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Good morning, ladies and gentlemen. Welcome to the Melcor REIT Q2 Conference Call. I would now 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 very much. Good morning, everybody. Thank you for joining our conference call and webcast. As always, our goal is to keep our opening comments brief so that we can give you a good time for any questions that you might have.With me on today's call is Naomi Stefura, who will run through our financial highlights for the quarter; and Brandon Park, who will provide a brief review of operations in the quarter.We are pleased to report on another stable quarter. We again maintained steady occupancy and growth in average rental rates in spite of continued challenges in some of our markets. We remain committed to being the landlord of choice by providing an exceptional service experience and well-maintained commercial space for our customers.This, coupled with proactive leasing strategies, continues to pay off with new lease deals, including commitment for future space. We also continued to execute on our growth strategy and completed the Staples acquisition in Calgary, Alberta, adding 56,000 square feet of retail space to our portfolio during the quarter and was immediately accretive.Now I will turn the call over to Naomi.
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 financial statements, are available on the Investor Relations section of our website at melcorreit.ca and also on sedar.com.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 MD&A.Second, we report our financial results in Canadian dollars and in accordance with IFRS. 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 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, 2019. Revenue was stable over Q2 2018 in both the quarter and year-to-date. Net operating income was up 3% in the quarter due to the new property acquired. Same-asset NOI was flat over Q2 2018 and up 2% from last quarter due to higher operating margins offsetting the decline in same-asset occupancies.Net income in the current and comparative periods is significantly impacted by noncash fair value adjustments on investment properties and on our Class B LP Units due to changes in the REIT's unit price. Management believes funds from operations, or FFO, is a better reflection of our true operating performance. FFO was $6.48 million or $0.23 per unit, down 4% in the quarter and $13.01 million or $0.46 per unit, down 3% year-to-date due to higher finance costs.Adjusted funds from operations, or AFFO, was $4.78 million or $0.17 per unit, down 4% from Q2 last year, and $9.39 million or $0.33, down 5% year-to-date. The decrease was due to lower FFO and higher reserves for tenant incentives and leasing commissions on account of continued challenging market conditions. Compared to last quarter, AFFO was up 3% due to higher NOI.We maintained distributions in April, May and June for our a quarterly payout ratio of 99% based on AFFO and 73% based on FFO. The REIT has maintained its distribution since its inception, paying steady distributions to our unitholders for 62 months.On April 1, 2019, we commenced a normal course issuer bid, enabling us to purchase and cancel approximately 5% of our outstanding trust units for cancellation. We believe that the trading range of our unit does not reflect our intrinsic value. In the second quarter, we purchased 19,140 units for $145,000 at a weighted average cost of $7.60 per unit.At June 30, 2019, we had $1.76 million in cash and $15.5 million in additional capacity on our credit facility. We conservatively manage our debt with the debt to gross book value on the low end of our target range.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.
Thank you, Naomi, and thank you, ladies and gentlemen for joining our call today. As Andy and Naomi mentioned, we are pleased to report stable operating results in the second quarter, with a 2% increase in weighted average base rent compared to December 31, 2018, counteracting the slight decline in occupancy to 89.2%.We continued to execute on our strategic leasing program through the first half of 2019 to mitigate ongoing market challenges and maintain occupancy. We proactively engaged tenant renewals and completed renewals representing 116,900 square feet, including holdovers, for a healthy retention rate of 78% as of June 30, 2019. New leasing has also been steady across the portfolio, with 27,200 square feet of new deals year-to-date in 2019 and an additional 53,000 square feet committed for future occupancy.We also continued to see impacts of competitive pressure on the office space in Edmonton, which again contributes to lower same-asset NOI as well as higher tenant incentives and direct leasing costs. We expect this trend to continue as we work hard to maintain occupancy.In support of our growth strategy, we acquired a 56,800 -- 56,084 square foot single-tenant retail building with warehouse space in Calgary, Alberta from a third party for $12,450,000 on April 24, 2019. This redeployment of capital following the sale of 2 assets last year was immediately accretive to AFFO.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 have many options. Continued 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, we'd like to open the lines to take your questions. Patrick, please open the lines.
[Operator Instructions] We'll take our first question from Sumayya Hussain with CIBC.
Just wanted to start with hopefully getting an update on the RBC space in terms of plans to reposition it or interest -- any updates there?
Yes. I am so glad you asked that question because I was tempted to talk about RBC in my opening comments. It's Andrew speaking. Firstly, a good question. And yes, we are deep into internal discussions on what we're going to do with the building and how we're going to move it forward.I want everybody to also just take a second to focus. I mean the RBC lease has been a big topic when you're looking at the Melcor REIT. But I think we all have to put it into context that it is only collectively a 47,000 square foot tenant on our portfolio, and it doesn't just break down -- it breaks down to 3 components. And one of them is office, which is -- of that 47,000 square feet, only 21,000 square feet is office space.And one of the things that Brandon didn't point out is we've already started backfilling that. We've completed one tenant already to -- which will take occupancy just pretty much as soon as the RBC lease expires. So it's very soon in the future, whether it's next quarter or the quarter after.We're not even going to call it RBC building. Although we love the RBC, we've got new tenants and a lot of other locations there, they'll lend us money, great relationship, but we got to change the name of the building and get on with it. And we're very excited about some of our plans and some of our repositioning that we're -- work that we're undertaking. Sorry, I turned the hose on you. I could have given you a glass of water, but I turned the hose on you there.
No, I like it. That's helpful. And I just want to touch on incentives and rent-free periods. Is that pretty much all for the office? Or are you seeing that on the retail side as well?
Brandon here. Good question, and I'll relate it to incentives and kind of which asset classes. Large predominantly, the increased TIs in free rent are on the office. And I would suggest it's in the Edmonton market, specifically downtown, and a little bit in the Regina. Retail incentives are fairly standard as they've been in the previous years. For new tenants, minimal on the rules.
Okay. And I think, Brandon, last quarter, you mentioned you were seeing positive trends on absorption just generally in the Edmonton office market. Can you just kind of give us an update on what you're seeing there now?
Year-to-date, in the Edmonton office market, there is a positive absorption. Taking a look at it, it's about 160,000 square feet for the year. There was a little bit of negative absorption downtown, but that's due to the shifts to some of the new towers. Where we're seeing some green shoots in the downtown Edmonton office is from the tech sector. There's recently been some significant leasing by Jobber, which is well known in the tech industry and a homegrown talent, as well as Aurora Cannabis leased 22,000 square feet in the downtown core.
[Operator Instructions] We'll take our next question from Matt Logan with RBC Capital Markets.
Just following up on Sumayya's question. Maybe you could talk a little bit about incentives in terms of the direction of where they're trending. And do you see the Edmonton office market as maybe finding a bit of a bottom and starting to maybe inch upwards?
Brandon here again. Thank you for your question. And I know you're looking for a little bit of an understanding of what things look like in the future. What we're seeing is a little bit stabilization on space rates. And flat is the new up. Rents, I think we're seeing rents being steady, but the incentives haven't increased too much from where they previously have been.
That's good color. And maybe on the tech side of the leasing equation. Are you seeing any interest from tech tenants in your property?
Absolutely. We have at downtown on 104 Street, it's an old historical warehouse district. One of our buildings, the Birks Building, has been just shy of 100% leased the past 4 years. And we got a lot -- we have a number of tenants in that building, which are in their incubation and have actually grown up as companies.One story would be Showbie, who has been a tenant in our portfolio for over 5 years. They're actually moving into the RBC building and taking almost double the space. That's one example in the quarter. And there's also another -- a number of other companies that are coming out of startup phase, especially AutoML, I mentioned Jobber, Drivewise. So again, smaller market compared to Toronto or Vancouver, but we are seeing the inner -- the beginnings of that tech boom.
And maybe just changing gears in terms of capital recycling. You've been chipping away at the NCIB. Have you given any thought to maybe recycling a little bit more capital and stepping up the NCIB activity?
Yes. We would love to purchase more. I think our biggest problem is that we're quite limited by the daily volume that we're allowed to purchase because our trading volume is so low. The only sort of major way that we could step up that program would be through a block acquisition, which unfortunately also just don't come around very often because again, our trading volume is quite low. So we're more constrained, I guess, by the limit and less by our desire to purchase.
Good color. And I guess last question for me. Any update on your thoughts for the convert coming due in December?
That's a daily topic. We're definitely looking to renew it in advance of December but sort of timing to be determined. We sort of continue to monitor the market and we'd like to get ahead of obviously the renewal date.
And any indications on kind of a potential rate?
Lower than the current expiry rate.
Lower?
Yes.
It appears there are no further questions at this time. Mr. Melton, I'd like to turn the conference back to you for any additional or closing remarks.
Thanks, everybody. I hope the lack of questions is due to the summer doldrums, and I hope everybody's enjoying their summer and just appreciate your ongoing assistance and support. It means a lot to us. Thanks very much.
The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.