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Ladies and gentlemen, thank you for standing by. And welcome to the Slate Office REIT Second Quarter 2020 Financial Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]I would now like to hand the conference over to your speaker today, Mr. Braden Lyons, Investor Relations. Thank you. Please go ahead, sir.
Thank you, operator, and good morning, everyone. Welcome to the Q2 2020 conference call for Slate Office REIT. I'm joined this morning by Steve Hodgson, Chief Executive Officer; and Michael Sheehan, Chief Financial 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 financial 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 Q2 2020 investor update, which is available now.I will now hand over the call to Steve Hodgson.
Thank you, Braden. And thank you to everyone for joining the call this morning. The COVID-19 pandemic has required us all to adapt to a substantial behavioral and cultural shift in the way we interact with one another. The experiment of working from home has been met with mixed reviews and many have concerns about the impact it could have on company culture and employee engagement. For many companies, Slate included, culture is a key competitive advantage. Our view is that companies will not risk their ability to attract and retain the best people just to save money on office space.The REIT collected 96% to 97% of rent in cash within each month of the second quarter, and we expect to substantially collect the residual rent through short-term deferral agreements. Our industry-leading rent collections are a function of both the quality of our tenant base and the strength of our team. Approximately 61% of our income is generated from government and credit-rated tenancies with limited concentration to nonessential retail and the energy sector.Now a few comments on the second quarter. The REIT completed over 100,000 square feet of leasing in Q2 at an average rent increase of 14%. The most notable renewal was approximately 29,000 square feet with a national accounting firm at Gateway Centre in Markham for a 10-year term.Our weighted average remaining lease term is 5.4 years, with in-place rents on average 9% below market. The REIT's financial performance continued to improve in the second quarter, highlighted by a 5% increase in adjusted funds from operations, further strengthening our payout ratio to 61.9%. Our loan-to-value ratio finished the quarter at 58.3%. The REIT has ample liquidity to fund ongoing operations, especially considering the strength of our rent collections and our prudent management of operating and capital spend.The last few months have presented us with unique set of challenges. However, we assembled our portfolio to be resilient in times like these and we continue to be pleased with the stability of the REIT's cash flows and operating performance during the COVID-19 pandemic.We are feeling very optimistic about the future and we remain committed to working hard to further build on the quality of our portfolio. On behalf of the entire Slate Office REIT team, we wish you good health, and we thank you for your continued support.I will now hand it over for Q&A.
[Operator Instructions] Your first question is from Jonathan Kelcher with TD Securities.
First question on -- as you look across the portfolio, how is the repopulating of your space going to the extent that you guys know?
Yes, it's a great question, Jonathan. It's a very difficult stat to measure perfectly. But anecdotally and through our property management partners, we've seen the utilization rates about 30% to 40% across the portfolio, which we're not privy to our peers that have downtown assets. But anecdotally, we believe that to be higher than what we're seeing downtown, just given the suburban nature of our properties and the ability of existing tenants that drive to those buildings, not have to use elevators and have a less dense environment within their workspace. And further in the secondary markets that we're in, such as Atlantic Canada, things are really opening up there a lot sooner than we've seen in the GTA or some of the more major concentrated markets.
Okay. Would it be higher in the Maritime's in the 30% to 40%?
Yes. Correct.
And what about Chicago?
Yes. Chicago initially had a similar time line to the GTA in terms of returning to work. Most of our major tenants, banks and law firms had been messaging in September. I think some of them given the recent spike in the U.S. are now revisiting that and pushing their expectations out to the early next year.
Okay. And then secondly, are you seeing any pickup in tours? And I'm thinking more of your suburban, like the bigger cities where you're in the -- or in the suburbs. Are you seeing any more inquiries there than you typically would?
Yes. We've continued to have inquiries and tours, but it's been primarily, Jonathan, on the smaller size, 5,000 square feet and less. The larger tenants are still where they have opportunities to are still renewing in place, either in our portfolio or competitors' portfolios. And -- so we're not seeing a lot of new leasing velocity at this point on a larger scale.
Okay. And then just lastly, it was small, but you did take a small IFRS write-down. Can you give us just a little bit of color on that?
Yes. Some of that is FX, and then there's just revised timing of certain leasing assumptions. So together -- Jonathan, the write-down that we took that was related to actual property fundamentals was in Q2 when we revised our leasing expectations on new leasing for the balance of the year in light of the pandemic. The adjustment that you saw in Q2 was entirely driven by FX.
Your next question comes from Chris Couprie from CIBC.
A couple of questions. On the data center, it looks like the income went up a touch sequentially. Was that contractual? And is that kind of the new run rate?
Yes, that's right. There's built-in steps in that agreement.
Okay. And then just with regard to that data center, is -- was that -- is Equinix going to be the tenant at that property following the completion of that transaction? And was that property kind of -- was there any negotiations with respect to that property when Equinix was making that deal with Bell?
No, we weren't privy to the negotiations, Chris. We're obviously aware of the transaction, and there's been a request for an assignment of the lease to Equinix. At this point in time, I can't tell you the exact outcome of that. But from our perspective, we're going to continue to have Bell on the covenant. And further, we'll have Equinix, which is, as you know, over $1 billion company. So we think it just strengthens the overall covenant from Slate Office REIT's perspective.
Okay. And then maybe just on the hotel, obviously, tough quarter, not surprising. Any commentary on how you think that, that might be trending since lockdown measures have been eased?
Yes. No, that's right, Chris. The hotel, for obvious reasons, has had a tough quarter, and we'll continue, the balance of the year will be difficult as well relative to the prior year. So year-to-date, we're down about $900,000 in income at the hotel versus the prior year. And the balance of the year will be another $900,000 versus the prior year, roughly. However, the distribution of that throughout the year, we're starting to see returning to profitability starting in July here. We are starting to see the Atlantic bubble drive some leisure demand. We've also been fortunate enough to secure some group's critical workers and companies that have a need for project. People working that need quarantine space. So we've been very fortunate in that regard. So the balance of the year will be profitable, but it just won't be at the same levels that we had seen in prior years.
Okay. Got it. And then just maybe lastly, with respect to overall occupancy, I think your commentary alluded to belief in good renewal activity, but maybe a moderation in new leasing activity. What are your thoughts on kind of overall portfolio occupancy. I know it's probably challenging to pin it down. But if you -- any color on where you think that might be trending? Any -- are there any planned move-outs that you're aware of for the balance of the year?
Yes. No, that's right. And we had some known vacates, as you know, that we've messaged in the past, primarily in Atlantic Canada. That are going to put a slight headwind for us in the balance of the year from an occupancy perspective. Those predated COVID. So to be clear, they're not COVID related, and we don't expect any incremental known vacates as a result of COVID. And in fact, we probably expect more renewal activity for the balance of the tenants.With respect to occupancy guidance for the balance of the year, as we messaged in the last quarter, we have reduced our expectation of new leasing, and that's reflective in our IFRS values as well. I think the current level we're at right now, our goal is to maintain that current level, but it's probably more likely that we would reduce occupancy slightly by the end of the year, then increase it. But looking forward to 2021, some of the -- we had a strong pipeline prior to the pandemic of some larger transactions in Atlantic Canada, in particular. And I think those will start to pick up steam again in 2021. They haven't gone away. They've just sort of been put on hold.
Right. And I noticed you extend -- you expanded a tenant at Speakman, and looks like conversations are still ongoing for the balance of the space. Is that accurate?
That's correct. Yes. We -- the government tenant that we had done a 40,000 square foot lease deal with and messaged in Q1 have expanded by an incremental 7,000 square feet. And so that brings our committed occupancy of that building to 52%. And the second floor of the building, we're actively trying to lease. It will be -- by its nature and physical layout, it will be larger tenant space. So I think in this environment, it may take some time to backfill that.
Your next question comes from Matt Kornack from National Bank Financial.
With regards to the mortgage debt that you have renewing, you did quite well on Maritime Centre. But just your thoughts with regards to spreads and financeability of assets for this year and maybe looking forward as well?
Yes. So the 2 assets that we have coming up in 2020 are high-quality tenancies and longer weighted average lease terms. So we expect to renew on similar terms for those assets. Going forward, we have a plan in place. Those maturities that are coming up are mostly our credit facilities. We have strong relationships with those banks. And we do have a plan in place, but it's a bit early to really comment too much further on what we have there, but we're confident that we'll get something done that's aligned with the terms we're expecting.
Okay. So with regards to the mortgage maturities, it sounds like those are -- the spreads would have increased, but all-in rates are fairly steady with what's maturing. Is that fair? Or will you see actually a decrease in interest rates?
I would say substantially consistent at this point, yes.
Okay. And on CECRA and any -- I know your collections were very good, but did you take any adjustments for CECRA or bad debt assumptions on the noncollected portion, although it's small?
Yes. So as a reminder, the CECRA program requires the landlord to abate 25% of the rent for those tenants that are eligible. We've had very little applicability across our tenant profile. So the amount of abated rent for each month in Q2 was $37,000.
Okay. And then occupancy ticked up a bit in -- I don't have in front, one of your Chicago assets. Was that previously leased space? Or was that something that happened incremental in this quarter?
That was the -- we messaged this deal in Q1. It was a large new deal with financial services tenant in -- at 120 South LaSalle. Their lease just commenced and came into occupancy this quarter.
And would that have been in straight-line rent in this quarter? Or is it -- was it fully cash-paying this quarter?
It would have been in straight line rent, yes.
Your next question comes from Jenny Ma with BMO Capital Markets.
With regards to the renewal in Markham, I was just wondering if it's coming off a previous 10-year lease? And if you can comment on the lift you got on renewal?
Yes. I can't tell you -- so it's not coming off a previous 10-year lease. That tenant had been expanding over time. So there had been a lot of blend and extend over a period of time. So not technically coming off a 10-year lease. But yes, this was a tenant that just -- they had strong conviction in the amount of space that they required. And they were willing to commit to it long term. We did receive about an 18% increase in rents. And we do think that this tenant has a desire to continue to expand within the building, but this was their existing footprint was the baseline that they felt comfortable committing to long term.
Okay. Great. And Steve, in your letter, you had mentioned that we're starting to see signs of a migration towards the suburbs amongst U.S. millennial. So I'm just wondering in the context of that comment, is it indicative of some of the growth plans you might have to expand into the suburbs in the U.S.? Or is that a commentary regarding how it might look for Canadian office as well or maybe a little bit of both?
Yes. It's definitely a bit of both. And thank you for reading the letter, Jenny. Our view is that suburban office will benefit in times like this. As I mentioned to Jonathan earlier, we've seen the utilization rates higher in the suburbs. And we do have a macro view that as larger portions of the workforce, i.e., millennials and the talent pool move out of the densely populated cities, we'll start to see companies want to follow them. And it won't benefit all suburban office, but suburban office like we own, which is well located and with strong amenities and good access to transit and parking will benefit from this longer-term trend.
And maybe it's a little early, but are you starting to see any sort of deals come across your desk in the U.S. or in Canada right now?
Yes. We're seeing deals. And the Slate asset management broader pipeline is quite large, mostly in the U.S. and as it relates to office and some deals in Canada. But we do think it's a little early. We have an abundance of liquidity right now. But we think it's prudent strategy to preserve our cash. At this point in time, it's difficult to price risk in this market on new acquisitions. So we're -- our strategy is to be patient and revisit allocation, yes.
So I guess, at least, my next question, what would you need to see to start getting a little bit more active on the deal pipeline? Like I presume, like a lot of others have said the bid-ask spread is probably pretty wide. So what are the data points you're looking for before you start really looking at these seriously?
Yes. I think it's the bid-ask spread. I mean in the U.S., we continue to think the fundamentals are strong in the office sector. We think that there's likely some capital structure distress that will happen with certain ownership groups. And we think that needs to play out before there's a realistic -- there's less of a wide bid-ask spread and something that we can be opportunistic on and transact on.
[Operator Instructions] Your next question comes from Brendon Abrams from Canaccord Genuity.
Just taking a look at your tenant profile and the REIT has a decent exposure to government tenants. It looks like about 1 million square feet or 13.5% of rent. Just wondering if you could comment on your conversations with some of these -- some of your government tenants and whether or not these would be materially different than conversations you've had with tenants in the private sector?
No, it's a good question. We have conversations with our government tenants. It's difficult to get to the decision-maker in those conversations sometimes, as you may imagine. If the question is about whether they have a different view on working from the office in the long term versus work from home, I don't think it's materially different. I see them returning to the office just as I see the private sector returning to the office.
Okay. Yes, that's helpful. And just a quick one also on the leasing for me. Just in terms of your portfolio, have you had any requests from tenants looking to either break leases early or sublet space? Maybe you could just provide some color on those items as it relates to your portfolio?
No, we haven't. And I view that as a positive. I've heard other landlords suggest that tenants have been -- they've had more tenants asking for incremental space versus wanting to shed any space. I can tell you with our portfolio, we haven't had really requests one way or the other. I don't know if that's just the nature of suburban versus downtown or secondary markets versus primary markets. But any tenants that we have that are maturing in the short term are looking for some flexibility in terms of how long they're willing to commit on their renewal. And that's, I think, a trend that we're seeing across the industry. But it's not coming with a request to downsize or request to increase space at this point.
We have no further questions at this time over the phone.
Thank you, everyone, for joining the Q2 2020 conference call for Slate Office REIT. Have a great day.
Ladies and gentlemen, this does conclude today's telephone conference. Thank you for participating. You may now disconnect.