Artis Real Estate Investment Trust

TSX:AX.UN

Earnings Call Transcript

[Operator]

Good afternoon, ladies and gentlemen. My name is Leonie, and I'll be your conference operator today. At this time, I like to welcome everyone to Artis REIT's Third Quarter 2018 Conference Call. [Operator Instructions]Today's discussion may include forward-looking statements, which include statements that are not statements of historical facts and statements regarding Artis REIT's future financial performance and its execution of initiatives to deliver unitholder value. Such statements are based on management's assumptions and beliefs.These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements.Please see Artis REIT's public filing for a discussion of these risk factors, which are included in their annual and quarterly filings, which can be found on Artis REIT's website and on SEDAR.I would now like to turn the meeting over to Mr. Armin Martens. Mr. Martens, please go ahead.

[Armin Martens, President, CEO & Trustee]

Thank you, moderator, and good day, everyone, welcome to our Q3 2018 conference call. So, again, my name is Armin Martens, the CEO of Artis REIT. With me on this call is Jim Green, our CFO; as well as Kim Riley, our SVP of Investments; Phil Martens, EVP of U.S. operations; and Heather Nikkel, VP of Investor Relations.So thanks, again, for joining us. I will be starting, as usual, by asking Jim to review our Q3 financial highlights, but this time more briefly, if you will, and I will continue with the review of our Q3 '18 investor presentation that has been somewhat customized to the press release that we have issued.And then we will open the lines for questions. Just as a further note, this call, we do have the option of extending this call if necessary if we get more questions. And then we will talk more about what happens after that. In anyway, I will turn the floor over to Jim now and then I will proceed after that.

[James Green, Chief Financial Officer]

Thanks, Armin. Good afternoon, everyone, and I would echo Armin's comment, welcome to our third quarter conference call for 2018. As Armin mentioned, and I'm sure majority of the people on the call are aware, third quarter earnings press release also announced a series of new initiatives announced by the REIT and the outcome is a fairly significant shift for the REIT. And as I expect most callers will probably prefer to spend time on the review of those announcements. And given the fact that the results from operations this quarter really contain no unusual items or surprises, I will keep my comments on the financial reports fairly short. I'm happy to answer any financial-related questions later if needed.As we have said before, Artis is a diversified commercial REIT. We have assets in 5 Canadian provinces and 6 U.S. states. Based on our Q3 NOI, that weighting is still roughly 44.1% in Western Canada, we're 11.1% weighted in Ontario, and 44.8% weighted in the United States.On an asset class basis, Artis is 52.6% weighted to office, 20.4% in retail and 27% in industrial.We do have a presence -- continuing presence in the Calgary office market, which as everyone knows has been very soft for the last 5 years or so. This quarter that contributed 7.7% of our NOI this quarter. We do have fairly manageable exposure to the Calgary office market leasing in the near future, with just over 83,000 feet left to renew in 2018, only 141,000 feet in all of 2019 and only 47,000 feet in 2020.Calgary office actually contributed positive same-property growth this quarter, really pleasant to see in a market like that. However, we do still see headwinds in Calgary and it is very slow to improve.As we mentioned before, our acquisition and disposition activities have mainly focused on capital recycling to further diversify and improve our portfolio. In this quarter, we completed the acquisition of an office property in Phoenix, and we had no dispositions closed in the quarter, although there was 1 subsequent to the quarter that did close. Artis continues to be active in both new developments and redevelopment of our existing properties and currently has approximately $105 million invested in projects currently under development.During the quarter, the increase in properties under development was roughly $16 million.As detailed in our MD&A, we have several new development projects that are just getting started, including a new residential tower at 300 Main Street in Winnipeg and new industrial space in Houston, Phoenix and Denver.As detailed in the MD&A, we have several development projects in the planning stages where construction has not actively started and they continue to progress well through the development stages. We've been able to maintain our balance sheet with debt to GBV currently at 48.6%, down slightly from 49.3% at December 31 of last year. Our interest coverage ratios and EBITDA interest coverage ratios remain healthy at 3x roughly.Sales program we implemented in 2016 and '17 to sell assets and reduce debt has had a dilutive effect on FFO however, funds from operations, with FFO coming in this quarter at $0.33 versus $0.36 in the comparative quarter last year. On a quarter-over-quarter basis, FFO is up slightly this quarter, roughly $0.01; it was $0.32 in Q2 and that's largely due to growth in same-property income as well as the new property we acquired in Phoenix.AFFO for the quarter was $0.24, which does result in our AFFO payout ratio being above 100%, it is 112.5% if we want to be exact. And this payout ratio was certainly not the only factor, but it was one of the drivers that led the REIT to consider implementing some new initiatives, which we'll be discussing shortly.Overall we were generally pleased with our results from this quarter, positive same-property growth, even as I mentioned positive same-property growth from the Calgary office market, very healthy weighted average growth in rents renewed during the quarter and the balance sheet metrics all staying fairly consistent to prior quarters.So I think I'm going to leave it there for now to allow more time for questions on the call. And I will turn it back to Armin for more discussion.

[Armin Martens, President, CEO & Trustee]

Okay. Thanks, Jim. The investors can now -- anybody on the call can turn with me then to our Q3 '18 investor presentation. I'm going to jump right into Page 3. There's a graph there, history of Artis unitholder returns. I'd like to draw everybody's attention to the year 2008 and '09, the last large recession. You will notice how we dropped and -- you remember our yield went up, but at that time our payout ratio went from the 80% range and went up to 120% range in 2008 and '09. Subsequent to that, we were able to raise a lot of equity. We were able to more than double our market cap and go back to a payout ratio of well below 100%. But you fast forward to today, it's a different situation. We're much a larger REIT today. We are basically unable to raise new equity and double our market cap and grow back to our payout ratio that's respectively below 100%. We're not in that situation anymore.Today, as we speak, interest rates of bond yields are at an 8-year high. Artis is trading at an 8-year low. And we still have above 10 years of supply of Calgary -- office properties in the Calgary office market. So the Board and management has come to the conclusion that the status quo was and is no longer an option. And hence, we have announced these new strategic initiatives.If you will just turn with me, skipping 4, and I think still I covered it, let's go to Page 5, the key objectives of our strategic initiatives or the key elements of any good strategic plan, first need to improve our payout ratio to improve the balance sheet and deliver growth, deliver AFFO per unit growth and deliver NAV per unit growth, all of which maximize unitholder value. And we feel these objectives are realistic and achievable with our initiatives.Turn to Page 6. We give you more details on our initiatives in improving unitholder value. Firstly, as we've announced, we will be reducing our distribution by 50% to $0.54 annualized, and that will free up about $83 million in cash flow. From that perspective, we feel it makes Artis a more bulletproof REIT with a great payout ratio and good positive cash flow. Number two, we will be repurchasing our units through our existing NCIB and, in essence, we'll be maxing out our NCIB by way of an automatic unit buyback as of Monday when our blackout is over.Number three. Over the next 2 to 3 years, we will sell between $800 million and $1 billion of non-core assets at or above our IFRS value to fund our program. This is something we've done before, and we're more than confident of our ability to execute on this again.And number four, we will be paying down debt and strengthening the balance sheet. This in turn should lead not just to better price, but better price multiple. And number five, we will continue to create value through our development pipeline and select acquisitions in Artis' major target markets. And we will focus on industrial developments, our existing land and on major markets that we're in. Again, we feel these new initiatives are both realistic and effective with minimal execution risk.Turning to Page 7 then. I'll refer to our improved operating and financial metrics that we're striving to achieve. So as our payout ratio will be in the 50% range, we will be freeing up, as I said, $83 million of cash flow. We have to generate about $600 million in net proceeds from our asset sales. Our model does show us delivering 4% annualized AFFO per unit growth and 4.5% annualized NAV growth. So it won't be a straight line, but for example, in year 3, we expect our NAV -- our AFFO to be $1.12-plus and we expect our NAV in year 3 to be $17.50-plus.And, of course, we'll have a better balance sheet, and we continue to be committed to our investment-grade rating.So a better payout ratio, better balance sheet, better AFFO per unit and better NAV per unit. All of this should lead not just to better price, but I think a better price multiple as we move forward.And that does actually bring me to the part 8, the classification of assets. I'm going to ask Kim Riley to take over, and then I'll wrap it up and then we move on to questions.

[Kim Riley]

Sure. Thank you, Armin, and good afternoon, everyone. Looking at Page 8, in order to assist us in optimizing the portfolio, we have recategorized our assets into 3 types. So they are core Artis asset, development asset and non-core Artis asset. The core Artis asset make up just over $4 billion of our portfolio. They are invaluable assets located in target markets, where we anticipate maintaining a long-term presence. These markets have historically produced healthy occupancy and same-property NOI growth. These properties are also leased to quality tenants, including retail properties with strong weighting towards necessity and service-based tenants.Development asset account for around $200 million of our portfolio. They include land upon which a development project is either underway or has the potential for future development. Development asset also include select assets that have growth potential through redevelopment and repositioning, all of which enable Artis to achieve yields that are 150 to 200 basis points higher than acquisition cap rate. Development properties will also be primarily new generation industrial.Non-core Artis asset, which account for $800 million to $1 billion of our portfolio are good quality asset, but are which Artis considers to be outliers in terms of type and location, and particularly, assets or asset classes where we do not anticipate maintaining a long-term presence. We will go into more detail on non-core assets in a few slides.If you turn now to Page 9, you can see several pictures of assets that we consider to be core within our portfolio. An example of an office building would be MAX at Kierland in Phoenix. On the right-hand side top corner, you can see Crowfoot Corner in Calgary, which is one of our best-performing retail asset and then 175 Westcreek is a newly constructed industrial property in the GTA. We see these types of assets forming the foundation of our portfolio, and they will continue to be prudently managed to realize maximum growth.Turning to the following page, you can see examples of developments that are currently underway, which are predominantly new generation industrial. These include multiple phases of Park Lucero, an industrial park that we own in Phoenix; Cedar Port, which is a fully pre-leased industrial property in Houston; and Tower Business Center is a new industrial development that's just getting underway in Denver.Turning to Page 11. You will see that over the last decade, Artis has established a solid track record of greenfield developments in both Canada and the U.S. Examples of these developments include Linden Ridge Shopping Center in Winnipeg, which is a retail site that was acquired with excess land. We pre-leased this development to several national tenants on long-term leases and developed the site over multiple phases. That property is currently 100% occupied. Another example is Midtown Business Center in Minneapolis. This was an industrial land site that was acquired by Artis. During construction, it was fully pre-leased to a strong medical use tenant on a long-term lease. This property is currently 100% occupied. Park Lucero, which we referenced in the previous slide is a more recent example of development success story. It is a new generation industrial park in a well-amenitized location. It was developed over 4 phases, the first 3 of which are now complete and the last is just wrapping up construction. This project is also 100% committed.It's these types of development that provide the REIT with new generation real estate at higher yields than acquisitions. Over the next 3 years, we plan to focus on developing more new generation industrial assets in major markets. These developments offer yields of 150 basis points to 200 basis points higher than acquisition cap rates and generate significant value for the REIT.Turning to our non-core assets on Page 12. Over the next 3 years, you will see that we're planning on selling between $800 million and $1 billion of non-core properties. Non-core assets were identified as outliers in terms of location and type within our portfolio. These assets will be sold in a disciplined manner and include the following example: Underperforming Calgary office properties to bring our Calgary office weighting down to a target of 5% of the portfolio; assets and asset classes in markets where we only own a few properties and do not intend to grow further, such as Ottawa, Nanaimo, Hartford and U.S. Retail. They also include specific property types where only a few are held, an example would be enclosed retail.And finally, select multifamily densification opportunities, which upon receiving rezoning approval will be sold to capitalize on strong demand for residential development as well as unlock incremental value for unitholders.In summary, on the following slide, over the next 3 years, we are looking to sell $800 million to $1 billion of assets, which represents approximately 17% of the current portfolio. They are non-core asset in nonstrategic markets or asset classes or markets where we lack scale. They also include multifamily densification projects once rezoned.These dispositions will align with our goal of owning a more focused and optimized portfolio.I'll now turn it back to Armin to wrap up.

[Armin Martens, President, CEO & Trustee]

Yes, and let's just move on to Page 14, which is our last slide, which show the current asset break -- class breakdown by NOI and then by geography and where we expect to be headed within the next 2 to 3 years. You will see from left to right, our current office portfolio is 45%, Calgary office is 8%. So 53% total office, will shrink that in total by 8%. So Calgary office will come down to 4% or 5%. The rest of the office will be 40%. Retail will shrink to 15%. Industrial will grow to 40%. That's -- we see that happening quite realistically. Then, of course, the net result will be that we want to increase our weighting in the U.S. and will be decreasing our weighting in Canada.In terms of the disposition program that Kim mentioned, you can ask us questions about that, but the low-hanging fruit is our -- some of our Canadian real estate, the densification opportunity that for the cap rates are the lowest and the higher achievable yields for new generation industrial real estate yield in the U.S. So Artis will continue to be a diversified REIT -- commercial REIT, will be in 2 countries, 3 asset classes, but will be shrinking in secondary markets, will be shrinking in Calgary office and office in general, will be growing in industrial and will be growing in major markets.So that brings us to the end of this presentation, folks. I will now ask the moderator to open the line for questions.

[Operator]

[Operator Instructions] Your first question is from Mike Markidis from Desjardins.

[Michael Markidis, Real Estate Analyst]

I was hoping you guys could just walk us a little bit more detail on the pro forma metrics in the deck and, I guess, in specific to you gave a 3-year AFFO figure. Obviously, the asset sales are there, but maybe just in terms of how much of the sale proceeds are from nonincome-producing today in terms of value extracted from your densification on the multifamily side? And what's -- that's the first question. And the second part of that would be, what NOI growth from the remaining stabilized assets you're expecting over that 3-year period?

[Armin Martens, President, CEO & Trustee]

Well, Kim was just opening up her model there. I believe your assumption was -- Kim, was flat on NOI growth?

[Kim Riley]

Flat on NOI growth. In terms of value -- incremental development value, we have about $150 million. So that would be unlocked value for the multifamily rezoning development.

[Michael Markidis, Real Estate Analyst]

Okay. And with that $150 million, you have 0 carrying value in your books today largely or...

[James Green, Chief Financial Officer]

That's correct, Mike. Yes, we have no value until we get those densities approved.

[Michael Markidis, Real Estate Analyst]

Okay. And how much of that would be the project, which I think is under construction now at -- on mainstream in Winnipeg, roughly?

[Armin Martens, President, CEO & Trustee]

15 right now.

[James Green, Chief Financial Officer]

Smaller piece of it, but expected to be $15 million to $20 million profit on that development.

[Michael Markidis, Real Estate Analyst]

Okay. So just to make sure I heard you correctly, flat on the same-property growth over the 3-year period.

[James Green, Chief Financial Officer]

Yes, we just went very conservative in there and didn't estimate anything that we didn't have already locked up sort of so.

[Michael Markidis, Real Estate Analyst]

Yes,that's correct. Okay, and just that $112 million on AFFO, Kim, what's the FFO number?

[Kim Riley]

I don’t really calculate FFO, we have to...

[Armin Martens, President, CEO & Trustee]

Yes, you're the second person that has asked that . We just focus on AFFO, but...

[Kim Riley]

We can easily calculate that and get back to you.

[Michael Markidis, Real Estate Analyst]

You can follow up offline. That's fine. Okay. Now on the CapEx, if we look at your stuff, we exclude what you classify as new development and redevelopment in your disclosure. So just TIs and leasing costs outside of those, I guess, greenfield and repositioning projects. You've been running at about $100 million annually for the last 3 years. With the initiatives you've announced now, how do you see that unfolding over the next couple of years?

[James Green, Chief Financial Officer]

All right, sorry, Mike, so you're saying what we will be just spending on new developments over the next 3 years?

[Michael Markidis, Real Estate Analyst]

No, no, I was actually -- so if we to look at your cap intensity or your cap spend, including TIs and leasing costs, excluding any new development and redevelopment, the way you're disclosing your MD&A. Annualized you guys are running anywhere from, we call it, $100 million annually over the last 3 years, '16, '17 and year-to-date. How do you expect that to trend? Do you think that's a good run rate going forward? Or do you think that's going to increase or moderate?

[James Green, Chief Financial Officer]

I would say expecting that to moderate a little bit based on some of the assets we're planning on selling.

[Michael Markidis, Real Estate Analyst]

Okay. And presumably, a good chunk of that capital is being going to Calgary office over the last couple of years, would that be fair?

[James Green, Chief Financial Officer]

Yes, that would be fair.

[Michael Markidis, Real Estate Analyst]

Okay, okay. Last question for me before I turn it back. Noticed the initiative to focus on industrial, I think that was something that you'd talked about over the last several calls, but one of the things that stands out is that you've actually been investing quite a bit in U.S. office over the last 1.5 or 2 years. And just noticed that if I look at your pro forma metrics, it would appear that that's going to stop. So just curious if you could give us a moment to talk about what's changed perhaps on the office side in the U.S. and why you don't want to put any more capital into that asset class?

[Armin Martens, President, CEO & Trustee]

Well, are you referring to acquisitions then, right, Mike?

[Michael Markidis, Real Estate Analyst]

Yes, I guess, it. Is it all development that is going forward, I guess, is that the plan?

[Armin Martens, President, CEO & Trustee]

Yes, all development, we'd self-select acquisitions, will always looking out for industrial, but it's really all developments, our development pipelines are pretty solid for industrial. We don't see ourselves -- we just did buy the Stapley Center, we are really happy with that asset, which has already gone from 94% to 98% occupied. We're doing really well with that, but we don't see ourselves increasing our weighting in office. We're not just an office REIT, we're diversified REIT, and it's no secret that industrial asset class is not just an asset class investors like, but it's performing very well for us in both sides of the border. We want to grow in that sector. We will focus on industrial for all of our growth. Just to give more balance in our portfolio, we always wanted more industrial and a little less office.

[Operator]

Your next question is from Jonathan Kelcher from TD.

[Jonathan Kelcher, Analyst]

First on the size of the distribution cut. How did you guys come around to the 50% number?

[Armin Martens, President, CEO & Trustee]

Yes, it took -- it didn't happen in 1 day. There were 2 perspectives. One is do we rightsize the distribution and carry on or do we elect for a more significant cut? We decided to have more significant cut that will give us some good positive cash flow that we can use to grow. And in terms of growing, it's not just about funding our development pipeline, but it's about buying back our units and paying down debt. So we landed on a bigger cut, instead of just rightsizing. Rightsizing might have been anywhere from 20% to 30% cut, 50% is the large cut, but it sends a good message, we feel, to investors that our payout ratio is always safe, we've always got positive cash flow, we've got flexibility now for unit buyback, flexibility for debt paydown. We've got a lot of options on the table now to create NAV growth. So that's -- and then we did some modeling. We modeled 44% cut, 50% -- 56% cut. Obviously, the higher the cut the more you can do with the money, more accretion you can generate, but we landed on the 50% cut in that way.

[Jonathan Kelcher, Analyst]

Okay. Fair enough. On the assets that you've identified for sale, I guess, some are in Mike's question not income producing. If you take the overall sort of $800 to $1 billion, what would be the cap rate or like, say, the IFRS cap rate on those?

[Armin Martens, President, CEO & Trustee]

The IFRS...

[Kim Riley]

It would be -- so 6.25 is where we are modeling.

[Armin Martens, President, CEO & Trustee]

Okay. And we really think we'll beat that because there's embedded value there that we haven't yet triggered by exiting that. We quoted that -- of those assets that we expect to dispose off whether it's Poco Place or 415 Yonge or Concorde, as we get the density or a 50% non-managing interest in Winnipeg Square here, all of those cap rates will be closing I think -- will be sub-5 even, but we feel very confident about our ability to be able to hit the 6.25% cap rate and do better than that, better than IFRS valuation, which, again, will support our model very well.

[Jonathan Kelcher, Analyst]

Okay. And then just lastly, the 45% longer-term target for leverage, does that include -- how do you treat your prefs in that, does that exclude them or include them?

[Armin Martens, President, CEO & Trustee]

Yes, we're still at the banks. We treat our prefs as equity. But no -- yes, so we don’t include our prefs in that. Looking ahead, the prefs don't come up for, I guess, a couple of years, right, James?

[James Green, Chief Financial Officer]

There is 1 series next year. We will see how that goes, whether we redeem that at maturity or not.

[Armin Martens, President, CEO & Trustee]

We will give serious consideration to eliminating our prefs in the years ahead and cleaning up our balance sheet. As you know, we don't have any converts anymore in our balance sheet and now that we're in this situation we will give serious consideration to eliminating the prefs as well and cleaning up the balance sheet some more.

[Operator]

Your next question is from Dean Wilkinson from CIBC.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Armin, if I just could follow along the lines of Jon's question there. Looking at the distribution and, obviously, things have changed, but from last quarter, you kind of did make the comment that in 14 years, we've never contemplated a cut, we've increased it twice. Have things materially changed that much since August to now and you're seeing a larger deterioration or was -- help us sort of get from point A to point B there?

[Armin Martens, President, CEO & Trustee]

Yes. It's -- I mean, in the last 90 days, I admit it started in July already, but we saw our units trade down a lot aggressively. And all of a sudden, we find ourselves in October trading at an 8-year low. And we acknowledged, and, of course, the central bankers have come out and -- with hawkish narrative and bond yields are trading at an 8-year high. That happened very quickly. In addition to that, Dean, we've got a lot of inbound calls from combination of investors and analysts suggesting that they want more clarity from Artis on its strategic direction and how we are going to grow back or get back into a payout ratio that was under 100%. And we could hardly -- we couldn't answer those questions well during the last quarter. We brought this to the board's attention, I guess, twice in the last 2 weeks and then the board landed on this decision in terms of new strategic initiatives.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

That makes sense. A tough decision, but probably the right one to make, right? In light of that and then looking at sort of this -- let's call it $1 billion of secondary market asset sales, which there are a few others that are also doing a similar kind of thing and rightsizing the portfolio and focusing on their core markets. Are you confident over the next 3 years, particularly in light of possibly rising interest rates and the impact that they may follow on cap rates that you're going to hit that those IFRS values or how confidence -- maybe the next year, you go sort of beyond that and there is a little more question as to what those ultimate values could be?

[Armin Martens, President, CEO & Trustee]

Right now we're very confident and we're basing this on the assumption that interest rates when they rise, they'll rise 1 step at a time and that the Fed and the Bank of Canada are not going to cause a recession. So -- but right now we're pretty confident and we're not anticipating interest rates to rise too much too soon. And as they do, we're cautiously optimistic. The bonds are moving up that at least we can -- that spreads will come down a bit and, but if they cause another financial crisis like they did in 2008 and '09, well, then things will change.

[James Green, Chief Financial Officer]

Our focus then would be to move very quickly on the asset sales today with the exception of the multifamily sites that still need the zoning to come through before we can really sell them at maximum value.

[Armin Martens, President, CEO & Trustee]

Yes, we really think we can do the bulk of this in less than 2 years.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

The bulk in less than 2 years. Okay. That makes total sense. Then last question for me is, did you anticipate in your model that entire $600 million of net proceeds going towards the share buyback? Or how much have you penciled in there?

[Armin Martens, President, CEO & Trustee]

No, not all of it. We've got $279 million roughly in the model budgeted for unit buyback and then the rest for our developments.

[Kim Riley]

And about $100 million for debt paydown.

[James Green, Chief Financial Officer]

And to bring the debt to GBV down a little lower as well, so some of it going to debt repayment.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Okay. So $370 million in the capital stack and then the rest of it is going to be work in progress or something like that?

[Kim Riley]

Correct.

[Operator]

Your next question is from Walter from Romin (sic) [ Ronin ] Management Inc.

[Walter Maughan]

Heard a great deal about how you derived 50%. Going forward, do we expect to stay at the 50% payout ratio -- not payout ratio, but the 50% cut for the full 3 years? Or is there a prospect that you might be increasing it again? And what criteria would you be using for an early increase earlier than the 3-year program you've laid out?

[Armin Martens, President, CEO & Trustee]

So it will be locked down for 2 years for sure, Walter. In year 3, as we can demonstrate more traction and success in our plan -- and this I don't mind sharing with everybody on the call. We did discuss it at the board level. At year 3, we can then review the distribution and then start moving it up. In the long run, a payout ratio between 60% and 70% is very good. It doesn't have to be in the 50% range, not necessarily should it be. But we will have the opportunity to move the distribution up and that is in the long run what every board wants to do. They want to be in a situation where they can increase distributions in a predictable manner, not just keep them fixed.

[Walter Maughan]

Right. I understand. Now, hypothetical, what if it went into the 40s as your payout ratio high 30s?

[Armin Martens, President, CEO & Trustee]

Yes. That would beg for an increase then.

[Walter Maughan]

But not until the third year at the earliest?

[Armin Martens, President, CEO & Trustee]

We're pretty much committed to 2 years working through this. If it drop to 30% in year 2, I mean -- we take things 1 quarter at a time. You have to stand in line behind several board members that would want to increase at that point as well, right? But it's hypothetical, so it's hard to predict. But for sure, the lower the payout ratio is the better the possibility is and the chance that it will be raising.

[Operator]

Your next question is from Howard Leung from Veritas Investment Research.

[Howard Leung, Investment Analyst]

Just want to ask about a follow-up on that net $600 million that you -- would you suspend from your disposition? $230 million - I guess, the numbers are $100 million would go down to paying extra debt, $270 million would go down to the buybacks and $230 million would go down to developments, is that the right split?

[Kim Riley]

Yes, that sounds correct.

[Armin Martens, President, CEO & Trustee]

Yes.

[Howard Leung, Investment Analyst]

Got it. And I guess, the NCIB right now, you're allowed to kind of buyback $130 million in total for the year. So the $270 million will be split between 2 years?

[James Green, Chief Financial Officer]

The -- yes, it's not quite because the NCIB also allows -- there is 1 block trade a week allowed in addition to the maximum NCIB number. So hard to see where that gets, it depends on the size of the block trades, but you get 1 exemption a week for a block trade.

[Howard Leung, Investment Analyst]

Okay. So it'll be a little faster than the $130 million.

[James Green, Chief Financial Officer]

I hope so, yes.

[Howard Leung, Investment Analyst]

So then, I guess, the -- when you talk about AFFO per unit growth at 4 and NAV per unit at 4.5, is the majority of that going to be because of the buybacks they will reduce unit count?

[Armin Martens, President, CEO & Trustee]

Buybacks will contribute for sure. And that's the lowest-hanging fruit and easiest in terms of execution. But part of it is also our new developments, right, Kim?

[Kim Riley]

Correct, yes and debt paydown.

[Armin Martens, President, CEO & Trustee]

And the debt paydown, of course, right.

[Howard Leung, Investment Analyst]

The debt paydown. Yes. And I want to touch on that as well. Looking at the debt and when you're deciding where to pay down the debt, is that more -- are you going to be prioritizing more towards the debt that's higher rates but fixed or the debt that's variable?

[James Green, Chief Financial Officer]

Probably just go with it as it matures so that we're not incurring penalties to pay off. At the moment, we're not planning on paying off any debt that's not maturing.

[Howard Leung, Investment Analyst]

Okay. That makes sense. And then the $900 -- the $90 million rough split of asset sales, can you kind of give a rough split between the various sectors and geographies? Just trying to see how much of that is actually going to go down to, for example, office, retail and you're probably not selling industrial, but want to see the split between those 2?

[Kim Riley]

Correct. So to give you a breakdown, approximately $225 million would be Retail, $125 million would be Calgary Office and then the balance would be various office properties in a few different markets.

[Howard Leung, Investment Analyst]

Okay, got it. So I guess, I'm trying to kind of get to that 6.25% cap rate that you're targeting to sell at. So the Retail and the Calgary Office, those would likely be higher than the 6% -- higher than the 6.25%. So it's really the other stuff that will be -- that will lower your weighted cap rate of sales? Is that the way to think about it?

[Armin Martens, President, CEO & Trustee]

Yes. It's hard to classify correctly. But for example, a 50% non-managing interest in Winnipeg Square, that's in the $225 million range, it will be a sub-6 cap. No matter what, it will be in the low 5s, we believe. We did just finish closing Centrepoint Winnipeg at a 5.9% cap rate as an example. And we've got Poco Place retail/office and we're planning for density there. That cap rate is 4% all day long. We've got 415 Yonge, that cap rate is sub-5. Concorde, that cap rate is sub-6. The bulk of the stuff is it will be easy to achieve a sub-6 cap rate on the bulk of the stuff. And then as you said to us, the odd thing that where the cap rate will be higher than 6.25%.

[Howard Leung, Investment Analyst]

Right, right. That makes sense. So, yes, because I see that you have 4, I guess, 1 active residential and 3 future residential developments lifted. So all 4 of those are kind of on the -- they will be sold, right? That's the plan.

[Armin Martens, President, CEO & Trustee]

Right.

[Howard Leung, Investment Analyst]

Okay. Now that is sensible. And then I think there is a question about the maintenance CapEx and leasing, just following up on that. Do you expect that to go back down to, let's say, like 2012, 2013 levels before our Calgary office was a big dream, I guess, on a per square foot basis or?

[James Green, Chief Financial Officer]

I'm sort of going to say probably not quite that low as we reduce our weighting in office you should see that cost start to come down, but tenants these days seem to still be expecting more tenant improvements than we used to have to pay in the strong days in Calgary for sure.

[Howard Leung, Investment Analyst]

That makes sense. And is that driven mainly still by Calgary properties or are you seeing that across the board like even...

[James Green, Chief Financial Officer]

No, that's kind of driven across all geographies. Calgary used to probably be the anomaly that it was very low prior to 2014. Today, Calgary, of course, is high, but so are the other markets, seemed to be gradually creeping up.

[Operator]

Your next question is from Matt Kornack from National Bank Financial.

[Matt Kornack, Analyst]

With regards to timing on the asset sales, just wondering from a tax standpoint, are you going to time it such that you don't have to pay any special distribution, I assume?

[James Green, Chief Financial Officer]

That's the plan, Matt. Yes, we think we've got the tax structuring worked out that...

[Matt Kornack, Analyst]

Okay. Because some of those assets that you mentioned that are lower cap rate, I would assume that's pretty low cost base as well for what you bought them for.

[James Green, Chief Financial Officer]

Correct. But on the flip side of that, unfortunately some of the Calgary offices has much higher cost base, so there should be some losses to us.

[Matt Kornack, Analyst]

Gives and takes.

[James Green, Chief Financial Officer]

Yes.

[Matt Kornack, Analyst]

Okay. Now that makes sense. And then just from an operation standpoint, your lease renewal spreads have been pretty good of late, not entirely jiving with your view on market versus maturing leases, at least in the table that shows sort of negative lease renewal spreads. Wondering if you're just outperforming expectation or if it's specific leases that have come up that have generated positive returns? And if we should expect sort of outperformance going forward if those are very conservative numbers in the lease maturity profile you put forward?

[James Green, Chief Financial Officer]

We try to keep those on a pretty conservative basis. So we hope we can deliver better results in those, but I think those are kind of our...

[Armin Martens, President, CEO & Trustee]

Yes, we're doing pretty good in that part for sure year long. But we've got a doubt every time we renew an office lease in Calgary we get beat up bad and that's the one place where we're not able to outperform.

[Matt Kornack, Analyst]

And with current occupancy, where it is. I mean, obviously, we had higher committed occupancy then in place, but is the expectation stay in the low 90% range for a while now or would you expect some occupancy improvement over the next couple of years as well?

[Armin Martens, President, CEO & Trustee]

It's going to be lumpy. We've got some good news coming from markets, but we think our Calgary office vacancy will increase. Calgary office NOI will decrease before next year before things get better for us there.

[Matt Kornack, Analyst]

Right. And presumably...

[Armin Martens, President, CEO & Trustee]

But will be north of 90% collectively, we should expect that.

[Matt Kornack, Analyst]

Okay. And I guess, those were higher rent markets at a time. So there is probably more rent there than there is actual square footage.

[James Green, Chief Financial Officer]

Yes. And as we move more into the U.S., the stabilized vacancies in the U.S. are a little bit higher than they're traditionally here in Canada. So not unusual to be 8% to 10% vacant in the U.S. market, whereas in Canada that would be less than that.

[Operator]

Your next question is from [ Tony Troiano ] from [ Tofino Capital ].

[Unknown Analyst]

Armin, after you being so adamant that you weren't going to cut the distribution and then cutting it by 50% and disclosing it on Page 4 of your press release was like a kick in the teeth. Now out of the $83 million that you're going to be saving from distribution, can you please confirm how much is going to be going back to buying back units?

[Armin Martens, President, CEO & Trustee]

So our plan, as we've said, and I will repeat it now, is that about $270 million of our total capital will be going to buy back units. We expect to average about $130 million a year in that range. But as Jim mentioned, there maybe times because of block trades where we buy back more. So we're still blacked out. As of Monday, we will be back in and will be maxing other NCIB in buying back units.

[Operator]

We have a follow-up question from Mike Markidis from Desjardins.

[Michael Markidis, Real Estate Analyst]

Sorry, just a couple of clarifications. On the $800 million to $1 billion, $150 million if I have that correctly was the no income producing and then the 6.25%, is that on the remainder, i.e., the $650 million or whatever that number would be because you dragged it from the total bucket or is it on the entire envelope?

[Kim Riley]

It's on the entire envelope. So it's a weighted average on the whole portfolio, including the value from the non-performing or non-income contributing assets right now.

[Michael Markidis, Real Estate Analyst]

Okay. So now I see why that 6.25% is a pretty low benchmark to hit. Okay, that's fair. And then just thinking about your segments going forward and looking at sort of the occupancy performance of individual segments. If I just focus on sort of the big ones, Canadian office is obviously one for you guys at 20% of NOI, Calgary office is a drag there. It does seem that you're in-placing -- your gap between your in-place and committed has been growing as well. Is that something over the next several years that you think will continue to persist or do you think that as we move forward here, in-place will start trending higher and the gap between in-place and committed will start to narrow?

[Armin Martens, President, CEO & Trustee]

Anybody want to grab that call? So specifically, Mike, I mean, in Calgary, that gap won't improve for a while, right? The in-place markets, that's not going to improve for a while. And we still haven't recycled all of our leases in from the market -- in-place and down to market yet. So we've got at least another year or 2 to go before we stabilize in Calgary and then hopefully, by then 1 or 2 pipeline shows up as well. I mean, the office margin in Canada is stable or good everywhere except Calgary is bad, of course, and when your PEG is becoming a bit of a battle zone, it doesn't take much to overbuild in Winnipeg, we feel comfortable with our situation here. You go down to the States. The office markets are pretty good, but even in Minneapolis, there has been some older building. We've got to watch, but holding on very well in Minneapolis, but we've got to watch it there. Once in a while you get a tenant leaving in markets like Phoenix or Denver and we've got to work through that, but at least they're good markets to be in. But on balance, I feel just it's all about Calgary is much true to the number, but on balance, I'd like to think that the metrics are improving. The U.S. real estate fundamentals are good, not just industrial, but office. But I think the trend is our friend providing that interest rates don’t ruin the party.

[Michael Markidis, Real Estate Analyst]

Okay. And then just thinking about the Canadian industrial, I would imagine your GTA portfolio is doing tremendous right now from a occupancy and re-leasing perspective, how are the assets in the vertical here?

[Armin Martens, President, CEO & Trustee]

Also very good. I mean, our industrial vacancy in Toronto is basically -- the GTA is basically 1%, and yes, we have very strong same-property NOI, Winnipeg is 2% and Alberta is about 3%, but improving, and so that's holding up very well. The Alberta industrial, retail sectors performing very well. I think multifamily has turned around, it's not our category, but we should feel -- based on what we know it's turning around. Office is much weak, it's just been too much overbuilding, the pipelines are maxed out, they need more pipeline so they can produce more, sell more, make more money and that's where the bottleneck is right now and, of course, in B.C., there is -- everything is airtight there, we only have 1 industrial or 2 industrial buildings in BC, they're both fully leased.

[Michael Markidis, Real Estate Analyst]

Are rents rolling down in the industrial segment in Calgary? I mean, their occupancy is obviously holding up very well, but are rents rolling down or they kind of stable?

[Armin Martens, President, CEO & Trustee]

No, they've stabilized for sure. And if anything, they would be moving up nice, but at least what we're seeing, they've stabilized for sure and they're trending north.

[Michael Markidis, Real Estate Analyst]

Okay. The cap rate on Stapley look really attractive at 8%. Is that an anomaly? I'm just wondering how should we think about that in terms of the quality of that building and how we should think about that relative to your other office assets you own in Phoenix?

[Armin Martens, President, CEO & Trustee]

I'd call that a historical anomaly, but this year what we have seen, you can check with brokers down there, is a bigger split, if you will, a bigger dichotomy between suburban office cap rates and downtown urban office cap rates and suburban office cap rates have moved up at a higher rate than urban, which maybe haven't happened move at all. So we found that to be a good opportunity. It's a heck of a good suburban office location, that's Stapley Center. Our property manager and our leasing manager in Phoenix office used to both lease and manage that building. So they recommend -- they knew the building well, they recommended it to us and so we bought it and it's since -- we barely owned it, and it's already outperforming. So we'll see how long that lasts, but there is a big dichotomy right now in many U.S. markets between suburban office valuations and downtown office valuations.

[Michael Markidis, Real Estate Analyst]

And how would that building compare to MAX at Kierland, Phoenix? MAX at Kierland is your trophy, right, in Phoenix?

[Armin Martens, President, CEO & Trustee]

MAX you call class AA. This one is A-. Phil is right here, you want to comment on that, Phil?

[Philip Martens, Executive Vice President of US Region]

Yes, the Stapley building is also older in a much more mature location, that's proven itself overall that Stapley building has never been below 90% in its entire history. It was built in the late 1990s. And Max was built in 2008. And yes, it is a class AA, but both are in high-amenitized locations.

[Michael Markidis, Real Estate Analyst]

Okay. Last question for me. Sorry for the long laundry list, but Millwright and the new Denver office property that you built on land adjacent to your existing asset there. Denver is an easy question. Is Millwright contributing anything from an NOI perspective right now? Or was it in Q3?

[Armin Martens, President, CEO & Trustee]

Jim, was it -- while we are committed at 60 -- 2/3 committed now at Milwright in terms of leasing.

[James Green, Chief Financial Officer]

One of those tenants is in occupancy and one not yet. The latest tenants is still undergoing TIs as UnitedHealthcare that's a Fortune 5 company, and so we're excited about Millwright, which is in Minneapolis that's helping the Millwright Building, and we continue to get quite a bit of interest from co-working as well for that Millwright Building.

[Armin Martens, President, CEO & Trustee]

Yes, in Denver, it's not we don't have anything signed yet, but we are trading papers with 2 different tenants to take a floor each and if we can conclude those deals that would be 50% leased with that smaller building at 169 Inverness. So we feel we're getting traction in a lot of good fronts.

[Michael Markidis, Real Estate Analyst]

Okay. And those properties are not in your part anymore right, those are in IPP?

[James Green, Chief Financial Officer]

Correct. I was hesitating on the Denver asset, but I believe you're correct, yes.

[Michael Markidis, Real Estate Analyst]

Okay. Well, if in addition to the Q3 FFO number, if you could confirm the carrying value of those assets and the NOI contribution in aggregate in Q3 that would be fantastic.

[Armin Martens, President, CEO & Trustee]

Okay.

[Operator]

[Operator Instructions] Your next question is from Michael Smith from RBC.

[Michael Smith, Analyst]

I guess over the last couple of years you've sold $1.5 billion of assets, a lot of which are -- the lot of Calgary office, which you've taken a loss. So you've got a bunch of buildings for sale now, including Calgary office for a loss. So I guess, my question is, is it fair to assume that you don't really have any cash considerations. In other words, if you sold the full $800 million next year, for example, like there is nothing really preventing you from doing that from a tax point of view, maybe from a strategic timing point of view or getting them you may want to stretch it out, but is it correct to assume that there is really nothing from a tax perspective from stopping you from doing that?

[Armin Martens, President, CEO & Trustee]

I would say that's generally correct. If you could sell -- yes, there is no tax reason that we would hesitate on selling those assets.

[Michael Smith, Analyst]

Okay. And so you have given yourself 3 years, but I think Armin you said you're taking the bulk of it, it will be done in 2 years. I'm just wondering if there is any motivation to doing it quicker? And second part of that it sounds like you've ruled out a substantial issuer bid. I wonder if you could just give us your thoughts on those things?

[Armin Martens, President, CEO & Trustee]

So yes, if we can hit plan on pro forma and on model and achieve these dispositions in these results, yes, sooner we will. We will do it all as fast as we can and move on from there. As I'd be -- we don't see ourselves doing that a couple of reasons, I guess, is the capital available -- the available capital. Also, we are watching our market cap, there is a limit to how many we want to buy back. The board is still committed to maintaining its investment-grade credit rating. And I guess, in SIB suggests a lot of units that one time above market and we're just not in that position to do that right now.

[Michael Smith, Analyst]

Okay. And just switching gears, can you just talk about your retail strategy?

[Armin Martens, President, CEO & Trustee]

No. We still like retail, and we're not -- don't -- we won't own any retail in the U.S., and we've got 2 small enclosed malls left in our portfolio, both in Saskatchewan, we'll sell those. After that, we know it's all performing well. I mean, Grande Prairie is performing well. Fort Mc is stabilized, moving north already, the rents there. All the retails performing well and giving us good same-property NOI growth. Still we don't mind owning it. We've got that retail in Port Coquitlam that has a densification opportunity. So we expect to be -- so that's on our books to be sold now. But all of the retail we have on balance -- most of the retail we have on balance is performing very well and we still like it. So we're not of the opinion that you just get out of retail. We're not of that opinion, but we will get out of the little bit of retail we have left in the States. We'll get out of those 2 small malls we have in Saskatchewan and then we move on from there.

[Operator]

Your next -- actually, it's a follow-up from Walter from Ronin Management Inc.

[Walter Maughan]

Just to be a little bit controversial. As one of your alternate strategies, did you ever look at Artis REIT from the perspective of an investor and ask yourself what would be the investor's return if you were to sell everything and distribute to current unitholders?

[Armin Martens, President, CEO & Trustee]

We give that some consideration in terms of a strategic review, if you will, and which wasn't formally undergone, there is 2 directions. One is, you sell the REIT to the best maximum price you can get and the other is implement a new strategic plan. And our largest shareholder that owns 11% of our units is on our board, our largest shareholder as well as other, all the board members unanimously were of the opinion that now is not a good time to pursue selling the REIT or selling all of the real estate and shutting down. They think we've got a good plan here, good opportunity to increase value, increase unitholder value, increase our NAV. The idea of selling the REIT or entertaining office for the REIT can always be revisited at another date, but -- so that's not the direction. The board unanimously agreed that the best way to maximize unitholders' value would be to implement these new strategic initiatives.

[Walter Maughan]

Even with the difference between the NAV and what the REIT is trading for on the market now?

[Armin Martens, President, CEO & Trustee]

Yes, there is a concern that in a rising interest rate environment, we might not get bids at our NAV of $15. It's a concern that as the bids would come in lower, they'll be underwhelming, and it wouldn't -- and then we'd be just wasting our time. Notwithstanding what I just said, the board will entertain any reasonable offer that maximizes unitholder value if it comes in. We've never, for example, had a friendly offer or any offer at all that we said no to, that we were never engaged in. We've just never had any offers at all in the first place.

[Walter Maughan]

Well, that's why I went to the selling of all of the assets and the distribution out to unitholders.

[Armin Martens, President, CEO & Trustee]

And so that takes it to -- I get that -- we would need -- my understanding is and Jim is right here, we would need unitholder approval to sell all of the assets and to return the money to our investors. Yes, we will have to call a special meeting on that or we'd have to deal with that as a special agenda item at our next AGM. But that's -- yes, that's -- sometimes that's the best way to maximize value, just liquidate all of the assets, right? Now it's very disruptive thing to do. You've got G&A issues, management team issues before you know it, you're negotiating retention, bonuses and retention, control bonuses with lot more employees...

[Walter Maughan]

I understand all of that, yes.

[Armin Martens, President, CEO & Trustee]

That's very disruptive. But that scenario might be the best one that maximizes value today, but the board doesn't want to pursue that right now.

[Walter Maughan]

But when the board reconsiders that, have them understand that, let's say, I got back my NAV on that minus a few transaction costs, if I got back my NAV, I would be able to go elsewhere and invest it so that I could rebuild not as well as Artis, of course, but approaching what Artis accomplishes, just a thought.

[Armin Martens, President, CEO & Trustee]

Point noted. Thank you.

[Operator]

We have a follow-up from Howard from Veritas Investment Research.

[Howard Leung, Investment Analyst]

Just wanted to ask about the follow-up on the development properties. On your -- I guess, in your MD&A, you have the value like just over $100 million and in the presentation, you were lifting $200 million. Is the difference because some of those future developments are -- that are not intact, that will be -- that's part of the $200 million?

[Armin Martens, President, CEO & Trustee]

That's correct.

[Howard Leung, Investment Analyst]

Okay. And then just in terms of timing, this is kind of a 3-year plan. Do you expect the $200 million of development assets to all be complete and kind of fully functional income-producing properties by the end of the 3 years or end of 2?

[Armin Martens, President, CEO & Trustee]

In the 2 to 3 range, I would say, yes.

[Howard Leung, Investment Analyst]

Okay. And then, I guess, in terms of thinking about how much NOI those properties can bring. I've kind of factored in a 7.5% cap rate for development. Is that kind of where you are thinking to or too high, too low?

[Armin Martens, President, CEO & Trustee]

That's exactly where we are.

[Operator]

There are no further questions at this time. Please proceed.

[Armin Martens, President, CEO & Trustee]

Well, thanks, again, moderator, and thanks, again, everybody for joining us on this call. Just as a footnote, there is a sidebar, Jim and I will, of course, be in Toronto during the Toronto Real Estate Forum the last week in November. There is a debt conference that we'll be participating in debt marketing conference. Then on Tuesday and Wednesday of that week, the November 27 to 28, we will be making ourselves available with follow-up meetings with real estate bank analysts and with institutional investors. You can feel free to reach out to us if you want to book meetings with us on November 27 and 28 in Toronto. So thank you, again, everybody for joining us, and have a good weekend.

[Operator]

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