Artis Real Estate Investment Trust

TSX:AX.UN

Earnings Call Transcript

[Operator]

Good afternoon, ladies and gentlemen, my name is Pam and I will be your conference operator today. At this time, I would like to welcome everyone to Artis REIT's Second Quarter 2022 Results Conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [Operator Instructions] Thank you.

I'd now like to turn the conference over to Ms. Heather Nikkel. Please go ahead.

[Heather Nikkel]

Thank you, operator and welcome everyone. Thank you for joining us for Artis REIT's second quarter 2022 results conference call. With me on today's call is Artis' President and CEO, Samir Manji; CFO, Jaclyn Koenig; COO, Kim Riley and Executive Vice President, US Region, Phil Martens.

Our second quarter 2022 results were disseminated yesterday and are available on SEDAR and on our website. A replay of this call will be available until Friday, August 12. In order to access the replays please use the telephone numbers and passcode that were provided in yesterday's press release. A recording of this call will also be made available on our website.

Before we get started, please be reminded that today's discussion may include forward-looking statements. Such statements involve known and unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied today. We have identified such factors in our public filings with the securities regulators and suggest that you refer to those filings.

In addition, we may refer to non-GAAP and supplementary financial measures that are not defined under IFRS and are not intended to represent financial performance, financial position or cash flows for the period, nor should these measures be viewed as an alternative to net income, cash flow from operations or other measures of financial performance, calculated in accordance with IFRS.

Lastly, as we discuss our performance, please keep in mind that all figures are in Canadian dollars unless otherwise noted.

With that, I will turn the call over to Samir.

[Samir Manji, President and Chief Executive Officer]

Thank you, Heather, and good afternoon everyone. Thank you for joining us for our Q2 results conference call. As I've done in prior quarters, I will keep my remarks today at a high level and will focus more specifically on the progress we've made in the execution of our business transformation plan announced in March 2021.

Our goal is for Artis to become a best-in-class real estate asset management and investment platform, with a focus on growing net asset value per unit and distributions for our investors though value investing. There are three components to this strategy. The first is, strengthening the balance sheet. This is a critical first step in order to provide the REIT with financial flexibility and liquidity to pursue other areas of the strategy.

Since the announcement of the new strategy in March 2021, we sold 46 assets, including 31 industrial, nine office and six retail properties. Proceeds from these dispositions were partially used to reduce outstanding debt. As a result, we ended the second quarter with total debt to gross book value of 46%. A notable improvement compared to 49.3% reported prior to the announcement of the business transformation plan. Since the announcement of the business transformation plan, we have also purchased the maximum number of units allowed under our NCIB in both 2021 and 2022.

The second pillar is driving organic growth. This will be achieved by creating value for our unit holders through identifying operational efficiencies, increasing occupancy and in-place rents and the successful completion and lease up of new development projects. We're pleased to report that leasing activity was strong during the second quarter. There has been a noticeable increase in interest from prospective tenants and in tour activity across all of our asset classes and markets. At June 30, our committed occupancy reached 92%, the highest level we've reported in over a year.

With respect to our existing tenants 388,000 square feet of renewals commencing in the quarter at a healthy weighted average increase in rental rates of 3.7% and our weighted average overall in-place rent increased from $13.29 per square foot in Q1 to $13.56 per square foot in Q2. We're pleased with the increase in leasing momentum we're experiencing and expect this trend to continue as people adapt to the pandemic related restrictions being lifted and with respect to our office properties, specifically will continue to work with tenants to ensure a safe, healthy and positive return to the office.

Turning to our development projects. Earlier this year, we completed the fifth and final phase of Park 8Ninety, an industrial development in the Greater Houston area. In addition to the fully leased 1.1 million square feet across the first four phases, this final phase comprises 675,000 square feet and is 35% leased. During the second quarter, we completed the first phase of Blaine 35, an industrial development in the Twin Cities Area. Over 70% of Blaine 35 Phase I was leased prior to completion and Blaine 35 Phase II, which is still under construction has been 50% pre-leased. The entire project is expected to total 317,000 square feet upon completion.

At Park Lucero East in the Greater Phoenix area, we have a 10% ownership interest and development management contract in place. We are pleased to report that we are making excellent progress on the development of this 561,000 square foot industrial project and the property is already 82% pre-leased. We look forward to providing additional updates on these projects in the quarters to come.

The third pillar of our strategy is focusing on value investing by allocating capital to investments that are undervalued, with potential to produce above average risk-adjusted returns over the medium to long term. From a broader perspective, the real estate sector continues to be impacted by the current economic and interest rate environment, particularly related to the rising interest rate situation we are facing. This has presented some opportunities and some challenges for Artis. We are closely monitoring interest rate trends and forecasts and are in regular active discussions with our lenders, while working diligently to manage our debt maturity schedule.

In the meantime, the downturn in the market has led to inefficiencies in the public real estate sector that has presented compelling opportunities that are in line with our value investing strategy. In time, we look forward to providing additional information about entities that we've invested in, but we believe it is in the best interest of our unit holders to do so in a thoughtful, calculated and disciplined manner in order to keep our average cost of investment as low as possible, thereby enhancing the probability of maximizing our return on the other side.

With respect to previously disclosed investments, during the quarter we announced that we reached a 14% of ownership position together with our joint actors in Dream Office REIT. Earlier this year, we also announced the closing of the transaction to privatize Cominar REIT. With the closing of this transaction now behind us, we are focused with our consortium partners in executing our plan and we look forward to reporting on our progress in future quarters. We are confident we will achieve a strong return on our investment over the next couple of years.

We've come a long way since the business transformation plan was announced in March of 2021. Our ultimate objective, as stated earlier, continues to be growing net asset value per unit through value investing in real estate. At June 30, our net asset value was 13 -- sorry, $19.37 per unit, a nearly 30% increase compared to a net asset value of $15.03 per unit reported prior to the announcement of the business transformation plan. We continue to focus on identifying operational and organizational efficiencies and to work towards adopting best practices in all areas of ESG, a high priority for our Board of Trustees and the team at Artis. We continue to have strong conviction in our vision and strategy. We've made good progress so far and we look forward to providing further updates in the coming months.

With that, I'll turn it back over to the operator to moderate the question-and-answer session.

[Operator]

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Jonathan Kelcher with TD Securities. Please go ahead.

[Jonathan Kelcher, TD Securities]

Thanks, good afternoon.

[Samir Manji, President and Chief Executive Officer]

Hi, Jonathan.

[Jonathan Kelcher, TD Securities]

First question just on the assets held for sale, they did jump up, I think, quarter-over-quarter. Can you maybe give a little bit of color on those assets? Where you stand in terms of timing of selling them, the location, expected cap rate, that sort of stuff?

[Samir Manji, President and Chief Executive Officer]

Sure. The majority of assets held for sale, are in the US side, where, as you know, we have assets that are exclusively focused on industrial and office. And within that overall figure you can confirm that a significant proportion relates to our industrial assets in the Minneapolis market.

[Jonathan Kelcher, TD Securities]

Okay. [Multiple Speakers] Sorry.

[Samir Manji, President and Chief Executive Officer]

From a timing standpoint, Jonathan, we are reasonably confident that most of that asset held for sale figure will be completed prior to December 31 of this year.

[Jonathan Kelcher, TD Securities]

Okay. So if I sort of handicap it, would it be largely in the Q3, beginning of Q4? I that kind of what you're thinking or closer to the end of the year?

[Samir Manji, President and Chief Executive Officer]

No, I think the timeline, you've suggested is appropriate.

[Jonathan Kelcher, TD Securities]

Okay. Are any of these under contract or are they just being marketed now?

[Samir Manji, President and Chief Executive Officer]

We have -- within the office side we have a few that are under contract, a couple that are in the late stages of having [PSA's] (ph) negotiated and on the Minnesota industrial, we anticipate that should be under contract over the next short while.

[Jonathan Kelcher, TD Securities]

Okay. Switching gears, just on the Cominar investments. I know you guys aren't giving a lot of information on it, but if you exclude the preferred shares that you guys have, roughly how much did it contribute to FFO this quarter and how much should we sort of think about it contributing to FFO on either quarterly or annually basis over the next couple of years.

[Jaclyn Koenig, Chief Financial Officer]

Hi, Jonathan. The Q2 contribution from Cominar is around $0.03 pennies on our FFO.

[Jonathan Kelcher, TD Securities]

Okay. And there is nothing unusual or anything in there -- one-time costs or gains or anything, so that’s something we should think about in sort of the next couple of quarters as well anyways?

[Jaclyn Koenig, Chief Financial Officer]

Correct.

[Jonathan Kelcher, TD Securities]

Okay. That's helpful. I'll turn it back. Thanks.

[Samir Manji, President and Chief Executive Officer]

Thanks, Jonathan.

[Operator]

Your next question comes from Matt Kornack with National Bank Financial. Please go ahead.

[Matt Kornack, National Bank Financial]

Hey guys. Just want to follow up on Jonathan's questioning with regards to the cap rate on the industrial. You carry it on your books, at least the US portfolio in general at [53] (ph) cap? Is that ballpark what we should be using if we're adjusting for the disposition?

[Samir Manji, President and Chief Executive Officer]

We're reasonably confident that we will achieve an exit no less than our IFRS value and possibly higher.

[Matt Kornack, National Bank Financial]

Okay. So we can use something along the lines of the figure. And then on the accounting for the joint venture, I saw the FFO impact that you referred to. But in terms of some of the line items there, I think $17.8 million or something in other costs, and then there is a fair value adjustment. In terms of the interest expense associated, should we just take the difference between the $9 million or $10 million of fair value adjustment in the FFO contribution and basically assume that that's the interest expense? I didn't know what the other costs would have been in that disclosure.

[Jaclyn Koenig, Chief Financial Officer]

Yeah, I think that's reasonable when you're trying to determine the FFO add back. And that's where we land around our $0.03 a quarter.

[Matt Kornack, National Bank Financial]

Okay, perfect. And then occupancy did pickup in office, in particular. Can you speak to kind of whose taking space? What you're seeing there? Any leasing costs or CapEx that was needed to go into that? And then also any progress on AT&T? I think you had mentioned on the prior call that that space will be vacating at the end, but it seems like you're making traction on office. So any comment you can make there.

[Jaclyn Koenig, Chief Financial Officer]

Yeah. For sure. So this quarter definitely we've seen a pickup in-office activity, which is great to finally see. And it's kind of all across the portfolio. We've done a few deals at MAX and some deals in Canada as well. So -- and it's from a mix of tenants, but it does feel like tenants are getting ready to make decisions and getting ready to get back to the office. So that's great to see. And then on AT&T, we do have it listed and we're working through that process right now. It is currently still occupied until early 2023. So no new leasing activity to report, but we are actively working on it.

[Matt Kornack, National Bank Financial]

And is that a property that you would list essentially for a tenant to take up on leasing or potentially purchase, I guess, if an end user who wanted to own it?

[Jaclyn Koenig, Chief Financial Officer]

That’s not something that we've contemplated. At the moment, we're looking at leasing it first. That's our priority.

[Matt Kornack, National Bank Financial]

Yeah. Fair enough. Thanks guys.

[Samir Manji, President and Chief Executive Officer]

Thanks, Matt.

[Operator]

Your next question comes from Sumayya Syed with CIBC. Please go ahead.

[Sumayya Syed, CIBC]

Thanks. Good afternoon. Just to go back to the held for sale [indiscernible] it's US industrial. I was wondering what your thoughts or plans are for the remaining. And [indiscernible] you do hold and the prospects there just given how [indiscernible] was currently?

[Samir Manji, President and Chief Executive Officer]

Hi, Samayya. You broke out at the end, but I think we caught the question. The plan right now is to continue to hold the remaining industrial assets that we have in the other US markets and here in Canada. We're feeling pretty comfortable with where this current group of dispositions that are within the held for sale category will get us to in so far as our overall liquidity position, our debt levels and the focus that we have on a couple of specific investment initiatives. So there's nothing planned beyond that Minnesota industrial as it relates to our overall industrial portfolio.

[Sumayya Syed, CIBC]

Okay. And then just on the same topic. So some of your peers have noted a bit of a pause and transaction some cap rate expansion, depending on the asset. And it sounds like you guys are pretty close, but just wondering what's been the impact to your distribution plans and if you had to adjust pricing or timing and to what extent?

[Samir Manji, President and Chief Executive Officer]

Sumayya, pricing and timing on what?

[Sumayya Syed, CIBC]

On just the held for sale assets. I mean it sounds like you guys are pretty close, but have you have to make any adjustments to reflect, I guess, the current sort of pause in the market.

[Samir Manji, President and Chief Executive Officer]

No, it's a good question. I think that the way the current environment has unfolded where we're seeing no doubt a decline in the universe of buyers and the number of bidders we're seeing on assets. But what's interesting is, those parties that are at the table, whether it's a conventional investor-buyer, family office, institutional, private equity or whether it's a strategic buyer that is looking at a specific asset, but we're seeing that there is generally strong traction with respect to values, cap rates. Yes, there's been a little bit of compression, but as I stated earlier regarding our Minnesota industrial and here I would also add the other assets that we are actively in discussions with. Generally speaking, we're reasonably comfortable and confident that we're going to transact at values that are not materially off of our IFRS values.

[Sumayya Syed, CIBC]

Okay. Thank you. I'll turn it back.

[Operator]

Your next question comes from Jimmy Shan with RBC Capital Markets. Please go ahead.

[Jimmy Shan, RBC Capital Markets]

Thanks. So just a clarification on the asset sale. So the four office sales, those are the ones in Texas? And then the value that you're looking to sell them at would also be consistent with the IFRS value?

[Samir Manji, President and Chief Executive Officer]

No. Jamie, sorry, I don't know where that may have come across, but we don't have office assets in Texas and the office assets that we currently have either under contract or are in the process of having PSA's negotiated would be in other markets, specifically Minneapolis and Denver.

[Jimmy Shan, RBC Capital Markets]

Okay. Sorry, I got confused. So the four Texas industrial assets, those are not as part of that portfolio sale.

[Samir Manji, President and Chief Executive Officer]

No, they're not, we have more than four assets in Greater Houston, but if you're referring to the Park 8Ninety Phase I to IV that I referenced in my commentary, no, those are not for sale.

[Jimmy Shan, RBC Capital Markets]

Okay. And so, maybe it's a bit ahead of time, but how do you plan to allocate the funds from the sale? Maybe if you could -- you got, obviously, few things you could deploy and debt paid down, unit buyback, buying other securities, how are you thinking about it at this point?

[Samir Manji, President and Chief Executive Officer]

We're not going to comment on specific dollar amounts or ratios. What I can say generally, number one, we will continue to look at our overall debt levels and the objective is to have a more conservative balance sheet as has been stated from the time that we announced our business transformation plan last year. And then secondly, as we touched on in our commentary earlier, the current environment that we're in present some extraordinary opportunities and there is a strong intention to allocate additional capital to one or two specific investee entities that we believe represent a very attractive opportunity for us and for our unit holders.

[Jimmy Shan, RBC Capital Markets]

Okay. And by that you mean public entities, right? I assume.

[Samir Manji, President and Chief Executive Officer]

That's correct.

[Jimmy Shan, RBC Capital Markets]

Okay. I think just last one, a technical one. So I think that was a lease termination income of about $1.7 million in the quarter, it was a little bit more than prior quarters, maybe you should comment on that kind of that related to? And likewise, it sounds like leasing activity has picked up, so leasing costs has picked up as well, so how do we think about the leasing costs going forward.

[Jaclyn Koenig, Chief Financial Officer]

So the termination income is related to AT&T, which we had discussed on the previous question. And then in terms of the leasing costs, they definitely have picked up this quarter. Looking back at previous quarters, into 2019, 2020, they are in line with those quarters. Obviously, during the pandemic office leasing decrease and then our leasing cost decreased. So we're actually happy to see them picking back up. That means that office leasing is picking back up, which is a great sign.

[Jimmy Shan, RBC Capital Markets]

Okay. So a number of somewhat similar to 2020 -- sorry, to 2019 would be -- will be in the ballpark.

[Jaclyn Koenig, Chief Financial Officer]

Okay.

[Jimmy Shan, RBC Capital Markets]

Okay. Thanks.

[Operator]

[Operator Instructions] Your next question comes from Mario Saric with Scotiabank. Please go ahead.

[Mario Saric, Scotiabank]

Thank you and good afternoon, guys. Good morning. Just following up on the last question on leasing costs, your renewal rate spread was 3.7% this quarter, do you have any sense on a high level what that would look like on net effective basis?

[Jaclyn Koenig, Chief Financial Officer]

Sorry. I missed the end of your question. On a same-property basis?

[Mario Saric, Scotiabank]

No, on a net effective rent basis [Multiple Speakers] the 3.7%.

[Jaclyn Koenig, Chief Financial Officer]

Yeah. I’d say, honestly I think it would be similar. We haven't seen leasing cost change that significantly. Obviously, that's something that we have our eye on with inflation and cost increases in general. But I think it would be fairly similar to previous quarters.

[Mario Saric, Scotiabank]

Okay. And then just maybe shifting to capital recycling. I think the assets held for sale, I think, the net equity is roughly about $475 million give or take based on the disclosure with the comment that most of it in the US, how should we think about the redeployment of that equity in terms of special distributions, the tax efficiency associated with taking the capital out of the US at this stage. The fact that it can be [indiscernible] your kind of capital recycling policy?

[Jaclyn Koenig, Chief Financial Officer]

Yeah. And in terms of the tax impact and any potential distribution. We're currently working through those numbers with our tax specialists, as well as we move along and finalizing the dispositions, we're going to continue -- be able -- be in a better position to provide more information in the coming quarters.

[Mario Saric, Scotiabank]

Okay. That’s it from me. Thank you.

[Samir Manji, President and Chief Executive Officer]

Thank you, Mac.

[Operator]

Ms. Nikkel, there are no further questions at this time. Please proceed.

[Heather Nikkel]

Thank you, operator. And we appreciate you all for taking the time to join us today and wish everyone a great weekend ahead.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and ask that you please disconnect your lines. Have a great day.