PRO Real Estate Investment Trust

TSX:PRV.UN

Earnings Call Transcript

[Operator]

Good morning, and welcome to the PROREIT Second Quarter Results Conference Call. [Operator Instructions]. Mr. James Beckerleg, President and Chief Executive Officer; and Mr. Gordon Lawlor, Executive Vice President, Chief Financial Officer and Secretary, will make a short presentation, which will be followed by a question-and-answer period open exclusively to financial analysts. [Operator Instructions] For your convenience, the press release, along with the second quarter financial statements and management's discussion and analysis are available at proreit.com in the Investor's 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 prove 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 August 11, 2021, and available at www.sedar.com. Forward-looking statements represent management's expectations as of August 11, 2021. 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 measures or results. For a description of these non-IFRS financial measures, please see the 2021 second 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 second quarter of 2021. Please refer to the non-IFRS and operational key performance indicators section in the MD&A for the second quarter for additional information. I will now turn the call over to Mr. James Beckerleg, please go ahead.

[James W. Beckerleg, President, CEO & Trustee]

Thanks very much, Carl. And good morning, everyone, and welcome again this quarter. I guess, well, many of you may still be working remotely and tuning in from home. I must say that for me, it's great to be getting back to the office gradually and I think safely. As we are all together moving towards the so-called new normal, it's nice to feel the confidence of our many stakeholders now and the communities where we operate, restored after a long period of uncertainty. But it's against this backdrop that I am pleased to report that PROREIT delivered what we are very confident is a solid performance for the second quarter of 2021. Those of you following us may recall, we actively returned to growth in the first quarter of this year, and we have maintained this momentum going through the second quarter as is reflected across our key operational and financial metrics, which were all announced in our press release yesterday evening. During the quarter, we completed the acquisition of 18 industrial properties for $133.7 million. They were financed in part from new first mortgages, which we believe history will show we're carrying very attractive deal terms. We sold out on 1 nonstrategic retail property in Fredericton, New Brunswick during the quarter for just a shade under $5 million, but still marginally above our IFRS carrying value. Therefore, on a net basis, our total portfolio is comprised of 107 properties now, covering 5.5 million square feet. The accretive acquisitions made over the last year have further diversified our tenant base, which we believe is important and increased our concentration in stronger asset classes and very desirable locations. Of special note, our exposure to the very robust industrial sector now represents 56.5% of our portfolio of base rent compared to just 48.2% a year earlier -- a year ago. These purchases have also increased our presence in Winnipeg and Ottawa, 2 markets that have shown remarkable resilience over the mid- to longer term. And we now own 15 properties in Winnipeg, 10 in Ottawa and look forward to further growth in those cities in the future. We believe both the -- both of the factors, industrial concentration and the markets that we're in will contribute to -- geographical markets we're in will contribute to improved operating results in the quarters going forward. As mentioned in our last call, during the quarter, we completed the $50 million private placement with the Bragg Group of Companies, which provided equity support for the transactions I've been speaking to. We welcome them, I must say, as major new shareholders and look forward to our future together. On the operational front, we have consistently maintained firm rent collections during the pandemic, was substantially all rent collected again in this quarter. This highlights that we believe the strength of our well-diversified tenant base across all sectors of the real estate that we're investing in. Leasing activity continued to be robust in the second quarter, and our occupancy rate actually increased slightly to 98.5% at June 30 compared to 98.1% a year ago. We have renewed approximately 80% of the total square feet maturing in 2021, have positive spreads to the maturing leases of 4% and we are actively engaged with the balance of the space in real time as we speak this morning. Attention, of course, at this time of the year has already turned to 2022 renewals and many negotiations with maturing leaseholders are already under date -- underway. To date, we have renewed 17% of leases maturing next year and average spreads there, again, a positive 3% across what we have renewed. So I'll now turn it over to Gordy, and Gordy will discuss our second quarter financial results in a little more detail.

[Gordon G. Lawlor, Executive VP, CFO & Corporate Secretary]

Thank you, Jim, and good morning, everyone. We delivered a strong financial performance in the second quarter. Revenues amounted to $17.8 million down for the -- dollars for the quarter, a 3.2% growth compared to the same period last year. Net operating income reached $10.7 million, an increase of 9.8% compared to Q2 2020. These increases are as a result of the favorable impact of net property acquisitions in the last 12 months. We're particularly pleased with the growth achieved across our 3 sectors of activity with 6.2% increase in same-property net operating income compared to the prior period. Excluding COVID-related expenses of $200,000 recorded in the second quarter of 2020, same-property net operating income increased 4.3%. The favorable impact reflects increased for occupancy contracted rent steps and higher net renewal rents in our portfolio. AFFO totaled $5.7 million, a 10% increase compared to the same prior period. Due to timing, our AFFO payout ratio increased to 92.3% in the second quarter of 2021. This is because of the lag between the deployment of the funds from the private placement and incremental monthly distributions paid in the current quarter on the newly issued units from the private placement. This number is expected to stabilize in the third quarter. We continue to make meaningful strides strengthening our financial position, which is a key component of our strategy. As Jim mentioned, we closed a $50 million private placement in the quarter. We now have an excess $20 million in operating liquidity. We've also entered into a new $24.8 million mortgage financing at a better rate and extended term for 6 of our retail assets, bringing the total amount of 2021 and 2022 mortgages refinanced $50.6 million year-to-date. Our debt to gross book value was 58.2% at the end of the second quarter. Weighted average interest on mortgage debt was 3.5%, down from 3.72% in the same quarter last year. The benefits of our financings and acquisition activity will more -- will be more fully reflected in our third quarter results. Turning to distributions, $0.037 per unit were declared monthly throughout the second quarter of 2021. Our weighted average cap rate for the portfolio is approximately 6.3% and -- or $137 per square foot. I'll now turn it back to Jim for closing remarks.

[James W. Beckerleg, President, CEO & Trustee]

Thanks for that, Gordy. I'll just conclude by saying with vaccination programs progressing well across Canada and the strong restart we're seeing in the economy. Our business outlook at PROREIT has become very positive. We believe we are poised to benefit from what is a solid position, and we are staying committed to our strategic goals. These include strengthening the value of our portfolio and optimizing our debt profile, which we've spoken to somewhat this morning as well as broader growth. Our current focus is mainly on the robust industrial sector and scaling up our presence in attractive midsized Canadian cities. In closing, I want to extend a special thanks to -- thank you to all of our employees. They have successfully navigated an unprecedented period, and I'm really truly gratified by the perseverance to the entire PROREIT team. I also want to recognize, of course, my fellow Board members for their continued support and counsel. And I truly look forward to seeing everyone, including the people on this call as we gradually and safely return to the office over the next few months. We believe with the economic expansion, many new opportunities will present themselves going forward. We are all motivated and committed to creating long-term value for our unitholders in this changing atmosphere. So that wraps up our formal comments, and I'm glad to turn it back to the operator who can manage any questions that the analysts may have for us this morning. Thanks very much for your attention.

[Operator]

[Operator Instructions] Okay. Your first question comes from Colin Healey from Haywood Securities.

[Colin Healey, Research Analyst of Mining]

Congrats on a pretty -- on a solid looking quarter. I was just wondering if you can give us an idea, and I'm not sure if you can on the Q2 kind of exit run rate revenue here with the 17 net new properties now fully integrated?

[James W. Beckerleg, President, CEO & Trustee]

Gordy, you want start.

[Gordon G. Lawlor, Executive VP, CFO & Corporate Secretary]

Yes. So you're talking about what the acquisitions would be in -- on an go-forward basis type thing, I mean?

[Colin Healey, Research Analyst of Mining]

Yes, sure. That was still not playing, for sure.

[Gordon G. Lawlor, Executive VP, CFO & Corporate Secretary]

With the 18 -- I mean, we've given estimated cap rates and what not, with the 18 acquisitions, there's -- it's about $8 million of incremental NOI to the REIT. There's only about $500,000 of that reflected in this quarter. Obviously, not the new interest rates on the new debt is not reflected in this quarter from an expense standpoint. It is from balance sheet standpoint. So about $8 million. And then you'll see the incremental interest rate on all this stuff is between 2.87%, 3.03%. So we're pretty happy with all of that.

[Colin Healey, Research Analyst of Mining]

Okay. Great. And do you have any update on the property that was acquired and designated for improvement. When that might be complete and hitting the revenue?

[James W. Beckerleg, President, CEO & Trustee]

Like you're tough. We just closed on it May 25 Colin, anyway, and we had a 2-year development plan for it.

[Colin Healey, Research Analyst of Mining]

I'm sorry. I was just wondering what -- 2-year development. That's...

[Gordon G. Lawlor, Executive VP, CFO & Corporate Secretary]

Yes. But that said, we're in the -- we have 1 RSP we're working on right now with a tenant, and we'll see in the next little while if that comes to fruition and not. It's an interesting property in that -- it's 82,000 square feet, it can be a single tenant of property. And it can be split up into 40,000 square foot base or actually 20,000 square foot base. So we're running this first opportunity to the ground and we'll see where that goes, but we're pretty confident in this property over the next couple of years, for sure.

[Colin Healey, Research Analyst of Mining]

Yes, that's great. That's kind of the time line that we had, but that's good color. I guess just last from me. I'm really comfortable with the occupancy levels, and it's great to see them come -- even improving. But do you have any comment on the unoccupied space and kind of where is it? What is it? And do you anticipate having that rented out or leased out at any point soon?

[Gordon G. Lawlor, Executive VP, CFO & Corporate Secretary]

Yes. I mean -- so I mean our unoccupied space of 5.5 million feet is about 80,000, I think, square feet. So I mean, we have got some flows and -- we have ebbs and flows in the quarter-over-quarter, bits and pieces there, but it's pretty fluid that way. But as you see, we've maintained basically the 92% to 95.5% -- 98.2% to 98.5% go forward. I mean we just purchased these industrial properties in Ottawa and Winnipeg there both 96%, 97% occupied. And I think Mark's got them both 100% occupied now. So there's -- it's hard to say there's significant upside when you have a 98.5% occupancy rate. That's -- but that's important there.

[James W. Beckerleg, President, CEO & Trustee]

I think we're comfortable with what's being backfilled in the vacant space is being rented at attractive rates above where we would have expected them to maybe lease up even a year ago. But having said that, as Gordy said, I mean, there's always some -- going to be some modest and planned vacancies because as we upgrade some of our tenancies in different buildings, there could be size of the quarter, something between tenancies.

[Colin Healey, Research Analyst of Mining]

Yes, for sure, that's why I just it's a very stable business and portfolio. So I'm just looking for color wherever I can get it.

[Operator]

Your next question comes from Yash Sankpal from Laurentian Bank.

[Yashwant Sankpal, VP & Equity Research Analyst of REIT]

Your Compass EBITDA was down a bit this quarter. Was there anything abnormal?

[Gordon G. Lawlor, Executive VP, CFO & Corporate Secretary]

There was about $170,000 of bonuses in their Compass accrues their bonuses on a 6-month period. So Q2 and Q4, you'll see Compass generally down a little bit. So there's about 170,000 in there. So Compass is on target budget-wise of about just over $1 million. That's so we expect they'll achieve that by the end of the year.

[Yashwant Sankpal, VP & Equity Research Analyst of REIT]

Million dollars of EBITDA?

[Gordon G. Lawlor, Executive VP, CFO & Corporate Secretary]

Yes, in the third-party line, yes.

[Yashwant Sankpal, VP & Equity Research Analyst of REIT]

And your corporate G&A, how should we model it going forward, given all these acquisitions and all -- What is a good run rate for that figure?

[Gordon G. Lawlor, Executive VP, CFO & Corporate Secretary]

I think if you look at the last 2 quarters, we've been pretty stable there. Yes. So if you look at that, I mean, the acquisitions didn't affect our G&A significantly. We have the ability to take these properties in with our current structure that we had. Property management might have needed a bit of people, but that's reflected in the Compass line. So I think that if you multiply that by 4, it's $4 million to $4.2 million for the year, I think.

[Yashwant Sankpal, VP & Equity Research Analyst of REIT]

Okay. And just wanted to get a bit more color about your office and retail leasing. What are you hearing from your tenants? Like any color would be helpful.

[James W. Beckerleg, President, CEO & Trustee]

Our renewal rates across the portfolio are staying very high in the retail and office sectors included. We're not getting the same increases in rent maturities in the office and retail that we are in the industrial sector. But having said that, we've got many of our leases with rent steps in our -- in place. And so we continue to see improved renewals property improvements in both the retail and office sector. We've only had 2 -- we've got -- we have to retail properties that we're probably having to negotiate a modest rent reduction reflecting the market, but they won't -- I'm just saying giving you color on the market. They don't have any significant impact on any of the numbers you're looking at. But we have seen a couple of national retailers come back to us.

[Yashwant Sankpal, VP & Equity Research Analyst of REIT]

Yes. Go ahead.

[James W. Beckerleg, President, CEO & Trustee]

So I was just going to say, our office is a pretty diversified portfolio, and we're seeing good renewals there.

[Yashwant Sankpal, VP & Equity Research Analyst of REIT]

And Jim, if you recall in the past, you had said -- but for some time, at least, you want to see the office market, how it recovers from this before you look at buying office properties. Has your view changed since then given what has happened between now and then?

[James W. Beckerleg, President, CEO & Trustee]

Well, our -- I mean our view of the office market really is the part that's most challenged is the downtown core markets in the big cities where protocols aren't fully in place yet for the return to work and there's still all kinds of discussion about new style of working and so on. We haven't seen that impact as much as our suburban office areas. And most of our -- from our talking to tenants, most of our suburban office, office space is back to being utilized by the tenants on a very broad basis. We -- for example, in Ottawa, we have a couple of tenancies coming up, new tenants coming in that were looking at taking less space than they originally planned and now returned to taking the same space that they originally planned. You know what I mean, because we're not seeing the same degradation. So I guess to answer your question, we've been focused on looking at industrial opportunities, but we are looking now if we got the right cap rates at some office investments if they are supported by long-term leases with rent steps and strong covenants. So I mean we see some under -- some very attractive cap rates, we would look at those, but that's all I can say on that.

[Yashwant Sankpal, VP & Equity Research Analyst of REIT]

Right. And one last question, if I may. You had an active year so far in terms of acquisitions. Do you have any appetite left for the rest of the year? Do you think you'll do anything before year-end?

[James W. Beckerleg, President, CEO & Trustee]

Well, the financial description that we already provided would indicate that we have some liquidity for modest acquisitions, but we're -- and we are looking at a couple right now. But essentially, we've invested -- the balance of the equity that we raised in the first quarter. And I guess like all REITs, we can find accretive opportunities, we'll look at that, we're definitely looking at them. We -- I mean the market went through it seemed to us in much of the second quarter, a pretty quiet period with a lot of property, I guess, vendors were assessing the market and so on, not a lot of stuff being offered. We're seeing that change. And there's a lot more attractive properties in the market right now, most of them being very competitively bid, but yes, we're watching it closely.

[Operator]

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

[Jenny Ma, Analyst]

I want to follow up on your answer about a couple of national retailers who've come to you for rent reduction. Can you share with us what the motivation for that was? Like was it a particular type of retailer? Was it location specific? And is there any read-through to the category or look at the same retailer within your portfolio?

[James W. Beckerleg, President, CEO & Trustee]

I don't think so. Gordy can provide some more color if he likes, but I don't want to disclose the specific tenants. We only have 1 or 2 locations with each of them. They would be people who are represented by natural or international brokerages who are managing their real estate and lease maturities on North American-wide basis in our cases. And they would just be seeing an opportunity here across the market to try and put some pressure on landlords. And we happen to be in a couple of locations where we're probably going to negotiate with them to some degree. But I don't -- I would just trying to give color to the market. So maybe that's why you're seeking to gain, but these aren't having any significant impact on us. I'm just giving some color on the market.

[Gordon G. Lawlor, Executive VP, CFO & Corporate Secretary]

Just to put it in context, these are rents $20 to $25 rents, $30 to $35 rents where we're talking a couple of dollars, right? We're not talking $30 going to $15 or anything like that. So it's just a typical taken an opportunity there to see what goes on. So I mean the asks with us have been between $2 and $5, which we've settled on a couple here and there. And it's both sides. And still with rent steps, even it's just while we only want -- if you come with a 5-year lease, and we only want to renew for a year and you say, well, to give you 5, I need x. So I mean it's just the to and fros in that, right? So I wouldn't call it systemic at all. I mean our other retail -- the strip malls that type of thing, we're not seeing anything like that there at all. These are just a couple of, actually, if you will, single-tenant buildings. So that's more prone to happen in those situations.

[Jenny Ma, Analyst]

Okay. So is it fair -- and I'm not trying to get caught up on these specific assets, but is it fair to say that this is just a one-off case of the tenant, the pushing the landlord as opposed to them running into financial trouble and needing a bit of rent relief?

[James W. Beckerleg, President, CEO & Trustee]

Absolutely.

[Gordon G. Lawlor, Executive VP, CFO & Corporate Secretary]

Yes. Absolutely.

[James W. Beckerleg, President, CEO & Trustee]

Folks we're talking about, are much stronger than we are.

[Gordon G. Lawlor, Executive VP, CFO & Corporate Secretary]

The Bank of Montreal was one of the tenant in our building they try to get a couple of bucks off of all of their stand-alone properties across Canada, Jenny. And I think they're good for the couple of bucks, but they're going to try to get it off, right?

[Jenny Ma, Analyst]

Well, you can't get it if you don't ask.

[Gordon G. Lawlor, Executive VP, CFO & Corporate Secretary]

That's right.

[Jenny Ma, Analyst]

Okay. Now I had a question about sort of how you view your office portfolio, and I think you sort of touched on it with Yash's last question about still looking at office. But with it being the smallest component of the portfolio, is it somewhere where you continue to spend the same amount of effort looking to grow? Or is it something that you'd be okay with shrinking as a proportion of the portfolio as you seek growth, particularly from the industrial side? Or do you still care to maintain so more as a balanced REIT amongst the 3 different asset classes.

[James W. Beckerleg, President, CEO & Trustee]

There is -- that's an active discussion at our Board and the management engages with. We -- there's no doubt that we are more focused right now on the industrial sector because we see greater rent growth there. And so when you're underwriting the properties, it's easier to rationalize some of these lower cap rates, if you speculate that you're getting 3, 4, 5, 6 or higher rent increases as some short-term leases mature. So that certainly focuses. We haven't taken a decision like some REITs have talked about becoming exclusively. I mean we're staying a diversified REIT. I think with respect to office, what I was trying to signal to Yash, we are opportunistically, looking at options where if we think something is superbly attractive to us, we would still be looking at it, but most of our efforts are focused on the competitive industrial space. Is that cleared up?

[Jenny Ma, Analyst]

Yes.

[Gordon G. Lawlor, Executive VP, CFO & Corporate Secretary]

And Jenny, if I can give you an example, it's just about which is harder right now. I mean the 2 portfolios you just bought in Winnipeg and Ottawa, you've seen the cap rates that we paid for them, I think, in 6 months when some other deals come across, you'll think that we did very well with those acquisitions. And as a couple of examples, and we just closed on it a couple of months ago, but we had $9 rents going to $11 in Ottawa. We have several examples of that. We had some vacant space, industrial space with a new tenant coming in at $13. So it's just when you see those opportunities for growth at least at this time, why wouldn't you focus on that a little bit more, right?

[Jenny Ma, Analyst]

Right, right. Well, that's great to hear. My last question is more broad-based. But traditionally, you guys have always been very focused on the secondary market and enjoyed a bit of a cap rate advantage on that front. Without asking to giveaway of any trade secrets, I'm just wondering if you're trying to see greater interest in some of these smaller markets as a result of more significant compression in larger markets. And what's the balance between getting a superior cap rate and having value recognized in these markets? And is there still much of an opportunity left for you guys and the other incumbent players?

[James W. Beckerleg, President, CEO & Trustee]

Look, the markets in some of the larger secondary cities, I mean -- and that certainly includes Halifax and Winnipeg and Ottawa, where we are have become much more competitive as well. But there are still investment spreads between those cities and the GTA, Montreal and Vancouver. And with current mortgage rates with 5- and 10-year, money where it is, we think that there are still opportunities in those markets. And there's certainly when you underwrite the properties with the kind of growth that Gordy was speaking to an example basis, providing us comfort that we can see future growth. I think that there's still good opportunities -- competitive opportunities available, but that's certainly going to -- we're going to see that a little bit more in the quarter or 2 ahead.

[Jenny Ma, Analyst]

Okay. Have you seen any spillover of new players coming into the secondary market because they've been priced out of the larger market?

[James W. Beckerleg, President, CEO & Trustee]

No. No, I think -- listen, I never know exactly who bids on these properties or we don't. But I would say that we run into new, I think, new private money. I mean there's so much liquidity in the system, but we're not finding -- I'm just using a silly example if you're asking, but we're not finding Brookfield as leading Toronto and coming into Halifax. If you know what I mean?

[Operator]

There are no further questions at this time. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.

[James W. Beckerleg, President, CEO & Trustee]

Thank you.

[Gordon G. Lawlor, Executive VP, CFO & Corporate Secretary]

Thanks.