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Granite Real Estate Investment Trust
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Good afternoon, ladies and gentlemen, and welcome to the conference call for Granite REIT. Speaking to you on the call this morning -- this afternoon 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 the statements and 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 and are subject to known and unknown risks and uncertainties. These risks and uncertainties are discussed in Granite material filed with the 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 2019 filed on March 6, 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 afternoon may include financial terms and measures that do not have a standardized meaning under International Financial Reporting Standards. Please refer to the Q1 2019 condensed combined financial results and management's discussion and analysis of Granite Real Estate Investment Trust and Granite REIT Inc. and other materials filed with the Canadian Securities administrators and U.S. Securities and Exchange Commission from time to time for additional relevant information.I will now turn the call over to Kevan Gorrie. Please go ahead.
Thank you, operator. And thank you, everyone, for joining us today for our Q1 call. Ilias and I are also joined today by Lorne Kumer, our Executive Vice President of Real Estate; Michael Ramparas, our Senior Vice President of Investments and Global Real Estate and Witsard Schaper our Head of Europe. Ilias will begin our discussion with the review of the financial highlights. I will then follow with comments on acquisitions, operations and strategies, and we'll open up the call to any questions that you may have.
Thank you, Kevan, and good morning to all or good afternoon to all. Financial and operating highlights for the first quarter of 2019 and events subsequent to the quarter were as follows. Net operating income was $55.2 million compared to $53.8 million in the prior year period. Same property NOI on a cash basis of $45.1 million increased by 4.8% when excluding the impact of foreign exchange. Our Novi, Michigan, property, which was partly leased to Hanon Systems and had a rent-free period during Q1 of 2018, contributed $1 million or 2.3% to that SP NOI increase. It was the single most significant contributor of that increase.FFO was $0.89 per unit compared to $1.11 per unit in the prior year period. FFO would have been $0.88 per unit in the prior year period if the foreign exchange gain on the remeasurement of U.S. dollar cash proceeds from the sale of investment properties in January '18 were excluded.AFFO was $0.86 per unit compared to $0.67 per unit in the prior year period. AFFO would have been $0.63 per unit in the prior year period if the foreign exchange gain I just mentioned and the tenant incentive allowance made in connection with the 2014 lease extension at our Eurostar facility were excluded.Kevan will elaborate on the acquisition, the recent ones we've made during the quarter and subsequent to it. I'll spend a minute on the dispositions made in the quarter and the assets held for sale. So during the quarter, as you know, we completed the sale of 6 properties comprising approximately 700,000 square feet for $44 million, most of which were tenanted by Magna.As at quarter end March 31, 2019, that is, we had a total of 5 additional assets held for sale, comprising approximately 700,000 square feet, an IFRS value of about $38.7 million and contributing annualized revenue of $3.6 million. All of these properties are located in Michigan and are Magna tenanted.The ongoing recycling that we've been doing has reduced our Magna concentration to 51% and 43% on an annualized revenue and GLA basis respectively at Q1 '19. You'll recall this -- the comparable figures would have been 54% and 47% respectively at the end of the year.In terms of our balance sheet, the investment properties had an IFRS value of a little over $3.5 billion at the end of the quarter. These were adversely impacted by the relative strengthening of the Canadian dollar versus both the euro and the USD to the tune of $85 million. The investment properties did benefit, however, from net fair value gains totaling approximately $50 million during the quarter. As at the end of Q1 '19, the overall cap rate for our properties was 6.51% relative to the 6.65% at Q4 '18.In terms of net leverage and liquidity, at March 31, we had then leverage ratio of 22%, and our liquidity was approximately $1 billion. We expect to tap our liquidity, including the net proceeds from the recent equity offering, which we completed and netted $220 million. We expect to fund acquisitions, future contractual commitments and developments as -- which would be in keeping with our strategy.I'd like to spend a minute just to give you a sense of the sources and uses of capital as we sit today pro forma that financing. So I mentioned liquidity of approximately $1 billion at Q1. That's comprised of cash, $500 million, which together with the net equity proceeds of $220 million and the assets held for sale, which we expect to monetize and generate approximately approaching $40 million, would give us about $760 million of cash equivalent resources.That money is earmarked for among other things the Mississauga properties that Kevan will elaborate on. We have another $147 million to spend on those. We announced those on April 9.We announced on April 11 the Columbus property that we were in advanced discussions on together with the Calgary development. Those 2 would account for $126 million. And you'll recall and you'll see in our MD&A, we've got commitments to acquire a development that's under construction. It's an e-commerce facility in Texas, which together with our E&D develop would require an additional $300 million. So those 3 items would comprise $573 million roughly. And together with the Altbach development, albeit that's more in the 2020 horizon, that would require another $30 million.So the sum total of what's on our horizon is in excess of $600 million. We've got $760 million of cash or cash equivalent, which leaves us with $160 million to be used for general corporate trust purposes as well as for eventual acquisitions in what I think we would characterize as a robust pipeline.And with that, I'll turn it over to Kevan.
Thank you, Ilias. I'll keep my comments brief because I trust you've had a chance to review the MD&A and press release. I would characterize our first quarter as being in line with our expectations generally and slightly ahead of schedule in terms of progress against our strategic plan. We acquired 2 assets in the Dallas market for $164 million, as mentioned, with the weighted average remaining term of roughly 10 years to creditworthy tenants. These assets will generate stable and growing cash flow and being situated on over to 225 acres of land collectively provide significant potential for future development and value in one of our target markets in the U.S.Subsequent to the quarter, we completed the acquisition of a $2 billion portfolio across from Pearson International Airport in Mississauga. The assets were both constructed in 2018 and represent best-in-class e-commerce and food distribution product in one of the premier locations in the country. The going in yield of 4.5% is expected to be significantly enhanced in the near to medium term through expansion activity and mark-to-market on the rent of the major tenancy upon renewal. These acquisitions fall strongly in line with our strategy of adding scale in our target markets of Toronto and Dallas and improving the quality of our portfolio and cash flow.As Ilias mentioned, we disposed off 6 assets in the quarter, including 4 Magna-tenanted assets in Iowa for a total sale price of roughly $44 million. All 6 properties were previously trust by those assets held for sale. And as disclosed in the MD&A, there are 5 Magna-tenanted assets located in Michigan that are being held for sale as at March 31.We are currently conducting a sales process and hope to conclude the transaction in the third quarter. As mentioned, all in the acquisitions and dispositions noted above, our Magna tenant concentration by revenue and GLA has decreased to 51% and 43% respectively putting us firmly ahead of schedule on our announced target of reducing our Magna concentration to under 50% on a revenue basis by the end of 2019.Operationally, we have renewed 1.7 million square feet of the 2.5 million square feet of space that was originally scheduled to expire in 2019, leaving us with roughly 760,000 square feet of space remaining to lease. We are currently negotiating renewals or expansion of existing tenants on 710,000 square feet of that remaining space. Further, we have negotiated extensions on 440,000 of the 1.8 million square feet of expiries in 2020.Of the 386,000 square feet of vacancy we currently have, 241,000 or 60% is located in the U.S., including 90,000 square feet related to the Novi asset in Michigan, with the remaining 145,000 square feet coming from our 600 TESMA asset in bond.We are currently negotiating new lease deals with prospective tenants on 3 of the 4 vacant properties. As an update on our development program, we have recently received zoning approval for our planned 300,000-square-foot development project in Altbach, Germany. We are proceeding to the billing permitting and tendering phase and hope to commence construction at the site in late Q3 or early Q4.Our marketing program is in its very early stages, but interest in the project has already been high due to extremely strong leasing demand in the greater Stuttgart market, combined with a lack of available space, particularly space having modern distribution characteristics. Additionally, we have received all municipal approvals and permits for our planned 510,000 square-foot development project on our existing site in the AllPoints Indianapolis market, and construction is expected to commence in the second quarter. As stated, we expect the unlevered development yield on these projects to be in the mid-6% to 7% range.Finally, as mentioned, we completed our $230 million equity-bought deal offering on April 30, which performed well by all accounts. The proceeds from the offering will be partially used to fund our planned acquisition in Columbus and our planned development projects in Calgary, Indianapolis and Stuttgart. More importantly, the proceeds will enable us to pursue additional development and acquisition opportunities within our pipeline while preserving our low leverage and balance sheet capacity. Looking forward, we remain very well positioned to execute on our stated objectives for 2019 from an acquisition, disposition, development and operations perspective.On that, I will open up the floor for any questions.
[Operator Instructions] And our first question comes from the line of Troy MacLean of BMO.
Kevan, on the GTA acquisition, you mentioned expansion potential. Is that a near term -- something you can start in the near term or is that more like a longer-term option?
It is scheduled, Troy, to be within the next 3 years. We are hoping that will be slightly earlier than that, but is an expansion that will occur within the next 3 years.
And then you've added the one development in Calgary. Is that a market that you want to add to beyond this development? Is there like a minimum size you want to get there to have an efficient portfolio? Or…
It is one of our target markets, not like Toronto or Dallas. I would characterize it that way. We feel it's an important distribution market for Western Canada. We feel that the leasing plan [ they'll ] continue to strengthen, but rents haven't yet moved, but we feel it's a good time to enter the market, particularly with new characteristics, new building characteristics, e-commerce characteristics. So we feel the timing is right. How big that portfolio gets, we don't feel that it needs to be 3 million feet per se. We worry more about that in Toronto and Dallas and other key markets. So Calgary to us would be a target market, but it would one of the primary markets like Toronto and Dallas would be.
And then on the acquisition completed so far in 2018, most of those look like modern logistics warehouses. The leases that you guys have in place there or putting in place on the developments, what's the typical annual rent like? Is there something in the leases that it -- is it like CPIs or fixed step every year?
In terms of the new developments?
Or just even like the properties you bought in 2019. From what I remember, I remember most of the Magna stuff was based on inflation. I was just wondering for the model logistics stuff you've added in the last couple of quarters, is that mostly fixed rent steps?
They're mostly fixed, contractual rent steps. A lot of times they're annual. Sometimes they're every 3 to 5 years. But they would be in the -- they would typically be in the 2% to 3% range. It's contractual rent, annual rent increases.
Is that in the U.S.? Or would that be in Toronto as well?
Up until very recently it would be in both, I would say. But that's typically what we've seen in the U.S. and maybe Toronto up until the last 12 months.
And then you may have said this, but I think I might have missed it, but just on the 2019 lease renewals you've completed so far, can you give us an indication of how rents -- the new rents have come in versus expiry?
Yes. So for I think for 2018 we averaged just under, well, like 4.5 to 5. 2019 was actually negative 3. And that was due primarily to a large lease deal that was concluded in the Netherlands, a deal that was done in early 2018, I think, under completely different circumstances. On the vacant space that we mentioned, 386,000 feet, we're expecting lease spreads of roughly 15%. On the deals that have been completed for 2020, we have averaged 6%. And for the remaining space in 2020, we are projecting a positive spread somewhere between 6% and 8%.
Our next question comes from the line of Nana Yang of Scotiabank.
SP NOI was really strong this quarter from the Novi, Michigan, property. But I recall you mentioned last quarter that SP NOI would be mostly the same as 2018, which was flat. So what's a good run rate we should expect for 2019?
I think we have felt -- I'm pretty sure we have provided guidance at some point in the 2% to 3% range for 2019 and expect it to be somewhat better in 2020. I think Q1 was very strong. And although it may exceed 3%, I think we're still comfortable with our guidance in the 2% to 3% range for 2019 same property NOI.
Okay. That's helpful. With regards to Magna, you're now at 51% of revenue, which is pretty close to your 50% target. I'm looking at your 5 properties held for sale in Michigan. Those are all Magna tenanted, right?
They are.
So aside from the 5 held for sale, will you look to dispose more Magna assets or are you more or less more comfortable with where you're at?
No. I think there are further opportunities in 2019 to dispose of Magna-tenanted assets. A few of them we're still negotiating lease extensions, which I think better positions us for a sale. I do not expect the 5 assets in Michigan to be the final Magna assets that we sell in 2019. I think we provided guidance in the $100 million to $200 million range of dispositions in 2019, and I think we'll still fall firmly within that range.
Okay. And with regards to the 2 Mississauga property you recently acquired, the ground lease was pretty interesting. Can you give us some background on why it was structured that way?
It's typical if you're within major infrastructure such as an airport or a port. So for us we see this as being a very strategic location. The land lease is with the Crown, the Government of Canada, but it's with the Greater Toronto Airport Authority. These are typical of lands that you would see around airports and major infrastructure.
[Operator Instructions] We have a question from the line of Sam Damiani of TD Securities.
Just curious on the IFRS fair value gains in Austria. Can you be specific on what sort of factors drove that? I'm assuming the low interest rate environment was part of it, but was there any other factors that drove that?
It was, Sam, primarily through our special purpose assets in Austria as well as lease extension in one of our special purpose assets. So it's a combination of things that contributed.
Okay. I didn't catch the lease extension in Austria, which asset and for how long?
Sorry, the [ Upasort ] facility had a renewable and an amended rent to it, and we had a valuation bump on it specifically.
Okay. What's the maturity of the lease now?
10 years. I think another one is like 10 years from now.
Yes, so it's about 10 years. I'll confirm that with you if it's different than that, but it's in the order of 10 years.
Our next question comes from the line of Chris Couprie of CIBC.
Just following up on the Magna exposure. The 51% is that including or excluding the properties that are currently held for sale?
Excluding.
Excluding. Okay. And then if we just think about the objective for year-end of 50%, I guess we're running pretty much there for the most part. Any thoughts on where it might end at this point?
Well, I mean I think our -- I would put it this way, Chris, our acquisition pipeline is in the $400 million range. If you exclude the -- you have the Michigan, which is around $40 million in dispositions. If you add another potentially $50 million to $70 million in additional dispositions of Magna assets, I'm not sure what percentage that comes out to, but that would be pretty reasonable guidance of where we could end up at the end of the year.
Yes. And I think it's fair to say, Kevan, it doesn't end there. It's simply that's where we get to at the end of the year, and we will continue to call by way of adding to the dominator, Chris, primarily.
Understood. And are you being approached by parties on these assets? Or are you basically going through and saying, okay, these are now for sale, these are not for sale. And show us...
On the -- I would say this, on the larger ones, on the larger Magna assets, we have at times get approached. And as we've said on previous calls, we feel very strongly that the right thing to do is create the -- create the right conditions for a strategic review of what we would do with those assets, which could involve dispositions. So on those we have. On the smaller ones not typically. We have run sale processes for that. We ran a sales process for Iowa. We are running sales process for Michigan. On the radar this year are a few other smaller assets, including those in Europe, which we'll typically run a sale process for. So on the larger ones, we have at times been approached. On the smaller ones, it typically requires a sales process.
Okay. Great. Switching gears, just in terms of your identified target markets. In Canada, you've got Ontario, Alberta, Québec and BC kind of shaded in. Just on the latter, British Columbia, is that a market -- how do you see yourself getting into that market or is that more of an aspirational one day?
I think you put it perfectly, that's aspirational. I think we monitor the market because it's somewhat in our backyard and we know the market well. But we have not seen -- it's not worthwhile for us to pursue assets that are openly marketed. We just feel that pricing is very high right now. So that's not a market that we're spending a lot of time on. If something comes up that's opportunistic and we feel strategically fits, maybe we'll pursue it strongly, but we haven't seen an opportunity like that come along.
And there are no further questions at this time.
Right. Well, thank you, everyone. On behalf of the trustees and management here at Granite, thank you for being on the call today. And to our unitholders, thank you for your continued trust and support.
Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation, and ask that you please disconnect your lines.