Primaris REIT just had another strong quarter. Sales are up, occupancy is rising, and they're snapping up prime shopping centers across Canada. The headlines tell a story of robust growth, but a deeper dive into their <a href="https://seekingalpha.com/symbol/PMREF/transcripts" alt="Primaris REIT Transcripts">transcripts</a> reveals a hidden engine driving this success, one that even the most seasoned analysts seem to be overlooking: <strong>the quiet conversion of pandemic-era leases back to standard terms.</strong>

This isn't just a minor accounting detail. These conversions are delivering a potent, sustained boost to Primaris' bottom line, creating a financial advantage that's setting them apart from their peers. While traditional leasing spreads tell only part of the story, the conversion of leases with preferred rental terms like percentage rent and lieu of base rent is where Primaris is quietly winning.

Remember the early days of the pandemic? Retailers, facing immense uncertainty, negotiated favorable lease structures to stay afloat. Percentage rent, a system where rent is tied to a percentage of sales, became a lifeline for many. But as the retail landscape stabilized and sales rebounded, these percentage rent deals became incredibly advantageous for tenants, leaving landlords like Primaris with less predictable income streams.

Now, as those pandemic-era leases expire, Primaris is strategically converting them back to standard net leases, capturing the full rental potential of their properties. And the numbers are remarkable. At the end of 2023, approximately 11% of their tenant base was still operating under preferred rental structures. That's down from 15% at the beginning of the year, and Primaris expects this figure to continue declining throughout 2024. (Source: <a href="https://seekingalpha.com/symbol/PMREF/transcripts" alt="Primaris REIT Transcripts">Primaris REIT Q1 2024 Earnings Call Transcript</a>)

Impact on NOI

The impact on NOI is significant. While their renewal leasing spreads are hovering in the mid-single digits, the conversion of these preferred leases is generating additional rental gains that aren't captured by traditional net-to-net leasing spread analysis. Think of it this way: Many percentage rent deals were structured at 8% to 10% of sales. Primaris' target operating cost ratio is 14%. That means a potential lift of 40% to 60% on those leases just by converting them to standard terms.

This hidden growth engine is fueling Primaris' above-average same-property NOI growth, and it's set to continue for several years, potentially even longer as they acquire new properties and unearth similar opportunities.

The Hypothesis: A Margin Story

The evidence of this hidden growth engine can be found in Primaris' steadily increasing gross margin. While their reported leasing spreads might not fully reflect the impact of these conversions, the margin expansion clearly demonstrates the underlying shift in their rental income structure. This suggests that Primaris is not only capturing the organic growth from rising occupancy and sales but also reaping the rewards of their strategic lease conversions.

The Numbers:

11%: The percentage of Primaris' tenant base still operating under preferred rental structures at the end of 2023, down from 15% at the beginning of the year.

40% to 60%: The potential lift in rent achievable by converting percentage rent leases from their pandemic-era rates (8% to 10% of sales) to Primaris' target operating cost ratio of 14%.

3% to 4%: Primaris' guided same-property NOI growth for 2024.

Preferred Lease Structure Conversion Trend

The following table shows the decline in the percentage of Primaris' tenant base operating under preferred rental structures:

Source: <a href="https://seekingalpha.com/symbol/PMREF/transcripts" alt="Primaris REIT Transcripts">Primaris REIT Q1 2024 & Q4 2023 Earnings Call Transcripts</a>

The Takeaway:

Primaris REIT is playing a long game. They're building a dominant platform in the enclosed shopping center space, and they're using their financial strength and strategic foresight to secure long-term growth. While the headlines focus on acquisitions and occupancy gains, it's the quiet conversion of pandemic-era leases that's quietly becoming their secret weapon.

"Fun Fact: Did you know that Primaris REIT owns two of Canada's top 15 most productive malls? (Source: Primaris REIT Q4 2023 Earnings Call Transcript [https://seekingalpha.com/symbol/PMREF/transcripts]) Their commitment to high-quality, market-leading properties is a key driver of their success."