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Good morning, ladies and gentlemen. Welcome to the Melcor REIT Fiscal 2018 and Q4 Conference Call. Today's call is being recorded. I would now like to turn the meeting over to Mr. Darin Rayburn, President and Chief Executive Officer of Melcor Development and Trustee of the REIT. Please go ahead, Mr. Rayburn.
Thank you, Christina. Good morning to all on the call. We appreciate your interest in our Melcor REIT. I'm here today with our Melcor REIT team, including Naomi Stefura, the Melcor REIT CFO; and Brandon Park, our Director of Asset Management, both will be reviewing our results with you shortly.I'd also like to pass some regards to Andy Melton, the Melcor REIT CEO. Andy is unable to attend this morning. The good news is he was touring some of our fine REIT assets last night. The unfortunate news is just around midnight, he was stuck between the Calgary and Edmonton airports closed because one of our infamous Alberta March snowstorms. Andy does pass on his hello.Now I'd like to turn the call over to Naomi Stefura to review our 2018 results. Naomi?
Thank you, Darin. Hello, everyone, and thank you for joining us today to hear about our results for 2018. 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 year and then open up the call to 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 & 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 a few key highlights from the fourth quarter and year ended December 31, 2018. Rental revenue grew by 7% in the quarter and by 5% for the year compared to the same period a year ago. Similarly, net operating income grew by 8% in the quarter and 4% year-to-date. This growth is the result of the Melcor acquisition completed in January and the third-party acquisition completed in December, offset by the sale of 2 retail properties in the first half of the year.A decline in same-asset occupancy, combined with continued competitive pressure on office space in Edmonton, contributed to lower same-asset NOI and FFO. Our payout ratio at 99% was negatively impacted by undeployed cash throughout most of the year due in part to the property sales. Our payout ratio was 73% of FFO. We have a strong cash position with ample availability on our line of credit to fund acquisitions, improvements and distributions throughout the year. Our 2014 debenture matures at the end of the current year. It is our intention to refinance this debt with a new debenture, and we will continue to monitor the market and interest rates throughout the year to determine an appropriate time to execute on this transaction. I will now turn the call over to Brandon Park, who will speak to our portfolio of operating performance.
Thanks, Naomi, and thank you, ladies and gentlemen, for joining our call today.In 2018, we executed on our growth strategy by adding over 205,000 square feet of GLA through our fourth quarter Melcor acquisition under our right of first offer and through a third-party acquisition. We were pleased to grow our portfolio through these acquisitions following 2 years spent focusing on improving and maintaining our existing assets. We also continued to look for capital recycling opportunities and sold 2 retail assets in 2018.May 1, 2018, marked the REIT's fifth year of operations. Over the past 5 years, the REIT portfolio has grown 83% or 1.3 million square feet.Growth across key indicators was tempered by a decline in same-asset performance, particularly in our Edmonton office assets, where market fundamentals remained challenging. We are proactively engaged in renewing existing tenants and pursuing new tenants and achieve a healthy retention rate of 77.4% at year-end and overall occupancy just shy of 90%.A 4% increase in weighted average base rent is a result of new properties acquired with the Melcor acquisition earlier this year and demonstrates how vend-ins like this one strengthen our overall portfolio. We continue to see the impacts of 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.However, we also continue to engage in strategic, proactive leasing programs, which has led to a strong retention rate of 77%. With our strong cash position, we continue to actively pursue acquisition opportunities that are a fit with our portfolio and our strategy. We continue to monitor and respond to market demand and trends in commercial real estate and to focus our 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. Christina, would you please open the lines?
[Operator Instructions] And we'll take our first question from Kyle Stanley with Desjardins Capital Markets.
I'm just wondering, have you identified any further assets that could make sense for some capital recycling?
Kyle, we're always looking at all of our assets from an angle. Right now, I can't tell you there's a specific asset that we're planning to list for sale, but it is part of our constant property management and asset management philosophy is to look at any asset in any market at any given time and see what its best and highest use could possibly be.
Okay. I guess, just looking at the acquisition in the fourth quarter, I'm wondering what attracted you to it. And maybe if you could just speak about that a little bit.
Sure, Kyle. I think you were speaking to the building in Lethbridge?
Yes, that's the one.
Right. Yes, absolutely. Lethbridge is a market that the Melcor REIT has been in for 5 years and Melcor Developments has been active in since the mid-1970s. So this particular asset, single-tenant asset, well located, strong government-backed tenant has been in this particular asset for over 25 years. So it checked all the boxes from our perspective. Also, the building was recently upgraded and renewed, so from a capital perspective, there's very little requirement. So again, while not a large asset, it is the type of asset that's always been the Melcor REIT's bread and butter with strong tenancy, good, easy-to-manage low capital requirement and in a market that we know.
Okay, perfect. I guess just turning over to the leasing side. There's about 150,000 square feet of space maturing in your Northern Alberta portfolio in 2019. I'm just wondering kind of what your expectations are. And we all know the kind of the difficulties in the Edmonton office, so I'm just interested to hear your thoughts.
Thanks, Kyle. Brandon here. You are correct in terms of that expiry coming, the lease expiries coming up. It's really a split between Northern and Southern Alberta, and probably half of that is in the office space. In terms of expectations, we already are aware that some of the tenants will be departing. But that being said, in the same token, we've already made good traction year-to-date on securing renewals.
Okay, that makes sense. And then I guess maybe along those lines, assuming there's going to be some incentives given, kind of what are your expectations for kind of your total CapEx number in 2019?
I think, you know what, we've given the expectation that if you look at our normalized capital, it will be along those lines. Keep in mind, though, in 2019, we're only turning over about 9% of the leasing portfolio. In 2018, it was higher at 16%.
We'll take our next question from Jenny Ma with BMO Capital Markets.
I have questions with regards to the debt stack, so probably for Naomi. It looks like the rates that are outgoing are sort of in the low 3s, which are fantastic. And given that the capital markets are fairly healthy right now, I'm just wondering what your thoughts were as far as rolling over these mortgages and also the Class Cs in 2020, what you're seeing in the market. And the last part of my question is, is there a differential on the spreads you're seeing just based on the location of these assets and some of the market weakness you're seeing? Or is it really just conventional debt that you see across the country?
Thanks, Jenny. So for the first part of your question, yes, Class C assets that we have up for maturity in 2019 are sort of in the 3.5% sort of rate, so obviously, we do expect that those rates will come up a bit. However, we did just recently got a competitive offer on another mortgage that we're looking at, at 5-year at about 3.5%. So it surprisingly might not be so much higher than you're expecting. I think we can probably still come in on some of these actually quite close to the rates that are going out. We also have a couple of assets that we're contemplating hang out on our line of credit. As you know, we have a large room and availability on our line of credit right now, and we think some of these assets, based on their current tenancy, might be better suited to be put on the line for the short term, and so we can relet them. So that's part of sort of the strategy for 2019. And I guess, for your last question, no, we have not seen sort of any negative sentiment on the spreads based on where the assets are located. If anything, I think they're fully in line with the rest of the country.
Okay. So I guess there's a lot of -- I guess it's fair to say there's a lot of debt capital out there, happy to finance some assets.
Very much so.
Okay. Okay. Is there any thought to actually paying off the converts with fixed mortgage financing? I know you had mentioned that you'd like to get another issue out. But if the mortgage rates are coming in better, is that something that's on the table? Or would you just prefer to keep the converts?
It's something we would look at, although most of our assets are already encumbered. So we don't really have a lot of excess assets or security on new mortgage financing to pay that out. And secondly, as Brandon will talk to, we're sort of also always looking for new acquisition opportunities. And so depending on how something like that plays out in the year, it might be an opportunity to upsize the convert to go along with another acquisition if that's something that we could find.
Okay. Well, I guess you have a couple of quarters to contemplate that.
Yes.
And actually, this is a question for Darin since you're on the line. Is there any thought to Melcor Developments sort of extending the preferential interest rate on some of the Class C? I know we're a little bit far out, but is that something you would consider given the related -- relationship between the 2?
Jenny, there's all kinds of thoughts and discussions going on. No, it's no surprise, no secret that Melcor Developments is the largest unitholder in the REIT, and we are aligned and focus on success. So without making any promises, as we get closer to that date, stay tuned because Melcor Developments will do everything it can to make sure that the REIT stays successful and strong.
[Operator Instructions] Your next question, from Michael Smith with RBC Capital Markets.
First, I'd say congratulations on your fifth anniversary, on your 5 years completed. And I guess, I'm wondering...
Five years already.
Five years already. It goes by fast. It is some challenging times, as you noted in your disclosures. I'm just wondering if you could just give us a bit of a vision on what you think the REIT will look like in the next 5 years.
Michael, I've known you for 5 years. That's like the hardest question you've given me because you know I can't give you a forward-looking statement. But I can tell you what hasn't changed. Yes, 5 years ago in May of 2013, we launched this. We didn't foresee the Alberta economy 2014, 2015, '16, '17, the way it is now. But what hasn't changed are the fundamentals when we created this, and I mentioned it earlier when I answered Kyle's question. Our acquisitions are bite-size pieces. They're in markets that we know. They're in assets that we know. So since you've done a fantastic job putting me on the spot, I will tell you in 5 years, I see our REIT still sticking to the fundamentals of the bricks-and-mortar because essentially, we are real estate people. We will ebb and flow based on the markets, and we'll have many conversations in these meetings about Class Bs and Class Cs and raising unit prices and the rest of it. But beyond it, this was designed for sustainability and longevity in distribution, so in 5 years, that's our expectation. Hopefully, I answered your question, Michael.
Fair enough, fair enough. And you did mention in your prepared remarks about you would be open to the idea of acquisition. So I'm just wondering, do you have a particular sector that you'd be interested in? Or is it more opportunistic?
Michael, good question. Brandon here. I think it's just being opportunistic. That's part of our DNA and how this portfolio was assembled over the past few decades. So that's our bread and butter. That being said, we have some soft targets. We remain very comfortable with our retail portfolio, service-oriented retail, grocery-anchored retail, continue to like that sector. Another sector we're watching closely in our home province within our geographic region is also industrial, and hence, we're also -- we're continuing to explore opportunities within that space as well.
And industrial is the hot sector nowadays. Very difficult to buy, with a lot of buyers chasing it. Do you -- is it possible for you to build to try and work with Melcor Developments and build some industrial? Or is there any -- any thoughts on how you could sort of increase your industrial portfolio?
Michael, Brandon here again. Good question, kind of touching on that relationship between Developments and the REIT. Developments does have 2 active industrial parks in Northern Alberta right now. Again, that would be -- I kind of point towards the future pipeline. There may be an opportunity in the future as our leasing team on the Developments side and the development team continues to pursue opportunities for those 2 industrial parks. Nothing is immediately, though, under construction or -- pending future vend-ins.
It appears there are no further questions registered at this time. I'd like to turn the meeting back to Mr. Rayburn for any additional or closing remarks.
Sure. Thank you, Christina. I would just like to mention on behalf of Andy and myself how incredibly proud we are of our Melcor team and the results we created for our unitholders. And it's no secret, it's been a very challenging environment. But as I mentioned earlier in answering Michael's question, essentially, we always have been and always will be bricks-and-mortar real estate people. So despite the challenging environment, we're going to continue to focus on and do what we do best, and that is to run our assets, run them appropriately, keep our clients happy and create return for our unitholders. So again, thank you, everyone, for calling us this morning. As always, we're open to your questions at any time, so feel free to reach out. Have a great Friday, a great weekend. I'm looking forward to chatting with you at the end of the first quarter. Take care, everyone.
The conference has now ended. Please disconnect your lines at this time. Thank you for your participation.