PRO Real Estate Investment Trust

TSX:PRV.UN

Earnings Call Transcript

[Operator]

Good morning, and welcome to the PROREIT Second Quarter Results Conference Call for Fiscal 2023. [Operator Instructions] Management 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 results release, along with second quarter financial statements and management's discussion and analysis, are available at proreit.com in the Investors section and on SEDAR and 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 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 assumptions and risks, please consult the cautionary statement regarding forward-looking statements contained in PROREIT's MD&A dated August 9, 2023, available at www.sedar+.ca. Forward-looking statements represent management's expectations as at August 9, 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 REIT's IFRS results. For a description of these non-IFRS financial measures, please see the second quarter earnings release and MDMA -- sorry, MD&A. A reconciliation on non-IFRS to IFRS results, as applicable, may also be found in the earnings release and MD&A for the second quarter. Please refer to the Non-IFRS measures section in the MD&A for the second 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, Colin. Good morning, everyone, and welcome. Joining me today is Alison Schafer, our CFO and Corporate Secretary. I will start with a high-level overview of our Q2 results. Alison will then provide a more detailed discussion on the quarterly financials.

With most of our key metrics up over last year, I am pleased with our performance. Our results reflect our solid operating environment and the strength of our balance sheet. We continue to benefit from our long-standing and robust tenant fees, as evidenced in our occupancy rate of 99% at June 30, 2023, which includes committed occupancy.

Leasing activity continues to be very favorable. To date, we've renewed 85% of our gross leasable area, or GLA, maturing in 2023 at a 43.2% positive average rental spread. Same-property net operating income or same-property NOI was up 0.8% in Q2 compared to the same period of the prior year. This is due to the occupancy increases in both retail and office sectors as well as contractual increases in rent and higher rental rates on lease renewals.

As I prefaced in our last call, our Industrial segment was impacted by a temporary vacancy in a 102,000-square-foot property in Montreal, vacant at April 1. The property has been fully released on 10-year terms with 2 tenants with occupancy starting in Q3 at an average positive spread over the previous rents of 55%. When excluding the impact of this temporary vacancy, adjusted same-property NOI was up 3.9% in Q2 year-over-year. On an annualized basis, NOI from this property will go from $900,000 to approximately $1.5 million with these 2 new lease deals. Our 2023 fourth quarter results will include the full benefit of this attractive renewal.

The temporary vacancy is also affected -- has also affected our AFFO payout ratio in Q2, which amounted to 97.3%. Higher variable interest rates on the credit facility and increased weighted average interest rate on mortgage debt also impacted our AFFO ratio during the current quarter. At June 30, 2023, the Industrial segment now represents 80.5% of our total GLA, 70.6% of our total base rent and 77.9% of our investment property value.

Moving to the balance sheet. I'm pleased to note that we significantly increased our liquidity position in Q2, mainly as a result of our successful $35 million convertible debenture offering that closed in May. We also received a new $10 million term loan in the second quarter. Proceeds from these transactions were used to partially repay our credit facility with the balance used for general corporate purposes.

With respect to our portfolio, we sold one noncore office property in the quarter for a gross proceeds of $2.1 million. Then on June 29, 2023, we entered into a binding agreement to sell 2 other noncore office properties for a gross proceeds of $9.1 million. We intend to continue strengthening our portfolio by recycling assets to capitalize on future acquisition opportunities.

I will now turn the call over to Alison for a more detailed look at our second quarter results for fiscal 2023.

[Alison Schafer, executive]

Thank you, Gordie, and good morning, everyone. As Gordie noted, our Q2 results were solid. At June 30, 2023, we owned 129 investment properties with 50% ownership interest in 42 of the properties compared to 120 investment properties fully owned at June 30, 2022. At the end of Q2, we owned approximately 6.5 million square feet of GLA, and we managed approximately 10.8 million square feet of GLA through our wholly owned subsidiary, Compass Commercial Realty.

Total assets amounted to $1.06 billion at June 30, 2023, up 1.6% year-over-year. We achieved property revenue of $24.9 million, a 5.1% increase compared to the same quarter last year. The increase was mainly due to the change in the number of properties in our portfolio and their related ownership percentages over the last 12 months.

Net operating income was $14.5 million, up 1.3% year-over-year, also as a result of the number of properties and ownership percentages in our portfolio. G&A expense was $1.3 million in Q2, in line with our G&A run rate for the remainder of the year. As you recall, we had a onetime CEO retirement costs of $2.2 million included in G&A expenses in Q1 this year.

Net cash flows provided from operating activities was $0.6 million in our second quarter compared to $2.2 million in Q2 2022, largely as a result of the timing of cash receipts and settlements of payables. AFFO totaled $7.0 million, down from $7.9 million in the same period last year. The decrease was related to the temporary vacancy in the industrial property that Gordie discussed and higher weighted average interest rates.

As Gordie noted, we are benefiting from a strong liquidity position at June 30, 2023, with $42 million available on our credit facility and an additional $15.8 million in cash. We have $33.8 million of maturing mortgages remaining for 2023 to be refinanced on market terms and in consideration of our overall strategy. The weighted average interest rate on mortgage debt was 3.75% at June 30, 2023, compared to 3.40% at the same date last year.

As mentioned on our last call, this quarter, we refinanced 6 industrial properties in Winnipeg, with a new 7-year mortgage with 5.07% interest rate or $20.5 million. Most of the proceeds were used to repay mortgages maturing in July 2023.

Debt to gross book value was 50.9% at June 30, 2023, down from 51.3% at the same date last year. Compared to the end of Q1 this year, debt to gross book value was negatively impacted at June 30, 2023, by our temporary excess cash position, annual property tax payments as well as the noncash impact of the fair market value adjustments, mainly in our office portfolio. At June 30, 2023, the weighted average cap rate of our portfolio was 6.0%.

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

[Gordon Lawlor, executive]

Thanks, Alison. We remain mindful of the high interest rate environment and the macroeconomic challenges that are still very much a reality. Despite these challenges, we are committed to our strategy to continue to grow our quality portfolio organically and through disciplined acquisitions in the light industrial sector.

This marked my official first quarter as CEO of PROREIT, and I'd like to thank the entire PROREIT team for their dedication and support. We look forward to pursuing our objectives, while optimizing our balance sheet and capital allocation to the benefit of all stakeholders.

This concludes our formal remarks. Colin, if you could please initiate the question-and-answer portion of this call. Thank you.

[Operator]

[Operator Instructions] And your first question comes from Mark Rothschild.

[Mark Rothschild, analyst]

Gordie, with the sale of office properties, can you just maybe give a little more color on -- with these sales, was it more opportunistic? Was it just deciding that we've maximized the value from these assets? I know that there's definitely a balance between you wanting to focus on certain property types and not wanting to sell assets, we still see good upside or stable cash flow.

[Gordon Lawlor, executive]

Yes. So this was 230,000-square-foot properties that one had a 15-year long-term lease on it with steps and the other one had 1.5 years left on the lease. So we had entertained a bid from -- these are Ottawa assets from Ottawa Group for the assets. So we put it under contract in the -- just over a [ 7 cap ]. In the due diligence period, we were notified by the 1.5 years remaining tenant that they would not be renewing. So it was a pretty advantageous timing to the purchaser, I'd say. That said, we proceeded with the deal with an adjusted price. And so that basically sold at an 8% cap, but on a nonstabilized basis. So the call there is keep the property and re-lease it, which it was under market rent by about $4. So I think a good deal was had here by both parties, but it's just tied strategically to reducing our office exposure.

[Mark Rothschild, analyst]

And to what extent should we expect more of that over the next few quarters?

[Gordon Lawlor, executive]

So we started, we had 9 office assets. One is jointly owned with our partner in Halifax. So after -- and we sold one. So we began to 6 here, 3 of them are Ottawa, 2 suburban office and 1 downtown office and then 2 small legacy office properties in Atlantic Canada. So it's a difficult off this market, as everybody knows right now. We're in no rush for those. But if we get interest on these properties at reasonable prices, we'd continue to sell. We most -- we have a mortgage due at the end of the year with most of this office portfolio.

So it's just all timely in that respect, whether we refinance some of these properties or if we're available to sell them by the end of the year, we don't need to refinance them, obviously. That said, we could still get short-term financing and keep them, and they're performing well. So it's just -- there's no need for a fire sale for any of this stuff. So we're just being opportunistic.

[Mark Rothschild, analyst]

Okay. Great. Maybe just one more question in regards to the balance sheet. When you look at the debt to EBITDA, is this a level that you're comfortable operating if you want to bring it down? Would you allow leverage to go higher? Just how you think about that and then as far as the way you're going to finance growth?

[Gordon Lawlor, executive]

Yes. So I mean our target since a long time has been to get to the 50%, and we're at that now, just slightly above. This quarter's a little bit of an anomaly. But we'd like to stay around the 50% range. Q2 is always a challenge for us. We actually pay out $10 million in property taxes in Q2 to the $20 million for the entire portfolio and don't get it back on -- only get it back over the next 12-month period. So that's a little bit of an anomaly for us. I think we've indicated that we'd like to go lower on a debt basis over the next 5 years with a target of 45%, but we're happy, plus or minus to 50% right now, but we would not lever up for acquisitions that's not in our plan, other than if this is temporary between an acquisition and a sale that was coming.

[Operator]

Your next question comes from Jenny Ma from BMO Capital.

[Jenny Ma, analyst]

You had a pretty strong rental spread achieved in Q2. I was just wondering if you could give us some more color on how much of it -- what you were getting for the industrial assets, which I presume is the vast majority of it and what you're getting from retail.

[Gordon Lawlor, executive]

Yes. So our industrial spreads like are in the plus 50%. I think 54% was our industrial spreads for the quarter. Alison is just pulling up the retail there. But so strong industrial retail kind of like above average as well. But I believe it's 54 -- I'll defer to that for a second, and I'll come back with the number, which is not at the top of my head, but it was in excess 50% on industrial, and then I think retail was almost close to 10% or...

[Jenny Ma, analyst]

Okay. Great. Is that broad-based? Or were there certain properties that skewed that number? Or are you just getting some good leasing spreads all around?

[Gordon Lawlor, executive]

Yes. I mean it's pretty much broad-based. The positive leasing spreads we're seeing of significance is Halifax and Southwest Ontario. Winnipeg is a little more muted that way, but still positive leasing spreads. But definitely, we see Halifax, Southwest Ontario. And then tied to these numbers is the downtown Montreal property and sales are off. So that's a 55% spread there on basically 100,000 square feet for that. That's a pretty good math driver for this quarter.

[Jenny Ma, analyst]

Absolutely. When it comes on terms, what are tenants looking to lock in for? And can you also talk about the quantum of rent steps that you've been able to negotiate?

[Gordon Lawlor, executive]

So for example, on the 2 Montreal properties, 1 has a 3% rent step and the other has 3.5%. In Halifax, we're achieving 3% rent steps on all of our deals right now. And we haven't done -- and Southwest Ontario recent deals that we've done as well were 3% rent steps as well. So 3% is almost our new base. And then every so often, we'll get to a 3.5% there.

[Jenny Ma, analyst]

And that's every year?

[Gordon Lawlor, executive]

Yes, annual rent steps. Yes.

[Jenny Ma, analyst]

Okay, great. And what about the...

[Gordon Lawlor, executive]

Sorry, Jenny, and I have that number. So it's 49.3% for industrial year-to-date, and retail average was 9.1%.

[Jenny Ma, analyst]

And what kind of lease terms are you getting for your renewals?

[Gordon Lawlor, executive]

We're getting 3 to 5 years in Halifax and the 2 Montreal were 10-year deals. And the rest of the country standard is pretty much 5 years. If somebody wants to go longer, these days, we're happy to look at it as you would expect.

[Jenny Ma, analyst]

Okay. Great. And then lastly, you mentioned the NOI contribution from the Montreal new deal. I think you said it was going from -- is it $900,000 annually to $1.5 million?

[Gordon Lawlor, executive]

Yes.

[Alison Schafer, executive]

Yes.

[Jenny Ma, analyst]

Okay. And do these leases start right at the beginning of Q4?

[Gordon Lawlor, executive]

Yes. I mean they're under tenant fit up right now. Targets would be September 1. And I believe we're on target for those. But to be safe, we were saying that effect that we should be fully rent falling by October 1 through [indiscernible].

[Jenny Ma, analyst]

Okay. Okay. So it would be a full clean contribution starting in Q4?

[Gordon Lawlor, executive]

That would -- that is our hope at this point.

[Operator]

Your next question comes from Himanshu Gupta from Scotiabank.

[Himanshu Gupta, analyst]

So just staying on the lease expiries, I mean the remaining lease expiries this year, I think it looks like all industrial as well. So any thoughts there in terms of rental spread expectations?

[Gordon Lawlor, executive]

Yes, I think we're still going to have the same lease experience like this. Consistency is pretty for everyone. Most of the leases are Halifax. I think what the lease is done this year, 60 of 1 month, 70 were Halifax based. So we will expect the same basically for the rest of the year. We don't have any indication of any problems in the rest of that 15% lease.

[Himanshu Gupta, analyst]

And I think, Gordie, you mentioned Halifax and Southwestern Ontario continue to be strong in terms of interest spreads, and Winnipeg a bit muted. So are you surprised with Winnipeg? Or is it just property specific? Because the market continues to be tight, and we're not seeing much supply there as well.

[Gordon Lawlor, executive]

Yes. No. I mean muted is only relative to the other 2 markets. So you're going from $7 to $13 in Halifax and then Southwest Ontario, we went from, for example, on 1 lease 4.40% to 8.80%. Winnipeg was -- it was -- our last deal was 6.30% and it went to 8.30%. So that's still $2 on 30,000 square feet. It's just that compared to the other 2, it's not 50% stock.

[Himanshu Gupta, analyst]

Got it. And you mentioned the Halifax, most of the remaining leases are due in Halifax, if I heard correctly. What kind of in-place rents do you have in Halifax? And what are you expecting for the remaining in this year?

[Gordon Lawlor, executive]

Yes. So when we bought the portfolio, most of the portfolios was between $6 and $7. So that's pretty much where the entire portfolio is since last November. And weighted average lease term is 3 years on them. So we're kind of coming up to a year through, but it's basically the $6 or $7 going to $12 and $13, actually that's [ low ]. But no TR.

[Himanshu Gupta, analyst]

Yes. For sure. Like GTA is now talking $20. So I think that $12, $13, I think, very much doable there. Maybe just turning to the balance sheet. I think you have around $13 million mortgage maturing. Is it all related to office portfolio?

[Gordon Lawlor, executive]

No. there's about 5 that's 3 small properties. One is already renewed. So there's another small property that's contracted for sale conditionally. So that will -- deal is about $1.7 million of it. There's another $1.7 million was this payout when it comes due. And then when you look at the sale of the office, that leaves us about $25 million left for the year. And that's Ottawa office with one industrial building, if you will. So 4 properties there. One is actually industrial. So we'll refinance that on a longer-term basis. And then depending on the other 3 assets, 2, 3 assets left there, they may put some short-term financing on it or -- but they're not long-term holds. So we're not going to put 5- or 10-year money on that mortgage, on those properties when they come due.

[Himanshu Gupta, analyst]

Yes. And -- but is 5-year money available on some of the suburban office you say? Or I mean, the preference is clearly going to credit facility or short-term financing on that piece.

[Gordon Lawlor, executive]

No. We've spoken to the lender, which is a large Canadian bank on those assets. And they're there for us for a short renewal or a 12 months renewal there. Those properties, we have full covenant of the REIT there. So they're not concerned about those assets property -- those office properties, and they're over 90% occupied right now. So that's not a concern when you have a relationship lender in these situations.

[Operator]

[Operator Instructions] There are no further questions. I'll turn it back to Gordon to close up the call. Actually, we do have someone who just came in. So this is from -- we've got a question from Sam Damiani from TD Cowen.

[Sam Damiani, analyst]

I'm not sure if this was asked already, but do you have an update on the backfilling of the 84,000 square feet in redevelopment?

[Gordon Lawlor, executive]

So that's 2 properties. So there's a 90,000-square-foot property there in Quebec City, and the other one is 65,000 feet in Montreal, East end of Montreal. We've got fit up for a 25,000-square-foot lease on the 65,000 there. So we've made progress that way. The other 40,000 is still available for occupancy. And so kind of that's where we are. The 19,000-square-foot property, that may turn into just be a sale of the property outright. So that's kind of an update. So all things being equal, the 19,000 property will likely be sold by the end of the year. So the only piece left would be this 40,000 square feet in Montreal.

[Sam Damiani, analyst]

Okay. Great. Besides the -- sorry, besides this and the Montreal 100,000, is there any other known or expected vacancies in the next 18 months or so?

[Gordon Lawlor, executive]

Looking at Alison, I'm thinking like -- no, I mean those 2 properties were unique in that they -- those development properties and that they had long-term leases on them like the Montreal property was a tenant was in for 30 years. So and COVID-19 hit and changed the demeanor of that property. So that's why those 2 are like that. We don't see any anything big here coming up in the next little while.

Just to finish some of the question, I mean, leasing has been strong, but one thing we've noted is it has slowed down a little bit just timing-wise as far as how long it takes to get deals done. Part of it's the summertime as well. But we haven't really seen any significant weakness in the markets of a few small tenants and things like that, hangovers from COVID here and there. But -- so there may be some surprises in the next 12 to 18 months, but we don't really have a lot of knowledge of it at this point in time. So everything seems pretty stable.

[Sam Damiani, analyst]

And how is the investment market in Halifax and the Burnside market there? How is transaction activity there? Or is it pretty quiet?

[Gordon Lawlor, executive]

No, it's very good. It's robust. There's -- we're still below, I think, 3% vacancy there. We're just about entirely full actually for the properties. The challenge always there is tenants expanding or contracting and can you fit them into something that you already have, that type of thing. There's not a lot of options for them for a small bay, and nobody is building any small bay now. So it's still a very solid market. And as you can see, we're seeing these leasing spreads with no tenant inducements. So we're really pleased with it, but I don't think our partner is as well. So we're happy there. I mean the Halifax, economically, there's still 5 or 6 cranes downtown and building rental housing, condos everywhere. Immigration is up there as well. It's a very robust market down there right now, and we're happy to be in, and that's for sure.

[Sam Damiani, analyst]

Great. Last one for me is on the dispositions. I know you had $36 million conditional last quarter. You've dealt with a couple. What's the expectation for the balance of the year and into 2024? And are you open to providing vendor financing? Do you feel that's necessary to get transactions across the finish line?

[Gordon Lawlor, executive]

Yes. I mean, it's a tough market out there. You've seen prolonged diligence periods being requested. I mean, in the good old days, I mean, when we were buying, we would underwrite a property before we put it under contract, almost 30 days new diligence, 10 days close. It's nothing like that now. It's 45 to 60 days due diligence, then they want sometimes 30 to 45 days for close. It's all around financing -- it's all around the debt financing basically.

And we talked on one tenant on a deal that actually didn't -- just a small asset that didn't go through. But if you put vendor financing behind the first financing, then they still look at the debt service coverage ratio, obviously, and the first lender won't improve it. So even though you would do some things to get a deal done, it's still controlled by the first lenders, whether you can be that creative or not.

[Operator]

There are no further questions at this time. I'll turn it back to Gordon to close out the call.

[Gordon Lawlor, executive]

I just wanted to say thanks from Alison and I and everybody at PROREIT. And hopefully, everybody enjoys the rest of the summer. Thank you.

[Alison Schafer, executive]

Thank you.

[Operator]

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