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Welcome to the Melcor REIT Second Quarter 2021 Results Conference Call. [Operator Instructions] The conference is being recorded. [Operator Instructions]I would like to now turn the conference over to Mr. Darin Rayburn, President and CEO. Go ahead, please.
Thank you, Michelle. Good morning, everyone, and welcome. With me on today's call is Naomi Stefura, Chief Financial Officer for the Melcor REIT. The story over the past 16 months has been the global COVID pandemic and how it would impact our business. While COVID-19 is by no means over, we are pleased to see the vaccination rates continuing to rise. This is our first conference call in over a year where businesses are functioning at full capacity. While we're optimistic going forward, during Q2 restrictions, they were still in place and we are in our third wave of COVID-19 virus.Today, optimism is abound. However, we remain cautious with the timing of our full recovery. We still have a ways to go yet. Optimism and positivity is a welcome change and a change in delays we see after 16 months of uncertainty and fear.Speaking of positive things to focus on, to review the financial highlights for the quarter and the first half of the year, I'll now turn the meeting over to Naomi. Naomi?
Thank you, Darin. 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 then open up the call to your questions. I have a few mandatory statements to make, and then I'll walk you through a few financial statement highlights.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 results in Canadian dollars and in accordance with IFRS. We supplement our financial reporting with nonstandard measures, including FFO, AFFO, ACFO, and NOI. We believe these measures are important in evaluating our performance but caution listeners, 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 quarter ended June 30, 2021. Our portfolio performance remained stable through the first half of 2021 with flat rental revenue and growth of 2% in net operating income compared to the first 6 months of 2020. Year-to-date, other revenue includes $1 million in early lease termination fees. This unusual other revenue was partially offset by lower recovery revenue and reduced straight-line rent. Net operating income was flat in the quarter and up 2% year-to-date on accounts of higher other revenue.First half FFO was up 3% and ACFO was up 10% compared to 2020. FFO and ACFO were significantly impacted by the increase in cash flows from operations and the reduced distribution paid in the current year-to-date period. Our normal distribution was paid in pre-COVID Q1 2020 and subsequently reduced by 47% for Q2 of 2020. In January of 2021, we increased the distribution by 17% based on stable results for a net reduction of 19% compared to the first half of 2020.Distributions made during the quarter represent a payout ratio of approximately 64% of ACFO in the quarter and 59% year-to-date compared to 57% and 80% in the comparable period last year. The fluctuation in the payout ratio is most significantly impacted by the distribution paid. Subsequent to quarter end, we are pleased to announce a 14% increase in our distributions for August and September 2021. The REIT's portfolio valuation remained stable in the first half of 2021, following a full revaluation of our portfolio by our external valuation professionals in the second quarter of 2020. The REIT have collected 98% of second quarter rent and 100% of first quarter rent, excluding amounts owing and receivables related to year-end reconciliations. We have also collected 94% of July rents with collections being impacted by transition to a third party -- a new third-party manager in our Calgary area property.As of June 30, we had $4.65 million in cash and $31.5 million in additional capacity under our revolving credit facility. We reactivated our NCIB following the lifting of our year end blackout period, and we renewed our NCIB for another year by financings year-to-date for net $10.55 million in proceeds at a weighted average rate of 2.77%. We extended our $35 million revolving credit facility to June 1, 2024, with our existing lender syndicate. The facility includes an accordion feature, which provides up to $15 million in additional borrowing capacity subject to lender approval.I will now call -- turn the call back over to Darin, who will speak to our portfolio's operations and performance.
Thank you, Naomi, and thanks also to your financial and administration team, and also to our property management, our operations, our leasing, human resources, our IT, and our marketing communications team. It's a team effort that got the Melcor REIT through the pandemic so far and it's a team effort that will keep us moving forward.Walking around our assets and the communities we support, it is clear that people are feeling optimistic about the future. They returned to work, they're returning to restaurants and patios and the energy feels generally positive. I even had trouble finding a parking spot in Downtown Edmonton last week. This is encouraging to see, and we trust that the recovery is stronger than the setback that COVID-19 caused.Throughout the COVID period, the REIT results have remained stable in part as a result of our quick action and work with tenants as well as the purposeful diversity in our tenant base. Our neighborhood shopping centers are comprised of many of the essential services that people rely on daily, including pharmacies, grocers, banks, gas stations, fast-food drive-throughs. In Alberta, where the majority of our portfolio is located, we are entering Phase 3 as of July 1.We're excited to see restaurants and other retail establishments back in full capacity and are hopeful that continued vaccination rollout will prevent further restrictions. However, the long-term impact of our work-from-home mandate on our office portfolio remains uncertain, we will not fully understand the impact on retail tenants until the current Canada Emergency Rent Subsidy expires in September. We are pleased to report second quarter rent collections of 98% across office, retail, residential, and industrial asset classes in light of the continued impact of the pandemic. As I mentioned earlier, the long-term impact on our retail, industrial, and office leases remain to be seen. However, our return-to-work plans are underway with many businesses starting in September to welcome back their full staff to the office.Meanwhile, the pandemic hasn't muted our focus on sustainability for our portfolio and reduced greenhouse gas emissions. We continue to actively seek out programs to benchmark our energy use and actions to support the continued intentional reduction of our carbon footprint. During the quarter, we joined the Edmonton Corporate Climate Leaders Program. We are proud to show that sustainability and good business goes hand in hand. Through our work with Green Economy Canada and the City of Edmonton's Corporate Climate Leaders Program, we've committed to measure our greenhouse gas emission footprint to develop an action plan and set reduction targets for 2025 and 2035.We are currently developing our greenhouse gas inventory with a target completion date of December 2021. Along with over 300 green economy leaders across Canada, we're demonstrating that a more sustainable economy is possible. Our commitment remains to update unitholders on our ongoing environmental, social responsibility, and governance initiatives throughout 2021.On the leasing front, lease renewals continued in 2021, and we completed just over 107,000 square feet of lease extensions for a healthy retention rate of 77.1% at the half year mark. In addition, new leasing has been active across the portfolio with just over 53,000 square feet in new deals commencing to date in 2021 and an additional 55,000 square feet committed for the near future.Occupancy is slightly down at 87.4% but has held relatively stable throughout these challenging markets. We truly believe that the relationships we build with our customers are a key differentiator for the REIT and help us to retain our tenants long term. To further this strategy, we launched our MelCARE app on July 1 to modernize our customer care program.We continue to focus on the fundamentals of real estate and to work with our clients and all stakeholders to recover and to grow our business. With a diversified portfolio, a proven management team, and a history of adapting to challenges, we remain well-positioned to manage through this period of uncertainty. As Naomi mentioned, we have cash available and availability of undrawn liquidity on our operating line. The distribution reduction last year was difficult but necessary. The increase just announced by Naomi, the second increase this year is another positive step forward. Maybe, just maybe, it's finally safe to say the economic recovery is underway and the optimism is now guiding our path forward.At this time, we'd like to open the phone lines to take your questions. Michelle, please open the line.
Our first question comes from Kyle Stanley of Desjardins.
So I just wanted to dig into your leasing activity thus far in 2021 a little bit. It looks like you've been able to maintain or even slightly increase rate on renewal and the holdover leasing activity, but it does look like new leasing rates are below, kind of weighted average in place. I'm just wondering if you could talk a little bit about the new leases you signed and what asset classes those were in and maybe just the genesis of those deals and the discussions with the tenants.
Sure. Let's talk about it from an asset class perspective, Kyle. From a retail perspective, retail remained resilient. And notwithstanding the hospitality industry, a number of our other retailers had pretty good years through COVID. And so, the retail renewals have held consistent and pretty steady and in some cases, even with some increases. It's the office renewals, and particularly in Downtown Edmonton, that we're seeing some decreases in, sometimes 7% to 10%. However, frankly, it's less than we thought. And so I know Avison Young released a report the other day about, I think, the Edmonton and Downtown; Edmonton and Calgary Downtown office vacancy is going to be 30%, which is the highest of all time. But really, what we're finding in both those cities, you really have to split the general term both Downtown into particular quadrants because there are certain quadrants I could tell you at Edmonton, of Downtown that are still doing well. So, generally speaking, to answer your question, Kyle, retail's hanging in there; office, we're seeing some reductions; and then, industrial, we don't have a large industrial footprint anyway, so it's staying pretty stable. But the general flavor going forward is there is activity, and when there's activity, it becomes a landlord's market, not a tenant's market. I'm not suggesting we're there yet but we are really encouraged by the volumes that we're seeing and the volumes that we're also seeing in the market. Did that answer your question, Kyle?
Yes, yes. That's clear. And I guess, it's probably difficult and you kind of touched on it a little bit in your response there, but do you -- given the current prospects that you may have in your markets, do you have a targeted occupancy level in mind over the next 12 to 18 months? Do you think you're able to get back to kind of pre-covid levels and approaching that 90% occupancy level?
Kyle, that sounds like a forward-looking question. Having said that though, yes. If you look where we're at, we were at 88%, 87%, so we've all sort of hung in there around that 90%. Even pre-COVID, the Melcor REIT, historically has been around the 90% range. So -- but we don't have a stated goal, we're still focusing to fill the vacant space because the vacant space isn't helping us.
Okay. And then, just looking at your distribution increase, that obviously highlights management and the Board's confidence in any current operating environment. Is the intention to return the distribution to the -- whatever, I think it was a $0.675 pre-pandemic level? And I guess, if that is the intention, what would management and the Board need to see to get there or is there a targeted payout ratio in mind?
Based on our current business and the uncertainty on when COVID's going to end, we're very comfortable with the distribution increase. Beyond that, only the future will tell.
Yes. I mean -- it's just that, I guess it's -- I'd like to say, Kyle, like pre-COVID, our payout ratio was probably edging on the uncomfortable level anyway. And so, I think, in order to return to that pre-COVID distribution level, we'd have to see a sort of improvements in our portfolio beyond where we were even pre-pandemic if that makes sense, which doesn't mean that's not achievable, and that's something we'll always strive for. But I think we'd have to see quite a bit more improvement before we got back there.
Our next question comes from Matt Logan, RBC Capital Markets.
Darin, just following up on Kyle's question with regards to the distribution, can you talk about the Board's decision to increase and maybe what the factors that give you confidence in the outlook to actually increase the distribution. Like what were they and what was the rationale to move it higher?
Sure. Long discussions were happening consistently throughout COVID. This wasn't just a onetime thing for us. But first and foremost, we have to look at cash and we have to look at collections, not receivables, but actual cash in the bank. So again, as Naomi mentioned, we're really encouraged by the high level of collections and that's important. What we are concerned about is with the newer program, government rental assistants, like we don't really know who's on rental assistance still; good news is we're getting paid and so that's I guess now looking to end in September. We really want to wait and see sort of how that comes about. Beyond that too, we look at future financings, we look at other potentials, what's the best use for our cash. So those conversations that we had, Matt, this quarter, last quarter, they've been the same conversations we typically always have. But I can tell you throughout the pandemic, once we cut the distribution, a lot more focus was on collections, occupancy, and also how our tenants are doing. So we spend a lot of time with our team walking around, talking to our tenants to go into their stores, see if they're moving merchandise and the rest of it. So I don't think I really answered your question because I can't tell you too many secrets but, generally speaking, those are the conversations we have.
Yes. And maybe just to add to that quickly too. Like in January, when we did the distribution increase, it was sort of based on our budget for the year and sort of key metrics being budgeted occupancy, budgeted renewals, and the cash flow forecast. And then, now in reviewing our budget and doing a reforecast midyear, we were significantly ahead of where we thought we would be in terms of renewals and occupancy. So -- and now that we feel a little bit more comfortable with that beating budget is probably sustainable going forward, hence, sort of the second increase this year. I'm sort of wondering why we did it in two steps. But at this point, I'm not again confident that we would see another increase in the very short term. We'd have to again, to Darin's point, what happens with our occupancy or renewals or releasing sort of once all the government assistant is done.
I think that's great color. And maybe just changing gears. In the MD&A, there was a reference to the retransitioning to a new third-party property manager in Calgary. Could you talk a little bit about that change and why that took place?
Sure. Yes. It was just -- we have great relationships with some of our third-property managers, and we're a unique type of landlord because we're very hands-on. And just because of a bunch of internal and external reasons, we thought it was time to make a change, so we did. And you know what happens, tenants use to write rent checks to a certain property manager, and then when you change, although you provided notice, you have to go back and remind them, they have to recut their check and do the rest of it. So that explains part of the lag. But again, generally speaking, that was just a normal internal type process and we're happy with the outcome.
Fair enough. And maybe just thinking about the transaction market in Alberta. In prior quarters, you talked about limited deal flow and wider-than-normal bid-ask spreads. Has there been any increase in activity with oil now north of $70 and leasing velocity picking up?
Matt, I would answer that question. I think there's increased activity, but we're still not seeing trade. I'm not seeing -- there's nearly a couple of one-off trade, we're not seeing significant trades. What we did find was the great anticipation of people panic selling never really came forth, simply because interest rates were low and people want to wait to see how things went through. So while we're seeing more activity, now that people are flying again, we're seeing people Downtown, we haven't seen in a while, we're looking at assets but I can't report any real increased transactional volume yet.
And maybe one last one for me, Darin. If you roll up some of the commentary on occupancy and kind of the face rates for leasing, how should we think about same-property NOI growth over the next 12 to 18 months? Would this be stable, slightly positive, perhaps a bit of erosion, any color you can provide will be appreciated?
Yes, with the uncertainty about if there's a wave forthcoming, it's hard to say. Let's assume there's not a wave forth and things are moving forward. I think that stable is something that we'd be positive about. I think that there's going to be some potential erosion in rates. Now, perhaps we can offset that and increase volume, which will all work out bottom line to keep it stable. But at this point, while we're always pushing for increases because that's what our goal is, I think realistically, Matt, I would answer that to say stable with some erosion with the next 12 to 18 months.
Our next question comes from Jenny Ma, BMO Securities.
I wondered if you could talk a little bit about the differential between same-store NOI growth between Southern Alberta and Northern Alberta, it seems to be a gap of 5%. I'm wondering if that's something specific to this quarter, is it really -- is it attributed to asset mix or are there other macro factors there differentiating performance between Northern and Southern Alberta I should account for that?
Sure. I think some of it is attributed to scale, believe it or not. You recall, we bought the Grande Prairie retail project in November prior to COVID, which was also included in the Northern Alberta, now as well. And so, when you look at some of the growth, there's a bit more of a complete mix and a bigger pool of assets in Northern Alberta. So there's a whole bunch of things that come into play. I would not say that there's a big market differential between Northern Alberta and South Alberta. I mean, right now, Alberta is Alberta. It is what it is, everyone's in the same boat. We had some occupancy increase in Southern Alberta, which helped that as well. But, generally speaking, I'd say, Jenny, it's a whole bunch of little things and not any sort of big particular tenant or any big particular trends that we're seeing.
Okay. Great. And then I wanted to dig a little bit into, I guess, some of the more cautious messaging you have in terms of things like collections on retail tenants' posters and then just your general outlook because it seems quite reserved, especially when you compare it to maybe the commentary of some other REITs, which admittedly have less Alberta exposure. But I'm just wondering if this is a function of your outlook that's specific to Alberta or if you're just being really, really conservative in how you're guiding your investors?
Sure. No, thanks, Jenny. The parent company of Melcor REIT is Melcor Developments, we're at our 98th year. You don't survive 98 years without being generally or overly conservative. And part of the culture for Melcor Developments has been to under-promise and over-deliver. And so, I could say that the tone seems somewhat conservative and overly conservative, but realistically, I'm not sure if I didn't watch the news this morning, but in Florida, the hospitals are filling up. And, Jenny, we've known each other for a long time, you know I'm an optimist by nature and so, I'm hoping it doesn't flow back but fourth time's the charm, so we went through this in Phase 3 and Phase 2 and Phase 1. So I think our cautious optimism, which is such an overused term is because it feels better but we're still not quite sure. And so, all of that flowed through our tone and everything that we do.
Okay. Well, I appreciate that under-promising and over-delivering. And that's it for me, but I'm just going to add that assuming everything goes somewhat back to normal, I expect to be invited to a big party in a couple of years from Melcor.
Yes. That's a fair comment. We're planning it already. We've got lots of time to plan it right now.
[Operator Instructions] Our next question comes from Sumayya Syed, CIBC.
Just wanted to see how traffic at your centers is looking post reopening and in terms of what's exceeding your expectations and what's lagging, if anything?
Yes. Thanks for the question, Sumayya. And that's -- when I think about our centers, I mean, one of the things that didn't slow down was the grocery-anchored retail seems pretty consistent; drugstores, the rest of it through COVID. Really, it's hospitality that I think took the biggest hit, service and hospitality. And we're seeing it busy but again, we just opened up July 1, and your perspective changes because when it was empty hours, they're seeing that pent-up demand we keep hearing about and people spending money, so I think that's important. Like, generally speaking, I wouldn't say there's anything that disappoints us or surprise us in a negative way. Our tenants were hanging in there through good and through bad and now that it's open, sort of keep pushing through. What I'm encouraged by was some of the pivoting that some of our tenants went through to sort of survive COVID, additional takeout, different events, patios, changing their product mix, providing delivery, I see that continuing but I don't think that has stopped and I don't see that stopping. So at the end of the day, any of our tenant[Audio Gap]
Everything's back to normal. It's actually quite almost unnerving, but the restaurants are completely full inside and outside, the patios are full every night you walk down the street. Last night, I went to the Taste of Edmonton, which was like an outdoor food truck event. I would argue to say it was busier than any year I've been there prior pre-pandemic, it has only bode well for all of our sort of retailers. And even Downtown's getting busy, like offices are filling back up. Our office is reopening September 1. A lot of other offices are reopening September 1 and so, that should all trickle down to rent collections, occupancy.
All right. That's pretty encouraging. And then on the office side of things, Darin, you spoke about, obviously, rent taking somewhat of a step down. But could you maybe elaborate?
The term's shrunk. The deals we were doing stand to be 3, 5, maybe 7. And it feels like now we're back to the 5 and 10-year type terms, which is interesting. Construction costs have gone up, which affects the TI amount and the fact that there was vacancy, tenants doesn't feel a whole lot different than it did pre-pandemic other than you're still fighting with the mindset that everyone wants a deal and people will say, I have a friend who just leased space down the street for X and now you have to honor that. And the good news is what's the occupancy going up in our portfolio and generally in certain quadrants that we're in, again, it just allows us to request a higher base rent from our tenants. Now, the flip side of that to me is we are -- free space doesn't help anyone. So filling the space with the right long-term tenants, not having to spend that much of money is what will really help the bottom line for our REIT going forward.
Right. And then I guess on the bad debt side of things, you -- there was a sort of a recovery in Q1 and a slight uptick in Q2. Was that just tied to the pace of reopening and closures or anything else there?
Yes. I think there's two things. It was the pace of reopening and closures. And again, to Jenny's earlier comment, we're very conservative. And I think our estimates on some of the bad debt were conservative. We never gave up and so, I would much rather be here on this call, explaining to the investors that we collected more bad debt than we thought we would than the other way. So that's -- I hope that answers your question, Sumayya. We were just -- I thought we're a bit over-conservative on the bad debt estimates.
Okay. That's helpful.
I want to express my gratitude to all of our teams who've helped us work through this strange last 16 to 19 months. And as I've been closing all of our calls the last 8 quarters, gratitude to all those who are working so hard to keep our community safe and livable. And a greeting that I say to everyone, stay safe, please stay strong. And we'll talk to you next quarter. Thanks, everybody.
This concludes today's conference call. You may disconnect your lines.