Q2 2024 H&R Real Estate Investment Trust Earnings Call
Speaker Change: Good morning and welcome to H&R Real Estate Investment Trust's 2024 Second Quarter Earnings Conference Call.
Speaker Change: 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.
Speaker Change: which reflect the current expectations of management regarding future events and performance.
Speaker Change: and speak only as of today's date.
Speaker Change: Forward-looking information requires management to make assumptions or rely on certain material factors and is subject to inherit risks and uncertainties and actual results could differ materially from the statements in the forward-looking information.
Speaker Change: and discussing H&R's financial and operating performance.
Speaker Change: And in responding to your questions, we may reference certain financial measures.
Speaker Change: 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.
Speaker Change: 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.
Speaker Change: H&R's management uses these measures to aid in assessing the routes underlying performance and provides these additional measures so that investors can do the same.
Speaker Change: 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.
Speaker Change: together with details on H&R's use of non-GAAP financial measures are described in more detail in H&R's public filings which can be found on H&R's website and www.cedarplus.com
Speaker Change: I would now like to introduce Mr. Tom Hofstedter, Chief Executive Officer of H&R EAT. Please go ahead, Mr. Hofstedter.
Tom Hofstedter: Thank you and good morning everybody. Joining me today is Jason Birkin, VP of Finance, and Emily Watson, Chief Operating Officer of LandTower. Larry Froom cannot be with us today, he is traveling. On that note, I'll hand it over to Jason.
Jason Birkin: Thank you, Tom, and good morning everyone. I'm very excited to be here today. In my comments to follow, references to growth and increases in operating results are in reference to the three-month end of June 30, 2024, compared to the three-month end of June 30, 2023.
Speaker Change: H&R's total same-property net operating income on a cash basis increased by 1.7%. Breaking the growth down between our segments, LandTower, our residential division, recorded a 0.3% increase, which was primarily driven by the stronger U.S. dollar.
Speaker Change: Emily will provide more details on this shortly.
Speaker Change: Industrial same-property NOI on a cash basis increased by 4.7%.
Emily: driven by rent increases for new and renewed tenants, as well as an increase in occupancy. The tenants that are newly completed industrial properties totaling 336,800 square feet in Mississauga are in occupancy. Their free rent period has ended and are now paying rent.
Emily: We have started construction on three new industrial developments totaling 350,000, 357,500 square feet at H&R's ownership share.
Emily: The average rent on our Canadian industrial portfolio, June 30, 2024, was $8.97 per square foot and is well below market rent, which bodes well for our industrial portfolio continuing to deliver strong results.
Emily: During the quarter we completed four industrial lease renewals totaling approximately 227,000 square feet at H&R's ownership share and achieved an average rent increase of $7.73 per square foot.
Emily: Office same property NOI on a cash basis decreased by 1.8%. This decrease was largely attributable to a decrease in occupancy at our properties slated for future redevelopment.
Emily: Our office properties are in strong urban centers with a weighted average lease term of approximately 6.3 years and leased to strong Creditworthy tenants with 88.5% of office revenue coming from tenants with investment grade ratings
Emily: I would like to draw investors' attention to the 7.9% cap rate on our remaining nine Canadian office properties that are not slated for redevelopment.
Speaker Change: The cabaret jumps from 7.08% last quarter primarily due to the sale of chorus.
Speaker Change: We also increased the cap rate on our remaining three U.S. properties from an average of 7.68% last quarter to an average of 9.02% this quarter.
Speaker Change: And lastly, retail same-property NOI on a cash basis increased by 7.9%, primarily driven by increased occupancy at River Landing Commercial.
Speaker Change: In accordance with our strategic plan, we have sold 800 million of property in 2023 in the first six months of 2024.
Speaker Change: We are very pleased that despite these property sales and the headwinds facing the real estate sector in general, Q2 2024's FFO was $0.306 per unit compared to $0.297 per unit in Q2 2023.
Speaker Change: H&R's cash distributions of $0.15 per unit for the quarter resulted in an FFO payout ratio of 49% and an AFFO payout ratio of 61%.
Speaker Change: Net asset value per unit as of June 30, 2024.
Speaker Change: It was $19.94 per unit, a decrease from $21.05 as of March 31st, 2024. This was attributable to $427.2 million of fair value adjustments during Q2 of 2024.
Speaker Change: Debt-to-Total Assets at the REITs proportionate share at June 30, 2024 was 44.8%, and Debt-to-EBITDA was a healthy 8.5 times. Liquidity at June 30, 2024 was in excess of $900 million, with an unencumbered property pool of approximately $4.1 billion.
Emily: Our unencumbered asset-to-unsecured debt coverage ratio was 2.2 times at June 30, 2024. And with that, I will now turn the call over to Emily.
Emily: Thank you very much for watching this video, and I'll see you in the next video, and I'll see you in the next video.
Emily: Thank you Jason and good morning everyone. Today I'm pleased to discuss our second quarter same store results from our multifamily platform and share some operational highlights.
Speaker Change: Our strategic focus is on positioning our portfolio to drive long-term value through geographic diversification, a robust development pipeline.
Speaker Change: repositioning opportunities, and technology investments aimed at mitigating cost, delinquency, and associate turnover.
Speaker Change: Our markets continue to experience strong demand for household formation driven by population and employment growth, apartment affordability, and positive demographic trends.
Speaker Change: Move-outs due to home purchases remain at historical lows in our Sunbelt markets, accounting for just 9% of our total move-outs.
Speaker Change: Renting an apartment remains an attractive choice, being on average 60% more affordable than owning a single family home.
Speaker Change: Our target renters are high earners with stable employment, which continues to support positive housing performance.
Speaker Change: We have seen improvement from our technology innovations with delinquency, as one example, at pre-pandemic levels, and bad debt in Sunbelt returning below the 50 basis points norm.
Speaker Change: These factors combined contribute to a 58% NOI margin with room for future growth.
Speaker Change: Given the declining levels of new supply ahead and consistent demand in our markets, combined with the strength of our operating platform, we are well positioned for substantial growth and value creation in the coming years.
Speaker Change: Occupancy ended the quarter at 94.6, an increase of 20 basis points from the first quarter and 50 basis points increase compared to Q2 of 2023.
Speaker Change: Same property net operating income on cash basis from our portfolio in U.S. dollars decreased by 1.2% for the three months ending on June 30, 2024, compared to the respective 2023 period.
Speaker Change: primarily due to high property operating costs, including property taxes and insurance costs, and a decrease in average rental rates from the Sunbelt properties, which was partially offset by rental growth at Jackson Park in Long Island City, New York, and River Landing in Miami, Florida.
Speaker Change: Lantower's asset management team oversees capital expenditure deployment and one highlight of our repositioning capital is Tortuga Bay in Orlando, Florida.
Speaker Change: Over half of the units have received kitchen, bath, and flooring renovation with around a 13% return on investment. Other projects include smart home amenity package with a 30% return, washer and dryer additions with a 55% return, and private yards at a 50% return on investment.
Speaker Change: Moving to our fair market value, based on recent sales comparisons, our fair market value capitalization rate for the residential portfolio is 4.55%.
Speaker Change: We maintain a 5% cap rate for our Sunbelt portfolio, which was further supported by a third-party appraisal received in Q2.
Speaker Change: Cap rates are expected to remain low, relatively speaking, for institutional quality assets in the Sunbelt, with capital flows interested and focused on long-term heavy Sunbelt multifamily allocation.
Speaker Change: Turning to developments, Land Tower West Love in Dallas, Texas, remains on schedule and on budget. We expect to be fully delivered by the end of Q3 with stabilization Q2 of 2025.
Speaker Change: Leasing commenced mid-April and we are currently 31% leased reflecting strong demand. Our thesis for securing great sites and designing best-in-class product has materialized in a strong initial lease up at Westlove.
Speaker Change: Our lease up absorption is well above what industry reports have stated for our market and is above what is budgeted.
Speaker Change: Also in Dallas, Texas, Landtower Midtown is progressing well. The first units are prepared for occupancy with final units expected by the end of the year.
Speaker Change: We received our first Certificate of Occupancy earlier this month, and we are encouraged by the high traffic volume of traffic in a short amount of time. A validation of demand for best-in-class product with unparalleled amenities.
Speaker Change: On the Reddit front, as we discussed last quarter, the investor interest in Invest alongside LandTower's existing development pipeline was highlighted by accelerated fundraising results, and we feel that this construct will create value for H&R shareholders as well as our Reddit investors.
Speaker Change: while maintaining financial flexibility and taking advantage of a favorable depressed Sunbelt supply pipeline in the upcoming years.
Speaker Change: We broke ground on both Landtower Sunrise, a 330-unit development in Orlando Market, and Landtower Bayside, a 271-unit development in the Tampa Market, in the second quarter, and they are progressing as expected.
Speaker Change: We expect these developments to reach completion in mid-2026, which we believe to be an excellent time to deliver units.
Speaker Change: LandTower currently has an additional 8 development projects in the Sunbelt pipeline totaling over 2700 suites at H&R's ownership interest, with multiple sites ready and prepared for construction.
Speaker Change: In summary, the LandTower platform continues to deliver top-tier results relative to our multifamily counterparts. I would like to extend my heartfelt thanks to the entire LandTower team as we proudly celebrate our spot on the 2024 Fortune Best Places to Work in Texas list.
Tom Hofstedter: This award is a testament to LandTower being an employer of choice that is adaptive, resilient, and innovative. And with that, I'll turn the conversation back to Tom.
Tom Hofstedter: Thanks, Emily. And with that, I'll turn it over to the operator for questions. Operator? Thank you.
Speaker Change: Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by the one on your touchtone phone. You will hear a prompt that your hand has been raised.
Speaker Change: Should you wish to decline from the polling process, please press star followed by 2. If you are using a speakerphone, please lift the handset before pressing any keys.
Speaker Change: You
Speaker Change: Your first question comes from Sam Damiani from TD Cowen. Please go ahead.
Sam Damiani: Thanks. Good morning, everyone.
Sam Damiani: Tom, just wondering what your thoughts are on the sort of the acquisition market, disposition market currently versus last quarter, what change you may have seen and how you see the market unfolding for the balance of the year.
Speaker Change: as it relates to the REIT's intention to dispose more assets.
Speaker Change: Good morning. We knew that would be your question. I landed at the airport last night.
Speaker Change: The write-down has really nothing to do with the disposition market. It has to do with the strength of the current value of the assets.
Speaker Change: There is very little going on, as you well know, as far as dispositions, as far as being able to target what a price will be or won't be.
Speaker Change: So we don't really have, at this market visit, so we don't really have a guidance to give you what our future sales are going to look like. The write-down was predicated on really what's going on in the market today. And what's going on in the market today is really very little. That being said...
Speaker Change: Take an office as an example. If you evaluate your assets based upon the present value of its cash flow and a terminal value,
Speaker Change: and your turnover value is static, as time marches on you have to write down the asset for the fact that you're taking an income and you don't know what the extension is going to look like. Not only do you not know what the extension of the lease is going to look like, you don't know what the turnover value at the end of that is going to look like. So bottom line is, if the market doesn't improve,
Speaker Change: In office, you have to take down a write-down periodically unless you see some form of a turn in the market. That can happen also because of interest rates, and interest rates hopefully will come down now that inflation has been tackled to a great extent, but until that does, they warrant a write-down.
Speaker Change: The land value, which involves our intensification properties, the Cove and the Gowanus, also reflects the current market where nothing is going along. As you well know, in downtown Toronto, there was supposedly going to be a deal for 212 King that never happened, never materialized. We were hoping it was going to be at $160 a foot, but nothing happened there. We have no visibility as to what the trade looks like, but just to be conservative, we took everything down by $10 a foot in Canada, $10,000 a door in the United States.
Speaker Change: to reflect the fact that there's very little going on. The reason there's nothing going on is because everyone is building to a seven-yield return on cost. And in order to achieve that with the construction costs and interest rates the way they are today, something has to give. And what gives, obviously, is the one element that has to give is the value of land. So you have to take down the value of land to reflect the fact that people are going to ultimately have to get their 6.75, 7% yield. And the only way to do that is through land reduction. So this doesn't reflect our desire necessarily to change the fact that it's easier for us to sell down the road. It reflects, regretfully, the oddest current conditions of where we see the world today.
Speaker Change: Thank you for that. And just with what you said and, you know, the REIT's overall sort of strategic objectives over the sort of medium term, does it pivot your attention more toward the retail portfolio as a source for dispositions at this time?
Speaker Change: So, I don't think so. I think that's like, I don't know, something in the market that I can't understand, to be honest with you.
Speaker Change: Our REIT portfolio, unlike many other REIT portfolios, is not speculative, it's not dangerous, it's almost irrelevant what the expiry schedule is. We have total visibility into ECHO as to what stores are doing well, the lease term, because that's a sister company to the real estate arm, which we own a piece of. And as far as our Canadian retail portfolio, that's as good as you're going to get as far as clipping a coupon with solid real estate. Really, you don't have to worry about lease expirations. That being said, there's no urgency to sell those. That's highly liquid to sell any kind you want. Giving up those assets in today's environment, which those assets are all really a reflection of the economy.
Speaker Change: a reflection on interest rate doesn't make a whole lot of sense. We'll wait till interest rates come down a bit. So in the case of Echo, we have someone looking at it. But if the prices are not going to meet our expectation and on the Canadian side, if someone comes forward with an offer that reflects tomorrow's values, not today's, and again today's cap rates are elevated because of interest rates, then we look at selling it. There's no burning issue to sell these assets at this point in time. Not when you're giving up good cash flow, good FFO, in return for what? For selling at a high cap rate if interest rates are high? It doesn't make a ton of sense. We don't feel the pressure to sell in other words.
Speaker Change: Okay, last one for me, just on, I think last quarter there was...
Speaker Change: a comment, probably from Larry, that the debt-to-EBITDA would stabilize around the 9.25 level before any additional disposition announcements. Is that still the outlook for the end of the year?
Speaker Change: Hi Sam, as you know in the MD day we use the trailing 12 month EBITDA but if you annualize Q2 that ratio would be around 9.2 times.
Sam Damiani: Perfect, thank you.
Eric: Thanks, Eric.
Speaker Change: Thank you. The next question comes from Jimmy Shen at RBC Capital Markets. Please go ahead.
Speaker Change: Thanks, so when it comes to portfolio trades there are trades happening in the multi-res US multi-res sector. I was wondering if you guys looked at those
Speaker Change: the KKR-Quartera deal, or even the Blackstone.
Speaker Change: Wondering how comparable would those portfolios be to the Land Tower?
Speaker Change: So, let's take HR as an example.
Speaker Change: They reported last quarter, just now, I think a week ago or something, that they sold that, that they purchased that portfolio, 5,000 units, call it a billion dollars if I recall correctly, and they reported it at a low force cap. And that put a little, you know, question to the market. Why is that a poor cap on housing compared to LandTower?
Speaker Change: The answer to the question is, it's very similar in geography, very similar in age, but it's, let's call it 18 stories instead of Arsic Belt, 3 stories. But that's not a huge difference. The explanation needs to be explained why they are a low 4 cap and why we're a 5 cap.
Speaker Change: The answer really lies in the fact that KKR didn't buy that asset for their portfolio. They bought it on behalf of an insurance company whereby the money that had to be spent by the end of June, otherwise they would have lost that allocation. So they were kind of anxious to spend it. They actually bought it at a 5.2 cap.
Speaker Change: And if you ask the question, well, leverage is at 5, therefore, it should be neutral to their overall return. They should have achieved a return on cash around 5. Why is it low 4s? And the answer is because the asset management fees embedded in KKR's charging of that portfolio for asset management fees brings it down to low 4s. So that's not a reflection of – that's a reflection endorsement of H&R's – LandTower's cap rate overall at the 5s and the non-competitive nature of asset managers because of their fee structure that brings it down so low. But again, KKR really didn't care. They were managing that money on behalf of an insurance company. The insurance company agreed to pay their fees. Therefore, that insurance company is getting a lower yield, not reflective of the market, which is at 5. So those trades really –
Speaker Change: endorse a low fives cap and I think it's pretty solid and Emily can tell you trades that have gone on, there's around six of them in our markets, it's all around 5.1, 5, maximum 5.2 in and around where we're at. So all those trades confirm, validate rather, our five cap.
Speaker Change: Okay, well that's helpful and
Speaker Change: I mean, at low five, that sounds like good pricing, and so, I know it's not in your strategic plan, but given these type of prices and what appears to be some level of interest.
Speaker Change: Does it make you rethink about Landtower and could that be a candidate for sale down the road? How are you thinking about Landtower here?
Speaker Change: So, Landtower is a very, very solid asset, very, very solid platform, very solid management group.
Speaker Change: It really doesn't change anything. The market's all concerned about the fact that there's a whole bunch of units going to be ready You know the hundred thousand square units that are being built in our markets and Sunbelt markets and cost pressure on rent. We look at it completely differently. We look at the fact that It's right now. There's a pressure on the rents. Those units are going to get absorbed in our markets sometime mid to the end of 2025, 2026. The rents are going to go way up again because the supply and demand could balance, but you're not, no one's building anything And as I mentioned before, no one's building any more because they have to build to a 6.75, 7% yield return on cost And that's not really doable in today's market very easily. Your land cost really has to be brought down You have to buy your land well and your land has to be ready to go. LandHour is a solid company. It's a keeper
Speaker Change: So it doesn't make sense to go ahead and increase your exposure to office by spinning off land power. You may get a good price for land power, but again, the remaining, what's behind, is going to suffer. I think we're going to more prudently stick to our original strategy, which is slowly but surely deal with our office, which, in our opinion, have value when the residential market returns as an ulterior use for the intensification properties, and for our three or four core office buildings, they're sticky tenants, and we expect to renew them and be able to sell the properties ahead of time. So we're going to stay the course, and land power is therefore going to be one of our keepers, and ultimately, we're going to achieve the result of that being an industrial-slash-residential REIT.
Speaker Change: Last one for me, Chevron made an announcement that they will move their headquarters to Houston. I just wondered, does that mean anything at all for Hess Tower? Does that mean anything at all for the potential sale of Hess Tower?
Speaker Change: So it just adds more confusion to what's going on over there. The courts haven't put down their ruling on what's with the Hess sale at all. We expect this coming in November, but my guess is that'll drag, as these things usually do. If Chevron buys Hess and is successful, then Chevron has to make the decision where they want to be located. They have space within their existing tower. They have made the announcement they're moving headquarters to Houston, which means they probably need overflow space into Hess and keep the Hess. Until this is all resolved, we have no idea what's going on. If a court case goes against them, Hess is not a saleable asset anymore. Hess can't be sold to Exxon, and Hess can't be sold to Chevron. Hess will remain a growing concern, and it will remain in the building the way it is.
Speaker Change: In either event, it really doesn't have any impact at all on us and our strategy for the Tower. We are currently dealing with one-third of the building that rolls in 2026, and I think successfully. We're very confident that we'll achieve our objective to have that leased, and then we have another 12 years to go past. We are very confident with that building. We're very confident with our TransCanada.
Speaker Change: Joint Venture, TransCanada Tower, T.C. Tower, Calgary with Hoop and with Two Gothels, those are all sticky tenants. We expect the tenants to renew, we expect them to be there long term, we just don't know what the rental rates will be. So again, the Hess situation with Chevron is, I guess, good news that Chevron is consolidating in Houston. It can't be bad news, we just don't know the final outcome. Until you know the final outcome, you can't really sell the asset because every buyer is going to be asking the same question as you did. Whereas Hess can be located, it has a strong impact on the long term value of the asset. And so therefore, right now, we're just dealing with releasing the space. It will come up in 2026, and I think successfully so. And then we'll see what happens.
Speaker Change: What happens next few months with the Chevron head situation? Okay, thank you.
Speaker Change: Thank you.
Speaker Change: Thank you. There are no further questions. I will turn the call back over for closing comments.
Speaker Change: Thank you everybody and enjoy the summer.
Speaker Change: Ladies and gentlemen, this concludes your conference for today. We thank you for participating and we ask that you please disconnect your lines.