Granite Real Estate Investment Trust

TSX:GRT.UN

Earnings Call Transcript 2023-Q1

[Operator]

Good morning. And welcome to Granite REIT's First Quarter 2023 Results Conference Call. Please note that the call is being recorded.

Speaking to you on the call this morning is Kevan Gorrie, President and Chief Executive Officer; and Teresa Neto, Chief Financial Officer.

I would now like to turn the call over to Teresa Neto to go over certain advisories.

[Teresa Neto, Chief Financial Officer]

Good morning, everyone. Before we begin today's call, I would like to remind you that statements and information made in today's discussion may constitute forward-looking statements and forward-looking information, including, but not limited to, expectations regarding future earnings and capital expenditures and that actual results could differ materially from any conclusion, forecast or projection. These statements and information are based on certain material facts or assumptions, reflect management's current expectations and are subject to known and unknown risks and uncertainties.

These risks and uncertainties are discussed in Granite's material filed with the Canadian Securities Administrators and the U.S. Securities and Exchange Commission from time to time, including the Risk Factors section of its annual information form for 2022 filed on March 8, 2023. Readers are cautioned not to place undue reliance on any of these forward-looking statements and forward-looking information. The review of its key assumptions regularly and may change its outlook on an ongoing forward basis, if necessary. Granite undertakes no intention or obligation to update or revise its key assumptions, any forward-looking statements or forward-looking explanation, whether as a result of new information, future events or otherwise, except as required by law.

In addition, the remarks this morning may include financial terms and measures that do not have standardized meaning under International Financial Reporting Standards. Please refer to the condensed combined unaudited financial results and management's discussion and analysis for the three-month period ending March 31, 2023, for Granite Real Estate Investment Trust and Granite REIT Inc. and other materials filed with the Canadian Securities Administrators and U.S. Securities and Exchange Commission from time to time for additional relevant information.

I'll commence the call with the financial highlights, and then Kevin will follow with the operational update. Granite posted Q1 2023 results exceeding expectations with strong NOI growth compounded by the strengthening of the euro relative to the Q4 as well as the U.S. dollar, partially offset by higher interest costs.

FFO per unit in Q1 was $1.25, representing a $0.05 or 4.2% increase from Q4 2022 and a 19% increase relative to the same quarter in the prior year. Strong NOI from acquisitions, developments and expansions that came online since the first quarter of '22 and same property NOI growth was enhanced by favorable foreign exchange movements, where the euro was 4.7% stronger and the U.S. dollar was flat relative to Canadian dollar in comparison to Q4.

In comparison to the prior year, the euro was 2% stronger and U.S. dollar 7% stronger, resulting in a positive $0.06 impact to FFO per unit. Offsetting the favorable Q1 2023 NOI relative to Q4 is the effect of higher interest costs resulting from interest on Granite's secured construction facility, which commenced to being expensed in January 2023 upon the substantial completion of Granite's Houston development and foreign exchange on euro-denominated borrowings and current income tax.

Lastly, in Q4 2022, we recognized a favorable $0.7 million current income tax recovery and the $0.7 million fair value gain, which did not recur in Q1. Granite's AFFO on a per unit basis in Q1 2023 was $1.18, which is $0.13 higher relative to Q4 and $0.18 higher relative to the same quarter last year, with the variances mostly tied to FFO growth and lower capital expenditures, leasing costs and tenant allowances incurred due to the timing of leasing turnover and weather. AFFO related capital expenditures, leasing costs and tenant allowances incurred in the quarter totaled $1.1 million.

For 2023, we continue to estimate AFFO-related maintenance capital expenditures and leasing costs coming in at approximately $22 million for the year, with the increase relative to the past couple of years being a direct result of approximately 9.7 million square feet of GLA turning over this year.

Same property NOI for Q1 '23 was strong relative to the same quarter last year, increasing 5.4% on a constant currency basis and 9.8% when foreign currency effects are included. Same-property NOI growth was driven primarily by higher than previous year CPI adjustments, positive leasing spreads, contractual rent increases across all of Granite's regions, lease renewals in the U.S. and Canada and includes the impact of a completed expansions in the GTA in Indiana.

G&A for the quarter was $14.7 million, which was $6.3 million higher than the same quarter last year and $6.1 million higher than Q4. The main variance relative to the prior quarter and Q4 is the change in non-cash compensation liabilities, which generated an unfavorable $6.7 million fair value swing relative to the same quarter last year and unfavorable $5.9 million fair value swing relative to Q4.

As we recognized fair value losses on these liabilities due to the 19.6% increase in Granite's unit price during the quarter. These fair value adjustments do not impact our FFO or AFFO metrics. For the remainder of 2023, we expect G&A expenses of approximately $9 million per quarter or roughly 7% of revenues, excluding any amounts for fair value adjustments related to these noncash compensation liabilities.

On income tax, Q1 2023 current income tax was $2.3 million, which is $0.3 million higher than the prior year and $0.8 million higher than Q4. As mentioned earlier, Q4, we recognized the net impact of adjustments pertaining to prior tax years in our European region of $0.7 million. Excluding the aforementioned adjustments in Q4, the increase in current tax over both Q1 '22 and Q4 is primarily attributable to the strengthening of the euro relative to the Canadian dollar as virtually all of Granite's current income tax is generated from its European region.

For 2023, on a run rate basis and factoring in a now stronger euro, we estimate current tax at approximately $2.2 million per quarter before recognizing any reversals of tax provisions. Interest expense was higher in Q1 2023 relative to Q4 by $1.1 million. This reflects interest on Granite's secured construction loans and foreign exchange. In the second quarter of '23, Granite intends to repay in full the secured construction loan withdraws from the credit facility, lowering the borrowing rate.

On a run rate basis, we estimate interest expense will run approximately $18.5 million per quarter before factoring any new debt for additional credit facility draws other than that draw for the repayment of the construction mall. When Granite refinances its upcoming $400 million debenture with during November this year, we expect our interest expense run rate will increase towards approximately $22 million per quarter. All of Granite's debt is fixed rate debt to cross currency and interest rate swap hedges with the exception of the credit facility, which is at a variable rate and subject to increases in underlying treasury rates. Currently, Granite's weighted average cost of debt sits at 2.29%.

Looking out to 2023 estimates, Granite's guidance provided on the March 8 call remains unchanged, which estimate FFO per unit was in the range of $4.90 to $5.05 per unit or approximately 11% to 14% increase over 22. For AFFO per unit, the forecasted range remains $4.30 to $4.45, representing an increase of 6% to 10%. Based on current foreign currency trends, we are projecting to achieve results closer to the higher end of the guidance. The foreign currency rates driving the high and low ranges remained virtually unchanged.

For the high end of the range, we are assuming foreign exchange rates of the Canadian dollar to euro CAD1.48 to USD of $1.37. On the low end of the range, we are assuming the exchange rates of the Canadian dollar to euro and Canadian dollar to USD of 1.42 and 1.32, respectively. As well, at this time, there are no significant changes to our operational forecast that would drive changes to our estimates.

Granite will provide updates to guidance each quarter as warranted based on leasing activity executed to date as well as any changes to foreign exchange rate assumptions. The trust's balance sheet comprising of total assets of $9.3 billion at the end of the quarter was negatively impacted by $73 million in fair value losses on Granite's investment property portfolio in the first quarter, offset by $33 million of translation gains on Granite's foreign-based investment products, particularly due to the 1.7% increase in the spot euro exchange rate relative to Q4.

The fair value losses on Granite's investment property portfolio were primarily attributable to the expansion in discount and terminal capitalization rates across all of Credit's markets in response to rising interest rates, partially offset by fair market rent increases across the GTA and selected U.S. and European markets, the renewals of three special purpose properties in Austria and Germany and the stabilization of three properties under development in Houston, Texas, which were completed and transferred to income-producing properties during the first quarter.

The Trust's overall weighted average cap rate of 5.01% increased 14 basis points from the end of Q4 and has increased 71 basis points since the same quarter last year. Total net leverage at March 31 was 32% and net debt to EBITDA was 7.8 times, which is slightly inflated due to branded partially funding its significant development program with debt. Granite expects its debt to EBITDA to decrease to the low 7 times by the end of the year and to improve thereafter to 2024 as the EBITDA from completed developments come online throughout this year.

The Trust's current liquidity is approximately $1.1 billion, representing cash on hand of about $110 million and the undrawn operating line of $990 million. As of today, Granite has $5 million drawn on the credit facility, and there are 4 million letters of credit outstanding. We continue to monitor the market conditions in the coming months to look to refinance our 2023 debentures, which come due in November.

I'll now turn the call over to Kevan. Thanks.

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Thanks, Teresa, and good morning, everybody. I will be brief. As usual, we spoke roughly 60 days ago, and we provided an outlook for 2023 at that time. I would echo Teresa's comments that results exceeded expectations due primarily to the pace of development stabilizations in the quarter and the continued strengthening in income from our European portfolio.

I will begin my prepared comments on our development program, where we have been focusing our capital deployment now for the past few quarters. As you can see from our press release and MD&A, we achieved substantial completion on our 690,000 square foot design build distribution center in Houston for e-commerce user [Indiscernible] for a term of just under 11 years, which commenced on February 1. We also achieved substantial completion of the two buildings totaling 669,000 square feet, which comprised Phase 1 of the site, and we have executed two leases totaling 521,000 square feet to third-party logistics providers for five and seven-year terms.

In addition, we achieved substantial completion in January of over 329,000 square foot expansion of our existing property in Whitestown, a suburb of Indianapolis. And the lease has been extended for 10 years in the entire ability. Further, we achieved substantial completion of our development project in Lebanon, a suburb of Nashville, Tennessee comprising roughly 500,000 feet over three buildings on April 6.

And finally, we completed the development of our 221,000 square foot property in Bolingbrook a suburb of Chicago on April 12, and the building is fully leased for a 12-year term. Collectively, these projects and stabilizations are expected to contribute strongly to NOI and cash flow growth in future quarters and all are expected to achieve green building certification in accordance with our published Supreme Bond framework. To date, approximately 1.8% of the 3.4 million square feet of development space delivered year-to-date has been leased, leaving just under 1.6 million square feet remaining to be leased.

Looking at our current construction pipeline. Our development projects in Branford and Ajax totaling roughly 450,000 feet continue to progress well with completion scheduled for the first quarter of 2024. The first phase of the Branford site comprising a single 410,000 square foot building has been fully leased for a 20-year term and will generate an unlevered development yield of approximately 6.8%. The 50,000 square foot expansion of our back asset in Ajax is being constructed on a speculative basis and is expected to generate an unlevered development yield of roughly 7.5%.

As mentioned previously, we are in the approval process for the next phase of our brand for development, a single 730,000 square foot building with potential commencing in late 2023. Operationally, to date, we have renewed roughly $8.1 million or 85% of the 9.6 million square feet of lease maturities in 2023 at an average increase of roughly 20% and we anticipate achieving an average increase of 28% on the remaining maturities, an increase of roughly 4% in our estimate from the previous quarter.

As mentioned on our last call, for 2024, we have renewed roughly 55% of the 9.6 million square feet of maturities and an average increase of 9.4%, primarily due to the 10-year loss renewal announced earlier this quarter. At this point, we continue to expect to achieve an average increase of 20% to 22% on the outstanding maturities in 2024. And I think it is worth repeating that our renewals in the quarter at Graz and Oberhausen in Germany totaling almost 5 million square feet in total, required no investment from Granite for TI's landlord work or leasing commissions. There was no CapEx associated with either renewal.

As Teresa mentioned, same-property NOI increased by 5.4% in the quarter on a constant currency basis within expectations. Same-property NOI was positive across all geographies on a constant currency basis, led by our portfolios in the GTA and the Netherlands at 8.3% and 6.3%, respectively, followed closely by the U.S. at 6.1% and Germany at 5%, driven partially by strong CPI increases in Q1 at a number of our properties in the GTA, Germany and the Netherlands.

We expect same-property NOI growth to improve over the coming quarters. And at this time, we are reiterating our range of guidance for 2023 same-property NOI growth of 6.5% to 7.5%. As you can see from our disclosure, we adjusted cap rates and discount rates further in the quarter. The resulting $160 million in fair value losses associated with TCR and DR adjustments, a modest reduction from the $230 million adjustment in Q4 was more than offset by development stabilizations, substantial completion of the development in Indianapolis on a forward purchase basis, foreign exchange gains as well as an increase in value from the long-term renewal of our properties in Graz, Austria Oberhausen, Germany.

As for a general market update, I would characterize leasing activity in the first quarter as lower than in the past two years, but in line to slightly above the 10-year average across our markets. Fundamentals remain strong with sentiment appearing somewhat more cautious among tenants in the face of greater economic uncertainty. Net absorption across our markets range from a low of negative 300,000 square feet ironically in the GTA to a high of almost 9 million square feet in dollars.

Availability rose in most of our markets in North America, but not all, as new supply outpaced demand in the first quarter. We expect this trend to continue for the next two to three quarters as the backlog of current projects are delivered to the market. However, we project that availability will begin to fall sometime in early 2024, as the pace of new starts has already began to decelerate acutely from past quarters. In most of our markets, we are witnessing a drop of 50% to 75% in starts from the first quarter of 2022.

As for rents, data suggests that market rents increased roughly 3% on average in the fourth quarter across our markets, with Dallas and Atlanta leading the way at 8% and 7%, respectively. I would add that most of the net absorption has occurred in the newer product segment, so there's an obvious rent to quality theme underway. So although demand is expected to moderate off exceptional highs in 2021 and even 2022, the spread to market on our in-place rents continued to widen in the first quarter. And the abrupt cessation of new supply should support continued rent growth over the near and medium term.

With respect to investment market conditions, I won't go into much detail. It won't surprise anyone that volume slowed drastically in the second half of 2022. And today, volumes appear to remain roughly 50% below the first quarter of 2022. The bid-ask spread continues to exist, but is narrowing as vendors slowly adjusted the current cost of more capital. That being said, industrial continues to be one of the preferred sector destinations for investor capital and flows appear to be improving with active buyers, including private investors concentrated on smaller transactions in certain markets and private equity funds, which have capital allocation and deployment needs. We're happy to discuss in more detail if needed.

In closing, I would like to thank our team for another strong quarter, and we remain exceptionally well positioned to execute on our plan for 2023 and once again deliver strong results for unitholders.

So moderator on that, I will open up the floor to any questions.

[Operator]

Thank you, sir. [Operator Instructions] Our first question comes from Michael Markidis with BMO Capital Markets. You may proceed with your question.

[Michael Markidis, BMO Capital Markets]

Thank you, operator. Good morning, Kevan, Teresa. Kevan, just thanks for your comments on what you expect to see in terms of supply of basin demand over the next couple of quarters. I'm interested to just get your take on your portfolio, the current occupancy level. And I realized this quarter was the slippage was a function of the forward development that you report Virtusa executed on. But how do you see your portfolio performing from an occupancy perspective over the next, call it, 12 to 18 months versus where you expect the market to go.

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Well, I mean, barring any unforeseen circumstances, I think we're expecting all of our turnovers this year to be leased or at least committed to be leased by the end of this year. So we should finish the year close to 99%. I think that's our expectation. In 2024, I'd have to think that through a little bit. But again, I don't think we're expecting occupancy to move that much off of that sort of 98% to 99% range.

[Michael Markidis, BMO Capital Markets]

And then just on that ending the year at close to 99%, are there any significant nonrenewal that you're aware of or just stuff that hasn't been locked down in the normal course yet, getting some cautious optimism on transitional dating.

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Yes. I think that, that's fair. I don't think that there's anything I think out there that we think will be surprised that there's one 300,000 feet in Memphis at the end of September that we're in discussions with a tenant that's still kind of up in the year. But I think the discussions have been pretty constructive. So at this point, we think that it will be a renewal, but that could be an additional 300,000 feet on top of the expected 1 million feet that we're working through right now.

And I would say, I think on those particular spaces, the activity has been very good. And in some cases, we're dealing with adjacent tenants to take that space as well. So I think that, that's going, we characterize that as going well overall.

[Michael Markidis, BMO Capital Markets]

And last one for me, just before I turn it back. Maybe if you could just provide some incremental activity and the color that you're seeing on the assets you just bought and then on the development that you just delivered that's still looking for times. Thank you.

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Yes. That's the main one, I think, that we're focused on in Indianapolis. So those are the two buildings that we just delivered in Avon, which is very close to our All Point asset. And I think we've seen -- I think you mentioned on the last call, we've seen good activity. But I think for us, we're focusing on a certain size of tenant and we're focused on what we believe to be a premium rent in the market based on the locations.

So although we've seen good activity on it, we just haven't seen, I think, the right tenant and the right fit for the size of buildings that we have in that market. So hopefully, we'll have some positive updates on our next call on that, but there's been quite a bit of activity in that market.

[Michael Markidis, BMO Capital Markets]

Okay, that's great. Thanks. I'll turn it back.

[Operator]

Our next question comes from Himanshu Gupta with Scotiabank. You may proceed with your question.

[Himanshu Gupta, Scotiabank]

Thank you. And good morning. Kevan, just a follow-up on your last comment on Indianapolis laser property. And you mentioned you have seen good activity. So would you say that tenant activity is comparable to the last two years? Or is it more comparable to 2019 and earlier years?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Well, I would compare it. I mean I think it's a bit unfair to compare it to 2021 and part of 2022 because those really were exceptional years. I would characterize the market as being strong to-- I would characterize the market as being strong. So I'm not sure 2019 was a while back, but it does feel like tenants, there's a lot of tenants floating around, but clearly, tenants are taking more time to decide on the space. But I would say it seems like they're delaying their decisions and not so much not needing the space. I just think that they're taking more time to do it.

So if you were to push me on are we close to 2019 or closer to 2021, we're somewhere in between both of those in terms of level of activity.

[Himanshu Gupta, Scotiabank]

Got it. And then in terms of the tenants being the decision -- so do you think the delay is more on larger spaces? Or is it more on the smaller spaces?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Yeah. In terms of the delay, I'm not sure there would be that much of the difference. But I would say we're seeing more activity in the 300,000-to-500,000-foot range than we are in the $600 million to $800 million foot range. So there's a lot more activity in that sort of 3% to 7% than there is 7% right now.

And I think 2022 characterized as really a lot of the $700,000 to million. There was an abnormal amount of activity in that range. Now it seems to be more reverting to the norm of that sort of 3 to 50,000-300,000-to-700,000-foot range.

[Himanshu Gupta, Scotiabank]

Thank you. And then in terms of capital allocation, acquisitions versus development, has cap rate expanded enough in the U.S. for you to come back to acquisitions rather than grow the development pipeline at this point of time?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

I think it's a great question. I think that -- I think the short answer is I don't think that there are too many compelling opportunities for us from slightly from a cap rate basis. One of the things we've discussed internally, and I think I mentioned on the last call, is we have a development pipeline we want to keep active, and we're looking at select development opportunities.

And although we have seen land costs come off in most markets, including the GTA to an extent. I don't think that we believe that they have moved enough to make a performance work financially for us to an appropriate level. So I think that there's -- from our perspective, before we were to move -- and this is assuming we have liquidity to do it. And that's -- again, that's a question mark.

But if we did, I think we would expect to see a little more movement before those opportunities become more compelling for us.

[Himanshu Gupta, Scotiabank]

Got it. Last question, in terms of fair value adjustments. I mean if I look at your Canada portfolio, I think it was hardly seen any negative adjustment? I mean, in fact, positive last year and margin flat in Q1 as well. So do you think market rent growth in GDA has more than offset any impact of high interest expenses?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

I think so. I was just looking back, actually, if you look at Q1 of 2022 and where we are today, the ingoing cap rate, which again takes into account rent growth and now it's moved. We have been moving roughly 50 basis points in Canada or in the GTA, 75 in the U.S. and 50 in Europe. And again, that's a function of TCRs and DR is moving substantially to being offset by rent growth.

In Europe, I think another part of the story is there's rent growth to be taken into account on our modern distribution assets. But for the legacy assets that we have, the Magna assets, we haven't seen that much movement in terms of cap rate and discount rate on those assets. So there hasn't been as much movement per se in the cap rates in the resulting cap rates in Europe as we've seen in the U.S.

[Himanshu Gupta, Scotiabank]

Okay. Thank you Kevan, and I'll turn it back.

[Operator]

Our next question comes from Sam Damiani with TD Securities. You may proceed with your question.

[Sam Damiani, TD Securities]

Thanks and good morning everyone. Just on the Europe portfolio, setting aside the Magna property, the special purpose properties, specifically, what sort of same property growth are you getting out of the newer assets you've acquired there in recent years?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

I think we've seen kind of in the low-teens, and that takes into account too that there are leases where the increases are fixed. And if I can, Sam, I just want to address this because I've seen a couple of comments last night on our results, pointing to at least in the U.S. on renewal where the renewal rent was the same as the experiment.

And just to point out to everybody to clarify at this point, these types of leases are common in all portfolios and not just ours and when we talk about our mark-to-market or our expected increases on renewal for 2023 or in any given year, we take it into account. And I say that because I understand that there might be other REITs that when they disclose a mark-to-market or an increase in rent, sometimes they exclude assets where the renewal rent is the same with the experiment.

And in this case, it wasn't a renewal, it was a tenant wanting their termination notice. So they had a termination rate, which was weight. So there was no rent adjustment. So technically, I wouldn't call it a renewal, but we put it in there, I think, to be conservative.

So just to say, when we provide -- so for example, 20% increase in 2024, that would include any renewals in North America or Europe, where the rent was fixed or flat. That takes into account in our estimates.

[Sam Damiani, TD Securities]

That's helpful. And that actually was going to be my next question. So thank you for answering that. I guess that asset, I believe, was just acquired a couple of years ago. I mean, has that sort of termination rate waiver played out the way you expected, I guess, when you bought the asset?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Well, yeah, because the rents on that asset that's in Cincinnati, at 670,000 square feet or thereabouts, and that's a $2.94 rent. So yeah, they are -- I think they're in there for three years and there is no adjustment this year. But our thesis for that is that was roughly, I think, a 5.5% cap on 294 rents. And I think we were roughly in the mid-50s per square foot. So the cost basis for that asset in that location was very attractive. So it is playing out. Would we have hope we didn't, yes. But we were -- we didn't go in expecting that this tenant was -- and there is a good covenant tenant that this tenant was not going to waive their way and termination rate. We were hopeful that we weren't expecting that to having.

[Sam Damiani, TD Securities]

Got it. Last one for me. Just on the development side, which it sounds like still the priority in terms of capital allocation, what is the expectation for building up the land portfolio over -- in the near term to facilitate a continued active development pipeline over the next few years?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Well, if I look at just what we have and what we've been talking about, I mentioned that we could move ahead with 730,000 feet in Branford. We could potentially add another building there. So that would be in the sort of 900,000-foot range in Branford. If we decide that it makes sense to move forward with the next stage of Houston that could be roughly $1 million. So that could be $2 million in 2024, depending on market conditions at the time, obviously.

And on top of that, we would have to have more land. And as I mentioned before, it's something we're looking at on a selective basis. I think it fits in with our long-term strategy. But we're not seeing any forced selling. We're not seeing any real distress in our sector. And that may not be a surprise but yet at the same time, I think for us to move forward, we want to see a little bit -- we want to see a little bit more of an adjustment in development performance before we buy additional land or move into sort of development play.

So for now, we think we could build $2 million next year. I'm not sure about building more that will depend on any new development opportunities we feel makes sense for us.

[Sam Damiani, TD Securities]

Okay, that's great. Thank you and I'll turn it back.

[Operator]

Our next question comes from Kyle Stanley with Desjardins Bank Capital Markets. You may proceed with your question.

[Kyle Stanley, Desjardins Securities]

Thanks. Good morning, everyone. Just kind of sticking with that same line of questioning, and you did kind of answer it there, but I'll ask it anyway. Would you say your view of progressing with the new spec development versus looking for a tenant to pre-lease has changed? And the question just comes from your, I guess, your commentary on tenants maybe being a bit more cautious in this environment.

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

It may, depending on the market and the flexibility you have in the land. Like for example, we have 13 acres in Columbus. That doesn't make sense to build on spec. I think that, that truly is a design build.

On Branford, depending on the size of the building, we have the ability to build and they make sense to do design build. So for example, that site would have a combination of design-build opportunities and spec development. And I think that, that was it. So 40 730,000 square foot building, we wouldn't wait for a design build opportunity there. I think we would move forward. And that's measuring just the availabilities in the market at that size and where we think the market is going.

So it depends. Houston is a bigger question for us, obviously. Now that is still continues to be a strong market. I think it's in the sort of low to 4% availability range. So we are trying to decide if we move forward with the next phase, the first two phases went very well, obviously, and part of that was the design build, the 690,000 well design build, which kicked off the site.

The next phase, we have the flexibility to go up to 1.2 million square feet on one pad or we could do two buildings. It could be a combination of design, build and speculative. So it all depends on our conviction in the market and where we think we could fit in a certain sized building within the pipeline. So I'm not really answering your question because I think it's on a case-by-case basis and on a site-by-site basis.

[Kyle Stanley, Desjardins Securities]

I think that makes a lot of sense. And you commented on, I guess, the strong kind of fundamentals you're seeing in Texas. And then I'm just curious, what do you think is really contributing to maybe the improved performance we're seeing in those southern markets? And what type of tenant is maybe driving that incremental demand in the Midwest and Southern U.S. right now?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Well, I just think, overall, these are markets that tenants do want to be in. There's more labor availability. I think the labor markets in general are more positive. But also you're seeing -- we talked about before, a shift in the supply chain away from the West Coast to the East Coast and markets right through Texas and the Port of Houston, et cetera.

And the other thing I would say is the investment by the U.S. government in onshoring certain industries back into the U.S. is a real thing, and we're seeing it. So 3PLs continue to be the largest single occupier in the market right now looking for space. But manufacturing is playing a part as well. And so that's taking up space. And that's not the type of tenant per se that we're targeting, but it certainly is fulfilling a part of the demand in those markets, particularly in Texas and some of the other markets that we're in.

[Kyle Stanley, Desjardins Securities]

Okay. And just one last one. You saw the small disposition this quarter with another asset held for sale. Do you have a disposition target that you might be looking at, which would help you achieve your goal of reducing leverage? Or is that mostly just going to be achieved with development deliveries?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

I think most of the development deliveries, we didn't really have -- we have one building in the GTA that we're working through a sale right now. We do expect to close this quarter, and we don't have anything imminent on top of that. It may happen just depending on the opportunity, but that's all we have in terms of expectations for this year.

[Kyle Stanley, Desjardins Securities]

Okay, great. I'll turn it back. Thanks for the color.

[Operator]

Our next question comes from Matt Kornack with National Bank of Canada. You may proceed with your question.

[Matt Kornack, National Bank Financial]

Thanks. Kevan, I don't know if you can provide these details or you have it at your fingertips, but you mentioned the 20% spread was inclusive of some of the renewals or rights that were waived that are at no spread. But what would be kind of the number on kind of market renewals? And then maybe as a tangent to that, when you approach leasing, it sounds like you're particular in terms of the tenants that you go after, but do you also leave a bit of meat on the bone with regards to the mark-to-market that you're achieving in those negotiations?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Yeah. We do leave meat on the bone. I think we're talking about the same thing for sure. And just to get back to the Indianapolis one too. I think we can afford -- we walked into this knowing we can afford to be patient. This is a location that we think should command a higher rent. We've seen some deals get done, not exactly in the size range we're looking for, but east of the market that we're in, for example, at lower rents, we feel this should command higher rents. And we think the best thing to do is be patient and wait for the right tenant and the right opportunity.

And so I think what we projected to the market is on the conservative side of what we can achieve. And I think we're talking about the same thing. In terms of the mark-to-market, there is some subjectivity through this whole exercise, and we talk about it internally, and I think the best thing to do is to be conservative on.

So for example, getting back to the Cincinnati asset. That's a $2.94 rent in a $4.50 to $4.80 market. So the mark-to-market on that asset is truly 50%. But we haven't -- in our projections of what we're telling you is zero because we can't get at that rent at least for three years. And probably longer. I don't know what the renewal is out for three years. But just to say, if we can't get at that rent, we don't show that as a mark-to-market of 50%.

So I hope that answers your question, but let me know if you…

[Matt Kornack, National Bank Financial]

Yeah. I guess it's maybe even for the remaining leases that would be coming due for the remainder of the year because obviously that's zero on a pretty sizable amount of square footage if you're going to get to 20%, presumably the mark-to-market spread on the remainder is 30-plus if not.

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

I think what we said was we originally had 24% on the remaining 1.5 million square feet. And now we're seeing that's roughly 28%.

[Matt Kornack, National Bank Financial]

Great, that's helpful. And then Teresa, just -- I don't know how much color you can provide with regards to the straight-line rent side of things, understandably you're delivering some development assets. There may be some free rent periods in the earlier phases of those. But how should we think about straight-line rent and where it trends over the balance of the year?

[Teresa Neto, Chief Financial Officer]

So I was looking at that, and you're right, like this quarter was like about $4.6 million. And yes, a bit of that is development and free brand associated. So I think for this year, Matt, I would take that number and that will be pretty consistent for the next three quarters in that $4.5 million range for the rest of the year.

[Matt Kornack, National Bank Financial]

Okay. And then next year, I guess, as those cover to cash rents or I guess, and the grade would be an issue maybe on the straight-line front as well at some point, but…

[Teresa Neto, Chief Financial Officer]

Actually graph, no because on a CPI lease, we don't do straight light rents, it will adjust. And so there won't be an effect, but we should see more, I guess, normalized, which is more in that $2 million range-ish per quarter. But yeah, it's a little bit elevated because of the new developments.

[Matt Kornack, National Bank Financial]

And then one more just in terms of the development. How much of the projected NOI that these are supposed to contribute to anticipate coming on this year, and it can be a rough percentage versus what would be to lease up that may come into next year?

[Teresa Neto, Chief Financial Officer]

It's going to be a pretty small amount, I'm going to say like 20%. Is that fair? Can you -- I think 20% maybe is a good number. For this year.

[Matt Kornack, National Bank Financial]

20% okay. So there's significant upside then to next year as well.

[Teresa Neto, Chief Financial Officer]

Yes.

[Matt Kornack, National Bank Financial]

Okay, fair enough. Thanks, guys.

[Operator]

Our next question comes from Gaurav Mathur with iA Capital Markets. You may proceed with your question.

[Gaurav Mathur, iA Capital Markets]

Thank you. And good morning, everyone. Just looking ahead from an acquisition viewpoint. Are you anticipating any dislocations or distressed asset sales in any of your markets going forward?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Well, I think we were expecting it already. And maybe we shouldn't be surprised, and we're not seeing as much in our sector. But the short answer is, I think we've seen very little. Do I expect that we will see some distressed opportunities? Yes. But I think part of the reason we hesitate is there was a lot of capital looking for the same opportunities in this sector.

So I mentioned before, we're seeing some recovery in deal flow. And I think in a lot of cases, buyers are jumping the gun a little bit on this. But all to say we think that there will be more distressed just generally in the market, which should open up opportunities for us. But there's a lot of capital chasing it. That is part of the reason why I talk about select development opportunities because that's why I feel our program, those would fit our program and probably not have a much immediate competition from large private equity funds who have capital deployment requirements.

[Gaurav Mathur, iA Capital Markets]

And that's a great segment to my next question because when you're looking at table cap rate on discount rates. Are you expecting further adjustments through the year ahead given the volume of capital that's chasing these assets as well?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Yeah. I think we've been -- we've remained very data dependent from quarter-to-quarter. So I would say it's possible, but I guess I think we're near the end of that assuming that the Fed is close to being finished making can as close to being finished, et cetera, the macroeconomic sort of themes are stabilizing. But that being said, assuming that pace, we think that if we're not done, we're very close to the end.

[Gaurav Mathur, iA Capital Markets]

Okay, great. And just last question for me. On your comments of onshoring by the U.S. government. Apart from the 3PLs, are you seeing any renewed tenant demand from any other tenants in the market that you possibly weren't sort of witnessing a year ago?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Well, I think it falls more into the manufacturing side. I think anything related to EV, anything, vehicle production in general and EV and solar panels, those tenants are very active. We've seen them across our sites in particular, and there's a lot of competition there right now. And I think that's where we've seen the biggest change from, say, a year ago or two years ago. Two years ago, it was all about e-commerce. And last year, we started to see a shift into the wholesaler distribution, retailers and 3PLs. And right now, it's been the 3PLs and the wholesale distribution that have been most active in the markets and third behind that would be manufacturing.

[Gaurav Mathur, iA Capital Markets]

Great. Thank you for the color, Kevin. I'll turn it back to the operator.

[Operator]

Our next question comes from Pammi Bir with RBC Capital Markets. You may proceed with your question.

[Pammi Bir, RBC Capital Markets]

Thanks, good morning. Kevan, maybe just coming back to the Avon property. You mentioned being patient. What can you share just in terms of the types of tenants that you are talking to? And then perhaps the timing of when you're actually hoping to have that -- or aiming to have that leased up as opposed to hope.

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Well, I was going to interject when Teresa said 20%. I was going to say what we're forecasting the market and what our expectations are internally are far two different things. Just be clear about that. But I think what we're seeing expansion before, we're seeing a lot of activity in that sort of -- so when you think about it, anything over three

is too large for a 300,000-foot building. And anything close to five could be a fit for the larger building, but with conditions. And so that's where we've seen the most activity in the market. And so for us, I think we just need to be selected.

So in terms of timing, it's our expectation that those buildings are fully leased by the end of the year. Now are we counting on cash flow? We may not, but our expectation is for the end of the year, those buildings are fully and leased. That is our expectation.

[Pammi Bir, RBC Capital Markets]

Okay, thanks. That was sort of the next part of that question as far as cash flow producing. And maybe just coming back to your comments on EV manufacturing. Just on that Volkswagen EV battery plant, I guess that's coming in, say, Thomas, still a few years away. But are you seeing any pickup in interest at all in the Branford site? I realize it's, call it, an hour's drive, but I'm just curious if that has seen some pickup in activity at all.

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Well, that was in the mix really it was a site that was considered. It was a market that was considered. And so I would say, pickup from that particular deal, no, that I think that there's a lot of interesting industries that are circling out right now and Branford is near the top of list for what a lot of these sectors are looking for.

[Pammi Bir, RBC Capital Markets]

Thanks so much. I'll turn it back.

[Operator]

Our next question comes from Brad Sturges with Raymond James. You may proceed with your question.

[Brad Sturges, Raymond James]

Hi. Just to touch on your comments on the flight to quality that you're seeing, I guess, within leasing and at risk of, I guess, as being more of a market specific answer. But I guess if you were to generalize, is there kind of a sweet spot in terms of the-- I guess, the property kind of amenities or characteristics that you would point towards in terms of where you're seeing kind of the most demand or flexibility in terms of diverse groups of types of users that you're seeing or would feel, I guess, would be more the type of asset to kind of show where the -- I guess the demand is trending towards right now?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

It's been really hard to see a clear pattern, I think, emerged, Brad, I think, like you always go into these things, trying to be everything to everyone. You're trying to build the best building and appeal to the largest group of users. You are agnostic to a degree. You just wanted to be -- you just wanted to fit the most state-of-the-art standards that are out there in the market. But we're not really seeing anything. We're seeing activity in our markets.

I wouldn't say it's location agnostic. That's not true. I think location has continued to matter. But one of these tenants, when -- just when you think the 700,000 feet is a sweet spot, then it's , when you think it's five , then it's so there has been no pattern that's really in leaders to show us that there was a particular size or characteristics of building other than clear-- all those functionality sort of characteristics that are important to us, access the highways, access to infrastructure, all these things remain important, but there's been no clear pattern emerge yet in this market as to the right size or particular characteristic that matters most.

[Brad Sturges, Raymond James]

Okay, that make sense. And going back to your comment that you're expecting maybe to see a little bit of stress and hasn't happened. In terms of who is actually executing on the vendor side from an asset sale point of view, -- is there a particular group that's emerged that has been a little bit more active in terms of the private REIT that you're seeing selling the liquidity opportunities with industrial or into other types of sellers that are actually executing on a little bit more on the asset sale side?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

I think on the asset sale side, I would just say it looks like some of the pension funds are selling some assets or selling into strength and probably diversifying a little bit. That's one thing that I would put out there.

Certainly, portfolio sales have been challenged. So we're seeing smaller portfolios and single assets on the market. From a buyer side, it depends on the market, but there's no other market like trona in terms of individual or private buyers just by the nature of this market. So there's been a lot of activity among private buyers here whose cost of capital is known only to them, and probably don't require debt to close these transactions. So we've seen that sort of dynamic play out here.

Whereas in the U.S., we've seen some private family buying in some of our markets in the Southwest. And in Europe, it's predominantly been the private equity funds that have been active and have been actively allocating capital in those markets. And probably a little bit more, I think, I'm not sure I would use the word distress, but we have seen you know that the private equity funds have a life as well, and they've been probably the most active sellers of product and portfolio at least in our sector in the market.

[Brad Sturges, Raymond James]

Okay, that's helpful. I'll turn it back. Thanks a lot.

[Operator]

And we do have a follow-up question from Mike Markidis with BMO Capital Markets. You may proceed with your question.

[Michael Markidis, BMO Capital Markets]

Thanks. Just a quick follow-up. Just, Kevan, on your comment that land costs haven't adjusted enough to potentially at the math work. Is that -- just to clarify, would you be willing to do a development at the similar yields relative to what you have on active today? Or is it that your yield threshold has gone up?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

No, I think our yield threshold has gone up but remember, I mean, when we're talking about yields and Bradford of 6.8%, I'm not sure we'd be very okay with that today. But just based on the land value and our cost to develop that yield, okay. In the U.S., I mean, obviously, we've seen terminal cap rates move. So our yield expectations have moved in those markets.

Fortunately for us and our developments that have been delivered, we have seen an increase in yield. So we've been able to maintain the profitability of those sites. We're assuming so for Indianapolis, obviously, if we achieve the rents that we expect to achieve.

We're achieving yields that are much higher than our pro forma, but we're obviously employing a stabilized cap rate that's higher in our pro forma as well. So when I say, for example, something has got to give on the land side in a lot of these markets, we're seeing development opportunities where they need to underwrite, and this is also based on the cost of construction, which has been sticky. We do expect it to moderate that so far, it has continued to be very high.

We've seen economic rents on those or what are being performed on those to be 15% to 20% above what we think market rents are. So until such time that the market rent expectations come down or the land prices adjust to a point where as economic sense for us. I don't think we feel any urgency to step into and in those opportunities.

And I guess part of it is you're hearing it in my voice. We don't -- we're waiting for the right opportunity, and I think we're positioned for it, which is important, but we don't have any urgency to do it. So we could end up -- if we don't find the right opportunities in this year, that's fine. We have a lot on our plate, obviously, that keeps us big. And so we don't feel any need to do a deal for the safe and doling deal. But we do believe that something has to give and a lot of the smaller developers will need to recapitalize, we'll face a wall, we need to recapitalize. And I think that's when we'll probably find some compelling opportunities.

[Michael Markidis, BMO Capital Markets]

Yeah got it. We seem to be in this very, very slow-moving period of adjustment here. So just to finish off on that topic, Kevan. If you were to start something in the U.S., let's say, Houston, like where would you -- what would you need to see for stabilize all else equal today?

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Well, we achieved the yield, I think, of the high 6s on what we did. I think we would have to achieve similar yields, if not higher, on future development.

[Michael Markidis, BMO Capital Markets]

Got it. That’s it for me. Thanks so much.

[Operator]

We have no further phone questions at this time. I will now turn the call back over to you. Please continue with your presentation or your closing remarks.

[Kevan Gorrie, President, Chief Executive Officer and Trustee]

Thank you, moderator. So on behalf of management, trustees at Granite REIT, thank you for taking the time for our Q1 call and look forward to speaking with you again in August.

[Operator]

That does conclude the conference call for today. We thank you for your participation, and we ask that you please disconnect your lines.