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Edited Transcript of BRP.TO^C15 earnings conference call or presentation 29-Jul-19 3:00pm GMT

Q2 2019 Brookfield Residential Properties Inc Earnings Call

CALGARY Aug 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Brookfield Residential Properties Inc earnings conference call or presentation Monday, July 29, 2019 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. - Chairman & CEO

* Thomas Lui

Brookfield Residential Properties Inc. - Executive VP & CFO

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Conference Call Participants

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* James Peter Finnerty

Citigroup Inc, Research Division - Director

* Lee Dickson Brading

Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst

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Presentation

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Operator [1]

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Welcome to the Brookfield Residential Properties Inc. Second Quarter 2019 Conference Call. (Operator Instructions) The conference is being recorded. (Operator Instructions)

I would now like to turn the conference over to Thomas Lui, Executive Vice President and CFO. Please go ahead, sir.

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [2]

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Thank you, and good morning, everyone. Thank you for joining us for Brookfield Residential's 2019 Second Quarter Conference Call. With me today is Alan Norris, our Chairman and Chief Executive 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 operating performance, we will make forward-looking statements, including forward-looking statements within 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 their potential impact on our company, please see our historical filings with the securities regulators in Canada and in the U.S. and in information available on our website.

Net income attributable to Brookfield Residential for the 3 months ended June 30, 2019, was $16 million compared to $50 million for the 3 months ended June 30, 2018. The decrease of $34 million is primarily a result of a decrease in gross margin of $47 million primarily due to lower gross margins, a decrease in other income of $4 million and an increase in lease expense of $3 million as a result of the adoption of new leases accounting standard. This was partially offset by an increase in equity earnings from unconsolidated entities of $7 million, a decrease in income tax expense of $6 million, a decrease in G&A expense of $3 million, a decrease in sales and marketing expense of $3 million and a decrease in interest expense of $1 million.

In the first half of 2019, we delivered 1,374 homes compared to 1,477 homes in the same period for the prior year. Included in 2018, we had closed 159 homes for our mid-rise condominium project in Aurora, Ontario. No such comparable closings in 2019.

Our housing gross margin percentage was lower at 16% in 2019 and reflects the increased incentives from slower U.S. and Canadian markets experienced in the latter half of 2018.

Housing revenue and gross margins were $405 million and $66 million, respectively, for the 3 months ended June 30, 2019, compared to $535 million and $104 million for the same period in 2018. The decrease in revenue and gross margin was primarily the result of 256 fewer home closings and a 4% decrease in the Canadian to U.S. foreign exchange rate partially offset by a 1% increase in the average home selling price. The gross margin percentage decreased 3% as a result of the mix of homes sold.

So looking at our housing activity by operating segment. Our Canadian segment had lower housing revenue and gross margin as a result of fewer home closings partially offset by a 4% increase in the average home selling price. The decrease in home closings was primarily the result of lower closings in our Ontario market, from the timing of community openings and an increase in the average home selling price was primarily due to an increase in our Ontario market from the product mix of homes sold.

Our California segment had a decrease in both housing revenue and gross margin primarily due to 150 fewer home closings partially offset by a 4% increase in the average home selling price as a result of the product mix of homes sold in Southern California.

The Central and Eastern U.S. segment had an increase in housing revenue, and while gross margin remained consistent with 2018 as a result of an 8% increase in the average home selling price partially offset by 18 fewer home closings.

At June 30, 2019, we had 1,390 units in our backlog with a value of $730 million compared to 1,923 units with a value of $1 billion at June 30, 2018. The decrease is primarily the result of slower sales pace in early 2019 and the impact of the lower backlog entering the year.

Our units of backlog in our Canadian segment at June 30, 2019, decreased by 217 units when compared to the same period in the prior year mainly due to the execution of our backlog with lower net new home orders in 2018 from our Ontario market.

Our California segment units and backlog decreased mainly due to a decrease in net new home orders in 2019. The Central and Eastern U.S. segment units in backlog decreased by 139 units due to a decrease in net new orders, where in 2018, in our Austin market, we had 134 bulk home sales with no comparable sale in the first half of 2019.

Our land revenue totaled $71 million for the 3 months ended June 30, an increase of $17 million, and land gross margin totaled $13 million, a decrease of $9 million compared to the same period in 2018. We closed a total 1,014 single-family lots in the first half of 2019, of which 456 lots were from our Homebuilder Finance program where minimal land gross margin is recognized at the time of closing but interest income is generated throughout the period that the lots are owned by Brookfield Residential.

Total land gross margin was reduced to 27% for the first half of 2019, but when the Homebuilder Finance program lots are -- lot closings are excluded, our land gross margin percentage from our land operations was actually 45% in 2019 compared to 41% in 2018.

When we look at our operating segments for 2019, land revenue and gross margin for our Canadian segment decreased as a result of a 28% lower average single-family lot selling price due to the mix of lots sold between the Calgary and Edmonton communities and 19 raw and partially finished acres sold in the second quarter of 2018 compared to none in 2019.

In California, land revenue and gross margin decreased due to 82 fewer single-family lot closings as a result of the timing of closings. Our Central and Eastern U.S. land revenue increased by $5 million, and gross margin increased $2 million when compared to the same period in 2018. This increase was primarily from an additional 68 single-family lot closings partially offset by an 8% decrease in single-family lot selling prices.

Moving to our balance sheet. As of June 30, 2019, our assets totaled $4.8 billion. Our land and housing inventory and investments in unconsolidated entities are our most significant assets with a combined book value of $3.4 billion or approximately 72% of our total assets.

Land and housing assets increased when compared to December 31, 2018, due to land acquisitions of $183 million and land development and home construction activity partially offset by sales activity. Our investments in unconsolidated entities increased as a result of continued development of land and construction of our inventory with our joint venture partner.

During the quarter, we also entered into a deposit agreement with Brookfield Asset Management, our parent company, to allow us from time to time cash to be deposited with Brookfield Residential at a lower rate than our current cost of borrowing.

At June 30, 2019, we had $200 million on deposit from BAM and our North American credit facility was undrawn. As a result, our liquidity available at June 30, 2019, included $105 million of cash and $617 million available on our North American unsecured revolving credit facility. Our net debt to total capitalization at June 30 was 46% compared to 44% at December 31, 2018.

I'll now pass the call to Alan, who will provide an overview of our operations and markets.

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [3]

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Thank you, Thomas, and good morning, everyone. Brookfield Residential's results for the first 6 months of 2019 were slower than last year and attributed to the slower U.S. housing market in the latter half of 2018 and early 2019, combined with the ongoing economic and regulatory challenges in the Canadian market. For the 6 months ended June 30, 2019, Brookfield Residential recorded income before income taxes of $30 million compared to $65 million in the same period of 2018.

The U.S. housing market improved in the second quarter with a decline in mortgage rates. This was combined with positive economic fundamentals, which were supported by continued job growth and limited housing supply. Although many of our U.S. markets were not as robust as the prior year spring selling season, we had net new home orders of 1,069 homes for the first 6 months of 2019 compared to 1,361 homes for the same period in 2018.

We are encouraged by the return of the market but remain cautious as affordability is a key consideration in markets such as California and Denver, Colorado. In addition, trade tensions and potential tariffs provide some degree of uncertainty and continues to affect consumer confidence.

Our Canadian operations continue to be impacted by the stress test mortgage rules and the economic conditions in Alberta. The new shared equity mortgage program may be implemented prior to the Federal election this fall, but we anticipate a marginal benefit to prospective home buyers. The Alberta economic environment continues to be challenged by Federal regulatory policies with the passing of bills C-69 and C-48, which may change future investments in the energy sector despite the Federal government reapproving the Trans Mountain pipeline expansion in June.

Net new home orders in Canada increased to 558 homes in 2019 when compared to 344 homes in 2018. The increase is directly attributable to 98 home orders -- new home orders from the new communities in Ontario where interest has been positive and at pricing that is similar to the homes closed last year. As per our expectations, the majority of these Ontario home sales are scheduled to close in 2020 versus 2019.

Also in the second quarter, we had our $300 million Class B junior preferred shares of Brookfield BPY Holdings Inc. redeemed and we used the proceeds to purchase $300 million of Series 1 Class A preference shares of Brookfield International Limited.

With our backlog at June 30, 2019, consisting of 1,390 units with a value of $730 million, the second half of the year continues to lend itself to generating the bulk of the year's net income with the highest proportion in the fourth quarter. We remain optimistic about the balance of 2019, and based on current forecast, we reaffirm our previously provided limited guidance of closing 950 homes and 850 lots in Canada and 1,950 homes and 1,650 lots in the U.S.

Our backlog also has improved margins over homes closed in the first half of 2019 as we reduced our selling incentives in our Q2 sales. We continue to project a number of multifamily, commercial and industrial partial sales in both countries in the last half of the year.

That wraps up the review of the results. Thank you for joining us in the Q2 2019 conference call. I'll now turn the call back to the operator, who will moderate the questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from James Finnerty with Citigroup.

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James Peter Finnerty, Citigroup Inc, Research Division - Director [2]

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I wanted to get your thoughts on the facility with BAM, the deposit facility. What is the cash used for? Is it reflected on the cash line? Is this something that you intend to use going forward? I know you said in the release that you tend to pay it down by year-end but will we be drawing on it again?

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

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Yes. This is Thomas here. And this is a very similar deposit agreement to what we had signed and agreed to in 2016. And it's just taking a look at from an overall Brookfield perspective, which is cash available from our parent company at a lower cost of borrowing and it is repayable back to them on demand. So we do anticipate that we will be required to repay this at some point within the year at the request of our parent company. The funds that were used was basically for general corporate purposes but also utilized to pay down our North American credit facility. So we would treat them as a borrowing at this time. So we anticipate that when BAM does require these funds back, we would just draw back on our credit facility.

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James Peter Finnerty, Citigroup Inc, Research Division - Director [4]

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Great. And then on the upcoming bond maturity, just any thoughts there with regard to refinancing? And would you look to be -- refinance the entire amount or is there some potential for overall debt reduction at that time?

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [5]

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Yes. The market's obviously bringing some opportunities to homebuilders and many have done some offerings. We're continuing to evaluate our options for 2020 bonds for refinancing at some point in the future. We don't really have an update at this time. So when we do, we'll obviously [launching] and let the group know.

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James Peter Finnerty, Citigroup Inc, Research Division - Director [6]

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Okay. Great. And then the last question would be just in terms of closings and orders for the quarter, where were they relative to your expectations? And I'm referring to home closings and home orders.

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [7]

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Sure. In terms of the expectations within home closings for the quarter, they continue to reflect -- as Alan mentioned earlier that it reflects a little bit of a slower U.S. market in the last half of 2018 combined with the slower Canadian market that we also experienced in Alberta and Ontario. As you recognize and then we spoke to all of last year, in Ontario, we had very limited sales and closings, and the lower closings in Canada does reflect the fact that we had limited sales rather in the last half of 2018. Alan can provide a little bit of the overview kind of what we're seeing in each of the markets, but we're much more -- recognize that the majority of our closings will still come in Q3 and Q4 of the year.

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [8]

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James, it's Alan here. Just to add to Thomas' comments, I mean, I think from an Ontario point of view, we stayed out of the market, and we've discussed this in past calls, consciously, as we were closing our backlog. And I think we've now started to see a little bit reaffirmation that our strategy was correct in Ontario to stay out. We've launched some new communities and we're seeing some [grounding] from a price point of view back at levels pre the frothiness. So I think we're feeling more comfortable with that particular market. And obviously, the market was slow for all participants in the market in the last half of last year and the early part of this year, which obviously gives rise to slightly lower closings at that point. Although we have reasonably good margin sitting in our backlog at this point, slightly ahead of what we did through the first half.

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James Peter Finnerty, Citigroup Inc, Research Division - Director [9]

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Okay. So therefore, just given the reaffirmation of your targets for full year, would the second quarter -- I mean from our perspective, I thought your closings and orders were better than what we were anticipating. I was just trying to gauge was it in line with what you were expecting for the quarter? I know you don't have guidance by quarter, but now that the quarter's passed, was what you generated in terms of closings and orders in line with the (inaudible)

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [10]

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Yes. I think we're close -- so I think we're close to where we thought we would be from the point [of view.] Given the lower backlog entering 2019 because we -- originally, we would prepare our expectations for 2019, that would be done in sort of September, October last year. But we assumed a slightly quicker recovery in the marketplace. So given that it didn't come back, I think we're okay with where we are now, and we will have stronger performance in the last half obviously as well as bottom line.

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Operator [11]

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The next question comes from Lee Brading with Wells Fargo Securities.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [12]

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I think this is -- is this the first quarter, like, I'm looking at my notes, that you guys have separately disclosed the Homebuilder Finance program?

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [13]

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Yes. Lee, that is correct. This is the first quarter that we have split out the Homebuilder Finance program. In previous quarters, they were very minimal, and the impact to overall margin did not have a significant impact as we did this time around. So yes, glad to answer any questions around it, but this is the first quarter and when we...

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [14]

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Yes. I guess going forward, is it something that'll be more material so you need to continue separate it out? Or is it kind of a onetime event?

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [15]

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Lee...

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [16]

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We'll continue to split it out, yes.

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [17]

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Yes. And just on the business side, really, we're utilizing some extra -- excess capital. And we're using it, in many cases, markets where we already have a presence but in some other markets as well. And it's got a fairly good return from a point of view of -- and most of the financing is between 2 or 3 years generally with a reasonable rate of return. So it's a good utilization of our capital.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [18]

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Got you. Yes, you answered some of my questions. So the typical holding period is 2 to 3 years. Is there a typical rate and, I guess, the minimal gross margin? So you're -- instead of a gross margin recognition, you're -- it's a -- you're financing, so it's a rate dynamic I guess. Is it more -- is it a more profitable transaction for you all versus an outright selling of land?

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [19]

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No. It would typically range between 12.5% and 14% from the point of view of the interest income earned. And we would take ownership of the lots and then we've been providing options to builders who would take down and they would be paying current pay interest for the most part. So it's -- with our knowledge of the marketplace and everything else, it -- we've got a good backstop in case something ever happens. And as you said, the security is the lot, so we're in a fairly good position. But it's a very -- it's a fairly traditional way of looking at it. But that's -- the multiple of capital [can be anywhere between] 1.2x and 1.5x depending on the term.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [20]

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Got you. And is it -- are there -- what are typical type of builders? Is it across the board larger nationals, the smaller builders? And in -- and I guess you touched on the markets, which market is it typically in?

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [21]

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I mean I would say probably about 60% to 70% of markets that we're in, and the rest would be in [maybe] some other markets that we're comfortable with. And the builders range from nationals to privates. I'm not going to go through the names, but we have a variety of builders that we deal with.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [22]

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Got you. Okay, great. And then you talked about it's a tougher comparison in Canada on the delivery side due to lack of a mid-rise product, I guess, this coming quarter on a year-over-year comparison. I guess could you just talk about the mid-rise market, what you see going forward?

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [23]

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Specifically, mid-rise was an Ontario closing, mid-rise product what we did there. They become a little bit lumpy. I mean we're not concerned about the mid-rise market, we just don't have that much on a regular basis coming in. Typically, in Alberta, the multifamily market would be townhomes. In many cases, we do the odd 3, 4-story walk-up type. That's a tough market in today's times, today's economics. We may have some future mid-rise in the Ontario market coming up in the next little while. So they tend to be a little bit lumpy. There's not as much there in our flow.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [24]

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Right. Got you. Okay. And then the ASP was up nicely across all of your markets. Looks like the biggest increase is in the Central and Eastern U.S., up almost 8%. Curious on, was it a particular market or particular product driving that?

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [25]

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Yes. Basically, you're correct. It is within a certain market there within the Central and Eastern U.S. when you take a look at things -- comparison to the previous year. A lot of the closings in 2018, last year, were from our Austin market, which typically have a lower ASP compared to this year where the majority of the closings did come from our Washington, D.C., market, which does have a bit higher of a ASP in comparison, and even within the Austin market, just due to the mix of the product that we're selling. In 2018, they were more the Cottages, which is a smaller product, that we had typically sold there. Whereas this year, there's -- the more of the larger single-family homes with the higher ASP, closer to the average for the segment of just under $500,000. So primarily, it's the mix within Austin and then just higher proportion in upper Washington, D.C., closings.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [26]

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Got you. Okay. And then can you touch on the incentives? You have a disclosure here in your [in doc]. It's very good and detailed as far as the incentive side. I guess increasing from a 2% last year revenue to 5% this year. But the one that really jumped out was Canada. It went up from 1% to 8%. I guess what are the types of incentives that are happening there? And are you seeing it -- is it leveling off or easing?

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [27]

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Yes. I could speak to just the numbers side of it initially, and then Alan could add any insight on the specifics of the incentives that are being provided. There is a higher incentive in Canada, you are correct, from the home closings that we've had. Predominantly, the incentives that were provided are in Alberta, in Calgary and Edmonton, just for the spec inventory that we have there. And then for the closings in the quarter, we did have some higher spec in Ontario that's just due to the continued execution of our backlog that we had it coming in initially from 2018. That was the -- many of the community openings that we've had so far in 2019 in Ontario, the level of incentives should come down in that market specifically but being balanced with continued incentives in Alberta. And Alan, like I said, can speak to some of the specifics.

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [28]

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Yes. I'll just expand on the Ontario ones. I mean what happened is, as we said earlier, we had sold a significant backlog going into 2018, and then we really stopped selling quite honestly as we continued just to work on our backlog and work with our customers. I mean what some of those incentives relate to is us negotiating with many of our customers when, in fact, they had entered into contracts at what I would call the peak pricing, and we wanted to work with them to try and get it back to where the market was. And so we worked closely with them perhaps to get increased deposits from them in return for some price relaxation that we had in the contracts to try and work closely with the customers. So hopefully, those are mostly just a one-off because the sales that we're entering into now are more at the levels where we were closing last year and this year. So I think we're -- it's a bit of a one-off when it comes to the Ontario thing, hopefully. And some of -- as Thomas alluded to on the Alberta stuff, some of [it is] just working our way through some of the product that we had on standing spec in Alberta.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [29]

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And the typical incentives in Canada, I guess, is it just basically absolutely reducing price? Or is there a mix of options?

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [30]

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In some cases in Alberta, it might be a combination. Most of it in Ontario was just really reducing price. I mean if you look at the marketplace there, they peaked probably 9 months prior to the slowdown in the Ontario market. And that I would suggest that it's now gone back down to what I call that 9-month pricing that was there pre the 9 months when it ran up. So all we're really doing is working with our customers to try and bring it back down. And again, we work with them so that they could close their deposits up. But in many cases, it was -- they were not going to be able to close. So we worked with them to try and come up with some common ground, and so we pushed some of it through incentives.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [31]

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Got you. And this is more of a macro industry question I've seen more discussed out there in the news, and I don't know to what involvement you have or if you've seen it, the involvement, I guess, is single-family rental companies. Do you all sell to deliver bulk sales to them or any product to them? Or in -- I guess start there and then (inaudible)

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [32]

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Yes. I mean we -- one, we believe that it is a new asset class and we have no issue with working with many of the large single-family rental companies. We did a transaction with one opening in our Austin market last year and closed about 134 units with them in one of our communities. We're looking to work with them in some the other markets as well. And we don't have a problem with adding that type of product as a segmentation within some of our communities across the board. So I think it is a new asset class, and it is attractive to certain consumers out there, customers. And so we can use that as, again, further segmentation of the product offerings that we give in our communities.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [33]

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Got you. Perfect. And then I guess on the Austin side, what price point is that? And is that a different product that you're having to make? Or is it a product that you already have and you are able to deliver?

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [34]

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It was very similar to a product we had in the community. And again, in fact, we found that the median income for many of those renters were such that they could've been buying product but it was just a lifestyle choice that many of them were making. So it's -- to me, it's just an additive to our community offerings.

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Operator [35]

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(Operator Instructions) This concludes the question-and-answer session. I would like to turn the conference back over to Alan Norris for any closing remarks.

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [36]

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Thanks very much. I appreciate everybody's interest. Thank you, and we will chat again at the end of Q3. Thank you.

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Operator [37]

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