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

Good morning, and welcome to H&R Real Estate Investment Trust's 2024 Third Quarter 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 requires management to make assumptions or rely on certain material factors and is subject to inherent risks 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 the REIT's underlying performance and provides these additional measures so that investors can do the same. Additional information about the material factors, assumptions, risks 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 H&R's website and www.sedarplus.com. I would now like to introduce Mr. Tom Hofstedter, Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstedter.

Thank you, operator, and good morning, everyone. Thanks for joining us today. With me are Larry Froom, and Emily Watson. I hand it over to Larry to give his recap of the quarter.

Thank you, Tom, and good morning, everyone. In my comments to follow, references to growth and increases in operating results are in reference to the 3 months ended September 30, 2024, compared to the 3 months ended September 30, 2023. Headline FFO per unit for Q3 2024 was $0.294, compared to $0.42 in Q3 2023. As a reminder, FFO in Q3 2023 included a $30.6 million gain on disposal of a purchase option held via a mortgage receivable. Excluding this gain, FFO would have been $87.1 million or $0.31 per share in Q3 2023. Overall, given the headwinds we faced at the end of last year with multifamily supply concerns, a weak office market, inflation and rising interest rates, we are pleased with our results. We continue to execute on a strategic repositioning plan. In 2023, we sold $432.9 million of income-producing properties and this year to September 30, 2024, we have sold $344.8 million of income-producing properties. We expect to end the year with approximately $440 million of real estate sales this year. I would now like to spend a few minutes providing commentary on each of our segments. Starting with office. We are hearing of more back-to-the-office policies from different companies, and it seems clear that more and more employees are heading back to the office, which is positive for the sector as a whole. Our office portfolio of 16 properties, which includes 4 properties of residential rezoning opportunities now only comprises 19% of H&R's total portfolio. 87.6% of our office revenue comes from investment-grade tenants, a testament to the quality and location of our office properties. Our office occupancy at September 30 was 96.8%, with an average remaining lease term of 6.1 years. Lease expiries between September 30, 2024, and December 31 2025, only approximate 400,000 square feet so the portfolio will continue to provide solid cash flow. Our downtown Toronto office properties with residential rezoning opportunities are valued at $140 per square foot, which is less than half the value they were at the peak of the market, and the rest of the portfolio has a weighted average cap rate of 8.86%. Our office properties are valued at approximately $1.9 billion, and there are only 2 mortgages totaling $140 million. The net of which equates to $6.24 per unit. Excluding our office portfolio in its entirety, our NAV per unit would be $13.42, which is significantly higher than our current share price. Our sales of office properties to date of $2.3 billion since the announcement of the strategic plan demonstrate that there is value to our office portfolio. On the residential segment. While there has been a lot of new supply added in our residential markets, the positive immigration trends have continued, and our tenants are also staying longer. Since the announcement of H&R's strategic plan, H&R's average U.S. residential rents increased from $21.16 per square foot as of June 30, 2021, to $26.97 per square foot at September 30, 2024 in U.S. dollars. Our residential portfolio at September 30, 2024, comprised 47% of H&R's overall portfolio and is continuing to grow. Lantower West Love in Dallas reached substantial completion and was transferred from a property under development to an investment property. West Love has become the 25th residential income-producing property in our portfolio. Lantower Midtown, also in Dallas, is not far behind and will become our 25th investment property very soon. In addition, we have another 2 residential developments currently under construction and expected to be completed in 2026. H&R's ownership interest in these 2 new developments is 29.1%. Our retail portfolio at September 30, 2024, comprises 15% of H&R's overall real estate assets. The tenants in our retail portfolio are mostly grocers, and the portfolio has been very stable with growth in rents and net operating income occurring from the lease-up at River Landing in Miami. Our largest retail tenant is Giant Eagle, who has close to 200 locations in our portfolio. Giant Eagle recently announced that they are selling the get-go convenience stores and leases to Couche-Tard. This will further diversify our tenant mix with Couche-Tard comprising about 1.7% of our revenue. Giant Eagle will then comprise about 3.9% of our revenue. Our industrial portfolio of 66 properties at September 30, 2024, comprises 19% of H&R's total real estate assets and continues to perform well. Since the announcement of H&R's strategic plan, H&R's average Canadian industrial rents increased from $7.17 per square foot as at June 30, 2021 to $9.42 per square foot as at September 30, 2024. In addition, industrial properties located in the GTA made up 35% of H&R's industrial portfolio as of June 30, 2021 compared to 50% of H&R's industrial portfolio as at September 30, 2024. We continue to grow our industrial portfolio and added 2 newly constructed properties at the beginning of this year. We currently have one industrial property and a 50% interest in 2 industrial properties under construction scheduled to be completed in 2025. Our balance sheet remains strong. Debt to total assets at the REIT's proportionate share at September 30, 2024 was 44.9% and debt-to-EBITDA was a healthy 9.1x. Liquidity at September 30, 2024, was in excess of $900 million with an unencumbered property pool of approximately $4.1 billion. Our unencumbered assets to unsecured debt coverage ratio was 2.2x at September 30, 2024. In summary, we are well positioned to continue executing in the strategic plan to sell office and retail properties as and when the market allows and management remains committed to doing so. On the ESG front, we are pleased to report that our projects at 6900 Maritz in the GTA was shortlisted for the World Demolition Award in the Recycling and Environmental Category. The previous 104,000 square foot steel structure office property had a total weight of 8,758 tonnes. The weight diversion program recycled 8,113 tonnes of steel and concrete or 93% of the total material weight. In addition, our Lantower West Love development in London -- and sorry, in Dallas reached substantial completion and received the National Green Buildings Silver certification. And with that, I would like to turn the call over to Emily. Emily?

Thanks, Larry, and good morning, everyone. I'm happy to be on this call to discuss our third quarter same-store results from our multifamily platform and discuss some operational achievements and market insights. Our year-to-date results continue to align with our expectations as the new supply deliveries officially peaked at a 50-year high in the third quarter. Additionally, ending Q3, the trailing 12-month absorption was 85% above the long-term average, further demonstrating the strengthening drivers for our industry. . We remain focused on the fundamentals of our business and creating NOI expansion through our repositioning opportunities, development pipeline and other innovative value-add strategies that add to our bottom line. Given the declining levels of new supply ahead and growing demand in our markets, combined with the strength of our operating platform, we are well positioned for substantial growth and value creation in the coming years. Same asset revenue growth in U.S. dollars increased 50 basis points for the third quarter and same asset net operating income for our portfolio in U.S. dollars decreased by 1.4% for the 3 months ending on September 30, 2024, when compared to the respective 2023 period, primarily due to higher property operating costs, including taxes and insurance and a decrease in average rental rents from the Sunbelt properties, which is partially offset by rental growth at Jackson Park in Long Island City, New York and River Landing Residential in Miami, Florida. Same asset occupancy ended the quarter at 94.1%, a 50 basis point decrease over the second quarter and an 80 basis point decrease from Q3 of 2023. Same asset occupancy in the Sunbelt for Q3 was 93.4%, with 51% retention and Jackson Park was 99.2% occupied and 64% retention. The Sunbelt continues to show strong demand metrics moving into fourth quarter with resident retention at 58% for October and 60% for November. Sunbelt blended trade-outs in Q3 were negative 2.5% in the third quarter, ranging from approximately negative 8% in Austin to slightly positive in North Carolina and Orlando, which coincides with levels of supply expansion. Based on this recent third-party appraisal and a handful of Sunbelt sales comps, we have maintained our fair market value Sunbelt cap rates at 4.98% and believe the rate is appropriate and supported. Cap rates are expected to remain low, relatively speaking, for the institutional quality assets in the Sunbelt with capital flows interested and focused on long-term heavy Sunbelt multifamily allocation. On the development front, Lantower West Love in Dallas, Texas received final TCO at the end of September and is currently 40% occupied and 43% leased. We are excited to celebrate Lantower West Love, the achievement of the National Green Building Standard Silver certification. We will share final development budget economics for West Love on the fourth quarter call after we close out the project. Also in Dallas, Texas, Lantower Midtown has received its final TCO on October 31 and is currently 15% occupied and 25% leased. Both properties are leasing well with an average monthly velocity of 25 leases per month, which is above industry reports for our market, another testament to the superior product and unparalleled amenities of our development team have delivered. We will also share final development budget economics for the Midtown project on next quarter's call. [ Reddit 1 ] properties are progressing well and remain on budget with completion expected in mid-2026. Lantower currently has an additional 9 development projects in the Sunbelt pipeline totaling over 2,900 suites at H&R's ownership interest with multiple sites ready and prepared for construction. We are progressing through the different phases of design, drawing and permitting on the remainder of our Sunbelt development pipeline and currently have an additional 2 projects shovel-ready. In summary, the Lantower Residential platform continues to achieve encouraging results and strong performance relative to our multifamily counterparts. I would like to recognize our Florida and central services team members for their preparation for back-to-back hurricanes Helene and Milton. By following the hurricane protocol and communication to our residents, we sustained only minor damage in a few areas. During Milton, over the course of 3 days, our central team members managed over 1,100 incoming and outgoing e-mails, calls, and text messages with our residents with an impressive 98% response rate under 4 minutes around the clock. The unity of our Lantower team is one of the many reasons we were certified as a Great Places to Work in the third quarter and Best Places to Work in Florida by the Best Companies Group. And with that, I'll pass it back to Tom.

Thanks, Emily. Operator, you can open up the call for questions.

[Operator Instructions] Your first question comes from Sam Damiani at TD Cowen.

Maybe, Tom, just for you, just like to get your sense on the outlook for dispositions today versus maybe versus last quarter considering everything that's unfolded over there in the last 3 months. Just wondering what the outlook and pipeline looks for activity into 2025.

Hey Sam, good morning. it's basically cloudy. Last quarter, there was more optimism on interest rate reduction, and therefore, there's more -- it was fueling the buy side. There's also fueling the debt side. The debt side is dormant and without debt, you're not going to have acquisitions. So nothing is on the market. It's really -- we have nothing on the market. It's very little in the market than anybody has, it's really off-market deals, and those are opportunistically driven, you can't forecast those. In general terms of -- tell you that the brokers are dry right now, and it's part and parcel of the uncertainty over interest rates. I have no visibility into when that is going to change. I don't think it's the office market deteriorating further. I think that is what it is, and the residential market is also pretty static. Industrial market is a little bit down, but there's more interest in industrial than in any other sector right now just because the institutional funds have to get their money somewhere and there's -- because of all the uncertainty, there's nowhere else for them to put it. So I don't really have a vision of what we'll be selling over the next 12 months. It's really, as I said, opportunistically driven. If we get better visibility after Trump comes in with interest rates and where the Canadian dollar lies, it will significantly alter and give us our ability to forecast our dispositions going forward.

And I guess, the cap rate on the U.S. office portfolio was up close to 30 basis points, if I'm not mistaken. Was there -- is there a reason for that, something that required that?

Well, as the time marches on, you keep on eating into your rents. The -- logically speaking, unless there's a change of sentiment in the office market, the NAVs of office will go down.

And maybe just one last one for Emily. Just on looking at the organic NOI sort of same-property NOI, trends at Lantower, what's your expectation for things to turn more meaningfully positive?

Good morning, Sam. Great questions. So I definitely think that we'll see some overhang in 2025. And every year, we meet with CoStar and RealPage and some market economists and really mid-2025, I think, for most of our markets, I think Austin where they have bigger expansion that might go to the end of 2025 before we go into 2026, which we anticipate to be a really robust year. So I think we still have 75,000 units that will deliver in 2025 on the heels of the 100 plus that delivered in '24.

Sorry, that was 75,000 units in the Sunbelt?

Yes, just in the Sunbelt in our market.

To come over the next year?

Yes.

[Operator Instructions] The next question comes from Mario Saric at Scotiabank.

Maybe just sticking to Lantower, Emily, in terms of your kind of expectations for new and renewal spreads in '25. Can you share any thoughts in terms of where that may trend?

Good morning, Mario. Yes, I definitely think that we will continue in Q4, kind of where we saw in Q3. In Q1 we usually get a little bit of an uptick, people kind of hunker down for Q4 and start to make any moves. And I think we'll continue on the same seasonality that we see every year with Q2, our strength and about the time that our peak is kind of behind us, and we're picking up some speed in Q3 and Q4, probably even better. So I think we'll end the year next year, probably flat on lease trade-outs in the Sunbelt. Again, diversification is our friend next year because New York will continue to post the 3% lift and Miami is set up for a really great year as well. So -- but the Sunbelt like be flat overall with kind of a slow start Q1 and Q2, a little bit of a hockey stick in Q3 and Q4.

Got it. And given the relatively low rent to income ratios in your portfolio, what are your thoughts in terms of renewal spreads?

Renewal spreads I expect to be in the 3%, 4% range next year, Mario. We don't see a lot of -- even before when interest rates were low, we didn't see a lot of home move-outs to single-family homes and so forth. So I think our renter base with over $100,000 in the salary range, I think they're not really looking to move to single-family homes regardless of what happens there. So I think the 3% to 4%, maybe 5% in the second part of the year will be a healthy range for renewals in 2025.

Got it. Okay. And just from an accounting standpoint, the transition of [ Dallas West loaded to IPP ] this quarter, what was the overall FFO impact on the results this quarter?

I'm going to kick that to Larry.

Good morning, Mario. The West -- it was pretty flat. It's still 40% occupied. So it's not producing -- it's probably flat in NOI, it's not producing much NOI this quarter.

Okay. So flat NOI but perhaps slightly negative on FFO?

Yes. I mean, we also had a bit of a decrease in capitalized interest to the project that is no longer being capitalized and that will continue to decrease going forward into next quarter. But offsetting that will be NOI growing. This quarter, we didn't have any positive NOI growth from West Love.

Okay. Maybe switching gears to the disposition environment kind of Sam talked about the broader overall environment. But can you talk specifically about Hess Tower in Houston and kind of the progress that you're making there on the lease up of the space expected to be given back and the implications of that progress to the salability of the assets?

So we have around 1/3 of -- we have exactly 1/3 of the building coming up in mid-2026. Out of that, this week, we shall have signed approximately 110,000-odd square feet of that on a new 10-year deal expected in 2026, and we're currently negotiating on another approximately 46,000 square feet of space in that building. I expect by 2026, that the space should be all done.

And then in terms of ECHO and Hess Tower, for example, these are very kind of unique assets or situations. Would it be fair to say that your broader commentary on the broader market in terms of it being cloudy and slow, would it pertain to those assets as well? Or is there something specific with those assets that you think can buck the trend?

That's a very good question because it specifically does not refer to those properties. There's a lot of interest today in ECHO simply because it's grocer and it's defensive. It's very, very conservative. We -- my guess is by the end of next year, if not sooner, we'll have something done on ECHO and Hess Tower again is opportunistic. I think there will be something done in Hess Tower as it is an A building in an A location. And it's just waiting right now for -- there's no large transactions in the office market period, but really nothing to speak of Houston. So I'm more optimistic on Hess and ECHO, just for the reasons I just mentioned, and they don't fall into the general category of slow market.

Got it. And would Hess Tower essentially the leasing, do you think it would have to be completed in order for the property to sell?

No, I don't think so at all. Again, it's waiting for -- there's no financeability of office in North America today. And I think because the long nature -- duration of that lease under the Hess, I think you could get financing. I think part of the cloud around Hess is, who is Hess? Is it Chevron? Is it Exxon or is it Hess? And if it is any one of the 3, what's their plans for Hess Tower, which we don't know yet. Because of that, we can't speak to -- that creates a cloud around trying to sell the asset or you having interest in the asset because they just don't know what the future occupancy is going to look like. From a cash flow perspective, it's solid. But again, that puts a little bit of a cloud. And by one year's time, we'll have the answer to those questions, and I'm sure they will be interested at that point in time, if not sooner.

Got it. Okay. My last question is just on the VTB mortgage receivables, there was a bit of a write-down this quarter. I may have missed it, but can you remind us what the remaining VTB mortgage receivable balance is, the average term to maturity and kind of conviction level in the collection?

So you're asking about the remaining mortgage receivable balance. We have -- on the property, we just sold Telus, Burnaby. That's our biggest mortgage receivable remaining. I think it's about $55 million. We have 160 Elgin was on the balance sheet at September 30 for $20 million, which we got repaid on October 1. We had our first tower in Calgary, about another $20 million, and we had 2 or 3 other mortgage receivables on land in the U.S. for the remaining balance of our mortgage receivable. The average term for those, I'll have to get back to you on the average term. I don't have that in front of me. .

It's around 4 to 5 years.

Okay. And presumably, you feel pretty comfortable with the disclosed balance today?

Yes.

In terms of commercial?

Yes.

The next question comes from Matt Kornack at National Bank Financial.

Just quickly on the office deleasing program. Can you give a sense as to how much NOI is may be generated by the development-oriented assets? And how you see that NOI coming off? I know 53 & 55 Yonge. It sounds like you're going to demolish the building and leave it as land for a period of time. But just want to get a sense as to the earnings impact of that before you ultimately monetize it.

The 53 & 55 is scheduled for demolition, I think, in around 4 weeks or so. We've done a deal with the tenant to buy out. It's around 145,000-odd square feet, including 53 Yonge, call it, 150,000 square feet, and it was leased around $12 a square foot. That was past. And, again, we did a buyout. So it's slated for demolition. Demolition will take around one year.

And just to add on to what Tom's saying for your first part of the question, we don't really break out the office NOI between the redevelopment properties and not. But we do break out the fair value and from there, you can maybe get a guess from it. But the fair value of those redevelopment properties is around $450 million around that for the 4 properties we have downtown Toronto. And overall, we haven't broken down NOI. But for 55 Yonge, it went vacant in August. So for Q3, we would have had already 2 months of occupancy and one month of vacancy. So there is still some to come off for Q4, but we already had part of that vacancy in Q3.

Okay. And that's very helpful. And then, Tom, maybe in terms of the process there, it sounds like you're still going back to get rid of office replacement on a number of these properties. What's the thought around kind of monetizing it through a sale or waiting until you get the approvals, et cetera?

So in all cases, we're going to wait for approvals. But approvals, I would say, are going to be done by no later than the end of next year for all of these properties. 53 & 55 will be slated -- will be demolished and will be done within a year from now. At that point in time, we'll wait for the market to recover. It is a phenomenal residential site, but the residential market is horrible right now, and just going to have to wait for that. There's no timing -- is not of the essence. We have patience for that. 145 Wellington will stay the course. We just renegotiating with one of the tenants to renew. The rental income will be fine over there. It's probably, I would say, 5 to 10 years, probably closer to 10 years away before we demolish that. We're just going through the rezoning process to put that asset to bed as far as its ultimate value. Again, it's across Roy Thomson Hall, Ritz Carlton. It's a fantastic location. It's a beautiful building in the market. They have not -- they right now, but the office market for that asset is still solid. That won't be a problem. Front Street is the more interesting project. It's 3 towers, 2 will be residential. One will probably be in storage or office or something, I don't know. It's also a year away from rezoning. And probably we'll have to wait and see what the residential market looks like. But ultimately, that highest and best use will be residential.

Okay. Perfect. And then just quickly, not as familiar with the New York City market. But can you give us a sense as to the land and condo markets as it relates to maybe Jersey City and your recent Brooklyn purchase. Is it better there tone wise than what we're seeing in Toronto at the moment? Or similar to...

Well, pretty well safe to say that anything is better than Toronto so how's that for a starting point. [ Guantas ] is very, very strong. There's a lot of institutional and large big money managers looking for sites that can build 1,000 units in prime locations. So [ Guantas ], our plan is to sell it probably in 2025. We're just waiting for some not zoning issues but more environmental issues to finish off over there. That will be in high demand and will sell for a significant dollar amount. There won't be any issue with that at all. Jersey is a very strong residential market, again, not like Toronto, Jersey, there is some development but Jersey is going to have to wait a little bit for purchase rates to come down. It's a large project. We haven't made a decision to pull the trigger on the first phase of Jersey, which will be finished as far as planning goes within around 4 or 5 months. At that point in time, we'll decide how we want to launch it. I don't think we'll be building it. The market is strong enough. It's waiting for interest rates to come down, and that's the only problem in the United States market unlike Canada, which has a host of other affordable issues that the United States does not have. So Cove and [ Guantas ], I think, long term are good assets. [ Guantas ] will be sold in 2025 and generate a lot of cash. Cove will wait for interest rates to come down and Toronto is wait and see.

The next question comes from Jimmy Shan at RBC Capital Markets.

Yes. Just couple of quick follow-ups on the asset sale. There's also a lot of optimism in the New York office leasing market. So what is your confidence in your ability to transact to Dawson? And then the Couche-Tard-GetGo transaction, does that have anything -- any implication on the sale of ECHO?

Good questions in both regards. The New York City market isn't an office market, it's much stronger than Toronto. Again, I hate to say this because I'm a Canadian and born and bred here, but Toronto is really, really lagging North America as is Canada lagging in the United States in a big, big way. The New York office market is getting stronger. There is -- more importantly than that, there will be a host of probably 30% of the office product that will be -- we converted under the [ S ] program in New York to residential, and that will happen sooner rather than later. I don't make the buildings that are not viable with office, which are, quite frankly, a host of buildings because of the age of the buildings, convertible to residential. I expect the United States market to pick up dramatically. 2 Gotham, it's not going to affect it's salability, it's a tenant that's using -- in the building completely. It's a perfect location for them. I think we'll have to wait for visibility as to -- our plan would be to wait and have patience as the market recovers. We expect the tenant to stay there. It's just a question of what the rental rate would be. So we're in no hurry to dispose 2 Gotham. We'll wait and see on that market. So Toronto way behind, New York way ahead, 2 Gotham not losing sleepover and Toronto has to wait for the residential market to improve. ECHO is an interesting story. The Couche-Tard is a game changer. Not only do we get the covenants on the GetGos. We also -- Giant Eagle disposes of an asset class within their portfolio that was not a lag in earnings but was hurting their ability to sell Giant Eagle as a company because the supermarket chains don't want to take on environmental responsibility nor do they want to get into the gas business, oil and gas business. So it now cleans up Giant Eagle. It pays off all the debt of Giant Eagle. Giant Eagle becomes debt-free. Our covenant then becomes a very high investment-grade tenant, although it has no debt. That's a shadow rating. And Couche-Tard now goes to -- will trade like a wawa in the market, probably 5-ish cap as opposed to probably 6.5%, which it was under the GetGo banner. So it improves all of the metrics. It improves the ability for Giant Eagle to be sold. And therefore, the attractiveness of ECHO is a lot better. Our value of our assets is a lot better because the covenants of our tenants is better. And as I said previously, I do expect something to occur by the end of -- no later than the end of next year.

That concludes today's question-and-answer session. I will turn the call back over for closing comments.

Thanks, everybody. Have a good [ time ].

Ladies and gentlemen, this concludes your conference for today. We thank you for participating, and we ask that you please disconnect your lines.