Hello everyone, and welcome to the European Residential Real Estate Investment Trust First Quarter 2023 Results Conference Call. My name is Nadia, and I'll be coordinating the call today. If you would like to ask a question at the end of the presentation, please press Star followed by one on your telephone keypad. I will now hand over to your host, Nicole Dolan, Associate Director, Investor Relations to begin. Nicole, please go ahead.
Thank you Operator. 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 three and our other regulatory filings for important information about these statements. I will now turn the call over to Mark Kenney, Chief Executive Officer.
Good morning everyone. I'm pleased to be joining you today. With me is Jenny Chou, our Chief Financial Officer. As this is my first conference call as the CEO of ERES, I'd like to start by looking back on the REIT's four years of strong performance. Looking at slide five, ERES had its beginnings when we entered the Netherlands back in 2016. From this point, the company grew exponentially, leading to the creation of ERES on March 29, 2019, with an initial 2,091 suites. Today, ERES remains Canada's only European-focused residential REIT. We own approximately 6,900 residential suites, well-diversified across the Netherlands. About half of our properties are located in the high-growth Randstad region, and the remainder in other strong, more suburban markets. We are also split with two-thirds of our portfolio being non-regulated.
On top of that, one-third of our portfolio is comprised of single-family homes, also known as Dutch row houses, or what we commonly refer to as townhouses here in Canada. On slide six, you'll see ERES's first quarter snapshot. Our closing unit price was CAD 3.325 at period end, which remained below our NAV per unit of CAD 4.91. This provides investors with the opportunity to capture what we consider to be strong value play, and it also provides investors with one of the highest distribution yields in our peer universe. Strong rental demand in the Netherlands has driven consistent rent growth for ERES, as you can see on slide seven. Since inception, we've achieved a constant annual growth rate of 4% in occupied AMR, which is at the upper end of our target range.
In the first quarter, occupied AMR grew by approximately 6% on the same property residential portfolio. At the same time, occupancy remained high and stable at 98.7%. On top of this, about 3/4 of our residential vacancy is intentional as we temporarily keep units offline on turnover in order to further invest in value add upgrades and renovation. This improves the quality of our suites, the enjoyment of our residents, and our future operational and environmental performance. Importantly, ERES has been accomplishing these strong operational results within a fluid and uncertain regulatory regime. In fact, this represents one of our primary competitive edges. We have a deep understanding of the regulatory framework, but we also are strategic, adaptable, and experienced at working within changing parameters. Turning to our other quarterly updates provided on slide eight.
As you can see, I am presenting this to you today in my new capacity as CEO of ERES, which became effective at the close of Q1. I'd like to acknowledge my predecessor, Phillip Burns, for his strong leadership throughout the REIT's first four years. Other significant developments for this past quarter include the EUR 25 million increase in our credit capacity, which Jenny will speak to shortly. On the valuation side, the fair value of our portfolio decreased to EUR 1.78 billion at March 31st. This was mainly due to cap rate expansion in the Dutch market, partially offset by higher forward NOI on our portfolio. Our diluted FFO per unit was EUR 0.04 for the quarter, trickling into an AFFO payout ratio of 85.2%, which is right in the middle of our long-term target range.
I'll now turn things over to Jenny to go through our financial results in detail.
Thanks, Mark. Good morning everyone. Slide 10 provides our financial performance in Q1 as we compare to the same quarter last year. Operating revenues on the total portfolio were up by 10%, a result of acquisitions and the strong same property AMR growth, which Mark highlighted earlier. Our NOI margin was 76.3%, including service charges, which is down by 0.5% due to higher R&M and advertising costs, partly offset by lower landlord levy expense.
On a stabilized basis, NOI margin was down for similar reasons, but to a lesser extent, with a 0.2% decline to 76.6% for the first quarter. Combined with higher interest costs, which we are absorbing on our mortgage portfolio and credit facility, as well as increased current income tax expense, diluted FFO and AFFO per unit both decreased by approximately 5% compared to the first quarter of 2022, but remained flat compared to Q4 of 2022. Inclusive of our distribution hike, which became effective last March, our AFFO payout ratio increased to 85.2%. On slide 11, you can see that we continue to maintain a firm financial structure. In fact, we fortified our liquidity position this past quarter by increasing our capacity on our revolving credit facilities by EUR 25 million, plus an additional EUR 25 million accordion feature.
Due to the fair value loss on our investment properties this quarter, our ratio of adjusted debt to portfolio market value decreased to 54%. Increased to 54%, which is still significantly below our covenant threshold. Our other debt metric also remains conservative, with consistently high coverage ratios that are safely within guidelines. Finally, slide 12 displays the well staggered disposition of our mortgage profile, which provides an invaluable safeguard in today's volatile interest rate environment. A 100% of our mortgages are financed with terms and arrangements that result in fixed interest payments. We also have a very low weighted average interest rate of 1.77% on the total portfolio. With less than 10% of our mortgage debt maturing both this year and the next, we are well positioned to withstand further macroeconomic adversity in the coming years.
I will now turn things back to Mark to wrap up.
Thanks, Jenny. Looking at the chart on slide 14, you can see that the Netherlands has been experiencing significant growth in its population. Although it's currently peaking with the rise in immigration due to a post-COVID catch-up and the war in Ukraine, it is forecast to stabilize at elevated levels. This population growth has been driving increasingly strong fundamentals in the Netherlands, which is already the most densely populated country in Europe and one of the most densely populated countries globally. As a result of its growing population and lack of buildable land, there is a severe national housing shortage, and that is expected to increase again this year. In order to meet projected Dutch housing demand, it is estimated that a target 100,000 residential units must be built per year over the next decade.
However, you can see on slide 15 that over the past decade, the Dutch haven't even come close to building 100,000 homes per year. Indeed, it is a very challenging target. The number of building permits for homes is lagging, while construction costs and personnel shortages remain high. As such, forecasts generally don't predict that the Netherlands will be able to meet this target. On the whole, this locks in those strong fundamentals for the long term, which continuously growing demand for accommodation is present in the country. That brings me to our final slide, 16. We believe the future for ERES is full of opportunity, and I am very excited to be leading it forward as we build on its strong track record established today. Our fundamental mission remains the maximization of value for all ERES unitholders.
Moving ahead in 2023, we will continue to actively work on doing just that. On this note, I would like to thank you for your time this morning, and we would now be pleased to take any questions that you may have.
Thank you. If you would like to ask a question, please press star followed by one on your telephone keypad. If you choose to withdraw your question, please press star followed by two. When preparing to ask your question, please ensure your phone is unmuted locally. Our first question goes to Sairam Srinivas of Cormark Securities. Sairam, please go ahead. Your line is open.
Thank you, operator. Good morning, Mark, Jenny. Thank you for opening comments. Just looking at the regulations that came out in Feb, and you know, it's been some time since then. How has the market digested that? What's the reaction of the broader real estate community out in the Netherlands in terms of how this housing supply crisis is gonna be solved over there?
Are you talking about the general market fundamentals of valuation, or are you talking about the fundamentals of operating metrics?
More from an operating perspective, Mark, in terms of, you know, the regulations that came in. Are developers now seeing, you know, are they more reluctant to kind of even add more supply into that market, or how have they generally received the new regulation?
Well, I think in the presentation I made brief reference to a quite a severe decline in building permits. Very much like what we're seeing in Canada and elsewhere in the world. The housing shortage is absolutely confronted with these realities of higher interest rates for development debt, higher costs on the construction side for both hard and soft costs, and a very slow environment to get permitting. You know, gate one of this, just like Canada, is the permitting process, which has fallen off a cliff. If the permitting process had been, you know, stacked with interest, I would say, you know, there's a chance for the next two gates to be open, but it's not looking very positive at all on the supply front.
That's good color, Mark. Just probably on that note, are you seeing any transaction activity in the market? I know capitalization rates were a bit higher this quarter. Is that a reflection of a weaker transaction market in New York or is that more asset-specific?
There continues to be a lack of transactions in all of Netherlands.
I would, I thought this would be definitely the first question up, and here it is. When we're doing the valuation exercise, the thing I wanna really highlight is in the Netherlands, there was 164 unit building that transacted in Q1. In that 64 unit building, I think there was 18 units that were socialized housing and the building was bought by a housing association. In terms of market clarity on where valuations sit, it's completely unclear. You know, valuators have no other option but to, you know, draw out a curve when there's a lack of information. On top of the lack of trade, there's been a lot of sideline activity in the Netherlands. First, because of a rising interest rate environment, where there appears to be more clarity on now.
Second, clarity on a new REIT, okay. The new REIT was established, and that was gonna, you know, potentially have effects in the market. I think a lot of market participants have been on the sidelines waiting to see the effect of that. You've got a couple of dynamics happening there. What we're also seeing in general in the marketplace, as we have discussed in the past, virtually all, not entirely all, but a large share of the apartments in the Netherlands are individually freehold title. What we are seeing is a lot of the apartment investors selling their units into the general market. With a regulatory overhang, with interest rate concerns, you're seeing the actual rental market in the Netherlands get much, much smaller.
In fact, you know, there's rising demand dynamics but an ever-decreasing inventory of available rental.
That's clear color, Mark. Thank you. I'll turn it back.
Thank you. The next question will go to Jonathan Kelcher of TD Cowen. Jonathan, please go ahead. Your line is open.
Thanks. Good morning. I guess just sticking with that thread, two sort of follow-up questions. One, first on what are the brokers saying in terms of expectations for properties to come on the market over the rest of this year?
I'd say the volume in the Netherlands on properties coming to market is a little bit higher than what we've seen in Canada. We still see in Canada virtually, you know, very few listings. I was just there on the ground, met with brokerage community, there is definitely talk of more product coming to market. I think you've got leveraged owners that are facing the reality of higher interest rates. I think the general theme that really struck me was that there are a lot of owners, individual owners leaving the marketplace and selling their units, which again, is back to what I just said in the last point. I guess it's appropriate, Jonathan, at this point to note that there is some attribution to privatization that's embedded in the valuation.
Anybody will tell you it's not building specific and it's market generalized. We think that there's incredible embedded value in the privatization of the individual units. Now, I wouldn't use that as a marker of change for the direction of the company, but it's definitely something that we're exploring. We can't help but explore it given our Randstad presence and given our townhouse presence, which is, which is actually extremely highly weighted in the ERES portfolio. I just think that there is caution should be given when looking at our NAV, because we think if anything, the appetite for individual privatization units is getting stronger and stronger as no supply or little supply comes to market. Meaningful supply, at least.
Okay. Would you look at, I guess you are looking at selling some individual units into the market, and I guess that would just be to sort of reduce drawings on your line?
It's a combination of exercises. Delevering, especially in the case of ERES, I think is something that must be looked at. It's just a matter of looking at our lowest cost to capital and pursuing that end. My role as the CEO of ERES is to maximize value for unitholders using any possible measure available to me. I think what I'm trying to message here is everything is on the table in terms of maximizing value for unitholders. The privatization of units is definitely something that struck me when I was over there as being an opportunity that ERES can pursue and look at more deeply.
Okay. Then just one last question for me. I noticed, post a quarter that ERES repaid the CAD 26 million Cap rate note. Was that through a new mortgage, or is that on the ERES credit facility now?
It's currently on the credit facility, but it'll be paid down using our mortgage proceeds that we're expecting to receive at the end of June.
Okay. What sort of rate would you expect on that at the end of June?
Mid to high fours.
Mid to high fours. Okay, thanks. I'll turn it back.
Thank you. The next question goes to Brad Sturges of Raymond James. Brad, please go ahead. Your line is open.
Hi there. Just to go back to the discussion on privatizing units. If you were to execute that on the row houses, is that potentially. Are you exploring across the portfolio, or would that be by, you know, are you more interested in certain regions where that makes potentially some sense?
The interesting thing about the Netherlands is that every unit that turns over, an analysis should be done on deciding whether letting value or sale value represents the greatest value for unitholders. Okay? At a very minimum, every unit that turns over, we should be looking at. Next to that, there is government incentive given to first-time home buyers, and there is the ability to sell to our existing tenants. Once we perform a proper analysis where NAV can be greatly enhanced by privatization of individual units versus perhaps the sale of a building or other means, we will 100% be looking at every possible option to maximize value, pull in equity, pay down this short-term debt problem, and get through to the other side.
Okay. That makes a lot of sense. Just on the, I guess, the operating results in the quarter, I think, you know, turnover rate was a little bit higher, but I'm assuming you'd still expect that to normalize to the kind of the traditional range for the rest of the year.
Yeah. Q1 was probably on the higher end. I would expect it to be more so in 10%-12% range for the year.
We're certainly encouraged by the opportunity to get at some of those unregulated unit rents. That's a positive. That positive I think will only be augmented by this exercise of truly bringing knowledge to market on the true embedded value of the portfolio.
Is there anything specific that would be driving a little bit higher, turn or churn, I guess, in the quarter? Or is it, you know, or is that more kind of seasonally expected?
I You know what? I think it's one of these anomaly things. It's not dramatically higher, it's slightly higher. There's a lot of, you know, COVID rebalancing effects. You know, the war has effects that we don't see in North America, in the Netherlands. Yeah, I wouldn't read too much into it at this point. We don't have anything sort of thematic to describe why it was elevated.
Yeah. Okay. Sounds good. I'll turn it back.
Thank you. The next question goes to Himanshu Gupta of Scotiabank. Himanshu, please go ahead. Your line is open.
Thank you. Thank you, and good morning. Just on the transaction activity, Mark, have you listed anything for sale in the market in the last thre months? If yes, how's the response been?
Yeah, I can't comment on that, Himanshu. I, all I can say is that I am fully dedicated as the CEO of ERES to maximize value for unitholders using any means available to me at all. Would that include.
Okay.
Potential listing of buildings? If deemed appropriate, no different than my prior experience or ongoing experience. If we can get higher than NAV valuation that's significant and noteworthy, we are absolutely open to selling assets. I think that, again, getting kind of into the weeds here, there's an interesting dynamic that's emerging in the Netherlands with housing associations. Because of the affordability crisis that they are also experiencing, we are hearing of housing associations getting back into the market of acquiring existing properties. It's hardly a trend when 164 unit building trades in Q1, but it is noteworthy that it was a housing association.
If the government strengthens its conviction on affordability, which it is in the Netherlands, I wouldn't be surprised to see a lot of activity with housing associations trying to get portfolios back in the mix to help maintain affordability.
Got it. That was helpful, Mark. Maybe on the same lines, you know, as you kind of take charge of ERES, what will be your top two or three priorities for this year? I mean, obviously, you mentioned, you know, everything is on the table and looking at everything, but any specific two or three priorities you have for the rest of the year.
Well, the operating metrics of the company are excellent. Like, the performance is great. I spent a little bit more time than normal on fundamentals because I'm really trying to get proper recognition of how very, very strong rental fundamentals are in the Netherlands. Like the rest of the world, the current topic of the moment is debt, and the topic of the moment is the cost of debt. Certainly, you know, we're keenly aware of that as a distribution vehicle. We are in excellent condition on the balance sheet front. We have no concerns whatsoever with weathering, you know, the conditions that are there. Where there's opportunity to get valuation above what's recognized on our books and use that equity in the lowest cost of capital way to pay down debt, we will absolutely do that.
That's been the tried and proven strategy that a lot of, you know, successful companies are employing out there right now.
Absolutely. That makes sense. Thank you, Mark, and all the very best. I'll turn it back.
Thank you very much, Himanshu.
Thank you. As a reminder, if you would like to ask a question, please press star followed by one on your telephone keypads. Our next question goes to Jimmy Shan of RBC. Jimmy, please go ahead. Your line is open.
Thanks. Just to follow up on that, privatization of units, discussion. Have you done any such letting versus sale value analysis on any particular units? I imagine it's a pretty relatively simple desktop analysis you could do, and kind of wonder what you've seen so far in terms of the delta between those two values.
When I went to the Netherlands, you know, I think we've transacted on four units so far. I wouldn't call it a meaningful, impactful effort to date. There's a little more. Just assume every unit is individually titled and can be sold tomorrow. You know, you've got the existing tenant market, and you've got the vacant possession market. You know, the balancing act, Jimmy, is you've got this regulatory effect coming in. Units that fall into the new net of the regulatory regime, it's very, very possible that those units have a much higher privatization value than they have letting value. That's consideration number one. Consideration is given to our existing tenants, residents, I should say.
The next consideration is given to, you know, looking at assets that we want to sell down in slowly over time. It could be a 100% owned rental asset will maintain a better value than something that we Swiss cheesed at 90%. We have to give some thought to that. On the townhome side, which I can't say enough of, that's really less of an issue. We have to give some thought to where we want to start the program to kind of dilute but pull out unbelievable value. When the unbelievable value is presented there in our analysis, we'll look at doing it.
You know, a bit of analysis on letting value versus privatization value on turnover, a further analysis on where first-time home buyers are concentrated, where we can again get higher privatization value. You know, other strategies around assets that we can sell well above NAV. All of these things are on the table to deal with in a balanced way to manage our debt situation, to delever, and to be well-positioned to grow again when the market finds calm.
As far as the asset value that you have in the books today. The, you know, given the lack of transaction, as you mentioned, how did you come up with that value? Like what was some of the reference point that you used to arrive at this revised value?
Well, as you probably have heard me say many, many times, as an organization, we take a very conservative approach to things like NAV. We always want to be ahead of, you know, gyrations in the market. The evaluators, we respect the process. This is an independent exercise. I would say that what we heard from the evaluators was we had this REIT issue sitting on the sidelines that had more clarity given to it. Without comparatives, they have to make assumptions on how an increased REIT could affect valuation. Whether that's right or whether that's wrong, I'll leave that for the, for you to digest. We respect the valuation process. There are some taxation issues that showed up in the marketplace.
They haven't really revealed anything as of yet. You know, we follow the path of the valuators. The point that's subtle and the point that really needs to be digested, and we haven't given enough transparency on this yet because we're gathering information, is in that valuation exercise, like I said, there's some attribution made for privatization. It is by no means a comprehensive review of privatization value. Valuators say that. They look at the market in general. They don't look at the volume of two bedrooms versus one bedrooms or renovation or anything like that. They look at the generalized marketplace, okay? They put some form of value because this is the traditional model of how to operate an apartment building in the Netherlands. You let and you sell, you let and you sell.
It's a combination of both letting return and privatization of individual unit return that the broad-based market uses in the Netherlands. You know, valuators understand this. For that reason, you get a slightly lower cap rate to recognize some degree of privatization. We hold the view very strongly on very limited information. There is quite a disconnect between that number of what's in the valuator's report and the actual number that can be achieved when you're picking the right units.
Okay. Okay, great. Maybe just one last one. In terms of the mortgages, can you remind me, is there an asset value test with respect to the mortgages?
Yes. I think they're on our existing mortgage, Jimmy, or you mean the one that we're entering into?
Existing. The existing mortgage.
Oh, okay. Yeah. There's a sort of a hard cap at 50%, and we're not anywhere near it.
Okay. 50%.
Because it's 50% on the mortgage, so yes, we have, like, our debt to LTV is at 54%, but that includes our credit facility.
Right. Okay. On the mortgages themselves, it'd be 50% and, I guess I could calculate. You guys are lower than that.
Yes.
The value would be based on what value? The value that you report, like, as part of the IFRS reporting, or is it their? Who comes up with the value?
It's a mix. Sometimes they rely on our valuers. Sometimes they would get their own independent valuation.
Okay. Okay, great. Thank you.
Thank you. Our next question goes to Gaurav Mathur of iA Capital Markets. Gaurav, please go ahead. Your line is open.
Thank you, and good morning, everyone. Just a quick question on the cost of financing on 5-year money. Could you talk about where you're seeing that at the current, you know, currently?
Yep. It's similar to what I was mentioning before. Five-year money would be roughly in the mid to high fours right now.
Okay. Okay, great. Just one last question from me. you know, with the suites and the turnover rate that we're seeing, how are you thinking about the CapEx spend, keeping in mind the mid-market regulations?
Yeah. We've eased off on our renovation program. It's actually a great question. We didn't touch on it. That in fact does add a little bit of repairs and maintenance pressure. When we're not doing capital expenditure in suite, we're doing some minor but accelerated repairs and maintenance work in place of that. We're really pulling back just given the general market dynamics of the unregulated units. That has had a little bit of an R&M effect as well. Not coming. It's already embedded in the Q1 results. Expect much of the same trend going forward.
Great. Thank you. Thank you for the color. I'll turn it back to the operator.
Thank you. As a final reminder, if you would like to ask a question, please press star followed by one on your telephone keypads. We'll pause for just a moment. Thank you. We have no further questions. I'll now hand back to Mark for any closing comments.
Thank you, operator. Again, thank you for joining us this morning, all. If you have any further questions, please do not hesitate to contact either of us at any time. Thanks so much.
Thank you. This now concludes today's call. Thank you so much for joining. You may now disconnect your lines.