Good morning, ladies and gentlemen, and welcome to the Slate Grocery REIT Third Quarter 2022 Financial Results Conference Call. At this time, all lines are on listen-only mode. Following the presentation, we'll conduct a question-and-answer session. If at any time during this call you require immediate assistance, please press star followed by one for the operator. This call is being recorded on Thursday, November 3, 2022. I would now like to turn the call over to Paul Wolanski. Please go ahead.
Thank you, operator, and good morning, everyone. Welcome to the Q3 2022 conference call for Slate Grocery REIT. I'm joined this morning by Blair Welch, Chief Executive Officer, Andrew Agatep, Chief Financial Officer, Connor O'Brien, SVP, Allen Gordon, VP, and Braden Lyons, associate. Before getting started, I would 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 Q3 2022 investor update, which is now available. I will now hand over the call to Blair Welch for opening remarks.
Thanks, Paul. The last quarter has further strengthened our confidence in the value of our grocery-anchored real estate, the resiliency of our cash flows, and the embedded growth in our portfolio. Grocery-anchored real estate has proven its ability to perform through various economic cycles, and we believe the current environment is only providing additional tailwinds for the sector. Surging construction costs and supply chain disruptions are limiting new supply in this market. This limited supply, coupled with strong demand for grocery-anchored space, is accelerating rental growth in this sector. Importantly, within our portfolio, average in-place rent is $12.17 per sq ft, significantly below our U.S. peer set weighted average. This means we have significant rental rate growth embedded in our portfolio, and we believe through modest increases to our below-market rents, we can unlock this embedded growth and significantly increase our revenue.
In the current interest rate and inflationary environment, which we know can contribute to cap rate expansion, our growth in revenue can more than offset any negative impact on our valuations. Our team's operational performance this quarter speaks to the growth embedded in our portfolio. Our asset management team has completed over 520,000 sq ft of leasing in the third quarter. New deals were completed at 9.5% above in-place rent and renewals over 4% above expiring rent. On a year-to-date basis, the REIT's new leasing spread is 26.6%, and total leasing spread is 9.6%, our highest rates of growth since 2018. Occupancy remains healthy at 93.1%, and we expect positive leasing to continue through the remainder of this year.
The grocery real estate market continues to present attractive buying opportunities, and the REIT's partnership with Slate North American Essential Real Estate Income Fund provides us with financial flexibility to pursue compelling investment opportunities. We also achieved meaningful improvements to our balance sheet and liquidity, amending over $600 million of existing revolving credit facility and term loans at improved pricing. As of quarter end, 89.7% of the REIT's debt is fixed, providing protection against inflation and rising rates. Lastly, after quarter end, the REIT completed two strategic dispositions at a total sale price of $19 million, representing a 6.6 cap rate. We expect to recycle the proceeds from those transactions into new opportunities that create value for our unitholders.
We have strong conviction in the healthiness of the grocery asset class in our grocery-anchored properties, in large part due to the embedded rent growth potential of our portfolio. With an attractive source of private funding now available for the REIT, in addition to its public equity sources, we are well positioned to take advantage of opportunities in a dislocated market. On behalf of Slate Grocery 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. Ladies and gentlemen, we'll now conduct the question-and-answer session. If at any time you'd like to ask a question, please press star followed by one on your touchtone keypad. If at any time you'd like to withdraw your question, please press star followed by two. Your first question comes from Gaurav Mathur from iA Capital Markets. Please go ahead.
Thank you, and good morning, everyone.
Good morning, Gaurav.
Just firstly focusing on the fact that, you know, that your rents are considerably below market and your peers, and as you increase them going forward, how should investors think about stabilized cap rates on your portfolio versus, you know, the peer set? What I'm getting at is how does that delta begin to change?
Well, I mean, it's excellent question and obviously very relevant in today's environment. However, I think a cap rate is kind of useless if you don't know what rent you're capping, which is kind of your question.
Right.
I think the cap rate and the rent equate to a total value. I think what we're saying is that our value, we believe, could probably go up just because our revenue growth because of our embedded rental growth will outpace any expansion in cap rate. Another way of saying it, cap rates should be lower on our portfolio where there is lower rents. I think that's what we're really talking about. That being said, we are extremely comfortable with our current cap rate on our IFRS value, probably much wider than most of our Canadian comps and even US comps. Yet still we can buy assets with positive leverage in the market. I think to answer your question is we believe NAV could probably grow in this cycle and the cap rate could expand.
We don't see that anytime soon just because our rents are so low, but we think NAV could grow just because of the amount of rental growth.
Okay, fantastic. That does lead me to my second question, which is, you know, the acquisition pipeline in a fragmented market must be looking very attractive. Can you talk about how that's changed or if that's changing or you know, the beginning of the year?
Yeah. I'll let Connor answer in more detail because he and the team do an excellent job covering the market. In general, I think there's a couple of things going on. Now, grocery, you can still get financing if you're well capitalized, and Slate Grocery has proven that we can do that. On the onesie, there's over, like, about 40,000 grocery stores or neighborhood strips anchored by grocery in the United States. It's a highly fragmented market and a lot of CMBS financing. That market's not there. I think what we're going to start to see is two things. Maybe people that can't refi at the old rates on onesie, twosies needing to sell, and then also people can sell grocery to get cash for other parts of their business.
I think it's changing and we're being cautious, but I think we're very excited about the coming months on opportunities. I'll pass it to Connor to kind of give some specific market color.
Yeah. I think overall the grocery-anchored sector has been more resilient than kind of other areas of the retail asset class, as well as kind of other asset classes where cap rates traded closer to their financing rates. Going forward, I think there may be some thinner buyer pools given the increased financing costs. I think that just may create opportunity for Slate going forward to identify opportunities where we can buy under market rents at a very attractive low basis at a discount to replacement cost and to continue to grow our portfolio strategically.
Okay, great. Just lastly, can you talk about the implications of the Kroger-Albertsons merger on the portfolio? I mean, is there any cause for concern just yet, or is it still very early days?
Sure. You know, we believe that it's too early to tell. That being said, we do not see any significant impact on our portfolio. You know, this deal is not scheduled to close till, I think, 2024, and I think it's a competition thing. What's interesting, unlike perhaps other things, people in these markets, like those food stores are still selling grocery, but it's a competition thing. Kroger and Albertsons will be very hesitant to shed those stores because they have to a competitor. It's not like those stores are not selling food or they need food. I think they're just being cautious of how they do it. The use of those stores will still need grocery. It's more of a competition thing.
We think it's too early to tell, but we don't see it as a negative on our portfolio. Moreover, because of our cheap in-place rents, we think our stores are actually quite attractive.
Just stay on that line of questioning, is there a positive that may come out from this entire merger for you guys?
Yeah. You know, I think that could be. Again, it's too early to tell. You know, to put in context from a U.S. perspective, you know, I think the top brands. How many grocers make up the 40% of the sales? Like, it's such a fractured market. Like, the combination of these two grocers are still less than 10% of the sales. I think the top 20 grocers in the U.S. are 40% of all grocery sales. Where in Canada you have three or four main grocers that dominate the market. Yes, it could be good, but, you know, I mean, the market's so big and vast, you know, we don't see this being a huge thing, for our portfolio or the segment.
To your question, it could be positive, but it's too early to tell.
Okay. Thank you for the color, Blair. I really appreciate it. I'll turn it back to the operator.
Thanks a lot.
Thank you. Your next question comes from Jenny Ma from BMO Capital Markets. Jenny, please go ahead.
Thank you. Good morning.
Morning, Jenny.
I'm reading through your letter to unitholders, and hopefully I'm not picking apart the words too much. About halfway through, one thing that you write was through modest increases to our below market rents, we're confident our ability to unlock embedded rental rate growth. I'm a bit fixed on the word modest just because it looks like there's a gap and you talk about rents being quite far below market, and I'm just a bit unsure about the disconnect between these modest increases versus the gap. Is it because of the contractual rent steps that are already in place, or are you just taking a little bit of a cautious view given the economic circumstances? Just maybe give us a bit more color on your thinking on that.
Jenny, you sound like my high school English teacher, but I think it's a good question.
I do write for a living.
You know, I think the word choice, we might be sandbagging a bit. You know, I think as we said, our annual kind of rental spread is 9.6%. Is that modest? No. Do we feel confident that we'll be a little bit better than modest? Yes. How long? That, that's not a forever thing. You know, if it is, you know, it's good for us. I think the next couple of years, maybe it's more than modest, but we're trying to be. We're not trying to shoot the lights out. I think Slate Grocery REIT has proven to be a stable company with defensive cash flows that always pays their distribution. We're looking forward to growing our revenue, but we're just kind of being cautious in this sector. I mean, I think the numbers speak for themselves with our current leasing spread.
You're right, maybe modest wasn't the right choice, but we're Canadian, we have to kind of be gentle.
Well, maybe we just dig a little bit deeper then. When you look at the portfolio, you know, are the grocers giving their longer term leases? Like, is the contractual rent step going to limit the kind of growth, and you have to look to your sort of smaller tenant CRUs to offset that? Or are the opportunity to get a let's say a bigger mark to market on some of the grocery anchors, just given how far below market you say Slate Grocery's rents are.
Yeah, you're right. It's a combination. Like, our grocery-anchored rents is just below $9 a sq ft, which is extremely cheap, especially when you compare that to Canada or industrial rent. You know, our grocers make up about 40% of the portfolio. We are seeing more dynamic growth, and I didn't use modest, Jenny, for our shop space and others. It's a fine balance. We are still seeing, I would say, above modest growth with our grocers. It's going to be mid-single digits, where usually I would say that's probably low single digits. When you blend them all together, I said, you know, that's why I said we're over 9% this year. I think it's. You know, we've always believed.
You don't need that much growth for to go from, like, $9 to, you know, $9.50 to $10. That's huge growth, right? Like, I mean, I think there's good steps there. I think it's a balance making sure our anchors are happy in doing it. You kind of blend that over time, because once you have that anchor there, that rent, and they love these stores, you have a little bit of room. Where you're gonna get more growth is once that anchor is anchoring that center, everyone's gonna be around that anchor. It's a blend of both. You're right.
Okay, great. Just look at your capital stack and that $83 million term loan that's coming due in the next few months. Just wondering what the plans are there. If you're gonna roll it into another term loan or maybe get some secured financing in place. What the indicative rates might be on that new piece that you need to refinance.
Sure. Andrew?
We're actively in the market now looking to refinance that. We don't have any particular concerns that we're getting that done. What we've seen is that the market has slowed down considerably, but there's still active interest for grocery assets. What they're really looking at when they're underwriting now is, what's the strength of your rent roll, how strong is your occupancy, and is it gonna grow? We check all the boxes, and we feel uniquely positioned to refinance this at a rate that we think is kind of consistently seen in the past. Like, interest rates have gone up, but spreads as it relates to grocers have sort of been the same. Our cost of debt would probably be slightly closer to, I'd say, high fives.
Yep.
Okay.
In terms of our weighted average cost of debt, that's probably a 10 basis point increase to our overall portfolio, so 4.3%. Point being is that we are still a positive leverage, and we have enough liquidity to sort of invest in opportunities during this time.
Okay. If you're talking about the high fives, that is a big jump on that piece specifically, right? Just given that you're coming off less than 3%.
Yeah. I think that's right, but there's still demand there, but I think that there's still growth in the rents to kinda offset that. Like, it's not, you know, there's still gonna be rental growth. You're right, the cost has gone up.
Yeah.
Well, we still have positive leverage for our rent valuation and cap rate, but we believe our revenue growth will more than offset that. I think, you know, being able to finance in this market, there is demand to do it from various sources, life cos or local banks, or we could do it on our bank line. There's all sorts of flexibility, and we're just gonna choose what's best for the company.
Okay. Is the desire still to keep it unsecured, versus, going secured to refi?
Yeah, we're looking at all options. You know, that's why I said we're looking at all options. It's nice to be in a real estate asset class where you actually have options for debt right now.
Right.
You know, I think that we're just gonna see what's best for flexibility and pricing.
Well, what's the spread that you're seeing between secured and unsecured debt?
Well, I think.
On U.S. grocery-anchored assets.
Well, I think it's more on size. I mean, I think the unsecured market's kinda choppy right now.
Mm-hmm.
I think in the secured market.
That's why I asked. Yeah.
I think you're gonna get better pricing in the secured. I'll answer that question. I think you're in the, you know, high 100 spreads over, you know, the base rate for fixed financing right now. And I think that's reasonable. My assumption, and I wouldn't trust unsecured pricing right now if I got it would be much higher than that.
Okay. Perfect. Thank you very much. I'll turn it back.
Thanks, Jenny.
Your next question comes from Himanshu Gupta from Scotiabank. Please go ahead.
Thank you, and good morning.
Good morning, Himanshu.
Just on the two asset dispositions, sounds like you got 6.6 cap rate on that, so looks like good pricing. Just wondering, what was the profile of the buyer? In general, how's the appetite for grocery-anchored assets in the current environment, I mean, the transaction market?
Both of those buyers were private groups focused on kind of a 1031 exchange. They were motivated to transact quickly, and that was something we identified when we were kind of bringing in from LOI stage to closing. They were looking for kind of a cash flow limited use of financing, and we're happy to kind of transact with them. Again, the profile of both of those assets, one being a non-grocery-anchored center, so non-strategic, and another having a larger exposure to gross leases, which is something in an inflationary environment we were looking to strategically move away from.
It's a good question, Himanshu. I think that one of the strengths of Slate Grocery in the sector that we focus on is it's very granular. You know, if you think about each deal size, it's, you know, $15 million-$25 million plus or minus. So it's for the large funds, it's hard to kind of focus. But we get to see all that stuff, and this granular nature means privates can do deals. What we're seeing globally is that's really where the activity is on the granular types of real estate. It's hard to do big deals right now because the way the financing market is, and I'm not talking about the cost of financing, I'm talking about the availability of financing big deals. We are still seeing globally, you know, more granular transactions and especially the grocery space getting done.
Got it. Yeah, that's helpful color there. You know, sticking to dispositions, like you expect to do more dispositions in the near term? I mean, any strategic like disposition program in the near term?
You know what, I think that we've historically at Slate Grocery always recycled. Like if we think we've executed our business plan and, you know, if we think that, you know, like one of the assets that was sold is like more gross leases, and we think in an inflationary environment we don't like that. We've always done pruning. You know, I don't think. I think our portfolio is in pretty good shape. There's probably a couple, but not many. You know, I think the team has done a really good job of executing strategies and then selling assets when we think it's the right time. I don't think there's gonna be a significant amount of dispositions just because I think our portfolio is in such good shape, and we wanna capture all that embedded rental growth before we sell anything.
I mean, we'll just continue to monitor, but there's not gonna be anything huge in my opinion. Unless you wanna, Himanshu, pay us a 4 cap for our portfolio, I'll sell it to you.
Well, that will be negative leverage still, so.
Okay.
Yeah. No, thanks for the color there. Just moving on to the leasing environment, you know, I mean, clearly leasing has been very strong in the last few quarters. Yet if I look at, you know, the small shop occupancy that continues to be in the range of 87%-88%, kind of, you know, give and take. I mean, just wondering in the recessionary scenario, do you see further downside from here, or are we still talking upside from this number?
Yeah. We foresee that. We've got a deep and an actual new leasing pipeline. You know, we've got a lot of national tenants that are continuing to show strong interest within the market. We certainly do not see that slowing down.
You know, Himanshu, like we are seeing demand from all sorts of different sectors. You know, I mean, I'm gonna keep on driving it home, so you'll be annoyed with me. Our average base rent is so attractive to all tenants, the traditional neighborhood strip tenants. But if you're leaving an enclosed mall, what you want is two things. You wanna be around traffic, which our grocers create because they use it as omnichannel, whether they shop in a store, click and collect or grocery delivery. So they want that traffic, and they are going to pay way less rent, even though it's good for us, than they would in an enclosed mall. In this inflationary environment where they have rising costs and they gotta look at their margins, we're seeing demand from tenants that we never thought would do this.
We also see demand from tenants that would traditionally be in a pad site going inline. I think we're confident that for the foreseeable future there will be demand, and I'm sure you know other companies that you cover in the U.S. or our peers, they're seeing the same thing. Like it's there has not been a lot of new supply added in this space since before the financial crisis, and construction costs are really high. We see occupancy going to be picking up and the demand for our space, like it's we're pretty excited.
No, that's fair enough. I think continues to be resilient, those grocery-anchored assets there. Yeah, I think just one question on the balance sheet. I think you did some $275 million term loan. What was your pricing on that?
The pricing of the term loan is pretty consistent with what we have with our other credit facilities. It's about 185 basis points spread on top of one month SOFR. We did enter into two swaps, which basically fixes that. Our debt, our fixed debt's about 90%.
Got it. What will be the rate on that, like in absolute numbers, including the spread there? Like it will be five-
It's about 4%. Below 4%.
Okay. Oh, that's fair enough. Yeah. Okay. Thank you, guys. I'll jump back.
Thank you.
Your next question comes from Pammi Bir from RBC. Please go ahead.
Thanks. Good morning. Just on the portfolio acquisition that was done in the quarter, what can you say with respect to the performance relative to your underwriting so far? As it looks like, if I'm not mistaken, that the occupancy does, I think it's actually up relative to the initial announcement, but just curious if you can provide some color there.
Yeah, I think we've been very pleased with that acquisition that was completed in July. We're seeing a strong leasing pipeline at those properties and kind of see ourselves outperforming kind of our initial underwriting and see substantial income growth within that property portfolio, kinda going into the next 12-18 months.
Part of it too is when we signed the deal, it was about high 91% occupancy. Just between that and actual closing, we had another 60 basis points to that portfolio. Plus the timing of our capital centers just been pushed out a little bit, so we've definitely seen a lift this quarter. There is embedded growth that we're excited to see over the next sort of 4-5 quarters that'll be accretive to our bottom line.
Was the leasing that you mentioned, you know, moving up or seeing some pickup there, was that particular to any of the specific markets like the Sun Belt or just was it more broad-based?
No, just more broad-based. It's just, like I said, the leasing has come on early, but just more timing of our capital spend, just, things like your roofing and that kind of spend has just been pushed out a bit.
Yeah. I think that, you know, we really like the, like, the Southeast and other places where there's population growth because it's cheap cost to live, cheaper cost to live than other cities. However, we have seen good demand from all of our assets from leasing. So it's not anything specific. It's not region specific. It's more asset class. Neighborhood strips are showing good demand across the board because of what we've talked about already in the call.
Got it. Just coming back to maybe the, you know, the acquisition outlook, are you seeing anything similar in terms of the opportunities of this size and scale? You know, would you be prepared to transact, or are you still taking a bit more of a cautious view?
I think we're being cautious because we always are. You know, I think that grocery-anchored is a pretty attractive asset class, so big deals are hard to do. We'll always look at ways to add value to unitholders. I think we see probably more opportunistic pricing on the single assets probably for the next little bit. You know, I think it's a combination of both. It's anyone who's well capitalized probably doesn't wanna sell their grocery unless they have to. That's, we think, probably gonna be in the smaller scale. You know, you never know what the future holds. We're always looking at portfolios and single assets, you know. We're seeing in Europe, like, picking up small portfolios is happening, but, you know, it really hasn't happened in the U.S. yet.
Perfect. Thanks very much. I'll turn it back.
Thanks, Pammi.
There are no further questions at this time. I'll turn it back to you.
Thank you everyone for joining the Q3 2022 conference call for Slate Grocery REIT. Have a great day.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.