CT Real Estate Investment Trust

TSX:CRT.UN

Earnings Call Transcript 2020-Q3

[Operator]

Good morning. My name is Valerie, and I will be your conference operator today. At this time, I would like to welcome everyone to CT REIT's Q3 2020 Earnings Results Conference Call. [Operator Instructions] The speakers on the call today are Ken Silver, Chief Executive Officer of CT REIT; Lesley Gibson, Chief Financial Officer of CT REIT; and Kevin Salsberg, Chief Operating Officer 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 2019 MD&A and AIF, which can be found on CT REIT's website and on SEDAR. I would now like to turn the call over to Ken Silver. Ken?

[Kenneth Silver, President, CEO & Trustee]

Thank you, operator, and good morning, everyone. Thank you all for joining us for CT REIT's Third Quarter 2020 Investor Conference Call. As the pandemic has unfolded, each quarter of 2020 has had a somewhat different focus. At the end of Q1, the priorities were crisis management, focusing on the health and safety of our employees, tenants, their employees and customers and on preserving liquidity. In Q2, the focus shifted to the financial health of a relatively small portfolio of ancillary and nonessential retail tenants, working with them to manage through the crisis and in preparing to participate in the CECRA program. With continued high occupancy and rent collections, the resilience of our business model shone through in the quarter and was recognized by our Board, who declared a distribution increase, which took effect in September. In Q3, our focus has once again returned to building for the future while managing the pandemic-related issues in the present. We're delighted to announce a number of new investments, marking a return to our growth strategy. These new investments are consistent with what we have been pursuing since day 1, low-risk net leases with strong covenants while leveraging our relationship with Canadian Tire to acquire well-located and highly desirable locations within their markets. We are confident these kinds of assets will stand the test of time, both in the short term in the face of the ongoing pandemic and in the longer term. With that, I'll turn things over to Kevin and Lesley to discuss our Q3 results in more detail.

[Kevin Salsberg, Chief Operating Officer]

Thanks, Ken, and good morning. As outlined in yesterday's press release, in the third quarter, CT REIT completed the vend in of a Canadian Tire store and Canadian Tire Gas+, Gas Bar in Napanee, Ontario. Subsequent to the quarter, the REIT acquired a property consisting of 2 single-tenant buildings leased to Mark's and Tim Hortons from a third-party in Yellowknife Northwest territories. Additionally, we announced that we will be acquiring 3 Canadian Tire stores from a third party. These properties are located in Drayton Valley and Leduc, Alberta as well as Saint-Jean-sur-Richelieu, Québec. As noted in our release, this new investment is anticipated to close in the fourth quarter and remain subject to customary closing conditions. We are very pleased to be resuming our investment activities based on the strength and resiliency of our business model, and these newly announced acquisitions will be a great complement to our existing portfolio of Canadian Tire properties and third-party net leased assets. In total, CT REIT will be spending approximately $77 million on these newly announced investments. And when completed, they will add 311,000 square feet of gross leasable area to the portfolio. They are expected in aggregate to earn a weighted average cap rate of 6.58%. At the end of the third quarter, CT REIT had 15 properties that were at various stages of development. These projects represent a total committed investment of approximately $187 million, $70.5 million of which has been spent to date and $48 million of which we anticipate will be spent in the next 12 months. Upon completion, these projects will add a total incremental gross leasable area of 785,000 square feet to the portfolio, nearly 94% of which has been pre-leased. As at September 30, 2020, and CT REIT's occupancy rate was 98.8%, in line with last year's Q3 rate, but down slightly from Q2 2020, reflecting the end of a short-term tenancy and a portion of our 11 Dufferin Place Southeast property in Calgary, Alberta. Lastly, with respect to the impact of COVID-19 on our property operations, tenants representing approximately 99.1% of annual base minimum rent fulfilled their October financial obligations to the REIT compared to 99% for September and August and 98.5% for July. The REIT continued to work with tenants whose businesses were negatively affected by the pandemic, including by continuing to participate in the CECRA program for approximately 50 of our tenants in the third quarter. I should also note that subsequent to the quarter end, the Federal Government announced a new rent relief program, the Canada Emergency Rent Subsidy, or CERS, to replace the CECRA program. Similar to CECRA, CERS is applicable for small- and medium-sized businesses significantly impacted by the COVID-19 pandemic. CERS is effective retroactively for the period beginning September 27, 2020, and will be provided directly to tenants on a sliding scale up to a maximum of 65% of eligible expenses. In addition to the 65% subsidy, a top-up of 25% is available to tenants who are temporarily shut down by a mandatory public health order issued by a qualifying public health authority. We are hopeful that this new program will assist tenants in need of and hence support property owners by ensuring the timely payment of rental obligations via CERS' subsidized amounts. With that, I will turn it over to Lesley for a review of our financial results.

[Lesley Patricia Gibson, Senior VP & CFO]

Thanks, Kevin, and good morning, everyone. Our Q3 2020 results continue to be sound despite the headwinds of the pandemic. We reported a diluted AFFO per unit of $0.262, a slight increase compared to $0.261 per unit in Q3 of 2019. The reported FFO per unit decreased 1.6% to $0.299 versus $0.304. Net operating income increased $1.2 million or 1.2% in the current quarter compared to Q3 of 2019. The primary contributor for the increase in the NOI growth was the acquisition of income-producing properties and properties under development completed in 2020 and 2019, which contributed approximately $1.2 million. Same-store NOI slightly decreased by $700,000 or 0.8% in Q3 2020 compared to Q3 -- to Q3 in 2019, while same-property NOI remained relatively flat compared to the prior year. There were several factors impacting these variances. Contractual rent escalations, which contributed nearly $1.7 million to same-store NOI growth, which includes the 1.5% on average contained within the Canadian Tire store leases. This was offset by the expected credit losses for tenants who were significantly impacted by the pandemic, including the bad debt expense related to the rental abatements and rent relief under the CECRA program, which decreased NOI by approximately $800,000 as well as a decrease of $600,000 related to vacancies and lower parking revenues. In addition, the proceeds of about $850,000 received in Q3 2019 from the assignment of the REIT's interest and claim against a former tenant under Companies' Creditors Arrangement Act negatively impacted same-store NOI growth in Q3 2020. Excluding this lump sum payment received in 2019, NOI would have increased 2.2% quarter-over-quarter and same-store NOI would have increased 0.1%. For the quarter, G&A as a percent of property revenue excluding fair value adjustments amounted to 2.1%, slightly less than the 2.2% for Q3 in the prior year. Improvement reflects elevated spend in 2019 associated with the implementation of the new ERP system. Moving over to liquidity and our financial condition for the quarter. The interest coverage ratio increased to 3.6x compared to 3.45x for Q3 of the prior year. The increase in the interest coverage ratio is due to both a decrease in the interest expense and an increase in the NOI in the current quarter compared to Q3 2019. Our balance sheet continues to be strong with a conservative 76.8% year-to-date AFFO payout ratio and a low debt to gross book value of 42.2% and approximately $331 million available through our committed credit facilities and cash on hand. CT REIT's assets with an IFRS value of approximately $6 billion are 97% unencumbered. In addition, as at September 30, 2020, the book value per unit was $14.75, which is slightly higher than our 2019 year-end value of $14.61 and the Q2 2020 value of $14.57 as net income exceeded distributions. Included in our net income in Q3 was a $4.3 million fair value decrease, which brings our year-to-date fair value decrease to $33.5 million. The decrease in the fair value adjustment on investment properties is primarily due to the updated inputs and assumptions in the property appraisal models, reflecting the impact of the COVID-19 pandemic on the REIT's portfolio. We continue to monitor the market for data points related to similar essential needs net lease retail assets. And with that, I'll turn things back to you, Ken.

[Kenneth Silver, President, CEO & Trustee]

Thank you, Lesley. I know it's a busy time for many of our listeners, so I'll turn the call back to the operator for any questions.

[Operator]

[Operator Instructions] Our first question is from Sam Damiani with TD Securities.

[Sam Damiani, Director, Institutional Equity Research]

Just a question for either Ken or Lesley. Just on the IFRS, you're buying some arguably tertiary market Canadian Tire stores. We don't know what the vault was, but that's around a 6.5% cap rate. And your overall IFRS is around 6.2%, but your overall sort of market footprint would be arguably more primary market than what you're investing in right now. Do you see the low interest rates pulling down cap rates for the most stable retail properties like many of which that you own, I'm just wondering how you think about your IFRS for value in this environment?

[Kenneth Silver, President, CEO & Trustee]

Sam, it's Ken. Maybe I'll just kick things off. I would say, generally, we're seeing valuations for the kind of assets we own to be stable. We haven't seen any significant movements. Obviously, they're not -- there haven't been a lot of data points to draw on. But generally, the feedback that we've had and the experience that we've had in the market would suggest that cap rates have been pretty steady for those kinds of assets.

[Sam Damiani, Director, Institutional Equity Research]

Okay. And maybe just one other question. Just given the volatility out in the marketplace and CT REIT's relative resilience, you're putting more capital to work in the types of assets that you know best. But given the difference in valuations, at least, based on perception for more multi-tenant retail properties that do require more leasing, do you see this potentially as an opportunity to take the REIT into more multi-tenant retail and reduce the concentration on Canadian Tire? Does that at all makes sense for the REIT during this time of dislocation?

[Kenneth Silver, President, CEO & Trustee]

Sam, certainly, when the market is disrupted, as we've seen, it can create interesting opportunities. I would say in terms of the strategy we're pursuing, we're going to continue on the path that we're on, which is primarily focusing on net lease assets. So the extent to which those kind of net lease assets, which fit our criteria that are not Canadian Tire assets, those would certainly be things that we would be looking at. But I don't think you'll see that we'll be diving into significant acquisitions in the multi-tenant space.

[Operator]

Our next question is from Himanshu Gupta with Scotiabank.

[Himanshu Gupta, Analyst]

Just sort of follow up on the 3 Canadian Tire stores acquisition from a third party. Just wondering how did you identify these properties? And how did you agree on a cap rate? And just wondering if these acquisitions were done on an opportunistic basis? Did you get any COVID discounts on valuation?

[Kevin Salsberg, Chief Operating Officer]

Himanshu, it's Kevin. So the deal was sourced off-market based on existing relationships that we had with the owner. We had been in discussions with them for some time, actually even pre-pandemic, working towards a potential deal. And then obviously, when this all first hit in the early parts of, I guess, Q2, we put our pens down in an effort to preserve liquidity. As we kind of went through Q2 and the early parts of Q3 and with our strong operating results and the resiliency of the portfolio, we decided it was prudent to pick it back up. And I would say there was a slight repricing in the asset, but very, very minor and probably less related to the tenancy or COVID-19 and more related to the fact that 2 of the properties were in Alberta. And since the original discussions, Alberta economy had continued to soften slightly. So all in all, pretty much acquired close to pre-pandemic pricing. Obviously, we have a lot of data points in terms of buying Canadian Tire stores and Canadian Tire rents more broadly. So we felt very comfortable with the cap rate and are very happy to be, I guess, acquiring these properties.

[Himanshu Gupta, Analyst]

Kevin, and then what is the weighted average lease term on these 3 acquired properties? And just wondering, given the uncertainty in the market, is there any attempt to acquire properties perhaps a longer lease term in order to minimize the risk?

[Kevin Salsberg, Chief Operating Officer]

Sure. I mean, for us, longer is always preferred. The 3 properties we're acquiring here have a lease term slightly under 5 years. So that will be on the shorter end of what we would typically look to buy. But we also, I would say, have a high degree of certainty that they're strong performing stores and that their locations at Canadian Tire will hopefully want to stay in for a longer period. We also bought the property in Yellowknife. And there, the third-party tenancy, which is a Tim Hortons, had 17 years of term. And the vend-in, we did have 15 years. So typically, we obviously want to go longer and do what we can to extend out our weighted average lease term. But on these ones, we felt pretty comfortable just based on our knowledge of the sites.

[Himanshu Gupta, Analyst]

Got it. And maybe another follow-up there, how is the acquisition pipeline looking going forward? And as you resume new investments post-COVID, do you think the underwriting criteria will change? Or are you looking to avoid certain store types or certain markets, which perhaps have become a bit weaker due to COVID?

[Kevin Salsberg, Chief Operating Officer]

So I mean the pipeline is, at this point, I would say, still opportunistic. We're not seeing a lot of stuff being marketed, but continue to have a lot of dialogue. I think there's a lot of stuff you can buy off-market right now. So stay tuned. In terms of the underwriting criteria, I mean, I think it's actually -- the pandemic has reinforced exactly what we're looking for, which is strong covenant, essential needs retail, fundamentally good underlying real estate and obviously, as we just discussed, long-term leases. So I think on a risk-adjusted basis, we still very much like that space, and we're hopeful there will be more opportunities in the coming quarters.

[Himanshu Gupta, Analyst]

Sure. And maybe just last question for me on the lease-up on the 11 Dufferin Street in Calgary. Is the format of the property a bit different compared -- or is there anything specific about the property? Like what has prevented it to be a traditional long-term lease there?

[Kevin Salsberg, Chief Operating Officer]

Well, the short-term arrangement that we had with the party that just vacated was actually supposed to be a longer-term lease. They sort had an option to occupy it for a couple of months with -- and we're intending to flip it into something longer. It was actually a film production studio. And basically, when COVID hit and they couldn't get their actors up from L.A. or wherever they're coming from, they decided to give back the space. So it's a pretty adaptable 100,000 square foot space. We're still showing it to tenants. We're in discussions with one particular group who's shown some keen interest. Our hope is we can materialize, as you say, a longer-term arrangement. But obviously, there is some softness in Alberta right now. Calgary industrial seems to be holding up okay, especially in that mid- to large bay type space. I think service or small day product is a little bit more challenging right now, but that's not what we're dealing with. So I think it will just take time to find the right occupant and cut a lease. So I think we're still optimistic we'll have somebody in the next 6 to 12 months in there and paying rent.

[Operator]

Our next question is from Jenny Ma with BMO Capital Markets.

[Jenny Ma, Analyst]

Going back to the third-party acquisition, can you tell us about the lease structure and whether or not it differs from the 1.5% annual rent steps that you have for most of the portfolio?

[Kevin Salsberg, Chief Operating Officer]

Sure. So as I mentioned, the weighted average lease term is just under 5 years there, Jenny. And it is a flat rent during that time.

[Jenny Ma, Analyst]

Okay. And then with regards to the funding, given that most of it is being acquired from third parties, is there any element of units being issued? Or should we presume that it's mostly debt financed?

[Lesley Patricia Gibson, Senior VP & CFO]

Jenny, it's Lesley. We're going to be using cash in the hand and our line of credit to finance the acquisition.

[Jenny Ma, Analyst]

Perfect. And then Lesley, with regards to the bad debt and CECRA expense, there was just a little bit of a discrepancy that I wanted to figure out. I think the actual provision total was $800,000. But in the same-property NOI, the difference was -- I think it was $923,000. Is there -- what am I missing between those 2 numbers?

[Lesley Patricia Gibson, Senior VP & CFO]

Nothing, Jenny, just rounding when we are taking the 9-month year-to-date number and what we reported last quarter and this quarter. The rounding just rounds perhaps a little bit less ideally than it would be. So there's really no difference. Okay.

[Jenny Ma, Analyst]

Okay. So largely immaterial. And then you had said -- you had talked about some same-property numbers, excluding some items. Could you just repeat those? I missed them when you were speaking initially.

[Lesley Patricia Gibson, Senior VP & CFO]

Sure, Jenny.

[Jenny Ma, Analyst]

I think it was 2.2%.

[Lesley Patricia Gibson, Senior VP & CFO]

Yes. We had a revenue, we've received about $850,000 in Q3 of 2019 regarding former tenant and as we sold CC delay claim. And so if I exclude that one, then the NOI would have been about 2.2% positive, and same-store NOI would have been a positive 0.1%. So a little bit better than what we would have reported.

[Operator]

Our next question is from Pammi Bir with RBC Capital Markets.

[Pammi Bir, Analyst]

Just with respect to these leases on these third-party acquisitions, when they do come up for renewal, is the intent to sort of switch them, I guess, to the structure that you would typically do with your other Canadian Tire leases?

[Kevin Salsberg, Chief Operating Officer]

Pammi, it's Kevin. The short answer is yes, we would like that. We'll see if we can achieve it. I mean it's subject to certain contractual provisions that are within the lease already around the rent in the renewal term. And so we'll just have to, I guess, negotiate it at the time, if not earlier.

[Pammi Bir, Analyst]

Got it. Just from an acquisition perspective, I guess coming back to the commentary, are you seeing any more opportunities from third parties that might be looking to perhaps raise some liquidity?

[Kevin Salsberg, Chief Operating Officer]

It's Kevin again, Pammi. Short answer is yes. I think there are a number of private and public players out there who had disposition programs in place pre-pandemic and obviously have certain commitments to meet and still view capital recycling as an option in terms of raising that required capital. But I think people aren't looking to give away the firm, right? So they're happy to sell on market terms, and I think they're deeming market terms to be pricing that is comparatively similar to pre-pandemic levels for that strong covenant that essentially needs retail. So I think there is stuff out there to be acquired. For us, it's just about measuring risk and return. So we're in discussions as we always have been with lots of various groups. And our hope is we can find a few more gems like the ones we just bought.

[Pammi Bir, Analyst]

Great. Just with respect to, I guess the incremental rise in vacancy, keeping in mind it is obviously very modest. But can you comment on the releasing prospects for some of that space? And also perhaps some color on the drop in occupancy at Canada Square?

[Kevin Salsberg, Chief Operating Officer]

Sure, Pammi. I'll take that. So you have about 90% of the 50 bp reduction in occupancy relates to 11 Dufferin, so that's our 100,000 square foot industrial vacancy that came back to us in the quarter. And as I mentioned, there's some groups that we're in discussions with. So I'm not going to repeat myself there. But the balance being really Canada Square, and I would describe the vacancy there as being purposeful just in terms of gearing up to be in a position to redevelop the property. Obviously, we have our municipal entitlements in place and can get at it in terms of the LRT construction being completed and hopping into, I guess, the first phase of that project.

[Pammi Bir, Analyst]

Okay. Is that -- any further updates on, I guess, the timing of that project or?

[Kenneth Silver, President, CEO & Trustee]

Pammi, it's Ken. Just a further comment on vacancy. Firstly, on Canada Square, we call it deleasing the property. So I'm not sure I've ever come across that term elsewhere, but as Kevin said, it is purposeful to get the property ready for development. In terms of a status update, concept design and municipal engagement are proceeding. And while we can't put a date on it right at this moment, we are expecting a municipal application in the foreseeable future. So the project is proceeding pretty much on schedule.

[Pammi Bir, Analyst]

Got it. Just last one. Just on the back of this, I guess, the new service program. What -- do you see bad debt sort of trending a bit lower partly a result of that? And/or any color you can provide in terms of the outlook on that?

[Lesley Patricia Gibson, Senior VP & CFO]

Pammi, it's Lesley. Yes, we do hope that service program when we are provided with a few more details will help some of the tenants that were previously in the CECRA program and help them through. But I think the restrictions that are put on in place and depending what happens with second and future waves are also going to have just as much impact on how those tenants perform. But I think until we hear more details about the CERS program and see how things are going for those tenants. It's hard to tell for sure. But there -- some tenants are being more impacted than others. So we do hope over time that bad debt sort of continues to trickle down. But I'm not expecting that to disappear in Q4.

[Operator]

[Operator Instructions] Our next question is from Tal Woolley with National Bank.

[Tal Woolley, Research Analyst]

I just wanted to start with Canadian Tire. Do you expect, like over the next year, you're obviously potentially one of the liquidity providers to the corporation. Any chance that we would expect to see maybe a higher number of drop-downs from Canadian Tire? Are there any assets they would still like to move into the REIT over the next year?

[Kenneth Silver, President, CEO & Trustee]

Tal, it's Ken. There are still assets in Canadian Tire that can be moved into the REIT. I couldn't comment right at this moment whether the pace of that would be different going into the New Year or not.

[Tal Woolley, Research Analyst]

Okay. And can you remind me if -- like do many of the individual dealers actually own their own real estate? Or is it like as part of the structure with Tire, like they absolutely do not own their own real estate, that the dealer will not own the real estate?

[Kenneth Silver, President, CEO & Trustee]

Yes. None of the Canadian Tire stores are owned by a dealer.

[Tal Woolley, Research Analyst]

Okay. Got it. And just back to the Canada Square project for a second. In terms of the plans that you have, like, is the existing zoning regulations like sufficient to do what you want to do? Or will there be -- you have to seek new zoning? And when would we expect to see that application and the ultimate decision?

[Kenneth Silver, President, CEO & Trustee]

Tal, there are existing planning documents, if you like, that apply to the Canada Square property. But having said that -- and existing entitlements. Having said that, given the size and complexity of the project, there is a process that you'll see beginning to unfold where those entitlements will be further crystallized. So more work to come. And I think, as I mentioned, I think you're going to see an application within the foreseeable future.

[Tal Woolley, Research Analyst]

Okay. And then finally, I guess this last one will just be for Lesley. You have the Series C debentures coming up, I believe, early or early next year. Any thoughts about how you're looking at refinancing this?

[Lesley Patricia Gibson, Senior VP & CFO]

Sure. Thanks, Tal. Yes, the June 1 $150 million of the debentures do come due. We're definitely monitoring the market right now in terms of U.S. election, future waves of COVID. But we are actively monitoring and seeing what the opportunities may be, and are very cognizant of that pending renewal. But at the same time, we don't feel a of lot pressure because we have plenty of liquidity on our line of credit and other sources. So there's definitely other backstops. But we will be actively watching and seeing what our options are over the coming weeks and months.

[Operator]

Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to you, Mr. Silver.

[Kenneth Silver, President, CEO & Trustee]

Thank you, operator, and thank you all for joining us today. We expect our fourth quarter results will be released in the 2nd week of February and look forward to speaking to you. In the meantime, we're wishing you all a safe upcoming holiday season.

[Operator]

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