Good morning, ladies and gentlemen, and welcome to the Dream Industrial REIT second quarter 2019 conference call for Wednesday, August 7, 2019. During this call, management of Dream Industrial 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 Industrial 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 Industrial REIT's filings with the securities regulators, including its latest annual information form and MD&A. These filings are also available on Dream Industrial REIT's website at www.dreamindustrialreit.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. Brian Pauls, CEO of Dream Industrial REIT. Mr. Pauls, please go ahead.
Good morning, everyone. Thank you for joining us today for the Dream Industrial REIT conference call, which is for the three and six months ended June 30, 2019. Speaking with me today is Lenis Quan, the Chief Financial Officer of the REIT. On today's conference call, I will start off with a brief overview of our strategic growth initiatives, followed by an update on our markets and operating results. Lenis will provide our financial highlights. We'll then be happy to field your questions. We continue to make significant progress in enhancing the quality of our portfolio. Year to date, we have acquired approximately CAD 350 million of assets in strong industrial markets and have added 4.3 million sq ft to our portfolio.
We have increased our footprint in existing markets such as the GTA, Ottawa, and Columbus, as well as added other strategic U.S. markets through our acquisition of the Midwest U.S. portfolio earlier this year. Last week, on July 31st, we completed the sale of our Eastern Canada portfolio, a significant milestone for the trust. Over the past two years, we have increased occupancy by 470 basis points in the East, which resulted in strong comparative properties NOI growth of 11% in 2018. Following the stabilization of our assets in the East, we felt this was an attractive opportunity to recycle capital out of that market and add scale in our core markets that offer stronger future cash flow and NAV growth potential. We continue to focus on improving portfolio quality and making our business safer, more valuable, and more flexible.
We continue to target investment properties that deliver above-average cash flow and net asset value growth over time. We currently have approximately CAD 300 million of assets in our pipeline and are focused on redeploying the capital from our Eastern Canada region, primarily in Canada. We've made our business safer by lowering our leverage and improving our liquidity. We're targeting leverage in the high 30s to low 40s range over the long term, which balances our priorities of growth and maintaining a strong balance sheet while growing our free cash flow and net asset value per unit. Moving on to our markets. The Canadian national availability rate remained low at 3.1%, with 5.3 million sq ft of new supply being largely balanced by 4.7 million sq ft of absorption during the quarter.
Driven by low, readily available supply, the national average net asking rent increased to CAD 8.34 per sq ft, making a 16% increase year-over-year. In our U.S. markets, demand for industrial real estate continues to be strong, both from tenants and investors. This has led to low availability and higher property values. We believe that industrial fundamentals on both sides of the border will remain strong, providing us with opportunities to capture rental growth in our current portfolio. With historically low availability rates in Ontario and Quebec, we continue to expect rental rate growth in these markets to be robust. In Ontario, approximately 225,000 sq ft of leases commenced during the quarter, with an average spread of 20% over prior rents. On 947,000 sq ft of lease commitments taking occupancy in 2019, we have achieved an average spread of 16% over prior rents.
In Quebec, approximately 200,000 square feet of leases commenced during the quarter at an average spread of 18% over prior rents. In 2019, we have 722,000 square feet of lease commitments in Quebec at an average spread of 14%. Strong leasing activity, market rent growth, and lower capitalization rates have led to increases in the value of our investment properties in these markets. Year to date, our investment property values have increased CAD 68 million in Ontario and CAD 14 million in Quebec. Our focus on driving occupancy in Western Canada has been successful with strong year-over-year comparative properties NOI growth of 4.8%. While we continue to see some pressure on expiring rental rates, we are building in contractual rent growth into the leases and investing capital prudently.
Notably, we were successful in leasing up a 48,000 sq ft vacancy in Edmonton that was vacant since the second quarter of 2018 at attractive rents with contractual rent growth. We expect positive comparative property NOI growth from the West for the full year, driven by increased occupancy and contractual rent growth. Our U.S. assets were 95.7% occupied at the end of the second quarter. On 190,000 sq ft of lease commencements within the Midwest US portfolio, we were able to achieve a 14% spread over prior rents. We have signed 371,000 sq ft of leases expected to take occupancy in 2019 at an average spread of 21% over prior rents. Tour activity on the 303,000 sq ft space in Louisville continues to be strong. With a strategic location just off the I-65 highway near the UPS Louisville hub, we are confident of filling this vacancy in the near term.
Overall, we have made our business safer and more valuable through active asset management and a disciplined capital allocation strategy. Our strategic initiatives have positioned us well for above-average free cash flow and net asset value growth over the long term. Lenis will now provide our financial update.
Thank you, Brian. Diluted funds from operations, or FFO per unit for the quarter was CAD 0.20 compared to CAD 0.21 in the second quarter of 2018. Higher FFO from strong comparative properties, NOI growth, and acquisitions was offset by lower average leverage, as we have decreased our average leverage by 8% year-over-year in order to have a stronger balance sheet and added financial flexibility. As Brian mentioned, we completed the sale of our Eastern Canada portfolio last week. As such, it is reported as discontinued operations for the second quarter and has been removed from our operating metrics. Comparative property NOI increased by 4.7% for the quarter, led by higher occupancy and rental rates in Quebec, higher occupancy in Western Canada, as well as higher rents in Ontario. In our GTA and Quebec markets, comparative property NOI growth for the quarter was strong, at 5.6% and 7.2%, respectively.
The value of our investment properties, excluding the Eastern Canada region, increased to CAD 2.3 billion from CAD 1.9 billion at the beginning of the year. We acquired approximately CAD 315 million of investment properties and recorded an CAD 82 million fair value gain in the first half of 2019. The fair value increase reflects strong leasing activity in Quebec, as well as lower cap rates in Ontario and on certain properties in the U.S. The Trust's reported net asset value, or NAV per unit, increased by CAD 0.50 or 4.7% to CAD 11.04 since the beginning of the year. Compared to the second quarter of 2018, NAV per unit has increased by CAD 0.99 or 10%. Our net debt to assets ended the quarter at 37.4%, and our net debt to EBITDA was 6.4 times.
At quarter end, our liquidity was strong with unencumbered assets totaling CAD 381 million and CAD 88 million of availability on our credit facility. Looking forward, we expect 2019 comparative properties NOI growth to be in the 3%-3.5% range, which excludes Eastern Canada. We continue to transform Dream Industrial with the goal of high-grading the portfolio and increasing the safety of our business with a strong and flexible balance sheet. Our FFO this year will be lower, as over the past 24 months, we have reduced leverage by more than 10% while growing our asset base by over CAD 650 million and improving portfolio quality. Following the sale of the Eastern Canada portfolio, we expect leverage to be approximately 32% with over CAD 280 million of liquidity. As such, Q3 and Q4 FFO will be lower than Q2 until we reinvest the proceeds.
As we execute on our CAD 300 million acquisition pipeline towards the end of 2019 and early 2020, we expect our leverage to increase to approximately 40%. We are targeting high-quality properties, largely in Canada, that are consistent with our investment criteria. At the same time, we intend to maintain a strong balance sheet, ample liquidity, and flexibility by targeting leverage in the high 30s to low 40s over the long term. We believe that this strategy will result in a significantly more stable portfolio with higher quality and stronger cash flow and NAV growth potential over the long term. We are excited about the positive outlook for internal and external growth for DIR. I will turn it back to Brian now to wrap up.
Thank you, Lenis. The first half of 2019 has continued to be eventful and exciting for Dream Industrial, including the successful execution of our U.S. expansion, disposition of the Eastern Canada portfolio, improved operating results, and addition to the S&P/TSX Composite Index and the FTSE EPRA Nareit Global Real Estate Index. Looking forward, we remain well-positioned to continue to create unitholder value through organic income growth and by using the strength of our balance sheet for new investment opportunities that meet our investment criteria. We'd now be happy to take any 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 iA Securities, we have Brad Sturges. Please go ahead.
Hi there. Brian, just in terms of your acquisition pipeline, CAD 300 million, it sounds mainly in Canada. Just want to get a context if you're seeing more opportunities from a portfolio perspective on the market, or is it a mix of portfolios and single assets?
It's a mix, Brad. We've seen portfolios that we've looked at. A lot of those have been bid up to very high prices, although we're looking at a number of portfolios that we'd like to pursue. We're also looking at one-off opportunities sourced by our people that are sometimes unmarketed, and then some that are marketed. We are seeing a lot, and we're really focused in Canada. We're seeing opportunities in the U.S. as well. I don't want to say that we're not looking at any, but I would say our focus has been in Canada. We like our current portfolio mix, and we're going to try to maintain that. It'll go up and down as we go, but we're looking at a lot of opportunities in Canada right now.
Would that be more Toronto, Montreal, or would you consider opportunities in Western Canada?
Our primary focus is Toronto, Montreal, and we're looking at a lot of opportunities there. Although, we have seen some smaller one-off opportunities in Western Canada, which may fit with some recycling we're doing. We're looking at both with the primary focus in Ontario and Quebec.
I think for the acquisitions completed this year, I think the cap rate was stated at 5.9%. In terms of going in cap rates target, is that kind of similar type of going in yield that you're looking to achieve on acquisitions going forward? Or should we think about that a little bit differently in the back half of the year?
Yeah, 5.9 would be a mix between U.S. and Canada. It's likely to be lower than that on the Canadian side of the acquisition.
Sure.
In addition to the going-in cap rate, Brad, we're also looking at the growth built in within the portfolio opportunities to increase cash flow over the long term. We're also looking at cap rate average yields over five and 10-year periods.
Yeah. Going in cap, I think, is just one metric, Brad. We're looking at pretty steep rent increases in NAV growth over the term of the whole hold period for an asset.
How would you characterize the sales price per foot today in Toronto, Montreal versus replacement cost?
I think in much of Ontario, it's approaching replacement cost. We've seen opportunities that are still below replacement cost, but it's quickly getting there. Replacement cost is growing. I think as we speak, it's growing every day. It's a moving target. It's going up.
Right. The gap's shrinking, I guess.
Yes.
Yeah. Okay. Thank you.
From Canaccord Genuity, we have Brendan Abrams. Please go ahead.
Hi, good morning, everyone. Just taking a look at the leasing spreads in Ontario and Quebec, obviously, really strong numbers year to date, 16%, 14% in Ontario and Quebec. Just trying to think about 2020, 2021. What's your expectation for renewal spreads kind of in the more near medium-term those years? Are these anomalies or is that your expectation going forward? How are you thinking about maybe renewals over 2020 to 2021?
Brendan, I would say the rental spreads that we've achieved in Ontario, Quebec have been very strong. Based on where we see the market today, and I think the market continues to change. It continues to be strong. I would say based on what we're seeing today, the rental spreads would be a little bit lower, probably low double digits in Ontario, and a little bit lower in our Montreal market on a go-forward basis as well, but still strong high single digit, low double-digit numbers on the spread going forward.
Right. Okay, that's helpful. Just in terms of Western Canada, maybe I missed it, but I'm not sure if you disclosed it for the quarter or year to date. Are you still seeing slightly negative spreads or is it flattened out?
Yeah, that's correct. For the year to date, it's about negative 6%. We probably see that trend to continue, maybe a little bit lower in the single digits. I think overall the leases are rolling off higher rents. What we're doing is building in contractual growth. In the West, we've also seen an uptick in occupancy. We believe that uptick in occupancy will lead to NOI growth, which more than offsets the rolling down of the rents going in over the next 18 months.
Brendon, just to add to Lenis' comments, that market continues to improve. We see rental rates in general across that whole market continuing to improve. There's new construction and higher rents. I think that rising tide will raise all the boats. I think our rents will continue to improve and the gap from our spreads will continue to shrink.
Right. Okay. That's very helpful. Just in terms of maybe, is there an update on the Louisville property that you acquired as part of the Midwest portfolio?
Yeah, I mentioned, Brendon, in the opening remarks, we've got a lot of tour activity on that. It's not leased right now, but we're confident, optimistic we'll have that leased in 2019. With the activity we have, that market's still quite strong, the Louisville market. It's a matter of finding the right fit in the tenant. We've got a great location. We get a lot of activity on that, and we've had a number of tenants interested, and we're optimistic about the short-term results.
Right. Okay, that's helpful. I'll turn it over. Thanks.
From CIBC, we have Chris Couprie. Please go ahead.
Good morning. Just want to turn back to the acquisition pipeline. Are you contemplating any development properties in your pipeline, or is that something that you're actively looking for?
Chris, we're actively looking for it. I think we've stepped up Our efforts in this regard, we're looking at developments on both sides of the border. We've looked at and pursued a number of opportunities. We don't have anything secured at this point, but we are actively looking at development. It'd be a good complement to our overall acquisition strategy. We're confident in the acquisition strategy. We're excited about the pipeline we have on that side. We're also very optimistic on adding development. It's a longer lead item than obviously buying income property, but we think it'd be a very good complement to get very high-quality assets, and it'd be a good complement to our portfolio. We're diligently pursuing that on both sides of the border and are expectant that in the medium term, we'll have some development that we're working on.
If you were to consider a development type of property, what type of spread to kind of market cap rates would you be looking for on a development?
It's probably a 50 to 75 basis point spread in your development yield to the cap rate returns. Cap rate's an indicator of market. It's only one metric. You got to know what the market rents are and what the rents are in a particular asset to whether that cap rate's an accurate reflection of the market. When you got below-market rents, a lot of times the cap rates are very low. Comparing cap rates to development yields isn't always apples to apples. There's probably a 50 to 75 basis point spread between buying and building.
Right. Got it. Just going back to Lenis' comments on FFO, I think you said that Q3 and Q4 should be lower than Q2, excluding acquisitions. Was that correct?
Yes, that's correct.
Oh, okay. How should we think about maybe, I mean, you can't predict these things, but in terms of timing of acquisitions maybe for the balance of the year, any help there?
Yeah. We'll have acquisitions through the balance of the year and into 2020. I would say we will have deployed some of our capacity this year and some into 2020. I think the dust will settle with our leverage and acquisitions probably sometime early to mid-2020.
Got it. Thanks. I'll turn it back.
From TD Securities, we have Sam Damiani. Please go ahead.
Thanks. Good morning, Brian. Good morning, Lenis.
Good morning.
Just onto the last question. Do you have a more specific sort of range of acquisitions that would close by the end of Q3 over and above the Ottawa property, which I guess is closed already?
Can't give you specific timing on that, Sam. I'd say we are looking at a lot of opportunities. We're excited about the opportunities we have to look at. There's also more product coming in the fall that we know of. We expect to have acquisitions in the balance of 2019 that will close this year, and then we'll have some coming into 2020. I would say it'll be lumpy just where the opportunities come. Certainly in Q4 we'll have closings, and into 2020 we'll have closings. I can't tell you specifically how much of our pipeline will close this year.
That's fair. No, that's helpful. Just your comment, Brian, about the pipeline and representing higher quality assets than, I guess, some of the existing portfolio. What metric are you focusing on there? Is it tenant quality, lease term, location, physical height, whatever? I'm just wondering what you're going to be focusing on in the next little while relative to the portfolio.
Yes, all of the above. I mean, functionality, quality of tenancy, but really quality of the real estate. We're looking at tenancy and quality of the tenants, but we're really focused on the functionality of the property, its location, its clear height, its truck court. The long-term value of the property is kind of how we gauge quality. We're looking at upgrading with every acquisition, with every trade we do, and every recycle. We want to go up the quality scale with properties that will fill up first and empty out last as cycles come and go, and where we can push rents as much as we can in a rising market.
Are you maybe a little more open to adding some assets with some leasing exposure to capture that market upside? Is that sort of what I’m hearing?
Yes.
Are you looking for long-term?
Yeah, I think we'd look at leasing exposure. We'd look at potentially shorter walls, particularly in Ontario and Quebec. If we had shorter walls, we'd see that as an opportunity.
Okay. Just looking at the IFRS fair values, I mean, the cap rates that are disclosed for Q2, there's almost 100 basis points between Quebec and Ontario. Ontario, of course, as you know, includes a little bit of London. Given the fundamentals there, the rent growth that you're seeing, NOI growth, and whatnot, how do you view that 95 basis point spread, and how that might migrate going forward?
Well, I think the Montreal leasing market is starting to follow what's happening in the GTA. I think as we see the continued market rent growth and a lot more investment activity in the Montreal market, if that shows cap rates coming down in the Montreal market, I think we'd probably see it following closely behind the GTA market in that regard. The way we calculate our IFRS values, it's somewhat backwards-looking because we're using appraiser information, so we may not be capturing the latest trades that are happening in the market.
You would see perhaps Montreal cap rates coming down relative to Toronto over the next year or two?
Yes.
Great. Thank you. I'll turn it back. Thank you.
Once again, if you have a question, please press star one on your telephone keypad. From Desjardins Securities, we have Michael Markidis. Please go ahead.
Hi, good morning, guys. Just with respect to Ontario and Quebec, the leasing spreads have been quite similar for your 2019 program. I think, Brian, in the past you've noted that in Ontario, you'd almost like to take some near-term vacancy in order to capture higher spread, which you guys have actually done when you look at the prior year. In Quebec, you guys are sitting at sort of almost a fully committed number. I'm just curious as to if that's intentional or if that's just a product of recent activity. Do you see yourself going forward in Quebec trying to push that vacancy number a little further in order to capture a higher spread?
Hi, Mike. We're pushing rents. We're going to continue to be very aggressive. I think it's a function of the market. It's nice to have space to lease at all times, and we're going to continue to push rents to the point where we generate a little bit of vacancy. That's the strategy in both markets. It's not different for Ontario or Quebec. I don't know if I'm answering your question, other than we're pushing rents. We're going to continue to be aggressive. As we do that, we may see a little bit of vacancy. I think we're full because of just the timing of the renewals and the fact that we've been able to retain our tenants. The tenants don't have a lot of options. They end up staying where we're at. If you look at our spreads, they're quite high.
We'd love to continue to push those and continue to be leaders in market rent.
Okay. Then just looking at your in-place versus market rent estimate for Quebec, even again in that sort of mid-teens level, and I think Lenis indicated that perhaps in the next year or two, you're expecting that to come down to the high singles. What's driving this? How do we think about the fact that on average, your in-place versus market rent estimate for Quebec is almost comparable for today?
Mike, I would say we have probably a lot more upside on the multi-tenant than our single-tenant properties in Montreal. I think that's probably why it's averaging out. I think as we continue to see the strong leasing market in Montreal, we'll continue to reevaluate what we show as market rents.
Okay, that's fair. Just given all the activity you've had in terms of adjusting your leasing strategy in Canada and Western Canada in particular, in terms of trying to get, I guess, greater contractual bumps built in and the stuff that you bought in the U.S. Do you have an estimate today of where on average your average annual escalator would be in your portfolio today?
It's at 2%, and that's actually up from, say, 1.5% about a year, 18 months ago.
Okay, 2% would be.
That's totally across the entire portfolio.
Okay.
We see it a little higher in GTA, in the U.S., maybe a little bit higher than 2% in Quebec, and a little lower in the West.
Okay. With the Eastern Canadian sale, there'll be some frictional costs there. Do you have a ballpark of what the transaction costs when you think about just commissions and debt breakage, even though that was small, might be in aggregate?
I think the net proceeds approximate IFRS before transaction costs. Are you asking about the transaction cost itself?
Yeah. The CAD 271 was the gross, I'm just getting a figure of, if we just look at the frictional costs you're incurring, what that might be.
It's probably about CAD 3 million-CAD 4 million.
CAD 3 million-CAD 4 million?
Yeah.
Great. Last one before I turn it back. Just we've had a pretty, I don't know if you want to call it impressive or not, but I'll call it impressive move to the downside on the rate environment in the last very recent term. I just wonder if you could give us an update on where you're seeing debt market. I see you got 10-year money at, I think it was 3.17 subsequent quarter-end, and just sort of how that's all evolving as we speak.
Yeah. That's right. That was for a mortgage with collateral in Ontario. Right now, where we're seeing in Canada is for five- to 10-year rates, we're looking at 3%-3.1%. In Canada and in the U.S., probably around 3.25% for five- and 10-year money.
Okay. That's a great update. Thanks very much.
We have a follow-up from Sam Damiani. Please go ahead.
Thanks. Just, yes, two quick ones here. Any further dispositions expected in the near to medium term besides, obviously, the Eastern Canada? Also, on the same property NOI growth for the year, were there any other changes to the number besides excluding the Eastern Canada portfolio?
Sam, let me start with the recycling question. I'll let Lenis answer the same property question. The short answer is yes, we do have a number of properties we are looking at recycling. They are one-offs in, I would say, every region. We have some that we've identified that may be quite valuable that we could recycle into other more long-term hold kind of assets. We're kind of just looking at those, the timing of those, and marrying them up with some of our acquisitions. Short answer is yes, we'll continue to do recycling. It won't be near to the scale of the Eastern portfolio.
On the comparative property NOI, the change from the prior guidance is the exclusion of the East. Quebec is also performing a little bit better than we had originally expected. The largest variation is really just the exclusion of the Eastern Canada portfolio in those numbers.
Perfect. Thank you very much.
We have no further questions at this time. We'll now turn it back to Brian Pauls for closing remarks.
Thank you everyone for your time today. We look forward to speaking again soon.
Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for joining. You may now disconnect.