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spk00: Good morning. I would like to welcome everyone to the Canadian Net REIT second quarter 2022 earnings conference call. At this time, all participants are on a listen-only mode. Following the presentation, we will conduct a question and answer session. To ask the question during the session, you will need to press star 1-1 on your telephone. I would like to advise everyone that this conference is being recorded. I would now like to turn the conference over to Ben Gazee, Canadian NET REIT's Chief Financial Officer. Sir, you may begin.
spk01: Thank you, Operator. Good morning, everyone, and thank you for joining us on our Q2 2022 results conference call. Before we begin today, we are obliged to advise you that in talking about our financial and operating performance and in responding to questions today, we may make forward-looking statements, including statements concerning Canadian NET's objectives and strategies to achieve them, as well as statements with respect to our plans, estimates, and intentions, or concerning anticipated future events, results, circumstances, or performance, which are not historical facts. These statements are based on our current expectations and assumptions and are subject to risk and uncertainties that could cause our actual results to differ materially from the conclusions in these forward-looking statements. Additional information on the risk that could impact our actual results and the expectations and assumptions we applied in making these forward-looking statements can be found in CanadianNet's most recent annual information form for the year ended December 31st, 2021, and management's discussion and analysis for the period ended June 30th, 2022, which are available on our website at www.canadiannet.ca and on CDAR at www.cdar.com. We will also refer to non-IFRS financial measures today, which are widely used in the Canadian real estate industry, including FFO, FFO, and NOI. CanadianNet believes these financial measures provide useful information to both management and investors in measuring the financial performance and financial condition of CanadianNet. These financial measures do not have any standardized definitions prescribed by IFRS and may not be comparable to similarly titled measures reported by other entities. For more information, please refer to the section Non-IFRS Financial Measures of our MD&A for the period ended June 30th, 2022. I will now turn the call over to Jason Paravano, Canadian Net REITs President and CEO. Jason.
spk04: Thank you, Ben. Good morning. In the second quarter of 2022, we continue to execute our business strategy. We have maintained a portfolio of 101 properties at a near 100% occupancy level. During the quarter, we completed four acquisitions, while adding a new tenant to the portfolio, a giant tiger in Shura, Nova Scotia. In addition, we purchased a metro anchored property in St. André-Avlin, a standalone metro in Cheneville, and a Couchetard sea store and service station in St. Jerome. We continue to add properties to the portfolio that diversify the tenant mix, as well as the geographies we are exposed to. Strong retail properties in A locations and secondary markets. More so, these properties fall within the category of essential needs-oriented retail. Following the end of the quarter, we purchased our 100th and 101st properties, one of them being the first in the province of New Brunswick. The properties are a Midas in Fredericton, New Brunswick, and a 53,000-square-foot Rona in Châtellier, Quebec, two firsts for Canadian Net Read. These properties are positioned in irreplaceable locations, in high-traffic retail nodes, and lease to strong covenant retailers, similar to the composition of the existing portfolio. We will be completing the development of a QSR in the Cerre de Terrebonne in the coming weeks, and we recently began the redevelopment of an old Burger King into a Benny & Co. in the city of Jonquière. In the next quarters, we also plan to begin the development of three previously announced additional locations for the Benny & Co. banner. The REIT has a 40% interest in all the projects mentioned above. Shifting to what we're seeing in the market and the macroeconomic landscape, a popular topic of conversation right now is inflation and interest rates. Our business, which is focused on owning and acquiring properties on a triple net lease basis, allows us to be somewhat immune to inflation as higher operating costs are borne by our tenants. The REITs operating costs for our properties are almost exclusively charged back to our tenants under the structure of those leases, with a few exceptions. With respect to interest rates, we have been able to take advantage of mortgage assumptions at pre-hike levels, which has allowed us to take advantage of a meaningful spread between interest rates and going-in cap rates on newly acquired acquisitions. I will now turn over the call to Ben Gizith, Canadian RETS CFO. Ben.
spk01: Thank you, Jason. We had another great quarter. For the six-month period ended June 30th, 2022, Canadian RETS reported an FFO per unit of 31.1 cents compared to 28.8 cents per unit for the same period in 2021, which represents an increase of 8%. FFO reached $6.4 million compared to $5 million for the same period which represents an increase of 26%. These increases were primarily due to the impact of newly acquired properties partially offset by interest on mortgages associated with these properties. During the same period, the trust's property rental income was $11.3 million compared to $9.1 million for the same period in 2021, which represents an increase of 24%. NOI reached $8.7 million compared to $6.7 million for the same period in 2021, which represents an increase of 30%, And these increases were also primarily due to the impact of newly acquired properties. The IFRS value of our adjusted investment properties, which is the total of our wholly owned investment properties and our proportionate share of the investment properties held in joint ventures amounted to $332 million, an increase of 33% compared to $249.5 million a year earlier. We continue to maintain a conservative approach with respect to our leverage and our payout ratio. having reduced our debt to gross assets to 56% compared to 57% at the same time last year, and an FFO payout ratio which increased slightly to 55% from 52% a year earlier. With respect to our leasing for the year, we have completed all of our 2022 renewals with no tenant turnover. We have 10 leases expiring in 2023, which represents approximately $800,000 of NOI, of which 50% have already been renewed and the remainder should be completed by the end of the fiscal year. The portfolio's wealth on our leases is currently 7.2 years. Our properties are typically financed with fixed-rate amortizing mortgages. There are three properties in the portfolio which are on variable-rate mortgages as well as the REITs line of credit. In addition, bridge loans on our development projects are at a variable rate until converted to takeout financing. There are three mortgage renewals remaining in 2022 with a balance at maturity of less than $4 million as of today's date. Over the years, our preference has been to take out the longest term available to us on our mortgages in order to mitigate our rate reset risk. We have $10 million of mortgages rolling over in 2023, excluding mortgages in our JVs, and the bulk of our renewals are not before 2027. The current average term to maturity on our mortgages is five and a half years. That summarizes our key results for the quarter. We will now open the line for any questions. Operator?
spk00: Thank you. As a reminder to ask the question, you will need to press star 1 1 on your telephone. Again, that's star 1 1 to ask the question. Please stand by while we compile the Q&A roster. Our first question comes from the line of Cal Stanley with Des Jardins Capital Market. Your line is open.
spk02: Thanks. Morning, guys. Good morning. So just generally, what are you seeing in your markets right now in terms of acquisitions? I mean, you talked about the interest rate environment and the impact that might be having on operations. I'm just curious what you're seeing out there. Have you seen any movement in cap rates or pricing adjustments? And you did mention, and I think we spoke about this last quarter, but your ability to assume mortgage debt at a higher rate
spk04: or a lower lower cost and and you know the spread still being intact so could you just kind of walk through what you're seeing there hey kyle it's jason yeah for sure so so um you know if if people are able to come to us or or vendors are able to come to the table with with properties uh with you know great mortgage terms associated with it for sure if you're able to maintain a greater spread they're able to achieve kind of the same pricing that we've seen historically And on the flip side, if you're looking at properties or we're looking at properties that have no debt associated with them, there has been a little bit of an adjustment. Vendor expectations have changed slightly. But I don't think, well, I think that a lot of people were expecting a much more material movement in cap rate expectations and cap rates on newly acquired properties. But we haven't seen a material movement yet. in terms of one, expectations, and two, on the buy side, people have just accepted to, in my opinion, make lesser spreads. And pricing seems very similar to kind of pre-interest rate levels. And I'd see probably a difference in 25 to 40 basis points on cap rates and 40 being on the high end. But just to say there is product coming to market. There is product on the market right now where expectations are are extremely high or extremely low in terms of the cap rates people are expecting to get for them because there is not a lot on the market. There is not a lot trading right now. So there's still a lot of money on the sidelines chasing the same product. What we have seen, the most important thing is where you'd have a vast variety of different people chasing the same product. due to the rise in rates, we're seeing less competition from private capital chasing the same deals due to the fact that the volatility and interest rates is kind of scaring them off a little bit.
spk02: Okay, fair enough. And then I guess maybe just building on that a little bit with regards to your strategy. So where would you be comfortable taking leverage to facilitate growth or how are you thinking about your funding at the moment? And I guess maybe if You probably don't want to provide guidance, but just for the balance of the year in terms of total deal volume, what do you think would be reasonable?
spk04: Well, total deal volume is all dependent on the capital that we can find to pair it with the potential acquisitions. We're always working on stuff. If you look at our track record, we've always been very active. There's no difference now. We're looking at a lot of deals that are being presented to us. Between now and the end of the year, Next week, we're already into September, heading back to the last quarter. I expect to see some ideal volume, but obviously the most important part is to see where we get the capital from. The equity market right now, the likelihood of issuing equity is, I would say, not on our kind of priority list. So alternate sources of potential capital could be of interest to us, whether it be debt or debt in a convertible nature.
spk02: Okay, great. That's it for me. I'll turn it back. Thanks for that.
spk00: Thank you. Please stand by for our next question. Our next question comes from the line of David Crystal with Echelon Wealth Partners. Your line is open.
spk03: Hey, thanks. Good morning, guys. Do you have a firm upper level of debt to GBV or a range maybe that you'd be comfortable taking your balance sheet today?
spk04: We never really put an upper level at the end of the day. This refers to my opinion from some of the larger REITs that kind of put the upper level of max level of debt that they put on their portfolio is that all of their portfolio is deprived of unpaid debt or non-conventional mortgage debt. So they're much more susceptible to rate resets when they come to renewal because they also haven't paid down any capital. the beauty of our business or the beauty of the way we structure is that we're all having our own business. So I'm more comfortable with being at a slightly higher level than the norm, but I don't see us going to a 70% if that's your question. Right now, sitting around the 50, 55% mark, going up to 60, I wouldn't shy away from it if the opportunities present itself, as long as we can pair long-term debt with the properties to ensure that we do what we've done in the past, which is pay down the capital on those mortgages to kind of immunize ourselves from rate resets at time of renewal.
spk03: And given that your commentary kind of suggests that you're not actually seeing a whole lot of cap rate expansion, would you look further afield? Would you target more kind of new Brunswick's like obviously your post quarter acquisition? with higher cap rates to maintain your investment spread? And would you consider maybe clipping some assets in lower cap markets in favor of pursuing higher cap acquisitions?
spk04: Yes and no. We're always looking in other provinces, and I wouldn't say that the New Brunswick market is that much higher in terms of cap rates on assets. It's probably even more difficult to find the assets in New Brunswick because nothing really trades. A lot of stuff is owned institutionally over there, believe it or not, or owner-occupiers that own their properties. So that being said, I think there are lesser opportunities in those markets than there are in, call it, Quebec, Nova Scotia, Ontario, or even Western provinces. So that being said, I think what everyone is just going to expect right now is that spreads are going to be lower between the cap rates and the interest rates on the properties. But it's not that it's at a historical low. It's that we're kind of back to where we were in college 2018. where stuff would trade at a 6.5% cap and you'd put 4.5% debt on it, and you had a 200-point spread. What we experienced in 2021, or at the peak of 2021, was the all-time high compression cap rates and all-time low of interest rates, where you'd be able to put five-year money at 2.5% and buy something at a 6% cap rate or a 5.5% cap rate. I think those 300 and 350 and 400 basis point spreads We're fun for a little while, but the reality is that we're not going to see those kind of spreads again for a long time.
spk03: Okay, thanks. And then you had some kind of high-level commentary on leasing, obviously. No new vacancies in 2022, and a lot of next year is addressed. Can you comment on any leasing spreads this year or next year, and if there's a gain on any of those maturities? Or are they mostly flat versus expiring?
spk04: Yes, so we completed about, I would say around $200,000 of NOI renewals over 2022. And the lower end at 5% renewal bump and the high end of 25% renewal bump. Somewhere in between, you had some 8% bumps and some CPI-related bumps, which we're only going to know once the actual term runs out because it was an early renewal. And these assets, some were rolled over for – well, most of them were rolled over for a period of five years, whereas one of them was rolled over with annuities for a period of 15 years. Looking into 2023, we've already completed, as I mentioned, around 50% of our renewals. The low end being at a 2.5% renewal. We had a couple of CPI renewals in there, as well as one which was at a 6% renewal. Some of those have been just rolled over five years per an option period, and some of them have been extended further beyond their first option period.
spk03: So fair to say on 2022, somewhere on average, maybe 6%, 8%. And then for 2023 is a little lower in the kind of 3%, 4% range on average so far?
spk04: No, 2023 probably north of 5%. And we didn't have much in 2022. So we kind of had one outlier that dragged the weighting higher to around 10% and a couple of lower ones. But not a heavy amount of renewals for 2022. 2023 is a bit heavier. And like I said, we're in the process of finalizing the remaining 50% and being between five and call it, or sorry, the low end being two and a half, 3% and the high end being around 6%.
spk03: Okay, that's perfect. Thanks. I'll turn it back.
spk00: Thank you. As a reminder, ladies and gentlemen, that's star one to ask the question. Please stand by for our next question. Our next question comes from the line of Moonish Guards with Loretta Bike Securities. Loretta Bike Securities, your line is open.
spk06: Yeah, hi, good morning, everyone. So my question is, could you expand a bit on Q2's fair value adjustment and your expectations for the rest of the year?
spk04: Sure. The Q2, we had a slight increase in some cap rates in some regions. Obviously, our IFRS cap rates are provided to us by third-party consultants. That being said, Those cap rates are based on activity in the market for the most part or similar activity in similar markets in which the properties we have are located. That being said, there wasn't much activity in Q2, so we saw some cap rate expansion in some markets as well as some of the adjustments are a result of our assumptions or estimates of change in future cash flows of the properties, either in a positive position or in a negative position. But for the most part, it's related to changes or slight expansion in certain cap rates in certain markets.
spk06: All right. Thanks.
spk00: Thank you. Please stand by for our next question. Our next question comes from the line of Mark Wachtstab with Canaccord. Your line is open.
spk05: Hey, thanks. Good morning, guys. Jason, in regard to your comments about... cap rates maybe not moving as much and spreads tightening. To what extent are you comfortable with just buying and getting those lower spreads? And that will result in a slower pace of FFL per unit growth as you've had in the past, but it still would be accretive.
spk04: Oh yeah, definitely accretive. The beauty of our structure is that those lower spreads still work for us. And I'll give you an example. If you look at our equity today, it costs us 5% to put out new equity. If you look at our kind of debt, it's similar to around 5%, 5.5% on mortgages on new properties. And I'm saying that on the high end right now. And if you were to issue a bond, it would be probably a little bit higher than that. But even with the spread that we experience on these properties, we can still generate 7%, 8% free cash flow returns, if not higher, depending on how we structure the debt. In addition to that, our FFO return is still north of 10%. So the only thing that's happening here is that the cash flow spread has reduced a little bit where we'll make a little bit less cash on cash returns because we're paying down capital. But the actual FFO returns taking the interest, the capital payment out of the equation is still accretive. So I think the beauty of our business and the way it's structured right now that we already have a low payout ratio, our yield is low, our cost of capital is, you know, is low as well for lack of better choice of words. But we have a well-positioned company and balance sheet that allows us to still be accretive regardless of the tightening of the spreads right now. I wouldn't want to be in a position where I have an 8% or 9% yield and I'm going out and making 7%. That would be dilutive on a cash flow basis and probably neutral on an SFO basis. But that being said, there's still active accretion here from doing deals. That's for sure.
spk05: Okay, great. Thanks. Maybe just one more in regards to it seems like you've been slightly surprised by the fact that cap rates haven't moved much. Do you think that that's going to continue? Do you see it maybe continue to rise a little more? Or do you think that this is just the way it's going to be, people accepting tighter spreads?
spk04: I think right now, I think most people have taken the summer off, to be completely blunt with you. That being said, the reason why things haven't moved is because there hasn't been a lot of product on the market, right? So supply is low, demand has reduced, but not reduced significantly enough to expand their cap rates in a meaningful way. I think the telltale will be what happens in the next few years. how much product they actually make to the market, and how those trades happen. It's really important in the matter that there's opportunities for people to not only have one property to bid on and have 100 properties to bid on. That could change cap rates. If things stay maintained at a slower pace of less product on the market, cap rates will be maintained, in my opinion.
spk05: Okay, great. Thanks so much.
spk00: Thank you. I'm not showing any further questions. I would now like to turn the call back over to Jason for closing remarks.
spk04: Well, thank you very much, everyone, for joining us on our first ever earnings call. Questions are always appreciated. I'm available offline if anyone has any further questions, as always, and looking forward to the next one. Thank you very much.
spk00: Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.
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