H&R Real Estate Investment Trust

Good morning and welcome to H&R Real Estate Investment Trust's 2024 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 inherit 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.cedarplus.com. I would now like to introduce Mr. Tom Hofstetter, Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstetter.

Thank you. Good morning, everybody. Joining me today is Jason Birkin, VP of Finance, and Emily Watson, Chief Operating Officer of Land Tower. Larry Froome cannot be with us today. He's traveling. On that note, I'll hand it over to Jason.

Thank you, Tom, and good morning, everyone. I'm very excited to be here today. In my comments to follow, references to growth and increases in operating results are in reference to the three months end of June 30th, 2024, compared to the three months end of June 30th, 2023. H&R's total same property net operating income on a cash basis increased by 1.7%. Breaking the growth down between our segments, Landtower, our residential division, recorded a 0.3% increase, which was primarily driven by the stronger US dollar. Emily will provide more details on this shortly. Industrial same property NOI on a cash basis increased by 4.7%, driven by rent increases for new and renewed tenants, as well as an increase in occupancy. The tenants that are newly completed industrial properties totaling 336,800 square feet in Mississauga are in occupancy. Their free rent period has ended and are now paying rent. We have started construction on three new industrial developments totaling 357,500 square feet at H&R's ownership share. The average rent on our Canadian industrial portfolio at June 30th, 2024 was $8.97 per square foot and is well below market rent, which bodes well for our industrial portfolio continuing to deliver strong results. During the quarter, we completed four industrial lease renewals, totaling approximately $227,000 per feet at H&R's ownership share, and achieved an average rent increase of $7.73 per square foot. Office-stained property NOI on a cash basis decreased by 1.8%. This decrease was largely attributable to a decrease in occupancy at our properties slated for future redevelopment. Our office properties are in strong urban centers with a weighted average lease term of approximately 6.3 years and leased to strong, credit-worthy tenants with 88.5% of office revenue coming from tenants with investment-grade ratings. I would like to draw investors' attention to the 7.9% cap rate on our remaining nine Canadian office properties that are not slated for redevelopment. The cap rate jumps from 7.08% last quarter, primarily due to the sale of course. We also increased the cap rate on our remaining three U.S. properties from an average of 7.68% last quarter to an average of 9.02% this quarter. And lastly, retail same property NOI on a cash basis increased by 7.9%, primarily driven by increased occupancy at River Landing Commercial. In accordance with our strategic plan, we have sold 800 million of property in 2023 in the first six months of 2024. We are very pleased that despite these property sales and the headwinds facing the real estate sector in general, Q2 2024's FFO was $0.306 per unit compared to $0.297 per unit in Q2 2023. H&R's cash distributions of $0.15 per unit for the quarter resulted in an FFO payout ratio of 49% and an AFFO payout ratio of 61%. Net asset value per unit as of June 30, 2024, was $19.94 per unit, a decrease from $21.05 as of March 31st, 2024. This was attributable to $427.2 million of fair value adjustments during Q2 of 2024. Debt to total assets at the REIT proportionate share at June 30th, 2024 was 44.8%, and debt to EBITDA was a healthy 8.5 times. Liquidity at June 30th, 2024 was in excess of $900 million, with an unencumbered property pool of approximately $4.1 billion. Our unencumbered asset to unsecured debt coverage ratio was 2.2 times at June 30, 2024. And with that, I will now turn the call over to Emily.

Thank you, Jason, and good morning, everyone. Today, I'm pleased to discuss our second quarter same-store results from our multifamily platform and share some operational highlights. Our strategic focus is on positioning our portfolio to drive long-term value through geographic diversification, a robust development pipeline, repositioning opportunities, and technology investments aimed at mitigating cost, delinquency, and associate turnover. Our markets continue to experience strong demand for household formation driven by population and employment growth, apartment affordability, and positive demographic trends. Move-outs due to home purchases remain at historical lows in our Sunbelt markets, accounting for just 9% of our total move-outs. Renting an apartment remains an attractive choice, being on average 60% more affordable than owning a single-family home. Our target renters are high earners with stable employment, which continues to support positive housing performance. We have seen improvement from our technology innovations with delinquency, as one example, at pre-pandemic levels and bad debt and Sunbelt returning below the 50 basis points norm. These factors combined contribute to a 58% NOI margin with room for future growth. Given the declining levels of new supply ahead and consistent demand in our markets, Combined with the strength of our operating app platform, we are well positioned for substantial growth and value creation in the coming years. Occupancy ended the quarter at 94.6, an increase of 20 basis points from the first quarter and 50 basis points increase compared to Q2 of 2023. Same property net operating income on cash basis from our portfolio in U.S. dollars increased decreased by 1.2% for the three months ending on June 30, 2024, compared to the respective 2023 period, primarily due to high property operating costs, including property taxes and insurance costs, and the decrease in average rental rates from the Sunbelt properties, which was partially offset by rental growth at Jackson Park in Long Island City, New York, and River Landing in Miami, Florida. Landtower's asset management team oversees capital expenditure deployment, and one highlight of our repositioning capital is Tortuga Bay in Orlando, Florida. Over half of the units have received kitchen, bath, and flooring renovation with around a 13% return on investment. Other projects include smart home amenity package with a 30% return, washer and dryer additions with a 55% return, and private yards at a 50% return on investment. Moving to our fair market value, based on recent sales comparison, our fair market value capitalization rate for the residential portfolio is 4.55%. We maintain a 5% cap rate for our Sunbelt portfolio, which was further supported by a third-party appraisal received in Q2. Cap rates are expected to remain low, relatively speaking, for institutional quality assets in the Sunbelt, with capital flows interested and focused on long-term heavy Sunbelt multifamily allocation. Turning to developments, Landtower Westlove in Dallas, Texas remains on schedule and on budget. We expect to be fully delivered by the end of Q3 with stabilization Q2 of 2025. Leasing commenced mid-April and we are currently 31% lease, reflecting strong demand. Our thesis for securing great sites and designing best-in-class products has materialized in a strong initial lease up at Westlove. Our lease up absorption is well above what industry reports have stated for our market and is above what is budgeted. Also in Dallas, Texas, Landtower Midtown is progressing well. The first units are prepared for occupancy with final units expected by the end of the year. We received our first certificate of occupancy earlier this month, and we are encouraged by the high traffic volume of traffic in a short amount of time. A validation of demand for best-in-class product with unparalleled amenities. On the Reddit front, as we discussed last quarter, the investments The investor interest in Invest alongside LandTower's existing development pipeline was highlighted by accelerated fundraising results, and we feel that this construct will create value for H&R shareholders as well as our Reddit investors, while maintaining financial flexibility and taking advantage of a favorable depressed Sunbelt supply pipeline in the upcoming years. We broke ground on both Landtower Sunrise, a 330-unit development in Orlando Market, and Landtower Bayside, a 271-unit development in the Tampa Market, in the second quarter, and they are progressing as expected. We expect these developments to reach completion in mid-2026, which we believe to be an excellent time to deliver units. Landtower currently has an additional eight development projects in the Sunbelt Pipeline totaling over 2,700 suites at H&R's ownership interest, with multiple sites ready and prepared for construction. In summary, the Landtower platform continues to deliver top-tier results relative to our multifamily counterparts. I would like to extend my heartfelt thanks to the entire Landtower team as we proudly celebrate our spot on the 2024 Fortune Best Places to Work in Texas list. This award is a testament to Landtower being an employer of choice that is adaptive, resilient, and innovative. And with that, I'll turn the conversation back to Tom.

Thanks, Emily. And with that, I'll turn it over to the operator for questions. Operator?

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 touchtone phone. You will hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press star followed by two. If you are using a speakerphone, please lift the handset before pressing any keys. Your first question comes from Sam Damiani from TD Cowan. Please go ahead.

Thanks. Good morning, everyone. Tom, just wondering what your thoughts are on the sort of the acquisition market, disposition market currently versus last quarter, what change you may have seen and how you see the market unfolding for the balance of the year as it relates to the REIT's intention to dispose more assets.

Good morning. We knew that would be your question. You highlighted that in your report last night. The write-down has really nothing to do with the disposition market. It has to do with the strength of the current value of the asset. There is very little going on, as you well know, as far as dispositions, as far as being able to target what a price will be or won't be. So we don't really have, at this market visit, so we don't really have a guidance to give you as to what our future sales will look like. The write-down was predicated on really what's going on in the market today. And what's going on in the market today is really very little. That being said, Take an office as an example. If you evaluate your asset based upon the present value of its cash flow and a terminal value, and your terminal value is static, as time marches on, you have to write down the asset for the fact that you're taking an income, and you don't know what the extension is going to look like. Not only do you not know what the extension of the lease is going to look like, you don't know what the terminal value at the end of that is going to look like. So bottom line is, if the market doesn't improve, In office, you have to take down a write-down periodically unless you see some form of a turn in the market. That could happen also because of interest rates, and interest rates hopefully will come down on the deflation and tackle to a great extent. But until that does, they warrant a write-down. The land value, which involves our intensification properties, the Cove and the Gowanus, also reflects the current market where nothing's going along. And as you well know, in downtown Toronto, there was supposedly going to be a deal for 212 King. That never happened, never materialized. We're hoping that it was going to be at $160 a foot. And nothing happened there. We have no visibility into what a trade looks like. But just to be conservative, we took everything down by $10 a foot in Canada, $10,000 a door in the United States to reflect the fact that there's very little going on. The reason there's nothing going on is because everyone's building to a seven yield return on cost. And in order to achieve that with the construction costs and interest rates the way they are today, something has to give. And what gives, obviously, is the one element that has to give is the value of land. So you have to take down value of land to reflect the fact that people are going to ultimately have to get their 6.75% yield, and the only way to do that is through land reductions. So this doesn't reflect our desire necessarily to change the fact that it's easier for us to sell down the road. It reflects the honest current conditions of where we see the world today.

Thank you for that. And just with what you said and the REIT's overall strategic objectives over the sort of medium term, does it pivot your attention more toward the retail portfolio as a source for dispositions at this time?

So... I don't think so. I think that's like, I don't know, something in the market that I can't understand, to be honest with you. Our REIT portfolio, unlike many other REIT portfolios, is not speculative. It's not dangerous. It's almost irrelevant what the expiry schedule is. We have total visibility into ECHO as to what stores are doing well, the lease term. Because that's a sister company to the real estate arm, which we own a piece of. And as far as our Canadian retail portfolio, that's as good as you're going to get as far as clipping a coupon with solid real estate debt. Really, you don't have to worry about lease expirations. That being said, there's no urgency to sell those. That's highly liquid to sell any time you want. Giving up those assets in today's environment, which those assets are all really a reflection out of the economy, a reflection on interest rates, doesn't make a whole lot of sense. We'll wait until interest rates come down a bit. So in the case of ECHO, we have something looking at it, but if the prices are not going to meet our expectation, and on the Canadian side, if someone comes forward with an offer that reflects tomorrow's values, not today's, And again, today's cap rates are elevated because of interest rates, and we look at selling it. There's no burning issue to sell these assets at this point in time, not when you're giving up good cash flow, good FFO, in return for what? For selling at a high cap rate because interest rates are high? It doesn't make a ton of sense. We don't feel the pressure to sell in other ways.

Okay. Last one for me. Just on, I think, last quarter, there was a comment probably from Larry that the debt-to-EBITDA would stabilize around the 9.25 level. before any additional disposition announcements. Is that still the outlook for the end of the year?

Hi, Sam. As you know, in the MD day, we use the trailing 12-month EBITDA, but if you annualize Q2, that ratio would be around 9.2 times. Perfect. Thank you.

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

Thanks. So when it comes to portfolio trades, there are trades happening in the multi-res, U.S. multi-res sector. I was wondering if you guys looked at those, you know, the KKR-Quartera deal or even Blackstone, and wondering how comparable would those portfolios be to the LandTower portfolio?

Good morning, Hajin. So let's take KKR as an example. They reported last quarter, just now, I think a week ago or something, that they purchased that portfolio, 5,000 units, call it a billion dollars, if I recall correctly, and they reported it at a low-force cap. That put a little... question to the market, why is that a four-cap and how is it compared to Land Tower? The answer to the question is, it's very similar in geography, very similar in age, but it's, let's call it 18 stories instead of artistic built three stores. But that's not a huge difference. The explanation needs to be explained why they are a low four-cap and why we're a five-cap. The answer really lies in the fact that KKR didn't buy that asset for their portfolio. They bought it on behalf of an insurance company whereby the money that has to be spent by the end of June, otherwise it would have lost that allocation. So they were kind of anxious to spend it. They actually bought it at a 5.2 cap. And if you ask the question, well, leverage is at 5, therefore it should be neutral to their overall return. They should have achieved a return on cash around 5, wise and low force. And the answer is to the asset management fees embedded in KKR's charging of that portfolio for asset management fees brings it down to low force. So that's not a reflection of – that's a reflection endorsement of H&R's – LandTower's cap rate overall at the 5s. and the non-competitive nature of asset managers because of their fee structure that brings it down so low. But again, KKR really didn't care. They were managing that money on behalf of an insurance company. The insurance company agreed to pay their fees. Therefore, that insurance company is getting a lower yield, not reflective of the market, which is at five. So those trades really endorse a low fives cap, and I think it's pretty solid, and Emily can tell you, trades that have gone on There's around six of them in our markets. It's all around 5.1, 5, maximum 5.2, and around where we're at. So all those trades confirm, validate, rather, our 5-cap.

Okay. No, that's helpful. And, I mean, at low 5, that sounds like good pricing. And so I know it's not in your strategic plan, but given these type of prices and what appears to be some level of interest, Does it make you kind of rethink about sort of LandTower, and could that be a candidate for sale down the road? How are you thinking about LandTower here?

So LandTower is a very, very solid asset, very, very solid platform, very solid management group. It really doesn't change anything. The market's all concerned about the fact that there's a whole bunch of units going to be ready, you know, the 100,000 square units that are being built in our markets and Sunville markets, and the cost pressure on rents. We look at it completely differently. We look at the fact that it's right now there's a pressure on the rents. Those units are going to get absorbed in our markets sometime mid to the end of 2025, 2026. The rents are going to go way up again because of supply and demand. They've balanced. No one's building anything. And as I mentioned before, no one's building anymore because they have to build to a 6.757% yield return on cost, and that's not really doable in today's market very easily. Your land cost really has to be brought down. You have to buy your land well, and your land has to be ready to go. LandTower is a solid company. It's a keeper. So it doesn't make sense to go ahead and increase your exposure to office by spinning off LandTower. You may get a good price for LandTower, but again, the remaining what's behind is going to suffer. I think we're going to more prudently stick to our original strategy, which is... slowly but surely deal with our office which, in our opinion, have value when the residential market returns as an ulterior use for the intensification properties. And for our three or four core office buildings, they're sticky tenants and we expect to renew them and be able to sell the properties at a time. So we're going to stay the course and Land Tower is therefore going to be one of our keepers and ultimately we're going to achieve the results of being an industrial slash residential REIT.

Okay. Last one for me. Chevron made an announcement that they will move their headquarters to Houston. I just wondered, does that mean anything at all for Hestower, and does that mean anything at all for the potential sale of Hestower?

So it just adds more confusion to what's going on over there. The courts haven't put down the ruling what's with the Hestower at all. We expect this coming in November, but my guess is that'll drag if these things usually do. If Chevron buys Hess and is successful, then Chevron has to make the decision where they want to be located. They have space within their existing tower. They have made the announcement they're moving headquarters to Houston, which means they probably need overflow space into Hess and keep the Hess. Until this is all resolved, we have no idea what's going on. goes against them, HES is not a saleable asset anymore. HES can't be sold to Exxon and HES can't be sold to Chevron. HES will remain a going concern and will remain in the building the way it is. In either event, it really doesn't have any impact at all on us and our strategy for the tower. We are currently dealing with one-third of the building that rolls in 2026 and I think successfully. We're very confident that we'll achieve our objective to have that leased and then we have another 12 years to build HES. We are very confident with that building. We're very confident with our TransCanada joint venture, TransCanada Tower, TC Tower, and Calgary with Hoop and with two bosses. Those are all sticky tenants. We expect the tenants to renew. We expect them to be there long-term. We just don't know what the rental rates will be. So, again, the HESS situation with Chevron is... I guess good news that Chevron's consolidating in Houston. It can't be bad news. We just don't know the final outcome. Until you know the final outcome, you can't really sell the asset because every buyer is going to be asking the same question as you did. Where is Hedge going to be located? It has a strong impact on the long-term value of the asset, and so therefore, right now, we're just releasing the space. It'll come up in 2026, and I think successfully so, and then we'll see what happens in the next few months with the with the Chevron Hess situation.

Okay. Thank you.

Thank you.

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

Thank you, everybody, and enjoy the summer.

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