Morguard Real Estate Investment Trust (TSX:MRT.UN) Q3 2021 Earnings Call

0:01 Good afternoon, ladies and gentlemen, and welcome to the Moorgard Real Estate Investment Trust third quarter 2021 results conference call. At this time, all lines are in listen-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 Thursday, October 28, 2021. I would now like to turn the conference over to Andrew Tamlin. Please go ahead.

0:31 Thank you. Good afternoon, everyone. My name is Andrew Tamlin, Chief Financial Officer of Moorgard REIT. Welcome to the Moorgard REIT's third quarter 2021 earnings conference call. I am joined this afternoon by John Guinness, Assistant Vice President of Retail Asset Management, Tom Johnson, Vice President of Western Asset Management, along with Ray Saeed, Chief Executive Officer and Chairman of the Board. Thank you all for taking the time to join the call. Before we jump into the call, I'd like to point out that our comments will mostly refer to the third quarter 2021 MD&A and financial statements which have been posted to our website. I refer you specifically to the cautionary language at the front of the MD&A, which would also apply to any comments that we make on this call.

1:24 The third quarter continues with the same theme that we saw in the past few quarters, which is hopefully a transition back to a normally functioning real estate market. We are pleased to see positive results again this quarter. Collections in our office and community strip asset classes continue to be strong, as well as our enclosed malls in Western Canada, which are back to 100% collections. Same asset net operating income for the quarter was improved across all asset classes, which is the second quarter in a row we have seen this trending. Net operating income increased 6.7% for the third quarter as compared to 2020, to $30.4 million from $28.5 million last year.

2:09 The increase that we saw this quarter was similar to the 6.5% increase we saw in the second quarter. The increase in NOI is due to a reversal of bad debt expense recorded in 2020 in relation to the large amount of uncollected and closed mall receivables and failed tenants, along with rental growth in the community strip and single-tenant asset classes. Same-store net operating income has increased almost 8% for the quarter as compared to 2020, with increases across all asset classes, including a 20% increase in enclosed regional centres. We have seen continued declines in interest expenses quarter, which declined 5.4% or $700,000 as compared to 2020.

2:58 This was primarily due to the lowering of the weighted average interest rate on our mortgage portfolio from 4.1% to 3.7%. This lower interest rate was the result of the large amount of refinancing in both the latter half of 2020 and earlier in 2021, all at lower rates. Total debt is $50 million lower at September 30th, 2021, as compared to a year ago. Interest expense for the nine-month period ending September 30th, 2021 is down $2.7 million on a year-over-year basis. Notwithstanding the improved results, there are still challenges, particularly in our enclosed mall portfolio. Our two Ontario enclosed malls, St.

3:45 Laurent and Cambridge, were closed for portions of 2021 due to Ontario lockdowns and are still subject to restrictions such as mask mandates. Although it is noted that there is now a roadmap for Ontario to be completely done with these restrictions. We are hopeful that with the strong rollout and take up of vaccines by both Canadians and Ontarians, that we have seen the end of the lockdowns. Rent collections have been strong, particularly in the office, community strip and industrial asset classes, which are functioning normally. Rent collections for enclosed regional centres range from 90 to 100% depending on the asset. While we are still working on rent solutions for certain retail tenants, the majority of the remaining retail rent arrears represents Ontario tenants.

4:37 From an industry perspective, we are seeing most of the uncollected rents coming from tenants that have been most severely impacted by the lockdowns, with gym operators, beauty services and food service tenants being at the top of the list. As these tenants have reopened across Canada and restrictions are eased, we are optimistic that we'll continue to see improvement in our cash collections for the rest of the year. The rent arrears and deferrals of September 30th, 2021 totaled $12 million, which was down from $16 million at the end of June and $20 million at the end of March. The allowance for doubtful accounts assigned to these arrears totaled $5.3 million, or approximately one-half, excluding sales taxes.

5:24 Approximately one-half of the arrears is due to the two malls in Ontario which have seen the most lockdowns under COVID. As mentioned, we are still working on rent solutions for these arrears, and we expect these balances to continue to decline over the next few quarters as these solutions are put in place and documented. Turning to FFO, it has increased during the quarter to $16.6 million in 2021 as compared to $14.4 million in 2020. The REITs PCME or operating capital reserve has been established to be $4.6 million per quarter for the year, which is approximately 75% of normal levels. We have spent approximately $10 million to date of the $13.9 million Q3 reserve. but do expect this variance to reverse in the fourth quarter as we have some capital projects lined up.

6:18 On a year-to-date basis, our FFO has increased 7.3% and AFFO has increased 6.7%. Our retail occupancy levels at September 30th were in line with a year ago at 94%. Our office occupancy levels have slipped to 87% from 90% a year ago, as we have seen some tenants look for other solutions upon their lease expiration. Our current occupancy level for all asset classes of 91% has only changed slightly from the start of the pandemic, which was 93%. This speaks to the fact that in most cases we've been able to keep tenancy at our assets. We are still seeing declines in traffic patterns across most of our enclosed malls from pre-pandemic levels. However, this is not always meant declines in sales.

7:10 Instead of folks coming to malls to window shop or lounge at the food court, we are seeing much more targeted traffic whereby folks are coming and going in an efficient manner. Looking at financings, there was one mortgage renewal completed during the quarter. Suburban office asset in Calgary resulting in up financing proceeds of approximately $8 million. We are working on one last mortgage renewal in the fourth quarter, which is secured by a government tenant office building in Vancouver. We believe there's a $35 million up financing potential for this mortgage and it is expected to close in September. We are mindful of our convertible to venture renewal, which is coming up at the end of the year. We have been in close touch with the various investment banking relationships we have and are currently considering renewal options.

8:01 We expect to make a decision on how to approach this maturity shortly. And now for an update on our leasing efforts. For the rest of 2021, there is $168,000 in retail GLA coming up for renewal. $120,000 of this GLA is from an anchor tenant, which will be renewing. Every other retail space greater than 5,000 square feet that is coming up for renewal between now and the end of the year either has been renewed or is expected to be renewed. Further, the vast majority of the 86,000 office GLA coming up for renewal in the fourth quarter is from a government lease in Ottawa, which has already been renewed. Management has continued ongoing discussions with the provincial government tenant at Petroleum Plaza in Edmonton, which came up for renewal on December 31, 2020, and is now in overhauled. While they have verbally told us that they expect to renew, they have unfortunately still been focused on the response to the pandemic, which has taken priority.

9:07 At this point, we are looking at 2022 in order to get this completed. Turning to financing and liquidity, the Trust has $163 million in liquidity at the end of the third quarter and $322 million in unencumbered assets. This liquidity position has increased from $127 million a year ago Factoring in the up financing expected to close in the fourth quarter, this would give us almost $200 million in liquidity by the end of the year. The trust has started the Save on Foods development job at Pine Center, which entails the retenanting of the empty Lowe's premises into a new 38,000 square foot Save on Foods grocery store. Demolition of the existing former Lowe's premises is pretty well completed.

9:56 This is expected to be completed in Q3 2022. The addition of grocery further complements the strong anchor tenant profile at this mall and has advanced leasing discussions with some discriminatory tenants looking to come into this marketplace. Wrapping up, while the economy and by extension some of the REITs assets are going through their challenges, we remain positive about a number of aspects of our business. There are some short-term challenges with our enclosed malls, but most of them remain dominant in their geographical area, and our strip malls, which are largely grocery anchored, have shown resilience in collections and results. Beyond our retail assets, we have high-quality office buildings in Canada's largest markets with a high degree of government office tenants.

10:46 We continue to be positive about our business and the objective of building value for our unit holders. We look forward to continuing to execute our strategy and thank you for your continued support. We will now open the questions. Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star followed by the one on your touchtone phone. You will hear a three-tone prompt acknowledging your request and your questions will be pulled in the order that they are received. Should you wish to decline from the polling process, please press star followed by the two. If you are using a speakerphone, please lift the handset before pressing any keys. One moment for your first question. Your first question comes from Jonathan Kelscher from TD Securities.

11:33 Please go ahead.

11:35 Thanks. Good afternoon. Thanks for the color on the retail expiries over the remainder of this year. That's helpful. As you look to 2022, you've got about 15% of your retail portfolio expiring. Are there any large leases in there that you're concerned about renewing?

11:58 John Guinness here. We are currently involved in negotiations with large format anchors that make up a good proportion of that 15% you just noted. Those discussions started some time ago. It's preliminary, so I don't want to answer your question directly, but for the most part, we expect to renew most of that 15%.

12:22 Okay, that's good. And if we think about expiring rental rates around $26 for that, should we think about any roll-downs or increases?

12:34 It varies on the sector and the retailer. Usually the large format guys, we typically hold our Income when it comes to rental rates, negotiations there, again, depending on the size and mass, you're limited on your upside. It's on the inline small base CRU, especially in the closed market format. That's more of a challenge, just given that it's gone on over the last 18 months. So especially in situations like Ontario, where it's been disproportionately impacted during COVID, those negotiations might be a little bit tougher. I can't quote you exactly what proportion that makes up, but all in all, you know, our hope is to maintain flat to slight regression in some of the inline small B rates for CRU in Moss.

13:22 Okay. I guess switching gears a little bit, you guys sold a small asset in the quarter. What was the thought process behind that, and what cap rate did you get on that?

13:39 So that was a strip mall in London, and it was a bit of an orphan, quite frankly. There wasn't really any other asset nearby, so it was a non-strategic asset from our standpoint. We did get a pretty attractive offer on it, so we decided to execute on it. I'll decline to quote the cap rate. We don't normally do that, but... On the other hand, it wasn't all that material either.

14:11 Okay. But was there a gain versus your IFRS value?

14:16 There was, yes.

14:18 Okay. How much of a gain?

14:23 Probably about 25%, give or take.

14:27 Okay. That is helpful. I'll turn it back. Thanks. Ladies and gentlemen, as a reminder, should you have a question, please press the star followed by the one. Your next question comes from Jenny May from BMO Capital Markets. Please go ahead.

14:44 Hi, good afternoon. With regards to the enclosed mall portfolio, it looks like you got a pretty nice lift in NOI sequentially. I'm wondering if you can comment on how far below a steady state potential that NOI is, given that there were still some limitations on the Ontario assets, and sort of like a post-COVID run rate or anything that could help us quantify that.

15:13 Well, there's three. I would just point out that the bad debt expense that we booked last year is partially being reversed, Jenny. So that's one of the reasons why we're seeing improved NOI in that asset class. I think as we move forward, we'll continue to see improvement in rental growth. There's some points deals that we have. But it's really tough to kind of pinpoint.

15:47 I guess I think the reversal is about half a million dollars and you did nine to this quarter. So I guess I'm just trying to get a sense of how far below potential that is.

16:01 I'm not sure I know what you mean. What do you mean how far below potential?

16:05 Like, is there, you know, was there pretty good rent collection coming from the Ontario guys? Like, would you expect that number, that 9-2 to grind upwards? Or do you think that with reopening happening July 1st, that a lot of that gap was picked up in Q3?

16:22 Well, we expect to see collections continue to decline as we move forward between the end of the year and probably into the first quarter of 2022. So, There might be a bit more reversal of bad debt expense as we get there. Typically, the way it's been working is that the bad debt reserves are more conservative than what's happened. But we'll have to see.

16:54 Okay. Moving to your debt stack, you mentioned the convert that's coming due in a couple of months. When you say renewal, do you mean the intention is to renew it into another convert, or do you mean it broadly just addressing the convert altogether with different options?

17:12 Well, right now we're looking at renewal options, and I think we will advise when we've made a decision on that.

17:23 Okay. And then I'm looking at the mortgage stack and the 2021 financing looks attractive, but it looks like there might be a bit of a shortfall next year, assuming a similar LTV for 2022. Do you think that the LTV might be a little bit off versus the market value, or would you look to maybe dipping into the unencumbered pool to make up for that shortfall for next year?

17:53 Yeah, I mean, we're aware of the maturities coming up for next year, and you're right, there will be a challenge. We will have the option of dipping into our unencumbered asset pool as well. You're right. So, you know, but we'll decide exactly how we approach that when we get into the year. A lot of that is happening later in the year, so it's not – kind of right off the bat, if you want to call it that.

18:25 Okay. And could you give us some indication of what kind of properties would be in there? Are they enclosed malls, office assets, or a mix across the board?

18:36 Primarily office.

18:37 Primarily office. Okay. Great. Thank you very much. I'll turn it back. There are no further questions at this time. Please proceed.

18:49 Okay. Thanks, everybody, for joining the call. Have a good night. Ladies and gentlemen this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.