Good morning. My name is Kim, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Slate Grocery REIT third quarter 2018 financial results 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 would like to withdraw your question, press the pound key. Thank you. Madeline Sarracini, you may begin your conference.
Thank you, operator, and good morning, everyone. Welcome to the third quarter 2018 conference call for Slate Grocery REIT. I am joined today by Robert Armstrong, Chief Financial Officer, and Greg Stevenson, Chief Executive 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 Grocery REIT's website to access all of the REIT's financial disclosure, including our Q3 2018 investor update, which is available now. I will now hand over the call to Greg Stevenson and Robert Armstrong for opening remarks.
Thank you, Maddy, and thank you to the participants for joining the call this morning. In the fourth quarter of last year, we laid out in detail the business plan for the REIT for 2018. The team has done an excellent job of executing and delivering on our plan, and the third quarter results highlight an inflection point for all the hard work that has been put in over the last 12 to 18 months. Specifically, occupancy is up 170 basis points year-over-year, currently at 94.3% on the back of solid leasing results and maintaining our industry-leading retention ratio above 90%. Our properties continue to be a place tenants want to operate their businesses, and as importantly, our asset management team are people they want and enjoy doing business with.
The level of service and dedication our team brings has, no question, played a big part in delivering on our plans. In addition, we have made progress on our development pipeline with $2.7 million of estimated incremental net operating income to be generated upon completion, representing an approximate 11% yield on cost. In addition to the incremental income these projects will generate, the capital spend and new tenancies will also serve to increase the value of the property significantly. Leasing was strong again this quarter, helping to drive 2.4% same-store NOI growth. In addition to this, signed leases with tenants that are not yet open for business and paying rent has grown in excess of $2 million of annual base rent, which will also be incremental to our Q3 results.
Lastly, we will continue to sell non-core properties that will allow us to recycle capital that can be more opportunistically deployed to generate future growth, as well as upgrade the quality of the portfolio along the way. I want to thank the Slate Grocery REIT team for all their hard work, and will now turn it over to its CFO, Robert Armstrong.
Thanks, Greg. Just a couple notes. During the quarter, the REIT entered into an additional $350 million of interest rate swaps. The REIT's net debt is now 99% fixed, eliminating our exposure to future interest rate hikes. Further, the weighted average rate of our swaps is about 2.03%. This is below the current one-month US LIBOR of 2.3%, and we think is a good spot given the market expectation of future rate hikes in 2019. As a result of our continued income growth, strong occupancy, and portfolio performance, the REIT will increase its monthly distribution to $0.855 annually. This is an increase of 1.8% over the current distribution and marks the fifth consecutive annual distribution increase since the REIT listed on the TSX in 2014.
Also, as an update on our unit repurchase activity, the REIT has repurchased 1.4 million units on a year-to-date basis for a total capital outlay of about $14 million. A significant number of these purchases occurred subsequent to quarter end. These repurchases have resulted in an immediate increase to NAV to unit holders, and we intend to continue to repurchase units where appropriate pricing exists. Both Greg and I thank you for our continued support, I'll hand it over for questions.
At this time, if you'd like to ask a question, please press star and the number one on your telephone keypad. Your first question comes from Sumayya Hussain from CIBC. Your line is open.
Thanks. Just firstly, your occupancy, like you mentioned, has ticked up a decent amount, over 94%. You've noted in the filings that there is still a significant leasing that's yet to show up in the numbers. Do you have a sense of what that gap is between in-place and committed occupancy, and over what timeframe would we see that show up in the numbers?
Hey, Sumayya, it's Greg. We've talked about this in last quarter, is really the approximately $2 million, which is slightly higher than that now, of annual base rent, where you have a signed lease, but the tenant is not yet in and rent paying. Some of that started in Q3, when we talked a lot about it early in the year, saying we expect most of the growth to be in the second half of 2018. A lot of that is what we're referring to, that we do have a good visibility on the leasing that we've done, and we can see the income expect to come in. In terms of timing, a little bit in Q3, more in Q4, I would say the lion's share of that will be coming in by the end of the first quarter.
Fairly near term.
Yeah.
Great. Okay. Can you just give some background on the joint venture with Kroger on Windmill Plaza and how it came about? If you see other similar opportunities down the road, especially given there's limited supply of quality assets out there?
That deal goes back a few years, it was really the team doing a great job being proactive and getting in front of the grocers, which is a big part of our strategy. Kroger identified Slate as a counterparty that they wanted to do business with, and they came to us as opposed to us going to them with the idea that we should look for sites where they could build their new store concepts, Windmill Plaza being one of them. At the time, it was a Kmart-anchored center. We purchased it, we being SLAM on behalf of Kroger, and the REIT gave a loan with the right to purchase the center. Kroger has signed the lease. They're working on building a store, and we're working on backfilling the former Kroger box. When you do this, two things happen.
One, you take $2-ish Kmart rent, you replace it with a slightly higher Kroger rent, you're also replacing a Kmart credit with a Kroger credit, which has significant cap rate compression that comes along with it, you're signing a 15- to 20-year lease with Kroger on a brand-new store where we expect sales to be significant. Where a lot of the return comes from is then backfilling that Kroger box with tenants who want to be next to a brand-new Kroger, that's a long list of tenants, you're earning, in some cases, four to five times the rent that Kroger or Kmart was paying on that box. We're really excited about Windmill. Tyler and the team have done a great job, our partnership with Kroger as a result just continues to grow. We're really excited about that opportunity.
Okay. That's great color. That's all for me. Thank you.
Your next question comes from Himanshu Gupta from GMP Securities. Your line is open.
Thank you. Good morning, guys.
Morning.
Hey, Himanshu.
Just to follow up on Sumayya's question on ABR signed but not commenced. When you say $2 million of incremental ABR, does this include the incremental NOI from development? I know in the MD&A you mentioned $2.7 million from the development repositioning efforts.
No, it doesn't. That's why we wanted to talk about both separately in the letter and on the call, is that if you take trailing 12-month NOI at the end of Q3, it's about $100 million. If you add what we know are signed, expected-to-pay-rent leases, that's another, let's call it, $2 million. You take incremental NOI from development projects, four of which are effectively pre-leased, like we talked about in the letter, very high probability of execution there. You add those together, you're $4.7 million on $100 million of trailing 12-month NOI. You can get a sense of what we think the growth over the next six to 12 months on a total portfolio NOI basis. Same-store will differ because same-store NOI excludes quite a few properties through our acquisition activity and development activity.
We look at it on a total portfolio basis. To answer your question, no, you have to add both those things together.
Okay. Well, thank you. By the way, thanks for the additional disclosure on the incremental development NOI. That was pretty useful. Moving on the acquisition of this Plymouth Station, can you elaborate here? Are you going to be more active on the acquisition front, or was it a case of a more opportunistic transaction?
It was really recycling capital. You probably note in the MD&A that we talked about selling non-core outparcels. Really what we sold is about the same dollar amount that Plymouth Station was acquired for. We sold an outparcel at one of our centers, which is effectively all power center, sort of big box retailers, which we don't have a lot of, and we don't want. We sold those, and we replaced that with Plymouth Station, which is a brand-new Hy-Vee anchor, just signed a 15-year lease, and the grand opening was actually two days ago, in a very affluent area and growing area of Minneapolis for effectively the same cap rate. I think it's two things. One, we're managing earnings. Two, as we talked about on the call and in the letter, we're going to recycle this capital.
We think we can do it accretively over time, if not to keep earnings neutral. I think where it becomes significant is the quality that we're getting in terms of upgrading. If you compare an unanchored strip parcel with power center tenants and you get the same cap rate, what we think is much more upside with an asset like Plymouth Station, and more importantly, a grocer like Hy-Vee, who came to us with the idea. Similar to Windmill, we're having grocers approach us. The risk-adjusted nature of that return we think is excellent.
It's something we're going to continue to look for. Effectively, any acquisitions we do, to answer your question, are going to be to replace income from sold assets if we don't have a better use for those proceeds.
Right. This looks like a brand-new asset there, right?
Yeah, that's correct. Bobby, I don't know if you want to add anything.
Yeah, Himanshu, what I would add is, just looking back what we've done in 2018 and coming out of 2017, we were very purposeful in that we wanted 2018 to be a year of integration. Given 2017, we had close to $400 million of acquisitions, and I think we're mostly through that. We've increased occupancy 170 basis points year-over-year. We've got six straight quarters of positive same property NOI growth. When I look forward to 2019, with that integration on track, and we're doing about 250,000 sq ft of leasing a quarter, I think we'll be more acquisition-focused in 2019. To Greg's point, a large part of that will be funded from capital recycling, where we're being opportunistic in either solidifying value where we think we've created value or de-risking.
Looking to really bring up the quality of the portfolio, but we do think there's a lot of opportunities out there, and I think we'll be net acquirers going into 2019.
Got it. Also, some of your large peers have been net sellers or have been selling assets in the secondary market like yours. Did you look into any of those assets as well? What kind of pricing do you think they were able to achieve in some of your markets?
Yeah. We see them all. We are still the only North American REIT that is 100% pure play grocery-anchored. Anything that happens in this space comes to us. We're constantly out understanding the opportunities in the market and the pricing. I would say for high-quality properties with a productive grocer and all that just means high sales and growing sales, which is what we look for. Pricing has held strong. I think market participants still view grocery as a ballast in their portfolio, because if you look back at the grocery-anchored asset class, you can go back decades. You can go back to the financial crisis, which was the worst financial crisis in the last 100 years. Grocery-anchored real estate held up extremely well and continues to hold up extremely well today. The demand has been strong.
I think in maybe some tertiary markets, demand has softened as capital flow has softened. It hasn't had anything to do with fundamentals or performance. I think it's just more temporary capital flows. Demand for the asset class has held up. I think I've gone through a lot of the Q3 earnings calls just to check in on some of those numbers, Kimco, Brixmor, Regency, Equity One, et cetera.
The numbers have been solid. They are selling hundreds of millions of dollars of assets in between 7% and 8%, let's call it 7.5% on average, for product that we believe is, on average, not nearly as high quality as the portfolio that we own. When we think about our implied cap rate today, part of that value is why we think purchasing our units is quite attractive.
Got it. Looking at your 2019 lease expiries, are you starting to have conversation with the anchor tenants? Is there any pushback, or do you need to spend some capital there?
I would say we never stop talking with our grocery tenants, expiries or otherwise. The answer is yes. No real capital pushback. I think the very simple math is you've got a grocer in a lot of cases, $6, $7 rent, in some cases lower. We've got some grocers paying $2. The rent at these stores on 40,000 feet at $6 is really a small part of their fixed cost base, and it's not something they're usually focused on. Where they may or may not come to us is if we're asking for extra term, i.e., generally these leases have five-year options, and they'll extend those options, and sometimes there'll effectively be no conversation, just, "We're happy.
Here's our five-year renewal." In other cases where we think there may be an opportunity to go 10 years because we can upgrade the property by landscaping, pylon signs, facades, or parking lots, which again, are all very inexpensive things for us to do.
Right.
We just try and figure out if that investment is worth it for both the grocer and ourselves, and we try and partner on these things. No, I think the renewals have gone very well, and they don't want to close productive, profitable stores. This is a business that relies on scale and distribution. Their end game is to keep their profitable stores open, and they're not going to try and push landlords around in good stores, which are the stores that we own.
Got you. Last question, and probably continuing the theme of your conversation with grocers, what are your thoughts on the grocery delivery model or the curbside pickup? What are the notable trends in terms of omni-channel going forward? What are you hearing?
I think there's a major push towards that. I think when people hear that online grocery purchases are expected to go from virtually 0% or 2% today in the U.S. to 10% by 2023 or the next 5 years, I don't think people fully understand what that means. What that actually means is that that sale is still coming from the store. I think what's happened is there have been a few participants who have tried to figure out bypassing the store. Hands down, that doesn't work. That's really what's happened. Bringing it to your house. As we talked about in the letter, I don't think people appreciate that the leaders in the innovation of this side are actually the grocers. You've got Walmart, Kroger, leading that charge, partnering with Ocado, et cetera.
We feel more confident today than we did 12, 18 months ago that the grocery store is a last mile distribution center, and that customers do want an omni-channel. Some people want delivery. I would say the majority of people still go to the store. The physical grocery store will be used for last mile delivery. Our conviction is so high on that. The grocers are saying the same thing. The Silicon Valley startups are saying the same thing. Effectively, all of the money and innovation is centered around figuring out how to best utilize the grocery store. What you may see is the store footprint shrink and some of that square footage be used for logistics and sorting and packing. For us, we don't really care what they use it for.
If they do that's great, because it means they're spending money and investing in the store, but all it really means is that they're continuing to rent space and pay us on that.
Yeah, I think, Himanshu, the underlying trend, as Greg kind of said, and just to put it simply, is that there's been overwhelming recognition by both owners of grocery stores, the grocers, and the innovators, that the physical distribution center, being the grocery store close to rooftops, has a massive competitive advantage over any distribution center that isn't close to rooftops. That's effectively what we've kind of heard over the last four to five, six months. We think that's going to be the trend and what people are talking about going into 2019, because that's what we're hearing on the ground right now.
Awesome. Thank you, guys. I'll turn it back.
Your next question comes from Johann Rodrigues from Raymond James. Your line is open.
Hey, guys. I have one quick clarification question first. Greg, in the letter, on page one, you have the chart there, and it shows organic growth of 3.5%. I guess I was just wondering where that number came from.
Yeah. If you look at that chart, you've got Q4 2017 total portfolio NOI of $24,592,000.
Right.
Q3 NOI is about 4%, Q3 2018 NOI. three quarters later, our NOI is $25,551,000, 3.9% higher. Sorry, go ahead.
No. That's, I guess, your nine months same property NOI growth, or?
It's the total portfolio.
Okay.
Which is.
Okay.
Yeah.
That's different.
Which is more how we think about it. Yeah. Because we were so acquisitive, and obviously there's development. As a unit holder of the REIT, you don't own a fractional interest.
Right
in just the same property portfolio. You own all of them. We really view this as what is total NOI growing by. That same property store count will grow over time. Right now, it's still 70% of the total portfolio, so we look at it holistically.
Yeah. The other way to kind of cut it is if you look over the last two years, six of the eight quarters have been positive NOI growth, and that's around 2%. Where you really gain a lot of fast-paced growth is on the acquisition activity, where there's some large gains being made right away, and that's not showing up in same store. You kind of put those two together, and it kind of triangulates to what Greg's letter is talking about.
Gotcha.
That's exactly right.
Okay. That's helpful. I guess my next question is, 2018 has been quite a different year than 2017. You guys kind of maybe stopped the acquisitions ship. Capital recycling was big for you guys. You bought back stock. I guess just, I'm wondering what the strategy is going into 2019, given that you guys are fairly levered up. The payout's still a little bit high. You're buying back stock. You can't really issue equity given the price, and then you just mentioned you think you'd be net acquirers. I guess I'm just wondering, what's the capital allocation strategy for 2019? How do you fund that?
I think part of it is our operating cash flow continues to grow. That'll bring the payout ratio down. I think the payout ratio is artificially high right now, driven by all of the leasing that we've done. We don't anticipate capital to be 17%, 18% of NOI into perpetuity.
Yeah
That number, sort of as the number we've used in our materials, is probably closer to 10. That probably starts to happen, meaning the capital probably starts to decrease back to normalized levels Q2-ish of next year. I think two things. One, we'll be patient. Two, as we talked about a bit earlier, there are assets in our portfolio that are going on. We've owned for eight years. We've done an exceptional job increasing value. I think there'll be capital recycling opportunities where we can take those, I'll call them very low growth assets, where the yield is fantastic, but not a ton of growth left, or upside probably in the cap rate.
I think we can sell some of those assets and upgrade the portfolio. We're investing money into an environment where we think it's pretty attractive because you can effectively replace that yield with similar yield, but a much higher quality asset with more upside. I think we'll continue to think about ways to grow. I think we're creative people. It's something that we're not going to stop thinking about from an acquisitions perspective. I think if we continue to be patient, it's been nine months so far, 2018, we may be looking at a different cost of capital even by the first quarter of next year.
Yeah. I think the growth on the leverage side, some of the leverage has kind of popped up because of the buybacks.
Yeah.
This is a business that is spitting out about $60 million a year in FFO, and we've got distributions about $40 million on that. That remaining $20 million, whether it goes to acquisitions or capital, that's accretive to NAV, in our view. Any capital we're spending on leasing and whatnot, as you'd obviously know, is growing value and creating additional NOI for us. We kind of see a natural compression on the LTV that's going to probably happen about 250-300 basis points throughout the year. Because of that, if cap rates stay stable. We think, plus that and the capital recycling, we should have the ability to be meaningfully acquisition-focused in 2019.
My last question is just looking at U.S. peers, definitely this year they've started to bounce back a little bit in terms of operations like rent growth or same property. I guess I was wondering where you guys think you'd slot in the group. Obviously, you'd be below like a Federal or Regency.
Yeah.
Will you be above Brixmor? Is that kind of how you view yourselves or in that group?
Yeah.
From a kind of a normalized same property, for two or three years. It's been like you guys have had a bunch of kind of one-time items here and there over the last few quarters or, I'd say probably half of the quarter since 2016. That's kind of impacted same property, but like on a normalized basis, I think you guys mentioned 2%. Is that how we should be thinking about it for 2019?
Yeah, I certainly think for the next Q4, Q1, Q2, as we talked about, you can understand the 2% from signed but not yet paying, the 2.7% from development, et cetera. The growth there is pretty visible. After that, 2% is probably a fair number, particularly if we can continue to recycle into assets where we see leasing opportunities, et cetera. I'll answer your question in terms of what sophisticated REIT investors in the U.S. that I meet with tell me and where we sit, and I would probably agree. I think that Brixmor is probably a very good comparable.
I think where we are more attractive to those REIT investors from a purely capital markets perspective, ignoring the fact that I think we're better real estate operators, and we've got asset management machine that we're a part of and we have behind us, that I think doesn't get talked about enough. I think that we're 86 assets. We're not 400 and something. We have a very good handle on every little thing that happens inside of our portfolio. It's easy to understand. We're 75% neighborhood strip centers. We have virtually no power center exposure. You heard a million things about retailer restructurings, et cetera. It's had virtually no impact on our results, which highlights really the asset class that we do own and the durability of our income. I don't think that's true for some of the larger U.S. strip center REITs.
I think they have a lot more power center exposure. I'm not sure they have a complete handle on their business plan because they do have a lot. These are very smart, talented people. That's not a criticism. I just think that they're in a different stage of their business, where they're still trying to figure out what they want to be when they grow up. I think the other thing is we're 100% grocery-anchored. There isn't a single REIT in North America that can say that. I think that's a huge differentiating factor when you think about risk-adjusted returns, and where we're getting our income. I think that there's probably a counter-cyclical nature to that as well, which proves to be defensive in a recessionary environment. I think those are the things that we get a lot of credit for.
I would say that from a real estate, household incomes, demographics, locations, Brixmor is probably as close as you're going to get. I would say from an asset class type, we're probably more like ROIC in terms that we are a pure play strip center, neighborhood strip center, as opposed to more community or power.
Okay. Thanks. I'll turn it back.
Thanks.
If you'd like to ask a question, please press star one on your telephone keypad. Your next question comes from Stefan Boyer from Echelon Wealth Partners. Your line is open.
Good morning. Thank you. I just wanted to quickly push a little further on your own questions regarding capital allocation, if you don't mind. I was just wondering if you quantify the amount of capital recycling for next year.
In the pipeline right now, which is what we have visibility on, it's probably $50 million. That number will change, I'm sure, as time passes. Right now, we've identified $50 million in that. There's effectively 2 buckets. One is you've got your sort of single tenant, generally quick service or bank out parcel where you get single and then net lease REITs
buying these things for below six caps, five caps, which is just an accretive recycling of capital for us. There's really nothing we can do with these outpads from a value perspective. We think that's a good trade. That would make up, let's call it, half that bucket.
The other half is our properties, like I said, that we've owned for a long period of time. We've executed on our strategy. We've created value, and we think we can take that money and put it into something with higher growth opportunities for the REIT.
Okay. In terms of net acquisition, so on top of that, how much do you expect you will be able to acquire?
It will probably be in and around that number. Maybe there's some capital that goes to paying down debt. Maybe there's some capital that goes to buying back units, so it may be not the full amount of the sold assets.
Somewhere close. It certainly probably won't be over and above that number. Bobby, I don't know if you have anything to add.
No, I think that's fine.
Okay. That's good. Thanks. Just want to make sure I understand. Basically, the buyback unit strategy is still on the table for next year?
Yeah. We're going to look at all different capital allocation opportunities, and if there's a point in time where the REIT units look like the best investment we have, that's what we're going to do. If it turns out that we find an asset that we think is better at the time, we're going to do that. If we think paying down leverage is the right thing or increasing distributions or whatever it may be, we're going to allocate capital accordingly.
Okay. That's good. Thank you.
Okay. Thanks.
Thanks.
There are no further questions at this time. I turn the call back to Madeline Sarracini, Investor Relations.
Thanks, everyone, for joining the third quarter 2018 conference call for Slate Grocery REIT. Have a great day.
This concludes today's conference call. You may now disconnect.