Good morning, ladies and gentlemen. Welcome to the Dream Industrial REIT second quarter 2018 conference call for Wednesday, August 8, 2018. 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&A. These filings are also available on www.dreamindustrialreit.ca. Later in the presentation, we will have a question and answer session.
To queue up for a question, press *1 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 months ended June 30, 2018. 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 our results. Lenis will provide our financial highlights. We'll then be happy to field your questions. The second quarter of 2018 was quite eventful, highlighted by an equity raise of CAD 144 million in the announced acquisition of one property in Etobicoke, Ontario, and two in the U.S. The asset located at 161 The West Mall in Etobicoke stands 205,000 sq ft and is occupied by two tenants. The building is very well located near the intersection of Highway 427 and the QEW.
As part of the acquisition, we also have a right of first refusal for the neighboring property, which is approximately two acres. This was an off-market deal. We close on the asset on August 2nd and believe there is significant long-term value in the building and location. As disclosed in our press release dated June 20th, 2018, we are also in advanced negotiations to acquire two high-quality industrial buildings in the Midwestern U.S. These properties total approximately 720,000 sq ft of GLA and are expected to close before the end of the third quarter of 2018. The purchase price for these properties totals CAD 115 million and represents a going-in cap rate of approximately 6.25%, with average annual rent escalators of approximately 1.2% over the term of the leases. Over the past nine months, we have actively grown our portfolio in the U.S. and Canada.
Including the recently announced transactions, the trust has acquired approximately 4 million square feet of distribution and light manufacturing facilities in strong industrial markets. We are also in advanced negotiations to acquire a 120,000-square-foot property in the greater Montreal area at a going-in cap rate of approximately 6%. We have grown the portfolio and the trust while lowering leverage and strengthening the balance sheet. On a net debt to assets basis, our leverage was just 41.4% as of June 30th, 2018, significantly below the 52.2% reported the same quarter last year. Following the early repayment of CAD 111 million of convertible debentures last week, we retain over CAD 200 million of liquidity to pursue acquisitions and development opportunities. The Dream and PaulsCorp acquisition teams continue their work to source new acquisitions in both Canada and the U.S. to identify opportunities that meet our investment criteria. Moving on to our markets.
Industrial fundamentals continue to strengthen. The Canadian industrial market remains robust, with overall industrial availability of 3.9%, a record low. New supply under construction remains limited at 19 million square feet, or only 1% of the market inventory. It is unlikely that the new supply will meet the continuing demand resulting from e-commerce and other economic drivers. The southeastern U.S. industrial markets in which we have invested all display robust industrial fundamentals supported by close proximity to major population and business centers in the U.S. The impact of these strong fundamentals are being realized across our portfolio, especially in Ontario and Quebec. Year-to-date, we have transacted 738,000 square feet of deals in Ontario at rates 11% above expiry or prior in-place rents. Our focus on active asset management continues to yield positive results.
Strong leasing activity and declining cap rates have led to continued increases in the value of our investment properties in these markets. Overall, the western Canadian industrial market is improving, with market availability dropping 120 basis points year-over-year in Calgary to 8.1% and 100 basis points in Edmonton to 7.5%. Occupancy in our western Canadian portfolio declined quarter-over-quarter, due primarily to 91,500 square feet of early terminations. While these terminations impact cash flow in the near term, we are now actively marketing these spaces and anticipate western occupancy recovering throughout 2018. Overall, with committed occupancy at 93% and a WALT of 3.5 years, our western Canadian portfolio should provide stable cash flow and is positioned to benefit from the broader market recovery. We remain focused on maximizing occupancy and free cash flow while prudently investing capital.
In Eastern Canada, occupancy increased 90 basis points since this time last year, which should deliver steady income to the trust. Our U.S. portfolio remains 100% occupied with a WALT of 6.1 years and no leases expiring before 2022. Overall, we continue to outperform the market in nearly every region that we operate in. Strong fundamentals in our core markets provide us with ample opportunities to increase our pace of organic growth. Lenis will now provide our financial update.
Thank you, Brian. Diluted funds from operations or FFO per unit for the quarter was CAD 0.211 compared to CAD 0.23 in the same quarter last year. Our FFO has increased due to higher comparative property NOI and contribution from acquisitions, offset by the impact of operating at lower leverage and higher G&A expense, largely deferred unit compensation. Comparative property NOI increased 1.7% from the same quarter last year, mainly reflecting higher average occupancy in Eastern Canada and rent growth in Ontario. We maintained a strong retention ratio of 75.4% for the second quarter and have secured leases representing 95% of our total 2018 expiries. The value of our investment properties increased to CAD 1.9 billion, compared to CAD 1.7 billion at the beginning of the year.
The increase was largely from CAD 150 million in acquisitions and a CAD 84 million increase in the value of the trust's properties, reflecting higher underlying cash flows, market rents, and lower capitalization and discount rates. Year-to-date, the trust's reported net asset value per unit increased by CAD 0.70, or 7.5%, to CAD 10.05, largely from higher investment property values in Ontario and Quebec. The trust's payout ratio on diluted FFO increased temporarily to 82.9% due to the timing difference between the equity raise in June 2018 and deployment of these proceeds. We would expect the ratio to trend downwards as these funds are deployed. As Brian mentioned earlier, our net debt-to-assets ratio ended the quarter at 41.4%, a decrease of 10.8% from the same quarter prior year. At quarter end, we had cash of CAD 197 million, unencumbered assets of CAD 94 million, and CAD 123 million of liquidity on our credit facility.
In the near term, operating with lower leverage will have some short-term impact on our results. For Q3, we expect our diluted FFO per unit to be modestly lower than Q2 following the June equity offering and financing of our U.S. properties until these proceeds are fully deployed. We utilized a portion of the proceeds towards the Etobicoke acquisition and debenture redemption last week and expect to deploy the remaining proceeds on announced acquisitions later in Q3. In addition, the recent vacancies in Western Canada will continue to impact comparative property NOI growth in Q3, and we expect occupancy to recover in Q4. We are continuing to drive organic growth through contractual rental increases and increasing rental spreads across most of our portfolio. It will take a bit of time for them to reflect through in our results, but we expect to deliver stronger comparative property NOI growth beyond 2018.
Following the closing of the announced acquisitions, leverage should increase to approximately 45% by the end of Q3. We expect our Q4 results to benefit from the completed acquisitions, as well as higher comparative property NOI growth. Directionally, our diluted FFO for Q4 is expected to be higher than Q2. Our well-capitalized balance sheet is at its strongest since inception. Following the redemption of our convertible debentures last week, we have over CAD 200 million of liquidity, and investment of this capital would increase FFO further once deployed. We are well-positioned to deliver stronger NOI, FFO, and NAV growth in 2019. I will turn it back to Brian now to wrap up.
Thank you, Lenis. Over the last six months, our management team has met with a number of investors, industry participants, as well as our tenant base. We've received a lot of good feedback from these meetings, which has influenced our strategy to surface value while reducing the risk of our business. As we move to the latter half of 2018, Dream Industrial is well positioned to improve the value of the business by organic income growth, identifying asset recycling opportunities to improve overall portfolio quality, and using the strength of its balance sheet for new investment opportunities that meet our investment criteria. We look forward to further improving our business in the second half of 2018 and are well positioned for continued growth in 2019. We would now be happy to take any questions.
Thank you. Ladies and gentlemen, 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 hash key. If you are using a speakerphone, you may need to pick up your handset first before pressing the numbers. Once again, if you have a question, please press star one on your phone now. Our first question is from Mike Markidis of Desjardins. Please go ahead.
Hi, thanks, everybody. Just circling back to what's going on in Western Canada, Brian, I noticed that, obviously this quarter you had some early terminations. I guess first off, I was hoping you can expand on that, I also noticed that in Western Canada, if you look at the last sort of several quarters, that you guys have lost a quite significant amount of occupancy. When you say occupancy getting back to or recovering in the back half of this year, are you expecting it to get back up to sort of the 97% level you saw up until the third quarter of last year? Are you kind of expecting to get halfway back there? Just give me a sense of what's happening.
Hi, Mike. Our in-place occupancy with commitments right now is 92.9% in Western Canada. We think that will continue to improve subsequent to the Q2 ending. We did 70,000 feet of new leases in the Calgary area. 52,000 of that was new tenants. 18,000 of that was renewals of tenants. We're starting to see the effects of the sort of recovery in the West. A lot of the leases that were reflected in our SPNOI in the West were done in late 2017. Some of the terminations, we had one in Edmonton that was a significant part of the 91,000 feet. They were paying half rent there, we are pretty optimistic we'll be able to lease that relatively quickly at a higher rent to that expiring rent.
I don't think it'll get to the point of the occupancy you mentioned, Mike, but we see significant increase in occupancy throughout 2018, and that'll poise pretty well for 2019.
The terminations this quarter, were those tenant failures, or were they a decision to terminate? I didn't see any lease termination income in the statements.
Hi, Mike, it's Lenis. I would say it was a combination of tenants that were just struggling financially, and failures. It was an opportunity for us to take back the space, and re-lease them to better tenants.
The 8% renewal downtick that you saw in Western Canada, is that something that you expect to improve and then back out this year and into 2019 as well?
Yes. Part of it is the way we'd answer, Mike, is NER, in the sense that we're getting less rent in some cases, but spending a lot less money to get that rent in terms of commissions and tenant improvements. Free cash flow in NER is improving, if the face rate is not necessarily improving.
Next topic of interest here would just be on the acquisitions. I don't know if you did disclose it or not, but, Brian, are you able to disclose the cap rate on the typical asset?
Mid fives.
Mid fives, okay. Just with respect to, I guess you said CAD 150 million of combined purchase price for the U.S. The one property you have in Montreal sounds like it might be around CAD 15 million or so. I guess just thinking about where the balance sheet is and where your capacity is, do you see the existing equity base supporting a higher figure than that in terms of acquisitions? Or stated alternately, if you're down to the 45% leverage level once you deploy or acquire these assets, where do you see moving to beyond that?
Yeah. Maybe, Mike, I'll answer to start and let Lenis follow up. We see the existing balance sheet supporting further acquisitions. Our target debt level would be somewhere under 50%. We've got liquidity to execute on the deals that we mentioned in the preamble to this call, as well as further acquisitions that are unidentified yet.
Okay. Last one from me before I turn it back. Lenis, can you just comment on what you're seeing in terms of financing costs on Canadian properties for five and 10-year terms currently?
Yeah, sure. Sorry, just to follow up on Brian's thing, I think in terms of our further acquisition capacity, we're looking at about another CAD 200 million following the announced acquisition. In terms of rates that we're currently seeing, I think for five to 10-year money, we're seeing around 4% in Canada and about 10 basis points or so higher than that, 10 to 20 basis points higher than that for five to 10-year terms in the U.S.
Okay, that's great. Thanks very much. I'll turn it back.
Thank you. Our next question is from Chris Couprie of CIBC. Please go ahead.
Morning. A question on Quebec. Your vacancy, or sorry, your occupancy is hitting its highs here. Montreal market's doing quite well. When do you think same property NOI might turn the corner for you guys?
We've actually done some leasing during the year in Montreal. That's reflected in our commitments, and they're going to take occupancy in the latter half over the year. We expect the same property NOI to pick up in the second half of the year for Quebec.
Okay, great. Just a question on, it's just kind of a big picture question. NAFTA impact. Is that anything being discussed by any of your tenants, whether on either side of the border?
Yeah, Chris, I think everyone's talking about it because it's in the news. Nobody knows what impact it's going to have. I think everyone's been kind of status quo with their business. We have not seen any direct impact from that, and don't know that we will. I guess our attitude on it is not really worth worrying about it at this point because we can't control that. We've got great properties, and we've got good tenants. We feel like their businesses will perform well regardless.
Okay, just a quick question on development, given your experience with PaulsCorp. Two questions, I guess. Number one, anything in the portfolio that you have identified from your review since you've been there? Number two, I know PaulsCorp has developed in Canada in the past. Would they do so again?
The first question is there's a few small opportunities within our portfolio to expand. We're talking to a few of our tenants about growing either within the site or expanding the building, those kind of things. They're not that material to our overall portfolio. Those are opportunities to increase value on a property-by-property basis, but it's not much. The second question, we are looking at development opportunities in a number of locations, both in the U.S. and in Canada. We'd like to add development to our portfolio. We're actively looking for opportunities.
Got it.
Chris, that'd be on the DIR balance sheet. We're talking about doing that PaulsCorp, if a Dream would be service providers for Dream Industrial, it'd be on Dream Industrial balance sheet.
Got it. Thank you.
Yep.
Thank you. Our next question is from Brad Sturges of Industrial Alliance. Please go ahead.
Hi, good morning.
Good morning.
Just circling back to the same property NOI questions and more relating to guidance. I think the last couple of quarters has been about 2% growth guidance for this year. Given the expectations for Q3 to be impacted by Western Canada, are you still comfortable with in around that 2% range for 2018?
Just with the recent terminations, it's going to be a bit lighter in Alberta. We're probably seeing more like 1%-1.5%, but we do expect 2019 to be a lot stronger across the portfolio.
Right. Given you have a little bit more expiries in Ontario and you're pretty tight in terms of your vacancy rates, can we expect you to take on more vacancy there in Ontario to be more aggressive to push rents? How do you balance that in order to get the growth?
Brad, I think we're going to keep pushing rents. We're going to push rents in every property in Ontario. That may produce a little more vacancy. We're running very full. In Ontario, there's not a lot of places for the tenants to go. We think we'll be able to continue to push SP NOI without sacrificing too much occupancy. It may produce a little more vacancy, for a greater good in terms of more growth.
The last question, you've highlighted the potential for further acquisitions and also have been reviewing potential for non-core asset dispositions and some capital recycling. I guess, where are you on that front from an asset sale perspective? Is it fair to say that first you like to use the excess capacity that you have first before looking at dispositions? Is that more of a near-term opportunity as well?
That's fair to say. It's fair to say we'd like to spend the cash that's sitting around before we want to generate more cash to spend. We are analyzing the whole portfolio. We're looking at what our best performers, and what are our assets or buildings that we should be culling to trade for higher quality or better performing assets. The first priority is spending the cash we have.
Really, that's potentially a 2019 initiative at this point.
Yeah. I think that's correct.
Great. Thank you.
Thank you. Our next question is from Brendon Abrams of Canaccord Genuity. Please go ahead.
Hi, good morning. With respect to the acquisition pipeline, just to clarify, the CAD 115 million figure referenced in the opening remarks, is that including the Etobicoke property or excluding that property? Maybe I missed it. Do you forecast those to be completed in Q3, or is that a Q4 event in terms of closing?
Hi, Brendon, it's Lenis. Yeah, the CAD 115 million includes the Etobicoke and the Midwest acquisition. Etobicoke is obviously closed, and for the Midwest, we are expecting that to close later in Q3.
Okay. Good for me. Thanks.
Thank you. Our next question is from Nana Yang of Scotiabank. Please go ahead.
Hello, good morning. Some of my questions have already been asked. I noticed there was a spike in your G&A compared to last year, partially from a change in vesting of the board's deferred units from five years to immediately vesting. How much of the increase in your G&A was attributed to this vesting change?
There's about CAD 600,000 in the G&A. We'd expect that to recur every sort of second quarter when the annual grants are done. Really that change in the compensation plan was following an overall review of the compensation structure of management and the board. The changes were made to the board's compensation, and that was to align with current best practices in Canada.
Could you give a bit more color on the business taxes on the Tennessee property? Are these recurring or one time?
These are recurring. We would bring them in sort of on a quarterly basis throughout the year.
Just a bit more color on your Western Canada portfolio. You discussed a bit earlier already. Can you comment on the prospects and your sense of timing for releasing the vacant space?
Sure. I'd say we've got active prospect lists. We are actively marketing the recent terminations. The market continues to recover. Every lease we are doing now is at a higher rate than we were doing even three or six months ago. The market continues to recover. It is still a battle in Western Canada, I think we are seeing significant signs of recovery. I think we have got good prospect lists. I mentioned earlier the 70,000 feet of leasing that we did in Calgary alone since subsequent to Q2. We anticipate that trajectory to continue.
Okay. That is all my questions. Thank you.
Thank you. We have a question from Michael Markidis with Desjardins. Please go ahead.
Hi. Sorry, just a quick follow-up from me. On the change in the deferred unit plan, can you walk us through the philosophy on why the unit is now immediately vest versus over a five-year period?
Sorry, that was the bit of background I was giving in terms of the overall comp review. The governance committee reviews that on an annual basis, and they do kind of review what best practices are in Canada. This change was made to align with those best practices. It's consistent with a lot of the other REITs out there as well as the other Dream REITs.
Okay. Great. Thanks.
Thank you. We have no further questions at this time. I will now turn the call back over to Brian Pauls for closing remarks.
Thank you for your time today. We look forward to speaking again soon.
Thank you. Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.