Earnings Call: Q2 2019

Aug 7, 2019

Earnings release

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 and 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 and 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. Your host for today will be Mr. Brian Pauls, CEO of Drave 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 3 6 months ended June 30, 2019. Speaking with me today is Lenis Kwan, 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. Lance 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 $350,000,000 of assets in strong industrial markets and have added 4,300,000 square feet 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 31, we completed the sale of our Eastern Canada portfolio, a significant milestone for the Trust. Over the past 2 years, we have increased occupancy by 4 70 basis points in East, which resulted in strong comparative properties NOI growth of 11% in 2018. Following 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 $300,000,000 of assets in our pipeline and are focused on redeploying the capital from our Eastern Canada region, primarily in Canada. We have 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 percent with 5,300,000 square feet of new supply being largely balanced by 4,700,000 square feet of absorption during the quarter. Driven by low readily available supply, the national average net asking rent increased to $8.34 per square foot, 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 square feet of leases commenced during the quarter with an average spread of 20% over prior rents. On 947,000 square feet 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 value of our investment properties in these markets. Year to date, our investment property values have increased $68,000,000 in Ontario and $14,000,000 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 square foot vacancy in Edmonton that was vacant since the Q2 of 2018 and attractive rents with contractual rent growth. We expect positive comparative property NOI growth in 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 square feet of lease commencements within the Midwest U. S. Portfolio, we were able to achieve a 14% spread over prior rents. We have signed 371,000 square feet of leases expected to take occupancy in 2019 at an average spread of 21% over prior rents. Tour activity on the 303,000 square foot space in Louisville continues to be strong. With a strategic location just off the I-sixty five 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 $0.20 compared to $0.21 in the Q2 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 Q2 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 $2,300,000,000 from $1,900,000,000 at the beginning of the year. We acquired approximately $315,000,000 of investment properties and recorded an $82,000,000 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 $0.50 or 4.7 percent to $11.04 since the beginning of the year. Compared to the Q2 of 2018, NAV per unit has increased by $0.99 or 10%. Our net debt to assets ended the quarter at 37.4% and our net debt to EBITDA was 6.4x. At quarter end, our liquidity was strong with unencumbered assets totaling $381,000,000 $88,000,000 of availability on our credit facility. Looking forward, we expect 2019 comparative properties NOI growth to be in the 3% to 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, but as over the past 24 months, we have reduced leverage by more than 10% while growing our asset base by over $650,000,000 and improving portfolio quality. Following the sale of Canada portfolio, we expect leverage to be approximately 32% with over $280,000,000 of liquidity. As such, Q3 and Q4 FFO will be lower than Q2 until we reinvest the proceeds. As we execute on our $300,000,000 acquisition pipeline towards the end of 2019 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, Lance. The first half of twenty nineteen 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 in addition to the S and PTSX Composite Index and the FTSE, EPRA and 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. And we'll now begin the question and answer session. And from IA Securities, we have Branch Sturges. Please go ahead. Hi, there. Brian, just in terms of your acquisition pipeline, dollars 300,000,000 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 are these generally 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, 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 are going to try to maintain that. It will go up and down as we build, 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. So we're looking at both with the primary focus in Ontario and Quebec. I think for the acquisitions complete this year, I think the cap rate was stated at 5.9%. Would that for 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 acquisition going forward? Or should we think about that a little bit differently in the back half of the year? Yes. $5,900,000 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. So we're also looking at Capra average yields over 5 10 year periods. Yes. Go ahead. Capra, I think it's just one metric, Brad. We're looking at pretty steep rent increases in NAV growth over the term of the hold period for an asset. And 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 quickly getting there. Replacement cost is growing, I think, as we speak, it's growing every day. So it's a moving target, but it's going up. Right. So the gap shrinking, I guess? Yes. Yes. From Canaccord Genuity, we have Brandon Abrams. Just taking a look at the leasing spreads in Ontario and Quebec, obviously, I mean, really strong numbers year to date, 16%, 14% in Ontario and Quebec. Just trying to think about 2020 to 2021. What's your expectation for renewal spreads kind of in the more near medium term those years? Like are these are these anomalies? Or is that your expectation going forward? How are you thinking about maybe renewals over 2020, 2021? So Brendan, I would say with 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 just 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. And then just in terms of Western Canada, maybe I missed it, but I'm not sure if you disclose it for the quarter or year to date. Are you still seeing slightly negative spreads or is it fund out? Yes, that's correct. For the year to date, it's about negative 6%. And we probably see that trend to continue, maybe a little bit lower in the single digits. But 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. So we believe that uptick in occupancy will have moving to NOI growth, which more than offsets the rolling down of the rents going in over the next 18 months. Brandon, just to add to Lenis' comments, that market continues to improve. You can see rental rates in general across the whole market continuing to improve. There's new construction and higher rents. I think that rising tide will raise all the boats. So I think our rents will continue to improve and the gap from our spreads will continue to shrink. Right. Okay. That's very helpful. And just in terms of maybe is there an update on the Louisville property that you acquired as part of the Midwest portfolio? Yes. I mentioned, Brendan, in the opening remarks, we've got a lot of activity on that. It's not leased right now, but we're confident, optimistic we'll have that leased in 2019. And with the activity we have, that market is still quite strong, the Louisville market. And so it's a matter of finding the right fit in the tenant, but 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. All 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 forward. I think we've stuck 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. So we're very 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 way be a good complement to our portfolio. So we're diligently pursuing that on both sides of the border and are expecting that in the medium term, we'll have some development that we're working with. And 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 50 to 75 basis point spread in your development yields to the cap rate returns. Cap rates are it's an indicator of market, but it is 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 is an accurate reflection of the market. Some when you get below market rents, a lot of times the cap rates are very low. So comparing cap rates to development yield isn't always apples to apples, but there's probably a 50 to 75 basis point spread between buying and building. Right. Got it. And then just going back to Lennox's comments on FFO, I think you said that Q3 and Q4 should be lower than Q2, all else excluding acquisitions. Was that correct? Yes, that's correct. Okay. And then how should we think about maybe I mean, you have to predict these things, but in terms of timing of acquisitions made for the balance of the year, any help there? Yes. We're We'll have acquisitions through the balance of the year and into 2020. I would say we will have deployed a lot of our 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-twenty 20. Got it. Thanks. I'll turn it back. From TD Securities, we have Sam Damiani. Please go ahead. Thanks. Good morning, Brian. Good morning, Lettis. Good morning. Just on to 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? I 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. So we expect to have acquisitions in the balance of 2019 that will close this year, and then we'll have some coming into 2020. But I would say it will be lumpy just where the opportunities come, but certainly in Q4 we'll have closings and into 2020 we'll have closings. But it's I can't tell you specifically how much of our pipeline will close this year. That's fair. That's helpful. And just your comment, Brian, about the pipeline 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 if the fixed profile relative to it? 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 what kind of how we gauge quality. So 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. So 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. Yes. Yes. 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. And Ontario, of course, as you know, includes a little bit of London. I mean, 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 GTA market I think well, I think the Montreal market is starting to fall the Montreal leasing market is starting to fall. It's happening in the GTA. So 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 probably see it falling 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 some of the latest trades that are happening in the market. So you would see perhaps Montreal cap rates coming down relative to Toronto over the next year or 2? Yes. Great. Thank you. I'll turn it back. Thank you. From Desjardins Capital, we have Mike Marquez. 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. And I think, Brian, in the past, you've noted that in Ontario, you're willing 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. But in Quebec, you guys are sitting at sort of almost a full year committed number. I'm just curious as to if that's intentional or if that's just a product of recent activity and do you see yourself going forward in Quebec trying to push that vacancy number a little further in order to capture a higher spread? Mike, we're pushing rents. We're going to continue to be very aggressive. I think it's a function of the market. We it's nice to have lease 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. So that's the strategy in both markets. It's not different for Ontario or Quebec. So I think 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. It's 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. But 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. And 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 Glen has indicated that perhaps in the next year or 2, you're expecting that to come down to the high singles. What's driving? I mean, how do we think about the fact that you're on average or in place versus market rent estimate for Quebec is almost comparable for today? So Mike, the I would say we have probably a little more upside on the multi tenant than our single tenant properties in Montreal. So I think that's probably why it's averaging out. And I think as we continue to see some strong leasing market in Montreal, we kind of 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 your 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. So 2% would be? That's totally across the entire portfolio. Okay. And we see it a little higher in GTA in the U. S, probably 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 don't I would say the I think the net proceeds approximate IFRS before transaction costs. But are you asking about the transaction costs itself? I think it's Yes. I mean, the $271,000,000 was the gross. And it's again a figure of if we just forget if we just look at the frictional cost you're incurring, what that might be? Okay. So probably about $3,000,000 to $4,000,000 $3,000,000 to $4,000,000 Yes. Great. Last one before I turn it back. We've had a pretty, 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 was just wondering if you could give us an update on where you're seeing debt market as you get tenure money at, I think it was 3.17 subsequent quarter and just sort of how that's all evolving as we speak? Yes, that's right. That was for a Ontario mortgage with collateral in Ontario. Right now, where we're seeing in Canada, it's for 5 to 10 year rates, we're looking at 3 to 3.1 In Canada and in the U. S, probably around 3.25 for 5 10 year money. Okay. That's a great update. Thanks very much. And we have a follow-up from Sam Damiani. Please go ahead. Just two quick ones here. Any further dispositions expected in the near to medium term besides obviously Eastern Canada? And 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 and I'll let Lettuce answer the same property question. We have 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. So short answer is yes, we'll continue to do recycling. It won't be near to the scale the Eastern portfolio. And on the comparative property NOI, what's the change from the prior guidance is the exclusion of the East. The Quebec is also performing a lot a little bit better than we had originally expected, but the largest variation is really just exclusion of the Eastern Canada portfolio in those numbers. Perfect. Thank you very much. And 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 to you soon. Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for joining. You may now disconnect.