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Good morning, my name is Denise, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Slate Office REIT Third Quarter 2018 Financial Results Conference Call. [Operator Instructions]Madeline Sarracini, Investor Relations, you may begin your conference.
Thank you, operator, and good morning, everyone. Welcome to the Third Quarter 2018 Conference Call for Slate Office REIT. I am 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 and analysis. You can visit Slate's website to access all of the REIT's financial disclosure, including our Q3 2018 investor update, which is available now. I will now hand over the call to Scott Antoniak.
Thanks, Maddie. Good morning, everyone, and thanks for joining the call today. Before we open up the lines for some questions, I'll take a few minutes to touch on some of the highlights from Q3 2018. During the third quarter of 2018, the team completed over 258,000 square feet of leasing at an attractive spread of 6.0% over expiring rents. Year-to-date, the numbers are even more impressive. In the first 3 quarters of 2018, the REIT completed over 925,000 square feet of leasing at a weighted average rental rate spread of 9.5%. As we maintain our active leasing momentum, overall portfolio occupancy has increased by 30 basis points from the prior quarter to 87.1%. We expect the occupancy will continue to be positively impacted in future periods as a result of leasing activity completed in the third quarter of 2018. Same property net operating income was up 13% compared to the same period in the prior year. This is largely result of new leasing coming online along with rental rate increases on renewals across the entire portfolio. We are very pleased with our leasing results, which continued to prove that the strategy of buying well-located assets, below replacement cost is an excellent way to drive organic growth and create value for unitholders. On the acquisition front, we're pleased to report that we closed on our previously announced acquisition of 120 South LaSalle and the adjacent parking garage in the Central Loop of Downtown Chicago for USD 155.5 million. In keeping with the philosophy of owning clusters of assets in a particular node, the REIT now owns over 1 million square feet in Downtown Chicago. The properties are in close proximity to each other and offer leasing and operation synergies. The acquisition affirms our commitment to recycling capital program and acquiring higher-quality assets at attractive prices. We will continue to pursue similar acquisition opportunities going forward. Continuing on that theme, the REIT disposed of 2 assets this quarter. 135 Queens Plate in Etobicoke was sold for $16.7 million, which is approximately 10% higher than our IFRS book value and reflected a 20% levered IRR during our ownership period. Additionally, 139 Water Street and the Water Street properties in St. John's, Newfoundland were sold for $17.3 million, a 40% premium to IFRS book value. The net proceeds from these dispositions were used to reduce outstanding debt and create liquidity for future investments. The team will continue to pursue similar opportunities and dispose of noncore holdings through outright or partial interest sales. Looking ahead at the remainder of 2018, we will continue with our program of selective dispositions and explore new opportunities to enhance the portfolio through acquisition or investment in our existing asset base in order to continue to generate value for unitholders. We thank you for your continued support, and I'll now open the line up for questions.
[Operator Instructions] Your first question comes from Chris Couprie with CIBC.
Just wondering if you could delve into the capital recycling program a little bit more in terms of your expectations for the balance of this year and how 2019 could shape up?
So I think I got the -- there was a siren in the background, but I think you asked about the capital recycling?
Yes.
Right, so through the remainder of 2018 and into 2019, there are certain assets would -- we would deem to be noncore, nonstrategic to the REIT going forward. For those assets, we'll pursue outright sales. Those would include things fully valued assets that don't really fit with our strategy or assets maybe in individual markets where we don't think we can continue to create critical mass, where we have a one-off or something like that situation. We'd look to dispose of those at 100%. We're also exploring and pursuing a strategy of potentially joint venturing in certain assets within the GTA portfolio and perhaps Atlantic Canada. And we expect that, that would unfold over the final quarter of 2018 and the first 2 quarters of 2019.
Okay. And what about the hotel? Would that be something that is kind of considered noncore in that bucket?
The hotel, Chris, in and of itself is probably not a strategy that we would look to expand, but because of the nature of it and the ownership of it as part of Brunswick Square, it's not easily kind of divisible or demisable. It's part of an office retail mixed-use development. So I would view that as an entire asset as opposed to just the hotel. I wouldn't look for us to increase our hotel holdings, but I think that's part of a larger whole.
There's probably still some value to be had there as well. So we'd be opportunistic if someone wanted to buy it, but in the short term, it's not on our sell bucket.
Right. The -- yes, the NOI on that hotel piece seems to have been showing some pretty good trajectory. When does that -- when do you think that kind of starts to stabilize?
2020.
Your next question comes from Jonathan Kelcher with TD Securities.
Just to follow up on Chris' questions on selling assets. Is it still around $250 million that you guys are looking to sell in aggregate?
Yes, plus or minus, Jon, maybe a little bit more than that. It's depending. But -- look, from an equity perspective, it would be in the range of -- like we're looking to raise between $100 million to $150 million, if you look at it that way. So that would probably translate into plus or minus $300 million, so $250 million to $350 million would be fair.
Okay. And do you have a target leverage?
Yes, I think in the short term given where we are now and the financing we undertook for the acquisition of South LaSalle, the proceeds immediately would go to repay that. We think once we execute on this disposition plan, we'll be down to 57%, 58% leverage. Looking to push it to about 55% in the short term to kind of restabilize the balance sheet a little bit, but we fully expect to be able to do that.
Okay. And that will be you target that sounds like by sort of middle or Q3 of next year?
Yes, that's fair.
Okay. And maybe give us your thoughts on fixed versus floating rate debt because it certainly looks like we're going to get at least a couple more bumps from the Bank of Canada over the next year or so?
Yes, we would agree going into 2019. And I think that what we tried to do over the last year has been reflective of that. We've taken a bunch of debt to the fixed-term market. We've also purchased some interest rate hedges in order to fix some of the debt. I think we're up to about 65% relative to, say, a year ago we were about 40%. So moving in the right direction. We've got a number of assets in the pipeline that over the next, call it, 6 months we'll also move to put to the fixed market. So that 65% fixed right now will continue to creep up. But we want to remain flexible where we are, looking to undertake capital recycling to make sure we do have flexibility to take those assets off of our balance sheet without having to be in a position of taking out some fixed-term debt. So we'll be cautious in balancing the flexibility of our balance sheet and the debt structure with our ability to execute on the capital recycling plan. But at the same time, where we can, we'll continue to increase the fixed-rate debt.
Your next question comes from Stephan Boire with Echelon Wealth Partners.
I just had a quick question on -- a quick, fairly general question on your views on the U.S. market versus Canadian market. With interest rates that might increase more than the market currently anticipates, do you continue to see much better opportunities south of the border and for how long do you think such discrepancies will exist?
That's a loaded question, Stephan. So let's maybe look at Canada and then the U.S. I think. From our perspective, Canada has shrunk somewhat for this vehicle. Our view of Alberta's volatility is still maybe it's a ways off perhaps. We think that the GTA -- Ontario and the GTA specifically and British Columbia are fairly expensive. Prices have moved aggressively in Montreal, and we already have significant holdings in Atlantic Canada. So that dramatically reduces the, kind of, investible universe. And that's not to say we wouldn't look for deals here, but I think they'd have to be, as we've done in the past, more creative opportunistic kind of deals and buying in the same marketed process. In the U.S., I think the first thing is the scale. It's enormous relative to Canada. We don't have to do like -- here, we have to really look at every single deal that comes up. In the U.S., we've limit -- not limited, but kind of narrowed our focus to look the markets we talked about before, so Chicago and Columbus, Minneapolis in the Midwest and then certain markets in the Southeast, like non -- I call them non-Miami, Florida, like Jacksonville, Tampa Bay, places like that. They're markets with significant growth, where we're still seeing on a per square foot basis relative to replacement cost and also relative to the per square foot basis here, I mean, 50% probably into 75% of what costs are here. And then yield perspective stabilized, the premium is a couple hundred basis points over similar product in Canada in a much bigger market with much deeper leasing and tenants and things like that. So we're not going to be -- as we've done here and I think even more focused on this now, we're going to try to focus to where we can cluster. So we've already started building that in Chicago and maybe look to add another market or 2 where we can build scale. But because of the nature of the market being so big, we think there's loads of opportunities. And there's still room, I think, even if interest rates do grow a little bit more aggressively than people think, there's still the returns on a related basis to Canada are more compelling for the foreseeable -- how long? I don't know, but for now.
What I might add as well is while we are making a macro view on Canada versus the U.S. at a certain level, where the acquisitions will take place, we still believe there always be a story related to the individual asset just like there was for 20 South Clark and 120 South LaSalle. We still think there's value creation there. So as opposed to taking that at macro level and allocating capital, at the asset level, it needs to make sense and we need to be able to see that we can increase NAV for the business as a whole over the short term of that asset.
That's a great point. Stephan, I think like we view this internally. So maybe we can start using it externally now too. Like I think you can think of Slate as buying office with a story. And right now, we think that story was -- is compelling in Chicago and there might be other places, but it's never going to be just a macro view, it'll always be where we can create that dynamic with replacement cost and in-place rents, et cetera and there'll always be a story around what we buy and why we're buying it.
Your next question comes from Himanshu Gupta with GMP Securities.
Just a follow-up on balance sheet, debt maturity specifically. So some amount of debt is up for renewal next year. What are your thoughts here on pricing on the renewals? And does the higher leverage will have any impact on the kind of pricing you guys achieve?
Yes, the maturities coming up in 2019, the largest one is the $120 million facility that's up next June. We expect a normal course renewal in that regard in and around the same pricing. We do think there's an opportunity in the portfolio as a whole where we have created value to take some assets out to the term market and get higher proceeds than we currently have now. But generally, notwithstanding base interest rates are going up, we do feel like there is some spread compression in the market generally. We think on a whole, we would be able to finance that at or better terms than we have now for the most part.
Okay, okay. And then moving on Chicago assets, you mentioned in the letter to drive leasing and rental rates in Chicago, I mean, through a capital plan. Can you elaborate? I mean, how much are you planning to spend? And is the increase in occupancy contingent upon this capital spend?
Was the question around 20 South Clark or 120 South LaSalle or just all of our properties in Chicago?
I think all the assets in Chicago, where you mentioned that through more amenities and better offerings at these complexes and there is some capital spend expected there.
Got it. So with 20 South Clark, it's a very boutique building. The average tenant size is about 3,000 to 5,000 square feet. There are some cosmetic renovations that we plan to do with that asset, but nothing overly extensive that would be kind of beyond normal course capital improvements that we would make in any of our properties. We just think the opportunity there is better management and more attentive on the brokerage relationships and the tenant relationships. With 120 South Clark -- sorry, South LaSalle rather, that's more of a repositioning. We have the stability of the income with the CIBC lease. But the balance of the building, there's a tremendous opportunity to grow rents and change the tenant mix in our favor from both a covenant and a growth perspective. And to do so, I wouldn't say it's contingent, Himanshu, but it's strategic and it's adding new amenity programs to 120 South LaSalle probably in the magnitude of -- we're still working out the budgets and the physical feasibility of the project, but probably in the magnitude of $3 million to $5 million of capital spend to add gym facilities, conference facilities and tenant lounge amenity. And we think -- but we know that, that's what the market is looking for, and at the basis that we own this and if we're able to add these amenities, we'll be very successful.
Yes, what I would add as well is that the plans for both the improvements at South Clark as well as the amenity package at South LaSalle and the budgets in that respect were both consistent with what we planned to do in underwriting. So we're still within our underwriting budgets at the execution phase.
I will note too that acquisition of 20 South Clark, we bought the property at 84.2% occupancy. We've increased -- we have now committed occupancy of 85.7%. So it's really that asset, as I mentioned, is just making incremental improvements quarter-over-quarter without a large-scale capital program.
All right. So nothing big, it's $3 million to $5 million you said. Okay. And maybe the last question, a general question on GTA assets. So Downtown Toronto Office Market continues to be tight and performing well. Do you see evidence of demand trickling down to the suburbs? And on the flip side, I mean, we keep hearing about co-working or open-floor format, tenant rightsizing the space requirements. Do you see any impact there?
Absolutely. Less so on the second part of your question, but certainly in the first part, Downtown is a very tight market as you noted in Toronto. The beneficiary of that -- assets that benefit most from that, I would say, would be the 427-Corridor, where we are seeing a lot of downtown requirements look at our properties. I think that's evidenced in the leasing we've done there since acquisition. I will also say that we were successful this quarter in leasing up the vacancy that we had at Sheridan Exchange, which would be technically in Mississauga, but on the border of Oakville and Mississauga. And that is tech business as well and that would be competing for -- with downtown space, but because it's transit orientated and it's a little bit more mature tech company, we were able to secure that business.
Your next question comes from Matt Kornack with National Bank Financial.
Just wanted to quickly touch on the disposition program. I think I heard in your opening comment that you're looking at a JV sale. Can you speak to the timing on that $250 million to $350 million? Is that going to be a chunky, sort of, onetime sale in the -- late this year or early next? And then just in terms of cap rates on sales, consistent with IFRS cap rate or are these higher or lower relative to the overall portfolio?
So I suspect, Matt, it will be probably more than one transaction. Your timing is right, it'll be end of this year, first quarter of next. It'll probably be more than one transaction. So -- but one larger and maybe a smaller supporting one. And in terms of valuation on a cap rate perspective, it would be consistent with or lower than on a cap rate basis IFRS.
Okay. And then, obviously, to take your leverage down to 55% near term, it's -- and sell that amount of assets at that cap rate, it's going to be dilutive to FFO and AFFO. Just wondering, the interplay between your lease up and stabilization of the existing portfolio versus that dilution, how that plays into your views on payout ratio and distributions?
Yes, we think if you turn back a number of quarters, we were in and around 58% leveraged. So we think that's kind of a return to that level and right size to where we would be at this point in time. And I think that the balancing of the capital recycling is that as opposed to selling assets and then buying, we've executed on over $500 million of acquisitions this year, so it's really trying to right size back to that point. So I think we've kind of chased ahead a little bit on the NOI growth from an acquisition standpoint. This is really just simply going back to where we otherwise would have been, but with a better portfolio, more focused and more upside.
And sorry, with regards to the -- so 58% is where you anticipate landing, but did I hear that you're temporarily going to be at 55% and then would that presume that you do further acquisition activity to get back to 58%?
No, I think, we'll continue to try to push that down either through earnings or just simply debt amortization or -- the other side of that is we still think that there's value upside in the portfolio that naturally will have the opposite effect of pushing that down based on what we're trying to execute on and fully expect that to happen, save for any changes in pricing environment. But ideally, as a team, we like to get that down into beyond or below 55%, just to be able to create some additional capacity on the balance sheet. But there's no plan to immediately take it back up for the sake of taking it back up.
Okay, fair enough. With regards to occupancy, you don't have a ton remaining in terms of lease maturities this year and a reasonable program next year. In the MD&A, I think it mentioned that you're in the process of pursuing a few large potential incremental tenancies. Can you speak to what those would be and how you see occupancy unfolding over the next few quarters? And then also, where do you see sort of a stabilized occupancy number for the portfolio more generally?
Sure, Matt. So I think it's worth noting initially that there's 1.2% of occupancy that has already been -- that is already contractual, that has not commenced yet, so would not be in our in-place number, that we'll see before the end of this year. And then in addition to that, there's some pockets of leasing that we think we can still do. Certainly in the 427, 2599 Speakman, we think there will be a deal there at some point in 2019 just currently sitting vacant and certainly a drag on our occupancy. And then I think the Chicago strategy with 120 South LaSalle, in particular, will help drive that number. And I think from a stabilized perspective, as we messaged in the prior quarter, low 90% or 91%, 92%.
Your next question comes from Brendon Abrams of Canaccord Genuity.
Just sticking with the capital recycling theme. I mean, you guys are in the market every day looking at assets, bidding at assets. How would you kind of characterize the disposition environment for the type of assets that you would be looking to sell? And I guess, secondly, how confident are you in that you'll achieve kind of the expected valuation that you're proposing?
I think we're confident on the valuation side of it. And then in terms of the demand metrics, I think for the reasons we explained earlier in the call with respect to expanding our markets and taking -- considering the U.S., et cetera, I think there's -- there remains lots of demand for office assets in Canada. And I think, we've been, to a certain extent, the beneficiary, given the largest concentration of our assets is within the GTA, and we've benefited from lower cap rates and increasing values there. I think we have some compelling assets and compelling stories in and around the GTA in the nodes where we've got concentration. So I think we're fairly confident on transactability, if that's the right word, and where valuations will be because there continues to be considerable demand, and it's competitive in Canada for office acquisitions.
Yes, and what I would add as well is we feel good about where we've got the portfolio marked and what we'll be able to execute on from the disposition plan. We think the values are realistic and potentially expect to do a little better than we currently got them marked at. We've been pleased with what we've seen so far on the disposition plan on being able to exit assets at fairly decent marks above what we had the assets valued at. So that's been really good from our perspective just looking at Queens Plate and the Water Street properties. And then we've got a number of deals in the pipeline that still some work to do on them, but we feel would be at decent prices and around where we expect.
Okay, that makes sense. And as you've deployed more capital in the U.S., and I guess, are looking to deploy further capital through acquisition, how do you guys view just at a high level the currency risk or foreign exchange in terms of handling that risk?
Yes, at this point in time, the NOI impact is not all that significant. You got about 12%, 13% of portfolio in the U.S. So the variability of the dollar at 13% of the portfolio isn't a huge magnitude. So we're watching that, we're paying attention. But it's not something we feel we need to actively synthetically deal with at this point in time. On the other hand, we do have $85 million of capital that we've deployed in the U.S. from an equity perspective and we do have variability there. We have entered into hedges to protect ourselves from that NAV risk of an appreciating Canadian dollar, but we'll be -- we'll pick our points in that respect. But again, it's not significantly material, but it's something we'll actively monitor as we go ahead.
Okay. And then just last question for me. I mean, leasing spreads were pretty healthy during the quarter about 6%. Would you say that's indicative -- specific to the leases that were rolling during the quarter? Or would you say that's reflective of the broader portfolio?
I think that's reflective of the broader portfolio. Every quarter, we look at our building in-place rents versus market and come up with a weighted average number that we reflect in our MD&A and that would be in and around that 6% to 7% number. So that's where we view it going forward.
Yes, and that's kind of been, not to pile on too much here, but I think that's been typical of our strategy, in the trying to purchase buildings below -- with below-market rents. You're seeing that come through in the same property NOI number, it's at 13% and it was 11% last year. I think that's really just a reflection of moving a number of those rents to market as well as the guys have done a ton of leasing. So we're really pleased to see that value creation come through. But I think Steve is right that, that will be the general theme going forward and about the right number.
[Operator Instructions] Your next question comes from Chris Couprie with CIBC.
So one quick one, G&A, how should we be thinking about G&A, the kind of run rate on an annual basis going forward?
Yes, I think this last quarter was a little bit higher, this quarter was a little bit lower, but it was really the timing of accruals. But I think in and around Q3, Q2 are -- is about the variability we expect, the average of the 2 is a good run rate.
There are no further questions queued up at this time. I turn the call back over to Madeline Sarracini.
Thanks, everyone, for joining the third quarter 2018 conference call for Slate Office REIT. Have a great day.
This concludes today's conference call. You may now disconnect.