Good morning. Thank you for attending today's Canadian Apartment Properties Second Quarter 2024 Results Conference call. My name is Cole, and I'll be the moderator for today's call. All lines will be muted during the presentation portion of the call, with an opportunity for questions and answers at the end. If you'd like to queue for a question, you can do so by pressing star one on your telephone keypad. I'd now like to pass it over to Nicole Dolan. Please go ahead.
Thank you, operator, and good morning, everyone. Before we begin, let me remind everyone that during our conference call this morning, we may include forward-looking statements about expected future events and the financial and operating results of CAPREIT, which are subject to certain risks and uncertainties. We direct your attention to slide two and our other regulatory filings for important information about these statements. I will now turn the call over to Mark Kenney, President and CEO.
Thanks, Nicole, and good morning, everyone. Joining me this morning is Stephen Co, our Chief Financial Officer, and Julian Schonfeldt, our Chief Investment Officer. Let's begin with the operational results for our Canadian apartment portfolio. As shown on slide 4, we continued our historical trajectory of strong performance. Occupancies remained high at 98.2%, on June 30, 2024, across which our average rent was CAD 1,577 per month. This was the primary driver of the 5.4%, increase in operating revenues for the three months ended June 30, 2024, as compared to the prior year period, which you can see on slide 5. Combined with solid cost control, our NOI was up by 7.2%, and our margin expanded by 110 basis points to 67%, for this second quarter.
As a result of higher NOI, as well as lower trust expenses, partially offset by higher interest costs, we're pleased to report that our diluted FFO per unit was up by 9.2%, to CAD 0.644 this past quarter. Results for the six months ended June 30, 2024, are summarized on slide 6. You can again see robust operational performance for the same property portfolio, with Canadian residential occupancy at 98.3%, and AMR growth at 6.5%. Our six-month margin for same property and total portfolio expanded by 50 and 110 basis points, respectively, while our diluted FFO per unit was up by 8.3%.
This was driven by higher same property NOI, alongside contribution from acquisitions and lower trust expenses, net of non-routine reorganization costs, partially offset by dispositions and higher interest expense. Let's move on to slide 7. I'm very excited about the ground we've covered on our strategy since the first quarter. Julian will shortly elaborate on our Canadian acquisition and disposition activity in detail, but at a very high level, we've completed nearly CAD 500 million in strategic transactions since Q1. This has increased the portion of our property portfolio represented by recently built properties in Canada to 13%, as of today, which is up from 11%, at the prior quarter end.
On top of that, in June, we were pleased to have fully disposed of our remaining equity interest in IRES, and we also announced the expected sale of our MHC portfolio for CAD 740 million in gross proceeds. These non-core dispositions are generating a significant amount of capital that we're using to fuel our high-grading strategy. Further to that, these deals are simplifying CAPREIT business, and we're thrilled to be refocusing resources on our core apartment portfolio, where our competitive advantage are the strongest. I will now turn things over to Julian to expand on our capital allocation progress.
Thanks, Mark. On slide 9, you can see how far we've come over the past couple of years. So far in 2024, we've closed on the acquisition of over CAD 500 million in on-strategy, recently constructed apartment properties in Canada, which is the most we've done in any year to date since we started exclusively targeting new builds. We've also completed nearly CAD 200 million in off-strategy dispositions in Canada, which brings our total Canadian transaction volume in 2024 to almost CAD 700 million. This approximates the total volume we achieved in all of 2023, and we still have significant runway left in the year. Slide 10 showcases our Canadian apartment transaction activity since the first quarter. You can see that we completed 6 acquisitions of high-quality, premium rental properties for an aggregate of CAD 387 million.
These recently constructed buildings are exceptionally well located in growing markets with strong fundamentals across the country, and we purchased them at a weighted average cap rate, which exceeds that of our three non-core dispositions. We're also continuing to sell at prices that are at or above our previously reported IFRS fair values, and importantly, all three off-strategy properties were sold to not-for-profit organizations. We said before that we're eager to transfer more of our older regulated residences into the hands of nonprofits, who can retain the affordabilities of these homes in perpetuity. We're pleased to be executing on that priority and helping with the resolution of the Canadian housing crisis in this way... We're equally excited to be improving the quality of our portfolio with these strategic transactions, and we're aiming to maintain this momentum in the quarters ahead.
Slide 11 provides an overview of our development model, which we've covered previously, but I'll take a minute to highlight our latest application. On the left, you can see that we've submitted an application for an infill development, proposing two new buildings containing a total of 635 residential suites at 1050 Markham Road in the GTA. This will provide for approximately 429,000 sq ft of new residential GFA to be constructed on a vacant site that is adjacent to one of our longest-owned properties, which is located within 300 meters of the future Durham- Scarborough Bus Rapid Transit station. We're also excited to have had our two Davisville applications approved, and we're looking forward to seeing more of our development pipeline progress through this program. I will now turn things over to Stephen for his financial review.
Thanks, Julian, and good morning, everyone. Referring to slide 13, our balance sheet remains strong in the second quarter, with capacity on our Canadian credit facilities increasing to approximately CAD 470 million. We have CAD 285 million in Canadian mortgage principal maturing in the second half of 2024, representing 6.3%, of the Canadian mortgage balance, and an overall weighted average term to maturity of 5.2 years, which is one of the longest in our multi-residential peer universe. The weighted average interest rate on our Canadian mortgage portfolio remains low at just over 3%, and we continue to conservatively fix all our interest costs to mitigate volatility risk.
Slide 14 shows our staggered maturity profile and highlights the fact that we have no more than 14%, of our total Canadian mortgages coming due in any given year. Proactive management of our debt financing continues to form a key part of our overall capital reallocation program, and this has empowered us to efficiently execute on our strategy. On Slide 15, you can see that our total debt to gross book value ratio remained relatively stable at 41.5%, on June 30, 2024. We've also maintained our debt service and interest coverage ratios consistent with the previous quarter at 1.8 times and 3.3 times, respectively. Finally, I want to take a minute to discuss Slide 16, which demonstrates our strategic reallocation of capital out of certain discretionary value-add improvements and into increased repairs and maintenance without impacting revenue growth.
For extra clarity, this initiative excludes energy, structural, life and safety, and other critical non-discretionary CapEx. That said, you can see that we've been scaling back on common area and in-suite capital expenditures, which are capitalized to the balance sheet. Instead, we're reallocating a portion of that spend into additional R&M work, which negatively impacts our NOI margins. However, overall, we're spending less and therefore growing our cash return. For the current six-month period, other property operating costs increased by 4%, on our total portfolio, or 8.5%, on the same property basis, with R&M representing the largest component of that. During the same period, our common area and in-suite CapEx declined by 29%, evidencing the net savings achieved by this strategy without negatively impacting our top-line growth.
We're continuing to actively manage our capital in accordance with our operating environment in order to enhance cash flows and ultimately returns for our unitholders. With that, I will now turn things back over to Mark to wrap up.
Thanks, Stephen. We're proud to have released our latest ESG report this past quarter, which highlights our many accomplishments in 2023. Some of these are displayed on slide 18. For example, the fact that we invested CAD 30.7 million in energy saving, resiliency, and water efficiency projects in Canada in 2023, which represents an increase of nearly 50%, from the CAD 20.7 million spent in 2022. This will lead to lower utility costs for CAPREIT and increased comfort for our residents, while also reducing the environmental footprint of our legacy properties. Affordable housing also continues to be a key focus of our ESG strategy, and we've remained committed and active in our endeavor to help with the solution to the housing crisis in Canada.
As Julian mentioned earlier, we're proud to say that all three buyers of the regulated properties we sold since Q1 were nonprofit organizations, who will be able to maintain the affordability of those homes for substantially less than the cost of building new. In addition, work remains ongoing with our peers through the Canadian Rental Housing Providers for Affordable Housing Initiative and its website, foraffordable.ca, which outlines all the ways in which we're advocating for changes in government policies and programs to address these important issues. We encourage all unitholders to visit that website and also our own to learn more about our ESG achievements and plans for the future. That brings me to slide 19. Our overarching objective revolves around enhancing earnings, and we're proud of the robust financial results and strategic performance that which we've presented to you this morning.
As a testament to that, and to thank you to our valued unitholders, we are announcing an increase in our annualized rate of distribution to CAD 1.50 per trust unit, effective for the August 2024 distribution and payable in September 2024. Moving forward, we remain focused on further optimizing and simplifying our business, especially with the upcoming sale of our MHC portfolio, which is expected to close in the fourth quarter of 2024. On that note, we're excited to continue to drive value and become an even better place to live, work, and invest in the quarters ahead. I would like to thank you for your time this morning, and we would now be pleased to take your questions.
If you'd like to queue for a question, you can do so by pressing star one on your telephone keypad. And if for any reason you'd like to remove your question, you can press star two. Again, to join the question queue, please press star one. Our first question is from Fred Blondeau with Green Street. Your line is now open.
Thank you, and good morning. Just three quick questions for me. Just on those CAD 500 million acquisitions, I was wondering if you could provide a bit more color on the average LTV on these, and what kind of LTV should we be expecting on acquisition expected to close in the second half of 2024?
Hey, Fred, thanks for the question. Look, it really depends on the property. You'll see some of them in the disclosure, but the ones that close... I think if you looked in our press release, you'll actually see the mortgage that came on them. But, you know, Grafton Park had nothing, Axir has nothing. The View had a pretty favorable one that we took in, that it was in the, I think, in the 80% LTV. But overall, we attempt to manage the leverage more globally and, you know, if an acquisition has over-levered or under-levered, we can take it in the portfolio and manage it after that. But generally, when there's favorable mortgage terms, whether it's high LTV or low LTV, we'll take them on.
Mm-hmm. No, fair enough. And how do you feel about the NCIB at this stage versus acquisitions?
Well, I think the stock is still incredibly good value. We are, as I think we've said before, playing a balancing act of, how to use our, our liquidity, our inbound liquidity with dispositions. And, you know, management will take a very thoughtful view to opportunities in the marketplace that we think, a window may be closing in the next 12-18 months. We're not exactly sure, obviously, but we, we love the real estate that we bought. We're incredibly excited about this real estate we bought, actually. The revolver remains a wonderful place to, to, you know, get accretive dollars to work. And just to kind of circle back, overall, overall leverage, as well, we don't mind storing some of the value in the assets that we've bought. It's really a cheaper revolver in our mind for the future.
We are in no rush to put additional leverage on those assets, Fred, because it'll be top CMHC insured money in the quarters ahead.
Mm-hmm. Perfect. And then last one for me. In terms of the new supply of rental units, especially in Ontario, I was wondering if you're starting to see an impact or some pressures on the portfolio, or it remains, I guess, a bit manageable given, you know, the strength of the demand.
Well, I think 2025 is set the stage for record condo deliveries in the GTA, so that is a big Ontario effect.
Mm-hmm.
I think that we've also seen the effects of inflation creep into the, you know, wallets of young Canadians. Rents are peaking out. We're seeing evidence at the top end of the market that things are flattening. And so they're just with inflation, I think in general, there's less money for people to spend, and that's finding itself in rent payments now. So we are seeing a flattening at the top end, and by top end, I mean, where +CAD 5 rent is, I think, going to be very challenged.
Mm-hmm.
But, you know, the deliveries in 2026 fall to a record trough low. So the market-
Mm-hmm
... is in for some interesting adjustments here over the next 24 months because you've got, you know, one year of a record high and followed by another year of a record low, and the years that follow appear to be even worse in terms of deliveries. So there's a moment in time here, and then the supply problem gets dramatically worse. So that story is kind of revealing itself across the country, Fred, and probably more-
Mm-hmm
... so in the GTA. But,
Mm-hmm
... the outlook is incredibly robust, but, you know, the next 12 months will be interesting. I think the CAPREIT portfolio is exceptionally well protected from that because we're not playing at that end of the market. In fact, we could become-
Mm-hmm
... the affordable option in the GTA, but those would be my comments. Completely speculative, of course.
Mm-hmm. That, that's great color. Thank you so much.
Our next question is from Jonathan Kelcher with TD Cowen. Your line is now open.
Thanks. Just keeping with the affordability theme here, Mark, like, how would the rent-to-income ratio for new leases differ between some of the new build properties you guys have been buying this year versus some of your older noncore properties?
Well, I love that question, Jonathan. Thank you very much. The upside down world of Canadian rental is that our most affordable buildings are new construction assets, because the incomes for the folks that are attracted to those assets are exceptionally high, and therefore, the rent-to-income ratios are exceptionally low. On the other side of the spectrum, in some of the buildings that we had sold to nonprofits, we were seeing the complete opposite, where the rents are the current lowest. We're seeing incomes, obviously, that are attracting folks that are the lowest, and therefore - not therefore, but what we're actually seeing in the math, is that the income-to-rent ratios are incredibly high. So the most affordable assets are tending to be our new construction assets, and our least affordable buildings are the rents, rental buildings that we are selling to nonprofits, as an example.
There are other examples of that, too, but this, again, is the upside-down world of Canada and a lack of understanding of we have an income distress problem in Canada more than we have a rent problem in Canada. And this is something that CAPREIT and our industry peers are working very hard to get the understanding across to policymakers.
Okay. I guess in the keeping on that, would it be fair to say that you guys are getting better lifts on your new build properties versus the older stuff? Or how should we think about that?
Well, I think a cautionary note, like every building is different, depends on the competency of the developer, depends on the stage of lease-up that we're getting it at, a lot of things. But what we are seeing clear evidence of is our ability in these unregulated assets to bring the entire rental to market, not unlike some of our other apartment peers. With the benefits of new construction and geographical diversification, really what we're doing here is diving into unregulated investment, versus the regulated investment, that we're seeing constraints in places like Ontario, for example, with the 2.5% guideline. So yeah, we're seeing that, but you know, the lease renewal spreads in some of the other provinces on the legacy assets are excellent. So it's just blending out the risk.
That's all we're really doing here, and delving into unregulated markets, in a more serious fast pace than the company's ever done before.
Okay. Thanks for that. That's helpful. I'll turn it back.
We have a question from Mario Saric with Scotiabank. Your line is now open.
Hi, good morning, everyone, and thanks for taking the call or the questions. Mark, just maybe sticking to the last point on lease renewal spreads, they were up almost 100 basis points this quarter, so averaged 4%, versus three percent last quarter. Is that sustainable, or are there some kind of one-off anomalous items in there, or is that simply just a reflection of the portfolio transition to new construct over time?
It's a bit of both. You know, why don't I let Stephen give some regional color on what we're seeing? Because it really is in the details of where it's happening.
Yeah. So, Mario, look, a lot of our renewals that were stuck at the, you know, 2.5%, really occurred in Q1. That's mainly Ontario. Q2, you can see really, it came across the board, where in Quebec, we had, you know, significant renewal increases, Nova Scotia, even on the unregulated markets like Alberta. So that really pushed up the renewal rates, for the second quarter, versus the first quarter.
Got it. Okay. And then, my second question, just coming back to the conversation about affordability and kind of the acquisition strategy. You know, the comment that market rents are flattening at the higher end seems to make sense. We're hearing that. At the same time, and Mark, you're mentioning the affordability in the new construct is actually higher than the older assets. The rent income ratios are lower. So what do you think is kind of flattening market rents at the higher end if affordability there is actually not that bad?
If you were to break it into tranches, it really does depend on what level of rent level you're at. So I'll make it simple. The market above CAD 5 a foot is very different than the market of 4 to 5. The condo deliveries, for example, are having an effect. There's no question. You've got condos coming online at a time when, you know, folks have less money in their pocket, and that's probably definitely starting to... The effect is being felt. Again, an old COVID effect here, right? Like, we had a slowdown in construction, followed by a surge, and we're now seeing those deliveries, followed by an interest rate shock, and we're seeing the... Like, you look forward at the deliveries, it is astonishingly low.
So that speaks well for sort of, you know, the stabilization of those rents. But the biggest effect is definitely across the country in the +CAD 5 a foot range, with some exceptions, obviously. But we just think it is affordability at the end of the day, at the high end, and that affordability problem starts to diminish as you move down the rent per foot ladder.
... Got it. Okay, and so just as a follow-up, like, if I look at slide 10 of the call deck, where you're highlighting your acquisitions and dispositions, are you able to highlight what the average rent per square foot would be on the six acquisitions and then perhaps even, like, the rent income ratios that you're, you're modeling there?
There are obviously varied. There's one in there that I'm incredibly, you know, proud of, that is on the high end. But why don't I get Julian to kind of give some examples of some of them?
Yeah, I mean, the Vancouver ones are gonna be in, you know, having, market rents in the, in the fives, and I mean, that's just the dynamic of that market. You know, one of the, the Axir one's a brand-new one, so that, that rent will be pretty close to market. We picked it up, leased up, but, it's pretty new. Pendrell was constructed in 2019, so even though those market rents are in the fives, you know, the in-places are below, and so we're, we're still, The rent roll still has some, some room to grow in there. You know, the other, the other ones, would be in the-- just I'm looking at them in the, call it in the high twos range per foot.
The other ones that we acquired, you know, give or take a bit. But that's just given those markets between Halifax, Ottawa, and Edmonton, it's a little bit lower on a per foot basis.
And the problem here is that we speak in the micro, and we speak in the macro. They're two different things, obviously. The fives that are in high density, high condo delivery neighborhoods, have, you know, cannibalized competition amongst different parties. The assets that Julian just referred to are on their own. There is no competition in those neighborhoods, of the, of the vintage, of the assets that we bought. So they would be the exception to where, like, we're not seeing resistance. Very different, I'm gonna say, than the downtown core of Toronto, where you have, you know, condos popping up on every other block. Those will be under, you know, generalized pressure because they're concentrated in and there's the volume of offering.
Yeah, I mean, one thing that's worth noting too, Mario, is like, I'm sure you've looked at these, but if you look at the locations of, you know, at least five of the six of those, they're exceptionally well located. I mean, you know, the types of locations that, frankly, are irreplaceable from any of the-
We honestly, we get a little bit possibly ahead of ourselves with excitement on this, but we think that we are actually buying some of the best locations in the country.
Yeah.
Like, when you look at the - zero in on Google Maps, you will see that these are unbelievable centralized locations for the cities in which they're located in.
Got it. I'll make sure I'll take a closer look. And then on the rent to commercial, is it fair to say, kind of, those are in the low 30s, like the low-to-mid 30s?
Yeah, we don't store those due to privacy reasons, but it is fair to say that it would be a little bit more of an affluent tenancy where it's less sensitive.
The indicator that we do have is lagging receivables and just bad debt in general, and we can definitely say that we're seeing a trend of extremely low trailing receivables and ultimately bad debt in the new construction assets versus the legacy assets.
Okay. That's it for me. Thanks, guys.
Thanks.
Our next question is from Kyle Stanley with Desjardins. Your line is now open.
Thanks. Morning, guys. Maybe just kind of sticking-
Morning
... Mark, just because you, you just kind of mentioned bad debts. I mean, it's very small, but it looks like inducements and bad debt did creep up just a little bit this quarter. You know, is there anything to read into there, given maybe the softening economic climate or just kind of normal course and inducements, given that you're, you're maybe leasing up a few newer build assets?
It's, it's more on the inducement side, and I would say nothing, nothing noteworthy there, to kind of point to. Perhaps, Stephen, you could give some additional color.
Yeah. I mean, what we're seeing in the inducement side, there are some, some inducements related to the new builds, but, I mean, I would say they're only temporary as we try to fill them up.
And, Kyle, when we're buying these, they're totally—they're completely modeled in. It's just a regular part of a lease-up of a building to put inducements.
Shows up in the statements as part of the model.
Yeah.
Okay. Nope, that, that makes sense. Maybe just going back to your kind of commentary on, on Mario's question a minute ago, you know, would you say that then maybe we're in a temporary softer patch for market rent growth, and that's driven by affordability and this uptick in supply, but as supply is delivered and absorbed and over the next, say, 12 to 18 months, you'd expect market rents to, to pick up again? I mean, you know, we're, we're well aware of the kind of supply-demand dynamic, so it, it seems only logical that that would be the trajectory, but just curious on your thoughts.
I hate using this phrase, but you kind of have to unpack the environment and say, "Wait, what is actually happening here?" In the GTA, I would say you can expect at the highest end of the market to see anemic rent growth because of competition, primarily, and an inflationary effect of folks just having less, less money in their pockets. It was very different when we had runaway wage inflation 6 to 8 months ago. You know, people were getting CAD 20,000, 30,000-dollar raises, so rent wasn't really the biggest focus in their life. That dynamic is changing, so that's at that end. On the more affordable end of the spectrum, you know, the opportunity is fantastic.
Our ability to harvest that is gonna be difficult because the bargains that people are sitting in are just, you know, too good to be true. So that end will be extremely solid. In terms of the overall environment for rents to rise, again, it's a tale of two cities. On the legacy assets, absolutely, if you can get at it, and on the new build side, you know, there is a plateau that happens. So the wonderful thing about a unregulated market is you can, you know, the tide lifts on all the rents, and then it kind of steadies. It's not perpetual.
So we do think we're finding that right blend of having assets that are we can get at the upside fast in a changing market, and then having that blend of assets that have a runway of growth that'll probably go on for decades. So I don't know if that directly answers the question, but the general dynamic is indicating that we can see sort of a, you know, a leveling off here, followed by another ramp-up. How dramatic that is, I really can't say. But when you're seeing deliveries going from, you know, 40,000 to 7,000 in 12 months, that tells you a lot.
Yeah. No, that's, that's very helpful. And then just my last question, you know, would you be able to talk about the market for development land today? I know we've talked about it over the last few quarters, but just curious if there's been any changes or signs of firming values, given maybe the changing rate environment, you know, as we think about the potential of, you know, timing towards monetizing the development rights at Davisville?
Well, I'll let Julian take the question, but I don't know. At the end of the day, I think you talk to any broker, they'll say it's a little soft out there for development land. However, anybody with a right mind that's capitalized should be jumping on that opportunity when you look at the deliveries in the next 24 months. The deliveries spike, and then there's nothing. And it doesn't take, you know, 24 hours to build a building. We're talking 7-year cycle. So if you actually look at the 7-year cycle, you are in... Or let's call it 5, if you're really efficient, or 4, if you've got zoned land, you're looking at the perfect time to build now. Now is the perfect time to get in the ground.
But, you know, there's a lot of skepticism, obviously, around that because of interest rates, a lot of skepticism because of deliveries, a lot of skepticism for a lot of reasons. That's normally the environment to get serious and get into it. So I think the prospects for land value are actually quite good. But, you know, it's a matter of, you know, the cost of capital right now is relatively, you know, high on a historic basis. So I don't know what Julian would add to that.
No, I think Mark said it perfectly. The rates are still high, and the, you know, the condo market has been a bit soft. We think the long-term fundamentals are good. But having said all that, those Davisville sites are just, you know, again, I'm using the same word, but exceptionally well located. So while the market still remains a bit soft, as interest rates are elevated and the condo market's soft, it's, you know, we still think that we could generate pretty good demand, just given how marquee those locations are.
Okay, that makes sense. I'll turn it back. That's it for me.
We have a question from Jimmy Shan with RBC. Your line is now open.
Thanks. Just to follow up on the renewal rate comment. So it sounds like mix was the main reason for the bump, but when we look at the second half of this year, is the mix skewed more to Q1 or Q2? I.e., are we gonna see 4% or 3%, in the second half?
Yeah, Jimmy, I think we're gonna see probably more of a Q2 effect versus Q1, because majority of the renewals that occurred in Q1 were in Ontario. So I would say if you look at it in the second half of the year, it's gonna be more of Q2 as being the benchmark.
Okay. And then, given all the acquisitions and dispositions, and I wondered if you could speak, generally about sort of whether or not that - that's going to have any impact on the operation side of things, like, you know, integration work or, you know, whether you need to bulk up leasing staff, because some of these assets are maybe a little bit more leasing-intensive. Maybe if you'd speak to that a little bit.
Well, one thing we pride ourselves on at CAPREIT is we are integration experts. We were able to, you know, go to other countries and new markets overnight and adapt quickly. There's no question that we're and the company is rallied around the fact that we are becoming a different type of operation. The needs and requirements of new construction are very different from the customer service side of things and the sales side of things. And a whole host of what you're offering is dramatically different, I'll say, than the legacy assets, where it does tend to be more administrative, customer-focused, but still not as monetized and just a different business. We're in the project management repositioning business in that part of our portfolio than the, you know, customer service rent-maximizing side on new construction.
We are working our way through that. Stephen has. We've had to make some difficult choices here at CAPREIT, and those choices have been reflected in some of our restructuring costs. But we are working our way through it, and we do expect to be a different company. You know, we are already becoming a very different company and very excited about that, but there will be additional change as we move into next year.
Okay. Thank you.
Our next question is from Matt Kornack with National Bank Financial. Your line is now open.
... Good morning, guys. Just going to the renewal variance here, that's the legacy of the COVID rent moratorium in Ontario. But, like, obviously, given low turnover in that portfolio, that's going to be a seasonal issue, probably for quite some time. But broadly speaking, I mean, Ontario seems to be way off the rest of the nation in terms of allowable rent increases. Do you think that creates a disincentive to invest in some of these assets, going forward? I know you get on new, there's no rent control, so it helps with supply, but you do need people to actively manage some of these older assets in Ontario as well.
Well, it's not going to attract investment, if that's the question. We're very fortunate at CAPREIT because the heavy lifting of investment has happened, and our Ontario portfolio is in exceptionally good physical condition. It is very hard to say what's going to happen here. The most difficult decision for, I'll say, Ontario policymakers to make, is to do the right thing and allow something closer to inflation to exist as a guideline. Sadly, Matt, it was just not an issue. When we were chugging along with inflation, we were unhappy when the government put this in place, this cap in place, but really, we never got there because inflation was ticking so low.
So what's happened is, it's not really the guideline that's the problem, it's the low churn that we're focused on, and we're coming up with some offerings to our residents, upgrade offerings to our residents, where you can, in fact, get an above-guideline increase or negotiate a new rent in some instances. So we are working on those kind of plans for the folks that do want to upgrade their suites. We're not forcing it. We're accepting requests, I'm going to say, of people that want to do upgrades, and we may be able to work with that a little bit. There's plans in the background to deal with this, is all I'm really going to say.
Okay. No, that's fair. And then when we look at turnover, it seems to have stabilized, albeit at a very low level. But can you give us a sense as to the nature of the turnover? Presumably, it's geographically more outside of Ontario, and then, like, can you give a sense as to the duration of leases that are turning? I don't know if you have that at your fingertips, relative to kind of maybe the average duration of a lease in the portfolio.
Yeah, it's a great question. One I want to be careful in answering because I would basically just say, again, a tale of two, two different businesses. In the market rent buildings, we have historical turnover numbers happening. There's nothing unusual happening there. It's in the legacy assets, in particular, Ontario, where the guidelines are so low, that we're seeing these, you know, caving of, of churn. Stephen can share some numbers or we haven't disclosed.
Yeah, we don't. We haven't disclosed.
You know, Matt, something we'll give consideration on, in our disclosure on, and, but it is an important question. We understand.
Yeah. No, fair enough. I think, like, we look at some of these turnover spreads that have bumped around a bit, but I don't think they're probably indicative of the mark to market in the portfolio at this point in some regions.
Well, they're not.
But then, just last one-
They're not. Yeah, just, just on that, though, that is an incredibly important question because one might say, "Well, what was happening? You know, CAPREIT, 30% increases, and it's come down to 21%." And the reality is that the churn is effectively getting even lower because it is the market rents that are turning, that are competing with the legacy rents that are slowing down even more. So as we work through this, we've seen the effect of, my goodness, the churn less, the market rent churn is actually even lower. So you can't look at churn on its own like we historically did, because there's a certain factor of that churn, which are market rent in the legacy buildings. If that makes any sense, Matt?
Yeah, Matt, I think-
Yeah.
Just in terms of, like, the... You'll see the more recent leases are the ones that are turning more than obviously the older leases, and, you know, you still see the very significant mark-to-market rents on, on the older leases. And now you just have a blend that's getting to that 20%, uplift on our portfolio.
But not like I would say in the past, of the mark to market is really the market rent, because there was a steady, steady release of units. It's being skewed. I would just say that the comfort that unit-- This sounds like a negative conversation, but the comfort that unitholders should take is the runway of released value for CAPREIT is absolutely astonishing. Because it might be coming slow, but it's going to be coming for a long, long, long time. That's the benefit of it coming slow. Versus where you have a rent roll that lifts with a tide in one giant shock event, and then it's over.
We're very, very, mindful of the fact that we want our portfolio to have a mix of the, you know, marquee locations on the legacy side of the fence, and, and new construction assets that are below replacement cost on the other side of the fence. That's really what we're trying to create here.
Yeah. Said otherwise, I guess, in the context of an economy that's softening, those legacy assets are incredibly defensive, to say the least. But, last one for me-
We agree
... Stephen, Stephen, like, I know we've, we've seen an uptick on a year-over-year basis. I think you've said that-
... that should persist and then stabilize into the second half of the year. Is that, that's still kind of the thought process? I know that was a great slide. I appreciate the, the incremental disclosure on CapEx versus R&M, but just any color as to how?
Yeah. Yeah. I think I stand by what I said previously in the prior quarters as well. I mean, you're gonna have a base effect in Q3 that likely will be the increase in R&M is gonna be a lot lower than what you saw in Q1 and Q2 of this year. You know, and again, I take a lot of pride in what the group is doing here, and investors should take comfort in the fact that a dollar is a dollar. And which side and where it's classified should not matter, even though it does have an effect on earnings. We don't care. We are very focused on the cash flow of the business, and I'm exceptionally proud of what the company's been able to do here, regardless of its impact.
A dollar is a dollar.
Yeah, no, the CapEx trend has been remarkable. Great. Thanks. Congrats on a good quarter.
Thanks. I appreciate it.
Our next question is from Sairam Srinivas with Cormark Securities. Your line is now open.
Thank you, operator. Good morning, guys, and congrats on a good quarter. Just looking at the acquisitions completed so far and, you know, the potential acquisitions coming in, can you comment a bit about the vendors that are essentially sourcing these assets from, and, you know, the potential sources you're looking over the next 12 months for new assets in the acquisition program?
It's a mix of... I'll take the question. It's a mix of merchant developers, so folks that, you know, their business model is to build and sell. But also, you know, we've been dealing with other kind of longer-term holders that are just seeking to raise new capital to redeploy elsewhere in their business. And so, you know, I do think there—the higher interest rate environment has, you know, caused some folks that otherwise may not have been sellers to be sellers and, you know, we're very well capitalized, and we'll continue to work with that same mix of folks going forward. It's really been a great opportunity to acquire, you know, irreplaceable properties.
We, you know, we're not of the view that this will, this will be open forever, but we, we still think the window's, window's there for us to capitalize, and we'll, we'll continue to work hard to keep getting properties like the ones that you've seen us transact on.
So definitely, it's a very opportunistic moment for these assets. Looking at Mark's comments on, you know, the softness broadly in the condo market, would that be something that could probably be a source of acquisition ahead? And, like, I mean, just from a-- I mean, this is a pretty naive question, but in terms of product, does this really make a lot of difference in terms of, you know, the condo product versus the part, the purpose-built rent product that you're seeing out there?
Well, we remain optimistic always. It's hard to predict the future. The good news is, we're getting great visibility in Julian's group with things that are available in the marketplace, and it's -- let's hope. You know, it feeds into our strategy and, if we can buy below replacement cost and we buy marquee locations, we're really trying to find that right mix, in the portfolio. So it's a wait and see, but it's something we've heard, from several sources now that, that might be interesting, in the future. We'll -- let's hope.
We are starting to see a little bit as the condo markets struggle, particularly pre-construction sales. Some developers are pivoting from otherwise building condo buildings to building purpose-built, and particularly as the HST was relieved. And you can still get some pretty decent financing from CMHC-insured sources. And so, it's potential that we'll see a shift more towards purpose-built, and with providing us with more acquisition opportunities. But as Mark said, we'll see how this all plays out.
You can, you can only imagine an environment where deposits like start getting canceled, like dropped and en masse, and there's buildings that are nearing completion. If we find, you know, those opportunities that were built with, you know, construction contracts of 6-7 years ago that are being built below replacement cost, and that, again, we're here to talk.
That's amazing. Thanks a lot, guys. We'll come back.
We have a follow-up from Mario Saric with Scotiabank. Your line is now open.
Hi, thank you. Just a quick one from me. Mark, coming back to this, upgrade program that you're offering to tenants, you may not be able to answer the question, but I'll give it a shot. Is there a target acceptance rate that you're thinking about when offering the program, in terms of what percentage of the portfolio? And then secondly, the increases in rent, on the upgrades, would those funnel through your renewal rates or turnover rates on the leaseback side?
Well, it's too soon to say, I guess, but what we've been surprised by is that we've been approached by a large number of tenants that are trying to get in the queue to rent apartments in a building that they already live in. And in that case, they would, they're prepared, they want to stay, they want an upgraded unit, and they'd be prepared to be a source of market for us within our own building. And that creates a cascading effect of then their unit is available. Maybe somebody else in the building is looking for the same thing, and it starts to release turnover. Okay? We have had a few examples of this where we said, "Of course, we would make our units available, maybe even at a more attractive rate to our existing residents," but it's too early to say.
We've had some exciting success, but I hate to kind of, you know, send a message here that this is something that could be more widely rolled out. It's just exciting. That's one scenario. The other scenario is, we have had been approached by residents that are wanting a new kitchen or wanting a new bathroom, and then that, that's the kind of situation we have to kind of do the math and see if a voluntary AGI is applicable. Very different than an AGI that's forced, that you can actually do a voluntary AGI in Ontario as well. So that's something that is really driven by the tenant.
Got it. Okay. Thank you.
Thanks.
We have a question from Dean Wilkinson with CIBC. Your line is now open.
Thanks. Morning, guys. Mark-
Morning.
More of a philosophical question. What do you think is the biggest gating factor for new purpose-built supply? Is it, you know, the development and construction costs? Is it the realizable rents, or is it the cost of capital? Or, you know, maybe it's a combination of all three, but how would they rank in sort of the matrix of putting a shovel in the ground?
It's different for every developer. You know, round one was always development fees, and they become more prohibitive, and that hasn't gone away. When you talk to most developers, there was a, you know, a bit of a sigh of relief on the HST front, because development fees had just made properties completely not viable, you know. And I heard-
Right
... stories about in Toronto, it was CAD 400,000 in before you, you get to the land and the shovel. So how does that create an affordable unit? There's that. Today, the distress we see in development is around mezz financing and, you know, guys that were performing very different financing rates, and that is, I'd say, the overarching theme of, I'll say, conversation that Julian's getting.
Yeah. I mean, look, Dean, if, if you look at all the acquisitions we did, you know, we're, we're below replacement cost. And, you know, the, those, the, the values that we pay tend to be IRR-driven, and when you've got IRR-driven values below replacement cost, who's going to build into that, right?
No, yeah.
And it's-
It's remarkable that you can buy. Yeah. It's-
Yeah
... remarkable that you can buy a new asset below replacement cost. Someone's taking a bath on it, right?
It's actually—sorry, we're all interrupting each other here. But it is the first time in Canada that we've seen this. It showed its head-
Mm-hmm
... about 24 months ago, and it's never, like, it's—we used to have these calls, and, and we used to talk about, "Oh, we're below replacement costs and the value of the portfolio." Imagine we're seeing this with brand-new assets. Like, it's like-
Yeah
... it's unbelievable. And so what Julian, you had a great line that, you know, when people ask us about development, say, "Well, why would we be building when we can buy something for 80 cents on the dollar, new?" With it, with people that are already renting, no development risk, in many cases, preferential financing in strong markets. Like, you know, people like, tell us, Dean, "Whoa, what a brilliant strategy," and we just don't think it's that complicated.
No, it's, I mean, it's great. I mean, you're doing what we all want to do, get younger and less regulated. But, you know, that's something. Thanks, guys. Appreciate it.
Yeah, thanks.
We have no additional questions at this time, so I'll pass the call back to the management team for any closing remarks.
I also want to thank everybody for your time today, and if you have further questions, please do not hesitate to contact us at any time. Thank you again, and have a great day.
That concludes today's call. Thank you all for your participation. You may now disconnect your lines.