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Good morning, ladies and gentlemen. Welcome to the Melcor REIT Q1 Conference Call. I would like to turn the meeting over to Mr. Andrew Melton, President and Chief Executive Officer of Melcor REIT. Please go ahead, Mr. Melton.
Thank you, Donna, and good morning, everyone. Thank you for joining our conference call and webcast. It is our privilege to report to you on the first quarter of 2018, just days after the REIT celebrated its fifth anniversary.5 years -- the last 5 years, we've seen a lot of interesting times in Alberta and in Western Canada. We have seen great opportunity in the real estate business, and that includes Melcor REIT. We've also seen some tremendous challenges for Western Canada, and that includes the REIT. The results that are in front of you, though, show a continuation of our ability to perform under either market.As some of you may know, our CFO, Naomi Stefura, is on a very brief maternity leave. Naomi typically reviews the financial component during our call. We thought we'd give her the day off, but she insisted on being here anyway. So she's in the room and will be part of the question-and-answer.We have, however, modified the format of our call this morning. Joining me on the call are Brandon Park, who is the Director of Asset Management for Melcor REIT. He will run through a review of our operations in the quarter. Kelsey Kelemen, who is the Director of Financial Planning and Analysis for Melcor Development, has also joined the call and will be running through our financial performance. Naomi, Kelsey, Brandon and I will participate in question-and-answer following our brief prepared remarks.With those introductions out of the way, I'd like to hand the call over to Kelsey.
Thank you, Andy. Hello, everyone, and thank you for joining us today. I'd like to remind you that the materials related to this call, including the MD&A and the financial statements, are available on the Investor Relations section of our website at melcorreit.ca and also on sedar.com. Our goal is to keep our remarks to a brief high-level review of the quarter and then open up the call for your questions.Before getting started, I have a few mandatory statements to make. First, certain statements made during this call may be forward-looking. For a complete discussion of items that may cause actual results to differ, please refer to the Business Environment and Risks section of our annual management discussion and analysis.Second, we report our financial results in Canadian dollars and in accordance with International Financial Reporting Standards. We supplement our financial reporting with nonstandard measures, including funds from operations, adjusted funds from operations, adjusted cash flow from operations and net operating income. We believe these measures are important in evaluating our performance but caution listeners that they may not be comparable to similar measures presented by other companies. These nonstandard measures are defined and reconciled in our management's discussion and analysis.I will now walk everyone through some of the financial highlights of our results for the quarter ended March 31, 2018.Rental revenue grew by 6%, and net operating income grew by 3% compared to Q1 2017. During the same period, FFO was down 2%, and AFFO and ACFO were both down 7%. Our debt-to-gross book value ratio at 56% was below our maximum threshold of 65% and little changed from a year ago. Same-asset NOI was down 5% over Q1 last year and by 2% compared to Q4 2017.I will now turn the call over to Brandon, who will speak to our portfolio's operating performance in the first quarter.
Thanks, Kelsey, and thank you all for joining us on our call today. A few key events over the past few months and years have shaped the challenges in our financial results that Kelsey just walked you through.First, we completed our fourth accretive vend-in from the Melcor Developments pipeline early in the quarter. This grew and strengthened our portfolio and contributed to steady occupancy, growth in average rents in spite of the continued challenges in some of our markets. This vend-in contributed to 6% growth in the portfolio gross leasable area as well as the growth in rental revenue and net operating income and AFFO and FFO. We are excited to get this deal done as the growth in one of our primary objectives and highlights the strategic importance of our relationship with Melcor and our proprietary assets to Melcor's commercial development pipeline.Second, the competitive pressure on office space, primarily in Edmonton, contributed to the lower same-asset NOI, which is substantially the result of higher tenant incentives and direct leasing costs. This was offset by the performance of our retail assets as well as properties outside of Alberta. We continue to find creative ways to overcome challenging markets by adjusting for and capitalizing on the market trends in all asset classes.As of today, we have commitments on approximately 50% of expiring leases into 2018. These 2 counteracting forces led to slightly lower occupancy of 90.5% at March 31, 2018.We continue to monitor and respond to market demand and trends in the commercial real estate markets we operate in and to focus on exceptional customer care as a differentiating factor in a market where tenants have many options. Recent positive momentum in leasing activity provides us with the comfort to remain cautiously optimistic about commercial real estate in our major markets.At this time, I'd like to open the phone lines to take your questions. Donna, please open the lines.
[Operator Instructions] And the first question is from Sumayya Hussain from CIBC.
So just firstly, on the 2 retail assets you guys sold in and after the quarter. Were the cap rates there pretty much in line kind of with the vend-in that you just finished, I guess, around the low 6% level?
Sumayya, Brandon here. I'd like to comment. Two retail assets, one was in the 5% cap range, the mid-cap 5%. The other was in the low 6% cap.
Low 6%. Okay. And then just when you guys were reviewing the assets for sale, can you walk us through your thinking in the process and how did you land on these and what made them noncore, if that was the case?
Two separate stories. The Corinthia Plaza one, which is a very small asset and has a lot of history, was -- it was really -- interestingly enough, it was the very first asset that Melcor Developments ever developed. So it's been on the Melcor Developments' balance sheet for many, many years. And it was a bit small of an asset, and we responded to an unsolicited offer from a local businessman in Leduc, and it just seemed we couldn't imagine how we could ever pay that level of cap rate for it. So we thought it was in the best interest of the REIT to sell it. The other one, Miller, was a conscientious decision that was made at the board level to take a look at the portfolio, which started actually last summer, to look at those assets that might be at the end of their life and to start a capital recycling program, which would assist us in the vend-in that we just transacted. So it was one of the assets that was in that analysis.
Okay. And just switching to your Edmonton office portfolio and I guess, more so in reference to the sequential occupancy decline. Can you just give an overview on what you're seeing there? And are you seeing tenants that have pretty much been in the suburbs kind of migrating to the downtown? And is that what's causing the occupancy drop-off?
Sumayya, Brandon here. Thank you for your question. If I understand it correctly, you're asking kind of what's the root cause of the occupancy drop-offs and if there is any migration from tenants to the office -- downtown office market from the suburbs or vice versa.
Yes, exactly.
Okay. We've told the story before about the new products hitting the Edmonton downtown market specifically. That's 1.8 million square feet that's coming online, with the final tower of that 1.8 million coming in mid- to early next year. In our minds, what we've seen is the decline is largely due to 2 tenants departing, and in those cases, they became owner-users. The migration from suburbs downtown hasn't happened yet or vice versa. It's a product of the new supply choices in the market.
Okay. That's good color. So nothing changing fundamentally there. And then just lastly, on the leasing you guys accomplished so far. Do you have a sense of what was the mix between office, retail, industrial? And then just for the balance of the year, same question, do you have any significant leases? Or are they pretty much evenly distributed?
Sumayya, Brandon here again. Immediately offhand, I don't have the mix in front of me. But I would say it's balanced in a similar manner to how our portfolio is spread between office, retail and industrial. So the main mix would be between office and retail tenants, that leasing completed year-to-date. I also want to mention, we have renewed our 3 largest tenant expiries of 2018. And they also -- those 3 tenants are also falling in our top 3 tenants on our tenant roster.
Top 10.
Top 10.
The next question is from Michael Smith from RBC Capital Markets.
Just wondering, just for modeling purposes, if you could give us a little bit of guidance on what you're expecting from a leasing perspective for the balance of the year.
Thanks for the question, Michael. I'll get Brandon to answer that.
So, Michael, thanks for your question. You're asking us what the balance of the year for leasing is going to look like?
Yes, yes, in terms of -- yes, exactly.
Guidance, year-to-date, I think I made a statement we've made some good headway as just under 50% of our expiring GLA 2018 has been secured or renewed. In terms of what the remaining balance is, trading paper, having conversations. On the office side, it's a tenant's market. There's a little bit of erosion on state's rates, incentives are up. But we're having positive conversations. Retail, stable would be my comment.
It's -- we've got to be careful with forward-looking statements, Michael, but I can also tell you that we're pretty confident that our overall occupancy level is going to stay in the brackets that you've seen over the last little while.
So pretty stable.
Yes.
[Operator Instructions] And your next question is from Kyle Stanley from Desjardins Capital Markets.
So just wondering, are you seeing any other capital recycling opportunities out there? Have you identified any other noncore assets that we can maybe see transacted later in the year?
Nothing is planned. So we -- I would say that we've sort of finished our strategic capital recycling program, Kyle. But you never know, you never know what offer might be lurking around there. We look at -- we give everything consideration when it comes in. But it would be a surprise.
Okay, that sounds good. And then I guess, just my last one here. I'm just wondering what a good run rate for straight-line rent would be. Would it be a kind of annualized number from Q1 here? Or would it change a little bit from that?
Yes, I think that Q1 is probably indicative. There's nothing abnormal as far as the [ needs ] sort of accounting adjustments, [ so that will be ] a Q1 number. So I think that's a fair comment.
There are no further questions registered at this time. I'd like to turn the meeting back over to Mr. Melton.
Well, thanks again and really appreciate the time and energy that everyone puts into this call. I know your lives are very busy, and these calls mean a tremendous amount, and your questions mean a tremendous amount of us. So thank you. We hope that spring has finally embraced our country and that we can all get the clubs out or the bikes out and have some fun. So have a great summer, and we'll talk to you in the second quarter. Thank you.
Thank you. The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.