Slate Office REIT (OTC:SLTTF) Q3 2022 Earnings Conference Call November 2, 2022 9:00 AM ET
Company Participants
Paul Wolanski – Senior Vice President-National Sales & Investor Relations
Steve Hodgson – Chief Executive Officer
Charles Peach – Chief Financial Officer
Conference Call Participants
Sairam Srinivas – Cormark Securities
Jonathan Kelcher – TD Securities
Brad Sturges – Raymond James
Jenny Ma – BMO Capital Markets
Matt Kornack – National Bank Financial
Operator
Good morning, ladies and gentlemen, and welcome to the Slate Office REIT Third Quarter 2022 Financial Results Conference Call. At this time, all lines are in listen-only mode. Following the presentation, we’ll conduct a question-and-answer session [Operator Instructions] This call is being recorded, Wednesday, November 2, 2022.
I would now like to turn the conference over to Paul Wolanski, Senior Vice President of National Sales and Investor Relations. Please go ahead.
Paul Wolanski
Thank you, operator, and good morning everyone. Welcome to the Q3 2022 Conference Call for Slate Office REIT. I’m joined this morning by Steve Hodgson, Chief Executive Officer; and Charles Peach, Chief Financial Officer.
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 Office 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 Steve Hodgson for opening remarks.
Steve Hodgson
Thank you, Paul. Good morning everyone. In the face of sectoral headwinds, including a rapid rise in interest rates not seen in many years, Slate Office REIT continues to demonstrate its resilience, offering unitholders a stable and attractive distribution yield, trading upside to its well-supported net asset value and a best-in-class management platform. Our conviction in the office sector remains strong. We know that physical workspace enables collaboration, culture and innovation. At the same time, we understand that in a post-pandemic era, certain tenants and industries will be more significant users of office space than others.
As such, we will continue to position our portfolio to focus on opportunities that align with tenant demand. We believe well-located, high-quality and modern office buildings with growing, strong credit tenants will continue to outperform. The REIT’s investment activity during and subsequent to the quarter is a great example of portfolio repositioning. We disposed at a very attractive price an older property in Toronto that has tenant and capital risk and we purchased a higher-yielding newer asset in Chicago, anchored by a long-term lease with Pfizer, which also has further upside in occupancy. This type of transaction enhances the REIT’s ability to provide stable performance.
Notwithstanding the REIT’s attractive assets and longer-term upside, our Board of Trustees recognizes that market disruptions related to the pandemic and elevated levels of inflation continue to weigh on the valuations of publicly traded REITs creating a divergence between asset values and unit price. As a Board and management team, it is our responsibility to consider every possible opportunity to surface value for our unitholders.
To this end, after quarter end, the Board formed a special committee of independent directors to oversee a review of strategic alternatives for the REIT. As we continue to navigate a highly volatile macroeconomic environment, the strategic review will play a key role in identifying additional ways to maximize value for all unitholders. All of our routine operations and investment activity will carry on as normal during this period and we intend to provide an update once the process is completed.
I will now hand it over to Charles for some additional highlights on the quarter.
Charles Peach
Thank you, Steve. In the third quarter of 2022, the REIT had a distribution yield of 9.2% and has provided an AFFO payout ratio of 75.9%. Loan to value was reduced to 58.4%, while net operating income rose by $500,000. While disposition costs reduced FFO and core FFO from the prior three months, AFFO for the quarter remained at $0.13 per unit. FFO core FFO each fell $0.02 to $0.12 and $0.13 respectively.
On a per unit basis, due to disposition costs on the mentioned before appraisal value sale of 95 and 105 Moatfield, while AFFO per unit was $0.13, unchanged from the first quarter prior quarter. Both during the quarter and subsequently, the REIT has continued to refinance its upcoming debt maturities having extended its Canadian dollar and US dollar revolving credit facilities, while reducing and extended — extending its largest single debt facility at 120 South LaSalle. There are $12 million of refinancing remaining for 2023, which is progressing well.
I’ll now hand over for questions.
Question-and-Answer Session
Operator
Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] There are no further questions. Please proceed.
Steve Hodgson
Operator, we believe that there’s a queue of questions that we’re seeing in the system.
Operator
Your first question comes from the line of Bernie John. Please go ahead.
Unidentified Analyst
So why did the AFFO for a unit decrease?
Steve Hodgson
Operator, I’m not sure we’re seeing the same questions as view. The first question should be from Sai from Cormark Securities in the queue.
Operator
Sairam Srinivas from Cormark Securities. Please go ahead.
Sairam Srinivas
Thanks, operator. So the question I had was around the Chicago acquisition. Could you just take us through the thought process behind the capital allocation there? And how do you guys see that putting into the broader plan?
Steve Hodgson
Yes. I mean, the Chicago acquisition, as I mentioned in my opening remarks, is really in line with our strategy of repositioning the portfolio. What we’ve done over the last quarter is, effectively reduced our asset base, created some liquidity to pay down debt, but also traded out of an older building that had some tenant and capital risk in Toronto at a 6.4% cap and bought an office building in Chicago with a long-term lease with an investment-grade tenant, with upside in occupancy at an 8.4% cap. And it’s a relatively new building with very little capital required in the near term. So it’s just consistent with our strategy of repositioning the portfolio.
Sairam Srinivas
Thanks, Steve. So the other question I had was on vacancy and I know this quarter we saw some of that. Is that mainly because of the SNC lease that’s expiring at — I mean the downsizing that’s happening at this month?
Steve Hodgson
Yes. There was a couple of things. The vacancy that we saw in the quarter I’m assuming you’re referring to, it’s a couple of things. It is the phased out vacancy of SNC-Lavalin at 195 the West Mall. In addition the disposition of 95-105 Moatfield being a higher occupied building, had impact on occupancy as well. But just as a reminder, there was a higher occupied building now, but our view was that there was some tenant risk there.
And then, in addition, there was the — mentioned I believe to you on the previous call, the airline industry tenant on the West Mall property as well that vacated. So a few sort of one-off situations. But, overall, we’re seeing some very positive momentum going forward and particularly, in Atlantic Canada as noted in our results.
Sairam Srinivas
Thanks a lot, Steve. I’ll turn it back.
Operator
Your next question comes from the line of Jonathan Kelcher from TD Securities. Please, go ahead.
Jonathan Kelcher
Thanks. Good morning.
Steve Hodgson
Good morning.
Jonathan Kelcher
Just staying with, I guess, the leasing, have you guys noticed or seen any change in sort of the length of time tenants are taking to make decisions or any slowdown in touring or anything like that?
Steve Hodgson
No, I don’t think so. I think, you see a little bit of that naturally in the summer quarter. But I would say, it’s actually the opposite of that, Jonathan, and that we’ve started to see tenants commit to longer-term deals. And like the deals — the new leasing that we did in our portfolio had a 9.2 average term — 9.2 years of average term. So that’s clearly a sign that tenants are committing long term to office space.
In terms of tour activity I think that’s where it generally slows down in the summer. With that said, some of the vacancy that we have along the 427, that’s recent and transitional, that space had not been vacant for a long time and we’re getting some — a lot of interest in — from other users.
Jonathan Kelcher
So you’ve seen touring — so touring activity slowed down in the summer and you’ve seen it pick up again in the fall.
Steve Hodgson
Yes, that’s right.
Jonathan Kelcher
Okay. And then, you had, I think, roughly 15 leases that didn’t renew in the quarter. Were those — and you talked about some, but were the rest of those mostly spread all around the portfolio or was there one geography that was better or worse than others?
Steve Hodgson
Yes. There was nothing — there was just those three. There was three that were over 5,000 square feet. The rest were spread out amongst the portfolio and small in nature.
Jonathan Kelcher
Okay. And then, the lease termination income you had in the quarter was that one big one or a bunch of little ones?
Steve Hodgson
That was related to SNC.
Jonathan Kelcher
Okay. Thanks. I’ll turn it back.
Operator
Your next question comes from the line of Brad Sturges from Raymond James. Your line is open.
Brad Sturges
Hi. Good morning. Just to follow up on the question on the lease termination fee income. Is there anything with the renewal income you’re expecting for the rest of the year, or would that be kind of after Q3?
Steve Hodgson
Not anticipating any more lease termination income for the balance of the year.
Brad Sturges
Okay. And given where you are from an occupancy rate today, where do you kind of see that trending in the next two, three quarters?
Steve Hodgson
So we still have the last phase of SNC-Lavalin vacating in Q4, which is just over 40,000 square feet. We do have some new leases coming online in the quarter, but I would expect occupancy at the end of the year to be relatively flat, because any new leasing we’ve done even this quarter and next, it won’t be in occupancy until the New Year, just given time to retrofit space, et cetera.
Brad Sturges
And just on the SNC space that you got back, it sounds like you’re getting good activity there. Just curious at this point what your time line might be just to release that space?
Steve Hodgson
Which was that the SNC-Lavalin space?
Brad Sturges
Yes, in the West Mall.
Steve Hodgson
Yes. So they’re still — they’re going through a phased exit of that building, but we’ve been marketing in it. There are several larger users that have toured. There are several sort of full floor users as well. We have some vacancy at 191 in which, I think, we’ll get some traction on putting the full floor tenants there in 195. Our immediate marketing strategy is try to get the larger users in there, given it is a full building opportunity with naming rights and signage rights.
Brad Sturges
Last question, just going back to the Chicago acquisition. Maybe I missed it, but where within Chicago would that building be located? And then, can you just talk through the lease-up potential a little bit more in terms of lease prospects for leasing up the rest of the building?
Steve Hodgson
Yes. So the location of the building is in Lake Forest. It’s adjacent to lab building that Pfizer owns. So it’s very strategic for them. A lot of the COVID vaccine lab development R&D was done in that facility. They — this is new space to the market. Pfizer previously occupied the entire building. And it’s a beautiful building that’s probably — it’s certainly the best in that immediate area and probably the second best in the region.
Lake Forest, as you may know, is a great demographic area. A lot of the tech and life science executives live there. So we’ve been quite pleased, even during due diligence. We had a couple of tours for the space.
So I think our plan having bought it at an 8.4% cap on in-place income. We put in financing as well that Charles can speak to, that allows us future funding to fund the lease-up. And if we’re able to execute on that in short order, it’s just an amazing real estate transaction for us.
Brad Sturges
Okay. Great. I’ll turn it back. That’s all.
Operator
Your next question comes from the line of Jenny Ma from BMO Capital Markets. Please go ahead.
Jenny Ma
Hi, thanks and good morning.
Steve Hodgson
Hi, Jenny.
Jenny Ma
Just want to follow up on the question about the Chicago assets. For the space that is available for lease right now, is it ready to go, or is there any work that you need to put into it, or any sort of specialized fit out that a potential tenant might require, or is it a fairly short time line to get it going when you find a new tenant?
Steve Hodgson
No. So the acquisition closed yesterday. Today, we’ve started work on the retrofit of the lobby because it was a single tenant building. We need to retrofit the lobby to make it dual access for multi-tenant. That’s where the only change Jenny. There’s two wings of the building, of which one is where the vacancy is. So it actually lays out quite well for multi-tenant.
And what differentiates this building is the amenities. There’s incredible conference space, fitness facilities. It’s adjacent to food and shops and we expect quite a bit of demand. And Pfizer doesn’t have any exclusives on – in their lease preventing us from leasing to any other life science or pharmaceutical companies. So we expect some strong demand.
Jenny Ma
Okay. Great. I just want to ask about the Irish portfolio. It looks like there’s been an improvement in the overall occupancy. But it would appear there’s a couple of assets that have occupancy below 50%. So could you remind us what the story is there and whether there’s an update on when that space could be released?
Steve Hodgson
Yes. I mean we purchased the buildings with that vacancy, so we view that as an opportunity. The new lease that we did as well was a 20-year deal. And so at about 7,000 square feet. So we’re quite pleased having executed on that. The vacancy that you’re referring to is that some pretty small buildings.
So it’s only going to take one tenant of each of those buildings to rectify that. And one of those in Cork in particular, we’ve had some interest and we’re just working through that. So as you can imagine, having taken over this portfolio, we’ve made some changes to the teams in place as well as the third-party sales teams in place and we’re sort of relaunching it in a marketing campaign more in line with what Slate’s accustomed to elsewhere.
Jenny Ma
Okay. Great. And then moving to the debt stack, could you provide what you’re seeing for indicative mortgage rates, I guess it would be the 2023 renewals that you’re looking at? And if there is – if it’s mostly concentrated in Canada or if there’s any US or Irish mortgages in that mix as well and whether or not those rates are different.
Charles Peach
Happy to come on that. So over the period so far, over the third quarter and what we’ve just seen as you noted in the subsequent events we’ve done over CAD 500 million equivalent of refinancing, some of which is length here, some of which is particularly shorter. For some of those we have rolled exactly the same rates that have been there before. For some of the others we have looked at some of the slightly higher rates that are there too.
What we have is the benefit of some of the swaps that we have in place extend in some instances beyond where the refinanced debt was refinanced at. So effectively we’ve got the benefit of cheaper swaps being in place from that point on.
If I look at sort of all-in rate of where things are in next year, on the swap side of things we’re down to the 3.7 or thereabouts. At the other end of the spectrum I think at the highest end we – our projection is around the 6.5% is what we see as those maturities coming up next year.
I would say that is based on projections we see from counterparties of where we expect rates to being similar. And there could be a fair amount of movement there, given the shape of the curve and just the movement we’ve seen in absolute rates both from a US perspective and Canadian perspective. And I wouldn’t also underestimate the fact that we have euro exposure there too. So on the European side of things, we have a closer outstanding at the moment. We are significantly progressed in looking at fixing that exposure. And if we were to do so that would reduce our floating rate exposure by over 50%.
Jenny Ma
Okay. That 6.5% that you mentioned Charles, is that a result of spread and/or term? And is that on the Canadian or the US side? It sounds a bit high. I know we can’t predict rates but just based on what we know still sounds a bit high.
Charles Peach
That’s on the Canadian side of things. What we see there is we have an asset where the – it had a swap against it that swap will no longer – well essentially matures at the maturity date. So we have to take into context not only the spread component but also where the actually underlying rate component is as well.
Jenny Ma
Okay. Great. And then my last question is – and I’m not sure if you can full simply answer this but I’ll try anyway. With regards to the review of strategic alternatives, how long do you expect the process to take?
Steve Hodgson
Yes. Thanks, Jenny. As you mentioned, we’re not really commenting specifics beyond what we said in the press release but I can speak more generally and provide some context. It’s very clear that these market disruptions related to pandemic and elevated inflation continue to weigh on valuations of publicly traded REIT’s, particularly in the office sector and that’s created a divergence between asset values and unit price. So our Board has a responsibility to the REIT and all of our unitholders to consider every possible opportunity to surface value and they’re taking action to do that.
So the review, which is led by the independent trustees and supported by external financial adviser, we’ll provide another layer of analysis and evaluation as we look to surface value creation for the opportunities for the REIT. So they’ll be looking at a broad range of options that could include acquisitions, dispositions, corporate transactions and other partnership opportunities.
Jenny Ma
Okay. It sounds like a fairly fulsome review then, right? So we’re talking a matter of probably months?
Steve Hodgson
Yes.
Jenny Ma
Is that fair?
Steve Hodgson
Yes.
Jenny Ma
Okay. Okay, great. Thank you very much. I’ll turn it back.
Operator
Your next question comes from the line of Matt Kornack from National Bank Financial. Please go ahead.
Matt Kornack
HI guys.
Paul Wolanski
Hi Matt.
Matt Kornack
Just wanted to quickly follow-up on Jenny’s line of questioning and I apologize if you already touched on it, but with regards to the near-term debt maturities is the expectation that you would get at least the amount that you have outstanding?
Or are there up financing opportunities at this point? I just want to get a sense as to liquidity and if you even maybe potentially have to reduce the size of some of those.
Charles Peach
The fact that we have been — that we have liquidity at the moment and we continue to keep that liquidity, I think allows an important amount of flexibility when it comes down to some of these debt re-financings. You will have noted that we gained initial CAD8 million in financing in – since the period end.
It’s moves like that which is on a particular asset that we owned already and financed already which allows us flexibility when we come around two other assets in the future, if we see that there’s a benefit in taking a lower leverage on an asset
In order to pay a lower spread to that we’d like to have that flexibility as we go forward into the next period. I think an example of our thoughts around what might be along that is along the 127, where we had 101, it from zero to 75, outstanding of which we paid down 20 million with a view that.
And going forward that should help significantly around spread availability and a number of counterparties willing to provide financing on that asset. And I think that’s an example of how we might use our liquidity and our capital to improve the cost and availability of financing we have over the next year.
Matt Kornack
Is it possible to quantify maybe what the benefit would have been on a relative basis?
Charles Peach
Rather not at the moment because,…
Matt Kornack
Okay.
Charles Peach
…we’re looking at further financing around those assets coming up within the next four, five months.
Matt Kornack
Okay. No, that’s perfectly fair enough. With regards to the West Mall, if someone were to take the large space what would be your expectations in terms of kind of signing the lease to ultimate cash payment? Does work need to be done in those spaces, or is it in pretty good shape for leasing?
Steve Hodgso
No. It’s in very good shape. You may recall the history of that building it was overbuilt in the Nortel days. SNC did some incremental work to make it work for them. Most of the walls are demountable wall systems, which provides some flexibility in layout for project space et cetera but also provides flexibility for future tenant use.
The building shows really well, Matt. And yes there will be some inducements and some time required for tenants to make it their own but not a significant amount of time.
Matt Kornack
Yeah. So…
Steve Hodgso
And just as a reminder to SNC vacated at a rent of $1,650 the starting rents that we have in the West Mall now are $18 to $19.
Matt Kornack
Okay. And it sounds like — I mean, if you find someone if someone takes the space you could potentially have them and paying cash rent at some point in 2023?
Steve Hodgso
Yes. Yes.
Matt Kornack
Okay. And then last one — and maybe you can provide a ballpark, if its competitive disclosure that you don’t want to give. But with regards to the recent acquisition in Chicago what would be your hope in terms of achieving market rents at that property?
Steve Hodgso
So we think the rent that Pfizer has leased is probably at or just maybe slightly below market. So our anticipation and what we’re underwriting for the balance of the space is very similar.
Matt Kornack
And is that sort of mid-teens, high-teens…
Steve Hodgso
It’s an $18 rent, net fully net, triple net with $0.50 escalations per year.
Matt Kornack
Okay. So I mean, I guess if you could get to 100% occupancy that’s an 18% cap rate. Am I thinking of that correctly?
Steve Hodgso
Certainly mid-teens. Yes.
Matt Kornack
Okay. Fair enough. Okay. Thanks guys.
Operator
[Operator Instructions] There are no further questions at this time. Please proceed.
Paul Wolanski
Thank you everyone for joining the Q3 2022 conference call for Slate Office REIT. Have a great day.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask you to please disconnect your lines.
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