Good morning, ladies and gentlemen. Welcome to Dream Office REIT First Quarter 2018 Earnings Call for Friday, May 11, 2018. 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. Late 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. I'd like to thank everybody for participating. We're in that awkward time where we have first-quarter results and the annual meeting. This year, what we're doing is we're having the annual meeting for all of our companies next Thursday. I think it's going to be a great day. I think we're going to have a lot of information. The purpose of today's call, we're going to try to keep to updating on the financial statements and answering your questions because we want to make sure that next Thursday is a great day, where we're going to talk a lot about what we're going to do with the business. With that, I'm just going to turn it over to Rajeev, and then afterwards, we're happy to answer your questions.
Thanks, Michael. Good morning, everyone. Our NAV per unit is up 7.5% year-over-year and just under CAD 24 a unit at the end of Q1, in line with our SIB and recently where we traded at yesterday. With valuations flat in the quarter, given most of our office properties were recently appraised at year-end, the NAV uplift in the quarter was really driven by retained cash flow and our share of income from our 26% interest in Dream Industrial REIT, which recorded significant fair value gains from its Ontario and Quebec portfolios during the quarter.
Our FFO per unit in the quarter also benefited by about CAD 0.07 from what I disclosed on the last call about lease termination fees at 700 DLG, which would otherwise have been down about CAD 0.01 versus Q4, driven by NOI declines from known vacates in our non-core markets and about 11,000 sq ft of tenant defaults in Toronto. Our comparative NOIs were down about 1.1% quarter-over-quarter, excluding some of those known vacates and those defaults, NOI growth would have been slightly positive. Despite the short-term cash flow reduction, the defaults really provide us an opportunity to improve covenant, rate, and term. We've already addressed over half of the 11,000 sq ft of tenant defaults in the quarter at rents 16% higher than what was previously paid, with the remainder set aside for a retail repositioning at Adelaide Place.
We believe Adelaide Place is an excellent example for quality retail tenants that will complement the asset's revitalization strategy. After excluding the significant lease termination fees during the quarter, our FFO per unit is expected to be relatively flat next quarter, with the previously mentioned vacancy of Bell at 700 DLG offset by a lower unit count. This week, we closed on our CAD 240 million SIB, shrinking the float from 75 to 65 million units, providing for future growth in NAV to have a greater positive impact on a per-unit basis. Following the SIB, our pro forma leverage is temporarily at 48%, which will reduce as capital from future dispositions is used to reduce debt. With the recent amendments to our operating lines, where we have increased availability and term, we have over CAD 400 million of available liquidity today.
Which is more than sufficient to repay the CAD 140 million of unsecured debentures maturing this June. Our operating performance continues to be muted by our weaker assets and major vacancies, with 2019 being the year we see operating performance stabilizing and improving. Toronto and the GTA comprise almost 70% of our property value today and will become an increasingly significant contributor to our results over the upcoming quarters as we continue to execute on dispositions, concentrating our capital in Toronto and reducing our exposure to other markets. Toronto represents the bulk of where we are spending our time and effort, as strong office demand provides us the confidence to focus our human and investment capital to drive long-term value. With that, I'll turn it back over to Michael.
Thank you, Rajeev At this time, we'd be happy to answer any of your questions.
Thank you. We will now begin the question and answer session. If you have a question, please press star then one on your touch-tone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. There will be a delay before the first question is announced. If you're on a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press star then one on your touch-tone phone. Our first question comes from Sam Damiani from TD Securities.
Thanks. Good morning, Michael. Good morning, Rajeev.
Morning.
Just on the balance sheet. With leverage now 48%, obviously it's going to go down, but longer term, as more capital gets invested into developments, where do you see leverage comfortably sitting a year or two from now?
It's a great question. I think there's two parts to it. As we sell more assets, we'll bring it back down, most likely to around 40%. On the development side, that's a couple of years out. I think there what happens is we have enough equity in any of the properties we develop. We don't need any more money. We can borrow money on a cost-complete basis to finish the project. The question becomes how much value creation is there? If we've got a property like 250 Dundas, that's CAD 40 million. I'm making this up. Let's say we borrow another CAD 160 million. That'll add a lot of debt, but if the underlying value goes to CAD 100 million, then the debt might go up by 150 or 200 basis points. A lot of it has to do with how much value creation there is.
The development is going to be relatively slow, so I don't think it's going to be a significant amount.
That makes sense. I understand that. Just for 2019, the numbers have been moving around a lot, obviously, the last couple of years. For 2019, we're kind of counting on more of a steady state. Just in terms of forecasting there, just what leverage, what sort of net disposition activity should we expect for the balance of this year, I guess, if there's any guidance you can give there?
Yeah. We'd expect to be down about 300 basis points or so, maybe 44% after we deal with our dispositions.
I agree. Okay.
Sure.
Second question. I may be touching on stuff maybe you want to save for next week, but when you look at the project at 250 Dundas West and future projects like it, how do you think about return on capital, and how much do you take into account the property's current value in its current state?
Okay.
What sort of return are you expecting over a five-year period if you started the demolishment and a redevelopment today?
Yeah. Look, I think that a lot of things are moving in the market right now. Planning is really unpredictable. Residential rental is probably worth somewhere between CAD 150 and CAD 200 a foot. That's what the density's worth. I would look at it based on what our IFRS value is today, what the valuation becomes when you achieve your zoning, and then how much increase do you get executing on it. Yes, we include full land cost, full market value of what we have now. That's the reason why we've been getting the share count down, is so that we can divide that gain by a smaller amount of shares. In that one, I don't know, it's about 500,000 sq ft, 130,000 of it is commercial. Commercial might be worth, what, CAD 100 a foot?
Yeah.
You got 100, that's CAD 13 million. You got another something like 370,000 at CAD 150 would be another CAD 55 million. You get to about CAD 70 million. Just the zoning will take you from CAD 40 million to CAD 70 million.
just to be clear, your intention-
we're all-
Sorry.
Beg your pardon?
Go ahead.
Everything is net asset value. That's what the return that we look at is.
Okay. That makes sense, and that answers the question. Just to be clear here, the plan is with this one and future projects is to make the application, get the zoning approvals, and actually execute on the redevelopment, as opposed to just sort of selling the rights.
100%. No, we don't consider that.
Okay. I don't want to hog the puck, I'll just ask one more. Obviously, the staff at Dream Unlimited has been involved in 250 with the application and everything. How are the economics going to be shared? What's the arrangement with this and future projects with Dream Unlimited?
We're working on that. In fact, we're kind of specializing between the companies. Effectively, 100% of the profit from any development of Dream Office's properties will go to Dream Office. The profit won't be split. Dream Office will get 100% of the profit.
Okay. Thank you.
Once again, if you have a question, please press star then one on your touchtone phone.
I guess Sam wasn't hogging the puck.
We have Sam Damiani.
Hey, Sam.
Hello again.
Hey. What's up?
It's just us. We can have a private call if you want. You spoke about, obviously, the value from the excess density. Does your IFRS right now include any component on any property for any value over and above the existing improved properties?
Yeah, Sam. It's Rajeev. No. Everything right now is valued basically using an income methodology as an office use.
What would be the rules under IFRS for when such value could be rolled into the balance sheet? For example, [250 CP].
Yeah. Look, I think we're sort of thinking through that stuff.
Yeah.
Yeah. I'd say probably the nearest opportunity we have to do that would really be if we got an application approved.
Right.
That's probably a trigger event for us.
Right. Yeah. That's, I guess, what, a year away or whatever?
I suspect it's longer.
Longer? Yeah. Okay.
Yeah. I would have estimated two years.
Right. Okay. Eglinton and Birchmount, you've done a temporary lease there. I don't know how long it is.
No. That's a 15-year lease. That's a long-term lease.
Oh, okay. 15-year lease. Okay. That sort of suggests that either that project has kind of been shelved for now, or there's a portion of the site that you still want to develop in the near term.
No. What happened is, the city requires that if you have an employment site and then you do residential, you keep a significant, a substantial amount of commercial. In any event, we would be required to have commercial space. The main building there is what was leased, and that would stay through development. What's important about this one is, this is in that Golden Mile Secondary Plan.
Yep.
The other owners are KingSett, Choice, SmartCentres, RioCan, and us. There's a 15-acre site. The commercial will probably be on an acre or so, and we're going to start our planning on that one probably this summer. We'll be looking for a lot of density, and what's great about that lease, the reason why I like Andrew Real so much is that lease means there's no cash required on that site, we can go about planning for the best outcome with no cash drawn. As we get that stuff rezoned and get underway, it'll be a good benefit to the company without having to have I guess we were looking at something in excess of CAD 2 million of losses every year it took us.
Yeah.
That lease is a real great strategic thing because the light rail trans is opening in about 18 to 24 months.
Yep.
It's dropping right at Birchmount, and I suspect we're sort of right in line to know what we're doing when it opens and get the full benefit of having public transportation right there.
Okay. Maybe just on Adelaide Place, not overly material in the grand scheme of the whole company, but you talked about a revitalization of the retail. I wonder if you could give a little more color as to what you envision there.
Look, we're going to try to do more to animate all of our buildings, particularly in Downtown Toronto. There's a lot of space in Adelaide Place that isn't used. It's a very prominent location. We're rethinking the whole ground floor now. We're working on a number of ideas that are kind of battling for pole position. We'll show you when we got it. I think we could have extra space there. I think we can generate a lot more revenue and create a space that our customers are quite comfortable in.
Okay. I'll bring it back and see if there's someone else on the line.
Otherwise, I'll call you after this.
Okay.
Our next question comes from Matt Kornack from National Bank Financial.
Good morning, guys. I didn't want to leave Sam all alone.
I was going to say, it's not Sam.
Although he'll probably come on after me.
Yeah
serious. Just quickly, in terms of the bridge to get to the turnaround on NOI, it sounds like the big positive is Q4 when you have your University Ave. lease come on. Are you expecting sort of a negative quarter into Q2 and then a turnaround in 2018 on just rent steps, et cetera?
That's right. Yeah, Matt, you got it right. 700 DLG impacting Q2, really Q4 is when you got the IO lease at 438 University coming online.
Okay. Then I saw, and you're probably happy with this, but the First Tower's no longer part of the portfolio. Just wondering, do you see further sales in Calgary at this point? It looks like you've got term on a lot of the existing ones, so you can probably stay there for a while. Also, have you seen any improvement in the leasing environment there as oil ticks up? I know it's still early days, but any sense on that?
The call was going so well, Matt. You are right. There was no tear shed when First Tower was sold. I don't know. I don't think Calgary's going that well, but I think oil's up. And I think you could see some further sales, but we haven't made up our minds.
Okay. Fair enough. Last question from me with regards to the balance sheet. You've got credit facility availability. Do you anticipate the divestitures being used to repay your unsecured debenture that matures, or will it be drawn on the credit facility in the near term and then followed up, paid down with those sales?
Yeah, I sort of look at it a little bit fungible, right? Depending on timing of dispositions, right now we're drawing on the lines. For the credit facility at this juncture, that would be the primary source of paying off the June CAD 140 million. It's a debt for debt, right? Dispositions will pay back the credit facility over time.
I guess one quick follow-up on that then. The dispositions, is it still the non-core markets that you'd be potentially looking to? And you spoke to your Dundas Street property. Would you at some point get the zoning and sell those types of buildings, or what's the view there?
Firstly, we have properties that we're working on now that are our non-core properties. They're part of our ongoing plan. Our board told us to never call it a strategic plan again. It's not that. We're continuing with that, and then we'll use that to pay down debt. With regards to the development properties, I think that our view is, the real upside is to actually do those development ourselves and get the development profit plus the rents and income once they're complete.
Okay, fair enough. Thanks, guys.
Thanks.
Our following question comes from Mike Markidis from Desjardins.
Hi. Thanks, everybody. Good morning. Again, not trying to steal thunder from next week's AGM.
There's lots of thunder.
Lots of thunder.
We're going to bring the thunder Thursday.
All right, great. Thunder Thursday. That sounds good. Sounds like a NASCAR event. With respect to the sequencing, I mean, 250 Dundas application's been submitted. It sounds like you're preliminarily planning on Birchmount, or that will start soon. Would that be the next big one in terms of a potential application being submitted, or is there anything else that might come before that?
What we're really focused on now is we want to get the application in on 250 Dundas for some specific planning reasons when we got it in, so that was a rush. On Eglinton and Birchmount, it's got some different planning issues and opportunities, so there's no rush on that, but we will get to it this summer. We are working on, which will take even longer, 212 King with our neighbor. We're looking at how to build something really special there, because that's an insane site. The other one is 357 Bay, where we're looking at doing an intense redevelopment of it, but keeping the skin, keeping the whole building the way it is on the exterior. I think that within the next three to six months, we'll have details on what we're doing there.
Those are the four buildings that we're really focused on.
Okay. Do you see yourselves, I mean, it sounds like you're not going to sell any of the air rights on the potential intensification. Do you guys see yourselves bringing in any partners to affect the redevelopments or intensifications on the sites?
I don't think so. It's an odd question in that we have no intention at this point to doing it. One of the great things about Dream Unlimited doing CAD 500 million of development a year for the last 20 years or something, we have a lot of the skills. I don't think we would bring a partner in because they can develop it. I told you, 212 King, we would partner on that one only because we need the neighbor's land. They need ours. That one is a really strategic reason. Other than that, I think our plan at this point is to develop on our own.
Okay. Last one, and this might be a little bit more of a boring question for Michael, but Rajeev.
Don't worry. I'm on my iPhone now.
As you start to invest capital and the preliminary capital in the pre-planning stages and the development submissions, are you capitalizing interest at this juncture, number one? Apologies because I haven't had a chance to dig through the MD&A yet. Secondly, are you seeing yourself putting together some sort of property under development disclosure to help people in your MD&A going forward?
Yeah. First question, interest, no, we haven't capitalized a penny as yet. The second, yes, we need to think through how we're going to, let's call it enhance our MD&A to give that disclosure. We haven't done anything yet. Stay tuned.
Okay. That's it for me. Thanks very much.
Thank you.
Our following question comes from Mario Saric from Scotiabank.
Hi, good morning.
Good morning. How are you?
I'm good. Maybe just one quick question for Rajeev. You talked about kind of pro forma leverage on a debt-to-fair value basis. After the CAD 200 million of assets are sold, what would the pro forma debt to EBITDA be?
Yeah. Assume 50% leverage on that. I don't know. Say 45%.
Say 45% LTV on the CAD 200 million?
I said on the CAD 200 million, assume 50%, so you get CAD 100 million of capital. I haven't done the math, but assume 50% loan to value on the CAD 200 million.
Okay. Maybe, this may come out on Thursday, but just when I sit back and think big picture, you've done a very good job of transforming the company over the past two years. The market has reflected that. You sold a big part of the company. You really shrunk the size of the company, really focusing on core assets with long-term growth potential. You're focusing a bit more on development. There isn't a ton of leasing risk in the story over the next couple of years. The development, while the process takes a long time, really is kind of two, three years onwards in terms of execution on the construction side. For Michael, how do you spend your time with Dream Office in the next couple of years? Where do you focus your time?
Come to Thunder Thursday. Honestly, on Thursday, we're going to talk a lot about how we're looking at our assets. Rajeev gets this call. He will not be speaking at the annual meeting. It's all going to be about qualitative things. I think we'll show you the kind of stuff we plan on doing to our buildings.
Okay. I'll be there on Thursday.
Okay.
Thank you.
Thank you, Mario.
We have no further questions at this time. I'd like to turn the call over to Mr. Cooper for final remarks.
Thanks, everybody. I think that it's a pleasure to have a new name for our annual meeting day, and I hope you guys will all come by. We have five companies reporting. It's going to be a real chance to get to know our whole business. Thank you.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.