Earnings Call: Q2 2018

Aug 3, 2018

Good morning, 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 2018 Conference Call. Thank you, everyone. And I would like to turn the meeting over to Mr. Armin Martins. Please go ahead, sir. Thank you, moderator, and good day, everyone. Welcome to our Q2 2018 conference call. So again, my name is Armin Martens. I'm the CEO of Artis REIT. And with me on this call is Jim Green, our CFO as well as Kim Reilly, Senior Vice President of Investments and Development Heather Nichols, VP of Investor Relations and Phil Martins has joined us today as well, EVP of U. S. Operations. So again, to begin with, I'd like to advise all listeners that during this call, we may at times be making forward looking statements and we therefore seek safe harbor. So please refer to our website as well as see our filings such as our financial statements, MD and A and our annual information form for full disclaimers as well as information on material risks pertaining to all of our disclosures. So again, thanks for joining us. I'll now ask Jim Green to review our financial and operational highlights, then I'll wrap up with some market commentary. And of course, then we'll open the lines up for questions. So Thanks, Armin, and good morning, everyone. So a quick summary of the REIT. This is a diversified commercial REIT. We have assets in 5 Canadian provinces and 6 U. S. States. We do some calculations in our MD and A disclosure to show the impact of an adjustment for a proportionate consolidation of our joint venture interests. In our opinion, some of this is more appropriate language. And while it does turn the numbers into what are considered non GAAP, in many cases, we feel it's more relevant and the bulk of my discussion will be about the proportionately consolidated numbers. Based on Q2 NOI, Artis is 45.3% weighted in Western Canada or 11.4% in Ontario and were 43.3% in the United States. On an asset class basis, we're 53.1% weighted in office, 20.7% in retail, 26.2% in industrial. Given our Western Canadian weighting, a specific focus for us since the oil prices collapsed in late 2014 has been to reduce our exposure to the province of Alberta and the Calgary office market in particular. Looking back 3.5 years ago to Q3 'fourteen before the oil prices crashed, our geographic mix resulted in 38.9 percent of our NOI coming from the province of Alberta with just over half of that or roughly 9.3% coming from Calgary office properties. And based on Q2, the adjustments we've made, our Alberta exposure is now down to 21.7%, Calgary office is only 8.2% and that's even with including some lease termination income. And without the lease termination income, we would have been down to around 7.5%. As mentioned on our year end call, we feel we fully executed our commitment to diversify while continuing to sell at good prices in the current market. But having said that, we are continuing with the process on a patient basis and we sold 2 more Calgary office properties this quarter along with a BC property at a very attractive cap rate. We have relatively manageable exposure to the Calgary office market in the near future with just over 116,000 feet left to renew in 2018, only 141,000 feet in 2019 and only 47,000 feet in 2020. As mentioned before, our acquisition and disposition activities have been mainly focused on capital recycling to further diversify and improve our portfolio. And in this quarter, as I mentioned, we completed the sale of 3 properties and acquired 2 new sites for future development opportunities, future office site in Madison in close proximity to our other assets and an industrial site in Denver that we have a preliminary start already with a joint venture partner to build that out. Artis continues to be active in both new developments and redevelopment of our existing properties, has roughly $89,000,000 invested in properties under development at the end of the second quarter. During the quarter, the increase is roughly $10,000,000 in development properties under construction. As detailed in our MD and A, we have several new development projects that are just getting started, including a new residential tower at 300 Main, a new industrial space in Houston, Phoenix and Denver. Also as detailed in our MD and A, we have several development projects in the planning stages where we haven't actively started yet, but they're progressing nicely through the development stages. We're not anticipating any difficulties being able to develop those properties. We've been able to maintain our balance sheet with debt to GBV relatively flat, up just a fraction from 48.9 at the end of Q1 to 49.0 at June 30, but still down from the 49.3 that we were at December 31 last year. Our EBITDA interest coverage ratios remain over 3 times and we're pretty comfortable with that. The sales program we implemented through 2016 'seventeen to sell assets and reduce debt has had a dilutive effect on our FFO and FFO came in this quarter at $0.32 versus $0.36 in the comparative quarter last year. And I'll talk a little more about the changes from Q1 a little later in my discussion. AFFO for the quarter was $0.24 which does result in our payout ratio being above 100 percent, actually 112 to be exact. AFFO was also impacted by some of the same items as FFO. And as we've said, at year end and in Q1, our mission is to grow back into that distribution and we're working as hard as we can to achieve that goal. So just highlighting for a few minutes the more financial position results. So on a fair value basis, our investment properties are valued at fair value. And this quarter, we saw an increase of $23,900,000 largely driven by the hot markets in Toronto and Vancouver, which continue to increase in value, mainly rent driven this quarter, not cap rate compression. So that's actually pleasing to us that we're seeing higher rents in those properties. Continue to monitor our retail valuations, although this is our smallest segment. And at the current time, we're not anticipating major changes in fair values for the rest of the year. However, we do think that we will see further increases in industrial valuations as recent market transactions in that sector have been at pretty low cap rates. We remain pretty comfortable with our debt to GBV ratios, as I mentioned, almost constant this quarter at 48.9 percent 49.0% versus 49.3% at year end. Unencumbered assets, we've maintained a pool of between $1,600,000,000 $1,700,000,000 of unencumbered assets, down slightly this quarter because the asset we sold in Vancouver production court was unencumbered. We'll be using the proceeds at least partially for new assets and maybe a little bit of debt repayment that will bring the unencumbered pool back up again. On our credit lines, Artis has a $500,000,000 unsecured revolving credit facility with a syndicate of lenders and we also have 2 non revolving unsecured credit facilities in the aggregate amount of a further 300,000,000 dollars We've extended the maturity dates on the revolving facilities this quarter such that one tranche now matures in 2021 and the second tranche in 2023. Both of the non revolving facilities have been drawn in full and we placed interest rate swaps to fix the interest rates on those facilities as we'll be expect they will be outstanding for the full 5 year term. Looking briefly at a couple of highlights from the results of operations. One we monitor fairly closely is, of course, the same property operating results. And this quarter, it was a positive 1.3% in functional currency, but unfortunately a small decline of 0.3% once foreign exchange was factored in. The FX ratios in Q2 of 2017 were quite a bit higher than they were in Q2 of 2018. We also present a stabilized same property calculation, which eliminates properties planned for disposition and repurposing as well as the entire Calgary office sector. And on this basis, we had growth of 3.5% in functional currency and 1.4% once FX was factored in. By asset class, the office segment in Canada was the weakest and also in the United States. Although interestingly enough, the Calgary office sector actually had positive same property growth of almost 6% this quarter. So that's an interesting statistic. Retail in both Canada and the U. S. Was remains fairly strong and we also had good results from the industrial portfolio with our strongest results coming in the U. S. Industrial segment. During the quarter, we were able to achieve a weighted average rental growth on leases maturing this quarter of 5%, and this growth will help contribute to further same property growth in future quarters. Looking at our FFO and payout ratio. All right, I guess that's the not so fun part, but we'll touch on it anyway. As I mentioned in my opening results, the FFO year over year has declined with the largest driver being the dilutive effect of asset sales with the proceeds being used good portion of the proceeds being used for debt reduction. So FFO for the quarter on a diluted basis was $0.32 down $0.01 from last quarter and down $0.04 from the same quarter last year. And then comparing back to Q1, so the Q1 FFO was $0.33 However, that did include a fairly large non recurring lease termination income. So overall property level NOI almost identical to Q1, numerous adjustments going both directions to result in that. No one major specific driver that was a big factor. We did have of course growth from the assets we acquired in Q1, but that was offset by the lower lease termination income this quarter. To put numbers on that, we received 2 point $15,000,000 in lease termination income in Q1, but only $860,000 this quarter. And if we run the math of calculating FFO exclusive of lease termination income, the drop from Q1 to Q2 is 0 point 0 $8 We did incur higher interest costs this quarter partly due to the acquisition of properties in Q1, but also driven by higher interest rates on the variable rate debt that continues to creep up. We also generally see higher corporate expenses in Q2 compared to Q1, our cost of holding the AGM and a few other reasons. But corporate expenses are comparable to Q2 'seventeen, but it is up just over $400,000 from Q1 of 'eighteen. That's not unusual for this time of year, but that's also an impact in the FFO decline. Despite the drop in FFO, we remain convinced that our strategy has been correct to improve the balance sheet in the current operating environment at the same time as we are diversifying away from Alberta. The FFO payout ratio this quarter was 84.4%. Flipping over to AFFO, it's impacted mainly by the same items as FFO declining from $0.25 at Q1 to $0.24 this quarter, but that is down $0.03 from the same quarter last year. But does give us as I mentioned an AFFO payout ratio of 112%. We are working as hard as we can to get that payout ratio back to a more reasonable ratio. On the EBITDA basis, there is EBITDA calculations in our MD and A and the main ratios we track are EBITDA interest coverage currently at 3.02 times and debt to EBITDA currently at 8.8 times. I guess one of our highlights this quarter would be our net asset value going up from $15.03 last quarter and $14.86 at year end up to $15.39 this quarter. So we're pleased to see our values continue to rise. Subsequent events, Artis ended the quarter with $165,000,000 cash on hand. The reason the balances are so high is that BC sale closed right at the end of June. So we had a lot of cash on the balance sheet with didn't get it moved within that day basically. And then we had $279,000,000 undrawn on the line of credit. We've detailed several events in our subsequent events note, which we believe continue to reflect our strategy of intelligent recycling of capital. Plan to continue our focus on a strong balance sheet and improving the overall quality of our portfolio while growing back into our distribution. That completes the financial review. We're pleased with the NAV growth, the same property income growth, our weighted average rental increases and our new development activities. Not as happy with the FFO decline, but I hope I explained that. We look forward to demonstrating results from operations in future quarter, and I'll pass it back to Armin now for a bit more discussion. Thanks, Jim. We're focused on balance. We feel that Artis is progressing well this year. Our earnings, our balance sheet, our liquidity are in good shape. Our NAV is trending well. But we're not out of the woods yet. Our industrial and retail properties are performing quite well and have a good history of doing that. But our office portfolio is still inconsistent, much of this was due to the Calgary office market. It continues to be our view that both the U. S. And Canadian economies will perform fair to good this year and next with the advantage going to the U. S. Economy. However, the hawkish monetary policy on both sides of the border is giving us some concern and increased interest rates are now impacting our earnings. Our capital recycling program for 2018 is on track and we continue to guide that we'll recycle between €200,000,000 €300,000,000 at properties this year with a view of continuing to reduce our exposure to the Calgary office market. Now in terms of the Calgary office market, we're grateful for our positive same property NOI this quarter as a result of a significant lease, but we're not out of the woods yet, including some of the space vacancy rates of about 28% in the Calgary now and will of course take some time before stabilizing and improving. Oil and gas prices, however, have stabilized and bridge Line 3, Easton XL transbounding will eventually get done as the OPEC deal continues to have good traction. We're bouncing along the bottom with respect to office leasing rates. Capital spending and job creation is slowly but surely increasing in Alberta, and we're seeing green shoots of economic and tenant activity. It may be slow protracted, but it is our view that the economic recovery is well underway in Alberta and will be sustained for many years thereafter. As mentioned, our industrial and retail portfolios are performing quite well on both sides of the border and indeed have a long standing track record of success. Our challenges remain isolated to our office portfolio. So looking ahead, we will continue to work hard to keep our buildings full whilst bringing the rents up to market and consistently improving our real estate portfolio as well as our NAV per unit to it as the message is on a good trend line. So that's our report for this quarter folks. Notwithstanding our challenges, we are pleased with the results and confident in our outlook. And I'll now ask the moderator to take over and filter your questions. Thank you, sir. And your first question will be from Jonathan Kelcher at TD. Please go ahead. Thanks. Good morning. Good morning. First, just on Calgary office, good to see positive same property NOI growth there again. Do you expect that to continue through the next few quarters given that your occupancy is, I guess, up 700 basis points or so quarter to quarter? Who wants to answer that in this room? The trend is our trend there, but our overall Calgary office NOI, it's not I mean, not all of our buildings are stabilized. Maybe half our buildings are stabilized in the sense that we finished resetting all the leases to the new market rents or maybe half of our leases is the right way of putting it and then the other half isn't. So we're not out of the woods yet as I've been saying. But it wouldn't surprise me to get a quarter or 2 more of positive data out of just because of that one major lease. And we don't have as you look at our lease profile, it's disclosed by MD and A, we don't have a lot of lease rollover right now in Calgary. Okay. That's good. And then just turning to, I guess, your capital recycling program, I guess you sold about $160,000,000 so far this year. You've committed to buying roughly $130,000,000 dollars in terms of acquisitions. Would it be fair to look at the balance of the 30,000,000 going into development? Actually, it will go to another acquisition, very good one that wasn't disclosable on time for the release of these results. But we'll go into another acquisition and we'll move on from there. So roughly a $30,000,000 acquisition? Closer to $50,000,000 Closer to $50,000,000 Really, really good acquisition. Okay. And I guess you're not going to give much more color on that? No, but you'll like it. Okay. Well, that's looking forward to hearing about it. How much would you expect to spend on your development program over the back half of this year? Got that number. Ballpark another $30,000,000 to $40,000,000 over the course of this year. Okay. And then just lastly, can you maybe give us an update on where you stand on leasing in Inverness? Glad Phil is here. What's the latest update, Phil? We continue to get interest on full building users. We also have potentials where we have owner users who just simply want to take us out. So it remains active in Denver. We have a program also to multi tenant the building and yet our brokers advise us to yet remain patient. We are in month 6 of our budget 18 month lease up program. So we're waiting to go through the summer and hopefully have a lot more traction in the fall. Okay. And now is that property in the rental pool or is still in the pod? It's now back in yes, it was transferred as a completed operation at the end of Q1, I believe. Okay. Thanks. I'll turn it back. Thank you. Next question will be from Fred Blondeau at Echelon Wealth Partners. Please go ahead. Thank you and good morning. Good morning, Fred. Three quick questions Ed, we've been in this situation before where our debt ratio was actually much higher and we've patiently worked our way through it. In the last 14 years, we've raised our distribution twice. We've never cut and we're not no discussion of cutting it. Okay, fair enough. And then maybe a more high level question on you have a rather ambitious business plan in terms of development, redevelopment and even intensification initiatives. How do you feel about the construction costs at this point? And how do you think they could affect or further affect expected yields? Yes. Costs are not coming down. In terms of our development pipeline, we're building this 1 multifamily building in Winnipeg because it's on top of a parkade we own, connected and office building we own. But otherwise, our ambitious densification program, the multifamily part of it, we expect to sell off the entitlements, the land once we get the rezoning. We don't expect to build any of those, because we don't expect to have multifamily in our our portfolio. We don't want to afford the asset class in our portfolio. Even the multifamily Winnipeg that we build, we'll look to exit that building as well as soon as possible. So we'll stay with our 3 asset classes. In the U. S, it's pretty manageable. The industrial buildings, these are working out very well for us. We've sold 1 at a time. We lease them. We keep going. Our industrial portfolio is performing well on both sides of the border and including new greenfield developments as we build the buildings that we get good leasing traction. Okay. And maybe lastly, I was wondering if you could give us a bit more color on the 3.3% and 5% cap rates achieved on Oak Air and Production Corp? Well, let's Ken address that a little bit if you want to. Heck of a cap rate, isn't it? Well, I mean, yes, I mean, it trends the O'Clare building and that other smaller building on Fifth Avenue, I guess it was the former Bridgecrest building, both of them were substantially empty. And so the cap rate automatically was low. But the price was based on price per square foot. It was right online, in line a little bit the price was a little bit better than our IFRS valuation, which translates or corresponds to $15 a unit. Then production corn was a clean 4.9 cap rate on NOI. It was 99% leased. The Burnaby market, not Downtown Vancouver, we thought we did well and we thought we know we have a good use of proceeds in terms of recycling that. Yes. Thank you. I'll leave it there. Thank you. Next question is from Mike Markidis at Desjardins. Please go ahead. Hi, everyone. Armin, just to start off, I was wondering if you just shed a little bit more color on the decision to sell CenterPoint. Your strategy has been to try and acquire new generation real estate and a 6 cap for a new generation office building in Canada didn't seem necessarily that robust. So maybe you could just share your thoughts on that one? You're right. A couple of things that come to mind there, Mike. First of all, we are heavily invested in the Winnipeg office market. We are for sure the largest office landlord in Winnipeg, right downtown Port au Main connected to the Skywalk system. And this building was partnership. We're fifty-fifty partners. We were not the managing partner. So that wasn't our preferred way to be a partner. And also the building did not have a Skywalk connection. We thought this we considered it after a while to be a non core asset. We had a long term lease there, I guess, 10 year lease, 11 year lease with Stantec with 7 years remaining. And you know the way it works, we decided that now was the right time to sell given the amount of tenure left in order to maximize the price. So those kind of things came to mind and we felt we had a good use of proceeds in terms of redeploying the money. Okay. That's helpful. Thanks. Second, I'm just trying to get a little bit just to make sure I'm clear in reconciling some of the disclosure in the MD and A in terms of the development activity in the balance sheet. So, Jim, if I understood you correctly, the PUD balance of $89,000,000 that doesn't include any of the 100% completed developments, it only would include the developments that are in process? That's correct. Okay. And sorry, go ahead. Yes. The completed one gets transferred out when their production is finished in essence. Okay. And what about Sierra Place? Is that in PUD or is that? That's a good question. No, I believe it's still in the income producing properties pool. Okay. So then just digging in a little further on that, the new developments that have been completed, but like do you have a sense of what the contribution of NOI for those three properties was during the quarter and then on a stabilized basis where you expect those to get to? No, okay. No, Mike, I'm sorry, I don't have a number off the top of my head on that. There was very little contribution from them this quarter. Of course Inverness is still not leased. It's actually a little bit of a negative drop because there's some operating costs getting written off now. Okay. We can follow-up offline. That would be helpful disclosure to get. And then just, I guess in your NOI reconciliation, there is a you've got your property NOI, your same property and then the acquisition dispositions and the contribution from development and redevelopment. So again, just trying to reconcile what that I think was $704,000 what's included in that figure. So if that's part of the offline discussion, we could certainly wait for that, but would be nice to sort of just reconcile all those different line items. We're going to have to take that one offline too, Mike. I don't have Okay. Let me get with me. Great. Last one for me before I turn it back. Just on Wisconsin, I noticed that when you guys first bought that portfolio, I think it was high 80s occupied and you drove it into the low 90s. And last several quarters, we've kind of been trending back down to the high 80s. I wonder if you could give us an update on what you're seeing there and how the NOI is performing? Yes. This is Phil here. Part of the real one tenant ended up building their own building and that we knew going in to due diligence. So this is at 8,401 Greenway. That's where you're seeing the biggest vacancy. So what we've done there is we have remodeled the lobby and we've created new building standards for the elevator lobbies and bathrooms and we do a regular broker events and we've had some very good traction there for about 4 floors now available and we've got RFPs on 2 out of 4 of those floors already. So we've had some good success with remarketing that building. Yes. So when we actually bought the portfolio, this goes back almost 2 years, right? We actually knew that tenant had signed an agreement to do a build to suit and to vacate. We were optimistic that we'd have the space leased to University of Wisconsin by the time they left. We didn't get that deal done, but we're now the space vacant. We have a very good leasing program in place and we're optimistic we'll get it leased up again. Okay, great. That's it for me. Thank you. Thank you. Next question will be from Jenny Ma at BMO Capital Markets. Please go ahead. Hi, good morning everyone. Good morning. Just as a follow-up to Wisconsin, you bought a piece of land out there And my understanding was that for a number of your properties in the Wisconsin portfolio that there was some excess density already. So when you think about the excess land you already have and the fact that Madison is typically generally be sort of in a stable market in the low 90s range. Can you just talk a little bit about what you're seeing as far as development opportunity and how this new piece fits into your plans for office development in that market? This is Phil again. This particular land that we acquired was a part of an auction that we inherited with the portfolio that we wish to exercise in order to protect at least at a minimum as a defensive position with our office assets adjacent to that site. And we also have a pretty large parking structure also adjacent to that site. So that was simply a completion of a plan when we first acquired the portfolio. We actually had been pursuing a build to suit. We've seen quite a bit of growth in the health area from everything from pharmaceuticals to insurance. And so we consider it to be a very good defensive strategy For some of the other lands that we have there particularly in Heartland Trail, we can announce more in the Q3, but we are negotiating with existing tenants to expand on their site. And we are just wrapping up leases there. So we're encouraged to see that we're getting quite a bit of growth from existing tenants. And we're glad that we have that land. That expansion is 50,000 square feet right now. It's actually more than that. It's going to be a 50,000 square foot extra structure, but also an additional 20,000 square feet expansion from the existing site. Yes. So we're grateful for having to have some surplus land in that market, Jenny. And that one property in particular, we do want to protect our flank, so to speak. We don't want a competitor a design build to suit for a candidate right beside us. So that bit of inventory we thought was a good investment. Okay, got you. And are you able to speak to whether or not the portfolio you have there appeals to sort of the burgeoning tech market in the local area? Or is it a different kind of space that those users are typically looking for? Yes. Well, we do sometimes get one of the big what the big tech company there is called Epic and they provide operating software for hospitals throughout the world. And they get often spin offs, which we have at times inherited, which has been great. And also they've expanded within our so yes, it's becoming increasingly a medtech hub in the Midwest. And it helps having University of Wisconsin as sort of incubator, but also this major software company also in Madison. So it's been we have other oddities like, I don't know if anybody knows about the Call of Duty video game, but the Is that Activision? That Activision, they occupy a bulk of 1 of our buildings as well. So we get a variety of tech, Madison. Okay. Okay, got you. And then moving to Calgary office, could you shed some color on what kind of buyer it was for Birchcliffe Place. I'm just trying to think about who's kicking the tires for properties that are basically empty in Calgary office and what do you think they're seeing in those properties? And what kind of opportunities over the longer term? This is Kim. I can comment specifically on the sale of the First Step building. That was a buyer that was planning on turning it into a hotel. So we're seeing a lot of buyers like that that are looking at properties as redevelopment opportunities, whether it's hotels or apartments, multifamily. So that was that specific buyer. Could you speak to the profile? Is it a local buyer? I think he was local. I'm not completely familiar with his background, but as far as I know, he was a local buyer and he's done this before in terms of turning buildings into hotels. So that was kind of his the company's business logic. Okay. And then just as a general observation, what kind of buyers are you seeing out in the Calgary office market these days? So opportunistic, private, some institutional. So it's definitely a blend. You gave them domestic institutional? Yes. Would you say? Yes, for I mean there's the U. S. Buyers out there as well. But what we're seeing what we've sold and you remember, Jenny, I guess, it was last year we sold Alpine Cortinal Alpine Buildings to an offshore buyer from Asia. So it's a mixture, but that I would call private buyer, not institutional. And the last interest so the last and Production Court Eau Claire was again a private buyer from BC. We are expecting and on that point, the BC buyers, the BC private buyers see value in Calgary right now. Okay. Great. That's all for me. Thank you. Thank you. And at this time, Mr. Martins, it appears that we have no other questions. Sir, I would like to turn the call back to you. Well, thank you, moderator, and thank you again, everybody, for joining us on this call. We wish you all a good productive day and a great long weekend. Take care. Bye bye. 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. Enjoy your weekend.