H&R Real Estate Investment Trust and H&R Finance Trust
2011 Annual Report
Including Combined MD&A and Financial Statements
The Bow, Calgary Two Gotham Center, NYC
Hess Tower, Houston Atrium on Bay, Toronto
H&R Profile
H&R Real Estate Investment Trust (“H&R REIT”) is an open-ended real estate investment trust, which
owns and manages a North American portfolio of 289 office, industrial and retail properties comprising
over 43 million square feet, and three development projects, with a total net book value of $7.6 billion at
December 31, 2011.
H&R Finance Trust is an unincorporated investment trust, which primarily invests in notes issued by a
subsidiary of H&R REIT. The units of H&R REIT trade together with the units of H&R Finance Trust as
“stapled units” on the Toronto Stock Exchange listed under the symbol HR.UN. In this annual report, we
refer to the combination of these two trusts as “H&R” or “the Trusts”.
Additional information regarding H&R REIT and H&R Finance Trust is available at www.hr-reit.com and
on www.sedar.com.
Property Operating Income *
by Geographic Region
Other 8%
Quebec
7%
Alberta
15%
Ontario,
47%
United
States
23%
Property Operating Income *
by Type of Asset
Retail
25%
Industrial
29%
Office
46%
* Property operating income is before interest, depreciation and amortization for the year ended December 31, 2011.
Primary Objectives
H&R strives to achieve two primary objectives: to provide unitholders with stable and growing cash
distributions generated by revenues derived from a diversified portfolio of income properties, and to
maximize the value of units through active management of H&R’s assets, acquisition of additional
properties, and development of new projects which are pre-leased to creditworthy tenants. We are
committed to maximizing returns to unitholders while maintaining prudent risk management and
conservative use of financial leverage.
Stability and Growth through Discipline
Since inception in 1996, H&R has executed a disciplined and proven strategy that has provided stable
cash flow and adjusted funds from operations. We achieve our primary objectives and mitigate risks
through long-term property leasing and financing, combined with conservative management of assets and
liabilities.
2011 Highlights
• Maintained portfolio occupancy rate at virtually 100% for the 15th consecutive year
•
Invested $1.4 billion in the acquisition of 11 properties, which were partially funded with mortgages
totalling $831 million with a weighted average term to maturity of 9.6 years and a weighted average
interest rate of 4.8% per annum. Three of these acquisitions were full ownership interests in Atrium
on Bay in Toronto ($345M), Two Gotham Center in New York City (US $416M) and Hess Tower in
Houston (US $443M).
Invested $349 million in properties under development, including $329 million for construction of The
Bow office complex in Calgary
•
• Raised $867 million of funding, primarily by issuing 23 million units ($512M) and debentures ($355M)
•
Increased distributions per stapled unit by 24%, while H&R’s unit price rose 20%
Average term to maturity of leases (years)
Average term to maturity of mortgages payable (years)
Gross leasable area (millions of sq.ft.)
Portfolio occupancy rate
Rentals from investment properties (millions)
Net income/(loss) (millions)
Funds from operations (millions) (2)
FFO per Stapled Unit (basic)
Adjusted funds from operations (millions) (2)
AFFO per Stapled Unit (basic)
Cash provided by operations (millions)
Cash distributions paid (millions) (3)
Distributions per Stapled Unit
Payout ratio per Stapled Unit (distributions/AFFO)
Assets (billions)
Debt as percent of gross book value of assets (4)
Equity market capitalization (billions)
2011
11.0
7.7
43.1
99.1%
$657
($25)
$272
$1.70
$237
$1.49
$405
$119
$0.98
66%
$7.6
51%
$4.0
2010 (1)
11.1
8.0
39.1
98.9%
$617
$497
$215
$1.43
$217
$1.45
$400
$104
$0.79
55%
$6.0
48%
$2.8
(1) 2010 numbers have been adjusted to reflect International Financial Reporting Standards
(2) Readers are encouraged to review, in H&R’s MD&A, reconciliations of: net income (loss) to FFO; FFO to AFFO; and AFFO to cash
provided by operations.
(3) Cash distributions paid exclude distributions reinvested in units pursuant to H&R’s unitholder distribution reinvestment plan and include
the distributions paid to the Class B Limited Partnership unitholders who can exchange their units for Stapled Units.
(4) Calculated in accordance with the REIT's Declaration of Trust
First Quarter 2012 Highlights
• Received a non-recourse U.S. mortgage for US $250 million for Hess Tower in Houston, bearing
interest at a rate of 4.5% per annum for an 8-year term; refinanced three U.S. mortgages totalling US
$73 million with new non-recourse U.S. mortgages totalling $61 million, each bearing interest at a rate
of 4.5% per annum for a 10-year term; and refinanced ten Canadian mortgages totalling $29 million in
total with new mortgages totalling $63 million, each bearing interest at a rate of 4.0% per annum for a
10-year term
• Purchased a 485,000 square foot, state-of-the-art office building located in Toronto for $186 million
before transaction costs and leased for 20 years to Corus Entertainment Inc.; secured a non-recourse
$60-million, interest-only mortgage with an interest rate at a spread of 2.3% over the 20-year
Government of Canada bond, for a term of 20 years, and secured a $37-million, non-recourse, first
mortgage on a pari passu basis for a term and rate to be determined
President’s Message to Unitholders
Over the past 12 months, commercial property owners in Canada have enjoyed continuing high
occupancy rates and steady rental rates, in addition to increased availability of low-cost debt capital
throughout North America. This allowed H&R REIT to produce solid financial results and to significantly
grow its property portfolio. We foresee a continuation of these favourable market conditions boding well
for the REIT in 2012 and beyond.
2011 Financial Results
For the 15th year since inception, H&R executed its conservative strategy of pursuing stability and
growth through discipline. Cash distributions to unitholders increased 24%. As equity and debt market
conditions further improved, we continued to acquire and develop high-quality properties on an accretive
basis and reduced the REIT’s financing costs. Our capital investments were partly financed by issuing 23
million stapled units at a weighted average price of $22.36 and $355 million of convertible and senior
debentures at a weighted average interest rate of 4.75%.
The price of H&R’s Stapled Unit closed at $23.26 in 2011, increasing 20% compared to 15% for the
S&P/TSX Capped Real Estate Index and a decline of 11% for the Composite Index. Including capital gain
and distributions, the overall return on investment to our unitholders was 25% last year and a compound
average annual return of approximately 15% since inception in 1996.
Strategic Investments
Over the past 12 months, we have invested approximately $1.2 billion in three acquisitions that have
become hallmarks of H&R’s property portfolio and will bolster our stable and growing income stream for
decades to come. These investments significantly increased our first-class office holdings in thriving
urban markets. They also signalled to the North American real estate industry that the REIT is a
resourceful and competitive buyer and developer of top-quality commercial properties. The two U.S.
acquisitions also increased the geographic diversification of H&R’s sources of income.
Atrium on Bay, Toronto
Atrium on Bay comprises approximately 915,000 square feet of Class A office space and 136,000 square
feet of prime retail premises. Our acquisition of this prestigious downtown complex for $345 million
represented Canada’s single largest commercial property transaction in 2011. We assumed a $190-
million mortgage maturing in 2017. The property has direct underground access to the subway and to the
underground pedestrian PATH. The premises are 99% occupied, and we are projecting a substantial
increase in net operating income as tenant leases roll over. The property also has excess density and
structural capacity for potential expansion of the office space by an additional 200,000 square feet.
Two Gotham Center, New York City
This new 22-storey, Class A office tower is located in the borough of Queens, across the East River from
mid-town Manhattan. It comprises approximately 661,000 rentable square feet of office space, which is
100% leased to the highly creditworthy New York City Department of Health and Mental Hygiene. The
lease has an initial term of 20 years, and includes contracted rental escalations of approximately 10%
every five years. Last year, the tenant began enjoying awesome views of America’s largest city, and
working only minutes from a major transportation hub with six subway lines, excellent bus service and
easy access to the nearby Queensboro Bridge, the Long Island Expressway, and the Long Island
Railroad Station. The building’s green technology will provide low operating costs and has obtained a
LEED Gold certification for Core and Shell. We purchased the property for US$415.5 million and partly
financed it with a US$250-million mortgage at 4.25% for 10 years. The new tower is the first building of
Gotham Center – a two-block development which, once completed, will comprise about 3.5 million square
feet of new office, retail, parking and residential development.
Hess Tower, Houston
Completed in June 2011, this property comprises a 29-storey tower offering approximately 845,000
rentable square feet of superior office space connected by a sky bridge to its adjacent 1,430-space
parking garage. Hess Tower is fully leased on a triple-net basis to Hess Corporation, a global, Fortune
100, integrated energy company listed on the NYSE. The tower is part of Houston’s Pedestrian Tunnel
System that connects 77 major downtown office buildings to an abundance of upscale restaurants, retail
stores, and world-class hotels, sports and entertainment destinations. Overlooking the recently completed
Discovery Green Park, the Hess Tower is one of the downtown’s most energy efficient office buildings,
having achieved the LEED Platinum certification for Core and Shell – the U.S. Green Building Council’s
highest rating. We purchased this state-of-the-art office tower for US $442.5 million and partly financed it
with a US $250-million mortgage at 4.5% for eight years.
The Bow, Calgary
The Bow is a world-class, approximately two-million square foot downtown office complex, fully leased to
EnCana Corporation on a triple-net basis for a term of 25 years. EnCana is a leading North American
natural gas producer and one of Canada’s largest public companies. With our development substantially
finished, tenants will begin taking occupancy in the second quarter of this year and we expect the new
premises to be fully occupied by the fourth quarter. The Class AAA skyscraper is an iconic landmark in
Calgary’s financial district. The Bow – the largest Canadian office tower west of Toronto, with a striking
design that crowns Calgary’s skyline – will be the keystone of our property portfolio. In addition to
featuring three sky gardens and an energy-efficient design, the tower is integrated with the city’s elevated
pedestrian walkway and rail and bus transit system.
At December 31, 2011, H&R REIT had invested approximately $1.5 billion in the 58-storey project
(excluding capitalized interest costs). The annualized year-one net income from The Bow is expected to
be approximately $93.5 million, and rental rates will increase 0.75% per annum on the office space and
1.5% per annum on the parking space during the lease. We have also made an application to the City of
Calgary to amend the approved development permit on the South Block to allow additional office and
ancillary retail uses.
Outlook
There continues to be strong demand from investors for REITs with potential for rising distributions and
capital gains. Commercial real estate experts have a fairly good outlook for office, industrial and retail
property markets in 2012. Steady economic growth and historically-low interest rates are forecast for both
Canada and United States. However, occupancy rates are projected to remain higher in Canada,
whereas U.S. property prices continue to be significantly lower than they were before the financial crisis in
2008.
The availability of high-quality commercial assets for sale is expected to remain relatively limited, but our
competitive position to bid for them is now stronger. We have a well capitalized balance sheet, attractive
borrowing costs, and both significant experience and a vast presence in North American real estate
markets. However, we will continue to acquire properties only in a very selective and disciplined manner –
when we have in place long-term leases with highly creditworthy tenants and cost-effective, long-term,
fixed-rate financing.
This year, we expect to see H&R’s strong, diversified portfolio perform well and continuing growth in
profitability from both contractual rental escalations and accretive acquisitions. We are therefore very
optimistic about our opportunities for growth and ability to prosper. With highly predictable cash flow, we
intend to increase annualized distributions this year, from $1.15 per stapled unit in the second quarter to
$1.25 in the fourth quarter.
Our management team wishes to thank H&R’s investors, trustees and employees for their trust and
commitment to our success over the past year. With your continued support, we look forward to further
achieving stability and growth through discipline.
President and Chief Executive Officer
March 28, 2012
COMBINED MANAGEMENT’S DISCUSSION AND
ANALYSIS OF H&R REAL ESTATE
INVESTMENT TRUST AND H&R FINANCE TRUST
For the Year ended December 31, 2011
Dated: March 12, 2012
TABLE OF CONTENTS
SECTION I
Basis of Presentation
Forward-Looking Disclaimer
Non-GAAP Financial Measures
Overview
Financial Highlights
Key Performance Drivers
Portfolio Overview
Outlook
Adoption of International Financial Reporting Standards
SECTION II
Selected Annual Information
Discussion of Operations
Segmented Information
Assets
Liabilities
Equity
1
1
2
2
4
4
5
7
8
10
11
18
19
23
25
Funds from Operations
Adjusted Funds from Operations
Liquidity and Capital Resources
Off-Balance Sheet Items
Financial Instruments and Other Instruments
SECTION III
Summary of Quarterly Results
SECTION IV
Critical Accounting Estimates
Disclosure Controls and Procedures
Internal Control over Financial Reporting
SECTION V
Risks and Uncertainties
Outstanding Unit Data
Subsequent Events
Additional Information
26
29
32
34
35
36
36
38
38
38
43
43
43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
SECTION I
BASIS OF PRESENTATION
Financial data included in this Management’s Discussion and Analysis (“MD&A”) of combined results of operations and combined
financial position of H&R Real Estate Investment Trust (the “REIT”) and H&R Finance Trust (“Finance Trust” and together with the
REIT, the “Trusts”) for the year ended December 31, 2011 includes material information up to March 12, 2012. Financial data
provided has been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International
Accounting Standards Board (“IASB”). The MD&A should be read in conjunction with the Combined Financial Statements and
appended notes for the years ended December 31, 2011 and 2010. All amounts in this MD&A are in thousands of Canadian dollars,
except where otherwise stated. Historical results, including trends which might appear, should not be taken as indicative of future
operations or results. Certain prior period items have been reclassified to conform with the presentation adopted in the current
period.
FORWARD-LOOKING DISCLAIMER
Certain information in this MD&A contains forward-looking information within the meaning of applicable securities laws (also known
as forward-looking statements) including, among others, statements made or implied under the headings “Discussion of Operations”,
“Liquidity and Capital Resources”, “Outlook” and “Risks and Uncertainties” relating to the Trusts’ objectives, strategies to achieve
those objectives, the Trusts’ beliefs, plans, estimates, projections and intentions, and similar statements concerning anticipated
future events, results, circumstances, performance or expectations that are not historical facts including, in particular, the Trusts’
expectation regarding future development in connection with the Bow. Forward-looking statements generally can be identified by
words such as “outlook”, “objective”, “may”, “will”, “expect”, “intend”, “estimate”, “anticipate”, “believe”, “should”, “plans”, “project”,
“budget” or “continue” or similar expressions suggesting future outcomes or events. Such forward-looking statements reflect the
Trusts’ current beliefs and are based on information currently available to management.
Forward-looking statements are provided for the purpose of presenting information about management’s current expectations and
plans relating to the future and readers are cautioned that such statements may not be appropriate for other purposes. These
statements are not guarantees of future performance and are based on the Trusts’ estimates and assumptions that are subject to
risks and uncertainties, including those described below under “Risks and Uncertainties” and those discussed in the Trusts’ materials
filed with the Canadian securities regulatory authorities from time to time, which could cause the actual results and performance of
the Trusts to differ materially from the forward-looking statements contained in this MD&A. Those risks and uncertainties include,
among other things, risks related to: credit risk and tenant concentration; lease rollover risk; interest and financing risk; financing
credit risk; currency risk; tax risk; environmental risk; development and financing risk relating to the Bow development; construction
risks; debentures; availability of cash for distributions; unit prices, ability to access capital markets, dilution; redemption right; and
risks relating to unitholder liability. Material factors or assumptions that were applied in drawing a conclusion or making an estimate
set out in the forward-looking statements include that the general economy is stable; local real estate conditions are stable; interest
rates are relatively stable; and equity and debt markets continue to provide access to capital. The Trusts caution that this list of
factors is not exhaustive. Although the forward-looking statements contained in this MD&A are based upon what the Trusts believe
are reasonable assumptions, there can be no assurance that actual results will be consistent with these forward-looking statements.
Readers are also urged to examine the REIT and Finance Trust’s materials filed with the Canadian securities regulatory authorities
from time to time as they may contain discussions on risks and uncertainties which could cause the actual results and performance
of the REIT and Finance Trust to differ materially from the forward-looking statements contained in this MD&A. Neither Finance
Trust nor any of its trustees or officers, assumes any responsibility for the completeness of the information contained in the REIT’s
materials filed with the Canadian securities regulatory authorities or for any failure of the REIT or its trustees or officers to disclose
events or facts which may have occurred or which may affect the significance or accuracy of any such information. Neither the REIT
nor any of its trustees or officers, assumes any responsibility for the completeness of the information contained in Finance Trust’s
materials filed with the Canadian securities regulatory authorities or for any failure of Finance Trust or its trustees or officers to
disclose events or facts which may have occurred or which may affect the significance or accuracy of any such information.
All forward-looking statements in this MD&A are qualified by these cautionary statements. These forward-looking statements are
made as of March 12, 2012 and the Trusts, except as required by applicable law, assume no obligation to update or revise them to
reflect new information or the occurrence of future events or circumstances.
Page 1 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
NON-GAAP FINANCIAL MEASURES
Property operating income, same-asset property operating income, funds from operations (“FFO”), adjusted funds from operations
(“AFFO”) and gross book value (“GBV”) are all supplemental financial measures used by management to track the Trusts’
performance. Such measures are not recognized under GAAP and therefore do not have standardized meanings prescribed by
GAAP. Management believes that these non-GAAP financial measures are a meaningful measure of operating performance as they
reject the assumption that the value of real estate investments diminishes predictably over time. These non-GAAP financial
measures should not be construed as alternatives to comparable financial measures calculated in accordance with GAAP. Further,
the Trusts’ method of calculating such supplemental financial measures may differ from the methods of other real estate investment
trusts or other issuers and accordingly, such supplemental financial measures used by management may not be comparable to
similar measures presented by other real estate investment trusts or other issuers. See “Funds from Operations” and “Adjusted
Funds from Operations” for a reconciliation of GAAP measures to non-GAAP measures.
OVERVIEW
The REIT is an unincorporated open-ended trust created by a Declaration of Trust and governed by the laws of the Province of
Ontario. Unitholders are entitled to have their REIT units comprising part of the Stapled Units redeemed at any time on demand
payable in cash (subject to monthly limits) and/or in specie, provided that the corresponding Finance Trust units are being
contemporaneously redeemed.
Finance Trust is an unincorporated investment trust. Finance Trust was established pursuant to a Plan of Arrangement (the “Plan of
Arrangement”) on October 1, 2008, as described in the REIT’s information circular dated August 20, 2008, as an open-ended limited
purpose unit trust pursuant to its Declaration of Trust. Each issued and outstanding Finance Trust unit is “stapled” to a unit of the
REIT on a one-for-one basis such that Finance Trust units and the REIT units trade together as stapled units (“Stapled Units”), and
such Stapled Units are listed and posted for trading on the Toronto Stock Exchange (“TSX”). Apart from provisions necessary to
achieve such stapling, each REIT unit and Finance Trust unit retains its own separate identity and is separately listed (but not posted
for trading) on the TSX (unless there is an event of uncoupling, in which case Finance Trust units will cease to be listed on the TSX).
The REIT has two primary objectives:
(cid:131) to provide unitholders with stable and growing cash distributions, generated by the revenue it derives from investments in
income producing real estate properties; and
(cid:131) to maximize unit value through ongoing active management of the REIT’s assets, acquisition of additional properties and the
development and construction of projects which are pre-leased to creditworthy tenants.
The REIT’s strategy to accomplish these two objectives is to accumulate a diversified portfolio of high quality income producing
properties in Canada and the United States occupied by creditworthy tenants on a long-term basis. The REIT does not have any
specific allocation targets as to property type, but rather focuses on creditworthy tenants with long-term leases.
The primary purpose of Finance Trust is to be a flow-through vehicle to allow the REIT to indirectly access the capital markets in a
tax-efficient manner by indirectly borrowing money from the REIT’s unitholders. Finance Trust’s primary activity is to hold debt
issued by H&R REIT (U.S.) Holdings Inc. (“U.S. Holdco”), a wholly owned U.S. subsidiary of the REIT. As at December 31, 2011,
Finance Trust holds U.S. $142.8 million of aggregate principal amount of notes payable by U.S. Holdco (“U.S. Holdco Notes”).
Subject to cash flow requirements, Finance Trust intends to distribute to its unitholders, who are also unitholders of the REIT, all of
its cash flow, consisting primarily of interest paid by U.S. Holdco, less administrative and other expenses and amounts to satisfy
liabilities.
Mechanics of “Stapling” the Units of Finance Trust and the REIT
Pursuant to the provisions of the Declarations of Trust for Finance Trust and the REIT at all times each REIT unit must be ‘‘stapled’’
to a Finance Trust unit (and each Finance Trust unit must be ‘‘stapled’’ to a REIT unit) unless there is an “event of uncoupling” (as
described below). As part of the Plan of Arrangement, the REIT and Finance Trust entered into a support agreement (the “Support
Agreement”) which provided, among other things, for the co-ordination of the declaration and payment of all distributions so as to
provide for simultaneous record dates and payment dates; for co-ordination so as to permit the REIT to perform its obligations
pursuant to the REIT’s Declaration of Trust, Unit Option Plan, Distribution Reinvestment Plan and Unit Purchase Plan (“DRIP”) and
Unitholder Rights Plan; for Finance Trust to take all such actions and do all such things as are necessary or desirable to enable and
permit the REIT to perform its obligations arising under any security issued by the REIT (including securities convertible, exercisable
Page 2 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
or exchangeable into Stapled Units); for Finance Trust to take all such actions and do all such things as are necessary or desirable
to enable the REIT to perform its obligations or exercise its rights under its convertible debentures; and for Finance Trust to take all
such actions and do all such things as are necessary or desirable to issue Finance Trust units simultaneously (or as close to
simultaneously as possible) with the issue of REIT units and to otherwise ensure at all times that each holder of a particular number
of REIT units holds an equal number of Finance Trust units, including participating in and cooperating with any public or private
distribution of Stapled Units by, among other things, executing prospectuses or other offering documents.
In the event that the REIT issues additional REIT units, pursuant to the Support Agreement, the REIT and Finance Trust will
coordinate so as to ensure that each subscriber receives both REIT units and Finance Trust units, which shall trade together as
Stapled Units. Prior to such event, the REIT shall provide notice to Finance Trust to cause Finance Trust to issue and deliver the
requisite number of Finance Trust units to be received by and issued to, or to the order of, each subscriber as the REIT directs. In
consideration of the issuance and delivery of each such Finance Trust unit, the REIT (solely as agent for and on behalf of the
purchaser) or the purchaser, as the case may be, shall pay (or arrange for the payment of) a purchase price equal to the fair market
value (as determined by Finance Trust in consultation with the REIT) of each such Finance Trust unit at the time of such issuance.
The remainder of the subscription price for Stapled Units shall be allocated to the issuance of REIT units by the REIT. The proceeds
received by Finance Trust from any such issuance shall be invested in additional notes of the same series as the U.S. Holdco Notes
or distributed to unitholders of Finance Trust.
An event of uncoupling (“Event of Uncoupling”) shall occur only: (a) in the event that unitholders of the REIT vote in favour of the
uncoupling of units of Finance Trust and units of the REIT such that the two securities will trade separately; or (b) at the sole
discretion of the trustees, but only in the event of the bankruptcy, insolvency, winding-up or reorganization (under an applicable law
relating to insolvency) of the REIT or U.S. Holdco or the taking of corporate action by the REIT or U.S. Holdco in furtherance of any
such action or the admitting in writing by the REIT or U.S. Holdco of its inability to pay its debts generally as they become due.
Investment Restrictions
Under Finance Trust’s Declaration of Trust, the assets of Finance Trust may be invested only in:
(a) U.S. Holdco Notes; and
(b)
temporary investments in cash, term deposits with a Canadian chartered bank or trust company registered under the
laws of a province of Canada, short-term government debt securities, or money market instruments (including
banker’s acceptances) of, or guaranteed by, a Schedule 1 Canadian bank (“Cash Equivalents”), but only if each of
the following conditions are satisfied: (a) if the Cash Equivalents have a maturity date, the trustees hold them until
maturity; (b) the Cash Equivalents are required to fund expenses of Finance Trust, a redemption of units, or
distributions to unitholders, in each case before the next distribution date; and (c) the purpose of holding the Cash
Equivalents is to prevent funds from being non-productive, and not to take advantage of market fluctuations.
Finance Trust’s Declaration of Trust provides that Finance Trust shall not make any investment, take any action or omit to take any
action which would result in the units of Finance Trust not being considered units of a ‘‘mutual fund trust’’ for purposes of the Income
Tax Act (Canada) (the “Tax Act”) or that would disqualify Finance Trust as a “fixed investment trust” under the Internal Revenue
Code of 1986 as amended (the “Code”) and the applicable regulations. In order to qualify as a ‘‘fixed investment trust’’ under the
Code, Finance Trust generally may not acquire assets other than the U.S. Holdco Notes or certain investments in cash or cash
equivalents.
Page 3 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
FINANCIAL HIGHLIGHTS
(in thousands of Canadian dollars except per unit amounts)
Total assets
Debt to gross book value of assets (per the REIT’s Declaration of Trust)
Debt to gross book value of assets (per the combined financial statements)
Debt to fair market value of assets (per the combined financial statements)
Stapled Units outstanding
Exchangeable units of H&R Limited Partnership outstanding
* The 2010 ratios have been restated for IFRS
Property rental revenue
Property operating income
Adjusted funds from operations (“AFFO”)
Weighted average number of basic Stapled Units for AFFO
AFFO per basic Stapled Unit
Distributions paid per Stapled Unit
Payout ratio per unit as a % of basic AFFO
December 31,
2011
December 31,
2010*
$7,637,801
50.5%
57.6%
53.6%
172,554
5,438
$5,998,640
47.8%
56.0%
52.7%
146,121
5,438
Three months ended
December 31,
2011
Three months ended
December 31,
2010
$178,174
118,203
60,192
167,691
0.36
0.26
72.2%
$160,700
105,038
55,361
150,624
0.37
0.22
59.5%
Net income (loss) is reconciled to FFO which is reconciled to AFFO. AFFO is reconciled to cash provided by operations, being the most comparable GAAP measure
to these non-GAAP financial measures. See pages 26-31.
KEY PERFORMANCE DRIVERS
OPERATIONS
Occupancy as at December 31(1)
Occupancy – same asset as at December 31(2)
Average contractual rent per square foot for the
three months ended December 31(3)
Office
Industrial
Retail
2011
2010
2011
2010
2011
2010
99.1%
99.2%
99.0%
99.3%
$21.74
$19.66
98.9%
98.3%
98.9%
98.5%
$5.73
$5.70
99.9%
100.0%
99.9%
99.9%
$13.15
$12.82
Total*
99.1%
98.9%
99.1%
98.9%
$11.24
$10.17
*
(1)
(2)
(3)
weighted average total
Excluding properties where tenants have filed for protection under Chapter 11 of the United States Bankruptcy Code and where the REIT has subsequently
handed over control of the subject properties to the non-recourse mortgage lenders.
Same asset refers to those properties owned by the REIT for the entire 2-year period ended December 31, 2011 and excludes properties sold and assets
where tenants have filed for protection under Chapter 11 of the United States Bankruptcy Code, and where the REIT has subsequently handed over control of
the subject properties to the non-recourse mortgage lender.
For all properties excluding those properties that are held for sale or sold and where tenants have filed for protection under Chapter 11 of the United States
Bankruptcy Code, and where the REIT has subsequently handed over control of the subject properties to the non-recourse mortgage lender.
Average remaining term to maturity of leases (years)
Average remaining term to maturity of mortgages payable (years)
December 31,
2011
December 31,
2010
11.0
7.7
11.1
8.0
Page 4 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
PORTFOLIO OVERVIEW
The geographic diversification of the REIT’s portfolio (excluding properties where tenants have filed for protection under Chapter 11
of the United States Bankruptcy Code and where the REIT has subsequently handed over control of the property to the non-recourse
mortgage lenders) as at December 31, 2011 is outlined in the charts below:
NUMBER OF PROPERTIES
Office
Industrial
Retail
Total
Ontario
23
49
32
104
United States
7
17
88
112
Alberta
4
19
5
28
Quebec
1
12
5
18
Square Feet (in thousands)
Ontario
United States
Alberta
Quebec
Office
Industrial
Retail
Total
6,124
9,252
1,895
17,271
2,024
7,352
5,128
14,504
1,406
2,810
515
4,731
452
2,978
498
3,928
Other
4
20
3
27
Other
884
1,280
524
2,688
Total
39
117
133
289
Total
10,890
23,672
8,560
43,122
PROPERTIES UNDER DEVELOPMENT
(in thousands of Canadian dollars)
Project
The Bow
Heart Lake
Airport Road
Address
5th Ave. at Centre Street, Calgary, AB
Mayfield West Business Park, Caledon, ON
7900 Airport Rd., Brampton, ON
December 31,
2011
$1,479,117
87,954
49,986
$1,617,057
December 31,
2010
$1,150,094
80,195
38,042
$1,268,331
MORTGAGES PAYABLE
2012
Periodic Amortized
Principal
($000’s)
$112,778
Principal on
Maturity
($000’s)
$266,290
Total Principal
($000’s)
$379,068
% of Total
Principal
12.1%
Weighted Average
Interest Rate on
Maturity
6.7%
2013
2014
2015
2016
Thereafter
110,077
113,398
113,200
110,610
108,147
182,632
235,938
291,260
Mortgages payable due on demand (net of financing cost of $152)(1)
Financing cost and mark-to-market adjustment arising on acquisitions(2)
Total
7.4%
6.2%
5.3%
5.4%
7.0%
9.4%
11.1%
12.8%
47.6%
100%
218,224
296,030
349,138
401,870
1,493,401
3,137,731
20,675
5,187
$3,163,593
(1) Relates to the two non-recourse mortgages to the REIT for investment properties in which the tenant (Great Atlantic & Pacific Tea Company) has filed for
protection under Chapter 11 of the United States Bankruptcy Code. The REIT expects to be released from any further obligations under these non-recourse
mortgages upon the transfer of title to the lenders.
(2) Mark-to-market adjustment represents the difference between the actual mortgages assumed on property acquisitions and the fair value of the mortgages at
the date of purchase and is recognized in finance cost over the life of the applicable mortgage using the effective interest rate method. Financing costs are
deducted from the REIT’s mortgages payable balances and are recognized in finance cost over the life of the applicable mortgage.
Page 5 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
TOP TWENTY SOURCES OF REVENUE BY TENANT
Tenant
Bell Canada
TransCanada Pipelines Limited
Telus Communications
Hess Corporation
Bell Mobility
New York City Department of Health
Rona Inc.
Canadian Tire Corp.
Versacold Logistics Canada Inc.
Royal Bank of Canada
Canadian Imperial Bank of Commerce
Lowes Companies Inc.
Ontario Realty Corporation and other
Ontario Agencies(2)
Nestle USA
Nestle Canada Inc.
Public Works of Canada
Shell Oil Products
Purolator Courier
Finning International
Marsh Supermarkets
Total
% of rentals from
income properties(1)
Number of
locations
REIT owned sq.ft.
(in 000’s)
Average lease term
to maturity (in years)
9.7
6.0
4.8
4.5
4.4
3.9
3.1
2.7
2.7
2.6
2.3
1.8
1.7
1.6
1.5
1.5
1.4
1.4
1.3
1.2
4
2
2
1
2
1
14
4
12
4
7
11
1
3
1
3
18
12
16
9
1,734
950
943
845
775
670
2,151
2,189
1,733
477
512
1,435
347
2,168
170
300
249
1,071
893
548
60.1%
127
20,160
13.8
9.3
11.4
(3)
13.9
18.9
8.1
14.3
15.4
4.7
3.1
7.2
4.6
5.9
7.7
4.9
10.5
10.4
10.3
14.9
The percentage of rentals from investment properties is based on estimated annualized gross revenue excluding the straight-lining of contractual rent and
investment properties held for sale.
Other Ontario agencies include: Legal Aid Ontario, Ontario Lottery and Gaming Corporation, Liquor Control Board of Ontario, and Hydro One Networks.
Due to the confidentiality under the tenant lease, the term is not disclosed.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
(1)
(2)
(3)
Office
Industrial
Retail
Total
LEASE
EXPIRIES
% of sq.ft.
Rent per
sq.ft. ($) on
expiry
Rent per
sq.ft. ($) on
expiry
% of sq.ft.
Rent per
sq.ft. ($) on
expiry
% of sq.ft.
Rent per
sq.ft. ($) on
expiry
% of sq.ft.
2012
2013
2014
2015
2016
0.6
1.3
1.6
1.0
2.2
6.7
18.22
17.60
16.80
22.31
18.58
18.49
1.3
3.5
3.2
1.6
5.1
14.7
5.63
5.35
4.52
6.35
3.93
4.81
0.1
0.4
0.4
0.3
0.3
1.5
32.70
11.80
15.00
27.10
19.60
18.67
2.0
5.2
5.2
2.9
7.6
22.9
10.76
8.91
9.10
14.00
8.79
9.72
Page 6 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
OUTLOOK
With limited new construction underway, shrinking vacancies and rising rents, the fundamentals for Canadian real estate are
promising. These factors together with the low interest rate environment and easy access to capital markets continue to compress
capitalization rates lower. In the United States, the recovery in the commercial real estate and capital markets has been much
slower, resulting in higher capitalization rates as compared to equivalent Canadian properties.
During 2011, the REIT acquired 11 properties in Canada and the United States for a total of $1.40 billion at an average capitalization
rate of 6.4%. The three largest properties purchased were:
(i) a multi-tenant office retail complex in downtown Toronto known as Atrium on Bay for $344.8 million at a capitalization rate of
6.48%;
(ii) a recently completed Class A LEED Gold office tower in Long Island City, New York, for U.S. $415.5 million at a capitalization
rate of 5.9%, fully leased to the City of New York for a term of 20 years;
(iii) a recently completed LEED Platinum office tower in Houston, Texas for U.S. $442.5 million at a capitalization rate of 6.6%, fully
leased to Hess Corporation on a long term lease.
The REIT partially funded the 2011 acquisitions with mortgages totalling $830.8 million. The weighted average term of these
mortgages is 9.6 years and the weighted average interest rate is 4.8% per annum.
To date in 2012, the REIT has purchased a 485,000 square foot state-of-the-art LEED Gold office building in downtown Toronto for
$186.0 million at a capitalization rate of 6.4% leased for 20 years to Corus Entertainment Inc. The REIT expects to continue making
acquisitions on a very select and disciplined basis.
The low interest rate environment is expected to benefit the REIT which has $266.3 million of mortgages maturing in 2012 at a
weighted average interest rate of 6.7% per annum. Subsequent to year end, the REIT has refinanced mortgages due in 2012
totalling $101.1 million which had an average interest rate of 6.5% per annum with new 10-year mortgages totalling $123.9 million at
an average interest rate of 4.2% per annum.
In addition, in July 2012 the REIT intends to redeem the 2013 convertible debentures and the 2014 convertible debentures which
bear interest at 6.65% and 6.75%, respectively. As these convertible debentures are currently in the money, the REIT expects to
convert them into equity thereby improving the REIT’s overall leverage ratios.
EnCana Corporation is expected to take occupancy of floors 3 to 22 in the Bow on April 2, 2012. Occupancy of further tranches will
occur throughout 2012. Once full occupancy is reached, the building will be generating $93.5 million of net operating income on an
annualized basis.
Management remains very optimistic and excited about the REIT’s ability to continue to grow and prosper in the coming year.
Consistent with this positive outlook, the Trusts’ trustees have adopted the following distribution policy:
Distribution Period
Q1 2012 (January, February and March)
Q2 2012 (April, May and June)
Q3 2012 (July, August and September)
Q4 2012 (October, November and December)
Intended Monthly
Distribution Per Stapled Unit
Intended Annualized
Distribution Per Stapled Unit
$0.09167
$0.09583
$0.10000
$0.10417
$1.10
$1.15
$1.20
$1.25
The Trusts’ trustees retain the right to re-evaluate the distribution policy from time to time as they consider appropriate. As all
distributions remain subject to approval and declaration by the Trusts’ trustees, there is no assurance that the actual distributions
declared will be as provided in the distribution policy. 2011’s total return (including distributions) to unitholders was 25%.
Page 7 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
ADOPTION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS
The Canadian Accounting Standards Board (“AcSB”) has mandated the adoption of IFRS effective for interim and annual periods
beginning on or after January 1, 2011 for Canadian publicly accountable profit-oriented enterprises. As a result, the Trusts have
adopted IFRS effective January 1, 2010 (the “transition date”) and have prepared the current combined financial statements in
accordance with IFRS accounting policies. Furthermore, these are the first annual combined financial statements that comply with
IFRS. The Trusts’ combined financial performance and financial position as disclosed under IFRS use a framework similar to the
one applied under previous Canadian generally accepted accounting principles (”Canadian GAAP”), however, there are significant
differences relating to measurement, recognition and disclosure. Refer to the December 31, 2011 combined financial statements for
the effect of the REIT’s transition to IFRS for the January 1, 2010 and December 31, 2010 periods.
Key changes between previous Canadian GAAP and IFRS:
For the actual quantitative effect of the changes below, please refer to note 3 of the financial statements.
The significant IFRS differences that had an impact on the Trusts’ financial statements include the following:
(a)
Investment properties
The REIT has elected to apply the fair value as deemed cost for certain properties as at January 1, 2010 and the cost model
for subsequent accounting for its investment properties. The carrying values of these selected properties were adjusted to
their fair market value at the transition date. Any adjustment to the carrying value at the transition date is reflected as an
adjustment in investment properties and an offsetting adjustment to retained earnings.
(b)
Foreign currency translation election
In accordance with IFRS 1, First-time Adoption of International Finance Reporting Standards (“IFRS 1”), the REIT has
elected to deem all foreign currency translation differences that arose prior to the date of transition in respect of all foreign
operations to be nil at January 1, 2010, with the balance reclassified to retained earnings. The only effect of this is a
restatement within the accounts of the unitholders’ equity.
(c)
Business combination election
In accordance with IFRS 1, the REIT has elected to apply the business combination accounting standard prospectively to all
business combinations subsequent to the January 1, 2010 transition date.
(d)
Impairment of investment properties
Previous Canadian GAAP generally uses a two-step approach to impairment testing: first comparing asset carrying values
with undiscounted future cash flows to determine whether impairment exists, and then measuring impairment by comparing
asset carrying values to their fair value (which is calculated using discounted cash flows). IAS 36, Impairment of Assets
uses a one-step approach for testing and measuring impairment, with asset carrying values compared directly with the
higher of fair value less costs to sell and value in use (which uses discounted cash flows). This resulted in write-downs
where the carrying value of assets were previously supported under previous Canadian GAAP on an undiscounted cash
flow basis, but could not be supported on a discounted cash flow basis. Unlike previous Canadian GAAP, which does not
permit reversals, IFRS allow for the reversal of an impairment loss in prior periods for an asset if there has been a change in
the estimates used to determine the assets recoverable amounts since the last impairment loss was recognized.
(e)
Accrued rent receivable
Under IFRS and previous Canadian GAAP, rental revenue is recognized on a straight-line basis over the term of the lease,
resulting in accruals for rents that are not billable or due until future years. Under IFRS, the accrued rent receivable amount
resulting from straight-lining rent is determined from the inception of each lease or the date the REIT assumed the lease.
Under previous Canadian GAAP only leases in place from January 1, 2004 were straight-lined.
Page 8 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
(f)
Convertible debentures
Under IFRS, the REIT has elected to measure its outstanding convertible debentures at fair value. At each period end, the
fair value of these convertible debentures is measured based on the ask price of each series of convertible debentures. The
fluctuation in the fair value between each period, is charged to gain (loss) in changes in fair values in comprehensive
income. Under previous Canadian GAAP, convertible debentures were bifurcated into a liability component, net of issue
costs, and an equity component, which represents the holders’ option to convert the convertible debentures into Stapled
Units. Interest expense was recorded as a charge to income using an effective rate representing the coupon rate and the
effective rate being credited to the debt component of the convertible debentures such that, at maturity, the debt component
was equal to the face value of the then outstanding convertible debentures.
(g)
Unit-based compensation
Under IFRS, the REIT is required to measure its cash-settled unit-based option plan at fair value and record a liability. The
fluctuation in the fair value between each period is charged to trust expenses in comprehensive income over the relevant
vesting period. Under previous Canadian GAAP, the REIT expensed and charged to equity the cost of unit-based
compensation over the weighted average vesting period.
(h)
Class B LP Units (previously non-controlling interest)
Under IAS 32, Financial Instruments: Presentation (“IAS 32”), the Class B LP Units of H&R Portfolio Limited Partnership
(“HRLP”) are considered puttable instruments and are classified as financial liabilities in the combined financial statements.
At each period end, the fair value of these units is measured based on the ask price of Stapled Units. The fluctuation in the
fair value is charged to comprehensive income and distributions on the Class B LP Units of HRLP are reflected as a
component of finance costs in earnings. Under previous Canadian GAAP, non-controlling interest was presented as a
separate item between liabilities and unitholders’ equity in the statement of financial position, and the non-controlling
interest’s share of income and other comprehensive income was deducted in calculating net income and comprehensive
income of the REIT.
(i)
Discontinued operations
The definition of discontinued operations under IFRS is more restrictive than under previous Canadian GAAP. Only
disposals of significant operations, such as a major line of business or geographical area of operation, meet the IFRS
requirements to present the results as discontinued operations. Discontinued operations in the financial statements as
presented pursuant to previous Canadian GAAP have been reclassified to continuing operations on the IFRS financial
statements, as they do not meet the IFRS definition of discontinued operations. This did not affect unitholders’ equity on
transition.
(j)
Net loss on foreign exchange
The foreign exchange gain (loss) recorded in net income as a result of exchanging Finance Trust’s U.S. dollar note
receivable from U.S. Holdco is not eliminated on combination as U.S. Holdco is a U.S. denominated foreign operation of the
REIT, which results in the foreign exchange on the note payable being reported in accumulated other comprehensive
income. Under IFRS, the extension option embedded in the note receivable between the REIT and Finance Trust meets the
definition of a loan commitment and is no longer treated as a derivative.
(k)
Rent amortization of above- and below-market rents
Under previous Canadian GAAP, the purchase price of an acquired property was recorded in several components, including
an intangible assets and liabilities for above- and below-market leases. These assets/liabilities were amortized against
revenue over the life of the underlying leases. Under IFRS, these assets/liabilities are amortized and recognized in
amortization and impairment expense.
(l)
Deferred tax
Under both IFRS and previous Canadian GAAP, deferred income taxes are recorded for the temporary differences arising in
respect of assets and liabilities for the periods when the REIT did not meet the REIT conditions. This is determined at the
tax rates that are expected to apply to the period when the asset is realized or the liability is settled. Under previous
Page 9 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
Canadian GAAP, future distributions were factored into the tax rate applied. Under IFRS, the tax rate applied to determine
the deferred income liability on January 1, 2010 and December 31, 2010 was 46.41%, the applicable tax rate excluding
future distributions. The deferred income tax liability was reversed during the quarter ended June 30, 2010 when the REIT
met the REIT conditions.
(m)
Income earned and property operating costs incurred during construction of the Bow
Approximately $30.1 million of rental income is expected to be received from EnCana Corporation prior to practical
completion of the building. Under previous Canadian GAAP, this rental income was recorded as a reduction to the cost of
the project. Under IFRS, income earned during the construction of the property will not reduce the cost to construct the
Bow, but will rather be included in rentals from income properties which will cause a corresponding increase to the cost of
the project. These figures assume all occupancies occur on time.
(n)
REIT units
Under IAS 32, puttable instruments such as the REIT units, are generally classified as financial liabilities unless, the
exemption criteria are met for equity classification. As a result of the REIT receiving consent of its unitholders to modify the
REIT’s Declaration of Trust to eliminate the mandatory distribution and leave distributions to the discretion of the trustees
and the ability of the trustees to fund its distributions by way of issuing additional units prior to the amendment, the REIT met
the exemption criteria under IAS 32 for equity classification. Nevertheless, the REIT units are not considered ordinary units
under IAS 33, Earnings Per Share, and therefore an income (loss) per unit calculation is not presented.
SECTION II
SELECTED ANNUAL INFORMATION
The following table summarizes certain financial information of the Trusts for the years indicated below:
(in thousands of Canadian dollars except per unit amounts)
Year Ended
December 31,
2011(1)
Year Ended
December 31,
2010(1)
Year Ended
December 31,
2009(1)
Rentals from investment properties
$656,911
$617,427
$605,165
Finance income
Net income (loss)
Comprehensive income (loss)
Total assets
Mortgages payable
Debentures payable
Cash distributions per unit
1,051
(25,277)
(22,681)
7,637,801
3,163,593
1,370,917
$0.98
2,589
496,600
490,438
5,998,640
2,706,707
965,828
$0.79
6,222
86,525
75,348
5,351,123
2,818,476
565,758
$0.72
(1)
2009 figures are based on previous Canadian GAAP, prior to change over to IFRS. The 2010 and 2011 figures are based on IFRS.
For a discussion on the above changes between the 2011 and 2010 figures, please see pages 11 to 25. For a discussion of the
changes between 2010 and 2009, please see the 2010 MD&A.
Page 10 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
DISCUSSION OF OPERATIONS
Three months ended December 31
Year ended December 31
(in thousands of Canadian dollars)
Property operating income:
2011
2010
%
Change
2011
2010
%
Change
Rentals from investment properties
$178,174
$160,700
11
$656,911
$617,427
Property operating costs
(59,971)
(55,662)
8
(219,997)
(204,386)
Finance costs:
Finance income
118,203
105,038
13
436,914
413,041
239
265
(10)
1,051
2,589
Finance cost - operations
(49,551)
(42,686)
16
(181,012)
(174,120)
6
8
6
(59)
4
Gain (loss) on extinguishment of debt
158
(332)
(148)
19,726
(21,538)
(192)
Gain (loss) on change in fair value
(69,191)
10,617
(752)
(108,378)
(83,282)
(118,345)
(32,136)
268
(268,613)
(276,351)
Amortization and impairment
(48,940)
(5,356)
814
(181,757)
(77,429)
Trust expenses
(5,463)
(2,344)
133
(15,366)
(14,554)
Gain (loss) on sale of investment properties
Transaction costs on issuance of convertible debentures
(26)
(2,813)
(40)
-
(35)
3,260
3,576
-
(2,813)
(4,535)
Net gain (loss) on foreign exchange
(3,881)
(4,469)
(13)
3,383
(6,828)
Net income (loss) before income taxes
(61,265)
60,693
(201)
(24,992)
36,920
Income tax recovery (expense)
(73)
(45)
(285)
459,680
Net income (loss)
(61,338)
60,648
(25,277)
496,600
30
(3)
135
6
(9)
(38)
(150)
(168)
Other comprehensive income (loss):
Unrealized gain (loss) on translation of U.S. denominated
foreign operations
Transfer of realized loss on cash flow hedges to net income
Deferred income taxes
(7,153)
(4,955)
2,211
(7,449)
98
-
94
-
385
-
372
915
(7,055)
(4,861)
2,596
(6,162)
Total comprehensive income (loss) attributable to unitholders
($68,393)
$55,787
($22,681)
$490,438
The change in net income (loss) for both the three months and year ended December 31, 2011 as compared to the respective 2010
periods is mainly due to the income tax recovery in 2010, the gain (loss) on extinguishment of debt, the gain (loss) on change in fair
value and the change in amortization and impairment expense.
Rentals from Investment Properties
Rentals from investment properties (“rentals”) include all amounts earned from tenants related to lease agreements, including basic
rent, parking income, operating cost recoveries and realty tax recoveries.
Page 11 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
Rentals from Investment Properties
Three months ended December 31
Year ended December 31
(in thousands of Canadian dollars)
2011
2010
Change
2011
2010
Same-asset – current rentals
$152,972
$153,057
($85)
$600,039
$598,195
Change
$1,844
Same-asset – straight-lining of contractual rent
(1,942)
4,157
(6,099)
(2,572)
8,959
(11,531)
Same-asset rent amortization of tenant
inducements
Acquisitions – current rentals, rent amortization of
tenant inducements
Acquisitions - straight-lining of contractual rent
Terminated leases due to U.S. bankruptcies
Properties sold
Total rentals
(278)
(236)
(42)
(1,028)
(938)
(90)
26,027
2,762
23,265
56,370
1,398
37
(40)
12
77
871
1,386
(40)
(911)
2,535
144
1,423
6,266
41
2,193
2,711
50,104
2,494
(2,049)
(1,288)
$178,174
$160,700
$17,474
$656,911
$617,427
$39,484
The decrease in same-asset current rentals of $0.1 million for Q4 2011 as compared to Q4 2010 is primarily due to the following
items:
(cid:131)
(cid:131)
(cid:131)
(cid:131)
(cid:131)
a net increase of $2.3 million in rentals;
a decrease of $1.1 million due to one-time rent blend and extend adjustments;
lower tenant recoveries of $3.9 million which resulted from lower regular property operating expenses;
an increase of $2.3 million in additional rent recoverable from tenants in accordance with their leases for items which were
capitalized to building improvements; and
an increase of $0.6 million due to the strengthening of the U.S. dollar, offset by the cash settlement of the forward exchange
contracts. The average exchange rate for the three months ended December 31, 2011 was Canadian $1.02 for each U.S.
$1.00 (Q4 2010 - $1.00).
The increase in same-asset current rentals of $1.8 million for the year ended December 31, 2011 as compared to the same 2010
period is primarily due to the following items:
(cid:131)
(cid:131)
(cid:131)
(cid:131)
(cid:131)
(cid:131)
a net increase of $8.1 million in rentals;
a decrease of $1.6 million due to one-time rent blend and extend adjustments;
a decrease of $0.8 million due to $1.5 million of sundry income and lease termination payments in 2011 compared to $2.3
million occurring in 2010;
higher tenant recoveries of $1.4 million which resulted from higher regular property operating expenses;
a decrease of $3.1 million in additional rent recoverable from tenants in accordance with their leases for items which were
capitalized to building improvements; and
a decrease of $2.2 million due to the weakening of the U.S. dollar, offset by the cash settlement of the forward exchange
contracts. The average exchange rate for the year ended December 31, 2011 was Canadian $0.99 for each U.S. $1.00
(December 31, 2010 - $1.03).
The decrease of $6.1 million in the same-asset straight-lining of contractual rent for Q4 2011 as compared to Q4 2010 includes a
one-time smoothing adjustment to a Canadian property of $0.9 million in Q4 2011 and a one-time smoothing adjustment to a U.S.
property of $2.4 million in Q4 2010. Without these one-time adjustments, straight-lining of contractual rent for the three months
ended December 31, 2011 and 2010 would have been ($1.0 million) and $1.7 million, respectively, and ($1.7 million) and $6.6 million
for the year ended December 31, 2011 and 2010.
Page 12 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
Rentals from acquisitions including current rentals, rent amortization and straight-lining of contractual rent increased by $24.7 million
in Q4 2011 compared to Q4 2010 and $52.6 million for the year ended December 31, 2011 as compared to the respective 2010
period. The increase is primarily due to the 27 property acquisitions between January 1, 2010 and December 31, 2011.
Property Operating Costs
For Q4 2011, realty taxes, maintenance, utilities and property management fees represented 48.9%, 31.3%, 9.1% and 6.1%,
respectively, of total property operating costs (Q4 2010 - 46.9%, 31.2%, 11.3% and 6.0%). For the year ended December 31, 2011,
these costs represented 51.2% 26.9%, 12.3%, and 5.7%, respectively, of total property operating costs (December 31, 2010 -
51.6%, 25.8%, 12.3% and 6.0%). Maintenance includes costs relating to such items as cleaning, interior and exterior building
repairs and maintenance, elevator, HVAC, security and wages and benefits.
Property Operating Costs
(in thousands of Canadian dollars)
Same-asset property operating costs
Acquisitions
Terminated leases due to U.S. bankruptcies
Properties sold
Three months ended December 31
Year ended December 31
2011
2010
$51,171
$55,254
Change
($4,083)
2011
2010
Change
$201,018
$201,090
($72)
8,778
29
(7)
489
(235)
154
8,289
264
(161)
18,350
1,050
17,300
141
488
1,222
(1,081)
1,024
(536)
Total property operating costs
$59,971
$55,662
$4,309
$219,997
$204,386
$15,611
The decrease in same-asset property operating costs of $4.1 million for Q4 2011 as compared to Q4 2010 is due primarily to the
following reasons:
(cid:131)
(cid:131)
(cid:131)
(cid:131)
lower regular property operating expenses of $3.9 million;
higher management fees of $0.1 million due to an increase of $0.3 million in the incentive fee payable to H&R Property
Management Ltd. offset by higher management fees being capitalized to leasing expenses;
lower major repair expenditures of $0.4 million; and
higher U.S. dollar operating costs of $0.1 million due to the strengthening of the U.S. dollar when converted into Canadian
dollars. The average exchange rate for the three months ended December 31, 2011 was Canadian $1.02 for each U.S. $1.00
(Q4 2010 - $1.00).
The decrease in same-asset property operating costs of $0.1 million for the year ended December 31, 2011 compared to the year
ended December 31, 2010 is due primarily to the following reasons:
(cid:131)
(cid:131)
(cid:131)
(cid:131)
higher regular property operating expenses of $1.4 million;
lower management fees of $0.7 million primarily due to a higher portion of management fees being capitalized to leasing
expenses, offset by an increase of $1.0 million in the incentive fee payable to H&R Property Management Ltd.;
lower major repair expenditures of $0.2 million; and
lower U.S. dollar operating costs of $0.6 million due to the weakening of the U.S. dollar when converted into Canadian dollars.
The average exchange rate for the year ended December 31, 2011 was Canadian $0.99 for each U.S. $1.00 (December 31,
2010 - $1.03).
Page 13 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
Same-Asset Property Operating Income*
Three months ended December 31
Year ended December 31
(in thousands of Canadian dollars)
2011
2010
Change
2011
2010
Change
Same-asset current rentals and straight-lining of
contractual rent
$151,030
$157,214
($6,184)
$597,467
$607,154
($9,687)
Same-asset - property operating costs
51,171
55,254
(4,083)
201,018
201,090
(72)
Total same-asset - property operating income
99,859
101,960
(2,101)
396,449
406,064
(9,615)
Total same-asset - property operating income
excluding straight-lining of contractual rent
$101,801
$97,803
$3,998
$399,021
$397,105
$1,916
*
Same-asset property operating income excludes the properties where the tenants have terminated their leases due to U.S. bankruptcies and the REIT has
subsequently handed over control of the subject properties to the non-recourse mortgage lenders.
Total same-asset property operating income, excluding straight-lining of contractual rent, has increased by $4.0 million for the three
months ended December 31, 2011 as compared to December 31, 2010, of which a $3.0 million increase is from Canadian
operations and a $1.0 million increase is from U.S. operations. For the year ended December 31, 2011 as compared to December
31, 2010, the increase of $1.9 million resulted from a $0.8 million increase in Canadian operations and a $1.1 million increase in U.S.
operations. See the table below for further details:
Three months ended December 31
Year ended December 31
Canada (in thousands of Canadian dollars)
2011
2010
Change
2011
2010
Change
Same-asset current rentals
$129,963
$131,085
($1,122)
$508,904
$507,476
$1,428
Same-asset property operating costs
47,659
51,802
(4,143)
186,806
186,154
Same-asset property operating income excluding
straight-lining of contractual rent
82,304
79,283
3,021
322,098
321,322
652
776
United States (in thousands of Canadian dollars)
Same-asset current rentals
23,009
21,972
1,037
Same-asset property operating costs
3,512
3,452
60
91,135
14,212
90,719
14,936
416
(724)
Same-asset property operating income excluding
straight-lining of contractual rent
19,497
18,520
977
76,923
75,783
1,140
Total same-asset property operating income*
$101,801
$97,803
$3,998
$399,021
$397,105
$1,916
*
Same-asset property operating income excludes the properties where the tenants have terminated their leases due to U.S. bankruptcies where the REIT has
subsequently handed over control of the subject properties to the non-recourse mortgage lenders.
Had the same-asset property operating income excluding the straight-lining of contractual rent for properties located in the United
States been shown in U.S. dollars, the adjusted property operating income would have been $19.1 million for the three months
ended December 31, 2011 as compared to income of $18.5 million for the three months ended December 31, 2010 and the adjusted
property operating income would have been $77.7 million for the year ended December 31, 2010 as compared to $73.6 million for
the year ended December 31, 2010.
Finance Income
(in thousands of Canadian dollars)
Finance income
Three months ended December 31
Year ended December 31
2011
$239
2010
$265
Change
2011
2010
Change
($26)
$1,051
$2,589
($1,538)
Page 14 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
Finance income decreased during the year ended December 31, 2011 as compared to the year ended December 31, 2010, primarily
due to the collection of a $58 million mortgage receivable in April 2010.
Finance Cost-Operations
(in thousands of Canadian dollars)
Three months ended December 31
Year ended December 31
2011
2010
Change
2011
2010
Change
Contractual interest on mortgages payable
$45,646
$41,532
$4,114
$171,193
$170,293
$900
Contractual interest on debentures payable
16,468
13,326
Interest on construction loans
Effective interest rate accretion
Bank interest and charges
Exchangeable unit distributions
2,536
1,276
121
486
1,680
1,721
1,428
67,879
1,183
59,524
3,142
1,260
(365)
(41)
245
61,262
46,400
14,862
7,235
908
4,389
5,302
7,369
1,772
3,573
4,282
(134)
(864)
816
1,020
16,600
8,355
250,289
233,689
Capitalized interest
(18,328)
(16,838)
(1,490)
(69,277)
(59,569)
(9,708)
Finance cost - operations
$49,551
$42,686
$6,865
$181,012
$174,120
$6,892
The increase in contractual interest on mortgages payable for the three months and year ended December 31, 2011 compared to the
respective 2010 periods is primarily due to an increase in mortgage interest from the REIT entering into and assuming mortgages in
2010 and 2011, which is partially offset by a decrease in foreign exchange rates, regular mortgage amortization payments, and
releases from five properties with bankrupt tenants in 2011.
Debenture interest increased for the three months and year ended December 31, 2011 by $3.1 million and $14.9 million compared to
the respective 2010 periods primarily due the following: (i) an increase of $3.1 million and $16.9 million for the three and twelve
month periods ended December 31, 2011, respectively, compared to December 31, 2010 in debenture interest due primarily to the
REIT issuing $100 million of convertible debentures in July 2010, $125 million of non-convertible debentures in September 2010,
$180 million of non-convertible debentures in January 2011, $100 million of non-convertible debentures in October 2011, $75 million
convertible debentures in November 2011 and (ii) for the year ended December 31, 2011 compared to December 31, 2010, there
was an additional decrease of $2.1 million in debenture interest due to the repayment of the debentures issued to Fairfax Financial
Holdings Limited or its affiliates (the “Fairfax Debentures”).
The amount of capitalized interest will continue to increase as the REIT continues to fund its development projects. The majority of
this increase is due to the Bow development.
Finance Cost - Gain (Loss) on Extinguishment of Debt
(in thousands of Canadian dollars)
Gain (loss) on extinguishment of debt
Three months ended December 31
Year ended December 31
2011
$158
2010
Change
2011
2010
Change
($332)
$490
$19,726
($21,538)
$41,264
In March 2011, the REIT was legally released from its mortgages on two Bruno’s Supermarkets LLC properties and two Boscov’s
Department Stores properties upon the lender accepting title to the properties. In July 2011, the REIT was legally released from its
mortgage on the final Boscov Department Store property upon the lender accepting title to the property. As a result, the investment
properties, the mortgages and the accrued interest on the mortgages were all derecognized resulting in a gain on extinguishment of
debt of $0.2 million for the three months and $19.7 million for the year ended December 31, 2011.
In February 2010, the REIT repaid the outstanding Fairfax Debentures having an aggregate face value of $200 million for a total
repurchase price of $230 million. The repurchase price included accrued interest of approximately $2.2 million. The REIT
recognized a one-time non-recurring charge to net income, included in the gain (loss) on extinguishment of debt of approximately
($38.8 million) in the twelve months ended December 31, 2010, representing the difference between the repurchase price, excluding
accrued interest expense, and the carrying value of the Fairfax Debentures of $189 million. In May 2010, the REIT was legally
released from its mortgage on the Circuit City Distribution Warehouse upon the lender accepting title to the property. In September
2010, the REIT was legally released from its mortgages on four of the Boscov Department Stores upon the lender accepting title to
the property. This released the REIT from the debt owing with respect to the mortgages on these properties. As a result, the
Page 15 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
investment properties, the mortgages and the accrued interest on the mortgages were all derecognized resulting in a gain (loss) on
extinguishment of debt of ($0.3 million) for the three months and $17.3 million for the year ended December 31, 2010.
Finance Cost - Gain (Loss) on Change in Fair Value
Three months ended December 31
Year ended December 31
(in thousands of Canadian dollars)
2011
2010
Change
2011
2010
Change
Gain (loss) on fair value of convertible debentures
($58,608)
$6,229
($64,837)
($84,670)
($56,119)
($28,551)
Gain (loss) on fair value of exchangeable units
(12,180)
1,740
(13,920)
(21,043)
(21,642)
599
Unrealized gain (loss) on derivative instruments
1,597
2,648
(1,051)
(2,665)
(5,521)
2,856
Finance cost - gain (loss) on change in fair value
($69,191)
$10,617
($79,808) ($108,378)
($83,282)
($25,096)
Under IFRS, the REIT has elected to measure the outstanding convertible debentures at fair value. At each period end, the fair
value of these convertible debentures is measured based on the ask price of each series of convertible debentures. The fluctuation
in the fair value between each period is charged to gain (loss) in changes in fair values in comprehensive income. At the end of
each quarter, the fair value of each exchangeable unit is measured based on the ask price of Stapled Units which was $23.30 on
December 31, 2011 (December 31, 2010 - $19.43).
The unrealized gain (loss) on derivative instruments resulted from:
(i)
(ii)
the REIT entering into an interest rate swap which effectively locked the interest rate on the Bow construction facility at 4.65%.
The interest expense on this facility is capitalized to properties under development during the eligible period. At the end of
each reporting period, the interest rate swap is marked-to-market, resulting in an unrealized gain or loss recorded in net
income. Upon completion of the development of the Bow and cessation of capitalizing interest, the difference between the
hedged rate and the actual rate will be recorded as a realized gain or loss in net earnings;
the REIT entering into foreign exchange forward contracts and swaps with a Canadian chartered bank which effectively locked
the REIT’s rate to exchange U.S. dollars in order to lock in a portion of the REIT’s projected USD FFO and AFFO at a fixed
Canadian dollar amount. The foreign exchange forward contracts are marked-to-market through earnings each reporting
period. As each month’s contract is realized, any gain or loss is recorded into earnings at that time;
(iii)
the REIT securing a floating rate mortgage on a U.S. property in June 2010. In order to fix the interest rate, the REIT entered
into an interest rate swap, which is marked-to-market through earnings each reporting period; and
(iv)
the REIT entering into two foreign exchange swaps with Canadian chartered banks which effectively locked the REIT’s rate to
exchange U.S. dollars for the acquisition of Hess Tower as the USD mortgage on this acquisition closed subsequent to year
end. These swaps are marked-to-market through earnings and any gain or loss is reported at the end of each reporting period.
Amortization and Impairment
Three months ended December 31
Year ended December 31
(in thousands of Canadian dollars)
2011
2010
Change
2011
2010
Change
Depreciation of investment properties
$29,456
$25,463
$3,993
$107,240
$98,943
$8,297
Amortization of intangible assets on acquisitions
12,794
Amortization of above- and below- market rents
Amortization of leasing expenses
Impairment loss on investment properties
5,581
1,016
1,693
9,841
5,256
991
2,953
46,398
40,052
6,346
325
25
19,634
21,052
(1,418)
4,445
6,892
3,685
760
14,862
(7,970)
14,862
(13,169)
Impairment reversal on investment properties
(1,600)
(51,057)
49,457
(2,852)
(101,165)
98,313
Amortization and impairment
$48,940
$5,356
$43,584
$181,757
$77,429
$104,328
All Canadian and U.S. properties were tested for impairment at January 1, 2010 in accordance with IAS 36 Impairment of Assets and
a write-down of $126.3 million was taken on January 1, 2010. However, there were impairment charges reversed due to changing
economic conditions of $51.1 million in Q4 2010 and $101.2 million for the year ended December 31, 2011. In Q4 2011, there was
Page 16 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
one property written down as its carrying amount continued to exceed its recoverable amount, and there was one Canadian impaired
property where a portion of the impairment loss was reversed due to an improvement in market rents and discount rates. For the
year ended December 31, 2011, there were six properties written down as their carrying amount exceeded their recoverable
amounts. There were also two Canadian impaired properties where their losses were reversed based on an improvement in market
rents and discount rates.
Trust Expenses
(in thousands of Canadian dollars)
Unit-based compensation
Other expenses
Trust expenses
Three months ended December 31
Year ended December 31
2011
$3,346
2010
$862
Change
2011
2010
Change
$2,484
$7,600
$6,882
2,117
1,482
635
7,766
7,672
$5,463
$2,344
$3,119
$15,366
$14,554
Other expenses are primarily comprised of salaries, professional fees, trustee fees and overhead expenses.
The REIT’s Unit Option Plan is considered to be cash-settled under IFRS 2, Share-based Payments and as a result, is measured at
each reporting period and settlement date at its fair value. The impact of the transition to IFRS from previous Canadian GAAP on
unit-based compensation is as follows:
Unit-based Compensation
(in thousands of Canadian dollars)
Unit-based compensation
Fair value adjustment to unit-based compensation
Three months ended December 31
Year ended December 31
Change
2011
2010
Change
2011
$537
2,809
2010
$310
552
$227
$2,034
$1,225
2,257
5,566
5,657
As reported under IFRS
$3,346
$862
$2,484
$7,600
$6,882
$718
94
$812
$809
(91)
$718
Net Gain (loss) on Foreign Exchange
(in thousands of Canadian dollars)
Three months ended December 31
Year ended December 31
2011
2010
Change
2011
2010
Change
Gain (loss) on sale on foreign exchange
($3,881)
($4,469)
$588
$3,383
($6,828)
$10,211
The net gain (loss) on foreign exchange, which was recorded in the financial statements of Finance Trust, is due to a difference in
exchange rates as the U.S. Holdco Notes receivable by Finance Trust are denominated in U.S. dollars while the financial statements
of Finance Trust are expressed in Canadian dollars. The notes are eliminated upon combination however, the foreign exchange
difference is not eliminated on combination as U.S. Holdco has a different functional currency than that of the REIT.
Gain (loss) on Sale of Investment Properties
(in thousands of Canadian dollars)
Gain (loss) on sale of investment properties
2011
($26)
2010
($40)
Change
2011
2010
Change
$14
$3,260
$3,576
($316)
Three months ended December 31
Year ended December 31
In July and August 2011, the REIT sold the following four industrial properties in Ontario: 880 Milner, 5230 Orbitor, 51 Kelfield and
738 Polymoore. For the twelve months ended December 31, 2010, the gain on sale of investment properties was from the sale of
the 110 Sheppard office building and the 2390 Argentia Road industrial building both located in Ontario.
Income Tax Recovery (Expense)
(in thousands of Canadian dollars)
Current income tax expense
Deferred income tax recovery
Three months ended December 31
Year ended December 31
2011
($73)
-
2010
($45)
-
Change
2011
2010
Change
($28)
($285)
($458)
$173
-
-
460,138
($460,138)
Income tax recovery (expense)
($73)
($45)
($28)
($285)
$459,680
$459,965
Page 17 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
The REIT is generally subject to tax in Canada under the Tax Act with respect to its taxable income each year, except to the extent
such taxable income is paid or made payable to unitholders and deducted by the REIT for tax purposes.
During the second quarter of 2010, the REIT completed the necessary restructuring to qualify for the REIT Exemption (as defined
herein) under the SIFT Rules (as defined herein). See the “Tax Risk” section for further discussion. Accordingly, the net deferred
income tax liability was reversed into earnings in the second quarter of 2010.
SEGMENTED INFORMATION
The REIT invests in investment producing properties in both Canada and the United States with creditworthy tenants on long-term
leases.
The REIT is not required to report in its financial statements on the performance of each class of assets separately due to
management’s assessment that all assets effectively adhere to the same investment policy of being leased on a long-term basis to
creditworthy tenants and the fact that the REIT manages all assets on a similar basis. Segmented disclosure is provided in the
financial statements by net property operating income on a geographic basis as the property operations in the United States are
considered to be a geographic segment. This segmented information on net property operating income is as follows:
Property operating income for the three months ended December 31, 2011
(in thousands of Canadian dollars)
Rentals from investment properties
Property operating costs
Property operating income
Property operating income for the three months ended December 31, 2010
(in thousands of Canadian dollars)
Rentals from investment properties
Property operating costs
Property operating income
Property operating income for the year ended December 31, 2011
(in thousands of Canadian dollars)
Rentals from investment properties
Property operating costs
Property operating income
Property operating income for the year ended December 31, 2010
(in thousands of Canadian dollars)
Rentals from investment properties
Property operating costs
Property operating income
Canada
United
States
Total
$140,150
$38,024
$178,174
(53,501)
(6,470)
(59,971)
$86,649
$31,554
$118,203
Canada
United
States
Total
$132,499
$28,201
$160,700
(51,956)
(3,706)
(55,662)
$80,543
$24,495
$105,038
Canada
United
States
Total
$534,681
$122,230
$656,911
(199,799)
(20,198)
(219,997)
$334,882
$102,032
$436,914
Canada
United
States
Total
$513,562
$103,865
$617,427
(187,177)
(17,209)
(204,386)
$326,385
$86,656
$413,041
The increase in U.S. property operating income of $7.1 million and $15.4 million for the three months and year ended December 31,
2011, as compared to the respective 2010 period, is primarily due to an increase in rentals from acquisitions as the REIT has
acquired 24 properties in the United States between January 1, 2010 and December 31, 2011. See page 14 for the effect of the
change in foreign exchange rates on the U.S. same-store property operating income.
Page 18 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
ASSETS
Investment Properties
The REIT acquired eleven properties during the year ended December 31, 2011. The cost of these acquisitions less mortgages
assumed were funded from the REIT’s general operating facility, funds from debenture issuances and proceeds from units issued
during 2011. There were 16 properties acquired during the year ended December 31, 2010.
2011 Acquisitions:
Property
Year
Built
Property
Type
Date
Acquired
Square
Footage
665 American Legion Dr., Teaneck, NJ
3773-3841 S. Hamilton Rd., Columbus, OH
1961
2009
Retail
Feb 15, 2011
42,047
Retail
Feb 18, 2011
118,066
2480 Rock House Rd., Lithia Springs, GA
2009
Office
May 6, 2011
79,570
1670 Rue Eiffel, Boucherville, QC
1999
Industrial
May 26, 2011
127,776
Cash
Purchase
Price
($ Millions)
$10.2
21.5
58.3
11.1
Anchor
Tenants
Stop & Shop
Giant Eagle
Pricewaterhouse
Coopers LLP
Carquest Canada
550 McAllister Dr., St. John, NB
2003
Industrial
May 26, 2011
104,094
8.7
Carquest Canada
595 Bay St., 20 & 40 Dundas St. & 306
Yonge St., Toronto, ON (Atrium on Bay)
1979-
2002
Office &
Retail
June 1, 2011
1,051,307
1 Academy Dr., Jeffersonville, GA
2008
Industrial
June 15, 2011
1,038,183
3642 Savannah Highway (U.S. 17),
Charleston, SC
150 New Jersey State, Hwy Route 73,
Voorhees, NJ
42-01 28th St., Long Island City, NY
(Gotham Tower)
1501 McKinney St., Houston, TX (Hess
Tower)
Total
2007
Retail
Sep 12, 2011
58,851
2004
Retail
Oct 6, 2011
115,396
2011
Office
Oct 26, 2011
670,000
415.5
City of New York
2011
Office
Dec 22, 2011
844,763
451.4
Hess Corporation
4,250,053
$1,403.5
344.8
54.2
11.3
16.5
CIBC, Ontario
Realty Corporation
Academy, Ltd.
Publix
Supermarkets Inc.
BJ’s Wholesale
Club, Inc.
Average
Remaining
Lease
Term
(years)
7
17
20
20
20
5
20
16
13
20
*
* Due to the confidentiality under the tenant lease, the term is not disclosed.
The dollar figures shown above for U.S. acquisitions are in Canadian dollars and are based on the exchange rates at the date of
such acquisitions.
The REIT secured a mortgage commitment on the acquisition of Hess Tower for U.S. $250.0 million. This mortgage closed in
January 2012. Including this mortgage, the REIT partially funded the acquisition of the above properties with mortgages totalling
$830.8 million bearing interest at an average contractual rate of 4.8% per annum. These mortgages have an average remaining
term of 9.6 years and only $5.0 million is recourse to the REIT.
The REIT sold four properties during the year ended December 31, 2011. There were two properties sold during the year ended
December 31, 2010.
Page 19 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
2011 Dispositions:
Property
880 Milner Ave., Toronto, ON
5230 Orbitor Dr., Mississauga, ON
738 Polymoore Dr., Corunna, ON
51 Kelfield St., Toronto, ON
Total
Property
Type
Industrial
Industrial
Industrial
Industrial
Date
Sold
Square
Footage
Gross
Proceeds
($ Millions)
Ownership
Interest
Disposed
July 4, 2011
July 6, 2011
Aug 4, 2011
Aug 16, 2011
60,028
22,000
76,136
57,976
216,140
$2.9
2.3
4.6
7.3
$17.1
70%
100%
100%
100%
The portfolio continues to remain in good condition. The average age of the total portfolio from the date built or renovated is 17.2
years at December 31, 2011 (December 31, 2010 - 16.9 years) and the average age of properties by type of asset is as follows:
Average Age by Type of Asset
Office
Industrial
Retail
Total
December 31, 2011
(years)
December 31, 2010
(years)
18.6
17.9
13.3
17.2
19.5
17.6
12.1
16.9
Legal title to each of the United States properties is held by a separate legal entity which is 100% owned, directly or indirectly, by
H&R REIT (U.S.) Holdings Inc. (“U.S. Holdco”), a subsidiary of the REIT. The assets of each such separate entity are not available
to satisfy the debts or obligations of any other person or entity; each such separate entity maintains separate books and records.
The identity of the owner of a particular U.S. property is available from U.S. Holdco. This structure does not prevent distributions to
U.S. Holdco provided there are no conditions of default.
The composition of the fair value and the net book value of investment properties expressed by type of asset and by region is as
follows:
Type of Asset (millions)
Office
Industrial
Retail
Total
Fair Value
December 31, 2011(1)
Net Book Value
December 31, 2011(2)
Net Book Value
December 31, 2010(2)
$3,963
1,794
1,454
$7,211
$3,387
1,354
1,210
$5,951
$2,146
1,328
1,208
$4,682
Page 20 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
Fair Value
Net Book Value
Net book Value
December 31, 2011(1)
December 31, 2011(2)
December 31, 2010(2)
$3,076
1,042
376
510
5,004
2,207
$7,211
$2,441
$2,156
774
273
394
3,882
2,069
$5,951
803
270
396
3,625
1,057
$4,682
Region (millions)
Ontario
Alberta
Quebec
Other
Canada
United States
Total
(1)
(2)
Please refer to note 4 of the financial statements for the assumptions and methods in determining the fair value of the portfolio.
Net book value includes investment properties and accrued rent receivable (including investment properties and accrued rent receivable
included in assets held for sale).
Significant costs associated with income properties are either capitalized and depreciated or expensed in the year incurred. The
REIT expects to incur the following costs:
Total Amount
Expected to
be Incurred
Amount
Expected to
be Capitalized
Amount Expected to
be Expensed to
Property Operating
Costs
Total
Expected
Recovery
$25 million
$14 million
$15 million
$10 million
$10 million
$20 million
$4 million
$12 million
Amount
Expected to be
Recovered in the
Year Incurred
$11 million
$9 million
Amount Expected to
be Recovered
thereafter
$9 million
$3 million
Year
2012
2013
The information contained in the table above is based on current tenancies in place and management’s estimates of these costs
being recovered through tenant’s leases.
Properties Under Development
The REIT is currently developing the Bow in Calgary, AB. The Bow is a 2-million square foot head office complex pre-leased, on a
triple net basis, to EnCana Corporation for a term of 25 years. The total annualized year one projected income from the Bow is
expected to be approximately $93.5 million. Rent escalations will be 0.75% per annum on the office space and 1.5% per annum on
the parking income for the full 25-year term. Occupancy is currently expected to occur in tranches commencing on April 2, 2012 with
full occupancy expected by the fourth quarter of 2012. The North Block budget has been revised to $1.63 billion to reflect IFRS
changes and the revised expected tranche delivery dates. Under previous Canadian GAAP the original budget included, as a
reduction to costs, net rent paid by EnCana Corporation during the initial tranches until the building was fully occupied. Under IFRS,
this net rent will be recorded in the income statement as revenue and not as a reduction of budgeted costs. Excluding capitalized
interest, these IFRS changes resulted in an increase to the budget of $30.1 million. Any delay in the delivery of the tranches will
result in a delay cost of $1.67 per square foot per month. The estimated delay cost of approximately $24.1 million has not been
included in the budget below as it will be payable by way of a credit against EnCana Corporation’s rent due. In addition, the budget
has increased due to labour and trade costs associated with the revised occupancy schedule. The presentation of the updated
budget also shows a reallocation of the costs incurred to date for the South Block. The REIT has made an application to the City of
Calgary to amend the approved Development Permit on the South Block to allow office and ancillary retail uses. Discussions are
underway with EnCana Corporation and the City of Calgary with respect to cultural uses in the South Block and with EnCana
Corporation’s cost sharing obligations and right to approve future development.
Page 21 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
The following table shows the previously reported budget, the updated budget and the costs to complete:
(in thousands of Canadian dollars)
Land
Financing costs
Capitalized interest on the REIT’s costs as incurred
Soft costs
Hard costs
Recoveries and other income
Contingency
Cost incurred to date/remaining costs/budget
Less capitalized interest on the REIT’s costs incurred
Total costs incurred to date/remaining costs/budget
less capitalized interest
Original
Budget
North Block
Budget
South Block
Budget
Costs Incurred
to Date
$60,804
41,721
215,722
192,644
1,131,211
(116,937)
21,557
1,546,722
(215,722)
$42,804
35,290
223,722
176,389
1,189,122
(69,328)
27,717
1,625,716
(223,722)
$18,000
-
-
-
10,087
-
-
28,087
-
$60,804
32,414
186,033
157,231
1,099,630
(56,995)
-
1,479,117
(186,033)
Costs to
Complete
$ -
2,876
37,689
19,158
99,579
(12,333)
27,717
174,686
(37,689)
$1,331,000
$1,401,994
$28,087
$1,293,084
$136,997
The estimated fair value of the Bow on completion is approximately $1.7 billion, determined as at December 31, 2011 by using a
5.50% capitalization rate on the first full year’s operating income.
Accrued Rent Receivable
Certain leases call for rental payments that increase over the lease term. To comply with IFRS, the rental revenue from these leases
are recorded on a straight-line basis, resulting in accruals for rents that are not billable or due until future periods. Accrued rent
receivable has decreased by 0.3% or $0.4 million from $156.9 million at December 31, 2010 to $156.5 million at December 31, 2011.
The chart below lists contractual rental step ups greater than $0.1 million for the REIT occurring over the next 12 months:
Property
160 Elgin St., Ottawa, ON
19100-94th Ave., Surrey, BC
6735-11th St. N.E., Calgary, AB
5099 Creekbank Rd., Mississauga, ON
2928-16th St., Calgary, AB
Sq.ft.
469,105
112,819
163,899
525,921
163,280
Rent increase
($ psf)
Effective date of
increase
Annualized rental
increases
(in thousands of dollars)
2.00
1.40
1.08
2.77
1.25
Feb 2012
Feb 2012
Feb 2012
Mar 2012
Mar 2012
$1,055
158
177
1,457
204
Other Assets (in thousands of Canadian dollars)
December 31, 2011
December 31, 2010
Current:
Restricted cash
Accounts receivable
Prepaid expenses and sundry assets
Derivative instruments
Other Assets
$22,110
12,711
12,959
1,273
$49,053
$22,802
7,420
6,932
1,225
$38,379
Restricted cash decreased from $22.8 million at December 31, 2010 to $22.1 million at December 31, 2011 due primarily to a
decrease in funds being held in escrow relating to rent paid in advance and costs to complete Bell Phase III.
Accounts receivable has increased from $7.4 million at December 31, 2010 to $12.7 million at December 31, 2011 primarily due to
the billing of large capital expenditures to a few large tenants at the end of the year. Prepaid expenses and sundry assets have
increased from $6.9 million at December 31, 2010 to $13.0 million at December 31, 2011 primarily due to mortgage application fee
deposits on several properties.
Page 22 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
The REIT also entered into two foreign exchange swaps with Canadian chartered banks which effectively locked the REIT’s rate to
exchange U.S. dollars for the acquisition of Hess Tower as the USD mortgage on this acquisition closed subsequent to year end.
The fair value of these swaps as at December 31, 2011 was an asset of $1.3 million and a liability of $1.1 million (December 31,
2010 - nil).
LIABILITIES
The REIT’s Declaration of Trust limits the indebtedness of the REIT (subject to certain exceptions) to a maximum of 65% of the GBV
of the REIT.
Total debt to GBV per the REIT’s Declaration of Trust(1)
Total debt to GBV per the combined financial statements
Total debt to fair market value of total assets (per the combined financial statements)
Non-recourse mortgages as a percentage of total mortgages
Floating rate debt as a percentage of total debt
Canadian properties total debt to GBV
U.S. properties total debt to GBV
December 31, 2011
December 31, 2010(2)
50.5%
57.6%
53.6%
59.8%
9.1%
61.5%
47.7%
47.8%
56.0%
52.7%
53.3%
2.4%
53.9%
65.2%
(1)
(2)
Total debt per the REIT’s Declaration of Trust excludes all convertible debentures and the U.S. Holdco Notes payable to Finance Trust. The REIT’s calculation
of total debt to GBV is not recognized under IFRS and therefore does not have a standardized meaning prescribed by IFRS.
The 2010 ratios have been restated for IFRS.
The non-recourse mortgages as a percentage of total mortgages. This ratio increased due to non-recourse mortgages acquired or
assumed from 2011 acquisitions. The U.S. properties total debt to GBV ratio decreased as the REIT acquired Hess Tower at an
acquisition price of U.S. $442.5 million in 2011 and the mortgage of U.S. $250.0 million was not received until January 2012.
Mortgages Payable
(in thousands of Canadian dollars)
Opening balance - December 31, 2010
Principal payments
Mortgage repaid upon maturity
New mortgages
Mortgages released upon lender taking title to properties
Mortgages released from sale of investment properties
Foreign exchange difference
Closing balance – December 31, 2011
$2,706,707
(104,658)
(70,543)
667,709
(59,056)
(4,071)
27,505
$3,163,593
The mortgages outstanding as at December 31, 2011 bear interest at a weighted average rate of 5.9% (December 31, 2010 – 6.2%)
and mature between 2012 and 2035. The weighted average term to maturity of the REIT’s mortgages is 7.7 years (December 31,
2010 - 8.0 years). Of the total mortgages (excluding mortgages due on demand), 12.1% will mature in 2012 and 7.0% will mature in
2013. The mortgages maturing during 2012 bear interest at a weighted average rate on maturity of 6.7% while mortgages maturing
during 2013 bear interest at a weighted average rate on maturity of 7.4%. For a further discussion of liquidity please see “Funding of
future commitments”. For a further discussion of interest rate risk, please see “Risks and Uncertainties”.
Debt related to certain Canadian properties is held by separate legal entities, where the rent received from each property is first used
to satisfy the related debt obligations with any balance then available to satisfy the cash flow requirements of the REIT.
Page 23 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
Segmented disclosure by geographic location is provided as follows:
(in thousands of Canadian dollars)
Mortgages payable - Canada
Mortgages payable - United States
Total
Debentures Payable
December 31, 2011
December 31, 2010
$2,015,424
1,148,169
$3,163,593
$1,890,881
815,826
$2,706,707
December 31,
2011
December 31,
2010
Contractual
Interest
Rate
Effective
Interest
Rate
Conversion
Price
Face
Value
(in millions)
Carrying
Value
(in millions)
Carrying
Value
(in millions)
Maturity
Convertible Debentures
2013 Convertible Debentures (HR.DB)
Jun 30, 2013
2014 Convertible Debentures (HR.DB.B)
Dec 31, 2014
2017 Convertible Debentures (HR.DB.C)
Jun 30, 2017
2020 Convertible Debentures (HR.DB.D)
Jun 30, 2020
2016 Convertible Debentures (HR.DB.E)
Dec 31, 2016
Senior Debentures
Series A Senior Debentures
Series B Senior Debentures
Series C Senior Debentures
Series D Senior Debentures
Series E Senior Debentures
Feb 3, 2015
Feb 3, 2017
Dec 1, 2018
Jul 27, 2016
Feb 2, 2018
6.65%
6.75%
6.00%
5.90%
4.50%
5.20%
5.90%
5.00%
4.78%
4.90%
6.65%
6.75%
6.00%
5.90%
4.50%
5.40%
6.06%
5.30%
4.96%
5.22%
$23.11
$114.9
$126.2
$121.3
14.00
19.00
23.50
25.70
n/a
n/a
n/a
n/a
n/a
127.9
169.9
100.0
75.0
587.7
115.0
115.0
125.0
180.0
100.0
635.0
214.4
210.6
113.0
78.0
742.2
114.3
114.2
122.9
178.7
98.6
628.7
203.0
188.1
102.6
-
615.0
114.1
114.1
122.6
-
-
350.8
Total
$1,222.7
$1,370.9
$965.8
Debentures payable increased by $405.1 million from $965.8 million at December 31, 2010 to $1.37 billion at December 31, 2011.
Convertible debentures increased by $127.2 million mainly due to the increase in fair value of the convertible debentures and the
issuance of the 2016 convertible debentures with a face value of $75.0 million. The senior debentures increased by $277.9 million
mainly due to the issuance of the series D senior debentures with a carrying value of $178.7 million and the Series E senior
debentures with a carrying value of $98.6 million. See the combined financial statements of the Trusts for detailed information
regarding the various debentures payable.
Derivative Instruments
Derivative instruments include the fair value of the interest rate swap on the Bow construction facility. At December 31, 2011, the fair
value of the interest rate swap on the Bow construction facility was a liability of $3.5 million (December 31, 2010 - liability of $2.9
million).
The REIT also entered into an interest rate swap on one mortgage. The fair value of this interest rate swap as at December 31,
2011 was a liability of $0.7 million (December 31, 2010 - liability of $0.4 million).
The REIT also entered into foreign exchange forward contracts and swaps with a Canadian chartered bank effectively locking the
REIT’s rate to exchange U.S. dollars into Canadian dollars. The fair value of these forward exchange contracts as at December 31,
2011 was a liability of $0.7 million (December 31, 2010 - asset of $1.2 million).
Page 24 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
Accounts Payable and Accrued Liabilities
Accounts payable and accrued liabilities increased by $5.3 million from $170.5 million at December 31, 2010 to $175.8 million at
December 31, 2011. Most of the change was due to an increase of $21.2 million in interest accrued on all of the debentures which
resulted from interest for 2011 that was paid on January 3, 2012 compared to interest for 2010 that was paid on December 31, 2010.
Accruals relating to properties under development totalled $54.3 million at December 31, 2011 compared to $66.9 million at
December 31, 2010. Included in accrued liabilities is an amount relating to interest accrued to date on the non-recourse mortgages
under default which decreased by $6.6 million from $8.1 million at December 31, 2010 to $1.5 million at December 31, 2011 due to
the lenders of five properties with bankrupt tenants accepting title during 2011. The remaining balance of accounts payable and
accruals increased as a result of routine transactions with tenants occurring in the normal course of business operations.
USE OF PROCEEDS FROM FINANCING ISSUED DURING 2011
Financing
Disclosed Use of Proceeds
Actual Use of Proceeds
Public offering of $180 million of unsecured
senior debentures on January 27, 2011.
To fund future property acquisitions, including to the
extent necessary, Atrium on Bay and for general trust
purposes.
The net proceeds were used to fund the
Bow and for general trust purposes.
Public offering of Stapled Units of $200 million
on May 31, 2011.
To fund development projects, property acquisitions
and for general trust purposes.
Public offering of $100 million of unsecured
senior debentures on October 27, 2011.
To repay bank indebtedness, to fund future property
acquisitions, and for general trust purposes.
Public offering of Stapled Units of $187 million
and of convertible debentures of $75 million
on November 22, 2011.
Public offering of Stapled Units of $125 million
on December 22, 2011.
To repay bank indebtedness which was incurred to
finance acquisitions and development activity, to fund
future property acquisitions and for general trust
purposes
The REIT intends to use its portion of such net
proceeds to repay, in part, the bank indebtedness
expected to be incurred to finance the Hess Tower
acquisition.
The net proceeds were used to fund a
portion of the acquisition of Atrium on
Bay, to repay bank indebtedness and
for general trust purposes.
The net proceeds were used to fund a
portion of the acquisition of Gotham
Tower and for general trust purposes.
The net proceeds were used to repay
bank indebtedness and for general trust
purposes.
The net proceeds were used to fund a
portion of the acquisition of Hess
Tower.
EQUITY
Unitholders’ Equity
Unitholders’ equity increased by $391.7 million between December 31, 2010 and December 31, 2011. The increase is primarily due
to the REIT and Finance Trust completing three public offerings in May, November and December of 2011, issuing a total of
22,900,000 units for gross proceeds of approximately $512.1 million. This increase was partially offset by net loss and distributions
paid to unitholders during the year ended December 31, 2011.
Other comprehensive loss consists of the unrealized gain (loss) on translation of U.S. denominated foreign operations and the
transfer of realized losses on cash flow hedges to net income.
Page 25 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
LIQUIDITY AND CAPITAL RESOURCES
FUNDS FROM OPERATIONS
Although funds from operations (“FFO”) is widely used by the real estate industry as a measure of operating performance, the Trusts’
method of calculating FFO may differ when comparing to other issuers. The Trusts present FFO calculations in accordance with the
Real Estate Property Association of Canada (REALPAC) except for the adjustment to exchangeable unit distributions, transaction
costs on issuance of convertible debentures and the fair value change to the unit-based compensation resulting from the adoption of
IFRS. Interest on exchangeable units were previously treated as distributions under previous Canadian GAAP, however under
IFRS, they are treated as finance costs and have therefore been added back to FFO. Transaction costs for non-convertible
debentures are capitalized against the total amount of issued debentures, however, for convertible debentures transaction costs are
expensed. To ensure FFO reflects consistent treatment of transaction costs, this has been added back. FFO is a non-GAAP
measure which should not be used as an alternative to comprehensive income, or cash flow from operations.
Three months ended December 31
Year ended December 31
(in thousands of Canadian dollars except per unit amounts)
2011
2010
2011
2010
($61,338)
$60,648
($25,277)
$496,600
Net income (loss)
Add (deduct):
(Gain) loss on fair value of convertible debentures and
exchangeable units
Unrealized (gain) loss on derivative instruments
Exchangeable unit distributions
Amortization and impairment
Fair value adjustment to unit-based compensation
(Gain) loss on sale of income properties
Transaction costs on issuance of convertible debentures
Net (gain) loss on foreign exchange
Deferred income tax recovery
70,788
(1,597)
1,428
48,940
2,809
26
2,813
3,881
-
(7,969)
(2,648)
1,183
5,356
552
40
-
4,469
-
105,713
2,665
5,302
181,757
5,566
(3,260)
2,813
(3,383)
-
77,761
5,521
4,282
77,429
5,657
(3,576)
4,535
6,828
(460,138)
$214,899
FFO
$67,750
$61,631
$271,896
Weighted average number of Stapled Units (in thousands of
Stapled Units adjusted for conversion of non-controlling interest)
Diluted weighted average number of Stapled Units (in thousands
of Stapled Units) for the calculation of FFO(1)(2)(3)(4)(5)
FFO per Stapled Unit (basic – adjusted for conversion of non-
controlling interest)
FFO per Stapled Unit (diluted)
167,691
150,624
159,607
149,786
197,699
180,391
188,652
172,136
$0.40
$0.39
$0.41
$0.39
$1.70
$1.62
$1.43
$1.38
(1) For the three months ended December 31, 2011 and 2010, 530,510 Stapled Units and 804,513 Stapled Units, respectively, are included in the determination of
diluted FFO with respect to the Unit Option Plan. For the year ended December 31, 2011 and 2010, 606,556 Stapled Units and 636,044 Stapled Units,
respectively, are included in the determination of diluted FFO with respect to the Unit Option Plan.
(2) The 2013, 2014, 2016, 2017 and 2020 Convertible Debentures are dilutive for the three months ended December 31, 2011. Therefore, debenture interest of $8.7
million is added to FFO and 29,477,013 Stapled Units are included in the diluted weighted average number of Stapled Units outstanding for this period.
(3) The 2013, 2014, 2017 and 2020 Convertible Debentures are dilutive for the three months ended December 31, 2010. Therefore, debenture interest of $8.6
million is added to FFO and 28,962,490 Stapled Units are included in the weighted average number of Stapled Units outstanding for this period.
(4) The 2013, 2014, 2016, 2017 and 2020 Convertible Debentures are dilutive for the year ended December 31, 2011. Therefore, debenture interest of $33.5 million
is added to FFO and 28,438,535 Stapled Units are included in the weighted average number of Stapled Units outstanding for this period.
Page 26 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
(5) The 2014, 2017 and 2020 Convertible Debentures are dilutive for the year ended December 31, 2010. Therefore, debenture interest of $23.2 million is added to
FFO and 21,713,768 Stapled Units are included in the weighted average number of Stapled Units outstanding for this period.
The primary reasons for the increase of $6.1 million in FFO between Q4 2011 and Q4 2010 are:
•
•
•
•
•
•
•
•
an increase of $16.4 million in property operating income due to acquisitions in 2010 and 2011;
a decrease of $6.1 million in property operating income due to straight-lining of contractual rent. See same-asset straight-
lining of contractual rent on page 12 for further details;
a decrease of $0.1 million due to lower same-asset current rentals. See same-asset current rentals on page 12 for further
details;
an increase of $4.1 million due to lower same-asset property operating costs. See same-asset property operating costs on
page 13 for further details;
a decrease of $1.1 million in property operating income due to terminated leases from U.S. bankruptcies and properties
sold;
a decrease of $6.6 million due to higher finance cost - operations;
an increase of $0.5 million from the change in the gain (loss) on extinguishment of debt; and
a decrease of $0.9 million due to higher trust expenses.
The primary reasons for the increase of $57.0 million in FFO for the year ended December 31, 2011 as compared to the same period
in 2010 are:
•
•
•
•
•
•
•
•
•
•
an increase of $41.3 million from the change in gain (loss) on extinguishment of debt;
an increase of $35.3 million in property operating income due to acquisitions in 2010 and 2011;
an increase of $1.8 million due to higher same-asset current rentals. See same-asset current rentals on page 12 for
further details;
a decrease of $11.5 million in property operating income due to straight-lining of contractual rent. See same-asset
straight-lining of contractual rent on page 12 for further details;
an increase of $0.1 million due to lower same-asset property operating costs. See same-asset property operating costs on
page 13 for further details;
a decrease of $1.7 million in property operating income due to terminated leases from U.S. bankruptcies and properties
sold;
a decrease of $1.5 million due to lower finance income;
a decrease of $5.9 million due to higher finance cost - operations;
a decrease of $0.9 million due to higher trust expenses; and
an increase of $0.2 million due to lower income tax expenses.
Page 27 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
The following table provides a reconciliation of FFO reported under previous Canadian GAAP to the FFO currently reported under
IFRS for the three months and year ended December 31, 2010 together with the unrealized gain (loss) on derivative instruments as
an adjustment to FFO:
(in thousands of Canadian dollars)
Previously reported FFO
IFRS adjustments resulting from the restated December 31, 2010 income statement:
Three months ended
December 31, 2010
Year ended
December 31, 2010
$57,046
$191,927
Change in rent amortization
Change in straight-lining of contractual rent
Change in effective interest rate accretion
Change in net loss on foreign exchange
Net loss on foreign exchange
Unrealized (gain) loss on derivative instruments
Revised FFO
612
(592)
2,760
(16)
4,469
(2,648)
$61,631
2,974
(1,979)
9,681
(53)
6,828
5,521
$214,899
Page 28 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
ADJUSTED FUNDS FROM OPERATIONS
Although adjusted funds from operations (“AFFO”) is a common measure in the real estate industry, the Trusts’ method of calculating
AFFO may differ to that of other issuers. Management views AFFO as an alternate measure to cash flow generated from
operations. AFFO is calculated by adjusting FFO for non-cash items such as: straight-lining of contractual rent, rent amortization of
tenant inducements, effective interest rate accretion, unit-based compensation and mortgage interest accruals on non-recourse
mortgage defaults which is a non-cash item that will become a (gain) loss on extinguishment of debt, once the lender of the bankrupt
properties takes title. Non-recurring costs that impact operating cash flow may be adjusted and capital and tenant expenditures
incurred by the Trusts and capitalized to the balance sheet are deducted from AFFO. AFFO is a non-GAAP measure which should
not be used as an alternative to comprehensive income or cash flow from operations.
Three months ended December 31
Year ended December 31
(in thousands of Canadian dollars except per unit amounts)
FFO
Add (deduct):
Straight-lining of contractual rent
Rent amortization of tenant inducements
Effective interest rate accretion
Mortgage interest accruals on non-recourse mortgage defaults
(Gain) loss on extinguishment of debt
Unit-based compensation
Capital expenditures
Tenant expenditures
2011
$67,750
544
278
121
311
(158)
537
(6,759)
(2,432)
2010
2011
2010
$61,631
$271,896
$214,899
(4,150)
236
486
1,191
332
310
(3,428)
(1,247)
288
1,028
908
2,199
(19,726)
2,034
(8,920)
938
1,772
6,783
21,538
1,225
(11,259)
(15,371)
(9,890)
(5,517)
AFFO
$60,192
$55,361
$237,478
$217,347
Weighted average number of Stapled Units (in thousands of
Stapled Units adjusted for conversion of non-controlling interest)
Diluted weighted average number of Stapled Units (in thousands
of Stapled Units) for the calculation of AFFO(1)(2)(3)
AFFO per Stapled Unit (basic - adjusted for conversion of non-
controlling interest)
AFFO per Stapled Unit (diluted)
Distributions per Stapled Unit
Payout ratio
167,691
150,624
159,607
149,786
192,724
175,415
183,676
172,136
$0.36
$0.35
$0.26
72.2%
$0.37
$0.35
$0.22
$1.49
$1.43
$0.98
$1.45
$1.40
$0.79
59.5%
65.8%
54.5%
(1)
(2)
(3)
For the three months ended December 31, 2011 and 2010, 530,510 units and 804,513 Stapled Units, respectively, are included in the determination of diluted
AFFO with respect to the Unit Option Plan. For the year ended December 31, 2011 and 2010, 606,556 Stapled Units and 636,044 Stapled Units, respectively,
are included in the determination of diluted AFFO with respect to the Unit Option Plan.
The 2014, 2016, 2017 and 2020 Convertible Debentures are dilutive for the three months and year ended December 31, 2011. Therefore, debenture interest of
$6.8 million and $25.8 million are added to AFFO and 24,502,505 Stapled Units and 23,462,761 Stapled Units, respectively, are included in the dilutive weighted
average number of Stapled Units outstanding for both of these periods.
The 2014, 2017 and 2020 Convertible Debentures are dilutive for the three months and year ended December 31, 2010. Therefore, debenture interest of $6.7
million and $23.2 million, respectively, are added to AFFO and 23,986,289 Stapled Units and 21,713,768 Stapled Units, respectively, are included in the dilutive
weighted average number of Stapled Units outstanding for both of these periods.
Page 29 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
Included in AFFO were additional recoveries for capital and maintenance expenditures in excess of items expensed in property
operating costs of $4.4 million for the three months ended December 31, 2011 (December 31, 2010 - $2.3 million) and $7.1 million
for the year ended December 31, 2011 (December 31, 2010 - $9.9 million).
Included in AFFO were capital and tenant expenditures of $9.2 million for the three months ended December 31, 2011 (December
31, 2010 - $4.7 million) and $21.1 million for the year ended December 31, 2011 (December 31, 2010 - $20.9 million).
Excluding the above items, AFFO would have been $65.0 million ($0.39 per Stapled Unit) compared to $57.8 million ($0.38 per
Stapled Unit) for the three months ended December 31, 2011 and 2010, respectively, and $251.5 million ($1.58 per Stapled Unit)
compared to $228.3 million ($1.52 per Stapled Unit) for the year ended December 31, 2011 and 2010, respectively.
The primary reasons for the increase of $4.8 million in AFFO between Q4 2011 and Q4 2010 are:
•
•
•
•
•
•
•
an increase in property operating income of $15.0 million due to acquisitions in 2010 and 2011;
a decrease of $0.1 million due to lower same-asset current rentals. See same-asset current rentals on page 12 for further
details;
an increase of $4.1 million due to lower same-asset property operating costs. See same-asset property operating costs on
page 13 for further details;
a decrease in property operating income of $1.1 million due to terminated leases from U.S. bankruptcies and properties
sold;
a decrease of $7.9 million due to higher finance cost - operations;
a decrease of $0.6 million due to higher trust expenses; and
a decrease of $4.5 million due to higher capital and tenant expenditures,
The primary reasons for the increase of $20.1 million in AFFO for the year ended December 31, 2011 as compared to the same
period in 2010 are:
•
•
•
•
•
•
•
•
an increase in property operating income of $32.8 million due to acquisitions in 2010 and 2011;
a decrease in property operating income of $1.5 million due to terminated leases from U.S. bankruptcies and properties
sold;
an increase of $1.8 million due to higher same-asset current rentals. See same-asset current rentals on page 12 for
further details;
an increase of $0.1 million due to lower same-asset property operating costs. See same-asset property operating costs on
page 13 for further details;
a decrease of $1.5 million due to lower finance income;
a decrease of $11.3 million due to higher finance cost - operations;
a decrease of $0.3 million due to higher capital and tenant expenditures; and
an increase of $0.2 million due to lower income tax expenses.
Page 30 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
The following table below provides a reconciliation of AFFO reported under previous Canadian GAAP to the AFFO currently reported
under IFRS for the three months and year ended December 31, 2010 together with the inclusion of the Fairfax Debentures as an
adjustment to AFFO:
(in thousands of Canadian dollars)
Previously reported AFFO
Loss on repayment of Fairfax Debentures
Revised AFFO
Three months ended
December 31, 2010
Year ended
December 31, 2010
$55,361
-
$55,361
$178,513
38,834
$217,347
The following is a reconciliation of the Trusts’ AFFO to cash provided by operations.
(in thousands of Canadian dollars)
Adjusted funds from operations
Straight-lining of contractual rent
Mortgage interest accruals on non-recourse mortgage defaults
Exchangeable unit distributions
Additions to capital expenditures and tenant expenditures
Finance cost - operations
Effective interest rate accretion
Transaction costs on issuance of convertible debentures
Change in other non-cash operating items
Realized gain (loss) on foreign exchange
Three months ended December 31
2010
2011
Year ended December 31
2010
2011
$60,192
$55,361
$237,478
$217,347
(544)
(311)
(1,428)
9,191
49,551
(121)
(2,813)
(9,525)
(9)
4,150
(1,191)
(1,183)
4,675
42,686
(486)
-
(288)
(2,199)
(5,302)
21,149
8,920
(6,783)
(4,282)
20,888
181,012
174,120
(908)
(2,813)
21,078
(23,394)
6
(8)
(1,772)
(4,535)
(4,126)
4
Cash provided by operations
$104,183
$125,096
$404,727
$399,781
Page 31 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
LIQUIDITY AND CAPITAL RESOURCES
Cash Distributions
In accordance with National Policy 41-201, the Trusts are required to provide the following additional disclosure relating to cash
distributions.
(in thousands of Canadian dollars)
Cash provided by operating activities
Net income (loss)
Actual cash distributions paid or payable relating
to the period
Excess of cash provided by operating activities
over cash distributions paid
Excess (shortfall) of net income over cash
distributions paid
Three months ended
December 31,
2011(1)
Year ended
December 31,
2011(1)
Year ended
December 31,
2010(1)
Year ended
December 31,
2009(1)
$104,183
(61,338)
$404,727
(25,277)
$399,781
$238,941
496,600
86,525
30,225
114,112
99,426
97,726
73,958
290,615
300,355
141,215
(91,563)
(139,389)
397,174
(11,201)
(1)
2009 figures are based on previous Canadian GAAP, prior to transition to IFRS. The 2010 and 2011 figures are based on IFRS.
For all of the periods noted above, cash provided by operating activities exceeded cash distributions. Management expects this
trend to continue. Cash distributions paid exceeded net income (loss) for the three months and year ended December 31, 2011 as
well as the year ended December 31, 2009 due to non-cash items which are deducted or added in determining net income. Non-
cash items such as gain (loss) on change in fair value impairment losses, gain (loss) on extinguishment of debt, deferred income tax
recoveries, depreciation and amortization, while deducted from or added to net income have no impact on cash available to pay
current distributions. Net income exceeded cash distributions paid for the year ended December 31, 2010.
Capital Resources
Subject to market conditions, management expects to be able to meet all of the REIT’s ongoing obligations and to finance short-term
development commitments through the issue of new securities, as well as by using conventional real estate debt, selling or
refinancing other assets, the general operating facilities discussed below and the REIT’s cash flow from operations. As at December
31, 2011, the REIT is not in default or arrears on any of its obligations including interest or principal payments on debt and any debt
covenant with the exception of the non payment of principal and interest for the two Great Atlantic and Pacific Tea Company non-
recourse mortgages following the Chapter 11 filings of this tenant. The REIT’s subsidiaries have handed over control of these
properties to the respective mortgage lenders and is waiting for the lenders to legally release the REIT’s subsidiaries from their debt
obligations.
The REIT’s general operating facility has been provided by the same chartered bank since the REIT’s inception. This general
operating facility expires on December 31, 2013 and is secured by certain income properties. At December 31, 2011, approximately
$63.0 million was available under this facility. The REIT also has a second general operating facility with another Canadian
chartered bank. This facility expires November 21, 2013 and is secured by the Bow. At December 31, 2011, approximately $167.0
million was available under this facility.
Other than the Bow development which is described in greater detail under “Properties under Development”, the following is a
summary of material contractual obligations of the REIT (excluding mortgages due on demand) including payments due as at
December 31, 2011 for the next 5 years and thereafter:
Page 32 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
Contractual Obligations
(in thousands of Canadian dollars)
Mortgages payable
2013 Convertible debentures
2014 Convertible debentures
2016 Convertible debentures
2017 Convertible debentures
2020 Convertible debentures
Series A Senior Debentures
Series B Senior Debentures
Series C Senior Debentures
Series D Senior Debentures
Series E Senior Debentures
Bank indebtedness
Property acquisitions(1)
Total Contractual Obligations
Payments Due by Period
2012
$379,068
-
-
-
-
-
-
-
-
-
-
-
126,000
$505,068
2013-
2014
2015-
2016
2017 and
thereafter
Total
$514,254
114,900
127,935
-
-
-
-
-
-
-
-
440,173
-
$751,008
$1,493,401
$3,137,731
-
-
75,000
-
-
115,000
-
-
180,000
-
-
-
-
-
-
169,871
99,990
-
115,000
125,000
-
100,000
-
-
114,900
127,935
75,000
169,871
99,990
115,000
115,000
125,000
180,000
100,000
440,173
126,000
$1,197,262
$1,121,008
$2,103,262
$4,926,600
(1) The total purchase price is approximately $186.0 million before transaction costs less the mortgage commitment of $60.0 million.
DBRS Limited (“DBRS”) provides credit ratings of debt securities for commercial entities. A credit rating generally provides an
indication of the risk that the borrower will not fulfill its obligations in a timely manner with respect to both interest and principal
commitments. Rating categories range from highest credit quality (generally AAA) to default payment (generally D).
DBRS has confirmed that the REIT has a credit rating of BBB with a Stable trend as at December 31, 2011. A credit rating of BBB
by DBRS is generally an indication of adequate credit quality, where protection of interest and principal is considered acceptable. A
credit rating of BBB or higher is an investment grade rating. There can be no assurance that any rating will remain in effect for any
given period of time or that any rating will not be withdrawn or revised by DBRS at any time. The credit rating is reviewed
periodically by DBRS.
The REIT has no material capital or operating lease obligations.
Funding of Future Commitments
The REIT believes that as at December 31, 2011, through the amount available under its general operating facilities of $230.0
million, it has sufficient funds for the property acquisition commitments and to complete the development of the Bow. Please see
“Properties under Development” for further details on the costs to complete.
The REIT’s capacity to fund future acquisitions, capital expenditures and commitments was in excess of $1.78 billion as at
December 31, 2011. This represents the amount by which the REIT can increase its debt, subject to market availability, before the
REIT reaches its maximum debt limitation of 65% of debt to its GBV of assets under its banking covenants.
Page 33 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
The following summarizes the estimated loan to value ratios that will be outstanding on properties whose mortgages mature over the
next five years:
Year
2012
2013
2014
2015
2016
Number of
Properties
Mortgage Debt due
on Maturity ($000’s)
Weighted Average
Interest Rate on Maturity
2012 Estimated Property
Operating Income ($000’s)(1)
Loan to
Value(2)
21
10
8
22
37
98
$266,290
108,147
182,632
217,938
291,260
$1,066,267
(3)
6.7%
7.4%
6.2%
5.3%
5.4%
$48,252
22,902
26,933
29,029
39,353
$166,469
39%
33%
47%
53%
52%
45%
(1)
(2)
(3)
Converting U.S. dollars to Canadian dollars at an exchange rate of $1.02.
Using a 7% capitalization rate.
Excludes $18.0 million vendor takeback mortgage on land held for development.
Based on the low percentage of the projected loan to values of the maturing mortgages, the REIT is confident it will be able to
refinance these mortgages upon maturity should it choose to do so. In February 2012, the REIT refinanced three U.S. mortgages
totalling U.S. $72.6 million, bearing interest at a rate of 5.94% per annum, with three new non-recourse U.S. mortgages totalling
$61.0 million, bearing interest at a rate of 4.50% per annum for a 10-year term. The REIT also refinanced ten Canadian mortgages
totalling $28.5 million, at a weighted average interest rate of 7.74% per annum, with ten new mortgages totalling $62.9 million,
bearing interest at a rate of 3.99% per annum for a 10-year term.
OFF-BALANCE SHEET ITEMS
The REIT has co-owners and partners in various projects. As a rule the REIT does not provide guarantees or indemnities for these
co-owners pursuant to property acquisitions because should such guarantees be provided, recourse would be available against the
REIT in the event of a default of the borrowers, in which case the REIT would have a claim against the underlying real estate
investment. However, in certain circumstances, where absolutely required but subject to compliance with the REIT’s Declaration of
Trust and also, when management has determined that the fair value of the borrower’s investment in the real estate investment is
greater than the mortgages payable for which the REIT has provided guarantees, such guarantees will be provided.
At December 31, 2011, such guarantees amounted to $74.3 million (December 31, 2010 - $41.3 million), expiring in 2016 and no
amount has been provided for in the combined financial statements of the Trusts for these items. These amounts arise where the
REIT has guaranteed a co-owner’s share of the mortgage liability. The REIT, however, customarily guarantees or indemnifies the
obligations of its nominee companies which hold separate title to each of its properties owned.
In addition, the REIT continued to guarantee certain debt assumed by purchasers in connection with past dispositions of properties,
and will remain liable thereunder until such debts are extinguished or the lenders agree to release the REIT’s covenants. At
December 31, 2011, the estimated amount of debt subject to such guarantees, and therefore the maximum exposure to credit risk is
approximately $113.4 million (December 31, 2010 - $116.4 million) with expiries between 2013 and 2018. There have been no
defaults by the primary obligor for debts on which the REIT has provided its guarantees, and as a result, no contingent loss on these
guarantees has been recognized in the combined financial statements.
Related Party Transactions
H&R Property Management Ltd. (the “Property Manager”), a company partially owned by family members of the Chief Executive
Officer, provides property management services for substantially all properties owned by the REIT, including leasing services, for a
fee of 2% of gross revenue. The Property Manager also provides support services in connection with the acquisition, disposition and
development activities of the REIT and is also entitled to an incentive fee. Acquisitions and development support services are
provided for a fee of 2/3 of 1% of total acquisition and development costs. The support services relating to dispositions of investment
properties are provided for a fee of 10% of the gain on sale of investment properties adjusted for the add back of accumulated
depreciation and amortization. Services are provided by the Property Manager pursuant to a property management agreement
which expires on January 1, 2015 with one automatic five-year extension.
During the three months ended December 31, 2011, the REIT recorded fees pursuant to this agreement of $9.6 million (December
31, 2010 - $3.6 million), of which $5.9 million (December 31, 2010 - $0.3 million) was capitalized to the cost of investment properties
acquired, $0.4 million (December 31, 2010 - $0.4 million) was capitalized to properties under development and $0.6 million
Page 34 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
(December 31, 2010 - $0.3 million) was capitalized to leasing expenses. The REIT has also reimbursed the Property Manager for
certain direct property operating costs and tenant construction costs.
For the three months ended December 31, 2011, a further amount of $0.9 million (December 31, 2010 - $0.6 million) has been
earned by the Property Manager pursuant to the above agreement, in accordance with the annual incentive fee payable to the
Property Manager.
During the year ended December 31, 2011, the REIT recorded fees pursuant to this agreement of $24.0 million (December 31, 2010
- $14.7 million), of which $9.5 million (December 31, 2010 - $1.1 million) was capitalized to the cost of the investment properties
acquired, $2.1 million (December 31, 2010 - $2.2 million) was capitalized to properties under development and $3.6 million
(December 31, 2010 - $1.8 million) was capitalized to leasing expenses. The REIT has also reimbursed the Property Manager for
certain direct property operating costs and tenant construction costs.
For the year ended December 31, 2011, a further amount of $3.5 million (December 31, 2010 - $2.5 million) has been earned by the
Property Manager pursuant to the above agreement, in accordance with the annual incentive fee payable to the Property Manager.
Pursuant to the above agreement, as at December 31, 2011, $3.5 million (December 31, 2010 - $1.7 million) was payable to the
Property Manager.
The REIT leases space to companies affiliated with the Property Manager. The rental income earned for the three months ended
December 31, 2011 is $0.3 million (December 31, 2010 - $0.3 million) and for the year ended December 31, 2011 is $1.4 million
(December 31, 2010 - $1.3 million).
These transactions are measured at the amount of consideration established and agreed to by the related parties.
FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS
Where appropriate, the REIT uses forward contracts to lock in lending rates on certain anticipated mortgages. This strategy provides
certainty to the rate of interest on borrowings when the REIT is involved in transactions that close further into the future than during
the normal timeframe of a transaction. At December 31, 2011, the REIT had no such forward contracts in place.
Where appropriate, the REIT uses forward exchange contracts to lock in foreign exchange rates. This strategy provides certainty in
the foreign exchange rates on transactions that will occur in the future. The REIT has entered into forward exchange contracts with
a Canadian chartered bank, which effectively locks in the REIT’s rate to exchange, U.S. dollars into Canadian dollars.
The REIT has entered into interest rate swaps on the Bow credit facility and on one U.S. mortgage which effectively locked the
interest rate at 4.65% and 5.25%, respectively. At the end of each reporting period, the interest rate swaps are marked-to-market
resulting in an unrealized gain or loss recorded in comprehensive income.
The REIT has entered into two foreign exchange swaps with Canadian chartered banks which effectively locked the REIT’s rate to
exchange U.S. dollars for the acquisition of Hess Tower as the USD mortgage on this acquisition closed subsequent to year end.
These swaps are marked-to-market through earnings and any gain or loss is reported at the end of each reporting period.
Page 35 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
SECTION III
SUMMARY OF QUARTERLY RESULTS
(in thousands of Canadian dollars)
Rentals from investment properties
Finance income
Net earnings (loss)
Total comprehensive income (loss)
Rentals from investment properties
Finance income
Net earnings(loss)
Total comprehensive income (loss)
December 31,
2011
September 30,
2011
$178,174
239
(61,338)
(68,393)
$169,582
215
58,301
72,478
December 31,
2010
September 30,
2010
$160,700
265
60,648
55,787
$152,778
248
(12,107)
(15,068)
June 30,
2011
$155,861
231
9,074
7,586
June 30,
2010
$151,369
802
505,151
509,619
March 31,
2011
$153,294
366
(31,314)
(34,352)
March 31,
2010
$152,580
1,274
(57,092)
(59,900)
Changes to the quarterly financial information are not reflective of seasonality or cyclicality but generally from new property
acquisitions, dispositions and income changes. Revenues may have significant fluctuations due to recoveries from tenants for
changes to property operating costs depending on when major maintenance projects are incurred.
SECTION IV
CRITICAL ACCOUNTING ESTIMATES
The preparation of the Trusts’ combined financial statements requires management to make estimates and judgements that affect
the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements
and reported amounts of revenue and expenses during the reporting period. The Trusts’ combined financial statements have been
prepared in accordance with IFRS.
Management believes the policies which are most subject to estimation and judgements are outlined below. For a detailed
description of these and other accounting policies refer to note 2 of the December 31, 2011 combined financial statements of the
Trusts.
Leases
The REIT’s policy for property rental revenue recognition is described in note 2(h) of the financial statements. The REIT makes
judgements in determining whether certain leases, in particular those tenant leases with long contractual terms where the lessee is
the sole tenant in a property and long-term ground leases where the REIT is lessor, are operating or finance leases. The REIT has
determined that all of its leases are operating leases.
Impairment of Investment Properties
The carrying amount of the REIT’s investment properties and properties under development is reviewed at each reporting date to
determine whether there is an indication of impairment. If such indicator exists, then the asset’s recoverable amount is estimated.
An asset is impaired when its carrying amount exceeds its recoverable amount. The recoverable amount of an asset is the greater
of its value in use and its fair value less costs to sell. In assessing value in use, the estimated future cash flows are discounted to
their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risk
specific to the asset.
Impairment losses are recognized in net income (loss). Impairment losses recognized in prior periods are assessed at each
reporting date for any indications that the loss has decreased or no longer exists. An impairment loss is reversed if there has been a
change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the
asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortization,
if an impairment loss had not been recognized.
Page 36 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
Depreciation of Investment Properties
Depreciation is based on the cost of an asset less its residual value. Significant components of individual assets are assessed, and
if a component has a useful life that is different from the remainder of that asset, then that component is depreciated separately.
Depreciation is recognized in net income (loss) on a straight-line basis over the estimated useful life of each component of an item of
property, plant and equipment. Land is not amortized. Depreciation and amortization methods, useful lives and residual values are
reviewed at each annual reporting date and adjusted as appropriate. Buildings are depreciated on a straight-line basis over their
useful lives for a period of approximately 40 years. Building improvements are depreciated over their useful lives, which typically
vary between 5 and 20 years. Improvements that do not meet the capitalization criteria are expensed in full in the period incurred.
Paving and equipment are depreciated on a straight-line basis over their useful lives, which is typically 10 years. Intangibles
resulting from in-place leases and above- and below-market leases are amortized over the related lease terms.
Property Acquisitions
Investment properties are held to earn rental income or for capital appreciation or for both, but not for sale in the ordinary course of
business. All of the REIT’s commercial properties are investment properties measured at cost less accumulated depreciation and
impairment losses.
The cost of replacing a major component of a building is recognized in the carrying amount of the building if it is probable that the
future economic benefits embodied within the component will flow to the REIT, and its cost can be measured reliably. The carrying
amount of the replaced component is derecognized at the time of replacement through the statement of comprehensive income.
Upon acquisition, the REIT performs an assessment of investment properties being acquired to determine whether the acquisition is
to be accounted for as an asset acquisition or a business combination. A transaction is considered to be a business combination if
the acquired property meets the definition of a business, being an integrated set of activities and assets that are capable of being
managed for the purpose of providing a return to the unitholders.
Whether the acquisition is accounted for as an asset acquisition or a business combination, the REIT determines the fair values of
the assets and liabilities including land, building and intangibles such as above- and below-market leases, in-place operating leases
and tenant renewal value. The REIT expenses transaction costs on business combinations and capitalizes transaction costs if it is
an asset acquisition.
The REIT has elected to apply the fair value method as deemed cost for certain properties as at January 1, 2010 and the cost model
for subsequent accounting for its investment properties. The carrying values of these selected properties were adjusted to their fair
value at the transition date. Significant judgments and estimates have been made by the REIT in order to fair value these properties.
Income Tax
During the second quarter of 2010, the REIT completed necessary restructuring to qualify for the REIT Exemption whereby defined
as the new taxation regime under SIFT rules that will not apply to a real estate investment trust that meets prescribed conditions
relating to the nature of its income and investments throughout the taxation year, commencing January 1, 2011. The REIT will not
be subject to the SIFT Rules provided that the REIT qualifies for the REIT Exemption at all times after 2010. See the “Tax Risk”
section for further discussion. Accordingly, the net deferred income tax liability of $465.2 million recorded as at March 31, 2010, was
reversed into net income as at December 31, 2010.
Prior to the SIFT Rules, income earned by the REIT and distributed annually to unitholders was not, and would not be, subject to
taxation in the REIT, but was taxed at the unitholder level. For financial statement reporting purposes, the tax deductibility of the
REIT's distributions was treated as an exemption from taxation as the REIT distributed and intended to continue distributing all of its
income to its unitholders. Accordingly, prior to the SIFT Rules, the REIT did not record a provision for income taxes, or future
income tax assets or liabilities, in respect of the REIT or its investments in its subsidiary trusts.
Deferred income taxes are recognized for the temporary differences between the financial statement carrying amounts of assets and
liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted or substantively
enacted tax rates and laws that are expected to apply to taxable income in the years in which those temporary differences are
expected to be reversed or settled. The effect on deferred income tax assets and liabilities of a change in tax rate is recognized in
income or unitholders’ equity, as appropriate, in the period that includes the date of enactment or substantive enactment.
Page 37 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
DISCLOSURE CONTROLS AND PROCEDURES (“DC&P”)
Each Trust’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) has designed, or caused to be designed under their
direct supervision, the applicable Trust’s DC&P (as defined in National Instrument 52-109 - Certification of Disclosure in Issuers’
Annual and Interim Filings (“NI 52-109”), adopted by the Canadian Securities Administrators) to provide reasonable assurance that:
(i) material information relating to the applicable Trust, including its consolidated subsidiaries, is made known to them by others
within those entities, particularly during the period in which the interim filings are being prepared; and (ii) material information
required to be disclosed in the interim filings is recorded, processed, summarized and reported on a timely basis. The combined
financial statements and MD&A were reviewed and approved by the Audit Committees and the Boards of Trustees of each Trust
prior to this publication.
INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of each Trust has reviewed its internal control over financial reporting as part of the conversion from previous Canadian
GAAP to IFRS. The most significant change to each Trust’s control environment is the disclosure of the fair value of investment
properties in the notes to the financial statements. Management has implemented controls and processes to ensure that accurate
fair values can be determined. Other than previous Canadian GAAP to IFRS, no changes were made to the design of either Trust’s
internal control over financial reporting during the three and twelve months ended December 31, 2011 that have materially affected,
or are reasonably likely to materially affect, the Trusts’ internal control over financial reporting
Each Trust’s management, including the CEO and CFO, does not expect that the applicable Trust’s controls and procedures will
prevent or detect all misstatements due to error or fraud. Due to the inherent limitations in all control systems, an evaluation of
controls can provide only reasonable, not absolute assurance, that all control issues and instances of fraud or error, if any, within the
Trusts have been detected. The Trusts are continually evolving and enhancing its systems of controls and procedures.
SECTION V
RISKS AND UNCERTAINTIES
All income property investments are subject to a degree of risk and uncertainty. They are affected by various factors including
general market conditions and local market circumstances. An example of general market conditions would be the availability of
long-term mortgage financing whereas local conditions would relate to factors affecting specific properties such as an oversupply of
space or a reduction in demand for real estate in a particular area. Management attempts to manage these risks through
geographic, type of asset and tenant diversification in the REIT’s portfolio. The major risk factors are outlined below and in the
REIT’s Annual Information Form.
Credit Risk and Tenant Concentration
The REIT is exposed to credit risk as an owner of real estate in that tenants may become unable to pay the contracted rents.
Management mitigates this risk by carrying out appropriate credit checks and related due diligence on the significant tenants.
Management has diversified the REIT’s holdings so that it owns several categories of properties (office, industrial and retail) and
acquires properties throughout Canada and the United States. In addition, management ensures that no tenant or related group of
tenants, other than investment grade tenants, account for a significant portion of the cash flow. The only tenants which individually
account for more than 5% of the rentals from income properties of the REIT are Bell Canada and TransCanada PipeLines Limited.
Each of these companies that have a public debt rating is rated with at least an A low rating by a recognized rating agency. Once
the Bow is completed, EnCana Corporation is also expected to account for more than 5% of the rentals from income properties.
EnCana Corporation’s current public debt rating is BBB high.
Lease Rollover Risk
Lease rollover risk arises from the possibility that the REIT may experience difficulty renewing leases as they expire. Management
attempts to enter into long-term leases to mitigate this risk. The leases for 22.9% of the REIT’s total leasable area will expire in the
next 5 years.
Interest and Financing Risk
In the low interest rate environment that the Canadian economy has experienced in recent years, leverage has enabled the REIT to
enhance its return to unitholders. A reversal of this trend, however, can significantly affect the business’s ability to meet its financial
Page 38 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
obligations. In order to minimize this risk, the REIT negotiates fixed rate term debt with staggered maturities on the portfolio and
attempts to match average lease maturity to average debt maturity. Derivative financial instruments may be utilized by the REIT in
the management of its interest rate exposure. In addition, the REIT’s Declaration of Trust restricts total indebtedness permitted on
the portfolio.
Financing Credit Risk
The REIT is also exposed to credit risk as a lender on the security of real estate in the event that a borrower is unable to make the
contracted payments. Such risk is mitigated through credit checks and related due diligence of the borrowers and through careful
evaluation of the worth of the underlying assets. Risk is further mitigated by the REIT’s investment guideline of only providing
construction financing after 70% of the project has been pre-leased.
Currency Risk
The REIT is exposed to foreign exchange fluctuations as a result of ownership of assets in the United States and the rental income
earned from these properties. In order to mitigate the risk, the REIT’s debt on these properties is also held in U.S. dollars to act as a
natural hedge.
The REIT is exposed to foreign exchange fluctuations as a result of the U.S. Holdco Notes being denominated in U.S. dollars.
Tax Risk
The REIT currently qualifies as a mutual fund trust for Canadian income tax purposes.
The Tax Act contains legislation (the “SIFT Rules”) affecting the tax treatment of “specified investment flow-through” (“SIFT”) trusts.
A SIFT includes a publicly-traded trust. The SIFT Rules provide for a transition period until 2011 for publicly-traded trusts like the
REIT which existed prior to November 1, 2006. Under the SIFT Rules, distributions of certain income by a SIFT are not deductible in
computing the SIFT’s taxable income, and a SIFT is subject to tax on such income at a rate that is substantially equivalent to the
general tax rate applicable to a Canadian corporation. The SIFT Rules do not apply to a publicly-traded trust that qualifies as a real
estate investment trust under the Tax Act. The REIT completed the necessary tax restructuring to qualify as a real estate investment
trust effective June 30, 2010. For periods before it qualified, the REIT recorded deferred tax liabilities in respect of temporary
differences expected to reverse after January 1, 2011. Such deferred tax liability was reversed as an adjustment to deferred income
tax expense in income and as an adjustment to other comprehensive income during the second quarter of 2010, when the REIT
became a qualifying real estate investment trust.
Management of the REIT intends to conduct the affairs of the REIT so that it qualifies for the REIT Exemption at all times after 2010;
however, as the requirements of the REIT Exemption include complex revenue and asset tests, no assurances can be provided that
the REIT will in fact so qualify at any time.
The REIT operates in the United States through U.S. Holdco which is capitalized with equity provided by the REIT and debt in the
form of U.S. Holdco Notes owed to Finance Trust and HRLP. As at December 31, 2011, U.S. Holdco owed $146.5 million to
Finance Trust and HRLP which is eliminated upon combination in combined financial statements.
U.S. Holdco intends to treat the U.S. Holdco Notes as indebtedness for U.S. federal income tax purposes. If the Internal Revenue
Service (“IRS”) or a court were to determine that the U.S. Holdco Notes should be treated for U.S. federal income tax purposes as
equity rather than debt, the interest on the notes could be treated as a dividend, and interest on the notes would not be deductible for
U.S. federal income tax purposes. In addition, if the IRS were to determine that the interest rate on the U.S. Holdco Notes did not
represent an arm’s length rate, any excess amount over arm’s length would not be deductible and could be recharacterized as a
dividend payment instead of an interest payment. This would significantly increase the U.S. federal income tax liability of U.S.
Holdco, potentially including the tax liability for prior years in which U.S. Holdco has claimed a deduction for interest paid on the U.S.
Holdco Notes. In addition, U.S. Holdco could be subject to penalties. The increase in tax liability could materially adversely affect
U.S. Holdco’s ability to make interest payments on the U.S. Holdco Notes or the REIT’s ability to make distribution on its units.
Additionally, payments of interest on the U.S. Holdco Notes to non-U.S. holders of Stapled Units could be subject to withholding
taxes.
To the extent that the REIT or a related party provided debt financing to U.S. Holdco (e.g., by acquiring U.S. Holdco Notes), in
determining income for U.S. tax purposes, U.S. Holdco is subject to possible limitations on the deductibility of interest, if any, paid to
the REIT. Section 163(j) of the U.S. Internal Revenue Code (the “Code”) applies to defer U.S. Holdings’ deduction of interest paid on
Page 39 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
debt to the REIT in years that (i) the debt to equity ratio of U.S. Holdings exceeded 1.5:1, and (ii) the net interest expense exceeds
an amount equal to 50% of its “adjusted taxable income” (generally, earnings before interest, taxes, depreciation, and amortization).
The REIT intends to take the position that, due to the treatment of Finance Trust as a grantor trust that is disregarded for U.S. federal
tax purposes, the interest paid to Finance Trust is treated as having been paid to the holders of the Finance Trust units and is
therefore not subject to section 163(j). If section 163(j) applied to interest paid to Finance Trust, depending on the facts and
circumstances and the availability of net operating losses to U.S. Holdco (which are subject to normal assessment by the IRS), the
U.S. federal income tax liability of U.S. Holdings could increase. In such case, the amount of income available for distribution by the
REIT to its unitholders could be reduced.
A foreign corporation will be classified as a passive foreign investment company ("PFIC") for United States federal income tax
purposes if either (i) 75% or more of its gross income is passive income or (ii) on average for the taxable year, 50% or more of its
assets (by value) produce or are held for the production of passive income. The properties of the REIT are managed by a third party
rather than directly by its own employees. Although the REIT's officers and employees oversee the activities of the manager, it is
likely that the REIT will be characterized as a PFIC for U.S. federal income tax purposes, though this conclusion is uncertain. In the
absence of certain elections being made by a U.S. holder of REIT units, any distributions in respect of the REIT units which exceed
125% of the average amount of distributions in respect of such REIT units during the preceding three years, or, if shorter, during the
preceding years in the U.S. holder's holding period ("excess distributions") and any gain on a sale or other disposition of the REIT
units will be treated as ordinary income and will be subject to special tax rules, including an interest charge. U.S. holders should
consult with their own tax advisors regarding the implications of these rules and the advisability of making one of the applicable PFIC
elections, taking into account their particular circumstances.
In compliance with U.S. Treasury Department Circular 230, which provides rules governing certain conduct of U.S. tax advisors
giving advice with respect to U.S. tax matters, please be aware that: (i) any U.S. federal tax advice contained herein is not intended
to be used and cannot be used by the reader for the purpose of avoiding penalties that may be imposed under the Code; (ii) such
advice was prepared in the expectation that it may be used in connection with the promotion or marketing (within the meaning of
U.S. Treasury Department Circular 230) of Stapled Units; and (iii) prospective investors should seek advice based on their particular
circumstances from an independent tax advisor.
On July 20, 2011, the Department of Finance announced proposed amendments to the provisions of the Tax Act concerning the
income tax treatment of SIFTs, real estate investment trusts (“Real Estate Trusts”) and publicly traded corporations. The proposed
amendments include changes which impact publicly traded stapled securities of SIFTs, Real Estate Trusts and corporations. The
proposals include amendments which will deny a deduction for payments made by another entity to a Real Estate Trust, or to a
subsidiary of a Real Estate Trust. The stapled unit structure of the Trusts (TSX: HR.UN; HR.DB; HR.DB.B; HR.DB.C; HR.DB.D,
HR.DB.E) does not involve the kinds of payments that are targeted by the proposed amendments. In particular, the REIT does not
receive interest or other income from Finance Trust. Finance Trust only receives interest income from a U.S. corporation which is a
wholly owned subsidiary of the REIT. Based on the information available in the Department of Finance’s press release, the Trusts
expect that the amendments will not affect the Stapled Unit structure. Detailed draft legislation was not released by the government
as at March 12, 2012, but will be reviewed by the REIT as soon as it is released.
Tax Consequences to U.S. Holders
Finance Trust qualifies as an investment trust that is classified as a grantor trust for U.S. federal income tax purposes under
Treasury Regulation section 301.7701-4(c) (a ‘‘Fixed Investment Trust’’) and section 671 of the Code. In general, an investment trust
will qualify as a Fixed Investment Trust if: (i) the trust has a single class of ownership interests, representing undivided beneficial
interests in the assets of the trust; and (ii) there is no power under the trust agreement to vary the investment of the holders. If
Finance Trust is a Fixed Investment Trust, then it will generally be disregarded for U.S. federal income tax purposes, with the result
that the holders of Finance Trust units will be treated as owning directly their pro rata shares of all of the Finance Trust assets (i.e.
primarily the U.S. Holdco Notes). Moreover, all payments made on the U.S. Holdco Notes will be treated as payments made directly
to the holders of the Finance Trust units in proportion to their interest in Finance Trust.
Provided that Finance Trust qualifies as a Fixed Investment Trust and the U.S. Holdco Notes are respected as debt for U.S. federal
income tax purposes, payments of principal and interest on the U.S. Holdco Notes that are attributable to U.S. holders will be treated
as payments directly to the U.S. holders. Interest on the U.S. Holdco Notes will generally be taxable to U.S. holders as ordinary
income at the time it is paid or accrued and will be subject to U.S. federal taxation at a maximum marginal rate of 35%. If the U.S.
Holdco Notes were treated as equity rather than debt for U.S. federal income tax purposes, then the stated interest on the U.S.
Holdco Notes would be treated as a distribution with respect to units.
Page 40 of 43
H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
Environmental Risk
As an owner and manager of real property in Canada and the United States, the REIT is subject to various laws relating to
environmental matters. These laws impose a liability for the cost of removal and remediation of certain hazardous materials
released or deposited on properties owned by the REIT on or adjacent properties.
As required by the REIT’s Declaration of Trust and in accordance with best management practices, Phase 1 audits are completed on
all properties prior to acquisition. Further investigation is conducted if Phase 1 tests indicate a potential problem. The REIT has
operating policies to monitor and manage risk. In addition, the standard lease requires compliance with environmental laws and
regulations and restricts tenants from carrying on environmentally hazardous activities or having environmentally hazardous
substances on site.
Development and Financing Risk Relating to the Bow Development
The REIT entered into agreements to develop the Bow an approximately 2.0 million square foot office and retail complex in Calgary.
The North Block budget, of approximately $1.63 billion (including capitalized interest), is pre-leased, on a triple net basis, to EnCana
Corporation for an initial term of approximately 25 years. Any delay in the delivery of the tranches will result in a delay cost of $1.67
per square foot per month. The estimated delay cost of approximately $24.1 million will be payable by way of a credit against
EnCana Corporation’s rent due. The REIT is currently bearing the risk for construction overruns and project delays as the REIT
does not have a fixed price contract for the entire project cost. To mitigate this, the REIT has entered into fixed price contracts
amounting to approximately 97% of the hard cost budget. The REIT is also at risk for interest rate fluctuations on this project during
the construction period. To mitigate this risk, the REIT entered into an interest rate swap which is intended to limit the interest rate to
an effective annual rate of 4.65%.
Construction Risks
It is likely that, subject to compliance with the REIT’s Declaration of Trust, the REIT will be involved in various development projects.
The REIT’s obligations in respect of properties under construction, or which are to be constructed, are subject to risks which include
(i) the potential insolvency of a third party developer (where the REIT is not the developer); (ii) a third party developer’s failure to use
advanced funds in payment of construction costs; (iii) construction or other unforeseeable delays; (iv) cost overruns; (v) the failure of
tenants to occupy and pay rent in accordance with existing lease agreements, some of which are conditional; (vi) the incurring of
construction costs before ensuring rental revenues will be earned from the project; and (vii) increases in interest rates during the
period of the development. See also “Development and Financing Risk relating to the Bow Development” above. Management
strives to mitigate these risks where possible by entering into fixed price construction contracts with general contractors (and to the
extent possible, on a bonded basis) and by attempting to obtain long-term financing as early as possible during construction.
Debentures
The likelihood that purchasers of the 2013, 2014, 2016, 2017 and 2020 convertible debentures and the Series A, B, C, D and E
senior debentures will receive payments owing to them under the terms of such debentures will depend on the financial health of the
REIT and its creditworthiness. In addition, such debentures are unsecured obligations of the REIT and are subordinate in right of
payment to all the REIT’s existing and future senior indebtedness as defined in each such respective trust indenture. Therefore, if the
REIT becomes bankrupt, liquidates its assets, reorganizes or enters into certain other transactions, the REIT’s assets will be
available to pay its obligations with respect to such debentures only after it has paid all of its senior indebtedness in full. There may
be insufficient assets remaining following such payments to pay amounts due on any or all of the debentures then outstanding.
The debentures are also effectively subordinate to claims of creditors (including trade creditors) of the REIT’s subsidiaries except to
the extent the REIT is a creditor of such subsidiaries ranking at least pari passu with such other creditors. Finance Trust is a creditor
of U.S. Holdco, a subsidiary of the REIT. A parent entity is entitled only to the residual equity of its subsidiaries after all debt
obligations of its subsidiaries are discharged. In the event of bankruptcy, liquidation or reorganization of the REIT, holders of
indebtedness of the REIT (including holders of the convertible debentures, may become subordinate to lenders to the subsidiaries of
the REIT. The indentures governing such debentures do not prohibit or limit the ability of the REIT or its subsidiaries to incur
additional debt or liabilities (including senior indebtedness), to amend and modify the ranking of any indebtedness or to make
distributions, except, in respect of distributions, where an event of default has occurred and such default has not been cured or
waived. The indentures do not contain any provision specifically intended to protect holders of debentures in the event of a future
leveraged transaction involving the REIT.
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H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
Availability of Cash for Distributions
The REIT’s current proposed distribution policy is outlined under “Outlook”. As the monthly cash distribution paid by Finance Trust
fluctuates monthly, the monthly cash distribution paid by the REIT will also fluctuate in order to result in an aggregate monthly cash
distribution as previously outlined. Although the REIT intends to make distributions of its available cash to unitholders in accordance
with its distribution policy, these cash distributions may be reduced or suspended. The actual amount distributed by the REIT will
depend on numerous factors including monthly cash distributions paid by Finance Trust, capital market conditions, the financial
performance of the properties, the REIT’s debt covenants and obligations, its working capital requirements, its future capital
requirements, its development commitments and fluctuations in interest rates. Cash available to the REIT for distributions may be
reduced from time to time because of items such as principal repayments on debt, tenant allowances, leasing commissions, capital
expenditures or any other business needs that the trustees deem reasonable. The REIT may be required to use part of its debt
capacity in order to accommodate any or all of the above items. The market value of Stapled Units may decline significantly if the
REIT and/or Finance Trust suspends or reduces distributions. The REIT trustees retain the right to re-evaluate the distribution policy
from time to time as they consider appropriate.
Unit Prices
Publicly traded trust units will not necessarily trade at values determined solely by reference to the underlying value of trust assets.
Accordingly, the Stapled Units may trade at a premium or a discount to the underlying value of the assets of the REIT and Finance
Trust. Investors in Stapled Units will be subject to all of the risks of an investment in units of Finance Trust and of an investment in
units of the REIT. Holders of Stapled Units should consult the Management’s Discussion and Analysis of Finance Trust and
specifically the risk factors therein. See also “Forward-Looking Disclaimer”.
One of the factors that may influence the market price of the Stapled Units is the annual yield on the Stapled Units. Accordingly, an
increase in market interest rates may lead investors in Stapled Units to demand a higher annual yield which could adversely affect
the market price of Stapled Units. In addition, the market price for Stapled Units may be affected by changes in general market
conditions, fluctuations in the markets for equity securities and numerous other factors beyond the control of the REIT and/or
Finance Trust.
Ability to Access Capital Markets
As the REIT distributes a substantial portion of its income to unitholders, the REIT may need to obtain additional capital through
capital markets and the REIT’s ability to access the capital markets through equity issues and forms of secured or unsecured debt
financing may affect the operations of the REIT as such financing may be available only on disadvantageous terms, if at all. If
financing is not available on acceptable terms, further acquisitions or ongoing development projects may be curtailed and cash
available for distributions or to fund future commitments may be adversely affected.
Dilution
The number of units the Trusts are authorized to issue is unlimited. The trustees have the discretion to issue additional Stapled
Units in certain circumstances, including under the REIT’s Unit Option Plan. Any issuance of Stapled Units may have a dilutive effect
on the investors of Stapled Units.
Redemption Right
Unitholders are entitled to have their units redeemed at any time on demand. It is anticipated that this redemption right will not be
the primary mechanism for unitholders to liquidate their investments. The aggregate redemption price payable by the Trusts is
subject to limitations. In certain circumstances, the REIT’s Declaration of Trust provides for the in specie distributions of notes of
H&R Portfolio LP Trust in the event of redemption of units of the REIT that are part of the Stapled Units. The notes which may be
distributed in specie to unitholders in connection with a redemption will not be listed on any stock exchange, no established market is
expected to develop for such notes and they may be subject to resale restrictions under applicable securities laws.
Unitholder Liability
The Trusts’ Declarations of Trust provide that unitholders will have no personal liability for actions of the Trusts and no recourse will
be available to the private property of any unitholder for satisfaction of any obligation or claims arising out of a contract or obligation
of the Trusts. The Declarations of Trust further provide that this lack of unitholder liability, where possible, must be provided for in
certain written instruments signed by the Trusts. In addition, legislation has been enacted in the Provinces of Ontario and certain
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H&R REIT AND H&R FINANCE TRUST - MD&A – December 31, 2011
other provinces that is intended to provide unitholders in those provinces with limited liability. However, there remains a risk, which
the Trusts consider to be remote in the circumstances, that a unitholder could be held personally liable for the Trusts’ obligations to
the extent that claims are not satisfied out of the Trusts’ assets. It is intended that the Trusts’ affairs will be conducted to seek to
minimize such risk wherever possible.
OUTSTANDING UNIT DATA
The beneficial interests in the Trusts are represented by a single class of Stapled Units which are unlimited in number. Each unit
carries a single vote at any meeting of unitholders. As at March 8, 2012, there were 175,413,549 Stapled Units issued and
outstanding.
As at December 31, 2011, the maximum number of Stapled Units authorized to be granted under the REIT’s Unit Option Plan was
18,000,000. Of this amount, 9,924,320 had been granted and 6,417,500 had been exercised and expired. As at March 8, 2012,
there were 3,506,820 options to purchase Stapled Units outstanding of which 1,015,835 are fully vested.
The following table lists the principal outstanding balance of the REIT’s convertible debentures as at March 8, 2012 and the number
of Stapled Units required to convert the convertible debentures to equity:
Convertible Debentures
2013 6.65% Debentures
2014 6.75% Debentures
2017 6.00% Debentures
2020 5.90% Debentures
2016 4.50% Debentures
SUBSEQUENT EVENTS
Principal outstanding as at
March 8, 2012
Maximum number of
Stapled Units issuable
$114.9 million
93.9 million
169.4 million
100.0 million
75.0 million
4,969,710
6,706,000
8,917,474
4,254,894
2,918,288
a) In January 2012, the REIT received a U.S. mortgage for U.S. $250.0 million for Hess Tower in Houston, Texas, bearing interest
at a rate of 4.50% per annum for an 8-year term.
b) In February 2012, the REIT refinanced three U.S. mortgages totaling U.S. $72.6 million each bearing interest at a rate of 5.94%
per annum, with three new non-recourse U.S. mortgages totaling $61.0 million, each bearing interest at a rate of 4.50% per
annum for a 10-year term.
c) In February 2012, the REIT refinanced ten Canadian mortgages totaling $28.5 million each bearing interest at a rate of 7.74%
per annum, with ten new mortgages totaling $62.9 million, each bearing interest at a rate of 3.99% per annum for a 10-year term.
d) In March 2012, the REIT purchased a 485,000 square foot, state-of-the-art office building in Toronto, Ontario for a purchase
price of $186.0 million before transaction costs. The REIT has secured a $60 million interest only mortgage for a term of 20
years. The interest rate will be at a spread of 2.30% over the 20-year Government of Canada bond. The REIT has the right to
place another $37.0 million first mortgage on this property.
ADDITIONAL INFORMATION
Additional information relating to the REIT and Finance Trust, including the REIT’s Annual Information Form, is available on SEDAR
at www.sedar.com.
Page 43 of 43
Combined Financial Statements of
H&R REAL ESTATE INVESTMENT TRUST
and
H&R FINANCE TRUST
Years ended December 31, 2011 and 2010
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Combined Statements of Financial Position
(In thousands of Canadian dollars)
December 31
December 31
January 1
2011
2010
2010
$
5,794,499
$
4,524,958
$
4,561,817
1,617,057
156,503
7,568,059
1,268,331
156,938
5,950,227
794,534
147,524
5,503,875
7,080
-
49,053
3,000
-
38,379
63,789
19,035
55,301
13,609
7,637,801
$
7,034
5,998,640
$
105,530
5,747,530
$
$
3,163,593
$
2,706,707
$
2,818,476
1,370,917
126,695
-
8,640
6,072
440,173
175,849
965,828
105,652
-
3,409
3,317
89,045
170,544
654,655
84,010
469,842
2,923
-
13,560
169,182
5,291,939
4,044,502
4,212,648
2,345,862
1,954,138
1,534,882
$
7,637,801
$
5,998,640
$
5,747,530
Assets
Real estate assets
Investment properties (note 4)
Properties under development (note 5)
Accrued rent receivable
Mortgages and amount receivable
Assets classified as held for sale (note 6)
Other assets (note 7)
Cash and cash equivalents (note 8)
Liabilities and Unitholders' Equity
Liabilities
Mortgages payable (note 9)
Debentures payable (note 10)
Exchangeable units (note 11)
Deferred tax liability (note 27)
Unit options payable (note 12(a))
Derivative instruments (note 13)
Bank indebtedness (notes 14)
Accounts payable and accrued liabilities (note 15)
Unitholders' equity
Commitments and contingencies (note 28)
Subsequent events (note 29)
See accompanying notes to the combined financial statements
2
.
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Combined Statements of Comprehensive Income (Loss)
(In thousands of Canadian dollars)
Years ended December 31, 2011 and 2010
Property operating income:
Rentals from investment properties (notes 17 and 26)
Property operating costs
Finance costs:
Finance income
Finance cost - operations (note 18)
Gain (loss) on extinguishment of debt (notes 4 and 10(c))
Loss on change in fair value (note 19)
Amortization and impairment (note 20)
Trust expenses
Gain on sale of investment properties
Transaction costs on issuance of convertible debentures
Net gain (loss) on foreign exchange
Net income (loss) before income taxes
Income tax recovery (expense) (note 27)
Net income (loss)
Other comprehensive income (loss):
Unrealized gain (loss) on translation of U.S. denominated foreign operations
Transfer of realized loss on cash flow hedges to net income
Deferred income taxes (note 27)
2011
2010
$
656,911
(219,997)
436,914
$
617,427
(204,386)
413,041
1,051
(181,012)
19,726
(108,378)
(268,613)
(181,757)
(15,366)
3,260
(2,813)
3,383
(24,992)
(285)
(25,277)
2,211
385
-
2,596
2,589
(174,120)
(21,538)
(83,282)
(276,351)
(77,429)
(14,554)
3,576
(4,535)
(6,828)
36,920
459,680
496,600
(7,449)
372
915
(6,162)
Total comprehensive income (loss) attributable to unitholders
$
(22,681)
$
490,438
See accompanying notes to the combined financial statements.
3
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Combined Statements of Change in Unitholders' Equity
(In thousands of Canadian dollars)
Years ended December 31, 2011 and 2010
UNITHOLDERS' EQUITY
Unitholders' equity, January 1, 2010
Proceeds from issuance of units
Net income
Distributions to unitholders (note 12(b))
Conversion of convertible debentures, note (10), net
Other comprehensive loss
Unitholders' equity, December 31, 2010
Proceeds from issuance of units
Issue cost
Net loss
Distributions to unitholders (note 12(b))
Conversion of convertible debentures (note 10), net
Other comprehensive income
Accumulated
other
comprehensive
Value of
Accumulated
Accumulated
income (loss)
Units
net income
distributions
(note 16)
Total
$
2,182,289
35,495
-
-
7,019
-
$
727,175
-
496,600
-
-
-
$
(1,371,328)
-
-
(113,696)
-
-
$
(3,254)
-
-
-
-
(6,162)
$
1,534,882
35,495
496,600
(113,696)
7,019
(6,162)
2,224,803
1,223,775
(1,485,024)
(9,416)
1,954,138
554,703
(22,465)
-
-
32,418
-
-
-
(25,277)
-
-
-
-
-
-
(150,251)
-
-
-
-
-
-
-
2,596
554,703
(22,465)
(25,277)
(150,251)
32,418
2,596
Unitholders' equity, December 31, 2011
$
2,789,459
$
1,198,498
$
(1,635,275)
$
(6,820)
$
2,345,862
See accompanying notes to the combined financial statements.
4
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Combined Statements of Cash Flows
(In thousands of Canadian dollars)
Years ended December 31, 2011 and 2010
Cash provided by (used in):
Operations:
Net income (loss)
Items not affecting cash:
Finance cost - operations (note 18)
Rent amortization of tenant inducements (note 17)
Amortization and impairment (note 20)
Gain on sale of investment properties
Loss (gain) on extinguishment of debt (notes 4 and 10(c))
Unrealized loss (gain) on foreign exchange
Deferred income tax recovery (note 27)
Loss on change in fair values (note 19)
Unit-based compensation (note 12(a))
Change in other non-cash operating items (note 21)
Investing:
Properties under development
Investment properties:
Net proceeds on disposition of investment properties
Acquisitions (note 4)
Capital expenditures (note 4)
Leasing expenses and tenant inducements
Mortgages receivable
Restricted cash
Financing:
Bank indebtedness
Interest paid
Mortgages payable:
New mortgages payable
Principal repayments
Proceeds from issuance of debentures payable
Repayment of debentures payable (note 10(c))
Proceeds from issuance of units, net
Finance cost - Class B LP unit distributions (note 18)
Distributions to unitholders (note 12(b))
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of year (notes 6 and 8)
Cash and cash equivalents, end of year (note 8)
Supplemental cash flow information (note 21)
See accompanying notes to the combined financial statements.
5
2011
2010
$
(25,277)
$
496,600
181,012
1,028
181,757
(3,260)
(19,726)
(3,391)
-
108,378
7,600
(23,394)
404,727
174,120
938
77,429
(3,576)
21,538
6,832
(460,138)
83,282
6,882
(4,126)
399,781
(292,007)
(411,162)
12,078
(1,123,537)
(11,259)
(9,890)
(4,080)
692
(1,428,003)
22,183
(80,422)
(15,371)
(5,517)
60,789
893
(428,607)
351,128
(220,333)
75,485
(207,822)
347,956
(175,201)
351,985
-
493,730
(5,302)
(114,112)
1,029,851
6,575
7,034
13,609
$
35,831
(107,273)
450,459
(227,752)
14,829
(4,282)
(99,426)
(69,951)
(98,777)
105,811
7,034
$
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
These combined financial statements include the accounts of H&R Real Estate Investment Trust (the "REIT") and H&R Finance Trust
("Finance Trust"). These combined financial statements are presented as supplementary information to the financial statements of the
REIT and Finance Trust (collectively, the "Trusts"), all of which are filed on SEDAR.
The REIT is an unincorporated open-ended trust and Finance Trust is an unincorporated investment trust both domiciled in Canada.
The REIT owns, operates and develops commercial properties across Canada and in the United States. The principal office and centre
of administration of the Trusts is located at 3625 Dufferin Street, Suite 500, Toronto, Ontario M3K 1N4. Unitholders of each Trust
participate pro rata in distributions of income and, in the event of termination of a Trust, participate pro rata in the net assets remaining
after satisfaction of all liabilities of such Trust.
The combined financial statements are a result of the REIT's completion of an internal reorganization on October 1, 2008, pursuant to a
Plan of Arrangement (the "Plan of Arrangement") as described in the REIT's information circular dated August 20, 2008, resulting in the
stapling of the Trusts' units. The Plan of Arrangement resulted in, among other things, the creation on October 1, 2008 of Finance Trust.
Each unitholder received, for each REIT unit held, a unit of Finance Trust. Each issued and outstanding Finance Trust unit is stapled to a
unit of the REIT on a one-for-one basis so as to form stapled units ("Stapled Units"), and such Stapled Units are listed and posted for
trading on the Toronto Stock Exchange ("TSX") listed under the symbol HR.UN. The units of each of the Trusts may only be transferred
together as Stapled Units unless an event of "uncoupling" has occurred.
The presentation of combined financial statements of the Trusts is useful to the unitholders on the following basis:
•
The units of the Trusts are stapled (as noted above), resulting in the two Trusts being under common ownership;
• A support agreement between the Trusts ensures that until such time as an event of “uncoupling” occurs, when units are
issued by the REIT, units must also be issued by Finance Trust simultaneously so as to maintain the stapled unit structure;
•
•
The sole activity of Finance Trust is to provide capital funding to H&R REIT (U.S.) Holdings Inc. ("U.S. Holdco"), a wholly
owned U.S. subsidiary of the REIT; and
The investment activities of Finance Trust are restricted in its Declaration of Trust to providing such funding to U.S. Holdco and
to make temporary investments of excess funds.
1.
(a)
Basis of preparation:
Statement of compliance
These combined financial statements have been prepared in accordance with International Financial Reporting Standards
(“IFRS”) as published by the International Accounting Standards Board (“IASB”) and using accounting policies described herein.
These are the Trusts’ first annual combined financial statements prepared in accordance with IFRS and IFRS 1 First-time
Adoption of International Financial Reporting Standards (“IFRS 1”) has been applied.
An explanation of how the transition to IFRS has affected the reported financial position, financial performance and cash flows of
the Trusts is provided in note 3.
The combined financial statements were authorized for issue by the REIT Board of Trustees on March 12, 2012.
6
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
1.
Basis of preparation (continued):
(b)
Basis of measurement
The combined financial statements have been prepared on the historical cost basis except for the following material items in the
statement of financial position which have been measured at fair value:
(i)
(ii)
Derivative financial instruments;
Liabilities for cash-settled unit-based payment arrangements; and
(iii)
Financial instruments at fair value through net income (loss).
(c)
Functional currency and presentation
These combined financial statements are presented in Canadian dollars, which is the Trusts’ functional currency. All financial
information presented in Canadian dollars has been rounded to the nearest thousand.
The Trusts present their combined statement of financial position based on the liquidity method, where all assets and liabilities
are presented in ascending order of liquidity.
(d)
Use of estimates and judgements
The preparation of these combined financial statements in conformity with IFRS requires management to make judgements,
estimates and assumptions that affect the application of accounting policies, the reported amounts of assets, liabilities, income
and expenses and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results may differ
from these estimates.
(i)
Use of estimates
Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are
recognized in the period in which the estimates are revised and in any future periods affected. Information about
assumptions and estimation uncertainties that have a significant risk of resulting in a material adjustment within the next
financial year are included in the following notes:
•
•
Fair value of investment properties;
Impairment of investment properties;
• Useful lives of investment properties and the significant components thereof used to calculate amortization;
•
•
Fair value of financial instruments; and
Fair value of cash-settled unit-based compensation.
7
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
1.
Basis of preparation (continued):
(ii) Use of judgements
The critical judgements made in applying accounting policies that have the most significant effect on the amounts
recognized in these combined financial statements are as follows:
• Leases
The REIT’s policy for property rental revenue recognition is described in note 2(h). The REIT makes judgements in
determining whether certain leases, in particular those tenant leases with long contractual terms and long-term
ground leases where the REIT is the lessor, are operating or finance leases. The REIT has determined that all of its
leases are operating leases.
•
Income taxes
The REIT is a mutual fund trust and a real estate investment trust pursuant to the Income Tax Act (Canada). Under
current tax legislation, the REIT is not liable to pay Canadian income tax provided that its taxable income is fully
distributed to unitholders each year. The REIT is a real estate investment trust if it meets prescribed conditions under
the Income Tax Act (Canada) relating to the nature of its assets and revenue (the "REIT Conditions"). The REIT has
reviewed the REIT Conditions and has assessed its interpretation and application to the REIT's assets and revenue,
and it has determined that it qualifies as a real estate investment trust pursuant to the Income Tax Act (Canada) for
the year.
•
Investment property componentization
The REIT’s accounting policies relating to investment property componentization are described in note 2(c). In
applying this policy, judgement is made in determining the degree of componentization for each property.
•
Tenant improvements
The REIT makes judgments with respect to whether tenant improvements provided in connection with a lease
enhance the value of the leased property, which determines whether such amounts are capitalized to investment
properties.
8
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
2.
Significant accounting policies:
The accounting policies set out below have been applied consistently to all periods presented in these combined financial
statements and in preparing the opening IFRS statement of financial position at January 1, 2010 for the purposes of the
transition to IFRS.
(a)
Basis of combination
The principles used to prepare combined financial statements are similar to those used to prepare consolidated financial
statements. The combined financial statements include the assets, liabilities, unitholders' equity, comprehensive income (loss)
and operating results of the Trusts, after elimination of the following:
(i)
the REIT's notes payable to Finance Trust; and
(ii)
the REIT's interest expense and Finance Trust's interest income from the notes payable to Finance Trust.
The foreign exchange gain (loss) recorded in net income as a result of exchanging Finance Trust's U.S. dollar note receivable
from U.S. Holdco is not eliminated on combination as U.S. Holdco is a U.S. denominated foreign operation of the REIT, which
results in the foreign exchange on the note payable being reported in accumulated other comprehensive income.
The combination of the Trusts does not result in the elimination of the equity of Finance Trust as neither of the Trusts hold any
interest in the other. The equity of the Trusts is presented by way of combining the two together.
(b)
Basis of consolidation
These combined financial statements include the accounts of all entities in which the REIT holds a controlling interest. Finance
Trust does not hold a controlling interest in any entity. The REIT carries out a portion of its activities through co-ownership
agreements and records its proportionate share of assets, liabilities, revenues, expenses, and cash flows of all co-ownerships in
which it participates. All material intercompany transactions and balances have been eliminated upon consolidation.
(c)
Investment properties
Investment properties are held to earn rental income or for capital appreciation or for both, but not for sale in the ordinary course
of business. All of the REIT’s commercial properties are investment properties which are measured at cost less accumulated
depreciation and impairment losses.
The cost of replacing a major component of a building is recognized in the carrying amount of the building if it is probable that
the future economic benefits embodied within the component will flow to the REIT, and its cost can be measured reliably. The
carrying amount of the replaced component is derecognized at the time of replacement through the statement of comprehensive
income.
Upon acquisition, the REIT performs an assessment of investment properties being acquired to determine whether the
acquisition is to be accounted for as an asset acquisition or a business combination. A transaction is considered to be a
business combination if the acquired property meets the definition of a business: being an integrated set of activities and assets
that are capable of being managed for the purpose of providing a return to the unitholders.
9
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
2.
Significant accounting policies (continued):
Whether the acquisition is accounted for as an asset acquisition or a business combination, the REIT determines the fair value
of assets acquired and liabilities assumed including land, building and intangibles such as above- and below-market leases, in-
place operating leases and tenant renewal value. The REIT expenses transaction costs on business combinations and
capitalizes transaction costs if it is an asset acquisition.
(d)
Properties under development:
Property under development for future use as investment property is accounted for as investment property under IAS 40,
Investment Property. The cost of properties under development includes direct development costs, realty taxes and borrowing
costs that are directly attributable to the development. Borrowing costs associated with direct expenditures on properties under
development are capitalized. Borrowing costs relating to the purchase of a site or property acquired for redevelopment are also
capitalized. The amount of borrowing costs capitalized is determined first by reference to borrowing specific to the project,
where relevant, and otherwise by applying a weighted average cost of borrowings to eligible expenditures after adjusting for
borrowings associated with other specific developments. Borrowing costs are capitalized from the commencement of the
development until the date of practical completion. The capitalization of borrowing costs is suspended if there are prolonged
periods when development activity is interrupted. The REIT considers practical completion to have occurred when the property
is capable of operating in the manner intended by management. Generally this occurs upon completion of construction and
receipt of all necessary occupancy and other material permits. Where the REIT has pre-leased space as of or prior to the start
of the development and the lease requires the REIT to construct tenant improvements which enhance the value of the property,
practical completion is considered to occur on completion of such improvements.
(e)
Assets held for sale and discontinued operations
Non-current assets comprising assets and liabilities, that are expected to be recovered primarily through sale rather than
through continuing use, are classified as held for sale. For this purpose, a sale is highly probable if management is committed to
a plan to achieve the sale; there is an active program to find a buyer; the non-current asset is being actively marketed at a
reasonable price; the sale is anticipated to be completed within one year from the date of classification; and it is unlikely there
will be changes to the plan. Immediately before classification as held for sale, the assets are re-measured in accordance with
the REIT’s accounting policies. Thereafter the assets are measured at the lower of their carrying amount and fair value less cost
to sell. Impairment losses on initial classification as held for sale and subsequent gains or losses on re-measurement are
recognized in net income (loss). Gains are not recognized in excess of any cumulative impairment loss. The net income (loss)
arising on sale of such an asset will be recognized as a gain (loss) on sale.
In accordance with IFRS 5, Non-Current Assets Held for Sale and Discontinued Operations, investment properties that
constitute a component of the REIT that has either been disposed of or is classified as held for sale are presented as
discontinued operations in all periods presented if the property operations are expected to be eliminated and the REIT will not
have significant continuing involvement following the disposition. A component of the REIT will generally represent a major line
of business or geographical area of operation.
10
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
2.
Significant accounting policies (continued):
(f)
Depreciation and amortization
Depreciation is based on the cost of an asset less its residual value. Significant components of individual assets are assessed,
and if a component has a useful life that is different from the remainder of that asset, then that component is depreciated
separately. Depreciation is recognized in net income (loss) on a straight-line basis over the estimated useful life of each
component of an item of property, plant and equipment. Land is not amortized. Depreciation and amortization methods, useful
lives and residual values are reviewed at each annual reporting date and adjusted as appropriate. Buildings are depreciated on
a straight-line basis over their useful lives for a period of approximately 40 years. Building improvements are depreciated over
their useful lives, which typically vary between 5 and 20 years. Improvements that do not meet the capitalization criteria are
expensed in full in the period incurred. Paving and equipment are depreciated on a straight-line basis over their useful lives,
which is typically 10 years. Intangibles resulting from in-place leases and above- and below-market leases are amortized over
the related lease terms.
Leasing costs, such as commissions and tenant inducements, are deferred and amortized on a straight-line basis over the terms
of the related leases.
(g)
Impairment of investment properties
The carrying amount of the REIT’s investment properties and properties under development is reviewed at each reporting date
to determine whether there is an indication of impairment. If such indicator exists, then the asset’s recoverable amount is
estimated. An asset is impaired when its carrying amount exceeds its recoverable amount. The recoverable amount of an
asset is the greater of its value in use and its fair value less costs to sell. In assessing value in use, the estimated future cash
flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time
value of money and the risk specific to the asset.
Impairment losses are recognized in net income (loss). Impairment losses recognized in prior periods are assessed at each
reporting date for any indications that the loss has decreased or no longer exists. An impairment loss is reversed if there has
been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent
that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or
amortization, if an impairment loss had not been recognized.
(h)
Revenue recognition:
The REIT retains substantially all of the benefits and risks of ownership of its investment properties and therefore, accounts for
its leases with tenants as operating leases. Rentals from investment properties include all amounts earned from tenants,
including recovery of operating costs.
Rental revenue from investment property is recognized in net income (loss) on a straight-line basis over the term of the related
lease. The difference between the rental revenue recognized and the amounts contractually due under the lease agreements is
recorded in accrued rent receivable. Lease incentives granted are recognized as an integral part of total rental income over the
term of the lease.
11
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
2.
Significant accounting policies (continued):
(i)
Income taxes:
Income tax expense comprises current and deferred tax. Current tax and deferred tax are recognized in net income (loss)
except to the extent that it relates to a business combination, or items recognized directly in equity or in other comprehensive
income (loss).
Current tax is the expected tax payable or receivable on the taxable income or loss for the year, using tax rates enacted or
substantively enacted at the reporting date, and any adjustment to tax payable in respect of previous years.
The REIT is a mutual fund trust and a real estate investment trust pursuant to the Income Tax Act (Canada). Under current tax
legislation, a real estate investment trust is entitled to deduct distributions of taxable income such that it is not liable to pay
income tax provided that its taxable income is fully distributed to unitholders. The REIT intends to continue to qualify as a real
estate investment trust and to make distributions not less than the amount necessary to ensure that the REIT will not be liable to
pay income taxes.
For periods in which the REIT does not qualify as a real estate investment trust and for the REIT’s corporate subsidiaries,
deferred tax is recognized in respect of temporary differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for taxation purposes. Deferred tax is not recognized for the following temporary
differences: the initial recognition of assets or liabilities in a transaction that is not a business combination and that affects
neither accounting nor taxable net income (loss), and differences relating to investments in subsidiaries and jointly controlled
entities to the extent that it is probable that they will not reverse in the foreseeable future. In addition, deferred tax is not
recognized for taxable temporary differences arising on the initial recognition of goodwill. Deferred tax is measured at the tax
rates that are expected to be applied to temporary differences when they reverse, based on the laws that have been enacted or
substantively enacted by the reporting date. Deferred tax assets and liabilities are offset if there is a legally enforceable right to
offset current tax liabilities and assets, and they relate to income taxes levied by the same tax authority on the same taxable
entity, or on different tax entities, if such entities intend to settle current tax liabilities and assets on a net basis or the entities tax
assets and liabilities will be realized simultaneously.
A deferred tax asset is recognized for unused tax losses, tax credits and deductible temporary differences, to the extent that it is
probable that future taxable profits will be available against which they can be utilized. Deferred tax assets are reviewed at each
reporting date and are reduced to the extent that it is no longer probable that the related tax benefit will be realized.
Finance Trust qualifies as a mutual fund trust that is not a specified investment flow-through trust under the Income Tax Act
(Canada). In accordance with the terms of Finance Trust’s Declaration of Trust, all of the net income for tax purposes will be
paid or be payable to unitholders in the taxation year so that no income tax is payable by Finance Trust. For financial statement
reporting purposes, the tax deductibility of Finance Trust's distributions is treated as an exemption from taxation as Finance Trust
has distributed and is committed to continue distributing all of its taxable income to its unitholders.
12
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
2.
(j)
Significant accounting policies (continued):
Unit option plan:
The REIT has a unit option plan available for REIT trustees, consultants, officers or employees as disclosed in note 12(a). The
unit option plan is considered to be a cash-settled liability under IFRS 2, Share-based Payment and as a result is measured at
each reporting period and at settlement date at its fair value. The fair value of the amount payable to participants in respect of
the unit option plan is recognized as an expense with a corresponding increase or decrease in liabilities, over the period that the
employees unconditionally become entitled to payment. Any change in the fair value of the liability is recognized as a component
of trust expenses.
(k)
Cash and cash equivalents:
Cash and cash equivalents include deposits in banks, certificates of deposit and short-term investments with original maturities
of less than 90 days.
(l)
Restricted cash:
Restricted cash includes amounts held in reserve by lenders to fund mortgage payments, repairs and capital expenditures or
property tax payments.
(m)
Foreign currency translation:
The REIT accounts for its investments in U.S. Holdco, a wholly owned subsidiary of the REIT, in the United States (“foreign
operations”) as a U.S. denominated foreign operation. Assets and liabilities of foreign operations are translated into Canadian
dollars at the exchange rates in effect at the balance sheet dates and revenue and expenses are translated at the average
exchange rates for the reporting periods.
The foreign currency translation adjustment is recorded as a separate component of accumulated other comprehensive income
(loss) until there is a reduction in the REIT’s net investment in the foreign operations. The U.S. dollar denominated bank
indebtedness is designated as a hedge of the REIT’s investment in self-sustaining operations. Accordingly, the accumulated
unrealized gains or losses arising from the translation of this obligation are recorded as a foreign currency translation
adjustment in accumulated other comprehensive income.
Finance Trust’s U.S. dollar denominated assets and liabilities are translated into Canadian dollars at the exchange rates in
effect on the balance sheet date and revenue and expenses are translated at the actual exchange rate on the date incurred,
resulting in any gain (loss) recorded in comprehensive income.
(n)
Financial instruments:
(i) Non-derivative financial assets
Cash and cash equivalents, accounts receivable and mortgages and amounts receivable are non-derivative financial
assets classified as loans and receivables with fixed or determinable payments that are not quoted in an active market.
Such assets are recognized initially at fair value plus any directly attributable transaction costs. Subsequent to initial
recognition, loans and receivables are measured at amortized cost using the effective interest method, less any impairment
losses.
13
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
2.
Significant accounting policies (continued):
The Trusts derecognize a financial asset when the contractual rights to the cash flows from the asset expire, or it transfers
the rights to receive the contractual cash flows on the financial asset in a transaction in which substantially all the risks and
rewards of ownership of the financial asset are transferred. Financial assets and liabilities are offset and the net amount
presented in the statement of financial position when, and only when, the Trusts have a current legal right to offset the amounts
and intends either to settle on a net basis or to realize the asset and settle the liability simultaneously.
(ii) Non-derivative financial liabilities
Non-derivative financial liabilities consist of mortgages payable, senior debentures, bank indebtedness and accounts
payable and accrued liabilities. Such financial liabilities are recognized initially at fair value plus any directly attributable
transaction costs. Subsequent to initial recognition these financial liabilities are measured at amortized cost using the
effective interest method.
The Trusts derecognize a financial liability when their contractual obligations are discharged or cancelled or expire.
(iii) Derivative financial instruments
The REIT holds derivative financial instruments to hedge its foreign currency and interest rate risk exposures. Derivatives
are recognized initially at fair value; attributable transaction costs are recognized in net income (loss) as incurred.
Subsequent to initial recognition, derivatives are measured at fair value at the end of each reporting period. Any resulting
gain or loss is recognized in net income (loss) immediately unless the derivative is designated and effective as a hedging
instrument. None of the REIT’s derivative instruments are accounted for as hedges.
(iv) Financial liabilities measured at fair value through net income (loss).
A financial liability is classified at fair value through net income (loss) if it is classified as held for trading or is designated as
such upon initial recognition.
The convertible debentures and Class B LP units of H&R Portfolio Limited Partnership (“HRLP”), a subsidiary partnership
of the REIT, were designated at fair value through profit or loss upon initial recognition. Any gains or losses arising on
remeasurement are recognized in net income (loss).
(o)
Stapled Units:
Under IAS 32, Financial Instruments: Presentation (“IAS 32”), puttable instruments, such as the Stapled Units are generally
classified as financial liabilities unless the exemption criteria are met for equity classification. As a result of the REIT receiving
consent of its unitholders to modify the REIT’s Declaration of Trust to eliminate the mandatory distribution and leave
distributions to the discretion of the trustees and the ability of the trustees to fund distributions by way of issuing additional units
prior to the amendment, the REIT met the exemption criteria under IAS 32 for equity classification. Finance Trust also met the
exemption criteria under IAS 32 for equity classification. Nevertheless, the Stapled Units are not considered ordinary units
under IAS 33, Earnings Per Share, and therefore an income (loss) per unit calculation is not presented.
14
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
2.
(p)
Significant accounting policies (continued):
Finance costs:
Finance costs are comprised of interest expense on borrowings, distributions on Class B LP units of HRLP classified as
liabilities, gain (loss) on change in fair value of convertible debentures, gain (loss) on change in fair value of Class B LP units of
HRLP, gain (loss) on derivative contracts and gain (loss) on extinguishment of debt.
Finance costs associated with financial liabilities presented at amortized cost are recognized in net income (loss) using the
effective interest method.
(q)
New standards and interpretations not yet adopted:
Standards issued but not yet effective up to the date of issuance of these financial statements are described below. The Trusts
intend to adopt these standards when they become effective.
Financial Instruments: Classification and Measurement (“IFRS 9”)
IFRS 9 as issued reflects the IASB’s work to date on the replacement of IAS 39, Financial Instruments - Recognition and
Measurement (“IAS 39”), and applies to classification and measurement of financial assets as defined in IAS 39. The approach
to classifying an asset as either amortized cost or fair value in IFRS 9 is based on how an entity manages its financial
instruments in the context of its business model and the contractual cash flow characteristics of its financial assets. The
standard is effective for annual periods beginning on or after January 1, 2015. In subsequent phases, the IASB will address
hedge accounting and impairment. The Trusts have not yet determined the impact of IFRS 9 on their combined financial
statements.
Consolidated Financial Statements (“IFRS 10”)
The IASB recently issued its new suite of consolidation standards, including IFRS 10, which replaces IAS 27, Consolidated and
Separate Financial Statements. IFRS 10 defines the principle of control over an investee when (i) it is exposed or has rights to
variable returns from its involvement with that investee; (ii) it has the ability to affect those returns through its power over that
investee; and (iii) there is a link between such power and returns. This standard is effective for annual periods beginning on or
after January 1, 2013. The Trusts have not yet determined the impact of IFRS 10 on their combined financial statements.
Joint Arrangements (“IFRS 11”)
On May 12, 2011, the IASB issued IFRS 11. This new standard replaces IAS 31, Interests in Joint Ventures. The new standard
eliminates the option to proportionately consolidate interests in certain types of joint ventures. This may impact the jointly
controlled entities which the Trusts currently proportionately consolidates under IFRS. The new standard is not expected to
have an impact on unitholders’ equity or net income going forward but is expected to have a presentation impact on the financial
statements. This new standard is effective for the Trusts’ year end beginning January 1, 2013.
15
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
2.
Significant accounting policies (continued):
Disclosures of Interests in Other Entities (“IFRS 12”)
The IASB issued IFRS 12 to replace the existing disclosure requirements for entities that have interests in subsidiaries, joint
arrangements and associates. This standard also contains disclosure requirements for entities that have interests in
unconsolidated structured entities. The disclosures aim to provide information in order to enable users to evaluate the nature of,
and the risks associated with, an entity’s interest in other entities, and the effects of those interests on the entity’s financial
position, financial performance and cash flows. This standard is effective for annual periods beginning on or after January 1,
2013. The Trusts have not yet determined the impact of IFRS 12 on their combined financial statements.
Fair Value Measurement (“IFRS 13”)
In May 2011, the IASB issued IFRS 13. This new standard replaces the fair value measurement contained in individual IFRS
with a single source of fair value measurement guidance. The standard defines fair value as the price that would be received to
sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The
standard also establishes a framework for measuring fair value and requires the fair value hierarchy to be applied to all fair
value measurements and expands disclosure requirements for fair value measurements to provide information which allows
users to assess the methods and inputs used to develop fair value measurements. The Trusts intend to early adopt this
standard beginning January 1, 2012. The impact of this change will be to use market prices of financial instruments, and certain
non-financial instruments should they arise, at the time of measurement.
3.
Explanation of transition to IFRS:
As stated in note 1(a), these are the Trusts’ first combined financial statements prepared in accordance with IFRS.
The accounting policies set out in note 2 have been applied in preparing the combined financial statements for the year ended
December 31, 2011 and December 31, 2010 and in preparation of an opening IFRS statement of financial position at January 1,
2010 (the REIT’s date of transition to IFRS).
In preparing their opening IFRS statement of financial position, the Trusts have adjusted amounts reported previously in
financial statements prepared in accordance with previous Canadian Generally Accepted Accounting Principles (“Canadian
GAAP”). An explanation of how the transition from previous Canadian GAAP to IFRS has affected the Trusts’ financial position,
financial performance and cash flows is set out in the following tables and the notes that accompany the tables.
16
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
3.
(i)
Explanation of transition to IFRS (continued):
Reconciliation of unitholders’ equity on January 1, 2010 and December 31, 2010
Assets
Real estate Assets
Investment properties
Properties under development
Accrued rent receivable
Mortgages and amount receivable
Assets classified as held for sale
Other assets
Cash and cash equivalents
Liabilities and Unitholders' Equity
Liabilities
Mortgages payable
Debentures payable
Exchangeable units
Deferred tax liability
Unit options payable
Derivative Instruments
Bank indebtedness
Accounts payable and accrued liabilities
Liabilities classified as held for sale
January 1, 2010
Effect of
Previous
December 31, 2010
Previous
Effect of
Note
3(iv)
Canadian
transition to
Restated
Canadian
transition to
Restated
GAAP
IFRS
under IFRS
GAAP
IFRS
under IFRS
a,d
$
4,124,958
$
436,859
$
4,561,817
$
4,022,517
$
502,441
$
4,524,958
e
l
f
h
l
g
i
i
794,534
125,212
5,044,704
63,789
19,035
60,828
105,530
-
22,312
459,171
-
-
(5,527)
-
794,534
147,524
5,503,875
63,789
19,035
55,301
105,530
1,268,331
136,605
5,427,453
3,000
-
38,379
7,034
-
20,333
522,774
-
-
-
-
1,268,331
156,938
5,950,227
3,000
-
38,379
7,034
$
5,293,886
$
453,644
$
5,747,530
$
5,475,866
$
522,774
$
5,998,640
$
2,818,476
$
-
$
2,818,476
$
2,706,707
$
-
$
2,706,707
565,758
75,122
138,122
-
-
13,556
166,971
2,215
88,897
8,888
331,720
2,923
-
4
2,211
(2,215)
654,655
84,010
469,842
2,923
-
13,560
169,182
-
822,340
77,261
-
-
3,317
89,045
170,544
-
143,488
28,391
-
3,409
-
-
-
-
965,828
105,652
-
3,409
3,317
89,045
170,544
-
3,780,220
432,428
4,212,648
3,869,214
175,288
4,044,502
Unitholders' equity
1,513,666
21,216
1,534,882
1,606,652
347,486
1,954,138
$
5,293,886
$
453,644
$
5,747,530
$
5,475,866
$
522,774
$
5,998,640
17
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
3.
Explanation of transition to IFRS (continued):
(i)
Reconciliation of unitholders’ equity on January 1, 2010
Equity
Component
of Warrants
Accumulated
Other
Note
3(iv)
Value of
Accumulated
Accumulated
and
Comprehensive
Units
Net Income
Distributions
Debentures
Loss
Total
$
2,182,289
$
682,994
$
(1,371,328)
$
50,093
$
(30,382)
$
1,513,666
b
a
d
f
e
h
g
l
-
-
-
-
-
-
-
-
-
(27,540)
563,145
(126,286)
(38,804)
22,312
(8,888)
(2,923)
(336,835)
44,181
-
-
-
-
-
-
-
-
-
-
-
-
(50,093)
-
-
-
-
(50,093)
27,540
-
-
-
-
-
-
(412)
27,128
-
563,145
(126,286)
(88,897)
22,312
(8,888)
(2,923)
(337,247)
21,216
$
2,182,289
$
727,175
$
(1,371,328)
$
-
$
(3,254)
$
1,534,882
Unitholders' equity, January 1, 2010
as reported under previous
Canadian GAAP
Foreign currency translation adjustment
Fair value as deemed cost
Impairment of properties
at January 1, 2010
Fair value of convertible debentures
Accrued rent receivable
Exchangeable units
Unit-based compensation
Deferred tax
Sub-total opening IFRS adjustments
Unitholders' equity, January 1, 2010,
as reported under IFRS
18
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
3.
(i)
Explanation of transition to IFRS (continued):
Reconciliation of unitholders’ equity on December 31, 2010
Note
3(iv)
Value of
Accumulated
Accumulated
Contributed
Warrants and
Comprehensive
Units
Net Income
Distributions
Surplus
Debentures
Loss
Total
Equity
Component of
Accumulated
Other
Unitholders' equity, December 31, 2010
as reported under previous
Canadian GAAP
Opening IFRS adjustments,
January 1, 2010
Fair value as deemed cost
Reversal of impairment of properties
taken on January 1, 2010
Depreciation on impaired properties
Fair value of convertible debentures
Accrued rent receivable
Exchangeable units
Unit-based compensation
Net loss on foreign exchange
Deferred tax
Sub- total of IFRS adjustments
Unitholders' equity, December 31, 2010,
as reported under IFRS
$
2,216,361
$
855,342
$
(1,485,024)
$
1,225
$
55,757
$
(37,009)
$
1,606,652
a
d
d
f
e
h
g
j
l
-
-
-
-
2,046
-
-
6,396
-
-
8,442
44,181
(36,158)
101,165
575
(50,973)
(1,979)
(19,503)
(5,657)
(53)
336,835
368,433
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
(1,225)
-
-
(50,093)
27,128
-
-
-
(5,664)
-
-
-
-
-
-
-
-
-
-
-
-
53
412
(1,225)
(55,757)
27,593
21,216
(36,158)
101,165
575
(54,591)
(1,979)
(19,503)
(486)
-
337,247
347,486
$
2,224,803
$
1,223,775
$
(1,485,024)
$
-
$
-
$
(9,416)
$
1,954,138
19
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
3. Explanation of transition to IFRS (continued):
(ii) Reconciliation of comprehensive income for the year ended December 31, 2010
Property operating income:
Rentals from investment properties
Property operating costs
Finance costs:
Finance income
Finance cost - operations
Loss on extinguishment of debt
Loss on change in fair value
Amortization and impairment
Trust expenses
Gain on sale of investment properties
Transaction costs on issuance of convertible debentures
Net loss on foreign exchange
Net income before income taxes, exchangeable units
and discontinued operations
Income tax recovery
Net income before exchangeable units
and discontinued operations
Exchangeable units
Net income from continuing operations
Net income from discontinued operations
Net income
Other comprehensive loss:
Unrealized loss on translation of self-sustaining foreign operations
Transfer of realized loss on cash flow hedges to net income
Deferred income taxes
Year ended December 31, 2010
Note
3(iv)
Previous
Effect of transition
Restated
Canadian GAAP
to IFRS
under IFRS
a,e,i,k
$
615,572
$
1,855
$
617,427
i
f,h
f,h
a,d,i,k
g
i
f
j
l
h
i
(204,084)
411,488
2,589
(179,519)
(21,538)
(5,521)
(203,989)
(139,996)
(8,897)
-
-
(6,775)
(302)
1,553
-
5,399
-
(77,761)
(72,362)
62,567
(5,657)
3,576
(4,535)
(53)
(204,386)
413,041
2,589
(174,120)
(21,538)
(83,282)
(276,351)
(77,429)
(14,554)
3,576
(4,535)
(6,828)
51,831
(14,911)
36,920
122,845
336,835
459,680
174,676
(6,272)
168,404
3,944
172,348
(7,502)
372
503
(6,627)
321,924
6,272
328,196
(3,944)
324,252
53
-
412
465
496,600
-
496,600
-
496,600
(7,449)
372
915
(6,162)
Total comprehensive income
$
165,721
$
324,717
$
490,438
20
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
3.
Explanation of transition to IFRS (continued):
(iii)
Impact on the statement of cash flows
The IFRS adjustments made to the comparative combined statement of comprehensive income (loss) for the year ended
December 31, 2010 have also been made to the combined statement of cash flows for the same period. In addition, interest
paid, which was previously disclosed as supplementary cash flow information, and borrowing costs capitalized in relation to
qualifying assets, are presented as interest paid within the financing activity caption in the combined statement of cash flows.
There are no other material differences between the statement of cash flows presented under IFRS and the statement of cash
flows presented under previous Canadian GAAP.
(iv)
Notes to the IFRS reconciliations
In preparing these combined financial statements in accordance with IFRS 1, the REIT has applied certain of the optional
exemptions from full retrospective application of IFRS. The optional exemptions are described below in (a), (b) and (c).
(a)
Investment properties - fair value as deemed cost
The REIT has elected to apply the fair value as deemed cost for certain properties as at January 1, 2010 and the cost model for
subsequent accounting for its investment properties. The carrying values of these selected properties were adjusted to their fair
market value at the transition date. Any adjustment to the carrying value at the transition date is reflected as an adjustment in
investment properties and an offsetting adjustment to retained earnings.
The resulting adjustment to the combined statement of financial position was:
Investment properties:
A decrease to land
An increase to building and improvements
An increase to intangible assets
An increase to below-market rent
A decrease to tenant inducements
A decrease to leasing expense
December 31
2010
January 1
2010
$
(7,595)
$
(7,595)
144,158
426,574
(1,990)
(22,461)
147,853
464,230
(2,365)
(24,756)
(11,699)
526,987
$
(14,222)
563,145
$
The resulting increased amortization expense of $38,453 for the year ended December 31, 2010 was included in amortization
and impairment expenses. The resulting decreased rent amortization of tenant inducements by $2,295 for the year ended
December 31, 2010 was included in amortization and impairment expense.
(b)
Foreign currency translation election
In accordance with IFRS 1, the REIT has elected to deem all foreign currency translation differences that arose prior to the date
of transition in respect of all foreign operations to be nil at January 1, 2010, with the balance reclassified to retained earnings.
The only effect of this is a restatement within the accounts of the unitholders’ equity.
21
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
3.
(c)
Explanation of transition to IFRS (continued):
Business combination election
In accordance with IFRS 1, the REIT has elected to apply the business combination accounting standard prospectively to all
business combinations subsequent to the January 1, 2010 transition date.
(d)
Impairment of investment properties
Previous Canadian GAAP generally uses a two-step approach to impairment testing: first comparing asset carrying values with
undiscounted future cash flows to determine whether impairment exists, and then measuring impairment by comparing asset
carrying values to their fair value (which is calculated using discounted cash flows). IAS 36, Impairment of Assets uses a one-
step approach for testing and measuring impairment, with asset carrying values compared directly with the higher of fair value
less costs to sell and value in use (which uses discounted cash flows). This resulted in write-downs where the carrying value of
assets were previously supported under previous Canadian GAAP on an undiscounted cash flow basis, but could not be
supported on a discounted cash flow basis. Unlike previous Canadian GAAP, which does not permit reversals, IFRS allows the
reversal of an impairment loss in prior periods for an asset if there has been a change in the estimates used to determine the
assets recoverable amounts since the last impairment loss was recognized. The factors used in assessing fair value are
described in note 4.
This adjustment decreased investment properties in the statement of financial position by $126,286 at January 1, 2010 and
$24,546 at December 31, 2010, which included a reversal of an impairment loss recognized in the year ended December 31,
2010 of $101,165 which was included in amortization and impairment expense. The resulting decreased amortization expense
of $575 for the year ended December 31, 2010 was included in amortization and impairment expenses.
(e)
Accrued rent receivable
Under IFRS and previous Canadian GAAP, rental revenue is recognized on a straight-line basis over the term of the lease,
resulting in accruals for rents that are not billable or due until future years. Under IFRS, the accrued rent receivable amount
resulting from straight-lining rent is determined from the inception of each lease or the date the REIT assumed the lease. Under
previous Canadian GAAP only leases in place from January 1, 2004 were straight-lined.
This adjustment increased accrued rent receivable in the statement of financial position by $22,312 at January 1, 2010 and
$20,333 at December 31, 2010. This adjustment also decreased straight-lining of contractual rent by $1,979 for the year ended
December 31, 2010.
(f)
Convertible debentures
Under IFRS, the REIT has elected to measure the outstanding Convertible Debentures at fair value. At each period end, the fair
value of these Convertible Debentures is measured based on the ask price of each series of Convertible Debentures. The
fluctuation in the fair value between each period, is charged to gain (loss) in changes in fair values in comprehensive income.
Under previous Canadian GAAP, Convertible Debentures were bifurcated into a liability component, net of issue costs, and an
equity component, which represents the holders’ option to convert the Convertible Debentures into Stapled Units. Interest
expense was recorded as a charge to income using an effective rate representing the coupon rate and the effective rate being
credited to the debt component of the Convertible Debentures such that, at maturity, the debt component was equal to the face
value of the then outstanding Convertible Debentures.
22
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
3.
Explanation of transition to IFRS (continued):
This adjustment increased the Convertible Debentures liability in the statement of financial position by $88,897 at January 1,
2010 and $143,488 at December 31, 2010. The effective interest rate accretion of $9,681 for the year ended December 31,
2010 was eliminated. This adjustment also increased the loss on fair value of Convertible Debentures by $56,119 for the year
ended December 31, 2010 and resulted in the expensing of transaction costs on issuance of the 2020 Convertible Debentures
of $4,535 for the year ended December 31, 2010.
(g)
Unit-based compensation
Under IFRS, the REIT is required to measure its cash-settled unit-based option plan at fair value and record a liability. The
fluctuation in the fair value between each period is charged to trust expenses in comprehensive income. Under previous
Canadian GAAP, the REIT expensed and charged to equity the cost of unit-based compensation over the weighted average
vesting period.
This adjustment increased the net liability to unit options payable in the statement of financial position by $2,923 at January 1,
2010 and $3,409 at December 31, 2010. This adjustment also increased trust expenses by $5,657 for the year ended
December 31, 2010.
(h)
Exchangeable units (previously non-controlling interest)
Under IAS 32, the Class B LP units of HRLP are considered puttable instruments and are classified as financial liabilities in the
combined financial statements. At each period end, the fair value of these units is measured based on the ask price of Stapled
Units. The fluctuation in the fair value is charged to comprehensive income and distributions on the Class B LP units of HRLP
are reflected as a component of finance costs in earnings. Under previous Canadian GAAP, non-controlling interest was
presented as a separate item between liabilities and unitholders’ equity in the statement of financial position, and the non-
controlling interests’ share of income and other comprehensive income were deducted in calculating net income and
comprehensive income of the REIT.
Exchangeable units of $75,122 at January 1, 2010 and $77,261 at December 31, 2010 as determined under previous Canadian
GAAP, has been reclassified as a liability. The fair value adjustment increased the exchangeable units liability in the statement
of financial position by $8,888 at January 1, 2010 and $28,391 at December 31, 2010.
The total effect of reclassifying the exchangeable units was $19,503 for the year ended December 31, 2010 as follows:
Finance cost
Loss on change in fair value
Non-controlling interests' share of earnings
Continuing operations
Discontinued operations
23
2010
$
4,282
21,642
(6,272)
(149)
19,503
$
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
3.
(i)
Explanation of transition to IFRS (continued):
Discontinued operations
The definition of discontinued operations under IFRS is more restrictive than under previous Canadian GAAP. Only disposals of
significant operations, such as a major line of business or geographical area of operation, meet the IFRS requirements to
present the results as discontinued operations. Discontinued operations in the financial statements as presented pursuant to
previous Canadian GAAP have been reclassified to continuing operations on the IFRS financial statements as they do not meet
the IFRS definition of discontinued operations. This does not affect unitholders’ equity under IFRS. As at January 1, 2010,
liabilities classified as held for sale of $2,211 was reclassified to accounts payable and accrued liabilities and $4 was reclassified
to bank indebtedness.
The effect of reclassifying discontinued operations on the statement of comprehensive income for the year ended December 31,
2010 is as follows:
Rentals from investment properties
Property operating costs
Amortization and impairment expense
Gain on sale of investment properties
Non-controlling interest from discontinued operations
Net income from discontinued operations
(j)
Net loss on foreign exchange
2010
$
860
(302)
(41)
3,576
(149)
(3,944)
-
$
The foreign exchange gain (loss) recorded in net income as a result of exchanging Finance Trust’s U.S. dollar note receivable
from U.S. Holdco is not eliminated on combination as U.S. Holdco is a U.S. denominated foreign operation of the REIT, which
results in the foreign exchange on the note payable being reported in accumulated other comprehensive income. Under IFRS,
the extension option embedded in the note receivable between the REIT and Finance Trust meets the definition of a loan
commitment and is no longer treated as a derivative. This adjustment increased the net loss on foreign exchange by $53 for the
year ended December 31, 2010 as the translation of such derivative was no longer required.
(k)
Rent amortization of above- and below- market rents
Under previous Canadian GAAP, the purchase price of an acquired property was recorded in several components, including
intangible assets and liabilities for above- and below-market leases. These assets and liabilities were amortized against revenue
over the life of the underlying leases. Under IFRS, these assets and liabilities are amortized and recognized in amortization and
impairment expense. This adjustment increased amortization and impairment expense and increased rental from investment
properties by $679 for year ended December 31, 2010.
24
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
3.
(l)
Explanation of transition to IFRS (continued):
Deferred tax
Under both IFRS and previous Canadian GAAP, deferred income taxes are recorded for the temporary differences arising in
respect of assets and liabilities for the periods when the REIT did not meet the REIT Conditions. This is determined at the tax
rates that are expected to apply to the period when the asset is realized or the liability is settled. Under previous Canadian
GAAP, future distributions were factored into the tax rate applied. Under IFRS, the tax rate applied to determine the deferred
income tax liability on January 1, 2010 and December 31, 2010 was 46.41%, the applicable tax rate excluding future
distributions. The deferred income tax liability was reversed during the quarter ended June 30, 2010 when the REIT met the
REIT Conditions.
This adjustment decreased the deferred tax asset by $5,527 and increased the deferred tax liability by $331,720 in the statement
of financial position at January 1, 2010 and increased accumulated other comprehensive loss by $412 as at January 1, 2010 with
an offsetting adjustment to retained earnings of $336,835. This adjustment also increased the income tax recovery by $336,835
for the year ended December 31, 2010.
(m) Mandatory exception to retrospective application
First-time adopters of IFRS must apply the provisions of IFRS 1. IFRS 1 requires adopters to retrospectively apply all IFRS
standards as of the reporting date with certain optional exemptions and certain mandatory exemptions. In preparing these
combined financial statements in accordance with IFRS 1, the REIT has applied the mandatory exemption from full retrospective
application of IFRS for estimates. The mandatory exemption requires that estimates determined under previous Canadian GAAP
cannot be revised due to the application of IFRS, except when necessary to reflect differences in accounting policies.
4.
Investment properties:
2011
2010
Opening balance, beginning of year
$
4,524,958
$
4,561,817
Acquisitions
Dispositions
Expenditures capitalized to building improvements
Additions to leasing expenses and tenant inducements
Amortization expense
Impairment reversal
Impairment loss
Investment properties legal title transferred to lenders
Change in foreign exchange
Closing balance, end of year
1,443,290
(12,714)
11,259
9,383
(178,745)
2,852
(6,892)
(47,665)
162,917
(17,429)
15,371
11,659
(164,670)
101,165
(14,862)
(82,378)
48,773
5,794,499
$
(48,632)
4,524,958
$
25
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
4.
Investment properties (continued):
December 31, 2011
Land
Building and improvements
Paving and equipment
Intangible assets
Below-market leases
Tenant inducements
Leasing expenses
December 31, 2010
Land
Building and improvements
Paving and equipment
Intangible assets
Below-market leases
Tenant inducements
Leasing expenses
January 1, 2010
Land
Building and improvements
Paving and equipment
Intangible assets
Below-market leases
Tenant inducements
Leasing expenses
Accumulated
depreciation and
Net book
Cost
amortization
value
$
1,044,624
$ -
$
1,044,624
4,284,442
121,422
1,163,894
(119,665)
15,201
31,338
(451,150)
(67,873)
(235,464)
25,408
(5,420)
(12,258)
3,833,292
53,549
928,430
(94,257)
9,781
19,080
$
6,541,256
$
(746,757)
$
5,794,499
Accumulated
depreciation and
amortization
Net book
value
Cost
$
866,393
$ -
$
866,393
3,257,289
120,126
895,084
(76,389)
15,311
25,551
(360,254)
(59,606)
(161,586)
18,731
(4,563)
(11,129)
2,897,035
60,520
733,498
(57,658)
10,748
14,422
$
5,103,365
$
(578,407)
$
4,524,958
Accumulated
depreciation and
amortization
Net book
value
Cost
$
842,618
$ -
$
842,618
3,194,485
128,817
885,805
(74,826)
8,521
22,112
(289,909)
(56,153)
(102,605)
15,224
(3,480)
(8,792)
2,904,576
72,664
783,200
(59,602)
5,041
13,320
$
5,007,532
$
(445,715)
$
4,561,817
26
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
4.
Investment properties (continued):
Legal title to each of the properties in the United States is held by a separate legal entity which is 100% owned, directly or
indirectly, by U.S. Holdco. The assets of each such separate legal entity are not available to satisfy the debts or obligations of
any other person or entity. Each such separate legal entity maintains separate books and records. The identity of the owner of
a particular United States property is available from U.S. Holdco. This structure does not prevent distributions to the entity
owners provided there are no conditions of default.
During the year ended December 31, 2011 the lenders to five U.S. investment properties (December 31, 2010 - five investment
properties) previously occupied by the bankrupt tenants Bruno’s Supermarkets LLC and Boscov’s Department Store (December
31, 2010 - Circuit City and Boscov’s Department Store) accepted title to such respective investment properties, thereby
releasing the REIT from any further obligation with respect to the mortgages on such properties. The REIT recorded a gain on
the extinguishment of this debt of $19,726 for year ended December 31, 2011 (December 31, 2010 - $17,296).
Acquisitions:
During the year ended December 31, 2011, the REIT acquired 11 investment properties (December 31, 2010 - 16 investment
properties). These acquisitions have been recorded by the acquisition method with the results of operations included in these
combined financial statements from the date of acquisition.
The following table summarizes the fair value of the identifiable assets and liabilities as at the respective dates of acquisition:
Assets
Land
Building
Paving and equipment
Intangible assets - in-place lease costs
Intangible assets - above-market leases
Intangible assets - tenant renewal value
Intangible below-market leases
Liabilities
Mortgages payable, net of mark to market adjustments
Total identifiable net assets at fair value settled by cash
2011
2010
$
180,269
$
35,308
1,031,952
100,801
2,782
187,289
33,695
49,720
(42,793)
1,442,914
4,173
16,253
8,485
1,640
(3,743)
162,917
319,753
82,495
$
1,123,161
$
80,422
During the year ended December 31, 2011, the REIT incurred additional costs of $376 in respect to 2010 acquisitions which are
not included in the above table.
Fair value disclosure:
Investment properties are measured at cost less accumulated depreciation and impairment losses. In accordance with IFRS,
the REIT is required to disclose the fair value of the investment properties.
27
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
4.
Investment properties (continued):
The estimated fair values of the REIT’s investment properties (excluding properties under development) are as follows:
December 31, 2011
December 31, 2010
January 1, 2010
Canada
United States
Total
Net Book
Fair Value
Fair Value
Fair Value
Value*
$
5,004,227
$
2,206,770
$
7,210,997
$
5,951,002
4,334,526
4,047,379
1,167,478
1,070,286
5,502,004
5,117,665
4,681,896
4,727,954
* Net book value includes investment properties and accrued rent receivable (including amounts in note 6).
The estimated fair values presented above are based on the following methods and key assumptions:
(i)
Consideration of recent sales of similar properties within similar market areas;
(ii)
The discounted cash flow analysis which is based upon, among other things, rental income from current leases and
assumptions about rental income from future leases reflecting market conditions at each reporting period, less future cash
outflows in respect of such leases discounted generally over a term of ten years;
(iii)
The direct capitalization method which is based on the conversion of current earnings directly into an expression of
market value. The normalized net income for the year is divided by an overall capitalization rate; and
(iv) For the December 31, 2011 fair value assessment, 38.9% (December 31, 2010 - 19.6%, January 1, 2010 - 96.7%) of the
portfolio was valued by professional external independent appraisers. The remainder of the portfolio is valued by the
REIT’s internal valuation team.
The REIT obtained valuations of selected properties prepared by qualified valuation professionals and considered the results
when arriving at its own conclusions on values. The final investment property valuation includes the accrued rent receivable
value of $156,503 (December 31, 2010 - $156,938, January 1, 2010 - $147,524) which is disclosed as a separate line item on
the statement of financial position.
The REIT utilizes capitalization and discount rates within the ranges provided by external industry sources. To the extent that
the externally provided capitalization rate ranges change from one reporting period to the next, the fair value of the investment
properties would increase or decrease accordingly.
28
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
4.
Investment properties (continued):
The REIT has utilized the following weighted average capitalization rates in estimating the fair value of the investment properties
(excluding properties under development):
Overall Capitalization Rate
Discount Rate
Terminal Capitalization Rate
Range
December 31, 2011
5.75%-9.50%
December 31, 2010
6.25% -10.00%
January 1, 2010
6.50% -11.00%
Canada
6.55%
6.98%
7.49%
United
States
6.99%
7.89%
8.60%
Total
Canada
6.68%
7.17%
7.70%
7.42%
7.85%
8.52%
United
States
7.72%
8.45%
8.89%
Total
Canada
7.51%
7.97%
8.59%
6.90%
7.36%
7.82%
United
States
7.33%
8.22%
8.97%
Total
7.03%
7.54%
8.05%
5.
Properties under development:
Project
Address
The Bow (note 28(a))
Heart Lake
Airport Road
5th Ave. at Centre Street, Calgary, AB
Mayfield West Business Park, Caledon, ON
7900 Airport Road, Brampton, ON
December 31
2011
December 31
2010
January 1
2010
$
$
$
1,479,117
87,954
49,986
1,617,057
1,150,094
80,195
38,042
1,268,331
$
$
$
719,173
39,809
35,552
794,534
The estimated fair value of the REIT’s properties under development as at December 31, 2011 is approximately $1,730,000
(December 31, 2010 - $1,449,000, January 1, 2010 - $962,000). The fair value of the Bow was determined by using a 5.50%
capitalization rate on the first full year’s operating income less the cost to complete. Heart Lake and Airport Road were valued at
the estimated market value per acre.
Balance, beginning of year
Acquisitions
Development including capitalized interest
Balance, end of year
2011
2010
$
1,268,331
$
794,534
17,500
331,226
1,617,057
$
-
473,797
1,268,331
$
29
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
6.
Assets classified as held for sale
There are currently no properties held for sale as at December 31, 2011 (December 31, 2010 - nil, January 1, 2010 - one
industrial and one office property).
The following table sets forth the balance sheet items associated with investment properties classified as held for sale:
Assets
Investment properties (net of accumulated depreciation
of $4,378)
Accrued rent receivable
Other assets
Cash and cash equivalents
7.
Other assets:
Current:
Restricted cash*
Accounts receivable
Prepaid expenses and sundry assets
Derivative instruments (note 13)
Deferred income tax asset (note 27)
December 31
December 31
January 1
2011
2010
2010
$ -
$ -
$
18,425
-
-
-
-
188
141
-
$ -
-
$ -
281
19,035
$
December 31
December 31
January 1
2011
2010
2010
$
22,110
$
22,802
$
23,695
12,711
12,959
1,273
7,420
6,932
1,225
6,543
12,811
3,463
-
49,053
$
-
38,379
$
8,789
55,301
$
*
Included in restricted cash are bank term deposits of $8,395 (December 31, 2010 - $3,696, January 1, 2010 - $3,694) at rates of interest varying
between 0.90% to 1.03% (December 31, 2010 - 1.00%, January 1, 2010 - 0.26%).
8.
Cash and cash equivalents:
Cash and cash equivalents at December 31, 2011 includes cash on hand of $13,358 (December 31, 2010 - $6,785, January 1,
2010 - $9,281) and bank term deposits of $251 (December 31, 2010 - $249, January 1, 2010 - $96,249) at a rate of interest of
0.75% (December 31, 2010 - 0.93%, January 1, 2010 - 0.11% to 0.20%).
30
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
9.
Mortgages payable:
The mortgages payable are secured by investment properties and letters of credit in certain cases, bearing fixed interest with a
contractual weighted average rate of 5.89% (December 31, 2010 - 6.20%, January 1, 2010 - 6.20%) per annum and maturing
between 2012 and 2035. Included in mortgages payable at December 31, 2011 are U.S. dollar denominated mortgages of U.S.
$1,125,656 (December 31, 2010 - U.S. $824,066, January 1, 2010 - U.S. $826,906). The Canadian equivalents of these
amounts are $1,148,169 (December 31, 2010 - $815,826, January 1, 2010 - $868,252).
Debt related to certain Canadian properties is held by separate legal entities, where the rent received from each property is first
used to satisfy the related debt obligations with any balance then available to satisfy the cash flow requirements of the REIT.
Future principal mortgage payments are as follows:
Years ending December 31:
2012
2013
2014
2015
2016
Thereafter
Mortgages payable due on demand (net of financing cost of $152)*
Financing costs and mark-to-market adjustment arising on acquisitions
$
379,068
218,224
296,030
349,138
401,870
1,493,401
3,137,731
20,675
5,187
$
3,163,593
* Relates to two non-recourse mortgages to the REIT for investment properties in which the tenant Great Atlantic and Pacific Tea Company (“A&P”),
has filed for protection under Chapter 11 of the United States Bankruptcy Code. The REIT expects to be released from any further obligations
under these non-recourse mortgages upon the transfer of title to the lenders.
31
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
10. Debentures payable:
The full terms of the debentures are contained in the public offering documents and the following table summarizes the key terms:
December 31 December 31 January 1
2011
2010
2010
Contractual
Effective
interest
interest
Conversion
Maturity
rate
rate
price
Face
value
Carrying
Carrying
Carrying
value
value
value
Convertible Debentures (a)
2013 Convertible Debentures (HR.DB)
June 30, 2013
2014 Convertible Debentures (HR.DB.B)
December 31, 2014
2017 Convertible Debentures (HR.DB.C)
2020 Convertible Debentures (HR.DB.D)
June 30, 2017
June 30, 2020
2016 Convertible Debentures (HR.DB.E)
December 31, 2016
Senior Debentures (b)
Series A Senior Debentures
Series B Senior Debentures
Series C Senior Debentures
Series D Senior Debentures
Series E Senior Debentures
February 3, 2015
February 3, 2017
December 1, 2018
July 27, 2016
February 2, 2018
6.65%
6.75%
6.00%
5.90%
4.50%
5.20%
5.90%
5.00%
4.78%
4.90%
6.65%
$
23.11
$114,900
$126,218
$121,325 $117,875
6.75%
6.00%
5.90%
4.50%
14.00
19.00
23.50
25.70
5.40% -
6.06% -
5.30% -
4.96% -
5.22% -
127,935
169,871
99,990
75,000
587,696
115,000
115,000
125,000
180,000
100,000
635,000
214,393
210,640
112,989
78,000
742,240
114,346
114,204
122,860
178,718
98,549
628,677
203,038
173,100
188,125
174,913
102,500
-
-
-
614,988
465,888
114,154
114,073
122,613
-
-
350,840
-
-
-
-
-
-
Non-Convertible Debentures (c)
-
11.50% 12.90% -
-
-
-
188,767
$1,222,696
$1,370,917
$965,828 $654,655
The carrying value of the Convertible Debentures is determined using the ask price on December 31, 2011, December 31, 2010 and
January 1, 2010.
(a)
2013 Convertible Debentures, 2014 Convertible Debentures, 2017 Convertible Debentures, 2020 Convertible Debenture and, 2016
Convertible Debentures (collectively, the “Convertible Debentures”):
In June 2008, the REIT completed a public offering of $115,000 convertible unsecured subordinated debentures (the “2013
Convertible Debentures”). The 2013 Convertible Debentures could not be redeemed by the REIT on or before June 30, 2011.
Thereafter, but prior to June 30, 2012, the 2013 Convertible Debentures may be redeemed, in whole or in part, only if the current
market price of a Stapled Unit is at least 125% of the conversion price. On or after June 30, 2012 and prior to the maturity date, the
2013 Convertible Debentures may be redeemed by the REIT, in whole or in part, at a price equal to the principal amount plus
accrued interest.
32
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
10.
Debentures payable (continued):
In July 2009, the REIT completed a public offering of $150,000 Series B convertible unsecured subordinated debentures (the
“2014 Convertible Debentures”). The 2014 Convertible Debentures may not be redeemed by the REIT on or before July 30,
2012. Thereafter, but prior to July 30, 2013, the 2014 Convertible Debentures may be redeemed, in whole or in part, only if the
current market price of a Stapled Unit is at least 125% of the conversion price. On or after July 30, 2013 and prior to the maturity
date, the 2014 Convertible Debentures may be redeemed by the REIT, in whole or in part, at a price equal to the principal
amount plus accrued interest.
In December 2009, the REIT completed a public offering of $175,000 Series C convertible unsecured subordinated debentures
(the “2017 Convertible Debentures”). The 2017 Convertible Debentures may not be redeemed by the REIT on or before June
30, 2013. Thereafter, but prior to June 30, 2015, the 2017 Convertible Debentures may be redeemed, in whole or in part, only if
the current market price of a Stapled Unit is at least 125% of the conversion price. On or after June 30, 2015 and prior to the
maturity date, the 2017 Convertible Debentures may be redeemed by the REIT, in whole or in part, at a price equal to the
principal amount plus accrued interest.
In July 2010, the REIT completed a public offering of $100,000 Series D convertible unsecured subordinated debentures (the
“2020 Convertible Debentures”). The 2020 Convertible Debentures may not be redeemed by the REIT on or before June 30,
2014. Thereafter, but prior to June 30, 2016, the 2020 Convertible Debentures may be redeemed, in whole or in part, only if the
current market price of a Stapled Unit is at least 125% of the conversion price. On or after June 30, 2016 and prior to the
maturity date, the 2020 Convertible Debentures may be redeemed by the REIT, in whole or in part, at a price equal to the
principal amount plus accrued interest.
In November 2011, the REIT completed a public offering of $75,000 Series E convertible unsecured subordinated debentures
(the “2016 Convertible Debentures”). The 2016 Convertible Debentures may not be redeemed by the REIT on or before
November 30, 2014. Thereafter, but prior to November 30, 2015, the 2016 Convertible Debentures may be redeemed, in whole
or in part, only if the current market price of a Stapled Unit is at least 125% of the conversion price. On or after November 30,
2015 and prior to the maturity date, the 2016 Convertible Debentures may be redeemed by the REIT, in whole or in part, at a
price equal to the principal amount plus accrued interest.
Each Convertible Debenture is convertible into freely tradeable Stapled Units at the holder’s option at (i) any time prior to the
maturity date and (ii) the business day immediately preceding the date specified by the REIT for redemption of the Convertible
Debentures, at a specified conversion price, subject to adjustment upon the occurrence of certain events in accordance with the
indenture governing the Convertible Debentures.
On redemption or maturity of the Convertible Debentures, the REIT may, at its option and subject to certain conditions, elect to
satisfy its obligation to repay all or any portion of the principal amount of the Convertible Debentures that are to be redeemed or
that are to mature through the issuance of Stapled Units by way of issuing (or causing it to be issued) a variable number of
Stapled Units equal to the principal amount of the Convertible Debentures that are to be redeemed or that are to mature divided
by 95% of the then fair market value of the Stapled Units.
Interest on the Convertible Debentures is payable semi-annually on June 30 and December 31.
33
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
10.
Debentures payable (continued):
(b)
Series A Senior Debentures, Series B Senior Debentures, Series C Senior Debentures, Series D Debentures and Series E
Senior Debentures (collectively, the “Senior Debentures”):
In February 2010, the REIT issued $115,000 Series A unsecured senior debentures (the “Series A Senior Debentures”). The
interest on the Series A Senior Debentures is payable semi-annually on February 3 and August 3. On issuance, the REIT
recorded a liability of $113,981, net of issue costs of $1,019.
In February 2010, the REIT issued $115,000 Series B unsecured senior debentures (the “Series B Senior Debentures”). The
interest on the Series B Senior Debentures is payable semi-annually on February 3 and August 3. On issuance, the REIT
recorded a liability of $113,953, net of issue costs of $1,047.
In September 2010, the REIT issued $125,000 Series C unsecured senior debentures (the “Series C Senior Debentures”). The
interest on the Series C Senior Debentures is payable semi-annually on June 1 and December 1. On issuance, the REIT
recorded a liability of $122,525, net of issue costs of $2,475.
In January 2011, the REIT issued $180,000 Series D unsecured senior debentures (the “Series D Senior Debentures”). The
interest on the Series D Senior Debentures is payable semi-annually on January 27 and July 27. On issuance, the REIT
recorded a liability of $178,475, net of issue costs of $1,525.
In October 2011, the REIT issued $100,000 Series E unsecured senior debentures (the “Series E Senior Debentures”). The
interest on the Series E Senior Debentures is payable semi-annually on February 2 and August 2. On issuance, the REIT
recorded a liability of $98,510, net of issue costs of $1,490.
Interest expense is recorded as a charge to income and is calculated at an effective interest rate with the difference between the
coupon rate and the effective rate being credited to the carrying value such that, at maturity, the carrying value is equal to the
face value of the then outstanding Senior Debentures.
At its option, the REIT may redeem any of the Senior Debentures, in whole at any time, or in part from time to time, prior to
maturity on payment of a redemption price equal to the greater of (i) the Canada Yield Price as defined in the relevant
supplemental trust indenture and (ii) par, together in each case with accrued and unpaid interest to the date fixed for redemption.
The REIT will give notice of any redemption at least 30 days but not more than 60 days before the date fixed for redemption.
Where less than all of any Senior Debentures are to be redeemed pursuant to their terms, the Senior Debentures to be so
redeemed will be redeemed on a pro rata basis according to the principal amount of Senior Debentures registered in the
respective name of each holder of Senior Debentures or in such other manner as the indenture trustee may consider equitable.
The Senior Debentures are rated BBB (with a Stable trend) by DBRS Limited.
34
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
10.
Debentures payable (continued):
(c)
Non-Convertible Debentures:
In April 2009, the REIT issued $200,000 of unsecured debentures (the “Non-Convertible Debentures”). In February 2010, the
REIT repaid the outstanding Non-Convertible Debentures for a total repurchase price of $229,989. The repurchase price
included accrued interest of $2,237. The REIT recognized a one-time non-recurring charge to the combined statement of
comprehensive income of $38,834, representing the difference between the repurchase price, excluding accrued interest
expense, and the carrying value of the Non-Convertible Debentures of $188,918.
A summary of the carrying value of debentures payable is as follows:
December 31
December 31
2011
2010
$
614,988
$
465,888
-
100,000
75,000
(103)
(26,436)
(5,869)
(10)
84,670
742,240
-
-
(7,019)
-
-
56,119
614,988
350,840
-
-
350,459
276,985
852
628,677
-
-
-
-
-
381
350,840
188,767
151
(188,918)
-
$
1,370,917
$
965,828
Convertible Debentures (note 10(a))
Carrying value, beginning of year
Issued - 2020 Convertible Debentures
Issued - 2016 Convertible Debentures
Conversion - 2013 Convertible Debentures*
Conversion - 2014 Convertible Debentures*
Conversion - 2017 Convertible Debentures*
Conversion - 2020 Convertible Debentures*
Loss on fair value (note 19)
Carrying value, end of year
Senior Debentures (note 10(b))
Carrying value, beginning of year
Issued - Series A, B and C Senior Debentures
Issued - Series D and E Senior Debentures
Accretion adjustment
Carrying value, end of year
Non-Convertible Debentures (note 10(c))
Carrying value, beginning of year
Accretion adjustment
Redemption
Carrying value, end of year
*
The conversion amounts above equals $32,418 (2010 - $7,019).
35
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
11.
Exchangeable units:
Exchangeable units represents the Class B LP units of HRLP issued to participating vendors in exchange for properties acquired
by HRLP. The accounts of HRLP are consolidated into the REIT, and thus included in the combined financial statements. The
Class B LP units are puttable instruments where the REIT has a contractual obligation to issue Stapled Units to participating
vendors upon redemption. These puttable instruments are classified as a liability under IFRS and are measured at fair value
through net income (loss). Fair value is determined by using the ask prices for the listed Stapled Units as all of the 5,437,565
Class B LP units of HRLP are exchangeable on a one-for-one basis, at the option of the holder, into Stapled Units. The ask
price as at December 31, 2011 was $23.30 (December 31, 2010 - $19.43, January 1, 2010 - $15.45).
Holders of the Class B LP units of HRLP are entitled to receive distributions on a per unit amount equal to a per Stapled Unit
amount provided to holders of Stapled Units. Under IFRS, these distributions are considered interest expense and are included
in finance costs in the statement of comprehensive income (loss).
As a result of a reorganization in 2009, HRLP, the REIT, Finance Trust and H&R Portfolio LP Trust (a subsidiary of the REIT)
entered into an exchange and support agreement that provides, among other things, for (i) certain capital contributions to be
made by the REIT in case HRLP has insufficient (a) funds to pay the required distributions on the Class B LP units of HRLP, or
(b) U.S. Holdco Notes to pay the fair market value of the Finance Trust units required to be delivered upon exchange of any
Class B LP unit; and (ii) the mechanics whereby Class B LP units may be exchanged for Stapled Units.
12.
Unitholders’ equity:
The REIT is an unincorporated open-ended trust. The beneficial interests in the REIT are represented by a single class of units
which are unlimited in number. Each unit carries a single vote at any meeting of unitholders and carries the right to participate
pro rata in any distributions.
Finance Trust is an unincorporated investment trust. The beneficial interests in Finance Trust are represented by a single class
of units which are unlimited in number. Each unit carries a single vote at any meeting of unitholders and carries the right to
participate pro rata in any distributions.
The units of the REIT are stapled with the units of Finance Trust effective October 1, 2008. These Stapled Units are listed and
posted for trading on the TSX. The Trusts have entered into a support agreement (“Support Agreement”) to coordinate the
issuance of Stapled Units under various arrangements (note 12(c)).
The units of the Trusts are freely transferable and, other than as disclosed herein, the trustees of the Trusts shall not impose any
restriction on the transfer of units. Provided that an event of uncoupling (“Event of Uncoupling”) has not occurred: (a) each
REIT unit may be transferred only together with a unit of Finance Trust; (b) no unit may be issued by the REIT to any person
unless: (i) a unit of Finance Trust is simultaneously issued to such person, or (ii) the REIT has arranged that units will be
consolidated (subject to any applicable regulatory approval) immediately after such issuance, such that each holder of a REIT
unit will hold an equal number of Finance Trust units and units of the REIT immediately following such consolidation; and (c) a
unitholder may require the REIT to redeem any particular number of units only if it also requires, at the same time, and in
accordance with the provisions of the Finance Trust Declaration of Trust, Finance Trust to redeem that same number of units of
Finance Trust. Equivalent provisions apply with respect to the transfer, issuance, consolidation and redemption of Finance Trust
units.
36
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
12.
Unitholders’ equity (continued):
An Event of Uncoupling shall occur only: (a) in the event that unitholders of the REIT vote in favour of the uncoupling of units of
Finance Trust and units of the REIT such that the two securities will trade separately; or (b) at the sole discretion of the trustees
of Finance Trust, but only in the event of the bankruptcy, insolvency, winding-up or reorganization (under an applicable law
relating to insolvency) of the REIT or U.S. Holdco or the taking of corporate action by the REIT or U.S. Holdco in furtherance of
any such action or the admitting in writing by the REIT or U.S. Holdco of its inability to pay its debts generally as they become
due. The trustees of the Trusts shall use all reasonable efforts to obtain and maintain a listing for the units of the REIT and,
unless an Event of Uncoupling has occurred, the Stapled Units, on one or more stock exchanges in Canada.
The unitholders have the right to require the Trusts to redeem their units on demand. Provided that no Event of Uncoupling has
occurred, unitholders who tender their units of one of the Trusts for redemption will also be required to tender for redemption
corresponding units of the other Trust in accordance with the provisions of the respective Declarations of Trust. Upon the tender
of their units for redemption, all of the unitholder’s rights to and under such units are surrendered and the unitholder is entitled to
receive a price per unit as determined by the applicable Declaration of Trust.
Upon valid tender for redemption of each unit of the REIT, the unitholder is entitled to receive a price per unit of the REIT as
determined by a formula based on the market price of Stapled Units less an amount based on the principal amount of U.S.
Holdco Notes owing per outstanding unit of Finance Trust. The redemption price payable by the REIT will be satisfied by way of
a cash payment to the unitholder or, in certain circumstances, including where such payment would cause the REIT’s monthly
cash redemption obligations to exceed $50 (subject to adjustment in certain circumstances or waiver by the trustees) an in
specie distribution of notes of H&R Portfolio LP Trust (a subsidiary of the REIT).
Upon valid tender for redemption of each unit of Finance Trust, the unitholder is entitled to receive, except as provided below, a
price per unit payable in cash equal to the Canadian dollar equivalent of the outstanding principal amount of the U.S. Holdco
Notes as of the redemption date, divided by the total number of Finance Trust units issued and outstanding immediately prior to
the redemption date. In certain circumstances, including where such payment would cause Finance Trust's monthly cash
redemption obligations to exceed $50 (subject to adjustment in certain circumstances or waiver by the trustees) the redemption
price per Finance Trust unit being redeemed, to which a redeeming unitholder is entitled shall be the fair market value of the
Finance Trust units being redeemed, as determined by the trustees, which shall be payable by way of delivery of U.S. Holdco
Notes.
37
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
12.
Unitholders’ equity (continued):
The following number of Stapled Units are issued and outstanding:
As at January 1, 2010
Issued under the Distribution Reinvestment Plan and Unit Purchase Plan (the "DRIP")
2014 Convertible Debentures converted into units
Options exercised
As at December 31, 2010
Issued under the DRIP
Issued on May 31, 2011 (at a price of $22.15 per unit)
Issued on November 22, 2011 (at a price of $22.00 per unit)
Issued on December 22, 2011 (at a price of $23.30 per unit)
2013 Convertible Debentures converted into units
2014 Convertible Debentures converted into units
2017 Convertible Debentures converted into units
2020 Convertible Debentures converted into units
Options exercised
As at December 31, 2011
143,825,262
814,074
355,205
1,126,101
146,120,642
1,726,620
9,030,000
8,500,000
5,370,000
4,327
1,220,874
269,940
425
311,169
172,553,997
The weighted average number of basic Stapled Units for the year ended December 31, 2011 is 154,168,966 (December 31,
2010 – 144,348,657).
(a)
Unit option plan:
As at December 31, 2011, a maximum of 18,000,000 (December 31, 2010 - 8,800,000) Stapled Units were authorized to be
issued to the REIT's officers, employees, consultants and certain trustees, of which 8,700,000 options (December 31, 2010 -
7,600,000 options) have been granted. The exercise price of each option approximated the market price of the Stapled Units on
the date of grant and shall be increased by the amount, if any, by which the fair market value of one Finance Trust unit at the
time of exercise of such option, exceeds the fair market value of one Finance Trust unit at the time of grant of such option. The
options vest at 33.3% per year from the grant date, will be fully vested after three years, and expire ten years after the date of
the grant.
During the year ended December 31, 2011, 1,100,000 options were granted (December 31, 2010 – 600,000).
38
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
12.
Unitholders’ equity (continued):
As described in note 2(j), under IFRS the unit option plan is considered a cash-settled plan with the value of the units recorded
as a liability on the combined statement of financial position. The liability is released to equity when the unit options are
converted to REIT units. The liability is revalued each reporting date based on the trading value of the Stapled Units. The fair
value of the unit options is measured using the Black-Scholes model. Measurement inputs include unit price on measurement
date, exercise price of the instrument, expected volatility (based on weighted average historic volatility adjusted for changes
expected due to publicly available information), weighted average expected life of the instruments (based on historical
experience and general option holder behaviour), expected distributions, and the risk-free interest rate (based on government
bonds). Service and non-market performance conditions attached to the transactions are not taken into account in determining
fair value. The fair value of the vested unit options as at December 31, 2011 is $8,640 (December 31, 2010 - $3,409 and
January 1, 2010 - $2,923).
Unit-based compensation expense of $7,600 for the year ended December 31, 2011 (December 31, 2010 - $6,882) was
included in trust expenses in the statement of comprehensive income (loss).
A summary of the status of the unit option plan and the changes during the respective periods are as follows:
Outstanding, beginning of year
Granted
Exercised
Expired
Outstanding, end of period
2011
Weighted
average
exercise
price
Units
2010
Weighted
average
exercise
price
Units
1,560,333
$
13.95
2,086,434
$
13.05
1,100,000
(311,168)
(66,665)
2,282,500
20.20
12.74
600,000
(1,126,101)
15.42
13.06
14.18
17.12
$
-
1,560,333
-
13.95
$
Options exercisable, end of period
657,501
$
14.95
410,333
$
15.00
The options outstanding at December 31, 2011 are exercisable at varying prices ranging from $9.30 to $20.83 (December 31,
2010 - $9.30 to $16.56) with a weighted average remaining life of 8.3 years (December 31, 2010 - 8.4 years). The vested
options are exercisable at varying prices ranging from $9.30 to $16.56 (December 31, 2010 - $9.30 to $16.56) with a weighted
average remaining life of 7.1 years (December 31, 2010 - 7.7 years).
(b)
Distributions
Under the REIT’s Declaration of Trust, the total amount of income of the REIT to be distributed to unitholders for each calendar
month shall be subject to the discretion of the trustees. The present intention of the trustees is to distribute and make payable
to the unitholders all of the amount necessary to ensure that the REIT will not be liable to pay income tax under Part I of the
Income Tax Act (Canada) for any year. For the year ended December 31, 2011 the REIT declared per unit distributions of
$0.88 (December 31, 2010 - $0.68).
39
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
12.
Unitholders’ equity (continued):
Pursuant to Finance Trust’s Declaration of Trust, unitholders of Finance Trust are entitled to receive all of the Distributable Cash
of Finance Trust, as defined in the Declaration of Trust. Distributable Cash means, subject to certain exceptions, all amounts
received by Finance Trust less certain costs, expenses or other amounts payable by Finance Trust, and less any amounts
which, in the opinion of the trustees, may reasonably be considered to be necessary to provide for the payment of any costs or
expenditures that have been or will be incurred in the activities and operations of Finance Trust and to provide for payment of
any tax liability of Finance Trust. Finance Trust paid per unit distributions of $0.10 for the year ended December 31, 2011 (2010
- $0.11).
The details of the distributions are as follows:
Cash distributions to unitholders
Unit distributions (issued under the DRIP)
(c)
Support agreement:
2011
2010
$
$
114,112
36,139
150,251
99,426
14,270
113,696
$
$
Pursuant to provisions of the Declarations of Trust for Finance Trust and the REIT, at all times, each REIT unit must be stapled
to a Finance Trust unit (and each Finance Trust unit must be stapled to a REIT unit) unless there is an Event of Uncoupling. As
part of the Plan of Arrangement, the REIT and Finance Trust entered into the Support Agreement which provided, among other
things, for the co-ordination of the declaration and payment of all distributions so as to provide for simultaneous record dates and
payment dates; for co-ordination so as to permit the REIT to perform its obligations pursuant to the REIT’s Declaration of Trust,
Unit Option Plan, DRIP and Unitholder Rights Plan; for Finance Trust to take all such actions and do all such things as are
necessary or desirable to enable and permit the REIT to perform its obligations arising under any security issued by the REIT
(including securities convertible, exercisable or exchangeable into Stapled Units); for Finance Trust to take all such actions and
do all such things as are necessary or desirable to enable the REIT to perform its obligations or exercise its rights under its
convertible debentures; and for Finance Trust to take all such actions and do all such things as are necessary or desirable to
issue Finance Trust units simultaneously (or as close to simultaneously as possible) with the issue of REIT units and to
otherwise ensure at all times that each holder of a particular number of REIT units holds an equal number of Finance Trust units,
including participating in and cooperating with any public or private distribution of Stapled Units by, among other things, signing
prospectuses or other offering documents.
In the event that the REIT issues additional REIT units, pursuant to the Support Agreement, the REIT and Finance Trust will co-
ordinate so as to ensure that each subscriber receives both REIT units and Finance Trust units, which shall trade together as
Stapled Units. Prior to such event, the REIT shall provide notice to Finance Trust to cause Finance Trust to issue and deliver the
requisite number of Finance Trust units to be received by and issued to, or to the order of, each subscriber as the REIT directs.
In consideration of the issuance and delivery of each such Finance Trust unit, the REIT (on behalf of the purchaser) or the
purchaser, as the case may be, shall pay (or arrange for the payment of) a purchase price equal to the fair market value (as
determined by Finance Trust in consultation with the REIT) of each such Finance Trust unit at the time of such issuance. The
remainder of the subscription price for Stapled Units shall be allocated to the issuance of REIT units by the REIT.
40
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
12.
Unitholders’ equity (continued):
(d)
Short form base shelf prospectus:
On March 31, 2011, the Trusts issued a short form base shelf prospectus allowing the Trusts to offer Stapled Units and the
REIT to offer and issue the following securities: (i) preferred units; (ii) unsecured debt securities; (iii) subscription receipts
exchangeable for Stapled Units and/or other securities of the REIT; (iv) warrants exercisable to acquire Stapled Units and/or
other securities of the REIT; and (v) securities comprised of more than one of Stapled Units, debt securities, subscription
receipts and/or warrants offered together as a unit, or any combination thereof having an offer price of up to $2,000,000 in
aggregate (or the equivalent thereof, at the date of issue, in any other currency or currencies, as the case may be) at any time
during the 25-month period that the short form base shelf prospectus (including any amendments) remains valid. As at
December 31, 2011, $512,136 Stapled Units, $100,000 Senior unsecured debentures of the REIT and $75,000 convertible
unsecured subordinated debentures of the REIT have been issued under the short form base shelf prospectus.
13.
Derivative instruments
Fair value (liability) asset **
Unrealized gain (loss) on
derivative contracts *
December 31 December 31
2010
2011
January 1
2010
December 31 December 31
2010
2011
Foreign exchange forward contracts
Foreign exchange swap
Foreign exchange swap
Interest rate swap - the Bow Facility
Mortgage interest rate swap
(a)
(a)
(a)
(b)
(c)
$
$
$
$
$
(730)
1,273
(1,106)
(3,520)
(716)
(4,799)
1,225
-
-
(2,897)
(420)
(2,092)
-
-
-
3,463
-
3,463
(1,933)
1,273
(1,106)
(623)
(276)
(2,665)
1,274
-
-
(6,360)
(435)
(5,521)
$
$
$
$
$
a) The REIT entered into foreign exchange forward contracts and swaps with Canadian chartered banks effectively locking the REIT’s rate to
exchange U.S. dollars into Canadian dollars.
b) The REIT entered into an interest rate swap that is intended to limit its interest rate exposure during the term of the Bow Facility (note 14(b)). As at
December 31, 2011, the expected annual effective interest rate for the Bow Facility, including the cost of the swap, is 4.65% (December 31, 2010 -
4.65%).
c) The REIT entered into an interest rate swap on one U.S. mortgage. The expected annual effective interest rate for this mortgage is 5.25%.
*
Excludes amounts relating to foreign exchange which have been recorded in accumulated other comprehensive income (loss) note (16).
** Derivative instruments in asset and liability positions are not presented on a net basis. When a derivative instrument is in an asset position, the
amount is recorded in other assets (note 7).
41
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
14.
Bank indebtedness:
The REIT has the following facilities:
(a) A general operating facility which is secured by fixed charges over certain investment properties due on December 31,
2013. The total facility as at December 31, 2011 is $300,000 (December 31, 2010 - $295,300, January 1, 2010 - $284,650)
and can be drawn in either Canadian or U.S. dollars (to a maximum of $150,000 U.S. dollars for U.S. borrowings). The
amount available at December 31, 2011, after taking into account the bank indebtedness drawn of $207,173 (December
31, 2010 - $62,603, January 1, 2010 - $13,560) and the outstanding letters of credit and other items, is $63,027 (December
31, 2010 - $188,148, January 1, 2010 - $236,716). The Canadian dollar bank indebtedness bears interest at rates
approximating the prime rate of a Canadian chartered bank. At December 31, 2011, the Canadian prime interest rate was
3.00% (December 31, 2010 - 3.00%, January 1, 2010 - 2.25%) per annum.
Included in bank indebtedness at December 31, 2011 are U.S. dollar denominated amounts of $144,825 (December 31,
2010 - U.S. $101, January 1, 2010 - U.S. $33). The Canadian equivalents of these amounts are $147,722 (December 31,
2010 - $100, January 1, 2010 - $35).
(b) A general operating facility which is secured by The Bow (“the Bow Facility”) due on November 21, 2013. The total facility
as at December 31, 2011 is $400,000 (December 31, 2010 - $425,000, January 1, 2010 - $425,000) and can be drawn in
either Canadian or U.S. dollars (to a maximum of $150,000 U.S. dollars). As at December 31, 2011, the REIT has drawn
$233,000 (December 31, 2010 - $26,442, January 1, 2010 - $nil) under the Bow Facility and the amount available at
December 31, 2011 is $167,000 (December 31, 2010 - $398,558, January 1, 2010 - $425,000).
Included in bank indebtedness at December 31, 2011 are U.S. dollar denominated amounts of $150,000 (December 31,
2010 - U.S. $nil, January 1, 2010 - U.S. $nil). The Canadian equivalents of these amounts are $153,000 (December 31,
2010 - $nil, January 1, 2010 - $nil).
15.
Accounts payable and accrued liabilities:
Current:
Accounts payable for properties under development
Other accounts payable and accrued liabilities
Debenture interest payable
Prepaid rent
Mortgage interest payable
Non-current:
Security deposits
December 31
December 31
January 1
2011
2010
2010
$
54,332
$
66,890
$
74,455
53,441
27,164
24,356
13,188
50,762
5,969
24,495
19,272
42,272
264
25,842
23,386
3,368
175,849
$
3,156
170,544
$
2,967
169,186
$
42
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
16.
Accumulated other comprehensive income (loss):
Balance as at January 1, 2010
Transfer of realized loss on cash flow hedges to net income
Deferred income tax
Unrealized loss on translation of U.S. denominated foreign operation
Balance as at December 31, 2010
Transfer of realized loss on cash flow hedges to net income
Unrealized gain on translation of U.S. denominated foreign operation
Balance as at December 31, 2011
17.
Rentals from investment properties:
Rentals from investment properties
Straight-lining of contractual rent
Rent amortization of tenant inducements
Operating Leases:
Cash flow
hedges
Foreign
operations
Total
$
(3,254)
$ -
$
(3,254)
372
915
-
(1,967)
385
-
-
(7,449)
(7,449)
372
915
(7,449)
(9,416)
-
385
-
(1,582)
$
2,211
(5,238)
$
2,211
(6,820)
$
2011
2010
$
658,227
(288)
(1,028)
656,911
$
$
609,445
8,920
(938)
617,427
$
The REIT leases out its investment properties held under operating leases (note 4). The future minimum lease payments under
non-cancellable leases are as follows:
December 31
2011
December 31
2010
January 1
2010
$
$
$
505,100
2,129,411
5,187,791
7,822,302
401,428
1,795,801
4,738,906
6,936,135
387,812
1,691,840
4,878,173
6,957,825
$
$
$
Less than 1 year
Between 1 and 5 years
More than 5 years
43
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
18.
Finance cost - operations:
Contractual interest on mortgages payable
Contractual interest on debentures payable
Interest on construction loans
Effective interest rate accretion
Bank interest and charges
Exchangeable unit distributions
Capitalized interest*
2011
2010
$
171,193
$
170,293
61,262
7,235
908
4,389
5,302
46,400
7,369
1,772
3,573
4,282
250,289
233,689
(69,277)
181,012
$
(59,569)
174,120
$
* The capitalized interest is determined using the REIT’s weighted average rate of borrowing on all financial liabilities of 6.10% (2010 - 6.58%).
19.
Loss on change in fair value:
Loss on fair value of convertible debentures (note 10)
Loss on fair value of exchangeable units (note 11)
Unrealized net loss on derivative instruments (note 13)
20.
Amortization and impairment:
Depreciation of investment properties
Amortization of intangible assets on acquisitions
Amortization of above- and below- market rents
Amortization of leasing expenses
Impairment loss on investment properties
Impairment reversal on investment properties
2011
2010
$
(84,670)
(21,043)
(2,665)
(108,378)
$
$
(56,119)
(21,642)
(5,521)
(83,282)
$
2011
2010
$
107,240
$
98,943
46,398
19,634
4,445
40,052
21,052
3,685
6,892
(2,852)
181,757
$
14,862
(101,165)
77,429
$
44
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
20.
Amortization and impairment (continued):
During the year ended December 31, 2011, the REIT recorded an impairment loss of $6,892 on four Canadian investment
properties and two U.S. investment properties. This impairment loss was recorded as the carrying value of the investment
properties was determined to exceed the recoverable value of the property based on the value in use. The events leading to the
impairments recorded resulted from the early termination of tenant leases or the bankruptcy of tenants. As a result of these
events, the REIT determined that the market rental rates for these properties were unfavourable compared to the current cash
flow stream.
The REIT recorded a reversal of previously recorded impairment losses of $2,852 relating to two investment properties during
the year ended December 31, 2011. IFRS allows for a reversal of a previously recorded impairment loss if there is a change in
the estimated cash flows or discount rate used to determine the recoverable amount of the asset. As there were changes in the
market conditions driving the estimated cash flows used to determine the previous impairment amount, a reversal of the
impairment loss was recorded. The change in the estimated cash flows was the result of the following:
• The REIT expected a tenant at one of their Canadian properties to vacate the property following the expiry of their lease, and
estimated that the market rent the REIT would be able to re-lease the property for would be unfavourable compared to the
existing tenant’s rent. A lease extension was renegotiated for a market rent greater than the previous estimated amount.
• The strengthening of demand for one of the REIT’s supermarket anchored properties has resulted in a favourable adjustment
to market rents and discount rates driving the estimated cash flows.
During the year ended December 31, 2010, the REIT recorded an impairment charge of $14,862 on two of its U.S. investment
properties. The tenants at these properties declared bankruptcy during the year, and the REIT determined that they would satisfy
their mortgage obligations by transferring the title of the properties to the lender. The impairment loss represents the fair value of
the income properties less the costs to sell.
During the year ended December 31, 2010, the REIT recorded the reversal of $101,165 in previously recorded impairment
losses on 63 properties (31 properties in the U.S. and 32 in Canada).
These reversals of previously recorded impairment losses were triggered by the significant improvement of the real estate market
during 2010. The economic downturn in 2008 and 2009 had decreased the market value of a number of the REIT’s investment
properties due to weak demand. During 2010, the economy began to rebound and the REIT’s investment properties increased
in value. This change in economic conditions increased the market rent and adjusted discount rates favourably for many of the
REIT’s previously impaired properties.
Management used the metrics disclosed in note 4 as a basis for the calculation of the fair value of the income properties less the
costs to sell and the value in use of such properties that were found to be impaired during 2011 and 2010, as well as the
properties where the previously recorded impairment loss was reversed during 2011 and 2010.
45
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
21.
Supplemental cash flow information:
The change in other non-cash operating items are as follows:
Accrued rent receivable
Prepaid expenses and sundry assets
Accounts receivable
Accounts payable and accrued liabilities
2011
2010
$
267
$
(9,285)
(6,027)
(5,291)
(12,343)
5,984
(841)
16
$
(23,394)
$
(4,126)
The following non-cash amounts have been excluded from operating, financing and investing activities in the combined
statements of cash flows:
Acquisition of investment properties through assumption of
mortgages payable, net of mark-to-market adjustments
Acquisition of property under development through assumption of mortgage payable
Release of mortgage obligations upon lenders' consent
Release of mortgage interest obligation included in accounts payable and accrued liabilities
Non-cash release of mortgage payable on disposition of investment property
Non-cash transfer of investment properties to lenders
Non-cash distributions to unitholders (note 12(b))
Non-cash conversion of convertible debentures (note 10)
Increase (decrease) in accounts payable for properties under development
Increase (decrease) in accounts payable for tenant inducements
Non-cash proceeds on options exercised
2011
2010
$
319,753
-
(59,056)
(9,038)
(4,071)
47,665
36,139
32,418
(12,558)
(507)
2,369
$
82,495
18,000
(89,484)
(9,675)
-
82,378
14,270
7,019
(7,565)
6,142
-
46
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
22.
Capital risk management:
The REIT’s primary objectives when managing capital are:
(a)
to provide unitholders with stable and growing distributions generated by revenue it derives from investments in
income-producing real estate properties; and
(b)
to maximize unit value through the ongoing active management of the REIT’s assets, the acquisition of additional
properties and the development and construction of projects which are pre-leased to creditworthy tenants.
The REIT considers its capital to be its unitholders’ equity, exchangeable units, mortgages payable, debentures payable and
bank indebtedness. As long as the REIT complies with its investment and debt restrictions set out in its Declaration of Trust, it is
free to determine the appropriate level of capital in context with its cash flow requirements, overall business risks and potential
business opportunities. As a result of this, the REIT will make adjustments to its capital based on its investment strategies and
changes in economic conditions.
The REIT’s level of indebtedness is subject to the limitations set out in its Declaration of Trust. The REIT is limited to a total
indebtedness to gross book value ratio of 65% (provided that for this purpose “indebtedness” excludes Convertible Debentures,
and U.S. Holdco notes payable to Finance Trust). As at December 31, 2011, this ratio was 50.5% (2010 - 50.3% based on
previous Canadian GAAP). Management uses this ratio as a key indicator in managing the REIT’s capital.
In addition to the above key ratio, the REIT’s general operating facilities (note 14(a) and 14(b)) have the following covenants
which are required to be calculated based on the REIT’s and Finance Trust’s combined financial statements:
(a) Maximum indebtedness to gross book value
(b) Minimum interest coverage ratio
(c) Minimum equity
Covenant
2011
2010(1)
65%
1.65 : 1
57.6%
2.40 : 1
$1,000,000
$2,345,862
50.4%
N/A(2)
$1,606,652
(1) As originally stated as at December 31, 2010 based on previous Canadian GAAP.
(2) For the year ended December 31, 2010, the financial covenant related to a minimum debt service coverage ratio of 1.20:1 which the REIT achieved 1.43:1.
The REIT has various other covenants with respect to its debt. The REIT is in compliance with the covenants as at December
31, 2011.
The REIT’s mortgage providers also have minimum limits on debt-to-service coverage ratios ranging from 1.10 to 1.50 as at
December 31, 2011 and December 31, 2010. The REIT monitors these ratios and is in compliance with such external
requirements, except for those on the mortgages due on demand (note 9).
47
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
23.
Risk Management:
(a)
Credit risk:
The REIT is exposed to credit risk as an owner of income properties in that tenants may experience financial difficulty and be
unable to fulfill their lease commitment or the failure of tenants to occupy and pay rent in accordance with existing lease
agreements. Management mitigates this risk by carrying out appropriate credit checks and related due diligence on significant
tenants. Management has diversified the REIT’s holdings so that it owns several categories of properties and acquires income
properties throughout Canada and the United States.
In addition, management ensures that no tenant or related group of tenants, other than investment grade tenants, account for a
significant portion of the REIT’s cash flow. The only tenants which account for more than 5% of the rental income from income
properties are Bell Canada and TransCanada PipeLines Limited. Each of these companies is rated with at least an A low rating
by a recognized rating agency. Once the Bow is completed, EnCana Corporation is expected to also account for more than 5%
of the rentals from income properties. EnCana Corporation’s current public debt rating is BBB high.
The REIT’s exposure to credit risk is as follows:
December 31
2011
December 31
2010
January 1
2010
Mortgages and amount receivable
Accounts receivable (note 7)
Derivative instruments (note 7)
(b)
Liquidity risk:
$
$
$
7,080
12,711
1,273
21,064
3,000
7,420
1,225
11,645
63,789
6,543
3,463
73,795
$
$
$
The REIT is subject to liquidity risk whereby it may not be able to refinance or pay its debt obligations when they become due.
The REIT’s liquidity risk is as follows:
Mortgages payable (note 9)
Debentures payable (note 10)
Derivative instruments
Bank indebtedness (note 14)
Accounts payable and accrued liabilities (note 15)
48
2012
Thereafter
Total
$
$
$
399,895
-
6,072
-
172,481
578,448
2,758,663
1,370,917
-
440,173
3,368
4,573,121
3,158,558
1,370,917
6,072
440,173
175,849
5,151,569
$
$
$
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
23.
Risk management (continued):
Management’s strategy for managing liquidity risk is to ensure, to the extent possible, that it will always have sufficient liquidity to
meet its liabilities when they come due, under both normal and stressed conditions, without incurring unacceptable losses or
risking damage to the REIT’s reputation. In order to meet this strategy, the REIT strives to enter into long-term leases with
creditworthy tenants which assists in the REIT’s primary strategy of maintaining predictable cash flows. The REIT attempts to
appropriately structure the term of mortgages to closely match the term of leases for each property. This strategy enables the
REIT to meet its contractual monthly mortgage obligations. Due to the long-term length of most of the REIT’s mortgages, a
significant amount of principal is usually paid by the time the mortgages mature.
The agreements and indentures governing indebtedness of the REIT contain covenants that, among other things, require the
REIT to maintain financial ratios and thresholds and impose on the REIT restrictions (subject in each case to exceptions)
regarding: the disposition of the Bow, lands related to the Bow; the creation of liens or granting of negative pledges; the
purchase or redemption of securities; the entering into any merger or similar transaction with any person; changes of a
fundamental nature (including senior management, business objectives, purposes or operations, capital structure, constating
documents, and subordinated debt); the cancellation or waiver of material contracts and changes to the Bow budget. As a
result, the REIT is limited by such covenants and restrictions.
Management monitors its liquidity risk through review of financial covenants contained in debt agreements and in accordance
with the REIT’s Declaration of Trust. In order to maintain liquidity, the REIT has two general operating facilities, as described in
note 14(a) and 14(b), available to draw on to fund its obligations.
(c)
Market risk:
The REIT is subject to currency risk and interest rate risk. The REIT’s objective is to manage and control market risk exposure
within acceptable parameters, while optimizing the return on risk.
(i)
Currency risk:
A portion of the REIT’s properties are located in the United States, resulting in the REIT being subject to foreign currency
fluctuations which may impact its financial position and results. In order to mitigate the risk, the REIT’s debt on these
properties is also held in U.S. dollars to act as a natural hedge.
A $0.10 weakening of the U.S. dollar against the average Canadian dollar exchange rate of $0.99 for the year ended
December 31, 2011 (2010 - $1.03) would have decreased other comprehensive income by approximately $46,800 (2010 -
$13,600) and decreased net income by approximately $200 (2010 - $500). This analysis assumes that all other variables,
in particular interest rates, remain constant (a $0.10 weakening of the Canadian dollar against the U.S. dollar at
December 31, 2011 would have had the equal but opposite effect).
49
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
23.
Risk management (continued):
(ii)
Interest rate risk:
The REIT is exposed to interest rate risk on its borrowings. It minimizes this risk by obtaining long-term fixed interest rate
debt. At December 31, 2011, the percentage of fixed rate debt to total debt was 90.9% (2010 - 97.5% based on prevous
Canadian GAAP). Therefore, a change in interest rates at the reporting date would not affect net income with respect to
these fixed rate instruments.
The bank indebtedness is subject to variable interest rates. An increase in interest rates of 100 basis points for the year
ended December 31, 2011 would have decreased net earnings by approximately $1,700 (2010 - $300). This analysis
assumes that all other variables, in particular foreign exchange rates, remain constant.
(d)
Fair values:
(i)
Financial assets and liabilities carried at amortized cost:
The fair values of the REIT's mortgages and amount receivable, accounts receivable, cash and cash equivalents, bank
indebtedness and accounts payable and accrued liabilities approximate their carrying amounts due to the relatively short
periods to maturity of these financial instruments.
The fair value of the mortgages payable has been determined by discounting the cash flows of these financial obligations
using year-end market rates for debt of similar terms and credit risks. Based on these assumptions, the fair value of
mortgages payable at December 31, 2011 has been estimated at $3,244,658 (2010 - $2,697,922) compared with the
carrying value of $3,163,593 (2010 - $2,706,707).
The fair value of the Senior Debentures payable has been measured based on the ask price of each series of Senior
Debenture similar terms and credit risks. Based on these assumptions, the fair value of the Senior Debentures payable
at December 31, 2011 has been estimated at $659,448 (2010 - $392,824) compared with the carrying value of $628,677
(2010 - $350,840).
(ii)
Assets and Liabilities carried at fair value:
Financial instruments measured at fair value in the statement of financial position are categorized using a fair value
hierarchy that reflects the significance of the inputs used in determining the fair values.
•
•
•
Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities;
Level 2: inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly
(i.e. as prices) or indirectly (i.e. derived from prices); and
Level 3: inputs for the asset or liability that are not based on observable market data (unobservable inputs).
50
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
23.
Risk management (continued):
December 31, 2011
Level 1
Level 2
Level 3
Total
Assets
Derivative instrument asset (note 7)
Liabilities
Convertible debentures (note 10)
Exchangeable units
Derivative instruments liabilities
-
-
(742,240)
(126,695)
-
(868,935)
1,273
1,273
-
-
(6,072)
(6,072)
-
-
-
-
-
-
1,273
1,273
(742,240)
(126,695)
(6,072)
(875,007)
$
(868,935)
$
(4,799)
$ -
$
(873,734)
December 31, 2010
Level 1
Level 2
Level 3
Total
Assets
Derivative instrument asset (note 7)
Liabilities
Convertible debentures (note 10)
Exchangeable units
Derivative instruments liabilities
-
-
(614,988)
(105,652)
-
(720,640)
1,225
1,225
-
-
(3,317)
(3,317)
-
-
-
-
-
-
1,225
1,225
(614,988)
(105,652)
(3,317)
(723,957)
$
(720,640)
$
(2,092)
$ -
$
(722,732)
51
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
23.
Risk management (continued):
January 1, 2010
Level 1
Level 2
Level 3
Total
Assets
Derivative instrument asset (note 7)
Liabilities
Convertible debentures (note 10)
Exchangeable units
Derivative instruments liabilities
-
-
3,463
3,463
(465,888)
(84,010)
-
(549,898)
-
-
-
-
-
-
-
-
-
-
3,463
3,463
(465,888)
(84,010)
-
(549,898)
$
(549,898)
$
3,463
$
-
$
(546,435)
24.
Joint venture and co-ownership activities:
These combined financial statements include the REIT’s proportionate share of assets, liabilities, revenue, expenses and cash
flows of the joint ventures and co-ownerships. The REIT’s proportionate share of these joint ventures and co-ownerships range
between 20% and 98.5%, summarized as follows:
Assets
Liabilities
Revenue
Expenses
Operating income from properties
Cash flows provided by operations
Cash flows provided by (used in) financing
Cash flows provided by (used in) investments
25.
Related party transactions:
2011
2010
$187,722
80,694
26,724
18,550
8,174
9,377
16,508
(25,043)
$186,031
89,713
26,802
18,806
7,996
11,276
(15,735)
4,194
H&R Property Management Ltd. (the “Property Manager”), a company partially owned by family members of the Chief Executive
Officer, provides property management services for substantially all properties owned by the REIT, including leasing services,
for a fee of 2% of gross revenue. The Property Manager also provides support services in connection with the acquisition,
disposition and development activities of the REIT and is also entitled to an incentive fee. Acquisitions and development support
services are provided for a fee of 2/3 of 1% of total acquisition and development costs. The support services relating to
dispositions of investment properties are provided for a fee of 10% of the gain on sale of investment properties adjusted for the
add back of accumulated depreciation and amortization. Services are provided by the Property Manager pursuant to a property
management agreement which expires on January 1, 2015 with one automatic five-year extension.
52
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
25.
Related party transactions (continued):
During the year ended December 31, 2011, the REIT recorded fees pursuant to this agreement of $23,978 (2010 - $14,657), of
which $9,481 (2010 - $1,062) was capitalized to the cost of the investment properties acquired, $2,128 (2010 - $2,191) was
capitalized to properties under development and $3,615 (2010 - $1,809) was capitalized to leasing expenses. The REIT has
also reimbursed the Property Manager for certain direct property operating costs and tenant construction costs.
For the year ended December 31, 2011, a further amount of $3,500 (2010 - $2,500) has been earned by the Property Manager
pursuant to the above agreement, in accordance with the annual incentive fee payable to the Property Manager.
Pursuant to the above agreement, as at December 31, 2011, $3,477 (2010 - $1,682) was payable to the Property Manager.
The REIT leases space to companies affiliated with the Property Manager. The rental income earned for the year ended
December 31, 2011 is $1,382 (2010 - $1,322).
These transactions are measured at the amount of consideration established and agreed to by the related parties.
Key management personnel compensation:
Short-term employee benefits
Employee unit-based compensation
26.
Segmented disclosures:
2011
2010
$3,258
7,033
$10,291
$2,758
6,544
$9,302
Segmented information on identifiable non-current assets by geographic region and rentals from investment properties is outlined
below.
Investment properties and properties under development are attributed to countries based on the location of the properties.
Canada
United States
December 31
December 31
January 1
2011
2010
2010
$
5,359,726
$
4,751,350
$
4,338,286
2,051,830
1,041,939
1,018,065
$
7,411,556
$
5,793,289
$
5,356,351
53
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
26.
Segmented disclosures (continued):
Rentals from investment properties:
Canada
United States
27.
Income tax recovery (expense):
Income tax expense included in the determination
of net income from continuing operations:
Current
Deferred
Deferred income tax included in the determination
of other comprehensive income
2011
2010
$
534,681
$
513,562
122,230
103,865
$
656,911
$
617,427
2011
2010
$
(285)
$
(458)
-
(285)
-
460,138
459,680
915
$
(285)
$
460,595
The Income Tax Act (Canada) contains legislation (the “SIFT Rules”) affecting the tax treatment of “specified investment flow-
through” (“SIFT”) trusts. A SIFT includes a publicly-traded trust. The SIFT Rules provide for a transition period until 2011 for
publicly-traded trusts like the REIT which existed prior to November 1, 2006. Under the SIFT Rules, distributions of certain
income by a SIFT are not deductible in computing the SIFT’s taxable income, and a SIFT is subject to tax on such income at a
rate that is substantially equivalent to the general tax rate applicable to a Canadian corporation. The SIFT Rules do not apply to
a publicly-traded trust that qualifies as a real estate investment trust under the Income Tax Act (Canada). The REIT completed
the necessary tax restructuring to qualify as a real estate investment trust effective June 30, 2010. For periods before it
qualified, the REIT recorded deferred tax liabilities in respect of temporary differences expected to reverse after January 1, 2011.
Such deferred tax liability was reversed as an adjustment to deferred income tax expense in income and as an adjustment to
other comprehensive income during the second quarter of 2010, when the REIT became a qualifying REIT.
54
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
27.
Income tax recovery (expense) (continued):
The SIFT tax effects of temporary differences that give rise to significant portions of the deferred income tax assets and liabilities
are as follows:
Deferred income tax liabilities:
Investment properties
Properties under development
Accrued rent receivable
Mortgages receivable
Other assets
Deferred income tax assets:
Issue costs
Mortgages payable
December 31
December 31
January 1
2011
2010
2010
$ -
$ -
$
387,389
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
20,071
59,524
336
2,522
469,842
8,296
493
8,789
Deferred income tax liability
$ -
$ -
$
461,053
The REIT has certain subsidiaries in the United States that are subject to tax on their taxable income at a rate of approximately
38%. Deferred tax assets have not been recognized for these subsidiaries in respect of the following items:
Deductible temporary differences
Net operating losses and deferred interest deductions
Total
2011
2010
$
3,775
$
16,594
125,229
113,158
$
129,004
$
129,752
Net operating losses will expire between 2018 and 2031. The deferred interest deductions and the deductible temporary
differences do not generally expire under current tax legislation. Deferred tax assets have not been recognized in respect of
these items because it is not probable that future taxable profit will be available against which these U.S. corporate subsidiaries
can utilize these tax benefits.
55
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
28.
Commitments and contingencies:
(a)
(b)
(c)
The REIT is currently constructing a two million square foot office building in Calgary, Alberta (the “Bow”), which is fully pre-
leased to EnCana Corporation for a 25-year term. The REIT has committed to incurring additional construction and
development costs for this project of approximately $163,000, including capitalized interest, over the remaining construction
period. As at December 31, 2011, the total cost incurred on the project amounted to $1,479,117 (note 5) (December 31, 2010 -
$1,150,094, January 1, 2010 - $719,173). This budget includes the construction of 1,358 parking stalls. It is currently expected
that the building will be occupied in tranches commencing in Q2 2012 with full occupancy expected by Q4 2012. Any delay in
the delivery of the tranches will result in a delay cost of $1.67 per square foot per month. The estimated delay cost is
approximately $24,100.
In the normal course of operations, the REIT has issued letters of credit in connection with developments, financings, operations
and acquisitions. As at December 31, 2011, the REIT has outstanding letters of credit totalling $29,775 (December 31, 2010 -
$44,524, January 1, 2010 - $34,349), including $17,431 (December 31, 2010 - $17,939, January 1, 2010 - $18,164) which has
been pledged as security for certain mortgages payable. These letters of credit are secured in the same manner as the bank
indebtedness (note 14(a)).
The REIT provides guarantees on behalf of third parties, including co-owners. As at December 31, 2011, the REIT issued
guarantees amounting to $74,303 (December 31, 2010 - $41,307, January 1, 2010 - $43,278), which expires in 2016 (December
31, 2010 - expires between 2011 and 2016, January 1, 2010 - expires between 2011 and 2016), relating to the co-owner’s share
of mortgage liability. In addition, the REIT continues to guarantee certain debt assumed by purchasers in connection with past
dispositions of properties, and will remain liable until such debts are extinguished or the lenders agree to release the REIT’s
covenants. At December 31, 2011 the estimated amount of debt subject to such guarantees, and therefore the maximum
exposure to credit risk, is $113,407 (December 31, 2010 - $116,357, January 1, 2010 $119,150) which expires between 2013
and 2018 (December 31, 2010 - expires between 2013 and 2018, January 1, 2010 - expires between 2013 and 2018). There
have been no defaults by the primary obligor for debts on which the REIT has provided its guarantees, and as a result, no
contingent loss on these guarantees has been recognized in these financial statements.
Credit risks arise in the event that these parties default on repayment of their debt since they are guaranteed by the REIT. These
credit risks are mitigated as the REIT has recourse under these guarantees in the event of a default by the borrowers, in which
case the REIT’s claim would be against the underlying real estate investments.
(d)
The REIT is involved in litigation and claims in relation to the investment properties that arise from time to time in the normal
course of business. In the opinion of management, any liability that may arise from such contingencies would not have a
significant adverse effect on the combined financial statements.
56
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Notes to Combined Financial Statements
(In thousands of Canadian dollars, except unit and per unit amounts)
Years ended December 31, 2011 and 2010
29.
Subsequent events:
(a)
(b)
(c)
(d)
In January 2012, the REIT received a U.S. mortgage for U.S. $250,000 for Hess Tower in Houston, Texas, bearing interest at
4.50% per annum for an 8-year term.
In February 2012, the REIT refinanced three U.S. mortgages totaling approximately U.S. $72,600 each bearing interest at a rate
of 5.94% per annum, with three new non-recourse U.S. mortgages totaling $61,000 each bearing interest at a rate of 4.50% per
annum for a 10-year term.
In February 2012, the REIT refinanced 10 Canadian mortgages totaling approximately $28,500 each bearing interest at a rate of
7.74% per annum, with 10 new mortgages totaling $62,900 each bearing interest at a rate of 3.99% per annum for a 10-year
term.
In March 2012, the REIT purchased a 485,000 square foot, state-of-the-art office building in Toronto, Ontario for a purchase price
of $186,000 before transaction costs. The REIT has secured a $60,000 interest only mortgage for a term of 20 years. The
interest rate will be at a spread of 2.30% over the 20-year Government of Canada bond. The REIT has the ability to place
another $37,000 first mortgage on this property.
57
Unitholder Distribution Reinvestment Plan and Direct Unit
Purchase Plan:
Since January 2000, H&R REIT has offered registered holders of its units
resident in Canada the opportunity
to participate in its Unitholder
Distribution Reinvestment Plan (the “DRIP”) and Direct Unit Purchase Plan.
The DRIP allows participants to have their monthly cash distributions of
H&R REIT reinvested in additional Stapled Units of H&R at a 3% discount
to the weighted average price of the Stapled Units on the TSX for the five
trading days (the “Average Market Price”) immediately preceding the cash
distribution date. The Direct Unit Purchase Plan allows participants to
purchase additional Stapled Units on a monthly basis at the Average
Market Price subject to a minimum purchase of $250 per month (up to a
maximum of $13,500 per year) for each participant. For more information
on the DRIP and/or the Direct Unit Purchase Plan, please contact us by
email through the “Contact Us” webpage of our website, or contact our
Registrar and Transfer Agent.
Corporate Information
H&R REIT Board of Trustees
Thomas J. Hofstedter (1), President and Chief Executive Officer, H&R Real Estate Investment Trust
Robert Dickson (2,4), Strategic financial consultant, marketing communications industry
Edward Gilbert (1,2,3,4), Chief Operating Officer, Firm Capital Mortgage Investment Trust
Laurence A. Lebovic (1,3,4), Chief Executive Officer, Runnymede Development Corporation Ltd.
Ronald C. Rutman (2,3,4), Partner, Zeifman & Company, Chartered Accountants
H&R Finance Trust Board of Trustees
Thomas J. Hofstedter, President and Chief Executive Officer, H&R Real Estate Investment Trust
Shimshon (Stephen) Gross (2), President, LRG Holdings Inc.
Marvin Rubner (2), Manager and Founder, YAD Investments Limited.
Neil Sigler (2), Vice President, Gold Seal Management Inc.
(1) Investment Committee
(2) Audit Committee
(3) Compensation and Governance Committee
(4) Nominating Committee
Officers
Thomas J. Hofstedter, President and Chief Executive Officer
Larry Froom, Chief Financial Officer
Nathan Uhr, Chief Operating Officer (H&R REIT)
Cheryl Fried, Vice-President, Accounting (H&R REIT)
Auditors: KPMG LLP
Legal Counsel: Blake, Cassels & Graydon LLP
Taxability of Distributions: 55% of the distributions made by the H&R REIT and 17% of the distributions made
by H&R Finance Trust to Unitholders during 2011 were tax deferred.
Plan Eligibility: RRSP, RRIF, DPSP, RESP, RDSP, TFSA
Stock Exchange Listing: Stapled Units and debentures of H&R are listed on the Toronto Stock Exchange under
the trading symbols HR.UN; HR.DB; HR.DB.B, HR.DB.C, HR.DB.D, HR.DB.E.
Registrar and Transfer Agent: CIBC Mellon Trust Company, P.O. Box 7010, Adelaide Street Postal Station,
Toronto, Ontario, Canada M5C 2W9 Telephone: 416-643-5500 within the Toronto area or 1-800-387-0825, Fax: 416
643 5501, E-mail: inquiries@cibcmellon.com, Website: www.cibcmellon.com
Contact Information: Investors, investment analysts and others seeking financial information should go to our
website at www.hr-reit.com, or e-mail info@hr-reit.com, or call 416-635-7520 and ask for Larry Froom, Chief Financial
Officer, or fax 416-398-0040, or write to H&R Real Estate Investment Trust, 3625 Dufferin Street, Suite 500,
Downsview, Ontario, Canada, M3K 1N4
H&R Real Estate Investment Trust and H&R Finance Trust
The Bow, Calgary Two Gotham Center, New York City
Hess Tower, Houston Atrium on Bay, Toronto
www.HR-REIT.com