Granite Real Estate Investment Trust

TSX:GRT.UN

Earnings Call Transcript 2023-Q2

[Operator]

Good morning, and welcome to Granite REIT's Second Quarter 2023 Results Conference Call. As a reminder the conference today is being recorded on Thursday, August 10, 2023.

Speaking to you on the call this morning is Kevan Gorrie, President and Chief Executive Officer; and Teresa Neto, Chief Financial Officer. I will now turn the call over now to Teresa Neto, to go over certain advisories.

[Teresa Neto, CFO]

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 REIT reviews 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 information, 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 3- and 6-month periods ending June 30, 2023, for Granite Real Estate Investment Trust and Granite REIT, Inc. and other materials filed in the Canadian Securities Administrators and U.S. Securities and Exchange Commission from time to time for additional relevant information.

I will commence the call as usual with financial highlights, and then Kevan will follow with an operational strategy update. Granite posted Q2 '23 results below Q1, but overall in line with management's annual forecast and guidance. Branded recorded strong NOI growth, offset by higher interest costs and G&A expenses. FFO per unit in Q2 was $1.21, representing a $0.04 or 3.2% decrease from Q1 '23 and slightly below our own internal forecast of 1.23 and is an 11% increase relative to the saving quarter in the prior year. The growth and NOI is derived from acquisitions, developments and expansions that came online since the second quarter of 2022 and strong same-property NOI growth enhanced by double digit leasing spreads in U.S. and inflationary increases in Europe.

While foreign exchange was relatively flat overall compared to Q1. In comparison to the prior year, the euro was 8% stronger and U.S. dollar 5% stronger, resulting in a positive $0.07 impact to FFO per unit. Offsetting the favorable Q2 2023 NOI relative to Q1 is the impact of higher interest costs resulting from draws made on Granite's credit facility during Q2 and lower capitalized interest of approximately $0.9 million relative to Q1 as a result of the substantial completion of the majority of Granite's active developments during Q1 and early Q2 as well as incremental foreign exchange losses on the settlement of foreign cash, which can fluctuate quarter-over-quarter. In addition, due to the timing of certain activities, FFO-related G&A expenses were approximately $1 million higher than in Q1.

Granite's AFFO on a per unit basis in Q2 2023 was $1.09, which is $0.09 lower relative to Q1 and $0.05 higher relative to the same quarter last year with the variances mostly tied to FFO growth, offset by higher capital expenditures, leasing costs and tenant allowances incurred due to the timing of leasing turnover and seasonality. AFFO related capital expenditures, leasing costs and tenant allowances incurred in the quarter totaled $4.5 million, which is an increase of $3.4 million and $3 million over Q1 in the prior year, respectively.

For 2023, we are estimating AFFO-related maintenance capital expenditures, leasing costs coming in at $25 million for the year, which is $3 million higher than our forecast provided in Q1. The $3 million increase related to tenant allowances and leasing costs tied to a new lease on a previously [indiscernible] that Granite's NOVI, michigan property. The increase in maintenance capital expendituer, tenant allowances and leasing costs relative to the past couple of years is a direct result of the approximately 9.7 million square feet of GLA turning this year.

Same-property NOI for Q2 2023 was very strong relative to the same quarter last year, increasing 7.7% on a constant currency basis and up 13.2% when foreign currency effects are included. Same property NOI 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 a free rent period in the prior year at our property in the U.S. and includes the impact of completed expansions in GTA in Indiana.

G&A for the quarter was $8.9 million, which was $2.9 million higher than the same quarter last year and $5.8 million lower than Q1. The main variance relative to the prior quarter and Q1 is the change in noncash compensation liabilities, which generated an unfavorable $2.1 million fair value swing relative to the same quarter last year, but a favorable $6.8 million fair value swing relative to Q1 as we recognize fair value gains on these liabilities due to a 5.7% decrease in Granite's unit price during the quarter. These fair value adjustments do not impact our FFO or AFFO metrics.

Stripping out the fair value adjustments. As mentioned earlier, G&A expenses that impact FFO and AFFO were approximately $1 million higher than Q1, which is mostly tied to costs pertaining to the AGM and timing of consulting and travel expenses as well as higher compensation costs directly linked to noncash compensation and the upward valuation of its performance stapled units. For the remainder of 2023, we expect G&A expenses of approximately $9.5 million per quarter or roughly 7% to 7.5% of revenues, excluding any amounts for fair value adjustments related to noncash compensation liabilities.

On income tax, Q2 2023 current income tax was $2.1 million which is $0.2 million higher than the prior year and $0.2 million lower than Q1. The movement in current tax relative to Q2 last year is mostly attributable to the strengthening of the euro relative to the Canadian dollar as all of Granite's current taxes generated from its European region as well as slightly higher taxes in the Netherlands due to depreciation limitations on certain non assets. The decrease in current tax related to Q1 2023 is mostly related to the timing of accrual for the remainder of '23, we estimate current tax to run approximately $2 million per quarter, assuming no significant change in the euro FX rate which is slightly lower than the past 2 quarters due to lower required provisions on tax positions taken going forward.

As with the past few years, Granite has the potential to recognize the reversal of tax provisions in Q4 relating to tax positions taken on taxation years, which will [indiscernible], totaling approximately $1.8 million. However, we cannot assess whether these reversals can be realized at this time.

Interest expense was higher in Q2 '23 relative to Q1 by $1.4 million as a result of borrowings made on the credit -- Granite's credit facility to fund development, interest on the secured construction loan, which was repaid in full late in Q2 and lower capitalized interest by approximately $0.9 million due to the substantial completion of the majority of Granite's developments. The draws on the credit facility in Q2 were higher than we had anticipated last quarter, due to the delay in cash repatriation from Europe that was resolved in July. For the remainder of 2023, we are assuming no additional draws on the credit facility and that the $400 million debenture maturing November 23 will be refinanced and swapped to euro at the beginning of Q4 with an estimated interest rate of 4.75%.

Therefore, for the third quarter, we estimate interest expense consistent with Q2, and then interest expense will increase to approximately $21.5 million in Q4. Granite's weighted average cost of debt is currently 2.27% and is expected to increase modestly to approximately 2.6% pro forma the 2023 debenture refinancing.

Looking out to our estimates -- our 2023 estimates, Granite's earlier guidance to FFO remains unchanged, which estimates FFO per unit within a range of $4.90 to $5.05 but we are currently expecting to be closer to the midpoint of this range. This still represents an approximately 11% to 14% increase over '22. For AFFO per unit, we are lowering the forecast range by $0.05 to $4.25 to $4.40, representing an increase of 5% to 9% over 2022. The $0.05 reduction is entirely due to the increase in forecasted AFFO-related capital expenditures discussed earlier due to the leasing of vacant space at our Novi, Michigan property.

The foreign currency rates drive in the high and low ranges remain unchanged from last quarter. For the high end of the range, we are assuming foreign exchange rates of the Canadian dollar to euro of 1.48 and canadian dollar to USD of 1.37. On the low end of the range, we are assuming exchange rates of the Canadian dollar to euro and Canadian dollar to USD of 1.42 and 1.32, respectively. Lastly, our forecast assumes that approximately 20% of the forecasted stabilized NOI relating to our recently developed properties in Houston Phase I, Nashville and Indianapolis will be realized mostly throughout Q4. Granite will provide updates to guidance next quarter as warranted based on new leasing activity executed as well as any changes to foreign exchange assumptions.

The Trust balance sheet comprising of total assets of $9.1 billion at the end of the quarter was negatively impacted by $14 million in fair value losses on Granite's investment property portfolio in the second quarter and was further compounded by $142 million of translation losses on Granite's foreign-based investment properties and that was due to a 2.1% and 1.8% decrease in the Spot USD and euro exchange rates, respectively, relative to Q1. The fair value losses on Granite's investment property portfolio were primarily attributable to the expansion in discount and terminal capitalization rates across selective credit markets in response to continued rising interest rates partially offset by fair market rent increases across the GTA and selected U.S. and European markets as well as the renewal of 1 industrial property in Germany and the appreciation of land values at Granite's development properties and land held for development in Brantford, Ontario, and the stabilization of 4 properties under development in the U.S., which were completed and transferred to income-producing properties early on in the second quarter of 2023.

The Trust's overall weighted average cap rate of 5.09% on in-place NOI increased 8 basis points from the end of Q1 and has increased 59 basis points since the same quarter last year.

Total net leverage as of June 30, 2023, was 32%, and net debt-to-EBITDA was 7.6x, which has improved from Q1 and Q4 as a result of the completion and stabilization of the majority of Granite's development properties. Granite continues to expect its debt to EBITDA to decrease to low 7x by the end of this year and to improve thereafter into 2024 as the EBITDA from completed developments comes online. The trust's current liquidity remains at $1 billion representing cash on hand of approximately $120 million and the undrawn operating line of $910 million. As of today, Granite has $87 million or EUR 59 million drawn under the credit facility and there are $2.7 million in letters of credit outstanding.

I'll now turn over the call to Kevan.

[Kevan Gorrie, President, CEO & Trustee]

Thanks, Teresa. Good morning, everyone. Thank you for joining our Q2 call. As usual, Teresa and I are joined by Lorne Kumer and Michael Ramparas, I would concur with Teresa's characterization of our results being more or less in line with our internal expectations when accounting for FX and some timing-related issues in the quarter. I will be brief in my formal comments as usual. And as before, I'll provide an update on our current development pipeline, our ESG program and our leasing program year-to-date, then provide an overview of the leasing and investment market fundamentals we're seeing across our business before taking your questions.

Beginning with development activity in the quarter, we achieved substantial completion of our development project in Lebanon, a suburb of Nashville, Tennessee, comprising roughly 500,000 feet over 3 buildings on April 6. And to date, we have executed 2 leases totaling approximately 180,000 feet at rates roughly 30% above our original underwriting and 6% ahead of budget for 2023.

We also completed the built-to-suit development of our 220,000 square foot property in Bolingbrook, a suburb of Chicago on April 12. And as you can see, the building is fully leased for a 12-year term. Our current construction pipeline includes 2 projects in Brantford and Ajax. Firstly, the 410,000 square foot built-to-suit project for [indiscernible] continues to progress on schedule, with substantial completion expected in the first quarter of 2024. Similarly, the 50,000 square foot expansion of our existing property in Ajax, is underway with substantial completion scheduled also for Q1 of next year.

I'd like to note that as disclosed in the MD&A, our projected unlevered return for the small expansion project has been reduced considerably to 5.6% due to a combination of higher construction costs, additional scope and the incorporation of some major base building improvements in the expansion project. As per our MD&A, we are in the approval process for the next phase of our granular development, which will include a single 730,000 square foot building to enable us to efficiently respond to suitable built-to-suit opportunities that may arise in the market, but we currently do not have any plans to commence with the construction of the building on a speculative basis.

As mentioned previously, 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 rebuilding certification in accordance with our published supreme bond framework. In addition to the projects just discussed, we have 160 acres of land remaining for development across Brantford, Houston and Columbus, which can accommodate up to 2.4 million square feet of space once constructed. As outlined in our MD&A, 6 lease maturities representing just over 1.9 million square feet that occurred in the quarter were renewed at an increase -- average increase of 15%. However, keep in mind that, that included the expiration of a termination right by a tenant in the U.S. and the renewal of a Magna facility in Germany.

Excluding those 2 properties, the average rent increased by 23% on average. As of this call, we have also executed renewals on 735,000 square feet of subsequent 2023 expiry and 2024 maturities at a weighted average increase in rents of 34%. Included in the numbers I just mentioned are extensions on 645,000 square feet of Magna leases across 3 properties, all located in the GTA and 2 in Austria at an estimated average increase in rent of roughly 22%. As a reminder, we do not anticipate any leasing cost or CapEx associated with these renewals. We are also finalizing lease extensions on another 1.1 million square feet of 2024 maturities, which, when combined with our renewals to date, would represent over 70% of our 9.7 million square feet in overall maturity 2024. At this point, we expect to achieve an average increase of 20% to 22% on the outstanding maturities in 2024.

As Teresa mentioned, same property NOI increased by 7.7% in the quarter on a constant currency basis within expectations. Same-property NOI was positive across all of our geographies once again, led by our portfolios in the U.S. and Germany, driven by strong renewal spreads in North America, development stabilizations and strong CPI increases year-to-date in Europe. We expect same-property NOI growth to moderate slightly in Q3 and Q4 and will likely come in at the lower end of our range of guidance, our Q1 forecast guidance for 2023 same-property NOI growth at 6.5% to 7.5% as we re-lease our current availabilities.

Vacancy increased to 3.7% from 2.2% last quarter due to the addition of a 640,000 square foot space in Louisville as was expected and the addition of roughly 500,000 feet of new development space in Nashville, 180,000 square feet of space, of which has since been leased as mentioned earlier. And I'm happy to answer specific questions on leasing following my comments.

We have now published our corporate ESG plus our report for 2022, and as you will see, we have made significant progress in a number of key initiatives of our program, including significant reductions in energy and GHG emissions intensity within our portfolio. Additionally, as at December 31, 2022, we have achieved operational or new construction green building certification on roughly 24% of our portfolio. And we have achieved rebuilding certification on an additional 21 properties totaling 11.3 million square feet so far this year. We have made a number of improvements to the report, and I invite all of you to review it at your convenience as posted on the Sustainability section of our website.

As you can see from our disclosure, and as mentioned, the adjusted cap rates and discount rates further, but only slightly in the quarter. As transactional data suggests that pricing has begun to firm up broadly across our markets in the U.S. and Europe. More so, I think, than we anticipated. Excluding FX movements, the roughly $210 million in negative fair value adjustments associated with TCR and discount rate adjustments year-to-date, has been partially offset by $116 million in gains from a combination of development stabilizations and increase in value resulting from the long-term renewal of 3 properties in Austria and 1 in Germany, and an increase in the fair market value of our land for development in Brantford.

As for a general market update, I would once again characterize leasing activity in the second quarter broadly as lower than in the past 2 years, which was exceptional but in line with 2019 or pre-COVID levels. Notably, our markets represented the top 8 markets in the U.S. for net absorption totaling just under 46 million square feet, with Dallas once again leading the country at 9.2 million square feet of net absorption. Net absorption also turned positive in the GTA in Q2 at 2 million square feet, but still well below the 10-year quarterly average similar to the Netherlands and Germany.

Availability rose in most of our markets in North America as new supply outpaced demand in the quarter. We do expect this trend to continue for the next 2 to 3 quarters as the backlog of current projects are delivered. However, we project that availability will begin to fall in early 2024, as I said on the first quarter call. As the pace of new starts has already begun to decelerate acutely from past quarters and a number of planned deliveries this year are being delayed. In most of our markets, we are witnessing a drop of 40% to 75% in new starts from Q2 versus Q2 of 2022.

As for rents, the data suggests that market rents increased roughly 5% on average over the first quarter across our U.S. markets. With the I-78/ I-81 corridor and Louisville leading the way at a staggering 19% and 11%, respectively, quarter-over-quarter. quarter-over-quarter rent growth in the Netherlands and Germany came in at 6.7% and 5.9%, respectively. So although demand has reverted to pre-COVID levels, the spread to market on our in-place rents continue to widening the quarter. And the substantial contraction in new starts, we believe should support continued rent growth over the near to medium term.

Correspondingly, although the delayed completion of our developments in Indianapolis and Nashville to the second quarter of this year may result in a longer stabilization period. The expected rents today are frankly much higher than they were at underwriting and even 1 year ago. With respect to investment market conditions, transaction volumes remain lower year-over-year, but are beginning to recover, particularly in the U.S. and the Netherlands, and data suggests that prices have begun to stabilize. Logistics clearly continues to be one of the preferred sector destinations for investor capital and flows appear to be improving. With private equity funds saved obviously for the $3 billion [indiscernible] acquisition of the [indiscernible] portfolio remaining as the most active buyers, both in North America and Europe.

In closing, I think that Teresa outlined our financial performed very well. Save for minor timing issues, FX movement and as mentioned, noncash compensation fair value adjustments, our results were in line with our expectations for the quarter as our Indianapolis and Nashville developments reached substantial completion and the associated costs, such as interest, TMI, et cetera, are now being expensed.

In addition, I realized that the drop in occupancy to 96.3% was noticeable, but it was in line with our expectations given the additional vacancy in the delivery of the Nashville and Indianapolis developments and the expected turnover of 600,000 square feet in Louisville and in no way does it alter our trajectory. Looking forward, as Teresa mentioned, we are maintaining our FFO guidance for 2023, and that is based on our projections for FX, the leasing activity for the remainder of the year. I'll repeat once stabilized the new developments will, of course, be a strong driver of NOI and cash flow growth for us in future quarters.

I will now turn the mic over for questions.

[Operator]

[Operator Instructions]. We'll get our first question on the line from Sam Damiani with TD.

[Sam Damiani, TD Securities]

Thank you for the thorough overview, both Teresa and Kevan that was very, very helpful. Just getting on to, I guess, the topic of the availabilities in the current portfolio, Kevan, you alluded to. I wonder if you could just give us a little more color on how, I guess, discussions are going on Louisville and Nashville and any other larger sort of availabilities in the portfolio today and the timing on getting the occupancy back toward 99%?

[Kevan Gorrie, President, CEO & Trustee]

Yes, happy to, Sam. And there are different availabilities obviously, from market to market. Louisville, 600,000 square feet just became vacant. And I would characterize the sort of level of activity being strong, but not to the [indiscernible] 600,000 feet and i think based on the location and the quality building that we have, we're looking at opportunities and the right prospects for the building, so we've seen more activity in the 200,000 to 400,000 foot range of prospects. And as of now, we think it would be better to wait for a single tenant for that building. So that's how we're approaching, I think, that availability.

Nashville, a number of prospects across all 3 buildings, I believe, of different sizes. And so I think that, that is going quite well. And I think we have a strong prospect for probably I would characterize is the 150,000 to 180,000 feet of prospect there. Indianapolis, more activity on the smaller building, the 300,000 square foot building than the 7. We have 1 prospect for the larger building, but that's very early discussion. And I would say that there's 2 to 3 decent prospects to the smaller building, again, early days, but we're looking at both multi-tenanting, the smaller building, or a single tenant, and that's for the larger one, too.

All of the buildings that we develop and, frankly, acquire can -- we prioritize the ability to divide the building. So all of our buildings can accommodate multiple tenants. We're just trying to find that sweet spot to maximize returns and the long-term value of the property, what makes sense? And despite the increase in vacancy, and I've already seen some negative comments around it, I think we've earned the right to be patient to find the right tenant that's going to maximize the value, the long-term value of the asset. And so we're being somewhat selective, I'm not suggesting that we're turning away tenants. That would be a gross mischaracterization but we are being selective in how we would divide up any of our buildings. So it has to be the right tenant, the right credit, the right rent, frankly, based on the premium location of these assets. It has to fit for us. So that's how it's going on the availability side. I hope that answers your question.

[Sam Damiani, TD Securities]

That is helpful. I mean the reported occupancy rate of 96.3%. It doesn't necessarily reflect some reason that you'd be commencing post quarter end. Is there sort of meaningful spread between what you reported and what would be a committed occupancy rate at this time?

[Kevan Gorrie, President, CEO & Trustee]

No, I think it would be best just to wait till the next quarter. We certainly don't want to put the cart before the [indiscernible] and also pointing out that we are in the middle of the summer. So we've already seen activity begin to pick back up after a slow July. So I think it would be better for us just to have a more meaningful conversation on this on our next call in Q3.

[Sam Damiani, TD Securities]

Okay. And last one for me, just on the transaction market, which certainly [indiscernible] here -- a sense of it stabilizing. As the market sort of evolves over the next 6 to 12 months, do you see capital allocation becoming more compelling? And if so, do you see acquisitions becoming incrementally more compelling versus development sort of a reversal over the last couple of years?

[Kevan Gorrie, President, CEO & Trustee]

I'm not sure we see anything that's really compelling for us right now in terms of -- as I said, we were a bit surprised by the strengthening in pricing, I think, particularly based on a few deals in Europe, for at market assets and newer assets. That sort of core pricing has really come in a lot more tightly than we thought. So from that perspective, I don't think we see anything that's truly compelling to us.

In terms of use of capital, I think we have enough in front of us for the next 6 months. I don't forecast us being in the market by the end of the year. I think 2024, we're quite optimistic that market conditions will improve, both from -- I wouldn't say -- I don't want to say leasing perspective because I think we're in a strong leasing market right. But I think 2024 will be a strong leasing market. But I also think it will be a more compelling market for us from an investment perspective. And hopefully, from a cost of capital perspective as well, we always have to keep that in mind. So I think it's going to be from a capital allocation investment perspective, Sam, it's going to be a relatively quiet second half of the year.

[Operator]

We'll go to our next question on the line is from Himanshu Gupta with Scotiabank.

[Himanshu Gupta, Scotiabank]

Kevan, thanks for the color on the [indiscernible] by the way. So just on the same lines, in your FFO same-property NOI growth guidance, do you expect backfilling of Louisville and Indianapolis vacancies?

[Kevan Gorrie, President, CEO & Trustee]

Sorry, can you repeat that, Himanshu?

[Himanshu Gupta, Scotiabank]

Kevan. The question is, I mean, you obviously put out your FFO guidance and same-property NOI growth guidance as well. So do you expect like level of vacancy will be back [indiscernible] by the year-end, in that guidance and also on your Indianapolis vacancy?

[Kevan Gorrie, President, CEO & Trustee]

Sorry, What are you saying? are you saying, Himanshu that you're asking is are we're assuming that the Indiana leases up and the Louisville lease up are in the guidance for the FFO, is that what you're asking?

[Himanshu Gupta, Scotiabank]

That's exactly what i was asking.

[Kevan Gorrie, President, CEO & Trustee]

Trying to think, well, from an FFO perspective, there is some contribution both in Louisville and from [indiscernible] and from Indianapolis, from the same property NOI perspective, only Louisville would impact that. And again, it's not a large contribution. We are not anticipating a large contribution to the same-property NOI from Louisville in 2023.

[Himanshu Gupta, Scotiabank]

Okay. Okay. Fair enough. And then on the 1.5 million square feet leasing in the U.S. done in the quarter. I think the rental [indiscernible] 19% -- was it in line with your expectations? Or were you expecting even higher rents?

[Teresa Neto, CFO]

Definitely in line with expectation Himanshu.

[Kevan Gorrie, President, CEO & Trustee]

Absolutely. Himanshu. Let me just clarify this because I've seen some things written that there seems to be more confusion. When we have -- is it a true mark-to-market? I'm not sure that it is. When we have a lease in place where the in-place rents are truly 30%, 40% low market, but the tenant, the renewal increase is set. We are mark-to-market as we disclose it is the renewal increase is the terms of the lease. And so when we look at that -- when you look at -- and you say, 19%, that's based on what we're actually achieving on renewal increases. And that does include some contractual limitations. Whereas it may not reflect a true mark-to-market on the rent. What it does reflect is if we can get the fair market value or the fair market rent than it would and what we achieve but it really is based on what we achieve on renewal and not necessarily a theoretical mark-to-market.

[Himanshu Gupta, Scotiabank]

Okay. Thanks for the clarification. And then just on 2024 lease expirees. And I think it looks like you're saying 70% are all done, are all [indiscernible]. So do you have a sense of what could be the seems to NOI growth next year? Will it look very similar to this year as well?

[Kevan Gorrie, President, CEO & Trustee]

We're expecting it to be similar. I think we're expecting it to be as strong as we sit here today. But just to clarify, the -- I mentioned $1.1 million. We're finalizing the lease. Everything was good, but we don't have -- we do not have signed renewals yet for that. So assuming that -- that's successful, and we assume that it will be, obviously, we'd be at roughly 73%. And yes, we [indiscernible] to be consistent with this year.

[Himanshu Gupta, Scotiabank]

And just last question, I think for Teresa, $400 million debentures. Did you mention you're doing euro swapping at 4.75. And is that like secure financing on using assets?

[Teresa Neto, CFO]

No, no, they're not secured. It's all unsecured, but we just based on where swap rates are today. We're estimating as high -- that's within my forecast is a 4.75 swapped euro fixed rates. They remain always unsecured.

[Operator]

We'll get our next question on the line. It's from the line of Matt Kornack with National Bank of Canada.

[Matt Kornack, National Bank Financial]

With regards to development spend, you haven't been kind of replacing as that projects have rolled off. Are you less inclined to put additional capital into the ground at this point? And I guess, subsequent to that, as you lease some of the existing space and the development that has been delivered would you then look to deploy more proceeds into development?

[Kevan Gorrie, President, CEO & Trustee]

Well, I think we're certainly in a wait-and-see approach. Even in [indiscernible] I think we have the opportunity to move forward to potentially be in the ground at the end of this year. But I think it makes more sense for us to be patient, if there's a build-to-suit opportunity in brand for take -- so for now, I think we're taking a [indiscernible] until 2024 at the earliest. I think I mentioned on either the Q4 call on the Q1 call that we were looking at potentially moving forward with the next phase in Houston as well because we're very close to full stabilization of the first 2 phases there. But again, I think despite it being a strong market, I think it makes more sense to us, particularly in Houston, given we're not really sure what we were going to build. We could build in excess of 1 million feet in a single building or multiple buildings. I think it makes more sense for us to continue to monitor the market and wait until at least 2024, and decide what we want to do. So for now, we're not planning to move forward with any additional development there.

[Matt Kornack, National Bank Financial]

Okay. Makes sense. And then I guess with regards to your commentary around the pricing firming and more incremental demand from investors, is that not changed your thought process around capital recycling at this point. And at this point, is there a place that you want to direct funds to relative to your existing portfolio exposure? Are you happy with where you are at this point?

[Kevan Gorrie, President, CEO & Trustee]

We will always look at opportunities. We continue to look at opportunities in the GTA. But I think for now, one of the things I would say about capital allocations and prices firm off. I think the [indiscernible] acquisition of the [indiscernible] portfolio was very interesting. It was a very -- To us that was a very tight cap rate. And I think 55% of that portfolio was in our markets. So I think that, that was a very interesting data point. And I think one of the comments that was made, I don't want to put words in anybody's mouth, but one of the comments that was made by [indiscernible] that was below replacement cost.

So there's also -- there's a lot of pressure on costs, not just on land, which is somewhat valuable, but construction costs are higher and they're not falling. And so the economic rents continue to rise and it puts pressure on new supply, et cetera, and we have to take that into account. If there are opportunities in our markets, and we have liquidity in our opinion, it may make more sense to buy stabilized assets. We'll see. And I think that's been consistent with our message all along that we're willing to look at new developments if we feel the returns are compelling. But we're also willing to switch a little bit and focus more on stabilized assets if we feel that they're truly below replacement costs and offer better returns.

[Matt Kornack, National Bank Financial]

Okay. That makes sense. And then, I mean, you made an interesting comment. You guys have been at 99% occupancy. I don't know if we should view 99% occupancy as a stabilized occupancy figure for any real estate portfolio. But as you think out -- like is the goal to get back to that? Or is there always going to be kind of a bit of vacancy and then pricing [indiscernible]?

[Kevan Gorrie, President, CEO & Trustee]

I'm glad you mentioned it because I think some people have been critical with 99% being too high and all we care about is occupancy. And I would kind of tend to agree with that. I think the nature of our portfolio is very stable. We have newer assets. We have major tenants, Magna is a tremendously stable tenant. So -- if a normal portfolio -- logistics portfolio is 97%, we should probably be 98% to 99%, just based on the stability characteristics of our portfolio. That being said, occupancy is not a driver for us. It really is growing NOI and then effect of rent [indiscernible], that's really a driver. And so do we need to be 99%? Absolutely not. Where will we kind of shake out? Probably more in the, as I said, more than 98% range just because of the nature of our portfolio and really -- you're absolutely right. I think 99% plus is just an arbitrary number and very hard to attain over a long period of time.

[Matt Kornack, National Bank Financial]

Yes. Fair enough. And then maybe last small detail from Teresa, I don't know if you have it in front of you. But do you know the same-property NOI, what it would have been including and excluding kind of the expansion activity?

[Teresa Neto, CFO]

Yes. So excluding the expansion, it's 6.8% for the quarter.

[Matt Kornack, National Bank Financial]

And then the 6.5% guidance, that's -- I should notice that that's in functional currency, not currency adjusted or is it currency adjusted?

[Teresa Neto, CFO]

No, that's constant currency. Correct.

[Operator]

Next question on the line is from the line of Kyle Stanley with Desjardins Capital Markets.

[Kyle Stanley, Desjardins Securities]

Maybe just going back to kind of the leasing environment. I'm just wondering, in your discussions with tenants now as you're kind of working through the leasing maybe what's changed? Are you seeing them negotiate more? Obviously, they are aware of kind of the dynamics at play in the market. But I'm just curious on how your discussions have maybe changed in the last maybe 6 months or so relative to what we saw in the post-covid frenzy. And then just specifically with kind of your leasing in the U.S., what would you be getting in terms of a contractual rent escalation?

[Kevan Gorrie, President, CEO & Trustee]

Well, number one, I think for the negotiations or discussions that we've been involved with -- the financial terms seem to be intact. We haven't had any one pushback for more free rent or more and rents as you see in beginning to climb. Put in perspective, just looking at the statistics, we had 5 markets in the U.S. that had stronger rent growth in Toronto. And 2 of them were actually almost double the rent growth in Toronto. Dallas is 40%, for example, I think Louisville is 30 something. Indianapolis is 30, right? So there's still -- I think we're in a very strong position as a landlord on the rent side. I think what we've seen, though, is the sort of hesitancy at the corporate level to make financial commitments. And I talked about this in the Q1 call, and we're certainly seeing a continuation of that.

Deals are taking longer because companies are just a little more uncertain about economic conditions and that makes sense. But there hasn't really been a pushback on the economic terms of the deal, I would say. And we were just -- I hope I mentioned in my formal comments, when we look at Nashville, I think we underwrote, I want to say $6 rents, [indiscernible] $6 rents. We're achieving $7.25-plus right now. So -- from a timing perspective, maybe the delay in deliveries has not been positive for us, but it certainly helped us from a yield perspective and from a rent perspective. And I think the second question is what escalations are we achieving? What would you say anything sort of -- Yes, roughly 4%, Kyle.

[Kyle Stanley, Desjardins Securities]

Okay. So fairly -- that you're kind of seeing in the GTA. So that makes sense. I think your commentary, obviously, is interesting about the rent growth being higher in some of those U.S. markets, namely Dallas and Louisville, Indianapolis and you mentioned -- what would you say is driving that right now? Historically, maybe the rent growth in the Midwest and the southern areas of the U.S. had not been quite as strong as what you were seeing out of the coastal, but we've obviously seen that shift a little bit. So in your view, what is really contributing to that?

[Kevan Gorrie, President, CEO & Trustee]

Well, I think to be fair, a lot of the net absorption that we've seen is newer product that's coming online. So I think number one, most of the leasing that we've seen has been in newer products. I think I didn't look at it this quarter, but in Q1, I think it was over 80% of all leasing within newer products. So certainly, I think what we're seeing is that sort of rent premium for newer products. And another trend I would say that we're just starting to notice is tenants are now actively inquiring on sustainability features in the building, which is a good thing for us because we're way ahead of the curve there in terms of the characteristics of our buildings.

So that's another trend that we're seeing where they're looking for that. To the degree that they'll pay for it, not quite sure, but it seems that there's a little more openness to paying a higher rent on buildings that are modern like ours and have those characteristics.

[Kyle Stanley, Desjardins Securities]

Okay. No, that makes perfect sense. And just the last one. I thought your comments on pricing in Europe firming maybe a little quicker than expected. It was interesting. What do you think is driving that? And have you seen any specific buyer or interested party become more active in European markets lately?

[Kevan Gorrie, President, CEO & Trustee]

Well, like we said before about private equity, there's certainly this sort of need to put money at the door. That's what we believe, and I think there is a consensus out there that a lot of this is just private equity funds needing to allocate capital. But even [indiscernible] view through [indiscernible] -- it's active. CBRE is active. A lot of the open-end funds in Germany are back in the market. So there's a number of them. And that's been consistent, I think, so far this year. I think that need to allocate capital. And the preferred destination, particularly in Europe, I think year-to-date, industrial is 40% to 50% of all investment volume. So it remains the sort of sector of choice for investors.

[Kyle Stanley, Desjardins Securities]

Okay. No, that makes sense. Maybe I said last question, but just building on that a little bit. I mean, obviously, historically, there's been discussions of the monetization of some of the Magna assets, gross -- I think we discussed earlier in the year, just given the lease renewal that was completed? Do you think transaction markets firming in Europe, would that make you reevaluate that at a certain point?

[Kevan Gorrie, President, CEO & Trustee]

Well, I mean, we're always open. We're always thinking about it. I think what we said is just I don't know if -- I don't know if I would characterize the market conditions as being there yet for that. And just to get back to the comment about why do we think that prices are stabilizing? I think the one thing that's interesting to us -- most interesting to us, and I mentioned newer buildings with at market rents are very close at market rents with long-term leases are trading, to me, well below financing costs in Europe. So we're seeing these types of deals occurring in a 4.5% yield when borrowing costs are probably closer to now in those markets.

And I think what that indicates is the sort of deep conviction that market rents are -- will continue to grow strongly in Europe. On a cost basis it will make sense in a few years, even if it's not accretive to their financing costs. So that's what we're seeing. So in that context, I think that market conditions continue to improve. And if there is the right opportunity for us with [indiscernible] or any of the other assets, we're certainly open to it, and we will be prepared for it.

[Operator]

Our next question on the line is from the line of Pammi Bir, RBC Capital Markets.

[Pammi Bir, RBC Capital Markets]

Kevan, just maybe sticking with the U.S., it sounds like you've made some progress on leasing there. But frankly, vacancy is, again, not such a bad thing, just given where rents are -- but overall, as we think about next year, are there any vacancies coming that you're aware of, call it, over the next 18 months or so?

[Kevan Gorrie, President, CEO & Trustee]

Yes, there's a few, but I'm trying to think -- I don't think there's anything too significant to us, too chunky. No, i don't think so. Let me put it in another way. I think we are 86%, 87% retention this year, I think it would be a similar number for next year. I'm looking at Mike and Lorne here. I think we'd be similar next year in terms of expectations for retention, if that helps.

[Pammi Bir, RBC Capital Markets]

Yes. And then just maybe coming back to the Louisville vacancy. I'm just curious, how does the market rent compared to the prior in place? And anything you can share just in terms of what drove that vacancy. Did the tenant outgrow the space? Or are they looking for something else? Or was it financially driven?

[Kevan Gorrie, President, CEO & Trustee]

Well, quick answer there. One, I think we're anticipating rents about 20% over expiring rents. And two, the tenant was GameStop. Remember, this was an expected move-out. We had talked about this for the past couple of quarters that GameStop had advisers that they were downsizing, obviously. And so this was completely expected. But to your question about, are they going somewhere else? I think I believe they're consolidating in their existing portfolio. That would be my guess.

[Pammi Bir, RBC Capital Markets]

Okay. And then just last one. On the Ajax development, it is a small project overall. But I'm just curious, was there an opportunity to maybe revisit the rents there or any discussions with the tenant just given the increase in the cost?

[Kevan Gorrie, President, CEO & Trustee]

Well, this is a speculative expansion, and I will tell you how we kind of got caught with it. When we were moving forward with the Brantford developments [indiscernible]. Obviously, we had time obligations there. So we ordered steel because we're in a market where the lead time on delivery of steel was up to 12 months. So we made the decision to preorder the steel for this expansion at the same time. And so when we did that, and we found that pricing came in above and it was in addition to the scope that were -- some were our decision to make and some were imposed on us by the city. At that point, we had already ordered the steel.

And so we are moving ahead with this project. And then we decided to incorporate some base building improvements which are now -- which are part of this project, which drove up the cost a little more. So that's kind of how that happened. But again, the main point is that we had preordered the steel for this in conjunction with the Brantford project. So it was kind of a unique situation that we found ourselves in there.

[Operator]

Thank you very much. Mr. Gorrie, we seem to have no other questions queued up. I'll turn it back to you for any closing remarks.

[Kevan Gorrie, President, CEO & Trustee]

Okay. Well, thank you, everyone, for participating in our call and we look forward to speaking with you again in November on our Q3 call. Have a good day.

[Operator]

Thank you very much. And that does conclude the conference call for today. We thank you for your participation. I ask you to disconnect your lines. Have a good day, everyone.