Dream Industrial REIT (OTC:DREUF) (TSX:DIR.UN) delivered an OK Q1 2019, with positive same property net operating income growth. We believe strong demand for industrial properties will continue to drive rental revenue growth for the REIT especially in Quebec and Ontario. Dream Industrial continues to trade at an attractive valuation to its peers. It also offers a 6.1%-yielding dividend. We believe Dream Industrial is a good investment choice for investors seeking both capital appreciation and dividend income.
Data by YCharts
Recent Developments: Q1 2019 Highlights
Dream Industrial had a good Q1 2019. The company saw its SPNOI grew by 0.4% year over year. The growth was primarily driven by growth in its Ontario and Quebec portfolio. Its SPNOI growth rates in Quebec and Ontario increased by 5.4% and 1.6% respectively. While Q1’s SPNOI growth rate was only modest, management reiterated its 2019 SPNOI growth guidance of 2% ~ 3%. Management also expects the growth rate to accelerate as the year unfolds.
Earnings and Growth Analysis
Strong market fundamentals
The rise of e-commerce and the demand for fast delivery has created strong demand for warehouses and fulfillment centres. In order for retailers to deliver products to the consumers quickly, these warehouses and fulfillment centres need to be located near urban centres. Unfortunately, industrial lands near larger cities are scarce, and in strong demand. This is exactly what PwC’s latest report states:
With increased need for last-mile delivery and e-commerce facilities, logistics and fulfillment continue to be a major opportunity for creating value. As tenants look for increasingly larger spaces, vacancy rates are tightening and rents are rising.
In fact, in PwC’s report, the article identified fulfillment centres and warehouse properties as the top two developments prospects for 2019. Similarly, fulfillment centres and warehouse are ranked first and third in terms of investment prospects for 2019. We believe Dream Industrial’s light industrial properties that are located within proximity of major cities are well suited to take advantage of these secular tailwinds.
Looking forward, we think e-commerce sales growth rate will remain robust. In addition, consumers increasingly demand quick delivery once they ordered their products online (e.g. within 24 hours). In order to satisfy the demand, the need for more warehouse and distribution centers closer to customers will not diminish any time soon. As an article published by National Real Estate Investor states:
We are likely still in the middle stages of building out the necessary infrastructure to continue to meet growing consumer demand and thus the industrial sector likely continues to expand (albeit at a much slower pace) even in the face of a minor recession.
This should provide some tailwinds for Dream Industrial as demand should remain robust in the next few years.
Favorable leasing spread
The strong demand for industrial properties has resulted in a decline in availability rate. As can be seen from the table below, availability rate of industrial properties in Canada is expected to drop to 2.9% by the end of 2019. This is significantly lower than 2017’s 4.1%. As a result, net asking rent is expected to climb from C$6.97 per square foot in 2017 to C$8.11 per square foot in 2019.
Source: CBRE Research 2019
Below is a table that shows Dream Industrial’s average in-place base rent and estimated market rent in different regions. As can be seen, Dream Industrial should be able to increase its base rent in Canada from C$7.26per square foot to C$7.70 per square foot if all are to be renewed now. This would mean an increase of 5.4% in average rental rate.
Source: Q1 2019 Report
In some markets, this ratio is even higher. For example, in Ontario, estimated market rent is 14% higher than in-place and committed base rent. Year to date, Dream Industrial has signed 39 leases totaling 389,000 square feet. Dream Industrial has locked in rates that are on average 26% above expiring or prior in-place rates, along with 3.0% annual rent increases over the term of the transacted leases. In Québec, Dream Industrial has signed 279,000 square feet of leases since the beginning of the year, locking in rates that are on average 7% above expiring or prior in-place rates.
A focus in Ontario and Quebec
With its initial U.S. expansion strategy successfully executed, Dream Industrial expects to focus on growing its Canadian portfolio. Management has indicated that the area of growth will be in Ontario and Quebec and has a potential acquisition pipeline of C$200 million.
Dream Industrial’s focus in Ontario and Quebec is beneficial as both provinces have much higher market rent growth rates than the national average. This is also evident in the strong SPNOI growth rate in Dream Industrial's portfolio of properties in Ontario and Quebec. As can be seen from the chart below, market rent growth rates in 2018 have reached 8.5% and 3.0% in Ontario and Quebec, respectively.
Healthy balance sheet with staggered debt maturity schedule
Dream Industrial’s debt to asset ratio is 42.4% at the end of Q1 2019. This was lower than Q4 2018’s 43.5%. The current ratio is also within management’s target range. The REIT also has a well-staggered debt maturity schedule with maturities well-distributed over 11 years. As can be seen from the table, there are no significant debts maturing before 2021.
Source: Q1 2019 Report
Risks and Challenges
Higher exposure in Western Canada
Since about 26% of Dream Industrial’s properties are located in Western Canada where the region’s economy is heavily dependent on the energy sector, a sharp decline in oil price may trigger a recession in the region (e.g. 2015/2016). This may negatively impact the demand for industrial properties in the region.
Possibility of elevated supply
Although oversupply is currently not an issue in Dream Industrial’s major markets, investors should keep in mind that industrial buildings are not difficult to build. A lengthy period of undersupply can trigger lots of new constructions. Fortunately, it appears that supply and demand will remain balanced in Canada as there are only 17.68 million square feet of industrial spaces under construction in 2019. This number is even below 2018’s 18.49 million square feet.
We expect Dream Industrial to generate adjusted funds from operations of C$0.71 per share in 2019. This means that it is trading at a price to 2019 AFFO ratio of 16.2x. This is significantly lower than its Canadian peers. Its peers Summit Industrial REIT (OTC:SMMCF) and Granite REIT (GRP.U) are trading at price to AFFO ratios above 20x. Therefore, we believe Dream Industrial is trading at an attractive valuation.
Attractive 6.1%-yielding dividend
Dream Industrial currently pays a monthly dividend of C$0.05833 per share. This is equivalent to a dividend yield of about 6.1%. As can be seen from the chart below, its dividend yield is towards the low end of its 3-year yield range. Even so, its dividend yield is still significantly higher than its peers. Summit Industrial REIT and Granite REIT have dividend yields of 4.2% and 4.5% respectively. Although Dream Industrial has not raised its dividend since 2013, its dividend is secure with FFO payout ratio of 83.7% in Q1 2019.
Data by YCharts
Dream Industrial should continue to benefit from the strong demand of industrial properties in Canada and the United States. We like the fact that it is also trading at an attractive valuation to its peers. It also has higher dividend yield than its peers. Therefore, Dream Industrial remain a fine choice for investors seeking dividend income and capital appreciation.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.