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 REIT's control that could cause actual results to differ materially from those that are disclosed in or implied by such forward-looking information. Additionally, additional information about these assumptions and risks and uncertainties is contained in Dream Office REIT's filings with securities regulators, including its latest annual information form and MDNA. These filings are also available on Dream Office REIT's website at .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. 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 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 in office leases from time to time, a tenant says they want to terminate. And over the last couple of years, those termination offices 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 -over-quarter basis, things have been 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. Gore, 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 waltz. 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 in 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 sub-market. 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 2020 too was the peak of the construction and supply impact costs. They had 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. We have been working on a number of projects with Paramount Films, their national head office, and we have also completed this quarter the new ICICI headquarters on Bay, and have turned over the space for the highly anticipated restaurant, Milos, to put their finishing touches on what will be a spectacular opening. We are also working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with Dream Office, which will be a new office in 2020, and we will be working on a number of projects with and private enjoy this and private enjoy this and private enjoy this overall exposure, but are overall exposure, but are keeping a close eye on it keeping a close eye on it. no one in the real estate market today is immune no one in the real estate market today is immune to the impact of rising interest rates, and it's become a more to the impact of rising interest rates, and it's become a more challenging lending environment today than three years ago. challenging lending environment today than three years ago. we work very well with our banking partners and are in we work very well with our banking partners and are in The 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 the replaceable 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 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.

Thank you, Gord. Good morning. I will provide a review of our financial results and also update on how we are internally forecasting our business for the second half of 2024. We reported diluted fund term operations of 76 cents per unit, up .7% from 70 cents per unit in the second quarter of 2023 after adjusting for the -for-one consolidation of units in Q1 of this year. We had approximately 4 cents per unit of lease termination income this quarter and also 4 cents per unit of short-term straight line rent for two larger tenants that took possession of their space a few months early. That income will be fully reflected in our cash net operating income over the second half of 2024. Total comparative properties NOI increased by .2% compared to the same quarter last year comprised of .6% increase in downtown Toronto offset by a decrease of .7% in other markets. Our net asset value per unit was $64.82 down $1.10 or .7% from Q1 to have a .9% increase in Q2. The decrease includes $25 million attributed to fair value adjustments on investment properties. As part of our valuation process this quarter, we externally appraised four assets totaling $333 million or 14% of our portfolio. In February, we provided our annual guidance of $2.80 to $2.90 per unit of FFO post-unit consolidation and flat to low single digit comparable properties NOI. Based on the information and results since February, we are still targeting the midpoint range of our guidance for both FFO and CPNOI. The key variability to our forecast will be the maturity of the 206,000 square feet lease with the federal government at 74 Victoria on October 31, 2024. As Gordon mentioned, we have received a renewal for 64,000 square feet with the existing federal government and we are currently in active discussions to lease another 50,000 square feet. With only the 64,000 square feet renewal and no other leasing, the in-place occupancy of the building will be approximately 55%. The temporary reduction in occupancy until we lease up the building will result in annualized NOI impact of approximately $8 million or about 40 cents. We are actively working on leasing strategies to mitigate this impact and look forward to reporting our progress next quarter. In addition, we have approximately 500 basis points of committed occupancy that will commence rent payments towards the end of this year. In aggregate, these leases will contribute approximately $7 million of higher comparative properties NOI in 2025 versus 2024, which covers much of the shortfall from the federal government lease expiry at 74 Victoria. There is approximately 90,000 square feet of maturities excluding 74 Victoria across our portfolio for the remainder of this year relative to the 271,000 square feet of leasing pipeline that Gore noted and we have five months this year to complete more leasing. Our expectation is to make reasonable progress on our leasing pipeline and we think that 2025 total comparative properties NOI could be at or above 2024. Consistent with prior years, we will provide full financial guidance for 2025 on our Q4 conference call next February. We have made substantial progress on our mortgage refinancing this year. Out of the 73 million of mortgage maturities in 2024, we have closed on 56 million and are in discussions to address the remaining 17 million. We are also making good progress on our mortgage maturities in 2025, most notably the $225 million mortgage at Adelaide Place. We believe we are close to receiving credit approval from the lenders and will look to With this mortgage addressed, we will have 141 million of mortgages remaining for next year of which we have already received credit approval for 44 million. Our $375 million revolving credit facility also matures in September 2025 and we will look to start the renewal process starting this fall. Currently we are seeing five-year mortgage rates at GLC plus 250 basis points or all-in rate of approximately 5.5%. Overall, the lenders have been supportive of Dream Office and we have benefited from Dream's overall relationship with the financial institutions. We will continue to take a cautious approach to refinancing our loans and so that we have better visibility on our liquidity over the next few years. Our current leverage is 51% and debt to EBITDA is 11.8 times. We would like to reduce our leverage and continue to de-risk our business in 2025. In July, we completed a sale of a small asset in Saskatchewan for $8.6 million. The cap rate for the asset was approximately .8% as the committed occupancy was only 53%. The proceeds were used to pay down our credit facility in Q3. We do not rely on dispositions in our forecast or guidance, but we will use the proceeds to repay mortgages and our credit facility. We estimate that for every $50 million of assets we sell, we expect leverage to decline 100 basis points and debt to EBITDA by 0.1 times. I will now turn the call back to Michael.

Thanks, Jay. Thanks, Gord. I mean, fundamentally what we are saying is in 2016, we had 172 assets. We decided to really focus on our best assets. We are down to 31 assets now. Those assets we took really good care of. We began upgrading them well before COVID and most of the capex has got the buildings proven to be popular with our tenants. And for the most part, we are very pleased with our progress leasing. Our team has done a great job in a demanding field. And I think we are getting through this quite well. And we are getting through with great buildings quite well. On the investment side, you know, H&R sold their chorus building to George Brown College. We sold 720 Bay to a health group. So I think you are seeing buildings selling when there is a motivated buyer who probably has a different use. What I have been pleased with is more and more of large allocators of capital have been speaking to us about their interest in office. It is very preliminary, but I think that when investors are looking at where the different sectors are, office looks like it has been beaten up pretty bad and there should be opportunities there. So I think we are starting to get more people interested in office, but not necessarily pulling the trigger. We have been working on a couple of things. We sold the arcade we had in Saskatoon. We are working on one other significant building. It is a slow process. We hope to be there by the end of the year. And we will see if there are other assets that make sense for us to sell. But things have been going as good as we could have hoped for. We made a list of what we thought were the risks to the company at the end of 2023. That is something that is a real focus for us. One by one we have been knocking off of those risks. There have been a few new ones, but not much. And the company is in better shape now than it was before. At this point we would be happy to answer any of your questions. Operator?

We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you are using a speaker phone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star and then 2. Our first question comes from Mark Rothschild with Canaccord Genuity. Please go ahead.

Thanks, Hank. Good morning, everyone. Michael, strategically it sounds like the asset sales that you are pursuing are ongoing, but maybe not with the sense of urgency or maybe just take time. Can you just comment a little bit on strategically if anything has changed in how you are viewing the asset sales and maybe connected with that? Is there anything else that you are considering or feel the need to increase liquidity in regards to maybe the Dream Industrial Investment? Is that still something that you intend to own for an extended period of time in the office, Reid? Thanks.

Well, I think our liquidity level is pretty good right now and we have been prepared for things to be more difficult, so we are pleased with that. I think the sale of one or two buildings might be appropriate and with the Dream Industrial units, they have been a great investment for us. They are obviously not office so that they are not our core strategy. If we need them or if we decide opportunistically to sell them, that is something we could consider, but we are not really considering that now nor do we feel we need to.

Okay, great. Thanks. And maybe for Gord, it sounds like there is a lot going on with the leasing and the face rates appear to be good. Can you just comment a little bit on the trends you are seeing on the net effective rents, if that is improving at all or if it is still really expensive just to get leasing done and how you see that evolving over the next year?

Yeah, good question, Mark. It is still really expensive to get leasing done. I think right across the board, we are competing with a lot of different spaces that are fully improved. So, for us, if we have base building space, it is table stakes to put in $70 a foot to $100 a foot to get it in a reasonably leaseable condition to match our competitive set. So, yeah, I see NERs, at least for the next 18 to 24 months, being relatively challenged. But overall, I am happy with how net rents are performing and I am happy with the pickup of tours and the velocity of people that are coming through our buildings. So, that is positive.

Yeah, I do want to point out that since September 6th last year when we presented our model for Dream Office, we had said at the time that we believe that in 2024, 2025, and 2026, things would be pretty much the same as in 2023. So, we are now seven months into that plan and things are basically the same as before. So, it is basically what we expected. We actually expect another 20, 30 months of this. So, I am glad it has not gotten worse. I think we have made improvements to our buildings. I have been pleased with our relationship with lenders and things we have been able to achieve. So, I think we are doing pretty good compared to where we said we would be.

Yeah, the only one quick observation I would make for you, Mark, as well too is we are seeing finishing trades. We are seeing a lot more come to bid on jobs and I think that is a result of there being a bit of a down cycle in development, not just residentially but commercially obviously as well. So, a lot of the finishing trades we are seeing instead of one or two come to bid on a job, we are seeing usually about three to five. So, that has been a positive sign for us. Okay, great. Thanks. I will turn it back.

And the next question comes from Sam Demini with TD and Cowan. Please go ahead.

Thank you and good morning. I guess first question just on dispositions. We talked about it a bit and had a question for Mark there. There was a couple of buildings listed for sale earlier this year. I just wondered if you could provide an update on those specifically, if those are still intended to proceed or how that is going.

I know you think that is an easy question, but the answer is hard. As I mentioned, we definitely have been making great progress in one, but it is a slow process. On the other one, we actually do not have an update. One thing that has been mentioned is I think that another source of capital for us, we have some buildings whose loans mature. While everybody expects that there will be pay downs on loans, we have a few that are under leveraged and they will be a great source of capital for the company. So, that is another choice that we have to look at. But our liquidity is in pretty good shape right now, at least as good as we had expected.

Okay, thank you. On the leasing, the occupancy was kind of flat on the quarter on an in-place basis, but there were some decreases in a few of the Bay Street type properties. I am just wondering if there are trends specific to the Bay Street properties that are any different than the overall trends that Gord, you talked about.

Yes, I think one of the biggest mitigating factors for the Bay Street properties, and I will be honest with you first, is just in the construction at the corner of Adelaide Bay and on Richmond, it has been very difficult to get groups there to tour and it has been very punitive for brokers to bring them along. But that being said, we have seen a cleanup a little bit over the course of the last six weeks right at the intersection of Adelaide, right in front of First Canadian Place, Adelaide Bay, and we have started to see more tours. We had a good pick up of tours at 330 and 80 Richmond especially.

That is good to hear. Last one for me, do you have an actual sort of CAPEX budget for this year and next year that you would be able to share?

Yes, sure. We will talk through the pieces. With leasing costs, I think consistent with the guidance in February and what Gord talked about in his commentaries with the net effective rent, it really depends on the duration of the lease. So typically we are budgeting about $10 per square feet per year and it is a bit less if you do a 10-year lease so you could go about $7.50. For maintenance capital, we have been really smart and only focusing on life safety and putting value in buildings where we can get a reasonable payback or lending value.

But that is because we have already improved the buildings and that is what is left over.

Yes, so on Bay Street it will be very light because we have put in the $50 million already. Otherwise, with respect to the reserves, it is about $1 to $2 per year per square foot.

Per square foot. Is that

sufficient,

Sam? Yes, that is very helpful. Thank you so much.

I do want to pick up on Gord's point, which I hear from everybody I speak to, which is it is hard for employees to get to work. That the traffic is a real problem. All the bike lanes that minimize cars is a problem. I think that is something we have got to work on as a community to help people get around.

Any other questions? The next question comes from Kiaram Srinivas with Cormark Securities. Please go ahead.

Thank you, Peter. Good morning, guys. Gord, this is probably a question for you. Maybe a year ago we were talking about the number of tours going up, but tenants essentially taking some time to actually sign those leases. When you look at the situation today, how does that compare and contrast with a year ago? Are tenants being more willing to come to the table and actually execute or is it more of the same?

Good question. We are starting to see more of these deals get executed. They are taking longer. We mentioned today that we have got at least 10 deals for about 270,000 square feet in the pipeline. These deals we have been working on for the better part of six to eight months on some of them. I think everybody is just being prudent on what the responsibilities are going to be in terms of construction and costs. But, yeah, to your point, a lot of the deals that we have seen come to fruition this year were deals that we started last year. I wouldn't say they are getting any faster to do in a competitive environment. There is a lot of leverage being set up by brokers and other landlords. So we just have to be patient and navigate through them. And every time we have a window to close, just do everything we can to try and get these things done. But I don't foresee deals getting any quicker in the near term. We just got to keep battling through each one as they come.

And maybe just looking at these deals that are being executed, like let's say in San Francisco or Victoria, when you look at the deal there, one signed and one tenant takes an occupancy there. How long does it take before that shows up in the NOI? Is it still like six to 12 months over there?

That's actually a good question. So one thing that we have been looking at instead of always putting capital in the deals is doing free rent out of term fixturing. So in that kind of case, we'll delay the occupancy date, but give the tenant the access to the space in advance of the occupancy date. So they have out of term free rent, but we start the term, say for example, we do a five year deal, maybe we'll give them five months of fixturing period. Takes us a month to do the space. They effectively get four months out of term free rent. And then their commencement date starts on the fifth year. So on bigger deals, you will see a bit of a lag from when the deal is signed to when the actual rent commencement date is. But a lot of the time that is out of term free fixturing. And we make sure to get a full term to amortize the cost that we put in. That answer your question?

Yeah, that's my guess. Maybe just switching to absorption in the market. You know, apart from obviously the subleases, another factor weighing on Toronto was the amount of supply that came into downtown. When you look at the absorption of the new supply today, like, do you see most of the spaces being actually absorbed or are they still in the market competing with you guys?

They're still in the, they're still very much in the market competing with us.

A lot of the buildings have tremendous amount of free leasing, but the amount that isn't is a competitor. What's the absorption been for the quarter of the year, that kind of stuff? How are we doing

for the market? So it's actually, the vacancy rates been growing in the core. And one thing to look at, and there's a lot of great publications and I don't want to name specifically, but there has been some buildings, commercial buildings built on spec that unfortunately haven't had any absorption. So I think that's a real challenge and that's what we compete against on a daily basis with some of the new space. A lot of it's periphery to the core, but there are still situations where there's vacancy on new space.

Right, and it's funny, my last question before I turn it back. When you look at these spaces and you know, all the competing spaces that came in, are they consistent in terms of their net rents, which means that maybe in a couple of years those concessions would roll off and the average rent of the market would kind of go up. Would that be a situation we could see in the next couple of years?

Yeah, I think so. So some of the deals that you would have done now at lower NERs or marginally lower face rates on the next renewal cycle, if it's three years, five years, seven years or 10 years, you should very much see a pickup on net rent. But more importantly, on the renewals, you have to put, you know, you often put in less capital. So you see a benefit on both sides. So that's a good question. And I think on the next cycle, you'll see better deals, better net effectives and better

rents. Awesome. Thanks for calling in. I'll turn it back.

Welcome. And the next question comes from Matt Kornak with National Bank Financial. Please go ahead.

Good morning, everyone. And just quickly, Jay, I wanted to walk through kind of the bridge between Q1 and Q2 on NOI. I think most of it is either in straight line rents or these termination income. But if you could give us a sense as to how that straight line rent, I think you mentioned that it will impact the second half of the year. But should we assume that the full kind of million dollars of straight line rent converts to cash rent? And is that a run rate for the remainder of the year? Sure.

No problem. To answer the first part of your question from Q1 to Q2, in addition to the noted straight line rent and these termination income, we were also a little bit higher, about 350K on comparative properties NOI sequentially. And that's just due to street rent burning off for tenants that have taken occupancy. Our property management and construction income was also higher by 150,000. And we did some work for tenants and were paid one time income for that. On straight line, we had two tenants in downtown Toronto that took occupancy a few months early this quarter, being Q2. They commenced rent payment, I think, one in July, one in September. So these are very quick free rent periods and that income will be reflected in the cash NOI in Q3. However, Ford mentioned ICICI Bank at 366 Bay. Their lease, I think, is in November, but they actually finished the work early and they have taken occupancy and began operations this summer, which is great. We will see some straight line for that. So the simple answer to your question is our straight line will actually be around the same, I think, for Q3 and Q4, but it's put in takes because we have two tenants burning off and then it will be replaced by 366 Bay.

Okay, so going into Q3, the only variance would then be the lease termination, which was one time in nature. So maybe NOI goes down a little bit sequentially. Was there anything in recoveries? I also noticed that the margins were fairly high this quarter. I don't think that may just be typical seasonality.

That's a good catch. We're actually, since January, been working collaboratively with the property management and accounting group to look for efficiencies with regards to our OPEX, and that has created a gain in the NOI margin. So, for example, we're looking at optimizing utilities, cleaning services that align with tenants' hybrid working schedules. So, for example, if they don't need to be in the space on Mondays or Fridays, we can actually save quite a bit of money by optimizing electricity and cleaning. A couple other things, we looked at suppliers for a lot of supplies, cleaning materials and labor as well. So hopefully that actually can flow through and become the normalized run rate, but we're still sort of in the phase right now where we're trying to figure out if we can save a bit more money.

Okay, fair enough. And then the last one for me on 74 Victoria, when you approach the leasing for that property, like obviously there's some long-term optionality to potentially densifying the site. Are you taking that into account? And for the remaining two-thirds of space, Gord, would those timelines that you provided in terms of the gap between signing and commencing cash rents be similar for the tenants that you're looking for for that space? And would you invest in that space against capex at this point, given that the building may not exist in a decade?

Gord, can you answer those seven questions? Yeah, no problem. They're all good questions, by the way. Yeah, so in terms of investing capital, we would for the right deal in that building. It's a great location. We've actually had quite a few tours of people going in because it is a large block of space that's available. So on a case by case, I think a lot of people have to appreciate in any single commercial deal, we have a definite demo and relocation provision in these leases. So we try to structure our leases very much like the industry standard, where if down the road there's flexibility, we work closely with the tenant to come up with optionality if we want to do something to the building. And we'll look at, much like any space, we'll look at every deal on a case by case basis. If it requires capital, we'll do the due diligence to understand if it's something that's going to benefit us. If it doesn't require capital, maybe a low net rent and immediate occupancy, then we'll look at that on a case by case as well. So we try to do everything. We also have our CIB facility, which we've talked about in the past. It's about $140 million Canadian infrastructure bank loan where we get a really low cost of capital to improve all of the base building in that building. And 74 Victoria is a building where we've done the studies on. We know what we need to do to do there and we've got this facility that we can lean on to do things cheap and then also to amortize those improvements to the tenants.

I think that's the most important point, Matt, that we're prepared to put money into the space, but we wouldn't expect to recover it after the existing tenant is gone. And that goes to the potential redevelopment. But for the right tenant, for the right lease, we're happy to keep it as an office building

for the right tenant. Perfect. Thanks, guys. I'll turn

it back. And the next question comes from Mario Garic with Scotiabank. Please go ahead.

Hi. Good morning. Maybe a general question, Michael, on your comment that it still may take 12 to 18 months for visibility to kind of stabilize on what tenants are doing with their space and so on and so forth. It's been over four years since the start of the pandemic. So is the comment, is it more so tenants having made decisions and now reconsidering those decisions in terms of how to optimize the space or is it simply like more tenants, like most tenants still haven't figured out what they're doing?

It's absolutely everything. I'm not sure how your company is dealing with it, but everybody I know says their companies have had maybe 20 or 30 different policies in the last four years. So I think we are seeing people trying to figure out what the combination is that works best for them. I think what's been added a little bit recently is, you know, we've seen that some buildings are doing, some businesses are doing great and that may translate into more space. But, you know, people are getting more concerned about a slow economy. And instead of it being a discussion about remote work or these big ideas, it feels like the old days where the CFO is trying to figure out how to save money on office space. So when I say 12 to 18 months, I don't want to be held accountable. It could be longer. I doubt it would be shorter. But I do think that businesses are trying to figure out how they're going to use space. But overall, the economy is growing. Overall, I think the demand for space is picking up and I think there is pent up demand. So as things settle out, which is why I said 12 to 18 months, I think we'll have better insight. Your point about it's been since 2020 and is that the people haven't made decisions or made the decisions of reconsidering. This is really an unusual situation. I don't think this was the issue in retail five years ago. I mean, this is like nothing I've seen. But what I would say is what's amazing about it is things are holding together pretty well. And there's been some, you know, big hits to the sector, let's say in the stock market, and there's been some loss of occupancy. But, you know, there's a lot of activity going on in all the buildings. We're starting to see some buildings getting converted, especially in Calgary, but we're seeing more and more of it in Toronto. And it will fix itself. But until then, I'm pretty pleased with how it's holding together.

And just on the building conversions, what's your sense in terms of the applicable inventory in Toronto that could be suitable for conversion?

So when people think about conversion, they're usually thinking about office to residential, but it can be office to institutional and office to a whole bunch of other things. We are seeing that. We're seeing that like with 720 Bay, it becomes a health care building. With George Brown College taking over Corus building, as time goes by, that will become a school building. So don't underestimate the significance in terms of the conversion to non-office uses that are still commercial. On the residential conversion, it's used loosely. Sometimes when people say conversion, it means like conversion of the use, which might include tearing down the building and building a new building. We're seeing that the City of Toronto on an ad hoc basis is reducing the requirement to replace office in some cases entirely. What we've seen is they're also prepared to say, well, why don't you have the office over on one side so you can build a residential and the density has to be held for office, but you don't have to build it. So it's starting to pick up steam. I think last year there was a million square feet that was converted. I could see that going to five million relatively easily across the country. And I think I've said this before, I suspect that we'll be looking at not the net addition to supply, but the net subtraction to supply over the next few years. So I think that'll be a significant factor as we go forward.

Got it. Okay. Switching gears from my second question, maybe for Jay, I think you mentioned that 14% of the portfolio was externally appraised during the quarter. In terms of the fair value change during the quarter, is it fair to say that it doesn't just apply to the 14% of the portfolio that was appraised, but rather it was extrapolated throughout the entire portfolio?

Yeah, you're right. We follow the external appraisal methodologies pretty closely. We also look for external data points. So all the brokerage research firms that released their cap rates, they were pretty flat this quarter. We make sure everything reconciles because over the course of the year we probably externally appraised 25% to a third of the properties historically. And then we want to make sure that the methodologies are consistent. And of course each quarter the auditors review the methodologies and year-end there is a more fulsome process. But you're right, typically the methodologies are extrapolated.

Okay, and then just one quick follow-on, Jay. Like you mentioned that the sensitivity to Tebidaw is .1 for every $50 million of sales. You're at 11.8. You've probably been asked this question before on prior calls in terms of what your target Tebidaw, but that's a lot of asset sales to get down to kind of sub 10. But

we want to grow the EBITDA.

So that's on the numerator side, but if we can grow the EBITDA, get the leasing done, it's a lot more meaningful on a denominator.

I know that makes sense. Is there a target EBITDA that you think you can get to by X date?

It's really hard to give a number, but we're really focused on this metric. And if we can get it down closer to 11 times within 12 to 18 months, I think that's a start.

Perfect. Okay. That's good. And the next question comes from Lorne Kalmar with Disjardin Dis. Please go ahead. Thank

you. Good morning. Just on the 74 Victoria, not to beat a dead horse or anything. I think you mentioned there's 64,000 that's been renewed, correct? Yes, we're in advanced negotiations for it. And I guess so, assuming this moves forward, there would be no downtime there. Can you maybe give us an idea of what sort of spread you're kind of looking at on that?

We don't want to disclose out of respect for the tenant right now. We're working through it. I'd say it's a market deal. Okay.

It's not done yet. And we want to provide you guys with as much transparency as possible, but we've got to take care of the business too.

Fair enough. Okay. Are there any other kind of material non-renewals that you guys are starting to work through now? So, net new deals? Sorry, non-renewals. Any non-renewals that you're looking to address in the not too distant future. Maybe looking at 2025.

Okay. So, non-renewals we usually classify as new deals on vacant space. We've got a pipeline in the pipeline of about 270,000 feet that we're working through now. I'd say close to about 90,000 of that is net new. And towards the end of next year, we want to pick up probably about another 114,000 square feet net new as well. And then Jay can give you a quick update on some larger expiries.

Yeah. I think, Lauren, you mean expiries are uncommitted in our MD&A disclosures. So, actually, over the past two years, we had a lot of expiries. But over the course of the next year, if you look at the disclosures, that number has come down quite a bit. The next largest expiry is actually the end of 2025. That's our asset in Kansas City, and we're currently in discussions with them right now. Other than that, we already pre-leased IO at 438 University. So, that was a large one, and we don't have any larger exposures beyond that.

Perfect. And then, Gord, I think you gave, in your real age and your prior remarks, you might have done a little bit of a rework of the WeWork deal. Could you maybe give us a little bit of colour on what you guys had to do to get that done?

I mean, they were great to deal with, and they were quite forthcoming and transparent throughout. So, we provided a small or reasonable market adjustment to their net rent for a fixed period of time. And, you know, the future rents and the future steps were preserved. And we also worked directly with them just to see what the pipeline was on occupancy for them and everything. And they've got a great plan for the building, and they've put in some great tenants. So, we just did kind of, I'd say, a relatively near-term adjustment. Protecting our long-term value.

Okay.

Thank

you very much for the colour. That's it from me.

Thank you. And the next question comes from Pammy Burr with RBC Capital Markets. Please go ahead.

Thanks. Good morning. At 74 Victoria, I think you mentioned the 40,000 to 50,000 square feet of discussions with prospective tenants that's in the works. Can you maybe just expand on that? I'm just curious what types of tenants that you're talking to and any colour would be helpful there. Thank you.

Yeah. So, there's a few different groups. So, we've got a couple of -for-profits that are looking at various opportunities in this space. We've got a professional services firm that's looking at space. And also, too, we own 30 Adelaide, which is right next door. We have a lot of people asking us about availability in this space. This is a great, well-coveted building. We have a lot of flexibility on kind of moving pieces throughout the portfolio and taking buildings where we have some vacancy and reallocating tenants from one building to another. And that's a real competitive advantage for us that not a lot of our peers have. And it really is a testament to the value of our portfolio. Having all these buildings so close together, I think it really helps us just plan our stacks and make sure we're forecasting the right way. So, you know, in closing, we've had about four groups take a pretty hard look at 74 Victoria, and they range from -for-profits right through to professional services.

And these would, if these deals are successful, I mean, this is, you know, hopefully for at some point 2025 economic occupancy, fair to say? The back end of 2025. That's correct. The back end, okay. And just coming back to the comments earlier on the loan to value on some assets, and maybe there's some are perhaps have lower ratios. On the refinancing talks that Adelaide placed, can you maybe share sort of what range of loan to value that maybe sits at, and are you anticipating any pay down on that property?

A simple answer is no pay down on the assets. We're refinancing for approximately the same amount of maturity. The LTVs are dictated by the lenders, and they engage in an external appraisal process for it. We're just in the final process for that, and we expect the LTVs to be in the 50s.

Sorry, Jay, did you say 50s? Five-oh? Yeah. Okay. And what sort of term would you be looking at? 50%,

depending on the appraisal, which they keep. We don't know, but that's typically how they scale the loan.

Okay. And term-ish would be five years-ish, or?

Yeah, we're looking at five years.

Okay. And then just lastly, at 438 University, can you maybe just expand on maybe where that sale process sits? I'm curious, on any dispositions that you're looking at in the portfolio, would you be considering any VTVs?

I can answer the second part. I can't answer the first part. The discussions we're having are an all-cash deal with no structuring, but it would be uncomfortable for our counterparty to provide any more detail.

All right. Thanks very much. I'm going to turn

it back. And the next question comes from Samalia Said with CIBC. Please go ahead.

Thanks. Good morning. First question on the leasing costs in the quarter. They're about 16, 17 a foot ahead of your last few quarters. Anything or any lease in particular that would have pushed that higher for this quarter?

No, not in particular. It's just kind of an aggregate of deals put together and leasing up some space that was in raw condition, which took a little bit more capital. To move them through. The other thing I'd say, Samalia, which is interesting is broker fees, even year over year, are up about 20%. So, you know, it's the price to pay and to play. So we're seeing some increases there, but nothing tied to anything in particular.

Okay. Thanks for that. And then just on the refinancing side, you did the Calgary mortgage in the quarter 665, right? Is that really reflective of what you're seeing for rates generally? I guess, Jay, in your comments, you mentioned more along the range of five and a half percent?

Yeah, we closed the Calgary mortgage a couple months ago and the benchmark has been moving down a bit and we're just quoting rates in downtown Toronto if we're to do a mortgage today. I would say that downtown Toronto is also a different market than in Calgary, so it's a bit more competitive on the spread. Every loan is a bit unique, but most of the quotes that we've been getting are around a five-year mark.

Okay, got it. And lastly, probably a question for Michael. You now have shareholders that own more than 20% of the rate. Just wondering what's the dialogue like with them and what you can share with us about their intentions?

The 20% holder runs artist's rate and they have conference calls. I think you should ask them.

Okay, got it. Thank you. I'll turn it back.

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