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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for standing by, and welcome to the Slate Office REIT First Quarter 2021 Financial Results Conference call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to turn the call over to Braden Lyons, Investor Relations. Please go ahead.
Thank you, Denise, and good morning, everyone. Welcome to the Q1 2021 conference call for Slate Office REIT. I'm joined this morning by Steve Hodgson, Chief Executive Officer; Michael Sheehan, Chief Financial Officer; and Lindsay Stiles, Chief Operating Officer. 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 Office REIT's website to access all of the REIT's financial disclosure, including our Q1 2021 investor update, which is available now. I will now hand over the call to Steve Hodgson.
Thank you, Braden. I would like to focus my comments on 3 key areas: one, the durability of our cash flows; two, our current trading discount to net asset value; and three, our scalable platform for growth. On the durability of our cash flows, 60% of our portfolio is comprised of government or credit-rated tenants. We paid investors an annualized distribution of 9.3% in the first quarter, which was well covered with a payout ratio of 79%. We completed over 100,000 square feet of leasing with positive rental spreads. We have continued to demonstrate organic rental rate growth in our portfolio and average leasing spreads of 13.6% since January 2020. Subsequent to quarter end, we completed a 10-year lease renewal with the Province of New Brunswick for over 100,000 square feet, highlighting the improving market fundamentals in Atlantic Canada. Our weighted average lease term is 5.3 years, with only 2.9% of our portfolio remaining to be renewed in 2021. On our trading discount to net asset value, there continues to be a disconnect between public and private office real estate values. We are trading at a 49% discount to our net asset value. However, our net asset value is supported by recent comparable transactions and 74% of the portfolio was externally appraised in 2020. Finally, on our scalable platform for growth, our best-in-class team and the strength and reach of the Slate Asset Management platform combined to create a tremendous opportunity to grow our business. We intend to focus on larger, more transformative acquisitions in growing markets in the United States, Canada and Europe. Growth is critical for the REIT's long-term success as it will further diversify and stabilize our portfolio, attract more institutional investors, reduce our cost of capital and further strengthen our balance sheet. Given the attractiveness of the investment opportunity and the improving operating fundamentals in our markets, the future is bright. On behalf of the Slate Office REIT team, we thank you for your continued support, and I will now hand it over for Q&A.
[Operator Instructions] Your first question comes from Jonathan Kelcher with TD Securities.
Europe -- is Europe a new market for you? I don't think you guys have previously talked about that. And what markets over there would you specifically be looking at?
Thank you for the question, Jonathan. We -- it is a new market for Slate Office REIT. Slate Asset Management, however, has been investing in Europe since 2016. And we have about 12 people on the ground in Germany, U.K. and Luxembourg. So the idea here is, we've a special meeting later today, to amend our declaration of trust to include the ability to invest in Europe. And it's really just because we have people on the ground there. There's some interesting deals, nothing imminent, but there are some interesting deals that we've seen, and we wanted to provide the REIT, the flexibility to potentially do something exciting and accretive in those markets. And to your question about which market specifically, it would be likely the U.K., Germany or France, where we sort of have a presence now.
And your leverage is still fairly elevated. Would you be looking to sell some assets here in order to fund acquisitions going forward?
No. I think -- like I think what we're looking to do from a growth perspective is we have some liquidity, but we don't intend to use all of that liquidity to just buy 1 or 2 assets. We'd rather use that liquidity to support a more transformative acquisition, whether that's a share deal or some sort -- or a merger of some sort. So -- and it's not really -- we probably will -- we always will continue to recycle capital as we fully valued assets and look to redeploy that equity to more accretive opportunities. But it's not really about selling from one market to another. It's just about growth.
Okay. And then -- and just on the government renewal, what sort of uplift did you get on that 100,000 square feet?
Jonathan. So we -- as Steve said, we're really pleased that we were able to complete this 10-year extension with the Province of New Brunswick and Fredericton. We don't disclose spreads for specific deals. But what I will say is they have been in place for 10 years. So certainly, there was an adjustment to bring that rate closer to what we feel is current market. We're happy with their commitment to the location in the market long term, and we're starting to see that from other tenants in the other markets we're operating in as well.
Okay. So we should be able to back into that next quarter, though, right? I assume that's going to be the bulk of your leasing spread that you reported when you report Q2?
Yes. I mean, what I'll say is since January 2020, our leasing spreads have averaged 13.6% of growth. And Q2 is pacing well ahead of that number.
Your next question comes from Brendon Abrams with Canaccord Genuity.
I'm not sure if it's disclosed in the MD&A, maybe I missed it, but what's been the kind of retention rate within the portfolio over -- maybe over the last few quarters?
Yes. So I mean, we had some known vacancies hit us in Q4 and Q1, which were really at the end of Q4 that hit the occupancy in Q1. So over the last couple of quarters, those known vacancies in Atlantic Canada did hit us. And so I would suggest that our retention rate was lower than usual. But we sort of normalized at a 85% retention rate.
Right. Okay. That's helpful. And with occupancy where it is currently and projected on a stabilized basis being much higher, where do you see, I guess, the opportunities in the portfolio maybe over the next 12 months to meaningfully move up occupancy? Is there 1 or 2 assets where you think you could really drive occupancy higher?
Yes. I think we're really encouraged by the momentum we've seen across the portfolio in all of the markets this quarter. Certainly, as we mentioned in Q4, we really viewed Atlantic Canada as a leading indicator for the rest of our markets. And to give you some indication for Q1, the bulk of the leasing activity we completed was specific to the GTA. Certainly, still solid numbers in Atlantic Canada and a few smaller deals in the U.S. and our Western portfolio. But we are really starting to see an uptick in the GTA and also lots of momentum in paper trading in Chicago as well. So I don't think I would pinpoint any specific assets. But certainly, the fact that we've got 85% of the portfolio located in suburban and secondary markets, we haven't seen the same impact of the rising vacancy and sublet space availability, a lot of the downtown core markets are struggling with right now.
Okay. That's helpful. And just last one for me before I turn it over. Just wondering if you could comment on kind of the TI environment right now within your submarkets and how maybe that would have compared to kind of pre-COVID environment?
Yes. I think -- so tenants that are doing deals today are either renewing long term or they're looking to put the least amount of capital investment into a new deal that they can. So what we're seeing is that renewals from a TI perspective are happening pretty much in line with what they were before because tenants are a little stickier and more apt to stay in place than to move in this market. And then from a new leasing perspective, there are some additional incentives, more so on the free rent side, to get tenants to make decisions now versus waiting until the conclusion of the pandemic. But otherwise, the TI packages are pretty similar to what they were before. And further, it's different because we don't have 85% of our assets are not in downtown cores in major markets. We're not seeing the same sublet activity that Lindsay noted. And so we don't have that competitive pressure from a TI perspective.
Your next question comes from Sairam Srinivas with Cormark Securities.
Just broadly on the leasing side, are you seeing more tenants getting into discussions in terms of changing of show plans and kind of requiring you to invest more capital in your properties?
It's a great question, Sai. We -- I can't cite a specific example where we've seen that. Certainly, I would say, as a general rule, a lot of the conversations we're having are just about when tenants are returning. At the moment, it sounds like with the quick vaccine rollout and things picking up, we expect a lot of our larger tenants to come back to the office sort of later in Q2, Q3 and certainly by the end of this year. Certainly, some based on corporate direction may look to do some reconfiguration of their space. But I think in a lot of instances, what's more likely to happen is a select few employees to continue to work from home, and that will allow some additional space for the necessary social distancing requirements to be implemented within existing premises. Having said that, we have had some discussions with groups to feel that they will need more space in order to accommodate social distancing. So it's a little early on to know exactly how that's all going to shake out, but I think we'll have a better sense in the next couple of quarters.
And probably I think the second question is around the average in-place rent. I think it's kind of trickled down a bit in Q1 at $17.86 versus $17.95, I think, in the last quarter. Any specific reason why there is a down trend? Is it because of lower spreads on renewals?
No. So the weighted average in-place rent would be exactly that a weighted average based on the buildings and the various rents. So it's likely that where we had some vacancy arrived or some new leasing arrive either moved up or down that weighted average. But from a building-by-building perspective, we're not seeing a decline in weighted average rent.
[Operator Instructions] Your next question comes from Jenny Ma with BMO Capital Markets.
Just back on the topic of the potential opportunities in Europe, I guess, given where the liquidity is at and your desire to not sell properties to fund it, would you consider doing any JVs with Slate Asset Management to pursue these deals?
We would consider joint ventures, not necessarily with Slate Asset Management, though. If there is a compelling opportunity and that's the way we had to structure it, then it's a possibility, but it's certainly not part of our going-in investment thesis.
Okay. And would you be looking toward managing partner on the ground? Or would you have the desire to actually take up the management with the team that you have there already?
No, we'd be looking for a management team on the ground to support us but -- I mean, in addition to the team that we have from an oversight perspective.
Okay. And I'm just wondering, like, I'm sure it's early days and you haven't gotten the declaration change yet, but are you starting to kick any tires there? Or sort of how far along are you in that process of exploring potential extension in Europe?
Yes. I mean, yes, we've been investing in Europe since 2016 and well in advance of that had started kicking tires in Europe. So the team is very well versed. As you may know, Brady Welch now lives in London, and he's a founding partner of Slate and has a team with him there that are sourcing opportunities for the entirety of the platform. As you may know, the way that we originate deals is Slate Asset Management looks at all kinds of real estate transactions that fit our profile of buying below replacement costs and being able to leverage our platform to create value. And some of those will fit more opportunistic type funds, some will fit more core type funds. And some might fit the core plus type returns and profile that the office REIT is looking for. So in that event, Slate Office REIT would like to participate in that. And again, this is just about -- this isn't about we have a deal, and we're going to talk about it in the next few weeks. This is about positioning ourselves to have more opportunities in the future.
Okay. Now I guess, what I'm trying to drill down to is whether or not you've seen anything in the office space that was compelling because I know the asset management group has looked at a variety of asset classes. But is there anything that's really emerging that fits into the Slate office bucket, which I presume would be primarily office properties?
Yes. And there are deals, and that's definitely why we're interested in exploring it further. So it's just nothing imminent at the moment that we're acting on, but there are deals that are coming in the pipeline or that we've seen transact that we think could be interesting and fit our profile.
Okay. Great. My next question is about the discussion about the U.S. LIBOR transition. I'm wondering if you can give us more color around that, what rate are you paying now? And I guess, what is the risk around this transition? When you're talking about transitioning away, are you able to find another -- get another lender in place or go into fixed rate debt? Like how should we think about this?
Yes. Quite honestly, there isn't going to be a material impact to the business, and that's the expectation at this point in time. Our counterparties on those transactions are Canadian banks, and we've had numerous discussions with them. There's fallback protocol, which you may be aware of, that basically outlined at what point in time the event is triggered that you transition away from LIBOR. And for U.S. LIBOR, it's actually 2023 for the 1-month LIBOR, that's the expected timing at this point. And based on discussions with our counterparts on all those transactions, we are expecting to be economically equivalent in terms of a benchmark rate once that transition does happen.
Okay. And how much term do you have left on those pieces of debt on the U.S. properties?
There's 1 that's up this year, and then the other 1 is next year.
Okay. So I guess -- sorry, go ahead.
I was going to say, Jenny, the one that's up this year is 120 South LaSall. And as a reminder, it's almost 90% occupied and growing. And the lead tenant is CIBC with 9 years left of lease term. So from a refi perspective, it's very stable, and we're comfortable.
Okay. And given that the maturities are fairly short term, would you be looking to fix these pieces of debt and sort of eliminate this U.S. LIBOR transition, I guess, discussion, not so much on the economics?
Yes. It's a possibility, certainly an option on the table. But what everyone is doing now is continuing to run their businesses and have provisions by which you would transition from LIBOR to the SOFR rate, which is the expected replacement rate for that the LIBOR loans currently. So we have flexibility there, and it's being contemplated by a number of counterparties in the market. So fixed rate is always an option. The floating rates an option as well with transition provisions when SOFR is a viable option as an alternative rate.
Okay, great. And then lastly, I'm not sure if I missed it, but did you disclose your Q1 rent collection or bad debt provisions?
We didn't, but I can tell you, it's consistent with prior quarters. So 96%, 98% each the month in cash of rent collections. Bad debt is disclosed as part of G&A. So we only wrote off $20,000 in Q1.
Your next question comes from Matt Kornack with National Bank Financial.
Apologies if I missed this, but did you disclose whether there were any -- was any free rent period associated with the lease extension in New Brunswick post quarter?
There was free rent. It's staggered over the term. And we would account for that when we do our rental spread calculations, of course. But that's typical for the government deals where they don't request TI, and you provide free rent in lieu. And -- but from an overall inducement perspective, it's relatively low because it was a renewal, and the government didn't have much of a need for dollars to invest into the space.
Okay. Fair enough. So from an accounting standpoint, we should expect that lease to be essentially -- there's no cash impact to the straight-line rent, it's amortized essentially?
Yes.
Yes.
Okay. Fair enough. And then just more broadly, I mean you guys have a platform that operates globally. Canada. we're a little bit behind here or you have assets in the U.S. where things are a bit ahead. But can you speak to sort of leasing dynamics that you're seeing either in underwriting new assets abroad or in your own assets in places where the vaccine rollouts been escalated? Just want to get a sense, we're all -- our Canadian context here is a little bit lagging, but interested in what you're seeing elsewhere.
Sure. And there's a report that Cushman & Wakefield just put out that I could direct you to as well subsequent to the call, that's pretty fulsome answer to your question. But Lindsay, maybe you could speak to the return to work in the U.S. versus Canada? And then I can touch on the investment part of that question.
Sure. Yes. So I mean, as you noted, absolutely, the rollout of the vaccine has been a lot faster in the U.S. and obviously, our experience is specific to Chicago there. From a leasing perspective, we've seen activity pick up significantly in Q2. There's a lot of paper trading. There's a lot of tours happening. People are eager to get back to the office. We've done a survey of our tenants and kind of their back to work plans. And a lot of the larger well-known corporate groups that you would be familiar with are planning to start to return later in Q2 with a full return to pre-pandemic occupancy levels by the end of Q3. So they're pretty much full steam ahead. It's getting very close to -- we expect business as usual towards the end of the year. So it's really encouraging, and we expect our other markets to follow.
Yes. And from an investment perspective, what we're seeing in general is that institutional capital has been more focused on residential, industrial and other sectors. But the private markets have still been doing a lot of office transactions and supporting the values. But that's limited in deal size with private capital. So for -- in Toronto, for example, there's still single asset suburban Toronto deals happening at or above values they were pre-pandemic because there's still liquidity. There's still attractive debt financing available. And that's consistent in the U.S., too. It's just that in the U.S., I would suggest there's a little bit more dislocation and competitiveness and oversupply situation. And if you think of Toronto, 70% of the downtown inventories owned by 5 landlords, and they're all large institutions that can weather the storm. In markets like New York or San Francisco, it's a little bit more bifurcated, and there's, as a result, more competitiveness and more debt on those assets, the need to be more competitive. So it's creating -- the fundamentals are not quite as strong as Canada right now. And so we need to be mindful of that when we review opportunities, but opportunities will come. And just right now, the bid-ask spreads are too wide still because of that uncertainty. But once things become more certain, we think that gap will close, and we're being patient, and we think there'll be lots of opportunities.
From what you said, I mean, it doesn't appear that there's any distress at this point in Canada, but are there pockets of distress in the U.S. that would be good from an opportunistic deployment of capital standpoint? Or are things holding up pretty well in that sense as well?
Yes. Look, I think there will be. And we're not necessarily targeting pure opportunistic type real estate. We're looking for assets with an element of stability but still some upside for us to leverage our platform and team and create value. And so those types of deals are still in pretty high demand. So there's not a lot of distress.
And I'll now turn the call back over to Braden Lyons for closing remarks.
Thank you, everyone, for joining the Q1 2021 conference call for Slate Office REIT. Have a great day.
This concludes today's conference call. You may now disconnect.