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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, and welcome to the Allied Properties REIT Second Quarter 2019 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Michael Emory, President and Chief Executive Officer. Please go ahead, Mr. Emory.
Thank you, Ron, and Good morning everyone. Welcome to our conference call. Tom, Cecilia, and Hugh are here with me to discuss Allied's results for the second quarter ended June 30, 2019.We may, in the course of this conference call, make forward-looking statements about future events or future performance. These statements, by their nature, are subject to risks and uncertainties that may cause actual events or results to differ materially, including those risks described under the heading Risks and Uncertainties in our most recently filed annual information form.Material assumptions that underpin any forward-looking statements, we make include those assumptions described under Forward-Looking Disclaimer in our most recent quarterly report.Now, for a very brief overview. We propelled strong internal and external growth in the first half of 2019. Percentage growth in same-asset NOI, FFO per unit and AFFO per unit was in the mid-single digit range and NAV per unit was up 11%. Perhaps most notably, we made $504 million of accretive acquisitions that fit squarely within our investment and operating focus.Cecilia will elaborate on our financial results for the quarter; Tom will follow with an overview of our operating results; Hugh will discuss our development pipeline; and I'll finish with a brief discussion of our strategic outlook.So now, over to Cecilia.
Good morning. I will highlight some of the key metrics we achieved in the quarter and what we think the underlying drivers are. This quarter was one of our strongest ever. We achieved a record level of $0.57 of FFO per unit even with $1.4 million of condo marketing cost at KING Toronto.Our annualized quarterly EBITDA reached $300 million for the first time ever. Our balance sheet is the strongest it's ever been. Even excluding cash on hand at quarter end, our debt-to-EBITDA at 6.3x is one of the lowest we've ever had and debt to fair value hit a new low of 26%.We've been benefiting from strong market fundamentals in the urban markets in which we operate. As a result of serving knowledge-based users, we've seen our portfolios of workspace perform better than the urban markets in which they are located.In Montreal, our urban portfolio is 96.4% leased after significant upgrade completions. This is within the context of a market with 8% vacancy. In Toronto, where there are record low levels of vacancy of 2%, our portfolio is 98.4% leased. Even our Calgary portfolio where we also serve knowledge-based users and the market is experiencing vacancy of 25%, we're holding at 91%, never having gone below 88% during the local downturn.Vancouver is also a strong market as it has transitioned from being a secondary to a primary office market, with our growing portfolio leased at 98.1% in a market with 3% vacancy. Our teamwork across departments and across cities continues to improve. This has helped us take full advantage of the current strong market fundamentals. We took the opportunity to raise $1 billion of equity over the last year.We used the capital to make acquisitions to fund developments and to improve our debt metrics. And taking advantage of our cost of equity, we achieved what we consider to be the optimal debt metrics for our business going forward. Recognizing this, DBRS and Moody's took us from stable to a positive trend in the quarter. Having constructed an optimal balance sheet, we now plan to take a more balanced approach to funding our activities with debt and equity.I will now pass the call to Tom for a discussion of our leasing and operating activities.
Thank you, Cecilia. The leasing environment remains strong, with demand in all of our markets. Between renewals, new deals in our existing portfolio and properties under development, we leased 332,000 square feet in Q2 for a total of just under 1.2 million square feet year to date. As of June 30, our occupied area is 96.2% and our leased area 96.3%.As throughout 2018, we continue to boost net rents on space renewed or replaced. For the first half of the year, rents grew by 17.2% on the affected area. While rental growth has largely been a result of substantial increases in Toronto, we're beginning to see rent increases in our portfolio in Montreal.Moving from East to West, I'll provide a brief update on leasing activity in our major markets, Montreal, Toronto, Calgary and Vancouver, and then conclude with an update on our urban data center space. Starting in Montreal. Over the last 18 months, we made great strides improving our leased area in this market, and we currently stand at 96.5% leased.Beginning the year, we had 3 priorities in Montreal. One, to continue marketing are smaller spaces aggressively, we're doing that successfully. Two, to increase net rents where possible and we're now seeing rents edge up. And 3, to complete the lease up of our redevelopment of 425 Viger. We currently stand at 53% leased in that project and there are active negotiations for the balance of the space, and we remain confident about leasing the rest of the building by year-end.Subsequent to the quarter end, we acquired 2 buildings in Montreal, which will both contribute meaningfully to our ecosystem in this city. The RCA Building in the Centre neighborhood is 350,000 square feet and leased to 240 small space users, a virtual incubator. Demand for this unique building is very strong and we look forward to accommodating some of these smaller tenants elsewhere in our portfolio as they require larger footprints. In fact, we have owned the property for less than a month, and there are already 3 tenants negotiating for space elsewhere in Montreal.The second building is 700 de la Gauchetiere with 935,000 square feet. While currently highly leased, we see this building with 34,000 square foot floor plates as a potential home for some of our larger existing users requiring additional area.Moving to Toronto, pre-leasing has been very successful at The Well our JV with RioCan. We just completed a deal with an international architectural firm and are now 76% pre-leased. Our leasing team remains very active touring prospects through our presentation center, particularly now that we're beginning to entertain 1 and 2-floor users. Excellent small floor plates at the top of the building are available for lease and will command the highest rents. Demand for our existing portfolio in Toronto remains very high with a leased area of 98.4%.Moving west to Calgary, we continue to maintain a very respectable 91% leased area. By far the most active segment at the office market in Calgary, our smaller tenant is in the 2,000 square foot to 5,000 square foot range. We can easily accommodate users of this size in our differentiated product along the belt line.At TELUS Sky, our development project with TELUS and Westbank, we recently completed one deal for 8,000 square feet and are in the final stages of negotiation with the tenant of 62,000 square feet which will bring us to 57% leased, if completed. As often happens in real estate as a building take shape and potential users can physically see and fully understand the opportunity, interest levels increase.TELUS Sky is nearing completion and it's very distinctive form on the Calgary Skyline is being noticed. As a result, our leasing activity has been up in recent months. In Vancouver, the office market like Toronto is exceptionally strong. We have very little space available in our existing portfolio and all units are seeing activity.Lastly, our urban data center space; on the last call, we reported being in the approval stages with a 10,000 square foot tenant at 250 Front. This deal turned out to be 12,000 square feet and it is now fully signed and unconditional. We continue to work with 3 smaller tenants totaling 20,000 square feet. If we complete these transactions, we will be at 80% leased at the property and just over 90% leased for our urban data center space.I will now turn the call over to Hugh for a discussion on our development activities.
Thanks, Tom. We made progress on both our active development projects, as well as our future development pipeline. I'll first provide an overview of our construction progress and then provide an overview of our approvals.Projects under development. We continue to make progress at our 425 Viger project. Having completed the structural framing for the additional floors, we have now started to work on the envelop. The project remains on track for completion at the end of 2019.We are nearing the completion of our work on the repositioning of the ground floor at Le Nordelec. The remaining work, including the new elevator system, should be complete in early 2020. All office users have taken occupancy and the team is now focusing on the remaining retail spaces. We expect condo purchasers at King Portland Centre to begin occupying the units in early September, and the majority of closings to occur late in November. The last remaining work is being completed and we anticipate achieving total completion in late November.Construction on The Well continues to progress on schedule. At the end of the quarter, we had reached the 6th floor of the office tower. All other buildings on the site are progressing well with the majority of the other buildings expected to reach grade throughout the fall. We are nearly complete on tendering the project with only a few miscellaneous trades to go. We have adjusted the anticipated costs on the project to represent the most up-to-date projections.For the JV project with Westbank at Adelaide and Duncan, we have completed the demolition of the existing building and have begun mobilization for the excavation. We currently stand at approximately 75% of the work tendered.Intensification approvals; we believe we have reached an agreement with the city for both our Adelaide and Spadina and our King and Brant projects. Both projects will go to council for approval in Q4. With the approvals in hand, we will commence active pre-leasing both projects. In Western Canada, we are progressing through the necessary approvals for the building permit for our redevelopment of the Lockheed building. We continue to project a 9-month construction period which should see the completion of the project in the summer of 2020.I will now turn the call back to Michael.
Thanks very much Hugh. The outlook for our urban workspace portfolio remains positive as is evident from what Cecilia, Tom and Hugh have just said. The outlook for our UDC space is equally positive, meeting or even exceeding our internal forecast for 2019. Our acquisition program got off to a strong start this year. By July 17, our acquisitions aggregated $504 million, with the largest component by far being allocated to income producing properties in Montreal and Vancouver and with the remainder being allocated to small infill acquisitions in Toronto, Kitchener and Calgary.Our acquisition outlook for the remainder of the year is positive, though we certainly don't expect to achieve the same level of acquisitions in the second half that we achieved in the first. We announced another funding and acquisition transaction with Westbank in urban Vancouver yesterday. This one involving 720 Beatty Street. The earlier transaction 400 West Georgia, has been exceptionally successful in terms of lease-up and is on schedule for completion late next year. It is now 84% leased to Deloitte, a global technology firm Spaces, and Northeastern University, with a high probability that Deloitte and the global technology firm will exercise expansion entitlements that expire early in 2020.720 Beatty is comprised of 51,817 square feet of land on which Westbank intends to construct approximately 620,000 square feet of distinctive urban workspace. While the final configuration of the project is not yet finalized or fully approved municipally, approximately 23% of the office component is pre-leased. Our portfolio in urban Vancouver is currently comprised of 435,000 square feet of GLA and will grow to 612,000 square feet on completion of 400 West Georgia late next year.On completion of 720 Beatty, which is expected to occur in late 2023, our portfolio will grow to 922,000 square feet of GLA, enabling us to become a leading provider of distinctive urban workspace in Vancouver, which is exactly what we set out to do 2 or 3 years ago.Overall, we continue to have deep confidence in and strong commitment to our strategy of consolidating and intensifying distinctive urban workspace and network-dense UDCs, all as we've outlined in this conference call presentation. We firmly believe that our strategy continues to be underpinned by the most important secular trends in Canadian and global real estate. We also firmly believe that we have the properties, the people, and the platform necessary to execute our strategy for the ongoing benefit of our unitholders.I hope this has been a useful and comprehensive update for you. We'd now be pleased to answer any questions you may have, Ron?[Technical Difficulty]For those hopefully listening at the other end of the line, we don't seem to be in contact with the operator, and as a result, we don't seem to be able to queue up the question-and-answer session. I will stand-by for a moment and we will try to do whatever we can do to correct this and I apologize for the technical difficulty.
If anyone wants to email questions to me I'm at cwilliams@alliedreit.com we can answer questions as they come through email.
So it seems you can hear us, which is great. I'm tempted to pose questions to myself and answer them in a very convincing and compelling manner, but that probably wouldn't be terribly helpful to those of you who are listening. So we do apologize for this technical glitch, and we're trying to correct it.
And my apologies Mr. Emery, this is Ron, your operator. I had lost connection. I am now back for the Q&A, I do apologize.
Not at all. Thanks, Ron.
[Operator Instruction] And we'll take the first question from the line of Caitlin Burrows from Goldman Sachs.
Guys, glad we figured this out. I guess maybe just starting with the 720 Beatty project. I know you have other similar agreements, but could you just give us some detail on why you decided to structure that project with Westbank initially as a financing agreement and later acquire the 50% interest? Is it just that the financial impact to you is better than building it together with Westbank or what drives that decision?
It's a good question and one we discussed at some length with the Board yesterday. One of the advantages of this structure which is reasonably well established in the Canadian REIT space, I can't speak as authoritatively for the U.S. REIT space, but the financing of a development allows us to generate a return on the capital we allocate right from the get go rather than allocate a large amount of capital which generates no return for a 3 to 4 year development period and then of course, hopefully, generates a very significant boost in earnings per unit and NAV per unit on completion. So what appeals to us about this is twofold; number one, it allows us to generate a return on the capital we allocate from the outset; number two, it's a basis upon which Westbank is prepared to allow us to participate in what is highly likely to be a very, very successful urban workspace development in the City of Vancouver and there is not a lot of available land left in downtown Vancouver. So, from Westbank's perspective, having the ability to utilize our balance sheet is valuable enough to warrant, giving us half of the ownership on completion of the development on terms that I think are much better than we could achieve if we were simply acquiring newly completed property in that very, very expensive market. So it is a very desirable transaction structure from Allied's perspective.
Got it. Okay. That makes sense. And then maybe just in terms of your same-store organic growth outlook. Leasing spreads in your portfolio have been really strong and they're still pretty strong. They are off some of their high, so from a year or 2 ago and the leased versus occupied spread has compressed, as you filled some of that space. So was just wondering, as you look out going forward, do you think this suggests occupancy and same-store NOI growth will slow going forward or does that not necessarily have to be the case?
Certainly, occupancy gain will become a progressively smaller contributor to same-asset NOI growth going forward, because we're so substantially occupied in almost every single market. I think built-in rent escalation will start to become a bigger contributor to same-asset NOI growth going forward, But I wouldn't want to overstate that because built-in rent escalation is still a relatively small component, but I do think it will become more important with the passage of time. And I think rent growth will continue in almost all markets where we have space or where we have leases expiring, we'll continue to drive same-asset NOI growth. If we were to look at the forward-looking estimates we made today which are necessarily hugely imperfect, we would see for the next 2 years, fairly significant same-asset NOI growth in our portfolio, certainly not inconsistent with what we expect to see in 2019. And what we did in fact see in 2018. I think after that point in time, so after 2021, we might expect to see same-asset NOI begin to temper, because I believe then the upward pressure on rents will be less significant than it is in 2019 and that we expect it to continue to be in 2020 and 2021.
Okay, got it. And then maybe one more on the balance sheet side. The earnings release pointed out that leverage was going to increase with the 700 DLG acquisition. So I guess just considering Cecilia's points earlier on more balanced equity versus debt usage going forward, do you think just natural EBITDA growth will bring that down? Do you think more equity would be necessary? And then on a kind of separate book, related note, just wondering your thoughts on setting up an ATM program going forward?
Caitlin, with respect to the first question, the debt-to-EBITDA at the end of the quarter was abnormally low because we were sitting on a huge amount of cash that was going to be deployed in the acquisition of 700 DLG. And that's why we, if you will disclose the post 700 DLG ratio, because that's actually the norm towards which we aspire. We wouldn't expect ourselves to be able to be in the 5s. But we very much want to remain in the 6s. So that was just a quarter-end anomaly that we wanted to call out, but post acquisition of 700 DLG, we're around 6.6%, which is exactly where we -- 6.6-to-1, pardon me, exactly where we want to be. And going forward, we see ourselves being able to stay at that level in large measure as a result of EBITDA growth that will flow from development completions. So we don't see ourselves, certainly in the near-term, needing to go back to the equity markets and indeed, I've said very publicly for some time now that going forward, we expect to take a more balanced approach to raising debt and equity than we've taken in the past, which clearly has been equity focused or equity biased. But going forward, I think we'll take a much more normal approach to debt and equity funding. The second part of your question escapes me now, oh the ATM?
Yes.
Yes. I very much like what an ATM could do for Allied given our ongoing need for capital and our exceptional ability to allocate capital for the benefit of our unitholders over the next 3 to 5 years. The rules in Canada are somewhat more prohibitive than they appear to be in the United States. So I don't want to claim expertise on this particular subject. I do know the Canadian investment bankers are working towards making the rules in Canada more conducive to Canadian issuers, availing themselves of ATMs and Allied would be very interested in considering that if the rules change in a way that would allow us to achieve meaningful impact on our capital program through an ATM. But right now, from what I understand, the rules impede us from using an ATM in a meaningful and substantial way. But if that were to change, obviously we'd look seriously at and consider whether it's in the best interest of Allied and its unitholders to establish an ATM.
We'll now take the next question from the line of Jonathan Kelcher with TD Securities.
Just going back to 720 Beatty. Does Westbank own the land now?
Technically no. An organization owned by the principal of Westbank owns the land. It's called District Energy, District Energy has entered into an agreement with the province I believe to relocate its facility, which will free up the land, and District Energy has agreed to sell the land to Westbank -- Creative Energy, pardon me, for that purpose in the very near future.
Okay. So, how can we think about the $185 million sort of playing out over the next couple of years? I'd assume you'd front for the land purchase and...
That's correct. I think Cecilia has done a fair bit of work on the timing of that outflow and probably address it better than I can.
It will be funded over the next 18 to 20 months the full amount.
More or less evenly over that period of time or any...
More or less evenly. There will be an amount in the second half of this year and then another amount in Q1 of next year and then it will build up to the full $185 million by late 2020, early 2021.
Okay. And then on TELUS Sky, I noticed you moved the transfer date back a quarter, this quarter. Can you maybe give a little bit of color on that and maybe remind us roughly how much of the annual NOI is forecast to come from the multi-res part versus the office?
With regards to the latter question, about half and half. With regards to the first one, we are just projecting out based off of the most recent construction schedule, which we had initially thought was going to have occupancy at the end of the summer, but it's looking that it's more of the late fall before we actually have occupancy. So the building will be occupiable for its intended use at the beginning of 2020.
Okay, fair enough. And then just lastly on the UDC and I know it's not a lot of space, but I did notice, it's a negative mark-to-market on the remaining 2019 leases and pretty flat for 2020 and maybe get a little bit of color on that and why that is?
In 2019, there was a tenant that was over holding, paying a lot of extra rent. This is common in an overhaul situation. And so the rents were somewhat inflated and that's ending. So that will explain 2019.
And we referred to that on the Q1 call as well. Jonathan, the holdover [ agreement] yes.
And then for -- it looks like you did some good leasing in Q2 for 2020?
We did.
So if I'm reading this stuff right. And was that just a function of what you actually leased versus what you thought the market rents were on those?
No, I think we did very well in the renewal at 151 Front. I can't tell you who the tenant is, but it was a sizable one and we ended up exceeding our own expectations on that deal. And then, as I mentioned, we did a deal at 250 Front for 12,000 square feet in the quarter. Took a long time, but we finally got there.
We'll now take the next question is from the line of Chris Couprie with CIBC.
Just couple of questions on refinancing; number one, the TELUS Sky construction loan; and then number two, credit rating. I know you had an improvement in the outlook. Can you maybe help us understand what some of the criteria might be for you guys to achieve a rating upgrade? And to that end, you have a couple of hundred million maturing -- unsecured maturing next year, how are you thinking about that refinancing?
Sure. On the TELUS construction loan, that will be addressed this month. So it comes due August 31 and we'll have that done before then. In terms of the credit rating and what I believe and what I understand to be the criteria to get an upgrade to BBB mid. What DBRS and Moody's are looking for, in my understanding, is for us to remain with our current debt metrics over a 6 to 8 quarter period. So we've currently been at our new debt metric targets, maybe for the last 3 or 4 quarters. I believe they would look for us to be remaining under 7 debt-to-EBITDA under 30 debt-to-gross book value and in the mid-3s in terms of interest coverage over the next 3 to 4 quarters, at which point they would feel comfortable upgrading us. So, I think there isn't as much focus on absolute dollar amount of EBITDA, for example, that there may have been in the past, but more looking for consistent debt metrics over a longer period of time.
And the unsecured that's maturing in the spring of next year -- financing.
Yes, so we have that coming due in May. We're always looking at how the debt markets are. They seem to be much more favorable today than they were at the end of 2018. So we're always looking at all of our options.
Okay. And then maybe just switching gears. A couple of years ago, you used to kind of provide a target addressable market, and my sense is that addressable market has likely changed. Can you maybe just comment on what you think the opportunity set looks like for Allied from an acquisition point of view going forward?
It's a good question, Chris. And yes, we used to quantify the addressable market as approximately $50 million, 5-0-million of inventory, with the possibility best represented today by 700 DLG, the addressable market has certainly grown from that 50 million square feet of inventory. I couldn't, today, tell you how much growth has occurred as a result of our ability to do vertically what we historically have done horizontally, but I do think it's material. I also happen to think that it's most achievable in a market where there is not a great deal of new construction. And of course, what that really means is that, of the 3 strong markets in Canada today, Montreal is the best with respect to that element of our opportunity set, because there is very little new construction underway in the city today, with the exception of almost the design build for National Bank. There is no new construction in the city, and that really creates a tremendous opportunity, in my opinion. We're transforming the right kind of vertical assets into work space that is ideal for knowledge-based organizations. If we were to try this in Toronto or Vancouver, I do believe it's achievable, with the right structure. But we'd have to be very attentive to the fact that a great deal of new supply is being created and that new supply is being created with the needs of knowledge based organizations, very much in mind. So it's not to say it couldn't be done in Toronto or in Vancouver, but we would be more attentive to the fact that a tremendous amount of new supply is being created in those markets and all of the developers or at least the majority of the them are very sensitive to, aware of, and focused on creating the attributes that will appeal to knowledge-based organizations even though most of the development is very vertical rather than horizontal. So that's kind of a long-winded way of saying we believe our addressable market has grown materially, but we're not in a position to, I guess confidently quantify that as we sit here today. We'll also want to evaluate the outcome of our efforts at 700 DLG a bit more carefully once they are achieved before we engage in that kind of upward quantification.
Okay. So just in terms...
I hope that's helpful?
Yes. No, that's very helpful. So just in terms of how we should be thinking about, you've given kind of an idea back half of the year to be less active than the first half on the acquisition front. But beyond that, should we think that the acquisition volume should be greater than it has been in the prior couple of years?
In our own crystal ball, Chris, we're assuming that. So I don't think we're assuming $500 million is a new normal for us, but as we looked forward into 2020 and 2021 and actually 2022, for the purposes of our own forecasting, we assumed a higher level of acquisitions than we would have seen in 2018 and 2017, and I think that's achievable. Again, it depends on all kinds of factors beyond our control, but those are the assumptions that we're making at this point in time with respect to the next 3 years.
We'll now take the next question from the line of Mario Saric with Scotiabank.
Out of curiosity, perhaps my first question might be to Michael, what would have been your first question you would have asked yourself, if the operator didn't connect us?
I think I would have asked myself who the best CEO in Canada was, but that would have made everyone around me ill, if I'd answered it in the obvious way. So other than that, Mario, I'm not really sure.
Fair enough. Okay, I wanted to come back to 720 Beatty really quickly, the structure of the deal is a little bit different than 400 West Georgia in that 400 West Georgia, the price was agreed upon in terms of construction cost. Here it looks like it's a predetermined formula. Can you talk about kind of the change in structure this time around, and what drove it and some thoughts on why it was done this way this time?
Yes. No, it's a very good question and you're quite right. It's the only material difference between the arrangements put in place for 400 West Georgia and the arrangement put in place for 720 Beatty. And it arose, in a way, mutually Westbank wasn't as far advanced in its costing when we structured the transaction as it was in 400 West Georgia. So, in an effort to protect us from a cost overrun or from costs coming in higher than currently expected, they proposed a cap rate which clearly protects us and means we're not going to pay in relation to cost. But we're going to pay in relation to the stabilized net operating income. And we debated internally as to whether or not we wanted to be more ambitious and have a price based on cost or perhaps let discretion be the better part of valor and have a cap rate govern. And we decided on reflection that it made more sense to let discretion be the better part of valor and to have a known unlevered yield that would be materially above the normalized capitalization rates for assets of this quality in the Vancouver marketplace. So that really -- it almost developed from both sides of the transaction and I think is, probably under the circumstances, the better way to structure this one. Our experience on 400 West Georgia has been extremely positive. The costs of course have gone up, but interestingly, the rental rates have gone up even more with the result that we may end up acquiring this at a slightly higher unlevered yield than we anticipated when we did the transaction. So we all know what's happening to cost. I do think there is still tremendous upward pressure on rental rates in urban Vancouver but we thought, we would insulate ourselves from adverse impact arising from cost escalation that wasn't at least matched by rent escalation.
Understood, okay. And then the unlevered yield, is it an absolute number or is it correlated or tied to changes in the 10-year bond yield for example, given the project will be completed in several years [indiscernible].
Good question. But it is an absolute number. And put differently, it could expose us to decompression in the cap rates in the City of Vancouver. But we do not consider that a meaningful risk at all.
Got it, okay. And in the notes to the financials, I noted that the commitments -- the disclosed commitments were up $370 million or so quarter-over-quarter, is that related 720 Beatty?
No, that relates to our -- the acquisitions that we closed on in July. So 700 DLG and RCA.
Okay. Shifting gears maybe to The Well, the unlevered target return came down about 60 basis points at the midpoint on a higher construction cost as Hugh alluded to. On the NOI side, it ticked up a little bit. How conservative would you say the NOI assumptions are in that revised yield, given the strength in market rents that you've seen in Toronto recently?
I think, Mario, we've tried to reflect the fact that office rents will come in higher than pro forma, especially in relation to -- let's call it the last third of the leasing. The wildcard in this particular transaction is the level of net rent we can attract from the retail component. My inclination and this won't surprise you, would be to be more aggressive in estimating what we can obtain from that space. But I think the team at this juncture, and when I say the team I mean the Allied team and the RioCan team, are choosing to stay at levels that were projected long before the cost escalation occurred. It's really hard for me to say that that's conservative but it could be, but it's how we've chosen to, in a way, project forward at this point in time. We may be able to modify that a year from now when we actually begin leasing the retail space. But right now, I think the team feels it would be maybe overly optimistic or maybe I should say Michael Emory to assume the retail rents are going to escalate the way the costs have.
Got it, okay. Two more really quick ones for me. First for Tom on 250 Front on the 12,000 square foot lease, when does that become rent paying?
It's in phases. The first and the largest portion of the space commences in June, I believe, of 2020 and the balance is a year later.
Okay. And is that kind of typical of the phase that you would expect with respect to the remaining vacancy, once that's leased up?
Say that again Mario, the typical of timing?
So the timing, is it -- like, do you expect the remaining vacancy that will ultimately hopefully be leased up the rent commencement relative to deal completion, would it be pretty consistent with this 1 year gap between completion and...?
It would be. It would be. Construction takes a long time.
Right. Okay. My last question, just turning to Cite multimedia, I noted that the last quarter annualized NOI came down about $3 million quarter-over-quarter. Looks like there is an increase in vacancy by about 20,000 square feet at one of the buildings. Can you maybe highlight what's happening there and what the plans are for that space going forward?
Yes, that was -- we had a vacancy from Sid Lee and Morgan Stanley has taken the space and they're currently on fixturing.
So it's effectively a turnover vacancy Mario. And the LQA, once Morgan Stanley is in and paying rent, will go up. So the decline is not a decline in the earnings potential of the asset, but simply a turnover vacancy decline, which is temporary.
We will now take the next question from the line of Mike Markidis with Desjardins Capital Markets.
Just on a similar topic there, the -- I guess the LQA for the urban data center platform also reflects a reduction to eliminate for some holdover lease income that's there. Is that transitional in nature would be the first question. Second would be, what's the square footage attributable to that? And then thirdly, what the expected downtime would be?
Which property are you seeing that in, Mike?
Well, it was -- I think we were talking about the UDC and the LQA NOI being lower than what was annualized based on your 2Q results, and I think the conclusion was there is [ hold or ] release income , I think you said that -- you mentioned that in Q1 as well that was going to come off.
Yes, correct. So that will -- that only is affecting the first half of the year, so it won't affect us in Q3 and going forward.
Right. So, do you know what the square footage is for that hold or release?
35,000 roughly.
Okay. And has that -- is that -- what's the expected downtime?
It's 6 to 8 months, we're very close to it -- it's probably 6, 8, 9 months. We're very close to having that backfilled and some of the premises are already ready to go. So it's not as long a downtime as we'd ordinarily see in raw space.
Okay, that's good. Just with respect to the marketing expenses at KING Toronto. I think last quarter, if I remember correctly, we were expecting that to come down materially, it looks like it's still fairly high. So I guess first, how do you expect that to progress for the next several months or quarters? And then second part of that question is, can you give us an update on how that pre-sell program has progressed and where we stand today?
So they -- I believe I said in the last quarter, we project it to actually decrease in Q3 and Q4. There is a last set of units that are coming to the market in September, so there will be some expenses throughout September but then it should drop actually quite a bit in Q4. So in terms of our actual activity, we're progressing well. We're on schedule according to that kind of pre-sales schedule that we had created and meeting the pro forma targets in terms of price points.
Okay. And would you be able to tell us how much or what percentage of the units will be pre-sold at this juncture?
We're not disclosing that at this point.
Okay, fair enough. Specifically, I think you had mentioned that there was some, there has been an increase in, I guess development fee income earned from your party -- your partners that pops up in NRI. Is that lumpy in nature or is it -- or is it a -- sort of based on just the amount of capital that's put into the building I'm just trying -- or into the development. I'm just trying to get a sense of how that might progress over the next...
Yes, I'm happy to elaborate on that. It's not too lumpy. We're actually seeing, you know you can expect it to be roughly between $1 million and $1.4 million a quarter in 2019. We see that growing in 2020 to be about $2 million a quarter and growing again in 2021 to be a bit more than $2 million a quarter. That's obviously based on our estimated spend or the estimated spend on development. But that's how we see it over the next few years. So it's certainly recurring in nature and you can expect it'll be a permanent part of our -- of a contribution to our NOI.
Okay. That's very helpful. TELUS Sky, I think Hugh, you mentioned that it's going to be ready to be occupied for its intended use at the beginning of 2020. Just from the mechanics, is TELUS already got their space and fit out and does that mean there is already some revenue being recognized on the income statement with respect to their space.
They are fitting out their space and we anticipate them actually having people occupy the building in November. So in terms of straight-line rent with that would have started at the beginning of Q2, I believe.
Okay. Last question for me. Sorry, I know it's been a laundry list here. 700 DLG, congrats on getting that done. Couldn't help me notice that there was an announcement with respect to the sale now of 600 DLG and it looks like the group there is intending to go on a repositioning, Michael, I was wondering if you had any thoughts as to how that might be an opportunity for 700 DLG or impact your plans or be a risk?
We know the people involved in the acquisition of 600 DLG. We know who the principal owner is, even though that hasn't been disclosed publicly. They are people we can work with collaboratively. So I believe we will be able to work collaboratively with the owner of 600 DLG. I also believe the lease maturity schedule for the respective buildings makes it unlikely that we're going to be competing for the same tenants at the same point in time. And I also believe that the attributes of 700 DLG are more conducive to what we want to achieve in terms of transforming the asset for use by knowledge-based organizations than they are at 600 DLG. The floor plates in particular are larger and the common area at grade is materially larger. And I think capable a more impactful transformation. But of course, I'm biased in this regard, because we happen to own 700 and not 600. I also think there is an opportunity in the fullness of time for us to acquire 600 DLG from the group that is currently reworking it, because I think they have more of what I'll call a private equity perspective on the transaction whereas we have a long-term owners perspective. But I think they are very credible. I think they will do a good job. And I think the likelihood of us engaging in any kind of direct competition for users is pretty remote.
We'll now take the next question from Johann Rodrigues with Raymond James.
Most of my questions have been answered. I just wanted to ask about Union Center. I know it hasn't been a priority, but has there been any kind of inbound increase from tenants or kind of interest at all?
Not really. And certainly, none of a magnitude that would warrant our -- changing our views on the timing of Union Center. So I think it remains an opportunity that we are highly unlikely to pursue in this cycle and hopefully we'll be able to pursue in the next cycle of development and new supply in downtown Toronto. There has been some interest, but it's one of those unusual circumstances where requirements of 300,000 and 400,000 square feet are nowhere near material enough to warrant our entertaining them for this particular opportunity. So I continue to see the likelihood of our progressing with that other than through the redesign, which will get us materially more buildable area. But then we currently have, I think we expect something close to $1.7 million compared to around $1.1 million today. And frankly, that fact which desirable in one respect is making it even less likely that we will initiate that transaction or that development in this cycle. And as I've said probably ad nauseam, but I still want to repeat it here. We are under no pressure in relation to that opportunity because we own the land for nothing, and it is generating in excess of $1 million per annum. So there is no IRR pressure on us whatsoever with respect to that particular opportunity whereas by contrast there was material IRR pressure on us at The Well which is why we initiated it when we did and I believe the outcome is going to be very desirable. But we're not going to initiate Union Center.
Your next question will come from the line of Howard Leung with Veritas Investment Research.
I just wanted to turn to the UDCs and follow-up on that quickly. The cap rates kind of stayed around -- the overall cap rates kind of stayed around the 5.83% for the year. Do you see that potentially compressing as the 250 property gets more leased up and there's more cross connect revenue or not really related to that.
Yes. Hi, Howard. We absolutely would expect the cap rate to come down in 250 to reflect the reduction of lease-up risk and as we build out our strategy and execute on it. I wouldn't be able to tell you what to, but we would expect it to come down.
Okay, awesome. And then one more on the, just a follow-up again on the rating or I guess the outlook upgrade. Should there be a ratings upgrade from the outlook by either DBRS or Moody's, would that change your thinking at all in terms of future funding plans. What do you want to do with the unsecured debentures rolling off next year?
No, it really wouldn't change our strategy at all whether we get upgraded or not. We will continue with our approach in terms of conservative financial management regardless of the credit rating agencies.
And I would add to that, Howard, that we're committed to our unsecured debenture program. We believe we will ultimately be upgraded. We also believe we're treated by the market as essentially a BBB mid already although not fully and our approach to the systematic unfolding of our unsecured debenture program will not change. It is something we're determined to achieve over time and it will not be predicated on the timing of any ratings change.
Right. Well would it change your thinking at all in terms of the duration of any future unsecured funding that you might look for?
Well, we're certainly, again independently of the rating and perhaps more related to the fact that we've established our own yield curve now. We're adamant about pushing out the tenure of the unsecured debentures we issue. We have always wanted 10-year tenures, and I believe and this is something I say with a bit of caution, I believe, we have the ability to issue unsecured debentures for terms of 10 years in the current market on financial terms that could be acceptable to us. So we very much want longer tenures. We very much want to push out our debt maturity schedule and we're quite confident of our ability to do that now in the unsecured debenture program, at the beginning, because it was almost a price of entry to issue 5-year paper to meet. Our debt maturity compressed a bit, but we now are very confident that we can begin to push it out in a meaningful way. And we very much want to do it, yes.
Your next question will come from the line of Matt Kornack with National Bank Financial.
Michael, just interested on 700 DLG, is that or should we take that as an indication that maybe the loft conversion theme in Montreal and some of the more peripheral areas is being exhausted or are you seeing a different set of tenants that are targeting downtown locations at this point?
I would say emphatically no to the loft concept being exhausted. And what I loved about the combination of acquisitions we announced here is that it was the RCA building 350,000 square feet of what I would call prototypical Allied space, along with 700 DLG, which is close to a million. But I think what the RCA Building reflects in very, very significant terms, along with the El Pro building, which we acquired late last year, is that the original format through which we satisfied the needs and aspirations of knowledge-based organizations is still very much and active component of our business and there is still a great deal of opportunity in the major urban centers with that format. So my view is that 700 DLG represents a new format for creating urban workspace for knowledge-based organizations. But we're not doing it because we're running out of the conventional Class I format. We're doing it because we believe we can and that there is such demand on the part of knowledge-based organizations for space that meets the criteria that we should do it this way, as well as the more conventional way for Allied, which is reflected in the RCA building. So I don't see what I would call Class I conversion opportunities beginning to deplete or diminish at all. I think the RCA building is just a beautiful example of that. I think some of the assets we're looking at in Vancouver are more modest, but still material examples of that. There is tons left in Toronto and we want to own it all. And we have a long way to go before getting there. So I see that the interest in the format isn't diminishing, but the supply of the format, the Class I format, is finite. However, the hybrid format that we've been so successful in creating, to me, is just an extension of the Class I format. And then the tower format that's converted is yet another format that achieves the same thing. But certainly, we're not looking at 700 DLG because we think interest is waning for the Class I format or for the hybrid format, quite the contrary. We think the interest for those formats is perhaps even deeper than the available supply.
Makes sense and Montreal has a pretty restricted density opportunity based on bylaws. But would you ever entertain looking at something in the core, that's Class B and has a mixed-use redevelopment opportunity or is the pricing on rents just not there yet to justify new development in Montreal.
You know I don't see us engaging in what I would call, from the ground-up development in Montreal in the near future. I do think it's possible. We could execute a material expansion at Nordelec of new construction. But it wouldn't be from the ground up. It would be expanding the existing asset which has unfolded beautifully for Allied, the users of space and our unit holders. RCA building has a significant amount of unutilized land. It too represents that kind of opportunity. So I see us doing things more akin to QRC West or KING Portland Centre in Montreal, but I don't see us in the near future doing anything comparable to The Well in Montreal.
We will now take the next question from the line of Neil Downey with RBC Capital Markets.
Cecilia, just for purposes of clarity on one of the earlier questions. With respect to the TELUS Sky construction lending facility. Is it simply the Group's intention to negotiate an extension of the existing facility?
Correct, yes.
We're in the process of doing that Neil and have no doubt we'll be successful.
Mr. Emory, there are no further questions at this time. I'll turn the call back over to you for any additional comments or closing remarks.
Thank you so much. And thank you all for participating in this conference call. We look forward to keeping you apprised of our progress. In the meantime, have a great day. Thanks again. Bye for now.
Ladies and gentlemen, this does conclude today's call. Thank you for your participation, and you may now disconnect your lines.