RioCan Real Estate Investment Trust

TSX:REI.UN

Earnings Call Analysis

RioCan's Prudent Management Amid Market Volatility

RioCan displayed robust operations, with strong leasing activity signaling confidence amidst an uncertain economic landscape. FFO for the latest quarter rested at CAD 0.45 per unit. The company anticipates a leaner investment in development in 2024, conserving capital amidst market turbulence while sensitively watching trends to guide future construction ventures. Asset disposals totaling CAD 295.2 million mirrored the cost of debt, neutralizing FFO impact but reinforcing credit standing. Meanwhile, acquisition strategies enhanced portfolio quality using CAD 110 million balanced by prudent debt assumptions. Strategic capital recycling is set to refine portfolio robustness and growth potential. RioCan's debt management exhibits astuteness, evidenced by a staggered maturity ladder, predominantly fixed interest rates, and strong liquidity of CAD 1.6 billion. With asset sales earmarked for debt reduction, net debt to EBITDA ratio improvements are projected into 2024, further solidified by reduced development spends, prominently at The Well after Q1 2024.

Introduction to The Well Development

RioCan, in partnership with Allied Properties REIT, is gearing up to inaugurate The Well. This ambitious mixed-use development in the King West community of Toronto is heralded as an extraordinary architectural feat and is anticipated to be received positively, with the majority of its retailers expected to be operational by the end of 2023. Confidence in this venture is high, and it is believed to embody RioCan's vision, passion, and expertise and contribute to its long-term stability.

Financial Performance Metrics

RioCan's Funds from Operations (FFO) for the quarter increased marginally to CAD 0.45 from CAD 0.44 year over year, with same-property Net Operating Income (NOI) growth being a significant contributor. The growth in same-property NOI was driven by improved occupancy rates and development deliveries. However, net income reflected a loss due to fair value adjustments, but operating income remained robust. Assets were sold, and the capital was redirected into higher-quality investments and developments, which are expected to enhance portfolio value and support medium-to long-term growth.

Development and Asset Recycling

RioCan continues to focus on development projects such as The Well and 83 Bloor Street project in Toronto, expecting the latter to comprise an 80-story high-end condominium tower. Additionally, the Trust actively pursues smaller scale infill opportunities. Asset recycling remains an integral part of RioCan's strategy to maintain high portfolio quality and balance sheet health, even in a less favorable retail transaction market.

Fiscal Prudence and Financing Strategies

Despite market volatility, RioCan seeks a strategic balance, applying prudent fiscal management in safeguarding unitholder capital and maintaining commitment to long-term objectives. The company is finalizing financing agreements expected to be completed by year-end. Their approach reflects a blend of short-term tactics with a view toward the future.

Government Initiatives and Long-Term Growth

RioCan acknowledges the positive impact of federal and provincial government policies designed to boost rental supply in Canadian markets. Although the current capital allocation strategy is conservative, the company's long-term outlook remains positive, underpinned by these initiatives. While RioCan is holding off on new construction starts, they are focused on delivering units currently in development and preparing for future endeavors when conditions are more conducive to investment.

Earnings Call Transcript 2023-Q3

[Operator]

Good day ladies and gentlemen and welcome to the RioCan Real Estate Investment Trust Third Quarter 2023 Conference Call and Webcast. As a reminder, this conference call is being recorded. I would like to turn the conference over to Ms. Jennifer Suess, Senior Vice President, General Counsel, ESG, and Corporate Secretary. Ms. Suess, you may begin.

[Jennifer Suess, executive]

Thank you and good morning, everyone. I'm Jennifer Seuss, Senior Vice President, General Counsel, ESG, and Corporate Secretary of RioCan. Before we begin, I am 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.In discussing our financial and operating performance and in responding to your questions, we will also be referencing certain financial measures that are not generally accepted accounting principal measures, 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 metric 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 additional 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 applied in making these forward-looking statements, together with details on our use of non-GAAP financial measures can be found in the financial statements for the period ended September 30, 2023, and Management's Discussion and Analysis related thereto, as applicable, together with RioCan's most recent Annual Information Form that are all available on our website and at www.sedar.com.I will now turn the call over to our President and CEO, Jonathan Gitlin.

[Jonathan Gitlin, executive]

Thanks so much, Jennifer, and thanks to everyone that has joined RioCan's senior management team today. The RioCan's Q3 operating results again reflect the excellence with which we are executing our strategy. However, because I know it's on the top of mind for many of you, I'm going to start today by addressing our guidance. I expect, due to interest rates, RioCan will end the year at the lower end of our 2023 guidance range of between a CAD 1.77 and CAD 1.80. Our long-range targets will need to be revisited if higher-for-longer interest rates persist, and we're going to provide an update on this in the first quarter of 2024.I'll now turn to our Q3 operating results and then I'm going to touch on the macroeconomic environment. I'll highlight how RioCan continues to strategically and responsibly manage every facet of our business over which we have control. Consistent with each successive quarter since our February 2022 Investor Day, RioCan's team and portfolio have performed exceptionally well. This performance reflects the quality of our locations and the cycle-tested experience of RioCan's team. Once again, RioCan's superior property fundamentals and the extensive demand for our space drove standout leasing spreads and record occupancy. Our development deliveries also continued to generate a steady stream of new and diversified NOI. Our key financial indicators for the quarter were strong, with same-property NOI growth of 3.7%, exceeding our target and providing the foundation for FFO per unit growth. FFO per unit for the quarter was CAD 0.45. Leasing velocity remained a dominant theme as RioCan's high-quality, necessity-based retail portfolio propelled results. Retail committed occupancy reached an all-time high of 98.3%.New and renewal leasing spreads of 21% and 11.2%, respectively, resulted in a blended leasing spread of 12.9%. The average rent per square foot for new deals was CAD 27.02, well above the average net rent for the portfolio of CAD 21.39. Now, we believe this expanding mark-to-market spread indicates a significant growth opportunity, as an increasing number of contractual fixed rate renewals start to burn off.You've heard me speak about Canada's tight zoning regulations and the vast gap between replacement costs and market values, which makes building new retail a very unlikely proposition. You've also heard me reference the pace of Canada's population growth and the natural gravitation to transit-oriented major market locations to live and to shop. These are the same markets in which retail space is supply constrained and also the same markets in which RioCan's portfolio is concentrated. In addition, our retail tenants are displaying health and strength, particularly in this inflationary environment. These factors converge, and they drive demand and create positive tension in lease negotiations for our brick-and-mortar spaces. All indicators are that the type of space RioCan offers will continue to be in short supply and high demand.But our operating results are rooted in factors far more deep seated than favorable supply-demand dynamics. RioCan's current strength and stability are a function of years of unwavering discipline in responsibly managing every aspect of our business over which we have control. This focus has resulted in a portfolio and team designed to thrive in promising economic conditions and to deliver strength and stability in downturns. This means we face the current conditions with confidence, and here's why. RioCan's portfolio has never been more desirable or more defensive. Our major market focus has resulted in a portfolio that's concentrated in densely populated areas. Within a 5-kilometer radius of our assets, the average population is 260,000 people, with a high average household income of CAD 140,000. This demographic profile provides a compelling opportunity for our retail tenants. The quality of RioCan's tenant base has improved in lockstep with the improvements in our portfolio's demographic profile.Combined with our commitment to resilient retail, the result is a tenant base tailored to offer a mix of convenience and necessity-based goods. We've also invested in our centers to make them even more attractive to tenants and to our customers. The steps we've taken over the last decade and the effective execution of our strategic plan have set up RioCan to weather the current environment. However, we're not a team known for simply weathering. We're a team that wins, and we understand that winning in these conditions requires hypervigilant discipline and capital allocation, specifically reducing costs associated with traditional expenditures such as G&A, construction, and acquisitions.RioCan hires for grit and we reward resilience. We encourage creative problem solving, courageous leadership, and continuous innovation. We're well equipped to take the logical and prudent steps required to offset some of the impacts of interest rates and to fortify our future. We're increasingly leveraging our national scale to reduce operating costs. We're also driving costs down through system improvements that generate efficiency and allow us to streamline expenses. This includes the 2024 implementation of a new Yardi-based ERP system.Regarding development, we're adding value by moving projects through the entitlement process, but we're taking a conservative stance in activating capital intensive construction. At the same time, we continue to focus on strengthening our balance sheet. Dennis will expand on the levers through which we'll do this, but for now, I'll emphasize that the 2,605 condominium and townhouse units we currently have under construction are expected to generate combined sales revenue of over CAD 800 million between now and 2026. These proceeds are earmarked for effective uses, including the repayment of debt. Last, in addition to the cost control and responsible balance sheet measures I just referenced, we will continue to take advantage of every revenue-driving opportunity presented by the current operating environment.I'll take a few moments to talk about The Well. I do this for 2 reasons. First, this project is emblematic of everything I just spoke about, namely, RioCan's ability to effectively manage every aspect of our business over which we have control, while at the same time investing in our future growth. This project demonstrates our resilience, ability to execute, commitment to intelligent diversification, customer centrism, responsible growth, and our ever-present balance of boldness and prudence. There is no more excellent reflection of RioCan's boldness than the vision and scale of this project. Our prudence is reflected in countless ways, but perhaps none as much as the patience and responsibility we and our partners at Allied demonstrated as we leased this project while in the throes of a global pandemic. We remain steadfast in our commitment to populate this incredible development with the right mix of innovative, experiential, and service-oriented retailers, and inspired food service offerings that Toronto has been waiting for.Approximately 96% of the total commercial space at The Well is leased, with about 89% in tenant possession. The retail component is 91% leased, with another 2% in late-stage negotiations. On this subject, I'm pleased to announce that Lululemon and Sephora have recently signed leases and will join The Well's impressive tenant roster. There's also been exceptional demand at FourFifty The Well, the 592-unit rental residential tower developed by RioCan with our partner Woodbourne. Beyond The Well offering obvious proof points of all that RioCan is capable of, I have a second reason for wanting to focus on this project right now.RioCan and our partner, Allied Properties REIT, are on the precipice of introducing the King West community, the GTA, and The Well to one of the most ambitious mixed use developments in Canadian history. By every measure, this is an outstanding architectural achievement, and the accolades we're receiving have fortified our belief that this is precisely the right product for Toronto. Momentum continues to build for our mid-November ribbon-cutting ceremony, and you'll continue to see a cascade of relevant businesses open at The Well in the coming months. The majority of retailers are expected to be open by the end of 2023. On behalf of the incredible team at RioCan, it's an honor to deliver this development. We are confident our vision, passion, and expertise will be reflected in all ways The Well has experienced in the weeks, months, and years to come.Before I turn the call over to Dennis, I'm going to reiterate that RioCan's long-term thesis remains very much intact. Retail real estate dynamics are in our favor and are producing meaningful demand drivers for our product. The fundamental quality of our assets fuels long-term growth and mitigates downside risk. Who knows if interest rates will move up, down, or stabilize? What I do know is that at times like these, RioCan is fortunate to be operating a best-in-class retail portfolio in the major markets of this great country. RioCan is well positioned regardless of the scenario. We've taken significant steps to make our business viable in any backdrop. We're now in a moment where these steps are being tested, and I'm proud to say we're standing up to that test. If interest rates stay higher for longer, it may temper our growth in the short term, but real estate is a long-term investment. Our consistency, vision, and demonstrated commitment to responsible growth will continue to serve our unitholders well, and at the same time, position the Trust for continued stability.With that, I'm happy to turn the call over to Dennis.

[Dennis Blasutti, executive]

Thank you, Jonathan, and good morning, everyone. Our FFO for the quarter was CAD 0.45 compared to CAD 0.44 in the same quarter last year. The key components of this increase were $0.02 from our 3.7% commercial same-property NOI growth. On a year-to-date basis, same-property NOI growth was 4.3%. This included the benefit of reversing pandemic related provisions as our team continues to work through legacy balances with tenants. Excluding the provision, year-to-date same-property NOI growth was 3.3% and remains on track to achieve our full-year target of 3%. Same-property NOI has benefited from a number of factors, including a notable improvement of 70 basis points in in-place occupancy as tenants signed in prior quarters have moved in. Other contributors were $0.02 from development deliveries, including The Well office and the ramp up of residential rental assets such as our Luma and Rhythm properties in Ottawa. These were partially offset by $0.02 due to higher interest rates in the current year as compared to the prior year and CAD 0.01 due to assets sold in the prior year net of the accretive impact of a prior year unit buybacks. We have recycled capital from assets sold into higher-quality investments and developments as well as use the proceeds to pay down debt. We believe that this short-term dilution in FFO is well worth it for the long-term benefits to quality, value improvement, medium- to long-term FFO growth, and balance sheet strength.Net income for the quarter was a loss of CAD 73.5 million, which was driven by a fair value loss of CAD 199.5 million. Excluding this unrealized loss, our business delivered strong operating income. The fair value loss was driven by a 10 basis point increase in our weighted average capitalization rate assumptions, partially offset by a 3 basis point decrease due to change in portfolio mix as we sold lower-quality assets and redeployed that capital into higher-growth assets, a continuation of a trend that we have seen over the last number of years. The fair value losses from the change in cap rate assumptions were partially offset by CAD 46.3 million of fair value gains driven by higher income at our properties; again, a continuation of a trend over the last number of quarters where the operating results that are in our control are adding to the value of our portfolio.Development deliveries continue to aid portfolio quality and income growth. In the quarter we delivered 151,000 square feet and remain on track to deliver over 600,000 square feet of new product this year that will contribute approximately CAD 25 million of NOI upon stabilization, which will ramp up over the coming year. The majority of deliveries in the quarter related to retail and residential components of The Well where leasing is very strong. With respect to development spend, we expect to be towards the lower end of our guidance range of CAD 400 million to CAD 450 million for the current year and anticipate this amount will be substantially lower in 2024. While we do not plan to start construction on new projects in the near-term, we will continue to create value through the development process by advancing our pipeline through zoning to shovel ready status. To that end, we recently received zoning for the 83 Bloor Street project in Toronto's prestigious Yorkville neighborhood. This is a location where we combined our existing retail assets with a partner who owned neighboring assets to create a land parcel of the scale required to redevelop. The plan for this site is an 80-story premium condominium tower that will include a commercial podium of approximately 18,000 square feet.In addition to our large-scale developments, which tend to get most of the attention, we also have more immediate infill opportunities at our retail centers. For example, in the quarter we delivered a 16,000 square foot retail strip at our Windfields Farms retail center that includes Service Canada as a tenant. We are currently constructing 2 additional strips that include tenants such as PetSmart and CIBC. Windfields Farms is a prime example of a high-demand GTA location that RioCan developed from a greenfield site. Today it comprises approximately 175,000 square feet of open air, grocery-anchored retail, 3 condo towers, including 2 currently under construction, and 406 townhomes. A community such as this creates significant demand and the rents that motivate RioCan to build this space. We are seeing these types of opportunities in a number of existing locations, with approximately 160,000 square feet of retail properties under development expected to be delivered between now and the end of 2024. While individually these projects are relatively small, we see these as good opportunities to deploy capital. We will, of course, remain disciplined and ensure we achieve the rents that support the construction costs.In spite of the challenging retail transaction market, our team has continued to source opportunities to recycle capital in ways that continuously improve our portfolio quality. This requires discipline as well as the ability to source special situations. So far this year, we have closed CAD 140.2 million of asset dispositions. This included an enclosed center in Winnipeg and a cinema-anchored center in Gatineau, Quebec, that were completed in the last month. We also have a firm disposition for a cinema and home improvement-anchored center in BC at a capitalization of 4.99%, which is expected to close in December and is expected to bring CAD 155 million of capital. The capital from closed and firm dispositions totaled CAD 295.2 million at a cap rate of 6.92%, which is similar to our incremental cost of debt on our corporate credit facilities, so these dispositions will be FFO neutral while being credit positive.Year to date, we have acquired CAD 110 million of assets, including a residential asset in Montreal and certain land assembly assets. These acquisitions included the assumption of CAD 45 million of debt at a weighted average contractual interest rate of 2.67% with 8 years of remaining term. Taken together, the equity for these acquisitions was CAD 65 million, leaving the remaining proceeds from asset sales for debt reduction. As you can see, our capital recycling strategy continues to improve our portfolio quality, growth potential, and balance sheet, while the attributes of the in-place debt within the acquisitions ensures that our economic return targets can be achieved.Our balance sheet continues to be a top priority. Our net debt to EBITDA at the end of the quarter was 9.45x compared to 9.51x at the beginning of the year. We expect this to decrease further by the end of the year as we close the aforementioned dispositions. Net debt to EBITDA is expected to continue to improve in 2024 as the EBITDA from our development deliveries ramps up and the spend on these developments decreases, most notably at The Well where the spend rate will reduce significantly after the first quarter of 2024.We manage risk in this environment by having a maturity ladder that is well staggered and having fixed interest rates for over 92% of our debt. Our strong liquidity position is very important, particularly within an uncertain economic environment. We have CAD 1.6 billion of available liquidity, predominantly in the form of undrawn operating credit lines and construction lines, with the committed lines spread across a number of banks. Our liquidity is sufficient to cover over a year's worth of obligations, inclusive of debt maturities and construction capital.Debt capital remains available for top tier borrowers like RioCan. We completed CAD 300 million of unsecured debentures in the third quarter. These were 3-year debentures with a call feature that allows us to repay the debentures at par and without penalty after 1 year. In light of the uncertain rate environment going forward, we paid a small premium for this flexibility. We believe that bolstering liquidity while maintaining optionality for a small portion of our debt stack is appropriate. We are currently in the process of finalizing agreements for certain commercial mortgages and a CMHC mortgage that we expect to close by the end of the year. In this time of turbulence, we will continue to be judicious with our unitholders' capital, balancing short-term tactics and long-term strategy. Our portfolio continues to produce strong operating results. As the fundamentals of top-quality retail real estate in Canada are among the best we've ever seen. We remain focused on what is under our control while continuing to strengthen our portfolio and position RioCan for accelerated growth as the market stabilizes.With that, I will hand over the call to the operator for questions.

[Operator]

[Operator Instructions] The first question is from the line of Dean Wilkinson with CIBC. Your line is now open.

[Dean Wilkinson, analyst]

This is probably going to be the first of a few questions on the guidance, Jon. Obviously, interest rate environment is ridiculously volatile, and what's happened over the past couple of days has put the 5 and the 10-year in Canada back to where you were in August. Pulling that guidance or pushing it out to 2024, when we look back to the August figure, were you guys contemplating a lower rate environment? Or if we were to stay around here, do you think that the numbers that you had previously mentioned would likely hold or is it just too early to say on that?

[Jonathan Gitlin, executive]

I think it is like we're all getting whiplash from the interest rate fluctuations and what I will say is that we're going to wait till Q1 and provide more appropriate updated guidance at that point. And, yes, and we'll have, I think, a little more color in where the medium-term interest rates will be at that time. So we will definitely look to provide more color.

[Dennis Blasutti, executive]

Yes, I think, Dean, [indiscernible] in a higher-for-longer rate environment, it does make the longer-term guidance a challenge. And I think the challenge right now is we've seen 50 basis point move over the last month. I think it was 75 basis points in the month before that in the 10-year. And the range of estimates for the end of 2024 from various bank economists is about 100 basis points wide. So it's really hard to pin down any guidance at the moment. But we are in our budget cycle now, working through that, and we'll provide that updated guidance, as Jonathan mentioned.

[Dean Wilkinson, analyst]

Yes, it's fair enough. It's incredibly volatile, I guess, dovetailing into that, your pen's down or perhaps shovel's down on new construction. What would you have to see to have you flipping the switch on that? Is it higher development yields or is it just a lower cost of variable rate debt that you have to finance that with?

[Jonathan Gitlin, executive]

I think it is a combination of both of those factors and a few others. As with everything, it's a capital allocation decision. So it's not just how good the returns are or not in the construction space, but it's also what the returns are on other potential uses of capital, including paying down debt, which in this environment is very accretive. And other things like potential acquisitions, doing mezz financings, things like that. So it would be a combination of elements that would lead us back into aggressive construction, but we have all the tools to do it. And one thing that we are always cognizant of is being able to jump the moment we see that the conditions are right and that it is the right capital allocation decision.

[Dean Wilkinson, analyst]

Okay. Makes sense. And the last one for me, it dovetails into just your target leverage metrics, more specifically terming out that debt. So how do you guys think about taking that 3.25-year term out to 5 just given what we've just been talking about interest rates there. Will that be a drag or could that be a target that might be maybe pushed out a little farther just given what the interest rate expense looks like if you were to go longer right now?

[Dennis Blasutti, executive]

Yes, I think it is something that probably is going to get pushed out a little farther from our target of getting there by 2026 simply because of the tactics that we've done over the last 18 months or so. We had some, I would say, gaps in our ladder in the shorter term that we thought we were comfortable with the amount of debt in those given years. And so we used that part of the ladder to do some of our more unsecured debentures to keep advancing that mix. And where we've seen advantages from a pricing perspective on CMHC mortgages and commercial mortgages that today are probably 80 to 100 basis points inside of the debenture pricing, that's where we've gone long. So we've barbelled into it as opposed to what we were doing in late '21, which is just all kind of 7 to 10. So that's what we've guided. It probably takes a little bit longer to get there, but I think, as Jonathan pointed out earlier, we are deploying some tactics right now until we can see a bit of stability and then the longer-term strategy has changed.

[Operator]

Next question is from the line of Lorne Kalmar with Desjardins.

[Lorne Kalmar, analyst]

Maybe just going back to the discussion around pulling back on developments. You guys obviously are continuing to move things through the zoning process. You have a very robust pipeline. Has there been any thoughts of doing any density sale as a consequence, assuming you get pretty low yields on that and could then recycle it back into debt reduction?

[Jonathan Gitlin, executive]

So, just to clarify, we're pulling back on construction, not development, which means that we continue to move the needle forward on getting properties entitled, getting them free of tenant obligations and things of that nature so that they are shovel ready. So it's construction that we're pulling back on. And I would say that we are always looking at ways to raise efficient and effective capital. And we've done so. We've demonstrated this over the course of the last few years. I think we've been very active in the disposition market, whether it's income-producing assets or development density. And that hasn't changed. I would say that that market is slower now than it would have been a year ago, Lorne. And we are, I would say, in the very fortunate position, given the amount of money we have coming in from condo sales or inventory sales over the next couple of years, our balance sheet is going in the right direction. We have enough to fund whatever construction we do have in the ground through just retained earnings and site-specific financings.So we really don't have a tremendous amount of pressure to need to raise capital. So if there is an opportunity in today's market where we can extract a lot of value for that density, sure, we'll jump on it because that's what we do. We're entrepreneurial, and we'll always do things where we feel there's an effective way to raise capital. But given where the current market is, which I'd say, while interest rates are fluctuating the way they are, there's a bit of a slowdown, I'd say, in the land market. So I don't think we would be active in trying to sell that today. But I think that, like everything, changes quickly. And we'll, of course, be ready, as we always are, to extract the most value out of our assets as possible, whether that's developing them ourselves, selling a partial interest to partners, and then getting fees from it, or just selling it outright.

[Lorne Kalmar, analyst]

Okay. Yes, I guess things could change by Monday. Who knows? On the condos, I think we've spoken about this before, and I know they're well located in good markets, but with everything that's been going on, I think it's still worthwhile asking. Has there been any change in terms of people pulling out of the condo deals and issues with closings, or are you guys still pretty confident in being able to achieve what you've set out?

[Jonathan Gitlin, executive]

We're confident for a couple of reasons. One, the sales that we did were a number of years ago. A lot of these condos are now in late stages of development, meaning that the sales were done in the teens. And that means that even though market values have dissipated a little bit, the values in which people have bought into these are still, I would say, above water. Secondly, we always were very careful to get sizable deposits and meaningful deposits. And I think people are loathe to walk away from generally 20% deposits. And third, people are generally also not inclined to walk away from their contractual obligations because it puts you in a situation of legal liability. But that being said, we are in unique times where people can afford what they can afford, and if they can't afford to close on these units, which again, I think is a very remote circumstance, RioCan is in the fortunate position where we have RioCan Living. And if these units happen to come back to us, if any parts of these units come back to us, we're well suited to deal with them and to extract value from them. But because of the 3 conditions I spoke about at the outset of answering this question, Lorne, I do really think that that is a remote circumstance. And yes, we are still confident in the ability to get that revenue in.

[Lorne Kalmar, analyst]

Okay. And just lastly for me, you guys new record high on occupancy, I think it was 21% on new leases. How high do you guys think you can push spreads before you can't anymore?

[Jonathan Gitlin, executive]

Well, look, I think that we're in a really good environment now, and I can't reiterate this enough, Lorne. There is no supply of new retail in major markets. We've got -- we and a few others have what I would say is really a gold mine of income-producing assets. And look, in certain circumstances, tenants are doing very well in this inflationary environment. They're protecting their margins, and therefore there is the ability to pay the rents that are necessary for our properties. There's always going to be that affordability quotient, but we keep on getting new and, I would say, thriving businesses coming into Canada, and that has created an upward push for our space. And like I said, given that there's no new space coming on stream, we feel pretty good about the continuous prospects of raising the revenue coming out of our income-producing properties.I would also say that there's a lot of ingenuity at RioCan, and I'm very proud of the team for continuously coming up with ancillary revenue methodologies that continues to also add to that bottom line. So between the 2 of those things, I think we've got a pretty steady growth profile. I won't be a total -- I'm always an optimist, but I don't think 21% new leasing spreads are here forever. But we are certainly in an environment where I think that we're going to see certainly the target we set out in our 2022 Investor Day of high-single-digit leasing spreads. I really think that is an enduring target and that we can achieve that. I don't know, Oliver, if you have any further commentary on the market these days.

[Oliver Harrison, executive]

No.

[Jonathan Gitlin, executive]

All right, well, I've said it all, Lorne.

[Oliver Harrison, executive]

You've covered it all.

[Operator]

Next question is from the line of Sam Damiani with TD Cowen.

[Sam Damiani, analyst]

And maybe I'll try and get Oliver to answer your question here. What are you guys seeing in terms know watchlist tenants or do you have any known tenant departures that you think are going to happen of any consequence in the next few months or a couple quarters?

[Jonathan Gitlin, executive]

I'll start and then John or Oliver can fill in any gaps I leave. And hey, Sam, I hope you're doing well. So we're actually in really good shape. We've worked very hard to get our tenant base -- the categories of strong and stable tenants up to a very high level, and they're at 87%. That means that the number of tenants on our watchlist is actually similar to what it was last quarter, which is pretty small. There's some small independent tenants that have called us about some rents that they're having trouble paying, but we're working with them and the hope is that we will be able to write those. But typically, if they're not capable of maintaining their businesses, the good news is that we've got a lot of backfill prospects for them. But really there's not a significant amount of softness right now. A couple of categories, should the economy continue to see challenges, there's always going to be categories that will have issues in that kind of environment. But right now we're seeing general strength across our portfolio. Jon or Oliver, if you have anything to add.

[John Ballantyne, executive]

Hey, Sam. I would just add there are a couple of categories we are keeping a close eye on. Sit-down restaurants, particularly more the mom-and-pop or independent operators, you read reports in the news about their ability to operate at a profit, which I think the most recent report about 35% of restaurant operators on the independent basis are operating at a profit. So that is something we keep an eye on. Our restaurants are predominantly national players where we feel good about their covenants. I would add more boutique gyms. We're hearing great things out of the GoodLifes and the LA Fitnesses. We are keeping an eye on the smaller operators. And furniture as well, as discretionary income becomes a little more challenged with what's going on in the economy, people are spending less on their homes and on renovations. So we are keeping an eye. Again, we have very few on the independent side, the covenants of our national players are strong, but always an area of concern.

[Oliver Harrison, executive]

Yes. And we do have -- Sam, specific to your question, we do have some larger vacancies coming up in the portfolio over the next few quarters. Fortunately, at the moment we have demand that exceeds the availability of what is coming back. And if you use an example of the Canadian Tire space we got back in Ottawa earlier this year, which was 140,000 square foot purpose-built building which we leased the day after Canadian Tire left. So we're always going to get space back. It's the nature of the business. But we are in the best position we've ever been to drive, rents and improve quality of tenants when those spaces become available to us.

[Sam Damiani, analyst]

Yes, I was thinking of the Canadian Tire space, or former Canadian Tire space. When you mentioned boutique gyms, John, I was just wondering, you're still obviously comfortable with the tenant that's going into that space?

[John Ballantyne, executive]

Oh, absolutely. The quality of service they provide, I had the pleasure of being at their Liberty Village location about a month ago. I also note that they've done a new location at [indiscernible]. We're very happy with the covenant, and we're very happy with the product they produce.

[Sam Damiani, analyst]

Great. Next question for me is just on the condo side, with the sale of the interest in 11YV, wonder if you could just tell us a little bit of what the rationale was for doing that at this stage.

[Dennis Blasutti, executive]

Sam, I think one of the things that comes with condo sales is they can get a bit lumpy, and we have a lot of sales lining up in 2025. And so both in terms of getting a steadier income stream but also managing any kind of tax exposures, et cetera, we thought it was prudent to do a transaction to pull some of that forward. It takes a proportion of construction loan off our credit metrics as well. So, all in all, we thought it was a good mechanism to effectively securitize those future gains and bring them forward into the current year.

[Jonathan Gitlin, executive]

And we had an enthusiastic counterparty who was very much inclined to do it.

[Sam Damiani, analyst]

Yes, it certainly looked like you didn't give up any profit by doing so. Doesn't look like it anyway. And then on the distribution increase, obviously nice 6% bump this past year with all the uncertainty and I guess pending guidance in February. Does your thought about an increase next year, is it any less than it would have been a year ago?

[Jonathan Gitlin, executive]

Well, it's a decision our Board makes, but the recommendation does come from management. And the one thing we always monitor is our payout ratio. And at times like this, you're quite right, Sam, it's more meaningful than ever to have retained earnings, because retained earnings are really the cheapest form of capital you can get. But that being said, we think we will be well within our comfort level on our payout ratio. And if we are, we would like to continue that upward momentum of consistent distribution increases. So provided we can afford to do so, it is something that we will continue to advocate for. But again, like everything, it's so volatile today, so we'll revisit that decision at the end of this year when we have a little more clarity on how 2024 is going to look.

[Operator]

Next question is from the line of Matt Kornack with National Bank Financial.

[Matt Kornack, analyst]

I'll keep it brief because I'm new to the REIT covering the story. But just with regards to RioCan Living, the federal and some provincial governments have been very active in putting out policy that would encourage the building of new rental product, notwithstanding challenging capital markets. Does that change your longer-term view on how much you'd potentially do in adding very necessary new apartment rental supply to the market?

[Jonathan Gitlin, executive]

Yes. So first of all, Matt, welcome back to RioCan. Good to have you. Second of all, I think the initiatives that the federal and provincial governments are taking are incredible steps and they are certainly something that will impact our long-term ability of delivering very good, purpose-built, multi-res buildings. It's something that is still very much part of our long-term strategy. It's something that we are currently benefiting from with the delivery of some of those developments. And I think it's something that this country sorely needs because I think we are in a bit of a housing crisis. So it definitely is something that we will be focusing on and the initiatives that the governments have taken will help with our prospects. Right now, as I said, it's just not an extremely prudent time to allocate a tremendous amount of capital. But that to me is a short-term view, and I think it'll improve partly because of some of these initiatives the government is taking over the next little while. Andrew, do you have any further commentary on that?

[Andrew Duncan, executive]

No. The only thing I'd add, Jon, I agree with everything you said, obviously, is that the changes to HST at federal and in some cases at provincial level definitely help the return on these projects. A number of other factors continue to have to happen, access to more affordable financing these projects would be very helpful to make these things work, improving timelines for approvals and improving the amount of density we can achieve, all things that the industry has talked about before, all things that require several levels of government to work together to solve the housing crisis, and all things that will improve our ability to deliver these projects at a beneficial return to our shareholders.

[Matt Kornack, analyst]

Okay. So it's fair to say that we shouldn't expect anything in the immediate term, but also you're going to continue along the lines of getting approvals for these sites and getting ready for when it makes sense from a capital allocation standpoint to invest in this platform.

[Jonathan Gitlin, executive]

And keep in mind, too, Matt, that we're in the process of delivering a lot of units, and we still have a lot of units that are currently in the ground. So it's not like we've abandoned multi-res. We are still very much active and growing our portfolio. So it's just, like I said, a slight pause in construction starts until there's a little more clarity on the expense side of the equation. And as Andrew said, there is a lot of uncertainty now when you start a project of what the approval process will be and what timeline that you're undertaking. So I think it's always good to get a little more clarity in that regard.

[Matt Kornack, analyst]

And I think your existing portfolio showcases it, but I would assume for the stuff that you are delivering, rents have exceeded our expectation in a number of different markets, but they'd be coming ahead of pro formas, I'd expect, given when you started those projects.

[Jonathan Gitlin, executive]

And I think that's a byproduct of the fact that our multi-res units are brand new, they are highly amenitized, they are part of RioCan properties, meaning they've got great retail at grade or right around it. And so we are seeing a very good rental market, but that's also a byproduct of the fact that there's limited supply. So, yes, we are doing very well on the revenue side, but it's on the backs of a lot of hard work and I think a well set up infrastructure in RioCan Living.

[Matt Kornack, analyst]

Awesome. And looking forward to covering the name in more detail going forward.

[Operator]

Thank you for your question. I am showing no further questions at this time. I would now like to turn the conference back to President and CEO, Jonathan Gitlin.

[Jonathan Gitlin, executive]

Okay. Well, thanks, everyone, for joining our call today, and we'll look forward to seeing and hearing from you all soon. All the best.

[Operator]

That concludes the conference call. Thank you for your participation. You may now disconnect your lines.