Dream Industrial Real Estate Investment Trust (DIRUN) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to the Dream Industrial REIT Year-end conference call for Wednesday, February 17, 2021. 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. [Operator Instructions] And your host for today will be Mr. Brian Pauls, CEO of Dream Industrial REIT. Mr. Pauls, please go ahead.

Good morning, everyone. Thank you for joining us today for Dream Industrial REIT's 2020 Fourth Quarter Conference Call. Speaking with me today is Lenis Quan, our Chief Financial Officer; and Alex Sannikov, our Chief Operating Officer. 2020 was one of the most unpredictable and challenging years in recent history. However, our team has done an excellent job navigating through these challenges, and our business has been firing on all cylinders. We have continued to achieve significant strategic milestones in Q4 and carried that momentum into 2021. We reported a 3% increase in FFO per unit in Q4, driven by CPNOI growth and a lower cost of debt. Our pace of CPNOI growth improved significantly in Q4 as our leasing momentum was realized. We expect the pace to accelerate in 2021. We continue to deploy our excess liquidity into high-quality assets. After completing over $620 million of acquisitions in 2020, we look to continue that trajectory in 2021 and have already completed $138 million of acquisitions with an additional $215 million under contract or in exclusive negotiations. We raised nearly $450 million of unsecured debt in Q4 at an average fixed interest rate of only 65 basis points after swapping the euros, resulting in a 100 basis points reduction in the cost of debt for the entire REIT. In terms of our operations, we believe that pandemic has permanently increased demand for industrial real estate. Our high-quality urban portfolio continues to attract national and global e-commerce occupiers. Leasing momentum continues to be strong, and we signed nearly 2 million square feet of leases across our portfolio since the end of the third quarter. These leases address a significant portion of our vacancies and will boost CPNOI growth in 2021. We continue to demonstrate strength in our acquisition platform by closing on over $620 million of assets, despite the market disruption in 2020. In just over a year, our European asset base totals nearly $475 million, representing 15% of our total portfolio. We have $355 million of acquisitions in our near-term pipeline, of which $138 million have closed already with the remainder expected to close in the next 30 to 60 days. All of these assets fit nicely within our focused investment strategy of acquiring high quality, mid- to large bay distribution and urban logistics facilities in strong industrial markets. In addition to improving our portfolio quality, these acquisitions allow us to create significant value through active asset management, enhancing our total return on investment. For example, at our 116,000 square foot property in Mississauga, acquired in August of 2020, we had underwritten a 90,000 square foot vacancy effective December 2020 as we expect -- intend to vacate the property. Within a month of the tenant leaving, we have signed a 7-year lease with a national logistics tenant at a 100% rental spread compared to the prior rental rate and 3.5% annual contractual rent growth over the lease term, exceeding our underwriting expectations. Our recently acquired 527,000 square foot Class A distribution facility in Montreal allows us to add over 220,000 square feet of additional density with a yield on construction cost exceeding 6.5%. Development will allow us to continue improving portfolio quality. With a strong balance sheet, access to low cost debt and improved organic growth profile, we are now executing on our development program. We have the capability and resources for development and anticipate commencing on 1 million square feet of development projects in 2021 across Canada, the U.S. and Europe. In Las Vegas, we expect to commence construction on a 36 foot clear Class A 460,000 foot distribution facility in mid-2021. We are forecasting a development yield of 6%, which is 100 to 150 basis points higher than comparable stabilized product in the market. We intend to expand an existing 110,000 square foot property in the GTA by 40,000 square feet with an estimated yield on construction cost of 8%. In Germany, we are planning a 200,000-plus square foot expansion at our property in Dresden, which will nearly double the current footprint. We are also evaluating redevelopments in our existing portfolio, primarily in the GTA and Montreal. The strong growth in land values and market rents over the past 12 months supports the business case for redeveloping these assets. In Whitby, we are in the design and planning stage of a potential redevelopment of a 211,000 square foot building that we acquired last year with the goal of redeveloping the asset for approximately twice the current density. We expect to be in a position to commence the project once the current lease expires in early 2023. In Mississauga, we are advancing planning of a potential redevelopment of a 200,000 square foot complex that currently sits on a 10-acre land parcel. We're evaluating the prospects of building a 40 foot clear, modern logistics facility, which is expected to meet the strong demand for last-mile logistics asset in the submarket and command premium rents and valuation. Lastly, given the urban nature of our portfolio, we have a number of sites, primarily in the GTA, where we believe there is opportunity to convert existing assets into mid- and high-rise residential uses, resulting in significant value creation. We are in early stages of activating this potential for a few sites within our GTA portfolio and will report additional details as we make progress on these projects. During 2020, we also made significant progress on ESG initiatives. We have summarized our progress and initiatives in our recent sustainability report that was published in December and can be accessed on our website. For 2021, we intend to advance this agenda further as we continue to collect more data, establish meaningful and realistic benchmarks and measure our progress in order to integrate our environmental and social obligations into the ways we manage our business and create value. We are also exploring the possibility of investing in renewable power in our buildings, which will further our sustainability initiatives. We continue to make significant progress on all aspects of our business. And now I will now turn it over to Alex to talk about our operations.

Thank you, Brian. Good morning, everyone. Starting with leasing. Industrial market fundamentals remain robust across all our markets, supported by accelerated penetration of e-commerce. Availability of rates have remained close to historic lows during the pandemic with healthy rental rate growth across our portfolio. Leasing volume has increased significantly in all our markets, taking our overall leasing volume since the beginning of 2020 to 4.6 million square feet. Since the end of Q3, we signed 1.1 million square feet of new leases at an average rental spread of 20% over prior rents, including leasing up 600,000 square feet of vacancy, which are expected to commence in the first half of 2021. We also signed nearly 900,000 square feet of renewals at an average rental spread of 10%. We also achieved annual contractual rental growth of 3% in our recent renewals and new leases. Earlier this year, we leased our largest vacancy to Amazon with rent payment commencing in Q2 2021. Pro forma the lease with Amazon, committed occupancy in the U.S. portfolio as well as our total portfolio will be approximately 97%. As we anticipated, Spectra has vacated the smaller of the 2 main properties we have with them in Montreal from January 1, 2021. The asset is a 180,000 square foot distribution and logistics property, well located in Laval. We have received strong interest in the assets and are already in negotiations with a major national distribution tenant for the entire building. In addition, we received strong unsolicited interest from multiple parties in acquiring the asset as is at a significant premium to our current book value. Spectra has expressed intention to remain at their other major states with us in Boucherville. Turning to our organic growth outlook. With the leasing activity over the past 6 months, our CPNOI growth profile has improved significantly for 2021 compared to 2020. We reiterate our previous forecast of mid-single-digit CPNOI growth for '21. In terms of quarterly guidance, we expect CPNOI growth to accelerate through the year as new leases take effect. On the operations front, rent collection levels in our portfolio have returned to pre-pandemic levels, and our tenant base has proven highly resilient. We collected 98% of contractual gross rents due for January and 99% of contractual gross rents due for Q4 2020. We have collected substantially all rents due for Q2 and Q3 2020 after adjusting for CECRA. Of the $2.3 million of rent deferred during Q2 2020, we have collected over 90% already, and we anticipate collecting the remaining amount in the near term. Lastly, touching on our valuations. During the quarter, the value of our portfolio increased by $92 million, reflecting robust demand for industrial assets in our markets, strong leasing activity and rental growth. The outlook for rental growth remained strong, and we look forward to engaging in value-add initiatives to increase the returns and surface additional value from our portfolio. I will now turn it over to Lenis, who will provide our financial update.

Thank you, Alex. The fourth quarter was eventful and a successful end of another transformative year for DIR. Our financial results for the fourth quarter were strong and in line with our expectations. Diluted funds from operations was $0.19 per unit for the quarter, 3% higher than the prior year comparative quarter due to higher NOI from our comparative properties and recent acquisitions and lower borrowing costs as we executed on our European debt strategy. During 2020, we made significant progress on our financing strategy. Our strong and flexible balance sheet, along with our superior tenant and geographic diversification, enabled us to obtain a BBB mid-investment-grade credit rating from DBRS in October. We shifted the REIT to operate on a primarily unsecured financing model and with our European expansion, we're able to access low-cost euro interest rate. We raised nearly $450 million of unsecured debt during the fourth quarter at an average rate of only 65 basis points after swapping to euro. The average interest rate on our in-place debt has decreased by over 100 basis points over the past year, and at the end of 2020, was 2.57%, with opportunity to reduce this further. We reduced our secured debt to 23% of total assets with overall net debt to assets of 31% and net debt-to-EBITDA at 6.2x. Over the course of 2020, our unencumbered asset pool increased by over 10x to $1.4 billion at the end of 2020, which represents 45% of our total investment property value. In conjunction with our unsecured credit facility, this provides a significant amount of financial flexibility as we continue to focus on improving portfolio quality. Last month, we completed a $259 million equity offering and used the proceeds to continue to pay off Canadian mortgages and to fund our near-term acquisition pipeline. With these mortgage repayments, our average cost of debt has come down further since the end of Q4. Our acquisition pipeline comprises the previously announced $355 million of high-quality acquisitions in Canada, the U.S. and Europe. We have closed on $138 million of these acquisitions to date in 2021, with the remainder expected to close in the next 30 to 60 days. Pro forma these transactions, our leverage is expected to be in the low 30% range with an unencumbered asset pool close to 60% of our total assets. We currently retain over $250 million of acquisition capacity. Assuming average leverage for the year in the low to mid-30% range and that current foreign exchange rates prevail, we expect 2021 FFO per unit to be approximately $0.80 or over 10% higher than 2020. For the first quarter of 2021, we expect our FFO per unit run rate to be in line with that of Q4 2020. Comparative property NOI growth, acquisitions and lower cost debt are expected to be offset by slightly lower average leverage in the first quarter. Then we expect our FFO run rate to increase in subsequent quarters as our comparative property NOI growth accelerates, and we deploy our acquisition capacity. I will turn it back to Brian to wrap up.

Thank you, Lenis. We continue to take significant steps in positioning DIR as the premier industrial REIT in Canada and delivering attractive overall returns to our unitholders. We'll now open it up for questions.

[Operator Instructions] Our first question is from Brendon Abraham from Canaccord.

Maybe just the first question on portfolio composition. I mean 2020 was the entry into Europe and you already have just slightly under 15% of the portfolio there. Just wondering how you're thinking about your target, be a pro forma target, geographical mix going forward, given the ramp-up in Europe has been so successful.

Yes, Brendon, it's a good question. We have a target allocation of 20% to 25%, potentially even to 30% in Europe, depending on the opportunities that we're able to find. So we're underallocated there in terms of our eventual target. We're basically at our U.S. target. We'd like to grow more in Europe. That gives us a lot of things. The assets there perform well on their own. It gives us access to very, very low-cost debt. And then we like the geographic and tenant diversification across the 3 platforms of Canada, U.S. and Europe. So we're on our way to continue to grow a little bit faster in Europe until we get to our target allocation there.

Okay. So I guess the idea would still be to have a majority waiting or about half waiting in Canada?

Yes. Roughly 20% target in the U.S., 20% to 30% in Europe and the rest in Canada.

Okay. And then just a quick question on utilized cap rates. I noticed a pretty big drop in Ontario quarter-over-quarter, just over 50 basis points. The drop in Europe, that might have been because of adding new assets, but maybe you could just speak to the change in Ontario. Was that a function of kind of the new appraisals over the last -- since last quarter or changes in the marketplace?

Yes. Well, it's a number of those things. I think as our asset quality goes up, the cap rates will go down. The market continues to be more and more competitive, pushing cap rates down. Alex, I'll let you comment on where you're seeing cap rates and what's happening in these markets.

Yes. Thanks. So specifically for Ontario, obviously, cap rate is one metric in the evaluation process. We've seen significant acceleration in rental rates and rental rate growth in -- primarily in Toronto, and that does push down the going-in cap rate as -- without necessarily changing the overall total return outlook. The total return gets more skewed towards future growth. Now having said the -- when we look at the implied cap rates for the fourth quarter for Ontario relative to the third quarter, and that is last quarter annualized NOI, the -- that cap rate drop is not as pronounced perhaps as you pointed out, simply because there is NOI growth as well in these numbers. So what we -- when we're looking at Q3 versus Q4, it's roughly 20 -- 20 and change basis points relative drop in the implied cap rates.

Our next question is from Bradley Sturges of Raymond James.

Maybe just to follow-on that line of questioning. When you were reviewing your fair market values, how much of the intensification or redevelopment potential is being baked into those numbers right now?

Yes. Brad, basically, we're -- the properties get evaluated as they are currently sitting there. So the intensification or the future value is not considered in our IFRS numbers. This would be value add that we would do in the future. All the development we mentioned, some of it's like Las Vegas greenfield, but a lot of it is intensification within our current portfolio, which would be additive in terms of overall value to the portfolio.

Okay. So it's more really based on in-place NOI?

Yes.

Okay. That's helpful. And in terms of the acquisition activity so far today, it's been a pretty robust start to the year for Dream Industrial. Just curious on your expectations for the rest of the year once you close. I guess, what's still in the immediate pipeline? You had a pretty successful year of over $600 million acquisitions. Is that something you think you can beat this year? And where do you think the REIT -- what would be the timeline for the REIT to more or less reach the stabilized financial leverage targets?

Yes. Brad, our team has hit the ground running in 2021. We've got a really active and robust pipeline. Some of it, we mentioned in the prepared remarks, but we're looking at a lot more things every day. So as I mentioned to Brendon, I think we will likely grow in Europe faster, although we're seeing opportunities in Canada, in our target markets as well as the U.S. So we anticipate doing acquisitions there as well. I would expect we would have a similar or more robust acquisition -- total acquisitions for 2021 compared to 2020 will likely be higher, depending on kind of what opportunities we can find. Alex, you can comment a little bit on where we're seeing opportunities, particularly in Germany, the Netherlands, where we're likely to grow faster.

Yes. We continue seeing it, rents. You suggested a strong pipeline of off-market, on-market opportunities leveraging our local network. So we're seeing more opportunities in Germany, Netherlands and as the travel restrictions get lifted, we will start looking closer at other the potential target markets in Europe that offer compelling fundamentals and the ability to grow further on the continent.

Okay. In terms of asset sales, any update in terms of your planning there and the potential to see some asset sales in Western Canada this year?

So we're looking at kind of targeted asset sales, targeted recycling. We're looking at this every day of which assets kind of would be good to recycle out or how can we continue to improve quality. Alex, you can -- give an update on what we're seeing, specifically in Western Canada that Brad is asking about.

Yes. So we've seen interest in some of our assets we've identified as we've communicated at the end of 2020. We've identified a list of nonstrategic assets. That's for the assets that we would sell at the right time for the right price. And we have been engaging with potential users and some investors on these assets over the past 6 months, and we've received some interest in some of our nonstrategic assets. And we're currently in discussions with some users, some investors on select opportunities in Western Canada in various markets. Obviously, we want to make sure that we hit the right price and the right terms. So we're happy to hold these assets or at the right price, we will look at parting with them.

Sorry to say. You can't comment on what that program may look like right now for this year?

It's a bit hard to predict that because the liquidity in Western Canada is not as robust as it is in Toronto, and the transaction volume has not been as robust as you know. So it's hard to predict that. There is -- we are in discussions with potential buyers, but it's a bit difficult to forecast.

Okay. Maybe my last question. Just to discuss the Laval property with Spectra vacating. Just what's your expected downtime at the property at this stage? And any general comment on what you believe the mark-to-market rent growth opportunity would be?

So we're in discussions with one prospective user who would like the space more or less immediately. There will be some fixturing period required. So it will be at least a few months if that deal advances. If not, we expect that we'll be in occupancy kind of in the summer. And as far as the mark to market goes, we expect that there is going to be better growth profile from the assets going forward. The immediate mark to market is likely going to be roughly flat, maybe a slight increase compared to the previous rent, but there is going to be a better growth profile from the asset over the lease term. And we're already seeing from the unsolicited interest that we've received on as if basis that the asset is going to be significantly more valuable as a result of this event compared to 2020. And whether it's leased or vacant, we've seen pretty strong valuation for the property. So overall -- story overall, total return is going to be quite positive for the company.

Next question from Pammi Bir of RBC Capital Markets.

Just maybe on the Amazon lease in Louisville, can you maybe provide just some background on maybe the terms, the duration, any rent steps in that lease, and having the rents compared to market rates?

Yes. Pammi, we can provide basically that the rent is going to commence in Q2. We're not allowed to disclose the specifics of it yet. It's right on market. It's slightly better than what we were forecasting. The tenant is certainly investing a lot in the space. And that's about all we are able to disclose at this point. We're certainly really delighted to have it entirely leased -- that Louisville building entirely leased to Amazon. They're a great tenant, will add a lot of value. The rental rate is right in line with market, and we'll disclose that when we're able.

Got it. And I guess, is there any capital being put in by the REIT at all? Or...

For the most part, the tenant. Alex, you can comment on any landlord work that's quite minimal.

Yes. The market standard contribution from the landlord, but the tenant is going to be putting in significant amounts of capital to get the property suitable for their last-mile operations. So the capital the tenants intends to invest is multiples of what we contributed.

Got it. Just with respect to the same-property NOI guidance, the mid-single-digit level for 2021. Do you see that sort of being fairly consistent or even across your 3 regions or just sort of continued leadership out of Canada relative to the U.S. So just curious if you could break that down?

Yes. So with respect to the regional breakdown, when we are guiding mid-single digits for the year, that excludes Europe. Now Europe will be in our same-property numbers later in the year, but when -- we're guiding without it because it's a full year guidance. So with respect to how that breaks down, we expect that Canada is going to be sort of in that -- in the midpoint of that guidance, and U.S. is going to be higher on the back of the Louisville lease-up. So U.S. is going to be in that high single digits, and Canada is going to be sort of right in the middle of the mid-single digits number for the year.

Okay. Alex, just one last one. I'm just curious with respect to the ATM, curious on your rationale to maybe put that program in place. And when do you see the potential size of that program, what it might look like?

You bet, Pammi. I think it's an additional tool as we go. If you look at the kind of the 3 tools of DRIP, ATM and then bought deals, those kind of go in order of size, and we expect to be able to issue equity through those 3 tools. As you know, the DRIP is back turned on. The ATM will be used in the future as needed. However, we've got quite a bit of capacity right now on our balance sheet to do acquisitions, which we will use first. I'll let Lenis comment more just in terms of how we will manage that, and how we will potentially use that in the future. Go ahead, Lenis.

Sure. Like Brian said, we view the ATM as a good tool to have just in addition to the other tools, such as the larger bought-deal equity offering. It could turn out to be a cost-effective means to find at smaller tuck-in acquisitions, smaller redevelopment projects, and we would utilize it in a manner that results in most value to unitholders. But as Brian also mentioned, we don't currently anticipate using it in the near term as we have ample acquisition capacity.

Our next questioner, Himanshu Gupta of Scotiabank.

So just on the FFO guidance for 2021. I think you mentioned 10% higher than 2020, almost $0.80. So just wondering what leverage or range of leverage are you assuming in that guidance? And also what level of acquisition or dispositions are baked in your guidance?

You bet, Himanshu. We are basically low to mid-30s as we start 2021. That's anticipated to grow over the year. However, it doesn't take effect till mostly later in the year. So basically, average leverage in the low to mid-30s for 2021 producing that FFO that you've mentioned. Lenis, you can elaborate on that and how we are forecasting leverage and guidance for FFO.

Sure. Yes. No, as you mentioned, leverage we're sitting low to mid-30s -- low to mid-30%. So I think pro forma, we had previously announced acquisitions that kind of gets us in that low 30% range. The guidance is assuming average leverage in that low to mid-30% range and also that our current FX rates, the U.S. and euro rates remain the same throughout the year, and that -- those are sort of the big -- big levers there in the guidance.

Got it. So maybe on the acquisition side, if you do, let's say, another $500 million of acquisition over and above what you have announced so far, I mean that could lead to an upside to the guidance. Is that a fair statement? I mean, more acquisitions versus what has been already announced would probably lead to some kind of upside there?

Yes. Himanshu, that's very fair statement. It would push leverage up into, call it, the upper 30s and would be upside of the FFO.

Sure. And then just on the mid-single-digit organic growth in 2020. I know you provided some color, but specifically for Western Canada, I mean, you have, I think, almost 800,000 square feet of leases coming up for renewal in 2021. Do you expect any softness in rents there? And I mean, how is the market performing? I know your occupancy was actually up year-over-year in Western Canada sequentially as well? I mean, any update on the market there?

Yes. You bet, Himanshu. The Western Canada market has proven -- if you look at our occupancy and look at the transactions we've been able to do, it's been quite a stable market there and has performed okay. Alex, you can elaborate on how you're feeling about leasing for 2021.

So we have been making good progress on leasing in Western Canada. We are working on just over 100,000 square feet of new leases right now across various markets. So what that translates into for the year is that we expect slightly higher occupancy over the course of '21. We're still seeing that there is going to be -- and as outlined in our MD&A that there is a bit of an over rent there where we're going to see some leases roll to market down. So that will offset that a little bit. And for the year, we expect that the same-property NOI in the west is going to be moderately up. So kind of that low single-digits number, so flat to slightly up for the year on same-property basis.

Got it. And then on the same subject, like collections in January, I know Q4 has been very strong. For January, I think around 2.3% is yet to be collected. Is there any particular region where you still need to collect? I mean are the collection in Western Canada, very similar to other regions in January as well?