Nexus Industrial REIT

TSX:NXR.UN

Earnings Call Transcript 2021-Q3

[Operator]

Thank you for standing by. This is the conference operator. Welcome to the Nexus REIT 2021 Third Quarter Results Conference Call. [Operator Instructions] And the conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Mr. Kelly Hanczyk, Chief Executive Officer, for opening remarks. Please go ahead.

[Kelly Clark Hanczyk, CEO, President & Trustee]

I'd like to welcome everyone to the 2021 third quarter results conference call for Nexus REIT. Joining me today, as always, is Robert Chiasson, Chief Financial Officer of the REIT. Before we begin, I'd like to caution with regard to forward-looking statements and non-GAAP measures. Certain statements made during this conference call may constitute forward-looking statements, which reflect the REIT's current expectations and projections about future results. Also during this call, we will be discussing non-GAAP measures. Please refer to our MD&A and the REIT's other securities filings, which can be found at sedar.com, for cautions regarding forward-looking information and for information about non-GAAP measures. The 2021 continues to be a game-changing year for the REIT, as we continue to rapidly execute on our strategy of becoming Canada's next pure-play industrial REIT. For the third quarter, we closed on $95.5 million of industrial acquisitions and subsequently closed on another $286 million. We are preparing to close at the end of the week on a $19.7 million strong covenant industrial distribution center in Alberta with a 10-year lease term which will be acquired at a very attractive cap rate. We continue to have a very active pipeline of deal flow. And you can see from our balance sheet, we have the liquidity to be able to execute on a significant amount of additional industrial acquisitions. Our occupancy for the quarter was up slightly from last quarter. And in the industrial portfolio, our vacancy continues to mainly be a 25,000 square foot industrial space at 41 Royal Vista Drive in Calgary. The good news is that we're in final negotiations on a deal that is scheduled to commence in January, a [indiscernible] [ plus 400 ] in St. John, New Brunswick. We have had some modest success in some of the 26,000 square feet that came back to us on April 1. We have leased 6,514 of that now, and we continue to have additional groups inquiring. We've actually targeted this property for disposition in early 2022. In Richmond, BC, we are continuing with the redevelopment of an approximately 60,000 square foot building for 2 tenants. Time lines have been extended from what we originally anticipated as we ran into some supply chain issues with the delivery of steel trusses for a complete new roof over 1 of the 2 tenants and for the delivery of the main chiller plant for the ice surfaces. We are now in possession of the chiller and hope to have it installed and connected this month to allow rental payments to begin for 1 of the 2 tenants in December on approximately 34,415 square feet at $34.25 per square foot. The space for the second tenancy, which is 26,319 square feet, at $33 a foot, should hopefully be complete by the end of December or January. This tenant's rent will commence once they take possession of the space. It's effectively an all new build for this space. As mentioned previously, upon completion, our NOI will increase by approximately $165,000 per month. We're also close to having building permits in hand to add an additional 74,000 square feet to the project, which once complete, which would hopefully be in about a year, we would expect this to create approximately $21 million in value creation. Montreal, we continue to work with the developer on the sale of some excess land at Les Halles d'Anjou. The developer is moving along quickly still with their approvals from the city. It looks positive that we'll close this transaction in April -- beginning of April, which will allow us to realize our first payments from the developer. So we'll receive 2 of our payments in April and 1 in about a year from them. In London, we are working towards adding 150,000 to 200,000 square foot that [ once peaked ] at one of our properties beginning next year. We're currently in the planning and costing phase of this project. We have 16 acres at another site that we are beginning to clear to get ready to develop in the near future. Vacancy in London is at an all-time low, little new build schedule in the near future. So it bodes well for us with some development activity there. On the disposition front, we have 3 of our suburban Montreal office properties and 2 smaller retail properties under contract or under PSA negotiations. These would be expected to close in January. We've targeted 4 additional properties for sale in the early new year, which would be a combination of retail and office. I will now hand it over to Rob Chiasson to give greater detail of the REIT's financials.

[Robert Paul Chiasson, CFO & Secretary]

Thanks, Kelly. Subsequent to completing the $35 million offering in March and $103.5 million London acquisitions where we paid approximately 65% of the purchase price by issuing Class B LP units, and subsequently balancing out our capital structure, we completed approximately $95 million of cash deals through to the end of Q3, and we also completed a $44 million unit deal. We began to see the positive impact of deploying our capital in Q3, and we'll see further benefit in Q4 and Q1 as further capital is deployed to acquire properties. On August 23, we completed a $112 million offering. Approximately $55 million of those proceeds were deployed on October 1 to complete the $230 million acquisition of the Loblaws distribution center portfolio. Per unit measures on our payout ratio will improve in future quarters as all of this capital is put to work. We ended the quarter with $63 million of cash, full availability of $45 million of credit facilities and $63 million of unencumbered properties. We're currently under contract or in negotiation to sell 5 office and retail properties, as Kelly mentioned, for an aggregate sale price of $45.7 million. We're busy deploying our available capital on a strong pipeline of potential acquisitions. In Q3, we saw further fair value gains on our properties and in particular, the carrying value of our Richmond, BC, property was written up by $11 million based on an appraisal received in the quarter. We also realized some gains on our Ontario industrial portfolio and a small increase in our old Montreal office portfolio. Same-store NOI was down in the quarter, primarily as a result of the 2 vacancies Kelly mentioned, a 25,000 square foot industrial vacancy in Calgary and a 26,000 square foot space in an office building in St. John New Brunswick, which came back to us at the end of April. As Kelly mentioned, we're making progress on releasing these spaces. Our debt to GBV was 36.6% at quarter end due to cash on our balance sheet from the August offering and due to having completed acquisitions in the quarter without placing mortgages on these properties. I'll now turn it back over to Kelly.

[Kelly Clark Hanczyk, CEO, President & Trustee]

Thanks, Rob. I'm now going to open up the line to any questions that you have.

[Operator]

[Operator Instructions] Our first question comes from Liyan Chen of IA Capital Markets.

[Liyan Chen]

Just a quick question for me. Just in regards to the Richmond property, in the context of the significant portfolio repositioning done this year, I was just wondering if you could give us a sense of optionality and time line related to the asset, more specifically in terms of intensification?

[Kelly Clark Hanczyk, CEO, President & Trustee]

Yes. So we're in for permit on the 74,000 square foot addition, which, quite frankly, is a pretty big value creation opportunity for us. So once we're in the ground and starting and going along, I think we're going to take a look at potentially adding additional square footage to the site. So there need to be some zoning variance, but we could add industrial square footage on a second tier drive up. So we're contemplating that, and it's fairly large square footage. So I think we'll evaluate it over the next 6 months. And then at the end of the day, if -- this project, if we choose not to do that, it would be one that eventually we'd probably look to sell as it doesn't fit our industrial strategy, per se. So -- but it does have an opportunity perhaps that we can add significant square footage. And I don't know if anyone knows, but the price of land and the value of land in BC, and Richmond in particular, things are going for almost $9 million an acre. So the ability to build up and do tiered industrial, it's kind of exciting. So as we go along next year, we're going to look in and evaluate the opportunity further.

[Operator]

Our next question comes from Brad Sturges of Raymond James.

[Bradley Sturges, MD & Equity Research Analyst]

I guess, starting with the lease -- on the leasing side, you said good news in Calgary in terms of leasing up some vacant space. How would the new rents compare to the previous rents for that space?

[Kelly Clark Hanczyk, CEO, President & Trustee]

Yes. It's [indiscernible] below what we had before. At the end of the day -- and I think we'll see rental flows start to come in, in January, where it ramps up by probably -- in April. We're still in negotiation on it. So I don't 100% know where it's going to pan out yet.

[Bradley Sturges, MD & Equity Research Analyst]

Okay. And I guess you had a pretty strong liquidity position to end the quarter, but lots of acquisitions announced are still pending post quarter, plus you highlighted some of the asset sales. On a kind of more pro forma basis, where do you see liquidity and leverage being once all the contemplated transactions close?

[Robert Paul Chiasson, CFO & Secretary]

Yes. So we've got a number of properties that are under LOI or PSA. I would say that we have liquidity to close most to all of them. All of them, I guess, we do have some that are -- we have quite a long pipeline in terms of acquisitions. But the ones that were in LOI, signed LOI, and PSA, we do have liquidity closed to probably push our debt to GBV up somewhere around 53.5% or something like that, closing on those if we did it by leveraging up some of the unencumbered assets and placing mortgages, so -- yes.

[Bradley Sturges, MD & Equity Research Analyst]

And beyond what's been announced from an acquisition point of view, Kelly, are you seeing more -- are you still seeing a balance, I guess, between deals you can do it in cash versus deals that you would potentially issue stock to vendors? Or do you see that strategy transitioning a bit from historically what you've been able to achieve from an acquisition point of view?

[Kelly Clark Hanczyk, CEO, President & Trustee]

Yes. I think it's transitioning. It was a great cost of capital for us and when we were struggling to raise equity. Most of the ones we're looking at right now are cash deals. The portfolio -- that family still owns upwards of 4 million square feet. So we could see additional product come in there over time, and those would tend to be unit deals. So that would be our pipeline there. But I -- everything I'm seeing right now and what's happening in the market, it's a lot of guys who want cash, but I still think that our -- the unit deals that we were doing are still relatively attractive for others. So I don't think you'll see an end to that, it will just become a smaller percentage of what we do.

[Bradley Sturges, MD & Equity Research Analyst]

Right. And last question, just in terms of acquisition strategy. You've been getting a little bit more active, I guess, from a primary market perspective. How do you see the balance between primary market, secondary market transactions as you high grade more towards higher quality, higher growth markets?

[Kelly Clark Hanczyk, CEO, President & Trustee]

Yes. The things that we have under contract right now in that we're going to close on are all pretty high-quality assets. And it's a mixture of -- where some lower cap rate mixed with some higher cap rate. We're closing on one this week. That's actually quite a high cap rate. And it's a balance for me. And we want to high-grade the portfolio, get some exposure to some of the major markets, but we don't want to blow our brains out either. So it's a mixture of both, where -- high, high-quality assets, we will target some of those, and then also high-quality assets that might be in that Tier 2 market, so -- but have a better cap rate. So we kind of look at a blend there. So I think if you were looking at it, I'd say it's probably 50-50, maybe 60-40, or 40% is the more attractive -- Montreal, et cetera, et cetera. So I think at the end of the day, we will make some headway in those markets, but we'll always be active in the other markets where we're seeing better cap rates.

[Operator]

Our next question comes from Kyle Stanley of Desjardins.

[Kyle Stanley, Associate]

Just maybe along the lines of the -- you mentioned the acquisition that you're supposed to close at the end of this week. You mentioned a favorable cap rate. Would you be able to just provide a range that we might be able to expect there?

[Robert Paul Chiasson, CFO & Secretary]

That was in the 7% range.

[Kelly Clark Hanczyk, CEO, President & Trustee]

Yes, that's in the 7s.

[Kyle Stanley, Associate]

Okay. Great. And then with regards to the 4 London-based assets that you're supposed to be closing on early '22, do you have a time line there just for modeling purposes?

[Robert Paul Chiasson, CFO & Secretary]

Sorry, the...

[Kelly Clark Hanczyk, CEO, President & Trustee]

The 4 London, it's the January 4?

[Robert Paul Chiasson, CFO & Secretary]

[ January 3 ], January 4 or 6. It's one of the first days of the month. There's another asset that they're adding an addition on that we close later on next year at the end of the year, hopefully. If they're done and that one is -- that will be a fantastic asset because that one -- they're adding 175,000 square foot brand-new distribution addition on there. And when we take it, it will still have the ability to put another 100,000 square foot on it so if it required. So still has expansion availability to it. So a fantastic deal.

[Kyle Stanley, Associate]

Okay. Great. You said, hopefully, by the end of next year, if it [indiscernible] in time?

[Kelly Clark Hanczyk, CEO, President & Trustee]

That they're going to be able to have it complete and turn it over to the tenant by the end of next year. That's the schedule right now.

[Kyle Stanley, Associate]

Okay. That's fantastic. [indiscernible], which I think was disclosed in the prospectus and the press release when we did an offering back in August. Okay. Just looking at your lease expiries next year, I believe there's 535,000 square feet. Off the top of your head, do you know the proportion that would be related to industrial assets? And then is there an expectation or do you have an idea of what the mark-to-market opportunity could be there?

[Robert Paul Chiasson, CFO & Secretary]

Yes. So a good chunk of that is actually in the London portfolio. And I'll maybe let Kelly speak to it a little bit, but there'll be some good opportunities.

[Kelly Clark Hanczyk, CEO, President & Trustee]

Yes, they're significant. So in a lot of the stuff that expires, we're seeing at about $7 growth. And I think that will be $7 to $9 triple net on renewal there. And I believe, if I'm not mistaken, there is one of our buildings in Saskatchewan, in Regina, that comes up next year. And that one has some fairly significant mark-to-market increase as well that could be significant. So early stages on that one. But I think next year will be a pretty decent year on the industrial side of things on the renewals

[Kyle Stanley, Associate]

Okay. Great. The only -- and the last one for me. So we saw your IFRS cap rate compressed by 10 bps sequentially. I'm just wondering, do you see more compression within the existing asset base? Is there more valuation work to be done into year-end and into '22?

[Robert Paul Chiasson, CFO & Secretary]

Yes. I think in particular, in Western Canada, we're starting to see some movement and some competition for assets. So I think there could be more valuations or revaluations and we're certainly seeing a lot of competition for product in Ontario that's driving cap rates down as well. So yes, we certainly could have additional revaluation at the year-end.

[Operator]

Our next question comes from Joanne Chen of BMO Capital Markets.

[J. Chen, Director of Equity Research]

Just wanted to clarify -- sorry to go back to the previous question on the pro forma leverage. I heard the 53%, is that just after the closing for what you've disclosed for October and November? Or does that include some of the other things that are in the pipeline right now?

[Robert Paul Chiasson, CFO & Secretary]

That includes undisclosed, that includes assets under PSA. So everything that we've -- everything that we're working towards [indiscernible] up, we can close on all of that and...

[J. Chen, Director of Equity Research]

Okay. And can you just remind us again where kind of your target leverage would be that you're comfortable with?

[Kelly Clark Hanczyk, CEO, President & Trustee]

I'd say our target leverage would be below 50%, somewhere in 45% to 50%, and we'll likely get there shortly after. I don't know for sure that we'll be able to close on everything in the pipeline. But if we did, we send the cash to do it and we put our debt to GBV at around 53.5%. We may not we may not get that high. And if we do, we'd look to then subsequently bring it back down.

[J. Chen, Director of Equity Research]

Okay. And I guess, with just the October and November acquisitions so far, would your leverage kind of be -- in kind of in the mid- to high 40s right now, excluding the stuff that's in the pipeline? And stuff you're not disclosing?

[Kelly Clark Hanczyk, CEO, President & Trustee]

I modeled it as of today, but we completed the Legend deal -- or sorry, the Loblaws on October 1. That was a $230 million deal with $172 million in mortgage financing. And then we completed the [indiscernible] deal, which was the unit deal. So those being the main transactions that would need to be modeled out to get to today's debt [indiscernible].

[J. Chen, Director of Equity Research]

Okay. And I guess, obviously, you mentioned the acquisition pipeline remains very strong, which is encouraging. But I guess are there any particular preferred markets that you guys are targeting right now?

[Robert Paul Chiasson, CFO & Secretary]

Yes. I mean we -- all around London, Southwestern Ontario, the Cambridge, [indiscernible], that whole side of things, Montreal, we're fairly active in trying to do something. Edmonton and Calgary, definitely still looking at Saskatchewan and Winnipeg as well. So those are the markets we're targeting right now.

[J. Chen, Director of Equity Research]

Got it. Okay. And I guess earlier, you mentioned the acquisition cap rates kind of range. And what would you say would be on the higher end of the cap rate range for some of the acquisitions you're looking to write? And what would be the cap rate at the lower end of what you guys [indiscernible] at right now?

[Robert Paul Chiasson, CFO & Secretary]

I'd say it's going to be a mixture of between 4, 4.2 to 6.75. So I think that's [ 6.75 7 ] is what we're targeting and things that we're looking at. So a mixture.

[Operator]

Our next question comes from [ Sid Kotak ], a Private Investor.

[Unknown Attendee]

Congratulations on the quarter. I was just noticing that your normalized AFFO payout ratio has been increasing. Last year, it was around 80%, and now it's crept up to about 96%. So I was just hoping to understand how you guys thought about the AFFO payout ratio going in the future because you guys closed some recent deals where you issued more Class B units, which would have the dividend obligation as well. So just trying to see how you guys are planning on funding that going into the future.

[Robert Paul Chiasson, CFO & Secretary]

Yes. So as mentioned, we did a $35 million offering in March and then we did the London portfolio deal in April, April 1. The London portfolio deal is a $103.5 million deal, where the vendor took back about 65% of the purchase price in units. And so it's sort of the inverse of our capital structure, but it did allow us an opportunity to put a credit facility on 3 of the properties that gave us access to $40 million, which we could then use to acquire further properties. So that, combined with the offering that we closed at the end of August, all had the impact of reducing our per unit measures and increasing our payout ratio. And as we execute on these acquisitions that are in the pipeline, we'll see the payout ratio come down into the low 80s and slightly below that into the 70s. But really, just the payout ratio has been a little bit higher just due to undeployed capital. We'll see that come back down and we'll continue our trend of reducing our payout ratio year-over-year.

[Unknown Attendee]

Do you have any guidance on when we would start to see that set to come down in the next 1, 2, 3 years?

[Robert Paul Chiasson, CFO & Secretary]

Well, it will be in the next 1, 2 quarters, we'll see it starting to come down as we continue to execute on acquisitions that we have.

[Operator]

This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Hanczyk for any closing remarks.

[Kelly Clark Hanczyk, CEO, President & Trustee]

All right. Thank you, everybody, for attending, and we will see you next quarter.

[Operator]

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.