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Good morning, ladies and gentlemen. Welcome to Melcor REIT Second Quarter 2018 Conference Call. I would now like to turn it over to Mr. Andrew Melton. Please go ahead, sir.
Thank you very much, Drew, and good morning, everyone. Thank you for joining our conference call and webcast. It is our privilege to report to you on the second quarter results of Melcor REIT for 2018.As some of you may know, our CFO, Naomi Stefura, is on maternity leave. However, Naomi stays quite involved in the company. Now she is actually in the room today to give us support, but she will not be reviewing the financial information as she typically does but will participate in question-and-answer session as required.So on our call today features Brandon Park, our Director of Asset Management, 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, Melcor Development, has also joined us on the call, and he will run through our financial performance.Following the prepared remarks, which will be brief, we will participate in a question-and-answer session.I will now turn the call over to Kelsey.
Thank you, Andy. Good morning, 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 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.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's Discussion & 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 that 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 MD&A.I will now walk everyone through some of the financial highlights of our results for the second quarter and half year ended June 30, 2018.Rental revenue grew by 6% in both the quarter and year-to-date compared to the same period a year ago. Similarly, net operating income grew by 5% compared to Q2 2017 and by 4% year-to-date versus the first half of 2017. This growth is a result of the Melcor acquisition completed in January of this year. If you recall, at a purchase price of $80.875 million, the REIT acquired nearly 173,000 square feet from Melcor Development through the unique development and opportunities agreement that exists between the 2 companies. The recently built and 100% leased property consisting of 128,000 square feet of Alberta retail and 44,000 square feet of industrial represents the fourth such transfer and greatly adds to the diversity and growth of the REIT's portfolio.For the second quarter and first half of 2018, FFO was down 2% compared to the same period a year ago. This was due to property sales completed over the past 12 months as well as competitive pressure on office space in Edmonton. This also impacted same-asset NOI, down 4% for the quarter and 5% during the first half of 2018 compared to a year ago.Following the same trend, AFFO was down 5% versus the same quarter a year ago and 6% for the first half of 2018 but grew in the quarter, up 2% over Q1 2018.ACFO was also down 5% in the quarter and 6% year-to-date versus the same period a year ago. Our debt-to-gross book value ratio finished the quarter at 56%, below our maximum threshold of 65%. The weighted average interest rate on our debt was 3.71%, down 4 basis points from the end of 2017.I will now turn the call over to Brandon, who will speak to our portfolio's operating performance in the second quarter and first half of the year.
Thanks, Kelsey. And for everyone on the line, thank you for joining our call today. We are pleased to report stable operating results in the second quarter with occupancy at 90% and a 4% increase in weighted average base rent.The vend-in from the Melcor Development's pipeline completed early in the first quarter continues to impact results. It has contributed to the steady occupancy and the increases in average rents, rental revenue and operating income. The vend-in was accretive and partially offset declines in same-asset FFO and AFFO.We also continue to see the impacts of the competitive pressure on office space in Edmonton, which, again, contributed to lower same-asset NOI as well as higher tenant incentives and direct leasing costs. Current occupancy in our Edmonton office properties is 80%.CICA recently issued a Q2 Edmonton office report and indicated 17% vacancy in the Edmonton office market. We continue to overcome these challenges -- these challenging markets by adjusting for and capitalizing on market trends in all asset classes.As of June 30, we have retained 72.5% of expiring leases and have had 35,958 square feet in new leases commence. We have commitments on approximately 70% of GLA that expires in 2018.In the first half year, we recycled capital with the sale of 2 Edmonton area retail properties. We also renegotiated our credit line in the quarter. These 2 factors placed the REIT in a solid position to take advantage of acquisition opportunities as they arise.We continue to monitor and respond to market demand and trends in commercial real estate and to focus on exceptional customer care as a differentiating factor in a market where tenants may 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. Ruth, please open the lines.
[Operator Instructions] Our first question is from Kyle Stanley from Desjardins Securities.
So just a couple of questions from me today. So CapEx thus far in 2018, in particular TIs, which you discussed, have been trending higher. I'm just wondering what you expect in the back half of the year and maybe into 2019. Would you expect this to moderate given maybe the significant leasing you've done in the first half or continue at this pace?
Brandon here. So we talked about TIs and I what to differentiate office from the rest of the portfolio being retail and industrial. Office in our Edmonton market, we continue to see a tenant's market. So we're seeing a little bit of base rate (sic) [ rent ] erosion and those high TIs continuing to be -- to remain competitive. So that should continue in the near future.
Okay, that makes sense. And then, I guess, just my second question here is, same-property NOI has been a little bit soft this year. I'm just wondering what your expectations are for organic growth in the balance of this year.
Kyle, you can't predict the future and don't know when we're at the bottom till we're off of it and moving back up. But it's feeling -- the ground swell here is it's feeling pretty good that we've gotten through the vast majority of our challenges on the office front. So we're actually -- there is capacity now in our Edmonton office portfolio. If we see any type of intake, that will have positive results on our bottom line.
Our next question is from Sumayya Hussain from CIBC.
So just firstly, on your renewals and the kind of the lower rents that you're seeing there. Office, obviously, makes sense given the changes in that market. What are you seeing on the retail side in terms of renewals and new leasing and the spreads you're getting there?
It's Brandon here again. Thanks for your question on the retail spreads and renewals and new leasing. Again, retail, from our perspective in the markets we're in, remains steady. Our properties continue to see interest on any vacancy and positive momentum in that regard. Consistent renewals with market rate rents is also a trend.
Okay. So in line with market trends?
Correct.
Okay. And then just, I guess, continuing on the retail segment. There was reference to more tenants being on rent-free periods. How does this compare to what you guys have typically given historically? And is this kind of more so in the power center side or the neighborhood shopping centers? Or where does this kind of trend lie?
So Sumayya, I just want to kind of paraphrase your question to make sure I understand it. You suggested that we're seeing a little bit more rent release on our retail tenants and kind of what segments of the market. Oh, free rent, sorry. Was that free rent or rent release?
Yes, just the rent-free periods. There was talk about it being more prevalent this quarter than prior. So just a bit more color on where that's coming from.
Okay, well, thank you. I understand your question now. Perfect. We're seeing it -- basically, it's based on our review and discussions with each individual tenant. We're really trying to specify any incentives to their needs. And often, we're finding that free rent rather than TI being more attractive on a renewal or new deal.
But predominantly those are the larger tenants in more of our larger-format shopping centers. In the smaller neighborhood centers that is less of a factor.
Right. So more so in the power centers?
Correct.
[Operator Instructions] Our next question is from Michael Smith from RBC Capital Markets.
So just a question. I understand like things are starting to pick up in Alberta, where WTI is trading. I mean, you've -- so there's certainly a lot more positive tone. The office market is -- it's got supply issues, which is affecting that. You're showing very good stability in retail and industrial. Just wondering, does -- and I know it would be tough to sell, but have you given any thought to maybe paring back your office and redirecting those funds into maybe industrial, where it is the most desired -- one of the most desired asset classes right now in the public markets?
Michael, were you at our board meeting yesterday? I was surprised by your question. I would say that every asset -- we love our portfolio, but we're not in love with any particular asset, Michael. We constantly look at whether that would make any sense to recycle some of that capital and redeploy it. We have done that. We sold 2 assets in the recent past. And if you drill down on our financial statements, you'll know that our -- from a financial perspective, we're in pretty good shape right now. My opinion, Michael, and if I -- subject to me being allowed to change this over the next 6 months, I think we're in pretty good shape holding our office assets, and they may end up actually helping us from a [ capital ] perspective on a go-forward basis. We're in a good position right that our -- that we can manage them, and we're happy continue holding them.
Right, right. Yes. No, I see. I mean, I guess part of it is the public markets sometimes are not the best owners of assets that are out of favor. So in other words, like you -- if you had -- if your portfolio was -- and I don't know if this is not possible in the short term anyway -- 50% industrial, 50% retail, you'd probably be trading a lot higher, which would enable you to issue equity to continue your roll-up. So that was my only thinking.
[Operator Instructions] There are no further questions registered at this time, so I'd like to turn it back with your, Mr. Melton.
Yes, I just want to thank everybody again. It's a beautiful day here in Alberta, and I hope same out there and hope everybody's enjoying their summer. And I'll just encourage everybody, whenever you've got any question, we're -- all of us here are open to taking a call and discussing it. Your involvement is super important to us, and so we thank you for your participation.
Thank you. This conference call has now ended. Please disconnect your lines at this time, and we thank you for your participation.