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Good morning, my name is Kacy, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Slate Office REIT Fourth Quarter 2018 Final -- Financial Results Conference Call. [Operator Instructions] Madeline Sarracini, with Investor Relations, you may begin your conference.
Thank you, operator, and good morning, everyone. Welcome to the Fourth Quarter 2018 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 Office REIT's website to access all of the REIT's financial disclosure, including our Q4 2018 investor update, which is available now.I will now hand over the call to Scott Antoniak.
Thanks, Maddie. Good morning, everyone, and thank you for joining the call. During the fourth quarter, the REIT maintained positive momentum, as the team demonstrated its ability to generate strong operating results that continued to build value for unitholders.We remain focused on our mission to provide meaningful total returns for unitholders and to position the REIT for continued value creation based on opportunities we see within our portfolio in the broader market today. I'd like to spend some time this morning to highlight a few announcements we've made in our press release.First, in early 2018, we announced our intention to a pursue strategic capital recycling program to strengthen our balance sheet and create liquidity for future investments that are accretive to net asset value.We're pleased to announce that we've entered into such an agreement with a fund managed by Wafra a sophisticated global private equity and alternative asset investor, whereby, they will acquire 25% interest in a portfolio of 6 office assets in the Greater Toronto Area.The transaction values the 6 assets at $527 million and generates net proceeds of approximately $54 million, which will be used to reduce outstanding debt and improve the financial flexibility of the REIT.Furthermore, the transaction represents an internal rate of return of 19% for SOT unitholders. Importantly, this transaction provides validation for the net asset value of 28% of the REIT's portfolio. If you include our recent U.S. acquisitions, almost half of the REIT's assets have been marked-to-market over the past 12 months, providing significant confidence in our net asset value estimate.At the same time, the current trading price implies that the remainder of the portfolio is valued at an almost 8% capitalization rate, which, we know, is not reflective of current conditions in the real estate investment market, especially when considering the occupancy of these assets is in the mid-80%.Our estimate of value has a residual portfolio at a 6.6% capitalization rate, consistent with what we're seeing in the investment market. Management believes there is a significant discount between the REIT's current trading price and IFRS net asset value, which management estimates to be $8.55. In our view, this value difference of almost $2 per unit represents a compelling investment opportunity. Accordingly, if the pricing disconnect persists, management will consider a buyback of units via the REIT's normal course issuer bid.Second, the REITs operating results continue to be strong. During the fourth quarter, the team completed over 158,000 square feet of leasing at an attractive spread of 11%. On a year-to-date basis for 2018, the team completed over 1 million square feet of leasing, equal to 14% of the total portfolio, increasing overall occupancy to 87.6% at year-end.As a result of strong leasing, continued occupancy gains and positive leasing spreads, the REIT achieved a 14.5% increase in same property net operating income. We're pleased with the underlying operating fundamentals in our portfolio that will drive future value creation.We are also taking advantage of a favorable debt financing environment to reduce risk and enhance the stability of future cash flows by converting more of our debt to longer-term, fixed-rate financing. Concurrent with the closing of the Wafra transaction, the REIT is in the process of fixing approximately 90% of its debt. This compares to 51% as at year-end December 2018.The fixed-rate financing will be accomplished through 5 loan extensions related to the Greater Toronto Area joint venture properties and long-term interest rate swaps. With approximately 90% of the REIT's borrowing being subject to fixed rates, we believe that there will be better stability in earnings going forward. The actions we've outlined today, improve the quality and diversification of our portfolio, strengthen our balance sheet and validate both the net asset value of the REIT, along with our ability to generate double-digit returns for unitholders.As we look forward and plan for the future, we've evaluated the asset allocation alternatives available to the REIT that will result in the best total return for unitholders. As a result, together with the board, we believe it is now time to revise the REIT's annual distribution. The revision announced this morning to $0.40 annually, will allow the REIT to retain incremental annual cash flow of $26 million.We intend to use this retained capital to reduce financial leverage in order to create capacity to invest in attractive new opportunities or reinvest in existing portfolio strategies that are accretive to net asset value. Simply, having incremental capital will allow management to provide unitholders with the kinds of returns that we have consistently shown, most recently, with the Wafra joint venture. We thank you for your continued support, and I'll now open the call to your questions.
[Operator Instructions] And your first question here comes from Brendon Abrams with Canaccord Genuity.
I guess, just focusing on obviously, the distribution cut announced this morning. Just wondering if you could provide some color in terms of how you came to this item, the new level of $0.40 annually. Is it just on a certain payout ratio or like how did you come to that?
Brendon, so we look to peers, both in the Canadian and U.S. REIT markets, and established a level of distribution going forward that we thought was appropriate within that band, for Slate Office REIT. And keeping in mind the capital investment opportunities available to us going forward and landed on $0.40 as being appropriate.
Okay. So it's more of perhaps what your trading yield would be relative to peers in the Canadian marketplace. Is that be fair to say?
Yes. I think that was one consideration, the other consideration was where that would that put us from a payout ratio, which we think will be, call it, 60% to 70%, going forward. But I think the primary view we had was that we want to be able to retain additional capital, because we still think there's great opportunity within our portfolio as well as within the investment market both in Canada and the U.S. So we wanted to make sure that we kept some of that back because we're focused on total returns. And we think we've got great ability to grow those returns within our portfolio as it stands today.
Okay. And just in terms of capital allocation going forward, I think, some comments in the opening remarks that if the valuation GAAP to NAV persists, you'll consider buyback. I guess, what does this mean in terms of -- like at what level would the discount have to be for you to really move aggressively on buybacks in the future?
Well, we think where it's trading right now is substantially below where we think our NAV is. We have --we think a conservative NAV of $8.55, and it's trading, let's call it, $6.70 at the current point. We'd be happy to be buyers at this point. We've notionally, as a first step, allocated $15 million to $20 million, and we'll be happy to reconsider that for the NCIB. But we'd see -- we have to see where we continue to trade.
Okay. And then just last question for me, just in terms of the JV sale. One, I mean, why 25%, I guess, is that just what the purchaser had wanted. Are there any fees that will be management fees in terms of going to the REIT. And are there any other kind of -- are you still proactive on the disposition front or is this kind of concludes that process?
That's multiple questions, Brendon. I'm just teasing. The 25% was reflective of the all-in capital allocation that the investor had. I think we're very pleased with 25%. These were assets that we're happy to stay around in and having 75% of them is consistent with our strategy going forward. We like these assets, although we've shown a 19% return to this point, we think there's still additional returns to be made in those assets. So we're happy to keep the 75% of that. In terms of fees, the fees on the portfolio going forward are consistent with the fees that are paid by the REIT, by their external management agreement. And your third question was, additional. So there are -- this is the bulk of the capital recycling plan. I think we, first, talked about this about a year ago, right now, in the first quarter of 2018, we've done excess of $235 million with gross proceeds in sales. There may be 1 or 2 more nonstrategic assets that, as leasing and market conditions dictate, we would look to monetize in 2019, but that would be from an all-in dollar basis in the range of between $50 million and $80 million, I would say. And then, that would be the extent of the capital recycling plan that we outlined in 2018. And we're going to pivot at that point and look for growth opportunities. The whole reason for the capital recycling plus the revision of the distribution is to generate capital so the REIT can continue to grow. We think 19% IRR is pretty compelling for any unitholder. And to the extent, we have more capital available to go seek those opportunities, we think it puts everybody in the best possible position going forward.
Your next question comes from Chris Couprie from CIBC.
I just want to follow-up on some of Brendon's line of questioning. With respect to the assets that were put into the JV. Did they come to you, did you find them? And how did you kind of land on which properties went into the JV?
Slate has a long-standing relationship with the folks at Wafra and I have had numerous conversations over the years about potential investment opportunities. I mean, again, I'd just point to the value and strategic value in the Slate relationship here. We've been talking to Wafra for the better part of 10 years on different opportunities. And in terms of the specific assets, their primary interest was in the Greater Toronto Area. And we've looked to monetizing assets that were further along in terms of their stability and maturity, where we could generate return for unitholders. And assets, again, that we would like to stay in over the longer-term. So as with most of these things, it was negotiated, but we're happy with the portfolio that we've joined up with them on.
Were you talking to anyone else about potential JVs or did this -- was this kind of a ...
Yes. I was going to say that the selection of a partner and we were talking to a number of people, all of which would have been great. We liked Wafra because of our long-standing relationship, but assets in particular, they like, we continue to like. But we also think it really reaffirms our viewpoint on valuation here to have a large global sophisticated investor come into these assets at a pretty compelling price where we've done okay on them, with a 19% return so far, but we definitely didn't want to exit them and there are other assets we would exit. But I think the longer-term hold that we can have together would be great. And just to, not to harp on this, Chris, but the follow-on [ body ] play, I think just to full circle on that, I think, having an investor, the likes of Wafra with $25 billion-ish of assets around the world. They've invested in real estate all over the world, have partners all over the world. And I think it's a pretty good testament to the team and to the assets that they've chosen to do a significant deal with us in the Greater Toronto Area. And I think it should give both you guys on the analyst side and the investors, significant comfort in the net asset value that we've been preaching over the last little while, when we got a sophisticated third-party global investor buying in at exactly those levels, so we can bet that's a pretty good walk to the $8.55 of NAV.
Okay, perfect. And then just kind of administrative question, has Duncan Mill closed, its position?
No.
Okay.
It's anticipated to close in the second quarter.
And this Wafra one is to be sometime in the first quarter, is that right?
Yes, we think, right in the end of March is most likely.
Your next question comes from Lorne Kalmar with TD Securities.
Just back to the Wafra partial interest sale. What was the cap rate on the sale?
It was $6.6.
$6.6. Okay.
At $269 a square foot.
Based on for 12-month predictions.
Okay, great. And then, interest costs were up a little bit this quarter, was any onetime items in there?
Yes, it was a little bit higher because of some capital spend, but really what it was primarily was the increased NPA's in the fourth quarter. We got as high as, let's call it, 225 basis points. I think that's come down a little bit, but also the bridge loan that we took out for the purchase of 120 LaSalle had a full quarters of interest in there. And that would be fully repaid upon closing of the sale to Wafra.
Okay, great. And then, I guess, with the capital recycling program reaching a conclusion, when would you guys look to get active on the acquisition front, again?
We like to get the capital recycling plan done. We continue to review opportunities in the market. The pricing we've seen is highly reflective of where we've got things marked at this point. But I think probably, late 2019 would be when we feel comfortable getting back in after we fully execute on what we have to do so far.
And then just lastly, what's the -- what leverage range do you guys be comfortable with? I think you said you're going to be about 60%?
Yes. At December 31, we were 63%. When we complete this, and Duncan Mill, this being the sale to Wafra, we'll go down to 60%, maybe just a little tad below that. With the $26 million of additional capital we have from the revision of the distribution we'll continue to push LTVs lower, but we'd like to get down initially to about 55%.
Your next question comes from Himanshu Gupta with GMP Securities.
Just to follow-up on the JV announcement, just wondering the JV partner has the option -- does the JV partner have any option to buy out the remaining ownership or increase ownership in the future?
So the entire agreement matches -- is subject to standard liquidity provisions in both directions. There's no option.
So there's no option, okay. And in terms of the sale price around $270 per foot, what was the cost basis on these assets? And do you think the full value has been realized on these assets? Was there any more opportunity to add value through lease up?
Yes, we think -- we definitely think there's value to be continuing to be had at that pricing, which is why we're choosing this again and I think basically, these assets would have been liquid at 100% sales, but we continue to like this, we're continuing to like, especially, in the 427, the somewhat control block that we have.
Right. And okay. And maybe just to confirm again, the sale price was consistent with the IFRS value, right?
It was -- Q3, was the last time we had the mark, and sale price to Wafra is 4% above our past mark.
4% above IFRS, okay, because that's great.
I think the -- just coming back to the same theme there, as we continue to think that there's the significant discount to where we are trading versus NAV. And the fact that we are doing these dispositions at prices in excess of IFRS plus we've got a sophisticated investor providing an opinion of value and all of our U.S. assets we've purchased in the last year. That's why we continue to harp on the fact that we think NAV is just simply wrong from the market's viewpoint. We think the $8.55 IFRS NAV we have is even at that conservative, and why we'd be buyers in the market today at these prices.
Right. Absolutely. And then just to follow-up on that 19% IRR, I mean, obviously looks very healthy. What was the source of that? Was it driven mostly by leasing or cap rate compression, or I guess, both?
Yes, I'd say it was a mix. I think the REIT bought these assets at good prices. So lot of that was embedded upon purchase. Since then, particularly in the 427 where we haven't owned those assets as long, we've had quite a bit of leasing success in a short amount of time, which would help propel that IRR to the levels that we saw on exit.
Himanshu, just to circle back to your first question, I think, the kind of original cost basis of these as compared to the $2.69 exit price is about $2.30 for the collection of assets. And I think, picking up on both Steve and Bobby's point, we're seeing material rental rate growth on the 427 quarter, probably there, more than anywhere else in the portfolio, which is why staying in for -- 19% is great, but we think there's significant incremental returns to realize there. We're starting -- I mean, in excess of 15% probably on face rates in the 16 months we've been around those 2 complexes. So with downtown as tight as it is, and that looking to persist for a while, we think there's significant rental rate upside, which will translate into returns and makes us excited to still have 75% of these going forward.
Got it. And maybe just switching gears on the leasing side, any update on 2599 Speakman Drive? And any other major leases, which is coming up for renewal in 2019? I mean, anything we should be watching out for?
Sure. With 2599, Himanshu, nothing significant to update on there yet. Relative to our last call, we anticipated doing some leasing in 2019, and we still do. The magnitude of that is to be determined, as we have several interested parties that are different square footage requirements. Shifting gears to the balance of the major expiries coming up in 2019. We did get unfortunate news in St. John's Newfoundland with respect to Exxon Mobil, who is electing to purchase a building in St. John's as opposed to lease, and will be vacating Cabot Place at the end of March 2019. So that market, I think with Exxon investing into a building, solidifies their long-term interest in that market. And I think with the new discoveries that they and others are involved with, there will be supplementary requirements for office space that will help us to backfill that Exxon vacancy.
Yes. And can you remind how much were they occupying right now, Exxon?
They were occupying 106 -- sorry, it's 96,000. It's not 2019, it's 2020. My apologies.
Your next question comes from Jenny Ma with BMO Capital Markets.
Going back to the Wafra transaction, most of my questions have been answered, but I was wondering if you could, I'm not sure if you can speak on their side, but the fund that this is going into, do you know if there is an end date to that fund, like a limited period to it, or if it's a perpetual fund?
Yes, there is an end date of 2023, but the capital behind that money would be classified as perpetual.
Okay. And do you know if they have any other Canadian office holdings? And the related question would be, when you sat down with them, did you go through the entire portfolio and consider investment options and landed at the 6 that you ended up with or is there any probability for future JV's within the portfolio?
Yes, they have other Canadian office holdings. One in Oakville and 1 in Montréal, I believe. In terms of portfolio strategy that's how it transpired. So -- I mean, their primary interest is in the GTA in terms of their Canadian investments, obviously Montréal as well, but the major markets. So GTA made sense for them, that's how we landed on the portfolio that we selected. And I can't speak for them in terms of the future, I think, they're careful when they select their partners, whether on the capital or asset management side. I think we are now a partner of theirs or will be on closing of this. Also, the possibility exists in the future to add to the relationship with other assets, whether they're existing or new ones in the future to be determined. In the meantime, we're focused on getting this transaction closed, but I think, we've established a relationship with a strategic capital partner going forward.
And you mentioned that there were standard liquidity provisions in the JV, so if either party elects to sell, is there a predetermined value that you set it at that or how do you measure that option?
No. It will be market driven, there is not a predetermined.
Okay. But there is a ROFO on either side to pick up the other side of the interest, correct?
Yes, both for their benefit and our benefit. Correct.
So that's equaled on both sides.
Yes, that's symmetric.
Okay. And then you had mentioned, I hope I wrote this down correctly. You had allocated about $15 million to $20 million to the NCIB coming from the capital saved from the distribution cut?
Yes, that's right, Jenny. I think as we've talked about and we've outlined in the press release, we think a sub-7 valuation where it's been trading recently at say $6.70 or so, it just doesn't make sense. If you take a below $7 NAV, it's implying a $6.5 cap rate, which we just don't think there's empirical evidence for. Effectively right now, with Wafra's investment and what we've purchased in the U.S. you got half of our portfolio in effect being mark-to-market. So there is just really not market trades nor empirical evidence to support a sub-7 or a $6.5 cap on the portfolio.
Do you think -- I know you mentioned that late 2019 was sort of, when you start to look at acquisitions, again. Are you seeing anything now out in the market or I guess, between now and the end of the year that would rival investment opportunity versus your units or do you think the units, right now, is simply the best use of your excess capital?
Well, it's a mix, Jenny. I mean, part of it is -- our intention has always been and continues to be to grow this vehicle. I think there's material value in scale from an unsecured debt to liquidity on the institutional side, there are compelling reasons for that. So I think, it's more than just simplest math, okay, it makes more sense to do a JV or buying asset. I think we look at that more holistically. In terms of market opportunities there are an abundant number of them. Whether that's more in the U.S. than Canada, at the present time, but that may change over time. But I think there are assets in markets that we like that we think would be worth pursuing and it'll just come down to a decision at the appropriate time as to what's the best direction to take this.
Your next question comes from Matt Kornack with National Bank Financial.
With regards to CapEx, the trend has been positive from 2017 to 2018. But what are your expectations for 2019? I think some of the major projects have been done, but just would be interested in what piece that will be in terms of capital outflow?
When you suggest the trend is positive?
I'm just looking at sort of the aggregate numbers here for CapEx and direct leasing costs. I think you went from $65 million in 2017 to about $40 million in 2018. I mean, would you expect similar spending in 2019 or will that number continue to go down?
Well, I guess, the reason I asked the question, Matt is, because I don't necessarily think of it as being positive trend. We reinvest in our portfolio and that's part of the reason that we're driving the returns we are driving. So I think, you will continue to see that in 2019. We have a pretty significant project, which we've announced at the Maritime Centre in Halifax, which is $20 million, part of which will be recoverable capital, part of which will be unrecoverable capital. But it's directed at driving the types of returns that we've demonstrated with the recent disposition. There's also some leasing capital that we've earmarked for 120 South LaSalle. We bought both the buildings in the U.S. at 84% occupied. They now have a committed occupancy of 87%. And we're going to continue to reinvest in those buildings via leasing and amenitizations that we talked about on prior calls. So that's driving, particularly, given it's -- they're larger assets, it's in US dollars, that's driving the -- will be driving a significant portion of our capital investment next year or the balance of this year rather.
And on those Chicago assets, what's the timing of the sort of accounting and actual cash recognition of that lease up?
I don't have the exact numbers, but I would suggest that the recognition of that lease up would be in the second half of this year.
And beyond those do you still have, I would think, a little bit more upside there, there was some commentary with your letter to unitholders that Chicago seems to be absorbing new supply pretty well. And then if anything it's better than expectations. So where do you think you can bring those occupancy levels to on a stabilized basis?
We're forecasting low-90s, 91%, 92%.
Okay, that's helpful. And then on the JV front, do you think, as you look to eventually expand the portfolio again, that you would potentially bring in partners to buy assets, if that makes it easier to scale the portfolio?
Yes, I think that's definitely an option on the table, and bringing in Wafra and having this partner was probably the first step in that regard. It could be them. It could be others as well that we have talked to throughout this process, but would definitely be the opportunity to grow, and listen we're still absolutely growth-focused, but allowing us to diversify, take down bigger assets, spread some of that risk around, bring some additional sophistication expertise to the table, we think this does all-around great things for the REIT.
Okay. And then the $50 million to $80 million of earmarked potential further dispositions, is there a specific market or is it noncore assets then you fully lease them up and they may be in different geographic regions, but you see less upside. And would those be 100% sales?
It would be the latter, Matt. And yes, it would be a 100% sale.
Okay. On interest rates, you mentioned pushing out some of the debt maturity profile there, but I think given where BA's were, I mean, from an interest-rate standpoint, are you actually getting savings on pushing out some of that financing or is it net neutral?
Yes. For the 6 sale assets we've got commitments from a number of lenders to extend that financing, additionally, 1.5 year, we're talking. I think the additional cost is about 13 basis points or so. It's pretty minimal. We have been really happy with the terms. And additionally, with that all of the finance we've put in place is fixed. And then, further we're undertaking to put on about another $200 million, $250 million of interest rate swaps. So going into Q2, we're expecting to have a balance sheet that has about 90% fixed rate debt.
Okay. And finally, your SNC exposure, I mean, it's a pretty specific subset of the company. I think it was a recent acquisition and it functions exclusive of the bidding and construction process. Is that a fair characterization of that business?
It is Matt. And specifically, in Sheridan, I mean, it wasn't that long ago, I think it was probably less than 5 years ago, where it was actually, Atomic Energy Canada. So our view is of the specific nature of our SNC exposure is that whatever the name may be, it continues to exist.
Your next question comes from Stephan Boire with Echelon Wealth.
Most of my questions have already been answered, but I just want to clarify a few points. First, it was mentioned I believe that the long-term debt leverage ratio would be around 55%. Is it something that's going to be by the end of the year or further out?
Yes. I think, I wouldn't even classify it as long term. I'd say, it was more medium-term target. We think with these sales plus what we've got in the pipeline continuing for capital recycling in Q2 and potentially Q3, we'd be down to 57% is a rough guess for the end of the year.
For the end of the year, 57%. Okay, perfect. And from a modeling standpoint, it was already mentioned that interest expense was a bit higher this quarter, and also you mentioned that after the sale of Wafra for -- to Wafra it would probably go down, but would go down to more run rate level or similar to Q3?
Yes, the way I look at it is, all of the proceeds that we'll get in from the Wafra sale will go to repay debt. So we got about $50 million of debt repayment happening. The additional $30 million of proceeds will effectively just add liquidity. But the way I kind of look at it, Stephan is, if our average cost of debt is about 4.3% all-in, I think that's a decent way to apply that against our debt base.
And same question for G&A. Should we consider this quarter to be a good run rate?
Yes, we're happy with this quarter.
And there are no further questions in the queue. At this time, I'll turn the call back over to Madeline Sarracini for any closing remarks.
Thanks, everyone, for joining the fourth quarter 2018 conference call for Slate Office REIT, have a great day.
And ladies and gentlemen, this concludes today's conference call. You may now disconnect.