Good afternoon, ladies and gentlemen. My name is Leonie, and I'll be your conference operator today. At this time, I'd like to welcome everyone to Artis REIT's third 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'd like to withdraw your question, please press star followed by two. 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 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. I would now like to turn the meeting over to Mr. Armin Martens. Mr. Martens, please go ahead.
Okay. Thank you, moderator, and good day, everyone. Welcome to our Q3 2018 conference call. Again, my name is Armin Martens, the CEO of Artis REIT. With me on this call is Jim Green, our CFO, as well as Kim Riley, our SVP of Investments, Philip Martens, EVP of U.S. Operations, and Heather Nichol, our VP of Investor Relations. Thanks again for joining us. I'll be starting, as usual, by asking Jim to review our Q3 financial highlights, but this time more briefly, if you will. Then I will continue with the review of our Q3-18 investor presentation that's been somewhat customized to the press release that we've issued. Then we'll open the lines for questions. Just as a further note, this call, we do have the option of extending this call if necessary if we get into more questions.
Then we'll talk more about what happens after that. In any event, I'll turn the floor over to Jim now, then I'll proceed after that.
Thanks, Armin. Good afternoon, everyone. I would echo Armin's comment, welcome to our third quarter conference call for 2018. As Armin mentioned, I am sure a majority of the people on the call are aware, our third quarter earnings press release also announced a series of new initiatives announced by the REIT. The outcome is a fairly significant shift for the REIT. As I expect, most callers will probably prefer to spend time on the review of those announcements. Given the fact that the results from operations this quarter really contain no unusual items or surprises, I'll keep my comments on the financial reports fairly short. I am happy to answer any financial-related questions later if needed. As we've said before, Artis is a diversified commercial REIT. We have assets in five Canadian provinces and six U.S. states.
Based on our Q3 NOI, that weighting is still roughly 44.1% in Western Canada. We're 11.1% weighted in Ontario and 44.8% weighted in the U.S. On an asset class basis, Artis is 52.6% weighted to office, 20.4% in retail, and 27% in industrial. We do have a presence, continuing presence in the Calgary office market, which, as everyone knows, has been very soft for the last 5 years or so. This quarter, that contributed 7.7% of our NOI this quarter. We do have fairly manageable exposure to the Calgary office market leasing in the near future, with just over 83,000 feet left to renew in 2018, only 141,000 feet in all of 2019, and only 47,000 feet in 2020.
Calgary office actually contributed positive same property growth this quarter. Really pleasant to see in a market like that. However, we do still see headwinds in Calgary. It is very slow to improve. As we've mentioned before, our acquisition and disposition activities have mainly focused on capital recycling to further diversify and improve our portfolio. In this quarter, we completed the acquisition of an office property in Phoenix. We had no dispositions closed in the quarter, although there was one subsequent to the quarter that did close. Artis continues to be active in both new developments and redevelopment of our existing properties and currently has approximately CAD 105 million invested in projects currently under development. During the quarter, the increase in properties under development was roughly CAD 16 million.
As detailed in our MD&A, we have several new development projects that are just getting started, including a new residential tower at 300 Main Street in Winnipeg and new industrial space in Houston, Phoenix, and Denver. As detailed in the MD&A, we have several development projects in the planning stages where construction has not actively started. They continue to progress well through the development stages. We've been able to maintain our balance sheet with debt to GBV currently at 48.6%, down slightly from 49.3% at December 31st of last year. Our interest coverage ratios and EBITDA interest coverage ratios remain healthy at 3 times, roughly.
The sales program we implemented in 2016 and 2017 to sell assets and reduce debt has had a dilutive effect on FFO, however, funds from operations, with FFO coming in this quarter at CAD 0.33 versus CAD 0.36 in the comparative quarter last year. On a quarter-over-quarter basis, FFO is up slightly this quarter, roughly CAD 0.01. It was CAD 0.32 in Q2, and that's largely due to growth in same property income, as well as the new property we acquired in Phoenix. AFFO for the quarter was CAD 0.24, which does result in our AFFO payout ratio being above 100%. It is 112.5%, if we want to be exact. This payout ratio was certainly not the only factor, but it was one of the drivers that led the REIT to consider implementing some new initiatives, which we'll be discussing shortly. Overall, we were generally pleased with our results from this quarter.
A positive same property growth, even as I mentioned, positive same property growth from the Calgary office market. Very healthy weighted average growth in rents renewed during the quarter. The balance sheet metrics all staying fairly consistent to prior quarters. I think I'm going to leave it there for now to allow more time for questions on the call, and I'll turn it back to Armin for more discussion.
Thanks, Jim. If anybody on the call can turn with me then to our Q3 2018 investor presentation. I'm going to jump right into page three. There's a graph there, a history of Artis' unitholder returns. I'd like to draw everybody's attention to the years 2008 and 2009, the last large recession. You will notice how we dropped and how you remember our yield went up. At that time, our payout ratio went from the 80% range right up to the 120% range in 2008 and 2009. Subsequent to that, we were able to raise a lot of equity. We were able to more than double our market cap and go back to a payout ratio well below 100%. You fast-forward to today, it's a different situation. We're a much larger REIT today.
We are basically unable to raise new equity and double our market cap and grow back to a payout ratio that's respectably below 100%. We're not in that situation anymore. Today, as we speak, interest rates, bond yields are at an 8-year high. Artis is trading at an 8-year low, and we still have about 10 years of supply of Calgary office properties in the Calgary office market. The board and management has come to the conclusion that the status quo was and is no longer an option, and hence, we've announced these new strategic initiatives. If you'll just turn with me, skipping four in a way, I think I feel I've covered it, let's go to page five.
The key objectives of our strategic initiatives, or the key elements of any good strategic plan, are firstly to improve our payout ratio, to improve the balance sheet, and deliver growth. Deliver AFFO per unit growth and deliver NAV per unit growth, all of which maximize unitholder value. We feel these objectives are realistic and achievable with our initiatives. If you turn to page six, we give you more details on our initiatives of improving unitholder value. Firstly, as we've announced, we'll be reducing our distribution by 50% to CAD 0.54 annualized, and that will free up about CAD 83 million in cash flow. From that perspective, we feel it makes Artis a more bulletproof REIT with a great payout ratio and good positive cash flow.
Number two, we will be repurchasing our units through our existing NCIB. In essence, we'll be maxing out our NCIB by way of an automatic unit buyback as of Monday when our blackout is over. Number three, in over the next 2-3 years, we will sell between CAD 800 million and CAD 1 billion of non-core assets at or above our IFRS value to fund our program. This is something we've done before, and we're more than confident of our ability to execute on this again. Number four, we'll be paying down debt and strengthening the balance sheet. This, in turn, should lead not just to a better price, but better price multiple. Number five, we'll continue to create value through our development pipeline and select acquisitions in Artis' major target markets.
We'll focus on industrial developments, our existing land, and on major markets that we're in. Again, we feel these new initiatives are both realistic and effective with minimal execution risk. Turn to page seven. It refers to our improved operating and financial metrics that we're striving to achieve. As our payout ratio will be in the 50% range, we'll be freeing up, as I said, CAD 83 million of cash flow. We hope to generate about CAD 600 million in net proceeds from our asset sales. Our model does show us delivering 4% annualized AFFO per unit growth and 4.5% annualized NAV growth. There won't be a straight line, but for example, in year three, we expect our AFFO to be CAD 1.12+, and we expect our NAV in year three to be CAD 17.50+.
Of course, we'll have a better balance sheet, and we continue to be committed to our investment-grade rating. A better payout ratio, better balance sheet, better AFFO per unit, and better NAV per unit. All of this should lead not just to a better price, but I think a better price multiple as we move forward. That does actually bring me to this part. Part eight, the classification of assets. I'm going to ask Kim Riley to take over. Then I'll wrap it up. Then we'll move on to questions.
Thank you, Armin, and good afternoon, everyone. Looking at page eight, in order to assist us in optimizing the portfolio, we have recategorized our assets into 3 types. They are core Artis assets, development assets, and non-core Artis assets. The core Artis assets make up just over CAD 4 billion of our portfolio. They are invaluable assets located in target markets where we anticipate maintaining a long-term presence. These markets have historically produced healthy occupancy and same-property NOI growth. These properties are also leased to quality tenants, including retail properties with strong weighting towards necessity and service-based tenants. Development assets account for around CAD 200 million of our portfolio. They include land upon which a development project is either underway or has the potential for future development. Development assets also include select assets that have growth potential through redevelopment and repositioning.
All of which enable Artis to achieve yields that are 150-200 basis points higher than acquisition cap rates. Development properties will also be primarily new generation industrial. Non-core Artis assets, which account for CAD 800 million-CAD 1 billion of our portfolio, are good quality assets, but are which Artis considers to be outliers in terms of type and location. Particularly assets or asset classes where we do not anticipate maintaining a long-term presence. We'll go into more detail on non-core assets in a few slides. If you turn now to page nine, you can see several pictures of assets that we consider to be core within our portfolio. An example of an office building would be MAX at Kierland in Phoenix. On the right-hand side, top corner, you can see Crowfoot Crossing in Calgary, which is one of our best-performing retail assets.
175 Westcreek is a newly constructed industrial property in the GTA. We see these types of assets forming the foundation of our portfolio, and they will continue to be prudently managed to realize maximum growth. Turning to the following page, you can see examples of developments that are currently underway, which are predominantly new generation industrial. These include multiple phases of Park Lucero, an industrial park that we own in Phoenix. Cedar Port, which is a fully pre-leased industrial property in Houston. Tower Business Center is a new industrial development that's just getting underway in Denver. Turning to page 11, you'll see that over the last decade, Artis has established a solid track record of greenfield developments in both Canada and the U.S. Examples of these developments include Linden Ridge Shopping Centre in Winnipeg, which is a retail site that was acquired with excess land.
We pre-leased this development to several national tenants on long-term leases and developed the site over multiple phases. That property is currently 100% occupied. Another example is Midtown Business Center in Minneapolis. This was an industrial land site that was acquired by Artis. During construction, it was fully pre-leased to a strong medical use tenant on a long-term lease. This property is currently 100% occupied. Park Lucero, which we referenced in a previous slide, is a more recent example of a development and success story. It is a new generation industrial park in a well-amenitized location. It was developed over 4 phases, the first three of which are now complete, and the last is just wrapping up construction. This project is also 100% committed. It's these types of developments that provide the REIT with new generation real estate at higher yields than acquisitions.
Over the next three years, we plan to focus on developing more new generation industrial assets in major markets. These developments offer yields of 150-200 basis points higher than acquisition cap rates and generate significant value for the REIT. Turning to our non-core assets on page 12. Over the next three years, you'll see that we're planning on selling between CAD 800 million and CAD 1 billion of non-core properties. Non-core assets were identified as outliers in terms of location and type within our portfolio. These assets will be sold in a disciplined manner and include the following examples. Underperforming Calgary office properties to bring our Calgary office weighting down to a target of 5% of the portfolio. Assets and asset classes in markets where we only own a few properties and do not intend to grow further, such as Ottawa, Nanaimo, Hartford, and U.S. retail.
They also include specific property types where only a few are held. An example would be enclosed retail. Finally, select multi-family densification opportunities, which, upon receiving rezoning approval, will be sold to capitalize on the strong demand for residential development as well as unlock incremental value for unitholders. In summary, on the following slide, over the next three years, we are looking to sell CAD 800 million to CAD 1 billion of assets, which represents approximately 17% of the current portfolio. They are non-core assets in non-strategic markets or asset classes or markets where we lack scale. They also include multi-family densification projects once rezoned. These dispositions will align with our goal of owning a more focused and optimized portfolio. I'll now turn it back to Armin to wrap up.
Let's just move on to page 14, which is our last slide. We show your current asset class breakdown by NOI, then by geography, and where we expect to be headed within the next two to three years. You'll see from left to right in our current office portfolio is 45%, Calgary office 8%, 53% total office. We'll shrink that in total by about 8%. Calgary office will come down to 4% or 5%. The rest of the office will be 40%. Retail will shrink to 15%, industrial will grow to 40%. We see that happening quite realistically. Of course, the net result will be that we will increase our weighting in the U.S. and be decreasing our weighting in Canada. In terms of the disposition program that Kim mentioned. You can ask us questions about that.
The low-hanging fruit is some of our Canadian real estate, the densification opportunities. That's where the cap rates are the lowest, and the higher achievable yields for new generation industrial real estate is really all in the U.S. Artis will continue to be a diversified REIT, commercial REIT. We'll be in two countries, three asset classes, we'll be shrinking in secondary markets, we'll be shrinking in Calgary office and office in general, be growing in industrial, and we'll be growing in major markets. That brings us to the end of this presentation, folks. I'll ask the moderator to open the lines for questions.
Thank you. Ladies and gentlemen, should you have a question, please press star followed by one on your touch-tone phone. If you're using a speakerphone, please lift your handset before pressing any keys. One moment, please, for your first question. Your first question is from Michael Markidis from Desjardins. Mike, please go ahead.
Hi, thank you. I was hoping you guys could just walk us a little bit more in detail on the pro forma metrics in the deck, and I guess in specific, too, you gave a 3-year AFFO figure. Obviously, the asset sales are there, but maybe just in terms of how much of the sale proceeds are from non-income producing today, in terms of value extracted from your densification on the multifamily side. That's the first question, and the second part to that would be what NOI growth from the remaining stabilized assets are you expecting over that 3-year period?
Kim is just opening up.
Yes
her model there. I believe your assumption, Kim, was flat on NOI growth.
Flat on NOI growth. In terms of incremental development value, we have about CAD 150 million, so that would be unlocked value for the multifamily rezoning developments.
Okay. Would that CAD 150 have zero carrying value on your books today, largely?
That's correct, Mike. Yeah. We have no value until we get those densities approved.
Okay. How much of that would be the project, which I think is under construction now on Main Street in Winnipeg, roughly?
CAD 15 right now.
Smaller piece of it, but expect it to be a CAD 15 million-CAD 20 million profit on that development.
Okay. Just to make sure I heard you correctly, flat on the same property growth over the three-year period.
Yeah.
Yeah, we just went very conservative in there and didn't estimate anything that we didn't have already locked up.
Yeah. No, that's fair. Okay. Just that CAD 112 on AFFO, Kim, what's the FFO number?
I don't know how to calculate FFO. We have to
Yeah, you're the second person that asked that. We just focus on AFFO.
We can easily calculate that and get back to you.
Mike, we'd have to
Yeah, you can follow up offline. That's fine. Okay. On the CapEx, if we look at your stuff, if we exclude what you classify as new development and redevelopment in your disclosure, just TIs and leasing costs outside of those, I guess, greenfield and repositioning projects, you've been running at about CAD 100 million annually for the last three years. With the initiatives you've announced now, how do you see that unfolding over the next couple of years?
Sorry, Mike. You're saying what will we be spending on new developments over the next-
No, if we look at your cap intensity or your cap spend, including TIs and leasing costs-
Yeah.
excluding any new development and redevelopment, the way you disclose it in your MD&A.
Yeah.
Annualized, you guys are running anywhere from, call it CAD 100 million annually over the last three years, 2016, 2017, and year to date. How do you expect that to trend? Do you think that's a good run rate going forward, or do you think that's going to increase or moderate?
I would say expecting that to moderate a little bit based on some of the assets we're planning on selling.
Okay. Presumably, a good chunk of that capital has been going to Calgary office over the last couple of years. Would that be fair?
Yeah, that'd be fair.
Okay. Last question from me before I turn it back. Noticed the initiative to focus on industrial. I think that was something that you'd talked about over the last several calls, but one of the things that stands out is that you've actually been investing quite a bit in U.S. office over the last year and a half or two. Just noticed that if I look at your pro forma metrics, it would appear that that's going to stop. Just curious if you could give us a moment to talk about what's changed, perhaps, on the office side in the U.S. and why you don't want to put any more capital into that asset class.
Well, are you referring to acquisitions then, right, Mike?
Yeah, I guess so. Is it all development that's going forward, I guess? Is that the plan?
Yeah. All development. Select acquisitions, we'll always look at for industrial. It's really all development. Development pipelines are pretty solid for industrial. We just did buy the Stapley Center. We're really happy with that asset. It's already gone from 94% to 98% occupied. We're doing really well with that. We don't see ourselves increasing our weighting in office. We're not just an office REIT. We're a diversified REIT. It's no secret that industrial asset class, it's not just an asset class that investors like. It's performing very well for us on both sides of the border. We want to grow in that sector. We'll focus on industrial for all of our growth. Just to give us more balance in our portfolio, we always wanted more industrial and a little less office.
Okay. Thanks very much. I'll turn it back.
Thank you. Your next question is from Jonathan Kelcher from TD. Jonathan, please go ahead.
Thanks. Good afternoon. First on the size of the distribution cut. How did you guys come around to the 50% number?
It didn't happen in one day. There were two perspectives. One is, do we right-size the distribution and carry on, or do we elect for a more significant cut? Do we decide on a more significant cut that'll give us some good positive cash flow that we can use to grow? In terms of growing, it's not just about funding our development pipeline, but it's about buying back our units and paying down debt. We landed on a bigger cut instead of just a right-sizing. Right-sizing might've been anywhere from 20%-30% cut. 50% is a large cut, but it sends a good message, we feel, to investors that our payout ratio is always safe. We've always got positive cash flow. We've got flexibility now for unit buyback, flexibility for debt pay down.
We've got a lot of options on the table now to create NAV growth. We did some modeling. We modeled 44% cut, 50%, 56% cut. Obviously, the higher the cut, the more you can do with the money, more creation you can generate. We landed on the 50% cut in that way.
Okay, fair enough. On the assets that you've identified for sale, I guess some are, in Mike's question, not income producing. If you take the overall sort of CAD 800 million to CAD 1 billion, what would be a cap rate or an NOI, like say the IFRS cap rate on those?
The IFRS cap rate?
Yeah. 6.25 is where we're modeling.
Okay.
Yeah. We really think we'll beat that because there's embedded value there that we haven't yet triggered by exiting that. Of the three-quarters of those assets that we expect to dispose of, whether it's Poco Place or 415 Yonge or Concord after we get the density or our 50% non-managing interest in Winnipeg Square here, all of those cap rates will be sub five even. We feel very confident of our ability to be able to hit the six and a quarter cap rate and do better than that, better than our IFRS valuation, which again, will support our model very well.
Okay. Just lastly, the 45% longer-term target for leverage. How do you treat your pref in that? Does that exclude them or include them?
Yeah, we're still like the banks. We treat our pref as equity. We don't include our pref in that. Looking ahead, the pref won't come up for, I guess, a couple of years. Right, Jim?
There's one series next year.
Next year.
We'll see how that goes, whether we redeem that at maturity or not.
Yeah. We'll give serious consideration to eliminating our pref in the years ahead and cleaning up our balance sheet. As you know, we don't have any converts anymore on our balance sheet, and now that we're in this situation, we'll give serious consideration to eliminating the pref as well and cleaning up the balance sheet some more.
Okay, thanks. I'll turn it back.
Thank you. Your next question is from Dean Wilkinson from CIBC. Dean, please go ahead.
Thanks. Hey, everyone.
Hi, Dean.
Hey, Armin, if I could just follow along the lines of John's question there. Looking at the distribution, and obviously things have changed, but from last quarter, you kind of did make the comment that 14 years we've never contemplated a cut. We've increased it twice. Have things materially changed that much since August to now, and you're seeing a larger deterioration? Help us sort of get from point A to point B there.
Yeah. In the last 90 days, I admit, I guess it started in July already, but we saw our units trade down a lot aggressively, and all of a sudden, we find ourselves in October trading at an 8-year low. We noticed. Of course, the central bankers have come out with hawkish narrative, and bond yields are trading at an 8-year high. That happened very quickly. In addition to that, Dean, we got a lot of inbound calls from a combination of investors and analysts suggesting that they wanted more clarity from Artis on its strategic direction and how we were going to grow back or get back into a payout ratio that was under 100%. We couldn't answer those questions well during the last quarter.
We brought this to the board's attention, I guess, twice in the last two weeks. The board landed on this decision in terms of new strategic initiatives.
It makes sense. I mean, a tough decision, but probably the right one to make, right? In light of that, then looking at sort of this, let's call it a CAD 1 billion of secondary market asset sales, which there are a few others that are out sort of doing a similar kind of thing and right-sizing the portfolio and focusing on their core markets. Are you confident over the next three years, particularly in light of possibly rising interest rates and the impact that may follow on cap rates, that you're going to hit those IFRS values? How confident? Maybe the next year, but you go sort of beyond that and there's a little more question as to what those ultimate values could be?
Yeah. Right now, we're very confident. We're basing this on the assumption that interest rates, when they rise, they'll rise one step at a time, and that the Fed and the Bank of Canada are not going to cause a recession. Right now, we're very confident, and we're not anticipating interest rates to rise too much too soon. As they do, we're cautiously optimistic, with bond yields moving up, that at least that spreads will come down a bit. If they cause another financial crisis like they did in 2008 and 2009, well then things will change.
Our plan would be to move very quickly on the asset sales today.
Yeah
With the exception of the multifamily sites that still need the zoning to come through before we can really sell them at a maximum value.
Yeah. We really think we can do the bulk of this in less than two years.
The bulk in less than two years. Okay. That makes total sense. The last question from me is, did you anticipate in your model that entire CAD 600 million of net proceeds going towards the share buyback, or how much have you penciled in there?
No, not all of it. We've got CAD 270 million roughly in the model budgeted for unit buyback, and then the rest for our developments.
The rest.
About CAD 100 million for debt pay down.
Yeah. To bring all the debt to GBV down a little lower as well. Some of it going to debt repayment.
Okay. CAD 370 in the capital stack, and then the rest of it is going to be work in progress and stuff like that.
Correct.
Perfect. I will hand it back. Thanks, everyone.
Thank you. Your next question is from Walter, from Ronin Management Inc. Walter, please go ahead.
Thank you, operator. Heard a great deal about how you derived the 50%. Do we expect to stay at the 50% payout ratio, or not payout ratio, but the 50% cut, for the full three years? Is there a prospect that you might be increasing it again? What criteria would you be using for an early increase earlier than the three-year program you've laid out?
It'll be locked down for two years for sure, Walter. In year three, as we can demonstrate more traction and success in our plan, I don't mind sharing with you, with everybody on the call, we did discuss it at the board level. At year three, we can then review the distribution, start moving it up. In the long run, a payout ratio between 60% and 70% is very good. It doesn't have to be in the 50% range, nor necessarily should it be. We will have the opportunity to move the distribution up, that is in the long run what every board wants to do. They want to be in a situation where they can increase distributions in a predictable manner, not just keep them fixed.
Right. I understand. Hypothetical, what if it went into the 40s as your payout ratio, high 30s?
That would beg for an increase then.
Not until the third year at the earliest.
We're pretty much committed to 2 years working through this. If it dropped to 30% in year 2, we take things 1 quarter at a time. You'd have to stand in line behind several board members that would want to increase at that point as well, right? It's hypothetical, so it's hard to predict. For sure, the lower the payout ratio is, the better the possibility is, and the chance that we'll be raising.
Thank you very much.
Thank you. Your next question is from Howard Leung from Veritas Investment Research. Howard, please go ahead.
Thank you. Just wanted to ask about a follow-up on that net CAD 600 million that you would use to spend from your disposition. I guess the numbers are CAD 100 million would go down to paying extra debt, CAD 270 million would go down to the buybacks, and CAD 230 million would go down to developments. Is that the right split?
Yes. That sounds correct.
Yes.
Got it. I guess the NCIB right now, you're allowed to buy back CAD 130 million in total for the year. The CAD 270 million will be split between two years?
Yeah. Not quite, because the NCIB also allows. There's one block trade a week allowed in addition to the maximum NCIB number. Hard to say where that gets, depends on the size of the block trades, but you get one exemption a week for a block trade.
Okay. It'll be a little faster than the CAD 130 then.
I hope so, yeah.
I guess when you talked about AFFO per unit growth at 4% and NAV per unit at 4.5%, is the majority of that going to be because of the buybacks? They'll reduce the unit count?
The buybacks will contribute for sure. That's the lowest hanging fruit and easiest in terms of execution. Part of it is also our new developments, right, Kim?
Correct. Yes.
Right.
The debt pay down.
The debt paid out, of course, right?
The debt pay down. Yeah, and I want to touch on that as well. Looking at the debt, when you're deciding where to pay down the debt, are you going to be prioritizing more towards the debt that's higher rates but fixed or the debt that's variable?
Probably just go with it as it matures so that we're not incurring penalties to pay off. At the moment, we're not planning on paying off any debt that's not maturing, yeah.
Okay. Yeah, that makes sense. Then the CAD 900 million rough split of asset sales, can you give a rough split between the various sectors and geographies? Just trying to see how much of that is actually going to go down to, for example, office, retail, and you're probably not selling industrial, but wanted to see the split between those two.
Correct. To give you a breakdown, approximately CAD 225 million would be retail, CAD 125 million would be Calgary office, and then the balance would be various office properties in a few different markets.
Okay, got it. I guess, I'm trying to get to that 6.25% cap rate that you're targeting to sell at. The retail and the Calgary office, those would likely be higher than the 6.25%, so it's really the other stuff that will lower your weighted cap rate of sales. Is that the right way to think about it?
Yeah, it's hard to classify them correctly, but for example, a 50% non-managing interest in Winnipeg Square, that's in the CAD 225 million range. It'll be a sub 6 cap no matter what. It'll be in the low 5s, we believe. We did just finish closing Centrepoint in Winnipeg at a 5.9% cap rate, as an example. We've got Poco Place retail/office. We're applying for density there. That cap rate is a 4% all day long. We've got 415 Yonge, that cap rate's sub 5. Concord, that cap rate is sub 6. The bulk of this stuff, it'll be easy to achieve a sub 6 cap rate on the bulk of this stuff. As you said, there's the odd thing that where the cap rate will be higher than 6.25.
Right. That makes sense. Yeah, because I see that you have four, I guess one active residential and three future residential developments listed. All four of those are They'll be sold, right? That's the plan.
Right.
Okay. No, that's helpful. I think there was a question about the maintenance CapEx and leasing, just following up on that. Do you expect that to go back down to, let's say, 2012, 2013 levels, before Calgary office was a big drain? I guess on a per square foot basis or
I'm sort of going to say probably not quite that low. As we reduce our weighting in office, you should see that costs start to come down. Tenants these days seem to still be expecting more Tenant Improvements than we used to have to pay in the strong days in Calgary, for sure.
That makes sense. Is that driven mainly still by Calgary properties, or are you seeing that across the board, like even in the-
No. That's kind of driven across all geographies. Calgary used to probably be the anomaly that it was very low prior to 2014. Today, Calgary, of course, is high, but so are the other markets seem to be gradually creeping up.
Okay, great. Thanks for this. I'll turn it back.
Thank you. Your next question is from Matt Kornack from National Bank Financial. Matt, please go ahead.
Hi, guys. With regards to timing on the asset sales, just wondering from a tax standpoint, you're going to time it such that you don't have to pay any special distributions, I assume?
That's the plan, Matt. Yep. We think we've got the tax structuring worked out that, yes.
Okay. Because some of those assets that you mentioned that are lower cap rates, I would assume have pretty low cost base as well for what you bought them for.
Correct. On the flip side of that, unfortunately, some of the Calgary offices-
Okay
have much higher cost base.
Okay.
There should be some losses to offset.
Gives and takes.
Yeah.
Okay. No, that makes sense. Just from an operations standpoint, your lease renewal spreads have been pretty good of late. Not entirely jiving with your view on market versus maturing leases, at least in the table that shows sort of negative lease renewal spreads. Wondering if you're just outperforming expectation or if it's the specific leases that have come up that have generated positive returns and if we should expect sort of outperformance going forward if those are very conservative numbers in the lease maturity profile you've put forward.
We try to keep those on a pretty conservative basis. We hope we can deliver better results than those, I think those are kind of our-
Worst case
estimate of where it could be, yeah.
Yeah, we're doing pretty good on that front, for sure, all year long. Without a doubt, every time we renew an office lease in Calgary, we get beat up bad, and that's the one place where we're not able to outperform.
With current occupancy where it is, I mean, obviously, you've got higher committed occupancy than in place, but is the expectation to stay in the low 90% range for a while now, or would you expect some occupancy improvement over the next couple of years as well?
Well, it's going to be lumpy. We've got some good news incoming some markets, but we think our Calgary office vacancy will increase. Calgary office NOI will decrease next year before things get better for us there.
Right.
We'll be north of 90% collectively. We sure expect that.
Okay. Yeah, I guess those were higher rent markets at a time, there's probably more rent there than there is actual square footage.
Yep. As we've moved more into the U.S., the stabilized vacancies in the U.S. are a little bit higher than they traditionally are in Canada, not unusual to be
8%-10% vacant in the U.S. market, whereas in Canada
Right
that would be less than that.
Okay, great. Thanks, guys.
Thank you. Your next question is from Tony Troiano from Tofino Capital. Tony, please go ahead.
How are you, Armin?
Very good, Tony.
Armin, after you being so adamant that you weren't going to cut the distribution, and then cutting it by 50% and disclosing it on page four of your press release was like a kick in the teeth. Out of the CAD 83 million that you're going to be saving from the distribution, can you please confirm how much is going to be going back to buying back units?
Our plan, as we've said, and I'll repeat it now, is about CAD 270 million of our total capital will be going to buy back units. We expect to average about CAD 130 million a year, in that range. As Jim mentioned, there may be times because of block trades where we'll buy back more. We're still blacked out. As of Monday, we'll be back in, and we'll be maxing out our NCIB and buying back units.
Thank you.
Thank you. We have a follow-up question from Michael Markidis from Desjardins. Mike, please go ahead.
Hi. Sorry, just a couple of clarifications. On the CAD 800 million-CAD 1 billion, CAD 150 million, if I had that correctly, was the no income producing. Then the six and a quarter, is that on the remainder, i.e., the CAD 650 million or whatever that number would be if you subtract it from the total bucket, or is it on the entire envelope?
It's on the entire envelope. It's a weighted average on the whole portfolio, including the value from the non-performing or non-income contributing assets right now.
Oh, okay. Now I see why you think six and a quarter is a pretty low benchmark to hit.
Correct.
Okay. That's fair. Then just thinking about your segments going forward and looking at sort of the occupancy performance of individual segments. If I just focus on sort of the big ones, Canadian office is obviously one for you guys at 20% of NOI. Calgary office is a drag there. It does seem that your gap between your in-place and committed has been growing as well. Is that something over the next several years that you think will continue to persist, or do you think that, as we move forward here, in-place will start trending higher and the gap between in-place and committed will start to narrow?
Anybody want to grab that call? Specifically, Mike, in Calgary, that gap won't improve for a while, right?
Right.
The in-place markets, that's not going to improve for a while, and we still haven't recycled all of our leases from market, from the in-place down to market yet. We've got at least another year or two to go before we stabilize in Calgary, and then hopefully by then one or two pipelines shows up as well. The office market in Canada is stable or good everywhere, except Calgary is bad, of course. Winnipeg is becoming a bit of a battle zone. It doesn't take much to overbuild in Winnipeg. We feel comfortable with our situation here. You go down to the U.S., the office markets are pretty good, but even in Minneapolis, there's been some overbuilding we've got to watch. We're holding our own very well in Minneapolis, but we've got to watch it there.
Once in a while, you get a tenant leaving, in markets like Phoenix or Denver, and we've got to work through that, but at least they're good markets to be in. On balance, Calgary is what skews the number. On balance, I like to think that the metrics are improving. The U.S. real estate fundamentals are good, not just in industrial, but office. I think the trend is our friend, providing that interest rates don't ruin the party.
Okay. Just thinking about the Canadian industrial, I would imagine your GTA portfolio is doing tremendous right now from a lead occupancy and re-leasing perspective. How are the assets in Alberta holding up?
Also very good. Our industrial vacancy in Toronto is basically the GTA is basically 1%, and yes, we are very strong, same property NOI . Winnipeg is 2%, and Alberta is about 3%, but improving. It's holding up very well. The Alberta industrial retail sector is still performing very well. I think multi-family has turned around. It's not our category, but based on what we know, it's turning around. Office is much weaker. There's just been too much overbuilding. The pipelines are maxed out. They need more pipelines so they can produce more, sell more, make more money. That's where the bottleneck is right now. Of course, in BC, everything's airtight there. We only have one industrial or two industrial buildings in BC. They're both fully leased.
Are rents rolling down in the industrial segment in Calgary? The occupancy is obviously holding up very well, but are rents rolling down, or are they kind of stable?
No, they've stabilized for sure. If anything, they'd be moving up now, at least what we're seeing.
Okay.
They've stabilized for sure, and they're trending north.
Okay. The cap rate on Stapley Center looked really attractive at 8%. Is that an anomaly? I'm just wondering how we should think about that in terms of the quality of that building and how we should think about that relative to the other office assets you own in Phoenix.
I'd call that a historical anomaly. This year, what we have seen, you can check with brokers down there, is a bigger split, if you will, a bigger dichotomy between suburban office cap rates and downtown urban office cap rates. Suburban office cap rates have moved up at a higher rate than urban, which maybe they haven't moved at all. We found that to be a good opportunity. It's a heck of a good suburban office location, that Stapley Center. Our property manager and our leasing manager inside our Phoenix office used to both lease and manage that building, so they knew the building well, they recommended it to us, and so we bought it, and since we barely owned it's already outperforming.
We'll see how long that lasts, but there's a big dichotomy right now in many U.S. markets between suburban office valuations and downtown office valuations.
How would that building compare to MAX at Kierland? Because I think MAX at Kierland's your trophy, right, in Phoenix.
Yeah, MAX is called Class AA. This one is A-minus. Phil is right here. You want to comment on that, Phil?
Yeah. The Stapley building is also older, in a much more mature location that's proven itself. Overall, that Stapley building has never been below 90% in its entire history. It was built in the late 1990s. MAX was built in 2008. Yes, it is a Class AA. Both are in highly amenitized locations.
Okay. Last question from me. Sorry for the long laundry list here. Millwright and the new Denver office property that you built on land adjacent to your existing asset there. Well, Denver is an easy question. Is Millwright contributing anything from an NOI perspective right now, or was it in Q3?
Jim, was it? Well, we're committed at two-thirds committed now at Millwright in terms of leasing.
Yeah. One of those tenants is in occupancy and one not yet.
Correct. Yeah. The latest tenant is still undergoing TIs. That is UnitedHealthcare. That's a Fortune 5 company. We're excited about Millwright, which is in Minneapolis. That's helping the Millwright building, and we continue to get quite a bit of interest from co-working as well for that Millwright building.
Yeah, in Denver, we don't have anything signed yet, but we are trading paper with two different tenants to take a floor each. If we can conclude those deals, that would be 50% leased with that smaller building at 169 Inverness. We feel we're getting traction on a lot of good fronts.
Okay. Those properties are not in your PUD anymore, right? Those are in IPP?
Correct.
Correct. Okay.
I was hesitating on the Denver asset, I believe you're correct, yeah.
Okay. Well, if in addition to the year three FFO number, if you could confirm the carrying value of those assets and the NOI contribution in aggregate in Q3, that would be fantastic.
Okay.
Thank you.
Thank you. Ladies and gentlemen, as a reminder, should you have a question, please press star followed by one. Your next question is from Michael Smith from RBC. Michael, please go ahead.
Thank you. Good afternoon. I guess over the last couple of years, you've sold CAD 1.5 billion of assets, a lot of Calgary office, which you've taken a loss. You've got a bunch of buildings for sale now, including Calgary office for a loss. I guess my question is it fair to assume that you don't really have any tax considerations? In other words, if you sold the full CAD 800 million next year, for example, there's nothing really preventing you from doing that from a tax point of view. Maybe from a strategic timing point of view or you may want to stretch it out. Is it correct to assume that there's really nothing from a tax perspective from stopping you from doing that?
I would say that's generally correct. There's no tax reason that we would hesitate on selling those assets.
Okay. Thank you. You've given yourself three years, but I think, Armin, you said you think the bulk of it will be done in two years. I'm just wondering if there's any motivation to doing it quicker. The second part of that, it sounds like you've ruled out a substantial issuer bid. I wonder if you could just give us your thoughts on those things.
Yeah, if we can hit plan, our pro forma and our model, and achieve these dispositions and these results a year sooner, we will. We'll do it all as fast as we can and move on from there. SIB, we don't see ourselves doing that. A couple of reasons, I guess, is the capital available. Available capital, and also we are watching our market cap. There's a limit to how many we want to buy back. The board is still committed to maintaining its investment-grade credit rating. I guess an SIB suggests a lot of units at one time above market, and we're just not in a position to do that right now.
Okay. Just switching gears, can you just talk about your retail strategy?
We still like retail. We won't own any retail in the U.S. We've got two small enclosed malls left in our portfolio, both in Saskatchewan. We'll sell those. After that, it's all performing well. Grande Prairie is performing well. Fort Mac is stabilized, moving north on the rents there. All the retail is performing well, giving us good same property NOI growth. We don't mind owning it. We've got that retail in Port Coquitlam that has densification opportunities. That's on our books to be sold now. All of the retail we have on balance, most of the retail we have on balance is performing very well, and we still like it. We're not of the opinion that you just get out of retail. We're not of that opinion.
We will get out of the little bit of retail we have left in the U.S. We'll get out of those two small malls we have in Saskatchewan, and then we'll move on from there.
Great. Thank you. That's it for me.
Thank you. Your next question. It's a follow-up from Walter from Ronin Management Inc. Walter, please go ahead.
Thank you. Just to be a little bit controversial. As one of your alternate strategies, did you ever look at Artis REIT from the perspective of an investor and ask yourself what would be the investor's return if you were to sell everything and distribute to current unit holders?
We give that some consideration in terms of a strategic review, if you will, and which was informally undergone. There's two directions. One is you sell the REIT to the best maximum price you can get, and the other is implement a new strategic plan. Our largest shareholder that owns 11% of our units is on our board. Our largest shareholder, as well as all of the board members unanimously, we have the opinion that now is not a good time to pursue selling the REIT or selling all of the real estate and shutting down. They think we've got a good plan here, a good opportunity to increase value, increase unitholder value, increase our NAV. The idea of selling the REIT or entertaining offers for the REIT, it can always be revisited at another date. That's not the direction.
The board unanimously agreed that the best way to maximize unitholders' value would be to implement these new strategic initiatives.
Even with the difference between the NAV and what the REIT is trading for on the market now?
Yeah. There's a concern that in a rising interest rate environment, we might not get bids at our NAV of CAD 15. The concern that the bids would come in lower, they'd be underwhelming, and then we'd be just wasting our time. Notwithstanding what I just said, the board will entertain any reasonable offer that maximizes unitholder value if it comes in. We've never, for example, had a friendly offer or any offer at all that we've said no to, that we've never engaged in. We've just never had any offers at all in the first place.
Well, that's why I went to the selling of all of the assets and the distribution out to-
Yeah
unitholders.
I get that. My understanding is, and Jim's right here, we would need unitholder approval to sell all the assets and to return the money to our investors. Yeah, we'd have to either call a special meeting on that, or we'd have to deal with that as a special agenda item at our next AGM. Sometimes that's the best way to maximize value, just liquidate all the assets, right? It's a very disruptive thing to do. You've got G&A issues, management team issues. Before you know it, you're negotiating retention bonuses and changing control bonuses with a lot more employees.
No, I understand all of that. Yeah.
It's very disruptive. That scenario might be the best one that maximizes value today. The board doesn't want to pursue that right now.
When the board reconsiders that, have them understand that, let's say I got back my NAV on that, minus a few transaction costs. If I got back my NAV, I would be able to go elsewhere and invest it so that I could rebuild. Not as well as Artis, of course, but approaching what Artis accomplishes. Just a thought.
Point noted. Thank you.
Thank you. We have a follow-up from Howard from Veritas Investment Research. Howard, please go ahead.
Thank you. Just wanted to ask about the follow-up on the development properties. I guess in your MD&A, you have the value at just over CAD 100 million. In the presentation, you're listing CAD 200 million. Is the difference because some of those future developments that are not input, that's part of the CAD 200 million?
That's correct.
Okay. Just in terms of timing, this is kind of a three-year plan. Do you expect the CAD 200 million of development assets to all be complete and kind of fully functional income-producing properties by the end of the three years or end of two?
In the two to three range, I would say. Yeah.
Okay. I guess, in terms of thinking about how much NOI those properties can bring, I've kind of factored in a seven and a half cap rate for development. Is that kind of where you're thinking too, or too high, too low?
That's exactly where we are.
Okay. Great. That's helpful. Thanks. I'll turn it back.
Thank you. There are no further questions at this time. Please proceed.
Thank you again, moderator, and thank you again, everybody, for joining us on this call. Just as a footnote, a sidebar, Jim and I will, of course, be in Toronto during the Toronto Real Estate Forum the last week in November. There's a debt conference that we'll be participating in, debt marketing conference. On Tuesday and Wednesday of that week, so November 27th and 28th, we will be making ourselves available for follow-up meetings with real estate bank analysts and with institutional investors. You can feel free to reach out to us if you want to book meetings with us on November 27th and 28th in Toronto. Thank you again, everybody, for joining us, and have a good weekend.
Ladies and gentlemen, this concludes your conference call today. We thank you for participating and ask that you please disconnect your lines.