Allied Properties Real Estate Investment Trust

Ladies and gentlemen, thank you for standing by and welcome to the Allied Properties REIT second 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, please press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. Thank you. I would now like to turn the call over to Cecilia Williams, President and CEO. You may begin your conference.

Thanks, Josh. Good morning and welcome to our conference call. I'll be presenting briefly on the second quarter and I'm joined by Nan and JP to answer questions. Michael is also here with us. We may in the course of this conference call make forward-looking statements about future events for future performance. These statements by their nature are subject to risk and uncertainty that may cause actual events or results to differ materially. Including those risks described under the heading risk and uncertainty in our 2022 annual report and our most recent quarterly report. Material assumptions that underpin any forward-looking statements we make include those assumptions described under forward-looking statements in our most recent quarterly report. Our second quarter was positive operationally. Demand for our space remains strong as indicated by tour activity. We also leave significantly more space than last quarter. And net rent for occupied square foot continues to increase up from last quarter to $23.51. Higher interest expense and longer lease-up timeframes resulted in lower-than-budgeted same math and NOI, FFO, and AFFO per unit in the first half of the year. Although temporary, as interest expense will materially decrease going forward with the pay down of $1,000,000 of debt, our results for the year have been impacted, moderating our outlook. The good news is that we continue to see demand for arts-based products. with tour activities continuing to increase. Closing of a UDC transaction will be liberating in many ways. Operationally, the entire team will now be focused on running the workspace portfolio. Financially, we'll be able to meet obligations while barely using our lines through 2027. Our debt metrics will also continue to improve as our development completions turn economically productive. Our fourth annual EST report was released on June 26th. I'm pleased with the progress on our plan to net zero carbon, including establishing an internal cost of carbon to support internal decision making and forecasting. More details on our progress will be disclosed in next year's report. My confidence in our long term outlook remains strong. Our portfolio has performed well over the last three and a half years of upheaval and will continue to do so through the current headwinds because ultimately we have the space that people want. More importantly, our team has never been stronger, more focused, or better integrated. I hope that was a helpful update. We'd now be pleased to answer any questions.

At this time, if you would like to ask a question, please press star followed by the number one on your telephone keypad. Your first question comes from the line of Jonathan Kilcher with TD Cowen. Your line is open.

Thanks. Good morning. Good morning. First, I guess just on the tourist facility, you talked about them being up year over year and quarter over quarter. On the quarterly change, how much of that, if any, is seasonality Q2 versus Q1?

It's hard to tell because we had actually a pretty strong Q1, and so I'm not sure. There doesn't seem to necessarily be a huge seasonal impact, to be honest, Jonathan, that we picked up on from a tourist perspective.

Okay. And then year over year... How would that, the number of tours, how would that compare to a stronger office market that we saw pre-COVID?

I think this quarter is representative of what we would have seen in a stronger office market. The average tour that we had over the last three and a half years is about $219 per quarter. This quarter we had $292. The tours were up in each So above the quarterly average in Toronto, in Vancouver, and in Calgary, with Montreal being at the quarterly average.

Okay, that's helpful. And then just switching to, you called out the castle as a non-renewal there for the bump in vacancy this quarter. And I think that is an intensification property over time. Can you maybe give us a little bit more color on that? Were you hoping to get this vacancy, or will you be looking to put in a short-term tenant? How should we think about that playing out?

If we had an opportunity immediately, we would have filled it. It's not a current-day intensification, but something that would be in the medium to longer term.

Okay, so you'll look to fill that with a short-term tenant, I guess?

That's fair. Yep.

Okay. I will turn it back. Thanks.

Thank you.

Your next question comes from the line of Lauren Kelmer with Desjardins. Your line is open.

Thanks. Good morning. Good morning. On the guidance, you referenced a couple of things that drove the revision and guidance. Was there anything different that's changed in your outlook from when you initially issued the guidance to present day?

No, just when we originally issued the guidance at the end of January, it was based on a different interest expense or cost of debt outlook than what

materialize in the first half of the quarter now that'll be addressed in the second half as we pay off a billion dollars of debt um so that would be the the main difference okay yeah the paid off billion dollars of debt will definitely help um and then i believe last quarter you mentioned um the goal of trying to get to around 90 committed occupancy by year end do you think that's still achievable we're targeting to finish the year with a higher lease area than what we started that's

That's always been the goal and we're still targeting that.

Okay, fair enough there. And then one other kind of ticky tacky one, I noticed the TELUS Skyloan was extended for a year. Could you maybe give some colour of what was behind that?

It's just finishing up the upgrade, sorry, the development and the residential component.

Yeah, and actually it is a loan to our partner. It is not a loan to us, so our partner has extended its facility allied that has no debt in relation to Telesky, nor does TELUS itself have any debt in relation to Telesky. It relates solely to our development partner, West Bank.

And it's not indicative of anything, maybe broader issues at West Bank. It's site specific. No, it is not. Okay, great. Thank you so much for the call.

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

Hey, guys. Just quickly going back to the occupancy side of things, you in the press release provided a fairly sizable list of leasing velocity that you've done, and Montreal seems to figure pretty prominently. I know there was some vacancy there. But is that a market where you're still expecting kind of to pick up some incremental occupancy? And then with regards to maybe the tannery, is there any news on that space?

Yes, on the Montreal, absolutely expecting to pick up occupancy there. And tannery, we are currently in negotiation with the user looking to take a significant amount of space.

Okay. Thank you. And then on leasing costs, TIs and leasing costs particularly, and it looks like renewal space more so than new leasing has picked up a bit over the last couple of quarters. Is there anything to that or is it just specific to the space that's being leased at this point?

It's specific to the space, Matt. If it's a space where the user has been in place for some time, it's time for it. for more work to be done, so to speak. So it is very much space specific.

Okay. And then the last one for me, I noticed in your commentary, you highlighted something that I think most of us know, but that you own one of the largest urban land banks. It's economically productive, but you mentioned mixed use density potential. If you could kind of give us a sense as to whether your thought has changed on the office versus residential component of that mixed-use density potential, and then maybe on the potential to monetize any of that in the near to medium term, or if you plan on building it out yourself.

Matt, it's Michael. No, we have not shifted or altered our focus on distinctive urban workspace. And we have always believed that mixed use intensification of very expensive land in the inner city is the best way to realize value. The well-being, probably the most spectacular example of that in our history. And going forward, we see the same thing. We will not develop condominium residential space King Toronto as an exception, not the norm, but we're very prepared to have mixed use retail office and rental residential on appropriate sites in the inner city. And no one owns more appropriate sites for that in the inner city than Ally. So it doesn't reflect a shift in our emphasis. It will always be on the state of urban workspace. But we have always recognized, going as far back as about 2012, that the best way to intensify high-value urban land in Toronto and elsewhere is with a mixed-use format. We will get more support from the municipal authorities, we'll get more support from the market, and we'll be able to create something that is more durable over time which is why we want it to be rental residential to the extent there is a residential component.

And just with regards to the residential rental, is that something, again, this is probably not imminent, but something that you would own yourselves and manage or would you like to have a partner?

We might have a partner to manage, but we would absolutely own our proportionate interest or entire interest in rental res. We are very pleased with the rental component of Telesky. We're happy to own that indefinitely. The rental component of 19 Duncan, which will start to fill up either late this year or early next year, will be an astounding asset. We'll own 50% of it for all time. So I think it's a very good asset for us to own in a mixed-use urban development. We won't go out, I can't imagine, and simply develop rental residential buildings, but we're very happy to own rental residential components of mixed-use urban development.

Makes sense. Thanks, guys.

Your next question comes from the line of Gares Mathur with IA Capital Markets. Your line is open.

Thank you, and good morning, everyone. Just on the leasing front, are there any non-renewals that you see coming up over the next few months across the portfolio?

Nothing of significance. We're already in negotiations with the leases coming up in the next 18 months, and most of them will be renewing.

Okay, great. And just as a follow-up to that, you know, on the positive renewals leaving spread this quarter, could you perhaps provide some color on what's driving that and how do you see that trend over the future?

We expect to continue having a higher level of renewals. As you know, we had a low level in 2022, primarily driven by the one non-renewal

in kitchener but we expect to be closer to our historical rate of 75 to 80 percent uh renewal rate this year okay okay fantastic and just lastly and this is a this is a broader macro question uh on your guidance trim um as you trimmed your guidance you know how much should you factor in you know the stubborn work from home uh that you're seeing in the mtv cities versus being in a negative economic cycle?

What we took into account, Gaurav, were two, I guess, opposing forces. One is the temporary impact with the higher interest rates in the first half of the year, which we will be more than offsetting in the second half when we get off debt, combined with the lengthening lease-up timeframes. parallel with our high level of tour activity, which we consider to be the leading metric, leading indicating metrics, means we are still very confident that the lease deals will come. It's a matter of time. So nothing really from a work from home perspective, because what we're seeing is more and more, or what I should say is increasing levels of physical reoccupation across our portfolio, across the country, and not just in our portfolio, but in all of the higher quality states across the country.

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

Your next question comes from the line of Tammy Burr with RBC Capital Markets. Your line is open.

Thanks. Good morning. Maybe just building on the last question and the comments there, just Again, just given maybe the resilience that we have seen in the economy and labor markets, are you noticing any shift in the tone with your tenants in terms of the leasing discussions? And is there perhaps any concern over a recession still weighing on space needs or maybe the timelines it's taken to commit to space?

It's really more around the macroeconomic uncertainties causing, I guess, longer decision-making timeframes. But no concern in terms of people believing that they no longer need office space. They still need it. It's more a question of whether it's the same amount or modestly more, modestly less. But we're still seeing great demand from tech, from educational uses, and from medical services. So, behavior that's consistent with being in this part of the cycle.

Okay. And then just on the Shopify sublease space, any update there on where that stands or progress on releasing it by Shopify?

I'll say, Tommy, that we're pleased with how things are progressing there, and I can't really comment any further at this point.

If there was a tenant of significance, like an interest in a big chunk of the space, in that type of scenario, would you engage with that tenant directly or is it too early to say at this stage?

Not to interject unduly, but we have found over a very long period of time that no large user will sublease space, they will always want to deal directly with the owner and that will certainly be the case here. There is almost no possibility of a large user subleasing from Shopify. They will want to be in direct contract with the owner and the owner will be quite prepared to enter into direct contract with good replacement users. And that would work to the benefit of both the owner and shopper by overtime. That's how I think this will unfold. Almost certainly, that's how it almost invariably unfolds, especially with large space, which we've dealt with on many instances over the years. So there's no question as to how this will unfold. It's just a question of when and with whom. And we will work. collaboratively with Shopify to achieve a result that is good for both the owner and the original. And we will be successful in doing that.

Got it. Okay, and then just one last one for me. Looking at the, I guess, the intensification pipeline that you disclosed in your MD&A, I think it's on page 68. I think you've disclosed the value of roughly $700 million, but what sort of NOI are these properties generating? I believe at some point early last year, you stopped disclosing the sort of annualized NOI. I'm not sure what maybe the reason was, but if you have any update on that, that'd be helpful.

I think the reason we would have stopped then, Tommy, was because of the uncertainty that in the market with respect to future demand for office space, with respect to construction costs, with respect to just about everything relating to development. So it was probably more speculative than it had been previously. And I think we would be reluctant to do anything other than give that very general orders of magnitude in the future if we do it all. I think that the more is there's extraordinary existing intensification potential how valuable that will be and how much value we can drive into that you know five ten years out I don't think is worth speculating about at this juncture

Oh, yeah. Sorry, Michael. So my question was more so on the NY that's currently in place on those assets. That's the piece that was no longer disclosed. Is that what you were referring to?

I don't have that number handy, Tommy, but you can probably assume it's a similar kind of portfolio-wide cap rate and apply it to... I don't have that number handy. We decided not to disclose it because we don't think it's useful information.

Okay. I'll turn it back. Thanks very much.

Our next question comes from the line of Dean Wilkinson with CIBC. Your line is open.

Thanks. Good morning, everyone. Quick question, Cecilia. On the new leases, are you utilizing more third-party brokers? Just noticed a big uptick in the leasing commissions there and just wondering if that's coming from external or internal sources.

We are using, in some situations, more third-party brokers, yes.

And then from the landlord's work perspective, would that just be taking some older space similar to the improvements you had to do for the renewals, like site-specific, or was that also an indication of general requirements in the market?

No, absolutely site-specific.

Great. That's it. Thanks.

Thank you.

Your next question comes from the line of Jenny Ma with BMO Capital Markets. Your line is open.

Hi, good morning, everyone. Hi, Jenny. Just wanted to go back on the Subly space with Shopify. When it comes to space of this magnitude, like how is Shopify involved in the process? Like is it everyone has a representative and you bring, you know, there's three parties at the table in discussions and is it possible that if you do find a user not to take up the whole space that at some point Shopify can exit out of the whole lease and no longer be involved going forward.

It invariably involves, if you will, the three parties you identified. They may or may not be represented, but they usually are. And yes, at the end of the day, if the transaction works out as best serves the interests of all involved, the original tenant is allowed off the hook and has that obligation behind them. Obviously, the owner is only prepared to do that when it gets an equivalent covenant or an equivalent quality covenant. We've done that in many, many instances where it's worked out really well for us as owner and really well for the original tenant or user. party can enter into direct privity of contract with the owner is if the original tenant is effectively relieved of its responsibility. Obviously there's economics involved in all of that, but it's a very workable arrangement and it's invariably in the interest of all concerned. The original tenant gets rid of a contingent, well a very real and contingent obligation the new tenant is very happy to commit to the space with the owner, and the owner is very happy with the coming to the new tenant. So that is how it will evolve. And yes, to answer your question, at the end of the day, Shopify will be able to put this behind it, and the owner will be in at least as good a position as it was in with the original tenant.

right so the ability that for shopify to get off the hook is really at your discretion then right to your satisfaction however the discussions play out absolutely we have no obligation to enter into direct contract with a new tenant that we will do that in an effort to help our existing tenants and to enter into a relationship with the new one

which is why we've always said when we're in a situation where good space is on the sublease market without being sort of self-satisfied, arrogant or overbearing, we are in control.

Okay, great. I have a housekeeping question related to the GNA. It looks like in this quarter there was some capitalized related to the sale of the UDC portfolio. So, I'm just wondering, is the delta the difference from Q2 to Q1, the piece related to UDC? And is there going to be any more of that coming through for Q3?

The delta is, and there will be minimal amount beyond Q2.

Okay, so it's mostly expense in this quarter then? Yes. Okay, perfect. Thank you very much. That's it for me. Thanks, Jenny.

As a reminder, if you would like to ask a question, please press star followed by the number one on your telephone keypad.

We'll pause for just a moment to gather any remaining questions. There are no further questions. I'd like to turn the call back to Cecilia Williams for closing remarks.

Thanks for joining our conference call. We'll keep you updated on our progress going forward.

This concludes today's conference. Thank you for joining. You may now disconnect.