Dream Office Real Estate Investment Trust

Jane Gavan - CEO Rajeev Viswanathan - CFO Michael Cooper - Chairman

Sam Damiani - TD Securities Mike Markidis - Desjardins Alex Avery - CIBC Capital Markets Mario Saric - Scotia Bank Neil Downey - RBC Capital Markets Mark Rothschild - Canaccord Genuity Matt Kornack - National Bank

Thank you very much. Good morning.

Welcome to the third quarter conference call for Dream Office REIT. With me today are Rajeev Viswanathan, our Chief Financial Officer; and Michael Cooper, our Chairman.

Rajeev and I are going to make a few comments and then we’re going to open up the call for questions. We continue to make good progress on our multiyear strategic plan for Dream Office.

As you know, we built the plan with the same approach of a private equity firm grouping our portfolio into three segments; core, private market and value-add. The private market assets are the properties that we believe would be the most lucrative, good pricing and for which we set a three-year target of 1.2 billion of sales.

To-date, we’ve sold almost 480 million with another 330 million under various stages of negotiation. The liquidity and pricing assumptions on our private market assets continue to prove out with these transactions being completed largely at our carrying value.

The eight assets sold during the quarter include a property in Markham, a suburban portfolio in Ottawa and Gatineau and some suburban assets in Vancouver. Our Alberta portfolio comprises the majority of our value-add assets.

At the onset of our strategic plan, we initially thought that an improvement in market fundamentals would be required to improve their demand profile and liquidity. However, we’re beginning to see potential opportunities to realize value at a reasonable price and we’ll have more to report on this front in the coming months.

As we execute on our plan and as we sell assets, we continue to make the REIT smaller and more concentrated around our highest quality real estate in the key office markets in Canada. On the leasing side, so far this year we’ve addressed 88% of our expiries for 2016 and with the committed and high-probability deals in our pipeline, almost 50% of our 2017 expires.

Our core portfolio, which represents 40% of the Trust’s comparative NOI performed in line with our expectations and continue to deliver stable performance this quarter. The core portfolio had in-place and committed occupancy of roughly 98% with a WALT of nearly six years.

We’ve addressed all of our leasing maturities in the core portfolio for 2016 and have made good progress in addressing our 2017 maturities with over two-thirds having been secured. And now I’ll give you a quick overview of our markets.

While Alberta continues to be a challenged market, there are however a few bright spots with some oil companies like Canadian National Resources and the Thai’s state-owned energy company PTT be starting oil sands projects; and of course with the election in the U.S. possibly a green light for Keystone.

Colliers noted in their Q3 report that they’re seeing increased activity for space under 5,000 square feet and we’d agree that we’re seeing more activity at least in terms of touring space which could start to translate into more transaction volume as the positive momentum continues. There are few examples about our province operators starting to look at Alberta for low cost space alternatives.

In our portfolio, we thought with De Beers relocating their Canadian head office from Toronto in our Airport Corporate Center in Calgary. During the quarter, we completed the lease-up of 444 and are pleased to have done a deal to convert office space on the ground floor to a strong retail amenity for almost 10,000 square feet.

Saskatchewan’s economy has not been hit as hard as Alberta; however, there is some softness with weaker commodity pricing including potash and uranium and this is leading the provincial government to reduce some of their space requirements. That said, in the quarter we’ve had some good traction renewing our government tenants.

Ottawa was a flat market as the federal government continues to work on space efficiency through their Workplace 2.0 program. We’ve invested in our buildings over the past years to meet the new requirements and we believe our assets are going to remain attractive for the government.

Our 175,000 square foot building at 400 Cumberland, for instance, is going to see the Department of National Defense leave in 2018; however, now it looks like they’re going to be staying longer and potentially for another three years. Montreal’s office market is rather flat; however, 700 700 De La Gauchetière is largely leased and our large floor place make the building more efficient and competitive than others.

The GTA is seeing some competition from new and existing supplies as well as subleased opportunities but the value proposition our properties provide with excellent amenities and location at a price well below new build continues to retract and retain tenants. Interest in our vacant space increased in the fall and we’re anticipating this is going to translate into greater volume with new leasing to close in the fourth quarter and early 2017.

Downtown Toronto continues to perform very well with market occupancy sitting at 97.6%. The new construction is well leased and we’re seeing that there are few options for large tenants currently in the market.

Our largest downtown vacancy is almost 200,000 square feet Scotia Plaza in 2017. We’ve completed 15,000 square feet.

We have 120,000 square feet that’s high probability and we have several prospects for the balance. Our other downtown properties are seeing strong leasing volume with our model suite program continuing to drive the 1,000 to 5,000 square foot leasing.

All-in-all, our 5 million square foot downtown is 98% leased. Now with that, I’m going to turn it over to Rajeev.

Thanks, Jane, and good morning, everyone. I’ll provide a brief overview of our Q3 financial results followed by an update on our balance sheet activities with a focus on some of the items Jane highlighted earlier.

For Q3 2016, diluted FFO per unit was $0.62 compared to $0.65 in the prior quarter. The decline is due largely to the impact of asset sales with comparative property NOI declines offset by interest savings.

In our core portfolio, we saw comparative property NOI increase of over 3% compared to last year and 1% versus last quarter. As we continue to execute on disposition within our private market assets, and as Jane mentioned, potentially some of our value-add assets, the core will become an increasingly bigger proportion of the portfolio.

Our IFRS NAV this quarter declined slightly to $23.46, just under $0.20 resulting from fair value write downs in Alberta, a modest increase in capitalization rates in Saskatchewan offset by gains in our private market assets related to pricing expected to be achieved on upcoming sales. In Alberta, as Jane mentioned, we’re starting to see some liquidity in that market and adjusted our valuations in accordance of IFRS requirements for assessing fair value.

This resulted in approximately $40 million downward adjustment in our Alberta portfolio to $890 million which implies a value of about $150 a square foot and it implies equity value of $3.30 per unit. In addition, we continue to realize interest savings through dispositions and refinancing activities.

During the quarter, we repaid mortgages totaling approximately $180 million with an average fixed rate of 5% and renewed our refinanced mortgage totaling $91 million at an average term of eight years at 3%. With eight properties disposed of since the end of last quarter and proceeds largely allocated to debt repayment and continuing investments in our core assets, our leverage metrics have improved with our debt to EBITDA now at 7.3 times and our overall leverage levels at 15%.

Our liquidity position also remains very strong with $700 million available in cash and undrawn on our lines. Our leverage and liquidity are key measures that will continue to improve.

In the fourth quarter, we made some reductions in our staffing to adjust to the changing scale of our business. These reductions were made in the operations of the REIT as well as in our shared services across the Dream platform.

Starting in 2017, we expect annual savings from these measures of over $10 million. The majority of this reduction will flow through to our tenants as we keep operating costs flat with the remainder to the REIT’s bottom line as we’ve reduced corporate costs.

For 2017, we should see up to $4 million of improvement to FFO as a result of this initiative and we’ll take a provision of between $5 million to $6 million. With that, I’m going to turn it back over to Jane.

Thanks, Rajeev. We’ll open the call to questions now.

Thank you. Good morning.

Good morning.

Just on the bids that you’re receiving on these Alberta properties, what types of properties are you entertaining bids on? Are they the ones with high occupancy and relatively stable cash flows or short-term leases?

What kind of cap rate relative to what you’re carrying it on the balance sheet right now in terms of the average?

Hi, Sam. It’s Michael.

Good morning.

We entertain everything, it’s just our way of doing business. On the specific assets in Alberta, we’ve looked at some assets that we think are great to own in long term and we plan on doing that.

And otherwise we’re seeing how the market is. There are some positive things happening in the oilfield and it’s pretty hard to get properties.

So we’re just working with different people to see if we can find a place to meet that makes sense for us and for them. But I’m not going to comment on specifically prices or anything like that.

We’re far from that.

Okay. And I understand any sales out of the value-add bucket would be in addition to the 1.2 billion out of the private market grouping?

Well --

Sorry.

Go ahead.

I was going to say what would the excess proceeds be directed towards? I know in the past you’ve talked about potentially buying back stock if there was excess proceeds around, but just wondering what your view is today?

We’re thrilled to get through our third quarter – next month we have a strategic review with our Board and then in February I think is the time we’re going to talk a lot about what the future plan is. So I want to keep you in suspense as our President-elect would say.

But specifically, we really like assets that we own that have quite a lot of predictability around cash flow and we’re going to focus on those. Those assets are quite expensive.

We’re not looking at buying any other assets, so there are only two other choices for what to do with capital is to pay down debt or look at buying back stock after we take care of our assets. So that’s on the table for sure but we’re not there yet.

But clearly that would be – if we were to get to the – meet our goals on dispositions, we would definitely be looking hard at buying back stock to right-size the company.

Okay. Thank you.

Thanks and good morning. Just to clarify on the $300 million of assets that you have under contract or various stages of discussion, would any of the properties in that bucket be located in Alberta?

Sorry, what was the question? There are some under discussion in Alberta and pretty much some that aren’t.

Okay. So that $300 million figure includes some Alberta properties then?

Yes. But we’re kind of – we’re working on some things based on the accounting, what we have to disclose.

It’s a really awkward position on a sale. When you’re buying assets, you don’t have to disclose until you’re committed and the deal’s done.

On a sale, you have to disclose when – you’re sort of working on deals and the auditors say you got to sort of recognize it. So it’s a very awkward process.

If it helps anybody, the way we look at the company, every – $25 million of value gain or loss off of what we think things are worth add about, almost about $0.01 per $1 million in terms of NAV for the company. We have a lot of work to do before we have really defined our thoughts around an ultimate NAV of what we want to own.

And as we get through the next months and year, let’s say, the actually proceeds have a really big impact on the NAV of the company. So we talked about stock buybacks and where we are on different things.

So much of what we’re doing is really in a zone that we got to complete our work before we have an ability to answer for you or our Board’s question. So it’s so sensitive to pricing, we need to get some more work done before we could answer far-reaching questions.

Okay. Second question for me and last question actually is just, Rajeev, on the CapEx side, I notice that your total spend, including TIs and leasing costs, did moderate this quarter, which is good to see.

Any thoughts on what a reasonable assumption for that figure would be in 2017?

Michael, we’re working through our business plan as we speak. We’re going to be having our Board strategy meeting in December.

I think I’ll provide more color on that come on the year-end call, Mike.

Okay. Thanks very much.

I’ll turn it back.

Thank you. Just on Scotia Plaza, you continue to invest in that property and modernize it.

But the recoverable portion seems to be declining a little bit as that spend goes on. Can you give us a sense of where you are in terms of the total spend on that project and what we can expect in terms of the recoverable portion of that on the remainder?

Hi, Alex. So the total project which incorporates the lead, the elevators, the food court and the lobbies and common areas is $80 million.

We’re about just under two-thirds of the way through that, so there is remaining about just under 20 million left to spend over '17 and '18. I think what you’re alluding to in terms of recoverable is really because of the food court and the common areas.

I’d say we’ve said before about 70% to 75% being recoverable and I think that’s about right over the entire $80 million project.

And is that 80 million for your interest or is that the total 100%?

Yes, that’s the total project’s size. We’re about halfway through that 80 million in June and so we’re committed to 50% along with our partner for 50%.

Okay, that’s great. Thank you.

Hi. Good morning.

I’ll give it my shot at a couple of Alberta questions. Just coming back to the bids that were received, can you give us a sense of the number of bids that have been received that provided the basis for the $40 million or so write down on the Alberta assets during the quarter?

A note was just passed to me that says no. Look, we took a write down end of August, which in a way was an advertisement to people who might be interested in acquiring assets in Alberta.

That started a series of conversations; some of them more serious and some of them not serious at all. We’re pleased with the level of interest.

We took a write down to a number we thought was reasonable. It is too early to tell how our IFRS number relates to what we could actually achieve, because we’re really on the frontend of it.

So can’t help a lot – I can’t give a lot of detail and I think that again for the February meeting, I think we’ll be in a much better position to talk about the capital and the core assets. Our business is clearly in transition.

We can’t tell everybody what we’re doing live. We’ve got to get some work done before we can disclose it.

Okay. I suspect you might refer to the same piece of paper for this one, but given your IFRS valuation for Alberta where it stands today, can you give us any color in terms of how that compares to your tax basis on those assets?

Ironically, it’s a different piece of paper that says no. Actually that one’s not too bad.

The IFRS value to tax, it’s okay. Meaning – sorry, do you know the number out for sure.

I don’t have the exact number. Mario, I’m happy to give you a call after.

Yes. When I say it’s okay, what I mean is if we sold the assets at IFRS value, we would not have a tax problem.

We may have a loss. But all those assets were written up a lot.

So the tax base isn’t that high. So it’s kind of insignificant, the difference, so you would be – I don’t think you’d be surprised to the tax effects from anything we do in Alberta.

Understood. But I guess what I was getting at is if theoretically you sold your entire Alberta portfolio, would be required to pay out a special distribution to meet REIT requirements?

No. What I meant was it actually may increase the amount of deferral we have.

It’s either neutral or it will increase the deferral.

Got it. Understood.

Okay. And then the last question for me is, like there’s a clear I think focus on potentially making the company smaller, really focused or using the downtown Toronto as the core of the portfolio.

You’ve done a great job of reducing leverage, becoming more efficient. How do you kind of balance that with the existing distribution and what would be kind of the target AFFO payout ratio if there is one, once all is said and done?

Look, in order for us to have a target payout ratio, we’d had to have a portfolio that we could identify. We’d have to know sort of how much debt is left and how much debt is left has a lot to do with what purchase price we get.

We’re probably a year away from being able to answer the question specifically but I would say that we want to get a company that has high-quality income, predictable income, probably a lot less CapEx because if there’s less turnover, there’s just more demand for the assets. And have a payout ratio that makes management comfortable to sleep at night.

But we can’t attach numbers to that until we figure out what the portfolio will be.

Okay, I appreciate the color. That’s great.

Thank you.

Hi. Good morning, everyone.

Jane, in your letter to unitholders, one of the points you made is that you think that reducing the Alberta exposure might kind of help now the discount between where the units trade in your net asset value. Is that point really just referencing the fact that I think – a few moments ago, Michael said that, ‘It’s just a bit too early to tell whether the IFRS numbers are equal to what can be achieved on the Alberta assets.’

How do we think about that statement?

Yes. I think what we’ve been seeing over the last quarters is that people ascribe no value or less than no value to the Alberta assets.

So I think we’re going to try and dispel that. We’re looking at reducing the risk profile overall for the company.

Obviously, Alberta’s a shadow for folks. People are worried about it.

So as we think about Alberta, we want to reduce the risk profile and give more visibility. So ultimately talking about driving toward a higher quality asset base and then it’s just going to be easier for investors to see what the value of the company is.

Great. Rajeev, if I think about I guess the three types of assets in the business; core, private market and value-add, at a high level you’ve given me an update at where the gross asset values are in that regard; I think 2.6 billion for core, 1.9 billion for private market and 1 billion for value add.

Do you have the debt numbers associated with each of those three categories?

Yes, sure, Neil. It should also be on our investor presentation but I’ll give it to you very quickly.

On the core bucket, about 1.1 billion of debt; on the private market bucket, roughly $800 million of debt; and on the value-add, roughly $0.5 billion.

Okay, thank you. And the 4 million to 6 million --

And you know about – obviously the $450 million of unsecured that I consider kind of corporate level debt.

Right, of course. Thank you.

The 4 million to 6 million of reorganization costs, those will be incurred – I guess is it split evenly between the fourth and the first quarter, or is there some different --?

The majority of it in the fourth quarter.

So most in Q4. Will they be charged against FFO, i.e.

they’ll reduce FFO and FFO per unit?

Yes.

Okay. And then in terms of, I’ll call it corporate structure and contractual arrangements some 18 plus months ago, the REIT was subject to the external asset management arrangements.

Would these same costs have been incurred, i.e. the 4 million to 6 million if that same AMA was in place today?

Because I think you indicated the private shared services, et cetera.

It’s Michael. None of the cost incurred or cost saved related to cost that used to be covered by the asset management.

The shared services like office services, I’d say, were all charged under an administrative agreement. And I think with regards to anybody affected by it, they were all people who worked for the REIT prior to 18 months ago.

Okay. Thanks, Michael.

That’s it for me.

Thanks and good morning. With all these asset sales, really a lot of capital gone to pay off debt and strengthen the balance sheet.

Maybe you can talk about the strategy going forward as you progress on these assets, they’ll get closer to completion as far as resuming growth in the REIT. Is there a focus on markets or types of assets that we should expect?

And also is this something that you would expect to resume in 2017?

Okay. I’m not sure I understand the question.

We’re in the beginning of this process. We’ve made some good waves so far but I think we’re going to continue.

So clearly it can go to 2017. We’ve got a lot of work to do over the next two months on this strategy and the business plan for next year.

So, again, we’re not ready to answer the question but we’re definitely not ready to talk about how we’re going to grow again after this. We’re talking about maybe 18 months from now and I don’t know what economy we’re going to have then or what the value of the properties will be or what the value of the stock will be.

But I think that once we get to a business that we’re really comfortable with and has high-quality assets, we’d be totally open to growing. But we only want to do that with assets that are equal to or better than what we have.

So we’ll see what opportunity there would be then. And we’ll see what opportunities there are intensifying or developing but it’s way too early to even quantify or really discuss in detail any of those things.

Okay. Thank you.

Thanks.

Good morning. Just wondering with regards to CapEx and allocating spending, are you looking at only investing in the core portfolio at this point, or would you put money into some of the existing assets that you may sell to lease or get them leased, so you maximize value there?

Look, I think you’re right in terms of how you’re thinking about it. We are focused on the core assets and we’re comfortable investing with the capital there.

As we mentioned on our last call, Alberta there really needs to be a lease tied to it and we really need to see a return on that. And I think with the private markets, I think it kind of depends.

In some cases, some of those assets aren’t ready yet to be taken to market, in which case we’re happy to invest the capital because we’re comfortable we’re going to get that money back.

Okay. And with regards to occupancy on an in-place basis looking into 2017 assuming no further asset sales, is that trend stabilizing?

I know there are a few tenancies coming off, but are you going to be net lower on occupancy or do you think you stabilize at this point?

I think you’re right in terms of being on an in-place being lower in 2017. As you know, we’ve got the major known vacates in our core portfolio, really the BLG space, as Jane talked about, and at 438 University.

Again, I’m talking about the core where we’ve leased that to a government tenant starting back up at the end of 2018. So I think generally speaking, you’re going to see occupancy dip next year but we’re fairly comfortable in terms of leased pipeline, particularly in the core portfolio to lease them back up.

Okay. And suburban Toronto, it looks like it was a little bit better this quarter; other segments, maybe not so much.

But geographically, what are you seeing? I know you talked to it high level, but the urban core versus suburban within your portfolio?

Matt, I think you’re right. I think we were pleased this quarter.

We’re seeing a lot more activity in our suburban Toronto assets. There’s more velocity there and I think we’re going to see that translate into occupancy over the coming quarters.

And I’d just refer back to my comment I on the urban core stays strong; Alberta is challenged; Ottawa, I think our buildings are ready to deal with whatever the government’s going to do and Montreal’s pretty flat.

Okay, great. Thanks, Jane.

Thank you everybody for joining us so early on a Friday morning and we really look forward to reporting to you next quarter. Thanks very much.