Good morning, ladies and gentlemen. Welcome to the CAPREIT second quarter 2018 results conference call. I would now like to turn the meeting over to Mr. David Mills. Please go ahead, Mr. Mills.
Thanks, Maude, 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, as 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 at sedar.com. I'll now turn things over to David Ehrlich, President and Chief Executive Officer.
Thanks, David. Good morning, everyone, and thank you for joining us today. With me are our Chief Operating Officer, Mark Kenney, and our CFO, Scott Cryer. Our record results generated in 2017 continued in 2018, with Q2 demonstrating even stronger performance than the first quarter of this year. Revenues were up 8.6% compared to last year due to the positive contribution of acquisitions and exceptional increases in average monthly rents and high occupancies. NOI rose a solid 12.3% in the quarter due to higher revenues, lower utility costs, and wages. AFFO rose 20.8% in the quarter, driven by the growth in revenues. The quarter also demonstrated a significant accretive growth as AFFO per unit was up 14.1%. Our record performance continues to thrive throughout the first six months of 2018, as demonstrated by the numbers shown on slide five.
Revenues were up over 8% compared to last year due to the positive contribution of acquisitions, exceptional increases in average monthly rent, and stable high occupancies. Same-property NOI rose a very strong 7.4% as a result of higher revenues, lower vacancies, reduced utility costs, and wages. AFFO, the main measure of our performance, rose significantly to 16% through the first six months of 2018, driven by the growth in revenues and our continuing strong increases in stabilized NOI, generating a strong payout ratio of 65.9%. All in all, it was an even stronger quarter for CAPREIT. I'll now turn things over to Mark to review in more detail our continuing strong operational performance.
Thanks, David. Good morning, everyone. Thanks again for joining us today. Turning to slide seven, we are very proud of our strong operating performance so far this year. In fact, the second quarter was one of the most successful in our 20-year history. This was due mainly to the solid rent increases we are achieving across the portfolio and continuing near full-term occupancies. We used a hands-on approach to our business, and our centralized rent management technology continues to contribute to our ability to maximize revenues in all of our markets. As you can see, average monthly rents increased by a solid 4.5% compared to the same time last year, while our occupancy rose to 98.9%. Another factor positively impacting growth in our monthly rents this year has been the upward trend of guideline increases in our British Columbia and Ontario markets.
In Ontario this year, we have a rental guideline increase of 1.8%, up from 1.5% in 2017. In British Columbia, the rental guideline increased to 4% this year from 3.7% in 2017. In addition, we continue to pursue applications in Ontario for above-guideline increases, where we have invested in major capital projects. As you can see on slide eight, we are seeing very positive trends in rent increases on suite turnovers. For the three and six months ended June 30, 2018, we generated an impressive 10.5% and 10.1% increase in average monthly rents on turnover. These numbers supersede last year, in which 5.9% and 5.1% increases were generated. Our performance in Ontario and BC was particularly strong in the second quarter. In Q2 2018, monthly residential rents in Ontario increased by 17.8% on suite turnovers. In British Columbia, monthly rents rose by 13.8% on suite turnovers.
Average monthly rent on lease renewals for the three and six months ended June 30, 2018 both increased by approximately 2.2%, up from the 1.9% increase last year. We are confident these positive trends will continue going forward. For the last 20 years, we have demonstrated a consistent ability to generate what we believe is industry-leading organic growth. Driven by high, stable occupancies, increasing revenues, managing our costs, and capturing enhanced operating efficiencies resulting from our increasing size and scale. As you can see on slide nine, our track record of organic growth is continuing in 2018, with same property NOI rising a very strong 7.4% through the first six months of this year. For the second quarter, organic growth was an even stronger 7.7%. Going forward, we are confident we can continue to deliver stable and steady growth in same property NOI in the years ahead.
We continue to be pleased with our performance in Dublin, as detailed on slide 10. Since the IRES IPO over four years ago, we have received a total of asset and property management fees of CAD 15.9 million to the end of 2017. To date, in 2018, the contribution continued with fees totaling CAD 3.5 million, up 21% from last year. During the second quarter, we increased our ownership of IRES from 15.7% to 18% as of June 30, 2018. The increase in our ownership position reflects our confidence that IRES performance will remain very strong going forward. Our retained interest in IRES also continues to generate a solid stream of dividend income amounting to CAD 13.3 million to date since the IRES IPO in April 2014. Turning to slide 11. Our portfolio in the Netherlands also continues to perform well while further enhancing our geographic diversification.
To date, we have grown our presence in the strong market to 2,091 suites, and we continue to evaluate further expansion opportunities in the country. Last year, we opened our own property management office in the country, helping us better manage our costs and our ability to strategically renovate suites on turnover to generate higher monthly rents. Looking ahead, we continue to evaluate strategies to grow in the Netherlands. I'll now turn things over to Scott for his financial review.
Thanks, Mark. Turning to our balance sheet. We continue to maintain a strong and flexible financial position, as shown on slide 13, with conservative leverage, strong coverage ratios, and a further reduction in our interest costs. Debt to GBV hit another all-time low of 40.5%, putting us in a great position for future acquisitions and development. On March 15th, we successfully completed a bought deal equity offering, raising gross proceeds of CAD 172.6 million, including the overallotment option. With the proceeds of the successful offering, as at June 30th, 2018, we had approximately CAD 162 million available in borrowing capacity on our various Canadian, U.S., and euro credit facilities. Our mortgage portfolio remains well-balanced, as shown on slide 14, with no more than 15% coming due in a single year. Our ability to top up on renewing mortgages through 2026 will provide significant liquidity to fund our acquisition and development pipeline.
Through the balance of 2018, we will have approximately CAD 115 million in mortgages maturing with an average interest rate of 3.34%, and we expect to refinance approximately CAD 58 million in principal repayments with new mortgages. It's also important to note that we have approximately CAD 315 million of our properties not encumbered by mortgages as at June 30th, 2018, providing further flexibility to fund our growth and investment programs going forward. As shown on the previous slide, our mortgage portfolio remains well-balanced. As we approach 2019, our ability to top up on renewal mortgages over the next five years will provide significant liquidity to fund our acquisitions and development pipeline.
Based on the mortgage refinancing assumptions indicated on slide 15, we could have approximately CAD 1.7 billion in top-up liquidity over the next five years to fund our capital investments, acquisitions, and development programs, and that excludes the additional mortgage funding on these new properties. As at June 30th, 2018, 97.3% of our current mortgages are CMHC insured, providing us with a large and diverse group of lenders willing to work with us at rates below conventional financing. Again, on the liquidity front, we remain well positioned to continue our growth programs, as shown on slide 16. With the completion of our bought deal equity offering in March, again, our liquidity position stands at CAD 162 million. I'll now turn things back to David to wrap up.
Thanks, Scott. Development remains a key component to our future growth strategy. Our management team has recently assessed the viability of development and validated there is potential to build well in excess of 10,000 net new apartments, much of which are by way of infill on vacant land we already own. We are finalizing a structured roadmap to guide how this development potential will be realized over the next 10 years. Together, our management team and the board will collaborate to decide how to best move forward and maximize value for unitholders. Currently, two rezoning applications are in the approval process for developments in the city of Toronto, which are now under review. Assuming we are able to successfully navigate the approval process, these applications would produce a combined 274 units at the well-located Davisville and Wellesley properties. In summary, we continue to remain very confident in our future.
We have proven our ability to capitalize on continuing strong fundamentals in the apartment business through all economic cycles. We continue to maintain a strong financial position with the flexibility and resources to continue our growth and sustain our monthly distributions over the long term. Thank you all for your time this morning. We would now be pleased to answer any 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 Dean Wilkinson from CIBC. Please go ahead.
Thanks. Morning, everybody.
Morning.
Just a quick question on the margin increase that happened in the quarter and the amount of that which was driven by reduced repairs and maintenance. Given that you've got more R&M coming on in the back half of the year, should we expect the margin to stabilize, or is this something structural that's changed?
I think, we've made reference to our capital programs being weighted towards the end of the year.
We don't see any fundamental change in our R&M spend. As we said last year, we've done a lot of different programs to catch up on the preventative maintenance front, and we're pretty confident going forward, R&M will stay stable.
Stable, there's a bit of a catch-up that we could expect here.
I wouldn't expect a dramatic catch-up of any sort.
Okay. Then just turning to the acquisition of the additional IRES units. Can you confirm that was in fact settled in cash?
Yes.
Yeah.
Yeah.
That was done at sort of the market price as those warrants were exercised?
Yes. In fact, the stock is trading well above that price now.
Oh, for sure. That's good. The last one for me, just, Scott, on the slide looking at the five-year liquidity position in the mortgage portfolio, am I reading this right? You're looking at an expected 85 basis point hike in the underlying cap rates, sort of from the, you call it, low, mid four. Your forecast-
Yes
would be anticipating something in the low fives?
Yeah, I think we're just trying to sensitize that based on what the economists would think was happening to interest rates.
Yeah.
We expanded our cap rates equivalent just to be conservative. Yeah.
No, that absolutely makes sense. I think that's the right way to look at it. That's it. I'll hand it back to Q. Thanks, guys.
Thank you. Our following question is from Michael Markidis from Desjardins. Please go ahead.
Good morning. Mark, you made reference to a 17% lift that you were getting in the Ontario portfolio. Would you be able to give us a little bit more color with respect to what you saw in the GTA versus Ottawa and Kitchener, Waterloo, and London?
Well, clearly the GTA is the strongest, although that being said, we're seeing very strong increases in the sub-markets as well. I think it's a housing supply issue that kind of finds its way throughout all of Ontario, to be perfectly honest. GTA is clearly leading the way.
Could you give us a sense of the magnitude? Like, would GTA be, I don't know, I'm throwing out numbers here, but 25% versus kind of high single digits in the others, or is it pretty much similar across the board?
We haven't given specific market updates, I can tell you it's extremely strong in the GTA, places like Ottawa aren't far behind.
Okay. That's fair. Thanks. I just noticed that your year-over-year operating expenses in B.C., Alberta, and Saskatchewan were done quite significantly this quarter. Is that partly a function of some of the streamlining of your operating platform you did that led to some of the non-executive severance earlier this year?
Yeah. Scott could give you some Are you talking about G&A? Are you talking about?
No, sorry, the actual operating expenses for B.C., Alberta, and Saskatchewan went down across the board quite significantly.
Yeah. We had in the third and fourth quarter of last year, really picked up some one-time preventative maintenance items in repairs and maintenance and have guided that we don't see that reoccurring in the near future.
Yeah, lower utilities also contributed significantly to that as well.
On the year-over-year change?
Yeah.
Okay. Last thing I have, there's actually two more here before I turn it back. Scott, there was CAD 900,000 roughly of other income in the finance and-
Yeah.
What does that relate to?
That is one-time. It was insurance proceed funding that came through this quarter.
Okay.
That's just a one-time item. Yeah.
I know you guys have had a lot of variability in your G&A, a lot of pressures in late last year and earlier this year with respect to opening your Netherlands office and some of that non-executive severance. The 2Q number that we saw, would that be indicative now of a decent run rate going forward or?
Yeah, I think as a baseline for sure. I mean, the one-time items, we call them one-time items, they end up reoccurring more frequently than we always expect. As a baseline, I think that's a good kickoff point for sure.
Okay. That's very helpful. Thanks very much.
Thanks, Mike.
Thank you. Following question is from Jonathan Kelcher from TD Securities. Please go ahead.
Thanks. Good morning.
Morning.
First up, in your presentation, you make reference to a deep pool of acquisition opportunities in the Netherlands. Is that something you'd expect to execute on in the back half of this year?
Yeah, we're confident that those opportunities will materialize this year.
Jonathan, as we've said in the past, but we're still working on it to find the very best way of maximizing growth in that portfolio, without keeping it all on our books. It's a growth.
Sorry, without keeping it on your books, did you say?
No, without keeping all of it on our books. In other words, grow the thing significantly, but have a substantial portion of it on our books. To grow it, not necessarily to put in significantly more of CAPREIT's capital. Again, that remains to be seen as we go forward.
Okay. You would be looking for partners to invest with?
Again, we're looking at a number of strategies for that.
Okay. Secondly, on the two developments that you highlighted, just from a high level, how should we think about costs for those and return expectations?
As we get a little bit closer to the approval process, we'll provide clarity on exactly how those pro formas are looking. Our first take on both of these properties is because there's parking that we can utilize and land with virtually no cost. They're quite accretive. We will provide some further detail as we get them finalized.
Okay. Thanks. I'll turn it back.
Thank you. Following question is from Brad Sturges from Industrial Alliance. Please go ahead.
Hi there. Mark, with the new PC government in power here in Ontario, I guess I'm curious to know what your interaction might have been with them so far in terms of either rent control legislation or development. Is there any color or takeaways that you could provide at this stage?
This government appears to be very serious about addressing the supply issue and encouraging rental investment in the province. There has been some open discussions. They're looking for feedback from our industry association, FRPO, on how to best address the supply issues. So far, they've been quite receptive to the recommendations that have been made. We don't expect to hear from them officially with any sort of changes for the next few months, but they are actively looking for our input right now. It's encouraging.
You're optimistic in terms of at least where the discussions are going at this stage.
We're certainly more optimistic than we were three months ago.
Right. Okay. Scott, just in terms of the top-up potential for mortgages to enhance liquidity, is the strategy to take full advantage of that top-up potential as it comes due, or is it more on an as-needed basis right now?
Generally, our approach has been to do it as it comes due. We have looked at pulling a couple mortgages forward or putting seconds on it. I'd definitely say our debt to GBV levels are quite low. A lot of that is driven by fair value, but we still would see the use of debt, a way to kind of bring that leverage up a little bit. We may look to accelerate some going into late 2018 and early 2019.
Right. Okay. Thank you.
Thank you. Following question is from Matt Kornack from National Bank Financial. Please go ahead.
Hi, guys.
Morning.
Morning.
Quickly on turnover in Ontario. For that 17% rent increase on turnover, are you seeing trends now sub 20% on an annual basis, would you think, for turnover in Ontario?
It's a number we've not provided, but that is very close to the trend of the industry, and there's clearly downward pressure on the number of units turning over that's being offset by robust increases when they actually do turn.
Are you guys, there's been some press and I don't think you guys have been mentioned, but having any issues with putting through AGIs at this point in the GTA?
We're fortunate that AGI process has gained a lot of attention. The bulk of our AGI applications in Ontario went through a couple of years ago.
Okay.
We do have active AGI applications. The attention around AGIs, to be quite frank, is around the common area improvements, lobbies, hallways, those kind of things, where current tenants resent the perception that landlords are getting increases on turnover because of those improvements. There's been very little backlash with respect to balconies, garages, brick, the structural work. We are taking a pretty conservative approach. Most of our common area work is done. Where we are putting applications in, it's for the structural type work.
Okay. No, that makes sense. Then on property taxes, we just did a quick look back at your IFRS fair values versus property tax growth, and your fair values have far outreached the increase in property taxes. Do you think municipalities are going to start pushing a bit more on valuations, or how does that process work at the end of the day from a property tax standpoint?
Scott, do you want to talk about our process?
Yeah. They continually push every year, definitely. It hasn't kept up with the total fair value gain. Ultimately, I guess, all property values have appreciated across those municipalities, so you're only getting a percentage of the total budget lift. We have a continuous feedback process with the municipalities. We basically challenge our property taxes every year with the use of consultants. We haven't seen any new pressures specifically. It's kind of fairly status quo as far as that process.
Okay. No, that makes sense. Then just want to follow up on the OpEx side. If I hear correctly, this quarter, it sounds like is an okay run rate, or should we look back to the second half of last year and assume that it will be somewhat similar? I know Q4 was a bit high on a number of things, so I would assume that wouldn't be replicated. Should we assume a slight increase, I guess, from the current quarter in terms of operating costs in the second half of the year?
We see our operating costs being quite stable right now.
Okay. No, that's fine.
I think utilities is probably the only piece that's hard to call. We've definitely had a win on utilities, so that could potentially have some pressure as we get into the colder months, but outside of that.
I guess that was a big election issue in Ontario, but have you seen any change in utilities costs subsequent to the election, or do you expect that the lower rates in Q1 would be replicated, I guess, going forward?
I don't think we see any changes in rates, but as Scott said, we get a rise in consumption, obviously, in a little bit in Q3 and Q4.
Okay. Last question on the other income. At this point, what's a good sort of stabilized recurring number there? We're around three and a half to maybe CAD 375,000 a quarter. Is that?
Scott, do you want to?
CAD 3.75 million.
Sorry, CAD 3.75 million?
Yeah.
Yeah. If you're backing out the CAD 900 and all the fair value gains, you're kind of pretty stable level. We've had some growth in asset management, property management fees, but it's not that significant. It should be a good run rate.
That makes sense.
It's typically a number that we're always pushing for more on. It's not a number that typically contracts. It's our ability to find new sources of other income that can grow to that. There's nothing substantial in the pipeline that should dramatically change the number. We'd like to see it rise.
Makes sense. Congrats on the quarters.
Thank you.
Thank you.
Thank you.
Thank you. Our following question is from Mario Saric from Scotiabank. Please go ahead.
Good morning.
Hi, Mario.
Coming back to the rent growth in Ontario of almost 18% on turn. I think we talked about it last quarter, but it sounds like the amount of CapEx you're putting into the buildings to get that type of rent growth is declining given the strength in the market. How should we think about the 18% growth in terms of the amount of CapEx put in this year versus last year, and how much of it is pure kind of market rent driven versus return on investment?
Well, interestingly enough, we're now finding a situation in the suburbs of the GTA, and I'm talking about Brampton and Scarborough, where the math is making sense again to do renovation work. Where in the GTA, I'll say in the core, there's very little differential in terms of the return that you get on that invested CapEx for in-suite, but we're seeing some very interesting opportunities deeper into the suburbs. We are actually not materially changing, but definitely in places like Scarborough and Brampton, investing in in-suite CapEx and seeing quite strong returns by doing that. That would outweigh what the market would naturally give us.
Got it. Okay. Clearly wages aren't going up at 18% in the province. So are you starting to feel a bit of pushback in terms of affordability? If not, is it a different tenant that's coming in with a different income profile that's paying the higher rents? What's affordability feeling like now?
It's a great question. I think the upscaling of the CAPREIT portfolio over the years has served us extremely well. Our bad debt levels are at all-time lows, so the trend towards default is actually falling in this rising rent environment. I think some of you have actually heard me say before that the default rate for the CAPREIT portfolio now is actually lower than the CMHC mortgage default rate. It's really the upscaling of the portfolio that's been a very wise strategy.
Got it. Okay. Just one more question on my end. Turning to development, on the development update slide, you talked about the in excess of 10,000 net new doors on existing land. There's also a bullet there on potentially kind of focusing on redevelopment of existing buildings. I'm wondering if you can kind of highlight how you think about redeveloping an existing building versus net new apartments, aside from excess land, and how big that opportunity may be in terms of a percentage of your portfolio today, where you think you could substantially redevelop a building and what types of return that may come from.
As I said, it's really a site-by-site analysis that you have to do. Every site is different as to how to maximize that particular location, and that analysis can change. Sites that may have been harder to develop today may, in three or four years, go to the top of the list. It's not a static number. Certainly, the ones where we are building on existing lands are less complicated to deal with. You're not dealing with existing tenants that have to be relocated and so forth. The well in excess of 10,000 number is predominantly those where we have the ability to build on our own land and are therefore much less complex, and take less time, where we can, for example, as Mark mentioned, use a common garage. That's a huge cost and time saving.
I can't make a statement about all these sites because every one's so different.
I think, Mario, to build on what David has said, is that we've actually done an incredibly intensive review of the opportunity, and that's how we've arrived at the 10,000. It's been done with a great deal of consideration. We only have today the two active applications that we've been talking about with Davisville and Wellesley. As the applications start rolling in, we will be giving additional insights on not only how the math is going to work, but also on the opportunity. As the applications come forward, you'll get a much more clear picture of the site-by-site opportunity that David's described.
Okay. When we talk about the additional opportunity for development through redevelopment of existing buildings, would that additional opportunity be already in that well in excess of 10,000 net new apartments that you referred to above?
That number is mostly made up of those opportunities. There are other opportunities where we may have to tear down something or phase a development by building something and then tearing something down. Those situations, which are a little more complicated. These would be the first to attack, subject to the fact that we reserve the right to change our minds tomorrow and find something that's so attractive that we move it up to the top of the list.
Okay. Thank you.
Thank you. Our following question is from Neil Downey from RBC Capital Markets. Please go ahead.
Hi. Good morning, everyone. Mark, at sites like Davisville and Wellesley, is your existing parking underutilized today, or when you add suites, at those sites, do you simply intend to charge higher parking rents? Parking rates, rather.
They are underutilized by our tenants but leased out to third parties. We've made the most of the opportunity. When the buildings were originally built, typically in the '50s and '60s, you get a parking ratio to apartments of about 1.5 parking spaces per apartment. Today in the city of Toronto, we're seeing condo applications at 0.35 parking spaces per apartment. Clearly the market has changed, the ratio requirement has changed. In those two buildings, we can accommodate, with a great deal of comfort, the parking requirements of the new property.
Great. Thank you.
You're welcome.
Thank you. We have no further questions registered at this time. I would now like to turn the meeting back over to Mr. Ehrlich.
Thank you, everyone. Have a great day.
Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.