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 about expected future events and the financial and operating results of CAPREIT. Our actual results may differ materially from these forward-looking statements, and 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&A, which can be found on our website or at sedar.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. Scott Cryer, our Chief Financial Officer, is also on the call today. Turning to slide four, we continue to increase the size, scale, and diversification of our portfolio through accretive acquisitions. Far this year, we have purchased 8,413 residential suites and MHC sites in Canada and the Netherlands for just over CAD 1 billion. 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 five. 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 six outlines our results through the first nine months of 2019. With revenues up almost 12%, NOI rising 13.5%, driving a 14.1% increase in NFFO. Again, our growth was accretive as NFFO per unit rose 3.4%, despite the 10.4% increase in the weighted number of 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 that 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.
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. An affordable cost for a CAPREIT rental home ranges between only 18% and 25% of family income, much more affordable than the estimated 56% of income being experienced for home ownership in Canada. As a percentage of median family income, the cost of home ownership in 2019 in the key cities of Toronto and Vancouver is even higher, at 79% and 88%, respectively, with Montreal home ownership 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 nine. Occupancies remain 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 nine months ended September 30th, 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 30th, 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 third-party mortgages at very favorable interest rates, utilizing our euro acquisition and operating facility, and entering into close to CAD 100 million euro swap to further hedge our euro exposures. Currently, we have over EUR 1.4 billion 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 2034 will provide significant liquidity to fund our acquisitions and development pipeline. Through the balance of 2019, we have CAD 85 million in mortgage maturing with an average interest rate of 2.8%. Expected mortgage renewal and refinancings for 2019 are between CAD 365 million to CAD 415 million, excluding financings on acquisitions.
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 CAD 288 million in funds, including the over-allotment option . To fund further growth, on April 23rd, we completed another successful bought deal offering, raising a total of CAD 345 million in funds, including the over-allotment option. This results in a total equity raise to date in 2019 of CAD 633 million. With the acquisitions completed so far this year, we have approximately CAD 50 million 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'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 unit holders. Our geographic diversification across Canada and internationally ensures that our unit holders 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. Finally, we have the opportunity to boost revenues in the future by selling homes to residents. Importantly, CAPREIT is now the second-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 first nine 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 IRES continues to grow its portfolio. IRES has also completed a successful equity raise earlier this year, which we increased our ownership position to 18.3%. This retained interest continues to generate a solid stream of dividend income amounting to CAD 7.2 million for the nine months ended September 30th, 2019.
Our presence in the Netherlands also continues to drive value for unit holders, 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 CAD 740 million. We now have sold all of our Netherlands properties to ERES, generating a growing base of fee revenues for our asset and property management services. CAPREIT now owns just under 74% of ERES, fully aligning our interest with all ERES unit holders. You can see through the first nine months of 2019, we earned EUR 29.2 million of NOI from ERES properties in Europe, and another EUR 9.7 million 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 30th, 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. 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. We would now be pleased to take any of the questions you may have.
Thank you. We will now take questions from the telephone lines. If you have a question and you are using a speakerphone, please lift your handset before making your selection. If you have a question, please press star one on your telephone keypad. If at any time you wish to cancel your question, please press the pound sign. Please press star one at this time if you have a question. There will be a brief pause while participants register for questions. We thank you for your patience. Our first question is from Jonathan Kelcher from TD Securities. Please go ahead.
Thanks. Good morning.
Morning.
First question's 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?
I think, we've talked about this before. Definitely R&M is something that's a little lumpy. We definitely saw a higher run rate there. That we would see as more of a temporary. There are a couple items that have been more permanent. First of all, we have four ground leases that all kind of came to a renewal period in the current year. That's impacted Q2 and Q3 pretty hard, to the tune of over half a million dollars each quarter in incremental land payments. That's something that it's an increase that will hit the next quarter as well and then flatten out there. That's definitely a permanent increase that we've had to incur.
Yeah. We don't see R&M at the end of the day being a rising trend increase. The third quarter, we 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.
Yeah.
Okay. For 2020, assuming you continue to get the revenue growth that it appears you should, you'd expect that to outpace cost growth?
Yes.
Okay. Sorry, Scott, those four ground leases, I guess that would be Toronto, Vancouver, and Calgary?
No, it's actually-
Calgary, Vancouver.
one in Vancouver and three in Calgary. Some of them are still being negotiated, but we've been prudent in making sure we're appropriately accruing for the potential step-up.
Okay. Just turning to slide eight. I guess that's 2016 family income versus the current AMR? Your stats should actually look a little bit better, assuming that family incomes went up the last two or three years.
That's right. Yep.
That's correct. Yep.
Okay. 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'll be producing more information on this. 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're seeing positive mark-to-market in Alberta of about 4% in our estimation, with Nova Scotia sitting at around 6%.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. As that, like the GTA, if you were thinking about that six 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. 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'll turn it back.
Thank you. Once again, please press star one at this time for any questions or comments. Our following question is from Mario Saric from Scotiabank. Please go ahead.
Hi, good morning.
Morning.
I'm going to stick to slide eight 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%-35% range. 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. You can see that by taking just average family incomes, the huge disconnect between affordability in homeownership versus the very attractive, even today, 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 our best to give some representation of how truly affordable the CAPREIT portfolio is.
If we look at your AMR divided by the household income estimate in your portfolio.
Yes
What would those percentages look like today?
They would be slightly higher, but still well within our traditional 35% guidance.
Got it. Okay. The second question, just on the fair value gain during the quarter, pretty substantial at CAD 264 million, 80% of it was due to higher expected NOI. Can you walk us through how that is calculated on the NOI side, and specifically how you capture the very attractive mark-to-markets in the portfolio that Mark alluded to earlier on the call in that IFRS valuation?
Yeah, we do a stabilized one-year forward roll of our rent rolls based on kind of turnover and renewal rates that we're seeing. We do that quarterly just to kind of keep up. We obviously have our third-party evaluator help us with cap rates. The reality is that the year-end process is obviously more robust in that you kind of need to take those growth rates into consideration on the cap rates. We generally just roll our rent rolls and take the impacts of those of a one-year roll forward.
The mark-to-market that we talked about earlier would be somewhat reflected in the cap rate when the appraiser takes a look. We've had a very conservative practice at CAPREIT 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.
Right. I guess to summarize, it's partially reflected in the cap rate, i.e., the IFRS.
Partially reflected in the cap rate. Yep.
Not nearly to the extent of the full mark-to-market upside over time.
No.
Correct.
That's true. CAPREIT upside mark-to-market is in excess of 20% portfolio-wide.
Okay. 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? Secondly-
Yep
would the Kings Club fair value bump be reflected in the CAD 264 at all?
Yeah. Definitely the transactions as of recently are not included in any of these. 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. Yeah, 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. Given similar mark-to-markets and given the quality of the CAPREIT portfolio, I would suggest that our unit holders are sitting on tremendous value.
Yeah. In regards to your second half of the question, we did take a fair value bump on that asset in this quarter that was fairly significant. That definitely had a strong contribution to the overall gain.
It's interesting, Mario, on Kings Club, only because we're on the topic of mark-to-market. I know that you know, and others know, that we've been progressing with the purchasing of brand-new properties in the portfolio quite robustly. Even with those big transactions, clearly the mark-to-market on those rents is zero if we're doing our job properly. Even with those fully mark-to-market properties, we're still seeing very significant overall spread.
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 the strength in the market on the valuation side that you're seeing in 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?
Yeah. I think you may have seen some of the assets that we recycled in 2018. We really have taken the non-strategic approach. If the asset is non-strategic, we'll consider disposition. 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. This is a seasonal change for us. However, our commitment to investing in the buildings is completely unwavered. 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? If so, what is driving it?
That's an incredibly astute observation.
I agree.
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 have 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. Very encouraged at the value creation that lays ahead. We've 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 free land, it's really not good news for the market in general in terms of delivering affordable supply.
Understood. Okay. Thanks for the color.
Thank you. 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 mentioned that you've been doing some work on that. Is that something that is going to be rolling itself into CAPREIT's quarterly disclosure in the near future?
Yes, it is. Yeah, 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 B.C. Some of the other markets, as we all learned, especially out West, can be quite punitive fast. We're really encouraged that all of our markets are firing well. 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, 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. Actually, we've seen Quebec probably accelerate. Definitely over the last year, we've seen Quebec performing quite well. 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 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 are at market, and we continue to strongly believe that if we are able to acquire assets at favorable cap rates with the quality of the assets and the CapEx profile that the market likes to understand, that there is a major benefit to that. 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 pays differently. Kings Club will be a great example of that.
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 ERES, are you able to give us a sense of what the run rate for your fee revenue would be now?
Yeah. I think we've actually got Hopefully, what you'll find is decent disclosure in our other income section on the MD&A.
Okay.
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 IRES 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. As our percentage ownership drops down, we'll see a bigger percentage of that hit the FFO line item. Yeah, there's some disclosure in there that'll get you numbers. I think it was about CAD 4.4 million for ERES as of Q3.
Got it. All of that is IRES, and the ERES portion is completely eliminated, but you actually get a bump in your FFO on the bottom below the line.
Sorry, the CAD 4.4 was just ERES. IRES is closer to CAD 6 million-
It's in the fly slide.
for the nine months. You'll see it there, and you can kind of translate what that looks like forward. Yeah, from an FFO point of view or from an income statement point of view, not to get too technical.
Okay
we eliminate the asset and property management fee. From an FFO point of view, we actually do include the non-controlling interest percentage of that fee in our FFO.
Got it.
That's trending around 25%-30% right now.
Okay. Awesome. Last one for me, and another technical question, apologies. Your liquidity position being what it was, I guess the promissory note being repaid from ERES 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?
Yeah.
Or it would-
Yeah.
Okay.
Totally.
All right.
Yeah. Obviously, normal course mortgage financings, et cetera. Obviously, our leverage continues to drop significantly. 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.
Hi, Matt.
Just a quick question on the mark-to-market. I assume that that doesn't include potential suite renovations in terms of improvements. Can you comment, you've done a lot of heavy lifting, obviously, on building improvements, but presumably you've also renovated a lot of your suites. Is there still an opportunity along those lines to generate higher mark-to-markets?
The mark-to-markets have been done on established rents. When we're running a reno 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 it on what we've achieved. There are opportunities perhaps where we decide a reno program in a particular building can have a dramatic impact, and that would change the mark-to-market. I would say to be clear, the current mark-to-market that we've been quoting here takes into account the reno program we've been running.
Okay. No, that makes sense. 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?
I think the path that we're currently on, the higher end is really showing up in the suburbs. As you may have heard us say that before, Matt.
Yes.
The move from the core and into the suburbs has really been where we've seen the most success. Affordability in general in the core has been pushed for so many years now that the renos 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 in that market in your portfolio as well?
Yeah, I think we said almost 6% mark-to-market. We also believe in that. The only caution here is that, when you get into that fully maximized highest level rent, you are now in a bigger churn environment.
Right.
Your cost can also be affected by that churn. Sometimes the math doesn't ultimately play out. It will in a year. 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. We explore that stuff. We explore it cautiously.
Yeah. Our actual turnover last year to date versus this year to date. Last year we were closer to five in Quebec overall, and this year we're closer to 11. We are definitely seeing a significant increase in the Quebec market there. Yeah.
Greater churn to the higher rents.
Interesting. I think the answer to this is going to be no, 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. 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 would have to be very compelling for us to do that.
I would assume that would be urban Toronto or maybe Vancouver, but.
Oddly enough, it's suburban, again, Toronto, where you're seeing real density allocations being given. Yeah, we've got a number of properties that as we get close to entitlements, we'll 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 from me. 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 20%? Would it be very different?
I don't have the number handy, but it would follow the trend of what's happened to date. I'm not sure who asked the question. We're not planning giant renos 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. 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're 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&A session. I would now like to turn the meeting over to Mr. Kenney.
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