Good morning, ladies and gentlemen. Welcome to the Dream Industrial REIT first quarter 2018 conference call for Wednesday, May 9th, 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 Dream Industrial REIT's website at www.dreamindustrialreit.ca. Later in the presentation, we will have a question and answer session.
To queue up for a question, press *1 on your telephone keypad. 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 three months ended March 31st, 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 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 million sq ft, 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 transacted 682,000 sq ft of deals at a rate CAD 0.66 or 11.3% above expiry 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 two 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 three offers to purchase this 209,754 sq ft property.
The offers were above our carrying value. 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 two and a half years earlier than the lease expiry, with 1.3% 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 CAD 10 million of value for the asset, as well as retained an important future income stream for the trust in Ontario. 2130 South Service Road is a 98,175 sq ft property in Oakville, which we had previously held for sale.
We were initially leasing the property on a short-term basis. We have now secured a five-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 three years. 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 first quarter 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 five months. 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 Pauls Corp. 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 first quarter of this year, we completed the acquisition of the remainder of our U.S. properties from the DCT portfolio.
Over the past six months, the trust has acquired 2.8 million sq ft of distribution and warehouse facilities in Memphis, Nashville, Orlando, and Charlotte for a purchase price of $151 million U.S., representing a weighted average cap rate of 6.4% and a purchase price of approximately $54 U.S. per sq ft, 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 an $8.4 billion U.S. deal at an implied cap rate in the low fours. 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, Lenis.
Thank you, Brian. Dream Industrial reported another quarter of healthy portfolio performance and solid financial results. Our leverage has declined 280 basis points since the first quarter of 2017, and I am happy to report that our diluted funds from operations, or FFO, per unit for the quarter was CAD 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 CAD 1.9 billion, compared to CAD 1.7 billion at the beginning of the year.
The increase was largely a result of CAD 115 million in acquisitions completed during the quarter and a CAD 57 million 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 CAD 0.50, or 5.4%, to CAD 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 captured in appraisal assumptions. The trust's payout ratio on undiluted FFO is a healthy 78.1%, compared to 78.8% one year ago. Our leverage is lower at 49.5%, and at quarter end, we have unencumbered assets of CAD 223 million, with CAD 90 million of liquidity on our credit facility.
Our portfolio is well-positioned to benefit from the continued strengthening in industrial fundamentals. Overall, we expect comparative property NOI growth to be up about 2% this year, coming from higher occupancies in Ontario, Quebec, and Eastern Canada, along with some rental growth in Ontario. Within our portfolio, we are continuing to drive organic growth through continued contractual rental increases and increasing rental spreads, primarily in Ontario and Quebec. We believe this will result in higher comparative property NOI growth beyond 2018. We have attempted to balance our healthy operating results with a disciplined investment and asset recycling strategy. We evaluate every acquisition with 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. 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 the hash key. If you are using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press star then one on your phone now. Our first question is from Frederic Blondeau of Echelon Wealth Partners. Please go ahead.
Thank you, good morning.
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 U.S. 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. 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. 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. 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.
Yep.
We are looking at our entire portfolio in terms of the most efficient assets, the best-performing assets.
Okay. Fair enough.
Thank you.
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%-
Yeah
comparative NOI growth for the year.
Is this still realistic? Don't you think it's a bit conservative?
No. I think what we're seeing is average occupancies in the East Quebec, Ontario, have all been positive, and we're obtaining rental growth.
Good.
Yeah. Kind of obtaining rental growth from our Ontario portfolio. Not to forget that we also have our contractual rental bumps in every region in our portfolio. 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.
Yeah. Fred, I'd just add to Lenis's points that we're pushing rents across the board. I think we've got the best opportunities in the markets we mentioned in Ontario and Quebec. That's where the 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, that's how we would answer that.
No, all I was saying is that I thought it was on the low side, but if it should be, so be it. That's the better. Lastly, your G&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 our total asset volume.
Sure
I think the G&A run rate from Q1 is a pretty good rate for the rest of the year.
Perfect. That's it from me. Thank you.
Thank you. Our next question is from Chris Couprie of CIBC. Please go ahead.
Hi there. Just in terms of the AFFO disclosure, which was removed in the quarter, just wondering, this is more of a technical question. How should we be thinking about incentive calculations, incentive fees?
The incentive fee calculation is not based on the, I guess, the recent REALPAC . It's a contractual definition, so that'll be included in our related party disclosures because it's based on a contractual definition between the REIT and Dream Asset Management.
Okay. 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 % 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. We're not necessarily looking to trim a certain %, 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. Look for, I would say, look for more asset recycling from us this year. It'll 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. 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.
Okay. Thanks.
Thank you. Our next question is from Michael Markidis of Desjardins. Please go ahead.
Thanks. I was hoping to get a little bit more clarity just to make sure I was on the same page with respect to just the evolution of your rental spreads in Ontario. If I just go back to the press release, you mentioned that of the 990 of renewals in the quarter, 695 of that Ontario at a 2% lift. Again, that was dragged down by those two single-tenant properties where it seemed to be the deal was reached a long time ago. If we could strip that out, but then what's the 682 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 the 682 are 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. 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.
I got you. The default of that, we assume we've got in Q2 and Q3.
That's right.
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 one quarter, anything that's holding you back in terms of bumping up your expectation for this year?
I think we're striving to do better at capturing rental growth in Ontario and Quebec. It takes a bit of time to get those to come through. We hope we will see better, but I think at this point, we're just guiding to 2%.
Okay. Maybe just with your recent in-place rent assumption did tick higher sequentially, specifically in the GTA. Is that 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 next several quarters.
Yes. I think we evaluate that every quarter. We take several inputs, external appraisers, our leasing teams, market stats. I think sometimes it takes a little bit of time for all the current events and recent deals to filter through in the numbers. Yes, I think we would expect in Ontario and Quebec, we see those numbers moving up throughout the year, probably staying flat in the West and East for now.
Okay. Just two more quick ones from 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 safe assumption for this year?
Yes, that's right. What I had mentioned last quarter, and it's still the same, is that our planned capital spending was going to be flat for 2017, and that our total leasing cost really varies on the space and the volume that we're doing. I think as a percentage of our total NOI, we would see that our total capital spending would be flat compared to 2017.
Got you. Briefly on this one, I haven't had a chance to do the math on the MD&A but I'm actually interested in maybe more specifically what's happened in the last couple of quarters. Have you seen any change in your DRIP participation rate, just given the recent ascension of your stock price?
Haven't materially changed from year-end.
Okay. Thanks very much.
Thank you. Our next question is from Mark Rothschild of Canaccord. Please go ahead.
Thanks. Good morning. Maybe follow up just on a comment, Lenis, that you made with the IFRS values, being you sounded confident 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 a little bit of both, Mark. The way we do our valuations for IFRS, we get a certain percentage of the portfolio externally appraised every year. As 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 Ontario and Quebec, start to ring through the appraisal assumption. For anything that's internal, we're appraising information from the external appraisers. Just to give you a sense, we think that a lot of the market assumptions that we're getting from that tend to lag. Just to give you a sense for Ontario, the cap rate ranges that we get from our external appraisers are in the 555 to 600 basis range for Ontario for Q1. I don't know, Brian, maybe you want to add a bit earlier.
Yes. Mark, it's Brian. I think just to add to Lenis' point about the lagging value, there's a number of transactions that are in the marketplace. There's Portfolio here, the Airport, the Blackstone deal. There's a lot of these things that are in the market that haven't necessarily closed, and they're kind of leading the value increase in the industry or in the markets. Those haven't necessarily been reflected on appraisals or kind of firm data yet. Those are contracted deals, but they haven't closed. As those kind of filter through the system, I think the IFRS will continue to rise.
Okay. Thanks. In regards to your comment about growth, it sounds like there's some good opportunity in various U.S. markets. It seems like you're more optimistic about completing acquisitions in the U.S. than in Canada. In the GTA in particular, cap rates have suppressed, as you noted and rents are rising. What are your thoughts about buying properties in Toronto now at these low cap rates where it may not be a good going in, but there seems to be some strong rent growth that's starting to come through?
Yeah. No, that's a good question. We are definitely looking in Toronto. We're definitely looking in the GTA, Montreal, all the markets that we're in and we like. There's more volume of activity in the U.S., we're seeing more deals, we're likely to maybe find opportunities quicker there. Really looking at NAV growth, free cash flow growth, asset level, adding to the quality of our portfolio. All those markets, I would say all the above we're looking at. We want to grow in Canada as well. As we cycle out of assets, we want to replace those ones in Canada as well as the U.S. I would say we're likely to grow a little faster in the U.S. just because there's just more volume of the market.
Okay, great. Thanks.
Thank you. Our next question is from Sam Damiani of TD Securities. Please go ahead.
Thanks, and good morning. Just to follow on Lenis' 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 of some assets?
Yes and yes
Yes, we did look at the airport portfolio. That got bid up pretty heavily. I think KingSett ended up outbidding Blackstone for that. Though I'm not sure the price is disclosed, but the cap rate was quite low. Again, it was a very expensive deal. As it relates to the DCT Prologis. The Prologis acquisition of DCT, we believe, and it's been disclosed, that they will be shedding some of those assets, maybe 6%, 7% is what I've heard. We'll go 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're within our criteria.
Those assets, as far as you're concerned, certainly include some of the target markets you mentioned.
Yes. We don't know yet.
Okay. Just on that 11% uplift in Ontario, that certainly was interesting and talked about already. Do you see that kind of growth continuing over the next year or two in Ontario? Or was there some one or two large leases that kind of drove 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. 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 certainly the M&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.
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. I think our past performance is hopefully an indication of what's to come.
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?
We certainly are. Oh, sorry, Sam. Yeah, we have a goal of initiating development. Toronto would be great. The replacement costs are high. Construction costs are high, and land price 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 pretty much becoming the case here in the Toronto GTA, as well as in some of the other markets.
You care to mention one or two 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 mention specifically.
Thank you.
Thank you. Our next question is from Matt Kornack of National Bank Financial. Please go ahead.
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 annual basis over 10 years. Yeah.
Similar in profile to what you'd expect from the Canadian portfolio. Also on the Canadian portfolio, it sounds like you're lapping some better occupancy numbers. 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.
We had a significant increase in occupancy in Eastern Canada last year. The NOI was picking up throughout the year for East. I think sequentially for that region, we'd probably see it coming, I guess, on a quarter-over-quarter basis, not being quite as high sequentially for the year. In terms of the overall impact for the year and Ontario growth, I think that's what we're seeing to continue to kind of push that.
Okay. On Atlantic Canada, it's turned into a better news story. Are you guys seeing increased traction there in Burnside? Are you starting to see the benefits of Halifax sort of taking off to some extent?
Matt, I think 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's good. I think we are seeing the benefits of some of that hard work of just focusing on that market.
Okay. With regards to Western Canada, obviously not back quite yet, 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? 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. We like that market. The vacancy rate's 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. 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 got good things to come with all the things you mentioned. 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?
We have dry powder now that we can use to fund acquisitions. 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. 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. When you talk about the pipeline or what you're looking at, can you comment on what might be in some sort of advanced stages from an acquisition standpoint or in terms of the volume that you could transact on, I guess, over the next several months?
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 CAD 50 million-CAD 100 million in dollar size. 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.
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 sixes. Maybe into the high fives. It's kind of where the market is right now.
Okay. I apologize if this was already answered, but just Ontario and Eastern Canada are tracking pretty well, but from an organic growth standpoint. Can you maybe just provide some color on the drop in Quebec and at what point that may return to stronger results?
I think the drop in Quebec was just a result of, I guess, just the short-term downtime rollover in some of our spaces. That space has been subsequently been leased up. I think we view that as 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.
Great. That's helpful. Thanks very much.
Thank you. Our next question is from Brad Sturges of Industrial Alliance Securities. Please go ahead.
Hi there. In terms of the acquisition strategy, I guess, for Canada, you're talking about more NAV 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? Just trying to get some context of what that NAV focus could look like.
Brad, I think it's both. I think we're 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. I think it's both of those things. When you look at an acquisition, I think cap rate is only a portion of the story. Cap rate, replacement costs, dollar price per square foot or replacement cost per square foot, as well as where the markets are compared to rent. Those three components really make up kind of how we would analyze the value of an asset.
Right. Obviously, you're making decisions within the existing portfolio on an asset-by-asset basis, and acquisitions are very opportunistic in nature. I guess if you're 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'd 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. There's a lot of markets we'd like to add to 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 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. Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.