Good morning, ladies and gentlemen, and welcome to the Dream Office REIT Year-End 2019 Conference Call for Friday, February 21st, 2020. During this call, management of Dream Office REIT may make statements containing forward-looking information within the meaning of applicable securities legislation. Forward-looking information is based on a number of assumptions and is subject to a number of risks and uncertainties, many of which are beyond Dream Office REIT's control, that could cause actual results to differ materially from those that are disclosed in or implied by such forward-looking information. Additional information about these assumptions and risks and uncertainties is contained in Dream Office REIT's filings with securities regulators, including its latest annual information form and MD&A. These filings are also available on Dream Office REIT's website at www.dreamofficereit.ca. Later in the presentation, we will have a question and answer session.
To queue up for a question, press star one on your telephone keypad. Your host for today will be Mr. Michael Cooper, Chair and CEO of Dream Office REIT. Mr. Cooper, please go ahead.
Thank you very much, operator. Welcome everybody to Dream Office's Year-End Conference Call. I'm here with Jay Jiang, the CFO, and Gord Wadley, the Chief Operating Officer. We'd like to begin with Jay providing some prepared remarks, then I have a few comments, and then after that, the three of us are happy to answer your questions. Jay?
Great. Thank you, Michael. Good morning. In the fourth quarter, we reported FFO per unit of CAD 0.40, which was in line with our internal expectations, and CAD 0.01 above Q4 in 2018. Overall, we are pleased with our 2019 results. Our leverage declined from 45% to 37.6% due to over CAD 500 million of asset sales. Despite having less assets and lower leverage, our FFO per unit increased CAD 0.01 for the year. Our exposure to Downtown Toronto increased from 68% to 83% as we sold approximately 2 million sq ft of assets in other markets. We were able to overcome lower leverage and lower yields by generating higher comparative property NOI growth of 12.2% for the year, reducing our G&A expenses and earning extra fees from our property management and construction business.
Net asset value per unit at year-end was CAD 26.70, an increase of 3.5% over last quarter and 6.9% for the year. In Q4, our portfolio saw an increase in value of CAD 62 million, of which CAD 28 million are from capital investments and CAD 34 million attributed to fair value increases through higher NOI. We also realized our share of net income from our Dream Industrial REIT investment of CAD 21 million, which is accounted for under the equity method in accounting. Based on current value of approximately CAD 14, the fair value of these units are worth over CAD 60 million or CAD 1 per unit relative to the book value of our balance sheet. Our weighted average capitalization rate used to determine fair value of the income properties did not change. This implies a 2019 total return of 11% to unitholders based on the audited fair value of the company and cash distributions.
For 2020, we will provide the following high-level guidance, assuming a steady state that is exclusive of potential acquisitions, dispositions, and unannounced major capital initiatives. We are expecting diluted FFO per unit of CAD 1.60. We expect comparative properties NOI of approximately 3%, consisting of 5% increase in Downtown Toronto, primarily attributed to higher rents, offset by - 5% in our other markets to reflect continuing market challenges in some of our remaining assets in Western Canada, particularly in Saskatchewan. We are working through these assets, and if we are able to sell some of them, we will be able to improve both the return profile and the comparative property NOI in 2020. We are anticipating our average leverage for the year to be below 40%.
Within the other market segment, there are approximately CAD 75 million of assets that we are currently working actively on the leasing and asset management front in the near term in preparation for a sale. We are currently not making any predictions or targets on disposition volumes in 2020. With regards to leasing, at year-end, we have 46% of the 157,000 sq ft expiring in Downtown Toronto this year already addressed at net rents in the mid- CAD 30s per sq ft. We expect to have most of the expiries in Downtown Toronto for 2020 committed by mid-year. We are also 82% leased on 2020 expiries for our other market segment. Late in the fourth quarter, we renewed a 185,000 sq ft lease at our only building in the United States for five additional years with net rents comparable to expiring.
This was an important renewal for us as our debt is currently locked up in a Commercial Mortgage-Backed Securities pool until 2021. Adding five years of term will help preserve the value and liquidity of this building. As announced in prior quarters, we will be making significant investments in our properties over the course of 2020. We turned over 357 Bay to WeWork in November. They are currently working on their construction and fixturing, and expect to collect NOI starting in November. We understand that WeWork is leasing the building to an enterprise client. We would expect to have a creditworthy tenant occupying the space. Similarly, in 1900 Sherwood in Regina, we expect to finish our construction obligation by mid-year. We'll turn over our space to the tenant's construction and fit-out program. NOI should commence from the new space in the summer of 2021.
In aggregate, we have spent CAD 33 million out of the CAD 55 million allocated to these redevelopments as of the end of the fourth quarter. Both projects are currently on time and on budget. We also announced a CAD 50 million investment in Bay Street earlier this year to enhance our lobbies, washrooms, facades, lighting program, and the alleyway. To date, we have completed all of our designs and have commenced construction. We plan to substantially complete the Dream Collection Bay Street Village this year. In January, we repaid our last tranche of the CAD 150 million unsecured debentures. We currently have about CAD 90 million drawn on our line with CAD 240 million of liquidity and CAD 280 million of unencumbered assets. We have significantly cleaned up our capital and debt structure over the past two years.
We have only one small mortgage maturing in 2020 and minimal refinancing or interest rate risk over the next three years. Our balance sheet is in good shape and support our capital and development initiatives, and we will continue to look for opportunities to improve our assets to the best-in-class standard and deliver solid long-term results for our unit holders. I will turn it back to Michael with his thoughts.
Thank you, Jay. I just want to spend a couple of minutes talking about our macro view on valuation and maybe why there's some very significant differences of views about what the value of the company is. I wouldn't mind spending a couple of minutes just going over our entire portfolio. On October 15th, 2008, the U.S. Fed came out and announced emergency interest rates that were such a tremendous decline in order to keep the economy going. They set the overnight Fed rate at 1.5%. Today, the target is 1.5%-1.75%, 12 years later. I think that what's really been happening over the last 12 years is something's changed, and the cost of money is a lot less than it used to be.
Growth is a lot harder to get than it used to be, and people are trying to figure out what's a fair return given the risk. When I look at it, what we start with is, if you use U.S. Treasuries as the risk-free rate, we're at 66 x cash flow for risk-free, and there's no upside or downside in nominal dollars. I think the main question is how much of a premium should people get from 66 x cash flow as they take on more risk? What we've seen in how we run our business is, we think that even at high prices, as it seems historically, high-quality assets that produce predictable income that have some upside are a much better buy today than assets that have unpredictable income.
I would say that today is not a day to buy cheap assets, because what we've been seeing is cheap assets get cheaper. High-quality assets have tremendous value. We're seeing rents going up, and we don't see the tenants choking on it. Rent used to be the second highest cost of most tenants, and now, after people, and now there's a lot of other costs that are way up there, too. We're seeing that rental rates in Downtown Toronto have gone up. There's lots of reasons for it, but the most important thing to me is, I don't think it is affecting tenants' ability to run their business, attract people, and grow, given the rents. We think there's a big backdrop for increasing rental rates, to the level they are now and to continue to do so.
What we are seeing is that the rental rates are significantly higher than a year ago, five years ago, and as I've mentioned before, last year is the first year we've exceeded 1989 rents. I mean, we probably have something like 1% rental rate growth over the last 30 years that's just occurred in the last 18 months. We think it's the right thing to do and only fair to provide our tenants with incredible space, incredible buildings that make it easier for them to attract people, run their business, and treat their clients well. That's why what we're doing is really focusing on how to create better and better experiences in our buildings. In a lot of cases, the rents are more than double what they were just four or five years ago, and we want our tenants to have a good experience.
Having said that, we believe that we're getting well rewarded for the money we're putting into the buildings. Right now, we're focused on nine buildings, eight buildings on Bay Street, and it's very small work. Some of these buildings are as small as 30,000 or 40,000 sq ft. We're expecting that by the end of this year, the work will be done. We've got private and public laneways connecting the buildings. We're upgrading everything in the buildings, and we think for this two-block area, Downtown Toronto, we're going to create something that's really special for our tenants, plus for the rest of the city. We're working now with retail tenants that I think are going to be really exciting and animate the space. This isn't just space that will be accessible from Bay Street or Richmond. This is a space that will be accessible from our private laneways.
We're going to create something that we hope to see you at, and hopefully, we'll have something for you at the spring of 2021. When we look at our other buildings in Downtown Toronto, 438 University, we're looking at some very interesting new uses on the ground floor, upgrading it. That's a 700,000 sq ft building at a really great location, and we expect the rents to continue to rise there and our tenants' enjoyment to continue to increase. 36 Toronto and 20 Toronto is a big building. It's right beside 30 Adelaide, 74 Victoria, 6 Adelaide East. I think we've got 1.1 million sq ft within 100 ft of each other, and that's going to be a real target of upgrading in the future. Downtown Toronto is where most our buildings are, and we're pretty much full. I think we're going to stay full.
By making special buildings and special opportunities, things we like to think of as like landmark buildings, we think we can get great rents when the economy's good, and we can keep them full when the economy isn't. I think, what's that, Jay? 85% of our value?
Yeah. It's most of it. Within a walking distance.
I just want to go over the other buildings that we have. We've got two buildings in Calgary. One is Kensington House, which is where Dream Unlimited's head office is out west. That is a very interesting part of Calgary. There's currently a building under construction just behind it. The value of the land exceeds the value of the building, and we think that's a great opportunity. We've got Barclay Centre, which was the best building where you combine location and quality. It's got a big parking garage on it, plus two office buildings. It's relatively well leased. I think that that's a building that we'll probably keep, but if there's anybody on the phone that wants to buy it, if it's a good price, we'd sell it. We got a parking garage and three buildings in Saskatoon.
Those ones we're working on, and we hope to sell them over time. We've got a beautiful building in Regina that's got an 18-year lease. I think we're building it to an eight cap. If we put 3.5% debt on for 50%, it's going to be something like a 14 running rate, and there's going to be no capital that's required. We would happily sell that at the price. If we can do better than those kind of returns, we'd sell it. We just did a five-year lease for our loan building in the U.S. That building we would've sold other than the fact that it's part of a CMBS security with a huge penalty if we sell it, but that comes up in September 2021, so we will sell it then. That's everything we own outside of Toronto.
We also own Sussex Centre, which is two blocks south of Square One, where Oxford announced a new city of 30,000 people. There's also a new train station. That building, I think around it is 30 buildings of 60 stories or more for residential. We like that building because there's a lot happening there, and the value's going up. I think we're really seeing increasing rental rates, increasing occupancy, and we think there's a lot that we can do with it. The other building we have in the GTA is 16 acres at Eglinton and Birchmount. We've referred to this many times. It's in the Golden Mile study area. We're working with the city. There's 100 acres there that will be rezoned for residential and mixed use.
On our site, we've got a 165,000 sq ft office building that's quite well leased, and we're expecting to get approval for at least 2,400 apartment units as well. That's going to be a major undertaking. I like it because it's probably 15 buildings. We can do it piecemeal and not take very much risk as we build out the residential on the newest public transportation. That's all of our other category. When we look downtown, we've got 250 Dundas approved, which we're really excited about. That building is really interesting because it's kind of at the nexus of some of the cultural parts of the city, the universities, the government.
It's on the subway. We think it's going to be attractive to a lot of people as an apartment. We think the office space is going to be really valuable as part of the hospital district. 212 King, we're working very aggressively to get ready within the next 60 - 90 days. It will be unveiled publicly as part of our process with the city. We're looking forward to showing it to everybody. It's going to be an exceptional building and one that I think will add a lot of value to our company. I'm pretty pleased that we can talk about our portfolio in a matter of minutes. The last comment I want to make is this one about what our company's worth. As I said earlier, the multiple on higher quality assets is double or triple the multiple on lower quality assets.
Our assets, I think, are among the highest quality commercial assets in any Canadian REIT. It's also very concentrated in Downtown Toronto. What our book value, I'm just giving this to you guys as a suggestion, a way to look at the business. We're at about CAD 570 a sq ft based on our book value. Our book value is basically based on historical precedence. Where we're trading now. At CAD 900 a ft, the stock would be worth CAD 45 a share. At CAD 1,000 a ft, it's CAD 51. At CAD 1,100, it's CAD 57. That's the leverage we have to the underlying market. I would suggest that, as Jay so eloquently speaks about comparative property + 0.00 or - 0.00, it's really missing the point.
The real point is what's Downtown Toronto worth when you've got high-quality income, reasonable growth, and the U.S. Treasuries are trading at 66 x cash flow. The average risk-free rate around the world is probably 1%, it's trading at 100 x cash flow. The question is, if you want to own a significant part of Downtown Toronto, what expected return do you have? I think that we put our money where our mouth is and bought back in excess of 50 million shares from the company. I personally, Dream Unlimited, have bought hundreds of millions of dollars of stock. We don't think the company's overvalued, we're totally open to you all deciding what you think it's worth. Now I'd be happy to answer questions.
Thank you. We'll now begin the question and answer session. If you have a question, please press star one on your telephone keypad. If you'd like to be removed from the queue, please press the pound sign or the hash key. There may be a delay before the first question is announced. If you're on a speakerphone, please pick up your handset first before dialing. Once again, if you have a question, please press star one on your telephone keypad. From Canaccord, we have Mark Rothschild. Please go ahead.
Thanks, good morning, everyone.
Good morning, Mark.
For 250 Dundas and the project on Eglinton, can maybe you just give a little bit more color on the timing of actually getting going further on development and when you'd actually plan on investing more material amounts of money in getting development going?
Great. We would say between 18 and 24 months, we'll get the site plan approval and get our drawings done, construction costs tendered. We'll probably do some of the leasing on the office component. We view that we'd probably start construction between 18 and 24 months. Until then, we don't have to spend a lot of money. On Eglinton, I've mentioned a few times that it's the Golden Mile study area. That means the city is looking at how that land should be used. It's not as if it's just our application. It's all part of how the city works on it. They're probably a year behind where they thought they would be. I think we would expect that within 18 months or so, the overview of that area should be complete. We put an application in for our site.
It will obviously be behind that, we're hoping that we can get some work done with the city at the same time as they're doing the overall plan. I would say we're probably two and a half years away from starting there.
Okay, thanks. With quite a bit of time before you're going to need to invest money in these projects, and with the unit price where it is stock buyback something that would still potentially be considered? Alternatively, are you seeing the opportunity to acquire properties in Downtown Toronto?
Well, that's a great question. The first thing I would say is, we have not made any decision to stop buying back stock. We'll see what the stock does. We'll see how the company goes, but that's a potential use of cash. I mean, we are looking at buying some properties. I don't think people realize how impossible it is to buy Downtown Toronto properties at prices that we're comfortable with unless there's something about the future or strategic how it fits with us. I mean, we're currently looking at a number of properties.
Okay, great. Thanks.
Thanks.
From Desjardins, we have Mike Markidis. Please go ahead.
Thanks for taking my questions. Just on the back of Mark's question on the stock buybacks and no real significant use of capital for the next couple of years. How do you marry the DRIP program with Dream Industrial and buying more stock there versus buying more Dream Office stock? How do you look at that?
I would say that for years we've been saying that Dream Industrial isn't necessarily a strategic investment for us. Most of our shares have a zero cost base, which means every dollar of proceeds is taxable. The only time we participate in an equity issue is one at CAD 8.75. We thought that was a strategic one to get the stock going, and it turns out to have worked out pretty well. I don't see us buying more Dream Industrial. I think we could sell some.
Yeah. Mike, it's Jay. We did identify a number of uses for the cash over the next couple of years. There's obviously the Bay Street redevelopment program. We're finishing up the construction at the 357 Bay and 1900 Sherwood. We're also looking at other opportunities, as Michael mentioned, within the core of the core, to upgrade those assets as well. We're trying to stagger it so we don't have a huge amount of construction ongoing at the same time. The Dream Industrial units, it provided a pretty good return. Over the last couple of years, one of the best performers. It's really nice. Without the need for cash, they were providing a pretty good CapEx free yield from our perspective.
There are some units that we have that we've been collecting through the DRIP that at any time if we needed cash, we could sell a little bit in a pinch. There's a lot of flexibility there, and we're pretty excited.
Yeah
with what they're doing with their business.
Okay. Appreciate that. My question wasn't so much with the long-term intentions were. I was just looking, I think you guys are still subscribed on, it's 100% on the DRIP, correct? On DIR.
Yes.
Right. I guess just given Mark's question on the Dream Office NCIB and re-upping on DIR through the DRIP, just curious how you balance those two.
To be blunt about it, we went into the DRIP to support DIR, so that they had more cash. We stayed on the DRIP. We're happy to. We get it at a discount. I would just say it's an arbitrage. We're getting a premium to the market value, and we don't need the cash. Those shares, as Jay was saying, we'd be happy to sell them. I don't see any reason why we'd come out of the DRIP. It's an easy way to get a bonus, and then we could either keep the stock or sell the stock. It's up to us.
Okay. Fair. Just, Jay, on 250 Dundas, maybe if you could just walk us through your valuation of that asset at December 31st and how that's treated, and now that you've got conditional zoning, how you'll be looking to value that either at the end of Q1 or subsequent to that, as the condition on the zoning approval is lifted?
Sure. As most of you know, we got zoning on January, I believe, the 21st. As of year-end, it was recorded on our books as income properties as that was the highest and best use at the time. We're actually working through both the underwriting of sort of a long-term development as well as engaging a third-party appraiser to value the property. By our Q1 results, we'll have a couple of data points to use to derive the fair value of the asset with the additional density and the development potential.
Okay. Got it. One more question for me, please. On Birchmount and Eglinton, I just noticed that you guys moved it from held for development to other. I guess clearly it's not a Downtown Toronto asset, but does the reclass to other and from future property held for development, does that alter or signal anything with respect to your desire to be a participant in the development long term? It seems up you're pretty bullish, but just curious on the reclass.
Okay. Let me answer. It has nothing to really do with that. Just as you recall, earlier in last year, we had a couple different segments. We had Ottawa and Montreal. There's no buildings there. We had North York and Mississauga. We have half a building left. Given that all the rest of the assets can be summarized fairly quickly by Michael, and also it's only 17%, we just figured for simplicity of our disclosures and reporting and how we look at the business, it's really Downtown Toronto, and then we have the other market. That was really the intent of it, to simplify the disclosures. Longer term, we expect develop on the site. We could do it in phases or all in one. It doesn't really have anything to do with disclosure.
Got it. Okay. Before I turn it back, I'd just say the simplicity of your business and disclosures is a really beautiful thing from our perspective.
Thank you. Appreciate it.
From BMO Capital Markets, we have Jenny Ma. Please go ahead.
Thanks. Good morning.
Morning.
Michael, going to your comments about the value of the stock and looking at it from a per square foot basis, how do you reconcile that with the book value that it's being carried at? Maybe talk about what needs to happen, at least from the IFRS standpoint, to really see a material change in the way you look at it. Is it cap rates and market transactions? Is it just NOI growth? Maybe expand on how you reconcile those two numbers.
I'd start with, I don't need any reconciliation, so I don't spend any time on it. I think that the way that IFRS numbers are calculated are historic and institutionalized, and we have a process, and it is what it is. There's a portion that I believe, which is that the value of high-quality things have changed dramatically from what they were, and they're not reflected. Jay probably has a more technical answer.
Thanks, Michael. I agree with Michael, but we do reconcile it. That's part of my job.
That's your job.
Yeah, sorry. Yeah, that's my job. I'd like to say, in the year, 44% of our assets were externally appraised, whether for financing or valuation purposes, so we have to use those data points for the audit and our quarterly statements. The rest of it, we're pretty transparent in how the assets are valued. Most of them would be under the direct capitalization method. The assumptions I use are, once again, are disclosed, and they are market, actually, if we look at the brokers' reports. Some of those assumptions, yes, it is just basically a reflection point of where things are at in terms of the discount rate, the cap rate, and the market rent. Over time, as rents do go up, the values will go up. I think it's tough to reconcile it versus the price per square foot today.
Okay. Yeah, that's fair. Going on to some of your Downtown Toronto properties, the occupancy rate is pretty high, but there's a handful of buildings where it looks like there is some room to be had. Is that related to just leasing friction, or is that related to some of the redevelopment you're doing along the Bay Street corridor? When can we see those gaps close?
That's a great question. I don't believe there's any space that we have that we couldn't lease if we wanted to. What we decided to do is maybe hold some space off until the adjoining space is available. There's a number of spaces where we think if we combine locations, we could do much better over the long term. I think that pretty much every vacancy is strategic.
Okay. I know you said same-property NOI growth this year from Downtown Toronto would be driven by rent growth. Is this occupancy lift sort of a 2021 event then after you're done with the work you're doing on Bay Street?
Some of them may actually carry out longer term out after this year. Just on that, if you look at the expiry table in the MD&A, less than 5% of the properties roll in 2020. The pickup's not going to be that high this year, but rents are continuing to go up, and these strategic vacates are actually tied to other spaces that are coming up. Most of them are on the ground floor or the retail sections into Downtown Toronto. We have bigger plans for those longer term.
Okay. It looks like you've made very good leasing progress on 2021 so early in the year. I just wanted to get some insight on whether or not that's being driven by tenants who are very keen on keeping their space. Is it just you guys rather taking what's known right now and rolling over the tenants? Who's really driving the renewal of the leasing and the timing?
It's Gord Wadley speaking. That's a great question. It's a lot of people wanting to get ahead of the curve. Rates are growing at such a high rate. We've done some government deals. We've done a number of private sector deals along Bay Street for the people that really covered the value that Michael was talking about and seeing what we're doing in the buildings. We've been able to lock in a lot of deals earlier. Predominantly, it's just people trying to retain their space. We're seeing a lot of year-and-a-half early blend and extend. It's been positive over the course of the last couple quarters.
Yeah, just to jump in, 2021, there is a large tenant that exercised a renewal option. It's the last one. That one's flat. The rest of the ones that we're doing are at market or above.
Okay. Is it fair to say, for the Downtown Toronto tenants, that having access and being able to commit space is more important than the pricing of the space?
I would say yes. Being able to have a well-located address in the downtown core of Toronto is driving a lot of these early decisions, and they're not as price sensitive.
Are they renewing for five, 10-year terms? Are they trying to max that out? How are you guys balancing that with getting?
You just want to hear Gord speak.
They are obviously trying to max out the terms if they can. We're being a lot more pragmatic in how we're approaching these leases. We're looking at them at shorter terms on some for full floors because we really think at the rate that the market is growing right now, we really think over the course of the next two, three, five years, we can capitalize. We've seen such a positive change on renewing tenants on Bay Street Collection expiring at CAD 21 and seeing average growth in the net rent up to about CAD 40. It's not saying that we don't want to do 10-year deals, but we want to be more thoughtful on the deals that we're locking in.
Just a last point on that. We're putting in a lot of capital in Bay Street, so we think that once the work is done, we could probably get a better lift. Some of those spaces, it might be more strategic to do shorter-term holds.
Exactly.
Okay, great. That's good color. Gord, congrats on the promotion and look forward to hearing more from you.
Thank you very much. Appreciate it.
Thanks.
From TD Securities, we have Sam Damiani. Please go ahead.
Thank you and good morning. Just to follow on that, could you just give us an update as to what extent leasing is already starting to reflect the redevelopment of the Bay Street properties? Are the leases being done in that sort of CAD 40 range?
Yes. We're well ahead of the curve, and our asset thesis is working. The important thing to notice is we're getting average net rents over CAD 40 on the expired rents of CAD 21. That also includes the CAM increase for us on recovering some of these improvements. We're still seeing the demand, and we're having a tremendous amount of absorption in these opportunities.
Sam, I think it's a really interesting question because we had a thesis that if we put money into these buildings, we'd get well rewarded for it. We're getting rents now that exceed the rents we planned on for when it's finished. We can't really tell how much of that is based on the fact that they see what we're doing and they see our plans and they're paying us for it, and how much of it is the market. I remember that we did a significant lease, I think it was like 65,000 sq ft on Richmond two years ago. We got an uptick from CAD 21 to CAD 27. Lots of high fives. I think we get more than CAD 40 today, so that was a mistake. We can't really tell.
I stick with the part that our tenants are paying us a lot of rent, and we want them to have a good experience in our buildings.
Would you be willing to share a little bit on the inducement side? How are those sort of structured on a five- or a seven-year lease?
What I would say over the course of the last year, our landlord work costs per square foot are down close to about CAD 10. We're down about 40%-50% on what we're paying. The other thing I'd say is we're paying brokers less, too. A lot of these tenants are trying to do things direct. That cost has gone down. On an NER basis, we've seen our NERs improve by almost CAD 8 a ft, which is up about 35% year-over-year.
I've been doing this a long time, and the market conditions we're having now is really exceptional. We are trying to be conservative and lock down as much space as we can at much higher rents, because who knows what it's like in the future. I do feel as if there's been a lot of changes in Toronto, and we've got higher rents for a lot longer. We're pretty excited about it. We're also appreciative.
Okay, great. Thank you. Maybe back to 250 Dundas. I know there's still work to be done, but you've obviously spent a lot of time and fully intend to proceed on the redevelopment. Is there like an IRR or return on investment that you're sort of hoping or planning for when numbers are finalized, including the sort of demolition of the existing property?
You know what, look, the real issue becomes what do you say your starting value is? It's on our books for CAD 41 million. Pick a number you say it's worth, and I'll tell you the IRR. Generally, at a reasonable value for the density, we should be mid-teens as an IRR from there. Having said that, I think what we're really looking at is we can get Going back to the thesis about things are between 66x and 100 x cash flow for risk-free. Once we build this new building, it will be among the highest quality. It's in a phenomenal location. There'll be almost no CapEx for the first 10 years, which makes it higher and higher quality. What we'll be doing is we'll be building an incredible building and getting it at a discount, including getting a huge profit on the land.
Your IRR number is great if you're getting paid to promote. There's no promote, it's not as important. I would say that, use your own math. If you use, let's say, a 14% or 15% IRR for four years, you end up getting a building a lot cheaper than if you had to buy it. As we said before, it's very hard to buy anything. I know what you're getting at, but use 14 or 15, I would say, off of a decent land value.
Any thoughts that you're willing to share on land value in that location right now?
What's happening now is people are buying land at market, and they're racing to go to market, and most of the time it's condos. For a lot of other people who might have land at CAD 50 or CAD 60 a sq ft, and you say market might be CAD 200 for residential. They're deciding whether they want to build an apartment or a condo, and they're looking at the long-term returns. If you have land at CAD 60 a ft and somebody says market's CAD 200, when you go to the bank, you show CAD 200. I would say when people are going to the banks, they're probably showing 12%, 13% IRRs on average based on fair value for the land. It helps them get the financing. I think a lot of people are trying to do assemblies where they're able to get land less expensive by the time they get approval.
You're asking for a specific question to put in a model. I'd probably say, without pushing the envelope, it's not for sale. We're not going to get 100 bids. I think the residential is probably worth CAD 200 a ft and the commercial maybe CAD 100 a ft, maybe CAD 120.
Thanks. That is helpful. Thank you.
From Scotiabank, we have Mario Saric. Please go ahead.
Hi, good morning. Just maybe on the operational side and specifically focusing on 2021 and the uptick in lease expiries, can you talk about whether there's any chunky leases in that 736 that are set to expire in Downtown Toronto?
Within that number, as I mentioned before from one of Jenny's questions, there's a large tenant that had to exercise their renewal option that was flat, that was around 230,000 sq ft. The rest of it is, there's a pocket, I think at Adelaide Place that was around 46,000. There's another one around 70,000. Otherwise, the rest of it's pretty small. A lot of tenants, as Gord mentioned, are trying to get ahead of sort of the expiry and lockdown certainty. Right now we're working with them. We'll find that we'll probably be able to lease up most of the space six months to a year in advance at the minimum.
Got it. Okay. Assuming no meaningful change in market rents over the next 12 months, is it a fair comment to make that the 2021 same-store NOI growth should be meaningfully above your expectations for 2020?
That's correct. Both on rents and probably, the amount of square footage is a lot higher, so you could do the math on that, yeah.
Okay. Then just maybe shifting gears back to the IFRS valuation, can you just walk us through the methodology in terms of how you reflect value based on in-place rent versus market rent? Like I noted that your estimation of market rent was up about 3.5% quarter-over-quarter, so Q4 versus Q3, and that's consistent with the increase in the reported book value per unit. Can you just kind of walk us through what rent is reflected in the CAD 2,670 today and how you think about showing the mark-to-market opportunity in that number over time?
Sure. Maybe I'll spend some time walking through the valuation methodology. We do it on an asset-to-asset basis. I believe most, if not all of the properties in Downtown Toronto are valued under a direct capitalization method, which you take the stabilized NOI or rent numbers over the cap rates. Keep in mind that we do have to reflect the existing leases in place. You can't cap what we think is market rent on day one because we have to acknowledge that there is existing WALs in each of the buildings. Over time, what happens is we make adjustments for leases that mature over the next, say five to seven years. We also assume inflations in the market rents as well. Over time, depending on the WAL profile of every single building, you realize the pickups, and that's basically the methodology.
Got it. Okay. Just to clarify, at 250 Dundas, the highest and best use as at December 31st, 2019 was office because you had not received the zoning at that time. Is that correct?
That's correct. There's no incremental value in density then.
Got it. Okay. In terms of capital recycling within the Dream entity, Dream Office was inactive during the quarter in terms of the buyback. Dream Unlimited was pretty active. I think it was buying 1.7 million units or so. Can you kind of walk us through how you decide which entity buys units and whether kind of the subsequent unsecured debenture redemption kind of impacted that decision in Q4 for Dream Office?
I actually think that there's not an issue about priorities. I think there's different businesses, different boards, different management teams. I think based on having a 15% or 20% premium to NAV, we kind of felt a little bit intimidated about continuing to buy back the stock. From Dream Unlimited's perspective, we were quite happy to buy the stock. I don't know if you're aware of it, but Dream Unlimited got a bunch of money recently. That was a pretty good use, was to flip it out of Dream Global and into Dream Office, and that's worked out pretty good. I think we're huge believers in Dream Office. In February 2016, we put out an announcement saying we're going to really change the company, and I'm not sure. I think we had some good ideas at the time.
Underlying it, I don't know that we thought it out completely, but what we were doing was we were going to the highest quality assets we had and shunning all the rest. We just keep buying it back. I think that if I would be critical, I would say we probably should have continued buying back stock in Dream Office, but we got a little bit gun-shy because we started at CAD 15. Around CAD 31, we started thinking, like, wow. It's shareholders' money. Are you sure? I think that we're open-minded to buy in the future. We'll see where it goes. The stock's been on a bit of a tear in the last 72 hours.
Yeah. The CAD 15 seems like a lifetime ago, that's for sure. Last question, just on ESG. I appreciated some of the disclosure and some of the things that you've done, especially on the energy side over the past several years. Can you maybe quantify or help quantify the impact on your gross rent per square foot in terms of the savings that you've achieved from your energy initiatives and what that might look like going forward in terms of benefits to the tenants?
Sure. Just as a background, ESG has been more of a focal point for investors. We've been doing it a long time. Not to sort of make checklists, but we thought it was the right thing to do, and it provided economic benefit. It's interesting to note, for the first time in 2020, within our management goals, we have a ESG section. There's a number of them with regards to building efficiencies. Two of them is, we're targeting water and energy consumption reduction of 2.5%. There's a couple initiatives. It's kind of hard to quantify a blended per square feet reduction on operating costs. One example with one of our largest assets, Adelaide Place, we reduced the utilities by almost 20%, and that had an impact about a quarter to CAD 0.50 per sq ft on additional rents just on that initiative.
What happens is all the tenants in the building, they're expecting to get a refund at the year-end adjustment. We're keeping our tenants happy, we're helping the environment, and it just creates more room on the additional rent. We could look at various capital initiatives that can improve the look and experience of the building, but at the same time, really optimize how we look at energy.
Got it. Yeah. No, it sounds like a win-win. Sorry, one more question for you, Jay. In your CAD 1.60 guidance on FFO for 2020, how much lease termination income is reflected in that, if any?
Well, we do not forecast lease termination income.
Okay. Thank you.
From RBC Capital Markets, we have Pammi Bir. Please go ahead.
Thanks, good morning. Michael, you mentioned it's tough to buy. You are looking at a number of properties. Can you maybe just comment on that disconnect and maybe the types of sellers that are out there?
The buyers are more interesting. The sellers are people who own properties, and they're being offered prices beyond anything they ever dreamt of. That's why they would sell. What's interesting is the buyers are everybody. I would say one area is extremely high net worth individuals who have a strong cash flow from other businesses are looking to buy real estate because it seems a lot better than a treasury bill. There's pension funds that want more. If you think about Downtown Toronto, you look at OMERS and Cadillac and a few others Allied Properties REIT, there's really not that many people who own Downtown Toronto, there's a lot more people that would like to. You've got private equity, you've got pension funds. I would say that it's interesting is just how much ultra high net worth money is looking for Downtown Toronto.
Got it. Just your comments on that, I guess the number of properties, or you've got a lot under review. What sort of volume are you looking at?
Well, it's all small. If we find a 40,000 sq ft building or a 60,000 sq ft building, that would be great.
Okay. Just the comments on rents going higher for longer, just what's your sense of perhaps, from your perspective, when that momentum may start to slow, and perhaps how new supply may factor into that?
We're living in a time of unprecedented demand for everything in Downtown Toronto, meaning office space or residences and stuff. I have no idea when it changes. I just look at the companies, and I've been really quite pleased that the increase in rental rate really hasn't changed people's behavior. We don't see them reducing their space. We don't see them moving to the suburbs, anything. More and more people are coming downtown. It looks to me like it's healthy, and companies can operate with CAD 40, CAD 45, and CAD 50 rents. I don't know if we've peaked and it flattens out, like we gapped up, or if it grows at 3% a year from here, I have no idea. I don't see anything that looks like it's going to be difficult on the rents. I think the new buildings are getting exceptional rents.
I mentioned before, there's not that many landlords in Downtown Toronto. They're all well-capitalized. The guys who are building new buildings are getting tremendous rents, and I don't think that that's hurting us in any way. If anything, I think it's helping at this point. I'm not concerned about them, maybe to a certain extent, the space that they're giving up, but I think it's really quite surprising how much space is being leased and nothing's been given up.
Right. Just last one for me. I apologize if this was somewhat asked earlier, at 250 Dundas, can you just provide some color on the range of costs for that project? It might be a bit early, just trying to get a sense there. Whether this is something that Dream would undertake on its own.
Easy to answer the second question. Yes. We will do it ourselves. I think there was some comment about 2,200. As I said, we're going to do that ourselves. We're not looking for partners. The first question is how much does it cost? A lot. We're probably looking at, generally, I think it might cost CAD 800 a ft all in at fair value, but that would probably be including CAD 200 a ft for land. CAD 600 for soft cost construction, TIs, everything, including residential or maybe office. Office might be a bit cheaper. Jay, you have a comment?
Yeah. We're actually, lastly, I think we were talking to various construction managers trying to get a plan going on there. I think you're probably in the right ballpark. It really depends on when this is built, what construction costs are at that time. I would use Michael's numbers as a rough guide.
Sorry, did you indicate at what point you might actually start construction on that?
Yeah. We think that we'll be in a position to start construction within 18-24 months.
Okay. Got it. Thanks very much.
Thank you.
We have no questions at this time. We'll turn it back to Mr. Michael Cooper for closing remarks.
We're exhausted. Thank you all for your interest. Feel free to follow up, and we look forward to seeing you or speaking to you next time. Thank you.
Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for joining. You may now disconnect.