Granite Real Estate Investment Trust (GRP.U) 2022 Q1 法說會逐字稿

Good morning, and welcome to Granite REIT's First Quarter Results for 2022. Speaking to you on the call this morning is Kevan Gorrie, President and Chief Executive Officer; and Teresa Neto, Chief Financial Officer.

I will now turn the call over to Teresa Neto to go over certain advisories followed by an introduction from Kevan Gorrie.

Good morning, ladies and gentlemen. Welcome to the con call of Granite REIT. Before we begin today's call, I would like to remind you that statements and information made in today's discussion may constitute forward-looking statements and forward-looking information, including, but not limited to, expectations regarding future earnings and capital expenditures 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, reflects management's current expectations and are subject to known and unknown risks and uncertainties. These risks and uncertainties are discussed in Granite's 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 the annual information form for 2021 filed on March 9, 2022.

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 Q1 2022 condensed combined unaudited financial results and management's discussion and analysis of Granite's 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'll turn it now back to Kevan.

Thanks, Teresa. And as always, I will keep my comments brief as I trust you've had the opportunity to review our MD&A and press release. I'm pleased to be joined this morning, as you've heard from Teresa Neto, our CFO; Lorne Kumer, our Executive Vice President of Global Real Estate; and Michael Ramparas, our Executive Vice President of Global Real Estate and Head of Investments.

For this call this morning, Teresa will begin our discussion with a review of the financial highlights. I will then provide an update on our operations, acquisitions, developments and ESG and then I'll open up the call for any questions that you may have.

Thanks, Kevan. Granite posted Q1 '22 results, a very strong Q1 '22 results, driven by healthy NOI growth and yet despite foreign currency headwinds with a continuing weaker euro. FFO per unit in Q1 was $1.05, representing a $0.03 or 2.9% increase from Q4 and 5% relative to the same quarter prior year, when you exclude debenture prepayment costs and credit facility accelerated financing costs, which we recognized in Q1 2021. Strong NOI from acquisitions and same property NOI growth was partially muted by unfavorable foreign exchange translation losses related to the euro, which was 7% weaker relative to the same quarter last year, resulting in a $0.02 decline in FFO per unit.

Granite's AFFO on a per unit basis in Q1 was $1, which is $0.10 and $0.04 higher, respectively, relative to Q4 '21 and the same quarter last year. AFFO related capital expenditures, leasing costs and tenant allowances incurred in the quarter totaled $3.1 million. For 2022, we estimate AFFO-related maintenance capital expenditures and leasing costs coming in between $15 million to $17 million for the year, which is slightly up from the $15 million estimate I provided in March on the March 10 call due to an incremental revenue-generating roof project in the GTA at -- which we've added for 2022, not previously contemplated.

Same-property NOI for Q1 '22 was very strong relative to the same quarter last year, increasing 4.6% on a constant currency basis, but up 1.9% when foreign currency effects are included. Same property NOI growth was driven primarily by higher than previous year CPI adjustments, positive leasing spreads and contractual rent increases across all of Granite's regions as well as the expiry of a free rent period that was realized in the prior year at Granite's Tilburg, Netherlands asset.

G&A for the quarter was $8.4 million, which was $0.4 million lower than the same quarter last year and $4 million lower than Q4. The main variants relative to Q4 is the change in noncash compensation liabilities, which generated a favorable $4.4 million fair value swing sequentially as we recognize fair value gains on those liabilities due to an 8.2% decrease in Granite's unit price during this quarter. All of the $0.8 million fair value gains realized this quarter related to our DSUs, which directly impacts FFO.

Given the continued pullback of Granite's unit price so far in the second quarter, we should expect to see additional fair value gains recognized in G&A related to noncash compensation liabilities, if all else remains equal. On a run rate basis, we expect G&A expenses to continue at about $8.5 million to $9 million per quarter or roughly 8% of revenues, excluding any amounts for fair value adjustments related to those noncash compensation liabilities.

For income tax, Q1 '22 current tax was $2 million, which is flat to prior year. Although current income tax is slightly higher than the prior year on a constant currency basis due to the weaker euro current taxes on the Canadian dollar basis is lower. On a run rate basis, we estimate current tax at approximately $2.2 million per quarter. With respect to the potential recognition of reversals of tax provisions for '22, Granite has a further potential of $2 million of tax liability reversal that may be recognized mostly in Q4 of this year relating to tax positions taken on taxation years, which will go statute Bard, but we cannot make that determination until Q4.

Interest expense was lower in Q1 '22 relative to Q4 by $1.2 million, reflecting the interest savings realized from the partial refinancing completed early February of its 2028 cross-currency interest rate swaps to euro-based interest payments. On a run rate basis, we estimate interest expense will run approximately $10.5 million per quarter before factoring in any new debt. All of Granite's debt is fixed rate debt through cross-currency interest rate swap hedges with the exception of our credit facility, which is at a variable rate and subject to increases in underlying treasury rates.

As of today, Granite has drawn USD 90 million outstanding on its credit facility. Subsequent -- with respect to '22 estimates, Granite continues to forecast FFO and AFFO per unit will come in the range provided on the March call, which was between $4.31 to $4.43 for FFO per unit and $3.96 to $4.08 for AFFO per unit. However, given the greater-than-anticipated weakness in the euro recently, our singular estimate has been lowered to FFO per unit of approximately $4.35 from the $4.39 and AFFO per unit of about $3.98 from the $4.04 provided on the March call. This estimate is based on foreign exchange rates of the Canadian dollar to the euro average of $1.39 and the U.S. dollar $1.26. The estimates in March were based on higher exchange rates of the Canadian dollar to the euro of $1.44 and to the U.S. dollar of $1.27.

As communicated before, we estimate that a $0.01 movement in the Canadian dollar relative to the U.S. dollar impacts FFO and AFFO by $0.02 and a $0.01 movement in the Canadian dollar relative to the euro results in a $0.01 impact to FFO and AFFO per unit. The Trust's balance sheet comprising of total assets of $9 billion at the end of the quarter was positively impacted by another $491 million in fair value gains to Granite's investment property portfolio in the first quarter. That was offset partially by $146 million of translation losses on Granite's foreign-based investment properties, particularly the 3.8% decrease in the spot euro exchange rate relative to the end of 2021.

The fair value gains on Granite's investment property portfolio are attributable to fair value gains across all of Granite's regions, but particularly the Trust assets in the GTA and the U.S. due to increases in fair market rent assumptions and declines in capitalization rates. The Trust's overall weighted average cap rate of 4.3% decreased a further 23 basis points from the end of Q4 and the full 110 basis points since the same quarter last year. Total net leverage as of March 31 was 25% and net debt to EBITDA remained steady at 6.9x. The current -- the Trust's current liquidity is approximately $1 billion, representing cash on hand of about $175 million and the undrawn operating line of $885 million.

As per our disclosures, Granite has drawn a total of USD 90 million under the credit facility, and Granite issued 136,100 units through the ATM program near the end of March and through April at an average price of 98.77% for gross proceeds of $13.4 million.

I'll now turn the call back to Kevan.

Thanks, Teresa. For everyone's information on the call, I'm dealing with what I think to be about food poisoning. So I'll do my best to get through the script and the questions. But if I'm unable to continue Teresa, Mike and Lorne are on the call are more than capable of answering your questions.

So once again, I think you see we posted an inline quarter characterized by strong cash flow growth, operating performance and gains in the fair value of our portfolio. The increase in the market value of our portfolio in the quarter was once again led by fair market value increases in the U.S. in GTA. Due to further increases in market rental rates and a slight decline in cap rates versus the fourth quarter for modern logistics assets across our markets based on available leasing and investment transactional data in the quarter.

We continue to execute well on the strategic plan in the fourth quarter, acquiring 2 newly constructed stabilized assets in Indianapolis and a pre-leased development project in the Bolingbrook submarket of Chicago. These assets stood out throughout in terms of asset quality, location, potential value-add expansion and tenant credit, which will further enhance the quality of our portfolio.

With respect to dispositions, we still expect the sale of our sole asset in the Czech Republic to close in the second quarter and most likely in May. We are currently preparing for the sale of 2 assets in the U.S., a combined price of roughly USD 120 million and may proceed with further asset sales in the second half of the year.

We continue to make progress on our development program and our active pipeline, including forward purchases, now comprised with 8 sites in various stages of development in the U.S., Germany and the Netherlands, plus expansion in Mississauga, Ajax and Indianapolis, totaling roughly 5.7 million square feet and $450 million commitment. Construction of the bulk of these properties is expected to be completed in the second quarter through the fourth quarter of this year. And to date, roughly 45% of the 5.7 million square feet is fully leased and activity is strong on the remaining buildings.

We have seen an increase in costs associated with most of our projects, but it has been mostly absorbed with an established budget contingencies to date and offset by higher rents versus pro forma. And as stated on the last call, I would estimate that project completion on average has been delayed by roughly 3 months from the initial schedule due to supply chain issues. As I have mentioned before, development is core to our growth strategy. And these projects are expected to further improve the quality and functionality of our portfolio and drive significant growth in cash flow and NAV upon stabilization. It is also worth repeating that all of the above-mentioned developments are expected to receive green building certification to satisfying the criteria outlined in our green bond framework.

On the ESG front, we continue to build upon the strong progress we made on several fronts in 2021. We are currently developing our 2021 ESG plus our report, which will outline the progress we've made in 2021 and set a detailed and likely more ambitious objectives and targets for 2022 and beyond. The report should be published early in the third quarter.

Operationally, we have now renewed $4.5 million of the roughly 6 million square feet of expiries at an average increase in raw rate of 11.5%. And we anticipate achieving an average increase of approximately 20% on the remaining maturities. A total of 9.6 million square feet in leases scheduled to expire in 2023. And at this time, we are anticipating an average increase in rental rate of between 20% to 25%.

As Teresa mentioned earlier and as disclosed in our MD&A, same-property NOI increased by 4.6% on a constant currency basis, driven by strong re-leasing spreads, contractual rent increases, particularly CPI increases and the expiry of rent-free periods on a few of our new assets in the U.S., Indiana, offset partially by contractual rent pre-rent period and short-term vacancy at one of our properties in Germany.

At this time, we are reiterating our same property NOI guidance for 2022 of between 3.5% to 4.5% as the impact of strong re-leasing spreads could be partially upset by short-term vacancy from turnover at 2 properties in the U.S. We also experienced bankruptcy of one of our smaller tenants in New Jersey, 86,000 feet, but we expect to re-lease the space at a rate of approximately 25% above existence.

And the further quick update on our European portfolio with respect to the Ukraine, notwithstanding the resulting disruption to supply chains in that region or around the world, all of our tenants in Europe continue to operate in their space, and we're not aware of any major disruption so far to their operations involving our properties. But we will, of course, monitor the situation for any major developments.

Before opening the call for questions, I'd like to finish by making a few comments on leasing fundamentals across our markets and obviously, happy to take any questions on that. Despite Amazon's recent comments on excess capacity, our outlook for the year has not changed. In fact, our current projections for rental rate growth exceed our budget projections for the year. On our development project in Fort Worth, for example, the team achieved a rental rate roughly 20% above pro forma on budgeted costs, thereby delivering much stronger returns and will have growth for unit holders and demonstrating continued strength and demand for modern logistics space. Those of us in the business, frankly, understood that Amazon's prodigious uptake of space in 2020 with neither sustainable nor healthy for the sector. 2021 absorption in the U.S. was still well above the 10-year average even when you exclude Amazon's contribution. So we remain in a very healthy territory till the end of the year.

On that note, I will now open up the floor for any questions, operator.

(Operator Instructions) Our first question comes from the line of Brad Sturges with Raymond James.

Thanks for your comments, Kevan, at the end on Amazon and your outlook for leasing. Just curious to get more thoughts on what you're seeing in the market today from other e-commerce users and if there's been any change in the leasing velocity from other users similar to Amazon?

No. We certainly haven't seen that trend. I mean when you look at UPS, FedEx, a lot of the 3-party logistics providers that are doing e-commerce, which we've been in regular contact with. No changes to the plans for 2022. And I would say -- I would like to say or don't like to say that there has been sort of a drop off in the last 6 or 7 weeks in demand because of what Amazon said, but it's just not there. We're continuing to see the tenants looking for space.

And as a matter of fact, one of the tenants that was supposed to move into a new development from our property in the U.S. now has decided to stay in our property and take on the new space because they just don't have enough space. I think -- and if I could put one reason behind it above all other reasons, it's this sort of just in case versus just-in-time approach. I think they realize that these constructions to the supply chain may be more structural nature may last a number of years, and they're looking to basically take down more space to accommodate larger volumes of storage. That's what we're seeing in the market so far.

And maybe drilling into the U.S. a little bit more, I guess, is there any markets where you're getting a little bit concerned about the levels of new supply under construction or in the pipeline? Or do you still see favorable demand supply metrics in your core markets right now?

Well, the supply is large, but when you look at -- I mean, they're thinking we'll probably absorb 350 million feet this year. We've got, I think, 350 million feet, roughly 380 million feet under construction, but roughly 40% of that is pre-leased. And U.S. is at a historical low vacancy at 3% or just under 3%. So I don't think that there's anything today that worries me more than what we have to pay attention to in the past years. And I think that's what people need to pay attention to, the amount of supply that's coming on is the level of pre-leasing that's already been done in those buildings. So I think that the market and lease that we're in and focus on will be more than able to absorb that space in 2022 and 2023.

And with the -- you noted a couple of asset sales in the U.S. that you're contemplating, can you give a little bit more color about location or end valuation metrics, either on a cap rate basis or, I guess, relative to your IFRS book going?

No, I don't want to, Brad. I would rather we focus on the sale and not disclose any information about the assets until such time that we're under firm contract or have closed the transaction.

(Operator Instructions) Our next question comes from the line of Himanshu Gupta with Scotiabank.

So just on 2023 lease expiries, I think, Kevan, you mentioned expectation of 20% to 25% rent growth that we spend there, so very strong. Has that expectation gone up in the last 6 months?

Yes. It has. I don't have an exact quantity for you, but I know last time we looked at that number, it wasn't over 20%.

And if I look at the expiry markets, I mean, obviously, U.S. and Germany did as well. So will that be mostly from the U.S.? Or are you seeing stronger growth from German market -- from Germany as well?

No, it's mostly the U.S. I mean there are some expiries, but a couple of releases have CPI increases even on the renewal. So our ability to unlock the values in 2023 in those assets is a bit muted. And we only have roughly 400 feet rolling in the GTA in 2023. So the bulk of the gains are in our U.S. portfolio, I think that roughly 6.2 million, 6.3 million feet of rolling.

Got it. And then talking of U.S. portfolio, you announced that acquisition in Canton, Indiana, a 10-year lease term. Just wondering what kind of rental escalators are you seeing now on the new leases being done? I mean have they moved up in response to inflation?

Yes. Certainly, we have seen a number of leases at 3%. I think the -- that's roughly -- I think that's what we are on our development in Texas. It's typically between 2% and 3%. But if you go back a few years ago, there's very few that had rent escalations above 2.25%. Now we're seeing them regularly about 2.25 to 3, sometimes 3.5, we have a number of renewals that we've done in the U.S. and particularly in the GTA, where we've had annual escalations of between 3% and 4%.

Got it. Okay. And maybe my next question is on the FFO per unit guidance. Teresa, you mentioned about the euro impact -- but what about the cost of that financing? I mean that has gone up as well. Are you baking in that impact as well? You would mean new debt to finance Clayton or some new developments also. So any thoughts there?

Yes. So Himanshu, yes, I did factor in the higher cost of debt. So -- and we're factoring kind of a blend between euro-based debt and U.S.-based debt. So I have assumed a blended rate closer to like 3.8% on any new debt. So that has been factored in.

Okay. That's great, actually, by the way. And do you have more capacity to do more euro-denominated swap, I mean, in terms of that debt, new debts?

Not at this point in time, no. We would be looking for incremental investments before we swap new debt into euros. So at this point, if I were in need of new debt, I would be swapping to USD or borrowing in USD as we've done with our first tranche.

And this is despite the Germany acquisition being done in Q1. So despite that, there is no much room on euro denominator growth?

Yes. We utilize that investment when we did the refi of our 2028 debentures. That was as a result of the -- the German investment in February.

Our next question comes from the line of Matt Kornack with National Bank Financial.

Just quickly on the Fort Worth development. The costs went up a bit, but your yield went up by almost 100 basis points. I think you may have touched on it, but is that something that you're generally seeing where rents are coming ahead of pro forma? And was that ultimately -- I mean it sounds like it's one tenant taking in the full 600,000 square feet, but is that what you're seeing?

And I think that the team has done a fantastic job of walking in costs. So we've had some incremental costs where it's appropriate on our projects, but the majority of our projects across our portfolio, including the U.S. are on fixed price contracts. And so we've been able to manage any cost increases within the contingency in the budget, and we've been achieving rents well above pro forma. It's the same thing on the leasing side as well, Matt. We're achieving new lease rates above -- in some cases, well above our budget projections through 2022.

(Operator Instructions) Our next question comes from the line of Sam Damiani with TD Securities.

Just hoping to get a little bit more color on the traction you're getting on your remaining lease-up properties under development. Kevan, you mentioned the 45% pre-leasing rate on the pipeline now up nicely from last quarter. But is there anything specific, I guess, you can point to? I know it's -- things aren't firm yet necessarily, but specifically some of the larger projects, Indiana, Tennessee and maybe in Germany.

Yes. And I think to be fair, Sam, what's helped is we're now vertical on all of our projects, it's actually not on both those in Indi. And that's a big help when you're going vertical. I just got off a (inaudible) in the market from a tenant broker perspective. It's important to be going vertical and they can see that they can see the progress. So it really is starting to pick up.

In Germany, we were pursuing a single tenant for the building and realize the market depth is much higher for 100,000 to 150,000 foot tenants. So we're pretty close on our first lease there for 1/3 of the building, which should be roughly 110,000 feet, and we're starting to really see good traction on our national buildings, particularly the larger ones in the (inaudible). So it is picking up. It's that time of year as well. This is when we would expect to see it, but also just seeing vertical construction is now starting to -- is a real catalyst for interest in the billings that we've seen.

And then just over in Branford here on Ontario, any update there? Any sort of change in the time line expected there? And what are you seeing in the marketplace? I understand there's been a big land purchase not too far away.

Yes, which I think certainly validates the price that we paid for the land and certainly the land values have gone up another as they have across the whole GTA. But in particular, we're seeing Branford. We are in discussions with a tenant on (inaudible). We don't have any information at this time on it. We definitely expect to have news on our second quarter results, second quarter call. And again, I would just characterize it this way, rents well above our pro forma.

Great. And just finally, just given the market conditions and just interest rates and the share price and everything else, I mean, are your capital allocation priorities different than in March? And if so what way in terms of development or acquisitions or geography? Is there anything changed in your capital allocation priorities?

Well, I think we, as a team, understand the situation we're in. Certainly, it believes us to be more selective. And I will say the -- we're very happy with the quality of the assets that we acquired recently, both in Chicago, I mean Bolingbrook is a great submarket of Chicago. It's fantastic. This is a trophy asset. And the themes, I think, of these assets in terms of asset quality location, the buildings in Indianapolis gives us the ability to expand, which we think we will be able to get at during the term of the lease, gives us some real upside there.

But I just think overall tenant credit, asset quality location are going to be very prevalent themes over the next couple of years. But we did acquire them. These are acquisitions we've been working on for months. So if you had asked me today, would we have moved forward with both of those, it's a question mark. I don't know. So I hope that in a roundabout way to answer your question, right now our priorities are to fund the development projects and lease them up. That's priority number one. Look at selective noncore disposition, priority number 2. And probably, I should say, priority number one is get through the leasing and drive rents as much as we can.

So I certainly would tell you we are not in the market for large portfolios unless there's something that's so transformational and compelling that we would have to look at it, not to say that we wouldn't look at smaller opportunities that we think are really compelling to us. But I hope I've laid out for you one of our priorities for the remainder of this year. And we're very aware of our balance sheet. And the situation around the capital markets at the moment.

Last question comes from the line of Sumayya Syed with CIBC Capital Markets.

Just following up on the Bolingbrook acquisition. The yield on that, the 3.9% seems a bit lower than your other underdevelopment projects. Is there anything specific driving that? And how does that compare to, I guess, stabilize the cap rates in that market?

Well, we -- it's just the quality of the location that we like, and it's a very low site coverage for that asset, particularly in that market. And that's what was really compelling to us. So you're right, the 3.9 is low. But we just think that the future growth in that market, that asset and the rents that tenants are paying have a lot of upside. So this is a real core acquisition for us. It is a forward purchase. And so we're not developing it ourselves. We're partnering on it. And what we like about it most of all is just the potential for rent growth in the future.

Okay. And just on the one tenant that you noted went bankrupt here it's been released. So just curious what kind of heads up our visibility you had? And if they were on a watch list and safe to assume it was an isolated incident?

Yes. I mean we went through 2020, and they were on our watch list, by virtue of -- they were one of the tenants that asked for a rent abatement, which they didn't get, we collected all of our rent in 2020. But they would be one of the ones that would have been on our watch list. But again, they're 90,000 feet, and the rents are way below market. And so I recall it was an isolated incident, but I wouldn't mind if we had a few more of these.

And we have no further questions on the audio lines at this time. I'll turn the conference back over to you.

Thank you. So on behalf of the trustees and the management team here at Granite, thank you for being on our call today. And to our unit-holders, thank you once again for your continued trust and support. Have a great day.

This does conclude today's conference call. We thank you for your participation, and ask that you kindly disconnect your lines. Have a good day, everyone.