Melcor Real Estate Investment Trust

TSX:MR.UN

Earnings Call Transcript

[Operator]

Good morning, ladies and gentlemen. Welcome to the Melcor REIT Q1 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.

[Andrew John Melton, President, CEO & Trustee]

Thank you, Lauren. And good morning, everybody, and thank you for joining our conference call and webcast for the first quarter 2019. I have to give you some warning. It's snowing in Edmonton, so we're a little grumpy. So be careful with your questions.With me on the call today is Naomi Stefura, who will run through our financial highlights for the quarter; and Brandon Park, who will provide a brief review of our operations in the quarter.We are pleased to report on yet another stable quarter in spite of continued challenges in some of our markets. This quarter further demonstrates our keen focus on fundamentals and our commitment to protect unitholder value. As you all know, operating environments that we -- our operating environment has restricted our flexibility as it relates to growth. However, we continue to also focus on other responsibilities like growth, and we are pleased to report that last week, we completed another third quarter -- our third-party acquisition of a property in a strong Calgary location, which Brandon will talk about in greater detail in a moment.I'll pass the call over to Naomi now to go through the financial highlights.

[Naomi Marie Stefura, CFO & Corporate Secretary]

Thank you, Andy. Hello, everyone, and thank you for joining us today to hear about our results for the first quarter of 2019.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 quarter and then open up the call for your questions.Before I get started, I have 2 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 management discussion and analysis.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 financial highlights for the first quarter of 2019. Rental revenue and net operating income were stable in the quarter. Slightly lower occupancy in the period led to a lower same-asset NOI. Our payout ratio at 103% was negatively impacted by undeployed cash.We have a strong cash position, and we continue to take steps to reduce our payout ratio by completing acquisitions and buying back shares. At March 31, 2019, we had $1.5 million in cash and $25 million in additional capacity on our credit facility. We conservatively manage our debt with a debt-to-gross book value on the low end of our target range.Net income in the current period 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 is a better reflection of our true operating performance.FFO was $6.53 million or $0.23 per unit, down 3% from Q1 2018 due to slightly lower occupancy. Adjusted funds from operations or AFFO was $4.62 million or $0.16 per unit, down 6% from Q1 2018 and down 4% over Q4 of 2018. The decrease was due to the lower FFO, as previously mentioned, and higher reserve for tenant incentives and leasing commissions on account of continued challenging market conditions.On April 1, 2019, we commenced a normal course issuer bid, enabling us to purchase and cancel up to 5% of our outstanding trust units. We believe that the trading range of our unit does not reflect our intrinsic value. Purchases under the NCIB will have a positive impact on the payout ratio going forward.I will now turn the call over to Brandon who will speak to our portfolio's operating performance.

[Brandon Park, Director of Asset Management]

Thanks, Naomi, and thank you, ladies and gentlemen, for joining our call today. We continue to execute on our strategic leasing program in the first quarter of 2019 to mitigate ongoing market challenges and maintain occupancy.We proactively engaged in tenant renewals and achieved a strong 88.9% retention rate in the quarter, which equates to just shy of 57,000 square feet in renewals. We also completed over 10,000 square feet in new leasing and have a further 45,000 square feet committed for future occupancy.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. We expect this trend to continue as we work hard to maintain occupancy.Despite Edmonton being a tenants market, office leasing activity continues. In the first quarter 2019, Colliers reported the Edmonton office market reported its highest level of positive absorption since 2011. It also marked the sixth consecutive quarter of positive absorption in Edmonton in the office market.With our strong cash position, we continue to actively pursue acquisition opportunities that are a fit with our portfolio and strategy. We completed the acquisition of a 56,000 square foot single-tenant retail building with warehouse space in Calgary for $12 million and -- for $12.45 million. Staples, a tenant, had a 15-year lease with rent escalations. By redeploying capital from dispositions completed last year, this acquisition will be immediately accretive to AFFO.We continue to monitor response 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. Recent positive momentum in leasing activity provide us with the comfort to remain cautiously optimistic of a commercial real estate in our major markets.At this time, we'd like to open the phone lines to take your questions. Lauren, please open the lines.

[Operator]

[Operator Instructions] We'll take our first question from Jenny Ma with BMO Capital Markets.

[Jenny Ma, Analyst]

So I have a question on the acquisition. Brandon, I'm not sure if I just missed it, but did you provide a cap rate on that?

[Brandon Park, Director of Asset Management]

No, we didn't. Historically, I know everybody calculates cap rates a little bit differently. So I'm happy to share a range. It was a high 6%, low 7%.

[Jenny Ma, Analyst]

Okay. And I believe that it was financed using the line. And I'm wondering -- maybe it's a question for Naomi, what the long-term funding plans for it would be. Because I think the last time I looked, the cost on your credit facility is actually quite a bit higher than what you could probably get on secured debt.

[Naomi Marie Stefura, CFO & Corporate Secretary]

You're right, Jenny. So we actually just bought it on cash deferred for the simplicity of close. But we do have financing already tied up, so that should fund in the second quarter. And it's a 10-year mortgage, 180 over Government of Canada bonds for $7 million. So yes, you're right on the rate.

[Jenny Ma, Analyst]

$7 million?

[Naomi Marie Stefura, CFO & Corporate Secretary]

$7.15 million, if you want to get technical.

[Jenny Ma, Analyst]

Okay, $7.15 million. Okay. And then with regards to the convert that is coming due close to the end of the year, is it possible for you to redeem it using units?

[Naomi Marie Stefura, CFO & Corporate Secretary]

It is possible, yes. It's not likely an option that we would take, but it is available as an option.

[Dean Mark Wilkinson, Director of Institutional Equity Research]

Okay. Have you had any discussions with -- in terms of rolling that over? Or is it a little bit too soon?

[Naomi Marie Stefura, CFO & Corporate Secretary]

We have had discussions. Yes, I think that our thoughts right now, though, are that we would wait until sort of closer to the second half of the year. So I can't really comment on our exact plans right now.

[Jenny Ma, Analyst]

Okay. And then I'll just -- I'll throw in one more question. The NCIB activity, is that something you're looking to continue for the balance of the year?

[Naomi Marie Stefura, CFO & Corporate Secretary]

Yes. Depending on the unit price, obviously. So, so far, we were under a lock-out period, so we were only buying under our automatic share purchase plan to date. Now that we're no longer locked out, we'll internally determine what price we want to continue to buy at. But yes, it is our intention to continue to be active in it.

[Operator]

[Operator Instructions] We'll take our first -- our next question from Kyle Stanley with Desjardins Capital Markets.

[Kyle Stanley, Associate]

So I just have a few questions related to the pending RBC vacancy in Edmonton. So I guess the first one is, I'm just wondering, is the space that's being vacated just related to the office? Or is that the branch as well?

[Brandon Park, Director of Asset Management]

Kyle, Brandon here. Good question. Thank you for that. It actually relates to the main core branch, basement space as well and then there's a little bit of office component. So the way I would describe that is about -- it tends out -- but it's -- yes, it's about 1/4 basement, 1/3 retail and the balance being office.

[Kyle Stanley, Associate]

Okay. Okay. And then I was just looking back in the prospectus, just trying to get an idea of the space. And I saw that there was kind of 2 lease terms within the RBC building. I'm just wondering, for the balance of that space that maybe isn't turning over, what would be the remaining lease term?

[Brandon Park, Director of Asset Management]

Kyle, that's -- I think I understand your question. So you're asking if we took out the RBC lease rollover with the balance of the weighted average. I can't -- yes, I wouldn't know that off the top of my head on the spot. So...

[Kyle Stanley, Associate]

Okay. That's -- no worries. And then I guess just taking a look, what kind of impact do you expect this vacancy to have on NOI going forward?

[Andrew John Melton, President, CEO & Trustee]

Yes. Kyle, Naomi is calculating it right now. We have to put it into perspective that the Royal Bank, it's a big asset for us, the Royal Bank Building. The Royal Bank is a big tenant. But if you take a look at it in terms of what percentage it is of our overall GLA as a tenant, it's not very significant.So Kyle, we'd be happy to sort of drill down on that with you. But I hate to say, we're going to have to get back to you, but we're going to have to get back to you.

[Brandon Park, Director of Asset Management]

Yes. Kyle, I'm going to provide a little bit more color and continue on where Andy left off. We've already secured a tenant to back floor -- backfill one of the floors. That tenant is 7,900 square feet. So again, I think the point we want to make is we are actively marketing that space. We are in the midst of a review of the podium level where the bank occupies a 13,000 square-foot banking hall and 13,000 square feet of office. And we see this as an attractive opportunity within the Edmonton market but also within our portfolio to reposition this asset. And I think the market will -- it's -- we're hoping it's going to be well received by the market.

[Kyle Stanley, Associate]

Okay. No, that makes sense. That makes sense.

[Andrew John Melton, President, CEO & Trustee]

We're actually quite excited about our opportunity there. And we're seeing early indications that we're on the right track. We can't really say very much because we're not ready to really announce what we're going to do with it. But early indications are that we're -- very soon, you're not going to hear us refer to that as the Royal Bank Building.

[Operator]

[Operator Instructions] And we have no further questions at this time. I would like to turn the meeting back over to Mr. Melton.

[Andrew John Melton, President, CEO & Trustee]

Well, thank you. That might be a record for us. So I appreciate that. I just wanted to finish by saying we are actually looking forward to the balance of 2019. I can't believe we're already a quarter into it.We have a high level of expectation that our new provincial government is going to get to work. Early signs are that our premier's working 24/7 to do those things necessary to encourage the much-needed investment in our province. So we're pretty optimistic about that. And like I said, we're looking forward to the year with confidence.As always, we'll be happy to answer any questions if you -- something comes up that you'd like to talk about with us. We're always open to your phone call. Thanks again for your participation.

[Operator]

The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.