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Good afternoon, and welcome to H&R Real Estate Investment Trust 2018 Fourth 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 the 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 of both 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 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, Mr. Hofstedter.
Thanks for joining us today. I'm Tom Hofstedter, and I'd like to welcome everyone. As is our custom, Larry Froom, CFO of the REIT, will give you a high-level summary of the quarter results, Pat will provide an update on Primaris, and Philippe will provide an update on Lantower, and then I'll conclude with some closing remarks.Over to you, Larry.
Thanks, Tom. Good afternoon, everyone. Jumping right into our bottom line. FFO on a fully diluted basis in Q4 was $0.43 per unit compared to $0.45 in Q4 of 2017. The decrease is directly attributable to the sale of $950 million worth of properties during 2018 compared to acquisitions of $280 million during the same period.AFFO on a fully diluted basis was $0.32 in Q4 of 2018 compared to $0.35 in Q4 2017. Additional CapEx deducted from AFFO in Q4 compared to -- Q4 2018 compared to Q4 2017 was approximately $6 million.Part of the proceeds from the asset dispositions have been used for our development pipeline, which will be a source of significant growth in property operating income and FFO in the next few years.On a same-asset basis, Q4 2018 property operating income from Canada was up 2.2% over Q4 2017. And on a same-asset basis, Q4 property operating income from the U.S. in local currency, that is in U.S. dollars, was up 2.4% over Q4 2017. These increases in same-asset property operating income are a testament to our capital recycling program to sell assets with low growth potential and replace them with assets that have higher growth potential.We recorded a fair value decrease on our real estate assets of $152 million in Q4 2018 and $247 million for the year ended December 31, 2018. Those arose mainly from adjusting Primaris portfolio cap rates, and we made those adjustments despite the lack of any recent sales comps. And furthermore, it was not made because of any operational performance issues. In fact, Primaris property operating income has risen in 2018 compared to 2017, rather this adjustment was made due to the market's overall negative perception to retail malls. And given this background, we felt it was the right thing to do.Despite this fair value adjustment, H&R's NAV per unit, net asset value per unit, rose from $25.57 per unit at December 31, 2017, to $26.30 per unit at December 31, 2018. This increase is partly due to $108 million fair value gain recorded at Jackson Park, Long Island City, which is accounted for as an equity investment. This gain was the result of an independent national firm's appraisal and was not based on Amazon's planned investment into the area. The rent assumptions and cap rates will not change at all for Amazon's initial planned arrival, and that was always considered too far out to impact us today.The U.S. dollar strengthening to CAD 1.36 at December 31, 2018, from CAD 1.26 a year ago was also a large contributor for the increase in NAV per unit.I will now hand over to Pat.
Thank you, and good afternoon. In 2018, Primaris assumed responsibility of the H&R retail portfolio, and we completed 2 significant transactions during the year. We negotiated lease extensions with Sobeys for 6 locations in the portfolio, with the average weighted lease term to maturity increasing from just over 3 years to 14 years.In addition, we negotiated lease extensions with 9 large-format Lowe's stores, occupying an area exceeding 1 million square feet for an additional 15 years with rental escalations every 5 years. As part of our agreement with Lowe's, we negotiated rates, which enabled us to add density to the sites, which we will pursue on an opportunistic basis. Following a thorough review of the portfolio, we have identified noncore assets located in small markets that will be marketed for sale over time. In this regard, we have recently entered into agreements to sell 2 retail projects that identified for disposition for $16.9 million.With respect to Sears, Sears paid annual base rent at H&R ownership interest of $2.3 million. We anticipate approximately $7 million in annual base rent will be generated from Sears store replacement tenants, with rental payments starting in Q4 2019 and most tenants open and paying rent by Q4 2020. Sears typically occupy prominent space at our properties. As such, we are being selective with replacement tenants, focusing on those tenants that are prepared to pay market rents and enhance our merchandise mix. Several of our redevelopment plans including -- include partial demolition of Sears and the addition of outparcel development.Leasing activity during 2018 was very strong. Our team completed 419 transactions, including 132 new lease deals. Our overall occupancy continues to be negatively impacted by the closure of Sears. However, our CRU occupancy rate has risen for the fourth straight quarter and is at its highest level in 2 years due to consecutive years of strong leasing activity. Primaris own dominant malls in the respective trade areas and ones which are often the only regional mall in their respective city. With tenants recognizing the importance of operating an online business in addition to maintaining a bricks-and-mortar presence, we continue to see strong tenant demand for space in our portfolio.12-month rolling same-store sales within our enclosed mall portfolio are relatively flat at $565 per square foot as compared to the prior year, but they are considerably higher than the $542 per square foot recorded in 2016.Over the past 3 years, we have been rebalancing our merchandise mix with a focus on reducing our exposure to fashion tenants. The result has been stabilized productivity from the fashion category, coupled with fashion tenants posting declining occupancy cost ratios. While categories such as health and beauty, food and footwear have all shown solid growth over the past years, electronics and jewelry categories have shown weakness after having been strong performers for many years.In 2018, we spent time reviewing opportunities within our portfolio to redevelop and intensify properties in markets such as Toronto where the economics of these projects has improved materially in recent years. With sales of approximately $700 per square foot, Dufferin Mall is not simply a high-performing shopping center but is also a 21-acre site proximate to a subway station.We have started public consultation meetings regarding our preliminary plans to add density to Dufferin Mall, which includes the addition of significant residential development, which will further benefit sales at one of our top-performing shopping centers once completed. We anticipate the approval process will take approximately 3 years. Thank you. I will now turn the discussion to Philippe.
Good afternoon, everyone. I'm pleased to be on this call today to share the latest news from Lantower Residential. As mentioned last quarter, we closed on a 308-unit property named Lantower Weston Corners located in the Cary submarket of Raleigh. Closing occurred on October 16, bringing our Class A Raleigh portfolio to nearly 1,000 units. The 5-story property benefits from its proximity to some of the most prized white-collar employers in the entire Raleigh MSA, such as Metlife's global technology headquarters campus and the SAS Institute's headquarters, which is the world's largest private software company.We also mentioned last quarter the potential acquisition of a property in Charlotte, North Carolina. We are happy to announce that we closed on the property on December 3, making our first acquisition in the Charlotte market. Built in 2016, Lantower Waverly is a 375-unit Class A development in one of the most affluent submarkets in Charlotte, characterized by high-income households and A-rated public schools. Lantower Waverly is also located within the Waverly mixed-use development, which includes over 250,000 square feet of retail and walkability to a Whole Foods Market. As a sidenote, we are also pleased to hear the news of the BB&T and SunTrust merger due to the proposed headquarter relocation in Charlotte.2018 was an active year for us. Lantower Waverly rounded out our 2018 acquisitions, bringing our total to approximately $340 million across 1,638 units. On the portfolio front, following the closing of Lantower Waverly, Lantower Residential consists of nearly 7,300 apartments across 22 properties. Lantower's weighted vintage of 2011 represents some of the newest multifamily portfolios in its sector. We expect this vintage to trend newer as we may dispose of our older assets and bring in more recently constructed properties as we complete our ground-up multifamily developments. As mentioned in previous quarters, our reported fourth quarter occupancy is artificially lower due to the inclusion of the lease-ups of Ambrosio and Edgewater in Austin and BullHouse and Weston Corners in Raleigh and Durham. Excluding the impact of these lease-ups, our portfolio occupancy was nearly 93% at the end of the fourth quarter. On the financial front, our same-asset year-end operating income increased in U.S. dollars from $25,867,000 to $27,010,000 in 2018. This roughly equates to same-asset year-over-year operating income growth of 4.4%, representing yet another strong year of NOI growth. On the development front, construction is underway at the $425 million River Landing project. With approximately 1,000 feet of waterfront on the Miami River, River Landing is a mixed-use development, including approximately 346,000 square feet of retail space, approximately 1,300 -- sorry, 136,000 square feet of office space and 529 residential units. To date, 66% of the retail space has been leased, with a further 10% under executed nonbinding letters of intent. We expect to start preleasing the multifamily towers towards the end of the fourth quarter this year, and construction is expected to be completed in the second quarter of 2020.Construction at Jackson Park has been progressing as scheduled, and the project is currently 96% complete. Jackson Park will be moved from properties under development to investment properties in the first quarter 2019. Leasing velocity remained strong over the fourth quarter, bringing total occupancy across the 3 towers to over 65%. We expect leasing to accelerate given almost all of the amenity areas are now open to residents and the fact that we're moving into higher leasing months. The last remaining unopened amenity space is the rooftop on top of Tower B1, which is scheduled to open in March. As we look into the future, we believe Lantower's investment strategy will pivot away from the acquisition of existing assets to focus on a more accretive approach to growth through the execution of our existing development pipeline and investing in opportunistic ground-up development. We look forward to sharing more exciting progress on the developments on the next quarterly call. And with that, I will pass along the conversation back to Thomas.
Thanks, Philippe. As I hope everyone can tell, the entire team at H&R has been very busy over the past year on multiple fronts. Highlights include recycling capital through over $1 billion of sales and reinvestments into higher-growth assets and the repurchase and retirement of 6.6 million units. Significant advancement of our $1.5 billion development pipeline, including our flagship Jackson Park development in LIC that is now 68% leased and our River Landing project in Miami, and material progress on enhancing our Primaris properties with the new tenancies commencing over the next 24 months will generate $9.4 million of additional NOI for H&R. These accomplishments align very closely with the goals we set out a year ago of streamlining and simplifying our portfolio, raising the internal growth profile of our portfolio, enhancing the profile of H&R to its unitholders. We believe the actions taken in 2018 have not only made H&R a better REIT for the long term, but we expect to see over $26 million of new NOI contribution in 2019 from Jackson Park, the lease-up of recently developed Lantower properties and the commencement of Sears and Target replacement tenancies.Amazon's announcement today that they are abandoning their plans to build the headquarters in Long Island City does not change the fact that Long Island City was chosen for its appealing characteristics, the same factors that drove our investment into Gotham and Jackson Park. These 2 properties sit at what we believe is the single best location in Long Island City atop the Queens Plaza Subway Station, gateway to LIC as the nexus of 3 main New York City subway lines. Our investment in LIC along with Corus Quay in Toronto and River Landing in Miami are key examples of how H&R has identified and made significant investments in attractive, gentrifying urban locations early in their development cycle, subsequently benefiting from the emergence of these locations as prime nodes. We've always maintained that despite the excitement created by Amazon's November announcement, it remains too early to forecast how Amazon's plans might impact our development. The assumption is used to support our appraisal -- our appraised value and our future cash flow forecast from Jackson Park have never reflected the move by Amazon to Long Island City. And so the decision today to back away from LIC will not have any impact on our value and our forecasted cash flows. We continue to be highly focused on growing the FFO and NAV per unit for H&R unitholders and are working towards continuing on the progress H&R has achieved in this regard in 2019 and beyond. Operator, you can open up the call for questions.
[Operator Instructions] Your first question is from Sam Damiani with TD Securities.
I had a question on Jackson Park, just on the appraisal. It did go up by 107 -- USD 108 million in Q4. And can you tell us what drove that particular increase? How much was it cap rate compression versus higher rents expected going forward or anything else?
Sam, it's Larry. I can give you a little bit of flavor. It was based on the current lease-ups. So it's not projecting rents increasing way up. It is based on a stabilized property capped at 4.25%. It was also based on deducting when the costs to complete for the construction and the cost to complete for lease-up. That was...
And I noticed you -- sorry?
That was the basis of the appraisal.
Yes. I noticed -- and I noticed your guidance for NOI in 2020. It -- went up slightly for Jackson Park, which I imagine might have been part of it. As well, your FFO guidance is up significantly with lower interest cost now expected on this project. Is there a financing plan in place to lock in a lower coupon than you were previously thinking?
No, it was actually an error in our last forecast that the current mortgage on the property or the current construction financing was capped at a -- with a swap rate. And Tishman's was allocating that to income as opposed to net interest expense. So I met with their forecast. They forecasted a higher rate of interest than they -- than we currently have locked in. And we have the interest rate locked in going until 2020, June 2020.
Okay. I'll just switch over one more question and then turn it back. Just on the balance sheet, the debt to gross book value is 47% now with -- Jackson Park is done, but there's still $0.5 million of cost to complete on Miami River and other projects. In terms of balance sheet management to fund that, is there going to be more dispositions in the next year or 2? And what is your long-term, let's say, 2- to 3-year leverage goal on a debt to gross book value basis?
Well, Pat alluded to a couple of dispositions on the retail front that we hope to execute. There will be probably a couple more going forward into the year that we have slated and hope to execute on, but it's pretty early. Leverage might tick up a little bit in the next quarter or so. Once you get those dispositions, that should probably trend that down to where we are today.
Your next question is from Jenny Ma with BMO Capital Markets.
I have a few questions about Primaris for Pat. So you're talking about some disposition plans in place. I am wondering if -- particularly for the ones in the small markets, if you're still pursuing sort of the 50-50 JV that you've done in the past or you're really looking to sell these at 100%. And if you can comment on what you're seeing as far as interest and perhaps cap rates.
I think in terms of JVs, I think we'd still look at executing on those, if the opportunity arose. There's still activity in that front right now, but we'll certainly keep our eyes open for it. And then just in terms of -- there's no real comp set there for -- to drive what the cap rates would be right now.
Jenny, I realize the question is the sales that are going to take place. They're not the enclosed malls. They're really on the outlier, old H&R portfolio. That's now going to be under the Primaris umbrella, which we'll be selling over time.
Okay. Is there any views here, looking at some of the enclosed malls, putting them on market?
No.
No? Okay, that's fine. And then with regards to the same-store performance, the numbers look really good, all things considered. I'm not sure if you have an idea of what the sort of same-store NOI would have been if you X out Sears when you're looking at the performance of everybody else.
Well, Sears would have added another $2.5 million, more or less to the Primaris numbers.
Okay, and back out of that math. And then one last -- one question on Jackson Park. As far as the appraisal goes, did the Amazon news have any bearing on the Q4 appraisal as far as forecast or cap rates or any sort of assumptions that went into that?
No, definitely not. It had no impact. It's not mentioned in the appraisal at all. It's just too early to see what was going to happen while we're doing the appraisal. Amazon's announcement was only in November. This appraisal was already -- well, it was already underway, way underway then. And I don't think it would have anyway in forecasting -- because I think -- when was Amazon set to move in? It was like after 10 years later.
No, no, no. It was -- the answer to the question is that we never increased the projected NOI -- projected rents on Amazon at all to reflect -- on LIC to reflect Amazon ever. And the appraisal went out before the Amazon decision to come in. And we stated empathically even before that, that it had no bearing at all on our -- on the appreciation. The location speaks to its own merits. Our investment spoke to its -- speaks to its own merits. Amazon has nothing to do with that.
Your next question is from Matt Kornack with National Bank Financial.
With regards to your mention of intensification opportunities in the Toronto portfolio, would you look to do those entirety by yourself? Or would you seek out partners on a JV basis?
Yes. In the Toronto areas, they're all going to be done by ourselves.
Okay. And then, Philippe, can you speak to sort of the opportunities that are unfolding in the Dallas market with regards to some of the merchant developers that are there? And it sounds like they've got a tough go of things. And how potentially you could maybe take advantage of those type of opportunities.
Yes. I think that [ Rick Campbell ] can't didn't mention it and probably had tipped the cards a little bit a couple of weeks ago on his call, and I think some of the analysts had picked it up. The disruption that he's mentioning, we're not seeing. I think his comment was more on Houston. What we are seeing is those merchant developers are coming underground with product and have been offering more concession than planned and having to hold the assets longer than planned. And so if their execution was -- or if their plan was to sell in the 9th or 10th month of a lease-up, now they're well into their second month. And so as far as we're concerned, the opportunities are starting to emerge. Our guess is some of the more aggressive merchant developers have probably gone over their skis. And if those opportunities arise, then we'll definitely take a look at them. But I think there's more pain elsewhere than in Dallas currently.
And then on the same token, for stabilized assets, 1031 exchange and fund interest is still there. So it sounds like cap rates have remained pretty tight on those type of assets.
I would argue that there's more equity in this space than at any point in time.
Interesting. Larry, on the lease termination in the U.S. industrial, I don't think it was quantified. But do you know what the value of that would have been just so I can back that -- it's not a substantial portfolio, but...
It was about $150,000.
It's -- you were lucky and smart. Now you're just smart, but I think things are turning around and looking good.
Thanks, Matt.
[Operator Instructions] Your next question is from Mario Saric with Scotiabank.
Just a follow-up question on the intensification opportunity in Toronto. Having gone through the properties, is it truly to quantify the type of GLA that you consider bringing online over the next 5 to 6 years -- or maybe longer, maybe let's say closer to 10 years given the new zoning...
We have 3 -- besides Dufferin Mall, we have 3 offices that have substantial intensifications. Too early to talk to them, though?
Okay. And when do you think you may be able to provide good color in terms of the magnitude of the opportunity?
Too early to tell.
Your next question is from Sam Damiani with TD Securities.
Philippe, just on the same-store occupancy, it did tick down a little bit in Q3. It ticked down a little harder in Q4, close to 1% year-over-year. Is there something driving that, that, I guess, gives you some concern about trends looking out to 2019?
No. I think, Sam, to be candid, we managed to NOI, not so much to occupancy. And so I -- while I understand why people look at the metric in U.S. multifamily, I'd be much more concerned about same-store NOI growth as opposed to same-store occupancy.
And so the NOI growth that you're putting up is a revenue story, it's not so much expenses going down or anything like that?
I think it's a combination of both, where obviously, we've got a great asset management team in Dallas that spends a tremendous amount of time in compressing those expenses best they can, but we also have a great team on site that is looking to increase funds. I can't speak to the exact percentages, but I would say it's probably healthy blend in both.
[Operator Instructions] And at this time, there are no more questions in queue. I'll turn the call back over to the presenters.
Thanks, everyone. Have a great long weekend, and we'll speak to you next quarter. Bye.
This concludes today's conference call. You may now disconnect.