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 Second Quarter 2021 Results Conference Call. [Operator Instructions] This call is being recorded on Thursday, July 29, 2021. I'd now like to turn the conference over to Andrew Tamlin. Please go ahead.

[Andrew Tamlin, Chief Financial Officer]

Thank you, and good afternoon, everyone. My name is Andrew Tamlin, Chief Financial Officer of Morguard REIT. Welcome to the Morguard REIT Second Quarter 2021 Earnings Conference Call. I am joined this afternoon by John Ginis, Assistant Vice President of Retail Asset Management; Tom Johnston, VP of Western Asset Management; Tullio Capulli, VP of Eastern Asset Management; along with Rai Sahi, CEO 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 refer mostly to the second 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 would make on this call. The second quarter continued with the same theme that we saw in the first quarter, which was the start of what we hope will be a transition back to a normal functioning real estate market. Collections in our office and community strip asset classes continue to be strong as well as our enclosed malls in Western Canada. Same-asset net operating income was up over the second quarter of 2020 across all asset classes as well. We are pleased to see the positive results in this quarter over last year. This represents the first quarter where we are now comparing like-for-like quarters which are both post pandemic in nature. Net operating income increased 6.5% for the second quarter as compared to 2020 to $29 million from $27.2 million a year ago. This increase was due to the large amount of bad debt expense recorded in 2020 in relation to the uncollected receivables and failed tenants with the COVID-19 pandemic. Same-store net operating income has increased 6.2% for the quarter as compared to 2020 with increases across all asset classes, including a 13% increase in enclosed regional centers. Just as a reminder, there were 2 nonrecurring items which impacted the results in the first quarter. First of all, we earned $2.6 million in lease cancellation fees in Q1, most of which was collected from Lowe's at Pine Centre. They had previously vacated their space, and we obtained control of it to facilitate the Save-on-Foods deal. 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 funds collected as part of the landlord group which participated in the action. We were able to achieve savings in interest expense this quarter, which declined $600,000 or 4.5% as compared to 2020. This was primarily due to the lowering of the weighted average interest rate on our mortgage portfolio from 4.1% down to 3.7%. This lower interest rate was the result of the large amount of refinancing in the latter half of 2020, in addition to renewals of 2021 mortgages, all at lower rates. Total debt is $38 million lower at June 30, 2021, as compared to a year ago. Unfortunately, there are still challenges particularly in the enclosed mall portfolio. Our 2 Ontario enclosed malls, St. Laurent and Cambridge, have remained closed for most of 2021 due to Ontario lockdowns. They have been actually closed for 130 of the 181 days so far this year and even when they were allowed to open, were subject to capacity restrictions. We are hopeful that with the strong rollout and take-up of vaccines by both Canadians and Ontarians that we have seen the end of lockdowns. Rent collections have been strong, particularly in the office, community strip and industrial asset classes, which are functioning normally. Rent collections for enclosed regional centers range from 99% at Pine Centre down to a 65% to 70% range for St. Laurent Centre in Ottawa. While we are still working on rent solutions for certain retail tenants, the majority of the remaining retail rent arrears represents Ontario tenants. From an industry perspective, we are seeing most of the uncollected rents from tenants that have been most severely impacted by the lockdowns with gym operators, cinemas and food service tenants being at the top of that list. As these tenants continue to reopen across Canada, we are optimistic that we will see continued improvement in our cash collections for the rest of the year. The rent arrears and deferrals at June 30, 2021, totaled $16 million, which was down from March 31, 2021, of $20 million and also down from $22 million at the end of the year. The allowance for doubtful accounts assigned to these arrears totaled $7.7 million or a little bit more than 50% excluding sales taxes. Approximately 1/2 of the arrears is due to 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. Turning to FFO. It has increased during the quarter to $15 million in 2021 as compared to $13.2 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 has increased to $10.7 million in 2021 as compared to $10 million in 2020. On a year-to-date basis, our FFO has increased 3.8%, and our AFFO has increased 6.9%. Our occupancy levels were up slightly to 91.1% from an average of 90.6% at Q1 due to strong demand at our community strips. The minor dip in industrial occupancy will be reversed in third quarter when we backfill some of the space for a tenant that left in the second quarter. Our current occupancy level for all asset classes of 91% has only changed slightly from the start of the pandemic, which was 93%. This speaks to the fact that in most cases, we've been able to keep tenancy at our retail assets. Our development work at the center in Saskatoon has now concluded. This was a $20 million project and was a complete renovation of the mall, which was very well received by tenants and shoppers alike. In conjunction with this work, leasing inquiries have been elevated in 2021. Looking at financings. We have now completed 2 enclosed mall mortgage renewals during the quarter, Pine Centre and Prairie Mall. Both were renewed at lower interest rates than the maturing mortgages. There are some up-financing opportunities which we are working on in the third and fourth quarters as well. And now for an update on our leasing efforts. For the rest of 2021, there is 437,000 in retail GLA coming up for renewal. More than half of this GLA is from anchor 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 has had continued ongoing discussions with the provincial government tenant at Petroleum Plaza at Edmonton, which came up for renewal on December 31, 2020, and is now in overhold. While they have verbally told us that they expect to renew, they have been unfortunately 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 the Alberta government response to COVID. Turning to financing and liquidity. The trust has $137 million in liquidity at the end of the second quarter and $333 million in unencumbered assets. This liquidity position has increased significantly from $54 million a year ago. The trust has started the Save-on-Foods development job 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 has now started. This is estimated to cost in the range of $15 million and is expected to be completed in the third quarter of 2022. The addition of grocery further complements the strong anchor tenant profile at this mall and has advanced leasing discussions with some discriminatory tenants looking to come into this marketplace. Wrapping up, while the economy and by extension, some of the REIT assets are going through some challenges, we do remain positive about a number of aspects of our business. There are absolutely 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 will now open the floor to questions.

[Operator]

[Operator Instructions] Your first question comes from Jonathan Kelcher with TD Securities.

[Jonathan Kelcher, Analyst]

First question just on the enclosed retail. I guess you've got 437,000 still to renew and half with anchor tenants. And the rest, it sounds like you expect most of that to renew. How should we think about rent renewal rates on that space?

[John Ginis, Director of Asset Management]

Jonathan, John Ginis here. So it varies depending on the nature of the asset. So as Andrew noted in his commentary, almost predominantly all of it will renew, so we're roughly talking about 200,000-plus square feet remaining outside of the anchor tenancies. But renewal might complete -- in Western Canada might deviate from what they do here in Ontario, which has really struggled during COVID-19. So all in all, all of them have expressed a desire to renew, hence our occupancy being what they are.

[Jonathan Kelcher, Analyst]

Okay. So on the anchor tenants, would you expect an increase?

[John Ginis, Director of Asset Management]

Most anchor tenants typically, the way their leases are structured, they have flat renewal rates. It'd be an option that they are afforded in the contracts. So I would expect them to be mostly flat as part of renewals.

[Jonathan Kelcher, Analyst]

Okay. And then on some -- I guess, on some of the renewals you've done year-to-date, some of those have switched to percentage rents. Are -- do you think any of the rest of the 200,000-plus or whatever switches to percentage rents?

[John Ginis, Director of Asset Management]

A lot of the renewals that you might reference that have switched to percentage rent -- you have to distinguish between ones that were part of CCAA restructuring and straight renewals done. For the most part, if you look at our enclosed mall portfolio, renewals we've structured deals are few and far between. So I would expect, as part of the renewal discussions, there might be some ones that are struggling that might want to go to a structured basis. But excluding those, our hope is to renew on existing contract rents.

[Jonathan Kelcher, Analyst]

Okay. Fair enough. And then just looking forward, how should we think about the enclosed retail coming out of this? Like the occupancy is down, around 92% right now. Do you think it's bottomed there and it starts to maybe grow next year?

[John Ginis, Director of Asset Management]

You know what, if you look at our occupancy statistics in retail, at the end of Q1 -- Q2 of 2021 versus the end of Q2 2020, we're effectively identical in terms of portfolio occupancy in both enclosed malls and community strips combined. So that's a testament to the management team and the entire Morguard team working with our retail tenants in order to retain occupancy. Like Andrew said as part of his comments, our hope is that we are now transitioning through recovery. So long as vaccination status continues to improve, we're hoping to work with our retailers to grow our portfolio occupancy once again.

[Operator]

Your next question comes from Jenny Ma with BMO.

[Jenny Ma, Analyst]

I wanted to ask about the unencumbered asset portfolio of over $300 million. I believe that is a change from year-end, right? Did a few assets come out into the unencumbered pool? And if you could tell us a little bit about the characteristics of that portfolio.

[Andrew Tamlin, Chief Financial Officer]

So there hasn't been any change in what has been part of that portfolio, Jenny. It obviously gets revalued every quarter. So I think what you're seeing there is just an uptick in that portfolio. So -- and quite frankly, it's just a mixed bag of various assets, including some strips, some office. So it really is just a bit of a mixed bag, no malls but just literally everything else.

[Jenny Ma, Analyst]

Okay. So when I look at your sort of near-term debt stack and what's due to come up over the next 12 to 18 months, really appreciate the disclosure on the LTVs you provide on your mortgages. You mentioned some up-financing opportunities. If you sort of look at the LTVs on '21, that's much lower versus 79% on 2022, could we see some pretty significant up-financing happen in 2021 to sort of cover off 2022? Is that a fair expectation?

[Andrew Tamlin, Chief Financial Officer]

Yes. I mean that's kind of what we're working on, Jenny. So yes, I think there's some opportunities there. And I think we'll be able to hopefully provide a bit more color on how that will look in the third quarter as we move towards the end of the year.

[Jenny Ma, Analyst]

Okay. And I guess on the same note, what would you say -- sort of on average, what's the LTV appetite on the lenders' parts? Like is something like 65% a reasonable expectation for the mix of what's coming due?

[Andrew Tamlin, Chief Financial Officer]

Yes, that's a pretty good estimate. I mean there's -- it's still a pretty strong market out there for mortgages and lending. So we're -- those are the -- 60% to 65% are -- is the numbers that we're looking at.

[Jenny Ma, Analyst]

Okay. And I'm also wondering about the convertible debenture that's coming due. I guess there's ample room on the unencumbered side. But is there -- has there been any discussions on what you might be doing about that, whether or not you want to or if you're able to roll it over as a convert or looking to sort of secure that debt?

[Kuldip Rai Sahi, Chairman, President & CEO]

This is Rai Sahi. I think we've talked about it. But we still got a bit of time to try and figure it out whether we'll -- what we'll do with it, whether we'll renew it or issue -- obviously, not renew it, just issue a new one or a combination thereof. So we've still got a bit of time to try and figure it out.

[Jenny Ma, Analyst]

Okay. Rai, could you remind me how much of the converts Morguard Corp holds?

[Andrew Tamlin, Chief Financial Officer]

$60 million.

[Kuldip Rai Sahi, Chairman, President & CEO]

Yes.

[Jenny Ma, Analyst]

6-0?

[Andrew Tamlin, Chief Financial Officer]

Yes, 6-0.

[Jenny Ma, Analyst]

Okay. Great. And then just going back to the mortgages. Between the room that you have on some of the 2021 expiries versus the unencumbered pool, do you have a preference for maxing out the 2021 first or tapping the unencumbered pool and having to bring it down a bit? Is there a preference either way?

[Andrew Tamlin, Chief Financial Officer]

Well, I think the first choice is really to see what opportunities we have on the mortgages that are coming due between now and the end of the year. And if we need to, we'll tap into the unencumbered asset pool. But it's easier to look at assets that are already mortgaged and there's typically an existing structure there or existing process that you can kind of leverage off of. So that would be first.

[Operator]

[Operator Instructions] Your next question comes from Pammi Bir with RBC Capital Markets.

[Pammi Bir, Analyst]

Just you previously mentioned that there was, I think, an $11 million hit to NOI, it's going back a few quarters, in terms of the -- from a retail standpoint from closures and rent adjustments. Do you think -- what are your thoughts with respect to how long it may take to recover that income?

[John Ginis, Director of Asset Management]

Pammi, it's John. So I'm going to take you back in time to the summer of last year. We faced the wrath of CCAA restructures and bankruptcies from a whole myriad of tenants in various sectors. So a lot of that $11 million is factored into that calamity that befell the industry. Retail market is evolving, it's changing. It's hard to predict the future. I can't say with certainty that all of that income will be recovered. No one really knows. So -- but where we have reopened is particularly in Western Canada, which has been stronger than here in Ontario. We're starting to see some more leasing inquiries coming from all types of sectors, all types of tenants, which is encouraging. Ontario though, it may be a little bit longer for it to truly come back. And no one really knows the answer to how long that will be because we're just coming out of a lockdown here.

[Pammi Bir, Analyst]

Got it. And just if we -- I don't know if you have this on you, but in terms of looking at that total impact, was the bulk of that felt in the Ontario mall portfolio? Or is it spread across the country?

[Andrew Tamlin, Chief Financial Officer]

I can maybe -- I would say the majority of it was felt in Ontario, Pammi, definitely sprinkled across the country as well. But definitely, the further west we get, the less impact.

[Pammi Bir, Analyst]

Got it. So I guess at the end, this is -- again, it's going to take a while for that to come back. Just you made some comments, I think this was going back to the Q4 call, with respect to potentially needing to pay down some of the mortgages that were coming due. And maybe that relates more so to the 2022 maturities. On any of the mortgages that you have renewed thus far this year, was that the case at all? Were there any reductions required or all sort of financed close to similar levels or up-financed?

[Andrew Tamlin, Chief Financial Officer]

So there was a small paydown on one of them, but by and large, they've been renewed as is. So I think out of $100 million, give or take, there was maybe a $3 million paydown on one small one. So -- but by and large, we've been renewing at -- the ones that have happened so far, they've just been renewed.

[Pammi Bir, Analyst]

Got it. Switching gears, coming back to Petroleum Plaza. Is that -- I know you mentioned the second half of this year in terms of having that -- hopefully closing the loop on that. Is that, at this stage, more likely a Q4 event? And then secondly, can you remind us again, does -- that rent adjustment, will that be retroactive to the start of the year?

[Andrew Tamlin, Chief Financial Officer]

Yes. So I can take that. So yes, I would say at this point, we're looking at Q4. Since we're not meaningfully engaged with them at this point, it's doubtful anything is going to happen in the third quarter, so I would say at this point, we're looking at the fourth quarter. And there will not be an impact to the numbers as far as -- or any material impact to the numbers when we do get to that renewal. We are estimating what that renewal will look like so that there isn't any kind of retroactive impact.

[Pammi Bir, Analyst]

Oh, I see. So you've been accruing for a possible rent reduction already in your numbers?

[Andrew Tamlin, Chief Financial Officer]

Correct.

[Pammi Bir, Analyst]

Okay. All right. Last one for me, just coming back to, I guess, retail and St. Laurent Centre and Cambridge Centre. Any updates here on the repositioning plans for the former Sears space? And -- or are these part of perhaps some larger mixed-use developments at some point in the future?

[John Ginis, Director of Asset Management]

We are constantly, Pammi, evaluating our options with respect to anchor vacancies. When we're ready to announce something insofar as a redevelopment of the boxes or any intensification of any of our sites, we'll come public with it. But it's a work in progress.

[Operator]

There are no further questions at this time. Please proceed.

[Andrew Tamlin, Chief Financial Officer]

Okay. Thanks, everybody, for joining the call, and enjoy your evening. Bye for now.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.