Good morning, and welcome to H&R Real Estate Investment Trust 2024 second quarter earnings conference call. Before beginning the call, H&R would like to remind listeners that certain statements, which may include predictions, conclusions, forecast 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.
In discussing H&R's financial and operating performance, and in responding to your questions, we may reference certain financial measures which do not have a meaning recognized or standardized under IFRS or Canadian Generally Accepted Accounting Principles, and are therefore unlikely to be comparable to similar measures presented by other reporting issuers. Non-GAAP measures should not be considered as alternatives to net income or comparable metrics determined in accordance with IFRS as indicators of H&R's performance, liquidity, cash flows, and profitability. H&R's management uses these measures to aid in assessing the REIT's underlying performance and provides these additional measures so that investors can do the same.
Additional information about the material factors, assumptions, risks, and uncertainties that could cause actual results to differ materially from the statements in the 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 H&R's website and www.sedarplus.com. I would now like to introduce Mr. Tom Hofstedter, Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstedter.
Thank you, and good morning, everybody. Joining me today is our Jason Birken, VP of Finance, and Emily Watson, Chief Operating Officer of Lantower. Larry Froom cannot be with us today. He's traveling. On that note, I'll hand it over to Jason.
Thank you, Tom, and good morning, everyone. I'm very excited to be here today. In my comments to follow, references to growth and increases in operating results are in reference to the three months ended June 30th, 2024, compared to the three months ended June 30th, 2023. H&R's total same property net operating income on a cash basis increased by 1.7%. Breaking the growth down between our segments, Lantower, our residential division, recorded a 0.3% increase, which was primarily driven by the stronger U.S. dollar. Emily will provide more details on this shortly. Industrial same property NOI on a cash basis increased by 4.7%, driven by rent increases for new and renewed tenants, as well as an increase in occupancy.
The tenants that are newly completed industrial properties, totaling 336,800 sq ft in Mississauga are in occupancy. Their free rent period has ended and are now paying rent. We have started construction on three new industrial developments, totaling 357,500 sq ft at H&R's ownership share. The average rent on our Canadian industrial portfolio at June 30th, 2024, was CAD 8.97 per sq ft and is well below market rents, which bodes well for our industrial portfolio, continuing to deliver strong results. During the quarter, we completed four industrial lease renewals, totaling approximately 227,000 sq ft at H&R's ownership share, and achieved an average rent increase of $7.73 per sq ft.
Office same-property NOI on a cash basis decreased by 1.8%. This decrease was largely attributable to a decrease in occupancy at our property slated for future redevelopment. Our office properties are in strong urban centers with a weighted average lease term of approximately 6.3 years, and leased to strong creditworthy tenants, with 88.5% of office revenue coming from tenants with investment-grade ratings. I would like to draw investors' attention to the 7.9% cap rate on our remaining nine Canadian office properties that are not slated for redevelopment. The cap rate jumps from 7.08% last quarter, primarily due to the sale of Corus .
We also increased the cap rate on our remaining three U.S. properties from an average of 7.68% last quarter to an average of 9.02% this quarter. And lastly, retail same-property NOI on a cash basis increased by 7.9%, primarily driven by increased occupancy at River Landing Commercial. In accordance with our strategic plan, we have sold CAD 800 million of property in 2023 in the first six months of 2024. We are very pleased that despite these property sales and the headwinds facing the real estate sector in general, Q2 2024's FFO was CAD 0.306 per unit, compared to CAD 0.297 per unit in Q2 of 2023.
H&R's cash distributions of CAD 0.15 per unit for the quarter resulted in an FFO payout ratio of 49% and an AFFO payout ratio of 61%. Net asset value per unit as of June 30th, 2024, was CAD 19.94 per unit, a decrease from CAD 21.05 as of March 31st, 2024. This was attributable to CAD 427.2 million of fair value adjustments during Q2 of 2024. Debt to total assets at the REIT's proportionate share at June 30th, 2024, was 44.8%, and debt to EBITDA was a healthy 8.5x. Liquidity at June 30th, 2024, was in excess of CAD 900 million, with an unencumbered property pool of approximately CAD 4.1 billion.
Our unencumbered asset to unsecured debt coverage ratio was 2.2 x at June 30th, 2024. With that, I will now turn the call over to Emily.
Thank you, Jason, and good morning, everyone. Today, I'm pleased to discuss our second quarter same-store results from our multifamily platform and share some operational highlights. Our strategic focus is on positioning our portfolio to drive long-term value through geographic diversification, a robust development pipeline, repositioning opportunities, and technology investments aimed at mitigating cost, delinquency, and associate turnover. Our markets continue to experience strong demand for household formation, driven by population and employment growth, apartment affordability, and positive demographic trends. Move-outs due to home purchases remain at historical lows in our Sun Belt markets, accounting for just 9% of our total move-out. Renting an apartment remains an attractive choice, being on average, 60% more affordable than owning a single-family home. Our target renters are high earners with stable employment, which continues to support positive housing performance.
We have seen improvement from our technology innovations with delinquency, as one example, at pre-pandemic levels in bad debt in Sun Belt, returning below the 50 basis points norm. These factors, combined, contribute to a 58% NOI margin, with room for future growth. Given the declining levels of new supply ahead and consistent demand in our markets, combined with the strength of our operating app platform, we are well positioned for substantial growth and value creation in the coming years. Occupancy ended the quarter at 94.6%, an increase of 20 basis points from the first quarter, and 50 basis points increase compared to Q2 of 2023.
Same-property net operating income on a cash basis from our portfolio in U.S. dollars decreased by 1.2% for the three months ending on June 30th, 2024, compared to the respective 2023 period, primarily due to high property operating costs, including property taxes and insurance costs, and a decrease in average rental rates from the Sun Belt properties, which was partially offset by rental growth at Jackson Park in Long Island City, New York, and River Landing in Miami, Florida. Lantower's asset management team oversees capital expenditure deployment, and one highlight of our repositioning capital is Tortuga Bay in Orlando, Florida. Over half of the units have received kitchen, bath, and flooring renovation, with around a 13% return on investment.
Other projects include smart home amenity package with a 30% return, washer and dryer additions with a 55% return, and private yards at a 50% return on investment. Moving to our fair market value. Based on recent sales comparisons, our fair market value capitalization rate for the residential portfolio is 4.55%. We maintain a 5% cap rate for our Sun Belt portfolio, which was further supported by a third-party appraisal received in Q2. Cap rates are expected to remain low, relatively speaking, for institutional-quality assets in the Sun Belt, with capital flows interested and focused on long-term, heavy Sun Belt multifamily allocation. Turning to developments, Lantower West Love in Dallas, Texas, remains on schedule and on budget. We expect to be fully delivered by the end of Q3, with stabilization Q2 of 2025.
Leasing commenced mid-April, and we are currently 31% leased, reflecting strong demand. Our thesis for securing great sites and designing best-in-class product has materialized in a strong initial lease-up at West Love. Our lease-up absorption is well above what industry reports have stated for our market and is above what is budgeted. Also, in Dallas, Texas, Lantower Midtown is progressing well. The first units are prepared for occupancy, with final units expected by the end of the year. We received our first certificate of occupancy earlier this month, and we are encouraged by the high volume of traffic in a short amount of time, a validation of demand for best-in-class product with unparalleled amenities.
On the residential front, as we discussed last quarter, the investor interest in investing alongside Lantower's existing development pipeline was highlighted by accelerated fundraising results, and we feel that this construct will create value for H&R shareholders as well as our residential investors, while maintaining financial flexibility and taking advantage of a favorable, depressed Sun Belt supply pipeline in the upcoming years. We broke ground on both Lantower Sunrise, a 330-unit development in the Orlando market, and Lantower Bayside, a 271-unit development in the Tampa market, in the second quarter, and they are progressing as expected. We expect these developments to reach completion in mid-2026, which we believe to be an excellent time to deliver units.
Lantower currently has an additional eight development projects in the Sun Belt pipeline, totaling over 2,700 suites at H&R's ownership interest, with multiple sites ready and prepared for construction. In summary, the Lantower platform continues to deliver top-tier results relative to our multifamily counterparts. I would like to extend my heartfelt thanks to the entire Lantower team as we proudly celebrate our spot on the 2024 Fortune Best Places to Work in Texas list. This award is a testament to Lantower being an employer of choice that is adaptive, resilient, and innovative. And with that, I'll turn the conversation back to Tom.
Thanks, Emily. With that, I'll turn it over to the operator for questions. Operator?
Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by the one on your touchtone phone. You will hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press star followed by two. If you are using a speakerphone, please lift the handset before pressing any keys. Your first question comes from Sam Damiani from TD Cowen. Please go ahead.
Thanks. Good morning, everyone. Tom, just wondering what your thoughts are on the sort of the acquisition market, disposition market, currently, versus last quarter, what change you may have seen and how you see the market unfolding for the balance of the year as it relates to the REIT's intention to dispose more assets?
So Sam, good morning. We knew that would be your question. You highlighted that in your report last night. The write-down has really nothing to do with the disposition market. It has to do with the strength, the strength of the current value of the assets. There is very little going on, as you well know, as far as dispositions, as far as being able to target what a price will be or won't be. So we don't really have a at this market visit, so we, we don't really have a guidance to give you as what our, our future sales are going to look like. The write-down was predicated on really what's going on in the market today. And what's going in the market today is really very little.
That being said, taking office as an example, if you valuate your assets based upon the present value of its cash flow and a terminal value, and your terminal value is static, as time marches on, you have to write down the asset for the fact that you're taking in income, and you don't know what the extension is gonna look like. Not only do you not know what the extension of the lease is gonna look like, you don't know what the terminal value at the end of that is gonna look like. So bottom line is, if the market doesn't improve in the office, you have to take down a write-down periodically, unless you see some form of a turn in the market.
That could happen also because of interest rates, and interest rates hopefully will come down now that inflation's been tackled to a great extent. But until that does, it warrants a write-down. The land value, which involves our intensification properties, Cove and Gowanus, also reflects the current market where nothing's going on. And as you well know, in downtown Toronto, there was supposedly going to be a deal for 212 King. That never happened, never materialized. We're hoping there was going to be at CAD 160 a foot, but nothing happened there. We have no visibility as to what a trade looks like. But just to be conservative, we took everything down by CAD 10 a foot in Canada, $10,000 a door in the United States, to reflect the fact that there's very little going on.
The reason there's nothing going on is because everyone's building to a 7- yield return on cost. And in order to achieve that with the construction costs and interest rates the way they are today, something has to give. And what gives, obviously, is the one element that has to give is the value of land. So you have to take down the value of land to reflect the fact that people are gonna ultimately have to get their 6.75%-7% yield. The only way to do that is through land reduction. So this doesn't reflect our desire necessarily to change the fact that it's easier for us to sell down the road. It reflects current, regretfully, reflects the honest current conditions of what, where we see the world today.
Thank you for that. Just with what you said, you know, the REIT's overall sort of strategic objectives over the sort of medium term, does it pivot your attention more toward the retail portfolio as a source for dispositions at this time?
So I don't think so. I think that's like, I don't know, something in the market that I can't understand, to be honest with you. Our REIT portfolio, other than, unlike many other REIT portfolios, is not speculative, it's not dangerous, there's nothing. It's almost irrelevant what the expiry schedule is. We have total visibility into ECHO as to what stores are doing well, the lease term, because that's a sister company to the real estate arm, which we own a piece of. And as far as our Canadian retail portfolio, that's as good as you're going to get as far as clipping a coupon, at with solid real estate. That really, you don't have to worry about lease expirations. That being said, there's no urgency to sell those.
That's highly liquid to sell anytime you want. Giving up those assets in today's environment, which those assets are all really a reflection on the economy, a reflection on interest rates, it doesn't make a whole lot of sense. We'll wait till interest rates come down a bit. So in the case of ECHO, we have been looking at it. B ut if the prices are not going to meet to our expectation, and on the Canadian side, if someone comes forward with an offer that reflects tomorrow's values, not today's, and again, today's cap rates are elevated because of interest rates, then we look at selling it. But there's no burning issue to sell these assets at this point in time, not when you're giving up good cash flow, good FFO, in return for what?
For selling at a high cap rate because interest rates are high. Doesn't make a ton of sense. We don't feel the pressure to sell in other words.
Okay, last one for me. Just on, I think last quarter, there was a comment, probably from Larry, that the debt to EBITDA would stabilize around the 9.25% level, before any additional disposition announcements. Is that still, is that still the, the, outlook for the balance for the end of the year?
Hi, Sam. As you know, in the MD&A , we use the trailing 12-month EBITDA, but if you annualize Q2, that ratio would be around 9.2 x.
Perfect. Thank you.
Thanks, Sam.
Thank you. The next question comes from Jimmy Shan at RBC Capital Markets. Please go ahead.
.. Thanks. So when it comes to portfolio trades, there are trades happening in the multi-res, U.S. multi-res sector. I was wondering if you guys looked at those, the KKR, Quarterra deal or even Blackstone, and wondering how comparable would those portfolio be to the Lantower portfolio?
So, good morning. Hi, Jim. So let's take KKR as an example. They reported last quarter, just now, I think a week or something, that they sold that—that they purchased that portfolio, 5,000 units, call it $1 billion, if I recall correctly, and they reported it a low- 4% cap. And that put a little, you know, questions to market. Why is that a 4% cap? How does it compare to Lantower? The answer to the question is, it's very similar in geography, very similar in age, but it's, it's let's call it 18 stories instead of our stick-built, 3 stories. But that's not a huge difference. The explanation needs to be explained why they are a low 4% cap and why we're a 5% cap.
The answer really lies in the fact that KKR didn't buy that asset for their portfolio. They bought it on behalf of an insurance company, whereby the money that had to be spent by the end of June, otherwise they would have lost that allocation. So they were kind of anxious to spend it. They actually bought it at a 5.2% cap. And if you ask the question, well, if leverage is at 5%, therefore it should be neutral to their overall return. They should have achieved a return on cash around 5%. Why is it low- 4%? And the answer is, to the asset management fees embedded in the KKR's charging of that portfolio for asset management fees, brings it down to low- 4%.
So that's not a reflection of—that's a reflection endorsement of H&R's, Lantower's, cap rate overall at the 5%. And, the non-competitive nature of asset managers, because of their fee structure, that brings it down so low. But again, KKR just could, really didn't care. They're managing that money on behalf of an insurance company. Insurance company agreed to pay their fees, therefore, that insurance company is getting a lower yield, not reflective of the market, which is at 5%. So those trades really endorse a low- 5% cap, and I think it's pretty solid. And, Emily can tell you, trades that have gone on, there's around six of them in our markets, that's all around 5.1%, 5.5%, maximum 5.2%, in around where we're at.
So all those trades confirm or validate, rather, our 5% cap.
Okay. No, that's helpful. And, I mean, at low- 5%, though, that sounds like good pricing. And so I know it's not in your strategic plan, but given these type of prices and what appears to be some level of interest, does it make you kind of rethink about sort of Lantower, and could that be a candidate for sale down the road? And how are you thinking about Lantower here?
Lantower is a very, very solid asset, very, very solid, solid platform, very well, pretty solid management group. It really doesn't change anything. The market's all concerned about the fact that there's a whole bunch of units going to be ready, you know, the 100,000 square units that are being built in our market, in Sun Belt markets, and cost pressure on rents. We look at it completely differently. We look at the fact that, it's right now, there's some pressure on the rents. Those units are going to get absorbed in our markets sometime mid- to the end of 2025- 2026. The rents are going to go way up again, because the supply/demand, the balance that no one's building anything.
As I mentioned before, no one's building anymore because they have to build to a 6.757% yield return on cost. That's not really doable in today's market very easily. Your land costs really has to be brought down. You have to buy your land well, and your land has to be ready to go. Lantower is a solid company. It's a keeper. It doesn't make sense to go ahead and increase your exposure to office by spinning off Lantower. You may get a good price for Lantower, but again, the remaining what's behind is going to suffer.
I think we're going to more prudently stick to our original strategy, which is slowly but surely deal with our office, which in our opinion have value when the residential market returns, as an ulterior use for the intensification properties and for our three or four core office buildings. There's sticky tenants, and we expect to renew them and be able to sell the properties ahead of time. So we're going to stay the course, and Lantower is therefore going to be one of our keepers. And ultimately, we're going to achieve the results of that being an industrial slash residential lease.
Okay. And last one for me. You know, Chevron made an announcement that they will move their headquarters to Houston. I just wondered, does that mean anything at all for Hess Tower, and does that mean anything at all for the potential sale of Hess Tower?
So it just adds more confusion to what's going on over there. The courts haven't put down the ruling, what's with the Hess sale at all. So that we expect this coming in November, but my guess is that'll drag, as these things usually do. If Chevron buys Hess and successful, then Chevron has to make the decision where they want to be located. They have space within their existing tower. They have made the announcement they're moving headquarters to Houston, which means they probably need overflow space into Hess to keep the Hess. Until this is all resolved, we have no idea what's going on. If the court case goes against them, Hess is not a saleable asset anymore. Hess can't be sold to Exxon, and Hess can't be sold to Chevron.
Hess will remain a going concern, and therefore will remain in the building the way it is. In either event, it really doesn't have any impact at all on us and our strategy for the tower. We are currently dealing with the 1/3 of the roll that of the building, the rolls in 2026. And I think successfully, we're very confident that we'll achieve our objective to have that leased, and then we have another 12 years to go with Hess. We are very confident with that building. We're very confident with our TransCanada joint venture, TransCanada Tower, TC Tower in Calgary, with HOOPP and with The Bow. Those are all sticky tenants. We expect the tenants to renew, expect them to be there long term. We just don't know what the rental rates will be.
So again, we're the Hess, the Hess situation with Chevron is, I guess, good news that Chevron's consolidating in Houston. It can't be bad news. We just don't know the final outcome. Until you know the final outcome, you can't really sell the asset, because every buyer is going to be asking the same question as you did: Where is Hess going to be located? It has a strong impact on the long-term value of the asset. And so therefore, right now it's we're just dealing with the re-releasing the space. It'll come up in 2026, and I think successfully so. And then we'll see what happens in the next few months with the Chevron- Hess situation.
Okay. Thank you.
Thanks, Jim.
Thank you. There are no further questions. I'll turn the call back over for closing comments.
Thank you, everybody, and enjoy the summer.
Ladies and gentlemen, this concludes your conference for today. We thank you for participating, and we ask that you please disconnect your lines.