H&R Real Estate Investment Trust

TSX:HR.UN

Earnings Call Transcript

[Operator]

Good morning, and welcome to H&R Real Estate Investment Trust 2017 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.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 at www.sedar.com.I would now like to turn -- to introduce Mr. Larry Froom, Chief Financial Officer of H&R REIT. Please go ahead, Mr. Froom.

[Larry Froom, Chief Financial Officer]

Thank you. Good morning, everyone. With me is Tom Hofstedter, President and CEO of H&R REIT; Patrick Sullivan, COO of Primaris; and Philippe Lapointe, COO of Lantower Residential. We will keep our remarks brief to allow more time for questions.Jackson Park, a 1,871 luxury residential rental unit development in Long Island City, New York, is nearing completion. We have a 50% interest in this project, which is equity accounted for in our financial statements. The first tower has obtained occupancy certificates for the 333 units. The leasing office opened in November 2017. And to date, 125 leases were entered into and 80 units are currently occupied. Part of the amenity space is expected to open in April. First occupancies in the second and third towers are expected to begin during Q2 this year. We are encouraged by the initial leasing velocity in what is typically slow winter months and that the project is on budget.Lease-up is expected to occur throughout 2018 and 2019. On stabilized occupancy of all 3 towers, the first year's property operating income at our 50% ownership interest is expected to be USD 36.9 million. That's U.S. dollars.The property was appraised by a nationally-recognized independent firm of appraisers as at December 31, 2017, for a value of $1.27 billion. The costs incurred till December 31 amounted to $964 million, resulting in a total fair value gain of USD 306 million. USD 109 million was recognized in income in 2016, which resulted in a fair value adjustment of USD 197 million for 2017. Our 50% share of $98.5 million have been included in net income from equity accounted investments.The new U.S. tax legislation, which came into effect in December 2017, is a big plus for us in that it allows for interest deductions on a related party debt. This is significant for us as we were planning a reorganization with Finance Trust would be recapitalized with approximately $1 billion to loan down to our U.S. subsidiary. With the new legislation, this is no longer necessary, and H&R REIT can now loan directly to our U.S. subsidiary. We, therefore, claim an unwinding and stapled unit structure. This will help simplify our structure going forward.On our theme of simplifying, we've given notice to redeem our only outstanding convertible debentures, which currently bear interest at 5.9% per annum and were due to mature in 2020. So going forward, our capital structure will be simplified with the elimination of H&R Finance Trust and without any convertible debt.Over the last 4 years, we have sold in excess of $2.6 billion of property and acquired $1.5 billion. These net dispositions have had an adverse effects on our FFO, which perhaps have strengthened our balance sheet, which had allowed us to reposition, diversify and derisk our portfolio, resulting in a safe and more secure investment for our unitholders.And with that, I would like to now hand the call over to Pat Sullivan, Chief Operating Officer of Primaris.

[Patrick James Sullivan]

Thank you, Larry, and good morning. 2017 proved to be a solid year for Primaris on a number of fronts. Occupancy rose approximately 5%, same-store sales increased to $545 per square foot and leasing activity was very strong with our team completing 164 new transactions during the year.While the backfill of former Target premises has taken longer than originally anticipated, approximately $10.2 million in annual base rental revenue at H&R ownership interest will be generated from GLA equating to 78% of the area formerly occupied by Target. Approximately 353,000 square feet of this area, equating to $6.03 million in annual base rent at H&R ownership interest, is open and paying rent as at the end of December 31, 2017. 73% of the $10.2 million in annual base rent is committed by way of signed leases.In mid-2018, Marshalls, Indigo, Dollarama and Urban Planet, a 15,000 square-foot store signed this month, will open at Cataraqui Center in Kingston. Leasing of the former Target at Sunridge Mall is advanced with 2 box deals equating to approximately 54,000 square feet finalized earlier this week and 3 major tenant transactions encompassing 55,000 square feet in the final stages of lease being negotiated. Occupancy for Sunridge is estimated to be summer 2019.With respect to sales within our enclosed mall portfolio, commercial retail same-store sales of the portfolio on a rolling 12-month basis for the period ending December 31, 2017, averaged $545 per square foot, an increase from the $542 per square foot reported for the same period last year. Orchard Park continues to lead productivity in the portfolio, with same-store sales of approximately $700 per square foot. Dufferin Mall same-store sales now at $689 per square foot continue to rise due to significant remerchandising efforts. A fewer properties saw notable declines in 2017, and I would like to adjust a few of those.At Medicine Hat Mall, we relocated the food court. As such, same-store sales dropped significantly due to the fact that the highly productive food court was removed from the number. Since opening in 2 locations within the 4 of our Target premises, food court sales have increased more than 8%, and we anticipate this productivity to exceed $1,900 per square foot compared to the previous figure of $1,500 per square foot. Medicine Hat, Sherwood Park and Sunridge Mall recorded declines in all-store sales productivity, primarily due to Ben Moss jewelry bankruptcy in 2016. Ben Moss conducted a closeout sale in 2016, which inflated sales figures for that year. In addition, at Sunridge and Sherwood Park Mall, we elected to shrink the jewelry category, following Ben Moss closure, which further impacted all-store sales.At McAllister Place, the driver behind declining all-store sales is the electronics kit category, specifically cellphone providers, who recorded a significant decline in sales during the year. Fashion sales across the portfolio were relatively flat during 2017. Footwear sales showed solid gains across the portfolio, especially in the fourth quarter, while health and beauty tenants continued to post solid increases.Leasing activity during 2017 was very strong. Our team completed 395 transactions, including 164 new lease deals. By way of comparison, during 2016, we completed 129 new transactions. And during 2015, there were 116 new deals completed. Over the past few years, we've been modifying our merchandising mix, reducing or fashion category, weighting in favor of food, health and beauty retailers, restaurants and entertainment uses. This approach has helped strengthen sales for our remaining fashion tenants, while adding nonfashion tenants that generally pay higher rent and further increase productivity. Several large premises that vacated in the past year, specifically Sobeys and McAllister Place in Saint John and Safeway, Garden City Square in Winnipeg, are now leased at substantially higher rents.Winners HomeSense will open in McAllister in the summer of 2018, and the new tenant at Garden City Square will open in the summer of 2019. Since the end of 2017, we have completed approximately 5 new transactions with large format tenants equating to approximately 100,000 square feet of space. This does not include the 2 that I just mentioned at Sunridge for 54,000 square feet.Sears occupies 9 stores within our portfolio, encompassing approximately 675,000 square feet at H&R's ownership interest and pays an average base rent of $3.47 per square foot. Unlike the situation with Target, we've anticipated the risk of Sears closure, redevelopment plans are advancing and discussion with potential replacement tenants are progressing. At this time, we are in advanced discussions for tenants encompassing approximately 400,000 square feet. In many cases, the footprint of the Sears boxes will be reduced so that the density can be redirected towards all parts of development. Whereas, we will have utilized approximately 78% of the Target premise gross leasable area upon completion, we expect to use a much lower percentage of the Sears' boxes. Having learned from our experience with Target, we will redevelop efficient layout for targeted tenants and tear down the remaining space. For the most part, Sears occupied high-profile locations in many of our best assets. With Sears leads restrictions such as no-build zones removed, we now have new opportunities for outparcel developments, which generate much higher rents than can be achieved from box tenants.Thank you, and I will now turn the discussion over to Philippe.

[Philippe Lapointe, Chief Operating Officer of Lantower Residential]

Good morning, everyone. I'm delighted to be on this call today to deliver the latest news on Lantower Residential. As mentioned last quarter, we acquired Lantower Grande Pines, a brand-new 282-unit class A community in Orlando on November 15. The property is located on the I-4 tourism submarket, with Disney World, Universal Studios, Lockheed Martin and Darden Restaurants' headquarters with a close proximity, enabling access to a line of white-collar employment base and benefiting from the city's 16 -- sorry, $60 billion tourism industry.Also on our last quarter, we referenced 2 properties at that time were under contract. We're delighted to announce that we've closed on both properties in mid-December. The first Lantower Brandon Crossroads is a flagship community located in one of the major employment corridors in the Tampa MSA. Built in 2017, the 450-unit property gives us operational scale in Tampa, following the acquisitions of Lantower Cypress Creek in October 2017 and Lantower Westshore in 2016. The property benefits from tremendous visibility to well over 150,000 cars per day at the intersection of Interstate 75 and Selmon Tollway.The second property, Lantower Legacy Lakes, is located in the Legacy West submarket of North Dallas, known for the recent relocations of Toyota's North American headquarters and major regional campuses for Liberty Mutual and JPMorgan Chase. The 2016-built, 301-unit property was built by Alliance Residential, one of the most respected developers in the U.S.Lantower's acquisition activity continues as we are currently under LOI and working towards the contract for 2 new institutional properties in Texas and Florida. Their locations in Austin, Texas, and Orlando, Florida, represent our desire to expand in the high-growth seminal cities in the U.S. We hope to formally announce the acquisitions along with sharing more details on our next call.On the portfolio front, Lantower currently consists of 5,633 apartments across 17 properties with a weighted average portfolio vintage of 2010. As promised on our third quarter call, Lantower's property management division, Lantower Luxury Living, has internalized management of our 4 most recent acquisitions in addition to our entire Austin portfolio in the fourth quarter. In January, we took over an additional property to bring our fully internalized count to 84% of Lantower's total portfolio, or said differently, we have only 3 properties left to internalize.A few comments on our latest MD&A. Our same-property occupancy dropped in the fourth quarter solely due to our acquisition of Ambrosio in Austin, which at the time was then leased up at 43% occupancy. Excluding Ambrosio, our occupancy percentage would have been much higher than last year's fourth quarter.Our year-end operating income increased in U.S. denominated dollars from $16,092,000 in 2016 to $16,252,000 in 2017. Our operating income reflected in the MD&A, notably in the fourth quarter, was impaired by a onetime $591,000 expense related to the creation of our property management platform. When removing this onetime expense, same-asset operating income actually increased 4.7% year-over-year, which we feel is outstanding in light of how potentially disruptive and negatively impacting the change of management can be on a property's bottom line.Furthermore, we're delighted to disclose that we successfully built a multistate best-in-class property management platform for only $591,000, and as of January 2018, are no longer running at a loss. On the development front, when casting aside Jackson Park, we're nearing the start of our Koenig Lane development in the heart of Austin, Texas. The 391-unit community is expected to commence construction in early summer after receiving favorable bids from general contractors in January. As our multifamily developments progress, we look forward to sharing more exciting news on our next quarterly call.And with that, I'll pass along the conversation back to Larry.

[Larry Froom, Chief Financial Officer]

Thank you, Philippe. Cheryl, we can now open up the line for questions, please.

[Operator]

[Operator Instructions] And we have a question from Matt Kornack, National Bank Finance.

[Matt Kornack, Analyst]

I think you're being penalized because it's been a fairly active morning in the real estate space in Canada. But with regards to Jackson Park, just wondering in terms of the timing of the capitalized interest and how that will come off as well as your expectations on lease-up, if you can provide any more sense of how you see that coming online?

[Philippe Lapointe, Chief Operating Officer of Lantower Residential]

I'll try and answer that question, Matt. The lease-up will occur throughout 2018 and '19, as we've said. We -- there's going to be phases that the building will come out of property under development as certain floors are completed and moving to normal income-producing properties. So throughout 2018, it's going to be very bumpy quarter to quarter on -- as the floors get transferred out of the construction, property under development into regular operating properties and the leasing capitalize will follow that same pattern.

[Matt Kornack, Analyst]

Okay. So it's going to be sort of patchwork but we'll see as it comes along. And then I guess also staying with the multifamily theme, but on the Lantower side, just looking at the occupancy levels, rent seems to be going up, occupancy has come down, may have been acquired, they can see. But just also the same-property NOI growth, I know there is a currency impact, but it was negative this quarter on a year-over-year basis. Is there something to that? Or is this just transitory?

[Larry Froom, Chief Financial Officer]

I think casting aside the onetime expense related to Lantower Luxury Living, occupancy is going up or rental revenue is going up. The fundamentals are also still very, very strong. And so I would chalk that up to either Lantower Luxury Living or a currency issue.

[Matt Kornack, Analyst]

Okay. So, it's -- the actual income-producing component and what you've purchased is doing as you expected and you're continuing to see rent growth. Can you speak to sort of what your view is on potential for same-property NOI growth or at least where rental growth has been in the market?

[Philippe Lapointe, Chief Operating Officer of Lantower Residential]

I think the trend that we're seeing will probably hold true for the next year as we made a lot of acquisitions in 2015, 2016 that weren't reported, obviously, on the same-store -- sorry, 2016, 2017 that weren't reported on the same property. I think one thing I've added to the list, and as the pool becomes bigger, the trend will be somewhat the same. And so I would expect the same growth. The fundamentals are very strong. We're not seeing any distress in the market. Our occupancies are very, very strong. We're not seeing any additional concessions apart from what we are planning on pro forma. And so I would probably say steady as it goes.

[Matt Kornack, Analyst]

Makes sense. And then, switching over to Primaris. I appreciate the commentary. Pat, I'll have to go back and listen to it again because there was a lot of detail in there. If I read the public disclosure, it sounds like the view is that even net of Sears, there's some organic growth to be had on the back of Target leasing this year, in 2018. But the bulk is now sort of shifting into 2019 as both Target and Sears come online?

[Patrick James Sullivan]

That's right.

[Matt Kornack, Analyst]

And you're 60% -- in terms of the 60% disclosed on Sears' discussions, are those very likely or what stage in the process are you at?

[Patrick James Sullivan]

For the most part, we're at the LOI stage with a lot of these tenants. We didn't get the possession of a lot of the Sears' stores until mid-January. So we couldn't go much further without getting into doing due diligence on the structural and the mechanical elements in the buildings. That's -- so we're really -- a lot of the basic financial terms are done and subject to getting construction detail finalized.

[Matt Kornack, Analyst]

Okay. That makes sense. Last question on my side is it sounded like in the letter to unitholders that there may be a more near-term transaction taking place on the U.S. retail. Just the commentary with regards to 2018 FFO, has your expectation changed that, that won't be done in Toronto, that may be sold in a single piece?

[Thomas J. Hofstedter, President, CEO & Trustee]

Matt, it's Tom. Our expectation is we're dealing with one company for the entire, but we could easily bifurcate it. Our expectation is that we will be selling at or greater than our at face value. And timing, though, really depends on we conclude the transaction with that one individual party.

[Matt Kornack, Analyst]

Okay. Hopefully, as your peers disappear one by one, people will realize that there is value to the real estate you own.

[Thomas J. Hofstedter, President, CEO & Trustee]

I think, Matt, the analysts have disappeared one by one.

[Operator]

[Operator Instructions] Our next question comes from Neil Downey, RBC Capital Markets.

[Neil William Edward Downey]

Pat, this may be a bit too much minutiae, but do you recall how much of Target rent was actually included in the fourth quarter results as you make your way to that -- your replacement of $10 million of income?

[Larry Froom, Chief Financial Officer]

It's Larry. Neil, I think we said it was $1.6 million. We will just check. We will check that figure, but I believe it was $1.6 million of net operating income in the fourth quarter from Target -- from ex Target space.

[Neil William Edward Downey]

Okay. I may have missed that. And, Philippe, are you in a position to, maybe, give us some valuation, data points or really cap rates on some of the recent acquisitions that have actually been completed as opposed to the pending deals in Texas and Florida, so Legacy Lakes, Crossroads, et cetera?

[Philippe Lapointe, Chief Operating Officer of Lantower Residential]

Yes. So, they're, obviously, in different markets. So, without going to too much detail, I will say they hover between 5.2% and 5.5% in terms of going in cap [ year 1 ] cap.

[Larry Froom, Chief Financial Officer]

Neil, sorry, I can confirm. It is the $1.6 million for the Target.

[Neil William Edward Downey]

In the quarter?

[Larry Froom, Chief Financial Officer]

Yes.

[Neil William Edward Downey]

Okay. And then, my final question. And I'm just trying to square off a comment that was made with respect to the, I guess, a half a dozen, or 6, U.S. industrial sales that occurred in the fourth quarter, your MD&A makes reference to the fact that the capital that was liberated from that was used to fund the Lantower Residential acquisitions. And this may be a timing issue, I'm not sure. But when I look at the disclosures under your equity accounted investments, if I'm reading this correctly, the capital's still sitting under this U.S. industrial column. It just it looks like there is, maybe, some cash and receivables sitting there. Is that just...

[Larry Froom, Chief Financial Officer]

It was put into reverse 1031 exchanges. So, it's changed shortly afterwards in January, transferred out of the escrow accounts.

[Neil William Edward Downey]

Right. So, the capital was deployed really in the new year? It wasn't deployed in the fourth quarter?

[Larry Froom, Chief Financial Officer]

Well, the acquisitions were in the fourth quarter, but those were put into the exchange accounts and then they came out in January.

[Operator]

[Operator Instructions] And I don't show any further questions in the queue at this time. I'll turn the call back to the presenters.

[Larry Froom, Chief Financial Officer]

Okay. Thank you. We realize it's a busy day in the REIT world today.

[Thomas J. Hofstedter, President, CEO & Trustee]

You know you're talking probably to nobody.

[Larry Froom, Chief Financial Officer]

Thank you, everyone, for joining.

[Thomas J. Hofstedter, President, CEO & Trustee]

All right. Bye.

[Operator]

Thank you very much, ladies and gentlemen. This does conclude today's call. You may now disconnect.