Good afternoon, welcome to H&R Real Estate Investment Trust 2018 first 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, 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, 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 and the forward-looking information, the material factors or assumptions that may have been applied in making such statements is described in more detail in H&R's public filings, which can be found on our website and sedar.com. I would now like to introduce Mr. Tom Hofstedter, President and Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstedter.
Good afternoon, everyone, welcome to our first quarter 2018 financial results conference call. On the call with me today are Larry Froom, our CFO, Patrick Sullivan, CEO of Primaris, and Philippe Lapointe, CEO of Lantower Residential. We're going to start off by bringing Pat to tell us a little bit about Primaris, followed by Philippe, then I'll basically bring up the rest of what's going on at H&R. Pat?
Thanks, Tom, good afternoon. Our enclosed shopping centers are typically the dominant or only enclosed mall in their primary markets. Sears, much like Target, occupied large premises that were situated prominently on the property. They paid significantly below market base rent, contributed very little toward the cost of operating the shopping center, thereby shifting the burden to small shop tenants, did not drive traffic to the shopping center in the end. With the departure of Target, we were afforded the opportunity to add new retailers to our properties, including Winners, London Drugs, H&M, HomeSense, and Indigo, to name a few. In some cases, tenants were new to market, while others relocated from nearby retail developments, seizing the opportunity to relocate to the dominant retail development in the market.
Further, over the long term, the elimination of lease restrictions provides us the opportunity to further develop our sites, creating growth in both revenue and traffic to the property. During the first quarter of 2018, we obtained vacant possession of the remaining seven Sears stores in our portfolio. Our two other Sears stores were disclaimed by the monitor in late 2017. We have now undertaken a thorough review of the condition of the Sears stores, redevelopment plans are advanced, construction groups have been engaged, and discussions with replacement tenants are progressing in advance. With the continuing growth and evolution of e-commerce, retailers are reshaping their operating platform. Using demographic information obtained from their e-commerce business, retailers are becoming increasingly sophisticated in understanding their bricks and mortar needs. Shipping costs, both for delivery and returns, are high, especially to areas outside of Canada's major urban centers.
As such, operating the physical store has become an essential component in the retailer's omni-channel strategy. With a physical store presence, retailers can reduce shipping costs by way of in-store pickup, simplify the return process, and create opportunity for additional sales from online customers that come to the store in person. One large format international fashion retailer stated that they're expanding into many regions where Primaris owns shopping centers as their online business strengthens with a physical store open, because without a bricks-and-mortar location, customers returning items are required to pay the cost of shipping. Our enclosed malls are typically the dominant retail property in their respective region, and we benefit from the retailers' increased understanding about their customers' shopping habits in our markets.
Strong e-commerce sales for selected retailers in many of the cities where we own properties, such as Fort McMurray and Fredericton, have aided in advancing discussions with potential new tenants such as Sephora. Leasing activity throughout the portfolio continues to be strong with our team completing 108 transactions during the quarter, including 33 new transactions. By way of comparison, in Q1 2017, our leasing team completed 93 transactions. We have completed a significant number of lease renewals in the first quarter, resulting in 66% of the 2018 expires being finalized. Significant store openings at our properties this spring include Marshalls, Dollarama, Indigo, and Urban Planet, all opening at Cataraqui Centre from a combined area of approximately 100,000 sq ft, as well as Urban Planet opening new stores at both Sherwood Park and Sunridge Mall from 35,000 sq ft in total.
Further, we have completed three deals with TJX totaling about 100,000 sq ft at Sunridge, Garden City Shopping Centre, and McAllister Place. At McAllister Place, TJX will open a Marshalls HomeSense combo store in the fall of 2018, while the other two TJX stores open in 2019. Thank you, and I'll now turn the discussion over to Philippe.
Good afternoon, everyone. I'm pleased to be on this call today to share the latest news from Lantower Residential. As mentioned on last quarter's call, we were under contract for a brand-new deal in Austin, Texas. We have since completed our due diligence, so we are now able to share details regarding our newest acquisition called Edgewater. The brand-new 328-unit development is a sister property of two of our other Austin assets, Northpoint Northeast and Ambrosio. The acquisition provides operational economies and gives us strategic control of the Tech Ridge submarket. Edgewater is about to begin its lease-up, which provides us with better quality control of tenants moving in for the first time, in addition to offering a higher stabilized cap rate, otherwise unavailable on fully marketed stabilized Austin properties. The most exciting news comes from our recent activity in Raleigh, North Carolina.
As a result of the market's recognition of the Lantower platform, we have secured two off-market opportunities with one of the largest multifamily equity investors in the U.S. Both assets are brand-new Class A properties in two of the most desirable submarkets in the Raleigh MSA. The first, currently called Woodfield Weston Corners, which upon closing will be rebranded as Lantower Weston Corners, is a 308-unit development in a Cary submarket of Raleigh. The five-story property benefits from its proximity to some of the most prized white-collar employers in the entire Raleigh MSA. MetLife's 641,000 sq ft global technology headquarters campus, that currently employs approximately 2,000 people, sits across the street from the property. Additionally, the SAS Institute's headquarters, the world's largest private software company, employing 6,000 people, is located five minutes away.
The second acquisition, Bullhouse Apartments, is a five-story, 305-unit mid-rise property located in the high-growth submarket of downtown Durham. The property earned a walk score of 90 due to its live, work, and play location, a short walk away from major Durham destinations. In addition to proximity to major breweries, one-of-a-kind eateries, and the Durham Bulls baseball stadium, the residents benefit from a quick commute to major employers such as Duke University and Hospital, and the large tech startup hubs, the Innovation District and Startup Factory. In addition to purchasing Edgewater and the two properties in Raleigh, we've secured another off-market opportunity from a renowned developer in Florida. We placed under contract a brand-new property in a very dynamic submarket of Tampa, Florida. This will mark our fourth acquisition in Tampa, a market that is well-positioned for strong and stable population and job growth.
We will disclose more information regarding this acquisition next quarter. On the portfolio front, following the acquisition of Edgewater, Weston Corners, and Bullhouse, Lantower will consist of 6,574 apartments across 20 properties with a weighted average portfolio vintage of 2011. As mentioned last quarter, our same-property occupancy is artificially below normal due to the inclusion of the lease-up of Ambrosio in Austin, which is 60% occupied at the end of the first quarter. Excluding the impact of Ambrosio's lease-up, our portfolio occupancy was approximately 93% at the end of the first quarter. On the financial front, our same asset quarter and operating income increased in US dollars from $6,793,000 in the first quarter of 2017 to $7,173,000 in the first quarter 2018.
This equates the same asset quarter-over-quarter operating income growth of 5.6%, demonstrating yet again our continued NOI growth quarter-over-quarter, primarily due to strong revenue growth and active asset management. On the development front, we're nearing the start of our Caning Lane development in the heart of Austin, Texas. The 383-unit mid-rise community called The Pearl is expected to commence construction in the late summer of 2018. Our Hercules project in Northeast San Francisco is also nearing construction mobilization. We expect to start shoring and grading work in June with vertical construction to start in August. This 172-unit development, now called The Exchange at Bayfront, represents the first phase of over 1,000 units within the Hercules Bayfront development. As our multifamily developments progress, we look forward to sharing more exciting news on our next quarterly call. With that, I will pass along the conversation back to Tom.
Thanks, Philippe. By now you probably all saw that we issued a press release at the start of this conference call regarding our sale of the majority of our U.S. retail portfolio in the United States for US $633 million. We're really going to the wire to get this done before the conference call. I apologize that it came out so late. Before mortgage and prepayment of closing costs, our proceeds are CAD 633 million. This reflects a 7.3% cap rate, which will naturally result in some near-term drag on our FFO per unit until the proceeds are redeployed. We estimate the FFO impact at approximately CAD 0.05-CAD 0.06 per unit in 2018 based on our current pipeline of acquisitions.
The sale is key to our strategy of recycling our capital into higher growth properties, most notably our Lantower residential division, which with this disposition reaches 15% of total assets. We expect near-term acquisitions to push that even further to eventually over time be approximately 25% of our total assets. On a local currency basis, same asset operating income of 1% was powered by a 5.6% increase from our Lantower residential division and 1.7% from our office portfolio. Our 12.3 million sq ft office portfolio accounts for nearly half of our assets and includes 5.3 million sq ft in the tight Toronto office market, where we estimate market rents for our portfolio are approximately 23% above our in-place rents, providing significant upside on future lease maturities and renewals. This positive internal growth came despite modest occupancy erosion from all of H&R REIT's portfolios.
At 94.1%, we expect portfolio occupancy to rise over the next several quarters as recent Lantower acquisitions still lease up stabilize, and as Primaris occupancy rises through 2018 and 2019 with the final target of tiers replacement tenancies taking occupancy. Jackson Park, as you heard, our 1,871-suite luxury rental building in New York, has begun lease-up and occupancy. The development is leasing up slightly ahead of our pro forma with both higher occupancy and higher achieved rents. We expect this project alone to add more than CAD 1 per unit NAV, some of which has already been recognized during construction. With Jackson Park nearing completion and expected to be fully leased and stabilized in late 2019, we have a significant pipeline of other projects now underway. We expect to be able to provide further details of these developments, which total more than CAD 1.5 billion of cost in coming quarters.
All of our development projects are located in strong primary markets, and we expect each to deliver value creation for unitholders and enhance the REIT's same asset operating income profile as it becomes income producing. Our Lantower portfolio, which is concentrated in high population employment growth markets, saw same asset operating income increase 5.6% in the first quarter. In the near term, we expect impact of Jackson Park's lease-up and the retail sale of our U.S. portfolio to reduce FFO in the next two or three quarters, followed by strong ramp-up in per unit FFO growth as Jackson Park completes its lease-up, as Primaris occupancy rebounds with targeted Sears replacement tenancy commencement, and as the rising weighting of Lantower Residential in our portfolio all contribute to a higher internal growth rate.
Finally, we are pleased to report that our amended reorganization plan has received final court approval, allowing us to collapse our stable unit structure during the third quarter, pending CRA approval, returning H&R to a simplified restructure. With that, operator, we'll open up the call to questions.
If you'd like to ask a question at this time, please press star, then the number one on your telephone keypad. If you'd like to withdraw your question, press the pound key. Your first question comes from Dean Wilkinson with CIBC World Markets. Please go ahead. Your line is open.
Good afternoon, everyone.
Good afternoon.
Busy day, Tom.
Well, we're going to start drinks here in 15 minutes. It's not so bad.
Maybe just a question for Larry on how we're thinking about the capitalized interest to come in. Should we think of that sort of CAD 0.02 a quarter over the next couple of quarters? Would that be the best way to think of that?
Hey, Dean. Yeah, I think you would be correct in thinking of it that way. CAD 0.02 a quarter would be a good
Then just in terms of the math there, it looks like there's about CAD 287 drawn against the facility, and you've got another CAD 74.5 to go. Would that be that you're calculating that interest expense on the CAD 362, which would imply something in the area of sort of a 4%-5% cost on that construction financing?
Yes, I believe the cost is 4.7%.
4.7. Okay. I got that one closest to the pin. That doesn't ever happen. In terms of when this then stabilizes, what do you think the interest savings are that you could term this out towards?
Sorry, Dean, I didn't follow the question.
You're asking with the permanent financing and the construction financing?
Yeah. When you term that out, I'm assuming you're going to take the 362 and just term it out.
Around 60 basis points.
Around 60?
Mm-hmm. If we do a 10-year term.
You'll take a 10-year term. Okay.
I don't know if we will, but if we took a 10-year term, it would be 60 bps.
Okay. You would think that you would do that as you hit substantial stabilization, like more a 2019 kind of thing?
You know what? That's into the future. It depends on what the yield curve looks like and what the world looks like at that point in time. Probably, if all things being equal.
Okay. Makes sense. Just on the asset sale that you just announced, would I be reading that right? You're going to have about CAD 430 million net cash afterwards, which is largely going to go towards Lantower?
It's going to go towards Lantower. There'll be some residual. Right now, we have to do the 1031 exchanges. We've lined up enough to basically defer all of those taxes. We should have no taxes payable at all under this disposition. Between the Lantower acquisitions, the paying off the mortgages, and excess cash left for NCIB or whatever we want, future acquisitions, you got your math right.
Perfect. Okay. I will hand it back to the queue. Thanks, guys.
Thanks.
Once again, if you would like to ask a question, press star, then the number one on your telephone keypad. Your next question comes from Sam Damiani with TD Securities. Please go ahead. Your line is open.
Good afternoon. Congratulations on the sale just announced.
Thank you.
Just on that, Tom, I wonder if you have any further thoughts on potentially using more of that, the proceeds to buy back stock, potentially through a substantial issue or bid?
The answer is depending where the stock is, what the opportunities are, but we're definitely open for that. There won't be a policy. It's really going to depend on where the stock is, as I said, and opportunities.
Okay, just flipping over to the IFRS adjustment in Q1, there was about roughly CAD 100 million taken on the Primaris assets. Could you give us a little bit of color on sort of what move was behind that?
Sam, hi, it's Larry. It was generally.
You know what I think it is, Sam, with Larry's accent, do you really think he has to say it's Larry anymore? I think from now on future conference calls, Larry should not say it's Larry. Okay, Larry, on that note.
Thanks, Tom. It was mostly the Sears that was contemplating the Sears redevelopment, and so the work that has had to be done on them, the lease-up, the fact that the lease-up's going to take probably a year or 18 months. Most of it has to do with the Sears redevelopment.
Okay. Just over in Alberta, there's rumors that the Stantec Tower there might get sold sometime soon. I wonder if you have any intelligence on that and if you see any follow-through on potentially a transaction involving The Bow.
I do not think it has anything to do with The Bow. I mean, The Bow is a different animal. A long-term lease, so a much larger credit tenant, as you well know. The Bow's challenge is its size, nothing else. The Bow can wait. It has about 20 years plus in lease term. I think it has no real reflection on that at all.
Thank you.
Thanks, Sam.
Once again, if you would like to ask a question, press star, then the number one on your telephone keypad. Okay, we do have a question from Neil Downey with RBC Capital Markets. Please go ahead. Your line is open.
Thank you. Good afternoon.
And-
Hi there. Philippe, these three assets you've agreed to acquire, Edgewater, Weston Corners, and Bullhouse. What's roughly the acquisition value of those three assets?
It's approximately, I'd say a little over CAD 200 million.
Okay, thank you. On the retail sale, Tom or Larry, you do mention closing costs and mortgage prepayment adjustments. Roughly how much will those figures be?
It's $15 million U.S.
Okay. The Pearl and the Hercules projects both were mentioned by Philippe, I believe, in your prepared remarks. I did not see any disclosures on the expected development yields on those assets, and those projects rather, I think we have had them in the past. I think the latest number I saw was about, if I'm correct, 5.4% for Hercules and around a 5.9% for The Pearl. Do those numbers hold, or are there some adjustments expected there?
I think the stabilized is higher than that, Neil, in the sixes for the stabilized yields.
I think a good rule of thumb, Neil, is probably to tack on, depends on the market between, let's say, 60 and 100 basis points over what a stabilized asset would yield. I think a 5.4% is too low. I don't know where those numbers come from.
Okay. I will circle back and look at my own records.
I guess on the same subject of development, there was some disclosure, I believe it was last summer with respect to Long Beach and a project called Shoreline Tower, then one up in Seattle as well. Are those still part of the pipeline?
Yes, they are. Shoreline's is just about ready to go, it should be going shortly. Seattle is not quite ready to go. Shoreline is 2018, and Seattle is 2019.
Okay. One last question, just sorry for the laundry list approach here, the buyer of the U.S. retail portfolio, can you give us a hint or maybe just a profile of the type of buyer?
I'd love to, you know what, Neil? He's listening. We have confidentiality, we can't.
Understood.
By closing, hopefully on closing, we'll be able to.
Okay. Thank you very much.
Thanks, Neil.
Once again, if you would like to ask a question, press star, then the number one on your telephone keypad. Your next question comes from Sam Damiani with TD Securities. Please go ahead. Your line is open.
Thank you. Just on the sale. I recall last quarter the fair value, I think, of the U.S. retail was a little over $700 million. Can you say the sale price today, how that compares to the fair value of those assets?
From last quarter's fair value?
Well, basically what I'm asking is there going to be a loss or a gain?
No, there is no loss.
Sorry, we did expect a loss for the prepayment and closing. Prepayment mortgage cost, mortgage prepayment, and closing costs.
Yeah, that's not for the quarter. That's for the following quarter. Added to, I think, Neil, $15 million U.S. is the closing cost and mortgage prepayment. To the accurate value, it's intact other than the $15 million costs.
Is roughly in line with the balance sheet value.
Yeah.
Yep.
Okay. You've a lot more development on the go, what's your target leverage for H&R maybe couple years out after Long Island and other assets are stabilized?
I don't expect it to change more than a point or so.
In and around the 48% level?
Yeah. In and around where we are now.
Okay, thank you.
Your next question comes from Mario Saric with Scotiabank. Please go ahead. Your line is open.
One really quick one on Jackson Park. I think, Tom, you mentioned about $1 per unit of upside to NAV on it. How much would have already been recognized in your IFRS values thus far?
Mario, I won't say it to Larry again. In Q4 2016, we recognized just under $55 million U.S. as an increase, and last quarter, 2017, we recognized just under $100 million U.S. I don't know, roughly we've recognized about $150 million.
Around $0.50.
For that's already recognized.
Yeah. You got CAD 0.50 there.
Understood. Okay. Thanks.
Thanks.
Once again, if you'd like to ask a question, please press star then the number one on your telephone keypad. Your next question comes from Matt Kornack with National Bank Financial. Your line is open.
Question on FFO per unit, the bridge between now and 2019. You mentioned the impact this year of the Jackson Park accounting items. Is the anticipation that the existing portfolio will generate positive FFO per unit growth, and then you'll get the benefit of Jackson Park in 2019?
Sorry. We will get the benefit of Jackson Park in 2019 and 2020. Is your question on the rest of the portfolio for FFO?
Yeah, I guess you've sold assets, you've bought. There's a lot of moving parts in terms of-
Right
where things have gone on an FFO per unit standpoint. I think the negative impact that you described, would you expect otherwise flat FFO per unit growth for the rest, and that we should see sort of CAD 0.05 to CAD 0.06 down or-
I would think, Matt, to answer your question, the Jackson Park we've discussed already should be an FFO adjustment down for 2018, or just a reported FFO down.
Right.
For the sale, the retail sale, there'll be dilution from, depending how quickly we can redeploy those units.
Right.
The question was around the portfolio. Not a dilution and not that.
Without those two areas should be coming up pretty much to where analyst consensus was for the rest of the portfolio.
Okay. Fair enough. That's it for me. Thanks.
Once again, if you'd like to ask a question, press star then the number one on your telephone keypad. We do not have any questions over the phone line at this time. I will turn the call over to Mr. Hofstedter.
Thank you all. Look forward to seeing you again, hearing you again next quarter.
This concludes today's conference call. You may now disconnect.