Dream Office Real Estate Investment Trust

Welcome to the Dream Office REIT Q2 2024 conference call for Monday, August 12, 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 with 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 a question, please press star 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 morning, everybody. Today I'm here with Gord Wadley and Jay Jang, who will both speak about operations and finance. I just want to start by a couple of comments on what's happening in the office market, particularly in Toronto. Just the last few weeks in conversations I've had with business leaders, one very large organization said that they redid all their space after COVID, and they did a hybrid they could probably accommodate people two, two and a half days a week. And now they have people who want to come in four days a week. So they've got to re-figure out how to do their space. Meanwhile, you know, traditionally an office leases from time to time a tenant says they want a right to terminate. And over the last couple of years, those termination options have been exercised more frequently than they otherwise would have been. And then some tenants have been trying to sublet space, some have been successful, some have taken it back. And we still have a lot of leases that haven't rolled over since 2020. So what I would say the fundamental issue we struggle with is our customers are trying to figure out how they use office space. We've got a lot more people coming back to the office. And I think that generally it looks quite positive. But it's just a slow process to get to the point where people have decided how they're going to use office space, what their demand is. and they can make decisions and we can make decisions. But overall, on a quarter-over-quarter basis, things are going quite well. We're making a lot of progress on all fronts, and we're quite pleased. And I expect that over the next 12 to 18 months, we'll start to get a little bit more clarity. But that's just a general comment. Gord, do you want to give some specifics?

Yeah, definitely. Thanks very much, Michael. What I'd say is when you look across the industry at every asset class, Nothing's been more polarizing, I guess, than the impact of value and negative sentiment around non-core markets, and in particular, B and C class office markets, which make up a large majority of the overall inventory in North America, but also Toronto. I said, you know what, essentially none of us are immune to these headlines and hot takes, but at Dream Office, you know, our team continues to work really hard and keep our buildings full with tenants that are generating good income, strong covenants, and long vaults. We often outperform the market, and in the process, we're doing some really good deals for the portfolio and ultimately the industry in Toronto as a whole. You know, supporting our results this quarter, we've seen some substantial growth year over year since 2021 on total square feet leased annually, with last year being our strongest, where we did approximately 100 deals for 775,000 square feet, which said differently represented about 13% of our portfolio. I'm pleased to say that already for this year, we're on pace with already 60 deals for approximately 360,000 square feet. This has been a real key catalyst and dream maintaining, a market leading current and committed occupancy versus our peers. We continue to be cautiously optimistic for the remainder of this year with another 14 high probability deals for an additional 270,000 feet that are either conditional or in advanced stages of negotiation. And we still have two quarters to go. On a gross leasing perspective, we've been outpacing our annual average deal volume and absorption year over year, and I want to say this is a testament to a slowly improving climate and a hard work and dedication of our team as a whole. 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 submarket. We've been able to secure our largest tenants for renewals right across the portfolio, including IO, BFL, DBRS, and State Street Bank, We've highlighted our largest expiry at 74 Victoria in previous calls, and that transpires at Q4 of this year. We assumed the building would be coming back essentially vacant as of November 1st of this year. That would result in an NOI hit of about $11 million per annum. Our team is very pleased to say that we've conditionally secured over a third of this expiring revenue well in advance of the termination date, and moreover, we're in very active conversations to add another $40 to 50,000 square feet in that building by the end of the year. This is all, please keep in mind, this is all much earlier than we had forecasted for 74 Victoria. From an income perspective, we're seeing very healthy trends. Year to date on the 360,000 square feet of leasing signed, we saw net rents carrying a healthy spread of 14% higher than expiries with an average weighted average lease term of about 5.5 years. This is much higher than the market average. As mentioned over previous quarters, not much has changed in terms of net effective rents. NERs continue to be compressed, given the challenges with inflation, rising broker fees, increased cost of materials and labor to build suites. Ultimately, net rents, though, have been quite resilient, and I feel good about the trajectory of our in-place NOI. I feel that 2022 was the peak of the construction and supply impact costs. They'd grown by almost 20% year over year. I remember Jay and I sitting down to talk about ways to mitigate the cost of construction, stay competitive and tendering, but also get competitive advantage on our peers and generate some really important fee revenue. We started an in-house construction management and materials procurement team as a way to mitigate GC charges, self-perform fit-ups, and of equal importance, be a trusted provider for our clients that's accountable and on demand to deliver the space that they covet. As a result, last year we generated approximately $2.4 million in construction fees, and we continue that trend in 2024, all while performing work in creating beautiful environments for some of the most sophisticated clients in banking, government, and professional services. Just for some quick context, our construction team has been actively working on marquee projects with Paramount Films, their national head office. We also completed this quarter the new ICICI Bank Headquarters on Bay, and have turned over the space for the very highly anticipated restaurant Milos to put their finishing touches on what will be a spectacular opening later this year. Although we at Dream Office continue to see tempered improvements from an overall performance perspective, the Canadian office market, as Michael's mentioned in the past, can still be described as erratic. For example, while one performance metric sees improvements for an indication of stability, such as overall vacancy rates or absorption, And then you see in term a bit of a leveling of cap rates, some improving interest rates, and some renewed interest in buyers. You'll see another metric like the amount of new vacant space arriving, sublet space, and pressure on NERs take effect. You often hear sublet space is being absorbed, but then the same week you'll hear about another large tenant adding sublet space to the supply. It honestly feels like a game of snakes and ladders. but our team remains laser focused on doing a good job with the assets we own and the variables in our control around leasing and property management. And I would say our results this quarter illustrate those efforts right up until the end. Overall vacancy this quarter stabilized across all classes in downtown Toronto at around 18%. This is a number not seen since the early 90s. It's buoyed largely by a very low vacancy rate in the Class A assets. Although the vacancy rates themselves did not see much movement quarter over quarter, our managed and reaped property saw some positive absorption and in doing about 580 basis points better than the market with a current and committed occupancy of almost 88% in our downtown assets. Many spectators on the sidelines for office have commented on concerns over the sublease market. Sublet space continued to decline as office users are beginning to make decisions to the return to office and or right-size their businesses. In Toronto, sublet space now represents approximately 6% of the existing inventory. Within Dream Office, sublet space only represents around 3% of our Toronto GLA. We're not too concerned about this overall exposure, but are keeping a close eye on it. 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. We work very well with our banking partners and are in lockstep with leasing strategy, operations, and are executing as such. Since the historical low of 40 basis points in the mid 2020s, the 10-year GOC bond yield and cost of debt has risen by over 270 basis points. The last quarter, we've seen an easing in rate pressure. However, lenders are actively reviewing their office loan exposure and are becoming more selective based on properties location, quality in addition to the covenant of the borrowers. They are evaluating tenant profiles with laser focus and leases carefully. Loans are sized more conservatively, which Jay can speak about a little bit more. Tenants too are much more sophisticated in their demands and are acutely aware of their own balance sheets and liquidity position. Hence, many are trying to push traditional costs to the landlords on transactions to induce their tenancy, which is having a real impact in a high-interest environment. In light of these challenges, as Jay will further mention, we have proactively addressed nearly all of our near-term debt maturities, including our biggest at Adelaide Place. In the same vein, it's also very important to note that we completed all of our biggest capital, maintenance, and base building projects, and are forecasting much less capital required for maintenance and capex in the next 24 months, thus in turn helping our annual cash flows. reducing our risk and protecting our balance sheet. It's always top of mind and we continue to improve and leverage our strong lender relationships to ensure the balance sheet is well protected through what we believe is a trough in the office lending market. I get asked all the time about 357 Bay. What I'll tell everybody on the call is WeWork's been a tenant in very good standing. They communicate very well with us. They've never missed a rent payment and have brought in some great clients to our premier asset at 357 Bay. Coupled with all the beautiful renovations done to the building, we have a great deal of confidence and optimism. We worked very closely with them during their bankruptcy proceedings and came up with a fair solution that supports a good tenant, doesn't significantly impact our NOI long term, and ultimately protects the terminal value of one of our best and most in-demand assets. Despite some of the macro challenges in the sector, I really couldn't be more pleased with how the whole team's navigated through some evolving challenges to the industry Their effort and dedication to not only our company but to our clients is what I'm most proud of. At the end of the day, everyone, what I'd say, it's a combination of having irreplaceable assets coupled with very high quality, high character team of people. We have operated and leasing those buildings. That gives me the greatest confidence closing out 2024. We're doing a lot of innovative deals that are making our assets better and we'll be in great shape as demand picks up and on future renewal cycles. As always, I always like to throw this out there, but if at any time you'd like to tour or see firsthand the work that we've done or the work that we're doing, please reach out to me directly. I'm always really proud to showcase it, and it would be a great excuse to pop into one of our many great restaurants. Thanks so much, everyone, and I'll pass you over to my friend, Jake.