Good morning, ladies and gentlemen, and welcome to the Slate Grocery REIT second quarter 2022 financial results conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. Today's call is being recorded on Wednesday, August 3rd, 2022, and I would now like to turn the conference over to Mr. Paul Wolanski, Senior Vice President, National Sales and Investor Relations. Please go ahead, sir.
Thank you, operator, and good morning, everyone. Welcome to the Q2 2022 conference call for Slate Grocery REIT. I am joined this morning by Blair Welch, Chief Executive Officer, Andrew Agatep, Chief Financial Officer, Connor O'Brien, Senior Vice President, Allen Gordon, Vice President, and Braden Lyons, an associate. Before getting started, I'd like to remind participants that our discussion today may contain forward-looking statements, and therefore we ask you to review the disclaimers regarding forward-looking statements as well as non-IFRS 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 Q2 2022 Investor Update, which is now available. I will now hand over the call to Blair Welch for opening remarks.
Thanks, Paul. Today, I'm pleased to share Slate Grocery REIT's strong second quarter results, which highlight our team's continued operational excellence and underscore once again the resiliency of grocery real estate. This quarter, Slate Grocery achieved significant growth through the acquisition of a $425 million grocery-anchored real estate portfolio. We acquired 14 high-quality properties, adding 2.5 million sq ft or 18.6% of gross leasable area to the REIT's portfolio. The acquisition increases our exposure to leading markets for population growth in the U.S. and top performing national and regional grocers. Importantly, the REIT's acquisition basis of $174 per sq ft implies that in-place rents in this portfolio are well below market. We believe there is an opportunity to grow organically over the long term with this portfolio.
The REIT also entered into a strategic joint venture with the Slate North American Essential Real Estate Income Fund or the North American Essential Fund. This partnership with the North American Essential Fund, which includes a leading sovereign wealth fund, provides institutional validation of the REIT's platform. It also establishes the structure for a consistent source of private capital in addition to the REIT's public funding strategies. As part of the joint venture, the North American Essential Fund made a $180 million cash investment into the REIT's assets at a valuation in line with the REIT's Q1 2022 IFRS value. This once again validates the value of the REIT's real estate. The REIT allocated the entirety of the investment by the North American Essential Fund toward the $425 million acquisition, which was completed in July.
Importantly, after the period, the REIT amended its existing revolving credit facility and term loans totaling $608 million. The amendments enhanced the REIT's liquidity position and financial flexibility through improved pricing terms and covenants. The REIT's debt profile mitigates near-term rising interest rate risk as 91.4% of the REIT's debt is fixed. Finally, our operational performance continues to trend positively, even amid a broader economic slowdown. Our asset management team completed 440,000 sq ft of leasing. Renewals were completed at a 5.9% rate above expiring rent and new deals at a 26.6% above in-place rent. On a one-year to-date basis, the REIT's total leasing spread is 12.4%, providing protection in an inflationary environment.
Occupancy has increased 20 basis points over the past quarter with net positive leasing expected through the second half. Additionally, our in-place average rent rate for the portfolio is only $11.82, which is significantly below market. We believe that limited supply of new construction and neighborhood centers in the market, coupled with increasing the cost of construction, will continue to drive demand at our location, which gives us the ability to push our rents over time. Slate Grocery REIT is uniquely positioned to benefit from the current macroeconomic environment as grocers continue to be the focus where people are spending their money. This is non-discretionary items. With inflation rates at all-time highs, consumers are pulling back on discretionary purchases and spending more on groceries and essential goods. We also continue to see a deep pipeline of accretive opportunities.
Our strategic joint venture with the North American Essential Fund, together with our recently upsized credit facility, gives us the flexibility to pursue strategically and opportunistically during challenging times. On behalf of the Slate Grocery team and the Board, I'd like to thank the investor community for their continued confidence and support. I will now hand it over for questions.
Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. If you would like to ask a question, please press star followed by the number one on your telephone keypad. If you would like to withdraw your question, please press star followed by the number two. One moment, please, for your first question. Your first question comes from Jenny Ma of BMO Capital Markets. Please go ahead.
Thanks. Good morning, everyone.
Morning, Jenny.
Morning.
Given that interest rates have risen quite materially, investment spreads have presumably compressed, especially when you consider that cap rates for your asset type have been flat or also saw a little bit of compression. I'm just wondering what your thoughts are, would be in terms of what the minimum investment spread would be for the market and maybe for Slate Grocery in particular. I mean, there's obviously a lot more wiggle room with the going-in cap rates where they're at, in that high 6% to low 7% range. But at what point do you start to see, I guess, the market flatten out or slow down?
Yeah. Thanks, Jenny. I think, you know, and you and I have talked about this a bunch. I think a cap rate is somewhat useless if you don't know what rent you're capping. We believe at Slate Grocery REIT, with our rents at $11.82, we estimate that's probably half of market. At our existing cap rate, there is tons of room to run. Effectively what we're saying is, I would compare our rents, 'cause we do, to any U.S. peer or any Canadian peer, and we'd be below all of them, and yet we still have a wide cap rate. I think investors get the benefit of our positive financing spread, which I think your question was, which we estimate right now, I think that the U.S. 10-year is well below 3%.
It's kind of volatile, but when you're buying in the mid-6, I think that's positive leverage, which is nice. More importantly, you're buying significantly discounted rent that should grow your top-line revenue. Because last time I checked, the only way to make money in real estate is compression of cap rates or growing your rents. I think we all know that cap rates are going up. Slate Grocery REIT has positive leverage 'cause we can still buy wide cap rates, but we can get significant revenue growth because of our low in-place rents. I think people need to start focusing on where rents are compared to market and where new supply is. I think the neighborhood-anchored grocery space is extremely compelling because of that.
We think, Jenny, we can buy positive leverage right now, and we have a lot of room, but it's really more because of our low in-place rents.
I mean, in that sense, when you look at the Slate Grocery portfolio, do you think that rent grows over time as leases roll? Or do you think you'd have to put some material capital to bring it up to market rents?
Well, I'll ask you the question. We've done 12.4% positive leasing spreads this year. I mean, I think that's pretty good. I mean, it's happening, and our capital spend hasn't changed because Slate Grocery shows actual cash spend on a quarter-over-quarter basis. I think that's pretty positive growth. You know, I think if you break that number out, is that a forever number? Well, if inflation stays like this, maybe. I think the next question could be. Can our tenants afford it? Well, our grocers are some of the biggest retailers in the world with great balance sheets, and the tenants need to pay for non-discretionary items like food.
I think where people are gonna get squeezed is the non-discretionary spend, and they might have issues, but we feel very confident that our tenants can pay modest increases in their minds from going from $11.82 to $12, $13, $14 bucks, and that's huge growth. It's still less than a new build that would cost them in the low to mid-$20s. We feel confident that we are a great inflation, kind of, protected bet. You know, I think we love that play because Slate Asset Management always focus on low basis because you buy low rents.
Right. Okay. When we talk about continued growth through acquisition, in the last deal that you did, you were able to get financing from the North American Essential Fund at IFRS NAV for 2.1x. That's great. Just given where, I guess, the public equity cost of capital is, it doesn't seem like it's necessarily a viable source of capital over the very near term. I guess my question is, you've got these additional sources of capital now, would you be willing to issue in the public markets to fund acquisitions if the math works?
Is IFRS NAV kind of that, you know, that line in the sand, that determines whether or not you would issue public equity and if you're not able to, maybe lean more heavily on your alternative sources of capital to get deals done?
You know, I think that, you know, we do what's best for the investor, and we will only do accretive deals and deals that make sense. I think right now in the public markets, that's a little bit challenging, but I can't comment on, like, deals in the future. Like, if, say, you said, "Here, Blair, here's a deal at a 50% return," like, I might look at it, but, you know, it needs to make sense. You know, we're not gonna rush out to dilute the equity. That's not what we do. We've never done that. We try to focus on total return for our investors. I think, you know, we feel really, really proud that we have some of the largest investors in the world supporting this strategy and supporting Slate Asset Management.
Like, they came in with a real cash bid for our NAV. It wasn't a stock for stock trade. It was real cash injected. They believe in the strategy. I think global investors want assets that earn U.S. dollars, that are defensive, that are inflation protected. I think the market in the U.S., the grocery real estate market is extremely fractured. There's almost 40,000 grocery stores, and we estimate the largest portfolio is only like 500. I think in a tougher financing environment, when the average asset size is $20 million-$30 million, when syndicators and privates typically use CMBS financing, I think well-capitalized buyers will see great opportunities. We're not gonna rush out to issue equity to be foolish. I think we're gonna do what we've always done and be prudent.
I think the deals we've done historically at Slate Grocery show that.
Okay, great. That's very helpful. Thank you very much.
Thanks, Jenny.
Ladies and gentlemen, once again, if you would like to ask a question, please press star one now. Your next question comes from Gaurav Mathur of iA Capital Markets. Please go ahead.
Thank you, and good morning, everyone. Two quick questions on my end, and I'll begin with the first. Now, you know, just staying with the acquisition line, there seems to be a healthy appetite for grocery-anchored assets in the U.S. Just a question here on how that's affecting your capital deployment strategies, especially in terms of the buyer pool that you're facing from maybe six to 12 months ago.
I mean, I'll start it, and Connor, if you're on, you can jump in. You know, I think that the market is kind of in two groups. One is I'll call it the onesie-twosie market. I know that's a very scientific term for it. You know, buy one grocery store, finance one grocery store, usually a group of privates. That market is tough to get financing on individual assets. As we all know, the financing market in North America and Europe for that matter is tightened. I think you can find good one-off deals that come up to refi or, you know, we're a well-capitalized buyer. That's how we've traditionally grown Slate Grocery, with the exception of the deal we did this year and the deal we did on the Annaly deal.
We're constantly looking at that. Then on the portfolio side, I think there are portfolios of grocery stores that are mixed together in portfolios of other assets similar to the Annaly deal we did. Sometimes they sell the grocery assets because they can and get liquidity, and we can get good pricing. We're looking at both, Gaurav, and I think there's no shortage of pipeline. We will only do deals that make sense. Really what we do is that means can we buy cheap rents? We believe buying cheap rents in this kind of environment make all the sense in the world. Well, we believe it makes all the sense in the world all the time. Right now, in an inflationary environment, that's what we're looking for, and there's no shortage of pipeline.
Connor, I don't know whether you want to add to that.
Yeah. I think right now it's kind of a wait and see. Right now, there's still been a lot of pricing tension in the grocery-anchored space. A lot of that has been from the 1031 exchange buyers, where they have the opportunity to take down an asset and not pay taxes on a previous trade. I think that will be interesting to see how that plays out over the next three-six months. Speaking to kind of our brokers in the business, if you go back six months ago, a grocery anchor deal, you would have a very deep buyer pool of qualified groups at very competitive pricing. The number they referenced is you'd average 12 qualified buyers around the purchase price.
Whereas now that's shifted down, and pricing really hasn't moved much on good quality grocery-anchored. You're really seeing more closer to maybe five to seven qualified buyers close to the purchase price. There's a lot more discipline with choosing a group that is well capitalized, that doesn't have to have financing contingencies. I think we're still in the early stages, but we're gonna continue to monitor and try and seek out interesting opportunities, and be there to pounce when the opportunity is right.
Okay, great. Just that leads into my next question. Look, we've seen, you know, the rental spread at 2.5% year -to -date. What kind of rental spreads can investors expect going forward, both on renewals and new leases, especially when you bifurcate the portfolio between the Sun Belt and the non-Sun Belt regions?
Yeah. I'll let Allen go in for details. I'll start by saying it's really we focus on the rents wherever we are. We want to focus on the number one or two grocer. We really break the portfolio into the grocer rental spread and then what we call the national or the junior anchor or the shop space spread. What we have found is, you know, tenants move from enclosed malls because they want to be around the traffic that the anchor generates. They also believe, if you think of our portfolio, you know, we can offer a much cheaper rent for those tenants coming out of the enclosed malls.
We're also seeing tenants that we usually have, whether it's a Ross or a typical pad buyer or a user like an Aspen Dental, they'll go in inline now because they can't afford to construct space. I think traditionally we have seen, before the inflationary environment in the last year or so, we've seen, you know, grocer rents probably go to 1%-3%, and we were doing shop space growth probably 3%-5%. You mush that together, we would do, you know, in the 2010 to 2018, like 3%-4% growth. Well, now what we're seeing is the grocers probably from 1%-2%, maybe that's 2%-5% because you want to keep them. Like, this is rough math. Then the shop space rents are growing much higher.
When you blend that out, I think we could do in the next little bit 6%-9%. You know, kind of bumpy. It's hard to tell, but we're beating that right now. You know, we're very conservative in what we do, but I just think there's no place for them to go. You got to do the fine balance of keeping your anchor and then. You know, there's no space being constructed. Allen, maybe you can jump in and correct all the math I just said.
No, I think that's very well said. I this past quarter we had on new leasing alone a 26.6% spread. Quite candidly, we do not see that slowing down on the new leasing side.
Okay, thank you. Thank you for the color, guys. I'll turn it back to the operator.
Your next question comes from Pammi Bir of RBC. Please go ahead.
Thanks, and good morning. Just looking at the leasing trends and given the current environment and all the concerns around a slowing economy, can you maybe just talk about what you're hearing from your tenants in terms of demand for new space, maybe where you're seeing strength versus weakness?
Yeah, I'll start, and then Allen, you jump in. We're seeing it across the board, but maybe you can give more detail, Allen, on like, say you had a pad user, they're deciding to go into inline space. That's an amazing decision because of costs. Or when you see a tenant that usually you have to spend a lot of money on façade work or whatever. Again, we're talking grocery centers, so it acts more like our below the line capital isn't like a normal enclosed retail or high shell retail. It's cheaper, but they're even scaling that back. We're seeing demand into built out space like we've never seen, and that's a good thing.
You know, I think moreover, historically, if you look at the neighborhood grocery-anchored strip center market in the U.S., I think it's always bounced around the low 90s, even in bad times. You know, the portfolios we purchased recently, the Annaly deal, which was below 90% and the most recent deal we closed that was in the low 90s. We feel that there's leasing upside because we're at 90%. Like, we think the market, like, all the space in the next short term, I believe, could go to 100% full. Do I think that's sustainable forever? No. I think you can look back historically, it's always in the low 90s. I think you're going to get full utilization of space, pressure on rents in the short to medium term here, and it's demand from across the board.
Allen, maybe talk about like what you're seeing from tenants and what you're hearing from what they need.
Absolutely. In this environment, as Blair stated, it's very costly to build. Timing is an issue as it relates to construction and getting projects completed. That's what we have to remember, is across our portfolio, we typically have white or vanilla shells and some second -generation boxes. Tenants are able to come into our shopping centers and open quickly and at a significant discount to new construction. That's where we see our real advantage.
Got it. I guess, you know, if I were to sum up, is it fair to say that doesn't sound like you're really seeing any signs of, you know, weakness between whether it's certainly not the grocers, it seems, but whether it's the juniors or some of the smaller shop independent space, it all seems to be fairly healthy. That's fair, or?
Yeah. I think that is exactly right. We know a lot of our tenants reported whether you're a Walmart or like, you know, I think the squeeze on them is the discretionary spend items. Those are higher margin items. Sales are going down, but the grocery spend is going up, and it's just a lower margin business. What does that mean? They're making money, but not as much. But the grocery sales are going up. But our tenants, the grocers, are very well capitalized. They're still making money, but it's the food business, and that's good. As it relates to the other tenants in our space, we still offer cheap rent, and I think, and compared to other options. It's like, are they gonna stay in business or not?
We feel very confident that our tenants that are in our space are healthy, but we also are the low cost provider because our weighted average rent is lower than any other retail and any new construction. The question is: Do they wanna be in business? Do they not? Where do they go? They wanna be around the activity of the grocer, and the grocer is fulfilling an omnichannel strategy. Shop in the store, click and collect, or online delivery pickup with the vans in the parking lot. I think that activity is where all the other retailers wanna be. You know, I think we see activity across the board. We offer the best rent in the street, and I think that's why demand is pretty strong and why we call this essential real estate.
Like, in the COVID lockdowns, people still went to their neighborhood center, and that's, you know, I don't think that's changing.
Right. Just, you mentioned the Annaly portfolio and some of the leasing there. Do you have an estimate of just how much the occupancy in that portfolio has risen since, or if it has, sorry, since the closing of the acquisition?
Yeah. Leasing has been positive. We came in at about 88% on the portfolio. I'd say it's about low 90s right now, so 91%, 92%. We still think that there's traction there, speaking to Blair's point of just the demand we see in our space. The in-place rents are really attractive to drive sort of the inline sort of shops.
Got it. Thanks for that. Just lastly, maybe just putting all those comments together, on the gap between in-place and market rents. You know, looking back, I think, you know, Slate's historical organic growth has averaged, maybe around 1%. It sounds like the next, call it one to two years, I mean, should we start to see some numbers that are, you know, closer to 2%, in the 2%-3% range, particularly, you know, on the with some of the rental spreads that you are getting? Or is it, you know, should we sort of stick with kind of this 1%, maybe a bit higher?
No, I think it should increase. You know, when we started in this space over a decade ago, I think there was rental growth. Then if you wanna pull out five years ago or when Amazon bought Whole Foods, people thought it was the end of bricks and mortar. For grocery, we didn't think so, and I think there was a pullback or a flattening, and then maybe that's the growth you're referring to. There was no new space built. People still use the bricks and mortar because it's the spoke to the hub of the distribution. It's last mile distribution. Now I think we're seeing significant rental growth because we actually look at the grocery store as logistics, and that's how the grocers use it. When you think of their rents in place, it's almost cheaper rents than their industrial hub.
I like to say it, I'll put it in the Canadian context because I think most people on this call are Canadian. If I live in Midtown Toronto, and I want my groceries delivered quick, Loblaws doesn't go to the Mississauga warehouse with 100 vans to deliver to 100 homes in Midtown. They drop a couple trucks in the main store, and then they do short trips because the biggest cost to the grocer, about 45%-65%, is transportation. You need to be more efficient on your distribution, and the next is labor. I think what we're seeing now is the value of the spoke to this logistics hub has become. Like if you think of industrial rents, and we love industrial, don't get me wrong.
When you think of a grocery box as just part of that distribution chain, I think you're gonna see extreme or really good rental growth. To answer your question, Pammi, I think we can bump that up a 2% and feel pretty comfortable about that.
Something closer to 3%?
Yep.
Thanks very much. I'll turn it back.
Your next question comes from Sumayya Syed of CIBC. Please go ahead.
Thanks. Good morning. Not sure if I missed this earlier, but just on the recently closed portfolio, what is the mark-to-market on rent there and the timeline or I guess the average lease term you have to capture that spread?
The in-place rent for that portfolio is close to $13. Again, it's still below market, especially compared to our peers in the U.S. space. The average lease term is kind of what we see in our portfolio. It's not too different from what we have across the REIT.
Cap rate spreads. Obviously you made a big move into the Sun Belt states recently. Just wondering how does pricing compare there versus other markets for similar product.
Hey, Connor, do you wanna talk about some?
Yes.
of the large portfolio deals and that stuff? Cool.
Yeah. I think the grocery anchored space kind of across the country has really over the last 18-24 months become more and more competitive with large institutional groups coming in and making kind of big portfolio and platform acquisitions. We've seen cap rates kind of as low as the low 4% cap rates kind of with several deals between kind of low 4% to the low 5%. There's a lot of kind of comps in there and capital looking for the stability of the grocery anchored space. In terms of the spreads between kind of a Sun Belt market to other markets, it is more competitive. There is a lot of money coming into specifically the state of Florida.
I think the nuance of the acquisition we just made, it was a little bit of a fragmented portfolio. It was across seven different states. There was lots of group bids and pricing pressure on just the Florida assets from multiple groups focused on that particular region. Because we have a national platform with a lot of assets in a lot of these markets, it fit really well for us and probably limited the amount of competition we should see there. I think simply put, more cap rate compression has been occurring in the Sun Belt markets. I think we've done a good job focusing on real estate fundamentals, continuing to buy at a discount to replacement cost with strong grocer performance.
There's been a little bit less competition in some of the, call it Northeast or Midwest markets. That's not to say, the fundamentals aren't still strong. There's probably just a thinner buyer pool that is driving pricing.
Okay, great. That's helpful. Thank you.
There are no further questions from the phone lines. I would like to turn the conference back to Paul Wolanski for closing remarks.
Thank you everyone for joining the Q2 2022 conference call for Slate Grocery REIT. Have a great day.
Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank you all for participating and ask that you please disconnect your lines.