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Crombie Real Estate Investment Trust
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Good afternoon, everyone, and welcome to Crombie REIT's Q2 Earnings Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded today, August 10, 2023.
I would now like to turn the conference over to Ms. Ruth Martin. Please go ahead.
Thank you. Good day, everyone and welcome to Crombie REIT's second quarter 2023 conference call and webcast. Thank you for joining us. This call is being recorded in live audio and is available on our Web site at www.crombie.ca. Slides to accompany today's call are available on the Investors section of our Web site, under Presentations and Events. On the call today are Mark Holly, President and Chief Executive Officer; and Clinton Keay, Chief Financial Officer and Secretary.
Today's discussion includes forward-looking statements. As always, we want to caution you that such statements are based on management's assumptions and beliefs. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. Please see our public filings, including our MD&A and annual information form for a discussion of these risk factors.
I will now turn the call over to Mark who will begin our discussion with comments on Crombie's overall strategy and outlook, along with a development update. Clinton will review Crombie's operating fundamentals, discuss our financial results, capital allocation and approach to funding. And Mark will conclude with a few final remarks.
Over to you, Mark.
Thank you, Ruth. Good day, everyone, and thank you for joining us today. Crombie's well-curated portfolio, our solid financial position, and our experienced and accomplished team for an incredibly strong base, coupled that with powerful strategic partnership, our robust development pipeline, and our persistent pursuit for operational excellence, we continue to generate value for our unitholders, driving results in the near and long-term. The hard work and dedication of our team continues to shine, and this quarter is no exception. We delivered stable committed occupancy of over 96%, same-asset NOI growth of 2.7%, adjusted FFO per unit growth of 7%, as well as renewal growth of 5.8% when comparing the weighted average rent during the renewal term.
These results highlight Crombie's strong fundamentals of a well-curated portfolio and our focus on operational excellence. Today, I'll comment on three notable drivers in the quarter; our Empire relationship, our development program, and ESG. One of our strategic differentiators is our partnership with Empire. Through our strategic alignment, we were able to plan and deliver initiatives that create significant value for both organizations, enhancing the quality of our portfolio from acquisition, modernization, conversion, and development management and construction of purpose built projects, like the industrial customer fulfillment centers.
The alignment in our real estate strategy allows us to leverage our strength, including development expertise to drive value on a sustainable basis. In the second quarter, we recognized revenue from development management services for the recently completed industrial customer fulfillment centers at the completion of those projects. We are pleased with this result, and look forward to building on this synergistic platform across our portfolio as a trusted development partner. And subsequent to the quarter, we closed on an agreement with a subsidiary as Empire, in which Crombie will receive third-party leases at 24 retail fuel sites in Western Canada, providing same-asset NOI growth and additional NAV creation.
With respect to development program, it is expansive, and provides AFFO and NAV growth, enhancing the quality of cash flows. At our mixed use residential property, Bronte Village, in Oakville, we continue to achieve month-over-month highs in leasing progress, with the residential portion of the property reaching 68% leased as of mid July, with rent continuing to exceed pro forma by over 10%. Tower one is expected to be fully leased by the end of the year, with full occupancy of Tower two and stabilization of NOI for the entire property expected in the second quarter of 2024. Last quarter, we announced the advancements of our next major project, The Marlstone, a 291-unit residential rental development in Halifax, Nova Scotia. And within a month of that announcement, shovels were in the ground.
This site is expected to be completed in the second quarter of 2026, and with Halifax vacancy rates around 1%, and little product coming on line to meet demand, this project will be a welcome addition to the community and to the Crombie portfolio. In June, Voilà CFC, our second industrial customer fulfillment center, commenced paying rent as Empire began grocery home delivery to customers in Calgary, Edmonton, and surrounding areas. Our dynamic and skilled team is focused on advancing projects through the entitlement process, which grants us flexibility and choice in our development planning. Last quarter, we stated that were focused on submitting four rezoning applications over the course of 2023.
I'm pleased to say that in the second quarter, we submitted an application on the development in the GTA. And subsequent to the quarter, in late July, we submitted a revised rezoning application at our major development in Vancouver Broadway and Commercial. There are currently 10 projects in various stages of having zoning in place, rezoning applications submitted or will have applications submitted by the end of 2023. These projects hold the capacity to contribute approximately 5.3 million square feet of commercial and residential GLA, comprising of approximately 5,900 residential units.
Lastly, on our ESG progress, in May, we announced our climate action plan to achieve net zero by 2050 for scopes 1, 2, and 3, and set a 2030 near-term commitment of reducing scope 1 and 2 emissions by a minimum of 50% from a 2019 base year. I'm very pleased to report that, last month, SBTi validated and approved our plan. In addition to this validation, we also submitted to GRESB for the third year. And I look forward to sharing our ESG Sustainability Report later this year.
I'm pleased with the momentum in the business and our results this quarter. We are focusing in on the right strategies to drive value for our unitholders, tenants, and team.
With that, I'll turn the call over to Clinton, who will highlight our second quarter operational and financial results, and discuss our capital funding approach.
Thank you, Mark, and good day, everyone. Solid occupancy continues in the second quarter, with committed occupancy of 96.4%, and economic occupancy at 95.9%. Year-to-date, new leases increased occupancy by 419,000 square feet at an average first-year rate of $19.86 per square foot. Over 93% of new leases, equivalent to 390,000 square feet, were completed in VECTOM and major markets, increasing Crombie's presence in these markets. Notable new leases include Empire's Voilà CFC 3, in Calgary, Alberta, which commenced payments in June, and two new Dollarama leases. At the end of the quarter, 87,000 square feet was committed at an average first-year of $26.84 per square foot, which will contribute to future NOI growth as tenants take possession.
Lease renewal activity during the quarter consisted of 245,000 square feet of renewals at a 3.3% increase over its prior rental rates. Driving the growth for the quarter was 71,000 square feet of renewals, and retail plaza properties was a 4.6% increase over expiring rental rates. When comparing the expiring rental rates to the weighted average rate for the renewal term, Crombie achieved an increase of 5.8% for renewals in the quarter. Year-to-date, Crombie completed 785,000 square feet of renewals at an increase of 5% over expiring rates.
Supported by solid operating fundamentals, same-asset NOI on a cash basis increased 2.7% compared to the same quarter in 2022. Primary drivers are renewals and new leasing, and higher supplemental rent from modernizations and capital improvements. For the quarter, AFFO per unit was $0.22, down from $0.25 for the same quarter last year, and FFO per unit was $0.26, down from $0.28 for the same quarter last year. Excluding the impact of employee transition costs in the quarter, of $7.2 million, of which $4.6 million is related to unit-based compensation, AFFO and FFO will be $0.26 and $0.30 respectively, an increase of 4% and 7% over the same quarter of 2022.
AFFO payout ratio for the quarter was 102.1%, and FFO payout ratio was 86.7%. Adjusting for employee transition costs, AFFO and FFO payout ratios are 86.2% and 75% respectively. We have worked hard to improve our balance sheet and overall financial condition. We are well-positioned to continue to reach our financial goals, and proactively pursue the right opportunities at the right time. In the second quarter, DBRS confirmed our rating of BBB low, with a stabilized outlook, and validated our plan to achieve an upgrade to BBB by reducing secured debt to total debt comfortably below 40% as margin matures over the next few years, and maintaining our solid debt-to-EBITDA metrics.
The fair value of our unencumbered asset pool increased from $2.2 billion at year-end, to a record high $2.5 billion in the second quarter primary due to mortgages maturing. We continue to maintain ample liquidity with $614 million available at the end of the quarter. Unencumbered assets as a percent of unsecured debt is 201%, an increase from 192% at December 31, 2022, providing Crombie with continued financing flexibility and optionality. Our debt to gross fair value was 42.3%, compared to 41.8% at Q4 2022. We ended the quarter with debt to trailing 12-month adjusted EBITDA at 8.17 times, up from 8.02 times at December 31, 2022. The increase is mainly due to employee transition costs incurred in the quarter.
Crombie remains committed to reducing risk and upholding financial strength through prudently managing our balance sheet and overall financial condition, enabling us to pursue long-term growth strategies.
With that, I will now turn the call back to Mark for a few closing comments.
Thank you, Clinton. Crombie's stable portfolio delivered solid and consistent results this quarter. There is momentum in the business, and the team remains focused on advancing our strategic initiatives throughout 2023, and beyond. We thank you for your time today.
We are pleased to now answer any questions you may have.
Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question will come from Tal Woolley at National Bank Financial. Please go ahead.
Hi, good afternoon.
Hi, Tal.
Just for the Marlstone development in Halifax, what's the sort of target demo, what sort of rents are you expecting, and given that it's sort at the corner of [main and main] (ph) in Halifax?
Yes, Tal, great question. As we said last quarter, we're really excited about The Marlstone, our first self-developed project, as you called it, main and main. It really is main and main right besides our Scotia Square asset. At that time, we were not in a position to disclose rental rates. We are working on providing an enhanced disclosure with the team, and hope in the next few quarters we'll be able to give a bit more color on yield on costs, et cetera, for that project. What we can say is we are anticipating to spend between $130 million and $150 million.
And when we worked on putting those performance together, we went through our -- a robust process on sensitivity analysis, scanned the market to find out what rental rates were today, and using those as a proxy to kind of showcase what we thought we'd be in for the range when we deliver, in 2026. Also at that time, we were really comfortable with the cost as we had 75% of the hard costs already under contract, and talked about on the prepared remarks that we're already in the ground advancing the project. And I know it's really early days, but as we started to get into the undergrounds, we're really pleased with what we're seeing; we're on time and on budget, so really happy with so far.
I guess where I'm sort of going with this is, it's not -- this will be more of a premium product in the market, is it fair to say?
It's going to be a product reflective of the demographics that we're seeing in that community and what the economic social fabrics are out there. It will be a product reflective of that area, yes.
Okay. And then just on Bronte Village, it's still a bit of an FFO drag for you guys this quarter, and I understand that because of where the occupancy currently sits. With your language about when you expect stabilization, when would you expect the FFO to flip from being a drag to a contributor to the bottom line?
I think, Tal, I'll answer that. We don't want to give forward guidance, but clearly when we reach stabilize down the line, that that's a good indicator when you could start to see the pivot. But just like with Davie, we saw that it takes a little time. And I guess I don't want to give that forward-looking information at this time, but I still think that what we're seeing is very encouraging, as you said. But with the current lease-ups, and these things are long-term projects, and Crombie has always thought long-term, and we're very happy with the long-term outlook for this product.
One thing that I'll just add on to that from Clinton comments is the lease-up. We are getting month-over-month highs. And so, while we have an anticipation of reaching NOI stabilization in 2024, our leasing and ops teams are very much focused on leasing that up and getting month-over-month. But I'm really pleased with some of the adjustments we've made over the last few months, and it's starting to show the results. We're also working very closely with CMHC, and getting CMHC mortgage financing put on there. The team, and with Clinton's team are working to bring that online some time late this year or early next year.
But we are in the [indiscernible], so --
Okay, got it. And then I'm wondering the Shell Canada transaction, so Empire is selling some of its retail fuel sites. And what exactly are you guys -- do you guys own the sites currently and you're making a payment on the transition? I'm just trying to understand what, for the $16 million-$17 million, what investors should be expecting as the return on that?
So, the transition that we're doing, they are [assignment] (ph) of subleases that Empire had on sites that we had the controlling rights to. Empire had announced earlier this year that they were getting out of the retail fuel business. And so, we were able to get an assignment of those leases into Crombie's portfolio, and we're able to get an immediately increase in NAV value, and growth in our same-asset NOI. The yield on that $16 million is going to between 6% and 8%.
Got it. And just lastly on the CFC Calgary development, so there's very modest contribution to FFO this quarter for the new DC. So, next quarter, we should expect like a full run rate contribution from that development being finished?
Yes, so, Tal, so we have basically the month of June, so one month. So, expect a full three-month run rate in Q3.
Okay, that's perfect. Thanks very much, gentlemen.
Thanks, Tal.
Thank you, Tal.
Your next question will come from Lorne Kalmar at Desjardins. Please go ahead.
Thank you. Good afternoon, everybody. Maybe on occupancy, it's kind of -- it's obviously not big tick down, but ticked down a little bit over the last couple of quarters, and you guys are hovering around 97%. I think you said you kind of wanted to be in that 97%. What's been driving that downtick, and do you think you can get back to 97%, and if so when?
Hi, Lorne. As far as the occupancy rate goes, we're happy where we are. So, fully occupancy for us is in that 98%, so between 96%-97% is essentially at full occupancy, you've got a little bit of ebbs and flows. There was one location with one tenant that did vacate. We were anticipating on expecting it, we're actively working to backfill it. And so, as far as occupancy goes, we're happy. And then if we start to look at the renewals and what's happening, we've got renewal growth of 5.8% when you look at the steps on those renewals, which we're pleased with.
What we're even more pleased with is the new leasing and committed leasing activity that we got going on. And so, our in-place rental rate is about $17.80. The new leases that came online are just shy of $20.00, and the committed leases are in the $26 range. So, you can see the growth that we have available in the portfolio. And our leasing and ops teams are focused on ensuring that we maintain a healthy occupancy, but just as importantly making sure that we maintain a healthy economic occupancy.
Fair enough, I guess like the hotel, you never want to be 100% full. On the industrial portfolio, I know it's not a huge chunk, but if I read correctly, same-property NOI was down about 3% in the quarter. Could you maybe give some color around what happened there and what your short outlook is for the balance of the year?
I'm going to have to get back to you on that Lorne; I don't have a note on that. I'll get back to you.
Fair enough. And then just one, ticky-tacky one on the Shell deal or on the gas station deal, that $16 million or $17 million, that won't hit FFO, it'll be kind of treated as an acquisition, correct?
Correct.
Okay, perfect. Thank you so much. That's all for me.
Thanks, Lorne.
Thanks, Lorne.
Your next question will come from Sumayya Syed at CIBC. Please go ahead.
Thanks, and hi, everybody. Just wanted to first touch on the renewal growth rates across your three market segments, and [want to get that to the] (ph) long-term trend. Should we be seeing higher spreads in VETCOM, then major, and then low and rest of Canada? Just want to figure out how much geographic differences would be influencing your rent growth.
Hi, Sumayya. The outlook is -- yes, VETCOM is driving higher rental than the rest of Canada, although we're getting good renewals lists in the rest of Canada, the dollar value difference is noted in our MD&As, and so, yes, there is -- VETCOM does have a healthier spread. There's just greater competition in VETCOM, and so there's more appetite for competition there. While the rest of Canada may not have those high numbers of growth rate, they are exceptionally stable, and so, most of our rest of Canada assets are really main and main. And they are grocery-anchored, with very healthy, stable [CRUs] (ph) that support the community. So, we're happy with the portfolio mix. It is allowing us for that stable, consistent delivery quarter-over-quarter.
Thank you for that. And then just to touch on your non-major developments. I'm wondering what will be the range of yields you expect for those smaller projects.
So, the non-major developments are -- have really good risk-adjusted returns. We haven't disclosed what they are. Again, we'll be enhancing some of our disclosure over the coming quarters. They are very much well-known projects where you can get in and get out, Sumayya, in about 18 to 24 months. They are predominantly [LUIs] (ph), so intensification of existing sites. They are expansions and conversions with grocery anchored, and really well supporting through our development platform supporting Empire. So, I don't believe we've given disclosure on those yields, but that is something that we're working to bring forward over the next couple quarters. I'm really looking forward to being able to share more of that with you and the others.
Okay, thank you. We'll stay tuned, and I'll turn it back with that.
Your next question will come from Mario Saric at Scotiabank. Please go ahead.
Hi, good afternoon.
Hi, Mario.
Just maybe a couple of clarification questions, the $2 million of revenue from management and developing services during the quarter, should we think of both that as being kind of a one-time item or is that something that you think could become more recurring than it has been in the past?
It's both. So, if we look at what's happened on behalf of Empire, we were able to manage the fixturing lease holds on a few CFC projects. And through that they are one-year fixturing period, so they're a long fixturing period, and we're able to use the expertise that we built up on our construction and development team, and navigate that on their behalf. And we're looking to continue to leverage that skill set in the future as we provide those services and oversights to other Empire projects. It's building on a bit of a synergistic platform. You could do it through conversions, modernizations, new stores, industrial. So, we are looking to build upon that.
Okay, but the revenue is generally recognized upon completion as opposed to like a percentage of completion over time, so that we shouldn't expect a similar $2 million revenue item in Q3 or Q4, for example?
Yes, I would not expect that for the back-half of this year. The $2 million that we brought in was at the completion of the project. But that's not to say that that's the formula we're going to use going forward. I think there is a great opportunity to leverage that as we leverage this synergistic platform that we're trying to create here, that you can start to bring them in at a consistent basis, and rely on them.
Got it, okay. Mark, just coming back to Bronte, you mentioned that you made some adjustments in the past couple months, and it apparently has resulted in some pretty strong occupancy gains. Can you just give a bit more color in terms of what adjustments you made and the implication?
Yes, absolutely. All the credit goes to our leasing team. They were hands-on onsite. We made an adjustment to the onsite leasing team that was there. We made adjustments to how we marketed the asset, so very much getting very focused in on the local community, and very focused in on a view of who were the renters and who was coming in to the asset, and really targeting more of that design. We built in some dynamic rental modeling so that we understood sort of what was ebbing and flowing. I'm really, really pleased with the momentum that we built up over the last three or four months. The team has just done an exceptional job.
We're still running 10% above performance, so we're really happy with how we've been able to maintain that, and so, really looking forward to hopefully being able to share the continued momentum in the quarters to come. But so far, so good, Mario; I'm very happy.
Okay. And maybe for Clinton, I'm not sure if you can answer this, but if we just step back and just coming back to Tal's question on the FFO. Not so much timing, but if we step back and if we look at the invested capital at the end of the day, for Bronte, Le Duke, and Davie, the interest environment has changed quite a bit in the past six to 12 months. What's a reasonable FFO yield that one could expect on that invested capital at the end of the day upon stabilization or when --?
Yes, I think what you're referring to -- yes, so I'd say Bronte is the one that has the floating rate debt, Mario. And I'm looking forward to getting the CMHC finalized. We've submitted, we're in the process to get fixed rate financing, and that right now is floating. So, it is hurting in the near-term, but we will certainly, with the CMHC financing, bring in more cost-effective funding. And all these are residential, Mario, so they do get CMHC funding. So, I think when you think long-term, CMHC financing, I think the original assumptions on our yield on cost, we would have disclosed previously I still believe are reasonable assumptions.
Okay. Sorry, on a levered basis or unlevered basis?
Well, on a levered basis -- I would say on an unlevered basis the same, and on the levered basis, I mean, you look at the long-term rates, where they are today, and we've already locked in two of the major developments, so it's the Bronte one that has some volatility, so -- but I would say -- I don't want to answer futuristically because I don't where interest rates will land, Mario. But I think we'll be overall very happy with these projects.
Okay. And then just last question, another clarification on the 6% to 8% return on the Shell stations. Just want to clarify that was an unlevered return as opposed to levered? So, effectively, we should think about it as a 6% to 8% cap rate acquisition?
Yes, that's fair. Yes.
Okay, great. Thank you.
[Operator Instructions] Your next question will come from Jenny Ma at BMO Capital Markets. Please go ahead.
Thanks, good afternoon.
Welcome back, Jenny.
Thank you. Most of my questions have been answered, but I just wanted to follow up on the management development services fee income. Was that related to mostly CFC 3 or the CFCs across Empire's entire portfolio?
Hi, Jenny. That is related to CFC 2 and CFC 3 only.
Okay. So, if we think about the opportunity, could you apply these services to the other properties within Sobeys' portfolio and earn fees from it? And then maybe as an extension, is it something that you'd contemplate for assets that are outside of the Crombie Empire network? I'm just trying to think of the opportunity of what this fee income could become over the longer-term.
Yes. And we're absolutely in the early innings of this. The platform we're trying to build on is with Empire, and it starts with the CFC 2, CFC 3. And absolutely, it can be extended to the entire platform that we have with Empire as we look at modernizations, conversions, new store builds, enhancements to other CFCs or extensions of their industrial platform. Beyond that, we're just focused in on what we can offer to that Empire partnership. Can it stretch beyond that? Time will tell, but for now we're pretty happy with where we're going with it. And we do anticipate and are working towards making sure that we can offer this on a continuous basis.
Okay. And if I heard you correctly in terms of how to think about this cash flow, the $2 billion is probably a high watermark over the near-term, right? And then it's just going to be kind of chunky here and there coming in, but not to the same extent as we saw in Q2?
That's right. That's exactly right.
Okay, great. Wanted to turn to the Sobeys initiatives that you guys do every year, I know, a while ago, you sort of guided to doing about $100 million every year at a 6% to 6.5% return. Is that something that you're still committed to in the current interest rate environment? I presume there's still plenty of opportunities within the Sobeys portfolio for these improvements.
Yes, so it sort of comes back to our deployment of capital and where we focus our efforts. And for us, we have a great advantage in that we invest into major developments and non-major developments. Most of the items that you're referring to would be non-major, they're in that 12 to 18-month range, it's modernizations, conversions, new stores. And we will absolutely continue to invest in that. And Empire had announced as part of their growth strategy, to continue to renovate and enhance 25% of their assets. And so, we're going to be a part of that program with them. And so non-major is a part of the total envelope of capital that we look at, and the returns are in that range.
Some might be higher, some might be on the low end, but there -- we're always working on the range, and they're always working on what's in the environment today, what are we up against in each market.
Okay, great. That's very helpful, thank you.
Thank you.
Your next question will come from Pammi Bir at RBC Capital Markets. Please go ahead.
Thanks. Hi, everyone. Just really one question for me, and I do apologize if this was answered earlier, I'm just not sure I caught it. But can maybe just expand on the employee transition costs that hit the quarter? And then just wanted to confirm that all of that was fully captured in Q2, and that there is nothing else beyond that? Thanks.
Yes, I will confirm that it was fully captured in the quarter. And as Clinton mentioned in the prepared remarks, of the $7.2 million of the employee transition costs, $4.6 million of it relates to unit-based compensation. And I just want to add on to that, when we've given color on our overall G&A on an annual basis, and we're in that 4% range, which is what we've given guidance on historically excluding base comp. And we're expecting that we'll fall in that range again this fiscal year.
Thanks very much.
At this time, we have no further questions. So, I will turn the conference back to Ruth Martin for any closing remarks.
Thank you for your time today. And we look forward to updating you on our third quarter call, in November.
Ladies and gentlemen, this does concludes your conference call for this morning. We would like to thank you all for participating, and ask you to please disconnect your lines.