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Higher big city leasing rates buoy RioCan’s financial outlook

Rising interest rates and changing economic conditions are causing a slowdown in RioCan Real Esta...

Rising interest rates and changing economic conditions are causing a slowdown in RioCan Real Estate Investment Trust’s (REI-UN-T) efforts to divest $2 billion of its retail assets across the country, CEO Ed Sonshine said on a Q3 financial results conference call. 

IMAGE: The Frontier is Phase I of a residential development by RioCan Living near Ottawa's Gloucester Silver City shopping centre. (Rendering courtesy RioCan)

The Frontier is Phase I of a residential development by RioCan Living near Ottawa’s Gloucester Silver City shopping centre. (Rendering courtesy RioCan)

However, those same conditions are boosting RioCan’s major markets strategy to increase its office and mixed-use holdings, and intensify existing retail properties through residential developments.

“While market forces are slightly slowing down one component of our existing strategy,” Sonshine told analysts and shareholders during the call, “they are significantly elevating and validating our creation of office and residential assets. The office market in the GTA is quite simply better than it has ever been.”

While discussing several office projects RioCan is involved with in Toronto – such as The Well and King Portland Centre – Sonshine said market rents in the GTA have seen “double-digit” increases during the past year.

The same goes for rental housing.

Housing rents hit $4 per square foot

“Rents of $4 per square foot per month are becoming relatively common in the GTA in the very few new, purpose-built rental buildings that are coming on stream,” he said. “We are quite optimistic the rents we will achieve will be well above our pro formas and result in significant value creation.”

On the divestment front, RioCan has executed 10 deals for 65 properties since announcing plans to sell $2 billion worth of retail holdings in secondary and tertiary markets. That represents about $1.3 billion, or 63 per cent of its target, at an overall cap rate of 6.49 per cent. RioCan is focusing its future strategy on Canada’s six largest urban markets: Toronto, Vancouver, Montreal, Ottawa, Calgary and Edmonton.

While the pace of sales has slowed, Sonshine said RioCan still hopes to have substantially completed the divestments by the end of 2019. The REIT hopes to move another $200 million worth of assets in Q4.

“The $1.5 billion is a number I’d like to see us at and I think we’ll come pretty close to it, if we don’t get there, by the end of 2018, i.e. over the next two months. We’ve got a lot of things on the hop, though they are not quite signed yet.”

He said many potential buyers are smaller private investors, or groups of private investors who will rely on leverage “to make these things be great deals for them.”

Three factors slow divestments

In addition to rising interest rates – and banks “tamping back a little” on the amounts they will lend for such purchases – Sonshine identified two other factors.

“There’s a lot of secondary market for sale. We are our worst overhang,” he explained. “When we’re talking about selling a billion and a half in just over a year in the secondary markets in this country, that is a lot of assets. So I think that is the second reason.”

RioCan’s own financial results illustrated the third reason. “The lack of growth in secondary markets is maybe becoming a little more apparent to everybody. I think you can see it in some of our numbers,” he said, noting the trend could “further narrow” the number of potential buyers.

RioCan’s increase in same-property NOI for the quarter, compared to 2017, was just 1.6 per cent, impacted by the results from these types of holdings. Sonshine said anchor tenant lease renewals (it signed 10 such leases in the quarter), had a big impact on that figure but called it “a one-time thing.”

With several potential sales in the offing, Sonshine also said RioCan was willing to accept slightly lower lease growth to lock up tenants and stabilize the assets.

He emphasized RioCan is in no rush to divest.

“Quite frankly, we’re not conducting a fire sale and if we can’t get a price we’re happy with for a property, we’ll take it off the market for a while.”

New revenues; affordable housing

On the development side, RioCan is about to see significant new income from several of the projects it has been working on for the past year or more.

Phase I of the Frontier residential development in Ottawa will soon be leasing, as well as eCentral in downtown Toronto. Combined, the projects will provide 700 income units.

The Kingly condos, part of Riocan and Allied Properties REIT’s (AP-UN-T) King Portland Centre mixed-use development in Toronto, are slated to begin occupancy in Q2 2019. 

Sonshine also opened the door to RioCan being involved in affordable housing in the GTA, though there are no commitments or agreements in place. He acknowledged rapidly rising costs have had a serious impact on many people’s ability to afford housing.

“I believe it is important for society that more affordable rental housing be created in the GTA for those young, and older people, who are not investment bankers or cannabis entrepreneurs,” Sonshine said, only partially tongue-in-cheek.

“We have existing shopping centres that could be very suitable for that type of rental development and we are working on a construction design that would address the affordable side of the market.”

Sonshine said Toronto Mayor John Tory has an “ambitious program” to develop affordable housing, though he wants all three levels of government more actively involved. Noting about 25 per cent of housing development costs are government fees, he said any reduction in that burden would also be helpful.

“We’re not really looking for anybody to give us any money to build affordable housing, we want them maybe to take a little less on the way through to achieve this social good,” he said. “We’d like to produce a fair amount of it.”

Other Q3 notes, figures

Sonshine said RioCan is not considering raising its distributions at this point, noting the current yield is about six per cent and with a pipeline of developments both on the go and planned, “our capital is very precious”.

Some other key notes and figures from RioCan’s Q3 report:

* Net income from continuing operations in the quarter was $128.9 million, down 28.5 per cent from Q3 2017. Net income per unit was $0.41, a 25.5 per cent decrease year-over-year; 

* RioCan now derives about 84 per cent of its revenues from the six major markets, and the GTA accounts for 45.5 per cent of that total. The goal is for 90 per cent from the major markets;

* The REIT has a 7.79 debt to adjusted EBITDA ratio;

* Chief operating officer Jonathan Gitlin said RioCan predicts two to three per cent same-property revenue growth during the next 12 months;

* RioCan expects 818,00 square feet of new, urban income-producing space to come on stream by the end of 2018 (at its share).

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