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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning. My name is Paul, and I will be your conference operator today. At this time, I would like to welcome everyone to CT REIT's Q2 2023 Earnings Results Conference Call. [Operator Instructions] The speakers on the call today are Kevin Salsberg President and Chief Executive Officer of CT REIT; Jodi Shpigel, Senior Vice President, Real Estate; and Lesley Gibson, Chief Financial Officer.
Today's discussion may include forward-looking statements. 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 CT REIT's public filings for a discussion of these risk factors, which are included in their 2022 MD&A and 2022 AIF, which can be found on CT REIT's website and on SEDAR.
I will now turn the call over to Kevin Salsberg, President and Chief Executive Officer of CT REIT. Kevin?
Thank you, Paul. Good morning, everyone, and welcome to CT REIT's Second Quarter Investor Conference call. Building on the strength of our Q1 results, I am very pleased with the accomplishments of our team in the second quarter. In an increasingly uncertain macroeconomic climate, our continued focus on providing our unitholders with a consistent, stable and growing investment option continues to bear fruit.
In Q2, we successfully extended leases, representing nearly 4.5% of our portfolio, thereby maintaining our weighted average lease term at 8.6 years, one of the longest in the sector. We made solid progress on our developments, completing nearly 200,000 square feet of new projects, which has now brought our total portfolio gross leasable area to over 30 million square feet. We also added over 50,000 square feet of new development projects to the pipeline.
We continue to benefit from the rollout of Canadian Tire's better connected strategy and are fortunate to have great opportunities to support our largest tenant and majority unitholders bricks-and-mortar real estate-related requirements. The impactful combination of our successful project completions through the course of 2022 and thus far in 2023 as well as the organic growth drivers within our existing portfolio that have contributed to strong same-store and same-property NOI expansion during that time have led to meaningful growth in earnings and net asset value on a per unit basis. And we have done this all while reducing our payout ratio by over 3% on a year-over-year basis and bringing our leverage ratio below 40%.
As we approach CT REIT's 10th anniversary, I am delighted with how far we have come since our IPO in 2013. Our portfolio has grown as has our team of dedicated professionals and the capabilities we now possess as an organization and we have established a truly remarkable track record with respect to driving cash flow per unit growth in service of annual distribution increases, while at the same time, improving our balance sheet and financial metrics in order to become one of Canada's most reliable real estate investment trust.
CT REIT is well positioned to withstand the current volatile environment and to continue to deliver on its purpose of providing investors with reliable, durable and growing results over time.
Jodi will now walk you through an overview of our investment leasing and development activities, and then Lesley will speak to our financial results. Jodi?
Thanks, Kevin, and good morning, everyone. As highlighted in our press release yesterday, we were pleased to announce 3 new investments this quarter, totaling $22.4 million. Once completed, these projects will add an incremental 53,000 square feet of GLA to the portfolio at a weighted average cap rate of 6.63%. These new investments include the intensification of 3 existing Canadian Tire stores located in Port Hawkesbury Nova Scotia, Barrhaven, Ontario and Peterborough, Ontario. . We also completed 4 projects in the quarter totaling $54 million, which added an additional 187,000 square feet of GLA to the portfolio. These included the development of a new Canadian Tire store in Sherbrooke, Quebec as well as intensifications of existing Canadian Tire stores in Casselman Ontario and Chambly and Drummondville, both located in Quebec. At the end of the quarter, CT REIT had 26 properties that were at various stages of development with 7 projects currently expected to be completed by the end of 2023. These development projects represent a total committed investment of approximately $372 million upon completion, $135 million, of which has already been spent and $96 million, of which we anticipate will be spent in the next 12 months. Once built, these projects will add a total incremental gross leasable area of just over 1.1 million square feet to the portfolio, 99.4% of which has been pre-leased at quarter end.
As Kevin mentioned, we were also pleased with our renewal activity in the quarter, which included the completion of 23 Canadian Tire store lease extensions. Lease extensions for all but 1 Canadian Tire store with 2024 expiry dates have now been finalized.
In total, leases representing over 1.3 million square feet of gross leasable area were extended in the quarter, which helped to maintain our weighted average lease term at 8.6 years, one of the longest in the sector. Finally, our portfolio remains 99% occupied in line with last quarter.
With that, I will turn it over to Lesley to discuss our financial results. Lesley?
Thanks, Jodi, and good morning, everyone. As Kevin highlighted, we were very pleased with the solid results delivered by the right REIT again this quarter. AFFO per unit on a diluted basis was up a strong 7.0% to $0.304 and compared to Q2 of 2022. This increase was primarily driven by growth in the same property net operating income as well as the positive impacts of the intensifications completed in 2022 and 2023. Partially offsetting this increase was our interest cost under credit facilities due to the higher interest rate environment we are in.
Diluted FFO per unit in the quarter was also strong for the same reasons coming in at $0.33, up 5.4% compared to $0.313 in Q2 of 2022. Same-store NOI grew by $3.6 million or 3.5% as a result of contractual annual rent escalations, contributing $1.3 million, primarily being the 1.5% average annual rent escalations included in the Canadian Tire leases. With the balance of the growth, primarily from the continued recovery of capital expenditures, and interest earned on the unrecovered balance which contributed approximately $2.4 million to NOI this quarter.
If you recall, the prime rates that drive our interest [indiscernible] was low at 2.7% at the beginning of Q2 2022, and were only up to 3.7% by the end of Q2 last year, as compared to Q2 of 2023 where prime rates were just under 7% for the quarter, effectively a doubling of rates that we are comping over.
In addition, same-property NOI for the quarter contributed a further $2.4 million in NOI from the intensifications completed in '22 and 2023. These all contributed to a quarter-over-quarter growth in net operating income of $6 million or a very healthy 5.8%. Excluding fair value adjustments, G&A expense as a percent of property revenue was 3.1% in the second quarter, which was unchanged from the same period in the prior year.
The fair value increase of approximately $31.5 million was mainly driven by changes to the growth in the underlying cash flows from completed developments and intensifications as well as lease renewals within our portfolio which include the renewal of the 23 Canadian Tire store leases that Jodi mentioned. Consistent with our valuation methodology, we had 24 properties externally appraised this quarter, spanning geographies across the country, which are reflective of our portfolio. As a result of the appraisal information and other market data, there was little movement in our investment metrics with the overall terminal cap rate for our portfolio increasing 2 basis points and the overall discount rate by 1 basis point compared to the prior quarter.
Despite the challenging transaction market, limited comparable sales and the continued higher borrowing environment, demand and pricing for necessity-based retail like our portfolio remains strong.
Distributions in the quarter grew 2.2% over the same period of last year to $0.217 resulting in an AFFO payout ratio of 71.4%, an increase of 3.2% over the same period last year, driven by strong AFFO per unit growth.
Also in Q2 2023, we repurchased units through our NCIB facility that was put in place towards the end of last year. Although no large quantum, we repurchased approximately $1.4 million of our units at an average price of $14.45 in the quarter.
Now turning to our balance sheet. Our debt metrics continue to remain strong with no significant changes from prior quarter. The interest coverage at 3.74x was improved from the second quarter of 2022. The indebtedness to EBIT fair value ratio was 6.63x, also an improvement from Q2 2022. CT Reit's indebtedness ratio was 39.9% was down from the same quarter last year, which marks the first time our leverage has dipped below 40%. Although this ratio currently sits slightly below our target range given the macroeconomic backdrop and interest rate environment, we continue to be pleased with the progress we have made to continuously improve our balance sheet and run our business with financial prudence.
We are also pleased to be well insulated from refinancing risks as we have no debt scheduled to mature in 2024 and no public unsecured debentures coming due until 2025. Our liquidity remains strong with $152 million available through our committed credit facility and a further $300 million available through our uncommitted facility with Canadian Tire Corporation.
And with that, I'll turn the call back to the operator, Paul, for any questions.
[Operator Instructions] The first question is from Jenny Ma from BMO Capital Markets.
I wanted to dig a little bit into the lease renewals. Congrats on the volume that was completed. Can you let us know if the contractual rent steps are similar to what you've seen in the past, the 1.5% annually. And then secondarily, I wanted to ask if there's any ability to insert some sort of inflation protection in rent steps or new leases that you're signing?
Jenny, it's Jodi. So I can answer your question for you. So this quarter, approximately 90% of the renewals were the Canadian Tire stores. Most of those were our typical escalations, but we did achieve some higher ones to your point, in this inflationary market, in our urban markets. So we did -- we are starting to see some increases in some select urban markets due to inflation.
For the other 10% of the renewals this quarter, the non-Canadian Tire stores, we are quite pleased with our results to getting north of a 10% spread also reflecting the inflationary times.
In terms of the inflation protection, Jenny, that's not something that we're contemplating at this time.
And then in terms of the SP NOI this quarter, it was pretty strong. And Lesley, you touched on the interest rate doubling being a contributor to that. Is that the main driver of it being up year-over-year? Or is there a greater volume of the recoveries themselves that's driving that number? And how should we think about this contribution going forward?
Sure, Jenny. Definitely, interest rate was a contributing factor. Also during Q2, when we completed the final billings for 2022, so there was a contribution of sort of just north of $1 million that related to recovery of capital and interest that was related to 2022. So a little bit of revenue there that will not be recurring. And so that will maybe mute things if you just compare Q2 to other ones.
So our same-store NOI does go up and down a little bit depending on when we may find development completion. So if you look back to Q3 or Q4 of 2022, they were also quite strong because we had a number of developments come online. So there is a bit of variability in that number quarter-over-quarter. But that would probably be the other contributing factors.
So it's -- the 2022 piece, the change in interest rate and just also the continued growth in the capital pool that we continue to amortize as we spend more money on our portfolio, that deferred balance overcoming from tenants has also been increasing. So that would probably be the other contributing factor that does continue each quarter.
The next question is from Pammi Bir from RBC Capital Markets.
Just maybe I wanted to come back to the renewals for a second, the 1 million square feet. It wasn't entirely clear to me in terms of, I guess, the answer there. But if we had to sort of simplify it what sort of lift did you get on those renewals?
So Pammi, what I think Jodi was trying to say is there was about 1.3 million square feet renewed in the quarter. Not all of that was the 23 Canadian Tire store lease extension. So if you look at the breakdown, it's about 90% contributing from the CTR stores and the balance, the 10% being third-party tenancies. . The third-party tenancies, we don't have the same rent features as the Canadian Tire store leases with the annual bumps. So the spreads we were able to achieve on, I would say, average 5-year renewals was over 10%. Within the Canadian Tire store bucket of lease extensions, we did get the continued annual rent growth, which, on average, it does approximate the portfolio, but in urban markets, we were able to push the envelope higher than the average, which is, I think, a benefit to us.
And I think in terms of the composition of the 23 stores, it was more highly skewed to small markets and large market, but that's just a timing issue, I guess, in various quarters or various years that composition and mix changes. So we did get -- I would describe it as, on average, 1.5%, but there was a focus on driving that annual escalation higher in those markets where we're seeing higher inflation.
Right. I guess the 1.5% is the annual escalator that sort of continues on the renewals. I was just thinking on the actual year 1 renewal I believe the lease has been -- there's a floor and there's a cap at 12%. That's what sort of I was looking at is the year 1 renewal spread on the Canadian Tire leases.
Yes. So I think the comment I would make is, on average, we actually feel that the portfolio of Canadian Tire releases is at market. So -- but for the small exception here or there, which does happen from time to time. Generally, we don't see a specific lift related to year 1 of the extension period, it's more a continuation of the annual increases over time.
Okay. Yes. That's what I want to clarify. And then just maybe looking at the development pipeline, it does look like a number of projects were pushed into 2025. Can you just comment on maybe some of the drivers there? And I'm curious if you're starting to see costs start to stabilize?
I'll take the second part of that question first. I think the short answer is yes. We are seeing costs stabilize. I would say we are seeing them stabilize at an elevated level. Things are still very expensive. And I think part of what's driving that is the fact that it's taking longer. So those development completion dates that got pushed out, whether it'd be municipal applications that are taking longer, the lack of availability of skilled trades, the ability to procure building systems equipment, it's all contributing to those delays. So I don't think there's one thing that we can point to. I think it's a bit of a global contribution of various impacts that is leading to project delays across the country, really. It's not even regional at this point.
Okay. And then just lastly, on the NCIB, again, you're a little bit active. I'm just curious with the unit price where it is, maybe a bit higher than what you were buying at in the quarter. What are your thoughts on buybacks at this point versus just the development program, which is still fairly substantial versus maybe some acquisitions that might be of interest and curious what you're seeing on the transaction market as well.
Maybe I'll start and then if Lesley wants to jump in, she can. The first thing I would say is the NCIB is probably not our preferred method of allocating capital. I mean we always prefer to reinvest in the core portfolio or find new investment or development opportunities but there is a level at which we find the need to support our unit price, and we certainly dipped below that floor in the quarter. You'll see the amount of activity was de minimis. It was not large. So I don't think we'll be big users of the NCIB on a go-forward basis. But when it does get to a certain percentage discount relative to where we feel our NAV is trading, we will jump into the market to support the units.
Lesley, I don't know if you have anything to add?
No, I think says -- that's definitely where we're going to be using the NCIB going forward.
Well, I guess maybe just to comment on any thoughts with respect to acquisitions or what's in the market?
Not a ton in the market right now. There are a couple of marketed opportunities, but nothing necessarily we're working on. I think I've mentioned in past calls that there's more chatter out there, I would suggest, more people taking calls, more people making calls to explore what it would look like to sell assets. I think it's going to be pretty quiet for the balance of the year. That's my best guess.
The next question is from Lorne Kalmar from Desjardins.
Maybe just quickly on the Dufferin distribution center. Can you remind us of the cost and the anticipated yield on the project?
I believe the cost is around $40 million. I don't think we've ever communicated the exact yield on the project. I think we've -- we talked about the yield in relative terms for having pursued the net zero building relative to a non-net zero building. And I think probably what I would suggest is from a spread to stabilize the value perspective, we generally target 100 to 150 basis points over stabilized, and I think this would be at the short end of the curve relative to the incremental cost.
Okay. Fair enough. And then I noticed on the interest rate range on the debt jumped up, the high end jumped up quite a bit. Was that the credit facility?
Yes, Lorne, it's Lesley. Yes, that is the credit facility as a result of the interest rate hikes that we're continuing to see.
Hopefully, not continuing for much more. And then maybe just lastly, would you guys consider doing another unsecured to kind of pay down the line given where the spread between probably what you get an unsecured and what the rate is on the credit facility?
Sure, Lorne. There definitely is a spread there. I think the -- we have to also balance the quantum of which were drawn under our line of credit and making sure that when we issue debentures into the market, that there's also sufficient size to maintain liquidity in any given issue. So I think where we are only sort of $150 million drawn probably shy of what you've seen us go out to market with for debentures as of late. So definitely on our radar screen as a potential opportunity for funding as we need -- as we look through things for the balance of the year, that is obviously one of the things we're looking at, but probably not today.
The next question is from Sam Damiani from TD Cowen.
First off, just on the yields that you're doing new investments at and also referencing the IFRS per value discount in terminal cap rate. We've seen obviously a substantial rise in bond yields over the last 18 months. And I see your IFRS yields are up about 10 basis points. Can you just talk about how you're pricing new investments? You did the 6.6% on the new deals announced last night in the context of, I guess, the risen bond yields and your IFRS as well?
Sure. I can take that, Sam. I think it's always interesting when we disclose our cap rates on a quarter-by-quarter basis because it really just describes the basket of investments that we're announcing at that time. Sometimes it could be more skewed development, intensification and in urban markets, small markets. So it really is a point in time and a composition -- a commentary on really the composition of that bucket. I think what we're always trying to do is improve the portfolio quality. So whether that'd be by improving our assets by expanding them or adding new developments to the portfolio, increasing the weighted average lease term in due process. We also disclosed the cap rates, but I would say we're even more focused on IRR. So the annual growth doesn't really necessarily get taken into consideration in the one metric we actually speak to in the press releases. So overall, I think we have seen the yields, the cap rates for our new investment activity rise over time, along with rising bond yields. We've had a lot of conversations that are productive with Canadian Tire on how the market is moving and how our cost of capital has impacted our ability to finance some of that new activity.
So I think we are keeping track lockstep with those movements. But obviously, each particular announcement is a moment in time speaks to a particular composition of assets and deals and we're trying to manage, obviously, the relationship and the ability to continue supporting Canadian Tires growth over time when we engage in those discussions as well.
That's great. That's helpful. And just a couple of quick ones for me to finish off here. I think you mentioned all but 1 Canada Tire store lease has now been extended. I wonder if you could just address that last remaining one. And also just on the third-party leasing spreads over 10%. I wonder if you could be a little bit more specific and compare that to CT REIT's historical average on third-party leases.
Sam, it's Jodi. So on your first question, in terms of the all but 1 2024 expiry, that one, there's no issue or anything there. It's Canadian Tire is contemplating potential expansion and on-site relocation in that particular case. And so while they work through that, it will get extended at -- long before the expiry it will get extended. So it's just -- they're trying to sort of what they want to do with that particular asset, which will result in further growth for the REIT.
On your second question, in terms of the north of 10% on the non-Canadian Tire stores. This is -- I'd say, this particular quarter is probably higher than previous quarters. I don't know if it's going to set a future trend in this regard. But certainly, we're always looking to get the highest spreads as possible, especially in this environment. So we'll see how this plays out with the next round of renewals that come forward. But we're quite pleased with this particular spread.
And that spread would be sort of 8% historically, would you say, Jodi?
Yes. We've always -- I think high single digits is probably accurate, Sam, and this would probably be almost double that.
The next question is from Tal Woolley from National Bank Financial.
Just wanted to ask about the development pipeline. One of the great things is that it moves along fairly quickly and converts to cash in fairly short order. Are -- in terms of like the ability to grow that maybe or accelerate that, is the rate limiting factor you or Canadian Tire?
It's probably a resource issue more than anything in terms of how quickly we can actually push new projects through the pipeline collectively, both on our side and Canadian Tire. I would suggest the current level is one we're quite pleased with in terms of managing risk and at the same time, growth. To the extent there is more we can do or should do, we will obviously contemplate adding to the size of the pipeline, but a nearly $400 million for the next, call it, 24 months. I think that's a level that we and Canadian Tire collectively have a level of comfort with.
Okay. And then just lastly, on the Canada Square development, I'm just wondering Eglinton and LRT, what your best kind of -- I know a lot -- that kind of has to get done before things can really kick off in earnest. But maybe you can just sort of give us an update on where you see timing and next steps for that project?
Well, before we got on the call, Jodi was just complaining about the construction and the fact that she might have got a nail in her tire. So we see no let up, visibly close to home office in terms of Qs or signals that would indicate it's nearing completion. There is no specific guidance or news from Metrolink, DTC or Crosslinks as it relates to progress they're making. So we have no specific update or guidance that we can provide.
The only thing I can say is the discussions with the city as it relates to our rezoning proposal that Oxford is managing and leading continues to go well. Our best guess is possibly by the end of this year, but more likely the beginning of next year, we're hoping to achieve our rezoning subject to certain site conditions, but we are working closely with Oxford to advance the plans, take next steps. And hopefully, the timing of our approvals will also dovetail with the timing of the LRT's completion, but that is obviously out of our hands.
The next question is from Sumayya Syed from CIBC.
Just maybe if you could share your thoughts around setting up the ATM in the quarter and the potential use of any funds?
Sure, Sumayya. The ATM, just as we said their NCIB last year, we set our -- the ATM concurrently with the renewal of our base shelf prospectus in the second quarter. And really, for us, it's another tool in the tool belt. We're not necessarily expecting to see any kind of huge issuances under this. But I think we want to be able to have that as an opportunity, assuming our unit price gets to a level where we will be comfortable issuing equity, that we would have that as another tool that we could use. And we think it suits us with the sort of smaller size asset and developments, et cetera, that's adding small bits of equity at the right time over the next couple of years would be a good fit for us.
Okay. And this is more of an overarching question, but how do guys view your industrial assets in the context of your portfolio. With the Calgary Center nearing completion, would you say that asset is a long-term hold? Or would you be open to recycling if the opportunity were to present itself?
I think we view them more as long-term holds. They're sort of mission-critical facilities for Canadian Tire. But for us, we have very long-term leases on. So with obviously embedded annual growth, and we like that. At about 15% of our portfolio a little bit less, it's certainly sizable component. It's one we'd be potentially interested in growing for the right type of asset. I mean we're not going to be out there expecting industrial land and just trying to compete with merchant developers, but we think there's opportunity within the Canadian Tire ecosystem to potentially find more industrial opportunities. And I wouldn't suggest that we're looking to recycle capital as it relates to those assets at this time.
Thank you. As there are no further questions at this time, I will turn the call over to Kevin Salsberg, President and CEO, for closing remarks.
Thank you, Paul, and thank you all for joining us today. I hope you enjoy the rest of your summer, and we look forward to speaking with you again in November after we release our Q3 results. Thank you. Have a good day.
Thank you. This concludes today's call. You may now disconnect your lines.