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 Third Quarter 2021 Results Conference Call. [Operator Instructions] This call is being recorded on Thursday, October 28, 2021. I would now like to turn the conference over to Andrew Tamlin. Please go ahead.

[Andrew Tamlin, Chief Financial Officer]

Thank you. Good afternoon, everyone. My name is Andrew Tamlin, Chief Financial Officer of Morguard REIT. Welcome to the Morguard REIT Third Quarter 2021 Earnings Conference Call. I am joined this afternoon by John Ginis, Assistant Vice President of Retail Asset Management; Tom Johnston, Vice President of Western 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 third 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 third quarter continues with the same theme that we saw in the past few quarters, which is hopefully a transition back to a normally functioning real estate market. We are pleased to see positive results again this quarter. Collections in our office and community strip asset classes continue to be strong as well as our enclosed malls in Western Canada, which are back to 100% collections. Same asset net operating income for the quarter was improved across all asset classes, which is the second quarter in a row we have seen this trending. Net operating income increased 6.7% for the third quarter as compared to 2020 to $30.4 million from $28.5 million last year. The increase that we saw this quarter was similar to the 6.5% increase we saw in the second quarter. The increase in NOI is due to a reversal of bad debt expense recorded in 2020 in relation to the large amount of uncollected enclosed mall receivables and failed tenants, along with rental growth in the community strip and single-tenant asset classes. Same-store net operating income has increased almost 8% for the quarter as compared to 2020 with increases across all asset classes, including a 20% increase in enclosed regional centers. We have seen continued declines in interest expense this quarter, which declined 5.4% or $700,000 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%. This lower interest rate was the result of the large amount of refinancings in both the latter half of 2020 and earlier in 2021, all at lower rates. Total debt is $50 million lower at September 30, 2021, as compared to a year ago. Interest expense for the 9-month period ending September 30, 2021, is down $2.7 million on a year-over-year basis. Notwithstanding the improved results, there are still challenges, particularly in our enclosed mall portfolio. For two Ontario enclosed malls, St. Laurent and Cambridge were closed for portions of 2021 due to Ontario [indiscernible] still subject to COVID restrictions such as mask mandates. Although it is noted that there is now a road map for Ontario to be completely done with these 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 90% to 100% depending on the asset. 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 coming from tenants that have been the most severely impacted by the lockdowns with gym operators, beauty services and food service tenants being at the top of the list. As these tenants have reopened across Canada and restrictions are eased, we are optimistic that we'll continue to see improvement in our cash collections for the rest of the year. The rent arrears and deferrals at September 30, 2021, totaled $12 million, which was down from $16 million at the end of June and $20 million at the end of March. The allowance for doubtful accounts assigned to these arrears totaled $5.3 million or approximately 1/2, excluding sales taxes. Approximately 1/2 of the arrears is due to the 2 malls in Ontario, which have seen the most lockdowns under COVID. As mentioned, we are still working on rent solutions for these arrears. And we expect these balances 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 $16.6 million in 2021 as compared to $14.4 million in 2020. The REIT's PCME, our operating capital reserve has been established to be $4.6 million per quarter for the year, which is approximately 75% of normal levels. We have spent approximately $10 million to date of the $13.9 million Q3 reserve, but do expect this variance to reverse in the fourth quarter as we have some capital projects lined up. On a year-to-date basis, our FFO has increased 7.3%, and AFFO has increased 6.7%. Our retail occupancy levels at September 30 were in line with the year ago at 94%. Our office occupancy levels have slipped to 87% from 90% a year ago as we have seen some tenants look for other solutions upon their lease expiration. 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 assets. We are still seeing declines in traffic patterns across most of our enclosed malls from pre-pandemic levels. However, this has not always meant declines in sales. Instead of folks coming to malls to window-shop or lounge at the food court, we are seeing much more targeted traffic, whereby folks are coming and going in an efficient manner. Looking at financing, there was one mortgage renewal completed during the quarter, suburban office asset in Calgary, resulting in up financing proceeds of approximately $8 million. We are working on one last mortgage renewal in the fourth quarter, which is secured by a government tenant office building in Vancouver. We believe there's a $35 million up financing potential for this mortgage and is expected to close [indiscernible].We are mindful of our convertible debenture renewal, which is coming up at the end of the year. We have been in close touch with the various investment banking relationships we have and are currently considering renewal options. We expect to make a decision on how to approach this maturity shortly. And now for an update on our leasing efforts. For the rest of 2021, there is 168,000 in retail GLA coming up for renewal. 120,000 of this GLA is from an anchor tenant, which will be renewing. Every other retail space greater than 5,000 square feet that is coming up for renewal between now and the end of the year either has been renewed or is expected to be renewed. Further, the vast majority of the 86,000 office GLA coming up for renewal in the fourth quarter is from the government lease in Ottawa, which has already been renewed. Management has 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 an overhaul. While they have verbally told us that they expect to renew, they have unfortunately still been focused on the response to the pandemic, which has taken priority. At this point, we are looking at 2022 in order to get this completed. Turning to financing and liquidity. The trust has $163 million in liquidity at the end of the third quarter and $322 million in unencumbered assets. This liquidity position has increased from $127 million a year ago. Factoring in the up financing expected to close in the fourth quarter, this would give us almost $200 million in liquidity by the end of the year. The trust has started the Save-on-Foods development job at Pine Centre, which entails the retenanting of the empty Lowe's premises into a new 38,000 square foot Save-on-Foods grocery store. Demolition of the existing former Lowe's premises is pretty well completed. This is expected to be completed in Q3 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 [indiscernible] some of the REIT's assets are going through their 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 and results. 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 from TD Securities.

[Jonathan Kelcher, Analyst]

Thanks for the color on the retail expiries over the remainder of this year, that's helpful. But as you look to 2022, you've got about 15% of your retail portfolio expiring. Are there any large leases in there that you're concerned about renewing?

[John Ginis, Director of Asset Management]

John Ginis here. We are currently involved in negotiations with large format anchors that make up a good proportion of that 15% you just noted. Those discussions started some time ago. It's preliminary. So I don't want to answer your question directly. But for the most part, we expect to renew most of that 15%.

[Jonathan Kelcher, Analyst]

Okay. That's good. And if we think about expiring rental rates around $26 for that, should we think about any roll downs or increases?

[John Ginis, Director of Asset Management]

It varies on the sector and the retailer. Usually, the large-format guys, we typically hold our income when it comes to rental rates -- negotiations there. Again, depending on the size of mass, you're limited on your upside on the in-line small bay CRU, especially in the enclosed mall format. That's more of a challenge [ that's given ] that it's gone on over the last 18 months. So especially in situations like Ontario, where it's been disproportionately impacted during COVID, those negotiations might be a little bit tougher. I can't quote you exactly what proportion that makes up. But all in all, our hope is to maintain a flat to slight regression in some of the in-line small [ bay ] rates for CRU in malls.

[Jonathan Kelcher, Analyst]

Okay. I guess switching gears a little bit. You guys sold a small asset in the quarter. What was the thought process behind that? And what cap rate did you get on that?

[Andrew Tamlin, Chief Financial Officer]

So that was a strip mall in London, and it was a bit of an orphan, quite frankly. There wasn't really any other asset nearby. So it was a nonstrategic asset from our standpoint. We did get a pretty attractive offer on it, so we decided to execute on a decline to quote the cap rate. We don't normally do that, but on the other hand, it wasn't [ all that ] material either.

[Jonathan Kelcher, Analyst]

Okay. But there is no -- was there a gain versus your IFRS value?

[Andrew Tamlin, Chief Financial Officer]

There was, yes.

[Jonathan Kelcher, Analyst]

Okay. How much of a gain? I don't...

[Andrew Tamlin, Chief Financial Officer]

Probably about 25%, give or take.

[Operator]

[Operator Instructions] Your next question comes from Jenny Ma from BMO Capital Markets.

[Jenny Ma, Analyst]

With regards to the enclosed mall portfolio, it looks like you got a pretty nice lift in NOI sequentially. I'm wondering if you can comment on how far below the steady-state potential that NOI is, given that there were still some limitations on the Ontario assets and sort of like a post-COVID run rate or anything that could help us quantify that?

[Andrew Tamlin, Chief Financial Officer]

Well, there's -- I would think -- I would just point out that the bad debt expense that we booked last year is partially being reversed, Jenny. So that's one of the reasons why we're seeing improved NOI in that asset class. I think as we move forward, we'll continue to see improvements in rental growth. There's some point deals that we have, but it's really tough to kind of pinpoint.

[Jenny Ma, Analyst]

I guess, I think the reversal of about $0.5 million, and you did [indiscernible] this quarter. So I guess I'm just trying to get a sense of how far below potential that is.

[Andrew Tamlin, Chief Financial Officer]

I'm not sure I know what you mean. What do you mean how far below potential?

[Jenny Ma, Analyst]

Like is there -- was there a pretty good rent collection coming from the Ontario guys? Or would you expect that number, that [indiscernible] to grind upwards? Or do you think that with reopening happening July 1, that a lot of that gap was picked up in Q3?

[Andrew Tamlin, Chief Financial Officer]

Well, we expect to see collections continue to decline as we move forward between the end of the year and probably into the first quarter of 2022. So there might be a bit more reversal of bad debt expense as we get there. Typically, the way it's been working is that the bad debt reserves are more conservative than what's happened. So -- but we'll have to see.

[Jenny Ma, Analyst]

Okay. Moving to your debt stack. You mentioned the convert that's coming due in a couple of months. When you say renewals, do you mean the intention is to renew it into another convert? Or do you mean it broadly just addressing the convert altogether with different options?

[Andrew Tamlin, Chief Financial Officer]

Well, right now, we're looking at renewal options. And I think we will advise when we've made a decision on that.

[Jenny Ma, Analyst]

Okay. And then I'm looking at the mortgage stock and the 2021 financing looks attractive, but it looks there might be a bit of a shortfall next year assuming a similar LTV for 2022. Do you think that the LTV might be a little bit off because of the market value? Or would you look to maybe dipping into the unencumbered pool to make up for that shortfall for next year?

[Andrew Tamlin, Chief Financial Officer]

Yes. I mean, we've -- we're aware of the maturities coming up for next year. And you're right, there will be a challenge. We will have the option of dipping into our unencumbered asset pool as well. You're right. So -- but we'll decide exactly how we approach that when we get into the year. A lot of those -- a lot of that is happening later in the year. So it's not kind of right off the bat, if you want to call it that.

[Jenny Ma, Analyst]

Okay. And could you give us an indication of what kind of properties would be in there? Are they enclosed malls, office assets or a mix [indiscernible]?

[Andrew Tamlin, Chief Financial Officer]

Primarily office.

[Jenny Ma, Analyst]

Primarily office. Okay. Great.

[Operator]

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

[Andrew Tamlin, Chief Financial Officer]

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

[Operator]

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