Choice Properties Real Estate Investment Trust

Good morning, and welcome to the Choice Property Real Estate Investment Trust third quarter 2022 earnings. My name is Colby, and I will be your conference operator today. Today's call is being recorded, and all lines have been placed on mute. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. I would now like to hand the conference over to your first speaker today, Erin Johnston. Please, go ahead.

Thank you. Good morning, and welcome to the Choice Properties Q3 2022 conference call. I am joined here this morning by Rayl Diamond, President and Chief Executive Officer, Mario Berrafato, Chief Financial Officer, and Anna Radek, Executive Vice President, Leasing and Operations. Before we begin today's call, I would like to remind you that by discussing our financial and operating performance and in responding to your questions, we may make forward-looking statements, including statements regarding choice properties objectives, strategies to achieve those objectives, as well as statements with respect to management's beliefs, plans, estimates, intentions, outlook, and similar statements concerning anticipated future events, results, circumstances, performance, or Exceptions that are not historical facts. These statements are based on our current estimates and assumptions and are subject to risks and uncertainties that could cause actual results to differ materially from the conclusions in these forward-looking statements. Additional information on the material risks that can impact our financial results and estimates and the assumptions that were made in applying and making these statements can be found in the recently filed Q3 2022 financial statements and management discussion and analysis which are available on our website and on CDAR. And with that, I will turn the call over to Rael.

Thank you, Erin, and good morning, everyone. To start the call, I'll provide a brief recap of our quarterly performance and cover the highlights of our transaction and development activities. Anna will cover our operational results, followed by Mario, who will conclude the call with a review of our financial results before we open the lines for Q&A. Through our remarks today, you will hear a common thread, and that is how well we are positioned to withstand the economic challenges that this environment may bring. I say this because we have a strong and talented team. Our core portfolio is stable, yet positioned for growth. Our strategic relationship with our major tenant, Love Law, is strong. Our balance sheet is rock solid, and finally, George Weston, our largest unit holder, is committed to supporting us as a long-term owner, manager, and developer of a high-quality real estate portfolio. Turning to our business, we delivered solid operating and financial results in the quarter. Our performance was underpinned by our team's consistent execution of our long-term strategy. We continue to deliver stable and consistent cash flows driven by the strength of our grocery anchored and necessity-based retail portfolio and the realization of embedded rent growth in our industrial portfolio. We further increased the quality of our portfolio through our capital recycling program. We unlocked significant value in our development pipeline, driving NAV growth, and we continue to manage risk and maintain flexibility through our industry-leading balance sheet. Looking at our operational performance, the strength of our portfolio and the hard work of our talented team is clearly apparent. With occupancy at 97.7%, we are near full in our retail and industrial asset classes. Our business once again delivered strong same-asset NOI growth of 3.4%. Normalizing for large, single-tenant industrial building in Montreal that we backfilled with Amazon, our same-asset growth was 4 percent. Moving to transactions, we continued to execute on our capital recycling program, completing 59.2 million of transactions, including 19.9 million of acquisitions and 39.3 million of dispositions during the quarter. On the acquisitions front, we completed the purchase of approximately 34,000 square foot anchored retail asset located in an established residential area in Toronto for $19.2 million. As part of this transaction, we entered into a new lease with Loblaw on the site with 15 years of fixed term. The site is a long-term covered land play given the location, mixed-use designation, and immediate area demographics. On the disposition front, we continue to focus on exiting offers as an asset class. and in the quarter completed the disposition of an office property in Montreal for $27 million. We have four remaining office assets which we plan to sell over time. These examples illustrate the thoughtfulness of our capital recycling program. While we remain active, we are currently in a period of price discovery with smaller bid pools being experienced across all asset classes. We are closely monitoring the market and seeing the impacts on pricing firsthand for both IPP and land transactions. Given our overall financial strength, we are not under any pressure to sell. We'll continue to sell when the time and price is right and acquire assets only when they increase the quality of our portfolio. That said, we expect that over the next few quarters, attractive opportunities will be unearthed in the current market, and we have the balance sheet to execute on these opportunities. We saw NAV growth in the quarter, primarily from the advancements of our development pipeline. We invested $55 million of capital in development and unlocked value by achieving key zoning and entitlement milestones at two of our development projects, Tullamore, an industrial development in Calgary, Ontario, and Golden Mile, a mixed-use development in Toronto. First, on industrial. Last quarter, I spoke about the size quality and growth potential of our industrial portfolio, including our ability to significantly increase the size and value of our $3.3 billion income-producing portfolio through development. Industrial fundamentals remain strong. We have seen this firsthand through the significant rental growth we have achieved on industrial renewals in 2022. In the third quarter, we demonstrated our ability to create value through our industrial development pipeline. Our 7 million square feet industrial development pipeline is now fully zoned and we continue to advance our active developments. At Tullamore, we hold an 85% interest in 380 net developmental acres. We achieve zoning in the quarter. This zoning allows for development of a warehouse distribution and industrial uses totaling over 6 million square feet and unlocks significant value on the site. As a result of achieving this zoning milestone, we recorded a fair value gain of approximately $204 million. We have assembled the land at Tullamore at a cost of approximately $740,000 per acre, or totaling $281 million at share. Based on the current zoning and market transactions, Our current I4S value is $1.6 million per acre, with a total value of approximately $515 million at share. We expect to recognize further value on this development as the project progresses and expect to start grading the site by the end of 2022. With zoning achieved, our partner and leasing team are actively responding to RFPs and seeing increased interest in the site. Now, starting in East Guinevere, Ontario, we made progress in the quarter on our 75% interest in 154 acres of fully zoned industrial land. As we discussed on a previous call, Loblaw has entered into a land lease and plans to build a 1.2 million square foot distribution facility on the first phase of the site. During the quarter, the foundation permit for the first phase was issued and the pad was delivered to Loblaw. Novlois started construction with rent commencement in Q1 2024. We expect an initial yield of between 6.5% and 7% on this first phase. Moving to our mixed-use development pipeline, we also achieved zoning in the quarter for approximately 19-acre Golden Mile development in Toronto. The current redevelopment plan contemplate a large mixed-use master plan community to be built in phases with a focus on high density residential and rental units. Working with our partner Daniels, we're on track to be the first development in the Golden Mile area. Assuming favorable market conditions, we will be in a position to commence the first phase of the project in approximately 18 months. Lastly, our balance sheet remains strong. We entered the quarter in a strong liquidity position with approximately $1.3 billion of available credit under the trust revolving credit facility, a $12.2 billion pool of unencumbered properties. I'm now going to pass the call on to Anna to discuss our operational results.

Anna? Thank you, Rayl, and good morning, everyone. As Rayl mentioned, we once again delivered strong operational results. We remain near full occupancy, ending the quarter at 97.7% occupied, an increase of 10 basis points compared to last quarter. During the quarter, we had approximately one and a quarter million square feet of lease expiry, and we renewed 577,000 square feet of them. And we completed 710,000 square feet of new leasing commencing in the quarter. resulting in positive absorption of 33,000 square feet. Turning to our asset classes, our approximately 44 million square foot retail portfolio, which consists of open-air centers with necessity-based tenants, continues to show strength. Demand for retail space is high. Consumers want immediate access to products, and retailers realize e-commerce sales require the support of bricks and mortar. Our tenants are optimistic as they look ahead, with various retailers actively looking to expand and spend capital renovating existing locations. We continue to benefit from the demand driven by retailers' desire to be located in our centers alongside quality anchor tenants. Many key retail categories, such as discount banners, pet food, QSR, and financial services, to name a few, continue to have a strong appetite for retail space, both looking to grow their store networks and improve it through expansion and relocating to better centers. Our retail portfolio occupancy once again continued to strengthen, increasing 20 basis points to 97.7%, with positive absorption occurring in almost all major markets. We completed 423,000 square feet of renewals in the quarter, resulting in tenant retention of 90%. Renewals were completed at rent, 2.5% above expiry, as 50% of the renewals this quarter occurred in our 5.2 million square foot power center portfolio. While in our 22.4 million square foot neighborhood center portfolio, we saw stronger rental growth, with the renewals completed at rent 5.3% above expiring rents. We report rental rate spreads only on leases that expired and were renewed in the current quarter, with most lease deals in a given quarter being executed six to 12 months earlier. This quarter, we had several lease extensions take effect that were done at lower rents as they were negotiated during COVID as part of rental assistance packages. such as a deal with an 80,000-square-foot cinema. In the current market, our team is completing lease deals at spreads much higher than those seen in Q3. These will take effect in future quarters. In the quarter, 49,000 square feet of space was vacated at an average rent of $17.07. 90,000 square feet of new retail deals commenced in the quarter at an average rental rate of $21.50. Turning to our industrial portfolio, industrial market dynamics remain solid. The national availability rate remained at an all-time low in the third quarter, holding at 1.5%, with nearly all markets having availability rates at or near 10-year lows. Year over year, Calgary and Edmonton have recorded the greatest contraction in availability. Asking industrial net rental rates grew year over year, by 29.4% to $12.89 per square foot, a record high increase. Increases were seen across all markets driven by high construction costs and the scarcity of large-rate product, which demands even higher rent premiums. Our industrial portfolio is fully occupied, with occupancy at 99%. We had 687,000 square feet of industrial leases expire in the quarter, of which a single building accounted for 600,000 square feet. As we have discussed in previous calls, this building was leased to Amazon in advance of the previous tenant vacating for a 10-year term at rents 100% higher than the previous tenant's expiring rent. We also secured annual rent steps of 2.75% throughout the term of the lease. In addition to this deal in Montreal, we completed a second deal with Amazon in Ottawa. The deal was done at a strong market rent, also with 2.75% in vetted annual rent steps. Both deals commence in September of this year, and Amazon begins paying rent in November once they complete fixturing. With respect to the balance of the expiries, We renewed 46,000 square feet of space in Western and Atlantic Canada at rents 5.5% above expiry. There were no lease expiries in Ontario this quarter. We have significant embedded rental rate growth in our industrial portfolio and continue to see lease deals across our entire industrial portfolio at rents well above current in-place rents. Our current average in-place industrial rent is $8.25 per square foot. Looking at residential, demand for rental residential continues to increase. National vacancy is at a multi-year low of 2.9%, and average rents continue to rise. Our rental residential portfolio consists of three stabilized assets, which ended the quarter at approximately 98% lease. Our two newest assets, the Brixton and Liberty House, located in the West Queen West and Liberty Village neighborhoods, are 87% occupied, resulting in a combined average occupancy rate of 91.4% across our residential portfolio. Subsequent to the quarter, we also concluded a 10-year deal with Sonder, a global apartment hotel operator, for 40 suites. This deal generates annual rent of over $1.3 million, or $4.53 per square foot, with contractual 3% annual rent increases. We completed this deal at the Brixton. We had minor landlord work to complete and anticipate rent for all the units will commence by January of next year. The residential portion of the Brixton, consisting of 350 units, has now reached stabilized occupancy of 98%. We expect to reach stabilized occupancy at Liberty House by the second quarter of next year, if not sooner. Across our entire portfolio, we have limited leasing exposure for the balance of 2022, with committed renewals and new leasing exceeding that of our remaining expiries. We are heading into 2023 with exceptionally well-occupied and in-demand necessity-anchored retail centers leased to strong Covenant tenants. as well as a fully occupied, high-quality industrial portfolio with significant embedded rental rate growth. Our portfolio will continue to deliver solid operating results and allow us to weather macroeconomic headwinds. I'll now pass the call over to Mario to discuss our financial performance.

Thank you, Anna, and good morning, everyone.

We are pleased with our solid financial performance in the third quarter. Our results reflect both the stability in our portfolio and the growth potential from strong industrial real estate fundamentals. Our reported funds from operations from the third quarter was 173.1 million, or 23.9 cents per unit. It was a very clean quarter with no significant or unusual one-time items. On a per-unit diluted basis, our Q3 FFO of 23.9 cents is in line with the third quarter of 2021. On a gross dollar basis, our funds from operations for the quarter increased slightly when compared to the prior year. Year-over-year increases in same-asset NOI were offset by higher borrowing costs and cash flow dilution from the allied transaction. And as a reminder, the foregone NOI from the sale of our office properties was only partially offset by distribution and interest income. Excluding the impact of the allied transaction, FFO growth over prior year would have been approximately 1%. Occupancy increased slightly in the quarter and contributed to our strong same asset results. Same asset cash in Hawaii increased by $7.4 million, or 3.4%, compared to the third quarter of 2021. By asset class, retail increased by $6.5 million, or 3.7%. The increase was primarily driven by higher rents on new leasing, contractual rent steps, and higher capital recoveries. The increase also reflects a reduction in bad debt expense of $900,000. One of our industrial buildings, Lisa Amazon, industrial increased by $1.6 million, or 4.8%. And this increase was driven on high occupancy and significant rent growth on renewals. And our mixed-use residential, another category, increased by $400,000, or 5.1%. Turning to our balance sheet, our IFRS NAP increased 3.4% to $13.06 per unit, an increase of $310 million over the last quarter. Our NAS growth was driven by fair value gains on investment and development properties, partially offset by a downward fair value adjustment on our investment and allied properties units, where we are required to drive for us to mark the market this investment to its trading price as of September 30th. Our fair value gains on investment properties of $344 million, representing an increase of 2.2%, were primarily driven by the progress on our future development pipeline and the strength of our industrial portfolios. In our future development portfolio, we continue to drive NAB appreciation as we move our assets through the zoning and approval processes. Our development gains in the third quarter reflect key zoning milestones we achieved at Telemore and Golden Mile. As Anna mentioned, industrial market dynamics remain strong. We continue to see our growth in our industrial portfolio with leases renewing at significantly higher rates with strong embedded growth. Our fair value gains reflect the impact of the strong leasing and cash flow growth. Looking ahead, we'll continue to evaluate our industrial portfolio valuations and incorporate the impact of any market transactions taking place subsequent to quarter end. With respect to our retail portfolio valuations, given the steps we took in the second quarter to reflect the current market conditions, no further cap rate adjustments were made during the quarter. We believe our valuations appropriately reflect the current market, including the pressure that higher cost capital is putting on real estate valuations. And turning to our debt maturities, we had minimal financing activity in the quarter. For the remainder of the year, we have a very manageable $105 million of debt obligations coming due, almost all of which are represented by construction debt that will be primarily refinanced with takeout mortgage financing, including CMXC financing. So we closed the quarter with strong debt metrics and ample liquidity. Our debt-to-ebitda ratio was and this is further supported by approximately $12.2 billion of unencumbered properties. So overall, our disciplined approach to financial management, including the steps we've taken so far in 2022, position us well to manage risk, maintain our distribution, as well as provide significant financial flexibility.

And with that, Rayl, Anna, Aaron, and I will be glad to answer your questions.

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.

We'll pause just for a moment to compile the Q&A roster.

Your first question comes from the line of Mark Rothschild from Canaccord. Your line is open.

Thanks, Dan. Good morning, everyone. Just focusing on the retail portfolio to start, the same property in Hawaii, I'm not sure if you mentioned, was there anything notable in the quarter that drove that number, and should we infer anything from that going forward?

Nothing unusual, Mark. It's a very strong quarter, and we know we're starting to get some impact with the industrial rents going up. Retail's been solid at NSF, and so no, I think the you know, for a bit.

And for the retail portfolio, what is driving that growth? It seems to have picked up. Is there anything notable there?

Just really, Mark, it's rental rate growth and higher occupancy.

Okay, great. Thanks. And then in the development assets where you had the value increase, can you just maybe give a little color on what happened in the quarter or this year that allowed you to get that value increase? And, you know, Bill, you mentioned as far as some other projects you have ongoing. Is this something that should continue to be material growth and value over the next year or two, or is it maybe just something that's going to happen periodically?

Hey, Mark. Thanks for the question. The most significant thing that happened in the quarter was the achieving zoning milestones at both Tullamore and Gautamal. As well as with Tullamore, industrial land has continued to trade up. So it's a combination of both achieving zoning milestones and where comparable land would be trading. You know, maybe Mario can comment on future quarters. I don't think you're going to see something as significant in future quarters with milestones achieved.

Yeah, exactly, Rael. So, Mark, where you have zoning milestones, you get that kind of one-time pop because now you have an undue use for that property that creates more value. Once you have visibility to leasing, you kind of get into a cash flow model, and then you'll just see gradual appreciation over time. So, really... of the one-time house.

It is important, also, Mark, even though you have zoning, you also have to be able to access the site. So both at Tullamore, obviously, we can access the site, and then at Golden Mile, you know, we have a phase that we can start construction on, as we said, over the next 18 months.

Okay, great. Thanks so much.

Again, if you would like to ask a question, press star, then the number one on your telephone keypad. Your next question comes from the line of Sam Damani from TD Securities. Your line is open.

Thanks, and good morning, everyone. Maybe just to get started again back on the retail leasing, which has been very strong and obviously driving strong same property NOI growth. Are you seeing any signs of changes in the leasing market, any lengthening of the conversion times to get leases signed? And if you have any comments on the Rona Lowe situation, do you see that causing any fallout as well?

Hi, Sam. No, I mean, we're seeing very strong activity across the retail portfolio with tenants, really looking for ready-to-go built sites. I think the development side has maybe slowed down in some areas, so we're seeing really strong demand and actually quicker turnover times because to the extent we have ready-to-go space. And then with respect to RONA, I actually see it as a good thing. There's someone coming in and investing in the business. We have long-term leases with Rona. And really, you know, some are currently not occupied, but there's talks of them reopening. And for those, if they don't, we actually have interest from other retailers where we could replace Rona and redemise the space.

Just also, Sam, to add a bit more comment, Anna can comment on the retail development. We have been working closely with Loblaw and Shoppers Drug Mart to particularly add pads in front of many of our stores, and I think we're doing five Shoppers Drug Marts at the moment. Is that correct, Anna?

Yes, we're doing five pads. We're still active in development, but from an overall supply perspective in the market, there is lower supply, which is also driving demand for Asbill products, kind of the point I was making.

Okay, thanks. And you mentioned the Loblaw store that was acquired and with a new lease signed, new 15-year lease signed. Did you identify the location? If you did, I missed it.

It was on Red Forest and Burnhamthorpe area in Etobicoke.

Okay, got it. Okay, good. Last question for me is on the development side. Again, congratulations on the zoning at Tullamore and Golden Mile. And it looks like, you know, those two have pretty good visibility of commencements, you know, I guess by 2024 perhaps. What steps do you need to achieve between now and then to actually be able to start to turn dirt on those projects, both on the projects themselves and also capital?

Yeah, look, I think on the industrial side, you know, There's not many more incremental steps. We have to obviously service the internal site, but we actually started to respond to RFPs. The market dynamics was still exceptionally favorable. On the residential side, we have a partner, Daniels. The first phase is going to be a combination of both purpose-built rental and condo. And as we are closer to the time, Sam, I think it's a combination of, you know, I believe in the pre-sales where rents are obviously construction costs and then the financing environment to see if we will commence construction. But as I say, 18 months out and we are very bullish on the site and we have a very low land cost and then have obviously brought in capital by bringing in a partner.

And just to finish up there, I mean, you're starting this, obviously, both Tillamore and Golden Mile would be done in phases, so not meaningfully stressing the liquidity or the capital spend versus current levels?

No. You know, we've always focused on making sure we have a very strong value sheet, and we'll never do anything that puts the entity at risk and will be very prudent in our approach to development.

Of course. Thank you very much.

Again, if you'd like to ask a question, press star, then the number one on your telephone keypad. Your next question comes from the line of Jenny Ma from BMO Capital Markets. Your line is open. Thank you. Good morning.

I wanted to ask about a comment that was made in the outlook where you talked about the expectation that there might be downward pressure on fair value for the rest of 2022 from interest rates. I'm just wondering if, you know, considering that you've already taken the adjustment on the retail portfolio and there's good things going on in the industrial development portfolio, I'm just wondering if that is just a general comment as you're watching the macro environment or if there's certain other things that you might be watching out for, for example, transactions in the market that would have you put that statement out there.

Yeah, Jenny, you're right. That was more of just a... values were very fulsome, and so we'll just compare that to our portfolio.

Right, right. Yeah, it's hard to call day by day for sure.

As far as – sorry, go ahead. Sorry, J.D., go ahead.

My next question is on the retail portfolio. It sounds like there's some very strong demand and good leasing activity happening. With retail, it's always been kind of like a 1 to 1.5% rent step kind of a situation for a very long time. And I'm just wondering when you combine the kind of demand that you're seeing, especially for the essential retailer tenants, as well as the inflationary environment, is there any sort of pressure on those annual rent steps like we've seen for industrial? Or is that still a fairly steady 1 to 1.5% clip? in terms of your new leases or your renewals? Any movement on manual and steps?

We're seeing slight movement, Jenny. We're trying. We're pushing because we do, in many instances, have multiple groups looking at similar spaces. And so we're seeing that increased demand and trying to leverage that as much as we can. So I'm hopeful we'll break that 2% barrier as we do more leasing.

Okay, great.

Is that concentrated towards more of the CRUs or is it across the board? No, it's across the board in terms of the activity, you mean?

No, the ability to push the rent steps.

Yeah, it is a bit across the board. On our anchors, you know, certain anchors, it's much more difficult, like a Walmart of the world. But once you get into the smaller tenants, it's a little easier.

Okay, great. And then my last question is on the notes receivable. It looks like that balance has gone up. Is that an area you expect to have some growth? And is there any sort of floating rate component on the interest receivable on that?

Yeah, Jenny. The balance has increased primarily because of the VTB we took with Allied. The majority of the low receivable do have, do, are tied to prime rate. So we do get the benefit of an increase in receivable income, or interest income, should I say.

Okay, great. Okay, that's all for me. Thank you very much. There are no further questions at this time.

I will now turn the call back over to Rayl Diamond for closing remarks.

Rayl Diamond Thank you, Colby. So, to summarize, we are very pleased with our third quarter operating performance. The consistency of our results, the strength of our balance sheet, and the progress on our development pipeline in quarter demonstrates our team's ability to continue to deliver on our long-term strategy in any environment.

Thank you for your interest, your investment in choice, and for joining us this morning. This concludes today's conference call. You may now disconnect.