Morguard Real Estate Investment Trust (TSX:MRT.UN) Q4 2020 Earnings Call

0:00 Good afternoon, ladies and gentlemen, and welcome to the Moorgard Real Estate Investment Trust four-quarter for the year ended December 31st, 2020. At this time, all lines are in 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 Thursday, February 18th, 2021. I would now like to turn the conference over to Mr. Ray Say. Please go ahead.

0:32 Maybe I'll jump in. Good afternoon, everyone. My name is Andrew Tamlin, Chief Financial Officer of Moorgard REIT. I'm joined this afternoon by Tom Johnson, Vice President of Western Asset Management, Tulio Capulli, Vice President of Eastern Asset Management, along with Ray Sahi, 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 just point out that our comments will mostly refer to the 2020 annual 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.

1:18 2020 was a very difficult year for the real estate industry in general, and specifically Moorgard REIT due to the COVID-19 pandemic. In March, we had to pivot as an organization in order to respond effectively to the demands brought on by the pandemic. And at the top of the list was to ensure the safety of our tenants, our employees, and our business. In addition, there was the burden of addressing rent solutions for the tenants that were struggling financially due to the economic shutdown in the spring and had difficulties paying rent. This included administering the secret program on behalf of our retail and office tenants. Once the country emerged from the first set of lockdowns into the summer, things looked favorable, both from an infection standpoint and from an economy standpoint.

2:10 Unfortunately, however, we are back into a second series of non-essential business orders, which have impacted most of the country. While things seem to be worse than the spring from an infection standpoint, the good news is that things do seem to be somewhat better economically and with rent collections this time around. However, the tenant failures, which were primarily as a result from the first series of lockdowns, have had a profound impact on both our net operating income and the resulting valuations that are calculated from the cash flows on the enclosed small portfolio. Due to the cumulative impact that COVID-19 has had on rent collection, value erosion, net operating income, and with multiple lockdowns being enacted by provinces across the country from COVID-19, the Board of Trustees concluded that it was prudent to reduce the distribution by 50% from $0.04 to $0.02 per unit.

3:11 This will allow the trust to either reinvest this cash flow or pay off debt, both of which would generate future funds from operations. This decision was not taken lightly. While our adjusted funds from operations distribution payout was 77% in 2020, the adjusted cash flow from operations payout, which incorporates working capital changes, was over 100%. Our expectation is that there will be further erosion of net operating income in 2021 due to failed tenants and the impact of COVID-19, along with increased vacancy. In addition, we are expecting elevated operating capital requirements in the future as we address these vacancies, in addition to elevated development capital requirements addressing past vacancies, such as our empty Sears premises at Cambridge and St.

4:04 Laurent. The combination of a possible further erosion in net operating income in 2021, along with elevated capital requirements, was a key factor in the distribution reduction. As part of this initiative, we are continuing to take action to mitigate the effects of the pandemic on our business operations, while also focusing on impacts on our staff, tenants and other stakeholders. In looking specifically as to what has been going on with our seven enclosed malls across Canada, six of these were impacted by non-essential business closures during the second quarter, resulting in periods where most tenants were not allowed to operate. The same six were subject to non-essential business closures to varying degrees once again as part of the second wave.

4:53 Only the Pine Centre in Prince George has had no meaningful non-essential business closures or restrictions. Two of our larger malls, which happen to be based in Ontario, Saint Laurent and Cambridge, have both been subject to non-essential business orders for the last two months and have been extremely quiet from a traffic perspective. Now that the secret program is complete, there is a new supplementary program that is being offered by the federal government to help with rent relief. The new program will be available until at least June 2021. It will fund up to 65% of rent for businesses that have seen a revenue decline of at least 70%. Businesses that have had revenue fall by less than 70% will receive a gradually decreasing level of support in line with revenue.

5:49 Businesses that are forced to temporarily shut down by mandatory orders will be able to qualify for funding that covers up to 90% of rent. This relief is paid directly to the tenant by the government and then it is the responsibility of the tenant to use that money to help fund the rent burden. While this program has been beneficial to tenants that have been impacted by the pandemic, there are caps on this program for larger companies. Collections to date across all asset classes during the fourth quarter averaged approximately 92%. Our office collections have done quite well, averaging approximately 99% for the fourth quarter, while our strip centers were at 97%.

6:37 Our office tenants include approximately 30% government tenants, which obviously have a solid covenant, and our strip centres are largely grocery anchored. Our enclosed regional centres averaged approximately 82% for the quarter, which was approximately double the collections that we were seeing for the malls back in the spring, but obviously still well below 100%. Collections for January and February have tapered off somewhat due to the lockdown spread across the country. One thing that we were monitoring is that there can be a two to three month delay between the tenant applying for rent relief under the SERS program, receiving the payment from the government, and remaining it off to the landlord.

7:25 As a total, we collected approximately 90% of our rent in 2020. It is our belief that most of the weaker retail tenants from a year ago have already failed, which is why collections now are somewhat better than the spring. However, we are far from having this pandemic being over. Also, we believe that most businesses seem to be better prepared for the second series of lockdown orders as compared to the first series, which definitely caught most businesses by surprise. Both of these factors seem to have affected collection rates. We have now caught up with the processing of negotiated rent solutions from the spring 2020 rent arrears.

8:11 Any negotiated abatements or forgiveness of past rent have been charged to bad debt expense. Bad debt expense also includes the landlord contribution to SECRA, failed tenants, and an estimate of future uncollectible amounts or tenant failures. Whenever possible, term extensions or other negotiated rights are being exchanged for abatements. In some cases, rent is not being paid by tenants in order to create leverage as part of these discussions. The rent arrears at December 31st, 2020 totaled $22 million, including sales taxes. The allowance for default accounts assigned to these arrears totaled $8.8 million, or approximately 45% excluding the sales taxes on the arrears.

8:59 Bad debt expense for 2020 totaled $15 million, which again includes all the abatements negotiated on the past rent arrears. Over the last nine months, there have been a number of tenant failures. The Trust has been able to keep occupancy for the majority of these locations. Out of a total of 64 locations where tenants have filed, the Trust has been able to keep approximately two-thirds of these locations occupied under restructured or percentage rent deals. The closures represent a total of approximately 50,000 in GLA. Looking at traffic patterns, as you might expect, there is some regionality with our enclosed mall results.

9:45 This is related to the amount of infections that have been identified in the area that the mall operates. For example, traffic at our enclosed mall in Prince George, which has had very few infections, is at approximately 90% normal traffic levels. whereas traffic at our two enclosed malls in Ontario are more in the 50% to 70% levels before the recent non-essential business closures. Now, turning to our results, for the three months ended December 31, 2020, the Trust has recorded $86 million in fair value losses to the portfolio. Most of these adjustments came from our enclosed regional centres, and our office assets in Alberta, both due to changes in cash flow assumptions.

10:37 As a total for the year, our enclosed mall portfolio has seen an erosion of value of almost 30% from both cap rate adjustments and changes in cash flow assumptions. Overall, the fourth quarter of 2020 was a quarter with results that were impacted by bad debt expense, resulting from COVID-19, as well as the recurring year-over-year impact of the obsidian rent relief negotiated back in the first quarter. This has produced declines in both NOI and FFO metrics on a year-over-year basis. Excluding bad debt expense, our fourth quarter results were somewhat better than expected due to elevated amounts of non-recurring lease cancellation fees as well as some non-recurring recoveries processed for prior capital amortization and wage subsidy amounts.

11:29 Combined, Q4 2020 occupancy rates were down slightly at 92% as compared to 93.5% one year ago. And now for an update on our leasing efforts. In 2021, there is $965,000 in retail GLA coming up for renewal. Of this, there is $552,000 in GLA from anchor tenants at lower weighted average rates, which are all expected to renew. Approximately 80% to 90% of the $965,000 has either been renewed or renewals are being worked on. We also expect renewals on the vast majority of the office GLA, which are coming up in 2021 as well.

12:16 There is approximately 200,000 in GLA coming up for renewal in 2020 for 111 Dunsmuir, which relate to two different tenants. These renewals have been completed with an average rate in the range of $31 to $32 with future steps, up from a weighted average of approximately $25. Management has had continuing ongoing discussions with the provincial government tenant at Petroleum Plaza in Edmonton, which came up for renewal on December 31, 2020, and is now an overhauled. While they have verbally told us that they expect to renew, they have been unfortunately focused on their response to the pandemic, which has taken priority. We expect to get this completed in the second quarter of 2021.

13:02 Turning to financing and liquidity, their trust is $142 million in liquidity at the end of the fourth quarter. which has increased from $127 million at the end of the third quarter and from $52 million at the end of 2019. Helping to enhance the liquidity position over the last quarter was the closing of approximately $92 million in upfinancings for the year, along with the sale of a vacant parcel of land for proceeds of $6.8 million. All of these upfinancings were completed for an average interest rate in the range of 2.9% to 3% which contributed to the decline in interest expense for the quarter.

13:51 The Trust curtailed discretionary operating capital expenditures for 2020 and also has curtailed it to a certain degree in 2021 in order to ensure the capital is preserved. Other work was postponed due to shortages or logistical challenges resulting from the pandemic. Actual operating and leasing capital expenditures for 2020 totaled $13.3 million against a reserve of $15.6 million and is compared to $22.8 million in 2019. As a result of COVID-19, it is expected that the PCME or operating capital expenditures for 2021 will still be less than the normal amount of $25 million, but will be elevated from 2020.

14:39 The trust has completed the first phase of the redevelopment of the former Sears premises at the Pine Center Mall in Prince George, British Columbia. The new wing consists of approximately 76,000 square feet of redeveloped GLA and is anchored by a winner's home sense that was completed this summer. Approximately 65% of the space is filled and other retailers that are now open include a BC cannabis store. The finalization of some of the remnant space, which includes an additional retailer and some small bay CRU, is expected to take until 2022. The development work on the center in Saskatoon has been continuing and is expected to be completed in the first quarter of 2021. The Trust is also pleased to announce another project for Pine Center, which entails the re-tenanting of the empty Lillis premises into a new, 38,850 square foot Save on Foods grocery store.

15:40 This will result in the demolition of the existing former lowest premises and is estimated to cost in the range of $15 million. This work is expected to be completed in Q3 2022. We believe this will be an effective complement to the mall and will effectively make this mall grocery anchored. A negotiated lease cancellation settlement was negotiated with Lowe's as part of this arrangement and was collected in the first quarter. Wrapping up, while the economy and by extension some of the REITs assets are going through their challenges, we do remain positive about a number of aspects of our business. There are absolutely 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.

16:35 Beyond our retail assets, we have high-quality office buildings in Canada's largest markets, with a high degree of government office tenants. 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 floor to 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 touchtone phone. You will hear a three-tone prompt acknowledging your request. Questions will be taken in the order received. Should you wish to withdraw your request, please press star followed by the two. If you are using a speakerphone, please leave the handset before pressing any keys.

17:24 One moment, please, before your first question. The first question comes from Jonathan Kelscher with TD Securities. Please go ahead.

17:33 Thanks. Good afternoon. First question, just I guess on the distribution cut. How did you guys settle on the amount?

17:50 Well, there are a number of things. This is Ray Salmi. It's not just one thing. There's a number of things, as you know, that we need to retain in a bunch of retail and we need the cash. And that's probably the main one. And beyond that, you know we have also getting ready to deal with the convertible adventure coming later part of the year. So we need to try to conserve as much cash as we can.

18:25 Okay, so if the cut's going to save roughly $15 million in cash per year on an annualized basis, do you think the majority of that goes into retail capex? Retail what? Retail capital expenditures.

18:47 I think it would go into a combination of capex and paying down debt. or at least added liquidity, Jonathan. So it would be a combination.

18:59 Okay. Secondly, just in terms of, it sounds like you got some lease termination income in Q4 and have some more in Q1 with lows. How much was that in Q4 and how much will that be in Q1?

19:19 So I can give you a range of that rather than giving a precise number. It's in the $2 million to $2.5 million range, Jonathan. For which? For Q4 or Q1?

19:33 Just for the lowest one. Okay. And how about in Q4?

19:40 Sorry. Sorry, what was your other question about?

19:49 I think you said in your prepared remarks there that there was some lease termination income in Q4. The results were a little better than you had expected.

19:58 All right. So that didn't really come from any one particular tenant. It came across our portfolio of retail and office tenants. You know, we are having conversations with tenants about, you know, sublease space and continuing on. And some of those conversations resulted in lease cancellations, arrangements, and fees. So, you know, not any one particular tenant, just more variety.

20:31 Okay. And then lastly, for me, just on the bad debts, When do you expect that to start to trend lower? Million dollar question, right?

20:50 This is predicting some of the future. We are hoping they will get better. But at this stage, I mean, I have kind of my view. And, you know, we have, as I said earlier, we have a bunch of vaccines here. We probably have probably another one tough year. And a lot of that coming from retail, some of that from office as well. So it's tough to predict anything at this stage.

21:28 Okay, thanks. I'll turn it back. Thank you. We have a following question from Jenny Mao with BMO Capital Markets. Please go ahead.

21:42 Thanks, and good afternoon. Andrew, just want to clarify the lease termination question that Jonathan asked. So the $2 to $2.5 million from Lowe's, just to be clear, that's going to be recognized entirely in Q1, or was there some that was already picked up in Q4?

21:58 No, that'll be a Q1 item.

22:01 Okay, and just squarely in Q1 without going into Q2?

22:06 Correct.

22:07 Okay, great. With respect to the revenue in Q4, you had mentioned that there was some pickup in non-recurring recoveries, and we can see that in the P&L. It looks like it was several million dollars. How much of that was the non-recurring recovery? So in other words, how much is not going to recur in Q1?

22:29 I would say pretty well all of it. So, you know, it was really just a situation where there were some year-end adjustments processed. And, yeah, I would consider that all to be non-recurring.

22:47 Okay. And also, along the same lines, how much of the revenue bump in Q4 was due to seasonal increases, knowing that, you know, this year's holiday season is quite a bit different than years past?

23:02 as compared to previous quarters, you mean?

23:06 How much of it was a contribution to Q4 that we won't expect to see again in Q1?

23:14 That's a bit of a tough one at this point, Jenny. I think our Q4 is typically a little bit better because we do have some holiday numbers included in that. You know, that trending of quarters compared to what they would typically be on a year-over-year basis, I think we would, you know, you could typically expect that.

23:44 Sorry, that it would be similar to year-over-year or that there was a pretty big impact this year versus last Q4?

23:51 No, I think the trending that you, so if you're trying to look at Q1 of 2021, You know, we'll have one more quarter of less revenue because of the obsidian rent relief that we processed at the beginning of 2020. And then, you know, you're just naturally going to see a decrease due to failed tenants and COVID-19. You know, I'd probably prefer not to put a box around it.

24:23 Okay, that's fair. Moving to the government lease at the petroleum place that you mentioned. So if they've gone into overhold, does that mean that they're paying the old rent for the time being?

24:38 Correct.

24:40 Okay. So you expect this to settle out. So there'll probably be a rent roll down expected when this settles out sometime in Q2, you said?

24:47 Yes. But what that typically means is that we would probably have to give that money back, assuming that the Um, new lease rate is less than the old lease rate, right?

25:02 Okay. Okay. Gotcha. So there'll be some sort of an adjustment. I guess that will happen.

25:08 Correct. Whenever you sign the lease.

25:09 Okay.

25:11 Correct. Okay. So I presume you wouldn't have details of how the mechanics of that would work for now.

25:17 Not really. No,

25:19 no. Okay. That's, uh, that's fine. And then we saw some slippage in office occupancy. Is that just related to some of the lease termination that you mentioned within the office portfolio? And can you speak to exactly where that was? Is it in the Alberta portfolio or the Ontario portfolio?

25:43 Tulio, do you maybe want to comment on kind of what you're seeing from an office perspective? Is that okay?

25:48 Yeah, no problem, Andrew. Well, in the east, we haven't seen any marked increase in vacancy. We're holding our own. The tenants are there. The majority of our properties have government tenants. Well, they're not in the building. They're paying the rent. And, in fact, we're working on government tenancies that are there. expiring later on in 2021. We're dealing with them now and we hope to have renewals on those tenants. So we're not seeing a marked increase in any vacancy.

26:28 Okay, great. That's all for me. Thank you. Thank you. Your next question comes from Bami Beer with RBC Capital Markets. Please go ahead.

26:42 Thanks and hi, everyone. Just with respect to the the $8 million impact, I guess, from tenant failures. I think it was about $3 million from lease amendments. How much of that has already been reflected in your Q4 results?

27:02 That's a bit of a tough one, Pammy. I would say certainly the majority of it has. It's kind of a number comparing back to 2019. If I had to guess, maybe two-thirds of it would be already reflected, kind of in the 50% to 75% at least.

27:23 And so the balance to come off would, I mean, would that generally hit? I guess that will hit once those tenants actually vacate and stop paying rent. So it may not necessarily be Q1, but over the course of this year then for the balance? Yes.

27:38 Yeah, I mean, I think you would see some adjustments in Q1 on a year-over-year basis, right? So you would have that at least. And then after that, it kind of gets blended into bad debt expense, quite frankly, somewhat.

27:55 Got it. Just one last one for me. I guess with the revised payout and maybe factoring in some of the additional capex spend that you talked about, how do you think that positions you in terms of the AFL payout ratio for this year or even sort of a range if you can provide one?

28:15 Yeah, we typically don't give guidance on ranges. We're still We're still trying to figure out what this year is going to look like, so I'd probably decline to provide much guidance on that if I could.

28:31 Got it. I guess said another way, just in terms of the CapEx and leasing costs, incremental spend this year, just to clarify, you think it's going to be less than, I guess, the $25 million that you would typically incur, but north of what you did last year?

28:48 That's correct, yes.

28:52 All right, I'll turn it back. Thanks very much.

28:55 No problem. Thank you. Thank you. We have a following question from Kumai Ganji, private investor. Please go ahead.

29:04 Hey, Ray. Hey, Andrew. Just a quick question here on distribution and payout ratios. Ray, when you decided with the board to cut the payout in 2020 by 50%, and then again recently, What has sort of surprised you? Is it just the duration of this pandemic? Is it the depth of it? Maybe it's a mix of both. But just trying to get some sense on when you guys initially cut, how were you thinking? I mean, the convertible was due and you knew that. So I'm just wondering if you can share some insight on what surprised you a bit on the impacts on the portfolio.

29:43 Well, I suppose as we go through this pandemic, it got worse and worse and worse. There is a lot of pressure on even trying to renew the existing mortgages. So we need to be ready for, as some of the mortgages come due, the lender who want to get paid out, and particularly on the retail front. So it's trying to conserve as much as we can. and uh and you as you put new tenant particularly in retail you need to spend money uh you really in in the olden days we used to be able to go to the lender and as you get a new tenant you can up an asset and most of the lenders are just not interested in uh or as a matter of fact, when the renewal comes, they would want paydown.

30:44 So we are just trying to do as much as we can. I mean, listen, it's painful for us. As you know, Morgar Corp owns about, what, 60% of the... Yeah, so it had a big impact on us as well. We take it pretty seriously. So we're trying to be... as careful as we can be. It's just, you know, I have, as I said earlier, I have a little bit of hope that we have a little bit of a positive view with a lot of vaccines being here. So we may still have another, at least a year or maybe 18 months, a tough time. So in the meantime, the board felt, you know, it had an impact because, you know, the Morgar Corp won pretty close to 60%.

31:35 Right. And we, in the past, have been kind of, you know, dripping in all of that, helping as much as we can. It has, you know, we take it very seriously. It has a major impact from cash flow MRC. So we don't take it lightly. And the board felt that it was prudent to do what we did.

32:05 Ray, that's helpful. Just as a follow-up, I mean, if I look at the asset revalue between Q3 and Q4, assets, I think, on a whole were marked down 3%. So just watching what happened between Q3 and Q4 and then watching the distribution cut, I was just hoping to get some insight on what changed. And from what you're telling me is you're being fairly conservative and you don't want to make any more cuts. So is that fair?

32:35 Listen, this is one of those things, just like the governments are trying to predict anything, it's very difficult to predict. So we are trying to do, we took it very, you know, we didn't do it earlier, but we took it, and some of the board members were also conscious about that we don't want to get the V to get into liquidity crisis as well. And as you know, you know, You know, 60% of the distribution go to MRC, and it has an impact on MRC cash flow. So we don't take it lightly. It's an unpredictable time. So we just continue to go each month and each quarter. So hopefully when things get better. And now, you see, you know, we're being hit from all fronts. As some of the mortgages come due, some of the lenders want pay down, particularly on retail.

33:32 and the best they might renew what we have. And some of them may want us to find other lenders, particularly on retail. It's pretty tough to find a new lender.

33:48 That's it for me, Ray. Thank you. That's helpful. Thank you. As a reminder, ladies and gentlemen, should you have a question, please press star followed by the one on your touchtone phone. There are no future questions for this. Oh, apologies. Your following question is from Vikram Ronad with PKR. Please go ahead.

34:11 Hi, good afternoon. I just have a quick question. You mentioned in your previous answer the idea of maintaining additional liquidity and making a provision for the ability to to pay down debt, which has come up for renewal. I'm just curious, what is the quantum of buffer fund that you're planning to put together over the course of, let's say, this year from savings and distribution cuts? And what is the number you're looking at putting aside for extingencies? Thank you.

34:57 I'm not sure we've defined those buckets. At this point, we're still sorting through various capital requirements and such based on new leasing opportunities and such. So, yeah, we haven't really defined what those buckets exactly look like.

35:29 Okay. All right. Thank you. Thank you. Your next question comes from Chanzing Lama, private investor. Please go ahead.

35:40 Thank you. I'm just curious to hear a little bit more about the refinancing reluctance by lenders for the retail properties. Could you talk a little bit about that? And I'm curious also, on those properties, what the characteristics are, like loan to value ratios, why are lenders sort of, is it across the board for retail or is there something specific about the properties where you're seeing that reluctance? Thank you.

36:09 I can answer that. I'm a former lender myself. I used to work for Bank of Montreal. The banks go through this cycle. They have their own policy. They don't really share with us. and particularly they're very, very conscious about, their credit departments are conscious about lending against retail period. So there's no distinction between good retail versus bad retail. It's just not a, and particularly as the mortgages come due, we've had incidents that they would like to pay down as opposed to renewing. In the past, we were able to up finance. So this is the reverse. of that. Some of that financing we've done over the past now is becoming challenging these days. So there's no particularly, it's probably pretty well across the board on retail. The lenders are not really interested in lending against retail.

37:14 They would prefer to get paid. So for relationship purposes, we are able to kind of renew as much as we can and in some places we may have to pay down because the value of the property has gone down. The cap rate changes and cash flow changes. So there's no one particular situation but all of them. That's what happens with the different kind of lenders.

37:50 Thank you for that. I wish you and the team good luck.

37:55 Thank you. The next question comes from RBC. Please go ahead.

38:02 Thanks. Just maybe along the same lines, coming back to the 2021 maturities, the mortgage maturities that are coming due, whether it's Pine Center or Prairie or even Petroleum Plaza, are there any concerns at all with refinancing any of those and And do you anticipate that you may actually be required to pay down some of those loans as they actually come due?

38:29 I don't think we want to be specific on any particular asset, Andrew. It will depend on the time. I think you've just got to take each one at a time at a cost, depending where it's located. Some of them a few years away. The retail world, all retail will be challenging. It's going to double down here, as I said earlier. One is renewal mortgages. Secondly, you have vacancies. You need to put tenants, and you need to put money in to get a tenant in. And some of the office may very well have challenges as well.

39:17 So we're just hoping and praying that this pandemic doesn't last too long. And as I said earlier, with multiple vaccines being here, hopefully within the next six months to 18 months, things will get better. And maybe the lender will change their own guidance. And there's not a whole lot more we can add.

39:49 That's helpful. Thanks, Ray. I will all turn it back. Thank you. Thank you. There are no future questions at this time. You may proceed.

40:01 Okay. Thank you, everybody, for joining the call, and 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.