Allied Properties Real Estate Investment Trust

TSX:AP.UN

Q2-2025 Earnings Call

[Operator]

Thank you for standing by. My name is JL and I will be your conference operator today. At this time, I would like to welcome everyone to the Allied Properties REIT Second Quarter 2025 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Cecilia Williams, President and CEO. You may begin.

[Cecilia Williams, executive]

Thanks, JL, and good morning, everyone. Welcome to our conference call. I'll highlight our progress towards 2025 goals and what we're focusing on for the remainder of the year. Nan will do the same from a financial perspective. JP will outline the positive leasing momentum by urban markets. We're then pleased to answer any questions. We may, in the course of this conference call, make forward-looking statements about future events or future performance.

By their nature, these statements are subject to risks and uncertainties that may cause actual events or results to differ materially, including those described under the heading Risks and Uncertainties in our 2024 annual report. Material assumptions underpinning any forward-looking statements we make include those described under forward-looking statements in our most recent quarterly report. We're focused on delivering long-term value. This includes driving leasing and operational results, development completion and strengthening the balance sheet. The quarter-end results reflect the resilience of our operating platform, and we're also making progress in executing our long-term strategy of portfolio optimization.

First, leasing and operational results. Our portfolio continues to demonstrate strength despite headwinds. JP and Nan will expand on the highlights, which include improved lease area, positive same-asset NOI, and the successful implementation of our rental residential platform. While these deals continue to take longer to complete due to the availability of options and ongoing macroeconomic disruptions, we continue to experience a shift towards improving fundamentals in urban centers with space mandates from organizations across industry, including significant bank mandates in the Toronto market, we expect leasing momentum to accelerate over the next few quarters.

Second, we made progress on our development and upgrade activities. At M4 in Vancouver, which is currently 77% leased to 3 users, fixturing has commenced, and we're negotiating leases on the remaining space. This includes a current user that's already looking to expand. We also agreed to acquire the remaining 50% interest, which will close on September 30. There will be no cash exchange as part of this transaction. We're pleased to be 100% owners of this property. It aligns perfectly with our operating focus and expand our urban office platform in the vibrant Mount Pleasant Vancouver neighborhood, enabling us to better serve knowledge-based organization. At Toronto House, our in-house rental residential operating platform has achieved a 48% lease-up, meeting our ambitious target to date. At King Toronto, we're heading toward successful completion alongside Westbank. Securing the international retailer that anchors the commercial component is facilitating the lease up of the remaining space.

We're currently in various stages of negotiation with 7 retailers. [indiscernible] is taking place on the fourth level, and we're pleased with the progress. As construction continues, we've been able to remove some of the boarding providing the public with a better sense of the street level experience. It's truly a distinctive project that will elevate the entire King West Village neighborhood upon completion next year. All the development and upgrade projects currently underway will be completed by the end of 2027. Last but certainly not least, our balance sheet. We're focused on strengthening it, keeping ample liquidity and improving our debt metrics. Nan will outline our plan to address debt coming due early next year, and we're confident in our ability to do so optimally, given the success we've had this year in addressing maturities with minimal impact on interest expense.

Our disposition program of noncore assets continues. Private market valuations remained robust, and our IFRS values continue to be validated. We currently have 9 assets under sale contracts totaling $200 million from proceeds. All proceeds will be allocated to debt reduction as part of our path to achieving a net debt-to-EBITDA ratio of under 10x by the end of 2025 and under 9x by the end of 2026. Nan will now elaborate on our financial results and balance sheet management.

[Nanthini Mahalingam, executive]

Thank you, Cecilia. Good morning, everyone. We are pleased with our performance this quarter and encouraged by the emerging positive market fundamentals which are reinforcing our strategic direction and operational resilience. I'll provide an overview of a few highlights from the quarter. NOI of the rental portfolio grew by 1.1%, driven in part by the successful transition of our development completions into the rental portfolio and their continued stabilization. Our average in-place net rent per occupied square foot increased by 1% compared to the same period last year, ending the quarter at $25.32. We saw strong leasing activity again this quarter. We leased over 588,000 square feet, including 75,000 square feet of expansion from existing users. Our leased area is now at 87.2% and our year-to-date retention ratio sits at 69%, modestly below our historical average.

We're also seeing a shift in user behavior with larger mandates in place and longer lease terms on new leases and renewals. That commitment reflects growing confidence in the market and in our portfolio. JP will expand further on this later. While we have seen short-term pressure on FFO and AFFO per unit, mainly due to higher interest costs from the 2024 acquisition, we are pleased to have solid -- made solid leasing progress in these properties that will meaningfully contribute to our growth in the future. We are finalizing the lease up of 4 full floors at 400 West Georgia which will be 100% leased, a significant milestone. Leasing at Toronto House is gaining strong traction with 222 residential units leased. These results reaffirm the quality of our assets and the strength of demand in our key urban markets.

Our development projects are making excellent progress with only 3 ground-up projects remaining. Our [indiscernible] gross book value is down to 6.8% compared to 11.4% last year. The remaining cost to complete is $119 million, with the majority of this to be invested by the end of 2026. As of December 31, 2023, we had ground-up and redevelopment projects that were expected to contribute $90 million to $103 million in stabilized NOI on completion. As of June 30, 2025, completed projects have contributed $60 million based on this quarter's annualized NOI. With the lease-up of Toronto House and rent commencement at M4 in Vancouver, there will be incremental annualized NOI of $3 million in the second half of 2025 and another $10 million expected in 2026. We will achieve stabilized NOI on these projects throughout 2027 and 2028, subject to the successful lease-up of any vacancy.

The decapitalization impact on NOI is approximately 50% on stabilized projects. Capitalized interest is expected to reduce by 20% in Q1 2026 compared to this quarter. Our balance sheet and deleveraging efforts are a top priority. We are firmly committed to reducing our net debt to EBITDA to below 10x by year-end and below 9x by the end of 2026. This will be driven by 3 key initiatives. First, focusing on operations by leasing our organic portfolio, stabilizing our 2024 acquisition and completing our development projects.

Second, our disposition program. We remain on track to divest approximately $300 million in noncore asset sales this year. As of today, we have $200 million under contract and these transactions will close in the second half of 2025. Third, the monetization of our loan receivable at 150 West Georgia. This process is underway with 14 prospective groups evaluating the opportunity. We are still targeting a December 2025 close. At quarter end, our liquidity remained strong with $635 million available on our unsecured credit facility. We issued $850 million in unsecured debentures in 2025 and used these proceeds to proactively address our upcoming debt maturities. We effectively refinanced 20% of our outstanding debt and saw only a marginal increase in our interest expense of approximately $1 million on an annualized basis related to this refinancing.

Through this, we also saw Moody's withdraw their unsolicited rating and our spreads tightened in the secondary market. Looking ahead, we have $850 million of debt maturing in early 2026. A portion of this will be repaid as part of our deleveraging plan with approximately half expected to be refinanced. We have optionality in addressing the refinancing, including both secured and unsecured financing, although our preference is to continue our unsecured debenture program. We made significant progress in the first half of the year, despite by macroeconomic and geopolitical uncertainties. We still have more work to do, but we remain confident in our strategy, in our platform and in our ability to deliver long-term value. Thank you for your time today. I'll now pass it over to JP.

[J.P. Mackay, executive]

Thanks, Nan. In Q2, we continued to experience strong conversion rates, robust expansion activity and a shift towards larger space requirements among the prospective users despite the uncertain macroeconomic environment. Following the close of the quarter, we've observed a noticeable increase in our leasing pipeline as more and more organizations reaffirm that the office is the principal venue for creativity and connectivity. In Q2, our lease area remained stable and outperformed each of the urban submarkets in which we operate, except for Vancouver, where we are making great progress in addressing acquired vacancy. We remain extremely encouraged by the number of existing users in our portfolio that continue to require more space.

In Q2, 75,000 square feet of new leasing activity represented expansions, a 50% increase compared to the previous quarter. We are also encouraged by our improving retention rate, which year-to-date is 69%, closer to our historical average of 70% to 75%. The average rental rate in the same period was up 3.1% when comparing the ending to starting base rent and up 13.2% when comparing average to average. The observed moderation in rental rate growth upon renewal is in line with our expectations and reflects the anticipated impact of increased supply, a message we have been communicating for several years. Tour activity continues to be strong. Tour activity in our rental portfolio was up 13% from the prior quarter and up 21% from the prior year.

Industries represented by touring organizations continue to be technology, media, professional services, education and medical uses. At the end of last quarter, we reported we had 1.3 million square feet of leasing activity under negotiation or at the prospect stage, including 684,000 square feet of new leasing activity. In Q2, we completed 588,000 square feet of leasing activity, including 407,000 square feet of new leasing, resulting in a 60% conversion rate.

At the end of this quarter, we had 1.2 million square feet of leasing activity under negotiation or at the prospect stage, of which 60% represents new leasing opportunities and 40% represents renewals. I'll now provide a brief overview of each market. In Montreal, we continue to observe strong demand from users with larger space requirements. There are currently 10 prospective groups with mandates greater than 50,000 square feet considering space in our portfolio, including 2 groups representing a total of 150,000 square feet with which we are in advanced discussions. We also continue to see strong demand from existing users with large mandates to expand because of increasing utilization. Most of our vacancy in Montreal is concentrated at La Cite, a portfolio of assets located between old Montreal and Griffintown, comprising of 8 buildings totaling more than 1.2 million square feet.

There are currently 5 prospective groups with mandates between 12,000 and 100,000 square feet considering these options at La Cite. These prospects represent the technology, professional services and medical sectors. In Toronto, in Kitchener, we continue to see an increase in demand from prospective users with larger space requirements. There are presently 34 users with mandates greater than 10,000 square feet touring our portfolio, including 9 groups representing a total of 130,000 square feet with which we are in advanced discussions. Last quarter, we reported we were in discussions with 7 existing users looking to expand. We are pleased to report that we completed 5 of those expansions and are currently in discussions with 12 other users looking to increase their footprints, representing 70,000 square feet of new leasing activity. Of the 12 users looking to expand, 11 are technology firms. At Toronto House, we are very pleased with our residential leasing efforts as we are almost 50% leased. In Kitchener, we observed an increase in leasing activity, 3 existing users recently expanded and we are in active discussions with a tech user looking to lease upwards of 50,000 square feet.

We are also in advanced stages of a renewal with a large tech firm that represents the largest maturity in 2026 across our national portfolio. In Calgary, we continue to see an increase in the size of mandates in the market as there are currently 6 prospective organizations with requirements in excess of 10,000 square feet evaluating options in our portfolio, including 3 groups representing a total of 30,000 square feet with which we are in advanced discussions. At Vintage Towers, we experienced a large known nonrenewal totaling 45,000 square feet in Q2 that we have been communicating for several quarters.

We're pleased to report that we have backfilled 2/3 of the space and continue to see strong productivity on the remaining availability. Vancouver remains the strongest leasing market in Canada. There are presently 8 users with mandates between 10,000 and 50,000 square feet evaluating space in our portfolio, including the 3 groups representing a total of 130,000 square feet with which we are in advanced discussions. We are also engaged in discussions with 4 existing users looking to expand, representing 40,000 square feet of leasing activity. At 400 West Georgia, we are now finalizing an agreement with an education user for the remaining vacant space totaling 64,000 square feet. We expect possession in September of 2025. While the uncertain macroeconomic may impact leasing activity in the near term, we remain confident in our ability to outperform the market in each city due to our concentration of distinctive urban workspace in many rich urban environments and the strength of our operating platform, as validated by our Net Promoter Score, which is 150% higher than our peer average. I will now turn the call back to Cecilia.

[Cecilia Williams, executive]

Thanks, JP. Before we turn to questions, I want to reiterate my confidence in our portfolio and our team. Our urban portfolio is not only unique but strategically positioned for the future. I say this as Canadian cities are increasingly concentrating into centers of creativity, innovation and opportunity and urban workspace plays a critical role in that, making Allied well positioned to meet the growing demand. Our team is focused, patient and confident that our fundamentals will ultimately be recognized. We'd now be pleased to answer any questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Jonathan Kelcher of TD Cowen.

[Jonathan Kelcher, analyst]

First question, just on the outlook for 2025. I guess your target is for FFO to be down 4% from last year. Just based on the first half of this year, that would imply a pretty good step up in FFO over the back half of '25. So -- like how did the first half track internally versus that expectation? And what are you seeing that gives you confidence to sort of maintain that target?

[Cecilia Williams, executive]

Sure. Yes. So the first half of the year tracked exactly as we expected, Jonathan. And what gives us confidence, and I'll ask Nan to outline the path forward but what gives us confidence is the momentum that me, Nan, and JP just outlined in the market. So Nan, why don't you just go through the pathway?

[Nanthini Mahalingam, executive]

Yes, Jonathan. So some of the key drivers that we're going to have in the second half of the year versus the first, stabilization from Toronto House in 400 West Georgia, disposition proceeds to pay down debt to reduce interest expense, no revenue that's going to be in the second half that was in the first half, commencement of leased area that's currently in our lease of 87.2% that will be productive in the second half and organic growth.

[Jonathan Kelcher, analyst]

Okay. That's helpful. And your -- so I guess a lot of the organic growth is -- sounds like the thing that is not guaranteed and everything else sounds like pretty sure. Is that how to think about it?

[Cecilia Williams, executive]

Yes. I mean nothing guaranteed, but we see a path towards achieving our target at the end of 2025, and that's what we remain focused on.

[Jonathan Kelcher, analyst]

Okay. And then secondly, JP, you gave a whole bunch of stats, which is very helpful. But at the beginning, I guess, you said the -- and we've seen articles on this, that there's been a pickup in demand more recently. Is -- are the stats you gave as of the end of June? Or are they current? I guess that's my first question, and then I have a follow-up on that.

[J.P. Mackay, executive]

At the end of Q2, Jonathan, we were working on 1.2 million square feet of leasing activity, of which 60% represented new leasing activity. Subsequent to the quarter end, we've seen that number increase by a couple of hundred thousand.

[Jonathan Kelcher, analyst]

Okay. That's helpful. And then is that -- I guess everybody has seen the articles and with financial firms. What -- are you seeing more of an increase from other sectors and maybe are there any markets, geographic markets that are seeing more versus others?

[J.P. Mackay, executive]

We're seeing an increase in demand across all sectors and all markets, Jonathan. That's a function of more and more organizations returning back to an office-centric model, which is increasing utilization and in turn demand and the availability of high-quality space is declining with no new supply coming online after 2026 and subsequently falling in line with near-historic lows. And as such, organizations recognize that the window is narrowing to secure the stage of space.

[Operator]

Your next question comes from the line of Lorne Kalmar of Desjardins Capital Markets.

[Lorne Kalmar, analyst]

Maybe just sticking with the target. Obviously, you guys kept your 90% in-place occupancy target, and you mentioned the lease-up of 400 West Georgia and a couple other of -- or some positive momentum on the leasing front. But could you maybe give us a bit of a bridge as to how you kind of get from that 85% to 90% in the next couple of quarters?

[Cecilia Williams, executive]

Well, it will be through continued lease-up and pushing the occupancy accordingly.

[Lorne Kalmar, analyst]

Okay. So are there any, I guess, known outside of, I guess, the Westbank -- or sorry, the West Georgia isn't necessarily 100% known. But outside of that, is there any other kind of known occupancy catalysts that you're expecting over the back half of the year? Or is it really just relying on the leasing momentum and whatever leasing activity gets done in the back half?

[J.P. Mackay, executive]

Lorne, we continue to see positive momentum in all markets across all sectors. In my remarks earlier, I touched on each city and made reference to the total square footage, with which we are in advanced discussions and the ever-increasing leasing pipeline that I made reference to in responding to Jonathan gives us confidence that we'll continue to see positive momentum.

[Lorne Kalmar, analyst]

Okay. Fair enough. And then just flipping to the acquisition of the remaining 50% from Westbank out in the -- or from the Vancouver office development, you guys have now done, I think, 3 of the 4 projects you've had, you bought them out of. King Toronto, I've asked about before. I'm just wondering, is there any change in your outlook as to whether or not you have to take that in as well?

[Cecilia Williams, executive]

No. We fully intend to continue working alongside Westbank at King Toronto and to complete the project alongside Westbank.

[Lorne Kalmar, analyst]

Okay. And then just the last one. I know you guys talked year-to-date retention. Q1 was obviously pretty solid. 2Q came down a bit. Can you maybe give us some color on what happened there and how you expect that to trend over the balance of the year?

[J.P. Mackay, executive]

Lorne, for the balance of the year, there's 800,000 square feet maturing. We're in advanced stages of renewal discussions on 400,000. We expect 200,000 to come back and we're very pleased with our ongoing efforts to backfill those known nonrenewals. And the balance of the maturities, we continue to work on.

[Operator]

Your next question comes from the line of Brad Sturges of Raymond James.

[Bradley Sturges, analyst]

Just following on the same line of questioning around leasing and potential upside or recovery on occupancy. Just in terms of the commentary, obviously, there is some potential demand improvement through the return-to-office mandates. Just I guess 1 of the headwinds you guys have seen of late is time lines to complete deals have been long. Do you think with the new mandate you'll start to see time lines starting to shorten up? Or what would be the catalyst to normalize on the negotiation front?

[Cecilia Williams, executive]

Yes. I think we see opportunities to shorten some of those time lines. I think the user that we're finalizing negotiations with at 400 West Georgia is a great example. They need to be in the space by September, and we'll be finalizing that paper over the next couple of weeks. So that's 1 example where we're able to capitalize on the need for certain organizations to -- they have urgency, and we have space that we can provide for them to occupy sooner rather than later. So we see the opportunity for more situations like that. But we'll see how Q3 plays out, and we remain cautiously optimistic.

[Bradley Sturges, analyst]

So at this point, it's probably wait and see until how the fall kind of starts to trend, but potentially, we could start to see those time lines start to narrow a bit.

[Cecilia Williams, executive]

Exactly.

[Bradley Sturges, analyst]

Okay. And in terms of 400 West Georgia, occupancy is potentially could be in September, when would the rent commence? And then how should we think about the term and the associated leasing costs with that lease?

[J.P. Mackay, executive]

Rent commencement would be January 2027. The terms are reflective of the market.

[Bradley Sturges, analyst]

I guess I mean more like in terms of the length of term of that lease. And then so -- and then just to clarify, the leasing cost would be more in line with market levels at this point?

[J.P. Mackay, executive]

Yes, 10 years leasing cost in line with market.

[Operator]

Your next question comes from the line of Matt Kornack of National Bank Financial.

[Matt Kornack, analyst]

Just with regards to the leasing that you're seeing right now, I mean, it sounds like tour activity is up and people are considering your space. Would you say the bulk of that is tenants looking to relocate in the market, relocate in your own buildings? Or is that new kind of space to the market? I'm just trying to think is somebody moving to your building from another building? Or are they kind of new to the space and maybe they bring down the overall vacancy rate across the market?

[J.P. Mackay, executive]

It's a function of tenants seeking high-quality assets to offer great workplace experiences, requiring in many cases, an increase in their footprint because of higher utilization. There are a couple of organizations which we're working, who have not maintained an office presence, and they are now wanting to introduce an office-centric model. So Matt, it's a reflection of a number of different variables.

[Matt Kornack, analyst]

Okay. Makes sense. And then -- and then just on the accounting front, for a few quarters, you've kind of seen straight-line rents grind down. Is that -- is there anything to that? Or is that dynamics of leasing, maybe free rent periods that I'm not entirely sure.

[Cecilia Williams, executive]

So Matt, the straight-line rent converting to cash rent, that's why same-asset NOI is up. It's mostly from our development pipeline, in particular properties like [indiscernible].

[Matt Kornack, analyst]

And should we expect that -- I mean it's near 0 at this point. Should we expect that it kind of flattens or you're expecting to kind of rebuild straight-line rent as you do some of these longer-term leases where I mean I think for the 400 West Georgia one, it sounds like they're going to be in place in September, but they won't be paying rent until January of '27. Is that correct?

[Cecilia Williams, executive]

Correct. So it will start rebuilding again, tenant in fixturing starting in Q3.

[Matt Kornack, analyst]

Okay. So as you do some of this lease-up, we'll see it more in FFO than AFFO?

[Cecilia Williams, executive]

Exactly.

[Matt Kornack, analyst]

And then just quickly on the Vancouver purchase, did you guys, with your partner, look at taking that to the market? Or was it just a logical purchase on your part to own the full 100%?

[Cecilia Williams, executive]

No, it was logical for us to take over the remaning interest back.

[Operator]

Your next question comes from the line of -- your next question comes from the line of Gaurav Mathur of Green Street.

[Gaurav Mathur, analyst]

On the $300 million of noncore asset sales, what would the average occupancy of the assets be currently?

[Cecilia Williams, executive]

It's very low.

[Gaurav Mathur, analyst]

Okay. Right. And would it be fair to say that the sale of these assets would potentially help in meeting the year-end occupancy goal?

[Cecilia Williams, executive]

They're not currently included in our leased area, there's an asset held for sale, so it's not part of the occupancy or lease area calculation currently. So no, I wouldn't have any impact on that.

[Gaurav Mathur, analyst]

Okay. Great. And then just switching to 150 West Georgia. And while there are multiple options for monetization there, would 1 of those options be an outright sale? And if so, what would the potential buyer pool look like?

[Cecilia Williams, executive]

Well, it is an outright sale, it is an outright 100% sale, and it's being marketed in a way that will get us the optimal outcome, which would be to have our loans being repaid full by December 31 of this year. .

[Gaurav Mathur, analyst]

And is there -- could you provide any color on the potential buyer pool?

[Cecilia Williams, executive]

Not at this stage. It's well underway, and we're pleased with the progress. That's all I'm able to say right now.

[Operator]

Your next question comes from the line of Pammi Bir of RBC Capital Markets.

[Pammi Bir, analyst]

JP, I think you mentioned some comments around utilization. Can you maybe just talk about what trends you're seeing in your portfolio through Q2? And whether the utilization trends have actually continued -- or have they changed through July?

[J.P. Mackay, executive]

Yes. Pammi, they continue to improve. As you know, Western Canada, Calgary and Vancouver have led their eastern counterparts in utilization throughout the past number of years and continue to perform exceptionally well in that regard. We're now seeing Toronto and Montreal improve utilization at similar levels, and that's driving demand as we articulated earlier.

[Pammi Bir, analyst]

And sorry, what would those levels be for Toronto and Montreal, like roughly like a percentage range or?

[J.P. Mackay, executive]

We're nearing 80%.

[Pammi Bir, analyst]

Okay. And that's -- if you were to compare that to, again, going back to maybe 2019, how would that stack up?

[J.P. Mackay, executive]

It represents approximately 3 to 4 days a week in the office. As you know, Pammi, organizations, including our own, are increasing their mandates, as there's widespread recognition that the office remains the principal venue for creativity and connectivity. So we expect trends around utilization to continue to improve. In our view, there's really no longer a question around utilization. Organizations are returning and that's driving demand, and will continue to do so.

[Pammi Bir, analyst]

Got it. just coming back to that 90% occupancy, I guess, expectation by year-end, how much of that is coming from some of the development leasing that starts to kick in, in the second half of the year versus, say, assumed lease-up of other vacant space?

[Cecilia Williams, executive]

The development lease-up wouldn't have a material impact, Pammi, because we would be adding the space to the numerator and the denominator. So mathematically, it just doesn't have that much impact. It's really the 4 things that Nan outlined.

[Pammi Bir, analyst]

Okay. And then just there was, I guess, the additional disclosure on the development NOI that's helpful. You mentioned another $10 million of contributions in 2026 for a couple of projects. I think that gets you to maybe $70 million-ish next year. So for the remaining $30 million or so or maybe $20 million to $30 million relative to your total range, what are some of the largest spaces that, that relates to?

[Cecilia Williams, executive]

It was primarily in the redevelopment portfolio Pammi. So RCA in Montreal, 1001 and portions of CCM in Montreal as well. Those would be the largest portions of buildings in redev.

[Pammi Bir, analyst]

And with the expectation there, like are you seeing any traction that maybe gives you some confidence that 2027 is a reasonable expectation for some of that space to get leased up? Or does it shift more to 2028?

[Cecilia Williams, executive]

I think actually the 2027 timing is going to prove to be perfect the way that the market is moving.

[Operator]

Your next question comes from the line of Tal Woolley of CIBC Capital Markets.

[Tal Woolley, analyst]

Just on the disposition pool, the $300 million, do you have a rough estimate that we could use for the NOI yields just so we've got an idea of what to take out for dispositions going forward?

[Cecilia Williams, executive]

Yes, it's about 3%, 3.5%. It's pretty low because it's very low occupancy. Some of the buildings are actually empty, so pretty low yielding.

[Tal Woolley, analyst]

Great. Okay. And then on the 150 West Georgia loan balance, do you have a rough estimate of how much of that is accrued interest versus principal?

[Cecilia Williams, executive]

We can get you that, Tal.

[Tal Woolley, analyst]

Okay. Perfect. And then just a broader question, I guess, overall. Operationally, financially, it would seem to me like you're sort of trying to communicate this. This feels like we're sort of in the trough of this cycle. Is that a fair characterization of what you're trying to message to the market?

[Cecilia Williams, executive]

Absolutely.

[Operator]

And your next question comes from the line of Mario Saric of Scotiabank.

[Mario Saric, analyst]

I just have a, I guess, a 2-part question on distribution sustainability. First part, internally, like when you think about occupancy and the push to get to 90% plus, is there a specific occupancy internally that you have in mind that you need to hit in order for you to view the distribution as sustainable given the expected leasing costs of the occupancy lease-up? And then secondly, how much time would you give yourselves or how much time does the Board give management before deciding on whether that occupancy is achievable before you reassess the distribution?

[Cecilia Williams, executive]

We're very comfortable with where we're sitting at relative to the distribution, Mario. Obviously, the payout is higher than what we would ultimately be targeting, but we see a path to having the payout ratio moderate and ultimately, in time, get closer to what our targeted levels would be. But both management and the Board that path today and are comfortable with the sustainability of the distribution.

[Mario Saric, analyst]

Got it. And is that path like a 2026 event? Or is that a path that can take us into 2027?

[Cecilia Williams, executive]

Path to what, sorry?

[Mario Saric, analyst]

A path to a sustainable distribution at an occupancy level, whatever you think that occupancy level may be required to have a sustainable distribution. Is that a '26 event or?

[Cecilia Williams, executive]

Yes, we see that it's sustainable today. And so with us seeing occupancy improving, it only becomes more sustainable with the passage of time.

[Mario Saric, analyst]

Okay. And then just my second question, you highlighted rightfully the multiple articles looking at financial service tenants, asking people to come back to work more often. Typically, financial services isn't a big part of your portfolio given the smaller kind of floor plates and space requirements. Can you maybe talk about the indirect impact of that to leasing demand for your portfolio and whether there actually may be some opportunities to expand your financial services kind of presence going forward.

[Cecilia Williams, executive]

Yes, you're right. We haven't typically had financial institutions in our portfolio. What we see is that the options that are available to users in the market will be soaked up. So absorption will accelerate with these large base mandates from the bank, and that will have a trickle effect in terms of there being more urgency in the market for users to lock down space as space dries up.

[J.P. Mackay, executive]

And Mario, it's representative of a broader theme that we're seeing across all sectors and markets in our portfolio.

[Mario Saric, analyst]

Okay. And with -- and I think someone else kind of asked a similar question, but with respect to the new tenant demand and your leasing discussion pipeline, how much of it maybe coming from suburban markets today? Have we seen a shift back into demand for downtown space from the suburbs? Or is that still something that is to be seen?

[J.P. Mackay, executive]

We have seen demand from organizations located in suburban markets, looking to urban centers. That continues to increase, but the nature of demand is diverse and representative of a number of different themes that we've touched on during this call, Mario.

[Operator]

There are no further questions at this time. This concludes our Q&A session. I will now turn the conference back over to Cecilia for closing remarks.

[Cecilia Williams, executive]

Thanks, JL, and thanks, everyone, for attending our conference call. My final message is this. We recognize the uncertainties in the broader macroeconomic environment, but we're encouraged by the growing signs of momentum in the cities where we operate. Canada, Canadian cities and Canadians will benefit in the long term from any short-term disruptions we may face. Canadian cities in particular, will emerge stronger and Allied is well positioned to benefit as a result. We look forward to keeping you updated on our progress going forward.

[Operator]

This concludes today's conference call. You may now disconnect.