H&R Real Estate Investment Trust
Q3 2020 Earnings Call Transcript

Published: 13 Nov 2020

[Operator:]

Good morning, and welcome to H&R Real Estate Investment Trust 2020 Third Quarter Earnings Conference Call. Before beginning the call, H&R would like to remind listeners that certain statements, which may include predictions, conclusions, forecasts or projections in the remarks that follow may contain forward-looking information, which reflect the current expectations of management regarding future events and performance and speak only as of today's date.

[Tom Hofstedter:]

Thank you, and good morning, everyone. I'd like to thank you all for coming and joining us on call today. With me, here are Larry Froom, our CFO; Pat Sullivan, COO, Primaris; Philippe Lapointe, COO of Lantower; Robyn Kestenberg, Executive Vice President, Corporate Development; and Alex Avery, Executive Vice President Asset Management and Strategic Initiatives. A lot has happened since our last conference call. The US election is finally over. Progress on treatments and vaccines for COVID-19, continued recovery in employment, economic activity. And it seems that society is getting better at living more normally as we wait for the end of the pandemic. We've continued to prioritize the safety of our employees, tenants and visitors to our properties following all the recommended protocols, including social distancing and frequent cleaning. From a business perspective, Q3 results reflect the high quality of our portfolio, the appeal of our properties to the creditworthy tenants that occupy them. Rent collections averaged over 93% in the quarter and continue to improve. Q3 FFO per unit was down less than 5%, primarily due to bad debts for the quarter. Absent which FFO per unit would have risen by 5%. Net asset value per unit increased slightly, primarily driven by increased investment demand for Sunbelt apartments.

[Larry Froom:]

Thank you, Tom. Good morning, everyone. Overall, we collected 93% of the rentals in Q3 2020, an increase from 90% in Q2. Q4 looks like this thing will continue as we've already collected 95% of October’s total billings. We increased our bad debt provision by $13.4 million in Q3 in addition to the $24.5 million booked in Q2; $5 million was for for tenants who have filed for creditor protection; $2.8 million was for the 25% rent abatements we agreed to under the Connect Canada Emergency Commercial Rent Assistance Program; and $5.5 million was for other rent abatements expected drawn on the general provisions. Net of these provisions our accounts receivable balance at September 30th at H&R’s ownership interest were $23.6 million down from $32.5 million at June 30, 2020. As can be expected most of our $13.5 million provision for bad debts arose from our retail division, which accounted for 95% of the total and specifically in an enclosed mall portfolio. Total provision for bad debt amongst our four segments can be found in the press release and the MD&A. As a reminder, we own 100% of tenant enclosed malls and own 50% of seven other enclosed malls. These malls at a proportionate share of ownership account for 21% of our total billings. Same asset property operating income on a cash basis decreased by 5.5% and 3.8% respectively for the three and nine months ended September 30, 2020 compared to respective 2019 periods, primarily due to the provision for bad debt. Excluding the provision for bad debt, same asset property operating income would have increased by 1.5% and 2.7% respectively. Same asset property operating income from office properties increased by 2% and for the three months ended September 30, 2020 increased 0.1% for the nine months ended September 30th compared to respective periods 2019. Included in the nine months ended September 30, 2020 were lease termination fees of $3.2 million compared to $5.8 million for the nine months ended September 30, 2019. Excluding lease termination fees, same asset property operating income from this office division would have increased by 1.1% for the nine months ended September 30th.

[Pat Sullivan:]

Thank you, Larry and good morning. During the third quarter, the retail division incurred an additional $12.8 million in bad debt bringing the year-to-date figure to $35.7 million and enclosed malls accounted for approximately 94% of this amount. As a result of this bad debt provision, the retail division has experienced a significant decline in NOI during the second quarter. On a positive note without this bad debt provision, the retail division would have experienced 5.3% gain during the quarter, further excluding bad debt provision, enclosed malls would have posted a 10.4% gain during the quarter and 4.1% gain through the first nine months of 2020 despite a significant decline in percentage rent and specialty leasing revenue. Significant leasing in prior quarters and new store openings has resulted in a notable gain in our retail rents and recovery ratios, which we will continue to benefit from during the duration of 2020 and beyond. In the third quarter of 2020, just under 80,000 square feet of large pharma tenants opened from former Sears premise with another three tenants opening in the fourth quarter from approximately 72,000 square feet. This is in addition to large format tenants that opened up from about 110,000 square feet in Q2. As we enter 2021, large format tenants accomplishing approximately 75,000 square feet is committed to open and we are in the final stages of negotiation with several tenants for approximately 55,000 square feet more. Additionally, we're closed to finalizing long term renewals and expansions with two tenants that will expand by almost 15,000 square feet in total and occupy almost 90,000 square feet in aggregate. Collection of rent in the retail portfolio have trended higher since the low point in May. In Q3, we collected 72% from our enclosed malls and 80% from the retail segment. Collection for October, November in enclosed malls are trending above 80%. With respect to tenant failures, we've retained 65% of the stores that have filed for protection under CCAA and including those that have already been replaced with new tenants, this figure rises to 82%. Le Chateau, which occupied approximately 43,000 square feet from 13 stores filed CCAA recently and will be closing all stores in our portfolio. Le Chateau has indicated they will remain in occupancy until March or April 2021, which will afford us time to source replacement tenants for their high profile locations.

[Philippe Lapointe:]

Thanks Pat. Good morning, everyone. I'd like to begin by revisiting our experience through COVID-19 pandemic successful by most metrics due to the complete and exceptional dedication of our onsite and corporate staff members. And so I'll begin with another encouraging collections update. Our high collections rate mentioned on our last call has persisted throughout the third quarter. I'm delighted to announce that our teams have continued its success as evidenced by receipt of over 97% of billed rent for every month from August to October. Additionally, as of yesterday, Lantower had collected over 94% of billed rents for the month of November, keeping pace with our collections rate of over 97%. On the value creation front, I'd like to provide an update on our smart apartment pilot program at three of our properties in Austin and two properties in Charlotte. As of November 1st, all hardware had been installed and the software is operational at our five properties. As expected, reception from residents and staff has been overwhelmingly positive. And in light of this over the next few months, we'll be studying the feasibility of rolling out the smart apartment platform across our portfolio. As a reminder, these smart apartment packages include smart locks, thermostats and leak sensors that will provide the residents full apartment control all from a single app. In addition, we expect operational efficiencies ranging from keyless and remote access to units in addition to expense savings via vacant unit climate control.

[Tom Hofstedter:]

Thanks Philippe, and thank you to the entire H&R team for their hard work and dedication in 2020 as the team has just reviewed H&R's portfolio is performing well under challenging circumstances. We are confident our portfolio will continue to deliver stable growing cash flows underpinned by the quality of our properties and our tenants. We'd now be pleased to answer the questions. Operator, please open the line for questions.

[Operator:]

Our first question comes from Sam Damiani from TD Securities.

[Sam Damiani:]

First question Tom probably for you, when you took the large IFRS marks in Q1. Did it contemplate the kind of incentives that might have been provided to Hess to extend this lease?

[Tom Hofstedter:]

We don't believe that did and we're fine with the value we put on Hess but nothing's changed. What we availed ourselves obviously financiability that asset is debt free. And in addition the liquidity on the asset to be able to sell the asset is obviously much greater. We eliminated the future risk of the asset. So we can sell it. We can finance it. We can do whatever we want with it. It's now an asset that's quite frankly quite .

[Sam Damiani:]

Just to be clear, I'm not sure if I heard correctly. You think the lease that you did will not affect the IFRS value as it currently stands?

[Tom Hofstedter:]

I think it provide in liquidity, which means that if anything the value has gone up but I think we're happy with the valuations we have.

[Sam Damiani:]

And then similarly, we have seen a return to activity within the investment market, specifically for shopping centers just in very recent weeks and months. And I know in the press release and MD&A you say you haven't seen enough transactions to revisit your valuations. But the transactions that you are seeing as few as they may be, do they support the big write downs that you did take back in Q1?

[Tom Hofstedter:]

I think the answer is the same, I don't know if you’re referring to, there has been almost no malls done is one done in DC, and we know that was called pre-COVID that came back alive. I don't know of any other malls that have transacted. I think we're still missing enough evidence of actual deals that have gotten done that have any requests or changed their opinion. I think we're comfortable with the valuations that we have.

[Sam Damiani:]

And just last question is on the Mississauga industrial that looks to be adjacent to the GlaxoSmithKline building. Is it on the north side or the south side of the building there that that lot that you bought?

[Tom Hofstedter:]

South side.

[Sam Damiani:]

And was that an off market deal or was it widely marketed?

[Tom Hofstedter:]

It was off market.

[Sam Damiani:]

And when does construction start there?

[Tom Hofstedter:]

Not to another year, nine months to 12 months.

[Operator:]

Thank you. And our next question comes from Matt Kornack from National Bank Financial.

[Matt Kornack:]

On Jackson Park, it sounds like things are turning around. Can you speak to the type of tenants that you're targeting? And would you as universities reopen go after the international student market again in terms of leasing that up?

[Pat Sullivan:]

So I'll take that question, Matt. So two questions. I think the makeup, one of the major factors as to why we're currently in situation that we're in right now is due to the fact that at a heavy concentration of international students. To be honest, I don't think that we would have done anything differently. If we think about the pace of the velocity of the lease up, it's obviously exceeded our expectations at Jackson Park and enabled us to get exceptional financing. And so I'm not sure that we would have done anything differently. And then , my guess is -- again, I don't think that the property was intentionally targeting international students. It’s just at the end of the day, it was opened where we came in through their marketing efforts and leased units. I would anticipate that as New York city would kind of unfreeze, no pun intended, you would see a rebound in that demographic and we would get right back to where we were pre-COVID. Now as to what the exact makeup would be and would it be the same proportion of US students as our international students, I don't know. But my guess is it probably would get close.

[Tom Hofstedter:]

It's also November right now, international students will be coming back for quite a few months. By the time they come back, let's hope that release to others. So in reality, just from a practical perspective, it's not going to be leased to the same proportion of students, because the students aren't back and they won't be back even if COVID is over they’re not going to be running back till probably next September.

[Matt Kornack:]

So what you're seeing now is young professionals probably that have started to migrate back to Manhattan or New York City?

[Pat Sullivan:]

Yeah, I think that's a reasonable statement. I also want to underscore the importance of the amenity mix that Jackson Park has that to my knowledge no other property has in one city, which is essentially a two acre park. And so if you think about potentially the city shutting down again and ultimately some of the businesses that tenants are coming to -- going to and then being closed but you have a private parks that you're given the opportunity to a tenant to have some outdoor space which is not closed, obviously, with social distancing. My guess is the desirability of that property over the short-term will increase. We have a very significant competitive moat to the remainder of the market due to those amenities.

[Matt Kornack:]

And then with regards to River Landing, is that -- I mean, Miami is a city and that's a semi-urban asset. But the Sunbelt generally seems to be outperforming the Northeast and California at this point. Is that the leasing traction there asset specific or is it due to the Sunbelt, generally seeing reasonable demographics? And can you speak to the rental rates as well relative to your forecast, are they coming in line as well?

[Pat Sullivan:]

So I'll deal with the rental rates. The rental rates are exactly are very close to where we thought they would be and so there's really no material deterioration there. As it relates to the velocity, I think it's a 100% asset specific. We have assets in Orlando and Tampa we had lease ups. We know what to expect or knew what to expect, but there's also a couple of properties not in the immediate sub market but within a three to five mile radius of river landing. We're also in lease up who's space is probably half of ours, which leads me to believe that it is probably 100% asset specific. And when I say we, it's a big them so much myself, but we as H&R have built one heck of an asset. And the fact that frankly of 95 leases seven weeks in is a testament to the quality of the product.

[Matt Kornack:]

On the Hess lease extension, can you just -- where were -- I don’t know what you can provide here. But where were rents relative to prior levels? And it's an extension for two thirds of the space I think, and I assume the full space will be renting until 2026. But how should we think about the remaining one third?

[Tom Hofstedter:]

Well, the remaining one third is currently sublet so other than two floors it's currently on the market. So I think you can safely assume that the one there that's being -- that they're not occupying is going to be sublet very shortly. As I said, it's all done other than two floors, and on the rent for tenants that you can assume will stay there for the long term, there's no reason that they wouldn't. So you can assume that the building will have a mix of single to primarily obviously Hess and one third of other tenants and it will be fully leased and should remain. It is one of the preeminent buildings in the market over there. It's platinum leased. So I expect that it will be a high profile class A building and remain fully occupied.

[Matt Kornack:]

And then last one for me on the retail side. It seems like you're actually getting some incremental tenants taking space. What type of tenants are leasing new space in this market and how do you think about that going forward?

[Tom Hofstedter:]

On the large format tenant size, it's kind of just a mixed bag of say Dollarama’s, there's some office tenants, medical uses, some of your other typical big box guys. And inside the mall itself, not a lot of fashion activity it’s primarily electronics, some food, some home goods, stuff like that. But fashion activity is really on the smaller side is really light right now. And going forward, I don't see us slowing down in terms of volume with the larger format deals. We've got a lot of discussions on the go. And on the small tenant side, there is a lot of dialog going on. I think some of the fashion guys are just waiting to see how the pandemic continues to evolve. But on the electronic side and some of the other uses, there's a lot more activity that should really kick into gear next year at the start of next year.

[Matt Kornack:]

Okay, great. Thanks. Lots of moving parts in the quarter but looks to be moving in the right direction. Take care guys.

[Operator:]

Thank you Our next question comes from Sam Damiani from TD Securities.

[Sam Damiani:]

Just following on the last question there. What do you see is the impact on your Winnipeg assets from the current situation in the province?

[Tom Hofstedter:]

Yeah, I mean, the malls effectively are closing. We've arranged for online pickup orders from the store to be done inside the mall, which is good given the time of year it is. Hopefully it's a short duration. The government Rents Assistant Program helps subsidize a further 25% of rent for qualified tenants in the event of government closures. So that should help significantly for a lot of the tenants but those malls we have in Winnipeg we own that 50% level, so that will mitigate whatever exposure we may have. But hopefully it's a short duration for the closures.

[Sam Damiani:]

And just one last question, on the new rent subsidy program compared to CECRA. Is it your view that that will ensure a much greater incidence of 100% of the rent collections compared to CECRA?

[Tom Hofstedter:]

Yes, my preliminary reading on it makes -- leads me to believe that we should see a lot better rent collection from the tenant for their portion just simply because I believe they have to pay the rent in order to get the money from the government. And from an administrative point-of-view, it's a huge relief for us. I think we pushed through 900 documents related to with the last program. So it's a tremendous burden on our internal resources.

[Operator:]

And our next question comes from Jenny Ma from BMO Capital Markets.

[Jenny Ma:]

Just looking at the debt stacks coming up for 2021 and it looks like there's some few chunky maturities coming up between the first tranche of the mortgage bonds and the securing -- a secured line of credit on the Primaris assets, the term loan and then of course some mortgages. Just wanted to get some additional color on how you're thinking about these pieces. And if you intend to sort of roll them over in a current form or look at different ways of accessing that?

[Larry Froom:]

If you look at mortgage maturities of $832 million on for 2021, we expect we'll have to repay, call it about $285 million of that and we'll be able to refinance the rest. As far as the other facilities that are coming due, I have spoken to some of our bankers and feeling hopeful -- pretty confident that we'll be able to renew all of them. So there's really just taking care of $285 million of repayments in 2021 of mortgages. The rest everything else we expect to roll or refinance.

[Jenny Ma:]

So when we think about the line of credit secured against Primaris. Can you remind me how many assets that secured against?

[Larry Froom:]

Four assets.

[Jenny Ma:]

Four assets?

[Larry Froom:]

Yes.

[Jenny Ma:]

And you expect to sort of roll it over and have secure against these four assets or I guess a basket of assets within Primaris?

[Larry Froom:]

Roll it over and we'll see what parts of assets have to be secured. We may have to give another asset as security but that would not be a problem.

[Jenny Ma:]

And you lasted the unsecured debt in June. Just wondering if you can give us an update on some of the indicative spreads you're seeing today versus five months ago?

[Larry Froom:]

I don't think we've seen the debentures but it’s come in that much in the last four months or so. I think they're kind of looking at the same kind of spreads on the unsecured market.

[Jenny Ma:]

And what about the secured market?

[Larry Froom:]

The secured market spreads, I think have tightened not necessarily but probably 10 to 15 bps, both in the five years and then the 10 year.

[Jenny Ma:]

And lastly, do you have a preference for being closer to five or 10 years, do you want to extend the term out as much as possible, notwithstanding the slight premium to that?

[Larry Froom:]

For our secured debt I think for that we would like to extend that as far as possible with tenure based bond right to that near full time low, so why not take advantage of…

[Tom Hofstedter:]

It really depends in order to get flexibility to sell assets, you want to have it shorter term. So it's not just a question of rates or locking into rates for long period of time, it's giving flexibility to being able to sell assets over time. And for that reason we use unsecured, even though unsecured are more expensive.

[Jenny Ma:]

And I guess just maybe one more question on the mortgages. Is there a certain timeframe in the year where a lot of them come due or is it fairly spread out in 2021?

[Larry Froom:]

For 2021, just looking at the list now, it looks pretty spread out throughout the year.

[Operator:]

Thank you. And our next question comes from Mario Saric from Scotiabank.

[Mario Saric:]

My question just relates to The Bow and whether since your last Q3 results call, has anything changed either in ability or appetite in terms of extracting that lease from that building?

[Tom Hofstedter:]

No update, there's nothing new at this point in time.

[Mario Saric:]

And then more broadly speaking we continue to hearing a strong appetite in the market for long lease office building single tenant which you have several. Any incremental thoughts on the ability to extract now you to disposition…

[Tom Hofstedter:]

The way the business is running so question is that’s what we do for living. So we've extended hands to extended belt. We really have no rollovers to be concerned about and everybody happy clipping their coupons and keeping heavy fully leased building. So at this point in time, it's really the steady as it goes.

[Operator:]

Thank you. And our next question comes from Sam Damiani from TD Securities.

[Sam Damiani:]

Just following on the River Landing. When will that be transferred into IPP, will it all happen at once and any guidance on the FFO impact at that time?

[Larry Froom:]

The commercial part of it, which is the retail part of it will be transferred in Q4. The residential costs maybe transferred in tranches and let’s not get to the -- in the two buildings that we have that may be done in two building phase. So probably the first building will also be transferred in Q4 and maybe the second building in Q1 that's the timing we have now. I have no updates in terms of the impact of FFO. But I would expect that initially while it's not fully leased and it should be some FFO shortage on some of those assets.

[Sam Damiani:]

And are the retailers paying rent as they open their stores, or is there a free rent period?

[Tom Hofstedter:]

There is a standard, 60, 90 days free rent period. But the answer is yes. All the majors are open other than TJ Max is still going to be open shortly and Planet Fitness will be next month.

[Sam Damiani:]

And how is the office leasing going?

[Tom Hofstedter:]

We have good demand and Miami, I think you probably know because of COVID has that strong demand in the rest of the country, which is many tenants have left many office prior to leaving other states to go to Florida. So we're seeing good demand and we are still negotiating, we'll not finish negotiating and to wrap up through approval process for around half the building, but we're seeing the demand.

[Operator:]

Thank you. And our last question at this time comes from Dean Wilkinson from CIBC.

[Dean Wilkinson:]

Tom, maybe it's a bit of a philosophical question, and the capital markets desire notwithstanding to have lower leverage on real estate on its balance sheet. In a world where a 10 year bond is 70 basis points and it doesn't look like that’s been anytime soon. How do you guys -- sort of does it change your view on leverage in that flawed metrics of debt to gross book value, which we talked about could be anything to bottom here at least, that your interest coverage could actually increase by actually levering up the balance sheet at this point. And what's the view there in terms of sort of the practicality of that cost of capital advantage on the debt side of things?

[Larry Froom:]

Dean, we're not sure of your question. Are you asking why don't we lever up? Is that your question in order to take advantage of the lowering…

[Dean Wilkinson:]

Essentially, yeah.

[Tom Hofstedter:]

Because the capital market doesn’t like it…

[Dean Wilkinson:]

Well, that’s one thing, capital markets aside…

[Tom Hofstedter:]

We're in the public arena from a timing perspective. I think you do it all day long as much as you can especially United States model, which is non recourse debt but that's always been the case quite frankly, it's been lowest rate for a long, long time and the capital markets, we follow the United States lead and United States lead is in the capital markets is much lower. That's the you're right, from a personal perspective, I always believe to load up a bit. But as CEO of a public company I don't think I have doing that.

[Dean Wilkinson:]

Maybe we should look to privatize.

[Tom Hofstedter:]

Just for the debt reasons alone.

[Dean Wilkinson:]

Just for the debt alone…

[Tom Hofstedter:]

But then you never talk to me, Dean come on.

[Dean Wilkinson:]

Yeah, I have plenty of other reasons to. All right. Thanks. That's it for me.

[Operator:]

Thank you. And at this time, I'll turn the call back to management for closing remarks.

[Tom Hofstedter:]

Thank you, everybody. Have a great weekend.

[Operator:]

Thank you for joining us today, ladies and gentlemen. This concludes our call. You may now disconnect.