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RioCan Real Estate Investment Trust
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Good morning. My name is Casey, and I will be your conference operator today. At this time, I would like to welcome everyone to the RioCan Real Estate Investment Trust Second Quarter 2018 Conference Call. [Operator Instructions] Thank you. Mr. Edward Sonshine, you may begin your conference.
Good morning, everyone, and thanks for dialing in on this rather dreary day. With me here are several executives from RioCan. The ones that will be speaking will be first Christian Green, who will read the interminably long forward information warning; and then Qi Tang, our Chief Financial Officer; and then before I come back on will be Jonathan Gitlin, our newly-minted Chief Operating Officer, and be gentle with him, he's got just over a week on the job, so I'm sure you'll treat him nicely.So with that, I'll turn it over to Christian Green.
Thank you, Ed, and good morning, everyone. Before we begin, I'd like to draw your attention to the presentation materials that we will refer to in today's call, which were posted together with the MD&A and financials on RioCan's website earlier this morning. Before turning the call over to Qi, I'm required to read the following cautionary statement. In talking about our financial and operating performance and in responding to your questions, we may make forward-looking statements, including statements concerning RioCan's objectives, its strategies to achieve those objectives, as well as statements with respect to management's beliefs, plans, estimates and intentions and similar statements concerning anticipated future events, results, circumstances, performance or expectations that are not historical facts. These statements are based on our current estimates and assumptions and are subject to risks and uncertainties that could cause our actual results to differ materially from the conclusions in these forward-looking statements. Also in discussing our financial and operating performance and in responding to your questions, we will be referencing certain financial measures that are not generally accepted accounting principle measures, or GAAP, under IFRS. These measures do not have any standardized definition prescribed by IFRS and are therefore unlikely to be comparable to similar measures presented by other reporting issuers. Non-GAAP measures should not be considered as alternatives to net earnings or comparable metrics determined in accordance with IFRS as indicators of RioCan's performance, liquidity, cash flows, and profitability. RioCan's management uses these measures to aid in assessing the Trust's underlying core performance and provides these measures so that investors may do the same. Additional information on the material risks that could impact our actual results and the estimates and assumptions we apply to making these forward-looking statements, together with the details on our use of non-GAAP financial measures, can be found in the financial statements for the period ended June 30, 2018, and management's discussion and analysis related thereto as applicable, together with RioCan's current annual information form that are all available on our website and at www.sedar.com. Qi?
Thanks, Christian, and good morning, everyone. Our second quarter results that were issued earlier this morning once again demonstrate the quality and strength of our portfolio. Before I get into our financial and operating results, I would like to update you that as of yesterday, August 7, we are more than halfway to our disposition target of $2 billion asset, with $1.2 billion or 58% of our overall disposition target either closed or under firm or conditional contract. The weighted average cap rate for the asset sales is approximately 6.5% based on in-place NOI, maturity in line with our IFRS valuations.As a result of our strategic disposition, our major market focus has increased by 1.4% from Q1 2018 to 81.4% as of June 30, 2018, including 43.5% from the GTA. Our COO Jonathan will speak more about this shortly.For the second quarter, we achieved same property NOI growth of 2.1% for the overall portfolio, and 2.5% for our major markets portfolio. Our major markets occupancy as at June 30, 2018, was very strong, at 98%, and overall portfolio occupancy was 20%, 20 basis points higher than last quarter at 96.8%. [ Excluding ] office space, our retail occupancy improved by 30 basis points in the quarter, to 97%.For the 6 months of 2018, higher occupancy in the portfolio, renew rental growth and contractual rent increases helped our same-property NOI increase by 2.3% for the entire portfolio and by 2.8% for our major markets portfolio, while secondary market same property NOI was relatively flat over the comparable period.The strength in occupancy and the strong same property performance gains from the sale of marketable securities and our active NCIB program resulted in a 2.5% increase in our FFO per unit, from $0.45 in Q2 2017 to $0.46 in Q2 2018, despite $583 million disposition completed since October of 2017 and $4.3 million one-time severance cost in Q2 2018. Excluding the severance cost, our FFO per unit for the quarter would have been $0.47 per unit, a $0.02 per unit or 5.5% increase over Q2 2017. As a result of the FFO per unit growth, our FFO payout ratio improved from 82% for the comparable period in 2017 to 78% in Q2 2018, a 4% improvement, and again, outperformed our 80% target.Excluding $20.2 million gains from the sale of marketable securities and $4.3 million one-time severance cost, FFO per unit was $0.41 in Q2 2018 versus $0.42 over the same comparable period in 2017, down by $0.08. Temporary loss of $1 million NOI, including co-tenancy loss due to Sears closures, which we have substantially completed releasing with income coming to earnings stream in late 2018 and 2019, and $1.2 million lower lease termination fees, have led to this $0.08 per unit decrease. It is important to note that this result speaks to the quality of our portfolio, considering dilution effect of the $583 million dispositions completed since October 2017, even with our active NCIB program.Furthermore, we are making excellent progress on our development program, with significant leasing progress as well, as we recently announced with Allied. Major mixed use residential projects coming to the earning stream in late 2018 and 2019, such as the rental and condo towers at the Eglinton northeast corner, King Portland Centre including Kingly Condos, and Frontier Apartments at Gloucester in Ottawa. Jonathan will speak more about our development pipeline and project progress shortly.We will continue to self-fund our development pipeline through our current strategic disposition program and future continuous pruning of the portfolio, as well as strategic partnerships, the sale of air rights, condos, and townhouses, sale of marketable securities, and so on. Next, let us look at our balance sheet strengths. In our review, the most important measure of the company's financial strength is debt to EBITDA. Despite our strategic disposition program and approximately $1.4 billion development on the balance sheet, including condo and townhouse development, our debt to adjusted EBITDA was 7.74x on a proportionate share basis as of June 30, 2018, below our target of 8x, and one of the lowest among our peers. Excluding the $1.4 billion development on the book, our debt to adjusted EBITDA would have been approximately 6x. In anticipation of receiving substantial disposition proceeds in July 2018, we increased our debt modestly to maximize our NCIB purchase prior to entering the blackout period in late June due to quarter-end reporting. For this reason, our leverage was 42.4% as of the quarter end, slightly above the upper end of our 38% to 42% target range.In addition to a conservatively-managed capital structure, we are focused on maintaining access to multiple sources of capital and financing flexibility by growing our portfolio of unencumbered properties. As of June 30, RioCan's pool of unencumbered assets was $8 billion, which generate 58.3% of our annualized NOI, above our target of 50%, unchanged from the last quarter. All of our debt metrics have met or exceeded our internal targets as of June 30, 2018.As you can see, we are generating tremendous momentum in our strategic disposition, operations and development program. We are confident that we will carry on this momentum into the second half of the year. With that, I would like to turn the call over to Jonathan for update on RioCan's operations this past quarter.
Thanks, Qi, and good morning, everyone. I'm very pleased to provide the operational highlights for the second quarter of 2018. As I've mentioned, I'm 1 week into this role as RioCan's Chief Operating Officer, and I can say that I'm truly excited about our progress and future. Q2's strong financial results demonstrate that we're well-positioned to continue driving our strategy forward. I would like to begin by focusing on RioCan's income-producing portfolio, followed by some points about our robust development pipeline.In Q2, our portfolio's operating performance remained strong, underscoring the logic behind our strategic decision to dispose of our secondary market assets. Now, as Qi mentioned, we continue to make excellent progress in the acceleration of our major market focus, with approximately $1.2 billion in transactions either completed or subject to firm or conditional purchase agreements. Now, assuming the successful completion of these transactions, rental revenue for major markets will represent approximately 86% of RioCan's overall annualized rental revenue. Now, for context, when we announced the accelerated focus in October of 2017, this same statistic was only 75%. Traction in our disposition program has a direct benefit to RioCan's operational results, as by shedding secondary market assets, RioCan can focus its valuable human and capital resources on extracting income growth and NAV creation from our exceptional assets in Canada's major markets. Q2's results, including strong same property growth and increased occupancy, demonstrate that the overall health of our existing portfolio is strong. As Qi mentioned, our outlook for the remainder of 2018 continues to be positive and our expectations for same property growth for the full year 2018 remains in the range of 2% to 3%.RioCan's portfolio committed occupancy rate increased from 96.6% in Q1 to 96.8% at Q2 2018. Retail occupancy increased from 96.7% to 97% in Q2. Committed occupancy in the major market portfolio increased to 98%. Our quarterly leasing and renewal results were also strong in Q2 2018. RioCan completed 496,000 square feet of new leasing in the second quarter, at an average rent of $18.26 per square foot. 196 renewals, totaling approximately 1.8 million square feet of space, were completed during the second quarter at an average rental rate increase of $0.62 per square foot, or 4.2%. The average growth rate on renewals was negatively impacted this quarter by 6 fixed-rate renewals that were completed with anchor tenants that included zero growth in rent. It is important to note that 5 of the 6 were in secondary market assets slated for disposition, and the 6 renewals accounted for 687,000 square feet of the total GLA renewed this quarter. The average rental rate increase of renewals completed in the major market portfolio was $1.10 per square foot, or 5%. Our retention ratio for the quarter was also very strong, at 91.8%. RioCan is poised for additional growth fueled by the advent of cannabis stores in the Canadian retail landscape. We have already completed 18 leasing transactions totaling approximately 53,000 square feet of space at an average net rent of close to $32 per square foot. All but 2 of these transactions are in properties outside of Ontario, and once the regulatory landscape within this province has been clarified, RioCan expects to see far more demand within its portfolio. Now, this is just one example of the benefits that will accrue to RioCan as new expansive retailers enter the market. In addition to our substantial retail real estate, RioCan also has approximately 1.9 million square feet of office GLA at our interest. Our office portfolio is currently 93.5% occupied. Some may characterize this as a bit of a drag on our overall metrics. We, however, view it differently, rather as another driver of future growth. Nearly 3/4 of our office portfolio is located in the GTA, where supply is coming under increased pressure and demand is high. With limited vacancy in the core and surrounding areas, there is increasing momentum for offerings that are on or near transit. Not only will this demand fuel higher occupancy, but it will also increase rents, which will benefit our transit-oriented office spaces such as Yonge Sheppard Centre and Yonge Eglinton Centre.There are also significant office components to numerous developments currently under construction, including The Well, King Portland Centre, Bathurst College Centre, ePlace, and 642 King Street, that upon completion will increase the square footage of our office portfolio to approximately 2.5 million square feet at RioCan's interest. And given the demand, as I mentioned before, in downtown Toronto, this newly built office space will make meaningful contributions to our net asset value and future growth.With regards to our expansion and redevelopment, urban intensification and greenfield development programs, an additional 119,000 square feet of space at RioCan's interest was completed and became income-producing in the second quarter. This brings total year-to-date development completions to 237,000 square feet. An additional 523,000 square feet at RioCan share is expected to be transferred from PUD to IPP over the remainder of 2018, bringing the total to 760,000 square feet of incremental urban income producing and NAV-enhancing space.This brings me to our strong and unparalleled development pipeline. In Q2, RioCan saw some significant progress in the construction and leasing of major developments. Many of these developments are mixed use transit-oriented properties in Canada's major markets, and I am pleased to see these progressing well. Notable development highlights include substantial completion of instruction at RioCan and Allied's 14-story 273,000-square-foot office tower at King Portland Centre. This space has already attracted several strong tenants, including Shopify, which took possession of 9 floors, totaling 183,000 square feet, in July of this year, and Indigo, which is expected to take possession of 4 floors totaling 79,000 square feet in September of 2018. In addition, site excavation continues at The Well and is anticipated to be complete by the end of 2018. The Well's 36-story, 800,000-square-foot office tower, located at Front and Spadina in Toronto, began construction in Q2. As you may have seen in last week's announcement, together with our partner Allied, we have made significant progress on the commercial component of this mixed-use project. To date, a lease has been completed with Index Exchange, a global advertising digital marketplace, for 200,000 square feet. Another high-caliber user has agreed to lease 125,000 square feet of office space, and Allied and RioCan are finalizing these transactions with two other office users for more than 533,000 square feet, which would bring the leased area of the office component of The Well to 80%. Early 2019 will also see the completion of construction of our first 2 residential rental projects, being eCentral at Yonge Eglinton in Toronto and Frontier in Ottawa. Both are high-quality projects located in prime areas adjacent to main transit lines, and are excellent example of our RioCan Living residential portfolio. Between the 2 projects, we will have just under 700 income-producing units in our portfolio by the end of 2019. From Q3 2018 to the end of 2020, we are expecting development completions of approximately 2.8 million square feet at 100%, or 1.6 million square feet at RioCan's interest net of air rights sales. These development completions will make significant contributions to our growth going forward. The value created through the completion of our development projects is significant, with the annualized stabilized NOI expected to be approximately $50 million at RioCan's interest. Our current total development pipeline consists of 66 projects, totaling over 26.2 million square feet; 44 projects or 12.1 million square feet have zoning approvals; and an additional 6 projects or 5.4 million square feet have zoning approvals that have been submitted. The extent of the zoning approvals we have in place is the result of RioCan initiating our development planning more than a decade ago. Zoning approvals take significant time and effort to obtain, and our current status provides RioCan with a competitive advantage and a 5- to 7-year head start relative to our peers. The further 16 projects of 8.7 million square feet have been identified as future density, and I would like to point out that these totals do not represent all intensification opportunities that exist within our great portfolio.I'm also proud of the community consultation we engage in as part of our development process. We consult with a number of constituents, including residents, on every project to ensure our development efforts responsibly enhance and [ involve ] in communities and best serve the future needs. If you have driven around Toronto lately, you can see the beginning of RioCan's evolution and the velocity at which the change is occurring. Construction of our mixed-use projects at some of the most iconic intersections in Toronto are underway, including Yonge and Eglinton, Yonge and Sheppard, King and Portland, Bathurst and College, Dupont and Christie, College and Manning, and of course The Well at Front and Spadina. The Toronto market is just one example of the tremendous value that exists in the portfolio that will be realized in the next decade through our urban intensification and residential development programs in major markets all across Canada. What you see now is just the beginning. In conclusion, our second quarter results were strong. Our major market results were even better, and there are countless opportunities for us to create value from our major market portfolio in the next decade. RioCan is evolving and the future is bright. I look forward to continuing to work closely with RioCan's incredibly strong and deep leadership team to drive our strategy further into the future. Those are the operational highlights, and I'll now turn the call over to you, Ed.
Thank you, Jonathan. For over two decades, RioCan has been seen and valued as the largest retail real estate REIT in Canada, with shopping centers virtually everywhere. As a result, over that timespan our unit value has probably been affected the most by the ebbs and flows in the retail sector itself. Of course, the level of interest rates and the state of the economy have a large impact on our valuation as well, but these affected pretty well everyone equally. But when large retailers ran into trouble or decided to retreat from Canada, there was an automatic assumption that RioCan would be the most affected, and that assumption was usually correct.Just yesterday, we saw American retail REITs fall somewhat dramatically, largely as a result of the rumored impending bankruptcy of Firm Mattress, which has about 5,000 stores in the U.S., and the actual bankruptcy announced over the weekend of Brookstone. Retail REITs in Canada were also impacted, notwithstanding that neither Firm nor Brookstone have any stores in this country. The foregoing is merely a preamble to the main point of my presentation, namely that as we move into 2019, the transformation of RioCan from what it was to what it will be will start to become evident to the investing world, including analysts. First, in some ways we will be smaller, less units outstanding due to our ongoing NCIB and the fact that we haven't issued equity units for several years and have no current intention of doing so, a far lower property count, going from over 300 not too long ago to under 200 by somewhere around this time next year. But our asset value will likely not diminish, as the new assets in which we are investing a large part of the funds generated by capital recycling will have much larger value growth in addition to NOI growth than the assets of which we are disposing. To put some flesh on the bones of my last statement, let me give you some concrete examples and specificity regarding what RioCan is becoming. We already own some of Canada's iconic mixed-use properties. Of our roughly $14 billion in assets today, just under 5% of that is represented by Yonge Eglinton Centre. And shortly, on completion of our development on the northeast corner of Yonge and Eglinton, we will have almost $1 billion worth of assets at what is arguably the most dynamic intersection in Toronto, at the meeting point of the city's primary north-south subway line and the soon-to-be-completed Eglinton Crosstown. Our mixed-use assets here will consist of 750,000 square feet of office space, over 400,000 square feet of retail on both sides of Yonge Street and connected underground, and 466 newly-built rental apartment units. When you add to that our 50% ownership of Yonge Sheppard Centre, also at the intersection of two subway lines, and include our 50% interest at The Well at Front and Spadina, both of which we'll have as part of the newly-constructed rental apartment towers, the result will be that these three fantastic properties will represent almost 15% of our assets. And when one considers what's going on in each of those areas, I believe they will represent an even larger proportion of our annual NOI and NAV per-unit growth. Jonathan has already mentioned the fairly significant office component, amounting, again, to about 5% of our net leasable area, which RioCan already owns, and where we see significant growth opportunities over the next few years. But we also have new and superbly-located office space that will start generating income in 2019, some of which Jonathan has mentioned. I can't stop speaking without also highlighting the superb residential rental portfolio we are in the midst of creating under the name RioCan living. By this time next year, our first two buildings will not only be complete but actually have tenants living there. A 228-unit building in Ottawa, developed with our partner Killam, and a 466-unit wholly-owned rental building at Yonge and Eglinton in Toronto will be the first 2 completions. Both are adjacent or connected to public transit, both are built to the highest environmental and building standards, and both will contain the most modern and desirable amenities. By 2022, just over 3 years from now, the RioCan Living portfolio will consist of almost 4,000 rental units, mostly in the GTA, but with good representation in Ottawa and Calgary, and all of them will share the characteristics I noted above with respect to the first two buildings. In addition, by 2022, we expect a further 3,000 units to be under construction, including three currently-owned sites in the Greater Vancouver area. These totals only include sites we already own, and in many cases we have owned them for much of our 25-year history. I have no doubt that by 2022, we will have many other locations that we will be already working on and that we expect will work from a zoning and economic perspective. By way of example, the numbers I mentioned above don't include anything for Shoppers World Brampton, where we are currently going through a master planning exercise with the city. Our existing shopping center will, on completion of the Hurontario LRT in 2021, become the transportation hub for this area, and is envisioned by the city as ultimately consisting of over 4 million square feet of mixed-use development. 2018 and into the beginning of 2019 were previously described by me as a bit of juggling act. We are in the process of disposing of $2 billion of secondary market assets while at the same time investing hundreds of millions of dollars annually in new developments, all while ensuring that our use of leverage remains within our target range and our FFO per unit continues to grow. A lot of balls to keep in the air, but we have done so and I am confident that we will continue to do so until the disposition program is completed sometime next year. To date, I believe the market has not appreciated the value that we are creating at RioCan. As our prime goal is of course total unit holder return, our task, if this under-appreciation continues, will turn from juggling to exploring the many avenues we believe are open to surfacing that value. Really, just starting to do on an entity level what we have been doing for many years on a property level, surfacing value. Thank you, and I'm certainly open at this point, and all of us are, to any questions any of you may have.
Thank you. [Operator Instructions] And your first question here comes from the line of Dean Wilkinson with CIBC.
Just in light of the substantial progress you've made on the asset dispositions, do you think you could possibly ramp up the development on the other end of it, or are you structurally limited by the zoning and the approvals and the permits and all of the rest of that stuff that's got to go in place there?
That's a good question, and we are limited certainly by the pace of zonings. As Jonathan mentioned and actually one of my peers once said, the zoning and predevelopment speed, it moves at a geological pace. From the time you start thinking about zoning a property 'til you actually can get zoning and actually be ready to put a shovel in the ground, it's typically about three years. Having said that, we are starting to get quite a few properties zoned, and we could proceed a little faster but for -- in fact, in some cases, probably quite a bit. But we have other guardrails besides the process, and they're part of those balls I mentioned we're juggling. We are very focused on the strength of our balance sheet. We think that's critical, and we're not going to go too far in the development program where our balance sheet gets out of where we want it to be.Secondly, we have distributions to pay and FFO growth to achieve. So every time you take a property out of -- you put it into development, it comes out of IPP and stops producing cash flow and income. So, again, we have to be very measured at this point into how many properties we put into development at any given time. You know, we currently have about $1.4 billion invested in our development program. I would think that for the foreseeable future, barring any structural changes that may happen, that is pretty close to our limit. Now, the good news is, things are finishing. As both Jonathan and I have mentioned, we've got a lot of buildings actually that will be going from properties under development to income-producing over the course just of the next 12 months. In fact, literally hundreds and hundreds of millions of dollars' worth moving from one to the other. That then opens us up. So we've got to keep -- and we certainly have the product to do so -- a pretty steady pipeline of that going. So, barring any structural changes, no, we can't ramp it up much.
Okay, that's great. I mean, it still sounds like the REIT structure at some level does limit your ability to tap into all the value.
It does. Just from a timing point of view.
From a timing point of view, which, I could ask you to elaborate, and I know you won't, on the comment of exploring the many avenues.
That is correct, I won't elaborate.
I thought I'd try, anyway. Just turning to the Toronto market and all of the residential development going on there, and I guess recently we've seen some, I'll call it campaign election promises for the introduction of up to 10,000 affordable units a year, if-come, kind of thing.
I think Jennifer Keesmaat's got that up to 100,000.
100 over the next --
Not per year, not per year.
Yeah. So a lot of people are talking about adding, adding, adding. So as you look at the market, and certainly yours wouldn't be in that realm, but what do you think this market can absorb?
I think the amount of absorption in quality rental housing is not the slightest problem, because you've got 2 big factors going on, and I'm going to come back to the affordable housing as well. But you've got 2 big factors going on that are demographic. You've got really quite high real estate prices, which prevents a lot of the younger demographic from becoming homeowners. I think the percentage of people over the course of the next 5 to 10 years that own homes in our major markets, particularly in Toronto and Vancouver, where the price increases have been the highest, but we're starting to see this in Ottawa as well, a bit of a laggard, and in Montreal as well, early days. So you're going to have a natural growth in the number of renters from that side because of the cost of owning housing.Secondly, the generation that I belong to, the baby boomers, many of them -- and I can tell you this even from some of my friends -- their biggest asset is their home, which has appreciated tremendously over the last 5 or 10 years, and what many of them are doing is selling their home and moving into rental housing as opposed to buying a condo, because they're looking at it and say, hey, you know what? What do I need to sink that capital into a residence for? I can invest it in RioCan units and make a lot of money, and in the meantime, pay rent that isn't going to go crazy because there's laws.So I don't think there's any problem with the newer quality absorption. And the other, the third factor I've seen, and I've already seen it start to happen in existing situations, is that people will pay -- they won't pay a lot extra, but effectively they are because they will move into a much smaller unit than what they currently rent when the prices aren't that different, and which we are able to achieve. Because, you know what? The difference in quality between the average age of buildings in Toronto and right across the country who are -- you know, the average age of most of these buildings are 40 to 50 years old. They don't have modern environmental things. The buildings leak air. The elevators, you know? We're busy replacing the elevators right now at Yonge Eglinton Centre. You know, once you get past 40 years, they're broken as often as they're working, and they really need to be replaced. Apartment building owners don't replace them so quickly, and they're not modern elevators anyway, so they fix them. There's a lot of reasons people want to live in new buildings. I've just touched on a couple of them. So I think between the changes in demographics of renters and the desire of people to live in new buildings, I think the absorption of our products will be fantastic. The second thing I just -- and you opened it up -- affordable housing. We have properties where we've gotten zoning, but it doesn't make sense to build it because we don't think we can get high enough rents because of the area. And we have initiated conversations with the city, particularly in Toronto here, and said, look, we can build affordable housing, but guess what? The highest cost we've got are your charges, the development charges. The different fees they want. If you waive those development charges, we will build -- we've got one site out at Markham and Eglinton where we could probably build close to a thousand units over the next few years of affordable housing in an area that really needs affordable housing, but quite frankly, with the development charges and other charges the city puts in, can't afford to do it. So there's ways of doing it and we would be happy to participate with the various municipalities, and not just here in Toronto, in creating that affordable housing, but we need some incentives to be able to do so.
Let's hope they're listening.
Let's hope.
Your next question comes from Pammi Bir with Scotia Capital.
Ed, I know you may not answer this, but I'm going to give it a shot maybe in a different way. But just going back to your comments about unlocking value, it seems like the decision there is partly dictated I guess by the unit price. So what sort of timeframe would you be thinking about? Is this something that -- you know, is it 6 months, is it a year, or is it -- or if you can provide any color.
Yeah. And again, I'm not going to get into any kind of the things that we are thinking about, because all we're doing is thinking about them. Quite frankly, we're very busy right now, and our prime sort of strategic goal, and there's always a few besides the obvious one of doing better and better on our existing properties, is to complete the disposition of the secondary market properties and to move forward as quickly as we can on the development of our RioCan Living portfolio.What we're going to do with all of those things, and try to unlock the value, if the market has not recognized that value by, let's say as we roll into 2019, then we'll start thinking about it very seriously and exploring alternatives. But I would say for the next 9 to 12 months, we've got our hands full, and we're just going to keep pursuing what we pursue, telling people exactly what we told them today, and hoping that the market recognizes the value that's being created and the alternatives that may be open to us to surface that value. Because I don't think that there's any magic formula, I think the various things that can be done are fairly obvious to people, at least they are to us. Okay, Pammi?
Yep, no, that's helpful.
Next year, next year.
Yeah, stay tuned. Maybe just looking at the asset sales, you made some good progress again. I guess, you're almost 60% done. What can you comment on in terms of the new round of buyers on the conditional 280 million, and then perhaps on other buyers that you're having discussions with? Has that mix perhaps changed much from what you've done in the past, or some color…
I'm not going to say a little bit, but I’m going to turn it over to our new COO, Mr. Gitlin, who still maintains responsibility for this program, as well as other things. So go ahead, Jonathan.
Sure. It's a very similar mix, Pammi. It's made up of private REITs, private individuals, syndicators, a very similar profile to the round of buyers that bought up the original tranche of assets in early 2018. There are different parties coming to the fold, depending on the geographical region, because like I said, there are some local high net worth individuals who like to buy assets that are local to them. So we've seen a lot of velocity out of those types of buyers, but by and large it's a mixed bag.
Great, that's helpful. Just maybe one last one. Going back to The Well, Allied has cited a 6% to 10% unlevered targeted yield on the commercial component. So after you factor in I guess residential rental building number 6, which I think you have a 50% stake in, where do you see your yield coming in for The Well? And secondly, is that number excluding or net of the air rights sales?
First of all, as far as the residential component, internally here, because we have different partners, we treat them as 2 separate projects, so I don't think we actually have a melded number. We could probably come up with it if we tried. But we're expecting that residential tower to do extremely well. We're working with our partner Woodbourne. It's all designed. It's got 590 units, which will probably be our single biggest residential building, and we're pretty excited about it.As far as the commercial component, we're quite confident that we will achieve 6% or better as a final yield. You have to appreciate, there's a lot of guesswork at this stage, which is we're really at the very beginning of starting to harden in some of this information. We've done our -- Allied has done the first lease, and we expect over the course of the next month or 2 to see a lot more. On the retail side, we are holding back and really won't really start leasing until next year. By that time, we think a couple of interesting things will have happened. The bulk of the office will be leased, retailers will understand that there's going to be probably 6,000 people working onsite every day, and they will also understand the type of people and that they're going to be relatively high-paid tech workers, by and large, and information workers. We will also -- well, not we -- our partners on the residential side, the condo side, primarily Tridel, will probably be going to market I suspect early next year with the condominiums. So, again, people will start to understand what we're really creating here, which is a site that will have 9,000 to 10,000 people that actually work or live there, never mind all the buildings in the neighborhood. So we're holding off the retail leasing, and really our guess as to what those retail numbers will be will become clearer in 2019. Having said all that, we're pretty comfortable with that 6%-plus number. I hope I answered some of your question.
Yeah, no, that's very helpful.
Your next question comes from Sam Damiani with TD Securities.
So just sticking with The Well, I noticed the costs did go up. I wonder if you could maybe offer something a little more specific as to what parts of the project saw the higher cost. Was it the office space, the retail space, common area, base building, and --
Yeah, I wouldn't break it into those. I would go with your last and just say base building. I mean, I don't think it's any secret that construction costs have gone up over the last year and a half. And so what we've encountered over, I'd say the last 4 or 5 months in The Well is that what we've actually gone into -- and we are in the process of hardening our construction costs, and quite frankly that's the 1 number in The Well, the construction costs, the hard construction costs, that I think we're getting relatively comfortable with. Having said that, we're working very hard to bring those costs down through various value engineering techniques. But the biggest increase -- in fact, I would say the bulk of it if not exclusively -- has been in hard construction costs. And I'm not saying we're contracted, but we're pretty hard-costed for about 70% of the total cost of that project at this point.
So that's good. And these higher costs, have they at all come with higher rents that you're getting on [ at least ] the office space today?
So far, again, it remains to be seen. I will tell you that the office deal -- and there's only 1 been firm-signed -- but all the other office deals that we are looking at are ahead of pro forma. So, has there been an increase in office rents? Yeah. And, you know, same old story. Just because it costs us more to deliver that building is not why the office rents have gone up. The office rents have gone up because there's so much demand for the limited amount of space that is in fantastic locations and in fantastic developments like this one, and that's one of the reasons we're holding off on retail. I think there's going to be demand for that space. And, you know, we're really not talking conventional retail tenants here. There's going to be a lot of local tenants, very heavy into food and entertainment and experiential retail, and we think that those rents will be well ahead of our current pro formas as well. So, yeah, you know what? That's why we're pretty comfortable in sticking with that 6%-plus yield, because, yes, costs are up, but so are our expectations and our experience on the income side.
And does the project have a lot of non-rental income via parking or signage? Is that meaningful in this case or really not that material?
Yeah, there actually is a fair amount. Jonathan can help me out here a little bit. But, for example, and the -- we announced that Enwave transaction, okay, where they're putting in a 6-million-liter tank. Well, it's a wonderful environmental thing, it's wonderful that it's going to be able to service other properties, including some of ours that we own with Allied in the sort of King West area, but it's a land lease as well, and they're paying us a very significant land rent for the right to have that tank on our land.We also have very, very unique digital signage approvals, I think which is really quite astonishing that we were able to get it, and I'll think Councilor Cressy for helping us on that. I don't know what the numbers are, but they're many hundreds of thousands of dollars per year. We also have, on the commercial side, leaving aside residential, in excess of 700 parking spaces, and yes, we are expecting revenue on that. Notwithstanding nobody wants to drive in Toronto anymore, I can tell you that every parking lot we own that's at a high-profile location is full, and we're able to increase the rates almost at will without losing anything. So those are probably the big three non-typical conventional rental revenue things that we're looking at, at The Well, and they're fairly significant.
And I think there will be additional opportunities. Given how dynamic this development is, there is going to be a lot of programming opportunities, none of which we've worked into the pro forma at this juncture. But I think as it comes closer to completion, those opportunities will surface.
That's helpful, and I have experienced those parking rate increases at the Yonge Eglinton Centre over the years, so thank you very much.
And we thank you for your business.
So just switching over to, Jonathan, your comments about cannabis leases, 18 deals, 53,000 square feet. I'm not sure if that's at 100% or your interest. But what types of spaces are these retailers taking in the properties, and how do you look at the creditworthiness of the operators behind the leases?
The spaces are just conventional in-line spaces, by and large.
Keep in mind, 15 out of the 18 are Alberta, and the 2 here in Ontario are with the Cannabis Control Board of Ontario, the CCBO.
And so, the spaces are generally conventional retail spaces that are in line in our unenclosed centers thus far, and they're not extremely sizable. I think they average about 2,500 to 3,000 square feet. With respect to the creditworthiness, I mean, I think we assess it the same way we assess any tenant's creditworthiness. We will look at their financials and make sure that they do have a balance sheet capable of paying the rent.
Yeah. I would add that the bulk of the leases, I think 10 out of the 15 or whatever we've got in Alberta, are with a public company where the -- they're actually a liquor distribution company, if I'm not mistaken. And listen, the big gold rush will quite frankly be -- depending on what the province finally does; there's been a lot of speculation -- does here in Ontario. I mean, this is where 40% of the population of Canada is, and presumably at least 40% of cannabis users, presumably. Well, maybe BC is a little overrepresented there perhaps. But we expect -- when I call it a gold rush, there's no question that whatever rules finally come down, they're not going to want 4 cannabis stores at one corner or -- you know, there's going to be some control over that, I suspect, no matter whether it goes private or not, so that the gold rush will be we've got all the private cannabis users looking to stake a claim at the best locations, many of which we own.You know, at the risk of making a joke, we're going to have, as I said, 6,000 tech/knowledge workers working at The Well. You think it's a good cannabis location? Probably. So we expect premium rents, quite frankly, for a lot of these properties, and it's not a big amount of space, but it's a good contributor.
Well, it's not a big amount now, but with Ontario --
It could be pretty big.
-- it could be a top-25 tenant.
Who knows?
One last question, just on eCentral and Frontier, when specifically do you expect to start marketing the units there?
Q3 and Q4. I think at eCentral, we're going to start writing leases in earnest in October, and on Frontier, we're going to start the leasing process in late September.
Great. Thank you.
So, yeah, by the fourth quarter, we'll be able to report on some progress there.
Looking forward. Good luck.
Your next question comes from the line of Michael Smith with RBC Capital Markets.
Just picking up on the cannabis opportunity, so you have I guess 15 stores or 18 stores in total, 15 in Alberta 53,000 square feet. What do you think the opportunity is in Ontario? Like I'm sure that you've had lots and lots of inquiries. Is it like 150,000 square feet, or do you have a ballpark on that?
You know, it's hard to say, because a lot of it is going to depend on what the government allows. I mean, the last thing I read, and I've read everything from nothing to many, is that the betting seems to be at this point that they're going to allow a mix of private stores but continuing with the public stores, which is an odd result, but nonetheless that may be. And then we have 2 leases, as I mentioned, with CCBO, so I don't know what's going to happen to those.But I would guess that the opportunity, probably in total in Canada for us, might be in that 150,000 to 200,000 square feet, and it really is a bit of a guess. But like I say, I suspect it'll be at premium rents. But a lot of it going to depend on even what municipalities do. I mean, Richmond Hill, for example, I recall when the first wave of stores were announced, they actually passed a council resolution saying they don't want any cannabis stores in Richmond Hill because --you know, so they'll send all their customers to Vaughan. I don't know what they're doing. But anyway, it's a bit of a silly statement, but nonetheless, municipalities will take positions. So, who knows?
Okay. And just switching gears, so you've made great progress on your asset sales, about 50%, including those under contract.
58%, but who's counting.
58%. Sorry, yeah, 58%. And just for the balance, do you expect to achieve more or less IFRS [ book ]?
Yeah. Now, having said that, because we're able to -- we do 2 things that I think maybe a little different than some of our peers. Because we're actively in the disposition market, we know what the market values are. Whereas typically IFRS values are basically pretty formulaic with some element obviously of judgment when it comes to cap rate, both the judgment and the formulaic parts of it are taken out of it when you go to market, because then it really is being valued by a willing buyer and a willing seller. So, which is the traditional, that I learned in school, measure of fair value. But obviously, you can't do that with a whole portfolio.So we are adjusting our values basically on a quarterly basis now to really reflect not what's happening in deals, but what we see happening 3 to 6 months down the road, because -- you know, so once we have gone through that process, and like I say, we go through it every quarter, we are quite comfortable that the values we will achieve in the final dispositions will be materially in line with our IFRS values.
Okay, thanks. And once you get -- I know it's early stages and you've still got a lot of asset sales slated, but are you thinking about adding to that $2 billion of plan dispositions?
You know what? It depends on the market reception as the work goes on. I mean, we're constantly jiggling and we have periodic meetings as to, should we keep this one, should we not. So there isn't a -- when we say $2 billion, that was our target. There wasn't an identified $2 billion worth of property. I think our whole secondary market is about $2.5 billion, at least when we started. Obviously, it's a lot less now. And we have looked at that we're going to end up selling about 80% of that, and that's where we came -- you know, the original announced targets, if I recall correctly, was that we were going to get ourselves down to having secondary markets be no more than 10% of our assets, i.e. 90% from major markets, as Jonathan and Qi mentioned. We're getting there pretty fast. We're up to 86%. Because you also have all of our developments as they're completed. They're all in major markets. So as they move to IPP and that process is starting to happen, that will bring up the percentage as well. So it's really a qualitative decision that we'll be making on a property-by-property basis over the course of the next 6 to 12 months.
Thank you. And last question. Just on the marketable securities, I mean you've had some nice gains there. What can we expect for the next few quarters?
I think the next few quarters, you'll see consistency, because we have other sources of gains. You know, for example, ePlace that we talked about earlier, we're talking about the substantial completion of the rental tower in the fourth quarter. That doesn't mean -- you won't have tenants in yet, but it'll be substantially complete by the end of this year. Well, that also means the condominium building, if our construction managers are correct, will be substantially complete by the fourth quarter as well, which means you start closings. So obviously there's gains coming from that.We have Kingly Condominium. That'll be gains in 2019, all of which are pre-sold. We've got townhouse projects in Oshawa that we're building, which the first phase, I think about 175 units, is all sold. So we have multiple sources of gains, it's not just securities, so that I can tell you with pretty good confidence -- and quite frankly, Michael, this was always the plan over the course of the last 18 months, as we're coming up with these strategies, is that we would have gains to roll out during the entire disposition period and beyond that would keep our FFO where it is or growing while all the development projects that we have underway are moving towards completion, so that there's never really an interruption in that FFO growth over the next several years. So that's the larger strategy, and so far it's unfolding the way we wanted it to and we fully expect that to continue into 2019. That's a very long answer to your question.
No, very helpful. That's it for me. Thank you.
Your next question comes from Matt Kornack with National Bank Financial.
Just want to take the opposite side of Michael's comment on the fair value there. You've now sold a fairly significant amount of assets at higher cap rates than your weighted average, but you haven't budged the weighted average all that much, and at the same time you sold some core assets with what you say is less upside at pretty low cap rates in core markets. So wondering if you're being conservative here on the IFRS cap rate for the remaining portfolio.
I was being conservative, and you know what, I would say, you know, we had this discussion actually in our [ audit ] committee meeting yesterday. It's not the first time. When our auditors, who tend to be conservative, think that our -- I think the phrase that we settled on was realistic. I personally think they tend to be conservative, but having said that, I am not on the committee that -- in fact, they don't even let me in the room because I tend to be a little optimistic perhaps, and less than conservative, so they might be a little bit conservative but quite frankly I would rather be that way than -- you know, sometimes I think some of our peers are maybe a little too aggressive. I mean, you know, I'm not going to get into individual names, but when you look at our sale values and you look at the makeup of some of our peers' portfolios and you look at their cap rates as compared to our disposition cap rates on secondary markets, you go, hmm, interesting.But on our major market assets, which like I say or like Qi says are up to 86%, are we conservative? You know, it's hard to say. Time will tell. But I certainly think we're realistic, and we want to be in a position on those assets not to have to take steps backward. But again, those numbers are important for NAV calculations and I guess to analysts and so on. But where they also reflect is on the leverage calculation, and that's one of the reasons why we started to focus last year and try to focus the market. And I think with some beginnings of success on the net debt to EBITDA calculation, which we think is far more important, and typically ratings agencies, sophisticated investigators will tell you that the leverage calculation is one that they don't even look at, because the denominator of that number is quite discretionary.
Yeah, no, I think there's definitely been a shift within the Canadian marketplace to look more at that figure, even on the equity side, which is fair. And then you trade at a fairly deep discount to NAV. I would assume that the pace of your NCIB program, contingent I guess on asset sales continuing to be around this 200 million to 300 million per quarter would be fairly in line going forward?
That's the plan.
Until the disposition program is complete?
That's correct.
Okay. And then just 2 quick accounting items. G&A was a little higher. Obviously, there's a one-time item there. No change in your view in terms of G&A as the portfolio shrinks in the near term? Should we run pretty much the same number on a revenue basis, or do you expect that to tick up in the interim and then come down, I guess, as these developments are complete and become revenue-generating?
Yeah. Hi, Matt. Our view is certainly we'll continue to take great efforts to bring down the overall G&A, especially with setting so much assets. But one thing I do want to point out is that because quite a number of the G&A savings, gross G&A savings as a result of the disposition program is actually recoverable cost to the tenants, so we would not be -- even though the fundamental, the gross G&A will be the reduction is much greater than you would see in the financial report under the G&A line, just because a chunk of those will be recoverable cost.
No, that makes sense, and appreciate that commentary. And then on capitalized interest, it was a little higher this quarter. Is that a good run rate for the remainder of I guess the year, given that The Well is starting to ramp up?
For the year, yes, because it's really, as you can imagine, driven by that balance in development. As we talked earlier, we currently have approximately $1.4 billion on the books for development, including under the PUD property under development and residential inventory. So because we are ramping up on development, until the major project get completed next year, the PUD balance will stay where it is, around that between 1.4 to probably up to around 1.5 billion. And so that will [ basically ] give you the run rate for the capitalized interest.
And our leverage modeling looks that you can sort of maintain current levels given dispositions, combined with the spend on your development portfolio over the next 12 to 24 months. Is that a fair commentary? And then once the disposition program is complete, how do you look to funding incremental developments beyond that point?
I'll answer for Qi on that one. The first one, the answer is yes. That model should be pretty accurate. As far as funding in the future, quite frankly, we'll see. I don't think we're ever going to be finished selective dispositions of assets, because we're constantly evaluating our portfolio, and where we see low growth properties or no growth or even properties going backwards, we won't hesitate to sell those properties, especially because we have good use of the funds. And now we're getting out sort of a year and a half from now, and I wouldn't want to be more definitive than that right now.
Nope, that's fair. Thanks, guys.
Okay. I think we have time -- we've gone over time, so I thank you for your interest. We have time for one more question if there is one.
Your next question comes from Johann Rodrigues from Raymond James.
I guess you talked a lot about creating value at the development pipeline and a few different analysts have tried to kind of figure out maybe how to better calculate some of that value by asking about questions about, you know, The Well and completed projects. I think Pammi did. I wanted to ask it from the other side. King Portland, you guys have finished, 98% leased, all the condos sold. So maybe I was wondering if you are able to give an idea of kind of, I think you spent $85 million or you will have spent $85 million. What is the value that you guys have created, either the IFRS value of the office component tacked on with the proceeds of the condos, and then the yields. Like how would that compare to maybe 2 years ago when it was a little bit less of an office market and it was going to be a rental building?
Well, you mean the condo building. But certainly, the condo building, when we made the decision to go as condos, the value creation is significant, because we sold it at a much higher value per square foot. On the office building, I'll be honest. We haven't done those calculations, but now that you've asked, we're going to do some. We tend to do them retrospectively rather than prospectively. When the building's finished, the tenants have moved in, we figure, well, that's when we mark it up to whatever current market says. So I don't have that information, unless Qi does?
Yeah, no. We did do some internal, but we don't know yet.
Yeah. So, you know what? But that's a very good question, and over the course of the next few months we're going to do some work on that.
Okay, great. And just one quick question. When you're all said and done with these asset sales and there's the 10% secondary market assets left over, or call it 5% to 10% over the longer term, can you characterize those secondary assets that you guys want to keep hold of and maybe give an example or 2?
Yeah. I mean, you know, for example, we own the largest shopping center in Kingston, Ontario. That's not on the disposition list right now. It's a great center. It's a huge piece of property, it's a big power center. I think it's about 700,000 square feet. And it's irreplaceable. Kingston as a city isn't going anywhere. You know, besides all kinds of educational assets, it's a growing tourist destination because it's a location near Prince Edward County, of course has Queen's University, has the Royal Military Institute, and has other industries that will keep it growing. And that's a city that we're actually seeing rental growth, because it's a big city from the point of view the market's probably 100,000 to 150,000, and it's not one that's diminishing, but it's not that big that people are building all kinds of new stuff. So we think the value and the lease-ability of a property like that will continue to grow over the next few years, but that'll be something that on an annual basis we'll review. But there's an example.
Okay. Thanks, appreciate it. I'll turn it back.
Thank you. Okay. I think, Casey, that'll do it.
Great, thank you. And any closing remarks?
No, just to thank everybody for their interest and we'll talk to them all again in three months if not sooner.
Thank you. And ladies and gentlemen, this concludes today's conference call. You may now disconnect.