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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 day, ladies and gentlemen. Welcome to the SmartCentres REIT Q4 2021 conference call. I'd now like to introduce Mitchell Goldhar. Please go ahead. .
Thank you, Mark. Good morning, and thank you for joining us today for our year-end conference call. I am Mitchell Goldhar, Executive Chairman and CEO; and I am joined by Peter Sweeney, Chief Financial Officer; Rudy Gobin, EVP Portfolio Management and Investments; and Mauro Pambianchi, Chief Development Officer. .Today, we will provide you with our Q4 highlights and update you on some of our major projects. Our commentary will refer mostly to the outlook and mixed-use development initiatives section of our MD&A, which are posted on our website. I refer you specifically to the cautionary language on Pages 1 to 6 of the MD&A materials, which also applies to comments any of the speakers make this afternoon, shall I say this morning. Momentum from early 2021 carried on throughout the fourth quarter with a strong performance, reflecting the strength and resilience of our tenants and portfolio. Small and midsized retailers were back. And even with some intermittent restrictions, occupancy and cash flow grew steadily throughout the year, reflecting the need for and rule of well-located, value-oriented open format retail. With Walmart and food store anchored Centres making up virtually 100% of our portfolio, physical stores met the online challenge head on. With a quick pickup, more selection, delivery options and easy to navigate websites demonstrating that physical and online can work together. Our portfolio comprised of nearly 95% prominent, strong national and regional tenants provides the financial covenants and stability that has returned us to over 98% rent collections and 97.6% leased by the end of 2021. While COVID tested us operationally, our portfolio has remained strong. Retailers solidified their positions with us with new and renewing locations, while simultaneously enhance their product lines and improving the customer experience, which has allowed us to maintain full distributions to our unitholders, a decision that we are proud of. Our wholly-owned smart living residential banner, a name that you will hear a lot more about and our other mixed-use developments continue to enhance value through continue to enhance value throughout 2021, unlocking deeply embedded NAV and to our unitholders on lands we already own. Here are a few highlights of the quarter and the year. Phase 1 of Smart Living's ArtWalk launched in Q4. ArtWalk is a 12-acre mixed-use art district in the heart of our flagship, transit connected SmartVMC development in the Vaughan Metropolitan Centre. Located on the former Walmart parcel, when fully completed, ArtWalk will consist of approximately 5 million square feet of density, including 5,000 residential units and up to 150,000 square feet of nonresidential buildings. The Phase 1 release in Q4 included over 320 condo units, nearly 95 of which sold by the end of the year. It is worth noting that SmartCentres REIT owns 50% of these condos, twice as much as the 25% it owned of the Transit City condos. In December, SmartCentres more than doubled its ownership in Smart VMC by acquiring a 2/3 interest and 53 acres within the 105-acre master planned Smart VMC City Centre. This acquisition united ownership across the property, making SmartCentres the largest owner in Vaughan's dynamic TTC subway connected downtown. 45,000 new residents are expected to call Smart VMC home ultimately. And it is, of course, the jewel in the crown of SmartCentres portfolio. Within Smart VMC, we are expecting to launch Park Place, which will be a new 1,100 unit 2-tower project on the West SmartCentres VMC, the West portion of the Smart VMC, which we purchased just 1.5 months ago. As you may recall, in Smart VMC, we completed the remaining 192 condo units closing in the Transit City 3 Tower in 2021, bringing the total to 1,741 units closed in the first 3 Transit City towers, delivering over $60 million in FFO to the REIT, and that's at 25%. Also within the Smart VMC, Transit City 4 and 5 continued beyond schedule with expected closings in 2023. The Milway Vaughan's first purpose-built rental tower is now available to rent with the first apartments units taking occupancy potentially in the fall. This is being leased out of our sales Centre permanently located on -- at the heart of our -- at the heart of the VMC, sorry. These development updates are in addition to our current permissions in place. In 2021, we have advanced zoning applications for over 25.5 million square feet of additional density as we continue to accelerate our transformational plans. Over time, you'll begin to see the NAV growth and fair value increments on completion of successful land use entitlements for our master plans combined with developments having been already initiated. We currently have over 3.1 million square feet under construction, which includes 6 rental apartment buildings, 2 in Mascouche, 1 in Laval, 2 in Ottawa and 1 in our flagship Smart VMC. In total, we have 59 projects either underway or for which work is currently being undertaken to start construction in the next 2 years. While Smart VMC represents our vision of the future, it is only 1 of 93 REIT properties currently slated for intensification. Pages 20 to 23 of the MD&A highlights over 20 mixed-use project totaling in excess of 55 million square feet of net incremental density to be built. Some of our -- some with partners and mostly on undeveloped lands in our -- within our portfolio upon approval. On the financial side, maintaining our conservative balance sheet is always top of mind with an unencumbered pool of in excess of $6.6 billion, a 42.9% debt level and significant liquidity, which Peter will speak more about shortly. We will continue to -- we will continue to only move forward with capital-intensive construction initiatives as market conditions warrant. Sufficient presales occur in the case of condos and only when financing is in place. We told you earlier in the year that we have -- we would undertake strategic and targeted capital recycling to strengthen the portfolio and assist with funding requirements. In this regard, we completed just over $100 million in dispositions during the year, consisting of assets where no intensification were identified and NOI was below market. Lastly, the world is facing a sustainability challenges such as climate change, an aging population and inequality. At SmartCentres, we prefer to do the right thing and have the results speak for themselves. Our actions over the past 3 decades speak to our commitment to the communities we serve. ESG is woven into the fabric of our organization. SmartCentres was founded with the economic realities of the average Canadian household in mind. We focused on bringing value and convenience oriented retail to the Canadian market with like-minded retailers. ESG is embedded in how we operate, oversee our business, engage with communities and develop and energize our associates. Although ESG is getting much more airtime today, it's not something we just started talking about. It has been part of our DNA since the beginning. And when you assess our portfolio, you can see these principles applied everywhere. We have been working to formally improve our retail Centres through BOMA BEST certifications, through improved resource management, occupant safety and stakeholder communications, and we continue to work towards an 80% certification by the end of 2022.These days, Canadians want transit connected homes with urban amenities. So SmartCentres is evolving from shopping Centres to city Centres and smart living has emerged with our $15.2 billion transformational plan to enhance Canadian communities. Smart living apartments, condos, towns and seniors residents are designed around public squares and central parks within pedestrian focused transit connected master planned communities, all of which contribute not only to the quality of the built environment, but also promote sustainability. We are grateful for the exceptional work of our talented and dedicated associates who represent the diversity of our community and the customers we serve. Stay tuned for more formal ESG reporting to come. We will like -- you will like what you will see. Given all of this, you should recognize that our team is capitalizing on what it does best, executing and focusing on change Centreed around each community. Now I would like to turn it over to Rudy Gobin.
Thanks, Mitch, and good morning, everyone. Throughout the fourth quarter and in fact, throughout all of 2021, we saw the underlying strength of our Centres in driving leasing and customer traffic. Tenants in most categories were back with an even better appreciation for our well-located and open format Centres. And with virtually 100% of our REIT's properties having a full-line grocery and near 70%, including a Walmart superCentre, a wide variety of tenants who are back doing deals, such as dollar stores, TJX banners, QSRs, medical uses, grocery stores, distribution and logistics warehouses, personal services, home decor, pet stores and a wide variety of service retailers, all driving traffic and improving our tenant mix and occupancy.Here are some highlights. Our leased occupancy continued to strengthen throughout the year, approaching pre-pandemic levels with a 97.6% achievement by year-end. We completed 3.6 million square feet of renewals, representing 85% of the maturities during the year. Over 925,000 square feet of leases were executed for built space within our portfolio. Our tenants continue to work with us to adopt by expanding their e-commerce product line, delivery model, pickup and space utilization, all while striving to maintain customer loyalty and sales, and we are there to support them along the way.Compared to the bankruptcies and CCAA filings in 2020, they were virtually none in 2021, reflecting and hopeful that the worst is behind us. From a rent collection perspective, we ended the year at just above 98%, and that is climbing, demonstrating the stability of the tenant mix and portfolio. Regarding our premium outlets in Toronto and Montreal, both are now open and are at 100% occupancy. With the pent-up demand, accumulated disposable savings and the reopening of the Canada U.S. border, Christmas shopping was very strong, and we expect to be back to full sales and rent collections by mid-2022 in these Centres.As highlighted previously, Walmart Canada plans to spend $3.5 billion to make the online and in-store shopping Centre experience simpler, faster and more convenient. This continued commitment to its retail operations in Canada speaks to the ongoing strength of Walmart and its growing ability to drive traffic to our Centres. 2021 demonstrated what you've heard us say all along, that this portfolio was built for heavy weather. Our high-quality tenants are adopting, customer traffic is improving. Occupancy and cash flow are back to near pre-pandemic levels, and most importantly, all of this is happening concurrently with the extensive mixed-use development initiatives already identified or underway in more than half of our Centres, translating into significant NAV growth and NAV growth to come. And now I will turn it over to Peter Sweeney.
Thanks very much, Rudy, and good morning, everyone. The financial results for the fourth quarter reflect the continued steady improvements in our core business that both Mitch and Rudy have mentioned. For the 3 months ended December 31, 2021, FFO per unit increased by 12% or $0.06 and over the comparable quarter last year. This increase resulted principally from lower ECL provisions, lower overall financing costs and contributions from our total return swap initiative as compared to the prior year's results. It's important to note also that there were no condominium closings in the fourth quarter of 2021 as compared to the same period in 2020 that included FFO per unit of $0.09 from closings in the Transit City 2 project. In addition, IFRS fair value adjustments in our investment properties portfolio increased by $581 million to $10.7 billion at the end of the quarter. This substantive increase resulted from progress in the zoning and entitlement process associated with several strategic properties together with improved market conditions. It is important to note that as we continue to advance additional properties through similar zoning and entitlement processes, we will be assessing the appropriateness of similar adjustments in the future. And lastly, note that our annual distribution level continues to be maintained at $1.85 per unit, as Mitch has noted. And given the cash generated by the business, our 12-month ACFO payout ratio ended the year at 90.3%. Each of these financial metrics are representative of a common theme of steady and continuous improvement in our core business, supported by our growing development pipeline that is now beginning to contribute to both earnings and cash flow. We have also continued our focus on further fortifying the strength of our balance sheet. In this regard, we note the following strong debt metrics for the fourth quarter of 2021 as compared to the same quarter in 2020. Number one, our debt to aggregate assets ratio has now improved to 42.9% as compared to 44.6% in the prior year. Number two, in keeping with our strategy to repay maturing mortgages and to further grow our unencumbered pool of assets, unsecured debt in relation to total debt increased to 71% from 68%. And as Mitch had mentioned, our unencumbered pool of assets continue to grow and now exceeds $6.6 billion growing by over $800 million over the past 12 months. We continue to employ a strategy to repay most maturing mortgages, and accordingly, we expect these metrics to further improve in the future. This strategy provides us further agility when considering opportunities and alternatives for a portfolio of mixed-use developments. Number three, pursuant to our refinancing activity over the last 12 months, our weighted average interest rate for all debt continued to decrease, and at the end of the quarter was 3.11% as compared to 3.28% for the prior year. While concurrently, our weighted average term of debt was maintained at approximately 5 years. Excluding construction financing, substantially all of the trust's current outstanding debt is fixed rate debt. This continued focus on both the weighted average term of our debt and fixing interest rates is deliberate and is yet just another example of the risk mitigation strategy that we have employed to significantly insulate the trust from interest rate volatility in a rising interest rate market. And lastly, number four, our interest coverage ratio, net of capitalized interest improved from the prior year level of 3.2x to 3.4x. This, in spite of the impact that COVID-19 has had on our operating results over the last 2 years and in addition to reaffirming the foundational strength and stability of our core business, provides us with a substantive advantage from which to fund our pipeline of development activity. From a liquidity perspective, as we look to the immediate future and continue to manage through the current uncertain capital markets environment, in addition to the conservative debt metrics noted previously, consider also that when factoring in our cash on hand, together with our new $300 million facility that was established just subsequent to year-end to support the $500 million VMC West acquisition, the $150 million new revolving line of credit that was completed last year and the $250 million accordion feature associated with our existing undrawn $500 million operating line, our current liquidity position of in excess of $1 billion provides appropriate flexibility for the capital funding requirements associated with our development pipeline activity. Recall also that the next series of debentures in our debt ladder does not mature until May of 2023, and notwithstanding the challenges associated with COVID, over the last 24 months, our business has continued to demonstrate its ability to generate sufficient cash flow to fund both our operating needs and our distributions. Accordingly, we anticipate a requirement for additional funding over the next 12 months to be limited to construction financing and any potential acquisition financing requirements that may arise. However, we continue to review opportunities to early redeem debentures and mortgages when appropriate. And with that now, I will turn it back to Mitch.
Thanks, Peter. As you can tell, the portfolio remains strong with significant NAV growth on its way, with much work to do for us. And with that, I will now turn it over to the operator in addressing your questions. Thank you.
[Operator Instructions]And we do have some questions already queued up. So our first question is going to be from Dean Wilkinson from CIBC Capital Markets.
Probably for Peter, just one question. The fair value gains that you booked for PUD, which added about $2 per unit. Was that all thresholds or milestones that were met in the quarter? Or was that an adjustment to methodology that perhaps there was some catch-up in that number?
Yes. It's a great question. I'm sure others will have similar questions, Dean. I think it's important that all of us understand this was not an adjustment in methodology per se. It really represents -- the bump in value represents progress and advancement that has been made on, in this case, several what we described, I think, in our press releases, strategic properties in their zoning and entitlement process, that's principally what's taken place over the course of the last several months, together with this, I think all of us can appreciate our improved market conditions. Mitch, any further thoughts on your side on that question?
Yes. I mean there is an aspect of that process that relates to when is the moment that we're satisfied that a project is sort of cleared for takeoff. There's lots of -- I mean, there is some, I think, probably some room for being more or less conservative, we're probably on the conservative side of that spectrum. So yes, there are things that happened on several properties that give us confidence that we're sort of cleared for zoning already, some of its restrictions that we have negotiated our way through. And that's only on a handful of properties. So we will be continuing to do those. If there are adjustments around the properties as we are cleared -- as we feel like we're cleared for takeoff.
Got it. And the methodology there, Peter, is that based upon just a marker or is that a DCF? And if it is a DCF, is that predicated on locked-in construction costs or just the budget at this point?
It's principally a function of third-party appraisals and where our third-party valuation experts are telling us these properties, today, at least are value based on what is expected to be developed on those sites net of any costs that might be incurred to get us to, as Mitch said, the takeoff point. So at least for now, Dean, that is the approach. And as Mitch had mentioned, we believe that we're on the more conservative side of that approach to valuation.
Our next question is going to be from Mario Saric from Scotia Bank.
Just following up on the line of questioning, the roughly $500 million fair value gain taken. Can you confirm whether that, like what is the cumulative fair value gains taken on your PUDs or your intensification potential upside to date or is that a relatively new number?
Yes. I think, Mario, it's fair to say that the amounts that were reflected in the fourth quarter are intended to represent at least for now the initial components associated with, as Mitch described, the fair value take off or the expected clearance for takeoff associated with, again, this handful of properties. We do have, as we -- as you would expect, many others to come that we will be assessing their status over the coming quarters. But for now, as we got to the end of 2021, we thought it was appropriate, and certainly, our appraisers confirmed it to be appropriate that given the status of zoning and entitlements associated with, again, a handful of properties that it was appropriate to fair value them based on what the market is telling us. Again, conservatively, they're worth net of some expected costs that it may take us to get to, again, the takeoff point.
Okay. So just to be clear, like the number is fairly close to the cumulative?
Yes, yes. I think that's fair. I mean, there may have been some, what we'll describe as a material amounts that may have been factored in prior years. But again, they would be immaterial.
Okay. And then you mentioned a couple of times kind of several properties that the fair value gain was attributable to like the other percentage of your quoted 40.6 million square feet of intensification upside over time that the roughly 500 million would correspond?
The 500-plus million is -- those several properties are -- certainly, they're GTA properties and high density. And yes, some of them are on mass transit. So I'll try and do that calculation before we hang up the question period here. And sorry I'm just trying to give you a guidance on that before we hang up.
I guess we're just trying to figure out whether it's on a price per bookable square foot or what not, you've got some very good assets...
The numbers that are being used on a per square foot basis are really quite conservative. So these projects were sold to the market. I think just because of the market, if it was today, they would probably achieve maybe just saying because the market is what it is right now. But this is based on just the more average level headed market. So yes, I mean, real estate, it does sound like a big number. But on the other hand, in the scheme of things I mean, with the city that's expanding like Toronto, and the pricing, it's actually -- yes, it's only a handful of properties, big densities, but there's -- there's a lot of value in going from a single story 25% coverage, 12 acres of land, and it's got 120,000 feet on it and you go from that to 2 million square feet of mass transit, it's big numbers, real estate is public. So I'll try and give you the math on that for you just try and state it before we hang up, if I can.
Okay. Maybe one last question just on the fair value in. Given the value of some of these properties, does the recognition of the fair value gain make you more or less like we potentially sell partial stakes in some of these upside projects in the near to medium term or is it just not correlated?
No, it's part of our strategy. I mean, to raise some capital. We want to maintain our -- we want to maintain a conservative balance sheet throughout this process and program. So yes, it is very much one of our levers is to bring in partners on some of these projects at fair value or market value or sell them even outright. It's not our first choice. But if it's the best choice and the easiest choice, we might sell a few of them just because they're so valuable, and we've got lots and lots to do. So it's definitely part of our -- and we're actively doing that right now, actively pursuing that and in discussions on that right now.
My last question maybe for Peter. Is there a -- for '22 it looks like the development gains will be more weighted to '23 than '22. With that in mind, is there a target of a full per unit growth rate that you're targeting '22 excluding gains?
Yes, Mario, we prefer -- I mean, I think particularly over the last couple of years, given the experience that COVID has impacted our industry with. We took the approach 2 years ago of not providing that kind of guidance to the market. And I think given that there's still so much uncertainty notwithstanding that we seem to be coming out of a more problematic period of COVID, there is still, we think, at least a lot of uncertainty associated with this pandemic. And so I think it would be our preference for now at least to not provide guidance, again, at least for now on the '22 growth trajectory.
Our next question is going to be from Pammi Bir from RBC Capital Markets.
Just when you look at maybe what you've submitted to date in terms of the mixed-use intensification, redrawing application, and those that are still in the process where you have not received the zoning. What are your thoughts on what may actually get approved over the course of -- if we think about 2022 or even if you have any visibility on a 1-to-2-year basis in terms of square footage?
You mean more like the amount of sort of approvals or whatnot in 2022 and 2023?
Yes. Yes, exactly.
I do think it's going to be -- again, I don't have the number right in front of me, but as you know, zoning is kind of -- margin of error is big. But it's going to be, I think, 2022 and 2023 are very big years for us in terms of approvals. So I would rather not just sort of speculate on how -- if you give me a chance to that calculation and call you or send it out to everybody who's interested. But we've been doing -- the applications for zoning amendments have been in for a long time. And so I think a lot of things are going to come together in 2022, 2023. But I don't want to sort of guess.
Got it. And I guess, again, you mentioned that today -- or I guess what you booked in Q4, it sounds like most of that was in GTA, is what's in the pipeline -- the pipeline is quite large and it spans over many markets. Is the bulk of what's may be coming through in the next 1 to 2 years? Is it predominantly GTA, Ontario or Quebec or any other?
It is a big bulk of it. It would be Ontario and Quebec. We've got quite a bit going on in Montreal. By the way Montreal, I guess market has come nicely, actually, has cooperated really very well with our timing because we've been pursuing approvals in Quebec for a number of years. Now they're coming through. And the market is pretty good there. But the bulk of it in terms of right now is Ontario and GTA, mostly GTA, super GTA and Montreal. Now there are some developments -- interesting developments we've got going on in surplus land in places like Alliston where we're approved, and we plan to proceed with a rental or sort of rental development there. So I'm including, for example, Alliston. When I say that, also, we're approved in Barrie. Barrie is also is quite a good market right now. I'm not including that when I say GTA, but it is part of the -- when I say Ontario, I mean, Barrie is a good -- when we're talking density there, we're approved for 20 plus, 30 towers there, including a hotel on the waterfront. So that is also an example of something that's approved. But those types of markets are the bulk of it.
Okay. And then maybe just comparing perhaps your approach to some of your peers, among the retail REITs or maybe even that's outside of the retail REITs. Some have not necessarily taken or booked these gains that -- for what these properties might be worth that they were to be sold in the market after receiving successful entitlements and zoning. So I'm just curious if you could help us think about your approach and how that might differ, I guess, to some of your peers and your decision, I guess, to book these amounts?
Yes. I mean we can't speak to our peers, but I mean, I think it's what we're meant to be doing from what I understand. I mean, it's meant to reflect the value of our properties accurately, it's obviously, as we've said a few minutes ago, I mean zoning approvals, entitlements and other restrictions, there's lots of steps, but at some point, you need to update your values based on your intentions. You can have value. You can have zoning and entitlements to something you don't plan on doing. So -- but we are very much planning to execute. I mean it's our core expertise. So we are planning to execute on things that we get our entitlements on. We're pushing very hard to do that. Maybe others are not as much, but I think we're doing what we're supposed to be doing.
Okay. And last one for me, and this one is more focused on the actual operations of business from a retail standpoint. Just on the leasing spreads, a very slight perhaps margin improvement relative to last quarter. Some of that -- some of these sort of muted spreads are really just, I guess, a function of the leasing that was done perhaps during the height of COVID. But how are the spreads trending on leases that you're renewing today? And I guess the effect of those may not be seen for several quarters or so. So I'm just curious how those compare to what we're seeing actually come through in the numbers?
I'm going to have Rudy answer -- the ones that I have involved in you see actually just ahead of Rudy's more overall answer. The ones I've seen actually have been quite decent bumps in the early renewals that I've been involved in. Rudy?
Yes, Mitch. Pammi, the -- we have our essential and nonessential type tenancies, and our essential, as you know, make up almost 70% of our tenancies in our major markets. And those tenancies are doing quite well, and there are the standard sort of bumps in those. And then for the nonessential the one that COVID had a bigger impact on those are still coming together and trying to bring their business back. And those are the ones I would say, when you combine them together, it's generating the slightly positive growth you're seeing in our lease renewals. So it's that combination. It's getting better. It's improving every month as we move further out of this pandemic. But that's the 70% of the portfolio is doing quite well and then the smaller ones are coming along.
Our next question is going to be from Kyle Stanley from Desjardins Capital Markets, please go ahead.
Just going back to the fair value gains for a minute. Could you comment on if any of the gains were attributable to the REIT purchase of the 2/3 interest in Smart VMC West and the corresponding -- potential corresponding revaluation of your interest in Smart VMCs?
That answer is yes. And Peter, do you want to expand?
I think the way to answer the question, Kyle, would be in 2 parts. From a timing perspective, we announced, as you know, the acquisition of the VMC West property in December. The process to get to the finish line on that position did not happen, as you would probably imagine, overnight. It was a lengthy process that required a tremendous amount of negotiation over time. The fair value increments that we've now spoken about over the last half hour or so, I think it's fair to say those increments are really a function of as we've said now, of the changes and improvements in zoning status that has occurred in again, a handful of properties, coupled with the movements in the market. And when we see movements in the market, the movements in the market were not predicated on what our experience was on the acquisition of the VMC lands. In fact, the appraisers that we spoke to and used to give us guidance on this, we're reflecting and commenting on so many other properties in the GTA area, and many of which are in the one area in particular, that have recently traded or are currently under contract will close shortly at values well in excess of now what we valued some of our properties at. So I think it's fair to say that the general market Kyle, particularly as it applies to the GTA area has improved considerably over the last several months, as a minimum. And when factoring in those improvements in value and the continuous seemingly unsatiated or non-satiable demand for development land we thought it was appropriate to, again, fair value of these properties, as Mitch said, on the basis that they're really now reflect -- should be reflected at as opposed to using the historical approach that we've used since the IFRS initiative came in, and I think it was 2010 or '11. So what does that all that mean? It means that we paid what we thought was a fair price for the VMC West lands. But to get to how we approached fair value of this other handful of properties, we didn't rely exclusively on the amount that we had paid on the VMC West lands. In fact, it was probably just the opposite where we're relying heavily on what the appraisers were telling us, where other properties that we're trading in the marketplace concurrently.
Okay. Okay. That makes sense. Just looking in your disclosure, you mentioned that DBR has confirmed the BBB high rating, but changed the trend to negative back in December. And there was some commentary about the trust continuing to work on alternatives with the intent to improve the credit rating. Just wondering if you could elaborate a bit on what those alternatives could be?
Sorry, the alternatives of what?
You mentioned that you would continue to work on alternatives to improve the credit rating. I'm just wondering what those alternatives could be?
Well, I mean, I mentioned one before, which is we would sell a portion, bringing in partner on some of development at market. So that would be one. I mean, selling -- selling a Phase 1 of a masterplan at market -- it would be another selling of the project entirely at market would be another. I mean those are some examples. We're not satisfied with our unit price, that pretty much speaks for itself. So those are examples of some of those levers. Peter, do you want to turn in?
Yes. I think, Kyle, Mitch has really referenced where our thinking is that given where our unit price is currently trading, we don't see that as we're now at least an alternative. So we are considering and focusing on other opportunities to sell interest or partial interest in some of the properties that are particularly development focused to some institutional type investors. So that's certainly an opportunity and an alternative that, as Mitch mentioned, we're pursuing. And there's some other sort of related themes to that, that we're also considering again, with the ultimate goal of raising equity that would be used to repay some of the debt that's currently on the balance sheet, again, with the ultimate objective permitting our credit rating to be restored to what it was prior to December. Does that help?
Okay. Yes, yes. No, very helpful. And just one last one. This one will be for you, Peter Sweeney, just housekeeping. On the -- could you remind us of what the total return swap is for? And then just where are the offsetting expenses in the P&L?
Yes. So the total return swap we initiated, believe it or not now a year ago, it was intended as an opportunity for the REIT to over a several year period to look at opportunities to deploy some of its liquidity to generate returns on an interim basis, that again would help during the period that COVID was impacting the business. We engaged with a well-known Canadian bank that has helped us through the process now for well over a year. And the intent is to allow for that TRS or total return swap to continue, hopefully, to augment the operating results of REIT. With respect to expenses, there are 2 potential expenses or 2 expenses that we would incur: number one, are fees associated with the TRS that are paid to the bank involved, and they are netted obviously through the returns as they're incurred; and then potentially, in the event that the unit price were to move in a contrary direction as opposed to where it's been moving over the last 12 months or so, then there would be an impact Kyle to FFO that would be an adverse impact as opposed to the positive impact that we experienced in 2021. There's -- I think we mentioned this last year. There's some safeguards that we established coming through the process to find a way to mitigate some of those risks and concerns by either modifying the term of the total return swap or reducing the exposure in the total return swap. Again, just to potentially mitigate any concerns over material changes to FFO. But for now, for the first 12 months at least of this initiative, we've seen substantial returns, as you've seen now in our public disclosure on moving this forward. So we're very pleased on how it's done so far.
Our next question is going to be from Tal Woolley from National Bank Financial.
Just want to start on the development side. So in your MD&A, you break out your development pipeline as the sort of it's underway, active projects and future projects. And if I just focus on the underway section of it, you've got about 59 projects for 9.4 million square feet, roughly $5 billion total cost at your share. That works out to about $532 a square foot, give or take. And then if I look at like Q3, you had 52 projects, 6.7 million square feet, $3.2 billion expected cost is about $478 a square foot. It's about 11% increase in that quarter-over-quarter. I'm just wondering if you can talk to me about how much of that is attributable just to the project mix? Obviously, you added some stuff that might be more expensive. I can understand that. Also just wondering too, though, if you're sort of thinking that some of the stuff you've got in the pipeline, those costs are going up and how we should think about those numbers going forward? .
Rudy, do you want to...
Yes. Yes, Tal, from one quarter to the next, there were some changes to the product mix, but it was minor. And the -- it would also include VMC West, as you can imagine, being added in the quarter. So each quarter, when we do this review, we would build it ground-up so to speak. So again, it's just a measure of each market and how each market is evolving from a development perspective. And the numbers end up being where they are. It's not a top-down, it's a bottom-up build.
Okay. And like how are you feeling, I guess, is a bigger sort of question just on development, like given that sort of in the middle of a shift economically here, and I'm not sure -- I think you could say that income growth is necessarily looking super robust for individuals in the near term, but it's clear like construction costs are rising. How are you feeling about greenlighting new stuff and getting underway on new stuff right now?
Good. I mean, you read about you do -- you read about construction cost increases, and it's generally true. It's not -- but each individual project is we value engineer each project around, and try to update around the materials that are rising the most and whatnot. So there are lots of things and stuff that we can do in the industry or things we know about how to do it industry to stay away from the highest increases in items and construction items. But it's sort of overall kind of unavoidable. They are -- prices are going up, but so our sale price is going up. So in fact, I mean we'll do better on ArtWalk than, say, on Transit City, and we locked in with pretty low prices on Transit City. And that is just because we found ways to save money materials. And we've also -- we're getting a lot of demand. And we're creating something there. So price was going up sort of exponentially. So everyone, every time will be assessed. I mean based upon what the market is, and we're acutely aware of and exposed to construction price increases but we won't commit to follow. We're not going to build for the sake of building. But remarkably, as much as you hear about prices going up, construction prices going up, it still makes sense, especially on our properties where we already own them. We're not buying the properties at market. So that helps a lot.
Okay. And then both you mentioned you, Peter, you've made some references to expanding partnerships on some of your marquee sites. Can you give us a flavor of what that might look like? Is it a series of individual deals? Or is it a bigger sort of master deal type joint venture with a solo partner? Like how are you thinking about structuring that kind of transaction?
Yes. They're both probably going to -- I mean, there's not going to be one master. I don't think there's going to be one master deal where there's one big institution on every deal. But I wouldn't be surprised if we do a deal with a larger institution or whatnot for a handful of deals. But I don't know. I mean, we find that just doing one at a time is the best way to go. So sometimes it leads to 2 and 3 and 4. So we're just focused on the bucket of properties we think are candidates for institutional investors or investors in general. And we see ourselves as being the development manager and the construction manager.And if it's a rental, the property manager and that the entity would buy in, say, between 25% and 50%, I think for the most part, we wouldn't take less than 50% of the partnership. And they would buy in initially at market. So that would be the big kind of capital event. And then we just go, let's say it's 50-50, we go shoulder to shoulder. Going forward, now we sometimes have a feature where we have a kicker potentially in our favor if we outdo the budget, the returns where we adjust what is really an adjustment to the value of the land that was rolled in at the end of the deal. That's kind of how it would be structure-wise. And maybe just in terms of the players or the players on the stage, the type of players on this stage and how it would go. I also wanted you to know, you reminded me, we're doing things -- we're also doing something, for example, with a general contractor where we are negotiating a deal with a general contractor to be our kind of partner in a sense, they're not going to be a partner in the land, but that we'll make a master agreement with a general contractor, so that they will be with us and beside us from design and help us find ways to value engineer our massive program. And of course, we'll be able to lower price. So they'll be able to set themselves up. There's a certain amount of efficiencies there. They all have enough of our deals that they'll be able to order certain materials in bulk. And we'll get the benefit of that because we're going to be -- it's going to be a construction management contract. So for example, there's lots of things that you can do when you've got a large program. And it is our sort of sweet spot in terms of our expertise. So in terms of partners or even construction and construction costs, there's a number of levers that we're doing.
Okay. And then just lastly, Peter, the gain on the TRS swap, is that on the P&L? Or is that something you bring out of other comprehensive income into your FFO?
It is included in both the accounting income and our FFO.
And so where would it be in the accounting income?
I don't have it in front of me, Tal, but let me respond to you offline, and I'll tell you exactly where you can find it.
We do have 2 more questions in the queue. Our next question is going to be from Jenny Ma from BMO Capital Markets.
I wanted to turn the focus to the operating portfolio. Just looking at the average term to maturity of your leases, and it's sitting at 4.4 years at year-end. But that's been on a pretty consistent downward trend for a number of years now. I think 5 years ago, kind of sitting at 6x. So I'm just wondering, particularly lately, is there anything to read into it in terms of shifting preferences in terms of how long tenants want to commit for? Is it anchor versus new mix? And has there been any change from tenant behavior post pandemic? Like anything we can read into it? And where you think that number stabilizes that or if there's an inflection point it starts moving up again?
Yes. It's a good question. There's a lot of factors, Rudy, I'll let you jump in here in one second. I think the last number of years, we haven't done a lot of new ground up construction where the leases are longer. And so it's been less of that. Although, there's some of that going on, and that will kick in soon. Rudy, do you want to weigh in?
Yes. And that's mostly it. I mean when we were building out the shopping Centres, most of the deals were 10-year deals with 5-year options in them or 15-year deals with 5-year options. And a few 20-year initial term deals, Jenny, with 5-year options. So as soon as the 10 years are up and you're into the 5-year options, then all of a sudden, the math works out that the average term to maturity keeps ratcheting down. So it is exactly as Mitch described, a greater proportion of the 5-year options that we're now into and even a few tenants coming in, wanting flexibility, we'll do a 5-year deal with 2- or 3-, 5-year options versus before they would have done when we were building out lots of these shopping Centres, a 10- or 15-year deal. So it's just a matter of tenants moving into their option periods.
Okay. So...
Also, we, in some cases, are not as open to longer terms in some places because it may be part of our Phase 2 or 3 of our development.
Okay. So I mean it reflects to some extent, a maturation of the SmartCentres business. When we look forward, like what are tenants asking for? Is it in or around 5 years, that's where they're comfortable at, which would suggest I guess your weighted average term probably settles out around, I don't know, call it, mid-3s to mid-4s is kind of where it's going to settle all up?
I mean, a new deal is 5 years. I mean any renewal is usually 5 years and then new deals is 5 years. There are scenarios -- we're talking to existing buildings, where they're 10 years. But we're a little bit -- we're reluctant subjects on certain projects for 10 years. But where there's work to be done or it's larger premises, 10 years is also happening, but most deals on existing space start off with a 5-year lease. It's just normal. It's just kind of the industry with options. If you build from scratch, usually 10 years is the minimum. I mean I don't think we've ever done a new deal ground-up construction with 5 years. So 10 years, 15 years, as Rudy said, they will merge for 20 years. We're not doing a lot of new Walmarts and not doing a lot of new food stores. So from that point of view, yes, those pieces are maturing, but they're cheap rents, and they have many options, and they renewed at 5 years at a time, and it's going to weigh on that average lease term that you're referring to. Rudy, do you want to weigh in?
That makes sense. I want to turn to -- talk about inflation sensitivity in the portfolio, not so much on the development side. It looks like the same property NOI ex ECL was a bit down, and there were some expenses involved. So I'm just wondering, within the leases that you have, is there any sort of linkage to CPI or potential pass-through of costs, let that inflation risk goes to the tenants? Like, how would you characterize the cash flow inflation sensitivity on the portfolio?
When I -- early days, we always used to call it CPI, but CPI is very harder to get . Our portfolio is focused on strength and high occupancy. So we give up, if you will, things like CPI for -- we'd rather have Bank of Montreal as a tenant than a souvlaki restaurant with no covenant or a Subway -- not a subway, so that is a sub-sandwich with no covenant. So we would get CPI from the independent restaurant operator, but we will not get CPI from Bank of Montreal. So we're proofed for -- we say we're built for heavy weather. We collect the rent through good times and bad, but not necessarily from the restaurant. So the restaurants give you the CPI, in that example the independents will give you the CPI, but the strong, strong nationals won't give you CPI. So our hedge against inflation is occupancy and collectibility and conservative but collectible bumps in our rents.
Okay. So when I look at the same property NOI, are the higher costs somewhat related to inflation? Or is there some lumpy items in there that would result in a sort of slight decline in NOI?
Sorry I didn't -- I'm sorry, I don't understand the question.
So for the same-property NOI, when you exclude the recovery in bad debt expense year-over-year is marginally negative. So it looks like there were some miscellaneous expenses and CAM recovery shortfalls that sort of aid into the rent growth that you did have. So I'm just wondering how much of that is inflation related? And what I'm getting at really is to how we should think about internal growth given a slightly inflationary environment?
Yes. I don't think we're not -- I mean, Rudy, you can touch on some of it here, but I would not say that the inflation issue has weighed in yet -- weighed in and then maybe it will, but weighed in yet in terms of in terms of inflation you're talking about, there might be erosion there. But Rudy, do you want to weigh in on that as well?
Certainly. Yes, I would say most of our -- the cost increases we're seeing are broad based. They're not particular to a market, they're not particular to a type of cost. It's pretty broad-based. And recall that our operating costs of our properties are if not the lowest amongst the lowest in the industry because it's not -- it's open format space. So we don't have enclosed space where we're looking after internal cleaning and HVAC and roofs and all of these things. So our starting point is a much better point for our tenants in terms of costs. And then the other thing to mention is, a year ago, we were at slightly higher occupancy, and we're building to back to that. So you might be seeing a little bit of the slippage to, Jenny, from the 98-plus percent, 98%, 99%. Over the last several years, we were at 99% for a long time, and so that slippage is now being built back. So that's probably a little bit of what we're seeing given the -- what's happened in the pandemic in 2020 and 2021. .
Okay. Okay. And then just lastly, Mitch, you mentioned in the early days, you saw more CPI. I'm just wondering maybe there's a bit of a history lesson. Was the CPI -- does CPI exist for most types of tenants, including high covenant tenants and then it kind of went away because I guess, CPI wasn't really an issue for a very, very long time? And if this inflationary environment persists, do you see CPI sort of returning or creeping back into leasing discussions with tenants?
Yes. I mean CPI used to be normal, really early days on talking like when I started in the business in the '80s. And I happen to know that it went into the '70s because I was dealing with businesses that had operated through the '70s into the '80s and CPI was normal. It used to be that landlords were -- the lord parts and the landlord was kind of -- sort of hangover from by-gone days and landlords dictated stuff like that. But it changed very quickly in the '90s, and late '80s and '90s, and it's been a tenant's -- pretty much a tenant's world almost ever since and CPI went away with value-oriented retail. And in the demodeling of the world, I mean -- so I mean. You see some CPI here and there, but obviously, I haven't seen it for like really mainstream, it's just not mainstream enough. You can stick it in an independent deal, they'll sign it, no problem, but you won't collect it. But anyway, look, I don't think like our leases are all met. We're not really a company that grows kind of -- we're not a rapidly growing company from rental bumps, okay? We'll have our standard rent rooms. We want our tenants to make money and stay with us, and then we can expand them. First of all, we collect the rent. They make money, they want more space a lot of the times, and we do more deals with them. And we stay highly occupied, we benefit from lower interest rates along the way, obviously. But at least we get the bumps and we stay highly occupied. But they're net lease, and they are net leases. I mean we have the lowest average rent probably. Like our portfolio, when you talk about these fair value adjustments, I mean, our portfolio is valued based on our rents historically. But our rents are based on the lowest coverage ratio, we have 25% or lower coverage of our properties, so 75% of our properties are parking lots with no income. And in that 25% coverage are the lowest average rents and then we value the company. So one thing that they are, though, is only net. So that helps a lot against certain inflationary factors. And we have our bumps, which generally speaking, they're not going to CPI, but they do bump probably that far off from CPI because I would say that most of our rents and, don't quote me on this and don't like throw the book at me on this, I would say our bumps kind of average somewhere in the 1 to probably 1.25, I don't know, maybe in some cases, more per year, but on a 5-year time frame for what it's worth, I'd say, over a 5-year period, like a $20 net rent. It should probably be 10% in the 5-year bump, that tenant generally, I mean, national would go from $20 to $22 would be normal, just to give you an example. But we can look at that, and I'm sure it's somewhere in our documents anyway, but it's not geared to inflation, but it's a fully net lease, and it's probably pretty close to inflation anyway and probably be much better than inflation for a number of years.
We do have our last question in the queue. It is from Sam Damiani from TD Securities.
And I certainly don't want to keep the people from their lunch, so we'll try and to make these last questions quick. But just -- and I got on the call a little bit late, and I apologize, but was there a maximum sort of development or PUD as a percentage of total assets under the REIT's declaration of trust that is a factor with the fair value gains that have been booked and the acquisition, of course, in December?
It's Peter. We're assessing that, and it may require an amendment to our Declaration of Trust, which we'll think about doing at our next AGM.
And then just on the fair value gains again, it sort of came out, I think, through some Q&A earlier that the VMC was a part of that, maybe a big part of it and it seems like perhaps the acquisition in December was marked up because that price was negotiated several months or longer ago, and then obviously the existing as well. So is it fair to think that perhaps of the total fair value gain in fourth quarter, perhaps over 50% of it was at the VMC?
Peter?
Yes. I think, Sam, and I think you know and perhaps others on the line know that historically for a variety of appropriate reasons, we have not believed that it was appropriate for us to provide value, Sam, on a per property basis, and I think we prefer to maintain this approach to public disclosure of our portfolio's values going forward. So it's not our intent, at least for now, to provide specific valuation parameters for each property. And I think for competitive reasons, we think it's appropriate to continue in that realm. And I'm not trying -- we're not trying to be coy or to deck your question, we just think for the benefit of our unitholders and our ability to generate these developments and progress them through the appropriate channels going forward, it's just not the right idea to publicly disclose how much we think each one of these things is worth.
Yes. No, that's fair, and I'm totally not surprised. But I guess I think, Mitch, your comments earlier, I mean -- or maybe it was Peter's -- part of the process was the appraisers and market comps or deals in process. But the unique thing with the VMC, of course, is that this is actually under development. You're actively selling condo units, you closed on condo units. So there's a very high visibility there that you don't have, let's say, for a 1900 Eglinton or Caledonia West side. But is it fair to say that the approach in Q4 with these fair valuation bumps was more exacting on the VMC than it would be for another site, perhaps is further away from actually selling condos or renting apartments?
We have -- each one of the properties ultimately there was valued, it was an exact amount. So they're all exactly amount based on, I guess, the assessment of what the market would pay for them. So obviously, you talk -- I love the fact that you can just reel off 1900 Eglinton and Westside, that's great. Those are 2 excellent projects, and they have value. Even though we're not a launch in the ground, but the market would recognize there's value there and any other projects. So yes, I mean I think that's about maybe the only way I can address that or address that question. Peter, do you want to expand at all?
No, I think that your description Mitch, is appropriate. Our approach, Sam, is really to -- as we did in Q4 was to identify those projects that we think have come through the zoning process and are at a point where -- and Mitch mentioned this earlier, and I think it was really hit you on the head by describing these things as being the appropriate way to value them in keeping with what an IFRS expectation would be vis-a-vis fair value. So I think it's -- again, we're not at a point where we're at liberty to describe or disclose values on a per property basis, but you should expect in the coming quarters for us to look at each of the other properties in the portfolio as they as well continue to sort of go through the entitlement and zoning processes, respectively, and to consider whether or not it may be appropriate to enhance their values, again, keeping in mind whatever may be happening in the market at that time. .
Okay. That's all very helpful. Just last real quick one. Maybe it was...
Sam, I just -- and again, Mitch was talking about history earlier on CPI bumps and inflation. I think it's important that everybody understand that this whole approach to valuation and maybe back to your first question, Sam, on our threshold for development and may be in the declaration trust. All of those initiatives predate the advent of IFRS. So they all reflect what any accountant on the line may recall as being cost account. And so when original ceilings or thresholds were established, they really sort of took into account what companies like SmartCentres were paying for actual properties, and we're restrictive on development as a percentage of total costs of actually amounts incurred. And as we know now for the last 10 or 11 years with the advent of IFRS and fair value accounting, we now have to look at and include bumps or losses as we experienced in 2020 from COVID that may appear from fair value in these properties. And so I think it's fair to say that those gains and our losses were no doubt not contemplated when most of the -- at least larger Canadian REITs were first established and what may or may not be included in the declaration of trust. Okay?
Yes. No, that's a very good point. And just a quick last one, $3 million of lease termination fees in the quarter, anything of note that you would want to share on that?
Rudy?
Yes. Nothing of significance. The units that generated those fees are interestingly enough, we are in discussions with 75% of that space being released in the first quarter. So the good and bad news is we had some turnover. That's the bad news. The good news is we've got some good solid leasing interest of tenants that want to come in and enhance the mix of uses within our Centres for those. So those were just the remnants of going through what we went through in 2020, Sam and into 2021, and it's wrapped up most all of our major challenges with tenants.
We thought if we did this call during lunch, your questions will be shorter.
Mitch, I just want to come back to Tal's earlier question maybe before we actually go to lunch. But Tal has asked the question earlier about how we account for our gain on the total return swap and where that might be found? Tal and team will direct you to 2 places. If -- in your bedtime reading, you get to Page 68 of our financial statements, note 26 on fair value adjustments, you'll see it under the Financial Instruments section in note 26 of the financials. Alternatively, if you don't want to review the financial statements, but you want a quick peek, you can see it on Pages 36 and 37 of the quarterly and year-to-date results on how we add back amounts to get to our FFO line. And you'll see the add-back for fair value on financial instruments, which is a noninclusive number, tying again back into Note 26 and then the add back from that number of the total return swap into FFO. So hopefully, you could follow that if you any further direction let us know, please. Mitch?
Yes. Okay. I guess -- that's the -- I don't know, is the operator.
Sorry, yes, so that was the last question in the queue, exactly.
Okay. So thank you all for taking the time to participate in our year-end call. And please reach out to any of us for any further questions. Stay safe, and have a good rest of your day.
Thank you. And ladies and gentlemen, this concludes the SmartCentres REIT Q4 2021 conference call. Thank you for your participation, and have a nice day.