Good afternoon, ladies and gentlemen. Welcome to the Dream Industrial REIT third quarter 2017 conference call for Wednesday, November 8, 2017. 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 and could cause actual results to differ materially from those that are not 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 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 questions, press star then one on your telephone keypad. Your host for today will be Mr. Brent Chapman, CEO of Dream Industrial REIT. Mr. Chapman, please go ahead.
Good afternoon, everyone. Thank you for joining us today for the Dream Industrial REIT conference call, which is for the three months ended September 30, 2017. Speaking with me today is Lenis Quan, the Chief Financial Officer of the REIT. Brian Pauls, our incoming CEO, is also here today, as well as Michael Cooper, Chief Responsible Officer of Dream Unlimited, who is available to answer questions. Lenis will provide our financial highlights. I'll wrap up with a few comments on the quarter, an update on the business, and our strategies targeted on driving growth and enhancing value. We'll then be happy to field your questions.
Thank you, Brent. Dream Industrial reported another quarter of strong portfolio performance and solid financial results. Our committed occupancy is strong at 96.7%, and we have retained 81.1% of our expiring tenants this year, which is the highest level in the REIT's history. Adjusted funds from operations or AFFO for the quarter was CAD 0.208 per diluted unit, up 1.5% from last quarter and 2.5% from the third quarter of last year. Our AFFO has increased due to higher comparative properties NOI, lower bad debts, and general and administrative expenses. We have been able to grow our AFFO even though we sold CAD 71 million of property last year, and at the same time, reduced our leverage and enhanced our position to execute on our strategic initiatives.
Diluted funds from operations or FFO per unit for the third quarter was CAD 0.23 and slightly ahead of the same quarter of last year. The strength of our operations is not fully reflected in FFO due to non-cash accounting adjustments included in FFO, such as straight-line rent, where we had rental steps kicking in during the quarter and higher free rent last year. Comparative property NOI was strong, improving by 1.4% from the same quarter last year and is up 1.5% year-to-date, reflecting higher occupancy in Ontario, Quebec, and Eastern Canada, as well as higher recoveries on capital invested in our properties. The value of our investment properties was stable at CAD 1.6 billion, reflecting an overall cap rate of 6.61%.
We continue to improve our debt metrics with leverage declining by 10 basis points over the same quarter of last year to 52.6%. Our interest coverage ratio was stable at 3.3 times and debt to adjusted EBITDA is 8.1 years. Our weighted average face interest rate is 3.81% with a weighted terms and maturity of 3.8 years. Our AFFO payout ratio for the quarter was 84.1%, improving 210 basis points from the same quarter last year. Looking at the remainder of the year, we expect occupancy to remain strong and have effectively addressed all of our 2017 expiries. We now have commitments representing 106% of our 2017 expiries and terminations and have increased our comparative property's occupancy by 110 basis points over Q3 2016.
On a comparative property basis, we expect NOI to be up about 1.5% and overall occupancy to be 80 to 100 basis points higher than our 2016 year-end. By region, Ontario and Quebec continue to be strong, and we expect NOI to further improve in both regions. Western Canada has stabilized, and we expect year-end occupancy to be largely flat. We are optimistic that we will see improvements in this market going forward, and we remain aggressive in maintaining occupancy and using that to drive rents in this market. In Eastern Canada, we are pleased with the progress we have made and have achieved a 370 basis point increase in occupancy since the beginning of the year. We expect the NOI contribution from the East to increase over the upcoming quarters as these leases take effect.
In conjunction with our cost reduction initiatives and the recently announced East End building acquisition, we are expecting approximately 3% growth this year over our 2016 reported AFFO. Regarding our upcoming convertible debentures, the 6.75% converts with a CAD 19.4 million balance mature at the end of this month. Our plan is to initially repay these using our line. The second set, bearing interest at 5.25%, is due at the end of December 2019 and with a principal balance of CAD 111 million. From January 2018 onwards, these debentures can be redeemed with no constraints on trading price. We are proactively evaluating options with respect to refinancing these converts.
With unencumbered assets of CAD 99 million, our CAD 100 million credit facility, up financing room on mortgage maturities over the next 1-2 years, and positive free cash flow after distributions, we have ample liquidity to address these debentures. We also expect to realize interest cost savings on these refinancings. We continue to expect overall building and leasing capital to be about 20% lower in 2017 compared to 2016, even though our leasing volume is higher this year, as some of our larger capital maintenance initiatives were completed in 2016. We expect to have positive free cash flow in 2017 after planned building capital, leasing costs, and distributions. We believe that the additional liquidity will provide us with enhanced flexibility and the ability to pursue our strategies. I will now turn the call back to Brent to give an update on the business.
Thank you, Lenis. The overall Canadian industrial market continues to improve and displays strong fundamentals, with national availability down over the past quarter to 4.3% and minimal new construction totaling just 0.65% of supply. All major markets in Canada recorded positive absorption in Q3, with Toronto, Montreal, and Calgary accounting for 84% of the net absorption nationally. The industrial sector also continues to be highly sought after by investors. Overall, the Dream Industrial portfolio delivered solid results for the quarter, with total occupancy just under 97%. We had positive absorption in each of our regions, with the exception of Quebec, where we have one transitory vacancy. The performance of all of our regions compares favorably to the market conditions, underscoring the resilience and strength of our portfolio, as well as the diversity of our tenant base.
By region, occupancy in Western Canada was 96.5%, Ontario 99.7%, Quebec 95.4%, and Eastern Canada at 93.5%. As Lenis mentioned, occupancy in Eastern Canada has improved by 270 basis points since the beginning of the year, reflecting our operational enhancement and leasing strategies targeted towards increasing tenant renewal, expansion, and attracting new tenants. As we enter 2018, we will continue to drive occupancy and rents to maximize the value of our properties, and we will continue recycling capital to increase the net asset value of our portfolio. With respect to our U.S. expansion, the previously announced agreement to purchase the 717,000 square foot Global Parts Distribution Center for Nissan in Nashville, Tennessee for CAD 60 million closed on October 31st.
This is a high-quality, modern, class A, 32-foot clear building with 93 doors on all four sides and centrally located to serve the 10 regional distribution buildings Nissan operates in North America. The property is a critical part of Nissan's infrastructure, located near Nissan's North American head office and in between its two main assembly plants in Tennessee. The Nissan lease has nine years of term remaining, with options to extend the building by 485,000 square feet. The going-in capitalization rate is 6.3%, averaging 6.5% over the term. We communicated earlier this year that we would be pursuing several strategic initiatives with our asset manager, Dream Unlimited. Through a strategic arrangement entered into with Dream Unlimited, we are now pleased to be working with the Pauls Corp to drive our strategic expansion into the U.S.
Pauls Corp is a Denver-based real estate firm with a 40-year track record, developing and managing millions of industrial square feet in the U.S. as well as in Canada. Brian and Pauls Corp have developed deep relationships with the brokerage, lending, banking, tenant, and construction communities on both sides of the border. Dream and Pauls Corp have had a strong relationship for 20 years, and we believe this relationship will be highly beneficial to the REIT. Pauls has an experienced team, enjoying excellent relationships with many reputable sellers in the U.S. that we believe will give DIR immediate credibility. We expect to have access to off-market opportunities and deals that have favorable economics for the REIT. In a short period, we have already seen several interesting prospects in both Canada and the U.S. and are actively pursuing certain opportunities.
As a reminder, all of these benefits come at no additional cost to the REIT. We're also leveraging Dream's relationships to develop properties on Dream's land bank of approximately 180 acres that's designated for industrial, as well as pursuing opportunities in Canada and in the U.S. to acquire quality income-producing assets. We look forward to updating you on progress on this front over the upcoming quarters. Overall, we are very pleased with the strong performance of our portfolio, the solid financial results of the REIT, and the significant progress made on our initiatives to grow the business and increase value for our unit holders. On a personal note, since this will be my last call as CEO, I would like to thank Dream for giving me the opportunity to work with such motivated and passionate individuals across the country.
I also want to thank the research analyst community and our unit holders for their trust and support. The future is bright for Dream Industrial, and I wish Brian all the best on leading the future growth of the company.
Thank you, Brent. Over the last few weeks, I've had the opportunity to meet some of the excellent people on the Dream Industrial team, both here in Toronto as well as the West. I'm excited to be joining, and while my official start date is at the beginning of January, we've been busy looking at and evaluating potential growth opportunities both in Canada and the U.S. and hope to provide an update soon. I've also been able to meet with many of you in the research community and look forward to speaking with you next quarter.
Brent will continue on as CEO until the end of the year, and we'll work together to ensure a smooth transition. As this is his last conference call, on behalf of the Dream Industrial team, I want to thank Brent for his motivational leadership. He's been a steady leader over the past three years, and he has shared his passion for real estate with all of us. The impact of his vision on the REIT, tenant service, and our operations will last long after his departure at the end of this year. We wish him all the best in his future endeavors. That concludes the formal part of our call. We thank you for your time today and are now happy to take your questions.
Thank you. We will now begin the question and answer session. If you have a question, please press star then one on your touch-tone phone. If you wish to be removed from the queue, please press the pound sign or hash key. There will be a delay before the first question is announced. If you're using a speakerphone, you may need to pick up the handset first before pressing any numbers. Once again, if you have a question, please press star then one on your touch-tone phone. It looks like our first question comes from Michelle Garrett. Michelle, your line is open. Please go ahead.
Hi, good afternoon. I just wanted to touch on market fundamentals. It sounds like they're improving in Alberta and Halifax. Can you talk more a little bit about what you're seeing in those markets, and particularly if you're seeing any potential for rental rate increases or starting to recover?
Okay. Yeah, Brent here. I can answer that. Certainly, in Alberta, both Edmonton and Calgary have had positive absorption year-to-date, quite significantly. I wouldn't say it's quite at the point yet where rents are starting to move up. They're stabilizing. In Halifax, the vacancy's down to just over 10%. Again, we're seeing not quite rental increases yet, but it's certainly moving in that direction. Neither of the markets have any real new supply coming on. As vacancy drops down, rents will naturally move up.
Great. Thanks. Maybe I missed it, but if not, can you provide a little bit more color on the Calgary acquisition, more particularly where it's located, the clear height, the weighted average lease term?
I can give you some general comments on that. I mean, it was a CAD 17 million acquisition. It's a multi-tenant building located in and around our portfolio, around our Manchester portfolio. Our management and leasing team actually have personal history with the building and the actual tenants that are in it. It was kind of a tuck-in acquisition that fits nicely with our portfolio. I don't know, I can't remember off the top of my head the height. It's a multi-tenant building, fully leased, and just fits well with our portfolio. It was an opportunistic acquisition.
Can you talk about the lease term there, or?
I'd have to get back to you.
Okay. No worries
put up on hand.
Okay. Pro forma the two acquisitions post the quarter, looks like leverage is going to tick up about 100 basis points. Where do you see leverage as you expand on the growth strategy? Maybe as part of that, can you discuss the pipeline of non-core assets that you have, that you could dispose to fund this growth?
Hey, Michelle, it's Lenis here. A couple parts to your question, so I'll address the leverage portion of it. We're comfortable being within, like, that 50%-55% targeted range that we've indicated on our past calls. Following those, the two acquisitions, we are in the high, in the 53s, but we would expect this to come down with asset recycling. Then in terms of acquisitions and pipeline, as Brent and Brian have mentioned, we have had several opportunities or several initiatives that we've been looking at, especially since Brian has come onto the team. There's been a lot of portfolios in both U.S. and Canada that we're pursuing, and we hope to be able to announce something in the near future.
Great, thanks. Within the 2018 expiries, are there any larger tenants of concern that we should be aware of?
No, there's none that are of concern.
Okay, perfect. That's it for me. I'll turn it back. Thanks.
It looks like we have Chris Cabiya on the line as well with a question. Chris, please go ahead. Your line is open.
Hi there. Just going back to Michelle Garrett’s comments on market fundamentals. In your Ontario portfolio, the market rent, your estimated market rent has been pretty much flat for the last couple of years. GTA rents are up about 20%, the asking rents are up about 20% in that same time period. Your portfolio looks to be heavily exposed to the GTA. Any comments on your estimated market rent for Ontario?
Well, definitely when we're at 99-point-something%, we're definitely in a mode of pushing our rents in Ontario, so we can be selective on renewals and on new tenants. We certainly expect to be pushing rents upwards in Ontario. The market in Toronto, I think, is about 2.3%. I think overall, the industrial market is kind of poised for a run-up in rents because the replacement cost for a new product is certainly not going down, whether it's land development charges, construction costs. The economics of industrial really point towards increasing rental rates.
With respect to our portfolio When on renewals, we typically try to hold or get slight increases on the expiring rents. We build in contractual rent steps. To the extent that we are investing in the building on capital building improvement, the large majority of our spending is recoverable from tenants. That will also attribute to growth as well.
Yeah. Hi, Chris Cabiya. It's Brian Pauls here. Just to add to Brent Chapman and Lenis Quan. In analyzing the Dream portfolio, particularly in Ontario, when you look at the Ontario fundamentals and you look at where we are occupancy-wise, it certainly points to higher rent. That's going to be one of our strategies for going forward into 2018, is to aggressively push rents, knowing that the fundamentals of the market and the occupancy, are going to give us an opportunity to do that.
Okay, thanks.
We have Amar Shah on the line with a question. Amar, please go ahead. Your line is open. Amar, we currently have your line open. If you'd like to ask your question.
Sorry, I was on mute.
That's okay.
I was just saying, some good commentary on market fundamentals. Just wondering if you could translate that to where SPNOI guidance might be for 2018.
We're actually preparing for our December strategy session. We aren't giving our guidance for 2018 at this point in time. We'll be in a better position to do so at our year-end call. I think generally speaking, what we can say is our, sorry, our portfolio is in good shape, and we are optimistic for next year. The West is stabilizing, and we expect occupancy to remain strong and with contractual rental growth offsetting some of the rental rate pressures. Ontario is at 99% occupancy, so any growth from there will be coming from rental uplifts on renewals and contractual growth. In Quebec, we do have the one transitory vacancy, as Brent mentioned, so the growth there is coming from contractual rent steps.
We increased occupancy in the East this year, NOI growth is expected to come through next year, the market there has improved since last year. No specific numbers, but we are very optimistic about next year.
Got it. Any chance you'll be able to touch on where you see leasing spreads for the next year?
No, you can't.
I mean, renewal spreads.
By region, I think probably you've sort of seen the trend that we're going, but I think on an overall portfolio basis, we're seeing rental growth of about 1% on total portfolio basis, and it's comparable to the comparative property growth that we're seeing this year.
Okay, perfect. Thank you.
We have Dave Crystal lined up for a question. David, please go ahead. Your line is open.
Thanks. Good afternoon, guys. Just on the interest income came in quite a bit higher than usual, or, sorry, interest and other income. The majority of it looks like it is related to the deposit on the Nissan property. There is a gap between the, I guess, headline number and the amount related to the deposit. Is there anything unusual there, or do we expect that difference to be reoccurring?
Yes. The interest in other income is up because of the interest on the Nissan deposit, so that is correct. We acquired the economics of the Nissan building from Dream Office effective August 1st. We made an interest-bearing deposit so that we could earn the equivalent FFO while we are awaiting lender consent on the transaction. The lender consent was obtained. The acquisition was closed on October 31st. Going forward, the economics are going to be included in our NOI and interest expense.
Okay. It is really just a gap between the way you are accounting for it. The economics themselves are consistent throughout, though.
Correct.
Okay. It looks like there was either a cash tax or current tax of about CAD 220,000 in the quarter. Is that recurring, or is that related to the economics again on the Nissan acquisition?
Right. Bang on. It's related to the interest on the deposit. We determined our equivalent to FFO on an after-tax basis.
Okay. We should really be looking at the gap between the two as-
Correct
the contribution?
That's right.
Okay. You talked about CapEx and leasing budget for 2017. Do you have a sense of where this will come in for 2018?
Again, 2017 was lower than 2016. We undertook a significant amount of capital initiatives in 2016. Our leasing volume has gone up this year, but yet, on a total overall basis, we're going to be 20% lower in 2017 than for 2016, and we're still finalizing our 2018 numbers. I think we would expect things to be relatively in line with what we're seeing with spent for 2017.
Okay. Relatively consistent with 2017 rather than any meaningful savings or uptick.
No.
Okay, great. That's it for me. Thanks.
Currently, we have no further questions queued up right now. Remember, ladies and gentlemen, if you'd like to ask a question, please press star then one on your touch-tone phone.
Okay. If there's no further questions.
It looks like we actually have Chris, who's come in with another question. One moment.
Okay.
Chris Cabiya, your line is open again.
Oh, hi there. Just in terms of, I know it's still early days on the whole U.S. strategy, but my impression is it's a pretty wide net in terms of the MSAs that you guys might be targeting. Just wondering if you can help us understand, maybe how you're going to narrow the focus.
Sure, Chris, this is Brian Pauls again. It is a wide net. There's a lot of opportunities in the U.S. We've mentioned, I think, last quarter, some of the markets that are attractive and interesting to us with being Dallas and Atlanta, Chicago, possibly. We're looking deeper into the Southeast U.S. There's a lot of markets there that are fundamentally very strong, may provide some opportunities that are kind of within a cap rate range that are attractive to us, that are higher cap rates than some of the really big markets but would be very attractive in terms of the size of the market. I mentioned when we had our get-together when you were here that 100 million sq ft of inventory is a good size market for us to chase. There's a number of those in the U.S., and we're looking at many of them.
Many of them that we have experience in, both under Dream and Pauls Corp, as well as those that we have relationships in. Southeast, I would say, we're really focused right now, in addition to the markets that were mentioned last time.
Okay, thanks a lot.
Once again, we have no further questions on the line queued up.
Okay, with that, we'd just like to thank everybody again for their time, and enjoy the rest of the day. Thank you.