Granite Real Estate Investment Trust (GRP.U) 2013 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the conference call of Granite REIT.

Speaking to you are, Tom Heslip, Chief Executive Officer, and Mike Forsayeth, Chief Financial Officer. Before we begin today's call, I would like to remind you that statements made in today's discussion are constituted forward-looking statements and actual results could differ materially from any conclusions, forecasts or projections.

These statements 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 Company'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 2012 filed, on March 5, 2013. Readers are cautioned not to place undue reliance on any of these forward-looking statements.

The Company undertakes no intention or obligation to update or revise any of these forward-looking statements, whether as a result of new information, future events, or otherwise , except as required by law. In addition, these 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 2013 condensed, combined financial results for Granite Real Estate Investment Trust and Granite REIT, Incorporated, and other materials filed with the Canadian Securities Administrators and U.S. Securities and Exchange Commission, from time to time, for additional information.

As a reminder, this conference is being recorded, today, Thursday, May 9, 2013. I would now like to turn the call over to Mr. Tom Heslip. Please, go ahead, sir.

Thank you, and good morning.

Joining me on the call today are, Mike Forsayeth, our CFO; Jennifer Tindale, Executive VP and General Counsel; John Deragon, our Executive Vice President Real Estate Investments; and Lorne Kumer, our Executive Vice President for Real Estate Portfolio and Asset Management.

Given the significant impact of re-conversion and IFRS on the report, it results that Mike will be covering, in his remarks, and to leave time for your questions. I will keep my comments fairly brief this morning. The first quarter of 2013 represented the first quarter in which Granite enjoyed the tax savings and benefits of being a REIT.

We completed our first acquisitions, developed an important, new joint venture relationship to accelerate our diversification strategy and growth phase, began making monthly distributions to our unit holders, and we adopted the IFRS accounting framework. These important milestones, combined with the improved operating performance, resulted in a very successful quarter for Granite.

The repositioning for Granite REIT for the future was a major accomplishment last year. It has allowed us to, now, fully focus our resources and act as a true value-oriented real estate investment trust. We believe that the results of Q1 show that we are on track.

Granite is now, more than ever before, fully engaged inportfolio managing, property repositioning, leasing, potential selected sales, and very importantly, new acquisitions and selective value creation developments.

With the eminent closing of Portal Way in Portland, Oregon, an acquisition of, approximately, $21 million, U.S., Granite will have completed over [$60 million] in acquisitions, totalling over one-million square feet of new state-of-the-art, multi-tenant facilities, which are measurably accretive to FFO and have enhanced the quality profile of our portfolio.

We have, also, added two quality development sites, one in Louisville, Kentucky; and the other in Berks, Pennsylvania, representing potential development of an additional 1.37 million square feet, over [$60 million] in development costs, and very significant potential, new ALP to come.

With these initiatives, and a healthy acquisition pipeline, we are, step-by-step, quarter-by-quarter, progessing on expansion of our tenant base and diversities. The quality of our properties, the overall diversification to our portfolio, that is an essential part of our strategic plan. We do not look at acquisitions and selective development as a race, but, rather, a disciplined building process, focused on quality and long-term property fundamentals, that not only add new and accretive income, but also enhance the overall value of Granite.

Taking into consideration the adjustment of Q1 2013, and the overall capital value and investments we have made this year, we see steady strides and progress being made towards the overall portfolio target mix we set out in our strategic plan. Regarding our leasing activities,as I've said in the past, and must note again, Granite cannot comment on the lease renewals or negotiations until such are fully completed and signed.

That being said, we can say that with some 33 leases that had or have 2013 expiration dates, we have, now, renewed nine of these and are engaged in active negotiations in the majority outstanding. As of today, there are 24 remaining leases expiring this year, representing 4.5 million square feet of annual lease payments of, approximately, $23 million.

Of these 24 properties, we are certain that Magna will vacate, or already has vacated, four; with some degree of uncertainty as to Magna's intentions to remain in a couple of additional properties. The remaining [18 properties] to 20 properties have leases expiring toward the end of 2013, and we expect it will take all of the coming three quarters to complete resolutions on these, while we, also, work on the releasing and repositioning of those properties Magna vacates.

As to new business, as I mentioned at the outset, diversification, growth, and new acquisitions is a primary focus and will continue to be so throughout this year and the years ahead. We are actively reviewing opportunities in various markets, with specific focus on the United States and Germany.

Overall, we continue to see greater depth in these markets, in terms of quality, pricing, and opportunities. Something we are not seeing a whole lot of in Canada at this time.

In summary, Q1 2013 was a very good quarter for Granite, though there is still much to be done. We remain focused on achieving results that demonstrate progress on our strategic initiatives. With that, I will turn it over to Mike Forsayeth.

Thanks, Tom. As Tom said, the first quarter of 2013 was a solid one and it was, also, another quarter of firsts for Granite. Our first quarter as a REIT, our first quarter reporting our results under IFRS.

We completed our first acquisitions and began playing distributions to our unit holders, monthly. The REIT conversions and the change to IFRS has significant impacts on our reported results, and I'll review each of them, separately, in a minute.

From an operating standpoint, there were no surprises. We slightly exceeded our tax saving targets as a REIT. The top line benefited from some contractual rent increases.

We have favorable foreign exchange rates. Our comps are in line and we are winding down the expenses associated with reconversion and the related Corporate organization. Before I get into the details of the quarter's results itself, let me give some more background on the impact of changing from U.S. GAAP to IFRS and, separately, the reconversion itself.

First, the change to IFRS. Although the underlying complexities of changing from U.S. GAAP to IFRS are immense, and the disclosures are much more extensive, as demonstrated by our 35 pages of financial statements, the practical reality of the impact on our financials is, primarily, found in the accounting for our real estate properties.

From a January 1, 2012, opening balance sheet prospective, the big entry is debit real estate for the fair value bump, credit-deferred taxes on the increased difference between tax and book, and credit equity. To be more specific, the major balance sheet impact as a result of changing to IFRS include, firstly, real estate properties are recorded at fair value, not depreciated costs.

As of January 1, 2012, the fair value bump was $737 million, these fair values were determined by Management and, in support of establishing those values, an external appraisal was completed for all of our real estate properties, with the information and results derived from those appraisals being integrated into Management's fair value determinations.

Deferred rent receivable and deferred revenues, resulting, primarily, from straight-lining the rents, deferred leasing commissions and tenant improvements, are no longer separate line items on the balance sheet, as they are encompassed in the fair value determination. Also, as allowed under the transition rules, our foreign currency translation account was zeroed out, as of January 1, 2012, to form part of the opening retainer earnings. Only the currency movement since January 2012 are reflected in this account.

Our deferred tax balances are substantially higher, due to the recording of, approximately, $164 million of additional deferred taxes, the vast majority of which was associated with a fair value bump in all jurisdictions. This amount includes, approximately, $65 million, attributable to our Canadian properties while Granite was a Corporation. As of January 1, the initial offset to the deferred tax liability entry was booked to the opening deficit.

As it relates to our income statement, the major IFRS items we're highlighting include, no deterioration being recorded on our income producing properties, but deterioration does continue to be incurred on our office furniture and fixtures. Fair value changes relating to our real estate are reported in the income statement, and we gave the fair value changes for our financial instruments, which would include our forward-exchange contracts, a separate line in the P&L. Deferred income taxes, if any, pertaining to the fair value changes, are also recorded.

Funds from operations, calculated under REALpac, are different than under NAREIT and U.S. GAAP. The significant differences pertaining to Granite are that, REALpac, [ASpac], deferred taxes, business transaction costs, and fair value changes in financial instruments, like our foreign exchange contracts, but does not add back depreciation on our fixed assets.

As previously reported on January 3rd of this year, Granite became a REIT. That had the following three impacts on the IFRS financial statements; upon conversion to a REIT, $41.9 million of the $65 million I just referred to of deferred taxes, relates to the fair value bump of the Canadian properties, were reversed into income this quarter.

This reversal is in addition to, approximately, $23 million of deferred taxes that, under IFRS, but not US GAAP, were reversed into income of Q4 of 2012, and that related to one of the corporate reorganization steps that occurred just before 2012 fiscal end. Also, although the US properties are, also, contained in a REIT, under current tax legislation, there could be corporate level taxes at regular income tax rates, should any of those properties be sold. Accordingly, this deferred tax liability was not reversed, as deferred tax opportunities were not available.

Lastly, all stock in unit based compensation is recorded as a liability as of January 3rd. With that as background, I'll, now, turn to the first quarter operating results of the business.

As a said at the outset from an operating standpoint, there were no surprises and we're very pleased with the results. Here are some of the highlights. On a reported basis, our quarterly net income was $94.4 million, or $2.01, and this compares with $28.3 million, or $0.60 per share for the first quarter of 2012.

Our reported net income is distorted not only by the nature impacts associated with the changing to IFRS, but, also, the added distortions caused by the REIT conversion. The significant items of note when reviewing our net income include; the quarter's tax provision contains the $41.9 million reversal of Canadian referred tax liabilities, as a result of converting to a REIT that I just mentioned; there were fair value gains of $18.7 million, before tax on our investment properties, largely attributable to the cap rate's impression in North America; and we had a $5.1 million gain on the settlement of a Meadows Holdback.

Our funds from operations, or FFO, is perhaps the most useful financial measure. And for the first three months of 2013, Granite's reported FFO with $34 million, up $4.5 million from Q1 of 2012, largely due to the increase of rental revenue of $2.4 million in the lower current income taxes of $2.5 million. These were partially offset by, approximately, $500,000 of increased interest and financing charges.

Turning to some of the line items. From a revenue prospective, the increased revenue over the comparable quarter last year was, mainly, attributable to $1.5 million of contractual rent increases, primarily in our Austrian properties; $500,000 related to the acquisition completed in February; and, approximately, $300,000 of favorable foreign exchange rates.

Additional rent from completed projects on stream was largely offset by vacancies in the straight line rent adjustment. Property operating costs were inline with last year, and as a result of recent acquisitions, now, includes a separate line for those operating costs recoverable from tenants. As we complete more acquisitions, we expect that you'll see this line grow.

Our G&A in the quarter was $7.1 million,and includes $1.4 million of REIT and related reorganization costs. For Q1 of 2012, our G&A was $6.5 million, and that included $1.1 million of REIT and severance costs.

We had a total foreign exchange gains of $1.1 million, $500,000 of which pertains to our forward contracts outstanding, and the balance relates to translating certain foreign currencies, denominated balances. Net interest expense to the quarter relative to last year was $500,000 higher, due to costs associated with setting up our new $175 million credit facility, the new interest expense associated with the mortgage financing, and lower interest income earned on cash balances.

The details of our tax provision, as you might expect, are complex, but I'll try to explain it. In somewhat over-simplified terms, our total tax provision compromises of a net, current tax provision of $900,000, and a net, deferred tax recovery of $35.5 million.

Our current expense reflects a provision of $1.8 million, being the current taxes pertaining to the first quarter's earnings of those jurisdictions, other than Canada and the U.S., that amount is reduced by the recognition of some previously-unrecognized tax benefits in the settlement of tax audits in Canada, Germany, and the U.S. For purposes of our FFO calculation, we used the $1.8 million.

Our deferred tax recovery reflects the $41.9 million reversal discussed earlier, and reduced by the deferred taxes associated with the fair value increases recognized in the quarter, and certain other timing differences. Some additional financial metrics and matters that I'd like to highlight include our annual lease payments at the end of the first quarter are up $8.7 millionsfrom the end of 2012. The two primary reasons for the increases are contractual rent adjustments for $4.9 million, and $3.2 million related to the February acquisitions.

In the quarter, we invested $2.4 millionin capital expenditures for various small projects, and during the first three months we declared $24.6 million of distribution to unit holders, of which [$16.4 million] was paid in the quarter.

At the end of the quarter of Q1, we had $63.6 million of cash in the bank; always a good thing.

Lastly, and in closing, I'd really like to acknowledge our staff and, in particular, our finance and accounting people in Toronto and in Vienna, Austria. In the last four months, accounting for the REIT conversion, the multiple corporate reorganizations we undertook, completing a year-end audit, then, immediately converting to IFRS, was a huge assignment and accomplishment, and I wanted to, both, thank and recognize them for their tremendous efforts. It was no easy task.

With that, I'll turn it back to Tom.

Thank you, Mike. Operator, we're open for questions.

Certainly. (Operator Instructions). Our first question comes from the line of Sam Damani with TD Securities. Please proceed with your question.

Thanks and good morning. Just on the tax front, there's a lot of detail there and a little bit confusing, but at the end of the day, are you sort of suggesting that the $900,000 is, kind of, a reoccurring number going forward or the [$1.8 million]?

The [$1.8 million] is more of the reoccurring number, Sam; the [$900,000], I'll call it a reversal of prior reserves.

Okay. What would cause that to change materially over the course of the next year or two?

The [$1.8 million]?

Yes.

The [$1.8 million] is going to be driven by income in the foreign jurisdictions.

Okay. All right. Okay.

Just from the acquisition front,you've talked about pipeline of a few hundred million dollars in the past. You've made a couple of deals so far this year, as you said, around $60-odd million. Can you give us a little bit more color as to where some of those pipeline opportunities are today versus a couple months ago?

Sure. Just commenting on the overall process of acquisitions, as well as selective development. It's not a sprint, but it definitely requires pace. We have gone after some larger portfolios, very, very intensely, in the United States and lots of hustling to get those. But we're able to continue at a quarterly pace.

I sort of look at it as, the first thing that drives us is quality. Over the course of two to three years of an acquisition and development program, what's going to differentiate us is the quality of assets we have. Our strategy is not only to diversify the tenant base, and less reliance on Magna as a tenant, but it's to enhance the quality of our overall assets, moving way from special purposes into high depth of tenancy potential for the assets that we acquire.

We look at that quarter and say, just barely through first quarter we've done over $60 million of income producing property, the development pipeline, based on the two sites that we acquired could, add another $60 million. We do look at those sites as high quality sites that, with some breaks, we would be developing over the next year and bringing on between [$4 million] and [$5 million] of NOI, if we're successful on the lease front for them.

I view our acquisition process as a pace quarter by quarter. If we can maintain where we've come, looking at this between [$65 million] and [$120 million] in pipeline that we've brought on this first quarter, and can maintain that pace, we're going to reach our goals. In between, if a high quality portfolio comes up, we're going to pursue it.

We're not seeing that high quality portfolio in Canada. We are in the United States. There's competition.

As I say, one big one we went after, we just missed, but we'll keep that going. I'd like to view it as, if we have, on the income producing property acquisition front, the pace we had in first quarter, that's going to lead to [$200 million] to [$250 million], or more, of acquisitions straight up, as well as selected development.

The other side is, what we've done to date that's worked well, has worked well with Dermody properties, a great JV partner, a tremendous development experience and, obviously, has delivered three high-quality assets to us, at North of 7% cap rates; something you just don't see in Canada. We want to do more direct on our own front, 100%, that's what we're pursuing right now.

We are looking very seriously at some opportunities in Germany, and some opportunities in the United States, but they're still under a competitive framework, so, they can't be guaranteed that we get them. One of the dilemmas that I find is what is the definition of pipeline?Is it things we're looking at? Is it things we have under contract?

Right line, if pipeline is things we're looking at, it's very large. If it's what we can land, that remains to be seen. We, certainly, have a strong, strong objective of maintaining this pace that we completed in the first four months of 2013. If we can maintain it, we're not only adding good rental revenue and significant FFO, but we are adding quality. I hope, in time, what's unique about Granite is, we go from very unique, special purposes properties to, potentially, being known as a Company with some of the highest quality industrial, logistics, and warehouse properties in North America and parts of Europe.

That's our objective. Some quarters we're able to lie [$200 million], the other quarters it's [$40]. As long as it's rooted in quality, we're going to get to where we want to get. And all in spurts, with our efforts to look at certain selective sales, none of which are firm right now, but discussions are going on. We're pulling that into high quality.

No apologies for the pace, but a commitment to maintaining it and in hope that, in between, a couple of large portfolios do break for us. We're pretty comfortable, more than anything, with the high quality of asset we're bringing on; that's what's going to serve us well in the long run.

Thank you. Just a couple of clarification questions on the acquisition side. The three deals announced last night, were those bought from Dermody?

The income producing property in Portland, Oregon was acquired from Dermody. The site in Louisville, Kentucky, and Berks, Pennsylvania, we acquired by Dermody, through some degree of sole sourcing by them. They were tied up several weeks ago, but we have been doing due diligence and planning, we've bought, together from third parties, those sites with Dermody.

Got you. Okay. You mentioned [$4 million] to [$5 million] of NOI, I think you mentioned the [$60 million] aggregate costs on those two sites, representing about a 7% to 8% yield. Is that the right math we should be thinking about on those two sites?

While cautioning and stressing that we don't like do forward-looking statements, but when we look at development, we look at enhance yields to investment straight up, and we certainly pro forma North of [$7 million], and in some cases closer to [$8 million], yes.

If you've been buying income producing properties in the low [$7 million], and these development yields aren't a whole lot higher --

Sam, what I have to stress there, Dermody have been better than a great partner to us. They have delivered these three properties to us North of [$7 million], an unequivocally, I believe, they would trade in the market, openly, at the low [$7 million]. Dermody did that as part of building a relationship with us.

I believe the quality of property we would be developing, particularly Louisville and Berks, and those sites would trade at close to [six to six and a quarter], so the spread between where we're developing and where the brand new asset would trade is, potentially, 200 basis points, so it is quite substantive.

Okay. Just on that $200 million fish that got away,has that been firmed up by another player? Is there any detail you can put to it at this point?

It's a portfolio that was actually closer to [$300 million] and it was bought by a U.S. REIT.

Which one?

I'm not sure I can say due to confidentiality agreement.

Okay. Just on the ALP, there was a nice increase on the quarter due to the contractual rent step-ups, almost $5 million, that, I assume, is not going to reoccur on a reoccurring basis. How much of that benefit would actually hit the Q1 revenues?

$1.5 million. So, [$1.5 million] was the year-over-year comparison, but just from December to March, the ALP rose by, almost, $5 million. That's an annual number, so you've got a chunk of the ALP.

If you look at the ALP, December to March, I think it was [$8.7 million], because it was [$185 million] to [$193 million], just being from memory. Of that, [$4.9 million] was contractual rent increases, then, you get a quarter of that in the quarter.

Okay. So, in other words, those rent increases were all in place at the beginning of the quarter?

January 1.

Okay, got it. Okay, I'll turn it back. Thank you.

(Operator Instructions). Our next question comes from the line of Neal Downing with RBC Capital Markets. Please proceed with your question.

Hi, guys, good morning. I, admittedly, have not been through all of your documentation, but, Mike, a quick question on the accounting for the Dermody income producing assets. Are you fully consolidating those assets on your balance sheet?

Yes.

Okay. That was, about, a U.S. $40 million deal at 100% basis; is that right?

Yes.

So the [$3.2 million] increase in your income, in the ALP roll-forward, I guess would equate, actually, probably closer to an 8% NOI yield, on [$40 million]; does that make sense?

You've got in there, Neal, you have in there the recoveries from the operating costs.

I see.

In that [$3.2 million].

Okay.

That's going to be your difference.

I see, that brings it together. One other question on the investment properties, as it relates to your fair valuation process. I was curious, with regard to the sizeable difference in the discount rates and terminal cap rates, between the Canadian properties and the U.S. properties,can you comment further on why the significant difference in the math and characteristics of the assets?

Well, Neal, Tom Heslip here. I do want to stress that we undertook external appraisals on all 106 properties. The appraisers in Canada was a separate firm from that in the United States. The methodology used by both was similar.

It was 10-year discounted cash flow approach, cost us on residual value. Canada appraisals and our interaction with them, and our auditors with Deloitte, we thought were, candidly, more realistic on discount rates, given the quality of the tenant in the facility and pretty good quality facilities.

In the United States, we have some terrific long-term leases in place and some very committed tenants. The discount rates used by the appraisers, which we ultimately settled with Deloitte and accepted, were higher discounted rates than expected. I don't have a great rationale for why they believe those are higher.

I think there's potential for more compression on those discount rates in the United States now, just given over what's happened over the last 6 months to 12 months, particularly the last quarter in the United States. So, your question is a great one because they were cautious, they were conservative on discount rates in the United States, and, yet, some of our most committed tenancies are in place, such as South Carolina, Kentucky, and Tennessee, where we have longer leases that go beyond 2017. So, maybe some upside there, but difference of a view on the appraisals and we accepted their discount rates.

Okay. Time will tell much thank you.

Our next question is a follow-up from the line of Sam Damani with TD securities. Please proceed.

Yes, thanks. On the IFRS,I didn't quite discern from your comments,the external appraisers, the values were higher than your own estimates? Did you move them higher from the appraisal amounts or lower?

Varied from jurisdiction to jurisdiction. There were somewhere we were lower; there were some we were higher. we undertook those appraisals all last year and, then, adjusted through certain assumptions on tenant renewal probabilities; that increased some, decreased others. Overall, adjusting for a year later and some cap rate compression that they advised us on, we weren't very far off.

Okay.

Overall.

Overall, right. Okay. These appraisals, I guess they're using comps of other specialized/manufacturing properties? How much?

You had some commentary report that you put out this morning that I thought was very, very accurate, just in terms of the difficulty and dilemma that goes with valuing the special purposes assets, which account for over half of the value. I'm not sure they necessarily used comps of other special purpose. The discount rates, particularly in the United States and Mexico, somewhat arbitrary.

Why a discount rate would be as high as [11% to 12%] versus [9% to 10%] wasn't really rationalized, but at the same time, in order to be transparent, in order for us to be objective, we have to accept, to some extent, those external, advised discount rates, and Deloitte scrutinizes them as well. No, it remains a difficult asset to value.

The most important component of the process is that it be done on a discounted cash flow basis and not on an income in place, static cap rate. The discussion has to be probability of tenant retention rate, upon which that tenant is renewed.

One of the things the appraisers tend to do is, while a lease may state a specific renewal rate and terms, stated in the lease, the appraisers will defer to fair market rent in their assessment, and that may differ from the actual rent contracted in the lease. That can lead to some value discrepancies. Overall, there was an arbitrariness to the Mexico and the United States discount rates that we don't have a complete explanation for, but we accept.

And, so, I hear you on the renewal rent, but to the extent that there's contractual rent increases within a term, were those accepted by the appraisers in their DCF work-ups?

Yes.

And when you said they were cautious on the residual, on average, what sort of percentage, not renewing, were they assuming; and how much down time were they baking into the DCF? I assume every property was done on a 10-year, so there would have been, definitely, captured some significant down time in that DCF. I'm just curious if you could add a little bit of color on what they were thinking there?

You would see, probably, a year down time, on average, and an implied market rent. In some cases, that was similar to rates being paid; in other cases, it could be as much as 25% to 40% lower.

And what percent renewal, probability, were they; on average?

On average, 75%, 25%.

75% renewal?

Yes.

Okay, that's great. Thank you very much.

There appear to be no further questions at this time. Please continue with your presentation or closing remarks.

Appreciate the caution and time people took, and we will be pursuing our goals. Thank you very much.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and we ask that you please disconnect your lines.