H&R Real Estate Investment Trust

Good morning and welcome to H&R REAP's Q4 2023 conference call. Before beginning the call, H&R would like to remind listeners that certain statements, which may include predictions, conclusions, forecasts, or projections, and the remarks that follow may contain forward-looking information, which 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 the 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 and 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 Hofstadter, Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstadter.

Thank you. Good morning, everyone. Thanks for joining us today to discuss H&R's fourth quarter and year-end 2023 results. With me on the call are Larry Frum, our Chief Financial Officer, and Emily Watson, Chief Operating Officer of our Land Tower Division. I'm pleased to report that we have continued to successfully execute on our five-year strategic plan to reposition the portfolio to a more simplified and growth-oriented reach, as was highlighted in our most recent press release. Since announcing our strategic re-resisting plan two and a half years ago, we have made considerable progress, having successfully completed the spin-off of Primaris Reef, valued at approximately $2.4 billion. And we have completed, to date, the sale of an additional 45 properties, totaling $2.4 billion, with a further $300 million of sales still to flow later this year. We have re-purchased today 27 million units for $340 million and have decreased our debt from $6.1 billion to approximately $3.7 billion at year-end, thereby improving our debt to total assets from 50% to 44% as of December 31, 2023. Importantly, at year-end 2023, our total office exposure was reduced to 17% of real estate assets, plus nine additional properties representing a further 7% that are advancing through the zoning and intensification process. We expect to continue the strong momentum with an announced sale this year of a further $293 million of properties, including the sale of $232 million of 25 Dobson Drive, an office building by the Waterfront in downtown Toronto. Our recent board initiatives, including independently Trustee Nadek Lo, Lindsey Brandt, and Leonard Hrabowski, underscored our dedication to effective governance and strategic advancement, and we look forward to working with them to help us achieve our objectives. And with that, I'll hand it over to Liz.

Thank you, Tom, and good morning, everyone. In my comments to follow, references to growth and increases in operating results are in reference to the year ended December 31st, 2023, compared to the year ended December 31st, 2022. H&R's same property net operating income on a cash basis increased by 10.3%. Breaking this growth down between our segments, Landtower, our residential division, led the way with an 18.7% increase or a 14.3% increase in US dollars. Emily will provide more details on this shortly. Industrial same property NOI on a cash basis increased by 12.5%, driven by rent increases for new and renewed tenants. The tenants at our two new industrial developments in Mississauga, totaling 336,800 square feet, took possession this month and will begin paying rent in Q2. Office same property net operating income on a cash basis increased by 5.2%. This increase was largely attributable to lease termination payments, bad debt recoveries and the strengthening US dollar. H&R received lease termination payments from office tenants in 2023 amounting to $5.2 million. $3.4 million of this relates to 6900 Moritz Drive in Mississauga where the current 105,000 square foot office property will be converted into a brand new 122,000 square foot industrial building. Demolition has already begun and construction on the new building is expected to begin in the spring. And lastly, retail same property net operating income on a cash basis increased by 5.7%, primarily driven by increased occupancy at River Landing and the strengthening of the US dollar. Q4 2023's FFO was 30 cents per unit compared to 31 cents per unit in Q4 2022. FFO for the year ended 2023 was $1.33 per unit compared to $1.17 per unit for the year ended 2022. Included in FFO for 2023 is $30.6 million of proceeds from the sale for an option to purchase land. Excluding this item and other non-recurring items such as these termination fees, FFO would have been $345.4 million for the year end of 2023, or $1.23 per unit, an increase of 3.9% compared to 2022. H&R's cash distributions of 70 cents per unit was 18.6% higher than the cash distributions of 59 cents in 2022. H&R's 2023 pay-up rate shows remained healthy, at 52.8% of FFO and 63% of AFFO, notwithstanding the increase in distributions. Net asset value per unit as of December 31st, 2023 was $20.75 per unit, a decrease from $21.80 at the end of 2022. H&R recorded a downward fair value adjustment of $197.6 million for Q4 2023 at the reached proportionate share, and the downward fair value adjustment for the year ended December 31st, 2023 was $486.1 million at the reached proportionate share. Debt to adjusted EBITDA improved from 9.6 times at the end of 2022 to 8.5 times at the end of 2023. Debt to total assets at the risk proportionate share on December 31st, 2023 was 44%, unchanged from the end of 2022. And liquidity at December 31st, 2023 was in excess of $950 million with an unencumbered property pool of approximately $4.2 billion. And with that, I'll now turn the call over to Emily.

Good morning. Thank you, Larry. I'm happy to be on the call to discuss our fourth quarter same store results from our multifamily platform and discuss some operational highlights. Occupancy ended the quarter at 94.6, 72 basis points lower than third quarter and 41 basis points lower when compared to Q4 of 2022. Same asset property net operating income from our portfolio in U.S. dollars increased by 12.6% and 14.3% respectively for the three months ending on December 31, 2023 and full year 2023 compared to their respective 2022 period. We continue to see positive signs of demand with Q4 resident retention at 62% and 94% occupancy in the Sun Belt. and Jackson Park is achieving a 75% retention and 99% occupancy. Moveouts due to home purchase remain low at 11% of total moveouts, and rent-to-income levels remain affordable in the low 20% range, allowing for future headroom for in-rental growth. Lingering high interest rates have maintained the spread between bid and ask prices and continue to constrain the number of trades completed in the fourth quarter. Based on our recent third-party appraisal and a handful of Sunbelt sales comps, we have raised our FMV cap rates by 25 basis points to 5% and believe the rate is appropriate and supported. Cap rates are expected to remain low, relatively speaking, for the institutional quality assets in the Sunbelt, with capital flows interested and focused on long-term heavy Sunbelt multifamily applications. On the development front, Landtower Westlove in Dallas, Texas is expecting its first TCO, including 75 units, in late March. We are very excited to deliver what we believe is a best-in-class asset with unparalleled amenities. We look forward to commencing pre-leasing later this month. Also in Dallas, Texas, Landtower Midtown has reached floor five, its top level, in three of its six turns and is currently 70% framed. Drywall is ongoing on turns one and two. We are progressing through the different phases of design, drawing, and permitting on the remainder of our Sunbelt development pipeline and expect to receive more building approvals as we progress through the year. On the operational front, we continue to focus on expanding NOI margins through our centralization efforts and value add opportunities. During the fourth quarter, we installed over 300 private yards with an average amenity charge of $150 and a 59% return on investment. This investment is focused on increasing the tenure of our resident stays, thus lowering our costs and increasing effective rent. In summary, the LandTower platform continues to achieve positive results and strong performance relative to our multifamily counterparts. I would like to recognize everyone on the LandTower team for receiving three awards in the fourth quarter. The Emerging Technology Award and Best Places to Work in Multifamily from Multifamily Leadership, as well as Glassdoor's Best Places to Work. These awards exemplify the winning culture that Landtower embodies and is the key reason the team continues to deliver top-tier results. And with that, I pass along the conversation to Tom.

Operator, you can open up the one-answer questions, please.

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 the one on your touch-tone 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. First question comes from Mario Saric at Scotiabank. Please go ahead.

Hi, good morning, and thank you for taking the questions. First question, I may have missed it, but if we exclude 25 dockside, is there enough visibility for you to provide a target disposition range for 2024?

Good morning Mario. We provided a target disposition pretty late in the year last year and to be quite frankly once we were sure we were going to hit that target. So we're not going to give any target right now. We have two assets that we have on the books almost totalling $300 million for sale. We've done $430 million last year and a lot more the year before. We hope to at least achieve those same levels as last year but we don't want to set any targets right now.

Perfect. Okay. And then just sticking to potential dispositions, any update on Hustower and what you're thinking there?

Good evening. The merger between Hess and Chevron right now, there's no visibility. First they have to get beyond their merger and make the deal, which I'm guessing is going to drag a little bit longer because the U.S. government is very concerned. But it will happen, is my guess, and it will probably happen in June. At this point in time, Hess and Chevron have not decided, made any decisions on space those early days. But I feel there's better clarity that there's nothing that's going to happen in Hess.

Got it. Okay. And then, Tom, just maybe sticking with you, I think on the Q3 call, you kind of talked about residential value per buildable in the $200 per square foot range. It was as high as $325. Where does that stand today?

Hi, Mario. It's Matt Kingston. I think we believe that the values in the GTA are down about 40% to 50% depending on the site. The most recent trade we can point to is First Capital and Woodborne. consummated on a deal at 1071 King West, which is around 200 to 10 a foot. I think that's a pretty premium price, though. I think, you know, realistically, downtown transit-oriented sites are probably mid to high one. So somewhere between 150 and 200 a foot, I think, is realistic, depending on how big the site is.

How good and how large the site is. There's a discount if it's, you know, $600, right?

Okay. That makes sense. And my last question, maybe for Emily, just with respect to LandTower, to the extent that you can, can you discuss 24 expected same-store revenues, same-store expense, and same-tier and why?

You know, we are not going to give guidance just yet on that. We're really looking at what the market – we do have the lead core properties or JV deals on the West Coast that are coming into our same-store universe. You know, we expect it to moderate from what we have experienced the last couple of years as kind of expected. There have been kind of banner years, but at this point, we're not providing guidance.

Okay. Are you able to kind of give us a sense of where kind of blended lease spreads are going, both kind of on including renewal and release spreads? Sure.

Yeah, you know, Q4 was really the height of the deliveries in the Sun Belt. So we saw a lot of just a combination of the heavy supply and the holiday season. That definitely had a downward pressure on the new lease tradeout, where they were down actually around 6%, 7%, 8%, I think, actually. But renewals still stayed in that 3% to 4% range. So we ended Q4 with a blended range or blended negative 3. But so far in Q1 that we've seen 160 basis point improvement in Q1 already with our new lease assigned. They're still down in that 6% range, but a blend of negative 1. Definite improvement, Q4 we had, or actually all of 23, we had about 100,000 units enter the areas that we operate in, with a lot of the merchant builders really having pressure in that Q4 to get heads on beds, if you will, before the season, before the end of the year. Where Q1, we're seeing that pick up, and then we'll continue to see just going into our leak, piecing leak, peak leasing season, excuse me, in Q2. So, you know, we'll have still some heavy supply delivered in 24, Mario, but, you know, 75,000 units. So I think we were in the eye of the storm in Q4, and so far we're off to a much better start in Q1.

Great. Okay. And would the expectation for that blended leaf spread to turn positive, would that be in the second half of the year, or is that something that may be more with 25 of them?

No, I do think that we'll see some pickup, you know, in Q3 and Q4. The supply is will start to drift off and people kind of settling into that new norm. So I expect that we'll probably end 2024 in a flat position and then definitely some pickup in 2025 as the market absorbs those units and really the deliveries just fall off a cliff. So flat for 2024 and then 2025 we should be able to. kind of get back to the new normal, not the days of 22 and 23.

Understood. Okay. Thanks for the call. That's it for me.

Thank you. The next question comes from Jimmy Shen at RBC Capital Markets. Please go ahead.

Thanks. Just sticking to Landtower still. So how are you thinking NOI margin running 24, seeing high insurance costs and all that? So how should we be thinking about Great question, Jimmy.

You know, I do think that we have concentrated on really focusing on the NOI margins for a while now through our centralization efforts, you know, reducing some of our payroll costs, you know, just economies of scale on our procurement initiatives, certainly adding the value add initiatives that we've added. Insurance costs, I think, won't forever be as elevated as we saw in the increase in 23. I think some of the reinsurance will open the market, at least coming back from NMHC last week. We had several, you know, kind of hopeful people saying that there was going to be more kind of normal increases next year, not what we saw in 23. So I think focusing on the NLR margins is definitely one of our strategic goals. and has been, so I don't anticipate our NOI margins to decrease. If anything, edge up just a tad over where we are now.

Okay. That's helpful. Thanks. And then just on the asset sales, I know you don't provide – maybe just a question that you don't provide any target, but can you characterize the environment today? Is it same, worse, or better? And then the other question on asset sale is, You have an industrial property held for sale. I didn't think you were looking to sell industrial. Maybe any color on that specific asset that you have for sale there.

We don't have any industrial properties for sale. The sale that occurs is really an option the tenant had to buy. So it's really not because of market conditions at all. The market today is, I would say, less liquid. It continuously gets liquid and less liquid. both on the debt side and on the equity side. That's why every deal that we're doing is almost an off-market deal. There's no point in putting it on the market. It's really tailor-made to specific buyers that have an asset in mind or have a use for that asset in mind. It's going to stay floppy until its rates come down, until there's positive leverage. And at that point in time, when the debt markets open up, the equity markets will open up. So it remains floppy. It remains very, very slow. And again, that's why it's hard for us to give guidance. And none of the properties that we will be selling probably are going to be put on the market. They'll be off-market deals just like they have been for the past year.

Okay. And CoreSki, obviously, the sale was at a really good price. And would there be any other assets? that would be similar in the sense that it could be strategic to somebody else or to a different buyer? Anything in the portfolio that would kind of resemble what you were able to achieve with Korsky?

So I think the answer is yes. It's really going to be the same this course. I'm not going to give specifics on that, but anywhere there is a user coming in, the user market is going to pay more obviously than the investor market. If you look at the industrial, not that we're selling the industrial, but just as a highlight, an example, you have the past few years, small, user-oriented 50 to 100,000 square feet or 20,000 to 100,000 square feet buildings that went for substantial premiums on a price per square foot basis to the larger counterparts because the users are the buyers. I think that's going to continue. You can look at any of our buildings and say that if there's a potential for a user to come in wanting to buy the real estate as a user, they'll pay a premium. That's exactly what happened with Forrest. And I think there are, I know there are assets that work. I don't want to be specific because I don't want to give it any weight, but there are assets that fit that bill still.

Okay. Okay, thank you.

Ladies and gentlemen, as a reminder, should you have any questions, please press star 1. Next question comes from Sam Damiani at TD Cowan. Please go ahead.

Thank you. Good morning. Good morning. Emily, maybe for you, just on the Land Tower market and Sunbelt there, have you seen the opportunity for acquisitions getting any more interesting? And if not, do you anticipate that to materialize over the course of 2024?

You know, Q4 was pretty bleak. We tracked about nine deals that were similar vintage, you know, same kind of footprint as we are. So that was really low. I think We'll pick up some in Q1 and Q2, but when we walked away from NMHC last week, it was really the second part of the year where they were anticipating, as Tom alluded, the interest rates come down a bit and really start to see trades. There is not the distressed market that I think we all hoped there would be. kind of sweep in and be, you know, a great dancer at all. So that really hasn't come to fruition. But if interest rates will play, then, you know, the second half of the year could be really interesting.

And you mentioned you walked from an MHC. Is that an asset class you're looking to add to the portfolio?

No. NMHC is the National Multi-Housing Council. Okay.

My mistake.

Yeah.

All right. Yeah, and last question for me, maybe for you, Tom. On the dispositions, I know you're not providing guidance, but is the priority still office over retail on the disposition front going forward?

Yeah, the answer is yes, but offices, as you can see from all the sales, is very much tailor-made. In some cases, we need to classify this. The market's going to be, not necessarily our business, we define financial engineering to move product out, with the seller financing, et cetera. On the retail side, it's kind of simple. Our retail is very scalable. There's no danger to it. It's not even food stores, same as the Echo in a way, that at least the $12 to $14 a square foot have decent term on it. High, high credit. They're all metros, blah, blah. So we shop this drug market. So they're easily scalable. But 100% of all buyers out there do financing. If you are of the opinion... Like I think most people believe that in the latter part of this year interest rates are going to come down. So your purchase price can be a direct reflection on where interest rates are going to go. Because if these prices will rise as the cost of financing lowers, there's no point putting them on the market selling right now if you believe that in six months from now the cap rate's going to go down due to the benefit of positive leverage or better leverage. Therefore, no sales or prior sales in the retail front. We're going to hold off until we get the price. We're not going to put it on the market at all until we see the interest rates come down. And on the office front, again, it's specific to a reason why someone would want to buy the asset. I do have hope and actually expectation that we will continue to sell some office assets. They're all going to be off-market deals. And, again, it's less a reflection on interest rates rather than liquidity in the market.

Thank you. I really appreciate the call. I'll turn it back.

Thank you. That concludes today's Q&A session. I will turn the call back over for closing comments.

Thanks, everybody. Have a good day.

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