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Executives

Tom Heslip - Chief Executive Officer

Mike Forsayeth - Chief Financial Officer

Analysts

Mark Rothschild - Canaccord Genuity

Sam Damiani - TD Securities

Frederic Blondeau - Dundee Capital Markets

Granite Real Estate Investment Trust (GRP) Q2 2013 Earnings Conference Call August 8, 2013 8:30 AM ET

Operator

Good morning ladies and gentlemen and welcome to the conference call for Granite REIT. Speaking to you on this call today is Tom Heslip, Chief Executive Officer; and Mike Forsayeth, Chief Financial Officer.

Before we begin today’s call, I would like to remind you that statements made in today’s discussion may constitute forward-looking statements and that actual results could differ materially from any conclusion, forecast or projection. These statements are based on certain material facts or assumptions, reflect management’s current expectations and are subject to known and unknown risks and uncertainties.

Theses risks and uncertainties are discussed in the company’s material filed with the Canadian Securities Administrators and the U.S. Securities and Exchange Commission from time to time, including the Risk Factors section of its annual information form for 2012 filed on March 5, 2013.

Readers are cautioned not to place undue reliance on any of these forward-looking statements. The company undertakes no intention or obligation to update or revise any of these forward-looking statements, whether as a result of new information, future events, or otherwise, expect as required by law. In addition, the remarks this morning may include financial terms and measures that do not have a standardized meaning under international financial reporting standards.

Please refer to the Q2, 2013 condensed combined financial results for Granite Real Estate Investment Trust and Granite REIT Incorporated and other materials filed with the Canadian Securities Administrators and U.S. Securities and Exchange Commission from time to time for additional relevant information.

During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded Thursday, August 8, 2013.

And I would now like to turn the call over to Tom Heslip. Please go ahead.

Tom Heslip - Chief Executive Officer

Thank you and good morning everybody. Joining me on the call today are Mike Forsayeth, our CFO as mentioned; Jennifer Tindale, our EVP and General Counsel; John De Aragon, our EVP, Real Estate Investment; and Lorne Kumer, our EV, Real Estate Portfolio and Asset Management. With the reporting of our second quarter results, Granite has reached the halfway point of fiscal 2013 and it warrants taking a measure, where we stand and where we are headed in terms of our strategic plan in particular two key components of that plan.

The first to optimize our relationship with Magna and second to grow and diversify into newer age, high quality properties, a more diversified tenant base all through acquisitions as well as non-core asset sales, new development and the effective deployment of our advantageous balance sheet.

This plan entails all activities that one would associate with building a strong, well positioned long-term oriented real estate company. Yes, Granite is structured as a real estate investment trust for all the beneficial reasons that come with a REIT structure yet we view our business is that of building a true value oriented real estate company. This means balanced consideration and resource allocation is given to the renewal of leases, acquisitions on an international level, a well-located high-caliber properties with strong tenants and maximum releasability qualities, selective new development in high demand markets, timely important sales of non-core, non-tax efficient properties and through effective asset management, the repositioning of older or vacated properties executed properly these activities create a successful real estate company in our case a strong REIT.

Q2 for Granite not only resulted in successful outcome on those items we reported on in terms of financial performance, acquisitions and late renewals but it was a quarter marked by a serious of events and activities that bode well for the remaining two quarters of 2013. It was a quarter, where we built great momentum and we feel we will execute on that in the months ahead. Of the 2013 Magna lease expiries, which totaled approximately 5.4 million square feet. We have now renewed leases with Magna totaling 2.25 million square feet. Equally important, discussions with Magna are progressing on the majority of the remaining properties with expected results in the remaining two quarters of this year.

Importantly also is that of approximately seven properties Magna is to vacate, we are in conditional contracts or discussions and negotiations with prospective buyers and or prospective tenants new tenants on several of these properties and we will keep focused on strive for the best outcome on all of these properties.

In terms of growth and diversification, the halfway point of 2013 demonstrates we are on track and making progress. With the expected closing of the Westchester, Cincinnati, Ohio property within the next couple of days now, we will have acquired over 1.5 million square feet of new age, state-of-the-art logistics distribution warehouses, this represents a total of approximately $18 million an income producing properties acquired thus far this year with a go-forward annualized rental income of nearly $6 million.

When including the new development sites we acquired in Louisville, Kentucky, and in Pennsylvania, total acquisitions exceed $100 million thus far. And with the commencement of the construction of the Louisville’s building just this couple of weeks ago on July 24 region with less than 4% vacancy rate we have an additional 624,000 square feet in our pipeline in a high demand rental market.

As I mentioned, much of what was put into action in Q2 and subsequent, bodes well for the remainder of the year and represents what I will refer to today as Granite’s pipeline. This means perspective activities in all four pipeline categories, acquisitions, sales, leasing and new development. Most importantly and I stress this is not a conceptual pipelines but in fact multiple activities that are underway. However, given that there remains some uncertainties, we are not at liberty to disclose more detail other than to anticipate that our overall pipeline in particular near term acquisition pipeline is material and robust. It has been a positive half year for Granite, but there is still as much work to do. I believe that all the facets of Granite are operating at the best levels they have been since became Granite REIT barely eight months ago.

Those are my comments for now. I'm going to hand it over to Mike Forsayeth to take you through our Q2 results.

Mike Forsayeth - Chief Financial Officer

Thanks, Tom. As Tom said, we had another solid operating quarter, and save for one tax item it will actually be a welcome change not that to talk to you about plans of arrangements, reconversions transitioning to IFRS or changing reporting currencies, but, rather, just our real estate business. So, that as an introduction, I’ll turn directly to our results for the second quarter and the first half of 2013.

Overall, for the quarter and the half, our top-line benefited from contractual rent increases, favorable exchange rates and our recent acquisitions. Much of this benefits rolled to the bottom-line as we leveraged both our REIT structure and our G&A platform which is largely denominated in Canadian dollars.

Here are some of the specific highlights. On a reported basis, our quarterly net income was $43.3 million, $0.93 per unit and compares with $41.2 million or $0.88 for the second quarter of 2012. There is one tax item in the quarter that has no impact on our reported net income but does impact our reported funds from operations calculation. Our second quarter’s current tax provision includes a net withholding tax payment of $4.2 million largely related to the repatriation of prior year’s earnings from foreign operations. This repatriation is associated with certain planned internal reorganizations undertaken post the REIT conversion. These withholding taxes have been previously charged in the deferred tax expense in the income statement in the year fee income was earned. Accordingly, this $4.2 million payments which now runs through the current tax expense was offset by the reversal of the deferred tax accrual of prior years. The net result being there is no impact on the total tax expense or the net income for the year.

However, recognizing the current taxes are included in the calculation of FFO and that we do not expect an earnings repatriation of this magnitude in the future, we’d added this $4.2 million net payment to FFO to arrive at a comparable number to prior periods. After adjusting for this plan withholding tax payments the current tax expense for the quarter relating to the earnings of 2013 would be $1.8 million and it’s consistent with our expectations and with the first quarter.

Looking at our comparable FFO for the second quarter, it was $35.5 million or $0.76 per unit up $0.14 when compared to the second quarter of 2012. This 22% increase in FFO is largely due to the increase in rental revenue of $4 million and lower current income taxes of $3.5 million as a result to becoming a REIT. These increases were partially offset by approximately $700,000 of increased interest cost and reduced net foreign exchange gains of approximately $500,000. Its also ($0.02) higher than at the FFO we reported for Q1 back in May.

Some of the significant items of note when revealing our net income and FFO in comparing to the – comparing them to the second quarter of 2012 are as follows. From a revenue perspective, the increased revenue over the comparable quarter last year was mainly attributed to $1.5 million of contractual rent increases mostly as a result of CPI increases related to our Austrian properties. $1.3 million of the increase related to acquisitions that we’ve completed and there was $800,000 from favorable foreign exchange rates and we had $600,000 from various completed projects that are now on stream.

The net impact of renewals, vacancies and straight-lined adjustments were not significant. Excluding those operating cost recoverable from tenants of approximately $300,000 our property operating cost decreased in the second quarter of 2013 mainly as a result of lower appraisal and environmental review cost. Our G&A for the quarter was $6.1 million slightly lower than a year ago and both years included similar levels of REIT and reorganization cost in the $600,000 to $700,000 range. Our net interest expense for the quarter was $4.7 million and relative to last year was $700,000 higher due to added interest cost associated with the borrowings for the new properties acquired. There were fair value gains of $10.9 million before tax on our investment properties largely attributed to changes in the leasing assumptions and projected cash flows into a lesser extent discount and terminal cap rate compression.

Also in the quarter, we had almost $400,000 in acquisition transaction cost and just over $640,000 of net unrealized losses on our financial instruments due to our out of the money foreign exchange contracts largely as a result of the stronger Euro and U.S. dollar on June 30th. On a year-to-date basis given the impact of our REIT conversion on our reported results our net income for the six months ended June 30, 2013 is really not comparable to the prior year. However meaningful comparisons can be made using FFO as the metric. Our comparable FFO for the first half of 2013 was $69.5 million or $1.48 per unit up $10.8 million or $0.23 per unit from the $58.7 million or $1.25 reported for the first six months of 2012.

The underlying reasons for this 18% improvement are consistent with the themes I outlined for our Q2 performance. We had higher revenue driven by contractual rent adjustments, completed projects now on stream, acquisitions and favorable exchange rates. We had lower current income taxes as a result of the REIT conversion and like Q2 these increases to FFO were partially offset by net higher interest expense.

Some additional financial metrics I’d like to bring your attention include our annualized lease payments at the end of the second quarter are up $4.9 million from the end of Q1. Favorable exchange rates accounted for $5.6 million of that increase in our annual lease payments as the Euro appreciated 5% when comparing it to March 31, 2013 to June 30, 2013 and the U.S. dollar appreciated 3%. This $5.6 million increase was reduced by $700,000 as vacancies more than offset the added lease revenue from acquisitions, completed projects and contractual rent adjustments. The value of our investment property portfolio increased from $1.94 billion at the beginning of the year to just over $2.1 billion at the end of the second quarter.

The three major components of the $170 million increase or acquisitions of almost $80 million foreign currency translation of just over $60 million as a result of the U.S Dollar depreciating 6% and the Euro 4% since the beginning of the year and fair value gains of approximately $30 million. Our total debt at the end of the quarter was approximately $330 million of which just over 20% is U.S Dollar denominated with cash on hand of $63 million that brings our net debt to $270 million and gives us a net asset value of $1.84 billion or $39.31 per unit. During the second quarter, we declared $24.6 million of distributions to unit holders and $49.3 million for the first half of the year. In terms of the payout ratio on a year-to-date basis we will declared distributions representing 71% of our comparable FFO.

In closing, we are very pleased with our performance for the quarter and the year-to-date virtually every metric. And I would like to thank our staff for their continued dedication and support to help make it all happen.

And with that, I’ll turn it back over to Tom.

Tom Heslip - Chief Executive Officer

Well, thanks, Mike. And with that we will open it up operator to questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question comes from the line of Mark Rothschild. Please go ahead.

Mark Rothschild - Canaccord Genuity

Hi. Good morning guys.

Tom Heslip

Hi, Mark.

Mark Rothschild - Canaccord Genuity

In the disclosure you gave for the run rate of rental revenue, what does that assume for the lease expiries in 2013? It sounds like you have some indication already that there will be some of the properties being vacated, so what have you assumed there?

Tom Heslip

Mark I just break it down I think we have a fairly clear picture of where a lot of it is had we have a 5.5 roughly million square feet that was coming to in 2013. Two in a quarter million of that has been renewed now. There is substantial progress further down the road on a another 2.3 million square feet and that leads about 1 million that would go vacant. These are a couple of properties in Maryland, couple in Germany and one or two in the United States. The revenue that comes from those that are being vacated is approximately.

Mike Forsayeth

$4.1 million all in.

Tom Heslip

All in.

Mark Rothschild - Canaccord Genuity

And that $4.1 million is still in the annual revenue because you don't lose that until the end of the year, correct?

Mike Forsayeth

That’s right. Mark it’s Mike on the when you look at the annualized lease payments that amount from June 30 on the that number is really sort of looking at what we think it would be as at the June 30 exchange rates takes on what we know today and what we’ve got from notices on those vacancies.

Tom Heslip

And then Mark that a little line for trying to just extrapolate a run rate is that we have other properties that had been vacant before that we that are going to come on stream in 2014 such as their Green Lane where we are renovating for Mercedes and of course the CPI adjustments or the contractual rental increases.

Mike Forsayeth

They are not in.

Tom Heslip

They are not in so a lot of that is not that substantially all of that is offset before we then discuss for example $6 million and new revenue from reaching acquisition and future acquisitions we hoped to make this year. So most of the slippage in renewals and even vacancies pre-releasing is getting offset by CPI contract and other properties.

Mark Rothschild - Canaccord Genuity

Okay. That’s helpful. And in regards to the tax that you had to pay this quarter, you seemed to say that it’s really a one-time thing, should we expect though that if you would have to repatriate cash again in a year, that there would be, that this could become something more recurring to a smaller degree, or is this really something we're not likely to ever see again?

Mike Forsayeth

Yeah. You are not, Mark you are not liked to see something about magnitude again. On an annual basis from our withholding tax perspective on a cash end you’ll probably see may be $1 million to $1.5 million of withholding tax that would bake into the that’s all to the current tax provision.

Mark Rothschild - Canaccord Genuity

And that $1.5 would be with the on top of the $1.8 or so a quarter that you’re saying now?

Mike Forsayeth

That’s not a quarter that would be…

Mark Rothschild - Canaccord Genuity

The $1.5 is annual number.

Mike Forsayeth

Yes, the 1.5 is a, would be $1 to $1.5 would be an annual number and is probably to a large extent baked in the $1.8.

Mark Rothschild - Canaccord Genuity

Okay, good. Your G&A, the number that we saw this quarter is it a good run rate that we should expect to see around here going forward?

Tom Heslip

Markets a big high I think it has some non-recurring in it, we like to think it between 5 and 6 per quarter sort of in the 20 to 21, 22 annualized and with respect to the 10% target of course I will share that kind of the best way to do that is to grow revenues without adding new G&A and based on what we’ve required this year and rather than a healthy pipeline we’re certainly heading in a right direction there.

Mark Rothschild - Canaccord Genuity

Okay, great. And just lastly one-off question it’s obviously still a while away, but is there anything at all to disclose as far as the 2017 expires with some of your big properties?

Tom Heslip

No, nothing as closing trends that of specific set of occurs there.

Mark Rothschild - Canaccord Genuity

Okay, thanks a lot.

Operator

(Operator Instructions) The next question comes from the line of Sam Damiani [TD Securities]. Please go ahead.

Sam Damiani - TD Securities

Thank you and good morning. Just on the acquisition front, Tom in the past you kind of spoken about an annualized piece of $250 million at least as a goal, I didn’t hear similar kind of comment this morning I wonder if you could update us on your thoughts on setting in sort of expectations in that range?

Tom Heslip

Well Sam, as I mentioned in my comments I mentioned that it’s a non-conceptual actual pipeline and the fact of the matter is it is a materials as it’s ever been we’re involved with some work that has a number of steps that have to be buckled down and we’ve never been more excited about what we’re working on of course we have to complete traditional steps and those are underway. Yes in terms of our target today we feel very confident that the $250 would actually be at the minimum size.

Sam Damiani - TD Securities

At the minimum size. You’ve done I guess a 100 sort of year-to-date, and feel that you could do at least sort of lease that again in the latter half of the year?

Tom Heslip

Based on our activities happening right now we’re feeling that way yes.

Sam Damiani - TD Securities

Okay. And, are you seeing any change in the acquisition market in terms of level of activity perhaps a view of cap rates just given the pullback in the sector valuations let me perhaps some of your competitors being active today?

Tom Heslip

Yeah what we’re observing is as more work we’re experiencing that was previously kind of talk is now really happening and that is we truly are an international REIT and our ability to pursue opportunities in the United States with the team we have in North America pursue opportunities and countries like Germany and elsewhere is really allowing us to kind of feel right now the differences and different markets. And more than other we’re finding a combination of volatility in certain places is opening up opportunities, the strength of our balance sheet is kind of manifesting the true advantage we have without a need to raise the equity, cash on hand and ability to borrow with the terrific what we have from our banks.

We’re really seeing that advantageous, it’s allowing us to respond quicker, act when others are hesitant and frankly right now is probably been the best window we’ve experienced not necessarily commenting on cap rates higher or lower in Canada, higher and lower in the United States. Just a matter of moving an end markets and how we’re accessing it and acting on it. And as I say it’s resulted in a pipeline while conditional that is indeed material and would exceed anything done thus far this year.

Sam Damiani - TD Securities

Okay. And then so far you basically announced acquisitions sort of once they’ve closed as opposed to announcement when they are under contract and what not, is there – can you quantify perhaps the sort of any activity on the acquisition front that is under conditional contract or where you’ve conditions pending closing?

Tom Heslip

Generally speaking, going forward, Granite as we have in our last two acquisitions when a transaction is firm and binding meaning any conditions of the purchaser ask or the vendor our counterparty are ways, we will announce that, we did that last Tuesday with respect to the Westchester property $21 million acquisition 10 year sale leaseback with Fifth & Pacific. All conditions were waived, that was a matter of customary closing conditions and as it turns out we expect to close that candidly as early as tomorrow. So we announced that last week we will announce short – briefly when it closes. I think that will be our pattern going forward that we won’t wait till closing, we will – conditions are waived in all parties part in firm and binding and announce it. And with that in mind I don’t want to say anymore in terms of detail but when I say material I do mean significantly more than we require to-date.

Sam Damiani - TD Securities

Okay. All right. And just over to the ALT, does this number that you’re disclosing today include also the roll down or perhaps roll up in the rents that you're renewing with Magna this year?

Mike Forsayeth

Yeah, it will be everything we note to-date.

Sam Damiani - TD Securities

In terms of the renewals perhaps a down-tick in the…

Mike Forsayeth

Yeah…

Sam Damiani - TD Securities

Okay. And what is the quantity of that? I think you were talking maybe a 15% roll down in the leases that you’re renewing with Magna this year?

Mike Forsayeth

The – I mean overall I think is between yeah it’s around that 15% number, yeah.

Sam Damiani - TD Securities

Okay, great. Thank you.

Operator

(Operator Instructions) The next question comes from the line of Richard Greenberg (indiscernible). Please go ahead.

Unidentified Analyst

I understand that your priority is growth through acquisition of new properties, but is there a point where your stock has come down enough relative to underlying asset value and is cheap enough on an FFO basis that you would start, restart the stock buyback program I mean how do you look at the returns on a stock buyback versus buying new properties?

Tom Heslip

It’s a fair question and of course the whole market has seen decline. We are not at this stage giving consideration to renewal of the normal course issuer, but really our focus is on growth. We think that the best way to deploy capital is not on a buyback and find ourselves basically caught with no further borrowing power but rather to acquire opportunistically in these times. We like the fact and is not meant to be to expense of others but we know that equity has been and will be harder to come by for a number of others and we think this is a window of opportunity to buy. We have thus far this year everything has been north of the 7% cap rate and that trend has been continuing for us with leverage of course is putting us into substantial double-digit returns. And we look at it on a long-term basis we think better to buy, better to build, in certain cases to sell assets. And I can’t say where we would say let’s buyback this stock as the metrics are more favorable from a accretion point of view but we are certainly not there right now.

Unidentified Analyst

Okay. Thanks.

Operator

Thank you. And the next question comes from the line of Frederic Blondeau (Dundee Capital Markets).

Frederic Blondeau - Dundee Capital Markets

Hi, thank you. Just two quick questions here and sorry if I missed that. It seems like Magna went public announcing a (indiscernible) in Europe. I was just wondering how would that affect your operations?

Tom Heslip

Frederic in a simplest way to put it Magna is a tenant of ours in approximately 90 property, their businesses in various regions impact new contracts, they get more businesses is stronger, new contracts come and probability of retaining them and increases. Their growth in different markets doesn’t really correlate to impact on our portfolio. We’re not building new plants for them, but we’re respecting and trying our best everywhere we can to keep them as a tenant and to keep them as a happy tenant. So, quite often the growth of Magna be it in China, India, Mexico, people will say well that’s great for Granite. And it’s great for Magna and we’re happy for Magna but what matters is where our properties are located is business going well for Magna and thee is, it will grow, it will grow well for us.

Frederic Blondeau - Dundee Capital Markets

Okay. But do you plan they could vacate some of your buildings in Europe?

Tom Heslip

Well not, not to any disproportionate level we’ve retained them in a significant number of properties this year in Europe already. Maybe an example of an asset where we would have said a year and a half ago even a year ago, they would remain. They just recently signed a five year extension. So, we’re not seeing specifically Europe disruption affecting on our portfolio in any unusual way.

And in fact a lot of their business in Europe is turning to corner. So, we’re a little more optimistic about our portfolio. I might add that the substantial part of your Europe portfolio is in Austria and sort of anecdotally the Austrian assets are probably they are physically most advanced and attractively located and doing well,. So, right now Europe isn’t a greater fear for us than anywhere else and we’re actually more optimistic than they were a year ago.

Frederic Blondeau - Dundee Capital Markets

Okay, thank you.

Operator

And at this time, Mr. Heslip, we have no further questions. So, I’ll now turn the call back over to you.

Tom Heslip - Chief Executive Officer

Thank you and thanks everybody for today. Take care.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s conference call. We thank you for your participation and ask that you please disconnect your lines. Have a great day.

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