Good day, ladies and gentlemen. Welcome to the SmartCentres REIT Q4 2021 conference call. I'd like to introduce Mitchell Goldhar. Please go ahead.
Thank you, Mike. Good morning, and thank you for joining us today for our year-end conference call. I am Mitchell Goldhar, Executive Chairman and CEO, and I am joined by Peter Sweeney, Chief Financial Officer, Rudy Gobin, EVP, Portfolio Management and Investments, and Mauro Pambianchi, Chief Development Officer. Today, we will provide you with our Q4 highlights and update you on some of our major projects. Our commentary will refer mostly to the Outlook and Mixed Use Development Initiative section of our MD&A, which are posted on our website. I refer you specifically to the cautionary language on pages one to six of the MD&A materials, which also applies to comments any of the speakers make this afternoon, shall I say this morning. Momentum from early 2021 carried on throughout fourth quarter, with a strong performance reflecting the strength and resilience of our tenants and portfolio.
Small and mid-sized retailers were back, and even with some intermittent restrictions, occupancy and cash flow grew steadily throughout the year, reflecting the need for and role of well-located value-oriented open format retail. With Walmart and food store anchored centers making up virtually 100% of our portfolio, physical stores met the online challenge head on with a quick pickup, more selection, delivery options, and easy to navigate websites, demonstrating that physical and online can work together. Our portfolio, comprised of nearly 95% prominent, strong national and regional tenants, provides the financial covenant and stability that has returned us to over 98% rent collections and 97.6% leased by the end of 2021. While COVID tested us operationally, our portfolio has remained strong.
Retailers solidified their positions with us with new and renewing locations, while simultaneously enhanced their product lines and improving the customer experience, which has allowed us to maintain full distributions to our unit holders, a decision that we are proud of. Our wholly owned SmartLiving residential banner, a name that you will hear a lot more about, and our other mixed-use developments continue to enhance value throughout 2021, unlocking deeply embedded NAV and to our unit holders on lands we already own. Here are a few highlights of the quarter and the year phase I of SmartLiving's ArtWalk launched in Q4. ArtWalk is a 12-acre mixed-use art district in the heart of our flagship transit-connected SmartVMC development in the Vaughan Metropolitan Centre.
Located on the former Walmart parcel, when fully complete, ArtWalk will consist of approximately 5 million sq ft of density, including 5,000 residential units and up to 150,000 sq ft of non-residential buildings. The phase one release in Q4 included over 320 condo units, nearly 95 of which sold by the end of the year. It is worth noting that SmartCentres REIT owns 50% of these condos, twice as much as the 25% it owned of Transit City condos. In December, SmartCentres more than doubled its ownership in SmartVMC by acquiring a two-thirds interest in 53 acres within the 105-acre master planned SmartVMC city center. This acquisition united ownership across the property, making SmartCentres the largest owner in Vaughan's dynamic TTC subway-connected downtown.
45,000 new residents are expected to call SmartVMC home ultimately, and it is of course the jewel in the crown of SmartCentres portfolio. Within SmartVMC, we are expecting to launch Park Place, which will be a new 1,100-unit two-tower project on the west SmartVMC, the west portion of the SmartVMC, which we purchased just one and a half months ago. As you may recall, in SmartVMC, we completed the remaining 192 condo units closing in the Transit City 3 tower in 2021, bringing the total to 1,741 units closed in the first three Transit City towers, delivering over CAD 60 million in FFO to the REIT, and that's at 25%.
Also within the SmartVMC, Transit City 4 and 5 continued to be on schedule with expected closings in 2023. The Millway, Vaughan's first purpose-built rental tower, is now available to rent, with the first apartment units taking occupancy potentially in the fall. This is being leased out of our sales center, permanently located at the heart of the VMC. Sorry. These development updates are in addition to our current permissions in place. In 2021, we have advanced zoning applications for over 25.5 million sq ft of additional density as we continue to accelerate our transformational plans. Over time, you'll begin to see NAV growth and fair value increments on completion of successful land use entitlements for our master plans, combined with developments having been already initiated.
We currently have over 3.1 million sq ft under construction, which includes six rental apartment buildings, two in Mascouche, one in Laval, two in Ottawa, and one in our flagship SmartVMC. In total, we have 59 projects either underway or for which work is currently being undertaken to start construction in the next two years. While SmartVMC represents our vision of the future, it is only one of 93 REIT properties currently slated for intensification. Pages 20-23 of the MD&A highlights over 20 mixed-use projects totaling in excess of 55 million sq ft of net incremental density to be built. Some with partners and mostly on undeveloped land within our portfolio upon approval of all.
On the financial side, maintaining our conservative balance sheet is always top of mind with an unencumbered pool of in excess of CAD 6.6 billion, a 42.9% debt level and significant liquidity, which Peter will speak more about shortly. We will continue to only move forward with capital-intensive construction initiatives as market conditions warrant, sufficient presales occur in the case of condos, and only when financing is in place. We told you earlier in the year that we would undertake strategic and targeted capital recycling to strengthen the portfolio and assist with funding requirements. In this regard, we completed just over CAD 100 million in dispositions during the year, consisting of assets where no intensifications were identified and NOI was below market.
Lastly, the world is facing sustainability challenges such as climate change and aging population and inequality. At SmartCentres, we prefer to do the right thing and have the results speak for themselves. Our actions over the past three decades speak to our commitment to the communities we serve. ESG is woven into the fabric of our organization. SmartCentres was founded with the economic realities of the average Canadian household in mind. We focused on bringing value and convenience-oriented retail to the Canadian market with like-minded retailers. ESG is embedded in how we operate, oversee our business, engage with communities, and develop and energize our associates. Although ESG is getting much more airtime today, it's not something we just started talking about. It has been part of our DNA since the beginning. When you assess our portfolio, you can see these principles applied everywhere.
We have been working to formally improve our retail centers through BOMA BEST certifications, through improved resource management, occupant safety, and stakeholder communications, and we continue to work towards an 80% certification by the end of 2022. These days, Canadians want transit-connected homes with urban amenities. SmartCentres is evolving from shopping centers to city centers, and SmartLiving has emerged with our CAD 15.2 billion transformational plan to enhance Canadian communities. SmartLiving apartments, condos, towns, and seniors residents are designed around public squares and central parks within pedestrian-focused, transit-connected master-planned communities, all of which contribute not only to the quality of the built environment but also promote sustainability. We are grateful for the exceptional work of our talented and dedicated associates who represent the diversity of our community and the customers we serve.
Stay tuned for more formal ESG reporting to come. You will like what you will see. Given all of this, you should recognize that our team is capitalizing on what it does best, executing and focusing on change centered around each community. Now, I would like to turn it over to Rudy Gobin.
Thanks. Thanks, Mitch, and good morning, everyone. Throughout the fourth quarter, and in fact throughout all of 2021, we saw the underlying strength of our centers in driving leasing and customer traffic. Tenants in most categories were back with an even better appreciation for our well-located and open format centers. With virtually 100% of our leased properties having a full line grocery, and near 70% including a Walmart Supercentre, a wide variety of tenants were back doing deals such as dollar stores, TJX banners, QSRs, medical uses, grocery stores, distribution and logistics warehouses, personal services, home decor, pet stores, and a wide variety of service retailers, all driving traffic and improving our tenant mix and occupancy. Here are some highlights. Our leased occupancy continued to strengthen throughout the year, approaching pre-pandemic levels with a 97.6% achievement by year-end.
We completed 3.6 million sq ft of renewals, representing 85% of the maturities during the year. Over 925,000 sq ft of leases were executed for build space within our portfolio. Our tenants continue to work with us to adapt by expanding their e-commerce, product line, delivery model, pickup, and space utilization, all while striving to maintain customer loyalty and sales, and we are there to support them along the way. Compared to the bankruptcies and CCAA filings in 2020, there were virtually none in 2021, reflecting, and hopeful that the worst is behind us. From a rent collection perspective, we ended the year at just above 98%, and that is climbing, demonstrating the stability of the tenant mix and portfolio.
Regarding our Premium Outlets in Toronto and Montreal, both are now open and are at 100% occupancy. With the pent-up demand, accumulated disposable savings, and the reopening of the Canada, U.S. border, Christmas shopping was very strong, and we expect to be back to full sales and rent collections by mid-2022 in these centers. As we have highlighted previously, Walmart Canada plans to spend CAD 3.5 billion to make the online and in-store shopping center experience simpler, faster, and more convenient. This continued commitment to its retail operations in Canada speaks to the ongoing strength of Walmart and its growing ability to drive traffic to our centers. 2021 demonstrated what you've heard us say all along, that this portfolio was built for heavy weather.
Our high-quality tenants are adapting, customer traffic is improving, occupancy and cash flow are back to near pre-pandemic levels, and most importantly, all of this is happening concurrently with the extensive mixed-use development initiatives already identified or underway in more than half of our centers, translating into significant NAV growth and NAV growth to come. Now I will turn it over to Peter Sweeney.
Thanks very much, Rudy, and good morning, everyone. The financial results for the fourth quarter reflect the continued steady improvement in our core business that both Mitch and Rudy have mentioned. For the three months ended 31 December 2021, FFO per unit increased by 12% or CAD 0.06 over the comparable quarter last year. This increase resulted principally from lower ECL provisions, lower overall financing costs, and contributions from our total return swap initiative as compared to the prior year's results. It's important to note also that there were no condominium closings in the fourth quarter of 2021 as compared to the same period in 2020 that included FFO per unit of CAD 0.09 from closings in the Transit City 2 project.
In addition, IFRS fair value adjustments in our investment properties portfolio increased by CAD 581 million to CAD 10.7 billion at the end of the quarter. This substantive increase resulted from progress in the zoning and entitlements process associated with several strategic properties together with improved market conditions. It is important to note that as we continue to advance additional properties through similar zoning and entitlements processes, we will be assessing the appropriateness of similar adjustments in the future. Lastly, note that our annual distribution level continues to be maintained at CAD 1.85 per unit, as Mitch has noted. Given the cash generated by the business, our 12 month ACFO payout ratio ended the year at 90.3%.
Each of these financial metrics are representative of a common theme of steady and continuous improvement in our core business, supported by our growing development pipeline that is now beginning to contribute to both earnings and cash flow. We have also continued our focus on further fortifying the strength of our balance sheet. In this regard, we note the following strong debt metrics for the fourth quarter of 2021 as compared to the same quarter in 2020. Number one, our debt to aggregate assets ratio has now improved to 42.9% as compared to 44.6% in the prior year. Number two, in keeping with our strategy to repay maturing mortgages and to further grow our unencumbered pool of assets, unsecured debt in relation to total debt increased to 71% from 68%.
As Mitch had mentioned, our unencumbered pool of assets continues to grow and now exceeds CAD 6.6 billion, growing by over CAD 800 million over the past 12 months. We continue to employ a strategy to repay most maturing mortgages, and accordingly, we expect these metrics to further improve in the future. This strategy provides us further agility when considering opportunities and alternatives for a portfolio of mixed-use developments. Number three, pursuant to our refinancing activity over the last 12 months, our weighted average interest rate for all debt continued to decrease, and at the end of the quarter was 3.11% as compared to 3.28% for the prior year. While concurrently, our weighted average term of debt was maintained at approximately five years. Excluding construction financing, substantially all of the trust's current outstanding debt is fixed-rate debt.
This continued focus on both the weighted average term of our debt and fixing interest rates is deliberate and is yet just another example of the risk mitigation strategy that we have employed to significantly insulate the trust from interest rate volatility in a rising interest rate market. Lastly, number four, our interest coverage ratio, net of capitalized interest, improved from the prior year level of 3.2 times to 3.4 times, in spite of the impact that COVID-19 has had on our operating results over the last two years. In addition to reaffirming the foundational strength and stability of our core business, this provides us with a substantive advantage from which to fund our pipeline of development activity.
From a liquidity perspective, as we look to the immediate future and continue to manage through the current uncertain capital markets environment, in addition to the conservative debt metrics noted previously, consider also that when factoring in our cash on hand together with our new CAD 300 million facility that was established just subsequent to year-end to support the CAD 500 million SmartVMC West acquisition, the CAD 150 million new revolving line of credit that was completed last year, and the CAD 250 million accordion feature associated with our existing undrawn CAD 500 million operating line, our current liquidity position of in excess of CAD 1 billion provides appropriate flexibility for the capital funding requirements associated with our development pipeline activity.
Recall also that the next series of debentures in our debt ladder does not mature until May of 2023. Notwithstanding the challenges associated with COVID, over the last 24 months, our business has continued to demonstrate its ability to generate sufficient cash flow to fund both our operating needs and our distributions. Accordingly, we anticipate our requirement for additional funding over the next 12 months to be limited to construction financing and any potential acquisition financing requirements that may arise. However, we continue to review opportunities to early redeem debentures and mortgages when appropriate. With that now, I will turn it back to Mitch.
Thanks, Peter. As you can tell, the portfolio remains strong with significant NAV growth on its way, with much work to do for us. With that, I will now turn it over to the operator in addressing your questions. Thank you.
Hi there. Perfect. Thank you. First, any participants who would like to ask a question, please press star one. If you'd like to withdraw your question, you can press star two. Again, press star one to ask a question. We do have some questions already queued up. Our first question is going to be from Dean Wilkinson from CIBC World Markets. Please go ahead.
Thanks. Morning, everybody.
Morning, Dean.
Morning, Dean.
Probably for Peter, just one question. The fair value gains that you booked for PUDs, which added about CAD 2 per unit, was that all thresholds or milestones that were met in the quarter, or was that an adjustment to methodology that perhaps there was some catch up in that number?
Yeah, it's a great question. I'm sure others will have similar questions, Dean. I think it's important that all of us understand. This was not an adjustment in methodology per se. It really represents, and the bump in value represents, progress and advancement that's been made on, in this case, several, what we described, I think in our press release as, strategic properties, in their zoning and entitlements process. That's principally what's taken place over the course of the last several months. Together with this, I think all of us can appreciate our improved market conditions. Mitch, any further thoughts on your side on that question?
Yeah, I mean, there is an aspect of that process that relates to, you know, when is the moment that we're satisfied that a project is sort of cleared for takeoff?
Mm-hmm.
I mean, there is some, I think, you know, probably some room for, you know, for being more or less conservative. We're probably on a conservative side of that spectrum. Yeah, there were things that happened on several properties that gave us confidence that we're sort of cleared for takeoff. Some of it's zoning related, some of it's restrictions that we have negotiated our way through. That's only on a handful of properties, so we will be continuing to do those, make those adjustments on other properties as we are cleared, sort of feel like we're clear for takeoff.
Got it. The methodology there, Peter, is that based upon just a market, or is that a DCF? If it is a DCF, is that predicated on locked-in construction costs or just a budget at this point?
It's principally a function of third-party appraisals and where our third-party valuation experts are telling us these properties today at least are valued based on what is expected to be developed on those sites, net of any costs that might be incurred to get us to, as Mitch said, you know, the takeoff point. At least for now, Dean, that is the approach. As Mitch had mentioned, we believe that we're on the more conservative-
Yes.
Side of that approach to valuation.
Perfect. That's it for me. I'll hand it back to the call. Thanks, guys.
Thank you. All right, our next question is going to be from Mario Saric from Scotiabank. Please go ahead. Hi, Mario Saric, your line may be on mute.
Hi.
Unmuted. Go ahead.
Hi, good morning, and thank you for taking the questions. Just following up on Dean's line of questioning. Dean, the roughly CAD 500 million fair value gain taken, can you confirm like, what is the cumulative fair value gains taken on your PUDs or your intensification potential upside today, or is that a relatively new number?
Yeah, I think, Mario, it's fair to say that the amounts that were reflected in the fourth quarter are intended to represent, at least for now, the initial components associated with, as Mitch described, the fair value takeoff or the expected clearance for takeoff associated with, again, this handful of properties. We do have, as you would expect, many others to come that we will be assessing, you know, their status over the coming quarters. For now, as we got to the end of 2021, we thought it was appropriate, and certainly our appraisers confirmed it to be appropriate, that given the status of zoning and entitlements associated with, again, a handful of properties, that it was appropriate to fair value them based on what the market is telling us.
Again, conservatively, they are worth net of some expected costs that it may take us to get to, again, the takeoff point.
Okay. Just to be clear, like the number is fairly close to the cumulative.
Yeah. Yeah.
Gotcha.
I think that's fair. I mean, there may have been some, what we'll describe as immaterial amounts that may have been factored in prior years, but again, they would be immaterial.
Okay. You've mentioned a couple times kind of several properties that the fair value gain was attributable to. Do you have a percentage of your quoted 40.6 million sq ft of intensification upside over time that the roughly CAD 500 million would correspond to?
I mean, the CAD 500+ million is because several properties are, you know, certainly they're GTA properties and, you know, high density. Yeah, some of them are on mass transit. I'll try and do that calculation before we hang up, the question period, and try and give you that guidance on that before we hang up.
Okay. Yeah. Thanks, Mitch. I guess we're just trying to figure out whether it's on a price per buildable square foot or whatnot. You got some very good assets.
Very concerned. The numbers that are being used on a per sq ft basis are really quite conservative. If these projects were sold to the market, I think just because of the market, if it was today, they would probably achieve maybe, you know, just saying because the market's what it is right now, but this is more based on, you know, just a more average, you know, level-headed market. So yeah, I mean real estate, it does sound like a big number, but on the other hand, you know, in the scheme of things, I mean, with the city that's expanding like Toronto, it's underpricing. It's actually. Yeah, it's only a handful of properties, big densities, but there's a lot of value in going from a single story, you know, 25% coverage, you know.
You have 12 acres of land, and it's got, you know, 120,000 sq ft on it, and you go from that to 2 million sq ft of mass transit. You know, it's big numbers. Real estate's coming. I'll try and do the math on that for you just before I try and state it before we hang up, if I can.
Okay. Well, thanks so much. Maybe one last question just on the fair value gain. Given the value of some of these properties, does the recognition of the fair value gain makes you more or less likely to potentially sell partial stakes in some of these upside projects in the near to medium term, or is it just not correlated?
No, it's part of our strategy. I mean, you know, to raise some capital, you know, we want to maintain a conservative balance sheet throughout this process and program. Yeah, it is very much one of our levers to bring in partners on some of these projects at market value or sell them even outright. It's not our first choice, but if it's the best choice and easiest choice, we might sell a few of them just because they're so valuable, and we've got lots to do. It's definitely part of our. We're actively doing that right now, actively you know pursuing that and just having discussions on that right now.
Then the last question may be for Peter. Is there, for 2022, it looks like the development gains will be more related to 2023 than 2022. With that in mind, is there a target kind of FFO per unit growth rate that you're targeting in 2022 excluding gains?
Yeah, Mario, we prefer. I mean, I think particularly over the last couple of years, given the experience that COVID has impacted our industry with, we took the approach two years ago of not providing that kind of guidance to the market. I think given that there's still so much uncertainty, notwithstanding everything we need coming out of more problematic period of COVID, there is still, we think at least, a lot of uncertainty associated with this pandemic. I think it would be our preference for now at least to not provide guidance again, at least for now on the 2022 growth trajectory.
Okay. Fair enough. Thank you, Peter.
Yeah. Thank you.
Perfect. Thank you. Our next question is going to be from Tanvir Singh from RBC Capital Markets. Please go ahead.
Thanks, good morning. Just when you look at maybe what you've submitted to date, in terms of the mixed use intensification, you know, rezoning application and those that are still in the process where you have not received the acknowledgement of the zoning, what are your thoughts on, you know, what may actually get approved over the course of, you know, if you think about 2022 or even if you have any visibility on a one to two year basis in terms of square footage?
You mean more like the amount of sort of approvals or whatnot in 2022 and 2023?
Yeah. Yeah, exactly. Thanks so much.
I do think it's gonna be. Again, I don't have the number right in front of me, but as you know, rezoning is kind of, you know, margin of error is big. It's gonna be, I think, 2022 and 2023 are gonna be very big years for us in terms of approvals. I would rather not just sort of speculate on how if you give me a chance, I can do that calculation and call you or send it out to everybody who's interested. The applications for zoning amendments have been in for a long time. I think a lot of things are gonna come together in 2022, 2023. I don't wanna sort of guess.
Got it. I guess, again, you mentioned that to date or I guess what you booked in Q4 sounds like most of that was in the GTA. Is what's in the pipeline, you know, just quite large and spans over many, many markets. Is the bulk of what's maybe coming through in the next one to two years predominantly GTA, Ontario or Quebec? Maybe Montreal?
Yeah. It is. A big bulk of it would be Ontario and Quebec. We've got quite a bit going on in Montreal. By the way, Montreal is, I guess, a market has come around nicely actually. Has cooperated really very well with our timing, because we've been pursuing, you know, approvals in Quebec for a number of years now. They're coming through and the market's pretty good there. But the bulk of it in terms of right now is Ontario and GTA, mostly GTA, super GTA, and Montreal.
Now, there are some interesting developments we've got going on in those kind of places like Alliston, where we're approved, and we're going to proceed with a rental, you know, rental development there. I'm including, you know, for example, Alliston. When I say that, also, you know, we're approved in Barrie. Barrie is also quite a big market right now. I'm not including that when I say GTA, but it is, you know, part of the, you know, when I say Ontario, I mean, Barrie is a good, you know, we're talking density there. We're approved for, you know, 20-plus story towers there, including a hotel on the waterfront. That is also an example of something that's approved.
You know, those types of markets are the bulk of it, yeah.
Okay. Maybe just, you know, comparing perhaps your approach to some of your peers among the retail REITs or maybe even outside of the retail REITs. You know, some have not necessarily taken or booked these gains that you know for what these properties might be worth if they were to be sold in the market after you know receiving successful entitlements and zoning. I'm just curious if you could help us think about your approach, you know, and how that might differ, I guess, to some of your peers and your decision, I guess, to book these announced.
Yeah, I mean, we can't speak to our peers, but I mean, I think it's what we're meant to be doing, from what we understand. I mean, you know, it's we're meant to reflect, you know, the value of our properties, you know, accurately. It's obviously, you know, as we said a few minutes ago, I mean, zoning approvals, entitlements, and other restrictions. You know, there's lots of steps, but, you know, at some point, you need to update your values based on your intentions. You can have value, you can have zoning and entitlements to something you don't plan on doing. So but we are very much planning to execute. I mean, it's our core expertise. So we plan to execute on things that we get our entitlements on.
We're pushing very hard to be able to do that. Maybe others are not as much. I think, you know, we're doing what we're supposed to be doing.
Okay. Thanks, Mitch. Last one for me, and this one's more focused on the actual operations of the business from a retail standpoint. You know, a very slight, perhaps marginal improvement relative to last quarter. You know, some of that, some of this, you know, these sort of muted spreads are really just, I guess, a function of the leasing that was done perhaps during the height of COVID. But how are the spreads trending on leases that you're renewing today? And you know, I guess the effect of those may not be seen for several quarters or so. I'm just curious how those compare to what we're seeing actually come through in the numbers.
I'm going to let Rudy answer. The ones that I am involved in, see, actually just ahead of Rudy's more you know maybe more overall answer. The ones I've seen actually have been you know quite you know decent bumps in the early renewals that I've been involved in, Rudy.
Yeah, Mitch. I mean, you know, we have our essential and non-essential type tenancies, and our essential, as you know, make up almost 70% of our tenancies in our major markets. Those tenancies are doing quite well, and there are the standard sort of bumps in those. Then for the non-essential, the ones that COVID, you know, had a bigger impact on, those are still coming together and trying to bring their business back. Those are the ones I would say when you combine them together, it's generating the slightly positive growth you're seeing in our lease renewal. It's that combination. It's getting better. It's improving every month as we move out, you know, further out of this pandemic.
That's you know the 70% of the portfolio is doing quite well, and then the smaller ones are coming along.
Thanks very much, Rudy. I will turn it back. Thank you.
Thank you. Our next question is going to be from Kyle Stanley from Desjardins Capital Markets. Please go ahead.
Thanks. Morning, everyone. Just going back to the fair value gains for a minute. Could you comment on if any of the gains were attributable to the repurchase of the two-thirds interest in SmartVMC West and, you know, the corresponding potential revaluation of your interest in SmartVMC?
Short answer is yes. Peter, do you want to expand?
I think the way to answer the question, Kyle, would be in two parts. From a timing perspective, we announced, as you know, the acquisition of the SmartVMC West property in December. The process to get to the finish line on that acquisition did not happen, as you would probably imagine, overnight. It was
A lengthy process that required a tremendous amount of negotiation over time. The fair value increments that we've now spoken about over the last half hour or so, I think it's fair to say those increments are really a function of, as we've said now, of the changes in improvements in zoning status that has occurred in, again, a handful of properties, coupled with the movements in the market. When we say movements in the market, the movements in the market were not predicated on what our experience was on the acquisition of the VMC lands.
In fact, the appraisers that we spoke to and used to give us guidance on this were reflecting and commenting on so many other properties in the GTA area, and many of which are in the Vaughan area in particular, that have recently traded or are currently under contract to close shortly at values well in excess of now what we valued some of our properties at. I think it's fair to say that the general market, Kyle, particularly as it applies to the GTA area, has improved considerably over the last several months, as a minimum.
When factoring in those improvements in value and the continuous, seemingly unsatiated or non-satiable demand for development land, you know, we thought it was appropriate to again fair value these properties, as Mitch said, on the basis that they are really now should be reflected at, as opposed to using the historical approach that we've used since the IFRS initiative came in in, I think it was 2010 or 2011. What does all that mean? It means that, you know, we paid what we thought was a fair price for the SmartVMC West lands. To get to how we approached fair value of this other handful of properties, we didn't rely exclusively on the amount that we had paid on the SmartVMC West lands.
In fact, it was probably just the opposite, where we were relying heavily on what the appraisers were telling us were other properties that were trading in the marketplace concurrently.
Okay. Okay, that makes sense. Thanks for that. Just looking, in your disclosure, you mentioned that DBRS has confirmed the triple B high rating, but changed the trend to negative back in December. You know, there was some commentary about the trust continuing to work on alternatives with the intent to improve the credit rating. Just wondering if you could elaborate a bit on what those alternatives could be.
Sorry, repeat please, of what?
You mentioned that you would continue to work on alternatives to improve the credit rating. I'm just wondering if, you know, what those alternatives could be?
Well, I mean, I mentioned one before, which is, you know, we would sell a portion, bring in the partner on some of our development at market. So that would be one. I mean, selling a phase one of a master plan at market, you know, would be another. Selling a project privately at market, you know, would be another. Those are, you know, some examples. You know, we're not shy selling the unit price of, you know, the payment speaks for itself. So, you know, those are examples of some of our levers. Peter, do you wanna chime in?
Yeah, I think, Kyle, Mitch has really referenced what our thinking is, that given where our unit price is currently trading, we don't see that as, for now at least, an alternative. We are considering and focusing on other opportunities to sell interests or partial interests in some of the properties that are particularly development-focused to some institutional-type investors. That's certainly an opportunity and an alternative that, as Mitch mentioned, we're pursuing. There's some other sort of related themes to that that we're also considering, again, with the ultimate goal of raising equity that would be used to repay some of the debt that's currently on the balance sheet. Again, with the ultimate objective of permitting our credit rating to be restored to, you know, what it was prior to December. Does that help?
Okay. Yes. Yeah, no, very helpful. Thanks for that. Just one last one. This one will be for you, Peter Sweeney. Just housekeeping. On the total return swap, could you remind us what it is for? And then, you know, just what are the offsetting expenses in the P&L? Thanks. I'll turn it back.
Yeah. The total return swap we initiated, believe it or not, now a year ago, it was intended as an opportunity for the REIT to, over a several-year period, to look at opportunities to deploy some of its liquidity to generate returns on an interim basis that, again, would help during the period that, you know, COVID was impacting the business. We engaged with a well-known Canadian bank that's helped us through the process now for well over a year. The intent is to allow for that TRS or total return swap to continue, hopefully, to augment the operating results of the REIT. With respect to expenses, there are two expenses that we would incur.
Number one are fees associated with the TRS that are paid to the bank involved, and they are netted obviously through the returns as they're incurred. Then potentially, in the event that the unit price were to move in a contrary direction as opposed to where it's been moving over the last 12 months or so, then there would be an impact, Kyle, to FFO that would be an adverse impact as opposed to the positive impact that we experienced in 2021. I think we mentioned this last year. There are some safeguards that we established coming through the process to find a way to, you know, mitigate some of those risks and concerns by either modifying the term of the total return swap or reducing the exposure in the total return swap.
Again, just to potentially mitigate any concerns over material changes to FFO. For now, for the first 12 months, at least of this initiative, we've seen some substantial returns, as you've seen there on our public disclosure, on moving this forward. We're very pleased on how it's done so far.
Okay, great. Thanks very much. I'll turn it back.
Thank you.
Perfect. Thank you. All right, our next question is going to be from Tal Woolley from National Bank Financial. Please go ahead, Tal.
Hi, good morning, everyone.
Morning, Tal.
Morning.
Just wanted to start on the development side. In your MD&A, you know, you break out your development pipeline into sort of projects underway, active projects and future projects. If I just focus on the underway section of it, you've got about 59 projects for 9.4 million sq ft, roughly CAD 5 billion total cost at your share. That works out to about CAD 532 per sq ft, give or take. Then if I look at, like, Q3, you have 52 projects, 6.7 million sq ft, CAD 3.2 billion expected cost. It's about CAD 478 per sq ft. It's about 11% increase in that quarter-over-quarter. I'm just wondering if you can talk to me about how much of that is attributable just from the project mix.
Obviously, you added some stuff that might be more expensive. I can understand that. Also just wondering too, though, if you know, you're sort of thinking that, you know, some of the stuff you've done in the pipeline, those costs are going up and how we should think about those numbers going forward.
Rudy Gobin, you wanna-
Hi, Tal. Tal, from one quarter to the next, there were some changes to the product mix, but it was minor. It would also include SmartVMC West, as you can imagine, being added in the quarter. Each quarter when we do this review, we would build it ground up, so to speak. Again, it's just a measure of each market and how each market is evolving from a development perspective. The numbers end up being where they are. It's not a top-down, bottom-up build.
Okay. How are you feeling, I guess, is the bigger sort of question just on development, like, given that, you know, sort of in the middle of a shift economically here, and I'm not sure, you know, like you could say that income growth is necessarily looking super robust for individuals in the near term. But, you know, it's clear, like, construction costs are rising. How are you feeling about green-lighting new stuff and getting underway on new stuff right now?
Good. I mean, you know, you read about construction cost increases, and it's generally, you know, true. It's not, you know, but each individual project, you know, is, you know, we value engineer each project around and try to navigate around the materials that are rising the most and whatnot. So there's lots of things and stuff that we can do in the industry or, you know, things we know about how to do in terms of industry to stay away from the, you know, the highest increases in construction items. But it's sort of overall kind of unavoidable. Their prices are going up, but so are sale prices going up.
In fact, I mean, you know, we'll do better on, you know, on ArtWalk, you know, than, say, on Transit City. We locked in on some pretty low prices on Transit City. That's just because, you know, we found ways to save money on materials, and we've also, you know, we're getting a lot of demand, and we're creating something there, so price was going up sort of exponentially. Every time will be assessed, I mean, based on what the market is, and we're acutely aware of and exposed to construction price increases. You know, we won't commit a folly. We're not gonna build for the sake of building.
Remarkably, as much as you hear about the construction price going up, still makes sense, especially on our properties where we, you know, where we already own them. We're not buying the properties on market. It helps a lot.
Okay. Both of you mentioned, you Peter, you know, you've made some references to, you know, expanding partnerships on some of your marquee sites. Can you give us a flavor of what that might look like? Is it a series of individual deals, or is it a bigger sort of master deal type joint venture with a solo partner? Like, how are you thinking about structuring that kind of transaction?
Yeah. They're both probably gonna. You know, I mean, you know, I don't think there's gonna be one master deal where, you know, there's one big institution in on, you know, every deal. But I wouldn't be surprised if, you know, we do a deal with you know with a larger institution or whatnot for a handful of deals. But I don't know. I mean, we find that just doing one at a time is the best way to go, so sometimes it leads to two and three and four. We're just focused on you know the bucket of properties we think are candidates for you know institutional investors or investors in general.
We see ourselves as being the development manager and the, you know, construction manager, and if it's a rental, you know, the property manager. That the entity would buy in, say, between 25% and 50%. I think for the most part, we wouldn't take less than 50% of the partnership. You know, they would buy in initially at market. That would be the big kinda capital event. Then we just go, let's say it's 50-50, we go shoulder to shoulder going forward.
Now, we sometimes have you know a feature where you know we have a kicker potentially in our favor if you know if we outdo the budget you know the returns to where we adjust what is really an adjustment to the value of the land that was rolled in at the end of the deal. That's kind of how it would be structure-wise, and maybe you know just in terms of the players or players on the stage, the type of players on the stage and how it would go. I also wanted you to know you reminded me, we're also doing something, for example, with a general contractor where we are negotiating a deal with a general contractor to be our kind of partner in a sense.
They're not gonna be a partner in the land, but that, you know, we'll make a master agreement with a general contractor, so that they will be with us and beside us from design and help us, you know, find ways to value engineer our massive program. Of course we'll, you know, we'll be able to lower price. They'll be able to set themselves up. There's a certain amount of efficiencies there. They all have, as you know, enough of our deals that they'll be able to order certain materials in bulk, and we'll take the benefit of that because we're gonna be. It's gonna be a construction management contract.
You know, for example, there's lots of things that you can do when you've got a large program, and it is our sweet spot in terms of our expertise. In terms of partners or, you know, even construction and construction customers, there's a number of, you know, levers that we're doing.
Okay. Just lastly, Peter, the gain on the TRS swap, is that on the P&L or is that something you bring out of other comprehensive income into your FFO?
It is included in both the accounting income and our FFO.
Where would it be in the accounting income?
I don't have it in front of me, Tal, but let me respond to you offline, and I'll tell you exactly where you can find it.
Perfect. Thanks, Peter. Appreciate it.
All right.
All right. Thank you. We do have about two more questions in the queue. Next question is going to be from Jenny Ma from BMO Capital Markets. Please go ahead.
Thanks, good afternoon. I want to turn the focus to the operating portfolio. Just looking at the average term to maturity of your leases, and it's sitting at 4.4 years at year-end, but it's been on a pretty consistent downward trend for a number of years now. I think five years ago, it was kind of sitting at six times. I'm just wondering, you know, particularly lately, is there anything to read into it, in terms of the shifting preferences, in terms of, how long tenants wanna commit for? You know, is it anchor versus CRU mix? Has there been any change, from, you know, tenant behavior post-pandemic?
Like anything you can read into it and, you know, where you think that number stabilizes at or if there's an inflection point starts moving up again?
Yeah, it's a good question. There's a lot of factors. Rudy, I'll let you jump in here one second. You know, I think, you know, the last number of years we haven't done a lot of new, you know, ground up construction, where, you know, the leases are longer. You know, it's been less of that, although there's some of that going on, and that'll kick in soon. Rudy, do you want to weigh in?
Yep. That's mostly it. I mean, when we were building out these shopping centers, most of the deals were 10 year deals with five year options, and then more 15 year deals with five year options, and a few 20 year initial term deals, Jenny, with five year options. As soon as the 10 years are up and you're into the five year options, then all of a sudden the math works out that the average term to maturity keeps ratcheting down. It is exactly as Mitch described, a greater proportion of the five year options that we're now into. Even a few tenants coming in wanting flexibility will do a five year deal with, you know, two or three five year options versus before they would have done when we were building out lots of these shopping centers, a 10 or a 15 year deal.
It's just a matter of tenants moving into their option periods.
Okay.
Also, you know, we in some cases are not as open to longer terms in some places because it may be part of our phase two or three of a development.
Okay. I mean, it reflects to some extent the maturation of the SmartCentres business. When we look forward, like, what are tenants asking for? Is it in and around five years that's where they're comfortable at? Which would suggest, I guess, your weighted average term probably settles out around, I don't know, call it mid-threes or to mid-fours, is kind of what's going to set all that.
I mean, typically, a new deal is five years. I mean, any renewal is usually five years, and a new deal is five years. There are scenarios where, you know, we're talking existing buildings, where they're 10 years. But we're a little bit, you know, we're reluctant subjects on certain, on certain projects for 10 years. But where there's work to be done, there's larger premises, you know, 10 years is also happening. But most deals on existing space start off with a five year lease. It's just normal. It's just kind of the industry with options. If you build from scratch, usually 10 years is the minimum. I mean, I don't think we've ever done a new deal ground up construction with five years. So 10 years, 15 years, as Rudy said, you know, the Walmarts for 20 years.
We're not doing a lot of new Walmarts and not doing a lot of, you know, new food stores. From that point of view, yeah, those leases are maturing, but they're cheap rents, and they have many options, and they renewed at five years at a time, and it's going to weigh, you know, it's going to weigh on that average lease term that you're referring to.
Okay.
We are-
Okay.
Weighing it.
That makes sense. I want to turn to talk about inflation sensitivity in the portfolio, not so much on the development side. It looks like the same-store property NOI ex ECL was a bit down, and there were some expenses involved. I'm just wondering, you know, within the leases that you have, is there any sort of linkage to CPI, or potential pass-through of costs to let the inflation risk go to the tenants? Like, how would you characterize the cash flow inflation sensitivity on the portfolio?
You know, early days when I leased, I always get CPI. But CPI is very unusual to get in a See, our portfolio is focused on strength and high occupancy. So, you know, we give up, if you will, things like CPI for, you know, we'd rather have Bank of Montreal as a tenant than, you know, a souvlaki restaurant with no covenant or a Sub, Subway, not a Subway, so it's a sub sandwich with no covenant. So we would get CPI from the independent restaurant operator, but we will not get CPI from Bank of Montreal. So, you know, we're proofed for, I wouldn't say we're built for heavy weather. We collect the rent through good times and bad from BMO, but not necessarily from the restaurant.
The restaurants give you know, that example, the independents will give you the CPI, but the strong nationals won't give you CPI. Our hedging against inflation is occupancy and collectability and, you know, conservative but collectible bumps in our rents.
Okay. When I look at the same property NOI, are the higher costs, you know, somewhat related to inflation, or are there some, you know, lumpy items in there that would result in a sort of slight decline in SPNOI?
I'm sorry, I don't understand the question.
For the same property NOI, when we exclude the recovery in bad debt expense year-over-year, it's marginally negative. It looks like there were some miscellaneous expenses and CAM recovery shortfalls that sort of ate into the rent growth that you did have. I'm just wondering how much of that is inflation related, and what I'm getting at really is to how we should think about internal growth-
Right.
Given a slightly inflationary environment.
Yeah. I mean, you can touch on some of it, Rudy Gobin, here, but I would not say that the inflation issue has weighed in yet. You know, maybe it will, but it hasn't weighed in yet in terms of the slight, you know, what you're talking about, the slight, you know, maybe erosion there. Rudy Gobin, do you wanna weigh in on that as well?
Certainly. Yeah. I would say most of our, you know, the cost increases we're seeing are broad-based. They're not particular to a market. They're not particular to a type of cost. It's pretty broad-based. Recall that our operating costs of our properties are, if not the lowest, among the lowest in the industry because it's open format space, so we don't have enclosed space where we're, you know, looking after internal cleaning and HVAC and roofs and all of these things. So our starting point is a much better point for our tenants in terms of cost. Then the other thing to mention is a year ago, we were at slightly higher occupancy, and we're building back to that.
You might be seeing a little bit of the slippage too, Jenny, from the 98%+. You know, 98, 99 over the last several years. We were at 99 for a long time. That slippage is now being built back. That's probably a little bit of what we're seeing given what's happened in the pandemic in 2020 and 2021. Yeah.
Then just lastly, Mitch, you mentioned in the early days you saw more CPI. I'm just wondering, maybe give us a bit of history lesson. You know, did CPI exist for most types of tenants, including high covenant tenants, and then it kind of went away because, I guess CPI wasn't really an issue for a very, very long time. You know, if this inflationary environment persists, do you see or do you see CPI sort of returning or creeping back into leasing discussions with tenants?
Yeah. I mean, CPI used to be normal, really early days. You know, I'm talking like when I started in the business in the eighties. I happen to know that it went into the seventies 'cause I was dealing with businesses that had operated through the seventies into the eighties, and CPI was normal. The landlords were, you know, the landlord was kind of, you know, sort of, hangover from bygone days, and landlords dictated stuff like that. It changed very quickly in the nineties or late eighties, nineties. It's been a tenant's, you know, pretty much a tenant's world almost ever since. CPI went away with value-oriented retail and, you know, and the de-malling of the world. I mean.
I mean, you see some CPI here and there and. Honestly, I haven't seen it for, like, really mainstream. It's just not mainstream. It's hard for this trend to come in. You can stick it in an independent deal, and you'll sign it, no problem, but you won't collect it. You know, most people haven't. Anyway, look, I don't think. Like, our leases are all net. We're not really a company that grows, you know, kind of, you know, we're not a rapidly growing company from rental bumps. Okay. We'll have our standard rent runs. We want our tenants to make money and stay with us, and then we can expand them.
You know, first of all, we collect the rent, they make money, they want more space a lot of the times, and we do more deals with them, and we stay highly occupied. You know, we benefited from lower interest rates along the way, obviously. But at least we get the bumps, and we stay highly occupied. But they're net lease, and they're net leases. I mean, we have the lowest average rent probably. Like, our portfolio, when you talk about these fair value adjustments, I mean, our portfolio is valued based on our rents historically, but our rents are based on the lowest coverage ratio. We have 25% or lower coverage of our property. So 75% of our properties are parking lots with no income. In that 25% coverage are the lowest average rents.
Then we value the company. One thing that they are, though, is fully net. That helps a lot against certain inflationary factors. We have our bumps, which generally speaking, though, they're not geared to CPI, but they do bump probably not that far off from CPI because I'd say that most of our rents. Don't quote me on this and don't you know, like, throw the book at me on this. I would say our bumps kind of average somewhere in the 1% to, you know, probably 1.25%, I don't know, maybe in some cases more per year, but on a five year timeframe, for what it's worth.
I'd say, you know, over a five year period, you know, like a CAD 20 net rent, you know, it should probably be 10% in the five year bump. That tenant generally, I mean, a national would go from CAD 20 to CAD 22 would be normal, just to give you an example. We all can look at that, and I'm sure it's somewhere in our documents anyway. It's not geared to inflation, but it's a fully net lease, and it's probably pretty close to inflation anyway and probably be much better than inflation for a number of years.
Mm-hmm. Okay. That's very helpful. Thank you very much.
All right. Thank you. We do have our last question in the queue. It is from Sam Damiani from TD Securities. Please go ahead, Sam.
Thanks. Hello, everyone.
Good morning.
Good afternoon, Sam.
Yeah, good afternoon. I certainly don't wanna keep people from their lunch, so we'll try and make these last questions quick. I got on the call a little bit late, and I apologize, but was there a maximum sort of development or PUD as a percentage of total assets under the REIT's declaration of trust that is a factor with the fair value gains that have been booked and the acquisition, of course, in December?
Yeah. Sam, it's Peter. We're assessing that, and it may require an amendment to our declaration of trust, which, you know, we'll think about doing at our next AGM.
Okay. Then just on the fair value gains again. It sort of came out, I think, through some Q&A earlier that the VMC was a part of it, maybe a big part of it. That, you know, it seems like perhaps, you know, the acquisition in December was marked up because, you know, that price was negotiated several months or longer ago, and then obviously the existing as well. Is it fair to think that perhaps of the total fair value gain in the fourth quarter, perhaps over 50% of it was at the VMC?
Peter.
Yeah. I think, Sam, and I think you know, and perhaps others on the line know that historically, for a variety of appropriate reasons, we have not believed that it was appropriate for us to provide value, Sam, on a per property basis. I think we prefer to maintain this approach to public disclosure of our portfolio's values going forward. You know, it's not our intent, at least for now, to provide specific valuation parameters for each property. I think for competitive reasons, we think it's appropriate to continue in that realm. I'm not trying-
Yeah.
We're not trying to be coy or detect your question. We just think for the benefit of our unitholders and our ability to generate the developments and, you know, progress them through the appropriate channels going forward, it's just not the right idea to publicly disclose how much we think each one of these things is worth.
No, that's fair.
Including the-
Yeah. No, that's fair. I'm totally not surprised. I guess, yeah, I think, Mitch, your comments earlier, I mean, or maybe it was Peter's. You know, part of the process was, you know, the appraisers and market comps and/or deals in process. The unique thing with the VMC, of course, is that this is actually under development. You're actively selling condo units. You've closed on condo units. You know, you've done all that. There's a very high visibility there that you don't have, let's say, for a 1900 Eglinton or a Westside Mall. Is it fair to say that the approach in Q4 with these fair valuation bumps was more exacting on the VMC than it would be for, you know, another site that perhaps is further away from actually selling condos or renting apartments?
Sam, we have each one of the properties ultimately, you know, that was valued was an exact amount. So they're all exact amounts based on, I guess, the assessment of, you know, what the market would, you know, pay for them. So, you know, like obviously, you talk about. I love the fact that you can just reel off 1900 Eglinton or Westside Mall. That's great. Those are two excellent projects, and they have value. Even though we're not going to the ground, but, you know, the market would recognize there's value there and many other projects. So, yeah, I mean, I think that's about maybe the only way I can address that or address that question. Peter, do you want to respond at all or?
No, I think that your description, Mitch, is appropriate. You know, our approach, Sam, is really to, as we did in Q4, was to identify those projects that we think have come through the zoning process and are at a point where Mitch mentioned this earlier, and I think it really hit the nail on the head by describing these things as being the appropriate way to value them, in keeping with what, you know, an IFRS expectation would be. These are fair values. You know, I think it's. Again, we're not at a point where we're at liberty to describe or disclose values on a per property basis.
You should expect in the coming quarters for us to look at each of the other properties in the portfolio as they as well continue to sort of go through the entitlement and zoning processes respectively, and to consider whether or not it may be appropriate to enhance their values. Again, keeping in mind whatever may be happening in the market at that time.
Okay, thanks. That's all very helpful. Just last real quick one. Maybe it was.
Sam, you know, Mitch was talking about history earlier on, CPI bumps and inflation. I think it's important that everybody understand that you know, this whole approach to valuation, and maybe back to your first question, Sam, on our threshold for development and maybe in the declaration of trust. All of those initiatives predate the advent of IFRS, so they all reflect what any accountant on the line may recall as being cost accounting. When original ceilings or thresholds were established, they really sort of took into account what companies like SmartCentres were paying for actual properties and you know, were restrictive on development as a percentage of total costs of actual amounts incurred.
As we know now for the last 10 or 11 years, with the advent of IFRS and fair value accounting, we now have to look at and include gains or losses, as we experienced in 2020 from COVID-19, that may appear from fair value in these properties. I think it's fair to say that those gains that are losses were no doubt not contemplated when most of the, at least larger Canadian REITs were first established and what may or may not have been included in the declaration of trust. Okay?
Yeah, no, that's a very good point. Just quick last one. CAD 3 million of lease termination fees in the quarter. Anything of note that you would wanna to share on that?
Rudy?
Yeah. Nothing of significance. The units, those that generated those fees are interestingly enough, we are in discussions with 75% of that space being re-leased in the first quarter. The good and bad news is we had some turnover, that's the bad news. The good news is, we've got some good, solid leasing interest of tenants that want to come in and enhance the mix of uses within our centers for those. Those were just the remnants of going through what we went through in 2020, Sam, and into 2021, and it's wrapped up most of our major challenges with tenants.
That's great. Thanks, Rudy. Thanks everyone. Everyone can enjoy their lunch now.
Thanks, Sam.
We'd not retire if we did this call during lunch, so it would be even less, just a few questions and shorter.
Mitch, I just want to come back to Tal's earlier question, maybe before we actually go to lunch. Tal had asked a question earlier about, you know, how we account for our gain on the total return swap and where that might be found. Tal and the team, we'll direct you to two places. If in your bedtime reading, you get to page 68 of our financial statements, note 26 on fair value adjustments, you'll see it under the financial instruments section in note 26 of the financials. Alternatively, if you don't wanna review the financial statements, but you want a quick peek, you can see it on pages 36 and 37 of the quarterly and year to date results on how we add back amounts to get to our FFO line.
You'll see the add back for fair value on financial instruments, which is an all-inclusive number tying again back into note 26, and then the add back from that number of the total return swap into FFO. Hopefully, you can follow that, and if you need any further direction, let us know, please. Okay. Mitch.
Yeah. Okay. I guess that's the operator.
Hi. Sorry. Yeah. Exactly. That was the last question in the queue. Exactly.
Okay, great. Thank you all for taking the time to participate in our year-end call, and please reach out to any of us for any further questions. Stay safe and have a good rest of your day. Thanks.
Thank you. Ladies and gentlemen, this concludes the SmartCentres REIT Q4 2021 conference call. Thank you for your participation, and have a nice day.