Dream Office REIT's (DRETF) CEO Jane Gavan on Q2 2014 Results - Earnings Call Transcript

Aug. 8.14 | About: Dream Office (DRETF)

Dream Office REIT (OTC:DRETF) Q2 2014 Earnings Conference Call August 8, 2014 9:00 AM ET

Executives

Jane Gavan – CEO

Ana Radic – COO

Mario Barrafato – SVP & CFO

Analysts

Sam Damiani – TD Securities

Mark Rothschild – Canaccord Genuity

Alex Avery – CIBC

Lewis Baker

Matt Kornack – National Bank Financial

Mario Saric – Scotia Capital

Operator

Welcome to the Dream Office REIT’s Second Quarter 2014 Conference Call for Friday August 8, 2014. (Operator Instructions). . 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.

Additional information about these assumptions and risks and uncertainties is contained in Dream Office REIT’s filings with the securities regulators, including its latest annual information form and MD&A. These filings are also available on Dream Office REIT’s website at www.dreamofficereit.ca. Later in the presentation, we will have a question-and-answer session. (Operator Instructions)

Your host for today will be Ms. Jane Gavan, CEO of Dream Office REIT. Ms. Gavan, please go ahead.

Jane Gavan

Thank you. Good morning everyone. Welcome to Dream Office REIT’s second quarter conference call. With me today are Ana Radic, Chief Operating Officer and Mario Barrafato, Chief Financial Officer. I’m going to provide my comments and then turn the call over to Ana and Mario to provide more color.

Against the backdrop of a lot of conversation right now but the challenges and trends for the office market but we had a good quarter. We completed almost 650,000 square feet of leasing this quarter both in-place and committed occupancy remained steady at 92.5% 94.1% respectively with the latter posting a modest decline over the prior quarter of 10 basis points. And as of now we have renewed or replaced over 80% of our lease expires for the year. In total numbers that equates to 2.6 million square feet of leasing year-to-date and 1.4 million square feet of renewals completed at over 8% of expiring rent.

NOI increased by 0.5% over the first quarter and our basic AFFO and FFO per unit increased over the prior quarter by 2.1% and 0.7% respectively. I became the CEO of Dream Office REIT on May 7th so this conference call marks the end of my first 90 days in the role. The fact that the quarter was quiet from a transaction perspective has given me time to focus on understanding both what we own and our markets and I’ve gained some appreciation for the headwinds the Office market spacing, what the REIT’s strengthens and the challenges we have in our real estate.

I remain convinced that the REIT owns a portfolio of valuable real estate and our 8% yield is very attractive return for the underlying assets.

Over the quarter I met with real estate brokers, analysts, lenders, investors, large tenants, our property managers and our leasing teams. I have had the opportunity to meet with U.S., Canadian and European investors and here with our thinking and saying about our company and our real estate and the Canadian office market in general. I also had the opportunity to tour assets in Vancouver, Calgary, Edmonton and Toronto and my goal is to see the rest of the portfolio before the end of the year.

We’re focusing our strategy on addressing what clearly are the trends in the office market. New building supply, office space intensification and organization and our team is ready for this operating environment. We have got new leasing and capital strategies that include building improvements to refresh our buildings and make them more attractive, marketing strategy to aggressively identify new tenants and incentives to keep us top of mind in the brokerage community.

We are building show suites to increase velocity and reduce downtime. We’re going to continue to focus our property management teams and onsite building operators on improving our customer service and the tenant experience in the buildings. Our process improvement projects and the technology initiatives are progressing well and we should start to see those efforts ultimately translate into better, more timely data for our teams to work with to anticipate trends with and most importantly free up times so we spend more of it in the buildings and with our tenants.

Our operating environment has brought into greater focus the value creation opportunities in the portfolio that we have put together over the last two years. Well there is not a lot of NOY growth in this environment; our assets have embedded development potential. Victor Settino, our VP of Commercial Development comes to us from First Gulf with a whole new development view point. He spent the last six months combing through what we have got and where we can build or improve on our real estate. We’re exploring opportunities for ground up development, intensification and converting existing buildings to alternative uses. On the ground up development we have identified our first four opportunities within our portfolio for around 650,000 square feet of new construction.

It's very preliminary and we wouldn’t proceed without preleasing. We targeted 12% to 14% return on equity and this pipeline will take anywhere from 2 to 5 years to execute depending on the leasing market.

We’re also exploring the opportunities in the portfolio to repurpose or intensify the use of our assets. In addition we have excess parking in some locations that can be converted into retail pad sites. Our buying and selling activities of the last few years put the spotlight on Dream Office skills as allocators of capital. We now want to focus on our strong operations and our ability to recycle out of those assets where it's appropriate to do so and spend capital elsewhere in the portfolio to get a greater return and improve the value.

To-date this year we sold our four properties for almost 27 million gross proceeds and will continue that effort for the balance of the year. We have a target to sell $75 million to a $100 million of assets in 2014.

Unlike in Dream Global REIT with a pipeline for acquisitions is large, in Canada, there have not been that many office transaction. That makes it harder to realign our capital. However there are some opportunities and we expect to recycle some of our capital to improve the quality of our assets. The opportunities to invest in our own portfolio is exciting and we anticipate achieving attractive returns. Accordingly we focus on recycling capital out of assets that don’t fit the portfolio and invest in some new assets and making investments in our existing real estate whether capital improvements, retain our retention, our improving revenue potential by repositioning the assets.

I’m now going to turn the call over to Ana.

Ana Radic

Thank you Jane. Good morning. Canada’s office vacancy rate rose marginally this quarter increasing 10 basis points to 10.4% as 2 million square feet of new office space became available. While the vacancy rate increased according to CB the Canada Office market is exhibiting signs of life with over 1.4 million square feet of positive absorption in the quarter after a prolonged period of lack luster leasing activity. The downtown markets of all major Canadian cities with the exception of Montreal and Kitchener Waterloo and Halifax some more office space lease during the second quarter that was put back on the market.

Demand was strong in the majority of suburban markets as well with over 740,000 square feet of space absorbed this quarter. Turning to our portfolio, quarter end in-place occupancy excluding forward lease commitments remained unchanged at 92.5%, negative absorption in Western Canada suburban Toronto and Eastern Canada was offset by gains made in suburban and downtown Calgary as well as in downtown Toronto.

In downtown Calgary quarter-over-quarter ending occupancy rose 240 basis points to 93.9% as a result of 77,000 square feet of positive absorption. Well in downtown Toronto over 29,000 square feet of space was absorbed increasing our quarter end occupancy 60 basis points to 95.4%.

Forward lease commitments of 384,000 square feet bring our committed occupancy rate to 94.1% only a 10 basis point decrease over the prior quarter. I will speak in further detail about our largest market Calgary and Toronto. As reported by CB, the downtown Toronto market recorded 371,000 square feet of positive absorption resulting in occupancy increasing to 94.3%. Sub-lease space was also absorbed causing sublease vacancy to decrease as a percentage of available space from 24.5% in the first quarter to 21.8%.

Our downtown portfolio closed the quarter with an in-place and committed occupancy of 97%. We continue to outperform the market with our portfolio of in-place occupancy, a 100 basis points better than market and committed occupancy 270 basis points above the market. Over 200,000 square feet of leasing was completed in the quarter consisting of just under 87,000 square feet of new transactions or existing tenant expansions and a 116,000 square feet of renewals.

Well the downtown market is facing new supply being delivered in 2016 through to 2019, the market today is very tight and both demand and rental rates have remained strong across our portfolio.

We continue to consistently lead or exceed our market rent targets both on new transactions and renewals. This quarter several renewals were completed with tenants expiring beyond 2014 with the largest both being legal firms, one a 38,000 square foot tenant at 438 University and the other 14,000 tenant at Nathalie Place. Both tenants extended for five years beyond their 2016 lease expires. We continue to engage tenants with expires beyond 2015 and renewal discussions with the aim of providing certainty of cash flow.

In downtown Toronto we have also seen excellent results from our model suite program. We have built out 20 suites totaling 46,000 square feet, to-date we have leased 21,000 square feet and have serious interest in further 11,000.

By investing in our vacant space we benefit from reduced vacancy periods and higher lease rates. We will continue to have a pipeline of suites ready to replace leased units as having this inventory of well-built out options is making us the go-to choice for brokers representing tenants with small to mid-sized requirements.

Tenant demand continues to be the strongest in the downtown market followed the by GTA West. Technology and marketing companies talk to a list of tenants looking for large amounts of space specifically in the downtown market however we’re seeing growing demand from the banking sector as well as from various tenants looking to approve the quality of the space they occupy.

As we continue to better our buildings by investing in common area upgrades, HVAC improvements, elevator modernizations and sustainability initiatives towards which we have spent 10.7 million to-date with an additional 10 million of projects planned are underway for the balance of the year. We’re well positioned to benefit from the growing demand in Toronto Central Business District by offering excellent quality space and delivering superior customer service in prime locations in the city.

New deal activity has been particularly strong in our suburban GTA portfolio with a 177,000 square feet of new lease transactions and 50,000 square feet of renewals commencing in 2014 completed this quarter. Last quarter we reported we had completed a conditional deal for 44,000 square feet with DB Schenker at Airway Center. The transaction did firm up and the tenant is presently fitting out the space for occupancy in the fourth quarter.

We also completed a 79,000 square foot deal at 2645 Skymark Avenue, a flex building we own in the airport corporate center for seven year term which resulted in no downtime after the existing tenants vacated in June. As part of this transaction the tenant leased over 10,000 square feet of challenging office space, the lease was completed with no interruption in cash flow and was lower than anticipated leasing cost.

During the quarter a new lease was also completed with one of the largest accounting firms in Canada for 40,000 square feet, 20,000 at owned share at Sussex Center and Mississauga. There has been greater pressure on rental rates to secure new tenants and select suburban notes where more options exist.

In addition to 50,000 square feet of lease renewals completed in 2014, 23,000 square feet of renewals commencing in 2015 and 2016 were also completed. The largest being with a 32,000 square foot tenant, 16,000 square feet of own share commencing in 2016 at Sussex Center.

Rental rates achieved on renewals has been strong down at rents at or above market. The Toronto West market is quite fragmented in terms of leasing characteristics with the activity more stagnant in certain markets while others such Airport Corporate Center, City Center (indiscernible) enjoy more leasing activity and leading the Toronto West market. This is certainly translating into success for us as evidenced by the number of large transactions that we have concluded in these nodes such as the 44,000 square foot DB Schenker deal at Airway, the 40,000 square foot lease with (indiscernible) at Sussex, the 20,000 square foot deal with (indiscernible) at Commerce West and a 16,000 square foot deal with Travel Nation at 2810 Matheson Boulevard, all of which were some of the most sizeable new transactions completed in the overall west market this year.

Moving on to Calgary, in the second quarter of 2015 the downtown Calgary market posted 400,000 square feet of positive absorption, though the vacancy rate did increase 90 basis points to 10% as the full leased 840,000 square foot 8th Avenue place was delivered to the market. Class B and C vacancy actually decreased by 10 basis points to 13.3% and amongst the mid-west core where we have a cost information of B Class assets, Q2 overall vacancy dropped to 9.7% with 26,000 square feet of positive absorption taking place.

Vacancy in the Calgary suburban market declined 230 basis points in Q2 to finish at 11.7%. With the lack of new supply immediately available much of the vacancy reduction was a function of tenant seeking sublease space off the market.

Commodity prices and oil and gas capital spending remained relatively strong and there remains good demand particularly from the energy sector. In-place occupancy in our Calgary CBD portfolio increased 250 basis points during the second quarter.

Well our in-place and committed occupancy slipped slightly to 95.7%. In our suburban Calgary portfolio in-place and committed occupancy strengthened during the second quarter increasing 20 basis points to 83.6%. During the quarter 24 lease transactions were completed totaling approximately 125,000 square feet of which 50% were renewals and 50% new transaction.

The largest transaction completed this quarter with t McFarlane Tower were an energy company renewed 24,000 square feet and leased an additional 12,000 square feet commencing in the third quarter. The largest of the 60 new deals concluded was with an energy company as well who was subleasing space at 606, 6th Avenue. This was converted into a five year head lease on 19,000 square feet. We continue benefit from the spread between market and in-place rents with renewals completed at an average of 15% above the expiring rent and in-line with market.

Our activity and interest from 2000 to 8000 square foot tenants continues to be strongest while demand for mid-sized users has been marginally slower. However there were main group’s in the market interested in 20,000 to 25,000 square feet of the 100,000 square feet we’re marketing at 444-7th.

Like in Toronto we’re making considerable investments in our Calgary portfolio, for example a new building amenity fitness center and conference facility is being planned at 444-7th to be shared with 606, 4th street. The 444-7th we’re also preparing to commence an extensive main court lobby upgrade and demolished the 5th floor to highlight the efficiency of this 25,000 square foot.

Notable transactions concluded in other markets include a 14,000 square foot expansion of an existing tenant at 700 de la Gauchetière in Montreal that will commence in the third quarter. This transaction will increase the building occupancy by a 130 basis points, also at 700 de la Gauchetière subsequent to quarter end we concluded a 35,000 square foot lease which will result in space currently on the sublease market being leased directly to a new tenant, at rents a 150% higher than in-place rents. This 10 year transaction will generate over $430,000 of additional annual NOI.

In Ottawa subsequent to quarter end we extended the lease with a Department of Defense who will a 170,000 square feet at 400 Cumberland from July 2015 to December 2018. The tenant also require two one year renewal options which they have indicated they will likely exercise.

We’re also working closely with the real estate teams at PWGSC as we plan sustainability upgrades for our two additional assets of Loerie Avenue in an effort to secure long term lease commitments with public works.

As we have discussed in our prior calls occupancy and our overall portfolio will decline approximately 100 basis points in total over the next two quarters as previously reported tenants vacate premises. We remain confident that we can deliver comparative property NOI growth over the year as positive spreads between in-place and expiring rents, improved occupancy and markets with higher growth rents such as Toronto, Calgary and Montreal as well as contractual rent steps will help offset these occupancy declines.

We have had a very strong quarter of leasing activity with an additional 500,000 square feet of lease transactions completed that commenced in in 2014, 370,000 square feet being new deals and a 128,000 square feet of renewals. We have thus renewed or secured new tenants for 83% of our 3 million square feet of 2014 lease expires.

We continue to benefit from the positive spread between market and expiring rents as the 1.4 million square feet of renewals we completed were in average rent, 8.2% higher than the expiring rent.

We have also completed approximately 250,000 square feet of leasing commencing in 2015 and an additional 100,000 square feet of renewals with tenants expiring in 2016 and later.

These transactions were down a rents in-line with our market rent expectations. Working with Dream's Development Group we are making good progress bringing several new development opportunities to market. In Saskatchewan we have presented a development proposal at 275, 2nd Avenue to the city and have been able to increase our development density to approximately 200,000 square feet. We’re now into position to respond to any RFP that comes to the Saskatchewan market. In Markham, where we have five acres of excess land on a site of our existing building 60, Columbia Way we have also had a preconsultation meeting with the City of Markham with respect to our development plan and the city had only minor comments.

We can develop between a 125,000 to 200,000 square feet of office on the site. This quarter we responded to site selection criteria for an undisclosed a 180,000 square foot tenant requirement in the market.

We continue to explore opportunities to unlock additional value from our 1 million square foot retail portfolio by both repositioning existing retail and adding new retail spaces. We’re also in the process of adding a dedicated retail leasing person to our team. For example we’re exploring an opportunity to convert 13,000 square feet of below grade storage space at 130 Slater in downtown Ottawa into retail space. We have completed architectural and preliminary mechanical reviews and are working on pricing for the redevelopment.

We have also discussed the opportunity with local brokers and have received feedback that we could achieve rents of $25 per square foot which would be a significant increase over the $4 that just currently earned on the space. On our Airport Road Side we have the ability to build 6000 to 10,000 square foot retail pad and have serious interest in this location from several restaurant operators. This will provide both a strong return and amenities that should assist office leasing at the site.

In downtown Montreal we are in discussions with the fit center, operator to lease 10,000 to 15,000 square feet of the low grade vacant storage space at rents that would add approximately $375,000 of annual NOI. Finally in downtown Toronto we’re working on eight opportunities to add or reposition existing retail that over the next two years could increase the annual NOI of that portfolio by $700,000 to a $1 million.

I will now turn the call over to Mario to speak to our financial results.

Mario Barrafato

Thank you Ana. Good morning everyone. Our second quarter results were in line with our expectations, this quarter we saw strong leasing activity which allowed us to maintain stable overall occupancy, capture favorable spreads on new leasing, and increase our overall in-place rent. This was especially evident in our two largest markets downtown Toronto and downtown Calgary, So to summarize our results our basic FFO for the period is $0.731 per unit it's up 2.1% from the same period last year and 0.7% to last quarter.

Our AFFO over the period was $0.638 per unit up 4.4% from the same period last year and 2.1% to the last quarter. The increase in both FFO and AFFO over the prior quarter were primarily the results of following, compared to last quarter we had comparable property NOI growth of 553,000 or one half of 1%. The increase was driven by higher rental rates on new leasing and contractual steps.

We also had interest expense savings on refinancing as we close $32 million of new mortgages with an average term of eight years and an interest rate of 3.9% and we use these proceeds to repay debt at an average rate of 5.2%.

These savings were offset by a full quarter of interest on our unsecured debenture which we issued last quarter. We also saw growth in the underlying FFO and AFFO from our investment in Dream Industrial REIT. In addition specifically applicable to FFO we saw a decrease in straight-line rent of 340,000 and recorded a onetime non-cash charge to G&A for 200,000.

Also included in our numbers is approximately $900,000 of non-recurring lease termination fees which is $600,000 higher than in last quarter. The second quarter was quite from a transactional perspective. In June we closed on the previously announced disposition of our 25% interest in three properties and 100% on property. In total the properties were sold for gross proceeds at 27 million less of a million of debt assumed to discharge. The properties were sold for a collective cap rate of 6.9% and the debt carrying interest rate of 3.8%.

The net proceeds were used to repay amounts drawn on our credit facility. With very little capital activity most of our debt metrics remain consistent with the prior quarter, leverage declined slightly to 47.3% from 47.6%. Our weighted average interest rate remained at 4.2%, our interest coverage ratio and debt to EBITDA ratio remained strong at 2.9 times and 7.9 times respectively and our pool on unencumbered assets remains at approximately 800 million.

From an operational perspective the portfolio fundamentals remain stable and our in-place rents continue to increase. We saw high level of leasing activity with 665,000 square feet of leasing taking effect during the quarter. Of this 351,000 of renewals resulting in tenant retention of 55% and 340,000 for the new tenants resulting in overall in-place occupancy remaining flat over prior quarter at 92.5%.

Within our reporting segments downtown Calgary and downtown Toronto saw the largest increases in in-place occupancy increasing 240 basis points and 60 basis points respectively. These increases were offset by occupancy decline in suburban Toronto.

The leasing spread on the 351,000 square feet renewals that took occupancy in the quarter was $0.54 or 3% of expiring rents. And new leasing was completed at an average rent of $20.77. This resulted in our overall in-place rents increasing by just under 1% to $18.14 from $17.97 in the prior quarter. On annual basis this increase in rents result in approximately 4 million of NOI growth.

We presently expect in-place rents to still be 8% below market with Calgary downtown rents at 16% below market and downtown Toronto at 8%. In our MD&A our overall rents for the portfolio did increase by $0.03 per square foot over the prior quarter but this wasn’t a change in our estimates for market rent, it rather just reflects the disposition of properties with low rent and the leasing of previously vacant space at higher market rents.

Looking to the remainder of 2014, we continue to benefit from the rental rate increases we captured to-date. However we will see our average occupancy decrease by approximately a 100 basis points next quarter as previously reported tenant vacancies take effect in the quarter, the largest being the National Energy Board in Calgary. As a result we expect our cash NOI to decrease by approximately $200,000 to $300,000 or one quarter of 1% relative to our Q2 NOI.

The above combined with the full quarter impact of property dispositions and the elimination of non-recurring items results in our forecasted Q3 basic FFO to be approximately $0.715 or $0.71 on a fully diluted basis.

For the year we’re forecasting basic FFO to be $2.88 per unit or $2.86 on a fully diluted basis. As Jane mentioned we’re focused on improving our balance sheet as opportunities arise we hope to sell properties that have lower growth profile and redeploy proceeds into new properties or make capital improvements that increase tenant retention or improve revenue potential. In the event that proceeds can’t be immediately deployed we will pay down debt in the interim.

With respect to that we started the process to refinance our largest 2015 mortgage maturity with a 10 year bond rate under 2.1% and down approximately 70 bps year-to-date and with lender spreads tightening for high quality properties we have an opportunity to execute a very large financing at a very attractive rate. I would now like to turn the call back to Jane.

Jane Gavan

Thanks Mario. I would like to open the call now for questions.

Question-and-Answer Session

Operator

(Operator Instructions). And our first question is from Sam Damiani of TD Securities. Please go ahead.

Sam Damiani – TD Securities

You guys are doing, I would say a very good job walking and tackling in a tough market and in the Q3 office decline is to be expected but when we look at 2.5 years we do see a lot of expires that are still not dealt with. Do you have at hand an analysis or a summary that shows what portion of that space is already been -- where you know the tenants are already leaving or the portion of the space that you’re still working on just to help people understand what really is the potential downside, it just seems like there is a cloud over the perception and I think just adding some clarity to the outlook would be helpful.

Jane Gavan

Well I think we do have let the market know about some of the expires that are vacating Scotia Plaza for example tell us and so forth. Other tenants are still in discussions with us, so in that respect there are many that haven't really been closed but we can put something together for you Sam, that gives you a better idea of what we know in terms of the expires. Like I said we’re working with the government in Ottawa and those negotiations are progressing well. So we feel some confidence there and in other markets as well.

Sam Damiani – TD Securities

I guess, you would just to make it more simple, if you could just say whether or not there have been any new additions to tenants that have confirmed the decision to vacate at the end of their lease? If there hasn’t been, that would be certainly helpful to know, just to know that we’re not adding another tenant to the list that’s going to vacate. Is that the case?

Mario Barrafato

I think all the larger ones we have talked be BLG (indiscernible) Aviva, National NGO Board [ph] is when we talked a year ago even before. For the coming year the only item we have is really winners and that’s in June and so in the near term next year we have 2.5 million square feet, I think 400,000 square feet is already leased. Winners is the largest -- it’s the largest known vacate and then next year we really have a lot of small tenants and so we think we can keep 55% retention and do some millions square feet of leasing we can keep NOI relatively flat but then again 2016 is when we get our biggest vacancies and right now we’re getting more traction as we close, it's hard for tenants to get actively involved in it but right now there has been nothing larger than what we have disclosed today.

Sam Damiani – TD Securities

Okay. Just a couple of smaller questions, I noted that the NOI growth over Q1 was quite healthy at 0.5% and I think in your MD&A you cited some rental step ups in downtown Toronto. Could that perhaps be one of your flagship buildings and your largest tenant?

Jane Gavan

No, it wasn’t driven by a rent step -- if that’s the question -- it was just really a lot of smaller transactions where across the portfolio we have been able to increase rents by a few dollars a square foot across a wider area of the portfolio.

Mario Barrafato

Yes the Scotia deal was negotiated for the first four years I believe, have no rents down.

Sam Damiani – TD Securities

Okay, so you’re two years in and then just lastly that was quite an interesting rental uplift you achieved at the 700 de la Gauchetière in Montreal. Was that a former Bell sublease space?

Jane Gavan

It was not actually, it was another tenant National Bank that had space that was on the sublease market one floor of excess space and the building there is very tight. We have no real availability so we were able to lease the space directly to a tenant on a 10 year basis and essentially more than doubled the rent. That was very below market rate of some $12 a square foot.

Sam Damiani – TD Securities

Is that tenant, well you’ve identified it National Bank, are they occupying a lot of space in that building at that low rent?

Jane Gavan

Yes, they have a few different rents because they have expanded at different periods of time but their rent is below market. Yes.

Operator

Thank you. Our next question is from Mark Rothschild of Canaccord Genuity. Please go ahead.

Mark Rothschild – Canaccord Genuity

Dream Global announced a very interesting joint venture was growing up (indiscernible) is Dream Office considering doing something similar as far as joint ventures to maybe increase the return on properties or to collect some capital from some properties to fund growth, is that something you guys are looking as well?

Jane Gavan

It's interesting, we do get approached by players that we have met through Dream Global. People want access to Canadian market and we do get calls about participating with us. I think for us it's a little bit about where we would deploy the proceeds, the difference with Dream Global is that there is a fair robust acquisition pipeline and for us it's a little less clear where we would use the money. That being said it was a good model and I think we’re open to it.

Mark Rothschild – Canaccord Genuity

And with not having the same opportunities as Dream Global to grow, you did talk about the difficulty of acquisitions. Is it possible that we’re going to be in a prolonged state now where it's going to be difficult for Dream Office to complete a large volume of external acquisition?

Jane Gavan

I think the market is definitely slower, I think we’re going to start seeing stuff coming on the market in the second half of the year that could be kind of interesting, so we will see.

Mark Rothschild – Canaccord Genuity

And then just lastly, I know you’re not going to indicate anything to the market but what is the rationale or is there a reason for Dream Office to still own units in Dream Industrial?

Mario Barrafato

It's not a strategic position Mark. We took the units back on the IPO, I think it goes down to what Jane said is if we get good value from them now, if we can monetize them and put the proceeds into something better we would but we’re not tied to holding the units, we would a seller if we could use the capital in a better way in our business.

Operator

Thank you. Our next question is from Alex Avery of CIBC. Please go ahead.

Alex Avery – CIBC

Jane, you mentioned the excess density potential in the portfolio and I think you said something like 650,000 square feet you’ve identified. I got the sense that that was mostly if not all office space, is that correct?

Jane Gavan

Yes exactly.

Alex Avery – CIBC

Have you looked at other uses for some of that density? Like you did -- or that you’ve indicated at the Aviva Corporate Center where you’ve suggested there is residential capacity.

Jane Gavan

Yes exactly. I mean, one of the nice things that Victor brings to our portfolio is a completely open mind in terms of what are the highest and best uses for the property. So we will look at multi-use, adding some retail, is there a residential opportunity. So I think all things are on the table and we will look at what maximizes the value for the site.

Alex Avery – CIBC

Have you made any further progress on the plans for the Aviva Corporate Center?

Jane Gavan

We have, we have met with several architects and had some discussions with the city because you know they have plans for that corridor with the LRT and they seemed very receptive to hearing that we’re looking at alternate uses there. So we’re moving forward with additional planning.

Alex Avery – CIBC

Okay. And then Jane you have mentioned capital recycling and the idea that you want to opportunistically I guess sell some assets and recycle into higher quality assets and I would imagine that the objective of that is to improve the growth profile of the REIT?

Jane Gavan

I think what we want to do is improve the quality of the portfolio, there is certainly assets that don’t fit and I think we would like to recycle out of those and then target assets that really work better for the REIT, overall move up the quality scale.

Alex Avery – CIBC

And when you think about that in the context of the REITs, do you’ve I guess a preference in terms or is there an appetite for improving the quality of the portfolio at the expense of FFO or is this more of a opportunistically when you can make it relatively neutral if you look at that?

Jane Gavan

That’s probably going to be a bit of both, we’re going to look at what makes sense for this company, sometimes it means that we’re going to see some FFO reduction because we’re going to trade some assets that naturally have a higher cap into stuff that has a lower cap. On the other hand we will try and do the best we can to smooth that out with timing and making sure that we don’t have -- we’re not holding on to cash for example. But we will have to sort of see, right now it's not like we’re choosing -- there is not so much on the market right now for us to look at.

Operator

Thank you. Our next question is from Lewis Baker, a private investor. Please go ahead.

Lewis Baker

I think you’re just making observation and I will ask for your comments, I have been a shareholder for 30 years now and what I’m finding is that the other investors and the brokers that I have managed -- that I’m involved with don’t have a great deal of enthusiasm for the Dream companies including yours that we’re talking about today. One of the concern is that the excessive fees both in terms of numbers and dollars charged and the shareholders don’t seem to be able to get the opportunity of getting any incremental value, growing on for some time and in most cases the Dream shares are below their issue prices. I’m just wondering if there is something you would like to comment on in terms of the data [ph] that I’m finding and got the shareholders don’t seem to be able to understand exactly where the Dream philosophy is going?

Jane Gavan

I think it's fair to say our -- if you’re looking at Dream Office we have been -- we are trading below where we obviously would like to and certainly below some of our peers. I think because we’re so office specific and the office is facing that market is definitely facing some headwinds, I think that’s certainly part of why we have seen a decline in our share price. It's well known that some of the trends that I’ve talked about I think people are baking into. We have got new supply coming on the market, so there is concern about the office market and we’re exclusively in office REIT. Vis-à-vis the Dream brand I mean we’re focusing a lot of time on making sure that people understand the merits of that platform and we do see merits in Dream, the cross pollination that happens across the REITs. The ability to have expertise like we’re talking about with a guy like Victor Settino in terms of all the efforts that we need to make in the construction, in the intensification of the portfolio. That’s sitting in the Dream Group.

We do get value from that platform but I think we’re going to start to realize over the next couple of years as we intensify this portfolio.

Mario Barrafato

And I think if I can add I mean, we have been very, very transparent with the structure and I think we’ve been very open into and I think demonstrating the value, the bench strength and the depth we have here up until a year ago our stock was trading at 37, so I don’t think it's the structure that is causing a problem. I meet with a lot of investors, retail institutional and we’re very open on how we do things and I think we have a style that people respect and I think we really respect capital.

I think what Jane said is, right now is a very difficult time to be excited about the office market in Canada, there is lot of uncertainty and we’re seeing a lot of capital, go to other places where we could generate higher returns, have a bit more certainty and what we’re trying to do right now is to really, really simply the story, take measures to derisk our company and also add elements of revenue growth and element some of that uncertainty so then people could investment choice. I think it's a really difficult time to be excited about the office market that’s where I think the reason is where there is lack of enthusiasm right now.

Lewis Baker

I’m going to ask one question, I’m very familiar with your international and your industrial in terms of the fee structure. Does Dream has the office building REIT has the same fee structure for various -- raising of funds, transaction fees et cetera. That the other two companies have?

Mario Barrafato

Yes it does. There is one change, international has a different fee structure, it's a little more complicated it requires little more resources but otherwise the office REIT and the industrial REIT for example has the same fee structure.

Lewis Baker

Well I think that’s one of the concerns of the shareholders that I think maybe management should address. In terms of the dollars involved every year and in relation to the price of the stock especially for the other REITs that are below their issue price, something just doesn’t add up for the shareholders and I think it makes many shareholders very uneasy and I think we’re going to see potentially what H&R did is sell off their management to the company at an exorbitant price and the management fees got high enough. So these are the concerns that I’m feeling and finding other shareholders are feeling. The primary benefit is not necessarily for the shareholders.

Mario Barrafato

I think sir, I mean, like I said we have tried to be very transparent. We have added a lot of value in the last five years especially. We took a company that was focused in one market. We have diversified the company, grown the company, we have made some great acquisitions that have increased in value. So it's all very transparent. At the end of the day it's just an investment decision and there is a period of time where with the fee structure that’s there the value generated is what an investor wants and there is times where sometimes the cost of the structure doesn’t generate the returns an investor wants but I think like in our case it's very transparent and investors have choice and we’re going to make it, we’re going to get to a point where it's going to be compelling to own Dream office units again.

Operator

Thank you. (Operator Instructions). Our next question is from Matt Kornack of National Bank Financial. Please go ahead.

Matt Kornack – National Bank Financial

Just quickly in terms of when you look at assets sales and moving the portfolio around, do you have a goal in mind in terms of moving from suburban to downtown or B to A or West to East or is it just on an asset specific basis that you’re looking at asset sales?

Jane Gavan

I think we’re looking specifically on the assets that just don’t fit in that, it could be geographically. We want to lighten up in a certain node or it's fairly asset specific. I don’t think we’re making a big call that we want to load up west to east or east to west. We’re just calling that portfolio and seeing on an asset by asset basis what doesn’t work.

Mario Barrafato

And also Matt, our company has risk and what we’re trying to do is derisk and so if we can trade a lot of roll over that’s happening in the next few years or more stabilized asset that’s a trade. We would make that makes our company better. So it's really individual by individual asset.

Matt Kornack – National Bank Financial

And on that basis the 6 – 9 cap rate should we be looking for sort of high six low seven cap rate for assets sales going forward?

Mario Barrafato

Yes I would say 6.5 to probably 7 yes.

Matt Kornack – National Bank Financial

Okay. And then just quickly on the development side, you mentioned ground up development, is that in the specific markets or is it pretty much across the portfolio that you’ve identified at this point?

Jane Gavan

We have identified it in specific markets where we have excess land in Saskatchewan and Vancouver and in Markham and we have a site in Kitchener Waterloo so that’s where we are focusing our efforts right now.

Matt Kornack – National Bank Financial

Okay but nothing sort of in terms of downtown Toronto with some of the older stock buildings that you could potentially tear down and then put up something new, nothing at that point has been or at this point has been discussed for that type of property?

Jane Gavan

So the four assets that we just talked about what we would consider sort of the low hanging fruit, the easy ones we first identified now there is going to be a next layer of enquiry exactly that. What are the sort of the jewels if you will in the portfolio and downtown Toronto? Where do we intensify those assets? Whether we do a redevelopment? That’s all part of our enquiry right now.

Operator

Thank you. And our next question is from Mario Saric of Scotia Capital. Please go ahead.

Mario Saric – Scotia Capital

Maybe just coming back to the JV with POBA and Dream Global to the extent that you can -- can you talk about whether POBA expressed any interest in investing in Canada? Or whether simply a situation where perhaps your Dream Office doesn’t have the use of proceeds to redeploy capital at this stage? I’m just trying to get a sense of the overall foreign investor appetite for Canadian real estate in the current environment.

Jane Gavan

That’s a good question, POBA not so much, they were really focused -- Germany was their target for 2014 and we focused on that potentially later but right now they were focused on Europe. That being said, we met when we went to Asia at the end of the year last year with a variety of investors some of whom are very interested in Canada. So, I think Canada doesn’t hit the radar as much as you would think. Typically we were meeting with people who are looking at the gateway centers, U.S. -- U.S. looked like it was more interesting in terms of growth.

Now Canada starts to look interesting again, but I think we see Europeans who are look at Canada. For the core stuff I think people are very interested in the joint venture with us and we look like we would be good partners.

Mario Saric – Scotia Capital

I think we often under appreciate our own cities, living in Toronto when you talk to international investors, you use Toronto as the gateway city or get off the radar?

Jane Gavan

You know want it's so interesting we have to explain to them how big Toronto is, how close it is to the United States, fourth largest city in North America really is surprising to a lot of investors. So part of every meeting there is an education on Canada, the economy, the opportunities, Toronto in particular. I think the Europeans are much more interested. They have been here, they left, maybe they are coming back. But the issue for international investors is how do they get scale?

Mario Saric – Scotia Capital

And then maybe just one question on the operational side a real quick one. I think Mario last quarter you indicated a target economic occupancy of 92.5% by the end of the year, is that still the case?

Mario Barrafato

I indicated that because we had some deals but due to the timing we’re probably going to end up 91.5% Q3 and probably around that in Q4. Some of the deals we thought we had in the pipeline now have been pushed out to the next year.

Mario Saric – Scotia Capital

Okay more of a timing issue as opposed to losing kind of tenants --

Mario Barrafato

Yes right now we’re seeing the velocity, we started the year with the higher to normal list of known tenants vacating and so tenant retention suffers and with that comes downtime and a bit of drag but we’re seeing velocity so it's really the issue right now is timing.

Operator

Thank you. We have no further questions at this time.

Jane Gavan

Okay. Thank you everyone and we look forward to reporting back next quarter.

Operator

Thank you. And thank you ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.

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