H&R REIT
Annual Report 2018

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H&R Real Estate Investment Trust 2018 Annual Report The Bow, Calgary Orchard Park, Kelowna  Airport Road, Brampton – Sleep Country H&R Profile H&R REIT is one of Canada’s largest real estate investment trusts with total assets of approximately $14.7 billion at December 31, 2018. H&R REIT has ownership interests in a North American portfolio of high quality office, retail, industrial and residential properties comprising over 42 million square feet. Additional information regarding H&R REIT is available at www.hr-reit.com and on www.sedar.com. Fair Value by Geographic region Ontario 33% United States 33% Other Canadian Provinces 9% Alberta 25% Fair Value by Type of Asset Multi-family 13% Industrial 7% Retail 31% Office 49% 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 from a high quality portfolio. We achieve our primary objectives and mitigate risks through long-term property leasing and financing, combined with conservative management of assets and liabilities. February 14, 2019 Fellow Unitholders, Looking back on 2018, H&R REIT (“H&R”) made significant progress towards the goals set out in our Letter to Unitholders a year ago. These goals include streamlining and simplifying our portfolio and recycling capital into higher growth properties, while enhancing the profile of H&R to our unitholders. In 2018 we sold approximately $1 billion of lower growth assets, including substantially all of our U.S. retail portfolio, and made significant investments into our attractive and well-advanced development projects and our U.S. residential rental portfolio, structurally enhancing the growth profile of the portfolio. While this capital reallocation program has had an impact on our financial results, we are pleased to note that it is essentially behind us. H&R returned to a single trust structure through the wind up of H&R Finance Trust, thereby simplifying H&R from the previous Stapled Unit structure. In 2018, we also repaid our final series of convertible debentures, eliminating the related potential future dilution and simplifying our capital structure. Building on the governance improvements made in recent years, we have implemented a sustainability policy focused on increasing energy efficiency and reducing waste, consumption and pollution at our properties. We are also proud to have also updated our diversity policy to include a new target for board composition reflecting a minimum target for women to comprise at least 25% of our board members by the 2021 annual general meeting. We believe the steps we have taken to simplify and streamline H&R’s portfolio and increase our internal growth profile will contribute to positive Funds from Operations (“FFO”) per unit and net asset value (“NAV”) per unit growth. In 2019 and 2020, this enhanced growth profile will be complemented by Sears and Target replacement tenancies commencing by lease-up of four recently built Lantower Residential properties, and by the contribution of Jackson Park, which is expected to reach stabilization later this year. We will continue to pursue opportunities to simplify and streamline our portfolio and enhance the REIT’s growth prospects in 2019, but believe the significant actions taken to date have already successfully elevated H&R’s growth profile. Developments Property development is a key contributor to H&R’s strategy of growing per-unit NAV and FFO. The scale and quality of our portfolio provides the stability and resilience of cash flow that, when paired with our balance sheet strength, allows H&R to pursue significant value creating developments. These investments enhance our existing portfolio by delivering value creation through the development process, increasing NAV per unit, and raising the growth profile of our overall portfolio. Our development projects all share the following characteristics: gateway city and/or primary market locations; strong prospects for rental rate growth over time driven by positive demand-growth and supply-constrained market fundamentals; and high-quality construction and profile, placing these properties at the top of their respective markets. Last year we added more detail to our disclosure of our development pipeline, including Jackson Park, our flagship 1,871-unit luxury residential rental development in Long Island City, New York (“LIC”). With this project well into lease- up and achieving rents slightly above our pro forma projections, we have already seen significant value creation delivered to our unitholders and expect cash flow contribution to increase throughout 2019 and into 2020. The appraised value of this project stands at U.S. $800 million at our 50% ownership interest, approximately U.S. $260 million more than our total investment to date. Amazon’s November 2018 announcement that LIC had been selected as one of its HQ2 locations included plans to invest $2.5 billion and create 25,000 new high-paying jobs in this market. Despite the excitement created by Amazon’s announcement, we have conservatively taken the position that it remains too early to forecast how Amazon’s plans might impact Jackson Park. The assumptions used to support the appraised value, and our future cash flow forecast for the property do not take into account Amazon’s announcement. What Amazon’s announcement has done however, is highlight the appealing characteristics of LIC, which are the same factors that drove our investment in Two Gotham and Jackson Park. These two properties sit at what we believe is the single best location in LIC, atop the Queens Plaza Subway Station - the gateway to LIC as the nexus of 3 main New York City subway lines. Our investment in LIC, along with Corus Quay in Toronto and River Landing in Miami, are notable examples of how H&R has identified and made significant investments in attractive, gentrifying urban areas early in their development cycle, subsequently benefitting from the emergence of these locations as prime nodes. P a g e  | 1          Construction is well advanced on our River Landing development in Miami. This 100% owned mixed-use urban infill project is located in the Miami Health District, two miles from downtown Miami, with 1,000 feet of waterfront on the Miami River. With a U.S. $425 million construction budget, this development includes office and retail components aggregating 482,000 sq.ft., and 529 luxury residential rental units. We expect an attractive 5.7% yield on cost, and strong growth in residential and commercial rents over time, as the local market intensifies and develops. Occupancy is expected to commence in Q2 2020. The completion of Jackson Park will contribute to H&R’s overall growth in property operating income and FFO in 2019 and 2020. In addition to Jackson Park and River Landing, H&R has several other developments in the gateway cities of San Francisco, Seattle, Dallas, Austin, Los Angeles and Toronto in various stages of development. Significant Intensification Opportunities With more than 460 properties, H&R’s portfolio includes many properties with the potential for higher and better use, as their locations have evolved since they were acquired by the REIT, including some owned since the REIT’s IPO over 23 years ago. Our Toronto portfolio in particular holds numerous significant opportunities among its 47 properties aggregating over 12 million square feet. While we have long considered these properties prime candidates for eventual intensification, the economics of these intensifications and redevelopments have only recently become attractive, and in some cases extraordinarily so. We plan to explore options to capitalize on these opportunities in the years ahead, including redevelopments, intensifications and/or dispositions. Outlook We believe that continuing to streamline and simplify our property portfolio into fewer but more significant segments, and increasing the focus on trophy and flagship properties in primary markets will not only enhance the growth prospects of our portfolio, but also improve the profile and transparency of H&R to its unitholders. The market volatility and economic uncertainty we witnessed in the final quarter of 2018 and the beginning of 2019 are reminders of the need for prudent and conservative strategic principles. For H&R REIT, these prudent and conservative principles are incorporated into all aspects of our strategy. High-quality and well located assets, a strong and diverse portfolio of credit tenants, long-term leases, a strong and flexible balance sheet with low leverage, a large pool of unencumbered properties, and the scale and stability provided by interests in over 460 properties across 42 million square feet, are all evidence of the steps we have taken to protect and grow your investment. As we continue to build on H&R’s strengths, we would like to thank our employees who have all contributed to the progress we have made over our 22-year history. Each member of our team has been crucial to the progress we have made and are the foundation of H&R’s bright future. The board, management and their families collectively own more than $400 million of equity in H&R REIT, and firmly believe that the units are deeply undervalued. We will continue our efforts to improve H&R’s investment profile, enhance our internal growth prospects, capitalize on opportunities within our portfolio, and narrow the gap between our unit price and NAV. Respectfully, _______________________________ Ronald C. Rutman Chairman ___________________________ Thomas J. Hofstedter President & Chief Executive Officer P a g e  | 2          MANAGEMENT’S DISCUSSION AND ANALYSIS OF H&R REAL ESTATE INVESTMENT TRUST For the Year ended December 31, 2018 Dated: February 14, 2019 TABLE OF CONTENTS SECTION I .................................................................................................................................................................................................................................................... 1  Basis Of Presentation ................................................................................................................................................................................................................................. 1  Forward-Looking Disclaimer ....................................................................................................................................................................................................................... 1  Non-GAAP Financial Measures ................................................................................................................................................................................................................. 2  Overview .................................................................................................................................................................................................................................................... 4  SECTION II ................................................................................................................................................................................................................................................... 5  Financial Highlights .................................................................................................................................................................................................................................... 5  Key Performance Drivers ........................................................................................................................................................................................................................... 6  Summary Of Significant 2018 Activity ........................................................................................................................................................................................................ 6  SECTION III ................................................................................................................................................................................................................................................ 10  Financial Position ..................................................................................................................................................................................................................................... 10  Assets ....................................................................................................................................................................................................................................................... 11  Liabilities And Unitholders’ Equity ............................................................................................................................................................................................................ 17  Results Of Operations .............................................................................................................................................................................................................................. 22  Property Operating Income ...................................................................................................................................................................................................................... 23  Segmented Information ............................................................................................................................................................................................................................ 23  Net Income, FFO And AFFO From Equity Accounted Investments ......................................................................................................................................................... 27  Income And Expense Items ..................................................................................................................................................................................................................... 28  Funds From Operations And Adjusted Funds From Operations .............................................................................................................................................................. 31  Liquidity And Capital Resources .............................................................................................................................................................................................................. 34  Related Party Transaction ........................................................................................................................................................................................................................ 36  Off-Balance Sheet Items .......................................................................................................................................................................................................................... 36  Derivative Instruments .............................................................................................................................................................................................................................. 36  SECTION IV ............................................................................................................................................................................................................................................... 37  Selected Financial Information ................................................................................................................................................................................................................. 37  Portfolio Overview .................................................................................................................................................................................................................................... 39  SECTION V ................................................................................................................................................................................................................................................ 42  Critical Accounting Estimates And Judgments ......................................................................................................................................................................................... 42  Significant Accounting Policies................................................................................................................................................................................................................. 43  Disclosure Controls And Procedures And Internal Control Over Financial Reporting ............................................................................................................................. 43  SECTION VI ............................................................................................................................................................................................................................................... 44  Risks And Uncertainties ........................................................................................................................................................................................................................... 44  Outstanding Unit Data .............................................................................................................................................................................................................................. 50  Additional Information ............................................................................................................................................................................................................................... 50  Subsequent Events .................................................................................................................................................................................................................................. 50  H&R REIT - MD&A – DECEMBER 31, 2018 SECTION I BASIS OF PRESENTATION Management’s Discussion and Analysis (“MD&A”) of the results of operations and financial position of H&R Real Estate Investment Trust (“H&R” or the “REIT”) for the year ended December 31, 2018 includes material information up to February 14, 2019. This MD&A also includes the results of operations of H&R Finance Trust ("Finance Trust" and together with H&R, the "Trusts") on a combined basis, up to August 31, 2018, the date of termination of Finance Trust (see “Overview” on page 4). The comparative periods ended December 31, 2017 and December 31, 2016 continue to reflect the financial position and results of the REIT and Finance Trust on a combined basis as previously reported, as units of the Trusts were previously stapled ("Stapled Units"). Financial data for the years ended December 31, 2018 and 2017 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 financial statements of the REIT and appended notes for the year ended December 31, 2018 (“REIT’s Financial Statements”). The REIT’s Financial Statements are defined to refer to the financial statements for the REIT or the Trusts for the applicable period. 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. For the periods prior to August 31, 2018, references to Units (as defined below) or calculations involving Units should be read as referring to Stapled Units. 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” and “Risks and Uncertainties” relating to the H&R’s objectives, strategies to achieve those objectives, H&R’s 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 statements made under the heading “Summary of Significant 2018 Activity” including with respect to the streamlining of H&R’s operations, H&R’s future plans, including significant development projects, dispositions, acquisitions and the repurchase and cancellation of Units, and management’s expectations that the reinvestment of sale proceeds and H&R’s enhanced growth profile will result in positive property operating income and FFO growth in 2019 and beyond, expectations for property operating income or rental growth from Lantower Residential and Primaris, H&R’s expectation with respect to the activities of its development properties, including redevelopment of existing properties and building of new properties, the expected total cost and lease-up of Jackson Park, the expected stabilized property operating income from Jackson Park, and the anticipated projected amounts of net income and FFO in 2019-2020 resulting from Jackson Park, the total cost and timing of the Hercules Project, The Pearl, Esterra Park and Shoreline, the expected total cost and stabilized property operating income from River Landing, expected capital and tenant expenditures, including 160 Elgin St., Ottawa, ON, the expected annual base rent from former Sears and Target space, management’s expectations regarding future distributions, management’s belief that H&R has sufficient funds for future commitments and management’s expectation to be able to meet all of its ongoing obligations and to finance short-term development commitments through its lines of credit and the adoption of new accounting policies. 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 H&R’s 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 H&R’s estimates and assumptions that are subject to risks, uncertainties and other factors including those risks and uncertainties described below under “Risks and Uncertainties” and those discussed in H&R’s materials filed with the Canadian securities regulatory authorities from time to time, which could cause the actual results, performance or achievements of H&R to differ materially from the forward-looking statements contained in this MD&A. Factors that could cause actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include, but not are limited to, the general economy is stable; local real estate conditions are stable; interest rates are relatively stable; and equity and debt markets continue to provide access to capital. Additional 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, cyber security 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. H&R cautions that these lists of factors, risks and uncertainties are not exhaustive. Although the forward- looking statements contained in this MD&A are based upon what H&R believes are reasonable assumptions, there can be no assurance that actual results will be consistent with these forward-looking statements. Readers are also urged to examine H&R’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 to differ materially from the forward-looking statements contained in this MD&A. None of the former trustees or officers of Finance Trust, 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 Page 1 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 authorities or for any failure of Finance Trust or its former trustees or officers to disclose events or facts which may have occurred or which may have affected 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 14, 2019 and the REIT, except as required by applicable Canadian law, assumes no obligation to update or revise them to reflect new information or the occurrence of future events or circumstances. NON-GAAP FINANCIAL MEASURES The REIT’s Financial Statements are prepared in accordance with IFRS. However, in this MD&A, a number of measures are presented that are not measures under generally accepted accounting principles (“GAAP”) in accordance with 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. Furthermore, the REIT’s 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 REIT’s proportionate share H&R accounts for investments in joint ventures and associates as equity accounted investments in accordance with IFRS. The REIT’s proportionate share is a non-GAAP measure that adjusts the REIT’s Financial Statements to reflect H&R’s equity accounted investments and its share of net income (loss) from equity accounted investments on a proportionately consolidated basis at H&R’s ownership interest of the applicable investment. Management believes this measure is important for investors as it is consistent with how H&R reviews and assesses operating performance of its entire portfolio. Throughout this MD&A, the balances at the REIT’s proportionate share have been reconciled back to relevant GAAP measures. H&R does not independently control its unconsolidated joint ventures, and the presentation of pro-rata assets, liabilities, revenue, and expenses may not accurately depict the legal and economic implications of the REIT’s interest in its joint ventures and associates. (b) Same-Asset property operating income (cash basis) Same-Asset property operating income (cash basis) is a non-GAAP financial measure used by H&R to assess period-over-period performance for properties owned and operated since January 1, 2017. Same-Asset property operating income (cash basis) adjusts property operating income to include property operating income from equity accounted investments on a proportionately consolidated basis at H&R’s ownership interest of the applicable investment and excludes two non-cash items;  Straight-lining of contractual rent; by excluding the impact of straight-lining of contractual rent, rentals from investment properties will consist primarily of actual rents collected by H&R.  Realty taxes accounted for under IFRS Interpretations Committee Interpretation 21, Levies (“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. It further excludes:  Acquisitions, business combinations, dispositions and transfers of properties under development to investment properties during the two-year period ended December 31, 2018 (collectively, “Transactions”). Management believes that this measure is useful for investors as it adjusts property operating income (including property operating income from equity accounted investments on a proportionately consolidated basis) for non-cash items which allows investors to better understand period-over-period changes due to occupancy, rental rates, realty taxes and operating costs, before evaluating the changes attributable to Transactions. Furthermore, it is also used as a key input in determining the value of investment properties. Refer to the “Property Operating Income” section in this MD&A for a reconciliation of Property operating income to Same-Asset property operating income (cash basis). Page 2 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 (c) Funds from operations (“FFO”) and Adjusted Funds from Operations (“AFFO”) FFO and AFFO are non-GAAP financial measures widely used in the real estate industry as a measure of operating performance particularly by those publicly traded entities that own and operate investment properties. H&R presents its consolidated FFO and AFFO calculations in accordance with the Real Property Association of Canada (REALpac) February 2018 White Paper on Funds From Operations and Adjusted Funds From Operations for IFRS. 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. Management believes FFO to be a useful earnings measure for investors as it adjusts net income for items 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. AFFO is calculated by adjusting FFO for the following items: straight-lining of contractual rent, capital expenditures, tenant expenditures and leasing costs. Although capital and tenant expenditures can vary from quarter to quarter due to tenant turnovers, vacancies and the age of a property, H&R has elected to deduct actual capital and tenant expenditures in the period. This may differ from others in the industry that deduct a normalized amount of capital and tenant expenditures, based on historical activity, 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. H&R’s method of calculating FFO and AFFO may differ from other issuers’ calculations. FFO and AFFO should not be construed as an alternative to net income or any other operating or liquidity measure prescribed under IFRS. Management uses FFO and AFFO to better understand and assess operating performance since net income includes several non-cash items which management believes are not fully indicative of the REIT’s performance. Refer to the “Funds From Operations and Adjusted Funds From Operations” section of this MD&A for a reconciliation of Net income to FFO and AFFO. (d) Interest coverage ratio The interest coverage ratio is a non-GAAP measure that is calculated by dividing the total of: (i) property operating income (excluding straight-lining of contractual rent and IFRIC 21); (ii) finance income and (iii) trust expenses (excluding unit-based compensation) by finance costs from operations (excluding effective interest rate accretion and exchangeable unit distributions). This excludes other income, transaction costs, gain (loss) on sale of investments and unrealized gains (losses) that may be taken into account under IFRS. Management uses this ratio and believes it is useful for investors as it is an operational measure used to evaluate the REIT’s ability to service the interest requirements of its outstanding debt. Interest coverage ratio is presented in the “Financial Highlights” and “Liabilities and Unitholders’ Equity” sections of this MD&A. (e) Debt to total assets at the REIT’s proportionate share 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 REIT’s Financial Statements. H&R also presents this ratio at the REIT’s proportionate share which is a non-GAAP measure. Debt includes mortgages payable, debentures payable, unsecured term loans and lines of credit. Management uses this ratio to determine the REIT’s flexibility to incur additional debt. Management believes this is useful for investors in order to assess the REIT’s leverage and debt obligations. Refer to the “Financial Highlights” and “Liabilities and Unitholders’ Equity” sections of this MD&A for debt to total assets per the REIT’s Financial Statements and at the REIT’s proportionate share. (f) Payout ratio per Unit as a % of FFO Payout Ratio per Unit as a % of FFO is a non-GAAP measure which assesses the REIT’s ability to pay distributions and is calculated by dividing distributions per Unit (or Stapled Unit, where applicable) by FFO per Unit (or Stapled Unit, where applicable) for the respective period. H&R uses this ratio amongst other criteria to evaluate the REIT’s ability to maintain current distribution levels or increase future distributions as well as assess whether sufficient cash is being held back for operational and capital expenditures. Refer to the “Financial Highlights” and “Funds From Operations and Adjusted Funds From Operations” sections of this MD&A for the REIT’s payout ratio per Unit as a % of FFO. (g) Net Asset Value (“NAV”) per Unit NAV per Unit is a non-GAAP measure that management believes is a useful indicator of fair value of the net tangible assets of H&R. NAV per Unit is calculated by dividing the sum of: (i) Unitholders’ equity, (ii) value of exchangeable units, and (iii) deferred tax liability by the total number of Units and exchangeable units outstanding. The rationale for including exchangeable units and the deferred tax liability are as follows: (i) under IFRS, exchangeable units are classified as debt, however, these units are not required to be repaid and each holder of these units has the option to convert their exchangeable units into Units, and therefore H&R considers this to be equivalent to equity; and (iii) the deferred tax liability is an undiscounted liability that would be crystalized in the event that U.S. properties are sold. H&R plans to continue to take advantage of U.S. tax legislation in order to further defer taxes owing on sold properties. H&R’s method of calculating NAV per Unit may differ from other issuers’ calculations. Page 3 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 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 units (“Units”) redeemed at any time on demand payable in cash (subject to monthly limits) and/or in specie. The Units are listed and posted for trading on the Toronto Stock Exchange (“TSX”) under the symbol HR.UN. On August 31, 2018, the REIT and Finance Trust effected a reorganization (“Reorganization”) by way of plan of arrangement involving the REIT, Finance Trust and certain of the REIT’s subsidiaries resulting in, among other things, (i) Finance Trust transferring debt owed to it by H&R REIT (U.S.) Holdings Inc. (“U.S. Holdco”) to the REIT for nil consideration and (ii) unitholders subsequently transferring their Finance Trust units to the REIT for nominal consideration and retaining their Units. Following these transactions, Finance Trust was terminated, resulting in the Units no longer being stapled to units of Finance Trust and unitholders holding only REIT Units. H&R has two primary objectives:  to maximize NAV 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; and  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. 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 leased by creditworthy tenants. H&R’s strategy to mitigate risk includes 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 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 and Lantower Management Services LP, both subsidiaries 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 and developing multi-family residential rental properties in the United States. H&R therefore has six operating segments and management assesses the results of these operations separately. Page 4 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 SECTION II FINANCIAL HIGHLIGHTS (in thousands of Canadian dollars except per Unit amounts) Total assets Debt to total assets per the REIT's Financial Statements(1) Debt to total assets at the REIT's proportionate share(1)(2) Unitholders' equity Units outstanding Unitholders' equity per Unit NAV per Unit(2)(3) Unit price December 31, December 31, 2017 2018 December 31, 2016 $14,691,009 $14,558,863 $14,155,012 44.6% 47.1% 44.6% 46.6% 44.3% 46.0% 7,200,100 7,179,763 6,912,650 285,678 291,320 285,280 $25.20 $26.30 $20.65 $24.65 $25.57 $21.36 $24.23 $25.45 $22.37 Three months ended Dec. 31, 2018 Dec. 31, 2017 % Change Dec. 31, 2018 Year ended Dec. 31, 2017 % Change Rentals from investment properties $297,416 $298,042 (0.2%) $1,176,558 $1,168,454 Property operating income Same-Asset property operating income (cash basis) - Canada(2) Same-Asset property operating income (cash basis) - U.S. in U.S. dollars(2) Same-Asset property operating income (cash basis) total in Canadian dollars(2) Net income from equity accounted investments Net income FFO(2) Weighted average number of basic Units for FFO(2) FFO per basic Unit(2) Distributions paid per Unit Payout ratio per Unit as a % of FFO(2) Interest coverage ratio(2) Net income is reconciled to FFO. See page 31. 192,009 137,493 37,203 186,987 148,165 61,115 130,470 301,200 0.433 0.345 79.7% 3.06 199,414 134,546 36,330 180,646 118,337 325,213 137,447 306,629 0.448 0.345 77.0% 2.99 (3.7%) 2.2% 2.4% 3.5% 25.2% (81.2%) (5.1%) (1.8%) (3.3%) -% 2.7% 2.3% 733,932 535,621 150,158 730,826 169,409 337,918 525,696 302,605 1.737 1.380 79.4% 3.03 741,441 528,285 149,106 722,122 167,407 667,870 560,090 304,462 1.840 1.380 75.0% 3.00 0.7% (1.0%) 1.4% 0.7% 1.2% 1.2% (49.4%) (6.1%) (0.6%) (5.6%) -% 4.4% 1.0% (1) Debt includes mortgages payable, debentures payable, unsecured term loans and lines of credit. (2) These are non-GAAP measures. See the “Non-GAAP Financial Measures” section of this MD&A. (3) See page 21 for a detailed calculation of NAV per Unit. Page 5 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 KEY PERFORMANCE DRIVERS The following table is presented at the REIT’s proportionate share and includes investment properties classified as assets held for sale: OPERATIONS Occupancy as at December 31 Occupancy – Same-Asset as at December 31(1) Average contractual rent per sq.ft. for the year ended December 31-Canadian properties(2) Average contractual rent per sq.ft. for the year ended December 31-U.S. properties (USD)(2) 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 H&R Retail 98.2% 97.4% 98.2% 97.7% 84.9%(4) 92.6% 84.9%(4) 92.6% $25.44 $23.36 $11.74 $11.75 ECHO 95.5% 94.1% 95.3% 94.6% N/A N/A N/A N/A $47.15(5) $13.11 $15.48 $15.17 4.8 4.9 3.3 4.2 8.4 6.1 3.6 5.0 10.1 10.6 10.7 11.0 Lantower Industrial Residential(3) 98.5% 98.4% 98.4% 98.7% $6.86 $6.65 $3.37 $3.54 6.7 7.2 6.5 6.0 88.0%(6) 90.0% 92.7% 93.6% N/A N/A $16.94 $15.99 N/A N/A 8.3 8.4 Total 94.0% 95.6% 94.9% 96.5% $18.80 $18.10 $19.04 $16.77 9.0 9.1 5.5 5.6 2018 2017 2018 2017 2018 2017 2018 2017 2018 2017 2018 2017 98.5% 97.0% 98.5% 98.3% $26.41 $25.92 $35.78 $35.75 11.1 11.8 4.1 5.0 (1) (2) (3) (4) (5) (6) Same-Asset refers to those properties owned by H&R for the two-year period ended December 31, 2018. Excludes properties sold in their respective year. Jackson Park has been excluded from the Key Performance Drivers above Primaris Occupancy and Occupancy-Same Asset as at December 31, 2017 includes eight Sears’ store locations totalling 609,749 square feet which closed and became vacant in January 2018. Primaris Occupancy would have been 92.6% had these eight Sears store locations been occupied as at December 31, 2018. In June 2018, H&R sold 63 of its 79 U.S. retail properties owned as at December 31, 2017 which resulted in average contractual rent per sq.ft. in U.S. dollars increasing from $13.11 for the year ended December 31, 2017 to $47.15 for the year ended December 31, 2018. Lantower Residential had four properties in lease-up with a weighted average occupancy rate of 67.5% as at December 31, 2018. Excluding these four properties, occupancy would have been 92.5% as at December 31, 2018. SUMMARY OF SIGNIFICANT 2018 ACTIVITY During 2018, H&R actively pursued its capital reallocation program through property dispositions, acquisitions, developments and the repurchase and cancellation of Units. The objectives of this program include 1) simplifying H&R by focusing on fewer property types and increasing the contributions from its core portfolio; 2) making H&R easier for investors to understand, analyze and value; and 3) enhancing the REIT’s internal growth profile. The following 2018 transactions highlight H&R’s progress in achieving the strategic objectives identified in its letter to unitholders included in H&R’s 2017 Annual Report:  Sold 63 lower growth U.S. retail assets for U.S. $633.0 million;  Sold H&R’s ownership interest in F1RST Tower in Calgary, AB for $53.5 million;  Sold H&R’s ownership interest in five non-core Canadian industrial assets and two non-core Canadian retail assets for $72.1 million;  Reinvested sales proceeds in higher growth assets by acquiring residential rental assets in the U.S. for U.S. $340.6 million;   Purchased and cancelled 6.6 million Units at an average price of $20.62 per Unit for a total cost of $136.3 million; and  Eliminated Finance Trust and the Stapled Unit structure to return H&R to a single trust in line with industry peers. Further advanced and expanded the development pipeline to $1.5 billion of properties under development; Developments Management believes that H&R’s development pipeline is an important driver of growth in NAV and FFO per Unit over time. H&R’s scale, low leverage and high quality tenant base serve as a competitive advantage enabling the REIT to pursue large format development opportunities not available to smaller entities, while managing risk exposures. During 2018, H&R has made significant progress in advancing its value-creating development program, with a well-staggered pipeline of projects. Jackson Park, the 1,871 luxury residential rental unit development in Long Island City, NY, in which H&R has a 50% ownership interest, is nearing completion and expected to be transferred to investment properties in Q1 2019. H&R’s trophy project is on budget and slightly ahead of the development lease-up schedule. As at December 31, 2018, 1,274 leases had been entered into and 1,231 units were occupied. The remaining lease-up is expected to occur during the balance of 2019 with stabilized occupancy expected to be achieved during Q3 2019. Upon stabilization, the first full year’s property operating income at H&R’s ownership interest is projected to be U.S. $35.9 million, equating to a 6.2% yield on budgeted cost of U.S. $580.7 million. Jackson Park, at the 100% level, has been valued at approximately U.S. $1.6 billion as at December 31, 2018 compared to costs to date of approximately U.S. $1.1 billion, resulting in a fair value increase of U.S. $522.6 million since the start of the project. Page 6 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 The following table presents net income and FFO for Jackson Park for the three months and year ended December 31, 2018 as well as projections through 2020: (H&R's ownership interest) (in thousands of U.S. dollars) Property operating income Finance cost - operations Fair value adjustment on financial instruments Fair value adjustment on real estate assets Net income Fair value adjustment on financial instruments Fair value adjustment on real estate assets Notional interest capitalization FFO Q4 2018 (Actual) YTD Dec 31, 2018 (Actual) Annual 2019 (Projected) Annual 2020 (Projected) $2,554 $1,988 $27,004 $35,921 (2,999) (5,475) (13,191) (13,600) (1,699) 1,549 107,718 107,718 - - - - 105,574 105,780 13,813 22,321 1,699 (1,549) (107,718) (107,718) 601 $156 5,777 $2,290 - - 232 $14,045 - - - $22,321 For Q4 2018, net income from Jackson Park exceeded the projection as at September 30, 2018 primarily due to a fair value increase to the property of U.S. $107.7 million at H&R’s ownership interest which was supported by an independent third party appraisal. FFO for Q4 2018 was lower than projected as at September 30, 2018 by $0.4 million primarily due to higher initial operating expenses. In April 2018, H&R acquired a 33.3% non-managing ownership interest in a residential development site zoned for 263 residential rental units for U.S. $8.7 million at the 100% level located in Seattle, WA. This development, known as “Esterra Park”, is part of a larger master planned community and is adjacent to Microsoft, Inc.’s headquarters, bus transit and future light rail which is expected to be completed in 2021. Construction commenced in November 2018 and the total budget is approximately U.S. $95.7 million at the 100% level. As at December 31, 2018, H&R’s investment was approximately U.S $6.2 million. In June 2018, H&R converted its mortgage receivable secured against the urban in-fill development site in Miami, FL, known as “River Landing” into a wholly-owned property under development. River Landing, with approximately 1,000 feet of waterfront on the Miami River, is adjacent to the Health District and is two miles from downtown Miami. River Landing is a mixed-use development including approximately 346,000 square feet of retail space, approximately 136,000 square feet of office space and 529 residential rental units. To date, 66.0% of the retail space has been leased, with a further 10.1% under executed non-binding letters of intent. Construction is underway with occupancy scheduled to commence in Q2 2020. The total cost of the project is expected to be U.S. $424.8 million and as at December 31, 2018, approximately U.S. $196.0 million had been invested in the development. Upon stabilized occupancy, the first full year’s property operating income is projected to be U.S. $24.4 million, equating to a 5.7% yield on budgeted cost. In June 2018, H&R purchased a 100% ownership interest in 20.3 acres of land in Prosper, TX, a suburb of Dallas (“Prosper”) for U.S. $14.6 million. The location along Dallas North Tollway enables quick access to the acclaimed Legacy West Development, home to major corporate employers including the regional headquarters of Toyota North America, Federal Express, Inc., Liberty Mutual Regional and JP Morgan Chase. The site is expected to consist of 1,000 residential rental units. In July 2018, H&R acquired a 30.9% non-managing ownership interest in the development of a 315 luxury residential rental unit tower, with 6,450 square feet of retail space for a total of U.S. $15.0 million, at the 100% level. Located in Long Beach, CA, “Shoreline Gateway” will become the tallest residential tower in Long Beach with 35 floors enjoying views overlooking the Pacific Ocean. Construction commenced in November 2018 and the total budget is approximately U.S. $227.1 million at the 100% level. As at December 31, 2018, H&R’s investment was approximately U.S. $6.4 million. In December 2018, H&R acquired a 100% interest in approximately 3.3 acres of land in downtown Dallas, TX (“2214 Bryan St.”) for approximately U.S. $23.5 million. The site was purchased for the future development of luxury residential rental units. The location benefits from great connectivity as the Pearl/Arts District DART (public rail) station is adjacent to the site. For a complete list of H&R’s current development projects, see page 14 of this MD&A. Page 7 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 Retail In June 2018, H&R sold 63 lower-growth U.S. retail properties, totaling 4,235,943 square feet for U.S. $633.0 million and realized a loss on sale of U.S. $19.6 million which was primarily due to mortgage prepayment penalties and closing costs. H&R used the proceeds from dispositions to repay 48 mortgages totaling U.S. $205.3 million, repay bank debt of approximately U.S. $152.4 million and fund Lantower Residential acquisitions of U.S. $255.7 million. The sale of H&R’s 63 U.S. retail assets reduced net income and FFO during the remainder of 2018. During 2018, H&R completed lease renewals for 15 single-tenanted properties totaling 1,207,474 square feet with an average lease extension of 13.2 years. Office Property operating income and Same-Asset property operating income (cash basis) from the Office segment increased by 0.2% and 1.8%, respectively, for the year ended December 31, 2018 compared to the respective 2017 period, primarily due to an increase in occupancy, contractual rental escalations and renewed leases at higher rents from H&R’s Ontario Office properties. The Office portfolio is leased on a long-term basis to creditworthy tenants, with 81.2% of Office revenue from tenants with investment grade ratings. In April 2018, H&R sold its 50% ownership interest in F1RST Tower in Calgary, AB for gross proceeds of $53.5 million and repaid the associated mortgage of $40.0 million at H&R’s ownership interest. As at December 31, 2018, H&R’s Alberta Office portfolio consists of four single tenant properties, all of which are fully leased to investment grade tenants, with a weighted average remaining lease term to maturity of 17.4 years. Primaris Property operating income and Same-Asset property operating income (cash basis) from the Primaris segment grew by 0.9% and 0.8%, respectively, for the year ended December 31, 2018 compared to the respective 2017 period, despite the decline in occupancy from 92.6% at December 31, 2017 to 84.9% at December 31, 2018. This reflects the relative low rents Sears had been paying on the vacated space in 2017, the commencement of new leases on the previous Target space as well as the strength of the remainder of the tenant base. Redevelopment of the former Sears stores has commenced, however, since each store is part of an existing property, they continue to be classified as investment properties. During the three months and year ended December 31, 2018, H&R capitalized $0.5 million and $1.1 million, respectively, of property operating costs and $1.0 million and $2.8 million, respectively, of finance costs attributable to the former Target and Sears space. Management expects positive rental growth from Primaris as the lease-up of the former Target and Sears space is expected to generate approximately $1.0 million, $5.4 million and $3.0 million of additional annual base rent in 2019, 2020 and 2021, respectively. In August 2018, Primaris sold a 44,158 square foot multi-tenant retail property known as Sherwood Park Plaza in Sherwood Park, AB for $13.3 million. Lantower Residential Property operating income and Same-Asset property operating income (cash basis) from Lantower Residential, now H&R’s third largest segment, grew by 60.2% and 4.4%, respectively, for the year ended December 31, 2018 compared to the respective 2017 period. The growth in property operating income was primarily due to 11 property acquisitions during 2017 and 2018. Growth in Same-Asset property operating income (cash basis) was primarily due to rental growth. During 2018, Lantower Residential acquired five properties totalling 1,638 residential rental units for an aggregate purchase price of U.S. $340.6 million. As at December 31, 2018, Lantower Residential has a portfolio of 22 properties comprising 7,271 residential rental units. Eleven properties are in Texas, seven are in Florida and four are in North Carolina. In December 2018, Apple Inc. announced it will be building a new 133-acre campus in Austin, TX to accommodate an additional 5,000 jobs with the capacity to grow to 15,000 jobs. This campus is located within a six-mile radius of Lantower Residential’s four properties in Austin, TX. As at December 31, 2018, Lantower Residential had four properties in lease-up with a weighted average occupancy rate of 67.5%. During the three months and year ended December 31, 2018, these properties contributed U.S. $1.2 million and U.S. $2.0 million, respectively, to property operating income. All four properties are targeted for stabilization by Q4 2019 and are expected to contribute an additional U.S. $7.8 million to property operating income in 2019. Industrial During 2018, H&R acquired ownership interests in two Canadian industrial properties for a total purchase price of $17.3 million at H&R’s ownership interest and H&R sold interests in five Canadian industrial properties for total proceeds of $51.3 million at H&R’s ownership interest. Page 8 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 Debt Highlights Debentures: During 2018, H&R issued the following debentures: Series O Senior Debentures Series P Senior Debentures(1) Maturity January 23, 2023 February 13, 2020 Contractual Interest Rate Principal Amount 3.42% 3.00% $250,000 170,000 $420,000 (1) Denominated as U.S. $125.0 million and bearing interest at a rate equal to 3-month London Interbank Offered Rate plus 79 basis points. The average interest rate for the year ended December 31, 2018 was 3.00%. In December 2018, H&R entered into an interest rate swap on the Series P senior debentures to fix the interest rate at 2.88% per annum. During 2018, the following debentures matured or were redeemed: Series E Senior Debentures Series J Senior Debentures(1) Series G Senior Debentures Series C Senior Debentures 2020 Convertible Debentures (HR.DB.D) (1) Denominated as U.S. $125.0 million. Maturity/Redemption February 2, 2018 February 9, 2018 June 20, 2018 December 1, 2018 March 12, 2018 Contractual Interest Rate 4.90% 2.04% 3.34% 5.00% 5.90% Principal Amount $100,000 157,500 175,000 125,000 99,582 $657,082 Mortgages: During 2018, H&R secured 14 new mortgages totalling $603.7 million at a weighted average interest rate of 4.1% for an average term of 9.3 years. In addition to repaying the 48 mortgages totalling $266.9 million (U.S. $205.3 million) on the U.S. retail assets that were sold in June 2018, H&R also repaid 19 other mortgages totalling $138.2 million. Together, these mortgages had a weighted average interest rate of 4.8%. Unsecured Term Loan: In December 2018, H&R borrowed $250.0 million by way of an unsecured term loan maturing in January 2026. Through an interest rate swap, H&R fixed the interest rate at 3.9% for the full seven-year term. Lines of Credit: As at December 31, 2018, H&R had $768.2 million of unused borrowing capacity available under its lines of credit. As at December 31, 2018, debt to total assets was 44.6% unchanged from December 31, 2017. The weighted average interest rate of H&R’s debt as at December 31, 2018 was 3.8% with an average term to maturity of 4.4 years. Unwinding of H&R’s Stapled Unit Structure On August 31, 2018, the REIT and Finance Trust effected a Reorganization by way of plan of arrangement involving the REIT, Finance Trust and certain of the REIT’s subsidiaries resulting in, among other things, the termination of Finance Trust. Accordingly, H&R’s Units are no longer stapled to units of Finance Trust with unitholders now only holding H&R Units, thereby returning H&R to a single trust in line with industry peers. Suspension of DRIP and Unit Purchase Plan In February 2018, the Trusts announced the suspension of its DRIP and Unit Purchase Plan until further notice. Commencing with the March 2018 distribution, unitholders who elected to participate in the DRIP received the full cash distributions on their Units. If H&R elects to reinstate the DRIP in the future, unitholders that were enrolled in the DRIP at the time of its suspension and remain enrolled at the time of its reinstatement will automatically resume participation in the DRIP. Unitholders who elected to participate in the Unit Purchase Plan will no longer have funds withdrawn for purchases of Units. H&R is well capitalized and has a strong balance sheet with significant financial flexibility. Accordingly, the trustees of H&R and management wish to assert greater control over when and on what terms H&R raises capital to fund its business. The trustees of H&R and management particularly wish to avoid issuing equity at a price below NAV per Unit, something that can occur from time to time under the DRIP. Page 9 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 Normal Course Issuer Bid (“NCIB”) With an increased focus on recycling capital into investments with higher risk-adjusted returns and the availability of excess capital generated from asset dispositions, H&R has taken advantage of the opportunity to acquire Units through its NCIB at what management believes to be significantly discounted trading prices. During the year ended December 31, 2018, the Trusts purchased and cancelled 6,609,420 Units at a weighted average price of $20.62 per Unit, for a total amount of $136.3 million. SECTION III The following foreign exchange rates have been used throughout this MD&A when converting U.S. dollars to Canadian dollars except where otherwise noted: For each U.S. $1.00 $1.36 CAD $1.26 CAD $1.33 CAD $1.27 CAD $1.30 CAD $1.30 CAD As at December 31 Three months ended December 31 Year ended December 31 2018 2017 2018 2017 2018 2017 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 Debt Exchangeable units Deferred tax liability Accounts payable and accrued liabilities Unitholders’ equity December 31, December 31, 2018 2017 $12,683,709 $13,074,123 404,814 83,132 13,088,523 13,157,255 1,284,985 1,125,135 110,940 153,488 53,073 - 234,189 42,284 $14,691,009 $14,558,863 $6,546,072 $6,493,617 329,482 392,214 223,141 7,490,909 7,200,100 341,321 325,131 219,031 7,379,100 7,179,763 $14,691,009 $14,558,863 Page 10 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 ASSETS Real Estate Assets: Change in Investment Properties (in thousands of Canadian dollars) Opening balance, January 1, 2018 Acquisitions, including transaction costs Dispositions Transfer of investment properties to assets classified as held for sale Operating capital: Capital expenditures Leasing expenses and tenant inducements Redevelopment (including capitalized interest) Amortization of tenant inducements, straight-lining of contractual rents and blend and extend rents included in revenue Transfer of properties under development that have reached substantial completion to investment properties Fair value adjustment on real estate assets Change in foreign exchange Closing balance, December 31, 2018 REIT's Financial Statements Plus: equity accounted investments REIT's proportionate share(1) $13,074,123 $846,431 $13,920,554 463,299 (933,403) (110,940) 57,825 32,441 60,892 3,088 - (246,967) 283,351 6,240 (2,111) - 2,754 2,730 1,030 (733) 13,932 (8,474) 68,500 469,539 (935,514) (110,940) 60,579 35,171 61,922 2,355 13,932 (255,441) 351,851 $12,683,709 $930,299 $13,614,008 (1) The REIT’s proportionate share is a non-GAAP measure defined in the “Non-GAAP Financial Measures” section of this MD&A. 2018 Acquisitions: Property 504 East Pettigrew St., Durham, NC 190 Goodrich Dr., Kitchener, ON(2) 15175 Integra Junction, Odessa, FL 14201 N. Interstate, 35 Frontage Rd., Austin, TX 3300-70th Ave., Leduc, AB(3) 6000 Elevate Circle, Cary, NC 6101 Ardrey Kell Rd., Charlotte, NC Total Year Built 2018 1980 2017 2018 2018 2018 2016 Segment Date Acquired Number of Residential Rental Units Purchase Price ($ Millions)(1) Ownership Interest Acquired Residential Jun 1, 2018 Industrial Jun 1, 2018 Residential Jun 11, 2018 Residential Sep 17, 2018 Industrial Oct 1, 2018 Residential Oct 16, 2018 Residential Dec 3, 2018 305 - 322 328 - 308 375 1,638 98.9 4.0 74.9 62.9 13.3 95.4 111.4 $460.8 100% 50% 100% 100% 33.3% 100% 100% (1) U.S. acquisitions have been translated to Canadian dollars at the exchange rate as at the date acquired. (2) Purchase price is stated at H&R’s ownership interest. The square footage at H&R’s ownership interest is 36,562. (3) Purchase price is stated at H&R’s ownership interest. The square footage at H&R’s ownership interest is 134,883. Page 11 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 2017 Acquisitions: Property 14233 The Lakes Blvd., Austin, TX 14301 N. Interstate Hwy. 35, Austin, TX 1810 Sweetbroom Circle, Lutz, FL 11660 Westwood Blvd., Orlando, FL 10440 Sanderling Shores Dr., Tampa, FL 2600 Lake Ridge Rd., Lewisville, TX Total Year Built 2016 2017 2010 2017 2016 2016 Segment Date Acquired Number of Residential Rental Units Purchase Price ($ Millions)(1) Ownership Interest Acquired Residential Apr 7, 2017 Residential May 26, 2017 Residential Oct 10, 2017 Residential Nov 15, 2017 Residential Dec 11, 2017 Residential Dec 12, 2017 375 370 451 282 450 301 2,229 $69.5 71.3 98.6 76.2 121.3 64.1 $501.0 100% 100% 100% 100% 100% 100% (1) U.S. acquisitions have been translated to Canadian dollars at the exchange rate as at the date acquired. 2018 Dispositions: Property 7350 Catherine St., Windsor, ON 1880 Matheson Blvd. E., Mississauga, ON(2) 1377 The Queensway, Toronto, ON(2) 411 1st Street, Calgary, AB(2) 10300 Rue Henri Bourassa, St. Laurent, QC(2) U.S. Retail portfolio - 63 properties 380 Spinnaker Way, Vaughan, ON(2) 650 Cataraqui Woods Dr., Kingston, ON(2) 101 Granada Blvd., Sherwood Park, AB Total Segment Date Sold Square Feet Selling Price ($ Millions)(1) Ownership Interest Sold H&R Retail Jan 31, 2018 Industrial Feb 20, 2018 Industrial Feb 23, 2018 Office Apr 10, 2018 Industrial Apr 19, 2018 102,997 194,657 92,449 353,140 40,750 H&R Retail June 2018 4,235,943 Industrial Industrial Jul 11, 2018 Jul 31, 2018 Primaris Aug 1, 2018 24,763 88,328 44,158 $7.5 31.3 7.0 53.5 3.6 823.3 4.6 4.8 13.3 5,177,185 $948.9 100% 50% 50% 50% 50% 100% 75% 50% 100% (1) U.S. dispositions have been translated to Canadian dollars at the exchange rate as at the date sold. (2) Square feet and selling price are based on the ownership interest disposed. 2017 Dispositions: Property Place du Royaume, Chicoutimi, QC(2)(3) Cataraqui Town Centre, Kingston, ON(2)(3) 914 E. North Ave., Belton, MO 2940 N. Broadway, Anderson, IN 8766 E. 96th St., Fishers, IN 2800 Skymark Ave., Mississauga, ON(4) 189/203 Queen St. N., Tilbury, ON(2) 12510 South Green Dr., Houston, TX(5) Total Selling Price ($ Millions)(1) Ownership Interest Sold Segment Primaris Primaris Date Sold Jan 16, 2017 Jan 16, 2017 H&R Retail Jan 27, 2017 Square Feet 301,859 310,311 88,248 $109.0 102.6 13.9 H&R Retail Mar 31, 2017 39,877 2.7 H&R Retail Mar 31, 2017 80,960 5.3 Office Q2-Q3 2017 12,202 1.6 Industrial Aug 21, 2017 85,068 3.8 Residential Sep 27, 2017 323,568 39.9 1,242,093 $278.8 50% 50% 100% 100% 100% 100% 50% 100% (1) U.S. dispositions have been translated to Canadian dollars at the exchange rate as at the date sold. (2) Square feet and selling price are based on the ownership interest disposed. (3) H&R retained an ownership interest of 50% in these properties. (4) As at December 31, 2017, all condominium units have been sold. (5) Property consisted of 428 units. Page 12 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 Investment Properties and Properties under Development by Segment and Region: The following tables disclose the fair values of the investment properties and properties under development by operating segment and geographic location, excluding assets held for sale: December 31, 2018 REIT's Financial Statements Equity Accounted Investments Operating Segment (in millions of Canadian dollars) Investment Properties Office Primaris H&R Retail ECHO Industrial Lantower Residential Total $6,659 2,733 570 - 966 1,756 $12,684 Properties Under Development $ - - - - 86 319 $405 Sub Total $6,659 2,733 570 - 1,052 2,075 $13,089 Investment Properties Properties Under Development $ - $ - - - 870 60 - $930 - - 12 - 1,133 $1,145 Sub Total $ - - - 882 60 1,133 $2,075 REIT's proportionate share(1) $6,659 2,733 570 882 1,112 3,208 $15,164 (1) The REIT’s proportionate share is a non-GAAP measure defined in the “Non-GAAP Financial Measures” section of this MD&A. December 31, 2018 REIT's Financial Statements Equity Accounted Investments Geographic Location (in millions of Canadian dollars) Investment Properties Ontario Alberta Other Canada United States Total $4,421 3,404 1,259 9,084 3,600 $12,684 Properties Under Development Sub Total Investment Properties Properties Under Development $86 $4,507 $ - $ - - - 86 319 $405 3,404 1,259 9,170 3,919 $13,089 - - - 930 $930 - - - 1,145 $1,145 Sub Total $ - - - - 2,075 $2,075 REIT's proportionate share(1) $4,507 3,404 1,259 9,170 5,994 $15,164 (1) The REIT’s proportionate share is a non-GAAP measure defined in the “Non-GAAP Financial Measures” section of this MD&A. H&R has utilized the following capitalization rates in estimating the fair value of the investment properties excluding assets classified as held for sale. The capitalization rates disclosed below are reported by segment and geographic location at the REIT’s proportionate share which differs from the REIT’s Financial Statements. Weighted Average Overall Capitalization Rates: December 31, 2018 Canada United States December 31, 2017 Canada United States Office Primaris 5.54% 5.27% 6.00% H&R Retail 6.44% ECHO Industrial Lantower Residential - 5.68% 8.55% - 5.09% - 11.25% 6.69% Office Primaris 5.58% 5.36% 5.54% - H&R Retail 6.38% 7.36% ECHO Industrial Lantower Residential - 6.78% 5.85% 8.06% - 5.12% Page 13 of 50 Total 5.73% 5.68% Total 5.63% 5.98% H&R REIT - MD&A – DECEMBER 31, 2018 At H&R Ownership Interest Ownership Interest Number of Acres Total Development Budget Properties Under Development Costs Remaining to Complete Expected Yield on Cost Expected Completion Date Properties Under Development: As at December 31, 2018 Development Name (in thousands of Canadian dollars) U.S. projects River Landing, Miami, FL(1) Prosper, Dallas, TX (Phase 1)(2)(3) 2214 Bryan St., Dallas, TX(2) Total in U.S. Dollars Total U.S. projects in Canadian Dollars Canadian projects 100.0% 100.0% 100.0% 8.1 20.3 3.3 31.7 144.0 175.7 2.7 - 0.9 2.2 36.2 5.0 1.1 $424,815 $196,022 $228,793 5.7% Q2 2020 424,815 577,748 15,103 23,616 234,741 319,247 85,567 228,793 311,158 $577,748 $404,814 $311,158 $580,654 $529,872 $27,760 6.2% Q1 2019 70,096 26,041 23,201 31,859 261,293 9,704 7,312 11,721 6,519 6,354 9,150 - 6.2% 6.5% 6.2% 6.0% - Q1 2021 Q2 2020 Q2 2020 Q3 2020 60,392 18,729 16,682 25,505 149,068 202,732 48.1 731,851 841,925 995,317 1,145,018 223.8 $1,573,065 $1,549,832 $513,890 Industrial Lands, Caledon, ON(2)(4) 100.0% Total per the REIT's Financial Statements Equity accounted investments: U.S. projects Jackson Park, Long Island City, NY(5) Jackson Park, Long Island City, NY (Fair Value Increase) Shoreline, Long Beach, CA(6) Hercules Project (Block N - Phase 1), Hercules, CA(7) Hercules Project (Remaining Phases), Hercules, CA(2)(7) The Pearl, Austin, TX(8) Esterra Park, Seattle, WA(9) ECHO: 11 properties under development(2) Total in U.S. Dollars Total U.S. projects in Canadian Dollars Total per the REIT's proportionate share 50.0% 50.0% 30.9% 31.7% 31.7% 33.3% 33.3% 33.6% (1) Mixed use development consisting of 529 residential rental units, approximately 346,000 square of retail space and 136,000 square feet of office space. (2) (3) (4) (5) (6) (7) (8) (9) Development budget metrics have not been determined as at December 31, 2018. Total development to be approximately 1,000 residential rental units over several phases in a master planned community, along the Dallas North Tollway in north Dallas. 2.7 million square feet of industrial property is expected to be built. Costs spent to date relate to land only. 1,871 luxury residential rental units. Stabilized occupancy is expected to be achieved in Q3 2019. The fair value of this property under development is U.S. $800.0 million at H&R’s ownership interest as at December 31, 2018, which includes amounts grouped in other assets. The total development budget less properties under development as at December 31, 2018 differs from costs remaining to complete as certain amounts spent have been accounted for as other assets or through net income. 35-storey residential tower consisting of 315 luxury residential rental units and 6,450 square feet of retail. Total project spans 38.4 acres and 1,081 residential rental units are expected to be built. Construction commenced on Phase 1 of this project which will consist of 172 residential rental units. 383 residential rental units. Close to major technology employers including Apple, IBM, Oracle & Samsung as well as the University of Texas at Austin and downtown Austin. 7-storey residential tower consisting of 263 residential rental units. Part of a larger master planned community and is adjacent to transit, Microsoft, Inc.’s headquarters, and future light rail which is expected to be completed in 2021. Page 14 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 Equity Accounted Investments: December 31, 2018 December 31, 2017 (in thousands of Canadian dollars) ECHO Jackson Park Six U.S. Industrial Properties Hercules Project The Pearl Esterra Park Shoreline Scotia Plaza(1) Total(2) Total(2) Investment properties $870,032 $ - $60,267 $ - $ - $ - $ - $ - $930,299 $846,431 Properties under development 12,445 1,075,984 - 25,884 8,866 8,642 13,197 - 1,145,018 815,472 Other assets Cash and cash equivalents 13,970 11,075 17,160 26,563 174 3,734 Debt Other liabilities (376,293) (379,108) (19,122) (47,234) (31,174) (659) - 490 (6,029) (1,832) - 111 - 34 335 - - 190 - 38 99 31,376 42,597 - (780,552) (245) (597) (726) (1,286) (83,753) 83,416 64,820 (613,585) (71,419) Equity accounted investments $483,995 $709,425 $44,394 $18,513 $8,732 $8,414 $12,661 ($1,149) $1,284,985 $1,125,135 (1) On June 30, 2016, H&R sold its 33.3% freehold and leasehold interests in Scotia Plaza and 100 Yonge. (2) Each of these line items represent the REIT’s proportionate share of equity accounted investments which are reconciled to the total equity accounted investments per the REIT’s Financial Statements. This is a non-GAAP measure defined in the “Non-GAAP Financial Measures” section of this MD&A. ECHO H&R owns a 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, primarily in Pennsylvania and Ohio. ECHO reports its financial results to H&R one month in arrears. ECHO’s financial information has been disclosed as at November 30, 2018 and November 30, 2017, respectively. During the twelve months ended November 30, 2018, ECHO acquired three investment properties totalling 28,616 square feet and eight properties under development for an aggregate purchase price of U.S. $10.5 million, at H&R’s ownership interest. During this period, Echo sold two investment properties totalling 23,722 square feet for gross proceeds of U.S. $1.0 million and transferred two properties under development to investment properties totalling 35,199 square feet for a total value of U.S. $10.1 million, at H&R’s ownership interest. During the twelve months ended November 30, 2017, ECHO acquired 11 investment properties and three land parcels totalling 176,500 square feet for an aggregate purchase price of U.S. $41.4 million, at H&R’s ownership interest. Major tenants at these properties include Acme Supermarket, Giant Foods, Redner’s Supermarket, Publix Supermarket and Harris Teeter. During this period, Echo sold an investment property for gross proceeds of U.S. $2.5 million, at H&R’s ownership interest. Long Island City Project-Jackson Park Jackson Park, the 1,871 luxury residential rental unit development in Long Island City, NY, in which H&R has a 50% ownership interest, is nearing completion and expected to be transferred to investment properties in Q1 2019. H&R’s trophy project is on budget and slightly ahead of the development lease-up schedule. During Q4 2018, 162 leases were entered into and 194 tenants began occupancy. As at December 31, 2018, 1,274 leases had been entered into and 1,231 units were occupied. The remaining lease-up is expected to occur during the balance of 2019 with stabilized occupancy expected to be achieved during Q3 2019. The five-storey 45,000 square foot amenity building known as “The Club at Jackson Park” is complete and open to residents. Upon stabilized occupancy, the first full year’s property operating income at H&R’s ownership interest is projected to be U.S. $35.9 million, equating to a 6.2% yield on budgeted cost of U.S. $580.7 million. Jackson Park, at the 100% level, has been valued at approximately U.S. $1.6 billion as at December 31, 2018 compared to costs to date of approximately U.S. $1.1 billion, resulting in a fair value increase of U.S. $522.6 million since the start of the project. Please refer to page 7 for an update on expected net income and FFO during the lease-up period. Page 15 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 Six U.S. Industrial Properties As at December 31, 2018, H&R owns a 50.5% interest in six industrial properties through a joint venture with its partners, all of which are located in the United States (December 31, 2017 - 6 properties). During 2017, this joint venture sold the following nine properties: Property 11 Cermak Blvd., Saint Peters, MO 827 Graham Dr., Fremont, OH 15573 Oakwood Dr., Romulus, MI 12090 Sage Point Ct., Reno, NV 930 Sherwin Pkwy., Buford, GA One Nestle Crt., McDonough, GA 1915-B Fairview Dr., Dekalb, IL 13600 Independence Pkwy., Fort Worth, TX 950 Stelzer Rd., Columbus, OH Total Segment Industrial Industrial Industrial Industrial Industrial Industrial Industrial Industrial Industrial Date Sold Aug 21, 2017 Aug 21, 2017 Aug 21, 2017 Nov 30, 2017 Dec 14, 2017 Dec 14, 2017 Dec 14, 2017 Dec 14, 2017 Dec 14, 2017 Square Feet(1) Selling Price ($ Millions)(1)(2) Ownership Interest Sold 71,710 43,634 50,740 $5.9 2.9 4.2 348,450 18.7 231,679 15.8 395,195 25.9 434,774 35.1 264,747 25.9 242,785 14.5 2,083,714 $148.9 50.5% 50.5% 50.5% 50.5% 50.5% 50.5% 50.5% 50.5% 50.5% (1) Square feet and selling price are based on the ownership interest disposed. (2) U.S. dispositions have been translated to Canadian dollars at the exchange rate as at the date sold. As at December 31, 2017, this joint venture had cash on hand of $51.8 million and restricted cash of $51.5 million which was primarily due to Section 1031 exchanges and U.S. tax planning relating to the nine properties sold during 2017. In January 2018, these funds were disbursed to the respective partners. Hercules Project H&R has a 31.7% non-managing ownership interest in 38.4 acres of land located in Hercules, CA, adjacent to San Pablo Bay, northeast of San Francisco, for the future development of residential rental units (“Hercules Project”). This waterfront, multi-phase, master-planned, in-fill mixed-use development surrounds a future intermodal transit centre, including train and ferry service, and is adjacent to an 11-acre waterfront future regional park. The initial investment to purchase the land was approximately U.S. $10.0 million (at H&R’s ownership interest). As at December 31, 2018, H&R’s investment was approximately U.S. $13.6 million. Phase 1 of the Hercules Project, known as “Block N – Creekside Apartments” will consist of 172 residential rental units, including lofts and townhomes and 13,979 square feet of ground level retail. The four-storey podium project sits on 2.2 acres over a one-level subterranean parking garage. Construction commenced in June 2018. The total budget for this phase is expected to be approximately U.S. $82.1 million and construction financing of U.S. $57.5 million was secured in July 2018, both at the 100% level. In addition, in July 2018, the Hercules Project obtained a U.S. $14.0 million land loan, at the 100% level, secured against the remaining land parcels. The Pearl H&R has a 33.3% non-managing ownership interest in approximately 5.0 acres of land in Austin, TX for the future development of 383 residential rental units which will be known as “The Pearl”. This residential development site is close to major technology employers including Apple, IBM, Oracle, and Samsung, as well as the University of Texas at Austin and downtown Austin. Construction commenced in October 2018. The total budget for this project is approximately U.S. $69.7 million and construction financing of U.S. $47.9 million was secured in October 2018, both at the 100% level. As at December 31, 2018, H&R’s investment was approximately U.S. $6.4 million. Esterra Park In April 2018, H&R acquired a 33.3% non-managing ownership interest in a residential development site zoned for 263 residential rental units for U.S. $8.7 million, at the 100% level, located in Seattle, WA. This development, known as “Esterra Park”, is part of a larger master planned community and is adjacent to Microsoft, Inc.’s headquarters, bus transit and future light rail which is expected to be completed in 2021. Construction commenced in November 2018. The total budget for this project is approximately U.S. $95.7 million and construction financing of U.S. $66.5 million was secured in October 2018, both at the 100% level. As at December 31, 2018, H&R’s investment was approximately U.S $6.2 million. Shoreline In July 2018, H&R acquired a 30.9% non-managing ownership interest in the development of a 315 luxury residential rental unit tower with 6,450 square feet of retail space for a total of U.S. $15.0 million, at the 100% level. Located in Long Beach, CA, “Shoreline Gateway” will become the tallest residential tower in Long Beach with 35 floors enjoying views overlooking the Pacific Ocean. Construction commenced in November 2018. The total budget for this Page 16 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 project is approximately U.S. $227.1 million and construction financing of U.S. $132.0 million was secured in December 2018, both at the 100% level. As at December 31, 2018, H&R’s investment was approximately U.S. $6.4 million. Assets Classified as Held for Sale As at December 31, 2018, H&R had a 50% ownership interest in one industrial property and a 100% ownership interest in one U.S. office property totalling $110.9 million (December 31, 2017 - no properties) classified as held for sale. Other Assets (in thousands of Canadian dollars) Mortgages receivable Prepaid expenses and sundry assets Restricted cash Accounts receivable Derivative instruments December 31, 2018 December 31, 2017 $96,909 25,861 12,872 12,401 5,445 $153,211 33,554 25,311 15,739 6,374 $153,488 $234,189 Mortgages receivable decreased by $56.3 million to $96.9 million as at December 31, 2018 primarily due to the River Landing and 2214 Bryan St. mortgages, which had a total balance of $100.6 million as at December 31, 2017, being converted into 100% wholly-owned properties under development during 2018. This was partially offset by a new mortgage receivable of $34.1 million issued as part of the sale of F1RST Tower in Calgary, AB and an increase of $6.9 million relating to 2217 Bryan St., which had a balance outstanding of $44.7 million as at December 31, 2018 (U.S. $32.9 million). Prepaid expenses and sundry assets decreased by $7.7 million to $25.9 million as at December 31, 2018 primarily due to the release of acquisition and new mortgage deposits in 2018. Restricted cash decreased by $12.4 million to $12.9 million as at December 31, 2018 primarily due to $13.3 million of funds held in escrow from the sale of a U.S. residential property in Q3 2017 being released in Q1 2018 due to a Section 1031 property exchange. LIABILITIES AND UNITHOLDERS’ EQUITY Debt to total assets per the REIT's Financial Statements(1) Debt to total assets at the REIT's proportionate share(1)(2) Unencumbered assets(3) (in thousands of Canadian dollars) Unsecured debt(3) (in thousands of Canadian dollars) Unencumbered asset to unsecured debt coverage ratio(3) Interest coverage ratio(2) Weighted average interest rate of debt(1) Weighted average term to maturity of debt (in years)(1) December 31, 2018 December 31, 2017 44.6% 47.1% $3,438,151 $2,069,419 1.66 3.03 3.8% 4.4 44.6% 46.6% $3,614,735 $2,144,992 1.69 3.00 3.9% 4.2 (1) Debt includes mortgages payable, debentures payable, unsecured term loans and lines of credit. (2) These are non-GAAP measures. See the “Non-GAAP Financial Measures” section of this MD&A. (3) Unencumbered assets are investment properties and properties under development without encumbrances for mortgages or lines of credit. Unsecured debt includes senior debentures, unsecured term loans and unsecured lines of credit. Page 17 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 Debt H&R’s debt consists of the following items: (in thousands of Canadian dollars) December 31, 2018 December 31, 2017 Mortgages payable Debentures payable Unsecured term loans Lines of credit Mortgages Payable (in thousands of Canadian dollars) Opening balance, January 1, 2018 Principal repayments: Scheduled amortization on mortgages Mortgage repayments New mortgages Effective interest rate accretion on mortgages Change in foreign exchange rates Closing balance, December 31, 2018 $4,150,459 1,613,040 450,629 331,944 $3,958,631 1,852,790 186,629 495,567 $6,546,072 $6,493,617 REIT's Financial Statements Plus: Equity accounted investments REIT's proportionate share(1) $3,958,631 $198,550 $4,157,181 (129,145) (407,763) 619,788 382 108,566 $4,150,459 (17,056) (4,760) - (467) 15,843 $192,110 (146,201) (412,523) 619,788 (85) 124,409 $4,342,569 (1) The REIT’s proportionate share is a non-GAAP measure defined in the “Non-GAAP Financial Measures” section of this MD&A. Future Mortgage Principal Payments 2019 2020 2021 2022 2023 Thereafter Financing costs and mark-to-market adjustments arising on acquisitions(1) Total balance outstanding as at December 31, 2018 Periodic Amortized Principal ($000’s) $126,503 124,829 109,366 71,103 61,436 Principal on Maturity ($000’s) $50,679 366,368 839,231 539,953 391,746 % of Total Principal Weighted Average Interest Rate on Maturity 3.8% 4.5% 3.9% 3.9% 3.9% 4.3 11.8 22.8 14.7 10.9 35.5 100% Total Principal ($000’s) $177,182 491,197 948,597 611,056 453,182 1,483,616 4,164,830 (14,371) $4,150,459 (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 costs over the life of the applicable mortgage using the effective interest rate method. Financing costs are deducted from the REIT’s mortgages payable balances and are recognized in finance costs over the life of the applicable mortgage. The mortgages outstanding as at December 31, 2018 bear interest at a weighted average rate of 4.2% (December 31, 2017 - 4.3%) and mature between 2019 and 2032 (December 31, 2018 – maturing between 2018 and 2033). The weighted average term to maturity of the REIT’s mortgages is 5.2 years (December 31, 2017 - 5.4 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”. Page 18 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 Debentures Payable Opening balance, January 1, 2018 Series O and P Senior Debenture issuances Senior Debenture redemptions 2020 Convertible Debenture redemption (HR.DB.D) Conversion - 2020 Convertible Debentures (HR.DB.D) Gain on change in fair value Change due to foreign exchange rates Accretion adjustment Closing balance, December 31, 2018 Unsecured Term Loans (in thousands of Canadian Dollars) H&R unsecured term loan #1(1) H&R unsecured term loan #2(2) (in thousands of Canadian dollars) $1,852,790 409,205 (557,500) (99,582) (70) (3,488) 8,737 2,948 $1,613,040 Maturity December 31, Date March 17, 2021 January 6, 2026 2018 $200,629 250,000 $450,629 (1) (2) The total facility as at December 31, 2018 is $200.0 million, plus a 3.00% 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 2.56% per annum on U.S. $130.0 million of the U.S. dollar denominated borrowing of this facility, maturing March 17, 2021. The REIT entered into an interest rate swap to fix the interest rate at 3.91% per annum, maturing January 6, 2026. Lines of Credit (in thousands of Canadian Dollars) Revolving unsecured operating lines of credit: Maturity Date Total Facility Amount Outstanding Drawn Letters of Credit Available Balance H&R revolving unsecured line of credit #1 September 30, 2022 $150,000 H&R revolving unsecured line of credit #2 H&R revolving unsecured line of credit #3 H&R revolving unsecured letter of credit facility January 31, 2023 September 20, 2023 Sub-total Revolving secured operating lines of credit(1) H&R co-ownership revolving secured line of credit September 30, 2019 H&R and CrestPSP revolving secured line of credit Primaris revolving secured line of credit April 30, 2020 July 1, 2020 Sub-total 200,000 350,000 60,000 760,000 3,514 62,500 300,000 366,014 $ - - (5,750) - (5,750) (3,514) (49,000) (273,680) (326,194) $ - $150,000 - (2,330) (23,439) (25,769) - (105) - (105) 200,000 341,920 36,561 728,481 - 13,395 26,320 39,715 December 31, 2018 $1,126,014 ($331,944) ($25,874) $768,196 (1) Secured by certain investment properties. The lines of credit can be drawn in either Canadian or U.S. dollars and bear interest at a rate approximating the prime rate of a Canadian chartered bank. Page 19 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 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 Units to participating vendors upon redemption. These puttable instruments are classified as a liability under IFRS and are measured at fair value through profit or loss. At the end of each period the fair value is determined by using the quoted prices of Units on the TSX as the exchangeable units are exchangeable into 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 Unit amount provided to holders of Units. During the year ended December 31, 2018, there were 23,889 exchangeable units exchanged for Units (year ended December 31, 2017 - 584,386 exchanged for Units). The following number of exchangeable units are issued and outstanding: As at December 31, 2018 As at December 31, 2017 Number of Exchangeable Units 15,955,541 15,979,430 Quoted Price of Units $20.65 $21.36 Amounts per the REIT's Financial Statements ($000’s) $329,482 $341,321 A subsidiary of H&R also holds 0.4 million Units to mirror certain of these exchangeable units. Therefore, when the approximately 0.4 million exchangeable units are exchanged for Units, the number of outstanding Units will not increase. 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 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 combined federal and state tax rate of approximately 24.3% in 2018 (2017 - 37.5%). As a result of U.S. Tax Reform (further discussed on page 49), deferred income taxes have been measured based upon a 21.0% federal income tax rate. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below: (in millions of Canadian dollars) Deferred tax assets: Net operating losses Accounts payable and accrued liabilities Other assets Deferred liabilities: Investment properties Equity accounted investments Deferred tax liability December 31, 2018 December 31, 2017 $22.6 0.6 1.4 24.6 284.0 132.8 416.8 $6.9 1.4 2.3 10.6 256.5 79.2 335.7 ($392.2) ($325.1) 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. Deferred tax liability increased by $67.1 million from $325.1 million as at December 31, 2017 to $392.2 million as at December 31, 2018 primarily due to a fair value increase to Jackson Park and the weakening of the Canadian dollar. The exchange rate as at December 31, 2018 was $1.36 for each U.S. $1.00 (December 31, 2017 - $1.26). Page 20 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 Unitholders’ Equity Unitholders’ equity increased by $20.3 million from $7,179.8 million as at December 31, 2017 to $7,200.1 million as at December 31, 2018. The increase is primarily due to net income, other comprehensive income and proceeds from the issuance of Units under the Distribution Reinvestment and Unit Purchase Plan (“DRIP”) and Unit Option Plan, partially offset by distributions paid to unitholders and Units repurchased and cancelled under the NCIB. Units issued under the DRIP and Unit Purchase Plan previously resulted in an increase in the number of Units. In February 2018, the Trusts announced the suspension of the DRIP and Unit Purchase Plan until further notice, commencing with the March 2018 distribution. Other comprehensive income (loss) consists of the unrealized gain (loss) on translation of U.S. denominated foreign operations and the transfer of realized losses on cash flow hedges to net income. Fluctuations in other comprehensive income (loss) is primarily due to changes in foreign exchange rates. NCIB On December 14, 2018, the REIT received approval from the TSX for the renewal of its NCIB, allowing the REIT to purchase for cancellation up to a maximum of 15.0 million Units on the open market until the earlier of December 16, 2019 or the date on which the REIT purchased the maximum number of Units permitted under the NCIB. With an increased focus on recycling capital into investments with higher risk-adjusted returns and the availability of excess capital generated from asset dispositions, H&R has taken advantage of the opportunity to acquire Units through its NCIB at what management believes to be significantly discounted prices. During the year ended December 31, 2018, under a previous NCIB, the Trusts purchased and cancelled 6,609,420 Units at a weighted average price of $20.62 per Unit, for a total amount of $136.3 million. During the year ended December 31, 2017, under a previous NCIB, the Trusts purchased and cancelled 755,420 Units at a weighted average price of $21.10 per Unit, for a total cost of $15.9 million. Unitholders' Equity per Unit and NAV per Unit Unitholders' equity Exchangeable units Deferred tax liability Total Units outstanding Exchangeable units outstanding Total Unitholders' equity per Unit(1) NAV per Unit(2) Unit Price (1) (2) Unitholders’ equity per Unit is calculated by dividing Unitholders’ equity by Units outstanding. This is a Non-GAAP measure. See the “Non-GAAP Financial Measures” section of this MD&A. December 31, 2018 December 31, 2017 $7,200,100 $7,179,763 329,482 341,321 392,214 325,131 $7,921,796 $7,846,215 285,678 15,522 291,320 15,546 301,200 306,866 $25.20 $26.30 $20.65 $24.65 $25.57 $21.36 Page 21 of 50                H&R REIT - MD&A – DECEMBER 31, 2018 RESULTS OF OPERATIONS (in thousands of Canadian dollars) Property operating income: Rentals from investment properties Property operating costs Net income from equity accounted investments Other income Finance costs - operations Finance income Trust expenses Fair value adjustments on financial instruments Fair value adjustment on real estate assets Loss on sale of real estate assets Gain (loss) on foreign exchange Net income before income taxes Income tax recovery (expense) Net income Other comprehensive income (loss): Items that are or may be reclassified subsequently to net income Total comprehensive income attributable to unitholders Three months ended December 31 Year ended December 31 2018 2017 2018 2017 $297,416 (105,407) 192,009 148,165 - (65,834) 2,254 (8,648) (17,332) (151,884) (267) - 98,463 (37,348) 61,115 139,335 $200,450 $298,042 $1,176,558 $1,168,454 (98,628) 199,414 118,337 1,040 (69,003) 1,407 (4,383) 9,553 3,984 (70) 2,263 262,542 62,671 325,213 (442,626) (427,013) 733,932 169,409 - 741,441 167,407 1,040 (267,087) (270,358) 8,638 (18,271) 11,197 (246,967) (19,602) 6,886 378,135 (40,217) 337,918 4,999 (18,111) 27,049 1,796 (7,729) (17,903) 629,631 38,239 667,870 10,253 194,876 (131,272) $335,466 $532,794 $536,598 Net income before income taxes decreased by $164.1 million and $251.5 million for the three months and year ended December 31, 2018 compared to the respective 2017 periods, primarily due to non-cash items including fair value adjustments, gain (loss) on sale of real estate assets and foreign exchange. Excluding these items, net income before income taxes increased by $21.1 million from $246.8 million in Q4 2017 to $267.9 million in Q4 2018 and by $0.2 million from $626.4 million for the year ended December 31, 2017 to $626.6 million for the year ended December 31, 2018. The increase of $21.1 million was primarily due to net income from equity accounted investments increasing by $29.8 million for Q4 2018 compared to the respective 2017 period. Page 22 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 PROPERTY OPERATING INCOME Property operating income consists of rentals from investment properties less property operating costs. Management believes that property operating income is a useful measure for investors in assessing the performance of H&R’s properties before financing costs and other sources of income and expenditures which are not directly related to the day-to-day operations of a property. Same-Asset property operating income (cash basis) adjusts property operating income (including property operating income from equity accounted investments on a proportionately consolidated basis) to exclude straight- lining of contractual rent and realty taxes accounted for under IFRIC 21. “Same-Asset” refers to those properties owned by H&R for the entire two-year period ended December 31, 2018. It excludes acquisitions, business combinations, dispositions and transfers of properties under development to investment properties during the two-year period ended December 31, 2018 (collectively, “Transactions”). Management believes that this measure is useful for investors as it adjusts property operating income (including property operating income from equity accounted investments on a proportionately consolidated basis) for non-cash items which allows investors to better understand period-over-period changes due to occupancy, rental rates, realty taxes and operating costs, before evaluating the changes attributable to Transactions. Furthermore, it is also used as a key input in determining the value of investment properties. Three months ended December 31 Year ended December 31 (in thousands of Canadian dollars) 2018 2017 Change 2018 2017 Rentals Property operating costs Property operating income Adjusted for: Proportionate share of property operating income from equity accounted investments(1) Straight-lining of contractual rent at the REIT's proportionate share(1) Realty taxes in accordance with IFRIC 21 at the REIT's proportionate share(1) Property operating income (cash basis) from Transactions at the REIT's proportionate share(1) Change $8,104 $297,416 $298,042 ($626) $1,176,558 $1,168,454 (105,407) (98,628) (6,779) (442,626) (427,013) (15,613) 192,009 199,414 (7,405) 733,932 741,441 (7,509) 20,165 16,066 4,099 60,939 70,045 (9,106) 1,175 605 570 3,683 5,373 (1,690) (11,166) (12,003) 837 - - - Same-Asset property operating income (cash basis)(2) $186,987 $180,646 $6,341 $730,826 $722,122 (1) (2) The REIT’s proportionate share is a non-GAAP measure defined in the “Non-GAAP Financial Measures” section of this MD&A. Same-Asset property operating income (cash basis) is a non-GAAP measure defined in the “Non-GAAP Financial Measures” section of this MD&A. (15,196) (23,436) 8,240 (67,728) (94,737) 27,009 $8,704 Property operating income per the REIT’s Financial Statements decreased by $7.4 million and $7.5 million, respectively, for the three months and year ended December 31, 2018 compared to the respective 2017 periods primarily due to the sale of 63 U.S. retail properties in June 2018, partially offset by an increase in property operating income from Lantower Residential as a result of properties acquired throughout 2017 and 2018. SEGMENTED INFORMATION Operating Segments and Geographic Locations: H&R has six reportable operating segments (Office, which also includes the REIT’s head office, Primaris, H&R Retail, ECHO, Industrial and Residential (operating as Lantower Residential)), in two geographic 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 REIT. The CEO measures and evaluates the performance of H&R based on property operating income on a proportionately consolidated basis for the REIT’s equity accounted investments. H&R's Office portfolio is comprised of 35 properties throughout Canada and in select markets in the United States, aggregating 11.9 million square feet, at H&R’s ownership interest, with an average lease term to maturity of 11.1 years as at December 31, 2018. The office portfolio is leased on a long-term basis to creditworthy tenants, with 81.2% of office revenue from tenants with investment grade ratings. With a very long average lease term and high credit tenants, this segment tends to generate very stable, gradual growth in property operating income driven by contractual rental rate increases, and to a lesser extent, lease renewals. The Primaris segment consists of 30 properties throughout Canada aggregating 8.0 million square feet, at H&R’s ownership interest, of enclosed shopping centres and multi-tenant retail plazas with an average lease term to maturity of 4.8 years as at December 31, 2018. Primaris continues to receive strong Page 23 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 tenant demand having completed 419 new lease and renewal transactions for the twelve months ended December 31, 2018. Occupancy was 84.9% as at December 31, 2018, rising to 87.5% including tenants committed, but not yet open. H&R’s Retail segment consists of 43 retail properties in Canada and 16 properties in the United States aggregating 2.8 million square feet, at H&R’s ownership interest, with an average lease term to maturity of 8.4 years as at December 31, 2018. As at December 31, 2018, ECHO segment is a portfolio of 230 grocery anchored shopping centres in select markets in the United States aggregating 3.2 million square feet, at H&R’s ownership interest. The ECHO segment’s average lease term to maturity was 10.1 years. The Industrial segment consists of 84 industrial properties throughout Canada and six properties in the United States comprising 9.7 million square feet, at H&R’s ownership interest, with an average lease term to maturity of 6.7 years as at December 31, 2018. As at December 31, 2018, Lantower Residential segment consists of 22 residential properties in select markets in the United States comprising 7,271 residential rental units, at H&R’s ownership interest. The investment policy of the Lantower Residential segment is to acquire properties in strong employment markets and where rents are increasing annually. Further disclosure of segmented information for property operating income can be found in the REIT’s Financial Statements. (in thousands of Canadian dollars) 2018 2017 % Change 2018 2017 % Change 2018 2017 Property operating income Occupancy Three months ended December 31 Year ended December 31 As at December 31 Operating Segment: Office(1) Primaris H&R Retail ECHO Industrial Lantower Residential $101,721 $101,060 42,674 10,792 15,275 16,111 25,601 41,814 27,488 13,623 17,615 13,880 0.7% 2.1% (60.7%) 12.1% (8.5%) 84.4% $389,856 $389,147 158,650 157,264 66,104 53,388 62,884 63,989 96,584 57,294 71,254 39,943 The REIT's proportionate share 212,174 215,480 (1.5%) 794,871 811,486 0.2% 0.9% (31.6%) (6.8%) (11.7%) 60.2% (2.0%) Less: equity accounted investments (20,165) (16,066) 25.5% (60,939) (70,045) (13.0%) The REIT's Financial Statements $192,009 $199,414 (3.7%) $733,932 $741,441 (1.0%) Geographic Location: Canada(2) United States(2) $138,238 $137,152 0.8% $538,141 $535,968 0.4% 73,936 78,328 (5.6%) 256,730 275,518 (6.8%) (2.0%) The REIT's proportionate share 212,174 215,480 (1.5%) 794,871 811,486 Less: equity accounted investments (20,165) (16,066) 25.5% (60,939) (70,045) (13.0%) The REIT's Financial Statements $192,009 $199,414 (3.7%) $733,932 $741,441 (1.0%) Includes the REIT’s head office. (1) (2) Property operating income relating to corporate entities has been included in Canada for Canadian properties and the United States for U.S. properties. 98.5% 84.9% 98.2% 95.5% 98.5% 88.0% 94.0% 96.6% 93.7% 94.6% 92.8% 94.0% 96.6% 93.7% 97.0% 92.6% 97.4% 94.1% 98.4% 90.0% 95.6% 95.6% 95.6% 95.7% 97.4% 95.6% 95.6% 95.6% Property operating income at the REIT’s proportionate share for the three months and year-ended December 31, 2018 decreased by 1.5% and 2.0%, respectively, due to the following: (i) the H&R Retail segment selling 63 U.S. retail properties in June 2018; (ii) the Industrial segment selling nine U.S properties and six Canadian properties throughout 2017 and 2018; and (iii) the ECHO segment (United States) receiving lease termination fees in Q3 2017 of $5.5 million at H&R’s ownership interest from tenants who terminated their leases which negatively impacted H&R’s year-over-year results. This was partially offset by an increase in property operating income from the Lantower Residential segment (United States) which was due to properties acquired throughout 2017 and 2018. Page 24 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 The following segmented information has been presented at the REIT’s proportionate share which is a non-GAAP measure defined in the “Non-GAAP Financial Measures” section of this MD&A. (in thousands of Canadian dollars) 2018 2017 % Change 2018 2017 % Change 2018 2017 Same-Asset property operating income (cash basis)(1) Occupancy (same asset) Three months ended December 31 Year ended December 31 As at December 31 Operating Segment: Office(2) Primaris H&R Retail ECHO Industrial Lantower Residential $98,545 $95,125 41,326 10,951 12,657 15,292 8,216 41,222 10,555 11,426 14,560 7,758 3.6% 0.3% 3.8% 10.8% 5.0% 5.9% $388,639 $381,594 156,085 154,831 42,905 48,527 59,557 35,113 42,238 50,517 59,315 33,627 The REIT's proportionate share (page 23) $186,987 $180,646 3.5% $730,826 $722,122 Geographic Location: Ontario(3) Alberta Other Canada Total – Canada United States(3) $64,136 $62,264 51,932 21,425 51,390 20,892 137,493 134,546 49,494 46,100 3.0% 1.1% 2.6% 2.2% 7.4% $250,569 $244,329 203,823 203,190 81,229 80,766 535,621 528,285 195,205 193,837 The REIT's proportionate share (page 23) $186,987 $180,646 3.5% $730,826 $722,122 United States in U.S. dollars: Office(2) H&R Retail ECHO Industrial Lantower Residential U.S. total in U.S. dollars $17,948 $17,758 2,562 9,522 1,012 6,159 2,522 9,019 911 6,120 1.1% 1.6% 5.6% 11.1% 0.6% $71,817 $70,729 10,277 37,328 3,726 27,010 9,950 38,859 3,701 25,867 $37,203 $36,330 2.4% $150,158 $149,106 1.8% 0.8% 1.6% (3.9%) 0.4% 4.4% 1.2% 2.6% 0.3% 0.6% 1.4% 0.7% 1.2% 1.5% 3.3% (3.9%) 0.7% 4.4% 0.7% 98.5% 84.9% 98.2% 95.3% 98.4% 92.7% 94.9% 95.5% 93.8% 93.1% 94.5% 96.1% 94.9% 98.3% 92.6% 97.7% 94.6% 98.7% 93.6% 96.5% 96.0% 97.5% 96.6% 96.6% 96.2% 96.5% 100.0% 100.0% 95.3% 100.0% 100.0% 94.6% 100.0% 100.0% 92.7% 96.1% 93.6% 96.2% (1) (2) (3) Same-Asset property operating income (cash basis) is a non-GAAP measure defined in the “Non-GAAP Financial Measures” section of this MD&A. Includes the REIT’s head office. Property operating income relating to corporate entities has been included in Ontario for Canadian properties and the United States for U.S. properties. Same-Asset property operating income (cash basis) from the Office segment increased by 3.6% and 1.8%, respectively, for the three months and year ended December 31, 2018 compared to the respective 2017 periods, primarily due to an increase in occupancy, contractual rental escalations and renewed leases at higher rents from H&R’s Ontario Office properties. Same-Asset property operating income (cash basis) from the ECHO segment in U.S. dollars, increased by 5.6% for the three months ended December 31, 2018 compared to the respective 2017 period primarily due to an increase in occupancy and contractual rental escalations. Same-Asset property operating income (cash basis) from the ECHO segment in U.S. dollars, decreased by 3.9% for the year ended December 31, 2018 compared to the respective 2017 period, primarily due to ECHO receiving lease termination fees in Q3 2017 of U.S. $2.4 million at H&R’s ownership interest from two tenants who terminated their leases, partially offset by an increase in occupancy and contractual rental escalations. Same-Asset property operating income (cash basis) from the Industrial segment increased by 5.0% for the three months ended December 31, 2018 compared to the respective 2017 period primarily due to a new tenant paying higher rent, as well as lease termination payments received for two U.S. properties in 2018. Same-Asset property operating income (cash basis) from the Lantower Residential segment in U.S. dollars increased 0.6% and 4.4%, respectively, for the three months and year ended December 31, 2018 compared to the respective 2017 periods primarily due to rental growth, partially offset by an increase in property taxes to five properties which are currently under appeal. Subsequent to December 31, 2018, Lantower Residential has successfully appealed two of the five properties and is expecting a refund of U.S. $0.2 million in Q1 2019. Page 25 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 Same-Asset property operating income (cash basis) from the Primaris segment increased by 0.3% and 0.8%, respectively, for the three months and year ended December 31, 2018 compared to the respective 2017 periods, primarily due to new lease commencements for former Target space, offset by the impact of Sears Canada's 2017 bankruptcy filing. Redevelopment of the former Sears stores has commenced, however, since each store is part of an existing property, they have not been transferred to properties under development. During the three months and year ended December 31, 2018, H&R capitalized $0.5 million and $1.1 million, respectively, of property operating costs and $1.0 million and $2.8 million, respectively, of finance costs attributable to the former Target and Sears space. Management expects positive rental growth from Primaris as the lease-up of the former Target and Sears space is expected to generate approximately $1.0 million, $5.4 million and $3.0 million of additional annual base rent in 2019, 2020 and 2021, respectively. The Primaris portfolio all store and same store sales were relatively stable for the rolling 12 months ended December 31, 2018 compared to the respective 2017 period. Management monitors tenant sales and actively pursues the replacement of tenants experiencing declining sales trends. Remerchandising at many of the properties continues to impact sales as the replacement of tenants may have a negative impact in the short term but a positive impact in the long term. 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 2017 % Change Primaris Enclosed Shopping Centres Location Cataraqui Town Centre(1)(2) Dufferin Mall Grant Park(1) Kildonan Place(1)(2) McAllister Place(1)(2) Medicine Hat Mall(2) Orchard Park Shopping Centre(2) Park Place Shopping Centre(2) Peter Pond Mall Place d’Orleans(1) Place du Royaume(1) Regent Mall(1)(2) Sherwood Park Mall St. Albert Centre Stone Road Mall(2) Sunridge Mall Total(3)(4) Kingston, ON Toronto, ON Winnipeg, MB Winnipeg, MB Saint John, NB Medicine Hat, AB Kelowna, BC Lethbridge, AB Fort McMurray, AB Orleans, ON Chicoutimi, QC Fredericton, NB Sherwood Park, AB St. Albert, AB Guelph, ON Calgary, AB 2018 $88,315 116,551 26,367 80,923 55,427 49,036 $86,340 121,296 26,662 80,876 53,280 50,572 171,110 167,793 81,669 71,551 90,472 87,426 80,841 42,751 34,025 84,789 71,857 94,301 89,298 81,109 46,079 31,365 111,664 93,839 112,683 96,237 2.3% (3.9) (1.1) 0.1 4.0 (3.0) 2.0 (3.7) (0.4) (4.1) (2.1) (0.3) (7.2) 8.5 (0.9) (2.5) 2018 $526 2017 $527 % Change (0.2%) 682 458 538 467 408 702 599 713 509 433 585 479 495 678 525 699 463 539 461 433 688 609 725 515 437 587 505 479 685 518 (2.4) (1.1) (0.2) 1.3 (5.8) 2.0 (1.6) (1.7) (1.2) (0.9) (0.3) (5.1) 3.3 (1.0) 1.4 $1,281,967 $1,294,537 (1.0%) $565 $568 (0.5%) (1) All store sales and same-store sales have been reported as if Primaris owned 100% of these enclosed shopping centres. (2) Location previously had a Sears store. (3) The total same-store sales figures have been presented on a weighted average basis. (4) Excludes Northland Village which is slated for redevelopment. Page 26 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 NET INCOME, FFO AND AFFO FROM EQUITY ACCOUNTED INVESTMENTS(1) The following table provides a breakdown of H&R’s net income from equity accounted investments which is further reconciled to FFO and AFFO from equity accounted investments: Three Months Ended December 31 Year ended December 31 (in thousands of Canadian dollars) Rentals from investment properties Property operating costs Property operating income Net income from equity accounted investments Finance cost - operations Finance income Trust expenses Fair value adjustments on financial instruments Fair value adjustment on real estate assets Gain (loss) on sale of real estate assets Income tax expense Non-controlling interest Net income from equity accounted investments Realty taxes in accordance with IFRIC 21 2018 $26,937 (6,772) 20,165 130 (9,104) 681 (904) (2,037) 139,726 271 - (763) 148,165 (1,252) 2017 $20,642 (4,576) 16,066 81 2018 $86,533 (25,594) 60,939 406 (4,332) (25,511) 109 (565) 3,402 1,311 (2,894) 3,236 103,834 133,520 (20) (46) (1,532) 89 (61) (286) 118,337 (1,306) 2017 $88,458 (18,413) 70,045 587 (18,807) 403 (2,291) 4,222 114,996 (677) (185) (886) 169,409 167,407 - - Fair value adjustments on real estate assets and financial instruments (137,689) (107,236) (136,756) (119,218) Gain (loss) on sale of real estate assets Incremental leasing costs Notional interest capitalization(2) FFO from equity accounted investments Straight-lining of contractual rent Capital expenditures Leasing expenses and tenant inducements Incremental leasing costs AFFO from equity accounted investments (271) 48 1,051 10,052 (181) (694) (1,122) (48) $8,007 (89) 63 3,342 13,111 (289) (3,016) (1,787) (63) 20 231 7,827 40,731 (430) (2,754) (2,730) (231) 677 203 13,799 62,868 (1,445) (11,120) (2,079) (203) $7,956 $34,586 $48,021 (1) (2) Each of these line items represent the REIT’s proportionate share of equity accounted investments which are reconciled to net income from equity accounted investments per the REIT’s Financial Statements, which is further reconciled to FFO and AFFO from equity accounted investments. These are non-GAAP measures defined in the “Non-GAAP Financial Measures” section of this MD&A. Represents an adjustment to add general or indirect interest incurred in respect of properties under development held in and through equity accounted investments. Property operating income from equity accounted investments for the three months ended December 31, 2018 compared to the respective 2017 period increased by $4.1 million primarily due to occupancy commencing in Jackson Park. Property operating income from equity accounted investments for the year ended December 31, 2018 compared to the respective 2017 period decreased by $9.1 million primarily due to the sale of nine U.S. industrial properties throughout 2017 and ECHO receiving lease termination fees of $5.5 million at H&R’s ownership interest from four tenants who terminated their leases in Q3 2017. This decrease was partially offset by an increase in property operating income from Jackson Park. Net income from equity accounted investments for the three months and year ended December 31, 2018 compared to the respective 2017 periods increased by $29.8 million and $2.0 million, respectively, primarily due to the fair value of Jackson Park increasing by U.S. $107.7 million at H&R’s ownership interest which was supported by an independent third party appraisal. This increase for the year ended December 31, 2018 compared to the respective 2017 period was offset by a decrease in property operating income from equity accounted investments and higher finance costs from Jackson Park. FFO from equity accounted investments for the three months and year ended December 31, 2018 compared to the respective 2017 periods decreased by $3.1 million and $22.1 million, respectively, primarily due to Jackson Park which is in lease-up and the sale of nine U.S. industrial properties in 2017. FFO from equity accounted investments for the year ended December 31, 2018 compared to the respective 2017 period further decreased due to ECHO receiving lease termination payments of $5.5 million at H&R’s ownership interest from four tenants who terminated their leases in Q3 2017. Page 27 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 INCOME AND EXPENSE ITEMS The income and expense items section of this MD&A provides management’s commentary on the Results of Operations per the REIT’s Financial Statements. Finance Costs (in thousands of Canadian dollars) Finance costs – operations: Three months ended December 31 Year ended December 31 2018 2017 Change 2018 2017 Change Contractual interest on mortgages payable ($42,271) ($43,083) $812 ($165,855) ($174,492) Contractual interest on debentures payable (14,355) (16,095) Effective interest rate accretion Bank interest and charges Exchangeable unit distributions Capitalized interest Finance income Fair value adjustments on financial instruments (1,073) (5,639) (5,511) (920) (3,588) (5,464) (68,849) (69,150) 3,015 147 (65,834) (69,003) 2,254 (17,332) 1,407 9,553 1,740 (153) (2,051) (47) 301 2,868 3,169 847 (26,885) (61,213) (3,666) (20,709) (22,050) (62,565) (1,808) (11,877) (22,254) (273,493) (272,996) 6,406 2,638 (267,087) (270,358) 8,638 11,197 4,999 27,049 (15,852) $8,637 1,352 (1,858) (8,832) 204 (497) 3,768 3,271 3,639 ($80,912) ($58,043) ($22,869) ($247,252) ($238,310) ($8,942) The decrease in contractual interest on mortgages payable of $0.8 million and $8.6 million, respectively, for the three months and year ended December 31, 2018 compared to the respective 2017 periods is primarily due to the repayment of mortgages upon maturity and sale of investment properties. The decrease in contractual interest on debentures payable of $1.7 million and $1.4 million, respectively, for the three months and year ended December 31, 2018 compared to the respective 2017 periods is primarily due to the repayment of an aggregate of $657.1 million of senior and convertible debentures since January 2018 as well as a decrease in contractual interest rates. This was offset by the issuance of an aggregate of $420.0 million of senior debentures since January 2018. The increase in bank interest and charges of $2.1 million and $8.8 million, respectively, for the three months and year ended December 31, 2018 compared to the respective 2017 periods is primarily due to unsecured term loans and lines of credit increasing to $782.6 million as at December 31, 2018 compared to $682.2 million as at December 31, 2017, as well as an increase in interest rates. The increase in capitalized interest of $2.9 million and $3.8 million, respectively, for the three months and year ended December 31, 2018 compared to the respective 2017 periods is primarily due to the increase in funding for the River Landing development. The change in fair value adjustments on financial instruments of ($26.9 million) and ($15.9 million), respectively, for the three months and year ended December 31, 2018 compared to the respective 2017 periods is primarily due to the following non-cash items: (i) gain (loss) on fair value of exchangeable units and convertible debentures, which are fair valued at the end of each reporting period based on quoted prices of Units on the TSX and (ii) gain (loss) on derivative instruments which are marked-to-market at the end of each reporting period, both of which result in an unrealized gain or loss recorded in net income. In addition, during the year ended December 31, 2017, H&R realized a one-time gain of $8.9 million on the sale of an investment previously classified as held for trading. Trust Expenses Three months ended December 31 Year ended December 31 (in thousands of Canadian dollars) 2018 2017 Change 2018 2017 Change Other expenses ($4,369) ($3,700) ($669) ($15,858) ($13,242) ($2,616) Unit-based compensation recovery (expense) (4,279) (683) (3,596) (2,413) (4,869) Trust expenses ($8,648) ($4,383) ($4,265) ($18,271) ($18,111) 2,456 ($160) Other expenses are primarily comprised of salaries, professional fees, trustee fees and corporate overhead expenses. Other expenses increased by $0.7 million and $2.6 million, respectively, for the three months and year ended December 31, 2018 compared the respective 2017 periods primarily due to higher salaries and corporate expenses from Primaris and Lantower Residential. Page 28 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 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 their fair value as defined by IFRS 2 based on the quoted prices of Units on the TSX. The fair value adjustment to unit-based compensation was ($3.2 million) and $0.3 million, respectively, for the three months ended December 31, 2018 and 2017 and $1.5 million and ($1.3 million), respectively, for the year ended December 31, 2018 and 2017. Fair Value Adjustment on Real Estate Assets Three months ended December 31 Year ended December 31 (in thousands of Canadian dollars) 2018 2017 Change 2018 2017 Change Fair value adjustment on real estate assets ($151,884) $3,984 ($155,868) ($246,967) $1,796 ($248,763) H&R records its real estate assets at fair value. Fair value adjustments on real estate assets are determined based on the movement of various parameters, including changes in capitalization rates, discount rates and future cash flow projections. The fair value adjustment on real estate assets for the three months and year ended December 31, 2018 of ($151.9 million) and ($247.0 million), respectively, is primarily due to fair value decreases to the Primaris segment in Q1 and Q4 2018 as a result of a changing retail landscape and increased competition in the retail industry. The weighted overall average capitalization rate for the Primaris segment was 6.00% as at December 31, 2018 compared to 5.54% as at December 31, 2017. Changes in fair value can also occur due to the following factors: (i) realty taxes in accordance with IFRIC 21, (ii) capital and tenant expenditures, (iii) redevelopment costs, and (iv) straight-lining of contractual rent and these factors also contributed to the negative fair value adjustment on real estate assets for both the three months and year ended December 31, 2018. Loss on Sale of Real Estate Assets (in thousands of Canadian dollars) Loss on sale of real estate assets Three months ended December 31 Year ended December 31 2018 ($267) 2017 ($70) Change 2018 2017 Change ($197) ($19,602) ($7,729) ($11,873) During the year ended December 31, 2018, H&R sold 64 retail properties, one Primaris property, a 50% ownership interest in four industrial properties, a 75% ownership interest in one industrial property and a 50% ownership interest in one office property and recognized a loss on sale of real estate assets of $19.6 million (Q4 2018 - loss on sale of $0.3 million). The loss on sale of real estate assets for the year ended December 31, 2018 of $19.6 million is primarily due to mortgage prepayment penalties and closing costs relating to the 63 U.S. retail properties sold in June 2018. During the year ended December 31, 2017, H&R sold three retail properties, a 50% ownership interest in two Primaris properties, a 50% interest in one industrial property, one residential property and an office property and recognized a loss on sale of real estate assets of $7.7 million (Q4 2017 - $0.1 million). The loss on sale of real estate assets includes mark-to-market adjustments of $3.5 million on the purchaser’s assumption of a mortgage. For a list of property dispositions, please refer to page 12 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 2018 2017 Change 2018 2017 Change $ - $2,263 ($2,263) $6,886 ($17,903) $24,789 The amounts in the table above were recorded by Finance Trust due to the translation of the U.S. Holdco Notes (a note payable previously owing by U.S. Holdco to Finance Trust) into Canadian dollars prior to the termination of Finance Trust on August 31, 2018. The U.S. Holdco Notes were previously eliminated in the Trusts’ Financial Statements. However, the related foreign exchange difference was not eliminated on combination as it flowed through net income of Finance Trust and other comprehensive income of the REIT as U.S. Holdco is a subsidiary of the REIT and formed part of its net investment in the United States. U.S. Holdco was not a subsidiary of Finance Trust. The exchange rate as at September 30, 2018 was $1.29 for each U.S. $1.00 (December 31, 2017 - $1.26). The exchange rate as at December 31, 2017 was $1.26 for each U.S. $1.00 (September 30, 2017 - $1.25, December 31, 2016 - $1.34). Page 29 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 Income Tax Recovery (Expense) Three months ended December 31 Year ended December 31 (in thousands of Canadian dollars) 2018 2017 Change 2018 2017 Change Income tax computed at the Canadian statutory rate of nil applicable to H&R for 2018 and 2017 Current U.S. income taxes Deferred income taxes recovery (expense) applicable to U.S. Holdco $ - $ - $ - $ - (142) (376) 234 (760) $ - (1,538) $ - 778 Impact of U.S. Tax Reform Other - 87,970 (37,206) (24,923) (87,970) (12,283) - 87,970 (87,970) (39,457) (48,193) 8,736 Income tax recovery (expense) in the determination of net income ($37,348) $62,671 ($100,019) ($40,217) $38,239 ($78,456) H&R is generally subject to tax in Canada under the Income Tax Act (Canada) (“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 recovery (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 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 and losses can be realized. Deferred income tax expense increased by $100.3 million and $79.2 million for the three months and year ended December 31, 2018 compared to the respective 2017 periods primarily due to the enactment of U.S. Tax Reform in Q4 2017 and a fair value increase to Jackson Park in Q4 2018. 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 are also recognized in equity. As at December 31, 2018, H&R had net deferred tax liabilities of $392.2 million (December 31, 2017 - $325.1 million) primarily related to taxable temporary differences between the tax and accounting bases of U.S. real estate assets. Page 30 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 FUNDS FROM OPERATIONS AND ADJUSTED FUNDS FROM OPERATIONS The REIT presents its FFO and AFFO calculations in accordance with REALpac’s February 2018 White Paper on Funds From Operations and Adjusted Funds From Operations for IFRS. FFO, AFFO and payout ratio per Unit as a % of FFO are non-GAAP measures defined in the “Non-GAAP Financial Measures” section of this MD&A. FFO AND AFFO Three Months Ended December 31 Year ended December 31 (in thousands of Canadian dollars except per Unit amounts) Net income per the REIT's Financial Statements Realty taxes in accordance with IFRIC 21 FFO adjustments from equity accounted investments (page 27) Exchangeable unit distributions Fair value adjustments on real estate assets and financial instruments(1) Fair value adjustment to unit-based compensation Loss on sale of real estate assets (Gain) loss on foreign exchange Deferred income taxes applicable to U.S. Holdco Incremental leasing costs FFO Straight-lining of contractual rent Capital expenditures Leasing expenses and tenant inducements Incremental leasing costs AFFO adjustments from equity accounted investments (page 27) AFFO Weighted average number of Units (in thousands of basic Units adjusted for conversion of exchangeable Units)(2) Diluted weighted average number of Units (in thousands of Units) for the calculation of FFO(2)(3)(4)(5)(6) Diluted weighted average number of Units (in thousands of Units) for the calculation of AFFO(2)(3)(4)(6) FFO per basic Unit (adjusted for conversion of exchangeable units) FFO per diluted Unit AFFO per basic Unit (adjusted for conversion of exchangeable units) AFFO per diluted Unit Distributions per Unit Payout ratio per Unit as a % of FFO 2018 $61,115 (9,914) (138,113) 5,511 169,216 3,291 267 - 37,206 1,891 2017 $325,213 (10,697) (105,226) 5,464 (13,537) (317) 70 (2,263) (63,047) 1,787 2018 $337,918 - (128,678) 22,050 235,770 (1,493) 19,602 (6,886) 39,457 7,956 2017 $667,870 - (104,539) 22,254 (19,910) 1,307 7,729 17,903 (39,777) 7,253 $130,470 $137,447 $525,696 $560,090 1,356 (23,330) (9,575) (1,891) (2,045) 894 (14,874) (9,394) (1,787) (5,155) 4,113 (57,825) (32,441) (7,956) (6,145) 6,818 (51,845) (28,722) (7,253) (14,847) $94,985 $107,131 $425,442 $464,241 301,200 306,629 302,605 304,462 301,881 311,836 304,131 312,433 301,881 $0.433 $0.432 $0.315 $0.315 $0.345 79.7% 307,595 $0.448 $0.445 $0.349 $0.348 $0.345 77.0% 304,131 $1.737 $1.732 $1.406 $1.403 $1.380 79.4% 312,433 $1.840 $1.821 $1.525 $1.514 $1.380 75.0% (1) During the year ended December 31, 2017, H&R realized a one-time gain of $8.9 million on the sale of an investment classified as held for trading which has not been added back above. (2) For the three months and year ended December 31, 2018, included in the weighted average and diluted weighted average number of Units are exchangeable units of 15,540,024 and 15,544,685, respectively. For the three months and year ended December 31, 2017, included in the weighted average and diluted weighted average number of Units are exchangeable units of 15,546,256 and 15,674,341, respectively. (3) For the three months and year ended December 31, 2018, included in the determination of diluted FFO and AFFO with respect to H&R’s Unit Option Plan and Incentive Unit Plan are 681,054 Units and 701,032 Units, respectively. For the three months and year ended December 31, 2017, included in the determination of diluted FFO and AFFO with respect to H&R’s Unit Option Plan and Incentive Unit Plan are 966,301 Units and 1,555,465 Units, respectively. (4) The 2020 convertible debentures are dilutive for the year ended December 31, 2018. Therefore, debenture interest of $1.1 million is added to FFO and AFFO and 824,855 Units are included in the diluted weighted average number of Units outstanding for this period. (5) The 2020 convertible debentures are dilutive for the three months ended December 31, 2017. Therefore, debenture interest of $1.5 million is added to FFO and 4,240,511 Stapled Units are included in the diluted weighted average number of Stapled Units outstanding for this period. (6) The 2018 and 2020 convertible debentures are dilutive for the year ended December 31, 2017. Therefore, debenture interest of $8.8 million is added to FFO and AFFO and 6,416,361 Units are included in the diluted weighted average number of Units outstanding for this period. Page 31 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 FFO for the three months and year ended December 31, 2018 compared to the respective 2017 periods decreased by $7.0 million and $34.4 million, respectively, primarily due to lower property operating income as a result of property dispositions and lower notional interest capitalization due to occupancy commencing at Jackson Park. FFO further decreased for the year ended December 31, 2018 compared to the respective 2017 period due to a one-time gain of $8.9 million on the sale of an investment classified as held for trading recorded in 2017. AFFO for the three months and year ended December 31, 2018 compared to the respective 2017 periods decreased by $12.1 million and $38.8 million, respectively, primarily due to the following: (i) a decrease in FFO explained above; (ii) higher capital expenditures in Q4 2018 compared to Q4 2017; and (iii) higher leasing expenses and tenant inducements for the year ended December 2018 compared to the respective 2017 period. Included in FFO at the REIT’s proportionate share are the following items which can be a source of variances between periods: (in thousands of Canadian dollars) Lease termination fees Mortgage prepayment penalties Jackson Park FFO loss during lease-up Notional interest capitalization (Jackson Park) Adjustment to straight-lining of contractual rent Other income One-time gain realized on sale of investment Three months ended December 31 Year ended December 31 2018 $705 (153) (608) 835 - - - 2017 Change 2018 2017 Change $4 (404) (708) 3,342 (252) 1,040 - $701 $2,631 $5,989 ($3,358) 251 100 (153) (4,533) (2,507) 7,511 252 (1,040) - - - - (952) (708) 13,799 (5,892) 1,040 8,935 799 (3,825) (6,288) 5,892 (1,040) (8,935) $779 $3,022 ($2,243) $5,456 $22,211 ($16,755) Excluding the above items, FFO would have been $129.7 million for the three months ended December 31, 2018 (Q4 2017 - $134.4 million) and $0.43 per basic Unit (Q4 2017 - $0.44 per basic Unit). For the year ended December 31, 2018, FFO would have been $520.2 million (Q4 2017 - $537.9 million) and $1.72 per basic Unit (Q4 2017 - $1.77 per basic Unit). Included in AFFO at the REIT’s proportionate share are the following items which can be a source of variances between periods: (in thousands of Canadian dollars) 2018 2017 Change 2018 2017 Change Three months ended December 31 Year ended December 31 Additional current year capital expenditure recoveries net of capital expenditures Lease termination fees Mortgage prepayment penalties Jackson Park AFFO loss during lease-up Notional interest capitalization (Jackson Park) Other income One-time gain realized on sale of investment Capital expenditures $2,297 ($1,445) 5,989 (3,358) $1,003 705 (153) (608) 835 - - $632 4 (404) (708) 3,342 1,040 - $371 701 251 100 (2,507) (1,040) - $852 2,631 (153) (4,533) (952) (708) 7,511 13,799 - - 1,040 8,935 799 (3,825) (6,288) (1,040) (8,935) (24,024) (17,890) (6,134) (60,579) (62,965) 2,386 Leasing expenses and tenant inducements (10,697) (11,181) 484 (35,171) (30,801) (4,370) ($32,939) ($25,165) ($7,774) ($89,442) ($63,366) ($26,076) Excluding the above items, AFFO would have been $127.9 million for the three months ended December 31, 2018 (Q4 2017 - $132.3 million) and $0.42 per basic Unit (Q4 2017 - $0.43 per basic Unit). For the year ended December 31, 2018, AFFO would have been $514.9 million (Q4 2017 - $527.6 million) and $1.70 per basic Unit (Q4 2017 - $1.73 per basic Unit). Page 32 of 50    H&R REIT - MD&A – DECEMBER 31, 2018 Capital and Tenant Expenditures The following is a breakdown of H&R’s capital expenditures and tenant expenditures (leasing expenditures and tenant inducements) by operating segment: (in thousands of Canadian dollars) 2018 2017 Change 2018 2017 Change Three months ended December 31 Year ended December 31 Office: Capital expenditures Leasing expenditures and tenant inducements Primaris: Capital expenditures Leasing expenditures and tenant inducements H&R Retail: Capital expenditures Leasing expenditures and tenant inducements ECHO: Capital expenditures Leasing expenditures and tenant inducements Industrial: Capital expenditures Leasing expenditures and tenant inducements Lantower Residential: Capital expenditures Leasing expenditures and tenant inducements Total at the REIT's proportionate share Less: equity accounted investments $10,207 $10,307 4,016 5,400 ($100) (1,384) $24,855 $33,675 ($8,820) 12,439 17,179 (4,740) 9,476 3,292 98 1,781 694 858 167 750 2,924 2,777 - 705 752 914 6,552 515 98 1,076 (58) (56) 2,343 1,385 (2,176) (635) 22,965 8,564 10,264 8,822 12,701 (258) 1,037 3,658 2,754 2,175 1,619 8,335 1,065 1,170 2,366 1,206 9,694 2,424 (28) 2,488 388 969 (8,075) 5,911 3,382 1,564 1,818 7,349 5,901 1,448 - - 34,721 29,071 (1,816) (4,803) - 5,650 2,987 - - 95,750 93,766 (5,484) (13,199) - 1,984 7,715 Total per the REIT's Financial Statements(1) $32,905 $24,268 $8,637 $90,266 $80,567 $9,699 (1) Equal to the sum of capital expenditures and leasing expenses and tenant inducements per the REIT’s Financial Statements. During 2017 and 2018, H&R’s largest office project was at 160 Elgin St., in Ottawa, ON at which a complete renovation of the lobby and retail space was substantially completed. H&R expects to spend an additional $4.9 million to complete this project. Total capital and tenant expenditures at 160 Elgin St., in Ottawa, ON during the three months and year ended December 31, 2018 were $2.0 million and $8.7 million, respectively, compared to the three months and year ended December 31, 2017 of $6.7 million and $27.3 million, respectively. Capital expenditures from the Office segment for the three months and year ended December 31, 2018 also included $4.7 million and $4.9 million, respectively, relating to an entrance and lobby renovation, washroom upgrades and electrical upgrades at Atrium in Toronto, ON. The largest capital expenditures from the Primaris segment for the three months and year ended December 31, 2018 included: (i) a food court re-location at Place d’Orleans in Orleans, ON; (ii) backfilling a former Sobey’s location with a new Marshalls/Home Sense store at McAllister Place in Saint John, NB; and (iii) backfilling a former Safeway location with a new Marshalls store at Garden City Square in Winnipeg, MB. Tenant expenditures from the H&R Retail segment for the three months and year ended December 31, 2018 included a $1.8 million tenant allowance paid as part of a 15-year lease renewal to a single tenant at an Ontario retail property occupying 118,526 square feet. Capital expenditures from the Industrial segment for the three months and year ended December 31, 2017 included $2.6 million and $9.1 million, respectively, which related to re-paving work being completed at two U.S. industrial properties which were subsequently sold in December 2017. Tenant expenditures from the Industrial segment for the year ended December 31, 2018 included a $4.6 million tenant allowance paid as part of a 5-year lease renewal to a single tenant at an Ontario industrial property occupying 369,051 square feet, at H&R’s ownership interest. Page 33 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 LIQUIDITY AND CAPITAL RESOURCES Cash Distributions In accordance with National Policy 41-201 - Income Trusts and Other Indirect Offerings, the REIT is 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 cash provided by operations over total distributions Excess (shortfall) of net income over total distributions Three months ended December 31, 2018 Year ended December 31, 2018 Year ended December 31, 2017 Year ended December 31, 2016 $122,239 $462,123 $479,239 $424,196 61,115 98,404 23,835 (37,289) 337,918 395,568 66,555 (57,650) 667,870 397,908 81,331 269,962 388,745 381,106 43,090 7,639 (1) Total distributions include cash distributions to unitholders and Unit distributions issued under the DRIP. In February 2018, the Trusts announced the suspension of the DRIP until further notice, commencing with the March 2018 distribution. Following the Reorganization, the DRIP remains suspended until further notice. Unit distributions issued under the DRIP were nil and $16.6 million, respectively, for the three months and year ended December 31, 2018 (December 31, 2017 - $107.4 million, December 31, 2016 - $106.8 million), which are non-cash distributions. Unit distributions issued under the DRIP previously resulted in an increase in the number of Units outstanding, however, the suspension of the DRIP commencing with the March 2018 distribution, has resulted in increased total cash distributions. Distributions exceeded net income for the three months and year ended December 31, 2018 primarily due to non-cash items. Non-cash items relating to the fair value adjustments on financial instruments and real estate assets, gain (loss) on sale of real estate assets, 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. Major Cash Flow Components (in thousands of Canadian dollars) Cash and cash equivalents, beginning of period Cash flows from operations Cash flows from (used) investing Cash flows from (used) financing Cash and cash equivalents, end of year Three months ended December 31 Year ended December 31 2018 2017 Change 2018 2017 Change $93,492 $51,727 $41,765 $42,284 $48,021 ($5,737) 122,239 128,512 (6,273) 462,123 479,239 (17,116) (232,622) (425,489) 192,867 175,186 (625,635) 800,821 69,964 287,534 (217,570) (626,520) 140,659 (767,179) $53,073 $42,284 $10,789 $53,073 $42,284 $10,789 Cash flows from operations decreased by $6.3 million and $17.1 million, respectively, for the three months and year ended December 31, 2018 compared to the respective 2017 periods primarily due to a decrease in property operating income and an increase in interest paid. The decrease for the three months ended December 31, 2018 compared to the respective 2017 period was partially offset by an increase in non-cash operating working capital. Cash flows from (used) investing increased by $192.9 million for the three months ended December 31, 2018 compared to the respective 2017 period primarily due to restricted cash released from escrow as a result of H&R completing Section 1031 property exchanges in Q4 2018 and a greater amount spent on acquisitions in Q4 2017 compared to Q4 2018. Cash flows from (used) investing increased by $800.8 million for the year ended December 31, 2018 compared to the respective 2017 period, primarily due to net proceeds on dispositions of real estate assets including the sale of nine U.S. industrial joint venture properties sold in 2017 with proceeds being disbursed in Q1 2018. The increase for both the three months and year ended December 31, 2018 compared to the respective 2017 periods was partially offset by additions to properties under development. For a list of property acquisitions and dispositions, see pages 11, 12 and 16 of this MD&A. Cash flows from (used) financing decreased by $217.6 million and $767.2 million, respectively, for the three months and year ended December 31, 2018 compared to the respective 2017 periods primarily due to the repayment of debt. Cash flows from (used) financing further decreased for the year ended December 31, 2018 compared to the respective 2017 period due to the Trusts’ purchase and cancellation of Units under their NCIB during 2018 and higher cash distributions to unitholders due to the suspension of the DRIP in March 2018. Page 34 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 Capital Resources Subject to market conditions, management expects to be able to meet all of the REIT’s ongoing contractual obligations through cash on hand of $53.1 million and amounts available under its lines of credit of $768.2 million as at December 31, 2018. In addition, the REIT has $172.8 million available under its secured construction facilities held through equity accounted investments as at December 31, 2018. As at December 31, 2018, the REIT is not in default or arrears on any of its obligations including interest or principal payments on debt and any debt covenant. As at December 31, 2018, H&R had 91 unencumbered properties, with a fair value of approximately $3.4 billion. Also, due to H&R’s 22-year history and management’s conservative strategy of securing long-term financing on individual properties, H&R had numerous other properties with very low loan to value ratios. As at December 31, 2018, H&R had 36 properties valued at approximately $1.3 billion which are encumbered with mortgages totalling $248.8 million. In this pool of assets, the average loan to value is 18.9%, the minimum loan to value is 0.3% and the maximum loan to value is 27.1%. The weighted average remaining term to maturity of this pool of mortgages is 3.3 years. The following is a summary of material contractual obligations including payments due as at December 31, 2018 for the next five years and thereafter: Contractual Obligations(1) (in thousands of Canadian dollars) Mortgages payable Senior debentures Lines of credit Unsecured term loans 2019 $177,182 350,000 3,514 - Payments Due by Period 2020- 2021 2022- 2023 2024 and thereafter Total $1,439,794 $1,064,238 $1,483,616 $4,164,830 345,000 322,680 200,629 575,000 5,750 350,000 1,620,000 - 250,000 - 331,944 450,629 Total contractual obligations $530,696 $2,308,103 $1,644,988 $2,083,616 $6,567,403 (1) The amounts in the above table are the principal amounts due under the contractual agreements. 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, 2018. This is a rating achieved by only three Canadian REITs (including H&R) and one real estate company as at December 31, 2018. 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, 2018, through cash on hand of $53.1 million and the total amount available under its lines of credit of $768.2 million and its unencumbered property pool of approximately $3.4 billion, H&R has sufficient funds for future commitments. Page 35 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 The following summarizes the estimated loan to value ratios on properties for which mortgages mature over the next five years: Year 2019 2020 2021 2022 2023 Number of Properties Mortgage Debt due on Maturity ($000’s) Weighted Average Interest Rate on Maturity Fair Value of Investment Properties ($000’s)(1) Loan to Value 6 15 11 39 10 81 $50,679 366,368 839,231 539,953 391,746 $2,187,977 3.8% 4.5% 3.9% 3.9% 3.9% 4.0% $145,298 992,225 3,567,636 3,053,530 1,862,380 $9,621,069 35% 37% 24% 18% 21% 23% (1) Converting U.S. dollars to Canadian dollars at an exchange rate of $1.36 as at December 31, 2018. 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. RELATED PARTY TRANSACTION In 2018, H&R paid approximately U.S. $14.6 million for 20.3 acres of land in Dallas, TX, to be developed into approximately 1,000 residential rental units, from an entity in which the CEO held a 50% ownership interest. OFF-BALANCE SHEET ITEMS 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, 2018, H&R has outstanding letters of credit totalling $25.9 million (December 31, 2017 - $32.9 million), including $17.3 million (December 31, 2017 - $15.1 million) which has been pledged as security for certain mortgages payable. The letters of credit are secured by certain investment properties. 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, 2018, such guarantees amounted to $263.9 million expiring between 2019 and 2029 (December 31, 2017 - $497.5 million, expiring between 2020 and 2029), and no amount has been provided for in the REIT’s 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. 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, 2018, the estimated amount of debt subject to such guarantees, and therefore the maximum exposure to credit risk is approximately $44.0 million, which expires in 2020 (December 31, 2017 - $119.3 million, expiring between 2018 and 2020). There have been no defaults by the primary obligors 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 REIT’s Financial Statements. DERIVATIVE INSTRUMENTS Where appropriate, H&R, including ECHO and Jackson Park, 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 manages risks related to foreign exchange rates on transactions that will occur in the future. Page 36 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 H&R had the following interest rate swaps outstanding: Fair value asset (liability)* Net gain (loss) on derivative contracts (in thousands of Canadian dollars) Debenture interest rate swap Debenture interest rate swap Debenture interest rate swap Term loan interest rate swap Term loan interest rate swap December 31 December 31 December 31 December 31 (1) (2) (3) (4) (5) 2018 $592 (331) - 4,853 (2,370) $2,744 2017 $2,231 - 177 3,966 - $6,374 2018 ($1,639) (331) (177) 887 (2,370) ($3,630) 2017 $1,455 - 584 7,350 - $9,389 (1) (2) (3) (4) (5) * To fix the interest rate at 2.36% per annum for the Series K senior debentures, maturing on March 1, 2019. To fix the interest rate at 2.88% per annum for the Series P senior debentures, maturing on February 13, 2020. To fix the interest rate at 2.54% per annum for the Series I senior debentures (settled when these debentures matured on January 23, 2017) and to fix the interest rate at 2.04% per annum for the Series J senior debentures (settled when these debentures matured on February 9, 2018). To fix the interest rate at 2.56% per annum on U.S. $130.0 million of term loan, maturing on March 17, 2021. To fix the interest rate at 3.91% per annum on $250.0 million term loan, maturing on January 6, 2026. 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. SECTION IV SELECTED FINANCIAL INFORMATION Selected Annual information The following table summarizes certain financial information for the years indicated below: (in thousands of Canadian dollars except per Unit amounts) Rentals from investment properties Net income from equity accounted investments Finance income Net income Total comprehensive income Total assets Total liabilities Cash distributions per Unit Year Ended December 31, 2018 $1,176,558 169,409 8,638 337,918 532,794 14,691,009 7,490,909 $1.38 Year Ended December 31, 2017 $1,168,454 167,407 4,999 667,870 536,598 14,558,863 7,379,100 $1.38 Year Ended December 31, 2016 $1,196,011 48,341 4,715 388,745 350,378 14,155,012 7,242,362 $1.35 Page 37 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 Summary of Quarterly Results The following tables summarize certain financial information for the quarters indicated below: (in thousands of Canadian dollars) Rentals from investment properties Net income from equity accounted investments Net income Total comprehensive income Rentals from investment properties Net income from equity accounted investments Net income Total comprehensive income (loss) Q4 2018 $297,416 148,165 61,115 200,450 Q4 2017 $298,042 118,337 325,213 335,466 Q3 2018 $286,223 8,143 105,509 71,065 Q3 2017 $289,568 3,072 78,784 (1,511) Q2 2018 $294,302 6,864 108,194 144,329 Q2 2017 $286,987 26,280 153,070 104,181 Q1 2018 $298,617 6,237 63,100 116,950 Q1 2017 $293,857 19,718 110,803 98,462 Fluctuations between quarterly results are generally due to property acquisitions, dispositions, changes in foreign exchange rates and changes in the fair value of real estate assets and financial instruments. Rentals from investment properties increased by $11.2 million in Q4 2018 compared to Q3 2018, primarily due to the following: (i) an increase in rentals from Primaris due to seasonality; (ii) contractual rental escalations from H&R’s office properties; and (iii) the lease-up and acquisition of Lantower Residential properties. Net income from equity accounted investments increased by $140.0 million in Q4 2018 compared to Q3 2018 primarily due to the fair value adjustment on real estate assets increasing by $141.6 million mainly due to the fair value of Jackson Park increasing by U.S. $107.7 million at H&R’s ownership interest. An independent third party appraisal was obtained for this property in Q4 2018. Net income decreased by $44.4 million in Q4 2018 compared to Q3 2018 primarily due to the following: (i) a decrease in the fair value adjustments on real estate assets and financial instruments and (ii) an increase in deferred income taxes. This was partially offset by an increase in net income from equity accounted investments. Total comprehensive income (loss) increased by $129.4 million in Q4 2018 compared to Q3 2018 primarily due to an unrealized gain on translation of U.S. denominated foreign operations of $139.3 million in Q4 2018 compared to an unrealized loss of $34.5 million in Q3 2018, partially offset by a decrease in net income explained above. Page 38 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 PORTFOLIO OVERVIEW The geographic diversification of the portfolio of properties in which the REIT has an interest and the related square footage is disclosed at the REIT’s proportionate share as at December 31, 2018 in the tables below: Number of Properties(1) Canada Office Primaris H&R Retail ECHO(2) Industrial Lantower Residential(3) Total Square Feet (in thousands)(1) Office Primaris H&R Retail ECHO(2) Industrial Lantower Residential(3) Total Ontario 20 6 34 - 36 - 96 Ontario 6,426 2,076 1,675 - 4,577 - 14,754 Alberta 4 17 2 - 19 - 42 Canada Alberta 2,607 3,821 240 - 2,030 - 8,698 Other 4 7 7 - 29 - 47 Other 893 2,090 707 - 2,012 - 5,702 Subtotal 28 30 43 - 84 - 185 Subtotal 9,926 7,987 2,622 - 8,619 - 29,154 United States 7 - 16 230 6 22 281 United States 2,023 - 219 3,178 1,068 6,811 13,299 Total 35 30 59 230 90 22 466 Total 11,949 7,987 2,841 3,178 9,687 6,811 42,453 (1) H&R has nine properties under development which are not included in the tables above. (2) ECHO has 11 properties under development which are not included in the tables above. (3) Lantower Residential’s properties contain 7,271 residential rental units. Page 39 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 LEASE MATURITY PROFILE The following tables disclose H&R’s leases expiring in Canada and the United States at the REIT’s proportionate share, excluding Lantower Residential. Canadian Portfolio: LEASE EXPIRIES 2019 2020 2021 2022 2023 Office Primaris H&R Retail Industrial Total Rent per sq.ft. ($) on expiry 25.03 Sq.ft. 972,308 22.36 1,046,416 18.34 24.58 21.86 720,805 722,270 462,898 Sq.ft. 215,720 234,603 483,976 623,173 506,186 2,063,658 22.24 3,924,697 Rent per sq.ft. ($) on expiry 24.91 21.68 27.23 24.73 35.50 25.69 Rent per sq.ft. ($) on expiry 9.15 15.23 11.48 Sq.ft. 764,485 708,995 276,949 11.33 1,147,156 12.68 386,899 Rent per sq.ft. ($) on expiry 5.65 8.55 5.83 6.83 6.61 Sq.ft. 2,100,036 2,087,298 1,690,677 2,546,478 1,405,761 Sq.ft. 147,523 97,284 208,947 53,879 49,778 557,411 11.61 3,284,484 6.82 9,830,250 Rent per sq.ft. ($) on expiry 16.80 17.00 19.23 16.35 21.83 17.86 Total % of each segment 20.8% 49.1% 21.3% 38.1% 33.7% U.S. Portfolio(1): LEASE EXPIRIES 2019 2020 2021 2022 2023 Total % of each segment (1) U.S. dollars. Office H&R Retail ECHO Industrial Total Rent per sq.ft. ($) on expiry - - - 71.76 5.86 6.29 Rent per sq.ft. ($) on expiry 46.44 52.38 47.64 46.21 37.97 46.88 Rent per sq.ft. ($) on expiry 11.82 8.00 16.16 16.86 21.86 13.71 Rent per sq.ft. ($) on expiry 3.94 - - 4.94 3.00 Sq.ft. 208,751 388,738 176,084 274,994 677,708 3.33 1,726,275 26.6% Rent per sq.ft. ($) on expiry 10.91 14.59 19.10 20.64 9.12 13.42 Sq.ft. 82,896 - - 54,654 412,585 550,135 51.5% Sq.ft. 112,487 331,047 159,619 163,240 147,272 913,665 28.7% Sq.ft. 13,368 57,691 16,465 56,537 32,126 176,187 80.5% Sq.ft. - - - 563 85,725 86,288 4.3% Page 40 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 TOP TWENTY SOURCES OF REVENUE BY TENANT The following table discloses H&R’s top twenty tenants at the REIT’s proportionate share: Tenant % of rentals from investment properties(1) Number of locations H&R owned sq.ft. (in 000’s) Average lease term to maturity (in years)(2) Credit Ratings (S&P) Encana Corporation(3) Bell Canada Hess Corporation New York City Department of Health Giant Eagle, Inc. Canadian Tire Corporation(4) TransCanada Pipelines Limited Lowe's Companies, Inc.(5) Canadian Imperial Bank of Commerce 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Corus Entertainment Inc. 11. Government of Ontario 12. Telus Communications 13. Shell Oil Products 14. Public Works and Government Services, Canada 15. 16. 17. Empire Company Limited(7) 18. Royal Bank of Canada 19. 20. Hudson's Bay Company Toronto-Dominion Bank Loblaw Companies Limited(6) The TJX Companies Inc(8) Total 11.4% 8.2% 5.1% 3.6% 3.2% 2.6% 1.8% 1.8% 1.7% 1.6% 1.3% 1.2% 1.2% 1.0% 0.9% 0.9% 0.9% 0.9% 0.7% 0.6% 50.6% 1 23 1 1 192 19 1 15 9 1 4 17 17 5 7 20 15 5 14 7 374 1,997 2,541 845 660 1,680 2,627 466 1,750 555 472 359 356 223 338 277 287 569 247 548 958 BBB- Positive 19.4 BBB+ Stable 6.6 (9) BBB- Stable 11.9 AA Stable 12.2 Not Rated 7.0 12.3 11.6 5.5 14.2 3.9 6.3 3.5 4.1 8.0 7.8 10.8 6.4 6.2 6.6 BBB+ Stable BBB+ Stable BBB+ Stable A+ Stable BB Negative A+ Stable BBB+ Stable AA- Stable AAA Stable AA- Stable BBB Stable BB+ Stable AA- Stable A+ Stable B Stable 17,755 10.9 (1) The percentage of rentals from investment properties is based on estimated annualized gross revenue excluding straight-lining of contractual rent, rent amortization of tenant inducements and capital expenditure recoveries. (2) Average lease term to maturity is weighted based on net rent. (3) Encana Corporation has sublet 27 floors to Cenovus Energy at The Bow located in Calgary, AB. Encana Corporation’s lease obligations expire on May 13, 2038. (4) Canadian Tire Corporation includes Canadian Tire, Mark’s, Sport Chek, Atmosphere and Sports Experts. (5) Lowe’s Companies, Inc. includes Rona. (6) Loblaw Companies Limited includes Loblaw, No Frills and Shoppers Drug Mart. (7) Empire Company Limited includes Sobeys, Sobey’s Liquor, Safeway and Lawtons Drugs. (8) The TJX Companies Inc. includes Winners, T.J. Maxx, Marshalls and Home Sense. (9) Due to the confidentiality under the tenant’s lease, the term is not disclosed. Page 41 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 SECTION V CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS Preparation of the REIT’s 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 REIT’s Financial Statements and reported amounts of revenue and expenses during the reporting period. For a description of the accounting policies that management believes are subject to greater estimation and judgement, as well as other accounting policies, refer to notes 1 and 2 of the REIT’s 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; and  Deferred tax asset (liability). 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 consolidated 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 in the REIT’s Financial Statements and this MD&A. Refer to note 3 of the REIT’s 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(r)(i) of the December 31, 2018 REIT’s 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, 2018 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, Page 42 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 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. SIGNIFICANT ACCOUNTING POLICIES Accounting Standards adopted in 2018: On January 1, 2018, the REIT adopted IFRS 15, Revenue from Contracts with Customers (“IFRS 15”) and IFRS 9, Financial Instruments (“IFRS 9”), in accordance with IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors. The policies were adopted retrospectively without restatement of the prior period. For the comparative year ended December 31, 2017, the policies applied were consistent with the 2017 disclosed policies. The adoption of IFRS 15 and 9 did not have a significant impact. New standards and interpretations not yet adopted: The REIT intends to adopt these standards when they become effective. (i) Leases (“IFRS 16”) IFRS 16, Leases, 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 REIT is evaluating the impact of IFRS 16. In particular, the REIT is assessing how the new standard may impact the identification of lease and non-lease components, including the allocation of consideration to each lease and non-lease component. The standard requires this allocation to be completed in accordance with the guidance in IFRS 15, that is, on the basis of relative standalone selling prices. Management does not expect the adoption of IFRS 16 to have a material impact on the REIT’s Financial Statements. (ii) IFRIC Interpretation 23, Uncertainty over Income Tax Treatments (“The Interpretation”) The Interpretation provides guidance on the accounting for current and deferred tax liabilities and assets in circumstances in which there is uncertainty over income tax treatments. The Interpretation is applicable for annual periods beginning on or after January 1, 2019 with early adoption permitted. The Interpretation requires the REIT to: a) contemplate whether uncertain tax treatments should be considered separately, or together as a group, based on which approach provides better predictions of the resolution; and b) determine if it is probable that the tax authorities will accept the uncertain tax treatment or if it is not probable that the uncertain tax treatment will be accepted, measure the tax uncertainty based on the most likely amount or expected value, depending on whichever method better predicts the resolution of the uncertainty. The REIT will adopt the Interpretation in its consolidated financial statements for the annual period beginning on January 1, 2019. Management does not expect the adoption of IFRIC 23 to have a material impact on the REIT’s Financial Statements. DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROL OVER FINANCIAL REPORTING H&R’s CEO and Chief Financial Officer (“CFO”) has designed, or caused to be designed under their direct supervision, the applicable 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 REIT, 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) information required to be disclosed in the annual filings, interim filings or other reports filed or submitted under securities legislation is recorded, processed, summarized and reported within the time periods specified in securities legislation. H&R’s CEO and CFO have evaluated, or caused to be evaluated under their supervision, the effectiveness of the REIT’s disclosure controls and procedures as at December 31, 2018, and based upon that evaluation have each concluded that such disclosure controls and procedures were appropriately designed and were operating effectively as at December 31, 2018. The REIT’s 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. H&R’s management has reviewed its respective internal control over financial reporting on an annual basis. The REIT’s management, under the supervision of the CEO and the CFO, has evaluated the effectiveness of internal control over financial reporting as at December 31, 2018 using the framework and Page 43 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 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, the CEO and the CFO have concluded that internal control over financial reporting was effective as of December 31, 2018. No changes were made to H&R’s internal control over financial reporting during the three-month period ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, the REIT’s internal controls over financial reporting. H&R’s management, including the CEO and CFO, does not expect that the REIT’s controls and procedures will prevent or detect all misstatements due to error or fraud. Due to the inherent limitations in all control systems, an evaluation of controls can provide only reasonable, not absolute assurance, that all control issues and instances of fraud or error, if any, within the REIT have been detected. H&R is continually evolving and enhancing its systems of controls and procedures. SECTION VI 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, 2018, approximately 26.0% of property operating income at the REIT’s proportionate share 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 and such termination rights are generally exercisable at a cost to the tenant only. The amount of space in H&R’s portfolio which could be affected is not significant. Page 44 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 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. 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, Bell Canada and Hess Corporation. All of these companies have a public debt rating that is rated with at least a BBB- Stable 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 32.4% 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 REIT’s 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. Derivative financial instruments may be utilized by 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 H&R is exposed to foreign exchange fluctuations as a result of ownership of assets in the United States and the rental income earned from these properties. In order to mitigate the risk, 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 U.S. mortgages, Series P senior debentures, U.S. unsecured term loans and U.S. lines of credit 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. Cyber Security Risk Cyber security has become an increasingly problematic issue for issuers and businesses in Canada and around the world, including H&R. Cyber attacks against large organizations are increasing in sophistication and are often focused on financial fraud, compromising sensitive data for inappropriate use or disrupting business operations. A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of H&R's Page 45 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 information resources. More specifically, a cyber-incident is an intentional attack or an unintentional event that can include gaining unauthorized access to information systems to disrupt operations, corrupt data or steal confidential information. As H&R's reliance on technology has increased, so have the risks posed to its systems. H&R's primary risks that could directly result from the occurrence of a cyber-incident include operational interruption, damage to its reputation, damage to H&R’s business relationships with its tenants, disclosure of confidential information regarding its tenants, employees and third parties with whom H&R interacts, and may result in negative consequences, including remediation costs, loss of revenue, additional regulatory scrutiny and litigation. H&R has implemented processes, procedures and controls to help mitigate these risks, but these measures, as well as its increased awareness of a risk of a cyber-incident, do not guarantee that its financial results will not be negatively impacted by such an incident. 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. 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 or on 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, Units may trade at a premium or a discount to the underlying value of the assets of H&R. See also “Forward-Looking Disclaimer”. One of the factors that may influence the quoted price of the Units is the annual yield on the Units. Accordingly, an increase in market interest rates may lead investors in Units to demand a higher annual yield, which could adversely affect the quoted price of Units. In addition, the quoted price for 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. Availability of Cash for Distributions 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 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 Units may decline significantly if H&R 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. Page 46 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 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. Dilution The number of Units H&R is authorized to issue is unlimited. The trustees have the discretion to issue additional Units in certain circumstances, including under H&R’s Unit Option Plan and Incentive Unit Plan. In addition, H&R may issue Units pursuant to the DRIP and Unit Purchase Plan. Any issuance of Units may have a dilutive effect on the investors of Units. Unitholder Liability H&R’s Declaration of Trust provides that unitholders will have no personal liability for actions of the REIT 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. H&R’s Declaration of Trust further provides that this lack of unitholder liability, where possible, must be provided for in certain written instruments signed by the REIT. 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 H&R considers 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 REIT’s assets. It is intended that the REIT’s 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 entitlement of holders of Units to receive cash upon the redemption of their Units is subject to the limitations that: (i) the total amount payable by H&R in respect of those Units and all other Units tendered for redemption in the same calendar month does not exceed $50,000 (subject to certain adjustments and provided that the trustees of H&R may waive this limitation at their sole discretion), (ii) at the time such units are tendered for redemption, the outstanding Units shall be listed for trading or quoted on a stock exchange or traded or quoted on another market which the trustees consider, in their sole discretion, provides representative fair market value prices for the Units; and (iii) the normal trading of the Units is not suspended or halted on any stock exchange on which the Units are listed (or, if not so listed, on any market on which the Units are quoted for trading) on the redemption date or for more than five trading days during the ten-day trading period commencing immediately prior to such date. 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. 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 Series F, K, L, M, N, O and P 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. 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. Page 47 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 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 2018. 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. 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 Units. If H&R 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), Units 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 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 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. During 2017 and 2018, H&R made loans to U.S. Holdco (“U.S. Holdco Loans”) to refinance existing loans, including U.S. Holdco Notes, or 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 Loans or H&R’s ability to make distributions on its Units. For taxable years beginning before January 1, 2018, Section 163(j) of the Code (prior to its amendment by U.S. Tax Reform, “Prior Section 163(j)”) applied to limit the deduction of interest paid to a related party, including debt financing provided by H&R to U.S. Holdco (e.g., the U.S. Holdco Loans or by acquiring U.S. Holdco Notes). With respect to the U.S. Holdco Notes, H&R took the position that, due to the treatment of Finance Trust as a grantor trust that was disregarded for U.S. federal tax purposes, the interest paid to Finance Trust was treated as having been paid to the holders of the Finance Trust units and was therefore not subject to Prior Section 163(j). If Prior 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 for years subject to Prior Section 163(j). As discussed below in “U.S. Tax Reform”, Prior Section 163(j) has been repealed and replaced with a new section 163(j) that is applicable to taxable years beginning after December 31, 2017. New section 163(j) applies to both related and third party debt and there is no debt to equity ratio safe harbor. New section 163(j) limits all interest deductions (related and third party) to 30% of “adjusted taxable income” (defined similarly to earnings before interest, taxes, depreciation and amortization for taxable years beginning before January 1, 2022, and earnings before interest and taxes thereafter). However, there is an exception to the limitation of new section 163(j) for certain “real property trades or businesses” that make an irrevocable election. If such an election is made, the real property trade or business is required to use the alternative depreciation system (ADS) to depreciate certain assets for U.S. federal income tax purposes. As discussed below, it is expected that H&R’s U.S. subsidiaries are eligible for the real property trade or business exception and may elect out of section 163(j) if the interest deduction limitation would cause adverse tax results. Page 48 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 U.S. Tax Reform Overview U.S. Tax Reform was signed into law by the president on December 22, 2017, and Management has considered the material effects of tax reform on H&R’s Financial Statements (if any). U.S. corporate rate reduction The U.S. federal corporate income tax rate was reduced to 21% effective January 1, 2018. Therefore, the U.S. federal corporate income tax rate applied to the gross deferred income tax assets or liabilities is 21% (24% including the effect of state taxes) instead of 35% (37.5% including the effect of state taxes). Section 163(j) carryover Under the tax reform bill, Prior Section 163(j) was repealed and replaced with a new section 163(j) effective January 1, 2018. H&R has U.S. $147.3 million of Prior Section 163(j) interest carryover that was recorded as a deferred tax asset under the old regime. Given the initial lack of specific guidance regarding the appropriate treatment of a deferred interest carryover under the old regime, H&R reversed the deferred tax benefit of its Prior Section 163(j) carryover, which resulted in a one-time expense of $48.1 million in 2017 (after taking into account the reduction in value due to the rate change described above). Management continues to monitor guidance from the IRS to determine the future deductibility, if any, of the deferred interest carryover. New Section 163(j) As mentioned above, a new section 163(j) has been enacted. However, a real property trade or business may elect out of this new regime. A real property trade or business is defined as an “any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business”. With input from its tax advisors, H&R has taken the view that the U.S. subsidiaries of H&R are engaged in real property trades or businesses and therefore are eligible to elect out of section 163(j) with respect to such businesses. Once an election is made, the election is irrevocable. If such an election is made, the real property trade or business is required to use the alternative depreciation system (“ADS”) to depreciate certain assets for U.S. federal income tax purposes. Risks relating to tax reforms As the new U.S. Tax Reform continues to move through the implementation process, there is risk that regulatory, administrative or legislative actions could have a materially adverse effect on H&R’s deferred income tax assets or liabilities. Management continues to monitor ongoing developments and IRS guidance. 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 Units, any distributions in respect of Units which are treated as “excess distribution” under the applicable rules and any gain on a sale or other disposition of 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 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). Units are treated as a specified foreign financial asset for this purpose. In addition, with respect to years during which unitholders held interests in Finance Trust, 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 on behalf of 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. Page 49 of 50 H&R REIT - MD&A – DECEMBER 31, 2018 A holder of 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 H&R paid or credited (whether in cash or in specie) in respect of such Units, subject to reduction under the U.S. Treaty if applicable. In the case of income paid or credited on Units, the withholding rate applicable to a U.S. unitholder entitled to the benefits of the U.S. Treaty in respect of such income generally would be reduced to 15%. U.S. unitholders may be entitled to a refund of a portion of such withholding tax if the rate applied by H&R were determined to be excessive. You should consult with your own tax advisor regarding the advisability of applying for such a refund. OUTSTANDING UNIT DATA The beneficial interests in the REIT are represented by two classes of Units: Units which are unlimited in number; and special voting Units of which a maximum of 9,500,000 may be issued. Each Unit carries a single vote at any meeting of unitholders of the REIT. Each special voting Unit carries a single vote at any meeting of unitholders of the REIT. As at February 6, 2019, there were 285,677,811 Units issued and outstanding and 9,500,000 special voting Units outstanding. As at December 31, 2018, 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, 477,764 have expired and 7,075,468 remain to be granted. Of the amount originally granted, 10,138,717 had been exercised or expired and 11,263,579 options to purchase Units remained outstanding. As at February 6, 2019, there were 11,263,579 options to purchase Units outstanding of which 8,867,636 have fully vested. As at December 31, 2018, the maximum number of incentive units authorized to be granted under H&R’s Incentive Unit Plan was 5,000,000. As at December 31, 2018, 935,049 incentive units had been granted, of which 46,308 had expired, 320,864 have been settled for cash and 6,635 had been settled for Units. Accordingly, 4,432,123 may still be granted under the plan and 561,242 incentive units remain outstanding. As at February 6, 2019, there were 564,145 incentive units outstanding. As at December 31, 2018, there were 15,955,541 exchangeable units outstanding of which 9,500,000 exchangeable units are accompanied by special voting units. As at February 6, 2019, there were 15,955,541 exchangeable units outstanding of which 9,500,000 exchangeable units are accompanied by special voting units. ADDITIONAL INFORMATION Additional information relating to H&R, including H&R’s Annual Information Form, is available on SEDAR at www.sedar.com SUBSEQUENT EVENTS (a) In January 2019, the REIT sold one U.S. office property which was classified as held for sale as at December 31, 2018, for gross proceeds of U.S. $69.8 million. (b) In February 2019, the REIT secured two new mortgages totalling $36.6 million, bearing interest at 3.36% per annum for a term of 10 years. Page 50 of 50 Consolidated Financial Statements of H&R REAL ESTATE INVESTMENT TRUST Years ended December 31, 2018 and 2017 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 Opinion We have audited the consolidated financial statements of H&R Real Estate Investment Trust (the Entity), which comprise:     the consolidated statement of financial position as at December 31, 2018 the consolidated statement of comprehensive income for the year then ended the consolidated statement of changes in unitholders' equity for the year then ended the consolidated statement of cash flows for the year then ended  and notes to the consolidated financial statements, including a summary of significant accounting policies. (Hereinafter referred to as the "financial statements"). In our opinion, the accompanying financial statements present fairly, in all material respects, the consolidated financial position of the Entity as at December 31, 2018 and its consolidated financial performance and its consolidated cash flows for the year then ended in accordance with International Financial Reporting Standards (IFRS). Basis for Opinion We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities under those standards are further described in the "Auditors' Responsibilities for the Audit of the Financial Statements" section of our auditors' report. We are independent of the Entity in accordance with the ethical requirements that are relevant to our audit of the financial statements in Canada and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our 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 Other Information Management is responsible for the other information. Other information comprises:   the information included in Management's Discussion and Analysis filed with the relevant Canadian Securities Commissions. the information other than the financial statements and the auditors' report thereon, included in a document entitled "Annual Report". Our opinion on the financial statements does not cover the other information and we do not and will not express any form of assurance conclusion thereon. In connection with our audit of the financial statements, our responsibility is to read the other information identified above and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit and remain alert for indications that the other information appears to be materially misstated. We obtained the information included in Management's Discussion and Analysis filed with the relevant Canadian Securities Commissions and the information other than the financial statements and the auditors' report thereon, included in a document entitled "Annual Report" as at the date of this auditors' report. If, based on the work we have performed on this other information, we conclude that there is a material misstatement of this other information, we are required to report that fact in the auditors' report. We have nothing to report in this regard. Responsibilities of Management and Those Charged with Governance for the Financial Statements Management is responsible for the preparation and fair presentation of the financial statements in accordance with International Financial Reporting Standards (IFRS), and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. In preparing the financial statements, management is responsible for assessing the Entity's ability to continue as a going concern, disclosing as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Entity or to cease operations, or has no realistic alternative but to do so. Those charged with governance are responsible for overseeing the Entity's financial reporting process. Page 3 Auditors' Responsibilities for the Audit of the Financial Statements Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditors' report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Canadian generally accepted auditing standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. As part of an audit in accordance with Canadian generally accepted auditing standards, we exercise professional judgment and maintain professional skepticism throughout the audit. We also:  Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.  Obtain an understanding of internal control relevant to the audit 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 Entity's internal control.  Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management.  Conclude on the appropriateness of management's use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Entity's ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditors' report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditors' report. However, future events or conditions may cause the Entity to cease to continue as a going concern.  Evaluate the overall presentation, structure and content of the financial statements, including the disclosures, and whether the financial statements represent the underlying transactions and events in a manner that achieves fair presentation. Page 4  Communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit.  Provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards.  Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Group Entity to express an opinion on the financial statements. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion. Chartered Professional Accountants, Licensed Public Accountants The engagement partner on the audit resulting in this auditors' report is Tony Marino. Toronto, Canada February 14, 2019 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 statement of financial position as at December 31, 2017, the combined statements of comprehensive income, changes in unitholders' equity and cash flows for the year 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 audit. We conducted our audit 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 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, 2017, and their combined financial performance and their combined cash flows for the year then ended in accordance with International Financial Reporting Standards. Chartered Professional Accountants, Licensed Public Accountants February 14, 2018 Toronto, Canada Note December 31 2018 December 31 2017 3 3 4 5 6 7 8 9 21 10 23 25 $ 12,683,709 404,814 13,088,523 $ 13,074,123 83,132 13,157,255 1,284,985 110,940 153,488 53,073 1,125,135 - 234,189 42,284 $ 14,691,009 $ 14,558,863 $ 6,546,072 329,482 392,214 223,141 $ 6,493,617 341,321 325,131 219,031 7,490,909 7,379,100 7,200,100 7,179,763 $ 14,691,009 $ 14,558,863 H&R REAL ESTATE INVESTMENT TRUST Consolidated 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: Debt Exchangeable units Deferred tax liability Accounts payable and accrued liabilities Unitholders' equity Commitments and contingencies Subsequent events See accompanying notes to the consolidated financial statements. Approved on behalf of the Board of Trustees: “Stephen Sender” “Thomas J. Hofstedter” Trustee Trustee 1 H&R REAL ESTATE INVESTMENT TRUST Consolidated Statements of Comprehensive Income (In thousands of Canadian dollars) Years ended December 31, 2018 and 2017 Property operating income: Rentals from investment properties Property operating costs Net income from equity accounted investments Other income Finance cost - operations Finance income Trust expenses Fair value adjustments on financial instruments Fair value adjustment on real estate assets Loss on sale of real estate assets, net of related costs Gain (loss) on foreign exchange Net income before income taxes Income tax recovery (expense) Net income Other comprehensive income (loss): Items that are or may be reclassified subsequently to net income Total comprehensive income attributable to unitholders See accompanying notes to the consolidated financial statements. Note 2018 2017 14 4 15 15 15 3 3 21 $ 1,176,558 (442,626) 733,932 $ 1,168,454 (427,013) 741,441 169,409 - (267,087) 8,638 (18,271) 11,197 (246,967) (19,602) 6,886 378,135 (40,217) 337,918 167,407 1,040 (270,358) 4,999 (18,111) 27,049 1,796 (7,729) (17,903) 629,631 38,239 667,870 13 194,876 (131,272) $ 532,794 $ 536,598 2 H&R REAL ESTATE INVESTMENT TRUST Consolidated Statements of Changes in Unitholders' Equity (In thousands of Canadian dollars) Years ended December 31, 2018 and 2017 UNITHOLDERS' EQUITY Note Value of Units Accumulated net income Accumulated distributions Accumulated other comprehensive income (note 13) Unitholders' equity, January 1, 2017 Proceeds from issuance of Units Net income Distributions to unitholders Conversion of convertible debentures, net Units repurchased and cancelled Other comprehensive loss Unitholders' equity, December 31, 2017 Proceeds from issuance of Units Net income Distributions to unitholders Conversion of convertible debentures Units repurchased and cancelled Other comprehensive income $ 5,354,930 144,360 - - 2 (15,939) - 5,483,353 19,313 - - 70 (136,272) - $ 4,552,274 - 667,870 - - $ (3,302,774) - - (397,908) - $ 308,220 - - - - - 5,220,144 - (3,700,682) (131,272) 176,948 - 337,918 - - - - - - (395,568) - - - - - - - - 194,876 12(c) 8(b)(iii) 12(d) 12(c) 8(b)(iii) 12(d) Total $ 6,912,650 144,360 667,870 (397,908) 2 (15,939) (131,272) 7,179,763 19,313 337,918 (395,568) 70 (136,272) 194,876 Unitholders' equity, December 31, 2018 $ 5,366,464 $ 5,558,062 $ (4,096,250) $ 371,824 $ 7,200,100 See accompanying notes to the consolidated financial statements. 3 H&R REAL ESTATE INVESTMENT TRUST Consolidated Statements of Cash Flows (In thousands of Canadian dollars) Years ended December 31, 2018 and 2017 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 (recovery) Change in other non-cash operating items Investing: Properties under development: Acquisition Additions 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 Proceeds from sale of investments Restricted cash Financing: Unsecured term loans Lines of credit Mortgages payable: New mortgages payable Principal repayments Redemption of debentures payable Proceeds from issuance of debentures payable Proceeds from issuance of Units, net of issue costs Units repurchased and cancelled Distributions to unitholders Increase (decrease) 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 16). See accompanying notes to the consolidated financial statements. 4 Note 2018 2017 15 4 14 3 3 15 12(b) 21 16 3, 16 3, 16 3 3, 16 3 3 6 8(c) 8(d) 8(a) 8(a) 8(b)(iii) 8(b)(iii) 12(d) 12(c) 7 7 $ 337,918 267,087 (268,156) $ 667,870 270,358 (258,328) (169,409) 1,988 (6,886) 246,967 19,602 (11,197) 2,413 39,457 2,339 462,123 (31,876) (115,491) 879,347 (463,299) (58,121) (57,825) (32,441) 110,603 (68,150) - 12,439 175,186 250,000 (196,323) 619,788 (536,908) (657,082) 409,205 8 (136,272) (378,936) (626,520) 10,789 42,284 $ 53,073 (167,407) 2,354 17,903 (1,796) 7,729 (27,049) 4,869 (39,777) 2,513 479,239 (71,260) (14,479) 115,432 (417,428) (111,986) (51,845) (28,722) 6,169 (107,233) 56,597 (880) (625,635) - 69,704 588,094 (585,659) (249,394) 619,299 5,051 (15,939) (290,497) 140,659 (5,737) 48,021 $ 42,284 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 H&R Real Estate Investment Trust (the “REIT”) is an unincorporated open-ended trust domiciled in Canada and H&R Finance Trust (“Finance Trust”) was an unincorporated investment trust domiciled in Canada. The REIT owns, operates and develops commercial and residential properties across Canada and in the United States. The REIT’s units (“Units”) are listed and posted for trading on the Toronto Stock Exchange (“TSX”) under the symbol HR.UN. The principal office and centre of administration of the REIT is located at 3625 Dufferin Street, Suite 500, Toronto, Ontario M3K 1N4. Unitholders of the REIT participate pro rata in distributions of income and, in the event of termination of the REIT, participate pro rata in the net assets remaining after satisfaction of all liabilities. On August 31, 2018, the REIT and Finance Trust effected a reorganization (“Reorganization”) by way of plan of arrangement involving the REIT, Finance Trust and certain of the REIT’s subsidiaries resulting in, among other things, (i) Finance Trust transferring debt owed to it by H&R REIT (U.S.) Holdings Inc. (“U.S. Holdco”) to the REIT for nil consideration and (ii) unitholders subsequently transferring their Finance Trust units to the REIT for nominal consideration and retaining their Units. Following these transactions, Finance Trust was terminated, resulting in the Units no longer being stapled to units of Finance Trust and unitholders holding only REIT Units. These consolidated financial statements include the accounts of the REIT and Finance Trust, (together with the REIT, the “Trusts”) up to August 31, 2018, the date of termination of Finance Trust. The comparative period ended December 31, 2017 continues to reflect the financial position and results of the REIT and Finance Trust as previously reported on a combined basis, as units of the Trusts were previously stapled (“Stapled Units”). For the periods prior to August 31, 2018, references to Units should be read as referring to Stapled Units. 1. Basis of preparation: (a) Statement of compliance These consolidated financial statements have been prepared in accordance with IFRS as published by International Accounting Standards Board (“IASB”) and using accounting policies described herein. The consolidated financial statements were approved by the Board of Trustees of the REIT on February 14, 2019. (b) Functional currency and presentation These consolidated financial statements are presented in Canadian dollars, except where otherwise stated, which is the REIT’s functional currency. All financial information has been rounded to the nearest thousand. The REIT presents its consolidated statements of financial position based on the liquidity method, where all assets and liabilities are presented in ascending order of liquidity. (c) Basis of measurement The consolidated financial statements have been prepared on the historical cost basis except for the following items in the consolidated statements of financial position which have been measured at fair value: (i) Real estate assets; (ii) Assets classified as held for sale; (iii) Derivative instruments; (iv) Liabilities for cash-settled unit-based compensation; and (v) Exchangeable units. 5 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 1. Basis of preparation (continued): (d) Use of estimates and judgements The preparation of these consolidated 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 3); and  Deferred tax asset (liability) (note 21). (ii) Use of judgements The critical judgements made in applying accounting policies that have the most significant effect on the amounts recognized in these consolidated 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 consolidated 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 consolidated financial statements. Refer to note 3 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. 6 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 1. Basis of preparation (continued):  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. 2. Significant accounting policies: The accounting policies set out below have been applied consistently for all periods presented in these consolidated financial statements. (a) Basis of consolidation: These consolidated 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. (b) Basis of combination: The principles used to prepare the 2017 comparative combined financial statements are similar to those used to prepare consolidated financial statements. The 2017 comparative combined financial statements include the assets, liabilities, unitholders' equity, other comprehensive 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 gain (loss) on foreign exchange recorded in net income as a result of translating Finance Trust's U.S. dollar note receivable from U.S. Holdco was not eliminated on combination as it flows through net income on Finance Trust’s books and other comprehensive income (loss) 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 was 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. (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”). 7 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 2. Significant accounting policies (continued): 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. (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: 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. 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 consolidated statement of financial position. These amounts are not offset or presented as a single amount. 8 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 2. Significant accounting policies (continued): (f) 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. 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 2018 and the 2017 comparative year. For financial statement reporting purposes, the tax deductibility of the REIT’s distributions is treated as an exemption from taxation as the REIT has distributed and is committed to continue distributing all of its taxable income to its unitholders. (g) 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 12(b). These plans are considered to be a cash-settled liability under IFRS 2, Share-based Payment (“IFRS 2”) and as a result are measured at each reporting period and at settlement date at their 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. The REIT adopted amendments to IFRS 2 beginning on January 1, 2018, the mandatory effective date. There was no material impact from the adoption of the amendments to IFRS 2. (h) 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. (i) Restricted cash: Restricted cash includes amounts relating to Internal Revenue Code Section 1031 U.S. property exchanges, amounts held in reserve by lenders to fund mortgage payments, repairs and capital expenditures or property tax payments. 9 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 2. Significant accounting policies (continued): (j) 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 consolidated 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 until there is a reduction in the REIT’s net investment in the foreign operations. The U.S. dollar denominated senior debenture, unsecured term loan and line of credit 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. 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 consolidated 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. (k) Units: Under IAS 32, Financial Instruments: Presentation (“IAS 32”), puttable instruments, such as the 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, the REIT met the exemption criteria under IAS 32 for equity classification. Nevertheless, the Units are not considered ordinary units under IAS 33, Earnings Per Share, and therefore an income per unit calculation is not presented. (l) 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. (m) Investment in associates and joint ventures: An associate is an entity over which the REIT 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 REIT accounts for investments in associates using the equity method. The REIT considers investments in joint arrangements to be joint ventures when the REIT jointly controls one or more investment properties with another party and has 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 REIT’s interests in its associates and joint ventures are accounted for using the equity method and are carried on the consolidated statements of financial position at cost, adjusted for the REIT’s proportionate share of post-acquisition changes in the net assets, less any identified impairment loss. The REIT’s share of profits and losses is recognized in the share of net income from the associate or joint venture investments in the consolidated statements of comprehensive income and the REIT’s other comprehensive income includes its share of the associate or joint ventures’ other comprehensive income. 10 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 2. Significant accounting policies (continued): 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 associate or joint venture and that event has a negative impact on the future cash flows of the associate or joint venture that can be reliably estimated. (n) Joint Operations: The REIT considers investments in joint arrangements to be joint operations when the REIT makes 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 REIT will include its share of the underlying assets, liabilities, revenue and expenses in its financial results. (o) 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 consolidated 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. (p) 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. (q) Subsidiaries Subsidiaries are entities controlled by the REIT. The REIT controls an entity when it is exposed to, or has rights to, variable returns from its 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 consolidated financial statements from the date on which control commences until the date on which control ceases. (r) Accounting standards adopted in 2018: On January 1, 2018, the REIT adopted IFRS 15, Revenue from Contracts with Customers (“IFRS 15”) and IFRS 9, Financial Instruments (“IFRS 9”), in accordance with IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors. These policies were adopted retrospectively without restatement of the prior period. For the comparative year ended December 31, 2017, the policies applied were consistent with the 2017 disclosed policies. The adoption of IFRS 15 and 9 did not have a significant impact. The new accounting policies and the impact from the adoption of IFRS 15 and IFRS 9 are described below: (i) Revenue from contracts with customers: IFRS 15 replaces all existing guidance in IFRS related to revenue, including (but not limited to) IAS 11 Construction Contracts, IAS 18 Revenue and IFRIC 15 Agreements for the Construction of Real Estate. IFRS 15 contains a single, control-based model that applies to contracts with customers and provides two approaches to recognizing revenue: at a point in time or over time. The model features a contract-based five-step analysis of transactions to determine whether, how much and when revenue is recognized. IFRS 15 also includes additional disclosure requirements for revenue accounted for under the standard. 11 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 2. Significant accounting policies (continued): The REIT adopted IFRS 15 on January 1, 2018, using the cumulative effect method, which means that the REIT did not apply the requirements of IFRS 15 to the 2017 comparative period presented. The effect of initially applying this standard would have been recognized at January 1, 2018, however, the adoption of IFRS 15 did not have an impact on the timing of recognition or measurement of revenue. The REIT earns revenue from its tenants from various sources consisting of base rent for the use of space leased, recoveries of property tax and property insurance, and service revenue from utilities, cleaning and property maintenance costs. Revenue from lease components is recognized on a straight-line basis over the lease term and includes the recovery of property taxes and insurance. Revenue recognition commences when a tenant has the right to use the premises and is recognized pursuant to the terms of the lease agreement. Revenue related to the services component of the REIT’s leases is accounted for in accordance with IFRS 15. These services consist primarily of utilities, cleaning and property maintenance costs for which the revenue is recognized over time, typically as the costs are incurred, which is when the services are provided. (ii) Financial instruments: IFRS 9 replaces IAS 39 Financial Instruments: Recognition and Measurement (“IAS 39”). The adoption of IFRS 9 was generally applied retrospectively, without restatement of comparative information. There was no material impact from the adoption of IFRS 9. IFRS 9 contains a new classification and measurement approach which requires financial assets to be classified and measured based on the business model in which they are managed and the characteristics of their contractual cash flows. IFRS 9 contains three principal classification categories for financial assets: measured at amortized cost, fair value through other comprehensive income and fair value through profit or loss, and eliminates the existing IAS 39 categories of held to maturity, loans and receivables and available for sale. A financial asset is measured at amortized cost if it meets both of the following conditions and is not designated at fair value through profit or loss (“FVTPL”): ‐ ‐ It is held within a business model whose objective is to hold assets to collect contractual cash flows; and Its contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. All financial assets not classified as measured at amortized cost as described above are measured at FVTPL. IFRS 9 largely retains the existing requirements in IAS 39 for the classification of financial liabilities. However, under IAS 39 all fair value changes of liabilities designated as fair value through profit or loss are recognized in profit or loss, whereas under IFRS 9 the amount of change in fair value attributable to changes in the credit risk of the liability is presented in other comprehensive income, and the remaining amount of change in fair value is presented in profit or loss. 12 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 2. Significant accounting policies (continued): The following table summarizes the classification impacts upon adoption of IFRS 9. Asset/Liability Mortgages receivable Accounts receivable Cash and cash equivalents Restricted cash Mortgages payable Senior debentures payable Classification under IAS 39 Classification under IFRS 9 Loans and receivables Loans and receivables Loans and receivables Loans and receivables Other liabilities at amortized cost Other liabilities at amortized cost Amortized cost or fair value through profit or loss Amortized cost Amortized cost Amortized cost Amortized cost Amortized cost Convertible debentures payable Fair value through profit or loss Fair value through profit or loss Exchangeable units Lines of credit Accounts payable and accrued liabilities Other liabilities at amortized cost Other liabilities at amortized cost Amortized cost Amortized cost Fair value through profit or loss Fair value through profit or loss Derivative instruments Fair value through profit and loss Fair value through profit and loss For impairment of financial assets, IFRS 9 replaces the ‘incurred loss’ model in IAS 39 with a forward-looking ‘expected credit loss’ (“ECL”) model. The new impairment model applies to financial assets except for investments in equity instruments, and to contract assets, lease receivables, loan commitments and financial guarantee contracts. The REIT adopted the practical expedient to determine ECL on accounts receivable using a provision matrix based on historical credit loss experiences adjusted for current and forecasted future economic conditions to estimate lifetime ECL. The other ECL models applied to other financial assets also require judgment, assumptions and estimations on changes in credit risks, forecasts of future economic conditions and historical information on the credit quality of the financial asset. Impairment losses are recorded in finance cost - operations in the consolidated statement of comprehensive income with the carrying amount of the financial asset or group of financial assets reduced through the use of impairment allowance accounts. IFRS 9 also includes a new general hedge accounting standard which aligns hedge accounting more closely with risk management. The U.S. dollar denominated senior debenture, unsecured term loan and line of credit are designated as a hedge of the REIT’s investment in self-sustaining operations. (s) New standards and interpretations not yet adopted: (i) Leases (“IFRS 16”) IFRS 16, Leases, 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 REIT is evaluating the impact of IFRS 16. In particular, the REIT is assessing how the new standard may impact the identification of lease and non-lease components, including the allocation of consideration to each lease and non-lease component. The standard requires this allocation to be completed in accordance with the guidance in IFRS 15, that is, on the basis of relative standalone selling prices. Management does not expect the adoption of IFRS 16 to have a material impact on the consolidated financial statements. 13 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 2. Significant accounting policies (continued): (ii) IFRIC Interpretation 23, Uncertainty over Income Tax Treatments (“The Interpretation”) The Interpretation provides guidance on the accounting for current and deferred tax liabilities and assets in circumstances in which there is uncertainty over income tax treatments. The Interpretation is applicable for annual periods beginning on or after January 1, 2019 with early adoption permitted. The Interpretation requires the REIT to: a) contemplate whether uncertain tax treatments should be considered separately, or together as a group, based on which approach provides better predictions of the resolution; and b) determine if it is probable that the tax authorities will accept the uncertain tax treatment or if it is not probable that the uncertain tax treatment will be accepted, measure the tax uncertainty based on the most likely amount or expected value, depending on whichever method better predicts the resolution of the uncertainty. The REIT will adopt the Interpretation in its consolidated financial statements for the annual period beginning on January 1, 2019. Management does not expect the adoption of IFRIC 23 to have a material impact on the consolidated financial statements. 3. Real estate assets: Opening balance, beginning of year Acquisitions, including transaction costs Dispositions Transfer from equity accounted investment December 31, 2018 December 31, 2017 Note Investment Properties Properties Under Development Investment Properties Properties Under Development $ 13,074,123 $ 83,132 $ 12,564,144 $ 118,268 463,299 (933,403) - 196,754 - - - - - - 430,537 (70,062) 62,500 - 51,845 28,722 113,212 71,260 - - - - - - Transfer of investment properties to assets classified as held for sale 5 (110,940) Operating capital: Capital expenditures Leasing expenses and tenant inducements Development capital: Redevelopment (including capitalized interest) 57,825 32,441 60,892 Additions to properties under development (including capitalized interest) Amortization of tenant inducements, straight-lining of contractual rents and blend and extend rents included in revenue Transfer of properties under development that have reached substantial completion to investment properties Fair value adjustment on real estate assets Change in foreign exchange Closing balance, end of year - 119,117 - 15,555 3,088 - (246,967) 283,351 - - - 5,811 (1,478) - 116,525 3,038 (224,860) (116,525) (1,242) (4,184) $ 12,683,709 $ 404,814 $ 13,074,123 $ 83,132 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. 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, 2018, the REIT acquired five residential properties, partial ownership in two industrial properties and three residential properties under development (year ended December 31, 2017 - five residential properties and one residential property under development which was transferred to investment properties upon substantial completion). The results of operations for these acquisitions are included in these consolidated financial statements from the date of acquisition. 14      H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 3. Real estate assets (continued): The following table summarizes the purchase price plus transaction costs of the assets as at the respective dates of acquisition: Assets Investment properties Properties under development December 31 2018 December 31 2017 $ 462,961 196,754 $ 659,715 $ 430,516 71,260 $ 501,776 During the year ended December 31, 2018, the REIT incurred additional costs of $338 (year ended December 31, 2017 - $21) in respect of prior year acquisitions which are not included in the above table. Asset dispositions: During the year ended December 31, 2018, the REIT sold 64 retail properties, one Primaris property, a 50% ownership interest in four industrial properties, a 75% ownership interest in one industrial property and a 50% ownership interest in one office property and recognized a loss on sale of real estate assets of $19,602. During the year ended December 31, 2017, the REIT sold three retail properties, a 50% ownership interest in two Primaris properties, a 50% interest in one industrial property, one residential property and one office property and recognized a loss on sale of real estate assets of $7,729. The loss on sale of real estate assets includes mark-to-market adjustments of $3,544 on the purchaser’s assumption of a mortgage. 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) Discounted cash flow analyses which are 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 calculates fair value by applying a capitalization rate to stabilized net operating income; and (iv) External independent appraisals. During the year ended December 31, 2018, certain properties were valued by professional external independent appraisers. These properties represent 25.4% of the fair value of investment properties as at December 31, 2018 (year ended December 31, 2017 - 32.3%). The remainder of the portfolio was valued by the REIT’s internal valuation team. The properties that were externally appraised are 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 for mortgage financing purposes. The REIT utilizes external industry sources to determine a range of overall capitalization, discount and terminal capitalization rates. To the extent that the ranges of these externally provided rates change from one reporting period to the next, the fair value of the investment properties is increased or decreased accordingly. 15 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 3. Real estate assets (continued): The following table highlights the significant assumptions used in determining the fair value of the REIT’s investment properties: Overall Capitalization Rates Discount Rates Terminal Capitalization Rates Canada 5.73% 5.63% United States 5.39% 5.78% Total Canada 5.64% 5.67% 6.48% 6.46% United States 6.29% 6.60% Total Canada 6.43% 6.50% 5.92% 5.88% United States 5.72% 6.08% Total 5.86% 5.94% December 31, 2018 December 31, 2017 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 overall capitalization rate applied as at December 31, 2018: Capitalization Rate Sensitivity Increase (Decrease) (0.75%) (0.50%) (0.25%) December 31, 2018 0.25% 0.50% 0.75% Overall Capitalization Rate Fair Value of Investment Properties 4.89% 5.14% 5.39% 5.64% 5.89% 6.14% 6.39% $ 14,629,063 $ 13,917,533 $ 13,272,007 $ 12,683,709 $ 12,145,351 $ 11,650,834 $ 11,195,011 Fair Value Variance $ 1,945,354 $ 1,233,824 $ 588,298 $ - $ (538,358) $ (1,032,875) $ (1,488,698) % Change 15.34% 9.73% 4.64% 0.00% (4.24%) (8.14%) (11.74%) 4. Equity accounted investments: The REIT has entered into a number of arrangements with other parties for the purpose of jointly developing, 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 joint control over the operations of such properties. The REIT’s arrangements fall into three categories: a) joint operations, where the REIT has joint control over the operations and the REIT has rights to the assets and obligations for the liabilities of the properties; b) joint ventures, where the REIT has joint control over the operations, where each investment is structured as a separate vehicle and the REIT has rights to the net assets of the entities; and (c) investments in associates, where the REIT has significant influence over the investment but does not have joint control over the operations. Joint operations are accounted for on a proportionately consolidated basis. Joint ventures and investments in associates are accounted for using the equity method. 16 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 4. Equity accounted investments (continued): During the year ended December 31, 2018, the REIT: (i) acquired a 33.3% interest in Esterra Park Development Partners LP (“Esterra Park”), a joint venture, for $3,799; and (ii) acquired a 30.9% interest in Shoreline Developments Partners LP (“Shoreline”), a joint venture, for $5,973. During the year ended December 31, 2017, the REIT: (i) acquired a 33.3% net interest in the Koenig Lane Development LP (“The Pearl”), a joint venture, for $6,413; and (ii) disposed of nine industrial properties. Investments in joint ventures:(1) 6 industrial properties Hercules Project The Pearl Esterra Park Shoreline Investments in associates:(2) ECHO Realty LP ("ECHO") Location Principal activity United States United States United States United States United States Own and operate investment property Develop, own and operate investment property Develop, own and operate investment property Develop, own and operate investment property Develop, own and operate investment property United States Own and operate investment properties LIC Operator Co., L.P. ("Jackson Park") United States Develop, own and operate investment property Ownership interest December 31 2018 December 31 2017 50.5% 31.7% 33.3% 33.3% 30.9% 33.6% 50.0% 50.5% 31.7% 33.3% - - 33.6% 50.0% (1) 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. (2) Where the REIT has significant influence over the investment but does not have joint control over the operations. The following tables summarize the total amounts of the financial information of the equity accounted investments 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: Equity accounted investments: Investment properties Properties under development Other assets Cash and cash equivalents Debt Deferred tax liability Accounts payable and accrued liabilities Non-controlling interest Net assets December 31, 2018 December 31, 2017 Investments in joint ventures Investments in associates Total Investments in joint ventures Investments in associates Total $ 119,340 $ 2,565,646 $ 2,684,986 $ 112,896 $ 2,328,749 $ 2,441,645 176,493 2,188,350 2,364,843 538 11,192 75,905 86,096 76,443 97,288 68,222 103,056 107,205 1,596,490 1,664,712 76,940 30,383 179,996 137,588 (56,907) (1,878,428) (1,935,335) (36,232) (1,530,339) (1,566,571) (335) (14,679) - - (123,477) (78,640) (335) (138,156) (78,640) (310) (4,393) - - (99,794) (74,428) (310) (104,187) (74,428) 235,642 2,835,452 3,071,094 350,444 2,328,001 2,678,445 REIT's share of net assets $ 91,565 $ 1,193,420 $ 1,284,985 $ 163,907 $ 961,228 $ 1,125,135 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, 2018 and November 30, 2017, respectively. 17 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 4. Equity accounted investments (continued): Net income (loss) from equity accounted investments: Investments in joint ventures Investments in associates Total Investments in joint ventures Investment in associates Total Rentals from investment properties $ 11,137 $ 228,522 $ 239,659 $ 31,506 $ 216,095 $ 247,601 Property operating costs (1,235) (64,421) (65,656) (4,855) (46,852) (51,707) Year ended December 31, 2018 Year ended December 31, 2017 Net income from equity accounted investments Finance income Finance cost - operations Trust expenses Fair value adjustments on financial instruments Fair value adjustment on real estate assets Gain (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 unitholders - 254 (2,033) (277) - (3,599) (628) (54) 3,565 - 3,565 1,208 2,638 (65,043) (8,200) 7,664 266,086 868 (56) 369,266 (4,559) 364,707 1,208 2,892 (67,076) (8,477) 7,664 262,487 240 (110) 372,831 (4,559) 368,272 - 87 (5,431) (293) - (30,517) (1,993) (236) (11,732) 1,750 1,071 1,750 1,158 (47,874) (53,305) (6,387) (6,680) 9,213 262,840 802 9,213 232,323 (1,191) (197) (433) 390,461 378,729 - (2,640) (2,640) (11,732) 387,821 376,089 $ 1,771 $ 167,638 $ 169,409 $ (5,854) $ 173,261 $ 167,407 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, 2017 to November 30, 2018 and December 1, 2016 to November 30, 2017, respectively. 5. Assets classified as held for sale: As at December 31, 2018, the REIT had a 50% interest in one industrial property and a 100% interest in one U.S. office property (December 31, 2017 - no properties) classified as held for sale. The following table sets forth the consolidated statement of financial position items associated with investment properties classified as held for sale: Assets Investment properties December 31 December 31 2018 2017 $ 110,940 $ 110,940 $ - $ - 18 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 6. Other assets: Mortgages receivable(1) Prepaid expenses and sundry assets Restricted cash Accounts receivable Derivative instruments December 31 December 31 Note 2018 2017 $ 96,909 $ 153,211 25,861 12,872 12,401 5,445 33,554 25,311 15,739 6,374 $ 153,488 $ 234,189 11 (1) As at December 31, 2018, mortgages receivable bear interest at effective rates between 3.25% and 9.00% per annum (December 31, 2017 - between 3.25% and 9.00% per annum) with a weighted average effective rate of 6.49% per annum (December 31, 2017 - 7.42%), and mature between 2019 and 2026 (December 31, 2017 - mature between 2018 and 2026). Future repayments are as follows: Years ending December 31: 2019 2020 2021 2022 2023 Thereafter 7. Cash and cash equivalents: December 31 2018 $ 4,533 - 44,731 34,100 2,297 11,248 $ 96,909 Cash and cash equivalents at December 31, 2018 includes cash on hand of $52,807 (December 31, 2017 - $42,022) and bank term deposits of $266 (December 31, 2017 - $262) at a rate of interest of 1.58% (December 31, 2017 - 0.85%). 8. Debt: The REIT’s debt consists of the following items: Mortgages payable Debentures payable Unsecured term loans Lines of credit Note 8(a) 8(b) 8(c) 8(d) December 31 December 31 2018 2017 $ 4,150,459 1,613,040 450,629 331,944 $ 3,958,631 1,852,790 186,629 495,567 $ 6,546,072 $ 6,493,617 19 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 8. Debt (continued): (a) 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 4.17% (December 31, 2017 - 4.26%) per annum and mature between 2019 and 2032 (December 31, 2017 - maturing between 2018 and 2033). Included in mortgages payable at December 31, 2018 are U.S. dollar denominated mortgages of U.S. $1,368,241 (December 31, 2017 - U.S. $1,189,793). The Canadian equivalent of these amounts is $1,860,808 (December 31, 2017 - $1,499,139). Mortgages payable related to certain properties are 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: 2019 2020 2021 2022 2023 Thereafter Financing costs and mark-to-market adjustment arising on acquisitions The following table provides a continuity of mortgages payable for the year ended December 31, 2018: Opening balance, beginning of year Principal repayments: Scheduled amortization on mortgages Mortgage repayments New mortgages Effective interest rate accretion on mortgages Change in foreign exchange Closing balance, end of year December 31 2018 $ 177,182 491,197 948,597 611,056 453,182 1,483,616 4,164,830 (14,371) $ 4,150,459 December 31 2018 $ 3,958,631 (129,145) (407,763) 619,788 382 108,566 $ 4,150,459 20 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 8. Debt (continued): (b) 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 2018 December 31 2017 Convertible Debentures (i) 2020 Convertible Debentures (HR.DB.D) 5.90% 5.90% $ 23.50 $ - $ - $ 103,140 Senior Debentures (ii) Series E Senior Debentures Series J Senior Debentures Series G Senior Debentures Series C Senior Debentures Series K Senior Debentures Series M Senior Debentures Series P Senior Debentures Series F Senior Debentures Series L Senior Debentures Series O Senior Debentures Series N Senior Debentures March 1, 2019 July 23, 2019 February 13, 2020 March 2, 2020 May 6, 2022 January 23, 2023 January 30, 2024 4.90% 2.04% 3.34% 5.00% 2.36% 3.06% 3.00% 4.45% 2.92% 3.42% 3.37% 3.21% 5.22% (1) 3.54% 5.30% (2) (3) (4) 4.58% 3.11% 3.44% 3.45% 3.29% - - - - - - - - - - - - - - - 200,000 150,000 170,000 175,000 325,000 250,000 350,000 - - - - 199,943 149,902 169,667 174,731 321,996 248,782 348,019 99,971 157,480 174,847 124,690 199,633 149,683 - 174,519 321,158 - 347,669 1,620,000 1,613,040 1,749,650 3.21% 3.29% $ 1,620,000 $ 1,613,040 $ 1,852,790 (1) Denominated as $125,000 U.S. dollars and bore 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 11). In February 2018, the REIT repaid all of its Series J senior debentures upon maturity for a cash payment of $125,000 U.S. dollars. 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 11). Bears interest at a rate equal to 3-month Canadian Dealer Offered Rate plus 123 basis points. The average interest rate for the year ended December 31, 2018 was 3.06%. (2) (3) (4) Denominated as $125,000 U.S. dollar and bears interest at a rate equal to 3-month London Interbank Offered Rate plus 79 basis points. The average interest rate for the year ended December 31, 2018 was 3.00%. In December 2018, the REIT entered into an interest rate swap on the Series P senior debentures to fix the interest rate at 2.88% per annum (note 11). (i) Convertible Debentures: The Convertible Debentures were measured at fair value, with fair value determined using the quoted price on the TSX on December 31, 2017. In March 2018, the REIT redeemed all of the outstanding 2020 Convertible Debentures for a cash payment of $99,582. 21 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 8. Debt (continued): (ii) Senior Debentures: In January 2018, the REIT issued $250,000 Series O unsecured senior debentures (the “Series O Senior Debentures”). On issuance, the REIT recorded a liability of $248,525, net of issue costs of $1,475. In February 2018, the REIT issued U.S. $125,000 Series P floating rate unsecured senior debentures (the “Series P Senior Debentures”). On issuance, the REIT recorded a liability of U.S. $124,553, net of issue costs of U.S. $447. At its option, the REIT may redeem any of the fixed rate Senior Debentures, in whole at any time, or in part from time to time (i) in the case of the Series N and Series O senior debentures, prior to the specified par call date; and (ii) in the case of any other fixed rate senior debentures, 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. Between the specified par call date and maturity, the applicable Senior Debentures may be redeemed on payment of a redemption price equal to par. The REIT will give notice of any redemption at least 30 days but not more than 60 days before the date fixed for redemption. Where less than all of any Senior Debentures are to be redeemed pursuant to their terms, the Senior Debentures to be so redeemed will be redeemed on a pro rata basis according to the principal amount of Senior Debentures registered in the respective name of each holder of Senior Debentures or in such other manner as the indenture trustee may consider equitable. The Series F, K, L, M, N, O and P unsecured senior debentures (collectively, the “Senior Debentures”) pay interest semi-annually or quarterly as noted below: Senior Debentures Series F Series K Series L Series M Series N Series O Series P Interest Payment Dates March 2 and September 2 March 1, June 1, September 1 and December 1 May 6 and November 6 January 23, April 23, July 23 and October 23 January 30 and July 30 January 23 and July 23 February 13, May 13, August 13 and November 13 22 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 8. Debt (continued): (iii) A summary of the changes in the carrying value of debentures payable is as follows: Convertible Debentures Carrying value, beginning of year Conversion - 2020 Convertible Debentures (HR.DB.D) Redemption - 2020 Convertible Debentures (HR.DB.D) Redemption - 2018 Convertible Debentures (HR.DB.H) Gain on change in fair value Carrying value, end of year Senior Debentures Carrying value, beginning of year Redemption - Series E Senior Debentures Redemption - Series J Senior Debentures Redemption - Series G Senior Debentures Redemption - Series C Senior Debentures Redemption - Series I Senior Debentures Redemption - Series B Senior Debentures Issuance - Series M Senior Debentures Issuance - Series N Senior Debentures Issuance - Series L Senior Debentures Issuance - Series O Senior Debentures Issuance - Series P Senior Debentures Change in foreign exchange Accretion adjustment Carrying value, end of year (1) (1) (1) (1) (1) (1) (1) (1) (2) (2) (2) (2) (2) December 31 December 31 2018 2017 $ 103,140 $ 178,898 (70) (99,582) - (3,488) - 1,749,650 (100,000) (157,500) (175,000) (125,000) - - - - - 248,525 160,680 8,737 2,948 1,613,040 (2) - (74,394) (1,362) 103,140 1,312,693 - - - - (60,000) (115,000) 149,461 347,393 122,445 - - (10,000) 2,658 1,749,650 $ 1,613,040 $ 1,852,790 (1) During the year ended December 31, 2018, the REIT redeemed debentures payable of $657,082 (2017 - $249,394). (2) During the year ended December 31, 2018, the REIT issued debentures payable of $409,205 (2017 - $619,299). 23 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 8. Debt (continued): (c) Unsecured term loans: The REIT has the following unsecured term loans: H&R REIT unsecured term loan #1(1) H&R REIT unsecured term loan #2(2) Maturity Date December 31 2018 December 31 2017 March 17, 2021 $ 200,629 $ 186,629 January 6, 2026 250,000 - $ 450,629 $ 186,629 (1) The total facility as at December 31, 2018 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 rate swap 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, maturing on March 17, 2021 (note 11). (2) The REIT entered into an interest rate swap to fix the interest rate at 3.91% per annum, maturing on January 6, 2026 (note 11). Included in unsecured term loans at December 31, 2018, are U.S. denominated amounts of $140,000 (December 31, 2017 - U.S. $140,000). The Canadian equivalent of these amounts is $190,400 (December 31, 2017 - $176,400). (d) Lines of credit: The REIT has the following lines of credit: Maturity Date Total Facility Amount Drawn Outstanding Letters of Credit Available Balance Revolving unsecured operating lines of credit: H&R REIT revolving unsecured line of credit #1 September 20, 2022 $ 150,000 $ - $ - $ 150,000 H&R REIT revolving unsecured line of credit #2 H&R REIT revolving unsecured line of credit #3 H&R REIT revolving unsecured letter of credit facility January 31, 2023 September 20, 2023 Sub-total Revolving secured operating lines of credit(1): H&R REIT co-ownership revolving secured line of credit H&R REIT and CrestPSP revolving secured line of credit Primaris revolving secured line of credit September 30, 2019 April 30, 2020 July 1, 2020 Sub-total 200,000 350,000 60,000 760,000 3,514 62,500 300,000 366,014 - (5,750) - (5,750) - (2,330) (23,439) (25,769) (3,514) (49,000) (273,680) (326,194) - (105) - (105) 200,000 341,920 36,561 728,481 - 13,395 26,320 39,715 December 31, 2018 $ 1,126,014 $ (331,944) $ (25,874) $ 768,196 (1) Secured by certain investment properties. As at December 31, 2017, the total facility was $828,514 less the amount drawn and outstanding letters of credit of $495,567 and $32,924, respectively, resulting in an available balance of $300,023. The lines of credit and can be drawn in either Canadian or U.S. dollars and bear interest at a rate approximating the prime rate of a Canadian chartered bank. Included in lines of credit at December 31, 2018 are U.S. dollar denominated amounts of $13,000 (December 31, 2017 - U.S. $327,000). The Canadian equivalent of these amounts is $17,680 (December 31, 2017 - $412,020). 24 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 8. Debt (continued): The following table provides a continuity of unsecured term loans and lines of credit for the year ended December 31, 2018: Opening balance, beginning of year Net advances (repayments) Change in foreign exchange Closing balance, end of year 9. Exchangeable units: Unsecured Term Loans Lines of Credit $ 186,629 $ 495,567 250,000 14,000 (196,323) 32,700 $ 450,629 $ 331,944 Certain of the REIT’s subsidiaries have in aggregate 15,955,541 (December 31, 2017 - 15,979,430) exchangeable units outstanding which are puttable instruments where, upon redemption, the REIT has a contractual obligation to issue Units. A subsidiary of the REIT also holds 433,174 (December 31, 2017 - 433,174) Units to mirror these exchangeable units. Therefore, when such exchangeable units are exchanged for Units, the number of outstanding 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 Unit amount provided to holders of Units. These puttable instruments are classified as a liability under IFRS and are measured at fair value through profit or loss. Fair value is determined by using the quoted prices for the Units as the exchangeable units are exchangeable into Units at the option of the holder. The quoted price as at December 31, 2018 was $20.65 (December 31, 2017 - $21.36) per Unit. A summary of the carrying value of exchangeable units is as follows: Carrying value, beginning of year Exchanged for Units Gain on fair value of exchangeable units Carrying value, end of year December 31 December 31 2018 2017 $ 341,321 (500) (11,339) $ 370,533 (13,324) (15,888) $ 329,482 $ 341,321 The REIT has entered into various exchange agreements that provide, among other things, the mechanics whereby exchangeable units may be exchanged for Units. 25 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 10. Accounts payable and accrued liabilities: Current: Other accounts payable and accrued liabilities Mortgage interest payable Prepaid rent Debenture interest payable Derivative instruments Unit-based compensation payable: Options Incentive units Non-current: Security deposits Unit-based compensation payable: Options Incentive units 11. Derivative instruments: Debenture interest rate swap Debenture interest rate swap Debenture interest rate swap Term loan interest rate swap Term loan interest rate swap (1) (2) (3) (4) (5) The REIT entered into interest rate swaps as follows: December 31 December 31 Note 2018 2017 $ 148,106 $ 149,282 9,885 24,030 14,869 2,701 1,834 1,688 9,376 23,059 13,295 - 2,249 3,156 6,051 5,752 9,045 4,932 10,297 2,565 $ 223,141 $ 219,031 11 12(b) 12(b) 12(b) 12(b) Fair value asset (liability)* Net gain (loss) on derivative contracts December 31 December 31 December 31 December 31 2018 $ 592 (331) - 4,853 (2,370) $ 2,744 2017 2018 2017 $ 2,231 $ (1,639) $ 1,455 - 177 3,966 - $ 6,374 (331) (177) 887 (2,370) $ (3,630) - 584 7,350 - $ 9,389 (1) (2) (3) (4) (5) * To fix the interest rate at 2.36% per annum for the Series K senior debentures, maturing on March 1, 2019. To fix the interest rate at 2.88% per annum for the Series P senior debentures, maturing on February 13, 2020. To fix the interest rate at 2.54% per annum for the Series I senior debentures (settled when these debentures matured on January 23, 2017) and to fix the interest rate at 2.04% per annum for the Series J senior debentures (settled when these debentures matured on February 9, 2018). To fix the interest rate at 2.56% per annum on U.S. $130,000 term loan, maturing on March 17, 2021. To fix the interest rate at 3.91% per annum on $250,000 term loan, maturing on January 6, 2026. 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 (note 6) and derivative instruments in a liability position are recorded in accounts payable and accrued liabilities (note 10). 26 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 12. 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 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. The aggregate number of Units which the REIT may issue is unlimited and the aggregate number of special voting units which the REIT may issue is 9,500,000. Units carry the right to participate pro rata in any distributions. As at December 31, 2018, 9,500,000 (December 31, 2017- 9,500,000) special voting units are issued and outstanding. Units are listed and posted for trading on the TSX under the symbol HR.UN. Units are freely transferable and the trustees shall not impose any restriction on the transfer of Units. Unitholders have the right to require the REIT to redeem their Units on demand. 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 Declaration of Trust. Upon valid tender for redemption of each Unit, the unitholder is entitled to receive a price per Unit as determined by a formula based on the market price of a Unit. 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) and in specie distribution of notes of H&R Portfolio LP Trust (a subsidiary of the REIT). Changes in the issued and outstanding number of Units during the years ended December 31, 2018 and 2017 are as follows: As at January 1, 2017 Issuance of Units: Issued under the Dividend Reinvestment Plan and Unit Purchase Plan ("DRIP") Options exercised Incentive Units settled in Units Exchangeable units exchanged into Units Conversion of convertible debentures Units repurchased and cancelled As at December 31, 2017 Issuance of Units: Issued under the DRIP(1) Options exercised Incentive Units settled in Units Exchangeable units exchanged into Units Conversion of convertible debentures Units repurchased and cancelled As at December 31, 2018 Note 12(d) 12(d) 285,279,707 5,557,815 652,291 1,354 584,386 85 (755,420) 291,320,218 933,594 1,271 5,281 23,889 2,978 (6,609,420) 285,677,811 (1) In February 2018, the Trusts announced the suspension of their DRIP and Unit Purchase Plan until further notice. Commencing with the March 2018 distribution, unitholders who elected to participate in the DRIP received the full cash distributions on their Units. Following the Reorganization, the REIT’s DRIP and Unit Purchase Plan remain suspended until further notice and unitholders who elected to participate in the DRIP will receive the full cash distributions on their Units. 27         H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 12. Unitholders’ equity (continued): The weighted average number of basic Units for the year ended December 31, 2018 is 287,060,425 (December 31, 2017 - 288,787,282). (b) 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, 2018, a maximum of 28,000,000 (December 31, 2017 - 28,000,000) options to purchase Units were authorized to be issued, of which 21,402,296 (December 31, 2017 - 21,402,296) options have been granted, 477,764 (December 31, 2017 - 452,170) options have expired and 7,075,468 (December 31, 2017 - 7,049,874) options remain to be granted. The exercise price of each option approximates the quoted price of the Units on the date of grant. 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. A summary of the status of the unit option plan and the changes during the respective years are as follows: December 31, 2018 December 31, 2017 Units Weighted average exercise price Units Weighted average exercise price Outstanding, beginning of year 11,310,383 $ 20.51 13,820,539 Granted Exercised Expired - (21,210) (25,594) - (18.98) (20.71) - (2,401,408) (108,748) Outstanding, end of year 11,263,579 $ 20.51 11,310,383 $ 20.26 - (19.15) (19.65) $ 20.51 Options exercisable, end of year 8,867,636 $ 20.93 6,008,045 $ 21.62 The options outstanding at December 31, 2018 are exercisable at varying prices ranging from $15.42 to $23.18 (December 31, 2017 - $15.42 to $23.18) with a weighted average remaining life of 5.8 years (December 31, 2017 - 6.8 years). The vested options are exercisable at varying prices ranging from $15.42 to $23.18 (December 31, 2017 - $15.42 to $23.18) with a weighted average remaining life of 5.4 years (December 31, 2017 - 5.7 years). (ii) Incentive unit plan: As at December 31, 2018, a maximum of 5,000,000 (December 31, 2017 - 5,000,000) incentive units exchangeable into Units were authorized to be issued under the incentive unit plan. Of this amount, 935,049 (December 31, 2017 - 651,026) incentive units have been granted, of which 46,308 (December 31, 2017 - 39,731) incentive units have expired, 320,864 incentive units have been settled for cash (December 31, 2017 - 178,408) and 6,635 (December 31, 2017 - 1,354) incentive units have been settled for Units. 4,432,123 (December 31, 2017 - 4,567,113) incentive units may still be granted under the plan and 561,242 (December 31, 2017 - 431,533) incentive units remain outstanding. 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 Units issued from treasury, with the result that the awards are classified as cash-settled unit-based payments and presented as liabilities. 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. 28 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 12. Unitholders’ equity (continued): The REIT grants restricted units under the incentive unit plan. 100% of the restricted 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 restricted units are, subject to the holder’s election, cash settled upon vesting. The REIT grants performance units under the incentive unit plan with a three-year performance period for certain senior executives. The performance units are and will be subject to both internal and external measures consisting of both absolute and relative performance over a three-year period and, subject to the holder’s election, cash settled upon vesting. A summary of the status of the incentive unit plan and the changes during the respective years are as follows: Outstanding, beginning of year Granted Settled Expired Outstanding, end of year December 31 December 31 2018 Units 431,533 284,023 (147,737) (6,577) 561,242 2017 Units 407,360 232,001 (179,762) (28,066) 431,533 The fair values of the unit options and incentive units, included in accounts payable and accrued liabilities, are as follows: Options Incentive units Unit-based compensation expense (recovery) included in trust expenses is as follows: Options Incentive units December 31 December 31 2018 $ 10,879 6,620 $ 17,499 2017 $ 12,546 5,721 $ 18,267 2018 $ (1,642) 4,055 $ 2,413 2017 $ 2,127 2,742 $ 4,869 29 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 12. Unitholders’ equity (continued): (c) Distributions: Under the REIT’s Declaration of Trust, the total amount of income of the REIT to be distributed to unitholders for each calendar month shall be subject to the discretion of the trustees 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. The method of payment is at the discretion of the trustees. For the year ended December 31, 2018, the REIT declared distributions per Unit of $1.38 (December 31, 2017 - $1.38). The details of the distributions are as follows: Cash distributions to unitholders Unit distributions (issued under the DRIP)(1) 2018 2017 $ 378,936 16,632 $ 290,497 107,411 $ 395,568 $ 397,908 (1) In February 2018, the Trusts announced the suspension of their DRIP and Unit Purchase Plan until further notice. Commencing with the March 2018 distribution, unitholders who elected to participate in the DRIP received the full cash distributions on their Units. Following the Reorganization, the REIT’s DRIP and Unit Purchase Plan remain suspended until further notice and unitholders who elected to participate in the DRIP will receive the full cash distributions on their Units. (d) Normal course issuer bid: On December 14, 2018, the REIT received approval from the TSX for the renewal of its normal course issuer bid (“NCIB”), allowing the REIT to purchase for cancellation up to a maximum of 15,000,000 Units on the open market until the earlier of December 16, 2019 or the date on which the REIT purchased the maximum number of Units permitted under the NCIB. During the year ended December 31, 2018, under a previous NCIB, the Trusts purchased and cancelled 6,609,420 Units at a weighted average price of $20.62 per Unit, for a total cost of $136,272. During the year ended December 31, 2017, under a previous NCIB, the Trusts purchased and cancelled 755,420 Units at a weighted average price of $21.10 per Unit, for a total cost of $15,939. 13. Accumulated other comprehensive income: Items that are or may be reclassified subsequently to net income: December 31, 2018 Cash flow hedges Foreign operations December 31 2017 Total Total Opening balance, beginning of year $ (282) $ 177,230 $ 176,948 $ 308,220 Transfer of realized loss on cash flow hedges to net income Unrealized gain (loss) on translation of U.S. denominated foreign operations Net gain (loss) on hedges of net investments in foreign operations 30 - - 30 - 139,409 55,437 194,846 30 139,409 55,437 194,876 30 (86,022) (45,280) (131,272) Closing balance, end of year $ (252) $ 372,076 $ 371,824 $ 176,948 30 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 14. Rentals from investment properties: Rental income Revenue from services Straight-lining of contractual rent Rent amortization of tenant inducements 2018 2017 $ 962,429 220,230 (4,113) (1,988) $ 1,177,626 (1) (6,818) (2,354) $ 1,176,558 $ 1,168,454 (1) The REIT did not apply the requirements of IFRS 15 to the comparative year (as described in note 2). Operating Leases: The REIT leases its investment properties under operating leases. 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 15. 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(1) Finance income Fair value adjustments on financial instruments(2) 2018 2017 $ 686,133 $ 725,151 2,150,004 3,182,837 2,323,815 3,615,459 $ 6,018,974 $ 6,664,425 2018 2017 $ 165,855 $ 174,492 61,213 3,666 20,709 22,050 273,493 (6,406) 267,087 (8,638) (11,197) $ 247,252 62,565 1,808 11,877 22,254 272,996 (2,638) 270,358 (4,999) (27,049) $ 238,310 (1) The weighted average rate of borrowings for the capitalized interest is 3.91% (December 31, 2017 - 4.0%). (2) During the year ended December 31, 2018, the REIT did not realize any gains on sale of investment previously classified as held for trading (December 31, 2017 – U.S. $6,718). 31 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 16. Supplemental cash flow information: Accrued rents receivable Prepaid expenses and sundry assets Accounts receivable Accounts payable and accrued liabilities 2018 2017 $ (5,077) $ (876) 7,693 3,338 (3,615) 8 (2,728) 6,109 $ 2,339 $ 2,513 The following amounts have been excluded from operating, investing and financing activities in the consolidated 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 from issuance of Units Non-cash assumption of mortgage payable on disposition of investment properties Mortgages receivable from the sale of investment properties Mortgage receivable used for the acquisition of property under development Restricted cash from the disposition of investment properties Restricted cash used for the acquisition of investment properties Exchangeable units exchanged for Units Other items: 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 17. Capital risk management: The REIT’s primary objectives when managing capital are: Note 12(c) 8(b)(iii) 9 15 15 2018 2017 $ 16,632 $ 107,411 70 2,033 140 - 34,100 (164,878) - - 500 9 362 (2,780) (3,626) 2 11,051 7,523 (126,567) 4,200 - 26,265 (13,109) 13,324 336 (1,809) (1,562) (1,076) (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: Debt Exchangeable units Unitholders' equity December 31 December 31 2018 2017 $ 6,546,072 329,482 7,200,100 $ 6,493,617 341,321 7,179,763 $ 14,075,654 $ 14,014,701 32 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 17. Capital risk management (continued): As long as the REIT complies with its investment and debt restrictions set out in its Declaration of Trust, it is free to determine the appropriate level of capital in context with its cash flow requirements, overall business risks and potential business opportunities. As a result of this, the REIT will make adjustments to its capital based on its investment strategies and changes in economic conditions. The REIT’s level of indebtedness is subject to the limitations set out in its Declaration of Trust. The REIT is limited to a total indebtedness to 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, 2018, this ratio was 44.6% (December 31, 2017 - 43.9%). Management uses this ratio as a key indicator in managing the REIT’s capital. In addition to the above key ratio, the REIT’s debt has various covenants calculated as defined within these agreements. The REIT monitors these covenants and was in compliance as at December 31, 2018 and December 31, 2017. 18. 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-positive rating by a recognized rating agency. The REIT’s exposure to credit risk on receivables is as follows: Mortgages receivable Accounts receivable (b) Liquidity risk: Note 6 6 December 31 December 31 2018 $ 96,909 12,401 2017 $ 153,211 15,739 $ 109,310 $ 168,950 The REIT is subject to liquidity risk whereby the REIT may not be able to refinance or pay its debt obligations when they become due. The REIT manages liquidity risk by:  Ensuring appropriate unsecured term loans and lines of credit available are available. As at December 31, 2018 the consolidated amount available under its lines of credit was $768,196 (note 8(d));  Maintaining a large unencumbered asset pool. As at December 31, 2018, there were 91 unencumbered properties with a fair value of $3,438,151; and  Structuring its financing so as to stagger the maturities of its debt, thereby minimizing exposure to liquidity risk in any one year (note 8). 33 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 18. Risk management (continued): Management monitors the REIT’s liquidity risk through review of financial covenants contained in bank credit facility agreements, debt agreements and compliance with the REIT’s Declaration of Trust. The REIT’s obligations are as follows: Debt(1) Accounts payable and accrued liabilities(2) (1) (2) Amounts in the above table only include principal repayments. Excludes options payable. (c) Market risk: Note 8 10 2019 $ 530,696 201,279 Thereafter $ 6,036,707 10,983 Total $ 6,567,403 212,262 $ 731,975 $ 6,047,690 $ 6,779,665 The REIT is subject to currency risk and interest rate risk. The REIT’s objective is to manage and control market risk exposure within acceptable parameters, while optimizing the return on risk. (i) Currency risk: 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 U.S. denominated debt of $278,000 (2017 - U.S $592,000) consisting of the Series P Senior Debentures, U.S. unsecured term loans and U.S. lines of credit (2017 - Series J Senior Debentures, U.S. unsecured term loans and U.S. lines of credit) as a hedge of its net investment in foreign operations of approximately U.S. $1,492,000 (2017 - U.S. $1,404,000). A $0.10 weakening of the U.S. dollar against the average Canadian dollar exchange rate of $1.30 for the year ended December 31, 2018 (December 31, 2017 - $1.30) as well as the Canadian dollar exchange rate as at December 31, 2018 of $1.36 (December 31, 2017 - $1.26) would have decreased other comprehensive income (loss) by approximately $177,000 (December 31, 2017 - $146,900) and decreased net income by approximately $14,600 (December 31, 2017 - $21,600). This analysis assumes that all other variables, in particular interest rates, remain constant (a $0.10 strengthening of the U.S. dollar against the average Canadian dollar would have had the equal but opposite effect). (ii) Interest rate risk: The REIT is exposed to interest rate risk on its borrowings. It minimizes this risk by obtaining long-term fixed interest rate debt. At December 31, 2018, the percentage of fixed rate debt to total debt was 91.6% (December 31, 2017 – 88.2%). Therefore, a change in interest rates at the reporting date would not have a material impact on net income as the majority of the REIT’s borrowings are through fixed rate instruments. As at December 31, 2018, unsecured term loans and lines of credit of $355,773 are subject to variable interest rates. An increase in interest rates of 100 basis points for the year ended December 31, 2018 would have decreased net income by approximately $3,600 (December 31, 2017 - $2,200). This analysis assumes that all other variables, in particular foreign exchange rates, remain constant. The floating rate Series K and Series P senior debentures are subject to variable rates, however the REIT entered into interest rate swaps to reduce exposure to fluctuations in interest rates. In 2018, the floating rate Series M senior debentures were subject to variable interest rates. An increase in interest rates of 100 basis points for the year ended December 31, 2018 would have decreased net income by approximately $1,500 (December 31, 2017 - $1,300). This analysis assumes that all other variables, in particular foreign exchange rates, remain constant. 34 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 18. Risk management (continued): As at December 31, 2018, a mortgage payable of $45,519 is subject to variable interest rates. An increase in interest rates of 100 basis points for the year ended December 31, 2018 would have decreased net income by approximately $460 (December 31, 2017 - $1,300). This analysis assumes that all other variables, in particular foreign exchange rates, remain constant. (d) Fair value measurement: (i) Financial assets and liabilities carried at amortized cost: The fair values of the REIT’s accounts receivable, cash and cash equivalents and accounts payable and accrued liabilities approximate their carrying amounts due to the relatively short periods to maturity of these financial instruments. The fair value of certain mortgages receivable, mortgages payable, senior debentures, unsecured term loans and lines of credit have been determined by discounting the cash flows of these financial obligations using market rates for debt of similar terms and credit risks. (ii) Assets and Liabilities carried at fair value: Assets and liabilities measured at fair value in the consolidated 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). December 31, 2018 Assets measured at fair value Investment properties Properties under development Assets classified as held for sale Derivative instruments Mortgage receivable Assets for which fair values are disclosed Mortgages receivable Liabilities measured at fair value Exchangeable units Derivative instruments Liabilities for which fair values are disclosed Mortgages payable Senior debentures Unsecured term loans Lines of credit Note Level 1 Level 2 Level 3 Total fair value Carrying value 3 3 5 6 6 6 9 10 8(a) 8(b) 8(c) 8(d) $ - - - - - $ - - - 5,445 - $ 12,683,709 404,814 110,940 - 44,731 $ 12,683,709 404,814 110,940 5,445 44,731 $ 12,683,709 404,814 110,940 5,445 44,731 - - (329,482) - - - - - (329,482) 52,306 57,751 - (2,701) (4,226,404) (1,611,734) (452,143) (332,739) (6,625,721) - 52,306 52,178 13,244,194 13,301,945 13,301,817 - - - - - - - (329,482) (2,701) (329,482) (2,701) (4,226,404) (1,611,734) (452,143) (332,739) (6,955,203) (4,150,459) (1,613,040) (450,629) (331,944) (6,878,255) $ (329,482) $ (6,567,970) $ 13,244,194 $ 6,346,742 $ 6,423,562 35 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 18. Risk management (continued): December 31, 2017 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 Liabilities for which fair values are disclosed Mortgages payable Senior debentures Unsecured term loans Lines of credit 3 3 6 6 8(b) 9 8(a) 8(b) 8(c) 8(d) $ - - - $ - - 6,374 $ 13,074,123 83,132 - $ 13,074,123 83,132 6,374 - $ 13,074,123 83,132 6,374 - - 155,656 162,030 - 13,157,255 155,656 13,319,285 153,211 13,316,840 (103,140) (341,321) - - - - (444,461) - - (4,067,657) (1,779,043) (184,293) (495,802) (6,526,795) - - - - - - - (103,140) (341,321) - (4,067,657) (1,779,043) (184,293) (495,802) (6,971,256) (103,140) (341,321) (3,958,631) (1,749,650) (186,629) (495,567) (6,834,938) $ (444,461) $ (6,364,765) $ 13,157,255 $ 6,348,029 $ 6,481,902 19. Compensation of key management personnel: Key management personnel are those individuals who 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 2018 $ 6,259 1,888 $ 8,147 2017 $ 3,794 3,353 $ 7,147 36 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 20. Segmented disclosures: (i) Operating segments: The REIT has six reportable operating segments (Office, which also includes the REIT’s head office, 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 REIT. The CEO measures and evaluates the performance of the REIT based on property operating income on a proportionately consolidated basis for the REIT’s equity accounted investments. The accounting policies of the segments presented here are consistent with the REIT’s accounting policies as described in note 2. Real estate assets by reportable segment as at December 31, 2018 and December 31, 2017 are as follows: December 31, 2018 Number of investment properties Real estate assets: Investment properties Office Primaris 35 30 H&R Retail 59 ECHO Industrial Lantower Residential 230 90 22 Total 466 $ 6,752,450 $ 2,733,296 $ 570,357 $ 870,033 $ 1,043,220 $ 1,755,592 $ 13,724,948 Properties under development - - - 12,444 85,567 1,451,821 1,549,832 6,752,450 2,733,296 570,357 882,477 1,128,787 3,207,413 15,274,780 Less: assets classified as held for sale (93,840) Less: REIT's proportionate share of real estate assets relating to equity accounted investments - - - - - - (17,100) - (110,940) (882,477) (60,267) (1,132,573) (2,075,317) $ 6,658,610 $ 2,733,296 $ 570,357 $ - $ 1,051,420 $ 2,074,840 $ 13,088,523 December 31, 2017 Number of investment properties Real estate assets: Investment properties Office Primaris 36 31 H&R Retail 123 ECHO Industrial Lantower Residential 227 93 17 Total 527 $ 6,562,552 $ 2,945,800 $ 1,399,672 $ 789,419 $ 1,035,920 $ 1,187,191 $ 13,920,554 Properties under development - - - 10,345 83,132 805,127 898,604 6,562,552 2,945,800 1,399,672 799,764 1,119,052 1,992,318 14,819,158 Less: REIT's proportionate share of real estate assets relating to equity accounted investments - - - (799,764) (57,012) (805,127) (1,661,903) $ 6,562,552 $ 2,945,800 $ 1,399,672 $ - $ 1,062,040 $ 1,187,191 $ 13,157,255 37 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 20. Segmented disclosures (continued): Property operating income by reportable segment for the years ended December 31, 2018 and December 31, 2017 is as follows: Office Primaris H&R Retail ECHO Industrial Lantower Residential Sub-total Less: Equity Accounted Investments December 31 2018 Rentals from investment properties $ 598,914 $ 284,505 $ 86,197 $ 68,237 $ 87,496 $ 137,742 $ 1,263,091 $ (86,533) $ 1,176,558 Property operating costs (209,058) (125,855) (20,093) (14,849) (24,612) (73,753) (468,220) 25,594 (442,626) Property operating income $ 389,856 $ 158,650 $ 66,104 $ 53,388 $ 62,884 $ 63,989 $ 794,871 $ (60,939) $ 733,932 Office Primaris H&R Retail ECHO Industrial Lantower Residential Sub-total Less: Equity Accounted Investments December 31 2017 Rentals from investment properties $ 600,792 $ 281,086 $125,194 $ 72,548 $ 96,838 $ 80,454 $1,256,912 $ (88,458) $ 1,168,454 Property operating costs (211,645) (123,822) (28,610) (15,254) (25,584) (40,511) (445,426) 18,413 (427,013) Property operating income $ 389,147 $ 157,264 $ 96,584 $ 57,294 $ 71,254 $ 39,943 $ 811,486 $ (70,045) $ 741,441 (ii) Geographical locations: The REIT operates 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: REIT's proportionate share of real estate assets relating to equity accounted investments Rentals from investment properties: Canada United States Less: REIT's proportionate share of rentals relating to equity accounted investments 38 December 31 December 31 2018 2017 $ 9,186,352 6,088,428 $ 9,344,350 5,475,050 15,274,780 14,819,400 (110,940) (2,075,317) - (1,662,145) $ 13,088,523 $ 13,157,255 2018 2017 $ 875,418 $ 871,955 387,673 384,957 1,263,091 1,256,912 (86,533) (88,458) $ 1,176,558 $ 1,168,454 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 21. Income tax expense (recovery): Income tax computed at the Canadian statutory rate of nil applicable to the REIT for 2018 and 2017 Current U.S. income taxes Deferred income taxes (recovery) applicable to U.S. Holdco: Impact of U.S. Tax Reform Other 2018 2017 $ - $ - 760 1,538 - 39,457 39,457 (87,970) 48,193 (39,777) Income tax expense (recovery) in the determination of net income $ 40,217 $ (38,239) 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 combined federal and state tax rate of approximately 24% in 2018 (2017 - 37.5%). As a result of U.S. legislation enacted on December 22, 2017, commonly referred to as the Tax Cuts and Jobs Act of 2017 (“U.S. Tax Reform”), deferred income taxes have been measured based upon a 21% federal income tax rate. The income tax recovery for the year ended December 31, 2017 reflects the impact of U.S. Tax Reform resulting from the reduction in the federal tax rate from 35% to 21% effective in 2018 (24% including state tax) and a reduction in certain deferred tax assets related to deferred interest deductions. 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 Accounts payable and accrued liabilities Other assets Deferred tax liabilities: Investment properties Equity accounted investments December 31 December 31 2018 2017 $ 22,551 $ 6,924 585 1,463 24,599 284,006 132,807 416,813 1,387 2,257 10,568 256,507 79,192 335,699 Deferred tax liability $ (392,214) $ (325,131) The change in deferred tax liability is the result of deferred income tax expense (recovery) of $39,457 (2017 - ($39,777)) and change in foreign exchange of $27,626 (2017 - ($21,867)) recognized in other comprehensive income. 39 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 21. Income tax expense (recovery) (continued): As at December 31, 2018, U.S. Holdco had accumulated net operating losses available for carryforward for U.S. income tax purposes of $92,805 (December 31, 2017 - $28,879), the benefit of which has been recognized and deferred interest deductions of $200,324 (December 31, 2017 - $194,489), the benefit of which has not been recognized as a result of U.S. Tax Reform. Certain aspects of U.S. Tax Reform may be subject to clarifications or varying interpretations including the treatment of deferred interest deductions. Certain of the net operating losses will expire between 2031 and 2032. Net operating losses arising after December 31, 2017 do not generally expire under current tax legislation. The deductible temporary differences do not generally expire under current tax legislation. 22. Related party transaction: In 2018, the REIT paid approximately U.S. $14,600 for 20.3 acres of land in Dallas, TX, to be developed into approximately 1,000 multi-family units, from an entity in which the CEO held a 50% ownership interest. 23. 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, 2018, the REIT has outstanding letters of credit totalling $25,874 (December 31, 2017 - $32,924), including $17,340 (December 31, 2017 - $15,120) which has been pledged as security for certain mortgages payable. The letters of credit are secured by certain investment properties. The REIT provides guarantees on behalf of third parties, including co-owners. As at December 31, 2018, the REIT issued guarantees amounting to $263,853 (December 31, 2017 - $497,539), which expire between 2019 and 2029 (December 31, 2017 - expire between 2020 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, 2018, the estimated amount of debt subject to such guarantees, and therefore the maximum exposure to credit risk, is $43,963 (December 31, 2017 - $119,279) which expires in 2020 (December 31, 2017 - expires between 2018 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 consolidated 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 material adverse effect on the consolidated financial statements. 24. 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 2018 100% 100% 100% 100% 100% 100% 2017 100% 100% 100% 100% 100% 100% 40 H&R REAL ESTATE INVESTMENT TRUST Notes to Consolidated Financial Statements (In thousands of Canadian dollars, except Unit and per Unit amounts) Years ended December 31, 2018 and 2017 25. Subsequent events: (a) In January 2019, the REIT sold one U.S. office property which was classified as held for sale as at December 31, 2018, for gross proceeds of U.S. $69,800. (b) In February 2019, the REIT secured two new mortgages totalling $36,550, bearing interest at 3.36% per annum for a term of 10 years. 41 Corporate Information H&R REIT Board of Trustees Thomas J. Hofstedter (1), President and Chief Executive Officer, H&R Real Estate Investment Trust Robert Dickson (2,3), Strategic financial consultant, marketing communications industry Edward Gilbert (2), Chief Operating Officer, Firm Capital Mortgage Investment Trust Laurence A. Lebovic (1), Chief Executive Officer, Runnymede Development Corporation Ltd. Ronald C. Rutman (1,3), Partner, Zeifman & Company, Chartered Accountants Stephen Sender (2,3), Financial Consultant Alex Avery (1), Private Investor Juli Morrow, Partner, Goodmans LLP Officers Thomas J. Hofstedter, President and Chief Executive Officer Larry Froom, Chief Financial Officer Robyn Kestenberg, Executive Vice-President, Corporate Development 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) (1) Investment Committee (2) Audit Committee (3) Compensation, Governance and Nominating Committee Auditors: KPMG LLP Legal Counsel: Blake, Cassels & Graydon LLP Taxability of Distributions: 33.3% of 2018 distributions (including those from H&R Finance Trust) will be treated as a return of capital and 1.7% will be designated as taxable capital gains. For taxable Canadian unitholders, 35.0% (2017 - 39.7%) of the distributions will not be subject to current income taxes. Plan Eligibility: RRSP, RRIF, DPSP, RESP, RDSP, TFSA Stock Exchange Listing: Units and debentures of H&R are listed on the Toronto Stock Exchange under the trading symbols HR.UN. Registrar and Transfer Agent: AST Trust Company (Canada), P.O. Box 4229, Station A, Toronto, Ontario, Canada M5W 0G 1, Telephone: 1-800-387-0825 (or for callers outside North America 416-682-3860), Fax: 1 - 8 8 8 - 4 8 8 - 1 4 1 6 , 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 Modera Westshore, Tampa Dufferin Mall, Toronto  Corus Quay, Toronto www.HR-REIT.com

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