Inovalis Real Estate Investment Trust

TSX:INO.UN

Earnings Call Transcript

[Operator]

Good morning, ladies and gentlemen. Thank you for taking the time to listen to the Inovalis REIT's Conference Call for the Q2 2020 Financial Results. The presentation will be made by Chief Executive Officer, David Giraud; and the Chief Financial Officer, 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 recurrent 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. I would now like to turn the meeting over to Mr. David Giraud and Mr. Khalil Hankach. Please go ahead.

[David Giraud, Chief Executive Officer]

Thank you, and thank you for joining us today. I would like to remind you that Inovalis REIT is managed by Inovalis SA, a first-class European asset manager with operations in France, Germany, Spain, and one of the REIT's largest shareholder, together with its management.After an extremely dynamic closing of 2019 for Inovalis REIT, the COVID-19 pandemic and its impact on European economies have turned the first half of 2020 an interesting time for our organization, but our 20-year experience in these real estate markets allows us to plan for the upcoming opportunities we foresee beyond the midterm crisis.Our local teams have suddenly allowed us to be very proactive in dealing with our tenants and our lenders and secure free cash flow and meet the initial uncertainty. But the resilience of our portfolio of office properties and our tenant diversity translate in solid performance, whether in occupancy, same-property NOI or rent collections.For the last 2 months, we have even started seeing letting inquiries in our portfolio at rental levels consistent with our pre-pandemic expectations.Following our year-end burden and asset disposals, we have started 2020 with $55 million earmarked for acquisitions, whether by us of some of our JV partners or direct purchase of quality assets at [ appropriate ] conditions. So we expect to deploy more of our balance sheet by year-end to further grow our NOI while improving FFO per unit.So the market, after the start of the pandemic and following the European government measures and European stimulus package, gross domestic product is now expected to drop by 6.25% in Germany, and 10.25% in France in 2020 before recovering, respectively, by 5.25% and 7.25% in 2021.Year-on-year, the real estate pocket dynamics, rental and investment activity have shown a slowdown in quarter 2 as leasing take-up has been standing and investment was mostly driven by transaction initiated before the pandemic. Still, investments should be driven by a more opportunistic approach in the second half of the year, sustained by a more selective, slightly more expensive, but still robust lending activity from European banks.Investment manager will bet on the recovery of the economy, boosted by the EU EUR 750 billion recovery effort, particularly on so-called real estate safe haven to capture the massive [ left-aside ] equity.Inovalis REIT is well-armed to source, select and acquire attractive opportunities in a post-pandemic environment.On the operations side, our same-store basis 2020 budget is based on a total asset under management of $673 million for NOI of $35.6 million, joint ventures included. Also independent assets appraisal in quarter 2 confirm the total portfolio value of $673 million, which will be unchanged since December 31, 2020. The resulting REIT's total equity as of June 30 is $355.4 million, which implies NAV per unit of about $12.5. So the REIT's current unit trading is recovering from the post-COVID volatility in the market, but still represent a significant undervaluation of its net asset value.As for the rent collection, through our weekly follow-up with local teams, we keep the pulse of the market and have achieved thus far a level of rent collection almost similar to the pre-pandemic months. Tenant retention is unchanged, and we have been working on the implementation of major leases, signing quarters for 2019 and the extension of existing ones.On the debt management front, deferrals were negotiated mostly in France and have resulted in cash outflows reduced by $4.3 million in 2020. We have also concluded our first post-COVID-19 debt renewal in Germany on Duisburg assets at 1.44% interest rate, proving the REIT's ability to fund operation and acquisition on a less costly basis than traditional financing in Canada, still taking advantage of historically low interest rates in Europe still today.As of June 30, the REIT had $63 million of cash available including JVs. And we assume that the $55 million earmarked for investment in 2020 induced a $0.03 to $0.04 drag on quarterly FFO.Out of the $26 million acquisition loan to reimburse further to the Rueil forward sale in 2020, $18.9 million have been repaid on July 30 to the REIT. And despite a 3-month delay in the building delivery, the profit participation recognized in our books is confirmed for this project in 2020.Last, further to the NCIB plan set up in quarter 2, the REIT has repurchased between May 19 and August 10, [ 640,900 ] units, which is about 2.3% of total issued and outstanding units.On investment activity, we believe that a strong key to the improvement of our performance is also the simplification of our portfolio, hence, our push to buy out JV partners or sell jointly owned assets. During Q2, we have kept working on a number of potential options and materialized mostly -- which materialized mostly after the second quarter closing date. First one is the negotiation of the buyback of the 50% interest of our COVID JV partner in the Bad Homburg asset. It's been finalized on the basis of June 30 valuation, standing at $23.9 million versus $23.3 million in quarter 4 2019 for a total interest of EUR 5.9 million. That's about $8.9 million. The closing is to occur by the end of quarter 3 2020.In July, brokerage mandate has been signed for the sale of the Stuttgart asset property in agreement with our capital JV partner, aiming for signing in quarter 4 2020. We believe that we are well positioned to make a profitable use of the war chest we are amassing and we should continue to create value for unitholders as soon as the pandemic-related market volatility will recede. Now I will turn things over to Khalil Hankach, our CFO and Chief Investment Officer, for the review of financial results.

[Khalil Hankach, CFO & Secretary]

Thank you, David. Good morning, everyone. In our Q2 MD&A available on our website and on SEDAR, management has continued to present the operating and financial results of the REIT using both GAAP and non-GAAP measures. I will focus on the results relating to the REIT's entire portfolio, including joint ventures, which are presented on a proportional consolidation basis and review the key following items: rental income, net rental income, administration expenses, financing activity, rent collection, NCIB and finally, FFO and AFFO.Rental income for the second quarter 2020. Our rental income across the entire portfolio was $9.5 million, reflecting a slight decrease of 600 -- $269,000, which is around 3% compared to the same period in 2019. Despite our Arcueil acquisition, Q2 rental income is dragged down by the Vanves half empty property following main tenant departure. And Duisburg vacancy, 87%, pending the Regus lease start, which occurs in August.The occupancy rate at the end of June for the entire portfolio is 89.9%, decreasing by 2.2% because of the above said factors. For comparable, the Q4 2019 occupancy rate was of 92.1%. Management will continue to seize opportunities to maximize unitholders' value through the completion of renovation works and subsidies to tenant against new lease or extensions. For the net rental income, the second quarter net rental income for the entire portfolio of $9 million, excluding IFRIC 21 impact, was slightly above the second quarter 2019, which was at $8.9 million.With the sale of Vanves and the acquisition of the remaining interest of Arcueil, the portfolio range has not significantly changed. The REIT is still reassessing its investment criteria against the pipeline of opportunities to invest its available cash. On rent collections, to answer a question many investors may ask, we will now talk about the rent collections on both our French and German portfolio.On the French portfolio, 92% of the second quarter rents have been received to date. And as the rents are invoiced on a quarterly basis, we already have cashed in 77% of the third quarter rent. Based on the figures and our weekly follow-ups with operational teams, we expect to reach more than 90% of collection during the third quarter before the end of September. On the German portfolio, where rents are invoiced on a monthly basis, 99% of the second quarter rents have been collected to date, and both July and August collection rates average around 98%.To summarize through our weekly follow-up with local teams, we keep the pulse on the market and have achieved thus far a level of rent collection almost similar to pre-COVID months. For the leasing activity in the second quarter, management has successfully extended for 6 firm years a lease on the Courbevoie property.Despite the pandemic, discussions have not stopped during the second quarter of 2020 for renewal of leases or lease take ups. We have been working on the implementation of major leases signed in Q4 2019 and extension of existing ones, and we anticipate several good news on leasing activities for the third quarter 2020 and beyond, notably on Arcueil and Metropolitain properties.On the administrative expenses in the second quarter 2020, administrative expenses for the entire portfolio, excluding asset management fees, were $1.8 million. This increase of $500,000 relative to the second quarter 2019 relates mainly to nonrecurring costs associated with the conversion into SIF regulated structure at the Luxembourg level for an amount of $158,000 and the reorganization of the REIT finance functions assisted by Deloitte for $216,000.On the financing activity, the entire portfolio, the debt-to-book value at the end of the second quarter was 47.3%, a slight increase over the Q4 2019 figure of 46%. Senior debt on French properties have been deferred following government measures to ease debt service conditions at the start of the pandemic. New arrangements with banks have been met, leading to a positive cash impact of $1.6 million over the quarter and $4.2 million over the full year 2020.On the Duisburg property, despite the general standstill in the financing sector during the month of March, April, and May, the bullet loan of EUR 22.5 million has been successfully extended for 3 years at an attractive interest rate all-in of 1.44%. Management is now working for a specific CapEx line with the same lender. It is important to note that in France and Germany, bank continue to provide financing at competitive and comparative terms to the period prior to the economic crisis caused by the COVID.For the normal course issuer bid, confident in our value, management undertook a normal course issuer bid in response to the extreme volatility that affected the trading price of the REIT in the second quarter. We started repurchasing shares with the cash at hand while looking for alternative investment pipeline. Over the second quarter, we bought back 510,000 shares at a price ranging between $6.4 per share to $8 per share for a total of $3.9 million.189,000 shares were canceled at the end of June, and the remaining 320,000 were canceled or the cancellation occurred early July and are not reflected yet in the calculation of our weighted average number of units on which AFFO and FFO per unit is based. Finally, if we look at the FFO and the AFFO figures. FFO for the second quarter 2020 amounted to $5.4 million compared to $5.9 million for the second quarter of 2019. The decrease of $500,000, which is roughly around 9%, is mostly attributable, sorry, to the higher profit sharing recognized last year as the Rueil project was moving towards completion.Following the 4.8 million units created in December 2019 through our secondary offering, a 17% year-on-year increase on diluted number of units and our willingness to pause our acquisition strategy and keep available cash for future acquisition since the start of COVID-19, the FFO per unit is only at $0.16 in the second quarter of 2020 compared to $0.21 for the same time in 2019.The FFO value for the first 6 months of 2020 amounts to $10.9 million, equivalent to the FFO for the first half of 2019. FFO per unit is $0.32 in 2020 and $0.38 in 2019.AFFO for the second quarter 2020 was at $0.15 per unit compared to $0.20 for the same time in 2019, in line with the FFO year-on-year variation. On top of the FFO induced variation, the 6-month level -- sorry, the 6-month AFFO level at $0.27 per unit compares to $0.39 per unit at the same time in 2019. And this is notably dragged down by the impact of the lease equalization repayment in January following the sale of Vanves.As already said by David, further the acquisition plan for the third and fourth quarter of new assets and existing joint venture, together with our efforts to relet vacant spaces and reduce our G&A, we anticipate to bring back both our FFO and AFFO to figures that we would expect to be higher than the ones pre-COVID.Thank you for your attention. We would be pleased to receive any questions you may have at this time. Furthermore, do not hesitate to contact the numbers of the management team. Our contact information is available in the press release.

[Operator]

[Operator Instructions] Our first question is from Peter Churchill-Smith with Newport Private.

[Peter Churchill-Smith]

Khalil and David, can you hear me?

[David Giraud, Chief Executive Officer]

Yes, perfectly well. Perfectly.

[Khalil Hankach, CFO & Secretary]

Yes.

[Peter Churchill-Smith]

Good effort and good update. Two questions. One is can you talk a little bit about sort of just the macro opportunity in Germany and France, what's happened to cap rates since February or -- and just general acquisition activity in the general pipeline, can you give us a sense for that?And my second question is, do you anticipate administrative cost will now start to -- will start to compare favorably going forward after the work that's been done in the finance area by Deloitte and the likes? So those 2 questions.

[Khalil Hankach, CFO & Secretary]

So David, I'll take the first question. I'll leave the second question for you. So on the first question, the market outlook and what we've been witnessing both in France and Germany, as you know, the world went into a sort of a standstill. So the comparables that we have today, whether it's in France or in Germany, are relatively rare compared to the ones that we used to have at the same time in the second quarter of 2019. So that being said, there has been transactions. Transactions, as David pointed out, were mostly transactions that were initiated towards the end of the year or in the first quarter of 2020.For an indication, the first quarter of 2020, in terms of transactions, was one of the highest quarters in the history of Germany and France. For the second quarter, of course, with the pandemic arriving, everything slowed down. We don't have a lot of data, a lot of information, but the market has so far helped in a very significant way. Two reasons behind that: the uncertainty has allowed the long-term real estate investment companies, which are mainly backed by retail investors, to continue to collect a significant amount of money, both in France and in Germany, money that is going to be deployed by the end of the year, so between September and December.And the second important impact was the reacted -- reaction of the banks. If you recall in 2009, the banks were somewhat at the beginning of the crisis because of their very bad ratios at the time. So very high LTVs and very high risks. As soon as the market faced a little bit of a downturn, their numbers were relatively hit. So they had to react and started executing a lot of the borrowers. This is not at all the situation today. The banks have been very understanding. They've even gone as far, as we mentioned in our text, to defer the amortization and interest of their loans by 3 to 6 months, giving a lot of breathing space to landlords. Even in our situation, for instance, where we have cashed in a significant amount of our rents, almost more than 90%. So despite that, we had a reprieve from the banks in France.So this situation has led to a nonpanic sale and has led to landlords and owners being able to wait and see, in a very simple situation, what was going to happen. Again, the large amount of cash that is available today within the investment community in France and in Germany as along with the strong [ dispensability ] of the banks through their lending activity and their very competitive conditions, we don't feel that the situation is going to go anywhere south by year-end. 2021 might be a completely different issue because of a larger economic crisis that could be coming, and that would affect the tenancy perspective, more the tenants than the landlords and directly afterwards, the landlords. But for the moment, the markets continue to be resilient. We continue to see transactions, for example, in Frankfurt at 3.6% cap rate. We continue to see transactions in downtown Paris and in the [ Vache Noire ] suburb with significant increases in rents per square meter and in price per square meter.So as we stand today and for the moment, there is no indication so far of prices falling. Again, this is from a macro perspective. Of course, you always have the individual seller who is in a bit of a difficult position because of other events and unrelated events that has to sell. But on a macro approach and from a generous perspective, things are still holding for the moment. David, I'll hand it over to you for the second question.

[Operator]

Mr. Giraud, we are unable to hear you at this time.

[David Giraud, Chief Executive Officer]

Sorry, can you hear me?

[Khalil Hankach, CFO & Secretary]

Yes.

[David Giraud, Chief Executive Officer]

Yes. Sorry. So Peter, sorry, I was just thinking, Khalil, and saying that, obviously, we've done the bulk of investment with the view to partly internalize the finance function and repatriate it to Canada. Obviously, COVID didn't help, but we were working with Canadian consultants on that matter so that we can transition over the third quarter. So this is a work in progress. And this will give us even more control on numbers, our budget and our capacity to get the best of our service providers.So this is on a good path, I will say, and we to -- this should show in our numbers from the next quarter onward.

[Operator]

[Operator Instructions] Our next question is from Alex Leon with Desjardins Capital Markets.

[Alex Leon, Associate]

David and Khalil, my first question is on the rent collection and deferrals. So in the MD&A, you guys noted that 10% of growth rent in the France portfolio was deferred for 3Q. Just wondering if there's going to be any provision recognized in those deferrals? And I'd like to confirm that there were no deferrals granted in the second quarter?

[Khalil Hankach, CFO & Secretary]

David, all yours.

[David Giraud, Chief Executive Officer]

Yes. So no -- so the -- effectively the only discussion on deferrals concern a couple of buildings in France. And if you prefer, the situation in France was way different than the one in Germany. Basically, in Germany, there was -- business was almost as usual, and banks were functioning on a way where they were collecting interest and debt service from their borrowers and conversely, all tenants were paying on time their rents. The situation in France was pretty different in the sense that the government has given financing to corporation to basically alleviate their shortfall in turnover. And some of these tenants have turned to landlords to get 1 to 2 quarter deferral of their rent payment. And this was pretty limited. And that was only done when it was justified by the kind of activity.So we have had this kind of discussion, and this has an impact of about less than 9% to 10% of the rent of the second quarter that are being deferred to the coming one. And you have to appreciate that actually since the deconfinement in the market, which was back in early -- end of May, early June, business has gone back to normal, at least for some of the tenants. And luckily, most of the tenants that we have are in businesses where they don't suffer like in retail or hospitality and so forth.So that's why so far, our view is that these deferrals are very constrained and that only pertains to the French assets.

[Khalil Hankach, CFO & Secretary]

So just a small -- sorry, just a small addition on the 10%. A part of it is deferral, another part is free rent that was given to tenants in exchange of the new longer leases so that are either being negotiated or have already been negotiated. So there's nothing that has been given, that was a free -- a freebie, let's put it simply. Every time there was a rent-free period that was provided to a tenant that was not in their original lease, there was something in exchange of it. So either by an increase in surfaces or the increase in the weighted average lease break. And when there was nothing in exchange, then it was simple deferrals, and both of those amount to just around or just under 10% for the French portfolio.

[Alex Leon, Associate]

Okay. And just to confirm, there isn't going to be no provision for bad debt against those deferrals?

[Khalil Hankach, CFO & Secretary]

They're deferrals, so they will be cashed in. So for the moment, there's no reason for us to presume that there will be provisions for bad debt.

[David Giraud, Chief Executive Officer]

And actually, we do follow-up the same way. We follow the rent collection. But clearly, we also checked the situation where we might have bad debts. So far, as Khalil was telling you, everything has been negotiated and written down. Accounting wise it doesn't qualify as a bad debt and it shouldn't because payments are coming in due time. And we're talking about discussions that were held back in May, and that were starting to come into force in July, August, and so on. So we see already this effect.But that would be monitored by all players in the market. And you know that we have the internal resource in terms of property management that gives us a direct view on this bad debt issues whenever they occur.

[Alex Leon, Associate]

Okay. Great. Thanks for the color. Last one for me is on the acquisition pipeline. Just looking out throughout the remainder of 2020. Is an emphasis going to be placed on buying out current JV partners or acquiring new assets? And if the latter, will the REIT be looking to acquire a wholly-owned interest or continue acquiring through a JV structure?

[Khalil Hankach, CFO & Secretary]

So the -- it will be both. So it would be both, as David pointed out, 1 of the acquisitions or the next acquisition that will take place is the joint venture acquisition of one of our assets. So we will be buying out our joint venture partner. So we continue to look at the joint ventures as one of the pipelines for the REIT, as we've done since the beginning. We will also be looking at third-party assets and as far as the third-party assets are concerned, they will be done as a sole investment by the REIT and not as joint ventures as we continue to simplify our structure.

[Operator]

Our next question is from Jenny Ma with BMO Capital Markets.

[Jenny Ma, Analyst]

I apologize I dialed in a little bit late, but I'm wondering if you can give an update to the CFO search process. Not sure if you had discussed it already?

[David Giraud, Chief Executive Officer]

No. Jenny, good to hear you. Khalil, if you allow me, I'm just going to give you a quick update. And I was explaining to -- following Peter Churchill-Smith's question, we've basically, after the COVID, we have organized ourselves with our consultants in Toronto to basically design the whole organization of the portion of the finance team that we are to partly internalize in Canada. And we've been working with them also on the hiring of a team.Because of that situation, we will stop the hiring process basically, and we are working with this consultant on a kind of [ loan staff ] agreement so that we can not only design but also implement the process. And we are going to resume -- we've decided that we're going to resume the hiring process from, I would say, October, once we have completed basically the third quarter with our new organization and with our new process.So the plan remains the same. We've just decided because of the COVID and the fact that nobody could travel between, basically, Canada and Europe, to do whatever we could with the people who have been working already in Canada, and renew our team and renew our service providers in Europe to keep the momentum and speed up the process.So this way, once we start the hiring, we know exactly what we'd be expecting from the people, and they will not have to basically build up everything from scratch. Everything would be a kind of turnkey organization, which we prefer.

[Jenny Ma, Analyst]

Okay. So I guess, we'll be really looking at the New Year then in terms of an announcement potentially?

[David Giraud, Chief Executive Officer]

Yes. Yes. Yes. Makes sense.

[Operator]

Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to you, Mr. Giraud.

[David Giraud, Chief Executive Officer]

Thank you. So well, as Khalil was saying at the end of his speech, we are pretty adamant in our view to keep on developing this REIT. We have resource to do it. We are amassing a war chest that will allow us to grow the business significantly, we hope in the next 2 to 3 quarters, and get our numbers where we're aiming to at the beginning of the year very soon. So we hope to get back with you next quarter to give you a confirmation of these targets. Thank you.

[Operator]

Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.