Slate Office REIT (OTC:SLTTF) Q2 2021 Earnings Conference Call July 30, 2021 9:00 AM ET
Company Participants
Jennifer Pyper - Investor Relations
Steve Hodgson - Chief Executive Officer
Michael Sheehan - Chief Financial Officer
Lindsay Stiles - Chief Operating Officer
Conference Call Participants
Jonathan Kelcher - TD Securities
Matt Kornack - National Bank Financial
Jenny Ma - BMO Capital Markets
Operator
Good day and thank you for standing by and welcome to the Slate Office REIT Second Quarter 2021 Financial Results Conference Call. At this time all participants are in a listen-only mode. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions]
I would now like to hand the conference over to Jennifer Pyper, Investor Relations. Please go ahead sir.
Jennifer Pyper
Thank you, operator and good morning everyone. Welcome to the Q2 2021 conference call for Slate Office REIT. I'm joined this morning by Steve Hodgson, Chief Executive Officer; Michael Sheehan, Chief Financial Officer; and Lindsay Stiles, Chief Operating Officer.
Before getting started I would like to remind participants that our discussion today may contain forward-looking statements. And therefore we ask you to review the disclaimers regarding forward-looking statements as well as non-IFRS measures both of which can be found in management's discussion and analysis. You can visit Slate Office REIT's website to access all of the REIT's financial disclosure including our Q2 2020 investor update which is available now.
I will now hand over the call to Steve.
Steve Hodgson
Thank you, Jen. We're very pleased with our second quarter results, in particular the leasing volumes and continued rental rate growth. As we expected with the rollout of the vaccine, we're seeing increased leasing activity and demand for office space in all of our markets. Our financial results in the second quarter also demonstrate the continued durability of the REIT income.
I'm going to ask Mike to summarize some of the key highlights from the quarter.
Michael Sheehan
Thank you, Steve. We completed nearly 350,000 square feet of total leasing in the second quarter, which is our best leasing performance since Q2 2018. This is almost three and a half times our first quarter leasing volume. These leases were completed at an average rental rate increase of approximately 17% which is our highest quarterly leasing spread since the onset of the pandemic.
As a result of this leasing, occupancy increased in the second quarter to 83.6%. And we are expecting continued momentum throughout the year. The durability of Slate Office REITs income continues to be a key component in our investment thesis. 60% of the REIT income is derived from government and credit rated tenants and our weighted average lease term is 5.4 years.
Now on the return to office and our discount to net asset value, global financial institutions like Goldman Sachs and JP Morgan Chase have majority of their employees back in their Manhattan based headquarters. These decisions illustrate the critical role that the office plays in optimizing employee engagement and productivity as well as maintaining company culture. Based on our conversations with the tenants in our portfolio, we expect other employers to follow shortly.
Despite these strengthening fundamentals and our proven income durability, we continue to trade at a significant discount to our net asset value. For investors, we see this as an opportunity. Our current trading discount coupled with our attractive well covered distribution yield combined to create one of the most compelling total return investment opportunities in the Canadian REIT sector.
Finally, on our growth going forward, are in place rents across the portfolio are on average 9% below market, which creates an opportunity to grow our rental rates. There's also upside between our current occupancy of 83.6% and where we believe our portfolio stabilizes.
Additionally, we continue to evaluate a pipeline of transformative and accretive external growth opportunities across Canada, the United States and Europe with the support of Slate Asset Management's global team and relationships. As the economic landscape continues to strengthen in both Canada and the United States Slate Office REIT is positioned well for both internal and external growth. On behalf of the Slate Office REIT team we thank you for your continued support.
I will now hand it over for questions.
Question-and-Answer Session
Operator
Thank you. The floor is now open for questions. [Operator Instructions] And your first question is from Jonathan Kelcher of TD Securities.
Jonathan Kelcher
Thanks. Good morning. First question and congrats on the good leasing quarter or for the leases you did in Q2. The renewal specifically when did those rents start to kick in?
Lindsay Stiles
Hey, Jonathan. Thanks for joining the call. So the deals that we've completed would reflect renewals for certainly later this year and into next year as well. They were staggered across the portfolio. So we completed - to give you a little bit more color, we completed 100,000 square feet of leasing in the Greater Toronto Area, 180,000 square feet in Atlantic Canada, and then the balance would have been in Chicago. And again spreads were really solid at 17% across the board.
Jonathan Kelcher
Okay, so over the next, say, three quarters, they would - you'd sort of expect the bumps to kick in.
Lindsay Stiles
Yeah, exactly.
Steve Hodgson
Most of it was in the year for the year. So within 2021
Jonathan Kelcher
Okay, that worked. And what were - were there any big TIs that you guys had to spend for that leasing.
Lindsay Stiles
I would say, we completed a number of large deals, you would remember that we completed 100,000 square foot renewal with a government tenant out in Atlantic Canada. So I would say inducements would be consistent with those larger deals, similar to what they would have been in pre-pandemic level to the extent there was space that required an abnormal amount of improvement, we potentially would have increased the TI slightly, but that wouldn't be any different than what we would have done pre-pandemic.
Steve Hodgson
Yeah. And I'll just add some color. I can address head on the negative rental spread on the new leasing side, that was really a strategic opportunity to get some tenants into our buildings in New Finland, where as you know, the oil and gas sector has been a little bit stagnant. We're trying strategically to bring in new tenants into our buildings, and growth companies, tech and mining, et cetera. And what we're doing there is we're offering short-term lower gross rent deals, as opposed to providing any sort of cash out of the door with a hope that as these growth companies grow that they'll grow with us, and we can convert them to a more conventional lease structure.
Jonathan Kelcher
Okay, that makes sense. So if we look at 2022, the 11% renewals or something around there. Do you have any large renewals similar to the New Brunswick government deal or is it more steady?
Lindsay Stiles
Yeah. Jonathan, there are a couple that would be similar in size to the deal we did in Atlantic Canada, we're very close to finalizing one of them. That would be in the next couple of weeks. And I would expect, the other again would follow, hopefully before the end of the quarter. One thing I would say is the bulk of that 11% is in Ontario. So we're certainly seeing a significant amount of demand for office space and increased activity in that particular market. So we're really comfortable. Some of those conversations were admittedly delayed due to the pandemic, but it picked up steam recently. We feel we're working really closely with those tenants to get those renewals completed in the back half of this year.
Jonathan Kelcher
Okay and then last one for me. You hit some lease termination income in the quarter. With the renewals, I guess over the remainder of this year and into next year, do you expect any more lease term or lease termination income?
Lindsay Stiles
No, we don't. So that one's specifically Jonathan, we expected that tenant would not renew on expiry just given the nature of their business. And what I would say on that particular termination is we've got 12 months' notice, we expected them to leave, they're paying well below market rent. So this gives us an opportunity to adjust that space to a market rent, which is off the top of my head, something like a 25% lift. And the termination income provides us with more than that money to re-lease that space. We don't expect again, any other terminations to be exercising the balance of this year.
Steve Hodgson
Yeah, this was a tenant that is in the travel industry. We didn't see them as being a long-term. We didn't expect them to renew after their term. There was some balance sheet and collectors' pressure to adjust things probably was in our favor really, because they only had a few years left of term, and they paid us a termination fee of $34 a square foot. And we have 12 months to lease until they actually vacate. So we think - and they're paying currently 27% below market rent. So we don't like tenants vacating. But in this case, there's some significant opportunity with this as well.
Jonathan Kelcher
Okay, that's helpful. I'll turn it back. Thanks.
Lindsay Stiles
Thank you.
Operator
Thank you. Your next question is from Matt Kornack of National Bank Financial.
Matt Kornack
Good morning, guys. Just a follow up with regard to your occupancy trajectory, if I look at where you've got kind of below market occupancy, it seems like most of its in Atlantic Canada. It sounds like the strategic leasing you're doing in New Finland may end up in some of that being picked up. But can you speak to maybe the New Brunswick and Nova Scotia opportunities as well?
Lindsay Stiles
Sure. And so in Nova Scotia, you would recall that we've got the redevelopment of Maritime Centre, well underway should be completed towards the end of this year. In a somewhat strategic fashion, we haven't been trying to do a whole ton of new leasing there. We feel that there's a real opportunity to drive rents once the redevelopment is complete. So we have seen increased activity recently. We've got - we're trading paper with a number of different groups, including existing tenants who are looking to expand. And then at our Chain Lake properties in Nova Scotia, occupancy is increased significantly. I believe it's up to about 83%, which would be an increase of 5% to 10% from where we were at this time last year. So that market in particular has done very well and probably part of that is just the travel restrictions that have been in place in Atlantic Canada.
And then in New Brunswick we were able to complete a couple of significant deals in the quarter, which we think similar to what Steve mentioned about are some of the strategic deals we did in New Finland. We've started to see positive momentum in New Brunswick. We've got new, larger tenants in the building, which just as a result, we've got more traffic, which is leading to increased activity and just positive market chatter that seems has rolled out utilization rates are up in a lot of the Atlantic Canada markets. They're going to be back open for business completely in the next month or two. So we feel really good about the activity we're seeing, 180,000 square feet in Atlantic Canada, in Q2 alone. So we feel really good about how things are trending. And we expect that to continue in the balance of the year.
Matt Kornack
Okay. No, that's helpful. Just if I had to ask - and again, it's forecasting, so feel free to tell me you can't give me any information. But if you had to think about the trajectory of office sort of over the occupancy, I should say over the next - I guess through the end of 2022. And then on top of that if you give us some sense as to the quantum you'd expect assuming things kind of normalize on parking as well as the hotel contribution, just trying to understand the potential upside particularly in 2022 if the markets normalize.
Steve Hodgson
Okay, yeah, I can speak to that, Matt. I'll let Mike speak to parking because he was looking into that specifically. But with respect to occupancy, I think for the balance of this year, it's going to be difficult. We will have positive increases in occupancy, but it'll be difficult to make a significant headway towards our stabilized target of 90%. Just because at this point in the year, we may do deals but they may not commence and be an occupancy until next year. And so I would say that we - I would look to kind of mid to late 2022 to get back to where we feel this should stabilize and a significant part of that will be leasing up 2599 Speakman in the West End. It'll be leasing up New Finland and it'll be leasing up Kings Place and 570 Queen in New Brunswick, all of which we have a very good pipeline on and there may be some kind of very smaller nonstrategic properties that have lower occupancy that might be shed from the portfolio as part of our natural recycling program that may just assist with the denominator as well.
With respect to the hotel, as you would obviously know, 2020 was a very challenging year. The government wage subsidy programs were helpful, but not helpful enough to lead us to profitability in 2020. Having said that in 2021 year-to-date, June, we have effectively broken even and the wage subsidy program continues until the end of September. And our forecast for the balance of the year is about $0.5 million of NOI with an expectation that in 2022 we can kind of get back to about doubling that again and then we stabilize the hotel at around 1.3 to 1.4 million of NOI eventually, which I think for this hotel will be sooner than your downtown core large markets, because its demand really comes from local and regional, which in these recoveries tends to pick up sooner.
Michael Sheehan
And I'll just touch on the parking income. But I guess for context on a quarterly basis, we can see about a million dollars of parking revenue when we're kind of back to normal. And I think that would take into the balance of 2022 to happen. But that would be the upside there.
Matt Kornack
Okay. No, that's very helpful. I appreciate the color there. Last one for me on the balance sheet and refinancing. Can you maybe speak to what remains outstanding and discussions on that?
Steve Hodgson
For sure, there's three pieces of debt that are due throughout the rest of this year. We're in discussions with lenders in all three of those. They're all very, very good credit quality tenants with long weighted average lease terms. So we expect some decent pricing when we get that done. And we don't have any concerns. We're quite confident getting those done in advance of the maturity dates there.
Matt Kornack
Okay, great. Thanks all.
Steve Hodgson
No worries.
Operator
Thank you. [Operator Instructions] And your next question is from Jenny Ma of BMO Capital Markets.
Jenny Ma
Hi, good morning. Just a quick follow up on the question about the hotel. I want to make sure I've heard you guys correctly. We're looking for positive $0.5 million in NOI for the total of 2021. Is that correct?
Steve Hodgson
Yeah, because year-to-date is effectively zero NOI and the balance of the year will be about 0.5 million. Well, we're forecasting $0.5 million. As you know, a forecast at a hotel is a lot less reliable than a forecast of an office building. But no, that's - we feel pretty confident based on the return of demand that we're seeing and the forward bookings we have, particularly from the association groups and the motor coach groups that are local, and have had a few years of not being able to visit and are pretty eager to visit. And then there's also an urban plant shut down in St. John later this year that is a regularly scheduled cycle thing that brings in a lot of contractors. And we've secured a number of them at our hotel. So we feel pretty good about that forecast.
Jenny Ma
Okay, great. And so you mentioned that you expected to eventually get to sort of '13, '14 normalized level. But if I'm looking at sort of the past couple of years, pre-COVID, you're tracking closer to sort of in and around $2 million NOI in 2018 and '19. I'm just wondering how you account for that gap and what would have to happen for the hotel NOI to get back to those levels? Of course recognizing those are pre-pandemic levels and pretty good years economically.
Steve Hodgson
Yeah, I was probably misquoting because you're right. It's generally around 1.8 million of EBITDA. But I'm speaking to kind of after capital and capital reserves.
Jenny Ma
Okay, so from a from a top line standpoint, to go back to '18 and '19 assuming the world back to some semblance of that so that would be a fair assumption.
Steve Hodgson
Yeah, that's right. Yeah.
Jenny Ma
Okay. Great. I just want to speak to what your renewal spread would have been ex the two bars deals at Cabot Place.
Lindsay Stiles
Yeah, I think if we were to remove those deals Jenny, would be looking at a lot closer to a flat spread. Again, as we mentioned they're really strategic, wanting to get some growing companies into the building, generated a lot of positive momentum, I expect we'll be announcing some additional deals as a result of getting people in the building. So yeah, we'd be about flat quarter-over-quarter if we were to take those out.
Steve Hodgson
Yeah. And then - but even the flat numbers skewed a little bit by a couple of deals we did in Chicago that were just lower in the stack of the building. Because the way we do the spreads is based on what the building average is and so if it's lower in the stack, generally doesn't garner the same rents. So that's kind of what that skew was. The denominator was unfortunately so small that those types of things can skew that spread.
Jenny Ma
Okay, so to be clear, the expiring two, day one spread was flat for - on average, ex Cabot Place pieces.
Steve Hodgson
Yeah.
Jenny Ma
Okay, great. Now, I know you don't disclose the rent collection. That's - it's been pretty good. It was Q2 fairly consistent with Q1 in the past few quarters at the high - at the mid high 90% level, and minimal bad debt.
Steve Hodgson
Yes, that's right. So with respect to cash collections, it's effectively become a non issue for us. So we haven't continued to report on it. The amount of collections would have increased honestly, beyond 96%, closer to 100% each month now. So for us, we're kind of back to normal in terms of rent collections. With respect to the bad debts, there was a slight increase this quarter, but that was related to a tenant that still has not been able to reopen as a result of restrictions in place. And so what we did is, had an allowance for that amount, we still continue to work with them to collect it. But for context that's 0.2% of total revenue for the quarter as well. And we don't expect to increase when they go forward.
Jenny Ma
That 0.2% for everybody or just one specific tenant?
Steve Hodgson
In total.
Jenny Ma
In total, okay. The tenant happened to be, okay.
Steve Hodgson
Sorry, go ahead.
Jenny Ma
The tenant happened to be in Ontario. And are they like retail or?
Steve Hodgson
They are in Ontario, yeah and it would be retail based. So they're unable to open.
Jenny Ma
No surprises there. Okay. And then my final question is probably for Michael. There's a bit of a discussion on the US LIBOR transition. And I'm not sure what to make out of all that, if you could just sort of summarize it. Is the risk mostly on the rate to you guys and that's the unknown? Or are there other potential maybe qualitative triggers that might be at risk as well? Like, how should we think about that transition? I'm not sure if there's more discussion than is warranted for what for this might be to the REIT.
Michael Sheehan
I would say that it's in there as an abundance of caution. We want to be transparent that there is a transition. And there are certain elements that are unknown, and particularly this specific mechanism by which that transition happens. But from all of our conversations with lenders, we don't expect an impact to REITs on an all-in basis. And we're not concerned with transitioning from LIBOR. We do have a plan in place. And we've adhered to the fallback protocols, which is the mechanism by which that transition will happen. And that's what everyone else is doing as well, so there isn't any concern of qualitative or numerically at this point.
Jenny Ma
Okay, so basically, you're not ready to do it.
Michael Sheehan
Wouldn't quite say that, it's just helpful to have everyone understand the mechanism and some of the uncertainty that surrounds that transition.
Jenny Ma
Okay. All right. Thank you very much. I'll turn it back.
Michael Sheehan
Thanks, Jenny.
Steve Hodgson
Thank you.
Operator
Thank you. We have no further questions at this time. I will turn the call back over to Jennifer Pyper for any additional or closing remarks.
Jennifer Pyper
Thank you everyone for joining the Q2 2021 conference call for Slate Office REIT. Have a great day.
Operator
Thank you. This does conclude today's conference call. You may now disconnect.
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