Crombie Real Estate Investment Trust (OTC:CROMF) Q3 2022 Earnings Conference Call November 10, 2022 11:00 AM ET
Company Participants
Ruth Martin – Investor Relations
Don Clow – President and Chief Executive Officer
Clinton Keay – Chief Financial Officer and Secretary
Conference Call Participants
Mario Saric – Scotiabank
Tal Woolley – National Bank Financial
Operator
Good morning, ladies and gentlemen and welcome to the Crombie REIT’s Third Quarter Earnings Call. [Operator Instructions] Note that this call is being recorded on November 10, 2022. I would now like to turn the conference call over to Ruth Martin. Please go ahead.
Ruth Martin
Thank you. Good day, everyone and welcome to Crombie REIT’s third quarter conference call and webcast. Thank you for joining us. This call is being recorded in live audio and is available on our website at www.crombie.ca. Slides to accompany today’s call are available on the Investors section of our website under Presentations and Events.
On the call today are Don Clow, President and Chief Executive Officer, and Clinton Keay, Chief Financial Officer and Secretary.
Today’s discussion includes forward-looking statements. As always, we want to caution you that such statements are based on management’s assumptions and beliefs. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. Please see our public filings, including our MD&A and annual information form for a discussion of these risk factors.
I will now turn the call over to Don, who will begin our discussion with comments on Crombie’s overall strategy and outlook along with the development update. Clinton will review Crombie’s operating fundamentals and highlights and then discuss our financial results, capital allocation and approach to funding, and Don will conclude with a few final remarks. Over to you, Don.
Don Clow
Thank you, Ruth, and good day, everyone. Thanks for joining us. We’re wrapping up our third quarter at a time when the world is facing substantial headwinds on many fronts whether they be geopolitics, the economy, inflation, rising interest rates, climate change or important social issues. At times like these when I’m especially thankful to be leading an organization that is focused on a long term strategy that is defensive in nature yet has a unique ability to drive solid consistent growth. Our commitment to strategic alignment and investing in our sustainable competitive advantage and our largest tenant empire, while at the same time investing in real estate development to accelerate growth and both AFFO and net asset value is underpinned by our proven stability and well-positioned portfolio.
We’ve supported this approach to capital allocation with a strong balance sheet and a respected team, which together give us confidence that we are not only prepared for any additional turbulence that may impact the real estate industry, or the economy in Canada, but we’re also poised to grow our company prudently well into the future. Consistently solid fundamentals have been a hallmark of Crombie from the time of IPO 16 years ago.
This quarter is no exception, as our third quarter results show record occupancy healthy NOI growth, one of the lowest debt to gross fair value and debt to EBITDA in history and the highest level of unencumbered assets at $2.2 billion. These solid operational and financial results come from a deliberate curation of our portfolio through purposeful investment and the acquisition of grocery assets, modernizations and conversions. The disposition of low growth and/or noncore properties paired with increased development of grocery anchored retail, retail related industrial, and mixed use residential properties in Canada’s largest cities. The improvement in our portfolio required a lot of hard work by our team over a long period of time. And we’re now seeing the benefits of this transition in our operational performance and financial results.
Grocery anchored retail, industrial and mixed use residential are three of the most desirable asset classes in Canada and as such have a profile of resiliency in tough times with the opportunity for growth during good times that we believe will outperform other market classes over the long term. Additionally, Crombie’s strategic relationship with Empire including our shared intelligence allows us to understand consumer markets and supply chains in real time, and anticipate the future performance of real estate with data driven analytics that we believe will also result in strong performance. This time of interest rate volatility and the highest inflation we have seen in over a generation.
Our focus on defensive assets with a unique ability to drive long term sustainable growth and a commitment to the continuous improvement of our balance sheet allows us to remain resilient, yet balanced, with a level of growth that we believe is responsible for these highly unusual times.
Development remains a key component of our strategy as after an initial drag during construction and lease up these projects will ultimately drive NAV and AFFO growth. While importantly expanding our presence in the country’s top markets, particularly [indiscernible] Bronte Village is our 481 unit mixed use residential development, inclusive of grocery and pharmacy, located in Oakville reached substantial completion earlier this year. Bronte continues to lease up as 50% or 240 units have been leased as of November 4, 2022. Rents over 10% above pro forma. Stabilization of NOI is expected to be reached in the first half of 2024.
Momentum continues at Le Duke our 387 unit mixed use grocery and residential development located in Montreal. Le Duke continues to demonstrate solid leasing results with 90% or 345 units least as of November 4, 2022 and rents over 5% above pro forma. Stabilization of NOI is expected in early 2023. about 300,000 square foot Voila customer fulfillment center in Calgary.
Base building work is nearing completion. Building handover occurred in late September allowing Ocado to commence their building of the interior grid, including the robotic grid platform. Our team continues the hard work of moving projects through the entitlement process. At the end of the third quarter eight projects had zoning in place or had rezoning applications submitted with the potential debts of 4 million square feet of GLA, including over 4000 residential units. The sale of our King George site and Surrey British Columbia closed in early November.
This transaction is proof of the concept we have stated over a number of years, where we worked hard on achieving the entitlement of mixed use development lands that’ll be utilized for the build out of our development pipeline, or from time to time be utilized to fund our business with low cost capital as an alternative to issuing equity that is trading at a significant discount NAV. King George was sold that a sub two cap rate to an honorable local Vancouver developer with the preservation of the retail opportunity for Empire a solid strategic outcome.
With that, I’ll now turn the call over to Clinton who will highlight our third quarter operational financial results and discuss our capital funding approach.
Clinton Keay
Thank you, Donnie, and good day everyone. Crombie achieved record occupancy in the third quarter with economic occupancy at 96.2% and committed occupancy at 96.8%. Year-to-date new leases increased occupancy by 286,000 square feet at an average first year rate of $21.39. While we experienced 171,000 square feet of net lease expires, vacancies, terminations and space adjustments. Approximately 68% of new leases were completed in VECTOM and major markets. At the end of the quarter 119,000 square feet of GLA was committed at an average first year rate of $22.86 per square foot which will boost future NOI growth as tenants take possession throughout 2022 and into 2023.
During the quarter, 152,000 square feet of renewals were completed and an average increase of 3.7% over expiring rental rates. Driving this increase was 160,000 square feet at retail plazas with an increase of 4.4% over expiring rental rates. An increase of 5.2% was achieved for third quarter renewals when comparing expiring rental rates to the average rental rate for the renewal term. Year-to-date, Crombie demonstrated portfolio stability with approximately 45% of renewals occurring VECTOM in major markets. Total renewal activity consisted of 682,000 square feet with an increase of 4.5% over expiring rental rates. We have achieved a balance of renewal growth across VECTOM major markets and rest of Canada.
Strong operating fundamentals supportive as quarterly same asset cash NOI increase of 2.1%, compared to the same quarter in 2021. Primary drivers of this increase are strong occupancy, higher percentage rent from increased sales and increased parking revenue. This is offset in part by a decrease in lease termination income, primarily in our office portfolio, adjusting for the removal of lease termination income in 2021 same asset cash NOI increased by 2.7%. For the quarter AFFO per unit was $0.26 increasing from $0.25 for the same quarter last year. While FFO per unit was $0.30 increasing from $0.29 for the same quarter last year.
AFFO and FFO payout ratios in the quarter were 84.5% and 75%, respectively. The increase in AFFO and FFO for the quarter is primarily due to lower finance costs from operations driven by lower mortgage interest as a result of mortgage repayments and disposition since the third quarter of last year and a decrease in G&A due to reduction in unit base compensation costs. For the third quarter G&A was 3.7 million or 3.6 as a percent of property revenue. Crombie has and will continue to prudently manage our balance sheet and responsibly allocate capital.
These actions have led to notable deleveraging, well ladder debt maturities with the minimal near term expires, and a healthy weighted average return to maturity, all of which are extremely important especially in today’s challenging macroeconomic environment. Our unencumbered asset pool reached a record high of approximately 2.2 billion, increasing from 1.8 billion to Q4 2021.
As a percentage of unsecured debt unencumbered assets were 183%, up from 129% in the fourth quarter of 2021 providing Crombie with additional financing flexibility and optionality. We also had ample available liquidity of 445 million at the end of the third quarter. Debt to gross fair value, including Crombie’s portion of debt and assets held an equity account of joint ventures was 42% at the end of Q3 improving from 45.3% at Q4, 2021. The improvement in our leverage ratio was primarily the result of an increase in total gross fair value of 390 million from acquisition activity, investment in development and the substantial completion of Bronte village in early 2022.
We ended the quarter with debt to trailing 12 months adjusted EBITDA at 8.5 times down from 8.99 times at December 31, 2021. The improvement is primarily due to lower outstanding debt as a result of mortgage repayments and higher adjusted EBITDA driven by increased property revenue mainly from acquisitions and strong occupancy.
Crombie had a weighted average cap rate of 5.71%, excluding joint ventures at the end of the third quarter compared to 5.65% at December 31, 2021. Property dispositions development completions and strong demand for grocery anchored assets all helped compress capitalization rates. However, this compression has been more than offset by the recent increase in capitalization rates for certain types of retail properties. Our weighted average cap rate and inclusive of joint ventures remained flat at 5.54% when compared to December 31, 2021.
As Donnie indicated earlier subsequent to the quarter on November 1, Crombie disposed to King George with net proceeds of approximately 84 million well above our book value. This transaction is a stellar example of the significant underlying value embedded within our portfolio. These funds will be used to repay short term debt and provide financing optionality for future growth initiatives, including Empire related investments and our development program.
With respect to the 150 million series D unsecured note maturing November 21, 2022 management intends to utilize a new unsecured non-revolving bank credit facility in order to provide maximum flexibility with respect to the timing of obtaining longer term unsecured debt while maintaining ample liquidity.
With that, I will now turn the call over to Donnie for a few closing comments.
Don Clow
Thank you, Clinton. Before we move to questions, I’d like to highlight the work our team has completed on the sustainability front. While we’ve always been mindful of our impact on the environment, we are upping our game through a focus on sustainability and the accountability created through external reporting, target setting and internal scorecard metrics. This is no small feat, and for those have also committed to this hard work I applaud you. Crombie completed at second submission to Grisby to the standing investments and development benchmarks. We are pleased to be awarded a Green Star for excellence and development. With that we are focused and committed to improving our performance for a greener tomorrow.
In September, Avalon mall BOMA won Canada’s 2022 outstanding building of the year, the TOBY award in the retail category, TOBY award as the most prestigious and comprehensive program of its kind in the commercial real estate industry in Canada.
Judging for this award is based upon building standards community impact, tenant relations, energy conservation, environmental and sustainability management, emergency preparedness and building personnel training. We are very proud of our team at Avalon mall for the significant accomplishment. Our continued and significant level of work on sustainability will evolve over time and I am excited to authentically confirm Crombie advancements over the next few years.
In conclusion, this quarter’s results are further proof that we have a solid strategy, a resilient portfolio A strong financial condition and a capable team that is able to withstand economic volatility, while also providing solid long term growth. Our team has earned this place through hard work, adaptation to significant external market forces and savvy delivery of our unique strategy. Well done team.
That concludes our prepared remarks. We’re now happy to answer your questions.
Question-and-Answer Session
Operator
Thank you, sir. [Operator Instructions] Your first question will be from Mario Saric at Scotiabank. Please go ahead.
Mario Saric
Hi, good afternoon.
Don Clow
Hi Mario.
Mario Saric
I wanted to focus a bit on the occupancy gain this quarter was up 30 basis points on a lease basis, which is good to see. It pretty much all came from rest of Canada as opposed to VETCOM or major markets. So hoping you can shed a bit of color on kind of which specific tenants are taking space. And kind of the geographic locations where you’re seeing the most traction.
Don Clow
Hi Mario, it’s Donnie. It’s all over. The good news is it’s widespread. I think it’s really more a commentary on the sector. The grocery anchored classes as a sector call it bifurcated from retail in general. But it’s pet stores is Dollarama. It’s QSR. But it’s old football analogy, I’m an old football player was blocking and tackling just the hard work day-to-day of leasing.
And I just give a shout out to our leasing team who’s doing I think an incredible job to get us to that record occupancy. We don’t often have records and it’s nice to have one. So but it’s all over the country, quite frankly, and it’s more of a sectoral issue than I think anything else and great teamwork. And I’ll call it a [quarter] we talked about curating our portfolio over the last decade, it’s just a consistent improvement of the quality of the portfolio. So I think it’s driving this.
Mario Saric
Got it. Some of the categories and Dollarama. Those are kind of they’re not new, kind of to your retail pro forma part of the discussion during and hopefully post COVID is the potential migration of retail tenants from enclosed structures to more open area and centers that that you use. Are you seeing any of that like, are you seeing any kind of format that you attended types coming in [indiscernible]?
Don Clow
I’d say we’re seeing it selectively. So you’re seeing a number of tenants that used to only be in enclosed, coming to plazas, outdoor plazas, and seeing the benefits of being near grocery stores. I think that theme is certainly started and moving but it’s not widespread. And especially I call it tertiary markets where the grocery stores are so important is the center of town often so. But it’s moving. Yes, I’d say it’s positive for our sector.
Mario Saric
Okay, and then having achieved record occupancy, when you look out into 2023 whether it be retail or office, are there any meaningful lease expires that you’re aware of that won’t be renewing at this stage?
Don Clow
No, no, no, we’ve got a small amount of leasing coming due rolling over and ’23 and ’24. First what we’re used to. So that’s a good thing in terms of especially at times when economy is a little more volatile, people are talking about recession, etc. So and again, the assets are defensive in nature. So we’re cautiously optimistic that we will be fine.
Mario Saric
Got it. Two more questions on my end, just any updated thoughts on owning 100% of CFC3?
Don Clow
Calgary that is on entirely by Crombie.
Mario Saric
No, I know. But any updated thoughts on continuing to own 100% of it, or do you see an opportunity given price –?
Don Clow
No, no. No, I’ll jump in Mario. So selling assets is not our strategy. Right. Keeping them for the long term and the cash flow growth is clearly our strategy. The sale of King George by way of example, or even 50% of CFC2 they were really just more funding issues, funding opportunities, I’ll call it. And so and it depends on when the conditions are right. But it’s definitely not our strategy to sell. And it’s a very strategic asset. But it obviously depends on the times as to what happens in the next year or two or three. The capital markets have been extremely volatile. We are seeing real prices bounce all over the place, and often with a massive disconnect to reality on the ground. So for us, it can from time to time be a funding issue, but it’s not our strategy.
Mario Saric
Okay. My last one, just for Clinton, the seven to eight basis point quarter-over-quarter, Q3 versus Q2, tap rate increase. Can you highlight kind of the breadth of that increase over the portfolio and how much of it would be kind of substantiated by actual transactions on the ground versus kind of, for lack of a better way of saying putting your finger up in the air [indiscernible]?
Clinton Keay
Mario quarter-over-quarter we didn’t see a lot of activity, most of that just have a follow some of the monitor sort of evaluations that we would have received. So it’s really minor adjustments, and no, we’re really in particular. So I would characterize the quarter as being sort of not much change at all from quarter-over-quarter from what we’ve been seeing.
Mario Saric
Okay. Thanks guys.
Don Clow
Thanks Mario.
Operator
Thank you. [Operator Instructions] And your next question will be from Tal Woolley at National Bank. Please go ahead.
Tal Woolley
Hey, good afternoon.
Don Clow
Good afternoon Tal
Clinton Keay
Hey Tal.
Tal Woolley
In terms of like the 100 million your plus you’re raising from the King George site sale. Do you have like an immediate use of proceeds for it? Like, should we be expecting some Empire dropdowns or something like that to come? Like, how are you thinking about using those funds as they come in?
Don Clow
Yes. I think in the short term, definitely to pay down our debt. We do have a series D unsecured note coming due at the end of this month. So clearly that sort of supports allowing us to have ample liquidity by the end of the year.
Tal Woolley
Okay. And then it’ll be sort of another meaningful year for dispositions as well. I think, I can’t remember, I think it was the last year before COVID where you sort of had significant volume and required a special distribution at the end. When you look at your textbooks [indiscernible].
Don Clow
Yes. Based on our current projections, certainly okay for this year.
Tal Woolley
Okay. And then it’s sort of the time where we start rolling out 2024 estimates. And Donnie I’m wondering if you can comment a little bit just about capital deployment. I know you sort of just got on prior calls that like ’23 might look a little lighter than normal. Is your working theory right now that 2024 will look a little bit normal as or a little bit more normal, based on what you expect to have proved and ready to go in the pipeline?
Don Clow
Yes. What we said last quarter was that we were just moderating our spending to some degree, based on external conditions. Everybody can see the call it various risks that are out there, and I named them all in my prepared remarks. There’s a lot of, and so we’re okay with that. I still think our ranges are in that 100 to 200, for Sobeys and 150, to 250 for development. And some years you’ll be at the upper end or some years at the lower end. I think, what I would say to you is that we probably be at the upper end for Sobeys and at the lower end on development, just some of the projects like Broadway commercial, we’re just taking a little more time to get extra density.
West Hill is looking like it’s we’re targeting getting it started, hopefully in 2023, but subject to lots of pre-work to get the development ready to make a decision. And other small developments, as we’ve called them, where we’re working very closely with Sobeys to increase the amount of I’ll call it risk adjusted or lower risk type spending. So but net-net, all sort of in those two ranges and the increase on the Sobeys side is again, just have what we think we start on second base.
We own the land. We have a great relationship with a tenant that gives you two big things and when you’re going to do some development, whether that be hubs or spokes, most likely they’ll be spokes now because the hubs are selected. But modernizations, expansions, conversions, etc, etc. Those are solid returns for us. They help our major tenants significantly meet its targets under project Horizon. So and the returns are good. And so it’s creative investment.
And so for us, that’s a little more of the focus then the major development in ’23. But nevertheless, still in those ranges Tal.
Tal Woolley
And I’m just wondering if we think about, like, maybe something that’s a little bit more a little larger and more complex, like the Broadway project, like, if you have the zoning in hand today. Do you think you’d be greenlighting that today? Because they appreciate that, like, today’s conditions might not be ideal, but it’s probably four to five years of work in front of you. I’m just wondering how you’re thinking about that these conditions that we’re sort of in right now persist for a while?
Don Clow
There’s no question it’s a tougher time for people to commit to large projects. I think you’re seeing it all over the real estate industry. We can talk about a number of different types of developers that have pushed/pause or pushed/ stopped, put pens down, but you’re still seeing others move forward.
The good news for Crombie is that our pipeline has a big weighting in Vancouver and Halifax. And in those markets, even though we’re seeing inflation, still ramping to some degree. We’re also seeing rents rise, and so the numbers still work. The margins may be a little smaller, but it’s still manageable. But we don’t, I wouldn’t tell you exactly would we go today or not. It would depend on us.
We generally pre price 70% of the contracts. We want to have them locked in. And in that project, you’re going to need a bit of pre-selling on. There is one condo tower three. So you have work to do to be ready to push the button to go. So I think the good news is the markets or if there’s any two markets in the country, I think those two are two of the best to actually continue on you look around Halifax is an example of Vancouver, there’s still cranes in the sky, people are still doing good work.
So they are still reasonable, but it’s on a macro level, it’s harder, no question. Right. So we’d have a tougher consideration of that as we’ve tougher lens to look through, no question.
Tal Woolley
Okay. And then just lastly Empire had put out a press release just about some IP issues that they were dealing with. I think everything’s completely separated between the two of you. I just wanted to verify that there’s, there’s no issue for you guys as a result of that.
Don Clow
We’re not going to comment on Empire. Just refer to the November 7 press release. And we’ll just say there’s no material impacts at Crombie to the best of our knowledge.
Tal Woolley
Okay. That’s great. Thanks very much, gentlemen.
Don Clow
Thank you.
Operator
Thank you. [Operator Instructions] And at this time, we have no other questions registered, I would like to turn the call back over to Ruth Martin.
Ruth Martin
Thank you for your time today. And we look forward to updating you on our fourth quarter call in February.
Don Clow
Thanks, everybody.
Clinton Keay
Thanks, everyone.
Operator
Thank you. Ladies and gentlemen, this does indeed conclude the conference call for today. Once again, thank you for attending. And at this time, we do ask you please disconnect your lines.
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