Melcor Real Estate Investment Trust

TSX:MR.UN

Earnings Call Transcript

[Operator]

Good morning, ladies and gentlemen, welcome to the Melcor REIT Q3 Conference Call. I would now like to turn it 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, Ruth, and good morning everyone. I imagine there's a few tired parents out there, after trying to deal with kids with sugar rushes. So I feel sorry for you there. I was listening to the global news this morning and this group of people came up with this concept of a candy tax. And I thought that's a really good idea, getting the kids sort of familiar with tax at an early age. Anyways, sorry.It is our privilege to report to you on the third quarter of 2018. We are pleased to welcome Naomi Stefura, our Chief Financial Officer, who is back from maternity leave. So thanks Naomi, we sure appreciate you're back on the plough. Naomi will lead us through the financial highlights of the quarter and year-to-date in a moment. Brandon Park, our Director of Asset Management is also on the call today. He will run through a review of our operations in the quarter. Kelsey Kelemen, who is the Director of Financial Planning and Analysis for Melcor Developments is also in the room and may chime in during the Q&A portion of the call.I will now turn the call over to Naomi.

[Naomi Marie Stefura, CFO & Corporate Secretary]

Thank you, Andy. Hello everyone, and thank you for joining us today. 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 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 and risk section of our Annual MD&A. Second, we will report our financial results in Canadian dollars and in accordance with IFRS. We supplement our financial reporting with non-standard 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 non-standard measures are defined and reconciled in our Management's Discussion and Analysis.I will now walk everyone through a few financial highlights for the third quarter and nine months ended September 30, 2018. Rental revenue grew by 3% in the quarter and by 5% year-to-date compared to the same period as the year-ago. Similarly, net operating income grew by 3% in the quarter and year-to-date. This growth is the result of the Melcor acquisition completed in January of this year, offset by the sale of 2 retail properties in the first half of the year. Continued competitive pressure on office space in Edmonton has contributed to lower same asset NOI and FFO. In addition, AFFO was also impacted by an increase in amortization of deferred finance fees. Our payout ratio of 105% for the quarter and 99% year-to-date was negatively impacted by undeployed cash due in part to the property sales and recent refinancing. We have a strong cash position and are comfortable with our distribution at its current rate.I will now turn the call over to Brandon Park, 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 are pleased to again report stable operating results in the third quarter.Occupancy remained steady at 90%. The 4% increase in weighted average base rent is a result of new properties acquired with the Melcor Acquisition early this year, and demonstrates how advantages like this one strengthen our overall portfolio. We continued to see the impact of the 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 continued to engage in a strategic proactive leasing programs, which has led to a strong retention rate of 76% and over 78,000 square feet in new lease deals. Notably, this includes 43,000 square feet of office space and 33,600 in Edmonton.With our strong cash position, we continue to actively pursue acquisition opportunities that are a fit within our portfolio and our strategy. We continue to monitor and respond to market demand and trends in commercial real estate and focus on exceptional customer care as a differentiating factor in our markets 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. Ruth, please open the line.

[Operator]

Thank you. We'll now take questions from the telephone lines. [Operator Instructions] Our first question is from Sumayya Hussain, from CIBC World Markets. Please go ahead, your line is now open.

[Sumayya Hussain, Associate]

Thanks. Good morning guys. Just firstly on the acquisition front, you guys have talked about putting some of the cash on hand to use. So where are you looking in terms of markets and deciding between retail, office or industrial?

[Andrew John Melton, President, CEO & Trustee]

Sumayya, we're trying to stay pretty consistent with the classes of real estate that are currently in our portfolio, obviously, office being the most challenged in the communities that we operate in particularly Edmonton and Calgary, and particularly downtown Edmonton and Calgary. Interest is limited on that, but retail and industrial are high on our agenda. And we like all the communities in Alberta. We know them very well and they had -- Melcor Developments has had a long track record of activity in most of them. So we're staying focused in those areas.

[Sumayya Hussain, Associate]

Okay. So are there we ready assets in the MRD pipeline that could be vended in the near term or are you looking more at third-party sources?

[Brandon Park, Director of Asset Management]

Sumayya, Brandon Park here. I think your question was about REIT-ready at income-producing properties in the with Melcor Developments today. You know what, there's nothing immediately available, but again, there is that pipeline available and Melcor Developments continues to build and construct and develop those sorts of assets.

[Sumayya Hussain, Associate]

Okay, great. And then just lastly, can you update us on the plan to address the convertibles that are due in 2019?

[Naomi Marie Stefura, CFO & Corporate Secretary]

Hi Sumayya. Yes, we're definitely looking at that right now. I think our intent is to have that dealt with sort of early in 2019, and so stay tuned, but presumably the most likely course of action would be to refinance with another convert.

[Operator]

Thank you. Our next question from Kyle Stanley from Desjardins Capital. Please go ahead, your line is now open.

[Kyle Stanley, Associate]

So just a few quick ones from me today kind of focused on Edmonton office. I'm just wondering, could you discuss maybe how your interactions with both perspective and your current in-place office tenants in Edmonton have been evolving. Maybe what's changing, what are they looking for?

[Brandon Park, Director of Asset Management]

Thanks, Kyle. Brandon here. Heard 2 questions there, existing tenants on the office front in Edmonton and the new tenants. There is similar theme in all office tenants without stable options today. With that being said, we have longstanding relationships with our existing tenants. Many of them have already been in our buildings for multiple terms. We understand what their needs are at this point and how their businesses are evolving. And I think by re-leasing that in the current year, we're also capturing a number of expansions. And again, I want to point -- that's kind of demonstrated by our retention rate at 76% for the year on those renewals.When it comes to new deals, tenants are actively looking in the market. Our conversation is to deliver value. Again we are a Class B operator and owner. We run those buildings like they're Class A in Edmonton markets, focusing on customer care, reinvestment and appropriate incentives, to capture those new deals.

[Kyle Stanley, Associate]

Okay. That makes sense. And I guess just kind of staying along the same theme. Where do you think we are in the cycle with regards to Edmonton office right now? I know there is still supply coming online and there's probably still some -- new supply that's still needs to be leased up. But do you expect the challenges that we're seeing right now to persist kind of for foreseeable future?

[Andrew John Melton, President, CEO & Trustee]

Kyle, it's Andy. I've seen a few of these significant swings in the office vacancy of the office market in my career, and some of them have lasted a long time. And I honestly would have to tell you that I don't see -- in particularly in Calgary, I don't see a lot of rapid improvement for a protracted period of time. This could take a while.

[Kyle Stanley, Associate]

Okay, that makes sense. That's consistent kind of with what I've seen, but I just figured to get your opinion. And then I guess just my last question here, again focused kind of on the office market in Edmonton and your strategy. So just wondering what your strategy is for are dealing with the market right now, and maybe in addition to offering increased TIs, is there anything that can be done on the asset management side, maybe redeveloping some space or something like that?

[Brandon Park, Director of Asset Management]

Hi Kyle, Brandon Park here again. Thanks for your question. And again, we are from the asset management side and the condition of our assets, we are continually looking at our downtown properties. And that's all properties throughout the whole portfolio to make sure they're current, and secondly functioning appropriately. With the new inventory coming online in Edmonton and actually across the country, it's important that these older buildings in the stock that landlords are reinvesting in HVAC systems in those core functions and that's something we are continually doing.

[Kyle Stanley, Associate]

Okay. That makes sense and that's it for me. So I'll just turn it back there.

[Andrew John Melton, President, CEO & Trustee]

Kyle, I would like to speak to the add-on question. The unique nature of our downtown Edmonton office, yes, you're right. Any vacancies that's in downtown Edmonton we compete against, our office buildings are -- we're looking for a smaller tenant in nature. We can't accommodate of 40,000 or 50,000 square foot tenant. So anybody of that size that's looking -- not looking at our properties. So we feel that we have somewhat of an opportunity and an advantage dealing in that smaller-sized market.

[Operator]

Thank you. [Operator Instructions] Our next question is from Michael Smith from RBC Capital Markets. Please go ahead.

[Michael Smith, Analyst]

Thank you, and good morning, and welcome back, Naomi. Just wondering in terms of cap rates, have you -- are you seeing any changes in cap rates and does that -- maybe you could talk about further dispositions or your acquisitions? It sounds like that any acquisitions you do might be in smaller markets. Is that a fair statement?

[Andrew John Melton, President, CEO & Trustee]

Mike, it's Andy, and hello. It's kind of frustrating right now, I have to tell you. If anything, the kind of properties that would fit into our portfolio in the major standards of Edmonton and Calgary, specifically, the cap rates are still very low. Again, we're hearing some deals, particularly industrial that they're very low. So it is causing us to consider investments in smaller centers. Just by nature, the cap rates are slightly higher in those centers. And the good news there is we like them. We understand the communities and feel very comfortable in them. So on the disposition side, never say never, because I don't know who is going to make us an offer, but there's nothing slated for disposition at this point.

[Michael Smith, Analyst]

Right okay. And putting the office sector aside, and obviously after that it's really retail for you, because you only have a small amount of industrial. What's the market like? Leasing market.

[Brandon Park, Director of Asset Management]

Michael, Brandon Park here. I'll just touch base on that retail leasing market, kind of a cross. Retails a funny thing, but I'll just focus in on Alberta. We're seeing stability in it. Most of our assets, more our experience life is on that grocery-anchored or service-oriented retail. People are still shopping, people still get haircuts, or go to the banks, or have dry-cleaning done and buy food. So we're seeing those businesses doing reasonably well and having rents that are stable and supportive to their operations.

[Operator]

Thank you. [Operator Instructions] There are no further questions registered at this time, so I would like to turn back over to you, Mr. Melton.

[Andrew John Melton, President, CEO & Trustee]

Thanks, Ruth, and thank you everybody for participating. It means a lot to us for you to spend the time and energy to listen to us. So just appreciate it very much. And always remember that any time, any of you can call the management team at Melcor REIT with any other follow-up questions. So thanks again for your questions and time.

[Operator]

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