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Good day, and welcome to the Allied Properties REIT Second Quarter 2018 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn conference over to Mr. Michael Emory, President and Chief Executive Officer. Please go ahead, sir.
Thank you very much. Good morning, everyone, and welcome to our conference call. Tom and Cecelia are here with me to discuss Allied's financial and operating results for the second quarter ended June 30, 2018. 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 conclude those assumptions described under Forward-Looking Disclaimer in our most recent quarterly report. To begin, our operating and development environments have been particularly supportive in 2018, and our team took advantage of the favorable conditions to deliver solid results for the second quarter and first half of the year. In the quarter, we continued to propel strong organic growth in our rental portfolio and made substantial progress in our development portfolio. In addition, we continued the ongoing strengthening of our debt metrics, which will enable us to execute our development program over the next 5 years, with added financial flexibility and discipline. Cecelia will now elaborate on our financial results for the quarter, Tom will follow with an overview of our operating results and I'll finish with a discussion of our outlook for 2018 and beyond. So with no further ado, over to Cecelia.
Good morning. I will address our financial results and balance sheet. First, financial results. Driven by occupancy gain and rent growth in Toronto and Montréal, our same-asset NOI in the second quarter was up 10% from the comparable quarter last year, driving 15% growth in our normalized AFFO per unit. Same-asset NOI at 250 Front West was up 52% in the second quarter, as full rent had commenced on all of the occupied space by the beginning of the year. Even excluding 250 Front West, our same-asset NOI was up 8%, which is encouraging and consistent with our internal forecast. Driven largely by the recent completion of upgrade properties in Montréal, our NAV per unit at the end of the quarter was up 6% from the end of the comparable quarter last year. The IFRS value adjustment in the quarter totaled $79 million, excluding incremental capital investment of $57 million. At $264 million, our annualized EBITDA was up 5% from the same quarter last year. This growth is also consistent with our internal forecast. Moving to the balance sheet. We took the opportunity at the end of June to issue $300 million of equity to pay off our highest rate mortgage and paid down our operating line. We were able to do this in a non-dilutive manner. This resulted in significant improvement in our debt metrics, which are now stronger than ever. At quarter-end, our debt ratio was at our target of 30%. Net debt-to-EBITDA was 6.8x, also within our targeted range. Interest coverage in the quarter, excluding the interest on the retired mortgage debt, was 3.3x, representing progress towards our target of 4x. We intend to continue paying off mortgages coming due in the balance of 2018, totaling $52 million at maturity. This will continue the growth in our pool of unencumbered property. At quarter-end, the pool totaled $3.8 billion, representing 64% of the IFRS value of our property. This was up 48% from the same time last year. We finished the quarter with $20 million drawn on our unsecured operating line, leaving us with $230 million of availability. Also, in the quarter, we received an unsecured debt rating of Baa3 with a Stable trend from Moody's. Now with 2 investment-grade credit ratings, our ability to access the debt capital market on favorable financial terms is enhanced, and we intend to continue our unsecured debenture program. I will now pass the call to Tom for a discussion of our leasing and operating activities.
Thank you, Cecelia. Our leasing environment has been very strong with demand in all markets. We've completed 7 significant transactions in recent weeks, totaling 640,000 square feet of space. 4 of the deals, totaling 195,000 square feet, were for our rental portfolio in the Eastern region. And 3 deals, totaling 445,000 square feet, were pre-leasing commitments on new developments in Toronto and Vancouver. More on these transactions shortly. Our occupied area increased in the quarter by 40 basis points to 94.9%, and our leased area increased by 40 basis points to 95.4%. We continue to show very healthy lifts in net rents on space renewed or replaced so far in 2018. For the 6-month ended June 30, rents increased by 23% on maturing leases. We fully expect renewal or replacement rents will continue to show very positive increases over the balance of the year. Moving from East to West, I will provide a brief update on leasing activity in our 4 major markets, and conclude with an update on our carrier hotels. Starting in Montréal. One of our leasing objectives in 2018 was to complete the lease-up of a large portion of the ground floor at Le Nordelec to office tenants. Most of the ground floor in this building had been previously occupied by industrial uses. We have now achieved full lease-up on the ground floor of the office component of this project. GSoft leaves 95,000 square feet and lodge back at least 40,000 square feet. While these transactions will not provide much additional revenue in 2018, they will represent significant uplifts in revenue in 2019. We are now focused on leasing the remaining retail space in the building. At 6300 Parc, we completed an expansion of Moment Factory for 17,000 square feet, bringing that building to 95.6% leased. At 740 St. Maurice, we completed the deal with Technicolor for 45,000 square feet, bringing that building to 100% leased. Construction at our redevelopment project at 425 Viger is going well. We are basically adding 100,000 square feet to a 200,000 square-foot building, and interest on the part of a large number of large users is encouraging. We are in advanced negotiations for 100,000 square feet with a global brand and expect to make an announcement within a few months. This project will be delivered for tenant work in Q3 2019. Moving to Toronto, our prime focus has been pre-leasing The Well, a joint venture with RioCan. We were very pleased to announce 2 transactions earlier this week for a total of 325,000 square feet. Index Exchange has committed to lease up to 200,000 square feet, and another high-caliber tenant has committed for 125,000. These 2 deals represent 30% of the office space in the project. Two other transactions totaling 520,000 square feet are at the final documentation stage and, if completed, will bring the office component to 80% leased. Now that we've made commitments to complete the commercial component of the projects, we will open up discussions with smaller size tenants. We expect the balance of leasing to progress smoothly. In Calgary, we continued to lease smaller suites, which have been improved essentially to move-in condition. Despite a 10,000 square-foot nonrenewal, we maintained leased area of 88.3% at quarter-end. With respect to TELUS Sky in Calgary, our development project with Westbank in TELUS, we are currently working with 3 prospects for a total of 120,000 square feet. If we can complete these deals, we will move to 61% leased. As the building takes shape, interest levels have increased. Moving to Vancouver. The office market there remains rock solid. We have one pocket of space of 11,000 square feet of Sun Tower, which is our only vacant unit in this market. At 400 West Georgia, a Westbank project we are financing with the obligation to acquire a 50% interest upon completion, Deloitte committed to 117,000 square feet for their new Vancouver headquarters. Negotiations are in final stages with 2 other high-quality tenants, which will bring this project to 80% leased. Delivery for tenant work is mid-2020. Now to our carrier hotels. 151 Front is 98.5% leased. 905 King is 93% leased. At 250 Front, we recently agreed to terms with a tenant requiring 5,000 square feet, bringing our leased area to 64%. We are still in negotiations with 3 tenants for a total of 36,000 square feet, and we expect progress in Q3. Ancillary revenue in this building is slowly building. We've also completed a deal to be the sole termination point for a large fiber-optic cable across Lake Ontario, linking Toronto and New York. The cable will terminate at 151 Front, providing existing tenants and new ones a low-latency, highly secured redundant link to the U.S. We will set up a separate Meet-Me-Room and collect recurring fees from all future connections. No capital investment is required on our part. The cable will be in place and operational in Q4. I will now turn the call back to Mike.
Thanks, Tom. Looking forward, our outlook for 2018 remains positive. Our internal forecast contemplates solid mid-single-digit percentage growth in same-asset NOI, low single-digit percentage growth in FFO per unit and high single-digit percentage growth in AFFO per unit. We expect continued growth in NAV per unit in 2018 with significant contributions from development completions, ongoing rent escalation and ongoing cap rate strengths in Canada's major urban centers. Our development outlook is positive and has come into much sharper focus in 2018. We expect to allocate $1.2 billion to our urban development program from the beginning of this year to the end of 2022, with approximately $300 million allocated in each of 2018, 2019 and 2020, and a much smaller amount in each of 2021 and 2022. We now expect to complete 8 urban development projects within that timeframe, with aggregate GLA at our share of approximately 2.3 million square feet, 175,000 of which will be in Vancouver, 316,000 in Calgary, 300,000 in Montréal and the balance, approximately 1.5 million, in Toronto. Our outlook for our carrier hotel assets is also positive and has also come into much sharper focus in 2018. When we acquired 151 Front West in 2009, we took the position publicly that we were not getting into the data center business. The expansion to 905 King West and 250 Front West did not contradict that position. Rather, these facilities were developed as extensions of 151 Front West. Much has changed since 2009, all of it favorable to Allied as the owner of 151 Front West and its extensions. In the broader market, the value of comparable facilities in the U.S. and elsewhere is rising, as evidenced by transactions concluded late last year. Similarly, the revenue-generating potential is increasing significantly and continuously, which, of course, is the main reason values are rising. The example Tom cited of the fiber optic cable being laid across Lake Ontario is a very good example of revenue-generating activity increasing even at 151 Front. Operating these assets is not fundamentally different from operating urban office properties designed for people, which was our initial core competence. After 9 years of operating 151 Front West very successfully, we know, one, that we have the necessary competence; and two, that the assets complement the remainder of our urban office portfolio in Toronto. We had a very good illustration of this recently with Index Exchange at The Well. As part of our lease agreement at Index Exchange required that we work with it to establish a direct link to 151 Front, which, of course, we're prepared to do. We didn't get the transaction solely because of that, but it certainly helped. By acquiring 151 Front West, we put ourselves at the Canadian epicenter of an important global trend. And despite repeated suggestions that we monetize our carrier hotel assets in the interest of capital recycling, I believe that disposing of these assets would be both irresponsible and tantamount to squandering an opportunity, the magnitude of which we can't currently quantify. Furthermore, we're now evaluating the possibility of increasing our exposure to assets where urban real estate and communications technology intersect. I believe we can do this credibly and without altering the risk profile of our business. I also believe the NOI margin on this activity could be high. Finally, this will not involve the kind of speculative development we engaged in at 250 Front West, but rather would be immediately accretive to our earnings per unit, and very possibly meaningfully creative over time to our NAV per unit. Increasing our exposure to assets where urban real estate and communications technology intersect is an exploration we're undertaking. It is not a definitive position we have established. Our goal is to formulate a detailed and credible plan that we can review with our board and with our constituents in due course. And to repeat what I said explicitly in 2009, we are definitely not getting into the data center business. We are, however, evaluating the possibility of augmenting our extraordinary carrier hotel asset base in a manner that doesn't alter the risk profile of our business. Overall, we continue to have deep confidence in, and commitment to, our strategy of consolidating and intensifying distinctive urban office space in Canada's major cities. 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. Tom, Cecilia and I would now be pleased to answer any questions you may wish to put to us.
[Operator Instructions] Our first question comes from Fred Blondeau at Echelon Wealth Partners.
I was looking at the estimated yield on cost on your projects, and it seems like you slightly reduced your estimates for King-Portland compared to Q1. I was just wondering if you could comment on that. And also, I understand it's still a bit early, in your opinion, what would be the risk for your 6% to 7% estimate for a project, given the trends that we're seeing in terms of development costs?
At King-Portland Centre, Fred, there was a slight reduction, but it was very slight. It may have to do with a timing estimate on the completion of the condominium units and the inflow of those funds. But it was very minor. I know it's still well into the 8-plus range if I'm not mistaken. As to the projection for The Well, which we made public for the first time in our quarterly report, there are probably 2 categories of risk associated with that projection as we speak today. Number one, we're still fixing our costs. They have risen, but I believe our current estimate more than adequately takes account of the escalated cost and more than adequately provides a contingency in relation to this very large project. The other risk that exists in a projection of this sort would be the ultimate rental rates we're able to achieve on the balance of the office leasing and the ultimate rental rates we're able to achieve on the retail leasing. We're very confident of both. There's a possibility we may even exceed our own expectations with respect to the remaining leasing of the office component. We're very confident about the achievable rental rates on the retail component. But of necessity, we won't even begin to execute the retail leasing for 1.5 years to 2 years because, a, we'll be in a much better position to extract the best possible rents then; and b, retail tenants typically don't pre-lease in the way office tenants do. They want to be much closer to the point of completion before making their commitments. So to summarize that long-winded answer, the categories of risk are basically construction costs and lease rates on the remaining space to be leased in the project. We do think, however, that we're on the verge of taking a very substantial part of that risk out of the office component. We won't be in a position to take that risk out of the retail component for another 1.5 years to 2 years. We know from long experience, as do our partners at RioCan, that retail leasing is best executed once the office components of the property is populated and once people understand who's going to populate it; and also in the case of The Well, once people know that the residential component will be populated and the kind of people who will populate it.
Perfect. My second question, in regards to your carrier hotels, as you mentioned, it looks like you're increasing your exposure there. I was just wondering if you might have a timeline here at this point, and if you are able to quantify the opportunities you're seeing at the moment?
The best timeline I can provide is we typically have our strategic planning session with our board in December. And this year, I think it's scheduled for December 9 or so. Our goal, as a management team, is to complete the evaluation process in a very systematic and professional way by that time and then to work with our board in terms of making the decisions we need to make based on that evaluation. So I wouldn't anticipate anything occurring in this regard in 2018. In terms of the magnitude of the opportunity, I wouldn't, at this juncture, want to suggest to anyone that it's enormous. It isn't, but we do think there is an opportunity to credibly enhance the asset base we have without changing its character in any way. But I wouldn't look upon this as an enormous initiative. I'd look upon this as an incremental initiative. What we're most convinced of with respect to our carrier hotel facilities is that it would be ludicrous and ill-conceived to dispose of these assets in the interest of some sort of abstract capital recycling. These are irreplaceable assets, and their ability to generate revenue increases almost continuously. And the revenue-generating capability is actually not linked to area or to space. It's linked to interconnection, which requires very little space, and requires very little power. So our adamant view in this regard, and I don't think I've left any room for ambiguity here, I've certainly tried not to, our adamant view is we will not, under any circumstances, dispose of these assets or any portion of them in the interest of capital recycling. The other thing I would add is, at least thus far, our access to capital, in order to fund our very significant development program responsibly and with great discipline, has been good. I don't expect it to materially diminish. And what we did in August -- sorry, in June was designed to give ourselves even more latitude going forward in terms of funding that with external sources, be it equity or debt.
Our next question is from Jonathan Kelcher at TD Securities.
Just going back to The Well, I guess, the 2 tenants you're still negotiating with, would it be fair to assume that one is for about 10% of the space and the other for 40%?
I don't think you should assume anything in that regard.
Okay. Because you were 3 for 41% of your call last quarter, right? And then...
It's a slightly different population. And as I say, I wouldn't spend too much time trying to figure out the composition between the 2 tenants with whom we're in negotiation or, actually, I should say, with whom we're finalizing documentation.
Okay. Just -- but on those tenants, will you -- will there be any back -- or any space in your current portfolio to backfill?
It's a very good question, and the answer is no.
Okay. And then just lastly, when we -- when you look at the NOI that you guys are expecting from The Well, how much of that would you expect to come from non-rental income, parking and stuff like that?
Well, just to be clear, especially with respect to our REIT status, I believe it's all rental income. But I think what you're alluding to specifically is parking, signage, and there's one other component. And yes, the revenue associated with the Enwave facility. We are not prepared, at this point, Jonathan, to break that out. I know you're trying to iterate your way to office rents and retail rents, but we're not prepared at this point in time to say anything other than we have achieved our targeted net effective rental rates for the office component that we've leased or feel is about to be leased. And we may be able to exceed those targets somewhat with the follow-on leasing to users with smaller requirements. But we've been very deliberate in not disclosing the rental rates that we've obtained on the office component, nor do we want to disclose the rental rates we're seeking on the rental component.
Okay, fair enough. Just switching to TELUS Sky. The commentary in your letter at the beginning says a mid-2019 delivery, and I think the table on Page 33 still says it's a Q1 transfer to rental income. Can you maybe clarify?
Good pickup. I think we may have neglected to update that table, but it is mid-2019.
Okay. And on the annual NOI you expect from that, can you remind us how much will come from the residential versus the office?
That is something I'm meant to do and haven't done. Do you know off-hand, Cecilia? I don't.
Jonathan, I can call you after the call. I've got it on my desk.
Okay. And then when that...
Yes, I can't remember, and I should've looked at it before this call.
No problem. And as soon as that transfers, you stop capitalizing for the whole development? There's no wait on the lease-up or anything?
The capitalization stops when our construction work is completed. So it actually doesn't have anything to do with the lease-up or the transfer back to the rental portfolio. I mean, there is obviously some linkage. But once we have all of the occupancy permits, it gets moved back to the rental portfolio. I don't know if the office and the res will receive the occupancy permits at the same time. So if we're still working on the res portion, once the office space is clear for occupancy, there might be a portion that is still capitalized as the res piece is completed. But we'll know once we get closer to that date.
My guess is -- and I think you're quite right, Cecilia. My guess is the office component will need to be transferred first. And the residential component, because it won't be complete in the same way, will need to be transferred later.
Right. And so...
So we have to actually build the suites out in order to rent them. And in some cases, we even have to furnish them.
Right. So the capitalization on the office, if I had to guess, will end before it ends on the res piece.
Okay. And you'd be thinking Q2 '19 would be a fair spot for that?
Yes.
Our next question is from Mike Markidis at Desjardins.
A quick one to start off. Same-asset NOI for the first half of this year is slightly in excess of 10%, and you're still sticking with the mid-single-digit for the year. So I was just wondering if you'd give us a sense of what's slowing in the back half of 2018.
We're expecting same-asset NOI to be lower in the second half. Part of it will be -- 250 Front did have economic occupancy, incremental economic occupancy in, I think, September or October of last year. So that will still be positive, but will be lesser than what we saw in the first half of the year. So we're sticking with our solid mid-single, with the expectation that the second half will be lower than the first half.
Okay. And is there anything else, downtime or anything, that is contributing significantly to the slowdown? Or is it just strictly...
No, no. That's the largest piece that I can think of.
Okay. Just circling back on augmenting the existing carrier hotel asset base. Michael, is this fair or safe to assume that this is something that's Toronto-focused on 151 Front? Or would it be something that we'd look at some asset in a different market?
I think the most immediate possibilities would be urban Toronto-focused. There is a more remote possibility that we might look to do something in Montréal that is akin to what we have done in Toronto, but I'd have to characterize that as truly remote. We haven't explored it. We haven't evaluated it, and it's one of the things we might think about and evaluate over the remainder of the year. So to answer your question I think most directly, your suspicion that it is urban Toronto-focused is probably the right one. And it really will be, in many respects, linked to 151 Front and 250 Front. The opportunities that exist involve allowing other people to link into those facilities, which has a twofold benefit for us. One, it increases our revenue, obviously, because we charge for the linkup on an ongoing annual basis. And number two, it makes the facilities more valuable for the users, and ultimately increases the rent we can establish by virtue of having made this denser interconnection. So it will very much be urban. It will very much be Toronto. There is a possibility. But it's -- right now, it's only theoretical that it might include another urban location in Canada. And the logical point for that might be Montréal, given our very significant presence there. But again, that's nothing more than an idea at this point. It's certainly not even risen to the level of a possibility or a probability.
Okay. And if I caught Tom's comments correctly, so there's a fiber cable that's being laid in Lake Ontario that will connect to 151 Front with New York, and that didn't require any CapEx or isn't requiring any capital on your side?
That's correct.
So establishing -- go ahead.
Sorry, Mike. It's a very good example of how revenue keeps increasing at these facilities without any further requirement for space or power. That linkage will generate revenue for us on a recurring annual basis, but it will also make 151 Front a denser interconnection point for all the users. And yes, Tom's entirely correct that there is no capital cost to Allied associated with this revenue source.
Okay. And -- but the potential opportunity that you're evaluating, that'd be similar in terms of being very capital-light? Or would be -- create a capital investment on your part?
I think, initially, it will be capital-light.
Okay, okay. That's great. And just last question for me before I turn it back. Michael, I think you were talking about the yield on King-Portland being well into the 8s when you factor in residential component. I was just trying to remember, I think in the property -- the estimated total cost, and correct me if I'm wrong, Cecilia, it's the cost to complete the residential component?
So what we're showing, if you look -- if you're referring to Page 33 in the MD&A, what we show there is net of the proceeds of the condos.
So the 101 is net of the...
The 101 includes the cost of the -- of building out the condo because we do have to fund our half interest in that. And -- but the estimated yield on costs is net of the proceeds. That's what we try to detail in Footnote 2.
Okay. So that -- I got you. So you take out the cost and the yield on the residential?
Correct.
Yes.
And then the 8s is where you would have some development margin, and that would enhance the yield into the 8s?
So the yield on cost, the midpoint, net of the proceeds of the res, is 7.9%. That range tightened this quarter as we've completed even more of the construction and the final buildout of the suites in terms of costs was known. So even the range of the sale of proceeds from the res components tightened, if you noticed, in Note 2, we originally had $10 million to $15 million. Now it's $10 million to $11 million.
[Operator Instructions] We'll take our next question from Jenny Ma at BMO Capital Markets.
My questions on the carrier hotels have mostly been answered. But when we think about the magnitude, you stressed that it wasn't very big, so would it be fair to quantify it as being somewhat similar to where the mission-critical weighting is in your NOI, assuming you got some portfolio growth over time, and this is really just incremental? So it's not really going from 18% to 25%, for example?
I think I agree with the thrust of your comment. And it's actually difficult now to really answer your question in any kind of informed way, other than intuitively. So what I want to make sure of is that no one sees this as a large game-changing potential initiative. It is not. And so the notion of incremental is the much better one. And using the current, say, 15% of our NOI is something that we can sustain going forward, even in the context of significant growth. And the remainder of our portfolio is not a bad way to think about it. I don't think it would be dramatically more. So certainly, I don't see 15% becoming 25% or even 20% with the passage of time. But perhaps we could keep pace with our growth and have the carrier hotel asset base grow at the same rate as the remainder as we hope and expect the remainder of our portfolio to grow. That would not be an unrealistic or an inappropriate guess. And it would be -- at this point.
Okay, that makes sense. Moving back to your comment about the 2 categories at risk when you're looking at the returns from The Well. The second one you mentioned, the rental rate on the balance of the office and retail leasing, did you assume the 30% that has been pre-leased or the 80%? I'm just trying to figure what the magnitude of the -- of this business.
Yes. The 30% is, I believe, bang on our net effective rent estimate target or pro forma. The remaining 50% could very modestly exceed it. And then the ultimate, I guess, it would be 20%, could exceed it somewhat materially because there really is tremendous upward pressure on rental rates now. So the impact of exceeding projections with respect to office revenue is not huge, but it is something that we think is reasonable to expect. So I think if I sort of get your question, the impact of the rent escalation we're seeing in the marketplace will be felt. But to some extent, we assumed it in what we've already achieved. And fortunately, we've achieved it with the result that our office projection is based much more on data today than it was when we made it.
Okay. My next question is probably for Tom as it relates to TELUS Sky. You've maintained some pretty good occupancy rates in Calgary, all things considered with the market. But I'm just thinking that given the amount of vacancy that's available, what is it that sets the space apart as far as pre-leasing and what tenants are looking for when they've got so much choice in the market? What is -- yes, what is that is differentiating TELUS Sky when they think about pre-leasing the phase as opposed to seeing what's out there currently?
One of the advantages we have, Jenny, at TELUS Sky is the relatively small floor plates. And tenants who are looking for 20,000 square feet, as small as actually total 12,000 square feet can actually occupy a single floor and have -- and not have to worry about sharing a floor with others. That's a big factor in Calgary, which is a city with very large floor plates and large-size tenants. So we can focus on a group that can't find identity as well in the larger towers elsewhere in downtown Calgary. What's happening in our existing portfolio is that we're able to offer small spaces, again, setting us apart from the most of the market. And we've had some success maintaining pretty good occupancy levels. So TELUS Sky is kind of the same. Plus, it's going to be architecturally unique and distinct in that marketplace that does have appeal too.
Our next question is from Howard Leung at Veritas Investment Research.
I just wanted to kind of reconcile the comments made on the development in the letter. Thanks for giving us a little budget and the table on Page 33. Michael, you had mentioned that there's 8 projects expected, and there's 7 in the table, but I don't see 1 for Vancouver. So I'm guessing there's another one in Vancouver for -- under development?
Well, it's a good question. I think the reconciliation is made in this way. 400 West Georgia is not in our PUD category. In fact, we don't own it at all as we speak. We're providing Westbank with funding in relation to the development, and we have an obligation to become a 50% co-owner on completion, subject to certain requirements at cost. So it is in the numbers that I aggregate, both in my letter to unitholders, in my presentation today, and I think even in the press release we issued when we did the bought deal in June, we were including 400 West Georgia as one of those developments, even though it isn't today our property or included in our property under development table.
Okay. No, that makes sense. And just on kind of deploying capital, $1.2 billion for the development, do you also have an idea in the next few years how much capital you'd like to allocate to redevelopment and densification?
It's a good question. I think the amount that we'll be allocating to either upgrade activity or redevelopment will be relatively modest in comparison to development to the $1.2 billion. For example, we will upgrade 468 King West probably in the next 18 months, but the amount that we'll allocate to that will literally be negligible in relation to the $1.2 billion. And there's nothing else I'm aware of now that would require a significant capital outlay on our part. The upgrades in Montréal are literally complete. There's some work left to be done on Nordelec in terms of construction, but that will be done by year-end or early next year at the latest. We do have to do some work on 468 King West, which is a great opportunity to upgrade that building, and then re-lease it under the current levels of rent that are achievable in the marketplace. But that would be about it. So I think the big capital outlays for Allied in the next 5 years are going to be all made in relation to pure development activity or the activity that's included in our PUD table.
Right, right. No, that's very helpful. And then just a question about the Index Exchange clients or tenant that is going to The Well. You mentioned that there is a direct link to the 151 Front facility. Any idea of the TI per square foot that we can expect for that tenant?
Well, just to be clear, the -- what we've agreed to is that we will work with the tenant to establish a direct connection to 151 Front. That particular cost will be a cost borne by the tenant, not by the landlord, and certainly not by Allied as the owner of 151 Front. So it's a cost that the tenant will bear. But having the ability to create -- pardon me, to connect to 151 Front is an enormous advantage for this particular tenant, given what they do, and given, if you will, the internet intensity on which their core business is based. But that will be a cost borne by the tenant. So the actual improvement allowance we're providing into Index Exchange is consistent with our practice in that building. It is the normal level and not materially different from any other tenant that will be going into the building.
Our next question is from Mario Saric at Deutsche Bank (sic) [ Scotiabank ].
Mario, did you change banks?
Apparently, I have.
Congratulations.
Apparently, I go back and forth between Deutsche and Scotiabank. My apologies.
Sorry.
Just to The Well, just a couple of quick questions. I may have missed it. But in terms of the fixing of the cost, the -- what percentage of the cost would be fixed today? And then which -- what type of cost would remain kind of variable, be kind of...
We've very advanced, Mario, on fixing the cost of the office component. I don't know the exact percentage. I should. And then in terms of the retail, we're not as far advanced because we're continuing to work closely with RioCan in formulating the most compelling vision possible for that retail space. And so we haven't fixed that cost. In terms of its relationship to the total cost, it's not that great. But we're less advanced in fixing the cost of the retail component. We're obviously very advanced in fixing the cost of the underground component. So we're well down the road. We didn't -- we had hoped to get to 85% of the total project by this point in time. We're not there yet. But we have made good progress, and we have had some success in value-engineering the project without compromising it in any way, shape or form.
Okay. And then the target return of 6% to 7%, I recognize that the project is viewed in totality. But in terms of the individual components, retail versus offices, is it fair to say that the target return for each individual asset class would fall within that range as well?
Pretty close. There is -- retail space costs more per foot to create. And of course, the rental revenue you can generate is higher; office, less. And the revenue, you can generate per foot is lower. If I had to guess, Mario, and we haven't looked at this, I think the return on the retail is probably a bit higher, and the return on the office is probably a bit lower, relatively speaking. Then we have, of course, the enhancement that exists by virtue of the third-party digital signage on the corner, which is very material. So whether you attribute that to the office or the retail is almost academic. And then you have the underground revenue, which would be the parking and the revenue from the Enwave facility. But if I had to guess, and if I'm -- I'm now looking back on some of our earlier pro formas, I think to the extent you can actually segment the cost between the different uses, retail is probably a bit more productive than office, at least initially. Over time, I'm not so sure.
Okay. And then just on the Index Exchange tenant itself, it's clear in terms of the reasons why it was interested in locating at the project. It looks like they're coming from a couple of different spots in Toronto and there's a bit of a consolidation there. But from Allied's perspective or from a JV's perspective, what was it about Index Exchange that you found particularly interesting? Anything within kind of the composition of the workforce that you found interesting or about the overall, say, Class I thesis or the urban thesis?
Well, there would be actually several factors. One of the most interesting things to us is, of the 4 tenants we've either completed transactions with or are working on transactions with now, it was the one with whom we had no pre-existing relationship. So that in and of itself made Index Exchange interesting to us. The second thing that interested me and the team a great deal was what Index Exchange does. And it's not easy to understand in technical terms. But I think in terms of business essence, what they've created, and they've created this on a global scale, is a stock exchange for ad impressions on the Internet, which is a very big thing and, as we all know, is where the advertising revenues and the advertising, if you will, space or impact is occurring. It's not occurring in traditional TV or newspaper or magazine formats the way it used to. So what they do interested us a great deal. What also interested us is that they are self-funded. That is to say, they have built this very significant business without debt, without venture capital participation and without public access to capital. And it's really quite impressive that they have the kind of earnings that have allowed them to build this business, as I say, on a self-funded basis. So it was really -- and finally, we believe that Index Exchange is exactly the kind of organization we work with best, exactly the kind of organization we want to be associated with and exactly the kind of organization that can actually be additive to and make a contribution to the community at King and Spadina. So it was really a combination of all those things. And no small part the fact that we didn't have a pre-existing relationship with them. And we think it's going to be a great relationship, and we think they're going to make a great contribution to the community at King and Spadina.
That sounds like a good fit. Okay. Two more questions, just on 151, and then on the augmentation. Just on 151, coming from the link between Toronto and New York and the additional room, is there a way you can kind of provide a quantification of the potential revenue upside from that adventure at this point?
I think we would be loath to do that at this point, Mario. I think it's probably fair to say, Tom, that it's not gigantic, but it's not insignificant either. And I think the longer-term benefit of having a denser interconnection environment will be much greater than the short-term benefit of recurring annual revenue for the connection. So it's not a game-changing revenue augmentation, but it's one that we didn't even recognize as being possible 3 years ago. And it's one that doesn't take up space or require capital from us. But I think we'd be loath to -- what we might do, Mario, going forward, and Cecilia, Tom and I need to think about this, and it's part of what -- we might want to better segment the revenue components of our carrier hotel facilities. And the biggest segmentation, I believe, would be between what we call conventional rental revenue and what American entities usually refer to as interconnection revenue. And this would fall, obviously, in the interconnection revenue area. And that's probably where the greatest growth rates are because conventional rental revenue is linked to square footage. Although, hopefully, the rent we can charge on a per square foot basis rises dramatically in relation to the interconnection density. But I think going forward, certainly in 2019 and beyond, we'll try to segment these revenue components because it is relevant in terms of gauging the ultimate productivity of these assets over time. So that's, I think, as helpful as I can be on that subject.
Okay. And then just a related question and my last question. When we're looking at the -- or thinking about the augmentation of the carrier hotel portfolio, as you alluded to, it may involve additional connections into 151 Front. When we think about real estate, and we think about supply and demand, generally, as supply increases, rental rates come down or there's an impact on rental rates. But it seems, based on your commentary, that it may be a little bit different when it comes to this type of asset given that interconnection kind of environment was created. So as more buildings or more entities are able to connect to 151 Front, what is the impact to the tenants at 151 Front?
It actually means they're sitting on, and have access to, and benefit from, an ever-increasing mass of interconnections. And that makes the facility more valuable to them, and it almost certainly makes us able to charge more on a per square foot basis or per kilowatt hour basis however you want to measure it, going forward. So yes. I mean, again, what I should say as well here is one of the things we want to examine is whether indeed there's any downside or diminishment that flows from that particular augmentation of the asset. Does it become less in any way? Are people less incented to locate there if they can't connect there? We believe the answer to that is emphatically no, and we believe the answer to that is the opposite. But we need to do a lot more work and evaluate this a lot more carefully than we have before we can draw definitive conclusions in that regard.
Our next question is from Matt Kornack from National Bank Financial.
Keeping with that theme, can you speak to what the direct connectivity is in the existing portfolio to 151 Front? I mean, other than the Index Exchange deal, are there others within the existing portfolio that also have direct connectivity? Because that was part of the goals. The hotel idea was that you could offer ancillary services to your portfolio, correct?
There are other tenants of ours, and they're all consequential in terms of space utilization, but there are other tenants of ours for whom that has been a differentiator in dealing with us. Some of the tenants here are QRC West, for sure. What I don't know off the top of my head is the magnitude of that. I couldn't -- of the 4.8 million square feet we have in Toronto, I couldn't tell you how much -- that kind of access. But I think I can say it's enough to be meaningful, but it certainly wouldn't be anything approaching 50%. It would be more like 10% of our...
Okay. And then it's more important than selling, I guess, in certain...
Yes. It's all always -- it's never been -- it is -- for the right tenant, it's a difference maker, just as parking is for the right tenant a difference maker. But it's not a difference maker for every tenant, that's for sure.
Makes sense. Just wanted to clarify the wording on, you mentioned to allocate $1.2 billion of capital to the development pipeline. If I understand that correctly, based on the chart on Page 33, that's the total cost, that's not cost to complete, correct? It's a lesser number that you have to spend over the period of time because you've already invested to date?
Correct. That's the total, total costs from Jan. 1, 2018, for the following 5 years.
So presumably, I mean, given the estimated cost to complete numbers, and we're missing a large one in the form of King and Spadina, but presumably you could leverage fund to all of that and still be at levels well below your peers on a debt to total assets basis?
Yes, we could. And Cecilia and her team have made those calculations quite carefully. And we could -- if my memory serves, Cecilia, we could finance it all with debt and stay below 40%.
Correct.
Okay. No, that's meaningful. And then just one clarification comment on something that came up earlier on same-property NOI growth. If I understand that, Cecilia, it's not that there's a slowing in that, it's just that the prior quarter periods are stronger?
That's correct.
Yes.
It'll still be -- we still expect it to be strong in the second half, but not as strong as in the first half.
And from an occupancy standpoint, I mean, you're at a cyclical high in Montréal. Toronto's essentially full once you strip out 250 Front. Calgary, we'll see what happens there. But at this point, is the rent growth story, plus the development upside, is that a fair characterization?
I think it is a good characterization. The only thing I would add is, there still are some occupancy gains and pretty material revenue growth items in Montréal. So the story is, rent growth in Toronto for the foreseeable future development activity, focus on Toronto, but not exclusively in Toronto, for the foreseeable future. But I think Montréal will contribute throughout the balance of '18 and the better part of '19 to organic growth through both added occupancy and the -- particularly Nordelec, where we're seeing an industrial tenant base give way to an office tenant base with a very, very material increase in net rent per square foot.
And it -- I mean, it seems like the commentary prior to this, is that Montréal was largely an occupancy story. Occupancy's up, but it sounds like you're more confident now about rent growth in that market. Is that fair?
Yes. Yes, we are. We -- 2 years ago, we would not have projected rent growth in Montréal. We are seeing rent growth. It's not dramatic. And it's certainly nothing compared to what we are seeing in Toronto and Vancouver, but there is rent growth in that market for the right product, definitely.
Our next question is from Chris Couprie at CIBC.
Two quick ones. First, on the fiber optic cable link, how exactly did this opportunity come up, guys? And is there an opportunity to do this with other cities? And the second question is just acquisition market, if you can kind of characterize it right now.
Well, I'll deal with the acquisition market quickly, and then Tom can address the cable question. We believe that we will continue to have opportunities to do smaller infill acquisitions over the remainder of the year. They may not prove to be very consequential in terms of aggregate acquisition cost, but we continue to see respectable infill opportunities. The likelihood of seeing a large transaction between now and the end of the year is small, in my opinion. Although these things usually come when you least expect them. So I would expect, at the end of the day, 2018 will be a somewhat modest year in terms of acquisition volume. But the acquisitions we're able to make are really helpful infills to existing concentrations. And that's something that has always been hugely beneficial to Allied going forward. And the other thing I would say they're all contributing to our earnings on a per unit basis modestly because they're modest in size. But we're not buying low-yielding assets that have future opportunity attached to them. We're buying assets that are yielding quite well today that augment existing concentrations. Tom?
With respect to the link cable, it's not new. Groups have approached us with this kind of thing before. And the group that we've done the deal with now hasn't required us to participate in the cost of laying the cable, where other groups were looking for us to help fund it as well as connect to 151 Front. We didn't really like those -- that idea. And this particular group has had really good experience in this. We're viable, and it didn't cost us anything to participate. So that's why we've gone along with it this time.
It appears there are no more questions at this time. I'd like to hand it back to Mr. Emory for any additional or closing remarks. Please go ahead.
Thanks very much. Thanks to all of you for participating on the call. We hope it was useful, and we look forward to keeping you apprised of the progress in our business over the remainder of the year. Thanks again, and have a great day.
Thank you. This marks the end of today's conference. We appreciate your participation, and you may now disconnect.