Slate Grocery REIT (OTC:SRRTF) Q1 2023 Earnings Conference Call May 4, 2023 9:00 AM ET
Company Participants
Paul Wolanski – SVP National Sales and IR
Blair Welch – Chief Executive Officer
Allen Gordon – Senior Vice President
Andrew Agatep – Chief Financial Officer
Connor O’Brien – Managing Director
Braden Lyons – Vice President
Conference Call Participants
Brad Sturges – Raymond James
Gaurav Mathur – iA Capital Markets
Munish Garg – Laurentian Bank Securities
Sairam Srinivas – Cormark Securities
Operator
Good morning, ladies and gentlemen, and welcome to the Slate Grocery REIT First Quarter 2023 Financial Results Conference Call. [Operator Instructions] This call is being recorded on Thursday, May 4, 2023.
And I would now like to turn the conference call over to Mr. Paul Wolanski. Please go ahead.
Paul Wolanski
Thank you, operator, and good morning, everyone. Welcome to the Q1 2023 conference call for Slate Grocery REIT. I’m joined this morning by Blair Welch, Chief Executive Officer; Andrew Agatep, Chief Financial Officer; Connor O’Brien, Managing Director; Allen Gordon, Senior Vice President; and Braden Lyons, Vice President. 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 Grocery REIT’s website to access all of the REIT’s financial disclosures, including our Q1 2023 investor update, which is now available.
I will now hand over the call to Blair Welch for opening remarks.
Blair Welch
Thanks, Paul. Our grocery-anchored real estate portfolio continues to demonstrate strong performance in today’s high interest rate and inflationary environment. Market fundamentals in the grocery-anchored real estate sector are favorable. The availability of neighborhood retail space is at historic lows in the U.S. and the cost of construction remains high. These conditions make our tenancies sticky. The cost for our tenants to relocate or build new is prohibitive. This dynamic also give landlords leverage to increase asking rents. For Slate Grocery REIT, the weighted average rent across our portfolio is well below market at $12.24 per square foot. We are well positioned to grow through steady increases to our below-market rents, which will, in turn, drive sustained valuation increases for our business.
Our leasing performance in Q1 demonstrates the embedded growth in our portfolio. We completed 590,000 square feet of total leasing at attractive spreads that drove up occupancy and revenue growth. New deals were completed at a 17.1% above comparable average in-place rent and renewals at 8.4% above expiring rent. Our new leasing drove a 50 basis point occupancy gain from the 2022 year-end. Occupancy at the close of the quarter was 93.7%.
As a result of our strong leasing momentum, same property net operating income increased by 3% year-over-year. We also enhanced the REIT’s financial flexibility and balance sheet to create liquidity for continued accretive growth. In Q1, the REIT closed a $56 million mortgage loan with a 2033 maturity. We used net proceeds from the loan to pay down the REIT’s nearest term debt maturity in 2023. Post refinancing, the REIT has no remaining debt maturities in 2023.
We have also repurchased over 240,000 units at a 30% discount to the REIT’s net asset value, which provides the REIT with additional liquidity. We believe the disruption and dislocation we are seeing in the broader market will create attractive buying opportunities for the REIT. We continue to underwrite well-located grocery real estate anchored by strong grocers at below-market rents. The REIT’s partnership with Slate North American Essential Fund provides a source of private equity capital in addition to the REIT’s public funding strategies. This allows us to be nimble in today’s environment.
We are well positioned for growth, and we’ll continue to allocate capital strategically in ways that are accretive for the REIT. On behalf of Slate Grocery REIT team and the Board, I’d like to thank the investor community for their continued confidence and support.
I will now hand it over for questions.
Question-and-Answer Session
Operator
[Operator Instructions] And your first question comes from Mr. Brad Sturges from Raymond James.
Brad Sturges
Starting on the IFRS value change there. You made, I guess, a small adjustment. Just can you walk through what was driving the change on the IFRS value? Is that tied to internal assumptions? Or are you tying that to some transactions you see in the market?
Blair Welch
Yes. It’s a little bit of both, Brad. I think that we feel really, really confident in our valuation, and it was a little change. But we have below-market rents, and when we compare our rents to our peers, we are below them. And we also feel that we have a conservative cap rate or, put another way, we are in a positive leverage territory at our IFRS value that I think rewards investors.
We feel comfortable that our assets would trade at that value. And I think as a management team, that’s what we try and always do. Really, do we think we could value our portfolio this, and we think we’re being fair? I know in the market, it’s challenging right now, but I think the team has done a really good job of showing that we can finance assets like we did with the lifeco financing of $56 million and where that was done in the mid-5s percent. I think it all kind of holds together.
So we don’t anticipate significant changes going forward because of our below-market rents and how we’re seeing rental growth.
Blair Welch
Okay. So I guess, the adjustments were, call it, broad-based across the portfolio, but it sounds like you’re starting to see some pickup in transaction activity that allowed for some of those sort of tweaks as well.
Blair Welch
Yes. I mean, obviously, we do also use third-party appraisals, so it’s like there’s a bunch of data points. I would say investment activity has been subdued, but there are some. But I think what we try and do is we see where financing is. We see what’s happening. Those there haven’t been many. And I think perhaps in the tail of 2023, given refinancings, there might be more visibility. But I think what we want to do is really focus on the cash flow this company throws out in the below-market rents and the occupancy. So I think that’s how we look at it. We kind of put it all together, work with appraisers, work with our auditors. And just, we’re in the market all the time, so it’s just trying to reflect that in our IFRS NAV.
Brad Sturges
Okay. Just maybe switching gears to — on the leasing side, obviously, a good start to the year in terms of the renewal and the new leasing spreads that you’re achieving. How should we think about the type of spreads you can get for what’s coming — what’s rolling over for the rest of the year? And I guess my timing question to that is, for the grocery-anchored renewals, has there been much change in terms of the TI packages required for a longer-term deal?
Allen Gordon
No, we’re not seeing much change on what is required from the grocery boxes. We see things being pretty consistent moving forward on our small shop space as well.
Blair Welch
We would really love to have more space to lease. Let’s just say that.
Brad Sturges
And in terms of spreads you’re expecting, like would we — could we see kind of similar kind of blended spreads for the rest of the year? Or was there something specific in Q1 that was driving some of the spreads you realized?
Allen Gordon
I think we see those remaining pretty consistent.
Andrew Agatep
Yes. Historically, we’ve had these spreads within this range, so it’s nothing unusual, 6% to 10% since inception. So just thinking about having limited availability in the market and just demand for our spaces, I think we’re going to continue to drive positive spreads in the future.
Operator
And your next question comes from — I do apologize for the pronunciation — Gaurav Mathur from iA Capital Markets.
Gaurav Mathur
Thank you, and good morning, everyone. Just on the tenant base, with the ongoing Albertsons-Kroger merger, do you foresee any store reductions across the portfolio?
Blair Welch
I’ll take a stab, and I’ll let the people on the ground answer it probably more correct than I can. But when we look at this merger across the entire space, we don’t see it really impacting real estate values for a bunch of reasons I can go into. But moreover, we look at it as Kroger and Albertsons are going to be forced to sell assets in markets that they like, but that’s a competition thing. And I think what they’re really trying to do is protect one of their competitors to getting access to these locations at a cheaper rent or cheaper price where they can be price competitive in the grocery business. So they’re actually playing defense. It’s not necessarily — and I’m not trying to [dig] the question, Gaurav, but it’s really those — that merger are forced to sell some assets, and there’s not that many. And they don’t want to give them away to a competitor. So that — there hasn’t been much chatter of late. They have until 2024, like next year, so there’s still some time. And we are still renewing leases, and it’s business as usual with both tenants. But I’ll pass it on to the team for some more color there.
Connor O’Brien
In terms of kind of the SGR total exposure, it’s quite limited. We did an analysis as soon as the announcement was made. And there are roughly 15 stores where there’s Albertson and a Kroger overlap within a 5-mile radius, which is quite substantial distance in terms of catchment area for the competition. But most importantly, what we really see limiting our downside is the low in-place rents that these tenants have. So if they’re determining which center they’re going to stay in regarding closure, they’re going to look at what rent they’re paying.
And the average rent for both the Kroger and Albertsons with this kind of overlap is around $8 per square foot. So we find ourselves really comfortable with that rent basis and give us a lot of optionality and negotiating power with these tenants going forward.
Gaurav Mathur
Okay. Great. And then just switching gears on capital allocation. We saw the NCIB use, which added to the cash flows. Just how you’re thinking about capital allocation going forward between the NCIB acquisitions and the development pipeline?
Blair Welch
Yes. I mean I think that it’s something that we are continuously reviewing whether we buy an asset, redevelop an existing asset or use liquidity to buy back our own stock if we think it’s at a discount. And we’re always talking to our Board about all 3 of those because I think the market is always changing, and we’re in the market looking to buy, and we’re in the market developing our assets. And we’re trying to create the best return for all unitholders. So I would say it’s probably going to be a bit of both or all 3, but it’s really more fluid than that. If we can buy back — there was a question from Brad, which is a good one, on our IFRS NAV. I feel 100% confident in that value, at our rents. And if we’re trading at a discount to that, that’s pretty compelling because we have a good team. We know all the assets. So if you can get a good return, that might be a good investment. So it’s something we’re always talking to our Board about, Gaurav, and it will change quarter-to-quarter.
Gaurav Mathur
Okay. Great. And just staying on the cash flow theme. We also noticed the uptick in the AFFO payout ratio. Is there a certain range which you’re targeting for 2023?
Andrew Agatep
Yes. So a slight uptick in our payout ratio just because we had dispositions last quarter, which is just fully baked into this quarter. So we have liquidity there, which we look to deploy later in the year. In terms of where we see payout ratio heading towards, it’s positive. There is a lot of leasing activity that we see, which is good. So occupancy is expected to tick up. But in turn, we think the payout ratio is probably going to go down.
Gaurav Mathur
Okay. But you wouldn’t be comfortable in giving some sort of guidance on that at this time.
Andrew Agatep
Yes. We’re targeting around mid-95.
Gaurav Mathur
Okay. Okay. Perfect. And just on your comment on occupancy, any guidance towards where you think occupancy will be by the end of the year?
Blair Welch
Higher. I think — I mean, we — the team did a really good job of buying assets that had low occupancy compared to the market, and that was a strategy. And now we’re — in some of the specific portfolios, the team’s done an excellent job increasing on occupancy, which gives portfolio-wide occupancy gains. I think we’ll continue to gravitate towards the mid-90s over time just because of the demand. But then — however, like we’ve never seen a leasing market this strong. And we want it to last forever, but it usually never does. But I would say we’re pretty confident that it will continue to uptick and we’re trying to get to that mid-90 range as quickly as possible.
Operator
And your last question comes from Munish Garg from Laurentian Bank Securities.
Munish Garg
On the mark to market in the portfolio, I was just wondering if you could provide some color on how do you see in terms of time lines to realize that mark to market.
Blair Welch
Do you mean the discount between our stock price and our NAV? Or what do you mean specifically?
Munish Garg
No, I mean the rents because you mentioned the rents are significantly below the market rents.
Blair Welch
Sure, sure. I mean I think that we feel we’re probably plus or minus half of market rents and for new builds and everything else. So I think, over time, you get there. And I think what we like to do, and you stated that, historically, we’ve achieved 6% to 10% rental spreads. And I think we’re confident that, that will continue. And what we like to do is we like to get lifts from our anchors. And then all the shop space wants to be around that activity that the grocery anchored provides, and you can get increased spreads from them. So I think that blends out to that 6% to 10%. And what we’re seeing, and I think we talked about this last time, in-line anchored — anchored in-line space had its traditional tenants. But now we’re seeing tenants come from B and C enclosed malls that want to be around this activity.
We’re also seeing tenants that were typically — wanted to be in their own pad in the parking field. Realizing that, that costs too much, so they’re coming in line or into the strip. That demand is exceptional for us. So I think we’re confident that we’ll be able to achieve leasing spreads. It’s going to take some time.
But if you kind of run it at 6% to 10% on a year-over-year basis, that’s how we’ll get there. So I think what it does is it shows revenue growth. Are we going to get to market anytime soon? No. But it’s a great durability of cash flow with growth. And I think that defensive nature really is something that Slate Grocery has and some of our peers don’t.
Munish Garg
Okay. Great. And just one more for me. In terms of supply for grocery anchored, what sort of scenarios are you guys seeing for 2023 in your markets?
Blair Welch
Like new supply of competitive space coming in?
Munish Garg
Yes.
Blair Welch
Yes. I mean, again, I’ll let the team jump in, but it’s at historic lows. I mean there’s not a lot of new supply. Where you are seeing grocery done would be perhaps in new subdivisions and growing towns in the Southeast, another town, I’m sure you recognize. However, those would be done at higher market rents. And what we like to do is buy the existing infill at low market rents because, I mean, it’s — the sales don’t change, and it’s a tight margin business, so the grocer is very focused on cost, which rents is one. So that stickiness is kind of how we focus. So there’s not a lot of new space. Then maybe a question you would an answer, well, what about bankruptcies and is there existing space that’s vacant. And as we said in this call, that’s all being taken up.
Like the health of the retail sector, like there’s no new build. Big kind of competitors of existing boxes has kind of been backfilled. So that’s what’s creating this occupancy uptick and rental increases in our portfolio.
Operator
And your last question comes from Sairam Srinivas from Cormark Securities.
Sairam Srinivas
Blair, thanks for the comments on the supply. I just want to kind of double down on that one. When you look at the reasons for the [supply] coming up, obviously, one, there is not much open space available. But would you say it’s only construction cost versus interest rates? Like what’s driving the lack of supply in those markets?
Blair Welch
Well, I think it’s all the above. And I just really want to focus at we own 100% grocery-anchored real estate. So when someone says the word retail, that’s a big word and have a bunch of different assets in that. We focus on grocery. It’s essential good, and in good times and bad, people go to the grocery store. And the grocery stores fulfill omni-channel distribution, so either go to the store. You click and collect or they deliver it to your home from that store. So that activity is different than a lot of other retail. What I would say is the cost to construct new can be prohibitive for new tenants. So they like to get into cheaper space because this is, simply put, if there was an empty field across from our grocery store or an empty box and they wanted to build a new store, pay market, the grocer would have to pay double the rent from one of the Slate Grocery REIT sites. So simple math, would they get double the sales moving across the street? And the answer typically is no. And in a tight margin business, they really — that’s why they like focusing on the cheap rents.
So costs are prohibitive to construct. We feel that we’re probably at — when you include fit-out and land, less than half of replacement cost for a comparable center, which is good. And then from a financing side, we can finance our assets through traditional means, either banks or lifecos. But the tenants are — some of the tenants have to deal with regional banks and other things to fund their businesses and we are watching that. So like construction financing is a little bit tighter, but we’re really happy we’re in the grocery space, not in some of the other sectors. It’s because we are seeing liquidity. We are seeing financing and our tenants are healthy. But yes, it’s cost. It’s availability of capital for construction. It’s what’s going to happen to other types of real estate. All that’s being factored in, but we’re feeling good and stable about our assets.
Sairam Srinivas
Other questions have been answered, so going back.
Operator
And there are no further questions at this time. Mr. Paul Wolanski, you may proceed.
Paul Wolanski
Thank you, everyone, for joining the Q1 2023 conference call for Slate Grocery REIT. Have a great day.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you very much for participating and ask that you please disconnect your lines. Have a great day.
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