Good morning, and welcome to the H and R Real Estate Investment Trust 2019 First Quarter Earnings Conference Call. Before beginning the call, H and R would like to remind listeners that certain statements, which may include predictions, conclusions, forecasts or projections in the remarks that follow may contain forward looking information, which reflects the current expectations of the 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 these forward looking statements information. In discussing H and R's financial and operating performance and in responding to your questions, MiWay reference certain financial measures, which do not have any meaning recognized or standardized under the IFRS or Canadian Generally Accepted Accounting Principles and are therefore unlikely to be comparable or 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 and R's performance, liquidity, cash flows and profitability.
H and 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 these forward looking information and the material factors or assumptions that may have been applied in making such statements, together with details on H and R's use of non GAAP financial measures, are described in more detail in HR's public filings, which can be found on our website at www.sedar.com. I would now like to introduce Mr. Hofstetter, Chief Executive Officer of H and R REIT. Please go ahead, Mr.
Hofstetter.
Thank you for joining us here today. Good morning, everybody. I'm Tom Hofstetter, CEO of The REIT, and I'd like to welcome everyone. Larry will give you a high level summary of the quarter results customary followed by Pat, who will give you an update on Primaris and then it's over to Felic who will give you an update on the Lantower portfolio. Here are the highlights for the Q1.
Firstly, we completed significant lease extensions in our core office portfolio, including a 10 year extensions with our 2nd largest tenant Bell Canada. We are quite pleased that these extensions incorporated rents that are now at market, annual contractual rental increases and 3, a significant commitment to these properties extending the average remaining lease term to over 16 years. We also extended our leases with AltaLink in Calgary to 20 years and reduced the contractual rent steps every 3 years. Following these extensions, the average remaining lease term for our Calgary office portfolio is now 17.7 years. This portfolio is now 100% leased to 3 investment grade tenants with the next lease maturity not until 2,031.
A little color on why we did the lease extensions. As we know customary in the Canadian marketplace, the contractual rental increases appear every 5 years and are really reflection of what's going on in inflation in the world at that point in time. Going back to the Bell deals were written around 17 years ago. At that point in time, inflation was significantly higher. Our bumps equated to around 20% to 25% resulting in the rail lands being above market.
To remove risk, we intend to not necessarily not renewing the space, but not renewing all of the space and bringing the rents down to market and more importantly being able to finance these assets. We actually always do lease extensions early on in time to bring down the rents, give the tenant some relief in that regard and get surety of tenancy term by through the lease extensions. This obviously increases the NAV, decreases the rent the NOI and decreases the cap rate. The net effect on NAV is usually not material. It gives us the security of tenancy and it also gives us the ability to go ahead and learn to do long term financing and allows us to sell assets at any point in time the near future as there is at least a sufficient lease term.
So this is customary in our portfolio. In almost all markets, we find that the contractual rental increases over time increases the actual net effect of rental rates achieved and therefore we always go for long term leases and we've been doing that for over 20 years and that's been our style and that's proven in the results. Right now Toronto is going through a boom with beforehand Calgary went through a boom. Obviously, there are cycles. At this point in time, the rental rates in Canada exceed the market rates for that we are rolling the assets on other than suburbans, with suburbans it's reverse.
But if you look at any portfolio over a long period of time, you'll that there always will be by definition above market rents and below market rents. Our 2 Gautam office building leased in New York City Department of Health is above is right now below market, our heads is above market, our Sony building in Culver City, California is below market. You have to look at the weighted average of the lease terms and the weighted average of the rental rates to arrive at the which is what we actually report on our numbers to actually arrive at what the proper average rental rate should be. But by definition, it's impossible that all rental rates will be below or above market at any point in time as in the long term lease. Moving on to developments, this quarter we transferred our flagship Jackson Park development in Long Island City to operations with the project now at 75% leased.
This development is on track to deliver 6.2% yield on cost, significant NAV accretion and what we expect will be attractive growth over time. Our next large share development is River Landing in Miami, which was recently topped off with occupancy to commence this time next year. The retail component of River Landing is over 60% pre leased with strong demand for the remaining 132,000 square feet. And with the ICSC's Las Vegas Convention coming this weekend, it should be a very busy weekend. We have advanced discussions underway on the remaining 136,000 square feet of office and are confident in the lease up prior to construction completion.
And finally, within our development portfolio, we are proceeding with the development of 526,000 square feet of new industrial space in the Caledon submarket of the GTA with construction starting next month. Ultimately to be followed by an additional 2,200,000 square feet on the remaining portion of these lands, We expect to achieve net rental rates for the 1st 5 years of the term of approximately $8 a square foot and the project should be providing us with very attractive yields based upon our historical land costs. Last Thursday, we announced the sale of the Atrium, taking advantage of tremendous demand for office property at a sale price of over $600 per square foot. This is approximately 80% above the price we acquired for it 8 years ago. The sale reflects a number of factors.
1 strong demand for Toronto office assets, significant near term capital requirements at the atrium, medium term tenant turnover and repositioning costs, we're more attractive returns on our other development and development projects and our commitments to our industry leading balance sheet. Last quarter, we outlined our plans for 2019 in a letter to unitholders, including exploring opportunities within our portfolio to service value through redevelopment and intensifications. We've made progress on advancing our understanding of several of these opportunities, including a number within the 1,700,000 square foot downtown Toronto office portfolio we continue to own, as well as Zephyrin Mall among others. We look forward to sharing more details on these opportunities as we advance these projects. In conclusion, I'd like to reiterate our commitment to streamlining and simplifying our portfolio, raising the internal growth profile of our portfolio and enhancing the profile of H and R to its unitholders.
We are highly focused on maximizing FFO and NAV per unit for H and R unit holders and are working towards continuing on the progress H and R has achieved in this regard in 2019 and beyond. I'll now hand it over to Pat. Not me. Now, let's turn it over to Pat.
Thanks so much, Tom. Good morning, everyone. I will give a really brief overview of our Q1 results. FFO on a fully diluted basis was $0.46 per unit compared to $0.44 in Q1 of 2018. $5,200,000 of lease termination fees and adjustments to straight lining of rent were included in 2019 results compared to $800,000 included in Q1 2018.
Excluding these items, normalized FFO would have been $0.44 per unit in both periods. During the 15 months ended March 31, 2019, we sold $1,100,000,000 worth of property compared to $460,000,000 of acquisitions. Considering these net asset dispositions, having no slippage in FFO per unit is quite an achievement. Part of our proceeds from asset dispositions have been used to fund our development pipeline, which will be a source of significant growth in property operating income and FFO in the next few years. On a same asset cash basis, Q1 2019 property operating income from Canada was up 4.3% over Q1 2018.
And on a same asset cash basis, Q1 profit and operating income 2019 in the U. S. And local currency was up 2.8% over Q1 2018. These increases in same asset property operating income are a testament to our capital recycling program to sell assets with low growth potential and replace them with assets that have higher growth potential. Same property operating income, cash basis in our office segment increased by 7.2%.
Excluding the lease termination, this increase would have been 1%. The lease termination fee received of $6,000,000 was from an office tenant. We will continue to occupy and pay rent until February 2021. Same asset property operating income on a cash basis from our Industrial division increased by 3.3%, primarily due to higher rents in the Canadian portfolio. I'll now turn the call over to Pat to give an update on our Retail division.
Thank you and good morning. Same property NOI for the Retail segment increased 3.5% during the Q1 and 4.5% excluding lease termination fees. Grocery anchored properties within the portfolio, which accounts for approximately 29% of the retail portfolio as measured by same asset property income generated 15.3% growth in the Q1 and closed malls which account for 54% of the retail portfolio post a modest decline in NOI during the Q1, but a gain of 1.5% excluding lease termination fees. Subsequent to the end of the Q1, we completed a transaction to sell a small retail plaza in Calgary anchored by stables. We will continue to prune the retail portfolio through disposition of retail assets that provide limited growth rental growth potential.
Our overall occupancy rate in the retail portfolio for the Q1 was 88.8%, which is lower than 91.2% recorded in the Q1 of 2018. Occupancy was negatively impacted by the enclosed mall portfolio due to target redevelopment at Sunridge where the premises had been occupied by a temporary tenant for the past few years, as well as the redevelopment of the former Safeway at Sherwood Park Mall. Including tenants committed but not yet open occupancy rises to 92%. Redevelopment of former Target locations is essentially completed. 7 tenants operating from an area exceeding 100,000 square feet are due to open at Sunridge this fall and this will drive incremental revenue growth throughout 2020.
With respect to Sears, at the end of the Q1, we had committed conditional transactions in place representing approximately CAD3.6 million in annual base rent at H and R share or just over 50% of our anticipated total rent upon completion. Sears have paid annual base rent of CAD2.3 million a day share. We are being selective with replacement tenants focusing on those tenants that are prepared to pay market rents and enhance our merchandise mix. Several of our redevelopment plans include partial demolition of Sears and the addition of outparcel developments. We expect rental income from these redevelopment projects to start in Q4 2019 and with substantial completion of all projects in late 2021.
At Dufferin Mall, we have held several public consultation meetings regarding our preliminary plans to add approximately 1,000 residential units to the property. We expect to make our formal application to the city this summer. Sales productivity in the portfolio was down 1.6 percent on a same store basis and 1.7% on an all store basis. Approximately 70% of the decline in all store sales is tied to significant sales declines posted by 1 travel agent at Duffer Mall and 2 travel agencies at Flat Door Lien as well as the closure of a local electronic store at Dufferin Mall and 4 tenants expanding from CRU small sized CRU and being reclassified as large non majors. By way of example, Shoppers Drug Mart who have been contributing significant sales and a higher productivity level than the mall sales at Parkway Shopping Center expanded to a size greater than 15,000 square feet as such they are no longer reflected in same and all store productivity figures.
On a same store basis, softness in the electronics and jewelry category combined with the loss in contribution from the electronics store at Dufferin and declining sales from travel agency previously noted were the primary drivers behind the decline. Nevertheless, portfolio same store sales remained strong at 5 $61 per square foot and we continue to realize strong tenant demand for space within our properties. Thank you and I'll now turn it over to Filip.
Good morning everyone. I'm pleased to be on this call today to share the latest news from Lantau Residential. As mentioned last quarter, we closed on Lantau Waverly in Charlotte, North Carolina marking our 1st acquisition in the Charlotte market. Built in 2016, Lantau Waverly is a 375 Unit Class A Development and one of the most affluent submarkets in Charlotte characterized by high income households in A rated public schools. Lantau Waverly is located within the Waverly mixed use development with walkability to a Whole Foods market.
On the portfolio front, Lantau Residential's portfolio consists of 7,271 apartments across 22 properties, when excluding Jackson Park. To include Jackson Park, our portfolio consists of 8,207 units across 23 properties. As we continue to actively monitor our portfolio, we are paying specific attention to our assets of older vintage that may have matured in our respective investment lifecycle to strategically determine which property should be sold while reinvesting the proceeds into newer and better assets. This portfolio reallocation should enable, 1, the outperformance of our projected financial returns and second, the replacement of older assets with increasing CapEx requirements into more recently constructed properties, thus successfully further improving one of the newest portfolios within our sector. As mentioned in previous quarters, our reported Q1 occupancy is artificially lower due to the inclusion of the lease subs of Ambrosio and Edgewater in Austin and Bullhouse in Western Corners in Raleigh Durham.
Excluding the impact of these lease subs, our portfolio's occupancy was over 92% at the end of the first quarter. In 2019, in the first half of twenty twenty, many of Land Tower's target markets will experience peak apartment deliveries. In anticipation of these deliveries, Land Tower constructed a program at the end of 2018 to reduce further tenant turnover and maintain high occupancy throughout the peak delivery seasons by incentivizing our leasing staff and prospective residents to enter into 18 month and 2 year leases. We are delighted with the results thus far as we have secured over 650 long term leases year to date across the Land Tower portfolio. Despite a nominal upfront cost via tenant concessions and leasing incentives, we believe the program will yield higher and more stable property NOI over the next 18 to 24 months through a reduction of future concessions and locator expense in addition to lower turnover repairs and maintenance and vacancy costs.
We have always managed to NOI and we believe that this initiative will lead to NOI outperformance in 2020 in comparison to our peer set. As such, this strategic program will be tested in the 1st 2 quarters of 2019 and we will closely monitor its efficacy. Following the management takeover of our Raleigh Durham portfolio, Lantaro's property management division, Lantaro Luxury Living now manages over 95% of our portfolio and will manage the entire portfolio by the end of the Q2. The expansion of the luxury platform has enabled us to recruit the very best on-site personnel, increased recruiting reach and consequently, we believe that this will manifest itself through higher operational efficiencies and higher NOI growth. An update on Long Island City, construction at Jackson Park has been progressing as scheduled and the project is substantially complete with all units turned over to the leasing staff.
Leasing velocity was very strong in the Q1 bringing total occupancy across the three towers to over 75%. All amenity spaces including the 1.6 acre park are now open to residents. Stabilized occupancy is still expected in the Q3 of 2019. With that, I will pass along the conversation back to Tom.
Thanks, Philippe. We'll open up the lines for questions.
Your first question comes from the line of Sam Damiani with TD Securities. Your line is open.
Thanks and good morning.
Just on the Caledon development, Tom, do you have any pre leasing traction on those first three buildings so far? And I was wondering also about the cost you've disclosed. Does that include a land allocation or not?
So the first the answer is it does 2 land allocation and we are in discussions right now with one tenant for the largest building. But we are very confident on the pre lease. So obviously, the stats for industrial building charms are great right now and we think we'll be able to achieve an 8th element delay.
Sorry, did you say it did include a land cost allocation? Yes. Okay.
Yes.
Thank you. And just over to leverage, the sale of Atrium clearly is a significant transaction for the REIT in many respects. I think last quarter you may have mentioned a sort of longer term mid-40s leverage target. Is that still your what you're thinking today over the next couple of years?
The answer, I think is yes. We haven't changed our opinion on leverage for many years right now. So, a sale like this is obviously going to bring it down again, whether we were depending on our stock price, we raised equity or not. Mid-40s is we are very comfortable at.
Okay. And finally, just over to Philippe on the new strategy of executing these longer term leases. I think you said 650 leases executed to date. That seems like a pretty strong take up in about the 6 months that you've been doing this. What sort of rent concession have you been giving up to achieve those longer term leases and are you pleased with the results so far?
Yes. No, we're more than pleased with the results. I look forward to obviously seeing the positive impact in 2020 as these leases were supposed to turn over and obviously they won't so we benefit from the longer term. I think that Camden lease 650 units is slightly less than 9% of our total leases and so we still have 91% of our rental that's not under this long term plan. And so that's still subject to any rental growth that we'll experience in our respective markets.
As it relates to your specific question as to what the costs were, candidly, they were quite negligible. If we're offering concession, we're probably adding a couple of $100 on top of it. We spent a little bit more money in training and incentivizing the staff. And so I don't have the stats in front of me, but if I were to guess, my guess is there was a great deal of money that was spent on training our leasing agents to essentially offer 18, 24 month leases and if there was any recall from the tenant to then cycle back to 12 months. And we were surprised to see how little opposition there was on behalf of the tenants to accept a 24 month lease almost at the same conditions and same advantage.
And for us, obviously, there's a tremendous advantage of obviously keeping a tenant for 24 months rather than losing that for 12 months. And so to the extent that we kept those costs low, there's some no luck on wood, but ultimately we're very, very happy with the results and very optimistic as to what it means to our NOI in the future.
And so does the same store NOI growth within Lantower likely improve over the course of 2019? It was fairly flat I think in Q1.
Yes. I think one of the reasons or one of the main reasons it was lower is because of the impairment due to the strategy, right? And so we took all of these costs quite upfront, whether it's an increase in our labor costs training our staff or giving them some sort of incentives or increasing on the upfront concessions that we're giving to tenants. I would strongly suspect that Q2 maybe Q2 we get into a little bit better in that we're still we decided to expand this program in Q1 and Q2 of 2019. So maybe your question is Q3, Q4, I would expect some healthy quarter over quarter growth, absolutely.
Sorry. Sorry, go ahead. No, go ahead. No, I was going to say and then obviously that holds true for the 1st and second quarter of next year as we see the benefit of what we're trying to do now.
Right. And are you implementing this across all your markets outside Long Island City?
I'm sorry, what was the question?
Are you implementing this strategy outside in all your markets outside Long Island City?
Yes. We implemented across the board, but I would tell you that there were some markets that we are at the end of the day, this is a defensive play versus supply temporary supply. And I would say that the bulk of this program is spent probably in Texas.
Thank you.
Your next question comes from the line of Mario Saric with Scotiabank. Your line is open.
Hi, thank you. Good morning. Just maybe sticking to Land Tower and the strategic initiatives to extend the leases. Of the 6 50 leases that were done to date, can you give us a sense in terms of what the success rate has been?
Mary, can you please speak up? We're having a hard time hearing you.
Okay. Just I want to focus on Land Tower and specifically the strategic initiatives. Of the 6 50 leases that have been done to date in terms of the longer lease term, like what kind of success rate is that? Like is it 50% of the tenants that are signing on 75%?
That's a good question. I think I know the number but candidly I'd rather double check and then send you it offline. But if I were to guess, I'd probably say maybe a quarter, roughly around 30%.
Okay. And then can you give us a sense of what the turnover rate in the portfolio is today versus what you would expect it to be with this initiative once stabilized?
Yes. I think a good rule of thumb for turnover in multifamily is somewhere between, let's say, 40% 50%. I think not to seem anecdotal, but if you're talking about Dallas or Austin or a market that's submerged with a ton of supply, obviously, that number is going to uptick. And so candidly, if we can stay well below 50% in those respective markets, then obviously, the strategy will have been quite successful.
Okay. And then just maybe shifting gears to capital recycling. As mentioned earlier, you're getting a lot of net proceeds from the Atrium, about 3 $85,000,000 You referenced kind of a lower leverage pro form a sale and then an attractive $1,600,000,000 development pipeline. Like how would you rank the priorities of the redeployment of that $385,000,000 over the next 12 months?
Well, initially morning, Mario. Initially, it will be used for the way to pay back up bank lines. And then as we proceed with the developments, we'll be funding our developments.
Yes, but don't forget we have half of it in B2B, right? It's coming due in January 2. So, we'll use the 1st tranche payout debentures and debt and then January 2nd we'll have more debt rolling and our development pipeline.
Okay. And then can you give us a rough sense of how much capital was put into the Atrium post your 2011 acquisition?
Sorry, I don't have that number on hand.
It's not significant though. But don't tell that to the tenants.
Okay. That's it for me. Thank you.
Your next question comes from the line of Mike Markidis with Desjardins. Your line is open.
Hi. Good morning, everybody. Philippe, just on the land tower, I just want to make sure I kind of understand. So the upfront costs were training, so that's understandable. But I'm just trying to get a sense of you're also offering concessions to the tenants and I would assume that hits your revenue line and you've got 9% of your rent roll sort of under the long term lease structure today.
So given that you're going to be trying to convert more and more and you got higher incentives coming in, in the middle of this year, how does the healthy growth return?
Okay. So I guess there's several questions, Stacy. Initially, at the end of the day, what we think is we ultimately manage NOI, right? And so we book some of these expenses similar to expenses, some of them are booked to revenue. No two groups look at the same.
Some groups will book concessions to expenses and will show higher revenue growth but a lower NOI number. And so what we find simpler is just a stick to NOI and that's our management philosophies. We want to see NOI growth. As it relates to where we stand, we're taking a small hit on NOI as evidenced by our muted growth for this quarter on a quarter over quarter basis. But candidly going forward, the costs, like I said, the turnover costs, the R and M of just having the turnover costs, the vacancy cost, having to pay another locator in the system locator market, having to pay a tenant concession in addition to a leasing staff leasing bonus.
If all that goes away in the Q1 2020 and the Q2 2020, you're going to see very significant NOI growth on a quarter over quarter basis. And I suspect that if we fast forward 12 months and we look back today, my guess is many people will have elected to take muted Q1 2019 growth for outperformance in the Q1 of 2020.
Got you. Okay. So the 2020, I guess, I was just really more thinking about just what the rest of 2019 looks like as you continue to implement the program.
Yes, I think that candidly there may be a little bit confusion that people tend to focus too much on revenue growth from quarter over quarter. But candidly, what's revenue growth if you're giving us everything away in an expense and things your NOI?
Okay. So if you were to think about your same property pool for 2019 2020, I mean ballpark ish, what kind of growth rate should we be thinking about on a same property basis?
To be honest, that's a good question. I have to go back to my estimates. We would probably have thought that this program probably dinged or impaired our NOI by 200 basis points roughly. And so had we not gone through the strategy and not been strategic as to how we see future supply hitting our markets, we've probably been in excess of 2%. And that's just ballpark my guess is probably higher than that, but definitely not lower.
And so as such, that's what I would expect probably in the 3rd Q4 as we peel off of this long term program.
Got you. Okay.
Just going back, Larry, on the $6,000,000 lease termination payment that you had there, and I guess it carries the lease now terminates in 2021. Are you able to tell us what building that relates to?
Thanks, Donna. 649 North Service Road, Burlington.
Single tenant office building occupied by West Ham, they're building a new building in Hamilton for their use.
Okay. Thank you. And then, Larry sorry, not Larry, Tom. Certainly appreciate your commentary on the leases being above market, some leases being below market across the portfolio at any given time. You don't publish it, some of your peers do, but would you have a sense of where you're in place versus market rents for your office portfolio would be today?
I cannot tell you off the I don't it would be impossible for me to give you that number off the top line.
Okay. That's it for me. I'll turn it back. Thank you.
Your next question comes from the line of Matt Kornack with National Bank Financial. Your line is open.
Good morning, guys. Philippe, with regards to the other assets that make up, I think it said $36,500,000 of residential income. Obviously, a portion of that is Jackson Park, but I think there's around $9,500,000 in other assets. Are you rolling out your strategy in the lease up assets as well? And how should we think about that income coming online?
No, I think that candidly we'd love to roll it out to a new lease up. However, on the lease ups, we're not offering any concessions. And so or sorry, I should say not any more concessions than we'd already be offering on the lease up. So if a tenant comes in and says I'd rather have an 18 month lease or 24 month lease and it's in a market where we believe supply is coming, then absolutely we would do it. But we would not be offering anything above and beyond that, apart in very, very small exceptions.
We to be candid, we're really excited about this. We thought that candidly, we didn't know what the appetite for this would be. We thought that if we landed with 2% or 3% of our rent roll, it would be too insignificant to have a material impact in 2020. We're really optimistic and very happy once we saw that there was a 9% bite. And also I think there's probably an element to this that is lost on some is the impact on the on-site team of having higher occupancy and lower turnover allows them to spend more time either from a leasing perspective, nurturing their tenants, improving the social media platform and the social media reputation, its positioning in the market.
And from the maintenance staff who is now running around trying to deal with so many make readies and vacant units, they can spend time doing the things that just keep getting pushed down to the to do list and taking care of the assets, whereas they may not have the time to get to it in a normalized rental situation. So I truly believe for a variety of reasons that candidly we would we absolutely are delighted by the fact that we're taking a hit in this quarter, next quarter for all the benefit that we're going to see in 2020.
And then with regards to lease up at assets undergoing lease up, are those tracking in line with expectation given new supply in some submarkets?
Yes, we're either tracking or exceeding. Our property in North Carolina, Western Corners is doing spectacular. Our lease ups in Austin are doing phenomenal. We've been doing great. We're very, very happy and candidly, a lot of the credit goes to our team in Dallas.
We have an incredible portfolio management team. We've got an incredible on-site management team. They get us and that's why we're outperforming our peers in our lease ups.
Okay. And then Larry, can you let us know how to think about FFO contribution from River Landing and from the industrial development in Caledon in 2020. I know with Jackson Park, it was there's a period of downtime before you get the upside. So should we think of it as a net neutral to 2020 at this point or no additional FFO?
So the construction only completes in 2020, then there's still the residential lease up that has to occur after that. So it'll be a time of lease up for residential.
2020, there'll be minimal growth.
2021.
No, that's fair. I don't think we have anything in our numbers at this point.
As we get closer to that time, we'll be putting out guidance.
Okay, perfect. Thanks, guys.
There are no further questions in queue at this time. I turn the conference back over to our presenters.
Thank you, everybody, and we'll speak again next quarter. Have a nice summer. Bye.
This concludes today's conference call. You may now disconnect.