Good afternoon, ladies and gentlemen. Welcome to the Dream Industrial REIT second quarter 2017 conference call for Wednesday, August 9, 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 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. Brent Chapman, CEO of Dream Industrial REIT. Mr. Chapman, please go ahead.
Thank you. Good afternoon, everyone. Thank you for joining us for the Dream Industrial REIT conference call, which is for the three months ended June 30, 2017. Speaking with me today is Lenis Quan, the Chief Financial Officer of the REIT. We are also joined today by Michael Cooper, Chief Responsible Officer of Dream Unlimited. Michael will be available to answer questions regarding strategic initiatives that we are working on with Dream Asset Management. Lenis will provide our financial highlights. I will 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 will then be happy to field your questions.
Thank you, Brent. Dream Industrial's operations have met or exceeded our expectations, and we are making good progress on our strategic initiatives. Overall, Dream Industrial's portfolio delivered financial results for the second quarter, which were in line with our expectations and ahead of the prior quarter. The value of our investment properties was stable at CAD 1.6 billion, reflecting an overall cap rate of 6.64%. Diluted funds from operations or FFO per unit for the second quarter was CAD 0.23, ahead of both the prior quarter and same quarter of last year. Adjusted funds from operations or AFFO for the quarter was CAD 0.21 per diluted unit, up 4% from last quarter and 2.5% from the second quarter of last year. Comparative property NOI increased 1.8% from Q1, largely due to higher occupancy as well as higher recoveries on capital invested in our properties.
Year-over-year comparative property NOI increased by 2.4%, largely driven by higher occupancy and recoveries in Ontario and Quebec, and partially offset by lower occupancy in the West and lower rent and recovery in the East. We continue to improve our debt metrics, with leverage declining by 90 basis points year-over-year to 52.4%. Our interest coverage ratio has improved to 3.3 times, and debt to adjusted EBITDA is eight years. Our weighted average base interest rate is 3.8%, with a weighted term to maturity of 3.8 years. We have been able to improve our payout ratio, reduce leverage, and report improved financial results relative to the same quarter of last year, even though we have sold CAD 62 million of assets since June of last year. Looking at 2017, we now have commitments representing 93% of our 2017 expiries, which compares favorably to the 85% at the same time last year.
I will now give some guidance on our existing portfolio. On a comparative property basis, we expect NOI to be flat to slightly up and overall occupancy to be 50 to 75 basis points higher than our 2016 year-end. By region, Ontario and Quebec have been strong, and we expect NOI increases in both regions. Western Canada is recovering, and we expect year-end occupancy to be almost flat, but the challenges of last year will result in slightly lower NOI for this year. In Eastern Canada, we have been focused on improving occupancy and have achieved a 270-basis point increase since the beginning of the year. However, the NOI contribution from the East, we see a bit of timing lag. In conjunction with our cost reduction initiatives and the recently announced Mississauga building acquisition, we are expecting approximately 2% growth this year over our 2016 recorded AFFO.
We expect overall building and leasing capital to be about 20% lower in 2017 compared to 2016, 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 explore and pursue our strategies. I will now turn the call back to Brent to give an update on the business.
Thank you, Lenis. I'll open with some brief commentary on the performance of each of our markets and then discuss the growth and value-enhancing initiatives we are working on. The overall Canadian industrial market continues to be very stable, with national availability at 4.7% and just 0.7% of new supply under construction. Vancouver, Toronto, Calgary, and Halifax all showed strong positive absorption over the past quarter, while the Edmonton and Montreal markets saw modest increases in availability. Positive economic activity in Halifax came through last quarter with leasing activity driving availability down 90 basis points to 10.9%. As widely reported, the industrial sector continues to experience solid fundamentals and is highly sought after by investors. Overall, the Dream Industrial portfolio delivered solid results for the quarter, with total occupancy hitting a four-year high of 96.8%. This was driven by improvements in the East and continued strong performance in Ontario.
By region, occupancy in Western Canada was 96.5%, Ontario 99.5%, Quebec 96.7%, and Eastern Canada at 92.5%. As previously announced, we have entered into an agreement to purchase the 717,000 square foot Nissan Parts Re-Distribution Center in Nashville, Tennessee, for CAD 60 million. This is a 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 expand the building by 485,000 square feet. The going-in capitalization rate is 6.3%, averaging 6.5% over the term. We are expecting the transaction to close in Q4.
In addition to the Nissan acquisition, we also announced several strategic initiatives that we are pursuing to drive growth and increase the value of our business with our asset manager, Dream Unlimited. We are working with Dream's Industrial Development Group to develop new buildings on Dream's land bank of approximately 180 acres, designated for industrial, with the potential of three million square feet of space. We are also leveraging Dream's relationships to pursue opportunities in Canada and in the U.S. to acquire modern income-producing assets. Dream is also currently exploring joint venture partnerships and development opportunities in major U.S. and Canadian markets on behalf of DIR. With Dream, we've effectively established a preferential acquisition pipeline to new industrial properties. Preliminary, we are excited by the various opportunities we are seeing, and as we continue to advance our work, we will share the progress with you in the upcoming quarters.
We are pleased that our portfolio and operations are able to deliver solid results. The value of our assets remains stable, and we are making significant progress on our initiatives to grow and add value to the business. That concludes the formal part of our call. We thank you for your time today, we're 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 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 one on your phone now. And our first question is from Michael Markidis of Desjardins Capital Markets. Please go ahead.
Hi, thanks. Good afternoon, everybody. Just with respect to the strategic initiatives and leveraging the Dream platform, is it possible to shed some light on what the involvement might be? The Land Bank is Dream Unlimited's. Would Dream Industrial be purchasing finished product, or would it be a financing partner in a development? Just trying to get a sense of what that might look like.
Hi, Mike. Michael Cooper. We're approaching it on the basis that Dream Unlimited will take all the risk. When we're finished, if the Industrial REIT would like it, they could buy it at basically a 2.5% discount to market based on transaction costs.
Okay. To get that 2.5% discount, would Dream Industrial be providing any financing on that basis? No. Okay.
No. What we're trying to do is we're trying to use resources of Dream Unlimited to benefit the Industrial REIT to make it better and better. All the things we're talking about are really as easy as possible for the Industrial REIT and its board to decide if they want to do something. Dream has it on their balance sheet now. As we progress, if the Industrial REIT would like to buy it, we'd be happy to sell it to them.
Okay. I think there's a couple hundred thousand sq ft that are either in progress or in the various stages of planning. When do you think the first development opportunity might be made available for the REIT?
Yeah, I just spoke to our guys, they think they can get the 50 or 100,000 sq ft a year within 24 months.
Okay. Michael, the development group that got recently established within Dream, it sounded like that was more on the industrial development expertise. Could you shed some light on the relationships that Dream Unlimited has in the U.S. and how deep those are in terms of acquiring assets south of the border?
Yeah. Historically, we've had some partnerships down there, we've got a partnership with Canadian Pacific Railway. We just started to work on those relationships to see if we can make progress for Dream Industrial to get a pipeline of assets.
Okay. Last one here before I turn it back. There's a fairly significant tranche of converts outstanding. They don't mature until 2019. I see there's a par call redemption that you could potentially exercise at the end of this year. Just wondering how you guys are looking at that relative to your desire to grow or establish a growth profile of the REIT and potentially take advantage of paying those down and replacing that with something, that mortgage financing that's a little bit cheaper.
Okay. Hi, Mike, it's Lenis. With regards to that larger tranche of the converts, which they don't actually mature until the end of December 2019. Like you said, it's coming next year. We're going to be able to repay them or replace them, either with secured debt or draw down on our line. That would result obviously in some significant interest savings. We are evaluating our options with respect to our refinancing strategy in conjunction with our growth initiatives. However, with our unencumbered assets of CAD 127 million, the CAD 100 million on the credit facility, positive free cash flow after distribution, we feel we've got sufficient liquidity to address these converts.
Okay. That's great. Thanks very much.
Thank you. Our next question is from Heather Kirk. Please go ahead.
In terms of the land, my understanding is it's primarily in Western Canada. Do you have any other land in other geographies or in the U.S. at all?
Dream Unlimited has a lot of land on Western Canada on its balance sheet. There's also lands with Canadian Pacific that's not on our balance sheet. Pretty much in Western Canada and the States.
Okay, there could be some potential for development in the U.S. as well.
Yes.
Okay. Just on the DRIP participation, which has really spiked up pretty materially, just wanted to get your thoughts on your commitment to keeping the DRIP in place and also on the 3% discount.
Well, as you've noticed, our DRIP's at about 36% right now. We believe it's actually a cost-effective way for us in terms of providing additional liquidity as we pursue our growth initiatives. There's no considerations of any change at this point.
Okay. Just moving to the operations, can you comment a little bit on the rent declines and what you mentioned in the disclosure that it was related to some competitive markets, I'm just curious to know what that was specifically.
On our actual expiring rents, on occupied space, we did have positive leasing spreads in all of our regions other than in Western Canada. We had, I think three mid to large bay tenants that were renewing. We are seeing a little bit more competition in that area of the market. I think if we excluded those three, the spreads on our renewals were actually positive for the rest of the portfolio.
Okay. Do you have a number for exactly what that would've been?
For the rest of the portfolio if we excluded those three units?
Yeah.
I believe it was about a 1.4% increase.
Just in terms of the entry into the United States, what's the thinking in terms of where this goes as a percentage of the portfolio? Was this just opportunistic given the opportunities with Dream Unlimited, or do you have a set target for how the balance between Canada and the U.S. is going to look?
We don't have a real number, but I think that to have any scale, we probably work towards like 20%. Right now, we probably do it out of recycling capital from assets when we get good prices and invest in the U.S.
Do you have a specific geography that you'd be concentrating on?
We picked out a variety of cities that we like as opposed to geography. I think we mentioned it before. We think Nashville's a pretty special place.
Okay.
For a lot of reasons. It's really booming there. Chicago, if we can get there. We're looking for stuff in Las Vegas, Atlanta, and Dallas. There's a number of desirable markets that if we can find a good way to access one of the better markets, we'd like to do that.
Thanks very much.
Thank you. Our next question is from Brad Sturges of Industrial Alliance Securities. Please go ahead.
Hi there. Just continuing on the U.S., on the market there, and the acquisition strategy. Based on your comment about looking at modern product, is that the Nashville asset, essentially what we should be thinking about in terms of what you're looking to acquire at this stage until you get a bigger foothold in the market?
I think so. I think we're looking for assets that are well leased and have some good lease term.
Okay. Until you get a bigger size, and then would something similar to what you have product-wise in Canada in terms of the smaller bay multi-tenant asset, is that something that would be on the table down the road, or are you looking to kind of shift the strategy a little bit from the type of asset perspective?
I think it's a great question because we like the multi-bay, but it's really hands-on grinding to manage it. We're comfortable here. I'm not sure if we'll get comfortable in the U.S. Depends on the ranges we have down there. At this point, no, we're not looking to multi-bay in the U.S.
Okay. That's good. Then just from the development program, just to clarify, at this stage, it's not going to be anything on balance sheet for the REIT specifically. It's more just with Dream Unlimited at this stage.
Yeah. What we're dealing with in Dream Unlimited is we have these significant communities out West, we're doing more and more of the building ourselves. I think that from Dream Unlimited's perspective, if the industrial REIT would like to buy them, it helps the industrial REIT. That's good. There's no obligation on the industrial REIT at all. We try to make it as beneficial for the industrial REIT as possible.
Okay. Great. I'll turn it back. Thank you for that.
Thank you. Our next question is from Sam Damiani of TD Securities. Please go ahead.
Thanks. Good afternoon. Just sticking with the debt profile. With the Nissan acquisition, the leverage will tick up a little bit. What is the strategy on leverage sort of on an overall basis going forward?
Sam, you are correct. After the Nissan acquisition, our leverage will increase temporarily, but it is still within our 50%-55% target range. We would expect leverage would come down over time with free cash flow after distributions and some capital recycling.
Okay. What is the status of the assets held for sale? I think there is, what, two assets on the balance sheet right now?
Yeah, they both have paper on them. One is close to being firm and closing, I would say, in the next 30-60 days. They're both in play.
There's very little income coming off those right now, as I understand it?
Correct.
All right. Sorry, I don't know if you had mentioned it, but what is the interest rate on the mortgage on the Nissan facility?
It was a complicated debt structure. We've figured out a structure that's both beneficial to ourselves and Office. The debt will be assumed at market rates for comparable terms. There's four years left on that mortgage.
I noticed the REIT had issued about CAD 15 million of mortgages in Q2 at about 4% for five-year terms. Is that indicative of market today for Dream Industrial in Canada right now?
Those two mortgages are secured by two properties in Edmonton. We would expect to see similar rates in Alberta, but not for properties in the rest of Canada. That was also done at the beginning, negotiated at the beginning of the year. Things with Alberta stabilizing, I think we could potentially push and get better rates.
Okay. Thank you.
Thank you. Our next question is from Dean Wilkinson of CIBC. Please go ahead.
Thanks. Afternoon, everyone. Could you just walk us through how you struck the valuation on buying the asset from Office into Industrial?
Each of Office and Industrial, we obtained independent third-party appraisals.
The value acquisition price was within the range of those two independent appraisals.
Okay. Were they materially different? I assume you just sort of split the difference.
No, they weren't materially different.
Okay. Is that the only asset that Office had down in the U.S. in the form of industrial properties? I believe it may have been, but I'm not entirely sure on that.
Yes.
Okay. Lenis, you mentioned that you expect the occupancy into the year-end 50 to 75 basis points higher than year-end 2016. Would that imply a slight downtick from where we are right now, including the committed space?
I think our level of commitments is fairly high, particularly in the East. We would expect that to come down. I think on an in-place basis, we're pretty comfortable with maintaining the levels, if not a slight increase between now and year-end.
Between now and year-end. Okay, perfect. On the last 374,000 feet in Western Canada, it looks like that's coming off about CAD 1 higher than market rent under your disclosure. Should we expect a similar dynamic for that as we saw in Q2 for the leases that you rolled there?
Yes.
It was down about CAD 1 there. Yeah.
Right. What's driving those negative spreads is some flex office units in Alberta.
Yeah.
We've built that into our guidance and our assumptions within our guidance for the rest of the year.
Okay, perfect.
We are seeing positive spreads in the other regions. I guess it's good to have a diversified portfolio.
That's why you did it, right? Last one for Michael. I guess it's more a Dream question. Looking at the opportunities to build on the existing land bank versus, say, perhaps going down into the U.S. buying land and construction costs usually are cheaper down there. Would there be a thought perhaps for DRM to, independent of, say, the CP partnership or anything like that, build up a bit of a land bank, not as extensive as you've got in Western Canada, but south of the border?
Dream Unlimited would not go and buy land like that. If we had an arrangement with a partner that could help Dream Industrial REIT, we would take a look at that. Although I think the Industrial REIT might be the owner of the land if we did that.
Okay. Nothing on spec then. It would just be if you had a specific use, that you would do that.
If Dream Industrial could enter into a relationship with a U.S. developer, maybe. I don't know that there's a reason why Dream would be involved in that.
Okay. That's clear. That's it for me. Thanks, everyone.
Thank you.
Thank you. Our next question is from Paul Meagher of Scotia Capital. Please go ahead.
Thanks. Good afternoon. Just with respect to the capital recycling program, have you gone through sort of the broader portfolio exercise and sort of come up with the overall program of targeted sales, and what could that look like over the next couple of years?
Yeah, we have been going through the exercise. Right now, we have the two assets held for sale, which is really the only two that we're marketing right now. We don't have a number that we can say is a target that we're going to look to dispose of. I think it's safe to say we'll be net acquirers, as we've been over the last year. Yeah, no specific number for you other than we'll be a net acquirer.
If I think about it, would it be reasonable to think of sort of sales kind of in the CAD 50 million range per year, or does that seem a bit light?
I'm not sure. I think what we're going to be focused on is being able to create out of one asset that value is quite high, that we don't think we can do a lot more to investing in something else where we have upside. I think it may be driven. If we found incredible opportunities, then we would dig deeper in our Canadian portfolio to free up the capital for it. We're not looking at a portfolio and saying we want to have some kind of turnover in the portfolio. I think it's really on an individual building basis where we think we can do better unless there's a bigger transaction, we need to free up more capital.
Okay. Got it. Just when you think about what sort of range of cap rates you can redeploy at in the U.S. beyond the first acquisition, how would that compare with what you could sell at, you think, in Canada? What sort of spread are you looking at?
It's a really efficient market. What we're seeing is generally, it's hard to pick up a spread. However, if a tenant wants to own a building before they invest a lot of money into their operations, we can do better. If somebody wants to use a building for a different purpose. I think what we're really trying to do is find those opportunities where we could sell at a purchase price that really doesn't relate to a cap rate.
Right.
Generally, I think it's I don't know, around the table, anybody have a different view that it's fairly comparable? In the U.S., there's quite a spread between different markets, and I think in Canada, there is, too.
Right. The end goal is you would be upgrading the asset quality, you think, based on what you'd be buying in the U.S. relative to what you'd be selling in Canada. Even if they are, call it, let's say, for argument's sake, the same cap rate.
Yeah. I think, just to keep in mind, we would do the same in Canada. We would sell an asset that we could upgrade in Canada as well as sell it to do it in the U.S. I think we're going to be pretty active, but a lot of it's driven by what opportunities we can find. I think that's the real scarcity now.
Okay. Maybe just switching gears, certainly some better momentum from a same property NOI perspective. Looking a little bit maybe further out into 2018 for Eastern Canada and Western Canada, does it feel like you've turned a corner there, or do you sort of see some bumps along the way over the next, call it, 18 months?
I think looking forward, we have turned a corner, certainly Calgary. Halifax seems to have stabilized and turning in the right direction. Edmonton's lagging a little bit just because in certain sub-markets in Edmonton, Nisku, and a couple others, Leduc, where it's heavy energy service companies. There's still kind of a recovery going on there. Definitely the trend is positive, and we don't see a major bump along the road.
Great. That's helpful. Thanks very much.
Thank you. Our next question is from Mark Rothschild of Canaccord. Please go ahead.
Thanks. Good afternoon. Just so I understand the strategy, leverage will increase slightly with this first acquisition in the U.S. Going forward, is the plan to fund acquisitions completely with asset sales, or would you look to raise leverage, or is issuing equity going to be something that's part of the strategy as well to grow?
I think all of those are things that are available. I don't think we want to raise our leverage. Right now, we're in between having sold some assets, bought some assets, sold some assets. Our leverage hasn't really moved around much. I think we're looking to recycle, and there may be opportunities to issue equity if the market is supportive of the opportunities we find.
Okay. You spoke about maybe high-grading the portfolio. Are there markets in Canada where you'd, in particular, like to reduce your exposure? Obviously with the unit price where it is, issuing equity is not that accretive, and then its units are trading at a discount to net asset value. Where would you really be looking to reduce your exposure?
It's Brent here. We're not looking at any specific region. We're kind of comfortable with the balance of the portfolio. As we evaluate the assets, it's really more building-by-building specific and looking at assets that we think we've got the most out of them, that maybe there's not a lot of lift left in them, or maybe there's CapEx that's going to be a big requirement going forward. We're really looking more on a building-by-building basis as opposed to changing our weighting in any geography.
Okay. Thank you very much.
Thank you. Our next question is from Matt Kornack of National Bank Financial. Please go ahead.
Hi, guys. Lenis, just a quick question in terms of your guidance on FFO. Did you say that you expect 2% growth in 2017 for the year?
That's on adjusted funds from operations, AFFO.
Oh, okay. FFO, do you expect it to be flat as in the past or more bullish on that front given the acquisition activity?
Yeah, I think it's going to be relatively flat, if maybe slightly up. The guidance I had given was on adjusted funds from operations.
Do you anticipate, or in that guidance, is there any incremental acquisition activity, or is it just the Nashville acquisition at this point?
Yeah, just Nissan at this point.
Okay. With regards to fair value, you took a write-down in the quarter, but cap rates compressed slightly. Is that on rent expectations, or what exactly would've driven that?
There's a few moving parts in there. The cap rate compression was largely driven by our Ontario region. That was driven by external and supported by external appraisals.
As well as information from our external appraisers on the stuff that we're valuing internally. In the West and the East, we had some property-specific adjustments, leasing assumption-driven, cash flow-driven, market rents as well as leasing activity. That would've been driving the declines in those two regions.
Okay. Final question. With regards to Alberta, the rent spreads have come down, and as much as things have stabilized, you're still comparing to leases that were signed five or so, maybe longer, years ago. Do you anticipate that comes down further at this point? Should we start to see those spreads widen out again?
Yeah. The market rents that did come down, there are some specific properties where we got higher select office components. Those were what were driving down the averages in Western Canada. As you've said, a lot of the leases that are in place now were signed five years ago or so. I think at this point in time, we're still seeing some pressures on the rents, but I think with Alberta stabilizing, we hope that over, we can't predict it, but next 12 months-24 months, we start to see some gains in that market.
Okay, thanks.
Thank you. Our next question is from Sam Damiani of TD Securities. Please go ahead.
Thanks. I just wanted to clarify, I think you have touched on it in response to some questions already, but in terms of growth by acquisition, Canada's not off the radar screen, it's just that you're factoring in the U.S. now. Is that right? You're still looking at acquisitions in Canada?
Yeah, correct. We're actively pursuing acquisitions in Canada.
Okay. Just secondly, there's a couple of your largest tenants with relatively short remaining lease terms. How are the talks going with extending those leases at this point? Maybe it's not, maybe it's too early.
Well, without getting into any specific tenants, we're pretty confident any big ones that we have, we're fairly confident that they'll be sticking around. Some of them, the smaller bays, looking out at more than a year, it's too early to be talking to them. Certainly, the big tenants that we're well-engaged with.
Perfect. Thank you.
Thank you. Our next question is from Heather Kirk. Please go ahead.
Just a quick follow-up. I'm just wondering if there's any update on the CEO transition and where that sits.
I think it's not appropriate for me to answer that. Unless Brent wanted to. Yeah, we're waiting for Brent to pick somebody. No. We have been working a lot on where we're going with the company. We've been working closely with the board. Our intention hasn't been to really start until the fall.
Okay. Is this going to be an external pick, or would you be looking at somebody internally as well?
We're setting up, I think we announced in the spring that Vincenza Sera is leading it. We would invite internal people and external people.
Okay, thanks.
Thank you. We have no further questions at this time.
Okay. Well, thank you again, everybody, for participating, and we look forward to speaking to you next quarter.
Thank you. Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.