Call Highlights. AP started the call down 3.3% (lagging CAD REITs and U.S. Office REITs by 3.2%) and finished the day down a similar 3.4%, lagging CAD REITs and U.S. Office peers by 1.4% (i.e., picked up 1.8% relative post call). Unsurprisingly, the call focused on occupancy and the Shopify sub-lease at The Well. AP reiterated expected ~91% leased occupancy by year-end, matching Q4/22A and 320bp above Q2/23A of 87.6% (Exhibit 7). Leasing decisions are taking longer (tenants are wary of a possible recession) but tenant tours are higher, as are leasing costs (Exhibit 8), which AP characterized as site-specific; we think that is part of it (other part = weak market). The reduced guidance was mostly on higher interest expense, which AP views as temporary given the UDC sale in mid-August will repay virtually all of its high-cost floating debt. Regarding Shopify (it continues to pay rent and is included in occupancy at The Well), Allied simply noted it is pleased with the progress and it is very likely the replacement tenant(s) will do a direct deal with Allied. Our sense (based on industry discussions) is that a deal for the entire space isn’t too far away, which should be positive for AP sentiment. Lastly, AP reiterated plans for mixed-use buildings on its vast land bank over time, including Office vs. our view of a market desire for almost exclusive residential construction (i.e., no Office).
Q2/23 Highlights & Developments
OUR TAKE: Net Neutral. AP FFOPU was slightly below internal forecast, while AFFOPU was slightly higher; same as in Q1/23. 2023 FFOPU/SSNOI/AFFOPU guidance was reduced to flat-to-low-single-digit y/y growth (i.e., 0%-2%) from low-to-mid previously (i.e. ~3%). We’re already in the flat-to-low range, as is consensus (-1.2%), so shouldn’t be too surprising.
Recurring FFOPU of $0.58 vs. $0.61 y/y was 1.5% above our $0.58 (on lower G&A) but ~2% below $0.60 consensus (range = $0.57-$0.62). The y/y FFOPU erosion slowed to -2.7% (vs. -4.1% in Q1/23; YTD = -3.4%).
UDC portfolio sale expected around August 16. Prior guidance was “closing by Q3/22”. See link to our original note (A Good Step Forward at a Good Price).
We chose “Net Neutral”. Positive = clarity on UDC portfolio closing date (important given 10.5x debt/EBITDA would move to ~8x by Q4/23). Neutral = Occupancy fell 80bp q/q (20bp light ex. PUD reclass). Slight Negative = downward guidance revision (albeit to Street expectations). AP is down 6% post Q1 results vs. +9% for Dream Office, +13% for U.S. Office REITs and flat for CAD REITs. We think UDC sale remains key.
UDC Sale details. It is worth noting (unclear in the original AP press release) the sales price was ~$1.46B given KDDI Corp is assuming a ~$100M lease liability at 250 Front. Tonight, AP broke down the use of proceeds ($740M to repay credit facility; Q3/23), $200M promissory note repayment (Dec/2023), ~$50M in mortgages in 2024, with the balance funding development through 2024. We didn’t see any update re: special distribution expected for holders as of Dec. 31/23.
High-level results. Disclosed AFFOPU fell 1.3% y/y (Q1 = fell 4.5%). Reported Leased and Economic occupancy fell 120p and 80bp to 87.6% and 87.4% (Q1 = -200bp and -140bp), with the 87.4% matching our forecast (~115,000sf of known departures by Q3/23 had an ~80bp impact). We est. the ~33k of RCA Building reclass into PUD raised occupancy by ~20bp. The “same-store” decline of ~100bp (i.e., including RCA reclassified portion; Q1 = ~90bp decline) compares to ~35bp for the broader market (Q1 = ~100bp). SANOI for Urban Office was +0.2% y/y vs. +0.2% in Q1/23. In-place rent growth grew 0.7% q/q to $23.51/sf (2.7% annualized; Q1 = 1% q/q or 4.3% annualized).
IFRS NAVPU increased $0.39 q/q (+0.8%) to $50.80 (Q1 = fell 1.1% q/q), well above our $33.50 and ~$38.00 cons. FV gain of ~$30M vs. $72M loss q/q, largely attributable to the UDC portfolio sale above IFRS NAV (~$100M), offset by development losses (at Adelaide/Duncan) and select asset write-downs. Overall IFRS cap rate fell 1bp q/q to 4.61% (Q1 = flat q/q) vs. our ~5.4%. Potential incremental density fell 0.1Msf q/q to 12.7Msf (vs. 14.5Msf current GLA).
Operational update. AP tenant tours were +20% q/q and 13% y/y to 292, leasing 0.7Msf vs. 0.4Msf q/q and 0.7Msf in Q2/22. Tenant retention was 52% vs. 47% q/q, still well below historical 70%+. The lease renewal spread was 7.6% on yr.1 (Q1 = 11.4%) and 13.7% over lease term (Q1 = 18.2%). Disclosed NER on Q2 leasing was $15.50 (incl. ~$6.75 of lease cost) vs. $19.50 q/q (~$4.00). We est. near-term market rent was ~2.6% higher q/q (Q1 = ~0.5% lower q/q). Sublet (as a % of portfolio) was +10bp q/q to 5.8% (Q1 = +240bp q/q); although each market was lower, except Toronto. We estimate sub-let space as a % of total vacancy = 31% vs. 33% q/q.
Leverage is largely flat and liquidity is lower q/q; Debt/GBV rose 40bp q/q to 36.9% (Q1 = +90bp q/q) and Net Debt/EBITDA was flat at 10.5x (Q1 = rose 0.7x q/q). PUD as a % of GBV fell 10bp to 11.4% q/q on the Well incremental reclass to rental portfolio (Q1 = fell 110bp). Target development yields at the midpoint were flat, aside from 700 Saint Hubert falling 35bp at the midpoint to 3.25%. Development completion on 700 Saint Hubert moved from Q3/23 to Q1/24. Note, AP has $345M of total debt maturities in 2023 (8% of total) and $298M of remaining development (Q1 = $351) spend on ongoing developments.