H&R Real Estate Investment Trust and H&R Finance Trust
2016 Annual Report
Including Combined MD&A and Financial Statements
The Bow, Calgary
Dufferin Mall, Toronto
Airport Road, Brampton – Unilever Distribution Warehouse
H&R Profile
H&R REIT is Canada’s largest diversified real estate investment trust with total assets of approximately
$14.7 billion at December 31, 2016. H&R REIT is a fully internalized real estate investment trust and has
ownership interests in a North American portfolio of high quality office, retail, industrial and residential
properties comprising over 46 million square feet.
H&R Finance Trust is an unincorporated investment trust, which primarily invests in notes issued by a
U.S. corporation which is a subsidiary of H&R REIT. The current note receivable balance is U.S. $220.5
million. In 2008, H&R REIT completed an internal reorganization which resulted in each issued and
outstanding H&R REIT unit trading together with a unit of H&R Finance Trust as a “Stapled Unit” on the
Toronto Stock Exchange.
Additional information regarding H&R REIT and H&R Finance Trust is available at www.hr-reit.com and
on www.sedar.com.
Fair Value
by Geographic region
Alberta
26%
Other
Canadian
Provinces 10%
United
States
34%
Ontario
30%
Fair Value
by Type of Asset
Industrial,
8%
Office 48%
Retail 38%
Lantower
Residential
6%
Primary Objectives
H&R strives to achieve two primary objectives: to maximize the value of units through active
management of H&R’s assets and to provide unitholders with stable and growing cash distributions
generated by revenues derived from a diversified portfolio of investment properties. 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.
2016 Annual Report
Financial Highlights
H&R undertook a strategic review of its assets and decided to sell certain investment properties to take advantage of the
high demand for good quality assets. During 2015 and 2016, H&R sold $1.3 billion of real estate assets and acquired $757.5
million of real estate assets for a net decrease of $542.5 million, at H&R’s ownership share.
Rentals from investment properties (millions)
Property operating income (millions)
Net income (loss) before income taxes (millions)
Funds from Operations (“FFO”) (millions)(1)
FFO per Stapled Unit (basic)
FFO per Stapled Unit (diluted)
Distributions per Stapled Unit
Payout ratio per Stapled Unit (as a % of FFO)
3 months ended December 31
Year ended December 31
2016
$305.5
$202.4
$182.6
$142.9
$0.48
$0.47
$0.34
70.8%
2015
$296.2
$202.1
($35.9)
$142.9
$0.48
$0.48
$0.34
70.8%
2016
2015
$1,196.0
$1,188.3
$764.7
$590.3
$584.3
$1.96
$1.93
$1.35
68.9%
$773.5
$375.1
$569.9
$1.95
$1.92
$1.35
69.2%
(1) FFO is a non-GAAP measure. See “Non-GAAP Financial Measures” in this press release. The Trusts’ combined MD&A includes a reconciliation of
FFO to net income. Readers are encouraged to review the reconciliation in the combined MD&A.
Operating Highlights
Occupancy as at December 31, 2016 was 95.7% compared to 95.9% as at December 31, 2015. Leases representing 3.7%
of total rentable area will expire during 2017 and H&R’s average remaining lease term to maturity as at December 31, 2016
was 9.5 years.
Development Highlights
Construction is progressing on the development of 1,871 luxury residential rental units for the LIC Project in which H&R has
a 50% interest. The total budget at the 100% ownership level is expected to be approximately U.S. $1.2 billion with occupancy
in the first tower scheduled to begin in early 2018. As at December 31, 2016, total costs incurred amounted to $655.3 million.
The remaining costs are expected to be funded through the construction financing facility. Approximately 99.3% of total hard
costs and 89.9% of total project costs have been fixed. Upon completion and stabilized occupancy, the contribution to FFO
from the LIC Project at H&R’s interest is projected to be U.S. $23.0 million, which equates to an approximate 8.8% year one
yield on H&R’s cash investment. During the year, the fair value of the LIC Project increased by U.S. $54.9 million, at H&R’s
interest. An independent third party appraisal was obtained for this property in 2016.
In Q1 2016, H&R entered into two separate 15-year build-to-suit leases for industrial properties to be developed in the Airport
Road Business Park in Brampton, ON for Sleep Country Canada and Solutions 2 Go Inc. The total net leasable area for
these properties will be approximately 341,775 square feet with occupancy of both projects expected to occur in Q3 2017.
Upon completion, the contribution to FFO generated from these two projects is expected to be $1.7 million.
In August 2016, H&R acquired a 31.7% non-managing interest in 38.4 acres of land located in Hercules, California, adjacent
to the San Pablo Bay, northeast of San Francisco, (“Hercules Project”) for the future development of multi-family residential
units. The initial investment to purchase the land was approximately U.S. $10.0 million (at H&R’s interest).
Office Segment Highlights
On June 30, 2016, H&R sold its 33.3% freehold and leasehold interests in Scotia Plaza and 100 Yonge Street (collectively,
“Scotia Plaza”) for approximately $438.3 million. The purchaser assumed H&R’s share of the existing financing on the
properties. H&R recorded a gain on sale, net of related costs, of $15.0 million. Proceeds to H&R amounted to $227.0 million,
which were primarily used to repay debt including the $180.0 million Series D Senior Debentures that matured in July 2016.
On November 17, 2016, H&R sold a non-managing 50% interest in the TransCanada Tower in Calgary, AB for gross proceeds
of approximately $257.4 million. H&R built this property in 2001 for a total cost of $265.8 million, at the 100% level. H&R
prepaid the entire mortgage on the property of $93.5 million upon closing. H&R recorded a loss on sale, net of related costs,
of $7.4 million. Proceeds to H&R amounted to $163.9 million, which were primarily used to repay debt and acquire a multi-
family residential property.
Alberta Office Exposure:
The weighted average lease term remaining in H&R’s Alberta office portfolio is 17.2 years. The leases expiring between
January 1, 2017 and December 31, 2018 in H&R’s Alberta office portfolio total 18,507 square feet. As at December 31, 2016,
H&R’s Alberta office portfolio had approximately 184,000 square feet of vacant space, at H&R’s ownership share, all of which
is in F1RST Tower (formerly Telus Tower). Of this vacant space, 12,667 square feet has been leased for a six-year term
commencing January 1, 2017.
Lantower Residential Highlights
H&R is continuing its expansion into the multi-family rental market in the United States. During 2016, Lantower Residential
acquired four multi-family properties in the United States, all of which were built between 2012 and 2015. These properties
comprise 1,246 units and were purchased for a total price of U.S. $232.2 million.
As at December 31, 2016, Lantower Residential has a portfolio of 12 properties, comprised of an aggregate of 3,832 units,
an average age of 13 years and an average monthly rent of U.S. $1,081 per unit.
Industrial Segment Highlights
In February 2016, H&R acquired a 50% managing interest in a 264,802 square foot newly constructed industrial property in
Calgary, AB for $15.5 million (at H&R’s interest).
During 2016, H&R sold its 50% ownership interest in a 139,734 square foot industrial property in Montreal, QC for $4.2 million
and its 50% ownership interest in a 52,792 square foot industrial property in Vaughan, ON for $3.0 million.
Retail Highlights
During 2016, H&R sold its 100% interest in five retail properties, totaling 490,839 square feet, all of which were located in the
U.S. for U.S. $61.8 million.
Primaris Highlights and Target Update
In November 2016, H&R entered into a conditional agreement to sell a 50% non-managing interest in two enclosed shopping
centres for $211.6 million which closed in January 2017. The purchaser assumed 50% of the existing financing on the
properties of approximately $126.6 million. The net proceeds of approximately $81.0 million have been used to repay debt.
Redevelopment of the former Target stores has commenced, however, the space has not been transferred to properties
under development because the space is part of an existing, already developed property. For the year ended December 31,
2016, H&R spent approximately $31.0 million in redevelopment and, in addition, capitalized $2.4 million of the property
operating and finance costs attributable to this space. The following table is a summary of H&R’s leasing progress on the
former Target space:
Former Target Canada space(1)
Backfill progress:
Committed space
Conditional agreements
Advanced discussions
Total backfill progress
Space currently being marketed
Total gross leasable area (“GLA”) upon completion of redevelopment
Potential GLA converted for landlord uses (common area etc.)
Space for demolition/potential redevelopment
Total(2)
Square Feet at
100%
Square Feet at
H&R’s Interest
1,062,676
774,035
583,989
191,364
44,215
819,568
49,759
869,327
135,508
57,841
1,062,676
404,270
176,364
25,645
606,279
32,593
638,872
106,242
28,921
774,035
Annual Base Rent
at H&R’s interest
($ Millions)
$4.0
6.4
1.5
0.8
8.7
0.6
$9.3
N/A
N/A
(1) The above table is disclosed as of February 6, 2017 and H&R’s interest has been updated to reflect the 50% sale of two enclosed shopping centres
which closed in January 2017.
(2) Represents square footage based on current redevelopment plans and is subject to change based on tenant demand.
H&R expects that, once the above leasing is complete, the new tenants will contribute approximately $9.3 million annually
or 225% of the total base rental revenue lost through Target’s departure. H&R expects most of the remaining leases will be
entered into by Q2 2017, with occupancy occurring between 2017 and early 2019. Throughout 2016, committed space
tenants occupied 73,736 square feet and contributed $0.4 million in base rent at H&R’s interest. The total remaining cost of
subdividing and re-leasing the premises is expected to be approximately $78.0 million at H&R’s ownership interest. A partial
lease settlement from Target of $20.4 million was received and recognized in the Trusts’ Financial Statements as Other
Income for the year ended December 31, 2016.
Debt and Liquidity Highlights
H&R repaid all of the outstanding Series D Senior Debentures upon maturity for a cash payment of $180.0 million in July
2016 and all of the outstanding 2016 Convertible Debentures upon maturity for a cash payment of $75.0 million in December
2016. In November 2016, H&R issued $200.0 million principal amount of 2.923% Series L Senior Debentures maturing May
6, 2022.
During 2016, H&R (excluding ECHO) secured 12 new mortgages and secured an increase to an existing mortgage adding
a total of $191.1 million of debt at a weighted average interest rate of 2.9% for an average term of 5.1 years and repaid 48
mortgages, which had a weighted average interest rate of 4.9%, upon maturity totalling $629.2 million. The current weighted
average interest rate on outstanding debt is 4.3% with an average term to maturity of 4.8 years.
As at December 31, 2016, the debt to total asset ratio per the Trusts’ Financial Statements was 44.3% compared to 46.2%
at December 31, 2015 and cash on hand plus undrawn credit facilities amounted to $400.3 million.
As at December 31, 2016, unencumbered assets were approximately $3.0 billion and unsecured debt was approximately
$1.7 billion, resulting in a coverage ratio of 1.8x (December 31, 2015 - 1.4x).
Distribution Increase
The trustees approved an increase in the current monthly distribution per Stapled Unit commencing December 2016,
resulting in a $0.03 annual increase to a total of $1.38 per annum.
Tom Hofstedter
President and Chief Executive Officer
March 31, 2017
COMBINED MANAGEMENT’S DISCUSSION
AND ANALYSIS OF H&R REAL ESTATE INVESTMENT
TRUST AND H&R FINANCE TRUST
For the Year ended December 31, 2016
Dated: February 15, 2017
TABLE OF CONTENTS
SECTION I .......................................................................................................................................................................................................................................................... 1
Basis Of Presentation .................................................................................................................................................................................................................................... 1
Forward-Looking Disclaimer .......................................................................................................................................................................................................................... 1
Non-Gaap Financial Measures ...................................................................................................................................................................................................................... 2
Overview ........................................................................................................................................................................................................................................................ 3
Change In Accounting Policy ......................................................................................................................................................................................................................... 5
SECTION II ......................................................................................................................................................................................................................................................... 5
Summary Of Quarterly Results ...................................................................................................................................................................................................................... 5
Selected Annual Information .......................................................................................................................................................................................................................... 6
Financial Highlights ........................................................................................................................................................................................................................................ 7
Key Performance Drivers ............................................................................................................................................................................................................................... 7
Portfolio Overview .......................................................................................................................................................................................................................................... 8
Financial And Operating Highlights 2016 .................................................................................................................................................................................................... 11
Summary Of Significant 2016 Activity ......................................................................................................................................................................................................... 11
SECTION III ...................................................................................................................................................................................................................................................... 14
Assets .......................................................................................................................................................................................................................................................... 15
Liabilities And Unitholders’ Equity................................................................................................................................................................................................................ 19
Results Of Operations ................................................................................................................................................................................................................................. 22
Property Operating Income .......................................................................................................................................................................................................................... 24
Segmented Information ............................................................................................................................................................................................................................... 25
Other Income And Expense Items ............................................................................................................................................................................................................... 28
Funds From Operations ............................................................................................................................................................................................................................... 30
Adjusted Funds From Operations ................................................................................................................................................................................................................ 33
Liquidity And Capital Resources .................................................................................................................................................................................................................. 37
Off-Balance Sheet Items .............................................................................................................................................................................................................................. 39
Financial Instruments And Other Instruments ............................................................................................................................................................................................. 39
SECTION IV ...................................................................................................................................................................................................................................................... 40
Critical Accounting Estimates And Judgements .......................................................................................................................................................................................... 40
New Standards And Interpretations Not Yet Adopted ................................................................................................................................................................................. 42
Internal Control Over Financial Reporting ................................................................................................................................................................................................... 42
SECTION V ....................................................................................................................................................................................................................................................... 43
Risks And Uncertainties ............................................................................................................................................................................................................................... 43
Outstanding Unit Data ................................................................................................................................................................................................................................. 49
Subsequent Events ...................................................................................................................................................................................................................................... 49
Additional Information .................................................................................................................................................................................................................................. 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
SECTION I
BASIS OF PRESENTATION
Financial data included in this combined Management’s Discussion and Analysis (“MD&A”) of combined results of operations and combined financial
position of H&R Real Estate Investment Trust (“H&R”) and H&R Finance Trust (“Finance Trust” and together with H&R, the “Trusts”) for the year ended
December 31, 2016 includes material information up to February 15, 2017. Financial data provided has been prepared in accordance with International
Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). This MD&A should be read in conjunction
with the combined financial statements of the Trusts and appended notes for the year ended December 31, 2016 (“Trusts’ Financial Statements”). 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 properties, owned by H&R through an investment in a joint venture or an associate are treated as equity accounted investments in the Trusts’
Financial Statements. For the purposes of this MD&A, the Trusts have accounted for these equity accounted investments on a proportionately consolidated
basis, and have included reconciliations to the Trusts’ combined statements of financial position and statements of comprehensive income on pages 14,
22 and 23, respectively. The Trusts refer to these proportionately consolidated amounts as “The Trusts’ interests”. This non-GAAP measure is calculated
as the sum of the applicable line item in the Trusts’ Financial Statements in accordance with IFRS and the Trusts’ proportionate share of equity accounted
investments for such line item. Management views this method as relevant because it is consistent with how H&R and its co-owners manage the net assets
and assess operating performance of each of its co-owned properties. See “Non-GAAP financial measures”.
On October 24, 2013, the Ontario Securities Commission (on its behalf and on behalf of the other provincial securities regulators) issued a decision which
permits H&R and Finance Trust to file one set of combined financial statements rather than separate financial statements. The Trusts’ Financial Statements
have been presented on a basis whereby the assets and liabilities of H&R and Finance Trust have been combined in accordance with the accounting
principles applicable to both H&R and Finance Trust in accordance with IFRS, to reflect the financial position and results of H&R and Finance Trust on a
combined basis. This same decision permits H&R and Finance Trust to file one combined MD&A which has been done for the year ended December 31,
2016.
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 “Results of Operations”, “Liquidity and Capital Resources”, “Risks
and Uncertainties” and “Subsequent Events” 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, the amount of distributions to unitholders, H&R’s expectation with respect to contributions to rental revenue by new tenants in
former Target locations, the timing of completion and occupancy of any leases relating to premises vacated by Target and the cost of subdividing and re-
leasing premises vacated by Target, the expected budget and occupancy of the Long Island City, NY Project (“LIC Project”), the expected cash flow to
H&R from the LIC Project, the expected net leasable area, occupancy date and the expected cash flow from the industrial properties at Airport Road
Business Park, the expected capital and tenant expenditures for 160 Elgin St., in Ottawa, ON and 310-320-330 Front St. in Toronto, ON, the adoption of
new accounting policies and qualification of H&R for the REIT exemption. 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: real property ownership, credit risk and tenant concentration; lease rollover risk, interest
and other debt-related risk; construction risks; currency risk; liquidity risk, financing credit risk, environmental risk; co-ownership interest in properties, joint
arrangement risks; unit price risk; availability of cash for distributions; ability to access capital markets; dilution; unitholder liability; redemption right risk;
risks relating to debentures, tax risk and tax consequences to U.S. holders. 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 other than in Alberta; local real estate conditions
are stable other than in Alberta; 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.
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H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
Readers are also urged to examine H&R 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 H&R 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 H&R’s materials filed with the Canadian securities regulatory authorities or for any failure of H&R 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
H&R 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 February 15,
2017 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.
NON-GAAP FINANCIAL MEASURES
The Trusts’ Financial Statements are prepared in accordance with IFRS. However, in this MD&A, a number of measures are presented that are not
generally accepted accounting principles (“GAAP”) measured under IFRS. These measures, as well as the reasons why management believes these
measures are useful to investors, are described below.
None of these non-GAAP financial measures should be construed as an alternative to financial measures calculated in accordance with GAAP. Further,
the Trusts’ method of calculating these supplemental non-GAAP financial measures may differ from the methods of other real estate investment trusts or
other issuers, and accordingly may not be comparable.
(a) The Trusts’ interests
The Trusts apply the equity method of accounting to investments in joint ventures and associates in the Trusts’ Financial Statements as prescribed
under IFRS. Throughout this MD&A, any references to the “Trusts’ Financial Statements” refer to amounts as reported under IFRS and any references
to “The Trusts’ interests” are non-GAAP measures which include amounts per the Trusts’ Financial Statements plus the Trusts’ proportionate share
of equity accounted investments. See “Basis of Presentation”.
(b) Property operating income (cash basis)
Property operating income is the rental revenue generated from H&R’s investment properties, net of the property operating expenses incurred.
Property operating income (cash basis) is a non-GAAP measure which adjusts property operating income to exclude two non-cash items; straight-
lining of contractual rent and realty taxes accounted for under IFRS Interpretations Committee 21, Levies (“IFRIC 21”). Effective January 1, 2014,
H&R adopted IFRIC 21 which relates to the timing of the liability recognition for U.S. realty taxes. By excluding the impact of IFRIC 21, U.S. realty
tax expenses are evenly matched with realty tax recoveries received from tenants throughout the period. Management believes this non-GAAP
measure is important for investors as it adjusts property operating income for non-cash items which allows investors to better understand H&R’s
operating performance.
(c) Same-Asset property operating income and Same-Asset property operating income (cash basis)
Same-Asset property operating income and Same-Asset property operating income (cash basis) are non-GAAP financial measures used by H&R
which management believes are useful for investors as they reflect period-over-period performance for properties owned by H&R throughout both
periods. This typically excludes acquisitions, business combinations, dispositions and transfers of properties under development to investment
properties during the last two fiscal years.
(d) Funds from operations (“FFO”)
FFO is a non-GAAP financial measure widely used in the real estate industry as a measure of operating performance. The Trusts present their
combined FFO calculations in accordance with the Real Property Association of Canada (REALpac) guidelines however, this method of calculating
FFO may differ when comparing to other issuers. Management believes this to be a useful measure for investors as it adjusts for items included in
net income that are not recurring including gain (loss) on sale of real estate assets, as well as non-cash items such as the fair value adjustments on
investment properties. FFO should not be construed as an alternative to net income or cash flows provided by operating activities calculated in
accordance with IFRS. See “Funds From Operations” for reconciliations of property operating income and net income to FFO.
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H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
(e) Adjusted funds from operations (“AFFO”)
AFFO is also a widely used measure in the real estate industry to assess the sustainability of cash distributions. 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 capital and tenant expenditures. Although capital and tenant expenditures can vary from quarter to quarter due to tenant
turnovers, vacancies and the age of a property, the Trusts have elected to deduct actual capital and tenant expenditures spent and capitalized in the
period instead of deducting a normalized amount based on historical activity. This differs from others in the industry as many entities deduct a
normalized amount of capital and tenant expenditures in their AFFO calculation. There is no standard industry definition of AFFO, and as a result,
the Trusts’ calculation of combined AFFO may differ from other issuers’ calculations. AFFO should not be construed as an alternative to net income
or cash provided by operations calculated in accordance with IFRS. See “Adjusted Funds from Operations” for a reconciliation of AFFO to cash
provided by operations.
(f)
Interest coverage ratio
The interest coverage ratio is reported at the Trusts’ interests and is calculated by dividing the sum of: (i) property operating income (excluding IFRIC
21), (ii) other income, (iii) finance income, (iv) trust expenses (excluding unit-based compensation) and (v) transaction costs; by finance costs from
operations (excluding effective interest rate accretion and exchangeable unit distributions). Management uses this ratio to evaluate its ability to
service the interest requirements of its outstanding debt.
(g) Debt to total assets ratios
H&R’s Declaration of Trust limits the indebtedness of H&R (subject to certain exceptions) to a maximum of 65% of the total assets of H&R, based on
the Trusts’ Financial Statements. The Trusts also present this ratio at the Trusts’ interests. Debt includes mortgages payable (including mortgages
classified as held for sale), the face value of debentures payable, bank indebtedness and loan payable. Management uses this ratio to determine its
flexibility to incur additional debt and ensure it is in compliance with H&R’s Declaration of Trust.
(h) Unencumbered asset to unsecured debt coverage ratio
The unencumbered asset to unsecured debt coverage ratio is reported at the Trusts’ interests (excluding ECHO) and is calculated by dividing the
sum of: (i) unencumbered assets, defined as investment properties without encumbrances for mortgages or bank indebtedness; by unsecured debt
which includes the face value of senior debentures and H&R’s unsecured bank facilities. Management believes this ratio is important for unsecured
debt holders, as a higher ratio indicates more properties available to be financed with mortgages to repay unsecured debt.
OVERVIEW
H&R is an unincorporated open-ended trust created by a declaration of trust (“H&R’s Declaration of Trust”) and governed by the laws of the Province of
Ontario. Unitholders are entitled to have their H&R units comprising part of the Stapled Units (as defined below) 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 H&R’s information circular dated August 20, 2008, as an open-ended limited purpose unit trust pursuant to its declaration
of Trust (“Finance Trust’s Declaration of Trust”). Each issued and outstanding Finance Trust unit is “stapled” to a unit of H&R on a one-for-one basis such
that Finance Trust units and H&R 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 H&R 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” (as described below), in which case
Finance Trust units will cease to be listed on the TSX).
H&R has two primary objectives:
to provide unitholders with stable and growing cash distributions, generated by the revenue it derives from a diversified portfolio of income
producing real estate assets; and
to maximize unit value through ongoing active management of H&R’s assets, acquisition of additional properties and the development and
construction of projects which are pre-leased to creditworthy tenants.
H&R’s strategy to accomplish these two objectives is to accumulate a diversified portfolio of high quality investment properties in Canada and the United
States occupied by creditworthy tenants.
H&R’s strategy to mitigate risk is diversification both by asset class and geographic location. H&R invests in four real estate asset classes which
management views as comprising six separate operating segments. H&R invests in office, retail, industrial and residential properties and acquires
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H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
properties both in Canada and the United States. H&R’s retail asset class is further viewed by management as being comprised of three different operating
segments: (i) enclosed shopping centres and multi-tenant retail plazas throughout Canada managed by Primaris Management Inc. (“Primaris”); (ii) other
retail properties throughout Canada and the United States managed by H&R REIT Management Services LP (“HRRMSLP”), a wholly-owned subsidiary
of H&R, (“H&R Retail”), and (iii) H&R’s 33.6% interest in Echo Realty LP (“ECHO”), a privately held real estate and development company which focuses
on developing and owning a core portfolio of grocery anchored shopping centres in the United States. H&R’s residential segment operates as Lantower
Residential, a wholly-owned subsidiary of H&R, and focuses on acquiring multi-family properties in the United States. H&R therefore has six operating
segments and management assesses the results of these operations separately.
The primary purpose of Finance Trust is to be a flow-through vehicle to allow H&R to indirectly access the capital markets in a tax-efficient manner by
indirectly borrowing money from H&R’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 H&R. As at December 31, 2016, Finance Trust holds U.S. $220.5 million of aggregate principal amount of
notes payable by U.S. Holdco (“U.S. Holdco Notes”) (December 31, 2015 – U.S. $220.4 million). Subject to cash flow requirements, Finance Trust intends
to distribute to its unitholders, who are also unitholders of H&R, all of its cash flow, consisting primarily of interest paid by U.S. Holdco, less administrative
and other expenses and amounts to satisfy liabilities. The U.S. Holdco Notes are eliminated in the Trusts’ Financial Statements, however the related
foreign exchange difference is not eliminated upon combination as it flows through net income (loss) on the Finance Trust financial statements and other
comprehensive income (loss) on H&R financial statements.
Mechanics of “Stapling” the Units of Finance Trust and H&R
Pursuant to the provisions of the Declarations of Trust for Finance Trust and H&R at all times each H&R unit must be ‘‘stapled’’ to a Finance Trust unit
(and each Finance Trust unit must be ‘‘stapled’’ to a H&R unit) unless there is an event of uncoupling. Any references in this MD&A to units should be
considered references to Stapled Units. As part of the Plan of Arrangement, H&R 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 H&R to perform its obligations pursuant to H&R’s Declaration of Trust, Unit Option Plan,
Incentive Unit 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 H&R to perform its obligations arising under any security issued by H&R
(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 H&R 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 H&R units and to otherwise ensure at all times that each holder of a particular number of H&R 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 H&R issues additional H&R units, pursuant to the Support Agreement, H&R and Finance Trust will coordinate so as to ensure that each
subscriber receives both H&R units and Finance Trust units, which shall trade together as Stapled Units. Prior to such event, H&R 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 H&R directs. In consideration of the issuance and delivery of each such Finance Trust unit, H&R (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 H&R) 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 H&R units by H&R. 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 H&R vote in favour of the uncoupling of units of Finance
Trust and units of H&R 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 H&R or U.S. Holdco or the taking of corporate
action by H&R or U.S. Holdco in furtherance of any such action or the admitting in writing by H&R 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 H&R and, unless an Event
of Uncoupling has occurred, the Stapled Units, on one or more stock exchanges in Canada.
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
Page 4 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
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.
CHANGE IN ACCOUNTING POLICY
Except as described below, the accounting policies applied by the Trusts as at and for the year ended December 31, 2016, are the same as those applied
in the Trusts’ Financial Statements as at and for the year ended December 31, 2015. The Trusts’ Financial Statements reflect the retrospective application
of a voluntary change in accounting policy adopted in 2016 to classify interest paid and finance cost-exchangeable unit distributions as an operating activity
in the combined statements of cash flows, instead of within financing activities, as previously reported. The change in accounting policy was adopted in
accordance with IAS 7, Statement of Cash Flows, which provides a policy choice to classify interest paid as either an operating activity or a financing
activity. H&R considers the classification of these interest payments within operating activities to be the most useful to financial statement users when
comparing distributions to cash provided by operations and, consequently, that this presentation results in reliable and more relevant information.
The following table outlines the effect of this accounting policy change for the year ended December 31, 2015:
Cash provided by operating activities
Cash used in financing activities
SECTION II
SUMMARY OF QUARTERLY RESULTS
Previously
reported
771,542
(466,202)
Restatement
(304,188)
304,188
Restated
$467,354
($162,014)
The following tables summarize certain financial information of the Trusts per the Trusts’ financial statements for the quarters indicated below:
(in thousands of Canadian dollars)
Rentals from investment properties
Net income (loss) from equity accounted investments
Finance income
Net income
Total comprehensive income (loss)
Rentals from investment properties
Net income (loss) from equity accounted investments
Finance income
Net income (loss)
Total comprehensive income
Q4
2016
$305,500
82,176
925
140,616
180,987
Q4
2015
$296,236
(39,017)
1,225
(39,454)
15,342
Q3
2016
$297,258
4,758
854
113,865
139,798
Q3
2015
$297,055
20,884
986
165,949
249,903
Q2
2016
$289,835
(19,722)
1,694
104,079
88,387
Q2
2015
$295,688
9,493
811
119,554
102,995
Q1
2016
$303,418
(18,871)
1,242
30,185
(58,794)
Q1
2015
$299,335
9,481
748
94,099
199,369
Page 5 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
Fluctuations between quarterly results are generally from new property acquisitions, dispositions, changes in foreign exchange rates and changes in the
fair value of real estate assets and the fair value of liabilities. Revenues may also have significant fluctuations due to recoveries from tenants for
changes to property operating costs depending on when major maintenance projects are incurred.
Net income (loss) from equity accounted investments increased by $77.4 million in Q4 2016 compared to Q3 2016 primarily due to the fair value adjustment
on real estate assets increasing by $53.3 million mainly due to the value of the LIC Project increasing by U.S. $54.9 million at H&R’s interest. An
independent third party appraisal was obtained for this property in Q4 2016.
Net income (loss) from equity accounted investments increased by $121.2 million in Q4 2016 compared to Q4 2015 primarily due to the fair value
adjustment on real estate assets increasing by $100.5 million, the majority of which relates to the value of the LIC Project increasing by U.S. $54.9 million
at H&R’s interest, and a fair value write-down in Q4 2015 to F1RST Tower in Calgary as a result of higher expected vacancies due to an overall weakening
of the Alberta economy.
Net income increased by $180.1 million in Q4 2016 compared to Q4 2015 primarily due to the following: (i) an increase in the fair value adjustment on real
estate assets in particular relating to several investment properties in Alberta that had been written down in Q4 2015 due to the overall weakening of the
Alberta economy and (ii) an increase in net income (loss) in equity accounted investments as explained above.
Total comprehensive income increased by $165.6 million in Q4 2016 compared to Q4 2015 primarily due to the increase in net income explained above
offset by a decrease in the unrealized gain on translation of U.S. denominated foreign operations.
SELECTED ANNUAL INFORMATION
The following table summarizes certain financial information of the Trusts per the Trusts’ Financial Statements for the years indicated below:
(in thousands of Canadian dollars except per unit amounts)
Rentals from investment properties
Finance income
Net income
Total comprehensive income
Total assets
Total non-current financial liabilities(1)
Cash distributions per unit
Year Ended
December 31,
2016
$1,196,011
4,715
388,745
350,378
14,155,012
5,186,536
$1.35
Year Ended
December 31,
2015
$1,188,314
3,770
340,148
567,609
13,990,315
5,771,833
$1.35
Year Ended
December 31,
2014
$1,227,803
901
424,655
515,190
13,368,380
5,226,705
$1.35
(1) The total non-current financial liabilities includes mortgages payable, the face value of debentures payable, bank indebtedness and accounts payable and accrued liabilities.
Page 6 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
FINANCIAL HIGHLIGHTS
(in thousands except per unit amounts)
Total assets(1)
Ratio of debt to total assets per the Trusts’ Financial
Statements(2)
Ratio of debt to total assets based on the Trusts’ interests(1)
Unencumbered asset to unsecured debt coverage ratio(1)
Stapled Units outstanding
Exchangeable units outstanding
Rentals from investment properties(1)
Same-Asset property operating income (cash basis)(1)(3)
FFO(1)
Weighted average number of basic Stapled Units for FFO(1)
FFO per basic Stapled Unit(1)
Distributions paid per Stapled Unit
Payout ratio per Stapled Unit as a % of FFO(1)
Interest coverage ratio(1)
December 31,
2016
$14,736,194
December 31,
2015
$14,714,535
December 31,
2014
$13,941,980
December 31,
2013
$14,107,004
44.3%
46.0%
1.78
285,280
16,564
46.2%
48.4%
1.41
279,610
16,664
46.3%
48.1%
1.30
274,773
16,664
49.2%
50.8%
1.05
269,975
17,403
Three months ended
December 31,
2016
Three months ended
December 31,
2015
Year ended
December 31,
2016
Year ended
December 31,
2015
$327,851
196,101
142,899
300,482
0.48
0.34
70.8%
3.00
$331,331
199,127
142,879
294,944
0.48
0.34
70.8%
2.82
$1,310,168
776,314
584,301
298,404
1.96
1.35
68.9%
2.91
$1,320,287
774,307
569,943
293,026
1.95
1.35
69.2%
2.84
Property operating income and net income are reconciled to FFO which is reconciled to AFFO. AFFO is reconciled to cash provided by operations, being the most comparable GAAP financial
measure to these non-GAAP financial measures. See pages 30-36.
(1)
(2)
(3)
These are non-GAAP measures reported at the Trusts’ interests. See “Non-GAAP Financial Measures” on pages 2 and 3.
This is a non-GAAP measure. See “Non-GAAP Financial Measures” on pages 2 and 3;
Same-Asset property operating income (cash basis) includes properties owned by H&R for the two-year period ended December 31, 2016 and excludes the impact of straight-lining of
contractual rent as well as realty taxes accounted for under IFRIC 21.
KEY PERFORMANCE DRIVERS
OPERATIONS(1)
Occupancy as at December 31
Occupancy – Same-Asset as at December 31(2)
Average contractual rent per sq.ft. for the year
ended December 31-Canadian properties(3)
Average contractual rent per sq.ft. for the year
ended December 31-U.S. properties(4)
Average remaining term to maturity of leases
as at December 31 (in years)
Average remaining term to maturity of mortgages
payable as at December 31 (in years)
Office
Primaris
96.9%
98.0%
96.9%
98.0%
$26.12
$26.20
$35.07
$34.03
12.6
13.1
5.2
5.9
87.4%
87.1%
87.4%
87.1%
$23.83
$24.32
N/A
N/A
4.6
4.5
4.3
5.6
H&R
Retail
98.6%
98.7%
98.6%
98.6%
$11.70
$11.52
$13.25
$12.87
7.1
7.5
5.8
5.0
ECHO
Industrial
Lantower
Residential
94.3%
94.5%
93.7%
94.0%
N/A
N/A
$15.01
$14.43
11.3
11.7
11.1
11.2
99.8%
99.0%
99.8%
99.6%
$6.52
$6.31
$3.64
$3.49
7.5
7.8
6.4
6.9
93.1%
93.8%
92.7%
95.5%
N/A
N/A
$14.04
$12.76
N/A
N/A
8.3
9.3
Total*
95.7%
95.9%
95.8%
96.1%
$18.32
$18.80
$14.59
$13.96
9.5
9.9
5.7
6.2
2016
2015
2016
2015
2016
2015
2016
2015
2016
2015
2016
2015
*
(1)
(2)
(3)
(4)
Weighted average total.
Includes properties held within equity accounted investments and investment properties classified as assets held for sale.
Same-Asset refers to those properties owned by H&R for the two-year period ended December 31, 2016.
All amounts are stated in Canadian dollars and exclude properties sold in their respective year.
All amounts are stated in U.S. dollars and exclude properties sold in their respective year.
Page 7 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
PORTFOLIO OVERVIEW
The geographic diversification of the portfolio of properties in which the Trusts have an interest and their related square footage, including those properties
held in entities that the Trusts account for as equity accounted investments as at December 31, 2016, are outlined in the charts below:
Number of Properties
Office
Primaris
H&R Retail
ECHO(1)
Industrial
Lantower Residential(2)
Total
Square Feet (in thousands)(3)
Office
Primaris
H&R Retail
ECHO(1)
Industrial
Lantower Residential(2)
Total
Ontario
21
6
35
-
38
-
100
Ontario
6,424
2,394
1,771
-
4,683
-
15,272
Canada
Alberta
5
18
2
-
18
-
43
Canada
Alberta
2,961
3,939
240
-
1,895
-
9,035
Other
4
7
7
-
30
-
48
Other
893
2,416
707
-
2,053
-
6,069
United States
7
-
82
215
15
12
331
United States
2,023
-
4,664
2,979
3,152
3,538
16,356
Total
37
31
126
215
101
12
522
Total
12,301
8,749
7,382
2,979
11,783
3,538
46,732
(1) ECHO also has four development projects and five parcels of vacant land areas which are not included in the table above.
(2) Lantower Residential’s properties contain 3,832 apartment units.
(3) Square feet (in thousands) is based on the Trusts’ interest in the net leasable area of properties.
Page 8 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
LEASE MATURITY PROFILE
The following tables disclose H&R’s leases expiring in Canada and the United States including equity accounted investments but excluding Lantower
Residential.
Canadian Portfolio:
LEASE EXPIRIES
2017
2018
2019
2020
2021
Office
Primaris
H&R Retail
Industrial
Total
Rent per
sq.ft. ($)
on expiry
28.42
Rent per
sq.ft. ($)
on expiry
27.81
Sq.ft.
833,568
Sq.ft.
36,354
19.55
1,172,840
23.62
163,718
20.35
24.83
17.75
953,302
999,460
889,818
20.41
1,007,577
20.65
23.46
96,715
567,110
Rent per
sq.ft. ($)
on expiry
16.54
11.12
10.49
15.32
12.56
Sq.ft.
175,525
418,075
507,147
174,026
425,424
Rent per
sq.ft. ($)
on expiry
7.94
4.93
5.90
8.30
5.83
Sq.ft.
1,165,630
2,715,265
3,296,893
1,963,379
2,159,301
Sq.ft.
120,183
960,632
828,867
693,178
276,949
1,700,197
20.79
4,848,988
23.07
1,871,474
11.54
2,879,809
6.23 11,300,468
Rent per
sq.ft. ($)
on expiry
25.50
15.63
13.72
16.40
17.21
16.53
Total % of each segment
16.5%
55.4%
68.8%
33.4%
37.2%
U.S. Portfolio(1):
LEASE EXPIRIES
2017
2018
2019
2020
2021
Total % of each segment
(1)
U.S. dollars.
Office
H&R Retail
ECHO
Industrial
Total
Rent per
sq.ft. ($)
on expiry
-
Sq.ft.
-
-
-
-
-
-
-
-
-
-
-
-
Rent per
sq.ft. ($)
on expiry
12.98
13.05
11.10
39.66
13.02
14.42
Rent per
sq.ft. ($)
on expiry
9.47
12.62
13.14
6.69
16.88
Rent per
sq.ft. ($)
on expiry
-
2.98
3.69
-
Sq.ft.
-
493,506
242,785
-
Sq.ft.
430,186
964,628
758,603
446,029
606,143
3.13
1,039,456
10.49
1,342,434
3.18
3,638,902
42.6%
28.4%
Rent per
sq.ft. ($)
on expiry
11.46
7.83
8.99
14.27
7.80
9.28
Sq.ft.
186,479
141,730
98,791
343,490
146,219
916,709
30.8%
Sq.ft.
243,707
329,392
417,027
102,539
287,094
1,379,759
29.6%
Page 9 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
TOP TWENTY SOURCES OF REVENUE BY TENANT(1)
Tenant
% of rentals
from investment
properties(2)
Number of
locations
H&R owned
sq.ft. (in 000’s)
Average lease
term to maturity
(in years)(3)
Credit Ratings
(S&P)
Encana Corporation
Bell Canada
Hess Corporation
New York City Department of Health
Giant Eagle, Inc.
Canadian Tire Corporation(4)
Lowe's Companies, Inc.(5)
TransCanada Pipelines Limited
Canadian Imperial Bank of Commerce
1.
2.
3.
4.
5.
6.
7.
8.
9.
10. Corus Entertainment Inc.
11. Telus Communications
12. Nestle Canada and USA
13. Ontario Realty Corporation and other Ontario Agencies(6)
14. Shell Oil Products
15. Marsh Supermarkets
16.
17. Public Works and Government Services, Canada
18. Toronto-Dominion Bank
19. Royal Bank of Canada
20. Publix Super Markets Inc
Loblaw Companies Limited(7)
Total
(1)
Includes the Trusts’ interests in equity accounted investments.
11.8%
8.0
5.0
3.6
3.5
2.5
2.5
1.9
1.7
1.6
1.6
1.5
1.2
1.1
1.0
0.9
0.9
0.9
0.8
0.8
52.8%
2
24
2
1
192
19
22
2
9
1
17
4
4
17
9
21
5
8
4
14
377
2,059
2,542
848
660
1,961
2,666
2,664
499
555
472
425
1,255
366
223
548
302
309
259
244
531
19,388
BBB Negative
BBB+ Stable
BBB- Stable
AA Stable
Not Rated
BBB+ Stable
A- Stable
A- Negative
A+ Stable
BB Stable
BBB+ Stable
AA Stable
A+ Stable
A Stable
Not Rated
BBB Stable
AAA Stable
AA- Stable
AA- Negative
Not Rated
20.9
8.6
(8)
13.9
13.2
8.7
3.2
13.8
7.3
16.2
6.4
7.1
3.6
5.5
14.3
9.2
5.8
9.8
7.6
9.5
12.0
(2) The percentage of rentals from investment properties is based on estimated annualized Same-Asset gross revenue excluding straight-lining of contractual rent, rent amortization of tenant
inducements and capital expenditure recoveries.
(3) Average lease term to maturity is weighted based on net rent.
(4) Canadian Tire Corporation includes Canadian Tire, Mark’s, Sport Chek, Atmosphere and Sports Experts.
(5) Lowe’s Companies, Inc. includes Rona.
(6) Other Ontario agencies include: Legal Aid Ontario, Ontario Lottery and Gaming Corporation, Liquor Control Board of Ontario and Hydro One Networks.
(7) Loblaw Companies Limited includes Loblaw, No Frills and Shoppers Drug Mart.
(8) Due to the confidentiality under the tenant lease, the term is not disclosed.
Page 10 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
FINANCIAL AND OPERATING HIGHLIGHTS 2016
Financial Highlights
H&R undertook a strategic review of its assets and decided to sell certain investment properties to take advantage of the strong property market and high
demand for good quality assets. During 2015 and 2016, H&R sold $1.3 billion of real estate assets and acquired $757.5 million of real estate assets for a
net decrease of $542.5 million, at H&R’s ownership share. This had the following impact on H&R’s financial results at the Trusts’ interests:
Rentals from investment properties decreased by $10.1 million for the year ended December 31, 2016 compared to the respective 2015 period.
Property Operating income decreased by $19.6 million for the year ended December 31, 2016 compared to the respective 2015 period.
FFO, excluding non-recurring items, decreased by $5.9 million for the year ended December 31, 2016 compared to the respective 2015 period.
FFO per unit, excluding non-recurring items, was $1.88 for the year ended December 31, 2016 compared to $1.93 per unit for the year ended
December 31, 2015.
While financial results have declined over the past two years due to net property sales, H&R has used the net proceeds from those sales to significantly
improve its financial position which has resulted in the following:
As at December 31, 2016, the debt to total asset ratio per the Trusts’ Financial Statements was 44.3% compared to 46.2% at December 31,
2015.
Interest coverage ratio was 3.00 for the three months ended December 31, 2016 compared to 2.82 for the three months ended December 31,
2015.
As at December 31, 2016, unencumbered assets were approximately $3.0 billion and unsecured debt was approximately $1.7 billion, resulting
in a coverage ratio of 1.8x (December 31, 2015 - 1.4x).
Operating Highlights
Occupancy as at December 31, 2016 was 95.7% compared to 95.9% as at December 31, 2015. Leases representing only 3.7% of total rentable area will
expire during 2017 and H&R’s average remaining lease term to maturity as at December 31, 2016 was 9.5 years (in each case, excluding leases from
Lantower Residential).
SUMMARY OF SIGNIFICANT 2016 ACTIVITY
Development Highlights
Construction is progressing on the development of 1,871 luxury residential rental units for the LIC Project in which H&R has a 50% interest. The total
budget at the 100% ownership level is expected to be approximately U.S. $1.2 billion with occupancy in the first tower scheduled to begin in early 2018.
As at December 31, 2016, total costs incurred amounted to $655.3 million. The remaining costs are expected to be funded through the construction
financing facility. Approximately 99.3% of total hard costs and 89.9% of total project costs have been fixed. Upon completion and stabilized occupancy,
the contribution to FFO from the LIC Project at H&R’s interest is projected to be U.S. $23.0 million, which equates to an approximate 8.8% year one yield
on H&R’s cash investment. During the year, the fair value of the LIC Project increased by U.S. $54.9 million, at H&R’s interest. An independent third party
appraisal was obtained for this property in 2016.
In Q1 2016, H&R entered into two separate 15-year build-to-suit leases for industrial properties to be developed in the Airport Road Business Park in
Brampton, ON for Sleep Country Canada and Solutions 2 Go Inc. The total net leasable area for these properties will be approximately 341,775 square
feet with occupancy of both projects expected to occur in Q3 2017. Upon completion, the contribution to FFO generated from these two projects is expected
to be $1.7 million.
In August 2016, H&R acquired a 31.7% non-managing interest in 38.4 acres of land located in Hercules, California, adjacent to the San Pablo Bay,
northeast of San Francisco, (“Hercules Project”) for the future development of multi-family residential units. The initial investment to purchase the land was
approximately U.S. $10.0 million (at H&R’s interest).
Office Segment Highlights
On June 30, 2016, H&R sold its 33.3% freehold and leasehold interests in Scotia Plaza and 100 Yonge Street (collectively, “Scotia Plaza”) for approximately
$438.3 million. The purchaser assumed H&R’s share of the existing financing on the properties. H&R recorded a gain on sale, net of related costs, of
$15.0 million. Proceeds to H&R amounted to $227.0 million, which were primarily used to repay debt including the $180.0 million Series D Senior
Debentures that matured in July 2016.
On November 17, 2016, H&R sold a non-managing 50% interest in the TransCanada Tower in Calgary, AB for gross proceeds of approximately $257.4
million. H&R built this property in 2001 for a total cost of $265.8 million, at the 100% level. H&R prepaid the entire mortgage on the property of $93.5
Page 11 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
million upon closing, which included a prepayment penalty of $13.6 million. H&R recorded a loss on sale, net of related costs, of $7.4 million. Proceeds
to H&R amounted to $163.9 million, which were primarily used to repay debt and acquire a multi-family residential property.
Alberta Office Exposure:
The weighted average lease term remaining in H&R’s Alberta office portfolio is 17.2 years. The leases expiring between January 1, 2017 and December
31, 2018 in H&R’s Alberta office portfolio total 18,507 square feet. As at December 31, 2016, H&R’s Alberta office portfolio had approximately 184,000
square feet of vacant space, at H&R’s ownership share, all of which is in F1RST Tower (formerly Telus Tower). Of this vacant space, 12,667 square feet
has been leased for a six-year term commencing January 1, 2017.
H&R Retail Highlights
During 2016, H&R sold its 100% interest in five retail properties, totaling 490,839 square feet, all of which were located in the U.S. for U.S. $61.8 million.
Primaris Highlights and Target Update
Primaris Highlights:
In November 2016, H&R entered into a conditional agreement to sell a 50% non-managing interest in two enclosed shopping centres for $211.6 million
which closed in January 2017. The purchaser assumed 50% of the existing financing on the properties of approximately $126.6 million. The net proceeds
of approximately $81.0 million have been used to repay debt.
Target Update:
Redevelopment of the former Target stores has commenced, however, the space has not been transferred to properties under development because the
space is part of an existing, already developed property. For the year ended December 31, 2016, H&R spent approximately $31.0 million in redevelopment
and, in addition, capitalized $2.4 million of the property operating and finance costs attributable to this space. The following table is a summary of H&R’s
leasing progress on the former Target space:
Former Target Canada space(1)
Backfill progress:
Committed space
Conditional agreements
Advanced discussions
Total backfill progress
Space currently being marketed
Total gross leasable area (“GLA”) upon completion of redevelopment
Potential GLA converted for landlord uses (common area etc.)
Space for demolition/potential redevelopment
Total(2)
Square Feet at
100%
Square Feet at
H&R’s Interest
1,062,676
774,035
Annual Base Rent at
H&R’s interest
($ Millions)
$4.0
583,989
191,364
44,215
819,568
49,759
869,327
135,508
57,841
1,062,676
404,270
176,364
25,645
606,279
32,593
638,872
106,242
28,921
774,035
6.4
1.5
0.8
8.7
0.6
$9.3
N/A
N/A
(1)
(2)
The above table is disclosed as of February 6, 2017 and H&R’s interest has been updated to reflect the 50% sale of two enclosed shopping centres which closed in January 2017.
Represents square footage based on current redevelopment plans and is subject to change based on tenant demand.
H&R expects that, once the above leasing is complete, the new tenants will contribute approximately $9.3 million annually or 225% of the total base rental
revenue lost through Target’s departure. H&R expects most of the remaining leases will be entered into by Q2 2017, with occupancy occurring between
2017 and early 2019. Throughout 2016, committed space tenants occupied 73,736 square feet and contributed $0.4 million in base rent at H&R’s interest.
The total remaining cost of subdividing and re-leasing the premises is expected to be approximately $78.0 million at H&R’s ownership interest. A partial
lease settlement from Target of $20.4 million was received and recognized in the Trusts’ Financial Statements as Other Income for the year ended
December 31, 2016.
Page 12 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
Lantower Residential Highlights
H&R is continuing its expansion into the multi-family rental market in the United States. During 2016, Lantower Residential acquired four multi-family
properties in the United States, all of which were built between 2012 and 2015. These properties comprise 1,246 units and were purchased for a total
price of U.S. $232.2 million.
As at December 31, 2016, Lantower Residential has a portfolio of 12 properties, comprised of an aggregate of 3,832 units, an average age of 13 years
and an average monthly rent of U.S. $1,081 per unit.
Industrial Segment Highlights
In February 2016, H&R acquired a 50% managing interest in a 264,802 square foot newly constructed industrial property in Calgary, AB for $15.5 million
(at H&R’s interest).
During 2016, H&R sold its 50% ownership interest in a 139,734 square foot industrial property in Montreal, QC for $4.2 million and its 50% ownership
interest in a 52,792 square foot industrial property in Vaughan, ON for $3.0 million.
Debt and Liquidity Highlights
H&R repaid all of the outstanding Series D Senior Debentures upon maturity for a cash payment of $180.0 million in July 2016 and all of the outstanding
2016 Convertible Debentures upon maturity for a cash payment of $75.0 million in December 2016. In November 2016, H&R issued $200.0 million principal
amount of 2.923% Series L Senior Debentures maturing May 6, 2022.
During 2016, H&R (excluding ECHO) secured 12 new mortgages and secured an increase to an existing mortgage adding a total of $191.1 million of debt
at a weighted average interest rate of 2.9% for an average term of 5.1 years and repaid 48 mortgages, which had a weighted average interest rate of 4.9%
upon maturity totalling $629.2 million. The current weighted average interest rate on outstanding debt is 4.3% with an average term to maturity of 4.8
years.
As at December 31, 2016, the debt to total asset ratio per the Trusts’ Financial Statements was 44.3% compared to 46.2% at December 31, 2015 and
cash on hand plus undrawn credit facilities amounted to $400.3 million.
As at December 31, 2016, unencumbered assets were approximately $3.0 billion and unsecured debt was approximately $1.7 billion, resulting in a
coverage ratio of 1.8x (December 31, 2015 - 1.4x).
Distribution Increase
The trustees approved an increase in the current monthly distribution per Stapled Unit commencing December 2016, resulting in a $0.03 annual increase
to a total of $1.38 per annum.
Page 13 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
SECTION III
FINANCIAL POSITION
(in thousands of Canadian dollars)
Assets
Real estate assets
Investment properties
Properties under development
Equity accounted investments
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
Liabilities classified as held for sale
Loan payable
Bank indebtedness
Accounts payable and accrued liabilities
Non-controlling interest
Unitholders’ equity
December 31, 2016
December 31, 2015
Amounts per
the Trusts’
Financial
Statements
Equity
accounted
investments
The Trusts’
interests(1)
Amounts per
the Trusts’
Financial
Statements
Equity
accounted
investments
The Trusts’
interest(1)
$12,564,144
$1,046,539
$13,610,683
$12,576,075
$1,512,361
$14,088,436
118,268
510,527
628,795
97,504
226,494
323,998
12,682,412
1,557,066
14,239,478
12,673,579
1,738,855
14,412,434
1,051,187
(1,051,187)
-
1,117,786
(1,117,786)
211,550
161,842
48,021
-
41,000
34,303
211,550
202,842
82,324
3,000
157,663
38,287
-
53,200
49,951
-
3,000
210,863
88,238
$14,155,012
$581,182
$14,736,194
$13,990,315
$724,220
$14,714,535
$4,001,451
$328,812
$4,330,263
$4,537,278
$572,669
$5,109,947
1,491,591
370,533
386,775
126,815
-
647,772
217,425
-
7,242,362
6,912,650
-
-
167
-
-
181,250
51,591
19,362
1,491,591
1,550,769
370,533
386,942
126,815
-
829,022
269,016
19,362
334,110
189,658
-
55,717
321,033
176,830
-
-
-
-
-
-
90,058
40,884
20,609
1,550,769
334,110
189,658
-
55,717
411,091
217,714
20,609
581,182
7,823,544
7,165,395
724,220
7,889,615
-
6,912,650
6,824,920
-
6,824,920
$14,155,012
$581,182
$14,736,194
$13,990,315
$724,220
$14,714,535
(1)
“The Trusts’ interests” is a non-GAAP measure which includes amounts per the Trusts’ Financial Statements and the Trusts’ proportionate share of equity accounted investments.
Properties under development per the Trusts’ Financial Statements as at December 31, 2016 increased by $20.8 million compared to December 31, 2015,
primarily due to the development of two buildings in the Airport Road Business Park. Refer to page 18 in this MD&A for further information.
Equity accounted investments per the Trusts’ Financial Statements as at December 31, 2016 decreased by $66.6 million compared to December 31, 2015,
primarily due to the sale of H&R’s interest in Scotia Plaza, offset by the development of the LIC Project and the acquisition of land for the Hercules Project.
Mortgages payable per the Trusts’ Financial Statements as at December 31, 2016 decreased by $535.8 million compared to December 31, 2015, primarily
due to the REIT repaying mortgages upon sale and maturity of $338.8 million, principal repayments of $151.0 million, mortgages reclassified to liabilities
held for sale of $126.6 million partially offset by new mortgages of $131.9 million.
Deferred tax liability per the Trusts’ Financial Statements as at December 31, 2016 increased by $197.1 million compared to December 31, 2015, primarily
due to increases in the fair value of U.S. investment properties resulting in higher deferred tax.
Bank indebtedness per the Trusts’ Financial Statements as at December 31, 2016 increased by $326.7 million compared to December 31, 2015, primarily
due to H&R using its banking credit facilities to repay mortgages and fund certain U.S. acquisitions.
Page 14 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
ASSETS
Real Estate Assets:
2016 Acquisitions:
Property/Acquisition
283009 Logistics Dr., Calgary, AB(1)(2)
3767 Southwest Durham Dr., Durham, NC
Hercules Bayfront, Hercules, CA(1)
4025 Huffines Blvd., Carrollton, TX
4504 W. Spruce St., Tampa, FL
327 W. Sunset Rd., San Antonio, TX
Total
(1) Purchase price is stated at H&R’s ownership interest.
(2) The square footage at H&R’s interest is 132,401.
(3) Translated to Canadian dollars as at the date acquired.
Segment
Date
Acquired
Number
Of Units
Purchase
Price
($ Millions)
Ownership
Interest
Acquired
Year
Built
2014
2014
Industrial
Feb 23, 2016
Multi-family
Jun 22, 2016
-
Multi-family-Dev.
Aug 10, 2016
2012
2014
2015
Multi-family
Aug 15, 2016
Multi-family
Oct 19, 2016
Multi-family
Nov 30, 2016
-
322
-
312
300
312
$15.5
76.8(3)
13.0(3)
59.9(3)
90.6(3)
76.2(3)
50%
100%
31.7%
100%
100%
100%
1,246
$332.0
During the year ended November 30, 2016, ECHO acquired four properties, four properties under development and two land parcels totaling 94,872 square
feet for a purchase price of $21.7 million, at H&R’s interest.
2015 Acquisitions:
Property
8401 Memorial Lane, Plano, TX
12932 Mallory Circle, Orlando, FL
12101 Fountainbrook Blvd., Orlando, FL
1801 Warner Ranch Rd., Round Rock, TX
325 Murray Farm Rd., Fairview, TX
125 & 175 Fountain Crt., Fairview, TX
Total
(1)
Translated to Canadian dollars as at the date acquired.
Year
Built
2008
2004
2000
2001
2008
2008
Segment
Date
Acquired
Number
Of Units
Purchase
Price
($ Millions)(1)
Ownership
Interest
Acquired
Multi-family
Feb 10, 2015
Multi-family
Apr 15, 2015
Multi-family
Apr 21, 2015
Multi-family
Oct 8, 2015
Multi-family
Oct 28, 2015
Multi-family
Oct 28, 2015
398
314
400
358
304
116
$65.8
61.0
65.5
61.5
57.4
19.1
100%
100%
100%
100%
100%
100%
1,890
$330.3
During the year ended November 30, 2015, ECHO acquired nine properties, two properties under development and four land parcels totaling 215,225
square feet for a purchase price of $73.5 million, at H&R’s interest.
Page 15 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
450-1st St. S.W., (TransCanada Tower) Calgary, AB(2)
Office
Nov 17, 2016
465,594
Total
1,906,460
$790.6
(1) Sold as separate condominium units.
(2) Square feet and selling price are based on the ownership interest disposed.
(3) Translated to Canadian dollars as at the date sold.
During the year ended November 30, 2016, ECHO sold a 34,815 square foot property for gross proceeds of $2.2 million, at H&R’s interest.
2016 Dispositions:
Property
2800 Skymark Ave., Mississauga, ON(1)
1929 N.E. Pine Island Rd., Cape Coral, FL
733 Pleasant Hill Rd., Lilburn, GA
1 Moyal Ct., Vaughan, ON(2)
150 New Jersey State Hwy Route 73, Voorhees, NJ
3712 Call Field Rd., Wichita Falls, TX
Scotia Plaza, Toronto, ON(2)
20600 Clark-Graham Ave., Montreal, QC(2)
110 S. Southwest Loop #323, Tyler, TX
3900 Gantz Rd., Grove City, OH(2)
2015 Dispositions:
Property
1400 Church St., Pickering, ON
2800 Skymark Ave., Mississauga, ON(1)
Industrial Portfolio - Tranche 2(2)(3)
6315 Kenway Dr., Mississauga, ON(2)
1 Kenview Blvd., Brampton, ON
44285 Ice Rink Plaza, Ashburn, VA
46651 Algonkian Pkwy., Sterling, VA
4527 Losee Rd., Las Vegas, NV
360 Spinnaker Way, Vaughan, ON(2)
7900 Airport Rd., Brampton, ON(4)
11 Kenview Blvd., Brampton, ON(2)
Total
Segment
Date
Sold
Square
Feet
Selling Price
($ Millions)
Ownership
Interest Sold
Office
Q1-Q4 2016
22,940
H&R Retail
Mar 28, 2016
119,598
H&R Retail
Mar 30, 2016
132,847
Industrial
Apr 7, 2016
26,396
H&R Retail
Apr 11, 2016
115,396
H&R Retail
May 19, 2016
108,178
Office
Jun 30, 2016
743,812
Industrial
Aug 31, 2016
H&R Retail
Sep 26, 2016
Industrial
Oct 27, 2016
69,867
14,820
87,012
$3.2
24.1(3)
6.0(3)
3.0
24.8(3)
14.7(3)
438.3
4.2
11.2(3)
3.7(3)
257.4
100%
100%
100%
50%
100%
100%
33.3%
50%
100%
50.5%
50%
Segment
Date
Sold
Square
Feet
Selling Price
($ Millions)
Ownership
Interest Sold
Industrial
Jan 29, 2015
716,261
Office Q1 and Q2 2015
11,098
$70.2
5.3
100%
100%
Industrial
Mar 24, 2015
3,497,440
239.6
49.5%-50%
Industrial
Apr 13, 2015
Office
May 28, 2015
H&R Retail
Jun 25, 2015
H&R Retail
Jun 25, 2015
Industrial
Jun 26, 2015
34,339
74,338
13,815
16,838
50,659
Industrial
Oct 9, 2015
31,429
Development
Dec 3, 2015
-
Industrial
Dec 8, 2015
72,118
3.7
6.3
10.5(5)
12.3(5)
5.5(5)
103.0
5.3
10.3
5.9
50%
100%
100%
100%
100%
100%
75%
100%
50%
4,832,368
$477.9
14111-14300 Entertainment Blvd. & 14140 Triangle Rd., Richmond, BC
H&R Retail
Sep 1, 2015
314,033
(1) Sold as separate condominium units.
(2) Square feet and selling price are based on the ownership interest disposed.
(3) H&R retained an ownership interest of 50%-50.5% in these properties.
(4) Part of Block 2, Plan 43M-1939, designated as Parts 9-11, Plan 43R-35791 which consisted of approximately 11.8 acres of land.
(5) Translated to Canadian dollars as at the date sold.
During the year ended November 30, 2015, ECHO sold three properties totaling 74,177 square feet for gross proceeds of $3.3 million, at H&R’s interest.
Page 16 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
Investment Properties by Segment and Region:
The following tables disclose the fair values of the Trusts’ interests in investment properties by operating segment and geographic location, excluding
assets held for sale:
Segment (millions)
Office
Primaris
H&R Retail
ECHO
Industrial
Lantower Residential
Total portfolio
Region (millions)
Ontario
Alberta
Other
Canada
United States
Total portfolio
Fair Value
December 31, 2016(1)
Fair Value
December 31, 2015(1)
$6,496
2,943
1,547
768
1,102
755
$13,611
$7,043
3,205
1,621
734
1,062
423
$14,088
Fair Value
December 31, 2016(1)
Fair Value
December 31, 2015(1)
$4,144
3,539
1,323
9,006
4,605
$13,611
$4,649
3,916
1,432
9,997
4,091
$14,088
(1) Please refer to note 4 of the Trusts’ Financial Statements for the assumptions and methods used in measuring the fair value of the portfolio.
The following weighted average capitalization rates as at December 31, 2016 are calculated based on stabilized property operating income at the Trusts’
interests, excluding assets held for sale, for the three months ended December 31, 2016 (December 31, 2015 - based on the three months ended December
31, 2015). The capitalization rates disclosed below are reported at the Trusts’ interests and include equity accounted investments which differs from the
Trusts’ Financial Statements.
Weighted Average Overall Capitalization Rates
Office
Primaris H&R Retail
ECHO
Industrial Residential
Canada
United States
5.92%
5.27%
5.53%
-
6.61%
7.09%
-
6.77%
6.41%
7.02%
-
5.39%
December 31, 2016
Weighted Average Overall Capitalization Rates
Office
Primaris H&R Retail
ECHO
Industrial
Residential
Canada
United States
5.96%
6.34%
5.56%
-
6.76%
7.36%
-
6.86%
6.79%
6.84%
-
5.82%
December 31, 2015
Total
5.88%
6.06%
Total
5.94%
6.68%
Page 17 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
Properties under Development
Long Island City Project
In June 2014, H&R purchased a 50% interest in the LIC Project. Tishman Speyer, a U.S. real estate company, is the developer and manager of the LIC
Project. The parcel is zoned for 1.3 million square feet of mixed-used development, potentially accommodating up to approximately 1,871 luxury residential
rental units and approximately 14,000 square feet of retail space. The site is located adjacent to H&R’s Two Gotham Center office property. Construction
commenced in Q1 2015 with occupancy in the first tower expected to begin in early 2018. H&R’s total cash investment in the LIC Project is $260.7 million.
The total project cost of all phases at the 100% level is expected to be approximately U.S. $1.2 billion. As at December 31, 2016, total costs incurred
amounted to $655.3 million. The remaining costs are expected to be funded through the construction financing facility. Approximately 99.3% of total hard
costs and 89.9% of total project costs have been fixed. Upon completion and stabilized occupancy, the contribution to FFO from the LIC Project at H&R’s
interest is projected to be U.S. $23.0 million, which equates to an approximate 8.8% year one yield on H&R’s cash investment. During the year, the fair
value of the LIC Project increased by U.S. $54.9 million, at H&R’s interest. An independent third party appraisal was obtained for this property in 2016.
Development of Airport Road Project
In Q1 2016, H&R entered into two separate 15-year build-to-suit leases for industrial properties to be developed in the Airport Road Business Park in
Brampton, ON for Sleep Country Canada and Solutions 2 Go Inc. The total net leasable area for these properties will be approximately 341,775 square
feet with occupancy of both projects expected to occur in Q3 2017. Upon completion, the contribution to FFO from these two projects is expected to be
$1.7 million.
Hercules Project
In August 2016, H&R acquired a 31.7% non-managing interest in 38.4 acres of land located in Hercules, California, adjacent to the San Pablo Bay,
northeast of San Francisco, for the future development of multi-family residential units. The initial investment to purchase the land was approximately U.S.
$10.0 million (at H&R’s interest).
ECHO
During the year ended December 31, 2016, eight ECHO properties were transferred from properties under development to investment properties. H&R’s
share of the square footage transferred was 79,922 and the value transferred was $60.9 million. Major tenants at these properties include Giant Eagle,
Inc. and Safeway Inc.
Assets and Liabilities Classified as Held for Sale
As at December 31, 2016, H&R had a 50% ownership interest in two Primaris properties with a fair value of $211.6 million and liabilities of $126.8 million
classified as held for sale. In January 2017, these assets were sold for $211.6 million. As at December 31, 2015, H&R had a 50% ownership interest in
one industrial property with a fair value of $3.0 million classified as held for sale. In April 2016, this asset was sold for $3.0 million.
Page 18 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
LIABILITIES AND UNITHOLDERS’ EQUITY
All ratios and amounts in the table below are non-GAAP measures.
Debt to total assets per the Trusts’ Financial Statements
Debt to total assets based on the Trusts’ interests
Ratio of non-recourse mortgages as a percentage of total mortgages
Unencumbered assets(1) (in thousands of Canadian dollars)
Unsecured debt
Unencumbered asset to unsecured debt coverage ratio
Interest coverage ratio
Weighted average interest rate of outstanding debt(2)
Weighted average term to maturity of outstanding debt (in years)(2)
(1) Excludes ECHO.
(2) Outstanding debt includes mortgages and the face value of debentures payable.
Mortgages Payable
December 31, 2016
December 31, 2015
44.3%
46.0%
54.2%
$3,011,721
$1,689,418
1.78:1
2.91:1
4.3%
4.8
46.2%
48.4%
55.6%
$2,063,794
$1,467,999
1.41:1
2.84:1
4.4%
5.3
The following table shows the change in the Trusts’ interests in mortgages payable from January 1, 2016 to December 31, 2016:
(in thousands of Canadian dollars)
Opening balance, beginning of year
Principal repayments
Mortgages repaid
New mortgages
Mortgages reclassified to liabilities held for sale
Mortgages released upon the sale of investment properties
Effective interest rate accretion on mortgages
Change in foreign exchange rates
Closing balance, end of year
$5,109,947
(175,505)
(424,863)
216,289
(126,567)
(208,948)
(4,823)
(55,267)
$4,330,263
Page 19 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
The following table shows the mortgage maturity profile at the Trusts’ interests as at December 31, 2016:
MORTGAGES PAYABLE
2017
2018
2019
2020
2021
Thereafter
Periodic
Amortized
Principal
($000’s)
Principal on
Maturity
($000’s)
Total Principal
($000’s)
% of Total
Principal
Weighted
Average Interest
Rate on Maturity
$152,220
$391,805
$544,025
153,959
165,639
146,186
126,716
148,879
146,229
372,820
718,136
302,838
311,868
519,006
844,852
1,801,192
4,323,781
6,482
$4,330,263
4.7%
4.8%
3.6%
4.4%
4.0%
12.6
7.0
7.2
12.0
19.5
41.7
100%
Financing costs and mark-to-market adjustments arising on acquisitions(1)
Total
(1) 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 Trusts’ mortgages payable balances
and are recognized in finance costs over the life of the applicable mortgage.
The mortgages outstanding as at December 31, 2016 bear interest at a weighted average rate of 4.4% (December 31, 2015 - 4.6%) and mature between
2017 and 2040. The weighted average term to maturity of the Trusts’ mortgages is 5.7 years (December 31, 2015 - 6.2 years). 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”.
Debentures Payable
Debentures payable decreased by $59.2 million from $1,550.8 million as at December 31, 2015 to $1,491.6 million as at December 31, 2016 primarily due
to H&R repaying; (i) all of the outstanding Series D Senior Debentures upon maturity for a cash payment of $180.0 million in July 2016 and (ii) all of the
outstanding 2016 Convertible Debentures upon maturity for a cash payment of $75.0 million in December 2016. This was offset by the issuance of the
$200.0 million Series L Senior Debentures maturing May 6, 2022.
In Q1 2016, H&R entered into three interest rate swap agreements to effectively fix the interest rate on the following: (i) $60.0 million floating rate Series I
Senior Debentures which matured in January 2017 were fixed at 2.54% per annum; (ii) U.S $125.0 million floating rate Series J Senior Debentures maturing
in February 2018 were fixed at 2.04% per annum; and (iii) $200.0 million floating rate Series K Senior Debentures maturing in March 2019 were fixed at
2.36% per annum. These interest rate swaps are intended to limit H&R’s interest rate exposure during the respective terms and are marked-to-market
through net income each reporting period.
H&R has elected to measure the outstanding convertible debentures at fair value. H&R uses the quoted prices on the TSX to determine the fair value of
each series of convertible debentures as permitted under IFRS 13, Fair Value Measurement. The fluctuation in fair value between each period is recorded
as a gain (loss) on change in fair value.
Exchangeable Units
Certain of H&R’s subsidiaries have exchangeable units outstanding which are puttable instruments where H&R 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.
At the end of each period the fair value is determined by using the quoted prices of Stapled Units on the TSX as the exchangeable units are exchangeable
into Stapled Units at the option of the holder. Holders of all exchangeable units are entitled to receive the economic equivalent of distributions on a per
unit amount equal to a per Stapled Unit amount provided to holders of Stapled Units.
During the year ended December 31, 2016, 100,000 exchangeable units were exchanged for Stapled Units.
Page 20 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
The following number of exchangeable units are issued and outstanding:
As at December 31, 2016
As at December 31, 2015
Number of
Exchangeable
Units
16,563,816
16,663,816
Quoted Price of
Stapled Units
Amounts per the
Trusts’ Financial
Statements
($000’s)
$22.37
$20.05
$370,533
$334,110
A subsidiary of H&R also holds 0.4 million Stapled Units to mirror 0.4 million exchangeable units. Therefore, when the approximately 16.6 million
exchangeable units are exchanged for Stapled Units, the number of outstanding Stapled Units will only increase by 16.2 million. These 0.4 million
exchangeable units have been excluded from the weighting of exchangeable units used to calculate FFO and AFFO per unit amounts as they are already
included in the total Stapled Units outstanding.
Deferred Tax Liability
H&R has certain subsidiaries in the United States that are subject to tax on their taxable income at a rate of approximately 37.5%. The tax effects of
temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below:
Deferred tax assets:
Net operating losses and deferred interest deductions
Accounts payable and accrued liabilities
Other assets
Deferred liabilities:
Investment properties
Equity accounted investments
Deferred tax liability
December 31,
2016
December 31,
2015
$79.2
2.3
1.8
83.3
405.1
65.1
470.2
$84.9
2.1
0.9
87.9
254.2
23.4
277.6
($386.9)
($189.7)
The deferred tax liability as at December 31, 2016 increased by $197.2 million compared to December 31, 2015, primarily due to increases in the fair value
of U.S. investment properties resulting in higher deferred tax. The deferred tax liability relating to the investment properties is derived on the basis that the
U.S. investment properties will be sold at their current fair value. The tax liability will only be realized upon an actual disposition.
Loan Payable
In February 2016, H&R repaid the remainder of the loan payable to ECHO for a total cash payment of U.S. $60.8 million. The amount presented on the
Trusts’ combined statements of financial position as at December 31, 2015 represents the loan payable amount net of H&R’s interest in the equity
accounted investment in ECHO.
Unitholders’ Equity
Unitholders’ equity increased by $87.7 million from $6,824.9 million as at December 31, 2015 to $6,912.6 million as at December 31, 2016. The increase
is primarily due to net income and the issuance of units under the DRIP, partially offset by distributions paid to unitholders and other comprehensive loss.
Other comprehensive income (loss) consists of the unrealized gain on translation of U.S. denominated foreign operations and the transfer of realized
losses on cash flow hedges to net income. Fluctuations in other comprehensive income (loss) is primarily due to changes in foreign exchange rates.
Normal Course Issuer Bid
On July 8, 2016, the Trusts received approval from the TSX for the renewal of their normal course issuer bid (“NCIB”), allowing the Trusts to purchase for
cancellation up to a maximum of 5.0 million Stapled Units on the open market until the earlier of July 13, 2017 or the date on which the Trusts have
purchased the maximum number of Stapled Units permitted under the NCIB. During the year ended December 31, 2016, under a previous NCIB, the
Page 21 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
Trusts purchased and cancelled 141,800 Stapled Units at a weighted average price of $19.28 per unit, for a total cost of approximately $2.7 million. During
the year ended December 31, 2015, under a previous NCIB, the Trusts purchased and cancelled 179,400 Stapled Units at a weighted average price of
$21.94 per unit, for a total cost of approximately $3.9 million.
RESULTS OF OPERATIONS
(in thousands of Canadian dollars)
Property operating income:
Rentals from investment properties
Property operating costs
Three months ended December 31
2016
2015
Amounts
per the
Trusts’
Financial
Statements
Equity
accounted
investments
The Trusts’
interests(1)
Amounts
per the
Trusts’
Financial
Statements
Equity
accounted
investments
The Trusts’
interests(1)
$305,500
$22,351
$327,851
$296,236
$35,095
$331,331
(103,134)
(4,008)
(107,142)
(94,134)
(9,638)
(103,772)
Net income (loss) from equity accounted investments
82,176
(82,065)
111
(39,017)
202,366
18,343
220,709
202,102
Other income
Finance cost - operations
Finance income
Fair value adjustments on financial instruments
Trust expenses
Fair value adjustment on real estate assets
Gain (loss) on sale of real estate assets, net of related costs
Gain on foreign exchange
Net income before income taxes
Income tax expense
Net income attributable to the Trusts’ unitholders
Non-controlling interest
Net income
Other comprehensive income:
Unrealized gain on translation of U.S.
denominated foreign operations
Transfer of realized loss on cash flow hedges to net income
25,457
39,413
-
227,559
396
-
1,454
-
1,454
-
(69,861)
(4,511)
(74,372)
(74,202)
(6,960)
(81,162)
925
6,198
(7,014)
(32,488)
(7,816)
6,695
182,635
(42,019)
140,616
(18)
9,588
(382)
907
15,786
(7,396)
1,225
11,803
(2,581)
162
(186)
(848)
1,387
11,617
(3,429)
59,931
27,443
(148,086)
(57,023)
(205,109)
(571)
(8,387)
-
6,695
1,665
11,212
315
182,950
(35,879)
(145)
(42,164)
(3,575)
170
140,786
(39,454)
(16)
-
(1)
146
145
1,649
11,212
(35,880)
(3,429)
(39,309)
-
(170)
(170)
-
(145)
(145)
140,616
-
140,616
(39,454)
-
(39,454)
40,363
8
40,371
-
-
-
40,363
54,788
8
8
40,371
54,796
-
-
-
54,788
8
54,796
Total comprehensive income all attributable to unitholders
$180,987
$ -
$180,987
$15,342
$ -
$15,342
(1)
“The Trusts’ interests” is a non-GAAP measure which includes amounts per the Trusts’ Financial Statements and the Trusts’ proportionate share of equity accounted investments.
Net income before income taxes per the Trusts’ Financial Statements increased by $218.5 million for the three months ended December 31, 2016 compared
to the three months ended December 31, 2015 primarily due to the following: (i) large write downs Q4 2015 to the fair value of certain investment properties
in Alberta due to the overall weakening of the Alberta economy and (ii) an increase in net income (loss) in equity accounted investments primarily due to
the value of the LIC Project increasing by U.S. $54.9 million in Q4 2016 at H&R’s interest, and a fair value write-down in Q4 2015 to F1RST Tower in
Calgary as a result of higher expected vacancies due to the overall weakening of the Alberta economy.
Page 22 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
RESULTS OF OPERATIONS
(in thousands of Canadian dollars)
Property operating income:
Rentals from investment properties
Property operating costs
Net income (loss) from equity accounted investments
Other income
Finance cost - operations
Finance income
Fair value adjustments on financial instruments
Trust expenses
Year ended December 31
2016
2015
Amounts
per the
Trusts’
Financial
Statements
Equity
accounted
investments
The Trusts’
interests(1)
Amounts
per the
Trusts’
Financial
Statements
Equity
accounted
investments
The Trusts’
interests(1)
$1,196,011
$114,157
$1,310,168
$1,188,314
$131,973
$1,320,287
(431,271)
(33,061)
(464,332)
(414,801)
(40,039)
(454,840)
764,740
81,096
845,836
773,513
91,934
865,447
48,341
20,353
(47,813)
528
-
20,353
841
-
(288)
-
553
-
(287,325)
(22,341)
(309,666)
(295,010)
(24,863)
(319,873)
4,715
461
5,176
(33,830)
(29,852)
(1,039)
(1,611)
(34,869)
(31,463)
3,770
36,240
(9,327)
447
(1,122)
(1,123)
4,217
35,118
(10,450)
Fair value adjustment on real estate assets
133,738
(22,489)
111,249
(178,868)
(61,763)
(240,631)
Gain (loss) on sale of real estate assets, net of related costs
Gain (loss) on foreign exchange
Transaction costs
Net income before income taxes
Income tax expense
(8,167)
(8,944)
(13,483)
590,286
14,484
-
-
6,317
(8,944)
(13,483)
(5,428)
49,375
-
(2,832)
-
-
(8,260)
49,375
-
748
591,034
375,106
390
375,496
(201,541)
(290)
(201,831)
(34,958)
(114)
(35,072)
Net income attributable to the Trusts’ unitholders
388,745
458
389,203
340,148
276
340,424
Non-controlling interest
Net income
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
-
(458)
(458)
-
(276)
(276)
388,745
-
388,745
340,148
-
340,148
(38,397)
30
(38,367)
-
-
-
(38,397)
227,430
30
31
(38,367)
227,461
-
-
-
227,430
31
227,461
Total comprehensive income all attributable to unitholders
$350,378
$ -
$350,378
$567,609
$ -
$567,609
(1)
“The Trusts’ interests” is a non-GAAP measure which includes amounts per the Trusts’ Financial Statements and the Trusts’ proportionate share of equity accounted investments.
Net income before income taxes per the Trusts’ Financial Statements increased by $215.2 million for the year ended December 31, 2016 compared to the
year ended December 31, 2015 primarily due to a 2016 increase in the fair value adjustment on real estate assets for U.S. real estate assets which
recorded fair value increases for Two Gotham Center in Long Island City, NY and Hess Tower in Houston, TX. This was partially offset by fair value
adjustments on financial instruments, specifically the gain (loss) on fair value of exchangeable units which is determined using the quoted prices of Stapled
Units on the TSX. The gain (loss) on foreign exchange also offset this increase due to the Canadian dollar weakening against the U.S. dollar.
Page 23 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
PROPERTY OPERATING INCOME
Property operating income consists of rentals from investment properties (“rentals”) less property operating costs. Rentals include all amounts earned
from tenants related to lease agreements, including basic rent, parking income, operating costs and realty tax recoveries. Property operating costs primarily
consist of realty taxes, maintenance and utilities. Maintenance includes costs relating to items such as cleaning, interior and exterior building repairs and
maintenance, elevator, HVAC, security and wages and benefits. Management believes that property operating income is a useful measure for investors
as it provides a snapshot of how H&R’s properties are performing before financing costs and other sources of income and expenditures which are not
directly related to the day-to-day operations of a property. Property operating income (cash basis) adjusts property operating income to exclude straight-
lining of contractual rent and realty taxes accounted for under IFRIC 21. Management believes this non-GAAP measure is important for investors as it
adjusts property operating income for non-cash items which allows investors to better understand H&R’s operating performance. “Same-Asset” refers to
those properties owned by H&R for the entire two-year period ended December 31, 2016. “Transactions” refers to property operating income earned
related to properties acquired, disposed of and transferred from properties under development to investment properties.
Three months ended December 31, 2016
Three months ended December 31, 2015
(in thousands of Canadian dollars)
Same-Asset
Transactions
The Trusts’
interests
Same-Asset
Transactions
The Trusts’
interests
Rentals
Percentage rent
Straight-lining of contractual rent
Total rentals
Property operating costs
Property operating income
Straight-lining of contractual rent
Realty taxes in accordance with IFRIC 21
$304,511
$20,839
$325,350
$299,816
$29,868
$329,684
1,380
1,294
307,185
(101,174)
206,011
(1,294)
(8,616)
(2)
(171)
20,666
(5,968)
14,698
171
(2,264)
1,378
1,123
327,851
(107,142)
220,709
(1,123)
(10,880)
1,325
1,453
302,594
(92,758)
209,836
(1,453)
(9,256)
17
(1,148)
28,737
1,342
305
331,331
(11,014)
(103,772)
17,723
1,148
(1,030)
227,559
(305)
(10,286)
Property operating income (cash basis)
$196,101
$12,605
$208,706
$199,127
$17,841
$216,968
Same-Asset property operating income (cash basis) decreased by $3.0 million for the three months ended December 31, 2016 compared to the three
months ended December 31, 2015 primarily due to Target vacating 831,688 square feet (at H&R’s ownership interest in Q2 2015) and Telus Corporation
vacating 170,918 square feet at F1RST Tower (at H&R’s ownership interest) in April 2016. Included in Same-Asset property operating income (cash basis)
for the three months ended December 31, 2016 and 2015 were lease termination payments of $0.1 million and $0.3 million, respectively.
Property operating income (cash basis) from Transactions decreased by $5.2 million for the three months ended December 31, 2016 compared to the
three months ended December 31, 2015, primarily due to the sale of Scotia Plaza. For a list of properties purchased and sold in 2016 & 2015, please refer
to pages 15 and 16 of this MD&A.
Year ended December 31, 2016
Year ended December 31, 2015
(in thousands of Canadian dollars)
Same-Asset
Transactions
The Trusts’
interests
Same-Asset
Transactions
The Trusts’
interests
Rentals
Percentage rent
Straight-lining of contractual rent
Total rentals
Property operating costs
Property operating income
Straight-lining of contractual rent
Realty taxes in accordance with IFRIC 21
$1,193,953
$107,188
$1,301,141
$1,182,249
$117,522
$1,299,771
3,454
6,195
1,203,602
(421,093)
782,509
(6,195)
-
15
(637)
3,469
5,558
3,584
16,908
55
(31)
3,639
16,877
106,566
1,310,168
1,202,741
117,546
1,320,287
(43,239)
(464,332)
(411,526)
(43,314)
(454,840)
63,327
637
-
845,836
(5,558)
-
791,215
(16,908)
-
74,232
31
-
865,447
(16,877)
-
Property operating income (cash basis)
$776,314
$63,964
$840,278
$774,307
$74,263
$848,570
Same-Asset property operating (cash basis) income increased by $2.0 million for the year ended December 31, 2016 compared to the year ended
December 31, 2015 primarily due to the strengthening of the U.S. dollar compared to the Canadian dollar and contractual rental escalations. This was
partially offset by Target vacating 831,688 square feet (at H&R’s ownership interest in Q2 2015) and Telus Corporation vacating 170,918 square feet at
Page 24 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
F1RST Tower (at H&R’s ownership interest) in April 2016. Included in Same-Asset property operating income (cash basis) for the year ended December
31, 2016 and 2015 were lease termination payments of $1.8 million and $2.3 million, respectively.
Property operating income (cash basis) from Transactions decreased by $10.3 million for the year ended December 31, 2016 compared to the year ended
December 31, 2015, primarily due to the sale of Scotia Plaza. For a list of properties purchased and sold in 2016 & 2015, please refer to pages 15 and 16
of this MD&A.
Refer to the “Segmented Information” section of this MD&A for further details on property operating income.
SEGMENTED INFORMATION
H&R’s strategy to mitigate risk is diversification both by geographic location and asset class.
Geographic Locations:
The Trusts operate in two geographic locations: Canada and the United States. Property operations for both Canada and the United States share the
same investment and operating policies as described above in the “Operating Segments” section of this MD&A. The Trusts have provided additional
disclosure for Ontario and Alberta but does not view these individual provinces as separate geographic locations.
Same-Asset property operating income (cash basis)
Occupancy (same asset)
Three months ended December 31
Year ended December 31
As at December 31
(in thousands of Canadian dollars)
Ontario(1)
Alberta
Other Canada
Total – Canada
United States(1)
2016
$66,793
51,985
22,848
141,626
54,475
2015
2016
2015
$66,536
$253,320
$256,420
54,628
22,898
144,062
55,065
207,621
86,537
547,478
228,836
214,671
86,287
557,378
216,929
The Trusts' interests
$196,101
$199,127
$776,314
$774,307
(1) Property operating income relating to corporate entities has been included in Ontario for Canadian properties and the United States for U.S. properties.
2016
96.4%
91.4%
95.9%
94.8%
98.1%
95.8%
2015
95.6%
93.0%
96.8%
95.1%
98.3%
96.1%
Same-Asset property operating income (cash basis) from Canada decreased by $2.4 million and $9.9 million, respectively, for the three months and year
ended December 31, 2016 compared to the respective 2015 periods primarily due to the Primaris segment discussed below. Included in Same-Asset
property operating income (cash basis) from the Canadian region was lease termination payments of $0.1 million and $1.8 million, respectively, for the
three months and year ended December 31, 2016, compared to $0.3 million and $2.3 million, respectively, for the three months and year ended December
31, 2015.
Same-Asset property operating (cash basis) income from the U.S. changed by ($0.6 million) and $11.9 million, respectively, for the three months and year
ended December 31, 2016 compared to the respective 2015 periods. The average exchange rate for the three months ended December 31, 2016 was
Canadian $1.32 for each U.S. $1.00 (Q4 2015 - $1.34). The average exchange rate for the year ended December 31, 2016 was Canadian $1.32 for each
U.S. $1.00 (December 31, 2015 - $1.28).
Page 25 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
The Trusts have provided the table below to disclose the United States region in U.S. dollars to eliminate the effect of fluctuations in foreign exchange.
United States:
Three months ended December 31
Year ended December 31
As at December 31
Same-Asset property operating income (cash basis)
Occupancy (same asset)
(in thousands of U.S. dollars)
Office (1)
H&R Retail
ECHO
Industrial
Lantower Residential
U.S. total in U.S. dollars
2016
$15,303
14,513
7,710
2,786
957
2015
$14,953
14,563
7,757
2,741
999
2016
2015
2016
2015
$70,168
$66,610
100.0%
100.0%
58,510
30,022
11,146
3,514
58,084
30,608
10,906
3,268
99.1%
93.7%
99.0%
94.0%
100.0%
100.0%
92.7%
98.1%
95.5%
98.3%
$41,269
$41,013
$173,360
$169,476
(1) Property operating income relating to corporate entities has been included in the Office segment with the exception of Primaris and ECHO, which have been reported in their specific
segment.
Same-Asset property operating income (cash basis) from the U.S. region increased by $0.3 million and $3.9 million, respectively, for the three months and
year ended December 31, 2016 compared to the respective 2015 periods primarily due to contractual rental escalations in certain office properties.
Operating Segments:
H&R invests in four real estate asset classes which management views as comprising six separate operating segments. H&R invests in office, retail,
industrial and residential properties both in Canada and the United States. H&R’s retail asset class is further viewed by management as being comprised
of three different operating segments: (i) enclosed shopping centres and multi-tenant retail plazas throughout Canada managed by Primaris; (ii) other retail
properties throughout Canada and the United States managed by HRRMSLP (“H&R Retail”), and (iii) H&R’s 33.6% interest in ECHO, a privately held real
estate and development company which focuses on developing and owning a core portfolio of grocery anchored shopping centres in the United States.
H&R’s residential segment operates as Lantower Residential, and focuses on acquiring multi-family properties in the United States. H&R therefore has
six operating segments and management assesses the results of these operations separately. The Chief Executive Officer measures the performance of
H&R’s real estate assets on the basis of property operating income, and, additionally, Same-Asset property operating income which highlights period-over-
period changes in rental rates, occupancy, percentage rent and sundry income. Further disclosure of segmented information by operating segment can
be found in the Trusts’ Financial Statements.
Same-Asset property operating income (cash basis)
Occupancy (same asset)
Three months ended December 31
Year ended December 31
As at December 31
(in thousands of Canadian dollars)
2016
2015
2016
2015
Office (1)
Primaris
H&R Retail
ECHO
Industrial
Lantower Residential
The Trusts' interests
$95,492
$97,179
$385,257
$379,498
44,761
26,651
10,177
17,757
1,263
46,332
26,835
10,386
17,071
1,324
169,694
106,792
39,629
70,303
4,639
178,676
103,737
39,178
69,034
4,184
$196,101
$199,127
$776,314
$774,307
2016
96.9%
87.4%
98.6%
93.7%
99.8%
92.7%
95.8%
2015
98.0%
87.1%
98.6%
94.0%
99.6%
95.5%
96.1%
(1) Property operating income relating to corporate entities has been included in the Office segment with the exception of Primaris and ECHO, which have been reported in their specific
segment.
Same-Asset property operating income (cash basis) from the Office segment decreased by $1.7 million for the three months ended December 31, 2016
compared to the respective 2015 period due to a decline in occupancy, primarily as a result of Telus Corporation vacating approximately 170,918 square
feet at F1RST Tower (at H&R’s ownership interest) in April 2016. Same-Asset property operating income (cash basis) from the Office segment increased
by $5.8 million for the year ended December 31, 2016 compared to the respective 2015 period primarily due to contractual rental escalations and the
strengthening of the U.S. dollar compared to the Canadian dollar. This was partially offset by a decline in occupancy primarily as a result of Telus
Corporation vacating approximately 170,918 square feet (at H&R’s ownership interest) in April 2016.
Page 26 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
Same-Asset property operating income (cash basis) from the Primaris segment decreased by $1.6 million and $9.0 million, respectively, for the three
months and year ended December 31, 2016 compared to the respective 2015 periods primarily due to several tenant bankruptcies that occurred in the
last 12 months. In addition, Target vacating in Q2 2015 further decreased Same-Asset property operating income (cash basis) for the year ended
December 31, 2016 compared to the year ended December 31, 2015.
Same-Asset property operating income (cash basis) from the H&R Retail segment increased by $3.1 million for the year ended December 31, 2016
compared to the respective 2015 period primarily due to the strengthening of the U.S. dollar compared to the Canadian dollar.
Same-Asset property operating income (cash basis) from the Industrial segment increased by $1.3 million for the year ended December 31, 2016 compared
to the respective 2015 period primarily due to the strengthening of the U.S. dollar compared to the Canadian dollar.
For the 16 enclosed shopping centres within the Primaris segment, sales per square foot, on a same-tenant basis, for Commercial Retail Units (“CRU”)
have decreased to $539 per square foot for the rolling twelve months ended December 31, 2016 from $547 in the comparative period. For the same 16
properties within the Primaris segment, all store sales decreased by 2.0%. These figures only include enclosed shopping centres owned by Primaris for
the entire rolling 24-month period ending December 31, 2016.
All Store Sales
(in thousands of Canadian dollars)
Rolling 12 month ended December 31
Same Store Sales
(per square foot)
Rolling 12 month ended December 31
2015
% Change
Cataraqui Town Centre
Dufferin Mall
Grant Park(1)
Kildonan Place(1)
McAllister Place(1)
Medicine Hat Mall
Orchard Park Shopping Centre
Park Place Shopping Centre
Peter Pond Mall(2)
Place d’Orleans(1)
Place du Royaume
Regent Mall(1)
Sherwood Park Mall
St. Albert Centre
Stone Road Mall
Sunridge Mall
Total(3)
2016
$87,874
113,645
25,269
77,355
56,263
55,125
$88,194
107,495
26,079
75,381
56,498
63,583
166,362
160,020
87,527
70,615
96,936
88,682
88,046
96,915
105,982
104,941
81,410
49,122
29,729
109,822
100,791
79,338
53,696
31,445
111,540
108,450
(0.4%)
5.7
(3.1)
2.6
(0.4)
(13.3)
4.0
(1.3)
(19.8)
-
1.0
2.6
(8.5)
(5.5)
(1.5)
(7.1)
2016
$536
2015
$510
620
453
541
509
475
676
592
623
450
418
577
467
497
607
490
608
463
529
509
506
643
606
784
455
407
576
512
530
601
524
% Change
5.1%
2.0
(2.2)
2.3
-
(6.1)
5.1
(2.3)
(20.5)
(1.1)
2.7
0.2
(8.8)
(6.2)
1.0
(6.5)
$1,313,827
$1,340,303
(2.0%)
$539
$547
(1.5%)
(1) All store sales and same-store sales have been reported as if Primaris owned 100% of Grant Park, Kildonan Place, McAllister Place, Place d’Orleans and Regent Mall for the entire rolling
12 months ended December 31, 2016 and 2015.
(2) All store sales and same-store sales have primarily decreased due to the recent wildfire in Fort McMurray, AB. Peter Pond Mall closed in accordance with a city-wide evacuation order on
May 3, 2016. The mall re-opened on June 1, 2016 and all stores were re-opened in July 2016.
(3) The total same-store sales figures have been presented on a weighted average basis.
Page 27 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
OTHER INCOME AND EXPENSE ITEMS
The other income and expense items section of this MD&A provides management’s commentary on the Trusts’ Results of Operations for line items below
net income from equity accounted investments, where there has been a significant change between periods or where a breakdown is needed for the reader
to recalculate FFO or AFFO.
Other Income
Three months ended December 31
Year ended December 31
(in thousands of Canadian dollars)
2016
2015
Change
2016
2015
Change
Other income
$1,454
$ -
$1,454
$20,353
$ -
$20,353
On January 15, 2015, Target Corporation announced plans to discontinue operating stores in Canada through its subsidiary Target Canada Co. (“Target”).
Primaris has an interest in nine malls where Target was a tenant: a 50% interest in four of these malls and a 100% interest in the other five malls. Three
of the leases were guaranteed by Target Corporation, the U.S. parent of Target. In March 2016, Primaris entered into binding agreements with Target and
Target Corporation concluding the terms of settlement relating to the leases that were disclaimed pursuant to the Companies’ Creditors Arrangement Act.
The binding agreements were approved by the courts in June 2016. An initial distribution in respect of the settlement proceeds, in the amount of $18.9
million was received on July 4, 2016. A further distribution in respect of the settlement proceeds, in the amount of $1.5 million, was received on October
25, 2016.
Finance Costs
(in thousands of Canadian dollars)
Finance cost – operations:
Three months ended December 31
Year ended December 31
2016
2015
Change
2016
2015
Change
Contractual interest on mortgages payable
($51,686)
($58,317)
$6,631
($219,131)
($230,134)
$11,003
Contractual interest on debentures payable
(14,543)
(15,730)
Effective interest rate accretion
Bank interest and charges
Exchangeable unit distributions
Capitalized interest
Finance income
Fair value adjustments on financial instruments
663
(4,074)
(5,630)
804
(2,295)
(5,624)
1,187
(141)
(1,779)
(6)
(60,019)
(64,715)
3,312
(13,457)
(22,480)
5,353
(7,881)
(22,496)
(75,270)
(81,162)
5,892
(311,775)
(319,873)
898
-
898
2,109
-
(74,372)
(81,162)
6,790
(309,666)
(319,873)
4,696
(2,041)
(5,576)
16
8,098
2,109
10,207
959
907
15,786
1,387
11,617
(480)
4,169
5,176
4,217
(34,869)
35,118
(69,987)
($57,679)
($68,158)
$10,479
($339,359)
($280,538)
($58,821)
The decrease in contractual interest on mortgages payable of $6.6 million and $11.0 million for the three months and year ended December 31, 2016
compared to the respective 2015 periods is primarily due to the repayment of mortgages upon sale and maturity, and contractual interest savings arising
from mortgage financings completed at lower interest rates.
The decrease in contractual interest on debentures payable of $1.2 million and $4.7 million for the three months and year ended December 31, 2016
compared to the respective 2015 periods is primarily due to the repayment of the Series H Senior Debentures in October 2015 and Series D Senior
Debentures in July 2016 offset by the issuance of the Series J Senior Debentures in February 2015, Series K Senior Debentures in July 2015 and Series
L Senior Debentures in November 2016. The repayment of the Series A Senior Debentures in February 2015 further decreased the contractual interest
on debentures payable for the year ended December 31, 2016 compared to the respective 2015 period.
The decrease in fair value adjustments on financial instruments of $70.0 million for the year ended December 31, 2016 compared to the respective 2015
period is primarily due to the gain (loss) on fair value of exchangeable units whereby at the end of each period, the fair value is determined by using the
quoted prices of Stapled Units on the TSX, as the exchangeable units are exchangeable into Stapled Units at the option of the holder. For the three months
and year ended December 31, 2016, the change in fair value is based on the quoted price of Stapled Units which was $22.37 as at December 31, 2016
(September 30, 2016 - $22.43, December 31, 2015 - $20.05). For the three months and year ended December 31, 2015, the change in fair value is based
on the quoted price of Stapled Units which was $20.05 as at December 31, 2015 (September 30, 2015 - $20.57, December 31, 2014 - $21.73).
Page 28 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
Trust Expenses
Three months ended December 31
Year ended December 31
(in thousands of Canadian dollars)
2016
2015
Change
2016
2015
Other expenses
Unit-based compensation
Trust expenses
($3,631)
($3,560)
($71)
($13,547)
($11,147)
(3,765)
131
(3,896)
(17,916)
697
($7,396)
($3,429)
($3,967)
($31,463)
($10,450)
($21,013)
Change
($2,400)
(18,613)
Other expenses are primarily comprised of salaries, professional fees, trustee fees and corporate overhead expenses. Other expenses increased by $2.4
million for the year ended December 31, 2016 compared to the respective 2015 period primarily due to an increase in salaries, professional fees and
corporate expenses relating to Lantower Residential and ECHO.
Unit-based compensation is comprised of the following two compensation plans: the Unit Option Plan and the Incentive Unit Plan. Both plans are
considered to be cash-settled under IFRS 2, Share-based Payments and as a result, are measured at each reporting period and settlement date at its fair
value as defined by IFRS 2 based on the quoted prices of Stapled Units on the TSX.
Fair Value Adjustment on Real Estate Assets
Three months ended December 31
Year ended December 31
(in thousands of Canadian dollars)
2016
2015
Change
2016
2015
Change
Fair value adjustment on real estate assets
$27,443
($205,109)
$232,552
$111,249
($240,631)
$351,880
H&R records its real estate assets at fair value. The fair value adjustment on real estate assets for the year ended December 31, 2016 of $111.2 million is
primarily due to the U.S. real estate assets having fair value increases of $394.4 million for Two Gotham Center in Long Island City, NY, Hess Tower in
Houston, TX and the LIC Project. Independent third party appraisals were obtained for these properties in 2016. This was partially offset by fair value
decreases to H&R’s Alberta portfolio of ($194.0 million) as a result of higher vacancies in H&R’s Office portfolio in Calgary and an overall weakening of
the Alberta economy. The fair value adjustment on real estate assets for the year ended December 31, 2015 of ($240.6 million) was primarily due to fair
value decreases to H&R’s Alberta portfolio of ($229.2 million) as a result of the overall weakening of the Alberta economy.
Gain (Loss) on Sale of Real Estate Assets, Net of
Related Costs
Three months ended December 31
Year ended December 31
(in thousands of Canadian dollars)
2016
2015
Change
2016
2015
Change
Gain (loss) on sale of real estate assets, net of related costs
($8,387)
$1,649
($10,036)
$6,317
($8,260)
$14,577
The loss on sale of real estate assets, net of related costs of $8.4 million for the three months ended December 31, 2016, is primarily due to a loss on sale
of $7.4 million from the sale of H&R’s 50% non-managing interest in TransCanada Tower in November 2016.
The gain on sale of real estate assets, net of related costs of $6.3 million for the year ended December 31, 2016, is primarily due to a gain on sale of $15.0
million from the sale of H&R’s 33.3% freehold and leasehold interests in Scotia Plaza in Q2 2016. This was partially offset by a loss on sale of $7.4 million
from the sale of H&R’s 50% non-managing interest in TransCanada Tower in November 2016.
For a list of properties sold in 2016 & 2015, please refer to page 16 in this MD&A.
Gain (Loss) on Foreign Exchange
(in thousands of Canadian dollars)
Gain (loss) on foreign exchange
Three months ended December 31
Year ended December 31
2016
2015
Change
2016
2015
Change
$6,695
$11,212
($4,517)
($8,944)
$49,375
($58,319)
The amounts in the table above were recorded by Finance Trust due to the translation of the U.S. Holdco Notes into Canadian dollars. The U.S. Holdco
Notes are eliminated in the Trusts’ Financial Statements however, the related foreign exchange difference is not eliminated on combination as it flows
through net income of Finance Trust and other comprehensive income of H&R as U.S. Holdco is a subsidiary of H&R and forms part of its net investment
in the United States. U.S. Holdco is not a subsidiary of Finance Trust. The exchange rate as at December 31, 2016 was Canadian $1.34 for each U.S.
$1.00 (September 30, 2016 - $1.31, December 31, 2015 - $1.38). The exchange rate as at December 31, 2015 was $1.38 for each U.S. $1.00 (September
30, 2015 - $1.33, December 31, 2014 - $1.16).
Page 29 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
Transaction Costs
Three months ended December 31
Year ended December 31
(in thousands of Canadian dollars)
2016
2015
Change
2016
2015
Change
Transaction costs
$ -
$ -
$ -
($13,483)
$ -
($13,483)
On February 18, 2016, the Ontario Ministry of Finance (the “Ministry”) announced retroactive amendments to the regulations under the Land Transfer Act
(Ontario) that impact the availability of an exemption from Ontario land transfer tax for certain transactions involving trusts (including real estate investment
trusts) and partnerships. On March 24, 2016, the Ministry announced relieving measures that limited the reassessment period to dispositions that occurred
on or after February 18, 2012 and provided a voluntary disclosure program (including interest and penalty relief) that runs to June 30, 2017. As a
consequence of the amendments in Q1 2016, H&R recorded a provision for additional land transfer tax.
Income Tax Expense
(in thousands of Canadian dollars)
Current income taxes
Deferred income taxes
Total income taxes
Three months ended December 31
Year ended December 31
2016
($989)
(41,175)
2015
Change
2016
2015
Change
($283)
(3,146)
($706)
($2,087)
($2,455)
$368
(38,029)
(199,744)
(32,617)
(167,127)
($42,164)
($3,429)
($38,735)
($201,831)
($35,072)
($166,759)
Current income taxes expense of $2.5 million for the year ended December 31, 2015, includes a minimum income tax expense of $1.1 million relating to
the sale of U.S. properties sold during 2015.
H&R 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 H&R for tax purposes. H&R’s current income tax expense is primarily due to U.S. state taxes.
H&R’s deferred income tax expense is recorded in respect of U.S. Holdco and arose due to taxable temporary differences between the tax and accounting
bases of assets and liabilities net of the benefit of unused tax credits, deferred interest deductions and losses that are available to be carried forward to
future tax years to the extent that it is probable that the unused tax credits, deferred interest deductions and losses can be realized.
Deferred tax assets and liabilities are measured at the tax rates that are expected to apply when the assets are realized or the liabilities are settled, based
on the tax laws that have been enacted or substantively enacted at the statement of financial position date. Deferred income tax relating to items recognized
in equity will also be recognized in equity.
As at December 31, 2016, H&R had net deferred tax liabilities of $386.9 million (December 31, 2015 - $189.7 million) primarily related to taxable temporary
differences between the tax and accounting bases of U.S. investment properties.
FUNDS FROM OPERATIONS
FFO is a non-GAAP measure that is widely used by the real estate industry, particularly by those publicly traded entities that own and operate investment
properties. FFO is a financial measure which should not be considered as an alternative to net income, cash flow from operations, or any other operating
or liquidity measure prescribed under IFRS. The Trusts present FFO in accordance with the REALpac White Paper on Funds from Operations. The use of
FFO, combined with the required IFRS presentations, has been included for the purpose of improving the understanding of the operating results of the
Trusts. FFO provides an operating performance measure that when compared period over period reflects the impact on operations of trends in occupancy
levels, rental rates, property operating costs, acquisition activities and finance costs, that is not immediately apparent from net income determined in
accordance with IFRS.
Realty taxes in accordance with IFRIC 21:
As a result of the requirements of IFRIC 21 wherein the obligating event that gives rise to the property tax liability (where such property taxes meet the
definition of a levy in IFRIC 21) does not occur over a period of time, an adjustment is made to FFO to reflect a pro-rata expense over the period of
ownership.
Incremental leasing costs:
Leasing costs related to full-time or salaried staff, and related internal costs, that can be directly attributed to signed leases and that would otherwise be
capitalized if incurred from external sources are added back to profit or loss in determining FFO. The purpose of this adjustment is to achieve consistency
between entities that use internal leasing personnel and those that use external leasing personnel.
Page 30 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
FFO
(in thousands of Canadian dollars)
Property operating income per the Trusts' interests
Add (deduct) items per the Trusts' interests:
Realty taxes in accordance with IFRIC 21
Net income (loss) from equity accounted investments
Other income
Three Months Ended December 31
Year ended December 31
2016
2015
2016
2015
$220,709
$227,559
$845,836
$865,447
(10,880)
(10,286)
111
1,454
396
-
-
528
20,353
-
553
-
Finance cost - operations (excluding exchangeable unit distributions)
(68,742)
(75,538)
(287,186)
(297,377)
Notional interest capitalization(1)
Finance income
Trust expenses (excluding the fair value adjustment to unit-based compensation)
Current income taxes expense
Non-controlling interest
Incremental leasing costs
FFO
Add (deduct) items per the Trusts' Financial Statements:
Realty taxes in accordance with IFRIC 21
FFO adjustments from equity accounted investments (page 36)
Exchangeable unit distributions
3,724
907
(4,946)
(989)
(170)
1,721
2,697
1,387
(4,416)
(283)
(145)
1,508
13,994
5,176
(18,811)
(2,087)
(458)
6,956
8,317
4,217
(14,456)
(2,455)
(276)
5,973
$142,899
$142,879
$584,301
$569,943
9,574
66,377
(5,630)
9,134
(58,770)
(5,624)
-
(23,191)
(22,480)
-
(74,034)
(22,496)
Fair value adjustments on real estate assets and financial instruments
(26,290)
(136,283)
99,908
(142,628)
Fair value adjustment to unit-based compensation
Gain (loss) on sale of real estate assets, net of related costs
Gain (loss) on foreign exchange
Transaction costs
Deferred income tax expense
Incremental leasing costs
(2,450)
(7,816)
6,695
-
(41,022)
(1,721)
987
1,665
11,212
-
(3,146)
(1,508)
(12,652)
(8,167)
(8,944)
(13,483)
(199,591)
(6,956)
4,006
(5,428)
49,375
-
(32,617)
(5,973)
Net income per the Trusts' Financial Statements
$140,616
($39,454)
$388,745
$340,148
(1) Represents an adjustment to add general or indirect interest incurred in respect of properties under development held in and through equity accounted investments.
Page 31 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
FFO
(per the Trusts' interests)
Three Months Ended December 31
Year ended December 31
(in thousands of Canadian dollars except per unit amounts)
2016
2015
2016
2015
FFO
$142,899
$142,879
$584,301
$569,943
Weighted average number of Stapled Units (in thousands of Stapled Units adjusted
for conversion of exchangeable Stapled Units)(1)
Diluted weighted average number of Stapled Units (in thousands of Stapled Units) for
the calculation of FFO(1)(2)(3)(4)
FFO per Stapled Unit (basic – adjusted for conversion of exchangeable units)
FFO per Stapled Unit (diluted)
Distributions per Stapled Unit
Payout ratio per Stapled Unit as a % of FFO
300,482
294,944
298,404
293,026
312,142
$0.48
$0.47
$0.34
70.8%
305,442
$0.48
$0.48
$0.34
70.8%
310,072
$1.96
$1.93
$1.35
68.9%
303,651
$1.95
$1.92
$1.35
69.2%
(1) For the three months and year ended December 31, 2016, included in the weighted average and diluted weighted average number of Stapled Units are exchangeable units of 16,130,642
and 16,188,019, respectively. For the three months and year ended December 31, 2015, included in the weighted average and diluted weighted average number of Stapled Units are
exchangeable units of 16,230,642.
(2) For the three months ended December 31, 2016 and 2015, 1,493,059 Stapled Units and 330,669 Stapled Units, respectively, are included in the determination of diluted FFO with respect
to H&R’s Unit Option Plan and Incentive Unit Plan. For the years ended December 31, 2016 and 2015, 1,501,069 Stapled Units and 457,248 Stapled Units, respectively, are included in
the determination of diluted FFO with respect to H&R’s Unit Option Plan and Incentive Unit Plan.
(3) The 2016, 2018 and 2020 convertible debentures are dilutive for the three months ended December 31, 2016 and 2015. Therefore, debenture interest of $3.3 million and $3.3 million,
respectively, is added to FFO and 10,167,061 Stapled Units and 10,167,133 Stapled Units, respectively, are included in the diluted weighted average number of Stapled Units outstanding
for these periods.
(4) The 2016, 2018 and 2020 convertible debentures are dilutive for the years ended December 31, 2016 and 2015. Therefore, debenture interest of $13.3 million and $13.3 million, respectively,
is added to FFO and 10,167,115 Stapled Units and 10,167,230 Stapled Units, respectively, are included in the diluted weighted average number of Stapled Units outstanding for these
periods.
Included in FFO per the Trusts’ interests are the following items which can be a source of variances between periods:
(in thousands of Canadian dollars)
Lease termination payments
Adjustment to straight-lining of contractual rent
Other income
Current income taxes(1)
Three months ended December 31
Year ended December 31
2016
$91
-
1,454
-
2015
$336
(3,910)
-
-
Change
($245)
3,910
1,454
-
2016
2015
Change
$5,855
(2,535)
20,353
$6,205
(1,684)
($350)
(851)
-
20,353
(1,087)
1,087
$1,545
($3,574)
$5,119
$23,673
$3,434
$20,239
(1)
Includes minimum income tax payable relating to the sale of U.S. properties.
Excluding the above items, FFO would have been $141.4 million for the three months ended December 31, 2016 (Q4 2015 - $146.5 million) and $0.47 per
basic Stapled Unit (Q4 2015 - $0.50 per basic Stapled Unit). For the year ended December 31, 2016, FFO would have been $560.6 million (December 31,
2015 - $566.5 million) and $1.88 per basic Stapled Unit (December 31, 2015 - $1.93 per basic Stapled Unit).
Page 32 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
ADJUSTED FUNDS FROM OPERATIONS
In calculating AFFO, the Trusts adjust FFO for costs incurred relating to leasing and capital expenditures, straight-line rent in excess of contractual rent
paid by tenants and non-cash expenses such as amortization. Although capital and tenant expenditures can vary from quarter to quarter due to tenant
turnovers, vacancies and the age of a property, the Trusts have elected to deduct actual capital and tenant expenditures spent and capitalized in the period
instead of deducting a normalized amount based on historical activity. This differs from others in the industry as many entities are deducting a normalized
amount of capital and tenant expenditures in their AFFO calculation. Capital expenditures excluded and not deducted in the calculation of AFFO relate to
capital expenditures which generate a new investment stream, such as the construction of a new retail pad during property expansion or intensification,
development activities or acquisition activities. AFFO is a supplemental measure that is used in the real estate industry to assess the sustainability of cash
distributions.
AFFO is a non-GAAP financial measure not defined under IFRS. AFFO should not be considered as an alternative to net income, cash provided by
operations or any other IFRS measure. There is no common industry definition or methodology for the calculation of AFFO. Furthermore, some entities
present AFFO as a modified earnings measure and not as a cash measure as presented herein.
(in thousands of Canadian dollars except per unit amounts)
2016
2015
2016
2015
Three Months Ended December 31
Year ended December 31
FFO
Add (deduct) items per the Trusts' interests:
Straight-lining of contractual rent
Rent amortization of tenant inducements
Effective interest rate accretion
Unit-based compensation
Capital expenditures
Tenant expenditures
Incremental leasing costs
AFFO
Weighted average number of Stapled Units (in thousands of Stapled Units adjusted for
conversion of exchangeable Stapled Units(1)
Diluted weighted average number of Stapled Units (in thousands of Stapled Units) for
the calculation of AFFO(1)(2)(3)(4)(5)
AFFO per Stapled Unit (basic - adjusted for conversion of exchangeable units)
AFFO per Stapled Unit (diluted)
$142,899
$142,879
$584,301
$569,943
(1,123)
876
(663)
1,315
(20,539)
(7,356)
(1,721)
(305)
844
(804)
856
(16,543)
(22,666)
(1,508)
(5,558)
3,707
(3,312)
5,264
(71,231)
(41,668)
(6,956)
(16,877)
3,328
(5,353)
3,309
(52,186)
(56,789)
(5,973)
$113,688
$102,753
$464,547
$439,402
300,482
294,944
298,404
293,026
312,142
301,202
310,072
303,651
$0.38
$0.37
$0.35
$0.35
$1.56
$1.54
$1.50
$1.49
(1) For the three months and year ended December 31, 2016, included in the weighted average and diluted weighted average number of Stapled Units are exchangeable units of 16,130,642
and 16,188,019, respectively. For the three months and year ended December 31, 2015, included in the weighted average and diluted weighted average number of Stapled Units are
exchangeable units of 16,230,642.
(2) For the three months ended December 31, 2016 and 2015, 1,493,059 Stapled Units and 330,669 Stapled Units, respectively, are included in the determination of diluted AFFO with respect
to H&R’s Unit Option Plan and Incentive Unit Plan. For the years ended December 31, 2016 and 2015, 1,501,069 Stapled Units and 457,248 Stapled Units, respectively are included in
the determination of diluted AFFO with respect to H&R’s Unit Option Plan and Incentive Unit Plan.
(3) The 2016, 2018 and 2020 convertible debentures are dilutive for the three months ended December 31, 2016. Therefore, debenture interest of $3.3 million is added to AFFO and
10,167,061 Stapled Units are included in the diluted weighted average number of Stapled Units outstanding for this period.
(4) The 2016 and 2018 convertible debentures are dilutive for the three months ended December 31, 2015. Therefore, debenture interest of $1.9 million is added to AFFO and 5,926,537
Stapled Units are included in the diluted weighted average number of Stapled Units outstanding for this period.
(5) The 2016, 2018 and 2020 convertible debentures are dilutive for the years ended December 31, 2016 and 2015. Therefore, debenture interest of $13.3 million and $13.3 million,
respectively, is added to AFFO and 10,167,115 Stapled Units and 10,167,230 Stapled Units, respectively, are included in the diluted weighted average number of Stapled Units outstanding
for these periods.
Page 33 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
Included in AFFO per the Trusts’ interests are the following items which can be a source of variances between periods:
(in thousands of Canadian dollars)
2016
2015
Change
2016
2015
Change
Three months ended December 31
Year ended December 31
Additional current year capital expenditure recoveries net of
capital expenditures
Lease termination payments
Other income
Current income taxes(1)
Capital expenditures
Tenant expenditures
$341
91
1,454
-
$2,663
($2,322)
336
-
-
(245)
1,454
-
$1,962
5,855
20,353
$4,488
($2,526)
6,205
(350)
-
20,353
-
(1,087)
1,087
(20,539)
(16,543)
(3,996)
(71,231)
(52,186)
(19,045)
(7,356)
(22,666)
15,310
(41,668)
(56,789)
15,121
($26,009)
($36,210)
$10,201
($84,729)
($99,369)
$14,640
(1)
Includes minimum income tax payable relating to the sale of U.S. properties.
Excluding the above items, AFFO would have been $139.7 million for the three months ended December 31, 2016 (Q4 2015 - $139.0 million) and $0.46
per basic Stapled Unit (Q4 2015 - $0.47 per basic Stapled Unit). For the year ended December 31, 2016, AFFO would have been $549.3 million (December
31, 2015 - $538.8 million) and $1.84 per basic Stapled Unit (December 31, 2015 - $1.84 per basic Stapled Unit).
H&R’s capital and tenant expenditures have been at an elevated level the last two years. The following is a breakdown of H&R’s capital and tenant
expenditures by operating segment:
Three months ended December 31
Year ended December 31
(in thousands of Canadian dollars)
2016
2015
Change
2016
2015
Change
Office:
Capital expenditures
Tenant expenditures
Primaris:
Capital expenditures
Tenant expenditures
H&R Retail:
Capital expenditures
Tenant expenditures
ECHO:
Capital expenditures
Tenant expenditures
Industrial:
Capital expenditures
Tenant expenditures
Lantower Residential:
Capital expenditures
Tenant expenditures
$11,595
$11,373
$222
$48,517
$37,269
$11,248
5,326
18,795
(13,469)
29,220
39,497
(10,277)
3,737
1,858
-
152
1,126
11
2,219
9
2,866
3,254
871
(1,396)
11,756
8,221
8,694
3,062
10,882
(2,661)
74
232
796
86
231
299
(74)
(80)
330
(75)
1,988
(290)
659
-
182
1,182
2,616
560
2,941
2,485
797
1,981
1,813
538
848
3,891
(615)
(799)
803
22
2,093
(1,406)
5,219
2,765
2,454
-
-
-
1,862
1,203
-
-
$27,895
$39,209
($11,314)
$112,899
$108,975
$3,924
Page 34 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
H&R’s Office segment had elevated capital and tenant expenditures for the last two years due to the following:
160 Elgin St., in Ottawa, ON is currently undergoing a complete renovation of the lobby and all of the retail space. Total capital and tenant expenditures
spent during the three months and year ended December 31, 2016 were $8.8 million and $29.1 million, respectively, compared to the three months and
year ended December 31, 2015 of $7.0 million and $11.2 million, respectively. H&R expects to spend an additional $13.6 million in capital and tenant
expenditures in order to complete these projects.
310-320-330 Front St., in Toronto, ON experienced significant tenant turnover when Royal Bank of Canada vacated 274,100 square feet on December
31, 2014. TD Bank moved into 231,170 square feet throughout 2015 & 2016 and Penguin Random House Canada moving into 53,500 square feet in
November 2015 resulting in higher than normal tenant expenditures. Total capital and tenant expenditures spent during the three months and year ended
December 31, 2016 were $0.8 million and $13.7 million, respectively, compared to the three months and year ended December 31, 2015 of $11.3 million
and $32.1 million, respectively. H&R expects to spend an additional $1.3 million in tenant expenditures in order to complete these projects.
Included in capital and tenant expenditures for the year ended December 31, 2016 and 2015 was $11.5 million and $9.8 million, respectively, relating to
Scotia Plaza. H&R will not incur any further capital or tenant expenditures for Scotia Plaza which was sold on June 30, 2016.
The following is a reconciliation of the Trusts’ AFFO to cash provided by operations per the Trusts’ Financial Statements:
(in thousands of Canadian dollars except per unit amounts)
2016
2015
2016
2015
Three Months Ended December 31
Year ended December 31
AFFO
Straight-lining of contractual rent
Net (income) loss from equity accounted investments
Finance cost - operations (excluding exchange-unit distributions)
Effective interest rate accretion
Interest paid
Transaction costs
Additions to capital expenditures and tenant expenditures
Adjustments for the Trusts’ interests in equity accounted investments
Change in other non-cash operating items
Cash provided by operations
$113,688
$102,753
$464,547
$439,402
816
(82,176)
64,231
401
116
39,017
68,578
594
4,781
(48,341)
264,845
2,595
15,823
(841)
272,514
4,337
(90,478)
(86,690)
(299,533)
(304,188)
-
24,833
69,707
(3,002)
-
(13,483)
37,248
(56,743)
93,606
(3,870)
42,615
(40,951)
-
96,344
(60,561)
4,524
$98,020
$147,488
$424,196
$467,354
Page 35 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
FFO and AFFO from Equity Accounted Investments(1)
Three Months Ended December 31
Year ended December 31
(in thousands of Canadian dollars)
2016
2015
Change
2016
2015
Change
Net income (loss) from equity accounted investments per the Trusts’
Financial Statements (pages 21 & 22)
Realty taxes in accordance with IFRIC 21
Fair value adjustments on financial instruments
Fair value adjustment on real estate assets
(Gain) loss on sale of real estate assets, net of related costs
Deferred income taxes expense
Notional interest capitalization(2)
FFO from equity accounted investments
Straight-lining of contractual rent
Rent amortization of tenant inducements
Effective interest rate accretion
Capital expenditures
Tenant expenditures
$82,176
($39,017)
$121,193
$48,341
$841
$47,500
(1,306)
(9,588)
(1,152)
(154)
186
(9,774)
(59,931)
57,023
(116,954)
-
1,039
22,489
-
1,122
-
(83)
61,763
(39,274)
(14,484)
2,832
(17,316)
571
153
16
-
555
153
3,724
2,697
1,027
15,799
19,753
(3,954)
(307)
301
(262)
(2,744)
(318)
(189)
333
(210)
(1,124)
(837)
(118)
(32)
(52)
153
13,994
71,532
(777)
1,466
(717)
-
8,317
153
5,677
74,875
(3,343)
(1,054)
1,228
(1,016)
277
238
299
(1,837)
(4,825)
(1,620)
(12,307)
(10,470)
519
(6,986)
(2,161)
AFFO from equity accounted investments
$12,469
$17,726
($5,257)
$52,211
$61,402
($9,191)
(1)
(2)
These amounts are at the Trusts’ proportionate ownership share held through their equity accounted investments.
Represents an adjustment to add general or indirect interest incurred in respect of properties under development held in and through equity accounted investments.
FFO from equity accounted investments for the three months and year ended December 31, 2016 compared to the respective 2015 periods decreased by
$4.0 million and $3.3 million, respectively, primarily due to the sale of Scotia Plaza in June 2016 and Telus Corporation vacating approximately 170,918
square feet (at H&R’s ownership interest) in April 2016. This was partially offset by notional interest capitalization relating to the LIC Project and specifically
for the year ended December 31, 2016 compared to December 31, 2015, H&R disposing of a 49.5% interest in 16 properties in the U.S. in March 2015
with the remaining 50.5% interest subsequently being accounted for as a joint venture.
ECHO reports its financial results to H&R one month in arrears due to time constraints on its reporting. The above amounts for the three months ended
December 31, 2016 and 2015 include ECHO’s financial information from September 1 to November 30, of the respective years. The above amounts for
the year ended December 31, 2016 and 2015 include ECHO’s financial information from December 1, 2015 to November 30, 2016 and December 1, 2014
to November 30, 2015, respectively. In December 2016, ECHO acquired three properties for approximately $23.5 million, at H&R’s share.
Page 36 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
LIQUIDITY AND CAPITAL RESOURCES
Cash Distributions
In accordance with National Policy 41-201 - Income Trusts and Other Indirect Offerings, the Trusts are required to provide the following additional disclosure
relating to cash distributions.
(in thousands of Canadian dollars)
Cash provided by operations
Net income
Total distributions(1)
Excess of cash provided by operations over total distributions
Excess (shortfall) of net income over total distributions
Three months ended
December 31,
2016
Year ended
December 31,
2016
Year ended
December 31,
2015
Year ended
December 31,
2014
$98,020
140,616
96,534
1,486
44,082
$424,196
$467,354
$438,347
388,745
381,106
43,090
7,639
340,148
373,072
94,282
(32,924)
424,655
366,802
71,545
57,853
(1)
Total Distributions include cash distributions to unitholders and unit distributions issued under the DRIP.
Total distributions include unit distributions issued under the DRIP of $26.6 million and $106.8 million respectively, for the three months and year ended
December 31, 2016, which are non-cash distributions. Total distributions include unit distributions issued under the DRIP of $105.4 million and $85.4
million, respectively, for the years ended December 31, 2015 and 2014, which are non-cash distributions. Unit distributions issued under the DRIP result
in an increase in the number of Stapled Units outstanding which may result in increased cash distributions in the future assuming a stable cash component
of distributions per unit. Distributions exceeded net income for the year ended December 31, 2015, respectively, primarily due to non-cash items. Non-
cash items relating to the fair value adjustments on real estate assets, gain (loss) on change in fair value, amortization, unrealized gain (loss) on foreign
exchange and deferred income tax expense are deducted from or added to net income and have no impact on cash available to pay current distributions.
Capital Resources
Subject to market conditions, management expects to be able to meet all of the Trusts’ ongoing obligations and to finance short-term development
commitments through the general operating facilities discussed below and the Trusts’ cash flow from operations. As at December 31, 2016, the Trusts
are not in default or arrears on any of its obligations including interest or principal payments on debt and any debt covenant.
Excluding equity accounted investments, the Trusts have cash and cash equivalents on hand of $48.0 million and have the following bank credit facilities
as at December 31, 2016:
Operating Facilities
(in thousands of Canadian Dollars)
Maturity
Date
Total
Facility
Bank Indebtedness
Drawn
Outstanding
Letters of Credit
H&R unsecured operating facility #1(a)
Primaris secured operating facility(a)
H&R unsecured operating facility #2(b)
H&R and CrestPSP secured operating facility(a)
H&R Retail co-ownership secured operating facility
Dec 18, 2018
Dec 18, 2017
Mar 17, 2021
Feb 19, 2019
Sep 30, 2017
$500,000
300,000
205,829
25,000
3,514
$166,089
262,640
205,829
9,700
3,514
$33,052
1,253
-
-
-
Available
Balance
$300,859
36,107
-
15,300
-
$1,034,343
$647,772
$34,305
$352,266
The bank facilities bear interest at a rate approximating the prime rate of a Canadian chartered bank.
(a)
(b)
Can be drawn in either Canadian or U.S. dollars.
The total facility as at December 31, 2016 is $200.0 million, plus a 3% allowance relating to the fluctuation of the foreign exchange rate, and can be drawn in either Canadian or U.S.
dollars. H&R entered into an interest rate swap agreement to fix the interest rate at 2.6% per annum on U.S. $130.0 million of the U.S. dollar denominated borrowing of this facility.
In December 2015, construction financing for the LIC Project for up to U.S. $640.0 million was secured through a syndicate of lenders. This construction
facility can only be used for the LIC Project, and in Q3 2016, H&R made its final contribution to the development prior to drawing on the facility. The
construction facility will be used to fund the remaining development costs of the project. As at December 31, 2016, total bank indebtedness drawn was
U.S. $91.6 million. The LIC Project is accounted for as an equity accounted investment and is therefore not included in the table above.
As at December 31, 2016, excluding ECHO, H&R had 112 unencumbered properties, with a fair value of approximately $3.0 billion. Also, due to H&R’s
20-year history and management’s conservative strategy of securing long-term financing on individual properties, H&R had numerous other properties with
Page 37 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
very low loan to value ratios. As at December 31, 2016, excluding real estate assets reported in the Trusts’ equity accounted investments, H&R had 47
properties valued at approximately $934.3 million which are encumbered with mortgages totalling $159.6 million. In this pool of assets, the average loan
to value is 17.1%, the minimum loan to value is 4.2% and the maximum loan to value is 29.8%.
The following is a summary of material contractual obligations of H&R including payments due as at December 31, 2016 for the next five years and
thereafter:
Payments Due by Period
Contractual Obligations(1)
(in thousands of Canadian dollars)
2017
2018-
2019
2020-
2021
2022 and
thereafter
Total
Mortgages payable
$544,025
$614,706
$1,363,858
$1,801,192
$4,323,781
Convertible Debentures
Senior Debentures
Bank indebtedness(2)
-
175,000
266,154
74,394
767,500
175,789
99,654
175,000
267,211
-
200,000
-
174,048
1,317,500
709,154
Total contractual obligations
$985,179
$1,632,389
$1,905,723
$2,001,192
$6,524,483
(1) The amounts in the above table are the principal amounts due under the contractual agreements.
(2) Excludes ECHO’s bank indebtedness of $119.9 million which is covered by ECHO’s revolving credit facility of U.S. $380.0 million with an accordion of an additional $100 million which
expires on April 3, 2020.
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). A credit rating is not a recommendation to buy, sell or hold securities.
DBRS has confirmed that H&R has a credit rating of BBB (high) with a Stable trend as at December 31, 2016. This is the highest Canadian real estate
industry rating achieved by only three REITs and one real estate company to date. A credit rating of BBB (high) by DBRS is generally an indication of
adequate credit quality, where the capacity for payment of financial obligations is considered acceptable, however the entity may be vulnerable to future
events. 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.
H&R has no material capital or operating lease obligations.
Funding of Future Commitments
Management believes that as at December 31, 2016, through cash on hand of $48.0 million and the combined amount available under its general operating
facilities of $352.3 million and its unencumbered property pool of approximately $3.0 billion, it has sufficient funds for future commitments.
The following summarizes the estimated loan to value ratios on properties whose mortgages mature over the next five years, including investments in the
Trusts’ interests of mortgages relating to equity accounted investments and mortgages classified as held for sale:
Year
2017
2018
2019
2020
2021
Number of
Properties
Mortgage Debt due
on Maturity ($000’s)(1)
Weighted Average
Interest Rate on Maturity
Fair Value of Investment
Properties ($000’s)(1)
Loan to
Value
19
34
31
20
36
140
391,805
148,879
146,229
372,820
718,136
$1,777,869
4.7%
4.8%
3.6%
4.4%
4.0%
4.3%
901,365
529,268
466,280
1,048,217
3,488,445
$6,433,575
43%
28%
31%
36%
21%
28%
(1)
Converting U.S. dollars to Canadian dollars at an exchange rate of $1.34 as at December 31, 2016.
Based on the low percentage of the projected loan to values of the maturing mortgages, H&R is confident it will be able to refinance these mortgages upon
maturity should it choose to do so.
Page 38 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
OFF-BALANCE SHEET ITEMS
H&R has co-owners and partners in various projects. As a rule H&R does not provide guarantees or indemnities for these co-owners and partners pursuant
to property acquisitions because should such guarantees be provided, recourse would be available against H&R in the event of a default of the co-owners
and partners. In such case, H&R would have a claim against the underlying real estate investment. However, in certain circumstances, subject to
compliance with H&R’s Declaration of Trust and the determination by management that the fair value of the co-owners’ or partners’ investment is greater
than the mortgages payable for which H&R has provided guarantees, such guarantees will be provided. At December 31, 2016, such guarantees amounted
to $171.1 million expiring between 2022 and 2029 (December 31, 2015 - $269.9 million, expiring between 2016 and 2029), and no amount has been
provided for in the Trusts’ Financial Statements for these items. These amounts arise where H&R has guaranteed a co-owner’s share of the mortgage
liability. H&R, however, customarily guarantees or indemnifies the obligations of its nominee companies which hold separate title to each of its properties
owned.
In addition, H&R continued 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 H&R’s guarantee. At December 31, 2016, the estimated amount of debt subject to such
guarantees, and therefore the maximum exposure to credit risk is approximately $133.0 million, expiring between 2017 and 2020 (December 31, 2015 -
$146.5 million, expiring between 2016 and 2020). There have been no defaults by the primary obligor for debts on which H&R has provided its guarantees,
and as a result, no contingent loss on these guarantees has been recognized in the Trusts’ Financial Statements.
In the normal course of operations, H&R has issued letters of credit in connection with developments, financings, operations and acquisitions. As at
December 31, 2016, H&R has outstanding letters of credit totalling $34.3 million (December 31, 2015 - $62.7 million), including nil (December 31, 2015 -
$18.6 million) which has been pledged as security for certain mortgages payable. The letters of credit are secured in the same manner as the bank
indebtedness.
FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS
Where appropriate, H&R, including ECHO and the LIC Project, uses forward contracts to lock-in lending rates on certain anticipated mortgages, debentures
and bank borrowings. This strategy provides certainty to the rate of interest on borrowings when H&R is involved in transactions that may close further
into the future than usual for typical transactions. At the end of each reporting period, an interest rate swap is marked-to-market, resulting in an unrealized
gain or loss recorded in net income.
Where appropriate, H&R 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.
Page 39 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
As at December 31, 2016, H&R had the following interest rate swaps outstanding at the Trusts’ interests:
Debenture interest rate swap
Debenture interest rate swap
Bank indebtedness interest rate swap
Mortgage interest rate swap
Mortgage interest rate swaps
Bank indebtedness interest rate swap
(a)
(b)
(c)
(d)
(e)
(f)
Fair value (liability) asset*
Net gain (loss) on derivative contracts**
December 31
2016
December 31
2015
December 31
2016
December 31
2015
$ 776
(407)
(3,384)
-
(945)
(1,285)
($5,245)
$ -
-
-
-
(1,209)
-
($1,209)
$ 776
(407)
(3,384)
-
226
(1,265)
($4,054)
$ -
-
-
161
1,122
-
$ 1,283
(a) Series K senior debentures bearing interest at 2.36% per annum, maturing on March 1, 2019.
(b) Series I senior debentures bearing interest at 2.54% per annum, which matured January 23, 2017 and Series J senior debentures bearing interest at 2.04% per annum, maturing on
February 9, 2018. The interest rate swap on the Series I senior debentures was settled in January 2017.
(c) U.S. $130.0 million bank indebtedness bearing interest at 2.56% per annum, maturing on March 17, 2021.
(d) One U.S. mortgage; this interest rate swap was settled in 2015.
(e) ECHO has entered into various interest rate swaps to fix the interest rate on certain mortgages.
(f)
LIC construction facility bearing interest at 4.26% per annum.
*
**
Derivative instruments in asset and liability positions are not presented on a net basis. Derivative instruments in an asset position are recorded in other assets and derivative instruments
in a liability position are recorded in accounts payable and accrued liabilities.
Excludes amounts relating to foreign exchange which have been recorded in accumulated other comprehensive income.
SECTION IV
CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS
Preparation of the Trusts’ 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.
Management believes the policies which are subject to greater estimation and judgement are outlined below. For a detailed description of these and other
accounting policies refer to notes 1 and 2 of the Trusts’ Financial Statements.
Use of Estimates
Information about assumption and estimation uncertainties that have a significant risk of resulting in a material adjustment within the next financial year
are:
Fair value of real estate assets;
Fair value of exchangeable units;
Fair value of cash-settled unit-based compensation;
Fair value of convertible debentures; and
Deferred tax asset (liability).
Page 40 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
Use of Judgements
Business combinations
Accounting for business combinations under IFRS 3, Business Combinations (“IFRS 3”) is only applicable if it is determined that a business has been
acquired. Under IFRS 3, a business is defined as an integrated set of activities and assets conducted and managed for the purpose of providing a
return to investors or lower costs or other economic benefits directly and proportionately to H&R. A business generally consists of inputs, processes
applied to those inputs and resulting outputs that are, or will be, used to generate revenues. In the absence of such criteria, a group of assets is
deemed to have been acquired. If goodwill is present in a transferred set of activities and assets, the transferred set is presumed to be a business.
Judgement is used by management in determining whether the acquisition of an individual property, or a group of properties, qualifies as a business
combination in accordance with IFRS 3 or as an asset acquisition.
Valuations of real estate assets
Real estate assets, which consist of investment properties and properties under development, are carried on the combined statements of financial
position at fair value, as determined by either qualified external valuation professionals or by management. The valuations are based on a number of
assumptions, such as appropriate discount rates and capitalization rates and estimates of future rental income, operating expenses and capital
expenditures. Valuation of real estate assets is one of the principal estimates and uncertainties of H&R. Refer to note 4 of the Trusts’ Financial
Statements for further information on estimates and assumptions made in the determination of the fair value of real estate assets. Judgement is
applied in determining whether certain costs are additions to the carrying value of the real estate assets, identifying the point at which practical
completion of the property occurs and identifying the directly attributable borrowing costs to be included in the carrying value of the development
properties.
Leases
H&R’s policy for property rental revenue recognition is described in note 2(f) of the December 31, 2016 Trusts’ Financial Statements. H&R makes
judgements in determining whether certain leases, in particular those tenant leases with long contractual terms and long-term ground leases where
H&R is the lessor, are operating or finance leases. H&R has determined that all of its leases are operating leases.
Income taxes
H&R currently qualifies as a real estate investment trust and a mutual fund trust for Canadian income tax purposes. A real estate investment trust will
not be subject to the tax levied on “specified investment flow-through” (“SIFT”) trusts provided it continues to meet prescribed conditions under the Tax
Act, including with respect to the nature of its assets and revenue, (the “REIT Conditions”) at all times throughout a taxation year. Accordingly, no
provision for current or deferred income taxes has been recorded by H&R as at December 31, 2016 in respect of its Canadian entities.
H&R will not be subject to income tax in a year to the extent that it continues to qualify as a real estate investment trust and distributes all of its taxable
income to its unitholders. Income allocated to unitholders will be taxed at the unitholder level. H&R currently distributes, and is required to distribute,
all of its income to its unitholders. Accordingly, for financial statement reporting purposes, the tax deductibility of H&R’s distributions is treated as an
exemption from taxation.
Impairment of equity accounted investments
H&R determines at each reporting date whether there is any objective evidence that the equity accounted investments are impaired. If so, H&R
calculates the amount of impairment as the difference between the recoverable amount of the equity accounted investment and its carrying value and
recognizes the amount in net income.
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NEW STANDARDS AND INTERPRETATIONS NOT YET ADOPTED
Standards issued but not yet effective up to the date of issuance of the Trusts’ Financial Statements are described below. The Trusts intend to adopt these
standards when they become effective.
(i) Amendments to Statement of Cash Flows (“IAS 7”)
In January 2016, the IASB issued amendments to IAS 7, Statement of Cash Flows. These amendments require disclosures that enable users of
financial statements to evaluate changes in liabilities arising from financing activities, including both changes arising from cash flow and non-cash
changes. The Trusts will adopt the amendments to IAS 7 in its combined financial statements for the annual period ending December 31, 2017. The
Trusts intend to satisfy the new requirements by providing reconciliations between the opening and closing balances for liabilities from financing
activities.
(ii) Financial Instruments: Classification and Measurement (“IFRS 9”)
In July 2014, the IASB issued IFRS 9 Financial Instruments: Classification and Measurements (“IFRS 9”), replacing IAS 39, Financial instruments:
Recognition and Measurement. IFRS 9 is effective for the annual period beginning on January 1, 2018, with early adoption permitted. The Trusts
currently plan to apply IFRS 9 on January 1, 2018. The actual impact of adopting IFRS 9 on the Trusts’ Financial Statements in 2018 has not yet
been determined.
(iii) Revenue from Contracts with Customers (“IFRS 15”)
In May 2014, the IASB issued IFRS 15 Revenue from Contracts with Customers. The new standard is effective for annual periods beginning on or
after January 1, 2018. IFRS 15 establishes a comprehensive framework for determining whether, how much and when revenue is recognized. It
replaces IAS 11 Construction Contracts, IAS 18 Revenue, IFRIC 13 Customer Loyalty Programmes, IFRIC 15 Agreements for the Construction of
Real Estate, IFRIC 18 Transfer of Assets from Customers, and SIC 31 Revenue - Barter Transactions Involving Advertising Services. The Trusts
intend to adopt IFRS 15 in the combined financial statements for the annual period beginning on January 1, 2018. The extent of the impact of adoption
of the standard has not yet been determined.
(iv) Amendments to Share-based Payments (“IFRS 2”)
In January 2016, the IASB issued amendments to IFRS 2, Share-based Payment clarifying how to account for certain types of share-based payment
transactions. The Trusts intend to adopt the amendments to IFRS 2 in its combined financial statements for the annual period beginning on January
1, 2018. The extent of the impact of adoption of the amendments has not yet been determined.
(v) Leases (“IFRS 16”)
In January 2016, the IASB issued IFRS 16, Leases. The new standard will replace existing lease guidance in IFRS and related interpretations, and
requires lessees to bring most leases on-balance sheet. Lessor accounting remains similar to the current standard. The new standard is effective for
years beginning on January 1, 2019. The extent of the impact of adoption of the standard has not yet been determined.
INTERNAL CONTROL OVER FINANCIAL REPORTING
Each of the Trust’s CEO and CFO has designed, or caused to be designed under their direct supervision, the applicable Trusts’ disclosure controls and
procedures (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 annual filings are being prepared; and (ii)
material information required to be disclosed in the annual filings is recorded, processed, summarized and reported on a timely basis. The Trusts’ CEO
and CFO have each concluded that such disclosure controls and procedures were appropriately designed and were operating effectively as at December
31, 2016. The Trusts’ Financial Statements and this MD&A were reviewed and approved by H&R’s Audit Committee and the Board of Trustees prior to
this publication.
Management of each Trust has reviewed its internal control over financial reporting on an annual basis. The Trusts’ management, under the supervision
of the CFO, has evaluated the effectiveness of internal control over financial reporting using the framework and criteria established in Internal Control –
Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission in May 2013 (2013 COSO Framework). Based
on this evaluation, management has concluded that internal control over financial reporting was effective and in accordance with the criteria established
in the 2013 COSO Framework as of December 31, 2016. No changes were made to the design of either Trust’s internal control over financial reporting
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during the three month period ended December 31, 2016 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 Trusts’ 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 their systems of controls and procedures.
SECTION V
RISKS AND UNCERTAINTIES
All real estate assets 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 H&R’s portfolio. The major risk factors including detailed
descriptions are outlined below and in H&R’s Annual Information Form.
Real Property Ownership
All real property investments are subject to a degree of risk and uncertainty. Such investments are affected by various factors including general economic
conditions, local real estate markets, demand for leased premises, competition from other available premises and various other factors.
The value of real property and any improvements thereto may also depend on the credit and financial stability of the tenants. Distributable cash and H&R’s
income would be adversely affected if one or more major tenants or a significant number of tenants were to become unable to meet their obligations under
their leases or if a significant amount of available space in the properties in which H&R has an interest is not able to be leased on economically favourable
lease terms. In the event of default by a tenant, delays or limitations in enforcing rights as lessor may be experienced and substantial costs in protecting
H&R’s investment may be incurred. Furthermore, at any time, a tenant of any of the properties in which H&R has an interest may seek the protection of
bankruptcy, insolvency or similar laws that could result in the rejection and termination of such tenant’s lease and thereby cause a reduction in the cash
flow available to H&R.
Given the prominence of the oil and gas industry in the province of Alberta, the economy of this province can be significantly impacted by commodity
prices. For the year ended December 31, 2016, approximately 26.7% of H&R’s Same-Asset property operating income (cash basis) was generated from
Alberta. Accordingly, any continuing decline or prolonged weakness in commodity prices, could adversely affect those tenants of H&R that are involved
in the oil and gas industry, thereby increasing the credit risk of such tenants to H&R which in turn may adversely affect H&R’s operating results.
With respect to the Primaris segment, retail shopping centres have traditionally relied on there being a number of anchor tenants (department stores,
discount department stores and grocery stores) in the centre, and therefore they are subject to the risk of such anchor tenants either moving out of the
property or going out of business. Within the Primaris segment, certain of the major tenants are permitted to cease operating from their leased premises
at any time at their option, however, they remain liable to pay all remaining rent in accordance with their leases. Other major tenants are permitted to
cease operating from their leased premises or to terminate their leases if certain events occur. Some commercial retail unit tenants have a right to cease
operating from their premises if certain major tenants cease operating from their premises. The exercise of such rights by a tenant may have a negative
effect on a property. There can be no assurance that such rights will not be exercised in the future.
The ability to rent unleased space in the properties in which H&R has an interest will be affected by many factors and costs may be incurred in making
improvements or repairs to property required by a new tenant. A prolonged deterioration in economic conditions could increase and exacerbate the
foregoing risks. The failure to rent unleased space on a timely basis or at all would likely have an adverse effect on H&R’s financial condition.
Certain significant expenditures, including property taxes, maintenance costs, mortgage payments, insurance costs and related charges must be made
throughout the period of ownership of real property regardless of whether the property is producing any income. If H&R is unable to meet mortgage
payments on any property, losses could be sustained as a result of the mortgagee’s exercise of its rights of foreclosure or sale.
H&R may, in the future, be exposed to a general decline of demand by tenants for space in properties. As well, certain of the leases of the properties held
by H&R have early termination provisions which, if exercised, would reduce the average lease term. However, such termination rights are generally
exercisable at a cost to the tenant only and the amount of space in H&R’s portfolio which could be affected is not significant.
A mortgage on any one property may, from time to time, exceed the estimated current market value of the related property. The cash flow from such a
property may not be sufficient to cover debt servicing for that property. The cash flow from H&R’s portfolio is, however, expected by management to be
sufficient to cover any cash flow shortfalls on such a property.
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Credit Risk and Tenant Concentration
H&R is exposed to credit risk in the event that borrowers default on the repayment of the amounts owing to H&R. Management mitigates this risk by
ensuring adequate security has been provided in support of mortgages receivable.
H&R 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 H&R’s holdings so that it owns
several categories of properties (office, retail, industrial and residential) 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 investment properties of H&R are Encana Corporation and Bell Canada.
Both of these companies have a public debt rating that is rated with at least a BBB Negative rating by a recognized rating agency.
Lease Rollover Risk
Lease rollover risk arises from the possibility that H&R may experience difficulty renewing leases as they expire. Management attempts to enter into long-
term leases to mitigate this risk. Management attempts to mitigate the risk by having staggered lease maturities and entering into longer term leases with
built-in rental escalations. The leases for 34.6% of H&R’s total commercial leasable area will expire in the next 5 years.
Interest and Other Debt-Related Risk
H&R has been able to leverage off the low interest rate environment that the Canadian and U.S. economy has experienced in recent years which has
enhanced its return to unitholders. A reversal of this trend, however, may lead to the Trusts’ debt being refinanced at higher rates, thereby reducing net
income and cash flows which could ultimately affect the level of distributions. In order to minimize this risk, H&R 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 H&R in the management of its interest rate exposure. In addition, H&R’s Declaration of Trust restricts total indebtedness permitted on the
portfolio.
Construction Risks
It is likely that, subject to compliance with H&R’s Declaration of Trust, H&R will be involved in various development projects. H&R’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 H&R 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. 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.
Currency Risk
The Trusts are 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, H&R’s debt on these properties is also denominated in U.S. dollars to act as a natural hedge.
H&R is exposed to foreign exchange fluctuations as a result of the U.S. Holdco Notes, Series J senior debentures and the U.S. bank indebtedness each
being denominated in U.S. dollars.
Liquidity Risk
Real property investments tend to be relatively illiquid, with the degree of liquidity generally fluctuating in relationship with demand for and the perceived
desirability of such investments. Such illiquidity will tend to limit H&R’s ability to vary its portfolio promptly in response to changing economic or investment
conditions. If for whatever reason, liquidation of assets is required, there is a risk that sale proceeds realized might be less than the previously estimated
market value of H&R’s investments or that market conditions would prevent prompt disposition of assets.
Financing Credit Risk
H&R 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.
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Environmental Risk
As an owner and manager of real estate assets in Canada and the United States, H&R 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 H&R on or
adjacent properties.
In accordance with best management practices, Phase 1 environmental audits are reviewed on all properties prior to acquisition. Further investigation is
conducted if Phase 1 tests indicate a potential problem. H&R has operating policies to monitor and manage risk. In addition, the standard lease utilized
requires tenants to comply with environmental laws and regulations, and restricts tenants from carrying on environmentally hazardous activities or having
environmentally hazardous substances on site.
Co-Ownership Interest in Properties
In certain situations, H&R may be adversely affected by a default by a co-owner of a property under the terms of a mortgage, lease or other agreement.
Although all co-owners agreements entered into by H&R provide for remedies to H&R in such circumstances, such remedies may not be exercisable in all
circumstances, or may be insufficient or delayed, and may not cure a default in the event that such default by a co-owner is deemed to be a default of
H&R.
Joint Arrangement Risks
H&R has several investments in joint ventures and investments in associates. H&R is subject to risks associated with the management and performance
of these joint arrangements. Such risks include any disagreements with its partners relating to the development or operations of a property, as well as
differences with respect to strategic decision making. Other risks include partners not meeting their financial or operational obligations. H&R attempts to
mitigate these risks by maintaining good working relationships with its partners, and conducting due diligence on their partners to ensure there is a similar
alignment of strategy prior to creating a joint arrangement.
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 H&R 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 H&R. See also “Forward-Looking Disclaimer”.
One of the factors that may influence the quoted 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 quoted price of Stapled Units. In
addition, the quoted 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 H&R and/or Finance Trust.
Availability of Cash for Distributions
As the monthly cash distribution paid by Finance Trust fluctuates, the monthly cash distribution paid by H&R will also fluctuate in order to result in an
aggregate monthly cash distribution as previously outlined. Although H&R 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 H&R will depend on numerous factors
including monthly cash distributions paid by Finance Trust, capital market conditions, the financial performance of the properties, H&R’s debt covenants
and obligations, its working capital requirements, its future capital requirements, its development commitments and fluctuations in interest rates. Cash
available to H&R 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. H&R 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 H&R and/or Finance Trust suspends
or reduces distributions. H&R’s trustees retain the right to re-evaluate the distribution policy from time to time as they consider appropriate.
Ability to Access Capital Markets
As H&R distributes a substantial portion of its income to unitholders, H&R may need to obtain additional capital through capital markets and H&R’s ability
to access the capital markets through equity issues and forms of secured or unsecured debt financing may affect the operations of H&R 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.
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Dilution
The number of units each of the Trusts is authorized to issue is unlimited. The trustees have the discretion to issue additional Stapled Units in certain
circumstances, including under H&R’s Unit Option Plan and Incentive Unit Plan. Any issuance of Stapled Units may have a dilutive effect on the investors
of Stapled Units.
Unitholder Liability
The Declarations of Trust of each of H&R and Finance 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 a trust. Each
Declaration of Trust of H&R and Finance Trust further provides that this lack of unitholder liability, where possible, must be provided for in certain written
instruments signed by the applicable Trust. In addition, legislation has been enacted in the Provinces of Ontario and certain 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 a Trust’s 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.
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,
H&R’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 H&R 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.
Debentures
The likelihood that purchasers of the 2018 and 2020 convertible debentures and the Series C, E, F, G, J, K, L, M and N Senior Debentures will receive
payments owing to them under the terms of such debentures will depend on the financial health of H&R and its creditworthiness. In addition, such
debentures are unsecured obligations of H&R and are subordinate in right of payment to all H&R’s existing and future senior indebtedness as defined in
each such respective trust indenture. Therefore, if H&R becomes bankrupt, liquidates its assets, reorganizes or enters into certain other transactions,
H&R’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 H&R’s subsidiaries except to the extent H&R 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 H&R. 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 H&R, holders of indebtedness of H&R (including holders of the convertible debentures), may become subordinate to lenders to the
subsidiaries of H&R. The indentures governing such debentures do not prohibit or limit the ability of H&R 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 H&R.
Tax Risk
The Tax Act includes rules (referred to herein as the ‘‘SIFT Rules’’) which effectively tax certain income of a publicly traded trust or partnership that is
distributed to its investors on the same basis as would have applied had the income been earned through a taxable corporation and distributed by way of
dividend to its shareholders. The SIFT Rules apply only to ‘‘SIFT trusts’’, ‘‘SIFT partnerships’’ (each as defined in the Tax Act, and collectively, “SIFTs”)
and their investors. A trust that qualifies as a “real estate investment trust” (as defined in the Tax Act) for a taxation year will not be considered to be a
SIFT trust in that year (the “REIT Exemption”).
Based on a review of H&R’s assets and revenues, management believes that H&R satisfied the tests to qualify for the REIT Exemption for 2016.
Management of H&R intends to conduct the affairs of H&R so that it qualifies for the REIT Exemption at all times. However, as the REIT Exemption includes
complex revenue and asset tests, no assurances can be provided that H&R will continue to qualify for any subsequent year.
The Tax Act includes rules affecting certain publicly traded stapled securities of SIFTs, REITs and corporations which can result in the denial of a deduction
for certain payments made by another entity to a REIT, or to a subsidiary of a REIT (the “Stapled Security Rules”). Management of each of H&R and
Finance Trust has reviewed the Stapled Security Rules and has concluded that the Stapled Security Rules should not materially adversely affect H&R,
Finance Trust or holders of Stapled Units. However, no assurances can be given in this regard.
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There can be no assurance that income tax laws and the treatment of mutual fund trusts will not be changed in a manner which adversely affects holders
of Stapled Units. If H&R or Finance Trust ceases to qualify as a “mutual fund trust” under the Tax Act and the units thereof cease to be listed on a
designated stock exchange (which currently includes the TSX), H&R Units or Finance Trust Units, as the case may be, will cease to be qualified investments
for registered retirement savings plans, deferred profit sharing plans, registered retirement income funds, registered education savings plans, registered
disability savings plans and tax-free savings accounts.
Pursuant to rules in the Tax Act, if H&R or Finance Trust experiences a “loss restriction event” (i) it will be deemed to have a year-end for tax purposes
(which would result in an unscheduled distribution of undistributed net income and net realized capital gains, if any, at such time to Unitholders to the
extent necessary so that such trust is not liable for income tax on such amounts under Part I of the Tax Act), and (ii) it will become subject to the loss
restriction rules generally applicable to a corporation that experiences an acquisition of control, including a deemed realization of any unrealized capital
losses and restrictions on its ability to carry forward losses. Generally, H&R or Finance Trust will be subject to a loss restriction event if a person becomes
a “majority-interest beneficiary”, or a group of persons becomes a “majority-interest group of beneficiaries”, of such trust, each as defined in the affiliated
persons rules contained in the Tax Act, with certain modifications. Generally, a majority-interest beneficiary of a trust is a beneficiary of the trust whose
beneficial interests in the income or capital of the trust, as the case may be, together with the beneficial interests in the income or capital of the trust, as
the case may be, of persons and partnerships with whom such beneficiary is affiliated for the purposes of the Tax Act, represent greater than 50% of the
fair market value of all the interests in the income or capital of the trust, as the case may be.
H&R operates in the United States through U.S. Holdco which is capitalized with debt and equity provided by H&R and debt in the form of U.S. Holdco
Notes owed to Finance Trust and H&R Portfolio Limited Partnership. As at December 31, 2016, Finance Trust holds U.S. $220.5 million of U.S. Holdco
Notes. During 2016, H&R made loans to U.S. Holdco (“U.S. Holdco Loans”) to indirectly fund additional U.S. Holdco acquisitions of income generating
real property and Management anticipates that U.S. Holdco will continue to borrow funds from H&R in the future for similar purposes, to fund its operations
or to refinance existing loans. U.S. Holdco treats the U.S. Holdco Notes and U.S. Holdco Loans as indebtedness for U.S. federal income tax purposes.
If the IRS or a court were to determine that the U.S. Holdco Notes and/or the U.S. Holdco Loans should be treated for U.S. federal income tax purposes
as equity rather than debt, the interest on the U.S. Holdco Notes and/or the U.S. Holdco Loans could be treated as a dividend, and interest on the U.S.
Holdco Notes and/or the U.S. Holdco Loans 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 and/or the U.S. Holdco Loans did not represent an arm’s length rate, any excess amount over the arm’s length
rate would not be deductible and could be re-characterized 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. Such an increase in tax liability could materially adversely affect
U.S. Holdco’s ability to make interest payments on the U.S. Holdco Notes and/or the U.S. Holdco Loans or H&R’s ability to make distributions on its units.
Additionally, payments of interest on the U.S. Holdco Notes considered to be paid to non-U.S. holders of Stapled Units as discussed below could be subject
to withholding taxes.
On October 13, 2016, the U.S. Treasury and the IRS issued final and temporary regulations under section 385 of the Code (“Section 385 Regulations”)
that could potentially apply to recharacterize as equity certain related party indebtedness issued after April 4, 2016. Generally, the Section 385 Regulations
(i) establish threshold documentation requirements that must be satisfied for related party indebtedness issued after January 1, 2018 in order for such
related party indebtedness to be treated as debt for U.S. federal income tax purposes, (ii) treat related party indebtedness as equity for U.S. federal income
tax purposes if such related party indebtedness was issued in certain transactions, including in exchange for stock of a related party or in a distribution
and (iii) recharacterize related party indebtedness as equity for U.S. federal income tax purposes in certain circumstances including where the debtor
corporation pays a distribution after April 4, 2016 in excess of the accumulated earnings and profits for tax years ending after April 4, 2016, during which
the debtor corporation is related to the holder of the debt. In general, the Section 385 Regulations only apply to related party indebtedness debt issued by
U.S. corporations after April 4, 2016 and so most of the U.S. Holdco Notes should not be impacted by the Section 385 Regulations. However, the Section
385 Regulations could apply to U.S. Holdco Notes that are refinanced in the future and/or to any issuances of related party indebtedness issued after April
4, 2016, including the U.S. Holdco Loans issued after this date. Management believes that the Section 385 Regulations should not apply to treat the
existing U.S. Holdco Loans as equity as the U.S. Holdco Loans were not issued in exchange for stock of a related party or otherwise in a transaction
described in the Section 385 Regulations and U.S. Holdco has not paid any distributions to H&R since April 4, 2016 or engaged in any other transaction
that would cause such loans to be recharacterized under the Section 385 Regulations. Management does not currently anticipate causing U.S. Holdco to
pay distributions in excess of U.S. Holdco’s earnings and profits accumulated in tax years ending after April 4, 2016 or engaging in any other transactions
that will cause indebtedness of U.S. Holdco to be treated or recharacterized as equity. However, there can be no assurance that such a distribution or
transaction will not occur in the future. In the event that any indebtedness of U.S. Holdco were recharacterized as equity, any interest paid or accrued on
such indebtedness would not be deductible by U.S. Holdco and any payments made by U.S. Holdco thereon could be treated as dividends subject to U.S.
withholding tax.
To the extent that H&R or a related party provided debt financing to U.S. Holdco (e.g., the U.S. Holdco Loans or 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 H&R or such related
party. Section 163(j) of the Code applies to defer U.S. Holdco’s deduction of interest paid on debt to H&R or such related party in years that (i) the debt to
equity ratio of U.S. Holdco 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). Section 163(j) is considered in the analysis of interest paid on the U.S. Holdco Loans.
With respect to the U.S. Holdco Notes, H&R’s position is that, due to the treatment of Finance Trust as a grantor trust that is disregarded for U.S. federal
Page 47 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
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 H&R and/or 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. Holdco could increase.
In such case, the amount of income available for distribution by H&R to its Unitholders could be reduced.
Additional Tax Risks Applicable to Unitholders
H&R is classified as a foreign corporation for United States federal income tax purposes. A foreign corporation will be classified as a 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 H&R are managed by subsidiaries of H&R rather than directly by its
own employees. Although H&R's officers and employees oversee the activities of the managers, it is unclear whether H&R will be characterized as a PFIC
for U.S. federal income tax purposes. If H&R were treated as a PFIC, then in the absence of certain elections being made by a U.S. Unitholder with respect
to such U.S. Unitholder’s H&R Units, any distributions in respect of H&R Units which are treated as “excess distribution” under the applicable rules and
any gain on a sale or other disposition of H&R Units would be treated as ordinary income and would be subject to special tax rules, including an interest
charge. In addition, if H&R were treated as a PFIC, then dividends paid on H&R Units will not qualify for the reduced 20% U.S. federal income tax rate
applicable to certain qualifying dividends received by noncorporate taxpayers.
The foregoing adverse consequences of PFIC characterization can be mitigated by making certain elections. U.S. Unitholders 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. If H&R were a PFIC, U.S. Unitholders would be required to file an annual return on IRS Form 8621.
U.S. individuals are required to report an interest in any “specified foreign financial asset” if the aggregate value of such assets owned by the U.S. individual
exceeds $50,000 (or such higher threshold as may apply to a particular taxpayer pursuant to the instructions to IRS Form 8938). H&R Units are treated as
a specified foreign financial asset for this purpose.
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 will be treated as payments directly to Unitholders. 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 income taxation at a maximum
marginal rate of 39.6% plus an additional 3.8% tax that applies to investment income earned by certain high income non-corporate taxpayer. Interest on
the U.S. Holdco Notes paid to Canadian resident Unitholders may be eligible for an exemption from U.S. withholding tax under the Canada-U.S. Tax
Convention (the “U.S. Treaty”) if the applicable limitation on benefit provisions contained in the U.S. Treaty are satisfied. 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.
U.S. Unitholders are required to file an information return on IRS Form 3520 to report their interest in the Finance Trust and to include a copy of their Form
3520-A Foreign Grantor Trust Owner Statement, which is being provided by Finance Trust to its registered U.S. Unitholders. If you have not received a
Foreign Grantor Trust Owner Statement, pro forma information to prepare a Form 3520-A Foreign Grantor Trust Owner Statement will be available on our
website. You should consult with your own tax advisor regarding the requirements of filing information returns.
A holder of Stapled Units that is a resident of the U.S. for purposes of the Tax Act will generally be subject to Canadian withholding tax under Part XIII of
the Tax Act at the rate of 25% on the portion of the income of H&R and Finance Trust paid or credited (whether in cash or in specie) in respect of such
Stapled Units, subject to reduction under the U.S. Treaty if applicable. In the case of income paid or credited on H&R units, the withholding rate applicable
to a U.S. Unitholder entitled to the benefits of the U.S. Treaty in respect of such income would generally be reduced to 15%. In the case of income paid or
credited to a U.S. resident holder of Finance Trust Units, there is uncertainty as to the appropriate rate of withholding under the U.S. Treaty and in light of
this uncertainty, management of Finance Trust currently applies the 25% withholding rate under the Tax Act to income paid or credited to U.S. residents.
U.S. Unitholders may be entitled to a refund of a portion of such withholding tax if the rate applied by Finance Trust were determined to be excessive. You
should consult with your own tax advisor regarding the advisability of applying for such a refund.
Page 48 of 49
H&R REIT AND H&R FINANCE TRUST - MD&A – DECEMBER 31, 2016
OUTSTANDING UNIT DATA
The beneficial interests in each of the Trusts are represented by a single class of units of each Trust respectively, which are unlimited in number. Each
such unit carries a single vote at any meeting of unitholders of the respective Trust. As at February 9, 2017, there were 285,744,257 Stapled Units issued
and outstanding (each comprised of an H&R unit and a Finance Trust unit).
As at December 31, 2016, the maximum number of units authorized to be issued under H&R’s Unit Option Plan was 28,000,000. Of this amount,
21,402,296 options had been granted, 343,422 have expired and 6,941,126 remain to be granted. Of the amount originally granted, 7,581,757 had been
exercised and expired and therefore, 13,820,539 options to purchase Stapled Units were outstanding. As at February 9, 2017, there were 13,820,539
options to purchase Stapled Units outstanding of which 5,186,652 are fully vested.
As at December 31, 2016, the maximum number of units authorized to be granted under H&R’s Incentive Unit Plan was 5,000,000. Of this amount,
419,025 had been granted, of which 11,665 had been expired, 4,592,640 remain to be granted and 407,360 incentive units remain outstanding as at
December 31, 2016. As at February 9, 2017, there were 500,347 incentive units outstanding.
As at December 31, 2016, there were 16,563,816 exchangeable units outstanding of which 9,500,000 exchangeable units are accompanied by special
voting units. As at February 9, 2017, there were 16,563,816 exchangeable units of which 9,500,000 exchangeable units are accompanied by special
voting units.
The following table lists the principal outstanding balance of H&R’s convertible debentures as at February 9, 2017, and the number of Stapled Units
required to convert the convertible debentures to equity:
Convertible Debentures
2018 Convertible Debentures (HR.DB.H)
2020 Convertible Debentures (HR.DB.D)
SUBSEQUENT EVENTS
Principal outstanding as at
February 9, 2017
Maximum number of Stapled
Units issuable
74.4 million
99.7 million
3,008,249
4,240,595
(a)
In January 2017, H&R sold a 50% non-managing interest in two enclosed shopping centres which was classified as held for sale as at December
31, 2016, for gross proceeds of approximately $211.6 million. The purchaser assumed 50% of the existing mortgages of approximately $126.6
million.
(b)
In January 2017, H&R issued $150.0 million principal amount of Series M senior debentures maturing on July 23, 2019.
(c)
In January 2017, H&R repaid all of its Series I senior debentures upon maturity for a cash payment of $60.0 million.
(d)
In January 2017, H&R issued $200.0 million principal amount of Series N senior debentures maturing January 30, 2024.
(e)
In January 2017, H&R secured a U.S. $55.0 million increase to a first mortgage for a term of 4.8 years.
(f)
In February 2017, H&R repaid all of its Series B senior debentures upon maturity for a cash payment of $115.0 million.
(g)
In February 2017, H&R repaid one Canadian mortgage of approximately $124.4 million.
ADDITIONAL INFORMATION
Additional information relating to H&R and Finance Trust, including H&R’s Annual Information Form, is available on SEDAR at www.sedar.com
Page 49 of 49
Combined Financial Statements of
H&R REAL ESTATE INVESTMENT TRUST
and
H&R FINANCE TRUST
Years ended December 31, 2016 and 2015
KPMG LLP
Bay Adelaide Centre
333 Bay Street, Suite 4600
Toronto ON M5H 2S5
Canada
Tel 416-777-8500
Fax 416-777-8818
INDEPENDENT AUDITORS' REPORT
To the Unitholders of H&R Real Estate Investment Trust
We have audited the accompanying combined financial statements of H&R Real Estate Investment
Trust and H&R Finance Trust (collectively, the "Trusts"), which comprise the combined statements of
financial position as at December 31, 2016 and 2015, the combined statements of comprehensive
income, changes in unitholders' equity and cash flows for the years then ended, and notes,
comprising a summary of significant accounting policies and other explanatory information.
Management's Responsibility for the Combined Financial Statements
Management is responsible for the preparation and fair presentation of these combined financial
statements in accordance with International Financial Reporting Standards, and for such internal
control as management determines is necessary to enable the preparation of combined financial
statements that are free from material misstatement, whether due to fraud or error.
Auditors' Responsibility
Our responsibility is to express an opinion on these combined financial statements based on our
audits. We conducted our audits in accordance with Canadian generally accepted auditing
standards. Those standards require that we comply with ethical requirements and plan and perform
the audit to obtain reasonable assurance about whether the combined financial statements are free
from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures
in the combined financial statements. The procedures selected depend on our judgment, including
the assessment of the risks of material misstatement of the combined financial statements, whether
due to fraud or error. In making those risk assessments, we consider internal control relevant to the
Trusts' preparation and fair presentation of the combined financial statements in order to design audit
procedures that are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Trusts' internal control. An audit also includes evaluating the
appropriateness of accounting policies used and the reasonableness of accounting estimates made
by management, as well as evaluating the overall presentation of the combined financial statements.
We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to
provide a basis for our audit opinion.
KPMG LLP, is a Canadian limited liability partnership and a member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.
KPMG Canada provides services to KPMG LLP.
Page 2
Opinion
In our opinion, the combined financial statements present fairly, in all material respects, the combined
financial position of the Trusts as at December 31, 2016 and 2015, and their combined financial
performance and their combined cash flows for the years then ended in accordance with International
Financial Reporting Standards.
Chartered Professional Accountants, Licensed Public Accountants
February 15, 2017
Toronto, Canada
Note
December 31
2016
December 31
2015
4
4
5
6
7
8
9
10
11
24
6
8
12
25
13, 27
$ 12,564,144
118,268
12,682,412
$ 12,576,075
97,504
12,673,579
1,051,187
211,550
161,842
48,021
1,117,786
3,000
157,663
38,287
$ 14,155,012
$ 13,990,315
$ 4,001,451
1,491,591
370,533
386,775
126,815
-
647,772
217,425
$ 4,537,278
1,550,769
334,110
189,658
-
55,717
321,033
176,830
7,242,362
7,165,395
6,912,650
6,824,920
$ 14,155,012
$ 13,990,315
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Combined Statements of Financial Position
(In thousands of Canadian dollars)
Assets
Real estate assets:
Investment properties
Properties under development
Equity accounted investments
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
Liabilities classified as held for sale
Loan payable
Bank indebtedness
Accounts payable and accrued liabilities
Unitholders' equity
Commitments and contingencies
Subsequent events
See accompanying notes to the combined financial statements.
Approved on behalf of the Board of Trustees:
“Robert Dickson”
“Thomas J. Hofstedter”
Trustee
Trustee
1
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Combined Statements of Comprehensive Income
(In thousands of Canadian dollars)
Years ended December 31, 2016 and 2015
Property operating income:
Rentals from investment properties
Property operating costs
Net income from equity accounted investments
Other income
Finance cost - operations
Finance income
Fair value adjustments on financial instruments
Trust expenses
Fair value adjustment on real estate assets
Loss on sale of real estate assets, net of related costs
Gain (loss) on foreign exchange
Transaction costs
Net income before income taxes
Income tax expense
Net income
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
Note
2016
2015
16
5
17
18
18
18
4
4
24
15
$ 1,196,011 $ 1,188,314
(414,801)
773,513
(431,271)
764,740
48,341
20,353
(287,325)
4,715
(33,830)
(29,852)
133,738
(8,167)
(8,944)
(13,483)
590,286
(201,541)
388,745
841
-
(295,010)
3,770
36,240
(9,327)
(178,868)
(5,428)
49,375
-
375,106
(34,958)
340,148
(38,397)
30
(38,367)
227,430
31
227,461
Total comprehensive income all attributable to unitholders
$ 350,378
$ 567,609
See accompanying notes to the combined financial statements.
2
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Combined Statements of Changes in Unitholders' Equity
(In thousands of Canadian dollars)
Years ended December 31, 2016 and 2015
UNITHOLDERS' EQUITY
Note
Value of
Units
Accumulated
net income
Accumulated
distributions
Unitholders' equity, January 1, 2015
Proceeds from issuance of units
Issue costs
Net income
Distributions to unitholders
Conversion of convertible debentures, net
Units repurchased and cancelled
Other comprehensive income
Unitholders' equity, December 31, 2015
Proceeds from issuance of units
Net income
Distributions to unitholders
Conversion of convertible debentures, net
Units repurchased and cancelled
Other comprehensive loss
14(d)
10(c)
14(f)
14(d)
10(c)
14(f)
$ 5,133,757 $ 3,823,381 $ (2,548,596)
-
-
-
(373,072)
-
-
-
(2,921,668)
107,000
(353)
-
-
5
(3,937)
-
5,236,472
-
-
340,148
-
-
-
-
4,163,529
121,175
-
-
17
(2,734)
-
-
388,745
-
-
-
-
-
-
(381,106)
-
-
-
Accumulated other
comprehensive
income (loss)
(note 15)
Total
$ 119,126 $ 6,527,668
107,000
(353)
340,148
(373,072)
5
(3,937)
227,461
6,824,920
-
-
-
-
-
-
227,461
346,587
-
-
-
-
-
(38,367)
121,175
388,745
(381,106)
17
(2,734)
(38,367)
Unitholders' equity, December 31, 2016
$ 5,354,930 $ 4,552,274 $ (3,302,774)
$ 308,220 $ 6,912,650
See accompanying notes to the combined financial statements.
3
H&R REAL ESTATE INVESTMENT TRUST
H&R FINANCE TRUST
Combined Statements of Cash Flows
(In thousands of Canadian dollars)
Years ended December 31, 2016 and 2015
Cash provided by (used in):
Operations:
Net income
Finance cost - operations
Interest paid
Items not affecting cash:
Net income from equity accounted investments
Rent amortization of tenant inducements
(Gain) loss on foreign exchange
Fair value adjustment on real estate assets
Loss on sale of real estate assets, net of related costs
Fair value adjustments on financial instruments
Unit-based compensation
Deferred income taxes
Change in other non-cash operating items
Investing:
Properties under development
Investment properties:
Net proceeds on disposition of real estate assets
Acquisitions
Redevelopment
Capital expenditures
Leasing expenses and tenant inducements
Equity accounted investments, net
Mortgages receivable
Restricted cash
Financing:
Bank indebtedness
Mortgages payable:
New mortgages payable
Principal repayments
Repayment of loan payable
Proceeds from issuance of debentures payable
Repayment of debentures payable
Proceeds from issuance of units, net of issue costs
Units repurchased and cancelled
Distributions to unitholders
Increase in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
See note on supplemental cash flow information (note 19).
See accompanying notes to the combined financial statements.
4
Note
2016
2015
(note 3)
18
5
16
4
4
18
14(c)
24
19
4, 19
4
4, 19
4
4
7
10(c)
14(f)
14(d)
8
8
$ 388,745
287,325
(299,533)
$ 340,148
295,010
(304,188)
(48,341)
2,241
8,944
(133,738)
8,167
33,830
17,916
199,591
(40,951)
424,196
(841)
2,100
(49,375)
178,868
5,428
(36,240)
(697)
32,617
4,524
467,354
(20,104)
(2,436)
347,454
(325,169)
(65,814)
(58,924)
(34,682)
92,447
58,363
5,182
(1,247)
355,714
(301,668)
(43,331)
(41,716)
(54,628)
(207,986)
13,016
(7,773)
(290,808)
331,359
197,170
131,949
(489,891)
(54,102)
198,185
(254,983)
1,266
(2,734)
(274,264)
(413,215)
9,734
38,287
$ 48,021
418,732
(408,042)
(119,886)
370,752
(350,000)
847
(3,937)
(267,650)
(162,014)
14,532
23,755
$ 38,287
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, 2016 and 2015
These combined financial statements include the accounts of H&R Real Estate Investment Trust (the "REIT") and H&R Finance Trust ("Finance Trust",
together with the REIT, the “Trusts”). 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 and residential 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.
On October 1, 2008, the REIT completed an internal reorganization 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 further resulted in, among other
things, the creation of Finance Trust on October 1, 2008. 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") 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.
On October 24, 2013, the Ontario Securities Commission (on its behalf and on behalf of the other provincial securities regulators) issued a decision
which permits the REIT and Finance Trust to file one set of combined financial statements rather than separate financial statements. These combined
financial statements are being presented on a basis whereby the assets and liabilities of the REIT and Finance Trust have been combined in accordance
with the accounting principles applicable to both the REIT and Finance Trust in accordance with International Financial Reporting Standards (“IFRS”) to
reflect the financial position and results of the REIT and Finance Trust on a combined basis. The combined presentation is useful to the unitholders of
the Trusts, for the following reasons:
The units of the Trusts are stapled (as noted above), resulting in the 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.
Basis of preparation:
(a) Statement of compliance
These combined financial statements have been prepared in accordance with IFRS as published by the International Accounting Standards
Board (“IASB”) and using accounting policies described herein.
The combined financial statements were approved by the Board of Trustees of the REIT on February 15, 2017.
5
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, 2016 and 2015
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 items in the combined statements
of financial position which have been measured at fair value:
(i) Real estate assets;
(ii) Derivative financial instruments;
(iii) Liabilities for cash-settled unit-based compensation;
(iv) Convertible debentures; and
(v) Exchangeable units.
(c)
Functional currency and presentation
These combined financial statements are presented in Canadian dollars, except where otherwise stated, which is the Trusts’ functional
currency. All financial information has been rounded to the nearest thousand.
The Trusts present their combined statements 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 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 real estate assets (note 4);
Fair value of exchangeable units (note 11);
Fair value of cash-settled unit-based compensation (note 14(c));
Fair value of convertible debentures (note 10); and
Deferred tax asset (liability) (note 24).
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, 2016 and 2015
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:
Business combinations
Accounting for business combinations under IFRS 3, Business Combinations (“IFRS 3”) is only applicable if it is determined that a
business has been acquired. Under IFRS 3, a business is defined as an integrated set of activities and assets conducted and
managed for the purpose of providing a return to investors or lower costs or other economic benefits directly and proportionately to
the REIT. A business generally consists of inputs, processes applied to those inputs, and resulting outputs that are, or will be, used
to generate revenues. In the absence of such criteria, a group of assets is deemed to have been acquired. If goodwill is present in
a transferred set of activities and assets, the transferred set is presumed to be a business. Judgement is used by management in
determining whether the acquisition of an individual property, or group of properties, qualifies as a business combination in
accordance with IFRS 3 or as an asset acquisition.
Valuations of real estate assets
Real estate assets, which consist of investment properties and properties under development, are carried on the combined
statements of financial position at fair value, as determined by either qualified external valuation professionals or by management.
The valuations are based on a number of assumptions, such as appropriate discount rates and capitalization rates and estimates of
future rental income, operating expenses and capital expenditures. Valuation of real estate assets is one of the principal estimates
and uncertainties of these combined financial statements. Refer to note 4 for further information on estimates and assumptions
made in the determination of the fair value of real estate assets. Judgement is applied in determining whether certain costs are
additions to the carrying value of the real estate assets, identifying the point at which practical completion of the property occurs and
identifying the directly attributable borrowing costs to be included in the carrying value of the development properties.
Leases
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) (“Tax Act”). 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 Tax Act 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 Tax Act. The REIT expects to continue to qualify as a real estate investment trust; however, should it no longer
qualify, the REIT would be subject to tax on its taxable income distributed to unitholders.
Impairment of equity accounted investments
The REIT determines at each reporting date whether there is any objective evidence that the equity accounted investments are
impaired. If so, the REIT calculates the amount of impairment as the difference between the recoverable amount of the equity
accounted investment and its carrying value and recognizes the amount in net income.
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, 2016 and 2015
2. Significant accounting policies:
The accounting policies set out below have been applied consistently for all periods presented in these combined financial statements.
(a) Basis of combination:
The principles used to prepare these 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 cash flows 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 translating Finance Trust's U.S. dollar note receivable from U.S.
Holdco is not eliminated on combination as it flows through net income on Finance Trust’s books and other comprehensive income on the
REIT’s books. This is because U.S. Holdco is a subsidiary of the REIT and forms part of its net investment in the United States, but is not
a subsidiary of Finance Trust.
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. The REIT carries out
a portion of its activities through joint operations and records its proportionate share of assets, liabilities, revenues, expenses and cash flows
of all joint operations 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 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 fair value, under IAS 40, Investment Property (“IAS
40”).
The REIT performs an assessment of each investment property 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 under IFRS 3, as set out in note 1(d)(ii). The REIT expenses transaction costs on business combinations and
capitalizes transaction costs on asset acquisitions.
Upon acquisition, investment properties are initially recorded at cost. Subsequent to initial recognition, the REIT uses the fair value model to
account for investment properties. Under the fair value model, investment properties are recorded at fair value, determined based on available
market evidence at each reporting date. The related gain or loss in fair value is recognized in net income in the year in which it arises.
Subsequent capital expenditures are capitalized to investment properties only when it is probable that future economic benefits of the
expenditure will flow to the REIT and the cost can be measured reliably. All other repairs and maintenance costs are expensed when incurred.
Leasing costs, such as commissions incurred in negotiating tenant leases, are included in investment properties.
Gains or losses from the disposal of investment properties are determined as the difference between the net disposal proceeds and the
carrying amount of the investment property and are recognized in net income in the year of disposal.
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, 2016 and 2015
2. Significant accounting policies (continued):
(d) Properties under development:
Properties under development for future use as investment property are accounted for as investment property under IAS 40. Costs eligible
for capitalization to properties under development are initially recorded at cost, and subsequent to initial recognition are accounted for using
the fair value method. At each reporting date, the properties under development are recorded at fair value based on available market evidence.
The related gain or loss in fair value is recognized in net income in the year in which it arises.
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.
Upon practical completion of a development, the development property is transferred to investment properties at the fair value on the date of
practical completion. 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 and liabilities held for sale:
Non-current assets 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 considered to be 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.
Non-current liabilities that are to be assumed by the buyer on disposition of the non-current asset, are also classified as held for sale. Non-
current assets and non-current liabilities held for sale are classified separately from other assets and other liabilities in the statement of financial
position. These amounts are not offset or presented as a single amount.
(f) 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 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 as accrued rent receivable,
which is included in the investment property balance. Lease incentives granted are recognized as an integral part of total rental income over
the term of the lease.
(g)
Income taxes:
Income tax expense comprises current and deferred tax. Current tax and deferred tax are recognized in net income except to the extent that
it relates to a business combination, or items recognized directly in equity or in other comprehensive income.
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.
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, 2016 and 2015
2. Significant accounting policies (continued):
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, 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.
The REIT is a mutual fund trust and a real estate investment trust pursuant to the Tax Act. Under current tax legislation, a real estate
investment trust is entitled to deduct distributions from 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. The REIT qualified as a real estate
investment trust throughout 2016 and the 2015 comparative year.
Finance Trust qualifies as a mutual fund trust that is not a specified investment flow-through trust under the Tax Act. 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 the REIT’s and Finance Trust's distributions are treated as an exemption
from taxation as the REIT and Finance Trust have distributed and are committed to continue distributing all of their taxable income to their
unitholders.
(h) Unit-based compensation:
The REIT has a unit option plan and incentive unit plan available for REIT trustees, officers, employees and consultants as disclosed in note
14(c). These plans are 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 as defined by IFRS. The fair value of the amount payable to participants in respect of
the unit option plan and incentive unit 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.
(i) 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.
(j) Restricted cash:
Restricted cash includes amounts held in reserve by lenders to fund mortgage payments, repairs and capital expenditures or property tax
payments.
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, 2016 and 2015
2. Significant accounting policies (continued):
(k) Foreign currency translation:
The REIT accounts for its investment in U.S. Holdco, a wholly owned subsidiary of the REIT in the United States (“foreign operations”), as a
U.S. dollar functional currency foreign operation. Assets and liabilities of foreign operations are translated into Canadian dollars at the
exchange rates in effect at the combined statements of financial position 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 senior debenture and bank
indebtedness are 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 these obligations are recorded as a foreign currency translation adjustment in accumulated other
comprehensive income (loss).
Assets and liabilities denominated in a currency other than the functional currency are translated into the functional currency at the exchange
rates in effect at the combined statements of financial position dates and revenue and expenses are translated at the actual exchange rate on
the date incurred, with any gain (loss) recorded in net income, unless the asset or liability is designated as a hedge.
(l) Financial instruments:
(i) Non-derivative financial assets
Cash and cash equivalents, restricted cash, accounts receivable and mortgages receivable, with fixed or determinable payments that are
not quoted in an active market, are non-derivative financial assets classified as loans and receivables. 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.
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 combined statements 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, loan 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 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 immediately unless
the derivative is designated and effective as a hedging instrument. None of the REIT’s derivative instruments, as described in note 13,
are accounted for as hedges.
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, 2016 and 2015
2. Significant accounting policies (continued):
(iv) Financial liabilities measured at fair value through net income
A financial liability is classified at fair value through net income if it is classified as held for trading or is designated as such upon initial
recognition.
The convertible debentures and exchangeable units were designated at fair value through net income upon initial recognition. Any gains
or losses arising on remeasurement are recognized in net income.
(m) 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 per unit calculation is not presented.
(n) Finance costs:
Finance costs are comprised of interest expense on borrowings, distributions on exchangeable units classified as liabilities, gain (loss) on
change in fair value of convertible debentures, gain (loss) on change in fair value of exchangeable units and net gain (loss) on derivative
instruments.
Finance costs associated with financial liabilities presented at amortized cost are recognized in net income using the effective interest method.
(o)
Investment in associates and joint ventures:
An associate is an entity over which the Trust has significant influence. Significant influence is the power to participate in an entity’s financial
and operating policy decisions, which is presumed to exist when an investor holds 20 percent or more of the voting power of another entity.
An investment is considered an associate when significant influence exists but there is no joint control over the investment. The Trusts account
for investments in associates using the equity method.
The Trusts consider investments in joint arrangements to be joint ventures when they jointly control one or more investment properties with
another party and have rights to the net assets of the arrangements. This occurs when the joint arrangement is structured through a separate
vehicle, such as a partnership, with separation maintained.
The Trusts’ interests in their associates and joint ventures are accounted for using the equity method and are carried on the combined
statements of financial position at cost, adjusted for the Trusts’ proportionate share of post-acquisition changes in the net assets, less any
identified impairment loss. The Trusts’ share of profits and losses is recognized in the share of net income from the associate or joint venture
investments in the combined statements of comprehensive income and the Trusts’ other comprehensive income includes their share of the
associate or joint ventures’ other comprehensive income.
An associate or a joint venture is considered to be impaired if there is objective evidence of impairment as a result of one or more events that
occurred after the initial recognition of the joint venture and that event has a negative impact on the future cash flows of the joint venture that
can be reliably estimated.
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, 2016 and 2015
2. Significant accounting policies (continued):
Effective January 1, 2016, the Trusts adopted the amendments to IFRS 11, Joint Arrangements (“IFRS 11”), which require that when an entity
acquires an interest in a joint operation in which the activity of the joint operation constitutes a business, it shall apply the principles of business
combination accounting (as described by the Trusts in note 2(q)). The Trusts applied this change in accounting policy on a prospective basis.
There was no impact of the adoption of the amendments to IFRS 11 on the combined statements of financial position, combined statements
of comprehensive income and combined statements of cash flow as at and for the year ended December 31, 2016.
(p) Joint Operations:
The Trusts consider investments in joint arrangements to be joint operations when they make operating, financial and strategic decisions over
one or more investment properties jointly with another party and have direct rights to the assets and obligations for the liabilities relating to the
arrangement. When the arrangement is considered to be a joint operation, the Trusts will include their share of the underlying assets, liabilities,
revenue and expenses in their financial results.
(q) Business Combinations:
The purchase method of accounting is used for acquisitions meeting the definition of a business. The consideration transferred in a business
combination is measured at fair value.
Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their acquisition
date fair values. The excess of the cost of acquisition over the fair value of the REIT’s share of the identifiable net assets acquired, if any, is
recorded as goodwill. If the cost of acquisition is less than the fair value of the REIT’s share of the net assets acquired, the difference is
recognized directly in the combined statements of comprehensive income for the year as an acquisition gain. Any transaction costs incurred
with respect to the business combination are expensed in the period incurred.
(r) Levies:
Under IFRS Interpretations Committee Interpretation, 21, Levies (“IFRIC 21”) realty taxes payable by the REIT are considered levies. Based
on the guidance of IFRIC 21, the REIT recognizes the full amount of annual U.S. realty tax liabilities at the point in time when the realty tax
obligation is imposed.
(s) Subsidiaries
Subsidiaries are entities controlled by the Trusts. The Trusts control an entity when it is exposed to, or has rights to, variable returns from their
involvement with the entity and has the ability to affect those returns through its power over the entity. The financial statements of subsidiaries
are included in the combined financial statements from the date on which control commences until the date on which control ceases.
(t) New standards and interpretations not yet adopted:
Standards issued but not yet effective up to the date of issuance of these combined financial statements are described below. The Trusts
intend to adopt these standards when they become effective.
(i) Amendments to Statement of Cash Flows (“IAS 7”)
In January 2016, the IASB issued amendments to IAS 7, Statement of Cash Flows. These amendments require disclosures that enable
users of financial statements to evaluate changes in liabilities arising from financing activities, including both changes arising from cash
flow and non-cash changes. The Trusts will adopt the amendments to IAS 7 in its combined financial statements for the annual period
ending December 31, 2017. The Trusts intend to satisfy the new requirements by providing reconciliations between the opening and
closing balances for liabilities from financing activities.
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, 2016 and 2015
2. Significant accounting policies (continued):
(ii) Financial Instruments: Classification and Measurement (“IFRS 9”)
In July 2014, the IASB issued IFRS 9 Financial Instruments: Classification and Measurements (“IFRS 9”), replacing IAS 39, Financial
instruments: Recognition and Measurement. IFRS 9 is effective for the annual period beginning on January 1, 2018, with early adoption
permitted. The Trusts currently plan to apply IFRS 9 on January 1, 2018. The actual impact of adopting IFRS 9 on the Trusts’ combined
financial statements in 2018 has not been determined.
(iii) Revenue from Contracts with Customers (“IFRS 15”)
In May 2014, the IASB issued IFRS 15 Revenue from Contracts with Customers. The new standard is effective for annual periods
beginning on or after January 1, 2018. IFRS 15 establishes a comprehensive framework for determining whether, how much and when
revenue is recognized. It replaces IAS 11 Construction Contracts, IAS 18 Revenue, IFRIC 13 Customer Loyalty Programmes, IFRIC 15
Agreements for the Construction of Real Estate, IFRIC 18 Transfer of Assets from Customers, and SIC 31 Revenue - Barter Transactions
Involving Advertising Services. The Trusts intend to adopt IFRS 15 in the combined financial statements for the annual period beginning
on January 1, 2018. The extent of the impact of adoption of the standard has not yet been determined.
(iv) Amendments to Share-based Payments (“IFRS 2”)
In January 2016, the IASB issued amendments to IFRS 2, Share-based Payment clarifying how to account for certain types of share-
based payment transactions. The Trusts intend to adopt the amendments to IFRS 2 in its combined financial statements for the annual
period beginning on January 1, 2018. The extent of the impact of adoption of the amendments has not yet been determined.
(v) Leases (“IFRS 16”)
In January 2016, the IASB issued IFRS 16, Leases. The new standard will replace existing lease guidance in IFRS and related
interpretations, and requires lessees to bring most leases on-balance sheet. Lessor accounting remains similar to the current standard.
The new standard is effective for years beginning on January 1, 2019. The extent of the impact of adoption of the standard has not yet
been determined.
3. Change in accounting policy:
The combined financial statements reflect the retrospective application of a voluntary change in accounting policy adopted in 2016 to classify interest
paid and finance cost-exchangeable unit distributions as an operating activity in the combined statements of cash flows, instead of within financing
activities, as previously reported. The change in accounting policy was adopted in accordance with IAS 7, Statement of Cash Flows, which provides
a policy choice to classify interest paid as either an operating activity or a financing activity. The REIT considers the classification of these interest
payments within operating activities to be the most useful to financial statement users when comparing distributions to cash provided by operations
and, consequently, that this presentation results in reliable and more relevant information.
The following table outlines the effect of this accounting policy change for the year ended December 31, 2015:
Cash provided by operating activities
Cash used in financing activities
Previously
Reported
$ 771,542
(466,202)
Restatement
$ (304,188)
304,188
Restated
$ 467,354
(162,014)
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, 2016 and 2015
4. Real estate assets:
Investment
Properties
2016
Properties Under
Development
2016
Investment
Properties
2015
Properties Under
Development
2015
Note
$ 12,576,075
$ 97,504 $ 12,116,983
$ 105,006
Opening balance, beginning of year
Acquisitions, including transaction costs
Dispositions
Transfer of investment properties to equity accounted investments
Transfer of investment properties to assets classified as held for sale
5
6
Operating capital
Capital expenditures
Leasing expenses and tenant inducements
Development capital
Redevelopment (including capitalized interest)
Additions to properties under development (including capitalized interest)
Amortization of tenant inducements, straight-line rents and blend and
extend rents included in revenue
Fair value adjustment on real estate assets
Change in foreign exchange
Closing balance, end of year
325,169
(337,428)
-
(211,550)
58,924
34,682
62,729
-
5,585
133,738
(83,780)
-
-
-
-
-
-
-
20,764
346,914
(148,680)
(194,970)
(3,000)
41,716
54,628
45,845
-
-
-
-
16,861
(178,868)
478,646
-
(9,938)
-
-
-
-
-
2,436
-
-
-
$ 12,564,144
$ 118,268 $ 12,576,075
$ 97,504
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,
a wholly owned subsidiary of the REIT. In certain cases, 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.
Asset acquisitions:
During the year ended December 31, 2016, the REIT acquired four residential properties and a 50% ownership interest in one industrial property (year
ended December 31, 2015 - six residential properties). The results of operations for these acquisitions are included in these combined financial
statements from the date of acquisition.
The following table summarizes the purchase price plus transaction costs of the assets and liabilities as at the respective dates of acquisition:
Assets
Investment properties
Liabilities
Mortgage payable
Total net assets settled by cash
December 31
2016
December 31
2015
$ 323,877
$ 346,822
-
(45,247)
$ 323,877
$ 301,575
During the year ended December 31, 2016, the REIT incurred additional costs of $1,292 (December 31, 2015 - $92) in respect of prior year
acquisitions which are not included in the above table.
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, 2016 and 2015
4. Real estate assets (continued):
Asset dispositions:
During the year ended December 31, 2016, the REIT sold five retail properties, a 50% ownership interest in two industrial properties, a 50% non-
managing interest in one office property and a portion of an office property (sold as separate condominium units) and recognized a loss on sale of
real estate assets of $8,167. The loss on sale of real estate assets includes prepayment penalties of $13,930 to discharge two mortgages.
Excluding these costs, the properties sold during the year ended December 31, 2016 generated a gain on sale of $5,763.
During the year ended December 31, 2015, the REIT sold a 49.5% ownership interest in 16 industrial properties, a 75% ownership interest in one
industrial property and a 50% ownership interest in three industrial properties. In addition, the REIT sold two industrial properties, three retail
properties, one office property, a parcel of land and a portion of an office property (sold as separate condominium units) and recognized a loss on
sale of real estate assets of $5,428. The loss on sale of real estate assets is primarily due to mark-to-market adjustments on the purchasers’
assumption of mortgages on 11 properties of $4,525 and prepayment penalties of $1,999 to discharge two mortgages. Excluding these costs, the
properties sold during the year ended December 31, 2015 generated a gain of sale of $1,096.
Fair value disclosure:
The estimated fair values of the REIT’s real estate assets 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 and
capital expenditures for the property utilizing appropriate discount rates and terminal capitalization rates, generally over a projection period
of ten years;
(iii)
The direct capitalization method which is based on the conversion of normalized net income directly into an expression of fair value. The
normalized net income for the year is divided by an overall capitalization rate; and
(iv) The use of external independent appraisers. During the year ended December 31, 2016, certain properties were valued by professional
external independent appraisers. These properties make up 30.2% of the investment properties fair value as at December 31, 2016 (year
ended December 31, 2015 - 21.3%). The remainder of the portfolio is valued by the REIT’s internal valuation team. The properties that are
externally appraised are judgmentally selected by management to form a representative cross section of the REIT’s portfolio based on size,
geography and the availability of market data. In addition, an external independent appraisal is often obtained for properties acquired or
properties where the associated mortgage is being refinanced.
The REIT utilizes external industry sources to determine a range of capitalization and discount rates. To the extent that the externally provided
capitalization and discount rates ranges change from one reporting period to the next, the fair value of the investment properties would increase or
decrease accordingly.
The REIT has utilized the following weighted average discount rates and terminal capitalization rates in estimating the fair value of the investment
properties:
December 31, 2016
December 31, 2015
Discount Rates
Terminal Capitalization Rates
Canada
6.66%
6.49%
United
States
6.78%
7.25%
Total Canada
6.69%
6.68%
6.09%
5.96%
United
States
6.24%
6.84%
Total
6.13%
6.18%
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, 2016 and 2015
4.
Real estate assets (continued):
The following weighted average overall capitalization rates as at December 31, 2016 are calculated based on stabilized property operating income
for the three months ended December 31, 2016 (December 31, 2015 - based on the three months ended December 31, 2015).
Weighted Average Overall Capitalization Rates
Canada
United States
Total
Weighted Average Overall Capitalization Rates
Canada
United States
Total
Office
5.90%
5.27%
Primaris
5.53%
N/A
December 31, 2016
H&R
Retail
6.61%
7.09%
Industrial
6.41%
N/A
Lantower
Residential
N/A
5.39%
Office
5.96%
6.34%
Primaris
5.56%
N/A
December 31, 2015
H&R
Retail
6.76%
7.36%
Industrial
6.79%
N/A *
Lantower
Residential
N/A
5.82%
Total
5.86%
5.85%
5.86%
Total
5.93%
6.66%
6.11%
* The U.S. industrial real estate assets are accounted for as equity accounted investments (note 5).
Fair value sensitivity:
The REIT’s investment properties are classified as level 3 under the fair value hierarchy, as the inputs in the valuations of these investment
properties are not based on observable market data. The following table provides a sensitivity analysis for the weighted average capitalization
rate applied as at December 31, 2016:
Capitalization Rate
Sensitivity
Increase (Decrease)
Weighted
Average Overall
Capitalization Rate
Fair Value of
Investment Properties
Fair Value
Variance
(0.75% )
(0.50% )
(0.25% )
December 31, 2016
0.25%
0.50%
0.75%
5.11%
5.36%
5.61%
5.86%
6.11%
6.36%
6.61%
$ 14,408,196
$
1,844,052
$ 13,736,172
$
1,172,028
$ 13,124,043
$
559,899
$ 12,564,144
$
-
$ 12,050,063
$
(514,081)
$ 11,576,397
$
(987,747)
$ 11,138,560
$
(1,425,584)
% Change
14.68%
9.33%
4.46%
0.00%
(4.09% )
(7.86% )
(11.35% )
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, 2016 and 2015
5. Equity accounted investments:
The REIT has entered into a number of arrangements with other parties for the purpose of jointly owning and operating investment properties. In
order to determine how these arrangements should be accounted for, the REIT has assessed the structure of the arrangement, and whether the
REIT has control over the operations of such properties. The REIT has found that its arrangements fall into two categories: a) joint ventures, where
the REIT has joint control over the operations, each investment is structured as a separate vehicle and the REIT has rights to the net assets of the
entities; and b) investments in associates, where the REIT has significant influence over the investment but does not have joint control over the
operations. Both of these types of arrangements are accounted for using the equity method.
During the year ended December 31, 2016, the REIT acquired a 31.7% net interest in the Hercules property, a joint venture, for $13,694 and
disposed of its 33.3% ownership interests in 100 Yonge and Scotia Plaza for a gain on sale of real estate assets at the REIT’s share of $14,965.
During the year ended December 31, 2015, the REIT disposed of a 49.5% ownership interest in 16 industrial properties in the U.S. and the remaining
50.5% interest is now accounted for as a joint venture. The amount transferred into equity accounted investments relating to these properties was
$194,970 (note 4).
Investments in joint ventures:(a)
100 Yonge
Scotia Plaza
Telus Tower
Location
Principal activity
Toronto, Ontario
Own and operate investment property
Toronto, Ontario
Own and operate investment property
Calgary, Alberta
Own and operate investment property
16 industrial properties
United States
Own and operate investment property
Hercules Development Partners LP ("Hercules")
United States
Develop, own and operate investment property
Investments in associates:(b)
ECHO Realty LP ("ECHO")
LIC Operator Co., L.P. ("LIC")
United States
United States
Own and operate investment properties
Develop, own and operate investment property
Ownership interest
December 31
December 31
2016
2015
-
-
50.0%
50.5%
31.7%
33.6%
50.0%
33.3%
33.3%
50.0%
50.5%
-
33.6%
50.0%
(a) Where the REIT has joint control over the operations, each investment is structured as a separate vehicle and the REIT has rights to the net assets of the entities.
(b) Where the REIT has significant influence over the investment but does not have joint control over the operations.
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, 2016 and 2015
5. Equity accounted investments (continued):
The following tables summarize the total amounts of the financial information of ECHO, LIC, Hercules, 100 Yonge, Scotia Plaza, Telus Tower and
the 16 industrial properties in the U.S. and reconciles the summarized financial information to the carrying amount of the REIT’s interest in these
arrangements. The REIT has determined that it is appropriate to aggregate each of the investments in joint ventures and investments in associates
as the individual investments are not individually material:
December 31, 2016
Equity accounted investments:
Investment properties
Properties under development
Loan receivable
Other assets
Cash and cash equivalents
Mortgages payable
Deferred tax liability
Bank indebtedness
Accounts payable and accrued liabilities
Non-controlling interest
Net assets
REIT's share of net assets
Elimination of intercompany loans
Investments in
joint ventures
Investments in
associates
Total
$ 553,633
$ 2,262,258
$ 2,815,891
1,002,968
1,046,304
43,336
17,200
2,636
7,115
-
93,304
90,978
(208,636)
(666,763)
(330)
-
(7,888)
-
-
(479,807)
(111,302)
(57,671)
17,200
95,940
98,093
(875,399)
(330)
(479,807)
(119,190)
(57,671)
407,066
2,133,965
2,541,031
196,721
(8,600)
863,066
1,059,787
-
(8,600)
Amount in the combined statements of financial position
$ 188,121
$ 863,066
$ 1,051,187
ECHO reports its financial position to the REIT one month in arrears due to time constraints on its reporting. Therefore, the above amounts include
ECHO’s financial information as at November 30, 2016. In December 2016, ECHO acquired three properties for approximately $23,500, at the
REIT’s share.
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, 2016 and 2015
5. Equity accounted investments (continued):
December 31, 2015
Equity accounted investments:
Investment properties
Properties under development
Loan receivable
Other assets
Cash and cash equivalents
Mortgages payable
Bank indebtedness
Accounts payable and accrued liabilities
Non-controlling interest
Net assets
REIT's share of net assets
Elimination of intercompany loans
Investments in
joint ventures
Investments in
associates
Total
$ 2,001,977
$ 2,162,079
$ 4,164,056
-
70,100
14,681
18,888
(906,289)
-
(26,262)
-
471,024
83,877
108,580
89,509
(667,601)
(268,248)
(82,563)
(61,388)
471,024
153,977
123,261
108,397
(1,573,890)
(268,248)
(108,825)
(61,388)
1,173,095
1,835,269
3,008,364
466,522
(34,083)
713,506
(28,159)
1,180,028
(62,242)
Amount in the combined statements of financial position
$ 432,439
$ 685,347
$ 1,117,786
ECHO reports its financial position to the REIT one month in arrears due to time constraints on its reporting. Therefore, the above amounts include
ECHO’s financial information as at November 30, 2015. In December 2015, ECHO secured new mortgages on two properties for approximately
$3,900, at the REIT’s share.
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, 2016 and 2015
5. Equity accounted investments (continued):
Year ended December 31, 2016
Year ended December 31, 2015
Investments in
joint ventures
Investments in
associates
Total
Investments in
joint ventures
Investment in
associates
Total
Net income (loss) from equity accounted
investments:
Rentals from investment properties
$ 131,627
$ 178,715
$ 310,342
$ 201,129
$ 163,146
$ 364,275
Property operating costs
(51,122)
(39,055)
(90,177)
(79,462)
(31,770)
(111,232)
Net income from equity accounted investments
Finance income
Finance cost - operations
Fair value adjustments on financial instruments
Trust expenses
-
1,758
(20,943)
-
(381)
Fair value adjustment on real estate assets
(220,908)
Loss on sale of real estate assets
Income taxes
Net income (loss)
Net income attributable to non-controlling
interest
Net income (loss) attributable to owners
REIT's share of net income (loss) attributable
to shareholders
REIT's share of gain on sale of investment in
joint venture*
Elimination of intercompany loan interest
Amount in the combined statements of
comprehensive income (loss)
1,573
1,487
1,573
3,245
(40,481)
(61,424)
(1,857)
(4,212)
129,436
(1,273)
(111)
224,222
(1,365)
222,857
(1,857)
(4,593)
(91,472)
(1,378)
(612)
63,647
(1,365)
62,282
-
2,784
(33,437)
-
(262)
(142,181)
-
(160)
(51,589)
-
(51,589)
1,646
4,570
1,646
7,354
(34,755)
(68,192)
(3,341)
(2,949)
(12,407)
(8,435)
(98)
75,607
(823)
74,784
(3,341)
(3,211)
(154,588)
(8,435)
(258)
24,018
(823)
23,195
(105)
(501)
(160,575)
-
(160,575)
(63,903)
98,194
34,291
(21,826)
25,140
3,314
14,965
(826)
-
(89)
14,965
(915)
-
-
-
(1,354)
(1,119)
(2,473)
$ (49,764)
$ 98,105
$ 48,341
$ (23,180)
$ 24,021
$ 841
* During the year ended December 31, 2016, the REIT disposed of its 33.3% ownership interests in 100 Yonge and Scotia Plaza for a gain on sale of investment in joint venture
at the REIT’s share of $14,965.
ECHO reports its financial results to the REIT one month in arrears due to time constraints on its reporting. Therefore, the above amounts include
ECHO’s financial information for December 1, 2015 to November 30, 2016 and December 1, 2014 to November 30, 2015.
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, 2016 and 2015
6. Assets and liabilities classified as held for sale:
As at December 31, 2016, the REIT has a 50% ownership interest in two Primaris properties (December 31, 2015 - 50% ownership interest in
one industrial property) classified as held for sale.
The following table sets forth the combined statement of financial position items associated with investment properties classified as held for sale:
Assets
Investment properties
Liabilities
Mortgages payable
Accounts payable and accrued liabilities
7. Other assets:
Restricted cash*
Derivative instruments
Accounts receivable
Prepaid expenses and sundry assets
Mortgages receivable**
December 31
December 31
2016
2015
$ 211,550
$ 3,000
$ 126,567
$ -
248
-
$ 126,815
$ -
Note
13
December 31
December 31
2016
$ 11,275
776
12,999
92,975
43,817
2015
$ 16,457
-
14,686
23,167
103,353
$ 161,842
$ 157,663
*
Included in restricted cash are bank term deposits of nil (December 31, 2015 - $4,151) at a rate of interest of N/A (December 31, 2015 – 0.75%).
** Mortgages receivable represent vendor take-back financing and other arrangements. As at December 31, 2016, mortgages receivable bear interest at effective rates
between 4.40% and 9.00% per annum (December 31, 2015 – between 3.13% and 9.00% per annum) with a weighted average effective rate of 7.99% per annum
(December 31, 2015 – 4.74%), and mature between 2020 and 2026 (December 31, 2015 – mature between 2016 and 2026).
Future repayments are as follows:
Years ending December 31:
2017
2018
2019
2020
2021
Thereafter
22
December 31
2016
$ -
-
-
34,158
-
9,659
$ 43,817
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, 2016 and 2015
8. Cash and cash equivalents and bank indebtedness:
Cash and cash equivalents at December 31, 2016 includes cash on hand of $47,760 (December 31, 2015 - $38,021) and bank term deposits of
$261 (December 31, 2015 - $266) at a rate of interest of 0.43% (December 31, 2015 - 0.44%).
The Trusts have the following bank credit facilities as at December 31, 2016:
Operating Facility
Maturity Date
Total
Facility
Bank
Indebtedness
Drawn
Outstanding
Letters of
Credit
Available
Balance
H&R REIT unsecured operating facility #1
Primaris secured operating facility
H&R REIT unsecured operating facility #2
H&R REIT and CrestPSP secured operating facility
H&R REIT co-ownership secured operating facility
(a)
(a)
(b)
(a)
Dec. 18, 2018
$ 500,000
$ 166,089
$ 33,052
$ 300,859
Dec. 18, 2017
Mar. 17, 2021
Feb. 19, 2019
Sept. 30, 2017
300,000
205,829
25,000
3,514
262,640
205,829
9,700
3,514
1,253
36,107
-
-
-
-
15,300
-
$ 1,034,343
$ 647,772
$ 34,305
$ 352,266
The bank facilities bear interest at a rate approximating the prime rate of a Canadian chartered bank.
(a) Can be drawn in either Canadian or U.S. dollars.
(b) The total facility as at December 31, 2016 is $200,000, plus a 3% allowance relating to the fluctuation of the foreign exchange rate, and can be drawn in either Canadian
or U.S. dollars. The REIT entered into an interest swap agreement to fix the interest rate at 2.56% per annum on U.S. $130,000 of the U.S. dollar denominated
borrowing of this facility (note 13).
Included in bank indebtedness at December 31, 2016 are U.S. dollar denominated amounts of $441,000 (December 31, 2015 - U.S. $115,500).
The Canadian equivalent of these amounts is $590,940 (December 31, 2015 - $159,390).
23
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, 2016 and 2015
9. Mortgages payable:
The mortgages payable are secured by real estate assets and letters of credit in certain cases, that generally bear fixed interest rates with a
contractual weighted average rate of 4.41% (December 31, 2015 - 4.60%) per annum and mature between 2017 and 2033 (December 31, 2015
- maturing between 2016 and 2033). Included in mortgages payable at December 31, 2016 are U.S. dollar denominated mortgages of U.S.
$1,024,869 (December 31, 2015 - U.S. $1,165,504). The Canadian equivalent of these amounts is $1,373,324 (December 31, 2015 - $1,608,396).
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:
2017
2018
2019
2020
2021
Thereafter
Financing costs and mark-to-market adjustment arising on acquisitions
December 31
2016
$ 516,782
226,705
259,616
497,332
825,835
1,670,972
3,997,242
4,209
$ 4,001,451
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, 2016 and 2015
10. Debentures payable:
The full terms of the debentures are contained in the trust indenture and supplemental trust indentures; the following table summarizes the key terms:
Contractual
interest
rate
Effective
interest
rate
Maturity
Conversion
price
Principal
amount
Carrying
value
Carrying
value
December 31 December 31
2016
2015
Convertible Debentures (a)
2016 Convertible Debentures (HR.DB.E)(1)
2018 Convertible Debentures (HR.DB.H)
December 31, 2016
November 30, 2018
2020 Convertible Debentures (HR.DB.D)
June 30, 2020
Senior Debentures (b)
Series D Senior Debentures (2)
Series I Senior Debentures (3)
Series B Senior Debentures(4)
Series E Senior Debentures
Series J Senior Debentures (5)
Series G Senior Debentures
Series C Senior Debentures
Series K Senior Debentures (6)
Series F Senior Debentures
Series L Senior Debentures
July 27, 2016
January 23, 2017
February 3, 2017
February 2, 2018
February 9, 2018
June 20, 2018
December 1, 2018
March 1, 2019
March 2, 2020
May 6, 2022
4.50%
5.40%
5.90%
5.69%
4.78%
2.54%
5.90%
4.90%
2.04%
3.34%
5.00%
2.36%
4.45%
2.92%
3.57%
4.50%
5.40%
5.90%
5.69%
4.96%
-%
6.06%
5.22%
-%
3.54%
5.30%
-%
4.63%
3.11%
3.71%
$ 25.70
$ -
$ -
$ 75,188
24.73
23.50
-
-
-
-
-
-
-
-
-
-
74,394
99,654
174,048
-
60,000
115,000
100,000
167,500
175,000
125,000
200,000
175,000
200,000
76,254
102,644
178,898
-
59,992
114,992
99,705
167,278
174,511
124,350
199,331
174,316
198,218
76,016
102,145
253,349
179,862
59,891
114,815
99,449
172,050
174,186
124,009
199,036
174,122
-
1,317,500
1,312,693
1,297,420
3.84%
3.95%
$ 1,491,548
$ 1,491,591
$ 1,550,769
The Convertible Debentures (as defined below) are measured at fair value, with fair value determined using the quoted price on the TSX on December
31, 2016 and December 31, 2015.
In December 2016, the REIT repaid all of its 2016 convertible debentures (HR.DB.E) upon maturity for a cash payment of $75,000.
In July 2016, the REIT repaid all of its Series D senior debentures upon maturity for a cash payment of $180,000.
(1)
(2)
(3) Bears interest at a rate equal to 3-month Canadian Dealer Offered Rate plus 165 basis points. The REIT entered into an interest rate swap on the Series I senior debentures
to fix the interest rate at 2.54% per annum. In January 2017, the REIT repaid all of its Series I senior debentures upon maturity for a cash payment of $60,000.
In February 2017, the REIT repaid all of its Series B senior debentures upon maturity for a cash payment of $115,000.
(4)
(5) Denominated as $125,000 U.S. dollars and bears interest at a rate equal to 3-month London Interbank Offered Rate plus 108 basis points. The REIT entered into an
interest rate swap on the Series J senior debentures to fix the interest rate at 2.04% (note 13).
(6) Bears interest at a rate equal to 3-month Canadian Dealer Offered Rate plus 143 basis points. The REIT entered into an interest rate swap on the Series K senior
debentures to fix the interest rate at 2.36% per annum (note 13).
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, 2016 and 2015
10. Debentures payable (continued):
(a)
2016 Convertible Debentures, 2018 Convertible Debentures and 2020 Convertible Debentures (collectively, the “Convertible Debentures”):
In July 2010, the REIT completed a public offering of $100,000 Series D convertible unsecured subordinated debentures (the “2020
Convertible Debentures”). 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. Interest on the 2020 Convertible Debentures is
payable semi-annually on June 30 and December 31.
In November 2011, the REIT completed a public offering of $75,000 Series E convertible unsecured subordinated debentures (the “2016
Convertible Debentures”). Interest on the 2016 Convertible Debentures was payable semi-annually on June 30 and December 31. The
2016 Convertible Debentures were repaid upon maturity in December 2016 for a cash payment of $74,983.
On April 4, 2013, the REIT assumed all of Primaris’s outstanding convertible debentures. On or after December 1, 2016 and prior to the
maturity date, the 2018 Convertible Debentures may be redeemed by the REIT, in whole or in part, at a price equal to the principal amount
plus accrued interest. Interest on the 2018 Convertible Debentures is payable semi-annually on May 31 and November 30.
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.
(b) Series B Senior Debentures, Series C Senior Debentures, Series D Senior Debentures, Series E Senior Debentures, Series F Senior
Debentures, Series G Senior Debentures, Series I Senior Debentures, Series J Senior Debentures, Series K Senior Debentures and Series
L Senior Debentures (collectively, the “Senior Debentures”):
In November 2016, the REIT issued $200,000 Series L unsecured senior debentures (the “Series L Senior Debentures”). Interest on the
Series L Senior Debentures is payable semi-annually on May 6 and November 6. On issuance, the REIT recorded a liability of $198,185
net of issue costs of $1,815.
Interest expense is recorded as a charge to net 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 principal amount of the then
outstanding Senior Debentures.
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, 2016 and 2015
10. Debentures payable (continued):
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.
(c) A summary of the changes in the carrying value of debentures payable is as follows:
Convertible Debentures
Carrying value, beginning of year
Conversion - 2016 Convertible Debentures
Conversion - 2018 Convertible Debentures
Repaid - 2016 Convertible Debentures (HR.DB.E)
(Gain) loss on change in fair value
Carrying value, end of year
Senior Debentures
Carrying value, beginning of year
Repaid - Series A Senior Debentures
Repaid - Series D Senior Debentures
Repaid - Series H Senior Debentures
Issued - Series J Senior Debentures
Issued - Series K Senior Debentures
Issued - Series L Senior Debentures
Change in foreign exchange
Accretion adjustment
Carrying value, end of year
December 31
2016
December 31
2015
$ 253,349
$ 261,438
(17)
-
(74,983)
549
178,898
1,297,420
-
(180,000)
-
-
-
198,185
(4,987)
2,075
-
(5)
-
(8,084)
253,349
1,274,400
(115,000)
-
(235,000)
171,855
198,897
-
-
2,268
1,312,693
1,297,420
$ 1,491,591
$ 1,550,769
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, 2016 and 2015
11. Exchangeable units:
Certain of the REIT’s subsidiaries have in aggregate 16,563,816 (December 31, 2015 - 16,663,816) exchangeable units outstanding which are
puttable instruments where, upon redemption, the REIT has a contractual obligation to issue Stapled Units. A subsidiary of the REIT also holds
433,174 (December 31, 2015 - 433,174) Stapled Units to mirror these exchangeable units. Therefore, when such exchangeable units are
exchanged for Stapled Units, the number of outstanding Stapled Units will not increase. Holders of all exchangeable units are entitled to receive
the economic equivalence of distributions on a per unit amount equal to a per Stapled Unit amount provided to holders of Stapled Units. These
puttable instruments are classified as a liability under IFRS and are measured at fair value through net income. Fair value is determined by using
the quoted prices for the Stapled Units as the exchangeable units are exchangeable into Stapled Units at the option of the holder. The quoted
price as at December 31, 2016 was $22.37 per Stapled Unit (December 31, 2015 - $20.05).
A summary of the carrying value of exchangeable units is as follows:
Carrying value, beginning of year
Exchangeable units of H&R Portfolio Limited Partnership ("HRLP") exchanged for Stapled Units
(Gain) loss on fair value of exchangeable units
Carrying value, end of year
December 31
December 31
2016
2015
$ 334,110
$ 362,105
(2,295)
38,718
-
(27,995)
$ 370,533
$ 334,110
The REIT and Finance Trust have entered into various exchange and support agreements that provide, among other things, the mechanics
whereby exchangeable units may be exchanged for Stapled Units.
12. Accounts payable and accrued liabilities:
Current:
Other accounts payable and accrued liabilities
Mortgage interest payable
Prepaid rent
Unit-based compensation payable
Debenture interest payable
Derivative instruments
Non-current:
Security deposits
Unit-based compensation payable
December 31
December 31
Note
2016
2015
$ 141,984
$ 117,181
14(c)
13
14(c)
10,595
20,757
10,432
10,495
3,791
4,932
14,439
11,561
22,883
4,594
13,207
-
4,038
3,366
$ 217,425
$ 176,830
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, 2016 and 2015
13. Derivative instruments:
Debenture interest rate swap
Debenture interest rate swap
Bank indebtedness interest rate swap
Mortgage interest rate swap
(a)
(b)
(c)
(d)
The REIT entered into interest rate swaps as follows:
Fair value (liability) asset *
Net gain on derivative contracts**
December 31
December 31
December 31
December 31
2016
2015
2016
2015
$ 776
$ -
$ 776
$ -
(407)
(3,384)
-
-
-
-
(407)
(3,384)
-
$ (3,015)
$ -
$ (3,015)
-
-
161
$ 161
(a) Series K senior debentures bearing interest at 2.36% per annum, maturing on March 1, 2019.
(b) Series I senior debentures bearing interest at 2.54% per annum, which matured on January 23, 2017 and Series J senior debentures bearing interest at 2.04% per
annum, maturing on February 9, 2018. The interest rate swap on the Series I senior debentures was settled in January 2017.
(c) U.S. $130,000 bank indebtedness (note 8) bearing interest at 2.56% per annum, maturing on March 17, 2021.
(d) One U.S. mortgage; this interest rate swap was settled in 2015.
*
Derivative instruments in asset and liability positions are not presented on a net basis. Derivative instruments in an asset position are recorded in other assets and
derivative instruments in a liability position are recorded in accounts payable and accrued liabilities.
**
Excludes amounts relating to foreign exchange which have been recorded in accumulated other comprehensive income (note 15).
14. Unitholders’ equity:
The REIT is an unincorporated open-ended trust. The beneficial interests in the REIT are divided into two classes of trust units: units of the REIT
and special voting units.
(a) Description of units:
Each unit of the REIT and special voting unit carries a single vote at any meeting of unitholders. Holders of special voting units do not have
any additional rights than those of holders of units of the REIT. The aggregate number of units of the REIT which the REIT may issue is
unlimited and the aggregate number of special voting units which the REIT may issue is 9,500,000. The units of the REIT carry the right to
participate pro rata in any distributions. As at December 31, 2016, 9,500,000 special voting units are issued and outstanding (December 31,
2015 - 9,500,000 special voting units).
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 REIT has entered into a support agreement (“Support Agreement”) with Finance Trust to coordinate the issuance
of Stapled Units under various arrangements (note 14(e)).
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, 2016 and 2015
14. Unitholders’ equity (continued):
The units of the Trusts are freely transferable and, other than as disclosed herein, the trustees shall not impose any restriction on the transfer
of units. Provided that an event of uncoupling (“Event of Uncoupling”) has not occurred: (a) each unit of the REIT may only be transferred
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.
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.
(b) Unit Purchase Plan and Dividend Reinvestment Plan (the “DRIP”):
The Trusts offer holders of Stapled Units and holders of exchangeable units resident in Canada the opportunity to participate in its DRIP.
The DRIP allows participants to have their monthly cash distributions reinvested in additional Stapled Units 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.
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, 2016 and 2015
14. Unitholders’ equity (continued):
Changes in the issued and outstanding number of Stapled Units during the years ended December 31, 2016 and 2015 are as follows:
As at January 1, 2015
Issued under the DRIP
Options exercised
2018 Convertible Debentures converted into Stapled Units
Repurchased through normal course issuer bid
As at December 31, 2015
Issued under the DRIP
Options exercised
2016 Convertible Debentures converted into Stapled Units
Exchangeable units exchanged into Stapled Units
Repurchased through normal course issuer bid
As at December 31, 2016
274,773,334
4,943,820
72,167
202
(179,400)
279,610,123
5,610,389
100,334
661
100,000
(141,800)
285,279,707
The weighted average number of basic Stapled Units for the year ended December 31, 2016 is 282,215,659 (December 31, 2015 -
276,795,506).
(c) Unit-based compensation:
In order to provide long-term compensation to the REIT’s trustees, officers, employees and consultants, there may be grants of options and
incentive units, which are each subject to certain restrictions.
(i) Unit option plan:
As at December 31, 2016, a maximum of 28,000,000 (December 31, 2015 - 28,000,000) options to purchase Stapled Units were
authorized to be issued, of which 21,402,296 options (December 31, 2015 - 14,056,429 options) have been granted, 343,422 options
(December 31, 2015 - 343,422 options) have expired and 6,941,126 options (December 31, 2015 - 14,286,993 options) remain to be
granted. The exercise price of each option approximated the quoted price of the Stapled Units on the date of grant and shall be increased
by the amount, if any, by which the fair quoted value of one Finance Trust unit at the time of exercise of such option exceeds the fair
quoted 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.
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, 2016 and 2015
14. Unitholders’ equity (continued):
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
December 31, 2016
December 31, 2015
Weighted average
exercise price
Units
Units
Weighted average
exercise price
6,575,006
7,345,867
(100,334)
-
$ 21.57
5,295,567
$ 21.41
18.98
11.74
1,628,363
(72,167)
-
(276,757)
21.94
15.74
22.02
Outstanding, end of year
13,820,539
$ 20.26
6,575,006
$ 21.57
Options exercisable, end of year
5,186,652
$ 21.66
4,001,868
$ 21.18
The options outstanding at December 31, 2016 are exercisable at varying prices ranging from $9.30 to $23.18 (December 31, 2015 -
$9.30 to $23.18) with a weighted average remaining life of 7.7 years (December 31, 2015 - 7.0 years). The vested options are
exercisable at varying prices ranging from $9.30 to $23.18 (December 31, 2015 - $9.30 to $23.18) with a weighted average remaining
life of 5.6 years (December 31, 2015 - 6.0 years).
(ii)
Incentive unit plan:
As at December 31, 2016, a maximum of 5,000,000 (December 31, 2015 - 5,000,000) incentive units exchangeable into Stapled Units
were authorized to be issued under the incentive unit plan. Of this amount, 419,025 incentive units (December 31, 2015 - 314,655
incentive units) have been granted, of which 11,665 incentive units (December 31, 2015 - 11,665 incentive units) have expired,
4,592,640 incentive units (December 31, 2015 - 4,697,010 incentive units) remain to be granted and 407,360 incentive units remain
outstanding (December 31, 2015 - 302,990 incentive units).
Incentive units are recognized based on the grant date fair value. The grant agreements provide that the awards will be satisfied in
cash, unless the holder elects to have them satisfied in Stapled Units issued from treasury, with the result that the awards are classified
as cash-settled unit-based payments and presented as liabilities. 100% of the incentive units vest on the third anniversary of the grant
date and are subject to forfeiture until the recipients of the awards have held office with or provided services to the REIT for a specified
period of time. The incentive units may, if specified at the time of grant, accrue cash distributions during the vesting period and accrued
distributions will be paid when the incentive units vest. These incentive units are recognized as liabilities, which are indexed to changes
in fair value of the Stapled Units.
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, 2016 and 2015
14. Unitholders’ equity (continued):
A summary of the status of the incentive unit plan and the changes during the respective periods are as follows:
Outstanding, beginning of year
Granted
Expired
Outstanding, end of year
The fair value of the vested unit options and incentive units payable are as follows:
Options
Incentive units
Unit-based compensation expense (benefit) included in trust expenses is as follows:
Options
Incentive units
(d) Distributions:
December 31
December 31
2016
Units
302,990
104,370
-
407,360
2015
Units
162,332
152,323
(11,665)
302,990
December 31
December 31
2016
$ 17,912
6,959
$ 24,871
2015
$ 4,594
3,366
$ 7,960
2016
2015
$ 14,323
$ (2,774)
3,593
2,077
$ 17,916
$ (697)
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, however, the total income distributed shall not be less than the amount necessary to ensure that
the REIT will not be liable to pay income tax under Part I of the Tax Act for any year. For the year ended December 31, 2016, the REIT
declared per unit distributions of $1.23 (December 31, 2015 - $1.23).
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 $0.12 for the year ended December 31, 2016 (December 31, 2015 - $0.12).
The details of the distributions are as follows:
Cash distributions to unitholders
Unit distributions (issued under the DRIP)
2016
2015
$ 274,264
$ 267,650
106,842
105,422
$ 381,106
$ 373,072
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, 2016 and 2015
14. Unitholders’ equity (continued):
(e) Support agreement:
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, Incentive Unit 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.
(f) Normal course issuer bid:
On July 8, 2016, the Trusts received approval from the TSX for the renewal of their normal course issuer bid (“NCIB”), allowing the Trusts
to purchase for cancellation up to a maximum of 5,000,000 Stapled Units on the open market until the earlier of July 13, 2017 or the date
on which the Trusts have purchased the maximum number of Stapled Units permitted under the NCIB. During the year ended December
31, 2016, the Trusts purchased and cancelled 141,800 Stapled Units at a weighted average price of $19.28 per unit, for a total cost of
$2,734. During the year ended December 31, 2015, under a previous NCIB, the Trusts purchased and cancelled 179,400 Stapled Units at
a weighted average price of $21.94 per unit, for a total cost of $3,937.
15. Accumulated other comprehensive income:
Items that are or may be reclassified subsequently to net income:
Balance as at January 1, 2015
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, 2015
Transfer of realized loss on cash flow hedges to net income
Unrealized loss on translation of U.S. denominated foreign operation
Cash flow
hedges
Foreign
operations
Total
$ (373)
$ 119,499
$ 119,126
31
-
(342)
30
-
-
227,430
346,929
-
(38,397)
31
227,430
346,587
30
(38,397)
Balance as at December 31, 2016
$ (312)
$ 308,532
$ 308,220
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, 2016 and 2015
16. Rentals from investment properties:
Rental income
Straight-lining of contractual rent
Rent amortization of tenant inducements
Operating Leases:
2016
2015
$ 1,193,471
$ 1,174,591
4,781
(2,241)
15,823
(2,100)
$ 1,196,011
$ 1,188,314
The REIT leases its investment properties under operating leases (note 2(f)). The future minimum lease payments under non-cancellable leases
are as follows:
Less than 1 year
Between 1 and 5 years
More than 5 years
17. Other income:
2016
2015
$ 665,873
$ 689,438
2,324,926
3,827,411
2,439,767
4,265,096
$ 6,818,210
$ 7,394,301
On January 15, 2015, Target Corporation announced plans to discontinue operating stores in Canada through its subsidiary Target Canada Co.
(“Target”). Primaris has an interest in nine malls where Target was a tenant: a 50% interest in four of these malls and a 100% interest in the other
five malls. Three of the leases were guaranteed by Target Corporation, the U.S. parent of Target.
In March 2016, Primaris entered into binding agreements with Target and Target Corporation concluding the terms of settlement relating to the
leases that were disclaimed pursuant to the Companies’ Creditors Arrangement Act. The binding agreements were approved by the courts in June
2016.
An initial distribution in respect of the settlement proceeds, in the amount of $18,899, was received on July 4, 2016. A further distribution in respect
of the settlement proceeds, in the amount of $1,454, was received on October 25, 2016.
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, 2016 and 2015
18. Finance costs:
Finance cost - operations
Contractual interest on mortgages payable
Contractual interest on debentures payable
Effective interest rate accretion
Bank interest and charges
Exchangeable unit distributions
Capitalized interest*
Finance income
Fair value adjustments on financial instruments
In addition, $13,930 was incurred as prepayment penalties on selling certain properties (note 4).
*
The weighted average rate of borrowings for the capitalized interest is 4.75% (December 31, 2015 - N/A).
19. Supplemental cash flow information:
Straight-lining of contractual rent
Prepaid expenses and sundry assets
Accounts receivable
Accounts payable and accrued liabilities
2016
2015
$ 196,228
$ 204,568
60,019
(2,595)
13,302
22,480
289,434
(2,109)
287,325
(4,715)
33,830
64,715
(4,337)
7,568
22,496
295,010
-
295,010
(3,770)
(36,240)
$ 316,440
$ 255,000
2016
2015
$ (7,828)
(69,808)
1,687
34,998
$ (19,047)
(1,411)
(2,423)
27,405
$ (40,951)
$ 4,524
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, 2016 and 2015
19. Supplemental cash flow information (continued):
The following amounts have been excluded from operating, investing and financing activities in the combined statements of cash flows:
Non-cash items:
Non-cash distributions to unitholders in the form of DRIP units
Non-cash conversion of convertible debentures
Non-cash distributions to exchangeable unitholders in the form of DRIP units
Non-cash adjustment to proceeds on options exercised
Non-cash release of mortgage payable on disposition of investment properties
Mortgages receivable from the sale of investment properties
Exchangeable units exchanged for Stapled Units
Acquisition of investment property through assumption of mortgage payable,
net of mark-to-market adjustment
Other items:
(Increase) decrease in accounts payable on redevelopment
(Increase) Decrease in accounts payable included in finance cost - operations
Capitalized interest on redevelopment
Capitalized interest on properties under development
20. Capital risk management:
The REIT’s primary objectives when managing capital are:
Note
14(d)
10(c)
11
2016
2015
$ 106,842
$ 105,422
17
9,767
1,005
-
-
2,295
5
-
378
(77,295)
37,135
-
-
45,246
4,534
3,341
(1,449)
(660)
(2,514)
(4,841)
-
-
(a)
to provide unitholders with stable and growing distributions generated by revenue it derives from investments in real estate assets; 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:
Mortgages payable
Debentures payable
Exchangeable units
Loan payable
Bank indebtedness
Unitholders' equity
December 31
December 31
2016
2015
$ 4,001,451
1,491,591
$ 4,537,278
1,550,769
370,533
-
647,772
6,912,650
334,110
55,717
321,033
6,824,920
$ 13,423,997
$ 13,623,827
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.
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, 2016 and 2015
20. Capital risk management (continued):
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 total
assets ratio of 65% (for this purpose “indebtedness” excludes, Convertible Debentures and U.S. Holdco notes payable to Finance Trust). As at
December 31, 2016, this ratio was 43.1% (December 31, 2015 - 44.4%). 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 8), debentures payable (note 10) and certain mortgages have
various covenants calculated as defined within these agreements. The REIT monitors these covenants and is in compliance as at December 31,
2016 and December 31, 2015.
21. Risk management:
(a) Credit risk:
The REIT is exposed to credit risk in the event that borrowers default on the repayment of the amounts owing to the REIT. Management
mitigates this risk by ensuring adequate security has been provided in support of mortgages receivable.
The REIT is exposed to credit risk as an owner of investment properties in that tenants may become unable to pay the contracted rent.
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 investment 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 REIT has two tenants which individually account for more than 5% of the rentals from investment
properties of the REIT: Encana Corporation and Bell Canada. Both of these companies have a public debt rating that is rated with at least
a BBB Negative rating by a recognized rating agency.
The REIT’s exposure to credit risk is as follows:
Mortgages receivable
Accounts receivable
(b)
Liquidity risk:
Note
7
7
December 31
2016
December 31
2015
$ 43,817
$ 103,353
12,999
14,686
$ 56,816
$ 118,039
The Trusts are subject to liquidity risk whereby it may not be able to refinance or pay its debt obligations when they become due.
The Trusts manage liquidity risk by:
Ensuring appropriate lines of credit available are available. As at December 31, 2016 the combined amounts available under its
general operating facilities is $352,266 (note 8);
Maintaining a large unencumbered asset pool. As at December 31, 2016, there are 112 unencumbered properties with a fair value of
approximately $3,014,001.
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, 2016 and 2015
21. Risk management (continued):
Entering into long-term mortgages on most of the REIT’s properties, whereby a significant amount of principal has been repaid at the
time of maturity which enables the REIT to refinance the debt; and
Structuring its financing so as to stagger the maturities of its debt, thereby minimizing exposure to liquidity risk in any one year (notes
8, 9 and 10).
Management monitors its liquidity risk through review of financial covenants contained in general operating facilities, debt agreements and
in accordance with the REIT’s Declaration of Trust.
The Trusts’ liquidity risk is as follows:
Mortgages payable*
Debentures payable*
Bank indebtedness*
Note
9
10
8
Accounts payable and accrued liabilities**
12, 14(c)
Amounts in the above table only include the principal amount for each debt obligation.
*
** Excludes options payable (note 14(c)).
(c) Market risk:
2017
Thereafter
Total
$ 516,782
$ 3,480,460
$ 3,997,242
175,000
266,154
191,603
1,316,548
1,491,548
381,618
7,910
647,772
199,513
$ 1,149,539
$ 5,186,536
$ 6,336,075
The Trusts are subject to currency risk and interest rate risk. The Trusts’ objective is to manage and control market risk exposure within
acceptable parameters, while optimizing the return on risk.
(i) Currency risk:
Foreign exchange risk is the risk that the fair value or future cash flows of an exposure will fluctuate because of changes in foreign
exchange rates. 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 denominated in U.S. dollars to act as a natural hedge. Additionally, the REIT has designated the Series J senior
debentures and the U.S. bank indebtedness as part of the net investment hedge of its U.S. operations.
A $0.10 weakening of the U.S. dollar against the average Canadian dollar exchange rate of $1.32 for the year ended December 31,
2016 (December 31, 2015 - $1.28) as well as the Canadian dollar exchange rate as at December 31, 2016 of $1.34 (December 31,
2015 - $1.38) would have decreased other comprehensive income (loss) by approximately $116,600 (December 31, 2015 - $101,900)
and decreased net income by approximately $26,700 (December 31, 2015 - $7,100). 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, 2015
would have had the equal but opposite effect).
(ii)
Interest rate risk:
The Trusts are exposed to interest rate risk on its borrowings. It minimizes this risk by obtaining long-term fixed interest rate debt. At
December 31, 2016, the percentage of fixed rate debt to total debt was 91.1% (December 31, 2015 - 86.8%). Therefore, a change
in interest rates at the reporting date would not have a material impact on net income as the majority of the Trust’s borrowings are
through fixed rate instruments.
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, 2016 and 2015
21. Risk management (continued):
The bank indebtedness is subject to variable interest rates. An increase in interest rates of 100 basis points for the year ended
December 31, 2016 would have decreased net income by approximately $3,800 (December 31, 2015 - $1,800). This analysis assumes
that all other variables, in particular foreign exchange rates, remain constant.
The REIT entered into interest rate swaps on the floating rate senior debentures in 2016. In 2015, the floating rate senior debentures
were subject to variable interest rates. An increase in interest rates of 100 basis points for the year ended December 31, 2015 would
have decreased December 31, 2015 net income by approximately $2,900. This analysis assumes that all other variables, in particular
foreign exchange rates, remain constant.
The floating rate mortgages payable are subject to variable interest rates. An increase in interest rates of 100 basis points for the year
ended December 31, 2016 would have decreased net income by approximately $1,000 (December 31, 2015 - $500). 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 Trusts’ 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 combined financial instruments.
The fair value of the mortgages receivable 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.
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.
The fair value of the Senior Debentures 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.
The fair value of the loan payable to ECHO approximates the carrying value as the loan payable was repaid in February 2016.
(ii) Assets and Liabilities carried at fair value:
Assets and liabilities measured at fair value in the combined statements of financial position, or disclosed in the notes to the financial
statements, 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).
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, 2016 and 2015
21. Risk management (continued):
December 31, 2016
Note
Level 1
Level 2
Level 3
Total
fair value
Carrying
value
Assets measured at fair value
Investment properties
Properties under development
Derivative instruments
Assets for which fair values are disclosed
Mortgages receivable
Liabilities measured at fair value
Convertible debentures
Exchangeable units
Derivative instruments
Liabilities for which fair values are disclosed
Mortgages payable
Senior debentures
4
4
13
10
11
13
$ -
-
-
-
-
(178,898)
(370,533)
-
-
-
(549,431)
$ - $ 12,564,144 $ 12,564,144 $ 12,564,144
118,268
776
118,268
776
118,268
-
-
776
-
776
-
-
(3,791)
47,402
47,402
43,817
12,729,814
12,730,590
12,727,005
-
-
-
(178,898)
(370,533)
(3,791)
(178,898)
(370,533)
(3,791)
-
-
(3,791)
(4,181,006)
(1,352,637)
(5,533,643)
(4,181,006)
(1,352,637)
(6,086,865)
(4,001,451)
(1,312,693)
(5,867,366)
$ (549,431)
$ (3,015)
$ 7,196,171
$ 6,643,725
$ 6,859,639
December 31, 2015
Note
Level 1
Level 2
Level 3
Total
fair value
Carrying
value
Assets measured at fair value
Investment properties
Properties under development
Assets for which fair values are disclosed
Mortgages receivable
Liabilities measured at fair value
Convertible debentures
Exchangeable units
Liabilities for which fair values are
disclosed
Mortgages payable
Senior debentures
4
4
$ -
-
-
-
10
11
(253,349)
(334,110)
-
-
(587,459)
$ - $ 12,576,075 $ 12,576,075 $ 12,576,075
97,504
97,504
97,504
-
-
-
-
-
-
-
-
105,183
12,778,762
105,183
12,778,762
103,353
12,776,932
-
-
(253,349)
(334,110)
(253,349)
(334,110)
(4,726,118)
(1,351,590)
(6,077,708)
(4,726,118)
(1,351,590)
(6,665,167)
(4,537,278)
(1,297,420)
(6,422,157)
$ (587,459)
$ -
$ 6,701,054
$ 6,113,595
$ 6,354,775
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, 2016 and 2015
22. Compensation of key management personnel:
Key management personal are those individuals that have the authority and responsibility for planning, directing and controlling the REIT’s activities,
directly or indirectly.
Salaries and short-term employee benefits
Unit-based compensation
23. Segmented disclosures:
(i) Operating segments:
2016
2015
$ 4,435
13,375
$ 4,913
(1,038)
$ 17,810
$ 3,875
The Trusts have six reportable operating segments (Office, which also includes the Trusts’ head office and Finance Trust, Primaris, H&R Retail,
ECHO, Industrial and Residential (operating as Lantower Residential)), in two geographical locations (Canada and the United States). The operating
segments derive their revenue primarily from rental income from leases. The segments are reported in a manner consistent with the internal reporting
provided to the chief operating decision maker, determined to be the Chief Executive Officer (“CEO”) of the Trusts. The CEO measures and evaluates
the performance of the Trusts based on property operating income which is presented by property type and geographical location below and on a
proportionately consolidated basis for the Trusts’ equity accounted investments. The CEO also reviews the real estate assets of the Trusts’ by
operating and geographical segment, with the equity accounted investments on a proportionally consolidated basis. The accounting policies of the
segments presented here are consistent with the Trusts’ accounting policies as described in the Trusts’ combined financial statements.
Real estate assets by reportable segment for the years ended December 31, 2016 and December 31, 2015 are as follows:
December 31, 2016
Office
Primaris
H&R
Retail
ECHO
Industrial
Lantower
Residential
Total
Number of investment properties
37
31
126
215
101
12
522
Real estate assets:
Investment properties
$ 6,495,994 $ 3,154,000 $ 1,547,286
$ 767,579 $ 1,102,016
$ 755,358 $ 13,822,233
Properties under development
-
-
-
10,240
118,268
500,287
628,795
6,495,994
3,154,000
1,547,286
777,819
1,220,284
1,255,645
14,451,028
Less: assets classified as held for sale
-
(211,550)
Less: Trusts' proportionate share of real estate
assets relating to equity accounted investments
(62,500)
-
-
-
-
-
-
(211,550)
(777,819)
(216,460)
(500,287)
(1,557,066)
$ 6,433,494 $ 2,942,450 $ 1,547,286
$ - $ 1,003,824
$ 755,358 $ 12,682,412
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, 2016 and 2015
23 Segmented disclosure (continued):
December 31, 2015
Office
Primaris
H&R
Retail
ECHO
Industrial
Lantower
Residential
Total
Number of investment properties
39
31
131
205
103
8
517
Real estate assets:
Investment properties
Properties under development
$ 7,043,480 $ 3,205,150 $ 1,621,292
$ 734,188 $ 1,064,535
$ 422,791 $ 14,091,436
-
-
-
18,940
97,504
207,554
323,998
7,043,480
3,205,150
1,621,292
753,128
1,162,039
630,345
14,415,434
Less: assets classified as held for sale
-
Less: Trusts' proportionate share of real estate
assets relating to equity accounted investments
(557,500)
-
-
-
-
-
(3,000)
-
(3,000)
(753,128)
(220,673)
(207,554)
(1,738,855)
$ 6,485,980 $ 3,205,150 $ 1,621,292
$ - $ 938,366
$ 422,791 $ 12,673,579
Property operating income by reportable segment for the year ended December 31, 2016 and December 31, 2015 is as follows:
Office*
Primaris
H&R
Retail
ECHO
Industrial
Lantower
Residential
Sub-total
Less: Equity
Accounted
Investments
December 31
2016
Property operating income:
Rentals from investment
properties
Property operating costs
Property operating income:
Rentals from investment
properties
Property operating costs
$ 655,856 $ 300,883 $ 142,432
(31,842)
(129,975)
(237,782)
$ 59,999
$ 98,197
$ 52,801 $ 1,310,168
$ (114,157)
$ 1,196,011
(13,112)
(27,327)
(24,294)
(464,332)
33,061
(431,271)
$ 418,074 $ 170,908 $ 110,590
$ 46,887
$ 70,870
$ 28,507 $ 845,836
$ (81,096)
$ 764,740
Office*
Primaris
H&R
Retail
ECHO
Industrial
Lantower
Residential
Sub-total
Less: Equity
Accounted
Investments
December 31
2015
$ 679,174 $ 309,968 $ 146,172
(32,967)
(130,351)
(242,901)
$ 54,772 $ 103,822
$ 26,379 $ 1,320,287
$ (131,973)
$ 1,188,314
(10,667)
(25,663)
(12,291)
(454,840)
40,039
(414,801)
$ 436,273 $ 179,617 $ 113,205
$ 44,105 $ 78,159
$ 14,088 $ 865,447
$ (91,934)
$ 773,513
*
Includes the Trusts’ head office.
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, 2016 and 2015
23. Segmented disclosure (continued):
(ii) Geographical locations:
The Trusts operate in Canada and the United States.
Investment properties and properties under development are attributed to countries based on the location of the properties.
Real estate assets:
Canada
United States
Less: assets classified as held for sale
Less: Trusts' proportionate share of investment properties and properties under development
relating to equity accounted investments
Rentals from investment properties:
Canada
United States
Less: Trusts' proportionate share of rentals relating to equity
accounted investments
December 31
December 31
2016
2015
$ 9,335,849
5,115,179
$ 10,098,153
4,317,281
14,451,028
14,415,434
(211,550)
(3,000)
(1,557,066)
(1,738,855)
$ 12,682,412
$ 12,673,579
2016
2015
$ 943,965
$ 989,525
366,203
1,310,168
330,762
1,320,287
(114,157)
(131,973)
$ 1,196,011
$ 1,188,314
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, 2016 and 2015
24.
Income tax expense:
Income tax computed at the Canadian statutory rate of nil applicable
to the REIT for 2016 and 2015
Current U.S. income taxes
Deferred income taxes applicable to U.S. Holdco
Income tax expense in the determination of net income
2016
2015
$ -
1,950
199,591
$ -
2,341
32,617
$ 201,541
$ 34,958
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. 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,
such as the REIT.
The REIT has certain subsidiaries in the United States that are subject to tax on their taxable income at a rate of approximately 37.5%. The tax
effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below:
Deferred tax assets:
Net operating losses and deferred interest deductions
Accounts payable and accrued liabilities
Other assets
Deferred tax liabilities:
Investment properties
Equity accounted investments
December 31
December 31
2016
2015
$ 79,159
$ 84,889
2,320
1,787
83,266
404,881
65,160
470,041
2,146
938
87,973
254,178
23,453
277,631
Deferred tax liability
$ (386,775)
$ (189,658)
As at December 31, 2016, U.S. Holdco had accumulated net operating losses and deferred interest deductions available for carryforward for U.S.
income tax purposes of $211,028 (December 31, 2015 - $228,687). The net operating losses will expire between 2031 and 2032. The deferred
interest deductions and the deductible temporary differences do not generally expire under current tax legislation.
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, 2016 and 2015
25. Commitments and contingencies:
(a)
(b)
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, 2016, the REIT has outstanding letters of credit totalling $34,305 (December 31, 2015 - $62,675), including nil (December
31, 2015 - $18,577) which has been pledged as security for certain mortgages payable. The letters of credit are secured in the same manner as
the bank indebtedness (note 8).
The REIT provides guarantees on behalf of third parties, including co-owners. As at December 31, 2016, the REIT issued guarantees amounting
to $171,064 (December 31, 2015 - $269,899), which expire between 2022 and 2029 (December 31, 2015 - expire between 2016 and 2029),
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
guarantees. At December 31, 2016, the estimated amount of debt subject to such guarantees, and therefore the maximum exposure to credit
risk, is $133,040 (December 31, 2015 - $146,541) which expires between 2017 and 2020 (December 31, 2015 - expires between 2016 and 2020).
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 combined 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.
(c)
The REIT is obligated, under certain contract terms, to construct and develop investment properties.
(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.
26. Subsidiaries:
Significant subsidiaries of the REIT are as follows:
Name of Entity
Bow Centre Street Limited Partnership
H&R Portfolio Limited Partnership
H&R REIT Management Services Limited Partnership
H&R REIT (U.S.) Holdings Inc.
Primaris Management Inc.
PRR Trust
Place of Business
Canada
Canada
Canada
United States
Canada
Canada
Ownership interest
December 31
December 31
2016
100%
100%
100%
100%
100%
100%
2015
100%
100%
100%
100%
100%
100%
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, 2016 and 2015
27. Subsequent events:
(a)
In January 2017, the REIT sold a 50% non-managing interest in two enclosed shopping centres which was classified as held for sale as at
December 31, 2016, for gross proceeds of approximately $211,550. The purchaser assumed 50% of the existing mortgages of approximately
$126,600.
(b)
In January 2017, the REIT issued $150,000 principal amount of Series M senior debentures maturing on July 23, 2019.
(c)
In January 2017, the REIT repaid all of its Series I senior debentures upon maturity for a cash payment of $60,000.
(d)
In January 2017, the REIT issued $200,000 principal amount of Series N senior debentures maturing January 30, 2024.
(e)
In January 2017, the REIT secured a U.S. $55,000 increase to a first mortgage for a term of 4.8 years.
(f)
In February 2017, the REIT repaid all of its Series B senior debentures upon maturity for a cash payment of $115,000.
(g)
In February 2017, the REIT repaid one Canadian mortgage of approximately $124,400.
47
Unitholder Distribution Reinvestment Plan and Unit Purchase Plan
H&R offers holders of Stapled Units and holders of Exchangeable Units resident in Canada the opportunity
to participate in its Unitholder Distribution Reinvestment Plan (the "DRIP") and Unit Purchase Plan.
The DRIP allows participants to have their monthly cash distributions reinvested in additional Stapled Units
at 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. In addition, participants will be entitled to
receive an additional distribution equal to 3% of each cash distribution reinvested pursuant to the DRIP
which will be reinvested in additional Stapled Units.
The 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 Unit Purchase Plan, please contact us by email through the
"Contact Us" webpage of our website or contact the plan agent: CST Trust Company, P.O. Box 7010,
Adelaide Street Postal Station, Toronto, Ontario M5C 2W9, Tel: 416-643-5500 (or for callers outside of the
416 area code: 1-800-387-0825), Fax: 416-643-5501, Email: inquiries@canstockta.com, Website:
www.canstockta.com.
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 (1,2,3,4), Strategic financial consultant, marketing communications industry
Edward Gilbert (1,2,3,4), Chief Operating Officer, Firm Capital Mortgage Investment Trust
Laurence A. Lebovic (1,2, 3,4), Chief Executive Officer, Runnymede Development Corporation Ltd.
Ronald C. Rutman (1,2,3,4), Partner, Zeifman & Company, Chartered Accountants
Stephen Sender (1,2,3,4), Financial Consultant
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)
Pat Sullivan, Chief Operating Officer (Primaris)
Philippe Lapointe, Chief Operating Officer (Lantower Residential)
Cheryl Fried, Executive Vice-President, Finance (H&R REIT)
Blair Kundell, Vice-President, Operations (H&R REIT)
Jason Birken, Vice-President, Finance (H&R REIT)
Auditors: KPMG LLP
Legal Counsel: Blake, Cassels & Graydon LLP
Taxability of Distributions: The 2016 distributions by H&R REIT were comprised of capital gains (53.8%), other
taxable income (27.7%), foreign non-business income (11.5%) and tax deferred return of capital (6.9%). The 2016
distributions by H&R Finance Trust were comprised of foreign non-business income (82.7%) and tax deferred return
of capital (17.3%). For a Canadian resident unitholder, only 67.7% of the 2016 distributions on a Stapled Unit are
subject to tax when considering these allocations and the non-taxable portion of the capital gains.
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.D and HR.DB.H.
Unitholder Distribution Reinvestment Plan and Direct Unit Purchase Plan: H&R REIT offers holders of
Stapled Units and holders of exchangeable 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.
Registrar and Transfer Agent: CST 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@canstockta.com, Website: www.canstockta.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, Toronto,
Ontario, Canada, M3K 1N4
H&R Real Estate Investment Trust and H&R Finance Trust
Cortona Gardens, Dallas
Sunridge Mall, Calgary
Gotham Center, New York
www.HR-REIT.com