H&R Real Estate Investment Trust
Q4 2021 Earnings Call Transcript

Published: 15 Feb 2022

[Operator:]

Good morning, and welcome to H&R Real Estate Investment Trust 2021 Fourth Quarter Earnings Conference Call. Before beginning the call, H&R would like to remind listeners that certain statements, which may include predictions, conclusions, forecasts or projections 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 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 that investors can do the same. Additional information about the material factors, assumptions, risks and uncertainties that could cause actual results to differ materially from the statements in the forward-looking information and the material factors or assumptions that may have been applied in making such statements, together with details on H&R's use of non-GAAP financial measures, are described in more detail in H&R's public filings, which can be found on our website at www.sedar.com. I would now like to introduce Mr. Tom Hofstedter, Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstedter.

[Tom Hofstedter:]

Good morning, and thank everyone for joining us today to discuss H&R's fourth quarter and year-end financial and operating results and provide an update on our strategic repositioning plan. With me on the call are Larry Froom, our CFO; and Philippe Lapointe, President of Lantower Residential. 2021 was a truly transformational year for the REIT. Despite the enduring global pandemic, our teams accomplished many substantial milestones. Through transactions valuing over $4 billion, we successfully enhanced our portfolio's geographical exposure, asset mix and tenant diversification while also lowering leverage and increasing liquidity. In the fall, H&R announced its transformational strategic repositioning plan to create a simplified, growth-oriented business focusing on residential and industrial properties to serve a significant value for our unitholders. Our target is to be a leading owner, operator and developer of residential and industrial properties, creating value through redevelopment and greenfield development in prime locations within Toronto, Montreal, Vancouver and high-growth U.S. sunbelt and gateway cities. The strategic plan encompasses 4 key initiatives. First initiative was the tax-free spin-off to unitholders of all of H&R enclosed malls into Primaris REIT, a new, completely independent stand-alone publicly traded entity. The spin-off simplifies and enhances H&R's asset mix and enables investors to value Primaris' full-service internal national management platform and properties. The second initiative will be the exit of our remaining retail assets, including our grocery-anchored and essential service retail properties and our interest in ECHO Realty. Our $600 million grocery-anchored and essential service portfolio is comprised of high-quality properties anchored by strong covenant tenants such as Lowe's, Metro, Sobeys and Walmart. These 55 properties comprising 2.7 million square feet are 98.5% leased and are primarily located in Ontario. Our investment in ECHO Realty comprises 236 grocery-anchored shopping centers. This portfolio is similarly 95.8% leased, primarily to Giant Eagle, the largest supermarket chain in Ohio and Pennsylvania. Our third initiative is the strategic disposition over time of all our office properties that not offer significant redevelopment potential. There are currently 16 unique high-quality office properties located in central business districts in major cities across the United States and Canada that meet this criteria. These properties are 99.5% occupied with a weighted average remaining lease term of 9.3 years and are leased primarily to strong investment-grade tenants. The development team has been working diligently on the balance of the Office portfolio to advance them through rezoning. We expect these 11 properties to yield 5,300 residential units and 390,000 square feet of industrial space upon approval. Last summer, we commenced the execution of our strategy to exit the office market with the successful sale of The Bow, a 2 million square foot office building in Calgary, Alberta, and the sale of the Bell office campus in Mississauga, Ontario. We are very confident in our ability to sell the remaining Office portfolio in line with our IFRS fair values. The fourth leg of our strategy is to grow our residential and industrial portfolios through the development in prime locations in high-growth U.S. sunbelt and gateway cities. We launched Lantower Residential in 2014, and to date have invested over $2.3 billion with construction of 6 developments expected to start later this year. 2021 was a monumental year for capital allocation, where we made huge strides forward in repositioning the REIT. To date, we have significantly transformed our portfolio of composition, geographical exposure, tenant mix, growth profile and balance sheet. These steps are moving us closer to our goals of streamlining and simplifying our portfolio and company. We have no doubt that we will achieve our disposition objectives. We'd like to be in a position to give you more concrete guidance at this time on our disposition program, but in order to prudently manage earnings, we make sure we always maintain our investment-grade rating. This position should be timed with capital deployment, whether it be for development to buyback units or for acquisitions as funds are acquired. At this time, the best use of our capital is buying back our units, which are trading at a substantial discount to NAV. In 2022, we plan to continue allocating capital diligently, starting with the utilization of our NCIB, buying back 4.2 million H&R units to date for $55 million at a weighted average cost of $13, representing a 27% discount to our net asset value per unit of $17.70. We plan to continue to buyback units if the significant discount persists. With our path forward now clearly established, our teams are executing efficiently and effectively on our plan to create a simplified, growth-oriented company focusing on expanding our residential Lantower platform and industrial portfolio to serve as significant value for our unitholders. And with that, I'll turn it over to Philippe to discuss our residential platform, Lantower. Philippe?

[Philippe Lapointe:]

Good morning, everyone. With the release of our strategic repositioning plan in October that carefully laid out H&R's vision, we are delighted to have successfully executed on the first key parts of this plan. We have shifted our focus to the next steps and are preparing to redeploy capital into our development pipeline as we manage through the remaining divestitures of the legacy office and retail properties. Jackson Park and Lantower Residential developments are especially relevant in giving comfort to unitholders that accretive redeployment of capital into the residential sector is weaved into H&R's DNA. And with that, let's dive into Lantower Residential's impressive quarterly results. When excluding Jackson Park, same-asset property operating income from our portfolio in U.S. dollars increased by 9% and 7.8%, respectfully -- respectively for the 3 months ending on December 31, 2021, and the full year 2021 compared to the respective 2020 periods. Including Jackson Park, same-asset property operating income from our portfolio in U.S. dollars increased by 33% and decreased by 3.5%, respectively, for the 3 months ending on December 31, 2021, and for the full 2020 year as compared to the respective 2020 periods. River Landing is a unique $500 million mixed-use development located in Miami, Florida. It's residential component leased up a full year ahead of schedule, while also capturing market rents above our expectations after increasing rents 7 times throughout the lease-up period. For example, on a net effective basis, our current lease rate is over 40% over our initial lease rate when the lease-up began. River Landing is truly a one-of-a-kind asset for the Miami market, and its exceptional design will provide H&R with a tremendous competitive advantage for years to come. As we mentioned previously, we are experiencing substantial rental growth momentum in all of our U.S. sunbelt markets. By way of example, our new lease trade-up for our entire portfolio, excluding Jackson Park, was approximately 14.7% throughout quarter 4. As an additional interesting data point, we have renewed or re-leased approximately 55% of our rent roll during those 8 months. Thus, we are encouraged by the strong demand fundamentals in the residential sector and very excited by the expected future value creation. On the development front, Lantower currently expects to break ground on at least 6 distinct projects in 2022 and further developments to follow in '23. In 2022, we expect to break ground on 6 projects

[Larry Froom:]

Thank you, Philippe, and good morning, everyone. The fourth quarter of 2021 was a very active quarter for H&R with a number of moving parts. We have added additional disclosures to the financial statement notes and MD&A to help understand the effects of the post sale and Primaris spin-off. In October 2021, the REIT sold its ownership in the property known as The Bow in Calgary, Alberta to Oak Street Real Estate Capital. The sale to Oak Street included a sale of 40% of the future income stream derived from The Bow's lease with Ovintiv until the end of the lease term in May 2038. In a separate transaction, H&R sold a further 45% of the future Ovintiv lease stream to Deutsche Bank. Total gross proceeds from the two transactions were $946 million. Effectively, after these two transactions, H&R is left with a 15% interest in The Bow's lease to Ovintiv, which runs to May 2038. The retail and option to repurchase 100% of The Bow for approximately $737 million or $368 per square foot in 2038 or earlier. This favorable call option is substantially below the current sale proceeds and provides H&R the ability to capture potential future upside in the Calgary office market over the next 16 years. Although the REIT has legally transferred ownership of The Bow to Oak Street, because of a favorable option to repurchase, the transaction did not meet the criteria of a transfer of control under IFRS 15, and as a result, we, a, continue to account for The Bow and investment properties on the balance sheet; b, recorded the net proceeds received by the REIT from these transactions as deferred revenue to be amortized over the remaining term of the lease; and c, we'll continue to record 100% of the lease revenues from The Bow, even though we only actually receive 15%. For FFO purposes, we have deducted the crude rent from the Ovintiv lease as well as added back the accretion finance expense on The Bow's deferred revenue. I encourage all of you to read Note 10 to the financial statements. In that note, we've also disclosed the income statement of The Bow for the quarter and for the year ended December 31, 2021, and have disclosed how much of that income was received in cash and how much revenue has been accrued for IFRS accounting. On Page 9 of the MD&A and in the press release, we have also expanded this financial statement note to reconcile The Bow's net income to FFO and AFFO for the quarter and year. We will continue to include this information going forward, and we welcome feedback as to how we can improve the disclosure and our border disclosure as a whole. The successful sale of The Bow and Bell office campus significantly reduced H&R's Calgary office exposure, improved the REIT's asset and concentration risks and improved our overall credit metrics. This transaction was critical to enable the successful spin-off of Primaris with the low leverage capital structure that it has, while at the same time, reducing H&R's overall leverage. The results from the Primaris spin-off -- of the Primaris properties are included in our results for the quarter and year ended December 31, 2021, but the property's assets and our abilities were not consolidated into H&R's balance sheet at December 31, 2021. Under IFRS, the spin-off is treated as a distribution to unitholders on December 31, and the details of those can be seen in Note 13D to our financial statements. We have also provided disclosure isolating Primaris' financial results for the 3 months and year ended December 31, 2021, including reconciliations to FFO and AFFO. This can be found on Page 11 of the MD&A and is included in our press release. Included in H&R's property operating income for the 3 months and year ended December 31, 2021, was $34.6 million and $134.1 million, respectively, relating to the 27 properties being contributed by H&R to Primaris REIT. Turning to our Office segment. Same-asset property operating income on a cash basis increased by 4.9% as compared to Q4 2020 and was primarily due to Hess Corporation's lease expansion agreement with full rent commencing in July 2021. Office occupancy was 99.2%, a testament to the high-quality nature of our Office portfolio. Retail same-asset property operating income on a cash basis decreased by 0.7% for the 3 months ended December 31, 2021, compared to Q4 2020, primarily due to the weakening of the U.S. dollar. Excluding this impact of foreign exchange, same-asset property operating income increased by 2.2%. As a reminder, the Primaris properties were excluded from same-asset. For our Industrial segment, same-asset property operating income on a cash basis decreased 3.4% compared to Q4 2020, primarily due to vacancy at an Oakville, Ontario industrial property. Overall, FFO per unit decreased from $0.42 in Q4 2020 to $0.35 in Q4 2021, primarily due to the property sales. Included in Q4 2021 FFO are debt prepayment costs totaling $4.7 million. Excluding this prepayment cost, FFO for Q4 2021 would have been $0.36 per unit. Moving to the balance sheet. At year-end, debt to total assets at the REIT's proportionate share, which has been adjusted to exclude The Bow, was 46.6% compared to 51.1% at the start of the year, and debt to adjusted EBITDA was 7.2x.Unencumbered assets as a percentage of unsecured debt was 1.95x coverage, an improvement from 1.48x at the beginning of the year. H&R ended the year with ample liquidity. We had cash on hand of approximately $124.1 million and $952.4 million available under our unused lines of credits. In addition, we have an unencumbered property pool of approximately $4 billion. And with that, I'll turn it back to Tom.

[Tom Hofstedter:]

Thank you, Larry. I'm very proud of what we have accomplished in 2021. Transacting on over $4 billion of real estate is no small feat, and I thank our loyal and hardworking employees for their tireless dedication, flexibility and adaptability through this considerable period of change at H&R. We will endeavor to continue the cadence of our work and perform in 2022, executing against our strategic repositioning plan. Management and the Board remain fully committed and are actively evaluating opportunities to increase unitholder value and address the significant discount at which our units trade to the REIT's $17.70 net asset value per unit. Management, members of the Board and their families collectively own more than $300 million or approximately 8% of the equity in H&R REIT, providing strong alignment with unitholders in pursuit of the REIT's objectives. Looking ahead, we recognize that we have an opportunity for better and broader communication of our strategic repositioning plan, in addition to continuing to demonstrate meaningful steps to arrive at our capital allocation goals. We are very excited about the future of H&R, and want to impress upon everyone on the call that 2022 marks the beginning of a new era for our company. Equipped with a strong balance sheet, significant liquidity, enhanced portfolio concentration to large primary markets with strong population and economic growth, we are very well positioned to take advantage of opportunities. We'd now be pleased to answer any questions. Operator, please open the line for questions.

[Operator:]

Our first question is from Mario Saric with Scotiabank.

[Mario Saric:]

Just with respect to the planned dispositions over the next 5 years, inflation is a really hot topic these days. So when you think about the disposition program that you're having and the conversations that you're having with potential buyers, how has that evolved over the past 6 to 9 months as inflation becomes kind of increasingly a subject of discussion?

[Tom Hofstedter:]

That's an interesting question. So -- because you're targeted to inflation, which is as quite -- I don't think that's paramount in everyone's minds. It's more the -- what I would have thought. It's more the uncertainty about the future of office, which we all know is a question mark, and the future of retail in light of what's going on out there and has gone on to the pandemic. I never actually heard anybody asked the question the way you have, which is in light of how is inflation. Although you could be off to something, I don't think that's a concern of the market. In the case of H&R, we've had numerous discussions. Obviously, we're looking to sell what we should be selling. So we've had discussions. Nothing surrounds around inflation, it surrounds around the uncertainty. But in the case of our assets, we have long-term leases with credit tenants and in good locations. So it really doesn't have a big impact on our valuations or on the demand for our assets. I think our assets are better positioned even than Royal Bank, which is one of the few assets that actually sold recently because it's more bite size than that large asset. Our largest asset, which is The Bow, involved creativity in selling it. The balance of our portfolio we've been looking to sell does not involve the level of creativity, it's straightforward real estate. In all cases, just about the rents are below market, almost all cases. And so we're expecting high demand. We don't think that's a very big challenge to achieve our goal and be able to sell at IFRS values. Probably, we'll be able to sell at significant values in excess of that. I give it to you, our Corus asset on the waterfront in Toronto is a good example of long-term lease, good tenant and very desirable asset, very typical of a lot of the assets we own. I don't think inflation is our problem. Inflation only manifests itself into what your opinion is on interest rates, and everyone will have different opinions on that. And that will affect every sector of real estate, whether it's in our Lantower division or our Office division. But right now, the inflation is not the issue, it's really the sectors and what are the demands, what are the buyers' expectations in the sectors of office and retail. And again, for our portfolio, which is high quality, surprisingly, enough through this pandemic, retail has survived in the form of a single tenant grocery. The ECHO portfolio is probably with more -- substantially more than with pre-pandemic. Sales are way, way higher. The company is way, way strong. It paid off all its debt. And all of our single-tenant retail assets are very simply sold without any question at all. So I don't have any hesitation to tell you that I'm very confident we'll be able to transact on a very timely basis. I don't think inflation is really key on everybody's minds.

[Mario Saric:]

Yes. I guess, rather than classifying as a potential challenge as perhaps maybe coming from the opposite end of the spectrum, and so far, as presumably a lot of that $3.4 billion has contractual rent increases, whether it's inflation indexed or based on some other measure, do you have -- which in an inflationary environment would presumably be more attractive as opposed to less attractive? Do you have a sense in terms of what percentage of that $3.4 billion would have inflation index leases or could contractual rent step-ups, so like, which are annually 5 years or so on and so forth?

[Tom Hofstedter:]

Yes. I can honestly tell you, the answer is 0. We don't -- none of our leases are CPI oriented, only upon you have a catch-up upon expiry. Everything else, for the past many years, are 10%, which is 10% refi-ed or 2% annually. Other than the latest trend in industrial is seeing 3% to 4% annual escalators, but that's just the industrial world. Retail, as you well know, does not even have the 2%. It has -- if you take a Shoppers or you take a Metro, it's $0.50 on a $13 rent. It doesn't align itself with the historical 2% or 10% of refi. Our portfolio there, for whatever is leased, has the contractual rental escalations. We've been using 2%, 1.5% to 2% annually for a long time. I think, inflation may have an impact on the rental growth. And as I said, you've seen it dramatically change overnight in the industrial world where it is -- in Canada is 3%. In the United States, it's tracking 4% on annual escalators.

[Larry Froom:]

Mario, just to be clear, so most of our property on our Office is long-term leased that does have contractual rental bonds. What Tom is saying, they're not linked to inflation, but they do have contractual rental escalators.

[Tom Hofstedter:]

Yes, 10% every 5 or 2% annually, whatever the case may be. None of them are annual escalators based on CPI. The industry doesn't even have that. Not even in industrial, do you see that. You see again a higher level of 3% to 4%, but you never find annually contracted based on CPI. I don't think you'd find tenants very receptive to that formula in America.

[Mario Saric:]

Got it. Okay. Two more quick ones on and I'll hand it back. In terms of the targeted 3% same-property growth in '22, could you perhaps break that down by vertical and how much of that would be as a result of what were expected bad debt expense in '22 versus '21? And then secondly, is that business 3% essentially, your long-term annual target growth with the revised portfolio?

[Larry Froom:]

Thanks, Mario. It's Larry. I'll try and answer that question. Basically, most of our growth will be coming from the residential portfolio. We're targeting on the residential portfolio significantly higher growth, circa 3%, which will be offset by the rest of the portfolio, which is probably slightly below the 3% or call it, office and industrial around 1%. A lot of industrial and office has -- although it has contractual rental escalators, those will affect the cash, but don't affect FFO. They only affect AFFO, not FFO. But overall, 3% is reasonable for the overall portfolio.

[Mario Saric:]

Okay. And then my last question. Just in the past, you provided some disclosure on the Jackson Park and River Landing NOI and FFO. I may have missed it this quarter. But if I haven't, is that something you can provide for Q4?

[Larry Froom:]

No, good question. We do not provide the disclosure. Jackson Park basically is -- for Q4 was operating pretty close to stabilized operating income. So no need to adjust for that. However, I do want to caution, going forward into 2022, although its operating at full stabilizing -- most of the lease-up that happened at Jackson Park happened in Q2 and Q3. There were concessions given when that lease-up occurred in terms of free rent months to the tenants. Some of that occurred at the beginning of the lease and some of that will occur at the end of the lease. So we're expecting in Q2 and Q3 of this year 2022 that there will be a slight drop-off on the current level at Jackson Park achieved in Q4 just as those concessions come up in Q2 and Q3. As far as River Landing goes, as Philippe mentioned, the residential is fully stabilized. The retail has been slower due to COVID. And so that is not operating as near stabilized yet, but probably won't be stabilized till the end of 2022.

[Tom Hofstedter:]

Well, I'll give you an update on River Landing. Just on the point of LIC, the reason that Larry is mentioning the concessions go over a period of time is because we didn't want to have roles where the tenants are competing with each other. It's a typical industry. So an incentivized tender to take longer-term leases, so we don't have expiries banging up against each other. We staggered the concessions depending on what was a year, 2 or 3-year lease. And that's why you're seeing them go into the future longer than they normally would have. In the case of River Landing, as Larry said, the residential totally stabilized its lease. So rental obviously hugely, significantly higher than originally forecasted. Usually are $2.40 going back when we do our projections, and we're hitting $4-ish right now, so way, way higher. The Office, thank God, is doing very, very well. We have 3.5 floors of office in total, let's call it, 140,000 square feet. The top floor is now leased long term, 20 years, to the county -- sorry, 10 years to the county. That's floor #7 and part of 6. Floor #5 is now leased fully on a 20-year basis to Jackson Memorial Hospital. 1M, which is a 17,000 square foot floor, is basically been approved and done to Jackson Memorial, not prove -- not gone through the Board yet. It went through the Board. One Board member got COVID, which seems to be the story of life right now. So the meeting was delayed to February 24. And the final little bits and pieces that are left, the part of the sixth floor, and it's right now a bidding war between 3 tenants that are in the area that have to move because they're building is being demolished. So we expect the office building will be fully leased within the next, I don't know, 90 days or so, at least all -- everything other than maybe a slight part of the sixth. And it will take us -- the first 10 is moving into the county. That's in March of this year paying rent. Jackson Memorial starts construction in -- of the leaseholds in around 30 days or 45 days, once the plans are approved and we have a permit. So I expect the rest of the office to be up and fully paying rent by Q4 towards the end of the year, for sure. The retail, now all of the restaurants based on the river is done, leased. Construction, it's an expensive build-out, it's a very high profile, it's very high in demand, river restaurants based today. So it's leased. It's leased to quality tenants. The build-out is going to be expensive, as I said. You can have the anchor tenant, which is the oldest restaurant chain in America coming in and taking their flagship, which is a 17,000 square foot store comprised of riverfront space, ground, mezzanine and rooftop. And that will be commencing construction probably in 45 days. All of the restaurants based on the river should be occupied by the end of the year. It's fully leased, as I said. It's just a question to build out. And the balance of the retail space is substantially leased or under LOI. Again, it should be totally stabilized by the end of the year.

[Mario Saric:]

Okay. Thanks for the color and the detail, Tom. And I, for one, am looking forward to the property tour, if and when H&R organizes one.

[Tom Hofstedter:]

So we're dying to take everyone there. The sooner the better. I'm just waiting for -- as you are prepared to head over. I'd love to show you the property. It really is spectacular.

[Operator:]

Your next question is from Matt Kornack with National Bank Financial.

[Matt Kornack:]

Just quickly, Larry, going back on the Jackson Park impact. In terms of that higher cost in Q2 and Q3, can you give us a sense as to the quantum of that number? Because I did notice sequentially, the JV costs came down quite a bit quarter-over-quarter.

[Larry Froom:]

Matt, I expect it will be somewhere, in terms of the overall annual basis, somewhere between $5 million and $6 million lower than on an annual basis. We'll take a USD 6 million based on for the concessions that are coming due in Q2 and Q3.

[Matt Kornack:]

Okay. No, that's helpful. With regards to the U.S. multifamily development, can you give us a sense as to the CapEx outlay when those projects ultimately will start throughout the course of this year and maybe an expected spend for the next 2 years on that development?

[Tom Hofstedter:]

Philippe, do you want to take it?

[Philippe Lapointe:]

Yes. Sure. So excluding The Cove, which is just kind of a different animal in and of itself, the 5 in the sunbelt, we're actually launching West Love, Midtown and Bay Side. West Love and Midtown are being launched in about 30 days. Bayside should be within the next 60 days. And then in the fourth quarter of this year, I think we launched Sunrise and CityLine. So we should have 5 active developments by the end of this year. As it relates to -- I'm sorry, so as it relates to total spend for 2022, I think, obviously, the sequence -- are you asking how much we're going to spend in '22 or what is the total construction budget for all 5?

[Matt Kornack:]

If you could give both and kind of the ramp-up as to how that construction process looks and how the capital outlay looks.

[Philippe Lapointe:]

Sure. I mean, Larry, chime in whenever you want. But as it relates to kind of the spend for '22, we're looking somewhere in the ballpark of about $150 million in '23, a blend of, obviously, the 6 additional starts in addition to continuing the construction for 5, so we're looking at probably another $380 million. Those figures, by the way, are in U.S. dollars. On total spend approximately, I don't have the exact numbers in front of us because we have it on a blended basis. But if I was to take the 2022 starts in total, their construction budget is going to be somewhere in the realm of about, I'd say, $400 million to $450 million. As a matter of fact, I've got the data somewhere here. But that's pretty much the right ballpark.

[Matt Kornack:]

Okay. And then construction timeline, it seems like it's around 2 years to complete those projects. And then, I guess, from a capital allocation and financing standpoint. In terms of the asset sales that would ultimately go to fund those, are you thinking of prefinancing, financing for the development cost itself, or waiting until completion and then selling assets thereafter?

[Philippe Lapointe:]

Yes. So Matt, obviously, all great questions. First of all, let me just circle back. So I have the data in front of me. It's about $408 million for the 5 assets that are launching in '22. As it relates to financing, frankly, we have a ton of optionality. And I think we're exploring all avenues as of right now. I don't know that we've landed on one, frankly, because of how dynamic, but frankly, how plentiful the financing options are for our developments. The point of the construction period, which I thought was really interesting, which is a departure from our past, is that the full recognition of the FMV of the asset is really done upon receiving the certificate of occupancy. And so I know that we were once upon a time asking ourselves, well, when does that full value recognition happen as we're looking at a Gantt chart of all of these 11 starts. And obviously, delighted to see them impacting NAV in a positive matter probably towards the fourth quarter 2024. So we lease up -- the lease-up for the 15 -- sorry, the 2022 starts actually begins next year. And so by the end of '23, we'll have 11 development projects. We're going to be nearing the end of the 3 of the 5 launched in '22, but we're also going to be in the middle of our lease-up for the 3 that we're launching within the next 60 days. So by the end -- in other words, by the end of '24 -- sorry, by the end of '23, early '24, I expect the completion of some of these assets in addition to the full recognition of the fair market value and an important contribution to FFO.

[Matt Kornack:]

Okay. Sounds like you've got a lot of exciting things ahead of you on that front. Just quickly on the Oakville industrial asset. Obviously, it's a strong market. Can you give us a sense on the timing of when that should be into same-property NOI?

[Tom Hofstedter:]

I would say we're negotiating with 3 players right now. You're right, the market is very strong. We initially had it under contract and around it -- it was initially rented to $5 square foot when the tender rolled out, went to $9 and the tenant that was -- that we lost. And right now, we're circling more like $14 a square foot. I think you'll see it leased up within the next 120 days and then occupancy 60 days thereafter. There's no problem with the asset. It's -- what happened was -- what was -- a name that you know leased it up. We had some issues. We had to rezone a parking -- excess parking to make it part of the building. We got through all of that, and that tenant couldn't wait around. That -- but meanwhile, the tenant paid for all the costs. So the downtime was paid for by the tenant and now it's just back in the market. There's no problem with the asset. It is state of the art. And as I said, it should lease in the $14 range.

[Matt Kornack:]

Okay. That's good. And then last one for me. I mean, you don't have much in the way of lease maturities. It sounds like at least Q1, you should have very strong same-property NOI growth, we'll have to adjust for some of the stuff on Jackson Park. But is there anything we should be concerned about? It seems like you've got a pretty good profile from a same-property NOI growth on the residential and industrial side and the office is stable, retail stable. Nothing in the office or retail that we need to worry about in the next 12 to 20 now?

[Tom Hofstedter:]

No, there's really nothing.

[Larry Froom:]

Nothing that we're worried about and we in '21 and '22.

[Tom Hofstedter:]

And that's why we say, we're confident we can sell the assets, back to Mario's initial question, we really are. These are assets that are rightsized. They are high-quality tenants. They're long-term leased, and they're good, good properties. But we'll have no problem selling them and interest rates grow, but I don't think it will be an impairment to our IFRS values.

[Matt Kornack:]

Okay. Great. And congrats on finishing a busy year, and it looks like you've got a few more ahead of you.

[Operator:]

The next question is from Jimmy Shan with RBC.

[Jimmy Shan:]

In your MD&A, the reference made to the $0.52 distribution resulting in a FFO payout ratio of 45% to 55%. And just kind of -- so it would imply an FFO of between $0.95 to $1.16. So I was wondering, how do we think about that number? Is that a run rate? Or -- and what kind of assumptions are embedded in that comment?

[Larry Froom:]

Jimmy, it's Larry. It's a good question. We -- our FFO, our distribution is about $0.52. We've tried to give you the best guidance as we can, expecting it to be between -- payout ratio to be between 45% and 55%. Obviously, there's a lot of moving parts between -- potential dispositions may happen. In the meantime, we can't give any further clarity. So for us, that's our expectation along with other comments I've given on the call up until now.

[Tom Hofstedter:]

Don't forget, it really depends on how we redeploy the proceeds from dispositions. If it goes into development, it's not accretive with those into -- and we're selling a 3% cap versus a 7% cap, it's going to have a huge impact. And that's why it's almost impossible for us to answer that question accurately.

[Larry Froom:]

Right. I mean, also the dispositions, are they going more into buying back our units or -- there's a lot of moving costs, right? Overall, we're just giving you the guide.

[Tom Hofstedter:]

Right. We can't even tell you how many units we're buying back.

[Jimmy Shan:]

No. No, that's fair. That's why I was wondering like what's -- what are the assumptions embedded in those 2 goalposts, right? Like it is a range. But like on one hand, are you assuming a lot of asset sales, or is that just a rough target that you think you'll hit at some point in time?

[Larry Froom:]

It's a target based on certain assumptions. I don't think it's appropriate to keep going into all the details of how much dispositions we expecting to sell, whether it may or may not happen as long as you have any thought of that information -- misleading information.

[Tom Hofstedter:]

As I did mention, the timing of disposition is going to be very much geared to the use of proceeds and how much of our NCIB we actually have to fund. So we can't just sell and report cash. We have ample liquidity, as you well know right now, to really do no dispositions. So we're going to sell on an orderly basis when the opportunity is there to get above-market pricing or when we have a strong use of proceeds. So it's very, very difficult for us to answer that accurately. If we knew the answer, we'd give it to you.

[Jimmy Shan:]

Okay. Fair enough. Just on the multi-res development, clearly, you have an active pipeline and the development yields look pretty interesting. Are you seeing any cost pressures at all perhaps eating away at those yields? And then second comment on that is, you mentioned the properties are now being valued without lease-up discount. I was curious as to kind of what you're seeing out there in terms of how investors are underwriting rent growth in this market.

[Philippe Lapointe:]

Jimmy, it's two great questions. The first is, yes, obviously, we're seeing a lot of upward pressure in some of the prices, specifically lumber and the unavailability of labor. But I would say that we've accounted for all of that in our yields and then some. And so I don't want to have faith, but I think we can withstand a normal plan increase up until we sign, obviously, our GMP contract, at which point the burden for these cost overruns now shifts from us to our nationally recognized general contractors that we select in our respective markets. And so, I'm not -- while I am seeing what you're seeing, I am not all that worried because of, again, the cushion, but also not to mention the fact that we are underwriting conservative rents. And so kind of dovetailing in the second part of your question, that rental growth that we're noticing across the board, we've only partially underwritten in our development yields. And so I think all in all, net-net, we have enough of a cushion there to give me the confidence in obviously sharing those development yields. As it relates to my comments on no lease-up for discounts and how people are underwriting rental growth, yes, I mean, the amount of equity, frankly, that is entering our space on a monthly basis just does not seem to increase -- sorry, to decrease. It's just constantly increasing and increasing. And so, what that ends up happening is, ultimately, there's very limited supply of available opportunities and the demand made it so that everyone is rushing to buy assets, income-producing or not. As far as what their underwriting on rental assumptions, frankly, I wouldn't be able to speculate as to what the other groups are doing. But suffice it to say that I'm sure most groups are underwriting a healthy renewal and new-lease increases above and beyond, frankly, the historical averages that we've seen. And that probably translates into why we're seeing record level low-cap rates for available U.S. multifamily, especially in the Class A space.

[Operator:]

The next question is from Sumayya Syed with CIBC.

[Sumayya Hussain:]

Just a question on the Union Street property and the development. Just wondering if you're seeing more of those kinds of deals in the pipeline as part of the residential development strategy, or is the thought to primarily utilize the existing assets for redevelopment?

[Tom Hofstedter:]

So sorry, it didn't come out clear. Can you repeat, please?

[Sumayya Hussain:]

Yes, just wondering about the Union Street acquisition in the quarter, and if we should see more of those kinds of deals in the pipeline.

[Tom Hofstedter:]

Oh, I see, Union Street. Sorry, I couldn't hear. So will you -- it's opportunistic. We have a division run by Matt Kingston that goes after -- was actually doing all of the reintensification projects in Toronto, for example, or the . In Vancouver, we have the Telus Tower that's being reintensified over there as well. So that is his level of expertise. We haven't made the commitment to go to residential in Canada, and that's why we didn't want to get involved in Dufferin Grove. Nothing wrong with Dufferin Grove. Obviously, it's a great asset. We just didn't want to make a commitment that we'd be building residential vertical in Canada. So this is a sale leaseback. It's not dilutive to us, and as such, is for just the luxury of buying it wholesale before the process of the zoning is going to happen. That's not the issue, but it allows us to buy at $75 of billable and sell later on in a couple of years now at $125 a square foot. In the 3 years when the lease is up, we expect the values to increase substantially. At that point in time, we'll elect either to sell or develop, but definitely no commitment develop. Will you be seeing further these properties if the opportunity arises, where we can buy at a wholesale pricing, not dilutive to our FFO, then we will consider them.

[Sumayya Hussain:]

Great. And then just wondering about the cap rate move on the residential segment has declined a bit from last quarter, and I was wondering if that's just a result of the strong rent growth and recovery or based on any specific transactions. Just any color there would be helpful.

[Philippe Lapointe:]

I'm sorry, Sumayya, you're not -- maybe it's on my end, but you're not coming in clearly. Would you mind restating that question a little bit louder?

[Tom Hofstedter:]

It's not a question of louder, it's gurgled. Sorry, I apologize. It's -- we have the same problem. For some reason, it's muffled.

[Sumayya Hussain:]

Okay. Let's try again. Hopefully, it's better. My question was around the slight movement decline in the multi-res cap rate. I'm just wondering the assumptions behind that, if that's just based on the all-around strong rent growth or any specific transactions that you can speak to.

[Philippe Lapointe:]

Yes. Okay. So thank you...

[Larry Froom:]

Sorry, Philippe, I'll just start on the historical and you can give forward-looking, maybe a bit of color on what you're seeing in the market. But I think the decrease in our cap rate was subdued to Jackson Park and the lease-up that was achieved in now full occupancy. That was the result of the decrease in our cap rate now Q4 compared to Q3. And then, Philippe, I know you want to give some color on what you're seeing on the cap rates on the market.

[Philippe Lapointe:]

Sure. I mean, I think this ties into the answer I gave previously, I believe, to Jimmy. But the demand for multifamily is obviously record-level high. Cap rates are definitely in the 3s. Now the issue is we've got two things. Cap rates have compressed very, very quickly. And so we do not want to be overly aggressive with some of our assumptions, which is why we apply the current cap rate that we have on the IFRS while recognizing that it probably will need adjustments at some point in the future. But frankly, the other mitigant is this increase in interest rates. And so if this were to continue and the rate hikes were to materialize, what does that mean for cap rates on a going-forward basis? Frankly, there's a little bit too much volatility, in our opinion, regarding cap rates. And so we're trying to be prudent with a -- some may say overly conservative cap rate applied to our NAV. But right now, cap rates are definitely in the -- well into the 3s, not the 4s.

[Operator:]

The next question is from Jenny Ma with BMO Capital Markets.

[Jenny Ma:]

So just continuing on the multifamily development. I'm not sure if I missed it, but did you disclose a yield on the 2022 projects, or in other words, would it be similar to what we've seen for some of the current development projects in that low 6% range?

[Philippe Lapointe:]

Jenny, yes, I believe in the latest publication or last quarter's publication, we did apply a development yield. Those development yields remain, generally speaking, unchanged. I don't know that they're low 6s. I would say, on a blended basis, they're, let's say, a shade under 6%.

[Jenny Ma:]

Under 6%, okay. Okay. So when we look at the 2022 starts, you guys have been selling some of the partial interest in the development. So the 6% that are slated to start this year are all at 100%. Is it fair to say that, that suggests these are sort of built to keep and really it was the partial interest you're looking at selling?

[Philippe Lapointe:]

Yes. The modus operandi or at least the investment thesis behind the partial developments were, frankly, optionality. It was the opportunity at no cost to us, so no promote to the developer to tag along and to benefit from their expertise in gateway markets, specifically on the West Coast and frankly, get a better feel for the market, identify whether or not we want to expand in those markets. And what we've -- I think I mentioned this on a previous call, what we quickly realized was the appetite for those assets versus, frankly, where we can redeploy that equity, but also on a risk-adjusted basis, we thought, was a little bit out-of-whack. And so we're more than happy to dispose of the assets at, obviously, record prices. I think that should that continue, we would be obviously -- we will welcome another opportunity to, call it, co-developer participate in JV developments on the West Coast with that group. We're currently looking at other opportunities. I wouldn't be surprised if we had more to announce in the future. But those developments, the delta, frankly, between the going-in cap rate, the stabilized development yield and ultimately, the going-in cap rate is too wide for us to meaningfully expand that presence. Now dovetailing to our 100% developments. Yes. So we're developing all of those assets with the intent on bringing them into our portfolio. Now that's not to say that all of them will fit the bill, but that's certainly the intent initially.

[Jenny Ma:]

Okay. So when we consider that against your comments about the market cap rates sort of in that 3% range, and that was very helpful, are you looking across your portfolio to see if there's any of those out-of-whack opportunities where you might be able to crystallize some value? Like how do you consider the potential for that versus the desire to continue to build out the multifamily portfolio for H&R? Like are you going to strike while the iron is hot or are you going to take a much longer-term view and try to build up as much of a portfolio as you can and as quickly as you can?

[Philippe Lapointe:]

Yes, it's a great question. It's something that I with, our portfolio managers here in Dallas, probably meet once a month and have those conversations, which we take a look at their entire portfolio and come up with a buy, hold, sell recommendation and explore that. I would say, though, in today's market where we've got rents increasing very, very quickly with very low or minimal capital investment, where back in the day you had to have a significant value-add strategy to achieve these returns, I would say that now is probably not the right time to dispose of any existing assets because of the exploding NOI. In other words, I don't know that we would be able to sell at a price where we'll be rewarded as opposed to just managing the asset for another year or two and seeing where this NOI kind of stabilizes. That's not to say that we won't be selling our assets. We've got -- on an average age, we're about 6 years old portfolio-wide, but there are some assets that were built in the early 2000s. Those may represent on a risk-adjusted basis, especially as we look at the CapEx coming down the line. We may look to sell. But again, with the disposition in the U.S., you have to always look at the potential 1031 exchange in the acquisition. So you're essentially buying into the markets you're selling. And so that's not to say we wouldn't do it, but I would like to see an arbitrage opportunity where I could benefit from today's market while not necessarily buying a fully-priced asset. Those opportunities will happen, I just don't think they'll come soon.

[Jenny Ma:]

Okay. Well, then maybe those pressures aren't so out-of-whack if you think about that. Okay. So there was a comment, maybe this is for Larry, in the MD&A about H&R's ownership of some Primaris units. I'm not sure I follow that. So I guess, my question is, right now, are there some Primaris units on the books? And is that something that's really a technical residual from the spin-off or is that something strategic and you might be looking to hold some Primaris units, to some extent, on a constant basis?

[Larry Froom:]

Jenny. Yes, we do have Primaris units on the books. That resulted from the spin-off of the -- getting them in return for the exchangeable units that we hold, that in other words, the exchangeable units were supposed to be switched into H&R units and Primaris units. And so we've got Primaris units to satisfy that obligation.

[Jenny Ma:]

Okay. So is it just something you hold in anticipation of fulfilling that obligation? So it's really just like a stagnant piece of it, or how should we think about it?

[Tom Hofstedter:]

It's not strategic, Jenny. It's the -- there's no relationship between Primaris and H&R, and it's not strategic.

[Jenny Ma:]

Okay. Okay. So this is just a technical comment on the spin-off, okay. Perfect. And then lastly, when we're thinking about leverage, you had a nice step down as a result of all that's happening in Q4. Do you have a specific target leverage you're getting to? How do you consider paying down debt versus buying back stock? Is the latter really dependent on pricing? Like how should we think about your target leverage, say, in the next 12 to 24 months?

[Larry Froom:]

That's a good question, Jenny. And again, there are many moving parts to it. But we'd like to keep it in the range where it is. It may trend slightly higher and then come back down as you do a disposition. So that may slow up and then come back down as we sell assets. But basically, we'd like to try and keep it where it is, and we would like to try to keep our credit rating on secured credit ratings. .

[Tom Hofstedter:]

No, we will keep working on better ratings. We understand that very clearly.

[Larry Froom:]

It is our goal that we are trying to keep trouble behind.

[Tom Hofstedter:]

We believe that debt level pretty much...

[Larry Froom:]

where it is.

[Jenny Ma:]

Okay. So the capital allocation towards unit buybacks, Tom, I think you had mentioned was really a function of where the stock would be trading then.

[Tom Hofstedter:]

Right. What do I say? I'll tell you, we hope it trades nice and low.

[Operator:]

The next question is from Sam Damiani with TD Securities.

[Sam Damiani:]

Two questions. The first one, sort of following up on one of the ones that Jenny just asked. On the unit count, there was some discussion, some reference to the gross-up in the MD&A with some -- potentially some added units of H&R being issued post quarter end. Is that true? And is that basically meant to offset the NCIB activity year-to-date or vice versa, I should say?

[Larry Froom:]

Yes, that is true. Subsequent to the year-end, January cost, what happened was -- and it was all outlaid in the circular to unitholders that exchangeable unitholders, for tax reasons and other -- many other reasons, wanted to only have H&R units. They don't want to get the Primaris units. So although we've got Primaris units, in orders exchange for them, we had to promise them a gross-up of the exchangeables so that they were economically equivalent to what they were before without getting Primaris units. So those Primaris, short answer, we don't have to hold on our balance sheet. We are free to sell them. And instead, the exchangeable unitholders will now get more H&R units than they previously had. And that's laid out in our subsequent events note disclosure.

[Tom Hofstedter:]

But there's nothing -- Sam, it has nothing to do with our NCIB. Our NCIB is totally related to the fact that we have capacity, and we're trading at a huge discount to NAV. So it's our best use of proceeds right now.

[Sam Damiani:]

Okay. Two quick follow-ups. So the unit count for H&R is higher today than it was at year-end?

[Larry Froom:]

The exchangeable units, yes, are higher. They went from like 13 to 13.4 -- these rough numbers, of the 13.4 million to roughly 18 million units outstanding for the exchangeable unitholders.

[Sam Damiani:]

Okay. And then secondly, if you have the Primaris units to...

[Larry Froom:]

And then -- sorry, Sam, just to interrupt. And then, obviously, the regular units have decreased by the activity that we've been doing on the normal course issuer bid.

[Sam Damiani:]

Right. That's separate, exactly. Understood. Okay. And then so is there any reason you would continue buying back stock given the development starts that you're planning for the rest of the year and I guess, so far, the lack of disposition activity?

[Larry Froom:]

There's no reason.

[Sam Damiani:]

Okay. And just on the disposition side, is there a level of dispositions by year-end '22 below which you'd be disappointed? .

[Tom Hofstedter:]

That's a really vague question. I didn't take my heart gauge to know what disappoints me right now.

[Sam Damiani:]

Hoping for a simple answer.

[Tom Hofstedter:]

I don't know. There's no answer. We're definitely going to sell something. You'd be disappointed in me, very disappointing if we sell nothing. And that really doesn't answer your question.

[Sam Damiani:]

That's an answer. Maybe one quick one since those were quick. The yields on your '22 starts, I think you were saying before sort of high 5s or below 6% on your current assets. Are you thinking close to 6% on the '22 and '23 starts?

[Tom Hofstedter:]

Sorry. Are we thinking below, call it, 5.5%, 5.75% on the '22 starts? Yes, we've said that earlier. What's your question?

[Sam Damiani:]

I just wanted to clarify.

[Philippe Lapointe:]

Sorry, Sam, are you asking about whether or not the starts in '23 are in line with our development yields for '22.

[Sam Damiani:]

Asking whether or not you could -- the comment you made, Philippe, earlier about sort of a 6% -- below 6% was in reference to the '22 starts.

[Philippe Lapointe:]

Yes. So it was referencing at '22 starts, but I would say that '23 starts are going to fall in line, if not higher, just given the benefit of time and increased rents. I mean, I suspect that you're probably focusing on what everyone else is focusing, which is ultimately the unbelievable value creation that these 11 starts are going to contribute to H&R. And if you take the delta between, frankly, those yields and where current cap rates are, it becomes very clear to us that that's where an interesting component of the value creation for the upcoming years is going to come from. And why, frankly, you could see the excitement in my voice and everyone else's.

[Tom Hofstedter:]

Yes. But Sam, just a note of caution. The cap -- to adjust your cap rates, our NAV values for the residential hasn't happened as quickly as it should because the cap rates have come down too quickly, which means that when it was 4.25% 6 months ago, it could have a 3-handle on it or 3.75%. I don't know if that's sustainable. So Philippe is talking about 5.75% to 3.5%. The 3.5% is probably not necessarily sustainable. If interest rates rise, the 3.5% will go up. In Canada versus the United States, which is a more mature market, I'd say, because it's much smaller. You have Toronto, Vancouver. In Toronto and Vancouver, you really don't have a whole lot else. Sometimes you have Montreal. You saw the land values go up. So there's a lot of developers in Canada. The prices have got frothy and the profit accrues to the landowner. In the United States, because there's so much more abundance of land, there's only more cities to participate in, the land values didn't go up as so acutely as they did in Toronto. Therefore, there's still a lot of room to make profit in the United States until those land values go up. Now in some cities, Orlando, Tampa, they have pretty close to double since pre-pandemic today. But that still doesn't take under the effect that the cap rates are down to 4.5% to, call it, 3.75% or something. I don't know when you're talking your numbers, if you should use 3.75% is sustainable. I think you should go back to your modeling and say, 2 years from now, we're building it today at 5.75%, we're probably going to be looking more like pre-pandemic 4.5%. Therefore, if it does stay at 3.5%, I can assure you that the costs are going to go up, but they're going to go -- they're going to translate into going up in land, not necessarily in building. Building is a commodity, land is not. Land is -- the profit always will accrue the land guy. So I don't think you can use 3.5%. I don't think we're going to take down our risk values to 3.5% just because there was a couple of transactions that Blackstone bought at 3.5%. That's not necessarily indicative of the future.

[Operator:]

We have no further questions at this time. I'll turn the call back over to the presenters.

[Tom Hofstedter:]

Thanks, everyone, for joining us today. We look forward to continuing to update you on our progress over the upcoming quarters. Have a great day.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.