Inovalis Real Estate Investment Trust

TSX:INO.UN

Ladies and gentlemen, thank you for standing by. And welcome to the Inovalis REIT third quarter financial results conference call. [Operator Instructions] I would now like to hand the conference over to your speaker today, Jacqueline Jordan. Thank you. Please go ahead.

Everyone, thank you for taking the time to listen to the Inovalis REIT's conference call for the Q3 2020 Financial Results. The presentation will be made by CEO, David Giraud; and CFO, Khalil Hankach. Please note that comments made during this call may contain forward-looking information within the meaning applicable to securities legislation, which reflects the REIT's current expectations regarding future events. This is based on several assumptions and subject to a number of risks and uncertainties, many of which are beyond the REIT's control that could cause actual results to differ materially. Please see the REIT's public filings for a discussion of these risk factors, which are included in our 2019 MD&A and Annual Information Form, which can be found on Inovalis REIT's website and on SEDAR.

Thank you, Jacqueline. Thank you, everyone, for joining us today. I would like to remind you first that Inovalis REIT is managed by Inovalis SA, a first-class European asset manager with operation in France, Germany and Spain, and one of the REIT's largest shareholder together with its management. As we started getting positive news from Pfizer and Moderna about potential vaccines for the COVID-19, the long-term impact of the pandemic on European economies and our portfolio remains uncertain, but our 20-year experience in the real estate markets allows us to plan for the upcoming opportunities and foresee beyond the short- to mid-term activity tranche.Our local teams have been very proactive in dealing with our tenants and lenders and secure free cash flow amid the initial uncertainty. The resilience of our portfolio of office properties and our tenant diversity translate in solid performance, whether in occupancy, same-property NOI or rent collection.We'll now give you -- I will now give you a market overview. In quarter 3 2020, the European economies recovered well after a difficult quarter 2. A number of factors have stabilized as countries have adopted practices for managing pandemic conditions. This has allowed many businesses to carry on, and employment remained strong. However, the resurgence in infection since September has led to the reintroduction of containment measures in many European countries, which are expected to weigh on economic activity and sentiment in the short run.It is likely that EU GDP growth will slow in the fourth quarter of 2020. GDP is now expected to decrease by 5.6% in Germany and 9.4% in France in 2020 before growing, respectively back by 3.5% and 5.8% in 2021.By the end of 2020, the unemployment rate is expected to increase slightly in the European region to 8.3% from the multiyear low of 7.1% in March. This is primarily due to the effect on tourism, the hospitality industry and other hard-hit sectors.Year-over-year, real estate market and investment activity have slowed in quarter 3. Some businesses are differing rental commitments, as they cautiously consider the effect of the pandemic on their operations over the winter months.Investment activity actually was mostly driven by a transaction that were initiated before the onset of the pandemic. Other investments seems to be partly driven by a more opportunistic approach in the second half of the year. This has been made possible by more selective, slightly more expensive, but still robust lending activity from banks.Thus far, there has been no indication of pandemic-related distress selling in the Paris or German real estate office markets. Savings are growing in many European countries, and significant amount of investment equity are being sidelined. Budget deficits are mounting across Europe as governments have no choice, but to maintain virus stimulus package, holding essential to sustain growth, contain unemployment and inflation.Coming to the operations. As of September 30, NOI for the total portfolio adjusted for IFRIC 21 was $26.4 million, and we are projecting a total NOI of $35.6 million for the full year as per our interim budget.Our business operations team has worked closely with tenants to respond and normalize operation to the extent possible. They have achieved quarter 2 and quarter 3 levels of rent collection, very close to the pre-COVID normal. Khalil will comment on this in more detail in a few moments.We can report to investors that due to the caliber of our tenants and the effectiveness of our rent collection, it has not been necessary to record any bad debt provision to date in 2020. Tenant retention remains strong, and all 4 rent inquiries are less recurrent than before the pandemic, slowly picking up. Weight average occupancy is currently 26.4% for the Paris asset and 92.9% for the German assets, which is only slightly down from Q4 2020.With respect to debt management, the REIT has negotiated deferrals on $6.3 million (sic) [ CAD 6.3 million ] of its loan, mortgage and lease loan financing, including in quarter 2. And to a lesser extent, these deferrals, which were primarily for properties in Paris arrange without penalty or adjustment to interest terms that actually improved the REIT's cash position. As updated as of September 30 and total portfolio market value amounts [indiscernible] versus CAD 691.5 million as of June 30 when GLL performed under the current valuation of all the REIT's assets.In terms of liquidity, as of September 30, the REIT had $79 million of cash available, including $6 million from the REIT's share in joint ventures. Also carrying $55 million from the REIT's last December disposals, has been relative to FFO. We are comfortable that with the prudent approach to preserving liquidity during the first 3 quarters of 2020. I'll comment on our plans for this shortly.I also have an update on the Rueil acquisition loan, which is winding up. Out of the initial $26.8 million acquisition loan from the Rueil followup sale, $19.4 million was repaid on July 30, and the remaining $9.9 million in profit participation is expected to be paid by the end of November.Finally, coming to the investment and divestment part of our business. Continuing with our initiative to streamline asset ownership arrangement, [indiscernible] for performance and simplification of our reporting process. So to that end, we are proceeding with plans to buy out JV partners or sell jointly owned assets. 2 of these are currently underway. First one is Stuttgart. First, we have -- brokerage mandate has been signed [indiscernible] in agreement with our JV partners, targeting a sale and purchase agreement to be placed -- to be in place in quarter 4 this year.We have received 16 signed [indiscernible] agreement, and we have granted a 6 weeks' exclusivity for 1B and in completion of the business. Second one is Bad Homburg. Bad Homburg is an asset with an update. We successfully completed the quarter. In October, we have finalized the buyback of the 50% interest from our COVID JV partner for $8.9 million. Also, we have received 8 offers. We had 2 brokers for the development assets located in the Courbevoie area of Paris. 1 offer currently under negotiation and places the contention of a building permit for reconversion of the assets into residential and [indiscernible] project. We have granted a bidder exclusivity until end of November to further assess the feasibility of their project.Now we are refocusing our attention on the opportunistic consideration of potentially repriced markets and put our cash reserves to work. The investment committee is being briefed on a regular basis in Germany, France and Spain. We believe that we are well positioned to profitably deploy the REIT's cash on hand and our fundamental focus in quarter 4 in 2021 with creation of value for unitholders through investment growth and equity acquisition.Now I will turn things over to Khalil Hankach, our CFO and CIO, for the review of financial results.

Thank you, David. Let me start by providing some additional information on rent collections. For the third quarter 2020, the rents on German and French properties have been collected at nearly 100% and 94%, respectively. As David noted previously, this is generally in line with the timeliness of pre-COVID-19 rent collection levels with a few minor exceptions. Q4 rent collections are tracking in parallel with Q3 results. We can confirm that 100% of October rents on German assets have been collected and nearly 100% of November rents is anticipated by the end of November. As at November 4, we already received 84% of Q4 rents on our French portfolio, and we expect to receive more than 95% by the end of the quarter.Moving on to the foreign exchange rate. The effect of change in the euro foreign exchange rate on the REIT's reported result is an important element when comparing results to previous periods. As at September 30, 2020, the euro CAD FX rate was higher at CAD 1.5615 compared to CAD 1.4565 as at December 31, 2019. This represents an unrealized increase of 7.2% for balance sheet items, such as investment properties, materialized by the positive impact of CAD 24.8 million in other comprehensive income.The average year-to-date euro exchange rate for income statement items was 1.4933 as at September 30, 2019, compared to 1.5217 for third quarter 2020, generating a positive impact of approximately 1.9%. Turning now to the financial statements. Let's discuss some major items. Net rental income for the third quarter increased from CAD 6.1 million in 2019 to CAD 6.55 million in '19/'20 -- sorry, in 2020. This increase is mainly due to the positive foreign exchange rate as gained from the Arcueil acquisition, and the new leases have been partially offset by the vacancy in Courbevoie this past year. David previously commented on the appraised value of the asset for the total portfolio. When adjusted to IFRS, the fair value of REIT's investment property portfolio as at 30th of September 2020 was CAD 513 million compared to CAD 478 million in -- at December 31, 2019. The increase is mainly attributable to foreign exchange adjustment, $34.5 million. The Q3 internal valuation of asset resulted in increase of CAD 156,000 over the investment property portfolio and a decrease of CAD 625,000 over the total portfolio. Quarterly general and administrative expenses remained relatively stable year-on-year, from CAD 1.36 million in 2019 to CAD 1.46 million in 2020. For the 3 months ended September 30, 2020, finance income in a total amount of $1.6 million consisted mainly of $1 million in interest on loans granted to joint ventures, $295,000 in interest earned on the remaining Rueil development loan balance, and CAD 235,000 gain from foreign exchange hedging contracts.Management has taken -- has undertaken further buybacks under the normal course issuer bid, as the reach unit price has been trading at a value below its net asset value. Between May 19, 2020, and September 30, 2020, the REIT bought back 884,675 units for a total amount of CAD 6.679 million, at a weighted average price of $7.55 per unit.We will now move to reviewing the MD&A. In terms of financial results for the total portfolio, including the REIT's interest in joint ventures, the key points are as follows: the third quarter 2020 net rental income for our total portfolio was CAD 8.79 million compared to CAD 9.12 million for the third quarter of 2019. The decrease is mainly attributable to the departure of a principal tenant in the Courbevoie property in the third quarter of 2019. Q3 2019 rents include both the rent of the tenant for $338,000 and an early departure indemnity for CAD 323,000. Over the first 3 quarters, the net rental income for our total portfolio decreased by $222,000 despite a positive FX impact of $506,000.As David commented earlier, the occupancy rate of the total portfolio decreased from 92.1% to 90.1%. This decrease reflects the impact of the end of the rental guarantee in property and the vacant floor in Duisburg since the end of December 2019. However, compared to the second quarter 2020, occupancy of 8.9%. The occupancy rate has increased as a result of 2 new leases at Délizy and Arcueil properties. In addition to these new leases, a lease was signed for the metropolitan building during the quarter for a total of 10,500 square feet for a newly leased space.As at September 30, 2020, the weighted average lease term is 3.9 years compared to 4.5 years as at the end of December 31, 2019. In the third quarter of 2020, the REIT reported funds from operations and adjusted funds from operations of CAD 0.19 per unit and CAD 0.18 per unit, respectively, while both ratios saw an increase compared to the second quarter where the FFO was at CAD 0.16 and the AFFO was at CAD 0.15. Financial performance has been affected by the cautious decision to pause the 2020 investment strategy until the impact of the COVID-19 pandemic on the REIT's business was more apparent. The weighted average interest rate across the total portfolio is 1.97%, and the debt ratio is 47.6%, comfortably within the REIT's mandated threshold of 60%. As well as the mortgage deferrals that David mentioned, management is considering other refinancing opportunities to take advantage of historically low interest rates in Europe. The REIT should be able to finance assets on a less costly basis than that offered by traditional financing in Canada.Subsequently to the quarter, on October 2, 2020, the REIT has exercised its option and acquired a 20% stake in the company that is financed to build the Rueil property for a purchase price of [ CAD 3,400 ], which will enable the REIT to crystallize the profit-sharing component of the loan in the amount of $9.937 million. This gain in fair market value has been recognized since the inception in December of 2016 in line with the initial loan plan. As the REIT is committed to the simplification of the structure and given that they had partially reached maturity, the 3 -- the REIT's 3 promissory notes were redeemed subsequent to quarter end, resulting in the holder of the notes taking 14% in the REIT's units. This concludes my comments on the financial statements and MD&A. I will now turn it back to David for -- and your questions. Thank you very much.

[Operator Instructions] Our first question comes from Brendon Abrams with Canaccord.

I was just wondering if you could provide an update on the special review that was initiated recently. Maybe just exactly what drove that decision to create the special committee and as well as your expectations going forward in terms of timing and potential outcomes?

Sure. So, Brendon, the special committee was put in place. So for information, the special committee is composed of all of the independent members of the Board. So it's a special committee, which comprises all the members of the Board, except for Stéphane Amine, who is not an independent board member. And the special committee is reviewing several elements of investment, elements of strategy. They are reviewing elements related to the G&A and elements related to the asset management contract of the REIT, which is up for discussion at the next G&A in March of -- in April -- sorry, in April, May of 2021. So this strategic committee has been meeting for the past 7 years and deciding on the strategy of the REIT in the month -- during the month of November. And this time around with the impact of the COVID and with the fact that we have quite a bit of money on our bank accounts and that we have not been active since the month of March due to the COVID pandemic, the decision was taken to communicate on this strategic committee. And we expect to have the results of the committee by the end of November, first week of December at the latest.

Okay. That's great. That's really helpful. Maybe just in terms of the investment activity recently for Stuttgart and Courbevoie, if I'm pronouncing those correctly. Just wondering your expectations in terms of pricing for those assets? Whether they would be in line with your current IFRS values? And what you see as the potential time line in terms of the sale of those 2 assets?

So as far as...

We got -- sorry, please go ahead. Go ahead.

No, I was saying, as far as Stuttgart is concerned, we accept an offer which is around or slightly higher than the IFRS numbers. And we hope to sign an SPA by the end of the year with a transaction that should conclude after administrative issues are sorted. Towards the end of the first quarter of 2021 -- sorry, 2021. And regarding Courbevoie, the offer that has been selected is higher than the existent IFRS value. However, it is subject to the obtention of the permit. And therefore, we have not yet finalized the due diligence with the buyer. And so we will know by the end of the year if it's an interesting offer to pursue or not.

Okay. That's great. And then just last question for me before I turn it over. Obviously, the REIT has been carrying a pretty high cash balance for the last few quarters, just undeployed capital. This has led to above 100% payout ratio. Just wondering in terms of the potential for deploying this capital, what type of opportunities you're seeing in the market? And maybe expectations for timing of closing some acquisitions?

So the -- go ahead, David.

I mean -- sorry, just 1 point. I mean just to -- Brendon, just to give you an impact to the Strategic committee. The purpose of the strategic committee is exactly that. It's to analyze all the opportunities that we have because we have buyback of joint venture, which are possible, and we have opportunities in the market. Khalil will tell you right away what they are. So there are so many opportunities that the key driver of the decision for us is to see how we increase basically the NOI, the numerator of our older ratios so that we can improve the performance of the REIT, the FFO, the AFFO and all the parameters. So that's the reason. And the reason that is driving the strategy committee that there are lots of opportunities, buyback and others.So Khalil now will give you a highlight on what we see just on the market. Sorry for this interjection. But I wanted to clarify the lead between the opportunities and the strategic committee. Khalil, please?

No, no, you're absolutely right. So as far as the opportunities are concerned, we have been explaining for several years that the joint ventures are potential pipeline for the future. So part of the use of funds would be some of the joint ventures, which we deem as accretive and where we feel that the REIT has -- should acquire and keep on a longer term. And then there are, of course, opportunities in the market, whether it's in France and Germany, and we've been looking closely at Spain for quite some time now with the REIT. And all 3 of those markets, we feel that there could be opportunities that the REIT could benefit from. And as David pointed out, the reinvestment of the cash that is available will definitely boost most of the numbers from the payout ratio to the AFFO to the FFO and the cash flow in general.

[Operator Instructions] Our next question comes from the line of Jenny Ma with BMO Capital Markets.

I wanted to ask a question about the Courbevoie vacancy that's been in there for a while. Just wondering if there is an update on leasing? And whether or not your discussions on the potential asset sale would be subject to any sort of lease-up or a consideration in your negotiation?

Thanks for the question, Jenny. So the -- on the Courbevoie asset, the vacancy was in end of the third quarter of 2019. And so it was put up for letting immediately after the departure of the tenant and also a little bit before. The vacancy on the asset is quite substantial because we're talking about a vacancy of around 55% to 60% after the departure of this tenant. The strategy that we decided to go with, and that's the reason why we decided to put it on the market, is because we feel at this level of vacancy that the asset is better used in a different configuration. And so it is easier to redevelop an asset when you have more than 50% of the asset which is vacant than when you have 85% of occupancy on the property. So something which we could not consider before is now considerable. And the offers that we received were all in line with this consideration because all of the offers that we received aimed for a conversion of the asset from an office building into something which is more in line with residential, co-living and other types of this bracket of product. So the process that we have entered into now is simple due diligence. Most of the offers that we received are subject to the obtention of the permit, and the permit is currently being discussed with the City Hall of Courbevoie. So we feel very strongly that if we sign an exchange contract by the end of the year on the Courbevoie property, that the person we will sign with would have done the sufficient due diligence and the sufficient communication with the City Hall to be able to go through till the end and acquire the property.

Okay. Is there any sort of delay in obtaining the permit from the city just because of COVID? Or what's the time frame you expect to be able to get that permit?

We don't -- for the moment, we have not been impacted by any delays from the COVID situation because the governmental agencies are working more or less normally. Of course, there's a lot less permits being deposited. So that helps when you have people that are not necessarily working at 100%. The delays that we are looking at for the moment are between 6 to 9 months, between the obtention and the purging of the preemption right of the -- sorry, the recourse right of the neighborhood.So this is a transaction that would close -- sorry, Jenny, this is a transaction that should be expected to close if we sign the exchange contract by the end of the year, that should expect to close between September and December of 2021.

September to December 2021. Okay. So then, I guess, it's fair to say that you're not really working on filling that vacancy then given the intention to redevelop on the part of post the bidders?

Not at this point. I mean the asset is -- as we speak, the asset is worth more vacant than it is worth occupied.

Okay. That's great color. And then turning to sort of the allocation of your cash. I understand you're working on some acquisition opportunities. But I'm wondering, in terms of sort of financial option, would you be considering a higher volume of unit buybacks than what you've done year-to-date? And then also, I know you guys did some debt deferrals as well. Just wondering what the thinking was behind that? Is it really just opportunistically taking advantage of these deferrals? Because from a cash perspective, it doesn't really look like they're necessary.

It was a mixture of opportunistic end of good sense at the moment because the deferrals were done quite quickly in the second quarter. So as soon as the situation started to get complicated in March, we very quickly contacted most of our banks and asked for the deferrals that we were allowed to ask for by government decree. That was much more in line in France than it was in Germany. We pursued with those deferrals during the third quarter, allowing us to have additional cash, while keeping in mind that the one or the assets where the deferrals have occurred, the LTV ratios are relatively low. So the deferral of the amortization to the end of the -- to the maturity of the loan will not generate additional stress on the cash flow in the following year. So it's not a loan which is specifically deferred to be repaid. It's a loan which is deferred mostly until maturity for most of them. And so it is some sort of a form of refinancing, a small form of refinancing, which we did. And so we benefited from that, even though, as you pointed out, our cash flow and our rent collection has been relatively high.And as far as your first question is concerned, we are continuing the NCIB program for the moment. We will readjust our numbers towards the end of the year to see for the coming year if we decide to propose a larger buyback or if we stick to the NCIB, and it all depends, of course, on the unit price of the REIT.

Okay. Great. And then my last question is whether or not you have any update on your discussions with Orange and their upcoming lease maturity in a couple of years?

So the lease maturity on the [indiscernible] building is in 2023, with a break option at the end of 2021. We are in discussions with them on the signing of a new lease. There's nothing definite, as I speak to you, in order to be able to give you any more information or more communication. But the discussions are ongoing. And we are hopeful that Orange should sign a lease. Hopefully, before the end of the -- their next break option, and not before the end of the lease in 2023.

There are no further questions in the queue. I'll turn the call to David Giraud for closing comments.

Okay. Thank you, Linsey. So if there is no more question, we just wanted to thank you again for participating in this call. We are very optimistic for the future. Even so, the situation is a bit gloomy in Europe and North America at the time. But we think that there are a lot of opportunities ahead of us. And hopefully for the next quarter, we'll give you a more about our plan for the very near future. Thank you so much to all of you, and goodbye.

This concludes today's conference call. You may now disconnect.