Dream Office Real Estate Investment Trust

Welcome to the Dream Office Street 3rd Quarter 2023 Results Conference Call for Friday, November 10, 2023. Please be advised that all participants are currently in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. To join the question queue, you may press star then 1 on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and 0. During this call, management at Dream Office REIT may make statements containing forward-looking information within the meaning of applicable securities legislation. Forward-looking information is based on a number of assumptions and is subject to a number of risks and uncertainties, many of which are beyond Dream Office REIT's control. That could cause actual results to differ materially from those that are disclosed in or implied by such forward-looking information. Additional information about these assumptions and risks and uncertainties is contained in Dream Office Reads' filings with securities regulators, including its latest annual information form and MDNA. These filings are also available in Dream Office Reads' website at www.dreamofficeread.ca. Your host for today will be Mr. Michael J. Cooper, Chairman and CEO of Dream Office Reads. Mr. Cooper, please proceed.

Thank you very much. I'd like to welcome everybody to our third quarter conference call. Today I'm here with J.J., the CFO, and Gord Wadley, the COO. I'm just going to make some opening comments before I turn it over to Jay and Gord. Over the last 18 months, we've seen some massive changes in interest rates, in economic activity, in the housing market, and generally in the economy, number one. Number two, as a result of COVID and changes in the workforce, we've seen some real changes in how office buildings have been used. It's really remarkable because Overall, lots of segments of the economy are doing quite well. But I would say that real estate generally and office buildings specifically are on the wrong side of the big trends. So, I mean, it's very frustrating and it makes it difficult. But I think our business is doing very well getting through this. Our view is that things are getting better. We don't know how long it will take. But the equilibrium level will be much more desirable for owners of buildings than what we have now. So what we see in the last 90 days is about a 10% increase in the number of people downtown. And it's been an incredibly slow recovery. But we are seeing a solid recovery. We're seeing lots of interest in retail downtown. The use of the retail stores, we're seeing more people in the premises. And we're actually seeing lots of tours. And if you've been paying attention, We talk a lot about tours. Over the last couple of years, we've got lots of tours, but we haven't necessarily got lots of leasing. And I think what we're seeing now is we have lots of tours and lots of leasing. And we have lots more tours and lots more leasing. So effectively, I think we are seeing a lot of progress. It's very expensive. But the run rate of the leases that we're doing now, we're glad to have great tenants in the building. It's a lot better than vacancy. We burn off the cost relatively quickly. And the building's in good shape. The expectation is that over the next two or three years, we will see decent rents and less costs. And that's what we modeled on September 6th, and we put out our numbers saying that over the next, you know, from September, I think we said the next three years, we're assuming the same cost of deals as we have now. And after that, we're looking at maybe half the way to where we were, half the way, increasing occupancy to where we were, and the company starts to look really good. We don't know if it's three years or not, but I think we're weathering this... really unique time quite well. And the other thing I would point out is I was teaching office space in 1992. There's a couple things about that. Way fewer tenants, way fewer transactions, even more expensive on the one hand. But the other thing was the economy generally was in much worse shape. So we see a lot of businesses growing. It's a very positive sign for our business. So I think the economy generally is much healthier than anything that's done in 1992. even though the environment right now is worse than we've seen in a lot of years. So we're happy to answer questions later, but I'd like to turn the call over to Jay and then Gord, Gord and then Jay, to go over some more details specific about our business, and we're happy to answer the questions after that.

Gord? That's great. Thanks, Michael. Hope everyone's doing well. Just to piggyback on a lot of what Michael was saying, none of us in the industry are immune to the headlines. And I don't think there's been anything more polarizing than the impact of value, slower than anticipated return to the office, and negative sentiment around office space and non-core, but predominantly B and C class assets. I would say Toronto's fared much better. We're quite optimistic year to date with about 614,000 square feet leased already. Just to give some perspective, we're on track to exceed last year's full year leasing velocity of 659,000 square feet. We've got another 240,000 square feet of deals that are conditional or under advanced negotiations, and we still have almost two months to go to close out the year. So on a gross leasing perspective, we've been outpacing 2022, which for some context was our best year since 2019. Our reputation and ability to manage, coupled with our well-located assets, has helped us secure some of the best covenant tenants for arguably some of the biggest deals in a very, very competitive sub-market. We're pleased to announce that we've been able to secure Infrastructure Ontario for their largest renewal of the year, 438 University, CEDCO Hedge Fund Administrators Headquarters at 20 Toronto, ICICI Bank Headquarters for the full building at 366 Bay Street, and we're conditional on a renewal for one of our largest tenants in the portfolio. From an income perspective, we're seeing a very healthy spread of 17% on a net length for two expiries. Walls for the large-scale deals completed year-to-date have a weighted average lease term of seven years, which is almost two and a half years higher than the market average. From a performance perspective, the Canadian office market over the last three years can best be described as dislocated. For example, when one performance metric sees improvements or an indication of stability, such as overall vacancy rates or absorption, another metric, such as the amount of new vacant space arriving on the market, trends upward. And alternatively, NERs and income metrics also fluctuate due in large part to costs. Couple this with growing interest rates and softening cap rates, there's undoubtedly been some challenges in the sector not seen since the great financial crisis. Up until the end of Q3, this pattern remains as deal velocity, like Michael said, absorptions and tours are all up significantly year over year. But to be clear, NERs continue to see material pressure with inducements, construction costs, commissions, and overall cost increases to transact. As a result, we've seen average NERs compressed, coming in at around $17. However, average net rents continue to remain strong and consistent to underwriting anywhere from $30 to $35 a foot. Overall and competitive vacancy this quarter stabilized across all classes in Toronto sits at about 17.5%. It's buoyed largely by a low vacancy in the Class A assets. Although the vacancy rates themselves did not see much movement quarter over quarter in the city, our managed and re-properties saw positive absorption and were doing about 600 basis points better than market, with a current and committed occupancy in Toronto of almost 89%. This is up almost 50 basis points quarter over quarter, and I want to point out it's the third straight quarter we've seen growth in our current and committed. This is supported by some key deals, including CHOP at Adelaide Place for 12,000 square feet, As I mentioned before, ICIC Bank for about 40,000 feet, and we also did IO for about 200,000 square feet at 438 University. That's going to see them extended until 2030. A lot of commentary has been made about the 20-year high in sublet space, which currently makes up about 30% of the total vacant space in downtown Toronto. Specific to our business, those subleased space only makes up about 2% in our portfolio today. The cost to improve suites has grown dramatically over the last three years. I'll be honest with everybody, gone are the days when you can simply induce with basic carpet, paint, and ceiling tiles. Tenants are so much more sophisticated in their expectations for a suite. CEOs have been replaced on tours by HR and facility managers. Front and center is HVAC quality, tech, video hubs, and smart building software, as well as adaptable furniture systems and wellness rooms. All of these cost drivers have seen NERs be compressed on average by about 20%. This is all coinciding with materials and soft cost increases and some supply chain and procurement challenges to deliver. I am, however, very proud of our team to date as we often self-perform the work and have consistently delivered on time and on budget. This reputation has been a real catalyst for us in helping us win deals and outperform the market. As a result, we've earned almost $400,000 in net fees and mitigated about $600,000 in third-party fees, which we end up retaining. We've had some very, very cautious optimism with the additional 240,000 square feet of LOIs and conditional deals in very active negotiation, which we hope to report on in subsequent quarters. One key driver to our future success is retail. The past few quarters, we've been highlighting the negotiations and prospect of completing four marquee deals on our Bay Street collection, We're proud to say we've completed all of them. We've welcomed Camilo's, Daphne, Cocktail, Aloe Bar, and now Chop Steakhouse's newest concept at Adelaide Place. These are major retail deals with some of arguably Canada's top restauranteurs, and when all is said and done, we'll total over 52,000 square feet. With the high cost of retail transactions and our strategy with retail finalized, we're optimistic leasing costs on a net basis will come down. This net new absorption with average rents close to $70 a square foot, an annualized NOI impact of an additional $4 million. These are all in our most desirable note, thus finishing off and finally supporting our thesis of bringing an elevated and all-new experience of boutique luxury to the core. This positions us well for tenants' flight to quality and really helping us drive value in these curated offerings that often appeal to Canada's top covenants and most discerning tenants who covet quality more so than face rates. I'd say no one in the real estate market today is immune to the impact of rising interest rates, and it's become a more challenging lending environment today than three years ago. Since a historical low of 40 basis points in the mid-20s, the 10-year government of Canada bond yield and cost of debt has risen by more than 330 basis points. Lenders are actively reviewing their office loan exposure and are becoming more selective based on properties location and quality. and really taking consideration and really putting into addition the covenant of wars. They're evaluating tenant profiles and leases very carefully, and loans are sized more conservatively. Getting back to my previous point on NER compression, tenants too are much more sophisticated in their demands, and they're acutely aware of their own balance sheet and liquidity position. And many are trying to push traditional tenant costs to the landlord on transactions to induce and win their tenancy. This is having a real impact in this high interest rate environment, and we're seeing this all over the sector. Our downtown Toronto committed occupancy continues to be very resilient, and our pipeline strong, which will continue to support healthy cash flows at our buildings. Covenant-wise, we have large commitments with the federal, provincial, and municipal government, as well as Crown Corps, coupled with our premium location, asset quality, and leasing prospects for our retrofitted downtown assets. Fundamentally, we continue to improve and leverage our strong lender relationships to ensure that our balance sheet is well protected through what we believe will be a trough in the lending market. We're renewing our largest tenants and have done so with IO, ILAC, State Street, federal government, and we're conditional with our last big large tenant for a material blend and extend. More to come on this next quarter when we can announce. Despite some of the macro challenges in the sector, I really couldn't be more pleased with how the whole team's navigated I'm most proud of. At the end of the day, it's this combination of having irreplaceable assets coupled with the quality, high character of the team of people that we have operating and leasing these buildings that really gives me the greatest confidence closing out 2023 and going into 2024 in spite of whatever headwinds or macro challenges we'll face. And I'm going to turn it over to my friend, Jay. Thanks, everyone.