Call highlights. AP was -1.3% vs. CAD REIT sector and -2.5% vs. U.S. Office REITs pre-call and ended -2.2% and -2.5% respectively post call. One unique element was the significant technical difficulty during the call. In terms of capital allocation, AP reiterated planning for strategic JVs for several years now and is very confident on its ability to execute on asset sales at attractive valuations. When prompted on willingess to sell, AP noted 3 criteria: 1) a good trade, 2) provides ability to pay-down debt, 3) surfaces a partner with complimentary capabilities. We do believe AP higher-than-normal leverage (Exhibit 3) on development completions ahead of a potential recession is a cause of investor concern, while we suspect any transaction pricing would exceed current AP implied $390/sf. Operationally, the bigger news was the non-renewal of a Cloud tenant at 250 Front in Q4/22 comprising 3.3% of AP revenue (i.e., largest tenant). AP will replace the hyperscale tenant with interconnection space (better use) at a potential 20%-25% higher rent (close to leasing 1/3rd of the pending vacancy now). While the higher rent and usage sound good, we think the unit price negatively reacted to potential NOI downtime (in combo with recession concerns). Our revised estimates have the ~67k sf leased by Q4/23.
Q3/22 Highlights & Developments
OUR TAKE: Neutral. AP results met internal forecast, with 2022 guidance intact. That said, we felt the disclosed outlook was more cautious (i.e., omission of expected propelling of NAVPU growth in 2022, citing growing macro-uncertainty impacting ability to hit prior 94% target occupancy in 2022).
Recurring FFOPU of $0.606 (Q2 = $0.605) was flat q/q and -2.4% y/y (Q3/21=$0.621), in line with our $0.612 and consensus $0.606 (range = $0.58-$0.62). We do note capitalized interest and G&A were +$2M and flat q/q. Disclosed AFFOPU was +1.3% y/y (Q2/22A = +1.9%; YTD = 3.3%). Leased and Economic occupancy were flat q/q (-20bp and +10bp) to 90.7% and 89.6%, in line with flat q/q market results but below our +120bp expectation. SANOI fell 0.6% (Q2 = +1.2%; YTD = +0.5%). Lease renewal spread was 7.3% on yr.1 vs. expiring (Q2 = 5.7%; YTD = 7.5%) and +16.6% over lease term (Q2 = +10.1%). We est. AP 2023E market rent est. was flat q/q, consistent with Q2. IFRS NAVPU fell $0.10 q/q to $51.10 (Q2 = +0.5% q/q) and in-place rent growth accelerated to 1.1% q/q (Q2 = +0.6%) and +3.8% y/y to $25.56/sf.
Possible call questions: Is prior “soft-guidance” of mid- to high-single-digit growth in 2023 still achievable and how delayed could the 94% target occupancy be (FYI, our Q4/22E and Q4/23E = 92.6% and 92.4% vs. Q3/22A of 89.6%). Any new tech tenant leasing trends surfacing? Are tenants seeking higher TI packages to execute leases? What private market transaction trends are you seeing and would you consider a more active asset disposition program to lower debt?
IFRS NAVPU of $51.10 is 16% above us and consensus (both ~$44.00) with a FV loss of $18M vs. $15M gain q/q mainly on a 42bp higher cap rate in Calgary, slightly offset by 1bp-2bp decline in Toronto/Kitchener (likely on the partial transfer of The Well) and UDC. Overall IFRS cap rate intact q/q at 4.58% (Q2 = -1bp) vs. our ~5.0%. AP did record a $16M residential inventory impairment (KING Toronto). Potential incremental density was flat q/q at 10Msf (vs. 15.0Msf current GLA; Q2 = flat q/q). We continue to believe the strong urban locations + residential density upside will protect against significant cap rate expansion (see last week’s Residential Note)
UDC Update: Leased occupancy was +160bp q/q to 99.5% (Q2 = +300bp to 97.9%). Ancillary revenue was flat q/q at $7.3M or 11.7% of Normalized LQA UDC NOI (Q2 = +$0.2M q/q), still well below the ~15% norm in the US.
Operational update. We were a bit disappointed with flat q/q occupancy, albeit perhaps understandable in the context of the market. AP noted lower lease renewals in Montreal and Toronto as an obstacle to gains, even with accelerated touring activity (i.e., leasing decision duration is rising). SANOI fell 0.6% y/y (Q2 = +0.6%) as strong 4.4% growth in UDCs (Q2 = +2.4%) was more than offset by a 1.7% decline in Urban Office (Q2 = +0.2%). NER as % of face rent = 68% and 90% for New and Renewal leases vs. 75% and 90% in Q2. Sublet (as a % of total portfolio) was flat q/q at 2.4% (Q2 = -10bp). We estimate sub-let space as a % of total vacancy = 26% vs. 21% q/q. Overall Toronto occupancy fell 80bp q/q to 90.6% (Q2 = -130bp). Residential occupancy at Telus Sky was +10% q/q to 74%.
Leverage flattish q/q. Debt/GBV was +40bp q/q to 34.3% (Q2 = +60bp) and Net Debt/EBITDA was flat q/q at 9.6x (Q2 = +0.2x). PUD as a % of GBV fell 70bp to 12.1% (Q2 = +200bp) q/q. AP noted $356M of liquidity (-$109M q/q; all development). AP sold one asset for $26M in Q3 (100 Lombard in Toronto), with $35M still classified as HFS (one property in Montreal). Target development yields at The Well fell 5bp at midpoint to 5.2% (Q2 = flat), while 108 East 5th Avenue (Vancouver) fell 10bp to 4.2% (Q2 = flat); Adelaide/Duncan and QRC West Phase intact at 5.1% and 5.05% respectively (Q2 = -15bp; -20bp); Only two development completions: Adelaide & Duncan and Breithaupt Phase III were pushed back by one quarter.