Good morning, ladies and gentlemen, welcome to the conference call of Granite REIT. Speaking to you on the call this morning is Kevan Gorrie, President and Chief Executive Officer, and Ilias Konstantopoulos, Chief Financial Officer. Before we begin today's call, I would like to remind you that statements or information made in today's discussion may constitute forward-looking statements and forward-looking information, and that actual results could differ materially from any conclusion, forecast, or projection. These statements and information are based on certain material facts or assumptions, reflect management's current expectations, are subject to known and unknown risks and uncertainties. These risks and uncertainties are discussed in Granite's material filings with Canadian securities administrators and the U.S. Securities and Exchange Commission from time to time, including the Risk Factors section of its annual information form for 2018, filed on March 6th, 2019.
Readers are cautioned not to place undue reliance on any of these forward-looking statements and forward-looking information. Granite undertakes no intention or obligation to update or revise any of these forward-looking statements or forward-looking information, whether as a result of new information, future events or otherwise, except as required by law. In addition, the remarks this morning may include financial terms and measures that do not have a standardized meaning under International Financial Reporting Standards. Please refer to the audited combined financial results and management's discussion and analysis for the year ending December 31st, 2018 for Granite Real Estate Investment Trust and Granite REIT Inc. and other materials filed with Canadian securities administrators and U.S. Securities and Exchange Commission from time to time for additional relevant information. I would like to turn the call over to Kevan Gorrie. Please go right ahead, sir.
Thank you, operator, good morning, everyone, welcome to our Q4 2018 call. Ilias and I are joined this morning by Lori-Ann Kramer and Michael Ramparas, our EVP and VP of Global Real Estate. Ilias will begin our discussion this morning with a review of the financial highlights. I will then follow with comments on acquisitions, operations, and strategy, we'll open up the call to any questions that you may have. Ilias, over to you.
Thanks, Kevan, good morning to all. 2018 was a transformational year for Granite on many levels. Financial and operating highlights for the three-month period and year ended December 31st, 2018, including events subsequent to the quarter, were as follows. Net operating income prepared in accordance with IFRS was CAD 52.4 million in the fourth quarter compared to CAD 54.5 million in the prior year period. Same property NOI, prepared on a cash basis, a non-IFRS measure, increased by 1.9% for the three-month period ended December 31st, 2018, excluding the impact of foreign exchange. For the year 2018, NOI was CAD 216.6 million compared to CAD 213.3 million in the prior year. Same property NOI on a cash basis increased by 0.3% for the year 2018, excluding the impact of foreign exchange.
Shifting to FFO for the quarter, it was CAD 0.90 per unit compared to CAD 0.89 per unit in the fourth quarter of last year. On a full-year basis, FFO was CAD 3.58 per unit compared to CAD 3.25 in 2017. There are some notable items that create a bit of noise in those numbers. I will provide you some clarity, excluding some of these one-time items or unusual items. Included in the number of CAD 3.68, there are some lease termination and close-out fees of CAD 1 million and a net FX gain on the remeasurement of U.S. dollar cash proceeds from sales we made early in the year, in the order of U.S. $8.5 million. Excluding these two items, our CAD 3.68 would be CAD 3.47 per unit for 2018.
Similarly, by eliminating the proxy contest expenses of CAD 5.9 million and the lease termination and close-out fees of CAD 1.6 million in the prior year, FFO would have been CAD 3.34 per unit. Shifting now to AFFO. For the quarter, it was CAD 0.87 per unit compared with CAD 0.69 per unit in the fourth quarter of 2017. For the full year, AFFO was CAD 3.01 per unit compared to CAD 3.09 in the prior year. Once again, making adjustments for the lease termination and close-out fee, the foreign exchange gain that I mentioned, and the payments of incentive allowance that we made in connection with the 2014 lease extension at our Eurostar facility of CAD 9.1 million, AFFO would have netted out to CAD 2.99 per unit in the year 2018 as compared with the prior year, which making the similar adjustments I mentioned would have been CAD 3.18.
Shifting gears now to the disposition activity during the year and subsequent to it. For the year 2018, we sold a total of 16 properties for CAD 730 million, which together with six properties that we held for sale and ultimately sold subsequent to the year-end for CAD 44 million. We lost roughly CAD 51 million of annualized revenue. Most of these properties that were sold were Magna-tenanted. Making up for some of those losses were acquisitions during the year, which amounted to 18 income-producing properties comprising roughly 6.2 million sq ft and 13 acres of development land for total proceeds of CAD 544 million at a 5.8% ongoing yield. That represents roughly CAD 31.6 million of incremental stabilized NOI.
In terms of commitments to acquire, construct, and develop properties, in addition to the acquisitions I just mentioned, we have made payments for and have further contractual commitments related to acquisitions, construction, and development projects amounting to CAD 690 million at an ongoing stabilized yield of 5.6%. Once completed and stabilized, that would represent roughly CAD 38.6 million of additional NOI. The significant recycling that we underwent during the year reduced our Magna concentration to 54% and 47% on a revenue and GLA basis respectively during the fourth quarter, as compared to 71% and 61% at Q4 of last year. We expect that our Magna concentration will drop to below 50% by revenue by the end of 2019.
In terms of our investment properties, these had an IFRS value of CAD 3.225 billion at year-end and benefited from favorable exchange rates in both the EUR and U.S. dollar to the tune of CAD 148 million. The overall cap rate for our income-producing properties was 6.65% at year-end versus 7.6% in the prior year, which reflects the change in our property mix to a greater portion of modern logistics and distribution properties, as well as compression in overall cap rates, terminal cap rates, cap rates, and higher market rents in several of our markets. The above, together with the sale prices realized on the disposition of 22 properties, including the six that were held for sale, resulted in net fair value gains of CAD 355 million approximately, which is roughly $7.75 per unit in 2018.
As you know, we completed two terminal financings in December, both of which were fully drawn and amounted to an aggregate of CAD 550 million. The first was a CAD 300 million senior unsecured facility that we swapped into EUR-denominated payments at a fixed rate of interest of 2.20%. The second was a U.S. $185 million 4-year term facility that we swapped as well into EUR-denominated payments at a 1.225% fixed rate of interest. Our balance sheet at December 31st, 2018, stood at a net leverage ratio for equivalent of sale of the six assets of 18%, giving us in excess of CAD 1.25 billion of additional debt capacity at a 40% net leverage ratio. We've said our target net leverage ratio to be in the order of 35%-40%. At a 35% net leverage ratio, the additional debt capacity would amount to just over CAD 900 million.
Our liquidity at year-end was CAD 1.2 billion before the sale of the six assets. We expect to tap this liquidity and debt capacity for, among other things, the CAD 628 million worth of future contractual commitments discussed earlier and as more detailed in our MD&A. I want to shift for a second to maintenance capital expenditures and leasing costs. We, as you know, report maintenance CapEx and leasing costs for purposes of deriving AFFO, and we do so on an actual basis. The inherent nature of these items are that they can be lumpy. The purpose of what I'm going to discuss is to give you a sense for what is hopefully a sustainable level. The maintenance and improvement CapEx and leasing costs paid by quarter and for the years ended December 31st, 2018 and 2017 are summarized in detail in our MD&A.
The two items I'd like to highlight are as follows. The first relates to our Novi, Michigan Flex office building. This 307,000 sq ft facility is one of the very few office properties in our portfolio. Commencing with the third quarter of 2017, we undertook to redevelop our Novi property, which was vacated by Magna in March 2017. We invested a total of $22.7 million in capital during 2017 and 2018 to reposition and lease our Novi Flex office property. You might recall we leased 71% of the space to Harman Systems for a minimum lease term of 15 years, commencing in January 2018. We are currently actively marketing the remaining 90,000 sq ft of available space and anticipate incurring additional cash outflows totaling approximately CAD 6.6 million in CapEx and leasing costs during 2019 to complete the Novi facility and lease up the remaining available space.
The second item involves a CAD 9.1 million payment we made in the first quarter of 2018 related to a tenant incentive allowance for 2014 lease expansion at our 1.1 million sq ft Eurostar facility in Graz, Austria. We view these two particular items as unique and do not believe they reflect a level of ongoing spending required to sustain our industrial portfolio. Excluding these two items, our actual spend on CapEx and leasing costs would have amounted to CAD 0.14 a foot and CAD 0.32 a foot for 2017 and 2018, respectively. We believe that a more representative level of CapEx and leasing cost spend required to sustain our industrial portfolio would be within this range in the order of CAD 0.20-CAD 0.25 a foot. Lastly, distributions.
As you're aware, we increased our 2019 targeted annual monthly distribution by 2.9% to CAD 2.80 per stapled unit, which amounts to CAD 0.233 per month, commencing with the monthly distribution we paid in January of 2019. This is Granite's seventh consecutive annual increase to its distribution and represents a cumulative increase of 40%. Lastly, as a result of the increase in taxable income generated primarily by the sale transactions in 2018, we declared a special distribution in December of 2018 of CAD 1.20 per stapled unit, which included CAD 0.30 per unit payable in cash, ultimately paid in January. With that, I'll turn the call back over to Kevan.
Thank you, Ilias. As you can tell, 2018 was another active and successful year for Granite, underpinned by strong financial results, approval of the new strategic plan in November, and significant progress against our corporate objectives. Our focus on effective capital allocation, portfolio enhancement, and active management provided strong results for the year and positioned us for future growth and performance in 2019. As mentioned, we acquired over CAD 540 million in modern e-commerce and distribution assets in the U.S. and Germany at a going-in yield of 5.8%, which, when combined with the gains generated from the sale of non-core assets, significantly increased NAV and improved the quality and tenant diversification of our portfolio. Two main principles of our priorities of our company. Dispositions totaled CAD 730 million on an average cap rate of 6.7%.
I will point out the location of the assets included Bowling Green, Kentucky, St. Thomas and Tillsonburg, Ontario, Duncan, South Carolina, and Clinton, Tennessee, which to us validates the liquidity and demand for assets with a Magna covenant. Despite the loss of CAD 48 million in annualized revenue from these dispositions in 2018, we were able to increase FFO per unit over 2017 while maintaining overall debt levels and liquidity with which to fund future acquisitions and development. As a result of these transactions, as mentioned, we reduced our Magna concentration to 47% of GLA and 54% of revenue. As an example of effective capital allocation, as Ilias mentioned, I think it's worth highlighting again. In December, we raised CAD 550 million in unsecured financing at an average fixed rate of 1.76% and average term of almost six years.
Our credit rating and European asset base enabled us to enter into a Euro currency swap to secure extremely competitive capital with which to pursue growth opportunities. Operationally, we renewed over 3 million feet of expiring space, primarily Magna-tenanted, in 2018 for an average increase in base rent of roughly 12.5% at an average lease term of over 7 years, and ended the year at a very respectable 99% occupancy rate. So far in 2019, we have closed on two acquisitions totaling roughly CAD 170 million in Dallas, Texas, and sold four Magna-tenanted assets in Iowa and one small property in Richmond Hill, Ontario. We also completed the 300,000 sq ft expansion of our Ace Hardware property in Columbus, Ohio. For the remainder of 2019, I think as been disclosed, we will focus on the following priorities. Increasing our scale in target markets.
Continuing to dispose of select non-core assets and exit non-core markets. Driving NAV, FFO, and AFFO per unit growth in 2019. Execute on our development projects in Plainfield, Indianapolis, and Altbach, Germany. Reduce our Magna concentration to below 50% as a percentage of revenue, and enhance our platform capabilities in both Europe and the U.S. With respect to platform enhancement, I am pleased to welcome Wenzel Hoberg to our team as our new Head of Europe. Wenzel joins us with over 15 years of experience in investment of real estate, including logistics, most recently with CPPIB in London, and will be working with our existing team in Vienna to execute on our strategy in Europe. As we deliver on these initiatives in 2019, we will continue to adhere to our core principle of delivering maximum long-term value per unit to Granite unitholders.
Accordingly, we will continue to prioritize net asset value, portfolio quality, platform capability, and maintaining a conservative capital structure. Looking forward, all of us at Granite are truly excited about meeting the challenges and fulfilling our potential in 2019, and I believe that we are very well positioned to do so. On that, I will now open up the floor to any questions.
Thank you. Ladies and gentlemen, if you would like to register any questions, just press the one followed by the four on your telephone. We're here to be prompt to acknowledge your request. If your question has been answered or to withdraw your registration, press the one followed by the three. If using a speakerphone, accept the handset before entering your request. Once again, it's the one-four for any questions or comments. One moment please for our first question. We'll get to our first question on the line from the line of Sam Damiani with TD Securities. Please go right ahead.
Thank you. Good morning. Just wanted to touch base on the acquisition side, the acquisition of the leasehold properties in Mississauga. I wonder if you could provide a little bit of color on the tenancy, the lease term, the square footage, and the terms of the ground lease. I have a follow-up question as well.
Well, Sam, we're still operating under a PSA for that acquisition. We are limited in what we can discuss. We do expect to close on that acquisition probably within the next 30 days. We'll have more details to announce then.
Okay. Maybe just a bigger picture, given the yield on that one and what else you're looking at in the GTA, is this indicative of cap rates that you're looking at for what you want to buy in the GTA?
Well, certainly, as we disclose in our strategy, we will pursue core acquisitions if it feels the right fit. This one represents to us one of the best locations in the country, period. The other thing too is due to a combination of expansion potential, contractual rent growth, and where the rents are vis-à-vis the market today, we feel that the growth prospects are superior for this. While it may be a low four and a half yield going in, we feel the prospects of generating a higher yield in the short term are very good.
Okay. Thank you. Look forward to learning more there. Maybe just a quick one, Ilias, on the tax side. I don't want to make a big deal of this, but there was a little bit of an adjustment, I guess, in Q4 related to Austria. I wonder if you could shed some light on that, if it's material for Granite's plans going forward.
Right. It relates, Sam, to an item that we had provided for many, many years ago, dating back to the MEC once upon a time, which you're probably familiar with. It went statute barred. Effectively, we reversed the provision we had and therefore benefited from that one time, half a million or so. What we expect to be helpful to your question, what we expect is our current income taxes to be in the order of CAD 8 million for the year, if you will, give or take. That item we view as one of them.
Great. Thank you. I'll turn it back.
Thank you very much. We'll get to our next question on the line from Mike Markidis with BMO. Please go ahead.
Hi. Thanks. Good morning, guys. Kevan, I was just curious, can you give us a sense for how large your disposition program is this year?
We've identified, I would say most of the assets that obviously Magna tenanted, Mike, that we've identified are in the smaller range. I think we'll be, in terms of disposition, somewhere between CAD 100 million and CAD 200 million.
Okay. Would that be incremental to what you've already done subsequent to the quarter, or including the stuff that you did subsequent to the quarter?
Incremental.
Okay, great. Just obviously I appreciate the PSA that you've got on the Mississauga assets that you're buying. Looking to get the details there. Just curious if you could shed some light on how you view your existing GTA footprint and how in the next, let's call it five years in conjunction with your strategic plan, you might see that evolving.
I've stated before, I would like us to be more relevant in Canada, and the GTA is obviously Canada's largest industrial market and the market we want to be active in. We have the expertise and then the connections to be successful doing that. This acquisition, we feel fits in very well to our strategy, a modern e-commerce location in this market. It is a perfect fit for our strategy. The remaining portfolio is largely Magna. A number of the assets I wouldn't consider would meet that criteria of modern distribution and logistics. The value of the land on which they sit, including the ones in Milton, are very good. We're very happy with our platform in this market. Overall, Mike, I would say our footprint in the GTA will be larger.
How much larger, how many opportunities we see that make sense both strategically and financially is hard to say. I would guess that our footprint in the GTA will be larger a couple years from now than it is today.
Okay. Last one from me. I'll turn it back. Just appreciate the disclosure on the same properties. Just thinking on a constant currency basis, based on what you guys know today, what we should be thinking about for 2019.
It's a good question. I think 2019, we expect to be similar to 2018 based on what we know today. I think we've had some good tailwinds in 2018 on the leasing side. 2019, We progressed well on the renewal side there, but the growth is not nearly as strong as it is in 2018. We expect it to be similar. I would point out, because of the nature of a few of the larger Magna assets, the rent increases are rather lumpy. They're not necessarily annual bumps. We expect 2019 to be very similar to 2018. There will be those years where we could get a rather attractive bump in top NOI as a result of the Magna assets.
Understood. Thanks for the color.
Thank you very much. We'll get to our next question on the line from Howard Leung with Veritas Investment Research. Go ahead.
Thank you. Good morning. I want to ask about the follow-up on the question of dispositions. I guess, Kevan, given you mentioned there's only another CAD 100 million or CAD 200 million, it's probably we won't be seeing a special distribution this year then?
That's too early to say. Among other things, you're right, Howard, that dispositions would be one of the items that would impact it. It would be too early to say. There certainly isn't an expectation at this point. There are many variables, I'd rather not speculate at this point.
Okay. No, that's fair. The question had to do with this lease step-ups. I'm currently just taking a calculation of the expense, so contractual adjustments divided by the base rent. It seems like it's around 1.2%. That's what we think about the contractual adjustments. I know that here you mentioned Magna tenants, there's going to be a bit of a step-up there. It should be a little higher this year than that?
I don't know an answer for 2019 specifically, but I will say a number of these assets, even the larger ones, are tied to CPI, but they're not necessarily annual. I would say 1%-1.2% would be on the low end.
Okay. That makes sense. Just the last one. The Magna diversification with a goal that you mentioned was to get below 50%. You're pretty close to that now, I think even after completing these developments, especially the large one in Chattanooga, you should be below that. Is there a lower number, maybe 20% or 30%, that you would eventually target? Is that as long as it's Magna is below 50%, you're comfortable?
No, I don't think we're done at below 50%. I think, as we stated earlier, it's really important that we're making the right real estate decision for investors. We'll continue on the disposition program, but where we feel there's an opportunity to extend the lease and increase the value of the asset or drive the value of the asset for, say, a potential disposition, we would do that. We're going about the disposition program as thoughtfully as we can and trying to maximize value.
Right. Yeah. You guys do have quite a good renewals pipeline, 4.5% over a kind of five-year term. That's pretty solid. I'll turn it back.
Yeah.
Thank you very much. We'll get to our next question on the line from Pammi Bir with Scotia Capital. Please go right ahead.
Thanks. Good morning. Just with respect to, I guess, a potential U.S. platform or plans for a U.S. platform, would you consider acquiring one? How would you describe the opportunities that you are seeing there at the moment?
It's a good question. The short answer is yes, we would and have. What we have seen is on the pricing side on M&A in the U.S., it's quite expensive. We have not seen a platform acquisition opportunity that has made any real sense to us. We continue to consider that as one viable option, if you will.
Okay. In terms of those opportunities that you have looked at, what would sort of the geographic mix of those portfolios look like?
I think that has been one of the challenges. Any acquisition opportunities like that that have been shown to us or we have seen have involved one or more markets that are outside of our target areas. That has been, for us, one of the factors that has prevented us from making any transaction like that.
Okay. Would your target areas include, I guess, some of the coastal markets?
No. I think, as you can see in our strategy, we've kind of laid out what markets we're focusing on in the U.S. It would not include L.A. or Seattle, for example, or even Miami. Those markets are very expensive. They're dominated by a number of large players. It's hard to see how we can have any real relevance or competitive edge in those markets.
Got it. Just last one, I apologize if you mentioned this already, on the Altbach developments in Germany, can you just describe what you're envisioning there and the expected cost and, I guess, target return?
It's a good question. We are targeting a return of in the mid-singles on an unlevered yield. It's just outside of Stuttgart in the southeast. I would say we're very excited about it. The level of interest in this site, if you know the Stuttgart market, it's a valley. I don't think there's a level piece of land. I think we happen to sit on one of the only remaining level pieces of land there. There has been a lot of interest early on. What's important to us as we develop, whether we go ahead on a speculative basis or we do a pre-lease deal, which could happen for sure, is to build an asset that fits our criteria. I will tell you, we've had prospects from multiple sectors for it, and right now, everybody would be happy to get that scale in that location.
We're quite confident in this, in our prospects for the site.
Sorry, this would be then a 2020 completion?
Yes.
Roughly the total investment?
EUR 25 million-EUR 27 million.
Perfect. Okay. Thanks, guys.
Thank you very much. We'll get our next question on the line from Sairam Srinivas from BMO. Please go right ahead.
Good morning, guys. My question was primarily around development and that too around the recent acquisition in Texas. I was hoping if you could kind of share some color around the demand you are seeing in that market as well as the plans you have for the Texas land around property.
Are you referring to the two acquisitions in Dallas that we just announced?
Yes, that's right. Yep.
One of them is a very large site, which we purchased only 200,000 sq ft on the, I think, 170 acres. Really a covered land play and a market in the southeast that we feel continues to be a really important distribution node for the Dallas market and its proximity to Houston and the UP Intermodal yard there. We feel it's a strategic site, particularly with proximity to the intermodal. It's a 12-year lease, so we certainly have stable cash flow and time to think about what we do with the land. If you look at that node in the southeast of Dallas, it continues to grow in importance as a distribution and e-commerce node. We feel that site will be very strategically positioned in the next 10 years.
Thanks for the color, Kevan. Broadly around 2019, do you guys have a broader developmental target?
Not necessarily a development target. We have the development project in Indianapolis, which we're moving forward. We have the development in Altbach, which we'll see how 2019 works out. We have some development opportunities we are looking at strongly and pursuing. We don't have any definitive target for 2019. We have said we want to do more development, and we hope to do that in 2019. We just don't have a specific target.
Perfect. Thanks for the color, Kevan. I'll go ahead and hang up.
Thank you very much. Once again, on the phone, press thirty-one four to register your question. We do have another follow-up question on the line of Sam Damiani with TD Securities. Go right ahead.
Thanks. I just wanted to follow up on the dispositions, the sort of four or five properties that have been sold in Q4 and Q1. Two gates are all in very small markets where it looked like the Granite building basically housed the major employer in town, hence the cap rate on those. I'm just wondering with the dispositions going forward this year for the CAD 100 million to CAD 200 million, are we going to see sort of similar profile assets in that mix or should we expect the disposition cap rates to be a little different?
I'm kind of looking around the room. I would say the assets that were sold in Iowa are probably the most rural, isolated assets that we have in our portfolio. I would not. We're looking at selling, and some of it's in Europe. I certainly wouldn't anticipate much lower cap rates, probably closer to what we achieved in 2018.
Very helpful. Thank you. Just one last one on the portfolio occupancy. It took a nice jump in the fourth quarter. Just wondering, was all of that recycling of capital portfolio changes, or was there some actual absorption in some of the properties of the portfolio?
No, no. It was leasing, including Bleiswijk in the Netherlands, which was a 300,000+ lease deal that was done. The remaining vacancy that we have now totaling just under 300,000 feet, we have some very good prospects on that space, and we're making good progress there. It was due to re-leasing within the portfolio.
I was wondering about the Netherlands. When does that rent begin?
December 1st was a commencement.
I believe May 1st is the end of the rent-free period. Sam, don't quote me April or May. It's, I think, a five-month rent free. Was it, Kevan?
Yeah.
Very helpful. Thank you.
Thank you very much. Mr. Gorrie, we have no further questions on the line. I'll now turn it back to you.
Well, thank you, operator. Thank you for joining us on the call. On behalf of the trustees and management here at Granite, we thank you for your continued trust and support and look forward to speaking to you on the Q1 call in May.
Thank you very much. Thanks everyone. Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation. Please disconnect your lines. Have a good day, everyone.