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Edited Transcript of Brookfield Residential Properties Inc earnings conference call or presentation 1-May-17 3:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Brookfield Residential Properties Inc Earnings Call

CALGARY May 31, 2017 (Thomson StreetEvents) -- Edited Transcript of Brookfield Residential Properties Inc earnings conference call or presentation Monday, May 1, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alan Norris

Brookfield Residential Properties Inc. - CEO, President and Director

* Thomas Lui

Brookfield Residential Properties Inc. - CFO and VP

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Conference Call Participants

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* Arjun C. Chandar

JP Morgan Chase & Co, Research Division - Research Analyst

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Presentation

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Operator [1]

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Welcome to the Brookfield Residential Properties First Quarter 2017 Results Conference Call. (Operator Instructions) And the conference is being recorded. (Operator Instructions)

I would now like to turn the conference over to Alan Norris, President and Chief Executive Officer. Please go ahead.

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Alan Norris, Brookfield Residential Properties Inc. - CEO, President and Director [2]

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Thank you. Good morning, everyone. Thank you for joining us for Brookfield Residential's 2017 First Quarter Conference Call. With me today is Thomas Lui, our Senior Vice President and Chief Financial Officer. This call is intended for current holders and beneficial owners of Brookfield Residential's debt securities as well as prospective investors, securities analysts, market makers and other interested parties.

I would, at this time, remind you that in responding to questions and in talking about new initiatives and our financial and operating performance, we will make forward-looking statements, including forward-looking statements within the meaning of applicable Canadian and U.S. securities laws. These statements reflect predictions of future events and trends and do not relate to historical events, are subject to known and unknown risks, and future events may differ materially from such statements. For more information on these risks and the potential impact on our company, please see our historical filings with the securities regulators in Canada and the U.S. and the information available on our website.

Brookfield Residential had positive results in the first quarter of 2017 as we continue to build on our strong performance in 2016 combined with a good start to our spring selling season. For the 3 months ended March 31, 2017, our income before income taxes was $14 million compared to a loss before income taxes of $3 million in 2016. Our homebuilding operations continued to grow as we closed 581 homes in the first quarter, representing a 13% growth when compared to the same period in the prior year. We also experienced a 16% increase in both net new home orders and backlog units in the first quarter of the year.

Our U.S. operations enjoyed a strong start to the year with net new home orders increasing more than 29% when compared to the same period last year. The increase can be attributed to the improved consumer confidence from general and positive economic trends in the U.S., combined with expanded product offerings in many of our new communities.

As an example, as a result of our collaboration with Apple and Amazon Alexa, many of our new product offerings have resulted in increased activity in some of our California and Washington, D.C. communities. However, the rainy weather in California and the overall tight labor availability in many of our U.S. markets, particularly in Northern California, Denver and Austin, could slow our planned home deliveries in 2017.

In Canada, we continue to operate in 2 very different markets in Alberta and Ontario. As the Alberta operations have been impacted by lower oil prices, recent stabilization has resulted in some improvement in consumer confidence. This was evident in the well-received opening of our newest master-planned community of Livingston in Calgary, which resulted in an increase in lot closings and net new home orders. Our Alberta operations benefited from the good initial impressions of our community openings as our net new home orders increased 42% when compared to the same period in 2016.

Our Ontario operations continue to take advantage of market conditions where we're seeing high demand for homes and price appreciation driven by an overall lack of supply. We continue to maintain all homes under contract necessary to achieve our projected 2017 closings and are steadily building our backlog for 2018 and '19.

The Ontario provincial government recently announced a number of measures to address affordability of housing in the greater Toronto area. One of the initiatives introduced was a new 15% nonresident speculation tax. As the new legislation only came into effect on April 21, 2017, the magnitude of this change and the other measures is somewhat unknown at this time. As we have mentioned previously, however, we believe that the real solution going forward means collaborative what needs to be done to change the regulatory environment and pace of approvals so there's more product in the market to address the supply deficit and the resultant affordability challenges.

Based on our outlook at this early point in the year, we anticipate that income before income taxes for 2017 will exceed our 2016 results, and we offer the following limited guidance for 2017. For our Canadian markets, our view for 2017 is for similar results to '16 for both our housing and land operations, where we expect to close approximately 1,450 homes and 650 lots. For our U.S. operations, we anticipate our growth to continue and to close approximately 1,875 homes and 1,900 lots. In addition, we project a number of sales of multifamily, commercial and industrial parcels in both countries. Many of our lot and acre closings are projected for the end of 2017 and are subject to normal timing risks of approvals and the development and closing process.

As in previous years, the nature and operating cycle of our business continues to lend itself to generating the highest proportion of the year's net income in the fourth quarter. The integration of ALBI Homes into our Calgary operation has expanded our design, product and marketing offerings, which led to Brookfield Residential being recently recognized as the 2016 BILD Calgary Region Builder of the Year.

In addition, the expansion of our U.S. homebuilding operations will lead to sustained growth, particularly in our Central and Eastern U.S. segment, where the acquisition of Grand Haven Homes allowed us to achieve growth in the Austin market. As we believe current market conditions will continue in both the U.S. and Canada for 2017, the investments we have made in the past few years into our homebuilding operations are resulting in positive returns.

I'll now pass the call to Thomas to speak to our financial results.

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Thomas Lui, Brookfield Residential Properties Inc. - CFO and VP [3]

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Thank you, Alan, and good morning, everyone. Net income attributable to Brookfield Residential for the 3 months ended March 31, 2017, was $16 million compared to a net income of 0 in 2016. The increase of $16 million compared to the same period in 2016 was primarily the result of an increase in gross margin of $21 million as a result of higher land and housing activity and an increase in other income of $2 million. This is partially offset by an increase in general and administrative expense of $3 million, an increase in sales and marketing expense of $3 million and a decrease in income tax recovery of $1 million.

Housing revenue and gross margins were $307 million and $57 million, respectively, for the 3 months ended March 31, 2017, compared to $239 million and $43 million for the same period in 2016. The increase in revenue was primarily the result of 65 additional home closings, a 14% increase in the average home selling price and a 4% increase in the Canada to U.S. dollar foreign exchange rate when compared to the same period in 2016.

The increase in gross margin was primarily due to an increase in the average home selling price, particularly in our Southern California and Ontario markets as well as higher closings across all of our operating segments. The increase in gross margin percentage was primarily driven by higher housing margins in our Ontario market, which have yielded a higher gross margin percentage due to price appreciation from strong market conditions.

In Canada, housing revenue increased $21 million when compared to the same period in 2016, primarily due to a 9% increase in the average home selling price and 33 additional home closings. The change in the average home selling price was primarily due to higher average selling prices in Ontario market as well as impacted by a 4% increase in the foreign exchange rate between the Canadian and U.S. dollar.

The average home selling prices in Canadian dollars for the 3 months ended March 31, 2017, and 2016 was $504,000 and $476,000, respectively, representing a 6% increase. The increase was primarily due to product mix with a larger proportion of homes sold from our Calgary luxury products and from Ontario, which typically have a higher average selling price. Gross margin increased $7 million and gross margin percentage increased 3% for the 3 months ended March 31, 2017, primarily as a result of product mix, price appreciation and an increase in the foreign exchange rate between the Canadian and U.S. dollar.

In California, we had housing revenue of $140 million for the 3 months ended March 31, 2017, an increase of $50 million when compared to the same period in 2016. The increase in revenue was primarily due to a 30% increase in the average home selling price and 27 additional home closings. The average home selling price increase is the result of the mix of homes closed, primarily in our Bay Area and Southern California markets with a higher proportion of closings coming from communities with higher average home selling prices compared to the same period in 2016. Gross margin increased $8 million as a result of increase in home closings when compared to the same period in 2016 while gross margin percentage decreased 2%, primarily as a result of product mix particularly in our Southern California market.

In the Central and Eastern U.S. segment, housing revenue decreased $3 million for the 3 months ended March 31, 2017, when compared to the same period in 2016. The decrease in revenue was primarily the result of a 9% decrease in the average home selling price, partially offset by 5 additional home closings. The decrease in the average home selling price was due to the mix of homes sold in our Austin and Washington markets.

As of March 31, the units in our backlogs increased compared to the prior period, primarily due to higher net new home orders across all 3 operating segments. The units in backlog in our Canadian operations increased due to higher backlog units from our Calgary and Ontario markets. This was partially offset by fewer backlogs units in Edmonton.

Our California operation units in backlog increased as a result of a 30% increase in net new home orders, driven by higher orders in both our San Francisco Bay Area and Southern California market. The increase of 64 units in the Central and Eastern U.S. segment was primarily due to a 29% increase in the net new home orders, particularly in our Austin market. Total backlog value increased 29% compared to the same period in 2016.

Land revenue totaled $31 million for the 3 months ended March 31, 2017, an increase of $3 million when compared to the same period in 2016 and gross margin increased $7 million to $17 million over the same period. The increase in land revenue was primarily due to a 54% increase in the average single-family lot selling price, resulting from the mix of lots sold as well as an increase in the average selling price from raw and partially finished acres.

This was partially offset by 68 fewer single-family lot closings and 3 fewer multifamily industrial and commercial acres sold compared to 2016. Gross margin and gross margin percentage increased for the 3 months ended March 31, 2017, primarily due to the mix of lots sold with increased single-family lot closings in the Canadian segment, which typically have higher average selling prices and gross margins.

When we look at our operating segments for 2017, land revenue in Canada was $19 million, an increase of $7 million when compared to the same period in 2016. The increase was primarily the result of 55 additional single-family lots closed and an increase in the average single selling -- average selling price for single-family lots. This was partially offset by 4 fewer multifamily, industrial and commercial acre sales and 80 fewer raw and partially finished acre sales in 2017 when compared to the same period in 2016.

Gross margin increased $5 million when compared to 2016, primarily as a result of additional single-family lot closings in 2017 and an increase in the average selling price for single-family lots. The increase in the average lot selling price is a result of the geographic mix of lots sold within the segment, with more lot sales coming from the Calgary market, which typically have higher average selling prices.

Land revenue in California decreased by $6 million when compared to the same period in 2016. This is primarily the result of having no single-family lot sales for the 3 months ended March 31, 2017, compared to 103 single-family lot closings due to the timing of lots sold during the same period in 2016. This was partially offset by 16 raw and partially finished acre closings in our Southern California market compared to none in the same period in 2016.

In the Central and Eastern U.S., land revenue and gross margin each increased by $2 million. The increase in revenue and gross margin is a result of an increase in the average lot selling price, primarily as a result of a change to the geographic mix of lots sold within the segment. This is partially offset by 20 fewer single-family lot closings when compared to the same period in 2016. Gross margin percentage increased to 25% as a result of mix of lots sold within the segment during the 3 months ended March 31, 2017, when compared to the same period in 2016.

Moving to our balance sheet. As at March 31, 2017, our assets totaled $4 billion. Our housing and land inventory and investments in unconsolidated entities are our most significant assets with a combined book value of $3.3 billion or approximately 82% of our total assets.

The land and housing assets increased when compared to 2016 due to $61 million of acquisitions, development activity and stronger backlog, partially offset by sales activity. Land and housing assets include land under development and land held for development, finished lots ready for construction, homes completed and under construction and model homes.

Taking a look at our liabilities and equity, our net debt-to-capitalization ratio at March 31, 2017, is 48%, which is generally in line with December 31, 2016.

That wraps up our review of our financial results for the first quarter. Thank you to those joining us in the quarter end conference call. I'll now turn the conference call back to the operator who will moderate questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from James Finnerty with Citi.

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Unidentified Analyst, [2]

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This is [Venetia] on for James. I guess, starting off, could you maybe walk us through your markets just discussing order cadence through the first quarter and in April, which markets where you see the most incentives, and I think they were up company-wide on a year-over-year basis.

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Alan Norris, Brookfield Residential Properties Inc. - CEO, President and Director [3]

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It's Alan here. Sorry, could you maybe -- I'd just clarify the question, is it walk through each of our markets and talk about first quarter activity or what the state of the markets were? I was unsure.

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Unidentified Analyst, [4]

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Yes, yes. Just order cadence through the first quarter and April so far and, I guess, traffic, which markets are you seeing the most use of incentives in.

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Alan Norris, Brookfield Residential Properties Inc. - CEO, President and Director [5]

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Okay. Yes, I'll start in Alberta here from a Canadian perspective. So the markets in Calgary, as I touched on briefly in the prepared remarks, we're seeing a little bit more restoration of consumer confidence. We had some openings in the first quarter for some new communities here in Calgary, which were very well received. And as an example, we sold 79 homes in Calgary in the month of March, which -- I mean, if we're looking at roughly 450 homes for the year, that's an extremely good month. So we are seeing some good return and confidence in the Calgary market. Edmonton is a little bit more fragmented but generally hanging in there and did okay in the first quarter. The Toronto market, I touched on a little bit on that in the prepared remarks. I mean, that marketplace has gone through a bit of overexuberance, and the problems stepped in to try and deal with housing affordability with some measures to try and address that through a speculative buyer tax similar to what Vancouver introduced as well as 15 other points, which, candidly, I'm not sure addresses all of the issues. I think we still believe, as I still believe, that we have a shortage on the supply side, which will not be solved overnight. And we have to get more supply into the market to address affordability on a more practical level. Some of the initiatives will dampen the market in the short run, but we don't see having much of an impact on us at this point. We have all of the homes that we are planning to occupy this year in backlog. And we have deposits from all of those customers. And in most cases, they have built-in equity based on the pricing that we are closing the homes at. So we're feeling comfortable in that market, albeit there's a fair bit of media surrounding the Toronto marketplace just now, which -- pricing went up 32% year-over-year, February-to-February, which obviously is unsustainable. But I think some [stairs] is starting to flatten out a little bit, which is actually all positive for us, to be quite honest. Going into the U.S. markets, Washington D.C. had a good first quarter. We were ahead of schedule as to what our expectations were from a sales pace. So we're feeling good on that market. Denver is a decent market at this point for all industry participants. And we missed a few closings. But generally speaking, our sales were in line with our expectations. Austin, we had a very good January in Austin, slowed a little bit in February, picked up a little again in March and was very good in April so -- for our new community offerings in the Austin market. Going to Phoenix, we don't have a housing operation there. But in our land operation, our lot sales in East -- or joint venture that we have with DMB Associates, the sales pace in that community is -- potentially could get up to almost 800 lot sales for the entire year. We've had a very, very strong start in the Phoenix market in that project through the first quarter. And so we're feeling good about that. California, good activity in Southern California across all product types, Inland Empire as well as the Playa Vista project; we are -- and then up in Northern California. I mean, both Southern and Northern California were affected a lot by the rains. I mean, the drought is officially over in California. We were probably hit a little bit harder in Northern California, which has pushed some of our openings back just because it was -- we lost about 52 days from December through March just from a what quantity and just getting things done. And then it was a bit of a quagmire in most of our communities. So we have been delayed somewhat. Now we're no different than other industry members as well. But the one overriding fact, though, in the U.S. is still a bit of a shortage on the labor side that we're observing. And then obviously, we've got the situation with softwood lumber from a tariff point of view, which will increase the price of lumber, albeit products from January 1 through March 31, the price of lumber increased close to 25%, absent anything on the tariff side. So I think the marketplace will deal with that. And I think probably that the result is going to be if there's decreased demand for Canadian softwood lumber, it will be an impact more on the lumber mills as opposed to anything too much on the pricing side. That's a bit of a snapshot, quickly. [Go ahead.]

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Thomas Lui, Brookfield Residential Properties Inc. - CFO and VP [6]

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Yes. And just maybe to recap. This is Thomas here. When you take a look at our net new orders across the board, they are up in the U.S. predominantly in every single one of our markets with the exception of the Bay Area, which Alan spoke to, that some of our product and community openings are a bit delayed due to the rain. And then when it comes to Canada, we were relatively flat in the first quarter for net new home orders. And that's primarily due to Alberta increasing due to the community openings offset by a decrease in Ontario just due to practically that we don't have any -- too many active storefronts right now as we are building our 2018 and '19 backlog where we already have everything in place for 2017.

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Alan Norris, Brookfield Residential Properties Inc. - CEO, President and Director [7]

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That's correct, yes.

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Unidentified Analyst, [8]

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Okay, perfect. That's actually very helpful. And you sort of touched on this already in your comments. But I'm just trying to get a sense of where you're focusing your community count growth. So is it fair to say that we should expect sort of growth in community count in Northern California and the U.S.? What about Canada? Any commentary there will be helpful.

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Alan Norris, Brookfield Residential Properties Inc. - CEO, President and Director [9]

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Yes. I mean, I'll touch on it a little bit. I mean, I think we're well positioned in Canada from an opening point of view. So we're in some very well-established communities, which are larger in size and scope than some of the ones in the U.S. So I would say that because some of the projects here are 1,000 acres in size, whereas, down in the States, maybe some of them are smaller, and therefore, there's more of them. But I would say from a growth point of view, we're definitely looking -- we were very comfortable with the growth prospects within the U.S. and future affordability, quite honestly. So we'll stay status in just normal growth, shall we say, from a Canadian point of view with a little bit more impetus probably in the U.S. side.

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Thomas Lui, Brookfield Residential Properties Inc. - CFO and VP [10]

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And you saw some of the community growth counts in Canada this quarter, primarily due to just expanded offering due to the ALBI integration of bringing in some move-up in luxury products, which resulted in some of the increase there. We may bring on some additional Ontario communities, once again, the build of 2018/'19 backlog, but those are more shorter term in nature. And then as Alan's mentioned, continued growth in the U.S. predominantly with California with some of the community openings there due to some of the delays we've had.

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Unidentified Analyst, [11]

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Okay. And then, I guess, my last question, just touching on leverage. I know in the past, sort of before the equity issuance in fourth quarter, you've said that you were targeting a debt-to-cap ratio of 50% to 55%. You've been below that. So has your target leverage changed? And are you happy with sort of operating on a lower year-over-year leverage on the business?

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Alan Norris, Brookfield Residential Properties Inc. - CEO, President and Director [12]

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Yes. I mean, I think we're obviously comfortable at the 48%. It gives us more flexibility. But as we bring more assets from the undeveloped state to the developed state, as we open up communities and we get more land in the developed category, then we can obviously carry a little bit more on the leverage side if we want to. So this gives us a little bit more dry powder, shall we say, as we move assets from undeveloped and entitled and we move it -- after a time, we move it into active development. So it gives us a little bit more leeway with respect to that. So we're a bit -- quite comfortable with where we are.

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Operator [13]

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(Operator Instructions) The next question is from Arjun Chandar with JPMorgan.

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Arjun C. Chandar, JP Morgan Chase & Co, Research Division - Research Analyst [14]

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One question on the -- you mentioned lumber inflation within the -- your U.S. footprint. How should we think about rising lumber costs on the back of the tariff in the U.S. versus your Canadian operations? Is there any material difference you're expecting from a cost perspective? Because, clearly, the tariffs are applied to U.S. lumber procurement. And how do we think about the Canadian operations?

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Alan Norris, Brookfield Residential Properties Inc. - CEO, President and Director [15]

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Yes. I mean, it's a very good question. I mean, I'm -- we've seen some increases in the pricing here already as well. I mean, obviously, the U.S. feels -- the U.S. lumber lobby feels that they can deal with the demands from a U.S. perspective within their own borders. But obviously, probably, I think it was 78% of Canadian lumber actually goes to the U.S. But I think the result is going to be shutting down some mills if necessary here in Canada. I mean, that doesn't affect us directly, but it could obviously -- I think they will end up doing that to just deal with the demand side if they can't export and they can't meet the exports to the U.S. decline from a Canadian point of view. I'm no expert on it. But bearing in mind, I mean, in a typical U.S. house, we're probably in -- and it'll be similar in Canada. It's a bit -- maybe on a $15,000 for a lumber package in there with respect to that. So it's not a huge, huge issue on a 20% tariff. Not that I'm condoning it in any way, shape or form. But it's probably about a $3,000 issue, ignoring the fact that some of the price of lumber went up, in my opinion, in anticipation of the tariff. So I don't think we'll see too much change, but it remains to be seen. I'm no expert on the futures.

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Arjun C. Chandar, JP Morgan Chase & Co, Research Division - Research Analyst [16]

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No, that's good color. Very helpful. And then just on the balance sheet. With regards to the 6.5% of '20, what are your latest thoughts around refinancing the front-end bond, just given the strength of the capital markets and what we're seeing not only in housing but in kind of the broader high-yield market today?

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Thomas Lui, Brookfield Residential Properties Inc. - CFO and VP [17]

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Yes. This is Thomas here, Arjun. And in regards to potential refinancing of our 2020s, that is something that we'll continue to evaluate on a regular basis. And obviously, considering market conditions and overall kind of leverage and requirements for the company, we'll continue to monitor until the right opportunity presents itself. We will continue to look and review and do what's best for our balance sheet.

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Operator [18]

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This concludes the question-and-answer session. I would now like to turn the conference back over to Alan for any closing remarks.

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Alan Norris, Brookfield Residential Properties Inc. - CEO, President and Director [19]

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Great. Thanks very much. I appreciate everybody taking interest in us, and look forward to chatting with you at the end of Q2. Thanks again.

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Operator [20]

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This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.