Granite Real Estate Inc.

Good morning and welcome to Granite REIT's third quarter 2023 results conference call. As a reminder, today's call is being recorded. Speaking to you on the call this morning is Kevin Gorey, President and Chief Executive Officer, and Teresa Netto, Chief Financial Officer. I will now turn the call over now to Teresa Netto to go over some advisories. 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 discussed in grants materials filed with the Canadian Securities Administrators and the U.S. Securities and Exchange Commission from time to time, including the risk factor section of the Annual Information Forum 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 and Granted, it 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 in management discussion and analysis for the three and nine-month periods ended September 30, 2023 – for Granite Real Estate Investment Trust and Granite REIT Inc. and other materials filed with the Canadian Securities Administrators and U.S. Securities and Exchange Commission from time to time for additional relevant information. As usual, I will commence the call with financial highlights and then Kevin will follow with the operational update. Granite posted Q3 2023 results ahead of Q2 and in line with expectations supported by strong NOI growth, high interest income and lower G&A expenses. FFO per unit in Q3 was $1.24, representing a $0.03 or 2.5% increase from Q2-23 and a 14.8% increase relative to the same quarter in the prior year. The growth in NOI is derived from developments and expansions that came online since the third quarter of 2022 and strong same-property NOI growth enhanced by double-digit leasing spreads in Canada and the U.S. and inflationary increases in Europe. partially offset by the disposition of two properties during the second and third quarters of 23 and some new vacancies in North America. While foreign exchange was relatively flat overall compared to Q2, in comparison to the prior year, the Euro was 11% stronger and the US dollar 3% stronger, resulting in a positive 6 cent impact FFO per unit. Interest expense was also lower in Q3 23 relative to Q2, due to the impact of lower interest costs resulting from the refinancing activity completed during the quarter and higher interest income as a result of incremental cash on hand that was invested in high-interest income accounts. In addition, due to the timing of certain activities, FFO-related G&A expenses were approximately $0.2 million lower than Q2. Granted, the FFO on a per-unit basis in Q3-23 was $1.09, which is flat relative to Q2, and 12 cents higher relative to the same quarter last year, with the variances mostly tied to FFO growth offset by higher capital expenditures, leasing costs, and tenant allowances incurred due to timing of leasing turnover and seasonality. ASFO-related capital expenditures, leasing costs, and tenant allowances incurred in the quarter totaled $6.7 million, which is an increase of $2.2 million and $0.1 million over Q2 and the prior year quarter, respectively. For the fourth quarter of 23, we are estimating AFFO-related maintenance capital expenditures and leasing costs of approximately $7 to $10 million for approximately $20 to $23 million for the year. Looking out to 2024, we expect maintenance capex, leasing costs, and tenant allowances to remain in line with 2023 levels in and around $25 million for the year. Same property NOI for Q3 2023 was very strong relative to the same quarter last year, increasing 7% on a constant currency basis and up 12.2% when foreign currency effects are included. Same property NOI growth was driven primarily by higher than previous year's CPI adjustments, positive leasing spreads, contractual rent increases across all of Granite's regions, lease renewals in the U.S. and Canada, and it includes the impact of completed expansions in Indiana and completed developments in Fort Worth, Texas and Altbach, Germany, which had free rent periods and vacancy in the prior year, partially offset by a free rent period in the U.S. related to a lease renewal and vacancy in certain properties in the U.S. and Canada. G&A for the quarter was $8.4 million, which was $1.9 million higher than the same quarter last year and $0.5 million lower than Q2. The main variance relative to the prior quarter and Q2 is the change in non-cash compensation liabilities, which generated an unfavorable 1.3 million fair value swing relative to the same quarter last year and a favorable 0.3 million fair value swing relative to Q2. These fair value adjustments do not impact FFO or AFFO metrics. Stripping out these fair value adjustments, as mentioned earlier, G&A expenses that impact FFO and AFFO were approximately 0.2 million lower than Q2, which is mostly related to timing of professional fees and travel expenses. For the fourth quarter of 23, we expect G&A expenses to come in at approximately 9 to 9.5 million, or roughly 7.5% of revenues, excluding any amount for fair value adjustments related to non-cash compensation liabilities. Looking out to 24 for G&A expenses, we expect a run rate of approximately $9.5 to $10 million per quarter. On income tax, Q3 2023, current income tax was $2.1 million, which is $0.2 million higher than prior year and flat as compared to Q2. The movement in current tax relative to Q3 2022 is mostly attributable to the strengthening of the euro relative to Canadian dollar as all of Granite's current income tax is generated from its European region, as well as slightly higher taxes in the Netherlands due to depreciation limitations on a couple of assets. For the fourth quarter of 2023, we estimate current tax to remain flat relative to Q3 to Q2, assuming no significant change in the Euro FX rate. As with the past few years, Granite has the potential to recognize the reversal of tax provisions in Q4 relating to tax positions taken on taxation years, which will go statute-barred, totaling approximately 1.8 million. However, we cannot assess whether these reversals can be realized until after year-end. For 2024, we are expecting current income taxes to increase to approximately $2.4 million per quarter as a direct result of higher revenues and the burn-off of TI amortization expenses in Austria related to the grass lease renewal commencing February 1, 2024, increasing taxable income in that region. Interest expense was lower in Q3 2023 relative to Q2 by $0.4 million as a result of lower interest expense resulting from the refinancing of the high-interest construction loan in Houston in June 2023, with lower interest cost draws from the credit facility, and then was further improved by the Euro 70 million term loan that closed September 7, which resulted in the repayment of the credit facility with lower cost debt at an effective rate of 4.3325%. Post the quarter end on October 12, Granite completed a $400 million green bond and concurrently entered into a cross-courtesy interest rate swap exchange, exchanging the Canadian dollar denominated principal and interest payments for euro denominated payments, resulting in an effective fixed interest rate of 4.9285% for the five-and-a-half-year term of these 2029 debentures. The net proceeds from the offering will be used to repay Granite's 2023 debentures, with a principal outstanding of $400 million due on November 30, 2023. Prior to that repayment of these 2023 debentures, Granite is earning interest on the net proceeds from these 29 debentures at approximately 5% to 5.5%, which will be reflected in interest income in the fourth quarter. Therefore, for the fourth quarter, we do estimate interest expense to increase to approximately $23 million partially offset by interest income of approximately $4 million. Granted, the weighted average cost of debt at the end of the quarter was 2.27% and is expected to increase modestly to approximately 2.6% after the repayment of the 23 debentures. For 2024, given that we have no debt maturing until December next year, our interest expense run rate is estimated to drop to approximately $21 million per quarter which will be offset by some interest income of approximately half a million to a million per quarter. With respect to our 2023 estimates, Granite's guidance to FFO has been updated and narrowed as we approach this final quarter of the year. We estimate FFO per unit within a range of $493 to $5 in comparison to previous guidance of $490 to $505. This represents approximately 11 to 13% increase over 2022. For AFFO per unit, our guidance has also been narrowed, estimated at $4.35 to $4.45 in comparison to last quarter's guidance of $4.25 to $4.40, representing an increase of 7 to 10% over 2022. The foreign currency rates driving the high and low ranges have been amended slightly for the fourth quarter. For the high end of the range, we are assuming foreign exchange rates of the Canadian dollar to Euro of 1.48 and the Canadian dollar to USD of 1.39. On the low end of the range, we are assuming exchange rates of the Canadian dollar to Euro and Canadian dollar to USD of 1.44 and 1.35, respectively, reflective of the current Canadian dollar weakness relative to both currencies. The trust balance sheet comprising a total assets of $9.2 billion at the end of the quarter was negatively impacted by $53 million in fair value losses on Granite's investment property portfolio in the third quarter, which was offset by $87 million of translation gains on Granite's foreign-based investment properties, primarily due to the 2.3% increase in the spot USD exchange rate relative to Q2. The fair value losses on Granite's investment property portfolio were primarily attributable to the expansion in discount and terminal capitalization rates across selective Granite markets in response to rising interest rates, partially offset by fair market rent increases on multiple properties in the GTA, the U.S., Netherlands, and Germany. The Trust's overall weighted average cap rate of 5.14% on in-place NOI increased 5 points five basis points from the end of Q2 and has increased the total 46 basis points since the same quarter of last year. Total net leverage as at September 30th was 32% and net debt to EBITDA was 7.3 times, which has improved from Q2 and as a result of same property NOI growth as previously mentioned and the completion and stabilization of the majority of grants development properties. Granite continues to expect Its net debt to EBITDA to decrease to 7.2 times by the end of this year and to improve thereafter into 2024 as the EBITDA from completed developments come online throughout the year. The trust's current liquidity is approximately $1.6 billion, representing cash on hand of about $600 million and the undrawn operating line of $997 million. As of today, Granite has no borrowings under the credit facility and there are $2.9 million in letters of credit outstanding. Granite's increased liquidity position from the end of Q3 is temporarily elevated due to the net proceeds obtained from the 29 debentures at the beginning of October. After repayment of the 23 debentures upon maturity and based on remaining development commitments, Granite estimates that it will end the year with approximately $120 million of cash on hand and no draws on the credit facility for a total liquidity of approximately $1.1 billion. I'll now turn over the call to Kevin.

Thanks, Teresa. and it's certainly an inline quarter for us driven by higher NOI and lower net interest expense, as mentioned. I'll begin with a brief update on our current development projects. Our 410,000-square-foot build-to-sue project for Barry Calvo continues to progress on schedule, with substantial completion expected in the first quarter of 2024. Similarly, the 50,000-square-foot expansion of our existing property in Ajax is underway with substantial completion also scheduled for the first quarter of next year. As a reminder, these projects are expected to achieve certification in accordance with our published green bond framework. In addition to the projects just discussed, we have 160 acres of land remaining for development in Brantford, Houston, and Columbus, which could accommodate up to 2.4 million square feet of space once constructed. As outlined in our press release in MD&A, the team executed renewals on three leases comprising roughly 1.9 million square feet involving two maturities in 2024 and one 2026 maturity at an average increase in rental rate of 33%. With respect to our 2024 maturities, we have now renewed 7.4 million or 75% of our 9.7 million square feet of maturities and an average increase in rental rate of 14%, with that increase primarily driven by the 10% increase on the garage renewal. Further, we anticipate achieving roughly a 20% increase in rental rate on our remaining maturities in 2024. As Theresa mentioned, same property NOI increased by 7% in the quarter on a constant currency basis, within expectations. Same property NOI was positive across all of our geographies, on a constant currency basis, exceeding 6% with the exception of our Austrian portfolio, driven partially by strong renewal spreads in North America, development stabilizations, and strong CPI increases year-to-date in Europe, offset by lower occupancy in our U.S. portfolio. We expect same-property NOI to moderate in Q4, as mentioned, and now project same-property NOI to average in the low to mid 6% range over the four quarters in 2023, due to higher vacancy and lower CPI increases in Europe in the fourth quarter versus budget. We will provide specific FFO and same property NOI guidance on our Q4 call, but for now we can state that we expect same property NOI growth to be higher for 2024. As you can see from our disclosure, we adjusted cap rates and discount rates nominally in the quarter based on relevant transactional data in the U.S. and the Netherlands. Excluding FX movement, the roughly $270 million in negative fair value adjustments associated with terminal cap rate and discount rate adjustments year-to-date has been partially offset by $120 million in gains from a combination of development stabilizations, an increase in value resulting from the long-term renewal of three properties in Austria and Germany, and an increase in the fair market value of our land for development in Brantford. Sorry, one second. Looking forward, we will continue to monitor comparable transactions in our markets and further adjustments may be appropriate. But at this point, it is difficult to estimate the direction of asset pricing. Recent optimism among investors that the pause in central bank increases will be sustained and reductions potentially on the horizon may incent buyers to return to the market but liquidity issues and limited access to credit could impair buyer prospects and asset values in the short term. As for a general market update, leasing activity continued to slow in the third quarter as higher interest rates and economic uncertainty continued to impact tenant activity broadly across the real estate sector. On a comparative basis, our markets once again represented eight of the top nine markets in the U.S. for net absorption, totaling 22 million square feet for the quarter, and over 100 million square feet year-to-date led by Dallas, Chicago, and Houston. So despite the increase in vacancy, the data illustrates that the logistics and manufacturing sectors continue to invest and grow in our key markets due to a combination of a strong business climate and labor force, critical logistics infrastructure, and proximity and connectivity with a large percentage of the U.S. population. These are characteristics that we believe will continue to attract tenants and drive growth over the long term. As for rents, the data suggests that market rents increased roughly 3% on average over the second quarter across our U.S. markets, led by the 7881 corridor, Savannah, and Louisville, all in double digits. Only Indianapolis posted a slight decline in rents at negative 1.6% quarter over quarter. Year over year, rent growth across the U.S. markets averaged roughly 15%, similar to the GTA. Although Q3 broker data for European markets is not yet available, our records of comparable transactions indicate year over year growth in the Netherlands and Germany coming in at roughly 7% and 12% respectively. So although new supply continues to outpace demand in the short term, new starts, for example, in the U.S. are currently at multi-year lows. and when combined with a significant increase in the cost of development for new products, should support rent stabilization and potential rent growth in the latter half of 2024 and into 2025. I will provide a more fulsome update on our ESG program in the fourth quarter, but I did want to mention that we were recently notified that we received the top ranking from Grespi among the listed North American peer group and further received the score of 94% for public disclosure ranking us second in the U.S. Industrial Real Estate Group. Both excellent results. In closing, results were in line with expectations. NOI continued to increase, as Theresa mentioned, despite lower occupancy, and we are maintaining our FFO and AFFO guidance for 2023, which has remained unchanged from our initial guidance provided on our Q4 call in March. Our upcoming $400 million Maturity on November 30th has been fully refinanced at a very competitive rate of 4.93% for five and a half years, and our liquidity position remains very strong at almost $1.2 billion post repayment of the bond in cash and available credit. In addition, we announced our 13th consecutive annual distribution increase to $3.30, which continues to reflect our philosophy of delivering consistent distribution growth for our unit holders while maintaining conservative capital ratios and sufficient free cash flow with which to reinvest in the business. I also wanted to mention that we are in the process of renewing our base shelf prospectus, which expired this month. This is simply a formality and is being renewed in normal course to facilitate any potential actions we may contemplate over the next 25 months. Addressing our current leasing availabilities and 2024 maturities and preserving capital for future opportunities remain our highest priorities. And we believe we are very well positioned to deliver industry-leading NOI, FFO, and AFFO growth once again in 2024. And on that, operator, I will open up the floor for any questions.