Earnings Call: Q4 2016

Feb 22, 2017

Earnings release

Good afternoon, ladies and gentlemen. Welcome to the Dream Industrial REIT Fourth Quarter twenty sixteen Conference Call for Wednesday, February 2237. 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 and 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. Your host today will be Mr. Brent Chapman, CEO 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 3136. Speaking with me today is Lennis Kwan, the Chief Financial Officer of the REIT. Lennis 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 $1,600,000,000 reflecting an overall cap rate of 6.71%. Diluted funds from operations, or FFO per unit for the quarter for the fourth quarter was $0.21 Excluding the impact of $1,000,000 charge related to our cost production program, FFO was $0.22 slightly lower than the prior quarter and same quarter of last year. Adjusted funds from operations or AFFO for the quarter was $0.19 per diluted unit or $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 and G and A, which we believe will be lower in future quarters. We expect the cost reduction program to result in annualized savings of approximately $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 $71,000,000 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. Our weighted average face interest rate is 3.8% with a weighted term to maturity of four point two 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 twenty sixteen 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, Linus. 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 912% range, while Vancouver and Toronto are at historic low availability rates of 3.93.3% 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 is 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 and 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 and developments and acquisitions. We are actively working on these initiatives and we'll provide updates over the course of the year. That concludes the formal part of our call. Thank you for your time today and we're now happy to take your questions. And thank you. We will now begin our question and answer session. And it seems that we have our first question from Matt Karnack with National Bank Financial. Please go ahead. Hi guys. Just 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 deleveraging 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 and we're acquisitions of stabilized properties and development are all things that are we're considering. And just I mean, we've seen some pretty tight cap rates in Ontario and the GTA for sure, but even in some markets like Montreal, I mean, would you look to increase your footprint in Alberta? Or are you trying to diversify risk from a geographic standpoint as well? Yes. I don't think we have sort of anything that can state on that right now specifically other than we're not excluding any geography where we think that we can acquire properties that will improve the portfolio and add value and income and NAV. Okay. And Lenis, with regards to 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. I think we in terms of our for the full year, I think we do believe we're going to be net buyers of assets instead of net sellers this year. And with regards to the amortization of the fair value, I know it's come down. Much longer before that sort of goes away with mortgage maturities? So you're referring to the sort of the off market or the mark to market accounting adjustment. We probably got a couple more years left on the call as the mortgages are rolling off. But it won't go up per se unless you do an acquisition where you assume a mortgage with a fair market adjustment, That's right. Okay. So at run rate, at the very least, would be this quarter annualized? Yes. That would probably be the highest because if the mortgage is mature, it's going to run down. Okay. And then you provided AFFO guidance to 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 noncash items? Well, the so AFFO, we had said, would be flat to slightly up for funds from operations. Yes. From that perspective, we'd probably be flat to slightly down because we have higher interest savings for AFFO as you've just explained. Yes. No, that makes sense. I just I was looking at FFO, not AFFO, but I'll take a look back at our model. Thanks, guys. And thank you. Our next question comes from Mark Rothschild with Canaccord. Thanks. Good afternoon, guys. Marked down the value you marked down the values from your assets for IFRS and I just wanted to be make sure I understood. Did you only mark down the value of assets that were appraised externally or when you used the same numbers did you review the entire portfolio? So when so each quarter, we do have a sample of our portfolio that is externally appraised. And 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, etcetera. So 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 an external or external appraiser. Okay. Guess just to be clear, it seems to me from disclosure that you had only marked on the assets that were appraised externally. But I guess from what you're saying now that wouldn't be the case. No, that's not Okay. And then in regards to Eastern Canada obviously that's where you have the biggest vacancy. When I look at your disclosure for the spread within in place rents and market rents it appears that there's the biggest upside there. So maybe if you could just talk a little bit more about that market and reconcile the difference there. If there is the upside in rents, vacancy is highest there and what you see the opportunity there over the next year? Yes. I think the market was a bit of a challenge last year. Think it lost 140 or 160 basis points of occupancy. So 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. So I think the market rents largely reflect to what types of buildings we have available. So it can change from time to time. We see things this year it's really an exercise of increasing occupancy and then as the year progresses pushing rents a little bit more. And where do you think you can get occupancy to? Well, our goal, our overall portfolio is what 96 ish and we're kind of close to 90%. So we want to get closer to say 95%, between 9095%. And 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 increase in occupancy in these. So the goal is not something that's achievable? That's a long referring to a 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. Hi, Brad. Hi, Brad. I guess just more on the commentary on from a same property perspective, it seems it sounds like your expectation is generally that you're expecting occupancies to generally improve overall. And what about in place rents? Or is that still going to be generally stable at this stage? In our embedded in our in place tenants in the leases, we do have some contractual rent steps. So 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. So we do expect to maintain those spreads. And then with the contractual rental increases, we'd probably expect in place rents to increase very nominally over the year. And on average, what's the contractual rent bump right now? I mean, it's sort of driven by the leases. I think our overall impact on NOI could be maybe half percent to 1% in total NOI. Okay. And in terms of leverage, 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? Well, in the past year, our leverage has come down just because of the capital recycling. We disposed of CAD71 million of assets and repaid debt while we're looking at opportunities to redeploy that capital. Our target leverage really is in that 50% to 55% range. So it really just depends on sort of what opportunities we see this year. And so we're happy to be within that 50% to 55% leverage range. So I guess maybe another way, if the right acquisition opportunity came around and 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. Okay, great. Thank you. And thank you. Our next question comes from Tommy Burr 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 infill assets in order to meet last mile delivery needs? Yes, it's definitely a trend. Mean a lot of our assets are located closer to the urban cores. So and they're smaller bay products. They that's really where the, call it, the last mile. And it's not just e commerce. I wouldn't say that we've had you know, done a deal with Amazon, but we have an awful lot of tenants that supply all the growth that you see in the urban core is the density and all the everything from the grocery stores to the restaurants to the bay everything that needs to be supplied. So there's certainly demand closer to the city. So whether it's e commerce or just serving the grower the general consumer base. So we definitely like I said, we haven't had a specific e commerce company come to us. But it's definitely something that certainly I know CB, Richard Ellis tracks that and they consider that a trend and we just haven't quite seen it materialize as yet. And I think it has more in The U. S. So I would expect it coming here. And then just I I guess in terms of any sort of redevelopment opportunities within the portfolio, does that is any of that possible just given some of these expected changes ahead? We have several properties that are have a higher and better use for them. I wouldn't say anything is on the slate to be redeveloped in 2017. But as we start to look out two, three, four, five years, there's a number of them that could be much higher uses. So 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. So 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? The Q4 bad debt was about $400,000 The full year was just over 800 I think historically we've averaged about just over $300,000 So the increase this year was pretty much attributable to one tenant in Alberta. The $300,000 is your normal sort of a normalized full year rate? Yes. I mean it's difficult to I mean it's kind of difficult to predict what it's going to be. But on a historical, looking back, yes, it's been about $300,000 a year. Okay. And then just looking at the DRIP participation, fairly substantial increase and I suspect most of that was Dream Office. But can you do you have any color around the rationale or their decision to participate in the DRIP? Well, mean, I can't comment on Dream Office's position. I know they are fully supportive of Dream Industrial. But I mean, the DRIP is helpful for our free cash flow. Notwithstanding where you're trading relative to NAV, I I guess you haven't given any well, it doesn't seem like there's been any consideration as to turning it off, Or has it been at all? No. No. And I think as our unit price has recovered, I think it's fully supportive of where we are. Okay. Okay. I will I'll turn it back. Thank you. Thank you. Our next question is from Dean Wilkinson with CIBC. Thanks. Good afternoon everyone. Hi Dean. Lenis, just had a question on the cost saving initiative that flowed through in the quarter. I mean you had previously disclosed that, so I don't think it came as a surprise to many. But the I think the initial take on it, it was going to save $1,000,000 a year in G and A and it looks like it's $700,000 now. Should I read that the other $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, you know, we announced it just as, you know, it was you know, it really was, you know, days after it was actually announced. You know, as we've worked through the numbers and fine tuned it, you know, came up with the $700,000 numbers and there is additional cost savings in our operating costs. There will be additional cost at the Yes. Property the property level. On top of the $700,000 Correct. Okay. So the original $1,000,000 should still be there. It's just perhaps the chess pieces have moved around on the board a bit. Yes, that's a fair statement. Okay. Everything else has been answered. That's all I had. Thanks. Okay. Thanks. Thank you. Our next question is from Heather Kirk with BMO Capital Markets. Good morning or afternoon, sorry. 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 state in Western Canada? So I guess how much of your Western Canadian maturities are taken care of? No, I don't Yes, 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. Okay. And 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? And do you have just a hard number that you're sort of targeting for the building improvements and the leasing costs? So we do expect our total building and leasing capital to be about 20% to 30% lower in 2017 compared to 2016. We did complete a number of initiatives on the capital maintenance side in 2016. So we know that that's trending down. Our leasing capital, we expect the leasing costs to be relatively flat compared to 2016. So a lot of that a lot of the reduction is coming on the capital maintenance side. Okay. And 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, West, like I said in my comments at the beginning, I was just out there for better part of a week, two weeks ago and it's definitely a more positive feel in the market and I met with a number of our tenants. So we have a couple that have been on rent relief and actually visited one of them. So their business has picked up. So they look like they're going to survive but it's going to take them a year or so to get business ramped back up again. I wouldn't say that we have other than that we don't have an extraordinarily high amount of people that are behind on their rent or requesting it. So it seems to be stabilized but, you know, that's assuming that the positive signs, you know, 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%, say about 50% just for Western Canada. So if you're looking at the Western Canada 2017 expiries, about 50% of those have been addressed. Okay. And just one last question. You had a pretty dramatic increase in Quebec in the occupancy. Was there something specific? Is that a trend that I know you said you expect things to kind of flatten out. 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 the Lodge that we leased up and we also had a property we had a 50,000 foot property that we had on the market for sale or for lease that was vacant. So we it was one of the assets that we sold in the quarter. So we've got a decent price for it and also had the, I guess, the side benefit of reducing our occupancy or our Okay. Vacancy, Yes. Thanks very 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, dollars 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 and to date for Q1. In the hopes that they'll ramp back up in short order, I gather? That's right. I mean they're still operating. They're just facing some financial challenges right now. Okay. Brian, 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? Yes. 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. So 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 acquire property or 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. And is the pursuit of partnerships a key component of that strategy or maybe just sort of or not so much? I don't know if I'd say it's a key component, but it could be a component. It's certainly something that other dream companies have done, other REITs have done. So it's definitely a tool in the box and we wouldn't exclude it. But we're really open minded to anything that we think can drive cash flow, AFFO and unit value. And just finally, Lenis, on 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. But Q1 is looking flat and for the full year, to slightly up. Very good. Thank you. And we have a follow-up question from Tommy Burr with Scotia Capital. Sorry, just to go back to 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, Punk. I mean the DRIP right now it's providing it helps in providing the free cash flow for us. And with that free cash flow, we're like Brent mentioned, we're actively pursuing opportunities or looking exploring opportunities to redeploy the capital. So with the capital recycling that we've completed and our free cash flow, it provides us some financial flexibility. And it's really we need to find opportunities to be able to redeploy that capital on an accretive basis, both AFFO and to NAV. But not buying back your units? I mean it's something that we always have looked at, but I think we're not at that we're not in that position right now. Okay. Thanks. And 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 and we look forward to speaking with everybody next quarter. And thank you, ladies and gentlemen. This concludes today's conference. We thank you for participating. You may now disconnect.