Granite Real Estate Inc.

Good morning and welcome to Granite REITs second quarter results for 2022. Speaking to you on the call this morning is Kevin Gorey, President and Chief Executive Office and Theresa Netto, Chief Financial Officer. I would now like to turn the call over to Theresa Netto to go over certain advisories, followed by an introduction of Kevin Gorey. Please go right ahead.

Good morning, everyone. 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, reflect management's current expectations, and are subject to known and unknown risks and uncertainties. These risks and uncertainties are disclosed and granted material filed with the Canadian Securities Administrators and the U.S. Securities and Exchange Commission from time to time, including the risk factor section of its 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. The REIT reviews its key assumptions regularly and may change its outlook on an ongoing forward basis if necessary. Granted, it undertakes no intention or obligation to update or revise its key assumptions or any 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 standardized meaning under international financial reporting standards. Please refer to the Audited Combined Financial Results in Management Discussion and Analysis for the three and six months ended June 30, 2022 for Granite Reef Real Estate Investment Trust and Granite Reef 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. With that out of the way, I will commence the call with the financial highlights and then turn it over to Kevin, who will follow with the operational update. Granite posted strong Q2 2022 results driven by healthy NOI growth and despite foreign currency headwinds with a continuing weaker euro, but that was partially offset by a strengthening US dollar. FFO per unit in Q2 was $1.09, representing a 4 cent or 3.8% increase from Q1, and a 10.1% increase relative to the same quarter in the prior year. Strong NOI from acquisitions and same property NOI growth was only partially muted by both unfavorable and favorable foreign exchange movements, where the euro was 8% weaker and the U.S. dollar 4% stronger relative to the same quarter last year, resulting in a nominal impact to FFO per unit. Granted, AFFO on a per unit basis in Q2 was 104, which is 4 cents and 8 cents higher, respectively, relative to Q1 in the same quarter last year. AFFO-related capital expenditures, leasing costs, and tenant allowances incurred in the quarter totaled $1.5 million, and for the year, the year-to-date period is $4.6 million. For 2022, we estimate AFFO-related maintenance capital expenditures and leasing costs coming in between $15 and $17 million for the year, which is unchanged from the estimate provided at the Q1 call. Same property NOI for Q2 2022 was very strong relative to the same quarter last year, increasing 3.6% on a constant currency basis, but up 2.2% when foreign currency effects are included. Same property on Hawaii was driven primarily by higher than previous CPI adjustments, positive leasing spreads, and contractual rent increases across all of Granite's regions, as well as the lease-up of a vacancy that was realized in the prior year at Granite Acid in Locust Grove, Georgia. G&A for the quarter was $6 million, which was $2.3 million lower than the same quarter last year, and $2.3 million lower than Q1. The main variance relative to the prior quarter in Q1 is the change in non-cash compensation liabilities which generated a favorable $4 million swing relative to the same quarter last year and a $2.2 million fair value swing relative to Q1. As we recognize fair value gains on those liabilities due to a 19.5% decrease in Granite's unit price during the quarter. Of the 3 million of fair value gains realized this quarter, 1.6 million related to the DSUs, however, as a result of amendments made to credit CSU plan on June 9, 2022, only fair value gains up to the amendment date of 0.9 million directly impact FFO. Post the amendment of the DSU plan, fair value gains and losses on our DSU liabilities will be added back or deducted for purposes of FFO consistent with the fair value gains and losses recognized on Granite's other non-cash compensation liabilities, essentially removing some of the noise that we've experienced in the last few quarters. On a run rate basis, we expect G&A expenses to continue at approximately $8.5 to $9 million per quarter or roughly 8% of revenues, excluding any amounts for fairly adjustments related to non-cash compensation liabilities. For income tax, Q2 current income tax was $1.9 million, which is $2.4 million lower than the prior year and essentially flat to Q1. The variance relative to Q221 is largely attributable to the 2.3 million of current taxes recognized on the dispositions that occurred in that prior quarter. After adjusting for the aforementioned current tax expense related to dispositions, current taxes are slightly higher than the prior quarter, resulting from a larger European portfolio. On a run rate basis, we estimate current tax at approximately 2.2 million per quarter before recognizing any reversals of tax provisions. Interest expense was lower in Q2 relative to Q1 by 0.2 million, reflecting the interest savings realized from the refinancing completed early February of its 2028 cross-currency interest rate swaps to Euro-based interest payments, partially offset by incremental interest expense on draws on Granite's credit facility beginning in the second quarter of 22. On a run rate basis, we estimate interest expense will run approximately $11 million per quarter before factoring in any new debt over and above credit facility borrowings. All of Granite's debt is fixed rate debt through cross-currency interest rate swap hedges with the exception of the credit facility, which is at a variable rate and subject to increases in underlying treasury rates. With respect to 2022 estimates, despite an overall weaker euro and rising interest rates impacting short-term borrowings, due to strong operational performance, Granite continues to forecast that FFO and AFFO per unit will come in the range provided in March of this year being 431 to 443 for FFOPU per unit and 3.96 to 4.08 for AFFO per unit. Further, our singular estimates remain unchanged for FFO per unit of approximately 4.35 and AFFO per unit of $3.98. We have updated our assumptions regarding foreign exchange rates and are estimating for the second half of 2022 a weaker Euro offset by a stronger U.S. dollar relative to the Canadian dollar. Our Canadian dollar to Euro average rate is now 1.32 from 1.39 assumed last quarter And our Canadian dollar to US dollar rate is 1.28 versus 1.26 from last quarter. As communicated before, we estimate that a one cent movement in the Canadian dollar relative to the US dollar impacts FFO and AFFO per unit by two cents, and a one cent movement in the Canadian dollar relative to the Euro results in a one cent impact to FFO and AFFO per unit. The trust balance sheet, comprising of total assets of $9.1 billion at the end of the quarter, was negatively impacted by $251 million in fair value losses on Granite's investment property portfolio in the second quarter, offset partially by $86 million of translation gains on Granite's foreign-based investment properties, particularly due to the 3.2% increase in the U.S. spot exchange rate. The fair value losses on Granite's investment property portfolio were primarily attributable to the expansion in discount rates and an expansion of terminal capitalization rates across all of Granite's markets in response to rising interest rates, partially offset by fair market rent increases across the GTA, U.S., and European markets, reflecting current market fundamentals. The Trust's overall weighted average cap rate of 4.48 increased 18 basis points from the end of Q1, but has still decreased a full 62 basis points since the same quarter last year. Total net leverage as of June 30th was 28%, and net debt to EBITDA remained steady at 7.4 times. The Trust's current liquidity is approximately $845 million representing cash on hand of approximately $85 million and the undrawn operating line of $760 million. As of today, Granite has drawn a total of US $188 million or approximately $240 million Canadian under the credit facility and there is $2.5 million in letters of credit outstanding. Based on forecasted dispositions and remaining development commitments for the year, Granite is estimating that approximately $260 million, or the equivalent of U.S. $205 million, will be drawn on the credit facility by the end of the year. Granite is currently reviewing options to convert the credit facility borrowings into longer-term, three-year-term financing with term loan debt. Further, Granite will also be monitoring market conditions in the coming months to look to refinance its 2023 debentures, which are coming due in November 2023. In other financing activities during the period between April 1 and April 29, Granite issued 120,300 stapled units under the ATM program at an average stapled unit price of $98.84 for gross proceeds of $11.9 million. And then later in the quarter, between June 15 and June 30, Granite repurchased 448,400 stapled units under its NCIB at an average stapled unit cost of $78.90 for total consideration of $35.4 million, excluding commissions. I will now turn the call over to Kevin. Thank you.

Thanks, Theresa. Building on Theresa's comments, I would begin by saying I would characterize the results for the quarter as being in line with our expectations, at least from a financial, operational, and strategic perspective. but impacted somewhat by reversal in fair value gains we have seen on our portfolio over the past several quarters. Although I would point out the negative fair value adjustments were themselves partially offset by higher NOI and market rents, as well as gains from the transfer of two of our properties under development to IPP in the quarter, which I will discuss in greater detail. To begin with investments, the majority of the acquisitions closed in the quarter were previously announced in our Q1 MD&A and press release, so I won't comment further on those, but I will highlight the two new smaller acquisitions completed in the GTA in the quarter. Despite changing market conditions, we completed these transactions based on a combination of an attractive yield and average cost basis below $265 per square foot, and a strong potential to increase returns through expansion and development. With the exception of a small parcel of land located near our site, our existing site in Brantford, there are no pending acquisitions in our pipeline. With respect to dispositions, as you can see, we completed the sale of our sole asset in the Czech Republic in the quarter. As stated in our MD&A, we have initiated the sale process for two of our assets in the U.S. and GTA for a combined value of roughly $150 million, and we may proceed with one to two further asset sales in the second half of the year. On the development front, you can see from our MD&A, we transferred two of our development projects, Village Creek in Dallas and Allpack Germany, from properties under development to IPP, generating a gain of approximately 80 million Canadian in the fair value of those properties. We also officially launched our development project in Brantford with a 409,000 square foot state-of-the-art food-grade facility for Barry Calbo, a leading global producer of chocolate and cocoa products on a 20-year lease term. Completion is scheduled for the first quarter of 2024, and the property is expected to generate an unlevered development yield of 6.5%, driven by contractual rents significantly above pro forma. As stated on our first quarter call, supply chain disruptions have caused delays to a number of our projects in the U.S., which we believe has impacted the leasing velocity to a degree. We are currently in advanced negotiations on over 1 million square feet of development space, and hope to have an update for you shortly. All of our developments are expected to receive applicable green building certification and will satisfy the criteria outlined in our Green Bond Framework. Our Village Creek property is expected to receive two Green Globes certification and our Altback property recently received DGNB Gold certification. Keeping with ESG, we are very pleased to present our Global ESG-R Report for 2021, which is now available on our website. This report documents the progress we made against several key targets set in 2021 and outlines our, in some cases, revised upward objectives and targets for 2022 and beyond. I won't repeat the details of the report, but I do think it's worth highlighting the advancement made by the team against a number of key targets, including energy and water reduction, EV charging stations, rooftop solar, green building certifications, and the alignment of our financial disclosure with globally accepted sustainability frameworks, which Theresa touched upon. Volunteering and community involvement were also notable for the team in 2021, and we are now proudly supporting over 50 charitable and community groups across our offices. I invite you to read our report and we welcome your feedback. Operationally, we signed renewals or new leases on just over 4 million feet of space since our last call, inclusive of our development leasing. That total includes roughly 1.6 million square feet of renewals at an average increase in rental rate of roughly 27%. There is currently now 340,000 feet of expiries remaining in 2022, and we anticipate achieving an increase in rental rate of roughly 60% on those expiries. Outlined in our MD&A, our occupancy decreased to 97.8 at the end of the quarter, but roughly half of that vacancy is represented by our Dallas development, which became IPP at the end of the quarter as discussed, but where the tenant's lease does not commence until the 1st of October. The introduction of our alt-back development to our IPP portfolio also added roughly 200,000 feet of vacancy. Including committed space, our occupancy increases to 98.9%, And we are close to agreeing to terms with the tenant on roughly 250,000 feet of the reported vacancy, which would bring our occupancy back over 99%. As Teresa mentioned, same property in Hawaii increased by 3.6% on a constant currency basis. in line with our expectations and guidance, driven by strong releasing spreads and leasing of vacant space at our Gardiner Logistics Park asset in Atlanta, offset by turnover of two U.S. properties. We anticipate achieving rents roughly 50% above expiring rents on both availabilities. At this time, we are reiterating our same property NOI guidance for 2022 of between 3.5% to 4.5%, but now expect to end the year at the higher end of that range. With respect to our investment properties, I would like to provide further detail on our fair value adjustment of approximately $250 million. Based on market data, both from an investment market, i.e., terminal cap rates and discount rates, and from a leasing market perspective, the majority of asset values in our portfolio were impacted by varying degrees by changes in market conditions. Because we perform discounted cash flow models on all of our properties in each quarter, we utilize terminal cap rates and discount rates in our analysis of fair value rather than simply applying cap rates on annual NOI. Beginning with the GTA, we adjusted our discount rates upward by roughly 25 basis points on average to reflect a higher premium on future cash flows, which negatively impacted asset values here. Fair market rents for the GTA were also revised upward by 25 cents per square foot on average, partially upsetting the value impact of the expansion in discount rate. Moving on to our U.S. portfolio, where we saw the highest quarterly movement in investment metrics, we adjusted our terminal cap rates and discount rates by 25 to 50 basis points, with a higher adjustment concentrated in assets with longer lease terms and lower contractual rent escalations. Fair market rents were increased between zero and 50 cents per square foot on average, reflecting strong leasing market fundamentals and rank growth across our markets in the quarter. Finishing in Europe, we adjusted TCRs and discount rates upward by zero to 25 basis points and zero to 40 basis points, respectively, and increased fair market rents by roughly 0.25 euros per square foot. In summary, these adjustments negatively impacted asset values, but the losses were mitigated by higher NOI and increases in market rents. Overall, as you can see, the fair value of our portfolio decreased by roughly 3%. Further adjustments in terminal cap rate and discount rates may be required in future quarters, but at this point we expect a negative impact of those adjustments on asset values for warehouse and distribution assets, to continue to be mitigated by improving NOI and higher market rents. Related to the value of our investment properties, it is worth repeating the contribution from our development assets, roughly adding $1.20 per unit in NAV and reducing the loss in the fair value of our portfolio in a quarter. We expect this trend to continue as our current pipeline of development projects reach stabilization as expected over the next several quarters, fully consistent with our strategic plan. I'd like to end my comments on market fundamentals before opening up the call for questions. As mentioned above, vacancy rates remain low across our markets and market rents continue to rise. Notably, the U.S. were data for the second quarter's strongest. finished the second quarter at 2.9% vacancy, the lowest on record, led by large bay demand from traditional retailers and wholesalers and third-party logistics providers. Net absorption fell to 76 million square feet from 110 in the first quarter, but that was hampered by low availability and delays in construction completions. There is currently over 600 million square feet under construction, with free leasing representing roughly a third of that total. Asking rents rose to $9.40 per square foot on average, an increase of over 5% from the first quarter and 15% year over year, another record, and rent growth is projected to continue into 2023. On that note, I'd like to open up the floor for questions.