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Good day, and welcome to the Allied Properties REIT Third Quarter 2020 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Michael Emory, President and Chief Executive Officer. Please go ahead, Mr. Emory.
Thank you so much, and good morning, everyone. Welcome to our conference call. Tom, Cecilia and Hugh are here with me to discuss Allied's results for the third quarter ended September 30, 2020. 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 and in our most recent quarterly report. Material assumptions that underpin any forward-looking statements we make include those assumptions described under forward-looking disclosure -- pardon me, disclaimer in our most recent quarterly report. Allied's urban workspace across the country continues to strengthen. With our rent deferral program beginning to scale down and the variable component of our parking revenue beginning to recover, our third quarter was stronger than our second with same-asset NOI and FFO per unit largely in line with the comparable quarter last year. We expect even stronger results in the fourth quarter, with rental revenue returning to more normal levels. This, again, confirms that our team, our properties and our user base are truly resilient. Cecilia will summarize our financial results as well as discuss our balance sheet and our short-term outlook. Tom will follow with an overview of leasing and operations. Hugh will provide a development update, and I'll finish with our current thinking on the future. So now over to Cecilia.
Good morning. First, our financial results. Although our rental revenue was temporarily depressed, our same-asset NOI and FFO per unit in the third quarter were largely in line with the comparable quarter last year. Our third quarter as a whole was stronger than our second quarter, particularly with respect to same asset NOI, which was up 2.9%; and FFO per unit, which was up 1.8%. We expect stronger results again in the fourth quarter with rental revenue returning to more normal levels. Second, our balance sheet. Our NAV per unit at September 30 was up 8.6% from the same time last year. Our IFRS value increment in the third quarter were $9 million, primarily as a result of rent growth in Toronto and cap rate compression at 905 King West, partially offset by a decline in the value of our properties in Calgary and Edmonton.We completed a private placement of equity last month for proceeds of $153 million. This strengthened our debt metrics as desired, and we now have enough liquidity to meet our obligations through 2021 without having to access the capital markets. We finished the third quarter with $142 million in cash and nothing drawn on our $600 million unsecured facilities, including the accordion feature. At the end of the third quarter, our net debt-to-EBITDA was 7.2x. Our total debt was 28.8% of IFRS value, and our interest coverage was 3.3x. We estimate our developments will increase our annual EBITDA by approximately $70 million over the next 4 years. Not only will this augment our earnings per unit significantly, along with anticipated organic growth, it will materially reduce our ratio of net debt-to-EBITDA and materially increase our interest coverage ratio, our 2 most important debt metrics. Our pool of unencumbered assets is $6.4 billion, representing 74% of our investment properties. We intend to continue prepaying or repaying mortgages as they come due with the goal of having the majority of our asset base unencumbered. We believe this will give us the strongest and most flexible balance sheet from both a defensive and offensive perspective. Third, our short-term outlook. Our original internal forecast for 2020 calls for mid-single-digit percentage growth in each of same asset NOI, FFO per unit and AFFO per unit. In light of our second and third quarter results, recent private placement of equity and outlook for the fourth quarter, we've revised our internal forecast to flat to low single-digit percentage growth in each of same asset NOI, FFO per unit and AFFO per unit. While we don't forecast NAV per unit growth, we continue to expect growth over the course of 2020. I'll now pass the call to Tom for a discussion of our leasing and operating activities.
Thank you, Cecilia. Our leasing teams in Toronto, Montreal, Calgary and Vancouver performed very well in the quarter, completing 80 transactions totaling 529,000 square feet. Rents continue to hold, and we achieved a healthy 19.3% increase on space renewed or replaced in the quarter. Our workspace portfolio was 93.4% leased at quarter end. The slight dip in leased area was largely related to nonrenewals, which were known to us before the pandemic. We fully expect to re-lease this space promptly and at expected rental levels. I'll provide a leasing update on our major markets, including an update on our UDC portfolio, and then conclude with some remarks on our leasing staff and brief commentary on the marketplace in general. Montreal was our most active market where the team completed 45 deals in the quarter. Our 2 properties on de Gaspé are 100% leased. Cité Multimédia is 97.5% leased. Nordelec is 94% leased. We are now finalizing our plans for the transformation of 700 DLG, which will enable us to launch our leasing program early next year. The downtown Toronto office market remains solid with very little vacancy overall. We are 96.5% leased at quarter end. The team completed 12 smaller lease transactions in Q3, averaging about 3,500 square feet in size. Just after the quarter ended, we reached agreement on 3 noteworthy and sizable lease deals: first, 82 Spadina, we did a long-term deal on 37,000 square feet with a fintech user replacing Shopify who had occupied the space on an interim basis; second, we leased 26,000 square feet at the Beardmore Building filling a vacancy that arose as a result of a known nonrenewal in Q2; third, we are in the conditional period on a 61,000 square foot lease renewal on Queen East. We achieved higher than in-place rents on each of these transactions.In Calgary, we completed 10 deals during the quarter and maintained a respectable leased area of 87% in that market. We expect to finalize a 16,000 square foot deal at TELUS Sky that will take us to over 70% leased in the office component. Interestingly, Calgary is the toughest leasing market in the country, but ranked second behind Montreal in the number of tours we conducted in the quarter. Small spaces ready for occupancy are moving in Calgary, and we have done a very good job preparing our vacant units for lease-up in these conditions. In Vancouver, we maintained leased area of 95%, completing 10 deals in the quarter. We just completed a 45,000 square foot renewal with significant rental uplifts. Our UDC portfolio remained 89.4% leased with ancillary revenues growing. There has been an increase in space available for sublease in our portfolio, which we see as an opportunity. Most of the space available for sublease in Toronto and Montreal is Tier 1 Class I space leased at significantly below current market rents. Given the scarcity of such space, we expect to benefit from the sublease process as we have in the past.Just to put these comments into context, we reviewed the 4 largest sublease spaces in our Toronto portfolio to compare in-place rents with market. Without identifying tenant names or exact locations, the difference between in-place rents and market rents range between 16% and 90%. The amount of space available for sublease actually declined in our Vancouver and Calgary portfolios during the quarter. On our last call, I mentioned the great work by our operations teams, preparing our buildings for reopening. This call, I'd like to highlight the work done by our leasing teams. The Allied leasing team headed by Tim Low has 22 people involved in leasing and lease documentation across our portfolio. Our leasing success is no accident. This team has done a superb job staying in touch with the market, giving us every opportunity to make pitches and compete for tenants. If a tenant is in the market, we know about it. Our leasing teams have been presenting Allied's available space to the brokerage community through regular Zoom calls, keeping space in our portfolio top of mind. When our leasing team finishes the outreach next week, they will have been in touch with over 600 individual leasing agents. Since starting these presentations, we've had a corresponding increase in tour activity. We completed an impressive 385 physical tours in our available space from March to September. What is interesting is that we conducted more tours in September than we did pre-COVID in January or February. Tour activity in October is even better than September. We've seen very few failures as a result of pandemic, and they've been limited to smaller users. As a result of case-by-case discussions with our storefront retail users, most of which are exceptionally well located in downtown Toronto, we are confident that the vast majority of our retail and restaurant users will survive. On the office side, because of tight supply, rents are actually increasing on renewal or replacement. Tours are happening, and there are large requirements for new space in every market. It is our job to keep the market fully aware of our portfolio. We must also remain in close contact with our tenants and maintain our buildings to a high standard. The Allied leasing team is in the office and ready to go the extra mile on every single deal. I will now turn the call over to Hugh for an update on our development activities.
Thanks, Tom. This quarter, I've seen a return to a more normal level of productivity for most of our projects. Despite the second wave of COVID, we have been able to maintain progress on our construction projects. I will begin by giving a brief overview of our active construction projects, and then I will give a brief overview of other work that we have -- that have progressed over the past 3 months. Construction activity. Across the country, we have experienced a more consistent level of progress for our major construction projects. Beginning in Montreal, our team has been focusing on the upgrade of 2 properties and various stake and suite upgrades that we believe will enable Allied to improve occupancy in the Eastern portfolio. For our 700 DLG repositioning project, we anticipate construction commencing in the fourth quarter and taking approximately a year to complete the majority of the common area work. We have started the transformation of the base building on some of the upper floors, which will give the leasing team a template for what we'll be able to offer to the market. In Toronto and Kitchener, our projects have progressed well. Working with our construction managers, we have been able to establish levels of productivity that are consistent with the levels seen before COVID. In Western Canada, we have completed the work on TELUS Sky. We have started the restoration of our Boardwalk Revillon Building in Edmonton. The work will transform this building into one of the highest quality brick-and-beam buildings in the country. The work on the restoration should be completed by the end of 2021. In Vancouver, our partners have topped off the steel construction of 400 West Georgia and are pushing to complete this project by Q3 of next year. Planning activity. Our focus this quarter has been to continue to push our development approvals for future projects in Montreal and Toronto. There is no urgency here. But we need to push harder than normal because of the reduced productivity of municipal planning departments. This quarter has seen the benefits of the Allied team working in unison to deliver space that serves our workspace users' needs. Despite the challenges of the second wave of COVID-19, the team understands our strategy and is seamlessly executing upon it. I will now turn the call back to Michael.
Thank you, Hugh. As Tom mentioned, our renewal and new leasing activity remains strong, and we're beginning to have specific discussions with users of workspace about how they expect their needs for workspace to evolve going forward. Preliminary indications are that our users across the country intend to return to the office with their entire workforce once the pandemic subsides, though we do need more data before we can make a definitive prediction in this regard. I also believe that the following should be kept clearly in mind by anyone trying to predict the future demand for urban workspace. First, the fact that urban workspace is not a static reality, but rather that it has been a dynamic reality for decades now and one that will continue to evolve going forward in response to all relevant influences, most of which are human rather than technological. And second, the fact that workspace has evolved recently in response to the needs and aspirations of knowledge workers with respect to human wellness, creativity, connectivity and diversity, which interestingly align with the environmental, social and governance issues that public entities need to address on an ongoing basis. Our job at Allied is to continue to anticipate how urban workspace will evolve, just as we've done for decades. In light of the factors mentioned above and our experience serving knowledge-based organizations, I continue to have deep confidence in and commitment to Allied's strategy of consolidating and intensifying distinctive urban workspace and network-dense UDCs in Canada's major cities. I firmly believe that our strategy is underpinned by the most important secular trends in Canadian and global real estate. And I firmly believe that we have the properties, the financial strength, the people and the platform necessary to execute our strategy for the ongoing benefit of our unitholders. A few words on acquisition and development. Acquisition activity has never been an end in itself for Allied, but rather has always been a means to providing knowledge-based organizations with distinctive urban workspace more effectively and more profitably. The same is true of our development, redevelopment and upgrade activity. Thus far in 2020, we've allocated $570 million to acquiring distinctive urban workspace in Montreal, Toronto and Vancouver. We remain intent on augmenting our urban workspace portfolio on an ongoing basis and our UDC portfolio within a 3- to 5-year time frame. Urban workspace in Canada is beginning to trade following a hiatus during the shutdown and the early stages of the reopening, with the most notable trade having occurred in downtown Vancouver at a very low capitalization rate. While I don't expect opportunities to emerge for us over the remainder of 2020, I do think they'll begin to emerge in 2021. For the kind of workspace we want, the cap rates will be largely consistent with those that prevailed before the shutdown. Any thought that there will be distressed properties of the sort we want on the market will prove to be misguided. We've committed to allocate $500 million to completing our active developments over the next 4 years. We recently arranged conventional construction financing on very favorable terms for $250 million of this amount and funded $150 million of the balance through a private placement of equity, which Cecilia mentioned. We expect to fund the final $100 million in 2022. The global pandemic and consequent economic disruption have not impaired our return expectations nor have they delayed completion of construction by other than a few months, and we estimate the developments will increase our annual EBITDA by approximately $70 million over the next 4 years. Not only will this augment our earnings per unit significantly along with anticipated organic growth, it will materially reduce our ratio of net debt-to-annualized EBITDA and materially increase our interest coverage ratio, 2 of our most important debt metrics. Turning finally to ESG. Environmental, social and governance issues have become a more conscious and explicit part of business life, especially for public entities like Allied. This is encouraging, and it's incumbent upon Allied to submit to scrutiny in this regard just as we've submitted to extensive financial and operational scrutiny since going public. Allied made a commitment 1.5 years or so ago to submit formally to independent scrutiny in regard to ESG by 2020. The most important single step in this regard was to obtain a GRESB assessment and to provide an annual ESG report. We are on schedule to do just that. The GRESB assessment will be finalized on November 16, and our first annual ESG report will be published before year-end. I have no doubt that these reports will identify some strengths and also opportunities for improvement at Allied. What's most important is they'll assist the Board and management in establishing rational priorities going forward and will provide benchmarks for measuring improvement. Allied's Board and management are committed to making our inherent approach to ESG more manifest, deliberate and measurable. We've always believed that submitting to inform scrutiny will make us a better business and formally submitting to ESG scrutiny is no exception in this regard. We look forward to your feedback as we progress in this area of our business.I hope this has been a useful and comprehensive update for you. We'd now be pleased to answer any questions you may have.
[Operator Instructions] We'll take our first question from Fred Blondeau with IA Securities.
I was just following up on your comment on subleasing. Just one quick question for me. Could you give us color on the trends you're currently seeing in the GT in terms of the overall subleasing space? And what are your views at this stage going forward, both in terms of the overall subleasing space as well as the subleasing space within your portfolio?
There's been a lot -- as you can see, Fred, there's been a lot of sublease space added to the market in Q3, and Allied has been no different. Most of the space being offered is from TAMI-type tenants, tech, advertise, media and information. And we have -- we look at subleasing as an opportunity to benefit from replacing the tenancy with no downtime. The existing tenant ends up subsidizing the replacement tenant, and we benefit from it, and we often get upticks in rent right off the bat. What we haven't seen yet is the downtown core financial services tenants come forward with subleasing, and we expect that's going to happen in the coming months.
That's great. And maybe a quick one for Michael. I guess your -- I understand you don't want to speculate here on demand, but is it fair to say that your base scenario on demand hasn't changed all that much since April, I guess?
That's correct, Fred. It has not changed at all. And fortunately, for Allied, we're back in the office across the country dealing with our tenants on an ongoing basis, and our tenants are making it quite clear to us that they intend to return to the office with their entire workforce once the pandemic is over. The question really revolves around when the pandemic is over and what exactly over means. But acknowledging those questions or that uncertainty, it is clear to us that the vast majority of our tenants want to return to the office with their entire workforce, both because their people want to be back and because the employer wants their people back. Now again, as I mentioned, in an effort not to be dogmatic and not to ignore reality, we don't have enough data yet to make definitive assessments. But I would say, in answer to your question, my outlook for continued demand for distinctive urban workspace of the sort we provide is as positive today as it was perhaps in March. Fortunately though, it's based on more data today than it was in March. Because in March, we were all operating in a surreal world where nothing was happening and where speculation and conjecture was kind of out of control. Now we are operating on data. And that, of course, is always the best basis from which to make predictions.
We'll take our next question from Mark Rothschild with Canaccord.
Michael, you've clearly put a focus on having a strong balance sheet and you issued equity to fund developments, even with the unit price clearly below where you think the value is. Can you maybe expand a little bit on to what extent you would continue to do that if the unit price remained where it is? Or at what point do you think the balance sheet is strong enough that you would maybe use some of that strength to maybe possibly repurchase units, even though I know that's not something you've generally done? And how you think about the unit price now?
Mark, I would say, in all sincerity, the balance sheet is exactly where we want it to be now. We don't need to access capital from the capital markets for another 12 to 18 months or longer if we need to. So I don't see us issuing equity or raising debt in the next 12 to 18 months. With respect to our unit price, clearly, our cost of capital has deteriorated from where it was in 2019. Fortunately, in 2019, we took extraordinary advantage of the exceptional cost of capital we had for the benefit of the balance sheet and for the benefit of the business. I clearly consider our current unit price to be severely disconnected from the underlying value of our asset base. But I also know from long experience, there's absolutely nothing we, as a management team, can do about that. We cannot control the capital markets. We certainly can't control the equity capital markets. What we can do is continue to run our business and to focus on operations and leasing, as Tom described. And I can honestly say to you without wanting to sound too promotional, Allied is in a league of its own when it comes to leasing space, both pre-pandemic and certainly during the pandemic. And so our confidence going forward is really based on experience we've had since returning to the office as early as May 18 and most recently on July 6. So our unit price is massively disconnected from the underlying value of our business. I think that relates more to the equity capital markets than it does to our business, and our job is to work through that. The other thing I think very strongly is we should not do anything today or in the near term that is predicated on our unit price reconnecting with the underlying value of our asset base. That will happen, I have no doubt, but I don't know when it will happen, and I don't know what the catalyst for it happening will be, but it will happen. As I say, I won't even try to predict when, and I won't allow any decision that the Allied management team and Board makes to be predicated on that cost of equity recovering because that would be a foolish thing to do, in my opinion. That's a little bit of a rambling answer, Mark, but those are my thoughts.
Okay. Great. And maybe for Tom, for the 2021 expiries that are in Western Canada, can you just break down what -- because I know it's listed as Calgary, Vancouver, what market specifically it is in? And if there's any sizable leases that we should be aware of or focused on?
The bulk of them, I would say, would be in Calgary, and they're made up of very small tenants. So there isn't a very large tenant that's going to be expiring in 2021.
We'll take our next question from Caitlin Burrows with Goldman Sachs.
Everyone I know that occupancy is hard to predict. But I guess on the occupancy side, the occupancy and lease rate did decline in the quarter, and you talked about how some of that was expected. But we saw declines in each of Edmonton, which I think might have been driven by de-leasing ahead of development, but also Calgary, Montreal and Toronto. So I guess, I was wondering if you could just give any color on how you expect occupancy to evolve, especially in the larger markets, like Montreal and Toronto. And kind of when we could reach a bottom and how much lower that could be?
Well, we did lose a little bit of ground in the quarter, but occupancy actually is on the rise for us. We've completed a number of transactions, which hopefully will demonstrate that in the next quarter and beyond. The deals that we lost, we've known for quite some time and they were predicted, and we're working on replacing them. Some of them we've already replaced. So we're looking at our occupancy numbers improving over the coming quarters.
Okay. That's encouraging. And then on the leasing spread side, it looks like you witnessed strong leasing spreads in the third quarter, which isn't surprising, given historical results. But then if we look at the current expectations for the future year mark-to-market, they have been revised somewhat lower granted from a very high level and now they're maybe just only "high." But could you give some color on market expectations for rent? And how the 3Q spreads remain robust, but the future year mark-to-market estimates may have come in a little bit?
Yes. We tempered the market rents. We check them every quarter, and they did come down a touch. But we're seeing really good positive increases. I should also point out that the 19.3% increase is year 1 of the renewal. That's not the average rent on the renewal. That's just year 1. So we're bullish about our future. Our spaces are unique and they are in demand.
We'll take our next question from Jonathan Kelcher with TD Securities.
Just going back to the capital raise that Mark was asking about, have you guys considered selling at least the partial interest in some existing assets to raise that equity? And I guess, related to that -- and I know you've looked at it in the past, would you consider that going forward? Because it would certainly help demonstrate the portfolio value.
We have considered it, Jonathan, and we have had opportunities to do it, and we have declined to do it. We are very confident in the cap rates applied to our asset base, and we don't think anything would be accomplished by selling an undivided half interest in anything because we'd never sell everything in order to validate that fact. We know where the market is going to start trading at, and it's going to start trading at a level that will validate the underlying value of our asset base. Again, without being dogmatic, we are certain of that. And I see absolutely no value in engaging in a trade just to try to demonstrate to the market that the underlying value of our assets is as we represent it to be in our IFRS values. So we have declined to do that. We're aware of a U.S. office issuer having done that on a rather large-scale with Blackstone. And it was, if you will, I won't say a dud, but it accomplished nothing, and it did nothing to address the concern that some people may have about cap rates going forward. So it would be one of those actions, in my opinion, that would be designed to, if you will, cater to the equity capital markets, and it wouldn't achieve the desired objective, number one, and it wouldn't, in my opinion, be a good decision for the business.
Okay. Fair enough. Just secondly, turning to the UDC portfolio, another strong quarter there. Were there any onetime items in the NOI this quarter?
I think -- and Cecilia can correct me on this, I think the $800-plus thousand that we adverted to in the press release, I think 68% of that is recurring. So I think by implication, the balance would be more onetime items. So we are trying to identify the unexpected growth there that is recurring and then the unexpected growth that is onetime. So what we gave was an aggregate number for the second and third quarter. And as I say, if I remember correctly, Cecilia, 68% was recurring and will recur, if you will, indefinitely, and the balance is nonrecurring or onetime. So it's a fairly good ratio. We'd obviously like 100%, but we'll take the nonrecurring any day of the week.
Okay. And the nonrecurring is -- I guess, is that something you expect sort of quarter-to-quarter just different nonrecurring revenue?
We have had sequential quarters of nonrecurring revenue, but I don't think we would be wise to assume that, that's going to continue indefinitely. They are, if you will, exceptional circumstances where we're certainly getting what we earned or what we deserve, but it would be unwise for us to look upon that as recurring. That doesn't mean we won't have other isolated items, but I would hate to characterize that as something we rely on going forward because there will certainly be months or quarters where there's nothing in that regard.
Okay. And then just lastly, and I don't think we've talked about this for a couple of quarters, but what's the leasing interest been recently at 250 Front? It seems kind of stuck in that -- the low 70% range?
We still are talking with a number of potential tenants for the building as well as talking about expanding the existing ones, but we just haven't been able to get anything finished in the last few quarters. It's an ongoing -- it's a work in progress. It's slow in that category.
We'll take our next question from Mike Markidis with Desjardins.
I guess just with the comment that you expect 4Q to be stronger, we know CECRA is now not there. Do you have a sense of how many of your tenants that have been relying on CECRA would be applying for ineligible for service?
For the new program, we don't yet know, Mike, and it's a little frustrating, but we don't yet know the eligibility criteria for the new program. We could assume that it will be the same as CECRA, but we just don't know. I'm hoping that it will expand somewhat in terms of eligibility because if you think about the $50,000 limitation that applied under CECRA, I understand the need for a bright line, but $50,000 in downtown Toronto is very different than $50,000 in theory or some other place. So I'm hopeful that they'll strive to expand the eligibility so as to include tenants that we have had to take care of in our deferral program, but we just don't know yet how that's going to shake out. My sense is the government is trying sincerely to support small- and medium-sized enterprise. And I think that's very sound economic policy because in aggregate, small- and medium-sized enterprises is vital to our economy and to our well-being. So -- but I just don't know the answer to that yet. What I do know, which is very encouraging to us about Q4 earnings or Q4 rental revenue to be precise is that as we sit here today, 70% of our users -- or is it 75%?
70%.
70%. 70% of our users who qualified under CECRA have paid their rent to us in October. And that's a very encouraging sign to us about the ability of those tenants to support themselves without subsidy. The other 3 things that encourage us about rental revenue in Q4 is the very visible recovery in our variable parking revenue, the absence of the need to abate rent at all, and finally, the scaling down of our deferral program, which is real, which Tom has done an extraordinary job of leading, and there's really not a tenant whose circumstances we're not fully conversant with and whose ability to survive we have confidence in. So those are the sort of 4 reasons that we anticipate more normal levels of rental revenue in Q4. But as to the new rent relief program, we are anxiously awaiting the details as are retail users across the country.
Sure, sure. No, that's very helpful. So I guess just taking that on the program and it's scaling down, I think you guys had $5.9 million in the second quarter and $5.4 million in the third, so you would expect that, that would trend down at a similar pace or are we going to start to see a more rapid taper in 4Q and 1Q?
Well, this is obviously risky territory for me. But my expectation is it will scale down at a more rapid rate in Q4 than it did between Q3 and Q2.
Okay. Just on the increased tour activity that you guys have seen, it's obviously a positive sign. Tom, I'm wondering if you could just give a couple of additional tidbits with respect to where you see that demand coming from. I mean, it would seem that at least in the short term, there's been a contraction in demand in the market. So I suppose it'll be an increase in people that are not looking for growth space, but maybe just to upgrade their existing premise. And then the second question is how your conversion rate would compare today versus the pre-COVID levels?
Well, our conversion rate is still very good. It's, I'd say, comparing favorably. With respect to growth, it's -- actually a lot of it is coming from our existing tenant base needing more space. There's a lot of deals that were done in Q3 that came from our existing tenant base wanting to grow. A couple of the deals that I mentioned that happened post quarter end in Toronto, 2 of them were tenants that were in our existing portfolio, who needed a whole lot more space. One of them went from 6,000 to 26,000, and the other one from about 18,000 or 20,000 to 37,000. So it's our existing tenant base continues to be supporting us.
Okay. Great. Last one for me before I turn it back. Just wondering if you could perhaps just remind us of the mechanics on 400 Georgia. I believe that it will be complete I think you said in the third quarter of 2021. I'm just trying to think about the timing of your obligation to purchase the 50% interest and how we should think about the capital that you have extended with the loan receivable and how the recap might affect sources and uses going forward.
Yes. We fully expect, Mike, that the transaction will occur in the third quarter of 2021, and the transaction will be, of course, the repayment to us of the advance we've made. And then the purchase by us of an undivided 50% interest in the property at a 5% cap rate, I believe. And we expect that to occur in Q3, and we expect the flow to be more or less concurrent. And it will also coincide with placement of a conventional first mortgage on the property. Allied wouldn't normally use first mortgage financing, as you know. But in this instance, when we have a private partner, we are prepared to use conventional first mortgage financing, just as we will with our partner Perimeter in Kitchener when we complete the Google building. So I would see that occurring, Mike, in the third quarter of 2021. And I think the probability of that is extremely high now, given the state of construction and given the fact that the building is essentially fully leased to extraordinary tenants.
Okay. And then -- and just on that point, so the repayment of the loan and putting -- I'm sorry, not construction, but take out permanent financing, would that mean that you guys would actually get some cash proceeds back once that closes?
Correct. That's right. So we are repaid our loan. And then the construction financing is placed.
We'll take our next question from Mario Saric with Scotiabank.
Just in terms of capital allocation in 2021, and just really external growth. I think, Michael, you noted the expectation for acquisition opportunities in 2021 with really no change in pricing relative to pre-COVID levels. Allied implied cap rate depending on the estimates is probably up 160 basis points plus during the COVID crisis resulting in a large 34% discount to your IFRS NAV. The balance sheet is kind of where you want it, and it doesn't sound like asset sales are something that, in the near term, are going to be material. So how do you think about growing the size of the company and the portfolio while trading at a bigger discount to NAV, something that's been relatively rare over Allied's history?
It's a good question, and it's one we've been asked a lot, and it's one we have been thinking about a great deal. And I think the best way I can answer that is as follows. With respect to development, the interesting difference is we're committed now to it. There's no discretion. We have made those commitments. We need to complete those construction projects. And that's why we took, if I can put it politely, the conservative or careful approach to funding our obligations in that regard. And I think the private placement we did was very much putting discretion ahead of valor, in an effort to be certain that we could meet those commitments with respect to which we have no discretion. When it comes to acquisitions, it's a much more interesting dynamic for us as a management team because it's an entirely discretionary act on our part. We can choose to do it or not to do it, depending on what we think is best for our business. And as I mentioned, if we think it will make us a better provider of distinctive urban workspace in major Canadian cities, we're going to want to do it. But because it's discretionary, that may be a circumstance where we'll use our balance sheet strength to fund the acquisition, at least initially, and it would be rational and appropriate for us to do that even if or especially if our cost of capital hasn't returned to a level that we consider appropriate. So I have said and our team has discussed the possibility of using that untapped balance sheet strength to fund acquisitions if our cost of equity isn't attractive to us in that regard. I'm not saying we'll do that. I'm not saying we'll do it to an extraordinary degree. But I am saying we would be predisposed to doing that on a discretionary basis, if we're convinced that doing so would make us a better provider of distinctive urban workspace in this country or in the major cities of this country. So certainly, our cost of equity is currently an impediment to making significant acquisitions. It's no impediment to making small infill acquisitions, which we continue to make. But in aggregate, they don't represent a large amount of capital. But in terms of larger acquisitions, our cost of equity is currently an impediment. But our cost of debt happens to be extraordinarily attractive. And we may, in the right circumstances, choose to use our balance sheet and to deploy our balance sheet. We're not prepared to deploy our balance sheet to meet fixed obligations over time. That would be perilous, but we might be prepared because, of course, fixed obligations for development actually bring significant deferred returns to us, but they bring no current returns. That's the difference. Acquisitions, if we're going to make them, we'll bring a current return in addition to making us a better provider of distinctive urban workspace. So that's how we would approach it, Mario. I can't say definitively what we would do if a marvelous acquisition came along in the first quarter of 2021 that was large. But frankly, we would make every effort to find an appropriate and successful way to achieve that acquisition. And we might, in that instance, use more debt than equity. We might even sell something because our ability to do that is clear beyond doubt. We keep sending people away, frankly, who say, please sell us half of this. So you can demonstrate a nice price to the market and your unit price will recover. It won't recover. It will be a resounding nothing. But if it was to facilitate a great acquisition, that's a whole different ballgame, and we might very well entertain that opportunity at that time. I -- again, a bit rambling, but hopefully helpful.
I appreciate the color. Is there -- have you thought about what type of balance sheet capacity exists in terms of maybe funding transactions or acquisitions in 2021?
I've resisted the temptation to do that, but it is not inconsequential. I mean we can maintain a very prudent balance sheet and stay close to our targets and fund a significant amount of acquisition with debt. But I've almost deliberately tried not to quantify that because I'll get in trouble with my colleagues.
Fair enough. I won't get you in trouble with your colleagues. I'll push on to the next question.
Please. I'm barely staying about the water line as it is.
The next question just relates to the sublet space. And actually, the commentary that the very preliminary discussions that you're having with tenants suggests will come back with full workforces. I thought that was interesting. But the sublet space in your portfolio is also coming up at the same time from 2.2% to the portfolio to 4.7%. So can you maybe just reconcile those 2 comments, one being that there's an expectation that people will come back in full force and then the second is that you're seeing any tenants put some of their space on the sublet market within your portfolio?
Mario, the honest reconciliation there, in my opinion, is that the TAMI tenants who are putting their space on the market for sublease are under some pressure on the top line. They need to reduce expenses. And it's interesting to us, it's not really tech tenants that are doing this in our portfolio. I don't know about others. It's advertising and media, and I think their top lines are under a bit of pressure. And I think they want to reduce their ongoing cost. And they're probably well enough advised to know that they have something that's very marketable. I mean if you have 25,000 square feet of Allied space at, let's say, 18 net, you're going to get off that very successfully and with minimal cost. And indeed, what will often happen is the tenant will come to us and say, we need your approval, a; and b, the subtenant would like to have longer term. Will you enter into direct lease arrangement with our subtenant? What we usually do then is say, we have a good opportunity for you. We'll actually enter into the direct lease from day 1. We'll let you get off the hook, provided the subtenant is appropriately strong, and we'll deal with the subtenant. And that's where we benefited on almost every sublease that any of our tenants have done.But the reconciliation, I think, comes with the fact that, to the best of my knowledge, Tom, every one of our significant sublease tenants, and again, we're talking 20,000 foot-type spaces. They want to manage their expenses going forward because their top line is under some pressure. The ad world, as you know, the conventional ad agencies, they're still viable businesses. But their top lines have been under pressure for several years now, and they're all looking to manage costs. And I believe the motivation for the subleasing of space within our portfolio is almost exclusively to manage cost, not because they don't want to bring their employees back to work. They just, I think, probably have fewer employees, period, and need less space, period. So they're trying to manage the cost.
Okay. That's helpful. Two more really quick ones on my end, one for Tom. The 120,000 square foot [Technical Difficulty] that you highlighted post Q3 and the 3 leases, how would the mark-to-market on those leases compare to the 19% that you delivered during Q3?
It would be about 20%-ish, Mario. I haven't done the exact calculation for those 3 deals. But also another interesting tidbit for those transactions, the allowance that we provided was tiny in all 3 cases, and we got -- still we got a rent uptick.
Okay. That's great. And my last one, the LQA NOI from 250 Front came down a bit quarter-over-quarter. I think it was $1.6 million or so to $12.4 million. The occupancy, as was discussed earlier, was flattish quarter-over-quarter. Can you provide some color in terms of what drove that downtick?
Yes. Mario, there was a recovery cap that affected us in Q3, but it was limited to Q3, and you won't see it again. And so it was $400,000 that got annualized, but it won't happen after October 1 onwards.
Got it. Does that mean, all else equal, onwards it will be up $0.4 million?
Absolutely.
We'll take our next question from Howard Leung with Veritas Investment Research.
I wanted to return to the question about the pandemic being over and your discussion with these tenants. You have mentioned that they've all said that they're so far that they will return to -- with their entire workforce. Have there been any discussions about the -- all employees were turning to the workforce, but returning with hybrid workdays, so where they would be in the office only part of the time?
Tom has had most of those discussions. So I'll let him...
I've taken upon myself to call pretty well all of our large users in the portfolio to just find out what they're thinking about returning to work and what's going to happen in the future with respect to flexibility with the employees. And all of them would say, they need their offices. They can't wait to be back. They probably will be providing some kind of flexibility to the work week for the employees, but it hasn't been defined or established by anyone as far as I'm aware.
Right. So it would be too early to, I guess, forecast a lower demand because of that, I guess, going forward?
Correct.
And then, I guess, more specifically, on the vacancies that popped up, I guess, quarter-over-quarter in Q3. I think the comment from you was that the REIT was kind of expecting those. But just to clarify, were you expecting them, I guess, prior to the pandemic, like those -- most of those vacancies were known before hand or was it during the pandemic that, that was found out?
I would say all of them were known pre-pandemic. We're in touch with the tenants on a regular basis way in advance of their expiry. And we were aware that this was happening. There were no surprises.
And to take that one step further, Tom, if I'm not mistaken, in every instance, the reason the tenant didn't renew -- and they are, without exception, really great tenants. The reason they didn't renew is because they needed more space and we couldn't afford it to them. And we hate losing tenants for that reason. We just hate it, but it had nothing to do with the pandemic.
That's true.
Right. I think that makes sense. A lot of your vacancies, I think, in your table, it's really just -- they're mostly under 10,000 square feet. So they wanted a larger space, I guess. I guess my other question is about the leasing activity. The table that's in the report, I guess, this quarter, does any of that relate to the sublease -- the leasing activity done on the subleases? So for example, the -- you highlighted the 80 to 82 Spadina transaction. Is that included in the leasing activity table or is that a separate transaction?
That was post quarter, and it wasn't the sublease.
Okay. Okay. Got it. And then just one more for me on the development activity. I guess the TELUS Sky, I think I see in the table, it's -- when it's transferring to rental properties pushed to Q4, can you remind me of the criteria where a property is transferred to the rental portfolio again?
Howard, it's when we have all of the necessary occupancy permits, which we expect to have in Q4.
[Operator Instructions] We'll take our next question from Matt Kornack with National Bank Financial.
I'll try to keep this quick. With regards to the sublet space, can you comment as to whether any of it is currently part of your deferral program? And then you gave some goalposts on rent spreads, but any sense on the weighted average rent spread and term to maturity on those leases?
Yes. First of all, none of them are part of the deferral program. All of them are very credible tenants. And there are significant upticks available to us from the in-place rents to market.
Okay. And...
3.5 years. The weighted average term is 3.5 years.
And I think you've mentioned this in the past, your leases don't allow for them to profit on a sublet. So if they were to get above market rent, they have to share that with you, correct?
That's correct.
On 425 Viger and TELUS Sky, is 425 Viger now fully in cash rent? And is TELUS Sky and straight-line rent all at this point?
TELUS Sky is in straight-line rent and 425 Viger is not yet fully in cash rent.
Cecilia, do you know any proportion of which it would be in at this point?
It would be a small portion that 425 is in cash rent. The bulk of it is -- begins in Q1 of next year.
Okay. Perfect. And then the last one for me. In terms of market rent changes. It seems like most of them were in Toronto in 2022 and beyond. I assume that's the confluence of new supply coming online as well as some expectation of financial institutions giving back space. But you didn't make any fair value adjustments to the portfolio. So were you running different rent numbers in your projections? Or how should we think about that? Maybe you brought cap rates down on some of those rent assumptions?
So just to clarify, on the market rents that we disclosed on the maturing space, we're not trying to guess what the future market rents will be. So we're not adjusting for any supply that we're expecting to come online in 2022. It's today's market rent on the specific space that matures. So every quarter, we assess along with the brokerage community what the market rate is today for all of the space that is maturing over the next 5 years. So the adjustments were made based on the nature of the space.
Okay. No, that's interesting. But when you do your DCS, I guess, you would assume a market rent at the time that it comes due. Is that fair?
Right. So on the DCS, and I think your question was around the uptick overall in the portfolio?
Or whether you would have made any changes to your rent assumptions going forward, I guess?
So the appraiser, which is Cushman, they would have made a change in the assumption. We had an uptick in our IFRS value in the quarter, primarily because of lease deals that materialized at higher than what was modeled in by the appraisers. So whatever they modeled, we ended up getting a bit better than that in the quarter.
We'll take our next question from Mike Markidis with Desjardins.
I'm sorry, I was on mute. I seem to do that a lot these days. But anyway, on the TELUS Sky, I just wanted to follow-up. I think on the last call, you had actually mentioned that you had your occupancy permits and that the first residents had moved in, in August. So I'm just trying to get a better picture of it is being transferred in 4Q, but is that going to be a full transfer, i.e., will the -- will it be a full decapitalization in the fourth quarter? And following on that, perhaps if you could give us an update on where the residential leasing is on TELUS Sky that would be helpful.
Sure. So at the end of Q2, we had occupancy permits up to a certain point of the residential floors. We've just been able to achieve at the beginning of Q4 the remainder of the occupancy permit. So now we have the full building that can be transferred into PUD. Our -- the deals that are being done on the residential floors are consistent with our pro forma. So it should -- we're seeing good traction there, and Westbank is working to lease-up the rest of the building.
Okay. And just not to push you at all, but where would the lease rate be today?
On a per square foot basis?
Not the rent, not the rent, the occupancy rates, sorry?
It's consistent with our projections on the lease-up for the residential floors, very early on.
Okay. Yes. And so then maybe just what was your -- if it's consistent with your assumptions, then what was the assumption in terms of time to lease in the initial pro forma?
It's about a year.
12 months.
12 months. Okay. And with the pro formas that you're achieving, is that including the impact of any potential incentives or is there not incentive activity?
That is inclusive of the incentive program. Yes. That was taken into account in our pro forma and assumed as part of the cost of the project and lease-up.
At this time, we have no further questions in queue.
Thank you, operator. Thank you all for participating in the call. Hopefully, our answers and presentation were helpful to you. We look forward to keeping you appraised of our progress. In the meantime, be well and be safe, and have a good day. Thank you.
Thank you. Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.