Primaris Real Estate Investment Trust

TSX:PMZ.UN

Earnings Call Analysis

Steady Growth and Optimism Reflect in Q3 Results

In their Q3 earnings call, Primaris indicated continued success with steady growth across key metrics, achieving a 5.2% rise in same-property cash NOI due to increased occupancy and strong leasing spreads. The recent acquisition of Conestoga Mall has integrated well and energized the team, highlighting the REIT's focus on market-leading malls with growth potential. Primaris expects to drive above-average same-property NOI growth in the coming years and has committed to a 2.4% increase in distribution. The company introduced 2024 guidance projecting further growth in occupancy, rents, NOI, and FFO. Primaris' financial strategy is noted for its low leverage and significant free cash flow, aiming for higher end 2023 same-property cash NOI guidance of 4% to 5.5%, and providing FFO per unit guidance at $1.56 to $1.58 for 2023 and $1.60 to $1.63 for 2024.

Enhanced Operational Performance and Distribution Increase

Primaris has reported a notable growth of 5.2% in same-property cash NOI for the first nine months of the year, propelled by increased occupancy and robust leasing spreads. This growth is illustrated by the recent acquisition of Conestoga Mall, which not only added to the overall portfolio performance but has also injected excitement and efficiency within the company. In light of these positive developments, Primaris has announced a 2.4% hike in its distribution, starting with the December payout in January. The company has set forth objectives to leverage the momentum by converting more leases to standard terms, which should yield above-average same-property NOI growth in the near future.

Strategic Market Positioning Amidst Population Growth

Primaris owns leading malls in medium-sized, rapidly growing Canadian markets, which benefit from a scarcity of quality retail space and a population boom forecasted at over 450,000 immigrants per year until 2025. This sets the stage for potent demand for space, enabling Primaris to escalate rents and thereby increase NOI. The portfolio’s strategic location at city centers and close to major transportation facilitates this potential, alongside the enhanced value from restructured leases that previously had developmental constraints.

Leveraging Tenant Demand to Drive Rent Growth

The leasing team at Primaris is now prioritizing rent growth, taking advantage of their growing negotiating leverage. With a declination in space availability, the company is intent on continuing to raise leasing spreads over the coming quarters. Moreover, as tenant sales and occupancy rates seem to be flourishing, and the switch back from pandemic-era preferential lease terms to net leases is underway, Primaris forecasts significant impacts on Q4 and 2024 NOI.

Financial Stability and 2023–2024 Guidance

Primaris REIT stands on strong financial pillars with low leverage, a low payout ratio, and healthy free cash flow. With an impressive operational track record, management is confident of hitting the higher end of the 2023 same-property cash NOI guidance which ranges from 4% to 5.5%, implying robust performance. For 2024, they envision an increase in occupancy and rental revenue, projecting same-property cash NOI growth between 3% to 4%, and FFO per unit guidance ranging from $1.60 to $1.63.

Capital Structure: Debt Management and ESG Initiatives

Primaris emphasized its strategic financial planning, highlighting the doubling of its weighted average interest rate yet maintaining an extended weighted average term to maturity of its debt. This forethought has mitigated the impact of rising interest rates. The company is also preparing to publish its inaugural ESG report by year-end, showcasing its commitment to governance, environmental stewardship, and social responsibility.

Asset Valuation and Net Asset Value

The fair value of Primaris’ investment properties stood at $3.4 billion, with a reported NAV of $21.76 per unit. Despite an unfavorable valuation adjustment this quarter, this underlines the substantial intrinsic value embedded within the company's assets.

Earnings Call Transcript 2023-Q3

[Operator]

Good morning, and welcome to Primaris REIT Third Quarter 2023 Results Conference Call. At this time all lines have been placed on mute. After the pedmarks, there will be a question-and-answer session. I will now turn the call over to Claire Mahaney, Investor Relations. Please go ahead.

[Claire Mahaney Lyon]

Thank you. During this call, management of Primaris REIT may make statements containing forward-looking information within the meaning of applicable securities legislation. Forward-looking information is based on a number of assumptions and is subject to a number of risks and uncertainties, many of which are beyond primaries control that could cause actual results to differ materially from those that are disclosed in or implied by such forward-looking information. Additional information about these assumptions, risks and uncertainties are contained in Primaris's filings with securities regulators. These filings are also available on Primaris website at www.primaris.com. I'll now turn the call over to Alex Avery, Primaris Chief Executive Officer.

[Alexander Avery, executive]

Thanks, Claire. Good morning, and thanks for joining Primaris REIT's Third Quarter 2023 Conference Call. Here with me today are Patrick Sullivan, President and Chief Operating Officer, Rags Davloor, Chief Financial Officer; Leslie Buist, Senior Vice President, Finance; Graham Procter, Senior Vice President, Asset Management; Morici Barowsky, Senior Vice President, Legal; and Claire Mahaney, Investor Relations. Our business continues to deliver steady and attractive growth across virtually all metrics. Same-property cash NOI rose 5.2% in the first 9 months of the year with rising occupancy and strong leasing spreads. We have now owned Conestoga Mall for almost 4 months and are very pleased with how the property is performing, how the staff we onboarded are fitting into the team and how the transaction has acted as a catalyst in accelerating discussions and negotiations for further acquisitions. Conestoga Mall is illustrative of the type of acquisitions Primaris is focused on being a market-leading mall with mass rapid transit connectivity in a medium-sized high-growth Canadian market. The benefits of the acquisition extend beyond just the positive effects on our portfolio and traction for further acquisitions. Completing the first major acquisition in nearly a decade has created a lot of excitement and energy amongst the team with further acquisitions on the horizon, Primaris is growing, which creates opportunities for our existing team members and the capacity to bring on new resources. At the same time, this growth creates efficiencies with our management platform capable of adding several more properties with only minimal additional overhead. We also just reconsolidated most of our Toronto staff into one office, which seems to have amplified the level of energy around the office growing as well. This quarter, we have made further progress towards our goal of driving NOI across our portfolio through raising occupancy to stabilized levels and converting leases back to standard terms. This opportunity remains very significant within our portfolio, and we expect to drive above-average same-property NOI growth over the next few years and potentially longer as we find further opportunities in the portfolio and acquire new properties where we believe we can surface further growth. Reflecting the continued strength and momentum we are seeing in the business with our Q3 results, we announced a 2.4% increase to our distribution effective with the December distribution payable in January. We also introduced 2024 guidance, reflecting continued growth in occupancy, rents, NOI and FFO. Capital investment and allocation perspective, as noted on our last call, we are actively pursuing both acquisitions and dispositions, including an increase to the assets held for sale line item on our balance sheet. While the capital markets may be volatile and participants might be somewhat hesitant, we are open for business and are finding lots of people to talk to. I'll now turn the call over to Pat to discuss operating and leasing results, followed by Rags who will discuss our financial results.

[Patrick Sullivan, executive]

Thank you, Alex, and good morning. Following several years of headwinds, the current environment for the Canadian mall ownership is very favorable. On the fundamentals, the current supply of quality retail space in Canada is limited. There has not been a new mall built in decades. Current new construction is very limited and the majority of vacancies made available by field department store anchors has primarily been absorbed or demolished. Population growth is expected to continue in Canada with record high immigration levels of over 450,000 immigrants per year to 2025. With the rising cost of living in Canada's largest cities, medium-sized high-growth markets where Primaris owns leading malls, are experiencing historically high population growth rates. Given the lack of new supply and the population growth over the last 20-plus years, malls in our markets are typically located in the center of town where the population has grown around the mall over the years. Our 23 shopping center portfolio is situated on over 1,000 acres of land. Not only are these properties in the center of their communities, but they are located close to major transportation nodes and public transit with broad zoning permitting a wide range of uses beyond retail, enabling potential future value creation. This land has been made more valuable over the past 10 years as traditional department store anchors have closed on their leases, the leases restructured removing development constraints. Tenant sales productivity and volumes have rebounded and surpassed pre-pandemic levels at the majority of our properties. The dialogue is very productive with tenants and retailers looking to transact. Rents have been adjusted downward during the pandemic. Ours are still considerably lower than where they were prepandemic. And with a financially healthier tenant base, Primaris is in an excellent position to capture this rental growth across our portfolio. Occupancy levels across the Canadian retail REIT peer sheet set are essentially a stabilization in the 95%-plus range. Primaris has at least 400 basis points of runway until we are at stabilized levels, allowing us to capture the strong demand for space that we are seeing from tenants. It is this combination of low supply, rising sales, population growth and increasing tenant demand for quality space that creates a significant opportunity to drive rents and occupancy higher to quality tenants with the ability to pay increasing rents over time, driving NOI growth. Our leasing and operations team have integrated Conestoga Mall into our platform and have begun to surface opportunities for growth in the center, including an increased interest from tenants, which we are confident will translate to significant income growth consistent with our existing assets over the next 24 months. With new and exciting retailers unique in the market, including Apple Lululemon and Lululemon Conestoga Mall is amongst the top 15 most productive malls in Canada and is highly accretive to the Primaris overall portfolio quality. Same-store sales at Canastoga Mall were $970 per square foot in August 2023, which makes the property the highest performing mall in the Primaris portfolio. Our growth opportunity for this property is to reduce the almost 50,000 square feet of vacancy and short-term temporary tenancies with long-term tenants. By way of comparison, Orchard Parking Colona produces $809 per square foot and has an occupancy rate including short-term vacancy rate that is 3% or 20,000 square feet. Further, given the high productivity of the mall, we are confident that we'll be able to increase rents paid by tenants with leases due to expire over the next few years. For the past several years, Primaris has been very focused on preserving occupancy as the Canadian mall sector absorbed the departures of Target and Sears, retailers transition to omnichannel business models and the pandemic-driven government-mandated lockdowns and mall closures. In 2023, portfolio in-place occupancy rose to 91%, and we have good visibility to reach to stabilize occupancy above 95% over the next few years. Our leasing team has begun to prioritize rent growth in their discussions as we gain negotiating leverage. This can be seen from our growing leasing spreads since the REIT formation. We expect to continue to push leasing spreads over the next several quarters as available space in our portfolio declines. Our NOI growth outperformance in the third quarter is supported by strong fundamentals we are experiencing in our national full-service platform and team. Specifically, growth is coming from a number of sources, being rising occupancy, completion of remerchandising of former anchor tenant premises, increasing sales due to healthy demand and partially due to rising inflation driving percentage rental income higher, especially leasing income is returning to pre-pandemic levels following nonrecoverable expenses due to lower bad debt along with increased occupancy specifically related to formerly vacant anchor premises, and our recovery ratios are improving as we convert tenants on preferred rental terms provided to maintain occupancy during the pandemic back to net leases. We ended the third quarter with committed occupancy of 92.8%, up from 91.5% at the end of the third quarter in 2022. Over the past 18 months, we have shown consistent progress in growing occupancy. Our in-place occupancy at Q3 2023 is 91%, which is 5% higher than at the start of 2022. Same property same-store sales productivity is at an all-time high of $621 per square foot as of August 2023 and including Conestoga productivity rises to $643 per square foot. We are starting to see sales for some tenant sales stabilized year-over-year, although tenant sales continue to be very strong and our negotiations with tenants for new leases and renewals are very robust. During the third quarter of 2023, our leasing team completed 155 transactions, encompassing 449,000 square feet, including 41 new deals, which is the highest number of new deals completed in the quarter since 2018. Of note, we completed 54,000 square feet of large-format deals, including a 20,000 square foot fitted facility at Medicine Hat. We also finalized new transactions with Hot Topic and Torrid for 5 locations and 3 deals with Lovisa an Australian-based jewelry chain. In addition, we renewed 5 major tenants encompassing 88,000 square feet, including Best Buy at Plaster and 2 old Navies at Orchard Park and Park Place. Overall, renewal rents increased 4.2% over previous in-place rents during the quarter and 5.8% if we look to the first 9 months of the year. With tenant sales having risen considerably over the past 24 months and growing occupancy, we anticipate continued positive momentum in rental growth. Not captured by our renewal rent change is the conversion of leases with preferred rental terms such as percentage rent Leo-based rent back to net leases. The implication being that there are additional gains to those that are captured by the traditional net to net lease renewal analysis. On a same-property basis at quarter end, there were 268 tenants representing approximately 12% of our tenant base on preferred rental structures. This is a reduction of 67 leases from December 31, 2022. With the number of other leases completed with a number of other leases completed and commencing later this year, this figure will continue to decline during the balance of the year, which will have a significant positive impact on our NOI for Q4 and into 2024 and beyond. And with that, I'll turn the call over to Rags to discuss our financial results.

[Raghunath Davloor, executive]

Thanks, Pat, and good morning, everyone. Strategically, we continue to focus on our differentiated financial model, represented by low leverage, low payout ratio and significant free cash flow, which we believe is a major strategic advantage for Primaris. We are reiterating our balance sheet targets and 2023 guidance and announced detailed 2024 guidance metrics. Reflecting strong results to date in the strength of our business, we are guiding towards the higher end of the range for our 2023 same-property cash NOI guidance of 4% to 5.5%. In connection with FFO per unit, we have provided 2023 guidance of $1.56 to $1.58 per unit. During the fourth quarter, we will be taking a $2.2 million onetime charge relating to the consolidation of our space and the resulting sublease of our office space on Wellington Street. Going forward, we will realize $750,000 per annum in G&A savings as a result of this deal. For 2024, we are forecasting an occupancy increase of 0.81%, contractual retaps and rental revenue of 1.25% to 1.5% and same property cash NOI growth in the range of 3% to 4%. G&A is expected to be in the range of $32 million. We expect recoverable operating CapEx to be in the range of $16 million to $18 million and leasing capital within $28 million to $30 million, reflecting increased leasing activity. Redevelopment CapEx is estimated to be $30 million to $40 million allocated primarily to Northland Village and Deventer Mall. We are providing guidance for 2024 FFO per unit of $1.60 to $1.63. Further details of our 2023 and 2024 guidance can be found in Section 4 of the MD&A titled current business environment and outlook. ESG is an essential component of Primaris overall strategy with both risk mitigation and opportunity optimization standpoint. Last month, we received our inaugural results and received 2 green stars within the peer group range. We scored above periods in a variety of areas, including energy, water, waste, emissions, building certifications and risk assessment. We have identified areas for improvement such as stakeholder engagement and tenants and communities to name a few, and our teams have already begun working in these areas. The submission was a culmination of months of data collection and analysis. The data collected from GRAS formulates the baseline environment and social data sets, which we intend to develop targets for the core environmental and social ESG factors. The results also highlight key areas of focus to advance Primaris ESG plan. We are looking forward to publishing our inaugural ESG report by year-end, providing relevant and important disclosures that addresses our key ESG factors and strategy, enabling our financial stakeholders to assess our progress, strategy and impact. With respect to financial results, same property cash NOI was up 3.1% for the quarter, driven primarily by higher revenues from base rent, specialty leasing and lower bad debt expense. Same property cash NOI growth for the shopping center portfolio was 3.2%. As Pat already mentioned, tenant health is strong across our portfolio and our many operating metrics are continuing to improve, capturing growth. Interest expense is up $6.7 million over Q3 last year, primarily attributable to year-over-year increase in interest rates, higher average borrowings primarily due to the impact of the Conestoga Mall acquisition. Our weighted average interest rate now sits at 4.96% versus 2.73% at December 31, 2021, almost doubling. While at the same time, we have extended the weighted average term to maturity of debt to 3.6 years from 1.7 years. With no debt maturing for the balance of 2023 and only 2 mortgages maturing in 2024, we are very comfortable with our capital structure and our loan leverage model. At this point in time, the majority of the impact of rising interest rates have been already baked into our financing costs, and we have very limited debt rolling over. FFO and AFFO per unit diluted for the quarter was $0.421 and $0.296 respectively. On the quarter, the AFFO and AFFO payout ratios were 49.4% and 70.3%. Primaris fair value of investment properties was $3.4 billion with external valuation received for 3 properties with fair values totaling $326.8 million. On a portfolio basis, we incurred an unfavorable fair value adjustment of $23 million for the quarter, mainly driven by adjustments to terminal cap rates and discount rates. Based on the value of our assets, we ended the quarter with a NAV of $21.76 per unit, average net debt to adjusted EBITDA of 5.3x and debt to total assets of 35%. Our exposure to floating rate debt is approximately 11% as a result of the Canestoga acquisition, which we intend to term out at fixed rates, most likely with an unsecured debenture issue in the near term with unsecured financing in the future. Unsecured debt now comprises 76% of total debt. With unencumbered assets of $3 billion and net debt maturing in 2023, we are well positioned with reduced refinancing risk and access to liquidity. Primaris has been in the market continuously repurchasing units since March 2022 under the NCIB. As of yesterday, we have purchased a cancellation of 7.3 million units at an average value per unit of approximately $0.13. The program is very accretive to unitholders given the current discount to our NAV of $0.2176. As we mentioned earlier, our financial structure enabled us to execute on our acquisition strategy. Conestoga Mall was acquired with existing liquidity without the need of incremental new financing. This transaction demonstrates the advantage Primaris has with having one of the lowest leverage among Canadian REIT providers. We are very pleased to have executed a transaction of this quality while preserving our industry-leading financial metric within target ranges, thereby enabling us to continue pursuing investment opportunities. We put a lot of emphasis on Primaris differentiated financial model in our disclosure. The power of this model is intentional and is a critical pillar to our strategy and our growth story and forms part of our compensation structure, maintaining a conservative financial model and generating free cash flow after distributions and CapEx as a core focus, which we will not deviate from. With that, I'll turn the call back to Alex.

[Alexander Avery, executive]

Thank you, Rags. Our strong third quarter results and our third annual distribution increase reflect the optimism we have about our business and our team's ability to capitalize on the opportunities we see in the market. We are pursuing multiple drivers of growth, including driving occupancy higher, converting modified leases back to conventional net lease structures, compounding excess free cash flow to drive per unit cash flow and NAV growth and capital recycling opportunities. The time we have invested in raising awareness about Primaris REITs and demonstrating our ability to acquire market-leading shopping centers in growing markets is beginning to be rewarded with more research coverage and growing investor confidence in our value proposition. Just this Monday, Mario Saric from Scotiabank initiated coverage. He joined Sam Damiani from TD, Sumayya Syed from CIBC, Mark Rothschild from Canaccord, Lorne Kalmar from Desjardins, Matt Kornack from National Bank; Brad Sturges from Raymond James, and Fred Blondeau from Laurentian, all of whom have initiated coverage over the last 22 months. We also concluded our second board outreach program last week, connecting members of our board directly with the investment community in the absence of management, which is considered a governance best practice that is rarely adopted. Following a highly successful first property tour in May, we are planning our second tour, which will be getting investors out to see Conestoga Mall later this month. We are looking forward to seeing all of you there. In conclusion, we are very pleased with our progress to date. We remain focused on communicating our strategy, building a public track record of strong results and demonstrating disciplined capital allocation, all of which are key to building institutional support. Our best-in-class capital structure is key to our ability to thrive in this environment, including our first milestone acquisition closed in July and plans to accelerate our capital recycling initiatives. We would now be pleased to answer any questions from the call participants. Operator, please open the line for questions.

[Operator]

Your first question comes from the line of Sam Damiani of TD Cowen.

[Sam Damiani, analyst]

So I was just wondering if you could outlay a little bit of the assumptions built into that in terms of acquisitions, dispositions or buybacks.

[Alexander Avery, executive]

As it relates to acquisitions, we've run the forecast a number of different ways. But as you know, our acquisition focus is really on assets that enhance the quality and medium-term, long-term internal growth profile. And our objective on acquisitions is to really have them be relatively neutral to to our FFO. And so acquisitions in or out, doesn't really have much of an impact on the go-forward forecast. But I guess while we're on the topic, we continue to advance discussions and negotiations on a number of fronts, and we're optimistic that we'll be able to deliver further acquisitions similar to the Conestoga transaction.

[Raghunath Davloor, executive]

Just on the disposition front, Sam, we've modeled roughly $100 million of dispositions during the course of the year that would impact FFO. No, that's basically the number, the amount that we've identified under investment properties out for sale. It's a number we continuously review and assess. And certainly, we would be looking to do more. It's really more of a timing issue on the dispo side, the market conditions dependent and also driven by the level of activity on the acquisition front.

[Sam Damiani, analyst]

And just finally, was there any buyback activity assumed in your guidance either for the rest of 2023 or into 2024?

[Frederic Blondeau, analyst]

Yes. At a lower rate than where we're currently running. If you recall, we had been running at 20,000 units a day for a long time. We had pulled it back to 5,000 in advance of a blackout period and sort of finalizing the terms of the Conestoga acquisition. And then when we came out of blackout after closing that transaction, we ramped it up to 30,000 units a day, and that was basically to catch up for having run at 5,000 units a day. In our forecast, I think we had estimated somewhere in the neighborhood of 10,000 units a day. But it's fluid. We review it all the time. We are in the highly advantageous position to have a very strong credit profile and low leverage balance sheet as well as a low payout ratio. So we have excess cash flow that we can direct towards what we think are the best return investment opportunities out there. And I think you can expect to see us continue to buy back units, but not likely at the same pace that we're currently running.

[Sam Damiani, analyst]

And last one for me, just on, I guess, Northland Village and ultimately, Devonshire, 2 rare instances of developing new functional retail real estate in the country. Just curious what you're seeing in terms of tenant demand for those projects specifically and if your plans for dementia are getting a little more refined?

[Patrick Sullivan, executive]

Northland Village tenant demand is very strong. We're approaching, I think, about just under 90% leased up on the space that's under development, and there's another 6% or 7% that relates to tenants that are conditional. So there's very little left to do. With regard to Devonshire, we are proceeding with work on the demolition of the Sears box. We'll be doing that in the upcoming year. And the space inside the mall that we're going to remerchandise, we're well advanced on lease negotiations with tenants for that space and master planning remaining the 18 acres that will be remaining after we tear down the Sears box.

[Operator]

The next question comes from the line of Fred Blondeau of Laurentian Bank Securities.

[Frederic Blondeau, analyst]

I was wondering, in terms of demand for space across your portfolio, I was wondering if you still see some of your retailers expanding their footprint or looking to do so or they're starting to fill the macro headwinds. I guess my question here is what's your scenario on the macro impact on demand for 2024?

[Patrick Sullivan, executive]

Fred, I think demand is not showing any signs of slowing up. Tenant sales have risen considerably since the end of the pandemic, and they're surpassed where they were pre-pandemic. I think that's got a lot of retailers feeling very good about the future. We're seeing Americans look to Canada. One of the dynamics that we're in, in the U.S., there's tenants that are closing stores across a lot of the C and D malls. So essentially, they're shrinking their footprint in the U.S., and they're looking to offset that by putting more stores in Canada. So there's an interesting dynamic at play there. But generally, with sales where there are tenants are still very bullish, and I'm not really hearing any concerns about a pullback as of yet.

[Frederic Blondeau, analyst]

And while I got your retention, Patrick, just looking at financing conditions that seems to arguably be stabilizing. Would you say the buyer pool for your targeted assets is becoming more competitive or it's more like status quo on that front?

[Patrick Sullivan, executive]

Fire pool for our assets. No, I don't think there's a lot of other competitors looking to buy shopping centers right now, especially at the size and scale that we're looking.

[Raghunath Davloor, executive]

Yes, really a big part of the sort of the liquidity issue or the financing dynamics is the larger the asset, the less likely it is that we're going to face competition. There's still reasonable liquidity sort of for the smaller-sized assets, which is why we're comfortable with our view that we can execute on these dispositions. So the financing is generally available for the smaller assets, but the larger assets as the market is a little bit dislocated right now. It's a smaller group of owners that own the types of properties that we're interested in acquiring and so it's a small community with which we're engaged, and we continue to have a lot of productive discussions with that group on the disposition side. The assets that we're selling are generally smaller, more liquid and have a broader buyer pool.

[Frederic Blondeau, analyst]

That's great. And then maybe last one for me, maybe for Alex or Rags, just following up on Sam's question, looking at your 3% to 4% same property NOI growth guidance for 2024. I was wondering if you could give us a bit more color on the assumptions there. Do you feel like it will come in a bit more from revenue or expenses or a combination of both?

[Alexander Avery, executive]

Would be a combination of both. There's really a few drivers that allows us to drive this growth is the rental embedded rent steps in our portfolio, which is quite strong. There's the mark-to-market on renewing leases and getting the rental uplifts, there's positive absorption as far as vacant space. And then there's a conversion of these hybrid structure leases that were done during the pandemic and converting them back to 2 net leases. So then we should see improvement in our recovery ratio. So there's the 4 big drivers that we have and we're not sort of what we're focused on.

[Operator]

We now have Mark Rothschild of Canaccord.

[Mark Rothschild, analyst]

Just in regards to the guidance and the occupancy increase that you're expecting, how much of that is most of that from specific vacancies, such maybe an enter space that you expect to lease up or is this just general overall portfolio improvement that you expect that maybe can even continue going forward over the next couple of years?

[Alexander Avery, executive]

No, I think there's a combination that's coming into play. One is we're going to demolish the Sears box at Devonshire next year, that's 200,000 square feet. So that's going to have an impact on occupancy. But as well, we have a considerable amount of new leasing that's taking place replacing vacant space. And that's going to be a catalyst for driving occupancy next year. So it's a combination of both.

[Raghunath Davloor, executive]

Well, and one thing, Mark, that we're really focused on is you see some seasonality in Q4, you have seasonal tenants or tenants that come in. And we are really focused on trying to move that into permanent tenants so that when you see the bump in occupancy, we get the benefit of that for the entire year rather than sort of some seasonal ups and downs. So that's an area that we're increasingly focused on as our occupancy levels get tighter and will drive sort of more consistent revenue.

[Mark Rothschild, analyst]

There clearly aren't many buyers out there for the types of properties that you guys own and even more so for weaker type of enclosed malls. Are you seeing any weaker assets that you maybe look at and say, well, we have the tenant relationships, we have expertise, we can create value and make some money in them or are you just going to continue to stay away from anything that's not up to the quality that you guys want for the long term?

[Alexander Avery, executive]

We have been approached by many, many, many owners of malls, a lot of whom own malls that we think are, as you've highlighted, opportunities. But really, our strategy is to continue to build on our portfolio of market-leading shopping centers in sized markets. And we're focused on upgrading the portfolio, not necessarily pursuing opportunistic turnaround opportunities. That might be an opportunity that we would consider at some point in the future. But right now, there's a window of time during which a lot of properties that would have generally as a statement, not have been available for acquisition over the last 20 years that are available today and so we're really focused on acquiring these scarce and highly attractive market-leading shopping centers. And I feel like the opportunities for turnaround are always there. There's always properties that have been undermanaged or undercapitalized. But we're pretty narrowly focused right now on doing deals like Conestoga. Fantastic asset. It's really been a pleasure to welcome it into the portfolio, and we're looking to do similar transactions.

[Operator]

We now have Lorne Kalmar of Dejardins.

[Lorne Kalmar, analyst]

Just flipping back to the acquisitions. How have, if at all, conversations changed with vendors since the Conestoga acquisition?

[Alexander Avery, executive]

I don't know if it's hoped or expected or some middle point between those 2 descriptors. We were optimistic that demonstrating a transaction like the Conestoga transaction would accelerate and facilitate further discussions and we're pretty confident that, that has happened. We have a lot of discussions ongoing. There's, I think, very few owners of enclosed malls in Canada that we don't have discussions going on with and we're optimistic we'll be able to deliver on some of these discussions. It came up earlier, but there's really relatively few others that have the same kind of buyer profile that we have. If you look in the transaction market today, there's very limited availability of financing for some parties. There are other constraints that hold people back. When it comes to enclosed shopping centers, we've talked about it before, but owning one enclosed mall is not a very good business plan. You need to have scale. You need to have a platform. We have a very strong platform with a 20-year plus track record. We have a differentiated financial model, very low leverage and the ability to finance. We don't go into our engagements with prospective vendors with financing conditions because we don't need to and that's highly unique. And as a general rule, we know these properties very well when we go into discussions. We have a really good idea of what the shopping center is, and we don't need to go back for haircuts and retrades, which seems to be an increasingly common occurrence in the transaction market today. So we make it as painless as possible to do deals with us. And I think it's resonating with vendors, and we're expecting to be able to transact further.

[Lorne Kalmar, analyst]

And then maybe for Pat, we've talked about the strength of the retailers you haven't really seen a pullback yet. What do you think has to materialize to see some sort of pull back?

[Patrick Sullivan, executive]

I think we're starting to see tenant sales level off right now. There's still strong traffic to the shopping centers. And I'm not sure I see that abate. I think there's a balance that's kicked in with the tenants in their e-commerce business where there was a great movement pre-pandemic to buying more online, and I think it shifted to picking up in store and shopping more at the store. So there's a better balance in that regard. I think at some point, we're going to see, like I said, we are seeing a leveling off now. There's been a tremendous run in sales for the past 24 months to a point where we're well beyond where a lot of tenants were in 2019. But that's not going to negate our ability to raise rents given where their sales have gone even if there is a modest pullback.

[Lorne Kalmar, analyst]

Just could you maybe give a little bit of color on the lease term income? And then also the, I believe that the parking and sundry revenues were elevated versus historical. Can you maybe give us idea if that's a good run rate or if there's something onetime in there?

[Patrick Sullivan, executive]

Yes. On the other sundry income, there is a big chunk of it is onetime. It was really some cleanup of tenant credit accounts and miscellaneous sort of revenue accounts, and we didn't want to internally put that or externally put that in revenue or contract expenses because we track our recovery ratios and it's a key KPI. So it really didn't fit anywhere. So to be honest, it just kind of got jammed into there rather than creating a separate line. For the most part, it's a one-timer. There's always noise every quarter because you're dealing with $400 million of gross revenue, so 1,750,000 is neither here or there in the grand scheme of things. But in the quarter, it created a little bit of noise. But for the most part, it would be nonrecurring.

[Operator]

We now have Matt Kornack of National Bank Financial.

[Matt Kornack, analyst]

It's nice to hear a discernible positive tone shift in terms of retail performance since I last covered the space. But with regards to pricing power, can you give us a sense as to what the threshold is before you can start to push rents. It's nice to see that they're no longer flat to down, you're getting a bit of a spread. But maybe give us a sense Orchard Park looks like it's a very well-performing asset. Like what would spread to be there versus the broader portfolio? And what will it take for the rest of the portfolio before you start to see the spreads, I think, that you alluded to in your initial comments moving higher?

[Alexander Avery, executive]

Yes. I think Orchard Park spreads are strong for a number of reasons. One is the mall performs over $800 a foot. And two, it's got a very high occupancy rate. And I think as we increase occupancy, we increase our ability to push rents higher just because there's a limited amount of space. But I think generally, what we're finding in Canada overall is there's no new supply, especially in the enclosed mall space, there won't be. There is a desire to be located in enclosed mall simply because it's typically where the majority of the retail sales are done in any of the communities, especially where we're located. And the space is shrinking. So tenants are looking to expand their footprint in Canada. The sales are very strong. And we have been able to drive rents higher. I mean one of the positive aspects of our leasing, we really have been able to push getting annual increases in our rents into leases in the past few years, and that's been a tremendous ability. That's given us the ability to show year-over-year growth in rental growth in rents outside of just the lease end increase.

[Matt Kornack, analyst]

And then I guess, as you look to the broader portfolio and kind of your peers in the unenclosed space pushing rents into the mid-teens. Is that something you see on the horizon at some point within the enclosed space? Or is it really an occupancy push for the next couple of years in then you'll get to the rent escalations?

[Alexander Avery, executive]

Yes. I mean it's generally an occupancy push. I mean our average CRU rent is considerably higher than the average rent found in most of the unenclosed format malls. So it's pretty typical both mall average rent lift to be in the single-digit range. But as I mentioned, I mean, we're pretty happy with our rental growth on an annual basis that we've been able to build into most leases.

[Raghunath Davloor, executive]

Matt, just having done what you do, there's a desire to have sort of a continuous steady data stream. But the reality is that our portfolio isn't that large and quarter-to-quarter, individual transactions do create noise in that metric. And we've had investor meetings where we got a question about like why did XYZ happen this quarter? Or why didn't XYZ not happen in this quarter? And Pat sometimes says it's been 90 days, like things take time. When you look at that leasing spread, the mall business is also in a unsatisfying manner. From an analyst perspective, it's a little bit more nuanced than office buildings or industrial buildings where market rent is market rent in an office building, the rent goes up a little bit as you go up floor by floor. Our property type is more complex than that. We're really focused on curating the right tenant mix, and sometimes that doesn't necessarily maximize short-term revenue. It's really a longer-term game that isn't well suited to measuring on a 90-day basis. All of that said, I think what you're getting at is are we feeling an acceleration in our ability to capture leasing upside. And I would say, absolutely, we are. We've got a slide in our investor presentation that shows the per capita enclosed shopping center space in Canada and it peaked in 1991. Some of that is the lack of new supply, some of that is population growth. But as we look at it between now and the end of this decade, that decline in per capita enclosed shopping center space is actually accelerating. And the amazing thing about that is 2 things. One, the replacement cost is 4x what our enterprise value reflects on a per square foot basis. And number two, even if you wanted to create that space and you could afford to build that space to assemble parcels of plan that are 40, 50, 60, 70 acres in central locations in Canadian markets, midsized, large markets is virtually impossible. So we have what we think is a tremendous medium-term, long-term opportunity. And as Pat referred to as we get our occupancy closer to that stabilized mid- to high 90s percent range, we really do move into the driver's seat in terms of a lot of these lease negotiations. But it's happening and on a quarter-to-quarter basis, you just have to bear with us because individual leases do skew these things. And I think last quarter, we were in the 8% range. This quarter, we're in the 4% range. I would think high single digits is a pretty reasonable place to expect us to come out and maybe it will be higher than that.

[Matt Kornack, analyst]

And just very quickly on CapEx and repositioning. It seems like this portfolio has already gone through a lot of that. There's a few smaller bits. But for the most part, would you say everything CapEx wise that you've wanted to do has been done with the exception of maybe a few anchor tenant boxes being cut up and repositioned.

[Alexander Avery, executive]

Yes. We're through the anchor transitions for the most part, there's a couple left. Devonshire will get knocked down, and we'll remerchandise the interior of them all. But for the most part, we're through that program. And really, the bulk of our CapEx is going towards leasing up the space and getting back to the 95% mark.

[Operator]

We now have the next question from Mario Zak of Scotia Bank.

[Mario Zak, analyst]

Given I'm the new kid on the block, I've got a couple of clarification questions and then a couple of thematic ones. Just one clarification on the occupancy guidance for '24 being up 80 to 100 basis points year-over-year. I think Pat mentioned it does include the demolition of the space, Devonshire, which I think would add about 200 basis points or so to occupancy. So can you just kind of reconcile those two? The occupancy expectation would be including excluding evolution, I guess in '24.

[Alexander Avery, executive]

Well, the Sears occupancy guidance like that the Sears demo is actually baked into the 2023 year-end sort of guidance on occupancy. So the 80 basis points, 100 basis points pickup in occupancy for 2024 exclude the impact of Devonshire because we assume that that's taken out of the denominator at December 31, 2023. So to the extent that the timing slips and the pickup might be bigger, but we've made the assumption that we'll adjust the denominator and numerator this year. And so that pickup is meant to be net absorption at the impact of Devonshire.

[Mario Zak, analyst]

I imagine you're somewhat happy to see the U.S. payroll number this morning with yields coming down if you have to do an NK venture today, can you give us a decent range in terms of where you can get it done?

[Alexander Avery, executive]

Sure. I mean it depends what time of day and what day of the week you asked, but it's been so volatile. I would say right now, you're in the 6.75% range. So if you asked me 1.5 weeks ago, I just said 7% to 710. If you asked me a week ago, I said 25 as now, I would say it's 6.75%, maybe lower. Somewhere between 3% and 10%. It is really coming around. It's $675 outside of a 75. The 7% is probably the zone that we're currently seeing.

[Mario Zak, analyst]

And then maybe a similar question in terms of that versus now just on Dufferin growth. Like we are seeing more articles come out what delayed condo construction in Toronto, given the higher rate environment. How would you characterize market perception on the fair value of BufomGrove versus 3 months ago? Like specifically, like do you sense the bid-ask spread is widening or is it narrowing?

[Alexander Avery, executive]

It's a unique development site in a lot of respects. It's shovel ready, it's biotransitsite. It's large 4 acres is a big parcel and the ticket size is very large as well. So to your point, over the last 30, 60, 90 days, it seems like there has been a growing awareness of the lack of liquidity in that market. We've seen that for 15 months, I would say. As we were coming into the summer last year, it was apparent that there wasn't a lot of depth to that market. and a lot of the transactions that have been taking place are highly structured. Two years ago, there was a real premium, if you could deliver shovel-ready sites and now there's a preference for holding income rather than shovel ready, which is kind of an inversion in that market. Do we know what that's worth? I mean, I don't want to say your guess is as good as mine, but I just did. We have an appraisal, and we carry it at that appraised value. It's on our balance sheet as a separate line item so that investors and analysts can look at it and come to their own conclusion. But it's challenging to assess what that might be. I mean, the bid-ask spread today would be wide. It's been wide for 1.5 years and we don't have any better information than anyone else as it relates to what to say on that asset. We're in the fortunate position where we don't need to be a seller of that asset today. And we're highly confident that the value of that site medium term, long term is very, very high. And we've had a lot of discussions about it being more than what is represented on our balance sheet under the right conditions, but we're sort of in the dark a little bit as well because we haven't been marketing it. We do regularly get approached about it. And there's a couple of different buyer pools that approach us about it. There's the opportunistic buyer who hears noise in the market about land values and then there's the strategic longer-term largely family office types and they don't generally start the conversation with price. They start the conversation with how do we plan this over 10, 15, 20 years. And if you made me pick, which type of a buyer will end up selling that too I think it will be that family office intergenerational wealth group. And I mean, the opportunity for that buyer to participate in the broader 21-acre parcel at Dufferin is also something that I think is a reasonable expectation to consider that's a site that has tremendous potential. You think you look at the well and Allied and RioCan have created a really special property there. This is 2.5x the size of that site from a land area perspective and sits on an existing subway station, not contingent on future transit plans.

[Mario Zak, analyst]

Just zoning in on the family office, if that indeed is, let's say, a potential type of buyer, would you say the family office buyer 15 months ago would have paid a premium for shovel-ready product or is it just a different mindset altogether in terms of how they think about the go versus loco decision?

[Alexander Avery, executive]

For the most part, I would say that 15 months ago, it was the merchant condo developer. And some of those are backed by the same family offices. But when you look at Dufferin, it really is a larger opportunity. We have all of the leases at Dufferin revert to our control by 2040, 2041, 16, 17 years from now. That seems like a long time, but in the time line of Toronto municipal approvals and planning and all of the rest of that, it's actually not that far in the future. And the 4 acres is an opportunity. And I think as we brought the 4 acres to the owned entitled severed phase that made us think a little bit more about the long-term opportunity at Dufferin. The benefit of time to reflect I think there's definitely an argument that the whole 21 acres should be dealt with together where you don't want to have someone buy and build a 4-acre parcel and then at some point over the next 17 years, someone comes in and buys another 4 acres and then buys another 4 acres. If you can do something on 21 acres. That's a real city building type of an opportunity. And to the discussion that we're having the right capital profile for that type of a project is really long term. You're starting with a discussion where 17 years is the starting point. And we're highly confident that it's a tremendous development site. There continues to be robust growth in Canadian population. Toronto continues to be a very attractive market globally and we're thrilled that we own the assets. And while we haven't 100% figured out what to do with it there's no gun to add.

[Mario Zak, analyst]

Just a question on Rock ratios. In your experience, are you able to generally increase them in an environment where tenant sales levels are flattening out notwithstanding, call it, the mark-to-market, how the rock ratio is too low or are you able to increase them in a tenant sales flattening environment?

[Patrick Sullivan, executive]

Yes.

[Claire Mahaney Lyon]

Occupancy discussion, your 92.8% committed. I'm looking at your projection for next year, the same amount increase as 2023. It sounds like retailer demand is still pretty strong. I was wondering if your production could be higher. And if there is some conservatives on that, you are factoring in, in your outlook. On the held for sale assets, if you have the LTV handy, that would be helpful and also expected use of proceeds?

[Mario Zak, analyst]

Is there any debt on the held for sale?

[Patrick Sullivan, executive]

No, all the assets are free and clear. They're all unencumbered.

[Claire Mahaney Lyon]

And then any thoughts on the expected use of proceeds?

[Patrick Sullivan, executive]

Well, just to pay down debt. As we draw the offline, we'll pay down. So we're always struggling looking at doing unsecured to term out draws on the offline. But if we have visibility on how we size the unsecured and factoring in potential proceeds from asset sales. It's that and then also potentially financing new acquisitions so using the proceeds into new acquisitions. So it's sort of a combination of everything.

[Operator]

We have our final question on the line from Brad Sturges with Raymond James.

[Bradley Sturges, analyst]

Just to round up the discussion on occupancy. I just want to clarify, does the guidance on occupancy year 24, does that include...

[Alexander Avery, executive]

I'm saying that this is where we see the drive in occupancy. So we didn't factor in because it's just like it's at the margin. A lot of the dispos are vacant land. So that has no impact. Yes. I mean look at a bunch of different things. We've got a whole bunch of leases that we have signed. We have a bunch of leases that we're close to signing. We look at that. We try to back into what that implies in terms of an occupancy lift. Then we look at where we are over a multiyear period between getting here to a stabilized occupancy. And it's kind of the core, excluding demolition of space, trajectory oriented kind of guidance. And the third piece that makes it complicated is that when we look at the business, we really look at what we describe as like real leases, the permanent tenants, multiyear lease, and we kind of look at the short-term specialty leasing type of a tenant as well, we refer to it internally as vacant, even though there are tenants paying rent in that space. And so we're looking at disclosure going into 2024 that will try to further refine how we describe occupancy and talk a little bit more the component of occupancy that is specialty leasing.

[Bradley Sturges, analyst]

Just as you continue to evolve from like a remerchandising perspective or thesis, is that kind of a stabilized level that you expect going into '24 or do you see that trending down further?

[Alexander Avery, executive]

#1 I think yes, there's going to be some lease surrender income next year. I'm pretty certain we're having a few discussions for tenants that we'd like to replace and they like this to facilitate it. In terms of the percentage of leases, when you include all the variable leases, including gross rent, ones with caps and stuff short, we're around 12%. That's sequentially gone down 1% in each of the past quarters this year. And the trend for that is to get it down to about 6%, which is our historical norm. So there's still quite a runway to get there, and we're making really good progress every quarter. And that ties into the recovery ratios as well which we're expecting to drive into the '90s. Ideally, it would be 100%. We'll see whether we get there.

[Operator]

As we have no further questions at this time, I'll turn it back to ClaIre.

[Claire Mahaney Lyon]

Thank you, operator. With no further questions today, we'll close today's call. On behalf of the Primaris team, we thank you all for participating in our self, and we look forward to speaking with you again on our Q4 call, and we will see you on our property tour later this month. Thank you, and have a great weekend.

[Operator]

You may now disconnect.