Choice Properties Real Estate Investment Trust

TSX:CHP.UN

Earnings Call Transcript 2019-Q4

[Operator]

Ladies and gentlemen, thank you for standing by. And welcome to the Choice Properties Real Estate Investment Trust Q4 earnings announcement conference call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]I would now like to hand the conference over to your speaker today, Adam Walsh, Vice President, General Counsel. Thank you. Please go ahead, sir.

[Adam Walsh, VP, General Counsel & Secretary]

Thank you, Jason. Good morning, and welcome to Choice Properties' fourth quarter conference call. I'm joined here this morning by Rael Diamond, President and Chief Executive Officer; and Mario Barrafato, Chief Financial Officer.Before we begin today's call, I'd like to remind you that by discussing our financial and operating performance and in responding to your questions, we may make forward-looking statements, including statements regarding Choice Properties' objectives, strategies to achieve those objectives as well as statements with respect to management's beliefs, plans, estimates, intentions, outlook and similar statements concerning anticipated future events, results, circumstances, performance or exceptions that are not historical facts. These statements are based on our current estimates and assumptions and are subject to risks and uncertainties that could cause actual results to differ materially from the conclusions in these forward-looking statements.Additional information on the material risks that can impact our financial results and estimates and assumptions that we applied in making these statements can be found in the recently filed 2019 annual report and management's discussion and analysis, together with Choice Properties' annual information form, all of which are available on our website and on SEDAR.I will now turn the call over to Rael.

[Rael Lee Diamond, President & CEO]

Thank you, Adam, and good morning, everyone. Thank you for taking the time to join our Q4 conference call. We are pleased with both the financial and operational results for the fourth quarter. I will start with an update on our operational results and Mario will then provide you with detail on our financial performance.Our income-producing portfolio is comprised of 708 properties and 65.8 million square feet of GLA and represents a total income-producing value of $15 billion. The portfolio continues to produce consistent and stable results with same-asset NOI growth of 3.1% for the quarter and year-end occupancy of 97.7%.Retail real estate represents the majority of our portfolio, with a focus on grocery-anchored properties and necessity-based tenants. These retailers are far less sensitive to short-term economic fluctuations and the ever-changing retail environment. Our retail portfolio is well situated to deliver stability and growth. Occupancy in our retail portfolio was consistent quarter-over-quarter at 98%. We continue to successfully add to our retail portfolio, both through acquisitions and development. During the year, we acquired 4 retail assets for $70 million, representing approximately 300,000 square feet of GLA. Each of these assets is anchored either by a Loblaw grocery store or Shoppers Drug Mart and were all acquired with long-term leases in place.On the development front, we added to the retail portfolio through a mix of greenfield developments and intensifications. These development initiatives continue to provide us with the best opportunity to add high-quality real estate to our portfolio at a reasonable cost. In total, we delivered 385,000 square feet of retail GLA at a total cost of $136 million during 2019. Included in the transfers for Q4 is a 33,000 square foot grocery store located on Coxwell Avenue, near Gerrard Street in Toronto. This No Frills store opened in December and is an exceptional urban retail asset that we've added to our income-producing portfolio.Our industrial portfolio is concentrating Canada's largest distribution markets. Apart from the small bay market in Alberta, industrial assets are operating under healthy fundamentals with low vacancy rates and increasing rent. Period-end occupancy was down 20 basis points to 97.9%, driven mostly by 100,000 square foot vacancy in Ontario. There's tenant demand for the space, and we expect to have this released shortly at higher rents than those historically in place. The acquisition environment for industrial properties continues to be extremely competitive. So we've worked with our development partners to grow our industrial portfolio.In 2019, we completed and transferred a total of 768,000 square feet of industrial development at a cost of $78 million. Incrementally, our development partners continue to provide us opportunities to acquire their interest in stabilized assets. In 2019, we acquired 3 industrial assets from our development partners, representing 335,000 square feet at a total cost of $48 million. This includes our partners' 15% interest in our Peddie Road and James Snow Parkway assets in Milton, Ontario, which were acquired in the fourth quarter. These assets are new-generation, large-bay distribution facilities in the GTA West Industrial node. We now own 100% of both of these properties.In addition to our development projects, we acquired 120,000 square foot industrial asset from Weston Foods in Q4. The property is located at Weston Road in Lawrence Avenue in Toronto and was acquired for a total cost of $13 million. We acquired the property with a short-term lease in place, and we will ultimately look to release the building long term. The asset is within walking distance to the Weston GO Station and Union Pearson's Express station stop and has great access to highways and a deep labor pool. These transactions represent a wonderful opportunity to continue growing our industrial portfolio in strong distribution markets.Next is our office portfolio. Our office portfolio is focused on large, well-located buildings in the downtown core of Canada's largest cities. Period-end occupancy of our total office portfolio was up slightly from the prior quarter to 93.3%, primarily due to positive absorption in our Vancouver and Calgary portfolio, offset by some declines in Montréal.Our residential platform provides an opportunity to further diversify our portfolio. Our focus has been on developing new rental residential assets, primarily in the GTA. The rental market in the GTA is strong as limited new supply and robust demand has driven our brands. Our current residential platform includes 3 residential assets that are income-producing and another 6 residential rental assets that are in various stages of development.To date, we are under vertical construction on 2 of these projects in the GTA. And we expect to commence construction on 2 additional development projects in 2020, including 1 project in Brampton, next to the Mount Pleasant GO Station; and 1 in the Westboro neighborhood of Ottawa. We have invested approximately $120 million into our residential developments to date, with an additional $425 million of additional spending planned on these 6 residential projects over the next few years.Finally, I'd like to provide an update on our transaction activities. We continued to be active with capital recycling. In Q4, we completed 2 dispositions for total proceeds of $24.3 million. This included a stand-alone retail asset in Red Deer and a parcel of development land in Edmonton. Subsequent to the quarter end, we completed the sale of the shops of Oak Brook for approximately $98 million. Oak Brook Plaza is in Chicago, and the asset was not aligned with our long-term strategic focus, considering it was the only asset we owned in the United States. Each of these transactions represent a good opportunity for us to recycle capital in both -- into both future acquisitions and into our development program. That concludes my comments.I'd now like to pass it over to Mario to provide an update on our financial performance for the quarter. Thank you.

[Mario Barrafato, Chief Financial Officer]

Thank you, Rael. Good morning, everyone. I'll begin with a brief overview of our financial results, and then I'll comment on our balance sheet activity.Overall, our results for the fourth quarter and for the year ended 2019 were in line with our expectations and continue to reflect the stability that is inherent in our portfolio. Our reported funds from operations for the fourth quarter was $166 million or $0.237 per unit diluted compared to $0.25 per unit at September 30. The decrease in FFO was primarily due to 2 reasons. One is a $3 million nonrecurring allowance for bad debts associated with a certain mortgage receivable and a $7.1 million nonrecurring reimbursement of previously recognized contract revenue for certain solar rooftop leases. This reimbursement relates to revenue received over the last 7 years by Choice in error that should have been received by Loblaw. Along with the reimbursement, Choice and Loblaw acknowledged that all future revenue and liabilities related to the solar rooftop leases and related rooftop repair costs belong to Loblaw. Excluding the impact of these nonrecurring items, FFO for the fourth quarter would have been $0.25 per unit diluted, which is consistent with the prior quarter.Included in our Q4 performance was growth in same-asset cash NOI of 3.1%. This growth reflects annual step rents embedded within the Loblaw portion of our portfolio, as well as incremental cash generated from leasing activity and year-end adjustments for recoveries in percentage rent.Quarter end occupancy remains strong at 97.7%, with retail occupancy at 98%, industrial occupancy at 97.9% and office at 93.3%. We did have negative absorption of 49,000 square feet, however, as Rael mentioned, that figure includes a 100,000 square foot industrial vacancy in Milton that is expected to soon be released at rents higher than those that were in place. This quarter caps off a strong operational performance here with consistently high occupancy, 403,000 square feet of positive absorption and annual same-asset cash NOI growth of 2.6%.Now on to our balance sheet. In 2019, we've made significant progress in improving our property portfolio, our financial position and our risk profile. We improved our property portfolio through ongoing investment in our development program with a $140 million of spending during the year on intensification, greenfield and residential development projects.In 2019, we completed and transferred $256 million of properties and development to income-producing status, delivering 1.1 million square feet of high-quality GLA to our existing portfolio. We also improved our portfolio through active capital recycling, disposing of $468 million in assets in 2019. And the proceeds we utilized to facilitate $153 million in acquisitions, including $133 million of income-producing properties and $20 million of development properties. The balance of the proceeds from our capital recycling were utilized to repay debt. And when combined with the $395 million of equity we raised in May 2019, we significantly improved our financial position and our risk profile.In 2019, we reduced our leverage ratio to 7.5x debt-to-EBITDA from 8x at the start of the year. We flattened out and extended our debt maturity ladder, and we maintained a strong liquidity position with $1.4 billion available on our credit facility and $11.8 billion pool of unencumbered properties. So overall, we're extremely pleased with the improvements made to our property portfolio and our financial profile in 2019.Looking forward to 2020, we expect to have continued stability in our core operations, and we will continue to improve our balance sheet as the opportunity arises.I'd now turn the call back to the operator for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Himanshu Gupta from Scotiabank.

[Himanshu Gupta, Analyst]

On the lease expiry in 2020, I think around 1.1 million square feet of retail GLA is coming up for renewal. And I think all of which is third party. So what are your thoughts there? What kind of challenges or opportunities do you think are there?

[Rael Lee Diamond, President & CEO]

Himanshu, this is Rael. Thanks so much for your question. I think you have to really look by asset class. And I don't have the numbers exactly handy, just give me a second. Look, I think generally what we're seeing across the portfolio, we don't have mass rolling on office and we're seeing real positive absorption in Toronto. Montréal continues to be strong, and Calgary continues to be weak. I think on the industrial side, again, Ontario is strong, and Alberta, we're seeing some roll-down, particularly on the small base space. And then there continues to be a decent demand for space in our retail portfolio.

[Himanshu Gupta, Analyst]

Sure. Okay. And you touched upon the industrial portfolio. Obviously, same-store NOI was strong, 3.9% in the quarter. Does that include the CREIT industrial portfolio?

[Rael Lee Diamond, President & CEO]

Yes, yes. So Mario, is the 3.9% in the quarter including CREIT?

[Mario Barrafato, Chief Financial Officer]

Yes.

[Rael Lee Diamond, President & CEO]

Yes. It includes both.

[Himanshu Gupta, Analyst]

Sure. And maybe just on industrial, how much of your industrial portfolio is in Alberta as a percentage of NOI or asset values? And what are the trends in, say, Calgary or Edmonton markets?

[Rael Lee Diamond, President & CEO]

So if you look at the non-Loblaw assets, it's approximately 45%, I believe, is in Alberta. Calgary is definitely stronger than Edmonton, but we are seeing weakness in the Calgary small-bay market, as we said. Having said that, we have quite a bit of potential expiry in Edmonton in 2020, which we expect in the middle, large bay to retain all the tenants.

[Himanshu Gupta, Analyst]

Sure.

[Rael Lee Diamond, President & CEO]

And actually we are seeing decent activity as well on our Great Plains. We have one building that is for lease that we are in discussion with a tenant to potentially take the whole space. So we actually -- we view that as very positive.

[Himanshu Gupta, Analyst]

Sure. And maybe just switching gears on the fair value adjustment this quarter. I think in the disclosure, you mentioned increased fair value of -- value on Ontario residential development project. How much was the size of fair value adjustment? And I'm assuming it must be Dufferin Street or East Liberty.

[Mario Barrafato, Chief Financial Officer]

Yes. The amount is approximately $8 million. And yes, it was on Dufferin. And so it's at a stage now where we've hit certain milestones on construction. And so we changed the fair value from cost to a modified cost to reflect the value today.

[Himanshu Gupta, Analyst]

Sure. And maybe just last question from me on the capital budget or the maintenance program. So property capital in 2019 came in much lower compared to last year. Is that the new trend? Or do we see capital budget going back up in 2020? Any color there?

[Mario Barrafato, Chief Financial Officer]

Sure. No, we intentionally slowed down our capital spending this year on maintenance projects just to revise the process and how we evaluate, how we spend, where we spend and we've added some additional resources, expertise to manage that. So it was lower this year intentionally. Next year, it will get back to levels around 2018 level.

[Operator]

Your next question comes from the line of Sumayya Syed from CIBC.

[Sumayya Syed Hussain, Associate]

Just firstly, can you give us a bit more detail on the residential developments in Brampton and Ottawa mentioned in the outlook, just how many units, any partners and just the scope of those projects?

[Rael Lee Diamond, President & CEO]

Sure. The one in Brampton, we own the land in conjunction with Daniels. We would look to do 270-odd rental units and about 90 to 100 condo units, I believe. We're actually going to build the condo units on spec, and they look to sell them at a later date. We just think that the Brampton market is more suited to that strategy. We basically have barely any land cost on the asset, given we -- it used to be a retail property or property that we were marking for retail development and we've actually sold some land at a gain. So we're actually very excited by the project. It's -- given its location, there's actually very strong demand in that vicinity and we've a very, very good partner.On the asset in Ottawa, we currently own 100%, but we actually are in discussions to potentially bring in a 50% partner that, I guess, once we finalize that, we will provide additional color. But we are potentially working with an existing partner. We have a development. We have a development manager in Ottawa, who's going to assist us with the project, and we'll provide you more color as we have it.And how many units -- sorry. So down in Ottawa, there's about 250 units.

[Sumayya Syed Hussain, Associate]

250. Okay, great. And then can you just go over, I guess, the potential for more major mixed-use sites outside of Toronto, for example, Montréal, BC, and how the scope there compares to what you've identified in Toronto so far?

[Rael Lee Diamond, President & CEO]

So we will disclose projects as we start a rezoning process. We haven't really disclosed much outside of the GTA. In Vancouver, we've disclosed one project in Coquitlam, and we actually have acquired some additional land, which, in our view, gives us some additional density because it connects access to the sites. But we are busy working through the zoning on that side. And as soon as we have more color, we'll provide it. We don't have anything yet to report in Montréal at this time.

[Sumayya Syed Hussain, Associate]

Okay, that's fair. And then just lastly for me, just on the, I guess, the No Frills store developed on Thompson Road, just how would the development yield there compared to what you would see in terms of market cap rates for similar assets?

[Mario Barrafato, Chief Financial Officer]

So well in excess. We would have just north of a 7% yield on our cost on that asset. So in the GTA and asset like that, market rents, 15-year lease would start with a low 5%, maybe even high 4%.

[Operator]

Your next question comes from the line of Sam Damiani from TD Securities.

[Sam Damiani, Analyst]

Most of my big questions have been asked but just run through some quick detailed ones. Just on the Chicago, first of all, congratulations there. Nice to see the nice successful sale there. How would that -- how did that sale price compare to your IFRS fair value in recent quarters?

[Rael Lee Diamond, President & CEO]

So Sam, last quarter, we actually -- we made some reference to some write-downs on power centers. We actually had decreased the asset value slightly. The U.S. market is different to Canada, that it's a very -- that was a very strong power center, but buyers of those assets definitely have a more negative outlook, just given what's going on in the U.S. So we did actually -- it was at our carrying value in Q4. But in Q3, we did have a small write-down.

[Sam Damiani, Analyst]

What kind of cap rate did the $98 million reflect?

[Rael Lee Diamond, President & CEO]

It was around a 6%.

[Sam Damiani, Analyst]

Interesting. Okay. And just on the property for $13 million, 125,000 square feet, I think you said. Sorry, what was the address or what was the division or tenant that was in the building right now?

[Rael Lee Diamond, President & CEO]

It's Weston Foods, and it was 1965 Lawrence Avenue West.

[Sam Damiani, Analyst]

Okay. And so that's going to stay as an industrial use for the foreseeable future?

[Rael Lee Diamond, President & CEO]

Yes. And we -- like from our point of view, that's a spectacular asset because we view it -- we buy it on an industrial basis, income reducing. But in the future, it has potential -- densification potential, but we intend to release it right now.

[Sam Damiani, Analyst]

Right on. And the vacancy you referred to in Milton, industrial, which building is that? I'm just wondering if it would be one of the newly developed ones.

[Rael Lee Diamond, President & CEO]

No. It's an older-generation building at [ 89 Park ], yes.

[Sam Damiani, Analyst]

Okay. And Mario, you gave us some outlook for 2020 in your comments there, looking for some opportunities possibly to further improve the balance sheet. So if you had an opportunity to successfully dispose assets, I mean, where would you like to see the leverage go down to?

[Mario Barrafato, Chief Financial Officer]

Well, I mean, we're pleased with our leverage right now. I mean we made a lot of progress from last year. We got rid of a lot of the acquisition debt. Now in the range of the -- where the rating agencies kind of want us to be. So I mean, if we had opportunities, it's really going to be more asset-based, like as we sell Chicago and other assets. We -- if we have opportunities to recycle that capital, we will. But if we have the opportunity to pay down debt, we're more than happy with that, too. But there's no urgency right now to get our debt level lower.

[Sam Damiani, Analyst]

Okay. That's helpful. And Rael, you did mention the outlook for retail in the U.S., obviously, much worse, and that's certainly a whole lot better in Canada. Nonetheless, are you looking at possibly you lightening up on some of the legacy CREIT retail properties in Canada as a way of capital recycling?

[Rael Lee Diamond, President & CEO]

Sam, we're looking -- we're going through a capital recycling process, as Mario mentioned. As we have more to update, we will, but it can be a combination of both legacy CREIT and Choice assets.

[Sam Damiani, Analyst]

And just for clarification, is there any exposure of any consequence to some recent retailers that have decided to close up shop like Papyrus and Carlton Cards, La Senza, Pier 1, whatnot?

[Rael Lee Diamond, President & CEO]

There is some exposure primarily in the power center portfolio that we own. But I don't know the exact numbers, but not significant.

[Sam Damiani, Analyst]

Well, not measurable, okay. And just lastly, you mentioned a couple of residential projects starting this year, and I appreciate the detail there. What is the timing on 1050 Sheppard and Grosvenor?

[Rael Lee Diamond, President & CEO]

Sam, 1050 Sheppard, the rezoning process has taken us a bit longer. Why don't I get back to -- we're hopeful that 1050, we can have a lot of progress towards the end of 2020 and maybe commence construction but likely next year. And Grosvenor, we still will be going through the rezoning process. As we have better timing, we'll give it to you.

[Operator]

[Operator Instructions] Your next question comes from the line of Jenny Ma from BMO Capital Markets.

[Jenny Ma, Analyst]

Rael, in the past, I guess, in Q1, we're going to start seeing the full contribution of the CREIT portfolio in the same-property NOI number that the Choice legacy assets have sort of been running in that 2.5% to 3% range for the last 3 years or so. Any update or commentary on what you think the pro forma full portfolio SPNOI number may be for 2020?

[Mario Barrafato, Chief Financial Officer]

Hi, Jenny. It's Mario, I'll take that one. No, you're right. As you get to a bigger base, the impact of the step rents get smaller. And so just by basis of math, rather than being in the high 2s, we'd probably more in that 1.5% to 2% range. And the -- what will impact that further is as we have rollover, most of that is in the CREIT portfolio or the ex CREIT portfolio, so you will have some temporary vacancy, such as the industrial property we talked about and some of the retail. So within kind of in that, that 1.5% range is likely where we'll be. Half of it ins by math. The other half is by more activity in the portfolio.

[Jenny Ma, Analyst]

Great. That's helpful. With the Chicago disposition, in the past, during the CREIT days, there were some tax implication around that sale. So in this instance, did you -- is there going to be a tax impact that will come in, in Q1? Or was that sort of resolved in the last couple of years?

[Mario Barrafato, Chief Financial Officer]

It was resolved. So basically, there will be no tax hit on that -- from that property.

[Jenny Ma, Analyst]

Okay, great. And then my last question is there were a couple of properties that were still in due diligence as part of the Oak Street portfolio transaction. I'm not sure if 1 of the 2 that were sold in Q4 was 1 of them. But do you have an update on where those 2 dispositions are at?

[Rael Lee Diamond, President & CEO]

Yes. Jenny, those 2 never proceeded. They were small. I think Oak Street was focused on other items, and I think it just dragged that. And eventually, they said, it was just too small to transact on.

[Jenny Ma, Analyst]

Okay. Are you still in discussions with them about potential acquisition -- sorry, dispositions down the road?

[Rael Lee Diamond, President & CEO]

Right now, we're not in discussions with them.

[Operator]

There are no further questions at this time. I turn the call back over to the presenters.

[Rael Lee Diamond, President & CEO]

So thank you, everyone, for joining us this morning. Starting tomorrow, hopefully, everyone enjoys the long weekend. Bye.

[Operator]

That concludes today's conference call. You may now disconnect.