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Thank you for standing by. This is the conference operator. Welcome to the Melcor REIT Second Quarter 2020 Results Conference Call. [Operator Instructions] And the conference is being recorded. [Operator Instructions]I would now like to turn the conference over to Darin Rayburn, President and Chief Executive Officer. Please go ahead.
Thank you, Anastasia. Good morning, ladies and gentlemen. Welcome to the Melcor REIT conference call for the second quarter and half year ended June 30, 2020. And what a quarter it was for the entire world. It's one I know I won't soon forget. I'd now like to turn the meeting over to Naomi Stefura, our Chief Financial Officer, at the Melcor REIT. Naomi, please go ahead.
Thanks, Darin. Good morning, everyone. Thank you for joining our conference call and webcast for the second quarter and first 6 months of 2020. If you have not reviewed the materials related to this call, including the MD&A and the financial statements, they are available on the Investor Relations section of our website at melcorreit.ca and on sedar.com. Our goal is to keep our remarks to a brief high-level review of the quarter and half year period and then open up the call for your questions. Before turning the call over to Darin to discuss our operating results, I have a few introductory and 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 risk 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 6 months ended June 30, 2020. Portfolio growth of 12% based on GLA contributed to revenue growth of 4% and NOI growth of 3% compared to Q2 2019. Net income in the current and comparative periods is significantly impacted by fair value adjustments on investment properties due to changes in NOI and capitalization rates and by noncash fair value adjustments on our Class B LP units due to changes in the REIT's unit price. We believe FFO is a better reflection of our true operating performance. FFO was up 2% year-to-date while ACFO was up 3% year-to-date. In order to conserve cash and to better support our tenants, our distribution was cut by 47% as of the April distribution. This resulted in a quarterly payout ratio of 55% based on ACFO and 40% based on FFO for the quarter. Year-to-date payout ratios were 78% based on ACFO and 57% based on FFO. Another cash conservation measure was we amended our mortgage agreements with some of our lenders in order to obtain temporary payment relief as a result of COVID-19. These arrangements resulted in $2.26 million in reduced payments in the quarter or 36% of our contracted secured debt payments. We also suspended purchases under our NCIB program and canceled our automatic share purchase plan following the expiration of our Q1 blackout on May 15, 2020. We still do believe that our units are trading in a price range, which does not reflect the value of the units in relation to our current and future business prospects However, we felt this suspension to be prudent while determining the current and long-term impact of COVID-19. I will now turn the call over to Darin, who will speak to our portfolio's operating performance.
Thank you, Naomi. For the past 7 years, the Melcor REIT's results have been pretty standard and consistent. Continued stability in spite of market challenges, steady growth through our internal pipeline with Melcor Development, third-party acquisitions, all combined with our commitment to service excellence. These have been the key themes, and they've not changed over the years. While our past results remain consistent, not volatile and relatively uneventful by most standards, the macro environment of the first half of 2020 has been anything but uneventful and has been definitely hold as volatile and has thrown additional challenges our way via the COVID pandemic, oil price wars and the social movement towards true quality for all. Despite this worldwide volatility and uncertainty, we are pleased with our results for Q2 2020 and the first half of the year, as the REIT continues to benefit from the strategic acquisitions completed in 2019, which contributed to growth in revenue, net operating income and adjusted cash from operations, in spite of the negative pressures all around us. While we do not believe we're out of the woods yet with respect to COVID-19 and the way that it has continued to impact our business, we do believe that our quick response to ensuring the cleanliness and safety of our properties reducing spending, conserving cash and our willingness to work with our tenants has placed us in the good position we are today. We collected 83% of Q2 2020 rents, leaving $5.15 million rent outstanding. We've recorded $770,000 in provisions for doubtful accounts in the quarter. The majority of our tenants are working cooperatively with us in finding mutually acceptable arrangements to repay arrears. We anticipate approximately half of the currently uncollected rents to be collected in the future through rental deferral agreements. We have a number of rental for our agreements in place now and continue to work with tenants to finalize these. Due to the nonessential business closure orders issued by the provincial governments, some of our retail tenants were closed at the beginning of the quarter. Most were allowed to reopen mid-May. However, many retailers took a very cautious approach to reopening, including delaying their opening to ensure that they could comply with the new recommendations and procedures to protect the health and safety of their customers and staff. One of the programs put into place to assist those businesses that were impacted by the restrictions is the Canada Emergency Commercial Rent Assistance program or CECRA. Approximately 10% of our tenants representing 8% of total GLA have requested that we apply for CECRA on their behalf. We cannot yet determine how many of these applications will be successful. We do believe that based on existing information, our net negative exposure to CECRA claims for the Q2 period is estimated to be approximately $0.5 million. Due to the rapidly evolving and widespread impact of the pandemic, the REIT's entire portfolio was revalued by our external valuation professionals in Q2 2020. Approximately 89% of the portfolio realized the valuation write-down, with individual asset losses ranging from 1% to 17%. The revaluations resulted in a fair loss aggregate value of $57.30 million. In addition to some of the cash conservation programs that Naomi described few moments ago, we've also deferred discretionary capital spending of approximately $1.3 million planned for 2020. This improves our near-term liquidity and reduces nonessential activities at our properties. Strategic value-add enhancements and preservation projects remain a cornerstone of our long-term strategy to improve our assets and retain and attract tenants. In the current environment, we remain focused on our long-term objectives while balancing near-term needs and establishing our priorities to withstand this pandemic. We will continue to monitor our maintenance programs as tenants resume operations in order to continue to provide best-in-class service while ensuring efficiency and cost effectiveness. We recorded a 23% reduction in recoverable operating expenses in the second quarter. We believe that continued solidarity and partnership with our tenants will provide them the best opportunity to endure the pandemic and be successful in the long term. In terms of operating results, our portfolio performance again remained stable through the first 6 months of 2020. While leasing activity has slowed initially as a result of this pandemic, we have continued to proactively engage with the existing tenants on renewal terms and to pursue new tenants. We completed lease renewals representing just over 150,000 square feet for a healthy retention rate of 79.4% at June 30, 2020. And year-to-date, we have secured renewal agreements totaling 224,000 square feet or 70% of our total 2020 expiring square footage. Leasing in the time of COVID, while different, does continue. New leasing has been steady across the portfolio with just under 90,000 square feet in new deals completed to date in 2020 and an additional 74,000 square feet currently under various stages of negotiation. To put this in perspective, in 2019, our total new leasing was just under $80,000 -- 80,000 square feet. We've already exceeded that in 2020, it's only August. Overall occupancy at quarter end was 88%. While the times seem uncertain, business continues. We experienced daily resilience and entrepreneurial spirit in our tenants as they resume are operating and find a way to survive and look forward to the changing economic, demographic pattern and social landscape in the markets where we operate. We are pleasantly surprised with second quarter results, but not foolish enough to ignore challenges ahead with continued uncertainty amongst economies and the virus. We will continue to build on our foundation of conservatism and adjust as appropriate while monitoring the ever-changing commercial property landscape. We'd now be happy to take your questions. Anastasia, can you please open up the phone line?
[Operator Instructions] Our first question comes from Matt Logan with RBC Capital Markets.
Wondering if you guys could talk a little bit about your outstanding balance from tenants. Darin, you mentioned that you expect to collect more than half of that. There's about $5.2 million outstanding, and the bad debt provision this quarter was around $800,000. So just wondering if you could reconcile those 2 figures for us?
Sure, Matt. And I also mentioned that we -- what we know, we think, we know with the CECRA applications that we're probably going to have to write-down about $500,000. So the $800,000 was a tenant by tenant basis and estimates of $500,000 from CECRA. And then throwing in some extra for those tenants who we've either not have agreements with or not talk to. Sorry, Naomi is shaking her head at me. I said something wrong.
No. Sorry. And just to be clear, because I don't know if this was entirely clear in the disclosure because I've had other questions. The CECRA $500,000 that we're expecting is not included in the $800,000 provision for bad debt. So the $800,000 or $878,000 that's currently included there is the tenant-by-tenant analysis of those tenants who do not qualify for CECRA and who we expect are not going to be able to pay fully. And then there will be a CECRA allowance on top of that next quarter. Just to be clear.
Thanks for the clarification, Naomi. We can all thank our federal government for the uncertainty in this program because I'm not sure if any landlords actually know what this is going to cost us. Beyond that, Matt, beyond that, when you look at the $5.15 million. Again, there are a couple of tenants. In the last conference call, I think, I mentioned 9 of our 644 tenants, we haven't talked to or how to raise this with. I can tell you, we have one large tenant that we're still talking to. But beyond that, time will tell.
But I guess suffice it to say the conversations for the -- for most of that $5.2 million have been going positively, and tenants are making some effort to pay those rents over the next few months?
Absolutely.
Maybe changing gears here to your fair value write-downs. You mentioned that the portfolio was appraised during the quarter. Wondering if you could talk about the valuation inputs the appraisers are using and given where the stock is trading, if you'd consider selling any assets and repaying debt or buying back any stock?
I'll speak to the selling or buying or something. Naomi can speak to the valuation inputs. I think -- I really appreciate all the work appraisers are putting into valuation. As a real estate professional that I'm supposed to be, I think, it's very challenging to come up with real valuations of real estate right now. But having said that, before Naomi goes on some of the inputs, Matt, your question about buying or selling, I mean, everything is always for sale for the right price. It's no secret that there are groups with capital circling trying to throw on some offers. I mean I did the same thing in 2008 in the U.S., so I'm not criticizing. But some of the values that are being thrown around on potential purchases really don't make it worthwhile for us to sell. Having said that, stay tuned because you just never know. Naomi, did you want to mention on the valuation input?
Yes. So we did have all of our properties revalued in Q2, which is abnormal. We typically wouldn't do that. But we just thought it was time to get all of our properties sort of reset and appropriate. So I guess some of the inputs that went in. As far as credit losses, we took an additional 25% credit loss allowance in year 1 on the cash flows. We took a 2% to 4% increase in the typical vacancy allowances. We inputted a 75% across the portfolio renewal probability, which is typically higher than that. And we increased the vacancy lag to 6 to 12 months lease-up from what used to be 3 to 6 months lease-up. So those would be sort of the major, I guess, inputs that went into the reduced ongoing cash flows that were used to determine the valuation. Does that answer your question, Matt?
That's great color, Naomi. And I guess when we look at the leasing trends that you've seen since the pandemic began, would it be fair to say that they support the rental input assumptions in those DCF values, at least in the early days?
Naomi and I are smiling because she knows what I'm going to say, and she's going to throw pen at me. I think we're doing better than the valuations they're giving us, Matt. I mean the numbers don't lie. And the only way that I can defend that is once our tenants are operating and paying rent and we look at where the NOI goes, but I think I just gave you a forward-looking statement. So perhaps I'll retract that. And the truth is I don't think anyone really knows. But as I said before, if you would have asked me in April, if we'd have 224,000 square feet of renewals done, I say no, I'd say the world was ending. And it feels a lot better now than it did in April. So I don't know if that answered your question, Matt, but that's kind of where we sit.
[Operator Instructions] Our next question comes from Kyle Stanley with Desjardins.
So I was just wondering, could you provide an update maybe on how your discussions have been going with your lenders on refinancing maturing debt? I think last quarter, we talked about this a little bit. And obviously, there's a ton of uncertainty when we spoke last, and things have progressed since then. So just wondering where that stands today?
Yes, for sure. I think, unfortunately, I don't know that I have much of an update. We're still working on renewals with all of the lenders. So for all of the upcoming maturities in 2020, we are working with renewals on the lenders. We don't have any of them solidified at this point, but they are all progressing positively. So I don't have any reason to believe at this point that the renewals won't be completed, but I can't say with certainty that, that's true. There is one mortgage that is coming up in September on a property that we own in a joint venture. So we only own half of it in Chestermere. And on that one, we have secured an LOI for an up finance on that property on a lower rate. So it was a 10-year term at 4.9%, and indicatively, it would be going into a 5-year at 2.5%. So I guess there is one that we do have some paper on as far as sort of refinance the same lender. And then three, that we are just still in conversation on renewals.
Okay. Great. That makes sense. And then so you mentioned the net exposure -- or the potential net exposure related to CECRA for the REIT would be about $500,000. I'm just wondering, is that the 25% that would be written off by the landlord?
Yes. That's correct. So that's not the full amount. That would be our 25% write-off, and that is only for the initial 3 months. So there would still need to be a determination if any of those tenants would apply, and if Melcor would apply for the program for July and August. And that is not -- that's only the tenants who have responded to date with attestations. So we are still expecting that some tenants are probably still going to be submitting their paperwork.
Okay. Great. And then I guess, just a last one for me. Are you seeing any renewed leasing interest now that the economy is reopened? And what kind of groups are you seeing out there potentially looking for space at this point, across all the asset classes?
Sure. I can answer that, too. And it's a bit of a mixed bag, Kyle, which is strange to me. So like from an office perspective, we're seeing a lot of consulting firms who -- like we had one deal, we literally did a deal in 2 days in some existing space, and I think the people are working off boxes because they just -- they provide some business overview consulting. And suddenly, they had a huge demand amongst a bunch of small businesses, and they needed to just get set up in 1 of the quadrants, we have a couple of buildings. So we're seeing a lot of that on the new leasing. And then from a retail perspective, you know what, a lot of our retail leasing paused for 2 or 3 months. But food, believe it or not, food services, the 1,500 square foot small in-line food services, depending on where they're at, and while I'm not intending to be on the Melcor Soapbox. But if you look at our retail projects that are mainly surrounded by the communities that Melcor Developments have built, there's always been demand for some of that retail, which is why our retail occupancy is so high. So we see some of that continuing. I can tell you, as a landlord, we're a lot more selective about the deals we're doing and spending a lot more time on covenants than operators. And again, so beyond that, I would say it's just a smattering of a bunch of different things.
[Operator Instructions] There are no further questions at this time. This concludes the question-and-answer session. I would like to turn the conference back over to Darin Rayburn for any closing remarks.
Thanks, Anastasia. I guess the one thing I want to say to everyone, again, thanks for your interest and for calling in. Like for those of you who are warning about the resilience of the Alberta Spirit, especially in time of COVID and oil price crashes unemployment just watch the 50-50 total from tonight's oiler game. This is no joke. We expect it to be over $10 million. If that isn't an indicator of the pent-up demand for hope in a province, nothing else is. So good luck to the person who wins the $6.5 million tax-free cash tonight. And good luck to all of you. I hope that you're safe and healthy. I hope that business is picking up for everyone, and I look forward to next quarter, hopefully, with smiles on our faces. Good weekend, everyone. Stay safe.
This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.