H&R Real Estate Investment Trust
TSX:HR.UN
Earnings Call Analysis
Q4-2023 Analysis
H&R Real Estate Investment Trust
H&R has been steadfast in its 5-year strategic plan, aimed at repositioning for growth. The most pivotal action was spinning off Primaris REIT and the sustainable divestiture of properties valued at $2.4 billion. A further $300 million in sales is expected later in the year. Unitholder equity has been enhanced with a repurchase of 27 million units at $340 million, and a significant debt reduction from $6.1 billion to $3.7 billion, improving the debt to total assets ratio from 50% to 44%. Office real estate assets now represent 17% of the portfolio, down by 9%, with additional downscaling planned through strategic sales like the $232 million disposal of 25 Dockside Drive in Toronto.
H&R's operational statistics present a mixed picture. Same-property net operating income (NOI) saw an encouraging rise of 10.3%, led by the Residential division with an 18.7% increase. Yet, funds from operations (FFO) dipped slightly in Q4 to $0.30 per unit year-over-year. Adjusted for one-time sales and lease termination fees, the full-year FFO per unit rose modestly by 3.9% to $1.23. The total distribution to unitholders increased by 18.6%, with a payout ratio of 52.8% of FFO. Despite a robust cash position exceeding $950 million, net asset value per unit softened from $21.80 to $20.75, and the REIT recorded a substantial fair value adjustment of $486.1 million.
Occupancy rates for Lantower Residential dipped marginally to 94.6%, but a strong NOI increase of 14.3% over the year signals robust underpinnings. Efforts are underway to expand NOI margins with centralization, value-add opportunities, and targeted investments yielding high returns, such as the installation of private yards. The Lantower division's operational excellence was recognized in the industry through multiple accolades. Looking ahead, the platform anticipates receiving more building approvals and maintaining a culture of performance.
The market's liquidity remains constricted, affecting both the debt and equity sides, compelling the REIT to engage in off-market deals tailored for specific buyers. This cautious environment has deferred clear guidance on future dispositions, with a current focus on $300 million worth of assets in the pipeline. Thomas Hofstedter, H&R’s CEO, noted that strategic sales at a premium are possible where properties offer unique value to specific users, as seen in the sale of Corus Quay.
Lease renewals remained resilient, showing only moderate negative impacts on new lease trade-outs in Q4. Blended lease spreads ended negatively due to high supplies and seasonality but are already showing recovery in Q1. Looking forward, Lantower Residential expects to return to neutral lease spreads in 2024, with a potential uptick in 2025 as market pressures ease and supply deliveries decrease.
Despite the challenges of mounting insurance costs, Lantower Residential focuses on increasing NOI margins through cost control measures, including centralization and value-add initiatives. While insurance costs remain high after a spike in 2023, the sector foresees more normal cost increases ahead. These efforts will attempt to maintain or slightly improve NOI margins.
Acquisition opportunities in the Sunbelt remained limited in Q4, with a bleak transaction environment. However, the second half of 2024 may offer more potential as interest rates adjust, opening prospects that were previously stifled by the absence of the anticipated distressed market.
Office assets remain the focus for dispositions over retail given their financial dynamics. However, decisions on selling retail assets are being held back, with expectations that interest rates may decline towards the latter half of the year, possibly improving capitalization rates and asset values.
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Good morning, and welcome to H&R REIT's Q4 2023 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 reflects 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 at www.sedar.com.
I would now like to introduce Mr. Tom Hofstedter, Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstedter.
Thank you, and good morning, everyone. Thanks for joining us today to discuss H&R's fourth quarter and year-end 2023 results. With me on the call are Larry Froom, our Chief Financial Officer; and Emily Watson, Chief Operating Officer of our Lantower division.
I'm pleased to report that we have continued to successfully execute on our 5-year strategic plan to reposition the portfolio to be a more simplified growth-oriented REIT as was highlighted in our most recent press release.
Since announcing our strategic repositioning planning 2.5 years ago, we have made considerable progress, having successfully completed the spin-off of Primaris REIT, valued at approximately $2.4 billion and we have completed to date sustainable investment of 45 properties totaling $2.4 billion with a further $300 million of sales still to close later this year. We have repurchased today, 27 million units, $340 million and have decreased our debt from $6.1 billion to approximately $3.7 billion at year-end, thereby improving our debt to total assets from 50% to 44% as of December 31, 2023.
Importantly, at year-end 2023, our total office exposure was reduced to 17% of real estate assets plus 9 additional properties representing a further 7% that are advancing through the rezoning and intensification process. We expect to continue the strong momentum with the announced sale this year of a further $293 million of properties, including the sale of $232 million of 25 Dockside Drive, an office building by the Waterfront in Downtown Toronto. Our recent board additions, including independent lead trustee, Donnie Clow, Lindsay Brand and Leonard Abramsky to underscore our dedication to effective governance and strategic advancements, and we look forward to working with them to help us achieve our objectives.
And with that, I'll hand it over to Larry.
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 year ended December 31, 2023, compared to the year ended December 31, 2022. H&R's same-property net operating income on a cash basis increased by 10.3%, breaking this growth down between our segments, Lantower, our Residential Division led the way with an 18.7% increase or a 14.3% increase in U.S. dollars. Emily will provide more details on this shortly. Industrial same-property NOI on a cash basis increased by 12.5%, driven by rent increases for new and renewed tenants. The tenants at our 2 new industrial developments in Mississauga totaling 336,800 square feet, took possession this month and will begin paying rent in Q2, of same-property net operating income on a cash basis increased by 5.2%. This increase was largely attributable to these termination payments, bad debt recoveries and the strengthening U.S. dollar.
H&R received lease termination payments from office tenants in 2023 amounting to $5.2 million, $3.4 million of this relates to 6900 Maritz Drive in Mississauga, where the REIT's current 105,000 square-foot office property will be converted into a brand-new 122,000 square foot industrial building. Demolition has already begun and construction on the new building is expected to begin in the spring. And lastly, retail same-property net operating income on a cash basis increased by 5.7%, primarily driven by increased occupancy at River Landing and the strengthening of the U.S. dollar. Q4 2023's FFO was $0.30 per unit compared to $0.31 per unit in Q4 2022. FFO for the year ended 2023 was $1.33 per unit compared to $1.17 per unit for the year ended 2022. Included in FFO for 2023 is $30.6 million of proceeds from the sale on option to purchase land, excluding this item and other nonrecurring items such as lease termination fees, FFO would have been $345.4 million for the year ended 2023 or $1.23 per unit, an increase of 3.9% compared to 2022.
H&R's cash distribution of $0.70 per unit was 18.6% higher than the cash distributions of $0.59 in 2022. H&R's 2023 payout ratios remained healthy at 52.8% of FFO and 63% of AFFO, notwithstanding the increase in distributions. Net asset value per unit as of December 31, 2023, was $20.75 per unit, a decrease from $21.80 at the end of 2022. H&R recorded a downward fair value adjustment of $197.6 million for Q4 2023 at the REIT's proportionate share and the downward value -- fair value adjustment for the year ended December 31, 2023, was $486.1 million at the REIT's proportionate share. Debt to adjusted EBITDA improved from 9.6x at the end of 2022 to 8.5x at the end of 2023. Debt to total assets at the risk proportionate share on December 31, 2023, was 44%, unchanged from the end of 2022 and liquidity on December 31, 2023, was in excess of $950 million with an unencumbered property pool of approximately $4.2 billion.
And with that, I will now turn the call over to Emily.
Good morning. Thank you, Larry. I'm happy to be on the call to discuss our fourth quarter same-store results from our multifamily platform and discuss some operational highlights. Occupancy ended the quarter at 94.6%, 72 basis points lower than third quarter and 41 basis points lower when compared to Q4 of 2022. Same-asset property net operating income from our portfolio in U.S. dollars increased by 12.6% and 14.3%, respectively, for the 3 months ending on December 31, 2023, and full year 2023 compared to their respective 2022 period. We continue to see positive signs of demand with Q4 resident retention at 62% and 94% occupancy in the Sunbelt, and Jackson Park is achieving a 75% retention and 99% occupancy.
Move-outs due to home purchases remained low at 11% of total move-outs and rent-to-income levels remain affordable in the low 20% range, allowing for future headroom for end rental growth. Lingering high-interest rates have maintained the spread between bid and ask prices and continue to constrain the number of trades completed in the fourth quarter. Based on our recent third-party appraisal and a handful of Sunbelt sales comps we have raised our [ SMB ] cap rates by 25 basis points to 5% 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 applications. On the development front, Lantower West Love in Dallas, Texas, is expecting its first TCO, including 75 units in late March. We are very excited to deliver what we believe is a best-in-class asset with unparalleled amenity. We look forward to commencing pre-leasing later this month. Also in Dallas, Texas, Lantower Midtown has reached floor 5, its top level and 3 of its 6 turns and is currently 70% framed. Drywall is ongoing on turns 1 and 2. We are progressing through the different phases of design, drawing and permitting on the remainder of our Sunbelt development pipeline and expect to receive more building approvals as we progress through the year. On the operational front, we continue to focus on expanding NOI margins through our centralization efforts and value-add opportunities. During the fourth quarter, we installed over 300 private yards with an average amenity charge of $150 and a 59% return on investment. This investment is focused on increasing the tenure of our resident's days, thus lowering our costs and increasing effective rent. In summary, the Lantower platform continues to achieve positive results and strong performance relative to our multifamily counterparts. I would like to recognize everyone on the Lantower team for receiving 3 awards in the fourth quarter. The Emerging Technology Award and Best Places to Work in multifamily from multifamily leadership as well as Glassdoor's Best Places to Work. These awards exemplified the winning culture that Lantower embodies and is the key reason the team continues to deliver top-tier results.
And with that, I'll pass along the conversation to Tom.
Operator, we can open up the lines for questions, please.
[Operator Instructions] First question comes from Mario Saric at Scotiabank.
First question, I may have missed it, but if we exclude the 25 Dockside, is there enough visibility for you to provide a target disposition range for 2024?
Mario. We provided a target disposition pretty late in the year, last year, and to be quite frankly, once we're sure we're going to be -- hit that target. So we're not going to give any target right now. We have 2 assets that we have on the books almost totaling $300 million for sale. We've done $430 million last year and a lot more the year before. We hope to at least achieve those same levels as last year, but we don't want to set any targets right now.
Perfect. Okay. And then just ticking to potential dispositions, any update on Hess Tower and what you're thinking there?
The merger between us and Chevron right now, we've -- there is no visibility. First, we have to get beyond the merger and make the deal, my guess is it's going to drag a little bit longer because the U.S. government is very concerned. But it will happen is my guess, and it will probably happen in June. At this point in time, Hess and Chevron has not decided -- made any decisions on-- basis of early days. But until there's better clarity, there is nothing that's going to happen with Hess.
Got it. Okay. And then, Tom, just maybe sticking with you, I think on the Q3 call, you kind of talked about residential value per buildable in the $200 per square foot range. It was as high as $325. Where does that stand today?
Mario, it's Matt Kingston. I think we believe that the value in the GTA are down about 40% to 50% depending on the site. The most recent trade we can point to is First Capital and [ Woodborn ] consummated on a deal at 1071 King way, which is around $200-$210 a foot. I think that's a pretty premium price, though, I think realistically, downtown transit-oriented sites are probably mid- to high ones. So somewhere between $150 and $200 what I think is realistic depending on how good the site is.
How good and how large the site is. If there's a discount, if it's get up to [ 600,000 square feet. ]
Okay. That makes sense. And my last question, maybe for Emily. Just with respect to Lantower to the extent that you can, can you discuss '24 expected same-store revenue, same-store expense and same-store NOI?
We are not going to give guidance just yet on that. We're really looking at what the market. We do have the Lead Core properties or JV deals on the West Coast that are coming into our same-store universe. We expect it to moderate from what we have experienced in the last couple of years as kind of expected, there've been kind of banner years, but at this point, we're not providing guidance.
Okay. Are you able to kind of give us a sense of where kind of blended lease spreads are going, both kind of on -- including renewal and new lease spreads?
Sure. Yes, Q4 was really the height of the deliveries in the Sunbelt. So we saw a lot of just the combination of the heavy supply and the holiday season, that definitely had a downward pressure on the new lease trade-outs where they were down actually around 6%, 7%, 8%, I think, actually. But renewals still stayed in that 3% to 4% range. So we ended Q4 with a blended range or blended negative 3, but so far in Q1 that we've seen a 160 basis point improvement in Q1 already with our new leases signed. It's still down in that 6% range, but a blend of negative 1. So definite improvement. Q4, we had, or actually all of '23, we had about 100,000 units enter or the areas that we operate in, with a lot of the merchant builders really having pressure in that Q4 to get heads on beds, if you will, before the season before the end of the year, where Q1, we're seeing that pick up, and then we'll continue to see just coming into our peak leasing season, excuse me, in Q2. So we'll have still some heavy supply delivered in '24, Mario, but 75,000 units. So I think we were in the eye of the storm in Q4. And so far, we're off to a much better start in Q1.
Great. Okay. And the expectation for that blended lease spread, the term positive, would that be in the second half of the year or is that something that may be more of a '25 event?
No, I do think that we'll see some pickup in Q3 and Q4. The supplies will start to drift off and people kind of settling into that new norm. So I expect that we'll probably end 2024 in a flat position and then definitely some pickup in 2025. As the market absorbs those units and really the deliveries just fall off a cliff. So flat for '24 and then '25, we should be able kind of get back to the new formal, not the days of '22 and '23.
The next question comes from Jimmy Shan at RBC Capital Markets.
Just sticking to Lantower still. So how are you thinking NOI margin trend in '24. We've seen high insurance costs and all that. So how should we be thinking about costs on '24?
Great question, Jimmy. I do think that we have concentrated on -- really focusing on the NOI margins for a while now through our centralization efforts, reducing some of our payroll costs, just economies of scale on, our procurement initiatives, certainly adding the value-add initiatives that we've added. So insurance costs, I think, will forever be as elevated as we saw in the increase in '23. I think some of the reinsurance will open the market, at least coming back from NMHC last week, we had several kind of hopeful people saying that there was going to be more kind of normal increases next year, not what we saw in '23. So I think focusing on NOI margins is definitely one of our strategic positions and has been. So I don't anticipate our NOI margins to decrease, if anything, edge up, just a tad over where we are now.
Okay. That's helpful. And then on the asset sales, I know you don't provide, maybe just two questions. You don't provide any target, but can you characterize the environment today? Is it same, worse or better? And then the other question on asset sale is you have an industrial property held for sale? I didn't think you were looking to sell industrial, maybe any color on that specific asset that you have for sale there?
So we don't have any industrial properties for sale. The sale that occurs is really an option the tenant has to buy, and so indicative of market conditions at all. The market today is, I would say, less liquid. It continues to be less liquid and less liquid, both on the debt side and on the equity side. That's why every deal that we're doing is almost an off-market deal. There's no point putting it on the market. It's really tailor-made to specific buyers that have an asset in mind, and we have a use for that asset in mind. It's going to stay sloppy until rates come down and put us in positive leverage. At that point in time when the debt markets open up, the equity markets will open up. So it's remaining sloppy, remains very, very slow. And again, that's why it's hard for us to give guidance. And none of the other properties that we will be selling, probably will be put on the market. They will be off-market deals just like they have been in the past year.
Okay. And in Corus Quay, obviously, this is -- the sale was at a really good price. And would there be any other assets that would be similar in the sense that it could be strategic to somebody else or to a different buyer? Anything in the portfolio that would kind of resemble what you were able to achieve with Corus Quay?
So I think the answer is yes. And it's really going to be the same as Corus Quay. I'm not going to give specifics on that. But anywhere there is a user coming in, user market is going to pay more, obviously, than the venture market. And if you look at the industrial, not that we're selling in the industrial, but just to highlight an example. We had in the past few years, small bay, small user-oriented, 15,000 to 100,000 square feet or 20,000 to 100,000 square feet buildings that went for a substantial premium, price per square foot basis to the larger counterparts because the users are the buyers. And I think that's going to continue. And you can look at any of our buildings, to say that there's a potential for a user to come in, wanted to buy the real estate, as a user, they will pay a premium. That's exactly what happened with ours. And I think there are, I know there are assets that were -- I don't want to be specific because I don't want to give it anyway, but there are assets that fit that…
[Operator Instructions] Next question comes from Sam Damiani at TD Cowen.
Emily, maybe for you, just on the Lantower market and Sunbelt there. You've seen the opportunity for acquisitions getting any more interesting? And if not, do you anticipate that to materialize over the course of 2024?
We track -- Q4 was pretty bleak. We tracked about 9 deals that were similar vintage, same kind of footprint as we are. So that was really low. I think will pick up some in Q1 and Q2 that when we walked away from NMHC last week, it was really the second part of the year where they were anticipating, as Tom alluded, the rates come down a bit and really start to see trades. There is not the distressed market that I think we all hoped there would be, kind of sweep in and be a gravedancer at all. So that really hasn't come to fruition. But if interest rates will play, then the second half of the year could be really interesting.
And you mentioned you walked from an NMHC. Is that an asset class you're looking to add to the portfolio?
No. NMHC is the National Multi-housing Council.
My mistake. And last question for me, maybe for you, Tom. On the dispositions, I know you're not providing guidance, but is the priority still Office over Retail on the disposition front going forward?
Yes. The answer is yes. But office business you can see for on sales, it's very much tailor-made. So in some cases, you need to classify as the markets not necessarily argue, we would find financial engineering to move products out with sell refinancing, et cetera. On the retail front it's kind of simple. Our retail is very salable, there's no danger to it, it's not even food anchors [indiscernible] stores, same as the ECHO in a way that at least 12,000 to 14,000 square foot, have decent [indiscernible] high credit, they're all metros level [indiscernible]. So they're easily salable, but 100% of all buyers out there be financing. If you are of the opinion, like I think most people believe that the latter part of this year interest rates will come down, so your purchase price is going to be a direct reflection on where interest rates are going to go.
If these prices will rise, the cost of financing lowers, there's no point in putting on the market something right now. So we believe that 6 months from now, the cap rates going to go down due to the benefit of deposit leverage or better leverage. Therefore, no sales or higher sales in retail front. We're going to hold off until we get the price. We put it on the market at all till we see the interest rates come down. And on the office front, again, it's specific to the reason why someone want to buy the asset. I do have hope and actually our expectation that we will continue to sell some office assets. They're all going to be off-market deals. And again, there's less reflection on mix rates rather than liquidity in the market.
Thank you. That concludes today's Q&A session. I will turn the call back over for closing comments.
Thanks, everybody. Have a good day.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.