Good morning, ladies and gentlemen. Welcome to the CAPREIT Third Quarter 2019 Results Conference Call. I would now like to turn the meeting over to Mr. David Mills. Please go ahead, Mr.
Mills.
Thank you very much, and good morning, everyone. Before we begin, let me remind everyone that the following discussion may include comments that constitute forward looking statements forward looking statements about expected future events and the financial and operating results of CAPREIT. Our actual results may differ materially from these forward looking statements, Such statements are subject to certain risks and uncertainties. Discussions concerning these risk factors, the forward looking statements and the factors and assumptions on which they are based can be found in our regulatory filings, including our annual information form and MD and A, which can be found on our website or atsedar.com. I'll now turn things over to Mark Kenney, President and Chief Executive Officer.
Thanks, David. Good morning, everyone, and thank you for joining us today. Doc Cryer, our Chief Financial Officer is also on the call today. Turning to Slide 4, we continue to increase the size, scale and diversification of our portfolio through accretive acquisitions. So far this year, we have purchased 8,413 residential suites and MHC sites in Canada and the Netherlands for just over $1,000,000,000 These acquisitions have strengthened our market presence and are driving further economies of scale and operating synergies through our experienced and proven property management teams.
Looking ahead, we continue to evaluate further accretive growth opportunities in both Canada and in Europe. With this portfolio growth and our continuing strong operating performance, we generated another strong period in Q3, as shown on Slide 5. Revenues were up over 15%, driven by the positive contribution from our acquisitions, increased monthly rents and continuing high occupancies. NOI rose more than 16% with NFFO up 15%. We also generated another strong quarter of strong organic growth with same property NOI up 3.7%.
In addition, our growth continued to be accretive as NFFO per unit was up 3.3% despite the 11% increase in the weighted average number of units outstanding. Slide 6 outlines our results through the 1st 9 months of 2019, with revenues up almost 12%, NOI rising 13.5%, driving a 14.1% increase in M and FFO. Again, our growth was accretive as NFFO per unit rose 3.4% despite the 10.4% increase in the weighted number units outstanding. Our strong performance this year continues to be driven by our portfolio growth, solid increases in monthly rents and continuing high occupancies. We look for this growth to continue.
Our growth and success for more than 21 years is also the result of strong fundamentals in the residential sector as detailed on Slide 7. Our focus remains on large urban centers that are experiencing strong population growth and rising demand for quality rental properties. A number of factors are driving this strong demand. Natural population growth around the world, immigration trends that largely favor moving to cities, the global trend to urbanization with families and young people gravitating to these urban centers for jobs and a quality lifestyle. Younger people are delaying having families and remaining in apartments and townhouses longer before they purchase a house or condo.
The growing seniors population is downsizing and finding rental properties more affordable and desirable. They also look to live on one floor and avoid stairs as they age, a perfect market for an apartment. And finally, the lack of new rental property development in most urban markets. We believe these market fundamentals will continue to drive demand in all of our target markets. In addition, demand continues to grow as people recognize how affordable renting can be.
As you can see on Slide 8, our average monthly rents in our largest Canadian markets, while they continue to rise, still remain very affordable compared to average family incomes in those neighborhoods. And affordable cost for a CAPREIT rental home ranges between only 18% 25% of family income, much more affordable than the estimated 56% of income being experienced for homeownership in Canada. As a percentage of medium family income, the cost of homeownership in 2019 in the key cities of Toronto and Vancouver is even higher at 79% and 88% respectively, with Montreal homeownership sitting at 46%. Looking ahead, as the cost of owning a home continues to become more expensive, we believe that the demand for quality rental accommodation will continue to increase. These strong market fundamentals continue to drive our growth and our performance as shown on Slide 9.
Occupancy has remained very strong, while average monthly rents continue to increase, driven by solid rent increases on turnovers and renewals. Our track record of organic growth also continues with same property NOI up 4.7% for the 9 months ended September 30, 2019. In summary, we are confident our strong growth and operating performance will continue going forward. I'll now turn things over to Scott for his financial review. Thanks, Mark.
Turning to our balance sheet on Slide 11, we continue to maintain a strong and flexible financial position with conservative leverage, strong coverage ratios and historically low interest costs on our mortgage portfolio.
Debt to GBV strengthened to just under 37% at September 30 putting us in a great position for future acquisitions and development. You'll also note that our historical cost debt to GBV went from 53% to 50%, showing our prudence managing our equity. As you can see on Slide 12, our foreign exchange exposure in Europe, including our investment in IRES, is at only 6% of our portfolio, while we maintain about 15% of our total asset value in Europe. We are managing our European exposure by utilizing a number of different tactics with favorable impacts including obtaining 3rd party mortgages at very favorable interest rates, utilizing our euro acquisition and operating facility and entering into close to CAD 100,000,000 swap to further hedge our euro exposures. Currently, we have over €1,400,000,000 of euro denominated debt after factoring in these swaps.
Our mortgage portfolio remains well balanced as shown on Slide 13. Looking ahead, our ability to top up renewing mortgages through 2,034 will provide significant liquidity to fund our acquisitions and development pipeline. Through the balance of 2019, we have $85,000,000 in mortgage maturing with an average interest rate of 2.8%. Expected mortgage renewal and refinancings for 2019 are between dollars to $415,000,000 excluding financings on acquisitions. And with the recent drops in the GOC rates, we have seen 10 year financing costs drop back below the 2.5% range, creating once again a tailwind for continuing lower interest costs.
On the liquidity front, Slide 14 demonstrates that we remain well positioned to continue our growth programs. In January 2019, we completed a successful bought deal offering raising a total of $288,000,000 in funds, including the overall allotment option. To fund further growth, on April 23, we completed another successful bought deal offering, raising a total of $345,000,000 in funds, including the over allotment option. This results in a total equity raise to date in 2019 of $633,000,000 With the acquisitions completed so far this year, we have approximately $50,000,000 available in borrowing capacity on our credit facilities at quarter end. In addition, there is an available borrowing capacity under an existing bridge facility as well as that that's available under ERES unsecured credit facility.
I'll now turn things back to Mark to wrap up.
Thanks, Scott. Before we take your questions today, I wanted to walk you through why we believe our diversification strategies are so key to our ability to drive value for our unitholders. Our geographic diversification across Canada and internationally ensures that our unitholders are not overly exposed to any one market or demographic segment of the population as detailed on Slide 17. Additionally, our increased presence in the manufactured housing community business this year has added to our strength. We really like the MHC space for a number of reasons.
Revenues are highly stable and with residents owning their own homes, capital requirements and maintenance needs are significantly reduced. From a geographic standpoint, they enable us to have a presence in smaller markets, which we wouldn't normally enter. They allow for great operational efficiency as we leverage the same platforms and people used across all of our other properties. And finally, we have the opportunity to boost revenues in the future by selling homes to residents. Importantly, CAPREIT is now the 2nd largest owner of manufactured home communities in Canada.
Internationally, we continue to be pleased with our performance in Ireland, as you can see on Slide 18. Through the 1st 9 months of 2019, asset and property management fees have increased 9%, driven by acquisitions and NAV appreciation, and we expect this revenue will increase as IRIS continues to grow its portfolio. IRIS has also completed a successful equity raise earlier this year, which we increased our ownership position to 18.3%. And this retained interest continues to generate a solid stream of dividend income amounting to $7,200,000 for the 9 months ended September 30, 2019. Our presence in the Netherlands also continues to drive value for unitholders as shown on Slide 19.
By the end of September, we had sold a total of 2,710 residential suites to ERES through our pipeline agreement for over $740,000,000 We now have sold all of our Netherland properties to ERES, generating a growing base of fee revenues for our asset and property management services. CAPREIT now owns just under 74 percent of ERES, fully aligning our interest with all ERES unitholders. You can see through the 1st 9 months of 2019, we earned $29,200,000 of NOI from ERES properties in Europe and another $9,700,000 from CAPREIT owned properties in the Netherlands, which have now been sold to ERES. ERES' strong presence in the vibrant Netherlands market further diversifies our business and provides opportunity for additional growth going forward. Driving this growth is our continuing ability to increase our average monthly rents in all of our markets.
As you can see on Slide 21, we are seeing solid increases in monthly rent on both turnover and renewals in Canada, the Netherlands and our investment in IRES REIT in Dublin. Overall, the strong fundamentals and demand in all of our markets resulted in an overall 4.8% in our total stabilized net AMRs as of September 30, 2019. Our diversification also allows us to capitalize on the attractive spreads between cap rates and interest rates in our markets, as you can see on Slide 22. The spreads in the Netherlands and at IRES are particularly attractive at roughly 2.4% and 3% respectively, and we don't believe we will see any major negative change in these spreads for the foreseeable future. In summary, we continue to focus on our long term goal of making CAPREIT the best place to live, to work and invest.
To become the best place to live, we strive to enhance the lives of our residents by building strong relationships through our hands on approach to management, a relentless focus on attracting and retaining the best residents and the use of new and innovative technologies. To ensure that we attract and retain the best people, we have introduced new tools to help everyone stay connected and up to date on CAPREIT and industry information. We have developed innovative leadership training programs to engage and help advance their careers, while implementing state of the art tools and technologies to become more efficient. Most importantly, our ultimate goal is to enhance unitholder value and CAPREIT has been one of the best places to invest for more than 21 years. Thank you for your time this morning and we would now be pleased to take any of the questions you may have.
Thank you. We will now take questions from the telephone Our first question is from Jonathan Kelcher from TD Securities. Please go ahead.
Thanks. Good morning. Good morning. First question is just on the same property operations, in particular the expense growth. That's been trending higher than your revenue growth for at least a couple of quarters now.
What are your expectations on that going forward?
So I think we've talked about this before. Definitely R and M is something that's a little lumpy. We definitely saw a higher run rate there. So that we would see as more of a temporary. There are a couple of items that have been more permanent.
First of all, we have 4 ground leases that all kind of came to a renewal period in the current year. So that's impacted kind of Q2 and Q3 pretty hard to the tune of over $500,000 each quarter in incremental land payments. So that's something that's it's kind of an increase that will hit the next quarter as well and then and kind of flatten out there. So that's definitely a permanent increase that we've had to incur.
Yes. We don't see R and M at the end of the day being a rising trend increase. The Q3, we've got a lot of moves that happened in our student portfolio, a lot of activity just in general people moving in the month of September. I would see a return to more stabilized numbers going forward.
Okay. So for 2020, you assuming you continue to get the revenue growth that you that it appears you should, you'd expect that to outpace cost growth?
Yes.
Okay. And then just and sorry, and Scott, those 4 ground leases, I guess, that'd be Toronto, Vancouver and Calgary?
No, it's actually Calgary, Vancouver. 1 in Vancouver and 3 in Calgary. And some of them are still being negotiated, while we've been prudent in making sure we're appropriately accruing for the potential step up.
Okay. And then just turning to Slide 8, I guess that's 2016 family income and versus the current AMR. So your stats would actually look a little bit better assuming that family incomes went up the last 2 or 3 years?
That's right. That's correct. Yes.
Okay. But and just flipping that to the other side, how under market do you think your average monthly rents are in those three markets?
Well, I can give some general views. We will be producing more information on this. But in the GTA, we see our mark to market being close to 30%. I would say the rest of Ontario 21. Quebec, we think we've mark to market 12 and BC 18.
With both Alberta, we are seeing positive mark to market in Alberta, about 4% in our estimation, with Nova Scotia sitting at around 6%. So what's notable here is that for one of the first times in our history, we've got very positive mark to market across the portfolio.
Good. And as that like the GTA, if you were thinking about that 6 months ago, how much would that have changed?
I think the number has been pretty stable over at least the last 18 months because the spread continues to hold, if not grow, due to the low churn. So just by virtue of rents gradually rising in the marketplace, our churn has been equally shrinking, which has been raising that mark to market overall.
Okay. Thanks. I will turn it back.
Thank you. Our following question is from Mario Saric from Scotiabank. Please go ahead.
Hi, good morning. I'm going to stick to Slide 8 as well. The percentage of household income that you're reporting there, I think in the past within the cap portfolio, we've talked about kind of rent to household income in the 30% to 35% range. So these numbers are meaningfully below that. Is that a calculation difference or is there something else that?
No, what we wanted to do there is to show just average family household incomes to compare the rental proposition and homeownership. If we took average family income for our portfolio and then took a different family income number for homeownership, you wouldn't have a true representation. But you can see that by taking just average family incomes, the huge disconnect between affordability in homeownership versus the very attractive even today, homeownership rental proposition in the CAPREIT portfolio. That's taking our actual rents, comparing it to average family income and comparing it to homeownership rates in the markets that we've described. It's quite compelling.
Quite often we're getting these affordability questions and we just thought it was better, our best to give some representation of how truly affordable the cap rate portfolio is.
So if we look at your AMR divided by like the household income estimate in your portfolio,
What
those percentages look like today?
They would be slightly higher, but still well within our traditional 35% guidance.
Got it. Okay. And just second question just on the fair value gain during the quarter, pretty substantial at $264,000,000 80 percent of it was due to higher expected NOI. Can you walk us through how that is calculated on the NOI side and specifically kind of how you capture the very attractive mark to markets in the portfolio that Mark alluded to earlier on the call in that IFRS valuation?
Yes. I mean, we do a stabilized 1 year forward roll of our rent rolls based on kind of turnover and renewal rates that we're seeing. So we do that quarterly just to kind of keep up. And then we obviously have our 3rd party valuator help us with cap rates. The reality is that the year end process is obviously more robust and that you kind of need to take those growth rates into consideration on the cap rates.
But so we generally just roll our rent rolls and take the impacts of those of a 1 year roll forward.
And we don't fully the mark to market that we talked about earlier is would be somewhat reflected in the cap rate when the appraiser takes a look, but we've had a very conservative practice at cap rate over the years of being careful with those cap rates, because there can be market distortions that happen. Just because one transaction happens doesn't mean it's truly reflective of the whole market.
Great. So I guess to summarize, it's partially reflected in the cap rate, I. E. The IFRS.
Partially reflecting the cap rate. Yes.
But not nearly to the extent of the full mark to market upside over time.
Correct. That's true. The cap REIT upside mark to market is in excess of 20% portfolio wide.
Okay. Then just there's been a lot of transaction activity or the expectation for transaction activity in the market in Q4 with larger portfolios including the Continuum deal announced last week. Is any of that reflected in your cap rates that you highlighted in Q3? And then secondly, would the Kings Club fair value bump be reflected in the 2.64 at all?
Yes. So definitely the transactions as of recently are not included in any of these. So obviously we've been paying attention to that transaction and it would only allude to a further compression definitely at least in the GTHA of course. So yes, those are not incorporated at all.
When we look at the mark to market rents, we feel that our properties are overall superior locations and condition wise are exceptional given our long record of investing in the properties and given similar mark to markets given the quality of the CAPREIT portfolio, I would suggest that our unitholders are sitting on tremendous value.
Yes. And with regard to your second half of the question, we did take a fair value bump on that asset in this quarter that was fairly significant. So that definitely had a strong contribution to the overall gain.
It's interesting, Mario, on King's Club because only because we're on the topic of mark to market. I think well, I know that you know and others know that we have been progressing with purchasing of brand new properties in the portfolio quite robustly. And so even with those big transactions, clearly the mark to market and those rents is 0, if we are doing our job properly. But even with those fully mark to market properties, we're still seeing very significant overall spread.
Okay. And then just on the liquidity position on Slide 14, that you noted the existing liquidity is back to where it was in early 2016 in terms of size. Given kind of the strength in the market on the valuation side that you're seeing and the acquisition opportunities going forward, how do you think about selling assets into the strength in terms of enhancing that liquidity or essentially recycling capital from one asset to another?
Yes, we I think you may have seen some of the assets that we recycled in 2018 and we really have taken the non strategic approach if sorry, if the asset is non strategic, we will consider disposition. But given these mark to market spreads in the CAPREIT portfolio, I would say overall, we would like to enjoy to deliver value to the unitholders. With these kind of mark to markets, we can't find assets of the quality of the CAPREIT portfolio. We talked a little bit earlier about repairs and maintenance spend. And I do this is a seasonal change for us.
However, our commitment to investing in the buildings is completely unwavered. And the quality of the portfolio, I think just really stands out relative to other transactions that have happened in the market.
Okay. My last question and I may be reading too much into this, but on the development side, I noted that you removed the word well in front of the excess of 10,000 suites in some of your disclosure when describing your pipeline. Is that an indication that you're perhaps becoming a little less optimistic on the development potential within the portfolio going forward? And if so, what is driving it?
That's an incredibly astute observation. I'm not sure we noticed the change. It was certainly not intentional. We remain extremely optimistic about our development opportunities in the CAPREIT portfolio, especially given our locations. The transactions that are happening, we look at condo prices hitting brand new records.
We know our land is not replaceable. That being said, we continue to be mildly frustrated with the length of time it's taking to get entitlement done. But very encouraged of the value creation that lays ahead. We have got no real change of heart in terms of our ambitions to move forward. We're really going as fast as we can and it's a slow process.
However, it continues to unfortunately just express that supply problem that the market has in general. If we're unable to do this with Freeland, it's really not a good news for the market in general in terms of delivering affordable supply.
Our following question is from Mike Markidis from Desjardins. Please go ahead.
Hi, everyone. Mark, thanks very much for all those spreads that you gave by region. I think that's very helpful. I think you managed or you mentioned that you've been doing some work on that. Is that something that is going to be rolling itself into cap REIT's quarterly disclosure in the near future?
Yes, it is. Yes, it's something that we feel that the market's been asking for. I know you've been asking for it, Mike. And it's such a great story. We temper everybody.
Market rents can change. We don't see that in Ontario anytime soon, even BC, but some of the other markets, as we all learned, especially at West can be quite punitive fast. So we're really encouraged that all of our markets are firing well, but I would continue to deliver caution around those numbers being permanent in all markets.
Of course.
They're indicative. They're indicative moment in time.
Okay. Small change, but I guess sequentially in the Canadian portfolio, your rent spread on turnover did come down a little bit. Is that impacted at all by your Quebec portfolio and the fact that there's still a high proportion of leases that turn on July 1 or is that not a factor?
No, I mean, actually we've seen Quebec probably accelerate generally over the definitely over the last year. We've seen Quebec performing quite well. So I don't think it's driven out of the Quebec market at all.
There is a little bit of like I said to repeat, there is a little obviously a bit of an effect of new construction assets as they come into the marketplaces. That will lower the mark to market, again, because we're at market and we continue to strongly believe that if we're able to acquire assets at favorable cap rates with the quality of the assets and the CapEx profile that the market likes to understand, there is a major benefit to that. So we are mindful of the fact that mark to market is important, but we are also mindful of the fact that buying good accretive acquisitions that don't have CapEx exposure in the future can also be meaningful.
Yeah. That's a good point. I didn't actually think about that. You guys have bought some new assets and obviously the turnover on that would be different, okay.
It may be different. Kings Club will be a great example of that.
Right, right. No, that's fair. Okay. Just in terms of your fee revenue, just given all the known activity that's been completed or announced in Erez, are you able to give us a sense of what the run rate for your fee revenue would be
now? Yes, I think we've actually got some hopefully what you'll find is decent disclosure in our other income section on the MD and A. Okay. So I'd point you towards that. I think what's excluded unfortunately, but we've added a note to kind of give a run rate.
We have the IRS income coming through. The ERES income because we consolidate, it's considered a related party transaction. So it's completely eliminated from our income statement, but we provided disclosure. So as our percentage ownership drops down, we'll see a bigger percentage of that hit the FFO line item. But yes, there's some disclosure on there that will get you numbers.
I think it was about $4,400,000 for e res as of Q3.
Got it. So all of that is IRES and the ERES portion is clearly eliminated, but you actually get a bump in your FFO on the bottom below the line?
So the $4,400,000 was just erez, irez is closer to $6,000,000 So it's in the flat side. For the 9 months. So you'll see it there and you can kind of translate what that looks like forward. But yes, from an FFO point of view or from an income statement point of view, not to get too technical, we eliminate the asset and property management fee. But from an FFO point of view, we actually do include the non controlling interest percentage of that fee in our FFO.
So that's trending around 25% to 30% right now.
Okay, awesome. And last one for me and another technical question, apologies. But your liquidity position being what it was, I guess the prom note being repaid from eRAS eRAS subsequent to quarter, the way you're disclosing and thinking about liquidity, that would be incremental to your liquidity at quarter end, would it not fully?
Yes. Yes. Okay. Yes. And then obviously, normal course mortgage financing, etcetera.
And we are obviously, our leverage continues to drop significantly. So we continue to look for other debt financing opportunities.
Very helpful. Thanks guys.
Thanks Mike.
Thank you. Our following question is from Matt Kornack from National Bank Financial. Please go ahead.
Hi guys. Just a quick question on the mark to market. I assume that that doesn't include potential suite presumably you've also renovated a lot of your suites. But presumably you've also renovated a lot of your suites. So is there still an opportunity along those lines to generate higher mark to markets?
The mark to markets have been done on established rents. So when we're running a rental program, it would take that into account. When we're mark to marketing, we're not guessing what the market can deliver. We're basing on what we've achieved. So there are opportunities perhaps where we decide a rental program in a particular building can have a dramatic impact and that would change the mark to market.
So I would say to be clear, the current mark to market that we've been quoting here takes into account the rental program we've been running.
Okay. No, that makes sense. And I don't know where it stands, but a rough percentage in terms of the opportunity you see at this point in terms of higher end suite renovations?
Well, I think the path that we're currently on, like the higher end is really showing up in the suburbs as you may have heard us say that before Matt, like the move from the core and into the suburbs has really been where we've seen the most success and affordability in general in the core has been pushed for so many years now that the rentals in the core don't seem to take hold as well as they are in the suburbs.
Some of your peers are pushing rents pretty aggressively in Montreal. I know it's an interesting rent control regime there, but are you seeing improved dynamics an interesting rent control regime there. But are you seeing improved dynamics in that market in your portfolio as well?
Yes. I think we said almost 6 percent mark to market. And we also believe in that. It would only the Cone caution here is that when you get into that fully maximized highest level rent, you are now in a bigger churn environment and your cost can also be affected by that churn. So sometimes the math doesn't ultimately play out.
It will in a year, but as you see over time, if you've got high increased churn at absolute high end rents, then a, your vacancy will be impacted, your churn costs will be impacted and you just end up with a little more volatility. So we explore that stuff, we explore cautiously. Yes.
Our actual like turnover last year year to date versus this year year to date, last year we are closer to 5 in Quebec overall and this year we're closer to 11. So we are definitely seeing a significant increase in the Quebec market there.
Greater churn to the higher rents.
Interesting. And I think the answer to this is going to be no. But would you ever consider selling the air rights in your properties or developing condos for profit as opposed to rental?
We are a rental company. That being said, as we get entitlements done, we will be looking for the highest and best use of that land. And if it's incredibly compelling to sell land at condo premiums, then we would consider doing that and recycling the money into value add or new income producing properties.
Okay.
It has to be very, very compelling for us to do that.
And I would assume that would be urban Toronto or maybe Vancouver.
Oddly enough, it's like suburban again Toronto that where you're seeing like real density allocations being given. But yes, we have got a number of properties that as we get close to entitlements we will give much better guidance in terms of what our intentions are.
Okay. That's perfect. Thanks, guys.
Thank you, Matt.
Thank you. Our following question is from Mario Saric from Scotiabank. Please go ahead.
Hi, sorry. Just one more for me. Just a clarification on the 20% plus mark to market on the total portfolio. What would the implied CapEx spend per door be to generate that
date. There would be no there's no I'm not sure who asked the question. We're not planning Giant Rentals to achieve those numbers. We would be continuing with the program that we have, because what we're doing is we're looking at actual rents that we've achieved and those actual rents that we've achieved have been a result of the CapEx program we currently have in place. So there wouldn't be a trend from the current CapEx spend.
That's a big number, Mario. If you look at our in suite trend
and you
look at the mark to market rents that we are achieving, that would give you the answer. I just don't have the per unit down.
Got it. Okay. Thank you.
Thanks. Thank you. This concludes today's Q and A session. I would now like to turn the meeting over to Mr. Kenny.
Well, thank you very much as we appreciate everybody's ongoing interest in CAPREIT. And thank you so much for your time today.
Thank you.