Dream Industrial Real Estate Investment Trust

TSX:DIR.UN

Earnings Call Transcript 2017-Q4

[Operator]

Good morning, ladies and gentlemen. Welcome to the Dream Industrial REIT Fourth Quarter 2017 Conference Call for Wednesday, February 21, 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 securities regulators, including the 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, you may begin.

[Brian D. Pauls, CEO & President]

Good morning, everyone. Thank you for joining us today for the Dream Industrial REIT conference call, which is for the 3 months and year ended December 31, 2017. Speaking with me today is Lenis Quan, Chief Financial Officer of the REIT. On today's conference call, I will start off with a brief overview of our results, an update on our markets and our strategic growth initiatives. Lenis will then provide our financial highlights. We'll then be happy to field your questions.I'm delighted to join Dream Industrial REIT. In the past couple of months, I've spent my time getting up to speed on the properties, people and the day-to-day operations of the trust. Overall, the business is running well and is positioned well to capitalize on growth through increased rents, acquisitions and aggressive asset management throughout the 4 Canadian markets we invest in as well as the U.S.For 2017, I'm happy to report that DIR outperformed our FFO, AFFO, tenant retention and occupancy targets.We grew our AFFO by 3%, reduced our leverage to below 50% and raised $113 million. This was our first equity offering since 2013, and it was well subscribed.The Canadian economy remains very strong with overall industrial availability of 4.1%, a 16-year low. New supply under construction remains limited at 14 million square feet or only 0.8% of the market inventory.It is unlikely that the new supply will meet the continuing demand resulting from e-commerce and other economic drivers fueling increasing demand for industrial space. Our leasing and management teams have done a tremendous job leasing 3.2 million square feet throughout the year, including commitments, and retaining 80% of our expiring tenants to bring overall occupancy to almost 97% compared to 95% 1 year ago. Our Western Canada assets have retained a very healthy occupancy rate, closing 2017 at 95% occupied as those economies continue to recover from the significant recent commodity correction.Our properties are well positioned to benefit as Western Canada continues to recover. Eastern Canada experienced positive absorption, and 2017 year-end occupancy is over 93%. Both Ontario and Québec remain extremely healthy with occupancy at 99.7% and 96.3%, respectively. In both of these markets, the trust has the opportunity to increase rents as tenant lease commitments renew. In the last 4 months, we have actively grown our portfolio in the U.S. The trust acquired 2.8 million square feet of distribution and light manufacturing facilities in strong industrial markets in Memphis, Nashville, Orlando and Charlotte for a total 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.The assets are 100% occupied by a mix of large blue chip companies and medium-sized enterprises, including Nissan North America and Coca-Cola Refreshments U.S.A Inc.The acquired properties are all under triple net lease structures with contractual rent increases and have a weighted average lease term of 6.7 years.The Dream and PAULS Corp. acquisition teams continue their work to source new acquisitions in both Canada and the U.S. to identify opportunities that meet our investment criteria.Lenis?

[Lenis W. Quan, Chief Financial Officer]

Thank you, Brian. Dream Industrial reported another quarter of strong portfolio performance and solid financial results. Our current portfolio continues to perform well, and our operational and financial performance in 2017 has improved significantly.Diluted adjusted funds from operations, or AFFO, per unit for the quarter was $0.204, up 9.7% compared to $0.186 in the same quarter prior year.Our AFFO has increased due to higher comparative property NOI, G&A savings and a onetime cost that was incurred in the prior year, offset slightly by the timing difference between the November equity offering and when the capital was deployed.Diluted FFO per unit for the quarter was $0.225, up 6.1% compared to $0.212 for the prior year same quarter.Diluted AFFO per unit for the year increased 2.9% to $0.813 compared to $0.79 for the prior year. Diluted FFO per unit for the year was $0.905 compared to $0.901 for the prior year. The increases in annual diluted FFO and AFFO were due to the same factors as the quarterly numbers.Comparative property NOI was strong, improving 2.3% from the same quarter last year and is up 1.7% for the full year, mainly reflecting higher average occupancy in Ontario.We maintained a healthy retention ratio for 2017 of 80.3% and have secured leases for 65% of our upcoming 2018 expiries compared to 53% this time last year.The value of our investment properties increased to $1.7 billion compared to $1.6 billion at the beginning of the year. The increase was largely as a result of the $95 million in acquisitions completed during 2017.The trust's payout ratio on a diluted -- on diluted FFO is a healthy 77.3% compared to 77.7% 1 year ago. We have grown our free cash flow per unit and lowered our payout ratio while reducing our leverage and have enhanced our financial flexibility to execute on our strategic initiatives.During the fourth quarter, the trust successfully completed a public offering and private placements for total gross proceeds of $113 million and issued 12.9 million in units. Net proceeds were used to repay the $19.4 million of 6.75% debentures that matured on November 30 and to fund the U.S. acquisitions which closed in December 2017 and January 2018.Our debt-to-total assets ended the year at 49.5%, a decrease of 310 basis points when compared to 2016, with interest coverage of 3.3x and a weighted average term to maturity of 3.8 years. At year-end, we retained unencumbered assets of $113 million with $123 million of liquidity on our credit facility.Looking forward, we expect the strong performance to continue. Our properties are well positioned to benefit as Western Canada continues to recover and occupancy is up significantly in Eastern Canada.In terms of our growth strategy, we have the balance sheet flexibility to be net acquirers during 2018. Our investment criteria demands assets that would be above the average quality of our portfolio, offer a good growth profile and be accretive to DIR. In terms of geography, we are open to opportunities in both the U.S. and Canada as long as the asset in question fits these investment criteria.Overall, on a comparative property basis, we expect NOI to be up about 2% this year, which should lead to FFO per unit growth in a low single-digit range. Currently, approximately 50% of the forecast comparative property NOI growth for 2018 is due to contractual rent steps and more than half of the remainder is due to the full year impact of the increased occupancy in Eastern Canada.So we feel confident about that growth and will strive to do better. Within our portfolio, we are continuing to drive organic growth through continued contractual and rental increases and increasing rental spreads, primarily in Ontario and Québec. We believe this will result in 2% to 3% comparative property NOI growth beyond 2018.In addition, 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, which include growing organically and identifying asset-recycling opportunities that can improve overall portfolio quality and generate higher net asset value growth.I will turn it back to Brian now to wrap up.

[Brian D. Pauls, CEO & President]

Thank you, Lenis. Recent M&A activity in the Canadian REIT space has highlighted the significant value in owning sizable quality portfolios of commercial real estate, including industrial assets. We believe this has positive implications for our net asset values going forward. Dream Industrial is well positioned to improve the value of the business by organic income growth, identifying asset-recycling opportunities to improve overall portfolio quality as well as using the strength of its balance sheet for new investment opportunities that meet our investment criteria.It has been an exciting first 6 weeks, and I look forward to discussing the company and our progress with the analyst community and our investor base. We would be happy now to take any questions.

[Operator]

[Operator Instructions] And our first question comes from Fred Blondeau from Echelon Wealth Partners.

[Frederic Blondeau, MD & Head of Real Estate Research]

I just wanted to further discuss the U.S. strategy at this point. How big is your acquisition pipeline at the moment? And would you be open to buy more land at this stage?

[Brian D. Pauls, CEO & President]

Sure, Fred. It's Brian Pauls here. We've got an acquisition pipeline in many states in the U.S. We're looking at opportunities in the markets we're in, the ones I mentioned earlier, in Nashville, Memphis, Charlotte and Orlando. We're looking to expand in those markets. An example, we recently underwrote a portfolio in Jacksonville, Florida. It was an attractive portfolio. But as it got bid up in price, down in cap rate, we decided it was getting too pricy. So that was likely to go at 6% or below a 6% cap rate. So we decided to opt out of that. Now we are continuing to look for opportunities, leverage relationships that we have in the U.S., like the one that produced the previous acquisition. And so we're looking in all those markets.

[Frederic Blondeau, MD & Head of Real Estate Research]

And you wouldn't buy more land at this point, right?

[Brian D. Pauls, CEO & President]

We don't have vacant land in the U.S. We would look to expand some of the existing tenants we have. So we would develop within the properties that we already have. If there is a new development opportunity that made sense, that was kind of a pile-on opportunity for -- that would be a complement to what we already have. We'd look at that as well. We're really focused on accretion for the REIT when we look at new acquisitions in the U.S. And so that's part of our investment criteria we're looking at.

[Frederic Blondeau, MD & Head of Real Estate Research]

Okay. And then -- and I was just looking at the price increase of industrial land in the U.S., which more than doubled last year. And I guess at the moment, you are benefiting from these conditions from a value standpoint. But do you think it could become an impediment to future accretive growth?

[Brian D. Pauls, CEO & President]

I think it's rising replacement cost, certainly. That's helping probably the overall value of industrial real estate, the stuff that we already bought. It's pretty competitive. So it's tough to buy new stuff. We do have dry powder, and there are acquisitions we can do out there that are accretive, but they are hard work to find.

[Frederic Blondeau, MD & Head of Real Estate Research]

Sure. And lastly, how would you characterize construction activity in your U.S. target markets at the moment now that industrial development activity is at an all-time high in the U.S.?

[Brian D. Pauls, CEO & President]

Fred, I think it's a market-by-market answer. All of the markets we're in are quite healthy. All of them would have mid-single-digit vacancy rate. They do have development going on but they've also got more absorption than they have supply coming on. So they're all healthy and continuing to get more healthy. The U.S., as you know, is quite a large market compared to the Canadian market. So there are many markets. It's a big pool to swim in. We're -- we think we'll continue to find opportunities that make sense for us. We're looking both in Canada and the U.S., and we think we'll find accretive opportunities that will be a compliment to what we have. But they're -- it's hard work. It's competitive space out there.

[Operator]

Next, we have Mark Rothschild from Canaccord Genuity.

[Mark Rothschild, MD & Real Estate Analyst]

Brian, you mentioned that you've been going through the portfolio in Canada as you progress as CEO. Can you maybe talk about are there any markets in Canada or any assets that you think that you want to sell? Obviously, the REIT sold a number of assets in the year before you joined. But as you go through the portfolio, how much of the portfolio is property that you want to own for the long term?

[Brian D. Pauls, CEO & President]

It's a good question, Mark. We're looking at it asset by asset. We're looking at which assets are probably worth more in the hands of others than they are in our hands. For example, we had an offer from a tenant within our portfolio who wanted to own their own building. And so those are opportunities that we probably would cycle out of. At the same time, we're looking to replace those assets with either higher-quality assets or better-located assets or more accretive assets. So we're looking to recycle where we can, where we can make positive trades.

[Mark Rothschild, MD & Real Estate Analyst]

Are there any markets in Canada where the REIT is currently operating that you would prefer not to be in?

[Brian D. Pauls, CEO & President]

No. I think all the markets we're in are performing well. Some are performing better than others. Certainly, Ontario's got record lows of vacancy, record highs of occupancy, rents are poised to grow fast there. We think that's where we'd like more space. Western Canada has been relatively flat through the kind of commodity crisis it's experienced. But we know from history that, that will rebound. And so it's current performance is less, although, we're not -- we like being there.

[Mark Rothschild, MD & Real Estate Analyst]

And then my only other question. Just maybe just adding on to what Fred was asking, but there was definitely talk before you joined about doing more development in Canada. Just wondering if there's any progress on that. If there's any site that maybe -- through Dream Unlimited maybe that you guys are partnering on. Or any other site that you see that you would want to get involved in on development.

[Brian D. Pauls, CEO & President]

Mark, we're -- the short answer is, yes. We're looking at opportunities all the time. The long answer is, it's slow. It's hard to find good sites. It's hard to find good opportunities. We're working with Dream Unlimited on some potential development opportunities. At the same time, we're looking at just market-based opportunities. Maybe an off-market piece of land or something that we can go and buy that would be a complement to our portfolio. Because as prices -- if prices go beyond replacement cost, we'd rather be building and we know that. It's not easy to find land. It's not easy to find well-located, appropriate land to build on. But we think it would be a great complement to our portfolio to have that. So we're looking for opportunities for that in Canada as well as in the United States.

[Operator]

Next, we have Mike Markidis from Desjardins.

[Michael Markidis, Real Estate Analyst]

Lenis, quick clarification. I think you said on your comments that same property NOI growth was expected to grow 2% to 3% beyond 2018. So is that a expectation for 2018? Or is it just a sort of general trajectory towards a figure of that magnitude in many -- in later years?

[Lenis W. Quan, Chief Financial Officer]

So for 2018, in my prepared remarks, I had commented about 2% comparative property growth and broke down the components. We've got contractual rent steps as well as some increases on average occupancy driving that for 2018. Our expectations in the future are, we'll continue to be growing organically through our contractual rent steps and opportunities where we can increase occupancy. But I think what we're focused on driving the organic growth through our increasing renewal spreads, rental spreads, particularly, in Ontario and Québec so that we can drive further growth. And we're going to do -- we're going to see better organic growth from within our portfolio beyond 2018.

[Michael Markidis, Real Estate Analyst]

Okay. That's great. Now obviously, you're seeing opportunities to maybe drive rents in the coming quarters, specifically, Ontario and Québec, and saw that your average in place estimate or your average estimate of market rents for the portfolio did increase a little bit versus the last quarter, 3Q specifically. Also noticed that your CapEx, TIs -- total CapEx including your TIs and leasing cost came down notably in 4Q, and we're down a decent clip from the prior year as well on a full year basis. Do you expect that, that trend will continue as well, just given what you're seeing in the market?

[Lenis W. Quan, Chief Financial Officer]

So you are correct. Our CapEx and leasing cost came in 20% lower in '17 compared to 2016. I think for 2018, the leasing cost are actually subject to the nature of our units rolling over. But I can't say that our planned capital spending for 2018 is going to be flat compared to 2018 (sic) [ 2017 ]. And I think that as the West and East markets are continuing to stabilize and the Ontario, Québec markets are continuing to tighten, part of our asset-recycling strategy is that to continue to upgrade our portfolio with higher-quality, less capital-intensive units. So we think that our overall costs will trend downwards.

[Michael Markidis, Real Estate Analyst]

Okay. Last one for me before I turn it back. Brian, just wondering, on a general comment, just given your experience in the U.S. If you could comment if you've seen any step change in the competition for assets or acquisition environment in the U.S. today versus, say, 6 to 12 months ago, given the change in the yield curve.

[Brian D. Pauls, CEO & President]

Mike, I think it's been competitive. It continues to be competitive. It's hard to gauge whether it's gotten more competitive or less competitive. The yield curve has certainly flattened, meaning that short-term rates have come up. There's -- you're not paying them much of a premium for longer-term rates. But we find that capital right now is still seeking yield. We find like the most desired real state asset class is industrial right now. It's producing heavy competition throughout Canada and the U.S. But there I think they're still good buys to have. We still think there's a lot of runway here. There is a lot of room for rents to continue to grow. When you look at where replacement costs are going with land and with construction, rents are likely to continue to grow. That's evidenced by the big capital transactions that are happening in the market with PIRET. You can see where the big investors are expecting rents to go. And we believe they're right. We believe we'll capitalize on the same kind of rising tide.

[Operator]

Next, we have Sam Damiani from TD Securities.

[Sam Damiani, Analyst]

Just to continue on the sort of market cap rate discussion. Just wondering if you could specifically say, Brian, you did the acquisition in the U.S. at a 6.4% cap rate. Could you replicate that acquisition on a same quality growth profile risk adjusted basis at the same cap rate today or in the next 3 months? Or do you think cap rates have moved one way or the other?

[Brian D. Pauls, CEO & President]

They -- Sam, it's a hard question to ask. They move up and down. It depends on the day. The portfolio we bought in the Southeast, Blackstone did not bid on. When they're in their bidding and some others are bidding, it can drive the price up and the cap rate down. If we can find portfolios like that off market with relationships that we currently have in the U.S., I think we can definitely replicate it. Those are -- you don't find those on every corner, but they're out there. And we continue to leverage those relationships and leverage kind of market experience that both Dream has and PAULS Corp. has to find opportunities that are unique that maybe others haven't found. So could we do that again? I think we can probably come pretty close. We thought we may have an opportunity in Jacksonville. But we're trying to stay quite disciplined to our criteria and our buy approach. So we're going to keep looking. It's very competitive. But with the change in the yield curve, with the change in interest rates, sometimes, it just depends on the day or the month of what opportunities are out there. But we have dry powder and we've got -- we're looking for opportunities and ready to grab them when they're there.

[Sam Damiani, Analyst]

Fantastic. And just sort of same question on Canada. You mentioned Blackstone and the PIRET transaction, obviously. If -- what's your expectation in terms of Blackstone's continuing appetite within Canada? And how does that impact the competitiveness for acquisitions today?

[Brian D. Pauls, CEO & President]

I think they've got -- I'm just speculating but I think they've got further appetite within Canada. The Canadian market is quite tight. Just because there's -- it's a smaller market. There's fewer markets and fewer assets to choose from. So I think they and other institutions still have an appetite to grow within Canada. It's likely to push prices up but it's also likely to push rents up. So I don't know if that answers your question. But I think they'll continue to buy. I think the kind of the same old players that are left in the market will continue to buy. We'd like to grow in Canada. We'd like to grow in the U.S. And we'll be looking to do so.

[Sam Damiani, Analyst]

All right. And is this -- it kind of feels like markets has been at a bit of an inflection point causing rents maybe to grow faster than they have in a long time. Is there a portion of the portfolio you see better positioned to benefit from that versus not? And does it maybe impact your view on what types of properties or markets to accelerate capital recycling?

[Brian D. Pauls, CEO & President]

You bet. So the first part of your question, what markets are poised best to push rents, Ontario and Québec, no doubt, are in the best position. They have big demand generators. They have big catalysts for rent growth. They've got a lot of capital wanting to invest. So those 2 markets are probably poised the best of our portfolio to grow. The West and the East are likely to not grow as fast. Recycling will likely occur all over the portfolio. We've honestly looked at assets. I'm just getting up to speed, but I've seen almost every asset. Some of them we've identified as potentially good recycling assets. But at the same time, we want to do the best we can to marry those up with acquisitions that are accretive.

[Sam Damiani, Analyst]

Okay. Just 2 quick questions before I wrap up on the debt side. What are mortgage spreads today in Canada for 5- or 7-year debt? And then I have one follow-up as well.

[Lenis W. Quan, Chief Financial Officer]

Sure, Sam. So right now, for 5, 7 and 10 years in Canada, we're seeing about 3.9%, 4% and 4.2% in Canada. The rates, as you know, have ticked up a little bit over the last few months.

[Sam Damiani, Analyst]

Okay. And then, Lenis, your FFO guidance for low single-digit growth, does that include any benefit for redemption of the convert -- of the last convert?

[Lenis W. Quan, Chief Financial Officer]

We -- as Brian had mentioned, we've got some dry powder following the equity offering. So we are contemplating redemptions of our convertible debentures. As you will -- may recall, they are due at the end of 2019, but are open for prepayment without penalty at par at any point between now and the maturity date. So we are contemplating a small partial repayment with some of our excess -- some of the liquidity following the equity offering. And so -- and they carry a coupon of 5.25%.

[Operator]

Next, we have Heather Kirk from BMO Capital Markets.

[Heather C. Kirk, Former MD of Equity Research & Analyst]

Just moving to the Western Canadian portfolio. It looked like the occupancy kind of ticked down just sequentially this quarter. And I'm just wondering if that's the sign of any kind of shift in the market. And if you could just give us a sense of, a, what that was related to. And what your outlook is for rents and occupancy in the West.

[Lenis W. Quan, Chief Financial Officer]

So for -- so just answering your question specifically on the West occupancy. We had a couple of departures of tenants in the fourth quarter in our -- in a couple of our smaller mid-bay industrial units. So that's the part of the market has been held up quite strong. So we are not -- I mean, it's just a matter of timing of re-leasing, nothing of significant concern with respect to those. They were not driven by flex office units. So I think what we're seeing in Alberta is the industrial portion of the market is stabilizing. And we believe that rents are bottoming out. There's still some rental rate pressure, but we do feel that they're bottoming out. And as we do those renewals, we are also building in rental growth for the contractual rent stuff.

[Heather C. Kirk, Former MD of Equity Research & Analyst]

And just in terms of the commentary around better rent growth. I'm just wondering, in the MD&A, looks like the market rents are only $0.10 higher in Ontario. Is that just conservativism? And can you just give us a sense of what your outlook is for rent growth there? It just seemed like a very modest spread, given your positive commentary on the call.

[Lenis W. Quan, Chief Financial Officer]

Yes. So when we derive our market rents, we do a combination of consulting with our leasing teams as well as getting information from our external appraisers. And I think, again, given that this was done in the fourth quarter and there's been some recent M&A equity in the first quarter, I think we would expect, especially in Ontario, that we would be a lot more bullish and a little bit more aggressive on pushing those -- on those market rents.

[Heather C. Kirk, Former MD of Equity Research & Analyst]

Okay. And just in terms of your growth expectations, it sounds clearly like you want to expand particularly in the U.S. What kind of scale of acquisitions are you looking at? And can you just give us a sense of how you expect to fund that? And what your thoughts are on capital recycling versus potentially issuing equity at a discount to NAV.

[Lenis W. Quan, Chief Financial Officer]

So in terms of our acquisition capacity on a leverage-neutral basis compared to prior to our equity offering, we've probably got acquisition capacity of about $100 million. And that's also -- as I alluded to and Brian has mentioned as well, we're being very disciplined, and we want to find assets that improve the quality of portfolio and are financially beneficial for the REIT. I'm sorry, I think -- was there a second part to your question, Heather, sorry?

[Heather C. Kirk, Former MD of Equity Research & Analyst]

Just whether this is going to be like funded through -- I mean, that's what you have existing. And is that all you're planning on doing so there's no intention to come back for equity? Or what's your thoughts on -- I guess, I'm just trying to figure out if you're doing acquisitions beyond the $100 million. Is this going to be funded through capital recycling or through coming back to the equity market?

[Lenis W. Quan, Chief Financial Officer]

Correct. I think we want to be focusing on -- at capital recycling and improving the quality of our assets, and hopefully, result in some benefits to the REIT net asset value such that we can reduce our cost of equity. So that's really where we're going to be funding a lot of the acquisitions.

[Operator]

And next, we have Carl Burton from Industrial Alliance.

[Carl A. Burton, Equity Research Senior Associate]

Most of my questions have been answered. But I was wondering if I can get some more guidance on same property growth going forward.

[Lenis W. Quan, Chief Financial Officer]

So for 2018, the 2%, I think half of that's coming from contractual rental increases. So stuff that's already been contracted. The other half of that for 2018 is really being driven by higher average occupancy, particularly, in our Eastern Canada region. And I think they're going -- so that comes to the 2%. I think going forward, we're going to strive to do better. We're looking -- we're targeting 3% beyond 2018. We would consider that sort of our stabilized run rate going forward. And part of that is adding to the mix of just driving organic growth through whether it's higher contractual rent steps, increasing the renewals, particularly in the renewal spreads, particularly in Ontario and Québec.

[Carl A. Burton, Equity Research Senior Associate]

Do you have the guidance broken down by geographical region?

[Lenis W. Quan, Chief Financial Officer]

For 2018 or...

[Carl A. Burton, Equity Research Senior Associate]

[ The core ] 2018.

[Lenis W. Quan, Chief Financial Officer]

I would say -- so on -- so the contractual rental steps are across the portfolio. And then the average increase, I think, it's largely driven by the East.

[Operator]

Next, we have Pammi Bir from Scotia Capital.

[Pammi Bir, Analyst]

Just maybe expanding on one of the earlier questions with respect to guidance. Can you maybe just provide a bit more color in terms of what you've underwritten or some of the underlying assumptions for acquisitions and asset sales in 2018?

[Lenis W. Quan, Chief Financial Officer]

So for 2018, I think, our -- we're targeting the -- so when we underwrite, we're looking for about 2% annualized growth somewhat similar to the organic growth within the core portfolio. And then in terms of cap rates, I guess, something similar to what our U.S. portfolio of acquisition would have been.

[Pammi Bir, Analyst]

Sorry, Lenis, can you just repeat the first part of your comment, the 2%?

[Lenis W. Quan, Chief Financial Officer]

Well, you're asking, so what kind of growth assumptions were in our underwriting models.

[Pammi Bir, Analyst]

Yes. No, just -- yes, just looking at the guidance for the year, the low single-digit FFO guidance. My question was really just some of the underlying assumptions with respect to acquisitions, like what have you built in into that number?

[Lenis W. Quan, Chief Financial Officer]

Sorry.

[Pammi Bir, Analyst]

Yes, relative to the $100 million of acquisition capacity that you referenced. And then secondly, from a disposition standpoint, have you sort of -- do you expect to be -- or is there -- are any dispositions in that guidance?

[Lenis W. Quan, Chief Financial Officer]

So the assumptions in the FFO, we've got this 2% comparative property NOI growth. We've kind of modeled more on a leverage-neutral basis. We're including some of the acquisition capacity. And in terms of targeting the capital recycling, I think that's going to probably impact free cash flow. It would be -- it would have been impact free cash flow more than asset value, more than FFO, initially.

[Pammi Bir, Analyst]

Okay. And just maybe switching gears. Going back to some of the commentary around M&A and positive implications for the -- for your NAV based on some of the deals that we've seen. Can you just expand on the positive implications for your NAV? Was that a reference to perhaps your cap rate assumptions? Or is it referring more to some of the commentary you've made with respect to pushing rents a little harder? So the numerator versus, say, the denominator in your asset values.

[Brian D. Pauls, CEO & President]

Yes, it's a good question. I think we are -- it implies 2 things. One is, our cap rate -- our implied cap rate is obviously, much, much higher than what these trades are in the market. So that's true. The underlying asset value -- the underlying property values are -- we see continuing to rise as a result of these trades. So I think it's going to impact both of those things. The appraisals, which will affect IFRS values on the ground as well as the market rents that Heather questioned about. Also, we think it'll impact our implied cap rate in the public markets.

[Pammi Bir, Analyst]

Any preliminary commentary on the potential impact on how you see kind of your cap rate moving over the next few quarters?

[Brian D. Pauls, CEO & President]

Well, I'd say that the market moves in -- it's not smooth it's lumpy. So we see -- certainly, we see net asset value going up. We see our cap rate going down. But some of this, it moves lumpy as rollovers happen. We've contracted for 65% of our 2018 rollover right now. So as -- we can deal with the balance of what hasn't rolled yet as we continue to push rents, but it takes some time for this whole effect to kind of work its way into the system.

[Pammi Bir, Analyst]

And just last one for me. Can you comment on the appetite from an investment standpoint? You've talked about capital recycling, but can you comment on how the market is for, say, multitenant, smaller bay assets versus, say, some of your single-tenant properties in Canada?

[Brian D. Pauls, CEO & President]

Sure. To us, it really doesn't matter whether there's 1 tenant in there or multiple tenants. It's a matter of the functionality of the property. How useful it is to not only the tenant that's using the space now, but future tenants. So the small -- the smaller multi-bay properties are usually the most utilitarian, meaning, they are the most useful to the widest array of tenants. So those have tremendous value. Those values are going up. The replacement cost of those particular assets are rising faster than the big boxes. So we like that asset class. We have a lot of that. And we think those values are going up. So we like that. We also like sprinkling in some balance of product. Some of the stuff that we just purchased in the U.S. is larger, big bay distribution-type space. But we think that complements our portfolio of smaller bay stuff well.

[Operator]

And we have a follow-up question from Sam Damiani from TD Securities.

[Sam Damiani, Analyst]

Just, if I may, on the 2% NOI growth guidance for 2018, Lenis, do you expect that to be front or back end weighted? I'm just looking at -- so the Eastern region, it sounds like being a key driver there, and the occupancy clearly picked up in the East over the course of 2017 from beginning to end quite a bit. So just wondering if that's going to drive the seasonality for...

[Lenis W. Quan, Chief Financial Officer]

Yes. It's probably more weighted to Q3 and Q4 we're really going to see that come in...

[Sam Damiani, Analyst]

Even though the year-over-year occupancy was actually quite strong in the last half of '17?

[Lenis W. Quan, Chief Financial Officer]

Correct, correct.

[Sam Damiani, Analyst]

Is there something you're going to do?

[Lenis W. Quan, Chief Financial Officer]

Yes. There could be some free rent periods in the last half of the year that are rolling off. So we do see more of that pickup towards the back half of the year. I think the first half of the year should be relatively -- would be stable. We do have the contractual rental increases occur throughout the year as well. But I think when we kind of pile on all the pieces together, you're going to see more of the growth in the second half of the year.

[Sam Damiani, Analyst]

And just finally, if I may. The leverage of the REIT does stand at sort of a top end of the range of the peers. Just wondering if there's a change in thought as to how -- Brian, how you see the REIT operating maybe 2 years out.

[Brian D. Pauls, CEO & President]

Sure. Right now, we're 49.5% debt. So I guess I wouldn't consider that top end of the range. We feel -- figure that's pretty healthy. Our target's been low 50s postclosing. We're going to put some secured financing on the U.S. assets. That'll take us probably to 51%. As our -- as we see our NAV increasing, our debt-to-NAV will obviously will go down by just -- by math. So we see that over the long term coming down and the short term being in the low 50s, which we see as reasonably healthy, it leaves us with dry powder to go capitalize on opportunities as we see them.

[Sam Damiani, Analyst]

Right. Okay. And just by top end of the range, I may have misspoke, but I meant of the peer group range, most of your peers are lower. Okay. But that's helpful.

[Operator]

Thank you. And we have no further questions at this time.

[Lenis W. Quan, Chief Financial Officer]

All right. Thank you, everyone for your time. And that we look forward to speaking with you on the next call.

[Brian D. Pauls, CEO & President]

Thank you.

[Operator]

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