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Inovalis Real Estate Investment Trust Reports Financial Results for the Second Quarter of 2018

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Inovalis Real Estate Investment Trust Reports Financial Results for the Second Quarter of 2018

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TORONTO, Aug. 9, 2018 /CNW/ - Inovalis Real Estate Investment Trust (the "REIT") (TSX:INO)  today reported its financial results for the second quarter of 2018.

HIGHLIGHTS

  • Inovalis REIT ("Inovalis REIT", or the "REIT" or "we") is a Canadian TSX-listed REIT managed by Inovalis S.A. ("Inovalis SA"), a local cross-border French and German real estate asset manager, managing $10 billion of real estate and financial assets. As of June 30, 2018, Inovalis SA and its founding partners held a 10.8% interest in the REIT's equity (directly and indirectly).

  • The REIT successfully raised CAD$22.0 million (€13.6 million) through the completion of a private placement ("Promissory Note 3") with a non-Canadian, institutional investor. The proceeds were raised through the issuance of a convertible promissory note ("Promissory Note 3"), paying interest at 7.95% and maturing on April 19, 2021. The convertible note may be converted at any time after April 19, 2019. Concurrent to the issuance of the Note, the investor and the REIT entered into a put/call agreement whereby the REIT may satisfy its obligation to the investor by delivering 2,121,008 REIT units. Management intends to use the proceeds from the private placements to fund new acquisitions.

  • In April 2018, the REIT extended its EUR/CAD hedging program for an additional eighteen months. The extension to the program, based on an average rate of $1.6412, capitalises on the Euro's continued outperformance relative to the Canadian dollar.

  • In Q2 the REIT's Board of Trustees approved the replenishment of the DRIP facility with a reserve of 525,000 additional units created to facilitate the continued issuance of DRIP unitholders subscribed to the DRIP. The initial DRIP reserve of 525,000 which was established in July 2013 had been depleted in the normal course of issuing monthly DRIP Units to Unitholders who have subscribed for the DRIP. Currently, 9.9% of Unitholders are subscribed to the DRIP; the replenishment of the DRIP allows the REIT to continue to offer this option to Unitholders which provides a bonus distribution of Units equal to 3% of the amount of the cash distribution reinvested under the Plan.

  • The Board of Trustees of the REIT approved the extension of the management agreement between the REIT and Inovalis S.A. The Board of Trustees and the External Manager agree that, given the REIT's relative size, it is in the REIT's best interest to not internalize the asset and property management function at the current time. As part of the terms of the extension of the agreement, the following modifications were approved:

  • Term: The initial term will be for three (3) years, not to exceed April 1, 2021. The Agreement shall be automatically renewed for an additional two (2) years if the REIT's AFFO per unit for the year ended December 31, 2020 is greater than 115% of the AFFO per unit of the REIT as at December 31, 2017. The AFFO calculation shall be consistently applied and approved by the Audit Committee.

  • Asset Management Fees: Has been reduced from 0.75% to 0.50% and calculated based on the book value of assets. Fees will be payable in cash and/or exchangeable securities, the exact composition of which will be determined by the Board annually based on the REIT's cash resources.

  • Acquisition Fees: 1.00% of the purchase price of properties acquired that are not currently owned or managed by the Manager and paid in cash consideration (Previously 0.50% of the purchase price of properties acquired that are not currently owned or managed by the Manager and paid 50% in cash consideration and 50% in Exchangeable Securities)

  • At the REIT's AGM in May 2018, Unitholders approved the resolution to issue up to 3,500,000 Units pursuant to the Unit Based Compensation Plan as potential payment of Asset Management Fees payable under the terms of the extended Management agreement outlined above. Management believes that the proposed payment of Asset Management fees to Inovalis SA in Units serves to further align Inovalis SA's long-term interests with those of Unitholders. The Unit Based Compensation Plan also serves to provide a degree of flexibility to the REIT – Asset Management fees are payable in cash and/or exchangeable securities, the exact composition of the payment will be determined by the Board on an annual basis based on the REIT's cash resources.

  • Q2 2018 saw the overall occupancy rates slightly increasing on a GAAP basis from 94.9% in Q1 2018 to 95.0% as at June 30, 2018. When we also incorporate the interests in properties held by the REIT as part of joint-venture arrangements, overall occupancy remained stable at 96.8%. Following the departure of certain tenants, notably at the Metropolitain property, the REIT applied its value maximisation strategy – completing renovation works which have allowed for the vacated space to be let at a higher rate. Management will continue to seize opportunities to maximize Unitholder value through the completion of renovation works across the portfolio as opportunities present themselves.

  • FFO / AFFO

In the table below, FFO and AFFO for the three-month period ended June 30, 2018 are compared to the Q2 2017 and Management's guidance.

















Q1 2018 (1)


Q2 2018 (2)


Q2 2017 (3)


Management's
Guidance (1)

Including private placement in the form of a promissory note








FFO per unit

0.25


0.21


0.20


0.21 - 0.24

FFO payout ratio

82.6%


99.6%


104.4%


90% - 96%

AFFO per unit

0.24


0.22


0.22


0.22 - 0.25

AFFO payout ratio

86.6%


93.7%


91.6%


88% - 94%









(1)

$1.5542 C$/€ foreign exchange rate

(2)

$1.5459 C$/€ foreign exchange rate (Including FX impact of previous quarter)

(3)

$1.4455 C$/€ foreign exchange rate

 

The Q2 2018 FFO of $0.21 per unit is $0.01 higher than Q2 2017 FFO of $0.20 and in line with Management's guidance. The AFFO for Q2 2018 of $0.22 per unit is consistent with Q2 2017 AFFO of $0.22 and in line with the run rate going forward as estimated by management.

The Q2 018 FFO payout ratio of 99.6% was ahead of management's guidance while the AFFO payout ratio of 93.7% was in line with Management's guidance.  

  • NOI (GAAP)

In the table below is the NOI presentation prepared under GAAP. The REIT guidance includes the application of forecast indexation for French assets. Indexation has not been applied to the German asset forecast as it is not applied until the index increases exceed 5%. Between 2013 and 2016, on average, the German index increased 0.50% per year. In 2017, the index grew at a rate of 1.74% per year, indicating an accelerating trend. If this trend continues, the indexation threshold of 5% could be reached between 2018 and 2021 at which time it will be applied to the German assets. These calculations include consideration of the contractual specificities of each lease. See the section Rental Indexation for details on French and German indices.







(in thousands of CAD$)

Q1 2018 (1)


Q2  2018(2)


Management's
Guidance (1)







NOI (GAAP)

3,842


6,882









IFRIC 21 impact

(2,602)


877









NOI (excluding IFRIC 21 impact)

6,444


6,005


5,900 - 6,300







(1)  $1.5542 C$/€ foreign exchange rate

(2)  $1.5459 C$/€ foreign exchange rate (Including FX impact of previous quarter)

 

  • The Q2 2018 NOI is $6.01M, which is within management's range of guidance for the quarter.

Management's guidance range for 2018 is based on the annualized NOI for the current portfolio. The reader is cautioned that Management's guidance information is forward-looking and actual results may vary from those reported.

  • NOI (Non-GAAP) (Excluding IFRIC 21 impact)

In the table below is NOI presentation for the whole portfolio including the REIT's proportionate interest in properties held in partnership. Management's guidance includes the application of 2018 forecast indexation for French assets. Indexation has not been applied to the German asset forecast as it is not applied until index increases exceed 5%.  See the section Rental Indexation for details on French and German indices.







(in thousands of CAD$)

Q1 2018 (1)


Q2 2018 (2)


Management's
Guidance (1)







NOI (Non-GAAP)

5,915


10,314









IFRIC 21 impact

(3,157)


1,063









NOI (excluding IFRIC 21 impact)

9,072


9,251


8,800 - 9,300







(1)       $1.5542 C$/€ foreign exchange rate

(2)       $1.5459 C$/€ foreign exchange rate (Including FX impact of previous quarter)

 

The Q2 2018 NOI, excluding the impact of IFRIC21, was $9.25M, in-line with Management's guidance.

  • Debt to Book Value (GAAP)

The REIT's debt to book value, in accordance with GAAP, was 42.4% as at June 30, 2018, compared to 43.7% as at December 31, 2017. Net of cash available, the debt to book value was 39.8% as at June 30, 2018, compared to 41.7% as at December 31, 2017. The reduction in the debt to book ratio is notably linked to the amortization of debt of approximately $4.4m throughout the six-month period.

  • Debt to Book Value (Non-GAAP)

The REIT's Non-GAAP debt to book value for the whole portfolio, including the REIT's proportional share in joint-ventures was 50.9% as at June 30, 2018, a decrease from 51.2% as at December 31, 2017. Net of cash available, the debt to book value was 48.4% as at June 30, 2018, compared to 49.2% as at December 31, 2017.

ABOUT INOVALIS REAL ESTATE INVESTMENT TRUST

Inovalis Real Estate Investment Trust is an unincorporated, open-ended real estate investment trust established pursuant to a declaration of trust under the laws of the Province of Ontario. The REIT has been created for the purpose of acquiring and owning office properties primarily located in France and Germany but also opportunistically in other European countries where assets meet the REIT's investment criteria.

Management's discussion and analysis

(Dollar amounts in the MD&A are presented in thousands of Canadian dollars, except rental rates, Unit or as otherwise stated)

OVERVIEW - GAAP and Non-GAAP

The table below presents a summary of both GAAP and Non-GAAP measures. For Non-GAAP, which include our proportionate share of income from investments in joint ventures, please refer to "Non- GAAP Reconciliation".








June 30, 2018


December 31, 2017








Operational information


GAAP Measures

NON-GAAP Measures (1)


GAAP Measures

NON-GAAP Measures (1)

Number of properties


7

14


7

13

Gross leasable area (sq.ft)


772,403

1,326,797


772,403

1,280,542

Occupancy rate (end of period) (2)


95.0%

96.8%


95.4%

97.0%

Weighted average lease term 


4.9 years

4.7 years


5.3 years

5.1 years

Average capitalization rate (3)


5.5%

5.7%


5.7%

5.4%








Financing information







Level of debt (debt-to-book value) (4)


42.4%

50.9%


43.7%

51.2%

Level of debt (debt-to-book value, net of cash) (4)


39.8%

48.4%


41.7%

49.2%

Weighted average term of principal repayments of debt


6.1 years

5.7 years


6.5 years

5.9 years

Weighted average interest rate (5)


2.15%

2.12%


2.16%

2.10%

Interest coverage ratio (6)


4.1 x

4.4 x


3.9 x

3.9 x

















Three months ended


Six months ended

(thousands of CAD$ except per Unit and other data)


June 30, 2018

June 30, 2017


June 30, 2018

June 30, 2017








Operating results







Rental income


6,539

6,271


13,253

12,242

Adjusted Rental income (1)


9,830

8,100


19,548

15,672

Net rental earnings


6,882

6,610


10,724

9,857

Adjusted net rental earnings (1)


10,314

8,522


16,230

12,893








Earnings for the period


5,034

159


3,060

3,300

Funds from Operations (FFO) (7) (8)


5,841

4,647


12,538

8,981

Adjusted Funds from Operations (AFFO) (7) (8)


6,210

5,300


12,594

9,759















FFO per Unit (diluted) (7) (8)


0.21

0.20


0.44

0.38

AFFO per Unit (diluted) (7) (8)


0.22

0.22


0.45

0.42








Distributions  







Declared distributions on Units and Exchangeable sec.


4,684

4,852


9,922

9,675

Declared distributions on Units and Exchangeable sec. & Promissory note


5,928

4,852


11,458

9,675

Declared distribution per Unit (diluted) (9)


0.21

0.21


0.41

0.41

FFO payout ratio (7)


99.6%

104.4%


92.8%

107.7%

AFFO payout ratio (7)


93.7%

91.6%


92.4%

99.1%










(1)

Taking into account the interest the REIT has in joint venture partnerships.

(2)

Calculated on weighted areas (activity, storage and intercompany restaurant areas being accounted for only a third of their effective areas), including vendor leases.

(3)

Calculated on annualized net rental earnings (based on net rental earnings for the year-to-date period).

(4)

The definition of debt-to-book value and of debt-to-book value, net of cash can be found under the section Non-GAAP Financial Measures.


The figures presented for the period ended December 31, 2017 have been reclassified, when appropriate, in order to ensure comparability with the figures for the period ending June 30, 2018.

(5)

Calculated as the weighted average interest rate paid on the finance leases and the mortgage loans (excluding derivatives)

(6)

Calculated as net rental earnings plus interest expense, less administrative expenses, divided by interest expense on the financial leases and mortgage financings.

(7)

The reconciliation of FFO and AFFO to earnings can be found under the section Non-GAAP Reconciliation (FFO and AFFO).

(8)

Based on the fully diluted weighted average number of Units during the period including conversion of Private placement promissory note.

(9)

Based on the fully diluted weighted average number of Units during the period excluding conversion of Private placement promissory note.

 

BASIS OF PRESENTATION

The following management's discussion and analysis ("MD&A") of the financial condition and results of operations of Inovalis REIT should be read in conjunction with the REIT's condensed interim consolidated financial statements for the period from January 1, 2018 to June 30, 2018, and the notes thereto.

The REIT has historically, within the MD&A, presented operating results based on financial information developed using proportionate consolidation for all the REIT's joint ventures, which are accounted for using the equity method, as required by IFRS 11 "Joint Arrangements".  This manner of presentation provided current and prospective investors with, in management's view, the most relevant information to assist them in understanding the REIT's financial performance, while providing for a reconciliation of such Non-Generally Accepted Accounting Principles ("GAAP") information to the REIT's financial statements as reported under IFRS in the relevant sections of the MD&A. The MD&A will begin with an Overview, providing a summary of the REIT's performance and operations for the period, including both GAAP and non-GAAP metrics. Management believes this presentation provides users of this MD&A additional information about the source of the revenue used by Inovalis to pay distributions on its units, as joint venture structures represent significant equity investments (joint ventures account for approximately 30% of the total value of all properties held by the REIT, including those owned by joint venture), are a significant part of the growth of the REIT and represent of an important part of the REIT's revenue and expenses. Management believes that this reformatting of the MD&A will provide greater prominence to the GAAP measures while still allowing for a reconciliation to the comparable non-GAAP measures. 

This MD&A has been prepared considering material transactions and events up to and including August 8, 2018. Financial data provided in the consolidated financial statements have been prepared in accordance with International Financial Reporting Standards. All amounts in this MD&A are in thousands of Canadian dollars, except per unit amounts and where otherwise stated. Historical results, including trends which might appear, should not be taken as indicative of future operations or results. Additional information about Inovalis REIT has been filed with applicable Canadian securities regulatory authorities and is available at www.sedar.com. The exchange rate used throughout this MD&A for statement of earnings items is the average rate during the said period, i.e. $1.5459 Canadian dollars per Euro for the six-month period ended June 30, 2018. In Q2 2018, this rate of $1.5459 includes the impact of the FX rate applied for the previous quarter. For balance sheet items, projections or market data, the exchange rate used is 1.5349 (exchange rate as at June 30, 2018).

FORWARD-LOOKING INFORMATION

Although we believe that the expectations reflected in the forward-looking information are reasonable, we can give no assurance that these expectations will prove to have been correct, and since forward-looking information inherently involves risks and uncertainties, undue reliance should not be placed on such information. Certain material factors or assumptions are applied in making forward-looking statements and actual results may differ materially from those expressed or implied in such forward-looking statements. The estimates and assumptions, which may prove to be incorrect, include, but are not limited to, the various assumptions set forth in this document as well as the following: (i) we will continue to receive financing on acceptable terms; (ii) our future level of indebtedness and our future growth potential will remain consistent with our current expectations; (iii) there will be no changes to tax laws adversely affecting our financing capability, operations, activities, structure or distributions; (iv) we will retain and continue to attract qualified and knowledgeable personnel as we expand our portfolio and business; (v) the impact of the current economic climate and the current global financial conditions on our operations, including our financing capability and asset value, will remain consistent with our current expectations; (vi) there will be no material changes to government and environmental regulations adversely affecting our operations; (vii) conditions in the international and, in particular, the French and German real estate markets, including competition for acquisitions, will be consistent with the current climate; and (viii) capital markets will provide us with readily available access to equity and/or debt financing. The forward-looking statements are subject to inherent uncertainties and risks, including, but not limited to, the factors listed under the Risk and Uncertainties section of this MD&A. Consequently, actual results and events may vary significantly from those included in, contemplated or implied by such statements.

MARKET AND INDUSTRY DATA

This MD&A includes market and industry data and forecasts that were obtained from third-party sources, industry publications and publicly available information as well as industry data prepared by Inovalis SA based on its knowledge of the commercial real estate industry in which we operate (including Inovalis SA estimates and assumptions relating to the industry based on that knowledge). Inovalis SA's knowledge of the real estate industry has been developed through its 20 years of experience and participation in the industry. Inovalis REIT believes that its industry data is accurate and that its estimates and assumptions are reasonable, but there can be no assurance as to the accuracy or completeness of this data. Third-party sources generally state that the information contained therein has been obtained from sources believed to be reliable, but there can be no assurance as to the accuracy or completeness of included information. Although Inovalis REIT believes it to be reliable, Inovalis REIT has not verified any of the data from third-party sources referred to in this MD&A or analyzed or verified the underlying studies or surveys relied upon or referred to by such sources, or ascertained the underlying assumptions relied upon by such sources.

BUSINESS OVERVIEW AND STRATEGY

Inovalis REIT is an unincorporated open-ended real estate investment trust governed by the laws of the Province of Ontario. Inovalis REIT was founded and sponsored by Inovalis SA, our asset manager. Our Units have been listed on the Toronto Stock Exchange under the trading symbol INO.UN since April 10, 2013. Our head and registered office is located at 151 Yonge Street, 11th floor, Toronto, Ontario, M5C 2W7.

Our long-term objectives are to:

  • generate predictable and growing cash distributions on a tax-efficient basis from investments in income-producing office properties;

  • maximize the long-term value of both our properties and Units through active and efficient management;

  • grow our asset base, primarily in France and Germany, but also opportunistically in other European countries where assets meet our investment criteria; and

  • increase the cash available for distribution to holders of Units ("Unitholders"), through an accretive acquisition program that successfully leverages Inovalis SA's extensive relationships and depth of commercial property and financing.

The REIT's Investment criteria encompasses office properties outside of Canada with an occupancy level above 80% (unless AFFO accretive), secured rental cash flows, a property value between €20 million ($30.7 million) to €60 million ($92.1 million) (unless AFFO accretive) and a potential future upside with respect to matters including rent and area development. According to management, the target investment size falls within a very liquid segment of the real estate market in Europe, and debt financing for such acquisitions is readily available from local lenders.

BUSINESS ENVIRONMENT

French commercial real estate investment market (1)

Overview

The Greater Paris Region market continued to perform well throughout the second quarter of 2018, with take-up in Paris reaching close to 221,000 sq.m during the of first half of the year. This performance was impacted by the limited space available in central Paris, which reported a 2.1% vacancy rate as at June 30, 2018. Driven by lack of supply in city center locations, the inner rim also reported strong results, accounting for approximately 47% of all rental activity. The Western Crescent district posted its best performance since 2000 with uptake of almost 382,000 sq.m (+29% year over year).

Paris commercial real estate investment market

Rental market

The supply of vacant space remains limited in Paris, with a vacancy rate of approximately 2.1% at the end of Q2. This lack of supply has driven an increase in headline rents, with most markets in the region posting year-over-year increases. Following a substantial number of transactions at rents over €770 and several over €800, the prime rent in the Paris Central Business District ("CBD") now stands at €780/sq m/year. In La Défense district, the prime rent posted a year-over-year decrease – although levels have risen compared with the beginning of the year – to €510/sq m/year.

Investment market

Parisian assets were in high demand over Q1 2018 and into Q2. Since the beginning of the year, Paris accounted for almost €5 billion in investments or 54% of activity. Fifteen transactions for lot sizes over €100 million contributed to these figures. Investment performance for the Paris CBD (€2.6 bn) as well as other Parisian submarkets (€2.3 bn) have never been as high by the end of Q2. Following a particularly active 2017, the La Défense market made a much slower start to 2018 with only €190 million in investments over the last six months. However, the considerable number of office towers currently on the market does mean that the outlook for market activity over the second half of the year is strong. The investment volume for the inner suburbs remained broadly stable year-over-year with almost €900 million in investments. The most active submarket was the inner northern suburbs (€637 million) which is benefiting from greater interest linked to the 2024 Olympic Games as well as the Grand Paris Project.

Greater Paris Region commercial real estate investment market

Rental market

The Greater Paris Region investment market continued to grow with over 1.3 million sq.m of office transactions during the first six months of the year, representing a 15% year-over-year increase. Year-over-year increases ranging from +4% to +28% were recorded across all real estate sectors. Q2 2018 also marked a reduction in office vacancies in the Greater Paris Region to near 3 million sq.m, a year-over-year reduction of 12%.

Investment market

€9.1 billion was invested in the Greater Paris Region in the first half of 2018, representing a 69% increase and a level of investment activity almost twice as high as the long-term average. Foreign investors have been very active since the end of 2017. Since the beginning of the year these foreign investors have invested approximately €3.7 billion, representing 41% of all activity.

(1) Source Jones Lang LaSalle

German Commercial Real Estate Market (2) 

Overview

The Q2 2018 German economic outlook was dampened by a trade dispute with the USA, disagreements with the EU and a poor World Cup performance. Recently the ifo Business Climate Index and the Centre for European Economic Research (ZEW) index have fallen to their lowest levels since November 2012. Consensus Economics have also revised their estimated GDP growth for the year downwards from 2.4% to 2.1%. However, the German labor market has continued to provide positive signals with unemployment falling to 5.2% in May 2018, from 5.5% in March 2018. The improving situation in the labor market is expected to strengthen private consumption within the German economy.   

Office market: Rents continue to rise with strong momentum in Berlin and Stuttgart

The lack of available office space has led to further increases in rental price growth in across the Big 7* cities. The JLL Prime Rental Price Index, which tracks rents in the Big 7 cities, reached 197.9 points at the end of Q2 2018 – the highest level since Q3 2001. In line with the increase in the index, rents have increased 4.4% over the last 12 months. The increase is even more pronounced in the two cities with the lowest supply of available office space – Berlin and Stuttgart - with prime rents in Stuttgart increasing almost 7% year-over-year.  The increasing rents in city centers and central business districts are also leading to increased demand in peripheral locations.

Transaction market: Transaction volume just below last year's level

The transaction volume in the German commercial real estate market reached €25.6 billion, which is in line with the recorded transaction volume for the first six months of 2017. Of these transactions, office properties represented around 45% of the total transaction volume for the quarter. The transaction volume in the Big 7 increased by 29% compared to the first six months of 2017. This indicates a preference for properties located in the Big 7 cities, with only one out of the twenty largest transactions of Q2 2017 not occurring in a Big 7 location. The average prime yield across the Big 7 cities is 3.24%, which is in line with the yield as at March 31, 2018 and represents a compression of 23 basis points compared to the yield as at Q2 2017.   

* "Big 7" major cities in Germany: Berlin, Dusseldorf, Frankfurt, Hamburg, Cologne, Munich and Stuttgart

(2) Source Jones Lang LaSalle

REAL ESTATE MANAGEMENT AND ADVISORY SERVICES

Pursuant to a management agreement, Inovalis SA is the manager of the REIT and provides the strategic, advisory, asset management, project management, construction management, property management and administrative services necessary to manage the operations of the REIT.

OUR OPERATIONS – GAAP and Non-GAAP

Performance indicators, incorporating both GAAP and Non-GAAP measures

As at

June 30, 2018


December 31, 2017


GAAP Measures

Non-GAAP Measures (1)


GAAP Measures

Non-GAAP Measures (1)

Gross leasable area (sq.ft)

772,403

1,326,797


772,403

1,280,542

Number of properties

7

14


7

13

Number of tenants

37

67


34

66

Occupancy rate (2)

95.0%

96.8%


95.4%

97.0%

Weighted average lease term (3)

4.9 years

4.7 years


5.3 years

5.1 years



(1)

Taking into account the interest the REIT has in the properties held in partnerships.

(2)

Calculated on weighted areas and including vendor leases (activity, storage and intercompany restaurant areas being accounted only for a third of their effective areas).

(3)

Excluding early termination rights. Considering early termination rights, the weighted average lease term is 3.6 years as at June 30, 2018 compared to 3.8 years as at December 31, 2017 (3.7 years vs 4.0 years for Non-GAAP respectively)

 

The above performance indicators do not consider the redevelopment loan granted to the property in Rueil (Paris Western periphery).

Portfolio

The REIT has an interest in fourteen properties, of which seven are entirely owned by the REIT (Baldi, Courbevoie, Jeuneurs, Metropolitain, Sablière and Vanves in France and Hanover in Germany) and seven are held through partnerships with various global institutional funds (Arcueil and Pantin in France, Bad Homburg, Neu-Isenburg, Duisburg, Stuttgart and Kösching in Germany). Eight properties are in France and six properties are in Germany.

Occupancy

The 95.0% weighted average occupancy rate at June 30, 2018 across the seven properties owned entirely by the REIT slightly decreased from 95.4% as at December 31, 2017. The weighted average occupancy rate across the fourteen properties decreased slightly from 97% as at December 31, 2017 to 96.8%; this includes properties owned through joint-ventures and the vendor lease relating to the Delizy (Pantin) property. The slight decline in occupancy rates is predominantly due to the departure of tenants in the Sablière, Courbevoie and Metropolitain properties. REIT management refurbished the space left vacant at the Metropolitain property and have now re-let this space beginning June 1, 2018, at a significantly more favorable rent/sq.ft.

During Q1 2018, the REIT completed the acquisition of the 100% occupied Kösching property, acquired as part of a joint-venture transaction. This acquisition accounts for the increase in gross leasable area under Non-GAAP measures from 1,280,542 sq.ft. as at December 31, 2017 to 1,326,797 sq.ft as at June 30, 2018.

The average lease term decreased to 4.9 years as at June 30, 2018 from 5.3 years as at December 31, 2017. The average lease term including properties held through joint-ventures decreased slightly to 4.7 years compared to 5.1 as at December 31, 2017.

Tenants

The tenant base in the portfolio is well diversified from an industry segment standpoint, with many national and multinational tenants. As at June 30, 2018, the REIT had thirty-four tenants across the seven properties owned entirely by the REIT, and sixty-seven tenants in aggregate including properties held through joint ventures.

Approximately 65.6% of quarter's gross rental income is attributable to French public agency tenants, is guaranteed by large German or international banks, or from investment grade corporations or affiliates of investment grade corporations. This percentage, including properties held through joint-ventures, equates to 64.9%.

The following table shows our five largest tenants, sorted by contribution to gross leasable area (GLA) in the REIT's seven fully owned properties.








Tenant


Tenant Sector


GLA
(sq.ft.) (1)

Weighted Areas
(sq.ft)(1)

% of
Weighted Areas

Orange (Formerly France Telecom)


Telecommunications


186,070

181,096

24.8%

Facility Services Hannover


Banking/ Real estate


124,074

124,074

17.0%

Rue Du Commerce


E-commerce


51,926

51,926

7.1%

CNAM


Education & Training


50,407

49,543

6.8%

ADEME


Government Agency


49,460

49,460

6.8%

Top 5 tenants





461,935

456,098

62.4%

Other tenants


Diversified


256,348

238,522

32.6%

Vacant





54,119

36,604

5.0%

Total GAAP Measures





772,403

731,225

100.0%


(1) Activity, storage and intercompany restaurant areas are weighted by being accounted for a third of their effective areas.

 

The REIT's five largest tenants across the portfolio of fourteen properties which includes the seven fully owned properties plus the additional seven properties held through joint-ventures, are presented in the table below. As at June 30, 2018, the REIT held a 50% interest in the Duisburg, Walpur (Bad Homburg), Pantin, Stuttgart, Neu-Isenburg and Kösching properties and a 25% interest in the Arcueil property.

Tenant


Tenant Sector


GLA
(sq.ft.) (1)

Weighted Areas
(sq.ft) (1) (2)

% of 
Weighted Areas

Orange (Formerly France Telecom)


Telecommunications


269,703

198,907

20.6%

Facility Services Hannover


Banking/ Real estate


124,074

124,074

12.9%

Daimler AG


Manufacturer


109,136

50,243

5.2%

Hitachi Power


Manufacturer


108,959

52,023

5.4%

Arrow Central Europe


E-commerce


55,871

25,974

2.7%

Top 5 tenants





667,743

451,221

46.8%

Other tenants


Diversified


596,841

475,334

49.3%

Vacant





62,213

37,953

3.9%

Total Non-GAAP Measures





1,326,797

964,508

100.0%


(1)    Taking into account the interest the REIT has in the properties held in partnerships

(2)    Activity, storage and intercompany restaurant areas are weighted by being accounted for a third of their effective areas.

 

Our largest tenant, Orange (formerly France Telecom), is rated BBB+/Baa1/BBB+ by S&P/Moody's/Fitch and has leases in two of our properties, the Vanves property and the Arcueil property (held in partnership).

Leasing profile

Lease rollover profile

The REIT has an average remaining lease term of 4.9 years in the seven fully owned properties (not including tenant early termination rights). Assuming all tenants leave at the earliest possible early termination rights, which the REIT believes is unlikely, the average remaining lease term in our portfolio is 3.6 years. The following graph sets out the percentage of total GLA of the properties subject to leases expiring during the periods shown (excluding early lease terminations).

Lease Maturity Profile as at June 30, 2018
(% of total GLA)

Lease Maturity Profile as at June 30, 2018 (% of total GLA) (CNW Group/Inovalis Real Estate Investment Trust)

 

Implicit Renewal

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029














0.1%

7.2%

8.3%

8.4%

38.0%

1.8%

2.6%

6.0%

5.8%

2.8%

1.2%

0.0%

17.9%

 

Including properties held in joint-ventures, the average remaining lease term is 4.7 years (not including tenant early termination rights) and 3.7 years including early termination rights.

The following graph presents the percentage of total GLA expiring in the fourteen properties during the periods shown (excluding early lease terminations), including the vendor lease at the Delizy property (Pantin).

Lease Maturity Profile as at June 30, 2018
Entire portfolio including joint ventures
(% of total GLA)

Lease Maturity Profile as at June 30, 2018 - Entire portfolio including joint ventures (% of total GLA) (CNW Group/Inovalis Real Estate Investment Trust)

 


Implicit Renewal

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

% of total GLA














Lease end

0.2%

4.6%

7.5%

14.7%

22.7%

1.6%

12.4%

14.0%

4.4%

3.0%

4.1%

0.0%

10.7%

Rental indexation

All leases contracts have rental indexation based on the French ICC (construction cost index), ILAT (index averaging construction costs and CPI indexes) or the German Consumer Price Index, as applicable.

CONSOLIDATED FINANCIAL INFORMATION

Interim Consolidated Statements of Earnings
(Unaudited - All dollar amounts in thousands of Canadian dollars except per unit amount)



Three months ended June 30


Six months ended June 30

(in thousands of CAD$)


2018


2017


2018


2017










Rental income 


6,539


6,271


13,253


12,242

Service charge income 


1,957


1,358


4,103


3,208

Service charge expenses


(1,721)


(1,165)


(6,893)


(5,782)

Other revenues


180


219


424


303

Other property operating expenses


(73)


(73)


(163)


(114)

Net rental earnings


6,882


6,610


10,724


9,857










Administration expenses


(1,510)


(1,326)


(3,027)


(2,572)

Foreign exchange gain (loss)


27


(62)


83


(62)

Net change in fair value of investment properties


(587)


(2,181)


1,338


108

Acquisition costs


-


-


(20)


(37)

Share of profit of an investment (equity method)


739


1,114


1,574


391

Operating earnings


5,551


4,155


10,672


7,685










Gain (loss) on financial instruments at fair value through P&L


(179)


(2,352)


(1,162)


(1,781)

Finance income


2,305


1,524


5,668


3,308

Finance costs


27


(1,404)


(5,222)


(3,057)

Distributions on Exchangeable securities


(286)


(398)


(554)


(777)

Net change in fair value of Exchangeable securities


(48)


(1,034)


66


(1,698)

Net change in fair value of Promissory notes


(2,202)


-


(1,074)


-

Earnings before income taxes


5,168


491


8,394


3,680










Current income tax expense


105


(87)


(14)


(97)

Deferred income tax expense


(241)


(190)


(5,320)


(224)










Earnings for the period


5,031


214


3,060


3,359

Non-controlling interest


(1)


55


1


59

Earnings for the period (part attributable to the Trust)


5,032


159


3,059


3,300

 

Discussion of Consolidated Statements of Earnings

Net rental earnings

Rental income for the three-month period ended June 30, 2018 was $6,539 compared to $6,271 in Q2 2017. The $268 year over year increase comes principally from $240 attributable to FX rate movements and indexation of $48. These gains were partially offset by the net reduction of ($20) resulting from new leases on Courbevoie, Metropolitain and Baldi properties and a tenant departure at the Courbevoie, Metropolitain and Sablière properties.

Rental income for the six-month period ended June 30, 2018 was $13,253 compared to $12,242 in Q2 2017. The $1,011 increase year over year increase comes from $850 attributable to FX rate movements, $113 corresponding to indexation of the portfolio, furthered by net increase of $48 resulting from new leases as outlined above.

Net rental earnings for the three-month period ended June 30, 2018 were $6,882 compared to $6,610 in Q2 2017. The $272 increase in net rental earnings, resulted chiefly from the positive FX rate impact of $351. Excluding the FX movement, the net reduction of $79 was mainly due to a reduction in other revenues.

Net rental earnings for the six-month period ended June 30, 2018 were $10,724 compared to $9,857 in Q2 2017. The $867 increase in net rental earnings, resulted chiefly from the positive FX rate impact of $685. The increase of $182 excluding the FX impact is predominantly due to the net increase in rental income arising from new leases.

Administration expenses

Administration expenses are primarily comprised of asset management fees paid to Inovalis SA and other general administrative expenses such as trustee fees, directors' and officers' liability insurance, professional fees (including accounting fees), legal fees, filing fees, Unitholder related expenses and other expenses.

Administration expenses for the quarter ended June 30, 2018 amounted to $1,510 vs. $1,326 for the same quarter in 2017. The $581 is related to the asset management fees paid to Inovalis SA vs. $738 for the quarter ended June 30, 2017 and $929 to other expenses vs. $588 for the quarter ended June 30, 2017. The overall decrease in management fees of $157, including the positive movement in foreign exchange of $27, is the result of the lower management fees in the agreement applicable from April 1, 2018, signed in Q2 2018, and the sale of the Cologne property. Other expenses increased $341 year over year, of which $23 is attributable to foreign exchange movement, the remaining increase of $318 includes approximately $200 in exceptional expenses in the form of listing fees related to the creation of the reserve for units to pay the management fees, the increase of the DRIP reserve and fees connected to the AGM held in Q2. The remaining $118 increase is related to the increased activity at the Luxembourg holding company level and the increase in costs related to the Canadian structure.

Administration expenses for the six-month period ended June 30, 2018 amounted to $3,027 vs. $2,572 for the same quarter in 2017. The $1,325 is related to the asset management fees paid to Inovalis SA vs. $1,438 for the six-month period ended June 30, 2017 and $1,702 to other expenses vs. $1,134 for the six-month ended June 30, 2017. The overall reduction in management fees of $113 is driven by the positive movement in foreign exchange of $100 and a reduction of $213 attributable mainly to the new management agreement terms and the sale of the Cologne property. Other expenses increased $568 year over year, of which $79 is attributable to foreign exchange movement. The remaining $489 includes the above-mentioned exceptional fees of approximately $200 and a $289 increase related to the increased activity at the Luxembourg holding company level and the increase in costs related to the Canadian structure.

Net change in fair value of investment properties

During the quarter ended June 30, 2018, the net change in fair value of investment properties recognized in earnings was a loss of $587. The French assets were valued as at June 30, 2018, which resulted in an increase of approximately $1.9m. The German assets are valued on an annual basis. The increase in value was offset by works completed across the portfolio and the IFRIC 21 impact which results in a net loss. This figure compares to the $2,181 loss in the quarter ended June 30, 2017.

Gain (loss) on financial instruments at fair value through profit and loss

The REIT recognized a loss on financial instruments for the quarter of $180 compared to a loss of $2,352 for the same period in 2017. The loss for the quarter corresponds to changes in value in the interest rate derivatives held by the REIT.

Finance income

For the three-month period ended June 30, 2018, finance income of $2,305 consists predominantly of $925 in interest on the acquisition loans related to the Rueil property, with $1,380 of finance income arising from joint ventures. The increase of $781 for the quarter from $1,524 in Q2 2017 corresponds mainly to the increase in interest income from the Rueil loan and the increase in interest income from joint ventures.

For the six-month period ended June 30, 2018, finance income of $5,668 consists predominantly of $2,951 in interest on the acquisition loans related to the Rueil property and $2,687 of finance income arising from joint ventures. The increase of $2,360 from $3,308 for the six-month period ended Q2 2018 corresponds mainly to the increase in interest income from the Rueil loan and an increase in finance income arising from joint ventures.

Finance income for the six-month period ended June 30, 2017 of $3,308 consisted of $974 in interest on the acquisition loan related to the Rueil property $183 in revenue from both the exchange hedging program and interest on cash deposit and $2,151 in finance income from joint ventures.

As at June 30, 2018, the REIT had deployed €17.2 million ($26.4 million) of the €21.75 million ($33.4 million) acquisition and redevelopment loan to a company 80%-owned by Inovalis SA, related to the Rueil property, in the Paris Western periphery. The loan bears an annual interest rate of 8.50%, with an effective interest rate of 13.89% which incorporates the 20% of the profit that will accrue to the REIT upon the sale of the property to a third party. The final portion of the loan commitment of €4.55 million ($7.0 million) is expected to be deployed in 2018.

Finance costs

For the three-month period ended June 30, 2018, the finance costs amounted to ($27) vs $1,404 for the same period in 2017 including $1,208 for interest costs related to finance leases, mortgage loans and the lease equalization loans, $958 of interest costs on the promissory note, $341 of interest related to SWAP contracts, a loss of $2,858 related to joint ventures (including the fair value variance of the Arcueil derivative which is supported 100% by the REIT) and $324 of other finance costs (including amortization of fair value adjustment on finance leases assumed at a discount at the time of a business acquisition, amortization of transaction costs on mortgage loans and other miscellaneous costs).The increase of $1,431 year on year is largely attributable to finance expenses associated with joint ventures and also to promissory note interest paid on the notes issued in 2017 and 2018.

For the six-month period ended June 30, 2018, the finance costs amounted to $5,222 vs $3,057 for the same period in 2017 including $2,430 for interest costs related to finance leases, mortgage loans and the lease equalization loans, $1,536 of interest costs on the promissory note, $661 of interest related to SWAP contracts and $595 of other finance costs (including amortization of fair value adjustment on finance leases assumed at a discount at the time of a business acquisition, amortization of transaction costs on mortgage loans and other miscellaneous costs).The increase of $2,165 year on year is largely attributable to promissory note interest paid on the notes issued in 2017 and 2018 and also to increased interest on bank loans.

Distributions on Exchangeable securities

Distributions to the holders of Exchangeable securities (see Note 9 in Condensed Interim Consolidated Financial Statements as at June 30, 2018) are calculated in a manner to provide a return that is economically equivalent to the distributions received by the Unitholders. During the three-month period ended June 30, 2018 the distributions recognized on Exchangeable securities were $286 compared to $398 for the same period in 2017. The year-over-year decrease arises from the reduction in the number of Exchangeable securities in issuance following the conversion by Inovalis S.A. of 500,014 Exchangeable securities into Units in December 2017 and a further conversion of 419,059 Exchangeable securities in January 2018, partially offset by the increase due to the additional Exchangeable securities received by Inovalis SA in lieu of asset management fees.

Net change in fair value of Exchangeable securities

The net change in value of the Exchangeable securities, as well as the cost of distributions recognized on Exchangeable securities, are recognized in profit and loss because, for financial reporting purposes, the Exchangeable securities have been classified as a liability at fair value through profit or loss.

For the three-month period ended June 30, 2018, the REIT reported a loss of $48 which is the result of the increase in the closing price of the units which was $10.10 on June 29, 2018 compared to $10.05 on March 31, 2018.

For the six-month period ended June 30, 2018, the REIT reported a gain of $66 which is the result of the increase in the closing price of the units which was $10.10 on June 30, 2018 compared to $9.97 on December 29, 2018 and the impact of the conversion of 419,059 Exchangeable securities in January 2018.

Current income tax expense

The current income tax expense of ($105) for the quarter ended June 30, 2018 and ($14) for the six-month period ended June 30, 2018 corresponds to the adjustment between estimated and final tax for 2016 for REIT's Luxembourg holding entity.

Deferred tax expense

The deferred income tax expense (and deferred income tax liabilities) corresponds to the origination of temporary differences arising from investment properties located in France and Germany.

On 20 March 2018, the Luxembourg and French Governments signed a new Double Tax Treaty (DTT), together with an accompanying Protocol. The tax treaty will enter into force once both parties complete the ratification process. Under the current DTT, the REIT, through its subsidiary located in Luxembourg, should incur French withholding tax at the 5% treaty rate on the dividend received from French OPCI*. Under the anticipated DTT, such dividend distributions would be subject to withholding tax at a substantively enacted rate of 30% rate which can potentially be reduced to 15% in some specific cases.

The governments of France and Luxembourg signed a new Double Taxation Treaty and accompanying Protocol on March 20, 2018.  The DTT is currently pending ratification before it comes into force.  If the DTT is ratified before December 31, 2018 by both parties it will come into effect in 2019. Should ratification by both parties occur after that date, the changes will not come into effect until 2020.

Management believes that the increase in tax rates can have a significant impact on the REIT as such, management is currently assessing available alternatives that would result in the REIT being subjected to a reduced rate of 15% once the DTT comes into effect.  Management has accounted for the deferred income tax liabilities based on the reduced rate of 15% and the assumption of the distribution of 50% of the OPCIs' net profits arising from capital gains upon disposition during the period ending June 30, 2018 since management is actively working to ensure the REIT will take the measures necessary to be subjected to this reduced rate. However, as management is still considering alternatives, any resulting impact on the operating structure has not yet been determined.

Last 24 Months -  Key Financial Information

The information provided in the table below has been calculated in accordance with GAAP.






3-month period ended

(in thousands of CAD$)

June 30,
2018

March 31,
2018

Dec. 31,
2017

Sept. 30,
2017

June 30,
2017

March 31, 
2017

Dec. 31, 
2016

Sept. 30, 
2016

Rental income

6,539

6,714

6,323

6,271

5,970

6,706

6,172

5,853

Net rental earnings

6,882

3,842

6,729

6,610

3,247

7,023

6,556

6,065

Earnings for the period

5,031

(3,604)

2,216

159

3,141

2,984

11,833

5,839

Earnings per Unit (CAD$)

0.18

(0.09)

0.10

0.01

0.15

0.14

0.60

0.37

 

PROPERTY CAPITAL INVESTMENTS

Fair value

The fair value of the REIT's investment property portfolio as at June 30, 2018 was $451.4 million (vs. $440.8 million as at December 31, 2017). The fair value of the French properties was $412.1 million (91.3% of investment properties value) and the fair value of the German properties was $39.2 million (8.7% of investment properties value).

The increase of $10.6 million is accounted for by a $7.6 million increase due to foreign exchange fluctuations, rent free periods of ($329) and CapEx charges of $980 and the net change in fair value of $1,925. Further details of the revaluation on the investment portfolio have been included in 'Net change in fair value of investment properties'.

Management principally uses discounted cash flows to determine the fair value of the investment properties. These values are supported by third party appraisals in conformity with the requirements of the Royal Institution of Chartered Surveyors Standards, and for the French properties also in conformity with the Charte de l'expertise immobilière, European Valuation Standards of TEGoVA (the European Group of Valuers' Association) and IFRS 13.

Building improvements

The REIT is committed to improving its operating performance by incurring appropriate capital expenditures to replace and maintain the productive capacity of its property portfolio to sustain its rental income generating potential over the portfolio's useful life.

Since the IPO in April 2013, a total of $1.7 million has been spent on the three initial French properties (Jeuneurs, Courbevoie, Vanves), funded by a reserve that was set aside by the vendors of the four initial properties. For the year to date, $2,290 has been spent on works completed across the portfolio.  

Guarantees, commitments and contingencies

The REIT and its subsidiaries have provided guarantees in connection with the finance lease liabilities and the mortgage loans, including pledge of affiliates of the REIT, first mortgages and assignment of receivables and future receivables. As at June 30, 2018, guarantees provided by the REIT with respect to its long-term debts include a preferential claim held by mortgage lenders on the Jeuneurs, Baldi, Veronese, Sablière and Hanover properties in the amount of $96.10 million. The REIT has also an undrawn commitment of $6.9 million (€4.5 million) relating to the Rueil development loan.

OTHER SIGNIFICANT ASSETS

Investments accounted for using the equity method

This section encompasses the 50% interest the REIT (through its subsidiaries) has in the Duisburg property, the 50% interest in the Walpur (Bad Homburg) property, the 25% interest in the Arcueil property, the 50% interest in the Neu-Isenburg property, 50% in the Stuttgart property and 50% in the Kösching property. Our share of fair value of the investment properties accounted for using the equity method was $92,337 as at June 30, 2018 compared to $79,094 as at December 31, 2017. This increase is due to the costs of $11,272 related to the acquisition of Kösching and refinancing of Neu-Isenburg, loan repayments on the Stuttgart property of ($875), the REIT's share of net losses from investments accounted for using the equity method of $1,574 and foreign exchange differences of $1,272

Acquisition loans and deposit

As at June 30, 2018, acquisition loans and deposit of $26.35 million consisted of the loan for the Rueil project.

Trade and other receivables

Trade and other receivables as at June 30, 2018 amounted to $6,273 compared to $5,192 as at December 31, 2017. The increase of $1,081 corresponds mainly to an increase of $78 arising from foreign exchange movements and an increase in trade receivables in relation recharged expenses relate to new joint venture acquisitions.

Other current assets

Other current assets as at June 30, 2018 amounted to $1,769 compared to $1,325 as at December 31, 2017. This resulted in a decrease of $444 for the quarter. This decrease is attributable to foreign exchange movements of $46 and an increase in VAT receivables.

PRESENTATION OF OUR CAPITAL

Liquidity and capital resources

Inovalis REIT's primary sources of capital are cash generated from operating activities, credit facilities, sharing the ownership of actual assets owned entirely and equity issues. Our primary uses of capital include property acquisitions, payment of distributions, costs of attracting and retaining tenants, recurring property maintenance, major property improvements and debt interest payments. We expect to meet all our ongoing obligations through current cash, cash flows from operations, debt refinancing and, as growth requires and when appropriate, new equity or debt issues. We can also sell some portion of assets owned to access capital, but this would be considered in the overall strategy of diversification of our portfolio.

The REIT's cash available was $27.0 million as at June 30, 2018 compared to $20.3 million as at December 31, 2017. The cash held as at December 31, 2017 was used to fund the acquisition of the Kösching asset in Q1, 2018. The increase in this cash balance is a result of the private placement completed during the Q2 2018, which will be used to fund future acquisitions.

Financing activities

Our debt strategy is to have secured mortgage financing with a term to maturity that is appropriate in relation to the lease maturity profile of our portfolio and then to put in place, when appropriate, interest-only financings. We intend to search for fixed rate financings or floating rate financings with a cap. As such, 91.1% of the REIT's senior debt benefits from an interest rate protection (67.8% in the form of a swap and 23.3% in the form a cap). Our preference is to have staggered debt maturities to mitigate interest rate risk and limit refinancing exposure in any particular period. With no financial institution representing more than 31% of our senior debt commitment, we also make sure that the REIT has a diversified base of senior debt providers. Our debt to book value stands at 42.4% and net of the $27.0 million of cash available (including financial current assets) as at June 30, 2018 (including the REIT's interest in the joint ventures), debt to book value stands at 38.0%.

Debt-to-book value

Indebtedness is calculated as the sum of (i) finance lease liabilities, (ii) mortgage loans, (iii) lease equalization loans, (iv) other long-term liabilities and (v) deferred tax liabilities. Indebtedness does not include the contribution from Unitholders that is recorded as a liability, as is the case at the REIT level for the Exchangeable securities, Private placement promissory note and at the partnership level for the contribution from the REIT and its partners.

Key performance indicators in the management of our debt are summarized in the following table.








As at June 30, 2018


As at December 31, 2017






Weighted average interest rate (1)


2.15%


2.16%

Debt-to-book value (2)


42.4%


43.7%

Debt-to-book value, net of cash (2)


39.8%


41.7%

Interest coverage ratio (3)


4.1 x


3.9 x

Debt due in next 12 months in thousand of CAD$


22,661


9,921

Weighted average term to maturity of debt (4)


6.1 years


6.5 years











(1)

Calculated as the weighted average interest rate paid on the finance leases and the mortgage financing.

(2)

The definition of debt-to-book value and of debt-to-book value, net of cash can be found in the Debt-to-book value note above.

(3)

Calculated as net rental earnings plus interest, less general and administrative expenses, divided by interest expense on the financial leases and mortgage financings.

(4)

Calculated as the weighted average term on all the financial leases and mortgage financings.

 

Leasehold and Mortgage Financing Maturity Profile
(% of amount outstanding as at June 30, 2018)

Leasehold and Mortgage Financing Maturity Profile (% of amount outstanding as at June 30, 2018) (CNW Group/Inovalis Real Estate Investment Trust)

 

2018

0%

2019

5%

2020

0%

2021

0%

2022

8%

2023

0%

2024

0%

2025

8%

2026

30%

2027

27%

2028

22%

 

ANALYSIS OF DISTRIBUTED CASH



Three months ended June 30


Six months ended June 30



2018


2017


2018


2017










Cash flows from operating activities (A)


(2,241)


6,283


9,937


16,087

Earnings before income taxes (B)


5,168


491


8,394


3,680

Declared distribution on Units (C) 


4,693


4,454


9,377


8,898

Excess (shortfall) of cash flows from operating activities over cash distributions paid (A-C)


(6,934)


1,829


560


7,189

Excess (shortfall) of profit or loss over cash distributions paid (B - C)


475


(3,963)


(983)


(5,218)










 

As shown in the table above, the cash flows related to operating activities as reported in the REIT's consolidated statement of cash flows was less than the distributions declared for the period ended June 30, 2018. This shortfall was financed by the excess of cash flows from operating activities of $7,494 from Q1 2018.

Every quarter, the REIT ensures that sufficient funds were being generated from rental operations to continue making distributions at the planned rate. To perform this assessment, management uses the FFO and AFFO measures presented in the section entitled Non-GAAP reconciliation (FFO and AFFO). These measures are used to determine the amount of funds generated by ongoing rental operations that are available for distribution. These measures remove from consideration, those gains and losses that are recognized for accounting purposes but that do not impact cash flow. They also remove from consideration various revenues and expenses that are recognized in profit or loss for accounting purposes but which do not arise from ongoing rental operations, for example because they were incurred to acquire revenue generating assets.

As quantified in the FFO and AFFO calculations, the funds used to make the distributions during the current quarter were generated through the REIT's ongoing rental operations.

The REIT expects to continue paying distributions based on the current plan.

RISK AND UNCERTAINTIES

We are exposed to various risks and uncertainties, many of which are beyond our control, the occurrence of which could materially and adversely affect our investments, prospects, cash flows, results of operations or financial condition and our ability to make cash distributions to Unitholders. We believe the risk factors described below are the most material risks that we face, however they are not the only ones. Additional risk factors not presently known to us or that we currently believe are immaterial could also materially and adversely affect our investments, prospects, cash flows, results of operations or financial condition and our ability to make cash distributions to Unitholders and negatively affect the value of the Units.

Risks relating to the REIT and its business

Risks inherent in the real estate industry may adversely affect our financial performance

Real estate ownership is generally subject to numerous factors and risks, including changes in general economic conditions, local economic conditions, the attractiveness of properties to potential tenants or purchasers, competition with other landlords with similar available space, and the ability of the owner to provide adequate maintenance at competitive costs.

The properties generate income through rent payments made by our tenants. Upon the expiry of any lease, there can be no assurance that the lease will be renewed, or the tenant replaced. Furthermore, the terms of any subsequent lease may be less favorable than the existing lease. Our cash flows and financial position would be adversely affected if our tenants were to become unable to meet their obligations under their leases or if a significant amount of available space in our properties could not be leased on economically favorable lease terms. In the event of default by a tenant, we may experience delays or limitations in enforcing our rights as sub-lessor and incur substantial costs in protecting our investment. Furthermore, at any time, a tenant may seek the protection of bankruptcy, insolvency or similar laws, which could result in the rejection and termination of the lease of the tenant and, thereby, cause a reduction in the cash flows available to us.

An investment in real estate is relatively illiquid. Such illiquidity will tend to limit our ability to vary our portfolio promptly in response to changing economic or investment conditions. The costs of holding real estate are considerable and during an economic recession we may be faced with ongoing expenditures with a declining prospect of incoming receipts. In such circumstances, it may be necessary for us to dispose of properties at lower prices to generate sufficient cash for operations and making distributions and interest payments.

Concentration of tenants may result in significant vacancies on the Properties

Five of our largest tenants, by percentage of total GLA, occupy approximately 62% of the total weighted areas. Although all five tenants are committed to multi-year leases, which are set to expire gradually between 2018 and 2029, there is no assurance that such tenants will continue to occupy such premises for the remainder of their lease terms. Some of them have break options before the end of their leases, and the earliest dates on which those five largest tenants may effectively move range between 2018 and 2021. To minimize this risk of vacancy, Inovalis REIT will continue to closely monitor all leases and ensure that they work with the current tenants to determine their future leasing plans, which would allow Inovalis REIT to source tenants in advance of the current tenants vacating the property.

Lease renewals, rental increases, lease termination rights and other lease matters

Expiries of leases for our properties will occur from time to time over the short and long-term. No assurance can be provided that we will be able to renew any or all of the leases upon their expiration or that rental rate increases will occur or be achieved upon any such renewals. The failure to renew leases or achieve rental rate increases may adversely impact our financial condition and results of operations and decrease the amount of cash available for distribution.

Although certain, but not all, leases contain a provision requiring tenants to maintain continuous occupancy of leased premises, there can be no assurance that such tenants will continue to occupy such premises which may have an adverse effect on us and could adversely impact our financial condition and results of operations and decrease the amount of cash available for distribution. In addition, certain leases contain a provision which gives tenants the right to terminate their leases upon payment of a penalty.

Moreover, pursuant to the lease agreement with the National Conservatory of Arts and Crafts, none of the value-added taxes on expenses legally due by the REIT are recoverable. However, property taxes and office taxes are recoverable. Similarly, pursuant to the Fresh & Co. and French Environment and Energy and Management Agency lease agreements, several forms of taxes, including but not limited to, property taxes, household refuse taxes and annual office taxes will be borne by the REIT. As a result, we will bear the economic cost of increases to these taxes.

Head Lease for properties

According to the head leases for certain of the properties, the owners of such properties have certain participation rights with respect to such properties pursuant to which a French dedicated SPV (a "French SPV") or the German SPV, as the case may be, would need to obtain written consent from the respective owner prior to taking certain actions with respect to such property, including cancelling or amending lease agreements for such property. If the owner does not give its prior consent to such actions, it may terminate the applicable head lease.

Environmental contamination on properties may expose us to liability and adversely affect our financial performance

The properties may contain ground contamination, hazardous substances, wartime relics (including potentially unexploded ordnance) and/or other residual pollution and environmental risks. Buildings and their fixtures might contain asbestos or other hazardous substances above the allowable or recommended thresholds, or the buildings could bear other environmental risks. Prior to acquiring the interests in the properties (including the leasehold interests), we undertook environmental studies on each property. No sign of pollution was evidenced on any of the properties.

We are subject to various federal, state and municipal laws relating to environmental matters. Such environmental laws impose actual and contingent liabilities on us to undertake remedial action on contaminated sites and in contaminated buildings. The costs of any removal, investigation or remediation of any residual pollution on such sites or in such buildings as well as costs related to legal proceedings, including potential damages, regarding such matters may be substantial.

We have insurance in place to protect against certain environmental liabilities in respect of certain of the properties, with limits, which are customary and available for portfolios similar to ours.

We make the necessary capital and operating expenditures to ensure compliance with environmental laws and regulations. Although there can be no assurance, we do not believe that costs relating to environmental matters will have a material adverse effect on our investments, financial condition, results of operations or distributions or cash interest payments.

We may incur significant capital expenditures and other fixed costs

Certain significant expenditures must be made throughout the period of ownership of real property, regardless of whether the property is producing sufficient income to pay such expenses. In order to retain desirable rentable space and to generate adequate revenue over the long term, we must maintain or, in some cases, improve each property's condition to meet market demand, which can entail significant costs we may not be able to pass on to our tenants.

Any failure by us to undertake appropriate maintenance and refurbishment work in response to the factors described above could entitle tenants to withhold or reduce rental payments or even to terminate existing letting contracts. Any such event could have a material adverse effect on our cash flows, financial condition and results of operations and our ability to make distributions on the Units.

Financing risks, leverage and restrictive covenants may limit our ability for growth

The real estate industry is capital intensive. We will require access to capital to maintain our properties, as well as to fund our growth strategy and significant capital expenditures from time to time. There is no assurance that capital will be available when needed or on favorable terms. Our failure to access required capital could adversely impact our investments, cash flows, operating results or financial condition, our ability to make distributions on the Units and our ability to implement our growth strategy.

A high level of indebtedness increases the risk that we may default on our debt obligations. Our ability to make scheduled payments of the principal of, or interest on, and to otherwise satisfy our debt obligations depends on future performance, which is subject to the financial performance of our properties, prevailing economic conditions, prevailing interest rate levels, and financial, competitive, business and other factors, many of which are beyond our control.

Changes in government regulations may affect our investment in our properties

We are subject to laws and regulations governing the ownership and leasing of real property, employment standards, environmental and energy efficiency matters, taxes and other matters. It is possible that future changes in applicable federal, state, local or common laws or regulations or changes in their enforcement or regulatory interpretation could result in changes in the legal requirements affecting us (including with retroactive effect). In addition, the political conditions in the jurisdictions in which we operate are also subject to change. Any changes in investment policies or shifts in political attitudes may adversely affect our investments. Any changes in the laws to which we are subject in the jurisdictions in which we operate could materially affect the rights and title to the properties. All of the properties are located in France and Germany. Although the governments in France and Germany are stable and generally friendly to foreign investments, there are still political risks. It is not possible to predict whether there will be any further changes in the regulatory regime(s) to which we are subject or the effect of any such change on our investments.

Failure to receive deductions for interest payments may adversely affect our cash flows, results of operations and financial condition

In the course of the acquisition of the properties, we entered into financing transactions with third parties and affiliates. These financing agreements will require us to pay principal and interest. There are several rules in German tax laws restricting the tax deductibility of interest expenses for corporate income and municipal trade tax purposes. Such rules have been changed considerably on several occasions in recent past. As a result, major uncertainties exist as to the interpretation and application of such rules, which are not yet clarified by the tax authorities and the tax courts. The tax deductibility of interest expenses depends on, among other things, the details of the security structure for debt financings, the annual amount of tax net-debt interest, the amounts and terms of unitholder or affiliate financings and our general tax structure. There is a risk of additional taxes being triggered on the rental income and capital gains in case the tax authorities or the tax courts adopt deviating views on the above. If this were the case, this would result in a higher tax burden and, consequently, could have a material adverse effect on our cash flows, financial condition and results of operations and ability to pay distributions on the Units.

Changes in currency exchange rates could adversely affect our business

Substantially all our investments and operations are conducted in currencies other than Canadian dollars; however, we pay distributions to Unitholders in Canadian dollars. We also raise funds primarily in Canada from the sale of securities in Canadian dollars and invest such funds indirectly through our subsidiaries in currencies other than Canadian dollars. As a result, fluctuations in such foreign currencies against the Canadian dollar could have a material adverse effect on our financial results, which are denominated and reported in Canadian dollars, and on our ability to pay cash distributions to Unitholders. We have implemented active hedging programs to offset the risk of revenue losses and to provide more certainty regarding the payment of distributions to Unitholders if the Canadian dollar increases in value compared to foreign currencies.

Changes in interest rates could adversely affect our cash flows and our ability to pay distributions and make interest payments

When concluding financing agreements or extending such agreements, we depend on our ability to agree on terms for interest payments that will not impair our desired profit and on amortization schedules and that do not restrict our ability to pay distributions. In addition to the variable rate portion of the leaseholds in respect of the properties, we may enter into financing agreements with variable interest rates if the current historical low level of interest rates continues. There is a risk that interest rates will increase, which would result in a significant increase in the amount paid by us and our subsidiaries to service debt, resulting in a decrease in distributions to Unitholders, and could impact the market price of the Units.

We rely on Inovalis SA for management services

We rely on Inovalis SA with respect to the asset management of our properties and the property management of the properties. Consequently, our ability to achieve our investment objectives depends in large part on Inovalis SA and its ability to advise us. This means that our investments are dependent upon Inovalis SA' business contacts, its ability to successfully hire, train, supervise and manage its personnel and its ability to maintain its operating systems. If we were to lose the services provided by Inovalis SA or its key personnel, our investments and growth prospects may decline.

While the Trustees have similar oversight responsibility with respect to the services provided by Inovalis SA pursuant to the management agreement, the services provided by Inovalis SA are not performed by employees of the REIT, but by Inovalis SA directly and through entities to which it may subcontract. On March 15, 2018, the Board of Trustees announced its approval of the extension of the management agreement effective April 1, 2018. The Management Agreement was extended for an initial term of three years, not to exceed April 1, 2021 and will be automatically renewed for an additional two years if the REIT's AFFO per unit for the year ended December 31, 2020 is greater than 115% of the AFFO per unit of the REIT as at December 31, 2017.

Investments in, and profits and cash flows from, properties may be lost in the event of uninsured or underinsured losses to properties or losses from title defects

We carry general liability, umbrella liability and excess liability insurance with limits that are typically obtained for similar real estate portfolios in France and Germany and otherwise acceptable to the Trustees. For the property risks we intend to carry "Multi-Risk" property insurance including but not limited to, natural catastrophic events and loss of rental income insurance (with at least a 12 to 18-month indemnity period). We also carry boiler and machinery insurance covering all boilers, pressure vessels, HVAC systems and equipment breakdown. There are, however, certain types of risks (generally of a catastrophic nature such as from war or nuclear accident) that are uninsurable under any insurance policy. Furthermore, there are other risks that are not economically viable to insure at this time. We partially self-insure against terrorism risk for our entire portfolio. We have insurance for earthquake risks, subject to certain policy limits, deductibles and self-insurance arrangements. Should an uninsured or underinsured loss occur, we could lose our investment in, and anticipated profits and cash flows from, one or more of our properties, but we would continue to be obligated to repay any recourse mortgage indebtedness on such properties. We do not carry title insurance on the properties. If a loss occurs resulting from a title defect with respect to a property where there is no title insurance, or the loss is in excess of insured limits, we could lose all or part of our investment in, and anticipated profits and cash flows from, such property.

GAAP reporting may result in our consolidated statement of financial position and consolidated statement of earnings being subject to volatility as the fair value of our portfolio changes

The fair value of our properties is dependent upon, among other things, rental income from current leases, assumptions about rental income from future leases reflecting market conditions, expected future cash outflow in respect of such leases, the demand for properties such as the properties, the availability and cost of financing and general economic conditions. A change in one or a combination of these factors, many of which are not controlled by us, may have a material impact to the fair value of our properties. Our chosen accounting policy under GAAP requires that real estate assets be recorded at "fair value" with changes in fair value being recorded in earnings in the period of change. Accordingly, our statement of financial position and our statement of earnings are subject to volatility as the fair value of its real estate portfolio changes and these changes may be material.

Reliance on partnerships

The REIT has a material non-controlling interest in partnerships with several institutional investors. These arrangements create a risk as the business objectives or economic interests of the partner, as in any joint business arrangement, may not be aligned with those of the REIT. The partner may want to make decisions that negatively affect the value of its real estate assets or income of the REIT. Such investments may involve risks not present in investments where a third party is not involved, including the possibility that a partner may have financial difficulties resulting in a negative impact on the investment or be liable for the actions of its third-party partner. Although the REIT may not have control over these investments and therefore, may have a limited ability to protect its position, such partnership arrangements contain terms and conditions which, in the opinion of the independent trustees, are commercially reasonable, including without limitation such terms and conditions relating to restrictions on the transfer, acquisition and sale of the REIT's and any joint venturer's interest in the joint venture arrangement, provisions to provide liquidity to the REIT, provisions to limit the liability of the REIT and its Unitholders to third parties and provisions to provide for the participation of the REIT in the management of the joint venture arrangements. The REIT's investment in properties through joint arrangements is subject to the investment guidelines set out in the Declaration of Trust.

Income taxes

Canadian income taxes

The Trust is considered a mutual fund trust for income tax purposes in Canada. In Canada, mutual fund trusts are not taxed on income earned in a taxation year, to the extent that such income has been distributed to Unitholders prior to the end of the taxation year. Indeed, according to Article 11 of the REIT's Amended and Restated Declaration of Trust, dated April 10, 2013, the trustees shall make payable to Unitholders a distribution of sufficient net realized capital gains and income that the Trust shall not be liable to pay taxes under Part 1 of the Tax Act. As a result, there is generally little possibility of the Trust being taxable on ordinary income under Part 1 of the Income Tax Act. Consequently, the Trust does not recognize Canadian income taxes under IAS 12 Income taxes because it has an "in-substance" exemption.

Foreign income taxes

The REIT's subsidiaries are subject to tax either on their taxable income or on a withholding basis under applicable legislation in France, Germany, Luxembourg and the United States. These subsidiaries account for their current or recovered taxes at the current enacted and substantively enacted tax rates and use the liability method to account for deferred taxes. The tax expense related to taxable subsidiaries for the period comprises current and deferred taxes.

The REIT's subsidiaries that hold the leasehold rights on the properties located in France are established in France and should therefore be considered as tax residents in France. Under current French tax legislation, income derived from the French REIT's subsidiaries, incorporated under the form of Société Civile Immobilière subject to article 8 of the French Tax Code, and allocated to INOPCI 1 should be corporate income tax exempt in the hands of INOPCI* 1 on the basis that INOPCI 1 complies with its distribution obligations. A withholding tax should be levied in France on dividend distributions made by INOPCI 1 which is an OPCI (a collective undertaking for real estate investment) to CCE. CCE, CCH, Arcueil SI Sarl and CanCorpCologne Sarl are established in Luxembourg as fully taxable companies, subject to annual corporate income, municipal business and net wealth taxes. There is a minimum net wealth tax and corporate income tax in Luxembourg under certain condition. Dividends and liquidation dividends derived by CCE from the French OPCI may be tax exempt in Luxembourg for corporate income tax and municipal business tax purposes. CCE will benefit from the Luxembourg participation exemption on any dividend income or liquidation proceeds received from CCH, Arcueil SI Sarl, CanCorpCologne Sarl and Square Isenburg GmbH.

Arceuil SCS is a Luxembourg partnership that is tax transparent for Luxembourg corporate income tax purposes, i.e. all the income and expenses are deemed to be realized directly by the partners. As CCE holds 25% of the partnership interest, 25% of the income and expenses will be allocated to the latter from a Luxembourg tax perspective.

On 20 March 2018, the Luxembourg and French Governments signed a new double tax treaty (DTT) with France, together with an accompanying Protocol. The tax treaty will enter into force once both parties complete the ratification process. Under the current DTT, the REIT, through its subsidiary located in Luxembourg, should suffer French withholding tax at the 5% treaty rate on the dividend received from French OPCI. Under the new DTT, such dividend distributions would be subject to withholding tax at a 30% rate which can potentially be reduced to 15% in some specific cases.

Deferred income tax liabilities are recognized to the deferred income tax expense relating to the origination of temporary differences arising from the unrealized gains on investment properties located in France and Germany. Management has estimated that the REIT should benefit from the reduced rate of 15% and has revised the deferred income tax liabilities on that basis for the period ending June 30, 2018. Since the French OPCI is required to distribute 50% of the capital gains realized on the disposal of assets, the deferred tax has been calculated on 50% of the unrealized capital gain.

Since 2016, CCH holds 94% of Hannover CanCorp GmbH & KG ("HCC"), investment property holding a building in Germany. The latter is considered a tax transparent entity from a German as well as Luxemburgish tax perspective. CCD and TFICC (collectively called the "Lux Co") are Luxembourg limited liability companies that are managed in Luxembourg and, therefore, should not be considered to be tax resident of Germany for German tax purposes. Similarly, Cologne is an SCI and should not be considered to be tax resident of Germany for German tax purposes (the Lux Co, Cologne and CCH are collectively called the "German Co"). However, the German Co would be subject to corporate income tax ("CIT") in Germany on their German source income (or in case German Co is a partnership and therefore transparent for CIT purposes its partners). As the German Co's rental revenues would be German source income, such (net) income would be subject to CIT, even if the German Co (and their shareholders) are not German tax residents. This is true irrespective of whether German Co is a corporation or a partnership and therefore transparent. The right to tax such income by Germany should not be waived under the double tax treaty between Germany and Luxembourg and the double tax treaty between Germany and France because the German Co's properties are located in Germany and income from German real estate is taxed in the country where the real estate is located. To determine taxable income for CIT purposes, a tax payer may deduct certain expenses incurred in connection with its German source income (e.g., with respect to the acquisition and ownership of real property (in particular depreciation) and certain operating expenses) provided that such costs are incurred on arm's length terms. Square Isenburg GmbH and TK Bau Verwaltung GmbH are German limited liability companies, fully taxable in Germany. That means the income from the real estate is not only subject to CIT but in principle also subject to trade tax. However, trade tax reductions or trade tax exemptions might be applicable.

*"INOPCI" refers to Organisme de placement collectif en immobilier which refers to French real estate collective investment undertakings. OPCIs are they are tax exempt vehicles once they distribute 50% of their net profit.

OUTLOOK

We believe that the current market environment is a favorable one for the REIT to prosper. In addition to actively managing our properties, we are continuously assessing potential acquisitions in our target markets and will focus on the ones offering value and stability. Our long-term credit worthy tenants, low cost of debt with proper maturity and the foreign exchange rate contracts for our distributions until October 2020, not only provide investors with steady cash flows, but also serve as a basis for future growth. In addition of the cash available, we can also sell some portion of assets that we own to get access to additional cash and at the same time diversify our portfolio risk.

CRITICAL ACCOUNTING POLICIES

The preparation of the REIT's audited consolidated financial statements in conformity with GAAP requires management to make judgments and estimates affecting the reported amounts of revenues and investment properties owned directly and indirectly at the reporting date. However, uncertainty about these estimates could result in outcomes requiring a material adjustment to the carrying amount of the asset or liability affected in future periods.

We consider the following policies and estimates to be the most critical in understanding the assumptions and judgments that are involved in preparing our financial statements and the uncertainties that could affect our financial results, financial condition and cash flows: (i) recognition and valuation of investment properties; (ii) distinction between business combinations or asset acquisitions and (iii) classification of and accounting for joint arrangements.

A more detailed description of significant accounting policies and critical accounting judgment and estimates that we apply under GAAP is provided in notes 3 and 4 of the consolidated financial statements as at December 31, 2017.

DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROLS OVER FINANCIAL REPORTING

The REIT's Chief Executive Officer (the "CEO"), and the Chief Financial Officer (the "CFO") of the REIT are responsible for establishing and maintaining the REIT's disclosure controls and procedures ("DCP") including adherence to the Disclosure Policy adopted by the Board of Trustees. The Disclosure Policy requires all staff and certain other personnel providing services to the REIT to keep senior management fully apprised of all material information affecting the REIT so that they may evaluate and discuss this information and determine the appropriateness and timing for public release.

The REIT's CEO and the CFO are also responsible for the design of internal controls over financial reporting ("ICFR"). Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and disposition of the assets of the REIT, (2) provide reasonable assurance that all transactions are recorded as necessary to permit the preparation of financial statements in accordance with International Financial Reporting Standards, and that receipts and expenditures of the REIT are being made only in accordance with authorizations of the management and Trustees of the REIT, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the REIT's assets that could have a material effect on the REIT's financial statements.

The CEO and CFO have evaluated the effectiveness of the Company's DCP and ICFR as required by National Instrument 52-109F2 issued by the Canadian Securities Administrators.

A control system, no matter how well conceived and operated, can provide only reasonable, and not absolute, assurance that the objectives of the control system are met. As a result of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, including instances of fraud, if any, have been detected. These inherent limitations include, amongst other items: (i) that Management's assumptions and judgments could ultimately prove to be incorrect under varying conditions and circumstances; or (ii) the impact of isolated errors. Additionally, controls may be circumvented by the unauthorized acts of individuals, by collusion of two or more people, or by Management override. The design of any system of controls is also based, in part, upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals.

Discussion of Non-GAAP metrics

NON-GAAP FINANCIAL MEASURES

Funds from Operations and Adjusted Funds from Operations

FFO and AFFO are not measures recognized under IFRS and do not have standardized meanings prescribed by IFRS. FFO and AFFO are supplemental measures of performance for real estate businesses. We believe that AFFO is an important measure of economic performance and is indicative of our ability to pay distributions, while FFO is an important measure of operating performance and the performance of real estate properties. The IFRS measurement most directly comparable to FFO and AFFO is net earnings. See the Non-IFRS Reconciliation (FFO and AFFO) section for reconciliation of FFO and AFFO to net earnings.

FFO is defined as net earnings in accordance with IFRS, excluding: (i) acquisition costs, (ii) gain on bargain purchase and option costs, (iii) net change in fair value of investment properties, (iv) net change in fair value of financial instruments at fair value through profit and loss, (v) changes in fair value of Exchangeable securities and Private placement promissory note, (vi) distribution on Exchangeable securities and Private placement promissory note (vii) adjustment for property taxes accounted for under IFRIC 21 (if any), (viii) loss on exercise of lease option, (ix) adjustment for foreign exchange gains or losses on monetary items not forming part of an investment in a foreign operation, * gain on disposal of an interest in a subsidiary and the non-cash portion of earnings from investments accounted for using the equity method, (xi) finance income earned from loans to joint-ventures, (xii) loss on refinancing of debts and other non-recurring finance costs, (xiii) deferred taxes and (xiv) gains or losses from non-recurring items, (xv) additional non-recurring income (loss) from JVs, (xvi) minority interest. It has also been adjusted to exclude the distributions declared on Exchangeable securities and on Private placement promissory note. These distributions are recognized in profit and loss consistent with the classification of the Exchangeable securities as a liability. However, they are not to be considered when determining distributions for the Unitholders as indeed they are subordinated to the distributions to the Unitholders.

Exchangeable securities and Private placement promissory note are recorded as liability. Exchangeable securities are recorded at fair value through profit and loss in accordance with IFRS and Private placement promissory note is recorded at fair value. However, both are considered as equity for the purposes of calculating FFO and AFFO as they are economically equivalent to the REIT's Units, with the same features and distribution rights that are economically equivalent to the distribution received by Unitholders.

Other non-recurring finance costs corresponds mainly to the foreign exchange hedge maintained on the Arcueil property in line with the Arcueil JV agreement.

Additional non-recurring income (loss) from JV's is related to the Arcueil JV. As per the JV agreement the REIT, upon asset disposal, is entitled to receive 75% of the variance of fair value of investment properties, reduced by 100% of foreign exchange derivative costs.

AFFO is defined as FFO subject to certain adjustments, including adjustments for: (i) the non-cash effect of straight line rents, (ii) the cash effect of the lease equalization loans (equalizing the rent payments, providing the REIT with stable and predictable monthly cash flows over the term of the France Telecom leases in the Vanves property, the Smart & Co. lease in the Courbevoie property and the Rue du Commerce leases in the Baldi property (iii) amortization of fair value adjustment on assumed debt, (iv) the non-cash portion of the asset management fees paid in Exchangeable securities, (v) capital expenditures, calculated based on the projected capital expenditure for the ensuing 24 months, apportioned equally across the 24 month period and adjusted on an annual basis based on the expenditures incurred and (vi) amortization of transaction costs on mortgage loans.

FFO and AFFO should not be construed as alternatives to net earnings or cash flow from operating activities, determined in accordance with IFRS, as indicators of our performance. Our method of calculating FFO and AFFO may differ from other issuers' methods and accordingly may not be comparable to measures used by them.

Debt-to-book value

Our debt-to-book value ratio is calculated on a look-through basis and takes into account the REIT apportioned amount of indebtedness at the partnership level. Indebtedness at the REIT level, as well as at the different partnership levels is calculated as the sum of (i) finance lease liabilities, (ii) mortgage loans, (iii) lease equalization loans, (iv) other long-term liabilities and (v) deferred tax liabilities. Indebtedness does not take into account the contribution from Unitholders that is recorded as a liability, as is the case at the REIT level for the Exchangeable securities, Private placement promissory note and at the partnership level for the contribution from the REIT and its partners.

CONSOLIDATED FINANCIAL INFORMATION

This presentation incorporates the REIT's proportionate share of income and expenses from investments in joint ventures. Please refer to "Non-GAAP reconciliation".



Three months ended June 30


Six months ended June 30

(in thousands of CAD$)


2018


2017


2018


2017


Rental income 


9,830


8,100


19,548


15,672

Service charge income 


2,897


1,747


5,856


3,927

Service charge expenses


(2,559)


(1,476)


(9,236)


(6,669)

Other revenues


226


(6)


233


80

Other property operating expenses


(80)


(74)


(171)


(116)

Net rental earnings


10,314


8,292


16,230


12,893










Administration expenses


(2,004)


(1,556)


(3,961)


(2,997)

Foreign exchange gain (loss)


27


(62)


82


(62)

Net change in fair value of investment properties


(778)


547


2,092


3,027

Acquisition costs


88


(1,079)


(1,111)


(1,116)

Operating earnings


7,647


6,142


13,332


11,746










Gain (loss) on financial instruments at fair value through P&L


(199)


(2,343)


(1,186)


(1,738)

Finance income


927


600


2,995


1,157

Finance costs


(3,141)


(1,989)


(6,312)


(3,944)

Additional income (loss) from Arcueil's JV


2,093


(224)


88


(741)

Distributions on Exchangeable securities


(286)


(398)


(554)


(777)

Net change in fair value of Exchangeable securities


(48)


(1,034)


66


(1,699)

Net change in fair value of Promissory notes


(2,201)


-


(1,074)


-

Earnings before income taxes


4,792


754


7,355


4,004










Current income tax expense


54


(92)


(94)


(126)

Deferred income tax expense


274


(448)


(5,743)


(519)










Earnings for the period


5,120


213


1,518


3,360

Non-controlling interest


(1)


55


1


60

Earnings for the period (part attributable to the Trust)


5,121


159


1,517


3,300

 

Net rental earnings

Rental income for the three-month period ended June 30, 2018 was $9,830 compared to $8,100 in Q2 2017. The $1,730 year over year increase includes $315 attributable to FX rate movement. The remaining increase of $1,415 includes $1,533 relating to new acquisitions – Stuttgart, Delizy, Neu-Isenburg and Kösching (Ingolstadt), the decrease from of $186 following the sale of the Cologne asset and the impact of indexation of $74. The departure of tenants is offset by new arrivals.

Rental income for the six-month period ended June 30, 2018 of $19,548 represented an increase of $3,876 compared to $15,672 for the same period in 2017. The year over year increase is accounted for by $1,089 attributable to FX, $166 of indexation. The remaining $2,415 comes from new acquisitions the Stuttgart, Pantin, Neu-Isenburg and Kösching (Ingolstadt) properties of $2,787 partially offset by the sale of the Cologne property ($372). The departure of tenants is offset by new arrivals.  

Net rental earnings for the three-month period ended June 30, 2018 was $10,314 compared to $8,292 in Q2 2017. Of the $2,022 increase year over year includes a positive variance of $426 attributable to FX movement. The remaining balance of $1,596 relates to $1,639 relating to the Pantin, Stuttgart, Neu-Isenburg and Kösching (Ingolstadt) properties, partially offset by the sale of the Cologne property ($56) and indexation of $113.

Net rental earnings for the six-month period ended June 30, 2018 was $16,230 compared to $12,893 for the same period in 2017. Of the $3,337 increase year over year $896 is attributable to FX movement. The $2,441 is comprised of $2,666 related to the above listed new acquisitions, the negative impact of ($360) from the sale of Cologne, indexation of $166 with the balance of ($31) corresponding to other revenue and IFRIC21 impact relating to the Delizy asset acquired in Q3 2017.  

Administration expenses

Administration expenses are primarily comprised of asset management fees paid to Inovalis SA and other general administrative expenses such as trustee fees, directors' and officers' liability insurance, professional fees (including accounting fees), legal fees, filing fees, Unitholder related expenses and other expenses.

Administration expenses for the quarter ended June 30, 2018 amounted to $2,004 vs. $1,556 for the same quarter in 2017. The $974 is related to the asset management fees paid to Inovalis SA vs. $889 for the quarter ended June 30, 2017 and $1,030 to other expenses vs. $667 for the quarter ended June 30, 2017. The overall increase in management fees of $85, including the positive movement in foreign exchange of $34, is a net increase of $51 arising from an increase of $216 from new acquisitions. This is offset by the impact in the overall reduction in asset management fees and the sale of the Cologne asset. Other expenses increased $363 year over year, of which $27 is attributable to foreign exchange movement, the remaining increase of $336 includes approximately $200 in exceptional expenses in the form of listing fees related to the creation of the reserve for units to pay the management fees, the increase of the DRIP reserve and fees connected to the AGM held in Q2. The remaining $136 increase is related to the new acquisitions, increased activity at the Luxembourg holding company level and the increase in costs related to the Canadian structure.

Administration expenses for the six-month period ended June 30, 2018 amounted to $3,961 vs. $2,997 for the same quarter in 2017. The $2,086 is related to the asset management fees paid to Inovalis SA vs. $1,727 for the six-month period ended June 30, 2017 and $1,875 to other expenses vs. $1,270 for the six-month ended June 30, 2017. The overall increase in management fees of $359 is driven by the movement in foreign exchange of $120 and an increase of $426 attributable to new acquisitions and a reduction of $187 attributable mainly to the new management agreement terms and the sale of the Cologne property. Other expenses increased $605 year over year, of which $88 is attributable to foreign exchange movement. The remaining $517 includes the above mentioned exceptional fees of approximately $200 and a $317 increase related to the new acquisitions, increased activity at the Luxembourg holding company level and the increase in costs related to the Canadian structure.

Net change in fair value of investment properties

During the quarter ended June 30, 2018, the net change in fair value of investment properties recognized in earnings was a loss of $778. The French assets were valued as at June 30, 2018, which resulted in an increase of approximately $1.9m. The German assets are valued on an annual basis. The increase in value was offset by works completed across the portfolio and the IFRIC 21 impact which results in a net loss. This figure compares to the $547 gain in the quarter ended June 30, 2017.

Acquisition costs

Acquisition costs were ($88) for the quarter ended June 30, 2018, relating to a reimbursement to the acquisition costs incurred in Q1 2018. This compares to acquisition costs of $1,079 for the quarter ended June 30, 2017.

For the six-month period ended June 30, 2018 acquisition costs were $1,111 corresponding mainly to the acquisition of the Kösching asset. This compares with acquisition costs of $1,116 for the six-month period ended June 30, 2017.

Gain (loss) on financial instruments at fair value through profit and loss

For the quarter ended June 30, 2018, the REIT recognized a loss of $199 on financial instruments at fair value through profit and loss compared to a loss of $2,343 for the same period in 2017. This loss is mostly the result of the variation in value realized on the interest rate derivative contracts. For the six-month period ended June 30, 2018, the REIT recognized a loss of $1,186 compared to a loss of $1,738 for the same period in 2017.

Finance income

For the three-month period ended June 30, 2018, finance income of $2,995 consists chiefly of interest on the acquisition loans related to the Rueil property.

As at June 30, 2018, the REIT had deployed €17.2 million ($26.4 million) of the €21.75 million ($33.4 million) acquisition and redevelopment loan to a company 80%-owned by Inovalis SA, related to the Rueil property, in the Paris Western periphery. The loan bears an annual interest rate of 8.5%, with an effective interest rate of 14.0% which incorporates the 20% of the profit that will accrue to the REIT upon the sale of the property to a third party. The final portion of the loan commitment of €4.6 million ($7.0 million) is expected to be deployed in 2018.

Finance costs

For the three-month period ended June 30, 2018, the finance costs amounted to $3,141 vs $1,989 for Q2 2017, a year-over-year increase of $1,152. The $3,141 includes $1,575 of interest costs related to finance leases, mortgage loans, the lease equalization loans, $362 of interests related to SWAP contracts, $958 relating to the promissory note and $247 of other finance costs corresponding mainly to amortization of transaction costs on mortgage loans and promissory notes and the foreign exchange hedge maintained on the Arcueil property in line with the Arcueil JV agreement. The interest on promissory notes, which were issued during 2017 and 2018, and new loans related to JV acquisitions (Stuttgart, Delizy, Neu-Isenburg and Kösching (Ingolstadt)) were chiefly responsible for the year-over-year increase of $1,152.

For the six-month period ended June 30, 2018, the finance costs amounted to $6,312 vs $3,944 for Q2 2017, an increase of $2,368. The $6,312 includes $3,381 of interest costs related to finance leases, mortgage loans, the lease equalization loans, $700 of interests related to SWAP contracts, $1,536 relating to the promissory note and $696 of other finance costs corresponding mainly to amortization of transaction costs on mortgage loans and promissory notes and the foreign exchange hedge maintained the monthly distribution. The interest on promissory notes, which were issued during 2017 and 2018, and new loans related to JV acquisitions (Stuttgart, Delizy, Neu-Isenburg and Kösching (Ingolstadt)) were chiefly responsible for the year-on-year increase of $2,368.

Additional income (loss) from Arcueil JV

For the Arcueil joint venture, the consolidation presentation reflects a 25% proportionate share of results which aligns with the REIT 25% ownership interest. Per the joint venture agreement, and as reflected in the condensed interim consolidated financial statements, the REIT is entitled to receive a 25% share of the net earnings and, upon asset disposal, 75% of the variance of fair value of investment properties, reduced by 100% of foreign exchange derivative costs. This additional gain from the Arcueil joint venture is $2,093 for the three-month period ended June 30, 2018 compared to a loss of ($224) in Q2 2017.

Distributions on Exchangeable securities

Distributions to the holders of Exchangeable securities (see note 9 in Condensed Interim Consolidated Financial Statements as at June 30, 2018) are calculated in a manner to provide a return that is economically equivalent to the distributions received by the Unitholders. During the three-month period ended June 30, 2018 the distributions recognized on Exchangeable securities were $286 compared to $398 for the same period in 2017. The year-over-year decrease arises from the reduction in the number of Exchangeable securities in issuance following the conversion by Inovalis S.A. of 500,014 Exchangeable securities into Units in December 2017 and a further conversion of 419,059 Exchangeable securities in January 2018, partially offset by the increase due to the additional Exchangeable securities received by Inovalis SA in lieu of asset management fees.

Net change in fair value of Exchangeable securities

The net change in value of the Exchangeable securities, as well as the cost of distributions recognized on Exchangeable securities, are recognized in profit and loss because, for financial reporting purposes, the Exchangeable securities have been classified as a liability at fair value through profit or loss.

For the three-month period ended June 30, 2018, the REIT reported a loss of $48 which is the result of the increase in the closing price of the units which was $10.10 on June 30, 2018 compared to $10.05 on March 31, 2018.

Current income tax expense

The current income tax expense of $54 for the quarter ended June 30, 2018 is mainly due to a withholding tax paid by the REIT's Luxembourg holding company on the dividends it received from affiliates and tax paid by the REIT's Luxembourg entities.

Deferred tax expense

The deferred income tax expense of $274 (and deferred income tax liabilities) corresponds to the origination of temporary differences arising from investment properties located in France and Germany. The increase of $722 results principally from the anticipated change in the withholding tax rate between France and Luxembourg. Please refer to Income Tax for further details.

Last 24 Months – Key Financial Information

The information provided in the table below includes our proportionate share of income from investments in joint ventures. Refer to "Non-GAAP section" for reconciliation to our condensed interim consolidated financial statements.











3-month period ended

(in thousands of CAD$)

June 30,
2018

March 31,
2018

Dec. 31, 
2017

Sept. 30,
2017

June 30,
2017

March 31, 
2017

Dec. 31,
2016

Sept. 30,
2016

Rental income

6,539

6,714

6,381

6,323

6,271

5,970

6,706

6,172

Adjusted rental income

9,830

9,718

8977

8,659

8,100

7,571

8,188

7,617

Net rental earnings

6,882

3,842

7,410

6,729

6,610

3,247

7,023

6,556

Adjusted net rental earnings

10,314

5,915

9891

9,012

8,292

4,601

8,698

7,902

Adjusted Earnings for the period

5,120

(3,604)

13,651

2,216

159

3,141

2,984

11,833

Adjusted Earnings per Unit (CAD$)

0.18

(0.09)

0.63

0.10

0.01

0.15

0.14

0.60

 

NON-GAAP RECONCILIATION

Funds from Operations ("FFO")

The REIT presents its FFO calculations in accordance with the Real Estate Property Association of Canada ("REALPAC") White Paper on FFO & AFFO for IFRS issued in February 2017.

Investments in joint ventures

The REIT's proportionate share of the financial position and results of operation of its investment in joint ventures, which are accounted for using the equity method under IFRS in the condensed interim consolidated financial statements, are presented below using the proportionate consolidation method (with the exception of Arcueil), which is a non-GAAP measure. For the purpose of the proportionate consolidation, the initial investment of both partners in the joint ventures were considered as being equity investments as opposed to a combination of equity and loans and accordingly, the related proportionate consolidation balance sheet items were eliminated as well as the associated finance income and finance costs.

For the Arcueil joint venture, the consolidation presentation reflects a 25% proportionate share of results which aligns with the REIT 25% ownership interest. Per the joint venture agreement, and as reflected in the condensed interim consolidated financial statements, the REIT is entitled to receive a 75% share of the net profit. A line entitled "additional gain or loss from Arcueil joint venture" in the consolidated statement of earnings reconciliation to condensed interim consolidated financial statements bridges both presentations. A reconciliation of the financial position and results of operations to the balance sheets and consolidated statements of earnings is included in the tables shown in the Non-GAAP Reconciliation section.

For the three-month period and year ended June 30, 2018, the proportional financial results include the following proportion of the revenues and expenses of each one of the joint ventures: 50% respectively for Duisburg, Walpur (Bad Homburg), Stuttgart, Pantin, Neu-Isenburg and Kösching and 25% for Arcueil.

FFO and AFFO



Three months ended June 30


Six Months ended June 30

(in thousands of CAD$)


2018

2017


2018

2017








Earnings for the period


5,121

159


1,517

3,300








Add/(Deduct):







Adjustment to related acquisition costs


(88)

1,079


1,111

1,116

Net change in fair value of investment properties


778

(547)


(2,092)

(3,027)

(Gain) loss on financial instruments at fair value through profit and loss


199

2,343


1,186

1,738

Adjustment for property taxes accounted for under IFRIC 21


(1,063)

(825)


2,094

1,781

Additional income (loss from Arcueil's JV)


(2,093)

224


(88)

741

Interest on promissory notes


958

-


1,536

-

Distributions on Exchangeable securities


286

398


554

777

Change in fair value of Exchangeable securities  


48

1,034


1,074

1,699

Change in fair value of Promissory Notes


2,201



(66)


Foreign exchange (loss) gain


(25)

62


(82)

62

Non-recurring finance income from Inovalis relating to the acquisition loan


-

-




Other non-recurring finance costs


(206)

216


50

216

Deferred income tax expense


(274)

448


5,743

519

FFO from Joint Ventures







Minority interest


(1)

55


1

60








FFO 


5,841

4,647


12,538

8,982








Add/(Deduct):







Non-cash effect of straight line rents


320

226


649

305

Cash effect of the lease equalization loans


(299)

(190)


(597)

(426)

Amortization of fair value adjustment on assumed debt 


-

22


-

44

Amortization of transaction costs on mortgage loans


74

50


149

91

Non-cash part of asset management fees paid

in Exchangeable securities (1)


974

445


1,530

864

Capex net of cash subsidy


(700)

100


(1,675)

(100)








AFFO 


6,210

5,300


12,594

9,760








FFO / Units (diluted) (in CAD$) (2)


0.21

0.20


0.44

0.38

AFFO / Units (diluted) (in CAD$) (2)


0.22

0.23


0.45

0.42


(1)

For purposes of this presentation, 50% of the asset management fee is included in the AFFO reconciliation.


50% of the asset management fee for Q2 2018 was paid in Exchangeable securities. 100% of the asset management fee for Q1 2018, Q1 2017 and Q2 2017 were paid in Exchangeable securities.

(2)

Based on the weighted average number of Units (fully diluted, including promissory notes issued in June and October 2017), i.e. 28,203,146 and 23,541,535 for the 3-month periods ended June 30, 2018 and June 30, 2017 respectively and 27,266,172 and 23,448,295 for the 6-month periods ended June 30, 2018 and June 30, 2017 respectively.

 

Management believes FFO is an important measure of our operating performance and is indicative of our ability to pay distributions. However, it does not represent cash flow from operating activities as defined by IFRS and is not necessarily indicative of cash available to fund Inovalis REIT's needs. This non-IFRS measurement is commonly used for assessing real estate performance. Our FFO and AFFO calculations are based on the average foreign exchange rate for the period (1.5459 Canadian dollars per Euro for the period ended June 30, 2018).

Balance sheet reconciliation to consolidated financial statements



As at June 30, 2018


As at December 31, 2017

Assets


As per REIT's
 financial
 statements (1)


Share from
investments in
joint-ventures


Proportionate
Consolidation


As per REIT's
 financial
 statements (1)


Share from
investments in
joint-ventures


Proportionate
Consolidation














Non-current assets












Investment properties

451,367


195,358


646,725


440,813


173,256


614,069

Investments accounted for using the equity method


92,337


(92,337)


-


79,094


(79,094)


-

Acquisition loans and deposit


26,348


354


26,702


27,035


333,720


27,369

Derivative financial instruments

440


-


440


59


89,968


149

Restricted cash


1,535


767


2,302


1,509


797,000


2,306

Total non-current assets

572,027


104,142


676,169


548,510


95,383


643,893














Current assets












Trade and other receivables

6,273


2,099


8,372


4,566


1,783


6,349

Derivative financial instruments

-


78


78


-


20


20

Other current assets


1,769


1,200


2,969


2,021


635


2,656

Financial current assets


-


-


-


1,267


-


1,267

Cash and cash equivalents

26,995


5,923


32,918


20,345


5,305


25,650

Total current assets

35,037


9,300


44,337


28,199


7,743


35,942

Total assets


607,064


113,442


720,506


576,709


103,126


679,835



























Liabilities and Unitholders' equity













Liabilities












Non-current liabilities













Mortgage loans

102,269


75,182


177,451


113,342


62,113


175,455

Finance lease liabilities

121,635


28,574


150,209


122,735


28,714


151,449

Other long-term liabilities

-


816


816


-


754


754

Lease equalization loans

2,678


-


2,678


3,196


-


3,196

Tenant deposits

2,357


104


2,461


2,292


105,000


2,397

Exchangeable securities

5,108


-


5,108


6,907


-


6,907

Derivative financial instruments

1,313


133


1,446


650


148


798

Deferred tax liabilities

8,393


2,633


11,026


3,059


2,175


5,234

Deferred income


-


-


-


3,260


-


3,260

Total non-current liabilities

243,753


107,442


351,195


255,441


94,009


349,449














Current liabilities













Promissory Notes


45,415


-


45,415


23,789


-


23,789

Mortgage loans

15,098


321


15,419


2,660


590


3,250

Finance lease liabilities

6,314


1,243


7,557


6,014


1,180


7,194

Lease equalization loans

1,249


1,000


1,250


1,247


-


1,247

Tenant deposits

247


72


319


162


67


229

Exchangeable securities

9,196


-


9,196


9,836


-


9,836

Derivative financial instruments

1,750


1


1,751


1,316


1


1,317

Trade and other payables

9,628


4,294


13,922


6,341


6,308


12,649

Other current liabilities


420


1,067


1,487


431


683


1,114

Deferred income


4,685


543


5,228


4,195


290


4,485

Total current liabilities

94,002


7,542


101,544


55,991


9,120


65,107

Total liabilities


337,755


114,984


452,739


311,432


103,129


414,556














Equity












Trust units

200,840


-


200,840


195,739


-


195,739

Retained earnings 

38,431


(1,542)


36,889


44,749


-


44,749

Accumulated other comprehensive income

29,672


-


29,672


24,436


-


24,436


268,943


-


267,401


264,924


-


264,924














Non-controlling interest

366


-


366


353


-


353

Total liabilities and equity

607,064


113,442


720,506


576,709


103,129


679,833



(1)

Balance sheet amounts presented for the REIT were taken from the condensed interim consolidated financial statements as at June 30, 2018 and audited financial statements as at December 31, 2017.

 

Consolidated statement of earnings reconciliation to consolidated financial statements



Three months ended





June 30, 2018


June 30,2017

(in thousands of CAD$)


Amounts per
REIT's
financial
statements(1)


Share of net
earnings from
investments
in joint ventures


Total


Amounts per
REIT's
financial
statements (1)


Share of
earnings from
investments
 in joint ventures


Total














Rental income 


6,539


3,291


9,830


6,271


1,829


8,100

Service charge income 


1,957


940


2,897


1,358


389


1,747

Service charge expenses


(1,721)


(838)


(2,559)


(1,165)


(311)


(1,476)

Other revenues


180


46


226


219


(224)


(6)

Other property operating expenses


(73)


(7)


(80)


(73)


-


(73)














Net rental earnings


6,882


3,432


10,314


6,610


1,683


8,292














Administration expenses


(1,510)


(494)


(2,004)


(1,326)


(229)


(1,555)

Foreign exchange gain


27


-


27


(62)


-


(62)

Net change in fair value of investment properties


(587)


(191)


(778)


(2,181)


2,728


547

Acquisition costs


-


88


88


-


(1,079)


(1,079)

Share of profit of an investment (equity method)


739


(739)


-


1,114


(1,114)


-

Operating earnings


5,551


2,096


7,647


4,155


1,989


6,143














Gain (loss) on financial instruments at fair value through P&L


(179)


(20)


(199)


(2,352)


9


(2,343)

Finance income


2,305


(1,378)


927


1,524


(925)


599

Finance costs


27


(3,168)


(3,141)


(1,404)


(585)


(1,989)

Additional income (loss) from Arcueil's JV  


-


2,093


2,093


-


(224)


(224)

Distributions on Exchangeable securities


(286)


-


(286)


(398)


-


(398)

Net change in fair value of Exchangeable securities


(48)


-


(48)


(1,034)


-


(1,034)

Net change in fair value of Promissory notes


(2,202)


-


(2,201)


-


-


-

Earnings before income taxes


5,168


(377)


4,791


491


263


754














Current income tax expense


105


(51)


54


(87)


(5)


(92)

Deferred income tax expense


(242)


516


274


(190)


(258)


(448)














Earnings for the period


5,031


88


5,119


214


-


214

Non-controlling interest


(1)


-


(1)


55


-


55

Earnings for the period (part attributable to the Trust)


5,032


88


5,120


159


-


159



(1)

Income statement amounts presented for the REIT were taken from the condensed interim consolidated financial statements as at June 30, 2018 and June 30, 2017.

(2)

Includes the REIT's share of the hedging cost of associated with the Arcueil joint-venture partnership.

(3)

Reflects the additional loss assumed by the REIT in reference to its 75% right to the net profit/loss of the Arcueil joint venture.

 

Consolidated statement of earnings reconciliation to consolidated financial statements - Continued



Six months ended



June 30, 2018


June 30, 2017

(in thousands of CAD$)


Amounts per
REIT's financial
statements (1)


Share of net
earnings from
investments in
joint ventures


Total


Amounts per
REIT's financial
statements (1)


Share of net
earnings from
investments in
joint ventures


Total














Rental income 


13,253


6,295


19,548


12,242


3,430


15,672

Service charge income 


4,103


1,753


5,856


3,208


719


3,927

Service charge expenses


(6,893)


(2,343)


(9,236)


(5,782)


(887)


(6,669)

Other revenues


424


(191)


233


303


(223)


79

Other property operating expenses


(163)


(8)


(171)


(114)


(2)


(116)

Net rental earnings


10,724


5,506


16,230


9,857


3,037


12,893














Administration expenses


(3,027)


(934)


(3,961)


(2,572)


(425)


(2,996)

Foreign exchange gain


83


(1,000)


82


(62)


-


(62)

Net change in fair value of investment properties


1,338


754


2,092


108


2,919


3,027

Acquisition costs


(20)


(1,091)


(1,111)


(37)


(1,079)


(1,116)

Share of profit of an investment (equity method)


1,574


(1,574)


-


391


(391)


-

Operating earnings


10,672


2,660


13,332


7,685


4,060


11,746














Gain (loss) on financial instruments at fair value through P&L


(1,162)


(24)


(1,186)


(1,781)


43


(1,738)

Finance income


5,668


(2,673)


2,995


3,308


(2,151)


1,157

Finance costs


(5,222)


(1,090)


(6,312)


(3,057)


(887)


(3,944)

Additionnal income (loss) from Arcueil's JV  


-


88


88


-


(777)


(777)

Distributions on Exchangeable securities


(554)


-


(554)


(777)


36


(741)

Net change in fair value of Exchangeable securities


66


-


66


(1,698)


-


(1,698)

Net change in fair value of Promissory notes


(1,074)


-


(1,074)


-


-


-

Earnings before income taxes


8,394


(1,039)


7,355


3,680


324


4,005














Current income tax expense


(14)


(80)


(94)


(97)


(29)


(126)

Deferred income tax expense


(5,320)


(423)


(5,743)


(224)


(295)


(519)














Earnings for the period


3,060


(1,542)


1,518


3,359


-


3,360

Non-controlling interest


1


-


1


59


-


59

Earnings for the period (part attributable to the Trust)


3,059


(1,542)


1,517


3,300


-


3,301



(1)

Income statement amounts presented for the REIT were taken from the condensed interim consolidated financial statements as at June 30, 2018 and June 30, 2017.

(2)

Includes the REIT's share of the hedging cost of associated with the Arcueil joint-venture partnership.

(3)

Reflects the additional loss assumed by the REIT in reference to its 75% right to the net profit/loss of the Arcueil joint venture.

 

PROPERTY CAPITAL INVESTMENTS

Fair value

The fair value of the REIT's investment property portfolio as at June 30, 2018 was $646.7 million including the REIT's interests in the properties held in partnerships (vs. $614.1 million as at December 31, 2017). The fair value of the French properties was $466.9 million (72% of total asset value) and the fair value of the German properties was $179.8 million (28% of total asset value).

The $32.6 million increase is principally due to a $18.7 million increase due to the Kösching asset acquisition, a $10.5 million increase attributable to foreign exchange and a $3.4 million increase due to IFRIC 21, capitalized letting fees and rent-free periods.

Management principally uses cap rates to determine the fair value of the investment properties. These values are supported by third party appraisals in conformity with the requirements of the Royal Institution of Chartered Surveyors Standards, and for the French properties also in conformity with the Charte de l'expertise immobilière, European Valuation Standards of TEGoVA (the European Group of Valuers' Association) and IFRS 13.

Building improvements

The REIT is committed to improving its operating performance by incurring appropriate capital expenditures to replace and maintain the productive capacity of its property portfolio to sustain its rental income generating potential over the portfolio's useful life.

Since the IPO in April 2013, a total of $1.7 million has been spent on the three initial French properties (Jeuneurs, Courbevoie, Vanves), funded by a reserve that was set aside by the vendors of the four initial properties. In 2017, $1,616 was spent on additional building improvements, principally for the Courbevoie and Metropolitain properties. For the year to date, $2,290 has been spent on works completed across the portfolio.   

Guarantees, commitments and contingencies

The REIT and its subsidiaries have provided guarantees in connection with the finance lease liabilities and the mortgage loans, including pledge of affiliates of the REIT, first mortgages and assignment of receivables and future receivables. As at June 30, 2018, guarantees provided by the REIT with respect to its long-term debts include a preferential claim held by mortgage lenders on the Jeuneurs, Baldi Veronese, Sablière and Hanover properties in the amount of $96.1 million. Including the REIT's interest in the properties held in partnerships, preferential claim held by mortgage lenders on the properties totals $151.6 million. The REIT has also an undrawn commitment of $6.9 million (€4.5 million) relating to the Rueil development loan.

OTHER SIGNIFICANT ASSETS

Investments accounted for using the equity method

This section encompasses the 50% interest the REIT (through its subsidiaries) has in the Duisburg property, the 50% interest in the Walpur (Bad Homburg) property, the 25% interest in the Arcueil property, the 50% interest in the Neu-Isenburg property, 50% in the Stuttgart property and 50% in the Kösching property. Our share of fair value of the investment properties accounted for using the equity method was $92,337 as at June 30, 2018 compared to $79,094 as at December 31, 2017. This increase is due to the costs of $11,272 related to the acquisition of Kösching and refinancing of Neu-Isenburg, loan repayments on the Stuttgart property of ($875), the REIT's share of net losses from investments accounted for using the equity method of $1,574 and foreign exchange differences of $1,272

Acquisition loans and deposit

As at June 30, 2018, Acquisition loans and deposit of $26.7 million consisted of the loan for the Rueil project.

Trade and other receivables

Trade and other receivables as at June 30, 2018 amounted to $8,371 including the REIT's interests in the properties held in partnerships compared to $6,349 as at December 31, 2017. The difference of $2,022, of which $109 is due to foreign exchange movements, includes balances to be recharged related to the acquisitions of Neu-Isenburg and Ingolstadt (Kösching) and has increased in size in accordance with the growth of the joint venture portfolio.

Other current assets

Other current assets as at June 30, 2018 amounted to $2,967 compared to $2,656 as at December 31, 2017. The increase of $311, which includes a positive exchange impact of $46, is principally linked to VAT receivable.

PRESENTATION OF OUR CAPITAL

Liquidity and capital resources

Inovalis REIT's primary sources of capital are cash generated from operating activities, credit facilities, sharing the ownership of actual assets owned entirely and equity issues. Our primary uses of capital include property acquisitions, payment of distributions, costs of attracting and retaining tenants, recurring property maintenance, major property improvements and debt interest payments. We expect to meet all our ongoing obligations through current cash, cash flows from operations, debt refinancing and, as growth requires and when appropriate, new equity or debt issues. We can also sell some portion of assets owned to access capital but also in the perspective of diversification of our portfolio.

Including the REIT's interest in the joint ventures, cash available totals $33.7 million as at June 30, 2018, compared to $25.7 million as at December 31, 2017.

Financing activities

Our debt strategy is to have secured mortgage financing with a term to maturity that is appropriate in relation to the lease maturity profile of our portfolio and then to put in place, when appropriate, interest-only financings. We intend to search for fixed rate financings or floating rate financings with a cap. As such, 93.8% of the REIT's senior debt benefits from an interest rate protection (77.4% in the form of a swap and 16.4% in the form a cap). Our preference is to have staggered debt maturities to mitigate interest rate risk and limit refinancing exposure in any particular period. With no financial institution representing more than 22% of our senior debt commitment, we also make sure that the REIT has a diversified base of senior debt providers. Our debt to book value stands at 50.9% and net of the $33.7 million of cash available (including financial current assets) as at June 30, 2018 (including the REIT's interest in the joint ventures), this debt to book value stands at 48.4%.

Key performance indicators in the management of our debt are summarized in the following table, which also considers the interests the REIT has in all assets held in partnerships.






Entire portfolio incorporating interest in joint-ventures


As at June 30, 2018


As at December 31, 2017






Weighted average interest rate(1)


2.12%


2.10%

Debt-to-book value (2)


50.9%


51.2%

Debt-to-book value, net of cash (2)


48.4%


49.2%

Interest coverage ratio (3)


4.4 x


3.9 x

Debt due in next 12 months in thousand of CAD$


24,226


11,690

Weighted average term to maturity of debt (4)


5.7 years


5.9 years








(1)

Calculated as the weighted average interest rate paid on the finance leases and the mortgage financing.

(2)

The definition of debt-to-book value and of debt-to-book value, net of cash can be found under the section Non-GAAP Financial Measures

(3)

Calculated as net rental earnings plus interest, less general and administrative expenses, divided by interest expense on the financial leases and mortgage financings.

(4)

Calculated as the weighted average term on all the financial leases and mortgage financings.

 

Leasehold and Mortgage Financing Maturity Profile
(Entire portfolio including joint-ventures)
(% of amount outstanding as at June 30, 2018)

Leasehold and Mortgage Financing Maturity Profile (Entire portfolio including joint-ventures) (% of amount outstanding as at June 30, 2018) (CNW Group/Inovalis Real Estate Investment Trust)

 

2018

0%

2019

9%

2020

0%

2021

0%

2022

8%

2023

11%

2024

3%

2025

6%

2026

22%

2027

25%

2028

16%

 

Equity

Our discussion about equity is inclusive of Exchangeable securities and Private placement promissory note which are economically equivalent to the REIT's Units. In our condensed interim consolidated financial statements, the Exchangeable securities are classified as a combination of current and non-current liabilities under GAAP because of the conversion feature that can be exercised by the holder of those securities.








3-month period ended
June 30, 2018


6-month period ended
June 30, 2018






Units





Number at beginning of period


22,730,086


22,235,421

Increase/(Decrease) in number during the period


-


419,059

Units issued pursuant to the DRIP


44,799


120,405

Number at end of period


22,774,885


22,774,885

Weighted average number during the period


22,744,669


22,661,872






Exchangeable securities





Number at beginning of period


1,375,109


1,679,370

Increase/(Decrease) in number during the period


41,105


(263,156)

Number at end of period


1,416,214


1,416,214

Weighted average number during the period


1,375,566


1,369,793






Promissory notes





Number at beginning of period


2,386,104


2,386,104

Increase/(Decrease) in number during the period


2,121,008


2,121,008

Number at end of period


4,507,112


4,507,112

Weighted average number during the period


4,082,910


3,234,507






Units, Exchangeable securities and Promissory notes





Number at beginning of period


26,491,299


26,300,895

Increase/(Decrease) in number during the period


2,206,912


2,397,316

Number at end of period


28,698,211


28,698,211

Weighted average number during the period


28,203,146


27,266,172






 

Further to the Distribution Reinvestment Plan ("DRIP"), 45,799 Units were issued to Unitholders during Q2 2018. As at June 30, 2018, 9.9% of the Units were enrolled in the DRIP.

Distribution and management of foreign exchange risk

Our Declaration of Trust provides our trustees with the discretion to determine the percentage payout of income that would be in the best interests of the REIT. Given that the level of working capital tends to fluctuate over time and should not affect our distribution policy, we do not consider it when determining our distributions.

To ensure the predictability of distributions to our Unitholders, we have established an active foreign exchange hedging program. As at June 30, 2018, the REIT was committed to sell €818 (on average) at an average rate of 1.5917 and to receive $1,300 on a monthly basis until October 2020 (included).



Three months ended June 30


Six months ended June 30

(in thousands of CAD$ except for per Unit amounts)


2018


2017


2018


2017










Declared distributions on Units


4,684


4,454


9,368


8,898

Declared distributions on Exchangeable securities


286


398


554


777

Total declared distributions


4,970


4,852


9,922


9,675










Distribution per Unit (diluted)


$ 0.20625


$ 0.20625


$0.41250


$0.41250










 

We currently pay monthly distributions to Unitholders of $0.06875 per Unit, or $0.825 per Unit on an annual basis.

SOURCE Inovalis Real Estate Investment Trust

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