Good morning, and welcome to H and R Real Estate Investment Trust 2018 Third 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 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 inherent risks and uncertainties, and actual results could differ materially from the statements in the forward looking information. 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 is described in more detail in H and R's public filings, which can be found on our website at www.sedar.com. I would now like to introduce Mr.
Larry Froome, Chief Financial Officer of H&R REIT. Please go ahead, Mr. Froome.
Thank you, Lindsay. Good morning, everyone. Welcome to our call. Thank you for joining us. Tom Hoegh Hofstetter, our President and CEO is with me Pat Sullivan, Chief Operating Officer of Primerus is on the call from Calgary and Philippe Lapointe, Chief Operating Officer of Land Tower Residential is on the call from Dallas.
I will begin with some brief remarks on this quarter, Pat and Philippe will follow-up with updates on their division and Tom will make some concluding remarks. And finally, we will open up for some questions. On August 31, H and R and Finance Trust affected a reorganization where Finance Trust was dissolved. Accordingly, the stable structure has been unwound and unitholders now only hold H and R REIT units. H and R's annualized distribution of $1.38 per unit will now be paid in its entirety by H and R REIT.
This is also the 1st full quarter post the sale of the U. S. Retail assets for US633 million dollars and the sale of First Tower and Calgary for CAD53.5 million. These dispositions were the main reason for the decrease in property, operating income and FFO. Q3 FFO was $0.42 per unit, down from $0.46 in Q3 2017.
However, Q3 2017 included lease termination fees of $5,500,000 compared to the lease termination fees of CAD 444,000 received this quarter. Excluding these lease termination payments, FFO decreased from $0.44 last year to $0.42 this year. On a same asset basis, Q3 2018 property operating income from Canada was up 2% over Q3 2017 and excluding the lease terminations just mentioned, the U. S. Portfolio in local currency was up 2.8%.
Same asset property operating income cash basis from the office division increased by 3.4%. From Merus, same asset property operating income cash basis increased by 0.8% despite this year's vacancy. Same asset property operating income from the H and R Retail division increased by 3%. Excluding the lease termination fees from 2017, same asset property operating income from Echo in U. S.
Dollars increased by 4.7%. Same asset property operating income from Nantower Residential in U. S. Dollars increased by 7.3%. 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.
Part of our proceeds from the assets positions 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. Unitholders' equity per unit, which is unitholders' equity for our financial statements, divided by the number of REIT units outstanding was $24.85 per unit as at September 30, 2018. This quarter, H and R disclosed net asset value NAV per unit for the first time. This is a non GAAP measure calculated by dividing the sum of unitholders' equity, exchangeable units and deferred tax liability by the total number of H and R units and exchangeable units outstanding. Under IFRS, exchangeable units are classified as debt.
However, these units are not required to be repaid. The exchangeable unitholders receive the same distributions of the REIT unitholders and each unitholders has the option to convert the exchangeable units into H and R units on a one to one basis at any time. Therefore, management considers them as equity. The deferred tax liability shown on the balance sheet is an undiscounted liability that would be only be crystallized in the event that U. S.
Properties are sold. Management expects to continue to take advantage of U. S. Tax legislation, specifically the 1031 exchanges to further deferred taxes owing on sold properties. The NAV per unit as per the above calculation as of September 30, 2018 was $25.73 per unit.
Management believes this is a useful indicator of the fair value of the net tangible assets of H and R. I will now hand over to Pat Sullivan. Pat?
Thank you, Larry, and good morning, everyone. We're nearing the completion of our target replacement program. Construction is progressing on the former target at Sunridge, and we anticipate $1,500,000 in annual base rent contribution from new tenants at Sunridge Mall starting in Q4 2019. New tenants opening at Sunridge include Mark's and Winners. With respect to Sears, Sears paid annual base rent at H and R ownership interest of $2,300,000 We anticipate $7,000,000 in annual base rent will be generated from Sears replacement tenants with rental payments starting in Q4 2019 and most tenants open and paying rent by Q3 2020.
In addition to paying rent below market rents, Sears and Target leases typically contain provisions restricting development on our sites. During our last quarterly call, we discussed development opportunities including intensification opportunities at several of our strongest properties, including Dufferin Mall and Orchard Park Shopping Center. With the closure of these department stores, we have added flexibility to pursue intensification opportunities at a number of our shopping centers creating a long term development pipeline. With management's focus on opportunities at our larger properties, we are pursuing the sale of assets that offer limited potential for growth. Earlier this year, we sold a 46,000 square foot neighborhood retail plaza in Sherwood Park, Alberta, situated nearby but not adjoining Sherwood Park Mall.
In 2019, 5 additional assets will be marketed for sale. We anticipate these properties will generate approximately $37,000,000 in net proceeds upon disposition in line with our IFRS valuations. We continue to add new tenants to the portfolio that will drive traffic to our malls, which are dominant in their respective markets and are often the only major regional closed mall in their region. Earlier this year, Marshalls HomeSense opened a new 40,000 square foot store at McAllister Place in St. John and later this year Old Navy will open a 15,000 square foot store at Place de Roiama Chiquoutime.
At Sherwood Park, Urban Planet opened a new 15,000 square foot store earlier this year and Shoppers Drug Mart will open from an expanded store later this year with a significant beauty boutique section. In 2019, Old Navy will open a 15,000 square foot store at Regent Mall in Fredericton and Marshall HomeSense will open a 40,000 square foot store at Garden City Square in Winnipeg. 4 months rolling same store sales within our enclosed mall portfolio are relatively flat at $5.69 per square foot, but considerably higher than the $5.39 per square foot recorded in 2016. Since 2013, our merchandise mix has evolved due to changing market conditions. Our allocation of space to fashion has declined in favor of food and electronics as well as health and beauty tenants.
The closure of Target and Sears has resulted in transformation of our properties. Both Target and Sears occupied large areas paid low rents and did not generate significant traffic to our malls. Department stores including the Bay, Walmart and Canadian Tire now accounts for 4.2% of gross revenue compared to 9% in 2013, while large format retailers such as Sport Chek, Indigo, Sobeys, Cineplex and Winners account for 24% of gross revenue approximately 5% higher than in 2013. These specialty large format retailers have recognized the significant traffic generated by our properties and seize the opportunity to locate within the dominant retail property in the market. In turn, our properties have and will continue to benefit from the additional traffic generated by these retailers.
Thank you, and I'll now turn the discussion over to Philippe.
Thanks, Pat, and good morning, everyone. Pleased to be on this call today to share the latest news from Lantower Residential. We mentioned last quarter the pending closing of Lantower Western Corners, a 308 unit development in the Cary submarket of Raleigh. We are happy to announce that we closed on Western Corners in October, which marks our 3rd acquisition in the Raleigh Durham market. The 5 storey 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 Headquarters, which is the world's largest private software company.
We have more exciting news coming from North Carolina with a pending acquisition of a new Class A asset in one of the most affluent submarkets in Charlotte. We are in due diligence and look forward to potentially closing on the property in early December. We will disclose more details on this potential acquisition on our Q4 call. On the portfolio front, upon closing on the acquisition of our Charlotte asset, Land Tower will consist of nearly 7,300 apartments across 22 properties. As a reminder, Land Tower's weighted vintage of 2011 represents 1 of the newest multifamily portfolios in our sector.
This vintage could continue to trend newer as we may complete our ground up multifamily developments. As mentioned last quarter, our occupancy is artificially lowered due to the inclusion of the lease ups of Ambrosio and Edgewater in Austin and Bullhouse in Durham. Excluding the impact of these lease ups, our portfolio occupancy was over 93% at the end of the 3rd quarter. On the financial front, our same asset quarter end operating income increased in U. S.
Dollars from $6,298,000 in the Q3 17 to $6,760,000 in the Q3 of 2018. This equates to same asset quarter over quarter operating income growth of 7.3%, representing yet another strong quarter of NOI growth. Furthermore, our same asset trailing 9 month ending operating income increased nearly 5 point 6% compared to the 1st 9 months of 2017. On the development front, we recently closed on the land for Shoreline Tower, a 35 story multifamily project in Long Beach, California. Land Tower's interest in the approximately $217,000,000 project is 30.7%.
We expect to start work shoring work by the end of the year and look forward to keeping you up to date on this high profile development. Construction at Jackson Park has been progressing as scheduled and the project is currently 92% complete. Strong leasing velocity has continued with well over 450 new leases signed in the Q3 alone. Jackson Park has 11 24 occupied units at the end of October, reflecting 60% of the total unit count. We expect leasing to continue to remain strong during the winter due to the fact that the entire amenity building is now open to residents and Tower B2 will be opening as a rooftop amenity space in November.
Additionally, Jackson Park's 2 acre park has grass laid and will be fully opened by the end of the year. Construction is expected to be 100% complete in the Q1 of 2019, and we look forward to sharing more exciting progress on our developments on our next quarterly call. And with that, I will pass along the conversation back to Tom.
Thanks, Philippe. As you just heard and can read about in our quarterly report, we have been very active in 2018 and we're very proud of our accomplishments. We have recycled $1,000,000,000 from our lowest growth assets to our highest growth assets through land power acquisitions, developments and buying back our units. All of this activity ties back to the objectives we outlined at the beginning of the year, namely enhancing the internal growth profile of our portfolio and streamlining and simplifying our business. In addition to all of the acquisitions and dispositions, we have advanced our development portfolio, including both investments in Gateway City mixed use and multi residential developments in the United States, as well as intensification opportunities in our Canadian portfolio, most notably, Dufferin Mall.
It's gratifying to see all the hard work our team has done and translating to real progress in our business. It is also nice to have luck on Aeroside and from time to time in this regard and we have 2 bits of luck that have come our way. Tax policy changes in the United States allowed us to simplify our structure this quarter, collapsing our staple unit structure into a simple REIT structure comparable to most Canadian REITs. And secondly, as the Wall Street Journal, CNN and The New York Times are to be believed, Amazon announced today that it chose Long Island City and Crystal City at the sites for its 2nd headquarters. Our Jackson Park development, which sits
in the heart of Long Island City,
has already been very rewarding for us delivering over US150 $1,000,000 of fair value gains and has a carrying value of approximately US675 $1,000,000 at our share today. This announcement from Amazon should cement Jackson Park as one of the most attractive residential developments in North America. Last night, New York City's Mayor Bill de Blasio described the Amazon announcement as the single biggest economic development deal in the history of New York City. Jackson Park is already leasing up at higher rents than forecast and Amazon's announcement should only improve the prospects for this development contributing to our overall growth profile. In conclusion, while the actions we have taken to enhance the growth profile of our portfolio have cost us an FFO period this year, we believe we are largely past the dilutive impact of these changes and are turning the corner on FFO growth.
We will continue to work to improve and streamline our portfolio and are pleased with the significant progress to date. And on that, I'll ask the operator to open
up the calls for questions.
Our first question comes from Mike McCartis with Desjardins. Your line is now open.
Good morning. Jackson Park, it sounds like lease up tracking ahead of expectations and then obviously HQ2 is a big event. Just curious, your projected NOI from those properties didn't really change in 2019 2020. Why perhaps that may be the case?
Hey Mike, we did not change our projections. We did not factor in HQ2 in our projections and we just kept with the same projections we've always had with the same release rate that we're currently be leasing at.
Why won't we change our projections on?
Yes. So I guess the but you're tracking ahead of expectations. So suffice to say that all else equal, your current projections for 2019 2020 just on that basis alone are somewhat conservative. And then can you just remind me and apologies I'm not as well steeped in the New York rent control scene as I should be. Does if HQ2 does come to reality and sounds like it's coming to reality, does that change your lease up strategy at all in terms of is there any rent control and would that change how you might view the lease of that asset delaying it somewhat given the developments around HQ2?
Isn't it fair to say and there is no rent control, isn't it fair to say that the reality of Amazon is still a couple of years away, at least? I mean, they have to rezone the site. They have to build the site and see it probably going to 3, 4 years away.
Okay. Nothing is going
to change in the short term. I think that what's going to change is the NAV.
Yes, but there's no rent control or rent affordability on our project.
That's exactly what it's going with. Okay. And then Larry, what was the change in the I mean, you got even though the NOI didn't really change, you've got an increase in FFO due to lower finance costs. Can you just help us understand what's driving that?
It was really sorry, lower finance costs?
Yes. It seemed that that came down considerably in terms of the projections.
Compared to last quarter, if Mike, I'll have to check with you. I mean, we stopped capitalizing as much interest, but that shouldn't be a driver. Sorry, I have to check with you what we had last quarter.
Yes, no problem. We'll follow offline. Just thanks for your disclosure on the net asset value, dollars 25.73 units trading at a big disconnect. Just curious, your NCIB did terminate in August and I haven't seen a renewal. Is there any reason why you wouldn't be buying at these levels?
No, we are about to we will be reinstating the NCIB in the next couple of weeks. The NCIB actually fell out of place when finance trust was dissolved. So we have to apply for a new one and we will, whether we start to buy will remain to be seen. We would like to buy and we need cash to buy and probably uses some more assets. We won't have some more cash to deploy into the NCIB.
But right now, we are not we have not been active on it.
Okay. And just, I think the original intention when you guys sold the U. S. Retail assets was to redeploy substantially all those proceeds into Land Tower. Assuming that hasn't changed, where would we be in terms of net incremental capital that you see yourself putting into Land Tower over the next,
let's call it, 6 months?
Besides the development pipeline, we only have one asset that we're looking to acquire and that's for about another $70,000,000 to $80,000,000 So that is that is into that topic.
And that's really a product of a reverse 1031 that we're involved in because we have a projected to sell some assets in the United States. So we took the opportunity to buy an asset to get in place with that 1031. Other than that, I think we're on a slowdown mode on acquisitions, waiting for to see what happens with NAVs and caps over to the increase in rental and interest rates, which hasn't manifested itself today into change in values. We expect it to change in values, show a change in values as the interest rates have an impact on valuations.
Okay. And just last one
for me before I turn
it back. The income growth on the assets and lease up from Lantower looks pretty substantial once they stabilize by the end of 2019. Larry, is there any interest being capitalized with those assets or no at this juncture?
No, there's not.
Okay. That's very helpful. Thank you.
Thanks.
Our next question comes from Matt Kornack with National Bank Financial. Your line is now open.
Hi, guys. Just with regards to Land Tower and the organic growth figures, occupancy on the same property portfolio was fairly stable. So what was the main driver? Was it rent increases or was there lack of incentives in that number as well? Just wondering what drove the 7% organic growth figure?
I would say it's a healthy combination of yes, sorry. I would say it's probably a healthy combination of both. We are seeing an uptick in our rental increases. I don't think there's been much change in the concessions, but we're also our asset management team has been tremendous in compressing expenses. So I would take less so in concessions, more so on rental growth and on expense compression.
And are you seeing from a supply standpoint less of an impact or at least slowing in the addition of new supply in the markets you're in?
Yes, quite noticeably as well.
Okay, fair. With regards to the Primaris portfolio, thanks for the disclosure with for Target and Sears space. Do you expect some common area recoveries as well on top of the base rent? Or how should we look at the NOI impact of that lease up over the next few years?
Yes. I mean, in terms of recovering costs, we will some of the commentary gains cost gains that we get from the new tenants coming in will be applied towards recovering some of the costs that we're spending. I don't I can't quantify it right now, but there will be a recovery.
Okay. So it'll be maybe incrementally more than that from an NOI standpoint as these tenants take possession?
Yes.
Okay. And then finally, with regards to the debt on Jackson Park, have you thought of what a long term financing solution is there? You have a partner, so I'm not sure how you'll go about it or will it be dealt with through the unsecured debt markets in Canada? Yes, We're
expecting to get an appraisal by the end of the year or
in January.
We're expecting to get an appraisal by the end of the year or in January. And they may be looking to put permanent financing on. And they are hopeful that we may be able to put permanent finance and get all our equity out of the project.
Okay. Wow. So if you did in fact do that, would the use of proceeds be to fund, I guess, your other development projects that you've highlighted?
No, to pay down debt, our construction financing.
Okay. Sorry, sorry. So you're not It's
not easy to pay down our debt. But the point is better as well, though, we don't need the project. Initially,
it's a point that our passing debt and that's and then it will be towards the rest of the development pipeline.
If you get anything incremental above the development debt?
Yes. Yes.
Okay, fair enough. Thanks
Our next question comes from Sam Damiani with TD Securities. Your line is now open.
Thank you. Good morning. Just on the last question regarding financing at Jackson Park, what would the market cost for fixed rate debt on that asset be today?
What is the interest rate?
Correct.
The yield curve is relatively flat, doesn't matter if
you're 5%, 7% or 10%. So probably around
the end of 4.5%.
4.5%?
Yes, it doesn't really matter, sir. 65% LTV.
And what is your equity in the project at this time?
US260 $1,000,000 Yes, but your real question is what will be at the time of financing, right? Equity won't change. Yes, so I said, the equity won't change, but it's the equity now will be equity then. It will take out the bank debt.
So your equity is CAD260 1,000,000? US260 At your share. And just on leverage again, what is the current plan from at the REIT level to operate going forward? And now that you've largely completed your disposition program, how do you see the REIT leverage 2 to 3 years out?
Well, we have 44% now, assuming we have no disposition, that where we are still planning on having some dispositions, but assuming no dispositions and obviously our leverage would tick up and with our development pipeline, feeding the development pipeline could take up to another to call it 46%. But again, we will expect to have more dispositions as we go into 2019.
Is that a level you're comfortable operating at sort of for the foreseeable future in sort of the mid-40s?
45%, yes.
Yes. Okay.
And just lastly, back to Toronto. What's the latest on what you're hearing from CIBC with respect to their relocation strategy from many of your buildings? And with respect to Atrium on Bay, are you still contemplating an expansion to that asset? And if so, can you give us an update?
So the answer to the question is there is never been a
decision coming out of CIBC, so
we don't really have clarity. And we are still working on an expansion. We haven't pulled the trigger on it yet. We're still doing the costing.
Okay. Thank you. Thanks, Tony.
There are no further questions in queue at this time. I'll turn the call back over to Mr. Larry Froome for closing comments.
Thank you, Ivan. Thank you for joining us. We look forward to reporting more good news at the end of the year. Have a good day.
This concludes today's conference call. You may now disconnect.