Plaza Retail REIT

TSX:PLZ.UN

Earnings Call Transcript

[Operator]

Good morning. I would like to welcome everyone to the Plaza Retail REIT Second Quarter 2018 Earnings Conference Call. [Operator Instructions]I would like to advise everyone that this conference is being recorded.I will now turn the conference over to Mr. Michael Zakuta, Plaza's Chief Executive Officer. Please go ahead, Mr. Zakuta.

[Michael Aaron Zakuta, President, CEO & Trustee]

Thank you, operator. Good morning. Thank you for joining us on our Q2 2018 results conference call. We are legally obliged to tell you that today's discussion includes forward-looking statements. We'd like to caution you that such statements are based on management's assumptions and beliefs. These forward-looking statements are subject to uncertainty and other factors that could cause actual results to differ materially from such statements. Please refer to Plaza's public filings for a discussion of these factors.We continue to be very positive about our prospects as we grow our business across our geography. Our highlights are as follows: we have 14 projects under construction and a solid pipeline of deals under development; our niche of value necessity and specialty retail continues to perform well; we have signed renewals or new deals for 755,000 square feet in the first 2 quarters. That is 200,000 square feet more than in 2017.In June, we attended the Québec ICSC convention. Our leasing team met with 60 retailers or their brokers who were there to do deals, and we see continuing demand for space in our market niche. We continue to recycle capital as we have firm deals or have sold 20 properties for $31 million. The sales proceeds are 12% greater than our IFRS values for these properties. The properties that we have sold are noncore and were all part of our Key REIT portfolio. The bulk of these properties would represent our least attractive assets. We will continue to look to surface value from our portfolio.We were seeing a lot of secondary market retail properties coming up for sale as large REITs look to exit these markets. To date, most of these assets are finished product or are being considered as finished product by purchasers. Some of these assets represent redevelopment opportunities and should be redeveloped. It is clear that current market pricing will not allow us to acquire these assets for redevelopment. There appears to be a surprising demand from private investors, syndicated -- syndicators and fund managers for secondary market properties. We are very comfortable owning assets in secondary markets, but we have too much discipline to chase these deals. We are very active in pursuing new development and redevelopment opportunities. Some of these opportunities are redevelopments of enclosed -- of challenged enclosed malls, recycling obsolete retail buildings, redevelopments following demolition of the existing building or buildings and new developments following land assemblies based on demand from growth-oriented retailers.We've built our business by developing new projects and transforming tired or challenged assets. In addition, we continue to be a very proactive landlord. We do not hesitate to initiate change in order to keep up or build value within our existing portfolio, whether it is in making leasing and tenant changes or physical improvements to the properties.Going forward, Plaza will continue to pursue its goal of building value for its unitholders and generating per unit growth and will continue to differentiate itself from other REITs.I will now turn the call over to Floriana Cipollone, Plaza's Chief Financial Officer, who'll provide you with a brief summary of our results for the quarter.

[Floriana Cipollone, Chief Financial Officer]

Thank you, Michael.Mainly impacting results for the quarter were nonrecurring lease buyout revenues of $1.6 million recorded in the prior year as well as early mortgage discharge fees incurred in the current year in order to lock in lower-rate financing. As well, impacting the year-to-date results was 1 month of overlap in interest expense on convertible debentures as the new Series E converts were issued on February 21 while the existing Series D converts were redeemed on March 27. Excluding the impact of these 3 items that are more nonrecurring in nature, funds from operations, or FFO, per unit for the quarter and year-to-date was up 5.5% and 4.7%, respectively, compared to the same period in the prior year. While adjusted funds from operations, or AFFO, per unit for the quarter was consistent with the prior year and for the year-to-date was up 0.5%. The increase in FFO and AFFO was mainly due to growth from developments, redevelopments and acquisitions net of property disposal as well as an increase in other income, mainly due to an increase in third-party leasing and development fees earned from co-owned properties.AFFO was further impacted by higher maintenance CapEx and leasing costs relating to new tenancies. Total net operating income was up 3.4% for the quarter and up 2.4% for the year-to-date, excluding the impact of the lease buyouts.Total net operating income was impacted by growth in developments, redevelopments and acquisitions net of property disposal.Same asset net operating income was up 0.2% for the quarter and up 0.04% for the year-to-date, excluding the impact of the lease buyouts.For the quarter, same asset net operating income was impacted by rent increases and lower operating costs, partly offset by lower same asset occupancy, mainly from the enclosed malls, while the year-to-date was further impacted by $156,000 bad debt expense recorded in the first quarter due to a tenant going into creditor protection.Excluding the impact of the lease buyout, the 1-month overlap of convertible debenture interest and the early mortgage discharge fees, our FFO payout ratio for the quarter and year-to-date were improved compared to the prior year.Our AFFO payout ratios were slightly higher for the quarter and year-to-date compared to the prior year, mainly due to the higher maintenance CapEx and leasing costs incurred. Our leverage ratios ended the year at 48.8% of assets excluding converts and 53.8% including converts.Those are the key points relating to our financial results for Q2 2018.With that, we'll now proceed to open up the lines for any questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Kyle Stanley from Desjardins.

[Kyle Stanley, Associate]

Just a couple of questions from me this morning. I was wondering if you could provide us an update on the progress on the lease-up to backfill the space that was vacated last year as part of the early lease termination. How maybe interest has been and how pricing is relative to your expectations?

[Michael Aaron Zakuta, President, CEO & Trustee]

So the space is leased, but it's not revenue generating yet.

[Kyle Stanley, Associate]

Okay. When would you expect that?

[Michael Aaron Zakuta, President, CEO & Trustee]

There were 2 spaces. One of them is leased. The second one is leased but not opening until, I think, November 2018.

[Kyle Stanley, Associate]

Okay, great. I guess, secondly, are there any updates on the Wicker Emporium, the CCAA process? I mean, you mentioned last quarter they were continuing to pay rent at their 4 locations. Just wondering if that's changed. You said they could relinquish maybe 1 or 2.

[Michael Aaron Zakuta, President, CEO & Trustee]

So 2 of the 4 were given back. We still have 2, and they're paying rent.

[Kyle Stanley, Associate]

Okay. And then could you provide a bit of color on the disposition of the development property in Anjou? It seemed like a -- good return there.

[Michael Aaron Zakuta, President, CEO & Trustee]

Yes. It's a property that I -- that we really didn't like. We didn't think it was the type of property that we wanted to own because of its location. We were able to redevelop it and actually sold it to a user. The effective cap rate is like 3.9% because there is some vacancy that the user will occupy. So it's really a question of is this the kind of property, the type of location that we want to own? If it came up as a single offering out in the market, we probably wouldn't look at it because I think the location kind of has some challenges, but it came with the Key REIT portfolio. So we're happy to exit from that type of property.

[Kyle Stanley, Associate]

Okay, that's great. And I guess, just the last one for me here. So when you're evaluating these enclosed mall vacancies, do you see this as more transitional in nature? Or would it be a bit more of a structural issue? And I guess, is there potential to re-lease the space? Or would it be more of an opportunity to maybe reposition some of those assets?

[Michael Aaron Zakuta, President, CEO & Trustee]

All the vacancy comes from 1 shopping center, Village Shopping Centre in St. John's, Newfoundland. We just leased 40,000 square feet for a call center space that's not on the mall. There's 1 large mall location that's available there, which is very, very good space. So we expect to lease it. But in this type of property, you're going to see a lot of up and down, continually going up and down. We bought that property with like 40% occupancy level. We brought it up to, say, 95%. It's down at 88% now, and I expect to bring it back over 90%. But there's a lot of slugging in the enclosed mall game, and I think that's a surprise. Our other enclosed malls are pretty stable. There's 2 other real enclosed malls in Montmagny and Rouyn-Noranda. And they're pretty stable and have -- they have good occupancy.

[Operator]

Our next question comes from the line of Sumayya Hussain from CIBC.

[Sumayya Hussain, Associate]

Michael, you've spoken previously about Sears and kind of the derivative impact on -- [ mostly ] on your development projects. And as you look through your development pipeline, are there specific assets or projects where you would expect more competition? And which ones would those be? Or was that more of kind of a macro statement on just like headwinds in retail?

[Michael Aaron Zakuta, President, CEO & Trustee]

I think it's more of a macro. I don't think that we're experiencing serious competition on some of the new stuff that's coming out of the pipeline. I guess, I've talked about retailers being very distracted by Sears, the opportunities -- and other opportunities like that. That's probably slowed us down and maybe it's cost us a deal or 2 in some places. But in general, business is still pretty solid for us in our niche. We feel very confident of what we're doing and how we're going about it and the type of deals that we want to do.

[Sumayya Hussain, Associate]

Okay. So it's more of a, I guess, macro environment?

[Michael Aaron Zakuta, President, CEO & Trustee]

Yes.

[Sumayya Hussain, Associate]

And on the 1000 Islands Mall, can you update us on your plans for the site and what you're seeing so far in terms of tenant demand there?

[Michael Aaron Zakuta, President, CEO & Trustee]

So we're well underway. The Sears box is in the middle of transformation. It's all spoken for. There's one deal that's not signed, but we have a deal. And it's with a tenant that we have a lot of locations with, so I consider that the deal is going to happen at the Sears space. The balance of the frontage is basically spoken for. I think there's going to be one opportunity when we shut down the mall where we take back the mall space and neighboring space to create a decent strip store. That will be the only available space in the property at this moment in time. So we're ahead of schedule. I think we're making things happen. When you're doing a mall to strip simplification, what you really have at the end of the day is frontage. I mean, you have lots of square footage, some of it is never going to get leased. But you have a lot -- you have frontage. And once your frontage is gone, you're finished. And our frontage is basically spoken for.

[Sumayya Hussain, Associate]

Are you still targeting by the end of 2019 [ before it becomes ] stabilized?

[Michael Aaron Zakuta, President, CEO & Trustee]

Yes.

[Operator]

Our next question comes from the line of Michael Smith from RBC Capital Markets.

[Michael Smith, Analyst]

Some of your -- some of the other REITs that operate in your neck of the woods, so to speak, they're suggesting that it's actually a buyer's market. In other words, there's a lot of stuff on the market and that prices are not that attractive. And I think from what I understood from what you're saying is that prices are still too high. I was wondering if you could comment on that. And then sort of related to that is, given the way retail REITs are being treated on the stock market, would it make sense to step up your sales program if you're happy with prices?

[Michael Aaron Zakuta, President, CEO & Trustee]

Okay. In terms of pricing, our geography is very, very large. But we are seeing -- you're seeing it, right? RioCan has had a lot of success in their secondary market sales program. What we're seeing is there are assets out there that we think should be redeveloped. But there are a number of purchasers, because they will get a higher cap rate than they will find in Southern Ontario, are going to step up and buy it and just milk it because they're making fees going in and fees during ownership and don't have the same view of property ownership as we have. So we're definitely competing with that, and we've had an attempt that -- thinking that we can buy some stuff and not have to do a lot of change and development, still make some healthy returns because pricing was going to be favorable to the buyer. We have not benefited from that approach yet.

[Michael Smith, Analyst]

And would it make sense to sell some of your assets, especially your stable ones?

[Michael Aaron Zakuta, President, CEO & Trustee]

Yes. Yes. I mean, that's something that -- we're running lots of models today to look at perhaps we should be selling some stuff. And I think some stuff will sell very -- quality stuff is going to sell, I think, no matter where it is or what market. If your quality is not good, then you're going to be challenged today. But our quality stuff is -- there are a lot of buyers. We're quite surprised. If you're talking enclosed malls in a small town of Quebec, that's probably a challenge. But if you're talking food-anchored and pharmacy-anchored product anywhere, there is demand.

[Michael Smith, Analyst]

And it sounds like you have no shortage of redevelopment opportunities where the real estate is broken, so it would be like -- you're already doing this, obviously. I'm just sort of looking at the volume of what you're doing, like just recycle the capital from those stabilized properties that are getting an attractive bid into more empty Sears, that type of thing.

[Michael Aaron Zakuta, President, CEO & Trustee]

Obviously, that is our business model, as you know, and it's all a question about opportunity and pricing. It's got to come to us. If the pricing is not there, then there's no sense in doing all of the work that you have to do to transform a property if you're not being rewarded. So I think we've been very disciplined over the years, and I expect that we will continue to have that discipline. I think there are opportunities, and we're pursuing. We're seeing a lot of stuff. There's a lot of analysis going on today regarding different opportunities and empty buildings and buildings where retailers are relocating to grow or to reposition themselves, and we're on it. That's exactly where we want to be.

[Michael Smith, Analyst]

Good. Okay. And could you like just define noncore for us? Just remind me what you consider noncore? Obviously, the Key REIT thing is one, but just in general.

[Michael Aaron Zakuta, President, CEO & Trustee]

So noncore, so we had a building in Halifax, 2 stories, a big office component. That's definitely noncore. And if you hung around with us, you know that we don't do -- we don't like to do second floor office. Never -- that's like a pro forma dream. Guys do it because they pro forma -- it looks good in the pro forma. But ultimately, you don't ever make any money and it becomes a burden. It can ruin your [ parking, ] whatever. There are a whole list of reasons never to do second floor [ but ] retail. But that was an example of a product with not a lot of parking, second floor offices, and so that's very noncore. In the case of Anjou, again, I just don't like the location for a variety of reasons. And so core to us is food, pharmacy, dollar store-anchored product. All that value stuff that we've been doing year in, year out, that, to me, is very much core product. KFC, here or there or anywhere is not core, and we're happy to own them. And we think that they're giving us solid cash flow, but we don't have to own them.

[Michael Smith, Analyst]

Right. Right. Okay. And can you talk about what retailers are expanding and maybe touch on cannabis stores?

[Michael Aaron Zakuta, President, CEO & Trustee]

Yes. So I mean, they're still the same usual suspects that are growing. You have the dollar store. You have the pet category. You've got PetSmart. You've got Ren's. You've got Global Pets. You've got Mondu. You've got Pet Valu and others. So like [ getting Tigers' ] announcement this week. You have all the TJX banners, the Michaels stores, Giant Tigers, Structube; all the fitness guys with Movati or Planet Fitness or others. You have Farm Boy. You have Metro banners. You have the quick-service restaurants, the Princess Autos of the world. All that niche continues to grow and it's seeking stores in our markets. As far as cannabis is concerned, quite interesting, I think I've talked about we've delivered 3 cannabis stores in New Brunswick. They're actually paying rent now although they're not open. Those are government -- they're liquor board leases. So in effect, liquor board is owned by the government. A lot of calls about our Ontario assets. So I think we're going to see some benefit. Hard to measure yet what that's going to look like. So I think the whole Ontario program is still unclear. But the retailers -- the cannabis retailers are clearly knocking on all landlords' doors, and we're going to see some activity if it really goes into a private model. Same thing in Newfoundland. Nova Scotia is a hybrid. Québec is government through the SAQ, or the Société Cannabis de Québec (sic) [ Société Québécoise du Cannabis ] . So that's slow moving. So there's definitely going to be action and financial benefit from cannabis retail. How it impacts our shopping centers, that's still unclear, but we're prepared to do the deals.

[Michael Smith, Analyst]

And what kind of like rents do you get? What's like the store size rents for the deals you have done and the ones you're talking about, rent store size and TI allowance kind of or build-out?

[Michael Aaron Zakuta, President, CEO & Trustee]

So the New Brunswick, I think, are particular -- in New Brunswick government, the government before was really quick out to shoot with a very complex building, building like -- built to bank and jewelry store specifications. Those are very expensive build-out and are very high rent with a 15-year lease. So that was New Brunswick model. I'm expecting in the private sector, it would be very, very different. And in the public, you're going to see more liquor store-like style buildings, and private is going to be different. I haven't seen the Alberta, what's going on out there. I've heard a lot about it. I think it's a little early to give sort of solid responses and direction. But there's clearly going to be a lot of activity, and it's going to be beneficial to landlords. And hopefully, you're going to sign the guy that's going to survive, and that's part of the challenge. In the case of a government lease, you're not worried about it. In the case of a private guy, you have to be concerned about who you're working with. So we're careful. We want to be very cautious about that.

[Michael Smith, Analyst]

Sure. Yes, that makes sense. And do you anticipate it being mostly inline-type stores or like pads?

[Michael Aaron Zakuta, President, CEO & Trustee]

I think the ideal -- from a landlord's perspective, the ideal is a freestanding. You take a quick service restaurant and you convert it to a cannabis store. Cannabis store will typically be between 2,000 and 3,000 square feet. Our New Brunswick model is 3,000 square feet. I think they can live with 2,000. So that way, you have no issues with neighbors or anything or use clauses or whatever restrictions that somebody may wish to apply, and off you go. So that's ideal. So we have some opportunities like that. And the stuff that we did in New Brunswick, we built -- basically, we built pads. We didn't put it inline. We would put it inline on the right circumstances, but we were cautious not to bid some of our, I call, our fancier strips that are -- that have a really strong tenant base. And we didn't know what the impact would be, so we're taking a cautious approach.

[Operator]

[Operator Instructions] Mr. Zakuta, there are no further questions at this time.

[Michael Aaron Zakuta, President, CEO & Trustee]

Thank you, operator. In conclusion, we continue to offer a very different real estate investment opportunity with a focus on per unit growth and value creation through our accretive developments and redevelopments. Plaza does not buy finished properties from third-party developers or related parties at low cap rates. We are fully internalized, able to develop new retail properties using in-house resources. Plaza locks in consistent long-term returns by financing with long-term debt, generally matched to lease maturities. We have consistently demonstrated our entrepreneurial abilities by adapting to changing market conditions in order to grow our business. [ Insiders ] hold an important ownership position and look forward to growing Plaza's distribution in the future.Thank you for participating in today's call.

[Operator]

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your lines.