Granite Real Estate Investment Trust

TSX:GRT.UN

Earnings Call Transcript 2019-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the conference call for Granite REIT. Speaking to you on the call this morning is Kevan Gorrie, President and Chief Executive Officer; and Teresa Neto, Chief Financial Officer.Before we begin today's call, I'd like to remind you that today's statements and information made in today's discussion may constitute forward-looking statements and forward-looking information and that actual results could differ materially from any conclusion, forecast or projections. 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 2019 filed on March 6, 2019. Readers are cautioned not to place any undue reliance on any of these forward-looking statements and forward-looking information. Granite undertakes no intention or obligation to update or revise any of these forward-looking statements or forward-looking information, whether as a result of new information, future events or otherwise, except required by law. In addition, the remarks this morning may include financial terms and measures that do not have a standardized meaning under International Financial Reporting Standards. Please refer to the Q3 2019 condensed combined audited financial results and management's discussion and analysis of Granite Real Estate Investment Trust and Granite REIT Incorporated 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 would now turn the call to Kevan Gorrie. Please, go ahead.

[Kevan S. Gorrie, President, CEO & Director]

Thank you, operator. Thank you, everyone, for taking the time to join us for our Q3 earnings call. I'm pleased to be joined this afternoon by Teresa; and Lorne Kumer, our Executive Vice President of Real Estate; and Michael Ramparas, our Senior Vice President of Investments and Global Real Estate. Teresa will begin a discussion with a review of the financial highlights, I will then follow with comments on acquisitions, operations, development and strategy, and then open up the call to any questions that you may have.

[Teresa Neto, Chief Financial Officer]

All right. Thanks, Kevan, and good afternoon, everyone. Thanks for making the time to join this call. The third quarter was one of Granite's strongest quarters ever posted. And we posted robust same-property NOI and FFO growth and a continuation of investment activity with Granite executing acquisitions of 3 investment properties totaling approximately $84 million, followed by an additional $110 million -- $102 million of new investments announced post quarter. FFO per unit for Q3 was $0.93, an 8% increase relative to Q3 of 2018 and up 4% relative to Q2 of this year. Included in this quarter's FFO is $0.4 million of additional G&A expense pertaining to final costs relating to the departure of the Trust's former CFO. Normalizing for this item, FFO per unit would be $0.94. The comparative FFO of Q3 2018 was also impacted by employee termination costs of $1 million, whereby, if adjusting for that item, FFO per unit would have been $0.88. Incremental FFO from new acquisitions, net of dispositions, lower current income tax expense as well as a net small positive foreign exchange impact, driven by our weaker Canadian dollar relative to the U.S. dollar and offsetting the effect of a strengthened Canadian dollar relative to the euro, all more than offset the temporary dilutive effect of the $231 million April equity offering, where proceeds have not yet been fully deployed in the quarter. Granite's AFFO on a per unit basis in Q3 was $0.90, which is $0.08 higher than Q3 2018 and $0.02 higher than Q2 of this year. AFFO per unit was favorably impacted by the higher FFO per unit and lower AFFO related capital expenditures incurred in the quarter of $1.4 million compared to $2.1 million in the same period last year. For fiscal year 2019, we are expecting total maintenance capital expenditures, leasing and commissions to reach approximately $7.5 million for the year. In Q4, specifically, AFFO-related CapEx is expected to be approximately $3.8 million to $4 million. As a result of a relatively low CapEx quarter and strong FFO performance, the AFFO payout ratio for this quarter came in at 78%. Operating metrics continue to demonstrate positive momentum. NOI on a cash basis for the quarter increased by $3.9 million or 6.9% from the same quarter of last year and by $2 million or 3.4% from the second quarter of 2019. Same-property NOI for Q3 2019 was very strong relative to last year, increasing 4.3% and on a constant currency basis, increasing by 5.8%, driven mostly by occupancy gains in Canada, the U.S. and the Netherlands and contractual rent or CPI increases in the U.S., Austria and Netherlands. On a year-to-date basis, same-property NOI is up $3.7 million or 2.8% relative to Q2 to last year, and on a constant currency basis, 3.9%. G&A for the quarter was $0.6 million lower than the same quarter last year and $1.7 million lower than the second quarter of 2019, which, if you recall, was impacted by $2.1 million of termination costs related to the CFO's departure. Included in the current quarter's G&A is $0.3 million of expense related to the fair value loss associated with the increase in noncash compensation liabilities due to the increase in Granite's unit price. On a year-to-date basis, these fair value losses amount to $1 million. Assuming no further fair value variances from the remeasurement of unit-based compensation liabilities, G&A for fiscal 2019 is estimated to be approximately $30 million for the year and for Q4, G&A is expected to remain flat with Q3 at approximately $7 million for the quarter. Note that the forecasted G&A for 2019 fiscal year would be $27.8 million as CFO termination costs totaling $2.5 million are excluded. In the fourth quarter, the Trust completed a reorganization of its Austrian entities, whereby, the ownership of the Trust and Austrian entities is now controlled by the REITs Netherlands structure. This reorganization will result in future savings relating to withholding tax on Austrian dividends and will facilitate a future share sale efficiently. This reorganization will, however, result in a recognition of a real estate transfer tax expense of approximately EUR 1.8 million or CAD 2.7 million in the fourth quarter. Although this will be a significant expense incurred in the current year, we expect to realize savings of the same EUR 1.8 million in 2020 when we anticipate distributing approximately EUR 36 million from Austria to Canada. And we'll continue to realize withholding tax savings every year thereafter, on Austrian distribution of approximately $0.7 million or CAD 1 million based on current distribution forecasts. The Trust's balance sheet remains very strong, comprising total assets of approximately $4.5 billion at the end of Q3, an increase of $70 million since the end of the second quarter of this year, driven by $78 million of fair value gains recognized on the Trust's investment property portfolio. Over 80% of this fair value gain is attributable to the Trust's properties located in the GTA and USA. The increase in total assets was partially offset by a decrease of about $45 million on the Trust's European investment property portfolio due to the strengthening of the Canadian dollar against the euro, but positively impacted by an increase of approximately $17 million on the Trust's U.S. assets due to a weaker Canadian dollar against the U.S. dollar. The Trust's overall weighted average cap rate decreased 10 basis points to 6.2% at the end of the third quarter. As disclosed, the REIT refinanced and extended its U.S. term loan in the quarter, which was -- will result in interest expense savings of $0.03 per unit going forward. The REIT continued to evaluate refinancing opportunities that can leverage its unique access to significantly lower European debt. Total net leverage at the end of the quarter was 20%, essentially flat with the second quarter. The Trust's current liquidity is approximately $1.1 billion, representing cash on hand of approximately $650 million and the undrawn operating line of $500 million. Net leverage and liquidity, pro forma, the October 31 equity offering, acquisitions and investments announced on October 21, and the completion of the disposition of the remaining 5 assets held for sale is estimated to be 20% and approximately $850 million liquidity. The recent equity offering is expected to have a dilutive impact to the fourth quarter. I'll now turn over the call to Kevan.

[Kevan S. Gorrie, President, CEO & Director]

Thanks, Teresa. As always, I will keep my comments brief because I trust you've had the opportunity to review our MD&A and press release. As in the second quarter, I would characterize the third quarter, albeit very strong as being in line with our expectations and slightly ahead of schedule in terms of progress against our strategic plan. During the quarter, we acquired a 260,000 square foot distribution center in the Netherlands and a newly constructed 300,000 square foot distribution center in Horn Lake, Mississippi, a suburb of Memphis with close proximity to Memphis International Airport and FedEx's main Global Air Hub. These assets were acquired at an average going in NOI yield of 5.9% and represent growth in 2 of our target markets in Europe and the U.S., respectively. Also in the quarter, we acquired in partnership with NorthPoint Development, a 191-acre infill site fronting U.S. Highway 90 in northeast Houston. This site will accommodate approximately 2.5 million square feet in total development, and we have launched Phase 1, comprising 2 buildings totaling roughly 650,000 square feet, which we expect to complete early in the third quarter of 2020. I will discuss the status of our other development projects shortly. During the quarter, we also closed on the disposition of our Finchdene asset in Scarborough and expect to close on the sale of the 5 Michigan assets in the fourth quarter. Our dispositions are expected to total just over $105 million by the end of the year, which is at the low end of our guidance for 2019. Execution of the lease extension documents and preparations for the sale of our assets held for sale -- sorry, I should say our assets planned for sale in Austria, Spain and Windsor, required more time than expected, and those transactions will now be pushed into 2020. We have decided for now to retain our asset in Redditch, England, pending clarity around Brexit and market conditions in Britain. Following the acquisitions and dispositions, which occurred on or before September 30, our Magna tenant concentration by revenue and GLA has decreased to 47% and 40%, respectively, putting us ahead of schedule on our previously announced target of reducing our Magna concentration to below 50% on a revenue basis by the end of 2019. Pro forma the sale of the Michigan portfolio and the announced acquisitions including the Dallas, Texas development, which is expected to close later this month. Our concentration is expected to decrease further to 41% and 35% of revenue and GLA, respectively, on a run rate basis. Operationally, we have now negotiated extensions on roughly $1.4 million or 65% of lease expiries in 2020 at an average rental rate increase in rental rate of over 5%. The remaining 750,000 feet of expiries in 2020, which occur in the second half of the year, we anticipate an average rental rate increase of 7% to 8% on renewal or re-leasing. At our current occupancy rate of 99.7%, we now only have 90,000 square feet of vacant space related to the Novi asset in Michigan. In the quarter, we executed a 10-year lease at our 600 Tesma property in Vaughan with the leading global e-commerce provider. As Teresa mentioned earlier and as disclosed in our MD&A, same-property NOI is up 3.9% year-to-date on a constant-currency basis. Movement quarter-over-quarter from 2018 was relatively broad-based and positive across all geographic segments on a constant-currency basis, ranging from 1.8% in Austria to over 70% in the Netherlands, led, as Teresa mentioned, by leasing activity and occupancy gains from 2018. We expect same-property NOI growth to moderate in Q4 from 5.8% this quarter and finish the year above our 2019 guidance of 2% to 3%. We also reiterate our same-property NOI growth guidance of 3% to 4% for 2020, 3% roughly excluding intensification and 4% including intensification. As an update on our development program, we are continuing with the tendering phase in our Altbach development project in Stuttgart, Germany, and hope to commence construction in early Q1 2020 for completion in late 2020. We remain in discussions with active prospects for the entire space. Our development project in AllPoints, Indianapolis continues to progress on schedule with substantial completion expected in early Q2 2020. As disclosed in our press release and MD&A, our development site in Dallas is now substantially complete, and the tenant has waived the right under the lease to purchase the building. Subject to normal closing conditions, we expect the transaction to close later this month. The proposed expansion of the Congebec food distribution facility on Logistics Drive in Mississauga, is currently in for permit and tendering. We anticipate commencing construction in the first quarter with completion scheduled for late Q2. As an update on the proposed development project in Calgary, announced earlier this year, we were unable to economically resolve certain planning and zoning issues related to the acquisition of the land and will not be moving forward with the transaction. As previously discussed, we anticipate that these development projects will further enhance the quality of our portfolio, generate superior long-term returns and create significant NAV growth for our unitholders upon stabilization, all a major component of our corporate strategy and philosophy. As Teresa mentioned, the combination of the Austrian restructuring charge and additional units from the October 31 equity offering will negatively impact our results for Q4. But the restructuring charge will improve our cash flow in 2020 and beyond, and the equity raise will enable us to execute on our growth plans for 2020, in conjunction with planned refinancing of potential financing initiatives. As an important part of our organizational and growth strategy, Jon Sorg joined our team in October and will lead our platform and portfolio strategy in the U.S. The addition of Jon and Witsard further improves our platform strength and capabilities in the U.S. and Europe, respectively. In closing, we are very pleased to announce our eighth consecutive annual distribution increase. It is a product of a conservative capital structure and stable and sustainable cash flow growth that enables us to increase the distribution in 2019 and maintain conservative capital ratios from future potential increases. And now, I will now open up the floor for any questions.

[Operator]

[Operator Instructions] And our first question is from the line of Sam Damiani with TD Securities.

[Sam Damiani, Analyst]

And congratulations on a great quarter. Kevan, can you just clarify the -- what you said about dispositions? And I think it was 3 markets that were being deferred, I think, you said until 2020. I didn't quite catch the details of what you were seeing there?

[Kevan S. Gorrie, President, CEO & Director]

Yes, the 3 markets involved, Sam, are Austria, Spain and the Portello asset in Windsor.

[Sam Damiani, Analyst]

Okay. What was the total sort of GLA of those assets, roughly?

[Kevan S. Gorrie, President, CEO & Director]

I think the total value is roughly $60 million. I don't have the GLA offhand.

[Sam Damiani, Analyst]

Okay. So they're not huge assets?

[Kevan S. Gorrie, President, CEO & Director]

No.

[Sam Damiani, Analyst]

Okay. And there was sort of pending sort of lease finalizations with the tenants?

[Kevan S. Gorrie, President, CEO & Director]

Yes. Leasing -- getting the lease extensions favored and then just preparing the assets for sale, including property condition reports and so forth. So those are now expected to commence in 2020 transaction.

[Sam Damiani, Analyst]

And then as we look forward to 2020 in terms of acquisitions with more people on the ground, obviously, in Europe, earlier this year and most recently in Dallas, how should we expect the mix of growth investments for Granite in 2020?

[Kevan S. Gorrie, President, CEO & Director]

Well, it looks like, I think, year-to-date, including land for development, we've acquired roughly $650 million of assets. We'll probably -- we hope to finish the year a little north of $700 million. Realistically, I think we'll do something similar to that in 2020, probably somewhat better, but in that range, Sam.

[Sam Damiani, Analyst]

And are you biasing U.S. over Europe? Are you looking seriously at more in Canada?

[Kevan S. Gorrie, President, CEO & Director]

Well, we're looking in Canada, but I think, rightly so, we're being very selective about what we're doing in Canada. We still are seeing superior returns in the U.S. and Europe. So I would say the bulk of our acquisitions, including development sites that we would look to acquire, would occur in Europe and the U.S.

[Sam Damiani, Analyst]

Okay. And just -- you mentioned the lease, I think, it was 600 Tesma, when does that lease, the rent -- what is the rent commence there? And are you able to name the tenant?

[Kevan S. Gorrie, President, CEO & Director]

I'm not able to name the tenant under the conditions of the lease. The rent commence September 1.

[Operator]

Our next question is from the line of Mark Rothschild with Canaccord Genuity.

[Mark Rothschild, MD & Real Estate Analyst]

In regard to the new development project that you bought in Dallas, can you talk about the market for finding those types of deals, find product newly developed? And then maybe in that context, how would the cap rate going in on this deal compared to buying an asset that maybe the tenant was already paying rent? And if you buy it later on in the process, did it matter at all? And considering there was a lease in place? I am not sure if that's played into this deal?

[Kevan S. Gorrie, President, CEO & Director]

Well, I think, it did, Mark. I would say, with assets like this because of their scale and the value of them, I think you have to be very selective. So we have looked at a few opportunities, frankly, globally for assets like this. We felt like it was a very good fit strategically. But I think we are quite selective on the markets and the locations within the markets that we are looking for. This one fit our investment criteria. In terms of the cap rate consideration, it is our belief that there was cap rate consideration for a repurchase. I wouldn't speculate today on what that is. But I would offer that buying that asset on a stabilized basis would be at a higher price than what we agreed to purchase it for.

[Mark Rothschild, MD & Real Estate Analyst]

Okay. Great. And then just maybe in regards to Calgary asset that you're not going forward on. Is there -- is that any significance related to your view on the market? Or is that completely separate? And maybe your view in general on the Alberta industrial market?

[Kevan S. Gorrie, President, CEO & Director]

I would say it this way, I think, it was more related to costs associated with infrastructure and servicing of the site. And there were some question marks that what we could eventually build there. The other layer that I would put on top of that, though, is we felt like our flexibility in terms of pricing or what we can achieve was quite tight. So this was a site where we weren't willing to push in terms of our pro forma and what we thought we could achieve on a rental rate basis and the timing basis. So I think that's kind of the best way I would put that.

[Operator]

Our next question is from the line of Chris Couprie with CIBC.

[Chris Couprie, Research Analyst]

Just 2 quick ones for me. Just on the organic growth outlook. Would you be able to give any color in terms of the different geographies? What your growth expectations are by geography? And then secondly, Kevan, you mentioned earlier, financing and refinancing initiatives for 2020? Just any color on that?

[Kevan S. Gorrie, President, CEO & Director]

I'll let Teresa talk about the refinancing opportunities. But on the same-property NOI, I think you're talking about probably -- we did provide some color in 2019. There was a lot of leasing activity that drove -- we're seeing property NOI growth this year, particularly in Europe. 2020, there was a segment done in Canada and the U.S. and Europe. So I think 2020, the expiries were more broad-based. Obviously, we're seeing better rental rate growth on our expiries and renewals and re-leasing in Canada. But we do expect them to be positive across all of the geographic segments with Canada, obviously, leading the way in 2020 in terms of growth.

[Teresa Neto, Chief Financial Officer]

And Chris, on the financing side of it. So we're always looking at kind of like opportunities. So for instance, we have a maturity of $250 million in 2021. Right now, it's still not worthwhile to refinance that due to the prepayment penalties on the debentures. So that's something we're going to park for a little while. We're looking at the term loans and does it make sense to do something similar to what we did with the U.S. dollar term loan. We have another Canadian term loan. Again, looking at the cost, we have a mark-to-market that's negative and a liability position on that particular term loan, but swap related to that. So we're looking at -- does it make sense to refinance, repay that economically? So that's another option. And then we're keeping an eye on the debenture market. And right now, it's very favorable and a lot of REITs have successfully raised money in the market. But for us, with the recent equity offering, we have to time this appropriately. And also, it depends largely, too, we would favor and lean towards financing, for instance, our European acquisition pipeline with financing and swapping into euro debt. So the timing of that will depend on the acquisition pipeline in Europe.

[Operator]

Our next question is from the line of Howard Leung with Veritas Investment Research.

[Howard Leung, Investment Analyst]

Just want to touch on the comments, Kevan, you have about next year same-property NOI growth being about 3% or 4% a few, including intensification. I guess, you guys are pretty well fully leased. So would most of that 3% growth come from the rental lifts that you're seeing? And if so, where -- which geographies or which kind of assets are you seeing the most potential for rental lift?

[Kevan S. Gorrie, President, CEO & Director]

No, you're right, Howard. It would be mostly related to rental rate growth, but I would point out that Novi, that 90,000 feet, that's actually really a suburban office asset. So re-leasing on that tends to move the needle on a portfolio -- on our portfolio more than any other asset. And then in terms of the geography, I think, as I mentioned, we have a number of expiries in the GTA area, which we think are going to lead that growth. But we do expect rental rate growth on renewals or re-leasing generally across all of our markets in 2020.

[Howard Leung, Investment Analyst]

Okay. No, that's good. And then just one for Teresa. The European debt capacity there, you have about, I guess, $1 billion, $1.2 billion, it's for the fair value of European properties. How much more euro debt can you think you can get against those properties?

[Teresa Neto, Chief Financial Officer]

Actually, right now, Howard, we're pretty well fully hedged on our net investment in Europe. We probably have very little room, maybe $25 million, I think, right now is a good estimate. So I mean it's really looking at total net equity there, and we're fully hedged at the moment.

[Howard Leung, Investment Analyst]

Okay. That makes sense. And then just last one on maybe the Finchdene disposition. I was wondering if you could give a little bit of color on that one. And why that one was sold? Was it -- did someone approach you? Or was it on the market?

[Kevan S. Gorrie, President, CEO & Director]

We actually had it on the market both for sale and lease, and we went back and forth. And in the end, we felt, I think it was probably best just to let-go of this asset at this time. So we made the decision to execute a sale of the asset versus re-leasing.

[Operator]

And there are no further questions on the phone lines at this time.

[Kevan S. Gorrie, President, CEO & Director]

All right. Well, thank you, operator. And on behalf of the trustees and the management team here at Granite, thank you all, again, for participating on our call today and to our unitholders, thank you for your continued trust and support. Have a good day.

[Operator]

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