Slate Grocery REIT

TSX:SGR.UN

Earnings Call Transcript

[Operator]

Good morning, ladies and gentlemen, and welcome to Slate Grocery REIT Fourth Quarter 2023 Financial Results Conference Call.

[Operator Instructions]

Also note that this call is being recorded on Wednesday, February 14, 2024. And I would like to turn the conference over to Jennifer Piper, Investor Relations. Please go ahead.

[Jennifer Pyper, executive]

Thank you, operator, and good morning, everyone. Welcome to the Q4 2023 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 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 Q4 2023 investor update, which is available now.

I will now hand over the call to Blair for opening remarks.

[Blair Welch, executive]

Thank you, Jen, and hello, everyone. Slate Grocery REIT delivered a strong year of growth in 2023. Our team set a new record of 2.9 million square feet of total leasing in the year at some of our highest annual rental spreads. Of the 635,000 square feet of total leasing we did in the fourth quarter, new deals were done at 31% above comparable average in-place rents. Non-option renewal spreads were similarly strong at almost 16% above expiring rents. And our leasing momentum supported healthy occupancy gains. We are up 150 basis points from the start of the year, bringing occupancy to 94.7% at the close of the quarter, our highest level in nearly a decade.

After adjusting for completed redevelopments, our same-property NOI increased by $2 million on a trailing 12-month basis. And we expect our 2023 leasing to further drive NOI growth in the coming year. We have continued to prudently manage the REIT's balance sheet to mitigate risk in the current interest rate environment. In November, we amended the terms of $137.5 million interest rate swap to look into a 2027 maturity and limit the REIT's exposure to floating rate debt. Over 94% of the REIT's debt is fixed at a weighted average interest rate of 4.4%.

Our low in-place rents provide additional protection at $12.41 per square foot. We are well below the market average, meaning we have significant runway to increase our rents and, in turn, grow NOI. The grocery-anchored sector has displayed resilience in the face of broader market turbulence. Tenant demand for grocery-anchored centers continues to accelerate and essential goods and service providers want to be in our well-located centers in populated markets close to consumers.

New supply has remained very limited. The amount of new retail space delivered in Q4 set an all-time quarterly low, and we expect elevated interest rates and high construction costs to continue to limit new supply into and throughout 2024. At the same time, our tenants are investing heavily into their stores, demonstrating continued conviction in their physical locations. Together, all these factors create a favorable dynamic for landlords, providing pricing power to increase rental rates.

We believe Slate Grocery REIT is uniquely well positioned to unlock higher rents and grow net operating income over time. In our view, the REIT's current discounted unit price presents a compelling investment opportunity for investors. The REIT's unit price at year-end indicates an implied cap rate of 7.9% on a trailing 12-month NOI, which represents a 33.5% discount to net asset value.

Year-to-date, the REIT has purchased 1.2 million class U units at a weighted average price of $9.61 per unit. This demonstrates management's belief that the underlying value of the REIT's units are well above current public market pricing. On behalf of Slate Grocery REIT team and the Board, I would like to thank the investor community for their continued confidence and support.

I will now hand it over for questions.

[Operator]

[Operator Instructions]

And your first question will be from Brad Sturges at Raymond James.

[Bradley Sturges, analyst]

Just want to touch on occupancy. First off, you're approaching the 95% level. I think that's a level that you've talked about in the past of where you expect it to trend to. I guess just looking forward, where do you think you go from here? It seems like you're getting good momentum on the shop space and seeing further lease-up on that side of things. Just curious your thoughts on occupancy trends.

[Blair Welch, executive]

Sure. What I think is the leasing -- the strong lease of the team has done over the last couple of years, you'll really start to see that net operating income growth in 2024 and 2025. So you'll see that pick up. So that couple of hundred basis points of occupancy gain, you'll see it in our income in the next couple of years, which is great. As it relates to your question specifically on where do you think occupancy is, the whole market is pretty tight. I think we believe there's probably a little bit more we can squeeze out in basis points for occupancy uptick.

However, you're getting to a point where it's full. But given the market is full, we're going to switch our attention or continue our attention to really driving face rates and operating efficiencies through the portfolio to keep focused on that NOI growth. We really don't think the strong leasing has flown through our numbers yet, but we're extremely confident for really good NOI growth in the next couple of years.

[Bradley Sturges, analyst]

That leads to my next question. Just on leasing spreads. When we look at your numbers, clearly, the spreads that you're achieving have been, I guess, at the higher end of the historical range, I guess, of the 6% to 10%. Do you have a different target in mind in terms of those leasing spreads going forward, given how full the market is from a -- or how tight it is now from a vacancy perspective? And is that range going forward to be -- going to be higher than that 6% to 10% range?

[Blair Welch, executive]

We think in 2024, for sure in the near term, rental spreads will continue to be high because they're coming off of such a low base rent that $12.41 is probably almost half of the Green Street average for the space in the entire United States. So we feel confident -- simply put, if there is no available space anywhere and our rents are that we think there's really good probability and momentum for us to keep those higher rental rate spreads given current market conditions. I mean as you know, Brad, we were always focused on buying cheap rents. And I think we're really going to see that really play to our favor in growing the net operating income in the next couple of years.

[Bradley Sturges, analyst]

Okay. Last question. Obviously, we've seen and you've highlighted some of the retailers focused on reinvesting into their own stores, and you guys highlighted the Walmart announcement in the fall. Just curious to see or curious to get thoughts on other discussions you're having with your tenant base today, whether they're approaching you to help fund that and maybe there's a return that you can generate or how we should think about sort of that activity in the near term in the context of the current economic environment?

[Braden Lyons, executive]

Yes. So, Brad, it's Braden. So a couple of interesting anecdotes from Walmart last year. Q4 '23, they came out saying they were going to invest multiple billion dollars across 1,400 stores, a [indiscernible] million investment across their entire retrofit portfolio, and our stores are in that portfolio as well, I would add. And then I said earlier this year, they're going to be opening 150 new stores over the next 3 to 4 years, which is the first time they've opened new stores in 3 or 4 years. So that's what we're seeing from Walmart. They're the most public about it, I would say, of our tenants, but we've had conversations with others like Publix and Kroger about similar type of investments in their stores.

We're seeing them -- it's investments in their stores across omnichannel across new service offerings inside the stores, new exterior improvements, et cetera. And I think the overwhelming fact is, those are within their own 4 walls. So that's grocer-funded. If they ask us for capital, there needs to be a return on that. And that's kind of the way that conversation goes.

[Blair Welch, executive]

So to be clear, in the Walmart case, there's $0 required from Slate Grocery REIT. And what Braden saying is when they do ask for something, then we get something in return. And I would say those development yields would be double digits. But right now, the announcements are that they do it all themselves. This is why we love the business because it's a little below the line costs are very thin. And I think it shows our commitment to the store. Moreover, in the last several years, I believe 100% of our grocers have invested in improving the stores for omnichannel distribution, have no ask from Slate Grocery REIT. So they're all doing it.

[Bradley Sturges, analyst]

Got it. And with Walmart, there's no change in the box size at this point. They're just making a change to the format or modernizing the format within the existing box.

[Braden Lyons, executive]

Yes, it's primarily like within the existing box, Brad. They might retrofit what's an existing pharmacy and instead have that be like an omnichannel portion of the store with cold storage, robotics, et cetera, for curbside click and collect, which is kind of emerging as the more favored method of omnichannel fulfillment for consumers, but they might expand by a very small amount. But yes, it's primarily it's not like a massive expansion.

[Blair Welch, executive]

But remember, if they expand outside the existing box terms, they have to come talk to us, and that's an ask and therefore, we would then get those development returns.

[Operator]

[Operator Instructions]

And your next question will be from Gaurav Mathur at Laurentian Bank Securities.

[Gaurav Mathur, analyst]

First question here. We've seen a lot of chatter around real estate debt and the market being overleveraged, especially in the States and grocery-anchored being sort of a safe haven for most investors. Are you sort of seeing opportunities now come up opportunistically that you would look to engage on from an acquisition standpoint over the next 12 months?

[Blair Welch, executive]

Yes. I would say that it's starting -- I mean, to answer your first question, lenders are still very comfortable lending to grocery-anchored real estate. But I think the difference in the market is if the average grocery store is plus or minus $25 million in value, it's pretty granular. Those individual purchases, if they were done by privates, many of them were financed through CMBS or regional banks. So that has been different in the U.S.

So I think they have to go to other sources. I think that's really good for a company like Slate Grocery REIT that has the capital to go financed through bank facilities and the like. We are seeing people need to sell as real estate assets because of just the overall market, they need -- and they can sell grocery. So we are seeing some opportunity, but I think we'll see more starting this year. And I mean there is always activity, but I think we'll see more motivated sellers in certain cases. We are starting to see that. It hasn't really happened. But I think it's almost related to other parts of people's portfolios or ownership, and they can sell grocery because there's a market, and it can still be financed.

[Gaurav Mathur, analyst]

And just back to your more motivated sellers point, does that mean that the bid-ask spread for these assets continues to narrow?

[Blair Welch, executive]

I would say like the bid-ask spread for office is massive. And you kind of go down like there is a pretty good bid-ask spread in grocery, but it's much tighter than other asset classes. I think you can probably be -- it's not like a 10 cap, but I mean I think you're going to get things in the 7s and depending on what the situation is like that's kind of what it is.

But I think you got to take a step back and really focus on the rents. If we can buy something and be at half of what we think market rent is, that's great NOI growth. So it's all relative. I think that it's whether your rents are at market and what is that cap rate, it's still wide because of the way the market is, and we think there's good compelling buying opportunities, but we're being very selective.

[Gaurav Mathur, analyst]

Okay. Okay. Fantastic. And just last question. We've seen the payout ratio trend upwards. I'm just wondering if you have a view to where you see that going to for 2024?

[Blair Welch, executive]

Yes. I think as you know, we do all of our TIs and capital and redevelopment flows right below the line. So it's actual cash. And we've done a lot of leasing in development, we get good returns. So it has crept up and for other reasons, as you know. We think given our NOI growth that we have -- that we forecast over the next couple of years, that is going to go down. And I think we will continue to focus on the payout ratio. But I think our income growth will help offset that. I think some operating efficiencies will help offset that. But I think it's crept up because we have done so much leasing and development that it's elevated because of how we do it, which is unlike some other of our peers.

[Operator]

Thank you. And at this time, Ms. Pyper, it appears we have no other questions registered. Please proceed.

[Jennifer Pyper, executive]

Thank you, everyone, for joining the Q4 2023 conference call for Slate Grocery REIT. Have a great day.

[Operator]

Thank you. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And then we ask that you please disconnect your lines.