Good morning, ladies and gentlemen, and welcome to the Slate Retail REIT First Quarter 2018 financial results conference call. As a reminder, this call is being recorded today, May 2nd, 2018, at 9:00 A.M. Eastern Time. Your host for today's call is Madeline Sarracini, Investor Relations. Please proceed, Ms. Sarracini.
Thank you, operator. Good morning, everyone. Welcome to the first quarter 2018 conference call for Slate Retail 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, 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's website to access all of the REIT's financial disclosure, including our Q1 2018 investor update, which is available now. With that, we will open the line for Q&A.
At this time, I would like to remind everyone, in order to ask a question, please press star and then the number 1 on your telephone keypad. We'll pause for a brief moment to compile the Q&A roster. Your first question comes from Sumayya Syed with CIBC. Your line is open.
Thanks. Good morning.
Morning.
Morning.
firstly, on your IFRS NAV and the fair value loss in the quarter, what markets does that relate to? Does that reflect the Southeastern leases being amended?
Yes, most of it's the Southeastern Grocers leases being amended just for the change in the cash flows, primarily at six of the properties. From there's a couple properties within the 86, so two to three where we made adjustments as well. For the most part, most of the properties across the portfolio are steady-state compared to December 31st.
just a couple of areas. Okay. On the completed redevelopments at Buckeye and County Line, once they're completed and stabilized, do you guys have a sense of what the market cap rate would be on those assets?
Yeah, I think we're going to look to dispose of both of those assets. We haven't gone out to market yet to see what those are. I would say that they're on our books at the price that we believe that they'll be sold at. I think it's TBD on cap rates at this point in time.
Okay. Thanks.
Yeah.
I'll turn it back.
Your next question comes from Himanshu Gupta with GMP Securities. Your line is open.
Thank you. Good morning, guys.
Morning.
Morning.
Just a general question to start with, how do you get a sense of retailer performance in your centers? Do you track their sales volume, operating margins? Basically, trying to know what visibility do you have on bad debts and overall exposure risk.
Sorry, Himanshu, was that on foot traffic and sales?
Yeah. I'm just trying to get a sense of what visibility do you have in terms of exposure, any tenants on your watchlist. Do you track their sales volume, operating margins?
Oh, I see. I'll start and let Bobby jump in it. We get sales reports for most of our anchors across the portfolio. We see how they're doing on a year-over-year basis. 2017 sales sort of are coming in now, and sort of from March to May, we start to get those year-over-year. Across the portfolio, from a sales perspective, they're up in the sort of mid-single digits range, with probably 30% of the portfolio left to come in. I think that's obviously a positive indicator for us. I think the big thing, the asset that we have is the relationships that the team has built with our grocery anchors and our other tenants across the portfolio. I think we view this as a service business, not necessarily as landlord-tenant.
I think the conversations that we're constantly having with all of our tenants, that as of late and going back into the past, we feel very confident in both foot traffic, sales volumes, and desirability of our centers. I think that the leasing activity that we've been doing over the last few quarters sort of highlights all that.
Yeah. Maybe the few points I'd add on that are, one, I do want to highlight the fact that sales are increasing across our centers at most of the grocers, and we think that's an extremely positive thing, and maybe even picked up in today's media environment. They're probably as healthy as ever from a sales perspective. Then just to specifically respond to your bad debts question, we haven't seen any change in the activity in any meaningful levels. It still tends to be very healthy. It's not something that we're really worried about in any way. I also think that looking at the health of the portfolio overall, on a same-property basis, we're up year-over-year, and we're continuing to do leasing. There's continuing to be demand for the space through our conversation on the leasing front.
Notwithstanding the general retail environment, I think most retail environment, especially in our practical and experience tended to be very strong.
Yeah, I think our retention ratio this quarter and going back into the past, is some of the highest in the space relative to our peers, and I think that highlights exactly what Bobby and I alluded to.
Yeah, that's helpful. On capital allocation, there are a fair bit of store closures expected in 2018 and 2019. How do you prioritize between share buyback and debt reduction? How much are you prepared to de-lever the balance sheet?
I'll let Bobby jump in. Just on the share buybacks, I think that at the value that we see there, where we can buy a fractional interest in a portfolio of 86 assets that we know very well, obviously at a price that we think is attractive, we're going to keep doing that. I think Bobby and I talked about the leverage thing a lot, and I don't think we're looking to de-lever necessarily. It's more that when we sell assets, we want to make sure that we pay down debt so that our leverage doesn't increase.
Yeah.
Sure.
That's right. The choice to do the buybacks has completely been a capital allocation decision. We think at the price that we're able to buy back at, doesn't make sense and has benefit to unitholders. The one thing I would say is that, we've done $4.5 million on the buybacks. I think that's aggressive and we've been quite lucky to do that volume over the last few months, but it has taken us two months just to do $4.5 million. I think it's going to be what we stretch to make the NCIB have a meaningful impact on leverage across the portfolio on top of the $1.5 billion of assets. We'll likely take on debt to do that, but we think it's positive, but it's probably at the margins from an LTV perspective.
Got it. On tenant improvements. Tenant improvements is tracking almost $2 million in quarter one. Do you see that increasing even further given all the store closures and changes in tenant mix? How do we see that number on a full year basis?
We report actuals, as you may or may not know, but it's worth stating because I know that that's not consistent across the board in Finland. That will bump around for us a little bit. I think that the good news is that our increase in capital, to your point, is because of TIs and leasing commissions, so it's a capital that comes with a return. It's not an increase in maintenance CapEx. We budgeted a number for the year on a quarterly basis that will be lower than the quarter i.e., we think that it will move around from quarter to quarter, but it won't be sort of as high as it is this quarter every quarter, if that makes any sense. We don't expect it to increase due to store closures or anything like that.
Sure. Finally on same property and NOI growth trends , looks like you expect a ramp up in the second half of the year. Can you quantify the ABR? I mean, the leases which were signed earlier, but rent is yet to commence.
Yeah, we've done a lot of leasing, as you can see, sort of in the last two quarters, and I think that will continue because the team is just doing a wonderful job being proactive, getting in front of lease expirations. Like I said, I think we spend a lot of time communicating with our tenants, both the grocers and our shop space tenants. I think it's just really timing of lease commencement. High level, you sign a new lease, for example, and there's anywhere between a three to nine-month build-out period, depending on size of the space and tenant use. It's really just having that period expire or run off before rent starts to be paid.
Like Bobby and I have said the last two quarters, because of that timing, a lot of the leases that we have signed in Q4 and Q1, and actually some in Q3 as well, will be sort of coming into the results in Q3 of Q4 this year.
Sure. Bobby, just one final question, a general question, on the demand for open-air centers in the private market. Some of your peer group are mentioning about increasing capital formation. Do you agree with this? Do you see demand for single assets? Then, is there any demand emerging for portfolios as well?
I don't think the demand has changed. I think we've always been of the view that for a grocery anchored, open-air center, strip center, neighborhood center, it's called a few different things. It's always been there in our view. We think that there's private buckets of capital that are local regional buyers. There's 1031 buyers out there, which are buyers that are looking to defer capital gains tax by taking sales proceeds of an existing asset and putting it in a like-kind asset within 180 days. We think that there's institutional buyers, there's some smaller mid-cap REIT buyers. For one-off assets, nothing has really changed. I think where pricing has softened a little bit on the capital formation side is when you start to look at larger portfolios in the hundreds of millions of dollars. That's still yet to be seen.
I think I would echo some of the other recent comments in the U.S., which is on a risk-adjusted basis, the valuation levels that we're seeing, and I think it's becoming more obvious to people that retail is not dead and strip center retail, i.e., everyday convenience retail, is still not only doing just fine, but increasing demand while there is a lack of supply. Fundamentals are strong. I think that capital formation for larger portfolios will start to recognize all of these things over time. It's certainly not yet obvious in the higher dollar amounts today.
Sure. Thank you. I'll turn it back.
Thanks.
Your next question comes from Stéphane Boire with Echelon Wealth Partners. Your line is open.
Thank you. Good morning.
Good morning.
Okay, I was wondering, what do you expect in terms of rents for current redevelopment and repositioning projects on the way, and how would that compare to the market rents?
The rents that we've been achieving are all laid out in the MD&A, sort of on pages 10 and 11. We think that spreads on renewals will continue to be anywhere between 5%-10% on shop space, which we define as spaces less than 10,000 square feet. We don't see any trend down or trend up. I think that will remain pretty consistent. If you look at our expiry profile, we've got sort of a $10-ish rent on a weighted average basis expiring contractually for effectively the next five years. We think we see that growth continue into the future for some time. On new leases, again, as you can see in our MD&A that we lay out, and it goes back four quarters, we've been doing spreads on leases, which is, again, weighted average across the portfolio about 10.5%.
We've been closer to 12.5%, 14%. Anywhere between 25%-50% above in-place rents. I think that will be sort of similar to what we see going forward. We see sort of no change than what you'd see in our MD&A today going forward. I think that's driven by the fact that you've got a multi-decade low in new supply in the strip center space. I think that, again, our team has done an excellent job from a leasing perspective, developing those relationships. We talk about this a lot. We're bringing capital to capital-starved markets where our TIs and leasing commissions go a really long way. I think, again, going back to the comment on the team is we're bringing a sophisticated team of institutional real estate ownership to markets where that doesn't really exist.
Okay. On another subject, regarding the properties affected by Southeastern Grocers, were there any discussions in regard to any lease extension?
Yes, there was. It was a mix across sort of the 10 assets that we have, but we received lease extensions at some, as well as capital investment commitments from Southeastern Grocers following bankruptcy across the board. To Bobby's earlier comment, and to Sumayya's question, while a large majority of the valuation changes within the REIT in both Q4 and Q1 were as a result of Southeastern Grocers, we do think that Southeastern comes out a better company. They're going to reduce debt. They're going to have more money to put into operations. They're going to close their underperforming stores. We do think that there's possibility in the future as this becomes more clear to the market and to us, although we're believers, there may be upside in those valuations in the future.
Okay, basically if they successfully restructure, they would have to provide upgrades or to improve the properties in which they're located, right?
That's correct.
Yeah. The other point of clarification there is the rents don't adjust either until they've exited as well.
Right. Okay.
It's probably
Sorry.
No, go ahead.
Actually on that same subject, it looks like you minimized your risk, and you got an option on improvement. If I remember correctly, the market conditions for the affected properties remain relatively solid. Is that correct?
Yeah, that's right. It's similar to Kroger in the Northeast or even, I think, a lot of the Kmart locations that you see in that we've picked off a few to be opportunistic. Southeastern Grocers is the oldest grocer in the state of Florida, they've been there for 100 years. As a result, they've got a lot of the best real estate in the markets, that location advantage goes a long way. I think that from an opco perspective, meaning at sort of the store level fundamentals at the stores that we've seen, both from an acquisition perspective and the ones we've owned, we've underwritten a lot of these over the last six years. They're still very solid. We couldn't agree more.
I think that the fundamentals are fine, the parent co, it was sort of an opco, propco thing where they really just over-indebted the company. Our view is that the real estate fundamentals and the sales at their stores, because their locations are so good, are still quite strong.
Yeah. I think while the Southeastern event was unfortunate, I think the way we kind of look at it is it's a positive reflection of what we try to do in just buying good real estate that people want to stay in. Not to be confirmed, but we believe that we're the only landlord in the U.S. under Southeastern that had 10 or more stores without a single store closure. I think that's reflective of the way we've been buying our acquisition discipline. That was the biggest event we had in 2017 and so far in 2018 as far as store closures are concerned, we've been relatively immune across the board. In 2017, we only had five shop tenants in the entire portfolio of, I think, 1,500-
Yeah
tenants that were affected. Those five, we released at a 10% spread up. I think it's been the type of real estate as well as the way you've been buying in the markets we've been buying in. We've been very fortunate. I think it's been just part of the strategy, we don't see any problems going forward either.
Okay. That's good. Also on another subject, I was wondering if you could expand a bit more on the retention rate for the quarter. I know you mentioned it was one of the best among your peers, I was wondering, if you could give some color on the fact that it decreased over the quarter and just in general.
There's not a ton to read into it, just this number will bump around a lot on a 90-day period. Overall, again, I think that, the close to 90% retention ratio that we saw in 2017, while this quarter was down to 85 and a half. We expect it to be closer to 90 for 2018 and sort of jump back up, going forward. It will bump around quarterly. Nothing really material or to read into. I think it's just, it'll fluctuate.
Okay, perfect. Last one, I was wondering, what's your view on the same property NOI for 2018? Again, you mentioned a little bit that it would improve near the end of this year, do you have any guidance for the year?
No guidance, I think that similar comment is that the 90-day period, we don't focus too much on because it jumps around a lot, and we had free rent at one center alone, move it from a positive to a negative figure. It just goes to show you how sensitive it is. Today, it's small changes being, 67-ish% of the total portfolio. I think the Q1 letter does a good job of highlighting our views on same property NOI and sort of what we think, how we think about the total portfolio and the different buckets within that portfolio, going forward.
Yeah. I wouldn't want to provide any guidance, but we do think it will move positive. We've been happy with what we've done over the last two years in that regard, regardless. The thing I'd point out though is it is a little bit, while we have estimates, I think it's a little bit hard to predict just because of the timing of the free rent, but also the timing of when properties come into same store based on our acquisition dates will skew it a little bit. It's not entirely representative. I think it's a decent representation, but I think over the course of the year, we're really happy with how things are progressing so far.
All right. Perfect. That's great. All right. Well, that's it for me. Thank you, gentlemen.
Thanks.
Thanks.
Your next question comes from Troy McLean with BMO Capital Markets. Your line is open.
Good morning.
Troy.
Hey, Troy.
Just on the same property NOI discussion, you mentioned it going up in the last half of the year. Does that include the settlement with Southeastern Grocers?
No.
Yeah. I think that's why we're shying away from guidance because the timing of their emergence is still a bit uncertain. It's progressing really well. They've stayed current during bankruptcy, which is quite frankly unheard of, and I think it speaks to how solid the underlying business is and how well this has been going. I think we're shying away from providing guidance just because we don't know what that timing yet will be.
You mentioned in your comments that you really haven't seen a trend in market rents, but I was kind of curious if you've seen like a renewal, or new or renewal leasing negotiations getting tougher with tenants. Like are there any new terms they want, like shorter lease terms or more tenant improvements? Is there any comment you can have there?
It still remains the same. The grocers have a cheaper cost of capital, it's usually their dollars going into anything in their space, which is great. Our capital as it relates to getting lease extensions with the grocers are still targeted toward new roofs or parking lots. On the shop space side, again, you have your regional tenants which are a little more sophisticated, we think we've got some of the better centers, and there's not a lot of better options, we think we're in a pretty good position there. Nothing has changed. On the shop space side, again, when we add acquisition, we really target centers where there's rents that are below market, which goes a long way because it's not like we're asking our tenants to go from market to above market.
All we're really asking tenants to do is take their rents below market, up towards market, either at or slightly below market or even slightly above market. That's a big part of our acquisition strategy, and it makes those conversations a lot easier.
Troy, just to loop back on the Southeastern piece, it will depend partly on the timing of when Southeastern exits from the restructuring because that's when the lease amendments will be effective. We provided guidance within the MD&A. It's supposed to be just over $0.3 million, assuming that there's an impact for about half the year. It's important just to represent that $0.3 million in what I'd expect NOI to be, say approximately $50 million for the back half of 2018. We really don't think it's a huge impact over the portfolio, as Greg kind of properly pointed out, $200,000 here and there on a 90-day period for two-thirds of our portfolio on the same property can skew things.
Fair enough. Just finally, on Springboro Plaza, I know you're working on the due diligence, has Kroger agreed to take over the Kmart or to expand its current store?
They haven't yet, no.
Is that dependent on your due diligence, or is the project waiting on them to agree to expand the store?
It's waiting on them right now. I think they're running all their sales projections and numbers that they do, similar to what they've done at Hocking Valley and some of the other marketplaces that we've built for them. I think we're going to have some clarity soon. They're a big company, and they move slower than Slate Retail, unfortunately. I think it's all positive. They just renewed for five years recently, so they're committed to the site in one way or another.
Are they taking longer to determine whether to do the store expansions versus the first couple projects you did last year?
I would say last year it was similar, they're definitely taking longer than we expected probably two years ago, which we don't view as a bad thing. I think that they're probably being a bit more thoughtful with their capital, and I would argue they're spending more capital on e-commerce initiatives and on their employees' training programs, et cetera. All good news. I think it's just slowed down their capital allocation process as it relates to real estate. We remain confident that Springboro is, again, a place they want to and will spend money. I think to your point, it's just going to be a bit slower as a result of the environment than it may have been two years ago.
Perfect. That's it for me. I'll turn it back. Thank you.
Thanks for asking.
Again, it is star one on your telephone keypad if you would like to ask a question. Your next question comes from Michael Schmidt with RBC Capital Markets. Your line is open.
Good morning. Greg, you mentioned earlier that your markets are capital starved. I realize there's lots of money flowing into coastal markets and big cities, maybe could you just give us a little color as to why your markets are capital starved?
I've been reading them, you guys probably have as well, it's not just in Q1, it's sort of been the last several quarters. The REITs in the U.S., that would be our peers that own centers in our markets, they're exiting. They're selling assets, it's two things that I think it's an opportunity for us is, A, they're selling, which we were buying from them in the past. Our cost of capital is too expensive today to do that. I would say that from an operational perspective, because they're selling, they're not focused there. Then it's sort of the same comment on the capital side is because they're exiting, they're just not spending money. It's not a place that they're allocating capital. To your point, they're allocating capital to their 6 to 10 top markets.
They're allocating capital to redevelopment projects, where because they can't acquire accretively in these core markets because prices have become so expensive and elevated, they're developing, trying to develop accretively. That's effectively just capital flows going into core product, into redevelopment, sort of out of the secondary market strategies.
Okay, thank you. That's it for me.
Thanks.
There are no further questions at this time. I will now turn the call back over to the presenters.
Thanks, everyone, for joining the call. Have a great day.
This concludes today's conference call. You may now disconnect.