CT Real Estate Investment Trust

TSX:CRT.UN

Earnings Call Transcript 2018-Q1

[Operator]

Good afternoon, my name is Bretta, and I will be your conference operator today. At this time, I would like to welcome everyone to CT REIT's First Quarter Earnings Results Conference Call. [Operator Instructions] The speakers on the call today are Ken Silver, Chief Executive Officer of CT REIT; Louis Forbes, Chief Financial Officer of CT REIT; and Kevin Salsberg, Senior Vice President of CT REIT. Today's discussion may include forward-looking statements. 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 CT REIT's public filings for a discussion of these risk factors, which are included in their 2017 MD&A and AIF, which can be found on CT REIT's website and on SEDAR. I would now like to turn the meeting over to Mr. Ken Silver, Chief Executive Officer of CT REIT. Ken?

[Kenneth Silver, President, CEO & Trustee]

Thank you, operator. And good afternoon, everyone. We're very pleased to welcome you to CT REIT's First Quarter 2018 Investor Conference Call and to share with you the results of another strong quarter. We continue to execute on the strategies that complement the core portfolio of Canadians Tire store properties, delivering attractive and reliable results, quarter in and quarter out. The highlights of the quarter include the completion of the acquisition of a portfolio of properties from RioCan that we announced late last year as well as a new round of investments related to Canadian Tire that will be completed this year and next. Our relationship with Canadian Tire and our ability to work with the Canadian Tire team as they plan their store networks provides not just a source of growth but great visibility and predictability to that growth. The transition from a Sears Canada tenancy to a CTC tenancy in our major distribution center property in Calgary is underway and is reflected in our reported results. In acquiring the Sears property in 2016, we understood the possibility of getting the building back and knew that if we did we would go through a transition period, that period now being this year. We're delighted to have this asset and the surrounding industrial properties in our portfolio, and events have unfolded as we had hoped. Another highlight of the quarter was the $200 million unsecured debt offering we completed in January. In keeping with our conservative financial management, we turned out our existing shorter-term floating rate debt for a fixed rate offering with a term of nearly 10 years. The offering was extremely well received, significantly oversubscribed and we are very pleased with the coupon achieved. We continue to maintain a weighted average term on our debt of 10 years, nearly double the average of our peer group and reflective of our conservative approach to managing our risk profile. And last but not least, beginning with our January distribution, we implemented a 4% increase, which now equates to a distribution of $0.728 on an annual basis. At this point, I will now turn the call over the Kevin Salsberg, our Senior Vice President of Real Estate, to discuss our leasing investment and development activities. Louis Forbes, our Chief Financial Officer, will then briefly review the financial aspects of the quarter, and I'll wrap things up before turning the call over for questions. Kevin?

[Kevin Salsberg, Senior Vice]

Thanks, Ken, and good afternoon. We're pleased to announce 4 new investments this quarter for an aggregate total investment of $35 million. These new projects are comprised of 2 vend-ins, 1 intensification and 1 new development where we will be building a 65,000 square-foot Canadian Tire store on a piece of land that we acquired from a third party located in Grand Falls-Windsor, Newfoundland. These investments when completed will result in an incremental 191,000 square feet of gross leasable area being added to our portfolio and are expected to earn an average going-in cap rate of 6.68%. As Ken mentioned, we have also completing the acquisition of the 2 remaining RioCan properties, which are located in Collingwood and St. Catharines, Ontario. Both are Canadians Tire anchored, and these investments have increased our GLA by an additional 351,000 square feet. As previously disclosed, the investment made by the REIT in these 2 assets was approximately $66 million. In the first quarter, we also completed the redevelopment of an existing Canadian Tire gas bar in La Sarre, Québec. As outlined in our earnings release, CT REIT also made a change to the development plan and timing for the Sherwood Park North property in Alberta. The initial plan was to build a 93,000-square-foot Canadian Tire and a free-standing 20,000-square-foot Mark's store. The revised plan for this site is to now develop a new 120,000-square-foot Canadian Tire store only, with construction expected to be completed in Q4 2019. At the end of the first quarter, CT REIT had 13 properties under development, representing a total committed gross leasable area of 747,500 square feet and a total committed investment of $150.8 million upon completion. As at March 31, 2018, on a committed basis, our portfolio is 98.7% occupied. Canadian Tire has taken occupancy of the former Sears distribution center in Calgary, and the leasing efforts for the smaller property at 11 Dufferin Southeast that CTC formerly occupied are underway. We're pleased with the initial response from the leasing market and continue to assess options for this property as well as the adjacent lands that we acquired at the end of last year. Beyond what was completed during and subsequent to Q1, we continue to make progress as expected on the balance of our develop projects as detailed in our latest MD&A. With that, I'll turn it over to Louis for a review of our financial results.

[Louis Marie Forbes, Senior VP & CFO]

Thanks, Kevin. In Q1, 2018, we reported FFO per unit of $0.277 as compared to $0.279 per unit in Q1 of 2017, a decrease of 0.7%. AFFO per unit was $0.233 as compared to $0.227 in the comparable period, representing a 2.6% growth rate. Net operating income was $84.4 million, increasing 6.6% over the $79.2 million of NOI reported for Q1 2017. This growth was primarily driven by acquisitions, the completion of income-producing properties which were under development in the prior year and contractual annual rent escalations. The same-store growth of 1.5% and same-property growth of 1.7% were driven by average annual rent escalations of 1.5% contained in the Canadian Tire store and CTC distribution center leases, which are generally effective January 1; the recovery of capital expenditures and the related interest earned. There were 2 unusual components of same-store growth this quarter. Our reported results reflect the loss of rent effective mid-January from the vacancy at the former Sears DC at 25 Dufferin Place, Calgary. This event hurt cash NOI in Q1 of 2018 by approximately $1.4 million. The other adjustment relates to prior period rent charges at 2 of our properties and amounts to approximately $700,000. This partially offsets the impact of Sears' departure. If we were to adjust the reported same-store NOI for these 2 components, then same-store NOI growth would've been 2.3%. Of less importance but to offer a full explanation, the REIT has provided $450,000 in Q1 for the write-off of previously recorded straight-line rent from Sears. This provision affects revenue, net income and FFO but has had no impact on reported FFO or NOI metrics, as their calculation excludes straight-line rent. While we are talking about Sears, there are a couple of further points we would like to make. Firstly, we expect NOI in the second quarter of this year will be negatively impacted by another approximately $750,000 for the transition from Sears to CTC. Thereafter, we expect a smaller drag on our results going forward until such time as we lease up the vacant space at 11 Dufferin Place Southeast. G&A expenses as a percentage of property revenue approved -- improved to 2.8%, 60 bps lower versus Q1 2017, which was at 3.4%. G&A expenses decreased 14.4% versus Q1 2017, primarily due to the impact of fair value adjustments on personnel and board compensation expenses. Interest expense increased by $2 million or 8.3% compared to Q1 of the prior year. This was principally the result of increased borrowings but also because of greater use in 2018 of more expensive longer-term debt. In February, CT REIT issued $200 million in debentures having an original term of 9.8 years and a fixed-rate coupon of 3.87%. This had the effect replacing short-term and expensive debt with longer-term fixed-rate debt. While this is impacting our earnings growth in the short term, the issuance ultimately leads to improved liquidity and a stronger balance sheet in the long term. This most recent issuance illustrates a couple of points about our debt strategy. The chosen term, 9.8 years, is consistent with our sector-leading weighted average term to maturity of 10 years. The coupon for the chosen term was, as typical, more expensive than a shorter-term debenture would've been but less so than some other occasions in the market, influencing our decision to go for the longer tenor. Additionally, the longer-term chosen provides flexibility for the REIT with respect to future borrowings and allows us to consider a broader range of potential terms in response to market conditions at that future time.The REIT recorded a fair value adjustment of $13.3 million for the first quarter of 2018. Valuation metrics used were virtually unchanged from those used in our December 2017 reporting. With respect to the balance sheet, we continue to maintain a strong financial position. At March 31, the REIT's indebtedness ratio remained at 46.7%, unchanged from last quarter. We also have approximately $265 million available on our credit facility as well as over $12 million of cash, which puts our balance sheet in a strong and liquid position. Debt as compared to earnings before our interest, taxes and fair value adjustments was 7.58x, slightly lower than the 7.62x recorded in Q4. Also, as at March 31, 332 of the REIT's assets were not encumbered, representing approximately $5.4 billion or 98% of our assets. As at March 31, only 2.7% of the REIT's debt bears interest at floating rates, reflecting the recent fixed-rate debt issuance. In terms of interest coverage, the ratio was at 3.31x in the first quarter, which was slightly lower compared to the prior year value of 3.43x. The decrease, which we do not view as material, is mostly the result of interest and financing charges increasing at a rate larger than that of income before interest, taxes and fair value adjustments. Our AFFO payout ratio this quarter was 78%, slightly higher than the 77% ratio in Q1 of 2017. The change in ratio reflects a more moderated growth in our AFFO per unit. Canadian Tire represents 92.6% of our annualized base minimum rent on a committed basis, and they occupy 94.5% of CT REIT's GLA. All of these metrics are largely unchanged from a year ago. I would also like to take a minute to speak to the trend in our book value per unit. At March 31, 2018, the book value per unit was $13.54, representing 1.1% growth over the book value of $13.39 reported at the end of the fourth quarter 2017. The following are contributing factors to this increase: a modestly higher value for the income-producing properties due to ongoing growth in cash flow, resulting from the annual rent increases; and retained adjusted funds from operations. On a trailing basis, combining distributions and book value per unit growth, CT REIT has since IPO consistently delivered a total annual return excess of 10%. With that, I'll turn it back to Ken.

[Kenneth Silver, President, CEO & Trustee]

Thanks, Louis. As I said at the opening, we're very pleased with the quarter. The only exception to that would be our unit price. On our last conference call, I pointed out that we were trading at a discount to NAV for the first time in our history, and this condition is not yet reversed. Given recent M&A activity in the REIT sector, we believe that our relative positioning has only gotten stronger, that our reliable growth, conservative balance sheet, investment-grade credit rating and potential for distribution growth provide today more than ever a unique set of positive attributes for our investors. We are confident in our ability to deliver and look forward to continuing to add to our track record. And now operator, I'll turn the call back to you for any questions from our listeners.

[Operator]

[Operator Instructions] The first question is from Sam Damiani of TD Securities.

[Sam Damiani, Analyst]

First off -- just first off just on the Dufferin District, can you provide a little bit of color on what you're sort of seeing or maybe Kevin did? But wonder if you can provide a little more sort of guidance as to when we should expect that backfill to be leased up? And the 5500 Dufferin Boulevard property, has that been leased?

[Kevin Salsberg, Senior Vice]

So I'll start with the 5500 -- sorry, Sam, it's Kevin. The 5500 Dufferin Boulevard property was leased effective the date we basically got the building back. The transportation company that occupied it stepped up and actually recently exercised an option to take additional lands. So that one was taken care of right away. With respect to 11 Dufferin, Canadian Tire remains in the building until mid-August. So we really just started our leasing efforts. And so far, the interest has been good. While I can't say exactly when the space will be occupied, we are positive about the prospects. We've noted there's not a lot of large-format industrial vacancies in Calgary right now, which bodes well for our asset. And we're seeing vacancy rates generally in Calgary industrial declining to down about 1.5% from Q1 of 2017. So hopefully, all that translates into a positive outcome for our vacancy.

[Sam Damiani, Analyst]

Okay, so just to -- just a follow-up there. Do you have a pending -- pending that vacancy to occur in August then when, I guess, CTC pulls out of the 11 Dufferin asset?

[Kevin Salsberg, Senior Vice]

Correct. We're reporting occupancy on a committed basis, so it's reflected in the numbers currently. But yes, we will have an actual vacancy once they leave.

[Sam Damiani, Analyst]

Okay. And so maybe over to Louis. You mentioned there would be a net negative -- or at least a negative adjustment to Q2 NOI of $750,000. And so I guess, there would be a further negative adjustment when CTC leaves the other Dufferin Place property?

[Louis Marie Forbes, Senior VP & CFO]

Well, yes and no. So let me be clear. You said further negative. CTC started paying rent the beginning of May for the larger Sears DC space that they occupied. And at that time, their responsibility for base rent at 11 Dufferin fell away. They're responsible for the operating expenses in both buildings until August. And then in -- at the beginning of August, their responsibilities for their operating expenses and their possession of 11 Dufferin cease at that time. So when I mentioned $750,000 as the Q2 hit, that included the large Sears space as vacant, nobody paying rent for the month of April; and then the loss of the base rent on the smaller building, 11 Dufferin, for May and June. And that's all together in the $750,000. I think the run rate loss at 11 Dufferin on a monthly basis will be about $120,000, $130,000 a month once it's vacant.

[Sam Damiani, Analyst]

Okay. All right, that's clear.

[Louis Marie Forbes, Senior VP & CFO]

A lot of detail but...

[Operator]

The next question is from Jenny Ma of BMO Capital Markets.

[Jenny Ma, Analyst]

My questions on Calgary, I think, have more or less been answered. So the small piece, the 5500 Dufferin, there was no interruption in rent, is that correct, just the new tenant leased it up as of February?

[Kevin Salsberg, Senior Vice]

That's correct. The only thing to note is the new tenant's paying a higher rent than the old tenant relative to that building, and they have also taken some additional lands that will come on stream once created, probably mid to end of July. And the additional rent that their paying related to those additional lands, I think, is incorporated in Louis's overall run rate number going forward.

[Jenny Ma, Analyst]

Okay, okay. Got you. And then just a clarification question, Louis. On the $700,000 of the adjustments to the prior-period rent, that's a onetime expense, correct -- or, sorry, a onetime income?

[Louis Marie Forbes, Senior VP & CFO]

Yes, that's correct.

[Jenny Ma, Analyst]

Okay. So then after we adjust for the DC here, we should have a pretty good run rate for Q2, Q3 going forward, nothing else onetime in nature?

[Louis Marie Forbes, Senior VP & CFO]

Correct.

[Operator]

The next question is from Pammi Bir of Scotia Capital.

[Pammi Bir, Analyst]

I think most of my questions are answered. Just maybe one last one with respect to the Sherwood Park property. Can you just elaborate there on what motivated the change and why the extended time line for the redevelopment versus the prior expectation?

[Kevin Salsberg, Senior Vice]

Pammi, it's Kevin. Originally, as I mentioned, Canadian Tire planned to do a 93,000-square-foot store. In reviewing the market generally, they decided a larger store was warranted. So I think that decision reflects their confidence in the market. The change in timing relates to municipal approvals that they had to go back and get for the amended store size. So they had sought the approvals, received them, then had to go in -- back in with the same plan amendment, so hence the delay.

[Operator]

The next question is from Sumayya Hussain of CIBC.

[Sumayya Hussain, Associate]

Just on the increase in the normalized CapEx reserve this quarter, was this done to reflect some of the more recent acquisition? Or did you guys kind of look at the overall mix of the portfolio and just made the decision more so from that perspective?

[Louis Marie Forbes, Senior VP & CFO]

Sumayya, it's Louis speaking. The reserve increase, I think, averaged about $0.03 a square foot of an increase. It does reflect in part that the nature of the portfolio has changed a bit, although that's small within the overall portfolio. It also acknowledges a little bit of the cost inflation in terms of getting things done, like it costs more to pave this year than it did last year.

[Sumayya Hussain, Associate]

Okay. And just on the investments announced in the quarter, just roughly speaking, how would the cap rates on the vend-ins compare to the Grand Falls acquisition? And can you also remind us, roughly, the yield you guys are targeting on intensification?

[Kevin Salsberg, Senior Vice]

So your first question was what are the -- what was yield on the 2 vend-ins relative to the new development? So did I get that right?

[Sumayya Hussain, Associate]

Yes.

[Kevin Salsberg, Senior Vice]

I think they're pretty comparable in terms of -- I'd have to go back and check the details. We can circle back with you on that, but I think they're mid to high 6s, generally speaking, probably more in the mid-6 ballpark.

[Operator]

The next question is from Tal Woolley of National Bank Financial.

[Tal Woolley, Research Analyst]

I just wanted to ask a question about some of your comments from the AGM this morning, Ken. You had made -- discussed mixed-use development and how you were sort of interested to see how some of your peers proved out that strategy going forward. And I guess implicit sort of in that statement, maybe or maybe not, is that you sort of have a bit of a different view about what that model will bear in terms of returns over time. Is there any particular that your sort of waiting to see as you go forward as you see some of these projects start to come to fruition?

[Kenneth Silver, President, CEO & Trustee]

Tal, I think there's 2 aspects to it. One is -- firstly, we're in an extremely fortunate position in that we have such solid growth and visibility to the growth that we have that we can continue to pursue what I would describe as a low-risk strategy that we think should be attractive to investors going forward. So that's sort of one component of how we view what I would describe, and I think most people would view, as higher-risk development activities. In view of -- our view on those activities is there's no question that, like others, we have intensification opportunities in the portfolio, but we are interested in seeing how exactly these unfold from the perspectives of the kind of achieved returns that you can [Audio Gap]. And so we have the luxury, really, of waiting to see, as I had described it this morning, as seeing the business case proved out.

[Tal Woolley, Research Analyst]

Okay. And then Louis, sorry, you might have touched on this in an earlier answer. But just to make sure I've got it through my thick skull, the straight-line rent number, the adjustment this year jumped down. Is that because of the reversal of the prior-period booked on the DC?

[Louis Marie Forbes, Senior VP & CFO]

Tal, that's perceptive question. It would drop for 2 reasons. It would generally drop -- the run rate would drop in Q1 of every year. And when I say every year, at IPO we had a weighted average lease term of about 16 years, not quite 16 years, which meant that the straight-line rents dynamic on the 255 buildings we started with would flip at year 8. So the straight-line rent adjustment should come down about $3.5 million every year for 8 years. And then it turns and becomes positive adjustment and grows in the opposite sense. So that is affecting Q1. But also, the Sears comment I made about straight line, which was about $450,000, I said that also affected Q1. So -- and we don't expect that to repeat in Q2. So the straight-line rent adjustment in Q2 should be bigger than the Q1 adjustment by $450,000 for that reason.

[Operator]

[Operator Instructions] The next question is from Sam Damiani of TD Securities.

[Sam Damiani, Analyst]

The other question I wanted to follow-up on, Ken, was just on -- with the 10-year bond yield, at its highest at about 4 years, how are you looking at cap rates and yields on transactions with CTC in the light of the relatively high interest rate we're in today. The consensus is we're going to further be in it over the next couple of years.

[Kenneth Silver, President, CEO & Trustee]

Sam, we review each transaction we do with Canadian Tire. We do appraisals. We benchmark against other transactions that we've done. We look at what's going on in the marketplace. So -- so far, we haven't seen really a change in the pricing. Nothing material really to report to you, but it's just something that we would continue to monitor on an ongoing basis.

[Operator]

As there are no further questions at this time, I will turn the call over to Ken Silver, Chief Executive Officer, for any closing remarks.

[Kenneth Silver, President, CEO & Trustee]

Thank you, operator, and thank you all for joining us today. We expect our second quarter results will be released the first week of August, and we look forward to speaking with you then. Thanks.

[Operator]

Thank you. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation.