Slate Grocery REIT (OTC:SRRTF) Q3 2022 Earnings Conference Call November 3, 2022 9:00 AM ET
Company Participants
Paul Wolanski – SVP, National Sales & IR
Blair Welch – CEO & Trustee
Braden Lyons – Analyst, IR
Andrew Agatep – CFO
Connor O’Brien – SVP
Conference Call Participants
Gaurav Mathur – iA Capital Markets
Jenny Ma – BMO Capital Markets
Himanshu Gupta – Scotiabank
Pammi Bir – RBC Capital Markets
Operator
Good morning, ladies and gentlemen, and welcome to the Slate Grocery REIT Third Quarter 2022 Financial Results Conference Call. [Operator Instructions]. This call is being recorded on Thursday, November 3, 2022.
I would now like to turn the call over to Paul Wolanski. Please go ahead.
Paul Wolanski
Thank you, operator, and good morning, everyone. Welcome to the Q3 2022 conference call for Slate Grocery REIT. I’m joined this morning by Blair Welch, Chief Executive Officer; Andrew Agatep, Chief Financial Officer; Connor O’Brien, SVP; Allen Gordon, VP and Braden Lyons, Associate.
Before getting started, I would like to remind participants that our discussion today may contain forward-looking statements and therefore, we ask you to review the disclaimers regarding forward-looking statements as well as non-IFRS measures, both of which can be found in management’s discussion and analysis. You can visit Slate Grocery REIT’s website to access all of the REIT’s financial disclosure, including our Q3 2022 investor update, which is now available.
I will now hand over the call to Blair Welch for opening remarks.
Blair Welch
Thanks, Paul. The last quarter has further strengthened our confidence in the value of our grocery-anchored real estate, the resiliency of our cash flows and the embedded growth in our portfolio. Grocery-anchored real estate has proven its ability to perform through various economic cycles, and we believe the current environment is only providing additional tailwinds for this sector. Surging construction costs and supply chain disruptions are limiting new supply in this market. This limited supply, coupled with strong demand for grocery-anchored space is accelerating rental growth in this sector. Importantly, within our portfolio, average in-place rent is $12.17 per square foot, significantly below our U.S. pure set weighted average. This means we have significant rental rate growth embedded in our portfolio. And we believe through modest increases to our below-market rents, we can unlock this embedded growth and significantly increase our revenue.
In the current interest rate and inflationary environment, which we know can contribute to cap rate expansion, our growth in revenue can more than offset any negative impact on our valuations. Our team’s operational performance this quarter speaks to the growth embedded in our portfolio. Our asset management team has completed over 520,000 square feet of leasing in the third quarter. New deals were completed at 9.5% above in-place for rent and renewals over 4% of expiring rent.
On a year-to-date basis, the REIT’s new leasing spread is 26.6% and total leasing spread is 9.6%, our highest rates of growth since 2019. Occupancy remains healthy at 93.1%, and we expect positive leasing to continue through the remainder of this year. The grocery real estate market continues to be present attractive buying opportunities, and the REIT’s partnership with Slate North American Essential Real Estate Income Fund, provides us with financial flexibility to pursue compelling investment opportunities. We also achieved meaningful improvements to our balance sheet and liquidity, amending over $600 million of existing revolving credit facility and term loans and improved pricing.
As of quarter end, 89.7% of the REIT’s debt is fixed, providing protection against inflation and rising rates. Lastly, after quarter end, the REIT completed 2 strategic dispositions at a total sale price of $19 million, representing a 6.6% cap rate. We expect to recycle the proceeds from those transactions into new opportunities that create value for our unitholders. We have strong conviction in the healthiness of the grocery asset class in our grocery-anchored properties, in large part due to the embedded rent growth potential of our portfolio. And with an attractive source of private funding now available for the REIT, in addition to its public equity sources, we are well-positioned to take advantage of opportunities in a dislocated market.
On behalf of Slate Grocery and the Board, thank the investor community for their continued confidence and support.
I will now hand it over for questions.
Question-and-Answer Session
Operator
[Operator Instructions]. Your first question comes from Gaurav Mathur from IA Capital Markets. Please go ahead.
Gaurav Mathur
Just firstly, focusing on the fact that your rents are considerably below market and your peers. And as you increase them going forward, how should investors think about stabilized cap rates on your portfolio versus the peer set? What I’m getting at is how does that delta begin to change?
Blair Welch
Well, I mean, excellent question and obviously very relevant in today’s environment. However, I think a cap rate is kind of useless if you don’t know what rent you’re capping, which is kind of your question. So I think the cap rate and the rent equate to a total value. And I think what we’re saying is that our value, we believe, could probably go up just because our revenue growth because of our rental — embedded rental growth will outpace any expansion in cap rate. Another way of saying it, cap rates should be lower on a portfolio where there is lower rents. And I think that’s what we’re really talking about. That being said, we are extremely comfortable with our current cap rate. On an IFRS value, probably much wider than most of our Canadian comps and even U.S. comps. And still we can buy assets with positive leverage in the market.
So I think to answer your question is, we believe NAV could probably grow in this cycle. And the cap rate could expand. We don’t see that anytime soon just because the rents are so low, but we think NAV could grow just because of the amount of rental growth.
Gaurav Mathur
Okay. Fantastic. And that does lead me to my second question, which is the acquisition pipeline in a fragmented market must be looking very attractive, but can you talk about how that’s changed or if that’s changing over the beginning of the year?
Blair Welch
Yes. I’ll let Connor answer more in detail because he and the team do an excellent job covering the market. But in general, I think there’s a couple of things going on. Now grocery, you can still get financing, if you’re well capitalized and Slate Grocery has proven that we can do that. But on the one — there’s over like about 40,000 grocery stores or neighborhood strips anchored by grocery in the United States, highly fractured market and a lot of CMBS financing, that market is not there.
So I think what we’re going to start to see is 2 things. Maybe people that can’t refi at the old rates on needing to sell, and then also people can sell grocery to get cash for other parts of their business. So I think it’s changing, and we’re being cautious. But I think we’re very excited about the coming months on opportunities. But I’ll pass it to Connor to kind of give some specific market color.
Connor O’Brien
Yes. I think overall, the grocery-anchored sector has been more resilient than kind of other areas of the retail asset class as well as kind of other asset classes where cap rates traded closer to their financing rates. So going forward, I think there may be some thinner buyer pools given the increased financing costs. I think that just may create opportunity for Slate going forward to identify opportunities where we can buy under-market rents at a very attractive low basis at a discount replacement cost and to continue to grow our portfolio strategically.
Gaurav Mathur
Okay. Great. And just lastly, can you talk about the implications of the Kroger-Albertsons merger on the portfolio? I mean is there any cause of concern just yet? Or is it still very early days?
Blair Welch
Sure. We believe that it’s too early to tell. But that being said, we do not see any significant impact on our portfolio. This deal is not scheduled to close until, I think, 2024. And I think it’s a competition thing. What’s interesting, unlike perhaps other things, people in these markets like those food stores are still selling grocery, but it’s a competition, then Kroger and Albertsons will be very, very hesitant to shed those stores because they have to, to a competitor. But it’s not like those stores are not selling food or they need food. So I think they’re just being cautious of how they do it. So the use of those stores will still need grocery. It’s more of a competition thing. But we think it’s too early to tell, but we don’t see it as a negative on our portfolio. Moreover, because of our chief in-place rents, we think our stores are actually quite attractive.
Gaurav Mathur
And just on that line of questioning, is there a positive that may come out from this entire merger for you guys?
Blair Welch
Yes. I think that could be, again, it’s too early to tell. But to put in context from a U.S. perspective, I think the top — how many grocers make up 40% of the sales, like it’s such a fractured market, like the combination of these 2 grocers are still less than 10% of the sales. But if you — I think the top 20 grocers in the U.S. are 40% of all grocery sales, where in Canada, you have 3 or 4 main grocers that dominate the market.
So yes, it could be good. But I mean the market is so big and vast. We don’t see this being a huge thing for our portfolio of the segment. It could, to your question, it could be positive, but it’s too early to tell.
Operator
Your next question comes from Jenny Ma from BMO Capital Markets.
Jenny Ma
I’m reading through your letter to unitholders, and hopefully, I’m not picking apart the words too much, but about halfway through, one thing that you write was through modest increases to our below-market rents, we’re confident our ability to market better rental rate grows. And I’m a bit fixed on the word modest just because it looks like there’s a gap and you talk about rent being quite far below market, and I’m just a bit — unsure about the disconnect between these modest increases versus the gap? Is it because of the contractual rent steps that are already in place? Or are you just taking a little bit of a cautious view given the economic circumstances? Just maybe give us a little more — a bit more color on your thinking on that.
Blair Welch
Jenny, you sound like my high school English teacher, but I think that — I think it’s a good question.
Jenny Ma
I do write for a living.
Blair Welch
I think the word choice we might be sandbagging a bit. I think as we said, our annual kind of rental spread is 9.6%. Is that modest? No. Do we feel confident that we’ll be a little bit better than modest? Yes. But how — that’s not a forever thing. If it is, it’s good for us. But I think the next couple of years, maybe it’s more than modest, but we’re trying to be — we’re not trying to shoot the lights out. I think Slate Grocery has proven to be a stable company with defensive cash flows that always pays our distribution. We’re looking forward to growing our revenue, but we’re just kind of being cautious in this sector. I mean, I think the numbers speak for themselves with our current leasing spread. But you’re right, maybe modest wasn’t the right choice, but we’re Canadian, we have to kind of be gentle.
Jenny Ma
Well, maybe I just dig a little bit deeper then. So when you look at the portfolio, the grocers, given their longer-term leases, like is the contractual rent step going to limit the kind of growth and you have to look to your sort of smaller tenant CRUs to offset that? Or are the opportunity to get, let’s say, a bigger mark-to-market on some of the grocery anchors, just given how far below market you say Slate Grocery rents are?
Blair Welch
Yes, you’re right. It’s a combination. Like our grocery-anchored rents is just below $9 a foot, which is extremely cheap, especially when you compare that to Canada or industrial rent. So our grocers make up about 40% of the portfolio. So we are seeing more dynamic growth, and I didn’t use modest, Jenny, for our shop base and others. But it’s a fine balance. We are still seeing, I would say, above modest growth with our grocers. It’s going to be mid-single digits, where usually, I would say that’s probably low single digits. And when you blend them all together, that’s why I said we’re over 9% this year.
So I think it’s — we’ve always believed — and you don’t need that much growth to go from like $9 to $9.50 to $10, that’s a huge growth, right? Like I mean I think there’s good steps there. So I think it’s a balance, making sure our anchors are happy in doing it, but you kind of blend that over time because once you have that anchor there that rent and they love these stores, you have a little bit of room, but where you’re going to get more growth is once that anchor is anchoring that center, everyone is going to be around that anchor. So it’s a blend of both. You’re right.
Jenny Ma
Okay. Great. Just look at your capital stack and $83 million term loan that’s coming due in the next few months. Just wondering what the plans are there, if you’re going to roll it into another term loan or maybe get some secured financing in place? And what indicative rents rates might be on that new piece that you need to refinance?
Blair Welch
Sure. Andrew?
Andrew Agatep
So yes, we’re actively in the market now looking to refinance that. We don’t have any particular concerns that we are getting that done. What we’ve seen is that the market has slowed down considerably, but there’s still active interest for grocery assets. What they’re really looking at when they’re underwriting now is what’s the strength of your rent roll? How strong is your occupancy and is it going to grow? And we check all the boxes and we feel uniquely positioned to refinance this at a rate that we think is kind of consistently seen in the past. Like interest rates have gone up, but spreads as it relates to grocers have sort of been the same.
So our cost of debt will probably be slightly closer to, I’d say, high 5s. But in terms of our weighted average cost of debt, that’s probably a 10 basis point increase to our overall portfolio, so 4.3%. Point being is that we are still a positive leverage, and we have enough liquidity to sort of invest opportunities during this time.
Jenny Ma
Okay. So if you’re talking about a high 5, that is a big jump on that piece, specifically, right, just given you’re coming off less than 3%?
Blair Welch
Yes, I think that’s right, but there’s still demand there. But I think that there’s still growth in the rents to kind of offset that, like it’s not — there’s still going to be rental growth. But you’re right, the cost has gone up, but it’s still — well, we still have positive leverage for our valuation and cap rate, but we believe our revenue growth will more than offset that. So I think being able to finance in this market, there is demand to do it from various sources, life cos or local banks or we could do it on our bank lines. There’s all sorts of flexibility, and we’re just going to choose what’s best for the company.
Jenny Ma
Okay. And is the desire still to keep it unsecured versus going secured to refi?
Blair Welch
Yes, we’re looking at all options. I think that we’re just going to — as I said, we’re looking at all options. It’s nice to be in the real estate asset class where you actually have options for that right now. And so I think that we’re just going to see what’s best for flexibility in investment pricing.
Jenny Ma
Well, what’s the spread that you’re seeing between secured and unsecured debts on U.S. grocery-anchored assets?
Blair Welch
Well, I think it’s more on size. I mean I think the unsecured market is kind of choppy right now. So I think in the secured market, we — I think you’re going to get better pricing in the secured, so I’ll answer that question. I think you’re in the high 100 spreads over the base rate for fixed financing right now. And I think that’s reasonable. My assumption, and I wouldn’t trust unsecured pricing right now, if I got it, it would be much higher than that.
Operator
Your next question comes from Himanshu Gupta from Scotiabank.
Himanshu Gupta
So just on the two asset dispositions. It sounds like you got 6.6% cap rate on that. So it looks like good pricing. So just wondering what was the profile of the buyer? And in general, how is the appetite for grocery-anchored assets in the current environment? I mean the transaction market.
Connor O’Brien
So both of those buyers were private groups focused on kind of a 1031 exchange. So they were motivated to transact quickly. And that was something we identified when we were kind of bringing in from LOI stage to closing. So they were looking for kind of a cash flow, limited use of financing, and we’re happy to kind of transact with them. Again, the profile of both of those assets, one being a nongrocery-anchored center, so nonstrategic and another having a larger exposure to gross leases, which is something in an inflationary environment, we were looking to strategically move away from.
Blair Welch
It’s a good question, Himanshu. I think that one of the strengths of Slate Grocery in the sector that we focus on is it’s very granular. If you think about each deal size, it’s $15 million to $25 million, plus or minus. So it’s — for the large funds, it’s hard to kind of focus. But we get to see all that stuff. And this granular in nature means privates can do deals. And what we’re seeing globally is that’s really where the activity is, is on the granular types of real estate. It’s hard to do big deals right now because of the way the financing market is, and I’m not talking about the cost of financing. I’m talking about the availability of financing big deals. We are still seeing globally more granular transactions and especially in the grocery space, getting done.
Himanshu Gupta
Got it. That’s helpful color there. And sticking to dispositions, like do you expect to do more dispositions in the near-term? I mean, any strategic like disposition program in the near-term?
Blair Welch
I think that we’ve historically at Slate Grocery REIT always recycled. Like if we think we’ve executed our business plan and if we think that like one of the assets that was sold is like more gross leases and we think in an inflationary environment, we don’t like that. So we’ve always done pruning. I don’t think — I think our portfolio is in pretty good shape. There’s probably a couple, but not many. I think we just — the team has done a really good job of executing strategies and then selling assets when we think it’s the right time. I don’t think there’s going to be a significant amount of dispositions just because I think our portfolio is in such good shape, and we want to capture all that embedded rental growth before we sell anything. So I mean, we’ll just continue to monitor, but there’s not going to be anything huge, in my opinion. Unless you, Himanshu, you want to pay us a fore cap for our portfolio.
Himanshu Gupta
Well, that will be negative leverage . And then just moving on the leasing environment. I mean, clearly, leasing has been very strong in the last few quarters. And yet, if I look at the small shop occupancy, that continues to range in the range — continues to be in the range of 87% to 88% kind of give and take. I’m just wondering in the recessionary scenario do you see further downside from here? Or are we still talking upside from this number?
Braden Lyons
Yes. We foresee that. We’ve got a deep and actual new leasing pipeline. We’ve got a lot of national tenants that are continuing to show strong interest within the market. So we certainly do not see that slowing down.
Blair Welch
Himanshu, we are seeing demand from all sorts of different sectors. I mean I’m going to keep on driving at home, so you’ll be annoyed with me. The — our average base rent is so attractive to all tenants to traditional neighborhood strip tenants, but if you’re leaving an enclosed mall, what you want is 2 things. you want to be around traffic, which our grocers create because they use it as omnichannel, whether they shop in a store, click and collect or in grocery delivery. So they want that traffic. And they are going to pay way less rents, even though it’s good for us than they would in a closed mall. And in this inflationary environment where they have rising costs and they got to look at their margins, we’re seeing demand from tenants that we never thought would do this. We also see demand from tenants that traditionally be in a going in line.
So I think we’re confident that for the foreseeable future, there will be demand. And I’m sure other companies that you cover in the U.S. or our peers, they’re seeing the same thing. Like it’s — there has not been a lot of new supply added in this space since before the financial crisis, and construction costs are really high. So we see occupancy going to be picking up and the demand for our space like it’s — we’re pretty excited.
Himanshu Gupta
That’s fair enough. I think continues to be resilient to grocer assets there. Yes. And I think just a final question on the balance sheet. I think you did some $275 million term loan. What was the pricing on that?
Andrew Agatep
So the pricing of the term loan is pretty consistent with what we have with our other credit facilities. So it’s about 185 basis point spread on top of 1 month SOFR. But we did enter into 2 swaps, which basically fixes that. So our debt are fixed, that’s about 90% .
Himanshu Gupta
Got it. And what will be the rate on that, like in absolute number, including the spread there? Like it will be 5%?
Andrew Agatep
It’s about 4%, low 4%.
Operator
Your next question comes from Pammi Bir from RBC.
Pammi Bir
Just on the portfolio acquisition that was done in the quarter, what can you say with respect to the performance relative to your underwriting for? It looks like, if I’m not mistaken, with the occupancy does — I think it’s actually up relative to the initial announcement. But just curious if you could provide some color there.
Andrew Agatep
Yes. I think we’ve been very pleased with that acquisition that was completed in July. We’re seeing a strong leasing pipeline at those properties and kind of see ourselves outperforming kind of our initial underwriting and see substantial income growth within that property portfolio kind of going into the next 12 to 18 months.
Connor O’Brien
Yes. Part of it, too, is when we signed the deal, it was about 91% — high 91% occupancy. And just between that and actual closing, we had another 60 basis points of that portfolio, plus the timing of our capital [indiscernible] has been pushed out a little bit. So we’ve definitely seen a lift this quarter. But there is embedded growth that we’re excited to see over the next sort of 4 to 5 quarters, that will be accretive to our bottom line.
Pammi Bir
And with the leasing that you mentioned moving up or seeing some pick up there. Is that — was that particular to any of the specific markets like the Sunbelt or just was it more broad-based?
Andrew Agatep
No. This is more broad-based. It’s just — like I said, the leasing has come on early, but just more timing of our capital spend. Just to feel like roofing and that kind of spend if it’s been pushed out a bit.
Blair Welch
Yes. I think that we really find — we like the Southeast and other places where there’s population goes because it’s cheap, cheaper cost moving in other cities. However, we have seen good demand from all of our assets from leasing. So it’s not anything specific. It’s not region specific. It’s more asset class. Neighborhood strips are showing good demand across the board because of what we’ve talked about already on the call.
Pammi Bir
Got it. And then just coming back to maybe the data acquisition outlook. Are you seeing anything similar in terms of the opportunities of this size and scale? And would you be prepared to transact? Or are you still — are you taking a bit more of a cautious view?
Blair Welch
I think we’re being cautious because we always are I think that grocery-anchored is a pretty attractive asset class. So big deals are hard to do. We’ll always look at ways to add value to unitholders. I think we see probably more opportunistic pricing on the single assets, probably for the next little bit. But I think it’s a combination of both. It’s anyone who’s well capitalized, it’s probably doesn’t want to sell their grocery unless they have to. And so that’s, we think, probably going to be in the smaller scale, but you never know what the future holds.
We’re always looking at portfolios and single assets. And we’re seeing in Europe like picking up small portfolios is happening, but it really hasn’t happened in the U.S. yet.
Operator
There are no further questions at this time. I’ll turn it back to you.
Braden Lyons
Thank you, everyone, for joining the Q3 2022 conference call for Slate Grocery REIT. Have a great day.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.
Be the first to comment