Dream Industrial Real Estate Investment Trust

TSX:DIR.UN

Earnings Call Transcript 2024-Q1

[Operator]

Welcome to the Dream Industrial REIT First Quarter 2024 Results Conference Call on Wednesday, May 8, 2024. Please be advised that all participants are currently in listen-only mode and the conference is being recorded. [Operator Instructions]. 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 securities regulators, including it's latest annual information form and MD&A. These filings are also available on Dream Industrial REIT's website at www.dreamindustrialreit.ca. Your host for today will be Mr. Alexander Sannikov, CEO of Dream Industrial REIT. Mr. Sannikov , please proceed.

[Alexander Sannikov, executive]

Thank you. Good morning, everyone. Thank you for joining us today for Dream Industrial REIT's First Quarter 2024 Conference Call. Speaking with me today is Lenis Quan, our Chief Financial Officer. We started 2024 with strong operating and financial results as we focused on executing on our key growth drivers. We reported 7.1% comparative properties NOI growth during the quarter, which drove FFO per unit to $0.24 for Q1, in line with our guidance provided on the last call. We saw a 20 basis point lift in committed occupancy over the last quarter, driven by healthy leasing momentum. Our balance sheet remains strong with conservative leverage and ample liquidity. The industrial leasing market is dynamic, but healthy. On one hand, availability has risen across our core markets when compared to the historic lows prevalent in the last couple of years. This was due to delivery of anticipated new supply to the market and a rise in sublease activity by tenants, largely in the 3PL industry. On the other hand, construction starts have fallen significantly over the past year. Speculative space under construction currently stands at less than 1% of inventory in the GTA and GLA markets. We are also seeing healthy levels of leasing activities and user acquisition demand. As a result, we continue to expect down supply and demand dynamics in our markets. We remain focused on driving NOI growth through achieving strong rents on leases that are rolling over and driving new leasing in our development projects. We expect that this will translate into continued FFO per unit growth in 2024 and beyond. Our outlook for the year remains intact. We continue to expect that organic growth in 2024 will be primarily driven by growing in-place rents as opposed to occupancy levels. Since the beginning of 2024, we have signed over 2 million square feet of new leases and renewals at an average spread of 43%. In Canada, was in 1.6 million square feet of leases at an average spread of 52%. And in Europe, we signed 0.5 million square feet of leases at an average spread of 11%. Rental steps remain strong. Our recent development leasing activity has also been healthy with approximately 0.5 million square feet of new leases transacted or in final phases of negotiations across our pipeline in Ontario and Alberta. Furthermore, activity levels remain in good shape. We have been responding to multiple requirements for our development projects, both on balance sheet and within our private ventures. Currently, we are engaging with prospective occupiers representing requirements of approximately 1 million square feet. Our 200,000 square foot net bureau redevelopment at Courtney Park in Mississauga is a good example of this. The project has achieved substantial completion and 60% of the building was leased in Q1 for a 10-year term with a starting rent of $200 per square foot and annual steps of approximately 4%. We are in the process of finalizing a lease on the balance of the space at similar rates in terms. We expect this asset to contribute to over $4.5 million to our annual NOI on a run rate basis, with rent commencement in Q4 2024. Our capital allocation priorities remain intact. Completion of our existing development projects is the main use of our capital for the next 12 months. While our private capital partnerships do not require significant capital, these co-investment opportunities continue to drive incremental FFO per unit. To date, in 2024, we have completed over $180 million of acquisitions in the Dream Summit Venture, which are accretive to our FFO per unit and a current total return pipeline profile. Our property management and leasing platform generated over $2.5 million in net margin for the quarter. We're also looking for opportunities to scale up our solar program, both in Canada and in Europe. We're advancing feasibility studies on multiple projects, resulting in yields on invested capital of over 10% on average. Our business is well funded to pursue these initiatives on a leverage-neutral basis through existing liquidity and retain cash flow. In addition to these sources of liquidity, we are pursuing several disposition of the takes of nonstrategic assets. We're going in discussions to sell over $100 million of assets at compelling pricing metrics. Many of the productive buyers or private groups for the transactions may require longer execution time frames. We expect to provide further details on these initiatives over the balance of 2024. I will now turn it over to Lenis to discuss the financial highlights.

[Lenis Quan, executive]

Thank you, Alex. Our financial results for the first quarter were strong. Diluted FFO per unit was open for the quarter, driven by strong NOI growth of 7.1% for the quarter and fee income generated from our property management platform. Our Q1 2023 FFO included $0.04 of lease termination income relating to an [indiscernible] vacancy in Europe. Excluding this nonrecurring income, our year-over-year FFO was relatively consistent with the prior year and in line with our guidance. Our net asset value per unit at quarter end was $16.72, a slight increase compared to the prior quarter due to higher asset values in Canada and stable values in Europe. We continue to actively pursue financing initiatives to optimize our cost of debt and maintain a strong and flexible balance sheet with ample liquidity. In January, we closed on a $200 million unsecured debt issuance via a reopening of our Series F unsecured bonds at a lower implied interest rates than the original issuance in early 2023. The proceeds were currently used to repay $44 million of mortgage maturities and repaid the outstanding $50 million balance on our credit facility, which bore an average rate of approximately 6.9%, with the remainder earmarked towards funding our development pipeline and contributions to our private capital partnerships. In May, we repaid an additional 2 European mortgages totaling $44 million. Our remaining unaddressed debt maturities of approximately $220 million for 2024 include our $200 million Series B unsecured debenture maturing in June at a floating interest rate, which is currently 4.5% and the European mortgage maturing in August. We are in advanced discussions to refinance the Series B bonds with a new unsecured term loan denominated in euros with a relationship lender. We expect to achieve a rate that is 50 basis points lower than the maturing bond in current market environment and more than 110 basis points lower than Canadian dollar-denominated debt. We ended Q1 with leverage in our targeted mid-30% range. With total available liquidity of over $600 million, we retain sufficient capital to execute on our strategic initiatives. Given our private joint ventures are reported on an equity accounted basis, our net debt-to-EBITDA could fluctuate quarter-over-quarter. We expect net debt to EBITDA to average low 8 on a run rate basis for 2024, which is lower than 2023 and the run rate prior to the Summit transaction. For 2024, we expect our in-place rents to grow in the high single-digit percentage range by the end of the year. Our outlook for comparative properties NOI growth remains intact in the mid-single-digit range on a constant currency basis, primarily driven by contractual rent steps and rent spreads on leasing. We are expecting that in-place occupancy will remain largely flat on average for the year. We are expecting some space to come back to us in Q2 and Q3, so in-place occupancy levels may fluctuate quarter-over-quarter. We are reiterating our prior guidance of mid-single-digit FFO per unit growth in 2024, which is predicated on current foreign exchange rates, leverage levels and interest rate expectations. Looking further out to 2025, we expect that the pace of organic growth within our portfolio will continue to exceed the pressure from higher interest rates as 93% of our debt maturities for next year occurred in November and December 2025, with some development assets achieving stabilization by the end of this year as well as upcoming lease maturities in late '24 and early '25, we expect both NOI and FFO per unit growth to accelerate into 2025. I will turn it back to Alex to wrap up.

[Alexander Sannikov, executive]

Thank you, Lenis. It has been a solid start to 2024, and we remain focused on delivering strong FFO and cash flow growth for all of our stakeholders. We will now open it up for questions.

[Operator]

[Operator Instructions]. Our first question is from Kyle Stanley with Desjardins.

[Kyle Stanley, analyst]

Last quarter, you mentioned being in negotiations are under contract to require upwards of 2.5 million square feet within the Dream Summit JV. Looks like since then, you've done about 800,000 square feet. So are you still progressing on the balance of that space? And could you disclose maybe total cost of the 800,000 square feet acquired if we participated at the 10% economics?

[Alexander Sannikov, executive]

You're absolutely right. The pipeline at last quarter was larger. One of the assets that was in the pipeline didn't materialize, and we are proceeding with the rest of the assets, as we commented, acquisitions to date amounted to $180 million. And we continue to pursue opportunities in our target markets, including Montreal. We're looking at opportunities in Vancouver and continue to obviously look for opportunities in the GTA.

[Kyle Stanley, analyst]

And just to confirm the economics as part of the JV still kind of 10%?

[Alexander Sannikov, executive]

That is correct. Yes, we invest 10%.

[Kyle Stanley, analyst]

Lenis, you gave some disclosure on the expecting to get back a bit of space in Q2, Q3. Would the expectation then still we have a bit of a stronger Q4 leasing period to then keep occupancy flat? Is that how I think we should think about things?

[Alexander Sannikov, executive]

I think that is fair. We probably expect that, that trajectory will be accurate.

[Kyle Stanley, analyst]

And then just the last one. I think you highlighted maybe some of the softer fundamentals in the space, broker staff have been suggesting the same. But just given your size and then portfolio scale across the country, speaking cannabis specific here, how are you interpreting what's happening? Are you seeing anything different in your portfolio, just given your geographic mix or asset type mix size of space?

[Alexander Sannikov, executive]

As we commented, our development leasing activity has been pretty healthy. We are finalizing many transactions as we speak, and we continue to see requirements and user demand, both in GTA and Alberta, which is where we're developing currently. We do see that user demand is bifurcating. There is pretty strong activity for what we would categorize as mid-day space, so that's less than 200,000 square foot footprint. We do see some requirements in the market for million square feet range as well, which helped. There's not a lot of supply of that product. And as a result, the requirements are also limited. But in the segment of the market that is core to our business, which is mid-turbine product, we continue to see pretty strong demand and pretty strong rates or Courtney Park project is a good example of that. We do have some exposure to small bay assets in key markets, in PTA in Calgary and Montreal. And as you know, there's been virtually no supply of this product over the last decade. And so we continue to see strong fundamentals and supply/demand dynamics are still very favorable. The availability that is in the market is generally larger spaces, in some cases, older spaces and doesn't always necessarily compete with our product.

[Operator]

The next question is from Sam Damiani with TD Cowen.

[Sam Damiani, analyst]

First question, just on the development pipeline, just given everything that's going on in the market, how are you feeling about starting destruction on the next phase of your Brampton project?

[Alexander Sannikov, executive]

We are advancing that project. We started marketing the asset on a pre-leasing basis. We are finishing horizontal development, if you will, finalizing site plan design of the building. So we are not necessarily in a position to launch construction just yet, but we continue to advance the project and start marketing it.

[Sam Damiani, analyst]

And just on the occupancy outlook you provided, Lenis, I think you basically said occupancy would be roughly flat for the balance of the year. What fluctuations do you see possible? And then for your 2025 outlook, accelerated growth, does that mean 1% or 2% faster? Or is that 3% to 4% faster if you could be any more specific that would be helpful.

[Alexander Sannikov, executive]

So let me maybe just start with the balance with the second part of the question. So when we say accelerated more meaningful than 1% to 2%, and we're not in a position necessarily to provide guidance at the moment but we are considering providing a multiyear outlook at some point later in 2024 that will capture not only 2025, but also 2026, et cetera. So when we say accelerate is more material than 1%. As far as the occupancy fluctuations, as we commented, we expect the average to remain largely flat and that the growth this year is going to be driven by rents as opposed to occupancy levels. And we're not guiding necessarily a quarter-over-quarter occupancy, but the swings can be 50 to 100 basis points from one quarter to another.

[Operator]

The next question is from Brad Sturges with Raymond James.

[Bradley Sturges, analyst]

To follow on questions around the development pipeline. Just based on the process you're looking to complete construction over the course of this year, totally 1.5 million square feet. How do you think about the buildup of NOI from those projects? And when would you expect a full contribution from an NOI perspective?

[Alexander Sannikov, executive]

So the 2 projects that are completing and we anticipate will be revenue producing this year, our Courtney Park and our smaller development project in Beaver. So we expect that both will be largely revenue producing in the fourth quarter. And those are the two most meaningful projects on balance sheet. We have other projects within our private partnerships that will also be revenue producing later this year, but because they're in our private partnership, the contribution to overall FFO and NOI is going to be lower. And then as you can see from our MD&A, we do disclose anticipated completion for other projects. So for example, our Whitby project is going to be completing in the first half of 2025. So that's when it's going to be revenue producing. The larger development in Calgary is slated to get completed at the end of '24, so it's going to be producing revenue into 2025.

[Bradley Sturges, analyst]

So that schedule is closely resembled when the NOI would kick in? Or is there a little bit like I guess there's still some leasing to do on some of the -- but would you expect a little bit of a lag overall?

[Alexander Sannikov, executive]

No, absolutely, we would expect the lag. So what we are disclosing is expected completion. So from respective completion, it takes time to build out the office for like a user. It takes some time to set up racking within the space. So there's usually at least a 6 months delay from completion to commencement of brands.

[Bradley Sturges, analyst]

And I think you said in your opening remarks that related to the development pipeline, you're in various stages of negotiations. I think it was 1 million square feet. From your experience, if that's the right number, like from your experience, how much could that translate into actual fund leases? Like what's the conversion rate typically?

[Alexander Sannikov, executive]

It's not as scientific as that some of these requirements we've been negotiating for some time, some are relatively new requirements. So this comment was rather aiming to address the overall level of activity and demand we see within our development program. We will be reporting on actual leasing as we finalize it in more detail.

[Operator]

The next question is from Himanshu Gupta with Scotiabank.

[Himanshu Gupta, analyst]

Quite a discussion on occupancy side. So just on your attention on the rental spreads, very strong on the equivalent miles you've done so far. Any change in outlook for the remaining 2 miles square. I mean do you see any slowdown in those rental spreads for [indiscernible]?

[Alexander Sannikov, executive]

No, we do not. And in fact, you will note that our Q1 disclosure as to the market rents that we expect for our assets is in line, slightly higher than what it was in the prior quarter. So we continue to see opportunities to market that which is consistent with our overall levels for the portfolio. And in fact, we have captured a couple of opportunities, some of them are sizable where we had contractual escalators previously or contractual renewal options previously with certain users, some of the reductions were even miss a not exercise, and we would be able to capture more upside on some of these spaces than we originally anticipated.

[Himanshu Gupta, analyst]

And then, Alex, I think in your prepared remarks, you did mention about subleasing activity. And I think you called out 3 third-party logistics as well. Is that putting pressure on the market rent here? Do you see any like slippage in market trends at all?

[Alexander Sannikov, executive]

It depends on the definition of market rents. So in the GTA, roughly 1/3 of the available space is coming from subleasing activity. Direct vacancy remains in the 2% range. And what we see from subleasing activity is that it's not always is competing with direct vacancy because in many cases, it's being over preferred return. In many cases, prospective occupiers do not see the opportunity to reconfigure the space, they need to or do not have the term security to pursue investments that they need to pursue in the space. And so yes, it does compete with certain direct vacancies, but it's not a 1:1 ratio. When it comes to the market rent levels, so as we commented before, the market rent levels that are being reported by various market participants are average asking rents and asking rents to change, and we do not always represent the true market rent levels. When we look at our portfolio and as we commented in response to the previous question, the market rents that we see for our assets are intact, and we actually increased them slightly from one quarter to another.

[Himanshu Gupta, analyst]

And then just on the third-party pages. Do you have a sense of how much 3PLs account for leasing in the Toronto market or the Montreal market?

[Alexander Sannikov, executive]

We do not have the [indiscernible], but we can get back to you. What we see from third-party logistics providers, we actually see both sides of activity from these groups. Some of these groups are in the clearing space on some of these market. But in many cases, they're also looking to take more space because many end users are looking to outsource their logistics needs to third-party logistics providers. And so we see both sides of the 3PL activity in the market, both subleasing and significant requirements.

[Himanshu Gupta, analyst]

Maybe just last question and turning to Europe. IFRS CapEx for Europe, I think it's around 5.9%, up like 50 basis point year-over-year, not much on a quarter-over-quarter basis. So are we mostly done with the adjustments? So any color on the valuation side there?

[Alexander Sannikov, executive]

So fundamentals are consistent with what we see in Canada. In Canada, what we've seen over the last 3, 4 years, let's say, a significant rise in market rents, on the back of increasing demand and very muted supply response. And so when we look at the market today, while it is not 0.5% of availability in the GTA, the market is very balanced. And so many markets in Continental Europe are similar, supply response has been limited, and these markets are increasingly subconstrained. And so we continue to see upward pressure on rent, albeit not to the same degree as what we've seen in GTA and G&A. So the outlook for fundamentals is healthy. When it comes to cap rates, we have seen more interest in urban industrial in Europe, which is what we own predominantly on the continent, and we continue to be get encouraged by the opportunities there and the valuation metrics that we are reporting are consistent with some of these transactions and opportunities that we are looking at or evaluating in Europe.

[Operator]

The next question is from Matt Kornack with National Bank Financial.

[Matt Kornack, analyst]

Just a few quick accounting questions here. On bad debt expense in the quarter, it seems elevated relative to historical levels. Was there anything to that and should be that as anomalous to this quarter?

[Lenis Quan, executive]

And so similar to the gains Alex was talking about and what we're seeing about some of the third-party logistics occupiers. And we do have ones that are doing well in our portfolio, and we have one in particular that's been a little bit struggling and took a little bit more space. So that similar leasing trend that we're seeing in some of the markets driven by sales has reflected that. We monitor our receivables. So we're just being careful with this one retail provider that seems to be struggling a little bit more. So we're prudently bumped up some provisions this quarter related to that.

[Matt Kornack, analyst]

But judging by your overall same-property NOI growth commentary I would assume that you're not assuming that level of adjustment in the remaining 3 quarters of the year. Is that fair?

[Lenis Quan, executive]

Yes. I think overall, that's fair. I think as we've mentioned, the growth from driving the set NOI is largely coming from contractual rents and achieve market rental spreads, not so much occupancy. So any dip in occupancy from quarter-to-quarter would be outpaced by the growth from the rest of the portfolio.

[Matt Kornack, analyst]

And then on fee income, that would have an opposite impact this quarter. It was an all-time high and was up sequentially. Is that a good proxy for where the fee income should be? Obviously, the portfolio changes. Obviously, that metric will change, but I'm trying to get a sense as to the trajectory of that sort of $4.7 million in the quarter.

[Lenis Quan, executive]

So Matt, are you referring to the property management income?

[Matt Kornack, analyst]

Yes.

[Lenis Quan, executive]

I mean, I think the run rate will be fairly lumpy because a lot of it would be based on leasing fees that we also earn as part of the property management contracts that we have with our private capital partnerships. So this quarter is releasing was actually a little bit on the lower side. We did have the Dreams Fame contract for the full quarter. So if you're looking year-over-year, there would be a bit of an increase driven by the ownership for the full quarter, amassing fees will be lumpy from a quarter-to-quarter basis on that.

[Matt Kornack, analyst]

And then the last one for me, just on the accounting side. Interest income was higher, but you carried more cash, but you've essentially deployed that into paying down debt post quarter. So should we expect the offset being lower interest expense with less interest income, I guess, as a result?

[Lenis Quan, executive]

You're correct that we were sitting on the cash largely from the bond that was raised at the beginning of the year. So we were reinvesting that as we are deploying that. So the interest income would wind down over the course of the second quarter. Some of it was used to repay debt gradually over Q1 and Q2. So yes, there will be some corresponding decrease, but I think we'll see some decrease on interest expenses from refinancing the floating rate bond towards the end of Q2. We're expecting, as I've mentioned on the call, about 50 basis points of savings given where we see pricing based on today. So let's see interest for the remainder of the year.

[Operator]

The next question is from Sumayya Syed CIBC.

[Sumayya Hussain, analyst]

Just on the acquisition side and the assets acquired by the summer JV in the quarter. Any more info there on the assets, if they're single or multi-tenant side? And then also what kind of NOI upside you expect from those?

[Alexander Sannikov, executive]

Very consistent with generally with Dream Summit venture or some used to own high-quality urban assets in the GTA, very functional. In terms of the upside and in terms of return metrics, these are consistent with what you've seen from the venture throughout 2023 in terms of acquisition profile. So we are expecting high 6s mark-to-market yields with seasonable walls to get there.

[Sumayya Hussain, analyst]

So the mark-to-market would be in line with the REIT's broader mark-to-market?

[Alexander Sannikov, executive]

In line with repromarket and generally in line with our valuation parameters. And generally speaking, I think it was important to highlight on the acquisition market and the overall activities, we continue to see more and more capital looking at Canadian and industrial from a broad primarily from the United States because the fundamentals are strong, and we have pretty low supply low availability especially in the GTA. And so we continue to see more interest from specifically U.S. institutional investors in the Canadian market.

[Sumayya Hussain, analyst]

And then on the flip side, just any more color you can provide on your position program and targeted assets for our markets?

[Alexander Sannikov, executive]

These are assets that have been nonstrategic cotton. So as these transactions materialize, we will provide, obviously, more color on pricing net rates, the assets themselves, why we regard them as not strategic. I think to describe them broadly is going to be perhaps premature at this point.

[Sumayya Hussain, analyst]

And then lastly, I'm not sure if I missed it, but on your development on the TMR side? And what are your expectations for a lease up there?

[Alexander Sannikov, executive]

We actually signed our first lease in Cambridge during the quarter at rents that are in line with our underwriting on a trended basis. So low 15s starting rents with good escalators and we're engaging with a number of prospects for the balance of the asset. It is going to be a multi-tenant lease-up, which is how the asset has been designed, and we are encouraged by the level of activity for this particular property.

[Operator]

Our next question is from David Chrystal with Echelon.

[David Chrystal, analyst]

Just a quick one for me. On the share of FFO from equity-accounted investments, looks like it went down a few hundred thousand sequentially. NOI was largely flat or down a little less. Is this interest expense? Or is there anything else to read into here?

[Lenis Quan, executive]

No, I think your summary is quite accurate in terms of the share of FFO pickup. Okay.

[David Chrystal, analyst]

So the organic interest expense increases and possibly some increases tied to acquisitions in the JV?

[Lenis Quan, executive]

No, that's great. There's some acquisitions financed by a combination of debt and equity. So the acquisitions, I mean, I think Al went through the metrics going in is getting good value growth on the acquisition. So it will take a couple of quarters to see that the accretion kick in from that.

[David Chrystal, analyst]

And then in terms of the growth outlook, I mean, it would be similar or slightly better than the outlook, I would say, for your Canadian portfolio if we're reading into the Summit JV in particular?

[Alexander Sannikov, executive]

Can you maybe elaborate on this question, growth outlook, you mean in terms of built-in mark-to-market potential within the Dreams assets?

[David Chrystal, analyst]

Yes, mark-to-market. So I guess the NOI growth and the FFO growth should be similar or superior to the Canadian portfolio, the consolidated Canadian portfolio?

[Alexander Sannikov, executive]

So we don't track FFO for Dream Summit because it's obviously a private venture that is focusing on total return strategy. However, in terms of NOI and mark-to-market, we have commented previously that the built-in mark-to-market opportunity within Dream Summit's portfolio is greater and has been greater at the time of acquisition compared to DIR's mark-to-market opportunity, primarily as a result of longer weighted average lease terms historically within the portfolio. And that thesis remains intact. And then the assets that we add in between summer generally have significant mark-to-market built into them as well. So there is still a pretty strong outlook for organic NOI growth within the venture.

[Operator]

[Operator Instructions]. Next question is from Pammi Bir with RBC Capital Markets.

[Pammi Bir, analyst]

I think will be a quick one. On the disposition side, coming back to that, is the expectation to get most of those, call it, the roughly $100 million is you into get most of that done this year? Or do you see that possibly trending or extending into 2025?

[Alexander Sannikov, executive]

The deals that we are working on, if they materialize will close this year, Pammi. And we expect from a modeling perspective, they will not have a material impact on the guidance that we just reiterated.

[Pammi Bir, analyst]

And then just the debt-to-EBITDA metrics, they did move up this quarter, a fairly sizable increase. And I think, again, Lenis, maybe that's some of that lumpy income from the distribution from the JV or the JV. So when you think about the growth that you've guided to this year and again, these dispositions, where do you see that metric trending by year-end?

[Lenis Quan, executive]

As you pointed out, the debt-to-EBITDA number can be a little bit lumpy based on the way that we have to treat the investments in the private ventures. But we do see that debt-to-EBITDA for averaging low 8 over the quarter closer to on a run rate basis and kind of getting down to closer to 8 by the end of the year on a run rate basis. Thanks very much, minus. I'll turn it back... This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Sonacol for any closing remarks. Thank you very much for your interest in Dream Industrial REIT. We look forward to reporting next quarter. Good day.