over the last 6 months, has that had any impact on pricing or investor demand for your assets? We can't put a finger on it, but yes, on balance sheet, the answer is yes, it is a good time to be selling real estate and there's a lot of money out there for especially if it's value add money or non money out there for especially and in the U. S. In particular for real estate. And it's still asset class and market submarket specific, but there's more money available for real estate commercial real estate than I'd say for them for sure at this time last year. And maybe looking forward in terms of your development pipeline, obviously this quarter was probably a little bit stronger than the average quarter, but how should we be thinking about deliveries over the next year or so? Like is there any color you can provide on the longer term pipeline? Well, right now for PARK-ninety, we are working on 3rd phase and possibly now 4th phase. 3rd phase will be completing construction in the Q4. The Denver development is completing construction in this quarter, the 3rd quarter. We are already getting good pre leasing activity on both of them. We closed on one of the buildings in Denver or the full building with accredited tenant and we hope to have them paying rent to be in the Q4. So we're hoping that by the Q4 we're going to see another pickup as well. And back to Park 890, that's Houston. And there's a couple of phases left to go there that we're going to we're accelerating. I think, Matt, again, right through this year and all of next year, we see ourselves being able to deliver NOI from new industrial developments. And we are working hard not to look for more industrial developments with our partners. That's great color guys. Appreciate the commentary. That's all for me. Thank you. Thank you. Your next question is from Jenny Ma from BMO Capital Markets. Jenny, please go ahead. Thanks. Good afternoon. Just wondering if you can give us any update or color on what the special committee has been up to and whether or not you've been fielding a lot of incoming calls or had conversations about maybe different strategies of how you want to take the REIT? None of us in this room are on the special committee. We talked about it earlier and I was reminded that I'm not a spokesperson for the special committee and can't give any comments there. And all I can do is assure you that in the event they have anything remotely important to announce, they will disclose it to the public immediately. They have been busy, but that's about all we can say, I guess. So presumably, they've met a few times since the announcement? Yes. Okay. All right. And then with regards to the asset sales, have you gotten a lot of incoming calls in terms of not just selling the one off assets, but maybe on a portfolio basis? Just trying to get a sense of, it's no secret with the attractiveness of industrial, whether or not you've fielded calls for that segment or other segments of your portfolio? Sure. The industrial, we like to say we could sell before dinner time, except it's already dinner time now. But industrial, we get a lot of calls about that, but that's the asset class we're disposing on, not one single building. We're already over 98% occupied on both sides of the border, our Canadian portfolio as well as our U. S. Portfolio. GTA Industrial is 99.9% occupied, embarrassing about that. Minneapolis Industrial is 99% occupied. Really good numbers, good organic growth, new developments as we build them. We want to grow our industrial portfolio. That's where the inbound calls are coming. Otherwise, what we're focusing on is we're very focused on what we're selling. And if we get inbound calls, it's only pertaining to the stuff we're selling. And I can't remember the last time I had a portfolio request. In this market, there still is a, in my view, a portfolio of discounts. We're not interested in that. The only portfolio premium we might get would be for industrial, but that's not we're not selling that. And we're doing fine with our dispositions. We feel very comfortable with them. And then including our Calgary office, we see some good things happening there soon, our Calgary office disposition. Okay. Actually, on the topic of Calgary it's small, but I'm just curious as to why you bought Center 70. I guess it cleans up the structure, but is there something compelling about that asset that you wanted to own or what was behind that acquisition? More to clean up the structure, just to be the 100% owner. But to be clear, it's performing very well also. It's 94% occupied. The rents have stabilized at a lower level. We've gone through the tough times with that building. It's in very good condition. It's a building we don't mind owning. But yes, it was about cleaning up the structure and simplifying things. Are there any major roles in that property? Or is it 95% pretty stable? Very stable, pretty good vault. Okay. And then last question is whether or not you have any update on some progress at 415 Young in terms of moving forward potential for development or selling off from that density? No, it's being actively marketed now. As you may be aware, we feel there's a lot of interest, a lot of interest and we're very confident that we'll be transacting on that and something will be firmed up here in Q3 for sure. In Q3? We're not closing. I said firmed up, not necessarily closing, but firmed up. Firmed up. So perhaps an update for Q3. Yes. Great. Thanks. I'll turn it back. Thank you. Your next question is from Mario Saric from Scotiabank. Mario, please go ahead. Hi, thank you. The target dispositions for this year, I mean, you mentioned 600, so it's fairly consistent with the guidance that you expressed last quarter. It seems like that process is moving along nicely. When you look at the fair value loss that you incurred on the assets sold during Q2, was there anything in particular with respect to those assets that would have driven that loss? Yes, it was largely on 2 of the buildings. It was on the 2 Denver office assets, one of which just lost its major tenant. So the tenant occupied roughly 70% of the building, We'll be vacating in October. The other one was a vacant building. So both of those, we took a loss on them just to clean them up out of the portfolio. Yes. We can tell you we had a gain in every single disposition except for those 2 Denver ones. And from there, we had bad luck with the major vacancy and we decided to solve the problem quickly and sell the property as best as we could and redeploy that proceeds in our unit buyback program. Both were going to require fairly substantial dollars in tenanting costs and matched with our strategy. Okay. So the vacancy at one of the buildings was unexpected? Yes. Okay. And then I appreciate the commentary on the NCIB. There's some pretty good progress there. I think during the last call, you kind of briefly touched on the potential SIB and I appreciate that the leverage has ticked up a little bit towards the upper end of where you want it to be. But once it seems like the disposition program is going fairly well, how do you think about a potential SIB in the second half of this year today versus 3 months ago? Not on the top of our priority list. We want to finish up with the NCIB. We're at 90% done. We want to get it to 100%. And we want to bring down our debt some more and then we'll take a look at that scenario. We wouldn't see it happening in Q3. Got it. Okay. And then just separately, I noted an acquisition or unconditional purchase agreement on page 12 of your MD and A in Minnesota. Is that a land purchase or is that purchase of a building? If you could just provide a bit of color in terms of what you're buying there? That's a purchase of a building that's 100% pre leased. It's just under construction. And as soon as the tenants well, actually the tenants in and paying in occupancy already, but not paying rent yet. So that will be completed towards the end of Q3 or early into Q4. Of course, that would be a forward purchase. Got it. Okay. And what kind of cap rate are you getting on it? It's a 6.2. It's a 6.2, but it's a 15 year lease with 2% annual rental increases. Accredited tenant. Yes. Okay. Thank you. Thank you. Your next question is from Dean Wilkinson from CIBC. Dean, please go ahead. Thanks. Hey, everyone. Hi, Dean. Carmen, just can you give us an update on 300 Main, 330 Main, constructions underway. How far along are you on that? What's the time horizon on that and the budget left to go? So we're just for sure, it's still early days. We're just getting almost at the typical floor level now. I mean, it's a 40 story building, almost at the typical floor level now. And it's we're looking at completion in the first half of twenty 22. So it's a long ways to go. I mean, it's on time, on budget so far. I shouldn't say on time. We got a slow start, but it's on budget and it's in a good place. We're in a good rhythm now with our typical floor construction. That's the 40 storey tower multifamily commercial on the main floor. The commercial is leased on the main floor. In addition to that, there's a link in between that 40 story tower and our 30 story office building that's almost finished and that's fully pre leased as well. But the link will be finished this fall and it will demonstrate progress. We're happy for that and fully leased for the 20 year lease term. And that's all about that 40 storey building getting built and then the joy of leasing up that building. That's a okay. So that will be a rental. They're not contracted. Yes. That's purpose built multifamily rental. There will be a lot of amenities, very practical amenities, there will be a dog run there, dog bath. And then at the top floor, the full penthouse floor is reserved, what we call social amenities for all of the residents. So you can live on the 3rd floor, you can live on the 16th floor, but you can still go to the 40th floor and enjoy the viewing and enjoy the meeting rooms and the games rooms and have parties up there as well. We think we have a good concept there. We've got you might recall, we qualified for property tax abatement for an 18 year term. So we have 18 years of property tax abatement, both school tax and municipal taxes. So that does help as well in terms of phasing and leasing up and getting the numbers that can work for us. Perfect. And what was the going in construction budget on that? I can't recall. We give a number. I don't want to give you different roughly $190,000,000 About $190,000,000 Okay, perfect. That's it. Thanks, guys. All right. Thank you. Thank you. There are no further questions at this time. Please proceed. Well, thank you again everyone for joining us at this time of the day. I'm looking forward to meeting you during the months ahead as the conference season starts again. So thanks again. Have a good evening. Of course, feel free to reach out to us if you have any follow-up questions by email or phone call. Thank you very much again, moderator. Ladies and gentlemen, this concludes your conference call today. We thank you for participating and ask that you please disconnect your lines.