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Good afternoon. My name is Adam, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Morguard Real Estate Investment Trust first quarter results conference call. [Operator Instructions] Thank you. I'd now like to turn the call over to our host, Pamela McLean, CFO.
Thank you, Adam. Hello, everybody. Rai Sahi is unable to attend the call today, so I will start on his behalf. I will provide -- oh, sorry, with me in the room is also Arjun Chowdhury, our Director, Asset Management for office industrial portfolio; and John Ginis, our Director of Asset Management for our retail portfolio. I will provide both financial and property overview. The property overview will be embedded with the financial commentary, where and when it supports the conversation. Real estate property balances have increased $4.9 million since December 31, 2017. Capital investment of $10.9 million is offset by negative market value adjustments of $6.0 million. The $10.9 million of capital expenditure includes productive capacity maintenance expenditure of approximately $2.9 million, with the remainder representing expenditures on a number of strategic projects, which are expected to either remerchandise 493,000 square feet of existing area, or are expected to add 60,000 square feet of new leasable area. With the exception of 188,000 square feet, this remerchandised and new area will start generating income in Q2 of 2018 and continue through 2Q of 2019. The remaining 188,000 square feet requires the remerchandising of the former Sears space at the ground -- at Pine Centre and the ground floor of St. Laurent. Complete plans for this area are yet to be determined. After adjusting for the Sears space, the trust has secured commitments on 63% of the remerchandised area and 93% of the area under intensification. During the quarter, the trust made a decision not to redevelop the Sears space at Cambridge Centre and on the top floor of St. Laurent. As a result, the trust has reduced the area of these 2 properties by 61,000 and 138,000 square feet, respectively. Part 12 of the MD&A provides a full reconciliation of all gross leasable area for the properties, including area either held or under development for this and the previous 7 quarters. The trust debt ratio at March 31, 2018, was 44.2%. This is largely unchanged from December 31, when the ratio was 44.5%. There was no new financing during the quarter. On May 1, 2018, the mortgage at center -- at Circle and Eighth matured. The trust has extended the mortgage under same terms, while we continue to discuss opportunities with the incumbent lender. The current mortgage matures at approximately $15.5 million and carries an interest rate of 6.9%. There is an opportunity to both increase the financing and realize the favorable interest rate. Turning our attention to the income statement. Income before fair value losses and net income from equity accounted investments was $22.7 million for the 3 months ended March 31, 2018, versus $25.1 million for the same period ended 2017. This represents a decrease of $2.4 million. Net operating income for the 3 months ended March 31, 2018, was $37.6 million versus $40.0 million for the same period ended March 31, 2017. During 2017, 290,700 square feet of area under development started generating revenue. This space related to the trust projects at 4 of our regional enclosed shopping centers and 4 community strip centers. Additional NOI from these development projects increased net operating income during the quarter by $1.4 million. However, this increase was offset by reduced lease cancellation fees of $700,000 and reduced subprime. Same-property net operating income was unfavorable $2.5 million. The unfavorable same-property net operating income derived from the enclosed regional shopping centers of $1.6 million were increased vacancy combined with decreases in basic rent. Included in this decrease is a $300,000 negative revenue impact associated with the removal of the Sears space from Cambridge and St. Laurent. The office portfolio also saw a decrease in net operating income of $1.2 million. This decrease was felt both in Ottawa and Alberta due to increased vacancy. These 2 negative impacts were slightly offset by improved net operating income in our community strip portfolio of $200,000. With respect to funds from operations, diluted FFO per unit for the 3 months ended was $0.37 per unit compared to $0.40 per unit for the same period ended 2017. The decrease in FFO of $0.03 per unit is the result of the reduced net operating income. With respect to adjusted funds from operations, AFFO per unit for the 3 months ended March 31, 2018, was $0.27 per unit versus $0.31 per unit for the same period ended 2017. The trust continues to use a sustainable reserve for maintenance capital and leasing. The reserve for 2018 is $25 million or $6,250,000 per quarter and is based on a review of the 3-year budgeted forecasted leasing and maintenance capital. Actual expenditures for productive capacity maintenance for the period ended March 31, 2018, was $2.9 million. I will now open the call to questions.
[Operator Instructions] And our first question comes from Jonathan Kelcher from TD Securities.
The first question is just on the Cambridge Centre. How do you see that property playing out over the next few years if the Sears are just going to leave dark? Or what might your plans be for that space?
Jonathan, John Ginis here. I'll respond to your question. So we took Sears off-line and we've advised on previous analyst calls of our dealings with the City of Cambridge on the potential building of a multiplex concept at the shopping center. So we're immersed in discussions, as we speak, with the city in that regard, and that will continue over the course of this calendar year, trying to effectuate a deal. So it's not like we're going to sit on it vacant, we're actually pursuing alternatives. To the extent that, that negotiation falls through, we'll look at other strategic options. But to get back to the generalities of the property, so you asked what is the future of that property over the next little bit, I should advise you that when -- in Pam's outset of the call, where she noted that there's more properties under development coming on stream from Q2 and thereafter, Cambridge qualifies as one of those properties, more specifically the former Target Canada premises. That will come on stream closer to the end of 2018 and there will be a sizable contribution of NOI to that property once those -- that redevelopment comes on.
Okay. Sounds good. And then, secondly, and I guess, Pam, this is for you, if I look at the stabilized NOI that you guys used to calculate your IFRS value, it's around $170 million. Concurrently, if you annualize Q1, and I know Q1 is a seasonally weak quarter, but you annualize that right now, you're at around $150 million. How long do you think you -- it will take to sort of close the gap between the two?
So a lot of it is tied to the development activity that's happening within the retail portfolio. So to John's point, by the end of 2018, the activity associated with all of the new space or the 70,000 square feet of new space will be income-producing by the end of the year. And then, all of the Target space and stuff starts coming on as well. So the only thing that we're left within is the Sears space yet to be determined. So in 2019, we should have a full year of stabilized income associated with that program.
So in 2019, you think you'll be in the ballpark of $170 million of NOI?
To just follow up on Pam's note, let's not forget here, we have 3 Sears stores in our portfolio, and we are currently working through redevelopment options on each one, St. Laurent, Cambridge Centre, as I noted at the outset of my commentary, and also Pine Centre, Prince George. So until we work through that program, we still -- I don't -- we won't get to that stabilized level. But I want to remind everyone, we've got our Target boxes back in April 15, and we expect stabilization on the redevelopment of those boxes by the end of this calendar year. So call it 3-plus years. So it takes time, but Sears will be the outlier here that will -- well, we'll have to work through that before we get to a stabilized NOI on the retail side.
And our next question comes from Troy MacLean from BMO Capital Markets.
I was just kind of curious what you're seeing, any tenant demand, any leasing trends in the Alberta office market. The market still seems to be struggling. I just wonder what you're seeing on the ground.
Troy, this is Arjun Chowdhury, so I'll comment on that. And you are right, the market still remains muted. There really isn't any major tenant demand, and we don't expect that to change anytime soon.
What about the renewals that you have up -- coming up in that market this year, are you hoping to keep the tenant but at lower rates? Or you're not expecting a very -- like a lower tenant retention ratio? What's the -- what's kind of the outlook there?
Well, so for 2018, Troy, we don't have a very large exposure in all of Alberta, especially in our multi-tenanted buildings. I have less than 30,000 square feet coming up for renewal, which is a pretty small number. It's less than 1% of our entire office portfolio. Having said that, we are engaging actively with the tenants and we are working with them to see what kind of deals we can offer to them to keep them in the space. Like you note, the market has almost 25% vacancy, and they have multiple options, but our main objective is to retain the tenants in the building for now.
And then, just on the enclosed mall portfolio, I was just kind of curious how the intensification and remerchandising is impacting leasing. Do you expect leasing to pick up either on tenant retention or better rental rates later in the year when some of the projects come online? Like how is that shaking out?
Troy, it's John. I have to admit, some of the projects that have come on stream and specifically the ones out West in Manitoba and Alberta, we're starting to see some real interesting leasing traction with respect to the impact that the new major tenants as part of the redevelopment of that space has elicited. So to answer your question directly, it's a net benefit to the property thus far. And I don't think it's going to be any different with the balance of the 2 properties coming on stream, again, being Cambridge Centre later this year and then Circle and Eighth that's come on in tranches with a couple of deals we've done. But it's only been positive based on the tenant profile and the diversification of users we've put into these boxes to help strengthen the centers.
So would it be fair to say that occupancy is probably stable -- will stabilize from here and that outside of the Sears, the same-property NOI declines should kind of moderate in the enclosed portfolio, like in 2018, or at least the last part of the year? Like would that be fair to say?
Well, you'll see -- as Pam noted, as these things come on stream, you're going to start seeing bumps in NOI to the positive on the enclosed stuff because we've been working on for 3 years here and there's a lot of GLA being brought back on stream. We've seen a lot over the last 3 years. There's nothing on the radar that would suggest that we're going to see more impending failures with restructures, et cetera. So our hope is that we've hit kind of like a trough here and then it's only -- but again, like I go back to my original comment, we're seeing real positive leasing spreads and new tenant demand based on clerical stuff, merchandising of the portfolio as it relates to the former anchor premises.
And then, just on -- would you look at any further asset sales? It's -- the REIT has done this every year, every couple of years, has sold something. Is there anything that you're looking at, maybe trimming from the portfolio, or any comments there?
So Troy, I'll comment on that. I think, at this point, we are exploring options. We haven't committed to anything yet, but we are looking at certain nonstrategic, non-core assets, which don't fit with the REIT's long-term objective.
And then, just to follow-up on that, like what would you consider to be non-core, like what type of asset? Is it looking at trimming different markets or is it a mix of different asset types?
So non-core would largely reflect an asset, which is in a location, which we don't want to be in long term. It's not necessarily asset type. It has to do with the asset location and potentially also the tenancy profile.
And is there any markets that you would like to lighten up on?
Nothing -- no market, in particular, at this point.
[Operator Instructions] Our next question comes from Sumayya Hussain from CIBC.
Just wanted to know, Sears spaces, have you put all leasing efforts entirely on hold? Or are you still kind of trying to put tenants for the 2 spaces?
Sorry, which 2 spaces you're referring? To the ones -- St. Laurent Shopping Centre and Prince George?
And Cambridge.
So as I noted earlier, Cambridge is a little bit unique only insofar as we were working with the City of Cambridge on building a multiplex concept there, where we submitted our candidacy back in late 2017, and we were selected as the winning proponent. So we're going to see that through and see what can materialize on that before we look at other options as it relates to the redevelopment of Sears premises at that shopping center. The other 2 assets, we're actively looking at redevelopment scenarios, be it for -- and as Pam noted, the ground floor at St. Laurent Shopping Centre because it's a single level mall for the most part, and Prince George with respect to the Sears premises there, we're looking at large bay and small bay redevelopment of the space, mothballing a portion of -- there are a lot of options being considered. So we're not just sitting here, we're actually actively trying to find solutions for the space, be it conventional retail solutions or mixed-use considerations.
Okay. And just kind of what's the interest level so far? Or is it too early to tell?
Still too early.
Too early? And just on the same-property expenses for the enclosed malls, they were up about 8.5%., was that just on higher vacancy or was there something else driving the increase?
Sorry, we're just flipping through right now. Okay, so we're just taking a look through our materials. Can we come back with that answer?
Sure. That's fine. That was all for me.
And our next question comes from Pammi Bir from Scotia Capital.
Just maybe building on some of the earlier questions with respect to internal growth. At what point do you see the overall momentum improving for both the retail and office portfolios? Or in other words, should we expect -- or do you expect 2019 internal growth to be positive in both of those portfolios?
Would you like to comment? Okay. So I'll start on the retail side. And I'll ask Arjun to speak on the office industrial component. So it's been an interesting 3 years here where we've gone through substantial change in retail, piloted by Target Canada as the biggest outlier insofar as vacancy that's [ ensued ] in Canada as it relates to retail space. We've done an exceptional job, in my mind, in terms of repurposing those units, really transition and strengthen the properties where Target Canada sat, and remerchandise it strategically in a way that helps improve leasing momentum, we think, going forward. It's taken time. And again, the stabilization of these assets won't happen until probably mid-2019 when it fully comes on stream. But in addition to that, we've also proceeded with intensification initiatives that have also helped complement the tenant roster. There's a couple of department -- grocery stores too where we were caught in the Sobeys-Safeway merger, where we had to refurbish that and we've done a good job on repurposing that GLA as well. So I've got to believe that we're worse -- through the worst of it. And again, as I said it earlier when the question was asked, we're seeing some interesting soliciting from now small [ reseller ] retailers who have seen what we've done on some of our boxes and have expressed interest on the mall space. On the strip portfolio, just to finish on that, that's always been a steady component of the overall weak performance. Nothing we think there will change in that regard. It's always been nominal, but good growth, and an asset class we still like and would like to reinforce over the course of time. And I'll turn it over to Arjun to speak on the office side.
Thank you, John. So Pammi, I will just comment a bit about the office sector and what we expect for '18 and '19 in terms of tenant growth, and I'll talk a bit about the different regions that we operate out of. So if I break it down between Ottawa, Alberta and then Vancouver and GTA, so we are seeing growth in our rental rates in GTA and in Vancouver, and we have some renewals coming up in 2019 and 2020, where we are expecting growth in the renewal rental rates, which should lead to a positive momentum and an uptick on the rental rates there and the NOI. If I look at Ottawa, Ottawa, we had a large Fed vacancy last year if you recall in our previous discussions and quarterly earnings calls. Most of that space that was given back to us by the Fed in 2017 at Heritage Place has been renewed, has been released to the Feds, who will be taking the space starting January 2019, and that should see a nice bump again -- bump up again in our NOI. And the LRT in Ottawa is also expected to come on stream by November 2018, which should also positively impact the overall market in terms of growth in rental rates and new tenant demand. If -- when it comes Alberta, as we discussed earlier on the call, Alberta still remains weak. However, the way we see it, where oil prices today are and where the market is, while the tenant demand remains muted, our rollover risk going into the next 2 years is pretty minimal. As for 2019, we have less than 12,000 square feet that is coming up for expiration, which means that our exposure to rental rates being renewed at much lower rental rates is pretty minimal. So we don't expect Alberta to perform any worse for us going forward, and we expect the growth to come from GTA, Vancouver and more stability from Ottawa.
Great. That's actually great color. Just maybe a broader question. Can you comment on just -- it sounds like the retail leasing environment is -- certainly, at your property seems to be picking up, but in the broader context of what you're seeing from tenants, can you just comment on what's happening on the ground? Is there -- do you feel like we are through the worst of it? Or is there still some challenges ahead, aside from the Sears space, but just in general, trying to get a sense of which tenants are expanding and which are shrinking?
Yes, so I'll answer that. It's interesting who you talk to insofar as this -- the retail space going forward. Again, we've seen a lot of change, particularly in secondary mall assets, where you've seen heightened vacancy in some of those assets. But we firmly believe that if you control the dominant center in a trade area, be it a large metropolis, like the GTA, Vancouver, Montréal, Vancouver, et cetera, or even if it's a smaller market but it's the dominant center for its area, there is demand. And that's been expressed to us, and we see no deviation from that where tenants want to be in bricks-and-mortar real estate. And we're fortunate that we actually control some of these assets in some of the secondary markets where that demand still is strong, where they feel they need a real estate footprint for their operating models to work. So -- I mean, in a general sense, I can't predict the future, but we feel reasonably confident. And then, take our enclosed portfolio with our traditional [ gross shrinkage ] strip or power center or community center portfolio, that's always been a nice complement for us. And again, it's always been slow but steady growth. And again, that's everyday essentials type of real estate you want to own, a bread-and-butter type of investment, I call it, that I don't see deviating and that will be in demand both in -- and you even see it in today's investment market where it's demanded by a lot of institutional players who want to complement their retail portfolio where it satisfies that criteria. So we're no different. We like that asset class, we'd like to buy more of it if we could.
That's helpful. And then, just last one for me. In terms of the intensifications space and the remerchandising space that's committed and the space coming on, what are your -- can you remind us of what the expected unlevered yields are on those projects. Just to -- not by project, but an overall range.
So an overall range, I mean, it varies from market, it depends on the operator or user, be it if it's single tenant or multi-tenanted, so I think -- I'm answering that question in the context of that background. But if you look at overall yields, we're probably between as low as 6% to as high as 8%.
And there are no further questions at this time. I'll turn the call back over to the presenters.
Okay. Thank you. We still owe you an answer with respect to the variance on the expense side. It doesn't seem to be sitting in one specific property, so I don't have a better answer for you at this point in time on that one. If there are no further questions, we'll arrange to close the call.
And there are no further questions at this time. So this does conclude today's conference call. You may now disconnect.
Thank you.
Thanks.