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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for standing by and welcome to the Choice Properties Real Estate Investment Trust Q3 Earnings Announcement. [Operator Instructions] I would now like to hand the conference over to your speaker today, Adam Walsh, Vice President, General Counsel. Please go ahead.
Thank you. Good morning and welcome to the Choice Properties Third Quarter Conference Call. I'm joined here this morning by Rael Diamond, President and Chief Executive Officer; and Mario Barrafato, Chief Financial Officer. Before we begin today's call, I'd like to remind you that by discussing our financial and operating performance and in responding to your questions, we may make forward-looking statements, including statements regarding Choice Properties' objectives, strategies to achieve those objectives as well as statements with respect to management's beliefs, plans, estimates, intentions, outlook and similar statements concerning anticipated future events, results, circumstances, performance or expectations that are not historical facts. These statements are based on our current estimates and assumptions and are subject to risks and uncertainties that could cause actual results to differ materially from the conclusions in these forward-looking statements. Additional information on the material risks that can impact our actual results and estimates and assumptions we applied in making these statements can be found in the 2018 annual report and management's discussion and analysis, together with Choice Properties' annual information form, all of which are available on our website and on SEDAR. I will now turn the call over to Rael.
Thank you, Adam, and good morning, everyone. Thank you for taking the time to listen to our conference call. We are very pleased with both our financial and operational results for the third quarter. This morning, I'll provide you an update on our operational results and transaction activities. Mario will then provide you with details of our financial performance. At a high level, another solid quarter. Our consolidated portfolio of income-producing assets include 707 properties, comprising 66 million square feet of GLA. This high-quality portfolio includes retail, industrial, office and residential properties and is located across the country, with a concentration in Canada's largest markets. Our retail portfolio is primarily focused on necessity-based tenants. This includes grocery-anchored neighborhood retail centers and standalone Loblaw locations. These retailers are far less sensitive to the ups and downs of the economy and the ever-changing retail environment. And our long-term leases with Loblaw provide for contractual annual rent growth. This makes our retail portfolio well suited to deliver stability and growth. Period-end occupancy in retail was 98%, which was up from 97.8% in the prior quarter due to 125,000 square feet of positive absorption. We continue to successfully add to our retail portfolio, both through related-party acquisitions and development. During the quarter, we closed on the acquisition of a grocery-anchored retail property from Loblaw for a total cost of approximately $23 million. The property is 128,000 square feet and is located in Langford, BC in the Greater Victoria area. On the development front, we added to the retail portfolio through a mix of greenfield developments and intensifications. These development initiatives continue to provide us with the best opportunity to add high-quality real estate to our portfolio at a reasonable cost.In Q3, we completed and transferred a total of 75,000 square feet of retail development at a total cost of $26 million. Included in the transfers is a 28,000-square-foot grocery store located in Sainte-Julie, Québec City. We have -- sorry, Sainte-Julie, Québec. We have a 75% ownership interest in the site with our development partner. The balance of this site is a 43,000 square foot -- is 43,000 square feet, including a liquor store, dollar store, bank and other service-based tenants and is expected to transfer next quarter. Industrial portfolio includes 112 properties and approximately 60 million square feet of GLA and is concentrated in Canada's largest distribution markets. With the exception of a small bay market in Alberta, industrial assets are operating under healthy fundamentals, with low vacancy rates and increasing rent. Period-end occupancy was down 10 basis points to 98.1%, driven primarily by some softness in the small bay market in Alberta. The acquisition environment for industrial properties continues to be extremely competitive, so development is a logical way to add high-quality assets to our portfolio. Incrementally, our development partners continue to provide us with opportunities to acquire their interest in stabilized assets on an off-market basis. As an example, subsequent to quarter end, we closed on our partners' 15% interest in 2 industrial buildings in Milton, Ontario. This includes our recently completed 665,000-square-foot Peddie Road development and our 635,000-square-foot development at 333 James Snow Parkway. We -- both assets are now 100% leased. The 15% interest in these assets was applied for $28 million. These assets are new-generation, large bay distribution facilities in the GTA West Industrial node. We now own 100% interest in both properties. As mentioned, new-generation industrial facilities are extremely difficult to acquire at a reasonable price, so this is a wonderful opportunity to continue to grow our industrial portfolio in a strong distribution market. Next is our office portfolio. Office portfolio is focused on large, well-located buildings in the downtown hall of Canada's largest cities. Period-end occupancy for our total office portfolio increased 50 basis points to 93.2% from 92.7% in the prior quarter, primarily due to positive absorption in our Vancouver and Halifax portfolios. Finally, our residential platform provides an opportunity to further diversify our portfolio. Our focus has been on developing new rental residential assets primarily in the Greater Toronto area. The rental market in the GTA is strong as limited new supply and robust demand has driven up rents. Our current residential platform includes 4 residential rental assets that are income-producing and another 6 residential assets that are currently in various stages of development. I'd like to highlight the progress of 2 of these assets. Construction at our 39 East Liberty Village site continues to progress well. The parking structure is now complete, and we are pouring concrete to the second floor. We currently have a 47% interest in the site, which includes 163 units at our ownership's share. We expect that the building will be complete in early 2022, with stabilization a year after. 390 Dufferin Street, located in the Queen West neighborhood of Toronto, is our most advanced residential development project as construction has reached the sixth floor. We currently have a 47% ownership interest in this project, and it will include 32,000 square feet of commercial space and 163 residential units at our ownership's share. The building will be complete in early 2021, and we anticipate stabilization in 2022. When our ongoing residential projects are complete, our residential portfolio will represent approximately 1,500 units at Choice's share. This includes over 1,000 units in the GTA, all of which are in close proximity to major transits. Next, I'd like to provide an update on the Oak Street disposition. At the end of the third quarter, we completed a 30-property portfolio sale for aggregate sale price of $426 million. The unencumbered portfolio included 27 standalone retail properties and 3 distribution centers, with an average lease term of approximately 12 years. This transaction represents an excellent opportunity for us to recycle capital, and the total portfolio was sold in an amount slightly above the aggregate IFRS carrying value. The proceeds of this transaction were used to repay debt and provide capacity to fund our development program. Mario will speak more about the impact on our leverage metrics in a moment. That concludes my comments. I would now like to pass it over to Mario to provide an update on our financial performance for the quarter.
Thank you, Rael. Good morning, everyone. I'll begin with a brief overview of our financial results, and then I'll comment on our balance sheet. Overall, our 2019 third quarter results were in line with our expectations and continue to reflect the stability that's inherent in our portfolio. Our reported funds from operations for the third quarter was $175 million or $0.25 per unit diluted. This is up slightly from the $0.248 per unit at June 30. The increase is primarily due to $1.5 million in nonrecurring items, which include items such as lease surrender revenue, prior year NOI adjustments and charges associated with the early repayment of our term loans. Excluding these nonrecurring items, FFO on a normalized basis would have been flat with Q2 2019. Included in our Q3 performance was stable year-over-year growth and same-asset cash NOI. For the quarter, same asset cash NOI increased by 3.1% or 2.6% when you exclude certain prior period adjustments. The growth reflects the annual step rents embedded within the Loblaw portion of our portfolio as well as incremental cash generated from leasing activity. On the leasing front, we had 151,000 square feet of positive absorption primarily from leasing activity in our retail portfolio. This improved our overall quarter-end occupancy by 10 basis points for Q2 to a strong 97.8%, with retail occupancy at 98%, industrial occupancy at 98.1% and office at 93.2%. Now on to our balance sheet. As Rael previously mentioned, during the quarter, we closed the sale of a 30-property portfolio for $426 million. These proceeds were utilized to repay our remaining $400 million variable rate term loan with the balance applied to the credit facility. This transaction, combined with both the equity and unsecured debenture offerings in the second quarter of 2019, has significantly improved our financial position and our risk profile. And over the last 9 months, we've reduced our leverage ratio to 7.5x debt-to-EBITDA from 8x at the start of the year. We flattened out and extended our debt maturity ladder, and we maintained a strong liquidity position with $1.3 billion of available credit and an $11.7 billion pool of unencumbered assets. Overall, Q3 was a very solid quarter with stable operating results and significant improvements to our balance sheet. Looking forward to the fourth quarter, we expect continued stability in our operations. However, the full impact of the Oak Street disposition will be reflected in our Q4 NOI and FFO. This is also the time of the year where we typically expect a seasonal pickup in CapEx spending as many of our ongoing projects are completed before winter sets in. So on the whole, while we expect a strong fourth quarter, FFO and AFFO will trend slightly lower than Q3. I'll now turn the call back to the operator for questions.
[Operator Instructions] Your first question comes from the line of Himanshu Gupta of Scotiabank.
On the asset dispositions, I mean, obviously, you sold Loblaw anchored assets in secondary market. Have this met your near-term goal or should we expect more dispositions in the near term?
Thanks so much for the question. So yes, as [indiscernible] our near-term goal, we wanted to bring our leverage down. We're very comfortable where our leverage is at the moment. And we'll continue to look for disposition opportunities but nothing of the scale in the near term.
Right. And just bigger picture, just trying to understand, what's your portfolio mix likely to be in, say, 2 to 3 years? I mean, do we see retail component further going down, I mean, in the medium term? Or the focus is to reduce secondary and tertiary market exposure?
No. In the medium term, I think it's very unlikely that the portfolio composition is going to change materially from where it is today, just given the size of our retail portfolio. In the longer term, as we get more traction on our mixed-use developments, you should see residential and mixed-use type income, so maybe offers trend up. But in the short term, I wouldn't expect any major changes. And we really view the Oak Street sale as an opportunistic sale to raise capital, not -- I wouldn't read much more into it than that.
Sure. And you mentioned about leverage, kind of, comfortable. So do you expect the leverage to bring it down further as the development portfolio grows? Or are you happy at the moment with 7.5x?
In the near term, I think, yes, we're happy with 7.5x. I mean we've lowered our leverage a lot in the last 9 months. And so we're really comfortable operating here. But like Rael said, as we, kind of, recycle assets, if there is capital, we -- sure, we could go a bit lower. But right now, we're pretty comfortable with what we've done in the last year.
Sure. And maybe just last question from my side on the residential development portfolio. I mean what development deals are you underwriting on East Liberty and Dufferin Street? And obviously, rents have gone up substantially but so has the construction cost. So have your pro forma development yields changed in the last, say, 12 months?
So on both of those, we were underwriting approximately a 5 yield. We were actually fortunate that we tendered our -- many of our construction costs before some of the increases. And so we've had the benefit of locking in the pricing and the benefit of rising rents. So we would expect to beat that yield.
Your next question comes from the line of Jenny Ma of BMO Capital Markets.
So just on the onetime items affecting NOI, I just want to be clear about it. The MD&A mentioned $0.6 million impact on same-property. Is that related to the prior year NOI adjustments? Or is there any lease termination captured in that?
No. So Jenny, no, so the $600 million is just pure, like, prior period adjustments catching up on property tax and that kind of stuff. And that's in the same asset NOI. No, the termination is totally separate.
Okay, great. With regards to some of the office expiries coming up, could you speak to where they are? Do you expect Calgary to be any impact? I know it's a small part of the portfolio but just wondering if Calgary is going to continue to weigh on the office segment.
For 2020, we don't expect Calgary to weigh on the Office segment. In fact, we have very little rolling. And we've done a very good job being proactive on our leasing. In '21 and '22, I think the numbers, Jenny, are around 30,000 or 40,000 feet at our ownership, but I don't have those exact numbers handy. But it's not material that those rents will roll down.
So is it fair to expect a little bit of an improvement on the office same-property NOI number, I guess, once you roll in the Creek office assets, given the strength we've seen in the Toronto, Vancouver, Montreal office markets?
I think you -- so I don't have that information handy, but what we do have is some vacancy in Suburban Montreal, which will drag down our NOI growth next year. But overall, I think it would be pretty stable.
Okay. That's helpful. And then sticking with the same-property NOI, you guys don't disclose it by geography anymore, but could you give us a general sense of what the distribution has been like in the different markets? Was it fairly stable across all the markets? Or are there stronger or weaker performers in that mix?
So obviously, retail has been performing well, and that's a function of the strength of the step rents. And so otherwise, we haven't had a lot of turnover. So retail, I'd say, is pretty consistent. The markets are strong right now. Alberta, industrial, maybe you're seeing a bit of pressure there. But I don't have the exact numbers by geography. But as we talked about, kind of, philosophically, the office markets in the big cities are doing fine. In the suburbs, you'll probably see less growth there, Jenny, with industrial strong in Toronto, strong in Vancouver, in Alberta, a bit of pressure. And the retail, because we're locked in, pretty consistent. But again, as we talked about, maybe power centers probably have -- will probably have lower growth.
Okay. And then my last question is, one of your peers who has done transactions with Oak Street announced a special distribution. Is that something that Choice will have to look into, given your transaction?
Jenny, we're in the process right now of assessing our level of taxable income. So we'll finish that process. And if we're at that level, we'll announce at that time.
[Operator Instructions] Your next question comes from the line of Sam Damiani of TD Securities.
I just wanted to get into Alberta a little more. The Creek portfolio did have exposure in all asset classes there. Just wondering, how are things performing on the retail and industrial sides, I guess, specifically. We've talked about office already.
Yes. So on the retail side, Sam, it's performing very well. It's neighborhood centers. We haven't really seen much pressure. On the industrial side, it's really a function of the different product types. And we're seeing pressure -- as we commented on the call earlier, we're seeing pressure on the small bay. So for example, in Calgary, we have about just under 1 million feet. I think it was 830,000 feet of GLA across 18 properties in the small bay product. And we're seeing both an increase in vacancy and some roll-down in rents. So that's where we're seeing the biggest pressure. And then Edmonton, as we've been commenting for the past few quarters, is a softer market in the large bay product.
And is your development there likely to -- there's some traction in the next quarter or so or no?
So we have 2. We have 1 in Calgary and 1 in Edmonton. Edmonton, the leasing has been slow. Calgary, we are currently speaking to a tenant, and we hopefully have something to announce next quarter.
And just wanted to look at the fair value gains on the portfolio. I know there's been some puts and takes year-to-date. But is there anything holding back, sort of, the ability to record some fair value gains in the current year or maybe even early next year, just given the drop in indices rates and the cap rate environment today?
Yes. Right now, Sam, I think like everything has been kind of -- has stabilized. We always just watch for retail and that things go out of favor, and sometimes, there's lack of a market. So we, kind of, look out for that. But right now, I think the office market has been stable. We're waiting -- we're starting to see some comps on industrial go up. So we're watching that, and we feel it's a regular, kind of, occurrence. But really, we're just watching the retail. But no, we expect things, kind of, right now, except on an individual basis as we get our appraisals done. We're not looking for any blanket, kind of, changes or concerns to the valuations right now.
And just maybe on industrial. You did do the buyout in Milton, which looks like it was priced at around 140 or 145 a square foot. Is that correct? And was the valuation there a negotiation or was it somehow a fixed-price agreement based on the JV agreement?
Yes. So the purchase was a negotiation. And also remember, we actually have some extra density on the 1 buildings on James Snow Parkway. I don't remember the exact number. It's about 200,000 feet of excess density. So that we essentially paid land value. So you'd have to deduct that from the price per foot. So slightly on a price per foot lower than what you just quoted.
There are no further questions over the telephone lines at this time. I'll turn the call back over to the presenters.
Thank you very much for joining our call today. Hopefully, everyone has a good rest of the week. Bye.
This concludes today's conference call. You may now disconnect.