MGRUF - Morguard Real Estate Investment Trust (MGRUF) Q3 2023 Earnings Call Transcript

2023-10-26 20:14:10 ET

Morguard Real Estate Investment Trust (MGRUF)

Q3 2023 Earnings Call Transcript

October 26, 2023 04:00 PM ET

Company Participants

Andrew Tamlin - Chief Financial Officer

John Ginis - Assistant Vice President of Retail Asset Management

Tom Johnston - Senior VP of Western Asset Management

Todd Febbo - Vice President of Eastern Office Management

Rai Sahi - Chief Executive Officer and Chairman of the Board

Conference Call Participants

Jonathan Kelcher - TD Securities

Tom Callaghan - RBC Capital Markets

Presentation

Operator

Good afternoon, ladies and gentlemen, and welcome to the Morguard Real Estate Investment Trust Third Quarter Conference Call. [Operator Instructions]. This call is being recorded on Thursday, October 26, 2023.

I would now like to turn the conference over to Andrew Tamlin, CFO of Morguard Real Estate. Please go ahead.

Andrew Tamlin

Good afternoon, everyone. My name is Andrew Tamlin, Chief Financial Officer of Morguard REIT. Welcome to Morguard REIT's third quarter 2023 earnings conference call. I am joined this afternoon by John Ginis, Assistant Vice President of Retail Asset Management; Tom Johnston, Senior VP of Western Asset Management; Todd Febbo, Vice President of Eastern Office Management; along with Rai 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 point out that our comments will mostly refer to the third quarter 2023 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 the call.

Overall, we're again pleased with the third quarter results, which showed continued improvement in net operating income on a year-over-year basis. In fact, net operating income for the quarter increased slightly to $30.6 million in 2023 from $30.4 million in 2022 due to steady net operating income results in the retail asset class. Net operating income for the nine months ended September 30, 2023, increased 4.4% to $92.6 million, due both to the increase in same asset income plus a onetime property tax refund received in the first quarter for one of the Trust & Co.'s regional centers in the amount of $2.8 million, which related to vacant space and past failed tenants such as Target.

FFO for the quarter decreased 16% to $14 million in 2023 as compared to a year ago due to higher costs in the Trust short-term or variable rate debt. Same asset net operating income for the third quarter remained steady from a year ago, buoyed by results from our retail asset class and in particular, our enclosed malls. Overall, our same asset net operating income was flat for the quarter as compared to a year ago. Interest expense has increased 20% to $16 million for the quarter on a year-over-year basis. The impact of lower debt on a year-over-year basis has been offset by higher short-term borrowing costs due to the higher interest rate environment we find ourselves in.

Higher interest costs and renewals and mortgages have also been a factor. The Trust has approximately 26% of its debt is variable at September 30, 2023, and which is elevated from approximately 18% at year-end. We anticipate that this number will decline by the end of the year as we work on renewing some of this debt on a long-term basis.

The Trust will continue to monitor this and would expect to see it somewhat elevated in the near future. As mentioned previously, our enclosed mall results continue to rebound from the downturn we saw under COVID. In the third quarter, we have seen more than half of our enclosed malls have double-digit increases in sales per square foot as compared to 2019. Pine Centre in Prince George, for example, is up more than 35%. This has led to positive rental growth upon renewals for tenants at our enclosed mall assets.

We are continuing to see a bounce back of the performance of these assets. During the quarter, we had a $52 million fair value loss in our real estate properties, which was attributable to a 25-basis point increase in cap rates for our office asset portfolio. This compares to a $73 million fair value loss recorded a year ago. The REIT's PCME or operating and leasing capital reserve was established to be $25 million for the year. However, the Trust has spent $26 million as compared to a reserve of $19 million for the nine months to date and capital in the amount of just $13 million spent last year at this time.

We are expecting elevated capital needs above the reserve amounts in future quarters into 2024. Approximately $9.5 million of this increase is due to enhanced leasing capital for this year. Otherwise, contractor delays from last year and some catching-up spending from past years has contributed to this increase. Our overall occupancy level of 90% at September 30 is relatively unchanged from last quarter and down from 91% a year ago. This decline is attributable to the softness in the office market, which continues to see challenges. We are seeing this downturn primarily in our Ontario office assets whereas our office assets at West are holding occupancy or even increasing.

And now for an update on our Leasing efforts. In 2023, there is an approximately 73,000 square foot and retail GLA coming due. We do expect that every retail tenant larger than 5,000 square feet to renew their space. There is also approximately 133,000 square feet in office space still coming due in 2023 and we believe will renew virtually all of the space. We feel positive about getting some good uplift in rental rates for the 82,000 square feet industrial space coming due in 2024 as well. Looking ahead to 2025, I note that we have 525,000 square feet and space at Penn West Plaza coming due. We are actively working with these tenants to determine their needs beyond this date.

Presently, we have renewals for approximately one half of this space, and we're having good conversations with all tenants. This will become a multi-tenant building at that point. Leasing discussions for both office and retail opportunities have definitely picked up in the last year as both current and prospective tenants now have a better handle on what to expect going forward.

This has led to numerous conversations about various opportunities at our properties across the country. Management has had 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 an overhaul. For most of the time since then, the province did not want to pursue renewal discussions. However, this has now changed, and we are having engaged -- and we're engaging with them about the renewal of this space. At this point, though, it is too early to tell how this will conclude.

Turning to financing and liquidity. The Trust has $126 million in liquidity at the end of the third quarter, which is comparable to $121 million at the end of 2022. The Trust completed two new financings this quarter on unencumbered strip assets for total proceeds of $36 million. During the fourth quarter, there was a scheduled paydown of $8 million from the Penn West Plaza renewal completed a year ago.

Further, we expect a paydown of $30 million in the fourth quarter for renewing a mortgage on an enclosed mall. We do expect that there will be limited opportunities of up financing available during 2024. We are especially pleased with the results from Pine Centre in Prince George, British Columbia. This mall now has a new Save-On-Foods grocery store, which opened at the end of September. This has led to leasing opportunities in this mall, including Lululemon, Sephora, H&M, and others. The addition of grocery further complements the strong anchor tenant profile at the mall.

The Trust has also announced a remerchandising development project at St. Laurent. This is intended to strengthen the tenant mix and promote long-term growth through targeted investment in discriminatory retailers. This cost is expected to be approximately $13.5 million and is expected to take 24 months to 36 months to complete.

The Trust is continuing to have conversations with new tenants for this mall and also existing tenants about possibly expanded space. Wrapping up, we are pleased with the resiliency of our assets and the improved results and activity levels from our enclosed mall and retail segment. While there still is room to grow to get back to pre-COVID results, we have seen positive results in the last year. We are looking forward to continued positive leasing conversations for our assets. Most of our enclosed malls remain dominant in their geographical area and our strip malls, which are largely grocery-anchored, have performed well. 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 unitholders. We look forward to continuing to execute our strategy, and thank you for your continued support. We will now open the floor to questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Your first question comes from Jonathan Kelcher of TD Cowen. Your line is already open.

Jonathan Kelcher

Thanks. Good afternoon. First question, just on the valuation of the office properties and the change in cap rates there. Did I catch that correct? You said 25 bps it went up because the MD&A, it kind of looks like it was up 70 -- 70 basis points.

Andrew Tamlin

You might be looking at the year-to-date, Jonathan.

Jonathan Kelcher

No, I think I've got June 30, it was a weighted average of 6.9% and now you have 7.6%. But in any event, the -- what was actually -- what's behind the increase? There hasn't been a lot of transactions. I was curious as to the thought process of increasing that.

Andrew Tamlin

Well, it's really just a challenging office environment as I'm sure you're well aware. You're right, there isn't really many transactions happening in the office asset class these days. However, our internal valuations team continue to look at surveys and data from surveys, and they just thought it was appropriate to make these adjustments based on that data.

Jonathan Kelcher

Okay. That's fair enough. Secondly, on the mortgage -- on your mortgage book. Next year, it looks like you have a 64% loan-to-value, I think in your prepared remarks, you said you expect limited upside potential. But could we expect to see any paydowns on some of those renewals?

Andrew Tamlin

It's possible. Nothing in the first half of the year, but it's something that we're monitoring. We do have an unencumbered asset pool to tap into as well. But we're not really looking at any major financings as part of that, for sure.

Jonathan Kelcher

Okay. And what's sort of like four 30 is quite a bit for you guys? What's sort of the cadence that over the course of the year? Is it evenly split or front or back half-loaded?

Andrew Tamlin

I would say it's probably evenly split throughout the year.

Jonathan Kelcher

Okay. And then just lastly, on the two mortgages you did in September, both on retail properties. What was the loan to value and spread that you were able to achieve on those?

Andrew Tamlin

They were about 60%, 60% to low 60s, give or take, from a loan to value and spread was around 190 bps.

Jonathan Kelcher

Okay. And what would you expect for office spreads right now?

Andrew Tamlin

Higher than that. I'm not sure I can give you an answer on that, Jonathan, but it's definitely -- it's not 190. That's for sure.

Jonathan Kelcher

Okay. And then I guess, lastly, just to close it out, on the four 30 next year, how much of that would be office versus retail?

Andrew Tamlin

So, off the top of my head, it might be about half and half, but I can get you a better answer on that off-line.

Operator

Your next question comes from John [indiscernible] private investor. Your line is already open.

Unidentified Analyst

Hello, everybody. Thank you for taking my call. I would love to hear your current thoughts about development opportunities within your portfolio, starting with how you plan to move forward with Burquitlam Plaza? And then whatever other properties you think have the most interesting future potential. Thank you.

Andrew Tamlin

At this point, Burquitlam would be the property that we would be looking at first for development. But right now, we're just working on the entitlements for that. So -- we need to get through that first. I don't know that there -- we do have other development opportunities in the book, but there's not anything that would be kind of ready to go, John.

Unidentified Analyst

I'm just thinking, looking out, say, five years or 10 years, to get a sense of how much potential there would be at some of the sites like you have a downtown Ottawa site that you've accumulated several parcels over time. And then the St. Laurent shopping center has a lot of growth potential. There's a subway stop right there. Just any thoughts that you could share about where those might have room to grow five years to 10 years from now?

Andrew Tamlin

That would be the right time frame, five years to 10 years from now. There’re still entitlements to get on some of those sites. We have partners in some of those sites as well. So, I think that's the right time frame.

Unidentified Analyst

And then with regard to the Burquitlam Plaza, do you have any expectation about how you would finance your capital requirement for that? Or would you look for a development partner for it?

Andrew Tamlin

I could see us looking for a partner on that, but it's still a little bit too early to tell, John.

Operator

Your next question comes from Tom Callaghan from RBC Capital Markets. Your line is already open.

Tom Callaghan

Just first one for me, Andrew. I just want to make sure I heard right in the prepared remarks. In terms of that overhaul out in Alberta with the government tenant, did you say you're now discussing options with them? Is that here, right?

Andrew Tamlin

That's right. Yes. For the longest time, they had just said, we'll get back to you when we get back to you -- and so it's pretty quiet. So now at least we're having conversations. It's tough to really know where they're going to go, but the good news is that we're having dialogue.

Tom Callaghan

And when you say tough to network, is the expectation still they'll look for that to keep that space or it's more broad in terms of options here going forward?

Andrew Tamlin

Yes. Sorry, what I meant was by like terms and like the term of the renewal and stuff like that.

Tom Callaghan

Got it. Yes. Okay. That makes sense. And then just maybe switching gears on occupancy levels, like they ticked up a bit there, I think, on a sequential basis in retail and office. Can you maybe just provide some color there and outlook? Retail -- is there anything seasonal in there that will roll off into 2024? Or was that more kind of the same type of momentum you guys have kind of talked about the last few quarters?

Andrew Tamlin

Would you mind talking about retail, John?

John Ginis

Sure. Thanks, Andrew. Retail during this time of year typically sees seasonality in its occupancy. We're entering the holiday season. So, you'll see a bigger pop in Q4 when we post results but some of that was also good momentum on leasing. Retail as Andrew has indicated through his opening remarks, has seen pretty good renaissance over the course of since it's coming out of COVID. So, it's co-mingling of both good occupancy from good leasing and also seasonality somewhat. But again, more of it will be seen in Q4.

Tom Callaghan

Got it. And then just any color on the office side of things? Like I know you guys kind of called out the divergence between Ontario and Alberta. Is that something you kind of continue to expect to see? Or any color there?

Andrew Tamlin

Yes. We have seen the divergence in between the two provinces. We've seen real good leasing activity in Alberta, which is good news. There has been some struggles in Ontario. I would say, going forward, it's probably going to be flattish to maybe a little bit down. I don't think there's anything that is really immediate that we need to worry about in the next couple of quarters.

Operator

[Operator Instructions]. There are no further questions at this time. We'll hand over the call to Andrew Tamlin. Please go ahead.

Andrew Tamlin

Thank you, everybody, for joining the call. We appreciate your time and look forward to next time. Thank you. Have a good night.

Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation, and you may now disconnect.

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Morguard Real Estate Investment Trust (MGRUF) Q3 2023 Earnings Call Transcript