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Dream Industrial Real Estate Investment Trust
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Good morning, ladies and gentlemen. Welcome to the Dream Industrial REIT First Quarter 2018 Conference Call for Wednesday, May 9, 2018. During this call, management of Dream Industrial REIT may make statements containing forward-looking information within the meaning of applicable securities legislation. Forward-looking information is based on a number of assumptions, and is subject to a number of risks and uncertainties, many of which are beyond Dream Industrial REIT's control that could cause actual results to differ materially from those that are disclosed in or implied by such forward-looking information. Additional information about these assumptions and risks and uncertainties is contained in Dream Industrial REIT's filings with the securities regulators, including its latest annual information form and MD&A. These filings are also available on Dream Industrial REIT's website at www.dreamindustrialreit.ca. [Operator Instructions] Your host for today will be Mr. Brian Pauls, CEO of Dream Industrial REIT. Mr. Pauls, please go ahead.
Thank you. Good morning, everyone. Thank you for joining us today for the Dream Industrial REIT conference call, which is for the 3 months ended March 31, 2018. Speaking with me today is Lenis Quan, the Chief Financial Officer of the REIT. On today's conference call, I will start off with an update of our business by area of focus over the last few months, and a few strategic initiatives we are working on. Lenis will then provide more details on our operations this quarter and financial highlights. We'll then be happy to field your questions. Industrial fundamentals have never been better. The Canadian economy remains very strong with overall industrial availability of 4%, a 16-year low. New supply under construction remains limited at 13 million square feet or only 0.7% of the market inventory. It is unlikely that the new supply will meet the continuing demand results from e-commerce and other economic drivers fueling increasing demand for industrial space. The impact of these strong fundamentals is being realized across our portfolio, especially in Ontario and Québec. With our recent focus on increasing rents in the Ontario region, we have transaction of 682,000 square feet of deals at a rate $0.66 or 11.3% above expiry or prior rents or prior in place rents, which take occupancy in 2018. Our focus on active asset management continues to yield positive results and create more value in these assets. I want to highlight 2 examples of recently completed lease deals in the Greater Toronto Area both in properties which we had previously considered selling. At 45 Progress Avenue in Scarborough, we received 3 offers to purchase the 209,754 square foot property. The offers were above our carrying value, and we considered selling it early in 2018. After running our analysis, we decided to capitalize on the leasing demand for the asset, and execute an early 16-year blend and extend to immediately recognize a 2% lift on rent 2.5 years earlier than the lease expiry, with 1.3% contractual escalators going forward. We are working with the tenant to invest capital's to create an addition and greatly improve the existing building. On the capital we invest, we will receive an 8% return annualized over the lease term. We estimate that this has created approximately $10 million of value for the asset, as well as retain an important future income stream for the trust in Ontario. 2130 South Service Road is a 98,175 square foot property in Oakville, which we had previously held for sale. We were initially seeking the property on a short-term basis -- sorry, leasing the property on a short-term basis, but have now secured a 5-year lease at a rental rate that is 50% higher than the prior in place rent. This, again, demonstrates the strength of demand in Ontario, and our ability to maximize rental rate growth from our portfolio. We think, over time, we can continue to critically examine each building and lease within our portfolio to become more nimble and proactive in driving higher cash flows and value out of each asset. Our multi-tenant portfolio in Ontario and Québec has an average lease term of 3 years. It will take a bit of time for these lifts to be reflected in our results, but we think there's a good opportunity over the upcoming years to increase value throughout the portfolio. Our occupancy in Eastern Canada has increased 280 basis points since this time last year, and our Western Canada portfolio occupancy has remained strong at 94.8%. In Alberta, market reports for the first quarter have shown that net rents are increasing and vacancies are declining. We think overall, our portfolio in Canada is very valuable and well-positioned to deliver solid stable results for the foreseeable future. While our core operations are running well, interest rates have increased approximately 50 basis points over the past 5 months, and cap rates have continued to compress. We have reviewed our acquisition and asset recycling strategies, with the focus on improving our free cash flow and net asset value growth potential of each asset. We are analyzing every property in our portfolio to understand how to maximize property value and enhance the overall cash flow growth profile of DIR. With the encouragement of the board at our meetings yesterday, we will continue to focus on asset recycling throughout 2018. We will look to trim the worst performers of our portfolio in terms of IRR and free cash flow performance, and replace it with stronger performing assets, which we have confidence will appreciate in value, going forward. On the growth front, Dream and PAULS Corp. acquisition teams continued their work to source new opportunities that meet our investment criteria in both Canada and the U.S. While spreads have tightened due to increasing demand, we are still seeing good opportunities in markets we are interested in. In the first quarter of this year, we completed the acquisition of the remainder of our U.S. properties from the DCT portfolio. Over the past 6 months, the Trust has acquired 2.8 million square feet of distribution of warehouse facilities in Memphis, Nashville, Orlando and Charlotte for a purchase price of USD 151 million, representing a weighted average cap rate of 6.4% and a purchase price of approximately USD 54 per square foot, which we believe represents a 10% discount to replacement cost of comparable properties in these markets. After acquisition, it was announced that DCT will be acquired by Prologis in a USD 8.4 billion deal and an implied cap rate in the low-4s. Lastly, over the last 90 days, our management team has toured across Canada and a few cities in the U.S. to talk to our investors. Our team is very excited over the potential of our business, and we've received a lot of good feedback from our unitholders, whom we greatly appreciate. Over to you, Lenis.
Thank you, Brian. Dream Industrial reported another quarter of healthy portfolio performance and solid financial results. Our leverage has declined 280 basis points since the first quarter of 2017, and I am happy to report that our diluted funds from operations or FFO per unit for the quarter was $22.4, flat compared to the same quarter prior year. Comparative property NOI was strong, improving by 2.8% from the same quarter last year, mainly reflecting higher average occupancy in Eastern Canada and Ontario. We maintained a healthy retention ratio for the quarter of 82.7%, and have secured leases for 76% of our upcoming 2018 expiries compared to 68% this time last year. The value of our investment properties increased to $1.9 billion compared to $1.7 billion at the beginning of the year. The increase was largely a result of $115 million in acquisitions completed during the quarter, and a $57 million increase in the value of our Ontario and Québec properties, reflecting higher underlying cash flows, market rents and lower capitalization and discount rates. During the quarter, the Trust's reported net asset value per unit increased by $0.50 or 5.4% to $9.85, largely from higher investment properties in Ontario and Québec. We think there will still be further runway for our IFRS values to improve over the course of 2018, as more of the demand for industrial and potential for rental growth is captured in appraisal assumptions. The Trust's payout ratio on diluted FFO is a healthy 78.1% compared to 78.8% 1 year ago. Our leverage is lower at 49.5%, and at quarter end, we have unencumbered assets of $223 million, with $90 million of liquidity on our credit facility. Our portfolio is well positioned to benefit from the continued strengthening in industrial fundamentals. Overall, we expect comparative property NOI growth to be up about 2% this year, coming from higher occupancies in Ontario, Québec and Eastern Canada, along with some rental growth in Ontario. Within our portfolio, we are continuing to drive organic growth through continued contractual rental increases, and increasing rental spreads, primarily in Ontario and Québec. We believe this will result in higher comparative property NOI growth beyond 2018. We've attempted to balance our healthy operating results, with the disciplined investment and asset recycling strategy. We evaluate every acquisitions with a microscopic lens to ensure it fits our investment criteria. We look for assets that would be above the average quality of our portfolio, offer attractive free cash flow profiles, and can contribute to above average NAV growth for the REIT going forward. Our well-capitalized balance sheet is at its strongest since inception, and we are well-positioned to focus on strategies to improve the value of our business. I will turn it back to Brian.
Thank you, Lenis. We would now be happy to take any questions.
[Operator Instructions] Our first question is from Fred Blondeau of Echelon Wealth Partners.
I have 3 quick questions. First, on your U.S. strategy act, could you give us a sense of your U.S. acquisition pipeline and how do you feel about pricing at this point?
Sure, Fred. It's Brian Pauls. We feel good about the U.S. acquisition pipeline. We're looking at a number of markets. The markets I mentioned in Nashville, Memphis, Charlotte, Orlando, we've got a presence there. We'd like to grow in those markets, if possible, but we are tracking many more markets, a dozen or so more markets that we have experience in, contacts in, relationships in, that we would be interested in growing in. So we feel good about the pipeline. It's competitive, as I mentioned in the opening remarks, but the U.S. is a big enough market that we think we can be competitive there.
Okay. And Brian, it sounds like you would be more than willing to sell assets in Canada to buy in the U.S.?
Well, I think we're looking at asset by asset recycling. We're not likely to recycle the ones we just purchased in the U.S. That's correct. But we are looking at our entire portfolio in terms of the most efficient assets, the most -- the best-performing assets.
Okay, fair enough. And your same-store NOI growth was quite solid for Q1. What should we expect for the rest of 2018?
Well, we had provided guidance of 2% compared to the NOI growth for the year.
And is this still realistic maybe? Do you feel it's a bit -- don't you think it's a bit conservative?
No, no. I mean, I think what we're seeing is average occupancies in the East Québec, Ontario, have all been positive, and we're obtaining rental growth into -- yes, and obtaining rental growth from Ontario portfolio. And not to forget that we also have our contractual rental bumps in every region in our portfolio. And we've had some pretty good results, as we've showcased in our numbers regarding just recent leasing in Ontario, and we're going to strive to continue to do better.
So I'd just add to Lenis's points that we're pushing rents across-the-board. I think we're -- we've got the best opportunities in the markets we mentioned in Ontario and Québec. That's where the markets are the tightest. I mentioned the 11.3% spread. That's a big spread. We're going to continue to be leaders in pushing rents. So that's how we'd get to that.
No, all I was saying is that I thought it was on the low side. But then, it should be -- so be it. It's better. And lastly, your G&A was a bit higher than our estimate. I was wondering what would be a good run rate from here?
Well, I think if we take out the Asset Management fee, because that's based on the assets, our total asset volume. I think the G&A run rate is -- from Q1 is a pretty good rate for the rest of the year.
Our next question is from Chris Couprie of CIBC.
So just in terms of the AFFO disclosure, which was removed in the quarter, just wondering, it's more of a technical question, how should we be thinking about incentive calculations, incentive fees?
Well, just to -- so the incentive fee calculation is not based on the -- I guess the recent real pack, it's a contractual definition. So that will be included in our relative party disclosures because it's based on the contractual definition between the REIT and Dream Asset Management.
Okay. And in terms of dispositions, Brian, I guess, you've had a chance to tour the assets a little bit. Any sense from you as to what percent of the portfolio you might consider to be up for disposition?
It's a good question Chris. I think we've built a model to look asset by asset. So we're not necessarily looking to trim a certain percentage, 10%, the bottom 10%. But we are looking to trim specific assets that we feel like the best days are behind them, and we can do better with new acquisitions. So look for -- I would say, it's -- look for more asset recycling from us this year. It'll depend on little bit what opportunities we find to acquire. It'd be -- ideally, we would match up dispositions with acquisitions, and use the funds as efficiently as possible. But basically, what we're doing is taking our financial model that we've built, look at what assets are underperforming, and look to trim those and try to match them up with acquisitions on assets that will outperform.
Our next question is from Mike Markidis of Desjardins.
I was hoping to get a little bit more clarity just to make sure I was on the same page with respect to the -- just the evolution of your rental spreads in Ontario. And if I just go back to the press release, you mentioned that of the 990 of renewals in the quarter, 695 of that Ontario, 2% lift, but then again, that was dragged down by those 2 single tenant properties, where it seem to be the deal was reached a long time ago. But then you said -- so we can strip that out, but then what's the $682 million that follows that? Is that stuff that didn't hit in the quarter? That's renewals that have been secured for Q2, Q3?
I think what we wanted to highlight or communicate to everyone was just, the 682 are actual lease deals that have been transacted in 2018, which is when we really started to focus on pushing for our rental growth in Ontario. And I think we wanted to show that once we shift that -- shifted that focus, this has been the result. Those $682,000 will take occupancy throughout 2018, so some of that has already taken occupancy in Q1.
Okay, I got you, so -- but the bulk of that, I would assume, would come in Q2 and Q3?
That's right.
Okay. And then maybe just following up on Fred's question on the same property NOI growth. Just given that you came in at closer to 3% this quarter, is there anything that's aside from it just being one quarter, anything that's holding you back in terms of bumping up your expectation for this year?
I mean, I think we're striving to do better of capturing rental growth in Ontario and Québec. It takes a bit of time to get those to come through. We hope we will see better. But I think, at this point, we're just guiding to 2%.
Okay. And then maybe just with your recent -- the in-place rent assumption did tick higher sequentially, specifically in the GTA. Is that sort of going to be something where you're going to continue? I would assume maybe that analysis hasn't hit through all properties, and that the bias to that number is going to be upwards in the next several quarters?
Yes. I mean, I think, we'll reevaluate that every quarter. So I think as -- we take several inputs, external appraisers or leasing teams, market stats. So I think, sometimes, it takes a little bit of time for all that -- all the current events and recent deals to filter through in the numbers. So yes, I think we would expect to -- in Ontario and Québec, we've seen those numbers moving up throughout the year, probably staying flat in the West and East for now.
Okay. Just 2 more quick ones from me before I turn it back. I think, Lenis, last quarter, you had mentioned that full year CapEx would likely come in at the level for 2017, if not, slightly lower. Would that still be a safe assumption for this year?
Yes, that's right. What I had mentioned last quarter, and it's still the same, is that our planned capital spending was going to be flat for 2017. And then our total -- the leasing cost really varies on the space and the volume that we're doing. But I think, as a percentage of our total NOI, we would see that our total capital spending would be flat compared to 2017.
Got you. And forgive me on this one, I haven't had a chance to do the math from the MD&A. But I'm actually interested in maybe more specifically what's happened in the last couple of quarters. But have you seen any change in your DRIP participation rate, just given the recent ascension of your stock price?
Haven't materially changed from year-end.
Our next question is from Mark Rothschild of Canaccord.
Maybe following up just on the comment Lenis made about IFRS value. You sounded confident that it would increase through the year. Is that based on cap rates that have already moved, and that you just haven't had an updated appraisal? Or is that based on expectation that values will continue to rise?
I think it's a little bit of both, Mark. I mean, the way we do our valuations for IFRS, we get a certain percentage of the portfolio externally appraised every year. So we -- as we continue to get the external appraisals for the rest of the year, we would expect to see a lot of the recent activities, particularly in Ontario and Québec, start filtering through the appraisal assumptions. For anything that's internally appraised, we're getting information from the external appraisers. And just to give you a sense, we think that a lot of the market assumptions that we're getting from them tend to lag. But just to give you a sense for Ontario, the cap rate ranges that we get from our external appraisers are in the 555 to 606 range for Ontario for Q1. And I don't know, Brian, maybe you want to add a bit of color?
Yes, Mark, it's Brian. So I think just to add to Lenis's point about the lagging value, there's a number of transactions that are in the marketplace. It's portfolio near the airport, the Blackstone deal. There's lot of these things that are in the market that haven't necessarily closed that are kind of leading the value increase in the industry in these markets. And those haven't necessarily been reflected on appraisals or kind of firm data yet. Those are contracted deals, but they haven't closed. And so as those kind of filtered through the system, we think the IFRS will continue to rise.
Okay. And in regards to your comments about growth, it sounds like there's some good opportunities in various U.S. markets. It seems like you're more optimistic about completing acquisitions in the U.S. than in Canada. In the GTA, in particular, cap rates have compressed, as you noted, and rents are rising. What are your thoughts about buying properties in Toronto now at these low cap rates, where it may not be accretive going in, but there seems to be some strong rent growth that's starting to come through?
Yes, yes. No, it's a good question. We are definitely looking in Toronto. We're definitely looking at the GTA, Montreal, the markets that we're in and we like. There are more -- there's a more volume of activity in the U.S. so we're seeing more deals, so we're likely to maybe find opportunities quicker there, but we're really looking at NAV growth, free cash flow growth, assets that will add to the quality of our portfolio. So all of those markets, I'd say, all the above we're looking at. We want to grow in Canada as well. And as we cycle out of assets, we'd like to replace them with ones in Canada, as well as the U.S. I would say we're likely to grow a little faster in the U.S. just because there's more volume and probably more opportunities.
Our next question is from Sam Damiani of TD Securities.
Just to follow on the last question, did you look at the airport portfolio in Toronto here? And with the merger with DCT, do you see some opportunities there as they may cycle out of some assets?
Yes, and yes. So yes, we did look at the airport portfolio, that got bid up pretty heavily. I think [King] ended up outbidding Blackstone for that. I'm not sure the price is disclosed, but the cap rate was quite low, and it's a very expensive deal. As it relates to the DCT Prologis -- the Prologis acquisition of DCT, we believe and it has been disclosed that they will be shedding some of those assets, maybe 6%, 7% is what they've -- what I've heard. We'd love to pick some of those up. We don't know what they are yet. We, as an organization, know the players, and we'll look to maybe acquire some of those assets if they fit within our criteria.
And those -- I mean, those assets, as far as you're concerned, certainly, includes some of target markets you mentioned?
Yes, we hope so. We don't know yet.
Okay. And just on that 11% uplift in Ontario that certainly was interesting, and then talked about already. I mean, do you see that kind of growth continuing over the next year or 2 in Ontario? Or was there some 1 or 2 large leases that kind of drove that, that may not be recurring?
We're pushing rents everywhere, Sam. I think, it's hard to make a blanket statement that that's going to happen across the province, because it's an asset-specific business. So where we can, I'll say as a general statement, we're pushing rents. We're putting rents hard. We think rents can grow fast. We think the -- certainly, the M&A activity in the market and the other transactions indicate the same thing. The fact that we're at a 16, 17-year low in vacancy, with replacement cost rising every day, we don't know exactly how far rents can go, but we know they can go much higher than they are today, and we're going to try to be leaders in that. I don't think it's -- I can't -- it would be impossible to give you an accurate view of what our whole portfolio is going to do because it's asset by asset. But I think our past performance is hopefully an indication of what's to come.
And the market for developments in Toronto would seem to be[Audio Gap] on its own or with Dream unlimited in developments in the near term?
Certainly, our -- sorry, Sam. Yes, the goal -- we have a goal of initiating development. Toronto would be great. The replacements costs are high. Construction costs are high and land price are high. It's very hard to find good development opportunities, but we're looking every day. We believe we may find some, whether it's here or elsewhere. But in markets where purchase prices are at or above replacement cost, those are markets we want to be building in. That is getting pretty much becoming the case here in the Toronto GTA, as well as in some of the other markets.
You care to mention 1 or 2 markets where we might hear about some initial development activity with Dream Industrial?
Not really, we're looking at a lot of different opportunities. I would say Toronto would be the one I mention specifically.
Our next question is from Matt Kornack of National Bank Financial.
I wanted to quickly touch on the organic growth side. The U.S. portfolio obviously isn't in your same property NOI growth numbers, and won't be for a little while in there. No near-term lease maturities there. What are the embedded rent steps for those assets generally?
I think it's about approximately 2% on an annualized basis over 10 years, yes.
Okay. So similar in profile to what you'd expect from the Canadian portfolio? And also, on the Canadian portfolio, it sounds like, I mean, you're lapping some better occupancy numbers, and is that in part the reason why you'd expect the same property NOI growth maybe to come down on a sequential basis quarter-over-quarter -- sorry, year-over-year?
Well, I mean, we did have some -- we had significant increase on occupancy in Eastern Canada last year. So I think a good chunk -- so the NOI was picking up throughout the year for East. So I think, sequentially, for that region, we'd probably see it coming, I guess, on a quarter-over-quarter basis, kind of not being quite as high sequentially for the year. But in terms of the overall impact for the year in Ontario growth, I mean, I think, that's what we're seeing to continue to kind of push that.
Okay. And on Atlantic Canada, it's turned into a better news story. Are you guys seeing increased traction there in Burnside? And are you starting to see the benefits of Halifax sort of taking off to some extent?
Matt, I think we've -- our team has done an amazing job getting the portfolio at least to where it is. I think we'll continue to do well there. I think we'll probably get a disproportionate share of the leases done there than are in the market because we got great properties. The location is good. I think we are seeing the benefits of some of that hard work of just focusing on that market.
Okay. And with regards to Western Canada, obviously, not back quite yet, but energy prices today are moving higher, and they have been for a little while here. Any sense in the market that things are returning to sort of maybe not the boom times, but a little bit better? And also on that front, would you be looking to add product in that market? Or do you think you have enough at this point?
We are looking at opportunities there. I mean, we like that market. The vacancy rates' down to 7.9%. The rents are growing there. I think it hasn't necessary totally hit stride, but it's certainly turning the corner. So I guess the answer to both of your questions, we believe it is improving. We think we're at somewhere near the bottom of the valley kind of climbing out of there, and get good things to come with all the things you've mentioned, and we would look at opportunities there. We have looked at them. I think we'd continue to look for good product that would complement what we have there.
Our next question is from Pammi Bir of Scotia Capital.
Just given the decent improvement in your cost of equity, what are your thoughts with respect to funding acquisitions with perhaps coming back to the markets at some point or versus sticking with the plan for asset sales?
So we have dry powder now that we can use to fund acquisitions. So what we want to do, I guess, Pammi, to answer your question, is maintain liquidity enough so that we can capitalize on opportunities as we find them. So the answer to your question is, we've got enough liquidity available to go and chase opportunities right now, and then we'll kind of address that later if there's not as much available.
That's helpful. And then just when you talk about the pipeline or what you're looking at, can you comment on sort of what might be in some sort of advanced stages for -- from an acquisition standpoint or in terms of the volume that you could transact on, I guess, over the next several months?
We're looking -- we've got a number of opportunities in front of us right now that we are chasing. I will say we're looking at portfolios that are somewhere between $50 million and $100 million in size of dollar size. And we're seeing more of them in the U.S. than we are in Canada, although we are currently actively chasing opportunities in both Canada and the U.S.
And just on those, I guess, what would the cap rate differential be between some of these transactions you're looking at?
Most of what we're looking at is low-6s maybe into the high 5s. It's kind of where the market is right now.
Okay. And I apologize if this was already answered. But just Ontario and Eastern Canada are tracking pretty well, but from an organic growth standpoint. But can you maybe just provide some color on the drop in Québec, and at what point that may return to stronger results?
I think the drop in Québec was just a result of, I guess, just a short-term downtime roll over in some of our spaces. So that space has been subsequently been leased up. So I think we view that as short-term in nature. Market is quite strong in Québec as well, so I think we're seeing some really good activity. I think -- and that's our sign of the activity picking up in that market.
Our next question is from Brad Sturges of Industrial Alliance Securities.
In terms of the acquisition strategy, I guess, for Canada, and you're talking about more NAV growth. Is that looking at assets that have that value-add development -- excess land for development opportunity? Or is it simply trying to find off-market deals, where the rents are well below market, and you can grow through some rent growth, for example? So just trying to get some context of what that NAV focus could look like.
Yes, Brad, I think it's both. I think we are looking for areas where we can grow rents if we can do some value add. If there's a value-added component to it, we would certainly look to capitalize on that as well. But I think it's both of those things. We're looking at a number -- when you look at an acquisition, I think cap rate is only a portion of the story. So cap rate, replacement cost, dollar -- price per pound or replacement cost per square foot, as well as where the markets are compared to rent. So those 3 components really make up kind of how we would analyze the value of an asset.
Right. And obviously, you're making decisions within the existing portfolio on an asset by asset basis, and acquisitions are very opportunistic in nature. I guess, if you're taking -- looking at it from an ideal scenario, it sounds like the weighting in the U.S. will increase. I guess when you're looking at Canada, are you comfortable with the general geographic mix of the portfolio today? Or are there areas where you'd like to increase or decrease within Canada?
I think we're looking at places where we can add kind of synergy, add more economies of scale in the markets we're in. But there's a lot of markets we'd like to add to that, that we're not currently in, particularly in the U.S. I'm not sure we're looking to shed any necessarily specific geography or grow, take a rifle shot at specific geographies. We're looking at opportunities where we can find them.
Thank you. We have no further questions.
Thank you, everyone, for your time today. We look forward to speaking again soon.
Thank you, and thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.