Good morning, and welcome to H&R Real Estate Investment Trust's 2022 Q2, 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 expectation of management regarding the 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 statements in the forward-looking information and the material factors or assumptions that 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.sedar.com. I would now like to introduce Mr. Tom Hofstedter, Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstedter.
Good morning, I'd like to thank everyone for joining us today to discuss H&R's second quarterly financial and operating results. With me on the call are Larry Froom, our CFO, and Philippe Lapointe, President. I'm delighted to share with you today our strong Q2 results. Our results highlight the quality of our properties and the embedded growth within our portfolio. The portfolio's organic growth, coupled with unit buybacks, are creating value for our unitholders. Dispositions announced to date, furthering our portfolio simplification strategy. Capital allocation is our utmost top priority and where our focus remains. Year to date, we have recycled capital out of or have under contract to sell CAD 406 million of office, retail, and other non-core assets and repurchased and canceled CAD 250 million of our units.
Highlighting a few key dispositions is the CAD 120.7 million agreement executed in July to sell the Canadian office property located at 100 Wynford Drive in Toronto. H&R will have an option to repurchase the property, thereby retaining future redevelopment optionality at no cost to our unitholders. We also entered into a CAD 47 million agreement to sell the second Canadian office property in Calgary and two Canadian retail properties in line with our office values, providing further support to our net asset value. The closing of these sales remains subject to certain customary conditions being satisfied and are expected to occur in September 2022.
Our net asset value per unit grew to CAD 21.06 at Q1 to CAD 20.14 at June 30, 2022, driven by the 10.5 million units that we purchased and canceled under NCIB during the quarter, organic net operating income, and the growth of and strengthening of the US dollar. Year to date, we have bought back 22.1 million units at a weighted average cost of approximately CAD 13 a unit, representing a substantial 41% discount to our NAV per unit of CAD 22.14. Our active unit buyback and very strong same-property net operating income growth are driving NAV growth and financial results. With today's strong quarter results, we are on our way to creating a simplified, growth-oriented company that will surface significant value to our unitholders.
With that, I'll turn it over to Philippe to discuss our residential platform, Lantower.
Good morning, everyone. I'm happy to be on this call to discuss the Q2 updates and to go over our quarterly highlights. Before I do, I wanted to thank our investors for their time, generosity, and feedback over the last 90 days. While the team and I are encouraged as H&R has been among the best-performing Canadian REITs year to date, we still have a lot of work to do and look forward to sharing more exciting updates before year's end. The U.S. Sunbelt and Gateway markets continue to experience amplified population and income growth, driving affordability in our rental portfolio. As of Q2, our rent-to-income ratio sits at approximately 20%, well below the standard benchmark for affordability, and so we are confident that we will continue to see strong future rental growth, however, not at the detriment of a resident's ability to pay.
Inflation is undoubtedly another area of conversation regarding how the overall economy will impact multifamily fundamentals. The common thinking goes that with inflation comes equivalent expense increases. While we do expect some increased cost creeps in the future, we have experienced only marginal increases in most expense categories. Through operational efficiencies stemming from our smart technology initiatives, self-guided leasing, and negotiated national accounts, our quarter-over-quarter and six-month year-to-date expenses have actually decreased slightly compared to the same time periods for 2021. More good news, as we have seen in previous quarters, we are continuing to experience substantial rental rate growth in all of our U.S. Sunbelt markets. By way of example, during Q2, our new lease trade out for the entire portfolio, excluding Jackson Park, was approximately 16.6%.
Moving on to Jackson Park, we continue to see positive trends in the amount of traffic, renewal rates, and number of leases executed. At the end of Q2 , Jackson Park's occupancy was 97.2%. The percent of residents renewing their leases during Q2 hovered in the high 50% range, which reflects another quarter of continued strength in demand fundamentals for the New York City rental market. On to dispositions. In June, we strategically disposed of our only asset in San Antonio, Texas. Given that San Antonio did not fit in our long-term growth strategy, we felt it prudent to dispose of that asset at a premium to our fair market values, further reinforcing our conviction in our NAV. We intend to reinvest the proceeds in our core markets and to transfer the equity in a tax-efficient manner into more accretive long-term investments.
On the portfolio evaluation front, considering what is occurring in the capital markets and the ongoing adjustments to monetary policy, we erred on the side of caution regarding valuation cap rates. While we are still witnessing competitive sale processes and believe in the sustainability of our values, we have elected to increase our portfolio's cap rates by an eighth of a point. However, in light of our rent and NOI growth, our overall portfolio value actually increased slightly in Q2. We feel confident that our strong NOI growth fundamentals will support our valuations despite the potential headwinds of future cap rate expansion. On the JV development front in Hercules, California, phase two of our development, named The Grand at Bayfront, received its final certificate of occupancy in March and is currently 59% leased.
Shoreline Gateway, our Long Beach tallest residential tower at 35 stories, has seen strong renter demand and is now 69% leased. On the wholly owned development front, Lantower West Love in Dallas, Texas is on schedule as we expect to lay the foundation for the tower crane in the coming weeks. Also, in Dallas, Texas, Lantower Midtown recently broke ground with site work well underway. Lastly, in Tampa, Florida, we are wrapping up the building permit for a development called Lantower Bayside. This development will consist of 271 units and is expected to break ground in the coming months. More good news on the development front. Again, during Q2 , we successfully rezoned a 5.8-acre land site from industrial to multifamily. This project will consist of 430 apartments and is adjacent to downtown Dallas.
Also, in Dallas, we closed on C Line phase two land site, which will accommodate 250 apartments on an eight-story podium development next to our currently planned 295-apartment, five-story wrap development in North Dallas. In April, we closed on an infill site along Highway 19 in Clearwater that will accommodate a 400-unit, five-story wrap development. Lastly, in late June, we closed on a 381-apartment garden-style development site in South Atlanta, Florida that sits at the entrance of Neo City, a mixed-use development anchored by a planned research park.
Our residential development platform is supported by our land pipeline of over 5,000 potential units at a basis of approximately $28,000 in US dollars per unit, which is a substantial discount to the 50,000+ per-unit pricing that we are seeing in the Sunbelt markets for similar A+ sites such as ours. In summary, we have continued excitement about the future value creation opportunities at H&R. With that, I will pass along the conversation to Larry.
Thank you, Philippe, and good morning, everyone. As Tom mentioned, we are excited to report our results this quarter, which reflects our simplified portfolio strategy and alignment with properties producing higher growth. That growth is clear from our year-to-date results of same-property net operating income on a cash basis, which grew 19% compared with the first half of 2021. Q2 total same-property net operating income on a cash basis continued to be strong and grew 18.8% compared with the same quarter last year. Our residential division led the way with a 43.7% increase or 39% in US dollars for the quarter, primarily due to an increase in occupancy at Jackson Park in New York, which was in lease-up last year. Excluding Jackson Park, growth was a very healthy 20.8%.
As Philippe has already discussed, Lantower Residential continues to see significant increases on new leases and renewals. Same property NOI cash basis from office properties increased 23.2% for the quarter, primarily due to the burn-off of Hess Corporation's rent-free period that expired in June 2021. Excluding the rent-free period, the increase is 1.5%. Our office properties are located in strong urban centers with a weighted average lease term of 8.5 years and leased to strong creditworthy tenants. I would like to point out that only 5% of our total office footage is subject to lease expiries between now and the end of 2023. 23,000 sq ft expires during the remainder of 2022, and 349,000 sq ft expires in 2023.
Retail same-property NOI on a cash basis decreased by 3.5% for the quarter, driven by higher non-recoverable property operating costs at River Landing Commercial, which is in lease up. Two major tenants are expected to commence occupancy in the near term. A 49,000 sq ft lease in Q4 of this year and another 63,000 sq ft lease in Q1 2023. Industrial same-property NOI on a cash basis increased by 4.9% for the quarter, primarily due to increased occupancy and contractual rental escalations. During the quarter, we leased the vacant 314,000 sq ft industrial property at 2121 Cornwall in Oakville, Ontario, which will commence in Q3 2022. H&R has a 50% ownership interest in this property.
We also completed a five year lease renewal on a 371,000 sq ft Montreal property at our ownership interest, with rent set to increase by 125% in January 2023. Overall, FFO for Q2 2022 was CAD 0.284 per unit, and AFFO per unit was CAD 0.257. Based on our distributions of CAD 0.135 per unit for the quarter, our AFFO payout ratio was a very healthy 52.5%. Debt to total assets at June 30, 2022 was 44%. We finished the quarter with cash on hand of CAD 71.7 million and CAD 619.6 million available under our unused lines of credit.
Our net asset value per unit grew from CAD 21.06 at March 31st, 2022 to CAD 22.14 at June 30th, 2022, primarily due to the purchase and cancellation of 10.5 million units under our NCIB and the strengthening of the US dollar. We repurchased these 10.5 million units at a weighted average price of CAD 13, a 41% discount to the CAD 22.14 NAV per unit at June 30th, 2022. In summary, we are very pleased with our Q2 results. Our high-quality portfolio properties are well positioned to produce strong operating results going forward. With that, I will turn the call back to Tom to open up for questions.
Go in.
Wherever you want.
Operator.
If you would like to ask a question, please press star followed by the number one on your telephone keypad. To withdraw your question, please press star one again. We'll pause for just a moment to compile the Q&A roster. Our first question comes from Sam Damiani from TD Securities. Please go ahead. Your line is open.
Thanks. Good morning, everyone, and congratulations on the solid results. First off, just on the dispositions, Tom, perhaps with the agreements set on these latest acquisitions set in June, obviously the process was underway in the spring during the market volatility. What if you tell us how that went? You know, what sort of buyer you're working with and how the pricing compares to the fair values at Q1.
Are you referring to the U.S. retail result?
No, I'm referencing, sorry, specifically, 100 Wynford and the three other assets that are also under contract.
Oh, I see. In line with our IFRS values, the right to purchase is because it has residential intensification potential, although that's down the road. We control the rezoning and, that's why we gave ourselves the right to buy it back.
Was there any fair value change on them during the quarter to true them up to the sale price?
No.
Okay. All right. That's good. Overall, the process like how would you characterize the process given the market volatility?
It was an off-market deal. I can't respond to your question on market volatility. If it would have gone to the market, I can't speculate, but since it was an off-market deal, it was very fluid.
Okay.
It was not an issue.
Okay. And just on the leasing in the residential and industrial side, have you seen any deceleration of momentum that would indicate, you know, slowing of the economy in your portfolio?
Hi, Sam. It's Philippe. No, not yet. We're still having, obviously, record level of renewals. As I previously mentioned, we're seeing a renewal rate that is in line with what we've seen in the last three quarters. Obviously paying close attention to the data, making sure that we're not increasing our rents at the detriment of our residents' balance sheets. No, we're not noticing any slowdown whatsoever.
Just on the same-property for Lantower, excluding Jackson Park, it was over 20%, I guess. You know, how does that portfolio do that? It's stabilized, I guess. I'm just kind of struggling a little bit with the math.
Sorry, Sam. One more time. How does the-
Too loud.
Yeah, how does the what? It's not coming across clearly on our end, Sam. I apologize.
Sorry, one sec, Sam. Let's just decrease the volume.
Sam, do you mind repeating the question?
Oh, sure. Yeah, no, just wondering how does a portfolio that's, you know, mid- to high-90s leased, you know, how does it generate 20%+ same-property? I guess, was there some properties that had an occupancy increase year-over-year? You know, just I guess help us understand how the occupancy and the rent change would triangulate into a 20%+ same-property NOI.
Yeah, I mean, Sam, the math is really simple, right? If you're looking at, if you think about our NOI margins of the upper fifties, I think it's 57% or 58%. As I previously stated, no significant expense creep year to date. Yet, I can't recall what we did last quarter, but we did 16.6% this quarter. The math is ultimately simple, right? It doesn't time perfectly. No, it's not an occupancy thing. It's purely a matter of revenue growing at a very fast clip and expenses somewhat muted.
That, you know, the muted expense experience that you're enjoying right now, is that something you see, you know, somewhat sustainable just given the specifics of the portfolio? Or will you see ultimately the portfolio being impacted by the macro inflation that we're seeing?
I think 95% of the expense creep that folks are experiencing, we've abated through us leveraging. It's not just us, right? Some of the larger publicly traded REITs in the US have done the same. Our utilization of technology has really muted that expense creep that are the folks who hadn't made the investment in the last 18 months are now, I guess, wishing that they had. Having said that, I think there's nothing that technology can do to help our property taxes and insurance. I would anticipate, and we're obviously accruing for it, but I would anticipate there being year-over-year some significant re-increases, especially on property taxes, as you would imagine, given that our values are obviously skyrocketing as a result of our very healthy NOI growth.
Kathleen, aside, to answer your question, no, I mean, I'm not surprised to see that there hasn't been much of a change because of the monumental investment we made on that side of the house, two years ago and last year.
Yeah. Okay.
Really, credit goes to the team in Dallas for really pushing that through. I mean, on the back end of COVID, it was a very difficult setting. Some groups had done it. It hadn't been completely proven yet. Despite that, there's a tremendous amount of leadership in Dallas that saw it through, and the execution was near flawless. So much credit goes to the team that saw the implementation of the tech packages.
Great. Thank you. I'll turn it back.
Our next question comes from Jenny Ma from BMO Capital Markets. Please go ahead. Your line is open.
Thanks. Good morning.
Morning, Jenny.
Maybe just expanding on the multifamily metrics. Philippe, did you say that there was 16.6% same-property rent growth in the portfolio?
That's right. For the quarter.
Okay, great. Can you talk to us about how you are raising rent on renewals on your tenants? You know, obviously there's the technology yield management software angle, but given how tight the market is, are you leaning on that or are you looking at the tenant's individual financial situation and trying to push as far as you can without losing them? How does that rent growth differ across the markets you're in?
It's a great question. I think generally speaking, I'll answer the last question first. Generally speaking, we see the same thing across the board only because we have. At Jackson Park, we happen to be in Sun Belt markets, and so the story is similar in North Carolina, Florida, and Texas. As it relates to the renewals, in Q1 , I'm using round numbers, but in Q1 , our renewal rate was about 4.5% in terms of the increases that we are asking of our current residents. The reason we had done that was a self-imposed governor. In Q1, much of the growth came in new leases. The delta between new leases was probably, and I'm stumbling, but my guess is anywhere between 12%-15%.
These were seeing some very healthy 18-20% increases in Q1 . This quarter, I think the delta is less than 2%. We took the governor off, and I think our renewals are somewhere in the ballpark of 14%-16%, as is our new leases. On a blended basis, it's a much more balanced increase that we're seeing. You know, in some respects, unexpectedly, our renewal ratio is also, I don't know if I'm lying. Last quarter was in the low 60s. This quarter is approximately 6%. Historically, we've seen anywhere between 40% and 50%. Not only are we increasing at a very healthy clip, but they're also renewing, you know, they're renewing at a healthier clip than we've seen in the past.
My biggest concern and what keeps me up at night is ultimately the balance sheet and the credit of the residents as we're increasing rents, whether on a renewal, new leases, is it really coming at a detriment of their balance sheet, more importantly, their ability to pay. I take comfort in knowing that the 20% rent-to-income ratio of 20% is almost identical to what it was in 2018 and 2019 in pre-COVID, which leads me to believe that there's still a ton of runway left.
Are the tenants willing to pay these higher rents because market rents are just going up across the board? Or is there any element of the housing market cooling down, with affordability actually getting worse and maybe some tenants that may have bought, let's say, last year or earlier are more inclined to stay? Is there any element of that in your markets?
Yeah, I mean, it's a great question. I think just to summarize the question, there's an enormous shortage of housing, period. Right? Apartments and homes in the Sun Belt markets. And there's obviously it was true before COVID, with COVID and the migration patterns within the U.S. that just exacerbated the issue. Obviously with interest rates rising, I don't know what the latest was, but a couple weeks ago, you can get a mortgage for about 5%, and ultimately what that made was an otherwise already expensive purchase that much more unattainable for residents. What we're seeing and what the data would suggest is that the
On the right side of the standard deviations, our residents are staying longer, but they're also a little bit older in our communities, and I think that's because of a lack of opportunity for them to move up to another house or frankly, there's just a lack of supply for them to move from one community to another. I think all of those factors play, or come into play. The truth of the matter is there's an enormous undersupply of apartments in the Sun Belt. Frankly, the stats that we're seeing in 2023, 2024, we think construction starts are gonna start plummeting. It's gonna exactly, like, further exacerbate the issue. I think that it is more a supply issue. There's a ton of demand.
There's just not enough supply to meet the demand, and therefore what we're seeing is obviously these very healthy increases across the board.
Okay, great. Turning to the development, is the intent of H&R still to eventually sell the partial interest that you have in Shoreline and Hercules phase two? Just wondering if you could comment on whether or not the buyers of previous partial interests might be interested in coming back for these ones?
I think the answer is yes, they're definitely meant to be sold.
Mm-hmm.
They weren't meant to build to core. They're also in markets that we're not in. From an operational standpoint, I don't know that it would make a ton of sense. We wanna be opportunistic. Frankly, we think that perhaps now is not the right time to be selling those assets, but in short order, they will be sold. Now, whether to our partners or to a third party, my guess is it's probably gonna be a third party. There's gonna be no shortage of buyers for that type of product.
When you say now is not the right time, do you mean just given the uncertainty in the market or the fact that it's a partial interest makes it harder to unload? Could you expand on that point?
No, it's not a partial interest because we're all on the same page. We're selling it as one, so it really isn't.
Okay.
You know, lack of liquidity for that discounted interest. No, I think it's more along the lines of given the potential headwinds that we've got than the fact that the property's not stabilized. We believe we could be wrong, but we believe that to get maximum pricing, I think it'd probably be best if we waited for the assets to be leased to about 80%. For Shoreline, we're at 69%. Hercules, we're a little bit behind that. In Q4, Q1 feels like just about the right time to put what we believe to be a best-in-class asset to the largest audience possible.
Okay. Gotcha. On the dispositions, for the Section 1031 like-kind exchange, I think your sales exceeded the land purchases in Florida. Does the Section 1031 like-kind exchange apply to land acquisitions, or is it just for IPP? I'm just trying to figure out if you could maximize the room that you have on Section 1031.
No, you absolutely can do it for land. We still have proceeds left to deploy. As Paul mentioned, you know, we're obviously very busy on the disposition side, both in Canada and U.S., and we're exploring a variety of opportunities. Whether those funds are commingled with other disposition proceeds or in and of itself, they will be reallocated to either land for development or income-producing assets within Lantower.
Okay, great. My last question is, when looking at the leasing activity, particularly with the industrial assets in Oakville and Montreal, just wondering if you can give us a bit more guidance on how to model that income coming in, I guess, Q4 and perhaps Q1 of next year.
Hey, Jenny. It's hard to say 'cause it's single tenant assets, and I don't wanna be cute. You know, it's just we have confidential agreements with our tenants. To give you the rents and what the increases are, I think is a bit unfair on them.
Okay.
Given you what I can, they are substantial increases. You know, ballpark, The one in Montreal is coming off, you know, about a CAD 5 per sq ft rent. You can model it that way. I think we said 125-
Okay.
% increase. Okay.
Yeah. Jenny, they were all leased in relation to the market. There was no discounts or was really-
Right.
It's a very vibrant market, and we got the market for it.
Right. Montreal is gonna have that big step up. Oakville, remind me, was it vacant throughout Q2?
Yes.
It's gonna be a big step.
It is.
Okay.
Oakville's was vacant for, you know, about nine months.
That's right. Okay. All right. I will run the math on that. Thanks very much. I'll turn it back.
Thanks, Jenny.
Hmm.
Our next question comes from Matt Kornack from National Bank Financial. Please go ahead. Your line is open.
Good morning, guys. I guess, Larry, just a quick follow-up to Jenny's questioning there on Oakville. Is there any fixturing or otherwise that would prevent it from being cash rent in Q3, or is that a cash contribution?
That is a good question. Is there a free rent period? I am not sure.
One month.
I've been signaled that there's a one-month rent-free period.
Okay. Perfect. Also follow-up to Jenny. With regard to Shoreline and The Grand, can you give a sense as to I know it's in the joint venture portfolio, and you're only a one-third interest, but the NOI contribution, how you think that kind of ramps up as you lease up? I know you have to get over your threshold of covering costs. There may not be much there, but just what should we expect on that front?
We've got estimated figures, but what I'll tell you, Matt, is, just I guess from our perspective, rather than trying to underwrite what a stabilized NOI is, I think you just tuck in the back of your mind the fact that we will be proceeding with dispositions of those assets. They weren't meant to be held, but in the event that they were to be held. Approximately both of them on a combined basis that our interest is approximately $6 million.
Okay. Do you know if it wasn't negative in the quarter, but was it above zero at this point or?
It was actually slightly negative.
Okay.
It was a couple hundred thousand dollars negative in the quarter.
Okay. No, that's helpful. Then on the CAD 110 million that is being held as restricted cash on the Section 1031, you're pretty certain that you will ultimately find an acquisition that you can put that tax benefit to? Is that fair to say?
Yeah. Without kind of tilting our hand, we're gonna have some exciting updates for the following quarter, but we're seeing some pretty enticing mispriced arbitrage opportunities, especially in the Sunbelt. Not meaning to be cute as a flex, but stay tuned and hopefully we'll have an interesting Q3 to expand on that very question.
Okay. Nope. Fair enough. The last one for me, just, there's been some transaction activity at some pretty impressive pricing for Caledon or close to Caledon land. I know you have a fair value that's not included in some of these H&R adjusted interest cost numbers for the industrial land in Caledon, but can you give us a sense as to where you're holding that on your books on a price per acre?
CAD 2.5 million an acre.
Okay. Some recent transaction activity proves that out, if not more.
Well, there's been one at 2.5%, but there's been more acreage around 3%.
Okay.
There's nothing that's been below 2.5 that I'm aware of.
Fair enough. Okay. Thanks, guys.
Our next question comes from Sumayya Syed from CIBC. Please go ahead. Your line is open.
Thanks. Good morning. Just wanted to go over 145 Wellington with the zoning progress this quarter. Just wondering what the next steps, if you guys are in discussions or received interest or just what the plan is with that asset.
Oh, I'm sorry. I couldn't hear the question. Can you repeat?
Yeah. Just wanted to, I guess, go over 145 Wellington, given the zoning progress in the quarter. Just wondering about next steps, if there's any discussions or interest, on that asset.
No. Right now, it's leased, and we've achieved zoning, as you know. Right now we're gonna just burn off the leases. There's no immediate plans to redevelop or to sell.
Just turning to Lantower, wondering if you could go over just the turnover trends in the portfolio and how they're sort of comparing to what you've seen historically.
Sorry, did you say renewal items or renewal?
Renewal volumes.
ratios?
Turnover trends.
Turnover trends. They're historically as low. Back to my original point, our renewal ratio is in the low 60s, and now in Q1 it's around 60%. In Q2 ., if i look back over the last nine years, it's probably a little lower than 50%. Not only are we achieving record rental rates, but also record renewal percentages. That's also true at Jackson Park in New York City.
Okay. Just sticking to U.S. multifamily, just wondering if there's any update or changes on the transaction market side in terms of pricing momentum having moved from last quarter to today.
No, it's surprising. I must admit, it's somewhat unexpected, but frankly, you know, the sheer amount of equity and capital that wants to be placed in multifamily, either because of a preference for that asset type or frankly, just the ability to come on and to have that explosive growth is rendering most of the properties that's still being valued in the mid 3%. What I think is going to happen is, as evidenced by our disposition in San Antonio, arguably our least best performing asset in the sleepiest of all of our markets, it's still achieving a 3.6 cap rate. I don't see there being any softness in our fair market values.
I think the transactions that are going to occur in the next 60 days as everyone comes off from their summer breaks and activity picks up post-Labor Day, we're gonna see further transactions being done at a sub-4 cap rate. Despite the fact that the interest rates may imply that there'd be negative leverage in the first year, the fact that people are growing their rental-wise at 14, 15% and getting out of that negative leverage very quickly is enticing to both private and institutional capital. In short, no. If anything, the amount of calls, the inbound calls that we receive on our own assets from folks trying to secure them on an off-market basis at those numbers give us additional comfort in our fair market values.
Okay, great. Thank you.
Our next question comes from Jimmy Shan from RBC Capital Markets. Please go ahead. Your line is open.
Thanks. Yeah, just on the office assets that you have in the process of rezoning, can you remind me how are they being valued on the balance sheet? I guess I'm thinking specifically at 145 Wellington now that it's rezoned. Is there an incremental value or are those assets essentially being valued as if they're existing office properties?
It's valued as an existing office property, but in reality, what happens in the entire REIT sector is the value of the revenue producing asset has gone up and the cap rate has been lowered by the fact that you'd have an intensification. It's not valuated, and you'll find the same thing with Choice and RioCan and everybody else. They're not valuating it based upon CAD 250 or CAD 300 a sq ft. They're valuating it based upon a decreased cap rate overall for someone buying a revenue producing asset. You can see when the old CICA-CSA building on Wellington she sold to Westdale, it was actually sold on the same basis as well as more aggressive cap than actually a valuation based upon the residential and commercial density that would be available upon rezoning.
In essence, you do get a lift, but you don't get a lift, a full lift to the market value as if it's land value. You get a lift, as a more aggressive cap because the buyer is not buying a project that's shovel-ready at this point in time, as we have tenants in place.
I see. The aggressive cap, I guess, embeds the incremental density. On 145 Wellington. Safe to assume the value was, is even with the rezoning, we shouldn't see any kind of lift this quarter or next quarter?
Not this quarter, but my guess is you'll find the value increase over time as we get closer to burn off of the lease. As now the fact it was just recently rezoned falls into our reappraisals.
Yeah. Just a bit more color, Jimmy, that we did a revaluation. We had a third party appraisal on that asset in Q1, and we got a bit of a bump up based on the expected rezoning. The expected rezoning came subsequent to Q2 , so we didn't change that value from Q1. There should still be a little bit more of an uptick now that we actually have it in our hand, that rezoning. But we didn't change it from Q1, where it was still expected. It was a bit of a discounted based on the expected rezoning that we now expect.
At the time it was recent on the rezoning. You can expect it to increase gradually, but not to the level of the value as vacant land.
Okay. Got it.
The appraisers will never do that. They won't give you the full value.
Right.
That's just the way the system works.
Okay. On Wynford Drive, maybe this is too simple, simplistic way to look at it, but the embedded upside in the rezoning of that asset is effectively the difference between sale price and the option price. Is that how kinda if I were to gauge what, you know, what that incremental value could be? It's essentially that CAD 39 million difference, less time value of money that
Sorry, I don't understand the question, but I'm also not hearing you well.
The question is, how is that repurchase option priced? Was it based on the revalue of the potential?
No, it's not priced at all. There's no math to it. It's just a negotiation.
The potential of the rezoning is far more.
Understand that the rezoning is speculative at this point in time. We have absolutely no idea what's gonna happen or when it's gonna happen. It's, we are controlling the process, but we're not confident that it's necessarily gonna happen and/or what we're gonna achieve and what we're gonna have to give to the city in order to get it. It does have the potential, therefore, we retain the rights. I wouldn't evaluate that option as significant. I don't know. It's totally speculative. It's very similar to the option in the Bow, which I can't put a dollar amount on either. The real question you should ask yourself is, can I sell that option today? What would someone pay me for that option today?
The answer is, since that person would have to pay in cash out of their pockets, they probably wouldn't pay a whole lot, but it does have, as a freebie, a whole lot of potential value. Good luck trying to evaluate it. It's not evaluated in our books at anything at this point in time.
Lastly, just on top of the valuation. On U.S. multifamily asset pricing, some of the U.S. REITs are commenting, seeing cap rates moving as high as 50-100 basis points in markets like Dallas, Raleigh. They're talking about 4-4.5, from 3-3.5 at the peak. I don't know, cap rates are tricky these days I think. I don't know what NOI people are capping. I'm just trying to square that with what you're talking about kind of sub-4. Is it that we're seeing pricing pressures in certain different types of assets or not? I'm just trying to see if there's any comment you can make in that regard.
No, I'm not disputing the information you received. It's just that it's not indicative in any of the data sets that we're looking at. You know, we're tracking about in every market, so I think I mentioned this previously, but we track about 100 live deals to get a better feel for, in the event that we had to make a quick acquisition or we are looking to take advantage of a mispriced opportunity. Most of the opportunities that we're sort of taking a look at, I would argue almost 90% of them are at a sub-3.7-3.8 cap rate currently.
Now there haven't been many trades, but I think the one confusing part is I think everyone is pontificating on cap rates because naturally you would expect cap rates to expand based on the cost of capital, and more specifically the cost of debt. However, there haven't been many trades, if any, certainly not any public trades, that would support a cap rate moving above 4%. Now, what happens in the next 90 days? You know, who knows? But again, I'm not looking at anything right now apart from the odd mispriced opportunity here or there by perhaps a developer that's distressed.
I would argue that most folks that are active in the market currently looking at current stabilized opportunities in the Sun Belt, in the Class A asset class, there are no low cap rates to be found.
Okay. Thank you.
We have no further questions in queue. I'd like to turn the call back over to Philippe Lapointe for closing remarks.
Thank you everyone for joining us today, and we look forward to continuing to update you on our progress over the upcoming quarters. Thank you and have a great weekend.
This concludes today's conference call. Thank you for your participation. You may now disconnect.