First Capital Realty is about to go through 12 months of intense transformation in both its structure and in its investment philosophy, says president and CEO Adam Paul.
Speaking to analysts, investors and other interested participants Wednesday during First Capital’s Q4 2018 earnings call, Paul outlined both the company’s plan to convert from a corporation to a REIT structure, and its strategy to focus even more tightly on being a “super-urban” investor.
“Becoming a REIT will provide us with a number of advantages,” Paul said, noting that in its present form First Capital (FCR-T) doesn’t have access to REIT indices, REIT ETFs or REIT-dedicated investment funds. “With our existing corporate structure we don’t qualify for all of these, so this capital would be incremental.
“We believe this will initially represent several million shares of additional demand at the time or near the time we convert.
“Second, the conversion to a REIT will enhance comparability to our peers, virtually all of which are REITS. And finally we will be able to deliver the benefits of our business to our investors in a more efficient manner.”
In response to questions about potential taxation benefits, Paul said “the efficiency is not limited to tax, there are a lot of variables.”
Increase shareholder value
Executive vice-president and CFO Kay Brekken focused on the potential impact for First Capital’s shareholders and partners.
“Our intention is to convert within the next 12 months and we do believe, for all the reasons Adam has previously mentioned, that a REIT conversion will have a positive effect on shareholder value,” she said.
First Capital’s board has yet to vote on the decision, because management still must finalize the process. Brekken said there are numerous paths to becoming a REIT. The board needs a “detailed plan” before it can grant approval, though Brekken said it “is in full support of this.”
“We do not expect any of the potential structures we are considering to have an impact on our current liquidity, or our leverage levels, or to have a negative impact on any of our current debtholders.”
The conversion will also require approval from shareholders.
“Super-urban” portfolio strategy
As First Capital is transforming its structure, the company will also be refining where it will make future investments. The company has traditionally leaned heavily on urban population density in its investment decisions. That metric has been tightened further, Paul said, and First Capital is already executing on the new strategy.
“We will increase our investment in portfolio weighting in high-quality, super-urban mixed-use properties focused on large positions in targeted high-growth neighbourhoods,” he said, laying out the three key factors in this decision.
“One, increasing our average population density. Two, surfacing value in and expanding our incremental density pipeline and three, making new investments which align with our strategy with capital from strategic dispositions that in some cases will also improve our market positions.”
First Capital’s current portfolio of 166 mainly retail properties across Canada (comprising about 24 million square feet) is situated in neighbourhoods with an average population of more than 250,000 within a five-kilometre radius. That will soon be a population density of 300,000 within five kilometres.
Across North America, no other real estate investor comes close, Paul said.
“Currently our closest North American peer on this metric is Federal Realty, whose population density is 160,000 people. Our goal is to increase ours to more than 300,000 within the next 24 months.”
No longer is investing just about being in large urban markets. It’s about being in the most densely-populated neighbourhoods in those major urban markets.
Divest up to 10 per cent of portfolio
Part of this strategy will be to divest properties which don’t meet the specifications of the new strategy, and Paul used White Oaks shipping centre in Abbotsford, B.C. as an example. Its population within five kilometres is about 110,000 and First Capital doesn’t see it as a site where it can add value through future development.
So, with co-owner Bentall Kennedy, it sold the mall for $91 million in December at a “mid-five” cap rate. Other such properties will also be sold outright.
First Capital will also invite offers for 50 per cent non-managing ownership of “certain stable but growing properties” and Paul said institutional investors will be targeted for these partnerships.
In all, these properties represent about 10 per cent of the current portfolio.
These sales will be one of two main funding sources for execution of the new strategy, be it investing in intensification or redevelopments of current assets, or future acquisitions.
“We are not planning to raise new equity capital to fund our real estate investments,” he said. “Instead the execution of our strategy will be financed through strategic dispositions and to a lesser extent retained operating cash flow.”
$640M “swing” in portfolio during 2018
The transformation might take a couple of years, but based on its activity during 2018, First Capital has already made significant headway.
It invested more than $390 million in property acquisition and development during the year, and made $250 million in dispositions.
“So, a $640-million swing in the composition in our portfolio before factoring in $290 million of urban development projects that we completed,” Paul said.
All of this activity was undertaken using the company’s updated population metrics — the average population density within five kilometres of the assets it purchased or developed is in excess of 500,000, while the density surrounding properties it sold is less than 150,000.
The strategy also means moving more toward diversified assets. Retail will remain its dominant asset class, but Paul said First Capital will focus first on the neighbourhood itself, then on the asset class in making investment decisions.
“I should be clear on this. The evolved strategy . . . we said it will end up diversifying the asset class to some degree, but that is not the primary objective,” he explained. “We are interested in the highest-quality positions we can make in the most attractive neighbourhoods.”
Thus, there is no target to own a certain percentage of, say, office or multi-res in its portfolio.
First Capital remains fan of retail
“Retail has a bit of a negative connotation to it, but that is not what we feel in our business or on the ground. The results year after year have demonstrated that.
“We actually love retail still and we see a lot of opportunity in retail. But we see great opportunity combining that retail with other uses to create dominant positions in high-growth neighbourhoods.”
Finally, Paul took paints to note the assets First Capital plans to sell are “not bad assets”, they simply don’t meet its new criteria. As such, he said there is no urgency to the divestments, and the process is expected to take a couple of years to complete.
“We are narrowing the boundaries of what defines urban to us, and doubling down on the fantastic portfolio that we have built over many years,” he said. “However, we believe real estate is a long-term proposition.
“And our plan will be carried out with an opportunistic approach, as a marathon not a sprint.”