H&R Real Estate Investment Trust T.HR.UN

Scotia comments after conference

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Continued Small Steps In the Right Direction

OUR TAKE: Neutral. We maintain our SP rating, but our 2% higher 2025E FFOPU/AFFOPU = +$0.25 TP to $11.25 (Exhibit 1); our average TP was flat for our universe post Q1 results (Exhibit 2). Our view on H&R is steadily improving. First, valuation looks cheap. HR is one of a few REITs with above-avg. spreads to 10YR (Exhibit 3), we estimate U.S. residential (33% of Q1 NOI in CAD) is trading at an implied cap of 7.5% (Exhibit 4). Second, we expect H&R to recover 2024E FFOPU erosion in 2025, positioning it as an attractive “earnings acceleration trade” as we approach 2025 (Exhibit 5); probably a bit too early for that now though. Third, there are clear and tangible catalysts, albeit timing is uncertain. The balance sheet should improve on recent dispositions (link to note) In order of (catalyst) importance, we think improved investor U.S. Residential Sunbelt sentiment, the sale of Echo, and the sale of Toronto Office repositioning assets would notably move the unit price with investors getting an 6.2% yield while you wait it out (at 2024E AFFO payout of 61%). In addition to 5% 2025E y/y FFOPU growth, we think the above-three can result in 20%+ multiple expansion, leading to a mid-20% NTM total return (with some upside)

KEY POINTS

Thoughts on the quarter. While Q1 results were in-line , we’re pleased to see NOI beat (offset by higher G&A and lower interest income (Exhibit 9). We also took some comfort in stabilizing Lantower lease spreads (see below and Exhibits 6-8), even if a recovery is likely a 2025 event (i.e., supply absorption; we think H&R unit price moves 3-6 months ahead of that). We’re also encouraged with HR’s more optimistic tone on the potential sale of Echo (disclosed $0.5M net investment) within 12 months (not currently on the market; H&R discussed 7.0%-7.5% cap rates vs. the 7% in our HR NAV), with one partial offset = expected Municipal approval date at 77 Union in Toronto pushed from 2024 into 2025 (1.1Msf potential residential density; currently = 0.2Msf Office). With respect to disposing of Toronto residential intensification opportunities, we believe a 25%-50% recovery in land values would be conducive, all else equal.

Key call highlights and takeaways. HR was +20bp vs. sector during the call but outperformed by ~1% right after the call finished. HR mentioned that leasing spreads on their residential portfolio was down ~2% in Q1 (+60bp q/q) due to seasonality, but is already flat in Q2 and is expected to continue doing better over the course of the year. The management team reiterated its focus on improving the balance sheet, so the priority is paying down debt vs. buying back shares with the proceeds from dispositions. HR continues to refrain from providing guidance, and also mentioned that the construction cost on 69 Yonge will most likely be $100/sf-$150/sf higher than usual because it's an old structure.