Good afternoon, welcome to H&R Real Estate Investment Trust 2018 fourth 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 in 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 dates. Forward-looking information requires management to make assumptions or rely on certain material factors and is subject to inherent risks and uncertainties. Actual results could differ materially from the statements in the forward-looking information. In discussing H&R's financial and operating performance, 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 the 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 our website and www.sedar.com. I would now like to introduce Mr. Tom Hofstedter, Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstedter.
Thanks for joining us today. I'm Tom Hofstedter. I'd like to welcome everyone, as is our custom. Larry Froom, CFO of the REIT, will give you a high-level summary of the quarter results. Pat will provide an update on Primaris. Philippe will provide an update on Lantower. I will conclude with some closing remarks. Over to you, Larry.
Thanks, Tom. Good afternoon, everyone. Jumping right into our bottom line. FFO on a fully diluted basis in Q4 was CAD 0.43 per unit, compared to CAD 0.45 in Q4 of 2017. The decrease is directly attributable to the sales of CAD 950 million worth of properties during 2018, compared to acquisitions of CAD 280 million during the same period. AFFO on a fully diluted basis was CAD 0.32 in Q4 of 2018, compared to CAD 0.35 in Q4 2017. Additional CapEx deducted from AFFO in Q4 2018 compared to Q4 2017, was approximately CAD 6 million. Part of our proceeds from the asset dispositions have been used for 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 basis, Q4 2018 property operating income from Canada was up 2.2% over Q4 2017.
On a same asset basis, Q4 property operating income from the U.S. in local currency, that is in USD, was up 2.4% over Q4 2017. 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. We recorded a fair value decrease on our real estate assets of CAD 152 million in Q4 2018 and CAD 247 million for the year ended December 31st, 2018. This arose mainly from adjusting Primaris portfolio cap rates. We made this adjustment despite the lack of any recent sales comps. Furthermore, it was not made because of any operational performance issues. In fact, Primaris property operating income has risen in 2018 compared to 2017. Rather, this adjustment was made due to the market's overall negative perception to retail malls.
Given this background, we felt it was the right thing to do. Despite this fair value adjustment, H&R's NAV per unit, net asset value per unit, rose from CAD 25.57 per unit at December 31st, 2017, to CAD 26.30 per unit at December 31st, 2018. This increase is partly due to CAD 108 million fair value gain recorded at Jackson Park, Long Island City, which is accounted for as an equity investment. This gain was the result of an independent national firm's appraisal and was not based on Amazon's planned investment into the area. The rent assumptions and cap rates were not changed at all for Amazon's initial planned arrival. That was always considered too far out to impact us today. The U.S. dollar strengthening to CAD 1.36 at December 31st, 2018, from CAD 1.26 a year ago, was also a large contributor to the increase in NAV per unit.
I will now hand over to Pat.
Thank you. Good afternoon. In 2018, Primaris assumed responsibility of the H&R retail portfolio. We completed two significant transactions during the year. We negotiated lease extensions with Sobeys for six locations in the portfolio, with the average weighted lease term to maturity increasing from just over three years to 14 years. In addition, we negotiated lease extensions with nine large format Lowe's stores occupying an area exceeding 1 million sq ft for an additional 15 years, with rental escalations every five years. As part of our agreement with Lowe's, we negotiated rights which enable us to add density to the sites, which we will pursue on an opportunistic basis. Following a thorough review of the portfolio, we have identified non-core assets located in small markets that will be marketed for sale over time.
In this regard, we have recently entered into agreements to sell two retail projects that identified for disposition for CAD 16.9 million. With respect to Sears paid annual base rent at H&R ownership interest of CAD 2.3 million. We anticipate approximately CAD 7 million in annual base rent will be generated from Sears store replacement tenants, with rental payments starting in Q4 2019, and most tenants open and paying rent by Q4 2020. Sears typically occupy prominent space at our properties. As such, we're 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 out parcel development. Leasing activity during 2018 was very strong. Our team completed 419 transactions, including 132 new lease deals. Our overall occupancy continues to be negatively impacted by the closure of Sears.
However, our CRU occupancy rate has risen for the fourth straight quarter and is at its highest level in two years due to consecutive years of strong leasing activity. Primaris owns dominant malls in their respective trade areas, and one which are often the only regional mall in their respective city. With tenants recognizing the importance of operating an online business in addition to maintaining a bricks and mortar presence, we continue to see strong tenant demand for space in our portfolio. 12 months rolling same-store sales within our enclosed mall portfolio are relatively flat at CAD 565 per sq ft as compared to the prior year. They are considerably higher than the CAD 542 per sq ft recorded in 2016. Over the past three years, we have been rebalancing our merchandise mix with a focus on reducing our exposure to fashion tenants.
The result has been stabilized productivity from the fashion category, coupled with fashion tenants posting declining occupancy cost ratios. While categories such as health and beauty, food, and footwear have all shown solid growth over the past years, electronics and jewelry categories have shown weakness after having been strong performers for many years. In 2018, we spent time reviewing opportunities within our portfolio to redevelop and intensify properties in markets such as Toronto, where the economics of these projects has improved materially in recent years. With sales of approximately CAD 700 per sq ft, Dufferin Mall is not simply a high-performing shopping center, but is also a 21-acre site proximate to a subway station.
We have started public consultation meetings regarding our preliminary plans to add density to Dufferin Mall, which includes the addition of significant residential development, which will further benefit sales at one of our top-performing shopping centers once completed. We anticipate the approval process will take approximately three years. Thank you. I will now turn the discussion to Philippe.
Good afternoon, everyone. Pleased to be on this call today to share the latest news from Lantower Residential. As mentioned last quarter, we closed on a 308-unit property named Lantower Weston Corners, located in the Cary submarket of Raleigh. Closing occurred on October 16th, bringing our Class A Raleigh portfolio to nearly 1,000 units. The five-story property benefits from its proximity to some of the most prized white-collar employers in the entire Raleigh MSA, such as MetLife's global technology headquarters campus and the SAS Institute's headquarters, which is the world's largest private software company. We also mentioned last quarter the potential acquisition of a property in Charlotte, North Carolina. We are happy to announce that we closed on the property on December 3rd, making our first acquisition in the Charlotte market.
Built in 2016, Lantower Waverly is a 375-unit Class A development in one of the most affluent submarkets in Charlotte, characterized by high-income households and A-rated public schools. Lantower Waverly is also located within the Waverly mixed-use development, which includes over 250,000 square feet of retail and walkability to a Whole Foods Market. As a side note, we are also pleased to hear the news of the BB&T and SunTrust merger due to the proposed headquarter relocation to Charlotte. 2018 was an active year for us. Lantower Waverly rounded out our 2018 acquisitions, bringing our total to approximately CAD 340 million across 1,638 units. On the portfolio front, following the closing of Lantower Waverly, Lantower Residential consists of nearly 7,300 apartments across 22 properties. Lantower's weighted vintage of 2011 represents one of the newest multifamily portfolios in our sector.
We expect this vintage to trend newer as we may dispose of our older assets and bring in more recently constructed properties as we complete our ground-up multifamily developments. As mentioned in previous quarters, our reported fourth quarter occupancy is artificially lower due to the inclusion of the lease-ups of Ambrosio and Edgewater in Austin, and Bullhouse and Weston Corners in Raleigh and Durham. Excluding the impact of these lease-ups, our portfolio occupancy was nearly 93% at the end of the fourth quarter. On the financial front, our same asset year-end operating income increased in US dollars from $25,867,000 to $27,010,000 in 2018. This roughly equates to same asset year-over-year operating income growth of 4.4%, representing yet another strong year of NOI growth. On the development front, construction is underway at the CAD 425 million River Landing project.
With approximately 1,000 feet of waterfront on the Miami River Landing is a mixed-use development including approximately 346,000 square feet of retail space. Approximately 136,000 square feet of office space and 529 residential units. To date, 66% of the retail space has been leased, with a further 10% under executed non-binding letters of intent. We expect to start pre-leasing the multifamily towers towards the end of the fourth quarter this year, and construction is expected to be completed in the second quarter of 2020. Construction at Jackson Park has been progressing as scheduled, and the project is currently 96% complete. Jackson Park will be moved from properties under development to investment properties in the first quarter of 2019. Leasing velocity remained strong over the fourth quarter, bringing total occupancy across the three towers to over 65%.
We expect leasing to accelerate, given almost all of the amenity areas are now open to residents and the fact that we're moving into higher leasing months. The last remaining unopened amenities space is the rooftop on top of tower B1, which is scheduled to open in March. As we look into the future, we believe Lantower's investment strategy will pivot away from the acquisition of existing assets to focus on a more accretive approach to growth through the execution of our existing development pipeline and investing in opportunistic ground-up development. We look forward to sharing more exciting progress on our developments on our next quarterly call. With that, I will pass along the conversation back to Tom.
Thanks, Philippe. As I hope everyone can tell, the entire team at H&R has been very busy over the past year on multiple fronts. Highlights include recycling capital through over CAD 1 billion of sales and reinvestments into higher growth assets and the repurchase and retirement of 6.6 million units. Significant advancement of our CAD 1.5 billion development pipeline, including our flagship Jackson Park development in LIC, that is now 68% leased, and our River Landing project in Miami, and material progress on enhancing our Primaris properties with the new tenancies commencing over the next 24 months that will generate CAD 9.4 million of additional NOI for H&R. These accomplishments align very closely with the goals we set out a year ago of streamlining and simplifying our portfolio, raising the internal growth profile of our portfolio, enhancing the profile of H&R to its unit holders.
We believe the actions taken in 2018 have not only made H&R a better REIT for the long term, but we expect to see over CAD 26 million of new NOI contribution in 2019 from Jackson Park, the lease-up of recently developed Lantower properties, and the commencement of Sears and Target replacement tenancies. Amazon's announcement today that they are abandoning their plans to build a headquarters in Long Island City does not change the fact that Long Island City was chosen for its appealing characteristics, the same factors that drove our investment in Two Gotham and Jackson Park. These two properties sit at what we believe is the single best location in Long Island City, atop the Queens Plaza subway station, gateway to LIC at the nexus of three main New York City subway lines.
Our investment in LIC, along with Quartz Key in Toronto and River Landing in Miami, are key examples of how H&R identified and made significant investments in attractive, gentrifying urban locations early in their development cycles, subsequently benefiting from the emergence of these locations as prime nodes. We've always maintained that despite the excitement created by Amazon's November announcement, it remains too early to forecast how Amazon's plans might impact our development. The assumptions used to support our appraised value and our future cash flow forecast from Jackson Park have never reflected the move by Amazon to Long Island City. So the decision today to back away from LIC will not have any impact on our value and our forecasted cash flows.
We continue to be highly focused on growing the FFO and NAV per unit for H&R unit holders, and are working towards continuing on the progress H&R has achieved in this regard in 2019 and beyond. Operator, you can open up the call for questions.
Certainly. At this time, I would like to remind everyone, in order to ask a question, press star followed by the number one on your telephone keypad. Again, that's star one. I will pause for just a moment to compile the Q&A roster. Your first question is from Sam Damiani with TD Securities. Your line is open.
Thank you. Good afternoon. I had a question on Jackson Park, just on the appraisal. It did go up by $108 million in Q4. Can you tell us what drove that particular increase? How much was it cap rate compression versus higher rents expected going forward, or anything else?
Hey, Sam. It's Larry. I can give you a little bit of flavor. It was based on the current lease-up, so it's not projecting rents increasing way up. It is based on a stabilized property capped at 4.25%.
Yep.
It was also based on deducting then the cost to complete for the construction and the cost to complete for lease-up.
Sorry?
That was the basis of the appraisal.
Yeah. I noticed your guidance for NOI in 2020 went up slightly for Jackson Park, which I imagine might have been part of it. As well, your FFO guidance is up significantly with lower interest costs now expected on this project. Is there a financing plan in place to lock in a lower coupon than you were previously thinking?
No, it was actually an error in our last forecast that the current mortgage on the property, or the current construction financing was capped with a swap rate. Tishman's was allocating that to income as opposed to netting it off to interest expense. When they did their forecast, they forecasted a higher rate of interest than we currently have locked in. We have the interest rate locked in going till June 2020.
I'll just switch over one more question and then turn it back. Just on the balance sheet, the debt to gross book value is 47% now with Jackson Park is done, but there's still a half a billion dollars of cost to complete on Miami River and other projects. In terms of balance sheet management to fund that, is there going to be more dispositions in the next year or two? What is your long-term, let's say two to three-year leverage goal on a debt to gross book value basis?
Well, Pat alluded to a couple of dispositions on the retail front that we hope to execute. There will be probably a couple more going forward into the year that we have slated and hope to execute on. It's pretty early. Leverage may tick up a little bit in the next quarter or so, but once we get those dispositions, that should probably trend back down to where we are today.
Thank you.
Your next question is from Jenny Yim with BMO Capital Markets. Your line is open.
Hi, good afternoon.
Hey, Jenny. Welcome back.
Thank you. I have a few questions about Primaris for Pat. You're talking about some disposition plans in place. I'm wondering if, particularly for the ones in the smaller markets, if you're still pursuing sort of the 50/50 JV that you've done in the past, or you're really looking to sell these at 100%. If you can comment on what you're seeing as far as interest and perhaps cap rates.
I think in terms of JVs, I think we'd still look at executing on those if the opportunity arose. There's no activity in that front right now, but we certainly keep our eyes open for it. There's no real comps out there to drive what the cap rates would be right now.
Jenny, the real answer to the question is the sales that are going to take place are not in closed malls. They're really in the outlier old H&R portfolio that's now going to be under the Primaris umbrella, which we'll be selling over time.
Okay. Is there any view to looking at some of the enclosed malls, putting them on the market?
No.
No? Okay. That's fine. With regards to the same-store performance, the numbers look really good, all things considered. I'm not sure if you have an idea of what the sort of same-store NOI would've been if you X out Sears, when you're looking at the performance of everybody else.
Well, Sears would've added another CAD 2.5 million, more or less, to the Primaris numbers.
Okay. Can back out, do that math. Then, one question on Jackson Park. As far as the appraisal goes, did the Amazon news have any bearing on the Q4 appraisal as far as forecasts or cap rates or any sort of assumptions that went into that?
No, definitely not. It had no impact. It's not mentioned in the appraisal at all. It was just too early to see what was going to happen while they were doing the appraisal. Amazon's announcement was only in November. This appraisal was already way underway then.
Okay.
I don't think it would've anyway been forecasting, when was Amazon set to move in? It was like five to 10 years later.
No, no. The answer to the question is that we never increased the projected NOI or projected rents on Amazon at all on LIC to reflect Amazon ever. The appraisal went out before the Amazon decision to come in, and we stated emphatically even before that it had no bearing at all on the appreciation. The location speaks to its own merits. Our investment spoke for its own merits. Amazon has nothing to do with that.
Okay. Great. Thank you. I'll turn it back.
Your next question is from Matt Kornack with National Bank Financial. Your line is open.
Good afternoon, guys. With regard to your mention of intensification opportunities in the Toronto portfolio, would you look to do those entirely by yourself, or would you seek out partners on a JV basis?
Yeah. In the Toronto areas, they'll all be done by ourselves.
Okay. Philippe, can you speak to sort of the opportunities that are unfolding in the Dallas market with regards to some of the merchant developers that are there, and it sounds like they've got a tough go of things, and how potentially you could maybe take advantage of those type of opportunities?
Yeah, I think that Ric Campo with Camden had mentioned it probably, had tipped the cards a little bit a couple of weeks ago on his call, and I think one of the analysts had picked it up. The distress that he's mentioning, we're not seeing. I think his comment was more on Houston. What we are seeing, though, is merchant developers are coming out of the ground with product and having to offer more concessions than planned and having to hold the asset longer than planned. If their execution was, or if their plan was to sell in the ninth or tenth month of a lease-up, now they're well into their second month. As far as we're concerned, the opportunities are starting to emerge.
Our guess is some of the more aggressive merchant developers have probably gone over their skis, and if those opportunities arise, then we'll definitely take a look at them. I think there's more pain elsewhere than in Dallas currently.
On the same token for stabilized assets, 1031 exchange and fund interest is still there. It sounds like cap rates have remained pretty tight on those type of assets.
Yeah, I would argue that there's more equity in this space than at any point in time.
Interesting. Larry, on the lease termination in the U.S. industrial, I don't think it was quantified, but do you know what the value of that would've been, just so I can back it out? I know it's not a substantial portfolio.
It was about CAD 150,000.
Okay. I think that's it for me. You were lucky and smart, and now you're just smart. I think things are turning around and looking good. Congrats on the quarter.
Thanks, Matt.
Again, to queue for a question, it is star and then one. Your next question is from Mario Saric with Scotiabank. Your line is open.
Hi, good afternoon.
Hey.
Just a follow-up question on the intensification opportunity in Toronto. Having gone through the properties, is it too early to quantify the type of GLA that you consider bringing online over the next five, six years? Or maybe longer, maybe let's take closer to 10 years given the zoning.
Besides the Dufferin Mall, we have three offices that have substantial intensification. It's too early to talk to them, though.
Okay. When do you think you might be able to provide a bit more color in terms of the magnitude of the opportunity?
Too early to tell.
Okay. That's it for me. Thanks.
Your next question is from Sam Damiani with TD Securities. Your line is open.
Thank you. Philippe, just on the same store occupancy. It did tick down a little bit in Q3, tick down a little harder in Q4, close to 1% year-over-year. Is there something driving that that gives you some concern about trends looking out to 2019?
No. I think, Sam, to be candid, we managed NOI, not so much occupancy. While I understand why people look at the metric in U.S. multifamily, I would be much more concerned about same-store NOI growth as opposed to same-store occupancy.
The NOI growth that you are putting up is a revenue story. It is not so much expenses going down or anything like that.
I think it's a combination of both. Obviously, we've got a great asset management team in Dallas that spends a tremendous amount of time compressing their expenses best they can. We also have a great team on site that is looking to increase rents. I can't speak to the exact percentages, but I would say it's probably a healthy blend of both.
Great. That's helpful. Thank you.
Again, to queue for a question, it is star and then one on your telephone keypad. At this time, there are no more questions in queue. I'll turn the call back over to the presenters.
Thanks, everyone. Have a great long weekend, we'll speak to you next quarter. Bye.
This concludes today's conference call. You may now disconnect.