PRO Real Estate Investment Trust

TSX:PRV.UN

Earnings Call Transcript

[Operator]

Good morning, and welcome to PROREIT's Third Quarter Results Conference Call for Fiscal 2023. [Operator Instructions] For your convenience, the results release along with the third quarter financial statements and management's decision 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, level of activity, performance, goals or achievement or other future events or developments. Forward-looking statements are based on information currently available to management and on estimates and assumptions based on the 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, level of activity, performance, achievements, future events or development to differ materially from those expressed or implied by forward-looking statements. As a result, PROREIT cannot guarantee 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 November 8, 2023, available at www.sedarplus.ca.

Forward-looking statements represent management's expectation as of November 8, 2023, and except as may be required by law. PROREIT has no intention and undertakes no obligation to update or revise any forward-looking statements, 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 the description of this non-IFRS financial measures, please see the third quarter earnings release and MD&A. A reconciliation of non-IFRS to IFRS results as applicable, may also be found in the earnings release and MD&A for the third quarter. Please refer to the non-IFRS measures sections in the MDA for the third quarter for additional information.

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

[Gordon Lawlor, executive]

Thank you, Lester, and good morning, everyone, and welcome. With me today is Alison Schafer, our CFO and Corporate Secretary; and Zach Aaron, our Director of Investments and Asset Management. I will start the call with an overview of our third quarter results before turning the call over to Alison for a deeper dive into the financials.

As you know, the real estate market continues to face a challenging economic environment. Against this backdrop, I'm pleased to report that we were able to maintain our operating momentum in the third quarter, which reflects the fundamental strength of our portfolio and our platform.

That being said, I'd like to note that our operating performance cannot be directly compared year-over-year. At September 30, 2023, we owned 126 properties compared to 132 properties at the same time last year, both with 50% ownership interest in 42 of the property.

Our portfolio continues to be resilient and generate organic growth. Same property NOI income increased 1.7% in the third quarter when excluding the impact of the temporary vacancy and 102,000 square foot industrial facility, which we mentioned on our last call. This Quebec property is fully leased as of October 1, 2023, on a 10-year lease with terms and average spread of 55% over the previous tenant rents. We will see the full benefits of this attractive renewal reflected in our fourth quarter results more specifically, positively impacting AFFO, payout ratio, net operating income and same-property NOI.

We continue to benefit from a high occupancy rate and high renewals at favorable spreads across all asset classes. More specifically, we have successfully renewed 88% of GLA maturing in 2023 at 43.9% average spread. [ After ] GLA maturing in 2024, approximately 18% has been renewed at approximately 30% average spread.

We are well positioned to capitalize on future growth in markets where we have a strong presence. Halifax, for example, where we have a leading position in the industrial market is experiencing rapid population growth and is poised to [ review ] major investment as a result of that surge. We look forward to incremental cash flows from our organic growth and GLA renewals.

Let me now briefly go over some recent portfolio transactions. In the third quarter, we sold two noncore office properties totaling 60,000 square feet for gross proceeds of $9.1 million. Proceeds were used to repay approximately $5.7 million of related mortgages and the balance was used for general business purposes.

Also during the quarter, we sold a 3,000 square foot nonstrategic retail property for gross proceeds of $2.2 million. Proceeds of the sale were used to repay approximately $1.5 million of related mortgage balance with the rest used for general business purposes. This brings the total to four successfully noncore properties sold for total proceeds of $13.4 million year-to-date.

Subsequent to quarter end, we entered into a binding agreement to sell two additional noncore properties in our retail segment for gross proceeds of $10.9 million. The first agreement signed was for a 45,000 square foot property with gross proceeds of $8.7 million where the purchaser will assume a $4.4 million mortgage. The second was with respect to 4,500 square foot property with gross proceeds of just under $2.2 million. These sales are expected to close in the fourth quarter of this year.

I'll now turn the call over to Alison for a more detailed look at our third quarter results.

[Alison Schafer, executive]

Thank you, Gordie, and good morning, everyone. At the end of Q3 2023, we owned approximately 6.4 million square feet of GLA and managed approximately 10.8 million square feet of GLA. Total assets amounted to $1.05 billion at September 30, 2023, up 1% year-over-year. Our property revenue for the third quarter was relatively flat at $24.1 million compared to the same period last year.

Net operating income was $14.1 million, down 5.1% from $14.8 million in Q3 2022, largely because of the impact of the decrease in properties owned that Gordie discussed. General and administrative expenses for Q3 this year was $1.2 million, down slightly from Q3 2022.

Net cash flows provided from operating activities was $11.0 million, which is relatively flat compared to the third quarter of 2022. AFFO totaled $7.0 million for the quarter compared to $7.9 million last year. The decrease is mainly due to the temporary vacancy at our Montreal property, a decrease in properties owned and ownership percentages as well as an increase in interest expenses. Our AFFO payout ratio was 96.9%, an improvement from 97.3% in Q2 2023.

From a balance sheet perspective, our liquidity position is strong with $46.0 million available from our credit facility plus $11.4 million in cash at September 30, 2023. We also paid down $14.4 million of debt and credit facility during the third quarter.

Our adjusted debt to gross book value was back at 50.0% at September 30, 2023, compared to 50.9% at June 30, 2023, with approximately $25.0 million of maturing mortgages remaining for 2023 and approximately $27 million for 2024. We continue to benefit from the well-staggered debt profile with limited material maturities until 2026 and only 2.7% of our total debt is at a variable rate.

As for the weighted average interest rate on mortgage debt, it was 3.76% at September 30, 2023, compared to 3.69% at the same date in 2022. Finally, our weighted average cap rate is 6.1%.

Gordie, back to you for closing remarks.

[Gordon Lawlor, executive]

Thanks, Alison. I'd like to conclude first -- by first, thanking the entire team for all the good work done in the third quarter. Through this market turbulence, we remain focused on executing on our long-term strategy while managing our risks to reinforce our solid foundation.

As we continue to operate in a volatile environment, we will manage our business strategically and are balancing prudently. Our portfolio benefits from solid fundamentals and we remain committed to strengthening it while increasing concentration in the industrial sector.

On the capital allocation front, our strategy also remains on course with regular distribution payments to our unitholders and the reduction of debt to gross book volume. Above all, we remain steadfast in commitment to sustainably deliver long-term value for the benefit of all of our stakeholders.

This concludes our formal remarks. Lester, we would be pleased to take questions from analysts at this time.

[Operator]

Thank you. Ladies and gentlemen, this is now our question-and-answer session. [Operator Instructions] Your first question comes from Brad Sturges from Raymond James.

[Bradley Sturges, analyst]

Gordie, I just wanted to clarify some of your leasing comments on -- at the start of the call there. It sounded like for your 2024 maturities, you're -- you've already addressed 18% at 30% rent spreads. Is that what I heard correct?

[Gordon Lawlor, executive]

Yes. Yes, that's correct.

[Bradley Sturges, analyst]

Okay. And how are you thinking about your 2024 maturities as we sit today? Do you have any guidance or general expectations of where you think you could land in terms of average spread on renewal for next year?

[Gordon Lawlor, executive]

I'll introduce Zach Aaron to the group to comment on that a little bit. He's heavily into this on a daily basis.

[Zachary Aaron, executive]

Sure. So we have about 75% to 80% of our expired GLA in 2024 as industrial expiring. And so far, from what we've seen across about 25 deals, we're about -- at a 40% spread on those industrial renewals. And that's kind of in line, what we saw in 2023, and that's a combination over our Burnside portfolio in Halifax, Ottawa, Winnipeg and Southwest Ontario. And so we see more of the same coming due for 2024 across our industrial renewals, kind of the expectation to be in that 30% to 40% renewal spread range throughout the year, similar to 2023.

[Bradley Sturges, analyst]

Okay. That's helpful. And any expectations around the nonrenewal or any transitional vacancy at this point with respect to your 2024 maturities or expires?

[Zachary Aaron, executive]

In 2024, at this moment, from what we know on hand, there's nothing major. There's a few retail office in some larger spaces that are later in the year. But we don't have knowledge of where those will end up one way or another. But on the industrial front, there's nothing major as well in terms of any large spaces coming due that we know are vacating just yet at least.

[Bradley Sturges, analyst]

Okay. And then just for the remainder of this year, I think just a little bit of space like 75,000. Just what are your prospects for what's left to do this year?

[Zachary Aaron, executive]

Yes. So in terms of what's remaining, if you're our 2023 list, there's really kind of 1 or 2 spaces of larger size that are kind of outstanding that lead that 11% that's remaining. Kind of where we're seeing in terms of the discussions we're having, I think we'll probably end up closer to 93%, 94% in terms of a final 2023 number in terms of our renewal spread. But that's kind of what we're seeing in terms of the last kind of 2 months of the year.

[Operator]

Your next question comes from Sam Damiani from TD Cowen.

[Sam Damiani, analyst]

Just wanted to start off on the, I guess, investment market. What are you seeing in your core markets for industrial investment activity cap rates? Have they changed obviously, specifically on the Halifax market as well?

[Gordon Lawlor, executive]

Sam, so it's Gordie. So from the Halifax market, we haven't seen anything significant going on there as of late. No major sales of interest. There's some building of a couple hundred thousand square feet in Bayers Lake on the Halifax side and some [ high bay ] energy-efficient type stock that's going, that's 200,000 to 300,000. That's in some of the occupancy numbers now. So you see, I think, Halifax might have gone from 3% vacancy to 4% in this quarter, but it's basically showing that new development space. That's really not in competition to any of our space at this time.

And then the other thing that's out there discussion is this Burnside Park finally after years. They're opening up a section at the top of the Burnside Industrial Park there, and there'll a bidding and whatnot for some space there. The acreage is, as we understand it, are quite small and with -- I think, the group or the city would be more attuned to owner-user type pieces, but there is room for a couple of 100,000 or 200,000 square foot buildings there. So we'll be looking at that with our partner once it gets live in the next 6 months, probably.

But it's been pretty much status quo there. And I said the new build has really -- started on the Bayers Lake side with some best-in-class type 30-foot clear buildings going up over there.

[Sam Damiani, analyst]

That's helpful. And just on that 84,000 square feet that's characterized as redevelopment, what's the status on backfilling that -- those vacancies?

[Gordon Lawlor, executive]

Well, one of the buildings we have under contract, for sale. So we'll see if that comes to fruition in Q4. And the other one, we actually have an offer on that from a developer as well. So time will tell, but we may see both of those being sold before the end of the year.

[Sam Damiani, analyst]

Okay. And just finally, I may have missed some of the discussion with Brad's questions. Did you provide sort of a target year-end occupancy on an in-place basis given the big change?

[Gordon Lawlor, executive]

No, we didn't. I mean, I think what you've seen this quarter is -- which is unusual for us, was 90,000 of industrial vacancy. That will be reduced, though to 60,000 come Q4. So we had a 50,000 square foot space in Winnipeg that was leased until the end of June. It was a long-term tenant in there. So we spent a bit of time and cleaned it up. And then we've successfully leased it effective October 1 to the neighboring tenant, which is good and bad.

The good is they're coming into the 60,000, but they're leaving the 30,000. So basically, big spots of space, there'll be 30,000 left in that building in Winnipeg. And we have another 30,000 on à côté de-esque property on the island of Montreal that's been available since June as well. There's $6.25 rents in that building and the market is in the $15 to $16 range. So we expect to have something done with that property quite soon, but we'll see.

[Operator]

Your next question comes from Gaurav Mathur from Laurentian Bank.

[Gaurav Mathur, analyst]

Just as I'm looking at your debt ladder and the about $40 million of maturity for 2024 and roughly $28 million for 2023. Could you provide some color on what lenders are saying in terms of refinancings and where the spreads currently lie?

[Gordon Lawlor, executive]

So the last real fixed rate deal was the 5.07% we did on a 7-year money earlier in the year. I think our spread on that was 2 05, 2 0...

[Unknown Executive]

I think it was actually closer to 1 90.

[Gordon Lawlor, executive]

190. So 190 on those for 7 years. The $25 million coming due this year, we're just in talks with a big bank lender just to renew that for a year just because all of those assets. There's a couple of office assets in that mix. So as we've indicated, we look to sell those assets in the next year or so. So we're just looking at that from a standpoint of putting 1 year debt on it or a floating rate option.

So we don't have any issue with that $25 million as far as getting it refinanced. It's just what we're doing with the assets. And the next $27 million, that's basically March and April. We're already chatting with lenders on those. But -- I mean, what we're seeing is spreads on good industrial between 1 90 and 2 10. That's what hearing in the market. So we don't think we'll have any problems with those.

You'd like your -- you'd like to lock the rates in a little lower than they are now. So hopefully, we'll see what goes on in the next number of months.

[Gaurav Mathur, analyst]

Okay. Great. And did I -- sorry, go ahead, please.

[Gordon Lawlor, executive]

No, I didn't say it.

[Gaurav Mathur, analyst]

And did I hear you correctly, the $27 million for next year, that's due in March and April?

[Gordon Lawlor, executive]

Do you have that list there of -- I think most of it's due in April.

[Alison Schafer, executive]

Yes.

[Gordon Lawlor, executive]

Yes.

[Gaurav Mathur, analyst]

Okay. Great. And then just switching gears here on capital recycling. We know that you have the disposition program, but is there anything on the acquisition front that's looking very attractive at the moment and may make sense as you look at 2024?

[Gordon Lawlor, executive]

I mean, Zach's in touch with the brokers all the time and there's just a large disconnect between vendor industrial values and what purchasers are available to pay right now based on anybody that's a leveraged buyer, right?

I mean -- so when you're sitting there looking at 6% to 6.5% debt or 5.8%, if you got the best-in-class on maybe yesterday's numbers, it's a challenge, right? So that's, I think, what we're seeing in the market right now. It's quite stalled. I mean, Zach, you haven't seen any significant trades in the last little bit?

[Zachary Aaron, executive]

No. I would say there's been a fairly significant amount of deals that have come to market post Labor Day on the industrial front. And I think that's just a bit strategic from brokers with just more people paying attention. But with rates continuing to kind of shoot up and down, I think it's just tough for buyers, especially institutional buyers, to have any sort of real confidence of where values are right now.

And then combine that with a tough financing environment, I think a lot of people are still in a very much pens down situation. So we just simply haven't seen much of the product that even came to market in, call it, early September trade. Some of it may be under contract that we're just not aware of yet, but it's definitely a slow grind out there right now kind of from what we're seeing across the country.

[Gaurav Mathur, analyst]

Okay, fantastic. And just one follow-up question. Is there a specific vendor type that you're seeing emerging as far as some of these assets that are coming to market?

[Gordon Lawlor, executive]

Yes, all private vendors. Family money, smaller firms, that's really what we're seeing. The single-tenant assets that we have are small -- small multi-tenant. It's just smaller private groups. And you have to work harder on those deals. And so it takes a lot longer. I mean, that's really what we're seeing.

But we're getting -- we're happy with the pricing we're getting. So for some of these smaller assets, they've been 7.5% caps, which we're fine with for those type of assets with the low growth and some leasing risk going forward. And then the $9 million asset that we alluded to; I think that's at a 7.25% cap. So that's -- we're happy with that pricing as well.

So we're not fire-sailing any of these assets at all. It's just some of them are coming to us at unsolicited offers and things like that. So it's a grind, but we're being successful at it. So we're pleased.

[Operator]

Your next question comes from David Chrystal from Echelon.

[David Chrystal, analyst]

Just on the -- you provided a bit of color on the Winnipeg, I guess, kind of tenant shift within the portfolio. I suppose the releasing is a good story. But the Winnipeg departure, and you alluded to a smaller Montreal tenant departure on that kind of 90,000 of vacant space, can you provide any commentary on the reason for vacating the space?

[Gordon Lawlor, executive]

The Winnipeg asset, it was a long-term tenant that needed more space that we couldn't accommodate. So that's what that was. I mean, those rents were $5 and $6.

[Zachary Aaron, executive]

Yes. I'm not sure what that sound was. The previous rent in the 60,000 square feet was $5.50 and the new tenant who starts payment -- or started payment October 1 is now paying $7.50 on a 10-year deal that includes 3% annual steps. So we're extremely happy with that. And now we're just working on backfilling their smaller 28,000 square foot space next door that's in good shape.

And then in Montreal, the previous tenant in there had gone bankrupt. So they vacated the space in early 2023. They were paying about $6.25 on a net basis. We had a temporary tenant come in for 3 months that basically just continued paying the same gross rent. And so now the space has been vacant since...

[Gordon Lawlor, executive]

End of June.

[Zachary Aaron, executive]

End of June. And so that's -- yes, 30,000 square foot industrial space. There's a bit more office in that space. It's about 30% office is the layout. The rest is 24-foot clear industrial warehouse with shipping access right along -- close to the -- near the airport. So we've budget tours and a lot of groups looking at it, a few offers already that just having got there. But we're fairly confident we'll get a deal done sooner than later in that $15 plus/minus range.

[Gordon Lawlor, executive]

The tenant there was a distribution facility for a retailer. So that's one thing that we're noticing when you have some of these smaller retailers that have run out of room with COVID and whatnot. So we got that space back, which we were happy to get back because like I said, the $6 rent could be $15 or $16, but you get transitional downtime with these deals to create more value, right? So we've been lucky on any of those departures to be significantly under market rent and prove to be good story longer term.

[David Chrystal, analyst]

And sorry, just to clarify, the tenant that went bankrupt was the -- was logistics for the retailer? Or was that was the temporary tenant that backfilled that space?

[Gordon Lawlor, executive]

No. So it was a, what is it, an electric shaving company or something in Quebec?

[Alison Schafer, executive]

It's a company called Centre du Rasoir.

[Gordon Lawlor, executive]

Yes. So they -- shaving materials that will likely be in the malls and that type of thing. So this was a distribution and returns facility for them. Then we just rented to the liquidator for 3 months while they were liquidating their inventory there. And the liquidator wanted to actually stay on, but we told them no because we wanted to get a better rent in the space.

[David Chrystal, analyst]

Okay. So really, like no material change in leasing dynamics is -- I mean, it's actually a mix of kind of good news stories and tenant expansion and inability to accommodate larger tenant requirements. So I suppose you're not seeing any broader challenges across your portfolio from any tenants?

[Gordon Lawlor, executive]

No. Honestly, we have, and if we look back in our 10-year history and -- that we've been lucky with minimal bankruptcies or having real estate that was attractive to release. And so we don't see anything systemic yet as far as recessional or anything like that. We just see everybody being a little slower. So if somebody wants to expand but then they're thinking about it again. So that works both ways.

Somebody wants to expand and thinks that your space is too small for them, they're rethinking and saying, well, maybe I'll stay for another couple of years. So you just got that -- this internal discussion among every tenant about their business, which may or may not affect our business. That's really the way I communicate it right now.

[David Chrystal, analyst]

Okay. And then Alison, maybe if we were just to back out the 90,000 of transitional vacancy, what would same-property NOI growth have been for the quarter?

[Alison Schafer, executive]

If we back out the Montreal vacancy?

[Gordon Lawlor, executive]

Yes.

[Alison Schafer, executive]

So if we back out the 90,000 square foot...

[Gordon Lawlor, executive]

I think we would have been in like 5% or 6% with that. We honestly didn't look at it for that point. We thought we did enough with the -- backing out the onetime other ones...

[Alison Schafer, executive]

The Montreal piece there.

[Gordon Lawlor, executive]

Yes. I thought the analysts wouldn't like it is every time we had a vacancy, we adjusted it -- adjusted the same-store. So -- but it would have been north of 4% or 5%, I think, on the industrial.

[Alison Schafer, executive]

Yes. High level of speaking, yes.

[Gordon Lawlor, executive]

Yes.

[David Chrystal, analyst]

Yes. Yes, fair. And then -- I mean, as far as you can give kind of soft guidance for '24, and based on your commentary on leasing velocity, it sounds like it's much the same as '23. Would it be fair to read kind of mid-single-digit NOI growth for the year ahead?

[Gordon Lawlor, executive]

Yes. So we just finished our 2024 budget and then did a 5-year cash flow. So -- I mean, it's a cash flow and it's based on what your occupancy is. But we were really pleased with the outcome of that. So we're seeing between, over the 5-year period, 5% to 8% NOI growth like an average CAGR of like 6%, 6.5%. So that's where we think our numbers are going over -- with these incremental rents.

[Operator]

There are no further questions at this time. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.

[Gordon Lawlor, executive]

Thanks very much.

[Alison Schafer, executive]

Thank you.

[Zachary Aaron, executive]

Thank you.