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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good afternoon, and welcome to H&R Real Estate Investment Trust 2023 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 and 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 those statements and 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 and 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.sedar.com.
I would now like to introduce Mr. Tom Hofstedter, Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstedter.
Good afternoon. I'm Tom Hofstedter. I'd like to thank everyone for joining us today to discuss H&R's first quarter financial and operating results and strategy. With me on the call are Donnie Clow, Lead Independent Trustee; Larry Froom, our Chief Financial Officer; and Emily Watson, Chief Operating Officer from our Lantower Residential division. Before I dive into my prepared remarks, I'd like to ask Donnie to make a few opening remarks. Donnie?
Thank you, Tom, and hello, everyone. I'm pleased to be here today with the H&R management team on behalf of the Board of Trustees. Over the last 2 months, I spent a considerable amount of time meeting with investors and activists alike to understand their point of view. I'm pleased the process resulted in the nomination of 2 strong Board members, Lindsay Brand and Leonard Abramsky, both of whom have extensive experience in the capital markets and the real estate industries and will add significant value to H&R.
I want everyone to know that H&R's Board is supportive of the repositioning strategy articulated in October 2021. We are also supportive of Tom and the management team and their strong execution of the strategy to date. The Board will continue to hold management accountable to deliver on this strategy over the short, medium and long term.
In summary, on behalf of the Board, we're excited about the Board renewal and expansion that's taken place. We're pleased with the caliber of trustees that have been assembled, and we look forward to supporting management to achieve our strategy. Tom?
Thanks, Donnie. Since we announced our transformational strategic repositioning plan on October 27, 2021, we have made very meaningful progress. By year-end 2021, we completed the sale of over $4 billion of retail and office properties, successfully enhancing portfolio geographical exposure, asset mix and tenant diversification, while also lowering leverage and increasing liquidity. Throughout 2022, we sold over $463 million in non-core properties, reallocating that capital to buy back stock through our NCIB.
Last year, we bought back and canceled almost $300 million of our units or 22.9 million units at a 40% discount to our net asset value, creating a $0.66 per unit increase in our NAV. As we are approaching the halfway mark for 2023, our year-to-date completed dispositions totaled $296 million, mainly comprised of the office property at 160 Elgin in Ottawa, and we anticipate a further $300 million in sales throughout the balance of the year, including the successful closing of 4 Canadian single-tenant in [ Ronas ]. As a result of this disciplined capital allocation approach over this time period, we have augmented our growth profile meaningfully, achieving double-digit growth in same-property NOI since the announcement of our repositioning strategy and increasing our allocation to residential and industrial from 23% and 8%, respectively, at Q2 2021 to 39% and 15%, a total of 54% as of Q1 of this year. Over this time period, our office exposure, excluding the rezoning portfolio, has declined from 38% to 20%.
Coinciding with this progress is the improvement to our liquidity position and balance sheet metrics. Our stock was also one of the top-performing REITs in 2022, beating Canadian Capped REIT Index by 17%. Year-to-date, our portfolio and team are producing strong financial and operating results across all our property classes. Residential continues to see strong rental rate growth. Our high-quality, well-located office properties with long-weighted average lease terms remain attractive investments for potential buyers at 98.6% occupancy. Industrial properties located in key industrial markets remain in high demand as we realize continued rental rate growth. And our high-quality grocery-anchored and single-tenant retail property portfolio are well -- are performing well, providing essential services to their respective communities.
With each passing quarter, we are moving H&R through our repositioning plan, and we'll continue to drive further momentum as we execute on our plans to deliver value to our unitholders.
As we announced earlier this week, Philippe Lapointe has stepped down as President of the REIT. In his almost 10-year tenure with H&R, he was instrumental in the creation and growth of Lantower Residential, where he oversaw the residential team. On behalf of the H&R REIT and the Lantower teams, I'd like to thank Philippe for his service and wish him the best of luck in his future endeavors.
We believe that H&R is in a strong position with a highly skilled and experienced residential management and development platform at Lantower that will continue H&R's successful execution against our repositioning plan. Leading this team is Emily Watson, Lantower's Chief Operating Officer, with over 25 years of multi-residential experience. Emily is responsible for driving operational execution and performance, including leading and overseeing portfolio property management, development, finance, operations and strategic planning. She's a highly experienced real estate executive and in combination with the Lantower senior leadership team, they have over $4 billion of transaction volume under their belts and $2.5 billion in development deliveries. I'm thrilled to have an individual of her caliber leading the Lantower team, driving growth for our unitholders.
Turning to our performance. We have achieved a number of key milestones year-to-date aligned to strategy. First is the successful disposition of 160 Elgin for $277 million, which closed on April 20, H&R's only Ottawa office property comprising 973,000 square feet in downtown Toronto. Given the considerable headwinds in the public and private real estate markets, we are very pleased to have completed this transaction. This one property represented 19% of our Canadian office portfolio and reduces our total office exposure, excluding the rezoning properties, to 20% on a fair value basis. This brings our year-to-date disposition to a total of $296 million.
Our remaining office portfolio consists of 3 segments, totaling approximately $3 billion. Number one is the U.S. office segment, which almost exclusively consists of 2 high rises in New York City and Houston, representing approximately $1.3 billion or approximately 42% with a $3 billion total office portfolio. Number two is the Canadian office segment currently undergoing rezoning, representing $815 million, which will increase the value once the rezoning is complete, moving properties to their highest and best use. And number three, the Canadian office portfolio not subject to rezoning but slated for disposition, which represents the remaining $674 million.
The second milestone accomplished during the quarter was the unlocking of value through the rezoning of selected office properties, which we've realized through fair value increases in the quarter. Third, we increased distributions by 11.1% effective January 2023. And lastly, we've enhanced our balance sheet with reduced leverage and increased liquidity.
As we approach our Annual General Meeting on June 15, on behalf of the H&R team, I'd like to thank Ronald Rutman for his 27 years of service as a trustee on H&R's Board, including 8 years as Chair and most recently as Vice Chair and Lead Independent Trustee. I'm really excited about the new trustees joining the Board, and we've already welcomed Donnie Clow as Lead Independent Trustee.
Many of you know Donnie from his Crombie days, where under his leadership, Crombie delivered consistent growth and superior unitholder returns while achieving record occupancy levels and significantly strengthening the balance sheet. His experience and expertise encompass the entire real estate [ landscape ] from land assembly, acquisitions and divestments, developments, planning approval and capital structure. In a very short period of time, Donnie has already made a meaningful impact on our company, and I know his guidance will continue to be valuable as we continue to complete the REIT's transformational strategy.
As Donnie mentioned earlier, last month, we announced 2 very strong Board nominees, Lindsay Brand and Leonard Abramsky, adding additional bench strength to our Board. Lindsay is an experienced real estate industry executive and investor who most recently served as Chief Investment Officer at Dream Unlimited, where she led over $2 billion of acquisitions and structured over $3 billion of development partnerships. Prior to Dream, Lindsay held positions at CIBC in real estate commercial banking and corporate development.
Leonard is the Founder and President of The Dunloe Group, a real estate investment company. Previously, he was managing partner at Brookfield Financial Corporation, where he held positions of increasing responsibility in a number of areas, including the active trading and financing of all forms of commercial property and also oversaw its international expansion.
Upon successful election of Lindsay and Leonard at our upcoming AGM and with the addition of Donnie Clow as Lead Independent Trustee, our Board will be comprised of 80% independent trustees and 40% women. As a result of our Board renewal process that began in 2017, all 8 of the REIT's independent trustees have joined the Board in the last 3 years. With the unwavering support of this distinguished Board, the H&R team continues to have a clear direction as we execute on our repositioning strategy.
You should expect us to continue to act on our plan and as we have been doing since October 27, 2021, with discipline, transacting when we can to service value for our unitholders. With today's strong quarterly results, we are on our way to creating a simplified growth-oriented company that will surface significant value for unitholders.
And with that, I will turn it over to Larry.
Thank you, Tom, and good afternoon, everyone. In my comments to follow, all references to growth and increases in operating results are in reference to the 3 months ended 2023 compared to the 3 months ended 2022. As Tom mentioned, the strategy of selling office and retail properties in order to increase allocations to residential and industrial properties is bearing fruit. H&R's same-property net operating income on a cash basis increased by 10.5%.
Breaking the growth down between our segments. Lantower, our residential division, led the way with a 21.3% increase, primarily driven by an increase in occupancy at Jackson Park in New York, a strengthening of the U.S. dollar and strong growth in rents from our properties in the sunbelt states. Lantower same-property net operating income in U.S. dollars grew by a very healthy 14.1%. Emily will provide more detail on this growth shortly. Industrial same-property net operating income increased by 10.2%, driven by rent increases from new and renewing tenants as well as an increase in occupancy. Office same-property net operating income increased by 5.4%. The increase was largely attributable to the strengthening U.S. dollar and the receipt of $865,000 as a lease termination payment. Our office properties are in strong urban centers with a weighted average lease term of 7.2 years and leads to strong creditworthy tenants with 80.4% of office revenues coming from tenants with investment-grade ratings.
I would like to point out that only 346,000 square feet of leases expire in our Canadian office property during the remainder of 2023, which is approximately 5% of the total square footage in our office portfolio. Of the 346,000 square feet that expire, 105,000 is from the 6900 Maritz in Mississauga, which now expires in 2023. H&R received a termination payment of $865,000 in Q1 2023, and we'll receive an additional $2.5 million in Q3. H&R is preparing a site plan application for submission to the city of Mississauga for a new single-story 120,000 -- 122,000 square foot industrial building to replace the 105,000 square foot building. Site plan approval is expected by Q4 of this year. And lastly, retail same-property NOI increased by 6.2%, primarily driven by the strengthening of the U.S. dollar.
Q1 2023 FFO was $0.31 per unit compared to $0.28 per unit in Q1 2022, an 11% increase, driven by strong operational performance across all segments and aided by the U.S. dollar. Momentum in January 2023, H&R's monthly cash distributions increased to $0.05 per unit or $0.60 per annum, an 11% increase over the 2022 distribution, excluding the special distribution in December of 2022. H&R's Q1 2023 payout ratios remained healthy at 48% of FFO and 58% of AFFO, notwithstanding the increase in distribution. Net asset value per unit as of March 31, 2023, was $21.95 per unit, up from $21.80 at December 31, 2022.
The following overall weighted average cap rates were used in deriving the fair values of the investment properties: 4.31% for residential properties; 5.2% for industrial properties; 6.4% for retail properties; 6.85% for U.S. office properties; 4.52% for the 8 Canadian office properties advancing through the rezoning and intensification process to be converted into predominantly residential properties; and 7.18% for the remaining 8 Canadian office properties.
On debt, I would like to draw your attention to Page 25 of the MD&A for new disclosures on the breakdown of debt per segment. Debt to total assets at March 31, 2023, was 43.9% compared to 44% at the end of 2022, and liquidity was in excess of $900 million. In terms of development spending for the remainder of this year, we expect to spend approximately USD 101 million on our U.S. residential developments and approximately $40 million in our Canadian industrial development.
In summary, we are very pleased with our 2023 results to date and confident that our high-quality properties and strong balance sheet will continue producing good results for the remainder of the year. With that, I will turn the call over to Emily.
Thank you, Larry. Good afternoon, everyone. I am delighted to join the call to share with you some of our first quarter highlights from our multifamily platform. But before we jump in, on behalf of the Lantower team, I'd like to thank Philippe for his leadership, guidance and mentorship, and wish him success in the future. I am excited to continue to lead the Lantower team in making meaningful contributions to H&R's repositioning plan. Additionally, I look forward to working more closely with Tom, the H&R executive team and the Board of Trustees.
Jumping into first quarter results, we are pleased with the performance of the portfolio. When excluding Jackson Park, same-property net operating income from our portfolio in U.S. dollars increased by 12.9% for the 3 months ending on March 31, 2023, compared to the respective 2022 period. When including Jackson Park, same-property operating income from our portfolio in U.S. dollars increased by 14.1%. As we have seen in previous quarters, long-term demographic trends remain strong for the apartment sector.
Although new supply continues to make headlines and overall housing shortage still remains, interest rates continue to rise with the gap between rent-to-own rates making it harder for our residents to become homeowners. We continue to experience strong rental rate growth in all of our U.S. sunbelt markets. For Q1, our blended lease trade-out for our portfolio including Jackson Park -- excluding Jackson Park, was 6.4%. Despite the reports of elevated supply, we believe our well-located and high-quality product will buoy our future occupancy and continue to support our rental growth. Despite the reported headwinds, our multifamily portfolio ended the first quarter at 95.3% occupancy, while still achieving healthy rent growth.
On the development front, Lantower West Love in Dallas, Texas is on schedule and on budget, and recently finished most of the concrete garage and foundation work. Framing for the first few turns of the development should reach floor 5, its top floor within a couple of weeks. Also in Dallas, Texas, Lantower Midtown is on schedule and on budget with framing commencing next week. As mentioned in previous quarters, we expect limited variance in the hard cost budget based on how we are tracking. As it relates to the balance of Lantower's development pipeline, we are progressing through the different phases of design, drawing and permitting. We've received multiple new building permits in Q1 for new projects, underscoring our intent to be fully prepared to capitalize our development pipeline when the time is right.
As we prepare for the future growth of our portfolio, we continue our prop tech initiatives to set the foundation for scalability. Fortunately, technology has emerged that creates efficiencies, provides transparency to optimize staffing levels, and reduces the dependency on thinning labor pools. In Q1, some of our prop tech advances included expanding our centralized services, which included transitioning renewal negotiations from our on-site teams to a central service team. Additionally, we began testing artificial intelligence to improve rent collection. Our AI software sends residents that are past due on their rent e-mails and text messages to encourage and remind payment is due. Early indicators showed great success with the artificial intelligence platform, saving over 170 hours of our team's time, handling over 1,000 conversations with late payers, while decreasing delinquency from prior months.
I would also like to take a moment to comment on our residential platform's growth and culture. We recently concluded Lantower's leadership conference at Universal Studios Orlando, where we hosted all of our leaders and future leaders across the Lantower platform. It was great to bring our team together, recognizing the achievements the team has made and part of the [ competency ] that has led us to being awarded Best Places to Work in Texas for 2023. I know many of you on the call today also saw a glimpse of that culture when you attended our Investor Day a few weeks ago. The team cohesion and vision alignment, paired with a strong track record, should provide support and continued outperformance from the Lantower platform.
In closing, our unified and skillful teams will continue the work we have done for years. We will execute the same vision with the same team and thus are confident in our ability to continue to grow the Lantower platform and make meaningful contributions to H&R's successful execution against the repositioning plan. I am thrilled to lead this incredible team and honored to continue along the same trajectory that we have created. And with that, I will pass it back to Tom.
Thank you, Emily. I want to thank our investors for their time, patience and feedback. Despite the persistent volatility in the public and private markets, a challenging disposition environment and macro kinetic headwinds, we are executing against strategy. Our strong financial results are a testament to our actions. Recognizing that there is still significant important work ahead of us, we are committed and are well on our way to creating a simplified growth-oriented company that will serve as significant value to our unitholders.
We'd now be pleased to answer any questions from the call participants. Operator, please open the line for questions.
[Operator Instructions] First question comes from Mario Saric from Scotia Capital.
Just wanted to ask a question on the strategic plan. In the press release, I think, in relation to welcoming Donnie Clow as an independent trustee, I noted that the comment was a plan to seek to accelerate the transformation strategy. Am I reading too much into that? Or do we need to plan to get stuff done sooner than what you laid out before?
It's -- when you're talking about a 5-year time line and you have COVID and you have all the other economic conditions that are out there, it's pretty hard to answer that question definitively. We would like to accelerate it. Whether we can actually achieve that result is not totally in our hands. So I think the answer, quite frankly, is yes, if possible, but it's not in our hands. So hopefully, we'll get there.
Okay. And then the end game has always been like 80% multifamily, 20% industrial, U.S. and Canadian, respectively. Not sure if there's a lot of synergy between those 2 asset classes. Is industrial a long-term asset class for you? Or would you consider disposing of the portfolio under the right scenario?
We'd consider disposing the portfolio in that scenario, but you have to appreciate the fact that we are a Canadian REIT with unsecured debt. And Canadian content is definitely paramount from a tax perspective, from unsecured banking -- from unsecured debt perspective and from a banking perspective. So whether we can actually become a totally based U.S. REIT is very questionable at this point in time. If the right deal comes across, depending where we are with the other -- with the disposition program, it's something that we would consider. But it's not something on our radar screen at this point in time.
Okay. And then with respect to the office assets, has there been any change in the overall acquisition disposition environment in the last 2 to 3 months of consequence?
So acquisitions, there's been no change. So I don't think the market from the acquisition side, at least from H&R, that's never been on our radar screen. The disposition side, I don't think anything's changed. I think when we -- if we manage and hopefully, we will manage to do some dispositions, they'll be strategic, they'll be creative. I don't think it will be real estate 101 where you put an asset on and off, spending on the market, and deal flow in the world -- that world currently doesn't exist, but we are still optimistic in our disposition program.
Got it. Okay. My last question, just with respect to the recent management changes. Any implications at all with respect to the strategy?
Any -- what was the question?
Any implications on the communicated strategic vision after the recent management changes?
I'm having a hard time understanding what the definition of that question really means. Maybe, Don, do you understand?
No. Sorry, Mario, we're having trouble -- a little bit of trouble hearing you. I apologize.
But maybe say the question in different words because we're not understanding the question.
Okay, following the recent -- following Philippe's departure, is there any implication to the strategic plan laid out as it was?
Yes. No, Mario. In simple terms, we've laid out the strategic plan in 2021. Philippe was a great leader, and it was a mutual departure. But at this stage, we're very pleased with Emily's leadership in Lantower. And in terms of the actual strategy, it's the same strategy we articulated in 2021. And we're very pleased with the Board. I can tell you within my remarks with management's execution to date, we're really cheering them on here and really going to hold them accountable to actually achieving this, executing the strategy. So there's no change, long-winded answer.
[Operator Instructions] Next question from Jimmy Shan at RBC Capital Markets.
So it looks like you're making some good progress on some of the rezoning the office. I think you've increased the value in your office portfolio this quarter. Are we -- should we expect any monetization of any of those projects in the near term? Are those -- are any one of them candidate for that?
Not in -- let's put it this way, not this year. And I would say not for the most part of next year, but you could see a monetization event of potentially one property towards maybe Q4 2024. We still have a lease on 55 Yonge Street with CIBC. We are not completely finished, all of the rezoning. The world has changed, and the rezoning process is -- that process -- the rezoning result is going to change as well as office becomes much more difficult for the city to rationalize replacing. And as residential -- the residential component probably needs a segment of affordable, which Toronto doesn't have currently. So when that process is finished, I think the first monetization event is going to be Q4 2024 or thereabouts.
Okay. Got you. And then I guess since Donnie is on the line, you mentioned a couple of times that you'll hold management accountable in the execution of strategy. Just curious as to sort of what are the key milestones or metrics that you guys are going to be setting to assess the success of the strategy and whether or not that would include time lines or maybe just give us your general kind of guidelines on how you would assess that.
I mean, Jimmy, the time line that was outlined in 2021 is a 5-year time line. And honestly, the progress the [ booking ] management team has made to date, I think, has been extremely strong. You're talking about $4.5 billion worth of dispositions, including Elgin, this early part of this year, and Tom indicated possibly another $300 million before the end of the year. I don't see anybody else in the industry executing with that kind of pace especially in office. It's very difficult. And so for us, we're sticking to that 5-year time line. Right now, they're ahead of plan. I know people are impatient, as we've seen over the last couple of months. But the Board is, I think, overall pleased with the progress. And then as I said, very strong, we're going to be holding management accountable to achieve the plan. So yes.
Okay. And then maybe just last question with respect to Philippe. I mean, hopefully, my questions are -- is clear. But so -- like we're outsiders looking at the company. Obviously, we're not privy on the discussions that go inside the tent. But when we look at sort of Philippe, he's been kind of the most visible cheerleader of the firm to the Street in the last year. And obviously, he's built -- or has helped build Lantower the last 8, 9 years and seem to be very passionate about it. And then we see sort of a 180-degree turn. And so rightly or wrongly, again, as an outsider looking in, it kind of raises the question of whether there's something going on that should or should not be of concern to shareholders. I don't know what my question is, but is there any comment that you can make to maybe help us get a better read of the situation?
It's Donnie. I'll speak to it. I mean, number one, we can't talk about Philippe's departure. I mean, as I think we indicated in the press release, it was a mutually agreed-upon departure. And so that is what it is. I think importantly, we are saying that we're committed to the strategy. There's no change in direction. We're very confident in both the H&R leadership and Lantower leadership.
Emily is an outstanding leader. Her team loves her in my experience in walking around properties with her, and their execution, I think, is very strong. So it's important that people know there's no change in the strategy. And the execution, as I said, is ahead of schedule. So if anything, Tom and the team deserve congratulations for executing what are very difficult transactions, as I'm sure many of you saw with the Elgin transaction, the complexity, how things are structured, and the financing at the end of the day.
This is not easy stuff. But we are sticking to the plan, and we're executing it well. So in terms of the interpretation of what happened, it's -- the people are creating their own narratives, and I don't think that's really going to help people too much. I think what is most important is that we stick to the plan and then execute the plan.
The next question comes from Sam Damiani at TD Cowen.
Maybe, Tom, for you, just on the sort of enhanced disposition outlook for this year, what types of properties or geographies are you thinking about that might be possible to transact on? Perhaps, you might be thinking...
Office and retail.
Okay. So Canadian retail?
Yes. Just for clarification, there is no U.S. retail. Almost none. I think in those are the small little couple little oil and gas that's left, but that's not meaningful.
Okay. And then any update on the 160 Elgin buyer with their ability to arrange full first mortgage financing?
I don't -- I have an update, but I can't disclose it. I think it's not baked yet. He had a 90-day VTB from us. We expect to be able to get there. There's no extension rights. If it's 90 days or 120 days, that's not meaningfully different. He expects to get there. I have no -- I can't confirm if that's going to actually happen or not. The buyer is optimistic that they're going to get there.
Okay. And with the remaining dispositions, the [ Ronas ] and others this year, do you see providing more VTB financing to the buyers?
Currently, under what we have under the go, when I say the $300 million, it does not have any VTBs. But I put a caveat to that. If those aren't the deals or other deals are going to the future beyond this year into next year, I think it's a way of life right now. And I think that most deals have some element of VTB. It's a function to -- really to where lenders are and what percentage of the purchase price you're going to finance and what interest rates are. So I see almost all deals out there, other than the deals that we currently have on the go in the $300 million, having some form of structured enhancement, whether it's a buy-down, a rate or whether it's a mass financing, I think that's a way of life right now.
Okay. Great. Last one for me, Larry, maybe for you is the same-property NOI growth guidance that was given last quarter. Any change to that?
Sam, yes, I think we've had a really strong start to the year, a really good quarter. So based on that and based on the U.S. dollar staying as strong as it was during the quarter and with 160 Elgin coming out of same property, which is kind of declining and been declining in its operating income, I think we're going to be at the top end of that range and probably maybe even a little bit better.
Thank you. There are no further questions. I will now turn the call back over for closing comments.
Thank you, everybody. Thanks for joining, and have a great quarter. Bye.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.