Granite Real Estate Inc.

Good morning, and welcome to Granite REIT's first quarter 2023 results conference call. Please note that the call is being recorded. Speaking to you on the call this morning is Kevin Gorey, President and Chief Executive Officer, and Teresa Nito, Chief Financial Officer. I will now like to turn the call over to Teresa Nito to go over certain advisories.

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 discussed in grants 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 2022 filed on March 8, 2023. 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. Granite undertakes no intention or obligation to update or revise its key assumptions, 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 condensed combined unaudited financial results and management discussion and analysis for the three-month period ending March 31st, 2023 for Granite Real Estate Investment Trust and Granite REIT Inc. and other materials filed with the Canadian Securities Administrators and U.S. Securities Exchange Commission from time to time for additional relevant information. I'll commence the call with the financial highlights and then Kevin will follow with the operational update. Granite posted Q1 2023 results exceeding expectations with strong NOI growth compounded by the strengthening of the Euro relative to the Q4 as well as the U.S. dollar, partially offset by higher interest costs. FFO per unit in Q1 was $1.25, representing a 5 cents or 4.2% increase from Q4 2022 and a 19% increase relative to the same quarter in the prior year. Strong NOI from acquisitions, developments, and expansions that came online since the first quarter of 22 and same property NOI growth was enhanced by favorable foreign exchange movements where the Euro was 4.7% stronger and the U.S. dollar was flat relative to Canadian dollar in comparison to Q4. In comparison to the prior year, the Euro was 2% stronger and U.S. dollar 7% stronger, resulting in a positive 6 cents impact to FFO per unit. Offsetting the favorable Q1 2023 NOI relative to Q4 is the effect of higher interest costs resulting from interest on Granite's secured construction facility, which commenced being expensed in January 2023 upon the substantial completion of Granite's Houston development and foreign exchange on Euro-denominated borrowings and current income tax. Lastly, in Q4 2022, we recognized the favorable 0.7 million current income tax recovery and the 0.7 million fair value gain, which did not recur in Q1. Granite's AFFO on a per-unit basis in Q1 2023 was $1.18, which is 13 cents higher relative to Q4 and 18 cents higher relative to the same quarter last year, with the variances mostly tied to FFO growth and lower capital expenditures, leasing costs, and tenant allowances incurred due to the timing of leasing turnover and weather. ASFO-related capital expenditures, leasing costs, and tenant allowances incurred in the quarter totaled $1.1 million. For 2023, we continue to estimate ASFO-related maintenance capital expenditures and leasing costs coming in at approximately $22 million for the year, with the increase relative to the past couple of years being a direct result of approximately 9.7 million square feet of GLA turning over this year. Same property NOI for Q123 was strong relative to the same quarter last year, increasing 5.4% on a constant currency basis and 9.8% when foreign currency effects are included. Same property NOI growth was driven primarily by higher than previous year CPI adjustments, positive leasing spreads, contractual rent increases across all of Granite's regions, lease renewals in the US and Canada, and includes the impact of a completed expansion to the GTA in Indiana. GNA for the quarter was $14.7 million, which was $6.3 million higher than the same quarter last year and $6.1 million higher than Q4. The main variance relative to the prior quarter and Q4 is the change in non-cash compensation liabilities which generated an unfavorable $6.7 million fair value swing relative to the same quarter last year and an unfavorable $5.9 million fair value swing relative to Q4. As we recognize fair value losses on these liabilities due to the 19.6% increase in Granite's unit price during the quarter. These fair value adjustments do not impact our FFO or AFFO metrics. For the remainder of 2023, we expect G&A expenses of approximately $9 million per quarter or roughly 7% of revenues, excluding any amounts for fair value adjustments related to these non-cash compensation liabilities. On income tax, Q1 2023 current income tax was $2.3 million, which is $0.3 million higher than the prior year and $0.8 million higher than Q4. As mentioned earlier, Q4 we recognize the net impact of adjustments pertaining to prior tax years in our European region of 0.7 million. Excluding the aforementioned adjustment in Q4, the increase in current tax over both Q1-22 and Q4 is primarily attributable to the strengthening of the Euro relative to the Canadian dollar as virtually all of Granite's current income tax is generated from its European region. For 2023, on a run rate basis and factoring in a now stronger Euro, we estimate current tax at approximately 2.2 million per quarter before recognizing any reversals of tax provisions. Interest expense was higher in Q1 2023 relative to Q4 by 1.1 million. This reflects interest on Granite's secured construction loan and foreign exchange. In the second quarter of 23, Granite intends to repay in full the secured construction loan with draws from the credit facility lowering the borrowing rate. On a run rate basis, we estimate interest expense will run approximately $18.5 million per quarter before factoring any new debt or additional credit facility draws other than that draw for the repayment of the construction loan. When Granite refinances its upcoming $400 million debenture, maturing November this year, we expect our interest expense run rate will increase to approximately $22 million per quarter. All of Granite's debt is fixed-rate debt through cross-currency and 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. Currently, Granite's weighted average cost of debt sits at 2.29%. Looking out to 2023 estimates, Granite's guidance provided on the March 8th call remains unchanged, which estimates FFO per unit within a range of 490 to 505 per unit or approximately 11 to 14 percent increase over 22. For AFFO per unit, the forecasted range remains 430 to 445, representing an increase of 6 to 10 percent. Based on current foreign currency trends, we are projecting to achieve results closer to the higher end of the guidance. The foreign currency rates driving the high and low ranges remain virtually unchanged. For the high end of the range, we are assuming foreign exchange rates of the Canadian dollar to Euro of 1.48 and Canadian dollar to USD of 137. On the low end of the range, we are assuming exchange rates of the Canadian dollar to Euro and Canadian dollar to USD of 1.42 and 1.32 respectively. As well, at this time, there are no significant changes to our operational forecast that would drive changes to our estimates. Granite will provide updates to guidance each quarter as warranted based on leasing activities executed to date as well as any changes to foreign exchange rate assumptions. The Trust's balance sheet comprising of total assets of 9.3 billion at the end of the quarter was negatively impacted by 73 million in fair value losses on Granite's investment property portfolio in the first quarter, offset by 33 million of translation gains on Granite's foreign-based investment properties, particularly due to the 1.7 increase in the spot Euro exchange rate relative to Q4. The fair value losses on Granite's investment property portfolio were primarily attributable to the expansion in discount and 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 and selective U.S. and European markets, the renewals of three special purpose properties in Austria and Germany, and the stabilization of three properties under development in Houston, Texas. which were completed and transferred to income-producing properties during the first quarter. The Trust's overall weighted average cap rate of 5.01% increased 14 basis points from the end of Q4 and has increased 71 basis points since the same quarter last year. Total net leverage at March 31st was 32% and net debt to EBITDA was 7.8 times, which is slightly inflated due to Granite partially funding its significant development program with debt. Granite expects its debt to EBITDA to decrease to the low seven times by the end of the year and to improve thereafter into 2024, as the EBITDA from completed developments come online throughout this year. The trust's current liquidity is approximately $1.1 billion, representing cash on hand of about $110 million and the undrawn operating line of $990 million. As of today, Granite has $5 million drawn on the credit facility, and there are 4.2 million letters of credit outstanding. We continue to monitor the market conditions in the coming months to look to refinance our 2023 debentures, which come due in November. I'll now turn the call over to Kevin. Thanks.

Thanks, Theresa, and good morning, everybody. I will be brief. As usual, we spoke roughly 60 days ago and we provided an outlook for 2023 at that time. I would echo Theresa's comments that our results exceeded expectations due primarily to the pace of development stabilizations in the quarter and the continued strengthening in income from our European portfolio. I will begin my prepared comments on our development program where we have been focusing our capital deployment now for the past few quarters. As you can see from our press release in MD&A, we achieved substantial completion on our 690,000 square foot design-build distribution center in Houston for e-commerce user Chewy for a term of just under 11 years, which commenced on February 1st. We also achieved substantial completion of the two buildings totaling 669,000 square feet, which comprise phase one of the site, and we have executed two leases totaling 521,000 square feet to third-party logistics providers for five- and seven-year terms. In addition, we achieved substantial completion in January of our 329,000-square-foot expansion of our existing property in Whitestown, a suburb of Indianapolis, and the lease has been extended for 10 years in the entire building. Further, we achieved substantial completion of our development project in Lebanon a suburb of Nashville, Tennessee, comprising roughly 500,000 feet, over three buildings, on April 6th. And finally, we completed the development of our 221,000 square foot property in Bolingbrook, a suburb of Chicago, on April 12th. And the building is fully leased for a 12-year term. Collectively, these projects and stabilizations are expected to contribute strongly to NOI and cash flow growth in future quarters. and all are expected to achieve green building certification in accordance with our published green bond framework. To date, approximately 1.8 of the 3.4 million square feet of development space delivered here to date has been leased, leaving just under 1.6 million square feet remaining to be leased. Looking at our current construction pipeline, Our development projects in Brantford and Ajax, totaling roughly 450,000 feet, continue to progress well, with completion scheduled for the first quarter of 2024. The first phase of the Brantford site, comprising a single 410,000 square foot building, has been fully leased for a 20-year term and will generate an unlevered development yield of approximately 6.8%. The 50,000 square foot expansion of our BEC asset in Ajax is being constructed on a speculative basis and is expected to generate an unlevered development yield of roughly 7.5%. As mentioned previously, we are in the approval process for the next phase of our Brantford development, a single 730,000 square foot building with potential commencement in late 2023. Operationally to date, we have renewed roughly 8.1 million or 85% of the 9.6 million square feet of leased maturities in 2023 and an average increase of roughly 20%. And we anticipate achieving an average increase of 28% on the remaining maturities, an increase of roughly 4% in our estimate from the previous quarter. As mentioned on our last call for 2024, we have renewed roughly 55% of the 9.6 million square feet of maturities and an average increase of 9.4%, primarily due to the 10-year garage renewal announced earlier this quarter. At this point, we continue to expect to achieve an average increase of 20% to 22% on the outstanding maturities in 2024. And I think it is worth repeating that our renewals in the corridor at Graz and Oberthausen in Germany, totaling almost 5.1 million square feet in total, required no investment from granted for TI's landlord work or leasing commissions. There was no capex associated with either renewal. As Theresa mentioned, same property NOI increased by 5.4% in the corridor on a constant currency basis within expectations. Came property in Hawaii was positive across all geographies on a constant currency basis, led by our portfolios in the GTA and the Netherlands at 8.3% and 6.3% respectively, followed closely by the U.S. at 6.1% and Germany at 5%, driven partially by strong CPI increases in Q1 and a number of our properties in the GTA, Germany, and the Netherlands. We expect same-property analyte growth to improve over the coming quarters, and at this time we are reiterating our range of guidance for 2023 same-property analyte growth at 6.5% to 7.5%. As you can see from our disclosure, we adjusted cap rates and discount rates further in the quarter. The resulting $160 million in fair value losses associated with TCR and DR adjustments, a modest reduction from the $230 million adjustment in Q4, was more than offset by development stabilizations, substantial completion of the development in Indianapolis on a forward purchase basis, foreign exchange gains, as well as an increase in value from the long-term renewal of our properties in Graz, Austria, and Oberhausen, Germany. As for a general market update, I would characterize leasing activity in the first quarter as lower than in the past two years, but in line to slightly above the 10-year average across our markets. Fundamentals remain strong, with sentiment appearing somewhat more cautious among tenants in the face of greater economic uncertainty. Net absorption across our markets ranged from a low of negative 300,000 square feet, ironically in the GTA, to a high of almost 9 million square feet in Dallas. Availability rose in most of our markets in North America, but not all, as new supply outpaced demand in the first quarter. We expect this trend to continue for the next two to three quarters as the backlog of current projects are delivered to the market. However, we project that availability will begin to fall sometime in early 2024 as the pace of new starts has already began to decelerate acutely from past quarters. In most of our markets, we are witnessing a drop of 50% to 75% in starts from the first quarter of 2022. As for rents, data suggests that market rents increased roughly 3% on average in the fourth quarter across our markets, with Dallas and Atlanta leading the way at 8% and 7% respectively. I would add that most of the net absorption has occurred in the newer product segment, so there is an obvious flight-to-quality theme underway. So although demand is expected to moderate off exceptional highs of 2021 and even 2022, the spread to market on our in-place rents continue to widen in the first quarter. And the abrupt cessation in new supplies should support continued rent growth over the near to medium term. With respect to investment market conditions, I won't go into much detail. It won't surprise anyone that volume slowed drastically in the second half of 2022. and today volumes appear to remain roughly 50% below the first quarter of 2022. The bid-ask spread continues to exist but is narrowing as vendors slowly adjust to the current cost of market capital. That being said, industrial continues to be one of the preferred sector destinations for investor capital, and flows appear to be improving. With active buyers, including private investors, concentrated on smaller transactions in certain markets, and private equity funds, which have capital allocation and deployment needs. We're happy to discuss in more detail if needed. In closing, I would like to thank our team for another strong quarter, and we remain exceptionally well-positioned to execute on our plan for 2023, and once again, deliver strong results for unit holders. So moderator on that, I will open up the floor for any questions.