Dream Industrial Real Estate Investment Trust (OTC:DREUF) Q2 2022 Results Conference Call August 3, 2022 10:00 AM ET
Company Participants
Brian Pauls – CEO
Lenis Quan – CFO
Alexander Sannikov – COO
Conference Call Participants
Mark Rothschild – Canaccord
Sam Damiani – TD securities
Kyle Stanley – Desjardins
Gaurav Mathur – iA Capital Markets
Matt Kornack – National Bank Financial
Pammi Bir – RBC Capital Markets
Sumayya Syed – CIBC
Operator
Good morning, ladies and gentlemen, welcome to the Dream Industrial REIT Second Quarter Conference Call for Wednesday, August 3, 2022.
During this call, management of Dream Industrial 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 Industrial REIT 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 Industrial REIT filings with securities regulators, including its latest annual information form and MD&A. These filings are also available on Dream Industrial REIT website at www.dreamindustrialreit.ca.
Later in the presentation, we will have a question and answer session. [Operator Instructions] Your host for today will be Mr. Brian Pauls, CEO of Dream Industrial REIT. Sir, you may begin.
Brian Pauls
Good morning, everyone. Thank you for joining us today for Dream Industrial REIT 2022 Second Quarter Conference Call.
Speaking with me today is Lenis Quan, our Chief Financial Officer; and Alexander Sannikov, our Chief Operating Officer. Dream Industrial’s operating results continue to highlight the quality of the business and the growth opportunities embedded. In our portfolio, we reported a 12.6% increase in FFO per unit for the quarter led by strong CPNOI growth and lower cost of debt.
Our pace of CPNOI growth rose to another record high of 10.1% in Q2 with Quebec leading the year-over-year growth at nearly 16% followed by Ontario with a 12% year-over-year growth, both driven by solid rental rate and occupancy increases. Despite higher interest rates due to inflationary pressures and a more hawkish tone from the central banks, industrial fundamentals continue to be strong across our operating markets. This has resulted in low availability, tight supply and strong capital values. There is now a significant disconnect between the public market pricing of industrial what we are seeing in the private markets. In Canada, we continue to build on our attractive market positioning in our core markets of the GTA, GGHA, and Greater Montreal area through high quality acquisitions, as well as executing on our development and intensification pipeline.
With the national vacancy rate at just 1.6% and several markets with sub 1% vacancy industrial fundamentals continue to remain exceptionally strong. On nearly 2.5 million square feet of leases transacted to date this year in Canada, we’ve achieved rental spreads of 31% led by spreads of 71% in Ontario and 42% in Quebec. In Europe, notwithstanding geopolitical events, we have continued to see strong demand for industrial space. Our European portfolio is essentially fully occupied with committed occupancy at 99%. Within place rents below market and a high efficacy level. We are confident of driving healthy rental rate growth on over 1.1 million square feet of leases transacted this year in Europe, we have achieved rental rate spreads of nearly 14%. Our development pipeline continues to be an accretive driver of cash flow and NAV growth while upgrading portfolio quality. Despite inflationary pressures on the cost side, market rent growth has continued to outpace cost increases. Our forecast and level yield on costs for our near term development pipeline have increased from our initial underwriting and now averages 6.3% over 50 basis points higher than our initial forecast. Our strategic initiatives over the past several years have positioned us well to navigate the current market volatility.
With our portfolio, essentially full and in place rents well below market rents, our organic growth profile remains robust and should allow us to drive strong per unit cash flow. Given the market volatility, we expect our near term acquisition activity to moderate compared to the first half of 2022. We have increased our focus on maintaining an ample liquidity cushion and low leverage. We are actively monitoring our target markets and our flexible balance sheet provides a sufficient capacity to capitalize on compelling investment opportunities that are of strategic importance for the rate. Since the end of the first quarter, we completed approximately $368 million of previously announced acquisitions during the quarter that added over 1.9 million square feet of high quality assets to the portfolio.
In Canada, we acquired 7 income producing assets, totaling 500,000 square feet for $136 million as well as 19 and a half acres of development land in the submarket of Calgary. These assets are primarily located in the GTA were acquired well below replacement costs and offer the opportunity to drive significant rental rate growth over time. The average in place rents are over 25% below current market rent. In Europe, we acquired 8 income producing assets, totaling 1.4 million square feet for $220 million. These assets are well located, close to major transportation corridors and leased to high quality tenants.
In the US, we continue to benefit from providing property management and leasing services to the US fund. In 12 months, since the inception of the US fund, we have recognized over $2 million in net property management and leasing income, which is ahead of our initial expectations and we expect the run rate to increase further as the US fund continues to grow. We continue to see a long runway for industrial fundamentals in our business as well positioned to outperform. I will now turn it over to Alex to talk about our organic growth and outlook of our operations.
Alexander Sannikov
Thanks Brian. During the quarter, the value of our assets increased by $45 million, primarily driven by high market rents and increased values for properties that appraise externally. Largely driven by the increase in asset values, DIR, NAV per unit increased to $16.64 and 21.5% increase year over year. As Brian mentioned, we continue to see a significant disconnect between public and private market valuations. For example, our current unit price implies a capital value of about $140 per square foot on our income producing properties, which is significantly below private market values especially as our operating performance remains robust.
Leasing momentum in that portfolio remains strong and we reported 10.1% year over year CPNOI growth this quarter, a new record for the REIT. This was driven by a 6.8% increase in in-place rents and a 1.4% increase in average occupancy. Since the beginning of the second quarter, we signed 1.4 million square feet of leases across that portfolio. In Canada, we have signed over 1 million square feet of leases at an average spread of 39%. I will go over a few key highlights.
We finalized a 275,000 square foot renewal with a major global corporate tenant in Regina for a tenure term was 2% annual steps at starting rents in line with expiring. Recently, we signed we leased our 43,000 square foot expansion project in Richmond Hill to a national tenant resulting in the yield on cost of 11%. Earlier this week, we finalized the commitment with an existing tenants in Montreal for our 120,000 square foot expansion at $14 per square foot was 4% annual steps. We expect to realize a yield on cost of over 8% on this project. In Terrebonne Quebec we finalized a renewal for 57,000 square feet at a rental approximately 100% higher than expiring.
As part of the renewal we agreed with the tenant to expand the building by 29,000 square feet. In Europe, we signed 300,000 square feet of leases at an average spread of 11%. The level of leasing activity in Europe remain strong. We are in advanced negotiations to lease the entire 241,000 square foot expansion, and dress them. We’re also in advanced negotiations on a new lease for of 400,000 square feet in France.
Contractual, rent steps are an important driver of steady CPNOI growth currently embedded steps equate to over 2 and a half percent per year on our Canadian leases and in our recent leases, we have been able to negotiate significantly higher growth with 4% per year in the GTA and 3% per year in the GMA. In Europe, 90% of our leases are indexed to CPI. As a result, the outlook for CPNOI growth remains strong and we continue to expect CPNOI growth of 8 to 10% for the full year of 2022. In addition to same property, CPNOI growth, we continue to see several drivers, NOI and NAV growth across our portfolio. We have made significant progress on our development pipeline and achieved strong yield owned cost on our recently completed projects.
We completed a 65,000 square foot expansion in the Netherlands, which was pre led at construction start. Over the next 12 months we expect to complete construction on 6 projects, totally 683,000 square feet. To date, we have leased approximately 200,000 square feet of space in these developments and are currently in various stages of negotiations and marketing for the balance of the space. We expect that these projects will be substantially leased before completion. We intend to commence the redevelopment of a cluster of 3 buildings on a 10 acre site located in Mississauga.
We’re working towards the construction over 209,000 square foot best in class, net zero carbon facility with an unlevered yield on cost of over 6 and half percent. We expect to start construction this fall, we have approximately 1.9 million square feet in advanced planning stages. Most of these projects are expected to be substantially completed over the next 18 to 24 months with an average yield on cost of 6%. Overall, our assessment is that the market brands continue to outpace increases in construction costs, resulting in improvements in the yield on cost metrics for our development program. We’re also progressing well in our value add CapEx initiatives within our portfolio.
For example, we’re executing on 15 solar projects across Canada and Europe that will add over 22,000 solar panels. We expect an overall capital investment of roughly $12 million within an unlevered yield of over 10%. We expect this income to come online in phases starting the second half of 2022. Overall, we are encouraged by the operating fundamentals in our markets and the opportunities within our business to drive organic NOI and NAV growth as we execute on our active asset management strategy, I will now turn over to Lenis who will provide our financial update.
Lenis Quan
Thank you, Alex. Our financial results are strong and demonstrate the success of our strategic initiatives over the past several years. Diluted funds from operations was 22 cents per unit for the, the quarter 12.6% higher than the prior year comparative quarter due to higher NOI from our comparative properties, successful deployment of our balance sheet capacity and lower borrowing costs as we executed on our European debt strategy. We ended the quarter with leverage just under 30% and with approximately $429 million of available liquidity. Since June 30th, we have closed on one acquisition for $23 million and have another 2 acquisitions totaling $85 million that are firm or in exclusivity, we retain sufficient liquidity and balance sheet capacity to execute on these acquisitions and fund about 70 million in development costs over the balance of 2022.
Our near term debt maturities are limited with only 270 million of debt maturing in the next 18 months. With access to Euro equivalent debt that continues to be priced about 200 basis points lower than north American debt, we expect refinancing these upcoming maturities to have limited impact on our financial results. Our Euro equivalent debt provides a natural currency hedge to our assets and income from Europe. As our assets are nearly fully hedged, we expect minimal movement in our net asset value per unit from changes in the Euro CAD FX rate. On the FFO side, there is some impact due to the spread between our NOI yields and interest rates, the recent, roughly 5% strengthening in the Canadian dollar versus the Euro since the end of the quarter of June, 30th has less than 1 cent impact on our FFO per unit forecast for 2022.
Given the recent market volatility, we intend to run at leverage in the low to mid 30% range and retain sufficient balance sheet capacity to pursue and execute on compelling investment opportunities. We expect FFO per unit for the full year 2022 to be in the range of our prior guidance with the biggest variables dependent on average leverage and foreign exchange rates. Our strong and flexible balance sheet and significant opportunities of driving cash flow and NAV continue to position as well to deliver strong operating and financial results. I will turn it back to Brian to wrap up.
Brian Pauls
Thank you, Lenis. Over the past several years, we’ve built, DIR into a high quality resilient business that is capable of producing strong returns for all of our stakeholders, with the strength of our balance sheet and significant drivers of organic growth. We remain well positioned to continue to create value for our unit holders. I’ll now open it up for questions.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question is from Mark Rothschild with Canaccord.
Mark Rothschild
Thanks, and good morning everyone. Brian, you guys have assembled quite a large development pipeline. Do you see development yields changing at all with rising costs? Things have definitely cost more now than a year ago. Does this change on yields and then does it maybe impact at all whether positive or negative your outlook on growing the development pipeline stronger obviously, rental rates have gone up quite a bit as well?
Brian Pauls
Yes. Thanks mark. I mentioned in my comments we’ve spreads have actually, our yields are actually going up more than the cost, so we’ve increased our outlook on our yield on cost for our developments going forward, so what we’re finding is costs have certainly gone up, but rents have gone up faster, so we’ve increased by 50 basis points our outlook of the development program. We’ve got a significant program in our joint venture with GIC, we’re looking for land throughout the GTA and anyway, so we see our development program continuing to grow. We see that as a great opportunity for us.
Mark Rothschild
Okay. Thanks. I guess I was just asking more about, with values where there are now is if you’re looking to see it growing. Yes. You did answer that. Maybe just moving on to something else as far as I see the move in the fair market values of your assets. Just maybe explain a little more, how you guys look at IFs values. Is it based only on transactions that have occurred in the past, or is it based on where you believe the market is today or where transactions would happen for the most part it’s a slower pace of transactions in the market. I just want to understand how you guys look at it?
Brian Pauls
Go ahead, Alex.
Alexander Sannikov
Thanks, Brian. We’ve looked at as we always do on any quarter we look at the market rent outlook, we look at the implied total returns by these values. We have seen some transaction evidence, especially in Canada. It’s not firm yet not announced, but we’ve we know that there’s been some bidding activity on some portfolios in the GTA in Calgary and the capital values that are implied by the level of bids suggest that our IFs values are reasonable. There was no reason to change that significantly.
We felt pretty confident with those data points supporting our IFs values. In addition, as we said in our prepared remarks the 45 millions of increase and values that we saw at this quarter was largely driven by external appraisals.
Operator
Our next question is from Sam Damiani with TD securities.
Sam Damiani
The business is obviously going extremely well in spite of the macro headlines that we’re all aware of, I guess, just how do you change in the approach of the business given the macro concerns, I guess specifically over in Europe have you changed your strategy in any way in the short as a result of those macro concerns?
Brian Pauls
Yes. Thanks Sam. Generally we’re running the business with very low debt. We’re basically treating liquidity as very precious, we’re re underwriting all of our acquisitions, not just in Europe, but in North America as well. I would say we’re seeing rent growth, we’re seeing opportunities, we’re looking at our acquisitions very carefully to make sure they are one accretive to our business, but 2 also strategic from a location and quality standpoint. Alex, you can talk a little bit about specifically in Europe what we’re looking at and how we’re underwriting given the current environment.
Alexander Sannikov
Yes, thanks Brian. We’ve we continue to see strong levels of leasing activity. In Europe, we don’t have a lot of agency, but we have some developments that are coming up and we’re engaging with tenants. What we’re generally seeing is that the level of leasing activity is robust. In fact, we would suggest that on our availabilities, the level of leasing activity now exceeds the levels that we’ve seen 6 months ago.
It could be a function of our projects being more advanced, or it could be a function of just generally the broad demand in the market. It’s not one or 2 tenants that we’re seeing, for example, on our development in Dresden, we’re engaging with 5 tenants. We won’t be able to accommodate all 5, but that’s the level of leasing activity we see on that particular asset.
Sam Damiani
That’s helpful. Just on the IFs for values, I noticed there was cap rate changes in most markets, very modest, but one market that didn’t see any cap rate changes was Europe. If I’m not mistaken, I wonder if you just I guess address that?
Alexander Sannikov
Yes. That’s a fair observation that said on the cap rate side what we see is we held values largely flat on a capital value basis and the market rent have gone up, NOI has gone up and that really resulted in expanding cap rate. This is consistent with what we see we see across the board.
Operator
We have our next question from Kyle Stanley with Desjardins.
Kyle Stanley
As you work through the planning phase for your future developments, are you starting to see cost inflation moderate, or has access to materials improved at all at this point?
Brian Pauls
Yes, I’ll just start by saying, I think what we are seeing it moderate Kyle it’s certainly going up at a slow rate than it was. The developments that we do are, are concrete steel glazing. Those are the main components and so we’re seeing certainly moderation in those. As I mentioned, as costs have increased, we’re certainly seeing a stronger benefit in rent. The yields are strong, but I think the development outlook for us is positive because of the yields that we can achieve and because of the outlook to supply chain, getting more positive access to labor, access to materials, I think is going to be better for us as we go and certainly intend to continue developing the markets that I mentioned in the prepared remarks.
Alexander Sannikov
One more, I think, to add to that. We just recently received the market for an RFP on a new project in the GTA and we received construction bids from a number of players and the range that we’ve seen in those bids about 7% from high and low and that range would’ve been much wider for 12 months ago. That seems to be a sign that the market is moderating as Brian suggested.
Kyle Stanley
Okay, great. And then you kind of discussed it a little bit, but I’m just thinking more on the tenant side here. Have you seen any changes, whether they be positive or negative in demand per space, desired floor plates types of tenants that are looking for space, or maybe just in another way, is there anything you’re seeing in the market currently that indicates there may be a change in demand or activity in the second half? Just given some of the macro concerns that you’ve mentioned?
Alexander Sannikov
I wouldn’t say that we have seen any significant changes in demand patterns. We continue to engage with 3PLs we have tenants who are looking to expand, we’ve done some renewals with larger corporate tenants. It seems to be a quite range and how we would’ve characterize the demand market 6 months ago. We can’t really point to any significant changes.
Brian Pauls
Kyle, the only thing I’d add to Alex’s comments are that we underwrite very closely, the quality of buildings, clear height base facing truck, maneuvering area, access to main highways and arteries. I would say the use of space is pretty utilitarian. If one particular tenant doesn’t want, it’s very generic space, so it works well for 3 deals for specific users. That’s how we underwrite space. That’s the portfolio we want to build.
Kyle Stanley
Okay. Just a quick, last one for me. I don’t know if you can, but would you be able to provide the average cap rate for the acquisition activity completed during the second quarter?
Alexander Sannikov
We don’t have the second quarter, right here in front of us. We can maybe follow up with you separately if that’s okay now.
Operator
Our next question is from Gaurav Mathur with iA Capital Markets.
Gaurav Mathur
Two quick questions at my end and I’ll begin with the first. Given the macroeconomic volatility and the fact that Europe is heading into a more certain recession how are you viewing the European industrial market from an acquisition and a capital deployment viewpoint? Is there a price discovery phenomenal currently at place or is that still too soon to be said for Europe?
Alexander Sannikov
Thanks for the question. We haven’t seen a whole lot of transaction evidence in Europe, on the investment side. When comments have been made about Europe going into a recession that’s characterizing the broad macroeconomic environment, perhaps. When we think of it just purely industrial market and the fundamentals in the industrial market, what we’re seeing is very low availability stated demand and we are seeing that rates arising rental rates arising and rising faster now than they were called 6 months ago because the development pipeline is flowing also with the cap rates, perhaps being an uncertain metric the development community is looking to get higher rent on their projects to get through the same return. Overall, we expect that if the demand stays as it is now, supply stays moderate or moderate further the operating fundamentals in industrial will remain strong and will outperform the broader real estate market in Europe.
With that, it will inevitably drive the capital market activity because the underwriting confidence will be there. We’ve seen that for example, with Western Canada, 12 months ago, we’ve seen the operating fundamentals kind of pretty robust the capital market activity wasn’t there or there wasn’t a lot of transactions. Then as we’ve seen a couple of quarters of those strong operating fundamentals, that followed by a wave of capital market activity that we’ve seen recently. We remain pretty constructive on industrial in Europe.
Gaurav Mathur
Okay, great. Given the dislocation in public and private markets and you alluded to that as well, are there any considerations towards buying back the stock at current levels?
Brian Pauls
Yes, I mentioned the disconnect between private and public. Right now we’ve not engaged in that we’ve basically kept our balance sheet available for opportunities. We do think we will see opportunities that are creative and very strategic for us. That’s an important priority for us.
Operator
Our next question is from Matt Kornack with National Bank Financial.
Matt Kornack
On your Canadian portfolio you had some of the best red spreads we’ve seen in many asset classes, but for you historically, and also your outlook in terms of the market to market potential increased pretty substantially quarter over quarter and massively year over year. Are we seeing any stabilization in market rents at this point in Canada? Maybe if you could extrapolate what you’re seeing in the US as maybe a more mature market in terms of how we should think of Market rates in the industrial space in Canada?
Brian Pauls
Sure. Maybe I’ll start, Matt, and let Alex elaborate as well. I think we’re seeing continued growth in rents to forecast when they’ll flatten out, I don’t know, but I think we need to reach a, basically an economic rent equilibrium where rents justify new construction. That’s continuing to go up. Rent land prices have maybe moderated, maybe that’s a sign that rents in the mid to high teens will settle in there.
It’s hard to predict that the question regarding the US. US fund continues to grow, what we’ve seen is in tight land constrained markets rents again are continuing to grow, to justify new construction. There’s more space demanded. The only relief valve is new construction and in order to justify new construction, rents are continuing to grow. I think in the tight markets, that’s the case in less land constrained markets we’re seeing rents not grow as fast.
There’s some US markets that don’t have many constraints on land or constraints on development and those markets are finding rents stabilizing much quicker, but in the GTA, certainly, and in Montreal, what we’re seeing is rents, continuing to grow. Alex, you can comment a little bit on what we’re seeing on the ground, but even for example, in Calgary we’re seeing significant rent growth there, that’s why we’re building there.
Alexander Sannikov
Yes. Thanks, Brian. Yes, and just starting with Western Canada, it’s a market that hasn’t seen significant rental growth for the last couple of years. We’re starting to see that availability is low, our portfolio is essentially full in Calgary so we are starting to see rental growth there. We are pretty constructive on Calgary.
When it comes to the GTA GMA, in addition to Brian’s comments, what we starting to see that some development projects are being put on hold when we’ll look at, let’s say our development pipeline and we’ll look at competition next to us. We haven’t done a full survey of the market, but we know anecdotally that there’s a couple of projects that are being delayed because maybe that exit cap rate is a little bit of a certain metric or some other factors. If that indeed translates into a broader phenomena for the market, it might mean that there’s going to be more rental growth than less. This is something we’re closely watching.
Matt Kornack
No, fair enough. I don’t there’s no availability for anybody to take up space, so hopefully someone builds somewhere. Just with regards to the US portfolio, there was a pretty substantial uptick in occupancy there. I don’t think there’s been any real change in the nature of the assets, did you lease up space and can speak to what that was?
Brian Pauls
That was just leasing of vacancy within that fund that produced that I don’t think there was anything out of the ordinary, Matt.
Matt Kornack
Okay. You’re still seeing occupancy gains in the states at this point in the market that you’re operating in?
Brian Pauls
Yes.
Matt Kornack
Okay. Yes. Last one for me, in terms of the financing cost Lenis how should we think of your current debt financing costs if you were to do something in Canada? I don’t know if you do at this point, unsecured versus secured as well as the European swap costs at this point.
Lenis Quan
Our Euro debt capacity at the end of the quarter was about CAD 400 million Canadian, so roughly about EUR 303 million. There is still some capacity to do additional Euro equivalent debt financing. We’re monitoring all the various options to do unsecured in Canada right now, it’s in the mid to high fours up to low fives if you’re looking at 5 to 10 years. We’re still seeing about 200 basis points pick up in terms of doing Euro equivalent debt. So if we’re seeing Euro equivalent debt sort of in the high twos below 3, so sorry to mid threes, 4, 5 to 10 years that’s the range of the rates that we’re seeing right now.
Matt Kornack
Is there any difference between unsecured debt in the market and maybe an unsecured term loan type offering, and could you swap that into euros as well, or is that not a possibility?
Lenis Quan
Yes, no, certainly we could do unsecured term loans, with any financial institution. We do have one with the Canadian bank currently that is swapped to euros. That’s also an alternative in terms of our debt portfolio. It’s — pricing’s probably, it’s quite similar as well.
Operator
We have our next question from Pammi Bir with RBC Capital Markets.
Pammi Bir
I might have missed this, but just with respect to the IFs valuations, was there anything notable about the larger increase in cap rates in Quebec versus some of the other Canadian markets?
Alexander Sannikov
It’s Alex here. No, nothing notable. It’s just a function of a us keeping the capital values flat primarily, and the rents have increased that’s really what drove that. So notable there. Just to highlights that these numbers are, if there’s a degree of conservatism to some of these estimates.
Pammi Bir
Right. So, sorry, I was just driven off the higher NOI, but holding the capital values flat. Got it.
Alexander Sannikov
That’s right.
Pammi Bir
You maybe just talk a bit about the, how the capital pool has changed in terms of buyers at the table on transactions that you might be looking at. I’m just curious if you’re seeing any evidence of transactions that might have been in the works getting repriced at all.
Alexander Sannikov
We haven’t seen any evidence of repricing. It’s hard to say just yet who the buyers are. We know anecdotally what the bid depth is on some of the recent portfolios. It seems good with a handful to maybe half a dozen bids on larger portfolios being consistently we crossed the board. Now these are all recent bids. We just don’t know who the buyers are or who the bidders were, so we’ll continue watching that.
Pammi Bir
Got it. Just…
Brian Pauls
I think we’re starting to see longer deals, maybe more impacted by price. Certainly less strategic locations having more impact on price or cap rate, but close in short wall, mark to market kind of deal, we’re seeing tons of demand from all different kinds of buyers.
Pammi Bir
Got it. Maybe just on the 85 million of acquisitions that you flagged that were under contractor in progress. Can you talk about where the pricing is on those and relative to, maybe from a CapEx standpoint in relative to maybe transactions done earlier this year?
Alexander Sannikov
The deals that we have on the contract are one deal that makes up the bulk of it is pretty strategic asset that is immediately adjacent to something that we already own in the GTA. It will help us complete a pretty large land assembly. When we think about it on a total return basis, we’re looking at high single digits for unlevered returns pre-land assembly value and if you layer on the land assembly value is probably move it by another 150 basis points on unlevered basis. That’s how we look at it and we continue working on it as we speak.
Pammi Bir
Okay. just last one for me, in terms of the coming back to the previous question on possibly looking at the NCIB, but if I look at your implied, capric kind of in the mid-5s, is there stuff out there that you could really buy at that type of pricing and maybe what might prompt you to consider an NCIB perhaps down the road.
Brian Pauls
Well, Alex, you can talk about whether we find deals in that capric range. I think there’s potential. We would certainly with rental rate growth and market to market opportunities we could see things that are created at our current cost of capital development opportunities and market to market opportunities. I think present really, really compelling investment opportunities for us Pammi. We we’d have to look at NCIB, what that is compared to market opportunities. As I mentioned before, I think our balance sheet is precious right now. We’re treating it that way and looking at the opportunities we see in front of us as being pretty strategic for the growth of our company.
Alexander Sannikov
Yes. As we commented on it, we’re seeing 6.3% yield on cost on our development program that includes land on our redevelopment and Greenfield, which is already owned. The yield on incremental capital investments invested is much higher. We are certainly seeing well north of 5 and a half on that and we intend to complete the development program that we have ahead of us and potentially find new opportunities. That’s, one area of focus for us.
In addition to our value add program, we talked about our solo program, there’s other smaller value add initiatives that are producing 10 plus yield on costs so they require capital and we intend to complete those. There’s we see lots of uses for capital within the business that produce strong returns.
Operator
We have our next question from Sumayya Syed.
Sumayya Syed
Just a question on the development pipeline and with yields going up this quarter. When you review the cost and expected grants, how frequently is that review? Then I guess my question being, should we expect more upward pressure on yield for the pipeline as rents keep out cost inflation?
Alexander Sannikov
That is a great question. Thanks for that. We do review it quarterly when we publish the table in our NDNA and so we continue kind of looking at market rents and we have live models for every project they’re being updated regularly. We continue monitoring that. As we get better information on construction costs and some of the projects in the timing phase, and as rents move, we have update our outlook.
Sumayya Syed
Okay. So it’s fairly dynamic. Then I wanted to, I guess, touch on tenant demand and I guess that cluster, that’s driven by wanting to hold higher inventory. Can you give us an update on that front, if that’s a meaningful driver for your portfolio or have been flawed or stabilized?
Alexander Sannikov
I can’t say that we have concrete data, we can point to anecdotally we still have tenants who are looking to expand and take more space. We engage with tenants within our portfolio who we’re looking to expand and we’re trying to find them space or build them additional space, which is completed that deal in Turban and Quebec where we renewed the tenants and expanded them by just about 50%. We talked about another deal in Montreal, where we have existing tenant lease an extension, which again, grows them by about 50%. We continue to see that activity from our tenants who are looking to expand. We have a one tenant we’re engaging with in Europe, who’s looking to expand their building also by about 50%.
We’re working on a development there. There’s a few of those anecdotes, but we don’t really have good data to point to on that front in our portfolio.
Sumayya Syed
Okay. That helps, and then there’s lastly, more of a modeling question looking at, I guess, the tenant incentives, and there was a comment that they were of this quarter, just on the higher construction cost and commissions on rent. Just wondering how to think about, I guess, an annualized spend number for TIs?
Lenis Quan
Yes. I mean, as Alex had mentioned, we do engage with our tenants and oftentimes they do want us to partner with them in terms of improving sustainability. We’ve been ramping up our L&D lighting program and upgrading units. Sometimes, tenants will come to us within term to do it early renewals, and we are able to recapture some of that through increased rents as well. I think the pricing of that will fluctuate depending on leasing volume and that’s a bit of the variability from quarter to quarter, it’s just really dependent on the leasing volume and, whether or not we’re investing additional amounts in the building just to prove sustainability energy efficiency of the space.
Operator
[Operator Instructions] Our next question comes from [Todd Voy].
Unidentified Analyst
It’s great to see continued positive rent growth solid supply demand dynamics. Following up on that last question. That was also something I was focusing on, can you explain as well, because I know, and above you talk about nonrecoverable capital expenditures and Lenis, just which you were describing sounded to me more like a nonrecoverable capital expenditure, which is a different bucket. Can you help me understand the difference between the 2 and then do you all publish a net effective rent growth? Clearly rent growth is strong, supply demand’s great.
I’m just trying to get down to a bottom line of what the net effective rent growth is after all of these incentives nonrecoverable CapEx, etcetera?
Alexander Sannikov
Thanks, Todd. Nonrecoverable CapEx is primarily Europe. There’s some minor nonrecoverable CapEx in Canada, but it’s very rare, like for example, structural capital there’s generally nonrecoverable in Canada, but it we don’t really see too much of that in our building. Majority of capital is recoverable. What we see in the nonrecoverable line is largely Europe.
When it comes to value add expenditures the way we think of about value add expenditures, these are all return generating capital. Solar, for example, would be in this value add development bucket and as we said, we see yield on cost of about 10%. With respect to LED upgrades, we have a program, some of our larger public peers as well have a program like this, where we work with tenants during the term. For example, we have a tenant with a 10- year lease, they’re lighting is not upgraded LED they’re paying well below market rent. We would approach them during the term and say why don’t we partner on LED upgrade in your space?
We will put the capital , we’ll invest the capital, we’ll amortize the capital, the terms of the lease, and we’ll have some sort of an interest rate on that and our interest rate usually is around 6 to 8% range. We’re seeing pretty strong unlevered return on that and tenancies payback during their lease. We see a strong return on capital and we end up with having a better building at the end of the lease is almost like a win, win type of a program. That’s what goes into the value, add bucket. There’s multiple examples of that.
We bought a building vacant building in Kitchener last year and we invested some from CapEx server to the building. When we think about the purchase price, plus the CapEx invested, we realized the yield on cost when we lease it well at 7%. That would- that kind of work would go into this bucket. It’s all return generating activity. Going back to your question about net effective rents, we don’t publish that.
I don’t believe, but we are seeing net effective rents increasing considerably even faster than face rents because we’re not really seeing a whole lot of incentives, especially markets like GTA and greater golden horseshoe and Montreal, we are not seeing a lot of incentives the free rent and things like that. There is some TI once in a while, where we need to upgrade the space, especially on the new lease, but yet that usually gets priced in through the rent. We are well covered there. We are seeing considerable increases in net effective rents, but we can look at putting more of that data together and show that at a later stage, but we don’t have that.
Unidentified Analyst
Yes, I meant it makes sense based on what you’re saying in terms of how strong the market is, you would have that net effective rank up. Just when I look at the disclosure, though, the leasing incentives indirect leasing costs are up 134% year on year, 3.7 million on a last year, 2.7 million. That suggests to me at least, and that’s only a 3 month period. I know that can be, it can be lumpy suggests at least if there was something very specific, at least for this period where leasing incentives and direct leasing costs were higher. That suggests at least for this quarter, that effective rents were lower than what’s reported on a gross basis. In the future, that would be helpful to better understand the net effect of rent growth that we see. Help me understand that.
Alexander Sannikov
Yes. Fully I’m looking at the table you looking at I think it could be a functional volume because we didn’t see any significant increases on per square foot basis this quarter. Let us look into that and we’ll come back to you, but it probably is a function of volume.
Unidentified Analyst
Yes, no doubt. You all grown very fast. I assume that was the major describer just was, it was much bigger than the growth you’ve had. So it seems…
Alexander Sannikov
Yes. Leasing volume. Yes.
Unidentified Analyst
Yes. Right. Well, very good. And I’d also echo the encouragement to pursue a stock repurchase program.
Brian Pauls
Thank you, Todd, thank you. Appreciate your input and thank you, Todd.
Operator
That was our last question. I will now turn the call back over to Mr. Brian Pauls for closing remarks.
Brian Pauls
Thank you. I’d like to thank everyone for your time today. We look forward to speaking again soon. In the meantime, please stay healthy and safe and enjoy the balance of summer. Take care.
Operator
Thank you. Ladies and gentlemen, this concludes our conference. Thank you for participating. You may now disconnect.
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