PRO Real Estate Investment Trust

TSX:PRV.UN

Earnings Call Transcript

[Operator]

Good morning, and welcome to PROREIT's Second Quarter Results Conference Call for Fiscal 2024. [Operator Instructions] For your convenience, the results release along with the second quarter financial statements and management's discussion and analysis for fiscal 2024 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 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 statements 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 7, 2024, available at www.sedarplus.ca. Forward-looking statements represent management's expectations as of August 7, 2024 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. 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 second quarter earnings release for fiscal 2024 and non-IFRS measures section in the MD&A for the second quarter of fiscal 2024 for additional information.

I will now turn the call over to Mr. Gordon Lawlor, President and Chief Executive Officer of PROREIT.

[Gordon Lawlor, executive]

Thank you, Joanna. Good morning, everyone, and welcome. Joining me today is Alison Schafer, our CFO and Corporate Secretary; Zach Aaron, Vice President of Investments and Asset Management is also joining us for the Q&A period. I will start with an overview of our performance for the second quarter of 2024. Alison will then provide a more detailed review of our financial results. In the second quarter, we continued to operate in a market that remains affected by economic uncertainty and high interest rates compared to recent years.

In this context, we maintained our momentum and continue to optimize our portfolio through the sale of non-core assets. This enables us to further increase the relative weight of our footprint in the industrial sector and to further strengthen our balance sheet. Since the start of the year, we've successfully disposed of six non-core properties for a total gross proceeds of $39.6 million. This includes three non-core properties sold in the second quarter for gross proceeds of $13.5 million. Let me provide some details on the Q2 transactions.

On May 15, we sold a retail property located in Saskatchewan, totaling approximately 11,000 square feet for gross proceeds of $4.8 million. On May 27, we sold a retail property located in Alberta, totaling approximately 8,500 square feet for gross proceeds of $2.2 million. The net proceeds for these two transactions were used for general business and working capital purposes. Then in June, we sold a non-core industrial property located in Manitoba, totaling approximately 38,000 square feet for gross proceeds of $6.5 million. The net proceeds were used to repay an unrelated $5.9 million mortgage and the balance for general and business and working capital purposes.

We therefore ended the second quarter with 170 investment properties, corresponding to approximately 6.2 million square feet of GLA. At the same date last year, we owned 129 properties. Both periods include our 50% ownership interest in 42 properties. In Q2, we also entered into binding agreements for the sale of three other non-core properties, which will generate an additional $31.6 million of gross proceeds. These transactions are expected to close in the third quarter of 2024.

Following these dispositions totaling $71.2 million year-to-date our industrial footprint will represent 85.5% of total GLA and 79.5% of total base rent. With only four office properties remaining in our portfolio valued at less than $30 million, our office segment will account for only 2.6% of total GLA on a pro forma basis. Our portfolio is also well-positioned in terms of geography and thanks to our long-standing and intentional focus on strong secondary markets.

Atlantic Canada, which currently represents 52% of our total GLA is a great example of this with Halifax experiencing the strongest rent growth in Canada for the second quarter of 2024, according to CBRE Q2 Canadian industrial market statistics. The quality of our asset base is also reflected in our capacity to generate recurring same-property NOI growth, mainly driven by robust leasing renewal spreads and rent steps. In the second quarter of 2024, we achieved an 11.4% increase in same-property NOI or 6.4% when excluding a onetime revenue adjustment and the impact of a temporary property vacancy in 2023.

As I mentioned on the last call, this 102,000 square foot industrial vacancy in Montreal was fully leased in September 24 at an average positive spread of 55% over the expiring leases. It's also worth noting that our same-property NOI has increased over the last 14 consecutive quarters. Let me now provide a brief operational update. At June 30, 2024, the weighted average in-place rent of our industrial portfolio was $8.66 per square foot, an increase of 6.7% compared to the same date last year. To-date, we've successfully renewed or replaced 66% of our GLA maturing in 2024 at a 34.6% average spread for the entire portfolio and a robust 49.5% for industrial properties.

Given the significant upcoming lease renewal spreads materializing in our portfolio in the next few months this leasing upside will be fully reflected in our results through the second half of the year and into 2025. Regarding the portfolio's occupancy rate, it stood at 91.7% as of June 30 compared to 99% the same date last year. This decrease in occupancy is primarily due to two larger vacancies in industrial properties. Our vacant space in Montreal is in advanced stations of negotiation, and we see positive momentum in leasing activity on our Woodstock, Ontario property.

I'll now turn the call over to Alison for a more detailed review of our financial results. Alison, over to you.

[Alison Schafer, executive]

Thank you, Gordy, and good morning, everyone. Property revenue for the second quarter decreased slightly by 1.4% from $24.9 million in Q2 2023 to $24.6 million in Q2 2024. This mainly results from the change in the number of properties in the portfolio during the last 12-month period ended June 30, 2024, partially offset by contractual rent increases and higher rental rates on lease renewals and new leases. Net operating income increased by 2.3% from $14.5 million to $14.8 million. This growth was mainly driven by contractual rent increases and higher rental rates on lease renewals and new leases, partially offset by the decrease in the number of properties.

We are pleased to have achieved this growth despite having 12 fewer properties in our portfolio compared to last year. General and administrative expenses for Q2 2024 were down slightly compared to the same period last year. For the first 6 months of the year, these expenses decreased by $2.1 million, mainly reflecting onetime retirement and CEO succession costs in 2023. Net cash flows provided from operating activities decreased slightly in the second quarter of 2024, largely as a result of the timing of cash receipts and the prepayment of property taxes and insurance.

FFO reached $7.4 million for the quarter, an increase of 1.5% also achieved with 12 fewer properties in our portfolio compared to last year. Of note, FFO reached $15.1 million for the first half of 2024, an increase of 23.6%. This was primarily driven by a general increase in contractual base rent, higher rates on renewals and new leases and a reduction of onetime costs, including CEO succession costs. This was partially offset by an increase in interest rate expense. Our basic AFFO payout ratio was 93.1% for Q2 2024 compared to 97.3% last year.

This improvement is primarily due to the general increases in contractual base rent and higher rates on renewals and new leases offset by an increase in interest expense. Now turning to the balance sheet; our liquidity position remained healthy with $38 million available through our credit facility, in addition to $8.9 million in cash at June 30, 2024.

Our total debt, including current and noncurrent portions, totaled $486.6 million at June 30, 2024, a reduction of $47.7 million compared to the same date last year, mainly as a result of property dispositions over the last 12 months. As planned, we maintained our debt-to-gross book value below 50%. It stood at 49.5% as at June 30, 2024. Our weighted average interest rate on mortgage debt was 3.94% at June 30, 2024, compared to 3.75% at the same date last year.

We are pleased to highlight that we only have $4.1 million of remaining mortgages expiring in 2024, and that only 4% of our total debt is at a variable rate. The weighted average cap rate for the portfolio was approximately 6.7% at June 30, 2024, up from 6% at the same date last year and 10 basis points higher from last quarter. Finally, we maintained our distribution of $0.0375 per unit for each month in the second quarter of 2024.

Gordy, back to you for closing comments.

[Gordon Lawlor, executive]

Thanks, Alison. The Canadian industrial market continues to experience some temporary cooling market conditions, especially in larger metropolitan cities that have witnessed the most pronounced shift in market dynamics. Most smaller markets [indiscernible] are strategically located, have shown relatively steady market conditions. There is also a noticeable bifurcation of vacancy and rental pressure with respect to large bay industrial assets versus mid- to small-bay industrial assets across Canada with the mid- to small-bay assets proving more resilient to-date.

Against this backdrop, we continue to manage our balance sheet prudently and maintain our financial flexibility. On the investment side, we will continue to focus on opportunities in the industrial sector. We remain prepared to act on the right deals as we look forward to the remainder of the year. We remain steadfast on our top priorities, aiming to deliver NOI, FFO and AFFO growth to the benefit of our unitholders and ultimately, all of our stakeholders. Finally, I'd like to conclude by thanking the entire PROREIT team for another quarter of solid execution.

That concludes our remarks. Joanna, over to you and the Q&A.

[Operator]

[Operator Instructions] First question comes from Sam Damiani at TD Cowen.

[Sam Damiani, analyst]

Just on the disposition activities, it's really picked up nicely. With the closings that are going to happen in Q3, how should we think about that additional balance sheet capacity being utilized? Like basically, what I'm wondering is how anxious you are to resume acquisitions or are you really going to prioritize getting that balance sheet leverage down to that 45% target?

[Gordon Lawlor, executive]

Hey Sam, it's Gordy. I mean, we're comfortable at the 50% level now. I mean we've indicated longer term, we'd be moving towards 45%. But when we look at this now, we've sold $71 million of assets for $24 million and another $26 million. So we're down $100 million in investment. So we are extremely interested in increasing industrial exposure through acquisitions here at least to a modest level as we see some opportunities come up.

[Sam Damiani, analyst]

And as you look at opportunities, are there markets that you're preferring to expand into and perhaps other existing markets that you're not so much looking to add to your exposure?

[Gordon Lawlor, executive]

We always work around our platform. So I mean Halifax will control 40% of the Burnside Industrial market with our partner there. So we're pretty full up there, so to speak. I mean we like Ottawa. We like Winnipeg, we like [indiscernible], Ontario. We've looked at assets on the Island in Montreal that could [indiscernible] for us. That would be the first time in five years that we've seen Island, Montreal Island assets that we could actually get our hands on. So that's interesting as well. And then Moncton is just a sleeper of 100% occupancy and proving itself to be a distribution hub that we're happy to buy some more assets there and [indiscernible].

[Sam Damiani, analyst]

Okay, great. And last one for me, just on the occupancy decline in Q2. I wonder if you could speak to what drove that 60 basis points decline.

[Gordon Lawlor, executive]

Yeah. Zach is here, he can touch on it, but I think there was a 20,000-odd transition in Halifax added there. And then there's a few bits and pieces, but he can give you some -- enlighten on some of the stuff that he's working on and where we see the next two quarters, I think. So go ahead, Zach.

[Zachary Aaron, executive]

Yeah, sure. So I mean the difference from last quarter, I think, is about 35,000 square feet of vacancy. And I would describe most of it as smaller segments within our portfolio across Winnipeg, Ottawa and our Burnside portfolio, and it's just the typical small bay tenants churning and time to backfill those tenants. So nothing of real kind of noise there. But kind of where we sit today is we're currently in various stages of either negotiation or trading paper on approximately 90,000 to 100,000 square feet of that about 180,000 square feet of current vacancy, including those two larger vacancy as we noted in the opening statements.

[Gordon Lawlor, executive]

But that said, Sam, things take time. So I don't think you'd see any of that in Q3 cash flow-wise, but hopefully Q4.

[Operator]

Next question comes from Mark Rothschild at Canaccord.

[Mark Rothschild, analyst]

In regards to 2025, you've already addressed one sizable lease -- for the lease, is there going to be a free rent period? Is there -- like is that just going to continue straight through? And maybe you can just give some more color on if there was any cost to that lease. And you obviously got a rent uplift, how that works.

[Gordon Lawlor, executive]

Yeah, I'll let Zach who worked tirelessly on that deal talk some good things about it, the 500 palladium lease.

[Zachary Aaron, executive]

The 500 palladium -- yeah, so the existing tenant expires at the end of January. And what's really exciting about this new lease is that the new tenant is going to be paying rent, February 1. So we had zero downtime on that deal. It will be a 15-year deal at a positive rent spread from where the deal we had before.

The previous tenant actually had a semi gross rent structure, whereas this new tenant will be fully triple net lease with 3% annual rent escalations over the 15-year period. So obviously, there was a TI involved in all that. But we're just excited that we have this really phenomenal national -- international defense contractor tenant long-term at this building and no downtime impacting '25 cash flow.

[Gordon Lawlor, executive]

And that TI, if you look at it, spread over 15 years, it's like $10 or something. Yeah. So yeah, give or take a $10 TI with no downtime, Mark, for a 15-year deal.

[Mark Rothschild, analyst]

Understood. That's great. And maybe just one more for me. You've previously spoken about over the next few years being able to achieve 5% annual organic growth with some softening in industrial fundamentals. Would you still stick with that or maybe you want to temper that somewhat?

[Gordon Lawlor, executive]

No, I think we keep proving it quarterly. I mean, we're a little annoyed at these temporary vacancy because we'd be in a more interesting spot than we are on the quarters, but we really haven't seen that weakness. I mean we're beating our budget on these renewals. Halifax and Winnipeg are -- if you look at the CBRE report of the strongest rent growth, I think, in Canada in the last two quarters.

So we haven't -- we're not thinking to temper that yet. That's for sure. We're really looking forward to '25 and '26 here. And I'm sure you're on calls with larger industrial REITs than us who has seen some modest increase in vacancy last couple of quarters, but they're still very confident that in the next 6 to 12 months that the pull out of that and see additional rent growth. So we're hopeful for that, too.

[Operator]

Your next question comes from Brad Sturges at Raymond James.

[Bradley Sturges, analyst]

Maybe starting or going back to the asset sales completely congrats on those deals. Just I guess curious on average on what's been recently announced. Can you give a little bit of guidance on how we should think about the NOI contribution or the cap rate on those deals?

[Gordon Lawlor, executive]

Yeah. So the asset sales -- they were in -- the office was about $160 a foot. It was give or take, 8% cap sale price. We had some upcoming renewals on that. So -- and we paid down just under 7% debt with them. So I'd say those asset sales actually were based on the debt that we had on them [indiscernible] for a couple of years is flat to slightly accretive to us. So I don't think we lose any on that. And then the other smaller retail, those were 8 caps sales. So some modest loss on those assets, but longer term, better opportunity for other growth assets.

[Bradley Sturges, analyst]

Okay. That's helpful. Just on the balance sheet, I guess there's not much left to do in terms of refi. And I guess there's a little bit more to do in '25. But I guess in terms of the maturities of '25, is that fairly equally weighted throughout the year? Is that weighted to any particular part of the year in terms of the upcoming maturities? And where would kind of cost of debt be today given where, I guess, bond rates have pulled back and where credit spreads would be today?

[Gordon Lawlor, executive]

Yeah. I'll just pull out a page on the split. But the $66 million, when you look at that, $18 million of it is taken care of in the two office asset itself. So you'll see next quarter, the $66 million goes down below $50 million. Alison is just pulling out the page on -- I don't have that -- we can get that for you, Brad, on the breakdown but as we split it up, some of its $80 million of assets to be sold or confirmed. There are some other things there that we probably plan to sell as well. So we want to have to deal with that.

So I think we're down to and back of my head, $20 million to $30 million of just regular stuff flowing through. As far as cost of debt, we were priced on a deal for a separate reasonable [ $175 ] over for 5 years. But I mean, we think when we talk to the team, we think our new debt rate when we look at 5-, 7- and 10-year spreads is going to be [ $475 million to $525 million ]. Maybe we get down to [ $450 million ]. I'd like when the [indiscernible] was below 3 there for a little while. So we'll see if it gets back there again. But that's the ballpark we're playing in.

[Bradley Sturges, analyst]

And how does that change the [ characters ] in terms of the stabilized cap rate you would look to achieve on an acquisition that if you're looking to redeploy some of the balance sheet capacity into growth opportunities.

[Gordon Lawlor, executive]

6.75% cap rate and a 5% debt pencils pretty good on accretion for us, marginally accretive day 1 and then with growth in steps and rents, which now since the last five years are kind of standard in industrial leases going forward, that's the kind of ballpark we were playing in, 6.5% to 7%. And like you said, the debt level there in that range. So there are some floors coming in on deals, too. So you don't get total benefit of watching the page every day.

But yeah, that's kind of where we are. But if you think that we can buy [ 6.50% ] assets, and those are stabilized assets. So -- but the 3 and 4 and 5 cap days are gone, but for significant under-market rents. But if you think you've got at-market rents, and Zach's seeing it all across the country, including GTA, if you've got an at-market rent, then a 6.25% to 7% asset depending on the location is -- 6.25% cap rate asset is kind of where the market is going to be. We just haven't seen many of those deals yet.

[Operator]

Next question comes from Sumayya Syed at CIBC.

[Sumayya Hussain, analyst]

Following up on the two, I guess, larger vacancies in Montreal and Woodstock [ wondering ], where are you seeing rents coming in relative to your expectations? And are you seeing them roll down at all?

[Zachary Aaron, executive]

Sure, it's Zach speaking. So on the Montreal asset, we're -- like Gordy said earlier, we had some advanced negotiations with some tenants on that about 30,000 square foot vacancy. Market rent wise, we're kind of talking about the $13 to $14 net rent range, which has kind of held steady in terms of our expectation, given that it's not kind of that brand new Class A space where in Montreal, they're kind of focusing on $16, $17 net rents.

So the tenant who was in there previously was paying about $6.25. So whether it ends up being $13, $14 or somewhere in that ballpark, we'll be pretty happy there. In terms of the Woodstock property, which is a 40,000 square foot tenant, we've had some more activity there with some showings. We responded to an RFP recently in kind of negotiations with another tenant potentially speaking there. There in Woodstock, we're kind of in the, I would say, high $10 to low $11 range in terms of market rent.

If you look at some of the new construction going up in Woodstock right now, industrial-wise, they're looking at high $11 to low to mid-$12 is what they seem to be asking. I know there are some deals that are completed in the high $11 range. Again, we have a great building and a great space there. It's a bit older than the brand-new stuff, obviously. But again, previous tenant there was also paying about $6.25 per square foot. So whether it ends up being $10.50 or $11.50, again, both pretty good outcomes there. So hopefully, we'll have those both locked up by the end of the year.

[Sumayya Hussain, analyst]

Okay. So -- nice lift there as well. And then secondly, just wanted to touch on the non-core sales in office specifically. Just wondering, are they different buyer groups? And what are you seeing there in terms of their access to capital?

[Gordon Lawlor, executive]

Yes. So both of those deals are -- so we've sold four assets now in Ottawa, counting these two. They were all private folks or syndicated people. They are usually office players, suburban office that have these portfolios and hold them for a longer term. So they're comfortable with where the market rents are in the suburban office with good parking and all that. I mean one of our buildings was kind of a medical office building next to RioCan major redevelopment.

So that's great land and space there for long-term. And the other one would be we consider like a Class A suburban office assets. So they'll do very well with that as well because you got $12 and $13 rents in those areas. Financing -- their financing is always the question mark. We would have announced one of these a lot earlier, except one of their lenders went away in the middle of it, but they were successful in getting a new one.

But it's -- I think it's really the guys that have some history and experience with the suburban office and that are comfortable with these that are getting deals done. And the market, whether one likes it or not seems to be about $160 a square foot, and that's really -- I think we sold ours $160 or $162 or something like that. So that leaves us with basically three single tenant assets in Atlantic Canada and then one Downtown Ottawa office asset that's got 2.94% debt on it until 2029. So we're not giving that away for the debt. There's no need to do that.

[Operator]

Ladies and gentlemen, this concludes today's Q&A session and the conference call. We thank you for participating, and we ask that you please disconnect your lines at this time. Thank you.