H&R Real Estate Investment Trust

Good morning and welcome to H&R Real Estate Investment Trust's 2021 First Quarter Earnings Conference Call. Before beginning the call, H&R would like to remind listeners that certain statements, which may include predictions, conclusions, forecasts, or projections in the remarks that follow, may contain forward-looking information, which reflect the current expectations of management regarding future events and performance and speak only as of today's date. Forward-looking information requires management to make assumptions or rely on certain material factors and is subject to inherent risks and uncertainties and actual results could differ materially from the statements in the forward-looking information. 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 our website and www.cedar.com. I would now like to introduce Mr. Tom Hofstadter, Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstadter.

Good morning, everyone. I'd like to thank you all for joining us here today. With me on the call are Larry Froome, our CFO, Pat Sullivan, COO Primaris, Philippa LaPointe, COO Landtower, Alex Avery, Executive Vice President, Asset Management and Strategic Initiatives, and Robin Kestenberg, Executive Vice President, Corporate Development. It has now been over a year since the pandemic began, with growth down to a halt. The past year has had its challenges, and our Q&A results remain impacted by the difficulties some of our attendees face. The REIT's business, however, has shown stability and resilience, despite a few notable areas of softness. We have continued to work hard to position H&R for success as the pandemic impacts states and the economy reopens broadly. I'll turn it over to our team to provide details of the first quarter 2021 financials and operating results. Philippe will review our multi-residential operations. Paul and Pat will provide an update on our retail portfolio. And Larry will provide some context to our financial results. And finally, I'll make some closing remarks. Philippe, over to you.

Good morning, everyone. We've got some notable updates for this quarter, and so I'm delighted to share the latest from Landtower Residential. On the JV development front, the Pearl in Austin, Texas is scheduled to fully deliver in the third quarter of 2021. Nightingale in Seattle is in the early stages of pre-leasing and the project will be fully delivered by June of this year. Construction of phase two of our Hercules department, sorry, development named The Grand has remained on schedule and is expected to deliver in the second quarter of 2021. Lastly, Shoreline Gateway, our 35 story tower in Long Beach, California, is also on schedule and expected to be delivered in august of 2021. as mentioned last quarter we plan to supplement our jv development partnerships with our wholly owned development platform within land tower first i would like to provide an update on our infill site in dallas texas with proximity to the dallas love field airport and medical district the plan for the 5.4 acre site that we refer to as west love is a five-story wrap community with approximately 413 units We are finishing schematic designs as we speak, and we'll be moving through the drawing process throughout the year with the target date to break ground by the end of this year. Additionally, on January 28th, we purchased a 4.2-acre infill site with direct frontage to North Central Expressway, one of the most traffic thoroughfares in the core of Dallas. We are also in schematic design with this five-story wrap product that will include approximately 350 units. Lastly, we are finishing up schematic designs for garden-style property in Tampa, Florida. This development with approximately 270 units is adjacent to Highway 19, one of the most dominant thoroughfare in all of Pinellas County. The development is located in an infill location characterized by low future supply and healthy rental growth. Also of note, we originally purchased the site with entitlements for approximately 200 units. However, upon working with the local municipality, we were able to increase our density to our current level at no cost, resulting in an increase in development yield. In light of our strategic shift towards a ground-up development to take advantage of the widespread between development yields and prevailing cap rates, we look forward to sharing more exciting development updates in the future. On the Lantau River landing front, our leasing pace continues to beat expectations and budget. As of today, we are 45% occupied and have leased over 280 apartments. For context, our budgeted number of occupied units at this time was approximately 200, underscoring the strength of our lease-up efforts at River Landing, despite increasing our asking rents multiple times to keep pace with the overwhelming demand for our property. Perhaps most importantly, we would like to share an update on Jackson Park. While the return to stabilization will largely be driven by the workers returning to the office and students returning to the classroom, we are very encouraged by the return to normalcy in New York City. Social activity is resuming with the successful rollout of the vaccine and the declining new COVID case numbers. Just last week, New York City increased the restaurant capacity from 50% to 75%, and the mayor has targeted a full reopening by July. The property is expected to gain positive absorption as we enter the favorable summer leasing season, a trend that we are already beginning to observe with an increase in traffic. For context, we received nearly 700 pieces of prospect traffic in March and April, compared to only 156 pieces of traffic in March and April of last year. In the span of last month, when including pending applications, we have gone from 60% lease to 69% lease. We remain confident that Jackson Park is one of the best value propositions for prospective residents in the submarket when considering location, amenities, and quality of construction. On the financial front, when excluding Jackson Park, our same-asset quarter-over-quarter operating income growth equates to a positive 4.1% for the first quarter of 2021 compared to the first quarter of 2020. We are proud to announce that Q1 operating income growth represents over 12 straight quarters of same-asset quarter-over-quarter positive NOI growth when excluding Jackson Park, a feat that we are particularly proud of when considering the tumultuous 2020. And with that, I will pass along the conversation to Pat.

Thanks, Philippe, and good morning, everyone. Following an encouraging fourth quarter from the retail segment, Q1 same-asset NOI declined 8.3 million, or 13.4%, from Q1 2020, including an 18.5% decline from enclosed malls. For enclosed malls, temporary rent reductions accounted for 34% of this decline. 28% relate to rent reductions we view as being more lasting in nature. 11% related to lower percentage rents, especially leasing and miscellaneous revenues, and the remaining 27% was due to vacancy, net and new leases commencing. Notably, bad debt expenses declined sharply from the highs of last summer. Throughout the pandemic, our primary focus has been to maintain occupancy. Occupancy at the end of the first quarter was 91.5% for the retail division, as compared to 92% at the end of Q4, and 91.1% at the end of Q1 2020. Enclosed malls contribute 55% of the NOI in the retail division with grocery anchored centers generating 28% of the NOI and other retail contributing just under 17%. For enclosed malls, occupancy at the end of Q1 2021 remained relatively stable at 87.2% compared to 88.1% at the end of Q4 2020 and 86.7% at the end of Q1 2020. The pandemic has impacted some retailers more than others, with some filing CCAA as a measure of last resort. To maintain occupancy, we agreed to provide rental relief or restructured rental terms on a short-term basis to those tenants whose business has been significantly impacted by the pandemic and others that may have otherwise closed as part of their CCAA filing. Revised terms typically involve lower base or gross rent plus a percentage rent over a reduced sales threshold. With these temporary lease terms in place, our rental revenue takes on a greater seasonality consistent with the seasonality of our tenant sales. Our fourth quarter results benefited from the seasonally high fourth quarter tenant sales. However, Q1 results were negatively impacted due to first quarter sales typically representing the lowest share of annual sales compared to other quarters. To better understand the increased seasonality impact of our revised rental terms, in Q1, percentage rent in lieu accounted for 4% of retail rent up from 2% in Q1 2020, with percentage rent accounting for a higher share of a lower total rent. By comparison, in Q4 2020, percentage rent accounted for 12% of total rent compared to 4% in Q4 2019. In addition to the amplified seasonality of temporary lease amendments, Q1 results were impacted by the fact that Ontario, Manitoba, and Quebec malls were closed for a portion of the first quarter, with malls in other regions being impacted by occupancy restrictions. Over the balance of the year, we anticipate higher contribution from revenue categories, including percentage rent and specialty leasing as malls reopen, restrictions ease, as well as a return to normal lease terms for many tenants currently subject to temporary lease amendments. Collection of rents in the retail portfolio continued to trend higher since a low point in May 2020. In Q1 2021, we collected 89% from our enclosed malls and 92% from the retail segment overall. This is an improvement from the 87% collected from our enclosed malls and 90% from the retail segment in Q4. While our April rent collection statistics lag the Q1 2021 figure, we expect improvement in time as we have consistently seen in prior periods. With malls in Ontario being closed again and occupancy restrictions tightened in Alberta and Manitoba, we expect continued drag in performance during Q2 and Q3. On a positive note, we have seen good leasing traction as retailers anticipate a return to more normal operating conditions. During the first quarter, we completed 98 lease transactions representing 475,000 square feet, of which 30 were new deals. The 30 new transactions completed is greater than the figure posted during the first quarter of each Q1 2020 and Q1 2019. Our leasing team continues to have positive discussions with retailers about opening new stores across the portfolio and we believe we will continue making progress improving our occupancy level throughout the remainder of the year. In terms of impact, we anticipate 1.9 million incremental contribution from new lease commencement in 2021 with large format tenants. Excuse me, we anticipate 1.9 million in incremental contribution from new lease commencement with large format tenants during the remainder of 2021. including rent from a new 39,000 square foot Savon food store that opened from a portion of the former Sears box in Kildonan Place at the end of April 2021. In addition, we've completed or are in the final stages of completing significant transactions that will create incremental rental growth of over $3 million in 2022, including a 27,900 square foot lease with the City of Toronto to occupy second floor office space at Dufferin Mall, at rents 1.8 times higher than the prior tenant. The former office tenant vacated at the end of 2020, with new rents expected to commence December 2021. Last summer, our malls had recovered well following the closures in the spring of 2020, with sales in the third quarter climbing to 83% of Q3 2019 figures. However, mall closures and occupancy restrictions reinstated in Q4 have resulted in notable sales declines, which have continued through the first quarter. Sales for the first quarter were 66% of first quarter sales last year, adjusted for late March declines. Sales during Q4 were 69% of Q4 2019. Our four malls in Ontario, which typically account for 31% of annual portfolio mall sales, were particularly impacted by closures, having reported Q1 21 sales equal to 41% of prior year comparable period. With the majority of our malls being located in secondary markets and typically the only regional mall in their trade area, once closures and restrictions were lifted, properties have shown solid gains. By way of example, at Plastro-Riam and Chicoutimi, mall sales have rebounded to 90% of pre-pandemic levels in February and March, following the mall being closed in January. In areas where malls have been open but operating with restrictions, sales have been relatively strong. Malls in Alberta posted 77% of pre-pandemic sales in Q1, despite retailers having occupancy limits in place. Orchard Park and Kelowna reported 85% of former year sales during Q1, with our New Brunswick malls at 81%. Based on feedback from retailers that also operate in the United States, we are optimistic that our malls will experience a return to pre-pandemic sales levels once restrictions are lifted. To close, we would like to provide an update on our redevelopment plan for Dufferin Mall. In July 2019, we submitted combined applications for rezoning and redevelopment for the north end of the property to create Dufferin Grove Village. The project is anticipated to include approximately 1,200 residential rental units. Discussions with the City are progressing and we anticipate rezoning and site plan approval in Q4 2021 and commencement of construction Q4 2022. Upon completion, this redevelopment project will transform a successful, established inner-city regional shopping center into a vibrant mixed-use development. Thank you, and I will now turn it back to Larry.

Thank you, Pat, and good morning, everyone. I'll start with our balance sheet. As at March 31, 2021, debt-to-total assets was 46.7%, compared to 47.7% as at December 31st, 2020. The weighted average interest rate of H&R's debt as at March 31st, 2021 was 3.6% with an average term for maturity of 3.6 years. As at March 31st, 2021, liquidity was 55 million of cash in hand and 1.4 billion of unused borrowing capacity available under our lines of credit. In addition, we have an unencumbered property pool of approximately $3.9 billion. With onset of COVID last year, we increased our liquidity to approximately $1 billion. The increase in current liquidity to $1.4 billion is expected to return to more normal levels as we expect to either utilize part of our unused facilities to repay mortgages or decrease some of the facilities. Bear debt expense has steadily decreased from 23.5 million recorded in Q2 2020 with the onset of COVID to 12.6 million in Q3 2020, 3.2 million in Q4 2020, and now 1 million in Q1 2021. At March 31st, 2021, we had a provision for expected credit losses of 14.4 million against the gross accounts receivable of 32.9 million. While the same asset property operating income cash basis from our office segment decreased 10% compared to Q1 2020, it is all due to HESCorp receiving a seven-month free rent period as part of a lease extension and amending agreement. This rent-free period ends June 30th, 2021. HESCorp continues to lease two-thirds of the property for an additional 10-year term beyond the original expiry of June 2026. Excluding the impact of the HES lease, same-asset property operating income from office properties would have increased by 2%. Same-asset property operating income from our industrial segment decreased 2.3% compared to Q1 2020 due to the decrease in occupancy from 99% to 97%. Given the pandemic backdrop, we are pleased to report our Q1 2021 FFO was $0.40 per unit compared to $0.45 for Q1 2020. On last quarter's call, we spoke about a few items which were expected to influence 2021 financial results, and I'd like to now review the impact on Q1's results. Firstly, as our river landing development has been completed, less interest has been capitalized to the project. The aggregate interest capitalized on all development projects amounts to $1.6 million for Q1 2021 compared to $5.6 million for Q1 2020. We expect the next drag on FFO until the project achieves stabilized occupancy. Property operating income from river landing only amounts to $600,000 in Q1 2021. and we expect that to grow to approximately $6 million a quarter, or $25 million annually once the project is fully leased. Secondly, Jackson Park in Long Island City, New York, has been particularly hard hit by COVID as foreign students left New York and others left for the suburbs. Property operating income on a cash basis for Q1 2020 was approximately $3 million at H&R's ownership interest. Prior to the onset of COVID, Q1 2020 property operating income for Jackson Park was approximately $8 million at H&R's ownership interest. We're encouraged by the recent pickup in leasing activity. The vaccine rollout from the U.S. appears to be giving people the confidence to return to the city. And lastly, in January 2021, H&R converted a $140 million mezzanine loan on a 12.4 acre development site in Jersey City to an ownership position. This will reduce interest income by approximately 14 million US dollars annually in 2021 compared to 2020. And interest will not be capitalized on the project until development commences. Finance income in Q1 2021 was 5.9 million compared to 8.2 million in Q1 2020. While these factors will temp out 2021 results, they're expected to substantially reverse in 2022 with anticipated lease-up of River Landing, Jackson Park, Hercules Phase I, and the commencement of future developments. We also expect the development activities to contribute to NAPA unit growth and improve the overall quality of our portfolio. And with that, I will turn it back to Tom.

Thanks, Larry. After a challenging year, we're all finally starting to see promising signs of recovery. We've seen a sharp improvement in leasing activity and occupancy at Jackson Park and strong leasing momentum at our largest recent development, River Landing in Miami. Vaccination rates are climbing every day, and when rare restrictions have been lifted, bricks and mortar retail sales have surged. Several retail properties still close by mandate, but we expect them to reopen over the next couple of months. We have received significant unsolicited interest from many parties looking to acquire a broad variety of our assets, and we expect to complete further dispositions over the next few quarters, taking advantage of the strong demand and pricing to further reduce our leverage. And finally, we remain committed to maximizing value for our unit holders and continue to work towards opportunities in 2021 to evolve H&R to a more narrowly focused REIT consistent with investors' preferences. Last quarter, we outlined plans to create at least one new entity in 2021 and remain on track to achieve that goal, and we are currently working on a number of other transactions and initiatives that we believe will materially enhance H&R REIT. We look forward to providing more details in this regard over the course of the summer. We'd now be pleased to answer any questions from the call participant. Operator, please open the line for questions.

At this time, ladies and gentlemen, if you would like to ask a question, please press star followed by the number one on your telephone keypad. We'll pause for a moment to compile the Q&A roster. Our first question comes from Matt Logan with RBC Capital Markets. Your line is open.

Thank you, Anne. Thank you, Anne. Good morning. Good morning. Good morning. In terms of your IFRS fair value marks, can you tell us what percentage of the $67 million was driven by your enclosed small portfolio and what tap rate you're carrying Primaris at today?

Hey, Matt. The $67 million... was mostly due to the Primaris increase in the malls. When the onset of COVID hit last year, we were very conservative and reduced those cap rates and assumptions on the leasing and the rent rates. Since then, we've had a few appraisals that were done and showed significantly higher than what we were carrying at it. So most of that $67 million that you referenced was the Primaris mall. What cap rate are we carrying it at? I know in our investor presentation, we have the overall retail. I'm just trying to look it up for you now, what the overall retail percentage cap rate was. I'll get back to that number to you in a second, but I don't think we split it up between malls and other retail. The overall cap rate is 6.8%.

So would it be fair to think about the enclosed moles in the order of maybe 100 basis points higher, 50 basis points higher than that average?

Would that be fair? Yes. I would say yes, at least 100 basis points higher than that average.

And in terms of your fair value markdowns in Q1 of last year, certainly you were quite conservative in taking about a billion three of collective markdowns. Was any of that related to your Canadian grocery anchored portfolio, or were those assets largely stable?

No. Last year, Q1, those assets were stable. We did not take a write-down in those assets. Those assets have continued to perform well, and maybe even the cap rates have even compressed in them, given the demand for grocery these days.

And if we turn to some of your strategic priorities in 2021 –

can you talk about how you're thinking about the bow and maybe give us some insight on where you're carrying that uh asset in terms of a cap rate today um well we've always been working since the day we built it actually to reduce our exposure as you well know and it's it's uh we're currently my reference at the end of uh what I spoke about before, references to Bo and Bo becomes critical in achieving our other objectives. So we are currently working on it. We are in the very advanced stages, but regretfully at this stage of the game I still can't give you more details. I can't say, as I said in the speech, that I fully expect that by the end of this year we shall, over the course of the summer, we shall be able to make some announcements. have to be vague on purpose, but we are, this is not something initiative that we're just looking at right now. We are well advanced in our strategic thinking, where we have actually strategic plans of where we're headed to. So go ahead. Sorry, Larry, you want to give the IPRES value? What do you want to do there?

I don't know if we can, since we haven't put it in any other disclosures. I don't know if we can give it on a call because not, equal opportunity. Matt, I would say, all I can give you a bit of color on is that, again, in Q1 2020, we took a substantial hit. I think it was an excess of $600 million on our office portfolio, specifically relating to oil tenants, oil and gas tenants in that industry with Calgary and Houston. And of that $600 million write-down, the bow was the biggest part of that. What we're carrying out now, we have not disclosed, and I don't know if I can give that. I'm sorry. I don't mean to be vague. We think we've been conservative with the value. We think whether it's a sale or whatever we end up doing in the future, we'll be able to achieve at least our offer as value, if not quite a bit more.

Appreciate that and completely understand. Maybe just changing gears to the residential side of your business, you've got some great leasing traction at River Landing and some very healthy same property and a wide growth for the Sunbelt Land Tower portfolio. Can you give us a sense of what's driving the lease up and the performance more broadly across the Sunbelt?

Hi, Matt. So great question. So as it relates to your question on River Landing, Not to oversimplify the answer, but frankly, I think we just have a terrific product. I think what was ultimately developed in terms of location, but also in terms of finished product and the amenity base that we're able to offer prospective residents in comparison to the sub-market is dramatically superior, and I think that plays probably an outsized role in the pace of the lease-up. As it relates to Sunbelt, I mean, I don't want to belabor the point. I think everyone's kind of read the reports of the net migrations from… Your call has been placed on hold.

Please wait.

Hello?

I'm still here, Philippe.

Okay. It rang in my ear. The operator rang in my ear. I think it's just the resilience and the strength of the Sunbelt markets. I mean, it's where jobs are being created. It's where the, from a tenant perspective, the income-to-rent ratio is probably the healthiest in the nation. And frankly, I think a lot can be said about the taxation or ultimately what the local governments have elected to do to attract those businesses and those tenants. In any event, I think that the Sunbelt markets are certainly helping River Landing and attracting that net migration to Miami. But I think, you know, first and foremost, it really comes down to the quality of the development.

Appreciate the commentary. And maybe just on that same property, NOI growth print for Land Tower, there wasn't like a weak comp in the prior quarter. This is a pretty clean year-over-year figure.

I'm sorry, Matt, could you repeat the question?

When we think about that 4% growth figure excluding Jackson Park, there was nothing in the prior period in terms of lease up of certain assets or anything anomalous. So that 4% growth was pretty clean.

I think generally speaking, that's true. It's difficult to part them out only because some assets we bought last year were in stabilization at different levels. But I think generally speaking... The right way in my mind to look at it is really that's just general NY growth produced with, frankly, a stabilized portfolio, or generally speaking, a stabilized portfolio.

Appreciate the commentary. That's all from me. I'll turn it back. Thank you.

As a reminder, ladies and gentlemen, to ask a question, please press star then 1 on your telephone keypad. And we do have a question from Sam Damiani with TD Securities. Your line is open.

Thanks. Good morning, everyone, or good afternoon, wherever everybody is. Just, I guess, on the BO and then the office portfolio, and I think some of the commentary alluded to this, but just with the low industry environment and you know, investor demand for properties coming back pretty hard in many sectors. You know, do you see some fair value write-ups, I guess, on some of your long-term leased office product, you know, in the near term?

I think the answer is yes. It's a little bit early days. There's a little bit of hesitation on still work from home and how that's going to shake itself out. But you're right, there's a very strong demand. You haven't seen a lot of product change at this point in time, but I think it's coming. And so I expect there to be enough evidence of transactions coming forward. Again, there's been almost nothing that's going in the rear view mirror to actually give us the ability to go ahead and increase our cap rates.

Thanks. And Tom, just on your comment, you mentioned there's been unsolicited bids. brassets and you're looking at stepping up dispositions, in what business segments are you focusing on in the near term in that regard?

It's cross-range. We're not culling our portfolio necessarily because we have bad assets or there's tremendous opportunities. Obviously, if you have a buyer, which we have right now for a portfolio of, let's say, our industrial properties, that has a strategic reason for paying a solid price, we'd look at that. Otherwise, we're looking to raise capital to enhance our balance sheet and further go forward with our strategic initiatives. So it's more of it right across the board. I don't think it's focused on any one particular sector.

Okay, last one for me is just on the land tower. I think last call, Philippe, the messaging was pretty clear that some of those developments or most of those developments were or build-to-sell strategies, is that still the plan as these projects reach completion and stabilization over the next year or two?

I think that's a fair statement as it relates to the JV developments. Not so much as we regard. We'll remain opportunistic and we'll want to secure optionality on our own developments in the wholly-owned developments. front, but those are built to core and meant to come into our portfolio. The JV developments are, generally speaking, yes, meant to be sold at some opportunistic moment.

Again, the strategy and why we went into those to begin with is it gives us optionality. We get to go ahead and get the first crack at buying it if we want to buy it. The challenge today is that the cap rates are so low for the assets we are building that It's even hard even though we have a profit and a higher return on our initial investment of, let's call it a third investment on those. Overall, the pricing is still very expensive. So that's why our strategy under LandTower is more to turn it to a developer rather than acquire it today because cap rates are just quite fact that they're very, very low. Prices are too expensive.

Thank you. We'll turn it back.

There are no further questions in queue at this time. I'll turn the call over to Mr. Tom Hofstadter for closing remarks.

Thanks, everybody, and we look forward to, I guess, virtually seeing you at the AGM. Have a great weekend. Bye.