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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, ladies and gentlemen, and welcome to the Slate Office REIT Fourth Quarter 2017 Financial Results Conference Call. As a reminder, this call is being recorded today, March 1, 2018 at 9:00 a.m. Eastern time. I would now like to turn the call over to Madeline Sarracini. Please go ahead, ma'am.
Thank you, operator, and good morning, everyone. Welcome to the Fourth Quarter 2017 Conference Call for Slate Office REIT. I'm 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 2017 investor update, which is available now. I will now hand over the call to Mr. Antoniak for some short comments.
Good morning, everyone. Thanks for joining the call. Just a few brief comments before we turn it over to Q&A. So first on the operations side, we completed 358,000 square feet of leasing across the portfolio in Q4, at an average deposit of leasing spread of 7.7% over expiring rents. That means, for the year, the REIT completed just shy of 1 million square feet of leasing at an average spread of 13.5% over expiring rents. And increased the weighted average lease term for the entire portfolio to 5.8 years, up from 5.4 years. On the acquisition side. Post quarter, the REIT acquired 20 South Clark Street in Chicago's central business district closing February 2, making this the first acquisition in our U.S. expansion strategy. We believe this Chicago market provides ample opportunity for future growth and is indicative of the type of opportunities available to us in the U.S. Additionally, the REIT is currently under contract to acquire a portfolio of assets from Cominar REIT located in the Greater Toronto Area and Atlantic Canada deepening our existing presence in both markets. Finally, just a quick comment on total return. So the impact of our strategy is being translated into value to meaningful returns to the REIT's unitholders. We've measured the total return to unitholders as 9.6% and 11.9% for 2017 and 2016, respectively. Please refer to the total return to unitholder section of the MD&A. Importantly, a large part of this total return to unitholders is provided by way of distributions. For 2017 and '16, 100% and 90.2%, respectively of the distributions received by unitholders were treated as a return of capital for taxation purposes, resulting in a meaningful deferral of the taxation returns being provided. So thanks for your participation. And I'll turn it over to you for questions.
[Operator Instructions] And your first question here comes from the line of Stephane Boire with Echelon Wealth Partners.
I got a couple of questions for you. Could you tell us what was the implied cap rate of your acquisition in Chicago? And does it compare to acquisitions you would be looking at in the GTA market?
So it was a mid-5 cap rate on a building that is about 84% occupied. And we think, it stabilizes in over the next 12 to 18 months, more in the range of, into the 7. So we think with for our comparable assets in the GTA with similar characteristics, it would be on the stabilized basis, a higher cap rate on the Chicago investment, which is really the whole part of the strategy. It's the fact that we can seek outsized returns on a comparable risk related profile. And when you compare that on a per square foot basis to the deals we're seeing in downtown Toronto, and we bought that asset at about a third of replacement cost and we're seeing a similar type of quality in product in the GTA at 10% to 15% over replacement cost. So again, right in line with our strategy and we're excited about it.
Right, makes sense. Okay. That's good. Could you give us an idea of the same property NOI growth you expect this year?
Sure. I think a couple of things for 2018, it's a mix of what's going to be in the same store. So just as a reminder, Commerce West and West Metro will go in the same store until Q3 and Q4, given they were acquired in Q2 of 2017. That's where we're seeing a lot of success, so we'll see that pop into those quarters and we're expecting to have modest positive numbers in that respect. I would think on the smaller portfolio for Q1 and Q2, will be positive to flat same store, but in part, and just -- and I think this is important, throughout the portfolio, we've done quite a bit of leasing, as you can see over the last year. And we're either in fixed-rent periods right now or rent hasn't yet commenced and I know Steve, you have the numbers on.
Yes, Stephane, it's Steve. In 2017, we did 157,000 square feet of leasing that commences in 2018.
Yes. And just the final point I'd make is, you can see some of that, the same theme show up in this quarter same store. So while we're down a couple percent on same store, I think the headwinds that we've based, that we've addressed and that we've known since underwriting primarily with Bell Aliant leaving Brunswick Square in Maritime and MMM leaving Sheridan Exchange. Those 3 buildings for those 2 tenants accounted for about $800,000 worth of NOI that we did have in 2016, that we did not have in 2017. Additionally, as we've disclosed in our MD&A, 2285 Speakman, our tenant there is in a fixed-rent period, which is about $700,000 of rent we otherwise would have that will start to kick in, in 2018. So if you adjust even just for Speakman, we're at 2% positive, which I think is a great story given where we come from. And that being said, we still have square footage to lease that has more upside potential going forward.
Okay. And speaking of Speakman 2599, given that it's reclassified as a redevelopment property, will it remain in the same property?
It will.
Okay. Also, I believe it was mentioned in the previous calls that the AFFO pay-out ratio target was approximately mid-80%, low 90%, if my memory is correct. Could you tell us what is your short term AFFO pay-out ratio target, say, at the end of 2018?
Yes, I think our target hasn't changed. I think that's where we think a good range is for this business. What I would say is, throughout 2018, factoring into account the acquisition of South Clark, which is a great quality asset in [indiscernible] strategy. And then the closing of the assets from Cominar, when you loop all that in with the recent equity offering, we'd expect that in '20, in the latter half of the year, we'd get down to a high 90%, low, possibly above 100%, but I think it will be dependent on a number of things. So I don't want to drive too much certainty around that. But regardless, we're really happy with how NOI is trending in that direction and then the progress the business has been made, and we still have a lot of upside from an occupancy and rent perspective. But it won't be -- it won't be in this year that we'll see numbers back down to the 85s.
Okay, okay. That's good. Also in previous calls, there were some discussions in regards to acquisitions in U.S. and Canada. And I was wondering, if you have some sort of target in terms of percentage of NOI that you would like to come from each country, or is it simply -- are you simply looking at this from an opportunistic standpoint without necessarily having a target in mind?
Yes, it's the latter, Stephane. So I mean, part of the benefit of this strategy is that it's transferable. So that's where we like -- including the U.S. piece of this, we started to talk about that mid last year. So in terms of future acquisitions, we'll go where we can achieve the investment characteristics that we're looking for. So we can do deals like 20 South Clark that are materially below replacement cost, with a little bit of upside on the occupancy et cetera, in markets, so like those are the deals we'll do. And if they're in the Greater Toronto Area or the Maritimes or Chicago or other places, we're less fussed about that, because we think that we can pick up that strategy and move it. So as opposed to -- it's a long-winded answer, but less than a specific asset split or mix across the board as more just where we can be opportunistic with the capital.
Okay, good. And final one. I was wondering how much acquisition you expect this year? And also to push on my previous question, what percentage you would expect from -- that would come from the U.S.?
It's hard to say specifically. So that, I mean, we're about at 1.5 million square feet in the first quarter. So I would say, we're a little bit ahead of schedule in terms of acquisitions. The year will unfold as it does in terms of where those opportunities are, but we'll continue to look for the type of investments that we've done in the past. And at this point, I'm uncertain as to where they will be, but we'll certainly be looking for them.
Yes, I think the symptomatic approach would be that -- we're quite happy to tell you the truth where we are right now, we're in March 1, and we've already got $300 million of acquisitions done for this year, including the Cominar acquisition. But I think the real opportunity will be on the potential for 2018 to be a year of capital recycling. And there may be opportunities where we take fully valued properties here. And where we have realized full value and recycle that capital into better opportunities, but the U.S. continues to be attractive, but there will be a capital allocation decision.
[Operator Instructions] Your first -- your next question comes from the line of Jonathan Kelcher with TT -- TD Securities.
First, on the Q4 results, we're below -- our expectation is below consensus. How did they compare to your internal expectations?
On an NOI basis, we were slightly ahead of where we thought we'd be. It was really close to our internal budgets, probably, within $50,000. I think interest costs were up a little bit just from the floating rate interest. And then, as you can see, as we've disclosed, G&A was up a little bit pursue cost that we -- where we didn't finalize acquisitions.
Okay. And if I look at, just looking at the -- your IFRS value and some of the commentary around that -- the MD&A. The $1.28 billion in investment properties and 6.21% cap rate. I guess, in there, it says that, that's based on your 12-month forward NOI expectations. Would that be fair? That's about $79.5 million.
Yes, that's the number it implies. It's correct.
Okay, so prior to, obviously, the Cominar and Chicago acquisitions, you'd expect your, like the Q4, or December 31 portfolio, to produce just under $80 million in NOI next year?
Yes, that's what we're -- that's what the number implies. That's correct.
Okay. And then just finally on 2285 Speakman, you said $700,000 in NOI, is that annual?
Sorry, Jonathan, just to clarify on that one point, the implication that there is $80 million of NOI will be $80 million of NOI plus the data center.
Yes, yes. For sure. The data center is not in your IFRS number, right?
That's right. Sorry, can you just repeat your second question?
Yes, the Speakman -- the 2285 Speakman, is that the $700,000, is that annual NOI number? Or quarterly?
That was the Q4 number.
Your next question comes from Matt Kornack with National Bank Financial.
Just wanted to drill a bit further into Stephane's question with regards to next year on the NOI front. Can you provide a little bit of color on when the major leases that you've talked about will come on? And is there a free rent period or is it going to be in straight line and then convert to cash rent? Just trying to get a sense of how NOI will progress over the course of 2018?
Sure, I think Steve can walk through some of the major leases. And just as a reminder, we do, do NOI on a cash basis, so we do have fixed rate of return periods. We're not getting the benefit. So there is a little bit of oscillation in that regard, but...
You don't -- there is no straight-line rent, if you sign the lease, but if they haven't started paying cash rents?
That's correct. In revenue for IFRS there is, but when we do NOI, we look at them on a cash basis. But I'll let Steve speak to the specific leases for 2018, where they're coming on and start paying cash rent because I think that is a substantial point.
Yes, of the 157,000 square feet that we completed in -- of new leasing that we completed in 2017 that commences in 2018, there is a few deals that I'd highlight. One being the Cogeco Peer 1 deal at West Metro Corporate Center. That's significant, because we actually allowed SNC to terminate one floor early, and so you would have seen some termination income in Q3. And we didn't -- and we saw they vacate in Q4 and so there is some downtime in Q4 as a result of that deal. That's 28,000 square feet, so they'll start paying rent again in -- on February 1, 2018. The Volta Labs deal at the Maritime Center, which is 58,000 square feet. They start paying rent April 1, 2018. Paladin Security at Commerce West at 13,000 square feet, they start paying rent in October. And that's a 10-year transaction as well. And then finally, Fortis Inc. at Fortis place, they did a blend and extend transaction. So their existing premise is, obviously, is rent paying, but they didn't expand by 11,000 square feet and that commences May 1, 2018. So generally, of the 157,000, most commence in Q1 or early Q2, with the exception of Paladin, which is later in the year.
Okay. So it sounds like there'll be a slight uptick into Q1, but it's mostly Q2, and then, the back half of 2018, you'll see the full impact of that. And then, in terms of -- so that's the positives. Is there any potential slippage that you see or nonrenewals of meaningful tenants in 2018?
No, in fact, same time last year, we would have been messaging that MMM was vacating, we would have been messaging that the head lease was coming up, we'd have been messaging that Bell Aliant was expiring. This year, the only messaging I would have with respect to known vacancies would primarily be 2599 Speakman, which as you recall, throughout this redevelopment of -- for SNC, one of the buildings has always been vacant. So it'll just be reverting. We'll start getting rent on 2285 Speakman and rent will stop being paid on 2599 Speakman. So it won't be a decline in income, it will actually present an opportunity once we release the 2599 Speakman space.
Okay, makes sense. So in-place occupancy should, I guess, trend up during the course of 2018 then?
Right. So the point is, it'll impact occupancy, but it won't impact NOI.
[Operator Instructions] Your next question comes from Chris Couprie with CIBC.
I was wondering if you could talk a little bit about the pursuit cost that you guys expense in the quarter, what that was related to? And is this something that -- I mean, is this just the ordinary course of business where you are looking for acquisitions that don't -- that you don't consummate?
Sure. There were a number of deals in there. Would have put in 2 buckets, there was -- in one bucket, there were deals where we just couldn't get to price that we could agree with on the vendor. And then, there were -- there was one deal that we dropped, because we concluded from a capital allocation decision that our return thresholds weren't going to be met, but we did incur some cost in that respect. And I think that's an important point because in Q4, we saw an opportunity, and there is always product to buy in Canada. We saw the opportunity in the U.S. that the returning thresholds were far superior than what we could buy at that time. And so, we decided to drop that transaction.
Okay. So -- and just on acquisitions, MD&A sites are significant pipeline in markets you're active in as well as new markets. Can you make some comments on some of the new markets you're considering?
Yes, Chris, it's Scott. So I mean, the obvious one would be Chicago, I think it's not necessarily new, but maybe suburban Chicago would be considered new in that. I think we're certainly seeing a number of interesting opportunities so far and that pipeline is -- remains robust. Other markets in the U.S., I mean, the part of the benefit of the broader Slate relationship, as you know. And most of these deals were referencing our off-market deals. The relationships that we have through Slate Retail REIT and at other ventures that we have. So some of the markets in the southeast might be of interest. We've started to look at some product there. We certainly view Chicago as kind of the beachhead in the U.S., but whether -- those were the nationals and rallies and places like that. So not gateway cities, again. But we started to look in the southeast, and then in Canada, it will be a return dependent. We think that pricing has moved materially up in the Toronto assets, which is the positive for our existing ownership. And so it's a little bit of challenging on the buy side. But to the extent, we can find more these off-market deals and do more in and around Toronto, we'd be happy to do that. It's just to Bobby's point earlier, it will be capital allocation decision through the year where we can find the returns. And I think just a final -- the final point on your first question is, I don't expect, we think that'll be a recurring number on the [indiscernible] cost, but it had some -- it's a one-time thing just in Q4.
Okay. And then, in terms of capital recycling, you sold a -- looks like, one of your industrial properties in the new year here. Can you talk about what you might be doing this year in terms of capital recycling?
Yes. There are -- I think there are 2 true noncore assets, there's one industrial and one retail, that will be market condition dependent. And I think that we'll look at there some -- perhaps some nonstrategic assets on the office side in the GTA that we might look at pruning. It will -- I expect we'll do some capital recycling through the year. And it'll be where we've either they're nonstrategic or we think we've taken them to full valuation and look to do other things with capital, where we can get outsized returns, like we're getting -- like we're forecasting on the Chicago and the Cominar deal, and for that matter, on the 427 deals we did last year.
Any kind of rough guidance on the magnitude that you may sell this year?
Probably, rough guidance, let's say, $50 million.
Okay. And then just one last kind of nitpick question. The bad debt jumped up in the quarter, anything to see here?
No, I think there's nothing really of note. I think the collections across the portfolio continue to be normal. And there were 2 small food vendors that had some larger write-offs but nothing of note.
And there are no further questions in the queue at this time. I'll turn the call back over to Madeline Sarracini for closing remarks.
Thanks, everyone, for joining the call. Have a great day.
Thank you.
And ladies and gentlemen, this concludes today's conference call. You may now disconnect.