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Ladies and gentlemen, thank you for standing by and welcome to the Slate Office REIT Third Quarter 2020 Financial Results Conference Call.[Operator Instructions]I would now like to hand the conference over to your speaker today, Braden Lyons. Thank you. Please go ahead.
Thank you, operator, and good morning, everyone. Welcome to the Q3 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 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 Q3 2020 investor update, which is available now.I will now hand over the call to Steve Hodgson.
Thank you, Braden, and good morning, everyone. We're pleased to report strong third quarter results, which reflects the continued stability of our portfolio. Tenant credit quality is fundamental to our investment strategy. Approximately 60% of our income is generated from government and credit rated tenants, and we have very little exposure to retail or the energy sector. We continue to have strong conviction in the office sector and believe the potential adverse impact the work-from-home experiment could have on office demand is overblown. We share the view of many Fortune 500 office users that ad hoc interaction with colleagues and an overall sense of community is critical to workplace culture.With 85% of our assets in suburban locations in major markets or urban locations in secondary markets, we are encouraged by the number of tenants returning to offices across our portfolio, especially relative to our peers who have assets in downtown locations within major markets.Now a few comments on our results. The REIT's industry-leading cash rent collections continued in the third quarter. The REIT has now collected between 96% and 98% of rent in each month since April 2020. We expect to substantially collect the residual rent through short-term deferral agreements.In September and October, the REIT completed CAD 395.7 million and USD 161.1 million of debt refinancing, including our revolving credit facilities and certain term loans, which enhanced the REIT's liquidity and addressed all of 2020 debt maturities and the majority of 2021 debt maturities. As part of these refinancings, 40% of our asset base was externally appraised, which further validates our net asset value. The REIT also completed 142,000 square feet of leasing in Q3, comprised of approximately 93,000 square feet of renewals and 50,000 square feet of new lease deals.In 2021, only 5.6% of the portfolio is maturing, which we view as a positive in the current environment. The REIT finished the quarter with a well-covered payout ratio of 62%. Looking forward, we expect renewal volumes to be strong for the remainder of the year and into 2021, and new leasing will be constrained by the logistics of touring space with COVID-related restrictions. We view these disruptions as short term in nature and expect occupancy to grow from current levels in 2021.Slate Office REIT is a compelling total return investment opportunity. We are paying a distribution of over 11% that is well covered with a AFFO payout ratio of 62%. We're also trading at an approximately 60% discount to net asset value, providing unit holders with the potential for significant capital appreciation. We are feeling optimistic about the future of our business, and we look forward to finishing the year on a strong note. On behalf of the entire Slate Office REIT team, we wish you good health, and thank you for your continued support.I'll now hand it over for Q&A.
[Operator Instructions] Your first question is from Jonathan Kelcher with TD Securities.
First question is just on office utilization. Can you maybe give us an update? And I realize it is an estimate, but I'm trying to see if there's much of a difference between what you're seeing in Atlantic Canada versus the rest of the markets that you're in.
Yes. It's consistent with prior quarter, around 30% to 40% across the portfolio. I will caveat that to your point, it is difficult to measure. And the different -- the Atlantic Canada would be on the higher end of that range, Jonathan. And I would suspect it would actually be higher. But some of the tenants that we have out there are national tenants that adhere to the guidelines that are driven out of their Toronto office. So we expect utilization rates will continue to outperform in our portfolio, given that we're in secondary markets, and we're in suburban locations.
Okay. And then just turning to the leasing spreads in the quarter, a little bit lower than the past. Was that just a function of the space that was leased or of market rents sort of step back a bit?
No, I don't think it's indicative of any change in market rents. And just to clarify, so our overall spread was about 3.5%. On new deals, we were over 10%. And on renewals, we are basically flat. And I think that's consistent with what's going on in the market because you also have to look at the weighted average lease term on our renewals was about 3.5 years, and on new deals was about 7.5 years. And what we're finding is that tenants that are maturing are looking to do short-term renewals on an as-is basis. And so what we're doing is we're offering short-term renewals to tenants at a similar rent to what they were paying before.
Okay. So if we look at 2021, would you expect the same sort of -- and I know there's not a lot of space rolling, but would you expect the same sort of thing on renewals kind of flattish rents and then some uplifts on any new leasing that you do?
Well, I think until like the reason that the shorter-term renewals are happening right now is because of the overall uncertainty in the economic environment and tenants understandably not wanting to make long-term commitments. I think when that changes, we'll revert to a more conventional deal structure that includes longer-term deals with some inducements that will push rents up to close the gap between in-place rents and market rents.
Okay. So maybe for the beginning of the year, similar dynamics, and then hopefully as it starts to open up in the middle or back half of next year, more normal environment?
Yes, I think that's fair.
Your next question is from Brendon Abrams with Canaccord.
Just taking a look at note 5, and I think you referenced the appraisals for the quarter for IFRS purposes. You got appraisals for 16 properties for almost $700 million. Can you just maybe elaborate a little bit on those appraisals in terms of cap rates and where the bulk of the properties were that were underwritten? And sorry, and how that would maybe compare to pre-COVID valuations?
Yes. So I'll start, Brendon, and Mike can jump in. Just to give a context on our IFRS values, in Q1 of this year, we took a hard look at what the impact of the pandemic would do to our new leasing activity, and we took a small write-down in our IFRS values reflecting the current leasing environment, and our expectation that new leasing would be lower than typical year. So -- and then through the refinancings that we just completed, we had externally appraised about 40% of the investment value of our portfolio. Those are the assets that are part of the credit facility as well as the assets that we just recently did term financing on. A bulk of them are in Atlantic Canada and a number of them in Toronto. And I think the view of the external appraisers was that we appropriately reflected the value based on the amendments we made in Q1.
Just a further context or clarity. A 11 of those 16 assets that were appraised were in Atlantic Canada. And then the rest, as Steve has pointed out have been GTA. There is one in Chicago and out west would make up the balance.
Correct.
Okay. Yes, that's helpful. And then just one other follow-up from me. I saw you disposed of the small asset in Yellowknife. Just wondering if any other dispositions are targeted or anything else you would deem noncore to dispose of going forward? Or you feel that that the bulk of the dispositions have been already completed?
That -- well, both. I mean, absolutely, the bulk of dispositions have already been completed. The property in Yellowknife was a retail property with the Tim Hortons and the Mark’s that we recently renewed both tenants on a long-term basis. So both -- it was not strategic to the office REIT long term. And it's an opportunistic time to sell given the leasing we have done there. We sold that property at an 8 -- roughly 8% cap rate, $400 a foot and generated a 16% IRR. So we're quite pleased with that outcome. There are a couple of other non-office assets within our portfolio that are pretty de minimis to overall value, but we'll look to dispose of it at the appropriate time.
Your next question comes from Chris Couprie with CIBC.
Maybe turning from the disposition to acquisitions. Just wanted to see if you've had any update in terms of how investment volumes are looking for you? And how active you think you might be over the next 6 months or so?
Yes. I think similar to last quarter, we're still seeing a lot of deal activity in the broader pipeline that Slate Asset Management is looking at. Most of the volume that we're seeing is outside of Canada. There are some deals in Canada. And just recently, there has been a few more put on the market that would be comparable to some of our GTA suburban assets. We have an abundance of liquidity right now, but we think it's still very prudent to preserve cash. It's difficult to price risk in this environment. There's not a lot of trades happening both on the leasing side, which speaks to the fundamentals of the assets and what that looks like from a cash flow perspective going forward. And then cap rates I think will be more resilient because interest rate environment is still low. But it's still early days, and our view on this is still consistent with last quarter.
Okay. Got you. And any update at all on 20 -- Speakman?
None. I mean, so we're fortunate in Q2 having completed the deal with the government of Canada to bring the committed occupancy to 52%. The balance of the building is 1 floor, 60,000 square foot floor plate, which lends itself to a larger tenant user. In this current leasing environment, large tenant users are not very active. We think there'll be a buildup of demand for that type of space once post-COVID world. And so we're optimistic that it will be leased up, but our horizon for that is pushed out.
Right. So kind of if you look at occupancy in the near term, kind of we've slid throughout the year here, part of it we knew about. Is there anything on the horizon, any known departures that we should be aware of?
So you saw the bulk of it in Q3 with the vacancies we incurred in Atlantic Canada. I think -- and those -- looking at those decisions by the tenants predated COVID, I think you'll see in Q4 another small tick down in occupancy. And in 2021, we'll see it ramp up.
Your next question is from Matt Kornack with National Bank.
Just a quick follow-up on that last point that you made with regards to the ramp up in 2021. Is that based on contractual sort of leasing that's already been done?
No, not yet. It's based on the pipeline that we're seeing and the backfill strategy for some of these vacancies that we've known of for quite some time now.
Okay. That makes sense. With regards to -- in the quarter -- and can you clarify the amount, but it seemed like there was some lease termination income in this quarter. What would that have related to? And is that space under negotiation? Or what's happened there?
Yes. So the lease termination income, and I'm glad you asked the question because we did want to clarify. This was related to decisions tenants made prior to COVID. And the bulk of it is Exxon.
Okay. And is it 1.3 -- there was one comment of $400,000. One was $1.3 million in the same-property figures sequential versus year-over-year, and I wasn't sure what the actual number was.
Yes. So $1.3 million is the total for the quarter. That other number you referred to is the non-Exxon, which is just forward the vacancies. But again, to Steve's point, decisions that were made pre-COVID.
Okay. That's perfect. And then lastly, with regards to capital allocation, how are you thinking about CapEx that you've discussed? I guess, acquisitions, and you'll be patient and see where things go on that front. But is there an opportunity to spend less? I mean, if you're doing these leases at sort of that prior rent levels, are you putting any CapEx into the deals? Or are they non CapEx leases at this point?
No. And to clarify on those renewals that are happening at similar rents to prior, I think that's a short-term dynamic because there is no CapEx in those deals. When tenants are looking to commit longer term, there will be CapEx and there will be increases in rent. Overall, our capital allocation strategy, we've been very prudent. Really, the bulk of the CapEx that we're spending in our portfolio is one on Maritime Centre, two, on a parking garage redevelopment in Toronto. That's the life safety project. And the third is really just leasing capital. And we -- 2021, we do intend to ramp up our occupancy. So there'll be leasing costs in parallel with that.
Right. And I take it no sense of doing unit buybacks at this point even with the liquidity that you have available?
Yes. We have the ability to do so. We believe that there's still some uncertainty in the overall economic climate. And the most prudent capital allocation for us and our Board agrees is to maintain a cash position.
[Operator Instructions] Our next question comes from Fred with iA Securities.
One quick question from me. Just in terms of the same-property NOI. What would be the contribution from the Chicago properties in USD, if possible? And what are your views generally speaking on the Chicago market today?
Yes. So the Chicago properties, they're usually about 15% of our total contribution on a somewhat run rate basis. So you can kind of attribute it to that in terms of same-property.
And tough question to answer exactly. We'd have to dig into that, Fred, but what I can say is that the occupancy -- both buildings we bought at 84% occupied. One is 20 South Clark is now at 87% occupancy and 120 South LaSalle is at 90% occupancy, and both have higher weighted average rents than they did when we acquired them. So if that's kind of the nature of the question, we've seen an increase in same-property NOI from those 2 properties.
Okay. So you did see an increase in some property…
I can't speak to the exact -- the numbers for this quarter, but I'm just trying to give you an overall trend of where we bought them to what we've achieved to date.
Okay. Great. And what would be your expectations for the next 6, 12 months?
Well, so at 120 South LaSalle, last quarter, we had completed a 40,000 square foot new deal that has not yet started paying rent. So I think overall, the U.S. portfolio will see positive same-property NOI growth.
We have no further questions at this time. I turn the call back to presenters for closing remarks.
Thank you, everyone, for joining the Q3 2020 Conference Call for Slate Office REIT. Have a great day.
This concludes today's conference call. You may now disconnect.