Slate Office REIT

Good morning, ladies and gentlemen, and welcome to the Slate Office Read for 2022 Financial Results Conference Call. At this time, all lines are in a lesson-only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Wednesday, February 22, 2023. I would now like to turn the conference over to Paul Wolenski, Senior Vice President, National Sales and Investor Relations. Please go ahead.

Thank you, operator, and good morning, everyone. Welcome to the Q4 2022 conference call for Slate Office REIT. I'm joined this morning by Steve Hodgson, Chief Executive Officer, and Charles Peach, Chief Financial Officer. 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 Office REIT's website to access all of the REIT's financial disclosures, including our Q4 2022 investor update, which is now available. I will now hand over the call to Steve Hodgson for opening remarks.

Thank you, Paul. Despite headwinds challenging the broader office market, the REIT successfully executed a number of high impact transactions throughout 2022 that have meaningfully advanced the quality of our real estate and the performance of our portfolio. Looking ahead, we remain focused on uncovering opportunities to maximize value for our unit holders and positioning our portfolio for stability and growth over the long term. As our tenants continue to return to work, our conviction in the office sector remains strong. We know that physical workspaces enable collaboration, culture, and innovation. At the same time, we understand that post-pandemic, certain tenants and industries will be more significant users of office space than others. We will continue to position our portfolio to focus on opportunities that align with tenant demand. We believe well-located, high-quality and modern office buildings with growing, strong credit tenants will continue to outperform. While the sector is facing a number of macroeconomic challenges, this environment can create unique opportunities to capitalize on historic market dislocations, and Slate Office REIT is well positioned to take advantage of these opportunities. Notwithstanding the REIT's attractive assets and longer-term upside, our Board of Trustees recognizes that market disruptions and elevated levels of inflation continue to weigh on the valuations of publicly traded REITs. creating a divergence between asset values and unit price. In October of 2022, the Board of the REIT formed a special committee of independent trustees to oversee a review of strategic alternatives for the REIT. As we continue to navigate a challenging operating environment, the strategic review will play a key role in identifying additional ways to maximize value for unit holders. I will now hand it over to Charles for some additional highlights.

Thank you, Steve. 2022 was a busy year for the REIT, completing $379 million of strategic transactions and closing over $600 million of senior debt capacity. On the asset side, the REIT acquired a portfolio of 23 properties in Ireland, anchored by government, technology and life sciences tenants. The local team have continued to demonstrate strong collections and performance from these assets. The REIT also purchased a modern office property in Chicago towards the end of the year, This is anchored by a 10-year lease with Pfizer at an 8.4% cap rate, with upside available from letting further space there. An older, higher-risk property at 95-105 Moatfield Drive in Toronto, Ontario, was sold at a 5% premium to the REIT's June IFRS NAV. The REIT's focus on operational performance continued, with 563,000 square feet of total leasing at a weighted average rental spread of 15.1% for the year, up from the prior 2021 6.5% spread. Net operating income rose by 21.2% when comparing Q4 2022 with Q4 2021, showing an increase in same property net operating income of $500,000 and a net increase of $3.8 million from acquisitions and dispositions mentioned earlier. This NOI is supported by an average weighted lease term, 5.6 years, and government or high-quality tenants making up 66.3% of the portfolio. In an increasingly expensive financing market, we closed financing in Canadian dollars, US dollars, and euros to support the REITs assets. Our universe of lenders increased. We arranged or refinanced term loans, revolving credit facilities, mortgages, and subordinated debt, while reducing our floating rate debt after the impact of swaps and caps to 75.4 million or 6.5% of our outstanding debt principal. I'll now hand over for questions.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by the one on your touch-tone phone. If you'd like to withdraw your question, please press the star followed by the two. If you're using a speakerphone, please lift your hands up before pressing any keys. One moment, please, for your first question. Your first question comes from Sriram Srinivas from Carmark. Please go ahead.

Thank you, operator. Good morning. Looking at the vacancies in Ontario, was that primarily because of the SNC lease or were there other assets that saw some vacancies in the quarter?

I think it was hard to hear you. I think you were asking about what drove the vacancy in the quarter. So two things. One was the acquisition of the building in Chicago, the Pfizer anchored building that they occupied 67% of the building. And we paid for that income, but we didn't pay anything for the vacancy. So there's upside with that building, but it does decrease our overall occupancy slightly. The other factor was the remaining income vacate from S&C Lavalin. They still had their last phase of exit in the fourth quarter, and it was about 44,000 square feet. Thanks for that, Steve.

Yeah, I was just actually asking about the Ontario lease and whether it's only because of S&C, but I think that gives me good color. Just looking at probably the U.S. vacancy we just spoke about, Are you guys in the process of actually closing in on that additional space on the building?

Yeah, we've had a lot of interest. There's a couple of things that we're working on. We need to bifurcate the building so that it can be multi-tenanted. There's some work we're doing in the lobby, and we're going to do some aesthetic improvements as well. but there's strong interest. We've had a few tours, both of which would take the entirety of the vacancy. This has historically been a 100% occupied building, so it's new to the market, and it's a very nice space, so there's been lots of interest.

That's good, Steve. And just probably on the same note of leasing, do you expect any vacancies to be coming in this year? Any terminations, I mean?

Yeah, not so much. We expect some vacancies. There's always expected vacancies. I would say that right now we have a good line of sight on vacancies for the balance of the year, of which half of those have already been replaced by new deals that haven't yet commenced in our occupancy. So we're having a lot of traction, particularly in Atlantic Canada and Ontario, on doing new leasing. Ireland's still a very strong market, but there's less new leasing to do there because they're already well occupied.

And so would it be safe to assume that some of the strong spreads you saw last year would probably be reflected in the leases that come in through the summer and these leases you just spoke about? Yes. All right. Okay. And I guess my last question would mainly be on leverage. I know it's kind of tickled up this quarter. What are your thoughts on actually decreasing leverage as well as the payout ratio?

I think decreasing leverage is generally an attractive thing for us. If we look at what has driven the increase in leverage over the quarter, that hasn't been so much through increased debt. It's been more due to the fact that there's been a decrease in the IFRS value of our assets that has been the driver of that. That said, when we have looked at refinancing, we have looked in certain areas of selectively reducing the leverage on certain assets and the debt that's applied to them. We look at that in two directions. The first of which is generally we would like to reduce the leverage for its level it is at the moment. The REIT has a target of 55%. The second of which is when it comes around to refinancing and financing, we look to allocate our capital in the area it might be best used. And there might be an instance to accept low leverage on one particular asset in order to gain additional leverage on another asset, should there be certain pricing benefits or availability benefits when it comes to other refinancings in the future. Given that we completed a lot of refinancing last year, that set us up for this year. This year, we have a fair amount of refinancing to come, which we're well advanced with.

Thanks for that, Charles. And probably just related to that, where is the refinance rates coming in at?

Our refinance rates, well, we're at the mercy to a certain extent of where interest rates are and where interest rates are going to be. We have a reasonably significant quantum of financing to come up this year. The majority of that occurs towards the end of April. And given that we are in negotiations on all of those financing areas, I'd rather not talk about levels and spreads that we have there. Rates have increased significantly between, let's say, where we were last year at this point and where we are today. And there will be an element of reflection of that in the cost. What I would say is that we have looked to, as far as possible, immunize ourselves from interest rate movements by looking for fixed debt as far as we can. And there are a couple of instances where we do have swaps on assets which extend beyond the term of that debt. So we continue to have that benefit. But unfortunately, I would expect an increase in our financing cost over the year as we look to refinance.

Just on that, Charles, looking at 2023, I know the interest rate expiring is about 5.4%. Would you say that the rates that you probably expect to get would be significantly higher?

Given that we have a significant amount of financing, which is in the market, I'd rather not mention that as being, I'd see that as being commercially sensitive at the moment. I think we could cover that better when we have a little more security on that.

All right. Thanks a lot, Gajal. I'll turn it back. Thanks, sir.

Your next question comes from Jonathan Kelcher from TD. Please go ahead.

Thanks. I guess just sticking with the leverage, you said 55% loan to value is your target. Do you have a target on the debt to EBITDA side?

We haven't got a specific target that we look at for there. I mean, it's something that occurs within a number of the covenants that we have on our... on our debt, so it's something that we obviously keep an eye on, but I think it's more the absolute level of leverage that we look at at the moment. One of the things that we have been reviewing across all of our debt is where we stand from a covenant perspective and ensuring, particularly there, as we have had increasing rates and similar, we take as much advantage as we can of certain derivative transactions, such as a cap we recently did on our Irish lending to ensure we stay well within those covenants and they may include the dscr as well i think our chief metric however when we look at this is ltv we have an absolute level which sits in the declaration of trust of 65 we have a target the reit has had and it has had for some time at 55 which we look to move towards and at 61.8 obviously we're looking to reduce to get to the 55

Okay, and then I guess switching gears, you had a small write-down on a vendor take-back loan on, I think, Water Street. Can you maybe give a little bit of color on that and what you expect with that loan going forward?

Well, we've taken a relatively small write-down on what the amount of the loan itself was. The reason being is we have security on that loan. We have the ability to – we believe we have the ability to take that security, and we therefore would expect to receive payment for that. What we took as a write-down was our view of what costs might be in a disappointing situation of that. We may achieve more. I'm not sure at the moment, but that's ongoing.

Okay. And which – I believe it was two properties you guys sold. Was it to the same vendor or is that separate?

Yeah, it was to the same vendor. We sold the former Fortas building in St. John's as well as a series of buildings that were sort of a land assembly along Water Street. And it's the Water Street land assembly, smaller retail with res above buildings that this VTB relates to. But we do have other security from the purchaser that Charles is referring to.

Okay, so that's something that should get sorted out this year then?

I would think so.

Okay, and then lastly, just on your occupancy, it sounds... I guess that's the end of SNC leaving. So 81% is hopefully the low on occupancy, and it kind of builds from there over the course of the next couple of years. Is that a way to think about it?

Absolutely, yeah. Okay, thanks. I'll turn it back.

Your next question comes from Brad Sturges from Raymond James. Please go ahead.

Hi there. Just on the IFRS valuation change, can you give a little bit more color in terms of, was that broad-based across the portfolio, or is that specific regions? And then I'm assuming that's more just based on changes to discount rate assumptions, or is there transactions that you're tying those fair value changes to?

No, good question. There's still, Brad, not a lot of transactions that we would view as comparable to our portfolio. There have been some trades, but you really have to look into the details and specifics on each of those trades because they're still highly structured. There's adjustments that are happening after the headline prices. So we don't view those as willing seller, willing buyer scenarios. What we do know is that investors are still looking for a certain levered return and financing rates are higher. So to get that same levered return, You need to pay less for an asset. So what we're seeing from both the third-party appraisal world, some of our peers, in collaboration with our audit team, we felt it was prudent to make some changes to our both cash flow assumptions and discount rates. in the fourth quarter, primarily in North America, as we felt that our Irish assets were appropriately valued, given we feel we bought them at a very good price.

Okay. Thanks for that. Just on the strategic review, I guess you commenced in October. You've been going through this process for a few months now. Where would you think you are in that process, and do you have a a rough estimate on the timeline in terms of what that could take and when that resolution might be found from the strategic review?

Yeah, no, the strategic review is still underway, and at this time I can't speak to the potential outcomes or timing. We think it's a very prudent process. We have two new board members as well now that we'll certainly have some opinions on the outcomes of that and we'd like to get them fully up to speed. Until that's done, there's nothing to speak to in terms of the outcomes or timing.

As part of that process, you highlighted potential transactions that could be contemplated. Would a change in the distribution rate also be part of that process in terms of maybe revisiting the amount of retained cash you want to keep for reinvestment or to de-lever, for example?

The short answer is I think the independent trustees, as part of the strategic review, are looking at all alternatives, Brad. I'll say this about the distribution is financing rates have obviously put upward pressure on our payout ratio. That said, our objective is to continue to increase NOI over the coming quarters, and we believe we're well positioned to do that. We also have liquidity in our business, as you'll see in our Q4 results, and there's a number of levers to preserve and enhance liquidity. So ultimately, the board will make capital allocation decisions, and that's all going to be evaluated as part of the strategic review.

That's great. I'll turn it back. Thanks.

Your next question comes from Tom Callaghan from RBC Capital Markets. Please go ahead.

Thanks. Good morning, guys. Maybe first one from me is can you just touch on kind of any updated utilization or traffic trends that you've seen across your assets? I think you specifically mentioned Atlantic Canada and Ireland as leaders, but what are you seeing across the broader portfolio? And maybe secondly, has there been any shift in that since the new year there?

Yeah, very good question. Atlantic Canada and Ireland are leaders. Atlantic Canada and Q4 sat at around 80% utilization in our portfolio, which we feel is a very strong number. Ireland is around 70%. And then in Chicago and Ontario, we're still seeing sort of that 30%, 40% range. That said, these are Q4 numbers. I'm eager to see Q1 because anecdotally, we just feel that a lot of companies have implemented return to work, particularly in February after the holidays. So we're eager to see the Q1 results, expect some improvements.

Got it. Makes sense. And then just as a follow up there, can you maybe provide an update on just that SNC space and any progress there with respect to lease up?

Yeah, so West Metro as a whole, because we have the SNC space and we have a few other floors of vacancy, we've got a pipeline of about 100,000 square feet right now. And most of that has materialized just in the new year. So we're starting to see some movement. You know, it really speaks to the flight to quality. I think a lot of people, when they hear that term, they think of downtown AAA buildings. But there's a lot of tenants that are currently in B and C buildings that are looking at West Metro and the opportunity we have there as a tremendous value add for their companies. As I think you know, the space that S&C left behind was also very well appointed, and it shows really well. So we're getting some traction. I hope to have some updates in subsequent quarters.

Got it. Thanks. I'll turn it back.

Your next question comes from Matt Karnak from National Bank Financial. Please go ahead.

Good morning, guys. Can you give us a sense as to the trend in retention rate for maturities? I mean, your 2023 and 2024 maturities are pretty modest in the context of the greater portfolio. And you've also got 1.4 million square feet of vacant space, including the assets you just alluded to, where you could potentially gain some occupancy. Just trying to understand kind of where we go from here on the occupancy front retention versus new leasing and vacant space?

Yeah, I mean, as I mentioned in an earlier answer, the vacancy that we expect that we know of for the balance of the year, half of that has already been replaced by new committed deals that haven't yet commenced. And we still have the balance of the year to replace the rest. So we're anticipating improvement in occupancy this year. The answer to your question around retention, it's different by market. I think what we're expecting from the Chicago market, for example, where we have one building that is fairly locked down from a leasing perspective with CIBC as the anchor tenant, we have another building that is smaller tenants that are a little bit more mobile, but we're at the right price point for them in the market. At that building, you'll see a bit of tenants leave and then they're quickly replaced by another. So we're expecting to maintain occupancy in that market. Atlantic Canada, still seeing some great momentum in Newfoundland and a little bit in New Brunswick, and certainly Maritime Centre in Halifax continues to be very successful. So I can see some of our occupancy increase there. And in Ontario, You know, backfilling, we've already done a deal at 2599 Speakman this quarter for 20,000 square feet and expect to do more there and more in the 427 corridor. Okay. No, perfect.

That's helpful. And then you mentioned that you're positioned to take advantage of some historic dislocations in Canada. office asset pricing. I think we saw a bit of that with the recent Chicago acquisition and Toronto sales. Is that how we should think about how you'd execute on that potential? Or, I mean, you also did YouGrove and used your equity. Like, is there potential to do, I guess, merger type transactions at this point or just generally interested in your thoughts on how you can take advantage of dislocations in pricing.

From a management team level, we're not currently contemplating any new acquisitions. We would like to continue to advance our repositioning of the portfolio towards higher quality, better tenants, longer-term lease deals, and better cash-yielding assets that have less below the line capital costs. But really, you know, the strategy and the way forward will be determined through the strategic review.

Okay. No, that makes sense. Thanks, guys.

Ladies and gentlemen, as a reminder, should you have a question, please press the star followed by the one. Your next question comes from Jake Stovalti from CIBC. Please go ahead.

Hey, good morning.

What were the leasing incentives like during the quarter, and how do those compare to Q4? So Q4 versus Q3, Jake? Yeah.

Yeah, so I'm assuming you're asking how the Q4 leasing incentives compared to Q3. Very much the same. Very much the same. We're still seeing, on the new tenant side, we are providing additional inducements, primarily in the form of out-of-term or in-term free rent. But on the renewal side, we tend to be lifting rents and just providing market TI packages.

There are no further questions at this time. Paul, please proceed with your closing remarks.

Thank you, everyone, for joining the Q4 2022 conference call for Slate Office Street. Have a great day.

Ladies and gentlemen, this concludes your conference call for today. We thank you for joining and ask that you please disconnect your lines.