Earnings Call: Q2 2021

Aug 5, 2021

Good morning, ladies and gentlemen, and welcome to the Killam Apartment Real Estate Investment Trust Second Quarter 2021 Financial Results Conference Call. At this time, all lines are in a listen only mode. Following the presentation, we will conduct a question and answer session. This call is being recorded on Thursday, August 5, 2021. I'd now like to turn the conference over to Philip Fraser, President and CEO. Please go ahead. Thank you. Good morning and thank you for joining Killam Apartment REIT's Q2 2021 conference call. I am here today with Robert Richardson, Executive Vice President Dale Noseworthy, Chief Financial Officer and Aaron Cleveland, Senior Vice President of Finance and Nancy Alexander, Vice President of Investor Relations and Sustainability. Slides to accompany today's call are available on the Investor Relations section of our website under Events and Presentations. I will now ask Nancy to read our cautionary statements. Thank you, Phil. This presentation may contain forward looking statements with respect to Killam Apartment REIT and its operations, strategies, financial performance, conditions or otherwise. The actual results and performance of Killam discussed here today could differ materially from those expressed or implied by such statements. Such statements are qualified in their entirety by the inherent risks and uncertainties surrounding forward looking statements. For further information about the inherent risks and uncertainties in respect to forward looking statements, please refer to Killam's most recent annual information form and other securities Regulatory filings found online on SEDAR. Unless otherwise stated, all forward looking statements made today speak only as of today's date. Unless otherwise stated, all forward looking statements speak only as of the date of which this presentation refers and the parties have no obligation to update such statements. Thank you, Nancy. We are very pleased with our strong financial and operating results for Q2 2021. We are hopeful that all non vaccinated Canadians will continue to book appointments to receive their 1st or second dose and the provincial restrictions will be lifted by this fall. Nonetheless, we are seeing increased leasing activity throughout our portfolio and increased activity in our seasonal MHC and commercial businesses. Our 2021 targets are outlined on Slide 3, showing the year to date performance. We have made good progress in the 1st 6 months of 2021 with all of our targets. We produced positive same property net operating income growth for the 29th consecutive quarter and increased our same property NOI target to exceed 3.5%, up from our initial target of +2%. Dale will take us through Killam's 2nd quarter financial results, followed by Robert, who will discuss our recent acquisitions. I will conclude with progress on both our newly completed developments and development pipeline. I will now hand it over to Dale. Thanks, Phil. Highlights of Killam's solid Q2 financial results can be found on Slide 4. Strong fundamentals for the multifamily rental market is Nova Scotia and Victoria, BC. Overall, we achieved net income of $136,700,000 3.8 percent FFO per unit growth and 4.5 percent AFFO per unit growth in the quarter. Killam's AFFO payout ratio decreased 400 basis points in Q2 to 75%. Please refer to Slide 5. Killam's same property portfolio achieved 4.5 percent NOI growth in the quarter and a 20 basis point improvement in operating margin from the Q2 last year. Year to date, same property NOI is up 3.6%. Killam's key revenue levers are charted On Page 6, apartment leasing and occupancy have been trending up since the beginning of 2021 And we achieved 96.9 percent same property occupancy in Q2. Rental rates were also higher in the quarter, up 3.1% from June 2020. Although we've seen an uptick in rental incentives in the last year, these incentive offerings Remain limited to 0.7 percent of rental revenue and are currently focused primarily in Alberta and specific properties with occupancy challenges. In addition to top line growth from our apartment portfolio, we have realized strong revenue growth for both our MHC and commercial portfolios. Revenue for our MHC portfolio was up 8.5%, driven primarily by our seasonal resorts, which realized revenue growth of 20% as we didn't face the same COVID related operating delays and capacity restrictions as last spring. For the commercial portfolio, Same property revenue was up 4.5 percent following new leasing activity and a reduction in COVID-nineteen related tenant Abatements versus Q2 2020. Killam's suite repositioning program is an important revenue driver that has remained resilient during the pandemic. Slide 7 shows that we are on track to meet our target of 550 repositionings for 2021. Of the 287 repositionings completed in the first half of the year, the average investment of $25,000 resulted in an average ROI of 13%. Killam only commences repositioning once its units become vacant. The capital investment on these repositions Not only support rental growth and attractive return, but can also improve the efficiency and modernization of the property. With unit repositioning processes, designs and trusted contractors in place, we are successfully completing and releasing most of these expenses for the quarter as to higher general operating expenses were modestly offset by lower overall property tax expenses. The operating expense increase was largely due to higher on-site staff salaries and higher repair and maintenance work versus the same period in 2020, in part due to COVID-nineteen related restrictions last year. Slide 9 highlights our debt maturity profile, including average apartment mortgage rates by year versus We realized a 69 basis point reduction in interest rates on $14,900,000 of maturing debt in the quarter. Based on current CMHC insured mortgage rates of between 1.8% 2%, we expect to continue to refine Slide 10. Debt as a percentage of total assets was 44.5 percent at June 30, below our target for the year of less than 47%. In addition, Killam finished the quarter with acquisition capacity of over $250,000,000 I will now turn the call over to Robert, We'll provide color on our recent results. Please refer to Slide 11. Killam continues to expand its portfolio coast to coast and today we own more than 18,000 apartment units, 5,800 MHC sites in 39 communities and approximately 1,000,000 square feet of commercial premises. Killam has over 35,000 residents And these residents, our 700 employees, valued unitholders and broader stakeholders are kept top of mind when we execute long term growth strategy, specifically growing earnings from our existing portfolio, acquiring accretive properties as we diversify our portfolio geographically Killam has made impressive gains with each of its 3 growth strategies year to date in 2021. Q222 was a record quarter for acquisitions led by a purchase in Ontario. Our core Ontario markets include Ottawa, The GTA, Kitchener Waterloo Cambridge and London. We anticipate acquisitions plus new developments will make 2021 a year of record growth for Killam's asset base. On June 30, 2021, we closed on a 785 Unit, Portfolium and Kitchener Waterloo. Please refer to Slides 12 through 15 for acquisition details. The acquisition price was $191,000,000 It represents a cap rate of approximately 3.5 percent, was completed with cash on hand, plus new first mortgage financings totaling 100 And $23,000,000 having a weighted average interest rate of 2.08%. We are very pleased to add this 11 building portfolio to our KWC asset base. These properties have been exceptionally well maintained, are in sought after neighborhoods and provide excellent opportunities for Killam's suite repositioning program. Recent leasing activity highlights the portfolio's strength and underlies the ability to move rents on turnover. Slide 12 shows The Estates, a 137 Unit Mid Rise Concrete Building in Kitchener That is currently 99% occupied with average in place rent of $1.53 per square foot or $13.20 per month. Market rents on turnover are more in the $1.70 range. The next slide profiles Heritage Place, which consists of 2 mid rise buildings totaling 160 units in Kitchener. It is fully occupied in Kitchener. It is 99% occupied with in place average rent of $1.58 per square foot or $11.70 per month. We are generating re leasing rental rates more in the $1.85 The KWC region is one of the fastest growing regions in Ontario over the last several years with incomes that are ranked amongst the highest in Ontario. It has undergone major renovations and revitalizations in downtown residential and commercial buildings To house its growing technology and innovation sector that counts Google, Toyota and OpenText as some of its largest employers to name a few. The region was ranked 4th overall out of 20 locations in Canada at surveys in CBRE's 2020 Scoring Tech Talent Report, Ranking it 1st place for quality of labor and talent quality to cost metrics. By the way, Halifax scored 8% overall on the same survey. KWC has a large university base, being home to the University of Waterloo and Wilfrid Laurier University and boasts improved transportation infrastructure With its new light rail transit system, plus the all day GO transit rail service into Slide 16 shows a map of Kitchener, Waterloo, Cambridge. The green balloons represent assets that Killam has owned in this region prior to our recent $191,000,000 acquisition. These highlighted properties include 4 40 units And 4 apartment buildings in Cambridge, 2 of which were built in the last 6 years, as well as Westmount Place, a 300,000 square foot commercial property with its national grocer anchored retail plaza and office tower. More importantly, the site has 2 acres of residential development opportunity on which we plan to break ground in late 2021. Phase 1 will have 130% to 25 percent interest in Charlottetown Mall, Taking Killam's total ownership now to 75 percent. As well, Killam added a 40 unit apartment building in St. John's, Newfoundland, Both are shown on Slide 17. Charlottetown Mall is a stabilized grocery anchored enclosed mall Located on 32 Acres in Charlottetown, adjacent to the University of Prince Edward Island Campus, Killam's former joint venture partner RioCan REIT sold their 50% interest on June 1, Killam acquired its additional 25 percent interest for $10,100,000 The remaining 25 percent interest was sold to a local PEI Real Estate Company, APM MacLean. This local partner is strategic as it brings a regional leasing perspective, further development expertise and community level involvement to assist in revitalizing the center. Kill now manages the mall and is identifying opportunities to reduce the property's operating expenses and carbon footprint in the near term. The 40 unit, 4 story apartment in St. John's, Newfoundland is located beside an existing Killam property. Killam paid $4,200,000 for 30 E Pasadena Crescent, which is fully occupied and has average monthly rents of $8.60 Before Shultz concludes the formal part of this conference call with his development update, I want to reiterate Kym's commitment to the continued health and safety of its employees, residents, Commercial tenants and communities. Cummins COVID-nineteen management has included policies and procedures to reduce the spread of the virus and this commitment is ongoing. We offer in office rapid COVID-nineteen testing and are pleased to report very high rates of vaccinations amongst our staff. We greatly appreciate the excellent work and dedication of our committed employees across the country, especially these last 16 months. We'll now hand you back to Philip. Thank you. Thank you, Robert. Leasing activity has been very strong for our 3 recently completed developments. As shown on Slide 19, We have all but 2 units of the 3 49 units leased today. All three had a short and successful lease period despite the COVID-nineteen environment. Impressively, they are contributing to FFO growth within 6 months of completion and during Q2 generated $300,000 of FFO. Slide 20 shows the operating margins in Annual NOI contribution of these assets. For the second half of twenty twenty one, the three properties are projected to produce $1,200,000 of FFO. And for the 2022, approximately $3,000,000 of FFO. Our development pipeline provides us with an excellent opportunity to add high quality real estate assets to our portfolio. Currently, we have 5 developments underway in the following cities: Halifax, Mississauga, Kitchener and 2 in Ottawa. Slide 21 shows the 4.97 units, which will add $240,000,000 of new properties to our balance sheet over the next 18 months. $240,000,000 is total cost, not the IFRS value of these high quality assets. Killam has invested $60,000,000 of equity into these developments and we expect to achieve approximately $0.07 to 0 point 0 $8 of FFO per unit on a fully stabilized basis. We are pre leasing the KA Mississauga and the Latitude in Ottawa and expect both to be open by Q1 2022. As shown on Slide 30, the first phase of Westmount in Waterloo Is expected to commence construction in Q4 of 2021. This is a 139 unit development and will be located at the corner of Erb and Deidt Street and is next door to our existing Westbound Plaza. We are building in markets where the demand is strong and the market Cap rate compression is still allowing for a healthy 50 to 150 basis point spread between construction yields and market cap rates. For reference, Slide 31 breaks down Killam's future development pipeline, totaling approximately 4,000 units For $1,300,000,000 in new product that is in various stages of development or pre development, I am pleased to report that yesterday, the Board of Trustees approved a $0.02 per unit increase in the distribution, Bringing the annualized unitholder distribution to $0.70 per year and making it the 5th consecutive year of a distribution increase. To conclude, I want to thank our residents, employees and unitholders for their support and investment in Killam. I am very pleased with our ability to make meaningful progress in all of our priorities and create value for our unitholders. Thank you. I will now open up the call for questions. Thank you. One moment for your first question. Your first question comes from Mark Rothschild with Canaccord. Please go ahead. Thanks and good morning everyone. Good morning, Matt. Thanks. In regards to the development Portfolio obviously leased up well. Can you just talk a little bit about how the rents were versus your pro form a? And also if there was any thought or impact on the rents that you were charging With considering that government rent controls have been getting stricter and perhaps could be stricter for longer. The first part of that question, our pro form a is what we started pre leasing. We kept those throughout the whole sort of lease up period once it was open on all three developments. And the second part, We believe that those rents are market rents today. And Basically, one of the properties is in PEI that does have rent control. One is in Alberta. There's no signs of rent control. And we believe that rent control is not in the picture for Nova Scotia as well. Okay, great. Thanks. And then maybe this question might be Dale, I'm not sure, but can you talk a little bit more about the process this quarter with arriving at the cap rate and fair value change? And to what extent do you believe that's really Reflective of current markets, obviously, it's a sizable move. Yes, sure. We would have looked at a lot of We know there's been some sizable transactions in those markets where we took those gains. Certainly, we found a lot of competition when we with our acquisition In the Kitchener Waterloo region, but you've seen some of our peers buying in London and Victoria as well. So we felt there was looking at what The cap rate both traded at, a lot of time spent digesting that and looking at which of our assets all into those categories, so that was a big driver for us. So I think in those markets, based on the information that we have, we feel that the Cap rates that we picked are reasonable, but it's been pretty specific in those markets when we looked in the quarter. Then in addition to that, You would have seen our revenue growth on the rents, so that's always a factor too that comes into play when we look at those fair value gains. So Those increases, of course, are more across the portfolio as you would have seen reported. But those specific areas, they relate to the transaction activity we've been seeing. Okay, great. Thanks so much. Your next question comes from Jonathan Kletcher with TD. Please go ahead. Thanks. Good morning. First question is just on, Phil, you're talking about you've started pre leasing at Okay. Latitude, how is that going? It's going as we expect. Basically, We have some already have signed up, but again, it's a little bit early, but we started these two properties earlier than we typically do. So we're very pleased of the interest in both properties. Okay. And then just switching gears, I guess on Kichir, Rob, you outlined very good uplifts there. Does that include your repositioning Program or is your would your repositioning program be on top of that? Yes, the repositioning program would be on top of that 100%. Didn't do any repositionings with those increases. Okay. And what's the turnover like in those properties? How long will We haven't had it long enough to really know the turnover at this time, Jonathan. We need a bit more time within the portfolio. We can answer that for you next quarter, maybe. Okay. I'll make sure I ask it next quarter. And then lastly, just Dale, I guess the R and M was higher in the quarter and Obviously, that's due to a catch up from COVID. What can we expect there for the balance of the year? Sorry, in what in terms of what? Well, is R and M going to be is it going to Oh, R and M, sorry. Yes. I think what you saw in Q2 is not representative of what you'll see the rest of the year. When we look at Q2 last year, we got a lot of Very extreme differences of what was happening in Q2. So I think you can expect much more moderate expense growth for the second half of the year. Okay. That's it for me. Thanks. Thank you. Your next question comes from Matt Logan with RBC Capital Markets. Please go ahead. Thank you and good morning. Good morning. Thanks. Would you guys be able to give us some color on how your leasing velocity is trending into the Kind of fall leasing season and maybe some color on where the committed occupancy for the portfolio is tracking for August September? Yes, I can say that we've the velocity has been we've had it's Really strong on the leasing front. And when we look in terms of the fall, numbers are looking strong, and I'd say kind of More in line with what we would have seen 2 years ago before COVID. We've even seen those students come back sooner Then we would have when we look at those student focused markets. We saw a big push in May June kind of earlier than we would normally see. So we're feeling pretty bullish on the occupancy trending for the fall. And I can say even when we look over the last number, Well, I guess the last 6 months, 7 months, we've seen those occupancies improving every month. And Peninsula Halifax is one we've talked about on the call since this time last year when we started to see a little bit more of the Vacancy kick in because of students staying home, and we've seen that come back in a big way, just as one example. But And St. John's is another one. We've made fantastic gains in the St. John's market. You would have seen that in our numbers this quarter, and that trend is continuing as well. So Overall, there's lots happening on the leasing front. In terms of any of those differences by region, would you say there is more Strength in some of those harder hit segments or is it fairly equal across the board in terms of demand? I mean, I'd say that St. John's is one that we've seen that is standing out compared Where it was, I don't think it's totally equal across, but I'd say that we are starting to see more movement in the downtown of Alberta than we had seen. I don't think it's quite what we're seeing in Halifax and some other regions, but it's definitely stronger. So not totally even, but I'd say improvement is pretty consistent across the board. And the 2, as Dale just mentioned, would be our 2 weakest in our Complete portfolio, sort of the Downtown, Alberta Cities and St. John's. I appreciate that, Phil. Maybe changing gears a little bit towards your same property NOI target, would you be able to give us some color on how your outlook breaks down by Segment for your apartment MHC and commercial portfolios? Sure. So when we look at the apartments, I mean, I think that that one Probably kind of 3 to 4 range when we look for the second half of the year. I think we're seeing those rent increases we've seen are going to continue, and we have some occupancy gains to be made on that front. And as I already mentioned, we're not going to see the same expense pressures we saw in the Q2. I think on commercial and MHCs, those could have the potential to be higher than the apartments. On the MHCs, we were Still that was seasonal. You saw that big lift in this quarter on the seasonal assets. Q3 last year, we were still dealing with COVID and We're still dealing with COVID, of course, but on the seasonals, we would have felt it more last Q3. And commercial, we've had good lease up on our commercial spaces. So I think all those things are going to come into play Those segments have the potential to outperform apartments in the second half. Well, I appreciate the commentary. I'll turn the call back. Thank you. Thank you. Your next question comes from Joanne Chen with BMO Capital Markets. Please go ahead. Hi, good morning. Thank you. Just maybe on that, could you talk to some of the drivers that you're seeing that drove such a big improvement in your St. John and New Brunswick Market, what are some of the trends that you're seeing there? Students would be 1. When we look at the St. John's market in particular, the students, We've also grown our team there from a leasing perspective, but I'd say that's one of the biggest factors in that market. We're seeing some employment gains as well, especially in St. John. The Erics are very busy and they've New office building and they're seeing an uptick in their employment for sure. So that's going on. I think forestry is doing well, relatively speaking, and that's Another contributor to what's going on in the marketplace is economically all major 3 centers in New Brunswick Are seeing good activity, but as Dale said, a big part of it is returning students is certainly helping the market. That's good to hear. And I guess more broadly, how should we think, I guess right now The mark to market opportunity for each of your major markets right now? Overall, we'd have about a 15% mark to market, we'd say kind of coast to coast on average. Some markets are better than others. The Halifax market continues to be strong as mark to market. I think Also, Newfoundland has come back in a big way. St. John's is surprisingly strong. And so I think there's an opportunity now as the market tightens up to See some gains there. And New Brunswick has been a big winner of last year. It really has been. And so there's probably more opportunity there. Not so much in the West. But certainly those are when we look at Kitchener Waterloo is in Toronto and London is another one. I mean those Ontario markets, of course, we're seeing that as well. So it's always a question of where do those units turn And how long is it going to take to be able to Right. Right, for sure. And I guess, if we were to move to the West Nile with Alberta, I guess, There was a little bit of a pickup, I guess, with the rental incentives, but how has that trended since Q2? Are you seeing some improving conditions there? We are. Okay. Yes, better leasing in the downtown. Downtown Calgary, it's made a good game. We've had The staffing improvements and we're seeing the markets get stronger. Yes. I mean as an indication, I mean we started the year With our new development that we were part of the building of it, but buying the remaining part the 1st January and we leased up 233 units In 6 months, and that's suburban, or the Northwest Calgary. And the vibe in downtown Edmonton also has done well. It's come on strong since the end of the quarter. That's helpful. And I guess maybe just switching gears, last one for me, to the acquisition side of things. How are you thinking, mean, you guys obviously have had a very busy Q2, but what do you think the pipeline is looking like for the remainder of the year, given how competitive I mean, there is good sort of supply In terms of what is being offered or is supposed to be offered right across the country, but as you also mentioned, It's very, very competitive. So we've got basically our eyes on a couple of other Opportunities in Ontario and out west, and we're even looking here in Atlantic Canada again at a couple of opportunities. Your next question comes from Matt Kornack with National Bank. Please go ahead. Good morning. Just a quick follow-up on the last question with regards to the pipeline. It seems like you're saying there's still a fair bit of product On the market, but have you found that as the operating environment has gotten a little easier and Who knows what happens with capital gains, but that some of the private sellers have shied away from selling? Or is it still the same sort of volume Of acquisition opportunities that we saw? The number of opportunities is probably greater, but it's not the sort of The mid sized portfolio opportunities that were available between reporting Q1 and now, So those are all have sort of been digested and basically bought or under contract or close. So when I talk about opportunities, you're back to looking at single asset opportunities in these markets. Okay. No, that's fair enough. And then on the affordable housing focus, So you noted, so you have 8 28 units, 5% of the portfolio, you want to grow it by 20% by 2025. Is that going to come in the form of acquisitions or would you potentially develop new product or even add affordable units Existing development projects just interested in how you scale the affordable housing component? I think it's going to be both. For instance, once we start our 1st phase of Westmount that will have an affordable component attached to it. We're looking at opportunities that have affordable housing already there that you can buy from existing developers. And even on the drawing board, we've got a couple more that we'd be looking to see that we can make that affordable portion of it as well. Okay. Thanks and congrats on a solid quarter. Thank you. Thank you. Your next question comes from Yash Sankdol with Laurentian Bank. Please go ahead. Good morning. Good morning. Just want to better understand your development projects. So those three projects That are fully leased now. What was your pro form a leasing period? What sorry, you asked what was our pro form a leasing period? What was yes, what were we modeling before? You know what, I mean, we probably even from a budgeting point of view, 8 months in all of them. Okay. And given this leasing success, How much NAV impact do you think could you give us some numbers like in terms of what you paid or your cost versus How much lift you expect from just the mark to market? Sorry, you're talking about like the Those 3 projects. The value? Yes. Well, we're still working on that. I mean, basically, I mean, what we have to do is get it stabilized. And again, like, we haven't fully leased, but up and running, we got to get basically Go through the at least the full cycle in terms of the operating expenses and some of them vary because we got solar power On the roof and we're just trying to figure that out. But once we get that, I mean we're expecting fairly good lifts from the Cost yield versus what they're worth from an IFRS point of view. So would that be between 25% to 30%? 25 would be about 125 basis point difference in cap rates. I think that's kind of where it goes in. And I think some of them we've already taken some lifts just to be clear. So when we're doing development, we would take some lifts throughout the So some of those increases have already flowed through from the fair value. Once we hit certain we start developing and we Certain hurdles, we'll start taking some of those gains. So there is still some to be taken, but some of it has already flowed through. So with all of our developments, You'll see that come in through the piece and then we'll kind of wait for the final once we've had it for a year and see what those Brent's actually end up being what the margins end up being that we yes, take that last. The accounting part, I'm not too worried. I was trying to understand real economic impact between the cost you paid and the value you will get after These projects are fully stabilized. Yes. Well, I think that we a lot of that information is When you look at our developments, what our actual yield is that we're expecting versus the cap rate. I I believe it's on the slides generally for the developments that are down the pipe. So those kind of spreads, Yes, we do include those expectations. Those are expectations. I mean, this is actually happening. Okay. So for The end of Q3, our reporting then, we will give exact sort of numbers of what we think we're going to be able to do on the sort of the increase And value of those three properties. Okay. And now given the success you How had with these projects, is your outlook about your development strategy changed anyway? Like do you want to Take on more projects or do you want to accelerate your existing pipeline, if any change in your view? Well, I think we've been actually that thought basically occurred to us a number of years ago, which has translated into the five Current ones that we're doing. So in terms of the dollar, the overall dollar amount of those 3 compared to the 5 that we have Basically in the ground today and a number of them that are going to be finished within 12 months, as I said earlier, It's $240,000,000 of cost and we will have $60,000,000 of equity in the ground. And through the slide deck, I mean, you can sort of see what we're thinking in terms of sort of creative value just from those 5 projects. So our share is 500 units. And then in behind that from our pipeline, we've got the next 3 or 4 that we're working on now. So as we finish up this batch around of these developments, we'll have A number of new ones hopefully started in the next 12 to 18 months. And do you have any internal threshold that you don't want to cross in terms of how much Investment you put in your development bucket? Well, we've always lived by it's less than 4% or 5% of the balance Okay. That's good color. Thank you. Thank you. Thank you. There are no further questions at this time. Please proceed. I would like to thank everyone today for Listening and participating on our Q2 call and we look forward to reporting our results in November on the results of our Q3. Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask