CA - Dream Industrial: Like It Love It Want Some More Of It

Summary

• Dream Industrial has performed poorly since our last article.
• We examine the recent results and the Summit Purchase.
• Risks from interest rate hikes are highest for Dream Industrial, but the starting interest rate coverage helps make the bull case even today.

All values are in CAD unless noted otherwise.

We wrote about Dream Office Real Estate Investment Trust (DRETF) (TSX: D.UN:CA ) recently . Today, we revisit another product from the Dream factory, Dream Industrial Real Estate Investment Trust ( DREUF ) ( DIR.UN:CA ). This one services a more favored sector in comparison to the former, not to mention is far larger in size and scale. It is also a personal holding of ours.

The industrial REIT owns and operates 235 industrial properties spanning 37.2 million square feet of gross leasable area or GLA across Canada and Europe. Bulk of the operations are in its motherland, Canada. It also has a 25.4% equity interest in a private industrial fund in the U.S, that it also provides management services to. The U.S fund owns 23 properties. While Dream Industrial's owned and managed portfolio is primarily comprised of distribution and urban logistic properties, they also have light industrial assets.

The difference between the Total and Owned GLA above is the portion of the U.S fund owned by other parties. The REIT was cheap the last time we wrote on it and has lost additional ground since then.

To be fair though, we can count on one finger those REITs that have provided flat or positive returns during this time frame.

Accretive leasing spreads coupled with short weighted average lease maturities, magnitude of unencumbered properties in relation to debt, and a modest payout ratio, there were many reasons to like this REIT back in May 2022. The double digit discount to NAV it was trading at back was just cherry on the top. We liked this one for both income and growth and said as much in that piece . Let us review the numbers and events since then that play a role in our current stance.

Summit

The portfolio size metrics that we quoted in the introduction to the article will undergo an expansion once Dream's acquisition of Summit Industrial Income REIT ( SMMCF ) ( SMU.UN:CA ) is completed in Q1. Dream Industrial announced its intention to acquire a 10% stake in the last quarter for around $470 million to be financed entirely by cash, available liquidity and debt. The transaction is part of a joint venture with GIC, a global wealth fund, that will own the remaining stake in Summit. Dream will also be adding the JV to its roster of managed properties increasing it from the current 46.5 million square feet to 69 million square feet. The valuation was definitely on the rich side with Summit being acquired for over 26X adjusted funds from operations (AFFO). Dream itself is trading at close to half that on 2024 metrics. You can also see the difference in where the acquisition is going through in relation to tangible book value or NAV and where Dream Industrial is trading in relation to its own NAV.

The good part is that dream is not buying the whole farm and the management fees on the total will help soothe this cut over time. We still will chop off $1 from our price target because of this acquisition.

Q3 Results

Higher rental rates on new and renewed leases, contractual rent step-ups and property acquisitions resulted in a higher rental revenue, with the trickle down effect on the NOI and FFO.

The FFO per unit remained static on a year over year basis as 2021 included a couple of one off income and expense items. The REIT also issued 19.6 million units for an average price of around $16.35/unit since the beginning of 2022. The funds raised were used for increasing their portfolio. The REIT added net 19 properties in the first three quarters of 2022.

The debt and interest metrics along with their unencumbered properties, all showed improvements compared to 2021.

With all the acquisition activity their liquidity was comparatively lower, however, subsequent to the quarter end, Dream upsized its unsecured credit facility by $150 million and added an additional $250 million accordion.

Valuation & Outlook

Dream Industrial trades at about 15X 2023 AFFO and at a 30% discount to its own NAV calculation. The latter is derived off these cap rates.

While we respect the risks from a much higher risk-free interest rate, we see these cap rates as rather reasonable, thanks to the kind of growth we are still seeing across the board. The funny part here is that Dream Office is using almost identical cap rates for its NAV calculation. That, we do not "buy" for one minute. But for Dream Industrial, the leasing spreads continue to speak volumes.

Yes, there are risks with the possibility of a recession but the valuation has discounted them adequately in our opinion.

Investors are also fretting over the higher interest rate impact on the REIT. It further hurts that the company has the lowest weighted average interest rate and this rate will likely double over the next 2 years, thanks to a short weighted maturity.

Nonetheless the starting interest coverage (EBITDA equals 12.5X Interest expense for 2022), and the leasing momentum help deal with this.

Verdict

The REIT currently yields 5.78% ($0.05833 cents/month dividend, current price $12.10). This is huge in relation to the industrial REIT Universe with only STAG Industrial ( STAG ) coming close. The rest of the bunch including, Prologis ( PLD ), Terreno Realty Corp ( TRNO ) and Rexford Industrial Realty Inc. ( REXR ) offer very little for the income investor.

STAG's assets are primarily in tier 2 locations and even that yield is lower. We can see a similar trend when looking at consensus NAV or price to AFFO multiples. Dream Industrial stands out, despite producing impressive growth and quality locations. The recent Summit purchase does dent our enthusiasm slightly, but the fact that they bought only 10% of this helps. We reiterate our Strong Buy rating on this and think the share price has a 40% upside in 2-3 years.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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