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Executives

Armin Martens – President and Chief Executive Officer

Jim Green – Chief Financial Officer

Kirsty Stevens – Chief Administrative Officer

Analysts

Matt Kornack – National Bank Financial Brokers

Jenny Ma – Canaccord Genuity

Mario Saric – Scotiabank

Michael Smith – Macquarie

Artis Real Estate Investment Trust (OTC:ARESF) Q1 2013 Earnings Call May 8, 2013 1:00 PM ET

Operator

Good afternoon ladies and gentlemen. Welcome to the Artis REIT’s 2013 First Quarter Conference Call. I would now like to turn the meeting over to Mr. Armin Martens. Mr. Martens, please go ahead.

Armin Martens

Well, thank you, moderator. Good day, everyone, and welcome to our Q1 2013 conference call. So again my name is Armin Martens, I’m the CEO of Artis REIT, and with me on this call is Jim Green, our CFO, as well as Kirsty Stevens, our CAO. So to begin with again, I would like to advice all listeners that during this call we may at times be making forward-looking statements and we therefore seek Safe Harbor. So please refer to our website as well SEDAR filings such as our financial statements, our MD&A, and our annual information form for full disclaimers as well as information on material risks pertaining to all of our disclosures.

So again thanks for joining us folks. To begin with now, I will ask Jim Green to review our financial highlights and then I will ask Kirsty Stevens to give us more color on our operational results. Then I will wrap up with some market commentary, and then we’ll open the lines for questions.

So go ahead. Please, Jim?

Jim Green

Thanks, Armen, and good afternoon, everyone, and welcome to our first quarter conference call for 2013. Artis has continued our strategy of external growth combined with gradual improvement over time of all of our operating metrics.

We added a further 77 million of assets in income producing properties during the quarter and have also announced further acquisitions to close after the quarter. We completed our third offering of preferred trust units, and we have improved all of our operating metrics, including net operating income, FFO, AFFO, and debt to gross book value. Metrics on a per unit basis also continue to show growth.

And as we mentioned on our year end call, we were awarded an investment grade rating by DBRS, and we trust this will help us to lower our cost of capital for the future. So just to flip to review the REIT’s financial position and operating results in a bit more detail. Total assets for the REIT are now over $4.5 billion, they continue to rise. Our investment properties make up the largest part of this, and are currently valued at $4.3 billion.

As I’m sure most people on the call are aware, investment properties on our balance sheet are recorded at fair value, meaning they are changed every quarter to the market value of the properties. Kirsty will talk a little more about the valuation methods, but the net effect was to record an unrealized gain of $34.8 million this quarter, slowing down a little bit from the gains we were reporting last year, but still showing the effect of continued cap rate compression in our markets, combined with increases in the value of our properties based on the rental increases.

The REIT has some debt in the form of convertible debentures and at March 31, there were three series outstanding, Series D matures next year in 2014, we would anticipate repaying that in cash. The Series F matures in 2020, and also the Series G maturing in 2018, which is denominated in U.S. dollars and this forms a part of our, what we consider our natural currency hedge against the assets we own in the United States.

Total amount of convertible debt outstanding at the end of March was $182.5 million. Moving on from that into total debt to gross book value ratios, it has continued to decline, partly due to appreciation in the property values as I just mentioned, but also due to a decision by management that we’ve been communicating fairly consistently to lower the leverage in the REIT and we expect this trend to continue in 2013 and very likely into 2014.

So at the end of Q1, our mortgage debt to gross book value was 46.1%, down from 47.3% at December, and total debt when you add in the convertible debentures is 50.2%, down from 51.5% at December.

Highlight for a second, the floating rate debt, Artis has $361 million of floating rate debt that has not been hedged to-date, and this represents approximately 15.7% of our total debt. The majority of this is in the United States and I know I have said this before, but I will reiterate it again. The management’s view is that interest rates in the U.S. are under even less pressure to rise than exists in Canada. And we do feel an amount of floating rate that is appropriate in any portfolio and we are benefiting from the low interest rates on our floating rate debt.

Further benefit especially on our U.S. strategy is, it allows us flexibility to sell assets if we choose to as an opportunity arises, without incurring large debt penalty costs. Our floating rate debt with the exception of our line of credit is all term debt, it’s not demand and cannot be called by the lenders until maturity. We can use interest rate swaps at any point in time to fix the interest rates or alternatively, because there is no penalties. We can just go out and arrange a new fixed rate mortgage.

Having said all that, we did announce our intention on our last conference call to reduce our floating rate debt over time. We took on no new floating rate debt in Q1 and subsequent to the end of the quarter, we did lock one of the U.S. mortgages an amount of just over $40 million into a fixed rate loan. Mortgage maturity schedule at March 31, Artis had approximately $98.5 million of mortgage obligations maturing in the next 12 months and this represents less than 5% of our total mortgage debt, and we don’t anticipate any difficulty in refinancing these as they mature.

Weighted average interest rate on our debt continues to decline in this low interest rate environment and the weighted average nominal rate on our debt is now down 0.12% down a further 11 basis points from Q4. And with the low interest rate we have been looking to extend the terms of our financing and we generally look at terms of 7 years and 10 years where possible, for new acquisitions or through refinancings.

Turning for a moment to the results of operations, total revenues from continuing operations were $71.5 million for the quarter, up from $52.8 million in the same quarter last year. Growth driven largely by acquisitions, however, it’s also aided by growth in our same property operating results.

I’m turning to that for a second, same property operating results, we’re pleased to report that we showed growth this quarter of $1.2 million or approximately 2.4%. We had guided on our last conference call that we expected Q1 to be relatively flat. So we are very pleased to have this growth ahead of where our budgets were anticipating us to be.

During the quarter, we did receive some substantial lease termination fees, however, we have backed those out of the same property statistics, so the 2.4% growth is excluding the lease termination fees. The coverage ratios, interest rate coverage ratio 2.83 times for the current quarter, improved from 2.6 times last quarter combination of slightly lower debt and lower interest rates, our debt service coverage 1.83 times for the quarter and remains well within any of the covenants given to our lenders.

EBITDA ratio, ratio getting more attention, so we’re starting to report it. Our debt-to-EBITDA has improved from 8.57 for the fourth quarter to 8.06 this quarter and that’s the quarterly calculation in our case, just taking the actual quarter results and multiplying by four and not factoring any addition of the impact of acquisitions completed during the quarter.

Foreign exchange gains and losses, we continue with our plan to expand into the United States and this requires we convert assets held in U.S. fund back to Canadian dollars. So this produces foreign exchange gains and losses on our income statement, but a portion of which hits the actual income statement itself and some of it flows into the section entitled other comprehensive income and that’s from March 31 another comprehensive income we showed an unrealized gain of $6.3 million.

As I mention before when I talked about the U.S. convertible debenture, we feel we have a natural currency hedge in place by way of the fact that, if you look at the segregated information for the quarter, we had $780 million of assets in the U.S. Against this, we have $465 million of U.S. debt, and we also have an $87 million debenture payable in U.S. dollars, and one series of preferred units in the amount of $75 million also denominated in U.S. dollars.

So in our opinion this gives us a natural currency hedge if you want to call it that of approximately 80% of our U.S. asset exposure and we currently have no plans to hedge the remaining exposure. Flipping over for a minute to the non-GAAP metrics, one of the key ones, of course, is FFO or funds from operations. Our definition complies with the real pack definition. We did not make any adjustments to it this quarter over and above what’s allowed in the REALpac definition. We have adjusted some prior quarters for transaction costs and things that we felt were unusual.

FFO for the quarter on a diluted basis was $0.38 compared to $0.34 last quarter, and $0.31 in Q1 of last year. Our payout ratio based on the current quarter is 71.1% of FFO versus 87.1% in Q1 of 2012.

And in our year end report, we introduced AFFO reporting. We’ve continued that trend. Based on our calculation, our AFFO was $0.33 for the quarter ended March 31, 2013, resulting in an AFFO payout ratio of 81.8%.

Just a few other highlights; the REIT does have a distribution reinvestment plan or DRIP program in place. We see in excess of 10% participation in that, so that provides us with a monthly source of cash flow. On tax status, the REIT believes we’ve met the REIT exemption for the previous three years. 100% of our distributions were return of capital in all of those years. We believe we will be able to continue to meet the REIT exemption for 2013 and beyond, however, that’s always an ongoing process.

The REIT has a small program in place to issue securities at the market; good for the next two years and wouldn’t be used for acquisitions, but it could be used to fund a smaller development project or short-term cash needs; to-date, we have not used that program. We replaced our operating line of credit last year, currently, have an $80 million facility. That was a small balance drawn at the end of March, but that was repaid a few days later using the cash on the balance sheet at March 31, and there is currently nothing drawn on the line.

There were several subsequent events and notes to our statements, I won’t highlight them one by one, because there are all disclosed. But if you do the math, Artis still has uninvested cash as well as capacity on our line of credit. We continue to review further potential acquisitions and plan to continue growing the REIT. And that completes the financial review from me. It was a great quarter in our opinion and we look forward to demonstrating our results from operations in the future quarters. Martens?

Armin Martens

Very good, thanks, Jim. And I’ll turn the floor over to Kristy to highlight some, go over our operational highlights.

Kirsty Stevens

Thanks, Armin. So we concluded the quarter with 223 properties in the portfolio. The GLA was just under $23.7 million square feet. Our asset allocation by property NOI at the end of March was relatively unchanged from December 31. We reported 50.4%, of this 25.2% retail and 24.4% industrial. Geographically, the mix changed slightly. The four largest segments are still Alberta, about 37%, Manitoba at 13%, Ontario at 15%, and Minnesota at 12%.

Subsequent to March 31, include 1110 Pettigrew, Century Crossing Street, 495 Richmond Road, and a 100% of the T20 Portage Avenue in Winnipeg property. We’ve also announced a number of other unconditional deals which were in our press release. Factoring all of this in, we expect the portfolio will grow to 230 properties and about 24.5 million square feet of leasable area.

The pro forma NOI shifts a bit to 54% office, 23% retail, and 23% industrial. It doesn’t change the geographical mix very much. Now, we have three properties in Calgary that will come into the portfolio, but even with those being factored in, the Calgary pro forma NOI office mix is still going to be under 19%, which is about where it has been for the past three quarters.

Occupancy improved slightly, up 20 basis points to 95.8% at the close of March, and that was up 50 basis points from the close of the prior quarter, Q3. We see activity that’s quite strong throughout Q1 of 2013. We did about 733,000 square feet of renewals. The weighted average rate increases on the renewals was a very healthy 6.9% this period and that’s before factoring in any step-ups or straight lining of rent.

The Fort McMurray properties, the retail properties we have up there were really the super stars of period. We saw renewal rates that doubled or more than doubled basically on every renewal that we did there. We also had a really healthy leasing activities in the Winnipeg office properties, particularly 360 Main and the Grain Exchange Building here we had a number of big lifts in renewals in those properties.

We are well underway with 2013 leasing overall. It’s about 80% complete or dealt with. For what’s left to roll in 2013, and just short of 50% of that is committed to renewals or new leases at this time. Significant new deals that we closed since the last quarter are a 28,000 square foot renewal of Winters, at King Edwards Center in BC, 116,000 square feet renewed in one of our industrial properties in Minneapolis, and about 14,000 in expansion and extension at Canadian Center in Downtown Calgary. All of these were done with good lifts on the rates.

At the end of March, the weighted average term to maturity of leases overall was 4.9 years, which is just up from 4.8 years at the end of December. Average market rent for the remaining 2013 expiries and the 2014 expiries are estimated to be about 5.8% and 7.7%, respectively, above the expiring in place rents. This translates to a potential revenue impact of over $4 million on an annualized basis.

Revenue growth is expected to be strongest in office segment of the portfolio over the long-term. Market rents for the entire portfolio at the end of March are about 8.9% above in place rents across the portfolio, again just slightly up from our estimate of 8.8% at the end of December. Our market rents do not allow for inflation and we don’t attempt to forecast to where we think rents are going in the future. So this is a reflection really of what the rates are in place today.

Portfolio growth, as Jim mentioned, we continue to look for acquisition opportunities, but we also have opportunities inside our portfolio that we’re pursuing. Where possible we’re intensifying on vacant land that we have. For example, we’re just about finished a built-to-suit project in the NIMO. We’ve got a 10-year lease signed up with a tenant and expect to have this property delivered to the portfolio towards the end of June. We’re also in the planing stage of Phase 3 of our 4L property in Edmonton.

We bought it with one building. We developed and leased the second building, and now we are just hoping to get the pre-leasing completed on the third building and get going with that one.

The biggest project right now is Linden Ridge here in Winnipeg. We’ve got just about finalized four leases with high profile national retailers, about 87,000 square feet we will put under construction, one part of that is already underway. It’s a great development opportunity along the Kensington Corridor here in Winnipeg. We are looking for rent rates around the $20 mark and are looking at ten-year term with these tenants. We are not quite ready to announce who the tenants are, but we look forward to reporting on that within the next 30 days or so.

We also have a number of properties in redevelopment. Oddly enough, quite a number of them are in Winnipeg. Most of these represent single tenant industrial space, some of the older stock in the portfolio. And as the tenants vacate, we are taking opportunity to improve those spaces and release and re-tenant them. So there is a number of those projects underway. Since we reported our MD&A yesterday, I have since found out that we just find a lease on one of those properties which will get it back to about 70% occupancy by towards the end of the summer.

In terms of portfolio valuation, as we disclosed in our MD&A, the weighted average cap rates were 6.4% at March 31, which is just slightly down from 6.46% at the end of December. Cap rate decreases were observed in the portfolio in Grand Prairie, Vancouver office, and Winnipeg office in retail primarily, because we do mark off available appraisals, surveys, CBRE published information, and what not, there is always some lag between what we see in the market right now in the valuations. And based on what we are seeing right now, we do expect there will be further compression noted as we move into our Q2 results.

And that concludes my part of the presentation. I’ll give this back to Armin.

Armin Martens

Okay. Thanks, Kirsty. Well, folks, overall, I think, 2013 continues to look like another great year to be in the real estate business. The global economic fundamentals continue to be spotty and somewhat on the weak side, but in our case, we continue to believe that in relative terms both Canada and the U.S. will lead the G7 countries in terms of economic growth in the years ahead with the U.S. getting a slight edge. Now with respect to government driven interest rate bond yields, we can see remain in a relatively low trading range. It continues to be our view that interest rate from both Canada and the U.S. will remain low for the foreseeable future.

Both equity and debt markets are open for business with spreads and bond yields trending well. Our current spreads are right now effective five-year mortgage interest rates are turning in about that 3.0% to 3.5% range and effective 10-year mortgage rates under 3.65% to 4.15% range. In the United States, these rates are lower, anywhere from 50 bps to 100 bps, but that does depend on the asset class. By example, you will notice the property we just announced 1700 Broadway in Denver, we have a non-recourse mortgage there, 50% LTV, 30-year amortization, 10-year term, 5-year interest only, the interest rate is 3.11% again for 10-year term, so all of this contributes to healthy real estate market in both countries.

Notwithstanding our view that interest rates will stay low for very long time, maybe decline a little more, we want to point out that since last summer already, all new mortgages being taken up by Artis have been for either seven-year or 10-year term and in addition, we are moving to fixed and extended term on some of our floating debt now to seven or 10 years as well.

In terms of acquisition cap rates, we all know they came down a lot last year, and today cap rates are still on the either level or declining depending on the asset class and specific property, but there is no evidence, whatsoever, cap rates are rising anywhere.

In terms of cap rates, four is the new five, five is the new six; six is the new seven and there basically is no seven or eight cap rate anymore. Generally, I feel that cap rates will compress at least another 25 bps to 50 bps across-the-board by the end of this year. That may sound like an aggressive suggestion, but that’s my viewpoint right now, and we should expect to see the same or more cap rate compression in the United States.

And all of our asset classes; office, industrial, retail, the property markets continued to experience healthy occupancy levels in our target markets that includes the Calgary office market, which demonstrated remarkable turnaround last year. [Fast forward] in 2013 that levels off. Nevertheless, it’s still healthy.

In our U.S. markets, we are enjoying the fruits of a slow, but steady economic recovery that is in turn producing positive real estate fundamental. The general consensus is that the wind is not behind the real estate market in the U.S. and our same property NOI growth in our U.S. portfolio is reflecting this.

In terms of our portfolio performance, we feel our metrics are good. We have a healthy gap between in-place rents and market rents, and we’re achieving very good weighted average rental rate increases and our same-property NOI growth is reflecting this. And as mentioned, our leasing progress is good, to date, over 80% of 2013 program is already complete and 23% of 2014.

In terms of our geographic diversification, we continue to be primarily a Western Canadian REIT with about 55% weighting in Western Canada, most of that in Alberta, over half of that in Alberta, and a 15% weighting in the GPA; 20% in the U.S. However, as previously mentioned, we continue to see a significantly better value proposition in the U.S. and we anticipate increasing our U.S. weighting to the 25% to 30% range. The economy, the real estate fundamentals and foreign exchange, we feel are all moving in favor of the U.S. right now.

Our target markets are Phoenix and Minneapolis–Saint Paul. We have added Denver to our target market as well. I think between now and the end of the year, you will see us with more than just one property in the Denver marketplace. There is a great case to be made for that market now.

On all three key metrics; our balance sheet, our payout ratio and the caliber of our real estate, Artis made significant improvement during 2012 and that continues to be our core strategy for this year 2013, one quarter at a time. Looking ahead, it is our goal and our mission to bring our total debt to GBV down to the 40% range and our AFFO payout ratio down to the 80% range. We won’t get there in just one year, but we will get there.

So that’s our report for this quarter, folks. We’ve closed off a very good quarter and we are quite confident in having a good year in total with improvements on all front. I’ll ask the moderator to take over and field your questions

Question-and-Answer Session

Operator

Thank you. We’ll now take questions from the telephone line (Operator Instructions) Thank you for your patience. The first question is from Matt Kornack from National Bank. Please go ahead.

Matt Kornack – National Bank Financial

Hey, guys.

Armin Martens

Hey, Matt.

Kirsty Stevens

Hi, Matt.

Matt Kornack – National Bank Financial

Just on the G&A, I know there was a change in accounting in terms of the reclassification of unit based compensation, but it seems to be down on the whole, is that a trend that we should use on a run rate going forward?

Armin Martens

A trend as in continuing to drop?

Matt Kornack – National Bank Financial

No, not continuing to drop, but is that the sort of run rate we should use?

Armin Martens

Yeah, this sort of level, probably not too far off of our run rate, Matt, I would say it’s – sometimes they bounce around a little bit per quarter. We get an AGM in there or something that pushes Q2 up a touch, but not a lot.

Matt Kornack – National Bank Financial

Okay.

Armin Martens

It’s pretty close to run rate.

Matt Kornack – National Bank Financial

Great, sounds good. And I may have missed it in the conference call, but what was the source of the lease termination fee?

Armin Martens

A number of leases…

Matt Kornack – National Bank Financial

Okay.

Armin Martens

But there was one large one in Ontario that we are pleased to report. We negotiated the surrender with the tenant. We had a tenant in hand, so the space has been released. And the termination fee we negotiated with the tenant more than covers the vacancy costs plus the cost of releasing the space, and it’s released at a higher rate than the expiring rate, so…

Matt Kornack – National Bank Financial

Great. That’s good. And in terms of – just in terms of the Calgary office, I know there is a bit of a bump in vacancy there, do you think that will impact your portfolio at all or are you fairly well protected against it?

Armin Martens

I’m not sure there is a much of bump in vacancy. I think there is – the absorption has slowed a little bit. And from what we understand, there is maybe a little bit more sublet space on the market, but I don’t think there is much more vacancy. If anything I think that’s maybe tightened a little bit in the market yet.

Matt Kornack – National Bank Financial

Okay.

Armin Martens

So no, we are not anticipating any material negative effect from changes in the Calgary market.

Matt Kornack – National Bank Financial

Great. Well, congratulations on the quarter. Nice surprise on the same property NOI.

Armin Martens

Thank you. We were happy with that one too.

Operator

Thank you. The next question is from Jenny Ma from Canaccord Genuity. Please go ahead.

Jenny Ma – Canaccord Genuity

Good afternoon, everyone.

Armin Martens

Good afternoon, Jenny.

Jenny Ma – Canaccord Genuity

Armin, I wanted to ask you about your thought process in entering the Denver market. Clearly, it’s a market that you’re looking to grow in. Is there a specific asset class that you are looking to buy in? Is it office or is it all three?

Armin Martens

Still, it’s all three. Our first opportunity to came us by way of a joint venture and this is NDC Jeff Conley, we’ve done business with him before and he is familiar to the Canadian real estate scene and he has an office here, it’s actually his head office in the U.S. for his property management team. They got us this deal, but we’ve been keeping – looking at other markets in anywhere and the Denver market makes sense, it’s starting to make the list, I wouldn’t call it a 24-hour gateway town yet, market yet. But it is a good market improving well, and energy and mining is picking up in a big way, energy in particular. But in addition to that, it has a good – well diversified economy and an easy nonstop flight from Winnipeg, a good fundamentals all around. I expect, between now and end of the year, we’ll see opportunities, we will see what it requires, but we expect to see good opportunities for retail and industrial as well as office. Again, we’re still committed to the diversified REIT model.

Jenny Ma – Canaccord Genuity

Is any one of the three asset classes more – are there more opportunities within one versus the others? Or is it just fairly equal across the board?

Armin Martens

It seems that the bigger opportunities are still with the office property. They are just bigger elephant deals in many cases, and just bigger numbers involved. And that’s reflected by our own portfolio where we have about a 52% weighting in office properties.

Jenny Ma – Canaccord Genuity

Okay. Now, I guess on the flip side, you have a couple of properties in, I guess, non-core U.S. markets. Do you have an update on what your thought process are on those ones, especially now that you’ve held them for a couple of years now?

Armin Martens

No, but we are still enjoying the income on those properties there and we are not ready to dispose of them, or market them yet, we’re, long story short, we haven’t made a decision in terms of disposal. But so for now we’re just enjoying the income from the properties, and they weren’t part of our portfolio if you look at them many years ago, and so that sometimes that happens. But they’re surely – they’re not hurting us, that’s for sure. They’re new generation real estate with good kind covenant tenants, annual rental increases, and we are pretty happy with them.

Jenny Ma – Canaccord Genuity

Is it fair to say that those are markets you’re not looking to grow in though?

Armin Martens

Right now, we are not. No.

Jenny Ma – Canaccord Genuity

Okay, and with regards to the 2013 rules in your U.S. other category, can you, I guess, maybe this is for Kirsty, can you speak about that? What’s going on there? Is it mainly related to your Phoenix properties?

Kirsty Stevens

Sorry, which year were you looking at, the 2013?

Jenny Ma – Canaccord Genuity

The 2013, yeah, on Page 15 of the MD&A.

Kirsty Stevens

Page 15. That one doesn’t stick out with me specifically, but I’m thinking it’s got to be in the Phoenix properties.

Jenny Ma – Canaccord Genuity

Okay, all right. I think that’s it for me then. Thank you.

Armin Martens

Thanks, Jenny.

Operator

Thank you. The next question is from Mario Saric from Scotiabank. Please go ahead.

Mario Saric – Scotiabank

Hello. And thank you for taking the call. Just coming back to the same property, NOI surprise, during the quarter, you do a good job of highlighting where that same property NOI growth is coming from, but I am curious as to where the kind of surprise relative to internal expectations was really being driven by?

Armin Martens

Little faster lease-up than we originally thought, a couple of tenants came in earlier and a couple of pleasant surprises on lease rolls, a little higher than we had anticipated. It’s kind of a – we went through it kind of tenant by tenant to try and track it ourselves and it is a whole number of tenants and number of buildings, but…

Jim Green

But in fairness, we knew we were giving out a cautious number in that quarter, but I guess we were too cautious.

Mario Saric – Scotia Capital

Okay.

Jim Green

Yeah, I get in trouble for that Mario, but that’s the way it goes.

Mario Saric – Scotia Capital

That’s fair enough. So is it fair to say that the surprises occurred in some of the areas and asset classes where you showed stronger same property NOI growth this quarter?

Jim Green

Yeah, I would say that’s fair.

Mario Saric – Scotia Capital

Okay. Now maybe just sticking to that, if it’s, several tenants here and there, is it an indication that those markets are doing a bit better than what you anticipated or was it predominantly tenant specific?

Jim Green

I’d say more tenant specific. The markets are pretty much where we were anticipating them to be it is just…

Kirsty Stevens

I would say it is more absorption actually.

Jim Green

More absorption I think is as a…

Armin Martens

Maybe a combination, but, I mean, we feel comfortable with achieving it, to achieve positive same property NOI growth in all year long. In that sense, our guidance for the year was to be in the 3% range by the end of the year and we think we can get there.

Mario Saric – Scotia Capital

Okay. Maybe just turning to the balance sheet, we can probably get to the number, but maybe Kirsty or Jim, you can help us out. After all kind of announced acquisitions, can you give us a sense of where your pro forma cash sits today?

Jim Green

Sorry, Mario. I didn’t actually run that math of what’s in the back of the subsequent events section versus the cash on hand. There is still some definite un-invested cash.

Mario Saric – Scotia Capital

Right.

Kirsty Stevens

I can definitely get back to you after the call, Mario.

Mario Saric – Scotia Capital

Yeah.

Armin Martens

We’ll quickly send our (inaudible).

Kirsty Stevens

Yeah.

Mario Saric – Scotia Capital

Okay. And then on the lease termination income, is there going to any gap between, is the space going to remain vacant for a little while the new tenants kind of pick up the space especially in Ontario or should we see a pretty seamless transition?

Jim Green

The biggest one in Ontario was, the actual surrender of the lease doesn’t happen until next quarter, but we picked up the income this, the tenant paid, so we picked up the income this quarter, throughout the end of April, I believe, and it’s released for September.

Armin Martens

The good news, Mario, it is mainly one lease in Ontario and a secondary another lease in Calgary, but in both cases, we are able to release the space in advance, negotiate the termination fees, and replace these tenants with brand new tender terms, steps ups in the rent, higher space rates, higher NERs and then as we mentioned collective termination fee. So this is a good situation, but it’s not a situation where we are getting termination fee and then we’re stuck with a bunch of empty space.

Mario Saric – Scotia Capital

Right, and what was the cause for breaking the lease?

Armin Martens

The one case, a tenant was bought was a, Japanese tenant was bought out by another company and they just moved. The company was good. They continued to pay the rent and then we’re able to find them a new tenant to take over their space and negotiate a termination fees, sort of a win-win situation, and that’s based on the same story with the property in Calgary. The tenant made a strategic decision to leave very early, we thought, but they did and they’re still coming with goods, still paying rent, but we were able to find a new tenant to take over their space on a 10-year basis and negotiate a termination fee

Mario Saric – Scotia Capital

Okay. And just maybe sticking to Calgary with the last question, I think Jim, maybe you alluded to it earlier on, and that we are seeing maybe a bit of sublet space coming into the market. Are you seeing any of that within your portfolio today? And how do you think you’re positioned to kind of compete with that sublet space going forward?

Jim Green

I don’t think we have a lot of any sublet space in our specific portfolio. You are always competing with it, but correspondingly, it’s usually there on shorter term basis and some tenants don’t want to commit to that knowing that they might not be there very long.

Mario Saric – Scotia Capital

Yeah, are there any kind of pockets of Calgary where we’re seeing maybe a bit more sublet activity like in the Beltline versus downtown versus the suburbs?

Armin Martens

I’d probably say it’s more downtown focus. It’s the guys that during the last year might have taken a little more space down than they really needed just to ensure they had it. Now they’ve put it a little bit back on the market. But – and Calgary is always that type of a market where, as Jim was saying, the big oil and gas players will – they will make sublease – try to sublease space one month and the next month take it off the market, and we are not sensing negative pressure because of that right now. We are – because the new construction coming up, I’m optimistic that right now it matches the annual absorption. We’ve got to watch over-building in the City of Toronto right now, we’ve got to watch over-building in the city of Vancouver as well, but I’m not worried about the Calgary office market.

Kirsty Stevens

We’ve got less than 500,000 square feet rolling at in 2013 in Calgary office and like almost 340,000 is committed at this point in time so, and we’ve also got commitments on the vacancies that are flowing through, so I mean, they have some timing issues in a couple of buildings, as we roll to the next quarter or two, but it’s looking pretty strong at this point, so.

Mario Saric – Scotia Capital

Can you, the last question, can you remind us of what the outcome has been with respect to AMEC at Heritage Square, if there is one?

Kirsty Stevens

It’s renewed and they are just negotiating…

Armin Martens

They are just negotiating rates, I believe. They exercised their renewal option and they’re still just negotiating on the rate. So I don’t have a final rate for you yet, but it will be somewhere in the mid 20s, I don’t know which way it will go compared to…

Mario Saric – Scotia Capital

Sounds fairly consistent to what is in place?

Armin Martens

Yeah.

Mario Saric – Scotia Capital

That’s what…

Armin Martens

Yeah.

Mario Saric – Scotia Capital

Okay. Thank you.

Operator

Thank you. (Operator Instructions) The next question is from Michael Smith from Macquarie. Please go ahead.

Michael Smith – Macquarie Research

Thank you. I just wanted to talk about your U.S. strategy. You’ve entered the Denver market. How many more markets are you going to enter?

Armin Martens

Yeah, fair question. Not all of them. We like Denver, and that will be our third market in essence, but we’re keeping an eye on Texas. Now Texas is a big market. Just that it’s a gateway state and it’s the place to be long-term I think in United States. However, you’re looking at great cities like Houston, and Austin, and then Dallas. Dallas is, it appears the entry are a little bit low in Dallas, so we have to watch it there. But we’re keeping an eye on Texas as well, but right now we’re focusing on again, Phoenix, Minneapolis, and Denver.

Michael Smith – Macquarie Research

So Phoenix, Minneapolis, Denver, so in the long-term we could see Phoenix, Minneapolis, Denver, Houston and Austin?

Armin Martens

Possibly.

Michael Smith – Macquarie Research

Possibly, and for Phoenix and Minneapolis, what do you see in terms of cap rate compression and what are the markets like? Have they caught up to the Canadian markets in terms of cap rate compression or?

Armin Martens

Still higher, but falling just as it is falling here. So like a 5.5 cap rate in Canada would be 6.25 to 6.5 there. The Class A single tenant building, good common buildings with rental increases are hotly contested right now. Good quality multi-tenant buildings are contested, but the buyers, including Artis, of course, they are paying up for the quality. In our case, we are not looking for the B buildings in the U.S. We’re trying to – in the U.S., in particular, we’re buying the better caliber real estate and basically always Class A real estate are better.

Michael Smith – Macquarie Research

And so would you say that cap rates are going to fall more there or do you think it’s pretty much done?

Jim Green

I think they have to. We were pleasantly surprised, when we first underwrote that building in Denver, we thought we’ll get 3.3%, 10-year money between 2.25% to 2.5%, and we are pleased to see the heavy bidding by the lenders bring it down to 2.11%. Again, 10-year term, five year’s interest on the 30 years non-recourse. In the last year, we’ve seen mortgage rates come down a good 100 bps.

Armin Martens

Yeah, that spread is really attractive for which I think will drive the cap rates down. If you can get debt in the U.S. cheaper than Canada, you are likely to see there cap rates become at or lower than Canadian cap rates.

Jim Green

Yeah, and that’s (inaudible) right from the beginning, as there was a time when with all of the exuberance, the U.S. cap rates were lower than Canadian cap rates. Post recession, that all changed, but with debt, the result of quitting the debt markets and the interest rates coming down as we said, like a year ago, 10-year money would have been over 4% and 5-year money of 2.75%. We’re just coming down lower than Canadian rates that in turn will drop down cap rates, because needless to say there is also no shortage of capital, equity capital chasing real estate.

Michael Smith – Macquarie Research

Just switching gears in terms of like your portfolio quality, I mean with your recent acquisitions particularly in Calgary, you’ve got newer properties, are you – maybe you could talk about sales. I know you had a couple of assets, some C quality assets on the market. What are your thoughts on disposing some of the bottom end of your portfolio, let’s put it that way?

Armin Martens

Sure. And we still consider ourselves to a young REIT, so in terms of allocating of capital and we’ve done a great job of allocating new capital to new heck acquisitions especially in the last couple of years and methodically we’ve improved the caliber of our portfolio.

We haven’t sold the lot of dwellings, but are expecting to sell a couple of – so we call them non-core buildings and in essence, it’s a matter of selling the worst and keeping the best. But you will see us I think between now and the end, sell a couple of properties as well and we deploy that money as well as possible. And we also noticed our development pipeline is wrapping up a little bit more and where we are going to try to keep that at about $100 million range right now at a time when it was basically nothing, and that’s all new generation real estate better than average yield. So we are focusing on that as well in terms of allocating capital and growing organically as well as externally. But we don’t have a formal program of replacement, for example, Michael, we’re taking the bottom 10% and saying, this is all for sale now, we’re not that bigger lease that we want to do that yet.

Michael Smith – Macquarie Research

Okay. And last question, just could you give us your thoughts on where you would like to be in terms of leverage and payout ratios?

Armin Martens

Yeah, I was alluding to that – we just once had a couple of days of non-deal marketing, I guess on our debenture, on a potential debenture often, we don’t know when we’ll do it an unsecured debenture.

But our sub-payout ratio and our balance sheet improved nicely, but our target balance sheet is down to total debt at about 48%. And of that, for example, 10.25% would be unsecured debentures in the long run, and two quarters would be mortgage debt. We do want to have more unsecured, unencumbered assets on our balance sheet to give us more flexibility. So we’ll look towards that and our payout ratio, we said at the rate, we want to bring it closer to 80%. We think we’re just what we’re seeing in the 90% range maybe in the high-80s now, but we want to bring it down to 80% as well.

Michael Smith – Macquarie Research

Thank you.

Operator

Thank you. There are no further questions at this time. I’d like to turn the meeting back over to Mr. Martens.

Armin Martens

Hey, listen. Thanks again everybody for joining us in the call. We know it’s a heck of a busy week for everybody. And so we appreciate your interest and enjoy working hard with these earnings teams, we’re looking forward to catching up with everybody on more downtime. Have a good day.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.

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