Morguard Real Estate Investment Trust

TSX:MRT.UN

Earnings Call Transcript

[Operator]

Good afternoon, ladies and gentlemen, and welcome to the Morguard Real Estate Investment Trust First Quarter 2021 Results. [Operator Instructions] Also note that the call is recorded today, April 29, 2021.At this time, I would like to turn the conference over to Mr. Andrew Tamlin. Please go ahead, sir.

[Andrew Tamlin, Chief Financial Officer]

Thank you, and good afternoon, everyone. My name is Andrew Tamlin, Chief Financial Officer of Morguard REIT. I'm joined this afternoon by John Ginis, Assistant Vice President of Retail Asset Management; Tom Johnston, Vice President of Western Asset Management; Tullio Capulli, Vice President of Eastern Asset Management; along with Rai Sahi, Chief Executive Officer and Chairman of the Board. Thank you all for taking the time to join the call.Before we jump into the call, I'd like to point out that our comments will mostly refer to the first quarter 2021 MD&A and financial statements, which have been posted to our website. I refer you specifically to the cautionary language at the front of the MD&A, which would also apply to any comments that we make on this call.The first quarter was the start of what we hope will be a transition back to a normal functioning real estate market. Collections in our office and strip asset classes continued to be strong as well our enclosed malls west of Ontario. Same asset NOI was down in our enclosed mall asset class, which was not unexpected, but both bad debt expense and fair value adjustments have levelled off as compared to past quarters.There were 2 nonrecurring items which happened -- which impacted the results in the first quarter. First of all, we earned $2.6 million in lease cancellation fees this quarter, most of which was collected from Lowe's at Pine Centre. They have previously vacated their space and we needed to obtain control to facilitate the Save-on-Foods deal at this property. Lease cancellation fees are a component of net operating income.Secondly, we collected a settlement of $2 million as part of litigation against the U.S. directors of Sears. The REIT had 3 locations impacted by the 2018 CCAA filing of Sears Canada, which were Pine Centre, Cambridge Centre and St. Laurent. This nonrecurring amount was recorded as other income and represents our share of the funds collected as part of a landlord group which participated in this action. We were able to achieve some savings and interest expense this quarter, which declined $1.3 million or 9% as compared to 2020. This was primarily due to the lowering of the weighted average interest rate on our mortgage portfolio from 4.1% to 3.7% as a result of the large amount of refinancings in the latter half of 2020 at lower interest rates.Lower short-term rates also had an impact. Unfortunately, there are still challenges, particularly in our enclosed mall portfolio. Our same asset net operating income for this asset class was down $5 million, with the majority of this decline coming from our 2 Ontario enclosed malls, St. Laurent and Cambridge. Due to Ontario lockdowns, other than a couple of weeks in February, the majority of the stores in these malls will have been closed and not allowed to operate for most of 2021 beyond curbside delivery up to at least May 20th. We are hopeful that the lockdown orders will not be extended beyond May.Rent collections have been relatively strong, averaging close to 95% in recent months. Office and strip collections are well into the upper 90% range, while our enclosed mall asset class have been averaging collections in the range of 80% to 85%. This includes malls which have -- this includes the St. Laurent and Cambridge malls, which have been probably the lockdowns in Ontario.Our FFO was down slightly during the quarter at $19.3 million in 2021 as compared to $20 million in 2020. The REIT's PCME or operating capital reserve has been established to be $4.6 million per quarter for the year, which is approximately 75% of normal levels. Our AFFO increased $1 million to $14.7 million in 2021 as compared to $13.7 million in 2020. Both the FFO and the AFFO metrics are elevated as compared to normal due to the $4.5 million in nonrecurring income items I previously described.Our occupancy levels were down 1.5% to an average of 90.6% from 92.1% at the end of 2020. This decline came mainly from our enclosed mall asset class resulting from the concluding of Christmas activities.During the quarter, our development work at the center was concluded. This was a $20 million project and was a complete remerchandising of the mall, which was very well received by tenants and shoppers alike. In conjunction with this work, leasing inquiries have been elevated so far into 2021.As I've mentioned, St. Laurent and Cambridge both remained closed due to lockdown orders in Ontario. Consequently, traffic has been minimal in these malls. On the other hand, our mall in Prince George has had normal traffic patterns as compared to past years, which is a positive sign of what we could expect when we can put COVID behind us latest at summer.The rent arrears at March 31, 2021 totaled $20 million, including sales taxes, down slightly from $22 million at the end of the year. The allowance for doubtful accounts assigned to these arrears totaled $8.8 million or approximately 50% of the amounts, excluding sales taxes. $18 million of the $20 million is from the retail asset class and half of that comes from the 2 malls in Ontario, which have been locked down. We are still working on rent solutions for these arrears, and we expect these balances to continue to decline over the next few quarters as these solutions are put in place and documented.Looking at financings, we were looking at renewing 2 mortgages on enclosed malls, Pine Centre and Prairie, which come up for renewal in the second quarter. We expect both of these to be renewed with the existing lenders at the existing amounts as well.And now for an update on our leasing efforts. For the rest of 2021, there are 670,000 in retail GLA coming up for renewal. Almost half the GLA is from anchored tenants at lower weighted average rates, which are all expected to renew. The vast majority of the remaining space is also expected to renew or has already been renewed.Management is at continued ongoing discussions with the provincial government tenant at Petroleum Plaza in Edmonton, which came up for renewal on December 31, 2020, and is now in overhold. While they have verbally told us that they expected to renew, they have unfortunately been focused on their response to the pandemic, which has taken priority. We expect to get this completed in the second half of 2021, once their attention has turned from their response to COVID.Touching briefly on financing and liquidity, the trust is $133 million in liquidity at the end of the first quarter and $327 million in unencumbered assets. This has increased from $82 million a year ago in liquidity.The trust has started with the Save-on-Foods developments at Pine Centre, which entails the re-tenanting of the empty Lowe's premises into a new 38,850 square foot Save-on-Foods grocery store. Demolition of the existing former Lowe's premises will start soon. This is estimated to cost in the range of $15 million and is expected to be completed in the third quarter 2022. The addition of grocery further complements the strong anchored tenant profile at this mall and has advanced leasing discussions with some discriminate tenants looking to come into this marketplace.Wrapping up, while the economy and by extension of some of the REIT's assets are still going through the challenges, we remain positive about a number of aspects of our business. There are some short-term challenges with our enclosed malls, but most of them remain dominant in their geographical area and our strip malls which are largely grocery anchored have shown resilience in collections.Beyond our retail assets, we have high-quality office buildings in Canada's largest markets with a high degree of government office tenants. We continue to be positive about our business and the objective of building value for our unitholders. We look forward to continuing to execute our strategy and thank you for your continued support.We'll now open the floor to questions.

[Operator]

[Operator Instructions] And your first question will be from Lorne Kalmar at TD.

[Lorne Kalmar, Associate]

So, yes, as you mentioned, it looks like bad debts are leveling off. Is that sort of the level you expect for the remainder of 2021, most of the bankruptcy filings, et cetera, are sort of out of the way now?

[Andrew Tamlin, Chief Financial Officer]

Well, let's put it this way. I don't have any reason to believe it's going to be changing materially, but you just never know within this pandemic, right? So to date, there really hasn't been any CCAA filings, material ones anyway in 2021. So that's a good sign. But on the other hand, we're still in lockdown in Ontario. And it's really difficult to know when that's going to be extended, too. So...

[Lorne Kalmar, Associate]

Okay. And then on the anchored maturities that you guys are saying you expect to renew, do you expect to get higher rents on those or they'll be flat or a bit of a roll down?

[Andrew Tamlin, Chief Financial Officer]

No, they'll be flat.

[Kuldip Rai Sahi, Chairman, President & CEO]

They'll be flat.

[Lorne Kalmar, Associate]

Be flat? Okay. And then maybe just turning to office, what are you guys seeing from your tenants in terms of plans to return to the office and any requests either change or add or remove space?

[Andrew Tamlin, Chief Financial Officer]

Kuldip Rai here can answer that.

[Kuldip Rai Sahi, Chairman, President & CEO]

This is Ray Sahi. It's pretty difficult to depending on -- fortunately, with some of the office we have in Ottawa, which is government and so we're quite comfortable with that. It wouldn't be that much impact. The rest is basically kind of unknown. There are a few tenants who have given us notice that they would -- they are adjusting, they may not renew. But it's still too early to actually deal with that situation at this stage.

[Lorne Kalmar, Associate]

But you guys haven't had anyone come to you or anyone material come to you and say, we don't need the space anymore.

[Kuldip Rai Sahi, Chairman, President & CEO]

We have. We have. We will now -- we have a couple of times at both in Toronto as well as in Montreal I think area have indicated that they would.

[Lorne Kalmar, Associate]

Fair enough. And then you mentioned there's sort of positive response adding that Save-on. Is there any desire to kind of shift some of these tenants towards more grocery-type tenants or necessity-based tenants, I guess?

[Kuldip Rai Sahi, Chairman, President & CEO]

Well, obviously, that depends on the availability of -- you would always prefer to have a grocery, particularly on the retail malls. But there are not that many opportunities.

[Operator]

[Operator Instructions] And your next question will be from Jenny Ma at BMO Capital Markets.

[Jenny Ma, Analyst]

On the Save-on development, what is the yield that you're expecting on that project?

[Andrew Tamlin, Chief Financial Officer]

We normally don't quote yields, Jenny. Yes, we -- I mean, we feel comfortable with the return, but it's not something that we usually quote. I mean it's somewhere in the range of 5% to 10%, but we typically do not quote those.

[Kuldip Rai Sahi, Chairman, President & CEO]

I mean, a lot depends on the long term -- it's a long-term lease, so it's not a -- very difficult how much money we're spending. Do we calculate based on the new money we spend or -- but bottom line is we're always happy to have a grocery in any mall.

[Jenny Ma, Analyst]

So the $15 million budget is the incremental spend you haven't associated any sort of land value, inherent in that set rate?

[Andrew Tamlin, Chief Financial Officer]

That's the incremental spend. Correct, yes.

[Jenny Ma, Analyst]

Okay. And what is the length of that lease with Save-on?

[Andrew Tamlin, Chief Financial Officer]

20 years.

[Kuldip Rai Sahi, Chairman, President & CEO]

20 years.

[Jenny Ma, Analyst]

20 years. Great. Okay. You talked about some percentage rent lease conversions at the enclosed mall. Could you give us some more color on how those are structured? Is that sort of a stock gap while the mall is under lockdown? Or are these permanent changes to the lease going forward?

[Andrew Tamlin, Chief Financial Officer]

Do you want to fill that, John?

[John Ginis, Director of Asset Management]

Sure. When you say percentage rent lease conversions, are you referring to our short-term tenancies? Are you talking about percentage rent structures on some of our tenants that we've reverted to that structure during COVID?

[Jenny Ma, Analyst]

Yes. I think it's the latter. So basically, the -- any changes that were made in response to COVID in terms of the lease. I'm just wondering if those are sort of temporary measures? Or is it your tenant saying, we're not certain about our future in this mall. So we're going to change our lease permanently or exit or do something else?

[John Ginis, Director of Asset Management]

So we've done our best over the course of the last 12 to 15 months to work with our retailers. And in some situations, particularly last summer, we were hit with a raft of CCAA filings and we're still dealing with that situation as it relates to tenants re-emerging from bankruptcy protection. There are other situations where we're dealing with retailers that have come to us for relief and where we've deemed it prudent to look at short-term relief as it relates to restructuring of contracts, we've looked at that.But what's also beneficial to us is that there are government subsidization programs out there, albeit varying depending on the -- if it's more so for the smaller or regional tenants versus national tenants. But all in all, we're saying, while mortgages there to offer systems where necessary, we're also pushing them to look at available subsidization via government programs as well. So to answer your questions, it's more short-term than long-term restructuring, unless it's a CCAA filing. There we have limited control.

[Jenny Ma, Analyst]

Right. That's helpful. Andrew, last quarter, you had mentioned that there was -- because of the percentage rents, there was going to be a reduction on NOI of about $3 million and that roughly 2/3 of that was already baked into Q4. For Q1 '21, would you say the rest of that's in the number? Or are there still more to come?

[Andrew Tamlin, Chief Financial Officer]

I'm not going to get into too much specifics on that, Jenny. It's always a bit of a fluid number. Our Ontario enclosed walls have been closed for basically all of 2021. So there really isn't much in the way of percentage revenue at those properties. So I would rather defer that question until things get a little bit more solidified.

[Jenny Ma, Analyst]

And my last question is about some of the bad debt reversals that were recognized in the office portfolio. What can you tell us about those situations? And do you expect it to be something that recurs as people or tenants have a better view of how they're going to use that space? Or if there's more confidence that there will be a return to the office.

[Andrew Tamlin, Chief Financial Officer]

Well, I think it's more just a function of the accounting for bad debt, Jenny. As part of IFRS, we're required to set up a bad debt expense. And it's based on the estimated future loss. And sometimes that view can spread out into 4, 5 years. But the reality is that there's a pretty good chance of collecting some of those arrears. And so as those arrears get collected, then just what happens is if there's no abatement or there's nothing that happens in receivable, then that just gets reversed, right? So what's happened during the quarter as we did have some arrears on the office side, those arrears have been collected. And just naturally, as part of that, the bad debt expense that we had set up at year-end gets reversed as part of that.

[Operator]

Next question will be from [ Kumail Gangjee ] at [ Aeternum Partners ].

[Unknown Analyst]

Just a quick question on credit. Last call, Rai, you mentioned that you were seeing that some banks were not willing to refi retail assets. And I wonder if you can share some commentary if you're seeing a different mindset as with regards to their approach? Or any commentary with regards to the appetite for refinancing?

[Kuldip Rai Sahi, Chairman, President & CEO]

Well, so far, we've been able to renew. But obviously, it is a market that the lenders are a little more challenging to trying to do -- they're not taking any new application on any other retail assets from anybody. So on -- so that will just continue on. We have good number of relationship with the lenders. So far, we've been able to renew, where we need it to be and on a short-term basis versus long term. So that will continue until the market opens.

[Operator]

Next question will be from [ Tenzin Lama ], investor.

[Unknown Attendee]

Just 2 quick clarifications. On your leasing activity details in the MD&A, in the -- could you clarify what the other adjustments of about 129,000 square feet is? And then also can you confirm, earlier you said for the remainder of 2021, the approximately 0.5 million square feet you're expecting to renew at about $16. And why -- what gives you that confidence versus the renewal rates you see for this year of $8 to $9 in the enclosed malls?

[Andrew Tamlin, Chief Financial Officer]

Well, to answer your first question, the 129,000 was just the GLA from the former Lowe's footprint out of Pine Centre coming off stream and while we execute on the Save-on-Foods development. So that's just taking out numbers as part of that. Okay. I'm not entirely sure how to address your other question. There are a good amount of anchor tenants that have options coming due for renewal in 2021 and also just be renewed at the normal rates. Sorry, I guess I just -- I'm not sure I quite understand what your question is about.

[Unknown Attendee]

Sorry. So I was just trying to understand why the renewals so far in the 3 months the rate you see is so much lower, like 990 for the renewals in the enclosed malls for the 3 months versus the anchor tenants at 1,586. Is it just the percentage rent that's driving that renewal rate down for the 3 months so far?

[Andrew Tamlin, Chief Financial Officer]

Yes. It's a -- well, the reality is it's a tough environment for enclosed malls these days, right? And as part of that, there is some percentage rent deals that are getting done for enclosed malls. And that differential is really just a function of the environment.

[Operator]

[Operator Instructions] And at this time, Mr. Tamlin, we have no further questions registered. Please proceed.

[Andrew Tamlin, Chief Financial Officer]

Okay. Thanks, everybody, for joining and have a good night.

[Operator]

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.