Plaza Retail REIT (OTC:PAZRF) Q3 2022 Earnings Conference Call November 11, 2022 1:30 PM ET
Company Participants
Kimberly Strange – General Counsel and Secretary
Michael Zakuta – President, CEO
Jim Drake – CFO
Conference Call Participants
Jenny Ma – BMO Capital Markets
Gaurav Mathur – iA Securities
Chris Koutsikaloudis – Canaccord Genuity
Operator
Good morning. I would like to welcome everyone to the Plaza Retail REIT Third Quarter 2022 Earnings Conference Call. [Operator Instructions] I would like to advise everyone that this conference is being recorded.
I will now turn the conference over to Kim Strange, Plaza’s General Counsel and Secretary. Please go ahead, Ms. Strange.
Kimberly Strange
Thank you, operator. Good afternoon, everyone, and thank you for joining us on our Q3 2022 results conference call. Before we begin today, we are legally obliged to advise you that in talking about our financial and operating performance and in responding to questions today, we may make forward-looking statements, including statements concerning Plaza’s objectives and strategies to achieve them, as well as statements with respect to our plans, estimates and intentions or concerning anticipated future events, results, circumstances or performance that are not historical facts.
These statements are based on our current expectations and assumptions and are subject to risks and uncertainties that could cause our actual results to differ materially from the conclusions in these forward-looking statements. Additional information on the risks that could impact our actual results and the expectations and assumptions we applied in making these forward-looking statements can be found in Plaza’s most recent annual information form for the year ended December 31, 2021, and management’s discussion and analysis for the period ended September 30, 2022, which are available on our website at www.plaza.ca and on SEDAR at www.sedar.com.
We will also refer to non-GAAP financial measures widely used in the Canadian real estate industry, including FFO, AFFO, NOI and same asset NOI. Plaza believes these financial measures provide useful information to both management and investors in measuring the financial performance and financial condition of Plaza. These financial measures do not have any standardized definitions prescribed by IFRS and may not be comparable to similarly titled measures reported by other entities. For more information on these financial measures and where to find reconciliations thereof, please refer to Part VII of our MD&A for the period ended September 30, 2022.
I will now turn the call over to Michael Zakuta, Plaza’s President and CEO. Michael?
Michael Zakuta
Thank you, Kim. Good morning. Our business remained strong and our outlook positive. Like other real estate, we faced the competing headwinds of inflation, interest rates and construction delays, and we are carefully managing our business to minimize our exposure to each. .
We’re also continuing with our business plan to grow through development and redevelopments, active leasing and recycling capital through the disposition of noncore assets despite these challenges. I recently attended the Canadian ICSC conference in Toronto with our leasing team. This was a very good event for growth and development-oriented REIT like Plaza.
The growth of our business is largely dependent on demand in Canada’s leading essential needs, value and convenience retailers, and we are currently experiencing some of the strongest demand that we have seen in years. We completed more leasing activity in the first nine months of 2022 than we did during similar periods in the past 5 years.
During the quarter, we completed 332,000 square feet of leasing of new space renewals in the backfilling of previously vacant space. Year-to-date, we have leased 1,038,000 square feet, 647,000 square feet of renewals, 190,000 square feet of leasing of new space and 201,000 square feet of backfill leasing a previously vacant space.
This is the first time in 5 years that we’ve reported occupancy of over 97%. As real estate is capital intensive, rising interest rates have an impact on the industry and will have an impact on Plaza’s results. We are managing our business accordingly.
We are being more selective in allocating investment capital as we navigate current headwinds and continue to work with groceries, pharmacies and value retailers. We have 5 new grocery-anchored developments in either planning or construction with strong preleasing in place and a number of other essential needs and value style developments in our pipeline.
You will find recent photos of a number of our projects posted in the Q3 2022 presentation in the Financial Reports section of our website. Construction costs remain highly variable across our geography. We have experienced some surprises along with some solid successes.
We are experiencing serious challenging — challenges, delivering some of our projects due to contractors repricing fixed price contracts, labor shortages and delivery of material delays. We have been very successful with our noncore sales program. Private investors remain active, buying smaller properties at low cap rates.
The subject of recession is top of mind for many investors. Our portfolio of essential needs and value retailers and quick service restaurants should prosper in a recessionary environment. One of the takeaways that I registered at the recent ICSC was the comments from some retailers and fast food chains that consumers were trading down. This trend should benefit most of our tenants. Additionally, we anticipate that supply chain and construction cost challenges should adjust in our favor as demand slackens.
I will now turn the call over to Jim Drake, Plaza’s CFO. Jim?
Jim Drake
Thank you, Michael. NOI this quarter was impacted by operating expenses, which were up over the same quarter last year. Much of this is timing only as costs normally incurred in Q2 were delayed until Q3, a result of supply chain delays and labor shortages.
Same asset NOI was also impacted by a few properties that we are improving, where we have allowed certain smaller tenants to expire to replace them with larger, stronger and more resilient secondary anchored tenants.
Even with that, year-to-date same-asset NOI is up 1.4%. FFO per unit for the quarter was $0.104, up 4% over last quarter and down slightly versus last year due to operating expense timing and insurance proceeds received last year. For year-to-date results, it is key to remember that 2021 included $3 million of lease termination income. Excluding the impact of same and excluding other unusual items such as insurance proceeds and COVID-related bad debt incurred last year, year-to-date FFO per unit is up 2%.
Year-to-date AFFO per unit adjusted for the same unusual items was down 1%. Higher leasing costs impacted AFFO in part due to inflation and in part due to increased leasing activity, which will result in increased revenue going forward. And that increased leasing is reflected in our committed occupancy of 97.2%, up 100 bps over last year and a record level over the last 5 years.
Strong leasing demand has also pushed lease renewal spreads at 3% year-to-date. Under our development program, given the current inflation and interest rate environment, we are proceeding cautiously but still have a full pipeline and active projects underway with fixed price contracts in place.
During the quarter, we advanced a number of projects. We started construction on a grocery-anchored development in [indiscernible] Nova Scotia, a community just outside Halifax, and we completed the final phase of Hogan Court, our grocery-anchored development in Halifax. We also closed on land in Dieppe, New Brunswick, a community adjacent to Moncton and Welland, Ontario, both of which will be grocery-anchored developments.
Our liquidity remains solid and at quarter end totaled $63 million, including cash, operating line and unused development and construction facilities with an additional $5 million of unused facilities on nonconsolidated properties. We also had $18 million of unencumbered assets, and our debt to total assets ratio has improved by 120 bps over Q3 last year, now at 56%.
For mortgage rollovers, at quarter end, we had 1 small mortgage maturity remaining for the year, which will be renewed shortly. In 2023, we have $31 million of mortgages maturing at a weighted average rate of 4.67%. Loan-to-value on these mortgages is less than 50% and a large portion related to freestanding pharmacies or pharmacy-anchored properties, so we are confident of renewals.
We also have our 47 million Series E convertible debentures maturing in March 2023. The convertible debenture market is currently expensive. If that market where our unit price has not improved before March, we will repay the maturing converts with a bridge loan of approximately $37 million with the remainder from noncore asset sales. The pricing on the bridge loan is anticipated at approximately prime plus 1% or BAs plus 2%.
And once the unsecured market improves, we would then anticipate replacing that bridge with a new unsecured debt issue. Finally, on cap rates and valuations. We were not overly aggressive with our valuations when cap rates were compressing. So the current pressure on cap rates for certain property types should have less of an impact.
Our starting point was relatively conservative. We also continue to see strong demand for essential needs and convenience assets such as ours and the sales of our noncore assets this year were above IFRS values. Significantly higher replacement costs also act as a barrier to entry and provide further support for our IFRS valuations.
Regardless with the increase in Government of Canada bond yields, we saw a nominal increase in cap rates this quarter and took a $4 million write-down. Our weighted average cap rate is now 6.78%. Those are the key points relating to the results for the quarter and year-to-date.
We will now open the line for any questions. Operator?
Question-and-Answer Session
Operator
[Operator Instructions] Your first question comes from the line of Jenny Ma from BMO Capital Markets.
Jenny Ma
Jim, you mentioned in your remarks that Plaza will be proceeding cautiously with respect to development. And I’m wondering if you could elaborate more on what it is that causing that view. Aside from the macro, which we all know. But is there anything specific to the markets that you’re in? Is it on the labor side, the cost side that’s holding you back or you’re causing you to be a bit more cautious going forward?
Jim Drake
It’s not specific to the markets that we’re in. It’s the macro issues that we’re all aware of being, obviously, interest rates pressure on labor and supply chain issues.
Jenny Ma
Okay. Is that some — is that reflective of what your tenants are telling you as well? Because I’m just thinking Plaza has got great relationships. You’ve got a lot of visibility for our tenants. So if you have certainty on a project certainty on the lease and on the cost and everything, would it make sense to continue to go ahead as per usual?
Michael Zakuta
Maybe I can answer that, Jim. Yes, it is, Jenny. We’re pushing forward with our pipeline because it’s pretty solid. And we like the type of assets that we’re going to be developing. So tenant demand is not an issue. It’s the supply side, that’s an issue. It’s just that costs can really be a challenge today. And again, as I said in my remarks, it’s highly variable.
There are instances where we get really good pricing and other instances where we can. So we have to be just a little bit more careful and higher interest rates in terms of how — what our takeout that is going to look like, obviously has an influence. And it means that we have to take a bit of a more cautious approach.
Jenny Ma
That’s fair. When we’re thinking about your development yields, and I know not too long ago, you had taken it down to the 7% to 9% % versus the 8% to 10%. Are you still comfortable with that 7% to 9%? And are you seeing any sort of upside on the rents that you’re getting on new deals that will probably offset some of the higher costs that you’re probably seeing?
Michael Zakuta
Yes. So rents are definitely higher on all deals that are being done today. And in terms of yield, yes, we’re in the 7% to 9% spread. Average yields are probably north of 8%. There’s probably been a slight deterioration just because of some costs and then a deterioration on levered yields based on the fact that term debt is more expensive.
Jenny Ma
Okay. Great. And then lastly, with respect to the convert that — thank you for that color. It’s very informative. But I’m just wondering, over the longer term, is there still an appetite to go back to the convertible market? And remind us how much you have by way of unencumbered assets? Like is that something you could take secured debt on? Or are you still comfortable pursuing a convert when the time is more appropriate?
Jim Drake
So we have about $18 million of unencumbered assets. And definitely, the plan is to go back out to the unsecured convert market when it’s priced better, when are you going to trading better.
Operator
Your next question comes from the line of Gaurav Mathur from iA Securities.
Gaurav Mathur
Just a couple of quick questions at my end. Firstly, when you’re talking about supply and demand dynamics, how should we think about net new store openings across the portfolio as we’re heading into 2023?
Michael Zakuta
Sorry, just repeat, sorry, I didn’t get the question. .
Gaurav Mathur
Just thinking about supply and demand. How should we think about net new store openings across the portfolio as you’re heading into 2023. Is that something that we can expect it to increase or decrease just given where supply stands at the moment?
Michael Zakuta
No. If you look at our MD&A, you could see the stuff that’s under construction. And I think we estimate our delivery dates, some of those delivery dates got pushed back, just looking at some of them. Our Q4 2023 or Q3, they would have been Q1 or Q2. So we’re full speed ahead.
And then you see the in-development stuff. There’s a lot of in-development stuff that we plan to put under construction in 2023. So it really is full speed ahead. We’ve got really good deals organized, what we consider the best retailers, and we’re not going to we’re not going to back down. We’re going to deliver that product.
Gaurav Mathur
Right. Okay. And just lastly on — just circling back on development deals. I know you said 7% to 9%. Just — do you see any change in that over the next sort of 12 to 18 months? Or is that fair to say that we’ll still be in that range for the moment?
Michael Zakuta
I think the range is solid from what we can observe, yes.
Operator
Your next question comes from the line of Chris Koutsikaloudis from Canaccord Genuity.
Chris Koutsikaloudis
Just on the capital recycling front, it appears that demand has held in pretty resiliently for single-tenant smaller retail properties and pricing is held in as well. Just kind of assuming you could sell all the properties you wanted to, how big would you estimate that pool of assets would be?
Michael Zakuta
Jim, you would like to step at that?
Jim Drake
Yes. Well, I was going to say, I think what we want to sell is what we’d like to sell to recycle capital to deal with our converts. So we need $10 million or $12 million of capital in addition to that bridge that I mentioned. .
Chris Koutsikaloudis
Okay. So I guess, nothing kind of beyond that?
Michael Zakuta
No. It’s not a large program. It’s something that we’ve been doing for a number of years, calling or trimming the portfolio, selling stuff that we think is maxed out that we think is not going to grow in value and offers us very, very low hurdle rates. And that’s really what, I guess, drives our thinking. .
Operator
[Operator Instructions] Mr. Zakuta, there are no further questions at this time.
Michael Zakuta
Well, thank you for joining us on our call. Operator? .
Operator
Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. You may disconnect your lines.
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