Good morning all, and welcome to the European Residential Real Estate Investment Trust fourth quarter 2023 results conference call. All lines have been placed on mute during the presentation portion of the call, with an opportunity for question and answer at the end. If you would like to ask a question, please press star followed by one on your telephone keypad. I would now like to turn this conference call over to our host, Nicole Dolan, from the Investor Relations team. 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 ERES, 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, Chief Executive Officer.
Thanks, Nicole. Good morning, everyone. Joining me this morning is Jenny Chou, our Chief Financial Officer, and Corinne Pruzanski, our Managing Director. Let's get started with slide four. Our operational performance remained strong in 2023. Occupancies were held as high as possible throughout the year, with 98.5% of residential suites occupied on December 31st, 2023, relatively consistent with 98.4% occupancy as of December 31st, 2022. We've always maintained a minor and ongoing level of vacancy, and this is the result of our operational strategy. At any given time, the majority of our vacancy relates to suites that we intentionally keep offline upon turnover in order to perform value-adding renovation work, which will drive further rent growth once the suites are re-let. We're also keeping certain suites vacant upon turnover and listing these for sale as part of our portfolio optimization and capital recycling objectives.
Occupied AMR grew by 7.2% to EUR 1,063 as of year-end. This is once again well above our target range of 3%-5%. This reflects the increasingly robust rental market fundamentals we are still experiencing in the Netherlands, with record growth of the Dutch population continuing to outstrip the pace of new housing supply. It also demonstrates the merits of our rent growth strategy and our ability to efficiently maneuver within a complex and ever-changing regulatory framework. Our strategy is comprised of uplifts on indexation and turnover, and the conversion of regulated suites to liberalized. This year, our indexation was 4%, and our weighted average increase on turnover was 20.4%. This compares to an indexation of 3% in 2022 and an uplift on turnover of 22%. Turning to slide five, I'll provide a brief update on the fourth quarter.
On December 20th, we announced the conclusion of the strategic review process. The strategic review was first announced back in June 2023 and was undertaken to evaluate all value-enhancing alternatives available to ERES to ultimately ensure we are actively maximizing value for our unit holders in every way that we can. Following the review, it was determined there was no proposal which achieved the objective of maximizing value as compared to our current strategy. As such, our focus remains on the execution of our proven operational platform, although we'll continue to explore additional liquidity-enhancing opportunities. That includes the potential divestiture of certain non-core suites or properties, where lucrative and most accretive to net asset value exists.
We only recently started to test the viability of this value surfacing strategy, and so we're pleased to have completed an additional 10 sales in the fourth quarter for EUR 3.7 million in gross proceeds, which represents a significant premium to IFRS value. That brings the total individual suite sales to 14 residential units this year, and we're excited to see this accelerate on our progress on this initiative as we go through 2024. Our investment portfolio fair value decreased by 1.9% during the quarter to CAD 1.68 billion as of December 31st, 2023. This was primarily due to persistent inflationary and interest rate pressures, as well as ongoing political and regulatory uncertainty in the Netherlands, partially offset by higher forward NOI. With this decrease in fair value, our NAV per diluted unit decreased to EUR 2.90 as of year-end. I'll now turn things over to Jenny to walk through our financial performance.
Thanks, Mark. Slide seven summarizes our financial performance for the fourth quarter of 2023. Due to strong rent growth, operating revenue increased by 7.8% compared to the fourth quarter of 2022. On the cost side, operating expenses decreased as a percentage of operating revenue, primarily due to the abolition of Landlord Levy Tax, which became effective January 1st, 2023. Together, this drove the 11.2% increase in our NOI, and our margin expanded to 78.9% for the three months ended December 31st, 2023, up by 240 basis points versus the comparative quarter. Solid organic growth positively contributed to FFO. However, this was offset by higher interest costs and current income tax. As a result, our FFO per diluted unit decreased by 5%, and our AFFO per diluted unit was down by 2.9%.
We held our annual rate of distribution steady at EUR 1.20 per unit, and our AFFO payout ratio was 87.8% for the quarter. Slide eight highlights some of the key metrics to summarize our annual performance. As Mark mentioned, our residential occupancy remained high at 98.5%, and our occupied AMR grew by 7.2% on the total and same property portfolio. For the same reasons I've described for our quarterly performance, same property NOI was up by 7.8%, and our margin increased by 140 basis points to 78.6% for the year-end at December 31st, 2023. FFO per diluted unit was EUR 0.1610 for the current year, which is down by 4.7%, again due to increases in interest rate and current tax, partly offset by strong organic growth. Our AFFO payout ratio was 82.3%, which remains within a long-term target range of 80%-90%.
Slide nine presents an overview of our leverage and coverage ratios. As of December 31st, 2023, we had up to EUR 189 million in available capacity on our credit facility and pipeline agreement with CAPREIT, including cash dedicated to ongoing operational and capital expenditures. Our ratio of adjusted debt to market value was up to 58.1%, and we're carefully managing this to ensure we maintain compliance with our covenant. Our debt service and interest coverage ratios also remain safely above thresholds at 2.4 times and 2.9 times, respectively, as of year-end. Finally, slide 10 presents our staggered mortgage renewal profile. We secured EUR 76.5 million in mortgage financing in 2023, and our weighted average effective interest rate on our mortgage portfolio remains low at 2.07% today. This reflects our conservative financing strategy as we fix 100% of our mortgage interest costs and ladder our maturities.
As of December 31st, 2023, our mortgage profile has a weighted average term to maturity of 2.9 years, but we are well-positioned for the upcoming year with only 9% of our mortgage debt maturing in 2024. Looking ahead, we'll continue to manage our debt and capital structure proactively and prudently, and we have liquidity-enhancing programs in place to strengthen our balance sheet, reduce volatility, and mitigate the impacts of mortgage maturity in future years. I will now turn things back to Mark to wrap up.
Thank you, Jenny. Since inception, we've been realizing consistently strong operational results, primarily through our rent growth strategy, which is outlined on slide 12. We also have had the additional opportunity of surfacing value through the sale of individual suites to end users, and we've been recently exercising this lever to generate additional liquidity for redeployment as part of our active capital allocation plan. At the end of the day, we're committed to value maximization for unit holders, and we're confident our strategy best achieves that objective. That brings me to our investment highlights on slide 13. ERES remains Canada's first and only European-focused multi-residential REIT, and it was my pleasure to have assumed the role of Chief Executive Officer in early 2023.
I'm proud of the progress we've made today, and especially the work we've put in the last year ensuring that we're on the right track for ongoing success in the future. As we forge ahead, we'll continue to assess all existing and potential new opportunities to generate unit holder value in the near and long term to ensure we're maximizing value for unit holders in all the ways that we can. With that, I'd like to thank you for your time this morning, and we would now be pleased to take any questions which you may have.
Thank you, Mark. If you would like to register for a question, please press star followed by one on your telephone keypad and ensure you are unmuted locally. If you would like to withdraw your question at any time, please do so by pressing star followed by two. Our first question comes from the line of Jonathan Kelcher, of TD Cowen. Your line is now open. Please go ahead.
Thanks. Good morning. First question just on Mark, you mentioned the 3%-5% AMR growth target, and obviously, you beat that in 2023. Would you expect to be above the top end of that again in 2024?
Yeah. Starting off strong, the market's getting stronger. On turnover, numbers are a little bit lower. It's slightly seasonally adjusted. But I would say in the Netherlands now, there's a real focus on property owners of apartment buildings selling individual units. We have one big, large competitor that's doing that, so there's just less and less product in the marketplace. And we expect that to accelerate. And quite frankly, there'll be less rental available as we go into the spring season because that will match up with the home sale season. So I think we're feeling very confident about the path that ERES was on in 2023 repeating itself in 2024.
Okay. Fair enough. You talked about home sales, and you guys did 10 in the fourth quarter. How should we think about the pace of home sales? Because I know there's a number of limiting factors there.
It takes a little bit of time to get warmed up in this regard. We started talking about it several quarters ago. But what you're seeing are closed properties, not executed deals. And our team is getting better at this, quite frankly. So I think we can see an accelerated pace, and I'm very confident to see an accelerated pace of home sales quarter-over-quarter. We're not quite ready yet to give guidance on what to expect, but I suspect we will be in that position in the quarters to come. It's just right now, we're not hitting a stable state. You're going to see a rapid ramp-up of home sales that will then hopefully level off as we get a better understanding of what to expect quarter-over-quarter.
Okay. Fair enough. And then, Jenny, just on the debt maturities this year, how are those weighted over the course of the year, timing-wise?
Yeah. About EUR 50 million of it is March maturity, so we've already started negotiating with banks on those, and then the remainder is December.
Okay. Thanks. I'll turn it back.
Thanks, Jonathan.
Our next question comes from the line of Jimmy Shan of RBC Capital Markets. Your line is now open. Please go ahead.
Thanks. So just going back to the rent growth, so the indexation on liberalized suites, I think you had mentioned it's going to be about 6.8% this year. Is that a done deal in terms of I think you made some comment about it being in draft legislation? I guess would be the first question. And then going back to Jon's question in terms of the 3%-5%, if that were to be the case, then when we and shouldn't we see a rent growth that is comfortably above 5% given the indexation level this year?
Indexation is quite strong. We may want to take offline the liberalized indexation from the non-liberalized, just for better clarity, Jimmy. I would say that, no, indexation is not in jeopardy given the talk about legislative change, which we think has been pushed down the road even further. Indexation is set now, and we have good visibility on what we're going to get. And there is no threat of that changing, if I understood the question. If you want to know the nuanced differences between the indexation of different types of units, we can do that offline. In terms of the second part of your question, yeah, I feel quite confident that we're going to provide the bottom-line growth in earnings given the kind of revenue expectations that we're seeing.
Or the notices that we sent out, and certainly the rents that we're achieving on turnover, suggest very strong results for ERES in 2024.
Okay. On the suite privatization strategy, I think last quarter, you talked about the approach being that you're approaching existing tenants, essentially, to see if they want to buy. How are you going about that strategy today? What would the rent versus own equation look like for the tenant that's in place today as they contemplate whether to buy the asset or not?
Well, without getting too complicated because it is a little bit complicated, when we're looking at properties available for sale, we've been focused on assets that have already had the breakup started. So we have not yet targeted assets that have not had the breakup started. So those are the difficult buildings to get at because those buildings where a prior owner would have sold units to individual owners, as an example, have already bought. Okay? People may have changed their mind over time. Their incomes may have changed, but we're getting good results given the fact that we were targeting those broken-up buildings. The next level of trouble that we have to get through as we go through time here is some of the most opportune units have mortgage considerations that we have to deal with.
Sometimes, even though it would seem not intuitive, some of the financing requirements don't allow for privatization until renewal. We'd have to negotiate that. So some of the pristine opportunities of dramatic uplift are in those mortgage pool. Doesn't mean it can't be done. It just means there's timing around financing. The next consideration is where we can actually take buildings that have not been broken up. There's a strategic decision as to whether we start breaking them up or not because once you start breaking up, you may make the sale of the property to an income buyer less interesting. All that being said, and we maybe should do a little more presentation work on this as we get more comfortable in the future here, all that being said, the results that we're seeing on our least desirable units are staggering.
They're well, well above NAV, well above our expectations, and this is not the pristine part of the portfolio to do this in. So we're extremely encouraged that we've got a situation where NAV is clearly a question mark when it comes to alternative privatization value. And we've got the benefit of holding income in the meantime. This was always something we talked about at the beginning, Jimmy. You'll remember the holding income attribute. Well, you can cherry-pick privatization opportunities. It's an awfully good place to be. We just haven't matured to a reliable flow of privatization quarter-over-quarter yet to really see the true value of ERES that's emerging.
Okay. All right. Thanks. Off to the caller.
Thank you. Our next question comes from the line of Alex Leon of Desjardins Capital Markets. Your line is now open. Please go ahead.
Hey. Good morning, everyone. One of my first questions is on the proposed changes to the mid-market regulation. So one of those changes was changing and aligning the indexation dates to January 1. So I was just hoping you could provide some clarity on how this would work for the indexation increases on July 1, 2024, and then again, if it would happen again on January 1, excuse me, 2025?
Yeah. There is no immediate impact on January 1, but I'll hand it to Jenny to give a quick summary of how that works.
Yeah. We always have done our indexation of July 1. That's always been the rule. It's just the timing of when the points and the rent associated with that indexation get updated. They're just aligning the timing of when they change the rent associated with certain points to the date of the indexation so it all happens on the same day. But like Mark said, it doesn't impact timing of when we get those uploads.
Not a revenue impact. It's a points catch-up. It's actually sensible.
Okay. Great. Thanks for that clarity. Next question's on the OpEx reductions. I was just wondering if that was entirely the result of the abolishment of the landlord levy or if there was more drivers there, and then if you could provide maybe an expectation for OpEx inflation for 2024.
It's majority due to the landlord levy. As we've mentioned in the past, the REIT is very inflationary-proof. So there's obviously going to be some inflation pressure on our R&M, but things like our property management costs, that's really just a set percentage of our revenue. We have no wage cost incurred. So absent just inflationary on our R&M, it's going to be pretty in line with current years.
Okay. Thanks. Maybe last one for me. I was just wondering if you could provide some commentary on the investor-owned rental market in the Netherlands. Given the increased number of properties that are subject to maximum rents, do you expect this is going to be a weight on asset values? Do you think that investors are still going to be interested in the space, or is the opportunity more just on transferring those rental units to being owner-occupied?
Well, this is the thing. Regulation actually doesn't matter when you think of it in terms of value impact because if regulation becomes too much of an impediment, the unit can be sold into the private market, which is not regulated. So there's income impacts, but the traditional model of holding assets in the Netherlands for decades has been to have a privatization strategy and have a holding income strategy. And that hasn't really changed. So I think it's unfortunate that the connection between what happens when you overregulate a sector, in this case, I don't think it's properly understood because investors will actually then flow to selling the units at a dramatic premium.
Appreciate the color. I'll turn it back.
Thank you. Our next question comes from the line of Stephen Spandler, a private investor. Your line is now open. Please go ahead.
Good morning. I'm a unit holder and have been since inception when you went public originally. I assume that the company paid for the strategic review, which means I paid part of it. Why are you not releasing the recommendations from the strategic review?
It's not information that companies would generally ever share in the public world. The conclusion of the strategic review, it wasn't as much of a report as it was a process, and the outcome of the process was not favorable to unit holders at this time.
Has there been any consideration of CAPREIT repurchasing the shares that are still in the public hands?
That's not something that we would comment on at ERES and certainly something I would doubt CAPREIT would comment on.
All right. Thank you.
Thank you.
Thank you. Our next question comes from Dean Wilkinson of CIBC. Your line is now open. Please go ahead.
Thanks. Morning, everybody. Mark, on the dispositions, do you look at the portfolio kind of say, "These are the core assets where we wouldn't want to sell them, and perhaps this is, for lack of a better term, the value-add opportunity by busting them up"? And do you have an allocation that way, or is it just more of, as the debt becomes available to move off the asset, you'll look at selling it?
A bit of all of the above. At the end of the day, if you want to hold, the premier assets to hold in the premier locations are generally the liberalized buildings that are performing well. Okay? They're not subject to regulatory review. It's the core mission of the REIT for income property, and those are well. That being said, the dilemma is those units represent the mega premium to IFRS because they're in premier locations. The thinking is that we want to maximize value, especially in the regulated space where there could be impairments to income, especially in buildings that may have upcoming CapEx, which would slow earnings. And when we can find these dramatic double-digit increases in IFRS value and solve the problem of CapEx and solve the problem of regulation and solve other problems, those are obviously the no-brainers that we kind of say, "Okay.
That makes a lot of sense." The way we've been approaching it, though, Dean, is not to break up buildings that have not been broken up yet. We're focused on the assets that have already had units sold in them. So we're just continuing that process. That's why it's a lot slower than most would think and giving our thoughts to in future quarters where we could really open up the true opportunity for ERES for liquidation. But right now, I know the numbers seem small. All I can say is we know that they're accelerating quite a bit because the process does take at least 90 days from you want to buy your unit to closing. And we really only started this 120 days ago. So all that being said, there's where we're going.
No, that makes sense. I guess.
Yeah.
Yeah. Rome wasn't built in a day. The Netherlands wasn't built in a day. I guess the immediate use of proceeds on those sales would just be paying down some of the debt to bring that leverage level down a bit.
Yeah. We're listening to investors. There's the debt tranche 2024 in December. There's the debt tranche in 2025. Everybody seems to want to talk about that. So it would be nice to see majorly accretive unit sales going towards relieving that anxiety. And the focus today of ERES is not to grow. The focus today for ERES is to maximize value for unit holders.
Right. Well, that's always the job, right? I don't want to spend too much time on the process, obviously. It's rearview mirror. But the rate environment has materially changed from, say, when you were in the middle of that process, and it probably goes lower from here. Without putting you on the spot, which I'm doing, do you think that the door becomes open maybe later in the year for something to come back potentially around that? If you look at where bond yields are in the Netherlands right now, they're in the mid-twos and probably going lower. Have you ruled out something potentially on a larger scale?
Well, thank you for doing your job and asking tough questions. I would answer it by saying what we have learned, that's not really that inspiring or insightful. There's no such thing as a portfolio premium pretty much anywhere in the world right now when it comes to residential real estate because there's not the when cap rates and interest rates are neutral, then you don't really have much of a portfolio premium. The Netherlands is no different than Canada in the sense that the real market that's active right now is the private market. Those are individual building sales. And in Canada, I can't even imagine what would happen to CAPREIT's value talking to the CAPREIT CEO if they could sell individual units. So ERES has that opportunity. ERES is going to pursue that opportunity. The easiest private market is the individual family or person.
Right above that person or that group is the private buyer for individual assets. Then it gets much more skinny in terms of interest of multifamily assets when you start talking large portfolios. That's all I can really say. That's the situation today, Dean.
Right. Always changes. Appreciate that. Thanks, Mark.
Bye-bye.
Thank you. Our next question comes from the line of Brad Sturges of Raymond James. Your line is now open. Please go ahead.
Hey. Good morning. Just to follow on Dean's questions there, and a lot of your commentary has been around the unit privatizations. I'm just curious then, at this stage, you're not pursuing or considering selling buildings that haven't been broken up, or would that be part of the potential disposition program this year?
ERES is committed to value-maximizing strategies and will consider surfacing value through any means it can for our unit holders.
Okay. When you're looking at your upcoming maturities on the debt side, where would you peg the cost of debt today, or what would you assume you could get in terms of a rate?
I would say five years around mid- to high 40s right now.
Okay. And one other modeling question. Just on the current taxes, it looked like it ticked up in Q4. Just curious what the guidance might be for full year 2024?
A couple of things that hit Q4. There's the tax on dispositions, which you would have to back out for FFO purposes, and that will fluctuate coming quarters. On top of that, there's about CAD 500,000 of sort of one-time items hitting Q4. I guess absent that, Q4 would be a pretty good run rate.
Okay. That's helpful. I'll turn it back. Thank you.
Thanks, Brad.
Our next question comes from the line of David Chrystal of Echelon Capital Markets. Your line is now open. Please go ahead.
Thanks. Good morning, guys. Just really quick one on the individual suite sales. Mark, you mentioned premium to IFRS value for what you've sold. Can you quantify that? And then you mentioned in certain kind of hotter markets, there's an even bigger premium. Can you do the same for those markets to give an idea of the delta?
It's a very good question. We haven't provided that guidance to the market yet. It's something that we're considering doing with a potential forecasting of sales or what we would like to be targeting for sales. And we are thinking, David, about doing that in the upcoming quarters. Just given the fact that we haven't done official disclosure on that yet, I'm limited by what I can say other than it's incredibly compelling. It's not on the margins at all. It's very, very compelling.
Okay. And maybe, again, harping on the asset sales, I guess post-quarter, there was another 14 units sold. So you're looking at 10 during the quarter. 14 over the kind of following month and a half is again, I know you're not giving guidance on the actual numbers, but if we kind of extrapolate that rate, is that a kind of good rate for the year, or is it going to continue to accelerate?
Yeah. Again, we are hearing the market loud and clear. Given the fact that we were single-digit announcing, we obviously didn't want to say too much. But we're very enthused with the progress that are being made on individual unit sales, and it is ramping up by quarter at a pace that we are very satisfied with.
Okay. Great. Thanks. I'll turn it back.
Thank you. As there are no additional questions waiting at this time, I'd like to hand the conference call back over to Mark Kenney for closing remarks.
Thank you, operator. Thank you, everyone, for joining us this morning. If you have any further questions, please do not hesitate to contact any of us at any time. Thank you again, and have a great day.
Ladies and gentlemen, I would like to thank you for joining us on today's call. Have a great rest of your day. You may now disconnect your line.