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Good morning. My name is Kim, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Slate Retail REIT Third Quarter 2018 Financial Results Conference Call. [Operator Instructions] Madeline Sarracini, you may begin your conference.
Thank you, operator, and good morning, everyone. Welcome to the third quarter 2018 conference call for Slate Retail REIT. I'm joined today by Robert Armstrong, Chief Financial Officer; and Greg Stevenson, Chief Executive Officer.Before getting started, I'd like to remind participants that our discussion today may contain forward-looking statements and, therefore, ask you to familiarize yourself with the disclaimers regarding forward-looking statements as well as non-IFRS financial measures, both of which can be found in management's discussion and analysis. You can visit Slate Retail REIT's website to access all of the REIT's financial disclosure, including our Q3 2018 investor update, which is available now. I will now hand over the call to Greg Stevenson and Robert Armstrong for opening remarks.
Thank you, Maddie, and thank you to the participants for joining the call this morning. In the fourth quarter of last year, we laid out in detail the business plan for the REIT for 2018. The team has done an excellent job of executing and delivering on our plan, and the third quarter results highlight an inflection point for all the hard work that has been put in over the last 12 to 18 months.Specifically, occupancy is up 170 basis points year-over-year, currently at 94.3% on the back of solid leasing results and maintaining our industry-leading retention ratio above 90%. Our properties continue to be a place tenants want to operate their businesses and, as importantly, our asset management team are people that they want and enjoy doing business with. The level of service and dedication our team brings has, no question, played a big part in delivering on our plans. In addition, we have made progress on our development pipeline with $2.7 million of estimated incremental net operating income to be generated upon completion, representing an approximate 11% yield on cost. In addition to the incremental income these projects will generate, the capital spend and new tenancies will also serve to increase the value of the property significantly. Leasing was strong again this quarter, helping to drive 2.4% same-store NOI growth. In addition to this, signed leases with tenants that are not yet open for business and paying rents has grown in excess of $2 million of annual base rent, which will also be incremental to our Q3 results.Lastly, we will continue to sell noncore properties that will allow us to recycle capital that can be more opportunistically deployed to generate future growth as well as upgrade the quality of the portfolio along the way. I want to thank the Slate Retail REIT team for all their hard work, and I'll now turn it over to our CFO, Robert Armstrong.
Thanks, Greg. Just a couple of notes. During the quarter, the REIT entered into an additional $350 million of interest rate swaps. The REIT's net debt is now 99% fixed, eliminating our exposure to future interest rates hikes. Further, the weighted average rate of our swaps is about 2.03%. This is below the current 1-month U.S. LIBOR of 2.3%, and we think is a good spike in the market expectation of future rate hikes in 2019. As a result of our continued income growth, strong occupancy and portfolio performance, the REIT will increase its monthly distribution to $0.855 annually. This is an increase of 1.8% over the current distribution. It marks the fifth consecutive annual distribution increase since the REIT listed on the TSX in 2014. Also as an update on our unit repurchase activity, the REIT has repurchased 1.4 million units on a year-to-date basis for a total capital outlay of about $14 million. A significant number of these purchases occurred subsequent to quarter end. These repurchases have resulted in immediate increase to NAV to unitholders, and we intend to continue to repurchase units where appropriate pricing exists. Both Greg and I thank you for your continued support, and I'll now hand it over for questions.
[Operator Instructions] Your first question comes from Sumayya Hussain from CIBC.
So just firstly, your occupancy, like you mentioned, picked up a decent amount, it's over 94%. And you've noted in the filings that there is still significant leasing that's yet to show up in the numbers. So do you have a sense of what that gap is between in-place and committed occupancy? And over what time frame would we see that show up in the numbers?
Sumayya, it's Greg. The gap is really the -- and we've talked about this in last quarter, it's really the approximately $2 million, which is slightly higher than that now of annual base rent, where we have a signed lease. But the tenant is not yet in and rent paying. Some of that started in Q3, and when we talked a lot about it earlier in the year saying we expect most of the growth to be in the second half of 2018, a lot of that is what we were referring to and we do have good visibility on the leasing that we've done. And we can see the income expected to come in. In terms of timing, a little bit in Q3, more in Q4, and I'd say the lion's share of that will be coming in by the end of the first quarter.
Okay. So fairly near term.
Yes.
Great, okay. And then can you just give some background on the joint venture with Kroger on Windmill and how it came about? And if you see other similar opportunities down the road, especially given there is limited supply of quality assets out there?
Sure. So that deal goes back a few years, and it was really the team doing a great job, being proactive and getting in front of the grocers, which is a big part of our strategy. Kroger identified Slate as a counterparty that they wanted to do business with. And they came to us as opposed to us going to them with the idea that we should look for sites, where they could build their new store concepts, Windmill Plaza being one of them. At that time, it was a Kmart-anchored center. We purchased it. We being [slam] on behalf of Kroger and the REIT gave a loan with the right to purchase the center. Kroger has signed the lease. They're working on building a store, and we're working on backfilling the former Kroger box. And when you do this, 2 things happen. One, you take $2-ish Kmart rent and you replace it with a slightly higher Kroger rent, but you're also replacing a Kmart credit with a Kroger credit, which has significant cap rate compression that comes along with it, and you're signing a 15- to 20-year lease with Kroger on a brand new store, where we expect sales to be significant. Where a lot of the return comes from is in backfilling that Kroger box with tenants who want to be next to a brand-new Kroger, and that's a long list of tenants and you're earning, in some cases, 4 to 5 times the rent that Kroger or Kmart was paying on that box. So we're really excited about Windmill. Tyler and the team have done a great job, and our partnership with Kroger as a result just continues to grow. So we're really excited about that opportunity.
Your next question comes from Himanshu Gupta from GMP Securities.
Just to follow up on Sumayya's question on ABR signed, but not commenced. So when you say $2 million of incremental ABR, does this include the incremental NOI from development? I know in the MD&A you mentioned $2.7 million from the development repositioning efforts?
No, it doesn't. And that's why we wanted to talk about both separately in the letter and on in the call is that, you take trailing 12-month NOI at the end of Q3, it's about $100 million. You then add -- we know our signed expected-to-pay rent leases, that's another, let's call it, $2 million. And then you take incremental NOI from development projects, 4 of which are effectively pre-lease. So like we talked about in the letter, very high probability of execution there. You add those together, you're $4.7 million on a $100 million of trailing 12-month NOI. You can get a sense of what we think the growth over the next 6 to 12 months on a total portfolio NOI basis. Now same-store will differ because same-store NOI excludes quite a few properties due our acquisition activity and development activity. So we look at it on a total portfolio basis. But to answer your question, no, you have to add both those things together.
Okay. And by the way, thanks for the additional disclosure on the incremental development NOI, so that was pretty useful. Moving on, on the acquisition of this Plymouth Station, can you elaborate here, are you going to be more active on the acquisition front? Or was it a case of a more opportunistic transaction?
It was really recycling capital. So you probably know in the MD&A that we talked about selling noncore outparcels. Really what we sold is about the same dollar amount that Plymouth Station was acquired for. So we sold an outparcel at one of our centers, which is effectively our power center, a sort of big-box retailers, which we don't have a lot of and we don't want. So we sold those and we replaced that with Plymouth Station, which is a brand-new Hy-Vee-anchored, just signed a 15-year lease and the grand opening was actually 2 days ago, in a very affluent area and growing area of Minneapolis for effectively the same cap rate. So I think it's 2 things. One, we're managing earnings. And two, as we talked about on the call and in the letter, we're going to recycle this capital, and we think we can do it accretively over time, if not to keep earnings neutral. And I think where it becomes significant is the quality that we're getting in terms of upgrading. I mean, if you compare an unanchored strip parcel with power-center tenants and you get the same cap rate, which we think is much more upside with an asset like Plymouth Station and, more importantly, a grocer like Hy-Vee, who came to us with the idea. And similar to Windmill, we're having grocers approach us. So the risk-adjusted nature of that return, we think, is excellent. It's something we are going to continue to look for, but effectively any acquisitions we do, to answer your question, are going to be to replace income from sold assets, if we don't have a better use for those proceeds.
Right. So this looks like a brand-new asset there, right?
That's correct. And Bobby, I don't know if you want to add anything.
Yes, Himanshu, what I would add is, just looking back at what we've done in 2018, and coming out of 2017, we are very purposeful in -- that we wanted 2018 to be a year of integration, given 2017 we had close to $400 million of acquisitions. And I think we're mostly through that. We've increased occupancy 170 basis points year-over-year. We've got 6 straight quarters of positive same-property NOI growth. And when I look forward to 2019 with that integration on track, and we're doing about 250,000 square feet of leasing a quarter, I think we'll be more acquisition-focused in 2019. But to Greg's point, a large part of that will be funded from capital recycling, where we will be opportunistic in either solidifying value where we think we created value or derisking, but looking to really bring up the quality of the portfolio. But we do think there is a lot of opportunity that's there, and I think we'll be net acquirers going into 2019.
Got it. And also some of your large peers have been net sellers or have been selling assets in the secondary market like yours. Did you look into -- I mean, any of those assets as well? And what kind of pricing do you think they were able to achieve in some of your markets?
I mean, we see them all. We are still the only North American REIT that's 100% pure-play grocery-anchored. So anything that happens in this space comes to us. And we're constantly understanding the opportunities in the market and the pricing. And I would say for high-quality properties with a productive grocer and all that, that's just means high sales and growing sales, which is what we look for, pricing has held strong. I think market participants still view grocery as a ballast in their portfolio. Because if you look back at the grocery-anchored asset class, you can go back decades, you can go back to the financial crisis, which is the worst financial crisis in the last 100 years, grocery-anchored real estate held up extremely well and continues to hold up extremely well today. So the demand has been strong. And I think, in maybe some tertiary markets, demand has softened as capital flow has softened. It hasn't had anything to do with fundamentals or performance, I think it's just more capital -- temporary capital flows. But the demand for the asset class has held up. And I think I've gone through a lot of the Q3 earnings calls, just to check in on some of those numbers, Kimco, Brixmor, Regency, Equity One, et cetera, and the numbers have been solid. I mean, they are selling hundreds of millions of dollars of assets in -- between 7% and 8%, let's call it, 7.5% on average for product that we will believe is on average not nearly as high quality as the portfolio that we own. So when we think about our cap rate, our implied cap rate today, part of that value is why we think purchasing our units is quite attractive.
Got it, got it. And then looking at your 2019 lease expirees, are you starting to have conversation with the anchor tenant? I mean, is there any pushback? Or do you need to spend some capital there?
I would say, we never stop talking with our grocery tenants, expirees or otherwise. So the answer is, yes. And no real capital pushback. I mean, I think, the very simple math is, you've got a grocer and in a lot of cases -- $6, $7 rent in some cases, although we've got some grocers paying $2. The rent at these stores on 40,000 feet at $6 is really a small part of their fixed cost base, and it's not something they're usually focused on. Where they may or may not come to us is if we're asking for extra term, i.e. generally these leases have 5-year options. And they will extend those options and sometimes there will effectively be no conversation, just we are happy, here's our 5-year renewal. In other cases, where we think there may be an opportunity to go 10 years because we can upgrade the property by landscaping, pylon signs, façades or parking lots, which again, are all very inexpensive things for us to do. We just try and figure out if that investment is worth it for both the grocer and ourselves, and we try and partner on these things. But no, I think the renewals have gone very well. And they're not -- they don't want to close productive, profitable stores. This is a business that relies on scale and distribution. So their end game is to keep their profitable stores open. And they're not going to try and push landlords around in good stores, which are the stores that we own.
Got you. So last question, and probably on the theme of -- continuing the theme of your conversation with grocers. What are your thoughts on the grocery delivery model or the curb-side pickup? I mean, what are the notable trends in terms of omnichannel going forward? What are you hearing?
I think, there is a major push towards that. I mean, I think when people hear that online grocery purchases are expected to go from virtually 0 or 2% today in the U.S. to 10% by 2023 or the next 5 years, I don't think people fully understand what that means. What that actually means is that, that sale is still coming from the store. I think what's happened is, there have been a few participants who have tried to figure out bypassing the store. Hands down, that doesn't work. I mean, that's really what's happened.[Audio Gap]Bringing it to your house. As we talked about in the letter, I don't think people appreciate that the leaders in the innovation of this side are actually the grocers. You've got Walmart, Kroger leading that charge, partnering with Ocado, et cetera. We feel more confident today than we did 12, 18 months ago that the grocery store is a last-mile distribution center and that customers do want an omnichannel, some people want delivery, some people still -- I would say the majority of people still go to store, but the physical grocery store will be used for last mile delivery. We are -- our conviction is still high on that. The grocers are saying the same thing. The Silicon Valley startups are saying the same thing. Effectively, all of the money in innovation is centered around figuring out how to best utilize the grocery store and what you may see is the store footprint shrink and some of that square footage be used for logistics and sorting and packing. For us, we don't really care what they use it for. If they do that, that's great, because it means they're spending money and investing in the store, but all it really means is that they're continuing to rent space and pay us on that. So...
Yes, I think, Himanshu, the underlying trend, as Greg kind of said, and just to put it simply, is that there's been overwhelming recognition by both owners of grocery stores, the grocers and the innovators that the physical distribution center being the grocery store close to rooftops has a massive competitive advantage over any distribution center that isn't close to rooftops. And that's effectively what we kind of heard over the last 4 to 5, 6 months. And we think that's going to be the trend and what people are talking about going into 2019. Because that's what we're hearing on the ground right now.
Your next question comes from Johann Rodrigues from Raymond James.
I've one quick clarification question first. Greg, in the letter on Page 1, you have that -- the chart there and it shows organic growth is 3.5%. I guess, I was just wondering where that number came from?
Yes, so if you look at that chart, you've got Q4 2017 total portfolio NOI of $24,592,000. And then Q3 NOI is about 4% -- Q3 2018 NOI. So 3 quarters later, our NOI is $25.551 million, so 3.9% higher. If you adjust for -- sorry, go ahead.
No, so that's, I guess, your 9-month same property NOI growth or...
It's the total portfolio, which is more how we think about it. We -- because we were so acquisitive and obviously there is development and I -- as a unitholder of the REIT, you don't own a fractional interest in just the same-property portfolio, you own all of them. We really view this is what is total NOI growing by. That number will -- that same-property store count will grow over time, but right now, it's still 70% of the total portfolio. So we look at it holistically.
Yes, the other way to kind of cut it is, if you look over the last 2 years, 6 of the 8 quarters have been positive NOI growth, and that's around 2%. But where you really gain a lot of fast-paced growth is on the acquisition activity, where there's some large gains being made right away. And that's not showing up in same-store. So you kind of put those 2 together and it kind of triangulates to what Greg's letter is talking about.
That's exactly right.
Okay, that's helpful. And then I guess, my next question is, 2018 was -- has been quite a different year than 2017. You guys kind of maybe stopped the acquisitions ship. Capital recycling was big for you guys, you bought back stock. So I guess, just I'm wondering what the strategy is going into 2019, given that you guys are fairly levered up, the payout is still a little bit high, you're buying back stock, you can't really issue equity given the price. And so -- and then you just mentioned you think you'd be net acquirers. So I guess I'm just wondering how you kind of -- like what's the capital allocation strategy for 2019, like how do you fund that?
I think, part of it is our operating cash flow continues to grow. So that will bring the payout ratio down. I think the payout ratio is artificially high right now, driven by all of the leasing that we've done. We don't anticipate capital to be 17%, 18% of NOI into perpetuity, that number, sort of is the number we've used in our materials, is probably closer to 10% and that probably starts to happen, meaning the capital probably starts to decrease back to normalized levels Q2-ish of next year. I think 2 things. One will be patience. And two, as we talked about a bit earlier, there are assets in our portfolio that are going on, we've owned for 8 years. We've done an exceptional job increasing value. And I think there will be capital recycling opportunities where we can take those, I'll call them, very low-growth assets, but the yield is fantastic, but not a ton of growth left or upside probably in the cap rate. I think we can sell some of those assets and upgrade the portfolio, and we're investing money into an environment where we think it's pretty attractive because you can effectively replace that yield with similar yield, but a much higher-quality asset with more upside. And I think, we'll continue to think about ways to grow. I think we're creative people, and it's something that we're not going to stop thinking about from an acquisitions perspective. But I think, if we continue to be patient, it's been 9 months so far 2018. We may be looking at a different cost of capital even by the first quarter of next year.
Yes. And I think the growth on the leverage side, some of the leverage has kind of popped up because of the buybacks. But this is a business that is spitting out about $60 million a year in FFO. And we've got distribution of about $40 million on that. So that remaining $20 million, whether it goes to acquisitions or capital, that's accretive to NAV in our view. And any capital we're spending on leasing and whatnot, as you'd obviously know, is growing value and creating additional NOI for us. So we kind of see a natural compression on the LTV that's going to probably happen, about 250, 300 basis points throughout the year because of that, if cap rate stays stable. So we think, you plus that and the capital recycling, we should have the ability to be meaningful -- meaningfully acquisition focused in 2019.
Okay. And then my last question is, just looking at U.S. peers, I mean, definitely, this year, they started to bounce back a little bit in terms of operations like rent growth or same-property. And so I guess, I was wondering where you guys think you'd slot in the group. Like obviously, you'd be below like a Federal or Regency. Will you be above Brixmor? Is that kind of how you view yourselves in that group from kind of a normalized same-property for 2 or 3 years? Because it's been -- I think you guys have had a bunch of kind of onetime items here and there over the last few quarters or I'd say probably half of the quarter since 2016, so that's kind of impacted same-property. But like on a normalized basis, I think you guys mentioned 2%. Is that how we should be thinking of that for '19?
Yes, I think -- I certainly think for the next Q4, Q1 and Q2, as we talked about, you can understand the 2% from signed, but not yet paying, the 2.7% from development, et cetera. The growth there is pretty visible. After that, 2% is probably a fair number, particularly if we can continue to recycle into assets where we see leasing opportunities, et cetera. I'll answer your question in terms of what sophisticated REIT investors in the U.S. that I meet with tell me and where we sit and I would probably agree. I think that Brixmor is probably a very good comparable, I think, where we are more attractive to those REIT investors from a purely capital markets perspective, ignoring the fact that, I think, we're better real estate operators, and we've got Slate Asset Management machine that we are a part of and we have behind us, that I think doesn't get talked about enough. I think that we're 86 assets, we're not 400 and something. It's -- we have a very good handle on every little thing that happens inside of our portfolio. It's easy to understand where 75% neighborhood strip centers, we have virtually no power center exposure. You heard a million things about retailer restructurings, et cetera, it's had virtually no impact on our results, which highlights really the asset class that we do own and the durability of our income. I don't think that's true for some of the larger U.S. strip center REITs. I think they have a lot more power center exposure. I'm not sure they have a complete handle on their business plan because they do have a lot, these are very smart and talented people, so that's not a criticism. I just think that they are in a different stage of their business, where they're still trying to figure out what they want to be when they grow up. I think the other thing is we're 100% grocery-anchored. There isn't a single REIT in North America that can say that. And I think that's a huge differentiating factor when you think about risk-adjusted returns and where we're getting our income. And I think that there is probably a countercyclical nature to that as well, which proves to be defensive in a recessionary environment. So I think those are the things that we get a lot of credit for. But I would say that, from a real estate, household incomes, demographics, locations, Brixmor is probably as close as you're going to get. But I would say from an asset class, that we're probably more like ROIC in terms that we are pure-play strip center -- neighborhood strip center as opposed to more community or power.
[Operator Instructions] Your next question comes from Stephan Boire from Echelon Wealth Partners.
I just wanted to quickly push a little further on questions regarding capital allocation, if you don't mind. I was just wondering, if you had quantify -- if you quantified the amount of capital recycling for next year?
In the pipeline right now, which is what we have visibility on, it's probably $50 million. That number will change, I'm sure, as time passes. But right now, we've identified $50 million and that -- there's effectively 2 buckets. One is, you've got your sort of single-tenant, generally quick service or bank outparcel before you get single. And then net lease REITs buying these things for below 6 caps, 5 caps, which is just an accretive recycling of capital for us, and there is really nothing we can do with these outpads from a value perspective. So we think that's a good trade. That would make up, let's call it, half that bucket. And the other half is our properties, like I said, that we've owned for a long period of time. We've executed on our strategy, we created value, and we think we can take that money and put it in something with higher growth opportunities for the REIT.
Okay. And in terms of net acquisition, so on top of that, how much do you expect you will be able to acquire?
It will probably be in and around that number. Maybe there's some capital that goes to paying down debt, maybe there is some capital that goes to buying back units, so it may be not the full amount of the sold assets. But somewhere close. It certainly probably won't be over and above that number. Bobby, I don't know if you have anything to add?
No, I think that's fine.
Okay, okay, that's good. And just want to make sure I understand. So basically the buyback unit strategy is still on the table for next year?
Yes, I mean, we're going to look at all different capital allocation opportunities. And if there is a point in time where the REIT units look like the best investment we have, that's what we're going to do. If it turns out that we find an asset that we think is better at that time, we're going to do that. If we think paying down leverage is the right thing or increasing distributions or whatever it may be, we're just -- we're going to allocate capital accordingly.
There are no further questions at this time. I turn the call back to Madeline Sarracini, Investor Relations.
Thanks, everyone, for joining the third quarter 2018 conference call for Slate Retail REIT. Have a great day.
This concludes today's conference call. You may now disconnect.