Earnings Call: Q2 2018

Aug 9, 2018

Good afternoon, ladies and gentlemen. Welcome to the Dream Office REIT Second Quarter 20 18 Conference Call for Thursday, August 9, 2018. During this call, management of Dream Office REIT may make statements 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 and A. These filings are also available on Dream Office REIT's website at www.dreamofficereit. Ca. Ca. Later in the presentation, we will have a question and answer session. Your host for today will be Mr. Michael Cooper, Chair and CEO of Dream Office REIT. Mr. Cooper, please go ahead. Thank you. Good afternoon and welcome to our Q2 conference call. I'm here with Rajiv who will address our financial and operating results in a moment. A couple of years ago, we realized that by July of 2018, our Alberta office properties would have negative cash flow before debt service and we would be obligated to pay distributions based on the sort of perceived equity. And we knew this was going to be a difficult situation. In addition to that, we had a number of large tenants move to newer buildings like LoyaltyOne, Aviva, Borner, Ladner, Gervais. In Alberta, we lost Enbridge, TELUS and the City of Edmonton and the National Energy Board. So we realized that 2018 was going to be a very tough year. With that in mind, we formed a plan to concentrate our business only on our irreplaceable assets and reduce the overall size of our business by shedding the assets that we did not think we could manage to be better in the future than they had been in the past. We've made considerable progress. Through the last couple of years' comments, I've identified January 1, 2019 at the time we would like to use to measure our business to determine long term value, just because leading up to then and especially 2018 is such a transitional time. I'm pleased with the progress we've made over the last few years. We have sold enough assets that could hurt us and used a substantial portion of the proceeds to pay down debt. Another portion of the proceeds have been used to reduce units outstanding so that our results on a per unit basis are reasonable. Going forward, we believe that we can drive the value of our core Downtown Toronto assets by leading in the creation of boutique office buildings. These combined customized customer service for smaller organizations, building up communities and our assets and capital upgrades which will help us not just participate in the current Voyant rental market, but actually exceed market rents. We are aspirational about what we can achieve in our 19 downtown Toronto buildings, which we believe will create irreplaceable properties. We're seeing progress currently with increased customer satisfaction, our increased retention levels and increased rents. Over the next year, we will have a much more to show how we are participating and outperform the Downtown Toronto metrics. We're continuing to achieve sales on our non core assets and expect the sales to ramp up in the second half of the year. Over the last two and half years, we've drastically transformed our portfolio. Going forward, we'll continue to refine our assets to provide what we believe will be the long term portfolio where we see opportunities to continually increase quality, grow cash flow and value. Going into 2019, we will continue to own some non core assets that require more time leasing or capital prior to being sold. As we get smaller, we'll also be looking at some of our non Toronto assets to see if they can contribute in cash flow and growth beyond the average in our portfolio, portfolio thereby making our business better. We believe that this is all part of normal operations. We refer to the potential for redevelopment and intensification over the last few quarters. Last quarter, we announced that we submitted a development plan for 250 Dundas Street West that will replace the office the existing office space and add a residential tower. In addition, we recently submitted an official plan amendment to redevelop 2,200 Edmonton other than where the existing office building is now. For background, this is a building occupied by Aviva up until last year. It was on our books for $41,000,000 We recently entered into a 95,000 square foot long term lease that will help pay all of the holding costs on the site. We are hoping to work with the city so that we can build residential on the balance of the site. If we are successful, the land and office building will substantially will be substantially more valued than our IFRS value. And in addition to the zoning, if we develop the asset ourselves and capture development profit, it will be even more valuable to the REIT. In order to add value to one of our assets in Regina, we've entered into a favorable long term lease that will add value to the building as we intensify and modernize the building to meet the needs of the lease. Would Gee can you provide an update on our financial and operating performance? Sure, Michael, and good afternoon, everyone. Our NAV is up roughly $0.15 to just under $24 a unit in Q2 2018 as a result of retained cash flow after paying distributions with valuations flat quarter over quarter. On the quarters, we generally perform a valuation review on each property and make adjustments for material known items, Given we just had appraisals done for most of the portfolio last December, we will do a more fulsome valuation update for the upcoming year end. Our Q2 FFO per unit was in line with our expectation of $0.40 a unit, down $0.06 from Q1 as the prior quarter benefited from about $0.07 per unit of lease termination fees related to the Bell Canada Lease 7 100 DLG. With 100 and 85,000 square feet of former Bell Canada space, 98,000 square feet has been leased and the remaining 87,000 square feet is being actively marketed. Excluding one time items, FFO per unit was largely flat quarter over quarter. Looking ahead, we are expecting our FFO per unit to be flat in Q3 relative to Q2 with a lower average offsetting modest NOI declines driven by occupancy and rental rate decreases in Calgary and our non core markets. However, improved results in Q4 as a 200,000 square foot government lease commences at 438 University. We also wanted to give a bit of color on how we think of our key markets and really how we think about the business internally. During the quarter, net rents for renewals were 11% above expiring rents and we see more upside in the near term as market rents are 14% higher than our contracted rents. As discussed earlier, NOI will start to recover by the Q4 of this year once the 4th 30 8 university deal with the government commences in December and we forecast the positive trend in Toronto continuing for a prolonged period. For those of you whom attended our AGM in May, we also showed several ways we are looking at investing capital in our buildings and we see this as a way to drive outsized returns. Saskatchewan included in our non core market segment and Calgary are tough office markets, representing about 15% of our total assets. As previously communicated, we are looking to sell most of our properties in Regina and Saskatoon with us opportunistically looking at further sales in Calgary. While the operating results for Saskatchewan and Calgary remain challenged, we believe the carrying values for our assets there are reflective of the market conditions, so continue to believe NAV is the most capital and resources in Toronto and the GTA, the results from our capital and resources in Toronto and the GTA, the results from our stronger assets will naturally be the primary driver of long term value. Consequently, when we think about markets like Saskatchewan and Calgary, which continue to weigh negatively on our operating results, these pose neither an opportunity nor threat to the business. In the quarter, we also moved 2 additional properties out of our comparative property portfolio into properties held for redevelopment, namely 1900 Sherwood Place in Regina and 357 Bay in Toronto. At 1900 Sherwood, we secured an 18 year lease with cooperators for 100 and 14,000 square feet or just under 2 thirds of the building's GLA commencing 2021, which requires a significant upgrade and expansion to the building, including both the interior and exterior as we reposition the property for the tenant. We are pleased to have secured one of the top tenants in Regina, which is indicative of our creative asset management strategies to maximize value. At 357 Bay, we gave our tenants notice to vacate last week, are in advanced stages of a lease deal for the entire building. From a balance sheet standpoint, in Q2, we closed on the $240,000,000 SIB in May, which allows future growth in NAV to have a more meaningful impact on a per unit basis. We also repaid the $141,000,000 with our credit facility, leaving ample liquidity of over $200,000,000 Our leverage in Q2 stands at 48%, up from 41% in Q1 as a result of the SIB and we expect our leverage metrics to decline over time as we execute on further dispositions. And I'll now turn it back over to Michael. Thank you, Rajeev. We'd be happy to answer any questions if anyone in the line has any. My mic is not working. Say your pardon? Pardon me. Can you hear me at this time? Yes, we can. Sorry about that. Thank And our first question is from Mike Markidis of Desjardins. Please go ahead. Hey, guys. Sherwood Place, is that building vacant today? It's about 40% leased. 40%. Okay. And do you expect those tenants will vacate while you do the intensification upgrade? Or do you expect to maintain them? We expect to maintain them. They have about a 5 year walk on them. 5 year. Okay. And is it too early to quantify the amount of capital required for collaboration? Let me I can talk a little bit about the lease deal. It's the economics are sort of in the low teens from an NER perspective and we got to put about $10,000,000 to $12,000,000 of what I'd call sort of value add capital in there, which is expanding the Parkade additional GLA and so on and so forth. So hopefully that gives you the rough deal economics. Okay. Just one other thing I'd say is, the way I sort of think about Sherwood Place in our numbers is we've baked sort of that value into our carrying value today. So, we're carrying it effectively on our books today inclusive of that lease. You are. Okay. That's helpful. Thanks. And then 357 Bay, it sounds like you're pretty confident of locking down the lease for the entire building, given that you gave notice to the other tenants. Does that with one tenant taking that entire building, does that kind of jive with the boutique office concept? Or should we be thinking about something a little bit different? It totally jives. It totally does. Okay. No, I wasn't sure. I don't know. I don't know. I've never seen the building jive. You know what, it's a little bit too early to talk about the use. I think if you saw the use, it would make perfect sense. But I think by next quarter, we'll be in a position to provide full insight. Okay. And Rajeev, just sort of with your comment on Sherwood Place being that lease being reflected on the books, 357 Bay would securing that lease have any upside in terms of the carrying value of the asset? Yes, it would. So we're carrying it sort of as a let's call it as an office building relative to what we carried it back in at year end. We've been sort of working through the framework on a deal. So there's probably some upside relative to what we're carrying. The carrying value we have now is the same as if it was empty. And with the work that we're going to do, we're going to end up with an incredible building. That value will be much higher than the current IFRS value plus the money we're putting in. Okay. And possible to talk about capital requirement there or still need to nail down the lease? Yes. We're probably going to put another $15,000,000 into the building. $15,000,000, 1.5? $15,000,000 Okay. Excellent. Last question for me before I turn it back. Just on the sales, you suggest it's going to ramp again in 2H 2018. I think it was $200,000,000 under contract and negotiations. Does that figure include 700 DLG? So what I said ramped up what I meant was I think we closed $110,000,000 in the 1st 6 months. We'll definitely do a lot more than that in the second half. It's the first comment. The second comment is, if we do sell 700 to La G, it wouldn't be included in the numbers we talked about. In the numbers we talked about, you're talking about the 200 or Yes, it's not in the 200. It's not in the 200. Okay, Great. And has that been listed? There was an article. I'm sure you saw it a bit more. Yes. We take it to market to see if this is the right time to do it and we'll see whether we can sell it or not. Okay. That's helpful. Thanks very much. I'll turn it back. Thank you. Our next question is from Sam Damiani of TD Securities. Please go ahead. Thanks and good afternoon. Michael, I hope that's not too bad of a cold I'm hearing there. I don't know what it is. It started at 2 o'clock. Yes, it started at 2. Every time we talk. So just to finish off on 357, is the proposed new tenant, is that going to be an office use or is the use going to change to some other use? Yes. I'd rather wait until the Q3 and talk about it. Okay. We're all as you can tell, we're all very curious. We saw a rendering at the annual meeting. Fair to say, I think you said at the time that was just a sort of an example of something possible, not necessarily what was planned? That rendering was actually originally Dream had looked into moving into that office for I'd take the whole building. And that rendering was an idea for our own use. And it had a cloud on top of the building considering our logo. So we're not doing that, but we might do something else that's quite interesting. Great. All right. Looking forward to that. With these dispositions planned in the second half and I guess beyond, what would be the primary Any thought of doing another substantial issue a bit with a few $100,000,000 more of proceeds of dispose? No, no. Look, we went from 113,000,000 down to 65,000,000. I suspect we'll continue to be somewhat active under the normal course issuer bid. But I think we've really got the size of the company on the equity where we want it. And at this point, we kind of did a substantial issuer bid ahead of getting the proceeds from dispositions. So we'll bring down the debt. Okay. You say you're confident about the Toronto market, can't remember the word you used, but for a very long time. What gives you that, I guess, that confidence today longer term? I think the growth I think Toronto is getting more and more market share. Downtown is getting more market share for the whole GTA and Toronto getting more market share here for the whole country. So I think that that trend is likely to continue. There's new buildings coming, but they're a fair ways off. So I think we have a good few years. And I think the product that we're working on is going to be pretty unique. Is that a good answer like complete? Yes. No, that's fair. So you do recognize there is some supply coming several years down the road, but it's sort of a good runway at least for the foreseeable future. There is a runway for the foreseeable future. Plus I think what we're trying to do is develop a product that tenants value very highly. And we sort of our customer would choose that rather than one of the new buildings or something like that. So hopefully, we're going to have some loyalty from our tenants. Right. Okay. That's great. I will turn it back. Thank you. Thank you. Thank you. Our next question is from Mark Rothschild from Canaccord. Please go ahead. Thanks. Good afternoon, guys. Good Maybe just following up on your comments to Sam, if you were to sell the property in Montreal, and I'm sure there will be good interest, you can pay down debt, your leverage is reasonable now. To what extent are there opportunities to actually acquire properties in downtown Toronto? It looks like you're pretty much out of the suburbs. Is there something is there stuff available that trades that you would be interested in? What type of cap rates would there be? And I guess on that point, are there any other markets besides for a downtown sponsor that you would consider buying? Last quarter, I would have said, nope, you can't find anything. I think that if we do a good job of what we're trying to do, our hope would be that we would be able to add value to other buildings. So I don't think there's a lot, but there might be some smaller buildings that we could buy. But I don't think it's going to be material in the short term. And are there markets outside of Toronto that you would look to consider buying? I don't think so. I mean, I'm hesitant because you never know what happens in the future. But I'm certainly not looking at any markets across the country that we'd want to put more money in. Okay, great. Thanks. That's it for me. Thanks. Thank you. We have no further questions at this time. I will now turn the call back over to Mr. Michael Cooper for closing remarks. I appreciate everybody's time. Please feel free to call Rajeev or me if you have any follow ups. Thank you very much. Thank you. And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.