Earnings Call: Q4 2018

Feb 20, 2019

Earnings release

Good morning, ladies and gentlemen. Welcome to the Dream Industrial REIT 4th Quarter 2018 Conference Call for Wednesday, February 20, 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 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 Dream Industrial REIT. Mr. Pauls, please go ahead. Thank you. Good afternoon, everyone. Thank you for joining us today for the Dream Industrial REIT conference call, which is for the 3 months year ended December 31, 2018. Speaking with me today is Launice 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 followed by an update on our markets and our operating results. Lance will provide our financial highlights. We'll then be happy to field your questions. The Q4 was productive as we focused on further improving our company performance as well as building and executing on our acquisition pipeline. During the quarter, we acquired 121,000 square feet distribution facility in Montreal for a purchase price of $13,600,000 representing a going in cap rate of 6%. Subsequent to year end, we waived all conditions on a 3,500,000 square foot portfolio in 5 cities across the Midwest U. S. The purchase price for the portfolio was approximately US175 $1,000,000 or CAD235 million and equates to a growing in cap rate of 6% and a stabilized cap rate of 6.5%. The portfolio is leased to over 50 tenants and includes an attractive mix of single tenant assets and multi tenant facilities that service a broad range of tenant uses and sizes from small base and large distribution facilities. The assets are well located and any city within the portfolio is supported by large commercial airports, intermodal transport hubs and is accessible to over 50% of the U. S. Population within a one day truck drive. There is strong interest in our tour activity on the recently vacated property in Louisville. The property is very well located and provides an opportunity to increase our initial yield. In addition, we expect the portfolio will provide steady cash flow growth through approximately 3% annual rent escalators embedded in the current leases. We expect the transaction to close in March. Since December 2017 and including the recently announced Midwest U. S. Portfolio acquisition, we have grown our asset base by over $500,000,000 and in less than 2 years, we have achieved our initial target of 20% of highly functional industrial assets in the U. S. At this time, we have strengthened our balance sheet and reduced leverage by 4.40 basis points. With our initial U. S. Expansion strategy successfully executed, we intend to focus on growing primarily in Canada with a focus on Ontario and Quebec. Our potential acquisition pipeline is approximately $200,000,000 and we continue to identify and execute on acquisition opportunities that deliver above average income and net asset value growth over time. Moving on to our markets. The Canadian industrial market continues to strengthen and underlying fundamentals support continued momentum for the foreseeable future. The Canadian national industrial availability rate tightened further in 2018 to a new record low of 3.2 percent with 10 consecutive quarters of declining availability. Our U. S. Portfolio is 100% occupied and demand for industrial real estate continues to drive asset values and occupancy rates. In Canada, the impact of these strong fundamentals is being realized across our portfolio, especially in Ontario and Quebec. We have signed 550,000 square feet of renewals taking occupancy in 2019 in our Ontario portfolio at an average spread of 11% over expiring rents, in addition to 3% annual rent increases each year. On 200,000 square feet of leases that were transacted in 2019, the spreads have been even stronger at over 16% and we expect this trend to continue. In Quebec, we've achieved an average spread of 9% on 400,000 square feet of renewals taking occupancy in 2019. At the end of 2018, we renewed Nelson Nutraceuticals, one of our largest tenants in Quebec, occupying 211,000 square feet in Machine for an additional 5 years with no costs at a 7% lift from the expiring rate. Strong leasing activity and declining cap rates have led to continued increases in the value of our investment properties in these markets. In 2018, our investment property values have increased $96,000,000 in Ontario and $45,000,000 in Quebec due to higher underlying cash flows, market rent growth and lower cap rates. In Western Canada, operating results in the first half of twenty eighteen were impacted by early terminations terminations, which led to a decline in occupancy. However, our focus on maximizing occupancy and cautiously investing capital in our lease deals has been successful. Our occupancy in the region has improved 230 basis points since mid-twenty 18 to reach 95.2% at year end, and we have achieved stronger NERs compared to the prior year. For 2019, we expect a rebound and positive comparative property NOI growth from the West, driven by increased occupancy and contractual rent growth. In Eastern Canada, occupancy increased 60 basis points during Q4 2018, capping off a strong year. We have significantly increased our occupancy in this region over the last 2 years, which led to 11% comparative property NOI growth in 2018 and should continue to generate steady cash flows. Our U. S. Portfolio remains 100 percent occupied with a WALT of 5.7 years and no leases expiring before 2022. Overall, we have increased occupancy in Western Canada, which along with strong rental growth in Ontario and Quebec should increase our pace of organic growth in 2019. Bynas will now provide our financial update. Thank you, Brian. Diluted funds from operations or FFO per unit for the quarter was $0.22 compared to $0.23 in the Q4 of 2017. Higher FFO from comparative property NOI growth and acquisitions was offset by lower leverage throughout 2018. FFO per unit for the year was $0.86 compared to $0.91 in 2017. Higher FFO from comparative property NOI growth and acquisitions was offset by lower leverage throughout 2018 and the timing difference between the equity raise in June and subsequent capital deployment. In 2018, comparative property NOI increased by 1.5% year over year, driven by higher average occupancy in Eastern Canada, higher average occupancy and rental rates in Ontario, partially offset by lower average occupancy and rental rates in Western Canada. The value of our investment properties increased to $2,100,000,000 from $1,700,000,000 at the beginning of the year. The increase was largely due to $248,000,000 in acquisitions and a $135,000,000 increase in the value of the Trust's properties, reflecting higher underlying cash flows, market rents and lower capitalization and discount rates. In 2018, the Trust reported net asset value per unit increased by $1.19 or 12.7 percent to $10.54 driven by higher investment property values in Ontario and Quebec. Our net debt to assets ended the year at 43.5%, a decrease of 4.40 basis points year over year. At year end, our liquidity was strong with unencumbered assets of $195,000,000 $98,000,000 of liquidity on our credit facility. Subsequent to year end, we completed a public offering of 13,800,000 REIT units at a price of $10.45 per unit for gross proceeds of $144,200,000 The net proceeds will be used to partially fund the Midwest U. S. Portfolio and for general trust purposes. Looking forward to 2019, we expect our strong leasing momentum to result in improved comparative property NOI growth in the 2% to 3% range, driven by higher occupancy in Western Canada and Quebec and rental rate growth in Ontario. We expect the stronger internal growth to be more apparent in the second half of the year. In terms of our growth strategy, we are looking to acquire assets that are well located, above the average quality of our portfolio and offer strong cash flow growth potential. As Brian mentioned, our primary focus for acquisitions will be in Canada, targeting properties in Ontario and Quebec. Following the Midwest U. S. Portfolio acquisition, we expect leverage to be around 43%. Over the long term, we are targeting leverage of approximately 47%. Operating at a lower leverage will impact our FFO per unit. However, as our acquisition activity ramps up, we expect corresponding pickup in FFO per unit. We will continue to prudently manage our capital expenditure and leasing costs and intend to focus on acquiring properties that are less capital and less management intensive. We expect our capital expenditure and leasing costs as a proportion of NOI to decline modestly from current levels. To summarize, over the past year, we have significantly reduced the risk of our business by lowering leverage and redeeming our convertible debentures. We have accomplished all this while growing our portfolio, enhancing our portfolio diversification and improving its overall quality. Looking forward, we are well positioned with sufficient liquidity and strategic strategies to further improve our overall portfolio quality as well as generate higher long term free cash flow and net asset value growth. I will turn it back to Brian now to wrap up. Thank you, Lenis. Looking forward, we intend to increase our focus on asset recycling and adding further scale in our target markets. Following the strong operating these properties. As a result of this interest, we have had very preliminary discussions to test the market appetite for this portfolio. At this stage, we have limited visibility on the outcome of our preliminary discussions. However, we continue to hold a dominant market position in the East and with occupancy at 93.7% and a WALT of 3.2 years, we expect the Eastern Canada portfolio to continue to deliver stable income. We significantly transformed the business in 20 18 and are off to an exciting start to 2019. We look forward to further improving our business and are well positioned for continued growth in 2019. We would now be happy to take any questions. Thank Our first question is from Sam Damiani of TD Securities. Please go ahead. Thank you and good morning. Brian, just on your comment there at the end there about dispositions, I just want to make sure I understood there's a portfolio that you've got in the market that you're in market that you're in discussions on, is that right? And did you specify where the portfolio is located? Hi, Sam. Yes. So the portfolio I mentioned at the buyers for that. The interest is not very specific at this point in terms of dollars or even which properties. So when I mentioned we're testing the market, it's for the Halifax portfolio. We don't know the outcome of that, whether it will be the right thing to sell or not, but we are going to entertain that interest and see how strong it is. Okay. So just to be clear, you're entertaining potentially selling the entire portfolio? Correct. Okay. And just flipping over to the acquisition side, the $200,000,000 pipeline, how much of that is in Canada versus the U. S? Nearly all of that's in Canada right now. We've got small property in the U. S. We're looking at, but it's almost entirely in Ontario and Quebec. Okay. And I'll just wrap up with the balance sheet, Lenis. Thank you for the comments on the leverage in terms of your goals. And in addition to debt to gross book value, do you have a debt to EBITDA goal in mind? We're currently in and around 7x. So I think somewhere in we'd like to target being less than 8 for sure on debt to EBITDA. And you successfully got rid of the converts last year. Is there any desire to put on a different kind of debenture on the balance sheet going forward, unsecured? Not in the near future, no. Okay, thanks. I'll turn it back. Thank you. Our next question is from Brendan Abrahams of Canaccord Genuity. Please go ahead. Hi, good morning. Brian, when you referenced the Halifax portfolio potential sale, just to be clear, would that effectively be the entire Eastern Canada portfolio or would this be specific properties within Halifax? We don't know the outcome, Brandon, but it could be the entire portfolio. Okay. Just flipping gears to leaking spreads, obviously, pretty strong for Ontario in 2018 and a good start to 2019. I mean, how should we think about leasing spreads going forward? And just a question in terms of your market rents for Ontario. I mean, the market is so tight, rents seem to be moving so quickly. Like, how do you come up with some market rents, just generally speaking, for your portfolio? I think we're trying to find Brendan, it's Brian. We're trying to find market every day. We're pushing market. As occupancy has gotten our Ontario portfolio occupancy has gotten into the very high 90s, 99 plus we're pushing to the point where we're actually creating more vacancy in our portfolio to find market. In some instances, that's 30% even 40 plus percent increase in rent. So we're looking for market, but I don't think we have found it. We're pushing every day when we have renewals. Every vacancy, every renewal in Ontario and Quebec, we see that as an opportunity to continue to push rents. So it's continuing to go up. It's a moving target, but one that we're pushing every day. We don't think we find it until we've actually created a little bit of vacancy. Okay. And then just on the opposite end of the spectrum in terms of Western Canada, renewal spreads were down 4.5% in 2018, but flat in Q4. Should we read into this at all in terms of a reflection of the market? Or is it too small of a sample size to say things are turning there? Yes. We're pushing for occupancy very hard in the West. Spreads are probably continuing to go down a little bit as some of the older leases roll. So that's probably a trend that continues, although we're very happy with our second half of twenty eighteen performance as it relates to occupancy. Yes. So with each of our deals out west, the NERs are up year over year. We're trying to invest less capital, hold on our going in rates and try to put in some contractual increases where possible. Right. Okay. That's it for me. Thanks. Thank you. Our next question is from Mike Markidis of Desjardins Capital. Please go ahead. Hi, thanks everybody. Brian, obviously a lot of focus on your entertaining offers for all or a portion of Halifax. But I was trying to just get a sense of a couple of things. Number 1, would be how long has that been listed? And then number 2, the comment that you've made in your disclosures regarding expecting to increase your capital recycling this year, Is that tied to an expectation surrounding Halifax? Or is that also including other potential activity within the portfolio? So we've talked to it's only been a few months since we've talked to potential interested parties in the Eastern portfolio. We have engaged both TD and CBRE to help us with entertaining that interest. My comment and Lenis' comment about increasing asset recycling is a reflection of that interest. So that's primarily what's driving it. There may be a few one offs, but this is really what we're in terms of asset recycling. This would be the biggest news we have of potential recycling for 2019. Okay. And the desire to sell that, is that just a function of expectations? I think you guys have stabilized the occupancy there, just that there's not a lot of rent tension? Or is it that it's more capital intensive? Just trying to get a sense of the desire because presumably the valuation metrics would be higher than the average for your portfolio as well. Yes, Mike, it's a reaction to interest from outside parties in the portfolio. We're not necessarily we'd be happy to keep the portfolio. We've created a lot value there and we think it's performed well. Our team there has done very well in leasing up the portfolio. It's doing well, so it's a reaction to market interest and a desire to potentially grow in the markets that we really targeted, those being Ontario and Quebec. So that would be a potential to do that, but it's a reaction to the market. It's not necessarily a foregone conclusion that we're going to sell it. Okay. I got it. So you've had some expressions of interest and that just sort of stimulated your desire to maybe take a more fulsome approach. Does that make sense? That's right. That's right. Okay. Got it. We can test the market and see how they react. We don't know what a fully marketed value would produce. We're going to find that out and then decide from there. Okay. Obviously, great results in the GTA. It seems a surprise on the upside every single quarter. I just want to get your views on Montreal because I guess if you look at the trend in market availability and absorption and just supply or lack of a supply response. One might make the argument that Montreal is maybe 18 to 24 months behind the GTA from a rent growth perspective. Do you have any thoughts on that? Do you have any expectations for additional runway in Montreal as we move forward? Yes, we're very optimistic for Montreal. That's why we keep mentioning it and it's kind of lumped in with Ontario. It's maybe not as capable of growing quite as fast as Ontario, but the supply the math doesn't lie. I mean, there's just very, very little supply, very little vacancy. We're going to continue to push rents there. It has historically been behind Ontario and probably will lag a little bit here, but we think there's a long runway of rent growth there as well. Okay. And then so for the commentary that your 2% or 3% same property expectation for this year seems like it might be back end loaded. Is that just because you expect to continue to lose a little bit of occupancy in the short term as you guys keep pushing in those two markets? That's a fair comment. We definitely see occupancy come down a little bit in the first half for Ontario, Quebec has just sort of caught up in occupancy. So we will see some occupancy gains sort of flowing through NOI on there. But yes, some of that some of the leases that we've been doing, it's going to be on the back half of the year where you'll see that income coming in. Okay. And last question for me before I turn it back. Just if you look back at the history of the Western Canadian portfolio, it sounds like you guys had some early terminations, but it really was an occupancy issue that crept up in late 2017 and maybe early 2018, which you guys have now successfully backfilled. Do you see that as being an isolated occurrence? Or is it something that could be a risk going forward, just given where the market is today? Mike, we're fighting every day for occupancy in the West. I think we've got some great tenants. We've had some tenants related to homebuilding that have had trouble in that market, and that's where we've had some exposure. The rest of the portfolio has done well. So I think we're going to continue to push for occupancy there. I think the team has done a good job. I don't know if we'll see the same trends that we saw before, but I think our team has done a good job really stabilizing that market and positioning that portfolio well going forward. Okay. That's helpful. Thanks very much. Thank you. Our next question is from Brad Sturges of Industrial Alliance. Please go ahead. Hi there. Good morning. Just in terms of the $200,000,000 acquisition pipeline, just wanted to get a little bit more of a sense of are those all stabilized assets? Or would you be considering assets that have value creation, whether it's development or expansion? Hi, Brad. The $200,000,000 is all stabilized assets and almost entirely in Canada, Ontario and Quebec. We do have opportunities within our portfolio to potentially add value to existing assets. That's not included in the $200,000,000 But for example, is a tenant in our U. S. Portfolio that would like to expand the building. We are in negotiations with them now to expand the building, extend the lease. And there are opportunities, other ones within our portfolio to do that. That had nothing to do with the $200,000,000 We're also looking at and entertaining development opportunities. Those are very, very preliminary discussions. So don't have much to report on that, but that was totally independent of the $200,000,000 as well. Great. And in terms of the I guess within the Houston portfolio, can you quantify what that those potential opportunities could be right now? Quantify the expansion opportunities or Yes, in terms of size or scale. The one I mentioned was about a 60,000 square foot expansion, which will be somewhere between it's really early stages, but I would say somewhere between $5,000,000 $7,000,000 of additional investment in that particular property. And that scale is reflective of kind of other opportunities. But that's a specific one that we're entertaining right now. Okay. And in terms of the acquisitions you're contemplating, can you give guidance or expectations for going in yields at this stage given it's Ontario and Quebec? Yes. They'll be in the 5s. That's pricing is yields and cap rates are lower in the markets that I mentioned than they are in the U. S. So they'll be in the 5s. Great. And last question, just with the recent portfolio acquisition and taking your, I guess, pro form a numbers up to the for U. S. Exposure to the 20% range. Is that still a range that you're looking to target or could that increase over time? Yes. We like the balance that we've got now. The portfolio in the U. S. Is really complementary to what we have in Canada. It's a very rough estimate, but eighty-twenty Canada, U. S. Is a good ratio that we'd like to maintain. That may flex depending on the timing of acquisitions and that kind of thing. But from a long term standpoint, long term target, that would be a good ratio for us. Got it. Thank you. Thank you. Our next question is from Pammi Bir of Scotia Capital. Please go ahead. Thanks. Good morning. Just on the Louisville property as part of the U. S. Portfolio, what are your thoughts on the lease up timing of that vacancy and then getting that to getting the acquisition overall to that 6.5% stabilized GAAP rate? Yes, Pammi. We've got 302,000 square feet that building. We've had a lot of tours. We've actually had proposals going back and forth. We're confident that, that property will be leased relatively quickly and that would increase our cap rate or our yield rate, as I mentioned on the opening remarks. So we're confident in that. The property is really, really well located. Louisville has experienced kind of unprecedented absorption and it's very healthy. So in terms of having vacancy, this would be the best vacancy to have in that portfolio. Right. And so maybe fair would it be fair to assume that we could see that get leased up this year? Yes. Okay. Lenis, you made some comments about FFO growth. I believe you factor in the equity raise and the same property NOI growth target that you guided to? And of course, the $200,000,000 what do you see as an achievable range of growth for this year? And then second to that is, do you expect with respect to leverage to get to about 47% by year end? So, Pammi, on the I guess, on our outlook for 2019, we talked about our comparative property NOI growth in the 2% to 3% range. When we kind of look down to the FFO line, I think a lot of that is going to be dependent on the amount of acquisitions and the timing of acquisitions, because as I mentioned, we're probably going to be running at about 43% leverage when we close on the Midwest U. S. Portfolio acquisition. If we talked about $200,000,000 in the pipeline, and I'm not saying it's going to be exactly the exact asset, but if we did acquire $200,000,000 by the end of the year, we'd probably be at the 47% leverage. I think in terms of acquisition timing, just we're probably looking at the second half of the year. So, I guess, would it be fair to assume then that 20 20 should be a better year, I guess, just given the timing of getting leverage back up to your target range? 2020 should be a better year overall for FFO growth? Yes, yes. No, absolutely. I think between the stabilization on the Heartland and the Midwest U. S. Portfolio as well as the deploying our additional balance sheet capacity, you're going to see 2020 much stronger than 2019 in terms of FFO. Great. That's it for me. Thanks very much. Thank you. And we have a question from Sam Damiani of TD Securities. Please go ahead. Thanks. Just one other one left. There was this vacancy in London, Ontario. Just wondering how much rent you recognized on that building in Q4? It's probably about half a quarter. Half a quarter? Yes. 3? Yes. Okay. Thank you. I will now turn the call back over to Brian Paltz for closing remarks. Thank you, everyone, for your time today. We look forward to speaking again soon. Thank you. And thank you, ladies and gentlemen. This concludes