PRO Real Estate Investment Trust

TSX:PRV.UN

Earnings Call Transcript

[Operator]

Good morning, and welcome to the PROREIT First Quarter Results Conference Call for Fiscal 2023. [Operator Instructions] For your convenience, the results release along with first quarter financial statements and management's discussion and analysis are available at proreit.com in the Investors section and on SEDAR.

Before we start, I have been asked by PROREIT to read the following message regarding forward-looking statements and non-IFRS measures. PROREIT's remarks today may contain forward-looking statements about its current and future plans, expectations, intentions, results, levels of activity, performance, goals or achievements or other future events or developments. Forward-looking statements are based on information currently available to management and on estimates and assumptions made based on factors that management believes are appropriate and reasonable in the circumstances.

However, there can be no assurance that such estimates and assumptions will be proved to be correct. Many factors could cause actual results, levels of activity, performance, achievements, future events or developments to differ materially from those expressed or implied by the forward-looking statements. As a result, PROREIT cannot guarantee that any forward-looking statement will materialize. And you are cautioned not to place undue reliance on these forward-looking statements.

For additional information on the assumptions and risks, please consult the cautionary statement regarding forward-looking statements contained in PROREIT's MD&A dated May 10, 2023, available at www.sedar.com. Forward-looking statements represent management's expectations as of May 10, 2023, and except as may be required by law, PROREIT has no intention and undertakes no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

The discussion today will include non-IFRS financial measures. These non-IFRS measures should be considered in addition to and not as a substitute for or in isolation from the REIT's IFRS results. For a description of these non-IFRS financial measures, please see the first quarter earnings release and MD&A. A reconciliation of non-IFRS to IFRS results, as applicable, may be found in the earnings release and MD&A for the first quarter. Please refer to the non-IFRS measures section in the MD&A for the first quarter for additional information.

I will now turn the call over to Mr. Gordon Lawlor, President and Chief Executive Officer. Please go ahead.

[Gordon Lawlor, executive]

Thank you, Inna. Good morning, everyone, and welcome. Joining me today is Alison Schafer. Alison was appointed CFO and Corporate Secretary as of April 1.

Prior to discussing PROREIT's performance, I'd like to take a moment to thank Jim Beckerleg, who led us through substantial growth over the past 10 years as CEO and Co-Founder to build PROREIT into what it is today. We look forward to continuing to benefit from his real estate and capital markets expertise as a member of the Board.

Let me begin with a high-level overview of our results from the first quarter of 2023. We delivered a good performance, both from an operational and financial standpoint. Our strong results reflect the quality of our portfolio and our sound strategic positioning in the industrial sector, which now accounts for 69.5% of base rent. Our high occupancy rate remained firm at 98.6% at March 31, 2023. We continue to generate consistent organic growth as reflected in our same-property net operating income growth of 4.9% this quarter.

Same-property NOI in the industrial sector was strong at 4.7%, while our retail same-property NOI achieved 1.0% for the quarter. Our same-property NOI for the office sector, which only accounts for 10.5% of total base rent, increased by 16.9% compared to 2022. This is due to higher occupancy in Q1 2023 compared to the previous year as a result of a 30,000 square foot property with the short-term vacancy during the first 3 months of 2022.

Continuing along with same-property income -- net operating income. And as discussed during our last call, in Q2 and Q3 of 2023, our industrial same property will be largely affected by a 6-month vacancy for our 100,000 square foot property in Montreal. Effective September 1, 2023, the property will be fully leased and cash flowing and at a 40% leasing spread to its current rents.

On the renewal front, we continue to experience good momentum with 68.5% of gross leasable area maturing in 2023 successfully renewed at an average positive lease rate spread of 40.9%. 2024 renewals are also moving along well.

We remain focused on strengthening both our portfolio and balance sheet. After quarter end, we sold 1 noncore office property for $2.1 million, excluding closing costs. We also have approximately $36 million of office and retail properties under conditional sales contract. Subject to market conditions, if the sales go through, they would close the end of July for net proceeds of approximately $13 million. On that note, we will continue to recycle assets to maximize long-term value as we look for potential acquisitions in the industrial sector.

Last night, it was with great pride that we released our 2022 ESG report. We've made significant strides over the past year. We set out clear priorities with measurable goals and introduced new initiatives to increase our impact in all 3 areas of ESG. As an organization, we're excited to move forward on this journey, making further progress on the information we track and share with our stakeholders.

As many of you may be aware, in March, we suffered a tragic loss of Mark O'Brien, our Senior Vice President, Leasing Operations and Sustainability and Head of our ESG Steering Committee. Mark made significant contributions to the ESG report and had enormous impact on our organization on a daily basis. The entire team greatly missed his friendship, leadership and guidance.

I will now turn it over to Alison, who will provide more details on the results for the first quarter of fiscal 2023.

[Alison Schafer, executive]

Thank you, Gordie, and good morning, everyone. We started the year on solid footing. At March 31, 2023, we owned 130 investment properties, including a 50% ownership interest in 42 of the properties compared to 120 investment properties fully owned at March 31, 2022. At the end of Q1, we owned approximately 6.5 million square feet and managed approximately 8 million square feet. Total assets amounted to $1.05 billion at quarter end, up 1.9% year-over-year.

Property revenue grew to almost $25.3 million, a 3.9% increase compared to Q1 2022. The increase was mainly due to the impact in the number of properties and related ownership percentages during the last 12-month period. Net operating income reached $14.5 million, up 3.3% year-over-year, also due to the impact in the number of properties and ownership percentages. In Q1 2023, net cash flows provided from operating activities reached $10.6 million compared to $6.7 million last year, an increase of 57.3%. This increase is mainly related to the timing of cash receipts and settlement of payables.

For Q1 2023, AFFO was $7.8 million, and basic AFFO payout ratio was 87.0%, both flat compared to the same quarter last year. FFO for Q1 was down $3.2 million compared to Q1 2022, mostly because of a onetime retirement fee of approximately $1.6 million plus other onetime costs associated with the CEO succession of approximately $0.6 million, both included in G&A expenses.

Also in connection with the CEO succession, long-term incentive plan expense includes an additional $1.0 million in Q1 this year related to accelerated vesting of certain LTIP units. These onetime costs increased our G&A during the first quarter. For the remainder of the year, we expect to have a G&A run rate of approximately $1.2 million a quarter. At $8.31 per unit at March 31, 2023, our NAV per unit continues its upward trend.

Moving to financing. We further reduced our debt to gross book value ratio from 49.7% at year-end to 49.2% at March 31, 2023. Subsequent to quarter end, we received a commitment letter to refinance 6 industrial properties located in Winnipeg for $20.5 million. The rate on these new mortgages was fixed at 5.07% with a 7-year term. The refinancing is expected to close in June 2023. Proceeds will be used to repay approximately $16.6 million of mortgages maturing in July 2023, with the balance to be used for general corporate purposes.

We have another $32 million in mortgages coming due in 2023 that we expect to refinance on market terms. In addition, we signed a $10 million term sheet with a current lender to bolster our liquidity as we capitalize on the increased cash flows provided by some lower levered industrial assets.

I will turn the call back to Gordie for some closing remarks before we open the call for financial analysts to ask questions.

[Gordon Lawlor, executive]

Thank you, Alison. We are mindful that the current macroeconomic factors, including the high interest rate environment present certain challenges. However, we remain committed to execute on our growth plan to reach $2 billion in assets within 3 to 5 years and to increase our industrial base rent to 90% over the same period. We would do so while remaining focused on strengthening our balance sheet and disciplined on capital allocation.

I look forward to continuing to work with the talented PROREIT team to build our strong foundation and to create sustainable value for all of our stakeholders. This concludes our formal remarks.

I'll now turn the call back over to Inna to take questions from participants and -- sorry, from participating financial analysts. Thank you.

[Operator]

[Operator Instructions] Your first question comes from the line of Mark Rothschild from Canaccord.

[Mark Rothschild, analyst]

Maybe starting with the leasing spreads, which were quite strong. If you could just talk about in industrial, in particular, was there any specific leases that drove that and how we should think about that going forward if numbers like that are sustainable.

[Gordon Lawlor, executive]

Yes, it's Gordie here. I can give a couple of examples. And interesting, while I've mentioned already the Montreal property, so 3200 Guénette, which is in the Saint-Laurent area by the airport, we had $10 and $11 rents on that property and renewed for 10-year deals for 2 tenants for the entire building, which originally was only 90% leased for $15.50 and $15.75 a square foot. So 40% rate there.

Another example is in Southwestern Ontario, we have a Woodstock property, 66,000 feet, $5.35 rent moved to $10.50 towards the end of November on another 5-year renewal with no tenant inducements. And then for Halifax, we're just seeing, all the time, rents of $6 and $7 being renewed at $10 to $13. So we're seeing solid leasing spreads across our areas. Winnipeg, we did a few deals there, and they were 17% to 20% spread as well.

[Mark Rothschild, analyst]

Okay. Great. And maybe just one more question in regards to the office properties. Fundamentals haven't shown signs of strength of late, while your industrial performance has been doing extremely well. Any changing thoughts or new thoughts as far as do you want to maintain your office assets? Or would you be looking to maybe sell those in the next year?

[Gordon Lawlor, executive]

Yes. No, I think definitely speaking to our investors and the market, the preference is for us to increase our industrial exposure. So we have 3 office assets under conditional contract right now. We only have 9 in total in our portfolio. So yes, I'd say over the next few years, we'd see a reduction of the office exposure for sure.

We're just being mindful of our values and pricing, and they're well performing. So there's no need for a fire sale on any of these assets. These are just opportunities that are coming to fruition, and we're capitalizing on them. That said, it's a very complicated debt market, as everybody knows right now. So we'll see if we can get all of those assets closed towards the end of July.

[Operator]

And your next question comes from the line of Sam Damiani from TD Cowen.

[Sam Damiani, analyst]

I guess just to continue on Mark's last question there, I think you mentioned you have, I think, $36 million conditional sale that could close at the end of July. How much of that is office? And I think you mentioned the $13 million net cash proceeds there. Is it contemplated that the REIT will provide a VTB loan to the buyer in this case?

[Gordon Lawlor, executive]

No, 2 of the 4 assets have financing on them. So they're subject to [ loan ] assumptions. So we'll be working through that. The other 2 assets don't. There's been no contemplation of a VTB on any of those assets. The $13 million, if achieved, would be cash flow free and clear to the REIT.

[Sam Damiani, analyst]

Okay. Great. And I guess as you think about, I guess, future asset sales, just to, I guess, confirm what you answered -- how you answered Mark, I mean you're committed to exiting the office space. Are you somewhat price agnostic? It's a difficult question to ask maybe, but how do you -- do you view the current environment as a reason to sort of slow down on exiting office properties?

[Gordon Lawlor, executive]

Well, office is, as we all know, very difficult. So there's the cloud about what does office look like in the next 5 years. We're not really commenting or having a view on that. I mean I still think the office will be around here. It's just been in a dip and a 3-year head scratching to see what happens here. But that said, it hasn't been our focus for a long time. So we don't have a need to sell right now.

It's not ideal timing right now because if you look at a standard sale that doesn't have financing on it, if it's 3 months from bidding to closing, you have no idea what your cost of your debt is going to be. So certainly, these assets that we have under contract already have fixed rate financing on them. So I think that's probably the opportunity that we're getting reasonable pricing for these assets right now, and the other items, we're just going to watch the market and see what goes on here.

[Sam Damiani, analyst]

Okay. Last one for me, just on the mortgages that are left to mature in the current year, which I believe you said were $32 million. Are you seeing a change in the sort of loan to values that are achievable in the mortgage market today on those specific assets? And what kind of rate do you see being achieved on those refinancings?

[Gordon Lawlor, executive]

So the assets -- the deal we just did, we -- $16 million, refinanced it back up to 65%. So we achieved an extra $4 million there, spread on that on -- it was based on a cost of funds of that bank, but the spread on that would be equivalent to about 210 over on the 7 years. So that's still very reasonable for us at this point. Certainly, there's no 160 or 170 over. We're not seeing that right now on 5 year or 7 or 10, obviously.

The real estate coming due at the end of the year, some of it is office, and then there's a bit of industrial as well. That may tie into what we're going to do with the assets, whether there's refinancing opportunities or, if indeed we're going to sell over the next couple of years, we might put short-term financing on it rather than locking in rate. So that's just kind of up in the air as we sit here in May and look to December.

[Operator]

[Operator Instructions] Your next question comes from the line of George Huang from Raymond James.

[George Huang, analyst]

Just quickly on the divestiture front. Is there a preference for the sale of lower levered assets as you try to maximize proceeds? Or is the divestiture process right now really centered around how each asset fits within the portfolio?

[Gordon Lawlor, executive]

It's Gordie. It's really a combination of both. We get unsolicited bids all the time, which is interesting. So on industrial as well, by the way, significant bids that makes you pause for a second. But our focus is in industrial. The assets that are for sale, like I said, 2 of them have a longer-term financing on them right now with under market debt. So that's really attractive on a sale basis to achieve close to your IFRS values.

And then as we started out with 0 assets 10 years ago, some of our financings are a little bit more complex in that we've got several assets on certain mortgages in that. So really kind of looking at one-off assets that has a stand-alone financing, that would be an easier sale. So it's not really about net proceeds per se. It's about does the asset fit. Certainly, we have assets in Western Canada here, stand-alone pharmacies that are smaller, $2 million to $3 million. We're looking to divest of those as well.

So it's just -- it's really a combination of all of them. But I mean our retail is still performing very well and strong. But that said, we are getting interesting bids and offers, unsolicited on some of these that makes you do the math.

[George Huang, analyst]

Fantastic. Just one more from me on the leasing side. I know it's a smaller piece of the pie, but I did notice the strong retail rent spreads realized in the quarter. I'm curious, is that just the mark-to-market opportunity on those leases given what's rolling? Or is there something like conversion from gross rents to net rents that we should be noting there?

[Gordon Lawlor, executive]

No. It's just really -- a lot of our retail is in Atlantic Canada as well. So if you recall, the net rents there are a lot lower than the rest of the country, but to some extent, are catching up. So we're just capitalizing on that. It's not gross rent to net or anything like that. Basically, our whole portfolio is largely net rent. We don't have much gross or semi-gross rents in the mix at all. So it's just really market driven.

[Operator]

Thank you. There are no further questions at this time. Ladies and gentlemen, that does conclude our conference for today. Thank you all for participating. You may all disconnect.

[Gordon Lawlor, executive]

Thank you very much.

[Alison Schafer, executive]

Thank you.