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Good afternoon, and welcome to H&R Real Estate Investment Trust 2018 First 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. 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 is described in more detail in H&R's public filings, which can be found on our website and www.cedar.com. I would now like to introduce Mr. Tom Hofstedter, President and Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstedter.
Good afternoon, everyone, and welcome to our first quarter 2018 financial results conference call. On the call me today are Larry Froom, our CFO; Pat Sullivan, COO of Primaris; and Philippe Lapointe, COO for Lantower Residential. We're going to start off by bringing Pat to tell us a little bit about Primaris, followed by Philippe and then I'll basically bring up the rest of what's going on at H&R. Pat?
Thanks, Tom, and good afternoon. Our enclosed shopping centers are typically the dominant or only enclosed mall in their primary markets. Sears, much like Target, occupies large premises that were situated prominently on the property. They pay significantly below market-based rent, contributed very little toward the cost of operating the shopping center, thereby shifting the burden to small shop tenants and did not drive traffic to the shopping center in the end. With the departure of Target, we were afforded the opportunity to add new retailers to our properties, including Winners, London Drugs, H&M, Home Sense and Indigo, to name a few. In some cases, tenants were new to market while others relocated from nearby retail development, seizing the opportunity to relocate to the dominant retail development in the market. Further, over the long-term, the elimination of lease restrictions provides us the opportunity to further develop our sites, creating growth in both revenue and traffic to the property. During the first quarter of 2018, we obtained vacant possession of the remaining 7 Sears stores in our portfolio. Our 2 other Sears stores were disclaimed by the monitor in late 2017. We have now undertaken a thorough review of the condition of the Sears stores, redevelopment plans are advanced, construction groups have been engaged and discussions with replacement tenants are progressing in advance. With the continued growth and evolution of e-commerce, retailers are reshaping their operating platforms. Using demographic information obtained from their e-commerce business, retailers are becoming increasingly sophisticated in understanding their bricks and mortar needs. Shipping cost both for delivery and returns are high, especially to areas outside of Canada's major urban centers. As such, operating the physical store has become an essential component in the retailer's omnichannel strategy. With the physical store presence, retailers can reduce shipping costs by way of in-store pickup, simplify the return process and create opportunity for additional sales from online customers that come to the store in person. One large format international fashion retailer stated that they're expanding into many regions where Primaris owns shopping centers as their online business strengthens with the physical store opened because without a bricks and mortar location, customers returning items are required to pay the cost of shipping. Our enclosed malls are typically the dominant retail property in their respective region, and we benefit from the retailers' increased understanding about their customers’ shopping habits in our markets. Strong e-commerce sales for selected retailers in many of the cities where we own properties, such as Fort McMurray and Fredericton, have aided in advancing discussions with potential new tenants, such as Sephora. Leasing activity throughout the portfolio continues to be strong, with our team completing 108 transactions during the quarter, including 33 new transactions. By way of comparison in Q1 2017, our leasing team completed 93 transactions. We have completed a significant number of lease renewals in the first quarter, resulting in 66% of the 2018 expiries being finalized. Significant store openings at our properties at spring include Marshalls, Dollarama, Indigo and Urban Planet, all opening at Catarqui Centre from a combined area of approximately 100,000 square feet as well as Urban Planet opening new stores at both Sherwood Park and Sunridge Mall from 35,000 square feet in total. Further, we have completed 3 deals with TJX, totaling about 100,000 square feet at Sunridge, Garden City Square and McAllister Place. At McAllister Place, TJX will open in Marshalls-Home Sense combo store in the Fall of 2018 while the other 2 TJX stores open in 2019. Thank you, and I'll now turn the discussion over to Philippe.
Good afternoon, everyone. I'm pleased to be on the call today to share the latest news from Lantower Residential. As mentioned in the last quarter's call, we are under contract for a brand-new deal in Austin, Texas. We have since completed our due diligence, and so we're now able to share details regarding our newest acquisition called Edgewater. The brand-new 328-unit development is a sister property of 2 of our other Austin assets, North by Northeast and Ambrosio. The acquisition provides operational economies and gives us strategic control of the Tech Ridge submarket. Edgewater is about to begin its lease up which provides us with better quality control of tenants moving in for the first time in addition to offering a higher stabilized cap rate, otherwise unavailable on fully marketed stabilized Austin properties. Perhaps the most exciting news comes from a recent activity in Raleigh, North Carolina. As a result of the market's recognition of the Lantower platform, we have secured 2 off-market opportunities with one of the largest multi-family equity investors in the U.S. Both assets are brand-new, Class A properties in 2 of the most desirable submarkets in the Raleigh MSA. The first currently called Woodfield Weston Corners, which upon closing will be rebranded as Lantower Weston Corners, is a 308-unit development in the Cary submarket of Raleigh. The 5-storey benefits -- the five-storey property benefits from its proximity to some of the most prized white collar employers in the entire Raleigh MSA. MetLife's 641,000 square-foot global technology headquarters campus that currently employs approximately 2,000 people sits across the street from the property. Additionally, the SAS Institute headquarters, the world's largest private software company employing 6,000 people, is located 5 minutes away. The second acquisition, BullHouse Apartments, the 5-storey, 305-unit, mid-rise property located in the high growth submarket of downtown Durham. The property earned a Walk Score of 90 due to its live, work and play location, a short walk away from major Durham destinations. In addition to proximity to major breweries, one-of-a-kind eateries and the Durham Bulls Baseball Stadium, the residents benefit from a quick commute to major employers such as Duke University and Hospital and a large Tech start-up hub in the innovation district and start-up factory. In addition to purchasing Edgewater and the 2 properties in Raleigh, we have secured another off-market opportunity from a renowned developer in Florida. We placed under contract, a brand-new property in the very dynamic submarket of Tampa, Florida. This will mark our fourth acquisition in Tampa, a market that is well positioned for strong and stable population and job growth. We will disclose more information regarding this acquisition next quarter. On the portfolio front following the acquisition of Edgewater, Weston Corners and BullHouse, Lantower will consist of 6,574 apartments across 20 of properties with a weighted average portfolio vintage of 2011. As mentioned last quarter, same-property occupancies are officially below normal due to the inclusion of a lease-up of Ambrosio in Austin, which is 60% occupied at the end of the first quarter. Excluding the impact of Ambrosio's lease-up, our portfolio occupancy was approximately 93% at the end of the first quarter. On the financial front, our same-asset quarter end operating income increased in U.S. dollars from $6,793,000 in the first quarter of 2017 to $7,173,000 in the first quarter of 2018. This equates to same-asset quarter-over-quarter operating income growth of 5.6%, demonstrating yet again our continued NOI growth quarter-over-quarter, primarily due to strong revenue growth and active asset management. On the development front, we're nearing the start of our Koenig Lane development in the heart of Austin, Texas. The 383-unit midrise community called The Pearl is expected to commence construction in the late summer of 2018. Our Hercules Project in northeast San Francisco is also nearing construction mobilization. We expect to start shoring and grading work in June with vertical construction to start in August. This 172-unit development now called The Exchange at Bayfront, represents the first phase of over 1,000 units within the Hercules Bayfront development. As our multi-family developments progress, we look forward to sharing more exciting news on our next quarterly call. And with that, I will pass more of the conversation back to Tom.
Thanks, Philippe. So by now, you probably all saw that we issued a press release the start of this conference call regarding our sale of the majority of our U.S. retail portfolio in the United States for USD 633 million. We're really going to the wire to get this done before the conference call, and so I apologize that it came out so late. So before mortgage and prepayment of closing comps, our proceeds was $633 million. This reflects a 7.3% cap rate, which will actually result in some near-term drag on our FFO per unit until the proceeds are redeployed. We estimate the FFO impact at approximately $0.05 to $0.06 per unit in 2018 based on our current pipeline of acquisitions. The sale is key to our strategy of recycling our capital to higher growth properties most notably, our Lantower Residential division, which with this disposition reaches 15% of total assets, and we expect near-term acquisitions to put that -- push that even further so eventually over time, we have approximately 25% of our total assets. On a local currency basis, same asset operating income of 1% was powered by a 5% -- 5.6% increase from our Lantower residential subdivision and a 1 point -- and 1.7% from our office portfolio. Our 12.3 million square foot office portfolio accounts for nearly half of our assets and includes 5.3 million square feet in the tight Toronto office market, where we estimate market rents for our portfolio are approximately 23% above our in-place rents, providing significant upside on future lease maturities and renewals. This positive internal growth came despite modest occupancy erosion from all of H&R REIT's portfolios. At 94.1%, we expect portfolio occupancy to rise over the next several quarters as recent Lantower acquisition still leased have stabilized and as Primaris occupancy rises through 2018 and '19 with the final Target and Sears replacement tenancies taking occupancy. Jackson Park, as you heard, our 1,871-suite luxury rental building in New York has begun lease-up and occupancy. The development is leasing up slightly ahead of our pro forma with both higher occupancy and higher achieved rents. We expect this project alone to add more than $1 per unit in NAV, some of which has already been recognized during construction. With Jackson Park nearing completion and expected to be fully leased and stabilized in late 2019, we have a significant pipeline of other projects now underway, and we expect to be able to provide further details of these developments, which total more than $1.5 billion of cost in coming quarters. All of our developed projects are located in strong primary markets and we expect each to deliver private value creation for unitholders and enhance the REIT's same asset operating income profile as they become income-producing. Our Lantower portfolio, which is concentrated in high population, employment growth markets saw a same-asset operating income increase 5.6% in the first quarter. In the near term, we expect impact of Jackson Park's lease-up and the retail sale of our U.S. portfolio to reduce FFO in the next 2 or 3 quarters followed by strong ramp up in per-unit growth -- FFO growth as Jackson Park completes its lease-up as Primaris occupancy rebounds the Target and Sears replacement tenancy commencements, and as the rising weighting of Lantower Residential on our portfolio all contribute to a higher internal growth rate. And finally, we are pleased to report that our amended reorganization plan has received final court approval, allowing us to collapse our Stapled Unit structure during the third quarter, pending CRA approval, returning H&R to a simplified REIT structure. And with that, I'll open -- the operator will open up the call to questions.
[Operator Instructions] Your first question comes from Dean Wilkinson with CIBC World Markets.
Maybe just a question for Larry. On the -- how we're thinking about the capitalized interest to come in, should we think of that sort of $0.02 a quarter over the next couple of quarters? Would that be the best way to think of that?
Dean, yes, I think you would be correct in thinking OpEx [ that way ]. $0.02 a quarter would be a good.
Okay. And then just in term of the math there, it looks like there's about $287 million drawn against the facility, and you've got another $74.5 million to go. So would that be that you're calculating that interest expense on the $362 million, which would imply something in the area of sort of a 4% to 5% cost on that construction financing?
Yes, I believe the cost is 4.7%.
4.7%., okay. I got that 1 closest to the pin, that doesn't ever happen. In terms of when this then stabilizes, what do you think the interest savings are that you could term this out towards?
Sorry, Dean, I didn't follow the question.
Asked what's in permanent financing and on the construction financing?
Yes, so when you term that, I assuming you're going to take the $362 million and just term it out.
Around 60 bps [ and we'll take a ] 10-year term.
And you'll take a 10-year term?
I don't know if we will. But if we took a 10-year term, it would be 60 bps.
And you would think that you would do that as you hit substantial stabilization like more a 2019 kind of thing?
The future depends on what yields sort of look like and what the world looks like at that point in time, but probably all things being equal.
Okay, make sense. And then just on the asset sale that you just announced. Would I be reading that right, you're going to have about $430 million net cash afterwards, which is largely going to go towards Lantower?
It's going to go towards Lantower, there'll be some residual. Right now, we have to the 1031 exchanges, so we've lined up enough to basically defer all of those taxes we'll have and should have no taxes payable at all under this disposition. So between the Lantower acquisitions, the paying off the mortgages and the exit cash left for NCIB or whatever we want, future acquisitions, you got your math right.
[Operator Instructions] Your next question comes from Sam Damiani with TD Securities.
Congratulations on the sale just announced. Just on that, Tom, I wonder if you have any further thoughts of potentially using more of the proceeds to buy back stock potentially through a substantial issuer bid.
So the answer is depending where the stock is, what the opportunities are, but we're definitely open for that. There won't be a policy. It's really going to be dependent on where the stock is as I said, and opportunities.
Okay, just flipping over to the IFRS adjustment in Q1, there was about roughly $100 million taken on the Primaris assets. Could you give us a little color on sort of what move was behind that?
Sam, it's Larry. Generally...
Sam, with Larry's accent, do you think he has to say "it's Larry" anymore? I think from now on, all future conference calls Larry, should not say "it's Larry." Okay, Larry, on that note.
Thanks, Tom. It took mostly the Sears -- contemplating the Sears redevelopments. And so the work that was actually done on them, the lease-ups, the tax of the lease-ups in effect probably at 1 year or 18 months. But most of it have to do with the Sears redevelopments.
Okay. And just over in Alberta, there's rumors that the Stantec Tower there might get sold sometime soon. I wonder if you have any intelligence on that and if you see any follow through on potentially a transaction involving The Bow.
I don't think it has anything to do with The Bow. I mean, The Bow is a different animal, a long-term lease, much larger credit tenant, as you well know. And The Bow's challenge is its size, nothing else. The Bow can wait to about 20 years-plus in lease term, so I think there is no really reflection on that at all.
[Operator Instructions] We do have a question from Neil Downey with RBC Capital Markets.
Philippe, these 3 assets you've agreed to acquire, Edgewater, Weston Corners and BullHouse, what's roughly the acquisition value of those 3 assets?
It's approximately -- it's a little over $200 million.
Okay. On the retail sale, Tom or Larry, you do mention closing cost and mortgage prepayment adjustments. Roughly how much will those figures be?
USD 15 million.
Okay. And The Pearl and the Hercules projects, both were mentioned by Philippe, I believe, in your prepared remarks. I didn't see the disclosures on the expected development yields on those assets, and I -- in those projects rather, and I think we had them in the past. I think the latest number I saw was about, if I'm correct, 5.4% for Hercules and around the 5.9% for The Pearl. Do those numbers hold or are there some adjustments expected there?
I think it stabilizes higher than that, Neil, in the 6% of stabilizing.
I agree. A good rule of thumb, Neil, is probably to tackle and under [indiscernible] on the market between let's say 60 and 100 basis points over what is stabilized asset with yield. So I think a 5.4% is too low. I don't know where those numbers come from.
Okay, I will circle back and look at my own records. And I guess on the same subject of development, there was some disclosure, I believe it was last summer with respect to Long Beach and a project called Shoreline Tower and then one up in Seattle as well. Are those still part of the pipeline?
Yes, our Shorelines is just about ready to go. It should be going shortly and Seattle was not quite ready to go. Shoreline is 2018 and Seattle is 2019.
Okay. And one last question, just sorry for the laundry list approach here, but the buyer of the U.S. retail portfolio, can you give us a hint or maybe just a profile of the type of buyer?
I'd love to, but you know what, Neil, he's listening. We have confidentiality, so we can't.
On closing, hopefully on closing, we'll be able to.
[Operator Instructions] Your next question comes from Sam Damiani with TD Securities.
Just on the sale, I recall last quarter, the fair value I think of the U.S. retail was a little over $700 million. Can you say the sale price today, how that compares to the fair value of those assets?
From last quarter's IFRS value?
Or basically what I'm asking is, is there going to be a loss or a gain?
No. There is no loss. So we did expect a loss for the prepayment at closing -- prepayment mortgage costs, mortgage prepayment and closing cost.
Yes, that's not for the quarter. That's for the following quarters. And it adds, I think, Neil, USD 15 million was the closing cost of mortgage pay down. But to the IFRS value of tax of those other than the $15 million cost.
Is roughly in line with your balance sheet value?
Yes.
Yes.
And then what's your -- you have a lot more development on the go. What's your target leverage for H&R maybe a couple of years out after Long Island and other assets are stabilized?
I don't expect it to change more than 1 point or so.
So in and around the 40% level?
In around where we are now.
Your next question comes from Mario Saric with Scotiabank.
Just one really quick one in Jackson Park. I think, Tom, you mention about $1 per unit of upside to NAV on it. How much would have already been recognized in your IFRS values thus far?
Mario, I won't say it's Larry again. In Q4 2016, we recognized just under USD 55 million of increase. And last quarter 2017, we recognized just under USD 100 million. So roughly, we've recognized about $150 million.
No, no, you got half of it down.
And half of it is already recognized.
You got $0.50 there.
[Operator Instructions] Your next question comes from Matt Kornack with National Bank Financial.
A question on FFO per unit, the bridge between now and 2019. You mentioned the impact this year of the Jackson Park accounting items. But is the anticipation that the existing portfolio will generated positive FFO per unit growth and then you will get the benefit of Jackson Park in 2019?
Sorry, we will get the benefit of Jackson Park in 2019 and 2020. But is your question on the rest of the portfolio, some FFO...
Yes, I guess, you've sold assets, you've bought -- there's a lot of moving parts in terms of where things have gone in an FFO per unit standpoint. I think the negative impact that you described, would you expect otherwise flat FFO per unit growth for the rest? And that we should see sort of $0.05 to $0.06 down or...
I think, Matt, to answer your question, the Jackson Park we've discussed already, should be an FFO adjustment down for 2018 or just our reported FFO down. And then for the sale, the retail sale will be dilution from depending how quickly we can redeploy budget.
So this question was unannounced in the portfolio and you just -- not a dilution and not that.
Without those 2 areas, it should be coming out pretty much to where analyst consensus was for the rest of the portfolio.
[Operator Instructions] We do not have any questions over the phone line at this time. I will turn the call over to Mr. Hofstedter.
Thank you all, and we look forward to seeing you again, hearing you again next quarter.
This concludes today's conference call. You may now disconnect.