Dream Industrial Real Estate Investment Trust

TSX:DIR.UN

Earnings Call Transcript 2021-Q1

[Operator]

Good morning, ladies and gentlemen. Welcome to the Dream Industrial REIT first quarter conference for Wednesday, May 5, 2021. 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 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 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.

[Brian D. Pauls, CEO & Trustee]

Thank you. Good morning, everyone. Thank you for joining us today for Dream Industrial REIT's 2021 First Quarter Conference Call. Speaking with me today is Lenis Quan, our Chief Financial Officer; and Alex Sannikov, our Chief Operating Officer.Dream Industrial carried its strong momentum into 2021 with an extremely active first quarter. In just over 90 days, we've completed significant strategic initiatives to grow and upgrade portfolio quality, strengthen our balance sheet, all while achieving solid rental rate increases and FFO per unit growth. We reported a 10% increase in FFO per unit in Q1 driven by CPNOI growth, rapid pace of capital deployment and a lower cost of debt. Our pace of CPNOI growth continues to improve and was 3.1% in Q1 as leases signed over the past 6 months took effect.Our pace of acquisitions has been robust. We have closed on over $350 million of assets already this year and have $155 million of additional acquisitions under contract or in exclusive negotiations. We have advanced our development pipeline with nearly 700,000 square feet of projects currently underway in Canada and the U.S. Since the beginning of 2020, we have closed or have contracted over $1.1 billion of acquisitions across Canada, the U.S. and Europe, a significant achievement given the challenges presented by the ongoing pandemic.Our local on the ground acquisition teams across our 3 operating regions provide us with a wide range of opportunity, while our geographic diversity allows us to access capital at the most optimal cost. Our acquisitions activity continues to enhance our portfolio quality. In the past 40 months, we have more than doubled our asset value while focusing on acquiring larger properties leased to high-quality credit tenants.Thus far in 2021, we have closed or have under contract or in exclusive negotiations over $500 million of assets across Canada, the U.S. and Europe. These acquisitions add over 3 million square feet of high-quality logistics GLA to the portfolio. Built in the 2000s and with an average clear height of approximately 30 feet, these assets are above the average quality of our portfolio. In-place rents for these assets are 10% below market, and we have the opportunity to drive cash flows higher as leases roll.We have closed on $350 million of these assets with the remainder expected to close in the next 45 to 60 days. Our recently completed $201 million equity offering in April of 2021 provides us capacity to execute on our sizable pipeline, and we expect to have our remaining acquisition capacity committed by the end of Q2. We are also incorporating sustainability metrics within our investment criteria, which allows us to operate and track sustainability goals and impact results.We continue to make significant progress on ESG goals across our business. Starting this quarter, we are providing an update on our ESG initiatives in our MD&A in addition to our annual sustainability reporting. We continue to make significant progress in all aspects of our business.And I'll now turn it over to Alex to talk about our operations and development pipeline.

[Alexander Sannikov, Chief Operating Officer]

Thank you, Brian. Good morning, everyone. Industrial market fundamentals remain robust across all our markets, supported by accelerated penetration of e-commerce. Availability rates have continued to trend down in most of our markets. Our predominantly urban portfolio is quite attractive to logistics-focused tenant, and we can continue to achieve strong rental rate growth. Since the end of Q4, we have signed about 2 million square feet of renewals and new leases at an average rental spread of 20%.On these leases, we also achieved annual contractual rental growth of 2.4%. Our leasing activity resulted in our Q1 in-place occupancy increasing 100 basis points compared to Q4 2020 to 95.7%. We also have lease commitments for about 450,000 square feet of vacancies, most of which are expected to commence in the first half of 2021, taking occupancy to above 97%. [Technical Difficulty] property that was recently vacated by Spectra, we already signed a new lease with a national logistics company for 5 years at higher rents, along with 2.5% annual contractual rent growth, which was absent in the prior lease.With the leasing activity over the past few months, our CPNOI growth profile has improved significantly for 2021 compared to 2020. And we reported 3.1% year-over-year growth this quarter. We reiterate our previous forecast mid single-digit organic growth in 2021. In terms of quarterly guidance, we expect that same-property NOI growth will accelerate through the year as new leases take effect.We are also increasing our focus on development as a key aspect of our strategy to add high-quality space to our portfolio, which will allow us to drive strong organic growth over the long term. We have 3 pillars to our development strategy. Greenfield development, expansion opportunities within our current portfolio and redevelopment of existing properties. Greenfield development is underway with construction commencing on previously announced 460,000 square foot distribution facilities in Las Vegas.We also recently acquired a 30-acre land parcel in Frampton, where we can build approximately 550,000 square feet of prime logistic space. The site is extremely well-located in one of the most sought-after industrial submarkets in Canada with excellent access to multiple highways. We acquired the site for $35 million or $1.20 million an acre, which is quite attractive compared to recently traded land parcels in the GTA. We expect to commence construction in the next 18 to 30 months, and we are forecasting a yield of 6%, well above cap rates on comparable brand stabilized products.In addition to our greenfield development, we are commencing construction on 2 expansion projects in the GTA and in Montreal that will add 260,000 square feet of additional density in these markets. We expect these projects to be completed in 2022. We also have several existing opportunities for near-term redevelopment in our portfolio. Some of the larger opportunities in the near-term pipeline include redevelopment of a 200,000 square foot small-bay complex in Mississauga and redevelopment of a property in Whitby for approximately double the density. In Mississauga, we expect to build a brand-new 40-foot clear logistics asset. We expect that our density will not increase. However, we will achieve a significant premium on rent given the location of the property.Turning to valuation. During the quarter, the value of our assets increased by $75 million, reflecting the robust demand for industrial assets in our markets, strong leasing activity and rental rate growth. The outlook for rental rate growth remains strong, and we look forward to engaging value-add initiatives to increase the returns and surface additional value from our portfolio.I will now turn it over to Lenis, who will provide our financial update.

[Lenis W. Quan, Chief Financial Officer]

Thank you, Alex. Our financial results for the first quarter were strong and in line with our expectations. Diluted funds from operations was $0.19 per unit for the quarter, 10% higher than the prior year comparative quarter due to higher NOI from our comparative properties and recent acquisitions and lower borrowing costs as we executed on our European debt strategy. The pace of our capital deployment remains strong, and we have closed, contracted or achieved exclusivity on over $500 million of acquisitions thus far in 2021.Specifically, we have acquired just over $350 million of assets to date in 2021, $274 million in Q1 with another $76 million since March 31 and have another $155 million expected to close in the next 45 to 60 days, subject to satisfactory due diligence. With access to euro-denominated debt at rates below 1%, we expect these acquisitions to be accretive to FFO per unit and our targeted leverage in the mid- to high 30% range.In April, we completed a $201 million equity offering, which will allow us to execute on our near-term acquisitions pipeline and fund approximately $90 million of identified development costs. Pro forma the previously mentioned $155 million in acquisitions, our leverage is expected to be approximately 28%, and we will retain sufficient capacity for our sizable acquisition pipeline and planned development projects.Our debt strategy continues to provide opportunities to lower cost of debt. The average interest rate on our in-place debt has decreased by over 100 basis points over the past year, and at the end of Q1 2021 was 2.44%, with opportunity to reduce this further. We expect our FFO per unit to grow as we deploy our current capacity and as the pace of organic growth increases. We continue to expect 10% year-over-year FFO per unit growth in 2021, assuming current FX rates prevail and assuming average leverage for the year in the low- to mid-30% range.I will turn it back to Brian to wrap up.

[Brian D. Pauls, CEO & Trustee]

Thank you, Lenis. Just to clarify, I think Alex's mic went out for a part of his presentation. He was making the point that the Laval property recently vacated by Spectra is now leased to a national logistics tenant. So all part of our progress during the quarter. But following a strong 2020, we have hit the ground running this year with a focus on making the business even stronger and more valuable. We continue to take significant steps in positioning DIR as the premier industrial REIT in Canada and delivering attractive overall returns to our unitholders.We'd now be happy to open it up for questions.

[Operator]

We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Sam Damiani from TD Securities.

[Sam Damiani, Director, Institutional Equity Research]

Congratulations on a really good quarter. I just wanted to touch on I guess, Brian, if you could give us your thoughts, the portfolio, as you mentioned, has grown significantly over the last I guess 15 months. And with the sort of evolving profile of the portfolio, how are you looking at dispositions from their strategic sense at this point going forward?

[Brian D. Pauls, CEO & Trustee]

Yes, Sam, thanks. We have -- we analyze all of our assets. We've got an IRR model for every property in our portfolio, and we're looking to kind of recycle ones that are at the bottom of that, where maybe we either realize the greater side of the IRR or its best days are behind it or it's not as accretive as opportunities that we're seeing going forward. So we do look at geographic regions. Certainly, the West, we're not buying as much as we are selling. And we keep kind of top-grading, we call it, or upgrading the quality of the portfolio. Anything we sell would be on the bottom half. Anything we buy would be on the top half.So we're really not necessarily looking at liquidating regions or recycling regions. What we're doing is upgrading individual assets as we go. And so it's something we're constantly thinking about, Sam, constantly trying to upgrade the quality. I mentioned in my remarks as did Alex that we're always looking to get better, high-quality buildings that will basically empty out last and lease up first in the various cycles that we're likely to hold them through.So we are continuing to recycle as we go. We've been active on the acquisitions front, but I expect we will be active on the dispositions front. We do have offers in place for some of our assets right now and we're analyzing those just given the strength of the market.

[Alexander Sannikov, Chief Operating Officer]

And just to add to that as well, just some color. We are seeing, specifically in the West, where most of our non-strategic assets are, we're seeing that over the last 3, 4 months, there's been a significant improvement and increase in demand. And we're starting to see that translate into offers and pricing. So -- and as we communicated in prior calls, these are not strategic assets to us, but it's not noncore assets. So we don't -- we're not in a rush to sell anything. And obviously we're price-sensitive. And with the pricing momentum we're starting to see in the West, we want to make sure that we are capturing as much of that momentum as we can in terms of our timing.

[Sam Damiani, Director, Institutional Equity Research]

That's much appreciated. That was actually my second question. So thank you for answering that. So I'll flip to my third, which is just on the development pipeline. I guess a couple of questions. I noticed the table in the MD&A didn't include the Frankfurt area project, unless I missed it. Just wondering what happened there. And secondly, if you could provide any details on the address or specific location of the Brampton parcel that was acquired?

[Brian D. Pauls, CEO & Trustee]

You bet. Alex, you want to speak to that?

[Alexander Sannikov, Chief Operating Officer]

Yes. So the Frankfurt opportunity, I think, Sam, you're referring to advertising, we were working through that. There is a long -- much, much longer list compared to what's included in the MD&A, was including in the MD&A something that is well underway. The expansion in the Frankfurt area would be -- it would be a relatively small expansion, as we pointed out when we acquired the asset. The [ Radeberg ] expansion or addition is in the table, and that's much larger project that's well over 200,000 feet, and we are working to get construction started on that this year. But as we continue working through the pipeline and our intensification opportunities, we'll be adding much more projects to the list. Does that answer your question, Sam?

[Sam Damiani, Director, Institutional Equity Research]

Yes. I was just wondering on the Brampton, if you have any details you can share on that site?

[Alexander Sannikov, Chief Operating Officer]

Yes, we will be disclosing the address. And obviously the kind of the drawings as we continue working through it and rendering. So absolutely. It's not in the press release yet, but we will be providing that. I don't know, Bruce, do you want to comment a little bit more about the location of the site?

[Bruce Traversy, Senior VP & Head of Investments of Europe]

Sure. Yes. Hi, Sam. The location is in -- on Countryside Drive in Brampton. So it's in an area where a lot of the big players are developing. And it's within the official plan industrial -- and it's already industrial designated. So it's a very near-term land in an area that's seen a lot of demand. You're close to a lot of tenants that are coming, Amazon, Canadian Tire, other tenants are really seeking out that area as you -- I'm sure you know Brampton is the heart of the GTA in terms of logistics, close to the CN, the CP intermodal terminal.

[Operator]

[Operator Instructions] And our next question is from Brendon Abrams from Canaccord.

[Brendon Abrams, Analyst of Real Estate]

Maybe just following up on the line of questioning on the Brampton acquisition. Can you provide any color or details around cost per square foot or expected net rents, so in terms of your underwriting assumptions to get to the 6% unlevered yield?

[Brian D. Pauls, CEO & Trustee]

Sure, Brendon. Let me start and I'll turn it over to Alex for a little more detail. What we're seeing is prices for existing properties are approaching and in some cases going higher than replacement cost for new. So development we see is a really good opportunity for us. Certainly, we're in the low- to mid-$200s on a price per square foot all in, and -- but at yields that are higher than what you would pay in a going-in cap rate. So Alex, do you want to elaborate a little bit about just the development pro forma metrics?

[Alexander Sannikov, Chief Operating Officer]

Yes. Thanks, Brian. So we're forecasting all-in cost of just in the low $200 per square foot range, including the land. As far as the rent goes, we are already hitting in our portfolio, $1,250 in some cases. So that's something that we're targeting for core locations in Mississauga, Brampton and not only targeting but hitting that in our leasing. So we expect that something like this will command rents certainly greater than that. And obviously, we're expecting that the rent will continue growing over the next 18 to 30 months.

[Brendon Abrams, Analyst of Real Estate]

Okay. That's -- yes, that's very helpful. And maybe just turning to leasing spreads, clearly very strong during the quarter, especially in the Ontario portfolio. Just wondering, was there any 1 or 2 leases that drove the Ontario leasing spreads to be so much higher than I guess what you're showing as kind of the estimated mark-to-market for the broader Ontario portfolio? It seems every quarter leasing spreads in Ontario are well above kind of what you indicate as the mark-to-market. So just wondering if there's -- if there was 1 or 2 leases that were anomalies or that drove that above 50% leasing spread in Ontario.

[Alexander Sannikov, Chief Operating Officer]

That's a fair observation. And the market rents continue evolving every quarter. And Q1 has seen a pretty significant pace of growth in market rents generally. So this is something that we continue catching up on, if you will, in our disclosure. Keep in mind that our disclosure generally is covering when we say Ontario, we include Ottawa. We include [indiscernible]. We include key generic Cambridge portfolio of ours.So it's a much larger portfolio than the GTA. In the GTA, there was a few anomalies that drove the spreads higher. Our financial drive asset is one of them where we acquired the asset in the third quarter of 2020 with really low in-place rents. And we -- and the tenant was vacating, and so we more or less doubled the rent compared to the expiring. So there was a few deals like that, including in Oakville and Mississauga. So there was a few outliers that's kind of one contributing factor and the other one is the market continues to evolve very quickly.

[Operator]

And our next question comes from Mr. Gupta from Scotiabank.

[Himanshu Gupta, Analyst]

So just a follow up on the Brampton land acquisition. Is the land already zoned for industrial use? And then you mentioned 18 to 20 months before you start construction. Why such a [indiscernible] there?

[Brian D. Pauls, CEO & Trustee]

Yes, you bet, Himanshu. I'll let Bruce Traversy who runs our acquisitions talk a little bit about the process and what we expect for timing.

[Bruce Traversy, Senior VP & Head of Investments of Europe]

Sure. Yes. The -- so the lands right now are within the official plan for industrial, for [indiscernible] industrial use. Rezoning, therefore, can follow fairly quickly. Obviously municipalities aren't able to move maybe as quickly today. There's certainly a lot of activity there. So to move through the process of site approval and getting the rezoning formally signed off on can take 12 months easily, even if you were to buy a site that it was ready zone, it would take 12 months. It's just the length of the process and all the -- all that goes with that. So that gives us also time to prepare our marketing and get ready to launch the project. But we think that that 18 to 30 months to get shovels in the ground is very realistic.

[Himanshu Gupta, Analyst]

Got it. Yes. So that's a bit an administrative process to be done. And then on the cost escalation, I mean are you seeing cost escalation compared to last year with respect to labor costs or material costs or for the development in GTA?

[Brian D. Pauls, CEO & Trustee]

Comment, Alex?

[Alexander Sannikov, Chief Operating Officer]

Yes. We are seeing that costs are rising. Steel, for example, is one of the factors that is increasing generally. We are trying to hedge that risk as much as we can when it comes to buildings that we are starting to construct, and we generally are not exposed to significant risks on that with Vegas or the expansions that we are currently pursuing in Montreal and the GTA. But generally for development projects that are further out, there is that factor. When we -- however, what affects it is the rents continue to increase at a much faster pace as compared to contracts.

[Brian D. Pauls, CEO & Trustee]

Yes. I'd just add to that, Himanshu, that most of the -- the Las Vegas project has been already bought out and committed to. Lumber has been the largest increaser in cost by a long shot. Most of our buildings are concrete, steel and glazing. So those materials have gone up, not quite as bad as lumber. So we're not seeing -- you can't really compare it to, say, residential construction costs. However, they are going up, and we're managing that and watching it very closely.

[Himanshu Gupta, Analyst]

Got it. Okay. And then just turning to the leasing activity in the quarter. I'm looking at 196,000 square feet of renewable [indiscernible] land at almost 20% higher than the expiring rent. So is that a function of very low expiring rents? Or do you think it's more like the market launching model and so rising at a clearly good gap?

[Alexander Sannikov, Chief Operating Officer]

It is a combination of both. We are seeing market rents increasing. And we expect that market rents will continue increasing faster in Europe generally. And that particular lease, that particular asset did have a low in-place rent. So there are both factors at play. And we expect that the market rent growth is going to continue to drive our performance in Europe.

[Himanshu Gupta, Analyst]

Okay. Fair enough. And then maybe final question for me on the acquisition front. Obviously you guys have been very active, almost $500 million of acquisitions in the year so far. So can you talk about the acquisition strategy here? I mean, what's your focus? Is it the size of the property? Or are you changing the embedded growth opportunity? Or do you have certain geographical focus in mind, which is driving your acquisition strategy?

[Brian D. Pauls, CEO & Trustee]

Yes. Let me start, Himanshu, and then I'll let Alex and Bruce comment as well. I mean, everything you mentioned is a factor. Certainly, we're looking at quality. We're looking at geographic focus, something that's complementary to what we currently have in our portfolio where -- those are the things we're chasing. We are not chasing yield at any cost. We're looking at quality, we're looking at location and we're looking at kind of long-term value. We do look at total return. We look at IRRs, we look at the opportunity to grow rents.And I think I've mentioned before that we look at really kind of 3 -- look at opportunities through 3 lenses. We look at the cap rate. We look at the in-place rents compared to the market. And then we also look at our overall price per foot compared to replacement cost. So those 3 things paint a pretty good picture of the quality of the acquisition or the opportunity we're looking at. When you layer on top of that geography and where we want to be, we want to be proximate to population centers. We want to be in the path of progress for logistics and distribution.So all of those things factor into the opportunities we look at. We have -- and I'll let the team talk a little bit about this, but we have boots on the ground in many markets. So we have longstanding relationships, experience in the markets that we're doing acquisitions in. So we're able to basically see all the deals that happen and chase the ones that fit our profile or fit our strategy. Alex, you may want to add to that as well as Bruce.

[Alexander Sannikov, Chief Operating Officer]

Yes. So just to maybe add a little bit of example. So what you've seen from us recently is a reflection of what we want to continue pursuing. More modern larger bay logistics space generally. We are looking to buy assets that have intensification opportunities and not only have the opportunities, but we intend to execute on those opportunities as we did with Marie Curie. If you recall, we acquired it in January. We started construction on Phase 1 of expansion in April.We're looking at buying vacancy and rollover risk with high-quality assets, so as we did with financial drive, it was a low going-in cap rate, but we doubled the rent in less than 4 months. And we're looking at a couple of assets right now in clusters that we already -- where we're already present, where there's maybe a bit of vacancy, and we're looking to take that vacancy risk. And because we're very comfortable with those nodes, we expect that we'll be achieving sort of value-add returns.And lastly, and also [indiscernible] importantly is we're looking to continue pursuing our clustering strategy. We have clusters in many markets and including places, Mississauga and Brampton, Kitchener and Cambridge, many central locations in Montreal, and we're gradually adding to our clusters, and that is a -- has been a very successful strategy for us. We're sourcing those -- a lot of these deals off market and pursuing a much larger footprint in one node, gives us economies of scale, operational synergies and also long-term -- opens up long-term redevelopment opportunities.

[Brian D. Pauls, CEO & Trustee]

Great. Thanks, Alex.

[Operator]

And we have no further questions in the queue. I'll turn the call back over to Mr. Brian Pauls for final remarks.

[Brian D. Pauls, CEO & Trustee]

Thank you, everyone, for your time today. We look forward to speaking to you soon. In the meantime, stay healthy and stay safe. Take care.

[Operator]

Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for participating, and you may now disconnect.