Canadian Net Real Estate Investment Trust

Good morning. I would like to welcome everyone to the Canadian Net REITs 2023 First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question and answer session, and instructions will be provided at that time. To ask a question during the session, you will need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. I would like to advise everyone that this conference is being recorded. I would now like to turn the conference over to Ben Gazit, Canadian Net REITs Chief Financial Officer. Please go ahead, Mr. Gazit.

Thank you, operator. Good morning, everyone, and thank you for joining us on our Q1 2023 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 nets, 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 risks and uncertainties that could cause our actual results to differ materially from the conclusions in these forward-looking statements. Additional information on the risks that could impact our actual results and the expectations and assumptions we applied in making these forward-looking statements can be found in Canadian NET's most recent annual information forum for the year ended December 31st, 2022 and management discussion and analysis for the period ended March 31st, 2023 which are available on our website at www.cnetread.com 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, AFFO, 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 March 31st, 2023. I will now turn the call over to Kevin Henley, Canadian Net REIT's President and CEO. Kevin.

Thank you, Ben, and good morning, everyone. I'm pleased to be hosting my first earnings call as CEO of the REIT. As many of you know, I've been with Canadian Net REIT since 2017, and I've occupied the position of CFO and most recently Chief Investment Officer. As such, I've been deeply involved in the REIT's growth from 20 properties to 100 today, and this has resulted in a seamless management transition. I'm excited about the growth opportunities ahead of us and eager to lead the REITs in generating strong, sustained return for unit holders. The business strategy remains intact with a focus In the first quarter of 2023, we continue to generate solid financial performance, including a 4% increase in FFO per unit. Importantly, we achieved this result in the face of headwinds, including a soft acquisition market and rising interest rates. This success is attributable to our distinctive business model that features 100% triple net leases. Under these leases, our tenants are solely responsible for variable costs, including insurance, taxes, and ongoing operating expenses, as well as the management of the property. This has obviously limited our exposure to inflation. This model also enables CanadianNet to operate under a lean management structure with minimal overhead while maintaining industry-leading occupancy level. At the end of the quarter, our occupancy was at 100%. In Q1, we also benefited from the positive contribution of our most recent acquisitions, in addition to the organic growth from incremental rent attributable to scheduled rent increases. At the end of Q1 2023, our occupancy was 100%. Only one of our Q1 2023 expiring leases remains to be renewed, and we expect to complete the renewal over the course of the third quarter. Looking forward to 2024, we have 12 leases coming up for renewal, representing approximately 1.7 million of NOI. Approximately 40% of these renewals have already been completed. The portfolio's weighted average length term is now of 6.9 years. As I indicated earlier, the M&A market continues to be quiet in Q1 2023. Following the end of the quarter, we started seeing more deals being marketed in our space. Nevertheless, the challenges of high debt costs and fluctuating rates present obstacles in successfully carrying out these transactions while achieving our desired returns. Subsequent to quarter end, we sold a single tenant restaurant property in Timmins, Ontario for a total consideration of $1.3 million. The sale price represented a capitalization rate of 6.2%, which was a premium of 19% over our IFRS cap rate. This premium underlines the conservative philosophy we follow with respect to the ongoing valuation of our portfolio. With respect to financing, we had five loans coming due in Q1 2023. One of them was on the Timmins property, which was sold. Three others were renewed during the quarter, and the last one subsequent to the quarter end. As mentioned earlier, there is significant volatility in rates, but overall, Those swings benefited us for those renewals. We refinanced certain properties at rates that were 100 bps lower than initially anticipated. We currently have two properties for sale which are still being marketed. We continue to survey the market for opportunities, and as we move forward, we expect interest rates and capitalization rates to stabilize, translating into a more favorable acquisition environment for the REITs. I will now turn the call back to Van de Gezeve, who will review the Q1 results in more detail. Ben?

Thank you, Kevin. We had another solid quarter. For the three-month period ended March 31st, 2023, we generated FFO per unit of 15.7 cents, an increase of approximately 4% compared to 15.1 cents in Q1 last year. FFO increased 5.3% year-over-year to $3.2 million from $3.1 million in Q1 2022. These increases were primarily due to the impact of newly acquired properties partially offset by interest on mortgages associated with these properties, as well as increases in floating interest rates on the various lines of credit. Property rental income for Q1 2023 was $6.4 million, an increase of 18.1% compared to $5.4 million in the same period last year. NOI was $4.9 million, up 15.4% from $4.2 million in Q1 2022. The increases were also primarily due to the impact of newly acquired properties. The RFRS value of our adjusted investment properties, which is the total of our wholly owned investment properties and our proportion share of the investment properties held in joint ventures, was $329.2 million as of March 31, 2023, an increase of 4.8% compared to $314.1 million a year earlier. We continue to maintain a prudent approach with respect to our leverage and our payout ratio. having a debt to gross assets ratio of approximately 59% at quarter end compared to 54% at the same time last year. Excluding convertible debentures, debt to gross assets is 55% compared to 51% last year. The primary reason for the increase is due to the fair market value write-downs during the year on the value of our investment properties. Our FFO payout ratio for Q1 2023 was 55%, a slight reduction from 56% in Q1 last year. Our properties are typically financed with fixed rate amortizing mortgages. As at March 31st, 2023, there were three properties in the portfolio, which were on variable rate mortgages, as well as the REITs lines of credit. As Kevin had mentioned, subsequent to quarter end, we sold a single tenant restaurant property in Timmins, Ontario, and we are in the process of selling two properties, both of which have variable rate mortgages. In addition, bridge loans on our development projects are at a variable rate until converted to takeout financing. 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 $14.1 million of mortgages rolling over in 2023, excluding mortgages in our JVs, and the bulk of our renewals are not before 2027. Included in the mortgages rolling over are $3.5 million of mortgages associated with properties held for sale. The current average terms of maturity on our mortgages is 4.8 years. That summarizes our key results for the quarter. I will now turn the call back to Kevin for some closing remarks before we open the line for questions. Kevin?

We believe the outlook for our business remains highly positive. With our experienced team, unique low-cost operating model, and established debt financing strategy, we are well-positioned to make further accretive acquisitions of properties that are too small for larger REITs, but too large for individual investors. We expect that this will drive further solid growth in FFO and drive stronger returns for unit holders. We will now open the lines for questions. Operator?

As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of David Crystal from Echelon.

Hey, good morning, guys. Good morning, David. In terms of the dispositions, you've got about $6 billion of assets held for sale, one closed post-quarter. Do you have any visibility on the two remaining dispositions in terms of timing or cap rates?

No, I would say no clear path. They are being marketed. The market is very volatile. We've seen the GOC five years ago up 40 bits this week. So we have interest people coming around, then obviously turns in rates, people go back. And so I would say we will sell them, but no visibility as to when exactly.

Okay. And if you look at your portfolio, should we expect to see any more dispositions beyond what's listed for sale?

Not at the moment. The Timmins property, for example, we received an offer we were not expecting, a very good offer. So obviously when that happens, we have to consider it. We have to be opportunistic. It was also well, it was scheduled at the same time as the debt renewal. So we avoided any breakup costs there, which makes sense. However, the properties we acquired over the years were acquired strategically at great cap rates. And so even if we were to go out there and sell them, the issue is what do you reinvest in? We don't see a lot of deals on the market. We're happy with our properties. They have great tenants, we have good relationships with them, and they're all very well located. And so for now, I would not forecast any other sales in the portfolio.

And that kind of leads me to my next question. In terms of proceeds, I mean, obviously the two listed for sale have variable rate debt. I'm guessing that's in the 7% plus range. But in terms of net proceeds, would your first priority be paying down the line? Yes. Okay. And then just shifting to the operations, you have no real lease expiries in 2023. What's your baseline organic growth just from contractual escalations?

We're about between 1.5% and 2% on average.

Okay. That's it for me. Thanks. I'll turn it back.

Thank you, David. Thank you. One moment for our next question. Our next question comes from the line of Mark Rothschild from Canaccord.

Hi, Mark. Hey, when you say that you're not seeing deals, is that you're not seeing deals at prices that you like or just there's a limited deal flow? And maybe you could also comment on the cap rates that you would be comfortable buying versus maybe what's available out there.

Perfect. Good question. So we're not seeing deals that price where we want. We've seen recently, post-quarter end, many deals coming to market in our space, especially in the grocery and pharmacy space. The issue really is the volatility in rates. Very, very hard for us even to stipulate on a cap rate because when you get 40 bits increase in a week on the GEOC. Obviously, in a deal where your rents are fixed for 15, 20 years, that really changes the entire situation. So we've seen more deals on the market, but we don't find the margin of safety we need to execute on them at the moment.

Can you actually comment on the cap rates that you're seeing or that you'd be comfortable buying at, or is it just impossible?

I mean, it would be north of seven. Definitely. And then depending on the asset, the financing we can get. But I would say anything below a seven is no go. And above seven, even then, it's really hard, again, to see if we don't know if we're going to get a 5% mortgage or a 6% mortgage these days. And so the cap rate at this point, it doesn't really matter if we can't get the good financing.

Okay, great. And then to the extent you would find deals that fit your criteria, how much would you be comfortable buying now with the current balance sheets and how much could you theoretically buy?

Depending on timing, obviously we generate, we have, we generate organic growth. I would say around 10 million right now at most, at most over the next, the next year.

Okay, great. And maybe just lastly, you know, with the, assuming the CEO position, do you see any holes in management they need to fill? Do you expect to be hiring any senior people in the near term?

I would say right now, so we already hired people not on a senior level, and on a senior level within the next 12 months, probably earlier six months, we will be hiring someone else, yes.

Okay, great. Thanks so much.

Thank you.

Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. I would now like to turn the conference back over to Kevin Henley for closing remarks.

Thank you all for being with us today for our next call, and please, we'll welcome you for our next one. Thank you.

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