CA - Dream Industrial: We Got The Pullback We Wanted

2023-11-08 17:51:31 ET

Summary

• Dream Industrial Real Estate Investment Trust owns and manages a portfolio of distribution, logistics, and industrial buildings in Canada, Europe, and the United States.
• The REIT's debt maturity profile is a little less than ideal.
• We tell you why we actually bought the dip.

All values are in CAD unless noted otherwise.

Dream Industrial Real Estate Investment Trust ( DREUF , DIR.UN:CA ) owns and manages a portfolio of distribution, urban logistics and light industrial buildings.

These assets are located in Canada, Europe, and the United States, and 233 of them are owned outright. Dream's exposure to the U.S. is via a private industrial fund, and the REIT also holds interest in a couple of joint ventures, most notable being the one that came about with the Summit acquisition , in early 2023.

We have covered this REIT several times on this platform and have provided an expanded introduction in the piece we wrote earlier this year, in June. Interested parties can read that article here , as we will not be repeating the details again in this piece. What we will summarize, however, is our outlook at that time. Despite the brisk leasing momentum, amazing rental spreads, and reasonable debt to asset level, we had neutral feelings for it.

On the other hand, the debt to EBITDA looks unwieldy, and that is often the case when the properties in question have very low cap rates. With a short weighted average maturity of 2.9 years on its debt, the interest rate will also show an uptick in the subsequent quarters. Dream Industrial is not the worst Canadian REIT abuser of the short maturity schedule, but this number will weigh on it in the quarters ahead.

Source: Dream Industrial: Look To Buy On A Pullback .

Yes, it was trading at a discount, which was not helped by the sale of its units by a sister company, Dream Office REIT ( D.UN:CA ). And yes, the price was reasonable owing to the discount, but there was simply no need to take risks in the prevailing macro environment. That said, this Dream vehicle has been our favorite industrial REIT in the Canadian space more often than not, and we were ready to jump in on a pullback and said as much. It is down about 10% since then.

In terms of total returns, it is far from the worst amongst its peers.

We go through the Q3 numbers below and explain why we did use the pullback to our advantage.

Q3 2023

Q3 had Dream execute around 1.2 million square feet of leases, the rental rates on which, on average, were 41% higher than the expiring leases. This was mostly driven by the Canadian side of things, where the spread was 45%, versus 9% for the European leases. Besides that, increase in the size of the REIT's portfolio (including the JVs), the contractual rent increases for existing tenants and higher property management fees, resulted in an over 17% increase in the year-over-year rental income.

The funds from operations, or FFO, followed suit, with around a 14% year-over-year increase. These positive results were despite Dream taking on more debt, to fund the joint venture investments over the last year. That, along with the rising interest rates, resulted in close to a 70% increase in year-over-year financing costs. The weighted average interest rate increased from 1.21% at December 31, 2022, to 2.33% at the end of Q3 2023 (1.96% at June 30), and the interest coverage almost halved in response.

The occupancy dipped slightly from 98% at the end of Q2 to 97.2% at September 30.

With the spreads this REIT is currently enjoying, this only gives it more opportunities to capture market rents on re-leasing the vacated space. The dip, as explained in the Q3 press release , was transitory in nature and related to recently completed developments. The REIT also changed the sheriff in charge this quarter.

Mr. Alexander Sannikov, currently President and Chief Operating Officer of Trust, has been appointed President and Chief Executive Officer of the Trust effective January 1, 2024. Mr. Brian Pauls will be stepping down as Chief Executive Officer at the end of 2023 to focus on Dream’s U.S. multi-family operations as Chief Executive Officer of Dream Residential Real Estate Investment Trust.

Source: Dream Industrial Press Release.

Outlook & Verdict

Dream Industrial Real Estate Investment Trust has been achieving fantastic spreads on new rentals and renewals over the last few quarters. That is because the overall portfolio rent is below the collective market average. This, we believe, more than offsets the interest rate risk which every business, especially REITs, are subject to currently and will be for the next little while. The dough that the new leases and renewals will bring also helps us deal with the (small but non accretive) unit issuances by Dream in recent times. We also believe that the capitalization rates that this REIT uses are within the realm of reality. The expansion of capitalization rates in the Q3 2023 from Q4 2022 looks entirely reasonable to us.

Of course, the REIT is trading at a large discount to even that number, and that is the cherry on top of a nice cake.

The current implied cap rate is near 6.5% using 2024 numbers. That offers a solid buffer when you combine that with the below market rents on the portfolio. We actually bought the dip at $11.76. At that point it was down over 15% from our last article, and that was enough compensation for sitting on our thumbs. We will not hesitate to add more to our position if it falls below $11.50. Since the current price is above what we consider an adequate buffer in this market, we go with a hold/neutral once again.

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