Allied Properties Real Estate Investment Trust
TSX:AP.UN
Earnings Call Analysis
Q4-2023 Analysis
Allied Properties Real Estate Investment Trust
Allied Properties Real Estate Investment Trust (REIT), in their fourth quarter 2023 earnings call, announced sustained leasing activities and an increase in productivity across their portfolio for the 18th consecutive quarter. The management, including President and CEO Cecilia Williams, remained optimistic, expecting leasing momentum to continue in the coming year, despite acknowledging longer lease-up timelines. The team emphasized their focus on user experience, team development, and a capital allocation plan that minimizes reliance on capital markets. Allied is entering 2024 with a lower level of economic occupancy but is determined to improve this through dedicated leasing efforts.
In terms of financial highlights, Allied exhibited a strong fourth quarter, influenced positively by the full impact of their UDC portfolio disposition. They saw a rise in funds from operations (FFO) per unit by 2.7% and adjusted funds from operations (AFFO) per unit by 3.1% compared to the previous quarter. Net rents increased by 4.3% year over year, showcasing the economic productivity of their space. End-of-year liquidity was robust at $1.1 billion, indicating the REIT's solid strategic position to continue operations with minimal dependence on public markets.
The final quarter of 2023 proved to be Allied's most active in terms of leasing activity. This includes a substantial increase in tour activity and over 1.1 million square feet of space under negotiation or at the prospect stage. The company has a firm commitment to enhancing user experiences, a sentiment reflected in their increased net promoter score, which stands 250% above the industry average. Executives demonstrated confidence in Allied's portfolio and its urban mixed-use neighborhoods remaining attractive to a range of industries.
Management expects tangible leasing activity to translate into improved occupancy though the timeline remains uncertain. They anticipate no major rollovers or nonrenewals impacting occupancy in 2024 and aim to surpass the current 83.7% occupancy level. The 1.1 million square feet of pending leases are roughly split between being under negotiation and prospective stages, providing clarity on near-future occupancy trends.
Allied disclosed the expiring rent being roughly 7% below the estimated market rent for 2024, leading analysts to expect a potential same-store net operating income (NOI) contraction between 0% to 5%. Furthermore, the company plans to complete all developments by the end of 2025. While residential intensification is on the radar, Allied is currently prioritizing leasing and optimizing their urban office portfolio.
The leadership is confident in their ability to obtain financing for higher-quality assets despite broader market conditions. They mentioned a hypothetical 10-year bond refinancing rate would be around a 6.8% coupon rate today. Their strong balance sheet is deemed an advantage in securing necessary financing moving forward.
Allied has observed lease timelines stretching from 12 to 18 months on average, a notable increase from the pre-pandemic range of 3 to 9 months. The economic environment has made companies reluctant to make long-term commitments. However, no significant lease maturities are anticipated in 2024. The company also noted an overall stabilization in leasing costs, with new effective rents (NERs) being 10% higher in 2023 compared to 2022.
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Ladies and gentlemen, good morning. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the Allied Properties REIT Fourth Quarter 2023 Earnings Conference Call. Today's conference is being recorded [Operator Instructions] Thank you. And I will now turn the conference over to Cecilia Williams, President and CEO. You may begin.
Thanks, Abby, and good morning, everyone. Welcome to our Q4 conference call. Nan and J.P are with me today. We'll each make brief comments and then answer any questions you may have. 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 2023 annual report and our most recent quarterly report. Material assumptions underpinning any forward-looking statements we make include those described under forward-looking statements in our most recent quarterly report. I'll start by describing sustained leasing activity. We're encouraged by the sustained leasing activity, which continued through the fourth quarter. The productivity of our portfolio also increased for the 18th consecutive quarter, and renewals were at healthy spreads to in-place rents. Considering that these spreads are on rates established in stronger markets, we're especially pleased with the results. We believe we're at an inflection point and that leasing momentum, which accelerated in the last quarter of 2023, will continue through the coming year. Our concentrated portfolio of urban workspace and mixed-use amenity-rich neighborhoods continues to appeal to knowledge workers. On to user experience, we focus intently on what we can control. That includes the quality of the user experience we provide, which we know from long experience is as important as the physical environments we create. We've been submitting ourselves to third-party scrutiny with respect to user experience for years to ensure that we're continuously improving. J.P will elaborate on the specifics, which we're pleased with. Comprehensive team development. The Allied team continued to evolve in 2023. We continued our Board renewal process, and we implemented a succession plan, empowering the next generation of leadership at Allied. Perhaps most importantly, we continued our ongoing successful efforts to liberate talent and foster teamwork across the country. With strong integrated team members, everyone contributes to the business in meaningful and measurable ways. We're increasingly organizing ourselves around assets rather than areas of specialization, with city teams managing our urban portfolios across the country. This gives us the benefit of expertise from multiple disciplines and optimizing our portfolio. More importantly, it creates various avenues for our talented team members' professional development by enabling them to contribute beyond their functional areas.Implementation of a 5-year capital allocation plan placing minimal reliance on the capital markets. With the sale of the UDC portfolio, we have strengthened the balance sheet and reaffirmed our commitment to distinctive urban workspace. We believe in Canada's future, and much of the economic and cultural future is concentrated in our cities. While far from perfect, our cities continue to thrive and demonstrate resiliency. We're confident they'll continue to attract a disproportionate share of global talent, which drives economic and cultural growth and evolution. The year ahead, we're heading into 2024 with a lower level of economic occupancy than we've ever had. While confident that our leasing activity will translate into improved economic occupancy over the course of 2024, the timing is difficult to predict. The one thing I'm certain of is that the entire Allied team across the country is dedicated to improving economic occupancy and is entirely confident of the outcome despite the uncertainty as to timing. In summary, our portfolio will not only hold up well in this economic environment as it has during past downturns. It will ultimately emerge stronger than ever because of our integrated team, our operating platform, our solid financial position and our unique and concentrated urban properties. With that, I'll pass it to Nan for a financial overview.
Thank you, Cecilia. Good morning, everyone. I'll provide a brief overview of our financial highlights. The fourth quarter was a strong quarter for Allied and the first quarter, reflecting the full impact of the disposition of our UDC portfolio. Our financial results in the quarter were solid and reflect our unwavering commitment to the balance sheet. Our FFO per unit was $0.614, 2.7% higher than it was in the third quarter. Similarly, our AFFO per unit for the quarter was $0.562 reflecting a 3.1% increase compared to the third quarter. These metrics illustrate the contributions to income from our PUD portfolio as our existing projects continue to reach completion milestones. This will enable us to generate material amounts of EBITDA going forward. This was further enhanced by lower interest expense due to the repayment of our unsecured facility with the proceeds from the UDC portfolio. Our weighted average in-place net rent per occupied square foot was $24.10 in the fourth quarter, a 4.3% increase from Q4 2022, which reflects the increasing economic productivity of our space. Lastly, we're ending the year with our unsecured facility completely undrawn, resulting in $1.1 billion of liquidity. We have the financial strength to continue operating and executing our strategy with minimal reliance on the public capital markets. Thank you, and I'll pass the call to J.P now.
Thanks, Nan. While we continue to experience longer leasing time lines, we are encouraged by the level of activity across our portfolio. Q4 was our most active quarter for leasing activity in 2023, the results of which are outlined in detail in our Q4 press release. Tour activity continues to be strong. We observed a 20% increase in tours in the quarter compared to the prior year. In total, tour activity was 12% higher in 2023 compared to 2022, with a noticeable acceleration of tours in the second half of the year. Uses represented by organizations continue to be technology, education, life sciences and medicine. As of today, we have more than 1.1 million square feet of leasing activity under negotiation or at the prospect stage. At the very core of our operating platform is an unrelenting commitment to user experience. For the past 4 years, Allied has retained Grace Hill cleanly surveys to assess user satisfaction within our portfolio. The results for 2023 were very encouraging. 100% of rating areas improved from the prior year. In addition, more than 80% of users were satisfied with Allied's commitment to sustainability, and more than 90% were satisfied with Allied's commitment to EDI. Most importantly, Allied's Net Promoter Score, a leading indicator for tenant retention and leasing activity was 250% higher than the industry average. The composition of our portfolio concentrated in mixed-use amenity-rich urban neighborhoods coupled with the strength of our operating platform and team, as validated by our user experience results gives us tremendous confidence and the continued demand for Allied's distinctive workspace across the country. I will now turn the call back to Cecilia.
Thanks, J.P. We'd now be pleased to answer any questions.
[Operator Instructions] And we will take our first question from Lorne Kalmar with Desjardins.
Maybe just first on the guidance. It looks like the guidance range for fall was kind of flat to down 5%. I just wanted to get an idea of what you think needs to happen to reach the high end and what is contemplated in the downside scenario. Is it really mostly occupancy driven, or is there more at play there?
Just to be clear, we have not provided guidance. That's what we were trying to make very clear in our press release. What we have provided is an indication of what we're striving for, which is flat metrics while recognizing that there will be dependent on the timing of leasing materializing. We have not provided guidance.
Okay. Apologies for the misunderstanding. And then maybe just moving on to West Georgia. I believe the property has been up and running for a little bit now. When do you expect to take it and what kind of needs to happen to facilitate that?
It is 82% economically productive right now. The development is completed, and there will be incremental leasing accomplished at which point the permanent financing will be put in place and according to the agreement, that's when we would buy into that property. So there just needs to be some incremental leasing done, and there is some currently under negotiation right now.
Is there a particular threshold like does need to get to 90% as an example?
I think once it's over 90%, then we can maximize the amount of permanent financing to put on the property, which would be ideal.
That makes sense, fair enough. And then maybe just lastly, it looked like CapEx on the rental properties jumped up quite a bit this quarter. I was wondering if you can maybe give a little bit of color there and where you sort of see it trending over the next 12 months?
It would be just normal course CapEx, and I would expect 2024 to be similar to 2023.
And we will take our next question from Jonathan Kelcher with TD Cowen.
I guess I won't call it guidance, but on your -- the outlook that you put out in your press release, I'm just trying to square your comments on leasing and leasing activity seemed fairly constructive or positive. And I'm just trying to square that with the fact that you don't expect any occupancy gains in the first half of the year on your outlook?
It's really just a function of the extended lease-up time frames, Jonathan. So there might -- they'll be leasing accomplished. But in terms of, let's say, cash generating leasing, we're expecting that to start in the second half of the year.
Okay. So you're -- and then you don't have a lot of rollovers this year. Are there any like larger nonrenewals that you're aware of in the 7% that you've got rolling this year?
This year, no.
Okay. So it would be fair to say that you expect to end the year above 83.7% occupancy?
We're not giving any sort of indication to that metric, but you can read between the lines as we've described, the first half of the year versus the second half of the year.
Okay. And then the 1.1 million square feet of either under negotiation or perspective, like how is the balance on that? Is it sort of 60-40 under negotiation versus prospects? Or how should we think about that?
That's correct, Jonathan. That's an appropriate breakdown.
Okay. And then just lastly, on your development program. It looks like you have roughly $200 million to complete the program. And the total NOI from that, I guess, you're estimating $91 million to $103 million. How much of that $91 million to $103 million was in Q4 results? And how much of that NOI is going to be coming out in the next 1.5 years or so?
So just to give you some context on that, Jonathan, there was about $39 million in the 2023 results. I don't have the exact quantification of how much that was in the Q4 results itself, but I can get that to you later.
We will take our next question from Mario Saric with Scotiabank.
The first one, just sticking to development. I know you highlighted in the press release kind of the expected EBITDA is expected to come in, in '24 and then the kind of run rate EBITDA from developments starting in '26, I think it was $20 million to $41 million, respectively. I think in the past, we've talked about potentially providing some FFO discussion on what FFO developments could bring about. Is that something that you're hoping to doing today? Or is that still work in progress?
That's not something that we're open to doing at this stage, Mario.
Got it. Okay. And then coming back to the outlook, striving for flat and then potentially up to 5% erosion. Just to clarify your response on an initial question, the data between the two is primarily related to timing in leasing as opposed to anything to do with kind of your JV completions and how those are accounting for that? Is that fair?
No, that's absolutely correct. It is entirely based on timing of economic occupancy, yes. Nothing to do with our joint ventures. Yes.
And when you talk about potentially 5% erosion year-over-year, does that pertain to each of the FFO per unit same-store NOI? I asked the question because if we look at what you're talking about from an occupancy standpoint in terms of kind of moving higher in '24 and then if you look at the mark-to-market that you've disclosed, and the MD&A, it looks like the expiring rent is about 7% below your estimated market rent for '24. So when I think about potentially higher occupancy and still a pretty decent mark-to-market, just trying to reconcile that to how same-store NOI could load up to 5%.
Yes. That contraction of up to 5% is really 0% to 5% as it covers all three of the metrics being FFO per unit AFFO per unit and same asset NOI.
Okay. So it doesn't necessarily mean that it could be up to 5% for each individual one.
Exactly.
Got it. Okay. And then just my last question. The capitalized interest was down $1.3 million versus Q3, but the capitalized G&A went up $0.4 million versus Q3. Can you just kind of explain the variance between the direction of those two?
So in terms of direction, the capitalized interest this quarter is mainly because they've been transferred into rental portfolio. So certain properties have moved out of the PUD category, Mario, and that's why there is a little bit of reduction there. The G&A is pretty much in line with previous quarters.
Okay. So the G&A, the capitalization amount went up a bit quarter-over-quarter. So if properties are coming online, it doesn't necessarily impact the G&A capitalization the same with interest expense?
Exactly, because we did have some transaction cost related capitalization to the UDC portfolio, and that's why the where you're seeing the gap.
We will take our next question from Pammi Bir with RBC.
I just wanted to clarify the comments around occupancy, particularly with respect to the first half. You mentioned you expect no economic occupancy gains in the first half. But to clarify, are you seeing -- like are you seeing there's potential for occupancy to actually drop through the first half? And then your comments are clear on the second half that you expect it to rise, but I just want to clarify the first half commentary.
We're not going to be getting that granular at this stage, Pammi.
Okay. And I think maybe looking a little further out to 2025, not necessarily guidance or anything, but I think you had talked about a sort of target or expectation that you could get to 94% to 95% by the end of next year. I'm just curious how you feel about that at this point.
I'm still feeling very confident that we will get back to a stabilized portfolio, which is in that 94% to 95% range. But I'm not going to be commenting on the exact timing of that.
Okay. Fair enough. Okay. Just on the developments for this year. Can you -- and I'm not sure if I missed it maybe in the MD&A, but what's sort of the outlook for spending this year?
We have it in the cost of complete, right? What we have is -- it's on Page 71, Pammi, on the MD&A, we do show the estimated cost to complete by project. And then deposit upon completion.
Yes, all of our development will be done by the end of next year. So we're really at the tail end of the investment in development.
Okay. All right. Last one for me. In terms of any sort of residential intensification in the portfolio, can you maybe just share in terms of any of the opportunities that you've looked at to maybe monetize value? And is this something that you're looking at maybe doing more work on? Or have you been approached by other parties to perhaps explore some of that?
We're looking at that really on the periphery. We do see the opportunity to intensify on sites that we already own with a residential component really to build out what we think is the best way to be community builders, which is with mixed-use sites. That being said, it's not our area of focus right now. Right now, we're focused on leasing up and optimizing our urban office portfolios.
[Operator Instructions] And we will take our next question from Gaurav Mathur with Laurentian Bank Securities.
Just focusing on the bet ladder here. Now there isn't a significant amount of refinancing in 2024. But for '25, you do have the 200 million senior unsecured debenture, and the $400 million unsecured term loan. Could you perhaps discuss where refinancing rates would be on both?
Refinancing rates today, if we were to do a 10-year bond, what is it, Nan, like 6.8% coupon.
Okay. And just lastly, from a macro perspective, given the broad decrease in office valuations on both sides of the border, could you perhaps speak to the Canadian lenders appetite of financing office assets in this environment?
I mean, I think the higher-quality assets are still able to find the financing that they need. We have been exploring as much on the secured side of debt financing, but we haven't -- I mean we don't -- other than the unsecured debenture market, which we haven't tapped in a couple of years. I think with established relationships, the financing tends to come easier. And certainly, with a higher quality portfolio, I don't anticipate us having any trouble. I think it's the lower-quality office assets that struggle more. And I think quality is always the driving force behind the ability to get financing. So -- and I think having a strong balance sheet is also helpful just in general.
[Operator Instructions] And we will take our next question from Sumayya Syed with CIBC.
Just firstly to follow up on your comments around lease-up and the time frames. And just maybe a question for J.P. So what are more recent typical leasing time frame is looking like in your, I guess, ongoing conversations? And how do they compare to the more normalized time frames you've seen previously?
Right now, we're seeing, as we've said, longer lease times on average anywhere from 12 to 18 months compared to pre-pandemic levels, which could have ranged between 3 months to 6 months, maybe even 9 months at the high end.
Okay. And then if you could just speak to the drivers for some of the nonrenewals in the quarter, Adelaide Street and Adelaide & Spadina. And any non-vacancy that could be on your radar?
Sorry, I'm not sure. What was the last part of your question?
I answered the first part. The reason for nonrenewals, which certainly we can speak to, but I didn't understand after that.
Yes. If there's any sort of known upcoming vacancies that are on your radar.
Oh, I see. In terms of nonrenewals, it's really related to just this economic environment. Companies have a harder time making long-term commitments with the uncertainty in the economy, particularly interest rates. So as stability returns and certainty returns, we do expect our level of renewal activity to improve. In terms of large maturities in the year, thankfully, we don't have any significant ones in 2024.
Okay. Great. And just lastly, just on the leasing side of things. Where do you expect your tenant incentives to track for the year maybe compared to what you saw in 2023?
It's always deal specific. We have seen leasing costs stabilize. In 2023, our NERs were 10% higher than our NERs in 2022. But again, they are very much deal and unit specific. But generally speaking, we're seeing leasing costs stabilize across the portfolio.
And we have no further questions at this time. I will now turn the call back to Ms. Cecilia Williams for closing remarks.
Thanks, Abby, and thank you everyone for joining our conference call. We'll keep you updated on our progress going forward.
And ladies and gentlemen, this concludes today's call, and we thank you for your participation. You may now disconnect.