Slate Grocery REIT

Good day. Thank you for standing by and welcome to the Slate Grocery Read 4th Quarter 2021 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. In addition, if you require any further assistance, please press star 0. Thank you. I would now like to hand the conference over to your speaker, Mr. Braden Lyons. Sir, please go ahead.

Thank you, operator, and good morning, everyone. Welcome to the Q4 2021 conference call for Slate Grocery REIT. I'm joined this morning by Blair Welch, Chief Executive Officer, Andrew Agatep, Chief Financial Officer, and John Herrick, Vice President, Asset Management. Before getting started, I would like to remind participants that our discussion today may contain forward-looking statements. And therefore, we ask you to review the disclaimers regarding forward-looking statements, as well as non-IFRS measures, both of which can be found in management's discussion and analysis. You can visit Slate Grocery REIT's website to access all of the REIT's financial disclosure, including our Q4 2021 investor update, which is available now. I will now hand over the call to Blair for opening remarks.

Thanks, Braden. Good morning, everybody. This past year has proven again that grocery-anchored real estate is extremely resilient. It is a central part of food distribution, which is required in all kinds of market conditions. And we have consistently loved this type of real estate. In 2021, it was a transformational year for Slate Grocery REIT. We achieved record growth at attractive valuations. We invested about $470 million in accretive grocery-anchored assets at compelling values. What does that mean? We grew by about 3.7 million square feet, or 40%. And we increased our exposure to leading omnichannel grocers in the U.S. in large metropolitan areas such as New York and Texas. And we further enhanced our portfolio's durability through proactive asset management. The team had a record year where we completed 375,000 square feet of new lease deals at a almost 18% weighted average rental spread. And we are now at about 94% occupied. It is our sixth consecutive quarter of occupancy growth. And when you look at that in the pandemic lockdowns, I think that's a very impressive stat that shows this real estate is in demand and people want to be in these assets. Our same property NOI was up about 3%. And I'll let Andrew later talk about our AFFO, which was about 22 cents. Heading into 2022, we feel the grocery rate is well positioned to pursue organic growth and high quality accretive acquisitions. We can do that through buying single assets as we've mostly done, but we can also be opportunistic as the market dictates or shows us opportunities. We are actively writing compelling investment opportunities always. and we've maintained a strong balance sheet through a period of growth, so we have ample liquidity and flexibility. Slate Asset Management owns and operates over 3 billion of grocery assets worldwide. Grocery REIT has over 100 assets in the US, and we own over 240 assets in Europe. And I think our expertise with these leading retailers gives us a competitive advantage to all the unit holders of Slate Grocery REIT. I will now hand it over for questions.

Thank you. And as a reminder, to ask a question, seem to press the star, then the number one on your telephone keypad. And your first question comes from the line of Lee Chen from Laurien Shan Bank Securities. Your line is open.

Hi. Good morning, guys. Some quick questions for me. Blair, can you give us some more color regarding your acquisition pipeline for 2022 and what would be the REITs acquisition capacity?

Yeah, I mean, I think we've always looked at, you know, the opportunity to acquire, you know, great assets at a strong basis where we know the tenants. You know, I think if I take a step back, you know, when we started it, we love this business. We know it's food logistics. And then about five years ago, you know, e-commerce, was changing things, and we knew it. We still believed in our business, but I think we kind of wanted to wait and see what was happening. Over the last several years, what we saw is our tenants like Walmart and Kroger have invested a billion dollars in click and collect and to make their stores able to really kind of embrace e-commerce. And when we saw that, we feel and we felt that this is just food logistics, and when they're investing in their stores to fulfill that, we wanted to buy more. So we started buying again, as you know, a couple of years ago, onesie twosies and in portfolios, you know, we were opportunistic during COVID. I think that will continue, you know, our pipeline in the U S if there's almost 40,000 grocery stores, it's kind of, it's kind of hard to put into context, but we're probably tracking, you know, three or 4 billion of grocery deals in the U S and that could be, you know, one off assets or portfolios. But, you know, I think what we'd like to do is, focus on a growth rate of, you know, if we could do a couple hundred million of assets, you know, acquisitions. But if there is a portfolio opportunity, we will look at that as well. You know, what Slate Asset Management sees as in the Annaly deal, that was a $3 billion deal that contained $400 million of grocery. There are grocery assets stuck in structures that we think is compelling where we can buy them very attractively. So we'll look to do that. However, we're not going to grow for growth sake. We love our in-place rents. There's going to be organic growth in our portfolio. Inflation will cause rents to grow. Our basis is cheap. So we are only going to buy if we think we can have stable cash flow that will grow in the long term. So I think that if we could do several hundred million of acquisitions, that would be our plan. Nothing too crazy. And we have the ability to do that. But we're always looking for compelling opportunities, and we can be dynamic.

That's great. And have you identified any potential assets for capital recycling in the new future?

Yeah, I mean, I think we always are. I'll let John talk about that, but I think we're always doing that.

Yeah, thanks, Blair. I would say, yeah, as Blair mentioned, we're always looking and reassessing our portfolio to see where there are opportunities to recycle out of assets and into other more opportunistic assets. I would say of our portfolio, currently there are three that are non-grocery anchored. So those would be ones in the next year or two that we would look to dispose of.

Okay, perfect. And can you just provide any updates on renewals regarding the remaining leases for 2022?

Yeah, I can take that one as well. In 2022, we have six anchors rolling annually. totaling about 390,000 square feet. We're in discussions with all of them already and don't expect to lose any of those tenants this year. And I'd also add that we don't expect on spending any capital meaningfully to renew those tenants either. Perfect. That's it for me.

Thanks, guys. I'll turn it back.

And your next question comes from the line of Jenny Ma from Capital Markets. Your line is open.

Thanks, and good morning. Just wanted to dig a little bit further into the potential acquisitions. In the MD&A, you mentioned that it was a deep pipeline, and I guess that's reflective of the size of the market. But can you talk about what's coming across your desk? Is it a mix of the onesies and twosies you're talking about, portfolios? where the bulk of the opportunities are in the market right now, and what kind of cap rates and geographies, if there's anything to be gleaned from that.

Yeah, I think that Slate Grocery was built predominantly on onesie-twosie acquisitions, and I think it made us really good on the buy, and we grew it. It took a lot of time. But in the last couple of years, we did a couple of portfolio deals. We did a Phillips Edison deal. We did an Armada deal, and we did the Anneli deal. And those were sizable transactions that we hadn't done before, more onesies, twosies. But we are seeing, so we're seeing both, Jenny. You know, I think there's been deals done in the U.S., large portfolios. You know, the Donahue-Schreiber deal in California. Blackstone buying preferred apartments, which is grocery and apartments. So there's more activity in the space, but I'd just like to highlight, to our knowledge, we don't think there's an owner of more than 500 grocery stores in the United States. So when you think about that as a percentage of the entire market, it's highly fragmented. So we're seeing activity on the portfolio side and on the onesie-twosie, but it still doesn't really put a dent in the opportunity that we see. So we are looking at portfolios. We are involved in the market. I think the team has done a great job. There's probably not a grocery anchor deal, a large one or even onesie twosies and where we wouldn't see or know about it. And I think that intelligence makes us better buyers. So I don't want to, you know, we're seeing it from all places. I feel what we really like and we've always known this. industrial is a great asset class we all know it and we like it but the problem is everyone likes it so it gets expensive I think people look at grocery as food logistics it acts like growth it acts like industrial you think of a grocery asset a neighborhood center the site coverage is similar it's a 30-foot clear height building with loading bay in the back and what they need is van parking or whatever to click and collect. That's what a grocery store is. It does act like industrial. I think people are starting to come to look at it like that. And, you know, we think we're in a really good position to benefit because of it.

Okay. And there's obviously been some cap rate compression. Can you talk about what degree you're seeing and how that compares to, I guess, the rising or cost of capital and whether or not the investment opportunity remains the investment spread for Slate Grocery remains the same or better or worse. How do you think about that going forward?

Yeah, sure. I mean, the cap rates are coming in. I mean, I think what it is, it's a function of where the asset is, the quality of the tenants and the like. And as I said, instead of cost of capital, it's coming in, but it's still a spread to our industrials. But if you think of, and I'll use Kroger as an example, or actually I'll put it as a Canadian example because we're in lovely Canada today. So if there is a Sobeys warehouse in Oshawa and it's a new facility, you know, their rent that they would have to pay on their hub, I'll call that, is probably, what is that, low double digits? Well, when you think of a grocer, like if they have a Sobeys in like Mississauga in a suburban neighborhood, maybe that grocer rent, if it's 10 years old, is probably the same cost or rent in place as the hub. So the spoke... where they deliver the grocery is probably at industrial rents. So that is extremely valuable for the retailer, the Kroger, the Sobeys, the whatever, because the last mile logistics is the most expensive mile. And they have these sites locked up for long terms at very cheap rents. So when you think about the rents in place, if our anchor rents are high single-digit rents, For us to develop that site, the cost of construction is probably $250 to $300 a foot. You would need high double-digit, high teen rents, low 20 rents to make that work. There is tons of protection for us to increase rents slowly with the tenants, but the tenants love that site because our in-place rents are low. So what are we seeing with cap rates? Yeah, they're coming in, but there's still wider... then industrial and there's embedded rental growth or rental rooms. So I think it's a combination of all those things that gets us excited. And we think there is opportunity to, to allocate, you know, real estate, our capital in good real estate. And again, we know, and then, you know, our distribution is covered and we love the yield and we're a big owner. We love this, but we also are creating a total return play. Like we know this real estate's valuable longterm. So the yield's important, but it's just not about buying a cap rate and matching it to a financing rate. It's about growing with these tenants and growing those rents over time.

Okay, great. I guess further on that point, if there's gonna be that gap between rent on the grocery store last mile and the distribution facility, when you guys go to renew your leases with your grocery tenants then, I mean, for the bulk of the portfolio, are there the options in place that you simply roll over or does every five years you come in and you get to renegotiate everything or really have the opportunity to raise the rent? Because if there is indeed this gap and it's growing over time, you know, what is your ability to capture that gap, I guess?

Well, I think there's a couple of things. You're right. I mean, these grocers that we deal with are some of the world's largest companies and they're extremely sophisticated. So many times, you know, when John said, If an anchor is renewing, they might have the site locked up for a long period of time at no to minimum kind of rent bumps, to your point. But if you think about it that way, well, if I'm buying it at a six cap and it's a Kroger lease, what is a Kroger bond for a 20-year? The spread on that is okay if I think of it that way. But more importantly, if they want capital or we can open up, that's when we can get more rental growth out of the anchors. But the anchors probably represent... you know, 40 to 50% of the GLA of the sites. And what, you know, when I said we had six consecutive quarters of occupancy growth, once you have that anchor and every other tenant wants to come and be beside it because of traffic, and that's where we're going to get more dynamic growth. So yeah, we might not get dynamic growth out of the grocer, but we think that that credit covenant is mispriced and we still like them, but having them there long-term, because Their business is a tough business. If their margin is 6%, so for every 100 of grocers they make $6, it's transportation costs and labor are the biggest, then rent. So if we can give them margin expansion by charging them or they have a low rent, they will be at that site for a long period of time. We will get rental growth off of all the other space, and that's how we'll get that growth, Jenny.

Okay, great. And the last question for me is, you get some good yields on your redevelopment projects, and you've always got a handful on the go at any given time. What opportunities are you seeing from the Annalie portfolio that you acquired? Is it a similar profile to the rest of the portfolio? And would you say the return opportunities and the yields are similar?

Hey, Jenny, it's John. I'll take that one. So in 2020 overall, we spent about $26 million on redevelopments, and we're coming off of a couple of larger ones that we're bringing back online. Yields were pretty attractive on those in the 14% range. In 2022, we expect redevelopment spend to be down slightly, maybe about 10% to 15% from 2021 based on what's under contract as well as projected. And as it relates to the annually portfolio, redevelopments typically happen under a couple of different scenarios, either where we find opportunities within the existing land to develop net new or in instances where we have lost a grocer, for example, or an anchor and we are going to backfill that space. Yields targeted are typically above 10% and we're not going to build on spec. So the SGR currently has no remaining vacant anchor boxes due to the lease up of the last remaining two in 2021. And we don't expect to get any back this year either. So while we're constantly reassessing, we see maybe slightly less spend in 2022 on redevelopments. There is one asset within the annually portfolio in Dallas where we recently signed a new anchor lease. So that would be considered a redevelopment. And that's going to be coming online this year.

Okay, great. Thank you very much. I'll turn it back.

Thank you. And once again, if you would like to ask a question, simply press the star, then the number one on your telephone keypad. Your next question comes from the line of Himanshu Gupta from Scotiabank. Your line is open.

Thank you and good morning. So just on the small shop occupancy, if I look at the occupancy, it has been in the range of 87% to 88% for the last, I think, few or many years. I mean, my question is, is this a stabilized occupancy for this asset class, for this product? And now, you know, given that we are seeing recovery in the retail leasing front, do you think there's a potential for small shop occupancy to go to like 90% level or even higher?

Hey, Manchu, it's John here. I'll take that one. So the answer is yes. I would say that there's certainly opportunity that we're seeing to grow occupancy within the small shop space. In 2021, particularly towards the latter half of the year, we saw renewed leasing demand from tenants who had maybe sat on the sidelines for most of 2020 and even early 2021. So salons, restaurants, and even gyms, for example. which has added some additional strength to the market in that under 5,000 square foot range. So in Q4 2021, of the 50,000 square feet of new leasing, about 40,000 square feet of that was in the shop space kind of category under 10,000 square feet at an average base rent of 1870 per square foot. If you look back at prior quarters, that's one of the highest, well, it was the highest in terms of square footage of any quarter in 2021, certainly. And also one of the highest quarterly average rents that we were able to achieve. So just what we're seeing in our own portfolio and then what we're hearing in the market from our tenants is that the shop space tenants would maybe sat on the sidelines earlier in the pandemic are really coming back and leasing space at, normal kind of rental rates and lease terms. Thank you.

And as that, you know, leasing is coming back, tenants are coming back. Do you see any upward pressure on the market rents as well? I mean, are you able to charge higher rents compared to what you were charging pre-pandemic?

Yes.

Yeah, I would say so. Okay. Okay. That's fair enough. Uh, and then, uh, And then the other question, similarly on the leasing spreads, actually, if I look at the leasing activity during, again, you know, for the last few quarters, very strong leasing activity, especially on the new leasing side in terms of, you know, leasing spreads, which category of tenants are, you know, driving these double-digit rental spreads? Any specific category?

On the new leasing spreads?

On the new leasing spreads, that's right. I think it's been... In the 20% range, just wondering, is there any particular category you're talking about?

I would say it's across the board, to be honest, that we're seeing larger leasing spreads. We executed in Q3 and in Q4, new leasing spreads were above 20%, which was a pretty significant increase over Q1 and Q2. We see those wider spreads continuing into 2022. And in terms of tenants, type of tenants. I mean, we're seeing the return of fitness tenants, for example, which had sat on the sidelines for most of 2020 and 2021, completed some larger transactions there, as well as medical. Those tenants sort of renewed interest in strip center real estate and tend to pay higher rents. Yes, those would be a couple of examples. And then all the daily needs tenants that I referenced in the earlier question that are coming back to the market.

Got it. Okay, thank you. That's helpful. And then, you know, just turning to the anchor leases, and I know you gave some color on the leasing, which is coming due in 2022. I think it's around 400,000 square footage. So I'm looking at the in-place rents. So it's around, you know, $6.80 or so. What is your view there? And especially in the context of, you know, Blair was comparing – the grocery rents with the industrial rents as well. In that context, do you think the renewal will be in an around $6 to $7 range, or do you see an upside to that number as well?

For the grocery rents specifically, as Blair mentioned in an earlier question, those rents are predominantly dictated by where the option rents are structured out. In many cases, those option rents are flat or may see minimal increases. As an example, in Q4, we executed two 2022 renewals early with Food Lion, which is Ajo Delhaize credit. One of them was flat rent and the other one was at 5%. In both cases, Food Lion just exercised on the option. So in 2022, we expect, probably for the most part, those rents to remain somewhat flat or maybe a slight increase. And that would be spending no capital. So in instances where the tenants are just exercising their options. If there are any situations where we would spend some capital, which would mostly be on common areas and for the general benefit of the center overall, then we would certainly seek out rental rate increases.

Got it. Okay. And then maybe a question for Blair. I mean, obviously you own a very large grocery portfolio in Europe as well. Any trends do you think you're seeing there in Europe, which is yet to come to North America? Any read across for your asset class?

I think what helps is that these tenants are very sophisticated and similar. I think what we see from Europe is more the discounted format, the all these and the legals, and how excellent they are at operations. So when I made my comment about transportation costs and labor costs, if you think about your local grocery store here, when I go to the grocery store, I notice now, compared to 10 years ago, there's less staff, there's more self-checkouts and things like that. So that's the grocer becoming more efficient with technology, but they're also lowering their labor costs. And I think... The North American grocers can learn a lot from the German discounters on efficiencies because they are very, very good operators. So I think that's coming in. I think that will make the grocers, you know, more, you know, that's what they'll be kind of fighting with. You know, all the grocers are embracing e-commerce. You know, we're... We're working with them to either add space so they can be more efficient with click and collect or they're doing it inside their existing box. So I would say what we really learn is operations from many of the Europeans. But that's just knowing our tenant. Like that's really – it's important to us, but that's really how we see the tenants changing. But I would say we're really pleased with how strong and healthy our grocers are and how they – you know, have had great, great sales or loss a little bit, and we don't really see, you know, significant change in them. I think they've used this to solidify their own balance sheets and they're going to continue to serve their customers. So we're pretty positive about the grocery space in general.

Got it. Thank you. And maybe just final question, maybe again for you, Blair. I mean, you've always looked at the replacement cost spaces versus, you know, the market pricing. And, you know, grocery anchor product in U.S. have been, you know, replacement cost has been much higher than the price where these assets have been trading at. So do you think, do you see further closing of this gap? I mean, as we come out of recovery, any thoughts on, you know, how replacement cost is trending or have trended relatively?

Yeah, I think that there will be a gap for some period of time, but we think the replacement costs in context of leasing, right? So like, I'll use an example. If we have a Kroger that pays us eight bucks for building a new Kroger for them, so say if they were to move across the street, for us to build a new Kroger, we might need to charge them 16, 18 bucks in rent because that's the cost. Now, for Kroger to move across the street, and double their rent, are they gonna get double the sales for moving across the street? Probably not. So what we find is the grocers want to be in these locations that are already existing with proven sales because they have these locked up for a long period of time. So that gives us durability of cash flow and slowly we can move them over time. So we look at replacement costs as a protection for our rent. So when we go in and talk to grocers, We think the biggest risk is are they going to leave the market in its entirety because it wouldn't make sense for them to move across the street. So that's how we think about replacement costs. So I think there will be a gap. I think we'll continue to, you know, it might, you know, the values will go up as inflation goes up and costs go up. But I think you'll see that gap for a while just because these grocers have options for a long period of time at lower rents. Got it.

Thank you. Thank you, guys. Awesome. And thanks for the call. I'll turn it back.

Thanks.

And now, once again, if you would like to ask a question, simply press the star, then the number one on your telephone keypad. Your next question comes from the line of Jenny Ma from Capital Markets. Your line is open.

Thanks. Just a quick follow-up. What was the rent collection for Q4? Did you see any impact from the Omicron variant, or was it consistent with the past few quarters?

Hey, Jenny. It's Andrew. Yeah, in short, collections have been consistent from what we've seen in the past periods. U.S. has been open since August 2020, and we've seen collections north of 95% since then. So really, since Delta and Omicron, we've been collecting business as usual.

Great. Thank you very much.

And there are no further questions at this time. I would like to hand it back to Mr. Braden Lyons for closing remarks.

Thank you, everyone, for joining the Q4 2021 conference call for Slate Grocery Reef. Have a great day.

And ladies and gentlemen, this concludes today's conference call. Thank you for participating in my now