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Good afternoon, ladies and gentlemen. Welcome to the Dream Office REIT Second Quarter 2018 Conference Call for Thursday, August 9, 2018. During this call, management of Dream Office 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 Office 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 Office REIT's filings with securities regulators, including its latest annual information form and MD&A. These filings are also available on Dream Office REIT's website at www.dreamofficereit.ca [Operator Instructions]Your host for today will be Mr. Michael Cooper, Chair and CEO of Dream Office REIT. Mr. Cooper, please go ahead.
Thank you. Good afternoon, and welcome to our Second Quarter Conference Call. I'm here with Rajeev, who will address our financial and operating results in a moment.A couple of years ago, we realized that by July of 2018, our Alberta office properties would have negative cash flow before debt service, and we'll be obligated to pay distributions based on a sort of perceived equity. And we knew this was going to be a difficult situation. In addition to that, we have a number of large tenants move to newer buildings like LoyaltyOne, Aviva, Borden Ladner Gervais. In Alberta, we lost Enbridge, Telus in the City of Edmonton and the National Energy Board. So we realized that 2018 was going to be a very tough year.With that in mind, we formulated a plan to concentrate our business only on our irreplaceable assets and reduce the overall size of our business by shedding the assets that we did not think we could manage to better in the future than they had been in the past. We've made considerable progress. Throughout the last couple of years' comments, I have identified January 1, 2019 as the time we would like to use to measure our business to determine the long-term value just because leading up to then, especially 2018, is such a transitional time.I'm pleased with the progress we've made over the last few years. We've sold enough assets that could have hurt us and used substantial portion of the proceeds to pay down debt. Another portion of proceeds have been used to reduce units outstanding, so that results on a per unit basis are reasonable.Going forward, we believe that we can drive the value of our core downtown Toronto assets by leading in the creation of boutique office buildings. These combine customized customer service for smaller organizations, building up communities in our assets and capital upgrades, which will help us, not just participate in the current buoyant rental market, but actually exceed market rents.We are aspirational about what we're going to achieve in our 19 downtown Toronto buildings, which we believe will create irreplaceable properties. We're seeing progress currently with increased customer satisfaction, our increased retention levels and increased rents.Over the next year, we will have much more to show how we are participating and outperforming the downtown Toronto metrics. We're continuing to achieve sales on our noncore assets and expect the sales to ramp up in the second half of the year.Over the last 2.5 years, we've drastically transformed our portfolio. Going forward, we'll continue to refine our assets to provide what we believe will be the best long-term portfolio where we see opportunities to continually increase quality, grow cash flow and value.Going into 2019, we will continue to own some noncore assets that require more time, leasing or capital prior to being sold. As we get smaller, we will also be looking at some of our non-Toronto assets to see if they can contribute in cash flow and growth beyond the average in our portfolio, thereby making our business better. We believe that this is all part of normal operations. We refer to the potential for redevelopment and intensification over the last few quarters. Last quarter, we announced that we've submitted the development plan for 250 Dundas Street West that will replace the office -- the existing office space and add a residential tower.In addition, we've recently submitted an official plan amendment to redevelop 2200 Edmonton, other than where the existing office building is now. For background, this is the building occupied by Aviva up until the last year. It was on our books for $41 million. We recently entered into a 95,000 square foot long-term lease that will help pay all of the holding costs on the site. We're hoping to work with the city so that we can build residential on the balance of the site.If we're successful, the [ main ] office building will substantially -- will be substantially more value than our IFS value. And if in addition to the zoning, if we develop the asset ourselves and capture development profit, it will be even more valuable to the REIT.In order to add value to one of our assets in Regina, we've entered into a favorable long-term lease that will add value to the building as we intensify and modernize the building to meet the needs of the lease.Rajeev, can you provide an update on our financial and operating performance?
Sure, Michael, and good afternoon, everyone. Our NAV is up roughly $0.15 to just under $24 a unit in Q2 2018, as a result of retained cash flow after paying distributions, with valuations flat quarter-over-quarter. On the quarters, we generally perform a valuation review on each property and make adjustments from material-known items. Given we just had appraisals done for most of the portfolio last December, we will do a more fulsome valuation update for the upcoming year-end.Our Q2 FFO per unit was in line with our expectation of $0.40 a unit, down $0.06 from Q1, as the prior quarter benefited from about $0.07 per unit of lease termination fees related to the Bell Canada lease, 700 DLG. With 185,000 square feet of former Bell Canada space, 98,000 square feet has been leased and the remaining 87,000 square feet is being actively marketed. Excluding onetime items, FFO per unit was largely flat quarter-over-quarter.Looking ahead, we're expecting our FFO per unit to be flat in Q3 relative to Q2, with a lower average unit count offsetting modest NOI declines, driven by occupancy and rental rate decreases in Calgary and our noncore markets. However, we anticipate improved results in Q4, as the 200,000-square-foot government lease commences at 438 University.We also wanted to give a bit of color on how we think of our key markets and really how we think about the business internally.Toronto is exceptionally strong, and we are seeing significant rental rate increases with lower inducements on renewals and new deals. During the quarter, net rents from renewals are 11% above expiring rents, and we see more upside in the near term as market rents are 14% higher than our contracted rents.I discussed earlier, NOI will start to recover by the fourth quarter of this year once the 438 University deal with the government commences in December and we forecast the positive trend in Toronto continuing for a prolonged period.For those of you who attended our AGM in May, we also showed several ways we are looking at investing capital in our buildings, and we see this as a way to drive outsized returns.Saskatchewan, included in our noncore market segment, and Calgary, are tough office markets, representing about 15% of our total assets. As previously communicated, we are looking to sell most of our properties in Regina and Saskatoon, with us opportunistically looking at further sales in Calgary. While the operating results for Saskatchewan and Calgary remain challenged, we believe the carrying values for our assets there are reflective of the market conditions, so continue to believe NAV is the most appropriate measure at this juncture to assess the value of the business. As we continue to dispose of these weaker assets and concentrate our capital and resources in Toronto and the GTA, the results from our stronger assets will naturally be the primary driver of long-term value.Consequently, when we think about markets like Saskatchewan and Calgary, which continue to weigh negatively on our operating results, these pose neither an opportunity nor a threat to the business. In the quarter, we also moved 2 additional properties out of our comparative property portfolio into properties held for redevelopment, mainly 1900 Sherwood Place in Regina and 357 Bay in Toronto. At 1900 Sherwood, we secured an 18-year lease with co-operators for 114,000 square feet or just under 2/3 of the building's GLA commencing 2021, which requires a significant upgrade and expansion to the building, including both the interior and exterior as we reposition the property for the tenant. We are pleased to have secured one of the top tenants in Regina, which is indicative of our creative asset management strategies to maximize value.At 357 Bay, we gave our tenants notice to vacate last week, are in advanced stages of a lease deal for the entire building.From a balance sheet standpoint, in Q2, we closed on the $240 million SIB in May, which allows future growth in NAV to have a more meaningful impact on a per unit basis. We also repaid $141 million of unsecureds with our credit facility, leaving ample liquidity of over $200 million. Our leverage in Q2 stands at 48%, up from 41% in Q1 as a result of the SIB. And we expect our leverage metrics to decline over time as we execute on further dispositions.And I'll now turn it back over to Michael.
Thank you, Rajeev. We'd be happy to answer any questions, if anybody on the line has any.
[Operator Instructions] And our first question is from Mike Markidis of Desjardins.
Sherwood Place, is that building vacant today?
It's about 40% leased.
40%, okay. And do you expect those tenants will vacate while you do the intensification upgrade? Or do you expect to maintain them should [ it push... ]
No, we expect to maintain them. They have about a 5-year WALT on them.
5-year, okay. And is it too early to quantify the amount of capital required for [ coverage? ]
I can talk a little bit about the lease deal. It's -- the economics are starting in the low teens from an NER perspective. And we've got to put about $10 million to $12 million of what I'd call sort of value-add capital in there, which is extending the parking, the parkade, additional GLA and so on and so forth. So hopefully, that gives you the rough deal economics. Just another thing I'd say is the way I sort of think about Sherwood Place in our numbers is we've baked sort of that value into our carrying value today. So we're carrying it effectively on our books today, inclusive of that lease.
You are. Okay. That's helpful. And then 357 Bay, sounds like you're pretty confident locking down the lease for the entire building given that you gave notice to the other tenants. Does that -- with 1 tenant taking that entire building, does that kind of jive with the boutique office concept? Or should we be thinking about something a little bit different?
It totally jives.
It totally jives, okay. No, I wasn't sure.
I don't know. I've never seen the building jive. You know what? It's a little bit too early to talk about the use. I think if you saw the use, it would make perfect sense. But I think by next quarter, we'll be in a position to provide full insight.
Okay. And Rajeev, just sort of with your comment on Sherwood Place being -- that lease being reflected on the books. 357 Bay would securing that lease have any upside in terms of the carrying value of the asset?
Yes, it would. So we're carrying it sort of as a -- let's call it as an office building relative to what we carried it back in -- at year-end. We've been sort of working through the framework on a deal so there's probably some upside relative to what we're carrying in there.
The carrying value we have now is the same as if it was empty, and with the work that we're going to do, we're going to end up with an incredible building, that value will be much higher than the current IFRS value plus the money we're putting in.
Okay. And possible to talk about capital requirement there? Or still need to nail down the lease?
Yes, we'll probably going to put another $15 million to the building.
15? 1-5?
1-5.
Okay. Last question for me before I turn it back. Just on the sales, your commentary suggests it's going to ramp again in 2H '18. I think it was $200 million under contract and negotiations. Does that figure include 700 DLG?
So when I said ramped up, what I meant was I think we closed $110 million in the first 6 months. We'll definitely do a lot more than that in the second half. It's the first comment. The second comment is if we do sell 700 DLG, it would be included in the numbers we talked about.
In the numbers we talked about, you're talking about the 200 or...
Yes, it's not in the 200.
It's not in the 200, okay. Great. And has that been listed? There was an article, I'm sure you saw it, about a month ago.
Yes, we've taken to market to see if this is the right time to do it, and we'll see whether we can sell it or not.
Our next question is from Sam Damiani of TD Securities.
Michael, I hope that's not too bad of a cold I'm hearing there.
I don't know what it is. It started at 2:00. Yes, it started at 2.
So just to finish off on 357. Is the proposed new tenant, is that going to be an office use? Or is the use going to change to some other use?
I'd rather wait until the third quarter and talk about it.
Okay. We're all -- as you can tell, we're all very curious. We saw a rendering at the Annual Meeting. Fair to say, I think you said at that time, that was just a sort of an example of something possible, not necessarily what was planned.
That rendering was actually -- originally, Dream had looked into moving to that office or, I think, the whole building and that rendering was an idea for our own use and it had a cloud on top of the building, considering our logo. So we're not doing that, but we might do something else that's quite interesting.
Great. All right, I'm looking forward to that. With these dispositions planned in the second half and, I guess beyond, what would be the primary immediate use of proceeds?
Primary immediate use would be to pay down debt.
Any thought of doing another substantial issuer bid, with a few hundred million more of proceeds disposed?
No. No, look, we went from $130 million down $65 million. I suspect we'll continue to be somewhat active under the normal course issuer bid. But I think we really got the size of the company on the equity where we want it. And at this point, we kind of did a substantial issuer bid ahead of getting the proceeds in dispositions, so we'll bring down the debt.
Okay. You say you're confident about the Toronto market. Can't remember the word you used, but for a very long time, what gives you that, I guess, that confidence today longer term?
I think that -- I think that growth -- I think Toronto's getting more and more market share downtown and getting more market share for the whole of GTA and Toronto's getting more market share here for the whole country. So I think that, that trend is likely to continue. There's new buildings coming, but their a fair ways off so I think we have a good view few years, and I think the product that we're working on is going to be pretty unique. Is that a good answer? Like, complete?
Yes. No, that's fair. So you do recognize there is supply coming several years down the road, but it's sort of a good runway, at least for the foreseeable future...
There is a good run rate for the foreseeable future plus I think what we're just trying to do is develop a product the tenants value very highly, and would sort of our customer would choose that rather than one of the new buildings or something like that. So hopefully, we're going to have some loyalty from our tenants.
Our next question is from Mark Rothschild from Canaccord.
Maybe just following up on your comments to Sam. If you were to sell the property in Montréal and I'm sure there will be a bit of interest, you can pay down debt. Your leverage is reasonable now. To what extent that there are opportunities to actually acquire properties in downtown Toronto? It looks like you're pretty much out of the suburbs. Is there something -- is there stuff available that trades that you would be interested in? What type of cap rates will there be? And I guess, on that point, are there any other markets besides downtown Toronto that you would consider buying?
Last quarter, I would have said no, I can't find anything. I think that if we do a good job of what we're trying to do, our hope would be that we would be able to add value to other buildings. So I think I don't think there's a lot, but there might be some smaller buildings that we could buy. I don't think it's going to be material in the short term.
And are there markets outside of Toronto that you would look to consider buying?
I don't think so. I mean, I'm hesitant because you never know what happens in the future, but I'm certainly not looking at any markets across the country that we'd want to put more money in.
We have no further questions at this time. I will now turn the call back over to Mr. Michael Cooper for closing remarks.
I appreciate everybody's time. Please feel free to call Rajeev or me if you have any follow-ups. Thank you very much.
Thank you. And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.