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Good morning. My name is Dennis, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Slate Office REIT First Quarter 2019 Financial Results Conference Call. [Operator Instructions] Thank you. Madeline Sarracini, Investor Relations, you may begin your conference.
Thank you, operator. And good morning, everyone. Welcome to the First Quarter 2019 Conference Call for Slate Office REIT. I'm joined this morning by Scott Antoniak, Chief Executive Officer; Robert Armstrong, Chief Financial Officer; and Steve Hodgson, Chief Operating Officer of Slate Office REIT.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 & Analysis. You can visit Slate Office REIT's website to access all of the REIT's financial disclosure, including our Q1 2019 investor update, which is available now.I will now hand over the call over to Scott Antoniak.
Thank you, Maddie. Good morning, everyone, and thanks for joining the call. The REIT maintained positive momentum during the first quarter, highlighted by the team's ability to generate strong operating results that continue to build value for unitholders. In addition, we have completed a number of positive initiatives that have positioned the REIT for continued value creation.At the end of the first quarter 2019, the REIT comprised over 7.5 million square feet of well-located, high-quality assets in target markets across North America. Approximately 53% of the REIT's assets are located in Toronto and Chicago, the third and fourth largest cities in North America, and over 61% of the REIT's income is generated by government and investment-grade tenancies. We believe that we have assembled a portfolio of stable and performing assets, as evidenced by the strong operating results achieved in the first quarter.During the quarter, the team completed over 250,000 square feet of leasing at attractive positive leasing spread of 18.5%, increasing overall occupancy to 87.7% at quarter end. Tenant demand continues to be particularly strong at our 2 properties in Chicago, where we completed over 44,000 square feet of leasing in the first quarter alone. As a result of the strong leasing, continued occupancy gains and positive leasing spreads, the REIT achieved a 4.9% increase in same-property net operating income. This is the fifth consecutive quarter of positive same-property net operating income growth.Subsequent to the quarter, we're pleased to announce that on April 12, we completed the previously announced sale of a 25% interest in 6 office properties located in the Greater Toronto Area to an investment fund advised by Wafra, a sophisticated global private equity and alternative asset investor. The transaction [ involved in ] these 6 assets at $527 million, representing a levered internal rate of return of 19% for unitholders.On closing, the REIT repaid approximately $70 million in debt and received incremental debt on 5 of the 6 properties, resulting in $30.4 million of additional proceeds to the REIT at share. This refinancing increased the amount of fixed rate debt by approximately $101 million. On a pro forma basis, 78% of the REIT's debt is now subject to fixed rates after giving effect to interest rate swaps executed subsequent to quarter end.This joint venture arrangement was a marquee transaction for the REIT on many levels. First, it establishes a joint venture relationship with a sophisticated global capital partner with the potential for future growth. Second, it provides the REIT with increased liquidity to fund future accretive investment opportunities. Finally and most importantly, it provides third-party validation for the net asset value of 28% of the REIT's portfolio. Including the recent U.S. acquisitions, more than half of the REIT's assets have been marked to market over the past 12 months, providing significant confidence in our current net asset value estimate of $8.49.Today, the REIT's units continue to trade at significant discount to our IFRS net asset value. We believe this presents a compelling investment opportunity. As a result of the gap between the trading price and net asset value, management is committed to repurchasing up to 10% of the REIT's units outstanding through a normal course issuer bid. This will reduce the number of outstanding REIT units, which is accretive to net asset value per unit and other per unit metrics for unitholders.To date, we have repurchased for cancellation approximately 950,000 units via the normal course issuer bid for a total cost of just under $6 million. We believe at current pricing levels buying back units provides meaningful value to unitholders, and we will continue to execute on this basis where possible. Furthermore, we announced today the suspension of the REIT's distribution and reinvestment plan until further notice. The suspension is intended to preserve value and eliminate dilution for the REIT's unitholders.In summary, we are extremely pleased with our portfolio of assets and confident in our ability to continue to deliver strong operating results to drive value for unitholders. Recent acquisitions, along with the completion of the joint venture arrangement, validate the current net asset value of the REIT. At current trading levels, we believe the best investment we can make is buying back units. By doing so, we are effectively investing in assets we already know and like at a discount to their net asset value.We thank you for your continued support, and I will now hand over the call for questions.
[Operator Instructions] Your first question comes from Brad Sturges with IA Securities.
I guess maybe just starting with, I guess, an update on your plan for asset sales and your thoughts on leverage by the end of the year. Is it still the same target of $50 million to $80 million in assets? And where would you see leverage trending to by the end of 2019?
So maybe split that in half. I'll let Bobby speak to the leverage. But on the asset sales, it will be, Brad, we're in process on about $50 million, and I think there could be an incremental maybe $50 million on top of it. So $80 million to $100 million in total. It'll be opportunity-driven, market-driven in terms of where liquidity is for assets and the opportunity to reinvest it [ separate ] going forward.
And then on the LTV. Looking at with about $80 million of asset sales, we'd expect the LTV to get down to about 57% or so. But the big change there will be how quickly we execute on the normal course issuer bid.
So that 57% does include expectations to execute on the NCIB?
No, it does not.
Does not? Okay. And in terms of timing of asset sales, that's sort of second and third quarter still the game plan there?
That's correct.
And then I guess, when you're comparing the opportunity to use funds into the NCIB versus reducing leverage, is there a preference given where the stock is trading today to deploy into either or, either bucket?
Yes, we definitely want it to do both, and I don't think it's an all-or-nothing strategy from our perspective. When we look in terms of the LTV, it's one aspect of how we're doing the lower side of the balance sheet. But importantly, is around our maturities, and we have coming up. We've already had advanced discussions with lenders throughout the remainder of the year for everything coming up, and we feel very confident about being able to do those on commercially reasonable terms. So from that perspective, we just think that simply the best investment we can make for unitholders is buying back our units at below $6 or $6 when we know NAV is close to $8.50.
Your next question comes from Lorne Kalmar with TD Securities.
Just quickly. Factoring in the leases that you guys completed post Q1, where does the occupancy...
Sorry, we couldn't hear you, Lorne.
Sorry about that. I said factoring in the leases that you guys did post Q1 where does that take occupancy to?
So can't speak to that directly, but the -- our expectation for the end of the year is still in the 90% range.
Okay. Fair enough. And then any updates on the leasing at the 2599 Speakman or at the Maritime Centre?
Sure. I'll start with the Maritime Centre. So as you know, we've leased a significant portion of the space that came back to us from Bell Aliant at 46% higher rents than Bell had been paying. And we still -- and so we replaced all the income and more from that lease and still have some upside with about 60,000 square feet to lease. That space, we've been -- it's been used as swing space for some of the new tenants that we brought in or new deals that we've done with existing tenants where we're removing them around the stack of the building. So we haven't been able to actively market that. So I think those leases are now commencing. So by the end of the year, we'll have some incremental leasing activity. We're sitting at about high 80s right now and expect to be in the low-90% range by the end of the year. 2599, 120,000 square feet vacant building currently. We've got active conversations on 50% of that building right now. I expect we had always been underwriting 1/3, 1/3, 1/3, 6 months, 6 months, 6 months. So we're right on target with that. And hopefully, by the end of the year, we'll have executed on at least 1/3 of the building leasing.
Okay. And then just lastly. You guys got some good pretty good uplifts on renewals and new leases. Where were you seeing the biggest uplifts, which regions?
Chicago and GTA.
Your next question comes from Chris Couprie with CIBC.
Just in terms of lease maturities. I know on the last call you called out an Exxon vacancy sometime in Q1 of next year. Is there anything else that we should be made aware of that's coming due?
No. I think you know in 2019 that the Fortis Tower in Corner Brook just lost a tenant. They vacated at the end of April, and that was about 40,000 square feet, paying $10 a foot net rent. So -- and then the other is Irving Oil at Brunswick Square. They were actually expected to vacate at the end of 2018 as they're building a new building in St. John, New Brunswick. But they actually extend it by 3 months and then extend it by 3 months again. So at the end of June, they will be vacating, and that's about 67,000 square feet. And then I think everything else we have previously messaged, highlighted by last quarter highlighting that 96,000 of Exxon Mobil space will come back at the end of April 2020 in St. John's.
Okay. And then just an administrative question. In terms of your fixed rate debt post Wafra, you're aiming to get to about 90%. Roughly what does that work out to? And what type of terms are you looking to put on for the swap?
Yes. So we have, as we announced before, we've got a target of getting to 90%. We're currently -- subsequent to Wafra plus what we've done additionally in the portfolio, we're at 78% today from a fixed rate debt perspective. And then looking to get to 90%, we're simply just going to pick our time in the market and execute a swap that would be an average maturity based on where our portfolio is today. But we'd either done fixed rate financing or we have done it synthetically through swaps. We've tried to place it similar to something we have maturing within the portfolio.
And Chris, I just wanted to highlight the -- that those known vacancies that I spoke to, those are included in our forecast to the end of the year that we are still forecasting an uplift in occupancy to that 90% range.
Your next question comes from Brendon Abrams with Canaccord Genuity.
Just focusing on the leasing spread, quite healthy number. Can you just provide some color into kind of what drove that and, I guess, your expectations going forward given, I guess, you still see about a 12% discount from portfolio rent to market?
Yes. So as mentioned earlier, it was primarily driven by the GTA and Chicago. I don't want to get into the specifics of which deals, for obvious reasons, Brendon, but we purchased 120 South LaSalle and 20 South Clark with rents in our view about 10% below market. So we've been able to execute on that. And in the GTA, it continues to be -- we've -- in the 427-Corridor, for example, rents were about $15 when we acquired the buildings. We had an asking rent last year of $17, and we've recently increased the asking rent to $19. And it's really just a function of that being a strong leasing node driven by the tightness downtown and the offsetting effect of more tenant demand in the suburbs for key trended orientated nodes.
Right. Okay. And just in -- I just want to make sure I heard it correctly. In terms of potential asset sales for the remainder of the year of $80 million, would these be assets that would potentially be marketed or that you would just have maybe conversations within Slate kind of group with different investors and other third parties?
What we forecast, there'll be marketed processes for the 2 assets that are underway, plus what we thought will be in the pipeline going forward. I expect those will be on marketed basis. And you're right. That doesn't account for what -- that there's often inbound interest on an unsolicited basis. So we'll manage that in terms of pricing and return expectations. But anything that we contemplated sort of in the remainder of 2019 would be on a marketed basis.
Right. Okay. And then just last question for me, I guess more administrative. But the NCIB, does 10% include Class B units? Like up to 10%, does that include Class B units or exclude that?
Yes. Correct. It'd be on the fully diluted basis.
Your next question comes from Himanshu Gupta with GMP Securities.
Just a follow-up on the leasing side. You have a total of 285,000 of expected vacancy in the remainder of 2019. So what is the associated NOI with respect to this vacancy? And do you budget any of the space getting backfilled by the end of the year?
Yes and no. Like -- so we will have backfilled not necessarily that particular space that's coming vacant, but we'll have -- we're still -- we're at 87.7% now of occupancy, and we're forecasting just over 90% for the end of the year. So we'll have increased the overall occupancy of the portfolio. That particular space that's coming back to us may or may not be where that comes from because I expect most of it comes back in the third quarter, which means that there will be some downtime in leasing that we'll see in the fourth quarter and probably trailing into the first quarter of 2020. And then that space will come back to us. In terms of NOI impact, it's fairly some of the bigger leases are concentrated in Atlantic Canada, where there's lower rents. So I would say the average net rent on that would be in the low teens. But I don't have that number, Himanshu. We can follow up with it after the call.
Sure. No. I think that's helpful. And on the same topic of the leasing and CapEx reserve in the books, so you have around 10% of NOI provided for. Do you think -- I mean can you remind us how you are tracking the actual amount spend versus the reserve? And is the 10% a reasonable assumption in the context of the market vacancy in almost double digits?
Yes, we think 10% is reasonable from a stabilized perspective. We still have certain assets that are -- require larger TIs, and there'll be a significant amount of leasing costs in there. So maybe a little -- it will be below what we think the current run rate is in order to be able to stabilize. But on a stabilized basis, we think it's probably fair. What I would say though is just given where the distributions are at the current moment, if you took our -- if you took the new distribution rate and applied it into the quarter, we still had 2 of the original $0.75 distributions for January and February. Within Q1, we're at a 65% AFFO payout ratio. So I think we're well covered no matter how you cut it.
Himanshu, I'd add on that too. So where we have, name it what you will, maybe a little incremental capital to the run rate capital we see on a stabilized basis going forward, that's at least on a dollar-for-dollar value amount value accretive to the bottom line. And I think we've kind of run it at that. So we're inventing $1 in assets. Probably Maritime Center, Brunswick and Chicago are the best examples of that. We're not getting a -- we're not showing a multiple on that internally, and I think there probably will be in the fullness of time, but -- so those invested dollars are value-added dollars and so why they're incremental to the run rate capital.
Yes. Just to reiterate. Our hope is that we spent a bunch of capital and have a lot of leasing costs this year because this means we're adding value to the portfolio.
Right. I think that's helpful. And just to follow up on Maritime Centre. I think you've committed to around $10 million of redevelopment. How much you have spent there? And how much is remaining to be spent?
By the end of this year, we'll have spent $5 million of the -- and so the balance will be spent in 2020. To date, we would have spent about $1 million.
Okay. Okay. That's helpful. And probably the last question, bigger picture on the validation of the portfolio. I mean, do you have a good understanding with Wafra transaction and recent U.S. acquisitions so in terms of validation of your portfolio? So now really the Atlantic portfolio is left for some kind of validation. So what cap rate is the Atlantic portfolio being marked at for IFRS valuation? And how does that compare to your acquisition cost?
Yes. So just first some context, and I think this is really important. If you look at where we're trading right now and you assume that Wafra came in and purchased their 25% interest at a market price, you get a sophisticated investor who wasn't compelled to act, we weren't compelled to act, you're effectively at -- and that's a good number, that's a market price, plus what we did in Chicago over the last, call it, a year and a bit, those are effectively market trades. That's over half of our portfolio where there is empirical evidence that that's our NAV. If you take the residual portfolio based on where we're trading today, which would be some of the GTA, some of what we have in Manitoba, Atlantic Canada, and you apply the market cap, it's an 8.6% cap rate, which we don't really think makes sense. And there hasn't been deals in those markets at those rates for the quality of buildings we have ever. And we think that's really important. Generally, we've got that stuff marked at 6.6% cap rate. So if we pull out Wafra and what we bought in Chicago, the residual of the portfolio is at 6.6%.
6.6%. And I mean, 6.6% for the Atlantic portfolio, I would say.
Himanshu, it should be a little bit more in Atlantic because -- that'll carry like 2599 Speakman and things like that in the 6.6%. So I think that the Atlantic assets on a weighted average basis would be in excess of 7%. And that includes Blue Cross, RFID, insurance, et cetera. So a significant number of credit tenancies. And I mean, I know for sure there hasn't been an 8.6% cap rate office trade, and there haven't been a whole lot of the 7s anywhere in Canada or North America, for that matter, in the last 36 months. So we're pretty confident in terms of valuation. And then with respect -- and I think part of the investment thesis has always been that we know what we're doing when we buy. So we own the Atlantic Canadian assets on a compelling basis from a square-foot value, which leads to all kinds of opportunities on the leasing side, et cetera. So that's really the -- the Maritime Centre is the best example of that. I mean we -- that acquisition was plus or minus $100 a square foot. So we can afford to put $10 million into this building. The Bell lease came off $9, I think, on an effective basis, and we re-leased 75% of that space already at low teen, like $13, $14 rents. So I think we're seeing rental growth in that. But to the extent we invest further in those assets, we'll still be well inside replacement cost; we'll still be well inside comp cost. So that can be significantly compelling from a leasing perspective in terms of what we can offer tenants.
Got it. Okay. That's helpful. And probably, sorry, just 1 last question. On 2599 Speakman -- and I know you already provided an update, it's a general mode of a general question. How is the demand for old product versus the new and renovated office buildings in the GTA suburban market? And I mean, do you think 2599 requires some kind of CapEx to be spent before you can optimize the leasing on this building?
No. I think it is an older building, but it had been improved over time. And as you may recall, we spent some money from a landlord's work perspective last year to white box the space. So it shows quite well. The other dynamic, if you're looking back to when we did the SNC deal, where rents were in the $17 to $19 range and we spent considerable CapEx to bring the buildings to that level, we're actually seeing rents and demand for 2599 at the 8 -- starting at $18, and that is with fairly modest TI package.
And what I would add is important there is in that market specifically there is certain new build that has been available. We've been competitive in the market, and we've been winning deals in that market that are economically attractive to us against new build because of our lower cost base, which provides us the ability to invest. The whole SNC campus was a great example of that because our major competition was a brand-new building next door, and what we were able to do there by investing reasonable capital with our attractive cost base lets us win the day more often than not.
Your next question comes from Matt Kornack with National[indiscernible].
A quick question. On the 90% occupancy figure, is that a committed or in-place figure? And then also where do you think longer term you'd be happy with this portfolio running at on an occupancy basis?
It's an in-place figure, and it's low-90s, 92%, I think, is where this portfolio stabilizes.
Okay. And in terms of time line to get there, is that -- and in terms of the space, I think someone asked earlier, that's coming off-line, are there any meaningful sort of re-leasing that you've done on that space with tenants? And what would be the time frame for re-leasing those spaces?
Nothing that we can formally announce yet, Matt. The time line for re-leasing those spaces, in particular, would be likely -- so we're talking -- when we're talking about vacancies that are coming back in 2019, we're really talking about Fortis Tower and Brunswick Square. The larger Exxon lease is not until 2020. So with Brunswick Square and Fortis Tower, we do have some demand. There's offers out there. I expect we will make meaningful re-leasing efforts until late 2019 through 2020. But the increase in occupancy is going to come from elsewhere. It's going to come from our portfolio in the GTA. It's going to come from 2599 Speakman and it's going to come from Chicago.
Okay. And when you spend money on sort of expansionary CapEx, what type of returns are you targeting? I mean, it gets kind of caught up in same-property NOI growth, but we don't have the full picture because there's CapEx associated with it. I'm just wondering when you're underwriting a lease and spending money on tenant improvements or trying to get a new tenant in this space, what type of returns are you looking at on that capital that you're deploying?
Yes. I think -- so when we look at the allocation of our capital, we have the same sort of investment thresholds that we would have on a new acquisition, which is a 10%-plus IRR on a levered basis. There's some element to CapEx that is defensive, and that -- we view that in our 10% of our reserve. So anything beyond that has to be accretive from an IRR perspective.
Okay. And then given liquidity and, obviously, it's improving with some of these asset sales, is there anything that you're not currently doing in the portfolio that you'd like to be doing if you had more capital? Or are you basically able to operate and get the portfolio up to the standards that you'd like it to be at given your current liquidity position?
There's nothing in the portfolio that we've [ shelved ].
I think -- just on that point. Like I don't think we would ever allow that to happen. We're real estate investors, and that's -- we're not going to sacrifice the real estate on -- in order to fine-tune certain metrics.
Okay. Fair enough. And then same-property NOI growth. I don't know if -- it's been volatile lately in some of those occupancy gains, and I think we expected it to decelerate a little bit into Q1. I don't know if you can provide it. But guidance-wise, are you expecting it to at least remain positive? And what would be your view for '19? And if you could provide 2020 sort of ballpark figure, that'd be awesome, but I doubt it.
Yes. I think, over the last -- over the last year, as you know, for the last 5 quarters, we've had some pretty strong same-property NOI growth. I think the 4.9% we had this quarter was the lowest we've had over the last -- since the beginning of 2018. So we've been really pleased with that because we've seen a number of quarters where we've had double-digit NOI growth. So we're happy with that volatility because it's been extremely positive. We think that will taper off. What you're seeing in this quarter, 4.9%, that's already on top of a double-digit NOI growth from Q1 of 2018. So on a run rate basis going forward, we think kind of going into later '19 and into 2020 we'll continue to see that taper down into about 2% to 3% will be our general expectation. There's still some lumps within the portfolio. So sometimes it will be higher. Sometimes it'll be lower based on when we have larger lease deals coming in.
Your next question comes from Stephan Boire with Echelon Wealth Partners.
Most of my questions have already been answered. But I was just wondering regarding the asset disposition program and, obviously, given the unit price and the, I guess, focus on the buybacks, do you expect to make any acquisition this year? And if so, do you expect to be net seller for the year?
We expect to be net sellers for the year at this point. The $90 million of sales, we've got a number of transactions where we're fairly decently further along but nothing to announce at this point. So we feel really good about that. Also consistent with how we've done it for the last 3, 4 years, those will be at or above IFRS from where we've had them marked previously. So we feel really good about the capital. Anytime we can sell at or above IFRS and buy back our units at significantly below, we think that's a fantastic trade. But overall, we'll definitely be net sellers throughout 2019.
Yes. And I think, Stephan, I guess, it's really the broader capital allocation strategy. So like the simple fact right now is that the most compelling investment is to repurchase units via NCIB, and I think that's like almost irrefutable from a back pattern perspective. But we'll monitor that, right? I mean -- I think over the longer term we'd like to continue to grow this business, and we'll -- we won't stop looking at real estate transactions on the acquisition side. We'll just have to compare them to where we can allocate capital and get the best results for unitholders. So I do think we'll be net sellers, I think Bobby is 100% right on that, for the year. But it doesn't mean we're suspended from acquisition opportunities. We still think there's some compelling investments out there, maybe more in the U.S. than in Canada at the present time. But we're still looking at those and measuring those against unit buy back, pay down of debt, et cetera, and managing all that on a -- in weekly if not daily basis.
Yes. And I think the strategy continue to be that in the short term if there was a compelling opportunity, because there are, we continue to underwrite all the deals on the market -- in the U.S. market, which [ we attracted us ] as well as Chicago. If there's an opportunity to buy something and where we have the opportunity to create some value and sell something that's fully valued within our portfolio, we would definitely take that opportunity.
There are no further questions queued up at this time. I'll turn the call -- oops, sorry. We do have 1 question from Jenny Ma from BMO Capital Markets.
Questions have been answered, but sorry to bother you. I was wondering if you could speak to some color on the buyer profile of some of the assets. You probably can't speak to where they are geographically, but just want to get a sense of who is out there kicking the tires on these types of office assets?
So I think as a rule, Jenny -- what they're probably [indiscernible]. I think it's all over. I think -- for some of the stuff that we would prune that we would deem to be noncore in markets where we're not long term to grow, I think there is a significant kind of private market for assets like this in some of the markets in Canada. So I think that they're not necessarily national or regional players, but they'd be specific to cities. And then on some of the bigger deals, there's still institutional, like a smaller fund institutional bid for this. It's the usual suspects, I think, that are buying office in these markets. I think that you'd have a pretty good sense of who they were. So I would say that it's a mixed bag. We haven't sold anything in the U.S. and have no plans to do that at this point. So it's probably a Canadian story for now. But I think it's a mix of local private and some of the smaller institutional capital.
Yes. And just some additional context as well. Where we have put stuff in the market for sale, the buyer that shows up can be pretty diverse, but we feel like the pool's pretty deep. We do get a number -- the assets we have sold recently, we've had significant tours, good interest, a lot of people digging in. So we feel really good about that. And then that's simply just for the stuff we've had for sale, which would be kind of at the lower end of where our portfolio is looking to improve some of this and definitely sell it where we've created some value. If you were to sell the GTA or the Chicago or a number of our properties elsewhere, we feel like the pool will be very deep.
That's fair. Do you have any color on sort of the ability to obtain financing from some of these buyers? Has that come up as an issue at all for even one-off players here and there or?
No. We think from what we've seen other than what we did in St. John's when we sold Water Street, where we provided a very, very small BTB, we think that from what we've seen all the buyers have [indiscernible] with no problem. Let me put it another way. Of everything we've sold or have in progress, we haven't ever need to drop a deal because the buyer hasn't shown up because they don't have financing.
There are no further questions queued up at this time. I turn the call back over to Madeline Sarracini.
Thanks, everyone, for joining the First Quarter 2019 Conference Call for Slate Office REIT. Have a great day.
This concludes today's conference call. You may now disconnect.