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

Scotia comments after conference

[incomedreamer11]

No Need to Rush

OUR TAKE: Neutral. We maintain our SP rating following an in-line recurring FFOPU quarter (Exhibit 12). Our key estimates are +2% – -11% (Exhibit 1) vs. down 0%-9% sector avg. (Exhibit 2). Bottom-line, no meaningful change in our neutral investment thesis, which should improve meaningfully in 2H/24 as two unit price catalysts draw near. In the near-term (i.e., next 3-6 months), we think there is no urgency to build positions, despite the cheap valuation (Exhibits 4-5). We think the primary unit price catalysts = improved U.S. Sun-Belt sentiment and fundamentals on peak supply absorption (we suspect Lantower sentiment likely not better until late 2024 or early 2025) and disposition of Office properties re-zoned with residential intensification (again, a year out; see below). Improved U.S. Sun-Belt sentiment is particularly crucial in our view given H&R’s strategic plan is largely driven by making Lantower (Residential) a much bigger part of the H&R story (Office and Retail...less)...we think investors need to want U.S. Sun-Belt multi-family exposure for H&R unit price to move materially higher (see recent downgrade of Sun-Belt Multifamily BSR REIT by our colleague Himanshu Gupta here).

KEY POINTS

What has changed? Consistent with most other REITs, we increased our NAV cap rate (+14bp vs. +20bp sector avg.) and lowered our Target Multiple (-2.5x vs. -1.9x avg.) to 6.28% and 11.5x, respectively; Exhibit 3 = Target Multiple support. As shown in Exhibit 4, H&R is one of only two REITs trading at an above-average AFFO and implied cap rate spread to the 10YR GOC today (joining AP), while trading at one of the lowest multiples in our universe (Exhibit 5).

Conference call highlights. Primary focus was on the two things we think matter most: Lantower ops and prospects for “accretive” dispositions (i.e., residential density). On Lantower, H&R noted blended flat rent spreads in Q3 should continue in 2024 as it prioritizes occupancy (SS +20bp q/q to 95.2%) in the face of elevated new supply in 2024. Concessions are being offered in < 5% of suites (at an avg. ~2 weeks). Lantower is on track for previously-guided low-teen 2023 SSNOI growth, but 2024E was not provided. Lastly, H&R noted ~20 transactions (~7,000 suites) in its markets traded in the 4.5%-5.0% range recently, supporting its intact 4.75% IFRS Sun-Belt cap rate (i.e. investors looking past 2024; not so much in the public markets in our view). Regarding dispositions, H&R noted $170M expected by year-end (at a “healthy” cap rate). It would not provide 2024 guidance given most transactions are expected to be “off-market”, which are lumpy. H&R views lower interest rates as the key catalyst for accelerated deals and thinks it could happen by mid-2024 (i.e., expect slower start to 2024). Importantly, it needs another year to dispose of its Office Rezoning sites (~1,000 future residential suites for now) for re-submission of approved proposals in order to eliminate the Toronto office-replacement requirement that H&R expects will be relaxed (i.e., should achieve higher sales/sf value vs. the ~$200/sf buildable H&R estimates today); market is not great today in any event.New 2025 estimates show improved per unit growth on “accretive” residential land dispositions and recovery in Lantower fundamentals. Our new 2025E FFOPU and AFFOPU are $1.21 and $1.02, equating to 3%-4% y/y growth (vs. 4%-5% y/y erosion in 2024E). Exhibit 6 provides our key assumption summary. Our 2024E and 2025E dispositions are $450M and $0M (4% and 0% of Q3/23 GAV), with the difference being cap rate as we’re including the sale of ~$300M of “Office Rezoning” assets in 2H/24 avg. 4.5% cap. We assume Lantower returns to blended ~5% lease spreads and occupancy returns to 97%, leading to total H&R 2025E SSNOI of 3.7% (vs. -0.3% in 2024E).