SmartCentres Real Estate Investment Trust

Huw Thomas - President and CEO Rudy Gobin - EVP, Asset Management Mario Calabrese - Interim CFO Steve Liew - VP, Finance and Acquisitions Anthony Facchini - VP, Operations John Darlow - VP, Leasing

Heather Kirk - BMO Capital Markets Michael Smith - Macquarie Sam Damiani - TD Securities

Thank you, operator and good morning everyone and welcome to Calloway's Third Quarter 2013 Conference Call. I am Huw Thomas, President and CEO of Calloway, my pleasure to be leading the call this morning.

Joining me on the call are Rudy Gobin, our EVP, Asset Management; Mario Calabrese, our Interim CFO; Steve Liew, VP Finance and Acquisitions; Anthony Facchini, VP Operations; and John Darlow, our VP of Leasing. I'll make some initial remarks about the quarter and general business conditions and then we'll open it up for questions.

And my comments will mostly refer to the first four pages of our supplemental information package posted on our website. Overall, if we look at the quarter we were very pleased with the third quarter results, considering the general economic climate and the overall retail market conditions.

FFO increased 10.8% to 62.5 million and 5.2% to $0.467 on a per unit basis compared to the third quarter of last year. Same property growth increased in excess of 1% and we continue our market leading occupancy level at 99% for now the 15th consecutive quarter.

And are well along the way with renewing or very close to renewing 86% of 2013 lease maturities, despite ongoing rationalization by a few of our tenants. And overall we expect to end the year with a mid 7% increase for this year's renewals.

And I will continue to emphasize our tenant or the tenant inducements on renewals are non-existent for us. If I look at our weighted average rent per square foot, excluding anchors, it's up to 20.77 per square foot at Q3 versus 20.2 at year end, which continues to reflect the increasing quality of our portfolio.

Overall, we're generally pleased with the tenant demand. For vacated space we've been able to release in reasonable timeframes at higher rents than previously obtained reflecting the strength and drawing power of our centers and in particular the significant traffic created by Walmart, particularly where they've added food.

With respect to the CIU category, we continue to see growth of the Dollar Store industry in Canada, together with other retailers such as Winners, Sport Chek, Toy's R Us, Michaels and we continue to see category growth in pharmacy, beer, liquor, banks and restaurants, overall ultimately providing healthy demands for space in most categories across the country. Overall we see the ongoing recognition of the strength of the fundamental building blocks for the business proposition to provide value oriented, well located and dominant retail centers, anchored by major retailers and in particular Walmart, all of which drives significant traffic to our site and provides good opportunities for our other tenants to best serve their customer's needs and simultaneously grow the business.

Now looking a little bit at future growth, the opening of the Toronto premium outlet site on the 401, at Trafalgar on August 1st provided a clear indication of how residents of the GTA felt with record traffic counts compared to other premium outlet openings south of the border, over that opening weekend and exceptional sales leveled by all tenants. That strong sales performance continues as our outlook retailers continue to bring designer and other high value labels at truly discounted outlet prices that customers have come to expect.

Based on updated sales numbers, the stabilized yield on the Toronto site is expected to ultimately be close to 9% and our JV partner Simon Property group continues to be extremely pleased with the performance to date, which bodes well for our next venture in Montreal which continues to move forward and construction has commenced with a fall 2014 opening. For Montreal specifically leasing is moving at a steady pace and we already have 25% of the project under lease and another 39% of the space is under commitment, and ultimately we see this as another very successful value driven outlet location.

And I would also note that we own a further 75 acres adjacent to this site in a joint venture which has the potential for additional related retail development. For acquisitions, we acquired four Walmart Supercenter anchored shopping portfolios in Ottawa, Kanata, Niagara Falls and Port Perry, totaling 820,000 square feet for a total of 231.5 million in the quarter.

And we’re very pleased to have partnered with Investors Group to acquire a 50% interest in the Ottawa site for 50.5 million. And the site also includes a five storey lead constructed office tower which is 75% leased to a leading North American consulting firm.

The acquisition of these properties embodies Calloway's strategy of acquiring newly built, dominant Walmart anchor centers in strong locations within the community and co-located with many of our established national tenants such as the LCBO, CIBC, Dollarama, Children's Place, Marks, RBC and so on A portfolio of over three quarters of 1 million square feet of Walmart SuperCentre Anchored properties doesn't come to market very often, so we were very pleased toad these sites to our already strong portfolio as a long-term investment. Our previously issued investment guidelines for 2013 acquisitions of $150 to $200 million has now been exceeded.

We will continue to look for more Calloway quality assets in the remaining few weeks of the year, if pricing is appropriate. Our internal development in our pipeline continues to deliver.

And during the quarter, we opened almost a 100,000 square feet of earnout and development space at an average yield of 7.4%. And we expect a further 103,000 square feet to come on stream over the last quarter of this year at similar or better yields.

So effectively therefore we expect to add the equivalent of two to three full size shopping centers this year at healthy yields. Our longer term potential is currently still centered on the Vaughan Metropolitan Center site and subway construction continues to be on track for a fall 2016 opening.

And we are moving forward to begin construction of the first building on the site, the KPMG Tower early next year. There continues to be lots of other planning activities going on in the background and overall we’re delighted with the level of cooperation that we continue to receive from all levels of government, who all remain very committed and excited about this significant project.

With respect to the balance sheet, we’re well positioned to take advantage of growth opportunities as they arise. Our own income pool of assets has now grown to almost $1.4 billion, certainly the largest in Calloway’s history.

Debt-to-total assets are at 43.2% and interest coverage has grown to 2.8 times and obviously both well within the trust target ranges. We do continue to look for other opportunities to refinance our various debt obligations, to take advantage of the still relatively low interest rate environment based on historic norms.

We now have commitments for all remaining maturing mortgages for 2013 and have obtained commitments for nearly 50 million till date for 2014, all of well below the maturing rates of close to 6% and those will provide positive reinforcing bottom line improvement opportunities despite the increases in interest rates over the last few months. And if I look at the overall performance during 2013, excluding floating rate debt on operating lines, we’ve raised the total of $522 million and have commitments for a further $77 million, so just under $600 million in total of long-term debt with a weighted average maturity of 9 years and an average interest rate of 3.85%.

So clearly positioning ourselves well for the future. Now, since becoming the President and CEO on a permanent basis I am continuing to assess the issues and opportunities within the Calloway portfolio.

Well the business has clearly demonstrated exceptional stability, predictability of operations and financial performance over the last many years. I do believe we need to strengthen our growth profile to truly deliver a balance between that stability and growth.

And I emphasize that metrics, at every opportunity both internally and with investors over the last few months. I see my challenge therefore to continue to provide the stability that our investors greatly appreciate and come to expect, want to ensure we run the REIT as efficiently as possible, provide enhanced top-line growth and optimize our cost of funds through looking at every opportunity to lower our interest costs on all forms of maturing debt.

Over the last few weeks I’ve spent a significant number of days touring our sites across Canada, as well as looking at future development opportunities and some of our competitors sites. In general I have been very impressed with the quality of our sites and their potential to continue to deliver meaningful income growth going forward, both from the existing properties and through development and intensification opportunities over time.

As I indicated on the second quarter call, I will be looking at accelerating our growth profile in the coming quarters. And consistent with my pervious comments this will be done through a combination of improving the same property income from the over 27 million square feet of shopping centers we currently own, looking at accelerating development intensification and earnouts from that existing portfolio, looking for further development within the joint venture with Simon Property Group, selective accretive acquisitions where they make sense, the ongoing development to the Vaughan Metropolitan Center, and then finally maximizing the potential of the SmartCentre relationship and the considerable resources that they bring.

Perhaps not surprisingly, to this end, the team is undertaking a comprehensive review of the portfolio to identify both future growth sites and those sites where we will consider alternate strategies which may include mixed use on a selective basis, and even disposition of certain properties that may provide lower growth potential. If we consider the potential overall from the suite of growth drivers together with an already superior covenant and the portfolio with very consistent and exceptional occupancy levels, I believe we should be able to provide significant growth potential for Calloway over time and also should ultimately provide us with the potential for a steady flow of modest distribution increases.

And just turning to distribution specifically for a moment, our payout ratio continues to decline and is now below our targeted range, and I expect that trend will continue for the balance of this year and into next year. My presence initially is to continue to lower our payout ratio and continue to support appropriate levels of leverage.

But then over time to provide a balance of regular modest distribution increases while still retaining a certain amount of our cash flow to fund future growth initiatives. And the platform that we are building I believe will allow us to do both of those things.

Finally on the management front; we’re actively working with the major executives search them to finalize the CFO position and the board and I expect to finalize the search over the next few weeks. But in the meantime Mario continues to provide variable service as our Interim CFO.

So overall I continue to be excited about Calloway’s future and before to spending time with you and our investors in the coming months continuing to discuss Calloway and its future growth. So with that operator I’d be pleased to open up the call for any questions.

I wanted to pick up on your comments with respect to sort of kicking up the growth elements in the portfolio. As you look forward you talked about developing the SmartCentre relationship and I'm just wondering exactly what you mean by that and how exactly you plan on maximizing that relationship?

I think it’s just, good morning Heather it’s Huw here. It’s really been very clear with the SmartCentre’s team exactly what we’re trying to do.

So as we’ve looking or as we’re looking at the overall portfolio, it isn’t just the Calloway group that we’re involving those discussions we’re involving all of the key people from the SmartCentre’s group from leasing, from development and so and leveraging all of their expertise, they built a large number of those sites initially. So looking at the site plans understanding the market understand what the various opportunities might be for each of our sites.

And by definition, our portfolio has four quarterlies so depending on the screens we use looking at the four quartile properties and understanding are all of those natural members of the portfolio going forward? Are there some small number of sites that may make sense to dispose off?

And similarly for the first quartile site, what can we do in terms of opportunity. And then in addition to that too Heather when we’re looking at product that comes to market and looking at any acquisition across the country with SmartCentre’s platform and having a presence in all of, in almost all of Canada in terms of B.C.

Ottawa, Montreal, obviously here in Vaughan, we are able to use that expertise and their market knowledge in assessing any portfolio or any property and that includes not only stuff that comes to market through the public world meaning through brokers but it also means privately. So that’s a huge amount of intelligence that we have accessible to us in anything we’re looking at or evaluating.

So again we do that on every asset we’re looking at to make sure that we have a very fulsome view of it before moving forward.

So just to encapsulate, if I understand correctly basically what you're saying is that you're looking to work more closely with them and just really to lever that relationship a little more intensely, maybe than has been done in the past?

Yes, I would say that’s a good start, Heather, yes.

Clearly intensification opportunities seem to be talked about more and more by a variety of management teams. I'm just wondering if there is additional opportunities that you see in your portfolio and how much of a shift this could potentially have in terms of the growth outlook over the next sort of three to five years.

I’ll let Rudy provide some comments on that.

And the intensification is coming as a result of three things; one is, when these properties were initially built, they were initially built with a certain view from the municipality that says we want parking ratios of a certain number, we want we’re happy with lots and lots of at-grade parking and so on. And now we see municipalities retracting from that saying hey you know what, we like a little bit of lifestyle living and we can do with some more intensification and even some mixed use and in some places they’re trying to encourage that and say listen, we'll help you with your planning and your zoning process if you do that.

So that’s something that has changed over time and is providing that opportunity to us. And especially because we’re in markets where there is population all around us.

That’s being very helpful to us. The second thing is our tenants are coming to us and saying we’re doing, like they’re doing so well, some of them want to expand and some of them want to rationalize their space, and the few that want to rationalize their space because they can do the same amount of sales in a slightly smaller space like a future shop.

We’re actually seeing very interestingly that we’re getting better rents than the outgoing tenants in some of those cases. So that’s working very, very well for us.

We’ve had in addition to that tenants who call up like a Walmart who says we have had so much space that were planning for and we overbuilt some of that stuff, if you want to utilize some of that space within their parcel. And we have done that.

We have intensified some of our sites across the country with stores like the Gap, Sport Check, with LCBO, with beer stores within the parcel. And we have done that over the last couple of years very quietly, but very strategically.

And then going forward we're planning more of the same. The intensification is one of more retail and certainly as you talked about earlier looking to see where we can take advantages of mixed use as well.

So are you able to quantify that like I guess what I am trying to get at is should we be expecting more of these deliveries and what would the quantum be?

I would say I mean we're at early stages of the process yet, Heather as soon as we’re comfortable and have been through the portfolio then obviously we'd be delighted to share a sense of the magnitude of the opportunities we see. But obviously I have only been in my role a few weeks relatively speaking.

So I want to make sure that we do proper job of looking at all of the sites and so on but as soon as we're able and certainly we'll be willing and delighted to do that.

And can you also comment on the IFRS cap rates, uptick whether what that was driven by?

Sure, we have a process in terms of how we do our -- adjust our cap rates. We use two national appraisal firms that provide us with quarterly updates on cap rates and we do have based across properties and transactions across the country.

So in the last quarter we didn't see much in the form of transactions, to benchmark again. So in our discussion with them it revealed our very minor softening that they believe has been -- is coming and it was coming as a gift of the result of both the debt and equity markets having some sight softening.

So again while there was no hard evidence of transactions that was their view of where they thought market reach were going and it was very minor. We think by the end of the fourth quarter we'll have some more transactions in the marketplace that will help guide and let everyone know what the direction will be.

So I would say Heather, we have always been somewhat conservative in the way we think about things. The feedback we were getting was getting, that's the way that third party external advisors reviewing how market pricing was trending so we made obviously a very modest adjustment to our pricing and would expect that we'll see similar movement over time from all of the REITs reduces there is more data becomes available.

Do you expect to get the same going in yield on the Montreal premium outlets?

That's a great question. We certainly hope so.

There is no reason the Montreal premium outlet is a market as you know that loves fashion, spent a lot of money on fashion and the location is ideal given where it is in North Montreal. Like we see no reason really why there would be a difference from Toronto.

The land cost was much lower going in. The site is about the same size and it has the ability to expand.

What's really great about this, you have a sort of a very value high fashioned 350,000 square foot outlet center in the middle of 125 acres of land. The outlook center will accomplish 50 acres of land.

But we also own 75 acres of land right adjacent and around the shopping center. And finalize the partner with us on all of it.

So we look at that as a 350,000 square foot value premium outlet anchor sitting in the middle of 125 acres. So certainly we believe that the tropic will be great and the yields will be excellent.

Based on the success of the Toronto premium outlets, in your discussions with Simon, are you stepping up any plans for more growth or is everything just on track?

There is two things I will say Michael, its Huw here. First would be with respect to Toronto, we already had some discussions with Simon about phase two of that site.

So there are variety of site plans that have already been crafted to see how we could expand the side. Anybody who has been there would realize we have some parking challenges that we'll have to manage and adjusted site plans would potentially include deck parking and so on to accommodate the traffic that we believe we would drive.

So that's the Toronto site, there we'll continue to have those discussions. We obviously continue to monitor sales activity and so far see no abatement whatsoever and the number of the stores continue to drive sales performance which basically would be better than any store that they have in their networks.

So that gives us some high degree of confidence about that site. And then in addition to Montreal or above Montreal we're actively talking to Simon looking for other sites in parts of the country to see if we can add additional sites over time.

So actively driving the roads and their team has been up here and so we spend time with them looking for additional sites. Nothing to highlight at this point but we’re actively trying to obviously find some additional sites.

Just switching gears, sounds to me like you're getting close to a modest distribution increase. Is that a fair assessment?

Certainly if we were using the payout ratio targets that we had in place previously Michael and we will end up below the lower end of that range this year. I think the only reason that we would not do something straight is simply me stepping back and having some discussion with the Board, just given what I think is the right thing to do which is a balance I think between modest distribution increases and simply managing our surplus cash and potentially using some of that surplus cash through reinvest back in the business.

So, certainly there is the potential layer and I’d like to see the year end numbers and like us to have a full view of next year and preliminary look at 2015. We’re certainly absolutely going in the right direction and very pleased about the trends of what we’ve been able to do to payout ratios and so on.

So, I hope that helps in terms of thinking.

Last question. Over the next say three to five years, what would you expect your same-store NOI growth to be?

We’re comfortably around 1% at the monument I mean over time I would hope that depending on market conditions and what’s happening in the overall economy, what’s happening with retail demand and so that we can drive same store above that. I’m always conscious that a percentage of our portfolio obviously has no growth in it because of the Walmart equation but on the other hand Walmart presence is what allows us to be so stable in our portfolio and what allows us to attract all of the other retailers and that’s the model that Calloway is operated but given the quality of the sites and some assistance from economic activity and retail demand that would hope that obviously we can grow above the number we have at the moment and we certainly very focused around that concept.

Just on the Toronto premium outlets, is it still showing up a property under development on the balance sheet at quarter end and how is it being valued on your IFRS today?

Just on the Toronto premium outlets, is it still showing up a property under development on the balance sheet at quarter end and how is it being valued on your IFRS today?

No its not. It was under development, it’s not brought online since it is been open.

So it is part of the income producing properties. There is a piece of it that because we have future development there will be a piece of the dirt that will still remain as under development but it’s now firmly in the income producing component and cap rate upraised.

So what's the capital rate that's being used to devalue that asset?

So what's the capital rate that's being used to devalue that asset?

I would tell you, it’s a very aggressive cap rate but it’s probably appropriate for an outlet center compared to our other centers. If you look at our overall average cap rate it will be at where I said the lower end of that range.

You built it to an 8-plus yield and it's being valued in the 5s.

You built it to an 8-plus yield and it's being valued in the 5s.

Sorry, say it again.

You built it to an 8% yield on cost and it's being valued in the 5s. Is that what you're saying?

You built it to an 8% yield on cost and it's being valued in the 5s. Is that what you're saying?

No, it wasn’t what I was saying but we build it to an above 8% yields and it’s being valued very appropriately for the portfolios. I would say, again look at all of the -- we have partnered this thing we obviously don’t disclose individual cap rates and individual properties for that reason.

But you can well assume that everyone in the market would know what are the first premium or the first real through outlet center in Canada and in Toronto would be valued at.

Based on the first few months of sales here, through the roof it sounds like. The percentage were in clauses or whatever; how quickly is that yield going to go through 9% and maybe toward 10%?

Based on the first few months of sales here, through the roof it sounds like. The percentage were in clauses or whatever; how quickly is that yield going to go through 9% and maybe toward 10%?

That’s a good question, it’s too early to tell. When we talk to Simon and then we talk to tenants and we get weekly sales from Simon and monthly from others.

We know that they’re doing very, very well and we don’t want to get out of line with it without seeing what the first month, two months, three months, six months look like, see what the Christmas season goes into it. But from what we're seeing so far, sales are phenomenal some of the centers there is few tenants who have never had these sales in any of their stores in the world.

So, it’s very, very interesting what’s happening. Its huge market as you know in Toronto market.

So, we expect that we will be in 2 percentage deals even as early as next year, because they are on the 12 month cycle. They have to see a year's worth of sales before that kick in I don’t know what that would be in term of yield and who would kick in but we probably need some more time behind us before we can figure that out.

Thank you all for joining us this morning. We as always appreciate your interest and support in Calloway and if you have any follow up calls then myself and the other members of the management team will clearly be available today to answer any questions.

Thank you very much again for your involvement. Thank you, operator.