Automotive Properties Real Estate Investment Trust

TSX:APR.UN

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Good morning, ladies and gentlemen, and welcome to the Automotive Properties REIT 2024 Second Quarter Results Conference Call and Webcast. [Operator Instructions].

Please be aware that certain information discussed today may be forward-looking in nature. Such forward-looking information reflects the REIT's current views with respect to future events. Any such information is subject to risks, uncertainties and assumptions that could cause actual results to differ materially from those projected in the forward-looking information. For more information on the risks, uncertainties and assumptions related to forward-looking information, please refer to the REIT's latest MD&A and Annual Information Form, which are available on SEDAR+.

Management may also refer to certain non-IFRS financial measures. Although, the REIT believes these measures provide useful supplemental information about financial performance, they are not recognized measures and do not have standardized meanings under IFRS. Please refer to the REIT's latest MD&A for additional information regarding non-IFRS financial measures. This call is being recorded on August 15, 2024.

I would now like to turn the conference over to Milton Lamb. Please go ahead, Mr. Lamb.

[Milton Lamb, executive]

Thank you, Joel. Good morning, everyone, and thank you for joining us today. On the call with me is Andrew Kalra, our Chief Financial Officer. We generated continued solid financial performance in the quarter, reflecting growth from contractual rent increases and acquisitions we completed last year. Compared to Q2, a year ago, property rental revenue increased by 2.5%. Cash NOI was up 3.2%. Same property cash NOI increased by 2.5%, and AFFO per unit diluted increased to $0.233 from $0.23.

Our portfolio continues to perform well in the current environment of elevated interest rates due to the triple net lease structure, where property level operating and energy costs are the responsibility of our tenants and our leases include either fixed or CPI-linked annual rent escalators. Leases with CPI-related adjustments currently represents approximately 36% of our base rents. On our property tour with analysts in Montreal last summer, we gave a presentation that highlighted the potential for higher density for many of our properties located in urban areas that are experiencing intensification.

The size and the location of many of these properties can provide compelling opportunities for us to be able to unlock underlying value by working with our tenants as their businesses evolve, creating significant incremental value for our unitholders, in addition to strong income throughout the lease term.

Subsequent to quarter end, we entered into an agreement to sell Kennedy Lands in Marco, Ontario for $54 million, which represents a 79% premium above the IFRS value of the property as of the date of the agreement, subject to customary adjustments, and represented an approximate 3.36% capitalization rent -- rate based on contractual base rent payable under the lease for the property from October 1, 2024 to September 30, 2025.

Over and above the net proceeds from the sale, we also have the potential to benefit from the successful rezoning of the property to receipt of additional cash consideration equal to $35 per square foot to the extent the approved rezoning exceeds 1.3 million square feet of density.

We're able to immediately unlock value at a strong price and in addition, are entitled to further cash consideration without incurring any risks related to redevelopment of the property. We expect that, assuming the closing of this transaction occurs around October 1, the net proceeds will initially be used to repay rent -- sorry, to repay indebtedness under our existing revolving credit facilities.

This will result in an expected debt-to-GBV ratio of approximately 41.8% as compared to 43.6% at the end of our second quarter. This will drive an increase in AFFO per unit and an increase in NAV. With the transaction closed in 2024, we expect to declare a special distribution to our unitholders in December as a result of the increase in taxable income generated on closing. The amount of the special distribution will be determined closer to the end of 2024.

We expect that the special distribution to our unitholders will be paid primarily by the issuance of REIT units. Immediately following the special distribution, the outstanding REIT units will be consolidated such as each unitholder will hold after consolidation, the same number of REIT units as held immediately prior to the special distribution.

So in summary, on closing the transaction, our unitholders will benefit from an immediate substantial premium above the IFRS value of the property, immediate AFFO accretion, enhanced NAV for our portfolio,and a potential density bonus upon rezoning and a special distribution. The net proceeds will also provide us with additional capacity moving forward.

Our portfolio benefits from stable, long-term triple net leases with Canada's leading automotive dealership operators and Tesla. 100% occupancy in rent collection since our inception, providing our unitholders with a reliable income and potential for underlying land appreciation. Embedded growth with contractual annual set or CPI-linked rent escalators and exposure to the automotive retail sector, which represents a growing and essential component of Canadian retail, providing underlying stability to our tenants.

All of these factors support steady and reliable cash flows and attractive current yield of more than 7.5% on our monthly cash distribution to unitholders. But our recent transaction also demonstrates that what we strongly believe that our portfolio and strategy provides the ability to take advantage of opportunities to unlock embedded value for unitholders which in turn opens up additional financial flexibility to further add to our portfolio and continue the value generation cycle.

I'd now like to turn it over to Andrew Kalra to review our second quarter results and financial position in more detail.

[Andrew Kalra, executive]

Thanks, Milton, and good morning, everyone. Our property rental revenue for the quarter totaled $23.5 million, a 2.5% increase from Q2 a year ago, reflecting growth from properties acquired last year and contractual annual rent increases. Total cash NOI and same-property cash NOI for the quarter totaled $19.5 million and $19.2 million, respectively, representing increases of 3.2% and 2.5% compared to Q2 a year ago.

Growth in cash NOI was primarily attributable to acquisitions and contractual rent increases, growth in same-property cash NOI reflects rent increases across our portfolio. Interest expense and other financing charges for the quarter were $6.3 million, an increase of $0.4 million from Q2 a year ago, reflecting additional debt incurred to acquire properties during the first 6 months of 2023 and a slightly higher weighted average interest rate.

Our G&A expenses of approximately $1.4 million were similar to last year. Net income was $37.3 million compared to $20.9 million in Q2 a year ago. The increase was primarily attributable to increases in fair value adjustment on investment properties, including a $23.8 million fair value gain as a result of entering into the agreement to sell our Kennedy Lands property in Marco. It should be noted that Dilawri converted all Class B LP units to REIT units on a one-to-one basis during the quarter.

In the future, the REIT will not be exposed to IFRS mark-to-market adjustments related to the Class B LP units. FFO decreased by 0.5% compared to Q2 last year due to higher interest expense and a reduction in straight-line rent adjustment due to the focus on CPI-related leases, which do not have an FFO adjustment. The decrease was partially offset by higher rental revenue. AFFO increased by 1.9% compared to Q2 a year ago, reflecting the impact of the property acquired during Q2 last year, and contractual rent increases, partially offset by higher interest costs.

The REIT paid total distributions of $9.86 million or $0.201 per unit in the quarter, representing an AFFO payout ratio of 86.3%, down from 87.4% in Q2 last year. The cap rate applicable to our portfolio was 6.68% at quarter end, up slightly from 6.59% at 2023 year-end. The increased cap rate was primarily due to the classification of our Kennedy Lands property as investment properties held for sale.

We had $528 million of outstanding debt at quarter end an effective weighted average interest rate of 4.31%. We continue to have minimal exposure to floating or short-term interest rates with 95% of our debt fixed through interest rate swaps and mortgages. We have a well-balanced level of annual maturities with a weighted average interest rate mortgages remaining of 4.4 years and a weighted average term maturity of debt of 2.4 years. Subsequent to quarter end, we amended and extended facility 2 from January 2025 to January 2028.

I'd like to turn the call back to Milton for closing remarks. Thank you very much.

[Milton Lamb, executive]

Thanks, Andrew. The Canadian automotive sector continues to be supported by strong fundamentals. According to Statistics Canada, total automotive industry sales were a record $211 billion in 2023, an increase of 12.3% from the prior year, that amounts to approximately 27% of Canada's overall retail sales of products and merchandise.

According to DesRosiers Automotive Consultants, new light vehicle unit sales in Canada increased by 15.7% in the first 5 months of this year compared to the same period of last year, reflecting continued strong consumer demand and availability of new vehicles. Looking ahead, we have a strong portfolio featuring essential retail properties located in prime urban markets, high-quality tenants, a triple-net lease structure, embedded, fixed or CPI adjusted rental growth and a strong financial position to facilitate growth.

Accordingly, we are well positioned to generate ongoing steady organic growth in support of distributions to our unitholders, while continuing to pursue strategic opportunities to drive further AFFO growth per unit.

That concludes our remarks. I'd now like to turn it over for questions. Joel, please go ahead.

[Operator]

[Operator Instructions] Your first question comes from Frank Liu with BMO Capital Markets.

[Frank Liu, analyst]

Congrats on the sell Kennedy Lands and another good quarter. I see the additional color on the densities threshold, which is good. So the property right now is zoned for a 1.3 million square foot. Just wondering, based on your experience and your conversation with Dilawri, what could be the incremental density upon rezoning? And how long roughly the rezoning process would likely take like, call it, 2 years?

[Milton Lamb, executive]

Yes. I mean that comes down to why we like the fact that we derisk this but still participate. Currently, it is not zoned for high density, but certainly in the [ marking ] official plan, that's what they're looking for. So we don't have an exact projection. And we've certainly, in advance of this transaction, worked with the planner to look at potential density.

Interestingly enough, that is not that old, and you're already seeing different levels of government pushing densities higher. So another properties we have looked at, we've seen densities move significantly upwards as the housing crisis continues to push, municipalities to drive density higher, which is why we wanted to kind of work alongside of them as they push for higher density, we get to benefit.

So it is not zoned right now for 1.3 million. But certainly, as higher in denser projects continue to go on, we certainly hope and believe we should be in the money. As far as timing, that is, again, another mystery. The municipalities, the Ontario government are certainly pushing for faster approvals. So is that 2 years? I mean I think that would be very fortuitous. A lot of the time, it's 4 years, 6 years. Certainly, they're motivated, I'm sure, to go forward and get the rezoning as soon as they possibly can. And again, just to clarify, we get paid on rezoning, not on building permits or completion or profits. So it's a very clean process for us.

[Frank Liu, analyst]

And my mistake, yes, I mean the -- I was referring to the 1.3 million square foot of the threshold.

[Milton Lamb, executive]

That's a threshold. Yes.

[Frank Liu, analyst]

Yes. [indiscernible]. That's great. With the -- so still on this topic with $54 million of capital recycle. I did my math correctly, this could give you additional like net of $25 million cash after paying down the outstanding balance on the revolver, you guys in a good spot to execute. And how is the market -- transaction market evolved over the last 3 months? I know summer is normally quiet. But do you see more opportunities in the market that APR could potentially capture, I guess, later of the year or into next year?

[Milton Lamb, executive]

I like to believe maybe it's my optimus side that this is fortuitous timing. We've traditionally done more deals at the end of the year. And at the same time, the discussions we've had with the automotive industry sector, there's still a bit of a buy-sell gap on the M&A that we opt in track, but that seems to be adjusting, and I'm really looking forward to the next 6 to 18 months.

[Frank Liu, analyst]

I see. So I guess in the interim, you will have the cash senior account. You get investment income -- I mean, interest income from that too, right? How do you capture next opportunity?

[Andrew Kalra, executive]

Well, the goal is to deploy the funds as we fit with an acquisition. But obviously, as we pay down our nonrevolving debt, revolver does go up. So we can use that even on a short-term basis. And the number you quoted was as of June 30, and our revolver balance does go up every quarter.

[Milton Lamb, executive]

Yes. And to be frank -- to be clear, we did this to recycle the capital, not just to pay down short-term debt. We walked into this transaction in a very strong financial position. So it was not done for the sake of paying down debt because we looked at a view that we needed to pay down debt. It's quite the other. This is being opportunistic and believing that we can recycle the capital and continue to drive AFFO per unit as we do acquisitions.

[Frank Liu, analyst]

Yes. For sure. That's for sure. It's a good value creation for the unitholders. Just lastly...

[Milton Lamb, executive]

It's nice to change the theory to reality.

[Frank Liu, analyst]

Yes. It's good to see the -- it's come to reality, and then we expect -- we hope there's more of this coming for APR, for sure.

[Milton Lamb, executive]

For unitholders. Yes. Sorry, go on.

[Frank Liu, analyst]

Yes, unitholders. Sorry, just a last question on the financing side. There's a $9.5 million swap entered at 5.4% rate. I'm just curious if kind of the rate you see today in the market when you speak to lenders because I know you have another, call it, $30 million of swaps coming due within the next 12 months.

[Andrew Kalra, executive]

Yes, we've seen drops in July and they're moving in the right direction. We're probably about 30 basis points lower from that one. So the anticipation and what we're seeing in the marketplace right now is rates headed downwards. And you're correct. We do have about $30 million coming up. So we'll be looking to put extensions and terms on that and get the best rates as possible, consistent with our overall policy.

[Milton Lamb, executive]

I'm even more optimistic, Andrew, as we go into the fall and early winter, we do expect to see rates to continue to move down.

[Frank Liu, analyst]

For sure. Yes, that's good. I mean like a similar -- it's consistent with our economists seen here at BMO. So lower rate.

[Operator]

Your next question comes from Mark Rothschild with Canaccord.

[Mark Rothschild, analyst]

As far as the sale goes, and you talked about recycling capital. To what extent was this motivated by -- it's just opportunity coming up or in that the equity markets are just not attractive and you're looking for alternative sources for raising equity to fund growth?

[Milton Lamb, executive]

Certainly, the equity markets are not at a place where we're trading right now that we would be looking to do a raise, but we still have capacity to do acquisitions. This is -- we've talked about having underlying land value. This is an opportunity to pull some of that land value out.

So we've certainly worked with planners on a number of our properties to understand what that means in the event that there is the opportunity that we can take advantage of it in an intelligent way. And that's exactly what we did. As the knock on, yes, I agree with you. It's fortuitous, that additional injection of capital may come at a time when we can certainly take advantage of it, and moving from a low to mid-3s to a high-6 -- mid-6 to mid-7, certainly creates incremental AFFO per unit.

[Mark Rothschild, analyst]

Okay. Great. And then just looking at the acquisition market, and I know it's difficult, does declining interest rates make it more difficult to get current owners, operators to sell? Would it make it easier for them to hold on to their properties and get a little more difficult on the cap rates? Would that be a reasonable assumption?

[Milton Lamb, executive]

Yes, if you took it as a very specific moment, but I mean this tends to be more of a trend line where a lot of -- as their debt rolls over, that's when they look at it. And certainly, as debt rolls over, it may be at a lower rate than 3 months ago, but it's certainly a significantly higher rate than it was 2, 3, 4, 5 years ago -- well, 2 or 3 years ago. .

So -- and at the same time, what you're seeing is, inventory going up, at the same time is inventory financing obviously goes up. So I certainly believe there will be more opportunities now than when you see -- when you saw interest rates at incredibly low levels in '22 and '21.

[Operator]

Your next question comes from Jonathan Kelcher with TD. Cowen.

[Jonathan Kelcher, analyst]

So I guess the Kennedy Land certainly demonstrated some of the land value that you guys have. Did the announcement of that sale prompt any discussions with any of your other tenants?

[Milton Lamb, executive]

Really, it more depends on what's happening in the specific regions and with specific businesses. I mean, we're 9 years in, we're in our tenth year. So as some of these properties mature at the same time, the cities and the businesses that are situated on the land matures. So I don't think it's a prompt on a press release or a news release that will get discussions going.

It's just more the evolution of the city and the business that will allow us to potentially -- it's tough to project when, but to be able to capture some of the underlying value by working with our tenants.

[Jonathan Kelcher, analyst]

Okay. Are you having discussions with any other tenants on a similar sort of thing.

[Milton Lamb, executive]

The same as acquisitions. We don't really discuss anything until we announce it. .

[Jonathan Kelcher, analyst]

Fair enough. And then just, I guess, related to that, are you really thinking of your bond site here where the lease comes up, but are you working to get some density on any other sites that you have?

[Milton Lamb, executive]

There's always a combination of looking at what we could put in place and moving it to a certain level. We've said consistently over the last number of years, we don't want to create a development company within APR. Certainly, entitlement or a significant portion of that entitlement process, I do think adds value. So that is something that we continue to look at and spend some money on. .

[Operator]

Your next question comes from Lorne Kalmar with Desjardins.

[Lorne Kalmar, analyst]

Maybe sticking on the disposition side of things. With some leases starting to roll in '26, do you think maybe that could be a year where we see a couple more of these deals come to fruition?

[Milton Lamb, executive]

As we've said before, and it was announced that has one more renewal option. We don't know if that group will end up renewing or not. Certainly, no, and like the site. No one like the tenant. So it's certainly an interesting site. At this point, we don't have any conclusive entities either way.

[Lorne Kalmar, analyst]

Okay. Would that be a site where there would be appetite for multi-res similar to the Kennedy lands?

[Milton Lamb, executive]

It's surrounded by high-quality retail and high-density projects. I mean that is an area that Vaughan wants to see higher intensification.

[Lorne Kalmar, analyst]

Okay. So I won't be surprise that. And then maybe just switching gears a bit here. The AutoCanada results were a little bit disappointing. I think there are some other externalities, but they quoted sort of some softness in fundamentals. And we've seen the EBITDA come down for Dilawri. Do you think maybe softening sales could be a catalyst for some M&A on the dealership side?

[Milton Lamb, executive]

I certainly believe that a lot of these dealerships were during the pandemic, incredibly profitable. I think they're going to be at more of at very healthy profitable number. And when you're seeing interest rates higher and profits being at a more healthy but normalized level, that means we have a bigger place at the table. So I certainly don't think that hurts. .

[Operator]

Your next question comes from Brad Sturges with Raymond James.

[Bradley Sturges, analyst]

Just to follow on to the acquisition commentary. And I guess in your opening comments, you talked about having more capacity. I'd be curious to know what you think your balance sheet capacity today would be for acquisitions?

[Milton Lamb, executive]

Short answer is significant. This -- the Kennedy Roads property was unencumbered. So this is pure cash to the bottom line, which we are already in a good position. So for us, it's not as much about capacity, it's about availability of properties and groups that we want to work with, and that's often driven by that buy-sell gap that we talked about before that we're seeing shrink. .

We think there's going to be a meeting of the minds. And from my 30-odd years in real estate, I've always been amazed that once there's a couple of benchmarks created, how quickly there's a domino effect with other deals.

[Bradley Sturges, analyst]

I guess, maybe put it a different way, is there a target -- is there a change in the target leverage you'd like to get to? Or is it still consistent with, I think, previous comments around the 50% the gross book value?

[Milton Lamb, executive]

I think that's consistent. And if you kind of sketch out the numbers, if we get to that level, our AFFO per unit is going to look very healthy. And if I look at where we are now, whether it's the traditional extension of our credit facilities that we just completed, whether it's the LTV that we have in pulling off some additional capital from Kennedy Roads, we're in a very good place now to really drive that AFFO growth per unit, which we want to do.

[Bradley Sturges, analyst]

And last question, I guess, the unencumbered pool down to a couple of assets. Would those be kind of lower density sort of redevelopment opportunities? Or how should we think about those 2 assets are still unencumbered?

[Milton Lamb, executive]

I think that's just -- whether it's the LTV on some of our corporate facilities or the fact that we've got a couple of outstanding properties. Certainly, Kennedy Road is something that we've known and looked at as having high density potential so kept it unencumbered. I think the other ones, that's just part of a natural rotation and timing.

[Andrew Kalra, executive]

Timing.

[Milton Lamb, executive]

Yes.

[Operator]

Your next question comes from Himanshu Gupta with Scotiabank.

[Himanshu Gupta, analyst]

Just on the balance sheet. Facility 2 was, I think, extended until 2028. Did you extend the swap as well? I mean, when does the swap expire on that Facility?

[Andrew Kalra, executive]

There was only that 9 point -- $9 million swap that we extended. All the other ones just flowed through.

[Milton Lamb, executive]

And this is -- I mean, this is traditionally what we've done with all 3 facilities that when we extend it, it doesn't affect the swaps. So those in-place swaps, we just carry on and certainly when the right time occurs or as they come closer to the exploration, we'll look at extending or replacing the swaps.

[Andrew Kalra, executive]

It's just the debt portion that was extended. That's what's been done on Facility 2 .

[Milton Lamb, executive]

That's just consistent rate that we've had since IPO. .

[Andrew Kalra, executive]

Yes.

[Himanshu Gupta, analyst]

Got it. Okay. And if I look at 2025 debt maturity, now what is left in '25?

[Andrew Kalra, executive]

So the debt maturity, we don't have debt maturities until 2026. I think you're referring to the swaps that are coming due, and they will be coming due -- so they will be coming due now over the 2024 to 2025. And as we commented, the -- as the rates are lowering, we'll look to extend those swaps and with the rates coming down, that will be better than today.

[Milton Lamb, executive]

And a lot of those -- just the natural cadence, a lot of those swaps are close to the year-end because a lot of our acquisitions are close to year-end.

[Himanshu Gupta, analyst]

All right. Okay. And then I think -- did you mention the target leverage is around 50% or so? I mean, that gives you a lot of acquisition capacity here.

[Milton Lamb, executive]

It does. And as a triple-net lease structure, we don't have a lot of leakage below the line. So we're comfortable of that 50 -- low 50s level Certainly, as we've continued to grow and mature, we've reduced those -- that LTV a bit from our IPO. So we continue to be comfortable in that kind of 50, very low 50s.

[Himanshu Gupta, analyst]

Got it. Okay. Maybe just a last question on the popular Kennedy Land's transaction. when does the Dilawri lease expire on this property? I'm just wondering if the lease term was a factor in deciding whether this property should go for a rezoning abrogation or not?

[Milton Lamb, executive]

Sure. I mean they've got a midterm lease with significant renewal options. So they had long-term control over the site, which is why we have to work with our tenants unless it's a lease expiration. And certainly, as Dilawri will be the owner and the operator on the site, I'm sure they've got the flexibility to tear up or redo their own lease, which we as the REIT did not.

So that's -- it's a situation where -- we've said this from day 1 that we expect there will be opportunities where if we leave a little money on the table, we can take some very good profits for our unitholders, which is what we did.

[Operator]

[Operator Instructions] There are no further questions at this time. I will now turn the call over to Milton for closing remarks.

[Milton Lamb, executive]

Thanks, Joel. We appreciate all of you joining us today and look forward to speaking with you again soon, enjoy the rest of the summer. Thank you. .

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.