Plaza Retail REIT

Thank you, Operator. Good morning, everyone, and thank you for joining us on our Q1 2022 results conference call.

Before we begin today, we are 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, which 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 & Analysis for the period ended March 31, 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 today, which are 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, please refer to Part VIII of our MD&A for the period ended March 31, 2022. I will now turn the call over to Michael Zakuta, Plaza's President and CEO.

Michael?

Thank you, Kim. Good morning.

In the first quarter, our positive momentum continued. Leasing activity is very strong for new and existing assets.

We attended our first ICSC Dealmaking Trade Show in two years at the end of March. We met 50 retailers or the representatives over a two-year period, and the mood was very, very positive.

There continues to be strong demand for essential needs, value, convenience and QSR locations across our geography. This demand is fueling our pipeline as we have a number of projects in planning and seven land acquisitions under contract.

This increased demand is not without new challenges as we are dealing with higher construction costs and material delivery delays. Higher costs will lower returns on projects where rents were set in advance of this pricing pressure.

We are rapidly adjusting to these challenges. We are achieving higher rents from retailers in response to higher costs.

Last quarter, we talked about our business strategy of identifying and executing development and redevelopment opportunities for grocery, pharmacy and other essential needs-oriented open-air properties. We made the point that as a result of our strategy, we have irreplaceable assets leased to strong covenant retailers in primary, secondary and tertiary markets throughout of Eastern Canada.

These assets have long been underappreciated and have taken an unprecedented pandemic to highlight their value. Over the last 20 years, Plaza has been developing new retail projects and transforming tired, outdated retail centers into modern relevant properties.

Before and after photos of more recent transformations are posted in the Q1 2022 presentation on our website. We are opportunity-driven, and we deliver.

Our growth is reflective of this and has largely been generated in two ways: retailer demand for new development and repositioning assets that we purchased for redevelopment. Our pipeline for new development project is very healthy, and it's being driven primarily by growth requirements for major grocers and other essential needs retailers.

In addition, we are evaluating a number of income-producing assets that would benefit from Plaza's vision experience, reputation and abilities. We are very excited about the diversity and quality of our new development and redevelopment pipelines.

Our credibility with major retailers continues to grow in this post-pandemic era. In essence, we are a supplier to the retail industry, and we have built our business and reputation by helping essential needs, value and convenience retailers grow throughout our geography.

We take pride in fulfilling our commitments to retailers, and we continue to prioritize this customer service approach. As a result, we are very active with a growing number of institutional quality essential needs retailers.

Our team works hard to deliver for our retailers and stakeholders and grow the business. We are not passive investors seeking acquisition opportunities of finished product that is marginally accretive to unitholders.

We want to create real unitholder value while actively working with retailers to help them expand their business as opposed to just buying properties and collecting rent. We anticipate continued growth in response to increasing demand for Plaza's platform and services.

I will now turn the call over to Jim Drake, Plaza's CFO. Jim?

Thank you, Michael. We had another great quarter, and our key indicators provide evidence of that.

Overall committed occupancy and same-asset committed occupancy are both at 96.3%, up 50 bps and 90 bps, respectively, over last year. Leasing demand and activity remains strong, and we leased 396,000 square feet across the portfolio during the quarter, including 268,000 square feet of renewals, 46,000 square feet of new leasing and 82,000 square feet of backfilling vacancies.

Same-asset NOI is also up 2.7% over last year. And FFO and AFFO per unit are up 7% and 5%, respectively, over last year, resulting in improved payout ratios at 71% of FFO and 79% of AFFO.

And our debt to total assets ratio has improved to 55%, down 350 bps over last year. Under our development program, we continue to advance a number of projects.

And during the quarter, we completed a small strip redevelopment and a few pads. And as Michael mentioned, our pipeline of projects is very solid, and we have a number of sites under contract for grocery and essential needs retailers.

To partially fund our development program, we sold a few non-core QSRs, where there is still strong demand at attractive pricing, resulting in very low hurdle rates on new sales. Our liquidity is also solid, and at quarter end, totaled $60 million, including cash, operating line and unused development and construction facilities.

We also had $16 million of unincumbered assets. For debt, at quarter end, we had $34 million of long-term mortgages maturing for the remainder of the year.

And subsequent to quarter end, we refinanced $14 million of these. $15 million of the remaining mortgages relate to freestanding pharmacies where the existing loan-to-value is approximately 30%.

We will refinance these assets at 60% to 65% loan-to-value to generate capital for our development program. And given the existing weighted average rate on these mortgages is 4.76%, which is similar to or above current all-in rates, there is nominal interest rate risk on these rollovers.

We also had $6 million of mortgage bonds maturing in June, July, and we anticipate renewing approximately $3 million of these for three to five years at market terms. There has been a lot of discussion around interest rate movement.

And although rising rates do obviously have an impact on real estate, we have mitigated our interest rate risk through a number of actions. First, we generally limit our floating rate exposure to our operating line and construction and interim facilities.

Next, our individual debt issues and mortgages are relatively small. So exposure on any given renewal is reduced.

We also have a well-staggered debt maturity ladder, so our exposure in any given year is balanced. And as mentioned, our exposure on rollovers for the remainder of this year is minimal.

And given the high existing rate, interest rate risk on these rollovers is nominal. Our long-term mortgage maturities in 2023 are also relatively light and at a weighted average rate of 4.88%.

So interest rate risk on these roles is also nominal. And finally, for new projects, we have always included sufficient contingencies, and we underwrite using appropriate interest rates to mitigate our risk.

Rising rates can also impact cap rates, but much of this has already been priced in. And the increasing demand for our essential needs, value and convenience assets also helps offset any impact.

As well, there are still some predictions that yields on longer-term Government of Canada bonds will moderate or potentially even decrease later this year. As a result, we recorded a $12 million gain on investment properties during the quarter, arising from cap rate compression and appraisals obtained with our weighted average cap rate now at 6.73%.

Those are the key points relating to our results for the quarter. We will now open the lines for any questions.

Operator?

A couple of questions from me. Just regarding your same-asset NOI, your portfolio continues to show so you'd see -- what are your expectations for 2022 for the remainder of the year on a quarterly basis?

And can you remind us how we should view the year-on-year impacts from factors, including COVID-related bad debt expenses, write-offs and lease buyouts going forward?

So I'll start. Last year, Q1, we did have some bad debt that brought us down.

So that's part of the reason for the increase year-over-year this quarter. But we've also seen an increase in revenue year-over-year.

We don't necessarily provide guidance on future same-asset NOI growth, but I think we're pretty safe to say that we should see continued growth going forward.

Okay. Great.

And last one for me. So just in terms of your internal goal to achieve your unlevered returns on developments and redevelopments, I think it's between 7% to 9%.

Do you see the size of your pipeline fluctuating to achieve this yield? Or could you become more flexible just given the current environment?

I think our volume will go up based on opportunities, and the returns will be within the range. And as I mentioned, some of the projects get stuck between when you set your rents and you actually finish your costs.

You're going to lose -- you might lose 50, 75 basis points, maybe 100 basis points on your return if you go into the low-end of our range. But we expect to have a busy year in 2022.

So just, I mean, sort of the depths of the pandemic, we never really saw much in terms of distressed asset sales. I think we talked about it on previous calls here.

You guys didn't see it. But in your opinion, just given your knowledge of the markets you operate in, in this higher rate environment, is this something that we could see and then could present opportunity for Plaza?

Or are there more well-capitalized real estate operators?

We haven't seen a lot of distressed opportunities. We're seeing more opportunities based on maybe larger landlords wanting to exit certain markets.

That's creating opportunities. Not seeing those distressed opportunities that we would have seen many years ago when real estate was really, really out of favor because interest rates are still very, very low.

And we're not getting -- we get the odd phone call something where purely somebody is underwater. And usually, it's an enclosed mall of some sort.

So we're interested if we have a clear vision on how to convert it to an open-air center. But the ones that I'm thinking of didn't need the clear vision requirement.

So I can't say that, that's what's driving our opportunities. I think it's more repositioning, not being good at retail, deciding that they should be focusing on other areas of real estate investments.

Okay. That makes sense.

And just kind of piggybacks on that. But I guess as you're looking to buy or sell assets, have you noticed a change in the composition of buyers or sellers recently?

No. I can't say that.

So we look at selling -- we're selling very, very small assets. We call our non-core assets.

And there's still strong demand, and it's a private investor who can -- wants to own a small -- a very small single-tenant building and will pay a very good price to do so. So that's on the selling side.

From the buying side, who's selling to us, again, it's all over the place, but again, its typically larger investor, institutional or more institutional style landlords that won't -- or don't have the ability or do not want to invest in the type of assets that we're looking at -- that require investment and a lot of hard work to transform and fix. It takes a special skill set, as I mentioned, to fix something to have a vision to reorganize a broken retail asset or retail assets not broken yet, but will be broken in the future, meaning it has a lot of vacancy, and that has to be addressed.

And you have to be organized to do that. And yes, a lot of owners are not organized to do that.

Okay, okay. Maybe just a quick update on the Northern Plaza redevelopment.

How is it progressing relative to your expectations? And then I think there's about -- I think it's about 30% leased at the moment, so -- or sorry, 70% leased.

Just wondering your thoughts on leasing up the remaining space there.

You're referring to Sault Ste. Marie?

Yes.

Yes. So, yes.

We have basically all of the Lowes committed, two leases out of three signed. The other deal is just about to be signed.

So we're in very good shape there. We'll have a couple of little CRU units that are left over, and we plan to build a small QSR-oriented pad building.

We're going through municipal approvals now, and we're working to lease it. But the -- all of the Lowes space is spoken for.

It's just -- the last deal is not -- the lease is not firm. So we're there.

We're there. We're very happy.

It's going to be a great asset when it's all completed and a wonderful transformation from a tired strip with an empty hardware store into something really, really dynamic. So very excited about that.

Okay. Great.

And just the last one for me. I think this one is probably for Jim.

Can you just remind us of what is contained in the other income line? And then maybe just a little bit of color on the sequential decline and your thoughts on how that progresses through 2022?

So other income is generally fees that we are billing to our partners on co-owned developments. So that would be management fees, development fees, financing fees, et cetera.

Year-over-year decline, last year, we had some insurance proceeds, both $300,000 grand went through that account. So that's why you see the year-over-year decline.

Going forward, this quarter would represent a relatively stable quarter. It's probably a little bit light compared to what we'll see for the rest of the year, because as we ramp up developments, obviously, we see more income from the development side.

I'm going to caveat my question by saying it's probably a bit too early, but I'm going to ask it anyway. We saw the cap rate on the IFRS come down a bit more.

So it's been a nice downward trend. And obviously, we know what's happening in the broader market.

Have you seen anything of late come across the desk in terms of indications of whether there's volume coming down or more coming to the market as sellers want to get this asset book? And do you see any, I guess, plateauing or upward pressure on cap rates recognizing that in the mid-6% to 7% range, there's still quite a bit of room on the investment spread?

Maybe I can start, Jim, and answer. I think it depends very much on the product that one is looking at.

So some of the really simple single-use stuff, demand is very strong. I think that our freestanding pharmacy properties, there's still downward pressure on cap rates.

Maybe it's going to be a little bit slowed down that downward pressure by increases in interest rates, but there appears to be demand in the market. We expect that there'll be a little bit of stall as people try to figure out where interest rates are going to settle, and that's going to impact the cap rates.

I think as you said, I think it's very, very early. And I think it's very dependent on the type of product and the type of location for the property.

Jim, I don't know, if you have any thoughts on that.

Yes. I'll just add that obviously, we're very comfortable at 6.73% for our weighted average cap rate.

And yet maybe too early, but I think Michael stated correctly, there's still huge demand for a number of our assets, whether that's pharmacy or grocery-anchored. So I think that wall of capital chasing that product is certainly going to help maintain those cap rates down.

So we'll see.

Okay. Are you seeing any changes in the volume of deals come across your desk?

I don't know if I can say it's a volume. I mean, there has been strong volume of deals over the last, say, six months.

I can't say that we're seeing more or less right now. And we'd anticipate, again, a little bit of a stall just because we have to figure out what is the proper pricing, but it's very much business as usual.

So we're not looking at finished product at all, which is probably -- is the bulk of the market. So we're buying land to assemble, to build new strips or we're buying buildings to tear down to build new strips or we're buying the really challenged retail, which is a very specific product.

And that cycle just goes up and down for all kinds of reasons, doesn't necessarily follow the cycle of finished product offerings.

Okay. Now Michael, when you say stall, do you mean that in a broader market sense?

Or does that include Plaza's approach to reviewing deals as well?

Yes. I'm talking the broader market.

We're loaded. Our pipeline is pretty full, and I don't see that we're stalling in any way.

We're driving forward. Again, we're not pricing the deals the same way as a finished product investor would look at a deal.

So if we're buying something with some revenue, there's got to be a ton of vacancy, and there's got to be a serious redevelopment play. And then -- so that's a whole different approach to looking at the business.

I'm referring -- I refer to stall, I'm really referring to investments style of dealings. And if I was a finished product buyer today, I'd be saying, okay, well, how is the market going to shake out?

That's what I'm referring to. For our business, it doesn't matter.

That's very helpful. Thank you.

And just turning over to debt. I think, Jim, you mentioned what you're seeing is about 4.75% on your remaining debt for the year.

I'm just wondering, if that reflects any change in the spread on your debt or if that's just characteristic of the assets that the debt is underwritten against.

So the 4.75% is the weighted average rate on the existing debt. Market today, we're probably seeing around 4.75% for 10-year term.

Okay, 10-year. Okay.

Five-year term would be. Yes, that's a 10-year term.

Five-year will be, say, 20 bps lower.

Okay. Got you.

I thought it was a little bit high end, so it is similar. So I guess on that note since you quoted the 10-year, are you inclined to push that longer for extra 20 bps?

Or would you be looking to sort of maximize your -- or minimize your interest rate and kind of go forward with a slightly lower one?

We're always trying to minimize interest rate, obviously, but we also want to match debt term with weighted average lease term remaining whenever possible. And although somebody may look at a 4.75% rate today and look at it as high relative to the last year, historically, it's still a pretty attractive rate.

So it really depends on the asset. But if we can lock in a 10-year rate, and it makes sense for the asset and it makes sense for our overall debt ladder schedule, we'll walk in long.

Okay. I mean, I guess, the 20 basis point differential between five and 10 years really is that substantial relative to what we've seen in the recent history.

Is that correct?

That's correct. And depending on the product and depending on the lender community, there's often a lot more five year money chasing that product.

So in certain cases, you can even see a slightly tighter spread in the five year.

Patrick Kealey here just on behalf of Chris Koutsikaloudis. Just looking at the seven land assemblies under purchase agreement.

Just wondering if you can give us some more color on geography and kind of potential development timeline for those?

Yes. So the majority of the geography is Ontario and some in Atlantic Canada.

Timelines will vary from two to four years for the development cycle. It's early.

Got it. Thanks.

And what you will see is, so I'm assuming when we close -- may not close on all seven. But as we close on them, they'll go on into our planning and development, and then you'll see a product size and clear timeline for completion.

Thank you, Operator. That concludes our call.