NorthWest Healthcare Properties Real Estate Investment Trust (OTC:NWHUF) Q3 2022 Earnings Conference Call November 15, 2022 10:00 AM ET
Company Participants
Paul Lana – Chairman & CEO
Shailen Chande – CFO
Conference Call Participants
Sairam Srinivas – Cormark Securities
Tal Woolley – National Bank Financial
Pammi Bir – RBC Capital Markets
Frederic Blondeau – Laurentian Bank Securities
Operator
Good morning, ladies and gentlemen, and welcome to the Northwest Healthcare Properties Real Estate Investment Trust Third Quarter 2022 Results Conference Call. [Operator Instructions]. This call is being recorded today. November 15, 2022. I’d now like to turn the conference over to Paul Lana, Chairman and CEO. Please go ahead.
Paul Lana
Thank you, operator, and good morning, everyone. Appreciate you joining us today. I’m joined by Shailen Chande, the REIT’s Chief Financial Officer. Together, we are pleased to share results for the third quarter of 2022. First, I’d like to point out that during today’s call, we may make forward-looking statements as defined under Canadian Securities law. While all such forward-looking statements reflect management’s expectations regarding our business plans and future results, they are necessarily based on assumptions that are subject to uncertainties and risks, which could cause actual results to differ materially.
We direct all of you to the risk factors outlined in our public filings. And now to the quarter. The REIT’s high quality and defensive $10.6 billion portfolio delivered strong financial results with revenues and net operating income increasing by 21.2% and 19.9% respectively, year-over-year, while net asset value grew by 2.7% to $13.97 per unit over the same period. However, as a result of nonrecurring items and lower transaction volumes and related management fees during the quarter and increased interest expense together with temporarily elevated leverage our AFFO decreased to $0.15 per unit.
The REIT’s foundational pillars remain stable. These included a high-quality, defensive portfolio, delivering strong built-in growth in this quarter, 2.5% constant currency SPNOI and supported by 97% occupancy and an almost 15-year weighted average lease expiry. The REIT’s portfolio continues to demonstrate market-leading cash flow stability with 81.7% of income subject to ransom fixation. During the quarter, the REIT reached agreement on the formation of a new U.K. JV initiative with an aggregate equity commitment of GBP 500 million to be funded 85% by U.K. institutional investor and 15% by the REIT.
In addition, this investor will make a GBP 50 million investment in the REIT’s existing portfolio. This was a key strategic priority for the REIT in 2022 and is highly strategic for the business as it expands the asset management platform and introduces a new institutional investor and further positions the REIT to execute on attractive opportunities as they emerge within the region. Agreements are expected to be finalized by year-end and proceeds from the GBP 50 million investment will be redeployed to repay higher-cost floating rate debt, resulting in interest rate savings as approximately per unit per quarter.
The REIT is considering additional investments in its U.K. portfolio going forward. During and post quarter, the REIT completed the following balance sheet initiatives, which included refinancing of approximately $1 billion of the REIT’s 2022 and 2023 debt maturities to extend term and fixed interest rates. These include a successful public offering of $155 million of unsecured convertible debentures with a $16 per unit conversion price bearing fixed rate interest at 6.25% and maturing on August 31, 2027.
The refinancing of 2 floating rate facilities with a combined outstanding balance of approximately $475 million, which extended the term to maturity by approximately 2 years and are expected to result in annual interest rate savings of approximately $0.02 per unit. And commitments to extend the maturity of its U.S. secured loan facility to 2025, which is expected to generate annual interest rate savings of approximately $0.01 per unit. The completion of an 18-month extension of which AUD 110 million facility. And additionally, the REIT extended the terms to maturity of its Australian term debt facilities maturing in November and December 2022 to April and June 2024, respectively.
Combined with the aforementioned U.K. initiative as well as the expected reversion of quarterly management fees historic levels, adding another approximate $0.02 per unit on a run rate basis, we expect future earnings to be in line with historic levels. Completion of these initiatives, along with the associated debt repayment is expected to increase long-term fixed rate debt exposure to approximately 65%, while generating strong interest rate savings and extending the average term to maturity of the REIT’s debt.
Overall, consolidated leverage is expected to decrease approximately 420 basis points to 43.5%. Separately, the REIT’s U.S. joint venture initiative continues to progress. And despite macroeconomic uncertainty, the REIT remains actively engaged with the short list of qualified partners and is working to agree commercial terms in Q1 2023. As a result of the expected U.K. JV formation post quarter end, in-place capital commitments increased to $12.5 million with deployed fee-bearing capital increasing to $5.9 billion. As the REIT fund management continues to scale, the pro forma the completion of the U.S. joint venture deployed and committed capital is expected to increase to $6.7 billion and $13.3 billion, respectively.
At a target ownership level of between 20% to 30% across its capital platform, the REIT anticipates generating an increased level of growth in both AFFO and NAV on a per unit basis as a result of leveraging its capital light model and internally generated capital to fund growth. In Q3, the REIT continued to execute on its growing asset management business and completed acquisitions totaling $125 million in its various Australasian platforms. The REIT also advanced its global health care piecing strategy by adding an approximately $150 million new development to its pipeline within the region.
While macroeconomic uncertainty resulted in lower neutral volume of acquisitions in the quarter, the REIT remains constructive on the long-term demand factors that drive value creation in Health Care real estate. With a growing investment pipeline, the REIT continues to evaluate new opportunities within its fee-bearing capital vehicles on an opportunistic basis while remaining disciplined in its capital allocation strategies. For the quarter, our results were temporarily impacted by the REIT’s flexible interim capital structure, resulting in AFFO per unit of $0.15.
However, with the completion of the previously disclosed balance sheet and JV formation initiatives and the revision in management fees to historic levels, future earnings are expected to revert to levels in line with previous quarters. Reported net asset value during the year increased 2.7% to $13.97, again, driven by fair value gains across the portfolio and the expansion of its global asset management business.
With respect to liquidity, the REIT is well positioned with over $150 million of available uncommitted resources today. This is expected to increase to more than $300 million on completion of the U.S. initiatives. Operationally, our results were in line with expectations with accelerating SPNOI growth of 2.5%, largely driven by contractual rent indexation and underpinned by the high occupancy and long-term leases previously noted, in all regards highly defensive. While the macroeconomic environment is creating uncertainty around inflation and interest rates, the REIT remains well positioned with 81.7% of its revenue indexed to local inflation, which includes over 97% indexation in its international markets.
Segmentally, I note the following. In Canada, we were on plan, portfolio occupancy remaining stable at 80%. We have recently committed to a new lease on 1 temporary vacancy in its Western Canadian portfolio and expects to have that occupancy increased to more than 90% again at historic levels. The property will be fully occupied by January ’24. We continue to see a return to pre-COVID level activities at our properties, including increased leasing activity quarter-over-quarter.
Additionally, we are making progress on a number of life sciences and ambulatory care initiatives, which are gaining momentum and expected to become part of the business in the near future. In the U.S., our newest region, our portfolio is performing as expected with occupancy at 97% and an almost 9-year weighted average lease term. NorthWest has successfully onboarded and integrated assets in respective management platforms and continues to progress on new renewal leasing activities.
In Brazil, we were on plan, steady 100% occupancy and continued strong cash currency SPNOI of 10.7%.
Operationally, we note that the REIT’s major tenant reach door continues to deliver exceptionally strong results and as well as Brazil’s top 10 companies by market capitalization. Europe continues to perform well with constant currency SPNOI growth of 3.7% and the occupancy stable at 97.2%. We continue to find good investment opportunities in Europe, allowing us not only to increase scale and critical mass in our existing regions, but also consider opportunities in adjacent markets.
And finally, in Australia and New Zealand, our largest market, occupancy remained stable at nearly 100% and delivering constant currency SPNOI growth of 8.3% with a weighted average lease term of almost 16 years. I am pleased with the progress we made during the quarter and particularly post quarter, which advanced the REIT’s strategic objectives and produced solid operating results. With deep strategic relationships, best-in-class regional operating platforms and strong access to both public and private capital, the REIT continues to transition for a more asset-light business and a best-in-class global Health Care real estate investment manager.
With that, I will now ask the operator to open up for questions.
Question-and-Answer Session
Operator
[Operator Instructions]. We’ll take our first question from Sairam Srinivas with Cormark Securities.
Sairam Srinivas
Paul, sticking to 2023 and the JV that you guys have performed, can you guide us on the pace of deployment to the proceeds from the JV?
Paul Lana
I’m sorry, I just got a part of that. And could you repeat your question, please?
Sairam Srinivas
Sure. Just looking at the JV that are being formed right now in the U.S. as well as the U.K. and more specifically, probably in the U.K., can you comment on the pace of deployment?
Paul Lana
Yes. The JV has a deployment of — the new U.K. JV has a deployment period of 3 years and with some extensions as with typical industry features. So that would be our expected deployment. And again, leverage focused in there in the 45% to 50% range, which is typical in the U.K. Behind that, again, we do see a number of interesting opportunities. Obviously, this has been a long time coming for the business. So we have quite an active opportunity set as we head into thinking about what to do with our new partner and opportunities that we’re pursuing.
Sairam Srinivas
That’s great color, Paul. And probably on that, keeping in mind the broader disconnect between the public market and the private market, are you seeing any opportunities there on the public market side that you’d probably be attracted towards?
Paul Lana
I think our focus remains on fairly traditional asset-level transactions in the U.K. for the time being. So we haven’t seen quite as sharp a correction there in terms of health care. And so we’re, again, focused more on the traditional side of things, and we do see some compelling opportunities in that direction, if I understood your question correctly.
Operator
[Operator Instructions]. Next, we’ll go to Tal Woolley with National Bank Financial.
Tal Woolley
I just wanted to — and apologies, I missed some of the preamble upfront. But in your management fee breakdown, you’ve got one online item in other fees and cost reimbursement that went negative this year. And I’m just wondering if you can talk a little bit about what exactly created that situation? Was that a catch-up from something else? Or if you can just give a little bit more color there.
Paul Lana
Shailen, would you like to address that? Or maybe even get into that detail offline, if that’s preferred?
Shailen Chande
Yes, thanks for that question, Tal. I can give you a high-level commentary on that. I mean, first off, I’d call out that management fees, in general, this quarter were lower than where we traditionally expect them on a run rate basis. I think all of that’s timing related and nonrecurring in nature. When we think through transaction activity and transaction-driven fees that was clearly lower than expected during the quarter, just given some of the macroeconomic volatility. But I would note that we have a high degree of visibility into transaction volumes in Q4 and expect activity-based fees from transactions to revert to historic levels, which were averaging around $4 million a quarter for the last 4 quarters or so.
In respect to your specific question on cost reimbursements and the other recoveries, if you may. Again, timing related. We’re engaged in some large transactions in the moment where arrangements contemplate us being reimbursed for a lot of the costs that the REIT is incurring in respect of management and ongoing management services in respect of procuring those transactions. There’s really just been a shift in timing. So you’d note that in Q2, we had some fairly material cost reimbursements and other recoveries in Q3, some of that reversed out. But we do expect to recover that over the coming quarters as against some of those transactions pick up speed.
Tal Woolley
Okay. So if we take — if we assume like the current asset base and then the U.K. JV transaction fee transaction goes through, what would you sort of estimate the run rate fees of the platform would be?
Shailen Chande
Yes, I don’t think we’ve given any…
Tal Woolley
On a proportionate basis.
Shailen Chande
Yes. Yes, Tal. I mean, I don’t think we’ve given any concrete guidance around management fees, noting that — I mean, we do have a steady level of recurring base transaction fees. I would call out that as we go into 2023, we’re likely be providing some more holistic guidance as a lot of these platforms come together. So maybe I’d defer that discussion to next quarter, but happy to work off of some of the historic — I mean, some of the historic results offline.
Tal Woolley
Okay. In the U.K., like I know in the past, you haven’t engaged in a huge amount of hedging or anything like that as you’ve gone around the world. I just wonder when you look at sort of like the macro situation in the U.K. and the fact that it is like a large liquid currency, you can trade in hedging pretty effectively. Like has your approach just sort of on managing the financial risk there shifted a little bit with respect to the U.K. versus some of the other jurisdictions?
Shailen Chande
Paul, I can kick off with the narrow U.K. part and then perhaps you can talk a bit more broadly around the global financial risk and management. In the U.K., over the course of the quarter — and sorry, just post quarter, we completed a 2-year renewal or extension of a new — I mean, of a new facility in respect of our U.K. portfolio. So that was quite a big accomplishment to do a whole scale refinancing against — that’s almost now almost $1 billion portfolio. I think that now gives us the ability to really lock into longer-term capital structure arrangements and we’re put in place hedges across various specific debt instruments that we have, whether they be in the U.K. and the U.S. post quarter end.
And we’ll be looking to very actively engage on a more comprehensive hedging program, including considering currency exposure going forward. Part of it has been — historically, our balance sheet has been quite transitionary in nature as we brought in a lot of these capital platforms. And as some of those parts are starting to lock in as expected, we’re able to take much more longer-term capital structure decisions. But maybe, Paul, if you want anything to add to that?
Paul Lana
No, Shailen. I think that covers it off nicely. And again, I think that’s exactly the point, which is where we have some visibility now and the permanent capital structure in place on the U.K. as an example. It allows us to move to both longer duration and some both interest rate and currency hedging as appropriate. And we’re looking at that as a — as an appropriate measure sort of throughout the portfolio.
Tal Woolley
Okay. And then just — I appreciate the color around how you see the sort of refinancing savings playing out. I guess I just have a couple of questions. Like one of the bullets, you discussed that extending the maturity of your U.S. secured loan facility to 2025, that’s going to generate interest rate savings. And I’m just — I’m wondering how extending a maturity gets you rate savings?
Shailen Chande
Yes, a couple of things. When we entered into the U.S. a year ago or so — or sorry, at the front end of this year and early Q2, we did put on a short-term floating rate facility that I’d say was just, yes, just higher cost nature. So looking forward as we’re putting on more permanent facilities, it gives us the ability to both extend term and reduce rate.
Tal Woolley
Okay. And then the same thing too with the floating rate facilities, like you’re refinancing those and extending the maturity. Is it just a question of like — I guess, I’m just surprised to hear that like credit — like your credit spreads and stuff like that would be better on a refinancing right now than they were let’s say, a year ago? And so can you just walk through like how you’re getting the savings on the refinance of the credit facility?
Shailen Chande
Yes. And I’d call out that it’s really a function of where our starting point was. So noting that coming into — I mean, coming into this moment of macro volatility, we had several 4, 5 corporate level secured and unsecured facilities that were just, I’d say, temporary in nature, revolving in nature to enable flexibility really in advance of our JVs. And now that we’ve brought certainty to the U.K. part of it and continue to make progress on the U.S. in respect to our JV initiatives, it’s allowed us to just bring more certainty in perhaps consider facilities that aren’t revolving and just have more structure associated with them and not as much flexibility associated with them, given that we don’t need it.
So it’s given us both the ability to bring rate down as well as extend term, which is counterintuitive in the current moment, but it’s really coming off of a very high starting point.
Tal Woolley
Okay. And then I guess just lastly, like within Canada, like, are you finding other opportunities sort of beyond the medical office portfolio for new projects? Like as government’s reworking how to handle finding incremental beds looking at transitional care-type beds across the province. I know you have — I believe you have got one facility up and running already in that regard. Is there scope to do more of those going forward?
Paul Lana
Yes, maybe I can take a crack at that, Tal. It is a really interesting time in Canada in the moment and lots of discussions going on about Health Care delivery in new formats. Our focus, as you know, has been in a couple of areas, the ambulatory and outpatient. And we have a facility that’s shortly completing in that space, and we are working on a number of others that would be similar in nature. Again, that’s an Ontario-driven initiative, but we are starting to see that come through in other provinces, including Alberta and Quebec our portfolio.
So certainly, that is a notable trend, and we do think that the ambulatory sort of space is underrepresented strongly in Canada. It’s really just working through what type of tenancies and the mix of tenants that can fulfill those facilities, we expect to see more of those coming over time. So that’s been a reasonably long-standing initiative, and we expect to be adding to that still pretty incremental to the portfolio. The other initiative that we are quite focused on is in the health care space. It’s one of our core global strategies, and that’s a real combination of health care, research, education and all of the ancillary uses.
And we are quite active on a number of initiatives there that we expect to be in [indiscernible] in the fourth quarter. That will be, I would say, transformative for the Canadian business in terms of size and certainly fitting the opportunity set that we see in other markets that we’re quite concentrated in particularly Australia, where we have a really significant opportunity set. So those are the 2 areas that we’re really focused on. You’re right though, there are other — there were management initiatives talking about different types of long-term care, in particular.
And we are keeping an eye closely on that as they look to provide beds and perhaps a little more structure to the nature of the operations in that space, but it hasn’t been something that’s quite reached actionability and clearly still continues to be maybe more early stage, I would say. So a little bit of a trip through Canada, but we are seeing some changes coming and ones that are very consistent with our core strategies globally.
Operator
[Operator Instructions]. Next, we’ll go to Pammi Bir with RBC Capital Markets.
Pammi Bir
Just in terms of the U.K. JV, can you just remind us or walk us through the anticipated capital repatriation that you’re expecting?
Paul Lana
Yes, Shailen, do you want to speak to that?
Shailen Chande
Pammi, thanks for that question. In terms of the capital that we expect to generate out of our recent both seed portfolio recapitalization as well as, I guess, the go-forward new JV initiatives, we did call out and do note that our ownership target in the — in both of those platforms, the seed portfolio as well as the new money JV is — I mean, it’s around 85%. And so we previously guided to selling down to about a 30% level. We’re now selling — I mean, obviously, that’s changed, and we’ll get into a variety of reasons that drove that change.
In terms of the capital coming back, I would note that we are doing the transaction at our current IFRS book value. So no change there. I mean, as expected in terms of our current valuations. And we really just haven’t seen the transactional evidence to support any changes in valuations there. So quite nice to be the mark there. And be able to transact at our current market. Maybe Paul, I’d defer to you a little bit in terms of the overall strategy around the 85% to 15% allocation versus the previous 70% to 30%.
Paul Lana
Sure. So I think, again, in this progression to sort of more capital light, clearly, we’ve been considering a range of outcomes. I think we were comfortable with our investment partner at this level and certainly requires Northwest to put out slightly less equity than some of the other institutional joint ventures, but still meaningful alignment and all the things that go with that as a principal investor. So we like that mix. I think otherwise, the JV itself sort of is quite similar to the ones we’ve done already and having place.
So broadly speaking, has a similar investment period, similar fees and related sort of governance structure. So I think it feels quite similar to the things that we’ve been doing. And again, it’s going to allow us to I think pursue what we see as some interesting opportunities in the U.K. that are starting to [indiscernible] and we’ve been working hard to get that in place in order to move quickly and efficiently into what we see as a continuing attractive market. And so that’s maybe a little backdrop there. I’m not sure if there’s anything else.
Pammi Bir
Got it. Just maybe one last one. In terms of the pro forma proportionate leverage once the U.K. JV is finalized and everything’s in place, where does that take pro forma leverage on a proportionate basis?
Shailen Chande
Pammi, I can come back to you with a specific number off-line. And I would call out that we previously guided to proportionate leverage around that 40-ish percent mark. I really pro forma our U.K. and our U.S. initiatives. As we just noted in our — in the prior question, the capital generated out of this current recapitalization in the U.K., it will generate about GBP 50 million, lower than we previously anticipated with a bigger sell down.
But we do think that just given our broader connections around the asset management business and perhaps that capital-light model in terms of lower look-through ownerships over time, we still see that proportionate leverage number into that low 40s is achievable. It just might require different tool kits within the business where, as you know, we’re still capital heavy in the majority of our platforms and regions.
Pammi Bir
Got it. Just the last one on the U.S. partner discussions, anything you can add there? Have you narrowed down to the sort of final strokes maybe a bit further than where you were last quarter? Or you’ve now, I guess, put sort of a time line on it for Q1? Just curious if there’s anything you can share there.
Paul Lana
Yes. I think what I would share, Pammi, is that, obviously, with market volatility in Q3 it was a difficult time to be working through pricing and discussing JVs and major transactions. So I think based on our current state, I’d say the market is certainly finding its level, and we’re confident that we can move forward on the time lines as proposed. So — and probably the biggest thing to call out is just that Q3 was a relatively volatile time in not just capital markets, but certainly interest rate and related markets.
And so that’s passed down, and I think we see market participants back in, and we’re having constructive dialogues with a number of parties. So we’re confident that we’ll be able to move forward here. And again, this is high-quality institutional portfolio that we acquired and was well sought out in the marketplace, and transactions in health care real estate are returning actively. So we’re confident that we’ll be able to move forward as planned.
Operator
Next, we’ll go to Fred Blondeau with Laurentian Bank Securities.
Frederic Blondeau
Just one quick question for me. With the closing of the U.K. JV this year and the closing of the U.S. JV and I guess in Q1 next year, is it fair to say that at the margin, you’ll be focusing a bit more on the pricing strategy in 2023? And so — and what are your views on the pricing strategy at this stage, especially in the context of — in the current context of the construction costs?
Paul Lana
Yes. So there’s a lot in there. I think, I mean, again, the business continues to have a number of active strategies, Fred including sort of the traditional partnering with health care operator strategy and/or ambulatory and outpatient strategies, all of which come through the existing JV. So I wouldn’t say that they’re deemphasized. But in terms of new initiatives, we are making progress in our developed core initiative in Australia, which is very much a precinct-driven sort of fund and has long-term development and appropriate development attached to it.
I think we’ve been able to find some spots where we can make good investments today and make development costs and pricing work. In fact, we’re seeing prices start to come in now in most of our markets. So that’s actually been a positive sign that’s come through the business over the $300 million or $400 million development that we have underway today and similar amount of things that are in planning in the business. So I would say that development, although as we come into this sort of market moment and economic moment, requires even more rigorous underwriting and that we’re approaching it with slightly more cautious opportunity set, the things that sort of support the Health Care precinct strategy and really that combination of major Health Care users and major educational research users is still quite a lot of market moment.
And so where we can find good and appropriate opportunities with appropriate contracts and certainty of leasing, et cetera, we’re still looking to do stuff. But again, hard to estimate that new initiative and developed [indiscernible] that we have a number of existing projects underway already that are moving forward and are on budget and on schedule and substantially at least, I think we’re feeling that there’s a consistent level of development the business can support as it looks to go forward. I hope that answers the question.
Frederic Blondeau
Yes. No, absolutely. And then it looks like you had quite an extensive process to find the right JV partner for at least in the U.K. and I guess, in the U.S. also. How should we view this process to find the right JV partners for a precinct strategy like what would be your views on that?
Paul Lana
Yes, I think we’re in active discussions with a small number of very significant investors, as I’ve mentioned before. And so that’s continuing. I think we’re hopeful that in the fourth quarter, we’ll have reached announcement on at least 1 of those 2. And again, we have a nice pipeline of opportunities and — quite a few portfolio. And there’s still land in early-stage opportunities, but broadly interesting opportunity. So quarter 4, we’re constructive that things can happen, as we’ve said in the context of Q4.
Operator
One moment. I show no further questions. I’ll now turn the call back over to our presenters for any additional or closing remarks.
Paul Lana
Thank you, operator. And ladies and gentlemen, appreciate you listening in on NorthWest Healthcare Properties REIT’s Q3 2022 Conference Call. Thank you.
Operator
Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation. You may now disconnect.
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