Nexus Industrial REIT (OTC:EFRTF) Q2 2022 Earnings Conference Call August 12, 2022 11:00 AM ET
Company Representatives
Kelly Hanczyk – Chief Executive Officer
Robert Chiasson – Chief Financial Officer
Conference Call Participants
Brad Sturges – Raymond James
Kyle Stanley – Desjardins
Gaurav Mathur – iA Capital Markets
Jimmy Shan – RBC Capital Markets
David Chrystal – Echelon Capital Partners
Operator
Thank you for standing by. This is the conference operator. Welcome to the Nexus Industrial REIT, Second Quarter 2022 Results Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation there will be an opportunity to ask questions. [Operator Instructions].
I would now like to turn the conference over to Mr. Kelly Hanczyk, Chief Executive Officer. Please go ahead.
Kelly Hanczyk
Thank you. I’d like to welcome everyone to the 2022 second quarter results conference call for Nexus Industrial REIT. Joining me today is Robert Chiasson, the Chief Financial Officer of the REIT.
Before we begin, I’d like to caution with regard to forward-looking statements and non-GAAP measures. Certain statements made during this conference call may constitute forward-looking statements, which reflect the REIT’s current expectations and projections about future results. Also during this call we will be discussing non-GAAP measures. Please refer to our MD&A and the REIT other securities filings which can be found at sedar.com for cautions regarding forward looking information and for information about non-GAAP measures.
It was another solid quarter in the books. As mentioned in the previous quarter, we look forward to the balance of 2022 and 2023 where we will begin to see significant rental rate growth in the portfolio, especially in our Southwestern Ontario portfolio.
In the second quarter we closed on an 80% interest in development land with RFA Capital Partners and Hamilton Ontario, where we plan to build a 250,000 square foot industrial building with completion in late 2024. This is our second parcel of land in Hamilton with RFA for future development and subsequent to the quarter we have closed on the third development parcel.
In southwestern Ontario, our London portfolio was not only clients with significant rental rate growth, but also has the ability to add additional square footage to our existing facilities. We have submitted for permits for the construction of 100,000 square foot addition to our building at 1285 Hubrey Road, which we hope to break ground early next year.
In addition, we currently are negotiating with existing tenants in the portfolio for another approximately 100,000 to 125,000 square feet of expansion to their existing premises. The REIT has 22 acres of excess land in the Titan Industrial Site in Regina, Saskatchewan that was acquired in February 2022, and we have completed the design build package and we are actively marketing to build approximately 300,000 square feet build out soon. We also have the option to transact on 10 additional acres of additional land at the Acropolis warehouse facility located on the Edmonton airport grounds.
As mentioned last quarter, we are under contract for three additional properties, a brand new strong covenant distribution center in Ottawa to be completed in January 2023. The one is London, which is the unit deal, which is in the process of having 150,000 square foot new addition being built and expect it to be completed mid-2023. This is an extremely valuable site as there is significant additional land to continue to expand the facility as the tenant continues to grow. And then thirdly, an approximately 85,000 square foot cross dock facility to be built in Balzac, Alberta with one of the existing tenants, which is expected to be completed in late 2023.
Subsequent to the quarter end we closed on a 94,000 square foot strong tenanted A Class industrial facility in Quebec City, where we assume debt at the rate of 3.63%. We have also weighed conditions on a 75,000 square foot industrial facility in Montreal, where we will see annual rental rate increases of approximately 3.5%.
We are also in due diligence on a four building, approximately 450,000 square foot industrial portfolio in southwester Ontario of approximately $37 million, which is at a very attractive cap rate in a price per square foot that we believe will provide considerable value to the REIT. As you can see we have an active pipeline of deal flow, but we will slow this process after these transactions and focus on developing the aforementioned sites with a higher returns within our existing portfolio.
In Richmond BC we continue with the redevelopment of approximately 60,000 square foot building for two tenants. It is now expected that completion and possession to occur in mid-September as the final set-up of their spaces in nearing. This will be a world class facility upon completion.
We’re also planning a 74,000 square foot addition which would provide significant lift to the REIT’s NAV. We are also applying for bonus density, which if approved would allow for approximately 450,000 square foot of additional usable square feet and can be built in the future providing additional value to the site.
Montreal, we continue to work with our developer on the sale of the excess land at [inaudible]. The developer is still moving on with approvals from the city. It’s expected now that our first payment from them will be in February 2023.
On the disposition front, we have sold a retail property located in Chateauguay, Quebec for $8.3 million and the purchaser has laid conditions on a mixed use property in Longueuil, Quebec. Post-sales and post-closing of our industrial acquisitions, the REITs Holding will increase to approximately 87% of NOI derived from the industrial sector.
Our three billing office portfolio will be relaunched in the fall, when it is anticipated that interest rates stabilize and the acquisition market begins to open up. In addition, our retail mall in Victoria, Quebec will be launched for sale in the fall, now that we have completed a lease extension and expansion with our largest tenant. We also continue to negotiate a deal with the non-solicited offer for our portfolio of non-core assets that would allow us to recycle this capital in the future.
I’ll now hand it over to Rob Chiasson to give greater detail on the REITs financials.
Rob Chiasson
Thanks Kelly. As Kelly mentioned, we put some more of our capital work on July 11 when we acquired a $19 million property in Quebec and we have a firm deal on another $18 million acquisition, and another $37 million deal under diligence. The acquisition is completed in Q1 contributed the REITs results for a full quarter in Q2 and we saw our AFFO payout ratio come down from 96.7% in Q1 to 90.3% in Q2. Absent the impact of a $460,000 unrealized foreign exchange loss in the quarter, the payout ratio would have been 87.4%.
The unrealized FX loss negatively impacted pre unit measures by $0.06. We have approximately $150 million of recently acquired properties that are on leverage and will begin to borrow against these properties in the third quarter to close properties we have under contract.
As anticipated, acquisitions completed mid-Q1 generated an additional $1.5 million of NOI in Q2 as compared to Q1, partially offset by higher associated interest expense. Our Q2 G&A was approximately $500,000 lower than Q1, primarily due to the timing of our SU expenses driven by investing. Q3 will see the positive impact of rental rate growths recorded in our Q2 MD&A, as well as leasing deals concluded subsequent to quarter end.
All of this contributed to an increase in normalized FFO per unit from $0.19 for Q1 to $0.20 for Q2, $0.21 excluding the unrealized foreign exchange loss in the quarter. AFFO per unit increased from $16.5 in Q1 to $17.7 for Q2, and it would have been $18.3 excluding unrealized foreign exchange loss in the quarter.
For the remainder 2022, we have approximately $20 million of mortgages at a weighted average interest rate of 3.55% that will mature. In 2023 we’ll have approximately $50 million of mortgages with the weighted average interest rate of 4.26% that will mature. Bond yields have come back recently, almost a 100 basis points off the recent highs.
I’ll now turn the call back to Kelly.
Kelly Hanczyk
All right, thanks Rob. We will open up the line to any questions that you may have.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions]. Our first question comes from Brad Sturges of Raymond James. Please go ahead.
Brad Sturges
Hi! Good morning.
Kelly Hanczyk
Hey! Good morning.
Brad Sturges
I appreciate the additional disclosures on the leasing front there. Just on the 191,000 square feet, you’re kind of in advanced negotiations in terms of renewal. Can you give us a sense of what you’re expecting from a rent spread perspective?
Kelly Hanczyk
Yeah, I think, let me just look here. Trying to just see what’s included in that. We have 156 million [ph] – I’d say overall in there you are probably around 100% spread. I’m trying to figure out what in the 191,000.
Brad Sturges
The 191,000 that’s mainly in London, is that correct?
Kelly Hanczyk
Yes, the majority of it. When I look at the balance, in April of next year we have 35,000 square feet, where we’ll probably see approximately $8 a foot, $7 or $8 a foot left on that. We have another one in – it comes at the end of January of next year. 115,000 square feet where we’ll probably see about $4.50 a foot on that, and then we had 44,000 square she come up in – starting with July of this year where we saw, I think it’s $2 and change on that 44,000. And then another one comes up and starts in November where we see about $1.20 left on that.
Brad Sturges
Okay. And then just more from a modeling perspective, but how should we think about the non-industrial expiries coming up. Would it be kind of more stable rents on renewal or how should we think about the spread there?
Kelly Hanczyk
Yeah, so when I’m looking at the next 12 months on the retail portfolio from a larger scale, here we’re probably sharing fairly well to be honest. So it’ll be kind of I’d say slight growth, not extreme, may be 1% or 2% on the retail portfolio. And when I go down to look at the office side, I think that would be probably stable or yeah, right around stable, no real growth there.
Brad Sturges
Okay. Just turning to the assets side, obviously starting to complete some transaction there, how is pricing still turning relative to your book value and where your expectations were maybe at the start of the process that valuations so far held in to your expectations.
Kelly Hanczyk
Yeah, so with the two that we did sell, I would say we are just slightly below book value. We pulled the three billing portfolio, because when we are marketing it interest rates were driving up significantly, which put – everybody seemed to have the pens down. So we pulled it and we are holding it to the fall. Because I think now that interest rates have stabilized, they’ll generate a greater amount interest. So that’s what we try to have planned for the Victoriaville three office assets.
It’s hard to tell right now, because the institutional side of buyers and that have gone pen down for a while just until interest rates stabilize. So I think you know hopefully September, October, November that will churn around once things are clearer in the market.
Brad Sturges
You’re working through the process on the Western Canadian industrial central bit there. I mean, where are you in that process, and you know is there any – can you give any thought in terms of a potential transaction at this point?
Kelly Hanczyk
It’s a little bit early, but what I can say, we’ve been back and forth a few times and we put our final kind of terms to paper and they are in the process to see if that works for them and their financing. I’m cautiously optimistic that we’ll have a deal, but you never know.
Brad Sturges
Okay, I’ll turn it back. Thanks a lot.
Kelly Hanczyk
Okay, thanks.
Operator
Our next question comes from Kyle Stanley from Desjardins. Please go ahead.
Kyle Stanley
Thanks. Good morning guys.
Kelly Hanczyk
Good morning.
Kyle Stanley
Would you be able to just talk about the contractual escalators you’re getting on new leases across the portfolio, and you know just generally maybe where you see the average escalation currently?
Kelly Hanczyk
Yeah. So we have our CPI increases last and when I look at what we’ve done and what we’re doing in southwestern Ontario right now, I’d say there are significant contractual. For example, we did do one I believe that’s 750. That’s going to go you know 8.25, 9, 9.75 something along those lines. So they are in southwestern Ontario, they are kind of averaging I’d say 7% to 10% on the renewals that we’ve recently done.
Kyle Stanley
Okay, okay perfect. Maybe just switching over to your view of the acquisition market currently, I mean it sounds like obviously you got a portfolio under diligence. Are you seeing the same volume of off market deals that you have in the past, and then you know how are you thinking about capital allocation here.
You did mention maybe the slowing down a little bit once maybe you can finalize this portfolio in southwestern Ontario and moving over to development, but maybe just a bit more information there on that portfolio in southwest Ontario. Is that from your existing vendor or is this a new relationship?
Kelly Hanczyk
Yes, so let me see, we had the Quebec City one under contract before. So we closed on it. It’s all solid asset; a great addition to the portfolio. The one that we have weighed due diligence on, sale leaseback, a nice property again in Montreal area with 3.5% negotiated rental rate increases. So I think sourcing stores is good on the rental rate increases.
And then the southwestern Ontario kind of fell in our lap and the cap rate is just extremely attractive and so nicely accretive for us. It’s well on a price per square foot. It’s very cheap and from an in-place rental rate standpoint, it’s well below market. So, we looked at that transaction and it’s nicely accretive for us, so we are going to move forward with it, if the due diligence all pans out, which we are in the process of doing right now.
But after that we’ve kind of gone down and that may change when we see how the Western Canada portfolio goes on a sale process, because then we will have some cash again, but we are being more selective, because we can see we have a number of development opportunities, so we will need cash to complete those and those are higher returning for us. So we’re kind of focused a little bit right now on that development side, ensuring through what we have and I’d say be very opportunistic on the acquisition side if we see a deal like the one in southwest Montero, which I forgot to answer is a separate vendor than our London vendor.
If we see that kind of deal come forward, we’ll act on them. But this one was just – the pricing was exceptional and we jumped on it.
Kyle Stanley
Okay, thanks for that. And just two kind of quick housekeeping modeling questions. The vender rent obligation added to FFO was up maybe about 150,000 sequentially. I’m just wondering how we should interpret that. Is that your expiation of kind of the NOI, you know once that becomes fully operational?
Robert Chiasson
Yes, so I think we added August and July, and so we amortized in the amounts that are current, and we accrued two months up till September 1 I believe. I think that there’s roughly about $200,000 a month of vender rent obligation that will come to NOI once that Phase 1 is fully tentative and the tenants are paying rent.
Also there’s adjustments’ happening. There is the adjustment for future, like the adjustment is going through other income for future NOI and then there’s the stuff that we would have accrued last quarter that we’re adjusting in our normalized AFFO form.
Kyle Stanley
Okay, no that makes sense. And just the last one is, maybe you could provide a little more detail on the FX loss and maybe why it’s just not added back to your FFO?
A – Robert Chiasson
Well, we follow the real pack white paper and it doesn’t seem to allow for a FFO add back. It allows for an add-back where you have foreign investments that are being translated back, but it doesn’t allow for any other add backs. So we’ve got about a $10 million liability that sits on our balance sheet, relating to an acquisition that we completed in 2021. And so when we sort of value that to the FX rate at the end of the quarter, it generated the $500,000 FX loss.
Kyle Stanley
Okay, understood. Thanks for that. I’ll turn it back.
A – Kelly Hanczyk
Alright, thanks Kyle.
Operator
Our next question comes from Gaurav Mathur of iA Capital Markets. Please go ahead.
Gaurav Mathur
Thank you and good morning everyone. A couple of quick questions at my end. So you know we’ve seen the spirit of price discovery happen across most induction markets in Canada, even though there are still being a record high demand for assets. So just in your opinion, do you think we’re closer to finding a tentative flow price in some of these markets or are we still somewhere – or are there still some ways to go, given that underwriting remains extremely strong and rents continue to grow.
A – Kelly Hanczyk
Yeah, it’s an interesting time right now, right, because of the interest rates and where they are going to settle. So it looked like, I don’t know, a month ago or three weeks ago, the five year was so expensive that we thought there’d be some cap rate decompression. But now it’s going the other way and it’s interesting, trying just to see where demand is going from an acquisition side.
So a lot of guys have gone pens down, so the number of buyers there right now are fewer, but I expect that to ramp up in the fall. And then from a rental rate standpoint, I think there’s still significant room to grow. You’re seeing it in GTA, you’re seeing it in Southwestern Ontario. You know I think in London they quoted new rental rates of $11 and change, so I think that’s slightly optimistic, just because it was based on relatively few transactions.
The rental rates are pushing and they are continuing to push. So I think we still have – I think we have still quite a bit of steam in the rental rate growth and last end in Ontario and Quebec, and I think we will see pretty strong activity in the fall, that’s what I’m predicting.
Gaurav Mathur
Okay, fantastic! And just staying on the rental rate theme here, how are you thinking about leasing velocity going into ‘23 with the upcoming lease renewals? I mean is that something that’s proving to still be a bit of a pens down situation among the possible tenants or are tenants pushing forward and looking for space in the non-core markets?
A – Kelly Hanczyk
No, for sure. You know we’re in discussions on expanding existing tenants in our portfolio and we are lucky to have quite a bit of land that we can build on. So you know some of our largest tenants that really aren’t going anywhere are looking to expand their space, so – and I’m talking about you know a tenant that’s been at $4 and change in that rental rate is going to be significant, and if we can build, you know it’s going to be a nice return for us there.
So we’re seeing rental rate growth across the board, so I think overall and even in Edmonton and Calgary you’re seeing movements, you’re seeing strong demand. So I think overall the fundamentals in the industrial sector are still strong, you know we’ll see them stronger in 2023.
Robert Chiasson
I think we’re seeing early renewal discussions more often than tenants putting off renewals.
Gaurav Mathur
Okay, great. And just lastly on this, how are you thinking about leasing costs going forward, because I understand that tenant demand is there, but is there anything on the leasing costs which may surprise on the upside?
A – Kelly Hanczyk
It depends. I mean when we’re talking about some of the ones that we have here other than a possible broker commission, there’s no significant leasing costs here, which puts you in the southwestern one, which is the south western Ontario, which is the majority of our expiry so. The demand is such that it’s a landlord market, not a tenant market, so that bodes well.
Gaurav Mathur
Okay, great. Well, thank you for the color everyone and I’ll turn it back to the operator.
A – Kelly Hanczyk
Thanks.
Operator
Our next question comes from Jimmy Shan of RBC Capital Markets. Please go ahead.
Jimmy Shan
Thanks, good morning.
A – Kelly Hanczyk
Good morning.
Jimmy Shan
I was wondering, in your lease expiry schedule there is – in 2024 in Alberta, there is about 245,000 feet coming due and it’s at $19 rent. I just wondered if you could talk a little bit about that and I’m not exactly sure about that, but it just kind of stands out on the schedule.
A – Robert Chiasson
Yes, so I believe that’s MasTec, one of our tenants in Blackfalds, Alberta. So I think currently they are subletting and there’s a fair amount of land attached to that, which is why the rental rate is higher.
A – Kelly Hanczyk
Yeah, to be honest at this point right now, those markets are improving, but I think we’d be a little bit high on the rental rate renewal, but it’s a little bit too soon to tell.
Jimmy Shan
Okay. And the majority of that 240,000 square feet are those guys?
A – Robert Chiasson
I think the other one in there is Canada Cartage towards the end of 2024. You know I honestly don’t have 2024 in front of me, but I could certainly get back to it with more details off the call.
Jimmy Shan
Okay, thanks. And then I guess similarly, you know Ontario you know in the next couple years rents are kind of at mid-5’s, high-5’s and you were saying earlier that southwestern Ontario rents are around $10, $11. Is that about right?
A – Kelly Hanczyk
They were $9 – yeah, they were $9 in change last quarter and the last CBRE report had them at $11. I think the $11 was a little high. So I think when I’m looking at things, we’re looking at somewhere between $9 and $10 going forward.
Jimmy Shan
Okay. And I think I might have misheard, but when you’re doing those reseals, what are the contractual step-ups. Is it the 3, 3.5 that you’ve done recently.
Kelly Hanczyk
No, it’s more like 6% to 9% on the ones that we’ve done recently.
Jimmy Shan
I’m sorry, 6% to 9% annually?
A – Kelly Hanczyk
Yeah. And for example and I guess it depends on the lease, but when I’m looking at two of the larger ones here, one has almost 10% annual increases and the other one has probably more like 7%.
Jimmy Shan
And this is off a $9 to $10 rent?
A – Kelly Hanczyk
One of them is off the $7.50 rent, so it’s a long term tenant and – or $6.50 rent and we kept it down to then increase them significantly throughout this term.
Jimmy Shan
Okay, I see.
A – Kelly Hanczyk
Yeah, so it depends on where we started them.
Jimmy Shan
Right, right, okay. Okay and then just on that southwestern Ontario that’s in diligence, any – can you share maybe a range, a cap rate range. You talked about how it sounds like it’s a really good deal where we’re in a range of price per foot.
Kelly Hanczyk
Yeah, $7.
Jimmy Shan
$7? Yeah.
A – Kelly Hanczyk
Okay, and is it – I mean obviously that’s not the market I would assume and so is there a – what – is there – can you provide some context as to the circumstance that has arose for you to get such a good deal?
A – Kelly Hanczyk
Not really. I think the vendor chose to deal with us knowing that we typically close and we’re easy to deal with. So it was, I wouldn’t say necessarily sophisticated real-estate vendors, so that’s not your business. So I think, it’s just a strong deal and we were happy to see it.
Jimmy Shan
Okay. Thank you.
Robert Chiasson
So just getting back to your earlier question, there’s eight expiries in 2024 that are making up that total in our [inaudible] that are making up that total in Alberta. And there are roughly, 20,000 to 50,000 square feet and I’d expect actually most of them will renew, but it’s still early.
Kelly Hanczyk
Definitely they are renewing.
Robert Chiasson
I would think that the rents on renewal there would be relatively flat to slight positive.
Jimmy Shan
Okay. Even the one that’s subletting the space? Like do you think that you will be able to revenue that at same high rate?
Robert Chiasson
Yes, so the sublet I think is actually 2025. So yeah, like in 2024 Alberta, after having looked at the details it’s a number of smaller square footages, some light industrial stuff, some warehousing. So on average I think we’ll have…
Kelly Hanczyk
I’d say it was probably flat. If anything it’s not too far below. Because when I look at it, it’s a mixed bag here.
Jimmy Shan
Okay, great. Thanks.
Kelly Hanczyk
Thank you.
Operator
This concludes…
Bob Chiasson
You can take the last call in the queue.
Operator
Okay. Our final question comes from David Chrystal of Echelon Capital Partners. Please go ahead.
David Chrystal
Hey, thanks guys. Just really quickly building on Jimmy’s question there, do you have a figure for maybe a portfolio wide mark-to-market GAAP in the industrial portfolio?
Robert Chiasson
We don’t, we provided the leasing details by province, the expiries by province and which will allow – you know to allow for analysis, but we’re not publishing market trends. I would, yeah – we have a significant lift in [inaudible] Quebec. We are probably relatively flat in [inaudible] I would say, but yeah we don’t have a control over that.
Yeah, so it would be fair to say that, I think you provided a lot of detail on Ontario there, and kind of you know rents probably pushing the double digits. But, if I look at kind of Alberta Saskatchewan and Quebec, you know broadly there’s not a huge amount of upside from current levels, would that be fair to say.
Kelly Hanczyk
I think Quebec is fairly strong in terms of, upside.
David Chrystal
In the near term. I guess, you just got a 0.5 million square feet already at that 14 level. So, it’s a lot of the near term upside.
Robert Chiasson
Yeah, there is not a lot of square footage coming up in Quebec in 12 months, yeah agreed.
David Chrystal
Okay, that’s helpful. And maybe building on the other line of question there, you mentioned in Saskatchewan in the MD&A, a roll-down on one lease. Is there any other near term risk of roll-downs that you see?
Robert Chiasson
I don’t think near term. I think towards the end of next year we might see one or two, so the one in Saskatchewan and a couple of others where we might see a little bit. Those are properties that have quite a lot of land attached to them. And those markets, I mean those markets are shifting a little bit. There is a lot more activity with oil prices increasing, but we might see, we might see some decrease there and that’s where we’re in that.
Those were leases where in that $19, $20 range and one of them is a little bit higher just due to the kind of land attached to it, they are relatively smaller buildings. So we could see towards the end of 2023 on some of those properties some decreases, but should be offset by leasing at other properties in the market.
David Chrystal
Okay, fair. And maybe be just quickly on development, you mentioned obviously the economics are superior and your presuming development where we can. Can you maybe talk about the delta on development yields versus transaction cap rates?
Kelly Hanczyk
Yeah so I mean, what we are expecting on, the development on our existing portfolio, so especially in southwest Ontario is going to be somewhere between 8% and 10%, which is very strong. I think in Saskatchewan, if we’re able to secure a tenant for the 300,000 square feet, it would be significant NOL, probably about 8% and then in Ontario, on those development projects probably 5.5%.
Robert Chiasson
Yeah, I’d say that the yield on the projects where we don’t – where we didn’t own the and we are not adding square footage is going to be lower definitely. So yeah, in that maybe 5%, 5.5% range.
Kelly Hanczyk
Yeah and you know the southwestern Ontario portfolio is really good, because the one we’re adding the 100,000 square feet, in fact we can probably add on another 150,000 on to that site.
One of the other ones that we’re talking, extending the tenant by 70,000 or 100,000 to 125,000 square feet, we potentially could add and we’re in talking with the city about potentially adding another 200,000 square feet on top of that. And then the one we close on next year in March or April, that is a very growing logistics company, strong growing southwestern logistics company, and I predict that by the time we take possession of that building they are going to come to us to ask to build another 150,000 square feet. So the availability for us to develop on our land at the moment is huge at those types of returns.
David Chrystal
Okay, perfect! That’s helpful, I’ll turn it back. Thanks.
Kelly Hanczyk
Thank you.
Operator
This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Hanczyk for any closing remarks.
Kelly Hanczyk
Hi there everybody! Thanks so much and we look forward to next quarters conference call and with – where we start to see some of the significant rental rate increases. So we will talk next quarter.
Operator
This concludes today’s conference call. You may disconnect your lines. Thank you for participating and have a pleasant day!
Be the first to comment