Dream Office Real Estate Investment Trust's (DRETF) CEO Jane Gavan on Q4 2015 Results - Earnings Call Transcript

| About: Dream Office (DRETF)

Dream Office Real Estate Investment Trust (OTC:DRETF) Q4 2015 Results Earnings Conference Call February 19, 2016 8:00 AM ET

Executives

Michael Cooper - Chairman

Jane Gavan - Chief Executive Officer

Rajeev Viswanathan - Chief Financial Officer

Analysts

Sam Damiani - TD Newcrest

Alex Avery - CIBC World Markets

Mark Rothschild - Canaccord Genuity

Adam Waldo - Lismore Partners

Mario Saric - Scotia Capital

Neil Downey - RBC Capital Markets

Michael Markidis - Desjardins Capital Markets

Matt Kornack - National Bank Financial

Operator

Good morning, ladies and gentlemen. Welcome to the Dream Office REIT Fourth Quarter 2015 Conference Call for Friday, February 19, 2016.

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 would 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 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. [Operator Instructions]

Your host for today will be Mr. Michael Cooper, Chairman of Dream Office REIT. Mr. Cooper, please go ahead.

Michael Cooper

Thank you, operator. Good morning and welcome to our year-end conference call for Dream Office REIT. I’m here today with the CEO, Jane Gavan; and our CFO, Rajeev. The strategic plan presentation is on our website and it might be helpful for people to follow along with it.

Getting into the call, we’ve been unhappy about the unit price for some time and we were investigating how to close the value gap. Last night, we announced our strategic initiatives which will make a profound difference on how we run the company. We’ve taken our time to get to this decision because we’re very disappointed to cut the distribution and we wish that we did not need to.

We’ve benefited over many years from the support from our retail investors and we value your support. We believe that the change announced yesterday will lead to a better unit price and a better business for all investors.

The market is very concerned about our ability to continue to pay our distributions over the long term, primarily due to the issues of owning office buildings in Alberta. Based on all of our work, discussions and observations, we’ve decided to target the sale of one-sixth of our assets over the next three years, which we believe would generate over $700 million of liquidity.

We’ve decided that we should take the same steps for our unit holders that a private equity firm would take on behalf of their investors. Our focus is on how to improve total return over the next few years rather than on income alone. We’ve performed exhaustive work on all of our assets and determined that there are three types of assets that we own.

We have about $2.9 billion of core assets with equity of about $1.7 billion. These assets are best assets in downtown Toronto, 700 De La Gauchetière in Montreal and Station Tower in Burnaby. These assets are core to our business and we don’t intend to sell an interest in the assets that we own 100% of.

The next grouping, private market assets, are assets that we believe are sellable at fair prices in the current state. These are the type of assets that private equity funds would start selling before transaction is completed. And as you expect, these are the assets that we start to sell with $154 million closed in 2015 and we’re in advance negotiation in additional almost $300 million.

In total, this year, we expect to close on the sale of these $300 million of assets that are currently under negotiation and then we will continue to bring other assets to market throughout the year and we will try to sell the $1.2 billion at a fair price as quickly as possible.

We’ve been working with our investment group over the last six months [indiscernible] selling assets as we have been in the past when we were active buyers. If we’re successful selling $1.2 billion of assets, they will contribute $700 million to our equity. Effectively, we’ll plan start using the proceeds to pay down debt, but as we make more progress we’re open to buying back stock quite aggressively.

The third bucket is value-add. These assets need some further leasing or change in the market conditions to sell at a reasonable price. The total value of these assets are about $1.5 billion. These are assets that attract the biggest discount to the perception of our company and we work to improve the assets and make progress on the sale when we can.

Another [indiscernible] that we’re pursuing to improve our metrics. We already have a reasonable debt ratio at 48%, but we’re hoping to reduce it to at least 43%. In addition with the cut in distribution, our payout goes to 67% of the 2016 consensus AFFO, which is a leading number in the industry.

As a result of these changes, we have an excellent balance sheet and payout ratio. In addition, we’re cancelling the DRIP so that we’re not issuing any unit at a big discount and we don’t have to buy units in the market to maintain the same outstanding units.

Finally, we’ve raised $800 million revolver facility with a syndicate of 10 banks. This is an increase over existing $355 million line by $445 million and at closing will have $550 million undrawn.

As you can see from our presentation we released this morning, between our cash, available credit, proceeds from our $1.2 billion sales program and remember that only one-sixth of our assets, we’ll have total liquidity of $1.3 billion for a company with $1.8 billion market cap.

We believe that reducing the dividend to have a low payout ratio, selling ordinary assets to crystallize the discount, eliminating the DRIP, the increase [indiscernible] completely changes the reason to own Dream Office. Of all of our announcements today, all will be completed over the next few days other than the sale of assets.

With $300 million either firm or in advance stages, we hope to achieve the sales goals faster than the three years. However, we don’t know how the market changes, so we want to give ourselves time to make excellent decisions.

In addition, we hope in the same time period to have progress on improving and selling the value-add assets. We believe that the core assets are difficult to replace and we want to own them into the future. Some value-add assets may become private transaction assets or core assets depending on how we do and how the economy changes.

As an example, [IDM Place] in Calgary would be a core holding as it is fully leased, it’s a relatively new building in a good location, it’s getting better. But we do not believe at this time any Calgary assets can be core. We’re beginning with the disposition target of $1.2 billion of private transaction asset sales and we’ll increase it as we make progress and the stock continues to trade at discount.

For a sense of scale, the core assets represent $15 per unit and the balance, net of corporate obligations, represent $16.70 per unit. From our highest IFRS value for our assets, we’ve already taken fair value write downs on private transactions assets of $180 million or 7% and $240 million or 14% write downs on the value-add assets. So our IFRS value that we [indiscernible] already reflect significant write downs in peak valuations.

To describe this in another way, the market cap of the business equals the value of the private market transactions and the value-add assets. It’s also equal to the value of the core assets. At the current price, [indiscernible]. Our plan is to surface value that is no longer the case.

Based on the changes of the distributions, the business [indiscernible] normalized CapEx and leasing, but also to fund the capital necessary to improve the marketability of the value-add assets. This means that we can carry on our business without reducing the value of our operations, without using up cash to support that.

As regards to the changes announced today, Dream Office has cash flow from its business for all of its needs. Second, there is no dilution or grinding of value based on pursuing our strategy for years. Thirdly, we have the most liquidity we have ever had, with the addition of our $800 million revolver and we will generate significant cash from our asset sales.

One last word to our retail investors, we have benefited from your support for many years. We much prefer to maintain our prior distribution rate which supports your financial planning. Some of the analysts and institutional investors think that we have waited too long to make these changes. However, we have taken our time because we know that this is a serious matter for you.

We believe that the changes that we announced today will provide you with more value even if we had not made any changes. I hope that you’re happy with your investment with these changes. And if you’re not a unit holder, I hope that these changes encourage you to become one.

I’ll now turn the call over to Jane.

Jane Gavan

Thanks, Michael. First, I’ll go into a bit more detail about our strategic plan and then I’ll provide an update on our operations and leasing progress in the fourth quarter of 2015 and year-to-date 2016.

Since December, we worked closely with our Board to formulate a strategy with the goal of improving the long-term value of the business and narrowing the discount between the unit price and our view of net asset value. I’d like to think of our strategic plan in these following steps.

First, we have revised our distribution from $2.24 to $1.50 per unit to preserve more of our cash flow in an uncertain environment. Given where the unit price are trading, we’ve also decided to suspend the DRIP to minimize dilution and preserve value of the unit. Previously, our DRIP was just below 40%, so the net cash distribution was effectively $1.40 per unit. Our revised distribution will approximate the cash distribution previously and will no longer have dilution from issuing units at low prices.

We’re very pleased to announce that we’ve received commitments from a three-year $800 million revolving line of credit from a large syndicate of Canadian and global lenders. Dream has always had a great relationship with its lenders and it’s encouraging to see they remain as confident in our business as we are. This revolver facility offers us tremendous flexibility in executing our strategic plan and day-to-day operations of the business.

Last year, we announced our intention to sell non-core assets to fund our NCIB program, because we identified early on the disconnect between the private market valuations in many of our assets versus the substantial trading discount in the public market. Our target of selling $1.2 billion of private market value-add assets over the next three years feels like a natural extension of our strategy in 2015.

Year-to-date, we have about $300 million of dispositions in negotiation, which will net us about $170 million. The assets are diversified geographically in Ontario, BC and Quebec. In total, we’ve identified approximately $2.6 billion of similar nature which we think will attract immediate interest from domestic and foreign buyers. We’re optimistic in achieving our target and getting fair value for our assets.

In our presentation, we’ve shown a few different ways of how Dream Office is undervalued in the marketplace. As you know, our core portfolio is worth about $15 per unit, which approximates our unit price just a few days ago. If we can crystallize value on any asset outside of the core portfolio, we think that will help narrow the discount to the trading price.

With respect to operating results, since Q4, we’ve been very successful in signing new leases and renewals. For 2015, Dream Office completed about 2.6 million square feet of renewals and new leasing. The REIT had its best year in terms of future leasing, addressing almost two-thirds of its 2016 expires by the end of 2015. That number is now almost 70% and the pipeline is very good.

This metric is important not only because it represents almost as much leasing which was completed in 2015, it demonstrates the stability of the real estate and addresses some concerns in the market that vacancy will be permanent, particularly in respect to some of the larger vacancies and that is simply not the case.

As we start 2016, we’re seeing good activity on our larger upcoming 2017 vacancies. We’re in advance discussions with an A+ credit rated tenant to take most of the building at 438 University, completely replacing Loyalty who lease the building in the fall of 2017.

National Bank has added another 67,000 square feet to the 120,000 square feet they took in the third quarter in 700 De La Gauchetière. Our Aviva building in Scarborough which has about 325,000 square feet of vacancy coming up on Aviva lease the building in 2017 is located right on the proposed LRT and will likely be sold at the development opportunity. And at Scotia Plaza, which VLG vacates at the end of 2016, we’re seeing a lot of tour activity.

At the end of the year, Dream Office concluded a deal with State Street to lease space occupied by Dream Office 30 Adelaide. The REIT has relocated to the 37th floor of Scotia Plaza, creating space designed to showcase the attributes of the building and how well it suited to collaborative open concept, higher-density usage.

We held an event in this space which was attended by over 100 brokers who are very impressed to have a floor layout. Together with the renovation of the lobby and the elevators, Dream Office’s space goes a long way to demonstrate the AAA quality of the REIT’s largest asset. We’ve already received an expression of interest to lease this space from us.

Calgary is and will likely remain a challenging environment. However, we’re very pleased with the leasing traction we’ve had there over the last months. In addition to the two 28,000 square foot deals at 444 7th subsequent to quarter end, we finalized a new 56,000 square foot 10-year deal with a top Canadian law firm. With this deal complete, we will substantially address the 100,000 square foot space formerly occupied by the National Energy Board.

We completed a major renovation of lobbies, elevators, washrooms and amenity space, conference and fitness centers to projects which we attribute to the success of the deal. This showcases our commitment to leasing this space and remaining a strong competitor in the market, taking the building from roughly 61% occupied to now virtually full.

Not only we’re committed to new leasing, we’re focused on tenant retention. We held our first ever broker roundtable this year to receive feedback on how to better improve our processes, [appeal] and marketing. We’ve also surveyed 60% of our tenants for performance feedback. These initiatives have provided valuable insight on what meaningful improvements can be made to our service and buildings and we act on those surveys and communicate back to tenants, again all focused on tenant retention.

Now, with that, I’m going to turn it over to Rajeev to talk about the Q4 financial highlights.

Rajeev Viswanathan

Thanks, Jane, and good morning everyone. I’ll provide a brief overview of our Q4 financial results, followed by an update on our balance sheet activities, with a focus on the strategic initiatives that were highlighted earlier on the call. Lastly, I’ll provide some color on our outlook before turning it back over to Jane.

For Q4, diluted FFO per unit was $0.70, a penny higher than Q3. The quarter over quarter difference is mainly attributed to interest cost savings from debt refinancing. We also took a fair value decline of approximately $80 million in the quarter on our investment properties, due largely to changes in cash flow assumptions for Alberta and Airport Road properties, while cap rates were held fairly consistent compared to Q3.

On our last conference call, I commented on how we were trading at a substantial discount to our NAV, even with no value assigned to Alberta. To put this in perspective, we presented a few ways to look at this on slide 17 through 20, but I’ll point you to slide 20.

If we were to write off the equity value of the entire Alberta portfolio, over $1 billion, and assume only the mortgage balance is left, it works out to about $110 per square foot, half of the replacement cost excluding land with an implied cap rate of 18.2% on a $117 million of NOI.

With respect to our leverage metrics, debt-to-gross book value and net debt to EBITDA, they are 48% and 7.7 times, respectively, safe levels that will only get better as we execute on our disposition strategy. For example, for every $400 million of asset sales, assuming all the proceeds go to delevering, we will see approximately 300 basis point decrease to our debt to gross book value and a half turn improvement to our net debt to EBITDA.

As noted earlier, we secured commitments on an $800 million revolving credit facility. This financial arrangement improves the safety of our business by, one, bolstering our liquidity with the potential to bring this to well over $1 billion as Michael mentioned, and two, providing us ample time to execute on our strategic plan to close the valuation gap.

The facility will provide us with a lot of flexibility, including the ability to move assets in and out of the collateral pool or to repurchase units opportunistically. Separately, we’re also close to refinancing our First Tower mortgage in Calgary for $40 million coming up in April of this year.

With our enhanced liquidity position, we plan to pay down on approximately $86 million of debentures in 2016. This includes the early redemption of our $51 million 5.5% convertible debentures and we will also pay $35 million of upcoming unsecured debentures that bear interest at 5.95%. We also have $350 million of mortgages maturing in 2016, with a weighted average interest rate of approximately 4.8%.

With the strategic initiatives highlighted, there are several moving pieces and it’ll be difficult to provide guidance. Alberta will remain a challenging leasing environment and in 2016 we expect occupancy to decrease with 175,000 square foot at [Shared Collins Departure] at First Tower, representing the largest vacancy.

Having said this, the outlook for the remainder of our markets should be flat year over year, with a few ups and downs over the course of 2016, which speaks to the durability and sustainability of the underlying asset cash flows.

And with that, I’m going to turn it back over to Jane.

Jane Gavan

Thanks, Rajeev. Operator, we would be happy to take questions at this time.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Sam Damiani from TD Securities.

Sam Damiani

I was just wondering if you could speak to your thoughts on Alberta, just thinking about where the unit price is today, it seems even you could sell some Alberta assets at even distressed pricing, you still crystallize some value above the current share price. So I’m just wondering why you’re choosing not to go at that exposure today.

Michael Cooper

I think that, right now, it feels as if Alberta is frozen. We have some assets in the middle bucket, the private market transaction bucket in Alberta that we think we can sell. Our take on what’s happening in Alberta is there is a dance going on between people who are interested in buying and people who might be interested in selling. And I think it’s probably best to see a few transactions happen rather than leaving the market.

So I think in the slide we used $110 a square foot is what the debt is, we said that’s pretty cheap. And I think that as things settle down, we might start to see some transactions. And I would say that right now, if you’re at a pension fund or you’re a pension fund advisor, it’d be pretty tough taking Alberta asset to your investment committee until a few other people done it.

So I think this is one of the cases where it’s probably better to be a little bit patient, improve the assets. Jane just did a great job with her team on 444 7th, so now that building, if there was a reasonable market could be sold. So I think we’re just going to take our time on that. I don’t think pushing it has been a help to the company.

Sam Damiani

So if you do see some trades over the course of the next several months, you could change your mind. But at this point, you just want to wait to see that happen?

Michael Cooper

I don’t think it’s the time to be a pioneer, but we’re watching it very closely.

Sam Damiani

And then regarding the dispositions that are underway, the $300 million, what’s the timing on that and do you have indications on pricing there in terms of them being in line or above or below your current IFRS values?

Michael Cooper

Yes, you know that. I’m wondering if I should tell you. [indiscernible] $10 million gain over IFRS value, but that could move around a little bit. So we’re selling a lot of work, there is a lot of information, you’re always at a mercy of the due diligence on the other side, take a long time to close. We’re looking at this $300 million I think will be between now and May.

Sam Damiani

In terms of closing?

Michael Cooper

Yes.

Sam Damiani

And what would the sort of average cap rate range be?

Michael Cooper

Just to be clear, Sam, we have some that are firm, we know when they’re going to close. We have other ones under contract, maybe they don’t go through at all. But all the stuff we’re working on is in the near-term. The cap rate, it’s about 6.5%.

Sam Damiani

Just one more and I’ll turn it back. On the NCIB, I understand the first priority is debt repayment which makes sense. But what is left under the current NCIB in terms of what you’re allowed to do and more of the take for you to go beyond NCIB limits to more aggressively repurchase shares?

Michael Cooper

I think we have about $7 million left. And I’m not sure when it comes up, but I think $7 million is a pretty good shot. I think what we’re trying to say is the priority is to get the business metrics in place, so that we have a wider audience of investors. Our company has been very active in share buyback from time to time and I could see a time where it’s just being very aggressive to buy back stock.

But we want to make sure we have more certainty within the business and get investors come along. So hopefully the stock price will be at a place where it doesn’t make sense to buy back stock, but we want to work on the plan first and then we’ll buy back stock.

Sam Damiani

If need be?

Michael Cooper

If the opportunity is there. Look, if we can get through $1.2 billion of assets and have $1.3 billion of firepower and buy back stock at $15, there is going to be a lot of arm wrestling as it was in the last year. And what we’re saying on this plan is we’re going to do the $1.2 billion. If that doesn’t do it, we’ll keep going. But what we’re saying is we’re looking at the fundamentals of the business first, not the financial engineering with the buyback, but we’re totally in favor of a buyback if it’s really accretive.

Operator

Our next question comes from Alex Avery from CIBC.

Alex Avery

I was just hoping, Michael, you mentioned that the $300 million of non-core asset sales that you’re working on right now would have a 6.5% cap rate roughly, can you expand on that a little bit and tell us what kind of a range of cap rates we might see on the non-core dispositions?

Michael Cooper

Yes, it goes from [4% to 10%]. You know what, this is what it’s like. It’s a variety of assets and quite honestly some of them are at a 40% premium to IFRS value, none of them are much of a discount. But by the nature of the assets and the state that they’re in, there is a real range to cap rates.

Alex Avery

It sounds like you’re not really contemplating any asset sales or anything non-stabilized on a per square foot basis, this is all substantially fully leased and appealing for a broad array of buyers?

Michael Cooper

You know what, it’s interesting you say that because I’ve never seen more different kind of a market than we do now. So something unstabilized or whatever the word is in Vancouver could go for a very high price so asset by asset, market by market. The other one I would say is it looks like Aviva is a development site, its 13 acres on light rail transit line and I think that’s probably the best thing for us to do with it. So it’s a real variety.

Alex Avery

And then just on the distribution reductions, I noted that in the presentation you’ve comped yourself against a number of other large Canadian REITs and just wondering if the target range that you chose to go with reflects your positioning within the REIT universe in terms of payout ratios or if there was some other science, not that there is a lot of science to it, but if there is some other science behind the magnitude of the reduction?

Michael Cooper

I think that the science is that at that rate, we think we have the cash to take care of all of the ongoing needs. To the way it was before this, with $2.24 distribution, 40% participation in the DRIP and buying back stock, we were using up cash. And if we didn’t, we would be degrading the value per unit. So we didn’t want to devalue the units at all. We want to be in a clean run rate, so that next year, the year after, the way we use cash doesn’t diminish the asset value. So I think we got the cash to do that now.

And I think the second point is if we have a chance to have the type of metrics that make our business much more attractive to institutions, we would like to appeal to them. So I think we wanted to make it safe and some of the people can count on.

Alex Avery

And I guess I’d also speak to the motivation for the substantial increase in the line of credit, just want to have more than enough firepower, that would be the thinking?

Michael Cooper

Tim Geitner spoke about putting cash in the windows during the depression, so that if you showed enough cash in the window of the bank nobody would come and ask for their money. So to be clear, we are showing almost as much liquidity as our market cap and there is no issues around liquidity. We have tremendous flexibility and Rajeev talked about how we’re going to – it gives a lot of money to take on any debt that we don’t like the terms of and maintain a relatively low debt level. And then with the sales, bring the debt level down further.

Operator

Our next question comes from Mark Rothschild from Canaccord.

Mark Rothschild

I think you answered a question in your presentation, but I want to make sure I’m clear. In the asset sales, are you considering selling even a partial interest in any of the core assets? And in particular, does that mean that you’re not looking to consider selling any part of Scotia Plaza?

Michael Cooper

What I said specifically, Mark, was, I’m going to find it, wait a second, I think what I was saying was we weren’t going to sell any portion of the assets we own 100% of and that was a way to say that we own two-thirds of Scotia Plaza now and we may make some changes to that in conjunction with our partner. So there you got it.

Mark Rothschild

You’ve laid out that it was – that the strategy is after three years to sell these assets or you said it could happen sooner. Concerning the liquidity in the market now, is it possible that it’s completed entirely in 2016?

Michael Cooper

We’ve done a lot of work on that and I think that’s ambitious even in this current marketplace. The difficult part is we don’t want to say things and then there is changes in the market and it makes it more difficult to execute on the plan. So the three years clearly is what we wanted to say is a safe amount of time. We’ll be striving to do better and we’ll keep you informed every quarter.

Mark Rothschild

And then just my last question, you talked about operating more like a private equity type fund and the strategy as far as distribution and the DRIP and selling assets, but you’re not really going to the full extent of maybe even buying back units quicker with your private equity fund, probably be more aggressive on. Maybe you can just let us know like was the payout ratio just have a certain comfort for this year or how did you really get to that number?

Michael Cooper

I think it’s a number that we use, we actually use a three-year timeframe and I think the number works fine for three years. A lot of it is predicting the future. Let me be clear on one thing. In 2008, during the financial crisis, we had 63% of our income coming out of Alberta and that was safer than 27% today. Alberta has gotten really tough and it’s gotten worse. So we can all have wonderful intellectual conversations, but we don’t know what happens next out there and we want to make sure that we’re as safe as we can be. Does that answer your question?

Mark Rothschild

Yes. Thank you.

Operator

Our next question comes from Adam Waldo from Lismore Partners.

Adam Waldo

With respect to the strategic plan in a very high level, physiologically I think what’s been depressing the unit price relative to NAV for some time is just emotion among your retail investor base about the Alberta exposure. And obviously if that’s carried at zero, the stock is still trading at a huge discount to the rest of the business. So in your strategic plan, why not consider a spin-off of the, which you’re calling the value added assets into a separate entity and hold the rest of the company for value accretion overtime?

And then the second part of my question is of the $1.3 million of liquidity you’ve identified to be developed by the strategic plan, how much do you expect to be earmarked through share repurchases versus deleveraging?

Michael Cooper

The first part about the spin-off, we spent a lot of time on that and that would have been an excellent choice. We actually look at it differently. Because of the debt, we want to keep the Alberta assets in Dream Office and spin out the stable assets. In that way, there’d be no guarantees by the good assets against the troubling assets. But that’s just technical. The issue came down to tax and the cost to the unit holders was prohibitive. So we went from that to this plan because it was too expensive to do that.

Adam Waldo

I’m sorry, so you couldn’t do that as a tax-free spin or a low tax rate spin then in any of the structures you contemplated?

Michael Cooper

No, we could do it at a highly taxable spin and it was literally prohibitive because you have to do it at a fair market value, so you end up paying tax, cash tax now and you still have the entity. And I don’t remember the number, but it was a number of something like $4 to $5. So we just couldn’t do it.

Again, I love that question because when we come out with a plan, you don’t see the 17 plans we didn’t come up with. But on that one, we actually had a way of doing it and then it just broke down. It was really complicated with collapsing partnerships and those strict rules we just couldn’t get around it.

On the buyback and I guess you know what, since your questions are so excellent, we’ll get the best answers. What we modeled was if we sold $1.2 billion of assets and we have $700 million of proceeds, if we use $350 million to pay down debt and $350 million to buy back stock at the range that the stock is in now, we’d end up with 43% debt level and we’d end up with a significant increase in both AFFO and NAV. Anybody can do the numbers if you want to, but I think the numbers turned out to be about a 6% increase in AFFO and a 14% increase in NAV. And that would be a wonderful position to be in.

Adam Waldo

And then the other liquidity, you’ve identified $1.3 billion of gross liquidity. You’ve talked about how the $700 million of net proceeds from that asset dispositions might be used. But would you tap your incremental revolver capacity as well as be cash flow freed up from reducing the distribution for further repurchases? I mean, I’m just trying to think about just back of the envelope, how of the $1.3 billion do we think are going to share repurchases or unit repurchases and how much to deleveraging or I know it’s a little bit of a moving target.

Michael Cooper

It is a moving target. I guess what I was saying was, we probably don’t want to take the debt level down, nor up. So in a situation we’re talking about, we take the $700 million, use half to reduce the debt, half to buy back stock and that would leave an additional $600 million liquidity on the line, which quite honestly we’d be happy to have it there.

But I guess, Mark had asked a question about will we buy back stock early and I think that that’s something we had a discussion at the Board yesterday. And if there was tremendous selling next week, we would start to buy back stock and it’s a draw. We would love to be aggressive on the buyback, but I think we want to make sure that we execute the plan as well.

Operator

Our next question comes from Mario Saric from Scotia Bank.

Mario Saric

Just maybe coming back to the priorities of delevering versus buying back stock, I think Michael you’ve addressed it quite well just now. Does that priority change at all depending on the magnitude of the discount to NAV? We’re getting a sense that you want to pay down debt before you look at NCIB, but hypothetically if you’re trading at a 60% discount to NAV as opposed to 50% or 40%, does that change things or are you fairly confident in your desire to pay down debt first before getting to NCIB?

Michael Cooper

I appreciate the opportunity to clarify the answer. Yes, we will have a trigger finger to buy back stock, if the stock price stays where it is after this plan is released. So your example was – and I’m going to stick to your example. If the stock was trading at 60% discount to value and we’re proceeding on some of the sales, we’d actually be paying down some of the debt. And I think in that case, we’ll be very aggressive.

We don’t know where the stock is going to be; we’re not allowed to participate until Tuesday. And we don’t know where the stock is going to settle out. But if the stock is down, I think you’ll see us being very active.

Mario Saric

With respect to the asset sales and the three buckets that you’ve broken out, I just want to get a better understanding of the liquidity and kind of ease of sale of the private market assets versus core assets. So let’s say on a scale of 1 to 10, your core assets would be 8, 9 or 10 in terms of ease of sale in this environment with respect to foreign capital coming in or domestic pension funds increasing allocations, what have you. On that scale, where would you peg the ease of sale for the private market assets? And is the marginal buyer a different buyer for that bucket than it was for the core?

Michael Cooper

Just so you know, we did that, but we didn’t do it your way. We said if it’s really a sale, do we use a 10 or a one? We used one as the most easy to sell and 10 the hardest. So we did it a little different than you said. But we actually went through the same exercise and that’s actually in a lot of ways how we ended up with these buckets. And I think we’re talking about the core assets were basically 8 and better, and the private market assets were probably 6 to 8.

Jane Gavan

And as it turns out – I mean the assets that we have for sale or in the process of being sold are sort of in that private market bucket, a good chunk of them where people have approached us to sell. So I think we’re feeling pretty confident about the liquidity of that bucket we intend to sell.

Michael Cooper

And the purchasers were a series of pension fund advisors, high net worth guys. I would say that the unspoken one is the high net worth guys.

Mario Saric

So would it be fair to say limited foreign interest in those assets?

Michael Cooper

No, those were also high net worth guys. Of the foreign interest, we are seeing individuals who are high net worth.

Mario Saric

And then maybe just once again on the asset classification, can you provide us your estimated replacement cost per square foot by bucket?

Michael Cooper

No. I mean, not because I wouldn’t, just we don’t know it. But we can get back to you.

Mario Saric

And then maybe debt to fair value for the private assets versus the value add asset?

Michael Cooper

Actually on the value add, low 30s. All the numbers have to do with secured mortgages, not with the unsecured. Does anybody here have it by bucket?

Rajeev Viswanathan

So roughly $2.9 billion for the core bucket, we got roughly $1.2 billion of mortgages. For the private market bucket, about $2.6 billion of assets, roughly $1 billion of mortgages. And then if you take our value add bucket, $1.5 billion of assets and just under $600 million of mortgages.

Operator

Our next question comes from Neil Downey from RBC Capital Markets.

Neil Downey

I did miss some of the opening remarks, so maybe this is answered. But the $2.6 billion of private market assets, what’s the significance of identifying $1.2 billion for sale versus let’s say $1 billion or $2 billion?

Michael Cooper

It could be $1 billion or $1.2 billion, but in our numbers we want it to be bigger than $1 billion. The $2.6 billion is a group and basically going back to Mario Saric’s question, we mark them all based on what we thought the liquidity was. In that $2.6 billion, we want to have flexibility as to how we get to the sale.

So we’ve been selling a lot of the assets that we wanted to, but we’ve got some pretty desirable assets that will be much higher rating that we could sell if we needed to. So we’ve left a lot of room so we can manage our way through this. So that’s why we had a $2.6 billion bucket.

One thing I think everybody should keep in mind is as time progresses assets will migrate from one bucket to another, either up or down. But we thought that the $2.6 billion, $1.2 billion was an achievable number.

Neil Downey

The remaining legacy of the asset management arrangement with Dream Unlimited, is as I recall, economically like a 15% carried interest in the upside value of the portfolio. So how does that pencil out today if you sell $1.2 billion of private market assets at their IFRS values? Are there some payments that are crystallized in favor of Dream Unlimited?

Michael Cooper

I think you wrote that that was worth over $50 million [is worth zero]. Just as a quick snapshot, if the proceeds were above, if the whole company was sold at about $29, there might be a payment. We’re nowhere near the money, it’s irrelevant.

Neil Downey

Michael, your memory is very good on that $50 million.

Michael Cooper

Yes, [you will be actually writing] something later on about the 202 actually is more like 96, but that’s a point you and I can talk a little privately.

Neil Downey

The distribution of $1.50 a unit, Rajeev, do you have numbers for 2015 in terms of all the tax character of last year’s actual distribution, like $2.24, how much is return of capital versus income versus other allocation?

Rajeev Viswanathan

It’s roughly 60% deferred and 40% taxable.

Neil Downey

And my final question and I suspect you’re probably going to tell me this is totally irrelevant to your business anyways, but this $51 million goodwill write off, just remind me what that goodwill actually related to originally and like what’s the significance of the write off all of a sudden in the fourth quarter?

I mean, I read what it said in black and white, it says that it was written off because of significant increase in the weighted average cost of capital during the fourth quarter, but it seems to imply that that’s related to the share price going down. But the share price was down last year and the year before, and there was no partial write off like – I suspect you’ll tell me it’s irrelevant to your business, but can you put some additional context to it?

Rajeev Viswanathan

The $51 million we wrote on the acquisition of Whiterock long before my time. So as we through a year-end audit process, we’re required to revisit our goodwill and with our weighted average cost of capital, with the unit price trading where it is, you run a very technical GAAP calculation and we work with our auditor and we wrote it off. Also, I’m a different CFO.

Operator

Our next question comes from Mike Markidis from Desjardins.

Michael Markidis

First of all, following up on Neil’s question on the tax character of the distributions, could you find yourself in a situation in 2016 or 2017 if you’re very aggressive on the asset sales where you might actually have to pay a special distribution?

Michael Cooper

That’s a possibility. It’s tough to comment on hypothetical, but yes, that is a possibility.

Michael Markidis

And then just with respect to shrinking the size of the company through the asset sales, have you had any discussions with your credit rating agency on how they view the plan and what the potential impact might be to your credit rating?

Michael Cooper

Not as yet, but we would think everything we’re doing is going to be credit positive.

Michael Markidis

Maybe just turning to the operating environment, close to 70% of your 2016 leasing or lease expires secured and I think it’s a very good outcome at this juncture of the year. Can you comment on the nature of that group with respect to how much of that was renewals and how much of that would be new leases?

Michael Cooper

Out of the 69%, 75% of it is renewals, 25% of it is new deals.

Jane Gavan

And it’s largely, fairly even across the country, more in Toronto than out West.

Michael Markidis

And then finally just with respect to a couple of large leases that you’ve signed, specifically the former NEB space in Calgary and the Loyalty one, can you give us a sense of where the new rents are penciling in versus what was expiring? I know NEB was all over and probably not comparable, but just trying to get a sense of what rent numbers are.

Jane Gavan

NEB isn’t comparable because we had extended them. So that was much higher rent. I think Michael and I were talking about this a few days ago and the truth is we are focused on the NAV of this asset; it was really helpful to get that building leased. It’s competitive, no doubt; we like the term and we certainly like the covenants. So we’re just pleased to take up the occupancy in that building. But it’s a tough market, no doubt. In the mid-20s.

Michael Markidis

Mid-20s would be?

Jane Gavan

[Base rate].

Michael Cooper

So what’s happening there was there is no formation of business in Calgary. So every tenant, you got to get from somewhere else and we’re happy to get a tenant at a base rate around $25, but you got to give a lot of stuff away to get them.

Michael Markidis

And then I may have missed it, but did you comment on the LoyaltyOne space as well, I mean obviously you’ve not signed a deal yet?

Jane Gavan

Yes, we are in negotiations for a big tenant that it will take up more than the Loyalty space and they are going to be – their base rate is better than what Loyalty’s was.

Michael Cooper

I would say that that’s really astounding [indiscernible] University, there is tremendous demand for that building. I don’t think – I mean I know our guys worked hard on leasing, but it’s not as people had anxiety about it. And I think it’s going to turn out to be the same thing as Scotia Plaza. And then when you go out west to Alberta, it’s very tough, so we’re seeing very dramatic differences in the various markets.

Jane Gavan

I think I said it in my comments, I think there was some concern that the vacant space in particular the big 2017 expires, people were marking as though those were permanent. So case after case, we’re demonstrating them not permanent. 438 is a good example, we moved actually a tenant from that building to another one of our downtown properties and now have more than replaced Loyalty and that tenant. So that building is now virtually full.

Michael Markidis

And last question for me would just be on with respect to CapEx, last year it was fairly elevated. I’m just wondering does the new strategic plan and having these value add assets now identified more clearly, is that going to change what you think your CapEx spend might be in 2016 and 2017, or should we be expecting something roughly a similar magnitude as to the prior year or what are you thinking there?

Michael Cooper

I’ll just talk and say order of magnitude roughly the same. Right now, we’re looking at just for 2016 right now about $60 million to $65 million, about a quarter of that is Scotia. And then when you look at that, roughly 70% to 75% of it is recoverable from tenants.

Michael Markidis

Sorry, I actually lied. I have one more. Rajeev, could you just comment – there has been a lot of views on financability of assets in Western Canada and it sounds like you are close to getting at least a bridge mortgage done for F1RST Tower. Is there something unique about that asset, because it does carry a substantial amount of short-term vacancy when that rolls? So how should we look at that asset versus maybe some of the other assets in terms of financability from a secured lending perspective?

Rajeev Viswanathan

To your point, it’s going to be a short-term bridge and it’s one that we’re leveraging our relationships with.

Jane Gavan

I think, Mike, recall, we spend a lot of money on that building. When you’re standing in the lobby of F1RST Tower, it feels like you’re in the lobby that’s above. We worked a lot on the connection, the past connection. I think that building is going to be leasable and I think the lenders believe so too. It’s just going to take some time. But in terms of the space relative to the pricing of the space, it’s really an attractive building.

Operator

Our next question comes from Matt Kornack from National Bank Financial.

Matt Kornack

With regards to this new private equity strategy, is this just a temporary response to where the market is today or going forward beyond this three-year plan, do you plan to continue having a low payout ratio type model and ultimately continue to invest in the properties and buy assets of core nature?

Michael Cooper

I think that this does free us from the treadmill of being close to full payout. So I think that that’s going to be more permanent. And I think it’s not a light statement, I think there was so much focus on AFFO historically that it made it hard to think longer-term and be more creative. So I think that this is a permanent change to how creative we’re going to be within the business.

If we ended up with core assets and 40 million shares, we’ll be okay with that. So if the discount continues we will just keep working with the assets to make the company smaller. If the discount doesn’t, I think we’re going to continue to have a lower payout ratio and pursue other kinds of opportunities that maybe we can add value to and use our expertise to make higher returns than we could if we paid out all of our capital.

Operator

[Operator Instructions] Our next question comes from Sam Damiani from TD Securities.

Sam Damiani

Just wanted to delve into the leasing on the former National Energy Board space, the rent is in the mid-20s and I think everyone agree that’s a pretty strong rent. But what were the leasing cost incentives provided to the tenants to achieve that and the term of those leases, just wondering if we could get a picture of what the NER is looking like on those deals?

Michael Cooper

I don’t have the details, but we don’t look at that way. Effectively the way we look at it is the space will continue to be vacant unless we do something and we look at it more how much time would have to pass, like if we want to lease this space, we’re going to have to pay people to move in with tenant [free rent] and then we will work on that space for a couple of years.

So if you do a net effective renting from day one, you’re going to start charging off cost to this space is low. But the way we look at it is if you go out 12 or 18 months, because it used to be empty anyways, it will be fine and the least add to net asset value a lot compared to not having the tenant. So we would look at net asset value and I’m sure it adds $5 million or $10 million to the value of the building by doing it.

Sam Damiani

But I’m just wondering if you could give us even a rough estimate or range of what I guess equivalent number of months was given to the tenant in terms of free rent and incentives?

Michael Cooper

I don’t have it and regional manager isn’t here. But we can get back to you on it.

Sam Damiani

Just more broadly speaking, your AFFO calculation for the year hasn’t changed in terms of your estimate of normalized leasing and incentive cost. What’s your outlook for that calculation that you’re going to be publishing over the next few quarters?

Rajeev Viswanathan

Look, it’s something that we’re looking at. In our disclosure, we indicate that there are elevated leasing costs over the next period of time. So it’s something that we’re going to be looking at. The other thing I’d say is hopefully we provide enough clear and sufficient disclosure in the MD&A for people to calculate it on their own and make their own estimates. But again, the way we think about it is on a more long-term normalized basis.

Operator

We have no further questions at this time.

Jane Gavan

Thank you everyone for joining us today. We’re really pleased to share with you our new strategic plan and look forward to updating you on the progress. Thank you very much.

Operator

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

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