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Edited Transcript of HR.UN.TO earnings conference call or presentation 14-Nov-19 2:30pm GMT

Q3 2019 H&R Real Estate Investment Trust Earnings Call

Toronto Dec 6, 2019 (Thomson StreetEvents) -- Edited Transcript of H&R Real Estate Investment Trust earnings conference call or presentation Thursday, November 14, 2019 at 2:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Larry Froom

H&R Real Estate Investment Trust - CFO

* Patrick James Sullivan

H&R Real Estate Investment Trust - COO of Primaris Management Inc.

* Philippe Lapointe

H&R Real Estate Investment Trust - COO of Lantower Residential

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Conference Call Participants

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* Mario Saric

Scotiabank Global Banking and Markets, Research Division - Analyst

* Sam Damiani

TD Securities Equity Research - Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to H&R Real Estate Investment Trust's 2019 Third Quarter Earnings Conference Call.

Before beginning the call, H&R would like to remind listeners that certain statements, which may include predictions, conclusions, forecasts or projections in the remarks that follow may contain forward-looking information, which reflect the current expectations of management regarding future events and performance and speak only as of today's date. Forward-looking information requires management to make assumptions or rely on certain material factors and is subject to inherent risks and uncertainties, and actual results could differ materially from the statements in the forward-looking information.

In discussing H&R's financial and operating performance and in responding to your questions, we may reference certain financial measures, which do not have a meaning recognized or standardized under IFRS or Canadian generally accepted accounting principles, and are, therefore, unlikely to be comparable to similar measures presented by other reporting issuers. Non-GAAP measures should not be considered as alternatives to net income or comparable metrics determined in accordance with IFRS as indicators of H&R's performance, liquidity, cash flows and profitability. H&R's management uses these measures to aid in assessing the REIT's underlying performance and provides these additional measures so that investors can do the same. Additional information about the material factors, assumptions, risks and uncertainties that could cause actual results to differ materially from the statements in the forward-looking information and the material factors or assumptions that may have been applied in making such statements, together with details on H&R's use of non-GAAP financial measures are described in more detail in H&R's public filings, which can be found on our website at www.sedar.com.

I would now like to introduce Mr. Larry Froom, Chief Financial Officer of H&R REIT. Please go ahead, Mr. Froom.

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Larry Froom, H&R Real Estate Investment Trust - CFO [2]

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Thank you. Good morning, everyone, and thank you for joining us on our call today. With me on this call are Tom Hofstedter, President and CEO of the REIT; Ed Sullivan, Chief Operating Officer of Primaris, our Retail Division; and Philippe Lapointe, COO, Chief Operating Officer of Lantower, our Residential division. I will begin with highlights of Q3, then Pat and Philippe will speak about their divisions. And finally, we will open the lines for questions.

Firstly, Encana, our tenants at The Bow, recently announced plans to redomicile to the U.S. We have received lots of questions on this. In short, we don't expect any impact to us. We have a robust lease in place with the tenant with an indemnity from the parent company. During 2019, we have continued to actively reallocate capital through net property dispositions to fund value-creating developments, expand the residential rental platform and strengthen H&R's balance sheet. We have completed approximately $1.8 billion of asset sales over the past 21 months, substantially repositioning the portfolio, enhancing the internal growth profile and reducing leverage. Debt-to-total assets for the financial statements has decreased from 44.6% at the beginning of this year to 43.3%. We expect leverage to decline modestly with the remainder of the proceeds from the sale of The Atrium due in Q1 of 2020.

Subsequent to the quarter end, H&R repaid a U.S. mortgage of approximately $219 million, bearing interest at 4.5% per annum. Jackson Park, the 18 -- 1,871 luxury residential rental apartments in Long Island City in New York, in which H&R has a 50% ownership, reached occupancy of 94% at September 30. Interest-only financing of $1 billion was secured by the property for 10 years at an annual interest rate of 3.25%. On closing of this financing, H&R received USD 195 million distribution from the joint venture, which was used to repay other debts. The project's unlevered yield on budgeted cost is expected to be 6.4% and the levered yield on H&R's net cash contribution is expected to be approximately 57%.

Q3 2019 basic diluted and normalized funds from operations, FFO, was $0.43 per unit compared to $0.42 per unit in Q2 -- in Q3 2018. Although office occupancy dropped to 98.3% at September 30, 2019, significant leasing has already occurred and committed occupancy was at 99.5%.

For our Industrial segment, we expect occupancy to increase from 96.5% at September 30, 2019, to 97.2% by December and committed occupancy to be 98.9%. On our 3 Industrial developments, the 3 industrial buildings currently under construction in Caledon, GTA totaling 526,000 square feet, has seen strong tenant interest, and we are optimistic that we'll have some leasing to report next quarter. We also expect completion of developments and new lease commencements in both the Retail and Residential segments to contribute to positive growth in FFO.

I will now turn the call over to Pat to give an update on our Retail division.

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Patrick James Sullivan, H&R Real Estate Investment Trust - COO of Primaris Management Inc. [3]

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Thank you, Larry, and good morning. Our enclosed mall properties have experienced significant disruption during the past year with anchor vacancies, redevelopment and retenanting impacting the shopping experience. However, we are pleased to report that the majority of anchor redevelopment activity is nearing completion.

Since late September of this year, approximately 210,000 square feet at H&R ownership share, including more than 110,000 square feet at Sunridge Mall, will open from an area formerly occupied by large-format tenants, while another 244,000 square feet is expected to open in 2020. This leasing activity is expected to generate additional revenue of approximately $5 million in 2020.

We continue to experience healthy leasing demand in our properties. Through the first 3 quarters of 2019, our Primaris leasing team has completed just over 300 lease transactions, which is a typical figure over the past 5 years. However, these 300 transactions represent approximately 1.6 million square feet, which is considerably greater than our historical average. This leasing activity has resulted in our occupied committed occupancy rate rising to 93.8% at the end of the third quarter.

As you may be aware, Forever 21 filed for bankruptcy in September of this year and occupied 3 stores in our portfolio, encompassing approximately 43,000 square feet. We anticipated the failure of Forever 21 and have negotiated terms with a replacement tenant for all locations. Leases are at the execution stage, and we expect the new tenant will take possession in December of this year and will be open within the next few months.

With respect to Sears, at the end of the third quarter, we had committed unconditional transactions in place representing approximately $3.7 million in annual base rent as H&R's share or just over 52%, our anticipated total rent upon completion.

Subsequent to the end of the quarter, we have completed or at the lease execution stage for tenants occupying just over 56,000 square feet of tenants at H&R ownership share. Including these tenants, we have $4.5 million in annual base rent committed, equating to approximately [63%] of the total amount anticipated. Sears paid annual base rent of $2.3 million at H&R ownership share. We are being selective with replacement of tenants, focusing on those tenants that are prepared to pay market rent and enhance their merchandise mix.

Turning to productivity. Sales were down 3% on a same- and all-store basis as compared to the 12-month period ended Q3 2018. The most recent data point has shown a return to positive same-store sales, with productivity increasing sequentially in Q3 of 2019 as compared to Q2. The 3-year tend -- trend in same-store sales remains positive, having risen from $540 per square foot to $557 per square foot, notwithstanding the disruption our centers have experienced. Over this time period, we have expanded successful tenants that performed above mall average and we moved a series of same-store sales such as Shoppers Drug Mart at Park Place and Ardène at Place du Royaume. While the change may result in a drag on productivity, both the tenant and the shopping center benefits from the tenant offering from their typical footprint.

We continue to remerchandise our properties to keep the tenant mix relevant, increase traffic and in turn, improve productivity. Over the past year, we have added many prominent retailers to our portfolio, which we believe will drive productivity including Tommy Hilfiger at Dufferin Mall, Stage at Cataraqui Centre, and Aritzia at Orchard Park Shopping Centre.

In closing, we're pleased to be nearing the completion -- nearing the conclusion of a difficult period of anchor tenant disruption, and believe we have been successful in improving the tenant mix and resiliency of our centers.

Thank you, and I will now turn this discussion over to Philippe.

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Philippe Lapointe, H&R Real Estate Investment Trust - COO of Lantower Residential [4]

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Good morning, everyone. We've been active in 2019 on multiple fronts and so I'm delighted to share some notable updates from Lantower Residential. As disclosed last quarter, we announced that we have acquired Lantower Garrison Park in Charlotte, North Carolina. The 322-unit Class A property is performing well and is nearly 65% leased as of this month. We expect Garrison Park to stabilize in the first half of 2020. The property benefits from proximity to 3 large business and research parks that collectively make up University City, which boasts over 75,000 jobs. Additionally, the property is a short commute to the major local university, UNC-Charlotte. As mentioned in the previous 2 quarters, one of our strategic initiatives for 2019 was to examine our existing portfolio to determine if any reallocations would be accretive. As we had alluded on last quarter's call, we are under contract to sell one of our assets that fit the criteria. The property, Mirabella Waterford Lakes, is a 400-unit property built in 2000 located in Orlando, Florida. Mirabella, purchased in April of 2017 (sic) [2015] for USD 53.25 million was successfully sold in September 25 for $77 million, underscoring the strong NOI growth during the whole period. This transaction results in a favorable financial returns, including an IRR of 19% and an equity multiple of over 2x in just over 4 years.

Furthermore, there was 0 capital gains tax leakage as the acquisition of Lantower Grande Flats in the second quarter fully covered the Mirabella disposition via reverse 1031 exchange. Additionally, we are currently under contract to sell 2 more legacy assets from Lantower's portfolio. We believe these pending dispositions complete our 2019 strategic initiative. We will disclose more information on those potential dispositions in the coming quarters. As always, our intent is to dispose these assets and reinvest via 1031 exchange into newer properties that are more representative of our underlying portfolio and investment strategy. And so we expect to announce the new acquisitions in the near future.

On the portfolio front, following the disposition of Mirabella, the Lantower Residential portfolio consists of 7,570 -- sorry, 7,507 apartments across 23 properties when excluding Jackson Park.

On the operations front, at the end of the third quarter, Lantower's property -- Lantower's portfolio was approximately 91.4% occupied. It was nearly 94% occupied when excluding our lease-up properties. On the financial front, our same-asset quarter end operating income increased in U.S. dollars from USD 10,220,000 in the third quarter of 2018 to USD 10,695,000 in the third quarter of 2019. This equates to same asset quarter-over-quarter operating income growth of 4.6%, representing another quarter of strong and sustaining NOI growth.

On the development front, our Sunrise project, the 321-unit Class A garden-style multihuman project in Orlando, Florida is scheduled to break brand in the coming months. The development site benefits from a short commute to Orlando's largest employer, Walt Disney World. The projected development yield of 6.1% represents a favorable spread between prevailing Orlando Class A multifamily market cap rates of 4.5% to 4.75%. We look forward to expanding our Central Florida development pipeline with more Class A developments in the future.

And with that, I will pass along the conversation back to Larry.

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Larry Froom, H&R Real Estate Investment Trust - CFO [5]

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Thank you, Philippe. Operator, we'd like to open the line for questions, please.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we have a question from the line of Mario Saric with Scotiabank.

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Mario Saric, Scotiabank Global Banking and Markets, Research Division - Analyst [2]

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Maybe just coming to The Bow [plan] -- I guess, Larry, your comment on no impact on achieving domicile. Can you give us an update in terms of your capital recycling initiatives there? And the timing and whether there's any implications to potentially selling stake in the building as a result of the announcement?

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Larry Froom, H&R Real Estate Investment Trust - CFO [3]

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We're still on target. The market has to digest and understand what the -- this change in domicile means and the proxy has to be voted on, but we're still on target moving forward with our strategy. No change.

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Mario Saric, Scotiabank Global Banking and Markets, Research Division - Analyst [4]

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Okay. So that's still something that you think could be resolved this year or...

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Larry Froom, H&R Real Estate Investment Trust - CFO [5]

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Well, this year is almost done. But within the next -- I will say that for the next quarter or 2.

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Mario Saric, Scotiabank Global Banking and Markets, Research Division - Analyst [6]

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Got it. Okay. And then I noticed that there was a bit of a fair value decline in your Alberta office portfolio quarter-over-quarter. Was that kind of spread across the 4 assets?

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Larry Froom, H&R Real Estate Investment Trust - CFO [7]

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We're always tweaking on our portfolio, our size, but anything in Alberta would have really been substantially The Bow, as it is the biggest one in Alberta.

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Mario Saric, Scotiabank Global Banking and Markets, Research Division - Analyst [8]

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Okay. And there's an $831 million principal maturity in 2021. Is that related to The Bow? Or can you give us some color in terms of what comprises that maturity?

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Larry Froom, H&R Real Estate Investment Trust - CFO [9]

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$831 million in 2021, we have -- part of that would be part of the first part of The Bow bonds, which would be $250 million, I believe, and the rest of it would be regular other mortgages on other properties.

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Mario Saric, Scotiabank Global Banking and Markets, Research Division - Analyst [10]

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Okay. And then maybe just shifting gears to Primaris. Pat, your comment on a recent positive print. I just want to clarify whether are you inferring that the same-store sales, which were down 3.1% this quarter, are you inferring that those are expected to become positive in Q4 and 2020?

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Patrick James Sullivan, H&R Real Estate Investment Trust - COO of Primaris Management Inc. [11]

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Not necessarily. I mean this -- sales figures ebbs and flow. It's what comes in and out of the same-store, what stores are we including. But I think last quarter, we were at 5.55% or 5.57%. So far retailers are reporting that they're performing well and all of them want to see how that translates at the end of the quarter.

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Mario Saric, Scotiabank Global Banking and Markets, Research Division - Analyst [12]

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Got it. Okay. And with the holiday season coming upon us, how does your kind of outlook for 2020 in terms of potential restructurings with tenants, which happened fairly often, but how does that watch list today compared to what that watch list may have looked like a year ago?

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Patrick James Sullivan, H&R Real Estate Investment Trust - COO of Primaris Management Inc. [13]

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I think every year since I've been doing this, which is quite a long time now, there's tenant failures that happen at the start of the year. So the watch list is not significant. I've seen it longer in prior years. We've had our eye on a few potentials, and we've been adjusting our waiting with those tenants for some time now. Forever 21, we were not surprised when they filed. We had, had discussions well in advance of their failures. So I fully expect that next year will bring the typical year for failures, but nothing out of the ordinary.

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Mario Saric, Scotiabank Global Banking and Markets, Research Division - Analyst [14]

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Great. Okay. And my last question just comes back to the balance sheet. The weighted average debt term came down below 4 years this quarter. The portfolios changed over time, so Lantower, for example, was a fairly significant part of your portfolio, where the average lease term is lower than what you typically see in Office or Retail. Is that a strategic decision to kind of lower the weighted average debt term consistent with the current portfolio shift to new asset classes like residential with an increased focus on development? Or is -- should we expect that number to kind of go up going forward?

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Larry Froom, H&R Real Estate Investment Trust - CFO [15]

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When you bring down your debt, by definition, you're bringing down [your debt]. It falls, one or the other. We're taking -- we're paying off debt and not renewing the debt and bringing down our debt. So by definition, it's going to go down. So the answer is it's going to continually go down. It's not a strategy as far as long-term or short-term debt, it's a strategy of bringing down the debt.

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Operator [16]

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(Operator Instructions) Your next question comes from the line of Sam Damiani with TD Securities.

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Sam Damiani, TD Securities Equity Research - Analyst [17]

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Just keeping with the balance sheet, what is the leverage target that you're looking at for 2020, maybe with or without sale of an interest in The Bow? What sort of capital recycling activity should we expect to see?

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Larry Froom, H&R Real Estate Investment Trust - CFO [18]

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Sam, without any activity on The Bow, we expect to be more or less the same where we are now. We have the development to complete, which if you look at the top table, properties under development table, we have approximately $250 million to complete those developments we have on the goal right now. That will be offset by the balance of the proceeds that we received from [H&R Bay. So we tend to keep that moving]. So at the end of the day, watch out to see where we are right now. Unless you do a significant transaction with sale. Again, it's very hard to move the needle on a company our size.

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Sam Damiani, TD Securities Equity Research - Analyst [19]

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And if an interest in The Bow were to be -- were sold, like what would be the use of proceeds there?

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Larry Froom, H&R Real Estate Investment Trust - CFO [20]

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Pay down debt. That we initially [issued].

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Sam Damiani, TD Securities Equity Research - Analyst [21]

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And Lantower is continually refreshing its portfolio. Is there any desire to grow? I know you're building, obviously, Industrial in Toronto. But is there any desire to expand your portfolio outside Lantower?

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Philippe Lapointe, H&R Real Estate Investment Trust - COO of Lantower Residential [22]

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I don't -- sorry, I don't really understand the question.

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Sam Damiani, TD Securities Equity Research - Analyst [23]

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Are you looking at acquisitions or developments in office right now? Or...

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Patrick James Sullivan, H&R Real Estate Investment Trust - COO of Primaris Management Inc. [24]

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We are looking at Industrial. We have 300 under construction, where we have good leasing activity, and we are looking to build potentially 2 other industrial buildings that we're currently negotiating the land on. So we're looking to increase our industrial platform through development and Lantower will be increasing its development platform on -- acquiring further lands. So the process right now is acquiring further lands. So our -- Lantower's goal for the foreseeable future is more to be a builder than an acquirer. The reason it acquires is to accommodate the 1031, but if it wouldn't be for the 1031, Lantower would be primarily a developer rather than an acquirer.

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Sam Damiani, TD Securities Equity Research - Analyst [25]

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I see. And then on the Caledon developments, what sort of rents are you targeting today versus earlier this year?

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Patrick James Sullivan, H&R Real Estate Investment Trust - COO of Primaris Management Inc. [26]

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We are currently negotiating on the big building. The rents are in-line with original budget, nothing's really changed. We were starting at [8.25], and that's what we're achieving with growth in the rents of approximately 3% per annum, in-line with -- exactly in line with our budget.

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Sam Damiani, TD Securities Equity Research - Analyst [27]

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Budget? Okay. And then Pat, great to see the 3 Forever 21 spaces filled quickly, could you give us a little bit of color on the type of user that's replacing them? And if it's all the same? And also the rent versus the prior as well would be helpful.

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Patrick James Sullivan, H&R Real Estate Investment Trust - COO of Primaris Management Inc. [28]

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A fashion tenant that took all 3 and the rent is comparable to what we were getting previously.

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Sam Damiani, TD Securities Equity Research - Analyst [29]

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And the downtime is, I guess, maybe 6 months?

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Patrick James Sullivan, H&R Real Estate Investment Trust - COO of Primaris Management Inc. [30]

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It will be much less than that, actually. We were pretty far ahead in advance and the time taking it is already advanced and hiring and such work. At least it was disclaimed at the start of November. We get it back at the start of December, and I would think it's maximum 90 days downtime.

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Sam Damiani, TD Securities Equity Research - Analyst [31]

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For rent to be flowing again?

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Patrick James Sullivan, H&R Real Estate Investment Trust - COO of Primaris Management Inc. [32]

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Yes.

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Operator [33]

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And there are no further questions at this time. I turn the call back over to our presenters.

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Patrick James Sullivan, H&R Real Estate Investment Trust - COO of Primaris Management Inc. [34]

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Okay. Thanks, everybody, and we'll speak to you next quarter. Have a great holiday season coming up. Thanks.

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Operator [35]

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Ladies and gentlemen, this concludes today's conference call. You may now disconnect.