H&R Real Estate (TSX:HR_u) Investment Trust (TSX: HR.UN) has disclosed its financial outcomes for the second quarter of 2024, revealing a varied performance across its portfolio. The company's total same-property net operating income (NOI) on a cash basis saw a slight increase of 1.7%, with industrial properties showing robust growth. However, office spaces experienced a decline due to lower occupancy rates.
H&R also reported substantial property sales, a conservative payout ratio, and maintained strong liquidity. Despite a cautious stance on the disposition market, the company is proceeding with new developments and technological advancements within its residential division, Lantower.
Key Takeaways
- Total same-property net operating income (NOI) on a cash basis increased by 1.7%.
- Industrial properties NOI grew by 4.7%, while office properties NOI declined by 1.8%.
- Retail properties NOI rose by 7.9%, bolstered by higher occupancy at River Landing Commercial.
- Lantower's occupancy increased to 94.6%, although its same-property NOI on a cash basis decreased by 1.2%.
- Funds from operations (FFO) were $0.306 per unit, with a conservative payout ratio of 49%.
- The company sold properties worth $800 million in 2023 and the first half of 2024.
- H&R reported a debt-to-total assets ratio of 44.8% and a debt-to-EBITDA ratio of 8.5 times.
- Liquidity remained robust at over $900 million, with an unencumbered property pool valued at $4.1 billion.
Company Outlook
- The company has a cautious outlook on the disposition market due to weak sales and uncertain pricing.
- H&R is taking a conservative approach to asset valuation, reflecting market challenges and the need for a 6.75% to 7% return on cost.
Bearish Highlights
- Office same-property NOI declined due to decreased occupancy at properties awaiting redevelopment.
- The company is cautious about the market's visibility and expects a decrease in land value.
- The write-down of assets is attributed to uncertainties regarding lease extensions and terminal values.
Bullish Highlights
- Industrial same-property NOI saw significant growth due to rent increases and higher occupancy.
- Retail same-property NOI improved substantially, driven by increased occupancy.
- The company is focused on technological innovation and positive housing performance within its Lantower division.
Misses
- Lantower's same-property NOI on a cash basis saw a slight decrease despite an increase in occupancy.
Q&A Highlights
- Tom Hofstedter discussed the weak disposition market and the company's conservative asset valuation approach.
- There is no immediate plan to sell the retail portfolio, and the debt-to-EBITDA ratio is expected to stabilize.
- The Lantower portfolio is considered a solid asset with no plans for sale.
- The potential sale of Hess (NYSE:HES) Tower and the impact of Chevron (NYSE:CVX)'s headquarters move to Houston are not expected to significantly affect the company's strategy.
H&R REIT 's second-quarter earnings reflect the resilience of its industrial and retail sectors, while the office division lags amid a challenging market. The company remains cautious but is actively managing its portfolio and seeking growth opportunities, particularly in its residential division. With a conservative financial approach and a focus on long-term value, H&R REIT is navigating through uncertain times with a strategy that balances risk and potential rewards.
Full transcript - None (HRUFF) Q2 2024:
Operator: Good morning, and welcome to H&R Real Estate Investment Trust 2024 Second 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 in responding to your questions, we may reference certain financial measures, which do not have a meaning recognized or standardized under IFRS or Canadian Generally Accepted Accounting Principles and are therefore unlikely to be comparable to similar measures, presented by other reporting issuers. Non-GAAP measures should not be considered as alternatives to net income or comparable metrics determined in accordance with IFRS as indicators of H&R's performance, liquidity, cash flows and profitability. H&R's management uses these measures to aid in assessing the REIT's underlying performance and provides these additional measures so that investors can do the same. Additional information about the material factors, assumptions, risks and uncertainties that could cause actual results to differ materially from 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 H&R's website and www.cedarplus.com. I would now like to introduce Mr. Tom Hofstedter, Chief Executive Officer of H&R REIT. Please go ahead, Mr. Hofstedter.
Tom Hofstedter: Thank you and good morning everybody. Joining me today are Jason Birken, VP of Finance; and Emily Watson, Chief Operating Officer of Lantower. Larry Froome cannot be with us today, he's traveling. On that note, I'll hand it over to Jason.
Jason Birken: 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 months ended June 30th, 2024 compared to the three months ended June 30th, 2023. H&R's total same property net operating income on a cash basis increased by 1.7%. Breaking the growth down between our segments, Lantower, our residential division recorded a 0.3% increase which was primarily driven by the stronger U.S. dollar. Emily will provide more details on this shortly. Industrial same-property NOI on a cash basis increased by 4.7%, 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 rents. We have started construction on three new industrial developments totaling 357,500 Square (NYSE:SQ) Feet at H&R's ownership shares. The average rents on our Canadian industrial portfolio at June 30, 2024 was $8.97 per square foot and is well below market rents which bodes well for our industrial portfolio continuing to deliver strong results. 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. Office same property NOI on a cash basis decreased by 1.8%. This decrease was largely attributable to a decrease in occupancy at our property slated for future redevelopments. 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. 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. The cap rate jumps from debt 7.08% last quarter primarily due to the sale of Corus (TSX:CJRb). 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. And lastly, retail same property NOI on a cash basis increased by 7.9%, primarily driven by increased occupancy at River Landing Commercial. In accordance with our strategic plan, we have sold $800 million of property in 2023 and the first six months of 2024. We are very pleased that despite these property sales and the headwinds facing the real estate sector in general, Q2 2024 FFO was $0.306 per unit compared to $0.297 per unit in Q2 of 2023. 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%. Net asset value per unit as of June 30th, 2024 was $19.94 per unit, a decrease from $21.05 as of March 31, 2024. This was attributable to $427.2 million of fair value adjustments during Q2 of 2024. Debt to total assets at the REIT's 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. Our unencumbered assets 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 Watson: 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. Our strategic focus is on positioning our portfolio to drive long-term value through geographic diversification, a robust development pipeline, repositioning opportunities and technology investments aimed at mitigating cost, delinquency and associate turnover. Our markets continue to experience strong demand for household formation, driven by population and employment growth, apartment affordability and positive demographic trends. Move-outs due to home purchases remain at historical lows in our Sunbelt markets, accounting for just 9% of our total move-out. Renting an apartment remains an attractive choice being on average 60% more affordable than owning a single-family home. Our target renters are high earners with stable employment, which continues to support positive housing performance. 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. These factors combined contribute to a 58% NOI margin with room for future growth. Given the declining levels of new supply ahead and consistent demand in our markets, combined with the strength of our operating app platform, we are well-positioned for substantial growth and value creation in the coming years. 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. 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 30th, 2024 compared to the respective 2023 period, primarily due to high property operating costs including property taxes and insurance costs, and the 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. Lantower's asset management team oversees capital expenditure deployment and one highlight of our repositioning capital is Tortuga Bay in Orlando, Florida. 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 55% return and private yards at a 50% return on investment. Moving to our fair market value. Based on recent sales comparison, our fair market value capitalization rate for the residential portfolio is 4.55%. We maintain a 5% cap rate for our Sunbelt portfolio, which was further supported by a third-party appraisal received in Q2. 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. Turning to developments. Lantower 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. 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 West Love. Our lease up absorption is well above what industry reports have stated for our market and is above what is budgeted. Also, in Dallas, Texas, Lantower Midtown is progressing well. The first units are prepared for occupancy with final units expected by the end of the year. We have 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. On the Reddit front, as we discussed last quarter, the investment -- the investor interest in invest alongside Lantower'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, while maintaining financial flexibility and taking advantage of a favorable depressed Sunbelt supply pipeline in the upcoming years. We broke ground on both Lantower Sunrise, a 330 units development in Orlando market and Lantower Bayside, a 271 units development in the Tampa market in the second quarter, and they are progressing as expected. We expect these developments to reach completion in mid-2026, which we believe to be an excellent time to deliver units. Lantower currently has an additional eight development projects in the Sunbelt pipeline, totaling over 2,700 suites at H&R's ownership interest with multiple sites ready and prepared for construction. In summary, the Lantower platform continues to deliver top tier results relative to our multifamily counterparts. I would like to extend my heartfelt thanks to the entire Lantower team as we proudly celebrate our spot on the 2024 Fortune's Best Places to work in Texas list. This award is a testament to Lantower being an employer of choice that is adaptive, resilient and innovative. And with that, I will turn the conversation back to Tom.
Tom Hofstedter: Thanks, Emily. And with that, I'll turn it over to the operator for questions. Operator?
Operator: [Operator Instructions]. Your first question comes from Sam Damiani from TD (TSX:TD) Cowen. Please go ahead.
Sam Damiani: Thanks, good morning, everyone. 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 as it relates to maybe its intention to dispose more assets?
Tom Hofstedter: Good morning. We knew that would be your question. You highlighted that in your report last night. 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 asset. There is a very little going on, as you well know, with as far as dispositions as far as it's been able to target what a price will be or won't be. So, we don't really have at this market because it's still weak, we don't really have a guidance to give you whether our future sales [indiscernible] really what's going on the market today. And what's going in the market today is really very little. That being said, take an office as a for example, if you evaluate your assets based upon the present value of the cash flow and the terminal value, and your terminal value is static, as time marches on, you have to write down the asset for the fact that you're taking in income, and you don't know what the extension is going to look like. Not only do not know what extension of the lease is going to look like, you don't know what terminal value at the end of that is going to look like. So, bottom line is, if the market doesn't improve, in office, you have to take down or 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 by the inflation and tackle to a great extent. But until that does, they warrant a write-down. The land value, which involves our intensification properties COVID warranted also reflects the current market where nothing is going along. And as you all know in the downtown Toronto, there was supposedly going to be a deal for 212 King that never happened, never materialized. We're hoping that was going to be the $160 a foot and 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 in the United States to reflect the fact that there's very little going on. Everyone -- the reason there's nothing going on is because everyone is building to a 7-year return on cost. And I already achieved that with the construction costs and interest rates where they are today, something has to give them. And one gives, obviously, is the one element that has to give is the value of land. So, you have to take the value of land to reflect the fact that people are going to ultimately have to get to 6.75% to 7% deal and the only way to do that is through land reduction. So, this reduction reflect our desire necessarily to change the fact that it's easier for us to sell down the road and reflects -- regretfully reflects the modest current conditions and what -- where we see the world today.
Sam Damiani: And just with what you said and the REIT's overall strategic objectives over the sort of medium term, does it pivot your attention more towards the retail portfolio as a source for dispositions at this time?
Tom Hofstedter: 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. The REIT-only portfolio, other than -- unlike many other portfolios, it's not speculative, it's not dangerous. There's nothing -- 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 to that sister company to the real estate [indiscernible] where we want a piece of. And as far as the Canadian retail portfolio, that's as good as you're going to get as far as getting a coupon with solid real estate. And really, you don't have to worry about lease expirations. That being said, there's no urgency to sell those. And that's highly liquid to sell any time you want, giving us those assets in today's environment, which those assets are all really reflection out of the economy, reflection on interest rate doesn't make a whole lot of sense. We'll wait until 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 be to our expectation and on the Canadian side, if someone comes forward with an offer that reflects tomorrow's value, not today. And again, today's CapEx are elevated because of interest rates, and we look at selling it. There's no burning issue to sell these assets at this point in time, not when you're giving good cash flow, good FFO in return for what? For selling at a high cap rate, because interest rates are high, doesn't make a ton of sense. We don't feel the pressure to sell in other words.
Sam Damiani: Last one for me. I think last quarter, there was 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?
Jason Birken: Sam, as you know, in the end of the day, we used the trailing 12-month EBITDA. But if you annualize Q2, that ratio would be around 9.2 times.
Operator: The next question comes from Jimmy Shan at RBC (TSX:RY) Capital Markets. Please go ahead.
Jimmy Shan: Thanks. So, when it comes to portfolio trades, there are trades happening in the multi-res -- U.S. multi-res sector. I was wondering if you guys looked at those the KKR, Quarterra deal and Blackstone (NYSE:BX) and wondering how comparable would those portfolios be to the Lantower portfolio.
Tom Hofstedter: So, let's take KKR as an example. They reported last quarter just now, I think a week or something that they sold that -- that they pitched that portfolio, 5,000 units, call it, $1 billion of our corporate team and they reported it a low 4s cap and that put a little question to the market, why that 4 cap and how does it compare to Lantower? The answer to the question is very similar in geography, very similar in age, but let's call it, 18 stories instead of our stick build 3 stories. But that's not a huge difference. The explanation needs to explain why they are a low-4 cap and why we're a 5 cap. And the answer lies in the fact that KKR didn't buy their assets for their portfolio. They bought them on behalf of the insurance company, whereby the money that has to be spent by the end of June, otherwise, they would have lost that allocation. So, they were kind of in actions to spend it. They actually bought it at a 5.2 cap and if you asked the question, well, leverage is at 5, therefore, it should be neutral to their overall return initiatives return on cash around 5, why is it low 4s. And the answer is to the asset management fee is embedded in the KKR is charging of that portfolio for asset management fee maybe down to low 4s. So, that's not a reflection of -- that's a reflection endorsement of H&R's -- Lantower's cap rate overall to 5 and the noncompetitive nature of asset managers, because of their fee structure that brings down so low. But again, KKR just really didn't take care. They're managing that money on behalf of an insurance company. And insurance company believed paid their fees. Therefore, that insurance company is getting a lower yield, not reflective of the market, which is at 5. So those trades really endorsed a low 5s cap, and I think it's pretty solid and Emily can tell you trades that have gone on -- there's around 6 of them in our markets that all were around 5.1, maximum 5.2 in and around [indiscernible]. So, all those traits confirm -- validate rather are 5 cap.
Jimmy Shan: That’s helpful. And I mean, low 5s that sounds like good pricing. And so, I know it's not in your strategic plan, but given this type of prices and what appears to be some level of interest, does it make you kind of rethink about Lantower? And could that be a candidate for sale down the road? And how are you thinking about Lantower here?
Tom Hofstedter: So, Lantower is a very, very solid asset, very, very solid platform, very solid management group. It really doesn't change anything. The markets all concerned about the fact that there's a whole bunch of units going to be ready. The 1000 square that has been built in our market and sunbelt markets and the cost pressure on rent. We look at it completely differently. We look at the fact that it's right now, there is some pressure on the rent. Those units are going to get absorbed in our markets sometime mid to end in 2025, 2026, the rents are going to go way up against the supply/demand to balance, but you're not -- no one's building anything. And as I mentioned before, no one's building anymore because they have to build to a 6.75% to 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. Lantower is a solid company, it's a keeper. So, it doesn't make sense to go ahead and increase your exposure to office by spinning off Lantower. You may get a good price for Lantower, 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 to deal with our office, which, in our opinion, have value when the residential market returns as an ulterior user for the intensification properties. And for our 3 or 4 core office buildings, there are sticky tenants, and we expect to renew them and be able to sell the properties at that time. So, we'll stay the course and Lantower is, therefore, going to be one of our keepers and ultimately, we're going to we achieve the result of having an industrial/residential REIT.
Jimmy Shan: Okay. 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 potential sale of Hess Tower?
Tom Hofstedter: So, it just adds more confusion to what's going on over there. The courts haven't put down their ruling what's with the Hess sale at all. So that -- we expect this coming in November, but my guess is that it will drag as these things usually do. If Chevron bypass is successful, then Chevron has to make the decision where they want to be located. They have space within their existing power. They have made the announcement they're moving headquarters to Houston, which means they probably need [indiscernible]. Until this is all resolved, we have no idea what's going on. If the court case goes against them, Hess does not have saleable asset anymore. Hess can't be sold to Exxon (NYSE:XOM) and Hess can't be sold to Chevron. Hess will remain a growing concern as it will remain the building the way it is. 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 1/3 of the world in 2026. I think successfully, we're very confident that we'll achieve our objective to have that lease and then we have another 12 years to go to Hess. We are very confident with that building. We're very confident with our TransCanada joint venture, TransCanada tower, Hess Tower and [indiscernible] 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 rally sell the asset, because every buyer is going to be asking the same question as you did, where is Hess going to be located? It has a strong impact on the long-term value of the asset. And so therefore, right now, it's [indiscernible] re-leasing the space that will come up in 2026 and I think successfully so. And then we'll see what happens in the next few months with the Chevron, Hess situation.
Jimmy Shan: Okay. Thank you.
Tom Hofstedter: Thanks, Jimmy.
Operator: Thank you. There are no further questions. I'll turn the call back over for closing comments.
Tom Hofstedter: Thank you, everybody, and enjoy the summer.
Operator: Ladies and gentlemen, this concludes your conference for today. We thank you for participating, and we ask that you please disconnect your lines.
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