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Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Allied Properties REIT First Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions].
Thank you. Michael Emory, President and Chief Executive Officer, you may begin your conference.
Thank you, Rob, and good morning, everyone. Welcome to our conference call. Tom and Cecilia are here with me to discuss Allied's results for the first quarter ended March 31, 2023. Nanthini Mahalingam, our incoming Chief Financial Officer is also with us today. 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 AIF and in our most recent quarterly report. Material assumptions that underpin any forward-looking statements we make include those assumptions described under forward-looking disclaimer in our most recent quarterly report. Despite ongoing macroeconomic uncertainty, Allied's business is larger, stronger and better managed than ever before.
Our operating income was up 14.5% in the first quarter, an all-time high made possible by development completions and contribution from last year's portfolio acquisition. Our interest cost was also up in the quarter, entirely due to variable rate debt encourage to fund developments that will continue to propel operating income in the coming years.
We plan to retire the variable rate debt fully and increase our liquidity materially with the proceeds from the sale of our UDC portfolio. While the sale process is not complete, it is definitely nearing completion. The first quarter of 2023 was positive from an operating perspective and supportive of our outlook. Cecilia will summarize our financial results. Tom will follow with an overview of leasing and operations. I'll finish with our current thinking about the future, particularly the future of the Allied team.
Now over to Cecilia.
Good morning.
I'll highlight key operating metrics, our financial position, progress on development and upgrade activity and priorities for the year. Our operating metrics continue to be strong. Operating income was up 14.5% from the comparable period due to a full quarter of contribution from the Choice portfolio as well as development completion.
Average in-place net rent per occupied square foot was also up to $23.35. This is higher from year-end by 1% and higher from a year ago by 3.6%. We also continued to see strong rent growth on renewing space in the quarter, which was 11.4% on an ending-to-ending basis and 18.2% on an average-to-average basis.
Tom will provide more details on our leasing activity. We're pleased with our financial position. We expanded our operating line by $100 million to $700 million, while keeping the $100 million intact.
On closing of the UDC portfolio sales, we intend to use the majority of the proceeds to pay off debt, including our operating line, which we expect to pay off in full, increasing our liquidity and pushing our debt metrics back within our targeted ranges. Our debt metrics will continue to improve thereafter, and our development completion continues to be increasingly economically productive. We do not intend to allocate any capital to discretionary activities, including acquisitions in the coming years.
We allocated $85 million of capital in the quarter to revenue-enhancing activity and development completions, which is what we'll continue focusing on for the foreseeable future. Our development and upgrade activity is progressing well. In Toronto at 19 Duncan, Thomson Reuters has taken physical occupancy. And at QRC West expansion, Northeastern University has finalized its fit-out design.
In Montreal, at Tour Viger, Novartis has taken physical occupancy and the remaining space is under negotiation with other interested users. Our priority for 2023 continue to be leasing, development and upgrade completion and completing the UDC sale to strengthen our balance sheet and reaffirm our commitment to urban workspace. The goal continues to be to propel our operating capability.
Our outlook for 2020 remains unchanged at low to mid-single-digit growth in each of FFO and AFFO per unit and same asset NOI. We also expect to continue increasing our distribution at our historical rate of 2% to 3% per year. Our team and our operating platform has never been stronger.
With that, I'll pass the call to Tom.
Thank you, Cecilia.
We had a solid Q1, completing 102 transactions totaling 425,000 square feet. Average net rents on renewal in the quarter were a healthy 18.2% higher than average net rents in expiring term. Average in-place rents in the portfolio have increased every quarter for 14 consecutive quarters.
Our rental portfolio at March 31 was 88.8%. We have good momentum heading into Q2, bolstered by a very aggressive approach by our leasing team. By mid-February, our leasing team completed presentations to the brokerage community in Montreal, Toronto, Calgary and Vancouver. Team called it the broker roadshow 30 separate presentations took place through in all major brokerage houses identifying leasing opportunities in each city. In all, they reached 550 individual agents.
Following these presentations, we have over 200,000 square feet of new transactions underway that we may not have had otherwise with 100,000 square feet now at the offer stage. We also experienced a large uptick in our tour activity in the month of March because of this program.
I'll now provide an update on our leasing activity from Montreal, Toronto, Kitchener, Calgary and Vancouver. Montreal continues to be active with the team completing 24 transactions in Q1. Our focus in 2023 continues to be leasing at 111 Robert Bourassa, and 1001 Robert Bourassa, as well as Place Gare Viger and --.
I'm pleased to report we have action on all four buildings, specifically when the final stage of negotiation for 50,000 square feet of Place Gare Viger, the global conglomerate, and we are working through an LOI with an educational use for 40,000 square feet in the same build.
We have approximately 70,000 square feet of space under negotiation with RCA for tenants and a full floor of 35,000 square feet with a tech company at 111 Robert Bourassa. In Toronto, we completed 38 transactions in the quarter. Most notable transaction was an early renewal and extension with sick kids hospital for 110,000 square feet at 525 University.
Our upgrade work at 185 Spadina and 468 King is nearing completion, and we're negotiating offers with single users in both buildings. In Kitchener, we have advanced negotiations with a tech tenant for up to 160,000 square feet, and if successful, we would be 99% leased in that market.
Moving to Calgary, our team has done a good job maintaining a leased area of 83.4%, which relative to the market is good. Work has been finalized to reposition the Lougheed and we're working with an educational use for a large portion of that building.
We are also active on three Milton suites at TELUS Sky. In Vancouver, the team completed 33 transactions, we maintained a 94%. Generally speaking, we are very encouraged with the pipeline of deals for the balance of 2023, the following reasons.
We try leasing activity very closely. And as late April 17, we have 820,000 square feet of new deals or expansions at the offer stage or in advanced discussions. We have action on seven large blocks of space totaling 40,000 square feet, we have action on amenity uses totaling 78,000 square feet in our large projects in Montreal.
We are currently in discussion with six educational users for new deals or expansions. We have an aggressive ready suite program, which is focused on upgrading vacant space between 2,000 and 10,000 square feet. The idea appears to provide space in moving condition to shrink negotiation time frames. Most of our leasing is done in this size rate.
We are very close to completing three significant retail deals in King West. And we maintain a very high degree of interaction with the brokerage community and in all of our markets to maintain maximum coverage. We have had picked the best agents in each market to list our available spaces.
In addition to our 15 in-house leasing sub, we have 52 agents working on --. While we will not complete all of the deals in the pipeline in 2023, we do expect to complete most of them, which will move the needle meaningfully on our lease areas of that. We look forward to providing an update on our progress next quarter.
I'll now turn the call back to Michael.
Thank you, Tom.
As you may know, Hugh Clark left Allied recently to join a private equity firm. We've divided his responsibilities among two exceptional young leaders at Allied. Both of whom will report directly to Cecilia when she takes on the role of Chief Executive Officer on May 2.
John Lindsay, our Vice President, Development, will oversee development and construction activity in projects where users don't take occupancy until completion. The Well in Toronto is a great example of such projects. Hersha Leung, our Vice President Construction and Technical Services will oversee construction activity and projects where users occupy a significant portion of the leasable area on a continuous basis through the construction process. 1001 Robert Bourassa and the RCA building in Montreal are great examples of these type of projects. Each of John and Hersha was trained as an engineer.
Each has made a significant contribution to our business and is an integral part of Allied's next generation of leadership. Other integral parts of the Allied leadership team will report directly to Cecilia when she takes on the role of Chief Executive Officer. Nanthini, of course, will do so as our Chief Financial Officer. Individuals who currently report to Tom will also do so, specifically Tim Low, our SVP leasing and JP Mackay, RSVP National Operations. This will allow Allied to evolve in the optimal manner going forward. As you'd expect, Cecilia will conduct our next conference call as Chief Executive Officer. Nanthini, JP, Tim, John and Hersha will contribute to the call going forward. I'll also be on the call, but I promised Cecilia and the team that I'll talk much less.
And against all were you, we've now be pleased to answer any questions you may have.
[Operator Instructions] Your first question comes from the line of Lorne Kalmar from Desjardins. Your line is open.
Thanks. Good morning, everyone. Just one quick one on the UDC and then I promise I'll leave it. You guys are obviously pretty far down the road. When are the final bids due and roughly when is closing expected?
We've said that all we're going to say on the process.
Can't blame a guy for trying. And then looking at developments, the Adelaide and Duncan costs were up quite a bit quarter-over-quarter. Could you maybe give some color on what drove that?
Yes, I'm happy to do that. About roughly half of the increase in the costs related to capitalized interest from the later completion pace and the rest is just higher costs related to the delayed completion.
Okay. Fair enough. And then it sounds like you guys have a lot of good leasing momentum across the portfolio. Obviously, occupancy took a bit of a dip this quarter. Any expectations for where you expect it to shake out at the end of the year?
Well, we're certainly projecting an increase between now and the end of the year, and it will be -- it's very difficult to think exactly, but we'll be in the low 90s for sure.
Okay, that's great. And then last one for me, kind of in the same vein. Any other known nonrenewals coming down the pipe?
I'm sorry, I didn't hear that.
My apologies. Any other known nonrenewals expected?
There are two that come to mind, one in Calgary for about 70,000 square feet and one in Toronto to about 45,000 square feet. And we're working on those [technical difficulty]
Okay, fantastic. That's all for me.
Your next question comes from the line of Jonathan Kelcher from TD Securities. Your line is open.
Thanks. Good morning. Just following up on Lorne's last question there. The two nonrenewals, what quarter would they come off?
Q2 Jonathan.
Okay. And then on the sublease space, it did jump up quite a bit in the quarter. Was that something that happened post the banking issues in the U.S.? Or was it sort of just a steady climb throughout the quarter?
No. The bulk of it was Shopify. Shopify space came on the market in Q1.
Okay. And on that, is there any update that you guys can give on that?
No.
Okay. And then last one for me. Just on the leasing, it sounds like you're obviously very active this year. Has there been any change in the TI requirements, the tenants are looking for?
No change in the last six months or a year.
Okay. Thanks, I'll turn it back.
Your next question comes from the line of Munish Garg from Laurentian Bank Securities. Your line is open.
Hi. Good morning, guys. Just a follow-up on the subleasing question. So I was wondering if you could share your views on what you are currently seeing so far in the Q2 on the ground in terms of sublet space in downtown Toronto? And what are your scenarios for 2023 for both the market and as well as Allied?
I think the best way to answer that question is we are not seeing any new sublease space of consequence in our portfolio following the Shopify announcement, which I believe was either late last year and hit our numbers, if you will, in the first quarter. We're not seeing anything new of consequence in our portfolio to date.
I think there have been sublease spaces come on the market in downtown Toronto, especially in the South quarter, if I'm not mistaken. It is relevant. It is not particularly consequential to us because we don't compete directly with that space in any way, shape or form and because the Well is for all practical purposes out for combines.
Okay, great. Thanks a lot. I'll turn it back.
Your next question comes from the line of Pammi Bir of RBC Capital Markets. Your line is open.
Thanks. Good morning. Just maybe on the occupancy. Can you talk about the interest that you've received to date on the space that I believe the tannery and the potential timing of re-leasing there? And then same question on the Lougheed building in terms of the timing of a lease on that site.
We're in negotiations with the group for the tenure that if we're successful rent will commence in early 2024. Sorry, how much respect to one building too early to say.
Okay. And then just on that tenant that you're in talks with at the January, would the rent be comparable? Or how would that compare to the product tenant?
It's actually higher.
Okay. And then just on the renewal leasing spreads, they did come in better than I think we've seen in a bit. Can you just provide some context on the drivers there? And was that regional related or tenant specific or any comments you can share?
A lot of the deals were done in Toronto in that quarter. So that makes the difference.
Okay. And then just in terms of Tour Viger with some of the leasing that's in the work, at what point do you expect that property to reach stabilized NOI?
Well. Sorry, we expect to complete leasing of the building of this year and rent commencing a couple of deals that we're doing July of next year.
Got it. Okay. Last one for me. Just where are you seeing some of the stronger sources of demand? It sounds like from an educational user standpoint, there seems to be some good activity there. And just any other sort of indications you can provide? And then just lastly, the Tour activity, I'm just curious if that picked up in April so far on a year-over-year basis?
I haven't seen the statistics for people yet, but I mentioned the Tour activity remained very, very good. With respect to the types of users, it's still a mix, but educational users would have to the topping the list at this stage of the game. There's still a lot of tech interest. We've got some financial services interest. We're working with a few retailers for their office space. It's a mix.
Thanks so much. I'll turn it back.
Your next question comes from the line of Matt Kornack from National Bank Financial. Your line is open.
Hi, guys. Just a quick one with regards to tenant retention. We've spoken about the potential on vacant space, and it seems like it's fairly material. But can you speak to kind of the trend on tenant retention.
Well, it's definitely lower in the first quarter than our normal level of retention and maybe even lower than the new normal. Normal for us is 75%. We certainly didn't achieve that in 2022, and we don't expect to achieve that in 2023. I think our internal forecast for 2023 calls for somewhere around 65% to 70% retention. And that forecast, if you will, assumes the nonrenewal that had the greatest impact on Q1, which was the nonrenewal in the Canary and Kitchener. So I think this quarter it's 58% or so retention, that's lower than we expect for the year and that's driven by an unusually large on retention.
Okay. So it sounds like outside of that and then the two mentioned previously in the call, your expectation is that most tenants are going to keep their existing space. And maybe beyond that, are you still seeing tenants expand into new space within the portfolio?
That continues certainly, especially in Montreal.
Okay. That makes sense. And then just with regards to -- so TELUS Sky is on the residential component getting towards -- closer to a stabilized level. And then you've got Adelaide and Duncan, that you'll be delivering. And I think some of those numbers were taken off -- up, I should say, in terms of the NOI contribution. I presume that's related to the expectation on the residential. But can you give us a sense, financing-wise, at what point you'd potentially look at putting CMHC-insured debt on those assets or if that is something that you're considering in the future?
I don't know whether either of those assets would qualify for CMHC financing in this environment. Certainly, we have not assumed in our thinking that we would be eligible for that kind of financing. And we have rather considerable flexibility in terms of how we finance those assets going forward. I think our current plan as Allied is to fund them with our own resources as opposed to placing first mortgages on them.
Our private partner in both instances may need to use conventional first mortgage financing, and there are, of course, mechanisms, which will allow it to do that. But our current plan is to use our own resources with respect to repayment of the construction loans on those assets. Well, actually more precisely on 19 Duncan. There is no construction loan for Allied on TELUS Sky.
Okay. No, that's a fair point. And then I guess with regards to capital allocation and the balance sheet, obviously, the deal we're not speaking to on the call will have a big impact. But is there anything else that we should think of in terms of potential disposition activity or just the changes in the capital stack and access to financing. It's been a big theme south of the border, but it doesn't seem to be as big of an issue up here.
It's -- there will be nothing material, Matt. We may sell a small asset in Montreal, that is very much noncore. We may sell a small asset in Toronto that is less noncore, but isn't part of any existing concentration. But that is literally incidental and inconsequential from a capital recycling perspective.
Okay, fair enough. Thanks, guys.
Your next question comes from the line of Gaurav Mathur from iA Capital Markets. Your line is open.
Thank you and good morning, everyone. In terms of leasing strength, can you discuss if there's any noticeable change in leasing conversion times? And if tenants are any closer to pulling the trigger on the space requirements as compared to the previous quarters?
When you say leading strength, leasing -- pardon me, leasing strength.
Yes. I'm just wondering if there's a change in tenants sort of pulling the trigger as far as the space requirements are concerned, unless that conversion time has now decreased or if it's increased in any manner?
Well, they're certainly taking more time. But the good news from our perspective is these entities are ultimately making decisions, and they are ultimately taking down space. Our preference, of course, is that they take it down with Allied, and we are, as always, getting way more than our fair share of the demand and the concluded transactions in our key markets. But it's definitely taking people longer. And I think there are two very good reasons for that. There are probably a wider array of options open to them now than there has been historically.
And second, there is continuing anxiety about where the economy is going, which is causing decision makers to be more careful, more thoughtful about the decisions they make going right up to the board level. So to summarize, there is no question that is taking users longer to conclude transactions. But there's also no question that they are ultimately concluding transactions.
And I attributed not at all to the whole working from home thing but rather to the fact that people are concerned and I'm uncertain as to what is going to transpire in our economy in the coming 12 to 18 months. And I don't think there's any other explanation for it, and it's entirely logical. And it is what we have always seen in an environment such as this one, where there is concern about a possible downturn in the economy.
Okay. Great. And just as a segue into my next question. Given the macroeconomic environment, are there any read-throughs from the collapse of Silicon Valley Bank on the tech and life sciences tenant base in your portfolio?
Yes. Very good question, and there is absolutely none.
Okay. Great. And just lastly, when you're thinking about fair value adjustments, what seems to be the toughest part for you to estimate in the current environment?
I think the most difficult part of a discounted cash flow analysis is the time required to address turnover vacancy and the rental rates. And those are the very, very large variables in a discounted cash flow analysis. So those are the hardest for us. I'm very glad we do it on a quarterly basis. And I do think to the extent there's variation in our IFRS values, whether positive or negative, which was the case this quarter. It will revolve around our estimate of rental rates in the relevant market and our estimate of the tone that will be required to fill the vacancy or put differently, the duration of turnover vacancy.
Okay, great. Thank you for the color, Michael. I'll turn it back to the operator.
Thank you.
Your next question comes from the line of Dean Wilkinson from CIBC. Your line is open.
Thanks. Good morning, everyone. Michael, does the proposed change over from closed-ended trust to an open-ended trust serve to ameliorate any potential tax implications from asset sales?
No. It will not have any impact, positive or negative on the tax implications from the sale of the UDC portfolio.
Okay. So it's just lining up with basically everyone else's structures out there?
Exactly.
And another change that you've put in there and maybe I'm reading a little too much into it, is the ability to do stuff down in the U.S., should we -- or could we read that as a reflection that you might be looking south of the border seeing some massive price dislocations in office properties down there and you see some attractive opportunities? Or is there something else in that amendment?
Well, I mean, my answer to your question would be potentially yes, but let me be very clear. It would not be yes in the near term. It would be to put Allied in a position where it could consider expanding its geography with at least the optimal structure to facilitate such an expansion. But I want to say being unequivocally now we have no intention to expand into the United States.
I do hope in the fullness of time Allied can evolve in a way that would make it worthwhile to consider expanding into major cities in the United States of America and potentially even elsewhere. But we're a long way from that point in time. And as I've said for years now, we have so much opportunity in Canada that looking further afield would almost be a misallocation of capital today.
But I sincerely hope and I hope I'm still involved with Allied at that point in time that we can rationally allocate capital to expansion beyond Canadian cities, but we're nowhere near that point in time as we sit here today. But having a structure that facilitates that is only in our interest, so we don't have to rush back to our unitholders on a transactional basis and seek modification.
That makes perfect sense, and it sounds like Cecilia is going to rack up a lot of frequent flyer miles. That's it for me. I'll hand it back. Thanks.
Your next question comes from the line of Mario Saric from Scotiabank. Your line is open.
Hi. Good morning. Just a couple of quick ones on my end. The first one for Tom. The comment on occupancy, I guess, by the end of the year in the low 90% range for sure. Just want to clarify whether you're referring to economic or leased.
Leased.
Okay. And then every quarter or so, there's some puts and takes in terms of assets going into PUD coming out of PUD. So in the context of that comment or just generally speaking, going forward, is there a range or a number of property GLA that you expect may come into PUD over the course of the year based on planned value-add initiatives?
Mario, I can't think of anything off the top of my head that will move from rental to PUD in 2023. I really can't. I think to the extent that was done, was done appropriately and it was done in either 2022 or perhaps to some limited extent in 2021. And I suspect the vast majority of it is in Montreal. But I can't think of a single instance where that will occur over the remainder of 2023.
Got it. Okay. One technical question on the UDCs, not necessarily specifically on the UDC but just from an accounting perspective, the IFRS fair value was flattish quarter-over-quarter. Again, from a technical perspective, would that value that was disclosed incorporate the first round of bidding that transpired on March 24. Would it take that data into consideration?
It incorporates everything relevant to making a sound and responsible judgment about the value of our UDC for a moment.
Okay. One last maybe quick one on my end. You mentioned that AFFO per unit for the quarter was below internal forecast, and you kind of highlighted the lower capitalized interest and so on and so forth. But AFFO per unit was above internal forecast. Can you reconcile the two for us in terms of what benefited AFFO this quarter?
No. Yes, happy to answer that. It's really the timing of capital that would have affected the AFFO. So, that would be it.
Okay. That's it for me. Thank you.
And we have a follow-up question from the line of Pammi Bir from RBC Capital Markets. Your line is open.
Thanks. Just a quick follow-up on me, the data centers. The drop in the NOI from Q1 versus Q4, was that entirely or predominantly driven by the vacancy that you indicated back with your Q3 results last November that was expected. I think that took hold in November. I just wanted to clarify that.
Yes.
Great, thanks very much.
And I will now turn the call over to Mr. Michael Emery for some final closing remarks.
Thanks, again, Rob. I hope this has been a useful and comprehensive update for all of you. Thank you for taking the time to participate in this call. We look forward to the next one where I repeat, I will be largely silent. Thanks very much. All the best.
This concludes today's conference call. Thank you for your participation. You may now disconnect.