2023-07-29 22:38:07 ET
Allied Properties Real Estate Investment Trust (APYRF)
Q2 2023 Earnings Conference Call
July 25, 2023, 10:00 AM ET
Company Participants
Michael Emory - President and CEO
Cecilia Williams - EVP and CFO
Conference Call Participants
Jonathan Kelcher - TD Securities
Lorne Kalmar - Desjardins
Matt Kornack - National Bank Financial
Gaurav Mathur - iA Capital Markets
Pammi Bir - RBC Capital Markets
Dean Wilkinson - CIBC
Jenny Ma - BMO Capital Markets
Presentation
Operator
Ladies and gentlemen, thank you for standing by, and welcome to the Allied Properties REIT Second Quarter 2023 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Cecilia Williams, President and CEO. You may begin your conference.
Cecilia Williams
Thanks, Josh. Good morning, and welcome to our conference call. I'll be presenting briefly on the second quarter, and I'm joined by Dan and JP to answer questions. Michael is also here with us. We may in the course of this constant call make forward-looking statements about future events or future performance. These statements, by their nature, are subject to risks and uncertainties that may cause actual events or results to differ materially, including those risks described under the heading risks and uncertainties in our 2022 annual report and our most recent quarterly report. Material assumptions that underpin any forward-looking statements we make include those assumptions described under forward-looking statements in our most recent quarterly report.
Our second quarter was positive operationally. Demand for our space remains strong, as indicated by true activity. We also leased significantly more space than last quarter, and net rent per occupied square foot continues to increase, up from one quarter to $23.51.
Higher interest expense and longer lease-up time frames resulted in lower than budgeted same asset NOI, FFO and AFFO per unit in the first half of the year. Although temporary net interest expense will materially decrease going forward with the paydown of $1 a cent [ph].
Our results for the year have been impacted, moderating our outlook. The good news is that we continue to see demand for our space products with store activity continuing to increase. Closing on the UGC transaction will be deliberating in many ways. Operationally, the entire team will now be potion binding the workspace portfolio. Financially, we'll be able to meet obligations while barely using our lines through 2027.
Our GAAP metrics will also continue to improve as our development completions turn economically productive. Our fourth annual ESG report was released on June 26. I'm pleased with the progress on our plan to net-zero carbon, including establishing an internal cost of carbon to support internal decision-making and forecasting. More details on our progress will be disclosed in next year's report.
My confidence in our long-term outlook remains strong. Our portfolio has performed well over the last 3.5 years of upheaval and will continue to do so through the current headwinds because ultimately, we have the space that people want. More importantly, our team has never been stronger, more focused or better integrated.
I hope that was a helpful update. We are now pleased to answer any questions.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question comes from the line of Jonathan Kelcher with TD Securities. Your line is open.
Jonathan Kelcher
Thanks. Good morning. First, I guess just on the tourist facility, you talked about them being up year-over-year and quarter-over-quarter. On the quarterly change, how much of that, if any, is seasonality Q2 versus Q1?
Cecilia Williams
It's hard to tell because we had actually a pretty strong Q1. And so I'm not sure, it doesn't seem to necessarily be a huge seasonal impact to the ones Jonathan that we've picked up on from a tourist perspective.
Jonathan Kelcher
Okay. And then year-over-year, the number of tours, how would that compare to like a stronger office market that we saw pre-COVID?
Cecilia Williams
I think this quarter is representative of what we would have seen in a stronger office market. The average store that we had over the last 3.5 years, about 219 per quarter and this quarter, we had 292, the tours were up in each. So above the quarterly average in Toronto and Vancouver and in Calgary with Montreal being at the quarterly average.
Jonathan Kelcher
Okay. That's helpful. And then just switching to -- you called out the castle as a nonrenewal there for the bump in vacancy this quarter. And I think that is an intensification property over time. Can you maybe give us a little bit more color on that? Were you hoping to get this vacancy? Or will you be looking to put in a short-term tenant? How should we think about that playing out?
Cecilia Williams
If we had an opportunity immediately, we would have built it. It's not a current-day intensification, but something that would be in the medium to longer term.
Jonathan Kelcher
So you'll look to fill out with the short-term tenant, I guess?
Cecilia Williams
That's fair.
Operator
Your next question comes from the line of Lorne Kalmar with Desjardins. Your line is open.
Lorne Kalmar
On the guidance, you referenced a couple of things that drove the revision in guidance. Was there anything different that's changed in your outlook from when you initially issued the guidance to present day?
Cecilia Williams
No, when we originally issued the guidance at the end of January, it was based on a different interest expense or cost of debt outlook than what materialized in the first half of the quarter. Now that will be addressed in the second half as we pay off $1 billion of debt. So that would be the main difference.
Lorne Kalmar
Pay off $1 billion of debt will definitely help. And then I believe last quarter, you mentioned the goal of trying to get to around 90% committed occupancy by year-end. Do you think that's still achievable?
Cecilia Williams
We're targeting to finish the year with a higher lease area than what we started. That's always been the goal. And we're still targeting that.
Lorne Kalmar
Fair enough there. And then one other ticky-tack one. I noticed the TELUS Sky loan was extended for a year. Could you maybe give some color on what was behind that?
Cecilia Williams
It's just finishing up the development and the residential component.
Michael Emory
Yes. And actually, it is a loan to our partner. It is not a loan to us. So our partner has its facility Allied that has no debt in relation to TELUS Sky nor does TELUS itself has any debt in relation to TELUS Sky. It relates solely to our development partner, Westbank.
Lorne Kalmar
And it's not indicative of anything maybe broader issues at Westbank. It's specific.
Michael Emory
No, it is not.
Lorne Kalmar
Okay. Great. Thank you so much for the color.
Operator
Your next question comes from the line of Matt Kornack with National Bank Financial. Your line is open.
Matt Kornack
Just quickly going back to the occupancy side of things. You and the press release provided a fairly sizable list of leasing velocity that you've done and Montreal seems to figure pretty prominently. I know there was a vacancy there. But is that a market where you're still expecting to pick up some incremental occupancy? And then with regards to maybe the tannery, is there any news on that space?
Cecilia Williams
Yes. On Montreal, absolutely expected to take a consultancy there. And Canary, we are currently in negotiations with the user looking to take a significant amount of space.
Matt Kornack
Okay. And then on leasing costs, TIs and leasing costs, particularly, and it looks like renewal space more so than new leasing has picked up a bit over the last couple of quarters. Is there anything to that? Or is it just specific to the space that's being leased at this point?
Cecilia Williams
Specific to the space pad is a base where the user has been in place for some time and this time for more work to be done so to speak, though it is very much space-specific.
Matt Kornack
Okay. And then the last one for me. I noticed in your commentary, you highlighted something that I think most of us know, but that you own one of the largest urban land banks. It's economically productive. But you mentioned mixed-use density potential.
If you could give us a sense as to whether your thought has changed on the office versus residential component of that mixed-use density potential? And then maybe on the potential to monetize any of that in the near to medium term or if you plan on building it out yourself?
Michael Emory
Matt, it's Michael. No, we have not shifted or altered our focus on distinctive urban workspace with respect to our intensification potential. As you know, we have always been prepared and we have always believed that mixed-use intensification of very expensive land at the inner city is the best way to realize value; the wellbeing probably the most spectacular example of that in our history. And going forward, we see the same thing.
We will not develop condominium residential space on our land going forward as we did in Toronto that was an exception of the norm, but we're very prepared to have mixed-use, retail, office and rental residential on appropriate sites in the inner city and no one owns more appropriate sites with that in the intercity vanillin. So it doesn't reflect the shift in our emphasis.
It will always be on the state of Ervin workspace. But we have always recognized going as far back in about 2012, that's the best way to intensify high-value urban land in Toronto and elsewhere is with the mixed-use format.
We will get more support from the municipal authorities. We'll get more support from the market, and we'll be able to create something that is more durable over time, which is why we want it to be rental residential to the extent there is a residential proponent.
Matt Kornack
And just with regards to the residential rental, is that something -- again, this is probably not imminent, but it's something that you would own yourselves and manage? Or would you like to have a partner...
Michael Emory
We might have a partner to manage, but we would absolutely own our proportionate interest or entire interest in rental res. We are very pleased with the rental component of Telus Sky happen to own that indefinitely. The rental component of 19 Duncan, which will start to fill up either late this year or early next year, we'll be in a sounding asset, we own 50% of it for all time.
So I think it's a very good asset for us to own in a mixed-use urban development. We won't go out. I can't imagine and simply develop rental residential buildings, but we're very happy to own rental residential components of mixed-use for the development.
Matt Kornack
Makes sense. Thanks guys.
Operator
Your next question comes from the line of Gaurav Mathur with iA Capital Markets. Your line is open.
Gaurav Mathur
Thank you and good morning, everyone. Just on the leasing front, are there any nonrenewals that you see coming up over the next few months across the portfolio?
Cecilia Williams
Nothing of significant priority and negotiations with the leases going up in the next 18 months and most of them will be renewing.
Gaurav Mathur
Great. And just as a follow-up to that, on the positive renewal leasing spread this quarter, could you perhaps provide some color on what's driving that? And how do you see that trend over the future?
Cecilia Williams
We expected to continue having a higher level of renewals. As you know, we had a loan level in 2022, primarily driven by the one on renewal in Kisner, but we expect to be closer to our distoble rate of 75% to 80% renewal rate this year.
Gaurav Mathur
Okay, fantastic. And lastly, and this is a bit broader macro question on your guidance trim. As you trim the guidance, how much did you factor in the stubborn work-from-home that you're seeing in the MTV cities versus being in a negative economic cycle?
Cecilia Williams
What we took it to account, I guess, opposing forces. One is that the temporary impact of the higher interest rate in the first half of the year, which we will be more than offsetting in the second half when we offset combined with the lengthening lease-up time frames, that parallel with our high level of tour activity, which we consider to be the leading indicating metric means we are still very confident that the lease deals will come.
It's a matter of time. So nothing really from a work-from-home perspective because what we're seeing is more and more or what I should say, increasing levels of physical reapplications across our portfolio, across the country and not just in our portfolio, but it's all of the higher quality space across country.
Gaurav Mathur
Okay, great. Thank you for the color, Cecilia. I'll turn back to the operator.
Operator
Your next question comes from the line of Pammi Bir with RBC Capital Markets. Your line is open.
Pammi Bir
Thanks. Good morning. And maybe just building on the last question and the comments there, again, just given maybe the resilience that we have seen in the economy and labor markets, are you noticing any shift in the tone with your tenants in terms of the leasing discussions? And is there perhaps any concern over a recession still weighing on space needs or maybe the timeline it's taken to commit to space?
Cecilia Williams
It's really more around the macroeconomic uncertainty causing, I guess, longer decision-making time frames, but to endure in terms of people believing that it may no longer be office space, they still need it. It's more a question of whether it's the same amount or modestly more, modestly less, but we're still seeing great demand from tech, from educational uses and from medical services. So we need to be consistent with being [indiscernible]
Pammi Bir
Okay. And then just on the Shopify sublease space. Any update there on where that stands or progress on releasing it from Shopify?
Cecilia Williams
I'll say, Pammi, that we're pleased with how things are progressing there, and I can't really comment any further at this point.
Pammi Bir
If there was a tenant of significance like the interest and a big chunk of the space. In that type of scenario, would you engage with that tenant directly? Or is it too early to say at this stage?
Michael Emory
Pammi, not to interject unduly, but we have found over a very long period of time that no large user will sublease space, they will always want to deal directly with the owner, and that will certainly be the case here. There is almost no possibility of a large user subleasing from Shopify, they will want to be in direct contract with the owner and the owner will be quite prepared to enter into direct contract with good replacement users, and that will work to the benefit of both the owner and Shopify over time.
That's how I think this will unfold almost certainly, that's how it almost invariably unfolds, especially with large space, which we've dealt with on many instances over the years. So there's no question as to how this will unfold. It's just a question of when and with who. And we will work comparatively with Shopify to achieve a result that is good for both the owner and the original. And we will be successful in doing that.
Pammi Bir
And then just one last one for me. Looking at the intensification pipeline that you disclosed in your MD&A, I think it's on Page 68. I think you've disclosed the value of roughly $700 million. But what NOI are these properties generating? I believe at some point, early last year you stopped disclosing the annualized NOI. I'm not sure if what maybe the reason was, but if you have any update on that, that would be helpful.
Michael Emory
I think the reason we would have stopped then, Pammi, was because of the uncertainty in the market with respect to future demand for office space, with respect to construction costs, with respect to just about everything relating to development. So it was probably more speculate than it had been previously.
And I think we would be reluctant to do anything other than give them very general orders of magnitude in the future if we do it all, I think the more important point being made there is there's extraordinary existing intensification potential, how valuable that will be and how much value we could drive into that five, 10 years out, I don't think it's worth speculating about at the structure.
Pammi Bir
Yes. Sorry, Michael. My question was more so on the NOI that's currently in place on those assets. That's the piece that was no longer disclosed. Is that what you were referring to or...
Cecilia Williams
I don't have that number handy, Pammi, but you can probably stay at a similar portfolio-wise cap rate and apply to – I don't have that number handy. We decided not to disclose it because we don't think it's useful information.
Operator
Your next question comes from the line of Dean Wilkinson with CIBC. Your line is open.
Dean Wilkinson
Quick question, Cecilia. On the new leases, are you utilizing more third-party brokers? I just noticed a big uptick in the leasing commissions there and just wondering if that's coming from external or internal sources.
Cecilia Williams
We are using some in some situation or third-party brokers, yes.
Dean Wilkinson
And then from the landlord's work perspective, would that just be taking some older space similar to the improvements you had to do for the renewals, like site-specific? Or was that also an indication of general requirements in the market?
Cecilia Williams
No. Absolutely site-specific.
Operator
Your next question comes from the line of Jenny Ma with BMO Capital Markets. Your line is open.
Jenny Ma
Just wanted to go back on the sublease space with Shopify. When it comes to state of this magnitude, how is Shopify involved in the process? Like is it everyone has a representative and there's three parties at the table in discussions? And is it possible that if you do find a user not to take up the whole space and at some point, Shopify can exit out of the whole lease and no longer be involved going forward?
Michael Emory
It invariably involves will of three parties to identify. They may or may not be represented, but they usually are. And yes, at the end of the day, if the transaction works as best serves the interest of all involved, the original tenant is allowed off the hook and has that obligation behind them. Obviously, the owner is only prepared to do that when it gets an equivalent covenants or an equivalent quality covenant.
We've done that in many, many instances where it's work held really well for us as owner and really well for the original tenants or user who we allowed to, if you will, get off the hook because the only way that a party can enter into direct privity of contract with the owner is if the original tenant is effectively relieving responsibility. Obviously, there's economics involved in all of that.
But it's a very workable arrangement and it's invariably in the interest of all concerns the original tenant gets rid of contingents, their real and contingent obligation. The new tenant is very happy to commit to the space with the owner.
And the owner is very happy with the governance of the tenant. So that is how it will evolve. And yes, to answer your question, at the end of the day, Shopify, we'll be able to put this behind it and the owner will be in at least as good a position as it was in with the original tenant.
Jenny Ma
Right. So the ability that for Shopify to be off hook is really at your discretion then, to your satisfaction. However, the discussions play out.
Michael Emory
Absolutely, we have no obligation to enter into direct contract with a new tenant. Now we will do that in an effort to help our existing tenants and to enter into a relationship with the new one. But it's entirely within our discretion, which is why we've always said when we're in a situation where good spaces on the sublease market without being self-satisfied arrogance or overbearing, we are in control.
Jenny Ma
Okay. Great. I have a housekeeping question related to the G&A. It looks like in this quarter, there was some capitalized related to the sale of the UDC portfolio. So I'm just wondering, is the delta of the difference from Q2 to Q1, the piece related to UDC? And is there going to be any more of that coming through for Q3?
Cecilia Williams
The delta is and there will be minimal amount beyond Q2.
Jenny Ma
Okay. So it's mostly expensed in this quarter then?
Cecilia Williams
Yes.
Operator
[Operator Instructions] We'll pause for just a moment to gather any remaining questions. There are no further questions. I'd like to turn the call back to Cecilia Williams for closing remarks.
Cecilia Williams
Thanks for joining our conference call. We'll keep you updated on our progress going forward.
Operator
This concludes today's conference. Thank you for joining. You may now disconnect.
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Allied Properties Real Estate Investment Trust (APYRF) Q2 2023 Earnings Call Transcript