Slate Grocery REIT

TSX:SGR.UN

Earnings Call Transcript

[Operator]

Good morning, ladies and gentlemen, and welcome to Slate Grocery REIT First Quarter 2024 Financial Results Conference Call. [Operator Instructions] This call is being recorded on Wednesday, May 1, 2024.

I would now like to turn the conference over to Shivi Agarwal, Manager, Finance, of Slate Grocery REIT. Please go ahead.

[Shivi Agarwal, executive]

Thank you, operator, and good morning, everyone. Welcome to the Q1 2024 Conference Call for Slate Grocery REIT. I am joined this morning by Blair Welch, Chief Executive Officer; Joe Pleckaitis, Chief Financial Officer; Allen Gordon, Senior Vice President; and Braden Lyons, Vice President.

Before getting started, I would like to remind participants that our discussion today may contain forward-looking statements, and therefore, we ask you to review the disclaimers regarding forward-looking statements as well as the non-IFRS measures, both of which can be found in management's discussion and analysis. You can visit Slate Grocery REIT's website to access all of the REIT's financial disclosure, including our Q1 2024 investor update, which is now available. I will now hand over the call to Blair Welch for opening remarks.

[Blair Welch, executive]

Thank you, Shivi, and hello, everyone. Slate Grocery REIT's first quarter results demonstrate the continued strong demand for our high-quality grocery-anchored real estate and the rental growth embedded in our portfolio. Our team completed over 770,000 square feet of total leasing in the quarter. Over 98,000 square feet of new deals were completed at 31% above comparable average in-place rent. Nonoption renewals were completed at 15% above expiring rents. And at quarter end, occupancy was 94.4%. Our positive leasing momentum at double-digit leasing spreads continue to translate to income growth for the REIT. Same property NOI increased by $1 million or 2.5% year-over-year. We expect NOI to continue to increase over the coming months as the impact of new leases completed over the last 12 months is realized. At $12.49 per square foot, our average in-place rent is well below the market average of $23.21, meaning we have significant runway to continue increasing our rents and growing our net operating income.

Our team also continues to prudently manage the REIT's balance sheet to ensure we remain protected in the current interest rate environment. The REIT exercised a 6-month extension option on its $300 million revolver and over 94% of the REIT's total debt remains fixed at a weighted average interest rate of 4.4% and a weighted average remaining term of 3.1 years on the REIT's interest rate swap contracts. This provides us with stability in today's interest rate environment.

We continue to have strong conviction in the fundamentals of the broader grocery-anchored real estate sector. Vacancy levels in the neighborhood community and strip center segment continue to hover near record lows and new retail supply remains muted. At the same time, tenant demand for well-located grocery-anchored spaces remains high and grocers continue to see increases in sales and foot traffic. America's leading grocers like Walmart, Kroger, Publix and Aldi continue to invest significant capital in both new and existing stores, underscoring the important role of physical stores as a local distribution hub. With in-place rents that are well below market, Slate Grocery REIT is uniquely and well positioned to capitalize on these fundamentals and increased rents over time to deliver long-term growth for our unitholders.

On behalf of Slate Grocery REIT team and the Board, I would like to thank the investor community for their continued support and confidence. I will now hand it over for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Sairam Srinivas of Cormark Securities.

[Sairam Srinivas, analyst]

My first question is on leasing. So when you look at the nonanchor renewal pads as such, or renewal on new leasing pads and when you compare the kind of tenants you're seeing in the last couple of years, how does that compare to the kind of tenant profile you saw maybe a couple of years ago or prepandemic. Has there been any change in the profile over there?

[Blair Welch, executive]

I'll try and answer the question a little bit, Sai, but if I missed it, please ask again. We're seeing tenant demand from different types of tenants that we would have seen 5 or 10 years ago in the neighborhood anchored strip center. I think a couple of reasons for that. I think B and C enclosed malls have higher costs and less foot traffic. So tenants that typically weren't located in these types of centers are relocating to centers like ours, grocery-anchored neighborhood strips. So that's creating more tenant demand than we've seen in the last decade. And I think that's because of foot traffic and our cost. But we're also seeing certain pad -- typical pad users come in line. Or in other words, the cost required to build a pad and therefore the rent they need to pay for that pad is higher than perhaps they want to do. So we're seeing demand from pad users come in line as well. So I think we're seeing tenant demand from all sorts of retail tenants. And I think it's because of the traffic the anchors generate and the low cost of our rents. Does that answer your question, Sai?

[Sairam Srinivas, analyst]

Yes, that's exactly the color I was looking for. And actually -- so the second question I had was on renewal spreads. Obviously, spreads this quarter looked really good, and as we looked in the last couple of quarters as well. Can you guide us as to how we should think about option versus nonoption renewals.

[Blair Welch, executive]

Yes. I think we'd like to quote our non-option renewal spreads like our U.S. peers do because I think that when a tenant has control of the space, there's a little bit different of a negotiation. That being said, what we try and quote is you've seen over the past quarters and years, our non-option renewal spreads are quite high. And I think that speaks to the demand that I just talked about earlier. So we -- given the entire market is pretty tight, there's not much vacancy and not much new construction with tenant demand, we anticipate those nonoption spreads will continue to be double digit. And I think that's a combination of tenant demand, our team's really good work with tenants that we know and being aggressive and really our strategy of buying low in-place rents. We quoted a lot, and we probably sound like broken records, but at $12.49 in-place rents when the market average is over $23, there's tons of room for growth because we offer quality space at a discount to operators where they can improve their margins.

[Sairam Srinivas, analyst]

That's great, guys. So when you look ahead for '24 now, how should we be thinking about the mix between option spreads, those leases with options for renewal versus stores that don't have it?

[Blair Welch, executive]

Yes. I mean, I think if you look at our nonoption renewals over the last 3 quarters, it's been in the mid-teens. So we continue to see double-digit nonoption renewal spreads. It gets a little bit choppy when you look at a quarterly basis because certain tenants at certain times in certain market rents roll. But I think if you're thinking double-digit on that, that's how we look at it. And renewals are going to be high single digits. So it's significant rental growth. And I'd just like to point out, we quote those spreads and it's important, but Slate Grocery REIT when we do a lease deal, we pay the cash from a landlord perspective in tenant inducement leasing commissions and any capital work at signing. And therefore the net operating income derived from that lease comes on in the following quarters. The team did over 3 million square feet of leasing in the last 12 months. And that NOI, you'll now start to see in 2024 and 2025. So we're pretty excited about our NOI growth because we can talk about leasing spreads, but I think our unitholders want to see some cash, and we're looking forward to delivering that to them in the coming years.

[Sairam Srinivas, analyst]

That makes sense. And probably the last question I had was, so if you think about all the renewals that are coming up this year, what would be the proportion of those renewals that have options in them?

[Blair Welch, executive]

I think that if they renew, I would say the shop space side, they're all going to renew at market. So you can kind of think about it as like it's a nonoption. A lot of them do have options. We're really talking about the difference between the grocers and the shop space in those renewal numbers. So I would say that when we think of all the shop space, assume that they're going to be renewing at the nonoption spreads just because they have less control and we kind of manage our grocers. It's a little bit different because we want to control that anchor. We're still seeing great growth in our grocery rent, to get more in the weeds. Our grocery rent in our portfolio is $9 a foot. So if you add a 5% or 10% lift, you're still under $10. And when you think about what comparable industrial rents would be, say, for their main warehouse, we're inside that. So we think our real estate is extremely valuable for their supply chain.

[Braden Lyons, executive]

And I might just add 1 more piece. For the 2024 expiries, we have about 1.1 million square feet remaining to be renewed. About 50% of that would be grocers and the remaining 50% is kind of shop space. So I think that's kind of that 50-50 to what Blair said is what I would model.

[Operator]

Your next question comes from the line of Brad Sturges of Raymond James.

[Bradley Sturges, analyst]

Just to go back to the leasing comment there in terms of what you've done so far, obviously you've had a lot of activity that hasn't been effective quite yet in the operating results. When would that start to really take effect? Is that back half of '24?

[Blair Welch, executive]

Yes. I think we're starting to see it now. But if we kind of think of 2024, we think we're going to get pretty good NOI growth. And that [indiscernible] is booked, like we can see that, and that's going to be 2.5-ish percent or more. And that will continue into 2025. So I think that if we did all that leasing in 12 months, by the time you kind of pay for all that stuff, that starts coming on 6, 9 months later, and that's what we're starting to see right now. So it will be muted now, even though it's not bad, but you'll start seeing it in the next 2 or 3 quarters for sure.

[Bradley Sturges, analyst]

And that 2.5% going into '25, that doesn't include redevelopment activity, right?

[Blair Welch, executive]

Well, I mean, yes, but I mean there's not too much. I mean I would say that of cash we spent without any kind of new leasing like stuff, we can kind of look through on what we've already spent. That's how we kind of quote that number. I mean there could be new stuff that could make it better, but that's kind of what we've already booked at 2.5%, everything.

[Bradley Sturges, analyst]

In terms of redevelopment, there was 1 project identified in your disclosures, East Little Creek. Just curious to get a sense of the budget, your time line and your expected return with the project.

[Allen Gordon, executive]

Yes. This is Allen, Brad. We're still working through that redevelopment. We've got several national tenants that are interested in that location. So as we continue to work through that, finalize pricing, we'll certainly update that. But there's definitely interest from the city in that redevelopment and multiple -- like I said, multiple tenants that we're in discussions with about a potential redevelopment at that site as well.

[Blair Welch, executive]

I think our development spreads historically have been -- I mean, excuse me, yield on costs have been in the double digit. So I mean that's kind of how we think about cash spend.

[Bradley Sturges, analyst]

Yes. Okay. Is there anything else at this point that would be earmarked for redevelopment? Or is this the only project in the near term we should be thinking about?

[Braden Lyons, executive]

Brad, it's Braden. So there is something coming online in the next little bit. We acquired a property in New York in 2021 that had a vacant grocery box, about 60,000 square feet. We allocated no value to it at the acquisition. And we're now looking at backfilling that with 3 national tenants, and we expect that will come online in the next little bit.

[Bradley Sturges, analyst]

Great. Just last question. Just on -- just looking at your debt maturities coming up, can you give us a sense of where cost of debt would be today, either from like a secured debt basis or if we're thinking about it through the use of fixed interest rate swaps?

[Blair Welch, executive]

Yes. I'll let Joe correct me, as he usually does, because I mean this is his thing. But we have swaps in place for the next several years. So we'll keep our effective rate of interest down kind of where it is between here and below 5, which is good. As it relates to, I think, a bit of your question is what's the market like, we have been extremely pleased with lender comment, lender interest in grocery-anchored retail. And I think the reason is when you look on a debt yield basis or rental growth basis, grocery-anchored retail is different than many types of real estate right now because we're talking NOI growth -- NOI erosion. So that has been -- we do not anticipate significant spread increases from where risk spreads were 2, 3, 4 years ago. What the difference is obviously the risk-free or the underlying rate. But we do not see spread increases. So for the next couple years, our swaps will protect us from the cost of debt, and we think our NOI growth over that period will offset any kind of interest rate increases because of the risk-free rate in years 3, 4 and 5.

[Operator]

We have 1 question again from the line of Pammi Bir of RBC Capital Markets.

[Pammi Bir, analyst]

Maybe trying to sneak one in here. Just on the commentary around same-property NOI growth, it sounds like the outlook is stronger than what it's been for a little while. And I'm wondering just how much of that is actually going to be coming from the rent growth that you talked about on the renewal spreads versus occupancy pickup. And I'm just curious if you have any comments on the occupancy outlook. It sounds like it's been pretty firm or pretty constructive. So I just wanted to get some thoughts there.

[Blair Welch, executive]

Yes. I'll let the team chime in, but thanks, Pammi. I think that there's -- it's going to be a bit of both. I think that the team did a really good job of increasing occupancy, both -- we bought some assets several years ago that we thought were underperforming, and we did it strategically. The team then went to work and we started to increase the occupancy and that money was spent in the last 12-ish months or so. So NOI growth will be a combination that you're seeing in 2024 of kind of leasing to increase the occupancy. Now that being said, the market's also tightened. So I would say, when you look in the future, the NOI growth will be just because of the difference between $12.49 and $23. But right now, I would say it's a combination of the work the team did to increase the occupancy because we were strategic in buying the vacancy. So we're kind of seeing that come up. But even though everyone in real estate wants their assets to be 100% full, that's kind of an impossibility with multi-tenant real estate. So I think the market is approaching stabilized occupancy. I don't know what the technical term would be. So you're just going to see that all on rental growth now.

[Pammi Bir, analyst]

Great. Just on the -- maybe switching gears and looking at from a capital standpoint, what can you sort of share with maybe what you're seeing in the transaction side of things, anything of interest at this stage? And also just thinking of, of course, where you are relative to where your cost of capital is certainly with the discount to NAV. So I'm just curious how you're thinking about where to put money to work.

[Blair Welch, executive]

Yes. So I would say like all real estate transactions have been -- are down. But that being said, there's 40,000 grocery stores in the United States, and it's a somewhat granular asset. So if the average deal size is $20 million to $25 million, we still see transactions because of, say, 1031 exchange buyers or locals. But it's not what it was. So I would say that there are transactions, but not like it was -- it's not as bad as other asset classes, but it's muted. But that still creates liquidity for us.

As it relates to our cost of capital, 18 months ago, we brought in an institutional investor at NAV, and we believe in our NAV where our IFRS cap rate is just north of 7. So we have positive leverage if you mark-to-market our whole debt, even when you think of our 4.5% debt now. I mean it's a huge spread. And we have the cheapest rents of all of our peers. So we believe in our NAV. We think it's fair and so we don't trade like that.

At Slate, we always are in the market looking at opportunities. And the pipeline in the U.S. for grocery is massive, but we're not going to do anything foolish to dilute our existing unitholders. We're a large unitholder. We believe in our performance and focused on that, and we always talk to the Board about allocating capital. And I think, just to say again, we thought it was a great idea to show our investor base that you bring in someone at your NAV because we weren't trading there. And I think there is -- I think that was a great deal for the company. We'll continue to try and add value and create value for our unitholders. But we're not going to do anything foolish because of where we trade. We think it's a great idea to buy the stock right now because our performance is excellent and the market is good. But we're always in the market looking at new deals just so we can always be able to do creative things.

[Operator]

We don't have any further questions at this time. Shivi, please continue.

[Shivi Agarwal, executive]

Thank you, everyone, for joining the Q1 2024 conference call for Slate Grocery REIT. Have a great day.

[Operator]

This concludes today's conference.