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Good day, and thank you for standing by. Welcome to the Slate Office REIT Second Quarter 2021 Financial Results Conference call. [Operator Instructions]I would now like to hand the conference over to Jennifer Pyper, Vice President, Investor Relations. Please go ahead.
Thank you, operator, and good morning, everyone. Welcome to the Q2 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 Q2 2021 investor update, which is available now.I will now hand over the call to Steve.
Thank you, Jen. We are very pleased with our second quarter results, in particular, the leasing volumes and continued rental rate growth. As we expected, with the rollout of the vaccine, we are seeing increased leasing activity and demand for office space in all of our markets. Our financial results in the second quarter also demonstrate the continued durability of the REIT's income.I'm going to ask Mike to summarize some of the key highlights from the quarter.
Thank you, Steve. We completed nearly 350,000 square feet of total leasing in the second quarter, which is our best leasing performance since Q2 2018. This is almost 3.5x our first quarter leasing volume. These leases were completed at an average rental rate increase of approximately 17%, which is our highest quarterly leasing spread since the onset of the pandemic. As a result of this leasing, occupancy increased in the second quarter to 83.6%, and we are expecting continued momentum throughout the year. The durability of Slate Office REIT's income continues to be a key component in our investment thesis. 60% of the REIT's income is derived from government and credit rated tenants and our weighted average lease term is 5.4 years.Now on the return to office and our discount to net asset value. Global financial institutions like Goldman Sachs and JPMorgan Chase have the majority of their employees back in their Manhattan based headquarters. These decisions illustrate the critical role that the office plays in optimizing employee engagement and productivity, as well as maintaining company culture. Based on our conversations with the tenants in our portfolio, we expect other employers to follow shortly.Despite these strengthening fundamentals and our proven income durability, we continue to trade at a significant discount to our net asset value. For investors, we see this as an opportunity. Our current trading discount, coupled with our attractive, well covered distribution yield combine to create one of the most compelling total return investment opportunities in the Canadian REIT sector.Finally, on our growth going forward, our in-place rents across the portfolio are on average, 9% below market, which creates an opportunity to grow our rental rates. There is also upside between our current occupancy of 83.6% and where we believe our portfolio stabilizes. Additionally, we continue to evaluate a pipeline of transformative and accretive external growth opportunities across Canada, the United States and Europe, with the support of Slate Asset Management's global team and relationships.As the economic landscape continues to strengthen in both Canada and the United States, Slate Office REIT is positioned well for both internal and external growth. On behalf of the Slate Office REIT team, we thank you for your continued support.I will now hand it over for questions.
[Operator Instructions] And your first question is from Jonathan Kelcher of TD Securities.
First question, and congrats on the good leasing quarter. For the leases you did in Q2, the renewals specifically, when do those rents start to kick in?
So the deals that we've completed would reflect renewals for certainly later this year and into next year as well. They were staggered across the portfolio. So we completed -- to give you a little bit more color, we completed 100,000 square feet of leasing in the Greater Toronto Area, 180,000 square feet in Atlantic Canada and then the balance would have been in Chicago. And again, spreads were really solid at 17% across the board.
So over the next, say, 3 quarters, they would -- you'd sort of expect the bumps to kick in?
Yes.
Exactly.
Most of it was in the year for the year. So within 2021.
And what were -- were there any big TIs that you guys had to spend for that leasing?
We -- I would say, we completed a number of large deals. You would remember that we completed 100,000 square foot renewal with a government tenant out in Atlantic Canada. So I would say inducements would be consistent with those larger deals similar to what they would have been in pre-pandemic levels. To the extent there was a space that required an abnormal amount of improvement. We potentially would have increased the TI slightly, but that wouldn't be any different than what we would have done pre-pandemic.
Yes. And I'll just add some color. I can address, head on, the negative rental spread on the new leasing side. That was really a strategic opportunity to get some tenants into our buildings in Newfoundland, where, as you know, the oil and gas sector has been a little bit stagnant. We're trying, strategically, to bring in new tenants into our buildings and growth companies, tech and mining, et cetera. And what we're doing there is we're offering short-term lower gross rent deals as opposed to providing any sort of cash out the door with a hope that as these growth companies grow, that they'll grow with us and we can convert them to a more conventional lease structure.
So if we look at 2022, 11% renewals or something around there. Do you have any large renewals similar to the New Brunswick government deal? Or is it more sort of steady?
Yes, Jonathan, there are a couple that would be similar in size to the deal we did in Atlantic Canada. We're very close to finalizing one of them. That would be in the next couple of weeks, and I would expect the other, again, would follow, hopefully, before the end of the quarter. One thing I would say is the bulk of that 11% is in Ontario. So we're certainly seeing a significant amount of demand for office space and increased activity in that particular market. So we're really comfortable. Some of those conversations were admittedly delayed due to the pandemic, but they've picked up steam recently. We feel we're working really closely with those tenants to get those renewals completed in the back half of this year.
And then last one for me. It's lease termination income in the quarter, with the renewals, I guess, over the remainder of this year and into next year, do you expect any more lease term, or at least termination income?
No, we don't. So that one specifically, Jonathan, we expected that tenant would not renew on expiry, just given the nature of their business. And what I would say on that particular termination is we've got 12 months' notice. We expected them to leave, they're paying well below market rent. So this gives us an opportunity to adjust that space to a market rent, which is off the top of my head, something like a 25% lift, and the termination income provides us with more than enough money to re-lease that space. We don't expect to get any other terminations to be exercising the balance of this year.
Yes, this was a tenant that is in the travel industry. We didn't see them as being a long term. We didn't expect them to renew after their term. There was some balance sheet and collectors pressure to adjust things probably in our favor, really, because they only had a few years left of term, and they paid up the termination fee of $34 a square foot. So -- and we have 12 months to lease until they actually vacate. So we think -- and they're paying currently 27% below market rent. So we don't like tenants vacating, but in this case, there's some significant opportunity with this as well.
Your next question is from Matt Kornack of National Bank Finance.
Just a follow-up with regard to your occupancy trajectory. If I look at where you've got kind of below market occupancy, it seems like most of it's in Atlantic Canada. It sounds like the strategic leasing you're doing in Newfoundland may end up in some of that being picked up. But can you speak to maybe the New Brunswick and Nova Scotia opportunities as well?
So in Nova Scotia, you would recall that we've got the redevelopment of Maritime Center well underway. It should be completed towards the end of this year. In a somewhat strategic fashion, we haven't been trying to do a whole ton of new leasing there. We feel that there's a real opportunity to drive rents once the redevelopment is complete. So we have seen increased activity recently. We've got -- we're trading paper with a number of different groups, including existing tenants who are looking to expand. And then at our Chain Lake properties in Nova Scotia, occupancy has increased significantly. I believe it's up to about 83%, which would be an increase of 5% to 10% from where we were at this time last year. So that market, in particular, has done very well. A big part of that is just the travel restrictions that have been in place in Atlantic Canada. And then in New Brunswick, we were able to complete a couple of significant deals in the quarter, which we think, similar to what Steve mentioned about our -- some of the strategic deals we did in Newfoundland, we've started to see positive momentum in New Brunswick. We've got new, larger tenants in the building, which just -- as a result, we've got more traffic, which is leading to increased activity and just positive market chatter. Vaccines have rolled out. Utilization rates are up in a lot of the Atlantic Canada markets. They're going to be back open for business completely in the next month or 2. So we feel really good about the activity we're seeing, 180,000 square feet in Atlantic Canada in Q2 alone. So we feel really good about how things are trending, and we expect that to continue in the balance of the year.
Just if I had to ask, and again, it's forecasting, so feel free to tell me you can't give me any information. But if you had to think about the trajectory of office, sort of the occupancy, I should say, over the next, I guess, through the end of 2022, and then on top of that, if you could give us some sense of the quantum, you'd expect, assuming things kind of normalize on parking as well as the hotel contribution. Just trying to understand the potential upside, particularly in 2022 if the markets normalize.
Yes, I can speak to that, Matt. I'll let Mike speak to parking because he was looking into that specifically. But with respect to occupancy, I think for the balance of this year, it's going to be difficult. We will have positive increases in occupancy, but it will be difficult to make a significant headway towards our stabilized target of 90% just because at this point in the year, we may do deals, but they may not commence and be in occupancy until next year. And so I would say that we -- I would look to kind of mid to late 2022 to get back to where we feel this should stabilize. And a significant part of that will be leasing up 2599 Speakman in the West End, it will be leasing up Newfoundland, and it will be leasing up Kings Place and 570 Queen in New Brunswick, all of which we have a very good pipeline on, and there may be some kind of very -- smaller, nonstrategic properties that are -- have lower occupancy that might be shed from the portfolio as part of our natural recycling program that may just assist with the denominator as well. With respect to the hotel, as you would obviously know, 2020 was a very challenging year. The government wage subsidy programs were helpful, but not helpful enough to lead us to profitability in 2020. Having said that, in 2021, year-to-date, June, we have effectively broken even. And the wage subsidy program continues until the end of September. And our forecast for the balance of the year is about $0.5 million of NOI, with an expectation that in 2022, we can kind of get back to about doubling that again, and then we stabilize the hotel at around $1.3 million to $1.4 million of NOI, eventually, which I think for this hotel will be sooner than your downtown core large markets because its demand really comes from local and regional, which in these recoveries tends to pick up sooner.
And I'll just touch on the parking income, but -- I guess, for context, on a quarterly basis, we could see about $1 million of parking revenue, when we're kind of back to normal. And I think that would take into the balance of 2022 to happen, but that would be the upside there.
Last one for me on the balance sheet and refinancing. Can you maybe speak to what remains outstanding and discussions on that?
So there's 3 pieces of debt that are due throughout the rest of this year. We're in discussions with lenders in all 3 of those. They're all very, very good credit quality tenants with long weighted average lease terms. So we expect some decent pricing when we get that done. And we don't have any concerns. We're quite confident in getting those done in advance of the maturity dates there.
[Operator Instructions] Our next question is from Jenny Ma of BMO Capital Markets.
Just a quick follow-up on the question about the hotel. I want to make sure I heard you guys correctly. We're looking for positive $0.5 million of NOI for the total of 2021, is that correct?
Yes. Because year-to-date is effectively 0 NOI. And the balance of the year will be about $0.5 million -- well, we're forecasting $0.5 million. As you know, a forecast of a hotel is a lot less reliable than a forecast of an office building, but that's -- we feel pretty confident based on the return of demand that we're seeing in the forward bookings we have, particularly from the association groups and the motor coach groups that are local and have had a few years of not being able to visit and are pretty eager to visit. So -- and then there's also an Irving plant shutdown in St. John later this year. That is a regularly scheduled cycle thing that brings in a lot of contractors, and we've secured a number of them at our hotel. So we feel pretty good about that forecast.
So you mentioned that you expect it to eventually get to sort of that 1.3%, 1.4% normalized level. But if I'm looking at sort of the past couple of years pre-COVID, you're tracking closer to sort of in and around $2 million of NOI in 2018 and '19. I'm just wondering how you would talk to that gap and what would have to happen for the hotel NOI to get back to those levels, of course, recognizing those are pre-pandemic levels and pretty good years economically?
Yes. And you know what, I was probably misquoting because -- you're right, it's generally around $1.8 million of EBITDA, but I'm speaking to kind of after capital and capital reserves, FF&E reserves, et cetera.
So from a top line standpoint, to go back to '18 and '19, assuming the world goes back to some semblance of that, but that would be a fair assumption?
Yes, that's right. Yes. Yes.
I just want to speak to what your renewal spread would have been ex the 2 large deals at Cabot Place?
Yes. I think if we were to remove those deals, Jenny, we'd be looking at a lot closer to a flat spread. We -- again, as we mentioned, they're really strategic. Wanted to get some growing companies into the buildings, generated a lot of positive momentum. I expect we'll be announcing some additional deals as a result of getting these people in the building. So yes, it would be about flat quarter-over-quarter if we were to take those out.
Yes. And then -- but even the flat number is skewed a little bit by a couple of deals we did in Chicago that were just lower in the stack of the building because the way we do the spreads is based on what the building average is. And so if it's lower in the stack, generally doesn't garner the same rents. So that's kind of what that skew -- the denominator was unfortunately so small that we -- those types of things can skew that spread.
So to be clear, the expiry to day 1 spread was flat for, on average, ex Cabot Place pieces.
Yes.
Now I know you don't disclose the rent collection, bad debts, it's been pretty good. Was Q2 fairly consistent with Q1 and the past few quarters at the high -- at the mid high 90% level and minimal bad debt?
Yes, that's right. So with respect to cash collections, it's effectively become a nonissue for us, so we haven't continued to report on it. The amount of collections would have increased, honestly, beyond 96% and are closer to 100% each month now. So for us, we're kind of back to normal in terms of rent collections. With respect to the bad debts, there was a slight increase this quarter, but that was related to a tenant that still has not been able to reopen as a result of restrictions in place. And so what we did is had an allowance for that amount. We still continue to work with them to collect it. But for context, it's 0.2% of total revenue for the quarter as well. And we don't expect it to increase on the go forward.
That's 0.2% for everybody or just one specific tenant.
In total.
Does the tenant happen to be...
So the 100...
Does the tenant happen to be in Ontario? And are they like, put on for retail, or...
They are in Ontario, yes, and it would be retail based. So they're unable to open.
And then my final question is probably for Michael. There's a bit of a discussion on the U.S. LIBOR transition, and I'm not sure what to make of all that. If you could just sort of summarize it. Is the risk mostly on the rates to you guys and that what's the unknown? Or are there other potential qualitative triggers that might be at risk as well? Like how should we think about that transition? Because I'm not sure if there's more discussion than is warranted for what the risk might be to the REIT.
I would say that it's in there as an abundance of caution. We want to be transparent that there is a transition, and there are certain elements that are unknown and particularly the specific mechanisms by which that transition happens. But from all of our conversations with lenders, we don't expect an impact to rates on an all in basis, and we're not concerned with transitioning from LIBOR. We do have a plan in place, and we've adhered to the fallback protocols, which is the mechanism by which that transition will happen, and that's what everyone else is doing as well. So there isn't any concerns, qualitative or numerically at this point.
So basically, your owners made to do it?
I wouldn't quite say that. It's just helpful to have everyone understand the mechanism and some of the uncertainty that surrounds that transition.
We have no further questions at this time. I will turn the call back over to Jennifer Piper for any additional or closing remarks.
Thank you, everyone, for joining the Q2 2021 conference call for Slate Office REIT. Have a great day.
Thank you. This does conclude today's conference call. You may now disconnect.