Allied Properties Real Estate Investment Trust

Good morning. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the Allied Properties REIT first quarter 2023 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press the star one. Thank you. Michael Emery, President and CEO, you may begin your conference.

Thank you, Rob, and good morning, everyone. Welcome to our conference call. Tom and Cecilia are here with me to discuss Allied's results for the first quarter ended March 31st, 2023. Anthony Mallingham, our incoming CFO, is also with us today. We may, in the course of this conference call, make forward-looking statements about future events or future performance. These statements, by their nature, are subject to risks and uncertainties that may cause actual events or results to differ materially, including those risks described under the heading Risks and Uncertainties in our most recently filed AIF and in our most recent quarterly report. Material assumptions that underpin any forward-looking statements we make include those assumptions described under forward-looking disclaimer in our most recent quarterly report. Despite ongoing macroeconomic uncertainty, Allied's business is larger, stronger, and better managed than ever before. Our operating income was up 14.5% in the first quarter, an all-time high made possible by development completions and contribution from last year's portfolio acquisition. Our interest cost was also up in the quarter, entirely due to variable rate debt encouraged to fund development. that will continue to propel operating income in the coming years. We plan to retire the variable rate debt fully and increase our liquidity materially with the proceeds from the sale of our UDC portfolio. While the sale process is not complete, it is definitely nearing completion. The first quarter of 2023 was positive from an operating perspective and supportive of our outlook. Cecilia will summarize our financial results. Tom will follow with an overview of leasing and operations. I'll finish with our current thinking about the future, particularly the future of the allied team. Now over to Cecilia.

Good morning. I'll highlight key operating metrics, our financial position, progress on development and upgrade activity, and priorities for the year. Our operating metrics continue to be strong. Operating income was up 14.5% from the comparable period due to a full quarter of contribution from the choice portfolio, as well as development completion. Average in-place net rent for occupied square foot was also up to $23.35. This is higher from year end by 1% and higher from a year ago by 3.6%. We also continue to see strong rent growth on renewing space in the quarter, which was 11.4% on an ending to starting basis and 18.2% on an average to average basis. Tom will provide more details on our leasing activity. We're pleased with our financial position. We expanded our operating line by $100 million to $700 million, while keeping the $100 million accordion intact. On closing of the UDC portfolio sale, we intend to use the majority of the proceeds to pay off debt, including our operating line, which we expect to pay off in full, increasing our liquidity and pushing our debt metrics back within our targeted ranges. Our debt metrics will continue to improve thereafter, and our development completion continues to be increasingly economically productive. We do not intend to allocate any capital to discretionary activities, including acquisitions in the coming year. We allocated $85 million of capital in the quarter to revenue enhancing activity and development completion, which is what we'll continue focusing on for the foreseeable future. Our development and upgrade activity is progressing well. In Toronto, at 19 Duncan, Thomson Reuters has taken physical occupancy. And at TRC West Expansion, Northeastern University has finalized its spit-out design. In Montreal, at Tour VJ, Novartis has taken physical occupancy, and the remaining space is under negotiation with other interested users. Our priorities for 2023 continue to be leasing, development and upgrade completion, and completing the UDC sale to strengthen our balance sheet and reaffirm our commitment to urban workspace. The goal continues to be to propel our operating capabilities. Our outlook for 2023 remains unchanged at low to mid single-digit growth in each of FFO and ASFO per unit and SAMASA and AWADO. We also expect to continue increasing our distribution at our historical rate of 2 to 3% per year. Our team and our operating platform has never been stronger. With that, I'll pass the call to Tom.

Thank you, Cecilia. We had a solid Q1, completing 102 transactions, totaling 425,000 square feet. Average net rents on renewal in the quarter. for a healthy 18.2% higher than average net rents in the expiring term. Average in-place rents in the portfolio have increased every quarter for 14 consecutive quarters. Our rental portfolio at March 31st was 88.8%. We have good momentum heading into Q2 bolstered by a very aggressive approach by our leasing team. By mid-February, our leasing team completed presentations to the brokerage community in Montreal, Toronto, Calgary, and Vancouver. The team called it the Broker Roadshow. 30 separate presentations took place through all major brokerage houses, identifying leasing opportunities in each city. In all, they reached 550 individual agents. Following these presentations, we have over 200,000 square feet of new transactions underway that we may not have had otherwise, with 100,000 square feet now at the offer stage. We also experienced a large uptick in our tour activity in the month of March because of this program. I'll now provide an update on our leasing activity for Montreal, Toronto, Kitchener, Calgary, and Vancouver. Montreal continues to be active with the team completing 24 transactions in Q1. Our focus in 2023 continues to be leasing at 111 Robert Barasa and 1001 Robert Barasa, as well as Pascavigie and the Arciagos. I'm pleased to report we have action on all four buildings. Specifically, we're in the final stage of negotiation for 60,000 square feet of the class garbage, the global conglomerate. And we are working through a LOI with an educational use for 40,000 square feet in the same building. We have approximately 70,000 square feet of space under negotiation with RCA, four tenants, and a full floor of 35,000 square feet with a tech company at 111 for us. In Toronto, we completed 38 transactions in the quarter. Most notable transaction was an early renewal and extension with SickKids Hospital for 110,000 square feet at 525 University. Our upgrade work at 185 Spadina and 468 King is nearly nearing completion, and we're negotiating offers with single users in both buildings. In Kitchener, we're in advanced negotiations with a tech tenant for up to 160,000 square feet. And if successful, we will be 99% leased in that market. Moving to Calgary, our team has done a good job maintaining a leased area of 83.4%, which relative to the market is good. Work has been finalized to reposition the Logie, and we're working with an educational use for a large portion of that building. We're also active on three built-in suites at Telesky. In Vancouver, the team completed 33 transactions, and we maintain a 94% lease area status. Generally speaking, we're very encouraged with the pipeline of deals for the balance of 2023 for the following reasons. We tried leasing activity very closely, and as of April 17th, we have 820,000 square feet of new deals or expansions at the offer stage for an advanced discussion. We have action on seven large blocks of space totaling 450,000 square feet. We have action on amenity uses totaling 70,000 square feet in our large projects in Montreal. We are currently in discussion with six educational users for new deals or expansions. We have an aggressive ReadySuite program, which is focused on upgrading vacant space between 2 and 10,000 square feet. The idea here is to provide space in move-in conditions to shrink negotiation timeframes. Most of our leasing is done in this size range. We are very close to completing three significant retail deals in King West. And we maintain a very high degree of interaction with the brokerage community in all of our markets to maintain maximum coverage. We have hand-picked the best agents in each market to list our available spaces. In addition to our 15 in-house leasing staff, we have 52 agents working on our behalf. While we will not complete all of the deals in the pipeline in 2023, we do expect to complete most of them, which will move the needle meaningfully on our leased area stat. We look forward to providing an update on our progress next quarter. I'll now turn the call back to Michael. Thank you, Tom. As you may know, Hugh Clark left Allied recently to join a private equity firm. We've divided his responsibilities among two exceptional young leaders at Allied, both of whom will report directly to Cecilia when she takes on the role of CEO on May 2nd. John Lindsay, our VP Development, will oversee development and construction activity in projects where users don't take occupancy until completion. The Well in Toronto, is a great example of such projects. HRVP Construction and Technical Services will oversee construction activity and projects where users occupy a significant portion of the leasable area on a continuous basis through the construction process. 1001 Rivera Barraza and the RCA building in Montreal are great examples of these type of projects. Each of John and Hersha was trained as an engineer. Each has made a significant contribution to our business and is an integral part of Allied's next generation of leadership. Other integral parts of the Allied leadership team will report directly to Cecilia when she takes on the role of CEO. Anthony, of course, will do so as our CFO. Individuals who currently report to Tom will also do so, specifically Tim Lowe, our SVP leasing, and J.P. Mackay, our SVP national operations. This will allow Allied to evolve in the optimal manner going forward. As you'd expect, Cecilia will conduct our next conference call as CEO. Nathanie, JP, Tim, John, and Hersha will contribute to the call going forward. I'll also be on the call, but I promised Cecilia and the team that I'll talk much less. And against all odds, I assure you, I will keep my promise. I hope this has been a useful and comprehensive update for you. We'd now be pleased to answer any questions you may have.

At this time, I would like to remind everyone in order to ask a question, press star, then the number one on your telephone keypad. Your first question comes from the line of Lauren Calmar from Desjardins. Your line is open.

Thanks. Good morning, everyone. Just one quick one on the UDC and then I promise I'll leave it. You guys are obviously pretty far down the road. When are the final bids due and roughly when is closing expected?

We've said all we're going to say on the process.

Can't blame the guy for trying. And then looking at developments, the Adelaide and Duncan costs were up quite a bit quarter over quarter. Could you maybe give some color on what drove that?

Yes, I'm happy to do that. But roughly half of the increase in the cost relates to capitalized interest from the later completion date, and the rest is just higher costs relating to the delayed completion.

Okay, fair enough. And then sounds like you guys have a lot of good leasing momentum across the portfolio. Obviously occupancy took a bit of a dip this quarter. Any expectations for where you expect it to shake out at the end of the year?

Well, we're certainly projecting an increase between now and the end of the year, and it'll be – it's very difficult to predict exactly, but we'll be in the low 90s for sure.

Oh, that's – okay, that's great. And then last one from me, kind of in the same vein. Any other known non-renewals coming down the pipe? I'm sorry, I didn't hear that. My apologies. Any other known non-renewals expected?

There are two that come to mind. One in Calgary for about 70,000 square feet and one in Toronto for about 45,000 square feet.

And we're working on those right now.

Okay, fantastic. That's all from me.

Your next question comes from a line of Jonathan Kelcher from TD Cowan. Your line is open.

Thanks. Good morning. Just following up on Lauren's last question there, the two non-renewals, what quarter would they come off? Q2, Jonathan. So they're empty now or they come off for Q3? They come off for Q3.

Okay.

Okay. And then on the sublease space, it did jump up quite a bit in the quarter. Was that something that happened post the banking issues in the US or was it sort of just a steady climb throughout the quarter?

No, the bulk of it was Shopify. Shopify space came on the market in Q1.

Okay. And on that, is there any update that you guys can give on that?

No.

Okay. And then last one for me. Just on the leasing, sounds like you're obviously very active this year. Has there been any change in the TI requirements that tenants are looking for?

No change in the last six months or a year. Okay. Okay. Thanks. I'll turn it back.

Your next question comes from a line of Munish Garg from Laurentian Bank Securities. Your line is open.

Hi. Good morning, guys. Just a follow-up on the sub-leasing question. So I was wondering if you could share your views on what you are currently seeing so far in the Q2 on the ground. in terms of sublet space in downtown Toronto? And what are your scenarios for 2023 for both the market and as well as Allied?

I think the best way to answer that question is we are not seeing any new sublease space of consequence in our portfolio following the Shopify announcement, which I believe was either late last year and hit our numbers, if you will, in the first quarter. We're not seeing anything new of consequence in our portfolio to date. I think there have been sublease spaces come on the market in downtown Toronto, especially in the south quarter, if I'm not mistaken. It is relevant. it is not particularly consequential to us because we don't compete directly with that space in any way, shape, or form. And because the well is, for all practical purposes, now focused.

Okay, great. Thanks a lot, and I'll turn it back.

Your next question comes from a line of Hemi Burke, RBC Capital Markets. Your line is open.

Thanks. Good morning. Just maybe on the occupancy, can you talk about the interest that you've received to date on the space at, I believe, the tannery and the potential timing of releasing there? And then same question on the Lougheed building in terms of the timing of a lease on that site. Okay.

We're in negotiations with a group for them, Henry, that if we're successful, rent will commence in early 2024. Sorry. Just after that. With respect to the Logie building, too early to say.

Okay. And then just on that tenant that you're in talks with at the Tangerine, would the rent be comparable or how would that compare to the prior tenant?

It's actually higher.

Okay. And then just on the renewal leasing spreads, they did come in better than I think we've seen in a bit. Can you just provide some context on the drivers there and was that regional related or tenant specific or any call that you can share?

A lot of the deals were done in Toronto in that quarter. So that makes a big difference.

Okay. And then just in terms of Tour Vigee with some of the leasing that's in the work, what point do you expect that property to reach stabilized NOI?

Well, we... I hope we expect to complete leasing of the building this year and rent commencing for the deals that we're doing July of next year. Got it. Okay, last one for me.

Just, you know, where are you seeing some of the stronger sources of demand? It sounds like, you know, from an educational user standpoint, there seems to be some good activity there. and just any other sort of indications you can provide. And then just lastly, the tour activity. I'm just curious if that picked up in April so far on a year-over-year basis.

I haven't seen the statistics for April yet, but I imagine the tour activity remained very, very good.

With respect to the types of uses, it's still a mix, but educational uses would have to be top of the list at this stage of the game. There's still a lot of tech interest. We've got some financial services interest. We're working with a few retailers for their office space.

It's a mix. Thanks very much. I'll turn it back.

Your next question comes from the line of Matt Cornack from National Bank Financial. Your line is open.

Hey guys, just a quick one with regards to tenant retention. We've spoken about the potential on vacant space and it seems like it's fairly material, but can you speak to kind of the trend on tenant retention?

Well, it's definitely lower in the first quarter than our normal level of retention and maybe even lower than the new normal. Normal for us is 75%. We certainly didn't achieve that in 2022, and we don't expect to achieve that in 2023. I think our internal forecast for 2023 calls for somewhere around 65 to 70% retention. And that forecast, if you will, assumes the non-renewal that had the greatest impact on Q1, which was the non-renewal in the Tannery and Kitchener. So I think this quarter it was 58% or so retention. That's lower than we expect for the year. And that's driven by an unusually large non-retention.

Okay, so it sounds like outside of that and then the two mentioned previously in the call, your expectation is that most tenants are going to keep their existing space and maybe beyond that, are you still seeing tenants expand into new space within the portfolio?

Oh, that continues certainly, especially in Montreal.

Okay, that makes sense. And then just with regards to, I saw Telesky is on the residential component getting closer to a stabilized level. And then you've got Adelaide and Duncan that you'll be delivering. And I think some of those numbers were taken up, I should say, in terms of the NOI contribution. I presume that's related to the expectation on the residential. But can you give us a sense, financing-wise, at what point you'd potentially look at putting CMHC insured debt on those assets or if that is something that you're considering in the future?

I don't know whether either of those assets would qualify for CMHC financing in this environment. Certainly, we have not assumed in our thinking that we would be eligible for that kind of financing. and we have rather considerable flexibility in terms of how we finance those assets going forward. I think our current plan as allied is to fund them with our own resources as opposed to placing first mortgages on them. Our private partner in both instances may need to use conventional first mortgage financing. And there are, of course, mechanisms which will allow it to do that. But our current plan is to use our own resources with respect to repayment of the construction loans on those assets. Well, actually, more precisely on 19 Dunkin, there is no construction loan or allied on telescope.

Okay, that's a fair point. And then I guess with regards to capital allocation and the balance sheet, obviously the deal we're not speaking to on the call will have a big impact, but is there anything else that we should think of in terms of potential disposition activity or just the changes in the capital stack and access to financing? It's been a big theme south of the border, but it doesn't seem to be as big of an issue up here.

There will be nothing material, Matt. We may sell a small asset in Montreal that is very much non-core. We may sell a small asset in Toronto that is less non-core but isn't part of any existing concentration.

from a capital recycling perspective. Okay, fair enough. Thanks, guys.

Your next question comes from the line of Gaurav Mether from IA Capital Markets. Your line is open.

Thank you, and good morning, everyone. In terms of leasing strength, can you discuss if there's any noticeable change in leasing conversion times? and if tenants are any closer to pulling the trigger on the space requirements as compared to the previous quarters when you say leaving strength leasing pardon me leasing strength yes i'm just wondering if you know there's a change in tenants sort of pulling the trigger as far as you know the space requirements are concerned and if that conversion time has now decreased or if it's increased in any manner?

Well, they're certainly taking more time to make a final decision than they were perhaps up until the third quarter of 2022. But the good news from our perspective is these entities are ultimately making decisions. And they are ultimately taking down space. Our preference, of course, is that they take it down with Allied. And we are, as always, getting way more than our fair share of the demand and the concluded transactions in our key markets. But it's definitely taking people longer. And I think there are two very good reasons for that. there are probably a wider array of options open to them now than there has been historically. And second, there is continuing anxiety about where the economy is going, which is causing decision makers to be more careful, more thoughtful about the decisions they make going right up to the board level. So to summarize, there is no question it is taking users longer to conclude transactions. But there's also no question that they are ultimately concluding transactions. And I attribute it not at all to the whole working from home thing, but rather to the fact that people are concerned and uncertain as to what is going to transpire in our economy in the coming 12 to 18 months. And I don't think there's any other explanation for it, and it's entirely logical, and it is what we have always seen in an environment such as this one, where there is concern about a possible downturn in the economy.

Okay, great. Thank you for the color on that. And just as a segue into my next question, given the macroeconomic environment, are there any read-throughs from the collapse of Silicon Valley Bank on the tech and life sciences tenant base in your portfolio?

Yeah, very good question. And there is absolutely none.

Okay, great. And just lastly, when you're thinking about fair value adjustments, what seems to be the toughest part for you to estimate in the current environment?

I think the most difficult part of a discounted cash flow analysis is the time required to address turnover vacancy, and the rental rates. And those are the very, very large variables in a discount and cash flow analysis. So those are the hardest for us. I'm very glad we do it on a quarterly basis. And I do think to the extent there's variation in our IFRS values, whether positive or negative, which was the case this quarter, it will revolve around our estimate of rental rates in the relevant market and our estimate of the time that will be required to fill vacancy, or put differently, the duration of turnover vacancy.

Okay, great. Thank you for the call, Michael. I'll turn it back to the operator.

Thank you. Your next question comes from the line of Dean Wilkinson from CIBC. Your line is open.

Thanks. Morning, everyone. Michael, does the proposed changeover from a closed-ended trust to an open-ended trust serve to ameliorate any potential tax implications from asset sales?

No, it will not have any impact, positive or negative, on the tax implications from the sale of the UDC portfolio.

Okay, so it's just lining up with basically everyone else's structures out there. Exactly. And another change that you've put in there, and maybe I'm reading a little too much into it, is the ability to do stuff down in the U.S. Could we read that as a reflection that you might be looking south of the border, seeing some massive price dislocations, and office properties down there and you see some attractive opportunities or is there something else in that amendment?

Well, I mean, my answer to your question would be potentially yes, but let me be very clear. It would not be yes in the near term. It would be to put Ally in a position where it could consider expanding its geography But I want to say, Dean, unequivocally now, we have no intention to expand into the United States. I do hope in the fullness of time, allies can evolve in a way that would make it worthwhile to consider expanding into major cities in the United States of America and potentially even elsewhere. But we're a long way from that point in time. And as I've said for years now, we have so much opportunity in Canada that looking further afield would almost be a misallocation of capital today. But I sincerely hope, and I hope I'm still involved with Allied at that point in time, that we can rationally allocate capital to expansion beyond Canadian cities, but we're nowhere near that point in time as we sit here today. But having a structure that facilitates that is only in our interest, so we don't have to rush back to our unit holders on a transactional basis and seek modification.

That makes perfect sense, and it sounds like Cecilia is going to rack up a lot of frequent flyer miles. That's it for me. I'll hand it back. Thanks.

Your next question comes from the line of Mario Sarek from Scotiabank. Your line is open.

Good morning. Just a couple of quick ones on my end. The first one for Tom, the comment on occupancy, I guess, by the end of the year in the low 90% range for sure. Just want to clarify whether you're referring to economic or lease. Okay, and then every quarter or so there's some puts and takes in terms of assets going into PUD, coming out of PUD. So in the context of that comment, or just generally speaking going forward, is there a range or a number of properties, GLA, that you expect may come into PUD over the course of the year? based on planned value-add initiatives?

Mario, I can't think of anything off the top of my head that will move from rental to PUD in 2023. I really can't. I think to the extent that was done, it was done appropriately, and it was done in either 2022 or perhaps to some limited in Montreal. But I can't think of a single instance where that will occur over the remainder of 2023. Got it.

Okay. One technical question on the UDC, not necessarily specifically on the UDC, but just from an accounting perspective. The IFRS fair value was flattish quarter over quarter. Again, from a technical perspective, would that value that was disclosed incorporate the first round of bidding that transpired on March 24th?

Would it take that data into consideration?

It incorporates everything relevant to making a sound and responsible judgment about the value of our UTC portfolio.

Okay. One last maybe quick one on my end. You mentioned that the FFO per unit for the quarter was below internal forecast and you kind of highlighted the lower capitalized interest and so on and so forth, but AFO per unit was above internal forecast. Can you reconcile the two for us in terms of what benefited AFO per unit as opposed to FFO per unit this quarter?

Yeah, happy to answer that. It's really the timing of capital that would have affected the AMFO, so that would be it.

Okay. That's it for me. Thank you.

And we have a follow-up question from the line of Pammy Burr from RBC Capital Markets. Your line is open.

Thanks. Yeah, just a quick follow-up on the data centers. The drop in the NOI from Q1 versus Q4, was that entirely or predominantly driven by the vacancy that you indicated back with your Q3 results last November that was expected? I think that took hold in November. Just wanted to clarify that.

Yes.

Great. Thanks very much.

And I will now turn the call over to Mr. Michael Emery for some final closing remarks.

Thanks again, Rob. I hope this has been a useful and comprehensive update for all of you. Thank you for taking the time to participate in this call. We look forward to the next one where, I repeat, I will be largely silent. Thanks very much.

this concludes today's conference call thank you for your participation you may now disconnect