Good afternoon, ladies and gentlemen. Welcome to the Dream Industrial REIT fourth quarter 2016 conference call for Wednesday, February 22nd, 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, please press star one on your telephone keypad. Your host today will be Mr. Brent Chapman, Chief Executive Officer of Dream Industrial REIT. Mr. Chapman, please go ahead.
Thank you, Vanessa. Good afternoon, everyone. Thank you for joining us today for the Dream Industrial REIT conference call, which is for the three months and the year ended December 31st, 2016. Speaking with me today is Lenis Quan, the Chief Financial Officer of the REIT. Lenis will provide our financial highlights, and I'll wrap up with a few comments on the quarter and an update on the business.
Thank you, Brent. Overall, Dream Industrial's portfolio delivered financial results for the fourth quarter, which were in line with our expectations and largely consistent with the prior quarter. The value of our investment properties was stable at CAD 1.6 billion, reflecting an overall cap rate of 6.71%. Diluted funds from operations, or FFO per unit for the fourth quarter was CAD 0.21. Excluding the impact of a CAD 1 million charge related to our cost reduction program, FFO was CAD 0.22, slightly lower than the prior quarter and same quarter of last year. Adjusted funds from operations, or AFFO for the quarter, was CAD 0.19 per diluted unit, or CAD 0.20 excluding the cost reduction charge. Comparative property NOI decreased 0.4% from Q3, largely due to lower recoveries in the East.
Compared to the same quarter last year, comparative property NOI increased by 0.5%, largely driven by higher occupancy in Quebec and higher recoveries in our Eastern region, offset by lower occupancy and recoveries in the West. The decline in FFO was also attributed to higher bad debt expenses in G&A, which we believe will be lower in future quarters. We expect the cost reduction program to result in annualized savings of approximately CAD 700,000 plus operating cost savings. Our debt metrics have declined by 10 basis points quarter-over-quarter to 52.6% and is down 120 basis points year-over-year. We completed the sale of CAD 71 million worth of properties this year and repaid debt until we find suitable opportunities to redeploy that capital. Our interest coverage ratio has remained stable at 3.1 times, and debt to adjusted EBITDA is 8.4 years.
Our weighted average face interest rate is 3.8%, with a weighted term to maturity of 4.2 years. Looking at 2017, we now have commitments representing 53% of our remaining 2017 expiries, which compares favorably to the 51% 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 consistent with our 2016 year-end. By region, we expect occupancy to increase in Ontario and Quebec, and we are focused on improving occupancy in Eastern Canada. In Western Canada, while we are seeing some initial signs of recovery, we expect leasing challenges to persist and recovery will be more gradual. In conjunction with our cost reduction initiatives, we are expecting flat to slight growth in AFFO this year.
We expect overall building and leasing capital to be noticeably lower compared to the prior year as some of our larger capital initiatives were completed in 2016. We are forecasting positive free cash flow in 2017 after expected building capital, leasing costs, and distributions. We believe that the additional liquidity will provide us with enhanced flexibility to pursue potential opportunities to improve the scale and quality of our portfolio while maintaining our leverage level. 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 some of the initiatives we will work towards in 2017. The overall Canadian industrial market continues to be stable, with national availability at 5.3% and less than 1% of new supply under construction. However, availability rates in Alberta and Halifax are at historic high levels in the nine and 12% range, while Vancouver and Toronto are at historic low availability rates of 3.9% and 3.3%, respectively. Overall, the Dream Industrial portfolio delivered stable results for the fourth quarter, with total occupancy at 95.2%. Regionally, occupancy in Western Canada was 96.1%, Ontario 96.5%, Quebec 96.3%, and Eastern Canada at 89.8%. Alberta continues to experience challenges with increased availability rates and downward pressure on rents. Our Western portfolio, however, continues to show resiliency and stable occupancy relative to the market.
We are starting to see some positive signs in the market. With oil price finding stability, OPEC production cuts, pipeline approvals, and increased drill rig utilization, the atmosphere in Alberta is much more positive than this time last year. The general feeling is that the worst is behind us and recovery has started, but it will be a bumpy ride through 2017. We remain optimistic that industrial has shown to be a more defensive product in Alberta and will recover quicker relative to other asset classes. Our Ontario portfolio occupancy was flat at 96.5%. Quebec performed well in the fourth quarter, with occupancy increasing to 96.3%. Halifax continued to be a challenging market in Q4, with our in-place occupancy at 87.4%.
Halifax is the market where we have the most opportunity to increase our occupancy and where we have ramped up broker promotions and created several show suites to attract potential tenants. Leasing activity has picked up, with new deals bringing committed occupancy up to 89.8%. Overall, 2016 was a challenging year for us as we experienced softer-than-expected results in Alberta and Nova Scotia. In our existing portfolio, we are beginning to see signs of positive momentum and hope that we are coming to an inflection point in improving the performance of our existing portfolio starting in 2017. We have focused our internal goals on improving occupancy and tenant retention and cutting costs in the most challenging segments of our portfolio. Meanwhile, we remain comfortable with the value of our business, its ability to generate relatively stable cash flows, and its desirability for tenants and investors.
We think our business is well-positioned for improved performance in the future. Lenis has provided some guidance on the existing portfolio today, but we will be more opportunistic in 2017 to drive growth in income and net asset value through actively managing our portfolio, asset recycling, and leveraging our platform to seek partnerships and accretive opportunities in developments and acquisitions. We are actively working on these initiatives and will provide updates over the course of the year. That concludes the formal part of our call. Thank you for your time today. We're now happy to take your questions.
Thank you. We will now begin our 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're using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press star then one on your touch-tone phone. It seems that we have our first question from Matt Kornack with National Bank Financial. Please go ahead.
Hi, guys. With regards to the capital recycling, you've been a net seller of assets and sold a fair bit. Where do you see those funds going? Is it going to be de-leveraging in the near term and then acquisitions of stabilized properties, or do you anticipate doing some sort of development repositioning-type projects?
Well, I think you kind of said it all there, that in the short run, we would pay down debt. Acquisitions of stabilized properties and development are all things that we're considering.
We've seen some pretty tight cap rates in Ontario and the GTA for sure, even in some markets like Montreal. Would you look to increase your footprint in Alberta, or are you trying to diversify risk from a geographic standpoint as well?
I don't think we have anything that I can state on that right now specifically, other than we're not excluding any geography where we think that we can acquire properties that'll improve the portfolio and add value and income and NAV.
Okay. Lenis, on the same note, with regards to your guidance going forward, is that just on the existing portfolio, or are you assuming some sort of acquisition activity over the course of 2017?
The guidance I provided was on our existing portfolio. For the full year, I think we do believe we're going to be net buyers of assets instead of net sellers this year.
Okay. With regards to the amortization of the fair value, I know it's come down. How much longer before that sort of goes away with mortgage maturities?
You're referring to the off-market or the mark-to-market.
Yeah
accounting adjustment? We've probably got a couple more years left on that.
Okay
as the mortgages are rolling off.
It won't go up per se, unless you do an acquisition where you assume a mortgage with a fair market adjustment, right?
That's right.
Okay. At run rate, at the very least, would be this quarter annualized.
Yeah, that would probably be the highest because as the mortgages mature, it's going to run down.
Okay. I know you provided AFFO guidance too. From an FFO standpoint, are you also expecting to be flat to up, or will it tick down a bit given the asset sales and some of those non-cash items?
AFFO, we had said, would be flat to slightly up for funds from operations.
Yeah.
From that perspective, we'd probably be flat to slightly down.
Okay
just because of higher interest savings for AFFO as you've just explained.
Yeah. No, that makes sense. I was looking at FFO, not AFFO, but I'll take a look back at our model. Thanks, guys.
Thank you. Our next question comes from Mark Rothschild with Canaccord.
Thanks. Good afternoon, guys. You marked down the values from your assets for IFRS. I just wanted to make sure I understood. Do you only mark down the value of assets that were appraised externally, or when you use the same numbers, did you review the entire portfolio?
Each quarter, we do have a sample of our portfolio that is externally appraised. For the rest of the portfolio that we value internally, we confirm our assumptions with an external appraiser for all of our assumptions, market rates, cap rates, vacancy allowance, et cetera. Whenever we do have changes driven by appraisals, we do look at the rest of our portfolio to see if it's a more broad-based change that needs to be applied, and then confirm those assumptions with our external appraiser.
Okay. I guess just to be clear, it seems to me from disclosure that you had only marked on the assets that were appraised externally. I guess from what you're saying now, that wouldn't be the case.
No, that's not the case.
Okay. In regards to Eastern Canada, obviously, that's where you have the biggest vacancy. When I look at your disclosure for the spread between in-place rents and market rents, it appears that there's the biggest upside there. Maybe if you just talk a little bit more about that market and reconcile the difference there. If there is the upside in rents, why vacancy is highest there, and what you see the opportunity there over the next year.
Yeah, I think the market was a bit of a challenge last year. I think it lost, I don't know, 140 or 160 basis points of occupancy. There really wasn't. There was actually negative growth in the market. That's turned around a little bit now, we're seeing more activity now. There's no new supply in the market. I think the market rents largely reflect to what types of buildings we have available. It can change from time to time. We see things. This year, it's really an exercise of increasing occupancy, then as the year progresses, pushing rents a little bit more.
Where do you think you can get occupancy to?
Well, our goal, our overall portfolio is what? 96-ish, we're kind of close to 90. We want to get closer to, say, 95, between 90% and 95%.
Do you think you can get there in 2017?
Well, that's our goal.
That's our goal. We're actually targeting maybe 100 to 200 basis points in the increase in occupancy in the East.
The goal is not something that's achievable.
That's a long Brent's referring to longer-term.
Longer-term meaning five years or two years, or?
Sure. Two, three years.
Okay, great. Thank you very much.
Thank you. Our next question is from Brad Sturges with Industrial Alliance.
Hi, good afternoon.
Brad.
Hi, Brad.
I guess just more on the commentary on from a same properties perspective, it sounds like your expectation is generally that you're expecting occupancies to generally improve overall. What about in-place rents, or is that still going to be generally stable at this stage?
Embedded in our in-place tenants in the leases, we do have some contractual rent steps. Those will drive our in-place rents upwards. I think over the last couple of quarters, our renewal spreads have been relatively flat, and there's ups and downs within regions. We do expect to maintain those spreads. Then with the contractual rental increases, we probably expect in-place rents to increase very nominally over the year.
On average, what's the contractual rent bump right now?
It's sort of driven by the leases. I think our overall impact on NOI could be maybe 0.5% to 1% in total NOI.
Okay. In terms of leverage, it sounds like the plan is to keep leverage basically where it's at today. Is that the case, or could you see leverage come down a little bit more as we've seen in the past year?
In the past year, our leverage has come down just because of the capital recycling. We disposed of CAD 71 million in assets and repaid debts while we're looking at opportunities to redeploy that capital. Our target leverage really is in that 50%-55% range. It really just depends on sort of what opportunities we see this year, we're happy to be within that 50%-55% leverage range.
I guess maybe another way, if the right acquisition opportunity came around, you might be net buyers this year, that you could see that leverage tick back up towards the higher end of the range?
That's right.
Great. Thank you.
Thank you. Our next question comes from Pammi Bir with Scotia Capital.
Thanks. Good afternoon. Just maybe looking at some of the locations of your assets, are you seeing any demand from e-commerce-related tenants or logistics companies with respect to some of the industrial assets in order to meet last-mile delivery needs?
Yeah, it's definitely a trend. A lot of our assets are located closer to the urban cores, and they're smaller bay products. That's really where the, call it the last-mile. It's not just e-commerce. I wouldn't say that we've done a deal with Amazon, but we have an awful lot of tenants that supply all the growth that you see in the urban cores, the density and everything from the grocery stores to the restaurants to the everything that needs to be supplied. There's certainly demand closer to the cities, so whether it's e-commerce or just serving the general consumer base. Like I said, we haven't had a specific e-commerce company come to us, but it's definitely something that certainly I know CBRE tracks that, and they consider that a trend, and we just haven't quite seen it materialize just yet.
I think it has more in the U.S., so I would expect that coming here.
Right. Then just, I guess, in terms of any sort of redevelopment opportunities within the portfolio, is any of that possible just given some of these expected changes ahead?
We have several properties that have a higher and better use for them. I wouldn't say anything is on the slate to be redeveloped in 2017. As we start to look out two, three, four, five years, there's a number of them that could be much higher uses. We're certainly well aware of those assets. We have plans for them, and we keep that in mind when we're leasing with respect to terms where we're investing capital. We have some embedded value there, but nothing this year that we could push the button on.
Okay. Maybe just turning to Lenis, your comments on the bad debts. How much was that in Q4, and how much higher would that be from, say, a more normal type level?
Q4 bad debts was about CAD 400,000. The full year was just over CAD 800,000. I think historically, we've averaged about just over CAD 300,000. The increase this year was pretty much attributable to one tenant in Alberta.
The 300 is sort of a normalized full-year rate?
Yeah. It's kind of difficult to predict what it's going to be, but on a historical looking back, it's been about 300,000 a year.
Okay. Just looking at the DRIP participation, a fairly substantial increase, and I suspect most of that was Dream Office. Do you have any color around the rationale, or their decision to participate in the DRIP?
Well, I can't comment on Dream Office's position. I know they are fully supportive of Dream Industrial. The DRIP is helpful for our free cash flow.
Notwithstanding where you're trading relative to NAV, I guess, it doesn't seem like there's been any consideration as to turning it off, or has there been at all?
No. I think as our unit price has recovered, I think it's fully supportive of where we are.
Okay. I'll turn it back. Thank you.
Okay.
Thank you. Our next question is from Dean Wilkinson with CIBC.
Thanks. Afternoon, everyone.
Dean.
Lenis, just had a question on the cost-saving initiative that flowed through in the quarter. You had previously disclosed that, so I don't think it came as a surprise to many. I think the initial take on it was going to save CAD 1 million a year in G&A, and it looks like it's CAD 700,000 now. Should I read that the other CAD 300,000 is being picked up at the property level, or has there been a change in that plan?
No change in the plan. I think we announced it just as it really was days after it was actually announced. As we've worked through the numbers and fine-tuned it, we came up with the CAD 700,000 numbers, and there is additional cost savings in our operating costs.
There will be additional savings at the property level.
Yes. At the property level
on top of the CAD 700?
Correct.
Okay. The original CAD 1 million should still be there. It's just perhaps the chess pieces have moved around on the board a bit.
Yeah, that's a fair statement.
Okay. Everything else has been answered. That's all I had. Thanks.
Okay.
Okay, thanks.
Thank you. Our next question is from Heather Kirk with BMO Capital Markets.
Morning. Oh, or afternoon, sorry.
Yeah.
It's all blending into one. You mentioned that you've got, I think you said 53% of the leasing accounted for. How much of that would be related to the stake in Western Canada? I guess how much of your Western Canadian maturities are taken care of by?
No, I don't know.
Yeah, we don't have the number off the top of our head, but we might be able to get back to you on the call.
Just in terms of the CapEx, you mentioned that it's going to be coming down. It was up a lot last year. Do you expect it to trend back to previous levels or to settle somewhere in between? Do you have just a hard number that you're targeting for the building improvements and the leasing costs?
We do expect our total building and leasing capital to be about 20%-30% lower in 2017 compared to 2016. We did complete a number of initiatives on the capital maintenance side in 2016, we know that's trending down. Our leasing capital, we expect the leasing costs to be relatively flat compared to 2016. A lot of the reduction is coming on the capital maintenance side.
Okay. In terms of the Western portfolio, can you just give us a little bit of color in terms of how you're feeling about your tenant base and whether there's anybody that you might have concerns about or are in talks with?
Okay. In general, in West, like I said in my comments at the beginning, I was just out there for the better part of a week two weeks ago, it's definitely a more positive feel in the market. I met with a number of our tenants. We have a couple that have been on rent relief and actually visited one of them. Their business has picked up. They look like they're going to survive, but it's going to take them one year or so to get business rent back up again. I wouldn't say that other than that, we don't have an extraordinarily high amount of people that are behind on their rent or requesting it. It seems to be stabilized, but that's assuming that the positive signs continue and there isn't something that disturbs the energy markets.
Okay. Thanks very much.
Actually, Heather, before, just to get back to you on your first question of the 53%, I'd say about 50% just for Western Canada.
Okay.
If you're looking at the Western Canada 2017 expiries, about 50% of those have been addressed.
Okay. Just one last question. You had a pretty dramatic increase in Quebec in the occupancy. Was there something specific? I know you said you expect things to kind of flatten out, but can you just provide a little bit of color whether that was one lease or a lot of smaller leases?
We didn't have any one major lease. We just had a few leases. We had a building in Milos that we leased up, and we also had a 50,000-foot property that we had on the market for sale or for lease that was vacant. It was one of the assets that we sold in the quarter.
Right.
We've got a decent price for it, and it also had, I guess, the side benefit of reducing our vacancy.
Okay. Yep. Thanks so much.
Thank you. We now have a question from Sam Damiani. Sam, could you please go ahead and state your company?
Thanks. Good afternoon. Just on the topic of the bad debts there, CAD 500,000, I think you said, Lenis, was one tenant in Western Canada. Are you still accruing rent on that tenant in Q4 and going forward?
There's no NOI coming through for that tenant for Q4, to date for Q1.
In the hopes that they'll ramp back up in short order, I gather.
That's right. They're still operating. They're just facing some financial challenges right now.
Okay. Brent, your comments about pursuing partnerships, capital recycling, being net buyers in 2017, could you give us a sense of what's driving that decision-making? Where are you seeing opportunity today versus a year ago? Is it more on the acquiring sort of broken properties in need of some TLC, or are you looking to buy stable assets? What's sort of the outlook there?
I think over the last year or so, we've really just been dealing with assets one on one as we've had a tenant leave, or for some reason, some of our assets are more valuable being sold empty than they are leasing. We've kind of have, on the disposition side, really dealt with it on an asset-by-asset basis. Going forward now, I think we're just going to be taking a little bit more of a strategic look at growth and where we can sell some properties, acquire properties that add to the quality of the portfolio, the NAV, lower CapEx requirements going forward. That's more of the approach that we'll be taking going forward. We don't have anything specific to outline today, but it's something that we're just getting a more active approach on.
Is the pursuit of partnerships a key component of that strategy, or not so much?
I don't know if I'd say it's a key component, it could be a component. It's certainly something that other dream companies have done, other REITs have done. It's definitely a tool in the box, and we wouldn't exclude it. We're really open-minded to anything that we think can drive cash flow, AFFO, and unit value.
Just finally, Lenis, in your outlook for FFO and AFFO for 2017, is there a trend in the first half versus the second half that you could speak to?
I think it's going to be relatively flat. Definitely Q1 is going to be flat to Q4. Like Brent said, we could have slight ups and downs. Q1's looking flat and, for the full year, flat to slightly up.
Very good. Thank you.
Thank you. As a reminder, if you have a question, please press star then one. We have a follow-up question from Tommy Burr with Scotia Capital.
Sorry, just to go back to the DRIP again. Can you just maybe help me reconcile, help me understand the rationale to just to leave it running, considering the dilution to both your AFFO and NAV?
Sorry. I mean, the DRIP right now, it helps in providing the free cash flow for us. With that free cash flow, like Brent mentioned, we're actively pursuing opportunities or exploring opportunities to redeploy the capital. With the capital recycling that we've completed and our free cash flow, it provides us some financial flexibility. It's really we need to find opportunities to be able to redeploy that capital on an accretive basis, both to AFFO and to NAV.
Not buying back your units?
It's something that we always have looked at, but I think we're not in that position right now.
Okay. Thanks.
Thank you. At this time, we have no further questions. I will turn the call back over to Brent Chapman for closing remarks.
Okay. Thank you, everybody, for calling in and participating. We look forward to speaking with everybody next quarter.
Thank you, ladies and gentlemen. This concludes today's conference. We thank you for participating. You may now disconnect.