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Good morning, ladies and gentlemen. Welcome to the Melcor REIT Q4 conference call. I would now like to turn the meeting over to Ms. Naomi Stefura, Chief Financial Officer of Melcor REIT. Please go ahead, Ms. Stefura.
Thank you, Lori. Good morning, everyone. Thank you for joining our conference call and webcast for the Fourth Quarter and Full Year of 2019. On the call with me this morning is Darin Rayburn, Chief Executive Officer of Melcor REIT.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 year and then open up the call for your questions. Before turning it over to Darin to discuss our results, 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 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 year ended December 31, 2019. Our portfolio performed consistently with growth of 1% for rental revenue and 3% for net operating income compared to 2018. This growth was driven by portfolio GLA growth, most of which took place late in 2019. Our operating margin also remained consistent at 59%.On October 29, 2019, we announced the successful issue and sale of a 5.1% unsecured convertible debenture for gross proceeds of $46 million, including $6 million for the exercise of the over-allotment option in full.Completing the Melcor Crossing acquisition in Grande Prairie had a negative impact on fourth quarter results due to timing gaps between issuing the 2019 debentures, closing the acquisition and related mortgage financing, then redeeming the 2014 debentures 30 days later. As such, we have both debentures and the new mortgage financing outstanding for a period of 30 days. This resulted in an adjusted cash flow from operations payout ratio of 112% in the quarter and 102% for the year.We expect this to normalize going forward, with the benefit of a full year of cash flow from the acquisition property in 2020 and now that the 2014 debentures are fully paid out. As always, net income in the current and comparative periods is significantly impacted by noncash fair value adjustments on investment properties and Class B LP Units owned by Melcor Developments. As such, management believes funds from operations or FFO is a better reflection of our true operating performance.FFO was $25.58 million or $0.91 per unit, down 2% from 2018. FFO was negatively impacted by higher finance costs due to timing related to the acquisition of Melcor Crossing and the redemption of the 2014 debentures, as discussed previously.Adjusted cash from operations was $18.61 million or $0.66 per unit, down 3% from 2018. ACFO was also negatively impacted by higher finance costs as well as increased normalized tenant incentive and leasing commissions as market conditions remain challenging.Management has determined that ACFO will be considered one of the primary metrics to analyze our business operations going forward. ACFO better reflects our cash position and therefore, our ability to pay distributions by excluding debenture accretion expense, which is a noncash item.Distributions made during the year ended December 31, 2019, represents a payout ratio of approximately 102% of ACFO compared to 99% in 2018. We generate sufficient cash flows from operations to sustain our current distribution rate for the foreseeable future.The 12% growth in portfolio GLA contributed to revenue growth of 1% and NOI growth of 3%. The major acquisition completed in 2019 closed in November and did not contribute to a full year of results.As of December 31, 2019, we had $2.3 million in cash and $11.88 million in additional capacity under our revolving credit facility. We actively monitor our debt levels and have a debt to gross book value within our target range. We continue to capitalize on opportunities to finance properties and to create liquidity on our balance sheet and held our weighted average interest rate steady at 3.78%.I will now turn the call over to Darin, who will speak to our portfolio's operations and performance.
Thank you, Naomi. Despite the challenging markets throughout 2019, the Melcor REIT team focused on our real estate and built on our foundation of revenue-producing assets as we continue to execute our strategy and completed 2 third-party acquisitions to increase our gross leasable area by 12%.On April 24, 2019, we acquired Staples Centre, a 56,000 square foot retail property with warehouse space in Calgary, Alberta, for $12.45 million from a third party. And on November 12, 2019, we closed on the acquisition of a 283,000 square foot retail center on a 33.3-acre site located in Grand Prairie, Alberta for a purchase price of $54.8 million from a third party.These 2 acquisitions added a total of 339,000 square feet of gross leasable area to our portfolio and support our long-term asset class diversification strategy. For the first time, retail makes up just over 40% of our portfolio, above the 40% target set at IPO.In addition, Melcor Crossing in Grand Prairie is an entry into a market that we've been monitoring closely for some time and are excited for its potential. And we're extremely proud of our team's execution on all fronts in what continues to be a challenging market.Throughout 2019, we have demonstrated time and again the reasons that we are the landlord of choice for so many of our clients. Both our property management and building operations teams achieved a tenant approval rating of 92% on a survey of all office properties conducted in November. Congratulations to the team for these positive results.Feedback from our clients is critical as it allows us to refocus our attention and make changes where required. Happy clients are typically renewing clients.Our portfolio performance remained stable throughout 2019 and we continue to see positive new leasing momentum. We're beginning to see new stability in spite of market fundamentals that remain challenging. We continue to execute on our proactive leasing strategy to both retain existing and attract new tenants.In 2019, we completed lease renewals representing 148,000 square feet for a retention rate of just under 60%. Our retention rate was negatively impacted by the departure of 1 office tenant. Although this office tenant only represented 47,000 square feet and approximately 1.5% of our portfolio, it did drag retention rates down. 20,000 square feet of this vacated space is currently conditionally committed to lease by new tenants.Excluding the vacating tenant, we retained 73.6% of expiring leases. New leasing has also been steady across our portfolio, with the completion of 74,000 square feet in new deals commencing in 2019.Same asset net operating income was flat over 2019 and down 4% in the fourth quarter. The decline in our Northern Alberta office assets due to the 1 large office vacancy previously mentioned was partially offset by stability in our retail and office assets in Southern Alberta and in British Columbia.With the positive leasing momentum experienced so far in 2020, we expect this negative same asset net operating income trend to be muted. With a diverse product portfolio, we're able to support tenants through all stages, start-up, growth and mature companies.Melcor REIT personnel-wise. As part of planned succession, Andrew Melton has stepped down from his position as President and Chief Executive Officer on October 1, 2019, and I was appointed his successor. I'm delighted to be back at the helm of the Melcor REIT and thank Andy for stepping in the role when needed. I look forward to his continued guidance as a member of our Board of Trustees.In addition to our -- accretive to AFFO per unit aforementioned 2019 acquisitions, on April 1, 2019, we commenced the normal course issuer bid, which allows the REIT to purchase approximately 5% of our issued and outstanding trust units for cancellation. We believe that our units have been trading at a price range, which does not reflect the value of the units in relation to our current and future business prospects.Under the NCIB, we purchased 53,504 units at a weighted average cost of $7.59 per unit or 77% of book value. Throughout the year, we also paid monthly distributions of $0.05625 per trust unit per month.Our payout ratios were impacted in the fourth quarter by elevated finance cost and lower same-asset NOI, as Naomi previously explained. We have maintained our distribution since inception, paying steady distributions to our unitholders for 76 consecutive months.We are committed to corporate sustainability in environmental practice, social responsibility, governance of our company and as stewards of the areas where we operate. Attaining best practices in all aspects of our business is our constant aspiration. Expect to hear much more of this in the near future.2019 was a steady year for the Melcor REIT in an unsteady economy, a year where we continued to navigate these choppy economic waters and execute on our strategy to strengthen our portfolio. We demonstrated there's still accretive acquisition opportunities for the right type of assets in the right markets. Sometimes in real estate, the best opportunities come during the most challenging times. Our focus on our real estate and goals of creating unitholder value remain.We'd now be happy to take your questions. Lori, can you please open up the phone lines?
[Operator Instructions] And the first question is from Matt Logan from RBC Capital Markets.
Darin, in terms of your occupancy, it looks like the decline in Q4 was driven by more than just the RBC vacancy in Edmonton. Can you elaborate on your prospects for backfilling some of your space? And maybe your thoughts on how you're making it with your 2020 lease maturities?
Sure. Thanks, Matt. As I mentioned in my script, we're seeing much more positive start to 2020 from a leasing momentum perspective in our entire market as opposed to 2019. I can tell you, for the Melcor REIT, for 2020, already, we've completed just under 30,000 square feet of new deals. And of our expiring tenancies, we've now committed renewals to over half of the square footage.So again, we're seeing an important start to the year. I guess beyond that, obviously, with things happening in the world right now, there's a whole bunch of uncertainty and a bunch of different things, but we're still touring space and trying to get offers out. Did I answer your question, Matt?
No, that's great. Certainly, with the leases that you've got committed so far, would they be mostly in the office or in the retail portfolios?
A combination of both. We have more vacancy in the office, so there tends to be more volume in the office. But with little vacancy we have in our retail portfolio, we're seeing some really good strong activity.
And when we think about overall NOI growth, do you think the office portfolio holds steady from the current levels? Or would maybe some of the lease maturities put pressure on NOI in 2020? And also, maybe your thoughts on how we should be thinking about incremental leasing opportunities from Melcor Crossing over the next year?
Sure. So I'll answer the question about office with some perspective. If we're just talking Downtown Edmonton office, it's still a struggle. I'll say it wasn't as much of a struggle as it was last year. Rates are creeping up. So if we're just talking Edmonton Downtown office, I would say, maintaining NOI is a very positive thing. And the advantage is, is we are not just in Edmonton, we also have Regina, which -- we're seeing some opportunities in Kelowna.So if you look at the Melcor REIT NOI guidance on office renewals, we do anticipate staying about flat. If you look at the retail, we're seeing increases in our retail rates. And as I mentioned before, because retail is a much larger part of our portfolio than it's been before, we're seeing the weighted balance go in our favor. So we anticipate -- we'll see what happens in the next couple of weeks with the world, but we anticipate NOI growth on renewals.Your second question, Matt, was about Grand Prairie. And -- sorry, go ahead.
Yes, that was it, just on Melcor Crossing.
Okay. On Melcor Crossing specifically, we just completed 1 small lease renewal with an increase in rates, which is a pretty positive step for all of us. And our expiry schedule there is pretty balanced, and we don't have any large expiries in the near term. So we don't see a lot of upside there in the near term, but we see it more in the midterm just because of the activity in retail and Grande Prairie and the positive feedback we're getting from the retailers on their sales volumes.
And maybe on your industrial portfolio, that really seems to be the bright spot in the portfolio, although it only is 3 assets, if I recall. Would you ever consider developing with Melcor and vending some of that into the REIT or some sort of transaction in that regard?
It's always on our radar. So when I take off my Melcor REIT hat and put on my Melcor Developments hat, I can tell you, I mean, Melcor Developments right now has about 215,000 square feet of active under-construction projects that are almost REIT-ready.Now I'm not here suggesting that REIT is in a position to buy them yet. Let's see where the market goes. But the answer to your question, Matt, is absolutely -- when we look at the development that Melcor is doing, there's a nice mix of some industrial, some retail.
And maybe last question for me, just on the balance sheet. The REIT's been able to deliver very steady operating performance over the last few years, but leverage has ticked a little bit higher. Do you see that leveling off? Or would you consider any capital recycling to bring that number down?
We're always considering it. I know we haven't sold a building since 2018, so again, not giving you any guidance, Matt, because, I guess, we'll see where the market takes us, but we always look at all of our assets on a regular basis and consider capital recycling opportunities.
The next question is from Kyle Stanley from Desjardins Capital Markets.
I was just wondering, looking back at Melcor Crossing, would you be able to disclose how much NOI was contributed from Melcor Crossing during the quarter?
Yes. I'm going to give you a number and I'll get back to you in actuality. But my recollection is about $500,000 in NOI just for the quarter because the NOI for the year is about $4.4 million. And remember, we only closed on it like November '19 and we have 6 weeks of it.
Okay. Great. And then just going through your disclosure, I think, in-place occupancy there was around 90% and then committed was about 98%. I'm just wondering when do you expect that gap to close between committed and in-place.
The quicker we can get the construction done on one tenant, the quicker I can answer that question. So we anticipate that to -- gap to close in the next couple of months, but really -- we're anticipating 2 months right now, but I don't have a construction update. So I can definitely confirm that, Kyle, if you give me an exact number later on.
Okay. No, that's helpful. And then I think just lastly here, just on the repositioning effort at the Royal Bank building, I'm just wondering if you can provide an update. I don't know if you have any thoughts on the capital we invested, timing or further lease up.
Yes, we have lots of thoughts on it. It's something that's sort of our priority and our focus right now. And I can't announce anything specific as we continue to work through pricing. I can tell you we are actively in the design stage. We -- as I mentioned before, we also have some tenants who are conditionally committed, waiting for our approval. So stay tuned for our next conference call, Kyle, and that's about all I can tell you for now.
Okay. That makes sense. And I guess, actually, just one last one. Just kind of touching on Matt's question about leverage. I'm just -- he mentioned that it's ticked up in the last little while. I'm just wondering, are you comfortable kind of at these levels? And would you consider -- I guess just are you comfortable at these levels? And what do you see going forward?
Working for a parent company -- Melcor Developments has been around for 97 years. They've only survived because we are never comfortable with stretched debt levels. So the answer for the Melcor REIT, we're not comfortable at the debt level. I mean we understand -- we can operate through where we are now. Do we want to see it grow? Absolutely not. We'd like to find ways to bring it down, if possible, and that's one of the things that we're working on right now.
The next question is from Jenny Ma from BMO Capital Markets.
So just to go back to Melcor Crossing just because it's so sizable for you guys. When you talk about the $4.4 million per year of NOI, that is based on the 90-ish percent in-place occupancy, correct?
Correct.
So with the lease-up, and it sounded like, is it a single tenant or is it a few tenants? I'll take you to 98.9%.
It's a single tenant.
Okay. So with that single tenant, does the NOI coming from them, is it proportional to the NOI that's in place right now? Or is there a rental rate higher than the average or nor?
No, it's in proportion.
Okay. So you expect that to kick in, say, mid Q2 then?
Hopefully, fingers crossed.
Okay. Okay. Sounds good. So just wanted to understand your views on the Grand Prairie market. Your commentary in the MD&A suggested that you guys have been looking at it for some time. So maybe if you could educate us here outside about Alberta, what is it about Grand Prairie that you find appealing to Melcor?
Sure, absolutely. And just to remind everyone that Melcor Developments has been successfully developing in small town Alberta, for many, many, many years. Grande Prairie is in Northern Alberta. It only has a population of about 80,000 people but has a trade area of almost 300,000 because of Northern BC. It is the youngest per capita age city in Canada. It's the highest per capita income for Canada.And it's not just your oil and gas boom that you see a lot of it. There's $8 billion in investments and infrastructure investments that are actually happening in Grand Prairie right now that are not just planned. So we haven't tracked that market for a couple of years now, looking for the right opportunity and missed on a couple that we tried, so we're pretty happy with this asset.But just from the fundamentals of small town Alberta, notwithstanding what everyone may think about Alberta right now, that is a community that continues to produce and continues to have net migration. And those are the type of communities that we like to be in.
Okay. That's fair. So with the RBC space, you had mentioned earlier in your commentary about some new leasing activity. I think I missed that number. How much of new -- of the RBC space have you backfilled so far?
We have conditional deals on around 22,000 square feet of the 47,000 square feet, okay? We have activity on some of the other spaces as well. But again, to Kyle's earlier question, our style is to make sure that we can execute on RB redevelopment plan and then talk about the deal. And we're right at the cusp of being able to announce that.
But that would be on the balance of the space, right, 25,000. Like the 22,000 conditional, does that depend on the redevelopment?
Yes.
It does. Okay. What kind of indicative rents are you seeing? How does it compare to what RBC was paying?
I can't remember what RBC was paying, Jenny, but I'll tell you, as far as rents in downtown market, I mean, they're mid-teen rents. So they're higher than some people would expect. I believe that Royal Bank and their retail was paying in the 20s, so a little bit less than what Royal Bank was paying.
Okay. And then my final question is just a technical one. When I look at the occupancy reconciliation, there is the 3,000 square feet of lease amendments. Can you maybe guys clarify exactly what goes on with that item? I know it's a small one, but I just want to understand the ins and outs.
Yes. So sometimes, we'll have a signed deal with the tenant based on a certain square footage, and then we get the space certified for measure. And there's a discrepancy between what the anticipated square footage was and what the actual was. So that's what part of that is, the reconciliation through that.
Okay. So there's no P&L impact from that? It looks like there's no rent associated with it.
Yes. That's why it has the sort of dash beside it.
[Operator Instructions] The next question is from Sumayya Syed from CIBC.
So Darin, you've noted in the press release and in your comments that you've started to see new stability. Just any more color on where you're seeing that? And what you think has changed there, say, from a year ago.
Sure. You know what? I think -- I'll try not to be too anecdotal. I'll talk to you for a fact. We are seeing quite an increase as many Canadians are seeing in the tech sector. And the University of Alberta right now has a world-leading artificial intelligence institute called Amii, that's relocated downtown, actually right by the Royal Bank building. So we're seeing an increased leasing around that. And what we're finding is with that tech clustering, it's bringing more groups to that area. So that's part of the stability.Also, if you look at the Edmonton office market, there were a number of buildings that were brought out of the inventory and have been converted to either hotel or residential or demolished, which is what Edmonton needed because we always joke that we weren't oversupplied. We were under demolished in some of our buildings. So just reducing the inventory that way has been helpful.And frankly, we're seeing some activity in even the AAA class space. So for instance, the Ice District that everyone hears about, where our hockey rink is and the office towers, are now at the 90% occupancy. And when it was built, it was built with some excess space, so that's working through.So we just see a little more optimism. Again, maybe my script will change next week when I see what the markets are doing this week. But we see a little more optimism this year amongst the business community in Alberta than we saw last year at this time.
That's interesting. And then just on your retail footprint a little bit above your target, but obviously, it's a pretty stable segment. Are you comfortable with taking that share of retail even higher?
We are, and I'll put a qualifier to that because if you look at our retail right now, about 70% of it is service retail. So we feel that a big chunk of our retail, we are buffered against the Amazon effect, so that side of it. So when I look at the Melcor Development's pipeline that the Melcor REIT has a sight line into, much of that retail that's being created right now is all service retail based in community areas as opposed to power centers. So for the right deal at the right price and the right location, we would absolutely grow our retail footprint.
Okay. And then just lastly, on the reserve amount for TIs and given your, I guess, strong leasing progress year-to-date, is around 10% of NOI a reasonable reserve to stick with for 2020?
We think so for 2020, because we're seeing some of the TI rates coming down with the market strengthening. Again, time will tell based on what's happening right now in the market. What we've also found is some of the vacant space that we've been successful at leasing last year and the year before has been some of our space that really required a bigger tenant improvement -- input, even while on the worst side of it. So again, it's something we monitor very closely because, at the end of the day, money is not endless. But to answer your question, we feel that the 10% at this point is still reasonable.
There are no further questions registered at this time. I'd now like to turn the meeting back over to Mr. Rayburn.
Thank you very much, everyone, for your time and interest in the Melcor REIT this morning. There's no doubt it's a strange time in our world right now for many, many reasons. And Naomi and I and our Melcor REIT teams wish everyone on this call and all of our shareholders and everyone good health and success in the upcoming days and weeks and months as this strange world we're in unfolds.And hopefully, by the next conference call, we're talking about getting out the other side of the coronavirus and the economy and talking about more positive things than looking at our phones and watching all the red in the stock market. Have a good day, everyone, a good weekend, and we'll talk to you in the next quarter.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.