Granite Real Estate Inc.

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

Speaking to you on the call is Kevin Gorey, President and Chief Executive Officer, and Theresa Netto, Chief Financial Officer. 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, as well as potential impact of COVID-19. And the 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 not subject to known and unknown risks and uncertainties. These risks and uncertainties are discussed and granted mature understanding 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 2020, filed on March 4, 2020. Readers are cautioned not to place any undue reliance on any of these forward-looking statements and forward-looking information, granted 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 were otherwise expected 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 Q2 2020 condensed combined unaudited financial results and management discretion and analysis of Granite Real Estate Investment Trust and Granite Week, Inc., and all other materials filed with the Canadian Securities Administrators and U.S. Securities and Exchange Commission from time to time for additional relevant information. As a reminder, this call is being recorded today, Wednesday, August 12, 2020. I will now like to turn the conference over to Kevin Gorey. Please go ahead, sir.

Thanks, Operator. Good morning, everyone. I hope you're doing well. Welcome to our Q2 call. As usual, I'm joined this morning by Theresa Netto, our CFO, Warren Coomer, our Executive Vice President of Global Real Estate, and Michael Rand-Parris, our Senior Vice President of Global Real Estate and Head of Investments. Theresa will begin this morning by taking you through our financial highlights, and then I will follow up with an update and hopefully some insights on our development and acquisition programs, leasing, and strategy, and then I'll open up the floor to any questions that you have. So, Theresa, over to you.

Thanks, Kevin, and good morning, everyone. Grant had posted a solid second quarter, delivering very strong same property NOI and FFO, ASFO per unit growth relative to the prior year. FFO per unit in Q2 is $0.97, an $0.08 or 9% increase relative to the prior year, and $0.08 lower than Q1 2020. Included in this quarter's FFO is a 0.9 million fair value loss on trustee deferred staples unit liabilities due to the increase in grants unit price during the quarter. Excluding this fair value loss, FFO per unit would be 99 cents. Further, in Q1 2020, It included a 2.8M foreign exchange gain and a 0.8M tax provision reversal where if excluding these items Q1 2020 FFO would be 98 cents on a more comparable basis. FFO this quarter has been positively impacted by strong same property NOI growth as well as positive foreign exchange translation of our foreign based income representing approximately 90% of our FFO. as both the Euro and U.S. dollar strengthened by 3% on average in Q2 2020 relative to Q1. These were partially offset by the temporary dilutive impact of the $289 million equity offering completed on June 2nd, where the full net proceeds have not yet been deployed, and higher interest expense from the $500 million green bond issued on June 4th. Subsequent to the quarter, the U.S. dollar has weakened while the Euro has strengthened further, which could result in a net negative impact to Granite's NOI, FFO, and AFFO, if FX rates remain at these current levels. Generally, a one-cent change in either the U.S. dollar or the Euro FX rate relative to the Canadian dollar, it will result in an approximate annual one-cent per unit change in FFO or AFFO. With the recent volatility in the FX market, Granite commenced mitigating part of the FFO-AFFO foreign currency translation risk by entering into derivatives that protects Granite against significant declines of both the US dollar and the Euro. Additionally, Granite's unit price has strengthened since the end of Q2. Therefore, we expect further fair value losses on the re-measurement of our trustee deferred stapled unit liabilities to negatively impact G&A in the third quarter of 2020. Granted ASFO on a per unit basis in Q2 is 93 cents, which is 5 cents or 6% higher than prior year, but 10 cents lower than Q1. Excluding the impact of the fair value loss on deferred stapled unit liabilities in this quarter and adjusting for the foreign exchange gain and tax provision reversal in Q1 2020, previously mentioned, ASFO per unit on a more comparable basis for Q2 2020 is $0.95, essentially in line with the $0.96 in Q1. ASFO-related capital expenditures, leasing costs, and tenant incentives incurred in the quarter total $2 million, which is higher than the $600,000 incurred in the same quarter last year and higher than the $1.1 million incurred in Q1 2020. For the remainder of 2020, we are estimating total maintenance capital expenditures, leasing costs, and commissions of approximately $7 million for a total year estimate of approximately $10 million, resulting in increased deductions to ASFO relative to the first half of the year. This year, maintenance capex includes approximately $4 million of recoverable maintenance capex that was pushed out from 2019. As a result of a relatively low CapEx quarter and strong FFO performance, our AFFO payout ratio came in at 78% for this second quarter. Operating metrics continue to remain positive. NOI on a cash basis for the quarter increased by $12.7 million or 21.8% from the same quarter in 2019 and by $3.2 million or 4.7% from Q1. Same property NOI for Q2 came in very strong relative to Q1 last year, increasing 7.4%, but on a constant currency basis, increasing by 5.5%, driven by occupancy gains in the GTA, New Jersey, and Mississippi, contractual rent increases, and rent from an expansion completed at one of our West Jefferson, Ohio properties. Excluding this expansion rent, same property NOI for the quarter is 6.9%, and on a constant currency basis, 5%. GNA for the quarter was $0.4 million higher than the same quarter last year and $3.3 million higher than Q1 2020. The swing in fair value adjustments to our unit-based compensation as a result of the changes in our unit price resulted in a negative variance of $3.4 million this quarter relative to Q1 2020. Outside of fair value adjustments, GNA remains on track with internal budgets. Where some savings have been realized from reduced travel, we have incurred to date a modest $100,000 in COVID-related costs thus far this year. Looking out to the remainder of 2020, we continue to estimate G&A to be approximately $7.5 million per quarter, which includes approximately $1.6 million of non-cash compensation expense per quarter, but assumes no fair value losses on gains associated with the increase or decrease in non-cash compensation liabilities, which cannot be predicted. With respect to current income tax, we are estimating approximately $2.1 million in current income tax per quarter for the remainder of the year. As mentioned on the first quarter earnings call, we have another potential reversal of $1.7 million in tax provisions in Q4 this year, but it is too early to assess whether these tax assets can be realized at this time. The trust balance sheet comprising total assets of approximately $5.8 million at the end of the second quarter increased $700 million since the end of Q1, driven by cash proceeds from both the equity and green bond issuance net acquisitions completed, and by approximately $35 million in fair value gains to Granite's investment property portfolio, offset by approximately $106 million translation losses on Granite's foreign-based investment properties. The fair value gain on Granite's investment property portfolio is attributable to the Trust's development property in Plainfield, Indiana, which was completed and leased in the quarter, as well as fair value gains in the Trust's GTA properties due to increases in fair market rent assumptions, partially offset by fair value reductions in a few of the Trust's Austrian assets. The Trust's overall weighted average cap rate did not change and remains at 6% at the end of Q2. Total net leverage as of June 30th was 23%, only slightly higher by 1% from Q1. The trust's current liquidity is approximately $1.1 billion, representing cash on hand $600 million and the Andron operating line of about $500 million. I'll now turn over the call to Kevin for operational discussion.

Thanks, Teresa. As always, I'll keep my comments brief. I trust you've had a chance to view our MD&A and press release. I would like to begin by acknowledging our entire team at Granite for their effort and commitment during a challenging time for the organization and all businesses, frankly, in general. Despite working remotely for effectively the entire quarter, our team was able to deliver strong financial results for unit holders. As well, we completed over 1.1 million square feet of leasing in the quarter, delivered a 511,000 square foot development project in Indianapolis, We raised almost $800 million in capital, partially through the issuance of Canada's largest REIT green bond, implemented a U.S. dollar currency hedge on roughly 50% of our U.S. dollar income, as Teresa mentioned. We closed on roughly $330 million in acquisitions, including 36 acres of land for development in Dallas. And lastly, we published our inaugural ESG update, and we collected over 99% of our rent for the quarter. Not bad for a lockdown. As reported in our MD&A and press release, we have now closed on the three development properties in the Netherlands, and we expect to complete the new 240,000 square foot grocery-related e-commerce distribution facility next month. As mentioned, this new development complements our stated strategy of adding new generation food distribution product, particularly in Europe, to our portfolio. Further, the property is being developed to green excellent certification, one of the highest green building designations available. Our development project in all points Indianapolis is now complete, as mentioned, and has been fully leased to a North American food distributor for 10 years. The resulting development yield slightly exceeded pro forma expectations. Further, the project achieved two Green Globes green building certification consistent with our sustainability program and our green bond framework. Site work is nearing completion on our Houston development, and we continue to evaluate market conditions for potential commencement of construction of the first two buildings later this year or early in 2021. Similarly, the construction of our project in Altbach, Germany was delayed due to the impact of the lockdown, We are now currently repricing the project and plan to commence construction of the building in Q4 or Q1 2021. And finally, as an update, we continue to review the scope and cost of the planned expansion with the tenant at 2,095 Logistics Drive in Mississauga and construction is expected to be delayed through 2020. From a leasing perspective, 2.4 million square feet of leases were scheduled to expire in 2020. To date, we have negotiated extensions of new leases on 1.95 million square feet, or roughly 81% of the expiries, and an average increase in rental rate of approximately 8%. The remaining 440,000 square feet of expiries in 2020 represents just under 1% of our GLA. For 2021, 1.9 million square feet or roughly 4% of our leases by GLA are expected to expire. To date, we have renewed roughly 700,000 square feet of those 2021 expiries at an average rate increase of 6.7%. As Teresa mentioned earlier and as disclosed in her MD&A, same property in Hawaii increased by 5.5% on a constant currency basis and 5% excluding expansions which is ahead of expectations. Moreover, St. Proppie NY growth was flat to positive across all geographic segments on a constant currency basis, led again by our U.S. portfolio of 9.7%, due in part to the expansion of our ACE Hardware Distribution Center property in Columbus, Ohio. With respect to rent collection and deferrals, we have received 99.3% of our rent for Q2. We have collected 99.7% of rent for July, and rent collection for August so far is in line with normal. Conditions are ongoing with select tenants on outstanding rents, and we have so far agreed to a deferral with one tenant in Europe for a two-month rent, of which only one-half month remains outstanding, totaling $72,000 Canadian. Conditions certainly may change. that at this point we expect to collect all outstanding rent. I would like to take the opportunity to thank our team once again for their efforts in achieving these results. The levels of rent collection to date are truly a testament to the quality of our tenants, the quality of our people, and our approach. I'm getting choked up. Further to my comments in Q1, I am very pleased to highlight our ESG update which was published in June in conjunction with their $500 million green bond offering. The update is available on our website and I would encourage anyone who's interested to review the details of our ESG program and please reach out to us with any questions or comments you may have. In closing, I would echo Teresa's comment that we posted a solid second quarter. We delivered strong same property NOI and FFO and AFFO per unit growth year over year, and we finished the quarter with $1.1 billion liquidity, including $600 million in cash. So we are very well positioned to continue to execute on our strategy and deliver strong results. Our acquisition pipeline remains strong in Europe, the U.S., and Canada, and we look forward to providing further updates on our Q3 calls. On that note, I will now open up the floor for any questions.

Thank you. If you would like to register a question, please press the one followed by the four on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw, please press the one followed by the three. Our first question is from the line of Sam Damiani with TD Securities. Please go ahead.

Thanks, and good morning. Maybe, Kevin, just to start off where you left off on the acquisition pipeline, could you give a little color as to if you see anything closing in the third quarter and fourth quarter and what types of geographies those might be?

Thanks, Sam. First of all, for 2020, we do expect to be able to deploy most of the cash on hand by the end of the year. And in terms of geographies, I would characterize it, we roughly have 100 million of acquisitions we're pursuing in Canada. And the remainder, roughly 500 million would be split relatively evenly between Europe and the U.S. In Q3, I do expect we will be able to close on one or two acquisitions. I don't think that they will be that material in size, though. I do expect that most of the activity in 2020 would occur in the fourth quarter.

Okay, that's helpful. And just obviously congratulations on a great operational result in the quarter, rent collections and no bad debts, et cetera. How do you think about same property NOI growth for the latter half, given the performance and the strong resilience to the impacts of COVID-19 to date?

Well, we've had a lot of internal discussions on that. I think we're encouraged by where our same property NOI is for the quarter, certainly. We do expect same property NOI for Q3 and Q4 to be below where it was this quarter. I think we agree on that. i think we feel the most appropriate guidance we could give is to revert to our initial um guidance for 2020 at three percent without expansions and four percent with expansions we may do better um but i think that is appropriate at this time to maintain our initial guidance for for same property and why for 2020. thank you maybe one last quick one

You saw the news, obviously, with Amazon and Simon potentially having some talks. Do you have any thoughts on the implications of that type of a hookup in the context of the industry?

I certainly think it's, I mean, I've said before, I certainly think it's possible, but there are a lot of obstructions to making that situation work. So it's not something we would really pay attention to. I think that Again, you've seen with the acquisitions we've made recently, the bullseye acquisition in Memphis, where we're seeing the strongest demand is in e-commerce distribution. What you're talking about there with those malls, it would clearly be a last stop or a last mile, and I think that there's room for both in terms of the growth and demand from e-commerce. So I don't have much to say on it, but I think that it would be, From where we sit, it would be quite difficult to make that work logistically on a large scale.

Interesting. Thank you very much.

Our next question from the line of Himanshu Gupta with Scotiabank. You may proceed.

Thank you and good morning. So just to follow up, I think you mentioned $100 million potential acquisitions in Canada. Are there any particular markets you are looking at? And do you now see better risk-adjusted returns in Canada versus some of the other markets?

No, I mean, Canada was always on the radar for us strategically in Manchu. We did see a very short blip in terms of cap rates because of COVID that has since, I think, recovered strongly. We're seeing that basically across our entire portfolio target markets, not just in Canada, the U.S. and Europe. The demand from an investment perspective for logistics assets, I think in many markets, has surpassed pre-COVID levels. for good reason. But I think we're finding opportunities that fit our strategy well. Pricing them makes sense. That's the best way I would characterize it. And our focus really is on the GTA. I think that we would look at potentially Montreal, potentially Vancouver, but right now I think we have enough in the GTA to keep us busy.

Got it. And then on the $500 million green bond issue in this quarter, how are you planning to use those proceeds? Are there any limitations or restrictions in properties where you can invest this month?

Yeah, I'm not sure I caught the second half of the question, but we're actually quite – I think we feel quite bullish and confident on the potential for uses for the green bond proceeds. If you look at what we have acquired – Over the past two years, what we have developed recently and what we are planning to development, we're pretty confident we'll be able to deploy the $500 million towards certified green projects within the next couple of years, which is well within, I guess, the timelines of a green bond framework.

That's right. I mean, to mention, I mean, the only restriction would be that the investments must meet the Green Bond framework and how we define eligible green projects. So as long as we obtain the certifications on the either development or the acquisitions that we acquire, for example, the two green globes that our Indianapolis development received, that is eligible under our Green Bond framework. So the proceeds can be allocated to that. And recall too that we have a three-year look back on investments that we've made in the past and three years forward.

Two years back.

Got it. That's very helpful. And this last question, general question on the safety stock in warehouses. So we keep hearing about this new team. Is that more of a discussion right now or actually on the ground you think tenants are keeping more inventory in warehouses or working towards that?

I'm sorry. I didn't hear the question, Himanshu.

So in terms of, you know, we hear from the brokers that the tenants are looking to keep more safety stock in warehouses, and probably the warehouse utilization is likely to go up. Some of the tenants will stock more inventory, more safety stock. I'm just wondering that are you tracking the utilization of the warehouses of your tenants?

I'm not sure we specifically track the utilization ratios of our tenants, but I will tell you what we're seeing. I mean, you're asking a question during a period of lockdowns and COVID. So it is admittedly very recently more difficult for our team to see what's going on behind the doors. And it differs slightly from jurisdiction, but certainly in Europe, it's tougher as again. But we did receive regular and by regular, I mean weekly property inspection reports during this. And I would just say that in some cases, we were well aware, Amazon being a good example, I would offer that the utilization rates were probably at their highest ever. A number of our tenants, particularly those in e-commerce and distribution, what makes up the majority of our portfolio, were very busy during COVID. So I don't have a particular ratio that I could share with you, but I will tell you that I certainly would agree with the tone that we've seen utilization of our properties among the logistics and e-commerce users, probably at their highest that they've ever been.

Thank you. Thank you for the comment.

Our next question from the line of Troy McLean with BMO. Please go ahead.

Good morning. Just curious on the Texas developments, would you start any of those projects on spec or would you want to pre-lease it? And are you targeting any specific tenants such as Food and E-commerce for those buildings? For the Texas, it's a good question, Troy. I think if the lease-up did not go as well in Indianapolis, I think we were pausing anyways because of the lockdown. But Absent the lockdown, I think we would have been, I think leasing the Indianapolis, seeing the demand for that product gave us comfort maybe to move forward with more spec than we would have before. So I think we are comfortable when the time, when it's available to move forward on spec in Dallas, just because of the location. I mean, that location is an eight-minute drive from downtown Fort Worth, 20-minute drive from the airport on the A20. So we would be, we are going to target e-commerce logistics there. It could be multiple users in the building. It could be single tenant. But we won't be in a position to make a decision to move forward with this probably for a number of months into 2021.

And then you mentioned being able to deploy all the proceeds by the end of the year.

would that mostly be on development land or stabilized assets or would you, is there an opportunity here to find some value adds or under leased properties that you could buy and lease up? Well, I would think all of the above. Remembering that we do have a good piece of land in Houston and now Dallas, we are looking for future development opportunities. We continue to look for the right stabilized assets. and we continue to look for the right value add properties. And it's hard to give you a breakdown because it depends on the opportunity, but we're looking for all three. But I would think just based on the pipeline we have in front of us, for the remainder of 2020, it will probably be more stabilized assets, some value add, and less development land for the remainder of 2020. Looking a couple of years out, which kind of your target mix for development versus acquisitions? I mean, development seems like it's becoming much more important and, you know, the yields are a little higher.

Do you have a target or just, you know, you kind of, you know, you can see what the market gives you?

Well, I mean, I think as a REIT, you need to be responsible how you're dealing with balance sheet on your, how you're dealing with development on your balance sheet. But I, I am, a big believer in the value that development adds, that it adds for unit holders in our portfolio and in our platform. And I think we've kind of built our platform around that. So in time, I would see development being as big or bigger than our acquisition program. I don't know exactly when that'll happen, but certainly, I mean, we do work within the parameters of the capital markets. As a REIT, we can only take so much land on our balance sheet at one time, but we're going to push the limits on that. We're going to incorporate as much development as we responsibly can. So certainly I think our development program is going to continue to grow. And then just finally for me, on the acquisition opportunities you're looking at now, would it be fair to say that you're not competing with as many buyer groups as you were before the pandemic started? I wish I could say that. The answer is no. There's just as many or more buyers. I would say, I think that the deal that we did during COVID was probably the earlier part of the curve. But the curve got awfully steep in the second quarter. So there are a number of buyers that are back at the table and there are buyers that are new to the table. I mean, we're used to dealing with competition. I think we have the right strategy and approach to acquisitions. So we will certainly find our fair share and close on our fair share of opportunities. But there is no continued drop-off in the number of bidders for the right product. Thank you for your commentary. I'll turn it back now.

As a reminder, if you would like to register for a question, you may press the one followed by the four. Our next question is from the line of Chris Scrupley with CIBC. Please go ahead.

Good morning. Just following up a little bit on Troy's line of questioning. Maybe just on the deal flow, if you look at the different geographies, would you say that deal flow in each of the markets in terms of the volume of deals that you're seeing is is getting closer to pre-COVID type of levels. And then with respect to development, would you entertain the idea of partnering with another capital provider to help de-risk development and maybe collect fees?

On the 1st, 1, Chris, I think that volume might be comfortable saying volume in the U. S. is is quickly approaching pretty COVID levels. I would not be surprised to see investment volume for logistics in the U. S. be the same as 2019. Frankly seeing what's going now in Europe. It has it is still returning the pre-COVID levels. Not quite there yet. And remember, this is the summer. And when they go pens down in Europe, they really go pens down in the summer. So we'll see if we have a busy fall. In Canada, it's kind of the same volume. The holders of the right real estate in Canada want to continue to hang on to it. So we don't expect that there will be a major uptick in Canada, but that's not because of a lack of demand. It's just a lack of supply. Okay. In terms of capital partners on development, it is something we think about. I think we want to be very selective about any capital partner that we bring in, and the timing has to be appropriate for us. That time is not now, but there may be a point in the future where it makes sense for months from a capital perspective, but we just don't think that that time is now.

Okay, understood. And last question for me, just on the fair value changes in the quarter. There's some commentary regarding Austria. I'm just wondering if you can shed some light on that.

No, I mean, we felt, I think it's in our MD&A, we did make a lot of fair value, major fair value adjustments in the quarter. Obviously, we did for all points because it went from a development project to a fully leased project. asset, that was a large gain in value, almost $20 million Canadian. So that was substantial. We did take some further smaller write-downs on our assets in Europe, sorry, in Austria specifically, just because of the size of the market. It was hard for us to really look at markets in the U.S. and Canada and see the fair values move. We did take a small uptick in the GTA just based on where we're seeing movement in market rents. We did take down in the second quarter as well. Okay. Thanks a lot.

Mr. Gordon, or for the questions at this time, I will turn the call back to you. You may resume with your presentation or closing remarks.

Okay, well, I just again, thank you to everyone for being on call. I know it's a very busy time and challenging circumstances. So thank you again for being on call into our unit holders. Thank you again for your continued trust and support.

Thank you. This does conclude the conference call for today. We thank you all for your participation and kindly ask that you please disconnect your line. Have a great day everyone.