RioCan Real Estate Investment Trust's (RIOCF) CEO Edward Sonshine on Q2 2014 Results - Earnings Call Transcript

Jul.31.14 | About: Riocan Real (RIOCF)

RioCan Real Estate Investment Trust (OTCPK:RIOCF) Q2 2014 Earnings Conference Call July 31, 2014 10:00 AM ET

Edward SonshineChief Executive Officer

Frederic Waks – President and Chief Operating Officer

Raghunath Davloor – Executive Vice President and Chief Financial Officer.

Analysts

Alex Avery – CIBC World Markets

Michael Smith – RBC Capital Markets

Pammi Bir – Scotia Capital

Sam Damiani – TD Securities

Heather Kirk – BMO Capital Markets

Operator

Thanks and welcome to RioCan Real Estate Investment Trust Second Quarter 2014 Conference Call for Thursday, July 31, 2014. Your host for today will be Mr. Edward Sonshine. Mr. Sonshine, please go ahead.

Edward Sonshine

Thank you very much. We welcome you to our second quarter conference call. With me today is, of course, Fred Waks, our President and Chief Operating Officer and Rags Davloor, our Executive Vice President, and Chief Financial Officer.

Before turning over the meeting to Rags and Fred for their respective presentations, I am required to read a warning which I is longer than my remarks. But here goes, and talking about our financial and operating performance and then responding to your questions, we may make forward looking statements including statements concerning RioCan’s objectives, its strategies to achieve those objectives, as well as statements with respect to management’s beliefs, plans, estimates, and intentions and similar statements concerning anticipated future events, results, circumstances, performance or expectations that are not historical facts.

These statements are based on our current estimates 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. And discussing our financial and operating performance and in responding to your questions, we will also be referencing certain financial measures that are not Generally Accepted Accounting Principles, GAAP under IFRS. These measures do not have any standardized definitions prescribed by IFRS and are therefore unlikely be comparable with similar measures presented by other reporting issuers.

Non-GAAP measures should not be considered as alternatives to net earnings or comparable metrics determined in accordance with IFRS as indicators of RioCan's performance, liquidity, cash flows and profitability. RioCan’s management uses these measures to aid and assessing the Trust’s underlying core performance and provides these additional measures so that investors may do the same.

Additional information on the material risks that could impact our actual results and the estimates and assumptions we applied in making these forward-looking statements together with details on our use of non-GAAP financial measures can be found in the financial statements for the period ending June 30, 2014 and Management’s Discussion and Analysis related thereto as applicable together with RioCan’s current Annual Information Form that are all available on our website and at www.sedar.com.

I am now going to rest and turn it over to Fred – sorry, to Rags first for his presentation regarding our financial results.

Raghunath Davloor

Thanks Ed, and good morning everyone. I’ll provide a brief overview of our financial results of the second quarter. For the quarter, RioCan reported operating FFO of $1127 million, an increase of $6 million or 5% compared to operating FFO of $121 million in the second quarter of 2013.

On a per unit basis, operating FFO also increased by 5% to $0.42 per unit in second quarter of 2014 compared to $0.40 per unit in Q2 2013. The increase in the current quarter is primarily due to higher NOI from rental properties of $5 million, which includes the impact of acquisitions net of dispositions, the completion of development projects, same-store growth of 2% for Canada and 1.4% for the U.S. portfolio. And the benefit of a $2 million increase in foreign currency gains from the US operations.

We had a decrease also in interest expense of $3 million, which is net of a $0.2 million unfavorable impact of FX and this was partially offset by an increase in G&A cost of $2 million due primarily to increased information technology costs associated with the Trust implementation of a new ERP in financial reporting system during the first half of 2014, as well as professional fees related to the introduction of the new senior executive incentive comp plan and a new deferred equity unit plan for non-employee trust fees.

Looking forward, the quarterly NOI run rate as of June 30, 2014 adjusted to include acquisitions and dispositions that have closed during the quarter is estimated at approximately $195 million, which excludes any potential lease buyouts, but does include approximately $2 million in straight-line rents.

For the third quarter of 2014, we expect same-store growth to be between 1.75% and 2% with the buyers to the higher end of the range. And for the year, we expect same-store growth is expected to be between 2% and 2.25%.

Property and asset management fees and other income are expected to be approximately $7 million to $7.5 million in Q3, due to higher development and financing fees of joint venture developments. Interest income for the third quarter is expected to be approximately $1.5 million.

G&A for the year is forecasted to come in at around $52 million. The increase is primarily due to the full year impact of the U.S. platforms and higher IT costs. For Q3, we expect G&A to be in the range of $11 million.

During the second quarter, RioCan completed two acquisitions of interest in income producing properties in Canada for a total purchase price of $23 million with a weighted average cap rate of 7%. There were no purchases in the U.S. during the quarter.

Regarding acquisitions under firm contracts, RioCan has three income properties, two in Canada and one in the U.S. that would represent acquisitions of $70 million at a weighted average cap rate of 5.7%.

RioCan also has income property acquisitions under contract in Canada and the US where conditions have not yet been waved, but if completed, will represent acquisitions of $79 million at our interest.

As to dispositions, there we no dispositions during the second quarter. As of today, we have one land parcel under firm contract at a sales price of approximately $200,000. RioCan has dispositions of certain land parcels and a conditional contract, where conditions have not yet been waived for $11 million. These land parcels are free and clear of financing.

RioCan is in the process of marketing for sale land parcels and one income property with a total fair value as of June 30, calculated under IFRS of approximately $43 million, at our interest. The underlying mortgage obligations related to these properties is $14 million.

Additionally, RioCan and its partner KingSett have entered into a conditional agreement with a developer, to sell up to $30 million in air rights representing 600,000 square feet above the CPA development site in downtown Calgary, along with approximately $40 million in cost reimbursements for infrastructure works. The transaction is subject to a number of mutual conditions. The intention is for two residential towers to be erected upon the planned retail podium.

Under IFRS at June 30, RioCan's investment properties will value to $15.5 billion at our interest, based on the weighted average cap rate of 5.86%, which was two basis points lower than March 31, 2014.

The decrease was a result of an 8 basis points decrease in cap rates in the U.S. portfolio. As a result, the cap rate in the U.S. portfolio decreased from 6.32% at the end of Q1 to 6.24% as of the end of Q2. The cap rate for the Canadian portfolios remains unchanged at 5.79%.

With respect to financing, RioCan completed the offering of $150 million Series V senior unsecured debentures, at a coupon of 3.746%, which matures on May, 2022. For the balance of the year, RioCan has Canadian maturing fixed rate mortgages, excluding lines of credit and construction loans of a $114 million at an average rate of 5.95%.

In addition, we have one floating rate mortgage of $50 million at approximately 2.6% in the US that will be refinanced with a five year fixed rate mortgage at 3.3%. During the second quarter, RioCan converted a term facility that would have matured in December 2014 to a revolving facility.

This facility has a capacity of $67.5 million with pricing similar to RioCan’s other operating lines the BA’s plus 125 with the maturity date extended to December 2015. This additional facility brings the current aggregate capacity under our operating facilities to $712 million.

Presently, $78 million is drawn on these facilities with another $42 million drawn to support outstanding letters of credit on our development activities. Our current undrawn balance is approximately $590 million.

In the second quarter, on a proportionate consolidation basis and excluding capitalized interest, our leverage metrics were as follows. Interest coverage of 3.28 times for the quarter that serve as coverage of $2.4 times and fixed charge coverage which includes preferred and common dividends of 1.12 times.

RioCan’s debt to total assets ratio on a proportionate consolidation basis was 44.2% unchanged from Q1 2014. Net operating debt to operating EBITDA was 7.7 times for the quarter and 7.56 times on a rolling 12 months basis.

We do continue to expect that these ratios will improve overtime through organic growth and the completion of development projects, dispositions, and the issuance of equity under our direct program.

The direct participation rate during Q2 was approximately $26 million, which would generate approximately $120 million of capital on an annual basis. In July, the participation rate exceeded 30%. Our payout ratio on an AFFO basis was 95% for the quarter and 94% for the first six months of the year. This continues to be our objective to bring this ratio down below 9%.

As of June 30, RioCan had 112 properties that are unencumbered with a fair value of approximately $2.4 billion, up from $2 billion as of the opening of the year and represents 137% coverage on the unsecured debentures. We will continue to focus on growing the size of this unencumbered pool.

With that, I will hand off to Freddie, who will provide further insight on our operations.

Frederic Waks

Thank you so much Rags. In terms of new deals over the six months ending June 2014, RioCan completed 164 new lease transactions totaling 560,000 square feet as compared to 724,000 in the previous year. Average deals were done at $23.05 as compared to $19.20 in the previous year.

Leasing Update. The retail environment continues to be challenging. RioCan is making great progress despite the tough ongoing market conditions. In our enclosed models, Victoria’s Secret and Sephora opened at RioCan Georgian Mall on July 11. Opening date sales exceeded tenant expectations by 25%, sales over the following weeks continued to trend higher than forecasted.

Growth in the retail sector continues to be driven by select American and International banners such as Limited Brands, Michael Kors, H&M, Chico's, White House and Chico’s, Forever 21 Sephora. Demand continues to be strong for outlet centers. 85% of the GLA is Canada’s RioCan’s two existing developments with Hanger is either a leased store in the final stage of lease negotiations.

Grand opening for each of the properties is on October and in November. Tenants have undertaken mergers and acquisitions activity in the last 12 months, for example, Selbies and Loblaws continue to evaluate their expanded portfolios to understand the long-term synergies of additional locations and brands.

DSW’s recent acquisition of interest in Town Shoes has provided a gateway for the tenant to start rolling out its 20,000 square foot modules in Canada. Selbies recently announced that it will be closing 50 stores that will have minimal impact on RioCan’s portfolio.

The tenant will only go – one of RioCan’s 36 Selbies’ anchored locations. RioCan’s ownership interest in the Eastern GTA property is limited to 20% and the tenant obligated continuing paying rent over the remaining 10 years of their turn. We are working closely with Selbies to find a suitable replacement tenant in the mean time.

Specialty grocery chains are more aggressively seeking growth opportunities. For example, Starsky’s, Abrella, The Donuts. Traditional big box players are coming up with smaller footprints in order to be able to be compete for higher cost serving locations joining business with Canadian Tire Loblaws and like those, all the pharmacies and all the grocery stars now.

Telecommunication companies such as Telus, Bell and Fiber are fighting for a new location. In terms of renewals, over the six months ending June 30, 2014, RioCan completed 353 renewals comprising just under 2.5 million square feet and average rents of $3.35 as compared to $3.07 the previous year with a renewal retention rate of 88.8% as compared to 81.2% in the previous year.

Highly to be noted is the enclosed malls we are seeing an 18.9% increase and our GTA locations with average rate of 29.2% with overall non-anchors being at 15.6% return or percentage increase. Vacancies in total, 172 tenants totaling 570,000 square feet to RioCan balance sheet vacated over the first six months as compared to 933,000 in the previous year.

In terms of occupancy, our occupancy has risen from 96.7% in the previous year to 96.9% this year. RioCan’s economic occupancy name open and paying rent was 95.9% over the next 12 months, 520,000 square feet will be coming online comprising of a 15.3 million of annual gross income.

Our top-10 has remained solid in terms of Loblaw Shopper’s Drug Mart combination being the number one tenancy in our portfolio with 4.1% of total revenue, Wal-Mart Canadian Tire, Metro, Cineplex, Winners, Target, Staples, Karen. Selby the subsequent nine.

In terms of the US, we continue to find great metrics. Our occupancy is running at 97.7%. RioCan continues to add value in our portfolio located in Texas Northeast states. In the first two quarters of 2014, RioCan completed leases for 27 new deals totaling 56,000 square feet, notable tenancies included Pest Mart, Pencil Day and Liquor Control Board and Zale.

In addition, RioCan finalized 10 LOIs of 39,000 square feet for vacancies. Lease for these premises are in advanced stages of negotiations. In addition, RioCan has approximately 150,000 square feet in the pipeline. Eddie?

Edward Sonshine

Oh, thank you Fred. As you could tell from all that, the second quarter results were quite satisfactory to us. Despite the odd retail headwind which I believe is primarily due to the slowed economic recovery in Canada, renewal rates and occupancy continue to decline.

And despite increased technology costs, and one-time costs associated with a revamp, senior executive and trustee compensation plans, we grew our OFFO per unit by 5%. And we manage this despite the temporary drag from our investment of over $700 million in our development program.

Of course, it is that very development program that will provide the even better growth I expect to see over the next several years. By way of a small uptick on that program, I’d like to point out the following. Our stock yard center at Sinclair and Western Road in Toronto will be having a grand opening on August 24.

Hopefully, many of you will be out to see this development which we first got involved in 2007. An example of how developments sometimes takes a long time to actually turn into income producing property.

Here in Yonge Eglinton which is quickly becoming one of the top three intersection and hubs in Toronto are fully leased cube edition at the front of the building is proceeding well and should be completed by early 2015 including the media screen revenue for which we have contracted with CBS, this small additional loan will generate about $4 million per year in net revenues.

On the East of Yonge Street, at Eglinton, demolition has commenced and we expect a full construction start by late fall 2014. The 58 storey condominium tower component has been 93% pre-sold and we will be keeping the 450 suite, 34 storey components as a rental building on completion in early 2017. The retail portion is almost pretty well fully leased and will ultimately be owned 100% by RioCan on completion.

The entire complex of almost 1100 dwelling units will be connected underground to not only two subway systems, but also to RioCan Yonge Eglinton Centre ensuring this center’s continued retail dominance of this growing area.

While zoning approvals seem to move at excruciatingly slow pace, we did receive some recent permissions this quarter for a once first for a proposed four storey 170,000 square foot building on Bathurst Street, South of College, the well-known Kromer Radio site. We also received permission for a site jointly owned with Allied Properties on College Street itself.

This latter redevelopment will contain what I believe will be the first to be completed rental residential component of our redevelopment program and more on that later.

Calgary continues to be the exciting center of our development program, between Sage Hill, East Hills and East Village site also known as the CPA site, we expect to have about 2 million square feet of retail under construction by this time next year. Particularly interesting is our East Village urban developments which is – to Calgary City Hall.

The property is already zoned for our proposed uses and as Rags mentioned, we recently entered into an agreement with the developer to sell a 600,000 square feet of air rights. This will leave us with about 250,000 square feet of retail which is already mostly spoken for.

And subject to receiving site plan approval and an actual building permit, we expect to be under construction of this development by early 2015. Quite frankly I could go on in this same for quite sometime. But I do want to leave some time for your questions.

Suffice it to say, that in the remainder of 2014, about $15 million of annualized rental income will come on stream from our development program and in 2015, currently identified over $15 million will come on stream and I expect these numbers to grow even larger in 2016 and 2017.

But none of these numbers take into account the rental residential initiatives which has attracted an enormous amount of interest from entities wanting to partner with us and what seem to be some of the best residential sites in Toronto, Calgary and Ottawa.

We are in the process of putting together an inventory of all our residential opportunities, spread across our entire portfolio and then ranking them by desirability, as well as the likelihood of actually being able to proceed within a reasonable timeframe in zoning and tenancy realities.

We expect to have this done by the end of this year and expect to quite smartly move this program forward in 2015. Thank you for your time and attention. And I would now like to open the call for questions.

Question-and-Answer Session

Operator

Thank you. We will now take questions from the telephone lines. (Operator Instructions) The first question is from Alex Avery from CIBC. Please go ahead.

Alex Avery – CIBC World Markets

Thank you. Ed, just on the East Village discussion, I just wanted to make sure that I clearly understood the transaction that you are contingently entered into there. You bought the property for $20 million, just over a year ago? And (Multiple Speakers) but generate up to $30 million in the deal, right, payments?

Edward Sonshine

That’s correct.

Alex Avery – CIBC World Markets

And the $40 million of infrastructure that would be related to, I guess the construction of the base to a standard above what would normally be required for a single-storey retail property, is that?

Edward Sonshine

Yes, that’s partly correct and also of course, for the residential component, they are doing they want a component of parking. So, the $40 million is a portion of the parking lot plus the upgrades of a podium that’s required to support the two towers. So, yes, that’s the $40 million and their commitment is a total of about $70 million.

Alex Avery – CIBC World Markets

Okay, and then I guess, just, putting that in the context of your residential development opportunities, when you talked about the Eglinton corridor, previously you sort of highlighted that you are more interested in owning the residential and in this case this is going more to a condo developer for resale. Is there, I guess a difference in the property profile, or is there some way that you decide between rental and the condo?

Edward Sonshine

Every property is individual and in these, what I’ll call newer properties like the East Village, you have to look at in this year of each one while our preference, every time we start look at it is to go rental. You have to take into account the reality of your partners’ desires.

We have different partners in different properties. The cost of the project and where you want to end up at a yield in the retail component, these type of new developments are very different for example than redoing one of our existing shopping centers where our cost base of the air ways and we spent a lot of time looking at this and let me unlike knew how we do it.

We’ll take an example which is probably a good example of the Sunnybrook property and while my numbers may not be exactly accurate and that’s that Eglinton here in Toronto where there will be a LRT subway stop right at that corner. Let’s say our current income from that property is about $2 million.

If you look at the – and you make the assumptions that the podium retail of the development will essentially be able to reproduce that $2 million of income. And that’s something we’ve seen in the odd development that we have done like on Avenue Road where we have already redone it.

In fact, even though there is sometime smaller in square footage, because they are brand new space and because they have residential above them and because of the area has improved, we actually end up doing better in the retail revenue than we started with.

But if you look at a down time of about three years and call it $6 million of lost revenues and then you look at an extra million dollars of cost that you might encourage us through moving around tenants from having to buyout at least, you come to a cost of $7 million, that we consider the cost of that – of the air rights.

Now, in that particular, obviously we haven’t filed for rezoning yet, although we would expect to do in the near future, of just finishing our plan. So on that example assuming that we get a minimum of 250,000 square feet of residential, and I think we will do better than that.

Our cost base would be just under $30 per square foot of residential. With that kind of cost base which is way under market, we can afford to build rental residential and still see a very good return that’s in keeping quite frankly it’s much higher than market value of rental residential but it also is in keeping with pretty close to the kind of returns we would like to see from our retail development.

So, we are going to be leaning more towards keeping rental on existing properties as opposed to new ones. Although you will see a mix of both such as you are seeing at Yonge Eglinton where above 40% of the units are going to be rental. Here at Calgary it just didn’t make sense to keeping that rental.

Alex Avery – CIBC World Markets

Okay, and then you mentioned that you are in the process of inventorying all of the opportunities like this throughout the portfolio. You have an early sense, I guess of the 350-ish properties that you own what proportion might fall into this category?

Edward Sonshine

Well, obviously, we are going to be focusing on only the major markets. I mean, I am not quite ready to build rental in Smith Falls. But the – I would be surprised if we didn’t come out to certainly on these first cut, if we didn’t come out to somewhere between 40 and 50 properties, which is only the properties in Canada, it’s only about 15% - 15 of the overall portfolio.

So, I’d be surprised if we didn’t come out the 40 to 50. I would then be equally surprised if we didn’t eventually knockout probably as many as a third of those, because of tenancy issues or zoning issues or the fact that if they are not close enough to transit because we really maybe focusing not only on the major market properties but also those properties that are quite close if not on transit lines that are already existing or are in the process of being built such as the LRT system out in Calgary.

When that process is all set and done, I would hope that we will have at least 30 and that’s not counting some of our new developments such as I mentioned at Yonge Eglinton or the well at the Front and Spadina, but 30 of our existing portfolio that were eligible for this type of process and I only want to guess what kind of square footage it is, we will then rank those by desirability and likely and timing.

And then we will sit down and figure out how to go about it and I hope to have that all in place like I say by the end of this year if not by early next year, you should expect to see a more fulsome report on that probably along with our year end reporting.

Alex Avery – CIBC World Markets

Okay, that will be very interesting. Thanks, Ed.

Edward Sonshine

It will, I agree that.

Operator

Thank you. The next question is from Michael Smith from RBC Capital Markets. Please go ahead.

Michael Smith – RBC Capital Markets

Thank you and good morning.

Edward Sonshine

Good morning, Michael.

Michael Smith – RBC Capital Markets

Good morning, yes, jut picking up on the residential strategy, when it’s all said and done, excluding let’s say the partners you already have, is it your desire to do all of this with dealt partners. You mentioned in your preamble that you are getting approach numerous times by investors who are wanting to partner with you on the residential?

Edward Sonshine

Yes, you know what, it’s a little early for us to the site. But let me put it this way. If we end up looking and it could easily be of this magnitude, having a program that over five, six years, it’s going to do, it’s hard for me to come up with a number, but it could be in the neighborhood of 6,000 or 7,000 apartment units.

You are looking at number one investment over that time period admittedly over a five year period of probably well over $2 billion. That’s number one. Number two, even though, we think we know how to do a lot of things, we haven’t built any residential. So some of the – quite frankly are not just investors but people who had these pockets, but have also built rental residential buildings.

They are very few in number. There is a handful of them quite frankly in Canada. But there are a few and I will have to say that some of them are quite impressive and they have all approached us. So, I wouldn’t be surprised to see us partner up with somebody who has got some experience in this area and on at least the first several.

We certainly don’t claim to be the repository of all expertise and excellence and I think between spreading the risk a little on the first few and bringing in somebody with some expertise and some knowledge, I think it would probably be the wise thing for us to do on the - I’d like to say at least the first several of these projects.

Michael Smith – RBC Capital Markets

Okay, that’s very helpful. Just switching to your comments on your land cost for Bathurst and Eglinton. You were saying that it’s about $30 per buildable which is well below …

Edward Sonshine

Yes, that was actually, Michael that was baby unit,

Michael Smith – RBC Capital Markets

Sorry, baby unit, I get in mind, sorry, so about $30 per buildable which is effectively what you would be – your land cost which is substantially below market. What would market be roughly?

Edward Sonshine

If it were a condominium in that location, it would be $80 to $100 a square foot. Freddy is shaking his head, I think it’s high or low?

Frederic Waks

It’s a $100.

Edward Sonshine

Freddy thinks, it’s a $100 I am being conservative which is not something I would do. But it’s certainly in that range. It’s hard to say what the market is for a rental residential because it ends up coming down to all your other numbers and of course there has not been enough rental residential sites create to really come up with a market. So, the best we can do is, is compare it to a condominium market. It’s considerably under that.

Michael Smith – RBC Capital Markets

And would you say that’s a similar number or let’s say for the well site?

Edward Sonshine

Well, the well site is very different and because it’s really the – well site is a new build as opposed to a redevelopment. It’s a whole different calculation. But, we bought, parking lot I am about to say, we bought the well, very well. And, we expect by the first half of 2015 to subject to elections and political vagaries and all those other wonderful things.

But we seem to have very good support for the – I think quite remarkable proposal put forward to the city, we will end up there with a total in excess of about 3 million square feet of density about half of which or obviously 1.5 million square feet is going to be residential.

That will probably be just something like what we have done in Yonge Eglinton a mix of condominium and rental. We have certainly there have been approached by virtually every high profile condo developer and by several guys who want to be our partner in residential.

And our cost there is real cost, as opposed to a calculative cost like I went through Yonge Eglinton, it is considerably undermarket for downtown properties of this stature which I think will enable us to have the luxury of keeping a large component of that 1.5 million square feet as rental.

But, we’ll have to see how all those numbers play out and the well itself is a very, very complicated project which by the time if you did a full build out scenario on it, it by itself is well over $1 billion project and we have to look at the staging of it. How it would be financed in a way that that makes sense that might even let us build the whole thing at once. But we are talking about 3 million square feet.

It’s a serious commitment and I would say that one of our biggest jobs over the course of next year is really figuring out how to go like the well from a point of view of what kind of partners are we going to bring in, how we are going to stage it.

And there are so many variables on that right this minute that I’d be helping you to even set out our alternatives. However, we are confident that at this point that we are going to be able to start construction on that by the end of 2016 which isn’t thus far away as I would have thought, we are waiting for the current tenants to move.

But, we’ve got time, that was only process as I mentioned doesn’t complete. And actually the timing on it will probably work out quite easily if we complete the zoning process by the first half of 2015. We still have to go through all our plans with pre-leasing being completed.

The financial plans, the sort of set up of – just whether it’s going to be rental, condo, and I am sure that will eat up the remainder of that year until we get started in a year later. So, and this is quite exciting but there is a lot of work to do.

Michael Smith – RBC Capital Markets

Thank you and last question, you had almost 14% increase in leasing spreads, in Canada up nicely from first quarter and the fourth quarter, wonder if you could just give us some color on that and if that’s what you expect in the future?

Frederic Waks

Michael, I think that, again, looking at the biggest increases we’ve had and spreads that we’re look at is because basically, of the calling and new developments that we are doing in terms of a GTA and in Calgary specifically is where we are seeing that great growth.

That’s where the tenant demand is, and as I said, everybody basically are jogging for urban GTA locations and Calgary locations. We are seeing rents – that have never been achieved in the past in terms of our anchors and the CRU. So, as long as we continue to hereto building in the GTA and Calgary which is what we are doing, we are going to continue to see that.

Raghunath Davloor

Just to add, Michael that for the past few quarters there is some skewing on the math because we did have a disproportionate amount of six to eight options that were new versus market options. When you look at for example, the last half of the current year, it’s more biased market we set options. So that does play into the math and it does create noise quarter-over-quarter. So it’s – but going forward, we do expect that those rent rate increases can be sustained.

Edward Sonshine

I would just add one little tit bit to Fred and Rags’ comments is that, when we were – I’ll call it building sort of our major tower centre portfolio starting in the mid-1990s. The standard at that time was to do a initial 10-year lease, maybe 15, but usually 10 and then the tenants who were, because tower centers were new and so were we.

The standard at that time and for the first few years of that process was, a 10 year lease with two five year options that were fixed and that creates the noise that Rags was talking about.

The good news is, over the course of the next four – actually next five years, almost every year, you will see even some of those fixed renewals had tenancies coming to an end.

And so, some of the lifts that you will see coming off of that and Freddie and I are looking at each other, because we have some specific tenancies who are waiting to live through those at periods of deals that were done in 1996 and 1997 and 1998.

You are looking at really the large increases on some of those tenants that could there I save the nature of doubles or even more. Where tenants are paying 20 odd dollars a foot because these are on a second fixed renewal and that rent is going to go up into the 40s.

So, it should be – we are quite enthusiastic about our portfolios and it’s growth prospects over a longer term.

Michael Smith – RBC Capital Markets

Thank you.

Operator

Thank you. The next question is from Pammi Bir from Scotia Capital. Please go ahead.

Pammi Bir - Scotia Capital

Thanks and good morning. Just going back to the apartment discussion, you mentioned expected returns in a similar range with some of the retail projects. So, would that target imply something in that 5% to 6% level or higher and then secondly, over the next five to six years, what portion of the overall NOI in the business do you see coming from apartment base?

Edward Sonshine

Yes, obviously, the returns will be very individual, but certainly, we will be targeting more in the 6% range than the 5% range. I am not sure we undertake a residential redevelopment or development that was just low as 5%.

I think we can do better than that. I don’t want to predict over 6%, but some will be over 6%. A lot of that comes down to cost of construction and so on and part of the expertise we are looking to in this. As far as where we are going with residential component, obviously, when you’ve got an entity that this year.

I don’t want to give out any numbers that are going to be wrong, habit of doing that, but I think our OFFO is well in excess of $500 million this year in gross numbers. I got a couple of accounts now being shifting ages now and I would have hoped that 5 or 6 years from now.

We might get up to 10%, 12%, I don’t think in that short period of time, it’s going to be much more significant than that. It may grow a little bit more by our disposition of secondary market properties. So that obviously the major market residential will be a larger. So did misspeak very much? No, they tell I am in the range, okay. So, that would be, but that’s just a guess, Pammi, at this point.

Pammi Bir - Scotia Capital

Okay, now that’s simple.

Edward Sonshine

Half educated guess, but just a guess.

Pammi Bir - Scotia Capital

Yes, but certainly higher than I guess the prior commentary of course with your program now for potentially bigger programs. So, just looking at the broader development program, you got maybe 5% of the assets invested in PUDs, but how high do you see that moving over the next few years? And then secondly, what are your thoughts with respect to meeting your near-term funding needs through either capital recycling versus from new equity?

Edward Sonshine

I think on the PUD question first, I spoke about at the – at our Annual Meeting with our creating, which we are also in the process of doing. There are some benefits for this pretty serious technology spend we’ve been going through and it really gives us much better analytics and the ability to forecast increased strategy based on this forecast. So, we are actually to do what I am about to say.

The focus would be at not letting that PUD amount grow significantly, but rather matching new developments commitments. As far as capital is concerned to what’s coming on stream in any given year. That’s not to say that it won’t vary by a $100 million or $200 million, but you’ll see that double over the next three years.

We are mindful of risk management that’s one of the main focuses that we have when we review these things on an ongoing basis. So, I wouldn’t see that grow very much. I would hope our intention is to keep it relatively flat. And what was the second part of your question?

Pammi Bir - Scotia Capital

Just in terms of how your thoughts with respect to funding near-term needs with equity versus capital cycling?

Edward Sonshine

Thank you for repeating that. The – I would hope that dispositions and sort of accumulation of capital through our drip program and retained earnings as our AFFO payout percentage gets better. We will make up the bulk of that but it doesn’t mean, we are against equity earning, equity issues at the timing as it is right. We don’t want to put ourselves and really put ourselves in a position where we have to do it.

We haven’t done an equity issue I think in probably over a year-and-a-half almost two. I think that’s a good thing, but certainly we are not against doing equity issues like I say, if the time is appropriate, keep in mind one of our other focuses is bringing down our overall leverage ratios. So it’s not just an issue of funding.

As Rags mentioned, we want to get on the one hand all of our metrics better as that 44% and we’d like to get closer to 40%. So depending how the disposition program is going depending how other things are happening, I don’t be surprised if sometime in the next year or so we do an equity issue.

Pammi Bir - Scotia Capital

Okay, and then just lastly, on the CPA side, what’s the expected timing of the closing of that air right sale? And when you say up to $30 million, what would be the low end of the range?

Edward Sonshine

I think we said $30 million, I mean, basically we’ve agreed on 600,000 square feet. That could only change if the plan that’s finally approved by the city. You don’t get lower or higher. But I – considering we already know what the zoning is and the initial comments we’ve received back from the city has been quite supportive. I think that will be the number and then on top of that, the number that actually is movable as of course their contribution towards infrastructure and parking costs.

As far as when it’s going to close that really depends on getting final municipal approvals through the process and it could be as early as next year.

Pammi Bir - Scotia Capital

Okay, thank you.

Operator

Thank you. The next question is from Sam Damiani from TD Securities. Please go ahead.

Sam Damiani - TD Securities

Thank you, good morning.

Edward Sonshine

Good morning.

Sam Damiani - TD Securities

Just a couple of questions. First off, on the value that’s being created in this rezone upzoning across your portfolio, is any of it included in your IFRS valuations and that would include the Calgary site there for $30 million?

Edward Sonshine

The answer is no. None of it is included, it’s too speculative and until deals and zonings are completed, I wouldn’t think our valuation group would even look at it. So the answer is no.

Sam Damiani - TD Securities

Okay, and then just on the source of proceeds to fund all this investment that you are – it is obviously very exciting here in Canada, particularly on the in terms of vacation side, in the acquisition environment in the US it seems it’s a little quite, particularly in the Northeast, you are seeing your asset values increase down there as cap rates continued to compress. I mean, are you thinking about perhaps exiting all or part of your US portfolios as a way of funding all this opportunity of northern port here?

Edward Sonshine

You know what, I would say the simple answer to that is, we are always open to thinking. We don’t the funding from that process, but quite honestly we are quite pleased with our American portfolio. The growth metrics while in this last quarter, the US was a little bit lower.

That was constrained a bit, so – leave it by the heavy snowfalls in the northeast with some cap leases. So it’s certainly over the course of a full year, particularly with the leasing progress and now we have our own people on the ground there. I suspect that the US will show higher same-store growth than Canada.

And, I think that the valuation will get quite frankly better, rather than worst because, I mean, the greatest thing, a lot of it is of course driven by interest rate. But the other thing that I am not sure people necessarily appreciate is that the amount of new retail being developed in the United States or in Canada, except for urban redevelopment projects like we are undertaking is almost nil.

There is very, very little happening and I think that over the course of the next few years, we may surprise ourselves by the rental growth both in the United States and in Canada. So, it’s a positive. And so at this moment, we have absolutely no plans to expose in the United States.

Sam Damiani - TD Securities

Okay, and you said $2 billion of rough estimate cost on sort of 6,000, 7,000 units. So that about close to 300,000 a suite…

Edward Sonshine

And that’s a very – that’s a very rough number.

Sam Damiani - TD Securities

Okay, just lastly on the quarter, the NOI was a little bit lower than we had been expecting of. But was there anything unusual in the quarter maybe in terms of not recovering quite as much is normal or anything unusual this quarter?

Raghunath Davloor

It was just in the US we did have some caps on recoveries. So that’s where the US goes.

Edward Sonshine

An extraordinary snowfall this winter.

Raghunath Davloor

But in Canada, we did expect have been around 2% sales for the growth which is where we came in. So this had performed as expected, but the US is a little lag which is because of the recurring cost side.

Sam Damiani - TD Securities

And is that going to continue into Q3 and Q4 or is that sort of a…

Raghunath Davloor

No we think it’s just a one quarter issue.

Sam Damiani - TD Securities

Thank you.

Operator

Thank you. The next question is from Heather Kirk from BMO Capital Markets. Please go ahead.

Heather Kirk - BMO Capital Markets

Can you comment on the lending environment? You have a fair amount of debt coming due and it seems like and the rates technologically attracted, please give us a sense of that improved in the market and what that trends it looks like?

Raghunath Davloor

Well, spreads are compressed anywhere unsecured continue to compress. So we are seeing that and the terms are getting more attractive as far as duration. And on the fixed rate they were very, very sticky for quite a long time and that we have seen them come in, in the last six months, I think as a differential between secured spreads and unsecured sort of widen.

We have seen moves in fixed rate. So fixed rates are probably coming about 25 basis points since the start of the year. I think that the other dynamic that we are seeing is we are fairly committed to a strong and secured debt program and as other people are shifting their balance sheets more to an unsecured waiting.

What’s happened is a lot of these lenders as institutions are finding themselves in the net inflow position which is making it very attractive for us that they do come to us and they trying to put out money and they are have in the office that affair. So we are seeing some interesting market dynamics on that side.

And the other trend that we are seeing more and more sort of migrating to the US structures is, people are more willing in Canada to look at interest-only debt at around the 55% leverage level which we would find very attractive when you look at the all-in cost.

So, it’s certainly moving in our direction. You still see rates in the 3.25% to 3.5% is what we are looking at and we are going to look more actively in switching some of our floating rate debt to fixed rate debt in the next little while.

Heather Kirk - BMO Capital Markets

So, from a cash flow perspective would you be looking to do more of the interest-only and potentially how much?

Raghunath Davloor

Well, we like to do all our mortgage debt on interest on liaisons really a function who the lender is and can they accommodate that that asset outside through three quarters of our debt now is shifting to interest-only on renewals on refis.

Heather Kirk - BMO Capital Markets

Thanks, you mentioned last quarter that, there was upside within the Texas portfolios, maybe you had gotten to save back. I am just wondering where that fits and just given the slower same-property NOI numbers that you discussed?

Edward Sonshine

Well, I don’t know that we had lower same-property NOI, lower growth perhaps, but, I think, the bulk of the leasing that Freddie spoke to and if you add it together sort of new leasing that are already signed but not yet in place and LOIs I think you were coming in at about close to 200,000 square feet in total spreads and the bulk of that is in the Texas portfolio.

Frederic Waks

Yes, of the 160,000 I said, that we are working on right now, 110,000 of that is in Texas.

Edward Sonshine

So we would expect to see some pretty good growth over the next 12 months out of that portfolio.

Heather Kirk - BMO Capital Markets

And this is on Target, there is clearly been a lot of talk and some speculation that they might even exit the Canadian market, just be interested to get your thoughts in terms of how that’s evolving and if they were to close stores at some point how that would affect you in terms of the lease structure that you have with us?

Edward Sonshine

Well, listen, I just happen to see before we came in here. They’ve just appointed a new CEO for Target Corp. some gentleman from Pepsi. So, you have to ask him about what they are going to do here. I would be very surprised.

I mean, they have an investment if they ever retrieved it from Canada notwithstanding a lot of the media speculation they have not only in the current investment, probably in the neighborhood of $5 billion here in Canada. All of our leases and I assume most of the others have the US covenants.

Our average sort of terms of maturity on the Target leases, both leases point 3 years something like that, certainly in excess of eight years. And, you would have to add together their obligation on top of that $5 billion under all those leases, and I think there is about a 120 of them in Canada, I don’t know if they all have the US covenant.

So, that seems to me the likelihood of their retrieving from Canada is slim to none when you add those numbers together. They are even in the scope of a Target Corporation they are pretty big numbers. I tend to be a believer that they are one of North America’s great retailers and they will fix the false and bad starts they got off to here in Canada.

I don’t think it’s a fix that will take a week or a month or even six months, I think it will take them a couple of years. In the mean time, they are proceeding. We have a new store opening this fall, I believe in Ottawa, St. Laurent, Ottawa with them and from where we sit there, they are continuing to get better.

Do they have ways to go? Yes, so our worst case, to answer the last part of your question is, that we would have a lot of empty space with 8.5 years of income still coming in and looking for ways to make it better, because quite honestly, their rents are quite low. So, because in most cases, they just took over the lease.

The premium on the space went to Hudson Bay Company. When they bought those leases for almost $2 billion, so, at the end of the day, I hope and expect that they will continue and revitalize themselves as the retailer I know they are and can be. But if that changes, I think it will be an opportunity for us.

Heather Kirk - BMO Capital Markets

Thanks very much.

Operator

Thank you. (Operator Instructions) The next question is from Lee Baker, shareholder. Please go ahead,

Unidentified Analyst

My question is with respect to the multi-unit project such as – just to look at the condo aspect also. Is there any exposed liability to re-okay in connection with the condominium development and is there any profit to be derived by re-okaying from the project?

Edward Sonshine

Yes, I would say, short answer, yes, to both questions. I mean, obviously, we are committed to build the building. The cost of the entire Yonge Eglinton project is considerable than over $400 million.

But as I said about 40% of it actually a little higher percentage when you include the retail space we are going to be keeping as a income producing property, rental property. On the condominium side, as I mentioned it’s 93% pre-sold with 20% downpayment by the time we actually start construction and most of that is already sitting in escrow.

So, from the point of view of profits, yes, we certainly if everything goes as currently planned there are what we call transaction gains on the condo components of that building which I don’t want to try to throwing around profit numbers, because too many things can change. But they are pretty material. They are pretty big.

Unidentified Analyst

Thank you very much.

Edward Sonshine

Thank you.

Operator

Thank you. There are no further questions at this time. And I would like to turn the meeting back over to Mr. Sonshine.

Edward Sonshine

Okay, well, thank you very much, Patrick and thank you all for dialing into our second quarter conference call. If all of you – if don’t and we don’t talk to you beforehand, we will talk to you in a few months, Bye-bye.

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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