Brookfield Canada Office Properties (NYSE:BOXC)
Q1 2016 Earnings Conference Call
April 26, 2016 9:00 AM ET
Jan Sucharda – President and Chief Executive Officer
Bryan Davis – Chief Financial Officer
Alex Avery – CIBC
Rob Sutherland – Echelon Wealth Partners
Michelle Gare – TD Securities
Please standby we’re about to begin. Good day. Welcome ladies and gentlemen to the Brookfield Canada Office Properties 2016 First Quarter Financial Results Conference Call. As a reminder, today’s call is being recorded.
It is now my pleasure to turn the call over to Jan Sucharda, President and Chief Executive Officer. Please go ahead.
Good morning and thank you for joining us for our first quarter 2016 conference call. I will be chairing today’s call. With me is Bryan Davis, our Chief Financial Officer. As per previous calls, I will start by discussing the highlights for the quarter, Bryan will then take us through the financial results, after which I will provide some commentary on the conditions of our markets and concluding remarks before taking questions.
During the first quarter of 2016, we experienced a stable market in Toronto, consistent with the past three quarters, and weakening marketing in Calgary as that economy continues to contract for a second consecutive year. Box's overall occupancy decreased by 70 basis points to 95.2% from 95.9% in the previous quarter, primarily due to vacancies at Brookfield Place, Toronto and Royal Bank Building at Bankers Hall in Calgary.
Compared to the prior year, occupancy increased by 10 basis points from 95.1%. We remain believe me focus on making headway on deals in our pipeline, which currently include a blend of renewals in new leases across all markets. During the quarter, we leased approximately 200,000 square feet versus 265,000 square feet that expired. Our ending occupancy of 95.2% compared favorably to the Canadian national average of 89.3%, which declined by 30 basis points from the prior quarter.
Leasing highlights include, an eight year new lease with FIS Financial Solutions Canada Inc for 26,000 square feet at First Canadian Place, a ten year new lease with Vanguard Investments Canada Inc at Bay Adelaide East for 23,000 square feet, a three renewal with ITG Canada Corp at Exchange Tower for 20,000 square feet, a five-year new lease with Portfolio Strategies Securities Inc at Bay Adelaide West for 15,000 square feet, and lastly, a ten year new lease with DHX Media Limited at Queens Quay Terminal for 11,000 square feet.
With respect to capital and operational initiatives; highlights include the sale of Royal Center in Vancouver generating net proceeds of $285 million after repayment of debt. We achieved very attractive returns on this transaction demonstrating our ability to enhance and unlock value in mature assets.
The declaration of a special distribution of $1.60 per unit or $150 million in total was paid on April 19, to unitholders of record as of April 5, 2016, as well and in addition to we repaid the $195 million balance outstanding on our corporate credit facility. The transition of Bay Adelaide East into a fully operational property is due in completion with the reinstatement of Arnell Plaza to be done before the end of the spring, and build out an and occupancy of the podium to follow shortly thereafter in July.
I will now turn the call over to Bryan to review our financial results.
Thank you Jan, and good morning everyone. Before I begin, let me caution that our discussions will include forward-looking statements. These statements that relate to future event results and events are based on our current expectations. Our actual results and future periods may differ materially from those currently expected because of a number of risks, uncertainties and assumptions. The risks, uncertainties and assumptions that we believe are material are outlined in our news release issued yesterday.
As noted in our news release, we reported funds from operation totaling $39 million or $0.42 per unit for the first quarter of 2016, this compares to $37.1 million or $0.40 per unit for the same period in 2015. The increase of $1.9 million in FFO over the prior year same period was largely driven by incremental net operating income from Bay Adelaide East of $8 million on transfer into commercial properties. Higher rent and recoveries of $2 million at Bay Adelaide West and Exchange Tower due to the subs and renewals, and these were offset by lower rents and recoveries of $3 million due to expiries at Brookfield Place, a loss of net operating income of $2 million from property that were sold including HSBC Building in Royal Center, and higher interest expense of $3 million, mainly as we seize the capitalizing interest at – related to the Adelaide East.
Compared to last quarter, FFO was up slightly by $0.5 million or $0.01 per unit, mainly due to higher net operating income of $5 million due to an additional two months of income from Bay Adelaide East and this was offset by lower rents and recoveries of $1.1 million due to expiries of Brookfield Place, higher interest expense of $2.4 million and higher general and administration costs of $0.7 million, largely due to a credit that we had in Q4 to our management fee related to the ground rent settlements at HPC.
Adjusted funds from operations for the quarter was $31.6 million or $0.34 per unit, this compares to $28.5 million or $0.31 per unit for the same period in 2015 and compares with $30.6 million or $0.33 per unit in the prior quarter. The changes in AFFO compared to prior periods are due to the changes in FFO, as previously discussed.
As per Page 9 of our supplemental; same property net operating income was consistent with the prior year same period, and increased by $1.2 million or 2.1% compared to the prior quarter, primarily due to higher rents and recoveries at the Adelaide West, as a result of lease ups and renewals.
As for changes to the balance sheet, our commercial property value decreased from $5.8 billion to $5.4 billion, largely due to successful sale of Royal Center in the quarter. In addition to that sale, we invested a further $14 million into our properties, mainly in the eastern region and we decreased values to the P&L by $28 million. On a square foot basis, our portfolio is now valued at $461 per square foot, down $6 from the prior quarter.
As per Page 7 of our supplemental, the decrease in values was mainly due to lower valuation on the Calgary portfolio of $81 million or approximately 5%. This is as a result of lower rental rate assumptions on vacant spaces and tightening in discounts in terminal cap rates to reflect the ongoing concerns in the region. The fair value loss in Calgary was offset by a favorable gain of $47 million in Vancouver related to the final transaction price for the sale of Royal Center.
On a portfolio basis compared to the prior quarter, our average discount in terminal cap rates increased by 10 basis points and 20 basis points to 6.2% and 5.7% respectively. Our goal period remains steady at 10 years on average. In addition to commercial properties, we incurred $59 million of development costs during the quarter at Brookfield Place Calgary East. Of the amount incurred during the quarter $47 million was funded through distinct construction facilities.
BOX's IFRS value per now stands at $33.89 compared with $35.72 in the prior quarter. The decrease is mainly due to the declaration of the special distribution during the quarter of $1.60 per unit.
Our balance sheet remained steady a loan to value level of 45% for our investment properties with an average term to maturity of our investment property debt of seven years, which continues to be well matched to our average remaining lease term of eight years. From a liquidity perspective, our corporate facility of $350 million is fully available and we anticipate the credit line to be mostly undrawn throughout the year.
On the operations front, our first quarter leasing of 200,000 square feet was completed at an average rent of $32 per square foot, which continues to be higher than expiring rents of $30 per square foot, as well as our average market rents of $29 per square foot.
With that, I'll now turn the call back over to Jan.
Thank you, Bryan. With respect to the market update, overall trends remained consistent when compared to the past several quarters. Occupancy levels in Toronto were stable, while they continue to decline in Calgary. As stated in previous calls, we expect vacancy rates on average to trend upward during 2016 as inventories in Toronto and Calgary come online. With respect to specific markets, Toronto’s downtown vacancy rate for all classes remained at 4.6% compared to the prior quarter.
With respect to Class A and AA space in the financial core, absorption was a healthy 266,000 square feet in Q1, notwithstanding the vacancy rate increased by 80 basis points to 5.9%, as a result of Bay Adelaide’s being added to inventory. The outlet goal over the next few quarters for the financial core remains optimistic, supported by the technology and financial sectors, migrations, and new entrants backing demand for new and high quality assets.
Box’s Toronto portfolio ended the quarter with a vacancy rate of 5.6%, an increase of 70 basis points from the last quarter. In Calgary, overall vacancy in the downtown core ended the first quarter at 20.5%, an increase of 2.4% from the prior quarter, as a result of negative absorption of over 1 million square feet. Class A and AA vacancy also experienced a 2.8% increase ending the quarter at 17.1%. The bulk of the vacancy in the A and AA category sublease space, head lease vacancy represents just 35% of the 17.1% available, which translates to 6% of the market.
Box’s Calgary portfolio ended the quarter with a vacancy rate of 3.2%, an increase of 50 basis points from prior quarter, and well below the market vacancy rate. We believe that our portfolio will continue to maintain an above market occupancy rate through 2016.
With respect to our Calgary retail tenant portfolio, the significant reductions in office building population and curtailed discretionary consumer spending both of which are the result of the continued slowdown in the Calgary economy have impacted the performance of many retailers. Our management team is developing strategies for those tenants with good business plans and product offerings.
In Ottawa, the overall vacancy rate in the central business district increased by 30 basis points from prior quarter to 9.3% and Class A vacancy also increased by 30 basis points to 6.5%. Box’s vacancy rate increased by 60 basis points from the prior quarter to 5.3%.
I’ll end with a few closing comments. First and foremost, we are focused on backfilling voids and reducing exposure and rollover risk. Since year-end rollover exposure was reduced by 0.5%, with just 2.7% remaining in 2016, primarily in Calgary. Given the current operating environment in the Western region, we're working diligently to complete deals in Toronto to guard against the potential losses in Calgary. Second, we will manage the integration of operations in the completion of the remaining construction activities of Bay Adelaide East, as well we continue to advance and actively manage the development of Brookfield Place Calgary and the lease up of both properties. It is important to remind investors that both Bay Adelaide East and Brookfield Place Calgary’s were acquired from Brookfield Property Partners on an as it completed and stabilized basis, where BPY retains development risk including the obligation and construct lease up and finance the property.
In summary, we continue to achieve stable results and maintain our high occupancy levels relative to market. The significant capital repatriate from the sale of Royal Center was a great accomplishment and we were pleased to use a portion of the proceeds of special distribution to our unitholders.
Operator, we will not take questions from analysts.
Thank you, sir. [Operator Instructions] And we’ll take our first question from Alex Avery with CIBC.
Thank you. Just a clarification, if you look on Page 11, you show the Calgary lease space going down by about 0.5%, and if you go to Page 12, you’re showing about 2.7 percentage points reduction in occupancy, wondering if you could reconcile the two numbers?
So you’re talking about the 1.2% difference.
If you look at Page 11, you’ve got the Calgary leased space at Q4 2015 at 5,480, going to 5,454, and then if you go to Page 12 you show the leased space at 94.7% down from 97.3%, so just wondering if there was in fact, you know which number we should be looking at? Is the Calgary occupancy 94.7%? And maybe…
We’ll get back to you on that one.
That sounds good. And then just on the 6000 square foot space that you leased in Calgary, very immaterial, and clearly a small space, but is there a story behind that, is the rent going from 30.65 to 11?
I don’t think there is a story behind that.
That was just a normal lease roll?
No, it’s not a normal, I'm just trying to find that. So, let me get back to you on that okay Alex.
Sure. I guess I have the hard questions today. And then just on Brookfield Place Calgary, if you can provide, you know where the leasing activity stands for the other 400,000 square feet, I know you're not exposed to that, but if you could just provide an update on where discussion stand or what your expectations are?
Well, Alex, it’s a tough market out there, there is some activity and proposals that we have out in the marketplace and we’re working through them. As you can imagine with 400,000 square feet that’s due to the market not for another year and a half, it’s of the early stage of actually trying to identify Brook’s to be there. We have been actively pursuing certain deals, but nothing to report, and just emphasizing it is obviously a tough market out there and we’re monitoring and looking for what it will be can to fill that space.
Okay. The way you structured that deal is looking better and better every day.
And now, just getting back to you on your question on Page 12; it looks like the lease percentages were just mapped incorrectly between Ottawa and Calgary. So Calgary is 96.8% leased and Ottawa should be 94.7% leased.
That clears it up. Thank you. That’s great. And then, you’ve had great success with the asset sales that you’ve undertaken in the last six months, what are you thinking at this point in terms of taking advantage of the strong bid?
Well Royal Center was the third one, you’re right, we’ve had a good run, we did 151 at the beginning of the year, 151 Yonge Street, followed by 70 York, and then the Royal Center. So we’ve got our corporate line paid off, and you know at this point we're reviewing other options, but nothing that we’re actively pursuing and moving down.
Okay. And then lastly, the debt on Bay Adelaide East is, you can extend it out to 2017, how are you feeling about terming that out?
The ideas is, as we said all along we’ll look to complete our lease up and then once we have the lease up finalized, we’ll turn around and look to perm out. So given that low-interest rate seem to be sort of sticking around and persisting for a little while, we're not in a real hurry to move it forward. We're on target with our – with the velocity of our lease up and we think we’ll probably take it through the normal course and wouldn’t be expecting to perm out until sometime through the latter half of 2017.
Okay. That’s great. Thank you.
We’ll go next to Rob Sutherland with Echelon Wealth Partners.
Morning guys, just further to Alex’s question, what are the leasing thresholds for the Bay Adelaide extension?
The first one, the Bay Adelaide extension is at 60%, so we’re through that, and the second one is 80%.
Perfect. And then I guess, kind of furthering on with that as well with potential dispositions, Hudson's Bay Centre I see that you’re currently finalizing a two-year term on it, is that just to give you flexibility if you want to do something with that building?
Yes, if you might recall, we did actually a one-year extension a year back or so. It’s combined with sort of ultimate flexibility on the project, mostly driven by the ground rent reset, that although we did actually resolve or get a number from the settlement, we are looking to appeal that. And so we want to try to get process through before we lock in.
Okay, perfect. That's it from me. Thanks guys.
We’ll go next to Michelle Gare with TD Securities.
Hi, good morning.
I was just thinking if you could provide a little bit of an outlook on leasing in terms of the Imperial Oil space, as well as the Bay Wellington Tower?
Sure. So, in Calgary, we’ve taken care of two-thirds of the Imperial Oil space with the TCPL lease that we’ll be kicking in. And with that, with the basically with the uptick in rents achieved on that we've essentially replaced the equivalent net operating income that we were generating from that lease prior to its expiry. So, as far as the remaining space there are groups that we’re looking at, we do have a couple of deals in our pipeline out there, nothing that I can report on formerly at this time, but what I would say about the Calgary market is that unlike about six months ago, when it was extremely quiet and there wasn't – there really wasn’t any activity happening, we are starting to see people come around and seek new alternatives for the space. And I would say that in Calgary, really it's one of two things, it’s the flight to quality aspect or it’s what we’ll call a return to the downtown, where tenants that have otherwise over the last number of years been out in the suburbs are now looking to take advantage of the change in the rental profile downtown properties and return to downtown type occupancy, where they were in a centralized position for their companies. So, long way to go there still, but more optimistic today than I was probably six months ago, as far as the lease activity we’re seeing out in Calgary.
With respect to Deloitte, we just recently returned that space to shall condition, we’re actively marketing it. And we have some prospects for roughly half of the space right now. So we’re working through that and we’re hoping to have some solid activity of movement on that over the next two quarters.
Perfect. And then just like, you know any upcoming Calgary lease expiries over the next few quarters, are there any tenants that you are currently aware that won’t be renewing?
Well obviously the Imperial Oil is the big net out there, and that’s really the only one that – it sort of lease everything.
Okay. And then, just I mean there has been a lot of media speculation on Synovus, Brookfield Place Calgary East in term of you know possibly having too much space, is there any potential for a buyout option in your view?
We have a lease with Synovus and we’re expecting them to honor that and I can’t speak as to what the company might be thinking as far as the lease.
Okay. Perfect. Thank you. I’ll turn it back.
[Operator Instructions] And with no further questions in queue, I’d like to turn the call back over to Jan Sucharda for any additional or closing remarks.
Well, thank you everyone for joining us today. We appreciate the support, and we look forward to speaking with you over the next quarter. Thanks very much and have a great day.
This does conclude today's conference. We thank you for your participation.
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