CT Real Estate Investment Trust

TSX:CRT.UN

Earnings Call Transcript 2023-Q1

[Operator]

Good morning. My name is Maud, and I will be your conference operator today. At this time, I would like to welcome everyone to CT REIT's Q1 2023 Earnings Results Conference Call. [Operator Instructions]

The speakers on the call today are Kevin Salsberg, President and Chief Executive Officer of CT REIT; Jodi Shpigel, Senior Vice President, Real Estate; and Lesley Gibson, Chief Financial Officer.

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 2022 MD&A and 2022 AIF, which can be found on CT REIT's website and on SEDAR.

I will now turn the call over to Kevin Salsberg, President and Chief Executive Officer of CT REIT. Kevin?

[Kevin Salsberg, executive]

Thank you, Maud. Good morning, everyone, and welcome to CT REIT's first quarter investor conference call. I am pleased to report that 2023 is off to a great start for CT REIT. Despite the uncertainty that continues to permeate the macroeconomic environment, our resilient portfolio and consistent growth were once again on display in Q1.

Lesley will provide more details in terms of our results, but I want to call out a few key metrics to highlight just how strong the quarter was for us.

Diluted AFFO per unit growth on a year-over-year basis came in at 5.8%. Same-property NOI increased by 4.5%. Our indebtedness ratio remained at a very conservative 40.7%. And we lowered our payout ratio even further to 73.8%.

A combination of a strong growth and a conservative financial management gave our Board the confidence to approve a distribution increase of 3.5% that will be effective with the July payment, the tenth increase since our inception. On a cumulative basis, CT REIT has raised its distributions by 38.2% since our IPO in 2013, which is a true testament to the REIT's solid performance and success over the years.

As part of our better connected real estate strategy, we continue to work alongside Canadian Tire, our largest tenant and majority unitholder to unearth enterprise-wide opportunities to create value within our collective portfolios. And these efforts continue to take shape and contribute to our financial results. For example, the Canadian Tire store intensifications completed over the last 12 months have meaningfully driven same-property NOI growth this quarter, and we are fortunate to have over 20 store expansion projects currently in the pipeline, which are set to deliver nearly 700,000 square feet of incremental gross leasable area over the next 2 years.

Opportunities to surface embedded value in some of our urban assets by seeking density permissions, funding other Canadian Tire retail and supply chain investments, and developing and advancing our ESG strategies are all ways that we work closely together with Canadian Tire.

Our 350,000 square-foot distribution center development in Calgary, Alberta, is yet another great way -- example of how we collaborate with CTC to create better connected opportunities. We are proud to announce last night that this project has now achieved the Zero Carbon Building Design Certification from the Canada Green Building Council. Not only does this development further expand CT REIT's industrial holdings and our ventures into responsible development, but it is also expected to increase the efficiency and sustainability of Canadian Tire Supply chain.

We are very excited about what the future holds, and CT REIT continues to be a durable, reliable and growing choice for investors seeking our dynamic combination of growth and stability. Working closely with Canadian Tire, we have great opportunities to leverage our unique relationship to the benefit of our unitholders, and I'm proud of the work that our teams have done together to convert these opportunities into meaningful results.

And with that, I will turn it over to Jodi and Lesley to walk you through an overview of our investment, leasing and development activities as well as our financial results. Jodi?

[Jodi Shpigel, executive]

Thanks, Kevin, and good morning, everyone.

As highlighted in our press release yesterday, we were pleased to announce one new investment this quarter totaling $6.6 million. Once completed, this intensification will add an incremental 22,000 square feet of GLA to the portfolio at a weighted average cap rate of 6.37%. We also completed one $13 million project and added 39,000 square feet of GLA to the portfolio from the development of mid-box and commercial retail space adjacent to the Canadian Tire store that we built last year in Moose Jaw, Saskatchewan.

At the end of the quarter, CT REIT had 27 properties that were at various stages of development with 11 projects currently expected to be completed by the end of 2023, which is consistent with our development pipeline over the past several years.

These projects represent a total committed investment of approximately $389 million upon completion, $140 million -- $141 million of which has already been spent and $123 million of which we anticipate will be spent in the next 12 months.

Once built, these projects will add a total incremental gross leasable area of nearly 1.3 million square feet to the portfolio, 99.4% of which has been pre-leased at quarter end.

We were also pleased to have completed two Canadian Tire store lease extensions in Q1.

At 8.5 years, the weighted average lease term for our portfolio continues to be one of the longest in the sector, and our portfolio remains 99.2% occupied, in line with last quarter.

As we noted on our last call, we had one Bed, Bath & Beyond within our portfolio that was located in our Collingwood Shopping Center. The Bed, Bath & Beyond lease has now been assigned to winners pursuant to the court-ordered process. This location is adjacent to our current winner store, and it is expected that they will use the former Bed, Bath & Beyond premises for their new home -- for their HomeSense banner. We are pleased that this has come to a resolution and that the center continues to attract and be occupied by high-quality retail tenants.

As Kevin highlighted, we achieved a significant milestone at our Calgary distribution center by obtaining our Net Zero certification, one of the first industrial developments to receive such an accreditation to date. Our leasing, operations, development and construction groups went to great efforts to design and construct this building so that it met the rigorous standards of the Canada Green Building Council's Zero Carbon Building Design criteria, which include thermally improved building construction, increased air tightness, a building-wide geothermal heating and cooling system, and roof-mounted solar panels.

Once the building is operational for a predetermined period of time, we will be applying for and expect to receive the zero carbon building performance certification, which is based on the building producing as much energy as it consumes. I am proud of the accomplishments of our cross-functional teams and the positive impact that this project will make.

And with that, I will turn it over to Lesley to discuss our financial results. Lesley?

[Lesley Gibson, executive]

Thanks, Jodi, and good morning, everyone. As Kevin highlighted, we were very pleased with the solid results delivered by the REIT again this quarter. AFFO per unit on a diluted basis was very strong, up 5.8% to $0.294, which is primarily driven by growth in AFFO exceeding the growth in weighted average diluted units outstanding.

Diluted FFO per unit this quarter was $0.32, up 4.2% compared to $0.307 in Q1 of 2022. Net operating income of $107.4 million, an increase of 4.5% or $4.6 million compared to Q1 of 2022.

Same-store NOI grew by $2.5 million, or 2.5%, as a result of the contractual annual rent escalations, contributing $1.8 million, including the 1.5% average annual rent escalations included in the Canadian Tire leases. The balance of the growth primarily from continued recovery of capital expenditures and interest earned on the unrecovered balance, which contributed approximately $1 million to NOI in the quarter.

Same-property NOI for the quarter grew $4.6 million, or 4.5%, as a result of increase in same-store NOI as well as $2.1 million in NOI from the intensifications completed in both 2023 and 2022.

Excluding fair value adjustments, G&A expense as a percent of property revenue was 3.0% in the first quarter, which was slightly less than the same period in the prior year of 3.2%.

The fair value decrease of approximately $4.2 million was mainly driven by changes to underlying investment metrics in our industrial portfolio, partially offset by cash flow growth during the quarter.

The overall terminal cap rate for our portfolio increased 2 basis points and overall discount rate by 3 basis points.

Distributions in the quarter grew 2.3% over the same period last year to $0.217, resulting in an AFFO payout ratio of 73.8%. As Kevin already mentioned, we announced a 3.5% increase to the monthly distribution effective with July 2023 payment to unitholders. This is the tenth increase in as many years, and we're pleased to have been able to raise our distributions at least once per year since inception.

Turning now to the balance sheet. Our debt metrics continue to remain strong. The interest coverage ratio at 3.70x improved from the first quarter of 2022. CT REIT's indebtedness ratio of 40.7% was broadly in line with last quarter.

With the current interest rate environment expected to remain elevated for at least the balance of the year, we're pleased to be presently insulated from refinancing risk, as we have no debt scheduled to mature until 2024 and no public unsecured debentures coming due until 2025.

Our liquidity remains strong with $135 million available through our committed credit facility and a further $300 million available on our uncommitted facility with Canadian Tire.

And with that, I will turn the call back to the operator for any questions.

[Operator]

[Operator Instructions] Our first question is from Lorne Kalmar from Desjardins.

[Lorne Kalmar, analyst]

Congrats on another solid quarter. Quick one for me. There is a little bit slower on the investment activity this quarter. Was that just a matter of timing? Or are you guys expecting a slower year just given the broader market volatility?

[Kevin Salsberg, executive]

No, I wouldn't read too much into it. I think it's somewhat seasonal in nature in terms of how we schedule the projects. Canadian Tire certainly remains committed to their better connected strategy. If you recall, component of that was investing $1.2 billion in the store and supply chain networks and improving the real estate. So we're still optimistic that the pipeline will remain robust. Obviously, this is a big quarter, so there's more or less to announce, and [ this would have to be a bit of a quiet improvement ].

[Operator]

[Operator Instructions] Following question is from Himanshu Gupta from Scotiabank.

[Himanshu Gupta, analyst]

Yes. Just on the IFRS valuation, I mean, do you think the impact of higher debt financing is now fully reflected on your discount rates or terminal cap rates, where it's been almost a year since we started seeing the spike in the bond yields?

[Kevin Salsberg, executive]

Certainly an interesting question. I can't say for certain. I mean we've seen pricing move a little. Obviously, retail has been a little less impacted than some other asset classes with positive leverage dynamics impacting our sector, which I think is a fairly good thing and has fared as well. To the extent we see more transactions, I think the last year has still been pretty quiet on a relative basis that could prove out to have further impacts on valuation, but that obviously remains to be seen. From our perspective, we think we're tracking to market at this point. Where market goes, obviously, is uncertain.

[Himanshu Gupta, analyst]

Fair enough. And are you seeing like return of transactions in the market? I mean it's been a slow second half. Are things finally picking up given that you're seeing some kind of stability in 10-year and 5-year as well?

[Kevin Salsberg, executive]

I would say it's been really lumpy. I mean a lot of fits and starts. Some things that have been marketed are unsold, some things that have gone through. There are a couple of transactions that we believe are in progress that we're following because I think they'll be -- they'll demonstrate kind of where the market is sitting for certain quality retail assets, but certainly not completed as of yet. So it's choppy.

[Himanshu Gupta, analyst]

Fair enough. Okay. And then just turning to Calgary Distribution Center. First of its kind, I think, mentioned by you, Net Zero Carbon Building. Are these building getting the rent premium over the traditional buildings out there? I mean just getting a sense of the market there.

[Kevin Salsberg, executive]

Yes. We've talked about it in past calls, Himanshu. There was a bit of a premium that we received and really what that worked out to be equal to was the utility cost savings that we were able to pass along to the tenant. I don't think there's necessarily a premium for the cachet of being a tenant in a net zero building. I think people are still focused on keeping occupancy costs as low as possible. But I think it is gaining importance to users, especially institutional quality users.

Our feeling though is the building is more valuable from a cap rate or discount rate perspective -- terminal cap rate perspective. For the fact that it is net zero, we think our buyers out there would pay a premium for it, and I think there's also some elements of future cost avoidance that could play into the valuation. So the combination of the slightly higher rent and the lower terminal cap rate certainly had an impact on our underwriting.

[Himanshu Gupta, analyst]

Last question is, I mean, obviously, you announced a distribution hike so congrats on that. Any thoughts on buyback as well? I mean the current price is below your book value, is that also becoming a priority here on the buyback side?

[Lesley Gibson, executive]

Himanshu, this is Lesley.

I think for the NCIB, really, it's opportunistic for us. So I think probably not at the current levels where we are. We continue to watch things every day, and if things get to a certain point, we could be in the market, but I don't think we're there today.

[Operator]

Our following question is from Tal Woolley from National Bank Financial.

[Tal Woolley, analyst]

I'm just wondering, a lot of your peers who have, sort of, gotten more into mixed-use development have effectively published a density estimate or pipeline that tries to give some sort of shape and dimensions to the development opportunity within their portfolios. Is that something you envision CT going down anytime soon?

[Kevin Salsberg, executive]

I think internally, we've done our own kind of scrub of the portfolio and where we think density opportunities are. I'm not sure that we've owned it on the exact amount of density that could be built. I mean you'll have to recall that our urban sites have operating Canadian Tire stores on them with long-term leases and renewal options. So we've always said we don't have a mixed-use residential development program. But that doesn't mean we shouldn't be investigating how to surface embedded value through the possibility of seeking those density permissions and working with Canadian Tire to determine if there might be a path. So I don't think we'll be publishing our density potentials in the near future. This will be a work in progress and probably a longer-term project for us.

But certainly, we also have great urban sites. I mean, about 45% of our portfolio would be in [ VECTOM. ] We have a lot of sites that are adjacent to subway infrastructure in transit. And certainly, we are commencing the work to think our way through what they could be and how we might get there, but I think it's a longer ways away for us.

[Tal Woolley, analyst]

Okay. And then last week, Lyons Group announced the potential for them to spin out REITs about 5.2 million square feet. I'm just wondering, like, strategically is that like the type of transaction that CT REIT would ever consider? I don't mean specifically Lyons, but if there were another retailer out there that maybe wasn't getting credit for the value of the real estate that they are owning that you could structure a relationship such that the properties could be vended into, maybe, an affiliated partner retail REIT?

[Kevin Salsberg, executive]

I mean, I think, the comment I would make on that, Tal, is we're always mindful of the opportunities that are out there and we'll evaluate each and every one of them as appropriate. I think it's great that there could be another net lease REIT out there to prove out how undervalued we are on a multiple basis, especially in relation to our peers in the U.S. Certainly, there's a lot of opportunity and a lot of interest and the net lease sector still commanding a premium from a pricing perspective. So more data points, the better for us.

[Operator]

Our following question is from Sam Damiani from TD Cowen.

[Sam Damiani, analyst]

I just wanted to start off by circling back on the fair values. Looking at the discount rates and terminal cap rates year-over-year, it looks like they're up less than 10 basis points. Just wondering if you could maybe shed some light on how that -- how you, sort of, triangulate that with the market rates we see out there and any big differences between the retail and the industrial properties within the portfolio?

[Kevin Salsberg, executive]

Yes. I mean, I could try to take that. Sam, I mean, we obviously have our fair value process in place, and we benchmark ourselves with as much data and market-based transactions as we can get our hands on. So what we're reporting reflects what we're seeing out there. We disclosed this quarter that a contributor to the small tick-up in -- in rates as it relates to our valuation and this quarter it was related to our industrial portfolio. We have long-dated leases in our industrial assets. Obviously, what we're seeing in the industrial transaction market is short duration leases where people think they can get at the rents and market are commanding a bit more of a premium relative to long-dated leases. So that's the movement -- or the contributor to the movement this quarter.

But we were pretty conservative over the last number of years in terms of writing the cap rates down, and I think we've treated the way back up similarly. So on a cumulative basis or an overall differential basis. I don't think the swings have been as volatile in our portfolio.

[Sam Damiani, analyst]

And just on the rent bumps in the quarter, Lesley, you talked about those. And I think maybe the line at least for me cut out a little bit. Was it $1.8 million of rent bumps in the quarter. Is that -- was that what you said?

[Lesley Gibson, executive]

Yes, Sam. It was about $1.8 million was the contribution for the same -- like the same -- same-store increase to NOI. It is the total NOI, yes.

[Sam Damiani, analyst]

Okay. And what portion of the overall Canadian Tire leases saw their rents bump in the first quarter versus, well, the bump in the latter part of the year?

[Lesley Gibson, executive]

I don't have that -- I don't have that split to hand, Sam.

[Sam Damiani, analyst]

Okay. Maybe just on the debt stock. If I'm not mistaken, the weighted average interest rate actually declined 9 basis points from year-end. What would have caused that?

[Lesley Gibson, executive]

One, we had in the quarter, we repaid the mortgage against Canada Square Property. That had a little bit of a higher weighted average interest rate than the other ones that probably be the one bit of a contributor. Then the other piece is really just the probably the weighting of what we have drawn on the line versus the rest of the portfolio that have remained stable.

[Sam Damiani, analyst]

Okay. And what remaining NOI is coming in from Canada Square that would fall away eventually over time?

[Lesley Gibson, executive]

As I mentioned before, I think the change in the leases for Canadian Tire, sort of, fell away begin January. There are some smaller tenancies in our 2200 Yonge Street building. over, I would say, the course of '23 into '24 as we approach development that, that will fall away. But it's a pretty small number relative to the other pieces at this point. So those will fall away in increments of 1,500 square feet over time in bits and pieces over the next probably 18 months.

[Kevin Salsberg, executive]

And we hope some of that would be offset by the re-leasing of the vacant space in 2018 that will probably take place, hopefully, in the next year or so.

[Sam Damiani, analyst]

Okay. Last one for me is just on the capitalized interest. It did jump a bit this quarter. Is that -- I guess, the new run rate, obviously, the transfer to PUD was 2,190 is, I guess the reason. Is that a good run rate going forward?

[Lesley Gibson, executive]

I think that's pretty fair, Sam. Year-over-year, obviously, the run rate had a different interest rate a year ago, and so we're still seeing a lot of that if you look quarter-over-quarter as well.

[Operator]

Our following question is from Pammi Bir from RBC Capital Markets.

[Pammi Bir, analyst]

Apologies if this was answered already because my line got disconnected. But just with respect to capital allocation. I think you mentioned some transactions in the market. Can you just talk about what you are seeing from an investment standpoint? Are there opportunities out there? Or is capital mainly earmarked for developments?

[Kevin Salsberg, executive]

I'd say it's slow in terms of seeing marketed opportunities. I think for us, as in past years, we've always seen the best potential opportunities to transact with third parties being more relationship-based and off-market. So we continue to engage in dialogue with others for net lease assets or Canadian Tire anchored properties. I think we still like allocating the majority of our capital towards Canadian Tire related development. Obviously, that is a big bang for our buck, and we view that as low risk development where we can allocate capital and get a return fairly seamlessly and quickly. And obviously, with the entire store and supply chain program, there's more than ample opportunity for us to do so over the near term. So I think that's where you'll probably see the majority of our capital being allocated through the course of this year.

[Pammi Bir, analyst]

Got it. And just on the transactions that you did reference, what types of retail are these? Are they sort of traditional power center type, grocery anchored or net lease type assets? Or can you share?

[Kevin Salsberg, executive]

There's been a bunch of -- there's been some grocery-anchored stuff, some shadow anchor stuff, some mid-box quality product, I would say. It's actually kind of across the country. And I think it seems to be mostly private buyers who are on the other side.

[Pammi Bir, analyst]

And any noticeable shift in pricing that maybe is more notable to you in terms of relative to, say, over the last 12 to 18 months from a cap rate standpoint?

[Kevin Salsberg, executive]

No, not really. A couple of them have been at lower cap rates than I would have thought or expected. Some of those are on the more urban side and I would say they may have redevelopment potential, but it would be much longer term that people are still willing to accept a lower yield for that future upside. But no, nothing too out of the ordinary.

[Operator]

As there are no further questions at this time. I will turn the call over to Kevin Salsberg, President and CEO, for closing remarks.

[Kevin Salsberg, executive]

Thank you, Maud, and thank you all for joining us today. We look forward to welcome you to our Annual Meeting of Unitholders, which we will conduct virtually later this morning. We hope that you will be able to listen in, and we look forward to speaking with you again in August after we release our Q2 results. Thank you very much.

[Operator]

Thank you. This concludes today's call. You may now disconnect your line.