H&R Real Estate Investment Trust
Q1 2021 Earnings Call Transcript

Published: 14 May 2021

[Operator:]

Good morning, and welcome to H&R Real Estate Investment Trust's 2021 First Quarter Earnings Conference Call. Before beginning the call, H&R would like to remind listeners that certain statements which may include predictions, conclusions, forecasts or projections 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.

[Tom Hofstedter:]

Good morning, everyone. I'd like to thank you all for joining us here today. With me on the call are Larry Froom, our CFO, Pat Sullivan, COO-Primaris, Philippe Lapointe, COO-Lantower; Alex Avery, Executive Vice President, Asset Management and Strategic Initiatives, and Robyn Kestenberg, Executive Vice President, Corporate Development. It has now been over a year since the pandemic began and the world came to a halt. The past year has had challenges, and our Q1 results remained impacted by the difficulties some of our tenants face. The REIT's business however has shown stability and resilience despite a few notable areas of softness. We have continued to acquire to position H&R for success as the pandemic impacts fade and the economy reopens broadly. Now I'll turn it over to our team to provide details of the first quarter 2021 financials and operating results. Philippe will review our multi-residential operations. Following, Pat will provide an update on our retail portfolio, and Larry will provide some context to our financial results. And finally, I'll make some closing remarks. Philippe, over to you.

[Philippe Lapointe:]

Good morning, everyone. We've got some notable updates for this quarter, and so I'm delighted to share the latest from Lantower Residential. On the JV development front, the Pearl in Austin, Texas is scheduled to fully deliver in the third quarter of 2021. Nightingale in Seattle is in the early stages of pre-leasing and the project will be fully delivered by June of this year. Construction of Phase 2 of our Hercules department, sorry, development, named the Grand, has remained on schedule and is expected to deliver in the second quarter of 2021. Lastly, Shoreline Gateway, our 35-story tower in Long Beach, California, is also on schedule and expected to be delivered in August of 2021.

[Pat Sullivan:]

Thanks, Philippe, and good morning, everyone. Following an encouraging fourth quarter from the retail segment, Q1 same-asset NOI declined $8.3 million or 13.4% from Q1 2020, including an 18.5% decline from enclosed malls. For enclosed malls, temporary rent reductions accounted for 34% of this decline. 28% relate to rent reductions we view as being more lasting in nature, 11% related to lower percentage rents, specialty leasing and miscellaneous revenues, and the remaining 27% was due to vacancy net of new leases commencing. Notably, bad debt expenses declined sharply from the highs of last summer. Throughout the pandemic, our primary focus has been to maintain occupancy. Occupancy at the end of the first quarter was 91.5% for the retail division as compared to 92% at the end of Q4 and 91.1% at the end of Q1 2020. Enclosed malls contribute 55% of the NOI in the retail division with grocery-anchored centers generating 28% of the NOI and other retail contributing just under 17%. For enclosed malls, occupancy at the end of Q1 2021 remained relatively stable at 87.2% compared to 88.1% at the end of Q4 2020 and 86.7% at the end of Q1 2020. The pandemic has impacted some retailers more than others with some filing CCAA as a measure of last resort. To maintain occupancy, we agreed to provide rental relief or restructured rental terms on a short-term basis to those tenants whose business has been significantly impacted by the pandemic and others that may have otherwise closed as part of their CCAA filing. Revised terms typically involve lower base or gross rent plus a percentage rent over a reduced sales threshold. With these temporary lease terms in place, our rental revenue takes on a greater seasonality, consistent with the seasonality of our tenant sales. Our fourth quarter results benefited from the seasonally high fourth quarter tenant sales. However, Q1 results were negatively impacted due to first quarter sales typically representing the lowest share of annual sales compared to other quarters. To better understand the increased seasonality impact of our revised rental terms, in Q1 percentage rent in lieu accounted for 4% of retail rent, up from 2% in Q1 2020, with percentage rent accounting for a higher share of a lower total rent.

[Larry Froom:]

Thank you, Pat, and good morning, everyone. I'll start with our balance sheet. As at March 31, 2021, debt to total assets was 46.7% compared to 47.7% as at December 31, 2020. The weighted average interest rate of H&R's debt as at March 31, 2021, was 3.6% with an average term to maturity of 3.6 years. As at March 31, 2021, liquidity was $55 million of cash on hand and $1.4 billion of unused borrowing capacity available under our lines of credit. In addition, we have an unencumbered property pool of approximately $3.9 billion.

[Tom Hofstedter:]

Thanks, Larry. After a challenging year, we're all finally starting to see promising signs of recovery. We've seen a sharp improvement in leasing activity and occupancy at Jackson Park and strong leasing momentum at our largest recent development, River Landing in Miami. Vaccination rates are climbing every day and where restrictions have been lifted, bricks-and-mortar retail sales have surged. Several retail properties are still closed by mandate, but we expect them to reopen over the next couple of months. We receive significant unsolicited interest from many parties looking to acquire a broad variety of our assets, and we expect to complete further dispositions over the next few quarters, taking advantage of the strong demand and pricing to further reduce our leverage. And finally, we remain committed to maximizing value for our unitholders and continue to work towards opportunities in 2021 to evolve H&R to a more narrowly focused REIT, consistent with investors' preferences. Last quarter, we outlined plans to create at least one new entity in 2021 and remain on track to achieve that goal, and we are currently working on a number of other transactions and initiatives that we believe will materially enhance H&R REIT. We look forward to providing more details in this regard over the course of the summer. We'd now be pleased to answer any questions from the call participants. Operator, please open the line for questions.

[Operator:]

. Our first question comes from Matt Logan with RBC Capital Markets.

[Matt Logan:]

In terms of your IFRS fair value marks, can you tell us what percentage of the $67 million was driven by your enclosed mall portfolio? And what cap rate you're carrying Primaris at today?

[Pat Sullivan:]

Hey, Matt. The $67 million was mostly due to the Primaris increase in the malls. When the onset of COVID hit last year, we were very conservative and reduced those cap rates and assumptions on the leasing and the rent rates. Since then, we've had a few appraisals that were done and showed significantly higher than what we were carrying on it. So most of that $67 million that you referenced was Primaris. What cap rate are we carrying it at? I know in our investor presentation, we have the overall retail, and I'm just trying to look it up for you now what the overall retail percentage or cap rate was. I'll get that number to you in a second. But I don't think we split it up between malls and other retail. The overall cap rate was 6.8%.

[Matt Logan:]

So would it be fair to think about the enclosed malls in the order of maybe 100 basis points higher, 50 basis points higher than that average?

[Pat Sullivan:]

Would it be fair? Yes. I would say, yes, at least 100 basis points higher than that average.

[Matt Logan:]

And in terms of your fair value markdowns in Q1 of last year, certainly, you were quite conservative in taking about $1.3 billion of collective markdowns. Was any of that related to your Canadian grocery-anchored portfolio? Or were those assets largely stable?

[Pat Sullivan:]

No. Last year Q1, those assets were stable. We did not take a write-down on those assets. Those assets have continued to perform well and maybe even the cap rates have even compressed in them given the demand for grocery assets.

[Matt Logan:]

And if we turn to some of your strategic priorities in 2021, can you talk about how you're thinking about The Bow and maybe give us some insight on where you're carrying that asset in terms of a cap rate today.

[Tom Hofstedter:]

Well, we've always been working since the day we built it actually to reduce our exposure, as you well know. And it's -- we're currently -- my reference at the end of what I spoke about before references to Bow and Bow becomes critical in achieving our other objectives. So we are currently working on it. We are in the very advanced stages, but regretfully at this stage of the game, I still can't give you more details. I can say, as I said in the speech, that I expect to, fully expect that by the end of this year we show, over the course of the summer, we should be able to make some announcements. I have to be vague on purpose, but we are -- this is not something initiative that we're just looking at right now. We are well advanced in our strategic thinking or actually strategic plans of where we're headed to. Larry, you want to give the IFRS? What do you want to do there?

[Larry Froom:]

I don't know if we can, since we haven't put it in any of our disclosures. I don't know if we can give it on a call because it's not equal opportunity. Matt, I would say all I can give you a bit of color on is that, again, in Q1 2020, we took a substantial hit. I think it was in excess of $600 million on our office portfolio, specifically relating to oil tenants, oil and gas tenants in that industry in Calgary and in Houston. And of that $600 million write down, The Bow is the biggest part of that. What we're carrying out now, we have not disclosed, and I don't know if I can give that. I'm sorry, I don't mean to be vague. We think we've been conservative with the value. We think whether it's a sale or whatever we end up doing in the future, will it be able to achieve at least our IFRS value, if not quite a bit more.

[Matt Logan:]

Appreciate that and completely understand. Maybe just changing gears to the residential side of your business, you've got some great leasing traction at River Landing and some very healthy same-property NOI growth for the Sunbelt Lantower portfolio. Can you give us a sense for what's driving the lease-up and the performance more broadly across the Sunbelt?

[Philippe Lapointe:]

Hi, Matt, so great question. So as it relates to your question on River Landing, not to oversimplify the answer, but frankly, I think we just have a terrific product. I think the -- what was ultimately developed in terms of location, but also in terms of finished product and the amenity base that we're able to offer prospective residents in comparison to the submarket is dramatically superior. And I think that plays probably an outsized role in the pace of the lease-up. As it relates to Sunbelt, I mean, I don't want to belabor the point. I think everyone's kind of read the reports of the net migrations from (Operator audio overrides]. Hello? Is it something I said?

[Matt Logan:]

I'm still here, Philippe.

[Philippe Lapointe:]

Okay. It rang in my ear, the operator rang in my ear. I think it's just the resiliency and the strength of the Sunbelt markets. I mean, it's where the jobs are being created, it's where the, from a tenant perspective, the income to rent ratio is probably the healthiest in the nation. And frankly, I think a lot can be said about the taxation or ultimately what the local governments have elected to do to attract those businesses and those tenants. But in any event, I think that the Sunbelt markets are certainly helping River Landing and attracting that now migration to Miami, but I think first and foremost, it really comes down to the quality of the development.

[Matt Logan:]

Appreciate the commentary. And maybe just on that same-property NOI growth print for Lantower, there wasn't like a weak comp in the prior quarter, this is a pretty clean year-over-year figure?

[Philippe Lapointe:]

I'm sorry, Matt, could you repeat the question?

[Matt Logan:]

When we think about that 4% growth figure, excluding Jackson Park, there was nothing in the prior period in terms of lease-up of certain assets or anything anomalous, so that 4% growth was pretty clean

[Philippe Lapointe:]

I think generally speaking, that's true. It's difficult to part them out only because some assets we bought last year were in stabilization at different levels. But I think, generally speaking, the right way in my mind to look at it is, really, that's just general NOI growth produced with frankly a stabilized portfolio. We're generally speaking, a stabilized portfolio.

[Operator:]

. And we do have a question from Sam Damiani with TD Securities.

[Sam Damiani:]

Thanks. Good morning, everyone, or good afternoon, wherever everybody is. Just I guess on The Bow and then the office portfolio, and I think some of the commentary alluded to this, but just with the low interest rate environment and investor demand for properties coming back pretty hard in many sectors, do you see some fair value write-ups I guess on some of your long-term leased office product in the near term?

[Tom Hofstedter:]

I think the answer is yes. It's a little bit early days. There's a little bit, a lot of hesitation on still work from home and how that's going to shake itself out. But you're right, there's a strong, very strong demand. We haven't seen a lot of product change at this point in time, but I think it's coming. And so I expect there to be enough evidence of transactions coming forward. Again, there's been almost nothing going in the rearview mirror to actually give us the ability to go ahead and increase our cap rates.

[Sam Damiani:]

And sorry, Tom, just on your comment, you mentioned there's been unsolicited bids for assets and you're looking at stepping up dispositions. In what business segments are you focusing on in the near-term in that regard?

[Tom Hofstedter:]

So it's across range. We're not culling our portfolio necessarily because we have bad assets or we have -- there's tremendous opportunities. Obviously, if you have a buyer, which we have right now on our portfolio of let's say our industrial properties that has a strategic reason for paying a solid price, we'd look at that. Otherwise, we're looking to raise capital to enhance our balance sheet and further go forward with our strategic initiatives. So it's more of it right across the board. It's not -- I don't think it's focused on any one particular sector.

[Sam Damiani:]

Okay. Last one for me is just on the Lantower. I think last call, Philippe, the messaging was pretty clear that some of those developments or most of those developments were build-to-sell strategies. Is that still the plan as these projects reach completion and stabilization over the next year or two?

[Philippe Lapointe:]

I think that's a fair statement as it relates to the JV developments. Not so much as the -- as we regard. We'll remain opportunistic, and we'll want to secure optionality on our own developments in the wholly owned development front, but those are built to core and meant to come into our portfolio. The JV developments are generally speaking, yes, meant to be sold at some opportunistic moment.

[Tom Hofstedter:]

Again, the strategy why we went into those to begin with is it gives us optionality. We get to go ahead and get a first crack at buying it if we want to buy it. The challenge today is that the cap rates are so low for the assets we are building, that it's even hard even though we have a profit and a higher return on our initial investments of let's call it a third investment on those, overall, the pricing is still very expensive. So that's why our strategy under Lantower is more just to turn it to a developer rather than acquire it today because cap rates are just quite frankly, they're very, very low, prices are too expensive.

[Operator:]

There are no further questions in queue at this time. I'll turn the call over to Mr. Tom Hofstedter for closing remarks.

[Tom Hofstedter:]

Thanks, everybody, and we look forward to I guess virtually seeing you at the AGM. Have a great weekend. Bye.

[Operator:]

This concludes today's conference call. Thank you for participating. You may now disconnect.