H&R Real Estate Investment Trust

Good morning and welcome to H&R Real Estate Investment Trust's 2024 Third 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 overlooking 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 Hofstadter, Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstadter.

Thank you, operator, and good morning, everyone. Thanks for joining us today with Mayor Larry Frum and Emily Watson. I'll hand it over to Larry to give his recap of the report.

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 three-month end of September 30th, 2024 compared to the three months end of September 30th, 2023. Headline FFO per unit for Q3 2024 was 29.4 cents compared to 42 cents in Q3 2023. As a reminder, FFO in Q3 2023 included a $30.6 million gain on disposal of a purchase option held via a mortgage receivable. Excluding this gain, FFO would have been $87.1 million or $0.31 per share in Q3 2023. Overall, given the headwinds we faced at the end of last year with multifamily supply concerns, a weak office market, inflation, rising interest rates, we are pleased with our results. We continue to execute on a strategic repositioning plan. we sold $432.9 million of income-producing properties, and this year, to September 30th, 2024, we have sold $344.8 million of income-producing properties. We expect to end the year with approximately $440 million of real estate sales this year. I would now like to spend a few minutes providing commentary on each of our segments, starting with office. We are hearing of more back to the office policies from different companies, and it seems clear that more and more employees are heading back to the office, which is positive for the sector as a whole. Our office portfolio of 16 properties, which includes four properties with residential rezoning opportunities, now only comprises 19% of H&R's total portfolio. 87.6% of our office revenue comes from investment-grade tenants. a testament to the quality and location of our office properties. Our office occupancy at September 30th was 96.8%, with an average remaining lease term of 6.1 years. Lease expiries between September 30th, 2024 and December 31st, 2025 only approximate 400,000 square feet, so the portfolio will continue to provide solid cash flow. Our downtown Toronto office properties with residential rezoning opportunities are valued at $140 per square foot, which is less than half the value they were at the peak of the market, and the rest of the portfolio has a weighted average cap rate of 8.86%. Our office properties are valued at approximately $1.9 billion, and there are only two mortgages totaling $140 million. the net of which equates to $6.24 per unit. Excluding our office portfolio in its entirety, our NAV per unit would be $13.42, which is significantly higher than our current share price. Our sales of office properties to date of $2.3 billion since the announcement of the strategic plan demonstrate that there is value to our office portfolio. On the residential segment, While there has been a lot of new supply added in our residential markets, the positive immigration trends have continued and our tenants are also staying longer. Since the announcement of H&R's strategic plan, H&R's average U.S. residential rents increased from $21.16 per square foot as of June 30th, 2021 to $26.97 per square foot at September 30th, 2024 in U.S. dollars. Our residential portfolio of September 30th, 2024 comprised 47% of H&R's overall portfolio and is continuing to grow. Land Tower West Love in Dallas reached substantial completion and was transferred from a property under development to an investment property. West Love has become the 25th residential income producing property in our portfolio. Land Tower Midtown also in Dallas is not far behind and will become our 26th investment property very soon. In addition, we have another two residential developments currently under construction and expected to be completed in 2026. H&R's ownership interest in these two new developments is 29.1%. Our retail portfolio of September 30th, 2024 comprises 15% of H&R's overall real estate assets. The tenants in our retail portfolio are mostly grocers and the portfolio has been very stable with growth in rent and net operating income occurring from the lease up at River Landing in Miami. Our largest retail tenant is John Eagle, who has close to 200 locations in our portfolio. John Eagle recently announced that they are selling their get-go convenience stores and leases to CouchTard. This will further diversify our tenant mix, with CouchTard comprising about 1.7% of our revenue. Giant Eagle will then comprise about 3.9% of our revenue. Our industrial portfolio of 66 properties of September 30th, 2024 comprises 19% of H&R's total real estate assets and continues to perform well. Since the announcement of H&R's strategic plan, H&R's average Canadian industrial rents increased from $7.17 per square foot as at June 30th, 2021 to $9.42 per square foot as at September 30th, 2024. In addition, industrial properties located in the GTA made up 35% of H&R's industrial portfolio as at June 30th, 2021, compared to 50% of H&R's industrial portfolio as at September 30th, 2024. We continue to grow our industrial portfolio and added two newly constructed properties at the beginning of this year. We currently have one industrial property and a 50% interest in two industrial properties under construction scheduled to be completed in 2025. Our balance sheet remains strong. Debt to total assets of the REITs proportionate share at September 30th, 2024 was 44.9% and debt to EBITDA was a healthy 9.1 times. Liquidity at September 30th, 2024 was in excess of $900 million. with an unencumbered property pool of approximately $4.1 billion. Our unencumbered assets to unsecured debt coverage ratio was 2.2 times at September 30th, 2024. In summary, we are well positioned to continue executing the strategic plan to sell office and retail properties as and when the market allows, and management remains committed to doing so. On the ESG front, we are pleased to report that our project at 6,900 marits in the GTA was shortlisted for the World Demolition Award in the recycling and environmental category. The previous 104,000 square foot steel structure office property had a total weight of 8,758 tons. The waste diversion program recycled 8,113 tons of steel and concrete or 93% of the total material weight. In addition, our Land Tower West love development in Dallas reached substantial completion and received the National Green Buildings Silver Certification. And with that, I would like to turn the call over to Emily. Emily?

Thanks, Larry, and good morning, everyone. I'm happy to be on this call to discuss our third quarter same-store results from our multifamily platform and discuss some operational achievements and market insights. Our year-to-date results continue to align with our expectations, as the new supply deliveries officially peaked at a 50-year high in the third quarter. Additionally, ending Q3, the trailing 12-month absorption was 85% above the long-term average, further demonstrating the strengthening drivers for our industry. We remain focused on the fundamentals of our business and creating NOI expansion through our repositioning opportunities, development pipeline, and other innovative value-add strategies that add to our bottom line. Given the declining levels of new supply ahead and growing demand in our market, combined with the strength of our operating platform, we are well positioned for substantial growth and value creation in the coming years. Same asset revenue growth in U.S. dollars increased 50 basis points for the third quarter and same asset net operating income for our portfolio in U.S. dollars decreased by 1.4% for the three months ending on September 30, 2024, when compared to the respective 2023 period, primarily due to higher property operating costs, including taxes and insurance. and a decrease in average rental rents from the Sunbelt properties, which is partially offset by rental growth at Jackson Park in Long Island City, New York, and River Landing Residential in Miami, Florida. Same asset occupancy ended the quarter at 94.1, a 50 basis points decrease over the second quarter, and an 80 basis points decrease from Q3 of 2023. Same asset occupancy in the Sunbelt for Q3 was 93.4 with 51% retention, and Jackson Park was 99.2 occupied and 64% retention. The Sunbelt continues to show strong demand metrics moving into fourth quarter with resident retention at 58% for October and 60% for November. Sunbelt blended tradeouts in Q3 were negative 2.5% in the third quarter. ranging from approximately negative 8% in Austin to slightly positive in North Carolina and Orlando, which coincides with levels of supply expansion. Based on a recent third-party appraisal and a handful of Sunbelt sales comps, we have maintained our fair market value Sunbelt cap rates at 4.98% and believe the rate is appropriate and supported. Cap rates are expected to remain low, relatively speaking. for the institutional quality assets in the Sun Belt with capital flows interested and focused on long-term heavy Sun Belt multifamily allocation. On the development front, Landtower West Lab in Dallas, Texas received final TCO at the end of September and is currently 40% occupied and 43% leased. We are excited to celebrate Landtower West Lab, the achievement of the National Green Building Standard Silver Certification. We will share final development budget economics for Westlove on the fourth quarter call after we close out the project. Also in Dallas, Texas, Landtower Midtown has received its final TCO on October 31st and is currently 15% occupied and 25% leased. Both properties are leasing well with an average monthly velocity of 25 leases per month, which is above industry reports for our markets. another testament to the superior product and unparalleled amenities of our development team has delivered. We will also share final development budget economics for the Midtown project on next quarter's call. Reddit One properties are progressing well and remain on budget with completion expected in mid-2026. Landtower currently has an additional nine development projects in the Sunbelt pipeline, totaling over 2,900 suites at H&R's ownership interest with multiple sites ready and prepared for construction. We are progressing through the different phases of design, drawing, and permitting on the remainder of our Sunbelt development pipeline and currently have an additional two projects shovel ready. In summary, The LandTower residential platform continues to achieve encouraging results and strong performance relative to our multifamily counterparts. I would like to recognize our Florida and Central Services team members for their preparation for back-to-back hurricanes Helene and Milton. By following the hurricane protocol and communication to our residents, we sustained only minor damage in a few areas. during milton over the course of three days our central central team members managed over 1100 incoming and outgoing emails calls and text messages with our residents with an impressive 98 response rate under four minutes around the clock the unity of our land tower team is one of the many reasons we were certified as a great places to work in the third quarter and best places to work in florida by the best companies group and with that i'll pass it back to tom

Thanks, Emily. Operator, you can open up 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 the one on your touchtone phone. You will hear a prompt that your hand has been raised. If you are using a speakerphone, please lift the handset before pressing any keys. Your first question comes from Sam Damiani at TD Cowan. Please go ahead.

Thanks, and good morning, everyone. Maybe, Tom, just for you, I'd like to get your sense on the outlook for dispositions today versus maybe versus last quarter, considering everything that's unfolded over the last three months. Just wondering what the outlook and pipeline looks for activity into 2025.

Hi, Sam. Good morning. It's basically cloudy today. Last quarter, there was more optimism on interest rate reduction, and therefore there was fueling the buy side. There's also fueling the debt side. The debt side is dormant, and without debt, you're not going to have acquisitions. So nothing's on the market. We have nothing on the market. There's very little on the market that anybody has. It's really off-market deals, and those are opportunistically driven. You can't forecast those. In general terms, I'll tell you that the brokers are dry right now, and it's part and parcel of the uncertainty over interest rates. I have no visibility into when that is going to change. I don't think it's the office market deteriorating further. I think that is what it is, and the residential market is also pretty static. The industrial market is a little bit down, but there's more interest in industrial than in any other sector right now just because the institutional funds have to put their money somewhere, and because of all the uncertainty, there's nowhere else for them to put it. So I don't really have a vision of what we'll be selling over the next 12 months. It's really, as I said, opportunistically driven. When we get better visibility after Trump comes in with interest rates and where the Canadian dollar lies, that will significantly alter and give us our ability to forecast our dispositions going forward.

Okay. And I guess the cap rate on the U.S. office portfolio was up close to 30 basis points, if I'm not mistaken. Was there a reason for that, something that required that?

Well, as the time marches on, you keep on eating into your rents. Logically speaking, unless there's a change of sentiment in the office market, the NAVs of office will go down. Okay.

And maybe just one last one for Emily. Just on looking at the organic NOI, sort of same property NOI trends at Landtower, what's your expectation for things to turn more than meaningfully positive?

Good morning, Sam. Great question. So I definitely think that we'll see some overhang in 2025, and every year we meet with CoStar and RealPage and some market economists, and really mid-2025, I think for most of our markets, I think Austin, where they have bigger expansion that might go to the end of 2025 before we go into 2026, which we anticipate to be a really robust year. So I think we still have 75,000 units that will deliver in 2021 on the heels of the 100 plus that delivered 2021.

Sorry, that was 75,000 units in the Sunbelt?

Yes, just in the Sunbelt in our market.

To come over the next year, okay.

Yep.

Thank you, and I'll turn it back.

Thank you. Ladies and gentlemen, as a reminder, should you have any questions, please press star 1. The next question comes from Mario Saric at Scotiabank. Please go ahead.

Hi, good morning. Maybe just sticking to LandTower, Emily, in terms of your kind of expectations for new and renewal spreads in 25. Are you sure you thought in terms of where that may trend?

Good morning, Mario. Yeah, I definitely think that we will continue in Q4 kind of where we saw it in Q3. In Q1, we usually get a little bit of an uptick. People kind of hunker down for Q4 and start to make any moves. And I think we'll continue on the same kind of seasonality that we see every year with Q2, our strength, and about the time that our peak is kind of behind us and we're picking up some speed in Q3 and Q4, probably even better. So I think we'll end the year next year probably flat on lease tradeouts in the Sun Belt. Again, Diversification is our friend next year because New York will continue to post the 3% lift, and Miami is set up for a really great year as well. So with the Sun Belt, I'd be flat overall with kind of a slow start Q1 and Q2, a little bit of a hockey stick in Q3 and Q4.

Got it. And given the relatively low rent-to-income ratios in your portfolio, what are your thoughts in terms of renewal spreads?

Renewal spreads, I expect to be in the three, four range next year, Mario. We don't see a lot of, even before when interest rates were low, we didn't see a lot of home move out to single family homes and so forth. So I think our renter base with over $100,000 in the salary range, I think they're not really looking to move to single family homes regardless of what happens there. So I think the three to four, maybe five in the second part of the year will be a healthy range for renewals in 2025. Got it.

Okay. And just from an accounting standpoint, the transition from Dallas West Florida to IPP this quarter, what was the overall FFO impact on the results this quarter?

I'm going to kick that to Larry.

Morning, Mario. It was pretty flat. It's still 40% occupied, but it's not producing – it's probably flat in NOI. It's not producing much NOI this quarter.

Okay. So it's flat in NOI, but perhaps slightly negative on FFO?

Yeah. I mean, we also had a bit of decrease in capitalized interest to the project that was no longer being capitalized, and that will continue to decrease going forward into next quarter. offsetting that will be NOI growing. First quarter, we didn't have any positive NOI growth from West Love.

Okay, maybe switching gears to the disposition environment, kind of Sam talking about the broader overall environment, but can you talk specifically about Hustow and Houston and kind of the progress that you're making there? on the lease up of the space expected to be given back and the implications of that progress to the solidity of the asset.

So we have exactly one third of the building coming up in mid-2026. Out of that, this week we shall have signed approximately 110,000 square feet of that on a new 10-year deal expected in 2026. And we're currently negotiating on another approximately 46,000 square feet of space in that building. I expect by 2026 that the space should be all done.

Okay. And then in terms of, you know, ECHO and Hess Tower, for example, these are very kind of unique assets or situations. Would it be fair to say that your broader commentary on the broader market in terms of it being cloudy and slow, would it pertain to those assets as well? Or is there something specific with those assets that you think can buck the trend?

That's a very good question because it specifically does not refer to those properties. There's a lot of interest today in ECHO simply because it's grosser and it's defensive. It's very, very conservative. My guess is by the end of next year, if not sooner, we'll have something done on ECHO and Hestower again is opportunistic. I think there will be something done in Hess Tower as it is an A building and an A location. And it's just waiting right now for – there's no large transactions in the office market, period, but really nothing to speak of in Houston. So I'm more optimistic on Hess and Echo just for the reasons I just mentioned, and they don't fall into the general category of slow market.

Got it. And would Hess Tower essentially be leasing? Do you think it would have to be completed in order for the property to sell?

No, I don't think so at all. Again, it's waiting for – there's no financeability of office in North America today. And I think there's a long nature duration of that lease under the HESS. I think you could get financing. I think part of the cloud around HESS is who is HESS? Is it Chevron? Is it Exxon? Or is it HESS? And if it is any one of the three, what's their plans for HESS Tower, which we don't know yet? Because of that, we can't speak to that creates a cloud around trying to sell the asset or you having interest in the asset because they just don't know what the future occupancy is going to look like. From a cash flow perspective, it's solid. But, again, that puts a little bit of a cloud. By one year's time, we'll have the answer to those questions, and I'm sure they'll be interested at that point in time, if it's not sooner.

Got it. Okay. My last question is just on the – The VTB mortgage receivable, there was a bit of a write-down this quarter. I may have missed it, but can you remind us what the remaining VTB mortgage receivable balance is, the average terms and maturity and kind of conviction level in the collection?

Hi, Marius. So you're asking about the remaining mortgage receivable balance we have on the property we just sold, Perlis Burnaby. That's our biggest mortgage receivable remaining. I think it's about $55 million. We have 160 Elgin was on the balance sheet at September 30th for $20 million, which we got repaid on October 1. We had First Tower in Calgary, about another $20 million. And we had two or three other mortgage receivables on land in the US for the remaining balance of our mortgage receivable. The average term for those, I'll have to get that to you on the average term. I don't have that in front of me. Okay. It's around four to five years.

Yeah. Okay. And presumably you feel pretty comfortable with the disclosed balance today. Yes. In terms of collection.

Yeah. Okay. Thanks, guys.

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

Good morning. Just quickly on the office de-leasing program, can you give a sense as to how much NOI is maybe generated by the development-oriented assets and how you see that NOI coming off? I know 53 and 55 Young sounds like you're going to demolish the building and leave it as land for a period of time, but just want to get a sense as to the earnings impact of that before you ultimately monetize it.

So 53-55 is scheduled for demolition, I think in around four weeks or so. We've done a deal with the tenant to eye out. It's around 145,000 square feet, including 53,000, call it 150,000 square feet, and it was leased around $12 a square foot. That was past tense. Again, we did a buyout, so it's slated for demolition. Demolition will take around one year.

Hi, Matt. And just to add on to what Tom's saying for your first part of the question, We don't really break out the office NOI between the redevelopment properties and not, but we do break out the fair value, and from there you can maybe get a guess from it, but the fair value of those redevelopment properties is around $450 million, around that, for the four properties we have in downtown Toronto. Overall, we haven't broken down the NOI, but for 55 Young, it went vacant in August, so for Q3, we would have had already two months of occupancy and one month of vacancy. So there is still some to come up for Q4, but we already had part of that vacant in Q3.

Okay, that's very helpful. And then Tom, maybe in terms of the process there, it sounds like you're still going back to get rid of office replacement on a number of these properties. What's the thought around kind of monetizing it through a sale or waiting until you get the approvals, et cetera?

So in all cases, we're going to wait for approvals. But approvals, I would say, are going to be done by no later than the end of next year for all of these properties. 53, 55 will be slated. It will be demolished and be done within a year from now. At that point in time, it will wait for the market to recover. It is a phenomenal residential site, but the residential market is horrible right now. It's going to have to wait for that. There's no timing. It's not of the essence. We have patience for that. 145 Wellington will stay the course. We just are renegotiating with one of the tenants to renew. The rental income will be fine over there. It's probably, I would say, five to ten years, probably closer to ten years away before we demolish that. We're just going through the rezoning process to put that asset to bed as far as its ultimate value. Again, it's across Roy Thompson Hall, Ritz Carlton. It's a fantastic location. It's a beautiful building to market. They're not there right now, but the office market for that asset is still solid. That won't be a problem. Front Street is the more interesting project. It's three towers. Two will be residential. One will probably be storage or office or something. I don't know. It's also a year away from rezoning. And probably we'll have to wait and see what the residential market looks like. But ultimately, that highest and best use will be residential.

Okay, perfect. And then just quickly, not as familiar with the New York City market, but can you give us a sense as to the land and condo market as it relates to maybe Jersey City and your recent Brooklyn purchase? Is it better there tone-wise than what we're seeing in Toronto at the moment or similar?

Well, pretty well safe to say that anything is better than Toronto. Okay. How's that for a starting point? Gowanus is very, very strong. There's a lot of institutional and large, big-money managers looking for sites that can build 1,000 units in prime locations. So Gowanus, our plan is to sell it probably in 2025. We're just waiting for some non-stoning issues and more environmental issues to finish off over there. That will be in high demand and will sell for a significant dollar amount. There won't be any issue with that at all. Jersey is a very strong residential market. Again, not like Toronto. Jersey, there is some development, but Jersey is going to have to wait a little bit for this race to come down. It's a large project. We haven't made a decision to pull the trigger on the first phase of Jersey, which will be finished as far as planning goes within around four or five months. At that point in time, we'll decide how we want to launch it. I don't think we'll be building it. The market's strong enough. It's waiting for interest rates to come down, and that's the only problem in the United States market, unlike Canada, which has a host of other affordable issues that the United States does not have. So Cove and Gowanus, I think, long-term are good assets. Gowanus will be sold in 2025 and generate a lot of cash. Cove will wait for interest rates to come down, and Toronto is wait and see.

Okay, perfect. Appreciate the color.

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

Yeah, just a couple of quick follow-ups on the asset sale. There's also a lot of optimism in the New York office leasing market. So what is your confidence and your ability to transact to Gotham? And then the Custar GetGo transaction, does that have anything, any implication on the sale of GetGo?

Good questions in both regards. The New York City office market is much stronger than Toronto. Again, I hate to say this because I'm a Canadian and born and bred here, but Toronto is really, really lagging North America, as is Canada lagging the United States in a big, big way. The New York office market is getting stronger. More importantly than that, there will be a host of probably 30% of the office product that will be reconverted under the YES program in New York to residential, and that will happen sooner rather than later. I don't make the buildings that are not viable as office which are quite frankly a host of buildings because of the age of the buildings convertible to residential. I expect the United States market to pick up dramatically. To Gotham, it's not going to affect its saleability. If it's a tenant that's using it in the building completely, it's a perfect location for them. I think we'll have to wait for visibility as to – our plan would be to wait and have patience as the market recovers. We expect the tenant to stay there. It's just a question of what the rental rate would be, so we're in no hurry to dispose of 2 Gotham. We'll just wait and see on that market. So Toronto way behind, New York way ahead, 2 Gotham not losing sleepover, and Toronto has to wait for the residential market to improve. Echo is an interesting story. The two-start is a game-changer. Not only do we get covenants on the get-goes, we also, Giant Eagle disposes of, an asset class within their portfolio that was not a lag on earnings, but was hurting their ability to sell Giant Eagle as a company because the supermarket chains don't want to take on the environmental responsibility, nor do they want to get into the gas business, oil and gas business. So it now cleans up Giant Eagle. It pays off all the debt of Giant Eagle. Giant Eagle becomes debt-free. Our Covenant then becomes a very high investment-grade tenant, although it has no debt. That's a shadow rating. And Custard now goes to, will trade like a wah-wah, In the market, probably five-ish cap as opposed to probably only six and a half, which it was under the GetGo banner. So it improves all of the metrics. It improves the ability for Giant Eagle to be sold, and therefore the attractiveness of Echo is a lot better. Our value of our asset is a lot better because the covenant of our tenants is better. And as I said previously, I do expect something to occur by the end of – no later than the end of next year. Okay, great. Thank you.

Thank you. That concludes today's question and answer session. I will turn the call back over for closing comments.

Thanks, everybody. Have a good one.

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