Webinar: Investing in Essential-Based Retail with Skyline Retail REIT
Transcript
[00:00:10] Mustafa Bukhari:
Good day everyone. My name is Mustafa Bukhari, National Team Lead here at Skyline where I head up the sales and distribution channels. Today, we have our new Retail REIT Fund President, Craig Leslie, who has recently stepped into the role, having previously been Vice President of the Fund, with Gord Driedger moving on to the Retail REIT board. Craig was previously with one of the major publicly-traded REITs, where he was responsible for their national grocery-anchored portfolio and various enclosed malls. Prior to that, he worked with one of the world’s largest accounting firms, having originally trained and operated on the appraisals and capital markets side with CBRE and Cushman & Wakefield.
So, tell me, Craig, can you describe your fund for those who are not familiar with the Retail REIT?
[00:01:05] Craig Leslie:
Yeah, certainly. Retail means different things to different people. When many people think about retail, they think of the headlines in the news about the latest failed retailer or maybe the mall apocalypse, where we’re seeing obsolete malls being demolished to make way for condos.
The REIT doesn’t own any enclosed malls, nor does it have any significant exposure to the retailers typically associated with those malls. Our typical tenants are not ones that are heavily dependent on discretionary spending, but rather the retailers that are focused on providing essential goods and services to local communities. What we own are grocery and pharmacy-anchored outdoor assets in smaller secondary and tertiary markets across the country, with a rental income derived from some of the strongest retailers in Canada.
[00:02:01] Mustafa Bukhari:
Given our tenant profile, how does the recent economic uncertainty impact the REIT?
[00:02:09] Craig Leslie:
When you look at the latest inflation data, it’s clear that higher rates for longer environment is definitely resulting in people experiencing increased financial pressure, particularly as you see more people see their original fixed mortgage terms coming up for renewal.
As far as that impacts us, though, I mentioned grocery and pharmacy, but at a wider level, the portfolio is filled with tenants that really thrive in those periods where the consumer is tightening their belt. Those tenants are, they’re doctors, they’re dentists, they’re banks, dollar stores. What that means is the REIT enjoys strong, stable cash flows with very low volatility as there’s very little fluctuation in tenant demand, regardless of where we are in the economic cycle. As a result, we’re very much insulated from any economic uncertainty that may happen because essential retail is just that: it is essential.
[00:03:05] Mustafa Bukhari:
I have to say, Craig, your historical performance has been stellar since inception. What is driving performance in the REIT these days?
[00:03:14] Craig Leslie:
These days, the overarching one I don’t think will be to anybody’s surprise, it’s population growth. Canada has seen a population boom. We all know that immigration is at an all-time high and at a very basic level, more people equate to more sales, which increases the ability of retailers to pay rent. That’s been very much what we’ve seen over the last 12 months. Rental rates on new deals have increased substantially, and that gradually trickles into the rest of the portfolio as tenants come to the end of their existing term and renew. Actually, very much like the current mortgage environment.
Going back to the slowdown, I also think it’s worth highlighting consumer spending per capita. Per person may reduce as people tighten their belts but as we keep hearing about in the news, people are focused on the essentials. And because there are more people spending overall, that more than offsets any reduction in individual spending that we may see.
[00:04:17] Craig Leslie:
Population growth increases demand and development of new space is also a major factor. Construction costs spiked during COVID and haven’t really moderated to any degree since, and they’re acting as a drag on the delivery of new space, which is well below historical levels. If you take perhaps the last three years of average delivered space delivered to the market, it’s approximately half what was being delivered pre-COVID.
So, strong demand, an increasing population, we’ve got limited availability of space (Skyline itself is now 99% committed retail occupancy), and little new supply. It’s a classic supply-demand imbalance and it’s resulting, as I say, in those rents for new space really accelerating over the last 12 months.
[00:05:13] Mustafa Bukhari:
Okay, so what does your strategy for the REIT look like?
[00:05:19] Craig Leslie:
Skyline is very much focused, as I said at the outset, on the smaller secondary and tertiary markets and that’s not going to change. We talked about population growth, and people assume that just means the primary markets but that’s just not true. The cost-of-living crisis, as everyone knows, is very, very real and that’s driving migration out of the major urban markets into the smaller markets where Skyline is strongest. They’re looking for lower house prices; they’re looking for reduced commutes, more outdoor space, and sometimes just that kind of perceived better quality of life, I think, from forming part of a smaller community. We aim to have the dominant center in those smaller markets so that when new retailers come to the market, they want to be in the best mousetrap, and that’s typically our assets.
Also, on the population growth side, actually, a few thousand people increase in population is material to the town. It’s very material to the retailer: more sales, more ability to pay rent again. But it’s typically not sufficient in those markets to warrant building an entirely new competing center. So again, we benefit from a further degree of insulation by being in a captive market over and above the benefits of just being focused on essential retail.
[00:06:43] Craig Leslie:
Despite the challenges facing development, it’s not impossible and we have been active in that area as well. We’ve been adding infill development to our existing sites, so we own the land already.
[00:06:56] Craig Leslie:
We have no carrying costs while going through the planning consent stage. We can then take our time and get the development fully costed and fully pre-leased beforehand. So, the development very much de-risked.
A good example of that, I think, is an asset we’ve got in Elmira, Ontario, where we bought the asset in 2016 for around, I think it was about 11 million. It’s worth more than double that today and what we’ve done is we’ve improved the tenant lineup and built new space. We’ve added a Rexall, an LCBO, and a multi-tenanted pad as well that’s anchored by a Starbucks drive-thru.
[00:07:41] Craig Leslie:
When we buy, I mentioned we focus on those secondary and tertiary markets, and there’s a reason for that. When we buy an asset in those markets, typically cap rates are higher than they are in major urban centers. And what I mean by that is the cap rate itself is, in fact, a multiplier; you apply it to the property income to arrive at a value. When cap rates are higher, the multiplier goes down and the value is lower. The tenants, though, are typically the same wherever you are in the country. If you go to a small-town grocery-anchored retail asset or one in the suburbs of Toronto, you will see a very similar tenant lineup.
[00:08:22] Craig Leslie:
So effectively, what we’re doing is paying less at the start for the same quality of income and covenant strength. The reverse example is also actually applicable. When interest rates go down, cap rates typically follow, which increases the multiplier on the income and the resulting value.
Revenue growth, I think, is the other one; obviously, that’s the other driver. We’ve spoken about rental growth over the last 12 months and those new deals are really accelerating. Now, an important part to note is only a percentage of our tenants typically expire in any given year because they sign multi-year agreements with us. That gives us security of income, and those agreements typically have contractual rental steps included, so you are getting rental growth throughout the term. But, as I say, we’ve seen some of the strongest rental growth in decades as a result of this major supply-demand imbalance.
So, when those tenants’ leases expire, tenants nearly always renew, particularly now where there’s a lack of available alternatives, and when they do renew, it’ll be at rents that are reflective of the new market rates. So that’s a further bump in revenue over and above the increases that they’ve seen during their contract lease term. Given typically tenants sign five- or ten-year deals, this provides a good runway I think for sustained incremental rental growth moving forwards.
[00:09:58] Mustafa Bukhari:
This seems all really positive. Can you speak to any clouds on the horizon for the Fund?
[00:10:04] Craig Leslie:
There’s nothing material on the horizon. Nothing is without risk, but on our side, I can talk to those risks. The typical risk is tenant failure, but as we’ve talked about, the portfolio is focused on essential retail, and that doesn’t follow the ebbs and flows of the economy. Our major tenants are some of the most financially secure retailers in the country, and we don’t have any significant exposure to any one tenant.
Cap rates could obviously increase, but grocery-anchored retail was road-tested to the extreme during COVID, and they didn’t really increase that point, and it passed with flying colors. There’s a lot of pent-up demand from investors for essential retail assets, and I don’t see that changing.
Something, I guess, that has had a lot of headlines over the last five to ten years, and that would be e-commerce. E-commerce typically impacts non-essential retail. So, it’s books, it’s electronics, it’s some fashion, for example, none of which we really have. Retailers don’t make money on e-commerce, and we see that perfectly illustrated with Sobeys parent company Empire. I saw the other month that they were pulling back on their e-commerce activities because what it was doing was undermining the performance of the brick-and-mortar retail. And even if someone does crack that profitability puzzle, retailers still need that last-mile distribution, and grocery stores are the perfect last-mile outlet. So fundamentally, I don’t see e-commerce being a material threat to essential retail.
[00:11:49] Mustafa Bukhari:
How would you summarize the outlook for the Retail REIT, particularly with the recent rate cut?
[00:11:55] Craig Leslie:
Our fundamental strategy is extremely strong. Migration to the smaller Canadian markets isn’t slowing down soon, and we’re extremely well placed to take advantage of that demand. The recent rate cuts have been great news, higher interest rates have dampened transactional activity over the last 24 months, but as those rates continue to come down, we’re going to see cap rate compression. Maybe not immediately, but that multiplier that we talked about will increase, and combined with the rental growth we will see that effect on values. More specifically, we’re looking at larger assets which give us more of an opportunity to actively manage the tenant roster and bring our in-house skills to bear and drive additional rental growth.
We’ll continue with acquisitions and development as well, where we can take some of that development risk off the table through pre-leasing. Part of that will be exploring any synergies that we may have with the Apartment REIT, for example, who are in similar markets to us. It’s not just in the major urban centers that you can see a combination of residential and retail working.
Otherwise, essential retail has typically offered strong, stable cash flows. That’s always been reflected in the yield. But with the acceleration in rents that we’ve seen, I think the Fund now shows a balance of yield and growth, and our values are underpinned by strong demand from a cross-section of investors who now see essential retail as a key part of their plans moving forward, and Skyline will be at the heart of that.
[00:13:34] Mustafa Bukhari:
Well, that’s the conclusion of our webinar. Thank you once again, Craig, for walking us through your strategy. As an investor, I know I’m really excited about the future direction of the Retail REIT. You’ve painted a picture of stability and growth.
For those tuning in, both Craig and I are happy to answer any questions that you may have. Feel free to email us after the presentation. Thank you all.
[00:13:59] Craig Leslie:
Thank you.