Morguard Real Estate Investment Trust (OTC:MGRUF) Q1 2023 Results Conference Call April 27, 2023 4:00 PM ET
Company Participants
Andrew Tamlin – CFO
Todd Febbo – VP of Eastern Asset Managemen
Conference Call Participants
Jonathan Kelcher – TD Securities
Tom Callaghan – RBC Capital
Operator
Good afternoon, ladies and gentlemen, and Welcome to the Morguard Real Estate Investment Trust First Quarter Conference Call. [Operator Instructions].
This call is being recorded on Thursday, April 27, 2023, and I would now like to turn the conference over to Mr. Andrew Tamlin. Please go ahead.
Andrew Tamlin
Good afternoon, everyone. My name is Andrew Tamlin, Chief Financial Officer of Morguard REIT. Welcome to Morguard REIT’s first quarter 2023 earnings conference call. I am joined this afternoon by John Ginnis, Assistant Vice President of Retail Asset Management; Tom Johnston, Senior VP of Western Asset Management; Todd Febbo, VP of Eastern Asset Management, along with Ray Cahill, CEO and Chairman of the Board. Thank you all for taking the time to join the call.
Before we jump into the call, I would like to point out that our comments will mostly refer to the first quarter 2023 MD&A and financial statements, which have been posted to our Web site. I refer you specifically to the cautionary language at the front of the MD&A, which would also apply to any comments that we would make on the call.
Overall, we are again pleased with the first quarter results, which showed continued improvement in the same asset metrics on the year-over-year basis.
Net operating income for the quarter increased 11% to $31.5 million in 2023 due to a one-time property tax refund for one of the trusts and closed regional centers in the amount of $2.8 million, which related to vacant space and space failed tenants such as Target. FFO for the quarter also increased 9% to $16.3 million in 2023 compared to a year ago.
The same asset net operating income for the first quarter, excluding the property tax refund, improved 1.3% from a year ago void by a 9% increase in same asset results for our enclosed model portfolio. This represents the eighth quarter in a row where we have achieved improved same asset results on a year-over-year basis.
Interest expense has increased 13% to $14.7 million for the quarter on a year-over-year basis. The impact of lower debt and the amount of $23 million on a year-over-year basis has been offset by higher short-term opening costs due to the higher interest rate environment that we find ourselves in.
Higher interest rate costs on renewal costs of mortgages have also been a factor. Consistent with year-end, the trust is approximately 18% of its debt is variable and the trust will continue to monitor this and would expect to see it somewhat elevated in the near future as well.
As mentioned previously, our enclosed model results continue to rebound from the downturn, we saw under COVID. During the quarter, we had a $21 million fair value loss on our real estate properties, which was almost all attributable to more conservative leasing assumptions on our office portfolio. This compares to a $25 million fair value gain recorded a year.
The REIT’s PCME or Operating at Leasing Capital Reserve was established to be $25 million for the year. While we only spent $3.6 million of the $6.3 million reserved this quarter, we are expecting elevated capital needs and future quarters into 2024 above the reserve amounts. This is due to both contractor delays from last year, some catch-up and spending, as well as some elevated leasing capital for upcoming renewals.
Our overall occupancy levels of 90% at March 31st is down slightly from a year ago. This compares to the percentage at the start of the pandemic, which is 93%. We are seeing continued softness in the office leasing market. However, there are pockets of activity including in Calgary and certain suburban office assets. This speaks to the fact that in most cases we’ve been able to keep tenancy at our quality assets. I also note that we’ve had a single tenant industrial asset for which the tenant did not renew in the fourth quarter. We are working to find a new tenant for this asset.
And now for an update on our leasing efforts. In 2023, there’s approximately 372,000 square feet in retail GLA coming due. We do expect that every retail tenant larger than 5,000 square feet to renew their space. There’s also approximately 329,000 square feet in office space coming due in 2023, and we feel good about the vast majority of this space as well. I do note that there is 13,000 square feet in Ottawa that will be vacated and further 19,000 square feet at 77 Bore that was vacated in this past quarter.
We say you now issue with the 40,000 square feet of industrial space renewing in 2023, which should be done with the good uplift and rates. Leasing discussions for retail opportunities have definitely picked up in the last year as both current and prospective tenants now have a better handle on what we expect going forward. This has led to numerous conversations about various opportunities at our properties across the country. Office leasing discussions on the other hand while gaining some momentum are still muted as tenants are still trying to figure out what their office needs are over a long-term basis in a post-COVID world.
Management has had continued ongoing discussions with the provincial government tenant at Petroleum Plaza in Edmonton, which came up for renewal on December 31st, 2020, and is now in Overhold, while they have verbally told us that they expect us to renew, they have unfortunately still been focused on their response to the pandemic and other initiatives which has taken priority. Our experience is similar to other Alberta landlords who have the provincial government as tenants. I do note that this space has remained occupied over this entire timeframe.
Turning to financing and liquidity, the trust has $120 million in liquidity at the end of the first quarter and $316 million in unencumbered assets. These [ph] numbers are very comparable from year end. Looking specifically at mortgage renewals, we had four mortgage renewals or financing so far this year with approximately $6 million in the financing proceeds. The trust does have elevated mortgage renewals over the 2023 and 2024, and we do expect that there’ll be limited opportunities of up financings available during this time.
We are especially pleased with the results from Pine Center in Prince George, British Columbia. This model will have a new Save-On Foods grocery store opening shortly, which has also led to leasing opportunities with discriminating tenants such as Lululemon and Sephora along with others. while the construction efforts with Save-On-Foods have seen delays, which is not uncommon these days, the marketplace is excited about all of these new tenants. We expect to be able to turn the Save-On-food space over to the tenant in the second. The addition of grocery further compliments the strong anchor tenant profile in this mall.
Last quarter, the trust announced that it had reached an agreement with Teamtown to convert the empty home outfitter space at Heritage Town Center in Calgary into a 34,000 square foot retail store focusing on sporting goods. The project cost approximately $3 million from a landlord perspective and was completed in the first quarter of 2023. This space is now open. The truss has also announced a refresh of the lobby and frontage of Rice Howard Place located in Edmonton, which will cost approximately $5 million. The trust owns 20% of this asset.
Wrapping up, we are pleased that the resiliency of our assets and the improved results and activity levels from our enclosed mall and retail segment. While there still is room to grow to get back to pre-COVID results, we have seen positive results in the last year. We are looking forward to continued positive leasing conversations for our assets. Most of our enclosed malls remain dominant in the geographical area and our strip malls, which are largely grocery-anchored, have performed well in the pandemic.
Beyond our retail assets, we have high-quality office buildings in Canada’s largest markets with a high degree of government office tenants. We continue to be positive about our business and the objective of building value for our unit holders. We look forward to continued executor strategy. And thank you for your continued.
We will now open the floor to questions.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question comes from Jonathan Kelcher from TD Cameron. Please go ahead.
Jonathan Kelcher
Thanks, good afternoon. First question, just on the office leasing side. You said you feel good about the remaining maturities this year, and I guess other than the 13,000 in Ottawa there, is there anything larger that you know that that will not be renewing?
Andrew Tamlin
No, that was really everything that I wanted to highlight from that perspective, Jonathan.
Jonathan Kelcher
Okay. And then what would your expectations be on renewal rates? What do you think the mark to market is in your office portfolio for what’s maturing this year?
Andrew Tamlin
Todd, do you want to maybe cover that?
Todd Febbo
Sure. So, the rates have been — they’ve been holding steady. The difference is that the cost to do those rates is where we’re having to often give more in TIs to compensate to keep the rates up. So, we’re holding strong with our rates. So, they’re going to keep as close to that as possible, but the inducements tend to have creeped up as the market has softened.
Jonathan Kelcher
That was kind of my next question. What are you seeing in terms of increases in TIs and is it different from market to market?
Todd Febbo
It is — there has been certainly a creeping up, but it is kind of all over the board still, unfortunately, it’s tough to narrow down to a specific trend other than it’s higher than what it was previously. There’s really no specific number that I can give it to you that can say that this represents the market, but I can say that it’s consistently higher that’s unfortunately the best. I can narrow it down because that is really truly what we’re seeing across the spectrum of the markets right now. At least in the east and we can talk about the weather the West is any different, but the east where I look after it has been a varied response to that over the three areas that I look after.
Andrew Tamlin
Yes. I think, it kind of varies depending on the market and the tenant, and the situation. Right. As far as trying to quote mounts, Jonathan.
Jonathan Kelcher
Okay. Fair enough. Higher and net effective are — will be obviously down then a little bit, but you’re holding face.
Andrew Tamlin
Correct.
Operator
[Operator Instructions] The next one is from Tom Callaghan from RBC Capital Markets. Please ask your question.
Tom Callaghan
Hey, sorry, I think I was on mute. Afternoon guys. Just first one from me was just on the retail side of the portfolio. Just wondering in terms of the sequential drop in occupancy was that something specific like a lumpier tenant or just kind of a collection of smaller leases?
Andrew Tamlin
Yes. There was no specific tenant. Tom, it was really, I mean, you could kind of chalk it up to the — there’s always a bit of a decrease from Christmas as well. So just a lot of small little things.
Tom Callaghan
Got it. And then maybe just building on that and some of your earlier comments in the prepared remarks, where do you guys kind of see portfolio occupancy trending here over the next kind of two, three quarters?
Andrew Tamlin
Do you want to make a comment on that John, from a retail perspective?
Unidentified Company Representative
Sure, Andrew, thanks very much, and appreciate the question. So, retail in general, if you compare over the course of the last two years, we’ve actually held pretty steady in terms of overall occupancy and clearly, we went through difficult times in the summer and later part of 2020. But we’ve been pretty good in terms of retaining portfolio occupancy across the board, whether it’s enclosed malls or strip centers.
So as Andrew noted, we usually see a tick in Q4 to represent some temporary inline leasing we do in our enclosed malls in anticipation of the Christmas season. But all in all, we’ve seen increased demand, which is good. Our strip portfolio’s been pretty consistent as relates to its occupancy, but the demand, and it varies across the country more so in the west than here in the east, but I would argue that portfolio occupancy from the retail perspective should may mean add or grow incrementally over the course of the calendar year.
Tom Callaghan
Got it. Thanks, that’s helpful. And maybe just one more, one last one from me on the credit side, but you guys provide some disclosure around this split with respect to mortgage financings between kind of the split between banks, pensions, and insurance companies. Just curious, have you guys seen any change in lending appetite or perhaps bifurcation amongst those groups, say over the past kind of six months?
Andrew Tamlin
No, not really. I think it’s all we do try to have a good variety there, Tom. So, I would continue to say that we will strive to have that variety as well, just to mix things up. But I would say no real change of note.
Tom Callaghan
Okay got it. And then just on kind of remaining refinancing this year, I think, you had mentioned last call, kind of 50 ish to 60 ish percent on LTVs. I assume that’s kind of still the target for the remainder?
Andrew Tamlin
Yes, it’s, yeah.
Tom Callaghan
Got it. Okay.
Operator
Your next question is from Dr. Chow Chowed, a private investor. Please ask your question.
Unidentified Analyst
Thanks for taking my call. New on this week, and I have some questions. Could you please let know what’s your current let asset value, please? [ph]
Andrew Tamlin
Sorry, you’re not coming through all that.
Unidentified Analyst
So, I said, a new investor in this suite and I’m trying to understand what is your current net asset value. And you are measure ratio, please.
Andrew Tamlin
Maybe I could — maybe you could reach out to me and I could clear some of these questions after the fact, if that’s okay.
Unidentified Analyst
I said, a new investor in this suite, and I want to know, what is your current net asset value and your ratio, please?
Andrew Tamlin
Well, the pay ratio is 37.5%.
Unidentified Analyst
37.5%. And what’s your net asset value, please?
Andrew Tamlin
The net asset value is in the range of $15 to $16.
Unidentified Analyst
Okay, so if you have a net asset value in the range of $15 to $16 and your stock price has been — over the years, — how do you guys feel about this for your long-term investors? When you have a house, you own a property that is what $15 to $16 per share and it is selling at less than $6 consistently. How do you guys feel about this?
Andrew Tamlin
Well, obviously there’s been a real estate downturn. I’m not entirely sure what you’re wanting us to convey. We’ve just gone through COVID. There’s macro-economic factors.
Operator
The next one is from [indiscernible] a shareholder. Please ask your question.
Unidentified Analyst
Hi, guys. Thanks for taking my question. I was just wondering sort of — if you could comment generally about your priorities for the excess capital that you have within the REIT. The distribution is sub-15 % of your adjusted front flow from operations. I’m just thinking in terms of sort of cost of financing is generally going inching up. I don’t know what the weighted average interest rate is currently, probably 5%. Maybe getting close to that and moving up. So, I was just curious how the management team thinks about between deleveraging or investing or, I don’t know, unit buybacks. What are your priorities for whatever excess funds you have within the REIT? Thank you.
Andrew Tamlin
Yeah, thanks for your question. We are focused on our debt right now, so I don’t see us, focusing too much on buybacks. We’ve talked about elevated amount of maturities and debt we can do over the next year or so. So, we will be focused on that rather than focusing on issue a bid purchases. There is a modest amount of development capital that we’re looking at as well. But nothing that’s going to be too high.
Unidentified Analyst
Okay. Thank you. So just to clarify, in terms, you’re not sort of planning to redeploy it into additional acquisitions or more properties, it’s just getting your leverage down, is that right?
Andrew Tamlin
Yes, we haven’t been too active on acquisitions in the last few years, so I don’t really see us moving ahead with any acquisitions in the near term. Anything else?
Unidentified Analyst
Nope. Thank you. That’s it for me.
Operator
No further questions at this time. Sir, please proceed.
Andrew Tamlin
Okay. Thank you. Thanks, everybody for joining the Q1 call and we’ll look forward to talking to everybody next quarter. Thank you.
Operator
Thank you. Ladies and gentlemen, the conference has now ended. Thank you all for participating, and call disconnect. Good bye.