Time, I would like to welcome everyone to the SLAIT Retail REIT First Quarter 2019 Financial Results 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. Session. Thank you.
Madeline Saracini with Investor Relations, you may begin your conference.
Thank you, operator, and good morning, everyone. Welcome to the Q1 2019 conference call for SLAIT Retail REIT. I am joined today by Greg Stevenson, Chief Executive Officer and Robert Armstrong, Chief Financial Officer. Before getting started, I'd like to remind participants that our discussion today may contain forward looking statements and therefore ask you to familiarize yourself with the disclaimers regarding forward looking statements as well as non IFRS financial measures, both of which can be found in management's discussion and analysis. You can visit Slate Retail REIT's website to access all of the REIT's financial disclosure, including our Q1 2019 investor update, which is available now.
I will now hand over the call to Greg Stevenson for opening remarks.
Thank you, Madeleine, and thanks to the participants for joining the call this morning. We continue to gain momentum on it and our achievements in the Q1 reflect both the team's tremendous efforts and highlight the durability and attractiveness of the REIT's grocery anchored and necessity based real estate portfolio. Strong organic growth continued throughout the quarter. We ended the quarter with an occupancy rate of 93.3% and executed on more than 375,000 square feet of leasing including 2 anchor renewals. Our proactive approach to leasing has resulted in 44% of all 2019 renewals already completed by the end of the Q1.
We also achieved an industry leading 94.8 percent tenant retention ratio demonstrating that our properties continue to be highly sought after by tenants in our markets. As a result of these efforts, we achieved a 0.4% increase in same property NOI year over year and a 2% increase when including the growth from recently completed redevelopment projects. We completed another redevelopment project during the quarter adding to the 2 completed in Q4 2018. NOI attributable to our 3 completed redevelopment projects increased to $600,000 in the Q1 a threefold increase over the same period last year. We expect completed redevelopment projects to continue to add to NOI growth in the coming quarters.
We have begun to make progress on our disposition pipeline selling 2 properties for $24,900,000 at a 7% cap rate. In addition, we have sold 2 non core out parcels for $3,200,000 at a 5.4% cap rate. The dispositions will allow us to pay down debt and reduce our leverage further strengthening our balance sheet. As importantly, we are able to accomplish this capital recycling program by selling properties that are stabilized where we have executed on our business plans and extracted value. The properties would rank in the lower tier of our portfolio.
Upon execution of the disposition pipeline, we'll be left with a higher quality portfolio and excess liquidity to deploy. In addition, as income grows and capital spend on existing project nearest completion, we expect our AFFO payout ratio to decline toward 90% setting the stage for a 6th consecutive distribution increase in 2019. Units of slate retail generate substantial excess yield today above 9% and we believe represent an attractive investment opportunity. To summarize, we are entering the quarter with a 93.3% occupancy rate. Steady NOI growth was achieved bolstered by redevelopment projects being completed.
2 property dispositions were completed at a 7% cap rate, which compares favorably to where units of slate retail are currently trading today. All such factors contributed to a very strong quarter. We are encouraged by the positive underlying fundamentals in our portfolio that will set the stage for our team to execute on the business plan ahead and deliver stable and growing distributions to our unitholders. We thank you for your continued support. And I will now hand the call over for Q and A.
And your first question comes from the line of Stefan Boire with Echelon Wealth Partners. Please go ahead.
Thanks. Good morning. I just had one very quick question regarding the Hocking Valley Mall. I was just wondering, is the yield on the redevelopment in line with your expectations?
Slightly below expectations. That Stefan, I think you'll see a mix of redevelopment projects. Some are going to be high yield on costs, where it's you see significant income generation. Others like Hocking Valley, where the yield on cost isn't as high, which is what I think you're alluding to, you're going to see meaningful cap rate compression. So that was the center that we redeveloped and we bought at a higher cap rate that I think we've probably achieved 1 150 to 200 basis points of cap rate compression.
So the IRRs in both instances which is whether it's a high yield on costs or cap rate compression project are always going to be probably similar like in the teens to low 20s. But, Hawken Valley, it's a 25 year brand new Kroger. And like we've scraped the box. It's a rebuild, new shop space tenants, everything is relatively new. So it's a bit different than the others where we've replaced a few tenants and using the existing box and where we've seen a high yield on cost.
So it's just a bit of a different plan, but the IRR is still very strong due to the cap rate compression.
Okay. Thanks. But could you remind me what was the initial or the expected yield on that project?
It was around 6% was the expected yield.
Okay.
Yes. I don't know that that really matters. But I think the important part is that we hit our IRR targets, which is how we calculate our return on invested capital.
Okay. Okay, great. Thanks.
Your next question comes from the line of Sumayya Hussain with CIBC. Please go ahead.
Thanks. Good morning. Good morning. Greg, if you wanted to unitholders, the tone felt a bit more positive and you mentioned that sentiment is improving. What are you seeing on the ground and maybe in your conversations that's behind this optimism?
Is it just feedback from your asset sales? Or do you think it was just a matter of time for people to realize that fears for e commerce just aren't playing out the way they expect it to?
Yes. I mean, I think we've always been positive. We believe in our business and I think going back for the last 2 years and more, the fundamentals have spoken for themselves and so have our results. And we've been effectively 94% 95% occupied for 5 years now. I think on the sentiment side outside of these four walls, I think everyone slate has always been a believer.
You're now starting you're for sure now starting to see and I'm sure you have as well that the headlines on grocery retail have been more positive. We talked at the AGM yesterday a lot about Amazon saying that they're really struggling with online grocery and that they're going to create their own brick and mortar grocery store outside of Whole Foods. You've read about how Walmart and Kroger and Publix have been very successful leveraging their network of stores. So I think it's a bit of a mix. I mean I think our operating fundamentals continue to be strong.
Our asset sales continue to have interest and are at prices that are very attractive both on an absolute and relative basis I. E. There's lots of demand for grocery anchored real estate. And thirdly, I think that the headlines Wall Street Journal or otherwise have just been far more positive in the last 6 months than they have in the last probably 2 years.
That's fair. And then just kind of to pull on that as you continue to sell more of your bottom tier assets, how do you see the NOI growth profile of the remaining portfolio evolving? And just related to that, what kind of valuation or CapEx do you think the residual portfolio should be valued at once you're sort of through your sales program?
Yes. I think the residual portfolio, we're definitely trying to sell assets that are either for risk profile, don't make sense, we want to upgrade the quality or 2. And I think just as importantly where we believe that we've realized maximum value and execute on our asset plans from that perspective. So the NOI growth that we would see from the residual portfolio, we still think would be on an annual basis between 1% to 3% depending on the year. But as far as the cap rate compression, we're at a 7.49 weighted average.
I think we would see that come in, all things being equal. But we think that if we sell the $170,000,000 $200,000,000 of properties within the next year, it would be a positive story for what's left for growth as well as what we have for growth capital and definitely upgrade the quality of the overall portfolio.
Okay, great. I'll turn it back. Thanks guys.
Your next question comes from the line of Matt Logan with RBC Capital Markets. Please go ahead.
Thank you and good morning.
Good morning, Matt.
Just following up on the last question. In terms of your organic growth, in your letter to unitholders, you mentioned about 3.4% NOI growth. How much of that would be organic and how much of that would be driven by redevelopments?
I think we I mean we've got signed leases that haven't yet commenced paying rent and that number in the letter is $1,700,000 which excludes recovery income. So I think you can comfortably move that number to $2,000,000 to include that. So that's $2,000,000 on less than $100,000,000 of NOI. So that's 2% right there. That's already contractual.
That just hasn't started yet. And then I think you can probably add the other $2,500,000 to $3,500,000 of NOI number that we used in the letter from redevelopment that won't all be 2019. Some of that will carry into 2018. If you sort of add those two numbers together, there's somewhere between 4.5 $1,000,000 to $5,500,000 of NOI on $99,000,000 of NOI. So we've got somewhere between 4.5% to 5.5% growth and you can sort of split that between organic and redevelopment that we expect to come in the next 18 months.
Okay. It's good color. Appreciate the commentary. Just shifting gears, in terms of some of your recent leasing activity, you give us a sense of which tenants are expanding in your portfolio and which ones are rationalizing space?
Expanding, it's been pretty consistent. You've got your health and beauty, you've got your fitness, your medical, your dental, quick service restaurants and your dollar stores. I would say at the top of the list, just on the top of that list and off the top of my head, not a ton of rationalization. I mean we've been and I think this is because we're less power and we have virtually no apparel and like no books or electronics or any of those things you see in a power center. The rationalization within our portfolio has been muted.
You can kind of see that just looking back at our occupancy levels. I think we've lost like a Payless shoe store or 2 and that's really it. So nothing yet and we don't see anything on the horizon. It doesn't mean it may not come, but we talk to all of our grocers and all of our junior and regional national tenants on a very, very regular basis and everyone's business seems to be going quite well. And in the markets that we're in, the customers are supportive of the businesses.
Again, it's everyday necessity based retail, so it's not discretionary spend. And I think we're pretty optimistic on the outlook for our portfolio being as durable in the next few quarters as it has been over the last 2 years.
Yes. And what I would add as well as in a number of cases where we don't have grocers turning back space and having any instances of that. We have had requests for additional capacity or different things at the site to able to support some of their e commerce activity that's being delivered by the store. So whether it be parking spots, places to deliver, van parking for delivery, all things which are positive and just making that real estate more valuable as they can entrenched in that business within our markets. So from that perspective, all positive as it relates to the grocers.
And in terms of your e commerce initiatives, is it still more along the lines of click and collect or are we starting to see grocers using their stores as kind of last mile distribution centers to an extent?
It's been a mix. You've got your click and collect. You've got your personal shoppers. You've now got a lot of mobile and digital technology coming into the stores, you've got your grocherons, which is a word I hate to use, but that's what they call it, which is just prepared foods and restaurants that are now taking space inside the grocery stores. And you've got I think we're in the early innings, but it's gaining momentum very quickly.
You've got a lot of our grocers and stores talking a lot about the last mile distribution and leveraging their stores in order to do that. I think that's moved from speculation or from theory into practice. We talked about this at the AGM yesterday, dollars 850,000,000,000 of at home food spend in the United States, there is a lot of venture capital in the United States looking to figure out how to help the grocers turn their boxes into many distribution centers and there's real life examples out there today. And we talked yesterday a bit about takeoff technologies and there's others. So it's happening not in massive quantities at the current moment, but the one thing we love about the U.
S. Is that these things tend to happen pretty quickly. So we're optimistic.
Well, I appreciate the color. That's all for me. Thank you very much.
Thanks, Matt.
And your next question comes from the line of Himanshu Gupta with GMP Securities. Please go ahead.
Thank you and good morning. On the asset disposition, what is your asset sales target in 2019? I mean should we still expect $200,000,000 of sales in the current year? And how far are you in that process? What kind of bids are you seeing in the market?
Yes. I think the plan is to hopefully still hit the $200,000,000 If it's $175,000,000 or something around there, we're not going to be disappointed. I think it's still a large enough number to both get the portfolio from a quality perspective to where we need to be, increase our liquidity to where we want it to be, delever to where we want it to be. And I think as importantly highlight that valuations relative to where slate retail is trading is there's some mispricing there by the public markets. So we're $25,000,000 in the Q1.
I think in Q2 we could do another $40,000,000 to $50,000,000 which would leave another $100,000,000 for the second half of the year. That's sort of what we're seeing right now from a timing perspective.
Right. And then on the large public listed peer group, are they still net sellers of the product? Or do you see them back in the acquisition market?
I would say they were large sellers in 2018 and I think most to all of them hit or exceeded their dispositions targets for a lot of the reasons we've talked about on this call and some of the other ones, which is is a lot of demand still at attractive pricing for strip center grocery strip center in the U. S. I think as a result of those REITs hitting their targets is that there's not as many of them selling as there was last year, which should be good for slate retail REIT with less supply in the market.
Got it. Okay. So and then shifting on the leasing side, looks like good momentum on the anchor tenant renewals. So around $220,000 of square footage of leases renewed at, I think, dollars 6.11 Where do you think the market rents were for these anchor renewals? And how much did you spend to for that renewal?
No dollars spent on renewals for the anchors, which is usually the case. They generally fund any store remodels themselves because their cost of capital is just so much cheaper than ours. With that said, they have options. So 90% of our portfolio when it comes to grocers is option rents. I mean we've only got a few that expire without options where we think we can lift rents.
Now some of those have options where it's 2% or 3%, some is 0%, which is why we've always said we think the anchor growth rate is probably somewhere between 1% and 3% over time. But both of those this quarter and 90% of them going forward will be renewed at their option rents.
Right, right. Okay. And then on the Windmill Plaza redevelopment, I think Kroger will build a brand new, I think, around 1300,000 square footage of Kroger Marketplace. How will the space look different compared to your existing Kroger stores? I mean apart from click and collect, what are the landlords being asked to install now to digitize their sales experience?
They're focusing right now on the inside of the store for the most part and then the parking stalls as Bobby mentioned earlier on. So it's really just coming to us for approvals on uses within their box and within the parking lot. We think that this will expand into the future which is they're going to want more space in the parking lot potentially for many logistics or sort of a distribution hub onto the side of the store as well as designated room for more designated van parking, again, which is why we think some of our access land could prove to be valuable in the future.
Okay. Okay. And then on the small shop occupancy at 87% And I know you gave some good color on the trends in the near term. Where do you see the upside or downside to this number? And then the 118,000 square footage of leases signed but not commenced, is that already included in that 87% number?
The small shop occupancy, yes. So there is a difference between leased occupancy and economic occupancy. And so that's sort of the upside right now. It's 2 to almost 3 percentage point difference between lease and economic, which is obviously a good thing because that just means that there's built in growth into our NOI. But there's only upside in that shop small shop space occupancy.
There's 3 boxes that drive a significant portion of that number going higher and we're making progress on all three of them. So only upside, we don't see any downside to that number whatsoever.
Right, right. And then on the same subject, I mean overall $3,300,000 of Are you accounting for certain tenant fallouts or expected vacancies in this number or that will be over and above that?
There is a vacancy factor built into that. And as we talked about in our letter, we think even with that included, we think we'll still hit that NOI growth number. And that's total NOI. That includes sort of to Matt's question that will include sort of organic plus redevelopment because we count both. But we I think the reason is because and this is going back 6 years of empirical data for slate retail reasons, we really expect the vacancy factor to be muted.
There's no new supply. Leasing has been strong. We're spending capital at our centers. We are still a very highly sought after landlord in our markets. I think our centers are at the top of the food chain in all of the markets that we're in.
So again, I think it's been historically this way and we see no change in the future. That will remain 94% 95% occupied for some time.
And Himanshu, I would add that growth target, half of that as Greg said before is redevelopment and when you kind of peel back that as to the normal recurring business of a percentage and a half, That's well within the range we'll be doing over the last couple of years as far as same store growth. So we don't think there's a lot of juice in that number. We think it's completely achievable on the portfolio as
a whole. Right. Okay. And then maybe just last final question. On the bankruptcy of Sears and Kmart, how do you think in general the demand has been for former Kmart grocery boxes in the market?
And I know you don't have much exposure there, but generally what are you seeing? I mean, are the bulk of them will be backfilled? And what rates are your peer group achieving on those vacant boxes? Yes.
I think there's been more demand than people expected. There's rumors Amazon is going to take 100 vacant Sears or Kmart boxes. And like I said similar to the abuses we've seen at our properties with health and beauty and fitness, medical and dental and theaters and entertainment etcetera, it's been strong. As it relates to our portfolio, we don't have a ton of that. We've got 2 vacant Kmart boxes, which is again when I said there's some units really driving that shop space number.
Those would be 2 of the reasons. And we've got very strong demand at both of those. And from an economic perspective, the math is pretty favorable because you can take a $2 Kmart rent up to somewhere between $9 to $13 depending on who your tenants are. You have to pay to do that and it can be expensive. But I still think that your high single digit yield on cost and you're taking your cap rate once you get rid of your Kmart center down at least 50 basis points.
So the IRR again is like high teens to low 20s on that box. So it feels pretty good.
Awesome. Thank you. Thank you for all the color. I'll turn it back.
And your next question comes from the line of Jenny Ma with BMO Capital Markets. Please go ahead.
Hi, thanks. Good morning.
Morning, Jenny.
I just have one question with regards to the distribution. You had mentioned in the letter, the MD and A that you're looking to raise the distribution again. And I'm just wondering how you reconcile that. I understand there's some same property NOI growth coming, but then you're also selling assets and you're deleveraging and the payout ratio is at about 100%. So given that, I guess, the general trend is to reduce payout ratios in the sector, I'm just wondering how you reconcile another distribution increase at this point and whether or not it would be more prudent to sort of hold that and save some capital for other uses?
Yes. So a couple of comments on that. So one, our current AFFO payout ratio is, you're right, is about 100%. A few things, one, that includes the capital leasing and TI costs that we're paying now for leases that will start about a year from now. We have historically run on leasing costs and TI is about 9% historically.
We think the new norm is about 12. Our current number is about 14% to 15%. But that's because we're doing a lot of leasing and we think that leasing is a good thing is going to drive a lot of the value in NOI growth that we're expecting to get over next year. So we feel pretty comfortable from that perspective. Secondly, on the payout ratio and the availability of capital, agreed we're selling down assets, but we have $225,000,000 of liquidity.
So we feel like from a balance sheet perspective, we're well served to be able to do that. And then lastly, as far as the distribution increase that we have to talk to our board about, we would like to reward unitholders for the growth we're having within this business. But my personal view would be that if we do have an increase, it would be moderate. Typically, we've had 3% increases in the past historically since we've listed on the TSX. It might be a little lower, but it will be in line and be prudent for how we want to manage this business.
Yes. I think to Bobby's point, from the buybacks that we did in just 2018 that canceled $2,200,000 of annual distributions, which is a big number. And even if we increased it this year, I'm going to just make up a number and say by a $0.01 that's $440,000 annually. So we'd actually have less distributions payable in 2019 after a raise than we did in 2018 on an absolute basis just as a result of the buybacks last year. But I do think to Bobby's point, the reduction in capital is a big part.
Even if it's what we're expecting, which is about $1,000,000 a quarter or $4,000,000 a year, that's $0.10 that you're adding back to AFFO as capital spend comes down. That excludes any growth in NOI. So if you just take our AFFO today and add $0.10 back to it, you get about $1 on $0.86 of distributions. You're down to an 86% payout ratio. And again that excludes any growth from income.
So that's sort of the math. Yes.
And additionally, you kind of view that all the capital and leasing costs that are going back into the business are really additive to value. So if you kind of peel back, we're actually earning from the business and what the business is yielding itself. Our FFO payout ratio is 70%, which we think is pretty prudent.
I guess you're sitting at a 9% yield. So where are you getting the pressure to raise it from? I mean, I hear you on the reduction in capital, but I just feel like generally the tone from the entire sector is really just to be more conservative on the payout ratio. And if you do get that coming back, I don't think it necessarily hurts to wait. Are you hearing from unitholders that they want another increase even though you're sitting at a 9 percent yield?
Or where is this coming from?
I think it's 1 consistent distribution growth over a long period of time and I'm talking about someone looking back 10 years from now, I think bodes well for our cost of capital in the future. And again, I don't think that and I'm using $0.01 and I don't even know if it will be that high or not. Dollars 400,000 on a business that generates 100 and $35,000,000 of gross revenue is going to kill us one way or another. Or said differently, if we were to keep that $400,000 would we have a much better use of capital and returning it to our shareholders and would it make an impact on our business by keeping it. And I think that the positive message that the business is growing, that we're being prudent on capital spend and that we're delevering, that distribution increase sends to the market far outweighs what Greg or Bobby or the team can do with that $400,000 that we keep inside the business.
Yes. I guess my view is it's
at least $400,000 every year year over year. So, okay, that's fine. Yes.
And we still have the option to buy back units. So there's that math as well. So it just means that the unitholders that don't sell their units to the NCIB, let's assume that we do more of that are the ones getting rewarded. And on a net net basis, we can actually keep our total distributions outstanding the same.
I just reiterate, I think Greg's point is a good one. We're not talking about having a 10% increase. We think it would be in the range of 1% to 3%. 1% is $400,000 as Greg discussed. In the context of our capital allocation, that is not a big deal.
We spent $17,000,000 last year on repurchasing units. So in the context of the grand scheme of things, we look to keep the consistency, but we aren't getting any pressure to increase it. It's more just a conversation with our board to deliver the returns. The business is doing phenomenally. And we think we just want to continue that and be able to communicate that to the market.
Okay, that's fair. Thank you very much.
Thanks.
And there are no further questions in the queue. I turn the call back over to Ms. Sarah Cheney.
Thank you everyone for joining the Q1 2019 conference call for SLAIT Retail REIT. Have a great day.
And this concludes today's conference call. You may now disconnect.