Good morning, ladies and gentlemen. Welcome to the Dream Industrial REIT’s Second Quarter Conference Call for Wednesday, August 3rd, 2022 . 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 zero, then one on your telephone keypad. Your host for today will be Mr. Brian Pauls, CEO of Dream Industrial REIT. Sir, you may begin.
Good morning, everyone. Thank you for joining us today for Dream Industrial REIT's 2022 Second Quarter Conference Call. Speaking with me today is Lenis Quan, our Chief Financial Officer, and Alexander Sannikov, our Chief Operating Officer. Dream Industrial's operating results continue to highlight the quality of the business and the growth opportunities embedded in our portfolio. We reported a 12.6% increase in FFO per unit for the quarter, led by strong CPNOI growth and lower cost of debt. Our pace of CPNOI growth rose to another record high of 10.1% in Q2, with Quebec leading the year-over-year growth at nearly 16%, followed by Ontario with a 12% year-over-year growth, both driven by solid rental rate and occupancy increases.
Despite higher interest rates due to inflationary pressures and a more hawkish tone from the central banks, industrial fundamentals continue to be strong across our operating markets. This has resulted in low availability, tight supply, and strong capital values. There is now a significant disconnect between the public market pricing of industrial and what we are seeing in the private markets. In Canada, we continue to build on our attractive market positioning in our core markets of the GTA, GTHA, and Greater Montreal Area through high-quality acquisitions, as well as executing on our development and intensification pipeline. With the national vacancy rate at just 1.6% and several markets with sub 1% vacancy, industrial fundamentals continue to remain exceptionally strong.
On nearly 2.5 million sq ft of leases transacted to date this year in Canada, we have achieved rental spreads of 31%, led by spreads of 71% in Ontario and 42% in Quebec. In Europe, notwithstanding geopolitical events, we have continued to see strong demand for industrial space. Our European portfolio is essentially fully occupied with committed occupancy at 99%. With in-place rents below market and the high occupancy level, we are confident of driving healthy rental rate growth. On over 1.1 million sq ft of leases transacted this year in Europe, we have achieved rental rate spreads of nearly 14%. Our development pipeline continues to be an accretive driver of cash flow and NAV growth while upgrading portfolio quality.
Despite inflationary pressures on the cost side, market rent growth has continued to outpace cost increases. Our forecast unlevered yield on costs for our near-term development pipeline have increased from our initial underwriting and now averages 6.3%, over 50 basis points higher than our initial forecast. Our strategic initiatives over the past several years have positioned us well to navigate the current market volatility. With our portfolio essentially full and in-place rents well below market rents, our organic growth profile remains robust and should allow us to drive strong per unit cash flow. Given the market volatility, we expect our near-term acquisition activity to moderate compared to the first half of 2022.
We have increased our focus on maintaining an ample liquidity cushion and low leverage. We are actively monitoring our target markets, and our flexible balance sheet provides us sufficient capacity to capitalize on compelling investment opportunities that are of strategic importance for the REIT. Since the end of the first quarter, we completed approximately CAD 368 million of previously announced acquisitions during the quarter that added over 1.9 million sq ft of high-quality assets to the portfolio. In Canada, we acquired seven income-producing assets totaling 500,000 sq ft for CAD 136 million, as well as 19.5 acres of development land in the Balzac submarket of Calgary.
These assets are primarily located in the GTA, were acquired well below replacement costs, and offer the opportunity to drive significant rental rate growth over time. The average in-place rents are over 25% below current market rent. In Europe, we acquired eight income-producing assets totaling 1.4 million sq ft for CAD 220 million. These assets are well-located close to major transportation corridors and leased to high-quality tenants. In the U.S., we continue to benefit from providing property management and leasing services to the U.S. fund.
In 12 months since the inception of the U.S. fund, we have recognized over $2 million in net property management and leasing income, which is ahead of our initial expectations, and we expect the run rate to increase further as the U.S. fund continues to grow. We continue to see a long runway for industrial fundamentals, and our business is well positioned to outperform. I will now turn it over to Alex to talk about our organic growth and outlook of our operations.
Thanks, Brian. During the quarter, the value of our assets increased by CAD 45 million, primarily driven by higher market rents and increased values for properties appraised externally. Largely driven by the increase in asset values, DIR's NAV per unit increased to CAD 16.64, a 21.5% increase year-over-year. As Brian mentioned, we continue to see a significant disconnect between public and private market valuations. For example, our current unit price implies a capital value of about CAD 140 per sq ft on our income-producing properties, which is significantly below private market values, especially as our operating performance remains robust. Leasing momentum in our portfolio remains strong, and we reported 10.1% year-over-year CPNOI growth this quarter, a new record for the REIT.
This was driven by a 6.8 % increase in in-place rents and a 1.4 % increase in average occupancy. Since the beginning of the second quarter, we signed 1.4 million sq ft of leases across our portfolio. In Canada, we have signed over one million sq ft of leases at an average spread of 39%. I will go over a few key highlights. We finalized a 275,000 sq ft renewal with a major global corporate tenant in Regina for a 10-year term with 2% annual steps at starting rents in line with expiring. Recently, we leased our 43,000 sq ft expansion project in Richmond Hill to a national tenant, resulting in a yield on cost of 11%.
Earlier this week, we finalized a commitment with an existing tenant in Montreal for our 120,000 sq ft expansion at CAD 14 per sq ft with 4% annual steps. We expect to realize a yield on cost of over 8% on this project. In Terrebonne, Quebec, we finalized a renewal for 57,000 sq ft at a rent approximately 100% higher than expiring. As part of the renewal, we agreed with the tenant to expand the building by 29,000 sq ft. In Europe, we signed 300,000 sq ft of leases at an average spread of 11%. The level of leasing activity in Europe remains strong. We're in advanced negotiations to lease the entire 241,000 sq ft expansion in Dresden.
We're also in advanced negotiations on a new lease for over 400,000 sq ft in France. Contractual rent steps are an important driver of steady CPNOI growth. Currently, embedded steps equate to over 2.5% per year on our Canadian leases. In our recent leases, we have been able to negotiate significantly higher growth with 4% per year in the GTA and 3% per year in the GMA. In Europe, 90% of our leases are indexed to CPI. As a result, the outlook for CPNOI growth remains strong, and we continue to expect CPNOI growth of 8%-10% for the full year of 2022.
In addition to same-property NOI growth, we continue to see several drivers of NOI NAV growth across our portfolio. We have made significant progress on our development pipeline and achieved strong yield on cost on our recently completed projects. We completed a 65,000 sq ft expansion in the Netherlands, which was pre-let at construction start. Over the next 12 months, we expect to complete construction on six projects totaling 683,000 sq ft. To date, we have leased approximately 200,000 sq ft of space in these developments and are currently in various stages of negotiations and marketing for the balance of the space.
We expect that these projects will be substantially leased before completion. We intend to commence the redevelopment of a cluster of three buildings on a 10-acre site located in Mississauga. We're working towards the construction of a 290,000 sq ft best-in-class net zero carbon facility with an unlevered yield on cost of over 6%-6.5%. We expect to start construction this fall. We have approximately 1.9 million sq ft in advanced planning stages. Most of these projects are expected to be substantially completed over the next 18–24 months, with an average yield on cost of 6%.
Overall, our assessment is that the market rents continue to outpace increases in construction costs, resulting in improvements in the yield on cost metrics for our development program. We're also progressing well in our value add CapEx initiatives within our portfolio. For example, we're executing on 15 solar projects across Canada and Europe that will add over 22,000 solar panels. We expect an overall capital investment of roughly CAD 12 million with an unlevered yield of over 10%. We expect this income to come online in phases starting the second half of 2022.
Overall, we are encouraged by the operating fundamentals in our markets and the opportunities within our business to drive organic NOI and NAV growth as we execute on our active asset management strategy. I will now turn it over to Lenis, who will provide our financial update.
Thank you, Alex. Our financial results are strong and demonstrate the success of our strategic initiatives over the past several years. Diluted funds from operations was CAD 0.22 per unit for the quarter, 12.6% higher than the prior year comparative quarter due to higher NOI from our comparative properties, successful deployment of our balance sheet capacity, and lower borrowing costs as we executed on our European debt strategy. We ended the quarter with leverage just under 30% and with approximately CAD 429 million of available liquidity. Since June 30th, we have closed on one acquisition for CAD 23 million and have another two acquisitions totaling CAD 85 million that are firm or in exclusivity.
We retain sufficient liquidity and balance sheet capacity to execute on these acquisitions and fund about CAD 70 million in development costs over the balance of 2022. Our near-term debt maturities are limited, with only CAD 270 million of debt maturing in the next 18 months. With access to euro-equivalent debt that continues to be priced about 200 basis points lower than North American debt, we expect refinancing these upcoming maturities to have limited impact on our financial results. Our euro-equivalent debt provides a natural currency hedge to our assets and income from Europe. As our assets are nearly fully hedged, we expect minimal movement in our net asset value per unit from changes in the euro-CAD FX rate.
On the FFO side, there is some impact due to the spread between our yields, our NOI yields, and interest rates. The recent roughly 5% strengthening in the Canadian dollar versus the euro since the end of the quarter of June 30th has less than CAD 0.01 impact on our FFO per unit forecast for 2022. Given the recent market volatility, we intend to run at leverage in the low to mid-30% range and retain sufficient balance sheet capacity to pursue and execute on compelling investment opportunities. We expect FFO per unit for the full year 2022 to be in the range of our prior guidance, with the biggest variables dependent on average leverage and foreign exchange rates.
Our strong and flexible balance sheet and significant opportunities of driving cash flow and NAV continue to position us well to deliver strong operating and financial results. I will turn it back to Brian to wrap up.
Thank you, Lenis Quan. Over the past several years, we've built DIR.UN into a high-quality, resilient business that is capable of producing strong returns for all of our stakeholders. With the strength of our balance sheet and significant drivers of organic growth, we remain well positioned to continue to create value for our unitholders. I'll now open it up for questions.
Thank you. We will now begin our question-and-answer session. If you have a question, please press zero, then one, on your touch-tone phone. If you wish to be removed from the queue, please press zero, then two. If you're using a speakerphone, please pick up the handset first before pressing the numbers. Once again, with your question, please enter the queue by pressing zero, then one. Our first question is from Mark Rothschild with Canaccord Genuity.
Thanks. Good morning, everyone. Brian, you guys have assembled, you know, quite a large development pipeline. Do you see development yields changing at all with rising costs? Things have definitely cost more now than a year ago. Does this change development yields? Does it maybe impact at all, whether positive or negative, your outlook on growing the development pipeline stronger? Obviously, rental rates have gone up quite a bit as well.
Yeah. Thanks, Mark. I mentioned in my comments. Our yields are actually going up more than the costs. We've increased our outlook on our yield on cost for our developments going forward. What we're finding is costs have certainly gone up, but rents have gone up faster. We've increased by 50 basis points our outlook of the development program. We've got a significant program in our joint venture with GIC. We're looking for you know land throughout the GTA. Anyway, we see our development program continuing to grow. We see that as a great opportunity for us.
Okay, thanks. I guess I was just asking more about, you know, with values where they are now is if you're looking to grow and, yeah, you did answer that. Maybe just moving on to something else as far as, I see the move in the fair market value of your assets. Can you just maybe explain a little more how you guys look at IFRS values? Is it based only on transactions that have occurred in the past, or is this based on where you believe the market is today or where transactions would happen? For the most part, it's a slower pace of transactions in the market. So just wanna understand how you guys look at it.
Go ahead, Alex.
Thanks, Brian. So we've looked at, kind of as we always do, on any quarter, we look at sort of the market rent outlook. We look at sort of the implied total returns by these values. We have seen some transaction evidence, especially in Canada. It's not firm yet, not announced, but we know that there's been some bidding activity on some portfolios in the GTA, in Calgary. The capital values that are implied by the level of bids suggest that, you know, that our IFRS values are reasonable and there was no reason to kind of change that significantly.
We felt pretty confident with that, with those data points supporting our IFRS values. In addition, as we said in our prepared remarks, the CAD 45 million of increases in value that we saw this quarter was largely driven by external appraisals.
Okay, great. Thanks so much, guys.
Thank you. Our next question is from Sam Damiani with TD Securities.
Thanks, and good morning, everyone. The business is obviously going extremely well in spite of the macro headlines that we're all aware of. I guess , just how are you changing the approach of the business given the macro concerns, and I guess specifically, over in Europe, have you changed your strategy in any way in the short term as a result of those macro concerns?
Yeah. Thanks, Sam. Generally, we're running the business with very low debt. We're basically treating liquidity as very precious. We're re-underwriting all of our acquisitions, not just in Europe, but in North America as well. I would say we're seeing rent growth, we're seeing opportunities. We're looking at our acquisitions very carefully to make sure they are, one, accretive to our business, but two, also strategic from a location and quality standpoint. Alex, you can talk a little bit about specifically in Europe, what we're looking at and how we're underwriting given the current environment.
Yeah. Thanks, Brian. We continue to see strong levels of leasing activity in Europe. We don't have a lot of vacancy, but we have some developments that are coming up, and we're reengaging with tenants. What we're generally seeing is that the level of leasing activity is robust, and in fact, we would suggest that on our availabilities, the level of leasing activity now exceeds the levels that we've seen, call it six months ago. It could be a function of, you know, our projects being more advanced, or it could be a function of just generally the broad demand in the market. You know, it's not one or two tenants that we're seeing.
For example, on our development in Dresden, we're engaging with five tenants. We won't be able to accommodate all five, but that's kind of the level of leasing activity we see on that particular asset.
That's helpful. Excuse me. Just on the IFRS fair values, I noticed, there was cap rate changes in most markets, very modest, but, one market that didn't see any cap rate changes was Europe, if I'm not mistaken. I wonder if you just, I guess, address that.
Yeah, that's a fair observation. That said, on the cap rate side, what we see is, you know, we held values largely flat on a capital value basis. The market rents have gone up, NOI has gone up, and that really resulted in, you know, expanding cap rates. This is consistent with what we see across the board.
Okay, great. Thank you.
We have our next question from Kyle Stanley with Desjardins.
Thanks. Good morning. As you work through the planning phase for your future developments, are you starting to see cost inflation moderate, or has access to materials improved at all at this point?
Yeah. I'll just start by saying I think we are seeing it moderate, Kyle. It's certainly going up at a slower rate than it was. You know, the developments that we do are concrete, steel, glazing. Those are the main components. We're seeing certainly moderation in those. As I mentioned, as costs have increased, we're certainly seeing a stronger benefit in rent. The yields are strong, but I think the development outlook for us is positive because of the yields that we can achieve and because of the outlook to supply chain getting more positive. Access to labor, access to materials, I think is gonna be better for us as we go. Certainly we intend to continue developing the markets that I mentioned in the prepared remarks.
One more anecdote to add to that. We just recently went out to the market for an RFP on a new project in the GTA. We received construction bids from a number of players. The range that we've seen in those bids is about 7% from high to low. That range would've been much wider, call it 12 months ago. That seems to be a sign that the market is moderating as Brian suggested.
Okay, great. Then, you know, you kind of discussed it a little bit, but I'm just thinking more on the tenant side here. Like, you know, have you seen any changes, whether they be positive or negative, you know, in demand for space, desired floor plates, types of tenants that are looking for space or maybe just in another way? Is there anything you're seeing in the market currently that indicates there may be a change in demand or activity in the second half, you know, just given some of the macro concerns that you've mentioned?
No. Yeah, I wouldn't say that we have seen any significant changes in sort of demand patterns. We continue to engage with 3PLs. We have tenants who are looking to expand. We've done some renewals with, you know, larger corporate tenants. It seems to be quite a range and how we would've characterized the demand market, you know, six months ago. We can't really point to any significant changes.
Kyle, the only thing I'd add to Alex's comments are that, you know, we underwrite very closely the quality of buildings, clear height, bay spacing, truck maneuvering area, access to main highways and arteries. I would say the use of space is pretty utilitarian. If one particular tenant doesn't want it, I mean, it's very generic space, so it works well for 3PLs, for specific users, and that's how we underwrite space. That's kind of the portfolio we wanna build.
Okay, thanks. Just a quick last one for me. I don't know if you can, but would you be able to provide the average cap rate for the acquisition activity completed during the second quarter?
We don't have the second quarter right here in front of us, so we can maybe follow up with you separately, if that's okay, Kyle.
Yep, no problem at all. I'll turn it back. Thanks, guys.
Thank you. Our next question is from Gaurav Mathur with iA Capital Markets.
Thank you, and good morning, everyone. Two quick questions on my end, and I'll begin with the first. Given the macroeconomic volatility and the fact that Europe is heading into a more certain recession, how are you viewing the European industrial market from an acquisition and a capital deployment viewpoint? I mean, is there a price discovery phenomenon currently in place, or is that still too soon to be said for Europe?
Thank you for the question. We haven't seen a whole lot of transaction evidence in Europe on the investment side. You know, when comments are being made about Europe going into a recession, that's kind of characterizing the broad macroeconomic environment, perhaps. When we think of it as just purely industrial market and the fundamentals. In the industrial market, what we're seeing is very low availability, steady demand, and we are seeing that rental rates are rising and rising faster now than they were call it six months ago, because the development pipeline is slowing, and also with the cap rates perhaps being an uncertain metric, the development community is looking to get higher rents on their projects to get the same return.
Overall, we expect that if the demand stays as it is now, supply stays moderate or moderates further, the operating fundamentals in industrial will remain strong and will outperform the broader, you know, real estate market in Europe. With that, it will inevitably drive the capital market activity, because the underwriting confidence will be there. We've seen that, for example, with Western Canada , 12 months ago. We've seen the operating fundamentals kind of pretty robust. The capital market activity wasn't there, or there wasn't a lot of transactions. As you know, we've seen a couple of quarters of that of those strong operating fundamentals, you know, that followed by a wave of capital market activity that we've seen recently. We remain pretty constructive on industrial in Europe.
Okay, great. You know, given the dislocation in public and private markets, and you all alluded to that as well, are there any considerations towards buying back the stock at current levels?
Yeah. I mentioned the disconnect between private and public. Right now, we've not engaged in that. We've basically kept our balance sheet available for opportunities. We do think we will see opportunities that are accretive and very strategic for us, so that's an important priority for us.
Okay. Thank you. Thank you for the color. I'll turn it back to your operator.
Thank you. Our next question is from Matt Kornack with National Bank Financial.
Hi, guys. On your Canadian portfolio, you had some of the best rent spreads we've seen in many asset classes, but for you historically, and also your outlook in terms of the mark-to-market potential increased pretty substantially quarter-over-quarter and massively year-over-year. Are we seeing any stabilization in market rents at this point in Canada? Maybe if you could extrapolate what you're seeing in the U.S. as maybe a more mature market in terms of how we should think of market rates in the industrial space in Canada?
Sure. Maybe I'll start, Matt and let Alex elaborate as well. I think we're seeing continued growth in rents. To forecast when they'll flatten out, I don't know. I think we need to reach basically an economic rent equilibrium where rents justify new construction. That's continuing to go up. Land prices have maybe moderated, so maybe that's a sign that rents in the mid to high teens will, you know, kind of settle in there. It's hard to predict that. The question regarding the U.S. fund continues to grow. What we've seen is in tight land-constrained markets, rents again are continuing to grow to justify new construction. So there's more space demanded. The only relief valve is new construction.
In order to justify new construction, rents are continuing to grow. I think in the tight markets, that's the case. In less land-constrained markets, we're seeing rents not grow as fast. There's some U.S. markets that don't have many constraints on land or constraints on development and those markets are finding rents stabilizing much quicker. But in the GTA, certainly and in Montreal, what we're seeing is rents continuing to grow. Alex, you can comment a little bit on what we're seeing on the ground. But even, you know, for example, in Calgary, we're seeing significant rent growth there. That's why we're building there.
Yeah. Thanks, Brian. Yeah, just starting with Western Canada, it's a market that hasn't seen significant rental growth for the last couple of years. We're starting to see that availability is low. Our portfolio is essentially full in Calgary. We're starting to see rental growth there, so we are kind of pretty constructive on Calgary. When it comes to the GTA, GMA, in addition to Brian's comments, what we're starting to see is that some development projects are being put on hold. When we look at, let's say, our development pipeline and we look at competition next to us.
We haven't done a full survey of the market, but we know anecdotally that there's, you know, a couple of projects that are being delayed because, you know, maybe that exit cap rate is a little bit over certain metric or some other factors. And so if that indeed translates into a broader phenomenon for the market, it might mean that there's gonna be more rental growth than less. That's something we're closely watching.
Okay. No, fair enough. I know there's no availability for anybody to take up space, so hopefully someone builds somewhere. Just with regards to the U.S. portfolio, there was a pretty substantial uptick in occupancy there. I don't think there's been any real change in the nature of the assets. Did you lease up space, and can you kind of speak to what that was?
That was just leasing of vacancy within that fund that produced that. I don't think there was anything out of the ordinary, Matt.
Okay. You're still seeing occupancy gains in the States, at this point in the markets you're operating in?
Yes.
Okay.
Yeah.
Last one for me. In terms of the financing costs, Lenis, how should we think of your current debt financing costs if you were to do something in Canada? I don't know if you do at this point, unsecured versus secured, as well as the European kind of swap costs at this point.
Our euro debt capacity at the end of the quarter was about CAD 400 million, say roughly about EUR 303 million euros. There is still some capacity to do additional euro equivalent debt financing. We're monitoring all the various options. To do unsecureds in Canada right now, you know, it's sort of in the mid- to high-4% up to low-5% if you're looking at five to 10 years. We're still seeing about 200 basis points pick up in terms of doing euro equivalent debt. If we're seeing euro equivalent debt sort of in the high-2% to low-3%, to mid-3 for five to 10 years. That's kind of the range of the rates that we're seeing right now.
Is there any difference sort of between unsecured debt in the market and maybe an unsecured term loan type offering? Could you swap that into euros as well or is that not a possibility?
You know, certainly, we could do unsecured term loans with, you know, with any financial institution. We do have one with a Canadian bank currently that is swapped to euro. That's also an alternative in terms of our debt portfolio.
Okay.
It's, you know, pricing is quite similar as well.
Okay. No, fair enough. Thanks. That's very helpful and congrats on a very strong quarter.
Thank you, Matt.
Thank you.
We have our next question from Pammi Bir with RBC Capital Markets.
Thanks. Good morning. I might have missed this, but just with respect to the IFRS valuations, was there anything notable about the larger increase in cap rates in Quebec versus some of the other Canadian markets?
Hi, Pammi. It's Alex here. No, nothing notable. It's just a function of us keeping the capital values flat, primarily. You know, the rents have increased. That's really what drove that. So it's not nothing notable there.
Got it. Sorry. Yeah.
The only thing I would probably highlight.
Yeah.
There's a degree of conservatism to some of these estimates.
Right. Sorry, it was just driven off the higher NOI, but holding the capital values flat. Got it.
That's right.
Can you maybe just talk a bit about the, how the capital pool has changed in terms of buyers at the table, on transactions that you might be looking at? I'm just curious if you're seeing any evidence of transactions, that might have been in the works getting repriced at all.
We haven't seen any evidence of repricing. It's hard to say just yet who the buyers are. We know anecdotally what the bid depth is on some of the recent portfolios. It seems good, you know, with a handful to maybe half a dozen bids on larger portfolios, being kind of consistently across the board. Now, these are all recent bids, so we just don't know who the buyers are or who the bidders were. There's. We'll continue watching that.
Got it.
Yeah. Pammi, I think we'd expect to see longer wall deals, maybe more impacted by price, certainly, less strategic locations having more impact on price or cap rate. But close in, short walled, mark-to-market kind of deals, you know, we're seeing tons of demand from all different kinds of buyers.
Got it. Maybe just on the CAD 85 million of acquisitions that you flagged that were under contract or in progress, can you talk about where the pricing is on those and relative to maybe from a cap rate standpoint and relative to maybe transactions done earlier this year?
The deals that we have under contract are one deal that makes up the bulk of it is a pretty strategic asset that is immediately adjacent to something that we already own in the GTA. It will help us complete sort of a pretty large land assembly. You know, when we think about it on a total return basis, we're looking at sort of high single digits for unlevered returns pre-land assembly value. If you layer on the land assembly value, it sort of probably moves it by another 150 basis points on unlevered basis. That's how we kind of look at it. We continue working on it as we speak.
Okay. Just last one for me. In terms of coming back to the previous question on, you know, possibly looking at the NCIB. You know, if I look at your implied cap rate kind of in the mid-fives, I mean, is there stuff out there that you could really buy at that type of pricing? Maybe what might prompt you to consider an NCIB perhaps down the road?
You know, I think. Well, Alex, you can talk about whether we find deals in that cap rate range. I think there's a potential we would certainly with rental rate growth and mark-to-market opportunities, we could see things that are accretive at our current cost of capital. Development opportunities and mark-to-market opportunities, I think present really compelling investment opportunities for us, Pammi. We'd have to look at NCIB opportunities— you know, what that is compared to market opportunities. As I mentioned before, I think, our balance sheet is precious right now. We're treating it that way and looking at the opportunities we see out in front of us as being pretty strategic for the growth of our company.
Yeah. I agree. As we commented, Pammi, we're seeing 6.3% yield on costs on our development program. That includes land on our redevelopments and greenfields, which is already owned. The yield on incremental capital investments invested is much higher. We are certainly seeing well north of, you know, 5.5% on that. We intend to kind of complete the development program that we have ahead of us and potentially even find new opportunities. That's one area of focus for us. In addition to our value add program, we talked about our solar program.
There's other kind of smaller value add initiatives that are producing 10+% yield on cost. They require capital and we intend to complete those. We see lots of uses for capital within the business that produce you know strong returns.
Thanks very much. I'll turn it back.
We have our next question from Sumayya Syed.
Thanks. Good morning. Just a question on the development pipeline and with yields going up this quarter. When you review the cost and expected rents, how frequently is that reviewed? I guess my question being, should we expect more upward pressure on yields for the pipeline as rents keep outpacing cost inflation?
That is a great question. Thank you for that. We do review it quarterly when we publish the table in our MD&A. We continue kind of looking at market rents and we have live models for every project that are being updated regularly. We continue monitoring that. As we get better information on construction costs on some of the projects in the planning phase, and as rents move, we update our outlook.
Okay. It's fairly dynamic then. Thanks. I wanted to, I guess, touch on tenant demand and, I guess, that cluster that's driven by wanting to hold higher inventory. Can you give us an update on that front, if that's a meaningful driver for your portfolio or have things sort of slowed or stabilized?
I can't say that we have, you know, concrete data we can point to. Anecdotally, we still have tenants who are looking to expand and take more space. We, you know, we engage with tenants within our portfolio who are looking to expand, and we're trying to find them space or build them additional space. We just completed that deal in Terrebonne in Quebec, where we renewed the tenant and expanded them by about 50%. We talked about another deal in Montreal, where we have an existing tenant lease, you know, an expansion which again grows them by about 50%. We continue to see that activity from our tenants who are looking to expand.
We have one tenant we're engaging with in Europe, who's looking to expand their building also by about 50%. We're kind of working on a development there. There's a few of those anecdotes, but we don't really have good data to point to on that front in our portfolio.
Okay. That helps. Just lastly, more of a modeling question, looking at, I guess, the tenant incentives, and there was a comment that they were up this quarter just on the higher construction costs and commissions on rent. Just wondering how to think about, I guess, an annualized spend number for TIs?
Yeah. I mean, as Matt says, Alex's admission, we do engage with our tenants, and oftentimes, you know, they do want us to partner with them in terms of improving sustainability. We've been ramping up our LED lighting program and upgrading units. Sometimes tenants will come to us within term to do early renewals. I think, you know, some of the, and we are able to recapture some of that through increased rents as well. I think, you know, the pricing of that will fluctuate depending on leasing volume. That's, you know, part of the variability from quarter -to -quarter is just really dependent on the leasing volume and, you know, whether or not we're investing additional amounts in the building to improve sustainability, energy efficiency of the space.
Okay. That's all for me. Thank you.
As a reminder, if you have a question, please press zero then one. Our next question comes from Todd Voigt.
Yes. Hello, Brian and Alex. It's great to see continued positive rent growth, solid supply-demand dynamics. Following up on that last question, and it was also something I was focusing on, can you explain as well, because I know in above, you talk about non-recoverable capital expenditures, and, Lenis, just what you were describing sounded to me more like a non-recoverable capital expenditure, which is a different bucket. Can you help me understand the difference between the two? Do you all publish a net effect of rent growth? Clearly, rent growth is strong, supply demand is great. I'm just trying to get down to a bottom line of what the net effect of rent growth is after all of these incentives, non-recoverable CapEx, et cetera.
Thanks, Todd. Non-recoverable CapEx is primarily Europe. There's some minor non-recoverable CapEx in Canada, but it's very rare. Like, for example, structural capital is generally not recoverable in Canada, but we don't really see that too much in our buildings. Majority of capital is recoverable. What we see in the non-recoverable line is largely Europe. When it comes to value add expenditures, the way we think about value add expenditures, these are all return-generating capital. Solar, for example, would be in this value add development bucket. As we said, we're seeing yield on cost of 10%. With respect to the LED upgrades, we have a program.
Some of our larger public peers as well have a program like this where we work with tenants during the term. For example, we have a tenant with a 10-year lease. Their lighting is not upgraded to LED. They're paying well below market rent. We would approach them during the term and say, "Why don't we partner on the LED upgrade in your space? And we will put the capital, we'll invest the capital, we'll amortize the capital with terms of the lease, and we'll have some sort of an interest rate on that." Our interest rate usually is around 6%-8% range. We're seeing pretty strong unlevered return on that. Tenancy is a payback during their lease.
We see a strong return on capital, and we end up with having a , you know, a better building at the end of the lease. Sort of is almost like a win-win-win type of a program. That's kind of what goes into the value add bucket. There's multiple examples of that. We bought a vacant building in Kitchener last year. We invested some CapEx to refurbish the building. When we think about the purchase price plus the CapEx invested, we realized the yield on cost when we leased it well north of 7%. That kind of work would go into this bucket. It's all kind of return-generating activity.
Going back to your question about net effective rents, we don't publish that, I don't believe. We are seeing net effective rents increasing considerably even faster than, you know, face rents because we're not really seeing a whole lot of incentives, especially in markets like GTA and Greater Golden Horseshoe, in Montreal. We are not seeing a lot of incentives like free rent and things like that. There is some TI once in a while where we need to upgrade the space, especially on the new lease. That usually gets priced into the rent, so we're well covered there.
We're seeing considerable increases in net effective rents, but we can look at putting more of that data together and show that at a later stage. We don't have the.
Yeah, I mean, that makes sense based on what you're saying in terms of how strong the market is. You would have that net effect of rent growth. Just when I look at the disclosure, though, the leasing incentives, indirect leasing costs are up 134% year-over-year, CAD 3.7 million on, last year, CAD 2.7 million. That suggests to me at least, and that's only a three-month period, so I know that can be it can be lumpy. Suggests at least that there was something very specific, at least for this period, where leasing incentives and direct leasing costs were higher.
That suggests, at least for this quarter, net effective rents were lower, than what's reported on a gross basis. In the future, that would be helpful to better understand the net effect of rent growth that we see.
That maybe-
Help me understand that.
By the way, I'm looking at the same way you're looking at. I think it could be a function of volume, because we didn't see any kind of significant increases on the per square foot basis this quarter. Let us look into that and we'll come back to you. It probably is a function of volume.
Yeah, no doubt. You all grown very fast. I assume that was the major driver. It just was much bigger than the growth you've had. It seems like
Yeah, I would say leasing volume.
Yeah.
Leasing volume. Yeah.
Yep. Great. Well, very good. Thank you so much. I'd also echo the encouragement to pursue a stock repurchase program. Thank you all for your time.
Thank you, Todd. Thank you. Appreciate your input. Thank you, Todd.
Thank you.
Thank you. That was our last question. I will now turn the call back over to Mr. Brian Pauls for closing remarks.
Thank you. I'd like to thank everyone for your time today. We look forward to speaking again soon. In the meantime, please, stay healthy and safe and enjoy the balance of summer. Take care.
Thank you. Ladies and gentlemen, this concludes our conference. Thank you for participating. You may now disconnect.