H&R Real Estate Investment Trust (HRUN) Earnings Call Transcript & Summary

Good morning and welcome to the H&R Real Estate Investment Trust 2019 Fourth Quarter's Earnings Conference Call. Before beginning the call, H&R would like to remind listeners that certain statements, which may include predictions, conclusions, forecasts or projections in the remarks that follow may contain forward-looking information, which reflect the current expectations of management regarding future events and performance and speak only as of today's date. Forward-looking information may -- requires management to make assumptions or rely on certain material factors and is subject to inherent risk and uncertainties, and actual results could differ materially from the statements in the forward-looking information. In discussing H&R's financial and operating performance and in responding to your questions, we may reference certain financial measures, which do not have a meaning recognized or standardized under IFRS or Canadian generally accepted accounting principles, and are, therefore, unlikely to be comparable to similar measures presented by other reporting issuers. Non-GAAP measures should not be considered as alternatives to net income or comparable metrics determined in accordance with IFRS as indicators of H&R's performance, liquidity, cash flows and profitability. H&R's management uses these measures to aid in assessing and the REIT's underlying performance and provides these additional measures so that investors can do the same. Additional information about the material factors, assumptions, risk and uncertainties that could cause actual results to differ materially from the statements in the forward-looking information and the material factors or assumptions that may have been applied in making such statements, together with details on H&R's use of non-GAAP financial measures are described in more detail in H&R's public filings, which can be found on our website and www.sedar.com. I would now like to introduce Mr. Tom Hofstedter, Chief Executive Officer of H&R REIT. Please go ahead, sir.

Good morning, everybody. Thanks for joining us today. I'd like to welcome everyone to the call. And joining me today are Larry Froom, our CFO; Patrick Sullivan, COO of Primaris; and Philippe Lapointe, COO of Lantower. First, Larry will summarize our quarterly and annual financial results. Pat will then provide an update to our retail portfolio, followed by Philippe, who will update us on our multi-res portfolio. And finally, I'll conclude with some closing remarks to be followed by your questions. Over to Larry.

Thanks, Tom. Good morning, everyone. I'll begin with some high-level remarks starting with FFO. Funds from operations, FFO. Q4 2019 basic diluted and normalized FFO was $0.44 per unit compared to $0.43 per unit in Q4 2018. For the year, normalized FFO was $1.74 per unit compared to $1.73 per unit in 2018. Although these are small increases, we view them as quite an achievement, given that we completed approximately $1.8 billion of asset sales over the past 24 months compared to $645 million of property acquisitions during the same period. Part of these acquisitions was a newly constructed U.S. residential properties that were in lease-up during 2019. They are expected to generate approximately $4.8 million more in FFO in 2020 than they did in 2019. Part of the proceeds from the asset dispositions were used to fund H&R's development pipeline. During the course of the year, we invested over $300 million into developments that will provide future FFO growth as they are completed and stabilized. We have 3 U.S. development projects scheduled to be completed in 2020: River Landing in Miami, Phase 1 of Hercules in San Francisco; and The Pearl in Austin. And in Canada, in Ontario, we are pleased to announce we recently re-leased -- recently leased the largest of the 3 industrial buildings we currently have under construction to Deutsche Post for 10 years. Occupancy is expected to commence in Q3 2020. Additionally, part of the asset disposition proceeds were invested in redeveloping the former Target and Sears stores in our portfolio. We're expecting growth in rental income of approximately $4.3 million from new tenants occupying this space. Our property development in Long Island City, New York, Jackson Park, was completed during the year and generated USD 10 million of FFO at our 50% percentage share. In September, interest-only financing of $1 billion was secured by the property for 10 years at an annual interest rate of 3.25%. After repayment of the construction financing, H&R received a USD 195 million distribution from the joint venture, which was used to repay other debts. The project's unlevered yield on budgeted cost is expected to be 6% and the levered yield on H&R's net cash contribution invested is expected to be approximately 50%. We have leased the majority of the vacancies in our Office and Industrial segments. And in addition, committed retail occupancy at December was 94.1% versus actual occupancy of 91.5%. Debt to total assets for the financial statements at year-end was 44.4%, but subsequent to year-end, the $256 million mortgage receivable that was secured by The Atrium was received. These funds were used to repay debt, which reduced the debt to total asset ratio to 43.4%. And with that, I will now turn the call over to Pat to give us an update on our Retail division.

Thank you, Larry, and good morning. Leasing activity during the past 2 years has been very strong with our leasing team completing more than 400 transactions during each year, including 250 new lease deals, of which there were 35 new large-format transactions. While our occupancy rate and net operating income have been negatively impacted by the closure of Sears and other tenant bankruptcies, we are starting to realize the positive momentum as tenants begin to open from the redeveloped boxes. During the last quarter of 2019, more than 220,000 square feet of box stores opened in the portfolio and approximately 280,000 square feet of new box stores will open in 2020. There continues to be tenant demand for space within our portfolio and we anticipate strong leasing activity, once again, in 2020. Our occupancy rate at the end of 2019 was 91.5% compared to 89.3% at the end of the third quarter, while our occupied and committed rate rose to 94.1% from 93.8%. 12-month rolling same-store sales within our enclosed mall portfolio were $545 per square foot, a decline from the end of 2018, but in line with the productivity figures posted in both 2016 and 2017. With respect to all-store sales volumes, we have been reducing the amount of CRU area for the past 3 years, which is the result, for the most part, of expanding existing tenants or leasing space. In both cases, the large-format tenants were not included in our sales reporting area. Many of these new large-format tenants, such as Winners, Mark's, Urban Planet and Old Navy have been great additions to our properties and generate significant traffic. With our anchor development projects nearing completion, we are exploring opportunities to diversify our shopping center sites to include office and residential uses. By way of example, with the city of Ottawa planning for light rail transit to stop at Place d'Orleans in Ottawa during -- in the next few years, we have relocated the food court to the main level of the mall with the goal of utilizing the second floor for office uses. Recently, we completed 2 long-term leases with public works, one for 53,000 square feet and the other for 9,500 square feet. In addition, we are in the preliminary planning stages for residential densification at Orchard Park in Kelowna, Stone Road in Guelph and Place d'Orleans in Ottawa. At Dufferin Mall, the approval process to add significant residential density is in progress. And we expect to start construction on that project in approximately 2 years. Thank you, and I'll now turn the discussion over to Philippe.

Thank you, Pat. Good morning, everyone. We've got some notable updates for this quarter. And so I'm delighted to share the latest news from Lantower Residential. As mentioned in the previous quarters, one of our strategic initiatives is to examine our existing portfolio to determine if any reallocations would be accretive to the overall portfolio. As we alluded in our last quarter's call, we were under contract to sell 2 legacy assets from Lantower's portfolio. In January of this year, we successfully disposed of Magnolia Grove, a 1984 vintage property in Houston, Texas and Tribeca, a 2008 vintage property in Dallas, Texas. Magnolia Grove purchased for $16.7 million in 2014, sold on January 23 for $23.9 million, representing an IRR of 24.2%. Tribeca purchased for $52.3 million in 2015, sold on January 9 for $66 million, representing an IRR of 17.6%. In light of these dispositions, we expect to disclose the new acquisition next quarter. On the portfolio front, the Lantower Residential portfolio consisted of 7,500 -- or 7,507 apartments across 23 properties at the end of the fourth quarter, when excluding Jackson Park. Following the recent dispositions in January, the Lantower portfolio, excluding Jackson Park, again, has a weighted average to vintage of 2014, representing one of the newest portfolios in our sector and underscoring our intent to maintain a quality portfolio supportive of long-term growth potential. On the operations front, at the end of the fourth quarter, Lantower portfolio was approximately 91% occupied, and over 92% occupied when excluding our lease-up properties. On the financial front, our same-asset quarter end operating income increased, in U.S dollars, from USD 9,559,000 in the fourth quarter of '18 to USD 11,165,000 in the fourth quarter of 2019. This equates to same-asset quarter-over-quarter operating income growth of 16.8%. Our same-asset operating income increased, again in U.S.-denominated U.S. dollars, from USD 40,456,000 during the year ended in 2018 to USD 42,912,000 during the year ended in 2009 (sic) [ 2019 ], representing an annual operating income growth of 6.1%. The above-average 16.8% quarter-over-quarter operating income growth is primarily due to rental growth, but most notably, the stabilization of a few assets in our portfolio. On the development front is our Phase I Sunrise project, a 321-unit Class A garden-style multifamily project in Orlando, Florida that's scheduled to break ground in the first quarter of this year. We look forward to expanding our Central Florida development pipeline and disclosing more exciting property development opportunities in 2020. And with that, I will pass along the conversation back to Tom.

Thanks, Philippe. Before we begin the Q&A portion of the call, I'd like to highlight a few items. Firstly, leverage continues to trend lower. Debt to total assets pro forma the receipt of the $256 million of vendor take-back mortgage on The Atrium was 43.4%, down 120 basis points from 44.6% a year earlier. Prudent leverage has always been core to our strategy and the trend to lower leverage over the past few years allows the need to prudently invest more in developments and also provides us with significant strategic flexibility. Second, our development pipeline of value-creating projects is large and exciting. In 2019, we delivered our flagship Jackson Park development, which reached 96% occupancy in Q4. We have secured, as Larry has mentioned, a 10-year interest only mortgage to return -- returned all but USD 31 million of our original investment, resulting in a 50% levered return on our net equity investment in the project. River Landing is nearing completion. Publix is scheduled to open in April of this year as being the first tenant followed by the balance of the retail space with residential leasing commencing very shortly. We're advancing our densification plans at Dufferin Grove Village, 145 Wellington, 55 Yonge and the 320 Front Street in Toronto and in Burnaby, BC. Phase 1 of our 2.7 million square foot Caledon industrial development was completed this year. The Toronto industrial market has effectively 0 vacancy and rents continue to rise. Augmenting Caledon, and we have a number of additional industrial development opportunities in the Toronto market providing attractive opportunities to grow our exposure to this strong market with state-of-the-art properties. In December 2019, we issued a mortgage receivable for USD 124.1 million secured against 12.4 acres of land in Jersey City, New Jersey, for a 2-year term. The loan is expected to increase up to USD 160 million and bears interest at 10% per annum. The land is adjacent to the Liberty State Park with views of downtime Manhattan and the Hudson River. The project is zoned for 1.7 million square feet of commercial space and 1,544 residential units with the full residential development option encompassing 2,835 units. The location is accessible to multiple nodes of transportation including the Grove Street PATH station, 0.7 miles away with direct access to Manhattan, to Penn Station and Wall Street and an 11-minute ferry transit ride to Google's new Manhattan campus as well as access to Manhattan's lower west side. The REIT has an option to convert its loan into an 80% equity ownership interest in the project. In the U.S., our pipeline is multi-res and mixed-use development projects will see deliveries this year with River Landing in Miami in Q2 of this year, Phase 1 of our Hercules project in San Francisco, also in Q2. And in Q3, The Pearl in Austin will be delivered. And In 2021, these completions will be followed by Shoreline in Los Angeles, Sunrise in Orlando, Phase 2 of Hercules and Esterra Park in Seattle. All these developments are expected to increase NAV per unit, and FFO per unit as they reach completion over the next couple of years. Lastly, we have fielded a number of questions over the past 6 months regarding The Bow in Calgary, our tenant at The Bow [indiscernible] its business to the U.S., and we confirm that the lease obligation at The Bow is assumed by the new lease [indiscernible] as required by the terms of lease. So any further developments regarding the Boris, we'll provide more detail at the appropriate time. Today, we don't have anything further to report on this front. We have a made significant progress on our goals of enhancing our internal growth profile and reducing leverage. We expect investments we have made in these areas to contribute to growth in our financial performance in the year ahead. With that, I'll turn it over to, Betsy, the operator for your questions. Operator?

[Operator Instructions] And your first question comes from Dean Wilkinson.

I guess, Larry, the first one is probably for you. On River Landing, as that flips over from PUD to IPP, will we see the same kind of lack of capitalizing -- like what we saw Jackson Park, so you have that -- a bit of dilution. And then as you lease-up, you catch that back up over the course of the next year, 1.5 years?

Yes, it should be exactly like we disclosed for Jackson Park and I'll try to keep the same kind of disclosure for River Landing as it happens.

Okay. And would the magnitude of that be about the same, given what your full interest is that versus what it was in Jackson Park?

No, Jackson Park is bigger. The retail leasing will occur a lot quicker at one time as opposed residential leasing will be over the next 18 months to 24 months. So the residential part will be the same kind of lease-up as Jackson Park whereas the retail will be a lot quicker.

Okay. Great. And how much is that quarterly capitalization of interest right now?

The quarterly capitalization of interest on River Landing, specifically?

Yes.

Give me a sec to look it up . I think we've said it.

Maybe while you're looking...

I think we're running at around $3.5 million a quarter.

$2.5 million a quarter? Okay.

$3.5 million.

$3.5 million. Great. And on the loan-advanced at Jersey City. I'm just trying to triangulate that exact location. Would that be the lot which is currently being used for the Zeppelin Hall Biergarten?

No, it's on New Jersey Park. Because the marina is right there. It's right at the foot of the marina.

So it's right at the foot of the marina, wow, that is a fantastic location.

Yes. The new road that's being built along this new highway, so it bounds the highway, it bounds the marina, which we'll have the ferryboat right to Manhattan. And you have the Jersey Park and we'll have the [indiscernible] the path to downtown or midtown Manhattan.

So you'd be able to come out of that residential development right into the ferry?

Correct.

Okay. Is -- there's zoning in place right now. Is that something that's going through sort of an application and permitting process and then...

Zoning is in place. It's -- as we -- as I mentioned, it's a mixed use zoning or all residential, it's totally in place. Everything is good to go. We have no affordable housing component in it at all. We are just doing our master planning and permitting. So the first phase of the residential will be ready to go in around a year. And if we do all residential and commercial, it's really a question of how we premarket it. We won't have a building a commercial -- spec building in either event and life sciences is a potential there as well.

Great location. Can you disclose who the partner is on that?

I think so, it's Argent Ventures from Manhattan.

Okay. And the last question for me is maybe for Philippe. As you sort of -- as you're rounding out the markets that you're in, in Lantower. Are there any other markets or perhaps markets outside of specifically the U.S. that you may be looking at? And how big do you need to be in any given market for the scale to make sense?

So it's a very good question. I think as of right now, obviously, we have nothing to announce regarding anything outside of the U.S. As it relates to entering a new market in the U.S. it's something that we're always kind of paying attention to. I would say, though, that we believe that the more attractive acquisition or development opportunities are in the markets that we are currently in. And so I'd love to extend our position in Tampa, in Orlando. I'd like for us to consolidate some of our markets in Texas. And Raleigh and Charlotte just keep doing very, very well. And opportunities there are few and far between, but we obviously wouldn't mind aggregating a more solid position in those markets. So I think our focus is more predicated on that than going say to an Atlanta, Georgia or Phoenix.

Okay. Great. Well, we are looking forward to Alex hosting a property tour down in River Landing sometime in the near future.

Your next question comes from Sam Damiani.

Just to start off on the Jersey City project to -- a couple of other questions I had there. What would be the budget on the first phase of residential that you're -- Tom, you're saying you could start next year?

We don't have those numbers yet. We don't have -- [indiscernible] we're not even too sure the first phase side because all the blocks within the 13-acre site have to be first allocated figured out. We also have a 2 -- 2.5-acre-ish park that we have to -- which is a water park, that has to be considered. So we're not at that stage yet to announce the budget on the first phase or the size of the first phase.

And like what would be, I guess, the next steps? You mentioned you're doing some planning and permitting and whatnot. But is there a sort of a next major step that we could look forward to in the next few months?

Yes, exercising our option would be smart. So right now, it's a mess. We have 9 months to look at it. Towards the end of the year, we will announce, if we were actually pulling the trigger on it. We're going to go through the entire master planning process, dividing up the blocks giving us optionality on the commercial. So we're not -- we haven't pulled the trigger on it yet. It's still just a mess.

Okay. And finally, your partner Argent Ventures, what sort of experience do they have in this type of development historically?

I have known them for -- going back to my youth Capital Hotels. When we used to build the process in America, and they were active in that business as well. To answer your questions, they are currently busy building in Jersey, some residential, and they've been very active in the redevelopment of concessionary office. They've been around for the past 40 years and have a lot of experience both within the residential and commercial New York area markets.

Did you see the need to bring in other partners on this project, given the size and all?

To get life sciences potentially. We wouldn't do life sciences on our own. There is a strong New Jersey life science market. So that would involve a partner for sure. And there's -- so we're also interviewing brokers to go ahead in the life sciences and assist us in case there's a campus potential for us with one of the big companies out there.

Okay. Just over to Miami River. I noticed the cost went up this quarter. Any color you can provide there as to the reason why?

Yes. Well, I'll -- so it's a couple of reasons. One of the major reasons is though we are currently negotiating with a very, very large, attractive -- what I mean by large, it's a 27,000 square foot restaurant space. The TIs in the restaurant space are substantially more than contemplated. We also are negotiating on the office space with the user that again the TI has gone up. The rents could go up but not necessarily for the size and infrastructure for the development. And just a few cost overruns, nothing too significant. It's really more that the overall quality of the outside of the retail has gone out -- it has gone up, and there's a cost factor to them.

And then I also noticed the budget went up a bit on the Sunrise development in Orlando. Any particular reason there?

No particular. I think as of right now, we're doing our best to essentially engineer the cost down, but I think candidly, once we're all said and done, those differences will be negligible.

Okay. One more question. Just on the debt maturities, there's a good chunk of mortgages coming up in 2021. What sort of rates on refinancing that -- should we expect is reasonable? I am not sure which properties, which locations those are secured by.

Sorry, asking what current -- what we'd expect to get currently on those mortgages?

Yes, if you were to finance them today.

That would be -- with 10-year financing would probably be a spread of 180 bps, call it would be conservative together.

And again, they may not be long we may be doing unsecured. It's just with the nonsecure market, you know where we trade at.

Okay. And -- but are those mortgages in the U.S., Canada? Like would you do more U.S. mortgages, more Canadian mortgages?