Dream Office Real Estate Investment Trust

Good afternoon, ladies and gentlemen. Welcome to the Dream Office REIT Q4 2023 conference call for Thursday, February 15, 2024. During this call, management of 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 REITs 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 REITs filings and securities regulators, including its latest annual information form and MD&A. These filings are also available on Dream Office REIT's website at www.dreamofficereit.ca. Later in the presentation, we will have a question and answer session. To queue up for questions, please press star, then 1 on your telephone keypad. Your host for today will be Mr. Michael Cooper, Chair and CEO of Dream Office REIT. Mr. Cooper, please go ahead.

Thank you, Operator, and good evening, everybody. Gord Wadley, our Chief Operating Officer, and Jay Jang, our CFO. I'm going to say a couple words about our update tonight. I'm going to turn it over to Gord and then Jay, and then we'd be happy to answer your questions. I want to start by saying that business continues to go as we've expected for the business plan for 2023. There's been a slight increase in occupancy pretty much every quarter, but barely, like a slight increase. We've been achieving our internal budgets and our cash flows. And we've achieved our debt refinancing as planned. So that's all good. Over the last four years, it's been very tough in the office sector. About four years ago, like next month, it's four years since everything shut down because of COVID. And at the time, there was an immediate halt to use of office space. It's probably been two years since public health has been an issue for the use of office space, but it's been a slow recovery since then. I think we're seeing improvements in the number of people coming downtown, but there's still a tremendous amount of flux in how people are using office space. Businesses are making slow decisions. And aside from a very uncertain geopolitical environment, a Canadian economic environment. Specifically in the office sector, we're seeing a very uncertain environment. So together with our board, we decided that given the environment that we're in, retaining cash is valuable. And we decided to effectively reduce the distribution and retain about another $18 million a year just to give us more shock absorbers with an uncertain environment. Now, in September 6th, we had an investor's day, and we did say that the way we look at the office read is for three years, you know, we think occupancy will be about the same and leasing costs will be about the same. And then in the fourth and fifth year, we get slightly better. We might end up at the end of five years, which would be the end of 2028, to have occupancy of around 93% better than it is now, but not as good as pre-COVID. and leasing costs being about the middle between what they were before, and then we'd end up with a pretty good value. So in the last six months, you know, we haven't seen improvements, but even still, we sort of think that with all the news and all the frustration around office, it's better to keep cash. So it's not that things have changed. We just think that the board has a responsibility to prudently look at what the best use of capital is in this case. maintaining capital to have more flexibility in such an uncertain environment is a good idea. Regardless of the distribution policy, the intrinsic value of the company doesn't change. So our view of it is it doesn't go to the value of the company, and in fact the company is stronger, retaining more cash. And we're focused on how do we maintain the value and increase the value of the company over the longer term. So we think this is a good long-term decision. And we'd like to see some more improvements in the environment, see some of that progress to what we talked about on September 6th with increasing occupancy and reducing leasing costs. And we'll be watching that, and as we feel like there's less uncertainty and we're making progress, we'll continue to look at the dividend policy, and hopefully we'll see an opportunity to raise the distribution as we're more certain about the conditions. So I think that that's where we're at. We're going to answer questions, but Gord, do you want to give us an update on what the operations are like?

Yeah, no problem. Thanks, Michael, and hope everybody on the line is doing well. It's good to speak to everyone today. I'd start by saying none of us are immune to the headlines, and nothing's been more polarizing in the impact of value and negative sentiment around non-core markets, specifically the Class B and C office markets. However, one thing's undisputable, and that's that Toronto downtown is regarded as the best office market in Canada for occupancy and rents due to a very talented workforce, a vibrant urban lifestyle with some of the best retailers nationally, making it an attractive destination for businesses seeking a prime location and competitive rates by any global standard. We own and manage nearly 85% of our assets from a value perspective in central and irreplaceable locations in downtown Toronto. As such, 2023 was our most active year of leasing for Toronto, with both direct and sublet space being absorbed market-wide. I'm pleased to say that we've been approximately 800,000 square feet of deals in 2023. This compares to 659,000 square feet completed in 2022. But of equal importance that I want to highlight is rents held up very well across the board. Net rents have continued to be strong at around $30 to $35 and in line with our business plan. This resulted in the spread of about 20% against expiring rents. However, as discussed in our last conference call, higher material and labor costs combined with higher commissions have continued to compress NERs, and we're averaging about $17 to $18 a square foot. Ultimately, we completed approximately just over 100 deals this year, which half were renewals and half new deals across the portfolio. For some additional context, we did one transaction over 190,000 feet, and we did six deals over 25,000 square feet. These key indicators support our optimism that deals of scale are getting done, and more importantly, companies are making major commitments to their office accommodations coupled with the reality that our rates have been very resilient to our guidance. It's a real testament to the quality and location of the buildings we own, the efforts of our operating team, and ultimately staying true to our asset and capital strategy, which I'll touch on a bit shortly. Despite having a strong year of leasing in 2023, we're being very cautiously optimistic for 2024 with 299,000 square feet already committed versus the 590,000 square feet approximate square footage expiring. Of the 590,000 square feet expiring, only one asset makes up 200,000 square feet, and that's 74 Victoria. The team is actively working on over 150,000 square feet of active prospects with varying stages of negotiation in the court and will report more on these in coming quarters. We feel we're very well positioned to meet our guidance and hope to see additional improvements as the year goes on. As a management team, we're focused on liquidity, given that the cost to improve suites has dramatically grown over the last four years. Gone are the days when you could do carpet and paint and ceiling tiles. Tenants are dramatically more sophisticated in expectations for a suite CEOs have now been replaced on tours by HR and facility managers. Front and center is HVAC quality circulation, tech hubs, and smart building software. All of these cost drivers have seen market NERs be compressed on average by about 20%. This coinciding with material and soft cost increases, as well as some supply chain and procurement challenges to deliver. I am very proud of our team to date as to help mitigate costs. We often self-perform the work. and have consistently delivered on time and on budget. This reputation has been a real catalyst in helping us win deals and outperform the market. Covenant is key. Much like our management team, lenders are very actively reviewing their office loan exposure, and they're becoming much more selective based on properties, location, and quality in addition to the covenant of the borrowers. They're evaluating tenant profiles and leases carefully, and loan sizes are getting upsized more conservatively. Getting back to my previous point on NER compression, tenants, too, are much more sophisticated in their demands and are acutely aware of their own balance sheet and liquidity position. Hence, many are trying to push traditional costs to the landlords on transactions to induce their tenancy, and this is having a real impact in a high-interest environment. Jake can touch on this a little bit more, but in light of these challenges, we've proactively addressed most of our near-term debt maturities and put hedges in place to reduce our floating interest rate exposure. Our downtown Toronto committed occupancy continues to be very resilient, and our pipeline remains strong, which will continue to support healthy cash flows at our buildings. Covenant-wise, we have large commitments with the federal, provincial, and municipal tenants. We continue to work hard, improve, and leverage our strong lender relationships to ensure that the balance sheet is well protected through what we believe will be a tough trough in the office lending market. Being honest, I think our reputation, 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 competitive sub-market. We're very pleased to announce this quarter that we've been able to secure DBRS Morningstar for a very large renewal and expansion at Adelaide Place, as well as deals with BFL Insurance and Paramount Films' new office at 36 Toronto. This is on top of doing ICICI Bank new headquarters at 366 Bay, and doing Citco Bank's new national head office at 20 Toronto, all on top of securing I.O. for their largest renewal of the year at 438 University. With our Bay Street collection now finished, the optimism on our offering is further supported by the 40 deals that we did in that specific project in 2023, with strong rents averaging over $38 a square foot on average. Keep in mind that we're replacing rents in the low 20s and high teens on new space. This is a new class of boutique trophy assets that don't compete with large towers. They're low rise, they're walkable, they've got small private floor plates, all new base building systems, and they have a level of luxury finish that's very unique to our market. In addition to the Bay Street collection, in our current pipeline, all across the country we're actively negotiating trading paper on about 55 deals, totaling just over 400,000 square feet. This is both in Toronto and other markets. There's a lot of press and focus around shadow vacancy in the state of the sublease market in Toronto and Canada as a whole. This has not been an issue or something we're seeing in the REAP. Currently, our portfolio is only about 35,000 square feet of sublet space available, and this totals less than 1% of our portfolio nationally. Average waltz in our portfolio continue to outperform the market at just over five and a half years. Our office utilization rates in Toronto downtown continue to improve gradually each quarter. Year over year, our downtown Toronto in-place occupancy rate improved from 82.7% to 85.4%. And in-place and committed occupancy improved from 87.7% to 89%. This compares very favorably to downtown Toronto market stats recently published by CBRE Research, where occupancy declined from 84.7% to just over 82% year over year in 2023. Since Q3, our occupancy in downtown Toronto increased 40 basis points from 88.6% to 89% committed. Our retention ratio this past quarter has been quite strong at over 85.7%. Average expiring rates in Q4 was about $24.48, and the new renewal and retention rate was just over $31. This represents a gain of about 30% in rents. Our in-place and committed rents increased from 29.8% or 29.26 in December 2022 to 29.99 in September 2023 to 31.23 this quarter. We signed leases totaling over 781,000 square feet in downtown Toronto alone. This is 25% of our entire portfolio. At a weighted average initial rent of 30.47 per square foot, or said differently, 13.7% higher than the weighted average prior for all net rents in the same space. For 2024, we're tracking toward being approximately mid to high 80s in current and committed occupancy, with mid 80s being a conservative number due to the following criteria. For additional context, we only have just over 300,000 square feet of expiries to lease by the end of the year, but the bulk of that number is attributed to one single tenant at 74 Victoria Street. They expire in November, and they make up almost 200,000 square feet. Our team is working through various options, including extensions, attracting other tenants, and looking at reconversions. Even if we retain a portion, lease some to a third party or extend it, the result will be upside to the mid-'80s guidance we provided. So we're being very proactive and cautiously optimistic. In addition to our leasing and operating metrics, we made tremendous strides in the back half of 2023 pertaining to our ESG operating sustainability strategy. We mentioned on our last call that we're working hard to secure a viable Gresby rating. We're pleased to report last quarter we had among the highest in Canada, about 87. We also had the country's top Sustainal Linux score and are still among the top 10% in this ranking globally. In addition, we were again recognized as a green lease leader platinum. We spent the better part of the past two years taking our well-located assets in downtown Toronto and transforming them into a new standard of boutique trophy assets, And this commitment to decarbonize takes our offering even further to ensure we will exceed the highest standards of environmental stewardship and responsible operating standards our clients and stakeholders have come to expect and covet. As we move forward, our team is very committed to our goals in operating and income. We're very passionate about the impacts we're making to our tenants, the community, and the environment. Now, for the coming years, it's incumbent on our team to capitalize on these initiatives and continue to position ourselves as a landlord that really does build better communities to work in while driving occupancy, driving rental growth, and adding value to our portfolio. Just in closing, I couldn't be more pleased with how the whole team's navigated through some of the challenges that Michael touched on earlier. Their efforts and dedication to not only our company but to our clients is what I'm most proud of. At the end of the day, it's this combination of having irreplaceable assets coupled with a quality, high-character team of people we have operating and leasing those buildings that give me the greatest confidence going forward into 2024 and beyond. As always, if any time or anyone would like to tour or see firsthand all the great work we've done, please reach out. We're always really proud to showcase it. Thanks, everybody, and I'll turn it over to my friend Jay.