H&R Real Estate Investment Trust

Good morning and welcome to H&R Real Estate Investment Trust's 2023 Second Quarter Earnings Conference Call. Before beginning the call, H&R would like to remind listeners that certain statements, which may include predictions, conclusions, forecasts, or projections, and the remarks that follow may contain forward-looking information which reflect the current expectations of management regarding future events and performance, and speak only as of today's date. Forward-looking information requires management to make assumptions or rely on certain material factors and is subject to inherent risks and uncertainties, and actual results could differ materially from 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 and www.cdar.com. I would now like to introduce Mr. Tom Hofstetter, Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstetter.

Good morning, and I'd like to thank everyone for joining us today to discuss our second quarter financial and operating results and strategy. With me today on the call are Larry Frum, our Chief Financial Officer, and Emily Watson, Chief Operating Officer from our Landtower Residential Division. New to date, our portfolio team are producing strong financial and operating results across all our property classes. Residential continues to see strong rental rate growth. Our well-located office properties with long-weighted average lease terms remain 98.7% leased. Industrial properties located in key markets remain in high demand as we realize continued rental rate growth, and our high-quality grocery, active, and single-tenant retail property portfolio are performing well, providing essential services to their respective communities. Given the line of sight we have into our current disposition pipeline and the demand we are seeing for our properties, we are reiterating our intent to sell approximately $600 million of non-core assets this year, of which $387 million has been sold to date. On April 20th, we closed on the successful disposition of 160 Elgin for $277 million, H&R's only Ottawa office property comprising 973,000 square feet in downtown Ottawa. Given the considerable headwinds in the public and private real estate markets, we are very pleased to have executed this transaction. This one property represented 16% of our Canadian office portfolio and reduces our total office exposure, excluding rezoning properties, to 20% on a fair value basis. We also sold four Quebec retail properties for $68 million, allocating net proceeds to repay debt and repurchase units for NCIB. During the first six months of the year, they repurchased and canceled 2.8 million units at a weighted average price of $10.26 per unit, representing an approximate 51.2% discount to NAV per unit. We intend to continue to buy back units through the NCIB with proceeds from future dispositions of non-core assets. As a result of our disciplined capital allocation approach, we have augmented our growth profile meaningfully, achieving double-digit growth in same-property NOI since announcement of our re-positioning strategy increased our allocation to residential and industrial investment properties from 23% and 8% respectively in Q2 2021 to 39% and 16%, a total of 55% as of Q2 this year. Over this time period, office exposure, excluding the rezoning portfolio, has declined from 38% to 20%. Inciting with its progress is the improvement to our liquidity position and balance sheet metrics. And on that, I'll hand it over to Larry.

Thank you, Tom, and good morning, everyone. I'll start on the operating results. In my comments to follow, references to growth and increases in operating results are in reference to the three months ended June 30th, 2023, compared to the three months ended June 30th, 2022. H&R's same property net operating income on a cash basis increased by 11.7%. Breaking the growth down between our segments, Landtower, our residential division led the way with a 22.9% increase or a 15.6% increase in US dollars. Emily will provide more details on this growth shortly. Industrial same property NOI on a cash basis increased by 18.6% driven by rent increases for new and renewed tenants. Occupancy in the industrial segment increased to 98.4% as of June 30th, 2023. Office same property NOI on a cash basis increased by 2.1%. This increase was largely attributable to the strengthening U.S. dollar. For the six months end of June 30th, 2023, same property NOI from our office portfolio increased by 4.5% compared to the same period in 2022. Our office properties are in strong urban centers with a weighted average lease term of 7.1 years and lease to strong creditworthy tenants with 81.1 percent of office revenue coming from tenants with investment grade ratings. I would like to point out that only 404,000 square feet of leases expire in our office portfolio during the remainder of 2023, which is approximately 7 percent of the total square footage of our office portfolio. Included in these 2023 expiries is 105,000 square feet at 6,900 millimetres drive in the GTA which now expires in December 2023. H&R received a termination payment of $856,000 in Q1 23 and will receive an additional $2.5 million in Q3. H&R is preparing a site plan application for submission to the City of Mississauga for a new single-story, 122,000 square foot industrial building to replace the 105,000 square foot office building. site plan approval is expected by Q4 of this year. In addition, 86,000 square feet shown as expiring in 2023 was for the Tampa office property that was subsequently sold in August for 13.3 million US dollars. And lastly, retail same property NOI on a cash basis increased by 9.1%, primarily driven by increased occupancy at River Landing and the strengthening of the U.S. dollar. Q2 2023's FFO was 29.7 cents per unit compared to 28.4 cents per unit in Q2 2022, a 4.6 percent increase driven by strong operational performance across all segments and aided by the U.S. dollar. FFO for the six months ended June 30th, 2023 was 61 cents per unit compared to 56 cents per unit in Q2 of 2022, an 8% increase. We are proud of our FFO growth despite current headwinds of higher interest rates facing all real estate classes and the current headwinds facing the office sector. Commencing in January 2023, H&R's monthly cash distributions increased to 5 cents per unit or 60 cents per annum, an 11% increase over the 2022 distribution excluding the special distribution in December. H&R's Q2 2023 payout ratios remained healthy at 51 percent of FFO and 61 percent of AFFO, notwithstanding the increase in distributions. Net asset value per unit at June 30th, 2023, was $21.04 per unit, a decrease from $21.95 on March 31st, 2023. 2.8 million units were repurchased during Q2 at an average price of $10.26 per unit for a total of $29.2 million. The following overall weighted average cap rates were used in deriving the fair values of our investment properties. 4.49% overall for the residential properties, which was split between Sunbelt properties at an average cap rate of 4.75%, and gateway cities at 4.08%. 5.28% for industrial properties, 6.35% for retail properties, 7.36% for our US office properties, 4.81% for our eight Canadian office properties, which are advancing through the rezoning and intensification process to be converted to predominantly residential properties. These eight properties comprise 30% of our office portfolio. and 7.24% for the remaining 10 Canadian office properties. The increase in cap rates used to value our properties resulted in a downward fair value adjustment of $274 million for Q2 2023 at the REITs proportionate share. As at June 30th, our office portfolio of 23 properties comprised 24.8% of total real estate assets. Page 14 of our management discussion and analyses shows the percentage allocations across all segments. Debt to total assets at June 30th, 2023 was 44.8% compared to 44% at the end of 2022, and liquidity at June 30th, 2023 was in excess of $900 million. In summary, we are very pleased with our Q2 results and confident that our high-quality properties and strong balance sheets will continue producing good results for the remainder of the year. With that, I will turn the call over to Emily.

Good morning, everyone. I'm delighted to join you today in delivering our second quarter highlights from our multifamily platform, as well as discuss some operational updates. Market conditions continue to be favorable in terms of employment, wage growth, and positive migration trends. We continue to deliver solid operating results with same asset revenue growth, excluding Jackson Park from our portfolio, in U.S. dollars increased by 10.5% and including Jackson Park 13.7% for the second quarter. When excluding Jackson Park, same asset net operating income from our portfolio in U.S. dollars increased by 8.3% for the three months ending on June 30, 2023, compared to the respective 2022 period. Including Jackson Park, same property operating income from our portfolio in U.S. dollars increased by 15.6%. We mentioned reports of elevated supply last quarter. However, we believe our institutional product will continue to perform well despite the short-term headwinds. By way of example, our multifamily portfolio ended the second quarter at 94.1 and remains stable today. For context, our community out-of-studa home purchase dropped 19.8% in the second quarter of 2022 to 13.7% in the second quarter of 2023. Additionally, our rent-to-income ratio is still hovering around 20%, with retention around 50%, underscoring the continued positive fundamentals for Sunbelt multifamily. With strong investment interest in the small number of deals that are being marketed, we expect cap rates to remain low, relatively speaking, for the institutional quality assets in the Sunbelt. While interest rates have induced cap rate movement, capital flows, which are a primary component of cap rates, are still very much interested in a heavy Sunbelt multifamily allocation. Based on our recent third-party appraisals and a few recent Sunbelt sales comps, we believe raising our internal FMV cap rates by 25 basis points to 4.75% is appropriate and supported. On the development front, Landtower Westlove in Dallas, Texas is still on schedule and on budget and recently dried in the roof on turns one through three. Exterior windows and doors are currently being installed along with exterior sheeting and waterproofing being installed for a considerable portion of the development. Also in Dallas, Texas, Landtower Midtown is on schedule and on budget and recently completed concrete work including the parking garage. Framing has commenced and currently is on level two of the first term. We are progressing through 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, as we approach normal seasonal performance and patterns, following historical high growth, it makes it paramount to focus on improving efficiencies and expanding NOI margins. Consistently identifying best practices is one of my primary goals and a major part of my leadership strategy. Let me share some of our value-add initiatives. Our SmartRent platform is deployed across almost 90% of our portfolio and provides efficiencies to our onsite teams, such as electronic locks, leak detection, and the ability to control thermostats in vacant units. Additionally, it generates an approximately 30% return on investment in amenity revenue. We've installed over 1200 in-unit washers and dryers, which yield over 55%. Dog yards are a popular amenity and have installed over 120 with an anticipated 40% return on investment. In summary, the LandTower platform continues to achieve positive results and progress, and I'd like to say thank you to the LandTower team for their commitment in helping facilitate H&R's repositioning plan while delivering top-tiered results. And with that, I'll pass along the conversation back to Tom.

Operator, you can now open the call for questions.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by one on your touchtone phone. You will hear a three-tone prompt acknowledging your request. If you are using a speakerphone, please lift the handset before pressing any keys. One moment, please, for your first question. First question comes from Jimmy Shen from RBC Capital Markets. Please go ahead.

Yeah, thanks. So first question would be on the land tower business. Can you talk to what sort of lease spreads you're seeing on new and existing leases and how you see that trending in the back half of the year?

Hey, Jimmy. Good question. You know, going into Q1 and Q2, we had much bigger spreads from a renewal front. In Q3, we're really coming off of the anniversary dates of the really higher leases. So the first half of the year, we came into the year about 5% of loss to lease spread, with it really probably a 7% or 8% renewal increase. The second half, I expect that to be closer in the 2% to 3% range for the renewal, because we're really closer to that spread for our new releases within a 3% range. I would expect 2% to 3% in Q2 and Q3. Okay.

And what about on the new lease?

New leases I expect to be flat, maybe 1% to 2%. But with the construction pipeline in our markets in Q3 and Q4, I expect those to be relatively flat.

Okay. You also mentioned seeing a few deals in the US Sun Belt that would support your cap rate. Can you share what some of those deals are?

Yeah, there's one Dallas and one Tampa. I mean, the volume is really down, as I'm sure you've read, you know, really true, 70% down as far as the transaction volume. But we did have a deal trade and a Tampa deal trade that we watched at a 4.7 range.

Okay. And then maybe turning to the office financing. So on the Elgin property sale, I did notice that the VTB was extended. Can I have any thoughts there? You're feeling pretty good about them coming up with the dollars.

Yeah. Hi, Jimmy. We've seen that term sheet already, so we're pretty confident that it's imminent that it'll happen this quarter. Okay.

And then maybe in generally, in terms of office financing, Tom, you had mentioned before, you know, to get a deal done, the banks aren't there really for financing. How is that environment like? Has it changed at all? Is it improving at all? What are you seeing?

I don't think it's improving. I think it's the other way around. I think it's getting worse. I think banks are putting pens down almost. Does the United States and Canada? So what you're seeing in both countries is you're seeing, to move real estate, you can see the last Atria deal is a good example of that. The sellers, the vendors, are providing financing to facilitate the deal. It solves the problem of the question mark in getting the financing and plugs the rate, which has also been very volatile. So I think the answer is it's really, really difficult to get. Only the best sponsors are going to get. As you well know, the United States is a non-recourse and therefore it basically pins down. The transactions that I'm seeing in both countries are vendor take-backs right now.

Okay. Okay. Sorry, then maybe lastly, just on the office rezoning, looks like you made some progress. Are there any assets that you think you'd be in a position to start thinking about selling? And then maybe relating to that, thinking about the Winford Drive deal you did with Oak Street. Can you replicate a deal like that with some of the assets that you're currently working on?

I didn't quite understand the question. It sounds like it was twofold. The Winford deal is a credit-tended lease deal. It's not a rezoning issue. It could be rezoning for the new buyer. We have the option to purchase it back, and the reason we put in that option is for exactly that reason. If during the term of the extended lease term, The next 12 years, the rezoning takes place and there's higher value. That's why we preserve ourself the right to buy it back. There are buyers of that transaction. We're in the credit lease business and on the residential business. For the most part, that type of a transaction is saleable. Again, it depends on the weather. It's a general question, not specific to our portfolio, but it'll really be the present value of the cash flow. and some residual in underwriting that and generically not again not applicable to our portfolio since we've gone through uh covid and post-covid and very few leases were long-term releases were signed over the past called three four years the lease the duration of the lease terms that are remaining for most landlords portfolios are not long enough to facilitate a transaction whereby you're buying it at the present value of the cash flow plus a residual because there's not enough term left for the most part. H&R does have a longer duration, as you all know, than I would say almost all other landlords throughout their portfolio. But it still makes it difficult to sell a predicated on the present value of that, and it's very hard to underwrite what the terminal value will be because we have very little visibility into what the lease rates are going to be or what the markets are going to look like five, ten years down the road. Okay.

And so on the assets that you currently rezone, like 145 Wellington, on those ones, I guess you can't sell that as a credit and then with development upside down the road to the same, to the credit buyers, right? Is that what you're saying?

Yeah, that's not a credit buyer lease because those are – and every one of our assets, we're talking about Front Street, 145 Wellington, 55 Yonge Street, 69 Yonge, Bouchard – All of those deals are predicated in converting it to residential, really an expiry of the tenant. In our case, since we're so laden with long-term leases to single tenants, in other words, It's not a multi-tenant building with a whole bunch of 2,000 to 4,000 square foot tenants, which makes it very difficult to convert to residential down the road. We're looking to the expiry of the major tenants, at which point in time rezoning will be completed, and you can go put it, sell it, or develop it as residential. At this point in time, until the rezoning is completed, it would not make sense to sell those assets.

Okay. Okay. That's it for me.

Thanks. Thank you.

Thank you. The next question comes from Sam Damiani at TD Cowan. Please go ahead.

Thank you. Thank you. Good morning. First question may be back to you, Emily, on land tower with the dynamics you're expecting in the second half. We did see occupancy come down a bit in Q2. Do you see that continuing in the back half of the year? And is what you're seeing, sort of the softness, more a result of the increased supply? weaker demand or a combination of both?

Definitely not demand. We are seeing an increase in demand actually over 22. So that's good for the strong fundamentals. But the supply is going to be some headwinds really between now and what I think the end of 2024. We had 50,000 units deliver year to date and just in our markets, in our sun melt markets that we operate in. And went head-to-head with about a little over 6,500 of them. And they only absorbed 30,000 in the first half of the year. So going into the second half of the year, we have 55,000 that are anticipated to be delivered that will go head-to-head about 9,000 of those. So we strategically really kind of traded occupancy in the first half of the year to get the renewal increases while we could, because we knew the second half was going to have a little choppier waters going forward. I do anticipate really getting our occupancy up in 95 and then trying to increase our retention to 60% over the 50% where we have. just to be able to have a hunker down effect, if you will, between now and the end of 2024 and kind of ride out any headwinds that might come our way.

That's great. That's very helpful. Thank you. And maybe one for you, Larry, just on the debt stack with the weighted average maturity now under three years, is there any plan or a path to terming out the REITs overall debt over the next couple of years?

Good morning, Sam. The reason our debt maturity has shortened quite quickly is because we've been selling assets and paying off the debt. So if you're not refinancing back at five and ten years, then everything could be just, you know, you're not getting that weighted back end of that financing and everything is just coming to you a lot sooner. So there's no plan to refinance everything. We'll do it year by year as it goes, depending on the proceeds from our sale. And proceeds that come in will be used to just keep our debt level the same on debt to assets and debt to EBITDA metrics. But from what we have in the pipeline of what's coming up, No, there's just a $350 million unsecured venture in January 2024, and that's the really big maturity that we have that we'll be looking to refinance probably towards the end of the year. Other than that, it's short mortgages, which are all loan-to-values, and we're pretty confident we'll have no problem refinancing them, or using our lines of credit, which are in excess of $900 million to pay some of that debt back in the short term until proceeds are available from sale of property.

Okay, great. Thank you. And last one for me is just on the office occupancy. So based on your comments at the outset, do you see occupancy remaining stable through the balance of the year in the office segment?

We have a very small lease all over schedule to the end of 2024, really. So there's a couple of floors here or there, but nothing significant. So the answer to your question is it should remain stable.

Great. Thank you. I'll turn it back.

Thank you. The next question comes from Mario Saric at Scotiabank. Please go ahead.

Hi, good morning. Just coming back to Landtower and more of a clarification question for Emily, the new lease spreads and the renewal spreads for Q2 specifically, would they be similar to the 7% to 8% renewal and kind of slot to 2% for new that you highlighted for the first half of the year?

That's Yes, basically. The renewals were 7.9, I believe. And I expect them, in fact, August, I think we got 6%. So they're still probably in that 5% range for the beginning of Q3. And then I expect the 2%, 3% for September through the end of the year. And the new lease is flat, basically.

Okay. And I recall that during COVID, H&R was proactive in signing as many two-year leases, not necessarily as you could, but it was elevated. So when you talk about Q3 being a reset quarter, is essentially the benefit of those two-year leases coming off, does it kind of terminate in Q3?

It's really nicely dispersed, actually. It's a great question. We didn't have an overwhelming amount of the percentage of the portfolio, so I don't think you'll see it overall. I'd say probably 3% to 5% of our portfolio took us up on those two-year leases. And they were a little staggered throughout early 23. So, yeah, I don't anticipate that to really be any significant headwinds or actually windfall. on being able to capture the loss-delete there.

Got it. Okay. And then just maybe a couple for Tom. On the disposition, the $600 million target versus roughly about $400 million to date, can you give us some color in terms of where the incremental 200 or so is expected to come from, whether it be by geography or by asset class?

Asset class would be office. Geography, that'd be too telling. It's the only R2 asset in the United States, so we won't go geography.

Got it. Okay. And then just a follow-up to Jimmy's question on the capability and kind of the willingness to sell, let's say, residential density ahead of all the requirements necessary to start construction. Is that... Simply, structurally, you're not able to do that, or do you feel like you're leaving too much value on the table doing it that far in advance?

The latter, we're leaving too much table. Just to qualify that point that you made, it's not until you can start construction, it's until you complete zoning. In other words, there's three components of this. There is getting the zoning done, there is getting the tenants out, and therefore, at that point, time demolishing and going forward subject to the market being right at that time. Once the zoning is done, then the rest is easy. Then it's just a question of the market conditions when to maximize pricing. Until the zoning is complete, we'd be leaving too much on the table. I might add also that at this point in time of the cycle, as I'm sure you're aware, the residential land values are depressed, and we will not be selling into this market right now. We fully believe that for the properties that we have, the quality of the properties that we have, And now it would be an inappropriate time to put them on the market. We'd wait until the market recovers.

And even though we have some rezoning in place, like on 145 Wellington, the plan is really we have some office components in that rezoning. So it's an office space, and we're going back into the city to try and switch that out into fully residential. So even though we have some zonings in place, we're trying to do better on them, and therefore not ready to sell them at this time.

Okay, that makes sense. Tom, what would you estimate residential land values are down for your types of assets from peak levels?

Peak levels for downtown Toronto are 325 a foot. And again, it's like everything else, there's not a whole lot of clearing. So line of sight, 175. There's been very few trades, don't forget. A lot of it has to do with the size of the deal. And nothing's really going on the market now either. But I think that's a fair answer. 325, and you can probably liquidate it at 175. But it's not a whole lot different than any other sector out there. There's very little liquidity in the world. And so that's why the decision is, even if you could clear at 175, we'll still wait. We believe that on the supply-demand side, there will be a shortage of the high-quality residential properties that we're talking about in downtown Toronto. And whether they go back to the office or not, it seems like they want to live downtown. So I do believe that the values will... We'll circle back to 275 plus in the not too distant future.

Okay, great. I appreciate the position and the answer. Thanks, guys.

Take care.

Thank you. The next question comes from Matt Cornack at National Bank Financial. Please go ahead.

Good morning, guys. Just to follow up on Jimmy and Mario's question with regards to the office repositioning, Has your sense changed or evolved at all in terms of office replacement and what the city would be able to grant or willing to grant on that front residential-wise?

Yeah, I'm going to hand that over to Matt Kingston. He's actually, I don't know what I'm talking about, as you probably figured out by now. This is his world, so why don't I hand it over to him?

Good morning, Matt. Yeah, I think we have an application at 69 Yonge Street where we were not replacing office, which is a little different than 145, 55, and 310. And I'll say we are feeling a difference. So it has always been a hard line from the city. You have to replace office. We're starting to actually see some progress and we've seen a few other examples. Kingston has a property at Bay and Bloor where they were successful reducing that number significantly on the office replacement. Reserve properties at 277 Wellington West similarly was able to reduce the amount of office replacement. So the city is starting to get it. They're slow. They are parliamentary in terms of their thinking, but we do see an opening, and as such, we're going to try and see if we can do better.

And remind me, what is the timing to kind of go back? I know you've firmed up the density, which was the important part of it, but what's the timing to go back to the city and go through that process?

Yeah, to that point, sir, so 310 Front was at Council. We got our approval last week. 55 Young, we managed our settlement conditions in Q1. 69 Young is headed to Council in October with a positive staff report. And 50, excuse me, 145 Wellington was done last August. So all four of those are quote unquote firmed up in their approval. For us to go back in, we're going to attempt to be back in Q4 or Q1 latest next year. In terms of approval, because we've dealt with all the minutiae of what's the absolute height of the building, how much density, what are the setbacks, all the stuff we normally hang on, it's difficult to say it'll be significantly less time, but we're hoping by mid-2025, we would have new approvals in place.

And that's downtown Toronto.

You can talk a little bit to Bouchard and Burnaby. For Quebec, it's a refreshing process. So at Bouchard, we're hoping by the end of this year, we've got new bylaws in place for that property. And for Burnaby, which is 3777 Kingsway, we're hoping to have our entitlement finished by Q3 of next year.

Okay, that's helpful. And then... I can't remember the timing on Prince Andrew, but you were waiting to win the lottery or not win the lottery on a timing basis there. Is there any update at this point as to the land use change?

Matt, you may or may not have heard that announcement on Wednesday, which was Not the most flattering announcement regarding our Minister of Municipal Affairs and Housing and his Chief of Staff. As a result of that, any discussion on official plan amendments has grinded to a halt. So we believe that we're still progressing well, but the problem is timing. So it's not a question of the substance of what we want to get done, it's a question of when we can actually get it done. So they are in firefighting mode.

Yeah, I can imagine it was only a couple billion dollars. But just switching gears to the U.S. multifamily side, Emily, is your sense that the markets that you're in is where you want to continue to be at this point. I saw you did a small land acquisition. I don't know if it's meant for ultimately owning the rental residential or if it's meant to be a play on kind of getting at value on development in the San Diego area. But do coastal markets fit into kind of your view as to where Landtower wants to be longer term?

I think I'll take that one. And let me just take that one. It's Land Tower, but not Land Tower. We have a joint venture with Leadcore Qualico. Qualico is from Winnipeg. Leadcore is from Vancouver. We've had a long-term relationship with them. The Leadcore Qualico, the reason I say it's not Land Tower is because it's under the Land Tower banners, guidance, not banner. Those are built to be sold, not built to keep. So that's just, that was a play we entered into a while ago and had certain conditions on the land. which was achieved. We don't plan to stay in those markets at all. Long Beach, which shoreline, which is now 90% occupied, would have been on the market if the market would have been stronger and would have been sold by now. So the answer to your question is it's not long-term. This is all Qualico, Letcor, all meant to be sold. They are experts in that market, and that's why we use their guidance in the West Coast market, similar to the New York market, which was not our expertise either, and that's managed by the Tishman. It's not under the Land Tower banner either.

Okay. But I guess, Tom, do you like those markets long-term as rental markets? Would it make sense eventually to go into them, or is the focus going to be – kind of Sunbelt at this point?

Well, they're different buckets. The answer to the question is long-term, Emily's business in Landtower is the Sunbelt, and that's going to be her focus and her strength going forward. To diversify yourself across the country is a big demand from a knowledge base and a capital base. I don't think we have the capital or the knowledge to go into those markets. The answer to your question is At this point in time, it will only be strategic with taking a one-third position or something like that where we see value and where we made a lot of money in the past, but I don't think LandTower is going to head into those markets. Not because those markets are good or bad, it's just you can't be everywhere.

Okay, fair enough. Thanks.

Thank you. The next question comes from Sumaya Saeed at CIBC. Please go ahead.

Thanks. Good morning. Just going to touch on capital allocation first. So, obviously buybacks have resumed in the quarter and you've also acquired some development lands in the U.S. I'm just wondering how do you prioritize allocating capital as you get proceeds from your future asset sales?

Good morning, Samaya, and welcome back. Proceeds will be first used to repay debt to keep our, as I said before, our debt to asset ratio in line, our debt to EBITDA ratio in line. And then the balance will be divided either between the developments that we have on the go, that we already have on the go. We have not committed to any further developments other than the ones currently under construction. And then besides that, then it will be used to pay back, to buy back units. So that is kind of the order.

Yeah, but just to give you clarification, the two land deals that you're looking at were not because strategically we decided we wanted to buy land. Those were entered into a couple years ago. There were certain milestones in which we put down a hard deposit and the vendor had to go ahead and achieve the milestones of zoning, which they did. So today, not because of value or anything else, they're good pieces of property, but we would not allocate capital specifically answering your question. to further acquisitions of land today post-COVID to where we are in the world today. Again, those were entered into a couple of years ago.

Okay, that's clear. And just more of a housekeeping question for Larry. On the capitalized interest in the quarter, would that be a good run rate for the balance of the year?

So my guess is that capitalized interest should more or less continue on the same pace as we had it in Q2.

Okay, thanks. I'll turn it back.

Thank you.

Thank you, ladies and gentlemen. As a reminder, should you have any questions, please press star 1. Next question comes from Jenny Ma at BMO Capital Markets. Please go ahead.

Thanks. Good morning, everyone.

Good morning.

I wanted to ask about your Caledon lands. I know you just mentioned in the last question that you haven't committed to any future developments, but what would you need to see or what triggers do you need for any development there to commence? And if you were to start today, do you think you'd be able to replicate the kind of yields you got on the Meadowvale developments?

Hi Jenny, it's Matt Kingston. In terms of getting the ability to proceed, we're currently tied up because of the 413 and 410 extension. There's a sort of moratorium on all our lands that we have remaining except for three acres of land. So we wouldn't proceed with those three acres because we'd want it to be a much bigger piece and there's, once this moratorium lifts, we would have a bigger contiguous piece to develop. So we're just sitting on those three excess acres for now. In terms of the balance of lands, we are in active discussions with the MTO and the region to say that we believe they are at a point where they're starting to scope down their corridor. We are exploring the options of expropriation and trying to see if we can get the land at least partially sold now that they're starting to finalize their plans for the highway. And we're also exploring possibilities of temporary servicing or servicing solutions that would allow us to break free. So there's a planning context because of the highway which is holding us up, and there's a servicing context which is linked to the planning one. So we're investigating a number of different options to go. With respect to the deal, I'll pass that back to Tom.

Yeah, in relative terms, the Mississauga lands are infill, much more so than the Caledon lands, and the returns are higher. We bought our lands in the Mississauga, both in the future ones that we'll be doing on Slate Drive and on Mississauga Road at a very, very low price, and that's why the yields are so high. The rental rates are very high because it's infill. Caledon is strong. I think there's a lot of development that's going to occur in Caledon. I don't think you're going to see the same type of returns, though.

Okay, so it sounds like it's going to be a while before you can commence on anything in Caledon.

Correct.

I appreciate the color on the land values for res development. Can you comment on what you're seeing on the industrial development side in the GTA?

Land values? Is that your question? Yes. Oh, yeah, they've softened. You know, I'll hand it over to Matt, back to Matt again, since I'm on vacation and around as soon as we're finished, Jenny, I'm out of here.

Hi, Jenny. I think we're seeing a softening of it. I think we're lucky with our location, so we're more focused on 6900, Moritz, 520 Slate, Meadowvale. I think we see price coming down about 10%, maybe. Again, there aren't a ton of trades to back things up. The residential land price Tom was referring to earlier, we think it's down about 40%. So relatively speaking, the industrial price is not quite as soft right now, but it's definitely leveling off or softening.

Let me just qualify that for a second, though. The big trades in industrial, the milestone to $3.2 million an acre, it's hard to answer your question, have they softened a whole lot, because there's almost no trades with 100-acre blocks, and it's not that they're not available, you want to probably lose, it's just no one's buying it. So they have softened, I don't think there's evidence to any great extent of what they have softened to. The $4.2 million or the $4 million per acre, let's talk about the 160 McNabb that ultimately we want to rezone. Well, it is zoned, but ultimately that may be prizes. That was at $4.2 million. If it's 8 to 13 acres, the prices have not come up much on this. infill is still very very strong large blocks 100 acres you're not seeing the trades institutions such as the hoops of the world and the the big pension funds they've had oxford etc they've already land back quite a bit of it and you're seeing almost no trades right now okay um and then turning to the the res land that you're talking about um i'm going to ask you to speculate a bit but i'll attempt the question anyway um the decline has been obviously bigger than you've seen it for industrial

what do you think needs to shift for the land values to recover back to that 275 that you had mentioned earlier is it about construction costs um you know for interest rates do they just need to stabilize around current levels uh or do they need to go down substantially for you to see that what's your view on how we get those land values back and any sense of timing

Jenny, I think definitely sales are the thing that need to drive it. We are seeing very low new home sales. We're seeing low new home sales because the demand is down because interest rates are so high. I don't think there's a panacea. I don't think it's a single thing that's going to solve the issue, but definitely interest rates I think are the most important. Construction costs on the early work things where you're not buying a manufactured product, so you're not a plumber buying a toilet or a kitchen manufacturer. On the shoring, earthworks, upfront works, we are seeing a softening, including formwork, which is one of our biggest divisions. So we're starting to see former prices, which were $21, $22 a foot, call it four months ago, are now getting quoted in this high 17s, low 18s. So that's a function of the work not starting over the last 12 to 18 months, and that's not changing over the next 6 to 12 months. So we are going to see construction costs come down. That'll help us. Interest rates got to come down to, though, or else it's, you know, the investors right now. They're basically anything over 700,000 dollars is not moving. it's kind of a hard stop in terms of an end price do you see people getting smaller and smaller with product our average unit size were 650 last year they're 550 now we cannot get any smaller literally we are at the code minimum so that is no longer a lever we can pull we can't say just make them smaller so it has to be a function of the hard cost coming down interest rates softening Those are the things that are going to help us.

And finally, don't forget, right across North America, it's the banks that have to be comfortable lending again. And if you're not one of the biggest banks in Canada, sorry, one of the biggest borrowers in Canada, you're not going to have access to bank financing. In the United States, if you are the biggest borrower, you're still not going to have access to... That's how tight it is down there. So all these stars have to align.

And we're seeing a lot of polygamy in our world. We're seeing a lot of people partnering up. One partner, two partners. So there's a lot of dilution of positions right now, not a lot of sales, whether on new home sales or land sales right now.

Okay, that's very helpful. Thanks. Lastly for me, the unsecured debenture coming due. Larry, can you share with us what kind of pricing or spreads you're seeing for that, how it compares versus secured debt, and whether or not you'd be inclined to maybe tap secured debt versus unsecured, given where interest rates have moved.

Hey, Jamie. I think to do a refinancing today of an unsecured venture would cost us around 6.5%, call it, in that ballpark. To do a secured financing would probably be 50 basis cheaper, around 6%. So what are we thinking? When it comes to renew, we'll see what our proceeds are from certain sales. And, you know, we may not refinance the whole thing. We may have some policies and only end up refinancing 250 of the 350 or something like that. That is the game plan for now.

It's really the same game plan as before. We always paid a premium to get unsecured debt to get the flexibility of being able to sell properties without having to be encumbered. And since our plan is to still continue to sell properties, I don't think we want to put unsecured debt and encumber the properties. So we will still, even if it costs 50 basis points more, continue with the unsecured world.

Okay, great.

Thank you very much.

Thanks. Thanks, Jamie.

Thank you. The next question comes from Eric Brown at Sunlight Capital. Please go ahead.

Hello. Just two questions on my end. First, on the retail portfolio, as you think about moving towards your target portfolio composition, what trends are you seeing on the disposition end, and what are you expecting going forward?

So our retail is very much grocery anchored, but it's not grocery anchored strip centers. It's primarily single tenant. Our Giant Eagle Echo portfolio is just predominantly Giant Eagle stores, single stores, not malls, not strip malls, and get-go's, which are gas bars together with convenience stores. They're long-term leased with visibility to a very strong tenant. In Canada, our portfolio is leased to the metros, the Sobeys, again, groceries, shoppers, et cetera. So those are very liquid. It's easy to sell them. We're not in a rush to sell them. They're good cash flow. There's a wide range of buyers, more so on the retail investor rather than the institutional investor that we can't sell. We're pacing our sales, and right now our focus is still on office. We haven't really pulled the trigger to sell any of the retail at this point in time.

Thanks, that's useful. And then lastly, just a further caller on the capital allocation and payment of debt. Is there a specific debt to EBITDA level you're targeting?

We have, we're currently at 9.5, I believe, of our debt to EBITDA, 9.4, 9.5, in that range. We want to try and keep it around there. We definitely don't want to go over 9.8, would be our maximum, maximum. So the range that we're currently in is where we'd like to keep it. Thank you.

Thank you. Thank you. The next question is a follow-up from Mario Saric at Scotiabank. Please go ahead.

Hi, sorry, one more quick one on my end. The planned conversion of the office to industrial in Mississauga, what types of returns should we think about on the incremental capital?

So you're talking about Maritz? Which project? Maritz Drive? That's right. So you put it in Maritz at its current, well, the value of the land, which is the value of the building upon demolition is the value of the land. If you put the land at the current market, then you're going to be looking probably in the range around five and a half.

Perfect. Okay, interesting.

Thank you. It's probably going to be 123,000 square foot, 40 feet high. We've just been negotiating with ourselves as to the height, but it'll probably be state-of-the-art. It could well be for studio space as well. So it may have a higher use than conventional office. Again, it'll be high cube space, and at 123,000 square feet, there's not a lot of that in Toronto.

So, Mary, you're talking about margin on a cost basis. The yield will be around 12%. Both in a development perspective and an ROI perspective, we think it's accreted.

Makes sense. Okay. Thanks. Thanks.

Thank you. There are no further questions. I will now turn the call back over for closing comments.

Thank you, everyone. Have a great weekend.

Ladies and gentlemen, this concludes our conference call for today. We thank you for participating, and we ask that you please disconnect your lines.