Earnings Call: Q1 2018

May 9, 2018

Earnings release

Good morning, ladies and gentlemen. Welcome to the Dream Industrial REIT First Quarter 2018 Conference Call for Wednesday, May 9, 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 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 morning, everyone. Thank you for joining us today for the Dream Industrial REIT conference call, which is for the 3 months ended March 31, 2018. Speaking with me today is Lenis Kwan, the Chief Financial Officer of The REIT. On today's conference call, I will start off with an update of our business, my area of focus over the last few months and a few strategic initiatives we are working on. Lenis will then provide more details on our operations this quarter and financial highlights. We'll then be happy to field your questions. Industrial fundamentals have never been better. The Canadian economy remains very strong with overall industrial availability of 4%, a 16 year low. New supply under construction remains limited at 13,000,000 square feet or only 0.7% of the market inventory. It is unlikely that the new supply will meet the continuing demand results from e commerce and other economic drivers fueling increasing demand for industrial space. The impact of these strong fundamentals is being realized across our portfolio, especially in Ontario and Quebec. With our recent focus on increasing rents in the Ontario region, we have transactioned 682,000 square feet of deals at a rate $0.66 or 11.3 percent above expiry or prior rents or prior in place rents, which take occupancy in 2018. Our focus on active asset management continues to yield positive results and create more value in these assets. I want to highlight 2 examples of recently completed lease deals in the Greater Toronto Area, both in properties which we had previously considered selling. At 45 Progress Avenue in Scarborough, we received 3 offers to purchase this 209,754 Square Foot property. The offers were above our carrying value, and we considered selling it early in 2018. After running our analysis, we decided to capitalize on the leasing demand for the asset and execute an early 16 year blend and extend to immediately recognize a 2% lift on rent 2.5 years earlier than the lease expiry with 1.3 percent contractual escalators going forward. We are working with the tenant to invest capital to create an addition and greatly improve the existing building. On the capital we invest, we will receive an 8% return annualized over the lease term. We estimate that this has created approximately $10,000,000 of value for the asset as well as retained an important future income stream for the trust in Ontario. 2,130 South Service Road is a 98 1,175 Square Foot property in Oakville, which we had previously held for sale. We were initially seeking the property on a short term basis sorry, leasing the property on a short term basis but have now secured a 5 year lease at a rental rate that is 50% higher than the prior in place rent. This again demonstrates the strength of demand in Ontario and our ability to maximize rental rate growth from our portfolio. We think over time, we can continue to critically examine each building and lease within our portfolio and become more nimble and proactive in driving higher cash flows and value out of each asset. Our multi tenant portfolio in Ontario and Quebec has an average lease term of 3 years. It will take a bit of time for these lifts to be reflected in our results, but we think there's a good opportunity over the upcoming years to increase value throughout the portfolio. Our occupancy in Eastern Canada has increased 280 basis points since this time last year, and our Western Canada portfolio occupancy has remained strong at 94.8%. In Alberta, market reports for the Q1 have shown that net rents are increasing and vacancies are declining. We think overall, our portfolio in Canada is very valuable and well positioned to deliver solid, stable results for the foreseeable future. While our core operations are running well, interest rates have increased approximately 50 basis points over the past 5 months and cap rates have continued to compress. We have reviewed our acquisition and asset recycling strategies with a focus on improving our free cash flow and net asset value growth potential of each asset. We are analyzing every property in our portfolio to understand how to maximize property value and enhance the overall cash flow growth profile of DIR. With the encouragement of the Board at our meetings yesterday, we will continue to focus on asset recycling throughout 2018. We will look to trim the worst performers of our portfolio in terms of IRR and free cash flow performance and replace it with stronger performing assets, which we have confidence will appreciate in value going forward. On the growth front, Dream and Polscorp acquisition teams continue their work to source new opportunities that meet our investment criteria in both Canada and the U. S. While spreads have tightened due to increase in demand, we are still seeing good opportunities in markets we are interested in. In the Q1 of this year, we completed the acquisition of the remainder of our U. S. Properties from the DCT portfolio. Over the past 6 months, the trust has acquired 2,800,000 square feet of distribution of warehouse facilities in Memphis, Nashville, Orlando and Charlotte for a purchase price of $151,000,000 representing a weighted average cap rate 6.4% and a purchase price of approximately US54 dollars per square foot, which we believe represents a 10% discount to replacement cost of comparable properties in these markets. After acquisition, it was announced that DCT will be acquired by Prologis in a $8,400,000,000 deal and an applied cap rate in the low 4s. Lastly, over the last 90 days, our management team has toured across Canada and a few cities in the U. S. To talk to our investors. Our team is very excited over the potential of our business, and we have received a lot of good feedback from our unitholders, whom we greatly appreciate. Over to you, reported another quarter of healthy portfolio performance and solid financial results. Our leverage has declined 280 basis points since the Q1 of 2017, and I am happy to report that our diluted funds from operations or FFO per unit for the quarter was $0.224 flat compared to the same quarter prior year. Comparative property NOI was strong, improving by 2.8% from the same quarter last year, mainly reflecting higher average occupancy in Eastern Canada and Ontario. We maintained a healthy retention ratio for the quarter of 82.7% and have secured leases for 76% of our upcoming 2018 expiries compared to 68% this time last year. The value of our investment properties increased to $1,900,000,000 compared to $1,700,000,000 at the beginning of the year. The increase was largely a result of $115,000,000 in acquisitions completed during the quarter and a $57,000,000 increase in the value of our Ontario and Quebec properties, reflecting higher underlying cash flows, market rents and lower capitalization and discount rates. During the quarter, the Trust's reported net asset value per unit increased by $0.50 or 5.4 percent to $9.85 largely from higher investment properties in Ontario and Quebec. We think there will still be further runway for our IFRS values to improve over the course of 2018 as more of the demand for industrial and potential for rental growth is is captured in appraisal assumptions. The Trust's payout ratio on a diluted FFO a healthy 78.1% compared to 78.8 percent 1 year ago. Our leverage is lower at 49.5%, and at quarter end, we have unencumbered assets of $223,000,000 with $90,000,000 of liquidity on our credit facility. Our portfolio is well positioned to benefit from the continued strengthening in industrial fundamentals. Overall, we expect Within our portfolio, we are continuing to drive organic growth through continued contractual rental increases and increasing rental spreads, primarily in a microscopic lens to ensure it fits our investment criteria. We look for assets that would be above the average quality of our portfolio, offer attractive free cash flow profiles and can contribute to above average NAV growth for the REIT going forward. Our well capitalized balance sheet is at its strongest since inception, and we are well positioned to focus on strategies to improve the value of our business. I will turn it back to Brian. Thank you, Lenis. We would now be happy to take any questions. Thank you. Good morning. I have three quick questions. First, on your U. S. Strategy, could you give us a sense of your U. S. Acquisition pipeline? And how do you feel about pricing at this point? Sure, Fred. It's Brian Pauls. We feel good about the AUS acquisition pipeline. We're looking at a number of markets. The markets I mentioned in Nashville, Memphis, Charlotte and Orlando, we've got a presence there. We'd like to grow in those markets if possible. But we are tracking many more markets, a dozen or so more markets that we have experience in, contacts in, relationships in that we would be interested in growing in. So we feel good about the pipeline. It's competitive, as I mentioned in the opening remarks. But the U. S. Is a big enough market that we think we can be competitive there. Okay. And do I understand well you would be more than willing to sell assets in Canada to buy in the U. S? Well, I think we're looking at asset by asset recycling. We're not likely to recycle the ones we just purchased in the U. S, that's correct. But we are looking at our entire portfolio in terms of the most efficient assets, the most the best performing assets. Okay. Fair enough. And your same store NOI growth was quite solid for Q1. What should we expect for the rest of 2018? Well, we had provided guidance of 2% compared to cost of NOI growth for the year. And is this still realistic? Maybe do you feel it's a bit don't you think it's a bit conservative? No, no. I mean, I think what we're seeing is average occupancies in the East, Quebec, Ontario have all been positive, and we're obtaining rental growth into yes, obtaining rental growth from Ontario portfolio. And not to forget that we also have our contractual rental bumps in every region in portfolio. And we've had some pretty good results as we've showcased in our numbers regarding recent leasing in Ontario, and we're going to strive to continue to do better. Yes. Fred, I'd just add to Lance's point that we're pushing rents across the board. I think we're markets are the tightest. I mentioned the 11.3% spread. That's a big spread. We're going to continue to be leaders in pushing rents. So that's how we would answer that. No. All I was saying is that probably was on the low side, but it should be so be it, that's better. And lastly, your G and A was a bit higher than our estimate. I was wondering what would be a good run rate from here? Well, I think if we take out the asset management fee because that's based on the assets our total asset volume, I think the G and A run rate is from Q1 is a pretty good rate for the rest of the year. Perfect. That's it for me. Thank you. Thank you. Our next question is from Chris Couprie of CIBC. Please go ahead. Hi there. So just in terms of the AFFO disclosure, which was removed in the quarter. Just wondering, it's more of a technical question, how should we be thinking about incentive calculations, incentive fees? Well, just to work. So the incentive fee calculation tax. It's a contractual definition. So that will be included in our related party disclosures because it's based on a contractual definition between the REIT and Dream Asset Management. Okay. And in terms of dispositions, Brian, I guess you've had a chance to tour the assets a little bit. Any sense from you as to what percent of the portfolio you might consider to be up for disposition? It's a good question, Chris. I think we've built a model to look asset by asset. So we're not necessarily looking to trim a certain percentage, 10% the bottom 10%, but we are looking to trim specific assets that we feel like the best days are behind them and we can do better with new acquisitions. So look for I would say it's look for more asset recycling from us this year. It will depend on a little bit what opportunities we find to acquire. Ideally, we would match up dispositions with acquisitions and use the funds as efficiently as possible. But basically, what we're doing is taking our financial model that we've built, look at what assets are underperforming and look to trim those and try to match them up with acquisitions on assets that will outperform. Our next question is from Mike just make sure I was on the same page with respect to the just the evolution of your rental spreads in Ontario. And if I just go back to the press release, you mentioned that of the $9.90 of renewals in the quarter, dollars 6.95 of that, Ontario had a 2 percent lift. But then again, that was dragged down by those 2 single tenant properties where it seemed to be the deal was reached a long time ago. But then you said, so we can strip that out, but then what's the $682,000,000 that follows that? Is that stuff that didn't hit in the quarter? That's renewals that have been secured for Q2, Q3? I think what we wanted to highlight or communicate to everyone was just specifically to our actual lease deals that have been transacted in 2018, which is when we really started to focus on pushing for our rental growth in Ontario. And I think we wanted to show that once we've shifted that focus, this has been the result. Those 682,000 will take occupancy throughout 2018, so some of that has already taken occupancy in Q1. Okay. I got you. So the fall that I would assume we've done in Q2 and Q3? That's right. Okay. And then maybe just following up on Fred's question on the same property NOI growth. Just given that you came in at closer to 3% this quarter, is there anything that's aside from it just being 1 quarter, anything that's holding you back in terms of bumping up your expectation for this year? I mean, I think we're striving to do better capturing rental growth in Ontario and Quebec. It takes a bit of time to get those come through. We hope we will see better, but I think at this point, we're just guiding it to 2%. Okay. And maybe just with your recent the in place rent assumption did tick higher sequentially, specifically in the GPA. Is that sort of going to be something where you're going to continue? I would assume maybe that analysis hasn't hit through all properties and that the bias to that number is going to be upwards in the several quarters? Yes. I mean, I think we'll reevaluate that every quarter. So I think as we take several inputs, external appraisers, our leasing teams, market stats. So I think sometimes it takes a little bit of time for all that all the current events and recent deals to filter through in the numbers. So yes, I think we would expect in Ontario and Quebec, we see those numbers moving up throughout the year, probably staying flat in Midwest and East for now. Okay. Just two more quick ones for me before I turn it back. I think, Lenis, last quarter, you had mentioned that full year CapEx would likely come in at the level for 2017, if not slightly lower. Would that still be a serious option for this year? Yes, that's right. So what I had mentioned last quarter is still the same is that our planned capital spending was going to be flat for 20 17. And our total leasing costs really vary on the space and the volume that we're doing. But I think as a percentage of our total NOI, would see that our total capital spending would be flat compared to 2017. Got you. And on this one, I haven't had a chance to do the math on the MD and A, but I'm actually interested in maybe more specifically what's happened in the last couple of quarters. But have you seen any change in your participation rate, just given the recent extension of your softness? That hasn't materially changed from year end. Okay. Thanks very much. Thank you. Our next question is from Mark Rothschild of Canaccord. Maybe a follow-up just on a comment letter they gave about the IFRS value. You had a confidence that it would increase through the year. Is that based on cap rates that have already moved and that you just haven't had an updated appraisal? Or is that based on expectation that values will continue to rise? Well, I think it's a little bit of a ballpark. I mean, the way we do our evaluations for IFRS, we get a certain percentage of the portfolio externally appraised every year. So we continue to get the external appraisals for the rest of the year. We would expect to see a lot of the recent activity, particularly in in Ontario and Quebec, but still to bring through the appraisal assumption. For anything that's in terms of accruing information from the external appraisers and just to give you a sense, we think that a lot of these market assumptions that we're getting from the tend to lag. But just to give you a sense for Ontario, the cap rate ranges that you get from our external appraisers are in the $555,000,000 to $606,000,000 range for Ontario for Q1. And Brian, do you want to add color? Yes. Mark, it's Brian. So I think just to add to Dennis' point about the lack in value. There's a number of transactions that are in the marketplace. Portfolio near the airport lacks some deals, a lot of new things that are And those have necessarily been reflected on the right those who are kind of firm data yet. Those are contracted deals that they haven't closed. So as those kind of filter through the system, maybe IRS will continue to rise. Okay. Thanks. In regards to your comment about growth, it sounds like there's some good opportunities in various U. S. Markets. It seems like you're more optimistic to have completed positions in the U. S. Than in Canada. And the GTA in particular, CapEx has suppressed, as you noted, Yes. No, it's a good question. We are definitely looking in Toronto, we're definitely looking in GTA, Montreal, all the markets that we're in and we like. There are more volume of free cash flow growth, assets that will add to all the of our portfolio. So all those markets, I'd say, all the we're looking at, we want to grow Canada as well. And as we cycle out of assets, we'd like to replace those in Canada as well as the U. S. Okay, great. Thanks. Thank you. Our next question is from Sam Damiani of TD Securities. Please go ahead. Thanks and good morning. Just a follow-up last question. Did you look at the airport portfolio in Toronto here? And with the merger with DCT, do you see some opportunities there as they may cycle out some assets? Yes and yes. So yes, we did look at the airport portfolio that got bit up pretty heavily. I think King said it ended up outbidding Blackstone for that. I'm not sure the price is disclosed, but the cap rate was quite low and it was a very expensive deal. As it relates to the DCT Prologis, the Agatha Prologis acquisition of DCT, we believe and it's been disclosed that they will be shedding some of those assets, maybe 6%, 7% what I've heard. We'd love to pick some of those up. We don't know what they are yet. We as an organization know the players and we'll look to maybe acquire some of those assets if they fit within our current share yet. And those assets to you as far as certainly include some of the further markets you mentioned? Yes. We hope so. We don't know yet. Okay. And just on that 11% uplift in Ontario that certainly was interesting and talked about already. I mean, do you see that kind of growth continuing over the next year or 2 in Ontario? Or was there some 1 or 2 large leases that kind of drove that that may not be recurring? We're pushing rents everywhere, Sam. I think it's hard to make a blanket statement that that's going to happen across the province because it's an asset specific business. So where we can, I'll say as a general statement, we're pushing rents. We're pushing rents hard. We think rents can grow fast. We think that the certainly, the M and A activity in the market and the other transactions indicate the same thing. The fact that we're at a 16, 17 year low in vacancy with replacement costs rising every day, we don't know exactly how far rents can go, but we know they can go much higher than they are today, and we're going to try to be leaders in that. I don't think it's I can't it'd be impossible to give you an accurate view of what our whole portfolio is going to do because it's asset by asset, but I think our past performance is hopefully an indication of what's to come. And the market for development in Toronto would seem to be one of the best we've seen in a long time. Do you anticipate the REIT getting involved either on its own or with Dream Unlimited in development in the near term? Certainly, our sorry, Sam. Yes, the goal we have a goal of initiating development. Toronto would be great. The replacement costs are high. Construction costs are high and land prices are high. It's very hard to find good development opportunities, but we're looking every day. We believe we may find some, whether it's here or elsewhere. But in markets where purchase prices are at or above replacement cost, those are markets we want to be building in. That is getting it's pretty much becoming the case here in the Toronto GTA as well as in some of the other markets. You care to mention 1 or 2 markets where we might hear of some initial development activity with Dream Industrial? Not really. We're looking at a lot of different opportunities. I would say Toronto would be the one I'd mentioned specifically. Thank you. Thank you. Our next question is from Matt Kornack of National Bank Financial. Please go ahead. Good morning, guys. I wanted to quickly touch on the organic growth side. The U. S. Portfolio obviously isn't in your same property NOI growth numbers and won't be for a little while and there are no near term lease maturities there. What are the embedded rent steps for those assets generally? I think it's about approximately 2% on an annualized basis over 10 years, yes. So similar in profile to what you'd expect from the Canadian portfolio. And also on the Canadian portfolio, it sounds like, I mean, you're lapping some better occupancy numbers. And is that in part the reason why you'd expect same property NOI growth maybe to come down on a sequential basis quarter over quarter sorry, year over year? Well, I mean, we did have some we had significant increase in occupancy in Eastern Canada last year. So I think a good chunk so the NOI was picking up throughout the year for East. So I think sequentially for that region, we probably see it coming, I guess, on a quarter over quarter basis, kind of not being quite as high sequentially for the year. But in terms of the overall impact for the year and Ontario growth, I mean, I think that's what we're seeing to continue to kind of push that. Okay. And on Atlantic Canada, it's turned into a better news story. Are you guys seeing increased traction there in Burnside? And are you starting to see the benefits of Halifax sort of taking off to some extent? Matt, I think we've our team has done an amazing job getting the portfolio leased to where it is. I think we'll continue to do well there. I think we'll probably get a disproportionate share of the leases done there than are in the market because we've got great properties. The location is good. I think we are seeing the benefits of some of that hard work of just focusing on that market. Okay. And with regards to Western Canada, obviously, not back quite yet, but energy prices today are moving higher and they have been for a little while here. Any sense in the market that things are returning to sort of maybe not the boom times, but a little bit better? And also on that front, would you be looking to add product in that market? Or do you think you have enough at this point? We are looking at opportunities there. I mean, we like that market. The vacancy rate is down to 7.9%. The rents are growing there. I think it hasn't necessarily totally hit stride, but it's certainly turning the corner. So I guess to answer both your questions, we believe it is improving. We think we're at somewhere near the bottom of the valley kind of climbing out of there and get good things to come with all the things you mentioned. And we would look at opportunities there. We have looked at them. I think we'd continue to look for good product that would complement what we have there. Okay, great. Thanks. Thank you. Our next question is from Pammi Bir of Scotia Capital. Please go ahead. Thanks. Good morning. Just given the decent improvement in your cost of equity, what are your thoughts with respect to funding acquisitions with perhaps coming back to the markets at some point or versus sticking with the plan for asset sales? So we have dry powder now that we can use to fund acquisitions. So what we want to do, I guess, Pammi, to answer your question is maintain liquidity enough so that we can capitalize on opportunities as we find them. So the answer to your question is we've got enough liquidity available to go chase opportunities right now, and then we'll kind of address that later if there's not as much available. That's helpful. And then just when you talk about the pipeline or what you're looking at, can you comment on sort of what might be in some sort of advanced stages for from the from an acquisition standpoint or in terms of the volume that you could transact on, I guess, over the next several months? We're looking we've got a number of opportunities in front of us right now that we are chasing. I would say we're looking at portfolios that are somewhere between $50,000,000 $100,000,000 in size of dollar size. And we're seeing more of them in the U. S. Than we are in Canada, although we are currently actively chasing opportunities in both Canada and the U. S. And just on those, I guess, what would the cap rate differential be between some of these transactions you're looking at? Most of what we're looking at is low 6s. Maybe into the high 5s, it's kind of where the market is right now. Okay. And I apologize if this was already answered, but just Ontario and Eastern Canada are tracking pretty well, but from an organic growth standpoint. But can you maybe just provide some Quebec was just a result of, I guess, just the short term downtime, rollover in some of our spaces. So that space has been subsequently been leased up. So I think we view that is short term in nature. Markets are quite strong in Quebec as well. So I think we're seeing some really good activity. I think that and that's a sign of the activity picking up in that market. Thank you. Our next question is from Brad Sturges of Industrial Alliance Securities. Please go ahead. In terms of the acquisition strategy, I guess, for Canada, and you're talking about more NEV growth. Is that looking at assets that have that value add excess land for development opportunity? Or is it simply trying to find off market deals where the rents are well below market and you can grow through some rent growth, for example? So just trying to get some context of what that NAV focus could look like. Yes, Brad. I think it's both. I think we are looking for areas where we can grow rents. If we can do some value add if there's a value add component to it, we would certainly look to capitalize on that as well. But I think it's both of those things. We're looking at a number when you look at an acquisition, I think cap rate is only a portion of the story. So cap rate, replacement costs, dollar price per pound or replacement cost per square foot as well as where the markets are compared to rent. So those three components really make up kind of how we would analyze the value of an asset. Right. And obviously, you're making decisions within the existing portfolio on an asset by asset basis and acquisitions are very opportunistic in nature. Guess if you're taking a looking at it from an ideal scenario, it sounds like the weighting in the U. S. Will increase. I guess when you're looking at Canada, are you comfortable with the general geographic mix of the portfolio today? Or are there areas where you like to increase or decrease within Canada? I think we're looking at places where we can add kind of synergy, add more economies of scale in the markets we're in, but there's a lot of markets we'd like to add to that, that we're not currently in, particularly in the U. S. I'm not sure we're looking to shed any necessarily specific geography or grow take a rifle shot at specific geographies. We're looking at opportunities where we can find them. Got it. Great. Thank you. Thank you. We have no further questions. Thank you everyone for your time today. We look forward to speaking again soon. Thank you. And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.